" HOUSE OF REPRESENTATIVES ! 108TH CONGRESS

2d Session 

REPT. 108–548

Part 1

AMERICAN JOBS CREATION ACT OF 2004

R E P O R T

OF THE

COMMITTEE ON WAYS AND MEANS 

HOUSE OF REPRESENTATIVES

TO ACCOMPANY

H.R. 4520

together with

DISSENTING AND ADDITIONAL VIEWS

[Including cost estimate of the Congressional Budget Office]

June 16, 2004.—Committed to the Committee of the Whole House on 

the State of the Union and ordered to be printed 


E:\Seals\Congress.#13
29–006

108TH CONGRESS REPT. 108–548 " HOUSE OF REPRESENTATIVES ! 2d Session Part 1

AMERICAN JOBS CREATION ACT OF 2004

JUNE 16, 2004.—Committed to the Committee of the Whole House on the State of 

the Union and ordered to be printed 

Mr. THOMAS, from the Committee on Ways and Means, 

submitted the following 

R E P O R T 

together with 

DISSENTING AND ADDITIONAL VIEWS 

[To accompany H.R. 4520] 

[Including cost estimate of the Congressional Budget office] 

The Committee on Ways and Means, to whom was referred the 

bill (H.R. 4520) to amend the Internal Revenue Code of 1986 to remove impediments in such Code and make our manufacturing, 

service, and high-technology businesses and workers more competitive and productive both at home and abroad, having considered 

the same, report favorably thereon with an amendment and recommend that the bill as amended do pass.

CONTENTS 

Page 

I. Summary and Background .............................................................................. 112

Title I—End Sanctions and Reduce Corporate Tax Rates for Domestic 

Manufacturing and Small Corporations ..................................................... 113

A. Repeal of Exclusion for Extraterritorial Income (sec. 101 of the 

bill and secs. 114 and 941–943 of the Code) .................................... 113

B. Reduced Corporate Income Tax Rate for Domestic Production Activities Income (sec. 102 of the bill and sec. 11 of the Code) .......... 115

C. Reduced Corporate Income Tax Rate for Small Corporations (sec. 

103 of the bill and sec. 11 of the Code) ............................................ 117

Title II—Corporate Reform and Growth Incentives for Manufacturers, 

Small Businesses, and Farmers .................................................................. 119

A. Small Business Expensing .................................................................. 119

1. Extension of increased section 179 expensing (sec. 201 of the 

bill and sec. 179 of the Code) ..................................................... 119

B. Depreciation ......................................................................................... 121

2

1. Recovery period for depreciation of certain leasehold improvements and restaurant property (sec. 211 of the bill and sec. 

168 of the Code) .......................................................................... 121

2. Modification of depreciation allowance for aircraft (sec. 212 

of the bill and sec. 168 of the Code) .......................................... 123

3. Modification of placed in service rule for bonus depreciation 

property (sec. 213 of the bill and sec. 168 of the Code) ........... 126

C. S Corporation Reform and Simplification (secs. 221–231 of the 

bill and secs. 1361–1379 and 4975 of the Code) .............................. 127

1. Members of family treated as one shareholder; increase in 

number of eligible shareholders to 100 ..................................... 128

2. Expansion of bank S corporation eligible shareholders to include IRAs ................................................................................... 129

3. Disregard of unexercised powers of appointment in determining potential current beneficiaries of ESBT ....................... 130

4. Transfers of suspended losses incident to divorce, etc. .............. 130

5. Use of passive activity loss and at-risk amounts by qualified 

subchapter S trust income beneficiaries ................................... 131

6. Exclusion of investment securities income from passive investment income test for bank S corporations ................................ 131

7. Treatment of bank director shares .............................................. 132

8. Relief from inadvertently invalid qualified subchapter S subsidiary elections and terminations ............................................ 133

9. Information returns for qualified subchapter S subsidiaries .... 133

10. Repayment of loans for qualifying employer securities ........... 134

D. Alternative Minimum Tax Relief ....................................................... 136

1. Foreign tax credit under alternative minimum tax; expansion 

of exemption from alternative minimum tax for small corporations; income averaging for farmers not to increase alternative minimum tax (secs. 241–243 of the bill and secs. 

55–59 of the Code) ...................................................................... 136

E. Restructuring of Incentives for Alcohol Fuels, Etc. .......................... 137

1. Reduced rates of tax on alcohol fuel mixtures replaced with 

an excise tax credit, etc. (secs. 251 and 252 of the bill and 

secs. 4041, 4081, 4091, 6427 and 9503 of the Code) ................ 137

F. Stock Options and Employee Stock Purchase Plan Stock Options .. 144

1. Exclusion of incentive stock options and employee stock purchase plan stock options from wages (sec. 261 of the bill 

and secs. 421(b), 423(c), 3121(a), 3231, and 3306(b) of the 

Code) ............................................................................................ 144

G. Incentives to Reinvest Foreign Earnings in the United States 

(sec. 271 of the bill and new sec. 965 of the Code) .......................... 145

H. Other Provisions .................................................................................. 147

1. Special rules for livestock sold on account of weather-related 

conditions (sec. 281 of the bill and secs. 1033 and 451 of 

the Code) ...................................................................................... 147

2. Payment of dividends on stock of cooperatives without reducing patronage dividends (sec. 282 of the bill and sec. 1388 

of the Code) .................................................................................. 149

3. Capital gains treatment to apply to outright sales of timber 

by landowner (sec. 283 of the bill and sec. 631(b) of the 

Code) ............................................................................................ 150

4. Distributions from publicly traded partnerships treated as 

qualifying income of regulated investment company (sec. 284 

of the bill and secs. 851 and 469(k) of the Code) ..................... 151

5. Improvements related to real estate investment trusts (sec. 

285 of the bill and secs. 856, 857 and 860 of the Code) ........... 153

6. Treatment of certain dividends of regulated investment companies (sec. 286 of the bill and secs. 871 and 881 of the 

Code) ............................................................................................ 161

7. Taxation of certain settlement funds (sec. 287 of the bill and 

sec. 468B of the Code) ................................................................ 167

8. Expand human clinical trials expenses qualifying for the orphan drug tax credit (sec. 288 of the bill and sec. 45C of 

the Code) ...................................................................................... 168

9. Simplification of excise tax imposed on bows and arrows (sec. 

289 of the bill and sec. 4161 of the Code) ................................. 170

3

10. Repeal excise tax on fishing tackle boxes (sec. 290 of the 

bill and sec. 4162 of the Code) ................................................... 171

11. Repeal of excise tax on sonar devices suitable for finding 

fish (sec. 291 of the bill and secs. 4161 and 4162 of the 

Code) ............................................................................................ 171

12. Income tax credit for cost of carrying tax-paid distilled spirits in wholesale inventories (sec. 292 of the bill and new 

sec. 5011 of the Code) ................................................................. 172

13. Suspension of occupational taxes relating to distilled spirits, 

wine, and beer (sec. 293 of the bill and new sec. 5148 of 

the Code) ...................................................................................... 174

14. Exclusion of certain indebtedness of small business investment companies from acquisition indebtedness (sec. 294 of 

the bill and sec. 514 of the Code) .............................................. 175

15. Election to determine taxable income from certain international shipping activities using per ton rate (sec. 295 of 

the bill and new secs. 1352–1359 of the Code) ......................... 176

16. Charitable contribution deduction for certain expenses in 

support of native Alaskan subsistence whaling (sec. 296 of 

the bill and sec. 170 of the Code) .............................................. 181

Title III—Tax Reform and Simplification for United States Businesses 182

A. Interest Expense Allocation Rules (sec. 301 of the bill and sec. 

864 of the Code) .................................................................................. 182

B. Recharacterization of Overall Domestic Loss (sec. 302 of the bill 

and sec. 904 of the Code) ................................................................... 186

C. Reduction to Two Foreign Tax Credit Baskets (sec. 303 of the 

bill and sec. 904 of the Code) ............................................................ 188

D. Look-Through Rules to Apply to Dividends from Noncontrolled 

Section 902 Corporations (sec. 304 of the bill and sec. 904 of 

the Code) ............................................................................................. 192

E. Attribution of Stock Ownership Through Partnerships to Apply 

in Determining Section 902 and 960 Credits (sec. 305 of the 

bill and secs. 901, 902, and 960 of the Code) ................................... 193

F. Foreign Tax Credit Treatment of Deemed Payments Under Section 367(d) (sec. 306 of the bill and sec. 367 of the Code) .............. 195

G. United States Property Not to Include Certain Assets of Controlled Foreign Corporation (sec. 307 of the bill and sec. 956 

of the Code) ......................................................................................... 196

H. Election Not to Use Average Exchange Rate for Foreign Tax 

Paid Other Than in Functional Currency (sec. 308 of the bill 

and sec. 986 of the Code) ................................................................... 198

I. Repeal of Withholding Tax on Dividends from Certain Foreign 

Corporations (sec. 309 of the bill and sec. 871 of the Code) ........... 200

J. Provide Equal Treatment for Interest Paid by Foreign Partnerships and Foreign Corporations (sec. 310 of the bill and sec. 

861 of the Code) .................................................................................. 201

K. Look-Through Treatment of Payments Between Related Controlled Foreign Corporations Under Foreign Personal Holding 

Company Income Rules (sec. 311 of the bill and sec. 954 of 

the Code) ............................................................................................. 202

L. Look-Through Treatment Under Subpart F for Sales of Partnership Interests (sec. 312 of the bill and sec. 954 of the Code) ......... 203

M. Repeal of Foreign Personal Holding Company Rules and Foreign 

Investment Company Rules (sec. 313 of the bill and secs. 542, 

551–558, 954, 1246, and 1247 of the Code) ...................................... 204

N. Determination of Foreign Personal Holding Company Income with 

Respect to Transactions in Commodities (sec. 314 of the bill 

and sec. 954 of the Code) ................................................................... 205

O. Modifications to Treatment of Aircraft Leasing and Shipping Income (sec. 315 of the bill and sec. 954 of the Code) ........................ 208

P. Modification of Exceptions Under Subpart F for Active Financing 

(sec. 316 of the bill and sec. 954 of the Code) .................................. 211

Title IV—Extension of Certain Expiring Provisions ..................................... 213

A. Extend Alternative Minimum Tax Relief for Individuals (sec. 401 

of the bill and sec. 26 of the Code) ................................................... 213

B. Extension of the Research Credit (sec. 402 of the bill and sec. 

41 of the Code) .................................................................................... 214

4

C. Extension and Modification of the Section 45 Electricity Production Credit (sec. 403 of the bill and sec. 45 of the Code) ................ 217

D. Indian Employment Tax Credit (sec. 404 of the bill and sec. 

45A of the Code) ................................................................................. 218

E. Extend the Work Opportunity Tax Credit (sec. 405 of the bill 

and sec. 51 of the Code) ..................................................................... 219

F. Extend the Welfare-To-Work Tax Credit (sec. 406 of the bill and 

sec. 51A of the Code) .......................................................................... 220

G. Extension of the Above-the-line Deduction for Certain Expenses 

of Elementary and Secondary School Teachers (sec. 407 of the 

bill and sec. 62 of the Code) .............................................................. 221

H. Extension of Accelerated Depreciation Benefit for Property on 

Indian Reservations (sec. 408 of the bill and sec. 168(j) of the 

Code) ................................................................................................... 222

I. Extend Enhanced Charitable Deduction for Computer Technology 

and Equipment (sec. 409 of the bill and sec. 170 of the Code) ....... 223

J. Extension of Expensing of Certain Environmental Remediation 

Costs (sec. 410 of the bill and sec. 198 of the Code) ........................ 224

K. Extension of Archer Medical Savings Accounts (‘‘MSAs’’) (sec. 411 

of the bill and sec. 220 of the Code) ................................................. 225

L. Taxable Income Limit on Percentage Depletion for Oil and Natural Gas Produced from Marginal Properties (sec. 412 of the 

bill and sec. 613A of the Code) .......................................................... 227

M. Qualified Zone Academy Bonds (sec. 413 of the bill and sec. 

1397E of the Code) ............................................................................. 228

N. Extension of Tax Incentives for Investment in the District of 

Columbia (sec. 414 of the bill and secs. 1400, 1400A, 1400B, 

and 1400C of the Code) ..................................................................... 230

O. Extend the Authority to Issue Liberty Zone Bonds (sec. 415 of 

the bill and sec. 1400L of the Code) ................................................. 231

P. Disclosure to Law Enforcement Agencies Regarding Terrorist Activities (sec. 416 of the bill and sec. 6103 of the Code) ................... 233

Q. Disclosure of Return Information Relating to Student Loans (sec. 

417 of the bill and sec. 6103(l) of the Code) ..................................... 235

R. Extension of Cover Over of Excise Tax on Distilled Spirits to 

Puerto Rico and Virgin Islands (sec. 418 of the bill and sec. 

7652 of the Code) ................................................................................ 236

S. Extension of Joint Review (sec. 419 of the bill and secs. 8021 

and 8022 of the Code) ........................................................................ 237

T. Parity in the Application of Certain Limits to Mental Health 

Benefits (sec. 420 of the bill and sec. 9812 of the Code) ................. 238

U. Disclosure of Tax Information to Facilitate Combined Employment Tax Reporting (sec. 421 of the bill) ......................................... 239

V. Extension of Tax Credit for Electric Vehicles and Tax Deduction 

for Clean-Fuel Vehicles (sec. 422 of the bill and secs. 30 and 

179A of the Code) ............................................................................... 239

Title V—Deduction of State and Local General Sales Taxes ........................ 240

A. Deduction of State and Local General Sales Taxes (sec. 501 of 

the bill and sec. 164 of the Code) ...................................................... 240

Title VI—Revenue Provisions .......................................................................... 242

A. Provisions to Reduce Tax Avoidance Through Individual and Corporate Expatriation ............................................................................ 242

1. Tax treatment of expatriated entities and their foreign parents (sec. 601 of the bill and new sec. 7874 of the Code) ........ 242

2. Excise tax on stock compensation of insiders in expatriated 

corporations (sec. 602 of the bill and secs. 162(m), 275(a), 

and new sec. 4985 of the Code) .................................................. 246

3. Reinsurance of U.S. risks in foreign jurisdictions (sec. 603 

of the bill and sec. 845(a) of the Code) ...................................... 250

4. Revision of tax rules on expatriation of individuals (sec. 604 

of the bill and secs. 877, 2107, 2501 and 6039G of the Code) . 251

5. Reporting of taxable mergers and acquisitions (sec. 605 of 

the bill and new sec. 6043A of the Code) .................................. 257

6. Studies (sec. 606 of the bill) ......................................................... 258

B. Provisions Relating to Tax Shelters ................................................... 260

1. Penalty for failure to disclose reportable transactions (sec. 

611 of the bill and new sec. 6707A of the Code) ....................... 260

5

2. Modifications to the accuracy-related penalties for listed 

transactions and reportable transactions having a significant 

tax avoidance purpose (sec. 612 of the bill and new sec. 

6662A of the Code) ...................................................................... 262

3. Tax shelter exception to confidentiality privileges relating to 

taxpayer communications (sec. 613 of the bill and sec. 7525 

of the Code) .................................................................................. 266

4. Statute of limitations for unreported listed transactions (sec. 

614 of the bill and sec. 6501 of the Code) ................................. 267

5. Disclosure of reportable transactions by material advisors 

(sec. 615 of the bill and secs. 6111 and 6707 of the Code) ...... 268

6. Investor lists and modification of penalty for failure to maintain investor lists (secs. 616 and 617 of the bill and secs. 

6112 and 6708 of the Code) ........................................................ 271

7. Penalty on promoters of tax shelters (sec. 618 of the bill 

and sec. 6700 of the Code) .......................................................... 273

8. Modifications of substantial understatement penalty for nonreportable transactions (sec. 619 of the bill and sec. 6662 

of the Code) .................................................................................. 274

9. Modification of actions to enjoin certain conduct related to 

tax shelters and reportable transactions (sec. 620 of the bill 

and sec. 7408 of the Code) .......................................................... 274

10. Penalty on failure to report interests in foreign financial 

accounts (sec. 621 of the bill and sec. 5321 of Title 31, 

United States Code) .................................................................... 275

11. Regulation of individuals practicing before the Department 

of the Treasury (sec. 622 of the bill and sec. 330 of Title 

31, United States Code) .............................................................. 276

12. Treatment of stripped interests in bond and preferred stock 

funds, etc. (sec. 631 of the bill and secs. 305 and 1286 

of the Code) .................................................................................. 277

13. Minimum holding period for foreign tax credit on withholding taxes on income other than dividends (sec. 632 of 

the bill and sec. 901 of the Code) .............................................. 280

14. Disallowance of certain partnership loss transfers (sec. 633 

of the bill and secs. 704, 734, and 743 of the Code) ................. 281

15. No reduction of basis under section 734 in stock held by 

partnership in corporate partner (sec. 634 of the bill and 

sec. 755 of the Code) ................................................................... 285

16. Repeal of special rules for FASITs, etc. (sec. 635 of the 

bill and secs. 860H–860L of the Code) ...................................... 287

17. Limitation on transfer of built-in losses on REMIC residuals 

(sec. 636 of the bill and sec. 362 of the Code) ........................... 292

18. Clarification of banking business for purposes of determining 

investment of earnings in U.S. property (sec. 637 of the 

bill and sec. 956 of the Code) ..................................................... 294

19. Alternative tax for certain small insurance companies (sec. 

638 of the bill and sec. 831 of the Code) ................................... 296

20. Denial of deduction for interest on underpayments attributable to nondisclosed reportable transactions (sec. 639 of 

the bill and sec. 163 of the Code) .............................................. 297

21. Clarification of rules for payment of estimated tax for certain 

deemed asset sales (sec. 640 of the bill and sec. 338 of 

the Code) ...................................................................................... 297

22. Exclusion of like-kind exchange property from nonrecognition 

treatment on the sale or exchange of a principal residence 

(sec. 641 of the bill and sec. 121 of the Code) ........................... 298

23. Prevention of mismatching of interest and original issue discount deductions and income inclusions in transactions with 

related foreign persons (sec. 642 of the bill and secs. 163 

and 267 of the Code) ................................................................... 299

24. Exclusion from gross income for interest on overpayments 

of income tax by individuals (sec. 643 of the bill and new 

sec. 139A of the Code) ................................................................ 302

25. Deposits made to suspend the running of interest on potential underpayments (sec. 644 of the bill and new sec. 6603 

of the Code) .................................................................................. 304

6

26. Authorize IRS to enter into installment agreements that provide for partial payment (sec. 645 of the bill and sec. 6159 

of the Code) .................................................................................. 307

27. Affirmation of consolidated return regulation authority (sec. 

646 of the bill and sec. 1502 of the Code) ................................. 308

28. Reform of tax treatment of certain leasing arrangements 

and limitation on deductions allocable to property used by 

governments or other tax-exempt entities (secs. 647 through 

649 of the bill, secs. 167 and 168 of the Code, and new 

sec. 470 of the Code) ................................................................... 312

C. Reduction of Fuel Tax Evasion ........................................................... 319

1. Exemption from certain excise taxes for mobile machinery 

vehicles (sec. 651 of the bill, and secs. 4053, 4072, 4082, 

4483 and 6421 of the Code) ........................................................ 319

2. Taxation of aviation-grade kerosene (sec. 652 of the bill and 

secs. 4041, 4081, 4082, 4083, 4091, 4092, 4093, 4101, and 

6427 of the Code) ........................................................................ 321

3. Mechanical dye injection and related penalties (sec. 653 of 

the bill and sec. 4082 and new sec. 6715A of the Code) .......... 327

4. Authority to inspect on-site records (sec. 654 of the bill and 

sec. 4083 of the Code) ................................................................. 330

5. Registration of pipeline or vessel operators required for exemption of bulk transfers to registered terminals or refineries (sec. 655 of the bill and sec. 4081 of the Code) ............... 330

6. Display of registration and penalties for failure to display 

registration and to register (secs. 656 and 657 of the bill, 

secs. 4101, 7232, 7272 and new secs. 6717 and 6718 of 

the Code) ...................................................................................... 331

7. Penalties for failure to report (sec. 657 of the bill and new 

sec. 6725 of the Code) ................................................................. 332

8. Collection from Customs bond where importer not registered 

(sec. 658 of the bill and new sec. 4104 of the Code) ................. 333

9. Modification of the use tax on heavy highway vehicles (sec. 

659 of the bill and secs. 4481, 4483 and 6165 of the Code) ..... 334

10. Modification of ultimate vendor refund claims with respect 

to farming(sec. 660 of the bill and sec. 6427 of the Code) ....... 336

11. Dedication of revenue from certain penalties to the Highway 

Trust Fund (sec. 661 of the bill and sec. 9503 of the Code) .... 336

12. Taxable fuel refunds for certain ultimate vendors (sec. 662 

of the bill and secs. 6416 and 6427 of the Code) ...................... 337

13. Two party exchanges (sec. 663 of the bill and new sec. 

4105 of the Code) ........................................................................ 339

14. Simplification of tax on tires (sec. 664 of the bill and sec. 

4071 of the Code) ........................................................................ 340

D. Nonqualified Deferred Compensation Plans ..................................... 341

1. Treatment of nonqualified deferred compensation plans (sec. 

671 of the bill and new sec. 409A and sec. 6051 of the 

Code) ............................................................................................ 341

E. Other Revenue Provisions ................................................................... 348

1. Qualified tax collection contracts (sec. 681 of the bill and 

new sec. 6306 of the Code) ......................................................... 348

2. Modify charitable contribution rules for donations of patents 

and other intellectual property (sec. 682 of the bill and secs. 

170 and 6050L of the Code) ....................................................... 351

3. Require increased reporting for noncash charitable contributions (sec. 683 of the bill and sec. 170 of the Code) ................. 355

4. Require qualified appraisals for charitable contributions of 

vehicles (sec. 684 of the bill and sec. 170 of the Code) ............ 356

5. Extend the present-law intangible amortization provisions 

to acquisitions of sports franchises (sec. 685 of the bill and 

sec. 197 of the Code) ................................................................... 358

6. Increase continuous levy for certain Federal payments (sec. 

686 of the bill and sec. 6331 of the Code) ................................. 360

7. Modification of straddle rules (sec. 687 of the bill and sec. 

1092 of the Code) ........................................................................ 361

8. Add vaccines against hepatitis A to the list of taxable vaccines (sec. 688 of the bill and sec. 4132 of the Code) ............... 365

9. Add vaccines against influenza to the list of taxable vaccines 

(sec. 689 of the bill and sec. 4132 of the Code) ......................... 366

7

10. Extension of IRS user fees (sec. 690 of the bill and sec. 

7528 of the Code) ........................................................................ 367

11. Extension of customs user fees (sec. 691 of the bill) .............. 367

Title VII—Market Reform for Tobacco Growers (secs. 701–725 of the 

bill) ................................................................................................................. 369

Title VIII—Trade Provisions ........................................................................... 371

A. Suspension of Duties on Ceiling Fans (sec. 801 of the bill) ............. 371

B. Suspension of Duties on Nuclear Steam Generators (sec. 802 of 

the bill) ................................................................................................ 371

C. Suspension of Duties on Nuclear Reactor Vessel Heads (sec. 802 

of the bill) ............................................................................................ 372

II. Votes of the Committee .................................................................................... 372

III. Budget Effects of the Bill ................................................................................. 375

IV. Other Matters To Be Discussed Under the Rules of the House ................... 398

V. Changes in Existing Law Made by the Bill, as Reported ............................. 399

VI. Dissenting Views .............................................................................................. 400

The amendment is as follows: 

Strike all after the enacting clause and insert the following:

SECTION 1. SHORT TITLE; ETC. 

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

2004’’. 

(b) AMENDMENT OF 1986 CODE.—Except as otherwise expressly provided, whenever in this Act an amendment or repeal is expressed in terms of an amendment 

to, or repeal of, a section or other provision, the reference shall be considered to be 

made to a section or other provision of the Internal Revenue Code of 1986. 

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

Sec. 1. Short title; etc. 

TITLE I—END SANCTIONS AND REDUCE CORPORATE TAX RATES FOR DOMESTIC MANUFACTURING 

AND SMALL CORPORATIONS 

Sec. 101. Repeal of exclusion for extraterritorial income. 

Sec. 102. Reduced corporate income tax rate for domestic production activities income. 

Sec. 103. Reduced corporate income tax rate for small corporations. 

TITLE II—JOB CREATION TAX INCENTIVES FOR MANUFACTURERS, SMALL BUSINESSES, AND 

FARMERS 

Subtitle A—Small Business Expensing 

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

Subtitle B—Depreciation 

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

Sec. 212. Modification of depreciation allowance for aircraft. 

Sec. 213. Modification of placed in service rule for bonus depreciation property. 

Subtitle C—S Corporation Reform and Simplification 

Sec. 221. Members of family treated as 1 shareholder. 

Sec. 222. Increase in number of eligible shareholders to 100. 

Sec. 223. Expansion of bank S corporation eligible shareholders to include IRAs. 

Sec. 224. Disregard of unexercised powers of appointment in determining potential current beneficiaries of 

ESBT. 

Sec. 225. Transfer of suspended losses incident to divorce, etc. 

Sec. 226. Use of passive activity loss and at-risk amounts by qualified subchapter S trust income beneficiaries. 

Sec. 227. Exclusion of investment securities income from passive income test for bank S corporations. 

Sec. 228. Treatment of bank director shares. 

Sec. 229. Relief from inadvertently invalid qualified subchapter S subsidiary elections and terminations. 

Sec. 230. Information returns for qualified subchapter S subsidiaries. 

Sec. 231. Repayment of loans for qualifying employer securities. 

Subtitle D—Alternative Minimum Tax Relief 

Sec. 241. Foreign tax credit under alternative minimum tax. 

Sec. 242. Expansion of exemption from alternative minimum tax for small corporations. 

Sec. 243. Income averaging for farmers not to increase alternative minimum tax. 

Subtitle E—Restructuring of Incentives for Alcohol Fuels, Etc. 

Sec. 251. Reduced rates of tax on gasohol replaced with excise tax credit; repeal of other alcohol-based fuel incentives; etc. 

Sec. 252. Alcohol fuel subsidies borne by general fund. 

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

Sec. 261. Exclusion of incentive stock options and employee stock purchase plan stock options from wages. 

Subtitle G—Incentives to Reinvest Foreign Earnings in United States 

Sec. 271. Incentives to reinvest foreign earnings in United States.

8

Subtitle H—Other Incentive Provisions 

Sec. 281. Special rules for livestock sold on account of weather-related conditions. 

Sec. 282. Payment of dividends on stock of cooperatives without reducing patronage dividends. 

Sec. 283. Capital gain treatment under section 631(b) to apply to outright sales by landowners. 

Sec. 284. Distributions from publicly traded partnerships treated as qualifying income of regulated investment 

companies. 

Sec. 285. Improvements related to real estate investment trusts. 

Sec. 286. Treatment of certain dividends of regulated investment companies. 

Sec. 287. Taxation of certain settlement funds. 

Sec. 288. Expansion of human clinical trials qualifying for orphan drug credit. 

Sec. 289. Simplification of excise tax imposed on bows and arrows. 

Sec. 290. Repeal of excise tax on fishing tackle boxes. 

Sec. 291. Sonar devices suitable for finding fish. 

Sec. 292. Income tax credit to distilled spirits wholesalers for cost of carrying Federal excise taxes on bottled 

distilled spirits. 

Sec. 293. Suspension of occupational taxes relating to distilled spirits, wine, and beer. 

Sec. 294. Modification of unrelated business income limitation on investment in certain small business investment companies. 

Sec. 295. Election to determine taxable income from certain international shipping activities using per ton rate. 

Sec. 296. Charitable contribution deduction for certain expenses incurred in support of Native Alaskan subsistence whaling. 

TITLE III—TAX REFORM AND SIMPLIFICATION FOR UNITED STATES BUSINESSES 

Sec. 301. Interest expense allocation rules. 

Sec. 302. Recharacterization of overall domestic loss. 

Sec. 303. Reduction to 2 foreign tax credit baskets. 

Sec. 304. Look-thru rules to apply to dividends from noncontrolled section 902 corporations. 

Sec. 305. Attribution of stock ownership through partnerships to apply in determining section 902 and 960 

credits. 

Sec. 306. Clarification of treatment of certain transfers of intangible property. 

Sec. 307. United States property not to include certain assets of controlled foreign corporation. 

Sec. 308. Election not to use average exchange rate for foreign tax paid other than in functional currency. 

Sec. 309. Repeal of withholding tax on dividends from certain foreign corporations. 

Sec. 310. Provide equal treatment for interest paid by foreign partnerships and foreign corporations. 

Sec. 311. Look-thru treatment of payments between related controlled foreign corporations under foreign personal holding company income rules. 

Sec. 312. Look-thru treatment for sales of partnership interests. 

Sec. 313. Repeal of foreign personal holding company rules and foreign investment company rules. 

Sec. 314. Determination of foreign personal holding company income with respect to transactions in commodities. 

Sec. 315. Modifications to treatment of aircraft leasing and shipping income. 

Sec. 316. Modification of exceptions under subpart F for active financing. 

TITLE IV—EXTENSION OF CERTAIN EXPIRING PROVISIONS 

Sec. 401. Allowance of nonrefundable personal credits against regular and minimum tax liability. 

Sec. 402. Extension of research credit. 

Sec. 403. Extension of credit for electricity produced from certain renewable resources. 

Sec. 404. Indian employment tax credit. 

Sec. 405. Work opportunity credit. 

Sec. 406. Welfare-to-work credit. 

Sec. 407. Certain expenses of elementary and secondary school teachers. 

Sec. 408. Extension of accelerated depreciation benefit for property on Indian reservations. 

Sec. 409. Charitable contributions of computer technology and equipment used for educational purposes. 

Sec. 410. Expensing of environmental remediation costs. 

Sec. 411. Availability of medical savings accounts. 

Sec. 412. Taxable income limit on percentage depletion for oil and natural gas produced from marginal properties. 

Sec. 413. Qualified zone academy bonds. 

Sec. 414. District of Columbia. 

Sec. 415. Extension of certain New York Liberty Zone bond financing. 

Sec. 416. Disclosures relating to terrorist activities. 

Sec. 417. Disclosure of return information relating to student loans. 

Sec. 418. Cover over of tax on distilled spirits. 

Sec. 419. Joint review of strategic plans and budget for the Internal Revenue Service. 

Sec. 420. Parity in the application of certain limits to mental health benefits. 

Sec. 421. Combined employment tax reporting project. 

Sec. 422. Clean-fuel vehicles. 

TITLE V—DEDUCTION OF STATE AND LOCAL GENERAL SALES TAXES 

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

TITLE VI—REVENUE PROVISIONS 

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

Sec. 601. Tax treatment of expatriated entities and their foreign parents. 

Sec. 602. Excise tax on stock compensation of insiders in expatriated corporations. 

Sec. 603. Reinsurance of United States risks in foreign jurisdictions. 

Sec. 604. Revision of tax rules on expatriation of individuals. 

Sec. 605. Reporting of taxable mergers and acquisitions. 

Sec. 606. Studies. 

Subtitle B—Provisions Relating to Tax Shelters 

PART I—TAXPAYER-RELATED PROVISIONS

Sec. 611. Penalty for failing to disclose reportable transactions. 

Sec. 612. Accuracy-related penalty for listed transactions, other reportable transactions having a significant tax 

avoidance purpose, etc. 

Sec. 613. Tax shelter exception to confidentiality privileges relating to taxpayer communications. 

9

Sec. 614. Statute of limitations for taxable years for which required listed transactions not reported. 

Sec. 615. Disclosure of reportable transactions. 

Sec. 616. Failure to furnish information regarding reportable transactions. 

Sec. 617. Modification of penalty for failure to maintain lists of investors. 

Sec. 618. Penalty on promoters of tax shelters. 

Sec. 619. Modifications of substantial understatement penalty for nonreportable transactions. 

Sec. 620. Modification of actions to enjoin certain conduct related to tax shelters and reportable transactions. 

Sec. 621. Penalty on failure to report interests in foreign financial accounts. 

Sec. 622. Regulation of individuals practicing before the Department of the Treasury. 

PART II—OTHER PROVISIONS

Sec. 631. Treatment of stripped interests in bond and preferred stock funds, etc. 

Sec. 632. Minimum holding period for foreign tax credit on withholding taxes on income other than dividends. 

Sec. 633. Disallowance of certain partnership loss transfers. 

Sec. 634. No reduction of basis under section 734 in stock held by partnership in corporate partner. 

Sec. 635. Repeal of special rules for FASITs. 

Sec. 636. Limitation on transfer of built-in losses on REMIC residuals. 

Sec. 637. Clarification of banking business for purposes of determining investment of earnings in United States 

property. 

Sec. 638. Alternative tax for certain small insurance companies. 

Sec. 639. Denial of deduction for interest on underpayments attributable to nondisclosed reportable transactions. 

Sec. 640. Clarification of rules for payment of estimated tax for certain deemed asset sales. 

Sec. 641. Recognition of gain from the sale of a principal residence acquired in a like-kind exchange within 5 

years of sale. 

Sec. 642. Prevention of mismatching of interest and original issue discount deductions and income inclusions 

in transactions with related foreign persons. 

Sec. 643. Exclusion from gross income for interest on overpayments of income tax by individuals. 

Sec. 644. Deposits made to suspend running of interest on potential underpayments. 

Sec. 645. Partial payment of tax liability in installment agreements. 

Sec. 646. Affirmation of consolidated return regulation authority. 

PART III—LEASING

Sec. 647. Reform of tax treatment of certain leasing arrangements. 

Sec. 648. Limitation on deductions allocable to property used by governments or other tax-exempt entities. 

Sec. 649. Effective date. 

Subtitle C—Reduction of Fuel Tax Evasion 

Sec. 651. Exemption from certain excise taxes for mobile machinery. 

Sec. 652. Taxation of aviation-grade kerosene. 

Sec. 653. Dye injection equipment. 

Sec. 654. Authority to inspect on-site records. 

Sec. 655. Registration of pipeline or vessel operators required for exemption of bulk transfers to registered terminals or refineries. 

Sec. 656. Display of registration. 

Sec. 657. Penalties for failure to register and failure to report. 

Sec. 658. Collection from customs bond where importer not registered. 

Sec. 659. Modifications of tax on use of certain vehicles. 

Sec. 660. Modification of ultimate vendor refund claims with respect to farming. 

Sec. 661. Dedication of revenues from certain penalties to the Highway Trust Fund. 

Sec. 662. Taxable fuel refunds for certain ultimate vendors. 

Sec. 663. Two-party exchanges. 

Sec. 664. Simplification of tax on tires. 

Subtitle D—Nonqualified Deferred Compensation Plans 

Sec. 671. Treatment of nonqualified deferred compensation plans. 

Subtitle E—Other Revenue Provisions 

Sec. 681. Qualified tax collection contracts. 

Sec. 682. Treatment of charitable contributions of patents and similar property. 

Sec. 683. Increased reporting for noncash charitable contributions. 

Sec. 684. Donations of motor vehicles, boats, and aircraft. 

Sec. 685. Extension of amortization of intangibles to sports franchises. 

Sec. 686. Modification of continuing levy on payments to Federal venders. 

Sec. 687. Modification of straddle rules. 

Sec. 688. Addition of vaccines against hepatitis A to list of taxable vaccines. 

Sec. 689. Addition of vaccines against influenza to list of taxable vaccines. 

Sec. 690. Extension of IRS user fees. 

Sec. 691. COBRA fees. 

TITLE VII—MARKET REFORM FOR TOBACCO GROWERS 

Sec. 701. Short title. 

Sec. 702. Effective date. 

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

Sec. 711. Termination of tobacco quota program and related provisions. 

Sec. 712. Termination of tobacco price support program and related provisions. 

Sec. 713. Liability. 

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

Sec. 721. Definitions of active tobacco producer and quota holder. 

Sec. 722. Payments to tobacco quota holders. 

Sec. 723. Transition payments for active producers of quota tobacco. 

Sec. 724. Resolution of disputes. 

Sec. 725. Source of funds for payments. 

10

TITLE VIII—TRADE PROVISIONS 

Sec. 801. Ceiling fans. 

Sec. 802. Certain steam generators, and certain reactor vessel heads, used in nuclear facilities.

TITLE I—END SANCTIONS AND REDUCE CORPORATE TAX RATES FOR DOMESTIC MANUFACTURING AND SMALL CORPORATIONS 

SEC. 101. REPEAL OF EXCLUSION FOR EXTRATERRITORIAL INCOME. 

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

(b) CONFORMING AMENDMENTS.—

(1) Subpart E of part III of subchapter N of chapter 1 (relating to qualifying 

foreign trade income) is hereby repealed. 

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

relating to subpart E. 

(3) The table of sections for part III of subchapter B of chapter 1 is amended 

by striking the item relating to section 114. 

(4) The second sentence of section 56(g)(4)(B)(i) is amended by striking ‘‘114 

or’’. 

(5) Section 275(a) is amended—

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

the end of paragraph (4)(B) and inserting a period, and by striking subparagraph (C), and 

(B) by striking the last sentence. 

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

(A) by striking: 

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

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

‘‘(3) TAX-EXEMPT ASSETS NOT TAKEN INTO ACCOUNT.—For purposes of’’, and 

(B) by striking subparagraph (B). 

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

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

(c) EFFECTIVE DATE.—Except as provided in subsection (d), the amendments made 

by this section shall apply to transactions after December 31, 2004. 

(d) TRANSITIONAL RULE FOR 2005 AND 2006.—

(1) IN GENERAL.—In the case of transactions during 2005 or 2006, the amount 

includible in gross income by reason of the amendments made by this section 

shall not exceed the applicable percentage of the amount which would have 

been so included but for this subsection. 

(2) APPLICABLE PERCENTAGE.—For purposes of paragraph (1), the applicable 

percentage shall be as follows: 

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

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

(e) REVOCATION OF ELECTION TO BE TREATED AS DOMESTIC CORPORATION.—If, 

during the 1-year period beginning on the date of the enactment of this Act, a corporation for which an election is in effect under section 943(e) of the Internal Revenue Code of 1986 revokes such election, no gain or loss shall be recognized with 

respect to property treated as transferred under clause (ii) of section 943(e)(4)(B) of 

such Code to the extent such property—

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

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

The Secretary of the Treasury (or such Secretary’s delegate) may prescribe such regulations as may be necessary to prevent the abuse of the purposes of this subsection. 

(f) BINDING CONTRACTS.—The amendments made by this section shall not apply 

to any transaction in the ordinary course of a trade or business which occurs pursuant to a binding contract—

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

(as defined in section 943(b)(3) of such Code, as in effect on the day before the 

date of the enactment of this Act), and 

(2) which is in effect on January 14, 2002, and at all times thereafter. 

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

renewal option, or replacement option which is included in such contract and which 

is enforceable against the seller or lessor. 

11

SEC. 102. REDUCED CORPORATE INCOME TAX RATE FOR DOMESTIC PRODUCTION ACTIVITIES 

INCOME. 

(a) LIMITATION ON TAX ON QUALIFIED PRODUCTION ACTIVITIES INCOME.—Section 

11 is amended by redesignating subsections (c) and (d) as subsections (d) and (e), 

respectively, and by inserting after subsection (b) the following new subsection: 

‘‘(c) LIMITATION ON TAX ON QUALIFIED PRODUCTION ACTIVITIES INCOME.—

‘‘(1) IN GENERAL.—If a corporation has qualified production activities income 

for any taxable year, the tax imposed by this section shall not exceed the sum 

of—

‘‘(A) a tax computed at the rates and in the manner as if this subsection 

had not been enacted on the taxable income reduced by the amount of 

qualified production activities income, plus 

‘‘(B) a tax equal to 32 percent (34 percent in the case of taxable years 

beginning before January 1, 2007) of the qualified production activities income (or, if less, taxable income). 

‘‘(2) QUALIFIED PRODUCTION ACTIVITIES INCOME.—

‘‘(A) IN GENERAL.—The term ‘qualified production activities income’ for 

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

‘‘(i) the taxpayer’s domestic production gross receipts for such taxable 

year, over 

‘‘(ii) the sum of—

‘‘(I) the cost of goods sold that are allocable to such receipts, 

‘‘(II) other deductions, expenses, or losses directly allocable to 

such receipts, and 

‘‘(III) a ratable portion of other deductions, expenses, and losses 

that are not directly allocable to such receipts or another class of 

income. 

‘‘(B) ALLOCATION METHOD.—The Secretary shall prescribe rules for the 

proper allocation of items of income, deduction, expense, and loss for purposes of determining income attributable to domestic production activities. 

‘‘(3) DOMESTIC PRODUCTION GROSS RECEIPTS.—For purposes of this subsection, 

the term ‘domestic production gross receipts’ means the gross receipts of the 

taxpayer which are derived from—

‘‘(A) any lease, rental, license, sale, exchange, or other disposition of—

‘‘(i) qualifying production property which was manufactured, produced, grown, or extracted in whole or in significant part by the taxpayer within the United States, or 

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

‘‘(B) construction, engineering, or architectural services performed in the 

United States for construction projects in the United States. 

‘‘(4) QUALIFYING PRODUCTION PROPERTY.—For purposes of this subsection, the 

term ‘qualifying production property’ means—

‘‘(A) tangible personal property, 

‘‘(B) any computer software, and 

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

‘‘(5) QUALIFIED FILM.—For purposes of this subsection—

‘‘(A) IN GENERAL.—The term ‘qualified film’ means any property described 

in section 168(f)(3) if not less than 50 percent of the total compensation relating to the production of such property is compensation for services performed in the United States by actors, production personnel, directors, and 

producers. 

‘‘(B) EXCEPTION.—Such term does not include property with respect to 

which records are required to be maintained under section 2257 of title 18, 

United States Code. 

‘‘(6) RELATED PERSONS.—For purposes of this subsection—

‘‘(A) IN GENERAL.—The term ‘domestic production gross receipts’ shall not 

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

‘‘(B) RELATED PERSON.—For purposes of subparagraph (A), a person shall 

be treated as related to another person if such persons are treated as a single employer under subsection (a) or (b) of section 52 or subsection (m) or 

(o) of section 414, except that determinations under subsections (a) and (b) 

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

(b) SPECIAL RULE RELATING TO ELECTION TO TREAT CUTTING OF TIMBER AS A

SALE OR EXCHANGE.—In the case of a corporation, any election under section 631(a) 

of the Internal Revenue Code of 1986 made for a taxable year ending on or before 

the date of the enactment of this Act may be revoked by the taxpayer for any taxable year ending after such date. For purposes of determining whether such taxVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00013 Fmt 6659 Sfmt 6621 E:\HR\OC\HR548P1.000 HR548P1
12

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

(c) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years beginning after December 31, 2004. 

SEC. 103. REDUCED CORPORATE INCOME TAX RATE FOR SMALL CORPORATIONS. 

(a) IN GENERAL.—Subsection (b) of section 11 (relating to tax imposed on corporations) is amended by redesignating paragraph (2) as paragraph (6) and by striking 

paragraph (1) and inserting the following new paragraphs: 

‘‘(1) FOR TAXABLE YEARS BEGINNING AFTER 2012.—In the case of taxable years 

beginning after 2012, the amount of the tax imposed by subsection (a) shall be 

determined in accordance with the following table:

‘‘If taxable income is: The tax is: 

Not over $50,000 ......................................................... 15% of taxable income. 

Over $50,000 but not over $75,000 ............................ $7,500, plus 25% of the excess over $50,000. 

Over $75,000 but not over $20,000,000 ..................... $13,750, plus 32% of the excess over $75,000. 

Over $20,000,000 ......................................................... $6,389,750, plus 35% of the excess over $20,000,000.

‘‘(2) FOR TAXABLE YEARS BEGINNING IN 2011 OR 2012.—In the case of taxable 

years beginning in 2011 or 2012, the amount of the tax imposed by subsection 

(a) shall be determined in accordance with the following table:

‘‘If taxable income is: The tax is: 

Not over $50,000 ......................................................... 15% of taxable income. 

Over $50,000 but not over $75,000 ............................ $7,500, plus 25% of the excess over $50,000. 

Over $75,000 but not over $5,000,000 ....................... $13,750, plus 32% of the excess over $75,000. 

Over $5,000,000 but not over $10,000,000 ................ $1,589,750, plus 34% of the excess over $5,000,000. 

Over $10,000,000 ......................................................... $3,289,750, plus 35% of the excess over $10,000,000.

‘‘(3) FOR TAXABLE YEARS BEGINNING IN 2008, 2009, OR 2010.—In the case of taxable years beginning in 2008, 2009, or 2010, the amount of the tax imposed by 

subsection (a) shall be determined in accordance with the following table:

‘‘If taxable income is: The tax is: 

Not over $50,000 ......................................................... 15% of taxable income. 

Over $50,000 but not over $75,000 ............................ $7,500, plus 25% of the excess over $50,000. 

Over $75,000 but not over $1,000,000 ....................... $13,750, plus 32% of the excess over $75,000. 

Over $1,000,000 but not over $10,000,000 ................ $309,750, plus 34% of the excess over $1,000,000. 

Over $10,000,000 ......................................................... $3,369,750, plus 35% of the excess over $10,000,000.

‘‘(4) FOR TAXABLE YEARS BEGINNING IN 2005, 2006, OR 2007.—In the case of taxable years beginning in 2005, 2006, or 2007, the amount of the tax imposed by 

subsection (a) shall be determined in accordance with the following table:

‘‘If taxable income is: The tax is: 

Not over $50,000 ......................................................... 15% of taxable income. 

Over $50,000 but not over $75,000 ............................ $7,500, plus 25% of the excess over $50,000. 

Over $75,000 but not over $1,000,000 ....................... $13,750, plus 33% of the excess over $75,000. 

Over $1,000,000 but not over $10,000,000 ................ $319,000, plus 34% of the excess over $1,000,000. 

Over $10,000,000 ......................................................... $3,379,000, plus 35% of the excess over $10,000,000.

‘‘(5) PHASEOUT OF LOWER RATES FOR CERTAIN TAXPAYERS.—

‘‘(A) GENERAL RULE FOR YEARS BEFORE 2013.—

‘‘(i) IN GENERAL.—In the case of taxable years beginning before 2013 

with respect to a corporation which has taxable income in excess of the 

applicable amount for any taxable year, the amount of tax determined 

under paragraph (1), (2), (3) or (4) for such taxable year shall be increased by the lesser of (I) 5 percent of such excess, or (II) the maximum increase amount. 

‘‘(ii) MAXIMUM INCREASE AMOUNT.—For purposes of clause (i)—

‘‘In the case of any taxable year beginning 

during: 

The applicable 

amount is: 

The maximum increase 

amount is: 

2005, 2006, or 2007 ........................................................................................ $1,000,000 $21,000

2008, 2009, or 2010 ........................................................................................ $1,000,000 $30,250

2011 or 2012 ................................................................................................... $5,000,000 $110,250. 

‘‘(B) HIGHER INCOME CORPORATIONS.—In the case of a corporation which 

has taxable income in excess of $20,000,000 ($15,000,000 in the case of taxable years beginning before 2013), the amount of the tax determined under 

the foregoing provisions of this subsection shall be increased by an additional amount equal to the lesser of (i) 3 percent of such excess, or (ii) 

$610,250 ($100,000 in the case of taxable years beginning before 2013).’’. 

(b) CONFORMING AMENDMENTS.—

13

(1) Section 904(b)(3)(D)(ii) is amended to read as follows: 

‘‘(ii) in the case of a corporation, section 1201(a) applies to such taxable year.’’. 

(2) Section 1201(a) is amended by striking ‘‘the last 2 sentences of section 

11(b)(1)’’ and inserting ‘‘section 11(b)(5)’’. 

(3) Section 1561(a) is amended—

(A) by striking ‘‘the last 2 sentences of section 11(b)(1)’’ and inserting 

‘‘section 11(b)(5)’’, and 

(B) by striking ‘‘such last 2 sentences’’ and inserting ‘‘section 11(b)(5)’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2004. 

TITLE II—JOB CREATION TAX INCENTIVES 

FOR MANUFACTURERS, SMALL BUSINESSES, 

AND FARMERS 

Subtitle A—Small Business Expensing 

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

Subsections (b), (c), and (d) of section 179 are each amended by striking ‘‘2006’’

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

Subtitle B—Depreciation 

SEC. 211. RECOVERY PERIOD FOR DEPRECIATION OF CERTAIN LEASEHOLD IMPROVEMENTS 

AND RESTAURANT PROPERTY. 

(a) 15-YEAR RECOVERY PERIOD.—Subparagraph (E) of section 168(e)(3) (relating to 

classification of certain property) is amended by striking ‘‘and’’ at the end of clause 

(ii), by striking the period at the end of clause (iii) and inserting a comma, and by 

adding at the end the following new clauses: 

‘‘(iv) any qualified leasehold improvement property placed in service 

before January 1, 2006, and 

‘‘(v) any qualified restaurant property placed in service before January 1, 2006.’’

(b) QUALIFIED LEASEHOLD IMPROVEMENT PROPERTY.—Subsection (e) of section 168 

is amended by adding at the end the following new paragraph: 

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

leasehold improvement property’ has the meaning given such term in section 

168(k)(3) except that the following special rules shall apply: 

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

made by the person who was the lessor of such improvement when such improvement was placed in service, such improvement shall be qualified leasehold improvement property (if at all) only so long as such improvement is 

held by such person. 

‘‘(B) EXCEPTION FOR CHANGES IN FORM OF BUSINESS.—Property shall not 

cease to be qualified leasehold improvement property under subparagraph 

(A) by reason of—

‘‘(i) death, 

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

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

so long as the property is retained in such trade or business as qualified leasehold improvement property and the taxpayer retains a substantial interest in such trade or business, 

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

includes an amount representing the adjusted basis of other property 

owned by the taxpayer or a related person, or 

‘‘(v) the acquisition of such property by the taxpayer in a transaction 

described in section 332, 351, 361, 721, or 731 (or the acquisition of 

such property by the taxpayer from the transferee or acquiring corporation in a transaction described in such section), to the extent that the 

basis of the property in the hands of the taxpayer is determined by reference to its basis in the hands of the transferor or distributor.’’. 

14

(c) QUALIFIED RESTAURANT PROPERTY.—Subsection (e) of section 168 (as amended 

by subsection (b)) is further amended by adding at the end the following new paragraph: 

‘‘(7) QUALIFIED RESTAURANT PROPERTY.—The term ‘qualified restaurant property’ means any section 1250 property which is an improvement to a building 

if—

‘‘(A) such improvement is placed in service more than 3 years after the 

date such building was first placed in service, and 

‘‘(B) more than 50 percent of the building’s square footage is devoted to 

preparation of, and seating for on-premises consumption of, prepared 

meals.’’. 

(d) REQUIREMENT TO USE STRAIGHT LINE METHOD.—

(1) Paragraph (3) of section 168(b) is amended by adding at the end the following new subparagraphs: 

‘‘(G) Qualified leasehold improvement property described in subsection 

(e)(6). 

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

(2) Subparagraph (A) of section 168(b)(2) is amended by inserting before the 

comma ‘‘not referred to in paragraph (3)’’. 

(e) ALTERNATIVE SYSTEM.—The table contained in section 168(g)(3)(B) is amended 

by adding at the end the following new items:

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

(f) EFFECTIVE DATE.—The amendments made by this section shall apply to property placed in service after the date of the enactment of this Act. 

SEC. 212. MODIFICATION OF DEPRECIATION ALLOWANCE FOR AIRCRAFT. 

(a) AIRCRAFT TREATED AS QUALIFIED PROPERTY.—

(1) IN GENERAL.—Paragraph (2) of section 168(k) is amended by redesignating 

subparagraphs (C) through (F) as subparagraphs (D) through (G), respectively, 

and by inserting after subparagraph (B) the following new subparagraph: 

‘‘(C) CERTAIN AIRCRAFT.—The term ‘qualified property’ includes property—

‘‘(i) which meets the requirements of clauses (ii) and (iii) of subparagraph (A), 

‘‘(ii) which is an aircraft which is not a transportation property (as 

defined in subparagraph (B)(iii)) other than for agricultural or firefighting purposes, 

‘‘(iii) which is purchased and on which such purchaser, at the time 

of the contract for purchase, has made a nonrefundable deposit of the 

lesser of—

‘‘(I) 10 percent of the cost, or 

‘‘(II) $100,000, and 

‘‘(iv) which has—

‘‘(I) an estimated production period exceeding 4 months, and 

‘‘(II) a cost exceeding $200,000.’’. 

(2) PLACED IN SERVICE DATE.—Clause (iv) of section 168(k)(2)(A) is amended 

by striking ‘‘subparagraph (B)’’ and inserting ‘‘subparagraphs (B) and (C)’’. 

(b) CONFORMING AMENDMENTS.—

(1) Section 168(k)(2)(B) is amended by adding at the end the following new 

clause: 

‘‘(iv) APPLICATION OF SUBPARAGRAPH.—This subparagraph shall not 

apply to any property which is described in subparagraph (C).’’. 

(2) Section 168(k)(4)(A)(ii) is amended by striking ‘‘paragraph (2)(C)’’ and inserting ‘‘paragraph (2)(D)’’. 

(3) Section 168(k)(4)(B)(iii) is amended by inserting ‘‘and paragraph (2)(C)’’

after ‘‘of this paragraph)’’. 

(4) Section 168(k)(4)(C) is amended by striking ‘‘subparagraphs (B) and (D)’’

and inserting ‘‘subparagraphs (B), (C), and (E)’’. 

(5) Section 168(k)(4)(D) is amended by striking ‘‘Paragraph (2)(E)’’ and inserting ‘‘Paragraph (2)(F)’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall take effect as 

if included in the amendments made by section 101 of the Job Creation and Worker 

Assistance Act of 2002. 

SEC. 213. MODIFICATION OF PLACED IN SERVICE RULE FOR BONUS DEPRECIATION PROPERTY. 

(a) IN GENERAL.—Section 168(k)(2)(D) (relating to special rules) is amended by 

adding at the end the following new clause: 

15

‘‘(iii) SYNDICATION.—For purposes of subparagraph (A)(ii), if—

‘‘(I) property is originally placed in service after September 10, 

2001, by the lessor of such property, 

‘‘(II) such property is sold by such lessor or any subsequent purchaser within 3 months after the date so placed in service (or, in 

the case of multiple units of property subject to the same lease, 

within 3 months after the date the final unit is placed in service, 

so long as the period between the time the first unit is placed in 

service and the time the last unit is placed in service does not exceed 12 months), and 

‘‘(III) the user of such property after the last sale during such 3-

month period remains the same as when such property was originally placed in service, 

such property shall be treated as originally placed in service not earlier 

than the date of such last sale, so long as no previous owner of such 

property elects the application of this subsection with respect to such 

property.’’. 

(b) EFFECTIVE DATE.—The amendments made by this section shall take effect as 

if included in the amendments made by section 101 of the Job Creation and Worker 

Assistance Act of 2002; except that the parenthetical material in section 

168(k)(2)(D)(iii)(II) of the Internal Revenue Code of 1986, as added by this section, 

shall apply to property sold after June 4, 2004. 

Subtitle C—S Corporation Reform and 

Simplification 

SEC. 221. MEMBERS OF FAMILY TREATED AS 1 SHAREHOLDER. 

(a) IN GENERAL.—Paragraph (1) of section 1361(c) (relating to special rules for applying subsection (b)) is amended to read as follows: 

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

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

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

estates) shall be treated as 1 shareholder, and 

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

effect under subparagraph (D), all members of the family shall be treated as 1 shareholder. 

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

‘‘(i) IN GENERAL.—The term ‘members of the family’ means the common ancestor, lineal descendants of the common ancestor, and the 

spouses (or former spouses) of such lineal descendants or common ancestor. 

‘‘(ii) COMMON ANCESTOR.—For purposes of this paragraph, an individual shall not be considered a common ancestor if, as of the later of 

the effective date of this paragraph or the time the election under section 1362(a) is made, the individual is more than 3 generations removed from the youngest generation of shareholders who would (but for 

this clause) be members of the family. For purposes of the preceding 

sentence, a spouse (or former spouse) shall be treated as being of the 

same generation as the individual to which such spouse is (or was) 

married. 

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

specified in subparagraph (B) exists, the rules of section 152(b)(2) shall 

apply. 

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

‘‘(i) may, except as otherwise provided in regulations prescribed by 

the Secretary, be made by any member of the family, and 

‘‘(ii) shall remain in effect until terminated as provided in regulations 

prescribed by the Secretary.’’. 

(b) RELIEF FROM INADVERTENT INVALID ELECTION OR TERMINATION.—Section 

1362(f) (relating to inadvertent invalid elections or terminations), as amended by 

section 229, is amended—

(1) by inserting ‘‘or section 1361(c)(1)(A)(ii)’’ after ‘‘section 1361(b)(3)(B)(ii),’’ in 

paragraph (1), and 

(2) by inserting ‘‘or section 1361(c)(1)(D)(iii)’’ after ‘‘section 1361(b)(3)(C),’’ in 

paragraph (1)(B). 

(c) EFFECTIVE DATES.—

16

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

taxable years beginning after December 31, 2004. 

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

elections and terminations made after December 31, 2004. 

SEC. 222. INCREASE IN NUMBER OF ELIGIBLE SHAREHOLDERS TO 100. 

(a) IN GENERAL.—Section 1361(b)(1)(A) (defining small business corporation) is 

amended by striking ‘‘75’’ and inserting ‘‘100’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years beginning after December 31, 2004. 

SEC. 223. EXPANSION OF BANK S CORPORATION ELIGIBLE SHAREHOLDERS TO INCLUDE 

IRAS. 

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

shareholders) is amended by inserting after clause (v) the following new clause: 

‘‘(vi) In the case of a corporation which is a bank (as defined in section 581), a trust which constitutes an individual retirement account 

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

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

such bank as of the date of the enactment of this clause.’’. 

(b) TREATMENT AS SHAREHOLDER.—Section 1361(c)(2)(B) (relating to treatment as 

shareholders) is amended by adding at the end the following new clause: 

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

(A), the individual for whose benefit the trust was created shall be 

treated as a shareholder.’’. 

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

FROM PROHIBITED TRANSACTION RULES.—Section 4975(d) (relating to exemptions) is 

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

end of paragraph (15) and inserting ‘‘; or’’, and by adding at the end the following 

new paragraph: 

‘‘(16) a sale of stock held by a trust which constitutes an individual retirement 

account under section 408(a) to the individual for whose benefit such account 

is established if—

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

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

this paragraph, 

‘‘(C) such sale is pursuant to an election under section 1362(a) by such 

bank, 

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

by an independent appraiser) and the terms of the sale are otherwise at 

least as favorable to such trust as the terms that would apply on a sale 

to an unrelated party, 

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

in connection with the sale, and 

‘‘(F) the stock is sold in a single transaction for cash not later than 120 

days after the S corporation election is made.’’. 

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

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

(e) EFFECTIVE DATE.—The amendments made by this section shall take effect on 

the date of the enactment of this Act. 

SEC. 224. DISREGARD OF UNEXERCISED POWERS OF APPOINTMENT IN DETERMINING POTENTIAL CURRENT BENEFICIARIES OF ESBT. 

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

amended—

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

the extent such power remains unexercised at the end of such period)’’ after ‘‘of 

the trust’’ in the first sentence, and 

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

(b) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2004. 

SEC. 225. TRANSFER OF SUSPENDED LOSSES INCIDENT TO DIVORCE, ETC. 

(a) IN GENERAL.—Section 1366(d)(2) (relating to indefinite carryover of disallowed 

losses and deductions) is amended to read as follows: 

‘‘(2) INDEFINITE CARRYOVER OF DISALLOWED LOSSES AND DEDUCTIONS.—

‘‘(A) IN GENERAL.—Except as provided in subparagraph (B), any loss or 

deduction which is disallowed for any taxable year by reason of paragraph 

(1) shall be treated as incurred by the corporation in the succeeding taxable 

year with respect to that shareholder. 

17

‘‘(B) TRANSFERS OF STOCK BETWEEN SPOUSES OR INCIDENT TO DIVORCE.— In the case of any transfer described in section 1041(a) of stock of an S corporation, any loss or deduction described in subparagraph (A) with respect 

such stock shall be treated as incurred by the corporation in the succeeding 

taxable year with respect to the transferee.’’ (b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years beginning after December 31, 2004. 

SEC. 226. USE OF PASSIVE ACTIVITY LOSS AND AT-RISK AMOUNTS BY QUALIFIED SUBCHAPTER S TRUST INCOME BENEFICIARIES. 

(a) IN GENERAL.—Section 1361(d)(1) (relating to special rule for qualified subchapter S trust) is amended— (1) by striking ‘‘and’’ at the end of subparagraph (A), 

(2) by striking the period at the end of subparagraph (B) and inserting ‘‘, and’’, and 

(3) by adding at the end the following new subparagraph: ‘‘(C) for purposes of applying sections 465 and 469 to the beneficiary of 

the trust, the disposition of the S corporation stock by the trust shall be 

treated as a disposition by such beneficiary.’’. (b) EFFECTIVE DATE.—The amendments made by this section shall apply to transfers made after December 31, 2004. 

SEC. 227. EXCLUSION OF INVESTMENT SECURITIES INCOME FROM PASSIVE INCOME TEST 

FOR BANK S CORPORATIONS. 

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

exceeds 25 percent of gross receipts for 3 consecutive taxable years and corporation 

has accumulated earnings and profits) is amended by adding at the end the following new subparagraph: ‘‘(F) EXCEPTION FOR BANKS; ETC.—In the case of a bank (as defined in section 581), a bank holding company (within the meaning of section 2(a) of 

the Bank Holding Company Act of 1956 (12 U.S.C. 1841(a))), or a financial 

holding company (within the meaning of section 2(p) of such Act), the term 

‘passive investment income’ shall not include—

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

‘‘(ii) dividends on assets required to be held by such bank or company, including stock in the Federal Reserve Bank, the Federal Home 

Loan Bank, or the Federal Agricultural Mortgage Bank or participation 

certificates issued by a Federal Intermediate Credit Bank.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years beginning after December 31, 2004. 

SEC. 228. TREATMENT OF BANK DIRECTOR SHARES. 

(a) IN GENERAL.—Section 1361 (defining S corporation) is amended by adding at 

the end the following new subsection: 

‘‘(f) RESTRICTED BANK DIRECTOR STOCK.—

‘‘(1) IN GENERAL.—Restricted bank director stock shall not be taken into account as outstanding stock of the S corporation in applying this subchapter 

(other than section 1368(f)). 

‘‘(2) RESTRICTED BANK DIRECTOR STOCK.—For purposes of this subsection, the 

term ‘restricted bank director stock’ means stock in a bank (as defined in section 581), a bank holding company (within the meaning of section 2(a) of the 

Bank Holding Company Act of 1956 (12 U.S.C. 1841(a))), or a financial holding 

company (within the meaning of section 2(p) of such Act), registered with the 

Federal Reserve System, if such stock—

‘‘(A) is required to be held by an individual under applicable Federal or 

State law in order to permit such individual to serve as a director, and 

‘‘(B) is subject to an agreement with such bank or company (or a corporation which controls (within the meaning of section 368(c)) such bank or 

company) pursuant to which the holder is required to sell back such stock 

(at the same price as the individual acquired such stock) upon ceasing to 

hold the office of director. 

‘‘(3) CROSS REFERENCE.—

‘‘For treatment of certain distributions with respect to restricted bank director stock, see 

section 1368(f).’’.

(b) DISTRIBUTIONS.—Section 1368 (relating to distributions) is amended by adding 

at the end the following new subsection: 

‘‘(f) RESTRICTED BANK DIRECTOR STOCK.—If a director receives a distribution (not 

in part or full payment in exchange for stock) from an S corporation with respect 

to any restricted bank director stock (as defined in section 1361(f)), the amount of 

such distribution—

18

‘‘(1) shall be includible in gross income of the director, and 

‘‘(2) shall be deductible by the corporation for the taxable year of such corporation in which or with which ends the taxable year in which such amount 

in included in the gross income of the director.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2004. 

SEC. 229. RELIEF FROM INADVERTENTLY INVALID QUALIFIED SUBCHAPTER S SUBSIDIARY 

ELECTIONS AND TERMINATIONS. 

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

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

(1), 

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

(1)(B), 

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

‘‘(A) so that the corporation for which the election was made is a small 

business corporation or a qualified subchapter S subsidiary, as the case 

may be, or’’, 

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

‘‘(4) the corporation for which the election was made, and each person who 

was a shareholder in such corporation at any time during the period specified 

pursuant to this subsection, agrees to make such adjustments (consistent with 

the treatment of such corporation as an S corporation or a qualified subchapter 

S subsidiary, as the case may be) as may be required by the Secretary with respect to such period,’’, and 

(5) by inserting ‘‘or a qualified subchapter S subsidiary, as the case may be’’

after ‘‘S corporation’’ in the matter following paragraph (4). 

(b) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2004. 

SEC. 230. INFORMATION RETURNS FOR QUALIFIED SUBCHAPTER S SUBSIDIARIES. 

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

owned subsidiaries) is amended by inserting ‘‘and in the case of information returns 

required under part III of subchapter A of chapter 61’’ after ‘‘Secretary’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years beginning after December 31, 2004. 

SEC. 231. REPAYMENT OF LOANS FOR QUALIFYING EMPLOYER SECURITIES. 

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

special rules) is amended by adding at the end the following new paragraph: 

‘‘(7) S CORPORATION REPAYMENT OF LOANS FOR QUALIFYING EMPLOYER SECURITIES.—A plan shall not be treated as violating the requirements of section 401 

or 409 or subsection (e)(7), or as engaging in a prohibited transaction for purposes of subsection (d)(3), merely by reason of any distribution (as described in 

section 1368(a)) with respect to S corporation stock that constitutes qualifying 

employer securities, which in accordance with the plan provisions is used to 

make payments on a loan described in subsection (d)(3) the proceeds of which 

were used to acquire such qualifying employer securities (whether or not allocated to participants). The preceding sentence shall not apply in the case of a 

distribution which is paid with respect to any employer security which is allocated to a participant unless the plan provides that employer securities with a 

fair market value of not less than the amount of such distribution are allocated 

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

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to distributions with respect to S corporation stock made after December 31, 2004. 

Subtitle D—Alternative Minimum Tax Relief 

SEC. 241. FOREIGN TAX CREDIT UNDER ALTERNATIVE MINIMUM TAX. 

(a) IN GENERAL.—

(1) Subsection (a) of section 59 is amended by striking paragraph (2) and by 

redesignating paragraphs (3) and (4) as paragraphs (2) and (3), respectively. 

(2) Section 53(d)(1)(B)(i)(II) is amended by striking ‘‘and if section 59(a)(2) did 

not apply’’. 

(b) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2004. 

19

SEC. 242. EXPANSION OF EXEMPTION FROM ALTERNATIVE MINIMUM TAX FOR SMALL CORPORATIONS. 

(a) IN GENERAL.—Subparagraphs (A) and (B) of section 55(e)(1) are each amended 

by striking ‘‘$7,500,000’’ each place it appears and inserting ‘‘$20,000,000’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years beginning after December 31, 2005. 

SEC. 243. INCOME AVERAGING FOR FARMERS NOT TO INCREASE ALTERNATIVE MINIMUM 

TAX. 

(a) IN GENERAL.—Subsection (c) of section 55 (defining regular tax) is amended 

by redesignating paragraph (2) as paragraph (3) and by inserting after paragraph 

(1) the following new paragraph: 

‘‘(2) COORDINATION WITH INCOME AVERAGING FOR FARMERS.—Solely for purposes of this section, section 1301 (relating to averaging of farm income) shall 

not apply in computing the regular tax liability.’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) shall apply to taxable years beginning after December 31, 2003. 

Subtitle E—Restructuring of Incentives for 

Alcohol Fuels, Etc. 

SEC. 251. REDUCED RATES OF TAX ON GASOHOL REPLACED WITH EXCISE TAX CREDIT; REPEAL OF OTHER ALCOHOL-BASED FUEL INCENTIVES; ETC. 

(a) EXCISE TAX CREDIT FOR ALCOHOL FUEL MIXTURES.—

(1) IN GENERAL.—Subsection (f) of section 6427 is amended to read as follows: 

‘‘(f) ALCOHOL FUEL MIXTURES.—

‘‘(1) IN GENERAL.—The amount of credit which would (but for section 40(c)) 

be determined under section 40(a)(1) for any period—

‘‘(A) shall, with respect to taxable events occurring during such period, be 

treated—

‘‘(i) as a payment of the taxpayer’s liability for tax imposed by section 

4081, and 

‘‘(ii) as received at the time of the taxable event, and 

‘‘(B) to the extent such amount of credit exceeds such liability for such 

period, shall (except as provided in subsection (k)) be paid subject to subsection (i)(3) by the Secretary without interest. 

‘‘(2) SPECIAL RULES.—

‘‘(A) ONLY CERTAIN ALCOHOL TAKEN INTO ACCOUNT.—For purposes of 

paragraph (1), section 40 shall be applied—

‘‘(i) by not taking into account alcohol with a proof of less than 190, 

and 

‘‘(ii) by treating as alcohol the alcohol gallon equivalent of ethyl tertiary butyl ether or other ethers produced from such alcohol. 

‘‘(B) TREATMENT OF REFINERS.—For purposes of paragraph (1), in the case 

of a mixture—

‘‘(i) the alcohol in which is described in subparagraph (A)(ii), and 

‘‘(ii) which is produced by any person at a refinery prior to any taxable event, 

section 40 shall be applied by treating such person as having sold such mixture at the time of its removal from the refinery (and only at such time) 

to another person for use as a fuel. 

‘‘(3) MIXTURES NOT USED AS FUEL.—Rules similar to the rules of subparagraphs (A) and (D) of section 40(d)(3) shall apply for purposes of this subsection. 

‘‘(4) TERMINATION.—This section shall apply only to periods to which section 

40 applies, determined by substituting in section 40(e)—

‘‘(A) ‘December 31, 2010’ for ‘December 31, 2007’, and 

‘‘(B) ‘January 1, 2011’ for ‘January 1, 2008’.’’

(2) REVISION OF RULES FOR PAYMENT OF CREDIT.—Paragraph (3) of section 

6427(i) is amended to read as follows: 

‘‘(3) SPECIAL RULE FOR ALCOHOL MIXTURE CREDIT.—

‘‘(A) IN GENERAL.—A claim may be filed under subsection (f)(1)(B) by any 

person for any period—

‘‘(i) for which $200 or more is payable under such subsection (f)(1)(B), 

and 

‘‘(ii) which is not less than 1 week. 

In the case of an electronic claim, this subparagraph shall be applied without regard to clause (i). 

20

‘‘(B) PAYMENT OF CLAIM.—Notwithstanding subsection (f)(1)(B), if the Secretary has not paid pursuant to a claim filed under this section within 45 

days of the date of the filing of such claim (20 days in the case of an electronic claim), the claim shall be paid with interest from such date determined by using the overpayment rate and method under section 6621. ‘‘(C) TIME FOR FILING CLAIM.—No claim filed under this paragraph shall 

be allowed unless filed on or before the last day of the first quarter following the earliest quarter included in the claim.’’ (b) REPEAL OF OTHER INCENTIVES FOR FUEL MIXTURES.— (1) Subsection (b) of section 4041 is amended to read as follows: ‘‘(b) EXEMPTION FOR OFF-HIGHWAY BUSINESS USE.— ‘‘(1) IN GENERAL.—No tax shall be imposed by subsection (a) or (d)(1) on liquids sold for use or used in an off-highway business use. ‘‘(2) TAX WHERE OTHER USE.—If a liquid on which no tax was imposed by reason of paragraph (1) is used otherwise than in an off-highway business use, a 

tax shall be imposed by paragraph (1)(B), (2)(B), or (3)(A)(ii) of subsection (a) 

(whichever is appropriate) and by the corresponding provision of subsection 

(d)(1) (if any). ‘‘(3) OFF-HIGHWAY BUSINESS USE DEFINED.—For purposes of this subsection, 

the term ‘off-highway business use’ has the meaning given to such term by section 6421(e)(2); except that such term shall not, for purposes of subsection (a)(1), 

include use in a diesel-powered train.’’ (2) Section 4041(k) is hereby repealed. 

(3) Section 4081(c) is hereby repealed. 

(4) Section 4091(c) is hereby repealed. 

(c) TRANSFERS TO HIGHWAY TRUST FUND.—Paragraph (4) of section 9503(b) is 

amended by adding ‘‘or’’ at the end of subparagraph (B), by striking the comma at 

the end of subparagraph (C) and inserting a period, and by striking subparagraphs 

(D), (E), and (F). 

(d) CONFORMING AMENDMENTS.— (1) Subsection (c) of section 40 is amended to read as follows: ‘‘(c) COORDINATION WITH EXCISE TAX BENEFITS.—The amount of the credit determined under this section with respect to any alcohol shall, under regulations prescribed by the Secretary, be properly reduced to take into account the benefit provided with respect to such alcohol under section 6427(f).’’ (2) Subparagraph (B) of section 40(d)(4) is amended by striking ‘‘under section 

4041(k) or 4081(c)’’ and inserting ‘‘under section 6427(f)’’. (e) EFFECTIVE DATES.— (1) IN GENERAL.—Except as provided by paragraph (2), the amendments made 

by this section shall apply to fuel sold or used after September 30, 2004. 

(2) SUBSECTION (c).—The amendments made by subsection (c) shall apply to 

taxes imposed after September 30, 2003. 

SEC. 252. ALCOHOL FUEL SUBSIDIES BORNE BY GENERAL FUND. 

(a) TRANSFERS TO FUND.—Section 9503(b)(1) is amended by adding at the end the 

following new flush sentence: ‘‘For purposes of this paragraph, the amount of taxes received under section 

4081 shall include any amount treated as a payment under section 6427(f)(1)(A) 

and shall not be reduced by the amount paid under section 6427(f)(1)(B).’’. (b) TRANSFERS FROM FUND.—Subparagraph (A) of section 9503(c)(2) is amended 

by adding at the end the following new sentence: ‘‘Clauses (i)(III) and (ii) shall not 

apply to claims under section 6427(f)(1)(B).’’ (c) EFFECTIVE DATE.— (1) SUBSECTION (a).—The amendment made by subsection (a) shall apply to 

taxes received after September 30, 2004. 

(2) SUBSECTION (b).—The amendment made by subsection (b) shall apply to 

amounts paid after September 30, 2004, and (to the extent related to section 

34 of the Internal Revenue Code of 1986) to fuel used after such date. 

Subtitle F—Stock Options and Employee Stock 

Purchase Plan Stock Options 

SEC. 261. EXCLUSION OF INCENTIVE STOCK OPTIONS AND EMPLOYEE STOCK PURCHASE 

PLAN STOCK OPTIONS FROM WAGES. 

(a) EXCLUSION FROM EMPLOYMENT TAXES.—

(1) SOCIAL SECURITY TAXES.—

(A) Section 3121(a) (relating to definition of wages) is amended by striking ‘‘or’’ at the end of paragraph (20), by striking the period at the end of 

21

paragraph (21) and inserting ‘‘; or’’, and by inserting after paragraph (21) 

the following new paragraph: 

‘‘(22) remuneration on account of—

‘‘(A) a transfer of a share of stock to any individual pursuant to an exercise of an incentive stock option (as defined in section 422(b)) or under an 

employee stock purchase plan (as defined in section 423(b)), or 

‘‘(B) any disposition by the individual of such stock.’’. 

(B) Section 209(a) of the Social Security Act is amended by striking ‘‘or’’

at the end of paragraph (17), by striking the period at the end of paragraph 

(18) and inserting ‘‘; or’’, and by inserting after paragraph (18) the following 

new paragraph: 

‘‘(19) Remuneration on account of—

‘‘(A) a transfer of a share of stock to any individual pursuant to an exercise of an incentive stock option (as defined in section 422(b) of the Internal 

Revenue Code of 1986) or under an employee stock purchase plan (as defined in section 423(b) of such Code), or 

‘‘(B) any disposition by the individual of such stock.’’. 

(2) RAILROAD RETIREMENT TAXES.—Subsection (e) of section 3231 is amended 

by adding at the end the following new paragraph: 

‘‘(12) QUALIFIED STOCK OPTIONS.—The term ‘compensation’ shall not include 

any remuneration on account of—

‘‘(A) a transfer of a share of stock to any individual pursuant to an exercise of an incentive stock option (as defined in section 422(b)) or under an 

employee stock purchase plan (as defined in section 423(b)), or 

‘‘(B) any disposition by the individual of such stock.’’. 

(3) UNEMPLOYMENT TAXES.—Section 3306(b) (relating to definition of wages) 

is amended by striking ‘‘or’’ at the end of paragraph (17), by striking the period 

at the end of paragraph (18) and inserting ‘‘; or’’, and by inserting after paragraph (18) the following new paragraph: 

‘‘(19) remuneration on account of—

‘‘(A) a transfer of a share of stock to any individual pursuant to an exercise of an incentive stock option (as defined in section 422(b)) or under an 

employee stock purchase plan (as defined in section 423(b)), or 

‘‘(B) any disposition by the individual of such stock.’’. 

(b) WAGE WITHHOLDING NOT REQUIRED ON DISQUALIFYING DISPOSITIONS.—Section 

421(b) (relating to effect of disqualifying dispositions) is amended by adding at the 

end the following new sentence: ‘‘No amount shall be required to be deducted and 

withheld under chapter 24 with respect to any increase in income attributable to 

a disposition described in the preceding sentence.’’. 

(c) WAGE WITHHOLDING NOT REQUIRED ON COMPENSATION WHERE OPTION PRICE

IS BETWEEN 85 PERCENT AND 100 PERCENT OF VALUE OF STOCK.—Section 423(c) (relating to special rule where option price is between 85 percent and 100 percent of 

value of stock) is amended by adding at the end the following new sentence: ‘‘No 

amount shall be required to be deducted and withheld under chapter 24 with respect to any amount treated as compensation under this subsection.’’. 

(d) EFFECTIVE DATE.—The amendments made by this section shall apply to stock 

acquired pursuant to options exercised after the date of the enactment of this Act. 

Subtitle G—Incentives to Reinvest Foreign 

Earnings in United States 

SEC. 271. INCENTIVES TO REINVEST FOREIGN EARNINGS IN UNITED STATES. 

(a) IN GENERAL.—Subpart F of part III of subchapter N of chapter 1 (relating to 

controlled foreign corporations) is amended by adding at the end the following new 

section: 

‘‘SEC. 965. TEMPORARY DIVIDENDS RECEIVED DEDUCTION. 

‘‘(a) DEDUCTION.—

‘‘(1) IN GENERAL.—In the case of a corporation which is a United States shareholder, there shall be allowed as a deduction an amount equal to 85 percent 

of the dividends which are received by such shareholder from controlled foreign 

corporations during the election period. 

‘‘(2) DIVIDENDS PAID INDIRECTLY FROM CONTROLLED FOREIGN CORPORATIONS.—

If, within the election period, a United States shareholder receives a distribution from a controlled foreign corporation which is excluded from gross income 

under section 959(a), such distribution shall be treated for purposes of this section as a dividend to the extent of any amount included in income by such 

22

United States shareholder under section 951(a)(1)(A) as a result of any dividend 

paid during the election period to—

‘‘(A) such controlled foreign corporation from another controlled foreign 

corporation that is in a chain of ownership described in section 958(a), or 

‘‘(B) any other controlled foreign corporation in such chain of ownership, 

but only to the extent of distributions described in section 959(b) which are 

made during the election period to the controlled foreign corporation from 

which such United States shareholder received such distribution. 

‘‘(b) LIMITATIONS.—

‘‘(1) IN GENERAL.—The amount of dividends taken into account under subsection (a) shall not exceed the greater of—

‘‘(A) $500,000,000, 

‘‘(B) the amount shown on the applicable financial statement as earnings 

permanently reinvested outside the United States, or 

‘‘(C) in the case of an applicable financial statement which fails to show 

a specific amount of earnings permanently reinvested outside the United 

States and which shows a specific amount of tax liability attributable to 

such earnings, the amount of such earnings determined in such manner as 

the Secretary may prescribe. 

Except as provided in subparagraph (C), if there is no statement or such statement fails to show a specific amount of such earnings or liability, such amount 

shall be treated as being zero for purposes of this paragraph. 

‘‘(2) DIVIDENDS MUST BE EXTRAORDINARY.—The amount of dividends taken 

into account under subsection (a) shall not exceed the excess (if any) of—

‘‘(A) the dividends received during the taxable year by such shareholder 

from controlled foreign corporations, over 

‘‘(B) the annual average for the base period years of—

‘‘(i) the dividends received during each base period year by such 

shareholder from such corporations, 

‘‘(ii) the amounts includible in such shareholder’s gross income for 

each base period year under section 951(a)(1)(B) with respect to such 

corporations, and 

‘‘(iii) the amounts that would have been included for each base period 

year but for section 959(a) with respect to such corporations. 

The amount taken into account under clause (iii) for any base period year 

shall not include any amount which is not includible in gross income by 

reason of an amount described in clause (ii) with respect to a prior taxable 

year. 

‘‘(3) REQUIREMENT TO INVEST IN UNITED STATES.—Subsection (a) shall not 

apply to any dividend received by a United States shareholder unless the 

amount of the dividend is invested in the United States pursuant to a plan describing the expenditures to be made with such amount—

‘‘(A) which, before the dividend is received, is approved by the president 

or chief executive officer of such shareholder, and 

‘‘(B) which is approved by the Board of Directors (or management committee) of such shareholder no later than its first meeting on or after the 

date the dividend is received. 

‘‘(c) DEFINITIONS AND SPECIAL RULES.—For purposes of this section—

‘‘(1) ELECTION PERIOD.—The term ‘election period’ means—

‘‘(A) if this section applies to the taxpayer’s last taxable year beginning 

before the date of the enactment of this section, any 6-month or shorter period during such year which is after the date of the enactment of this section and which is selected by the taxpayer, and 

‘‘(B) if this section applies to the taxpayer’s first taxable year beginning 

on or after such date, the 1st 6 months of such taxable year. 

‘‘(2) APPLICABLE FINANCIAL STATEMENT.—The term ‘applicable financial statement’ means the most recently audited financial statement (including notes and 

other documents which accompany such statement)—

‘‘(A) which is certified on or before March 31, 2003, as being prepared in 

accordance with generally accepted accounting principles, and 

‘‘(B) which is used for the purposes of a statement or report—

‘‘(i) to creditors, 

‘‘(ii) to shareholders, or 

‘‘(iii) for any other substantial nontax purpose. 

In the case of a corporation required to file a financial statement with the Securities and Exchange Commission, such term means the most recent such statement filed on or before March 31, 2003. 

‘‘(3) BASE PERIOD YEARS.—The base period years are the 3 taxable years—

23

‘‘(A) which are among the 5 most recent taxable years ending on or before 

March 31, 2003, and ‘‘(B) which are determined by disregarding— ‘‘(i) 1 taxable year for which the sum of the amounts described in 

clauses (i), (ii), and (iii) of subsection (b)(2)(B) is the largest, and ‘‘(ii) 1 taxable year for which such sum is the smallest. 

Rules similar to the rules of subparagraphs (A) and (B) of section 41(f)(3) shall 

apply for purposes of this paragraph. ‘‘(4) COORDINATION WITH DIVIDENDS RECEIVED DEDUCTION.—No deduction 

shall be allowed under section 243 or 245 for any dividend for which a deduction is allowed under this section. ‘‘(d) DENIAL OF FOREIGN TAX CREDIT.— ‘‘(1) IN GENERAL.—No credit shall be allowed under section 901 for any taxes 

paid or accrued (or treated as paid or accrued) with respect to the deductible 

portion of any dividend or of any amount described in subsection (a)(2). No deduction shall be allowed under this chapter for any tax for which credit is not 

allowable by reason of the preceding sentence. ‘‘(2) DEDUCTIBLE PORTION.—For purposes of paragraph (1), unless the taxpayer otherwise specifies, the deductible portion of any dividend is the amount 

which bears the same ratio to the amount of such dividend as the amount allowed as a deduction under subsection (a) for the taxable year bears to the 

amount described in subsection (b)(2)(A) for such year. ‘‘(e) INCREASE IN TAX ON INCLUDED AMOUNTS NOT REDUCED BY CREDITS, ETC.— ‘‘(1) IN GENERAL.—Any tax under this chapter by reason of nondeductible CFC 

dividends shall not be treated as tax imposed by this chapter for purposes of 

determining— ‘‘(A) the amount of any credit allowable under this chapter, or 

‘‘(B) the amount of the tax imposed by section 55. 

Subparagraph (A) shall not apply to the credit under section 53 or to the credit 

under section 27(a) with respect to taxes attributable to such dividends. ‘‘(2) INCLUSIONS MAY NOT BE OFFSET BY NET OPERATING LOSSES.—

‘‘(A) IN GENERAL.—The taxable income of any United States shareholder 

for any taxable year shall in no event be less than the amount of nondeductible CFC dividends received during such year. 

‘‘(B) COORDINATION WITH SECTION 172.—The nondeductible CFC dividends 

for any taxable year shall not be taken into account—

‘‘(i) in determining under section 172 the amount of any net operating loss for such taxable year, and 

‘‘(ii) in determining taxable income for such taxable year for purposes 

of the 2nd sentence of section 172(b)(2). 

‘‘(3) NONDEDUCTIBLE CFC DIVIDENDS.—For purposes of this subsection, the 

term ‘nondeductible CFC dividends’ means the excess of the amount of dividends taken into account under subsection (a) over the deduction allowed under 

subsection (a) for such dividends. 

‘‘(f) ELECTION.—This section shall apply for the taxpayer’s first taxable year beginning on or after the date of the enactment of this section if the taxpayer elects its 

application for such taxable year. The taxpayer may elect to apply this section to 

the taxpayer’s last taxable year beginning before the date of the enactment of this 

section in lieu of such first taxable year.’’

(b) ALTERNATIVE MINIMUM TAX.—Subparagraph (C) of section 56(g)(4) is amended 

by adding at the end the following new clause: 

‘‘(v) SPECIAL RULE FOR CERTAIN DISTRIBUTIONS FROM CONTROLLED

FOREIGN CORPORATIONS.—Clause (i) shall not apply to any deduction allowable under section 965.’’. 

(c) CLERICAL AMENDMENT.—The table of sections for subpart F of part III of subchapter N of chapter 1 is amended by adding at the end the following new item:

‘‘Sec. 965. Temporary dividends received deduction.’’.

(d) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years ending on or after the date of the enactment of this Act. 

Subtitle H—Other Incentive Provisions 

SEC. 281. SPECIAL RULES FOR LIVESTOCK SOLD ON ACCOUNT OF WEATHER-RELATED CONDITIONS. 

(a) RULES FOR REPLACEMENT OF INVOLUNTARILY CONVERTED LIVESTOCK.—Subsection (e) of section 1033 (relating to involuntary conversions) is amended—

(1) by striking ‘‘CONDITIONS.—For purposes’’ and inserting ‘‘CONDITIONS.—

24

‘‘(1) IN GENERAL.—For purposes’’, and 

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

‘‘(2) EXTENSION OF REPLACEMENT PERIOD.—

‘‘(A) IN GENERAL.—In the case of drought, flood, or other weather-related 

conditions described in paragraph (1) which result in the area being designated as eligible for assistance by the Federal Government, subsection 

(a)(2)(B) shall be applied with respect to any converted property by substituting ‘4 years’ for ‘2 years’. 

‘‘(B) FURTHER EXTENSION BY SECRETARY.—The Secretary may extend on 

a regional basis the period for replacement under this section (after the application of subparagraph (A)) for such additional time as the Secretary determines appropriate if the weather-related conditions which resulted in 

such application continue for more than 3 years.’’. 

(b) INCOME INCLUSION RULES.—Subsection (e) of section 451 (relating to special 

rule for proceeds from livestock sold on account of drought, flood, or other weatherrelated conditions) is amended by adding at the end the following new paragraph: 

‘‘(3) SPECIAL ELECTION RULES.—If section 1033(e)(2) applies to a sale or exchange of livestock described in paragraph (1), the election under paragraph (1) 

shall be deemed valid if made during the replacement period described in such 

section.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to any 

taxable year with respect to which the due date (without regard to extensions) for 

the return is after December 31, 2002. 

SEC. 282. PAYMENT OF DIVIDENDS ON STOCK OF COOPERATIVES WITHOUT REDUCING PATRONAGE DIVIDENDS. 

(a) IN GENERAL.—Subsection (a) of section 1388 (relating to patronage dividend 

defined) is amended by adding at the end the following: ‘‘For purposes of paragraph 

(3), net earnings shall not be reduced by amounts paid during the year as dividends 

on capital stock or other proprietary capital interests of the organization to the extent that the articles of incorporation or bylaws of such organization or other contract with patrons provide that such dividends are in addition to amounts otherwise 

payable to patrons which are derived from business done with or for patrons during 

the taxable year.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to distributions in taxable years beginning after the date of the enactment of this Act. 

SEC. 283. CAPITAL GAIN TREATMENT UNDER SECTION 631(b) TO APPLY TO OUTRIGHT SALES 

BY LANDOWNERS. 

(a) IN GENERAL.—The first sentence of section 631(b) (relating to disposal of timber with a retained economic interest) is amended by striking ‘‘retains an economic 

interest in such timber’’ and inserting ‘‘either retains an economic interest in such 

timber or makes an outright sale of such timber’’. 

(b) CONFORMING AMENDMENTS.—

(1) The third sentence of section 631(b) is amended by striking ‘‘The date of 

disposal’’ and inserting ‘‘In the case of disposal of timber with a retained economic interest, the date of disposal’’. 

(2) The heading for section 631(b) is amended by striking ‘‘WITH A RETAINED

ECONOMIC INTEREST’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to sales 

after December 31, 2004. 

SEC. 284. DISTRIBUTIONS FROM PUBLICLY TRADED PARTNERSHIPS TREATED AS QUALIFYING INCOME OF REGULATED INVESTMENT COMPANIES. 

(a) IN GENERAL.—Paragraph (2) of section 851(b) (defining regulated investment 

company) is amended to read as follows: 

‘‘(2) at least 90 percent of its gross income is derived from—

‘‘(A) dividends, interest, payments with respect to securities loans (as defined in section 512(a)(5)), and gains from the sale or other disposition of 

stock or securities (as defined in section 2(a)(36) of the Investment Company Act of 1940, as amended) or foreign currencies, or other income (including but not limited to gains from options, futures or forward contracts) 

derived with respect to its business of investing in such stock, securities, 

or currencies, and 

‘‘(B) distributions or other income derived from an interest in a qualified 

publicly traded partnership (as defined in subsection (h)); and’’. 

(b) SOURCE FLOW-THROUGH RULE NOT TO APPLY.—The last sentence of section 

851(b) is amended by inserting ‘‘(other than a qualified publicly traded partnership 

as defined in subsection (h))’’ after ‘‘derived from a partnership’’. 

25

(c) LIMITATION ON OWNERSHIP.—Subsection (c) of section 851 is amended by redesignating paragraph (5) as paragraph (6) and inserting after paragraph (4) the following new paragraph: 

‘‘(5) The term ‘outstanding voting securities of such issuer’ shall include the 

equity securities of a qualified publicly traded partnership (as defined in subsection (h)).’’. 

(d) DEFINITION OF QUALIFIED PUBLICLY TRADED PARTNERSHIP.—Section 851 is 

amended by adding at the end the following new subsection: 

‘‘(h) QUALIFIED PUBLICLY TRADED PARTNERSHIP.—For purposes of this section, the 

term ‘qualified publicly traded partnership’ means a publicly traded partnership described in section 7704(b) other than a partnership which would satisfy the gross 

income requirements of section 7704(c)(2) if qualifying income included only income 

described in subsection (b)(2)(A).’’. 

(e) DEFINITION OF QUALIFYING INCOME.—Section 7704(d)(4) is amended by striking ‘‘section 851(b)(2)’’ and inserting ‘‘section 851(b)(2)(A)’’. 

(f) LIMITATION ON COMPOSITION OF ASSETS.—Subparagraph (B) of section 

851(b)(3) is amended to read as follows: 

‘‘(B) not more than 25 percent of the value of its total assets is invested 

in—

‘‘(i) the securities (other than Government securities or the securities 

of other regulated investment companies) of any one issuer, 

‘‘(ii) the securities (other than the securities of other regulated investment companies) of two or more issuers which the taxpayer controls 

and which are determined, under regulations prescribed by the Secretary, to be engaged in the same or similar trades or businesses or related trades or businesses, or 

‘‘(iii) the securities of one or more qualified publicly traded partnerships (as defined in subsection (h)).’’. 

(g) APPLICATION OF SPECIAL PASSIVE ACTIVITY RULE TO REGULATED INVESTMENT

COMPANIES.—Subsection (k) of section 469 (relating to separate application of section in case of publicly traded partnerships) is amended by adding at the end the 

following new paragraph: 

‘‘(4) APPLICATION TO REGULATED INVESTMENT COMPANIES.—For purposes of 

this section, a regulated investment company (as defined in section 851) holding 

an interest in a qualified publicly traded partnership (as defined in section 

851(h)) shall be treated as a taxpayer described in subsection (a)(2) with respect 

to items attributable to such interest.’’. 

(h) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after the date of the enactment of this Act. 

SEC. 285. IMPROVEMENTS RELATED TO REAL ESTATE INVESTMENT TRUSTS. 

(a) EXPANSION OF STRAIGHT DEBT SAFE HARBOR.—Section 856 (defining real estate investment trust) is amended—

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

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

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

‘‘(1) IN GENERAL.—In applying subclause (III) of subsection (c)(4)(B)(iii), except 

as otherwise determined by the Secretary in regulations, the following shall not 

be considered securities held by the trust: 

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

paragraph (2). 

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

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

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

‘‘(D) Any obligation to pay rents from real property (as defined in subsection (d)(1)). 

‘‘(E) Any security issued by a State or any political subdivision thereof, 

the District of Columbia, a foreign government or any political subdivision 

thereof, or the Commonwealth of Puerto Rico, but only if the determination 

of any payment received or accrued under such security does not depend 

in whole or in part on the profits of any entity not described in this subparagraph or payments on any obligation issued by such an entity, 

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

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

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

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

requirements of this paragraph if such securities are straight debt, as defined in section 1361(c)(5) (without regard to subparagraph (B)(iii) thereof). 

26

‘‘(B) SPECIAL RULES RELATING TO CERTAIN CONTINGENCIES.—For purposes 

of subparagraph (A), any interest or principal shall not be treated as failing 

to satisfy section 1361(c)(5)(B)(i) solely by reason of the fact that— ‘‘(i) the time of payment of such interest or principal is subject to a 

contingency, but only if— ‘‘(I) any such contingency does not have the effect of changing the 

effective yield to maturity, as determined under section 1272, other 

than a change in the annual yield to maturity which does not exceed the greater of 1⁄4 of 1 percent or 5 percent of the annual yield 

to maturity, or 

‘‘(II) neither the aggregate issue price nor the aggregate face amount of the issuer’s debt instruments held by the trust exceeds $1,000,000 

and not more than 12 months of unaccrued interest can be required to 

be prepaid thereunder, or 

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

a default or the exercise of a prepayment right by the issuer of the 

debt, but only if such contingency is consistent with customary commercial practice. 

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

that otherwise would be described in paragraph (1)(A) shall be considered 

not to be so described if the trust holding such securities and any of its controlled taxable REIT subsidiaries (as defined in subsection (d)(8)(A)(iv)) hold 

any securities of the issuer which—

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

subparagraph), and 

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

outstanding securities determined without regard to paragraph 

(3)(A)(i). 

‘‘(3) LOOK-THROUGH RULE FOR PARTNERSHIP SECURITIES.—

‘‘(A) IN GENERAL.—For purposes of applying subclause (III) of subsection 

(c)(4)(B)(iii)—

‘‘(i) a trust’s interest as a partner in a partnership (as defined in section 7701(a)(2)) shall not be considered a security, and 

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

of the assets of the partnership. 

‘‘(B) DETERMINATION OF TRUST’S INTEREST IN PARTNERSHIP ASSETS.—For 

purposes of subparagraph (A), with respect to any taxable year beginning 

after the date of the enactment of this subparagraph—

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

proportionate interest in any securities issued by the partnership (determined without regard to subparagraph (A)(i) and paragraph (4), but 

not including securities described in paragraph (1)), and 

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

price thereof, as defined in section 1272(a)(4). 

‘‘(4) CERTAIN PARTNERSHIP DEBT INSTRUMENTS NOT TREATED AS A SECURITY.—

For purposes of applying subclause (III) of subsection (c)(4)(B)(iii)—

‘‘(A) any debt instrument issued by a partnership and not described in 

paragraph (1) shall not be considered a security to the extent of the trust’s 

interest as a partner in the partnership, and 

‘‘(B) any debt instrument issued by a partnership and not described in 

paragraph (1) shall not be considered a security if at least 75 percent of the 

partnership’s gross income (excluding gross income from prohibited transactions) is derived from sources referred to in subsection (c)(3). 

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

(including through the issuance of a written determination, as defined in section 

6110(b)) that an arrangement shall not be considered a security held by the 

trust for purposes of applying subclause (III) of subsection (c)(4)(B)(iii) notwithstanding that such arrangement otherwise could be considered a security under 

subparagraph (F) of subsection (c)(5).’’. 

(b) CLARIFICATION OF APPLICATION OF LIMITED RENTAL EXCEPTION.—Subparagraph (A) of section 856(d)(8) (relating to special rules for taxable REIT subsidiaries) 

is amended to read as follows: 

‘‘(A) LIMITED RENTAL EXCEPTION.—

‘‘(i) IN GENERAL.—The requirements of this subparagraph are met 

with respect to any property if at least 90 percent of the leased space 

of the property is rented to persons other than taxable REIT subsidiaries of such trust and other than persons described in paragraph 

(2)(B). 

27

‘‘(ii) RENTS MUST BE SUBSTANTIALLY COMPARABLE.—Clause (i) shall 

apply only to the extent that the amounts paid to the trust as rents 

from real property (as defined in paragraph (1) without regard to paragraph (2)(B)) from such property are substantially comparable to such 

rents paid by the other tenants of the trust’s property for comparable 

space. 

‘‘(iii) TIMES FOR TESTING RENT COMPARABILITY.—The substantial comparability requirement of clause (ii) shall be treated as met with respect to a lease to a taxable REIT subsidiary of the trust if such requirement is met under the terms of the lease—

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

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

to exercise a right to terminate, and 

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

trust and the taxable REIT subsidiary if the rent under such lease 

is effectively increased pursuant to such modification. 

With respect to subclause (III), if the taxable REIT subsidiary of the 

trust is a controlled taxable REIT subsidiary of the trust, the term 

‘rents from real property’ shall not in any event include rent under 

such lease to the extent of the increase in such rent on account of such 

modification. 

‘‘(iv) CONTROLLED TAXABLE REIT SUBSIDIARY.—For purposes of clause 

(iii), the term ‘controlled taxable REIT subsidiary’ means, with respect 

to any real estate investment trust, any taxable REIT subsidiary of 

such trust if such trust owns directly or indirectly—

‘‘(I) stock possessing more than 50 percent of the total voting 

power of the outstanding stock of such subsidiary, or 

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

value of the outstanding stock of such subsidiary. 

‘‘(v) CONTINUING QUALIFICATION BASED ON THIRD PARTY ACTIONS.—If 

the requirements of clause (i) are met at a time referred to in clause 

(iii), such requirements shall continue to be treated as met so long as 

there is no increase in the space leased to any taxable REIT subsidiary 

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

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

clause (v) during any calendar quarter with respect to any property, the 

requirements of clause (iii) shall be treated as met during the quarter 

and the succeeding quarter if such requirements are met at the close 

of such succeeding quarter.’’. 

(c) DELETION OF CUSTOMARY SERVICES EXCEPTION.—Subparagraph (B) of section 

857(b)(7) (relating to redetermined rents) is amended by striking clause (ii) and by 

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

(vi), respectively. 

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

read as follows: 

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

from a hedging transaction (as defined in clause (ii) or (iii) of section 

1221(b)(2)(A)) which is clearly identified pursuant to section 1221(a)(7), including gain from the sale or disposition of such a transaction, shall not 

constitute gross income under paragraph (2) to the extent that the transaction hedges any indebtedness incurred or to be incurred by the trust to 

acquire or carry real estate assets.’’. 

(e) CONFORMITY WITH REGULATED INVESTMENT COMPANY RULES.—Clause (i) of 

section 857(b)(5)(A) (relating to imposition of tax in case of failure to meet certain 

requirements) is amended by striking ‘‘90 percent’’ and inserting ‘‘95 percent’’. 

(f) SAVINGS PROVISIONS.—

(1) RULES OF APPLICATION FOR FAILURE TO SATISFY SECTION 856(c)(4).—Section 856(c) (relating to definition of real estate investment trust) is amended by 

inserting after paragraph (6) the following new paragraph: 

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

‘‘(A) DE MINIMIS FAILURE.—A corporation, trust, or association that fails 

to meet the requirements of paragraph (4)(B)(iii) for a particular quarter 

shall nevertheless be considered to have satisfied the requirements of such 

paragraph for such quarter if—

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

which does not exceed the lesser of—

28

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

of the quarter for which such measurement is done, and ‘‘(II) $10,000,000, and ‘‘(ii)(I) the corporation, trust, or association, following the identification of such failure, disposes of assets in order to meet the requirements of such paragraph within 6 months after the last day of the 

quarter in which the corporation, trust or association’s identification of 

the failure to satisfy the requirements of such paragraph occurred or 

such other time period prescribed by the Secretary and in the manner 

prescribed by the Secretary, or ‘‘(II) the requirements of such paragraph are otherwise met within 

the time period specified in subclause (I). ‘‘(B) FAILURES EXCEEDING DE MINIMIS AMOUNT.—A corporation, trust, or 

association that fails to meet the requirements of paragraph (4) for a particular quarter shall nevertheless be considered to have satisfied the requirements of such paragraph for such quarter if— ‘‘(i) such failure involves the ownership of assets the total value of 

which exceeds the de minimis standard described in subparagraph 

(A)(i) at the end of the quarter for which such measurement is done, ‘‘(ii) following the corporation, trust, or association’s identification of 

the failure to satisfy the requirements of such paragraph for a particular quarter, a description of each asset that causes the corporation, 

trust, or association to fail to satisfy the requirements of such paragraph at the close of such quarter of any taxable year is set forth in 

a schedule for such quarter filed in accordance with regulations prescribed by the Secretary, 

‘‘(iii) the failure to meet the requirements of such paragraph for a 

particular quarter is due to reasonable cause and not due to willful neglect,

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

subparagraph (C), and 

‘‘(v)(I) the corporation, trust, or association disposes of the assets set 

forth on the schedule specified in clause (ii) within 6 months after the 

last day of the quarter in which the corporation, trust or association’s 

identification of the failure to satisfy the requirements of such paragraph occurred or such other time period prescribed by the Secretary 

and in the manner prescribed by the Secretary, or 

‘‘(II) the requirements of such paragraph are otherwise met within 

the time period specified in subclause (I). 

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

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

application of this subparagraph, there is hereby imposed a tax on the 

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

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

shall be the greater of—

‘‘(I) $50,000, or 

‘‘(II) the amount determined (pursuant to regulations promulgated by the Secretary) by multiplying the net income generated by 

the assets described in the schedule specified in subparagraph 

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

tax specified in section 11. 

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

this clause is the period beginning on the first date that the failure to 

satisfy the requirements of such paragraph (4) occurs as a result of the 

ownership of such assets and ending on the earlier of the date on which 

the trust disposes of such assets or the end of the first quarter when 

there is no longer a failure to satisfy such paragraph (4). 

‘‘(iv) ADMINISTRATIVE PROVISIONS.—For purposes of subtitle F, the 

taxes imposed by this subparagraph shall be treated as excise taxes 

with respect to which the deficiency procedures of such subtitle apply.’’. 

(2) MODIFICATION OF RULES OF APPLICATION FOR FAILURE TO SATISFY SECTIONS

856(c)(2) OR 856(c)(3).—Paragraph (6) of section 856(c) (relating to definition of 

real estate investment trust) is amended by striking subparagraphs (A) and (B), 

by redesignating subparagraph (C) as subparagraph (B), and by inserting before 

subparagraph (B) (as so redesignated) the following new subparagraph: 

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

failure to meet the requirements of paragraph (2) or (3), or of both such 

29

paragraphs, for any taxable year, a description of each item of its gross income described in such paragraphs is set forth in a schedule for such taxable year filed in accordance with regulations prescribed by the Secretary, 

and’’. 

(3) REASONABLE CAUSE EXCEPTION TO LOSS OF REIT STATUS IF FAILURE TO SATISFY REQUIREMENTS.—Subsection (g) of section 856 (relating to termination of 

election) is amended—

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

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

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

‘‘(5) ENTITIES TO WHICH PARAGRAPH APPLIES.—This paragraph applies to a 

corporation, trust, or association—

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

of this part apply for the taxable year due to one or more failures to comply 

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

or (c)(7) of section 856), 

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

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

Secretary in regulations and in the same manner as tax) a penalty of 

$50,000 for each failure to satisfy a provision of this part due to reasonable 

cause and not willful neglect.’’. 

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

Subparagraph (E) of section 857(b)(2) is amended by striking ‘‘(7)’’ and inserting 

‘‘(7) of this subsection, section 856(c)(7)(B)(iii), and section 856(g)(1).’’. 

(5) EXPANSION OF DEFICIENCY DIVIDEND PROCEDURE.—Subsection (e) of section 

860 is amended by striking ‘‘or’’ at the end of paragraph (2), by striking the period at the end of paragraph (3) and inserting ‘‘; or’’, and by adding at the end 

the following new paragraph: 

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

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

(g) EFFECTIVE DATES.—

(1) IN GENERAL.—Except as provided in paragraph (2), the amendments made 

by this section shall apply to taxable years beginning after December 31, 2000. 

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

(d), (e), and (f) shall apply to taxable years beginning after the date of the enactment of this Act. 

SEC. 286. TREATMENT OF CERTAIN DIVIDENDS OF REGULATED INVESTMENT COMPANIES. 

(a) TREATMENT OF CERTAIN DIVIDENDS.—

(1) NONRESIDENT ALIEN INDIVIDUALS.—Section 871 (relating to tax on nonresident alien individuals) is amended by redesignating subsection (k) as subsection (l) and by inserting after subsection (j) the following new subsection: 

‘‘(k) EXEMPTION FOR CERTAIN DIVIDENDS OF REGULATED INVESTMENT COMPANIES.—

‘‘(1) INTEREST-RELATED DIVIDENDS.—

‘‘(A) IN GENERAL.—Except as provided in subparagraph (B), no tax shall 

be imposed under paragraph (1)(A) of subsection (a) on any interest-related 

dividend received from a regulated investment company. 

‘‘(B) EXCEPTIONS.—Subparagraph (A) shall not apply—

‘‘(i) to any interest-related dividend received from a regulated investment company by a person to the extent such dividend is attributable 

to interest (other than interest described in subparagraph (E) (i) or (iii)) 

received by such company on indebtedness issued by such person or by 

any corporation or partnership with respect to which such person is a 

10-percent shareholder, 

‘‘(ii) to any interest-related dividend with respect to stock of a regulated investment company unless the person who would otherwise be 

required to deduct and withhold tax from such dividend under chapter 

3 receives a statement (which meets requirements similar to the requirements of subsection (h)(5)) that the beneficial owner of such stock 

is not a United States person, and 

‘‘(iii) to any interest-related dividend paid to any person within a foreign country (or any interest-related dividend payment addressed to, or 

for the account of, persons within such foreign country) during any period described in subsection (h)(6) with respect to such country. 

Clause (iii) shall not apply to any dividend with respect to any stock which 

was acquired on or before the date of the publication of the Secretary’s determination under subsection (h)(6). 

30

‘‘(C) INTEREST-RELATED DIVIDEND.—For purposes of this paragraph, an interest-related dividend is any dividend (or part thereof) which is designated 

by the regulated investment company as an interest-related dividend in a 

written notice mailed to its shareholders not later than 60 days after the 

close of its taxable year. If the aggregate amount so designated with respect 

to a taxable year of the company (including amounts so designated with respect to dividends paid after the close of the taxable year described in section 855) is greater than the qualified net interest income of the company 

for such taxable year, the portion of each distribution which shall be an interest-related dividend shall be only that portion of the amounts so designated which such qualified net interest income bears to the aggregate 

amount so designated. ‘‘(D) QUALIFIED NET INTEREST INCOME.—For purposes of subparagraph 

(C), the term ‘qualified net interest income’ means the qualified interest income of the regulated investment company reduced by the deductions properly allocable to such income. ‘‘(E) QUALIFIED INTEREST INCOME.—For purposes of subparagraph (D), the 

term ‘qualified interest income’ means the sum of the following amounts derived by the regulated investment company from sources within the United 

States: ‘‘(i) Any amount includible in gross income as original issue discount 

(within the meaning of section 1273) on an obligation payable 183 days 

or less from the date of original issue (without regard to the period held 

by the company). 

‘‘(ii) Any interest includible in gross income (including amounts recognized as ordinary income in respect of original issue discount or market 

discount or acquisition discount under part V of subchapter P and such 

other amounts as regulations may provide) on an obligation which is 

in registered form; except that this clause shall not apply to—

‘‘(I) any interest on an obligation issued by a corporation or partnership if the regulated investment company is a 10-percent shareholder in such corporation or partnership, and 

‘‘(II) any interest which is treated as not being portfolio interest 

under the rules of subsection (h)(4). 

‘‘(iii) Any interest referred to in subsection (i)(2)(A) (without regard 

to the trade or business of the regulated investment company). 

‘‘(iv) Any interest-related dividend includable in gross income with respect to stock of another regulated investment company. 

‘‘(F) 10-PERCENT SHAREHOLDER.—For purposes of this paragraph, the 

term ‘10-percent shareholder’ has the meaning given such term by subsection (h)(3)(B). 

‘‘(2) SHORT-TERM CAPITAL GAIN DIVIDENDS.—

‘‘(A) IN GENERAL.—Except as provided in subparagraph (B), no tax shall 

be imposed under paragraph (1)(A) of subsection (a) on any short-term capital gain dividend received from a regulated investment company. 

‘‘(B) EXCEPTION FOR ALIENS TAXABLE UNDER SUBSECTION (a)(2).—Subparagraph (A) shall not apply in the case of any nonresident alien individual 

subject to tax under subsection (a)(2). 

‘‘(C) SHORT-TERM CAPITAL GAIN DIVIDEND.—For purposes of this paragraph, a short-term capital gain dividend is any dividend (or part thereof) 

which is designated by the regulated investment company as a short-term 

capital gain dividend in a written notice mailed to its shareholders not later 

than 60 days after the close of its taxable year. If the aggregate amount 

so designated with respect to a taxable year of the company (including 

amounts so designated with respect to dividends paid after the close of the 

taxable year described in section 855) is greater than the qualified shortterm gain of the company for such taxable year, the portion of each distribution which shall be a short-term capital gain dividend shall be only 

that portion of the amounts so designated which such qualified short-term 

gain bears to the aggregate amount so designated. 

‘‘(D) QUALIFIED SHORT-TERM GAIN.—For purposes of subparagraph (C), 

the term ‘qualified short-term gain’ means the excess of the net short-term 

capital gain of the regulated investment company for the taxable year over 

the net long-term capital loss (if any) of such company for such taxable 

year. For purposes of this subparagraph—

‘‘(i) the net short-term capital gain of the regulated investment company shall be computed by treating any short-term capital gain dividend includible in gross income with respect to stock of another regulated investment company as a short-term capital gain, and 

31

‘‘(ii) the excess of the net short-term capital gain for a taxable year 

over the net long-term capital loss for a taxable year (to which an election under section 4982(e)(4) does not apply) shall be determined without regard to any net capital loss or net short-term capital loss attributable to transactions after October 31 of such year, and any such net 

capital loss or net short-term capital loss shall be treated as arising on 

the 1st day of the next taxable year. 

To the extent provided in regulations, clause (ii) shall apply also for purposes of computing the taxable income of the regulated investment company.’’ (2) FOREIGN CORPORATIONS.—Section 881 (relating to tax on income of foreign 

corporations not connected with United States business) is amended by redesignating subsection (e) as subsection (f) and by inserting after subsection (d) the 

following new subsection: ‘‘(e) TAX NOT TO APPLY TO CERTAIN DIVIDENDS OF REGULATED INVESTMENT COM- PANIES.—

‘‘(1) INTEREST-RELATED DIVIDENDS.— ‘‘(A) IN GENERAL.—Except as provided in subparagraph (B), no tax shall 

be imposed under paragraph (1) of subsection (a) on any interest-related 

dividend (as defined in section 871(k)(1)) received from a regulated investment company. 

‘‘(B) EXCEPTION.—Subparagraph (A) shall not apply—

‘‘(i) to any dividend referred to in section 871(k)(1)(B), and 

‘‘(ii) to any interest-related dividend received by a controlled foreign 

corporation (within the meaning of section 957(a)) to the extent such 

dividend is attributable to interest received by the regulated investment company from a person who is a related person (within the meaning of section 864(d)(4)) with respect to such controlled foreign corporation. 

‘‘(C) TREATMENT OF DIVIDENDS RECEIVED BY CONTROLLED FOREIGN CORPORATIONS.—The rules of subsection (c)(5)(A) shall apply to any interest-related dividend received by a controlled foreign corporation (within the 

meaning of section 957(a)) to the extent such dividend is attributable to interest received by the regulated investment company which is described in 

clause (ii) of section 871(k)(1)(E) (and not described in clause (i) or (iii) of 

such section). 

‘‘(2) SHORT-TERM CAPITAL GAIN DIVIDENDS.—No tax shall be imposed under 

paragraph (1) of subsection (a) on any short-term capital gain dividend (as defined in section 871(k)(2)) received from a regulated investment company.’’. 

(3) WITHHOLDING TAXES.—

(A) Section 1441(c) (relating to exceptions) is amended by adding at the 

end the following new paragraph: 

‘‘(12) CERTAIN DIVIDENDS RECEIVED FROM REGULATED INVESTMENT COMPANIES.—

‘‘(A) IN GENERAL.—No tax shall be required to be deducted and withheld 

under subsection (a) from any amount exempt from the tax imposed by section 871(a)(1)(A) by reason of section 871(k). 

‘‘(B) SPECIAL RULE.—For purposes of subparagraph (A), clause (i) of section 871(k)(1)(B) shall not apply to any dividend unless the regulated investment company knows that such dividend is a dividend referred to in 

such clause. A similar rule shall apply with respect to the exception contained in section 871(k)(2)(B).’’. 

(B) Section 1442(a) (relating to withholding of tax on foreign corporations) 

is amended—

(i) by striking ‘‘and the reference in section 1441(c)(10)’’ and inserting 

‘‘the reference in section 1441(c)(10)’’, and 

(ii) by inserting before the period at the end the following: ‘‘, and the 

references in section 1441(c)(12) to sections 871(a) and 871(k) shall be 

treated as referring to sections 881(a) and 881(e) (except that for purposes of applying subparagraph (A) of section 1441(c)(12), as so modified, clause (ii) of section 881(e)(1)(B) shall not apply to any dividend 

unless the regulated investment company knows that such dividend is 

a dividend referred to in such clause)’’. 

(b) ESTATE TAX TREATMENT OF INTEREST IN CERTAIN REGULATED INVESTMENT

COMPANIES.—Section 2105 (relating to property without the United States for estate 

tax purposes) is amended by adding at the end the following new subsection: 

‘‘(d) STOCK IN A RIC.—

‘‘(1) IN GENERAL.—For purposes of this subchapter, stock in a regulated investment company (as defined in section 851) owned by a nonresident not a citVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00033 Fmt 6659 Sfmt 6621 E:\HR\OC\HR548P1.000 HR548P1
32

izen of the United States shall not be deemed property within the United States 

in the proportion that, at the end of the quarter of such investment company’s 

taxable year immediately preceding a decedent’s date of death (or at such other 

time as the Secretary may designate in regulations), the assets of the investment company that were qualifying assets with respect to the decedent bore to 

the total assets of the investment company. 

‘‘(2) QUALIFYING ASSETS.—For purposes of this subsection, qualifying assets 

with respect to a decedent are assets that, if owned directly by the decedent, 

would have been—

‘‘(A) amounts, deposits, or debt obligations described in subsection (b) of 

this section, 

‘‘(B) debt obligations described in the last sentence of section 2104(c), or 

‘‘(C) other property not within the United States.’’

(c) TREATMENT OF REGULATED INVESTMENT COMPANIES UNDER SECTION 897.—

(1) Paragraph (1) of section 897(h) is amended by striking ‘‘REIT’’ each place 

it appears and inserting ‘‘qualified investment entity’’. 

(2) Paragraphs (2) and (3) of section 897(h) are amended to read as follows: 

‘‘(2) SALE OF STOCK IN DOMESTICALLY CONTROLLED ENTITY NOT TAXED.—The 

term ‘United States real property interest’ does not include any interest in a 

domestically controlled qualified investment entity. 

‘‘(3) DISTRIBUTIONS BY DOMESTICALLY CONTROLLED QUALIFIED INVESTMENT ENTITIES.—In the case of a domestically controlled qualified investment entity, 

rules similar to the rules of subsection (d) shall apply to the foreign ownership 

percentage of any gain.’’

(3) Subparagraphs (A) and (B) of section 897(h)(4) are amended to read as follows: 

‘‘(A) QUALIFIED INVESTMENT ENTITY.—The term ‘qualified investment entity’ means any real estate investment trust and any regulated investment 

company. 

‘‘(B) DOMESTICALLY CONTROLLED.—The term ‘domestically controlled 

qualified investment entity’ means any qualified investment entity in which 

at all times during the testing period less than 50 percent in value of the 

stock was held directly or indirectly by foreign persons.’’

(4) Subparagraphs (C) and (D) of section 897(h)(4) are each amended by striking ‘‘REIT’’ and inserting ‘‘qualified investment entity’’. 

(5) The subsection heading for subsection (h) of section 897 is amended by 

striking ‘‘REITS’’ and inserting ‘‘CERTAIN INVESTMENT ENTITIES’’. 

(d) EFFECTIVE DATE.—

(1) IN GENERAL.—Except as otherwise provided in this subsection, the amendments made by this section shall apply to dividends with respect to taxable 

years of regulated investment companies beginning after December 31, 2004. 

(2) ESTATE TAX TREATMENT.—The amendment made by subsection (b) shall 

apply to estates of decedents dying after December 31, 2004. 

(3) CERTAIN OTHER PROVISIONS.—The amendments made by subsection (c) 

(other than paragraph (1) thereof) shall take effect after December 31, 2004. 

SEC. 287. TAXATION OF CERTAIN SETTLEMENT FUNDS. 

(a) IN GENERAL.—Subsection (g) of section 468B (relating to clarification of taxation of certain funds) is amended to read as follows: 

‘‘(g) CLARIFICATION OF TAXATION OF CERTAIN FUNDS.—

‘‘(1) IN GENERAL.—Except as provided in paragraph (2), nothing in any provision of law shall be construed as providing that an escrow account, settlement 

fund, or similar fund is not subject to current income tax. The Secretary shall 

prescribe regulations providing for the taxation of any such account or fund 

whether as a grantor trust or otherwise. 

‘‘(2) EXEMPTION FROM TAX FOR CERTAIN SETTLEMENT FUNDS.—An escrow account, settlement fund, or similar fund shall be treated as beneficially owned 

by the United States and shall be exempt from taxation under this subtitle if—

‘‘(A) it is established pursuant to a consent decree entered by a judge of 

a United States District Court, 

‘‘(B) it is created for the receipt of settlement payments as directed by a 

government entity for the sole purpose of resolving or satisfying one or 

more claims asserting liability under the Comprehensive Environmental 

Response, Compensation, and Liability Act of 1980, 

‘‘(C) the authority and control over the expenditure of funds therein (including the expenditure of contributions thereto and any net earnings 

thereon) is with such government entity, and 

‘‘(D) upon termination, any remaining funds will be disbursed to such 

government entity for use in accordance with applicable law. 

33

For purposes of this paragraph, the term ‘government entity’ means the United 

States, any State or political subdivision thereof, the District of Columbia, any 

possession of the United States, and any agency or instrumentality of any of 

the foregoing.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years beginning after December 31, 2004. 

SEC. 288. EXPANSION OF HUMAN CLINICAL TRIALS QUALIFYING FOR ORPHAN DRUG CREDIT. 

(a) IN GENERAL.—Paragraph (2) of section 45C(b) (relating to qualified clinical 

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

‘‘(C) TREATMENT OF CERTAIN EXPENSES INCURRED BEFORE DESIGNATION.—

For purposes of subparagraph (A)(ii)(I), if a drug is designated under section 526 of the Federal Food, Drug, and Cosmetic Act not later than the 

due date (including extensions) for filing the return of tax under this subtitle for the taxable year in which the application for such designation of 

such drug was filed, such drug shall be treated as having been designated 

on the date that such application was filed.’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) shall apply to expenses incurred after the date of the enactment of this Act. 

SEC. 289. SIMPLIFICATION OF EXCISE TAX IMPOSED ON BOWS AND ARROWS. 

(a) BOWS.—Paragraph (1) of section 4161(b) (relating to bows) is amended to read 

as follows: 

‘‘(1) BOWS.—

‘‘(A) IN GENERAL.—There is hereby imposed on the sale by the manufacturer, producer, or importer of any bow which has a peak draw weight of 

30 pounds or more, a tax equal to 11 percent of the price for which so sold. 

‘‘(B) ARCHERY EQUIPMENT.—There is hereby imposed on the sale by the 

manufacturer, producer, or importer—

‘‘(i) of any part or accessory suitable for inclusion in or attachment 

to a bow described in subparagraph (A), and 

‘‘(ii) of any quiver or broadhead suitable for use with an arrow described in paragraph (2), 

a tax equal to 11 percent of the price for which so sold.’’. 

(b) ARROWS.—Subsection (b) of section 4161 (relating to bows and arrows, etc.) is 

amended by redesignating paragraph (3) as paragraph (4) and inserting after paragraph (2) the following: 

‘‘(3) ARROWS.—

‘‘(A) IN GENERAL.—There is hereby imposed on the sale by the manufacturer, producer, or importer of any arrow, a tax equal to 12 percent of the 

price for which so sold. 

‘‘(B) EXCEPTION.—In the case of any arrow of which the shaft or any other 

component has been previously taxed under paragraph (1) or (2)—

‘‘(i) section 6416(b)(3) shall not apply, and 

‘‘(ii) the tax imposed by subparagraph (A) shall be an amount equal 

to the excess (if any) of—

‘‘(I) the amount of tax imposed by this paragraph (determined 

without regard to this subparagraph), over 

‘‘(II) the amount of tax paid with respect to the tax imposed 

under paragraph (1) or (2) on such shaft or component. 

‘‘(C) ARROW.—For purposes of this paragraph, the term ‘arrow’ means any 

shaft described in paragraph (2) to which additional components are attached.’’. 

(c) CONFORMING AMENDMENTS.—Section 4161(b)(2) is amended—

(1) by inserting ‘‘(other than broadheads)’’ after ‘‘point’’, and 

(2) by striking ‘‘ARROWS.—’’ in the heading and inserting ‘‘ARROW COMPONENTS.—’’. 

(d) EFFECTIVE DATE.—The amendments made by this section shall apply to articles sold by the manufacturer, producer, or importer after December 31, 2004. 

SEC. 290. REPEAL OF EXCISE TAX ON FISHING TACKLE BOXES. 

(a) REPEAL.—Paragraph (6) of section 4162(a) (defining sport fishing equipment) 

is amended by striking subparagraph (C) and by redesignating subparagraphs (D) 

through (J) as subparagraphs (C) through (I), respectively. 

(b) EFFECTIVE DATE.—The amendments made this section shall apply to articles 

sold by the manufacturer, producer, or importer after December 31, 2004. 

SEC. 291. SONAR DEVICES SUITABLE FOR FINDING FISH. 

(a) NOT TREATED AS SPORT FISHING EQUIPMENT.—Subsection (a) of section 4162 

(relating to sport fishing equipment defined) is amended by inserting ‘‘and’’ at the 

34

end of paragraph (8), by striking ‘‘, and’’ at the end of paragraph (9) and inserting 

a period, and by striking paragraph (10). 

(b) CONFORMING AMENDMENT.—Section 4162 is amended by striking subsection 

(b) and by redesignating subsection (c) as subsection (b). 

(c) EFFECTIVE DATE.—The amendments made this section shall apply to articles 

sold by the manufacturer, producer, or importer after December 31, 2004. 

SEC. 292. INCOME TAX CREDIT TO DISTILLED SPIRITS WHOLESALERS FOR COST OF CARRYING FEDERAL EXCISE TAXES ON BOTTLED DISTILLED SPIRITS. 

(a) IN GENERAL.—Subpart A of part I of subchapter A of chapter 51 (relating to 

gallonage and occupational taxes) is amended by adding at the end the following 

new section: 

‘‘SEC. 5011. INCOME TAX CREDIT FOR WHOLESALER’S AVERAGE COST OF CARRYING EXCISE 

TAX. 

‘‘(a) IN GENERAL.—For purposes of section 38, in the case of an eligible wholesaler, 

the amount of the distilled spirits wholesalers credit for any taxable year is the 

amount equal to the product of—

‘‘(1) the number of cases of bottled distilled spirits—

‘‘(A) which were bottled in the United States, and 

‘‘(B) which are purchased by such wholesaler during the taxable year directly from the bottler of such spirits, and 

‘‘(2) the average tax-financing cost per case for the most recent calendar year 

ending before the beginning of such taxable year. 

‘‘(b) ELIGIBLE WHOLESALER.—For purposes of this section, the term ‘eligible wholesaler’ means any person who holds a permit under the Federal Alcohol Administration Act as a wholesaler of distilled spirits. 

‘‘(c) AVERAGE TAX-FINANCING COST.—

‘‘(1) IN GENERAL.—For purposes of this section, the average tax-financing cost 

per case for any calendar year is the amount of interest which would accrue at 

the deemed financing rate during a 60-day period on an amount equal to the 

deemed Federal excise per case. 

‘‘(2) DEEMED FINANCING RATE.—For purposes of paragraph (1), the deemed financing rate for any calendar year is the average of the corporate overpayment 

rates under paragraph (1) of section 6621(a) (determined without regard to the 

last sentence of such paragraph) for calendar quarters of such year. 

‘‘(3) DEEMED FEDERAL EXCISE TAX BASED ON CASE.—For purposes of paragraph 

(1), the deemed Federal excise tax per case of 12 80-proof 750ml bottles is 

$22.83. 

‘‘(4) NUMBER OF CASES IN LOT.—For purposes of this section, the number of 

cases in any lot of distilled spirits shall be determined by dividing the number 

of liters in such lot by 9.’’

(b) CONFORMING AMENDMENTS.—

(1) Subsection (b) of section 38 is amended by striking ‘‘plus’’ at the end of 

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

‘‘(16) in the case of an eligible wholesaler (as defined in section 5011(b)), the 

distilled spirits wholesalers credit determined under section 5011(a).’’

(2) Subsection (d) of section 39 (relating to carryback and carryforward of unused credits) is amended by adding at the end the following new paragraph: 

‘‘(11) NO CARRYBACK OF SECTION 5011 CREDIT BEFORE JANUARY 1, 2005.—No 

portion of the unused business credit for any taxable year which is attributable 

to the credit determined under section 5011(a) may be carried back to a taxable 

year beginning before January 1, 2005.’’. 

(3) The table of sections for subpart A of part I of subchapter A of chapter 

51 is amended by adding at the end the following new item:

‘‘Sec. 5011. Income tax credit for wholesaler’s average cost of carrying excise tax.’’.

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2004. 

SEC. 293. SUSPENSION OF OCCUPATIONAL TAXES RELATING TO DISTILLED SPIRITS, WINE, 

AND BEER. 

(a) IN GENERAL.—Subpart G of part II of subchapter A of chapter 51 is amended 

by redesignating section 5148 as section 5149 and by inserting after section 5147 

the following new section: 

‘‘SEC. 5148. SUSPENSION OF OCCUPATIONAL TAX. 

‘‘(a) IN GENERAL.—Notwithstanding sections 5081, 5091, 5111, 5121, and 5131, 

the rate of tax imposed under such sections for the suspension period shall be zero. 

During such period, persons engaged in or carrying on a trade or business covered 

35

by such sections shall register under section 5141 and shall comply with the recordkeeping requirements under this part. ‘‘(b) SUSPENSION PERIOD.—For purposes of subsection (a), the suspension period 

is the period beginning on July 1, 2004, and ending on June 30, 2007.’’. (b) CONFORMING AMENDMENT.—Section 5117 is amended by adding at the end the 

following new subsection: ‘‘(d) SPECIAL RULE DURING SUSPENSION PERIOD.—Except as provided in subsection (b) or by the Secretary, during the suspension period (as defined in section 

5148) it shall be unlawful for any dealer to purchase distilled spirits for resale from 

any person other than a wholesale dealer in liquors who is required to keep records 

under section 5114.’’. (c) CLERICAL AMENDMENT.—The table of sections for subpart G of part II of subchapter A of chapter 51 is amended by striking the last item and inserting the following new items:

‘‘Sec. 5148. Suspension of occupational tax. 

‘‘Sec. 5149. Cross references.’’.

(d) EFFECTIVE DATE.—The amendments made by this section shall take effect on 

the date of the enactment of this Act. 

SEC. 294. MODIFICATION OF UNRELATED BUSINESS INCOME LIMITATION ON INVESTMENT IN 

CERTAIN SMALL BUSINESS INVESTMENT COMPANIES. 

(a) IN GENERAL.—Paragraph (6) of section 514(c) (relating to acquisition indebtedness) is amended to read as follows: 

‘‘(6) CERTAIN FEDERAL FINANCING.—

‘‘(A) IN GENERAL.—For purposes of this section, the term ‘acquisition indebtedness’ does not include—

‘‘(i) an obligation, to the extent that it is insured by the Federal 

Housing Administration, to finance the purchase, rehabilitation, or construction of housing for low and moderate income persons, or 

‘‘(ii) indebtedness incurred by a small business investment company 

licensed under the Small Business Investment Act of 1958 and formed 

after the date of the enactment of the American Jobs Creation Act of 

2004, if such indebtedness is evidenced by a debenture—

‘‘(I) issued by such company under section 303(a) of such Act, and 

‘‘(II) held or guaranteed by the Small Business Administration. 

‘‘(B) LIMITATION.—Subparagraph (A)(ii) shall not apply with respect to 

any small business investment company during any period that—

‘‘(i) any organization which is exempt from tax under this title (other 

than a governmental unit) owns more than 25 percent of the capital or 

profits interest in such company, or 

‘‘(ii) organizations which are exempt from tax under this title (including governmental units other than any agency or instrumentality of the 

United States) own, in the aggregate, 50 percent or more of the capital 

or profits interest in such company.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to indebtedness incurred by small business investment companies formed after the date of 

the enactment of the American Jobs Creation Act of 2004.

SEC. 295. ELECTION TO DETERMINE TAXABLE INCOME FROM CERTAIN INTERNATIONAL SHIPPING ACTIVITIES USING PER TON RATE. 

(a) IN GENERAL.—Chapter 1 of the Internal Revenue Code of 1986 is amended by 

inserting after subchapter Q the following new subchapter: 

‘‘Subchapter R—Election To Determine Taxable Income From Certain 

International Shipping Activities Using per Ton Rate

‘‘Sec. 1352. Alternative tax on qualifying shipping activities. 

‘‘Sec. 1353. Taxable income from qualifying shipping activities. 

‘‘Sec. 1354. Qualifying shipping tax election; revocation; termination. 

‘‘Sec. 1355. Definitions and special rules. 

‘‘Sec. 1356. Qualifying shipping activities. 

‘‘Sec. 1357. Items not subject to regular tax; depreciation; interest. 

‘‘Sec. 1358. Allocation of credits, income, and deductions. 

‘‘Sec. 1359. Disposition of qualifying shipping assets.

‘‘SEC. 1352. ALTERNATIVE TAX ON QUALIFYING SHIPPING ACTIVITIES. 

‘‘(a) IN GENERAL.—The taxable income of an electing corporation from qualifying 

shipping activities shall be the amount determined under this subchapter, and the 

corporate percentages of the items of income, gain, loss, deduction, or credit of an 

electing corporation and of other members of the electing group of such corporation 

which would otherwise be taken into account by reason of its qualifying shipping 

activities shall be taken into account to the extent provided in section 1357. 

36

‘‘(b) ALTERNATIVE TAX.—The taxable income of an electing corporation from qualifying shipping activities, if otherwise taxable under section 11, 55, 882, 887, or 

1201(a) shall be subject to tax only under this section at the maximum rate specified 

in section 11(b). The income of a foreign corporation shall not be subject to tax 

under this subchapter to the extent its income is excludible from gross income under 

section 883(a)(1). 

‘‘SEC. 1353. TAXABLE INCOME FROM QUALIFYING SHIPPING ACTIVITIES. 

‘‘(a) IN GENERAL.—For purposes of this subchapter, the taxable income of an electing corporation from qualifying shipping activities shall be its corporate income percentage of the sum of the amounts determined under subsection (b) for each qualifying vessel operated by such electing corporation or other electing entity. ‘‘(b) AMOUNTS.—For purposes of subsection (a), the amount of taxable income of 

an electing entity for each qualifying vessel shall equal the product of— ‘‘(1) the daily notional taxable income from the operation of the qualifying vessel in United States foreign trade, and ‘‘(2) the number of days during the taxable year that the electing entity operated such vessel as a qualifying vessel in United States foreign trade. ‘‘(c) DAILY NOTIONAL TAXABLE INCOME.—For purposes of subsection (b), the daily 

notional taxable income from the operation of a qualifying vessel is 40 cents for each 

100 tons of the net tonnage of the vessel, up to 25,000 net tons, and 20 cents for 

each 100 tons of the net tonnage of the vessel, in excess of 25,000 net tons. ‘‘(d) MULTIPLE OPERATORS OF VESSEL.—If 2 or more persons have a joint interest 

in a qualifying vessel and are treated as operators of that vessel, the taxable income 

from the operation of such vessel for that time (as determined under this section) 

shall be allocated among such persons on the basis of their ownership and charter 

interests in such vessel or on such other basis as the Secretary may prescribe by 

regulations. ‘‘(e) NONCORPORATE PERCENTAGE.—Notwithstanding any contrary provision of this 

subchapter, the noncorporate percentage of any item of income, gain, loss, deduction, or credit of any member of an electing group shall be taken into account for 

all purposes of this subtitle as if this subchapter were not in effect. 

‘‘SEC. 1354. QUALIFYING SHIPPING TAX ELECTION; REVOCATION; TERMINATION. 

‘‘(a) IN GENERAL.—Except as provided in subsections (b) and (f), a qualifying shipping tax election may be made in respect of any qualifying entity. ‘‘(b) CONDITION OF ELECTION.—An election may be made by a member of a controlled group under this subsection for any taxable year only if all qualifying entities 

that are members of the controlled group join in the election. ‘‘(c) WHEN MADE.—An election under subsection (a) may be made by a qualifying 

entity in such form as prescribed by the Secretary. Such election shall be filed with 

the qualifying entity’s return for the first taxable year to which the election shall 

apply, by the due date for such return (including any applicable extensions). 

‘‘(d) YEARS FOR WHICH EFFECTIVE.—An election under subsection (a) shall be effective for the taxable year of the qualifying entity for which it is made and for all 

succeeding taxable years of the entity, until such election is terminated under subsection (e). 

‘‘(e) TERMINATION.—

‘‘(1) BY REVOCATION.—

‘‘(A) IN GENERAL.—An election under subsection (a) may be terminated by 

revocation. 

‘‘(B) WHEN EFFECTIVE.—Except as provided in subparagraph (C)—

‘‘(i) a revocation made during the taxable year and on or before the 

15th day of the 3rd month thereof shall be effective on the 1st day of 

such taxable year, and 

‘‘(ii) a revocation made during the taxable year but after such 15th 

day shall be effective on the 1st day of the following taxable year. 

‘‘(C) REVOCATION MAY SPECIFY PROSPECTIVE DATE.—If the revocation 

specifies a date for revocation which is on or after the day on which the 

revocation is made, the revocation shall be effective on and after the date 

so specified. 

‘‘(2) BY ENTITY CEASING TO BE QUALIFYING ENTITY.—

‘‘(A) IN GENERAL.—An election under subsection (a) shall be terminated 

whenever (at any time on or after the 1st day of the 1st taxable year for 

which the entity is an electing entity) such entity ceases to be a qualifying 

entity. 

‘‘(B) WHEN EFFECTIVE.—Any termination under this paragraph shall be 

effective on and after the date of cessation. 

‘‘(f) ELECTION AFTER TERMINATION.—If a qualifying entity has made an election 

under subsection (a) and if such election has been terminated under subsection (e), 

37

such entity (and any successor entity) shall not be eligible to make an election under 

subsection (a) for any taxable year before its 5th taxable year which begins after 

the 1st taxable year for which such termination is effective, unless the Secretary 

consents to such election. 

‘‘SEC. 1355. DEFINITIONS AND SPECIAL RULES. 

‘‘(a) DEFINITIONS.—For purposes of this subchapter: 

‘‘(1) The term ‘controlled group’ means any group of trusts and business entities whose members would be treated as a single employer under the rules of 

section 52(a) (without regard to paragraphs (1) and (2) thereof) and section 

52(b)(1). 

‘‘(2) The term ‘corporate income percentage’ means the least aggregate share, 

expressed as a percentage, of any item of income or gain of an electing corporation or electing group of which such corporation is a member from qualifying 

shipping activities that would, but for an election in effect under this subchapter, be required to be reported on the Federal income tax return of an electing corporation during any taxable period. In the case of an electing group 

which includes two or more electing corporations, the corporate income percentage of each such corporation shall be determined on the basis of such corporations’ direct and indirect ownership and charter interests in qualifying vessels 

of the electing group or on such other basis as the Secretary may prescribe by 

regulations. 

‘‘(3) The term ‘corporate loss percentage’ means the greatest aggregate share, 

expressed as a percentage, of any item of loss, deduction or credit of an electing 

corporation or electing group of which such corporation is a member from qualifying shipping activities that would, but for an election in effect under this subchapter, be required to be reported on the Federal income tax return of an electing corporation during any taxable period. 

‘‘(4) The term ‘corporate percentages’ means the corporate income percentage 

and the corporate loss percentage. 

‘‘(5) The term ‘electing corporation’ means any C corporation that is an electing entity or that would, but for an election in effect under this subchapter, be 

required to report any item of income, gain, loss, deduction, or credit of an electing entity on its Federal income tax return. 

‘‘(6) The term ‘electing entity’ means any qualifying entity for which an election is in effect under this subchapter. 

‘‘(7) The term ‘electing group’ means a controlled group of which one or more 

members is an electing entity. 

‘‘(8) The term ‘noncorporate percentage’ means the difference between one 

hundred percent and the corporate income percentage or corporate loss percentage, as applicable. 

‘‘(9) The term ‘qualifying entity’ means a trust or business entity that—

‘‘(A) operates one or more qualifying vessels, and 

‘‘(B) meets the shipping activity requirement in subsection (c). 

‘‘(10) The term ‘qualifying shipping assets’ means any qualifying vessel and 

other assets which are used in core qualifying activities as described in section 

1356(b). 

‘‘(11) The term ‘qualifying vessel’ means a self-propelled (or a combination 

self-propelled and non-self-propelled) United States flag vessel of not less than 

10,000 deadweight tons used in the United States foreign trade. 

‘‘(12) The term ‘United States domestic trade’ means the transportation of 

goods or passengers between places in the United States. 

‘‘(13) The term ‘United States flag vessel’ means any vessel documented under 

the laws of the United States. 

‘‘(14) The term ‘United States foreign trade’ means the transportation of goods 

or passengers between a place in the United States and a foreign place or between foreign places. 

‘‘(b) OPERATING A VESSEL.—For purposes of this subchapter: 

‘‘(1) Except as provided in paragraph (2), an entity is treated as operating any 

vessel owned by, or chartered (including a time charter) to, the entity. 

‘‘(2) An entity is treated as operating a vessel that it has chartered out on 

bareboat charter terms only if—

‘‘(A) the vessel is temporarily surplus to the entity’s requirements and the 

term of the charter does not exceed three years; or 

‘‘(B) the vessel is bareboat chartered to a member of a controlled group 

which includes such entity or to an unrelated third party that subbareboats or time charters the vessel to a member of such controlled group 

(including the owner). 

38

‘‘(c) SHIPPING ACTIVITY REQUIREMENT.—For purposes of this section, the shipping 

activity requirement is met for a taxable year only by an entity described in paragraph (1), (2), or (3). 

‘‘(1) An entity in the first taxable year of its qualifying shipping tax election 

if, for the preceding taxable year, the test in paragraph (4) is met. 

‘‘(2) An entity in the second or any subsequent taxable year of its qualifying 

shipping tax election if, for each of the two preceding taxable years, the test in 

paragraph (4) is met. 

‘‘(3) An entity that would be described in paragraph (1) or (2) if the test in 

paragraph (4) were applied on an aggregate basis to the controlled group of 

which such entity is a member, and vessel charters between members of the 

controlled group were disregarded. 

‘‘(4) The test in this paragraph is met if on average at least 25 percent of the 

aggregate tonnage of qualifying vessels operated by the entity were owned by 

the entity or chartered to the entity on bareboat charter terms. For purposes 

of the preceding sentence, vessels chartered (including time chartered) to an entity by a member of a controlled group which includes the entity, or by a third 

party that bareboat charters the vessels from the entity or a member of the entity’s controlled group, shall be treated as chartered to the entity on bareboat 

charter terms. 

‘‘(d) EFFECT OF TEMPORARILY CEASING TO OPERATE A QUALIFYING VESSEL.—

‘‘(1) A temporary cessation by an electing entity in operation of a qualifying 

vessel shall be disregarded for purposes of subsections (b) and (c) if the electing 

entity gives timely notice to the Secretary stating—

‘‘(A) that it has temporarily ceased to operate the qualifying vessel, and 

‘‘(B) its intention to resume operating the qualifying vessel. 

‘‘(2) Notice shall be deemed timely if given not later than the due date (including extensions) for the electing entity’s tax return (as set forth in section 

6072(b)) for the taxable year in which the temporary cessation begins. 

‘‘(3) The treatment provided by paragraph (1) shall continue until the earlier 

of—

‘‘(A) the electing entity abandoning its intention to resume operation of 

the qualifying vessel, or 

‘‘(B) the electing entity resuming operation of the qualifying vessel. 

‘‘(e) EFFECT OF TEMPORARILY OPERATING A QUALIFYING VESSEL IN THE UNITED

STATES DOMESTIC TRADE.—

‘‘(1) The temporary operation in the United States domestic trade of any 

qualifying vessel which had been used in the United States foreign trade shall 

be disregarded for purposes of this subchapter if the electing entity gives timely 

notice to the Secretary stating—

‘‘(A) that it temporarily operates or has operated in the United States domestic trade a qualifying vessel which had been used in the United States 

foreign trade, and 

‘‘(B) its intention to resume operation of the vessel in the United States 

foreign trade. 

‘‘(2) Notice shall be deemed timely if given not later than the due date (including extensions) for the electing entity’s tax return (as set forth in section 

6072(b)) for the taxable year in which the temporary cessation begins. 

‘‘(3) The treatment provided by paragraph (1) shall continue until the earlier 

of—

‘‘(A) the electing entity abandoning its intention to resume operations of 

the vessel in the United States foreign trade, or 

‘‘(B) the electing entity resuming operation of the vessel in the United 

States foreign trade. 

‘‘(f) EFFECT OF CHANGE IN USE.—

‘‘(1) Except as provided in subsection (e), a vessel that is used other than for 

operations in the United States foreign trade on other than a temporary basis 

ceases to be a qualifying vessel when such use begins. 

‘‘(2) For purposes of this subsection, a change in use of a vessel, other than 

a commencement of operation in the United States domestic trade, is taken to 

be permanent unless there are circumstances indicating that it is temporary. 

‘‘(g) REGULATIONS.—The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section.

‘‘SEC. 1356. QUALIFYING SHIPPING ACTIVITIES. 

‘‘(a) QUALIFYING SHIPPING ACTIVITIES.—For purposes of this subchapter the ‘qualifying shipping activities’ of an electing entity consist of—

‘‘(1) core qualifying activities, 

‘‘(2) qualifying secondary activities, and 

39

‘‘(3) qualifying incidental activities. 

‘‘(b) CORE QUALIFYING ACTIVITIES.—

‘‘(1) The ‘core qualifying activities’ of an electing entity are—

‘‘(A) its activities in operating qualifying vessels in United States foreign 

trade, and 

‘‘(B) other activities of the electing entity and other members of its electing group that are an integral part of its business of operating qualifying 

vessels in United States foreign trade, including ownership or operation of 

barges, containers, chassis, and other equipment that are the complement 

of, or used in connection with, a qualifying vessel in United States foreign 

trade, the inland haulage of cargo shipped, or to be shipped, on qualifying 

vessels in United States foreign trade, and the provision of terminal, maintenance, repair, logistical, or other vessel, container, or cargo-related services that are an integral part of operating qualifying vessels in United 

States foreign trade. 

‘‘(2) ‘Core qualifying activities’ do not include the provision by an entity of facilities or services to any person, other than—

‘‘(A) another member of such entity’s electing group, 

‘‘(B) a consignor, consignee, or other customer of such entity’s business of 

operating qualifying vessels in United States foreign trade, or 

‘‘(C) a member of an alliance, joint venture, pool, partnership or similar 

undertaking involving the operation of qualifying vessels in United States 

foreign trade of which such entity is a member. 

‘‘(c) QUALIFYING SECONDARY ACTIVITIES.—For purposes of this subsection—

‘‘(1) the term ‘secondary activities’ means activities that are not core qualifying activities, and—

‘‘(A) are the active management or operation of vessels in the United 

States foreign trade, 

‘‘(B) the provision of vessel, container, or cargo-related facilities or services to any person, or 

‘‘(C) such other activities as may be prescribed by the Secretary pursuant 

to regulations, and 

‘‘(2) the ‘qualified secondary activities’ of an electing entity are its secondary 

activities and the secondary activities of other members of its electing group, 

but only to the extent that, without regard to this subchapter, the aggregate 

gross income derived by the electing entity and the other members of its electing group from such activities does not exceed 20 percent of the aggregate gross 

income derived by the electing entity and the other members of its electing 

group from their core qualifying activities. 

‘‘(d) QUALIFYING INCIDENTAL ACTIVITIES.—Shipping-related activities carried on by 

an electing entity or another member of its electing group are qualified incidental 

activities of the electing entity if—

‘‘(1) incidental to its core qualifying activities, 

‘‘(2) not qualifying secondary activities, and 

‘‘(3) without regard to this subchapter, the aggregate gross income derived by 

the electing entity and other members of its electing group from such activities 

does not exceed 0.1 percent of such entities’ aggregate gross income from their 

core qualifying activities. 

‘‘SEC. 1357. ITEMS NOT SUBJECT TO REGULAR TAX; DEPRECIATION; INTEREST. 

‘‘(a) EXCLUSION FROM GROSS INCOME.—Gross income of an electing entity shall 

not include the corporate income percentage of—

‘‘(1) income from qualifying shipping activities in the United States foreign 

trade, 

‘‘(2) income from money, bank deposits and other temporary investments 

which are reasonably necessary to meet the working capital requirements of 

qualifying shipping activities, and 

‘‘(3) income from money or other intangible assets accumulated pursuant to 

a plan to purchase qualifying shipping assets. 

‘‘(b) ELECTING GROUP MEMBER.—Gross income of a member of an electing group 

that is not an electing entity shall not include the corporate income percentage of 

its income from qualifying shipping activities that are taken into account under this 

subchapter as qualifying shipping activities of an electing entity. 

‘‘(c) DENIAL OF LOSSES, DEDUCTIONS, AND CREDITS.—

‘‘(1) GENERAL RULE.—Subject to paragraph (2), the corporate loss percentage 

of each item of loss, deduction (other than for interest expense), or credit of any 

taxpayer with respect to any activity the income from which is excluded from 

gross income under this section shall be disallowed.

40

‘‘(2) DEPRECIATION.—Notwithstanding paragraph (1), the deduction for depreciation of a qualifying shipping asset shall be allowed in determining the adjusted basis of such asset for purposes of determining gain from its disposition. 

‘‘(A) Except as provided in subparagraph (B), the straight line method of 

depreciation shall apply to the corporate income percentage of qualifying 

shipping assets the income from operation of which is excluded from gross 

income under this section. 

‘‘(B) Subparagraph (A) shall not apply to any qualifying shipping asset 

which is subject to a charter entered into prior to the effective date of this 

subchapter. 

‘‘(3) INTEREST.—The corporate loss percentage of an electing entity’s interest 

expense shall be disallowed in the ratio that the fair market value of its qualifying vessel assets bears to the fair market value of its total assets. 

‘‘(d) SECTION INAPPLICABLE TO UNRELATED PERSONS.—This section shall not apply 

to a taxpayer that is not a member of an electing group. 

‘‘SEC. 1358. ALLOCATION OF CREDITS, INCOME, AND DEDUCTIONS. 

‘‘(a) QUALIFYING SHIPPING ACTIVITIES.—For purposes of this chapter, the qualifying shipping activities of an electing entity shall be treated as a separate trade 

or business activity from all other activities conducted by the entity. 

‘‘(b) EXCLUSION OF CREDITS OR DEDUCTIONS.—

‘‘(1) No deduction shall be allowed against the taxable income of an electing 

corporation from qualifying shipping activities, and no credit shall be allowed 

against the tax imposed by section 1352(b). 

‘‘(2) No deduction shall be allowed for any net operating loss attributable to 

the qualifying shipping activities of a corporation to the extent that such loss 

is carried forward by the corporation from a taxable year preceding the first 

taxable year for which such corporation was an electing corporation. 

‘‘(c) TRANSACTIONS NOT AT ARM’S LENGTH.—Section 482 shall apply in accordance 

with this subsection to a transaction or series of transactions—

‘‘(1) as between an electing entity and another person, or 

‘‘(2) as between an entity’s qualifying shipping activities and other activities 

carried on by it. 

‘‘SEC. 1359. DISPOSITION OF QUALIFYING SHIPPING ASSETS. 

‘‘(a) IN GENERAL.—If an electing entity sells or disposes of qualifying shipping assets (as defined in subsection (c)) in an otherwise taxable transaction, at the election 

of the entity no gain shall be recognized if replacement qualifying shipping assets 

are acquired during the period specified in subsection (b), except to the extent that 

the amount realized upon such sale or disposition exceeds the cost of the replacement qualifying shipping assets. 

‘‘(b) PERIOD WITHIN WHICH PROPERTY MUST BE REPLACED.—The period referred 

to in subsection (a) shall be the period beginning one year prior to the disposition 

of the qualifying shipping assets and ending—

‘‘(1) 3 years after the close of the first taxable year in which the gain is realized, or 

‘‘(2) subject to such terms and conditions as may be specified by the Secretary, 

on such later date as the Secretary may designate on application by the taxpayer. Such application shall be made at such time and in such manner as the 

Secretary may by regulations prescribe. 

‘‘(c) TIME FOR ASSESSMENT OF DEFICIENCY ATTRIBUTABLE TO GAIN.—If an electing 

entity has made the election provided in subsection (a), then—

‘‘(1) the statutory period for the assessment of any deficiency, for any taxable 

year in which any part of the gain is realized, attributable to such gain shall 

not expire prior to the expiration of 3 years from the date the Secretary is notified by the entity (in such manner as the Secretary may by regulations prescribe) of the replacement tonnage tax property or of an intention not to replace, 

and 

‘‘(2) such deficiency may be assessed before the expiration of such 3-year period notwithstanding the provisions of section 6212(c) or the provisions of any 

other law or rule of law which would otherwise prevent such assessment. 

‘‘(d) BASIS OF REPLACEMENT QUALIFYING SHIPPING ASSETS.—In the case of replacement qualifying shipping assets purchased by an electing entity which resulted 

in the nonrecognition of any part of the gain realized as the result of a sale or other 

disposition of qualifying shipping assets, the basis shall be the cost of such property 

decreased in the amount of the gain not so recognized; and if the property purchased consists of more than one piece of property, the basis determined under this 

sentence shall be allocated to the purchased properties in proportion to their respective costs. 

41

‘‘(e) REPLACEMENT QUALIFYING SHIPPING ASSETS MUST BE ACQUIRED FROM UNRELATED PERSON IN CERTAIN CASES.—

‘‘(1) IN GENERAL.—Subsection (a) shall not apply if the replacement qualifying 

shipping assets are acquired from a related person except to the extent that the 

related person acquired the replacement qualifying shipping assets from an unrelated person during the period applicable under subsection (b). 

‘‘(2) RELATED PERSON.—For purposes of this subsection, a person is related to 

another person if the person bears a relationship to the other person described 

in section 267(b) or 707(b)(1).’’

(b) TECHNICAL AND CONFORMING AMENDMENT.—The second sentence of section 

56(g)(4)(B)(i), as amended by this Act, is further amended by inserting ‘‘or 1357’’

after ‘‘section 139A’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after the date of the enactment of this Act. 

SEC. 296. CHARITABLE CONTRIBUTION DEDUCTION FOR CERTAIN EXPENSES INCURRED IN 

SUPPORT OF NATIVE ALASKAN SUBSISTENCE WHALING. 

(a) IN GENERAL.—Section 170 (relating to charitable, etc., contributions and gifts), 

as amended by this Act, is amended by redesignating subsection (n) as subsection 

(o) and by inserting after subsection (m) the following new subsection: 

‘‘(n) EXPENSES PAID BY CERTAIN WHALING CAPTAINS IN SUPPORT OF NATIVE ALASKAN SUBSISTENCE WHALING.—

‘‘(1) IN GENERAL.—In the case of an individual who is recognized by the Alaska Eskimo Whaling Commission as a whaling captain charged with the responsibility of maintaining and carrying out sanctioned whaling activities and who 

engages in such activities during the taxable year, the amount described in 

paragraph (2) (to the extent such amount does not exceed $10,000 for the taxable year) shall be treated for purposes of this section as a charitable contribution. 

‘‘(2) AMOUNT DESCRIBED.—

‘‘(A) IN GENERAL.—The amount described in this paragraph is the aggregate of the reasonable and necessary whaling expenses paid by the taxpayer during the taxable year in carrying out sanctioned whaling activities. 

‘‘(B) WHALING EXPENSES.—For purposes of subparagraph (A), the term 

‘whaling expenses’ includes expenses for—

‘‘(i) the acquisition and maintenance of whaling boats, weapons, and 

gear used in sanctioned whaling activities, 

‘‘(ii) the supplying of food for the crew and other provisions for carrying out such activities, and 

‘‘(iii) storage and distribution of the catch from such activities. 

‘‘(3) SANCTIONED WHALING ACTIVITIES.—For purposes of this subsection, the 

term ‘sanctioned whaling activities’ means subsistence bowhead whale hunting 

activities conducted pursuant to the management plan of the Alaska Eskimo 

Whaling Commission.’’. 

(b) EFFECTIVE DATE.—The amendments made by subsection (a) shall apply to contributions made after December 31, 2004. 

TITLE III—TAX REFORM AND SIMPLIFICATION 

FOR UNITED STATES BUSINESSES 

SEC. 301. INTEREST EXPENSE ALLOCATION RULES. 

(a) ELECTION TO ALLOCATE ON WORLDWIDE BASIS.—Section 864 is amended by redesignating subsection (f) as subsection (g) and by inserting after subsection (e) the 

following new subsection: 

‘‘(f) ELECTION TO ALLOCATE INTEREST, ETC. ON WORLDWIDE BASIS.—For purposes 

of this subchapter, at the election of the worldwide affiliated group—

‘‘(1) ALLOCATION AND APPORTIONMENT OF INTEREST EXPENSE.—

‘‘(A) IN GENERAL.—The taxable income of each domestic corporation which 

is a member of a worldwide affiliated group shall be determined by allocating and apportioning interest expense of each member as if all members 

of such group were a single corporation. 

‘‘(B) TREATMENT OF WORLDWIDE AFFILIATED GROUP.—The taxable income 

of the domestic members of a worldwide affiliated group from sources outside the United States shall be determined by allocating and apportioning 

the interest expense of such domestic members to such income in an 

amount equal to the excess (if any) of—

42

‘‘(i) the total interest expense of the worldwide affiliated group multiplied by the ratio which the foreign assets of the worldwide affiliated 

group bears to all the assets of the worldwide affiliated group, over ‘‘(ii) the interest expense of all foreign corporations which are members of the worldwide affiliated group to the extent such interest expense of such foreign corporations would have been allocated and apportioned to foreign source income if this subsection were applied to a 

group consisting of all the foreign corporations in such worldwide affiliated group. ‘‘(C) WORLDWIDE AFFILIATED GROUP.—For purposes of this paragraph, the 

term ‘worldwide affiliated group’ means a group consisting of— ‘‘(i) the includible members of an affiliated group (as defined in section 1504(a), determined without regard to paragraphs (2) and (4) of 

section 1504(b)), and ‘‘(ii) all controlled foreign corporations in which such members in the 

aggregate meet the ownership requirements of section 1504(a)(2) either 

directly or indirectly through applying paragraph (2) of section 958(a) 

or through applying rules similar to the rules of such paragraph to 

stock owned directly or indirectly by domestic partnerships, trusts, or 

estates. ‘‘(2) ALLOCATION AND APPORTIONMENT OF OTHER EXPENSES.—Expenses other 

than interest which are not directly allocable or apportioned to any specific income producing activity shall be allocated and apportioned as if all members of 

the affiliated group were a single corporation. For purposes of the preceding 

sentence, the term ‘affiliated group’ has the meaning given such term by section 

1504 (determined without regard to paragraph (4) of section 1504(b)). 

‘‘(3) TREATMENT OF TAX-EXEMPT ASSETS; BASIS OF STOCK IN NONAFFILIATED 10-

PERCENT OWNED CORPORATIONS.—The rules of paragraphs (3) and (4) of subsection (e) shall apply for purposes of this subsection, except that paragraph (4) 

shall be applied on a worldwide affiliated group basis. 

‘‘(4) TREATMENT OF CERTAIN FINANCIAL INSTITUTIONS.—

‘‘(A) IN GENERAL.—For purposes of paragraph (1), any corporation described in subparagraph (B) shall be treated as an includible corporation for 

purposes of section 1504 only for purposes of applying this subsection separately to corporations so described. 

‘‘(B) DESCRIPTION.—A corporation is described in this subparagraph if—

‘‘(i) such corporation is a financial institution described in section 581 

or 591, 

‘‘(ii) the business of such financial institution is predominantly with 

persons other than related persons (within the meaning of subsection 

(d)(4)) or their customers, and 

‘‘(iii) such financial institution is required by State or Federal law to 

be operated separately from any other entity which is not such an institution. 

‘‘(C) TREATMENT OF BANK AND FINANCIAL HOLDING COMPANIES.—To the 

extent provided in regulations—

‘‘(i) a bank holding company (within the meaning of section 2(a) of 

the Bank Holding Company Act of 1956 (12 U.S.C. 1841(a)), 

‘‘(ii) a financial holding company (within the meaning of section 2(p) 

of the Bank Holding Company Act of 1956 (12 U.S.C. 1841(p)), and 

‘‘(iii) any subsidiary of a financial institution described in section 581 

or 591, or of any such bank or financial holding company, if such subsidiary is predominantly engaged (directly or indirectly) in the active 

conduct of a banking, financing, or similar business, 

shall be treated as a corporation described in subparagraph (B). 

‘‘(5) ELECTION TO EXPAND FINANCIAL INSTITUTION GROUP OF WORLDWIDE

GROUP.—

‘‘(A) IN GENERAL.—If a worldwide affiliated group elects the application 

of this subsection, all financial corporations which—

‘‘(i) are members of such worldwide affiliated group, but 

‘‘(ii) are not corporations described in paragraph (4)(B), 

shall be treated as described in paragraph (4)(B) for purposes of applying 

paragraph (4)(A). This subsection (other than this paragraph) shall apply 

to any such group in the same manner as this subsection (other than this 

paragraph) applies to the pre-election worldwide affiliated group of which 

such group is a part. 

‘‘(B) FINANCIAL CORPORATION.—For purposes of this paragraph, the term 

‘financial corporation’ means any corporation if at least 80 percent of its 

gross income is income described in section 904(d)(2)(C)(ii) and the regulaVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00044 Fmt 6659 Sfmt 6621 E:\HR\OC\HR548P1.001 HR548P1
43

tions thereunder which is derived from transactions with persons who are 

not related (within the meaning of section 267(b) or 707(b)(1)) to the corporation. For purposes of the preceding sentence, there shall be disregarded 

any item of income or gain from a transaction or series of transactions a 

principal purpose of which is the qualification of any corporation as a financial corporation. ‘‘(C) ANTIABUSE RULES.—In the case of a corporation which is a member 

of an electing financial institution group, to the extent that such corporation— ‘‘(i) distributes dividends or makes other distributions with respect to 

its stock after the date of the enactment of this paragraph to any member of the pre-election worldwide affiliated group (other than to a member of the electing financial institution group) in excess of the greater 

of— ‘‘(I) its average annual dividend (expressed as a percentage of 

current earnings and profits) during the 5-taxable-year period ending with the taxable year preceding the taxable year, or ‘‘(II) 25 percent of its average annual earnings and profits for 

such 5-taxable-year period, or ‘‘(ii) deals with any person in any manner not clearly reflecting the 

income of the corporation (as determined under principles similar to 

the principles of section 482), 

an amount of indebtedness of the electing financial institution group equal 

to the excess distribution or the understatement or overstatement of income, as the case may be, shall be recharacterized (for the taxable year and 

subsequent taxable years) for purposes of this paragraph as indebtedness 

of the worldwide affiliated group (excluding the electing financial institution group). If a corporation has not been in existence for 5 taxable years, 

this subparagraph shall be applied with respect to the period it was in existence. 

‘‘(D) ELECTION.—An election under this paragraph with respect to any financial institution group may be made only by the common parent of the 

pre-election worldwide affiliated group and may be made only for the first 

taxable year beginning after December 31, 2008, in which such affiliated 

group includes 1 or more financial corporations. Such an election, once 

made, shall apply to all financial corporations which are members of the 

electing financial institution group for such taxable year and all subsequent 

years unless revoked with the consent of the Secretary. 

‘‘(E) DEFINITIONS RELATING TO GROUPS.—For purposes of this paragraph—

‘‘(i) PRE-ELECTION WORLDWIDE AFFILIATED GROUP.—The term ‘preelection worldwide affiliated group’ means, with respect to a corporation, the worldwide affiliated group of which such corporation would 

(but for an election under this paragraph) be a member for purposes 

of applying paragraph (1). 

‘‘(ii) ELECTING FINANCIAL INSTITUTION GROUP.—The term ‘electing financial institution group’ means the group of corporations to which this 

subsection applies separately by reason of the application of paragraph 

(4)(A) and which includes financial corporations by reason of an election under subparagraph (A). 

‘‘(F) REGULATIONS.—The Secretary shall prescribe such regulations as 

may be appropriate to carry out this subsection, including regulations—

‘‘(i) providing for the direct allocation of interest expense in other circumstances where such allocation would be appropriate to carry out the 

purposes of this subsection, 

‘‘(ii) preventing assets or interest expense from being taken into account more than once, and 

‘‘(iii) dealing with changes in members of any group (through acquisitions or otherwise) treated under this paragraph as an affiliated group 

for purposes of this subsection. 

‘‘(6) ELECTION.—An election to have this subsection apply with respect to any 

worldwide affiliated group may be made only by the common parent of the domestic affiliated group referred to in paragraph (1)(C) and may be made only 

for the first taxable year beginning after December 31, 2008, in which a worldwide affiliated group exists which includes such affiliated group and at least 1 

foreign corporation. Such an election, once made, shall apply to such common 

parent and all other corporations which are members of such worldwide affiliated group for such taxable year and all subsequent years unless revoked with 

the consent of the Secretary.’’. 

44

(b) EXPANSION OF REGULATORY AUTHORITY.—Paragraph (7) of section 864(e) is 

amended—

(1) by inserting before the comma at the end of subparagraph (B) ‘‘and in 

other circumstances where such allocation would be appropriate to carry out the 

purposes of this subsection’’, and 

(2) by striking ‘‘and’’ at the end of subparagraph (E), by redesignating subparagraph (F) as subparagraph (G), and by inserting after subparagraph (E) the 

following new subparagraph: 

‘‘(F) preventing assets or interest expense from being taken into account 

more than once, and’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2008. 

SEC. 302. RECHARACTERIZATION OF OVERALL DOMESTIC LOSS. 

(a) GENERAL RULE.—Section 904 is amended by redesignating subsections (g), (h), 

(i), (j), and (k) as subsections (h), (i), (j), (k), and (l) respectively, and by inserting 

after subsection (f) the following new subsection: 

‘‘(g) RECHARACTERIZATION OF OVERALL DOMESTIC LOSS.—

‘‘(1) GENERAL RULE.—For purposes of this subpart and section 936, in the case 

of any taxpayer who sustains an overall domestic loss for any taxable year beginning after December 31, 2006, that portion of the taxpayer’s taxable income 

from sources within the United States for each succeeding taxable year which 

is equal to the lesser of—

‘‘(A) the amount of such loss (to the extent not used under this paragraph 

in prior taxable years), or 

‘‘(B) 50 percent of the taxpayer’s taxable income from sources within the 

United States for such succeeding taxable year, 

shall be treated as income from sources without the United States (and not as 

income from sources within the United States). 

‘‘(2) OVERALL DOMESTIC LOSS DEFINED.—For purposes of this subsection—

‘‘(A) IN GENERAL.—The term ‘overall domestic loss’ means any domestic 

loss to the extent such loss offsets taxable income from sources without the 

United States for the taxable year or for any preceding taxable year by reason of a carryback. For purposes of the preceding sentence, the term ‘domestic loss’ means the amount by which the gross income for the taxable 

year from sources within the United States is exceeded by the sum of the 

deductions properly apportioned or allocated thereto (determined without 

regard to any carryback from a subsequent taxable year). 

‘‘(B) TAXPAYER MUST HAVE ELECTED FOREIGN TAX CREDIT FOR YEAR OF

LOSS.—The term ‘overall domestic loss’ shall not include any loss for any 

taxable year unless the taxpayer chose the benefits of this subpart for such 

taxable year. 

‘‘(3) CHARACTERIZATION OF SUBSEQUENT INCOME.—

‘‘(A) IN GENERAL.—Any income from sources within the United States 

that is treated as income from sources without the United States under 

paragraph (1) shall be allocated among and increase the income categories 

in proportion to the loss from sources within the United States previously 

allocated to those income categories. 

‘‘(B) INCOME CATEGORY.—For purposes of this paragraph, the term ‘income category’ has the meaning given such term by subsection (f)(5)(E)(i). 

‘‘(4) COORDINATION WITH SUBSECTION (f).—The Secretary shall prescribe such 

regulations as may be necessary to coordinate the provisions of this subsection 

with the provisions of subsection (f).’’. 

(b) CONFORMING AMENDMENTS.—

(1) Section 535(d)(2) is amended by striking ‘‘section 904(g)(6)’’ and inserting 

‘‘section 904(h)(6)’’. 

(2) Subparagraph (A) of section 936(a)(2) is amended by striking ‘‘section 

904(f)’’ and inserting ‘‘subsections (f) and (g) of section 904’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to losses 

for taxable years beginning after December 31, 2006. 

SEC. 303. REDUCTION TO 2 FOREIGN TAX CREDIT BASKETS. 

(a) IN GENERAL.—Paragraph (1) of section 904(d) (relating to separate application 

of section with respect to certain categories of income) is amended to read as follows: 

‘‘(1) IN GENERAL.—The provisions of subsections (a), (b), and (c) and sections 

902, 907, and 960 shall be applied separately with respect to—

‘‘(A) passive category income, and 

‘‘(B) general category income.’’

45

(b) CATEGORIES.—Paragraph (2) of section 904(d) is amended by striking subparagraph (B), by redesignating subparagraph (A) as subparagraph (B), and by inserting 

before subparagraph (B) (as so redesignated) the following new subparagraph: 

‘‘(A) CATEGORIES.—

‘‘(i) PASSIVE CATEGORY INCOME.—The term ‘passive category income’

means passive income and specified passive category income. 

‘‘(ii) GENERAL CATEGORY INCOME.—The term ‘general category income’ means income other than passive category income.’’

(c) SPECIFIED PASSIVE CATEGORY INCOME.—Subparagraph (B) of section 904(d)(2), 

as so redesignated, is amended by adding at the end the following new clause: 

‘‘(v) SPECIFIED PASSIVE CATEGORY INCOME.—The term ‘specified passive category income’ means—

‘‘(I) dividends from a DISC or former DISC (as defined in section 

992(a)) to the extent such dividends are treated as income from 

sources without the United States, 

‘‘(II) taxable income attributable to foreign trade income (within 

the meaning of section 923(b)), and 

‘‘(III) distributions from a FSC (or a former FSC) out of earnings 

and profits attributable to foreign trade income (within the meaning of section 923(b)) or interest or carrying charges (as defined in 

section 927(d)(1)) derived from a transaction which results in foreign trade income (as defined in section 923(b)).’’

(d) TREATMENT OF FINANCIAL SERVICES.—Paragraph (2) of section 904(d) is 

amended by striking subparagraph (D), by redesignating subparagraph (C) as subparagraph (D), and by inserting before subparagraph (D) (as so redesignated) the 

following new subparagraph: 

‘‘(C) TREATMENT OF FINANCIAL SERVICES INCOME AND COMPANIES.—

‘‘(i) IN GENERAL.—Financial services income shall be treated as general category income in the case of—

‘‘(I) a member of a financial services group, and 

‘‘(II) any other person if such person is predominantly engaged 

in the active conduct of a banking, insurance, financing, or similar 

business. 

‘‘(ii) FINANCIAL SERVICES GROUP.—The term ‘financial services group’

means any affiliated group (as defined in section 1504(a) without regard to paragraphs (2) and (3) of section 1504(b)) which is predominantly engaged in the active conduct of a banking, insurance, financing, or similar business. In determining whether such a group is so engaged, there shall be taken into account only the income of members 

of the group that are—

‘‘(I) United States corporations, or 

‘‘(II) controlled foreign corporations in which such United States 

corporations own, directly or indirectly, at least 80 percent of the 

total voting power and value of the stock. 

‘‘(iii) PASS-THRU ENTITIES.—The Secretary shall by regulation specify 

for purposes of this subparagraph the treatment of financial services 

income received or accrued by partnerships and by other pass-thru entities which are not members of a financial services group.’’

(e) CONFORMING AMENDMENTS.—

(1) Clause (iii) of section 904(d)(2)(B) (relating to exceptions from passive income), as so redesignated, is amended by striking subclause (I) and by redesignating subclauses (II) and (III) as subclauses (I) and (II), respectively. 

(2) Clause (i) of section 904(d)(2)(D) (defining financial services income), as so 

redesignated, is amended by adding ‘‘or’’ at the end of subclause (I) and by 

striking subclauses (II) and (III) and inserting the following new subclause: 

‘‘(II) passive income (determined without regard to subparagraph 

(B)(iii)(II)).’’

(3) Section 904(d)(2)(D) (defining financial services income), as so redesignated, is amended by striking clause (iii). 

(4) Paragraph (3) of section 904(d) is amended to read as follows: 

‘‘(3) LOOK-THRU IN CASE OF CONTROLLED FOREIGN CORPORATIONS.—

‘‘(A) IN GENERAL.—Except as otherwise provided in this paragraph, dividends, interest, rents, and royalties received or accrued by the taxpayer 

from a controlled foreign corporation in which the taxpayer is a United 

States shareholder shall not be treated as passive category income. 

‘‘(B) SUBPART F INCLUSIONS.—Any amount included in gross income under 

section 951(a)(1)(A) shall be treated as passive category income to the extent the amount so included is attributable to passive category income. 

46

‘‘(C) INTEREST, RENTS, AND ROYALTIES.—Any interest, rent, or royalty 

which is received or accrued from a controlled foreign corporation in which 

the taxpayer is a United States shareholder shall be treated as passive category income to the extent it is properly allocable (under regulations prescribed by the Secretary) to passive category income of the controlled foreign corporation. ‘‘(D) DIVIDENDS.—Any dividend paid out of the earnings and profits of 

any controlled foreign corporation in which the taxpayer is a United States 

shareholder shall be treated as passive category income in proportion to the 

ratio of—

‘‘(i) the portion of the earnings and profits attributable to passive category income, to ‘‘(ii) the total amount of earnings and profits. ‘‘(E) LOOK-THRU APPLIES ONLY WHERE SUBPART F APPLIES.—If a controlled 

foreign corporation meets the requirements of section 954(b)(3)(A) (relating 

to de minimis rule) for any taxable year, for purposes of this paragraph, 

none of its foreign base company income (as defined in section 954(a) without regard to section 954(b)(5)) and none of its gross insurance income (as 

defined in section 954(b)(3)(C)) for such taxable year shall be treated as 

passive category income, except that this sentence shall not apply to any 

income which (without regard to this sentence) would be treated as financial services income. Solely for purposes of applying subparagraph (D), passive income of a controlled foreign corporation shall not be treated as passive category income if the requirements of section 954(b)(4) are met with 

respect to such income. 

‘‘(F) COORDINATION WITH HIGH-TAXED INCOME PROVISIONS.—

‘‘(i) In determining whether any income of a controlled foreign corporation is passive category income, subclause (II) of paragraph 

(2)(B)(iii) shall not apply. 

‘‘(ii) Any income of the taxpayer which is treated as passive category 

income under this paragraph shall be so treated notwithstanding any 

provision of paragraph (2); except that the determination of whether 

any amount is high-taxed income shall be made after the application 

of this paragraph. 

‘‘(G) DIVIDEND.—For purposes of this paragraph, the term ‘dividend’ includes any amount included in gross income in section 951(a)(1)(B). Any 

amount included in gross income under section 78 to the extent attributable 

to amounts included in gross income in section 951(a)(1)(A) shall not be 

treated as a dividend but shall be treated as included in gross income under 

section 951(a)(1)(A). 

‘‘(H) LOOK-THRU APPLIES TO PASSIVE FOREIGN INVESTMENT COMPANY INCLUSION.—If—

‘‘(i) a passive foreign investment company is a controlled foreign corporation, and 

‘‘(ii) the taxpayer is a United States shareholder in such controlled 

foreign corporation, 

any amount included in gross income under section 1293 shall be treated 

as income in a separate category to the extent such amount is attributable 

to income in such category.’’

(5) TREATMENT OF INCOME TAX BASE DIFFERENCES.—Paragraph (2) of section 

904(d) is amended by redesignating subparagraphs (H) and (I) as subparagraphs (I) and (J), respectively, and by inserting after subparagraph (G) the following new subparagraph: 

‘‘(H) TREATMENT OF INCOME TAX BASE DIFFERENCES.—Tax imposed under 

the law of a foreign country or possession of the United States on an 

amount which does not constitute income under United States tax principles shall be treated as imposed on income described in paragraph (1)(B).’’

(6) Paragraph (2) of section 904(d) is amended by adding at the end the following new subparagraph: 

‘‘(K) TRANSITIONAL RULES FOR 2007 CHANGES.—For purposes of paragraph 

(1)—

‘‘(i) taxes carried from any taxable year beginning before January 1, 

2007, to any taxable year beginning on or after such date, with respect 

to any item of income, shall be treated as described in the subparagraph of paragraph (1) in which such income would be described were 

such taxes paid or accrued in a taxable year beginning on or after such 

date, and 

‘‘(ii) the Secretary may by regulations provide for the allocation of 

any carryback of taxes with respect to income to such a taxable year 

47

for purposes of allocating such income among the separate categories 

in effect for such taxable year.’’. 

(7) Section 904(j)(3)(A)(i) is amended by striking ‘‘subsection (d)(2)(A)’’ and inserting ‘‘subsection (d)(2)(B)’’. 

(f) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2006. 

SEC. 304. LOOK-THRU RULES TO APPLY TO DIVIDENDS FROM NONCONTROLLED SECTION 902 

CORPORATIONS. 

(a) IN GENERAL.—Section 904(d)(4) (relating to look-thru rules apply to dividends 

from noncontrolled section 902 corporations) is amended to read as follows: 

‘‘(4) LOOK-THRU APPLIES TO DIVIDENDS FROM NONCONTROLLED SECTION 902

CORPORATIONS.—

‘‘(A) IN GENERAL.—For purposes of this subsection, any dividend from a 

noncontrolled section 902 corporation with respect to the taxpayer shall be 

treated as income described in a subparagraph of paragraph (1) in proportion to the ratio of—

‘‘(i) the portion of earnings and profits attributable to income described in such subparagraph, to 

‘‘(ii) the total amount of earnings and profits. 

‘‘(B) EARNINGS AND PROFITS OF CONTROLLED FOREIGN CORPORATIONS.—In 

the case of any distribution from a controlled foreign corporation to a 

United States shareholder, rules similar to the rules of subparagraph (A) 

shall apply in determining the extent to which earnings and profits of the 

controlled foreign corporation which are attributable to dividends received 

from a noncontrolled section 902 corporation may be treated as income in 

a separate category. 

‘‘(C) SPECIAL RULES.—For purposes of this paragraph—

‘‘(i) EARNINGS AND PROFITS.—

‘‘(I) IN GENERAL.—The rules of section 316 shall apply. 

‘‘(II) REGULATIONS.—The Secretary may prescribe regulations regarding the treatment of distributions out of earnings and profits 

for periods before the taxpayer’s acquisition of the stock to which 

the distributions relate. 

‘‘(ii) INADEQUATE SUBSTANTIATION.—If the Secretary determines that 

the proper subparagraph of paragraph (1) in which a dividend is described has not been substantiated, such dividend shall be treated as 

income described in paragraph (1)(A). 

‘‘(iii) COORDINATION WITH HIGH-TAXED INCOME PROVISIONS.—Rules 

similar to the rules of paragraph (3)(F) shall apply for purposes of this 

paragraph. 

‘‘(iv) LOOK-THRU WITH RESPECT TO CARRYOVER OF CREDIT.—Rules 

similar to subparagraph (A) also shall apply to any carryforward under 

subsection (c) from a taxable year beginning before January 1, 2003, of 

tax allocable to a dividend from a noncontrolled section 902 corporation 

with respect to the taxpayer. The Secretary may by regulations provide 

for the allocation of any carryback of tax allocable to a dividend from 

a noncontrolled section 902 corporation to such a taxable year for purposes of allocating such dividend among the separate categories in effect for such taxable year.’’. 

(b) CONFORMING AMENDMENTS.—

(1) Subparagraph (E) of section 904(d)(1) is hereby repealed. 

(2) Section 904(d)(2)(C)(iii) is amended by adding ‘‘and’’ at the end of subclause (I), by striking subclause (II), and by redesignating subclause (III) as 

subclause (II). 

(3) The last sentence of section 904(d)(2)(D) is amended to read as follows: 

‘‘Such term does not include any financial services income.’’. 

(4) Section 904(d)(2)(E) is amended—

(A) by inserting ‘‘or (4)’’ after ‘‘paragraph (3)’’ in clause (i), and 

(B) by striking clauses (ii) and (iv) and by redesignating clause (iii) as 

clause (ii). 

(5) Section 904(d)(3)(F) is amended by striking ‘‘(D), or (E)’’ and inserting ‘‘or 

(D)’’. 

(6) Section 864(d)(5)(A)(i) is amended by striking ‘‘(C)(iii)(III)’’ and inserting 

‘‘(C)(iii)(II)’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2002. 

48

SEC. 305. ATTRIBUTION OF STOCK OWNERSHIP THROUGH PARTNERSHIPS TO APPLY IN DETERMINING SECTION 902 AND 960 CREDITS. 

(a) IN GENERAL.—Subsection (c) of section 902 is amended by redesignating paragraph (7) as paragraph (8) and by inserting after paragraph (6) the following new 

paragraph: 

‘‘(7) CONSTRUCTIVE OWNERSHIP THROUGH PARTNERSHIPS.—Stock owned, directly or indirectly, by or for a partnership shall be considered as being owned 

proportionately by its partners. Stock considered to be owned by a person by 

reason of the preceding sentence shall, for purposes of applying such sentence, 

be treated as actually owned by such person. The Secretary may prescribe such 

regulations as may be necessary to carry out the purposes of this paragraph, 

including rules to account for special partnership allocations of dividends, credits, and other incidents of ownership of stock in determining proportionate ownership.’’. 

(b) CLARIFICATION OF COMPARABLE ATTRIBUTION UNDER SECTION 901(b)(5).—

Paragraph (5) of section 901(b) is amended by striking ‘‘any individual’’ and inserting ‘‘any person’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxes 

of foreign corporations for taxable years of such corporations beginning after the 

date of the enactment of this Act. 

SEC. 306. CLARIFICATION OF TREATMENT OF CERTAIN TRANSFERS OF INTANGIBLE PROPERTY. 

(a) IN GENERAL.—Subparagraph (C) of section 367(d)(2) is amended by adding at 

the end the following new sentence: ‘‘For purposes of applying section 904(d), any 

such amount shall be treated in the same manner as if such amount were a royalty.’’. 

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

amounts treated as received pursuant to section 367(d)(2) of the Internal Revenue 

Code of 1986 on or after August 5, 1997. 

SEC. 307. UNITED STATES PROPERTY NOT TO INCLUDE CERTAIN ASSETS OF CONTROLLED 

FOREIGN CORPORATION. 

(a) IN GENERAL.—Section 956(c)(2) (relating to exceptions from property treated 

as United States property) is amended by striking ‘‘and’’ at the end of subparagraph 

(J), by striking the period at the end of subparagraph (K) and inserting a semicolon, 

and by adding at the end the following new subparagraphs: 

‘‘(L) securities acquired and held by a controlled foreign corporation in the 

ordinary course of its business as a dealer in securities if—

‘‘(i) the dealer accounts for the securities as securities held primarily 

for sale to customers in the ordinary course of business, and 

‘‘(ii) the dealer disposes of the securities (or such securities mature 

while held by the dealer) within a period consistent with the holding 

of securities for sale to customers in the ordinary course of business; 

and 

‘‘(M) an obligation of a United States person which—

‘‘(i) is not a domestic corporation, and 

‘‘(ii) is not—

‘‘(I) a United States shareholder (as defined in section 951(b)) of 

the controlled foreign corporation, or 

‘‘(II) a partnership, estate, or trust in which the controlled foreign corporation, or any related person (as defined in section 

954(d)(3)), is a partner, beneficiary, or trustee immediately after 

the acquisition of any obligation of such partnership, estate, or 

trust by the controlled foreign corporation.’’. 

(b) CONFORMING AMENDMENT.—Section 956(c)(2) is amended by striking ‘‘and (K)’’

in the last sentence and inserting ‘‘, (K), and (L)’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years of foreign corporations beginning after December 31, 2004, and to taxable 

years of United States shareholders with or within which such taxable years of foreign corporations end. 

SEC. 308. ELECTION NOT TO USE AVERAGE EXCHANGE RATE FOR FOREIGN TAX PAID OTHER 

THAN IN FUNCTIONAL CURRENCY. 

(a) IN GENERAL.—Paragraph (1) of section 986(a) (relating to determination of foreign taxes and foreign corporation’s earnings and profits) is amended by redesignating subparagraph (D) as subparagraph (E) and by inserting after subparagraph 

(C) the following new subparagraph: 

‘‘(D) ELECTIVE EXCEPTION FOR TAXES PAID OTHER THAN IN FUNCTIONAL

CURRENCY.—

49

‘‘(i) IN GENERAL.—At the election of the taxpayer, subparagraph (A) 

shall not apply to any foreign income taxes the liability for which is denominated in any currency other than in the taxpayer’s functional currency. 

‘‘(ii) APPLICATION TO QUALIFIED BUSINESS UNITS.—An election under 

this subparagraph may apply to foreign income taxes attributable to a 

qualified business unit in accordance with regulations prescribed by the 

Secretary. 

‘‘(iii) ELECTION.—Any such election shall apply to the taxable year for 

which made and all subsequent taxable years unless revoked with the 

consent of the Secretary.’’. 

(b) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2004. 

SEC. 309. REPEAL OF WITHHOLDING TAX ON DIVIDENDS FROM CERTAIN FOREIGN CORPORATIONS. 

(a) IN GENERAL.—Paragraph (2) of section 871(i) (relating to tax not to apply to 

certain interest and dividends) is amended by adding at the end the following new 

subparagraph: 

‘‘(D) Dividends paid by a foreign corporation which are treated under section 861(a)(2)(B) as income from sources within the United States.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to payments made after December 31, 2004. 

SEC. 310. PROVIDE EQUAL TREATMENT FOR INTEREST PAID BY FOREIGN PARTNERSHIPS 

AND FOREIGN CORPORATIONS. 

(a) IN GENERAL.—Paragraph (1) of section 861(a) is amended by striking ‘‘and’’ at 

the end of subparagraph (A), by striking the period at the end of subparagraph (B) 

and inserting ‘‘, and’’, and by adding at the end the following new subparagraph: 

‘‘(C) in the case of a foreign partnership, which is predominantly engaged 

in the active conduct of a trade or business outside the United States, any 

interest not paid by a trade or business engaged in by the partnership in 

the United States and not allocable to income which is effectively connected 

(or treated as effectively connected) with the conduct of a trade or business 

in the United States.’’. 

(b) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2003. 

SEC. 311. LOOK-THRU TREATMENT OF PAYMENTS BETWEEN RELATED CONTROLLED FOREIGN CORPORATIONS UNDER FOREIGN PERSONAL HOLDING COMPANY INCOME 

RULES. 

(a) IN GENERAL.—Subsection (c) of section 954, as amended by this Act, is amended by adding after paragraph (4) the following new paragraph: 

‘‘(5) LOOK-THRU IN THE CASE OF RELATED CONTROLLED FOREIGN CORPORATIONS.—For purposes of this subsection, dividends, interest, rents, and royalties 

received or accrued from a controlled foreign corporation which is a related person (as defined in subsection (b)(9)) shall not be treated as foreign personal 

holding company income to the extent attributable or properly allocable (determined under rules similar to the rules of subparagraphs (C) and (D) of section 

904(d)(3)) to income of the related person which is not subpart F income (as defined in section 952). For purposes of this paragraph, interest shall include factoring income which is treated as income equivalent to interest for purposes of 

paragraph (1)(E). The Secretary shall prescribe such regulations as may be appropriate to prevent the abuse of the purposes of this paragraph.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years of foreign corporations beginning after December 31, 2004, and to taxable 

years of United States shareholders with or within which such taxable years of foreign corporations end. 

SEC. 312. LOOK-THRU TREATMENT FOR SALES OF PARTNERSHIP INTERESTS. 

(a) IN GENERAL.—Section 954(c) (defining foreign personal holding company income), as amended by this Act, is amended by adding after paragraph (5) the following new paragraph: 

‘‘(6) LOOK-THRU RULE FOR CERTAIN PARTNERSHIP SALES.—

‘‘(A) IN GENERAL.—In the case of any sale by a controlled foreign corporation of an interest in a partnership with respect to which such corporation 

is a 25-percent owner, such corporation shall be treated for purposes of this 

subsection as selling the proportionate share of the assets of the partnership attributable to such interest. The Secretary shall prescribe such regulations as may be appropriate to prevent abuse of the purposes of this paraVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00051 Fmt 6659 Sfmt 6621 E:\HR\OC\HR548P1.001 HR548P1
50

graph, including regulations providing for coordination of this paragraph 

with the provisions of subchapter K. ‘‘(B) 25-PERCENT OWNER.—For purposes of this paragraph, the term ‘25-

percent owner’ means a controlled foreign corporation which owns directly 

25 percent or more of the capital or profits interest in a partnership. For 

purposes of the preceding sentence, if a controlled foreign corporation is a 

shareholder or partner of a corporation or partnership, the controlled foreign corporation shall be treated as owning directly its proportionate share 

of any such capital or profits interest held directly or indirectly by such corporation or partnership.’’. (b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years of foreign corporations beginning after December 31, 2004, and to taxable 

years of United States shareholders with or within which such taxable years of foreign corporations end. 

SEC. 313. REPEAL OF FOREIGN PERSONAL HOLDING COMPANY RULES AND FOREIGN INVESTMENT COMPANY RULES. 

(a) GENERAL RULE.—The following provisions are hereby repealed: 

(1) Part III of subchapter G of chapter 1 (relating to foreign personal holding 

companies). 

(2) Section 1246 (relating to gain on foreign investment company stock). 

(3) Section 1247 (relating to election by foreign investment companies to distribute income currently). 

(b) EXEMPTION OF FOREIGN CORPORATIONS FROM PERSONAL HOLDING COMPANY

RULES.—

(1) IN GENERAL.—Subsection (c) of section 542 (relating to exceptions) is 

amended— (A) by striking paragraph (5) and inserting the following: ‘‘(5) a foreign corporation,’’, (B) by striking paragraphs (7) and (10) and by redesignating paragraphs 

(8) and (9) as paragraphs (7) and (8), respectively, 

(C) by inserting ‘‘and’’ at the end of paragraph (7) (as so redesignated), 

and 

(D) by striking ‘‘; and’’ at the end of paragraph (8) (as so redesignated) 

and inserting a period. 

(2) TREATMENT OF INCOME FROM PERSONAL SERVICE CONTRACTS.—Paragraph 

(1) of section 954(c) is amended by adding at the end the following new subparagraph: ‘‘(I) PERSONAL SERVICE CONTRACTS.— ‘‘(i) Amounts received under a contract under which the corporation 

is to furnish personal services if— ‘‘(I) some person other than the corporation has the right to designate (by name or by description) the individual who is to perform 

the services, or ‘‘(II) the individual who is to perform the services is designated 

(by name or by description) in the contract, and ‘‘(ii) amounts received from the sale or other disposition of such a 

contract. 

This subparagraph shall apply with respect to amounts received for services 

under a particular contract only if at some time during the taxable year 25 

percent or more in value of the outstanding stock of the corporation is 

owned, directly or indirectly, by or for the individual who has performed, 

is to perform, or may be designated (by name or by description) as the one 

to perform, such services.’’. (c) CONFORMING AMENDMENTS.— (1) Section 1(h) is amended— (A) in paragraph (10), by inserting ‘‘and’’ at the end of subparagraph (F), 

by striking subparagraph (G), and by redesignating subparagraph (H) as 

subparagraph (G), and 

(B) by striking ‘‘a foreign personal holding company (as defined in section 

552), a foreign investment company (as defined in section 1246(b)), or’’ in 

paragraph (11)(C)(iii). 

(2) Section 163(e)(3)(B), as amended by section 642(a) of this Act, is amended 

by striking ‘‘which is a foreign personal holding company (as defined in section 

552), a controlled foreign corporation (as defined in section 957), or’’ and inserting ‘‘which is a controlled foreign corporation (as defined in section 957) or’’. 

(3) Paragraph (2) of section 171(c) is amended—

(A) by striking ‘‘, or by a foreign personal holding company, as defined 

in section 552’’, and 

(B) by striking ‘‘, or foreign personal holding company’’. 

51

(4) Paragraph (2) of section 245(a) is amended by striking ‘‘foreign personal 

holding company or’’. 

(5) Section 267(a)(3)(B), as amended by section 642(b) of this Act, is amended 

by striking ‘‘to a foreign personal holding company (as defined in section 552), 

a controlled foreign corporation (as defined in section 957), or’’ and inserting ‘‘to 

a controlled foreign corporation (as defined in section 957) or’’. 

(6) Section 312 is amended by striking subsection (j). 

(7) Subsection (m) of section 312 is amended by striking ‘‘, a foreign investment company (within the meaning of section 1246(b)), or a foreign personal 

holding company (within the meaning of section 552)’’. 

(8) Subsection (e) of section 443 is amended by striking paragraph (3) and by 

redesignating paragraphs (4) and (5) as paragraphs (3) and (4), respectively. 

(9) Subparagraph (B) of section 465(c)(7) is amended by adding ‘‘or’’ at the end 

of clause (i), by striking clause (ii), and by redesignating clause (iii) as clause 

(ii). 

(10) Paragraph (1) of section 543(b) is amended by inserting ‘‘and’’ at the end 

of subparagraph (A), by striking ‘‘, and’’ at the end of subparagraph (B) and inserting a period, and by striking subparagraph (C). 

(11) Paragraph (1) of section 562(b) is amended by striking ‘‘or a foreign personal holding company described in section 552’’. 

(12) Section 563 is amended—

(A) by striking subsection (c), 

(B) by redesignating subsection (d) as subsection (c), and 

(C) by striking ‘‘subsection (a), (b), or (c)’’ in subsection (c) (as so redesignated) and inserting ‘‘subsection (a) or (b)’’. 

(13) Subsection (d) of section 751 is amended by adding ‘‘and’’ at the end of 

paragraph (2), by striking paragraph (3), by redesignating paragraph (4) as 

paragraph (3), and by striking ‘‘paragraph (1), (2), or (3)’’ in paragraph (3) (as 

so redesignated) and inserting ‘‘paragraph (1) or (2)’’. 

(14) Paragraph (2) of section 864(d) is amended by striking subparagraph (A) 

and by redesignating subparagraphs (B) and (C) as subparagraphs (A) and (B), 

respectively. 

(15)(A) Subparagraph (A) of section 898(b)(1) is amended to read as follows: 

‘‘(A) which is treated as a controlled foreign corporation for any purpose 

under subpart F of part III of this subchapter, and’’. 

(B) Subparagraph (B) of section 898(b)(2) is amended by striking ‘‘and sections 551(f) and 554, whichever are applicable,’’. 

(C) Paragraph (3) of section 898(b) is amended to read as follows: 

‘‘(3) UNITED STATES SHAREHOLDER.—The term ‘United States shareholder’ has 

the meaning given to such term by section 951(b), except that, in the case of 

a foreign corporation having related person insurance income (as defined in section 953(c)(2)), the Secretary may treat any person as a United States shareholder for purposes of this section if such person is treated as a United States 

shareholder under section 953(c)(1).’’. 

(D) Subsection (c) of section 898 is amended to read as follows: 

‘‘(c) DETERMINATION OF REQUIRED YEAR.—

‘‘(1) IN GENERAL.—The required year is—

‘‘(A) the majority U.S. shareholder year, or 

‘‘(B) if there is no majority U.S. shareholder year, the taxable year prescribed under regulations. 

‘‘(2) 1-MONTH DEFERRAL ALLOWED.—A specified foreign corporation may elect, 

in lieu of the taxable year under paragraph (1)(A), a taxable year beginning 1 

month earlier than the majority U.S. shareholder year. 

‘‘(3) MAJORITY U.S. SHAREHOLDER YEAR.—

‘‘(A) IN GENERAL.—For purposes of this subsection, the term ‘majority 

U.S. shareholder year’ means the taxable year (if any) which, on each testing day, constituted the taxable year of—

‘‘(i) each United States shareholder described in subsection (b)(2)(A), 

and 

‘‘(ii) each United States shareholder not described in clause (i) whose 

stock was treated as owned under subsection (b)(2)(B) by any shareholder described in such clause. 

‘‘(B) TESTING DAY.—The testing days shall be—

‘‘(i) the first day of the corporation’s taxable year (determined without 

regard to this section), or 

‘‘(ii) the days during such representative period as the Secretary may 

prescribe.’’. 

(16) Clause (ii) of section 904(d)(2)(A) is amended to read as follows: 

52

‘‘(ii) CERTAIN AMOUNTS INCLUDED.—Except as provided in clause (iii), 

the term ‘passive income’ includes, except as provided in subparagraph 

(E)(iii) or paragraph (3)(I), any amount includible in gross income 

under section 1293 (relating to certain passive foreign investment companies).’’. 

(17)(A) Subparagraph (A) of section 904(h)(1), as redesignated by section 302, 

is amended by adding ‘‘or’’ at the end of clause (i), by striking clause (ii), and 

by redesignating clause (iii) as clause (ii). 

(B) The paragraph heading of paragraph (2) of section 904(h), as so redesignated, is amended by striking ‘‘FOREIGN PERSONAL HOLDING OR’’. 

(18) Section 951 is amended by striking subsections (c) and (d) and by redesignating subsections (e) and (f) as subsections (c) and (d), respectively. 

(19) Paragraph (3) of section 989(b) is amended by striking ‘‘, 551(a),’’. 

(20) Paragraph (5) of section 1014(b) is amended by inserting ‘‘and before January 1, 2005,’’ after ‘‘August 26, 1937,’’. 

(21) Subsection (a) of section 1016 is amended by striking paragraph (13). 

(22)(A) Paragraph (3) of section 1212(a) is amended to read as follows: 

‘‘(3) SPECIAL RULES ON CARRYBACKS.—A net capital loss of a corporation shall 

not be carried back under paragraph (1)(A) to a taxable year—

‘‘(A) for which it is a regulated investment company (as defined in section 

851), or 

‘‘(B) for which it is a real estate investment trust (as defined in section 

856).’’. 

(B) The amendment made by subparagraph (A) shall apply to taxable years 

beginning after December 31, 2004. 

(23) Section 1223 is amended by striking paragraph (10) and by redesignating 

the following paragraphs accordingly. 

(24) Subsection (d) of section 1248 is amended by striking paragraph (5) and 

by redesignating paragraphs (6) and (7) as paragraphs (5) and (6), respectively. 

(25) Paragraph (2) of section 1260(c) is amended by striking subparagraphs 

(H) and (I) and by redesignating subparagraph (J) as subparagraph (H). 

(26)(A) Subparagraph (F) of section 1291(b)(3) is amended by striking ‘‘551(d), 

959(a),’’ and inserting ‘‘959(a)’’. 

(B) Subsection (e) of section 1291 is amended by inserting ‘‘(as in effect on 

the day before the date of the enactment of the American Jobs Creation Act of 

2004)’’ after ‘‘section 1246’’. 

(27) Paragraph (2) of section 1294(a) is amended to read as follows: 

‘‘(2) ELECTION NOT PERMITTED WHERE AMOUNTS OTHERWISE INCLUDIBLE

UNDER SECTION 951.—The taxpayer may not make an election under paragraph 

(1) with respect to the undistributed PFIC earnings tax liability attributable to 

a qualified electing fund for the taxable year if any amount is includible in the 

gross income of the taxpayer under section 951 with respect to such fund for 

such taxable year.’’. 

(28) Section 6035 is hereby repealed. 

(29) Subparagraph (D) of section 6103(e)(1) is amended by striking clause (iv) 

and redesignating clauses (v) and (vi) as clauses (iv) and (v), respectively. 

(30) Subparagraph (B) of section 6501(e)(1) is amended to read as follows: 

‘‘(B) CONSTRUCTIVE DIVIDENDS.—If the taxpayer omits from gross income 

an amount properly includible therein under section 951(a), the tax may be 

assessed, or a proceeding in court for the collection of such tax may be done 

without assessing, at any time within 6 years after the return was filed.’’. 

(31) Subsection (a) of section 6679 is amended—

(A) by striking ‘‘6035, 6046, and 6046A’’ in paragraph (1) and inserting 

‘‘6046 and 6046A’’, and 

(B) by striking paragraph (3). 

(32) Sections 170(f)(10)(A), 508(d), 4947, and 4948(c)(4) are each amended by 

striking ‘‘556(b)(2),’’ each place it appears. 

(33) The table of parts for subchapter G of chapter 1 is amended by striking 

the item relating to part III. 

(34) The table of sections for part IV of subchapter P of chapter 1 is amended 

by striking the items relating to sections 1246 and 1247. 

(35) The table of sections for subpart A of part III of subchapter A of chapter 

61 is amended by striking the item relating to section 6035. 

(d) EFFECTIVE DATES.—

(1) IN GENERAL.—Except as provided in paragraph (2), the amendments made 

by this section shall apply to taxable years of foreign corporations beginning 

after December 31, 2004, and to taxable years of United States shareholders 

with or within which such taxable years of foreign corporations end. 

53

(2) SUBSECTION (c)(29).—The amendments made by subsection (c)(29) shall 

apply to disclosures of return or return information with respect to taxable 

years beginning after December 31, 2004. 

SEC. 314. DETERMINATION OF FOREIGN PERSONAL HOLDING COMPANY INCOME WITH RESPECT TO TRANSACTIONS IN COMMODITIES. 

(a) IN GENERAL.—Clauses (i) and (ii) of section 954(c)(1)(C) (relating to commodity 

transactions) are amended to read as follows: ‘‘(i) arise out of commodity hedging transactions (as defined in paragraph (4)(A)), ‘‘(ii) are active business gains or losses from the sale of commodities, 

but only if substantially all of the controlled foreign corporation’s com- modities are property described in paragraph (1), (2), or (8) of section 

1221(a), or’’. (b) DEFINITION AND SPECIAL RULES.—Subsection (c) of section 954 is amended by 

adding after paragraph (3) the following new paragraph: ‘‘(4) DEFINITION AND SPECIAL RULES RELATING TO COMMODITY TRANS- ACTIONS.—‘‘(A) COMMODITY HEDGING TRANSACTIONS.—For purposes of paragraph 

(1)(C)(i), the term ‘commodity hedging transaction’ means any transaction 

with respect to a commodity if such transaction— ‘‘(i) is a hedging transaction as defined in section 1221(b)(2), determined—

‘‘(I) without regard to subparagraph (A)(ii) thereof, 

‘‘(II) by applying subparagraph (A)(i) thereof by substituting ‘or- dinary property or property described in section 1231(b)’ for ‘ordinary property’, and ‘‘(III) by substituting ‘controlled foreign corporation’ for ‘taxpayer’ each place it appears, and ‘‘(ii) is clearly identified as such in accordance with section 1221(a)(7). ‘‘(B) TREATMENT OF DEALER ACTIVITIES UNDER PARAGRAPH (1)(C).—Commodities with respect to which gains and losses are not taken into account 

under paragraph (2)(C) in computing a controlled foreign corporation’s foreign personal holding company income shall not be taken into account in 

applying the substantially all test under paragraph (1)(C)(ii) to such corporation. 

‘‘(C) REGULATIONS.—The Secretary shall prescribe such regulations as are 

appropriate to carry out the purposes of paragraph (1)(C) in the case of 

transactions involving related parties.’’. 

(c) MODIFICATION OF EXCEPTION FOR DEALERS.—Clause (i) of section 954(c)(2)(C) 

is amended by inserting ‘‘and transactions involving physical settlement’’ after ‘‘(including hedging transactions’’. 

(d) EFFECTIVE DATE.—The amendments made by this section shall apply to transactions entered into after December 31, 2004. 

SEC. 315. MODIFICATIONS TO TREATMENT OF AIRCRAFT LEASING AND SHIPPING INCOME. 

(a) ELIMINATION OF FOREIGN BASE COMPANY SHIPPING INCOME.—Section 954 (relating to foreign base company income) is amended—

(1) by striking paragraph (4) of subsection (a) (relating to foreign base company shipping income), and 

(2) by striking subsection (f) (relating to foreign base company shipping income). 

(b) SAFE HARBOR FOR CERTAIN LEASING ACTIVITIES.—Subparagraph (A) of section 

954(c)(2) is amended by adding at the end the following new sentence: ‘‘For purposes 

of the preceding sentence, rents derived from leasing an aircraft or vessel in foreign 

commerce shall not fail to be treated as derived in the active conduct of a trade or 

business if, as determined under regulations prescribed by the Secretary, the active 

leasing expenses are not less than 10 percent of the profit on the lease.’’

(c) CONFORMING AMENDMENTS.—

(1) Section 952(c)(1)(B)(iii) is amended by striking subclause (I) and redesignating subclauses (II) through (VI) as subclauses (I) through (V), respectively. 

(2) Subsection (b) of section 954 is amended—

(A) by striking ‘‘the foreign base company shipping income,’’ in paragraph 

(5), 

(B) by striking paragraphs (6) and (7), and 

(C) by redesignating paragraph (8) as paragraph (6). 

(d) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years of foreign corporations beginning after December 31, 2004, and to taxable 

years of United States shareholders with or within which such taxable years of foreign corporations end. 

54

SEC. 316. MODIFICATION OF EXCEPTIONS UNDER SUBPART F FOR ACTIVE FINANCING. 

(a) IN GENERAL.—Section 954(h)(3) is amended by adding at the end the following: ‘‘(E) DIRECT CONDUCT OF ACTIVITIES.—For purposes of subparagraph 

(A)(ii)(II), an activity shall be treated as conducted directly by an eligible 

controlled foreign corporation or qualified business unit in its home country 

if the activity is performed by employees of a related person and— ‘‘(i) the related person is an eligible controlled foreign corporation the 

home country of which is the same as the home country of the corporation or unit to which subparagraph (A)(ii)(II) is being applied, ‘‘(ii) the activity is performed in the home country of the related person, and 

‘‘(iii) the related person is compensated on an arm’s-length basis for 

the performance of the activity by its employees and such compensation 

is treated as earned by such person in its home country for purposes 

of the home country’s tax laws.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years of such foreign corporations beginning after December 31, 2004, and to taxable 

years of United States shareholders with or within which such taxable years of such 

foreign corporations end. 

TITLE IV—EXTENSION OF CERTAIN EXPIRING 

PROVISIONS 

SEC. 401. ALLOWANCE OF NONREFUNDABLE PERSONAL CREDITS AGAINST REGULAR AND 

MINIMUM TAX LIABILITY. 

(a) IN GENERAL.—Paragraph (2) of section 26(a) is amended—

(1) by striking ‘‘RULE FOR 2000, 2001, 2002, AND 2003.—’’ and inserting ‘‘RULE FOR

TAXABLE YEARS 2000 THROUGH 2005.—’’, and 

(2) by striking ‘‘or 2003,’’ and inserting ‘‘2003, 2004, or 2005,’’. 

(b) CONFORMING PROVISIONS.—

(1) Section 904(h) is amended by striking ‘‘or 2003’’ and inserting ‘‘2003, 2004, 

or 2005’’. 

(2) The amendments made by sections 201(b), 202(f), and 618(b) of the Economic Growth and Tax Relief Reconciliation Act of 2001 shall not apply to taxable years beginning during 2004 or 2005. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2003. 

SEC. 402. EXTENSION OF RESEARCH CREDIT. 

(a) EXTENSION.—

(1) IN GENERAL.—Section 41(h)(1)(B) (relating to termination) is amended by 

striking ‘‘June 30, 2004’’ and inserting ‘‘December 31, 2005’’. 

(2) CONFORMING AMENDMENT.—Section 45C(b)(1)(D) is amended by striking 

‘‘June 30, 2004’’ and inserting ‘‘December 31, 2005’’. 

(b) EFFECTIVE DATE.—The amendments made by subsection (a) shall apply to 

amounts paid or incurred after June 30, 2004. 

SEC. 403. EXTENSION OF CREDIT FOR ELECTRICITY PRODUCED FROM CERTAIN RENEWABLE 

RESOURCES. 

(a) IN GENERAL.—Subparagraphs (A) and (B) of section 45(c)(3) (defining qualified 

facility) are both amended by striking ‘‘2004’’ and inserting ‘‘2006’’. 

(b) EFFECTIVE DATE.—The amendments made by this section shall apply to facilities placed in service after December 31, 2003. 

SEC. 404. INDIAN EMPLOYMENT TAX CREDIT. 

Section 45A(f) (relating to termination) is amended by striking ‘‘December 31, 

2004’’ and inserting ‘‘December 31, 2005’’. 

SEC. 405. WORK OPPORTUNITY CREDIT. 

(a) IN GENERAL.—Subparagraph (B) of section 51(c)(4) is amended by striking ‘‘December 31, 2003’’ and inserting ‘‘December 31, 2005’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) shall apply to individuals who begin work for the employer after December 31, 2003. 

SEC. 406. WELFARE-TO-WORK CREDIT. 

(a) IN GENERAL.—Subsection (f) of section 51A is amended by striking ‘‘December 

31, 2003’’ and inserting ‘‘December 31, 2005’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) shall apply to individuals who begin work for the employer after December 31, 2003. 

55

SEC. 407. CERTAIN EXPENSES OF ELEMENTARY AND SECONDARY SCHOOL TEACHERS. 

(a) IN GENERAL.—Subparagraph (D) of section 62(a)(2) (relating to certain trade 

and business deductions of employees) is amended by striking ‘‘or 2003’’ and inserting ‘‘, 2003, 2004, or 2005’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) shall apply to taxable years beginning after December 31, 2003. 

SEC. 408. EXTENSION OF ACCELERATED DEPRECIATION BENEFIT FOR PROPERTY ON INDIAN 

RESERVATIONS. 

Paragraph (8) of section 168(j) (relating to termination) is amended by striking 

‘‘December 31, 2004’’ and inserting ‘‘December 31, 2005’’. 

SEC. 409. CHARITABLE CONTRIBUTIONS OF COMPUTER TECHNOLOGY AND EQUIPMENT USED 

FOR EDUCATIONAL PURPOSES. 

(a) IN GENERAL.—Subparagraph (G) of section 170(e)(6) (relating to special rule 

for contributions of computer technology and equipment for educational purposes) 

is amended by striking ‘‘December 31, 2003’’ and inserting ‘‘December 31, 2005’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) shall apply to taxable years beginning after December 31, 2003. 

SEC. 410. EXPENSING OF ENVIRONMENTAL REMEDIATION COSTS. 

(a) IN GENERAL.—Subsection (h) of section 198 (relating to termination) is amended by striking ‘‘December 31, 2003’’ and inserting ‘‘December 31, 2005’’. 

(b) EFFECTIVE DATE.—The amendments made by subsection (a) shall apply to expenditures paid or incurred after December 31, 2003.

SEC. 411. AVAILABILITY OF MEDICAL SAVINGS ACCOUNTS. 

(a) IN GENERAL.—Paragraphs (2) and (3)(B) of section 220(i) (defining cut-off year) 

are each amended by striking ‘‘2003’’ each place it appears in the text and headings 

and inserting ‘‘2005’’. 

(b) CONFORMING AMENDMENTS.—

(1) Paragraph (2) of section 220(j) is amended—

(A) in the text by striking ‘‘or 2002’’ each place it appears and inserting 

‘‘2002, or 2004’’, and 

(B) in the heading by striking ‘‘OR 2002’’ and inserting ‘‘2002, OR 2004’’. 

(2) Subparagraph (A) of section 220(j)(4) is amended by striking ‘‘and 2002’’

and inserting ‘‘2002, and 2004’’. 

(3) Subparagraph (C) of section 220(j)(2) is amended to read as follows: 

‘‘(C) NO LIMITATION FOR 2000 OR 2003.—The numerical limitation shall not 

apply for 2000 or 2003.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall take effect on 

January 1, 2004. 

(d) TIME FOR FILING REPORTS, ETC.—

(1) The report required by section 220(j)(4) of the Internal Revenue Code of 

1986 to be made on August 1, 2004, shall be treated as timely if made before 

the close of the 90-day period beginning on the date of the enactment of this 

Act. 

(2) The determination and publication required by section 220(j)(5) of such 

Code with respect to calendar year 2004 shall be treated as timely if made before the close of the 120-day period beginning on the date of the enactment of 

this Act. If the determination under the preceding sentence is that 2004 is a 

cut-off year under section 220(i) of such Code, the cut-off date under such section 220(i) shall be the last day of such 120-day period. 

SEC. 412. TAXABLE INCOME LIMIT ON PERCENTAGE DEPLETION FOR OIL AND NATURAL GAS 

PRODUCED FROM MARGINAL PROPERTIES. 

(a) IN GENERAL.—Subparagraph (H) of section 613A(c)(6) is amended by striking 

‘‘January 1, 2004’’ and inserting ‘‘January 1, 2006’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) shall apply to taxable years beginning after December 31, 2003. 

SEC. 413. QUALIFIED ZONE ACADEMY BONDS. 

(a) IN GENERAL.—Paragraph (1) of section 1397E(e) is amended by striking ‘‘and 

2003’’ and inserting ‘‘2003, 2004, and 2005’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) shall apply to obligations issued after the date of the enactment of this Act. 

SEC. 414. DISTRICT OF COLUMBIA. 

(a) DISTRICT OF COLUMBIA ENTERPRISE ZONE.—Subsection (f) of section 1400 is 

amended by striking ‘‘December 31, 2003’’ both places it appears and inserting ‘‘December 31, 2005’’. 

56

(b) TAX-EXEMPT ECONOMIC DEVELOPMENT BONDS.—Subsection (b) of section 

1400A is amended by striking ‘‘December 31, 2003’’ and inserting ‘‘December 31, 

2005’’. 

(c) ZERO PERCENT CAPITAL GAINS RATE.—

(1) Section 1400B is amended by striking ‘‘January 1, 2004’’ each place it appears and inserting ‘‘January 1, 2006’’. 

(2) Subsections (e)(2) and (g)(2) of section 1400B are each amended by striking ‘‘2008’’ each place it appears in the headings and text and inserting ‘‘2010’’. 

(3) Subsection (d) of section 1400F is amended by striking ‘‘December 31, 

2008’’ and inserting ‘‘December 31, 2010’’. 

(d) FIRST-TIME HOMEBUYER CREDIT.—Subsection (i) of section 1400C is amended 

by striking ‘‘January 1, 2004’’ and inserting ‘‘January 1, 2006’’. 

(e) EFFECTIVE DATES.—

(1) IN GENERAL.—Except as otherwise provided in this subsection, the amendments made by this section shall take effect on the date of the enactment of 

this Act. 

(2) TAX-EXEMPT ECONOMIC DEVELOPMENT BONDS.—The amendment made by 

subsection (b) shall apply to obligations issued after December 31, 2003. 

SEC. 415. EXTENSION OF CERTAIN NEW YORK LIBERTY ZONE BOND FINANCING. 

Subparagraph (D) of section 1400L(d)(2) is amended by striking ‘‘2005’’ and inserting ‘‘2010’’. 

SEC. 416. DISCLOSURES RELATING TO TERRORIST ACTIVITIES. 

(a) IN GENERAL.—Clause (iv) of section 6103(i)(3)(C) and subparagraph (E) of section 6103(i)(7) are both amended by striking ‘‘December 31, 2003’’ and inserting ‘‘December 31, 2005’’. 

(b) DISCLOSURE OF TAXPAYER IDENTITY TO LAW ENFORCEMENT AGENCIES INVESTIGATING TERRORISM.—Subparagraph (A) of section 6103(i)(7) is amended by adding 

at the end the following new clause: 

‘‘(v) TAXPAYER IDENTITY.—For purposes of this subparagraph, a taxpayer’s identity shall not be treated as taxpayer return information.’’. 

(c) EFFECTIVE DATES.—

(1) IN GENERAL.—The amendments made by subsection (a) shall apply to disclosures on or after the date of the enactment of this Act. 

(2) SUBSECTION (b).—The amendment made by subsection (b) shall take effect 

as if included in section 201 of the Victims of Terrorism Tax Relief Act of 2001. 

SEC. 417. DISCLOSURE OF RETURN INFORMATION RELATING TO STUDENT LOANS. 

Section 6103(l)(13)(D) (relating to termination) is amended by striking ‘‘December 

31, 2004’’ and inserting ‘‘December 31, 2005’’. 

SEC. 418. COVER OVER OF TAX ON DISTILLED SPIRITS. 

(a) IN GENERAL.—Paragraph (1) of section 7652(f) is amended by striking ‘‘January 1, 2004’’ and inserting ‘‘January 1, 2006’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) shall apply to articles brought into the United States after December 31, 2003. 

SEC. 419. JOINT REVIEW OF STRATEGIC PLANS AND BUDGET FOR THE INTERNAL REVENUE 

SERVICE. 

(a) IN GENERAL.—Paragraph (2) of section 8021(f) (relating to joint reviews) is 

amended by striking ‘‘2004’’ and inserting ‘‘2005’’. 

(b) REPORT.—Subparagraph (C) of section 8022(3) (regarding reports) is amended—

(1) by striking ‘‘2004’’ and inserting ‘‘2005’’, and 

(2) by striking ‘‘with respect to—’’ and all that follows and inserting ‘‘with respect to the matters addressed in the joint review referred to in section 

8021(f)(2).’’. 

(c) TIME FOR JOINT REVIEW.—The joint review required by section 8021(f)(2) of the 

Internal Revenue Code of 1986 to be made before June 1, 2004, shall be treated as 

timely if made before June 1, 2005. 

SEC. 420. PARITY IN THE APPLICATION OF CERTAIN LIMITS TO MENTAL HEALTH BENEFITS. 

(a) IN GENERAL.—Subsection (f) of section 9812 is amended by striking ‘‘and’’ at 

the end of paragraph (1), by striking paragraph (2), and by inserting after paragraph (1) the following new paragraphs: 

‘‘(2) on or after January 1, 2004, and before the date of the enactment of 

American Jobs Creation Act of 2004, and 

‘‘(3) after December 31, 2005.’’. 

(b) EFFECTIVE DATE.—The amendments made by this section shall apply to benefits for services furnished on or after December 31, 2003. 

57

SEC. 421. COMBINED EMPLOYMENT TAX REPORTING PROJECT. 

(a) IN GENERAL.—Paragraph (1) of section 976(b) of the Taxpayer Relief Act of 

1997 (111 Stat. 898) is amended by striking ‘‘for a period ending with the date 

which is 5 years after the date of the enactment of this Act’’ and inserting ‘‘during 

the period ending on December 31, 2005’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) shall apply to disclosures on or after the date of the enactment of this Act. 

SEC. 422. CLEAN-FUEL VEHICLES. 

(a) CREDIT FOR QUALIFIED ELECTRIC VEHICLES.—Paragraph (2) of section 30(b) 

(relating to phaseout) is amended to read as follows: 

‘‘(2) PHASEOUT.—In the case of any qualified electric vehicle placed in service 

after December 31, 2005, the credit otherwise allowable under subsection (a) 

(determined after the application of paragraph (1)) shall be reduced by 75 percent.’’. 

(b) DEDUCTION FOR QUALIFIED CLEAN-FUEL VEHICLE PROPERTY.—Subparagraph 

(B) of section 179A(b)(1) (relating to phaseout) is amended to read as follows: 

‘‘(B) PHASEOUT.—In the case of any qualified clean-fuel vehicle property 

placed in service after December 31, 2005, the limit otherwise applicable 

under subparagraph (A) shall be reduced by 75 percent.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to property placed in service after December 31, 2003. 

TITLE V—DEDUCTION OF STATE AND LOCAL 

GENERAL SALES TAXES

SEC. 501. DEDUCTION OF STATE AND LOCAL GENERAL SALES TAXES IN LIEU OF STATE AND 

LOCAL INCOME TAXES. 

(a) IN GENERAL.—Subsection (b) of section 164 (relating to definitions and special 

rules) is amended by adding at the end the following: 

‘‘(5) GENERAL SALES TAXES.—For purposes of subsection (a)—

‘‘(A) ELECTION TO DEDUCT STATE AND LOCAL SALES TAXES IN LIEU OF

STATE AND LOCAL INCOME TAXES.—

‘‘(i) IN GENERAL.—At the election of the taxpayer for the taxable year, 

subsection (a) shall be applied—

‘‘(I) without regard to the reference to State and local income 

taxes, and 

‘‘(II) as if State and local general sales taxes were referred to in 

a paragraph thereof. 

‘‘(B) DEFINITION OF GENERAL SALES TAX.—The term ‘general sales tax’

means a tax imposed at one rate with respect to the sale at retail of a broad 

range of classes of items. 

‘‘(C) SPECIAL RULES FOR FOOD, ETC.—In the case of items of food, clothing, 

medical supplies, and motor vehicles—

‘‘(i) the fact that the tax does not apply with respect to some or all 

of such items shall not be taken into account in determining whether 

the tax applies with respect to a broad range of classes of items, and 

‘‘(ii) the fact that the rate of tax applicable with respect to some or 

all of such items is lower than the general rate of tax shall not be 

taken into account in determining whether the tax is imposed at one 

rate. 

‘‘(D) ITEMS TAXED AT DIFFERENT RATES.—Except in the case of a lower 

rate of tax applicable with respect to an item described in subparagraph 

(C), no deduction shall be allowed under this paragraph for any general 

sales tax imposed with respect to an item at a rate other than the general 

rate of tax. 

‘‘(E) COMPENSATING USE TAXES.—A compensating use tax with respect to 

an item shall be treated as a general sales tax. For purposes of the preceding sentence, the term ‘compensating use tax’ means, with respect to 

any item, a tax which—

‘‘(i) is imposed on the use, storage, or consumption of such item, and 

‘‘(ii) is complementary to a general sales tax, but only if a deduction 

is allowable under this paragraph with respect to items sold at retail 

in the taxing jurisdiction which are similar to such item. 

‘‘(F) SPECIAL RULE FOR MOTOR VEHICLES.—In the case of motor vehicles, 

if the rate of tax exceeds the general rate, such excess shall be disregarded 

and the general rate shall be treated as the rate of tax. 

58

‘‘(G) SEPARATELY STATED GENERAL SALES TAXES.—If the amount of any 

general sales tax is separately stated, then, to the extent that the amount 

so stated is paid by the consumer (other than in connection with the consumer’s trade or business) to the seller, such amount shall be treated as 

a tax imposed on, and paid by, such consumer. ‘‘(H) AMOUNT OF DEDUCTION TO BE DETERMINED UNDER TABLES.— ‘‘(i) IN GENERAL.—The amount of the deduction allowed under this 

paragraph shall be determined under tables prescribed by the Secretary. ‘‘(ii) REQUIREMENTS FOR TABLES.—The tables prescribed under clause 

(i)— ‘‘(I) shall reflect the provisions of this paragraph, 

‘‘(II) shall be based on the average consumption by taxpayers on 

a State-by-State basis, as determined by the Secretary, taking into 

account filing status, number of dependents, adjusted gross income, 

and rates of State and local general sales taxation, and ‘‘(III) need only be determined with respect to adjusted gross incomes up to the applicable amount (as determined under section 

68(b)). ‘‘(I) APPLICATION OF PARAGRAPH.—This paragraph shall apply to taxable 

years beginning after December 31, 2003, and before January 1, 2006.’’. (b) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2003. 

TITLE VI—REVENUE PROVISIONS 

Subtitle A—Provisions to Reduce Tax Avoidance 

Through Individual and Corporate Expatriation 

SEC. 601. TAX TREATMENT OF EXPATRIATED ENTITIES AND THEIR FOREIGN PARENTS. 

(a) IN GENERAL.—Subchapter C of chapter 80 (relating to provisions affecting 

more than one subtitle) is amended by adding at the end the following new section: 

‘‘SEC. 7874. RULES RELATING TO EXPATRIATED ENTITIES AND THEIR FOREIGN PARENTS. 

‘‘(a) TAX ON INVERSION GAIN OF EXPATRIATED ENTITIES.— ‘‘(1) IN GENERAL.—The taxable income of an expatriated entity for any taxable 

year which includes any portion of the applicable period shall in no event be 

less than the inversion gain of the entity for the taxable year. ‘‘(2) EXPATRIATED ENTITY.—For purposes of this subsection— ‘‘(A) IN GENERAL.—The term ‘expatriated entity’ means— ‘‘(i) the domestic corporation or partnership referred to in subparagraph (B)(i) with respect to which a foreign corporation is a surrogate 

foreign corporation, and ‘‘(ii) any United States person who is related (within the meaning of 

section 267(b) or 707(b)(1)) to a domestic corporation or partnership described in clause (i). ‘‘(B) SURROGATE FOREIGN CORPORATION.—A foreign corporation shall be 

treated as a surrogate foreign corporation if, pursuant to a plan (or a series 

of related transactions)— ‘‘(i) the entity completes after March 4, 2003, the direct or indirect 

acquisition of substantially all of the properties held directly or indirectly by a domestic corporation or substantially all of the properties 

constituting a trade or business of a domestic partnership, ‘‘(ii) after the acquisition at least 60 percent of the stock (by vote or 

value) of the entity is held—

‘‘(I) in the case of an acquisition with respect to a domestic corporation, by former shareholders of the domestic corporation by 

reason of holding stock in the domestic corporation, or 

‘‘(II) in the case of an acquisition with respect to a domestic partnership, by former partners of the domestic partnership by reason 

of holding a capital or profits interest in the domestic partnership, 

and 

‘‘(iii) after the acquisition the expanded affiliated group which includes the entity does not have substantial business activities in the 

foreign country in which, or under the law of which, the entity is created or organized, when compared to the total business activities of 

such expanded affiliated group. 

59

An entity otherwise described in clause (i) with respect to any domestic corporation or partnership trade or business shall be treated as not so described if, on or before March 4, 2003, such entity acquired directly or indirectly more than half of the properties held directly or indirectly by such 

corporation or more than half of the properties constituting such partnership trade or business, as the case may be. 

‘‘(b) DEFINITIONS AND SPECIAL RULES.—

‘‘(1) EXPANDED AFFILIATED GROUP.—The term ‘expanded affiliated group’

means an affiliated group as defined in section 1504(a) but without regard to 

section 1504(b)(3), except that section 1504(a) shall be applied by substituting 

‘more than 50 percent’ for ‘at least 80 percent’ each place it appears. 

‘‘(2) CERTAIN STOCK DISREGARDED.—There shall not be taken into account in 

determining ownership under subsection (a)(2)(B)(ii)—

‘‘(A) stock held by members of the expanded affiliated group which includes the foreign corporation, or 

‘‘(B) stock of such foreign corporation which is sold in a public offering 

related to the acquisition described in subsection (a)(2)(B)(i). 

‘‘(3) PLAN DEEMED IN CERTAIN CASES.—If a foreign corporation acquires directly or indirectly substantially all of the properties of a domestic corporation 

or partnership during the 4-year period beginning on the date which is 2 years 

before the ownership requirements of subsection (a)(2)(B)(ii) are met, such actions shall be treated as pursuant to a plan. 

‘‘(4) CERTAIN TRANSFERS DISREGARDED.—The transfer of properties or liabilities (including by contribution or distribution) shall be disregarded if such 

transfers are part of a plan a principal purpose of which is to avoid the purposes of this section. 

‘‘(5) SPECIAL RULE FOR RELATED PARTNERSHIPS.—For purposes of applying 

subsection (a)(2)(B)(ii) to the acquisition of a trade or business of a domestic 

partnership, except as provided in regulations, all partnerships which are under 

common control (within the meaning of section 482) shall be treated as 1 partnership. 

‘‘(6) REGULATIONS.—The Secretary shall prescribe such regulations as may be 

appropriate to determine whether a corporation is a surrogate foreign corporation, including regulations—

‘‘(A) to treat warrants, options, contracts to acquire stock, convertible 

debt interests, and other similar interests as stock, and 

‘‘(B) to treat stock as not stock. 

‘‘(c) OTHER DEFINITIONS.—For purposes of this section—

‘‘(1) APPLICABLE PERIOD.—The term ‘applicable period’ means the period—

‘‘(A) beginning on the first date properties are acquired as part of the acquisition described in subsection (a)(2)(B)(i), and 

‘‘(B) ending on the date which is 10 years after the last date properties 

are acquired as part of such acquisition. 

‘‘(2) INVERSION GAIN.—The term ‘inversion gain’ means the income or gain 

recognized by reason of the transfer during the applicable period of stock or 

other properties by an expatriated entity, and any income received or accrued 

during the applicable period by reason of a license of any property by an expatriated entity—

‘‘(A) as part of the acquisition described in subsection (a)(2)(B)(i), or 

‘‘(B) after such acquisition if the transfer or license is to a foreign related 

person. 

Subparagraph (B) shall not apply to property described in section 1221(a)(1) in 

the hands of the expatriated entity. 

‘‘(3) FOREIGN RELATED PERSON.—The term ‘foreign related person’ means, 

with respect to any expatriated entity, a foreign person which—

‘‘(A) is related (within the meaning of section 267(b) or 707(b)(1)) to such 

entity, or 

‘‘(B) is under the same common control (within the meaning of section 

482) as such entity. 

‘‘(d) SPECIAL RULES.—

‘‘(1) CREDITS NOT ALLOWED AGAINST TAX ON INVERSION GAIN.—Credits (other 

than the credit allowed by section 901) shall be allowed against the tax imposed 

by this chapter on an expatriated entity for any taxable year described in subsection (a) only to the extent such tax exceeds the product of—

‘‘(A) the amount of the inversion gain for the taxable year, and 

‘‘(B) the highest rate of tax specified in section 11(b)(1). 

For purposes of determining the credit allowed by section 901, inversion gain 

shall be treated as from sources within the United States. 

60

‘‘(2) SPECIAL RULES FOR PARTNERSHIPS.—In the case of an expatriated entity 

which is a partnership— ‘‘(A) subsection (a)(1) shall apply at the partner rather than the partnership level, ‘‘(B) the inversion gain of any partner for any taxable year shall be equal 

to the sum of— ‘‘(i) the partner’s distributive share of inversion gain of the partnership for such taxable year, plus ‘‘(ii) gain recognized for the taxable year by the partner by reason of 

the transfer during the applicable period of any partnership interest of 

the partner in such partnership to the surrogate foreign corporation, 

and ‘‘(C) the highest rate of tax specified in the rate schedule applicable to 

the partner under this chapter shall be substituted for the rate of tax referred to in paragraph (1). ‘‘(3) COORDINATION WITH SECTION 172 AND MINIMUM TAX.—Rules similar to the 

rules of paragraphs (3) and (4) of section 860E(a) shall apply for purposes of 

subsection (a). ‘‘(4) STATUTE OF LIMITATIONS.— ‘‘(A) IN GENERAL.—The statutory period for the assessment of any deficiency attributable to the inversion gain of any taxpayer for any pre-inversion year shall not expire before the expiration of 3 years from the date the 

Secretary is notified by the taxpayer (in such manner as the Secretary may 

prescribe) of the acquisition described in subsection (a)(2)(B)(i) to which 

such gain relates and such deficiency may be assessed before the expiration 

of such 3-year period notwithstanding the provisions of any other law or 

rule of law which would otherwise prevent such assessment. ‘‘(B) PRE-INVERSION YEAR.—For purposes of subparagraph (A), the term ‘pre-inversion year’ means any taxable year if— ‘‘(i) any portion of the applicable period is included in such taxable 

year, and ‘‘(ii) such year ends before the taxable year in which the acquisition 

described in subsection (a)(2)(B)(i) is completed. ‘‘(e) SPECIAL RULE FOR TREATIES.—Nothing in section 894 or 7852(d) or in any 

other provision of law shall be construed as permitting an exemption, by reason of 

any treaty obligation of the United States heretofore or hereafter entered into, from 

the provisions of this section. ‘‘(f) REGULATIONS.—The Secretary shall provide such regulations as are necessary 

to carry out this section, including regulations providing for such adjustments to the 

application of this section as are necessary to prevent the avoidance of the purposes 

of this section, including the avoidance of such purposes through— ‘‘(1) the use of related persons, pass-through or other noncorporate entities, 

or other intermediaries, or ‘‘(2) transactions designed to have persons cease to be (or not become) members of expanded affiliated groups or related persons.’’. (b) CONFORMING AMENDMENT.—The table of sections for subchapter C of chapter 

80 is amended by adding at the end the following new item:

‘‘Sec. 7874. Rules relating to expatriated entities and their foreign parents.’’

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years ending after March 4, 2003. 

SEC. 602. EXCISE TAX ON STOCK COMPENSATION OF INSIDERS IN EXPATRIATED CORPORATIONS. 

(a) IN GENERAL.—Subtitle D is amended by inserting after chapter 44 end the following new chapter: 

‘‘CHAPTER 45—PROVISIONS RELATING TO EXPATRIATED ENTITIES

‘‘Sec. 4985. Stock compensation of insiders in expatriated corporations.

‘‘SEC. 4985. STOCK COMPENSATION OF INSIDERS IN EXPATRIATED CORPORATIONS. 

‘‘(a) IMPOSITION OF TAX.—In the case of an individual who is a disqualified individual with respect to any expatriated corporation, there is hereby imposed on such 

person a tax equal to 15 percent of the value (determined under subsection (b)) of 

the specified stock compensation held (directly or indirectly) by or for the benefit 

of such individual or a member of such individual’s family (as defined in section 

267) at any time during the 12-month period beginning on the date which is 6 

months before the expatriation date. 

‘‘(b) VALUE.—For purposes of subsection (a)—

‘‘(1) IN GENERAL.—The value of specified stock compensation shall be—

61

‘‘(A) in the case of a stock option (or other similar right) or a stock appreciation right, the fair value of such option or right, and ‘‘(B) in any other case, the fair market value of such compensation. ‘‘(2) DATE FOR DETERMINING VALUE.—The determination of value shall be 

made—

‘‘(A) in the case of specified stock compensation held on the expatriation 

date, on such date, ‘‘(B) in the case of such compensation which is canceled during the 6 

months before the expatriation date, on the day before such cancellation, 

and ‘‘(C) in the case of such compensation which is granted after the expatriation date, on the date such compensation is granted. ‘‘(c) TAX TO APPLY ONLY IF SHAREHOLDER GAIN RECOGNIZED.—Subsection (a) shall 

apply to any disqualified individual with respect to an expatriated corporation only 

if gain (if any) on any stock in such corporation is recognized in whole or part by 

any shareholder by reason of the acquisition referred to in section 7874(a)(2)(B)(i) 

with respect to such corporation. ‘‘(d) EXCEPTION WHERE GAIN RECOGNIZED ON COMPENSATION.—Subsection (a) 

shall not apply to— ‘‘(1) any stock option which is exercised on the expatriation date or during the 

6-month period before such date and to the stock acquired in such exercise, if 

income is recognized under section 83 on or before the expatriation date with 

respect to the stock acquired pursuant to such exercise, and 

‘‘(2) any other specified stock compensation which is exercised, sold, exchanged, distributed, cashed-out, or otherwise paid during such period in a 

transaction in which income, gain, or loss is recognized in full. 

‘‘(e) DEFINITIONS.—For purposes of this section—

‘‘(1) DISQUALIFIED INDIVIDUAL.—The term ‘disqualified individual’ means, 

with respect to a corporation, any individual who, at any time during the 12-

month period beginning on the date which is 6 months before the expatriation 

date—

‘‘(A) is subject to the requirements of section 16(a) of the Securities Exchange Act of 1934 with respect to such corporation or any member of the 

expanded affiliated group which includes such corporation, or 

‘‘(B) would be subject to such requirements if such corporation or member 

were an issuer of equity securities referred to in such section. 

‘‘(2) EXPATRIATED CORPORATION; EXPATRIATION DATE.—

‘‘(A) EXPATRIATED CORPORATION.—The term ‘expatriated corporation’

means any corporation which is an expatriated entity (as defined in section 

7874(a)(2)). Such term includes any predecessor or successor of such a corporation. 

‘‘(B) EXPATRIATION DATE.—The term ‘expatriation date’ means, with respect to a corporation, the date on which the corporation first becomes an 

expatriated corporation. 

‘‘(3) SPECIFIED STOCK COMPENSATION.—

‘‘(A) IN GENERAL.—The term ‘specified stock compensation’ means payment (or right to payment) granted by the expatriated corporation (or by 

any member of the expanded affiliated group which includes such corporation) to any person in connection with the performance of services by a disqualified individual for such corporation or member if the value of such 

payment or right is based on (or determined by reference to) the value (or 

change in value) of stock in such corporation (or any such member). 

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

‘‘(i) any option to which part II of subchapter D of chapter 1 applies, 

or 

‘‘(ii) any payment or right to payment from a plan referred to in section 280G(b)(6). 

‘‘(4) EXPANDED AFFILIATED GROUP.—The term ‘expanded affiliated group’

means an affiliated group (as defined in section 1504(a) without regard to section 1504(b)(3)); except that section 1504(a) shall be applied by substituting 

‘more than 50 percent’ for ‘at least 80 percent’ each place it appears. 

‘‘(f) SPECIAL RULES.—For purposes of this section—

‘‘(1) CANCELLATION OF RESTRICTION.—The cancellation of a restriction which 

by its terms will never lapse shall be treated as a grant. 

‘‘(2) PAYMENT OR REIMBURSEMENT OF TAX BY CORPORATION TREATED AS SPECI- FIED STOCK COMPENSATION.—Any payment of the tax imposed by this section directly or indirectly by the expatriated corporation or by any member of the expanded affiliated group which includes such corporation—

‘‘(A) shall be treated as specified stock compensation, and 

62

‘‘(B) shall not be allowed as a deduction under any provision of chapter 

1. ‘‘(3) CERTAIN RESTRICTIONS IGNORED.—Whether there is specified stock compensation, and the value thereof, shall be determined without regard to any restriction other than a restriction which by its terms will never lapse. ‘‘(4) PROPERTY TRANSFERS.—Any transfer of property shall be treated as a 

payment and any right to a transfer of property shall be treated as a right to 

a payment. ‘‘(5) OTHER ADMINISTRATIVE PROVISIONS.—For purposes of subtitle F, any tax 

imposed by this section shall be treated as a tax imposed by subtitle A. ‘‘(g) REGULATIONS.—The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section.’’ (b) DENIAL OF DEDUCTION.— (1) IN GENERAL.—Paragraph (6) of section 275(a) is amended by inserting ‘‘45,’’ before ‘‘46,’’. (2) $1,000,000 LIMIT ON DEDUCTIBLE COMPENSATION REDUCED BY PAYMENT OF

EXCISE TAX ON SPECIFIED STOCK COMPENSATION.—Paragraph (4) of section 

162(m) is amended by adding at the end the following new subparagraph: ‘‘(G) COORDINATION WITH EXCISE TAX ON SPECIFIED STOCK COMPENSA- TION.—The dollar limitation contained in paragraph (1) with respect to any 

covered employee shall be reduced (but not below zero) by the amount of 

any payment (with respect to such employee) of the tax imposed by section 

4985 directly or indirectly by the expatriated corporation (as defined in 

such section) or by any member of the expanded affiliated group (as defined 

in such section) which includes such corporation.’’

(c) CONFORMING AMENDMENTS.—

(1) The last sentence of section 3121(v)(2)(A) is amended by inserting before 

the period ‘‘or to any specified stock compensation (as defined in section 4985) 

on which tax is imposed by section 4985’’. 

(2) The table of chapters for subtitle D is amended by inserting after the item 

relating to chapter 44 the following new item:

‘‘Chapter 45. Provisions relating to expatriated entities.’’

(d) EFFECTIVE DATE.—The amendments made by this section shall take effect on 

March 4, 2003; except that periods before such date shall not be taken into account 

in applying the periods in subsections (a) and (e)(1) of section 4985 of the Internal 

Revenue Code of 1986, as added by this section. 

SEC. 603. REINSURANCE OF UNITED STATES RISKS IN FOREIGN JURISDICTIONS. 

(a) IN GENERAL.—Section 845(a) (relating to allocation in case of reinsurance 

agreement involving tax avoidance or evasion) is amended by striking ‘‘source and 

character’’ and inserting ‘‘amount, source, or character’’. 

(b) EFFECTIVE DATE.—The amendments made by this section shall apply to any 

risk reinsured after the date of the enactment of this Act. 

SEC. 604. REVISION OF TAX RULES ON EXPATRIATION OF INDIVIDUALS. 

(a) EXPATRIATION TO AVOID TAX.—

(1) IN GENERAL.—Subsection (a) of section 877 (relating to treatment of expatriates) is amended to read as follows: 

‘‘(a) TREATMENT OF EXPATRIATES.—

‘‘(1) IN GENERAL.—Every nonresident alien individual to whom this section 

applies and who, within the 10-year period immediately preceding the close of 

the taxable year, lost United States citizenship shall be taxable for such taxable 

year in the manner provided in subsection (b) if the tax imposed pursuant to 

such subsection (after any reduction in such tax under the last sentence of such 

subsection) exceeds the tax which, without regard to this section, is imposed 

pursuant to section 871. 

‘‘(2) INDIVIDUALS SUBJECT TO THIS SECTION.—This section shall apply to any 

individual if—

‘‘(A) the average annual net income tax (as defined in section 38(c)(1)) of 

such individual for the period of 5 taxable years ending before the date of 

the loss of United States citizenship is greater than $124,000, 

‘‘(B) the net worth of the individual as of such date is $2,000,000 or more, 

or 

‘‘(C) such individual fails to certify under penalty of perjury that he has 

met the requirements of this title for the 5 preceding taxable years or fails 

to submit such evidence of such compliance as the Secretary may require. 

In the case of the loss of United States citizenship in any calendar year after 

2004, such $124,000 amount shall be increased by an amount equal to such dollar amount multiplied by the cost-of-living adjustment determined under section 

63

1(f)(3) for such calendar year by substituting ‘2003’ for ‘1992’ in subparagraph 

(B) thereof. Any increase under the preceding sentence shall be rounded to the 

nearest multiple of $1,000.’’. (2) REVISION OF EXCEPTIONS FROM ALTERNATIVE TAX.—Subsection (c) of section 877 (relating to tax avoidance not presumed in certain cases) is amended 

to read as follows: ‘‘(c) EXCEPTIONS.— ‘‘(1) IN GENERAL.—Subparagraphs (A) and (B) of subsection (a)(2) shall not 

apply to an individual described in paragraph (2) or (3). ‘‘(2) DUAL CITIZENS.— ‘‘(A) IN GENERAL.—An individual is described in this paragraph if— ‘‘(i) the individual became at birth a citizen of the United States and 

a citizen of another country and continues to be a citizen of such other 

country, and ‘‘(ii) the individual has had no substantial contacts with the United 

States. ‘‘(B) SUBSTANTIAL CONTACTS.—An individual shall be treated as having no 

substantial contacts with the United States only if the individual— ‘‘(i) was never a resident of the United States (as defined in section 

7701(b)), ‘‘(ii) has never held a United States passport, and 

‘‘(iii) was not present in the United States for more than 30 days during any calendar year which is 1 of the 10 calendar years preceding the 

individual’s loss of United States citizenship. 

‘‘(3) CERTAIN MINORS.—An individual is described in this paragraph if—

‘‘(A) the individual became at birth a citizen of the United States, 

‘‘(B) neither parent of such individual was a citizen of the United States 

at the time of such birth, 

‘‘(C) the individual’s loss of United States citizenship occurs before such 

individual attains age 181⁄2, and 

‘‘(D) the individual was not present in the United States for more than 

30 days during any calendar year which is 1 of the 10 calendar years preceding the individual’s loss of United States citizenship.’’. 

(3) CONFORMING AMENDMENT.—Section 2107(a) is amended to read as follows: 

‘‘(a) TREATMENT OF EXPATRIATES.—A tax computed in accordance with the table 

contained in section 2001 is hereby imposed on the transfer of the taxable estate, 

determined as provided in section 2106, of every decedent nonresident not a citizen 

of the United States if the date of death occurs during a taxable year with respect 

to which the decedent is subject to tax under section 877(b).’’. 

(b) SPECIAL RULES FOR DETERMINING WHEN AN INDIVIDUAL IS NO LONGER A

UNITED STATES CITIZEN OR LONG-TERM RESIDENT.—Section 7701 (relating to definitions) is amended by redesignating subsection (n) as subsection (o) and by inserting 

after subsection (m) the following new subsection: 

‘‘(n) SPECIAL RULES FOR DETERMINING WHEN AN INDIVIDUAL IS NO LONGER A

UNITED STATES CITIZEN OR LONG-TERM RESIDENT.—An individual who would (but 

for this subsection) cease to be treated as a citizen or resident of the United States 

shall continue to be treated as a citizen or resident of the United States, as the case 

may be, until such individual—

‘‘(1) gives notice of an expatriating act or termination of residency (with the 

requisite intent to relinquish citizenship or terminate residency) to the Secretary of State or the Secretary of Homeland Security, and 

‘‘(2) provides a statement in accordance with section 6039G.’’. 

(c) PHYSICAL PRESENCE IN THE UNITED STATES FOR MORE THAN 30 DAYS.—Section 

877 (relating to expatriation to avoid tax) is amended by adding at the end the following new subsection: 

‘‘(g) PHYSICAL PRESENCE.—

‘‘(1) IN GENERAL.—This section shall not apply to any individual to whom this 

section would otherwise apply for any taxable year during the 10-year period 

referred to in subsection (a) in which such individual is physically present in 

the United States at any time on more than 30 days in the calendar year ending in such taxable year, and such individual shall be treated for purposes of 

this title as a citizen or resident of the United States, as the case may be, for 

such taxable year. 

‘‘(2) EXCEPTION.—

‘‘(A) IN GENERAL.—In the case of an individual described in any of the following subparagraphs of this paragraph, a day of physical presence in the 

United States shall be disregarded if the individual is performing services 

in the United States on such day for an employer. The preceding sentence 

shall not apply if—

64

‘‘(i) such employer is related (within the meaning of section 267 and 

707) to such individual, or 

‘‘(ii) such employer fails to meet such requirements as the Secretary 

may prescribe by regulations to prevent the avoidance of the purposes 

of this paragraph. 

Not more than 30 days during any calendar year may be disregarded under 

this subparagraph. 

‘‘(B) INDIVIDUALS WITH TIES TO OTHER COUNTRIES.—An individual is described in this subparagraph if—

‘‘(i) the individual becomes (not later than the close of a reasonable 

period after loss of United States citizenship or termination of residency) a citizen or resident of the country in which—

‘‘(I) such individual was born, 

‘‘(II) if such individual is married, such individual’s spouse was 

born, or 

‘‘(III) either of such individual’s parents were born, and 

‘‘(ii) the individual becomes fully liable for income tax in such country. 

‘‘(C) MINIMAL PRIOR PHYSICAL PRESENCE IN THE UNITED STATES.—An individual is described in this subparagraph if, for each year in the 10-year period ending on the date of loss of United States citizenship or termination 

of residency, the individual was physically present in the United States for 

30 days or less. The rule of section 7701(b)(3)(D)(ii) shall apply for purposes 

of this subparagraph.’’. 

(d) TRANSFERS SUBJECT TO GIFT TAX.—

(1) IN GENERAL.—Subsection (a) of section 2501 (relating to taxable transfers) 

is amended by striking paragraph (4), by redesignating paragraph (5) as paragraph (4), and by striking paragraph (3) and inserting the following new paragraph: 

‘‘(3) EXCEPTION.—

‘‘(A) CERTAIN INDIVIDUALS.—Paragraph (2) shall not apply in the case of 

a donor to whom section 877(b) applies for the taxable year which includes 

the date of the transfer. 

‘‘(B) CREDIT FOR FOREIGN GIFT TAXES.—The tax imposed by this section 

solely by reason of this paragraph shall be credited with the amount of any 

gift tax actually paid to any foreign country in respect of any gift which is 

taxable under this section solely by reason of this paragraph.’’

(2) TRANSFERS OF CERTAIN STOCK.—Subsection (a) of section 2501 is amended 

by adding at the end the following new paragraph: 

‘‘(5) TRANSFERS OF CERTAIN STOCK.—

‘‘(A) IN GENERAL.—In the case of a transfer of stock in a foreign corporation described in subparagraph (B) by a donor to whom section 877(b) applies for the taxable year which includes the date of the transfer—

‘‘(i) section 2511(a) shall be applied without regard to whether such 

stock is situated within the United States, and 

‘‘(ii) the value of such stock for purposes of this chapter shall be its 

U.S.-asset value determined under subparagraph (C). 

‘‘(B) FOREIGN CORPORATION DESCRIBED.—A foreign corporation is described in this subparagraph with respect to a donor if—

‘‘(i) the donor owned (within the meaning of section 958(a)) at the 

time of such transfer 10 percent or more of the total combined voting 

power of all classes of stock entitled to vote of the foreign corporation, 

and 

‘‘(ii) such donor owned (within the meaning of section 958(a)), or is 

considered to have owned (by applying the ownership rules of section 

958(b)), at the time of such transfer, more than 50 percent of—

‘‘(I) the total combined voting power of all classes of stock entitled to vote of such corporation, or 

‘‘(II) the total value of the stock of such corporation. 

‘‘(C) U.S.-ASSET VALUE.—For purposes of subparagraph (A), the U.S.-asset 

value of stock shall be the amount which bears the same ratio to the fair 

market value of such stock at the time of transfer as—

‘‘(i) the fair market value (at such time) of the assets owned by such 

foreign corporation and situated in the United States, bears to ‘‘(ii) the total fair market value (at such time) of all assets owned by 

such foreign corporation.’’

(e) ENHANCED INFORMATION REPORTING FROM INDIVIDUALS LOSING UNITED

STATES CITIZENSHIP.—

65

(1) IN GENERAL.—Subsection (a) of section 6039G is amended to read as follows: ‘‘(a) IN GENERAL.—Notwithstanding any other provision of law, any individual to 

whom section 877(b) applies for any taxable year shall provide a statement for such 

taxable year which includes the information described in subsection (b).’’. (2) INFORMATION TO BE PROVIDED.—Subsection (b) of section 6039G is amended to read as follows: ‘‘(b) INFORMATION TO BE PROVIDED.—Information required under subsection (a) 

shall include— ‘‘(1) the taxpayer’s TIN, ‘‘(2) the mailing address of such individual’s principal foreign residence, ‘‘(3) the foreign country in which such individual is residing, 

‘‘(4) the foreign country of which such individual is a citizen, 

‘‘(5) information detailing the income, assets, and liabilities of such individual, 

‘‘(6) the number of days during any portion of which that the individual was 

physically present in the United States during the taxable year, and ‘‘(7) such other information as the Secretary may prescribe.’’. (3) INCREASE IN PENALTY.—Subsection (d) of section 6039G is amended to 

read as follows: ‘‘(d) PENALTY.—If— ‘‘(1) an individual is required to file a statement under subsection (a) for any 

taxable year, and ‘‘(2) fails to file such a statement with the Secretary on or before the date 

such statement is required to be filed or fails to include all the information required to be shown on the statement or includes incorrect information, such individual shall pay a penalty of $10,000 unless it is shown that such failure 

is due to reasonable cause and not to willful neglect.’’. (4) CONFORMING AMENDMENT.—Section 6039G is amended by striking subsections (c), (f), and (g) and by redesignating subsections (d) and (e) as subsection (c) and (d), respectively. 

(f) EFFECTIVE DATE.—The amendments made by this section shall apply to individuals who expatriate after June 3, 2004. 

SEC. 605. REPORTING OF TAXABLE MERGERS AND ACQUISITIONS. 

(a) IN GENERAL.—Subpart B of part III of subchapter A of chapter 61 is amended 

by inserting after section 6043 the following new section: 

‘‘SEC. 6043A. RETURNS RELATING TO TAXABLE MERGERS AND ACQUISITIONS. 

‘‘(a) IN GENERAL.—According to the forms or regulations prescribed by the Secretary, the acquiring corporation in any taxable acquisition shall make a return setting forth— ‘‘(1) a description of the acquisition, 

‘‘(2) the name and address of each shareholder of the acquired corporation 

who is required to recognize gain (if any) as a result of the acquisition, 

‘‘(3) the amount of money and the fair market value of other property transferred to each such shareholder as part of such acquisition, and 

‘‘(4) such other information as the Secretary may prescribe. 

To the extent provided by the Secretary, the requirements of this section applicable 

to the acquiring corporation shall be applicable to the acquired corporation and not 

to the acquiring corporation. 

‘‘(b) NOMINEES.—According to the forms or regulations prescribed by the Secretary—

‘‘(1) REPORTING.—Any person who holds stock as a nominee for another person shall furnish in the manner prescribed by the Secretary to such other person the information provided by the corporation under subsection (d). 

‘‘(2) REPORTING TO NOMINEES.—In the case of stock held by any person as a 

nominee, references in this section (other than in subsection (c)) to a shareholder shall be treated as a reference to the nominee. 

‘‘(c) TAXABLE ACQUISITION.—For purposes of this section, the term ‘taxable acquisition’ means any acquisition by a corporation of stock in or property of another corporation if any shareholder of the acquired corporation is required to recognize gain 

(if any) as a result of such acquisition. 

‘‘(d) STATEMENTS TO BE FURNISHED TO SHAREHOLDERS.—According to the forms 

or regulations prescribed by the Secretary, every person required to make a return 

under subsection (a) shall furnish to each shareholder whose name is required to 

be set forth in such return a written statement showing—

‘‘(1) the name, address, and phone number of the information contact of the 

person required to make such return, 

‘‘(2) the information required to be shown on such return with respect to such 

shareholder, and 

66

‘‘(3) such other information as the Secretary may prescribe. 

The written statement required under the preceding sentence shall be furnished to 

the shareholder on or before January 31 of the year following the calendar year during which the taxable acquisition occurred.’’

(b) ASSESSABLE PENALTIES.—

(1) Subparagraph (B) of section 6724(d)(1) (relating to definitions) is amended 

by redesignating clauses (ii) through (xviii) as clauses (iii) through (xix), respectively, and by inserting after clause (i) the following new clause: 

‘‘(ii) section 6043A(a) (relating to returns relating to taxable mergers 

and acquisitions),’’. 

(2) Paragraph (2) of section 6724(d) is amended by redesignating subparagraphs (F) through (BB) as subparagraphs (G) through (CC), respectively, and 

by inserting after subparagraph (E) the following new subparagraph: 

‘‘(F) subsections (b) and (d) of section 6043A (relating to returns relating 

to taxable mergers and acquisitions).’’. 

(c) CLERICAL AMENDMENT.—The table of sections for subpart B of part III of subchapter A of chapter 61 is amended by inserting after the item relating to section 

6043 the following new item:

‘‘Sec. 6043A. Returns relating to taxable mergers and acquisitions.’’.

(d) EFFECTIVE DATE.—The amendments made by this section shall apply to acquisitions after the date of the enactment of this Act. 

SEC. 606. STUDIES. 

(a) TRANSFER PRICING RULES.—The Secretary of the Treasury or the Secretary’s 

delegate shall conduct a study regarding the effectiveness of current transfer pricing 

rules and compliance efforts in ensuring that cross-border transfers and other related-party transactions, particularly transactions involving intangible assets, service contracts, or leases cannot be used improperly to shift income out of the United 

States. The study shall include a review of the contemporaneous documentation and 

penalty rules under section 6662 of the Internal Revenue Code of 1986, a review 

of the regulatory and administrative guidance implementing the principles of section 482 of such Code to transactions involving intangible property and services and 

to cost-sharing arrangements, and an examination of whether increased disclosure 

of cross-border transactions should be required. The study shall set forth specific 

recommendations to address all abuses identified in the study. Not later than June 

30, 2005, such Secretary or delegate shall submit to the Congress a report of such 

study. 

(b) INCOME TAX TREATIES.—The Secretary of the Treasury or the Secretary’s delegate shall conduct a study of United States income tax treaties to identify any inappropriate reductions in United States withholding tax that provide opportunities for 

shifting income out of the United States, and to evaluate whether existing antiabuse mechanisms are operating properly. The study shall include specific recommendations to address all inappropriate uses of tax treaties. Not later than June 

30, 2005, such Secretary or delegate shall submit to the Congress a report of such 

study. 

(c) IMPACT OF CORPORATE EXPATRIATION PROVISIONS.—The Secretary of the Treasury or the Secretary’s delegate shall conduct a study of the impact of the provisions 

of this title on corporate expatriation. The study shall include such recommendations as such Secretary or delegate may have to improve the impact of such provisions in carrying out the purposes of this title. Not later than December 31, 2005, 

such Secretary or delegate shall submit to the Congress a report of such study. 

Subtitle B—Provisions Relating to Tax Shelters 

Part I—Taxpayer-Related Provisions 

SEC. 611. PENALTY FOR FAILING TO DISCLOSE REPORTABLE TRANSACTIONS. 

(a) IN GENERAL.—Part I of subchapter B of chapter 68 (relating to assessable penalties) is amended by inserting after section 6707 the following new section: 

‘‘SEC. 6707A. PENALTY FOR FAILURE TO INCLUDE REPORTABLE TRANSACTION INFORMATION 

WITH RETURN. 

‘‘(a) IMPOSITION OF PENALTY.—Any person who fails to include on any return or 

statement any information with respect to a reportable transaction which is required under section 6011 to be included with such return or statement shall pay 

a penalty in the amount determined under subsection (b). 

‘‘(b) AMOUNT OF PENALTY.—

67

‘‘(1) IN GENERAL.—Except as provided in paragraph (2), the amount of the 

penalty under subsection (a) shall be—

‘‘(A) $10,000 in the case of a natural person, and 

‘‘(B) $50,000 in any other case. 

‘‘(2) LISTED TRANSACTION.—The amount of the penalty under subsection (a) 

with respect to a listed transaction shall be—

‘‘(A) $100,000 in the case of a natural person, and 

‘‘(B) $200,000 in any other case. 

‘‘(c) DEFINITIONS.—For purposes of this section—

‘‘(1) REPORTABLE TRANSACTION.—The term ‘reportable transaction’ means any 

transaction with respect to which information is required to be included with 

a return or statement because, as determined under regulations prescribed 

under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion. 

‘‘(2) LISTED TRANSACTION.—The term ‘listed transaction’ means a reportable 

transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes 

of section 6011. 

‘‘(d) AUTHORITY TO RESCIND PENALTY.—

‘‘(1) IN GENERAL.—The Commissioner of Internal Revenue may rescind all or 

any portion of any penalty imposed by this section with respect to any violation 

if—

‘‘(A) the violation is with respect to a reportable transaction other than 

a listed transaction, and 

‘‘(B) rescinding the penalty would promote compliance with the requirements of this title and effective tax administration. 

‘‘(2) NO JUDICIAL APPEAL.—Notwithstanding any other provision of law, any 

determination under this subsection may not be reviewed in any judicial proceeding. 

‘‘(3) RECORDS.—If a penalty is rescinded under paragraph (1), the Commissioner shall place in the file in the Office of the Commissioner the opinion of 

the Commissioner or the head of the Office of Tax Shelter Analysis with respect 

to the determination, including—

‘‘(A) a statement of the facts and circumstances relating to the violation, 

‘‘(B) the reasons for the rescission, and 

‘‘(C) the amount of the penalty rescinded. 

‘‘(e) COORDINATION WITH OTHER PENALTIES.—The penalty imposed by this section 

shall be in addition to any other penalty imposed by this title.’’

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

of chapter 68 is amended by inserting after the item relating to section 6707 the 

following:

‘‘Sec. 6707A. Penalty for failure to include reportable transaction information with return.’’

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to returns and statements the due date for which is after the date of the enactment of 

this Act. 

(d) REPORT.—The Commissioner of Internal Revenue shall annually report to the 

Committee on Ways and Means of the House of Representatives and the Committee 

on Finance of the Senate—

(1) a summary of the total number and aggregate amount of penalties imposed, and rescinded, under section 6707A of the Internal Revenue Code of 

1986, and 

(2) a description of each penalty rescinded under section 6707(c) of such Code 

and the reasons therefor. 

SEC. 612. ACCURACY-RELATED PENALTY FOR LISTED TRANSACTIONS, OTHER REPORTABLE 

TRANSACTIONS HAVING A SIGNIFICANT TAX AVOIDANCE PURPOSE, ETC. 

(a) IN GENERAL.—Subchapter A of chapter 68 is amended by inserting after section 6662 the following new section: 

‘‘SEC. 6662A. IMPOSITION OF ACCURACY-RELATED PENALTY ON UNDERSTATEMENTS WITH 

RESPECT TO REPORTABLE TRANSACTIONS. 

‘‘(a) IMPOSITION OF PENALTY.—If a taxpayer has a reportable transaction understatement for any taxable year, there shall be added to the tax an amount equal 

to 20 percent of the amount of such understatement. 

‘‘(b) REPORTABLE TRANSACTION UNDERSTATEMENT.—For purposes of this section—

‘‘(1) IN GENERAL.—The term ‘reportable transaction understatement’ means 

the sum of—

‘‘(A) the product of—

68

‘‘(i) the amount of the increase (if any) in taxable income which results from a difference between the proper tax treatment of an item to 

which this section applies and the taxpayer’s treatment of such item (as 

shown on the taxpayer’s return of tax), and ‘‘(ii) the highest rate of tax imposed by section 1 (section 11 in the 

case of a taxpayer which is a corporation), and ‘‘(B) the amount of the decrease (if any) in the aggregate amount of credits determined under subtitle A which results from a difference between the 

taxpayer’s treatment of an item to which this section applies (as shown on 

the taxpayer’s return of tax) and the proper tax treatment of such item. 

For purposes of subparagraph (A), any reduction of the excess of deductions allowed for the taxable year over gross income for such year, and any reduction 

in the amount of capital losses which would (without regard to section 1211) 

be allowed for such year, shall be treated as an increase in taxable income. ‘‘(2) ITEMS TO WHICH SECTION APPLIES.—This section shall apply to any item 

which is attributable to— ‘‘(A) any listed transaction, and 

‘‘(B) any reportable transaction (other than a listed transaction) if a significant purpose of such transaction is the avoidance or evasion of Federal 

income tax. ‘‘(c) HIGHER PENALTY FOR NONDISCLOSED TRANSACTIONS.—Subsection (a) shall be 

applied by substituting ‘30 percent’ for ‘20 percent’ with respect to the portion of 

any reportable transaction understatement with respect to which the requirement 

of section 6664(d)(2)(A) is not met. 

‘‘(d) DEFINITIONS OF REPORTABLE AND LISTED TRANSACTIONS.—For purposes of 

this section, the terms ‘reportable transaction’ and ‘listed transaction’ have the respective meanings given to such terms by section 6707A(c). 

‘‘(e) SPECIAL RULES.—

‘‘(1) COORDINATION WITH PENALTIES, ETC., ON OTHER UNDERSTATEMENTS.—In 

the case of an understatement (as defined in section 6662(d)(2))—

‘‘(A) the amount of such understatement (determined without regard to 

this paragraph) shall be increased by the aggregate amount of reportable 

transaction understatements for purposes of determining whether such understatement is a substantial understatement under section 6662(d)(1), and 

‘‘(B) the addition to tax under section 6662(a) shall apply only to the excess of the amount of the substantial understatement (if any) after the application of subparagraph (A) over the aggregate amount of reportable 

transaction understatements. 

‘‘(2) COORDINATION WITH OTHER PENALTIES.—

‘‘(A) APPLICATION OF FRAUD PENALTY.—References to an underpayment in 

section 6663 shall be treated as including references to a reportable transaction understatement. 

‘‘(B) NO DOUBLE PENALTY.—This section shall not apply to any portion of 

an understatement on which a penalty is imposed under section 6663. 

‘‘(3) SPECIAL RULE FOR AMENDED RETURNS.—Except as provided in regulations, in no event shall any tax treatment included with an amendment or supplement to a return of tax be taken into account in determining the amount of 

any reportable transaction understatement if the amendment or supplement is 

filed after the earlier of the date the taxpayer is first contacted by the Secretary 

regarding the examination of the return or such other date as is specified by 

the Secretary.’’

(b) DETERMINATION OF OTHER UNDERSTATEMENTS.—Subparagraph (A) of section 

6662(d)(2) is amended by adding at the end the following flush sentence: 

‘‘The excess under the preceding sentence shall be determined without regard to items to which section 6662A applies.’’

(c) REASONABLE CAUSE EXCEPTION.—

(1) IN GENERAL.—Section 6664 is amended by adding at the end the following 

new subsection: 

‘‘(d) REASONABLE CAUSE EXCEPTION FOR REPORTABLE TRANSACTION UNDERSTATEMENTS.—

‘‘(1) IN GENERAL.—No penalty shall be imposed under section 6662A with respect to any portion of a reportable transaction understatement if it is shown 

that there was a reasonable cause for such portion and that the taxpayer acted 

in good faith with respect to such portion. 

‘‘(2) SPECIAL RULES.—Paragraph (1) shall not apply to any reportable transaction understatement unless—

‘‘(A) the relevant facts affecting the tax treatment of the item are adequately disclosed in accordance with the regulations prescribed under section 6011, 

69

‘‘(B) there is or was substantial authority for such treatment, and 

‘‘(C) the taxpayer reasonably believed that such treatment was more likely than not the proper treatment. 

A taxpayer failing to adequately disclose in accordance with section 6011 shall 

be treated as meeting the requirements of subparagraph (A) if the penalty for 

such failure was rescinded under section 6707A(d). 

‘‘(3) RULES RELATING TO REASONABLE BELIEF.—For purposes of paragraph 

(2)(C)—

‘‘(A) IN GENERAL.—A taxpayer shall be treated as having a reasonable belief with respect to the tax treatment of an item only if such belief—

‘‘(i) is based on the facts and law that exist at the time the return 

of tax which includes such tax treatment is filed, and 

‘‘(ii) relates solely to the taxpayer’s chances of success on the merits 

of such treatment and does not take into account the possibility that 

a return will not be audited, such treatment will not be raised on audit, 

or such treatment will be resolved through settlement if it is raised. 

‘‘(B) CERTAIN OPINIONS MAY NOT BE RELIED UPON.—

‘‘(i) IN GENERAL.—An opinion of a tax advisor may not be relied upon 

to establish the reasonable belief of a taxpayer if—

‘‘(I) the tax advisor is described in clause (ii), or 

‘‘(II) the opinion is described in clause (iii). 

‘‘(ii) DISQUALIFIED TAX ADVISORS.—A tax advisor is described in this 

clause if the tax advisor—

‘‘(I) is a material advisor (within the meaning of section 

6111(b)(1)) and participates in the organization, management, promotion, or sale of the transaction or is related (within the meaning 

of section 267(b) or 707(b)(1)) to any person who so participates, 

‘‘(II) is compensated directly or indirectly by a material advisor 

with respect to the transaction, 

‘‘(III) has a fee arrangement with respect to the transaction 

which is contingent on all or part of the intended tax benefits from 

the transaction being sustained, or 

‘‘(IV) as determined under regulations prescribed by the Secretary, has a disqualifying financial interest with respect to the 

transaction. 

‘‘(iii) DISQUALIFIED OPINIONS.—For purposes of clause (i), an opinion 

is disqualified if the opinion—

‘‘(I) is based on unreasonable factual or legal assumptions (including assumptions as to future events), 

‘‘(II) unreasonably relies on representations, statements, findings, or agreements of the taxpayer or any other person, 

‘‘(III) does not identify and consider all relevant facts, or 

‘‘(IV) fails to meet any other requirement as the Secretary may 

prescribe.’’

(2) CONFORMING AMENDMENTS.—

(A) Paragraph (1) of section 6664(c) is amended by striking ‘‘this part’’

and inserting ‘‘section 6662 or 6663’’. 

(B) The heading for subsection (c) of section 6664 is amended by inserting 

‘‘FOR UNDERPAYMENTS’’ after ‘‘EXCEPTION’’. 

(d) REDUCTION IN PENALTY FOR SUBSTANTIAL UNDERSTATEMENT OF INCOME TAX

NOT TO APPLY TO TAX SHELTERS.—Subparagraph (C) of section 6662(d)(2) (relating 

to substantial understatement of income tax) is amended to read as follows: 

‘‘(C) REDUCTION NOT TO APPLY TO TAX SHELTERS.—

‘‘(i) IN GENERAL.—Subparagraph (B) shall not apply to any item attributable to a tax shelter. 

‘‘(ii) TAX SHELTER.—For purposes of clause (i), the term ‘tax shelter’

means—

‘‘(I) a partnership or other entity, 

‘‘(II) any investment plan or arrangement, or 

‘‘(III) any other plan or arrangement, 

if a significant purpose of such partnership, entity, plan, or arrangement is the avoidance or evasion of Federal income tax.’’

(e) CONFORMING AMENDMENTS.—

(1) Sections 461(i)(3)(C), 1274(b)(3), and 7525(b) are each amended by striking 

‘‘section 6662(d)(2)(C)(iii)’’ and inserting ‘‘section 6662(d)(2)(C)(ii)’’. 

(2) The heading for section 6662 is amended to read as follows: 

70

‘‘SEC. 6662. IMPOSITION OF ACCURACY-RELATED PENALTY ON UNDERPAYMENTS.’’

(3) The table of sections for part II of subchapter A of chapter 68 is amended 

by striking the item relating to section 6662 and inserting the following new 

items:

‘‘Sec. 6662. Imposition of accuracy-related penalty on underpayments. 

‘‘Sec. 6662A. Imposition of accuracy-related penalty on understatements with respect to reportable transactions.’’

(f) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years ending after the date of the enactment of this Act. 

SEC. 613. TAX SHELTER EXCEPTION TO CONFIDENTIALITY PRIVILEGES RELATING TO TAXPAYER COMMUNICATIONS. 

(a) IN GENERAL.—Section 7525(b) (relating to section not to apply to communications regarding corporate tax shelters) is amended to read as follows: 

‘‘(b) SECTION NOT TO APPLY TO COMMUNICATIONS REGARDING TAX SHELTERS.—

The privilege under subsection (a) shall not apply to any written communication 

which is—

‘‘(1) between a federally authorized tax practitioner and—

‘‘(A) any person, 

‘‘(B) any director, officer, employee, agent, or representative of the person, 

or 

‘‘(C) any other person holding a capital or profits interest in the person, 

and 

‘‘(2) in connection with the promotion of the direct or indirect participation of 

the person in any tax shelter (as defined in section 6662(d)(2)(C)(ii)).’’

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to communications made on or after the date of the enactment of this Act. 

SEC. 614. STATUTE OF LIMITATIONS FOR TAXABLE YEARS FOR WHICH REQUIRED LISTED 

TRANSACTIONS NOT REPORTED. 

(a) IN GENERAL.—Section 6501(c) (relating to exceptions) is amended by adding 

at the end the following new paragraph: 

‘‘(10) LISTED TRANSACTIONS.—If a taxpayer fails to include on any return or 

statement for any taxable year any information with respect to a listed transaction (as defined in section 6707A(c)(2)) which is required under section 6011 

to be included with such return or statement, the time for assessment of any 

tax imposed by this title with respect to such transaction shall not expire before 

the date which is 1 year after the earlier of—

‘‘(A) the date on which the Secretary is furnished the information so required, or 

‘‘(B) the date that a material advisor (as defined in section 6111) meets 

the requirements of section 6112 with respect to a request by the Secretary 

under section 6112(b) relating to such transaction with respect to such taxpayer.’’

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years with respect to which the period for assessing a deficiency did not expire before the date of the enactment of this Act. 

SEC. 615. DISCLOSURE OF REPORTABLE TRANSACTIONS. 

(a) IN GENERAL.—Section 6111 (relating to registration of tax shelters) is amended 

to read as follows: 

‘‘SEC. 6111. DISCLOSURE OF REPORTABLE TRANSACTIONS. 

‘‘(a) IN GENERAL.—Each material advisor with respect to any reportable transaction shall make a return (in such form as the Secretary may prescribe) setting 

forth—

‘‘(1) information identifying and describing the transaction, 

‘‘(2) information describing any potential tax benefits expected to result from 

the transaction, and 

‘‘(3) such other information as the Secretary may prescribe. 

Such return shall be filed not later than the date specified by the Secretary. 

‘‘(b) DEFINITIONS.—For purposes of this section—

‘‘(1) MATERIAL ADVISOR.—

‘‘(A) IN GENERAL.—The term ‘material advisor’ means any person—

‘‘(i) who provides any material aid, assistance, or advice with respect 

to organizing, managing, promoting, selling, implementing, or carrying 

out any reportable transaction, and 

‘‘(ii) who directly or indirectly derives gross income in excess of the 

threshold amount (or such other amount as may be prescribed by the 

Secretary) for such advice or assistance. 

71

‘‘(B) THRESHOLD AMOUNT.—For purposes of subparagraph (A), the threshold amount is— ‘‘(i) $50,000 in the case of a reportable transaction substantially all 

of the tax benefits from which are provided to natural persons, and ‘‘(ii) $250,000 in any other case. ‘‘(2) REPORTABLE TRANSACTION.—The term ‘reportable transaction’ has the 

meaning given to such term by section 6707A(c). ‘‘(c) REGULATIONS.—The Secretary may prescribe regulations which provide— ‘‘(1) that only 1 person shall be required to meet the requirements of subsection (a) in cases in which 2 or more persons would otherwise be required to 

meet such requirements, ‘‘(2) exemptions from the requirements of this section, and 

‘‘(3) such rules as may be necessary or appropriate to carry out the purposes 

of this section.’’ (b) CONFORMING AMENDMENTS.— (1) The item relating to section 6111 in the table of sections for subchapter 

B of chapter 61 is amended to read as follows:

‘‘Sec. 6111. Disclosure of reportable transactions.’’

(2) So much of section 6112 as precedes subsection (c) thereof is amended to 

read as follows: 

‘‘SEC. 6112. MATERIAL ADVISORS OF REPORTABLE TRANSACTIONS MUST KEEP LISTS OF 

ADVISEES, ETC. 

‘‘(a) IN GENERAL.—Each material advisor (as defined in section 6111) with respect 

to any reportable transaction (as defined in section 6707A(c)) shall (whether or not 

required to file a return under section 6111 with respect to such transaction) maintain (in such manner as the Secretary may by regulations prescribe) a list— ‘‘(1) identifying each person with respect to whom such advisor acted as a material advisor with respect to such transaction, and ‘‘(2) containing such other information as the Secretary may by regulations 

require.’’ (3) Section 6112 is amended— (A) by redesignating subsection (c) as subsection (b), 

(B) by inserting ‘‘written’’ before ‘‘request’’ in subsection (b)(1) (as so redesignated), and 

(C) by striking ‘‘shall prescribe’’ in subsection (b)(2) (as so redesignated) 

and inserting ‘‘may prescribe’’. (4) The item relating to section 6112 in the table of sections for subchapter 

B of chapter 61 is amended to read as follows:

‘‘Sec. 6112. Material advisors of reportable transactions must keep lists of advisees, etc.’’

(5)(A) The heading for section 6708 is amended to read as follows: 

‘‘SEC. 6708. FAILURE TO MAINTAIN LISTS OF ADVISEES WITH RESPECT TO REPORTABLE 

TRANSACTIONS.’’

(B) The item relating to section 6708 in the table of sections for part I of subchapter B of chapter 68 is amended to read as follows:

‘‘Sec. 6708. Failure to maintain lists of advisees with respect to reportable transactions.’’

(c) REQUIRED DISCLOSURE NOT SUBJECT TO CLAIM OF CONFIDENTIALITY.—Paragraph (1) of section 6112(b), as redesignated by subsection (b), is amended by adding 

at the end the following new flush sentence: ‘‘For purposes of this section, the identity of any person on such list shall not 

be privileged.’’. (d) EFFECTIVE DATE.— (1) IN GENERAL.—Except as provided in paragraph (2), the amendments made 

by this section shall apply to transactions with respect to which material aid, 

assistance, or advice referred to in section 6111(b)(1)(A)(i) of the Internal Revenue Code of 1986 (as added by this section) is provided after the date of the 

enactment of this Act. 

(2) NO CLAIM OF CONFIDENTIALITY AGAINST DISCLOSURE.—The amendment 

made by subsection (c) shall take effect as if included in the amendments made 

by section 142 of the Deficit Reduction Act of 1984. 

SEC. 616. FAILURE TO FURNISH INFORMATION REGARDING REPORTABLE TRANSACTIONS. 

(a) IN GENERAL.—Section 6707 (relating to failure to furnish information regarding tax shelters) is amended to read as follows: 

‘‘SEC. 6707. FAILURE TO FURNISH INFORMATION REGARDING REPORTABLE TRANSACTIONS. 

‘‘(a) IN GENERAL.—If a person who is required to file a return under section 

6111(a) with respect to any reportable transaction—

72

‘‘(1) fails to file such return on or before the date prescribed therefor, or 

‘‘(2) files false or incomplete information with the Secretary with respect to 

such transaction, 

such person shall pay a penalty with respect to such return in the amount determined under subsection (b). 

‘‘(b) AMOUNT OF PENALTY.—

‘‘(1) IN GENERAL.—Except as provided in paragraph (2), the penalty imposed 

under subsection (a) with respect to any failure shall be $50,000. 

‘‘(2) LISTED TRANSACTIONS.—The penalty imposed under subsection (a) with 

respect to any listed transaction shall be an amount equal to the greater of—

‘‘(A) $200,000, or 

‘‘(B) 50 percent of the gross income derived by such person with respect 

to aid, assistance, or advice which is provided with respect to the listed 

transaction before the date the return is filed under section 6111. 

Subparagraph (B) shall be applied by substituting ‘75 percent’ for ‘50 percent’

in the case of an intentional failure or act described in subsection (a). 

‘‘(c) RESCISSION AUTHORITY.—The provisions of section 6707A(d) (relating to authority of Commissioner to rescind penalty) shall apply to any penalty imposed 

under this section. 

‘‘(d) REPORTABLE AND LISTED TRANSACTIONS.—For purposes of this section, the 

terms ‘reportable transaction’ and ‘listed transaction’ have the respective meanings 

given to such terms by section 6707A(c).’’

(b) CLERICAL AMENDMENT.—The item relating to section 6707 in the table of sections for part I of subchapter B of chapter 68 is amended by striking ‘‘tax shelters’’

and inserting ‘‘reportable transactions’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to returns the due date for which is after the date of the enactment of this Act. 

SEC. 617. MODIFICATION OF PENALTY FOR FAILURE TO MAINTAIN LISTS OF INVESTORS. 

(a) IN GENERAL.—Subsection (a) of section 6708 is amended to read as follows: 

‘‘(a) IMPOSITION OF PENALTY.—

‘‘(1) IN GENERAL.—If any person who is required to maintain a list under section 6112(a) fails to make such list available upon written request to the Secretary in accordance with section 6112(b) within 20 business days after the date 

of such request, such person shall pay a penalty of $10,000 for each day of such 

failure after such 20th day. 

‘‘(2) REASONABLE CAUSE EXCEPTION.—No penalty shall be imposed by paragraph (1) with respect to the failure on any day if such failure is due to reasonable cause.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to requests made after the date of the enactment of this Act. 

SEC. 618. PENALTY ON PROMOTERS OF TAX SHELTERS. 

(a) PENALTY ON PROMOTING ABUSIVE TAX SHELTERS.—Section 6700(a) is amended 

by adding at the end the following new sentence: ‘‘Notwithstanding the first sentence, if an activity with respect to which a penalty imposed under this subsection 

involves a statement described in paragraph (2)(A), the amount of the penalty shall 

be equal to 50 percent of the gross income derived (or to be derived) from such activity by the person on which the penalty is imposed.’’

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to activities after the date of the enactment of this Act. 

SEC. 619. MODIFICATIONS OF SUBSTANTIAL UNDERSTATEMENT PENALTY FOR NONREPORTABLE TRANSACTIONS. 

(a) SUBSTANTIAL UNDERSTATEMENT OF CORPORATIONS.—Section 6662(d)(1)(B) (relating to special rule for corporations) is amended to read as follows: 

‘‘(B) SPECIAL RULE FOR CORPORATIONS.—In the case of a corporation other 

than an S corporation or a personal holding company (as defined in section 

542), there is a substantial understatement of income tax for any taxable 

year if the amount of the understatement for the taxable year exceeds the 

lesser of—

‘‘(i) 10 percent of the tax required to be shown on the return for the 

taxable year (or, if greater, $10,000), or 

‘‘(ii) $10,000,000.’’

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable 

years beginning after the date of the enactment of this Act. 

73

SEC. 620. MODIFICATION OF ACTIONS TO ENJOIN CERTAIN CONDUCT RELATED TO TAX SHELTERS AND REPORTABLE TRANSACTIONS. 

(a) IN GENERAL.—Section 7408 (relating to action to enjoin promoters of abusive 

tax shelters, etc.) is amended by redesignating subsection (c) as subsection (d) and 

by striking subsections (a) and (b) and inserting the following new subsections: ‘‘(a) AUTHORITY TO SEEK INJUNCTION.—A civil action in the name of the United 

States to enjoin any person from further engaging in specified conduct may be commenced at the request of the Secretary. Any action under this section shall be 

brought in the district court of the United States for the district in which such person resides, has his principal place of business, or has engaged in specified conduct. 

The court may exercise its jurisdiction over such action (as provided in section 

7402(a)) separate and apart from any other action brought by the United States 

against such person. ‘‘(b) ADJUDICATION AND DECREE.—In any action under subsection (a), if the court 

finds—

‘‘(1) that the person has engaged in any specified conduct, and 

‘‘(2) that injunctive relief is appropriate to prevent recurrence of such conduct, 

the court may enjoin such person from engaging in such conduct or in any other 

activity subject to penalty under this title. ‘‘(c) SPECIFIED CONDUCT.—For purposes of this section, the term ‘specified conduct’ means any action, or failure to take action, subject to penalty under section 6700, 

6701, 6707, or 6708.’’ (b) CONFORMING AMENDMENTS.— (1) The heading for section 7408 is amended to read as follows: 

‘‘SEC. 7408. ACTIONS TO ENJOIN SPECIFIED CONDUCT RELATED TO TAX SHELTERS AND REPORTABLE TRANSACTIONS.’’

(2) The table of sections for subchapter A of chapter 76 is amended by striking the item relating to section 7408 and inserting the following new item:

‘‘Sec. 7408. Actions to enjoin specified conduct related to tax shelters and reportable transactions.’’

(c) EFFECTIVE DATE.—The amendment made by this section shall take effect on 

the day after the date of the enactment of this Act. 

SEC. 621. PENALTY ON FAILURE TO REPORT INTERESTS IN FOREIGN FINANCIAL ACCOUNTS. 

(a) IN GENERAL.—Section 5321(a)(5) of title 31, United States Code, is amended 

to read as follows: ‘‘(5) FOREIGN FINANCIAL AGENCY TRANSACTION VIOLATION.— ‘‘(A) PENALTY AUTHORIZED.—The Secretary of the Treasury may impose 

a civil money penalty on any person who violates, or causes any violation 

of, any provision of section 5314. ‘‘(B) AMOUNT OF PENALTY.— ‘‘(i) IN GENERAL.—Except as provided in subparagraph (C), the 

amount of any civil penalty imposed under subparagraph (A) shall not 

exceed $5,000. 

‘‘(ii) REASONABLE CAUSE EXCEPTION.—No penalty shall be imposed 

under subparagraph (A) with respect to any violation if—

‘‘(I) such violation was due to reasonable cause, and 

‘‘(II) the amount of the transaction or the balance in the account 

at the time of the transaction was properly reported. 

‘‘(C) WILLFUL VIOLATIONS.—In the case of any person willfully violating, 

or willfully causing any violation of, any provision of section 5314—

‘‘(i) the maximum penalty under subparagraph (B)(i) shall be increased to the greater of—

‘‘(I) $25,000, or 

‘‘(II) the amount (not exceeding $100,000) determined under subparagraph (D), and 

‘‘(ii) subparagraph (B)(ii) shall not apply. 

‘‘(D) AMOUNT.—The amount determined under this subparagraph is—

‘‘(i) in the case of a violation involving a transaction, the amount of 

the transaction, or 

‘‘(ii) in the case of a violation involving a failure to report the existence of an account or any identifying information required to be provided with respect to an account, the balance in the account at the time 

of the violation.’’

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to violations occurring after the date of the enactment of this Act. 

SEC. 622. REGULATION OF INDIVIDUALS PRACTICING BEFORE THE DEPARTMENT OF THE 

TREASURY. 

(a) CENSURE; IMPOSITION OF PENALTY.—

74

(1) IN GENERAL.—Section 330(b) of title 31, United States Code, is amended—

(A) by inserting ‘‘, or censure,’’ after ‘‘Department’’, and 

(B) by adding at the end the following new flush sentence: 

‘‘The Secretary may impose a monetary penalty on any representative described in 

the preceding sentence. If the representative was acting on behalf of an employer 

or any firm or other entity in connection with the conduct giving rise to such penalty, the Secretary may impose a monetary penalty on such employer, firm, or entity 

if it knew, or reasonably should have known, of such conduct. Such penalty shall 

not exceed the gross income derived (or to be derived) from the conduct giving rise 

to the penalty. Any such penalty imposed on an individual may be in addition to, 

or in lieu of, any suspension, disbarment, or censure of such individual.’’

(2) EFFECTIVE DATE.—The amendments made by this subsection shall apply 

to actions taken after the date of the enactment of this Act. 

(b) TAX SHELTER OPINIONS, ETC.—Section 330 of such title 31 is amended by adding at the end the following new subsection: 

‘‘(d) Nothing in this section or in any other provision of law shall be construed 

to limit the authority of the Secretary of the Treasury to impose standards applicable to the rendering of written advice with respect to any entity, transaction plan 

or arrangement, or other plan or arrangement, which is of a type which the Secretary determines as having a potential for tax avoidance or evasion.’’

Part II—Other Provisions 

SEC. 631. TREATMENT OF STRIPPED INTERESTS IN BOND AND PREFERRED STOCK FUNDS, 

ETC. 

(a) IN GENERAL.—Section 1286 (relating to tax treatment of stripped bonds) is 

amended by redesignating subsection (f) as subsection (g) and by inserting after subsection (e) the following new subsection: 

‘‘(f) TREATMENT OF STRIPPED INTERESTS IN BOND AND PREFERRED STOCK FUNDS, 

ETC.—In the case of an account or entity substantially all of the assets of which consist of bonds, preferred stock, or a combination thereof, the Secretary may by regulations provide that rules similar to the rules of this section and 305(e), as appropriate, shall apply to interests in such account or entity to which (but for this subsection) this section or section 305(e), as the case may be, would not apply.’’

(b) CROSS REFERENCE.—Subsection (e) of section 305 is amended by adding at the 

end the following new paragraph: 

‘‘(7) CROSS REFERENCE.—

‘‘For treatment of stripped interests in certain accounts or entities holding preferred stock, 

see section 1286(f).’’

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to purchases and dispositions after the date of the enactment of this Act. 

SEC. 632. MINIMUM HOLDING PERIOD FOR FOREIGN TAX CREDIT ON WITHHOLDING TAXES 

ON INCOME OTHER THAN DIVIDENDS. 

(a) IN GENERAL.—Section 901 is amended by redesignating subsection (l) as subsection (m) and by inserting after subsection (k) the following new subsection: 

‘‘(l) MINIMUM HOLDING PERIOD FOR WITHHOLDING TAXES ON GAIN AND INCOME

OTHER THAN DIVIDENDS ETC.—

‘‘(1) IN GENERAL.—In no event shall a credit be allowed under subsection (a) 

for any withholding tax (as defined in subsection (k)) on any item of income or 

gain with respect to any property if—

‘‘(A) such property is held by the recipient of the item for 15 days or less 

during the 30-day period beginning on the date which is 15 days before the 

date on which the right to receive payment of such item arises, or 

‘‘(B) to the extent that the recipient of the item is under an obligation 

(whether pursuant to a short sale or otherwise) to make related payments 

with respect to positions in substantially similar or related property. 

This paragraph shall not apply to any dividend to which subsection (k) applies. 

‘‘(2) EXCEPTION FOR TAXES PAID BY DEALERS.—

‘‘(A) IN GENERAL.—Paragraph (1) shall not apply to any qualified tax with 

respect to any property held in the active conduct in a foreign country of 

a business as a dealer in such property. 

‘‘(B) QUALIFIED TAX.—For purposes of subparagraph (A), the term ‘qualified tax’ means a tax paid to a foreign country (other than the foreign country referred to in subparagraph (A)) if—

‘‘(i) the item to which such tax is attributable is subject to taxation 

on a net basis by the country referred to in subparagraph (A), and 

75

‘‘(ii) such country allows a credit against its net basis tax for the full 

amount of the tax paid to such other foreign country. 

‘‘(C) DEALER.—For purposes of subparagraph (A), the term ‘dealer’

means—

‘‘(i) with respect to a security, any person to whom paragraphs (1) 

and (2) of subsection (k) would not apply by reason of paragraph (4) 

thereof if such security were stock, and 

‘‘(ii) with respect to any other property, any person with respect to 

whom such property is described in section 1221(a)(1). 

‘‘(D) REGULATIONS.—The Secretary may prescribe such regulations as 

may be appropriate to carry out this paragraph, including regulations to 

prevent the abuse of the exception provided by this paragraph and to treat 

other taxes as qualified taxes. 

‘‘(3) EXCEPTIONS.—The Secretary may by regulation provide that paragraph 

(1) shall not apply to property where the Secretary determines that the application of paragraph (1) to such property is not necessary to carry out the purposes 

of this subsection. 

‘‘(4) CERTAIN RULES TO APPLY.—Rules similar to the rules of paragraphs (5), 

(6), and (7) of subsection (k) shall apply for purposes of this subsection. 

‘‘(5) DETERMINATION OF HOLDING PERIOD.—Holding periods shall be determined for purposes of this subsection without regard to section 1235 or any 

similar rule.’’

(b) CONFORMING AMENDMENT.—The heading of subsection (k) of section 901 is 

amended by inserting ‘‘ON DIVIDENDS’’ after ‘‘TAXES’’. 

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

amounts paid or accrued more than 30 days after the date of the enactment of this 

Act. 

SEC. 633. DISALLOWANCE OF CERTAIN PARTNERSHIP LOSS TRANSFERS. 

(a) TREATMENT OF CONTRIBUTED PROPERTY WITH BUILT-IN LOSS.—Paragraph (1) 

of section 704(c) is amended by striking ‘‘and’’ at the end of subparagraph (A), by 

striking the period at the end of subparagraph (B) and inserting ‘‘, and’’, and by 

adding at the end the following: 

‘‘(C) if any property so contributed has a built-in loss—

‘‘(i) such built-in loss shall be taken into account only in determining 

the amount of items allocated to the contributing partner, and 

‘‘(ii) except as provided in regulations, in determining the amount of 

items allocated to other partners, the basis of the contributed property 

in the hands of the partnership shall be treated as being equal to its 

fair market value at the time of contribution. 

For purposes of subparagraph (C), the term ‘built-in loss’ means the excess of 

the adjusted basis of the property (determined without regard to subparagraph 

(C)(ii)) over its fair market value at the time of contribution.’’

(b) SPECIAL RULES FOR TRANSFERS OF PARTNERSHIP INTEREST IF THERE IS SUBSTANTIAL BUILT-IN LOSS.—

(1) ADJUSTMENT OF PARTNERSHIP BASIS REQUIRED.—Subsection (a) of section 

743 (relating to optional adjustment to basis of partnership property) is amended by inserting before the period ‘‘or unless the partnership has a substantial 

built-in loss immediately after such transfer’’. 

(2) ADJUSTMENT.—Subsection (b) of section 743 is amended by inserting ‘‘or 

which has a substantial built-in loss immediately after such transfer’’ after ‘‘section 754 is in effect’’. 

(3) SUBSTANTIAL BUILT-IN LOSS.—Section 743 is amended by adding at the end 

the following new subsection: 

‘‘(d) SUBSTANTIAL BUILT-IN LOSS.—

‘‘(1) IN GENERAL.—For purposes of this section, a partnership has a substantial built-in loss with respect to a transfer of an interest in a partnership if the 

partnership’s adjusted basis in the partnership property exceeds by more than 

$250,000 the fair market value of such property. 

‘‘(2) REGULATIONS.—The Secretary shall prescribe such regulations as may be 

appropriate to carry out the purposes of paragraph (1) and section 734(d), including regulations aggregating related partnerships and disregarding property 

acquired by the partnership in an attempt to avoid such purposes.’’

(4) ALTERNATIVE RULES FOR ELECTING INVESTMENT PARTNERSHIPS.—

(A) IN GENERAL.—Section 743 is amended by adding at the end the following new subsection: 

‘‘(e) ALTERNATIVE RULES FOR ELECTING INVESTMENT PARTNERSHIPS.—

‘‘(1) NO ADJUSTMENT OF PARTNERSHIP BASIS.—For purposes of this section, an 

electing investment partnership shall not be treated as having a substantial 

76

built-in loss with respect to any transfer occurring while the election under 

paragraph (6)(A) is in effect. 

‘‘(2) LOSS DEFERRAL FOR TRANSFEREE PARTNER.—In the case of a transfer of 

an interest in an electing investment partnership, the transferee partner’s distributive share of losses (without regard to gains) from the sale or exchange of 

partnership property shall not be allowed except to the extent that it is established that such losses exceed the loss (if any) recognized by the transferor (or 

any prior transferor to the extent not fully offset by a prior disallowance under 

this paragraph) on the transfer of the partnership interest. 

‘‘(3) NO REDUCTION IN PARTNERSHIP BASIS.—Losses disallowed under paragraph (2) shall not decrease the transferee partner’s basis in the partnership 

interest. 

‘‘(4) EFFECT OF TERMINATION OF PARTNERSHIP.—This subsection shall be applied without regard to any termination of a partnership under section 

708(b)(1)(B). 

‘‘(5) CERTAIN BASIS REDUCTIONS TREATED AS LOSSES.—In the case of a transferee partner whose basis in property distributed by the partnership is reduced 

under section 732(a)(2), the amount of the loss recognized by the transferor on 

the transfer of the partnership interest which is taken into account under paragraph (2) shall be reduced by the amount of such basis reduction. 

‘‘(6) ELECTING INVESTMENT PARTNERSHIP.—For purposes of this subsection, 

the term ‘electing investment partnership’ means any partnership if—

‘‘(A) the partnership makes an election to have this subsection apply, 

‘‘(B) the partnership would be an investment company under section 

3(a)(1)(A) of the Investment Company Act of 1940 but for an exemption 

under paragraph (1) or (7) of section 3(c) of such Act, 

‘‘(C) such partnership has never been engaged in a trade or business, 

‘‘(D) substantially all of the assets of such partnership are held for investment, 

‘‘(E) at least 95 percent of the assets contributed to such partnership consist of money, 

‘‘(F) no assets contributed to such partnership had an adjusted basis in 

excess of fair market value at the time of contribution, 

‘‘(G) all partnership interests of such partnership are issued by such partnership pursuant to a private offering and during the 24-month period beginning on the date of the first capital contribution to such partnership, 

‘‘(H) the partnership agreement of such partnership has substantive restrictions on each partner’s ability to cause a redemption of the partner’s 

interest, and 

‘‘(I) the partnership agreement of such partnership provides for a term 

that is not in excess of 15 years. 

The election described in subparagraph (A), once made, shall be irrevocable except with the consent of the Secretary. 

‘‘(7) REGULATIONS.—The Secretary shall prescribe such regulations as may be 

appropriate to carry out the purposes of this subsection, including regulations 

for applying this subsection to tiered partnerships.’’. 

(B) INFORMATION REPORTING.—Section 6031 is amended by adding at the 

end the following new subsection: 

‘‘(f) ELECTING INVESTMENT PARTNERSHIPS.—In the case of any electing investment 

partnership (as defined in section 743(e)(6)), the information required under subsection (b) to be furnished to any partner to whom section 743(e)(2) applies shall 

include such information as is necessary to enable the partner to compute the 

amount of losses disallowed under section 743(e).’’. 

(5) CLERICAL AMENDMENTS.—

(A) The section heading for section 743 is amended to read as follows: 

‘‘SEC. 743. SPECIAL RULES WHERE SECTION 754 ELECTION OR SUBSTANTIAL BUILT-IN LOSS.’’

(B) The table of sections for subpart C of part II of subchapter K of chapter 1 is amended by striking the item relating to section 743 and inserting 

the following new item:

‘‘Sec. 743. Special rules where section 754 election or substantial built-in loss.’’

(c) ADJUSTMENT TO BASIS OF UNDISTRIBUTED PARTNERSHIP PROPERTY IF THERE IS

SUBSTANTIAL BASIS REDUCTION.—

(1) ADJUSTMENT REQUIRED.—Subsection (a) of section 734 (relating to optional 

adjustment to basis of undistributed partnership property) is amended by inserting before the period ‘‘or unless there is a substantial basis reduction’’. 

(2) ADJUSTMENT.—Subsection (b) of section 734 is amended by inserting ‘‘or 

unless there is a substantial basis reduction’’ after ‘‘section 754 is in effect’’. 

77

(3) SUBSTANTIAL BASIS REDUCTION.—Section 734 is amended by adding at the 

end the following new subsection: ‘‘(d) SUBSTANTIAL BASIS REDUCTION.— ‘‘(1) IN GENERAL.—For purposes of this section, there is a substantial basis reduction with respect to a distribution if the sum of the amounts described in 

subparagraphs (A) and (B) of subsection (b)(2) exceeds $250,000. ‘‘(2) REGULATIONS.—

‘‘For regulations to carry out this subsection, see section 743(d)(2).’’

(4) CLERICAL AMENDMENTS.— (A) The section heading for section 734 is amended to read as follows: 

‘‘SEC. 734. ADJUSTMENT TO BASIS OF UNDISTRIBUTED PARTNERSHIP PROPERTY WHERE 

SECTION 754 ELECTION OR SUBSTANTIAL BASIS REDUCTION.’’

(B) The table of sections for subpart B of part II of subchapter K of chapter 1 is amended by striking the item relating to section 734 and inserting 

the following new item:

‘‘Sec. 734. Adjustment to basis of undistributed partnership property where section 754 

election or substantial basis reduction.’’

(d) EFFECTIVE DATES.—

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

contributions made after the date of the enactment of this Act. 

(2) SUBSECTION (b).—

(A) IN GENERAL.—Except as provided in subparagraph (B), the amendments made by subsection (b) shall apply to transfers after the date of the 

enactment of this Act. 

(B) TRANSITION RULE.—In the case of an electing investment partnership 

which is in existence on June 4, 2004, section 743(e)(6)(H) of the Internal 

Revenue Code of 1986, as added by this section, shall not apply to such 

partnership and section 743(e)(6)(I) of such Code, as so added, shall be applied by substituting ‘‘20 years’’ for ‘‘15 years’’. 

(3) SUBSECTION (c).—The amendments made by subsection (c) shall apply to 

distributions after the date of the enactment of this Act. 

SEC. 634. NO REDUCTION OF BASIS UNDER SECTION 734 IN STOCK HELD BY PARTNERSHIP 

IN CORPORATE PARTNER. 

(a) IN GENERAL.—Section 755 is amended by adding at the end the following new 

subsection: 

‘‘(c) NO ALLOCATION OF BASIS DECREASE TO STOCK OF CORPORATE PARTNER.—In 

making an allocation under subsection (a) of any decrease in the adjusted basis of 

partnership property under section 734(b)—

‘‘(1) no allocation may be made to stock in a corporation (or any person related (within the meaning of sections 267(b) and 707(b)(1)) to such corporation) 

which is a partner in the partnership, and 

‘‘(2) any amount not allocable to stock by reason of paragraph (1) shall be allocated under subsection (a) to other partnership property. 

Gain shall be recognized to the partnership to the extent that the amount required 

to be allocated under paragraph (2) to other partnership property exceeds the aggregate adjusted basis of such other property immediately before the allocation required by paragraph (2).’’

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to distributions after the date of the enactment of this Act. 

SEC. 635. REPEAL OF SPECIAL RULES FOR FASITS. 

(a) IN GENERAL.—Part V of subchapter M of chapter 1 (relating to financial asset 

securitization investment trusts) is hereby repealed. 

(b) CONFORMING AMENDMENTS.—

(1) Paragraph (6) of section 56(g) is amended by striking ‘‘REMIC, or FASIT’’

and inserting ‘‘or REMIC’’. 

(2) Clause (ii) of section 382(l)(4)(B) is amended by striking ‘‘a REMIC to 

which part IV of subchapter M applies, or a FASIT to which part V of subchapter M applies,’’ and inserting ‘‘or a REMIC to which part IV of subchapter 

M applies,’’. 

(3) Paragraph (1) of section 582(c) is amended by striking ‘‘, and any regular 

interest in a FASIT,’’. 

(4) Subparagraph (E) of section 856(c)(5) is amended by striking the last sentence. 

(5)(A) Section 860G(a)(1) is amended by adding at the end the following new 

sentence: ‘‘An interest shall not fail to qualify as a regular interest solely because the specified principal amount of the regular interest (or the amount of 

78

interest accrued on the regular interest) can be reduced as a result of the nonoccurrence of 1 or more contingent payments with respect to any reverse mortgage loan held by the REMIC if, on the startup day for the REMIC, the sponsor 

reasonably believes that all principal and interest due under the regular interest will be paid at or prior to the liquidation of the REMIC.’’. 

(B) The last sentence of section 860G(a)(3) is amended by inserting ‘‘, and any 

reverse mortgage loan (and each balance increase on such loan meeting the requirements of subparagraph (A)(iii)) shall be treated as an obligation secured 

by an interest in real property’’ before the period at the end. 

(6) Paragraph (3) of section 860G(a) is amended by adding ‘‘and’’ at the end 

of subparagraph (B), by striking ‘‘, and’’ at the end of subparagraph (C) and inserting a period, and by striking subparagraph (D). 

(7) Section 860G(a)(3), as amended by paragraph (6), is amended by adding 

at the end the following new sentence: ‘‘For purposes of subparagraph (A), if 

more than 50 percent of the obligations transferred to, or purchased by, the 

REMIC are originated by the United States or any State (or any political subdivision, agency, or instrumentality of the United States or any State) and are 

principally secured by an interest in real property, then each obligation transferred to, or purchased by, the REMIC shall be treated as secured by an interest in real property.’’. 

(8)(A) Section 860G(a)(3)(A) is amended by striking ‘‘or’’ at the end of clause 

(i), by inserting ‘‘or’’ at the end of clause (ii), and by inserting after clause (ii) 

the following new clause: 

‘‘(iii) represents an increase in the principal amount under the original terms of an obligation described in clause (i) or (ii) if such increase—

‘‘(I) is attributable to an advance made to the obligor pursuant 

to the original terms of the obligation, 

‘‘(II) occurs after the startup day, and 

‘‘(III) is purchased by the REMIC pursuant to a fixed price contract in effect on the startup day.’’. 

(B) Section 860G(a)(7)(B) is amended to read as follows: 

‘‘(B) QUALIFIED RESERVE FUND.—For purposes of subparagraph (A), the 

term ‘qualified reserve fund’ means any reasonably required reserve to—

‘‘(i) provide for full payment of expenses of the REMIC or amounts 

due on regular interests in the event of defaults on qualified mortgages 

or lower than expected returns on cash flow investments, or 

‘‘(ii) provide a source of funds for the purchase of obligations described in clause (ii) or (iii) of paragraph (3)(A). 

The aggregate fair market value of the assets held in any such reserve shall 

not exceed 50 percent of the aggregate fair market value of all of the assets 

of the REMIC on the startup day, and the amount of any such reserve shall 

be promptly and appropriately reduced to the extent the amount held in 

such reserve is no longer reasonably required for purposes specified in 

clause (i) or (ii) of this subparagraph.’’. 

(9) Subparagraph (C) of section 1202(e)(4) is amended by striking ‘‘REMIC, 

or FASIT’’ and inserting ‘‘or REMIC’’. 

(10) Clause (xi) of section 7701(a)(19)(C) is amended—

(A) by striking ‘‘and any regular interest in a FASIT,’’, and 

(B) by striking ‘‘or FASIT’’ each place it appears. 

(11) Subparagraph (A) of section 7701(i)(2) is amended by striking ‘‘or a 

FASIT’’. 

(12) The table of parts for subchapter M of chapter 1 is amended by striking 

the item relating to part V. 

(c) EFFECTIVE DATE.—

(1) IN GENERAL.—Except as provided in paragraph (2), the amendments made 

by this section shall take effect on January 1, 2005. 

(2) EXCEPTION FOR EXISTING FASITS.—Paragraph (1) shall not apply to any 

FASIT in existence on the date of the enactment of this Act to the extent that 

regular interests issued by the FASIT before such date continue to remain outstanding in accordance with the original terms of issuance. 

SEC. 636. LIMITATION ON TRANSFER OF BUILT-IN LOSSES ON REMIC RESIDUALS. 

(a) IN GENERAL.—Section 362 (relating to basis to corporations) is amended by 

adding at the end the following new subsection: 

‘‘(e) LIMITATION ON TRANSFER OF BUILT-IN LOSSES ON REMIC RESIDUALS IN SECTION 351 TRANSACTIONS.—If—

‘‘(1) a residual interest (as defined in section 860G(a)(2)) in a REMIC is transferred in any transaction which is described in subsection (a), and 

79

‘‘(2) the transferee’s adjusted basis in such residual interest would (but for 

this paragraph) exceed its fair market value immediately after such transaction, 

then, notwithstanding subsection (a), the transferee’s adjusted basis in such residual 

interest shall not exceed its fair market value (whether or not greater than zero) 

immediately after such transaction.’’ (b) EFFECTIVE DATE.—The amendment made by this section shall apply to transactions after the date of the enactment of this Act. 

SEC. 637. CLARIFICATION OF BANKING BUSINESS FOR PURPOSES OF DETERMINING INVESTMENT OF EARNINGS IN UNITED STATES PROPERTY. 

(a) IN GENERAL.—Subparagraph (A) of section 956(c)(2) is amended to read as follows: ‘‘(A) obligations of the United States, money, or deposits with persons described in paragraph (4);’’. (b) ELIGIBLE PERSONS.—Section 956(c) (relating to exceptions to definition of 

United States property) is amended by adding at the end the following new paragraph: ‘‘(4) FINANCIAL SERVICES PROVIDERS.— ‘‘(A) IN GENERAL.—For purposes of paragraph (2)(A), a person is described 

in this paragraph if at least 80 percent of the person’s income is from the 

active conduct of a banking business which is derived from persons who are 

not related persons. ‘‘(B) SPECIAL RULES.—For purposes of subparagraph (A) all related persons shall be treated as 1 person in applying the 80-percent test. ‘‘(C) RELATED PERSON.—For purposes of this paragraph, a person is a related person to another person if— ‘‘(i) the related person bears a relationship to such person specified 

in section 267(b) or 707(b)(1), or ‘‘(ii) such persons are members of the same controlled group of corporations (as defined in section 1563(a), except that ‘more than 50 percent’ shall be substituted for ‘at least 80 percent’ each place it appears 

therein).’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall take effect on 

the date of the enactment of this Act. 

SEC. 638. ALTERNATIVE TAX FOR CERTAIN SMALL INSURANCE COMPANIES. 

(a) IN GENERAL.—Clause (i) of section 831(b)(2)(A) is amended by striking 

‘‘$1,200,000’’ and inserting ‘‘$1,890,000’’. 

(b) INFLATION ADJUSTMENT.—Paragraph (2) of section 831(b) is amended by adding at the end the following new subparagraph: 

‘‘(C) INFLATION ADJUSTMENT.—In the case of any taxable year beginning 

in a calendar year after 2004, the $1,890,000 amount in subparagraph (A) 

shall be increased by an amount equal to—

‘‘(i) $1,890,000, multiplied by 

‘‘(ii) the cost-of-living adjustment determined under section 1(f)(3) for 

such calendar year by substituting ‘calendar year 2003’ for ‘calendar 

year 1992’ in subparagraph (B) thereof. 

If the amount as adjusted under the preceding sentence is not a multiple 

of $1,000, such amount shall be rounded to the next lowest multiple of 

$1,000.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable years beginning after December 31, 2003. 

SEC. 639. DENIAL OF DEDUCTION FOR INTEREST ON UNDERPAYMENTS ATTRIBUTABLE TO 

NONDISCLOSED REPORTABLE TRANSACTIONS. 

(a) IN GENERAL.—Section 163 (relating to deduction for interest) is amended by 

redesignating subsection (m) as subsection (n) and by inserting after subsection (l) 

the following new subsection: 

‘‘(m) INTEREST ON UNPAID TAXES ATTRIBUTABLE TO NONDISCLOSED REPORTABLE

TRANSACTIONS.—No deduction shall be allowed under this chapter for any interest 

paid or accrued under section 6601 on any underpayment of tax which is attributable to the portion of any reportable transaction understatement (as defined in 

section 6662A(b)) with respect to which the requirement of section 6664(d)(2)(A) is 

not met.’’. 

(b) EFFECTIVE DATE.—The amendments made by this section shall apply to transactions in taxable years beginning after the date of the enactment of this Act. 

SEC. 640. CLARIFICATION OF RULES FOR PAYMENT OF ESTIMATED TAX FOR CERTAIN 

DEEMED ASSET SALES. 

(a) IN GENERAL.—Paragraph (13) of section 338(h) (relating to tax on deemed sale 

not taken into account for estimated tax purposes) is amended by adding at the end 

80

the following: ‘‘The preceding sentence shall not apply with respect to a qualified 

stock purchase for which an election is made under paragraph (10).’’. 

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

transactions occurring after the date of the enactment of this Act. 

SEC. 641. RECOGNITION OF GAIN FROM THE SALE OF A PRINCIPAL RESIDENCE ACQUIRED IN 

A LIKE-KIND EXCHANGE WITHIN 5 YEARS OF SALE. 

(a) IN GENERAL.—Section 121(d) (relating to special rules for exclusion of gain 

from sale of principal residence) is amended by adding at the end the following new 

paragraph: 

‘‘(10) PROPERTY ACQUIRED IN LIKE-KIND EXCHANGE.—If a taxpayer acquired 

property in an exchange to which section 1031 applied, subsection (a) shall not 

apply to the sale or exchange of such property if it occurs during the 5-year period beginning with the date of the acquisition of such property.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to sales 

or exchanges after the date of the enactment of this Act. 

SEC. 642. PREVENTION OF MISMATCHING OF INTEREST AND ORIGINAL ISSUE DISCOUNT DEDUCTIONS AND INCOME INCLUSIONS IN TRANSACTIONS WITH RELATED FOREIGN 

PERSONS. 

(a) ORIGINAL ISSUE DISCOUNT.—Section 163(e)(3) (relating to special rule for original issue discount on obligation held by related foreign person) is amended by redesignating subparagraph (B) as subparagraph (C) and by inserting after subparagraph 

(A) the following new subparagraph: 

‘‘(B) SPECIAL RULE FOR CERTAIN FOREIGN ENTITIES.—

‘‘(i) IN GENERAL.—In the case of any debt instrument having original 

issue discount which is held by a related foreign person which is a foreign personal holding company (as defined in section 552), a controlled 

foreign corporation (as defined in section 957), or a passive foreign investment company (as defined in section 1297), a deduction shall be allowable to the issuer with respect to such original issue discount for 

any taxable year before the taxable year in which paid only to the extent such original issue discount (reduced by properly allowable deductions and qualified deficits under section 952(c)(1)(B)) is includible during such prior taxable year in the gross income of a United States person who owns (within the meaning of section 958(a)) stock in such corporation. 

‘‘(ii) SECRETARIAL AUTHORITY.—The Secretary may by regulation exempt transactions from the application of clause (i), including any 

transaction which is entered into by a payor in the ordinary course of 

a trade or business in which the payor is predominantly engaged.’’. 

(b) INTEREST AND OTHER DEDUCTIBLE AMOUNTS.—Section 267(a)(3) is amended—

(1) by striking ‘‘The Secretary’’ and inserting: 

‘‘(A) IN GENERAL.—The Secretary’’, and 

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

‘‘(B) SPECIAL RULE FOR CERTAIN FOREIGN ENTITIES.—

‘‘(i) IN GENERAL.—Notwithstanding subparagraph (A), in the case of 

any item payable to a foreign personal holding company (as defined in 

section 552), a controlled foreign corporation (as defined in section 957), 

or a passive foreign investment company (as defined in section 1297), 

a deduction shall be allowable to the payor with respect to such amount 

for any taxable year before the taxable year in which paid only to the 

extent that an amount attributable to such item (reduced by properly 

allowable deductions and qualified deficits under section 952(c)(1)(B)) is 

includible during such prior taxable year in the gross income of a 

United States person who owns (within the meaning of section 958(a)) 

stock in such corporation. 

‘‘(ii) SECRETARIAL AUTHORITY.—The Secretary may by regulation exempt transactions from the application of clause (i), including any 

transaction which is entered into by a payor in the ordinary course of 

a trade or business in which the payor is predominantly engaged and 

in which the payment of the accrued amounts occurs within 81⁄2

months after accrual or within such other period as the Secretary may 

prescribe.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to payments accrued on or after the date of the enactment of this Act.

81

SEC. 643. EXCLUSION FROM GROSS INCOME FOR INTEREST ON OVERPAYMENTS OF INCOME 

TAX BY INDIVIDUALS. 

(a) IN GENERAL.—Part III of subchapter B of chapter 1 (relating to items specifically excluded from gross income) is amended by inserting after section 139A the 

following new section: 

‘‘SEC. 139B. EXCLUSION FROM GROSS INCOME FOR INTEREST ON OVERPAYMENTS OF INCOME TAX BY INDIVIDUALS. 

‘‘(a) IN GENERAL.—In the case of an individual, gross income shall not include interest paid under section 6611 on any overpayment of tax imposed by this subtitle. ‘‘(b) EXCEPTION.—Subsection (a) shall not apply in the case of a failure to claim 

items resulting in the overpayment on the original return if the Secretary determines that the principal purpose of such failure is to take advantage of subsection 

(a). 

‘‘(c) SPECIAL RULE FOR DETERMINING MODIFIED ADJUSTED GROSS INCOME.—For 

purposes of this title, interest not included in gross income under subsection (a) 

shall not be treated as interest which is exempt from tax for purposes of sections 

32(i)(2)(B) and 6012(d) or any computation in which interest exempt from tax under 

this title is added to adjusted gross income.’’. 

(b) CLERICAL AMENDMENT.—The table of sections for part III of subchapter B of 

chapter 1 is amended by inserting after the item relating to section 139A the following new item:

‘‘Sec. 139B. Exclusion from gross income for interest on overpayments of income tax by individuals.’’.

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to interest received in calendar years beginning after the date of the enactment of this Act. 

SEC. 644. DEPOSITS MADE TO SUSPEND RUNNING OF INTEREST ON POTENTIAL UNDERPAYMENTS. 

(a) IN GENERAL.—Subchapter A of chapter 67 (relating to interest on underpayments) is amended by adding at the end the following new section: 

‘‘SEC. 6603. DEPOSITS MADE TO SUSPEND RUNNING OF INTEREST ON POTENTIAL UNDERPAYMENTS, ETC. 

‘‘(a) AUTHORITY TO MAKE DEPOSITS OTHER THAN AS PAYMENT OF TAX.—A taxpayer may make a cash deposit with the Secretary which may be used by the Secretary to pay any tax imposed under subtitle A or B or chapter 41, 42, 43, or 44 

which has not been assessed at the time of the deposit. Such a deposit shall be 

made in such manner as the Secretary shall prescribe. 

‘‘(b) NO INTEREST IMPOSED.—To the extent that such deposit is used by the Secretary to pay tax, for purposes of section 6601 (relating to interest on underpayments), the tax shall be treated as paid when the deposit is made. 

‘‘(c) RETURN OF DEPOSIT.—Except in a case where the Secretary determines that 

collection of tax is in jeopardy, the Secretary shall return to the taxpayer any 

amount of the deposit (to the extent not used for a payment of tax) which the taxpayer requests in writing. 

‘‘(d) PAYMENT OF INTEREST.—

‘‘(1) IN GENERAL.—For purposes of section 6611 (relating to interest on overpayments), a deposit which is returned to a taxpayer shall be treated as a payment of tax for any period to the extent (and only to the extent) attributable 

to a disputable tax for such period. Under regulations prescribed by the Secretary, rules similar to the rules of section 6611(b)(2) shall apply. 

‘‘(2) DISPUTABLE TAX.—

‘‘(A) IN GENERAL.—For purposes of this section, the term ‘disputable tax’

means the amount of tax specified at the time of the deposit as the taxpayer’s reasonable estimate of the maximum amount of any tax attributable 

to disputable items. 

‘‘(B) SAFE HARBOR BASED ON 30-DAY LETTER.—In the case of a taxpayer 

who has been issued a 30-day letter, the maximum amount of tax under 

subparagraph (A) shall not be less than the amount of the proposed deficiency specified in such letter. 

‘‘(3) OTHER DEFINITIONS.—For purposes of paragraph (2)—

‘‘(A) DISPUTABLE ITEM.—The term ‘disputable item’ means any item of income, gain, loss, deduction, or credit if the taxpayer—

‘‘(i) has a reasonable basis for its treatment of such item, and 

‘‘(ii) reasonably believes that the Secretary also has a reasonable 

basis for disallowing the taxpayer’s treatment of such item. 

‘‘(B) 30-DAY LETTER.—The term ‘30-day letter’ means the first letter of 

proposed deficiency which allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals. 

82

‘‘(4) RATE OF INTEREST.—The rate of interest allowable under this subsection 

shall be the Federal short-term rate determined under section 6621(b), compounded daily. 

‘‘(e) USE OF DEPOSITS.—

‘‘(1) PAYMENT OF TAX.—Except as otherwise provided by the taxpayer, deposits shall be treated as used for the payment of tax in the order deposited. 

‘‘(2) RETURNS OF DEPOSITS.—Deposits shall be treated as returned to the taxpayer on a last-in, first-out basis.’’. 

(b) CLERICAL AMENDMENT.—The table of sections for subchapter A of chapter 67 

is amended by adding at the end the following new item:

‘‘Sec. 6603. Deposits made to suspend running of interest on potential underpayments, etc.’’.

(c) EFFECTIVE DATE.—

(1) IN GENERAL.—The amendments made by this section shall apply to deposits made after the date of the enactment of this Act. 

(2) COORDINATION WITH DEPOSITS MADE UNDER REVENUE PROCEDURE 84–58.—

In the case of an amount held by the Secretary of the Treasury or his delegate 

on the date of the enactment of this Act as a deposit in the nature of a cash 

bond deposit pursuant to Revenue Procedure 84–58, the date that the taxpayer 

identifies such amount as a deposit made pursuant to section 6603 of the Internal Revenue Code (as added by this Act) shall be treated as the date such 

amount is deposited for purposes of such section 6603. 

SEC. 645. PARTIAL PAYMENT OF TAX LIABILITY IN INSTALLMENT AGREEMENTS. 

(a) IN GENERAL.—

(1) Section 6159(a) (relating to authorization of agreements) is amended—

(A) by striking ‘‘satisfy liability for payment of’’ and inserting ‘‘make payment on’’, and 

(B) by inserting ‘‘full or partial’’ after ‘‘facilitate’’. 

(2) Section 6159(c) (relating to Secretary required to enter into installment 

agreements in certain cases) is amended in the matter preceding paragraph (1) 

by inserting ‘‘full’’ before ‘‘payment’’. 

(b) REQUIREMENT TO REVIEW PARTIAL PAYMENT AGREEMENTS EVERY TWO

YEARS.—Section 6159 is amended by redesignating subsections (d) and (e) as subsections (e) and (f), respectively, and inserting after subsection (c) the following new 

subsection: 

‘‘(d) SECRETARY REQUIRED TO REVIEW INSTALLMENT AGREEMENTS FOR PARTIAL

COLLECTION EVERY TWO YEARS.—In the case of an agreement entered into by the 

Secretary under subsection (a) for partial collection of a tax liability, the Secretary 

shall review the agreement at least once every 2 years.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to agreements entered into on or after the date of the enactment of this Act. 

SEC. 646. AFFIRMATION OF CONSOLIDATED RETURN REGULATION AUTHORITY. 

(a) IN GENERAL.—Section 1502 is amended by adding at the end the following new 

sentence: ‘‘In carrying out the preceding sentence, the Secretary may prescribe rules 

that are different from the provisions of chapter 1 that would apply if such corporations filed separate returns.’’. 

(b) RESULT NOT OVERTURNED.—Notwithstanding the amendment made by subsection (a), the Internal Revenue Code of 1986 shall be construed by treating Treasury Regulation § 1.1502-20(c)(1)(iii) (as in effect on January 1, 2001) as being inapplicable to the factual situation in Rite Aid Corporation and Subsidiary Corporations v. United States, 255 F.3d 1357 (Fed. Cir. 2001). 

(c) EFFECTIVE DATE.—This section, and the amendment made by this section, 

shall apply to taxable years beginning before, on, or after the date of the enactment 

of this Act. 

Part III—Leasing 

SEC. 647. REFORM OF TAX TREATMENT OF CERTAIN LEASING ARRANGEMENTS. 

(a) CLARIFICATION OF RECOVERY PERIOD FOR TAX-EXEMPT USE PROPERTY SUBJECT

TO LEASE.—Subparagraph (A) of section 168(g)(3) (relating to special rules for determining class life) is amended by inserting ‘‘(notwithstanding any other subparagraph of this paragraph)’’ after ‘‘shall’’. 

(b) LIMITATION ON DEPRECIATION PERIOD FOR SOFTWARE LEASED TO TAX-EXEMPT

ENTITY.—Paragraph (1) of section 167(f) is amended by adding at the end the following new subparagraph:

83

‘‘(C) TAX-EXEMPT USE PROPERTY SUBJECT TO LEASE.—In the case of computer software which would be tax-exempt use property as defined in subsection (h) of section 168 if such section applied to computer software, the 

useful life under subparagraph (A) shall not be less than 125 percent of the 

lease term (within the meaning of section 168(i)(3)).’’. (c) LEASE TERM TO INCLUDE RELATED SERVICE CONTRACTS.—Subparagraph (A) of 

section 168(i)(3) (relating to lease term) is amended by striking ‘‘and’’ at the end of 

clause (i), by redesignating clause (ii) as clause (iii), and by inserting after clause 

(i) the following new clause: ‘‘(ii) the term of a lease shall include the term of any service contract 

or similar arrangement (whether or not treated as a lease under section 

7701(e))—

‘‘(I) which is part of the same transaction (or series of related 

transactions) which includes the lease, and ‘‘(II) which is with respect to the property subject to the lease or 

substantially similar property, and’’. (d) EXPANSION OF SHORT-TERM LEASE EXEMPTION FOR QUALIFIED TECHNOLOGICAL

EQUIPMENT.—Subparagraph (A) of section 168(h)(3) is amended by adding at the 

end the following new sentence: ‘‘Notwithstanding subsection (i)(3)(A)(i), in determining a lease term for purposes of the preceding sentence, there shall not be taken 

into account any option of the lessee to renew at the fair market value rent determined at the time of renewal; except that the aggregate period not taken into account by reason of this sentence shall not exceed 24 months.’’

SEC. 648. LIMITATION ON DEDUCTIONS ALLOCABLE TO PROPERTY USED BY GOVERNMENTS 

OR OTHER TAX-EXEMPT ENTITIES. 

(a) IN GENERAL.—Subpart C of part II of subchapter E of chapter 1 (relating to 

taxable year for which deductions taken) is amended by adding at the end the following new section: 

‘‘SEC. 470. LIMITATION ON DEDUCTIONS ALLOCABLE TO PROPERTY USED BY GOVERNMENTS 

OR OTHER TAX-EXEMPT ENTITIES. 

‘‘(a) LIMITATION ON LOSSES.—Except as otherwise provided in this section, a taxexempt use loss for any taxable year shall not be allowed. 

‘‘(b) DISALLOWED LOSS CARRIED TO NEXT YEAR.—Any tax-exempt use loss with respect to any tax-exempt use property which is disallowed under subsection (a) for 

any taxable year shall be treated as a deduction with respect to such property in 

the next taxable year. 

‘‘(c) DEFINITIONS.—For purposes of this section—

‘‘(1) TAX-EXEMPT USE LOSS.—The term ‘tax-exempt use loss’ means, with respect to any taxable year, the amount (if any) by which—

‘‘(A) the sum of—

‘‘(i) the aggregate deductions (other than interest) directly allocable 

to a tax-exempt use property, plus 

‘‘(ii) the aggregate deductions for interest properly allocable to such 

property, exceed 

‘‘(B) the aggregate income from such property. 

‘‘(2) TAX-EXEMPT USE PROPERTY.—The term ‘tax-exempt use property’ has the 

meaning given to such term by section 168(h) (without regard to paragraphs 

(1)(C) and (3) thereof and determined as if property described in section 

167(f)(1)(B) were tangible property). Such term shall not include property which 

would (but for this sentence) be tax-exempt use property solely by reason of section 168(h)(6) if any credit is allowable under section 42 or 47 with respect to 

such property. 

‘‘(d) EXCEPTION FOR CERTAIN LEASES.—This section shall not apply to any lease 

of property which meets the requirements of all of the following paragraphs: 

‘‘(1) AVAILABILITY OF FUNDS.—

‘‘(A) IN GENERAL.—A lease of property meets the requirements of this 

paragraph if (at any time during the lease term) not more than an allowable amount of funds are—

‘‘(i) subject to any arrangement referred to in subparagraph (B), or 

‘‘(ii) set aside or expected to be set aside, 

to or for the benefit of the lessor or any lender, or to or for the benefit of 

the lessee to satisfy the lessee’s obligations or options under the lease. For 

purposes of clause (ii), funds shall be treated as set aside or expected to be 

set aside only if a reasonable person would conclude, based on the facts and 

circumstances, that such funds are set aside or expected to be set aside. 

‘‘(B) ARRANGEMENTS.—The arrangements referred to in this subparagraph include a defeasance arrangement, a loan by the lessee to the lessor 

or any lender, a deposit arrangement, a letter of credit collateralized with 

84

cash or cash equivalents, a payment undertaking agreement, prepaid rent 

(within the meaning of the regulations under section 467), a sinking fund 

arrangement, a guaranteed investment contract, financial guaranty insurance, and any similar arrangement (whether or not such arrangement provides credit support). 

‘‘(C) ALLOWABLE AMOUNT.—

‘‘(i) IN GENERAL.—Except as otherwise provided in this subparagraph, 

the term ‘allowable amount’ means an amount equal to 20 percent of 

the lessor’s adjusted basis in the property at the time the lease is entered into. 

‘‘(ii) HIGHER AMOUNT PERMITTED IN CERTAIN CASES.—To the extent 

provided in regulations, a higher percentage shall be permitted under 

clause (i) where necessary because of the credit-worthiness of the lessee. In no event may such regulations permit a percentage of more 

than 50 percent. 

‘‘(iii) OPTION TO PURCHASE OTHER THAN AT FAIR MARKET VALUE.—If 

under the lease the lessee has the option to purchase the property for 

a fixed price or for other than the fair market value of the property (determined at the time of exercise), the allowable amount at the time 

such option may be exercised may not exceed 50 percent of the price 

at which such option may be exercised. 

‘‘(iv) NO ALLOWABLE AMOUNT FOR CERTAIN ARRANGEMENTS.—The allowable amount shall be zero with respect to any arrangement which 

involves—

‘‘(I) a loan from the lessee to the lessor or a lender, 

‘‘(II) any deposit received, letter of credit issued, or payment undertaking agreement entered into by a lender otherwise involved in 

the transaction, or 

‘‘(III) in the case of a transaction which involves a lender, any 

credit support made available to the lessor in which any such lender does not have a claim that is senior to the lessor. 

For purposes of subclause (I), the term ‘loan’ shall not include any 

amount treated as a loan under section 467 with respect to a section 

467 rental agreement. 

‘‘(2) LESSOR MUST MAKE SUBSTANTIAL EQUITY INVESTMENT.—

‘‘(A) IN GENERAL.—A lease of property meets the requirements of this 

paragraph if—

‘‘(i) the lessor—

‘‘(I) has at the time the lease is entered into an unconditional atrisk equity investment (as determined by the Secretary) in the 

property of at least 20 percent of the lessor’s adjusted basis in the 

property as of that time, and 

‘‘(II) maintains such investment throughout the term of the 

lease, and 

‘‘(ii) the fair market value of the property at the end of the lease term 

is reasonably expected to be equal to at least 20 percent of such basis. 

‘‘(B) RISK OF LOSS.—For purposes of clause (ii), the fair market value at 

the end of the lease term shall be reduced to the extent that a person other 

than the lessor bears a risk of loss in the value of the property. 

‘‘(C) PARAGRAPH NOT TO APPLY TO SHORT-TERM LEASES.—This paragraph 

shall not apply to any lease with a lease term of 5 years or less. 

‘‘(3) LESSEE MAY NOT BEAR MORE THAN MINIMAL RISK OF LOSS.—

‘‘(A) IN GENERAL.—A lease of property meets the requirements of this 

paragraph if there is no arrangement under which the lessee bears—

‘‘(i) any portion of the loss that would occur if the fair market value 

of the leased property were 25 percent less than its reasonably expected 

fair market value at the time the lease is terminated, or 

‘‘(ii) more than 50 percent of the loss that would occur if the fair market value of the leased property at the time the lease is terminated 

were zero. 

‘‘(B) EXCEPTION.—The Secretary may by regulations provide that the requirements of this paragraph are not met where the lessee bears more than 

a minimal risk of loss. 

‘‘(C) PARAGRAPH NOT TO APPLY TO SHORT-TERM LEASES.—This paragraph 

shall not apply to any lease with a lease term of 5 years or less. 

‘‘(e) SPECIAL RULES.—

‘‘(1) TREATMENT OF FORMER TAX-EXEMPT USE PROPERTY.—

‘‘(A) IN GENERAL.—In the case of any former tax-exempt use property—

85

‘‘(i) any deduction allowable under subsection (b) with respect to such 

property for any taxable year shall be allowed only to the extent of any 

net income (without regard to such deduction) from such property for 

such taxable year, and 

‘‘(ii) any portion of such unused deduction remaining after application 

of clause (i) shall be treated as a deduction allowable under subsection 

(b) with respect to such property in the next taxable year. 

‘‘(B) FORMER TAX-EXEMPT USE PROPERTY.—For purposes of this subsection, the term ‘former tax-exempt use property’ means any property 

which—

‘‘(i) is not tax-exempt use property for the taxable year, but 

‘‘(ii) was tax-exempt use property for any prior taxable year. 

‘‘(2) DISPOSITION OF ENTIRE INTEREST IN PROPERTY.—If during the taxable 

year a taxpayer disposes of the taxpayer’s entire interest in tax-exempt use 

property (or former tax-exempt use property), rules similar to the rules of section 469(g) shall apply for purposes of this section. 

‘‘(3) COORDINATION WITH SECTION 469.—This section shall be applied before 

the application of section 469. 

‘‘(4) COORDINATION WITH SECTIONS 1031 AND 1033.—

‘‘(A) IN GENERAL.—Sections 1031(a) and 1033(a) shall not apply if—

‘‘(i) the exchanged or converted property is tax-exempt use property 

subject to a lease which was entered into before March 13, 2004, and 

which would not have met the requirements of subsection (d) had such 

requirements been in effect when the lease was entered into, or 

‘‘(ii) the replacement property is tax-exempt use property subject to 

a lease which does not meet the requirements of subsection (d). 

‘‘(B) ADJUSTED BASIS.—In the case of property acquired by the lessor in 

a transaction to which section 1031 or 1033 applies, the adjusted basis of 

such property for purposes of this section shall be equal to the lesser of—

‘‘(i) the fair market value of the property as of the beginning of the 

lease term, or 

‘‘(ii) the amount which would be the lessor’s adjusted basis if such 

sections did not apply to such transaction. 

‘‘(f) OTHER DEFINITIONS.—For purposes of this section—

‘‘(1) RELATED PARTIES.—The terms ‘lessor’, ‘lessee’, and ‘lender’ each include 

any related party (within the meaning of section 197(f)(9)(C)(i)). 

‘‘(2) LEASE TERM.—The term ‘lease term’ has the meaning given to such term 

by section 168(i)(3). 

‘‘(3) LENDER.—The term ‘lender’ means, with respect to any lease, a person 

that makes a loan to the lessor which is secured (or economically similar to 

being secured) by the lease or the leased property. 

‘‘(4) LOAN.—The term ‘loan’ includes any similar arrangement. 

‘‘(g) REGULATIONS.—The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the provisions of this section, including regulations which—

‘‘(1) allow in appropriate cases the aggregation of property subject to the same 

lease, and 

‘‘(2) provide for the determination of the allocation of interest expense for purposes of this section.’’. 

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

subchapter E of chapter 1 is amended by adding at the end the following new item:

‘‘Sec. 470. Limitation on deductions allocable to property used by governments or other taxexempt entities.’’.

SEC. 649. EFFECTIVE DATE. 

(a) IN GENERAL.—Except as provided in this section, the amendments made by 

this part shall apply to leases entered into after March 12, 2004. 

(b) EXCEPTION.—

(1) IN GENERAL.—The amendments made by this part shall not apply to qualified transportation property. 

(2) QUALIFIED TRANSPORTATION PROPERTY.—For purposes of paragraph (1), 

the term ‘‘qualified transportation property’’ means domestic property subject to 

a lease with respect to which a formal application—

(A) was submitted for approval to the Federal Transit Administration (an 

agency of the Department of Transportation) after June 30, 2003, and before March 13, 2004, 

(B) is approved by the Federal Transit Administration before January 1, 

2005, and 

(C) includes a description of such property and the value of such property. 

86

(3) EXCHANGES AND CONVERSION OF TAX-EXEMPT USE PROPERTY.—Section 

470(e)(4) of the Internal Revenue Code of 1986, as added by this section, shall 

apply to property exchanged or converted after the date of the enactment of this 

Act. 

Subtitle C—Reduction of Fuel Tax Evasion 

SEC. 651. EXEMPTION FROM CERTAIN EXCISE TAXES FOR MOBILE MACHINERY. 

(a) EXEMPTION FROM TAX ON HEAVY TRUCKS AND TRAILERS SOLD AT RETAIL.— (1) IN GENERAL.—Section 4053 (relating to exemptions) is amended by adding 

at the end the following new paragraph: ‘‘(8) MOBILE MACHINERY.—Any vehicle which consists of a chassis— ‘‘(A) to which there has been permanently mounted (by welding, bolting, 

riveting, or other means) machinery or equipment to perform a construction, manufacturing, processing, farming, mining, drilling, timbering, or 

similar operation if the operation of the machinery or equipment is unrelated to transportation on or off the public highways, ‘‘(B) which has been specially designed to serve only as a mobile carriage 

and mount (and a power source, where applicable) for the particular machinery or equipment involved, whether or not such machinery or equipment is in operation, and ‘‘(C) which, by reason of such special design, could not, without substantial structural modification, be used as a component of a vehicle designed 

to perform a function of transporting any load other than that particular 

machinery or equipment or similar machinery or equipment requiring such 

a specially designed chassis.’’. (2) EFFECTIVE DATE.—The amendment made by this subsection shall take effect on the day after the date of the enactment of this Act. 

(b) EXEMPTION FROM TAX ON USE OF CERTAIN VEHICLES.— (1) IN GENERAL.—Section 4483 (relating to exemptions) is amended by redesignating subsection (g) as subsection (h) and by inserting after subsection (f) the 

following new subsection: ‘‘(g) EXEMPTION FOR MOBILE MACHINERY.—No tax shall be imposed by section 

4481 on the use of any vehicle described in section 4053(8).’’. (2) EFFECTIVE DATE.—The amendments made by this subsection shall take effect on the day after the date of the enactment of this Act. 

(c) EXEMPTION FROM TAX ON TIRES.— (1) IN GENERAL.—Section 4072(b)(2) is amended by adding at the end the following flush sentence: ‘‘Such term shall not include tires of a type used exclusively on vehicles described in section 4053(8).’’. (2) EFFECTIVE DATE.—The amendment made by this subsection shall take effect on the day after the date of the enactment of this Act. 

(d) REFUND OF FUEL TAXES.— (1) IN GENERAL.—Section 6421(e)(2) (defining off-highway business use) is 

amended by adding at the end the following new subparagraph: ‘‘(C) USES IN MOBILE MACHINERY.— ‘‘(i) IN GENERAL.—The term ‘off-highway business use’ shall include 

any use in a vehicle which meets the requirements described in clause 

(ii). ‘‘(ii) REQUIREMENTS FOR MOBILE MACHINERY.—The requirements described in this clause are— ‘‘(I) the design-based test, and 

‘‘(II) the use-based test. ‘‘(iii) DESIGN-BASED TEST.—For purposes of clause (ii)(I), the designbased test is met if the vehicle consists of a chassis— ‘‘(I) to which there has been permanently mounted (by welding, 

bolting, riveting, or other means) machinery or equipment to perform a construction, manufacturing, processing, farming, mining, 

drilling, timbering, or similar operation if the operation of the machinery or equipment is unrelated to transportation on or off the 

public highways, ‘‘(II) which has been specially designed to serve only as a mobile 

carriage and mount (and a power source, where applicable) for the 

particular machinery or equipment involved, whether or not such 

machinery or equipment is in operation, and 

‘‘(III) which, by reason of such special design, could not, without 

substantial structural modification, be used as a component of a 

vehicle designed to perform a function of transporting any load 

87

other than that particular machinery or equipment or similar machinery or equipment requiring such a specially designed chassis. 

‘‘(iv) USE-BASED TEST.—For purposes of clause (ii)(II), the use-based 

test is met if the use of the vehicle on public highways was less than 

7,500 miles during the taxpayer’s taxable year.’’. 

(2) NO TAX-FREE SALES.—Subsection (b) of section 4082, as amended by section 652, is amended by inserting before the period at the end ‘‘and such term 

shall not include any use described in section 6421(e)(2)(C)’’. 

(3) ANNUAL REFUND OF TAX PAID.—Section 6427(i)(2) (relating to exceptions) 

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

‘‘(C) NONAPPLICATION OF PARAGRAPH.—This paragraph shall not apply to 

any fuel used solely in any off-highway business use described in section 

6421(e)(2)(C).’’. 

(4) EFFECTIVE DATE.—The amendments made by this subsection shall apply 

to taxable years beginning after the date of the enactment of this Act. 

SEC. 652. TAXATION OF AVIATION-GRADE KEROSENE. 

(a) RATE OF TAX.—

(1) IN GENERAL.—Subparagraph (A) of section 4081(a)(2) is amended by striking ‘‘and’’ at the end of clause (ii), by striking the period at the end of clause 

(iii) and inserting ‘‘, and’’, and by adding at the end the following new clause: 

‘‘(iv) in the case of aviation-grade kerosene, 21.8 cents per gallon.’’. 

(2) COMMERCIAL AVIATION.—Paragraph (2) of section 4081(a) is amended by 

adding at the end the following new subparagraph: 

‘‘(C) TAXES IMPOSED ON FUEL USED IN COMMERCIAL AVIATION.—In the case 

of aviation-grade kerosene which is removed from any refinery or terminal 

directly into the fuel tank of an aircraft for use in commercial aviation, the 

rate of tax under subparagraph (A)(iv) shall be 4.3 cents per gallon.’’. 

(3) CERTAIN REFUELER TRUCKS, TANKERS, AND TANK WAGONS TREATED AS TERMINAL.—Subsection (a) of section 4081 is amended by adding at the end the following new paragraph: 

‘‘(3) CERTAIN REFUELER TRUCKS, TANKERS, AND TANK WAGONS TREATED AS TERMINAL.—

‘‘(A) IN GENERAL.—In the case of aviation-grade kerosene which is removed from any terminal directly into the fuel tank of an aircraft (determined without regard to any refueler truck, tanker, or tank wagon which 

meets the requirements of subparagraph (B)), a refueler truck, tanker, or 

tank wagon shall be treated as part of such terminal if—

‘‘(i) such truck, tanker, or wagon meets the requirements of subparagraph (B) with respect to an airport, and 

‘‘(ii) except in the case of exigent circumstances identified by the Secretary in regulations, no vehicle registered for highway use is loaded 

with aviation-grade kerosene at such terminal. 

‘‘(B) REQUIREMENTS.—A refueler truck, tanker, or tank wagon meets the 

requirements of this subparagraph with respect to an airport if such truck, 

tanker, or wagon—

‘‘(i) is loaded with aviation-grade kerosene at such terminal located 

within such airport and delivers such kerosene only into aircraft at 

such airport, 

‘‘(ii) has storage tanks, hose, and coupling equipment designed and 

used for the purposes of fueling aircraft, 

‘‘(iii) is not registered for highway use, and 

‘‘(iv) is operated by—

‘‘(I) the terminal operator of such terminal, or 

‘‘(II) a person that makes a daily accounting to such terminal operator of each delivery of fuel from such truck, tanker, or wagon. 

‘‘(C) REPORTING.—The Secretary shall require under section 4101(d) reporting by such terminal operator of—

‘‘(i) any information obtained under subparagraph (B)(iv)(II), and 

‘‘(ii) any similar information maintained by such terminal operator 

with respect to deliveries of fuel made by trucks, tankers, or wagons 

operated by such terminal operator.’’.

(4) LIABILITY FOR TAX ON AVIATION-GRADE KEROSENE USED IN COMMERCIAL

AVIATION.—Subsection (a) of section 4081 is amended by adding at the end the 

following new paragraph: 

‘‘(4) LIABILITY FOR TAX ON AVIATION-GRADE KEROSENE USED IN COMMERCIAL

AVIATION.—For purposes of paragraph (2)(C), the person who uses the fuel for 

commercial aviation shall pay the tax imposed under such paragraph. For purVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00089 Fmt 6659 Sfmt 6621 E:\HR\OC\HR548P1.002 HR548P1
88

poses of the preceding sentence, fuel shall be treated as used when such fuel 

is removed into the fuel tank.’’. (5) NONTAXABLE USES.— (A) IN GENERAL.—Section 4082 is amended by redesignating subsections 

(e) and (f) as subsections (f) and (g), respectively, and by inserting after subsection (d) the following new subsection: ‘‘(e) AVIATION-GRADE KEROSENE.—In the case of aviation-grade kerosene which is 

exempt from the tax imposed by section 4041(c) (other than by reason of a prior imposition of tax) and which is removed from any refinery or terminal directly into 

the fuel tank of an aircraft, the rate of tax under section 4081(a)(2)(A)(iv) shall be 

zero.’’. (B) CONFORMING AMENDMENTS.— (i) Subsection (b) of section 4082 is amended by adding at the end 

the following new flush sentence: ‘‘The term ‘nontaxable use’ does not include the use of aviation-grade kerosene in 

an aircraft.’’. (ii) Section 4082(d) is amended by striking paragraph (1) and by redesignating paragraphs (2) and (3) as paragraphs (1) and (2), respectively. 

(6) NONAIRCRAFT USE OF AVIATION-GRADE KEROSENE.— (A) IN GENERAL.—Subparagraph (B) of section 4041(a)(1) is amended by 

adding at the end the following new sentence: ‘‘This subparagraph shall not 

apply to aviation-grade kerosene.’’. 

(B) CONFORMING AMENDMENT.—The heading for paragraph (1) of section 

4041(a) is amended by inserting ‘‘AND KEROSENE’’ after ‘‘DIESEL FUEL’’. 

(b) COMMERCIAL AVIATION.—Section 4083 is amended by redesignating subsections (b) and (c) as subsections (c) and (d), respectively, and by inserting after 

subsection (a) the following new subsection: 

‘‘(b) COMMERCIAL AVIATION.—For purposes of this subpart, the term ‘commercial 

aviation’ means any use of an aircraft in a business of transporting persons or property for compensation or hire by air, unless properly allocable to any transportation 

exempt from the taxes imposed by sections 4261 and 4271 by reason of section 4281 

or 4282 or by reason of section 4261(h).’’. 

(c) REFUNDS.—

(1) IN GENERAL.—Paragraph (4) of section 6427(l) is amended to read as follows: 

‘‘(4) REFUNDS FOR AVIATION-GRADE KEROSENE.—

‘‘(A) NO REFUND OF CERTAIN TAXES ON FUEL USED IN COMMERCIAL AVIATION.—In the case of aviation-grade kerosene used in commercial aviation 

(as defined in section 4083(b)) (other than supplies for vessels or aircraft 

within the meaning of section 4221(d)(3)), paragraph (1) shall not apply to 

so much of the tax imposed by section 4081 as is attributable to—

‘‘(i) the Leaking Underground Storage Tank Trust Fund financing 

rate imposed by such section, and 

‘‘(ii) so much of the rate of tax specified in section 4081(a)(2)(A)(iv) 

as does not exceed 4.3 cents per gallon. 

‘‘(B) PAYMENT TO ULTIMATE, REGISTERED VENDOR.—With respect to aviation-grade kerosene, if the ultimate purchaser of such kerosene waives (at 

such time and in such form and manner as the Secretary shall prescribe) 

the right to payment under paragraph (1) and assigns such right to the ultimate vendor, then the Secretary shall pay the amount which would be 

paid under paragraph (1) to such ultimate vendor, but only if such ultimate 

vendor—

‘‘(i) is registered under section 4101, and 

‘‘(ii) meets the requirements of subparagraph (A), (B), or (D) of section 6416(a)(1).’’. 

(2) TIME FOR FILING CLAIMS.—Subparagraph (A) of section 6427(i)(4) is 

amended—

(A) by striking ‘‘subsection (l)(5)’’ both places it appears and inserting 

‘‘paragraph (4)(B) or (5) of subsection (l)’’, and 

(B) by striking ‘‘the preceding sentence’’ and inserting ‘‘subsection (l)(5)’’. 

(3) CONFORMING AMENDMENT.—Subparagraph (B) of section 6427(l)(2) is 

amended to read as follows: 

‘‘(B) in the case of aviation-grade kerosene—

‘‘(i) any use which is exempt from the tax imposed by section 4041(c) 

other than by reason of a prior imposition of tax, or 

‘‘(ii) any use in commercial aviation (within the meaning of section 

4083(b)).’’. 

(d) REPEAL OF PRIOR TAXATION OF AVIATION FUEL.—

89

(1) IN GENERAL.—Part III of subchapter A of chapter 32 is amended by striking subpart B and by redesignating subpart C as subpart B. 

(2) CONFORMING AMENDMENTS.—

(A) Section 4041(c) is amended to read as follows: 

‘‘(c) AVIATION-GRADE KEROSENE.—

‘‘(1) IN GENERAL.—There is hereby imposed a tax upon aviation-grade kerosene—

‘‘(A) sold by any person to an owner, lessee, or other operator of an aircraft for use in such aircraft, or 

‘‘(B) used by any person in an aircraft unless there was a taxable sale 

of such fuel under subparagraph (A). 

‘‘(2) EXEMPTION FOR PREVIOUSLY TAXED FUEL.—No tax shall be imposed by 

this subsection on the sale or use of any aviation-grade kerosene if tax was imposed on such liquid under section 4081 and the tax thereon was not credited 

or refunded. 

‘‘(3) RATE OF TAX.—The rate of tax imposed by this subsection shall be the 

rate of tax specified in section 4081(a)(2)(A)(iv) which is in effect at the time 

of such sale or use.’’. 

(B) Section 4041(d)(2) is amended by striking ‘‘section 4091’’ and inserting 

‘‘section 4081’’. 

(C) Section 4041 is amended by striking subsection (e). 

(D) Section 4041 is amended by striking subsection (i). 

(E) Sections 4101(a), 4103, 4221(a), and 6206 are each amended by striking ‘‘, 4081, or 4091’’ and inserting ‘‘or 4081’’. 

(F) Section 6416(b)(2) is amended by striking ‘‘4091 or’’. 

(G) Section 6416(b)(3) is amended by striking ‘‘or 4091’’ each place it appears. 

(H) Section 6416(d) is amended by striking ‘‘or to the tax imposed by section 4091 in the case of refunds described in section 4091(d)’’. 

(I) Section 6427(j)(1) is amended by striking ‘‘, 4081, and 4091’’ and inserting ‘‘and 4081’’. 

(J)(i) Section 6427(l)(1) is amended to read as follows: 

‘‘(1) IN GENERAL.—Except as otherwise provided in this subsection and in subsection (k), if any diesel fuel or kerosene on which tax has been imposed by section 4041 or 4081 is used by any person in a nontaxable use, the Secretary shall 

pay (without interest) to the ultimate purchaser of such fuel an amount equal 

to the aggregate amount of tax imposed on such fuel under section 4041 or 

4081, as the case may be, reduced by any payment made to the ultimate vendor 

under paragraph (4)(B).’’. 

(ii) Paragraph (5)(B) of section 6427(l) is amended by striking ‘‘Paragraph 

(1)(A) shall not apply to kerosene’’ and inserting ‘‘Paragraph (1) shall not 

apply to kerosene (other than aviation-grade kerosene)’’. 

(K) Subparagraph (B) of section 6724(d)(1) is amended by striking clause 

(xv) and by redesignating the succeeding clauses accordingly. 

(L) Paragraph (2) of section 6724(d) is amended by striking subparagraph 

(W) and by redesignating the succeeding subparagraphs accordingly. 

(M) Paragraph (1) of section 9502(b) is amended by adding ‘‘and’’ at the 

end of subparagraph (B) and by striking subparagraphs (C) and (D) and inserting the following new subparagraph: 

‘‘(C) section 4081 with respect to aviation gasoline and aviation-grade kerosene, and’’. 

(N) The last sentence of section 9502(b) is amended to read as follows: 

‘‘There shall not be taken into account under paragraph (1) so much of the taxes 

imposed by section 4081 as are determined at the rate specified in section 

4081(a)(2)(B).’’. 

(O) Subsection (b) of section 9508 is amended by striking paragraph (3) 

and by redesignating paragraphs (4) and (5) as paragraphs (3) and (4), respectively. 

(P) Section 9508(c)(2)(A) is amended by striking ‘‘sections 4081 and 4091’’

and inserting ‘‘section 4081’’. 

(Q) The table of subparts for part III of subchapter A of chapter 32 is 

amended to read as follows:

‘‘Subpart A. Motor and aviation fuels. 

‘‘Subpart B. Special provisions applicable to fuels tax.’’.

(R) The heading for subpart A of part III of subchapter A of chapter 32 

is amended to read as follows: 

90

‘‘Subpart A—Motor and Aviation Fuels’’. 

(S) The heading for subpart B of part III of subchapter A of chapter 32, 

as redesignated by paragraph (1), is amended to read as follows: 

‘‘Subpart B—Special Provisions Applicable to Fuels Tax’’. 

(e) EFFECTIVE DATE.—The amendments made by this section shall apply to aviation-grade kerosene removed, entered, or sold after September 30, 2004. 

(f) FLOOR STOCKS TAX.— (1) IN GENERAL.—There is hereby imposed on aviation-grade kerosene held on 

October 1, 2004, by any person a tax equal to— (A) the tax which would have been imposed before such date on such kerosene had the amendments made by this section been in effect at all times 

before such date, reduced by 

(B) the tax imposed before such date under section 4091 of the Internal 

Revenue Code of 1986, as in effect on the day before the date of the enactment of this Act. 

(2) LIABILITY FOR TAX AND METHOD OF PAYMENT.— (A) LIABILITY FOR TAX.—The person holding the kerosene on October 1, 

2004, to which the tax imposed by paragraph (1) applies shall be liable for 

such tax. 

(B) METHOD AND TIME FOR PAYMENT.—The tax imposed by paragraph (1) 

shall be paid at such time and in such manner as the Secretary of the 

Treasury (or the Secretary’s delegate) shall prescribe, including the nonapplication of such tax on de minimis amounts of kerosene. 

(3) TRANSFER OF FLOOR STOCK TAX REVENUES TO TRUST FUNDS.—For purposes 

of determining the amount transferred to any trust fund, the tax imposed by 

this subsection shall be treated as imposed by section 4081 of the Internal Revenue Code of 1986— (A) at the Leaking Underground Storage Tank Trust Fund financing rate 

under such section to the extent of 0.1 cents per gallon, and 

(B) at the rate under section 4081(a)(2)(A)(iv) to the extent of the remainder. 

(4) HELD BY A PERSON.—For purposes of this section, kerosene shall be considered as held by a person if title thereto has passed to such person (whether or 

not delivery to the person has been made). 

(5) OTHER LAWS APPLICABLE.—All provisions of law, including penalties, applicable with respect to the tax imposed by section 4081 of such Code shall, insofar 

as applicable and not inconsistent with the provisions of this subsection, apply 

with respect to the floor stock tax imposed by paragraph (1) to the same extent 

as if such tax were imposed by such section. 

SEC. 653. DYE INJECTION EQUIPMENT. 

(a) IN GENERAL.—Section 4082(a)(2) (relating to exemptions for diesel fuel and 

kerosene) is amended by inserting ‘‘by mechanical injection’’ after ‘‘indelibly dyed’’. (b) DYE INJECTOR SECURITY.—Not later than 180 days after the date of the enactment of this Act, the Secretary of the Treasury shall issue regulations regarding mechanical dye injection systems described in the amendment made by subsection (a), 

and such regulations shall include standards for making such systems tamper resistant. 

(c) PENALTY FOR TAMPERING WITH OR FAILING TO MAINTAIN SECURITY REQUIRE- MENTS FOR MECHANICAL DYE INJECTION SYSTEMS.— (1) IN GENERAL.—Part I of subchapter B of chapter 68 (relating to assessable 

penalties) is amended by adding after section 6715 the following new section: 

‘‘SEC. 6715A. TAMPERING WITH OR FAILING TO MAINTAIN SECURITY REQUIREMENTS FOR MECHANICAL DYE INJECTION SYSTEMS. 

‘‘(a) IMPOSITION OF PENALTY—

‘‘(1) TAMPERING.—If any person tampers with a mechanical dye injection system used to indelibly dye fuel for purposes of section 4082, such person shall 

pay a penalty in addition to the tax (if any). 

‘‘(2) FAILURE TO MAINTAIN SECURITY REQUIREMENTS.—If any operator of a mechanical dye injection system used to indelibly dye fuel for purposes of section 

4082 fails to maintain the security standards for such system as established by 

the Secretary, then such operator shall pay a penalty in addition to the tax (if 

any). 

‘‘(b) AMOUNT OF PENALTY.—The amount of the penalty under subsection (a) shall 

be—

91

‘‘(1) for each violation described in paragraph (1), the greater of—

‘‘(A) $25,000, or 

‘‘(B) $10 for each gallon of fuel involved, and 

‘‘(2) for each—

‘‘(A) failure to maintain security standards described in paragraph (2), 

$1,000, and 

‘‘(B) failure to correct a violation described in paragraph (2), $1,000 per 

day for each day after which such violation was discovered or such person 

should have reasonably known of such violation. 

‘‘(c) JOINT AND SEVERAL LIABILITY.—

‘‘(1) IN GENERAL.—If a penalty is imposed under this section on any business 

entity, each officer, employee, or agent of such entity or other contracting party 

who willfully participated in any act giving rise to such penalty shall be jointly 

and severally liable with such entity for such penalty. 

‘‘(2) AFFILIATED GROUPS.—If a business entity described in paragraph (1) is 

part of an affiliated group (as defined in section 1504(a)), the parent corporation 

of such entity shall be jointly and severally liable with such entity for the penalty imposed under this section.’’. 

(2) CLERICAL AMENDMENT.—The table of sections for part I of subchapter B 

of chapter 68 is amended by adding after the item related to section 6715 the 

following new item:

‘‘Sec. 6715A. Tampering with or failing to maintain security requirements for mechanical 

dye injection systems.’’.

(d) EFFECTIVE DATE.—The amendments made by subsections (a) and (c) shall take 

effect on the 180th day after the date on which the Secretary issues the regulations 

described in subsection (b). 

SEC. 654. AUTHORITY TO INSPECT ON-SITE RECORDS. 

(a) IN GENERAL.—Section 4083(d)(1)(A) (relating to administrative authority), as 

previously amended by this Act, is amended by striking ‘‘and’’ at the end of clause 

(i) and by inserting after clause (ii) the following new clause: 

‘‘(iii) inspecting any books and records and any shipping papers pertaining to such fuel, and’’. 

(b) EFFECTIVE DATE.—The amendments made by this section shall take effect on 

the date of the enactment of this Act. 

SEC. 655. REGISTRATION OF PIPELINE OR VESSEL OPERATORS REQUIRED FOR EXEMPTION 

OF BULK TRANSFERS TO REGISTERED TERMINALS OR REFINERIES. 

(a) IN GENERAL.—Section 4081(a)(1)(B) (relating to exemption for bulk transfers 

to registered terminals or refineries) is amended—

(1) by inserting ‘‘by pipeline or vessel’’ after ‘‘transferred in bulk’’, and 

(2) by inserting ‘‘, the operator of such pipeline or vessel,’’ after ‘‘the taxable 

fuel’’. 

(b) EFFECTIVE DATE.—The amendments made by this section shall take effect on 

October 1, 2004. 

(c) PUBLICATION OF REGISTERED PERSONS.—Beginning on July 1, 2004, the Secretary of the Treasury (or the Secretary’s delegate) shall periodically publish a current list of persons registered under section 4101 of the Internal Revenue Code of 

1986 who are required to register under such section. 

SEC. 656. DISPLAY OF REGISTRATION. 

(a) IN GENERAL.—Subsection (a) of section 4101 (relating to registration) is 

amended—

(1) by striking ‘‘Every’’ and inserting the following: 

‘‘(1) IN GENERAL.—Every’’, and 

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

‘‘(2) DISPLAY OF REGISTRATION.—Every operator of a vessel required by the 

Secretary to register under this section shall display proof of registration 

through an electronic identification device prescribed by the Secretary on each 

vessel used by such operator to transport any taxable fuel.’’. 

(b) CIVIL PENALTY FOR FAILURE TO DISPLAY REGISTRATION.—

(1) IN GENERAL.—Part I of subchapter B of chapter 68 (relating to assessable 

penalties) is amended by inserting after section 6716 the following new section: 

‘‘SEC. 6717. FAILURE TO DISPLAY TAX REGISTRATION ON VESSELS. 

‘‘(a) FAILURE TO DISPLAY REGISTRATION.—Every operator of a vessel who fails to 

display proof of registration pursuant to section 4101(a)(2) shall pay a penalty of 

$500 for each such failure. With respect to any vessel, only one penalty shall be imposed by this section during any calendar month. 

92

‘‘(b) MULTIPLE VIOLATIONS.—In determining the penalty under subsection (a) on 

any person, subsection (a) shall be applied by increasing the amount in subsection 

(a) by the product of such amount and the aggregate number of penalties (if any) 

imposed with respect to prior months by this section on such person (or a related 

person or any predecessor of such person or related person). 

‘‘(c) REASONABLE CAUSE EXCEPTION.—No penalty shall be imposed under this section with respect to any failure if it is shown that such failure is due to reasonable 

cause.’’. 

(2) CLERICAL AMENDMENT.—The table of sections for part I of subchapter B 

of chapter 68 is amended by inserting after the item relating to section 6716 

the following new item:

‘‘Sec. 6717. Failure to display tax registration on vessels.’’.

(c) EFFECTIVE DATES.—

(1) SUBSECTION (a).—The amendments made by subsection (a) shall take effect on October 1, 2004. 

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

penalties imposed after September 30, 2004. 

SEC. 657. PENALTIES FOR FAILURE TO REGISTER AND FAILURE TO REPORT. 

(a) INCREASED PENALTY.—Subsection (a) of section 7272 (relating to penalty for 

failure to register) is amended by inserting ‘‘($10,000 in the case of a failure to register under section 4101)’’ after ‘‘$50’’. 

(b) INCREASED CRIMINAL PENALTY.—Section 7232 (relating to failure to register 

under section 4101, false representations of registration status, etc.) is amended by 

striking ‘‘$5,000’’ and inserting ‘‘$10,000’’. 

(c) ASSESSABLE PENALTY FOR FAILURE TO REGISTER.—

(1) IN GENERAL.—Part I of subchapter B of chapter 68 (relating to assessable 

penalties) is amended by inserting after section 6717 the following new section: 

‘‘SEC. 6718. FAILURE TO REGISTER. 

‘‘(a) FAILURE TO REGISTER.—Every person who is required to register under section 4101 and fails to do so shall pay a penalty in addition to the tax (if any). 

‘‘(b) AMOUNT OF PENALTY.—The amount of the penalty under subsection (a) shall 

be—

‘‘(1) $10,000 for each initial failure to register, and 

‘‘(2) $1,000 for each day thereafter such person fails to register. 

‘‘(c) REASONABLE CAUSE EXCEPTION.—No penalty shall be imposed under this section with respect to any failure if it is shown that such failure is due to reasonable 

cause.’’. 

(2) CLERICAL AMENDMENT.—The table of sections for part I of subchapter B 

of chapter 68 is amended by inserting after the item relating to section 6717 

the following new item:

‘‘Sec. 6718. Failure to register.’’.

(d) ASSESSABLE PENALTY FOR FAILURE TO REPORT.—

(1) IN GENERAL.—Part II of subchapter B of chapter 68 (relating to assessable 

penalties) is amended by adding at the end the following new section: 

‘‘SEC. 6725. FAILURE TO REPORT INFORMATION UNDER SECTION 4101. 

‘‘(a) IN GENERAL.—In the case of each failure described in subsection (b) by any 

person with respect to a vessel or facility, such person shall pay a penalty of $10,000 

in addition to the tax (if any). 

‘‘(b) FAILURES SUBJECT TO PENALTY.—For purposes of subsection (a), the failures 

described in this subsection are—

‘‘(1) any failure to make a report under section 4101(d) on or before the date 

prescribed therefor, and 

‘‘(2) any failure to include all of the information required to be shown on such 

report or the inclusion of incorrect information. 

‘‘(c) REASONABLE CAUSE EXCEPTION.—No penalty shall be imposed under this section with respect to any failure if it is shown that such failure is due to reasonable 

cause.’’. 

(2) CLERICAL AMENDMENT.—The table of sections for part II of subchapter B 

of chapter 68 is amended by adding at the end the following new item:

‘‘Sec. 6725. Failure to report information under section 4101.’’.

(e) EFFECTIVE DATE.—The amendments made by this section shall apply to penalties imposed after September 30, 2004. 

93

SEC. 658. COLLECTION FROM CUSTOMS BOND WHERE IMPORTER NOT REGISTERED. 

(a) TAX AT POINT OF ENTRY WHERE IMPORTER NOT REGISTERED.—Subpart B of 

part III of subchapter A of chapter 32, as redesignated by section 652(d), is amended 

by adding after section 4103 the following new section: 

‘‘SEC. 4104. COLLECTION FROM CUSTOMS BOND WHERE IMPORTER NOT REGISTERED. 

‘‘(a) IN GENERAL.—The importer of record shall be jointly and severally liable for 

the tax imposed by section 4081(a)(1)(A)(iii) if, under regulations prescribed by the 

Secretary, any other person that is not a person who is registered under section 

4101 is liable for such tax. ‘‘(b) COLLECTION FROM CUSTOMS BOND.—If any tax for which any importer of 

record is liable under subsection (a), or for which any importer of record that is not 

a person registered under section 4101 is otherwise liable, is not paid on or before 

the last date prescribed for payment, the Secretary may collect such tax from the 

Customs bond posted with respect to the importation of the taxable fuel to which 

the tax relates. For purposes of determining the jurisdiction of any court of the 

United States or any agency of the United States, any action by the Secretary described in the preceding sentence shall be treated as an action to collect the tax 

from a bond described in section 4101(b)(1) and not as an action to collect from a 

bond relating to the importation of merchandise.’’. (b) CONFORMING AMENDMENT.—The table of sections for subpart B of part III of 

subchapter A of chapter 32, as redesignated by section 652(d), is amended by adding 

after the item related to section 4103 the following new item:

‘‘Sec. 4104. Collection from Customs bond where importer not registered.’’.

(c) EFFECTIVE DATE.—The amendments made by this section shall apply with respect to fuel entered after September 30, 2004. 

SEC. 659. MODIFICATIONS OF TAX ON USE OF CERTAIN VEHICLES. 

(a) PRORATION OF TAX WHERE VEHICLE SOLD.— (1) IN GENERAL.—Subparagraph (A) of section 4481(c)(2) (relating to where vehicle destroyed or stolen) is amended by striking ‘‘destroyed or stolen’’ both 

places it appears and inserting ‘‘sold, destroyed, or stolen’’. (2) CONFORMING AMENDMENT.—The heading for section 4481(c)(2) is amended 

by striking ‘‘DESTROYED OR STOLEN’’ and inserting ‘‘SOLD, DESTROYED, OR STO- LEN’’. (b) REPEAL OF INSTALLMENT PAYMENT.— (1) Section 6156 (relating to installment payment of tax on use of highway 

motor vehicles) is repealed. 

(2) The table of sections for subchapter A of chapter 62 is amended by striking the item relating to section 6156. 

(c) ELECTRONIC FILING.—Section 4481 is amended by redesignating subsection (e) 

as subsection (f) and by inserting after subsection (d) the following new subsection: ‘‘(e) ELECTRONIC FILING.—Any taxpayer who files a return under this section with 

respect to 25 or more vehicles for any taxable period shall file such return electronically.’’. (d) REPEAL OF REDUCTION IN TAX FOR CERTAIN TRUCKS.—Section 4483 is amended by striking subsection (f). 

(e) EFFECTIVE DATE.—The amendments made by this section shall apply to taxable periods beginning after the date of the enactment of this Act. 

SEC. 660. MODIFICATION OF ULTIMATE VENDOR REFUND CLAIMS WITH RESPECT TO FARMING. 

(a) IN GENERAL.— (1) REFUNDS.—Section 6427(l) is amended by adding at the end the following 

new paragraph: ‘‘(6) REGISTERED VENDORS PERMITTED TO ADMINISTER CERTAIN CLAIMS FOR RE- FUND OF DIESEL FUEL AND KEROSENE SOLD TO FARMERS.— ‘‘(A) IN GENERAL.—In the case of diesel fuel or kerosene used on a farm 

for farming purposes (within the meaning of section 6420(c)), paragraph (1) 

shall not apply to the aggregate amount of such diesel fuel or kerosene if 

such amount does not exceed 250 gallons (as determined under subsection 

(i)(5)(A)(iii)). ‘‘(B) PAYMENT TO ULTIMATE VENDOR.—The amount which would (but for 

subparagraph (A)) have been paid under paragraph (1) with respect to any 

fuel shall be paid to the ultimate vendor of such fuel, if such vendor—

‘‘(i) is registered under section 4101, and 

‘‘(ii) meets the requirements of subparagraph (A), (B), or (D) of section 6416(a)(1).’’. 

(2) FILING OF CLAIMS.—Section 6427(i) is amended by inserting at the end the 

following new paragraph: 

94

‘‘(5) SPECIAL RULE FOR VENDOR REFUNDS WITH RESPECT TO FARMERS.— ‘‘(A) IN GENERAL.—A claim may be filed under subsection (l)(6) by any 

person with respect to fuel sold by such person for any period— ‘‘(i) for which $200 or more ($100 or more in the case of kerosene) 

is payable under subsection (l)(6), ‘‘(ii) which is not less than 1 week, and 

‘‘(iii) which is for not more than 250 gallons for each farmer for which 

there is a claim. 

Notwithstanding subsection (l)(1), paragraph (3)(B) shall apply to claims 

filed under the preceding sentence. ‘‘(B) TIME FOR FILING CLAIM.—No claim filed under this paragraph shall 

be allowed unless filed on or before the last day of the first quarter following the earliest quarter included in the claim.’’. (3) CONFORMING AMENDMENTS.— (A) Section 6427(l)(5)(A) is amended to read as follows: 

‘‘(A) IN GENERAL.—Paragraph (1) shall not apply to diesel fuel or kerosene 

used by a State or local government.’’. (B) The heading for section 6427(l)(5) is amended by striking ‘‘FARMERS

AND’’. (b) EFFECTIVE DATE.—The amendment made by this section shall apply to fuels 

sold for nontaxable use after the date of the enactment of this Act. 

SEC. 661. DEDICATION OF REVENUES FROM CERTAIN PENALTIES TO THE HIGHWAY TRUST 

FUND. 

(a) IN GENERAL.—Subsection (b) of section 9503 (relating to transfer to Highway 

Trust Fund of amounts equivalent to certain taxes) is amended by redesignating 

paragraph (5) as paragraph (6) and inserting after paragraph (4) the following new 

paragraph: ‘‘(5) CERTAIN PENALTIES.—There are hereby appropriated to the Highway 

Trust Fund amounts equivalent to the penalties paid under sections 6715, 

6715A, 6717, 6718, 6725, 7232, and 7272 (but only with regard to penalties 

under such section related to failure to register under section 4101).’’. 

(b) CONFORMING AMENDMENTS.—

(1) The heading of subsection (b) of section 9503 is amended by inserting ‘‘AND

PENALTIES’’ after ‘‘TAXES’’. 

(2) The heading of paragraph (1) of section 9503(b) is amended by striking 

‘‘IN GENERAL’’ and inserting ‘‘CERTAIN TAXES’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall apply to penalties assessed after October 1, 2004. 

SEC. 662. TAXABLE FUEL REFUNDS FOR CERTAIN ULTIMATE VENDORS. 

(a) IN GENERAL.—Paragraph (4) of section 6416(a) (relating to abatements, credits, and refunds) is amended to read as follows: 

‘‘(4) REGISTERED ULTIMATE VENDOR TO ADMINISTER CREDITS AND REFUNDS OF

GASOLINE TAX.—

‘‘(A) IN GENERAL.—For purposes of this subsection, if an ultimate vendor 

purchases any gasoline on which tax imposed by section 4081 has been paid 

and sells such gasoline to an ultimate purchaser described in subparagraph 

(C) or (D) of subsection (b)(2) (and such gasoline is for a use described in 

such subparagraph), such ultimate vendor shall be treated as the person 

(and the only person) who paid such tax, but only if such ultimate vendor 

is registered under section 4101. For purposes of this subparagraph, if the 

sale of gasoline is made by means of a credit card, the person extending 

the credit to the ultimate purchaser shall be deemed to be the ultimate vendor. 

‘‘(B) TIMING OF CLAIMS.—The procedure and timing of any claim under 

subparagraph (A) shall be the same as for claims under section 6427(i)(4), 

except that the rules of section 6427(i)(3)(B) regarding electronic claims 

shall not apply unless the ultimate vendor has certified to the Secretary for 

the most recent quarter of the taxable year that all ultimate purchasers of 

the vendor covered by such claim are certified and entitled to a refund 

under subparagraph (C) or (D) of subsection (b)(2).’’. 

(b) CREDIT CARD PURCHASES OF DIESEL FUEL OR KEROSENE BY STATE AND LOCAL

GOVERNMENTS.—Section 6427(l)(5)(C) (relating to nontaxable uses of diesel fuel, kerosene, and aviation fuel) is amended by adding at the end the following new flush 

sentence: ‘‘For purposes of this subparagraph, if the sale of diesel fuel or kerosene 

is made by means of a credit card, the person extending the credit to the ultimate 

purchaser shall be deemed to be the ultimate vendor.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section shall take effect on 

October 1, 2004. 

95

SEC. 663. TWO-PARTY EXCHANGES. 

(a) IN GENERAL.—Subpart B of part III of subchapter A of chapter 32, as amended 

by this Act, is amended by adding after section 4104 the following new section: 

‘‘SEC. 4105. TWO-PARTY EXCHANGES. 

‘‘(a) IN GENERAL.—In a two-party exchange, the delivering person shall not be liable for the tax imposed under section 4081(a)(1)(A)(ii). 

‘‘(b) TWO-PARTY EXCHANGE.—The term ‘two-party exchange’ means a transaction, 

other than a sale, in which taxable fuel is transferred from a delivering person registered under section 4101 as a taxable fuel registrant fuel to a receiving person 

who is so registered where all of the following occur: 

‘‘(1) The transaction includes a transfer from the delivering person, who holds 

the inventory position for taxable fuel in the terminal as reflected in the records 

of the terminal operator. 

‘‘(2) The exchange transaction occurs before or contemporaneous with completion of removal across the rack from the terminal by the receiving person. 

‘‘(3) The terminal operator in its books and records treats the receiving person 

as the person that removes the taxable fuel across the terminal rack for purposes of reporting the transaction to the Secretary. 

‘‘(4) The transaction is the subject of a written contract.’’. 

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

subchapter A of chapter 32, as amended by this Act, is amended by adding after 

the item relating to section 4104 the following new item:

‘‘Sec. 4105. Two-party exchanges.’’.

(c) EFFECTIVE DATE.—The amendment made by this section shall take effect on 

the date of the enactment of this Act. 

SEC. 664. SIMPLIFICATION OF TAX ON TIRES. 

(a) IN GENERAL.—Subsection (a) of section 4071 is amended to read as follows: 

‘‘(a) IMPOSITION AND RATE OF TAX.—There is hereby imposed on taxable tires sold 

by the manufacturer, producer, or importer thereof a tax at the rate of 9.4 cents 

(4.7 cents in the case of a biasply tire) for each 10 pounds so much of the maximum 

rated load capacity thereof as exceeds 3,500 pounds.’’

(b) TAXABLE TIRE.—Section 4072 is amended by redesignating subsections (a) and 

(b) as subsections (b) and (c), respectively, and by inserting before subsection (b) (as 

so redesignated) the following new subsection: 

‘‘(a) TAXABLE TIRE.—For purposes of this chapter, the term ‘taxable tire’ means 

any tire of the type used on highway vehicles if wholly or in part made of rubber 

and if marked pursuant to Federal regulations for highway use.’’

(c) EXEMPTION FOR TIRES SOLD TO DEPARTMENT OF DEFENSE.—Section 4073 is 

amended to read as follows: 

‘‘SEC. 4073. EXEMPTIONS. 

‘‘The tax imposed by section 4071 shall not apply to tires sold for the exclusive 

use of the Department of Defense or the Coast Guard.’’

(d) CONFORMING AMENDMENTS.—

(1) Section 4071 is amended by striking subsection (c) and by moving subsection (e) after subsection (b) and redesignating subsection (e) as subsection (c). 

(2) The item relating to section 4073 in the table of sections for part II of subchapter A of chapter 32 is amended to read as follows:

‘‘Sec. 4073. Exemptions.’’

(e) EFFECTIVE DATE.—The amendments made by this section shall apply to sales 

in calendar years beginning more than 30 days after the date of the enactment of 

this Act. 

Subtitle D—Nonqualified Deferred Compensation 

Plans 

SEC. 671. TREATMENT OF NONQUALIFIED DEFERRED COMPENSATION PLANS. 

(a) IN GENERAL.—Subpart A of part I of subchapter D of chapter 1 is amended 

by adding at the end the following new section: 

‘‘SEC. 409A. INCLUSION IN GROSS INCOME OF DEFERRED COMPENSATION UNDER NONQUALIFIED DEFERRED COMPENSATION PLANS. 

‘‘(a) RULES RELATING TO CONSTRUCTIVE RECEIPT.—

‘‘(1) IN GENERAL.—

96

‘‘(A) GROSS INCOME INCLUSION.—In the case of a nonqualified deferred 

compensation plan, all compensation deferred under the plan for all taxable 

years (to the extent not subject to a substantial risk of forfeiture and not 

previously included in gross income) shall be includible in gross income for 

the taxable year unless at all times during the taxable year the plan meets 

the requirements of paragraphs (2), (3), and (4) and is operated in accordance with such requirements. 

‘‘(B) INTEREST ON TAX LIABILITY PAYABLE WITH RESPECT TO PREVIOUSLY

DEFERRED COMPENSATION.—

‘‘(i) IN GENERAL.—If compensation is required to be included in gross 

income under subparagraph (A) for a taxable year, the tax imposed by 

this chapter for such taxable year shall be increased by the amount of 

interest determined under clause (ii). 

‘‘(ii) INTEREST.—For purposes of clause (i), the interest determined 

under this clause for any taxable year is the amount of interest at the 

underpayment rate plus 1 percentage point on the underpayments that 

would have occurred had the deferred compensation been includible in 

gross income for the taxable year in which first deferred or, if later, the 

first taxable year in which such deferred compensation is not subject 

to a substantial risk of forfeiture. 

‘‘(2) DISTRIBUTIONS.—

‘‘(A) IN GENERAL.—The requirements of this paragraph are met if the 

plan provides that compensation deferred under the plan may not be distributed earlier than—

‘‘(i) separation from service as determined by the Secretary (except as 

provided in subparagraph (B)(i)), 

‘‘(ii) the date the participant becomes disabled (within the meaning 

of subparagraph (C)), 

‘‘(iii) death, 

‘‘(iv) a specified time (or pursuant to a fixed schedule) specified under 

the plan at the date of the deferral of such compensation, 

‘‘(v) to the extent provided by the Secretary, a change in the ownership or effective control of the corporation, or in the ownership of a substantial portion of the assets of the corporation, or 

‘‘(vi) the occurrence of an unforeseeable emergency. 

‘‘(B) SPECIAL RULES.—

‘‘(i) SPECIFIED EMPLOYEES.—In the case of specified employees, the requirement of subparagraph (A)(i) is met only if distributions may not 

be made earlier than 6 months after the date of separation from service. For purposes of the preceding sentence, a specified employee is a 

key employee (as defined in section 416(i)) of a corporation the stock 

in which is publicly traded on an established securities market or otherwise. 

‘‘(ii) UNFORESEEABLE EMERGENCY.—For purposes of subparagraph 

(A)(vi)—

‘‘(I) IN GENERAL.—The term ‘unforeseeable emergency’ means a 

severe financial hardship to the participant resulting from a sudden and unexpected illness or accident of the participant, the participant’s spouse, or a dependent (as defined in section 152(a)) of 

the participant, loss of the participant’s property due to casualty, 

or other similar extraordinary and unforeseeable circumstances 

arising as a result of events beyond the control of the participant. 

‘‘(II) LIMITATION ON DISTRIBUTIONS.—The requirement of subparagraph (A)(vi) is met only if, as determined under regulations 

of the Secretary, the amounts distributed with respect to an emergency do not exceed the amounts necessary to satisfy such emergency plus amounts necessary to pay taxes reasonably anticipated 

as a result of the distribution, after taking into account the extent 

to which such hardship is or may be relieved through reimbursement or compensation by insurance or otherwise or by liquidation 

of the participant’s assets (to the extent the liquidation of such assets would not itself cause severe financial hardship). 

‘‘(C) DISABLED.—For purposes of subparagraph (A)(ii), a participant shall 

be considered disabled if the participant—

‘‘(i) is unable to engage in any substantial gainful activity by reason 

of any medically determinable physical or mental impairment which 

can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, or 

97

‘‘(ii) is, by reason of any medically determinable physical or mental 

impairment which can be expected to result in death or can be expected 

to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than 3 months under 

an accident and health plan covering employees of the participant’s em- ployer. ‘‘(3) ACCELERATION OF BENEFITS.—The requirements of this paragraph are 

met if the plan does not permit the acceleration of the time or schedule of any 

payment under the plan, except as provided in regulations by the Secretary. ‘‘(4) ELECTIONS.— ‘‘(A) IN GENERAL.—The requirements of this paragraph are met if the requirements of subparagraphs (B) and (C) are met. ‘‘(B) INITIAL DEFERRAL DECISION.—The requirements of this subparagraph 

are met if the plan provides that compensation for services performed during a taxable year may be deferred at the participant’s election only if the 

election to defer such compensation is made not later than the close of the 

preceding taxable year or at such other time as provided in regulations. In 

the case of the first year in which a participant becomes eligible to participate in the plan, such election may be made with respect to services to be 

performed subsequent to the election within 30 days after the date the participant becomes eligible to participate in such plan. 

‘‘(C) CHANGES IN TIME AND FORM OF DISTRIBUTION.—The requirements of 

this subparagraph are met if, in the case of a plan which permits under 

a subsequent election a delay in a payment or a change in the form of payment—

‘‘(i) the plan requires that such election may not take effect until at 

least 12 months after the date on which the election is made, 

‘‘(ii) in the case an election related to a payment not described in 

clause (ii), (iii), or (vi) of paragraph (2)(A), the plan requires that the 

first payment with respect to which such election is made be deferred 

for a period of not less than 5 years from the date such payment would 

otherwise have been made, and 

‘‘(iii) the plan requires that any election related to a payment described in paragraph (2)(A)(iv) may not be made less than 12 months 

prior to the date of the first scheduled payment under such paragraph. 

‘‘(b) RULES RELATING TO FUNDING.—

‘‘(1) OFFSHORE PROPERTY IN A TRUST.—In the case of assets set aside (directly 

or indirectly) in a trust (or other arrangement determined by the Secretary) for 

purposes of paying deferred compensation under a nonqualified deferred compensation plan, for purposes of section 83 such assets shall be treated as property transferred in connection with the performance of services whether or not 

such assets are available to satisfy claims of general creditors—

‘‘(A) at the time set aside if such assets are located outside of the United 

States, or 

‘‘(B) at the time transferred if such assets are subsequently transferred 

outside of the United States. 

‘‘(2) EMPLOYER’S FINANCIAL HEALTH.—In the case of compensation deferred 

under a nonqualified deferred compensation plan, there is a transfer of property 

within the meaning of section 83 with respect to such compensation as of the 

earlier of—

‘‘(A) the date on which the plan first provides that assets will become restricted to the provision of benefits under the plan in connection with a 

change in the employer’s financial health, or 

‘‘(B) the date on which assets are so restricted. 

‘‘(3) INCOME INCLUSION FOR OFFSHORE TRUSTS AND EMPLOYER’S FINANCIAL

HEALTH.—For each taxable year that assets treated as transferred under this 

subsection remain set aside in a trust or other arrangement subject to paragraph (1) or (2), any increase in value in, or earnings with respect to, such assets shall be treated as an additional transfer of property under this subsection 

(to the extent not previously included in income). 

‘‘(4) INTEREST ON TAX LIABILITY PAYABLE WITH RESPECT TO TRANSFERRED PROPERTY.—

‘‘(A) IN GENERAL.—If amounts are required to be included in gross income 

by reason of paragraph (1) or (2) for a taxable year, the tax imposed by this 

chapter for such taxable year shall be increased by the amount of interest 

determined under subparagraph (B). 

‘‘(B) INTEREST.—The interest determined under this subparagraph for any 

taxable year is the amount of interest at the underpayment rate plus 1 percentage point on the underpayments that would have occurred had the 

98

amounts so required to be included in gross income by paragraph (1) or (2) 

been includible in gross income for the taxable year in which first deferred 

or, if later, the first taxable year in which such deferred compensation is 

not subject to a substantial risk of forfeiture. ‘‘(c) NO INFERENCE ON EARLIER INCOME INCLUSION OR REQUIREMENT OF LATER IN- CLUSION.—Nothing in this section shall be construed to prevent the inclusion of 

amounts in gross income under any other provision of this chapter or any other rule 

of law earlier than the time provided in this section. Any amount included in gross 

income under this section shall not be required to be included in gross income under 

any other provision of this chapter or any other rule of law later than the time provided in this section. ‘‘(d) OTHER DEFINITIONS AND SPECIAL RULES.—For purposes of this section— ‘‘(1) NONQUALIFIED DEFERRED COMPENSATION PLAN.—The term ‘nonqualified 

deferred compensation plan’ means any plan that provides for the deferral of 

compensation, other than— ‘‘(A) a qualified employer plan, and 

‘‘(B) any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan. ‘‘(2) QUALIFIED EMPLOYER PLAN.—The term ‘qualified employer plan’ means— ‘‘(A) any plan, contract, pension, account, or trust described in subparagraph (A) or (B) of section 219(g)(5), and ‘‘(B) any eligible deferred compensation plan (within the meaning of section 457(b)) of an employer described in section 457(e)(1)(A). ‘‘(3) PLAN INCLUDES ARRANGEMENTS, ETC.—The term ‘plan’ includes any 

agreement or arrangement, including an agreement or arrangement that includes one person. ‘‘(4) SUBSTANTIAL RISK OF FORFEITURE.—The rights of a person to compensation are subject to a substantial risk of forfeiture if such person’s rights to such 

compensation are conditioned upon the future performance of substantial services by any individual. ‘‘(5) TREATMENT OF EARNINGS.—References to deferred compensation shall be 

treated as including references to income (whether actual or notional) attributable to such compensation or such income. ‘‘(e) REGULATIONS.—The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section, including regulations—

‘‘(1) providing for the determination of amounts of deferral in the case of a 

nonqualified deferred compensation plan which is a defined benefit plan, ‘‘(2) relating to changes in the ownership and control of a corporation or assets of a corporation for purposes of subsection (a)(2)(A)(v), ‘‘(3) exempting arrangements from the application of subsection (b) if such arrangements will not result in an improper deferral of United States tax and will 

not result in assets being effectively beyond the reach of creditors, ‘‘(4) defining financial health for purposes of subsection (b)(2), and 

‘‘(5) disregarding a substantial risk of forfeiture in cases where necessary to 

carry out the purposes of this section.’’. (b) W–2 FORMS.— (1) IN GENERAL.—Subsection (a) of section 6051 (relating to receipts for employees) is amended by striking ‘‘and’’ at the end of paragraph (11), by striking 

the period at the end of paragraph (12) and inserting ‘‘, and’’, and by inserting 

after paragraph (12) the following new paragraph: ‘‘(13) the total amount of deferrals under a nonqualified deferred compensation plan (within the meaning of section 409A(d)).’’. (2) THRESHOLD.—Subsection (a) of section 6051 is amended by adding at the 

end the following: ‘‘In the case of the amounts required to be shown by paragraph (13), the Secretary (by regulation) may establish a minimum amount of 

deferrals below which paragraph (13) does not apply and may provide that 

paragraph (13) does not apply with respect to amounts of deferrals which are 

not reasonably ascertainable.’’. (c) CONFORMING AND CLERICAL AMENDMENTS.— (1) Section 414(b) is amended by inserting ‘‘409A,’’ after ‘‘408(p),’’. 

(2) Section 414(c) is amended by inserting ‘‘409A,’’ after ‘‘408(p),’’. 

(3) The table of sections for such subpart A of part I of subchapter D of chapter 1 is amended by adding at the end the following new item:

‘‘Sec. 409A. Inclusion in gross income of deferred compensation under nonqualified deferred 

compensation plans.’’.

(d) EFFECTIVE DATE.—

(1) IN GENERAL.—The amendments made by this section shall apply to 

amounts deferred after June 3, 2004. 

99

(2) CERTAIN AMOUNTS DEFERRED IN 2004 UNDER CERTAIN IRREVOCABLE ELECTIONS AND BINDING ARRANGEMENTS.—The amendments made by this section 

shall not apply to amounts deferred after June 3, 2004, and before January 1, 

2005, pursuant to an irrevocable election or binding arrangement made before 

June 4, 2004. 

(3) EARNINGS ATTRIBUTABLE TO AMOUNT PREVIOUSLY DEFERRED.—The amendments made by this section shall apply to earnings on deferred compensation 

only to the extent that such amendments apply to such compensation. 

(e) GUIDANCE RELATING TO CHANGE OF OWNERSHIP OR CONTROL.—Not later than 

90 days after the date of the enactment of this Act, the Secretary of the Treasury 

shall issue guidance on what constitutes a change in ownership or effective control 

for purposes of section 409A of the Internal Revenue Code of 1986, as added by this 

section. 

(f) GUIDANCE RELATING TO TERMINATION OF CERTAIN EXISTING ARRANGEMENTS.—

Not later than 90 days after the date of the enactment of this Act, the Secretary 

of the Treasury shall issue guidance providing a limited period during which an individual participating in a nonqualified deferred compensation plan adopted before 

June 4, 2004, may, without violating the requirements of paragraphs (2), (3), and 

(4) of section 409A(a)(2) of the Internal Revenue Code of 1986 (as added by this section), terminate participation or cancel an outstanding deferral election with regard 

to amounts earned after June 3, 2004, if such amounts are includible in income as 

earned. 

Subtitle E—Other Revenue Provisions 

SEC. 681. QUALIFIED TAX COLLECTION CONTRACTS. 

(a) CONTRACT REQUIREMENTS.—

(1) IN GENERAL.—Subchapter A of chapter 64 (relating to collection) is amended by adding at the end the following new section: 

‘‘SEC. 6306. QUALIFIED TAX COLLECTION CONTRACTS. 

‘‘(a) IN GENERAL.—Nothing in any provision of law shall be construed to prevent 

the Secretary from entering into a qualified tax collection contract. 

‘‘(b) QUALIFIED TAX COLLECTION CONTRACT.—For purposes of this section, the 

term ‘qualified tax collection contract’ means any contract which—

‘‘(1) is for the services of any person (other than an officer or employee of the 

Treasury Department)—

‘‘(A) to locate and contact any taxpayer specified by the Secretary, 

‘‘(B) to request full payment from such taxpayer of an amount of Federal 

tax specified by the Secretary and, if such request cannot be met by the 

taxpayer, to offer the taxpayer an installment agreement providing for full 

payment of such amount during a period not to exceed 5 years, and 

‘‘(C) to obtain financial information specified by the Secretary with respect to such taxpayer, 

‘‘(2) prohibits each person providing such services under such contract from 

committing any act or omission which employees of the Internal Revenue Service are prohibited from committing in the performance of similar services, 

‘‘(3) prohibits subcontractors from—

‘‘(A) having contacts with taxpayers, 

‘‘(B) providing quality assurance services, and 

‘‘(C) composing debt collection notices, and 

‘‘(4) permits subcontractors to perform other services only with the approval 

of the Secretary. 

‘‘(c) FEES.—The Secretary may retain and use an amount not in excess of 25 percent of the amount collected under any qualified tax collection contract for the costs 

of services performed under such contract. The Secretary shall keep adequate 

records regarding amounts so retained and used. The amount credited as paid by 

any taxpayer shall be determined without regard to this subsection. 

‘‘(d) NO FEDERAL LIABILITY.—The United States shall not be liable for any act or 

omission of any person performing services under a qualified tax collection contract. 

‘‘(e) APPLICATION OF FAIR DEBT COLLECTION PRACTICES ACT.—The provisions of 

the Fair Debt Collection Practices Act (15 U.S.C. 1692 et seq.) shall apply to any 

qualified tax collection contract, except to the extent superseded by section 6304, 

section 7602(c), or by any other provision of this title. 

‘‘(f) CROSS REFERENCES.—

‘‘(1) For damages for certain unauthorized collection actions by persons performing services under a qualified tax collection contract, see section 7433A. 

100

‘‘(2) For application of Taxpayer Assistance Orders to persons performing services under 

a qualified tax collection contract, see section 7811(a)(4).’’.

(2) CONFORMING AMENDMENTS.—

(A) Section 7809(a) is amended by inserting ‘‘6306,’’ before ‘‘7651’’. 

(B) The table of sections for subchapter A of chapter 64 is amended by 

adding at the end the following new item:

‘‘Sec. 6306. Qualified Tax Collection Contracts.’’.

(b) CIVIL DAMAGES FOR CERTAIN UNAUTHORIZED COLLECTION ACTIONS BY PERSONS PERFORMING SERVICES UNDER QUALIFIED TAX COLLECTION CONTRACTS.—

(1) In general.—Subchapter B of chapter 76 (relating to proceedings by taxpayers and third parties) is amended by inserting after section 7433 the following new section: 

‘‘SEC. 7433A. CIVIL DAMAGES FOR CERTAIN UNAUTHORIZED COLLECTION ACTIONS BY PERSONS PERFORMING SERVICES UNDER QUALIFIED TAX COLLECTION CONTRACTS. 

‘‘(a) IN GENERAL.—Subject to the modifications provided by subsection (b), section 

7433 shall apply to the acts and omissions of any person performing services under 

a qualified tax collection contract (as defined in section 6306(b)) to the same extent 

and in the same manner as if such person were an employee of the Internal Revenue Service. 

‘‘(b) MODIFICATIONS.—For purposes of subsection (a)—

‘‘(1) Any civil action brought under section 7433 by reason of this section shall 

be brought against the person who entered into the qualified tax collection contract with the Secretary and shall not be brought against the United States. 

‘‘(2) Such person and not the United States shall be liable for any damages 

and costs determined in such civil action. 

‘‘(3) Such civil action shall not be an exclusive remedy with respect to such 

person. 

‘‘(4) Subsections (c), (d)(1), and (e) of section 7433 shall not apply.’’. 

(2) CLERICAL AMENDMENT.—The table of sections for subchapter B of chapter 

76 is amended by inserting after the item relating to section 7433 the following 

new item:

‘‘Sec. 7433A. Civil damages for certain unauthorized collection actions by persons performing services under qualified 

tax collection contracts.’’.

(c) APPLICATION OF TAXPAYER ASSISTANCE ORDERS TO PERSONS PERFORMING

SERVICES UNDER A QUALIFIED TAX COLLECTION CONTRACT.—Section 7811 (relating 

to taxpayer assistance orders) is amended by adding at the end the following new 

subsection: 

‘‘(g) APPLICATION TO PERSONS PERFORMING SERVICES UNDER A QUALIFIED TAX

COLLECTION CONTRACT.—Any order issued or action taken by the National Taxpayer Advocate pursuant to this section shall apply to persons performing services 

under a qualified tax collection contract (as defined in section 6306(b)) to the same 

extent and in the same manner as such order or action applies to the Secretary.’’. 

(d) INELIGIBILITY OF INDIVIDUALS WHO COMMIT MISCONDUCT TO PERFORM UNDER

CONTRACT.—Section 1203 of the Internal Revenue Service Restructuring Act of 1998 

(relating to termination of employment for misconduct) is amended by adding at the 

end the following new subsection: 

‘‘(e) INDIVIDUALS PERFORMING SERVICES UNDER A QUALIFIED TAX COLLECTION

CONTRACT.—An individual shall cease to be permitted to perform any services under 

any qualified tax collection contract (as defined in section 6306(b) of the Internal 

Revenue Code of 1986) if there is a final determination by the Secretary of the 

Treasury under such contract that such individual committed any act or omission 

described under subsection (b) in connection with the performance of such services.’’. 

(e) EFFECTIVE DATE.—The amendments made to this section shall take effect on 

the date of the enactment of this Act. 

SEC. 682. TREATMENT OF CHARITABLE CONTRIBUTIONS OF PATENTS AND SIMILAR PROPERTY. 

(a) IN GENERAL.—Subparagraph (B) of section 170(e)(1) is amended by striking 

‘‘or’’ at the end of clause (i), by adding ‘‘or’’ at the end of clause (ii), and by inserting 

after clause (ii) the following new clause: 

‘‘(iii) of any patent, copyright (other than a copyright described in section 1221(a)(3) or 1231(b)(1)(C)), trademark, trade name, trade secret, 

know-how, software (other than software described in section 

197(e)(3)(A)(i)), or similar property, or applications or registrations of 

such property,’’. 

101

(b) CERTAIN DONEE INCOME FROM INTELLECTUAL PROPERTY TREATED AS AN ADDI- TIONAL CHARITABLE CONTRIBUTION.—Section 170 is amended by redesignating subsection (m) as subsection (n) and by inserting after subsection (l) the following new 

subsection: ‘‘(m) CERTAIN DONEE INCOME FROM INTELLECTUAL PROPERTY TREATED AS AN AD- DITIONAL CHARITABLE CONTRIBUTION.— ‘‘(1) TREATMENT AS ADDITIONAL CONTRIBUTION.—In the case of a taxpayer who 

makes a qualified intellectual property contribution, the deduction allowed 

under subsection (a) for each taxable year of the taxpayer ending on or after 

the date of such contribution shall be increased (subject to the limitations under 

subsection (b)) by the applicable percentage of qualified donee income with respect to such contribution which is properly allocable to such year under this 

subsection. ‘‘(2) REDUCTION IN ADDITIONAL DEDUCTIONS TO EXTENT OF INITIAL DEDUC- TION.—With respect to any qualified intellectual property contribution, the deduction allowed under subsection (a) shall be increased under paragraph (1) 

only to the extent that the aggregate amount of such increases with respect to 

such contribution exceed the amount allowed as a deduction under subsection 

(a) with respect to such contribution determined without regard to this subsection. ‘‘(3) QUALIFIED DONEE INCOME.—For purposes of this subsection, the term ‘qualified donee income’ means any net income received by or accrued to the 

donee which is properly allocable to the qualified intellectual property. ‘‘(4) ALLOCATION OF QUALIFIED DONEE INCOME TO TAXABLE YEARS OF DONOR.— For purposes of this subsection, qualified donee income shall be treated as properly allocable to a taxable year of the donor if such income is received by or 

accrued to the donee for the taxable year of the donee which ends within or 

with such taxable year of the donor. ‘‘(5) 10-YEAR LIMITATION.—Income shall not be treated as properly allocable 

to qualified intellectual property for purposes of this subsection if such income 

is received by or accrued to the donee after the 10-year period beginning on the 

date of the contribution of such property. ‘‘(6) BENEFIT LIMITED TO LIFE OF INTELLECTUAL PROPERTY.—Income shall not 

be treated as properly allocable to qualified intellectual property for purposes 

of this subsection if such income is received by or accrued to the donee after 

the expiration of the legal life of such property. ‘‘(7) APPLICABLE PERCENTAGE.—For purposes of this subsection, the term ‘applicable percentage’ means the percentage determined under the following table 

which corresponds to a taxable year of the donor ending on or after the date 

of the qualified intellectual property contribution:

‘‘Taxable Year of Donor 

Ending on or After Applicable 

Date of Contribution: Percentage: 

1st ................................................................................................................................................................... 100

2nd .................................................................................................................................................................. 100

3rd ................................................................................................................................................................... 90

4th ................................................................................................................................................................... 80

5th ................................................................................................................................................................... 70

6th ................................................................................................................................................................... 60

7th ................................................................................................................................................................... 50

8th ................................................................................................................................................................... 40

9th ................................................................................................................................................................... 30

10th ................................................................................................................................................................. 20

11th ................................................................................................................................................................. 10

12th ................................................................................................................................................................. 10.

‘‘(8) QUALIFIED INTELLECTUAL PROPERTY CONTRIBUTION.—For purposes of this 

subsection, the term ‘qualified intellectual property contribution’ means any 

charitable contribution of qualified intellectual property—

‘‘(A) the amount of which taken into account under this section is reduced 

by reason of subsection (e)(1), and 

‘‘(B) with respect to which the donor informs the donee at the time of 

such contribution that the donor intends to treat such contribution as a 

qualified intellectual property contribution for purposes of this subsection 

and section 6050L. 

‘‘(9) QUALIFIED INTELLECTUAL PROPERTY.—For purposes of this subsection, the 

term ‘qualified intellectual property’ means property described in subsection 

(e)(1)(B)(iii) (other than property contributed to or for the use of an organization 

described in subsection (e)(1)(B)(ii)). 

‘‘(10) OTHER SPECIAL RULES.—

‘‘(A) APPLICATION OF LIMITATIONS ON CHARITABLE CONTRIBUTIONS.—Any 

increase under this subsection of the deduction provided under subsection 

(a) shall be treated for purposes of subsection (b) as a deduction which is 

102

attributable to a charitable contribution to the donee to which such increase 

relates.

‘‘(B) NET INCOME DETERMINED BY DONEE.—The net income taken into account under paragraph (3) shall not exceed the amount of such income reported under section 6050L(b)(1). 

‘‘(C) DEDUCTION LIMITED TO 12 TAXABLE YEARS.—Except as may be provided under subparagraph (D)(i), this subsection shall not apply with respect to any qualified intellectual property contribution for any taxable year 

of the donor after the 12th taxable year of the donor which ends on or after 

the date of such contribution. 

‘‘(D) REGULATIONS.—The Secretary may issue regulations or other guidance to carry out the purposes of this subsection, including regulations or 

guidance—

‘‘(i) modifying the application of this subsection in the case of a donor 

or donee with a short taxable year, and 

‘‘(ii) providing for the determination of an amount to be treated as 

net income of the donee which is properly allocable to qualified intellectual property in the case of a donee who uses such property to further 

a purpose or function constituting the basis of the donee’s exemption 

under section 501 (or, in the case of a governmental unit, any purpose 

described in section 170(c)) and does not possess a right to receive any 

payment from a third party with respect to such property.’’. 

(c) REPORTING REQUIREMENTS.—

(1) IN GENERAL.—Section 6050L (relating to returns relating to certain dispositions of donated property) is amended to read as follows: 

‘‘SEC. 6050L. RETURNS RELATING TO CERTAIN DONATED PROPERTY. 

‘‘(a) DISPOSITIONS OF DONATED PROPERTY.—

‘‘(1) IN GENERAL.—If the donee of any charitable deduction property sells, exchanges, or otherwise disposes of such property within 2 years after its receipt, 

the donee shall make a return (in accordance with forms and regulations prescribed by the Secretary) showing—

‘‘(A) the name, address, and TIN of the donor, 

‘‘(B) a description of the property, 

‘‘(C) the date of the contribution, 

‘‘(D) the amount received on the disposition, and 

‘‘(E) the date of such disposition. 

‘‘(2) DEFINITIONS.—For purposes of this subsection—

‘‘(A) CHARITABLE DEDUCTION PROPERTY.—The term ‘charitable deduction 

property’ means any property (other than publicly traded securities) contributed in a contribution for which a deduction was claimed under section 

170 if the claimed value of such property (plus the claimed value of all similar items of property donated by the donor to 1 or more donees) exceeds 

$5,000. 

‘‘(B) PUBLICLY TRADED SECURITIES.—The term ‘publicly traded securities’

means securities for which (as of the date of the contribution) market 

quotations are readily available on an established securities market. 

‘‘(b) QUALIFIED INTELLECTUAL PROPERTY CONTRIBUTIONS.—

‘‘(1) IN GENERAL.—Each donee with respect to a qualified intellectual property 

contribution shall make a return (at such time and in such form and manner 

as the Secretary may by regulations prescribe) with respect to each specified 

taxable year of the donee showing—

‘‘(A) the name, address, and TIN of the donor, 

‘‘(B) a description of the qualified intellectual property contributed, 

‘‘(C) the date of the contribution, and 

‘‘(D) the amount of net income of the donee for the taxable year which 

is properly allocable to the qualified intellectual property (determined without regard to paragraph (10)(B) of section 170(m) and with the modifications described in paragraphs (5) and (6) of such section). 

‘‘(2) DEFINITIONS.—For purposes of this subsection—

‘‘(A) IN GENERAL.—Terms used in this subsection which are also used in 

section 170(m) have the respective meanings given such terms in such section. 

‘‘(B) SPECIFIED TAXABLE YEAR.—The term ‘specified taxable year’ means, 

with respect to any qualified intellectual property contribution, any taxable 

year of the donee any portion of which is part of the 10-year period beginning on the date of such contribution. 

103

‘‘(c) STATEMENT TO BE FURNISHED TO DONORS.—Every person making a return 

under subsection (a) or (b) shall furnish a copy of such return to the donor at such 

time and in such manner as the Secretary may by regulations prescribe.’’. (2) CLERICAL AMENDMENT.—The table of sections for subpart A of part II of 

subchapter A of chapter 61 is amended by striking the item relating to section 

6050L and inserting the following new item:

‘‘Sec. 6050L. Returns relating to certain donated property.’’.

(d) COORDINATION WITH APPRAISAL REQUIREMENTS.—Subclause (I) of section 

170(f)(11)(A)(ii), as added by section 683, is amended by inserting ‘‘subsection 

(e)(1)(B)(iii) or’’ before ‘‘section 1221(a)(1)’’. (e) ANTI-ABUSE RULES.—The Secretary of the Treasury may prescribe such regulations or other guidance as may be necessary or appropriate to prevent the avoidance 

of the purposes of section 170(e)(1)(B)(iii) of the Internal Revenue Code of 1986 (as 

added by subsection (a)), including preventing— (1) the circumvention of the reduction of the charitable deduction by embedding or bundling the patent or similar property as part of a charitable contribution of property that includes the patent or similar property, 

(2) the manipulation of the basis of the property to increase the amount of 

the charitable deduction through the use of related persons, pass-thru entities, 

or other intermediaries, or through the use of any provision of law or regulation 

(including the consolidated return regulations), and 

(3) a donor from changing the form of the patent or similar property to property of a form for which different deduction rules would apply. 

(f) EFFECTIVE DATE.—The amendments made by this section shall apply to contributions made after June 3, 2004. 

SEC. 683. INCREASED REPORTING FOR NONCASH CHARITABLE CONTRIBUTIONS. 

(a) IN GENERAL.—Subsection (f) of section 170 (relating to disallowance of deduction in certain cases and special rules) is amended by adding after paragraph (10) 

the following new paragraph: ‘‘(11) QUALIFIED APPRAISAL AND OTHER DOCUMENTATION FOR CERTAIN CON- TRIBUTIONS.— ‘‘(A) IN GENERAL.— ‘‘(i) DENIAL OF DEDUCTION.—In the case of an individual, partnership, 

or corporation, no deduction shall be allowed under subsection (a) for 

any contribution of property for which a deduction of more than $500 

is claimed unless such person meets the requirements of subparagraphs (B), (C), and (D), as the case may be, with respect to such contribution. ‘‘(ii) EXCEPTIONS.— ‘‘(I) READILY VALUED PROPERTY.—Subparagraphs (C) and (D) 

shall not apply to cash, property described in section 1221(a)(1), 

and publicly traded securities (as defined in section 

6050L(a)(2)(B)). ‘‘(II) REASONABLE CAUSE.—Clause (i) shall not apply if it is 

shown that the failure to meet such requirements is due to reasonable cause and not to willful neglect. ‘‘(B) PROPERTY DESCRIPTION FOR CONTRIBUTIONS OF MORE THAN $500.—In 

the case of contributions of property for which a deduction of more than 

$500 is claimed, the requirements of this subparagraph are met if the individual, partnership or corporation includes with the return for the taxable 

year in which the contribution is made a description of such property and 

such other information as the Secretary may require. The requirements of 

this subparagraph shall not apply to a C corporation which is not a personal service corporation or a closely held C corporation. 

‘‘(C) QUALIFIED APPRAISAL FOR CONTRIBUTIONS OF MORE THAN $5,000.—In 

the case of contributions of property for which a deduction of more than 

$5,000 is claimed, the requirements of this subparagraph are met if the individual, partnership, or corporation obtains a qualified appraisal of such 

property and attaches to the return for the taxable year in which such contribution is made such information regarding such property and such appraisal as the Secretary may require. 

‘‘(D) SUBSTANTIATION FOR CONTRIBUTIONS OF MORE THAN $500,000.—In the 

case of contributions of property for which a deduction of more than 

$500,000 is claimed, the requirements of this subparagraph are met if the 

individual, partnership, or corporation attaches to the return for the taxable 

year a qualified appraisal of such property. 

‘‘(E) QUALIFIED APPRAISAL.—For purposes of this paragraph, the term 

‘qualified appraisal’ means, with respect to any property, an appraisal of 

104

such property which is treated for purposes of this paragraph as a qualified 

appraisal under regulations or other guidance prescribed by the Secretary. ‘‘(F) AGGREGATION OF SIMILAR ITEMS OF PROPERTY.—For purposes of determining thresholds under this paragraph, property and all similar items 

of property donated to 1 or more donees shall be treated as 1 property. ‘‘(G) SPECIAL RULE FOR PASS-THRU ENTITIES.—In the case of a partnership 

or S corporation, this paragraph shall be applied at the entity level, except 

that the deduction shall be denied at the partner or shareholder level. ‘‘(H) REGULATIONS.—The Secretary may prescribe such regulations as 

may be necessary or appropriate to carry out the purposes of this paragraph, including regulations that may provide that some or all of the requirements of this paragraph do not apply in appropriate cases.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to contributions made after June 3, 2004. 

SEC. 684. DONATIONS OF MOTOR VEHICLES, BOATS, AND AIRCRAFT. 

(a) IN GENERAL.—Subsection (f) of section 170 (relating to disallowance of deduction in certain cases and special rules) is amended by adding after paragraph (11) 

the following new paragraph: 

‘‘(12) CONTRIBUTIONS OF MOTOR VEHICLES, BOATS, AND AIRCRAFT.—

‘‘(A) IN GENERAL.—Except as provided in regulations or other guidance, 

in the case of a contribution of a specified vehicle to which paragraph (8) 

applies, no deduction shall be allowed under subsection (a) for such contribution unless the taxpayer obtains a qualified appraisal of the specified 

vehicle on or before the date of such contribution. 

‘‘(B) EXCEPTION FOR INVENTORY PROPERTY.—Subparagraph (A) shall not 

apply to property which is described in section 1221(a)(1). 

‘‘(C) SPECIFIED VEHICLE.—For purposes of this paragraph, the term ‘specified vehicle’ means any—

‘‘(i) motor vehicle manufactured primarily for use on public streets, 

roads, and highways, 

‘‘(ii) boat, or 

‘‘(iii) aircraft. 

‘‘(D) QUALIFIED APPRAISAL.—For purposes of this paragraph, the term 

‘qualified appraisal’ means any appraisal which is treated for purposes of 

this paragraph as a qualified appraisal under regulations or other guidance 

prescribed by the Secretary. 

‘‘(E) REGULATIONS OR OTHER GUIDANCE.—The Secretary shall prescribe 

such regulations or other guidance as may be necessary to carry out the 

purposes of this paragraph.’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) shall apply to contributions made after June 3, 2004. 

SEC. 685. EXTENSION OF AMORTIZATION OF INTANGIBLES TO SPORTS FRANCHISES. 

(a) IN GENERAL.—Section 197(e) (relating to exceptions to definition of section 197 

intangible) is amended by striking paragraph (6) and by redesignating paragraphs 

(7) and (8) as paragraphs (6) and (7), respectively. 

(b) CONFORMING AMENDMENTS.—

(1)(A) Section 1056 (relating to basis limitation for player contracts transferred in connection with the sale of a franchise) is repealed. 

(B) The table of sections for part IV of subchapter O of chapter 1 is amended 

by striking the item relating to section 1056. 

(2) Section 1245(a) (relating to gain from disposition of certain depreciable 

property) is amended by striking paragraph (4). 

(3) Section 1253 (relating to transfers of franchises, trademarks, and trade 

names) is amended by striking subsection (e). 

(c) EFFECTIVE DATES.—

(1) IN GENERAL.—Except as provided in paragraph (2), the amendments made 

by this section shall apply to property acquired after the date of the enactment 

of this Act. 

(2) SECTION 1245.—The amendment made by subsection (b)(2) shall apply to 

franchises acquired after the date of the enactment of this Act. 

SEC. 686. MODIFICATION OF CONTINUING LEVY ON PAYMENTS TO FEDERAL VENDERS. 

(a) IN GENERAL.—Section 6331(h) (relating to continuing levy on certain payments) is amended by adding at the end the following new paragraph: 

‘‘(3) INCREASE IN LEVY FOR CERTAIN PAYMENTS.—Paragraph (1) shall be applied by substituting ‘100 percent’ for ‘15 percent’ in the case of any specified 

payment due to a vendor of goods or services sold or leased to the Federal Government.’’. 

105

(b) EFFECTIVE DATE.—The amendment made by this section shall take effect on 

the date of the enactment of this Act. 

SEC. 687. MODIFICATION OF STRADDLE RULES. 

(a) RULES RELATING TO IDENTIFIED STRADDLES.—

(1) IN GENERAL.—Subparagraph (A) of section 1092(a)(2) (relating to special 

rule for identified straddles) is amended to read as follows: 

‘‘(A) IN GENERAL.—In the case of any straddle which is an identified 

straddle—

‘‘(i) paragraph (1) shall not apply with respect to identified positions 

comprising the identified straddle, 

‘‘(ii) if there is any loss with respect to any identified position of the 

identified straddle, the basis of each of the identified offsetting positions in the identified straddle shall be increased by an amount which 

bears the same ratio to the loss as the unrecognized gain with respect 

to such offsetting position bears to the aggregate unrecognized gain 

with respect to all such offsetting positions, and 

‘‘(iii) any loss described in clause (ii) shall not otherwise be taken into 

account for purposes of this title.’’. 

(2) IDENTIFIED STRADDLE.—Section 1092(a)(2)(B) (defining identified straddle) 

is amended—

(A) by striking clause (ii) and inserting the following: 

‘‘(ii) to the extent provided by regulations, the value of each position 

of which (in the hands of the taxpayer immediately before the creation 

of the straddle) is not less than the basis of such position in the hands 

of the taxpayer at the time the straddle is created, and’’, and 

(B) by adding at the end the following new flush sentence: 

‘‘The Secretary shall prescribe regulations which specify the proper methods 

for clearly identifying a straddle as an identified straddle (and the positions 

comprising such straddle), which specify the rules for the application of this 

section for a taxpayer which fails to properly identify the positions of an 

identified straddle, and which specify the ordering rules in cases where a 

taxpayer disposes of less than an entire position which is part of an identified straddle.’’. 

(3) UNRECOGNIZED GAIN.—Section 1092(a)(3) (defining unrecognized gain) is 

amended by redesignating subparagraph (B) as subparagraph (C) and by inserting after subparagraph (A) the following new subparagraph: 

‘‘(B) SPECIAL RULE FOR IDENTIFIED STRADDLES.—For purposes of paragraph (2)(A)(ii), the unrecognized gain with respect to any identified offsetting position shall be the excess of the fair market value of the position at 

the time of the determination over the fair market value of the position at 

the time the taxpayer identified the position as a position in an identified 

straddle.’’. 

(4) CONFORMING AMENDMENT.—Section 1092(c)(2) is amended by striking subparagraph (B) and by redesignating subparagraph (C) as subparagraph (B). 

(b) PHYSICALLY SETTLED POSITIONS.—Section 1092(d) (relating to definitions and 

special rules) is amended by adding at the end the following new paragraph: 

‘‘(8) SPECIAL RULES FOR PHYSICALLY SETTLED POSITIONS.—For purposes of subsection (a), if a taxpayer settles a position which is part of a straddle by delivering property to which the position relates (and such position, if terminated, 

would result in a realization of a loss), then such taxpayer shall be treated as 

if such taxpayer—

‘‘(A) terminated the position for its fair market value immediately before 

the settlement, and 

‘‘(B) sold the property so delivered by the taxpayer at its fair market 

value.’’. 

(c) REPEAL OF STOCK EXCEPTION.—

(1) IN GENERAL.—Paragraph (3) of section 1092(d) (relating to definitions and 

special rules) is amended to read as follows: 

‘‘(3) SPECIAL RULES FOR STOCK.—For purposes of paragraph (1)—

‘‘(A) IN GENERAL.—The term ‘personal property’ includes—

‘‘(i) any stock which is a part of a straddle at least 1 of the offsetting 

positions of which is a position with respect to such stock or substantially similar or related property, or 

‘‘(ii) any stock of a corporation formed or availed of to take positions 

in personal property which offset positions taken by any shareholder. 

‘‘(B) RULE FOR APPLICATION.—For purposes of determining whether subsection (e) applies to any transaction with respect to stock described in subVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00107 Fmt 6659 Sfmt 6621 E:\HR\OC\HR548P1.002 HR548P1
106

paragraph (A)(ii), all includible corporations of an affiliated group (within 

the meaning of section 1504(a)) shall be treated as 1 taxpayer.’’. 

(2) CONFORMING AMENDMENT.—Section 1258(d)(1) is amended by striking ‘‘; 

except that the term ‘personal property’ shall include stock’’. 

(d) HOLDING PERIOD FOR DIVIDEND EXCLUSION.—The last sentence of section 246(c) 

is amended by inserting: ‘‘, other than a qualified covered call option to which section 1092(f) applies’’ before the period at the end. 

(e) EFFECTIVE DATE.—The amendments made by this section shall apply to positions established on or after the date of the enactment of this Act. 

SEC. 688. ADDITION OF VACCINES AGAINST HEPATITIS A TO LIST OF TAXABLE VACCINES. 

(a) IN GENERAL.—Paragraph (1) of section 4132(a) (defining taxable vaccine) is 

amended by redesignating subparagraphs (I), (J), (K), and (L) as subparagraphs (J), 

(K), (L), and (M), respectively, and by inserting after subparagraph (H) the following 

new subparagraph: 

‘‘(I) Any vaccine against hepatitis A.’’

(b) EFFECTIVE DATE.—

(1) SALES, ETC.—The amendments made by subsection (a) shall apply to sales 

and uses on or after the first day of the first month which begins more than 

4 weeks after the date of the enactment of this Act. 

(2) DELIVERIES.—For purposes of paragraph (1) and section 4131 of the Internal Revenue Code of 1986, in the case of sales on or before the effective date 

described in such paragraph for which delivery is made after such date, the delivery date shall be considered the sale date. 

SEC. 689. ADDITION OF VACCINES AGAINST INFLUENZA TO LIST OF TAXABLE VACCINES. 

(a) IN GENERAL.—Section 4132(a)(1) (defining taxable vaccine), as amended by 

this Act, is amended by adding at the end the following new subparagraph: 

‘‘(N) Any trivalent vaccine against influenza.’’. 

(b) EFFECTIVE DATE.—

(1) SALES, ETC.—The amendment made by this section shall apply to sales 

and uses on or after the later of—

(A) the first day of the first month which begins more than 4 weeks after 

the date of the enactment of this Act, or 

(B) the date on which the Secretary of Health and Human Services lists 

any vaccine against influenza for purposes of compensation for any vaccinerelated injury or death through the Vaccine Injury Compensation Trust 

Fund. 

(2) DELIVERIES.—For purposes of paragraph (1) and section 4131 of the Internal Revenue Code of 1986, in the case of sales on or before the effective date 

described in such paragraph for which delivery is made after such date, the delivery date shall be considered the sale date. 

SEC. 690. EXTENSION OF IRS USER FEES. 

(a) IN GENERAL.—Section 7528(c) (relating to termination) is amended by striking 

‘‘December 31, 2004’’ and inserting ‘‘September 30, 2014’’. 

(b) EFFECTIVE DATE.—The amendment made by this section shall apply to requests after the date of the enactment of this Act. 

SEC. 691. COBRA FEES. 

(a) USE OF MERCHANDISE PROCESSING FEE.—Section 13031(f) of the Consolidated 

Omnibus Budget Reconciliation Act of 1985 (19 U.S.C. 58c(f)) is amended—

(1) in paragraph (1), by aligning subparagraph (B) with subparagraph (A); 

and 

(2) in paragraph (2), by striking ‘‘commercial operations’’ and all that follows 

through ‘‘processing.’’ and inserting ‘‘customs revenue functions as defined in 

section 415 of the Homeland Security Act of 2002 (other than functions performed by the Office of International Affairs referred to in section 415(8) of that 

Act), and for automation (including the Automation Commercial Environment 

computer system), and for no other purpose. To the extent that funds in the 

Customs User Fee Account are insufficient to pay the costs of such customs revenue functions, customs duties in an amount equal to the amount of such insufficiency shall be available, to the extent provided for in appropriations Acts, to 

pay the costs of such customs revenue functions in the amount of such insufficiency, and shall be available for no other purpose. The provisions of the first 

and second sentences of this paragraph specifying the purposes for which 

amounts in the Customs User Fee Account may be made available shall not be 

superseded except by a provision of law which specifically modifies or supersedes such provisions.’’. 

107

(b) REIMBURSEMENT OF APPROPRIATIONS FROM COBRA FEES.—Section 13031(f)(3) 

of the Consolidated Omnibus Budget Reconciliation Act of 1985 (19 U.S.C. 58c(f)(3)) 

is amended by adding at the end the following: 

‘‘(E) Nothing in this paragraph shall be construed to preclude the use of appropriated funds, from sources other than the fees collected under subsection (a), to pay 

the costs set forth in clauses (i), (ii), and (iii) of subparagraph (A).’’. 

(c) SENSE OF CONGRESS; EFFECTIVE PERIOD FOR COLLECTING FEES; STANDARD FOR

SETTING FEES.—

(1) SENSE OF CONGRESS.—The Congress finds that—

(A) the fees set forth in paragraphs (1) through (8) of subsection (a) of 

section 13031 of the Consolidated Omnibus Budget Reconciliation Act of 

1985 have been reasonably related to the costs of providing customs services in connection with the activities or items for which the fees have been 

charged under such paragraphs; and 

(B) the fees collected under such paragraphs have not exceeded, in the 

aggregate, the amounts paid for the costs described in subsection (f)(3)(A) 

incurred in providing customs services in connection with the activities or 

items for which the fees were charged under such paragraphs. 

(2) EFFECTIVE PERIOD; STANDARD FOR SETTING FEES.—Section 13031(j)(3) of 

the Consolidated Omnibus Budget Reconciliation Act of 1985 is amended to 

read as follows: 

‘‘(3)(A) Fees may not be charged under paragraphs (9) and (10) of subsection (a) 

after September 30, 2014. 

‘‘(B)(i) Subject to clause (ii), Fees may not be charged under paragraphs (1) 

through (8) of subsection (a) after September 30, 2014. 

‘‘(ii) In fiscal year 2006 and in each succeeding fiscal year for which fees under 

paragraphs (1) through (8) of subsection (a) are authorized—

‘‘(I) the Secretary of the Treasury shall charge fees under each such paragraph in amounts that are reasonably related to the costs of providing customs 

services in connection with the activity or item for which the fee is charged 

under such paragraph, except that in no case may the fee charged under any 

such paragraph exceed by more than 10 percent the amount otherwise prescribed by such paragraph; 

‘‘(II) the amount of fees collected under such paragraphs may not exceed, in 

the aggregate, the amounts paid in that fiscal year for the costs described in 

subsection (f)(3)(A) incurred in providing customs services in connection with 

the activity or item for which the fees are charged under such paragraphs; 

‘‘(III) a fee may not be collected under any such paragraph except to the extent such fee will be expended to pay the costs described in subsection (f)(3)(A) 

incurred in providing customs services in connection with the activity or item 

for which the fee is charged under such paragraph; and 

‘‘(IV) any fee collected under any such paragraph shall be available for expenditure only to pay the costs described in subsection (f)(3)(A) incurred in providing customs services in connection with the activity or item for which the fee 

is charged under such paragraph.’’. 

(d) CLERICAL AMENDMENTS.—Section 13031 of the Consolidated Omnibus Budget 

Reconciliation Act of 1985 is amended—

(1) in subsection (a)(5)(B), by striking ‘‘$1.75’’ and inserting ‘‘$1.75.’’; 

(2) in subsection (b)—

(A) in paragraph (1)(A), by aligning clause (iii) with clause (ii); 

(B) in paragraph (7), by striking ‘‘paragraphs’’ and inserting ‘‘paragraph’’; 

and 

(C) in paragraph (9), by aligning subparagraph (B) with subparagraph 

(A); and 

(3) in subsection (e)(2), by aligning subparagraph (B) with subparagraph (A). 

(e) STUDY OF ALL FEES COLLECTED BY DEPARTMENT OF HOMELAND SECURITY.—

The Secretary of the Treasury shall conduct a study of all the fees collected by the 

Department of Homeland Security, and shall submit to the Congress, not later than 

September 30, 2005, a report containing the recommendations of the Secretary on—

(1) what fees should be eliminated; 

(2) what the rate of fees retained should be; and 

(3) any other recommendations with respect to the fees that the Secretary 

considers appropriate.

108

TITLE VII—MARKET REFORM FOR TOBACCO 

GROWERS 

SEC. 701. SHORT TITLE. 

This title may be cited as the ‘‘Fair and Equitable Tobacco Reform Act of 2004’’. 

SEC. 702. EFFECTIVE DATE. 

This title and the amendments made by this title shall apply beginning with the 

2005 marketing year of each kind of tobacco. 

Subtitle A—Termination of Federal Tobacco 

Quota and Price Support Programs 

SEC. 711. TERMINATION OF TOBACCO QUOTA PROGRAM AND RELATED PROVISIONS. 

(a) MARKETING QUOTAS.—Part I of subtitle B of title III of the Agricultural Adjustment Act of 1938 (7 U.S.C. 1311 et seq.) is repealed. 

(b) PROCESSING.—Section 9(b) of the Agricultural Adjustment Act (7 U.S.C. 

609(b)), reenacted with amendments by the Agricultural Marketing Agreement Act 

of 1937, is amended—

(1) in paragraph (2), by striking ‘‘tobacco,’’; and 

(2) in paragraph (6)(B)(i), by striking ‘‘, or, in the case of tobacco, is less than 

the fair exchange value by not more than 10 per centum,’’. 

(c) DECLARATION OF POLICY.—Section 2 of the Agricultural Adjustment Act of 

1938 (7 U.S.C. 1282) is amended by striking ‘‘tobacco,’’. 

(d) DEFINITIONS.—Section 301(b) of the Agricultural Adjustment Act of 1938 (7 

U.S.C. 1301(b)) is amended—

(1) in paragraph (3)—

(A) by striking subparagraph (C); and 

(B) by redesignating subparagraph (D) as subparagraph (C); 

(2) in paragraph (6)(A), by striking ‘‘tobacco,’’; 

(3) in paragraph (10)—

(A) by striking subparagraph (B); and 

(B) by redesignating subparagraph (C) as subparagraph (B); 

(4) in paragraph (11)(B), by striking ‘‘and tobacco’’; 

(5) in paragraph (12), by striking ‘‘tobacco,’’; 

(6) in paragraph (14)—

(A) in subparagraph (A), by striking ‘‘(A)’’; and 

(B) by striking subparagraphs (B), (C), and (D); 

(7) by striking paragraph (15); 

(8) in paragraph (16)—

(A) by striking subparagraph (B); and 

(B) by redesignating subparagraph (C) as subparagraph (B); 

(9) by striking paragraph (17); and 

(10) by redesignating paragraph (16) as paragraph (15). 

(e) PARITY PAYMENTS.—Section 303 of the Agricultural Adjustment Act of 1938 (7 

U.S.C. 1303) is amended in the first sentence by striking ‘‘rice, or tobacco,’’ and inserting ‘‘or rice,’’. 

(f) ADMINISTRATIVE PROVISIONS.—Section 361 of the Agricultural Adjustment Act 

of 1938 (7 U.S.C. 1361) is amended by striking ‘‘tobacco,’’. 

(g) ADJUSTMENT OF QUOTAS.—Section 371 of the Agricultural Adjustment Act of 

1938 (7 U.S.C. 1371) is amended—

(1) in the first sentence of subsection (a), by striking ‘‘rice, or tobacco’’ and 

inserting ‘‘or rice’’; and 

(2) in the first sentence of subsection (b), by striking ‘‘rice, or tobacco’’ and 

inserting ‘‘or rice’’. 

(h) REGULATIONS.—Section 375 of the Agricultural Adjustment Act of 1938 (7 

U.S.C. 1375) is amended—

(1) in subsection (a), by striking ‘‘peanuts, or tobacco’’ and inserting ‘‘or peanuts’’; and 

(2) by striking subsection (c). 

(i) EMINENT DOMAIN.—Section 378 of the Agricultural Adjustment Act of 1938 (7 

U.S.C. 1378) is amended—

(1) in the first sentence of subsection (c), by striking ‘‘cotton, and tobacco’’ and 

inserting ‘‘and cotton’’; and 

(2) by striking subsections (d), (e), and (f). 

109

(j) BURLEY TOBACCO FARM RECONSTITUTION.—Section 379 of the Agricultural Adjustment Act of 1938 (7 U.S.C. 1379) is amended—

(1) in subsection (a)—

(A) by striking ‘‘(a)’’; and 

(B) in paragraph (6), by striking ‘‘, but this clause (6) shall not be applicable in the case of burley tobacco’’; and 

(2) by striking subsections (b) and (c). 

(k) ACREAGE-POUNDAGE QUOTAS.—Section 4 of the Act of April 16, 1955 (Public 

Law 89–12; 7 U.S.C. 1314c note), is repealed. 

(l) BURLEY TOBACCO ACREAGE ALLOTMENTS.—The Act of July 12, 1952 (7 U.S.C. 

1315), is repealed. 

(m) TRANSFER OF ALLOTMENTS.—Section 703 of the Food and Agriculture Act of 

1965 (7 U.S.C. 1316) is repealed. 

(n) ADVANCE RECOURSE LOANS.—Section 13(a)(2)(B) of the Food Security Improvements Act of 1986 (7 U.S.C. 1433c–1(a)(2)(B)) is amended by striking ‘‘tobacco and’’. 

(o) TOBACCO FIELD MEASUREMENT.—Section 1112 of the Omnibus Budget Reconciliation Act of 1987 (Public Law 100–203) is amended by striking subsection (c). 

SEC. 712. TERMINATION OF TOBACCO PRICE SUPPORT PROGRAM AND RELATED PROVISIONS. 

(a) TERMINATION OF TOBACCO PRICE SUPPORT AND NO NET COST PROVISIONS.—

Sections 106, 106A, and 106B of the Agricultural Act of 1949 (7 U.S.C. 1445, 1445–

1, 1445–2) are repealed. 

(b) PARITY PRICE SUPPORT.—Section 101 of the Agricultural Act of 1949 (7 U.S.C. 

1441) is amended—

(1) in the first sentence of subsection (a), by striking ‘‘tobacco (except as otherwise provided herein), corn,’’ and inserting ‘‘corn’’; 

(2) by striking subsections (c), (g), (h), and (i); 

(3) in subsection (d)(3)—

(A) by striking ‘‘, except tobacco,’’; and 

(B) by striking ‘‘and no price support shall be made available for any crop 

of tobacco for which marketing quotas have been disapproved by producers;’’; and 

(4) by redesignating subsections (d) and (e) as subsections (c) and (d), respectively. 

(c) DEFINITION OF BASIC AGRICULTURAL COMMODITY.—Section 408(c) of the Agricultural Act of 1949 (7 U.S.C. 1428(c)) is amended by striking ‘‘tobacco,’’. 

(d) POWERS OF COMMODITY CREDIT CORPORATION.—Section 5 of the Commodity 

Credit Corporation Charter Act (15 U.S.C. 714c) is amended by inserting ‘‘(other 

than tobacco)’’ after ‘‘agricultural commodities’’ each place it appears. 

SEC. 713. LIABILITY. 

The amendments made by this subtitle shall not affect the liability of any person 

under any provision of law so amended with respect to any crop of tobacco planted 

before the effective date of this Act. 

Subtitle B—Transitional Payments to Tobacco 

Quota Holders and Active Producers of Tobacco 

SEC. 721. DEFINITIONS OF ACTIVE TOBACCO PRODUCER AND QUOTA HOLDER. 

In this subtitle: 

(1) ACTIVE TOBACCO PRODUCER.—The term ‘‘active tobacco producer’’ means 

an owner, operator, landlord, tenant, or sharecropper who—

(A) shared in the risk of producing tobacco on a farm where tobacco was 

produced or considered planted pursuant to a tobacco farm marketing quota 

or farm acreage allotment established under part I of subtitle B of title III 

of the Agricultural Adjustment Act of 1938 (7 U.S.C. 1311 et seq.) for the 

2004 marketing year; and 

(B) was actively engaged on that farm. 

(2) CONSIDERED PLANTED.—The term ‘‘considered planted’’ means tobacco that 

was planted, but failed to be produced as a result of a natural disaster, as determined by the Secretary. 

(3) TOBACCO QUOTA HOLDER.—The term ‘‘tobacco quota holder’’ means a person that was an owner of a farm, as of July 1, 2004, for which a basic tobacco 

farm marketing quota or farm acreage allotment for quota tobacco was established for the 2004 tobacco marketing year.

(4) SECRETARY.—The term ‘‘Secretary’’ means the Secretary of Agriculture. 

110

SEC. 722. PAYMENTS TO TOBACCO QUOTA HOLDERS. 

(a) PAYMENT REQUIRED.—The Secretary shall make payments to each eligible tobacco quota holder for the termination of tobacco marketing quotas and related price 

support under subtitle A, which shall constitute full and fair compensation for any 

losses relating to such termination. 

(b) ELIGIBILITY.—To be eligible to receive a payment under this section, a person 

shall submit to the Secretary an application containing such information as the Secretary may require to demonstrate to the satisfaction of the Secretary that the person satisfies the definition of tobacco quota holder. The application shall be submitted within such time, in such form, and in such manner as the Secretary may 

require. 

(c) INDIVIDUAL BASE QUOTA LEVEL.— (1) IN GENERAL.—The Secretary shall establish a base quota level applicable 

to each eligible tobacco quota holder identified under subsection (b). 

(2) POUNDAGE QUOTAS.—Subject to adjustment under subsection (d), for each 

kind of tobacco for which the marketing quota is expressed in pounds, the base 

quota level for each tobacco quota holder shall be equal to the basic tobacco 

marketing quota under the Agriculture Adjustment Act of 1938 for the marketing year in effect on the date of the enactment of this Act for quota tobacco 

on the farm owned by the tobacco quota holder. 

(3) MARKETING QUOTAS OTHER THAN POUNDAGE QUOTAS.—Subject to adjustment under subsection (d), for each kind of tobacco for which there is marketing 

quota or allotment on an acreage basis, the base quota level for each tobacco 

quota holder shall be the amount equal to the product obtained by multiplying—

(A) the basic tobacco farm marketing quota or allotment for the marketing year in effect on the date of the enactment of this Act, as established 

by the Secretary for quota tobacco on the farm owned by the tobacco quota 

holder; by 

(B) the average county production yield per acre for the county in which 

the farm is located for the kind of tobacco for that marketing year. 

(d) TREATMENT OF CERTAIN CONTRACTS AND AGREEMENTS.—

(1) EFFECT OF PURCHASE CONTRACT.—If there was an agreement for the purchase of all or part of a farm described in subsection (c) as of the date of the 

enactment of this Act, and the parties to the sale are unable to agree to the 

disposition of eligibility for payments under this section, the Secretary, taking 

into account any transfer of quota that has been agreed to, shall provide for the 

equitable division of the payments among the parties by adjusting the determination of who is the tobacco quota holder with respect to particular pounds 

of the quota. 

(2) EFFECT OF AGREEMENT FOR PERMANENT QUOTA TRANSFER.—If the Secretary determines that there was in existence, as of the day before the date of 

the enactment of this Act, an agreement for the permanent transfer of quota, 

but that the transfer was not completed by that date, the Secretary shall consider the tobacco quota holder to be the party to the agreement that, as of that 

date, was the owner of the farm to which the quota was to be transferred. 

(e) TOTAL PAYMENT AMOUNTS BASED ON 2002 MARKETING YEAR.—

(1) CALCULATION OF ANNUAL PAYMENT AMOUNT.—During fiscal years 2005 

through 2009, the Secretary shall make payments to all eligible tobacco quota 

holders identified under subsection (b) in an annual amount equal to the product obtained by multiplying, for each kind of tobacco—

(A) $1.40 per pound; by 

(B) the total national basic marketing quota established under the Agriculture Adjustment Act of 1938 for the 2002 marketing year for that kind 

of tobacco. 

(2) MARKETING QUOTAS OTHER THAN POUNDAGE QUOTAS.—For each kind of tobacco for which there is a marketing quota or allotment on an acreage basis, 

the Secretary shall convert the tobacco farm marketing quotas or allotments established under the Agriculture Adjustment Act of 1938 for the 2002 marketing 

year for that kind of tobacco as the Secretary considers appropriate. 

(f) INDIVIDUAL PAYMENT AMOUNTS.—The annual payment amount for each eligible 

tobacco quota holder with respect to a kind of tobacco under this section shall bear 

the same ratio to the amount determined by the Secretary under subsection (e) with 

respect to that kind of tobacco as the individual base quota level of that eligible tobacco quota holder under subsection (c) with respect to that kind of tobacco bears 

to the total base quota levels of all eligible tobacco quota holders with respect to 

that kind of tobacco. 

(g) DEATH OF TOBACCO QUOTA HOLDER.—If a tobacco quota holder who is entitled 

to payments under this section dies and is survived by a spouse or one or more deVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00112 Fmt 6659 Sfmt 6621 E:\HR\OC\HR548P1.002 HR548P1
111

pendents, the right to receive the payments shall transfer to the surviving spouse 

or, if there is no surviving spouse, to the estate of the tobacco quota holder. 

SEC. 723. TRANSITION PAYMENTS FOR ACTIVE PRODUCERS OF QUOTA TOBACCO. 

(a) TRANSITION PAYMENTS REQUIRED.—The Secretary shall make transition payments under this section to eligible active producers of quota tobacco. 

(b) ELIGIBILITY.—To be eligible to receive a transition payment under this section, 

a person shall submit to the Secretary an application containing such information 

as the Secretary may require to demonstrate to the satisfaction of the Secretary that 

the person satisfies the definition of active producer of quota tobacco. The application shall be submitted within such time, in such form, and in such manner as the 

Secretary may require. 

(c) CURRENT PRODUCTION BASE.—The Secretary shall establish a production base 

applicable to each eligible active producer of quota tobacco identified under subsection (b). A producer’s production base shall be equal to the quantity, in pounds, 

of quota tobacco subject to the basic marketing quota marketed or considered planted by the producer under the Agriculture Adjustment Act of 1938 for the marketing 

year in effect on the date of the enactment of this Act. 

(d) TOTAL PAYMENT AMOUNTS BASED ON 2002 MARKETING YEAR.—

(1) CALCULATION OF ANNUAL PAYMENT AMOUNT.—During fiscal years 2005 

through 2009, the Secretary shall make payments to all eligible active producers of quota tobacco identified under subsection (b) in an annual amount 

equal to the product obtained by multiplying, for each kind of tobacco—

(A) $0.60 per pound; by 

(B) the total national effective marketing quota established under the Agriculture Adjustment Act of 1938 for the 2002 marketing year for that kind 

of tobacco. 

(2) MARKETING QUOTAS OTHER THAN POUNDAGE QUOTAS.—For each kind of tobacco for which there is a marketing quota or allotment on an acreage basis, 

the Secretary shall convert the tobacco farm marketing quotas or allotments established under the Agriculture Adjustment Act of 1938 for the 2002 marketing 

year for that kind of tobacco to a poundage basis before executing the mathematical equation specified in paragraph (1). 

(e) INDIVIDUAL PAYMENT AMOUNTS.—The annual payment amount for each eligible active producer of quota tobacco identified under subsection (b) with respect to 

a kind of tobacco under this section shall bear the same ratio to the amount determined by the Secretary under subsection (d) with respect to that kind of tobacco as 

the individual production base of that eligible active producer under subsection (c) 

with respect to that kind of tobacco bears to the total production bases determined 

under that subsection for all eligible active producers of that kind of tobacco. 

(f) DEATH OF TOBACCO PRODUCER.—If a tobacco producer who is entitled to payments under this section dies and is survived by a spouse or one or more dependents, the right to receive the payments shall transfer to the surviving spouse or, if 

there is no surviving spouse, to the estate of the tobacco producer. 

SEC. 724. RESOLUTION OF DISPUTES. 

Any dispute regarding the eligibility of a person to receive a payment under this 

subtitle, or the amount of the payment, shall be resolved by the county committee 

established under section 8 of the Soil Conservation and Domestic Allotment Act (16 

U.S.C. 590h) for the county or other area in which the farming operation of the person is located. 

SEC. 725. SOURCE OF FUNDS FOR PAYMENTS. 

There is hereby appropriated to the Secretary, from amounts in the general fund 

of the Treasury, such amounts as the Secretary needs in order to make the payments required by sections 722 and 723, except that such amounts shall not exceed 

the lesser of—

(1) amounts received in the Treasury under chapter 52 of the Internal Revenue Code of 1986 (relating to tobacco products and cigarette papers and tubes), 

or 

(2) $9,600,000,000. 

TITLE VIII—TRADE PROVISIONS

SEC. 801. CEILING FANS. 

(a) IN GENERAL.—Subchapter II of chapter 99 of the Harmonized Tariff Schedule 

of the United States is amended by inserting in numerical sequence the following 

new heading:

112

‘‘ 9902.84.14 Ceiling fans for permanent installation (provided for in subheading 8414.51.00) .................... Free No change No change On or before 

12/31/2006 ’’. 

(b) EFFECTIVE DATE.—The amendment made by this section applies to goods entered, or withdrawn from warehouse, for consumption on or after the 15th day after 

the date of enactment of this Act. 

SEC. 802. CERTAIN STEAM GENERATORS, AND CERTAIN REACTOR VESSEL HEADS, USED IN 

NUCLEAR FACILITIES. 

(a) CERTAIN STEAM GENERATORS.—Heading 9902.84.02 of the Harmonized Tariff 

Schedule of the United States is amended by striking ‘‘12/31/2006’’ and inserting 

‘‘12/31/2008’’. 

(b) CERTAIN REACTOR VESSEL HEADS.—Subchapter II of chapter 99 of the Harmonized Tariff Schedule of the United States is amended by inserting in numerical 

sequence the following new heading: 

‘‘ 9902.84.03 Reactor 

vessel 

heads for 

nuclear reactors (provided for in 

subheading 

8401.40.00) Free No change No change On or before 12/

31/2008 ’’. 

(c) EFFECTIVE DATE.—

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

on the date of the enactment of this Act. 

(2) SUBSECTION (b).—The amendment made by subsection (b) shall apply to 

goods entered, or withdrawn from warehouse, for consumption on or after the 

15th day after the date of the enactment of this Act.

I. SUMMARY AND BACKGROUND 

A. PURPOSE AND SUMMARY

The bill, H.R. 4520, as amended, (the ‘‘American Jobs Creation 

Act of 2004’’) repeals the exclusion for extraterritorial income (the 

‘‘ETI’’ regime) and provides a reduced corporate income tax rate for 

domestic production activities and other corporate reform and 

growth incentives. 

The bill provides net tax reductions of over $21.136 billion over 

fiscal years 2004–2008. 

B. BACKGROUND AND NEED FOR LEGISLATION

The provisions approved by the Committee comply with the 

World Trade Organization holding that the ETI regime constitutes 

a prohibited export subsidy under the relevant trade agreements. 

The provisions approved by the Committee provide other corporate 

reform and growth incentives. The estimated revenue effects of the 

provisions comply with the most recent Congressional Budget Office revisions of budget projections. 

C. LEGISLATIVE HISTORY

The Committee on Ways and Means marked up the American 

Jobs Creation Act of 2004 on June 14, 2004, and ordered the bill, 

as amended, favorably reported by a roll call vote of 27 yeas and 

9 nays (with a quorum being present). 

113

1Section references are to the Internal Revenue Code of 1986, as amended (the ‘‘Code’’), unless 

otherwise indicated. 2 ‘‘Foreign trade income’’ is the taxable income of the taxpayer (determined without regard to 

the exclusion of qualifying foreign trade income) attributable to foreign trading gross receipts. 3 ‘‘Foreign sale and leasing income’’ is the amount of the taxpayer’s foreign trade income (with 

respect to a transaction) that is properly allocable to activities that constitute foreign economic 

processes. Foreign sale and leasing income also includes foreign trade income derived by the taxpayer in connection with the lease or rental of qualifying foreign trade property for use by the 

lessee outside the United States. 

TITLE I—END SANCTIONS AND REDUCE CORPORATE TAX 

RATES FOR DOMESTIC MANUFACTURING AND SMALL 

CORPORATIONS 

A. REPEAL OF EXCLUSION FOR EXTRATERRITORIAL INCOME

(Sec. 101 of the bill and secs. 114 and 941–943 of the Code) 1

PRESENT LAW

The United States has long provided export-related benefits 

under a series of tax regimes, including the domestic international 

sales corporation (‘‘DISC’’) regime, the foreign sales corporation 

(‘‘FSC’’) regime, and the extraterritorial income (‘‘ETI’’) regime. 

Each of these regimes has been found to violate U.S. obligations 

under international trade agreements. In 2000, the European 

Union (‘‘EU’’) succeeded in having the FSC regime declared a prohibited export subsidy by the WTO. In response to this WTO ruling, the United States repealed the FSC rules and enacted a new 

regime under the FSC Repeal and Extraterritorial Income Exclusion Act of 2000. The EU immediately challenged the ETI regime 

in the WTO, and in January of 2002 a WTO Appellate Body held 

that the ETI regime also constituted a prohibited export subsidy 

under the relevant trade agreements. 

Under the ETI regime, an exclusion from gross income applies 

with respect to ‘‘extraterritorial income,’’ which is a taxpayer’s 

gross income attributable to ‘‘foreign trading gross receipts.’’ This 

income is eligible for the exclusion to the extent that it is ‘‘qualifying foreign trade income.’’ Qualifying foreign trade income is the 

amount of gross income that, if excluded, would result in a reduction of taxable income by the greatest of: (1) 1.2 percent of the foreign trading gross receipts derived by the taxpayer from the transaction; (2) 15 percent of the ‘‘foreign trade income’’ derived by the 

taxpayer from the transaction 2; or (3) 30 percent of the ‘‘foreign 

sale and leasing income’’ derived by the taxpayer from the transaction.3

Foreign trading gross receipts are gross receipts derived from 

certain activities in connection with ‘‘qualifying foreign trade property’’ with respect to which certain economic processes take place 

outside of the United States. Specifically, the gross receipts must 

be: (1) from the sale, exchange, or other disposition of qualifying 

foreign trade property; (2) from the lease or rental of qualifying foreign trade property for use by the lessee outside the United States; 

(3) for services which are related and subsidiary to the sale, exchange, disposition, lease, or rental of qualifying foreign trade 

property (as described above); (4) for engineering or architectural 

services for construction projects located outside the United States; 

or (5) for the performance of certain managerial services for unrelated persons. A taxpayer may elect to treat gross receipts from a 

114

4This rule also applies to a purchase option, renewal option, or replacement option that is 

included in such contract and that is enforceable against the sellor or lessor. For this purpose, 

a replacement option will be considered enforceable against a lessor notwithstanding the fact 

that a lessor retained approval of the replacement lessee. 

transaction as not foreign trading gross receipts. As a result of 

such an election, a taxpayer may use any related foreign tax credits in lieu of the exclusion. 

Qualifying foreign trade property generally is property manufactured, produced, grown, or extracted within or outside the United 

States that is held primarily for sale, lease, or rental in the ordinary course of a trade or business for direct use, consumption, or 

disposition outside the United States. No more than 50 percent of 

the fair market value of such property can be attributable to the 

sum of: (1) the fair market value of articles manufactured outside 

the United States; and (2) the direct costs of labor performed outside the United States. With respect to property that is manufactured outside the United States, certain rules are provided to ensure consistent U.S. tax treatment with respect to manufacturers. 

REASONS FOR CHANGE

The Committee believes it is important that the United States, 

and all members of the WTO, comply with WTO decisions and 

honor their obligations under WTO agreements. Therefore, the 

Committee believes that the ETI regime should be repealed. The 

Committee believes that it is necessary and appropriate to provide 

transition relief comparable to that which has been included in the 

past in measures taken by WTO members to bring their laws into 

compliance with WTO decisions and obligations. 

The Committee also believes that it is important to use the opportunity afforded by the repeal of the ETI regime to reform the 

U.S. tax system in a manner that makes U.S. businesses and workers more productive and competitive than they are today. To this 

end, the Committee believes that it is important to provide tax cuts 

to U.S. domestic manufacturers and to update the U.S. international tax rules, which are over 40 years old and make U.S. companies uncompetitive in the United States and abroad. 

EXPLANATION OF PROVISION

The provision repeals the ETI exclusion. For transactions prior 

to 2005, taxpayers retain 100 percent of their ETI benefits. For 

transactions after 2004, the provision provides taxpayers with 80 

percent of their otherwise-applicable ETI benefits for transactions 

during 2005 and 60 percent of their otherwise-applicable ETI benefits for transactions during 2006. However, the provision provides 

that the ETI exclusion provisions remain in effect for transactions 

in the ordinary course of a trade or business if such transactions 

are pursuant to a binding contract 4 between the taxpayer and an 

unrelated person and such contract is in effect on January 14, 

2002, and at all times thereafter. 

In addition, foreign corporations that elected to be treated for all 

Federal tax purposes as domestic corporations in order to facilitate 

the claiming of ETI benefits are allowed to revoke such elections 

within one year of the date of enactment of the provision without 

recognition of gain or loss, subject to anti-abuse rules. 

115

EFFECTIVE DATE

The provision is effective for transactions after December 31, 

2004. 

B. REDUCED CORPORATE INCOME TAX RATE FOR DOMESTIC

PRODUCTION ACTIVITIES INCOME

(Sec. 102 of the bill and sec. 11 of the Code) 

PRESENT LAW

A corporation’s regular income tax liability is determined by applying the following tax rate schedule to its taxable income.

TABLE 1.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2004

[Percent of taxable income] 

Taxable income Income

tax rate 

$0–$50,000 .................................................................................................................................................................... 15

$50,001–$75,000 ........................................................................................................................................................... 25

$75,001–$10,000,000 .................................................................................................................................................... 34

Over $10,000,000 ........................................................................................................................................................... 35

The benefit of the first two graduated rates described above is 

phased out by a five-percent surcharge for corporations with taxable income between $100,000 and $335,000. Also, the benefit of 

the 34–percent rate is phased out by a three-percent surcharge for 

corporations with taxable income between $15 million and 

$18,333,333; a corporation with taxable income of $18,333,333 or 

more effectively is subject to a flat rate of 35 percent. 

Under present law, there is no provision that reduces the corporate income tax for taxable income attributable to domestic production activities. 

REASONS FOR CHANGE

The Committee believes that creating new jobs is an essential 

element of economic recovery and expansion, and that tax policies 

designed to foster economic strength also will contribute to the continuation of the recent increases in employment levels. To accomplish this objective, the Committee believes that Congress should 

enact tax laws that enhance the ability of domestic businesses, and 

domestic manufacturing firms in particular, to compete in the global marketplace. 

The Committee believes that a reduced tax burden on domestic 

manufacturers will improve the cash flow of domestic manufacturers and make investments in domestic manufacturing facilities 

more attractive. Such investment will create and preserve U.S. 

manufacturing jobs.

EXPLANATION OF PROVISION

In general 

The bill provides that the corporate tax rate applicable to qualified production activities income may not exceed 32 percent (34 

percent for taxable years beginning before 2007) of the qualified 

production activities income. 

116

5The Secretary shall prescribe rules for the proper allocation of items of income, deduction, 

expense, and loss for purposes of determining income attributable to domestic production activities. Where appropriate, such rules shall be similar to and consistent with relevant present-law 

rules (e.g., secs. 263A and 861). 6Domestic production gross receipts include gross receipts of a taxpayer derived from any 

sale, exchange or other disposition of agricultural products with respect to which the taxpayer 

performs storage, handling or other processing activities (other than transportation activities) 

within the United States, provided such products are consumed in connection with, or incorporated into, the manufacturing, production, growth or extraction of qualifying production property (whether or not by the taxpayer). Domestic production gross receipts also include gross receipts of a taxpayer derived from any sale, exchange or other disposition of food products with 

respect to which the taxpayer performs processing activities (in whole or in significant part) 

within the United States. 7 It is intended that principles similar to those under the present-law extraterritorial income 

regime apply for this purpose. See Temp. Treas. Reg. sec. 1.927(a)-1T(f)(2)(i). For example, this 

exclusion generally does not apply to property leased by the taxpayer to a related person if the 

property is held for sublease, or is subleased, by the related person to an unrelated person for 

the ultimate use of such unrelated person. Similarly, the license of computer software to a related person for reproduction and sale, exchange, lease, rental or sublicense to an unrelated person for the ultimate use of such unrelated person is not treated as excluded property by reason 

of the license to the related person. 

Qualified production activities income 

‘‘Qualified production activities income’’ is the income attributable to domestic production gross receipts, reduced by the sum 

of: (1) the costs of goods sold that are allocable to such receipts; (2) 

other deductions, expenses, or losses that are directly allocable to 

such receipts; and (3) a proper share of other deductions, expenses, 

and losses that are not directly allocable to such receipts or another 

class of income.5

Domestic production gross receipts 

‘‘Domestic production gross receipts’’ generally are gross receipts 

of a corporation that are derived from: (1) any sale, exchange or 

other disposition, or any lease, rental or license, of qualifying production property that was manufactured, produced, grown or extracted (in whole or in significant part) by the corporation within 

the United States; 6 (2) any sale, exchange or other disposition, or 

any lease, rental or license, of qualified film produced by the taxpayer; or (3) construction, engineering or architectural services performed in the United States for construction projects located in the 

United States. However, domestic production gross receipts do not 

include any gross receipts of the taxpayer derived from property 

that is leased, licensed or rented by the taxpayer for use by any 

related person.7

‘‘Qualifying production property’’ generally is any tangible personal property, computer software, or property described in section 

168(f)(4) of the Code. ‘‘Qualified film’’ is any property described in 

section 168(f)(3) of the Code (other than certain sexually explicit 

productions) if 50 percent or more of the total compensation relating to the production of such film (other than compensation in the 

form of residuals and participations) constitutes compensation for 

services performed in the United States by actors, production personnel, directors, and producers. 

Under the bill, an election under section 631(a) made by a corporate taxpayer for a taxable year ending on or before the date of 

enactment to treat the cutting of timber as a sale or exchange, may 

be revoked by the taxpayer without the consent of the IRS for any 

taxable year ending after that date. The prior election (and revocation) is disregarded for purposes of making a subsequent election. 

117

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2004. 

C. REDUCED CORPORATE INCOME TAX RATE FOR SMALL

CORPORATIONS

(Sec. 103 of the bill and sec. 11 of the Code) 

PRESENT LAW

A corporation’s regular income tax liability is determined by applying the following tax rate schedule to its taxable income.

Table 1.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2004 

[Percent of taxable income] 

Taxable income Income

tax rate 

$0–$50,000 .................................................................................................................................................................... 15

$50,001–$75,000 ........................................................................................................................................................... 25

$75,001–$10,000,000 .................................................................................................................................................... 34

Over $10,000,000 ........................................................................................................................................................... 35

The benefit of the first two graduated rates described above is 

phased out by a five-percent surcharge for corporations with taxable income between $100,000 and $335,000. Also, benefit of the 

34–percent rate is phased out by a three-percent surcharge for corporations with taxable income between $15 million and 

$18,333,333; a corporation with taxable income of $18,333,333 or 

more effectively is subject to a flat rate of 35 percent. 

REASONS FOR CHANGE

The Committee believes that reducing the tax burden on small 

and medium sized businesses will enable them to continue to create and maintain new jobs in the United States. A reduced tax burden on smaller businesses simultaneously makes investments by 

small businesses more attractive and improves the cash flow of 

such businesses, thus facilitating the financing of investments. 

New investment by small business is responsible for substantial job 

creation in the economy and provides the foundation for new industries, new technology, and the future of the U. S. economy. 

EXPLANATION OF PROVISION

Under the provision, a corporation’s regular income tax liability 

is determined by applying the following tax rate schedules to its 

taxable income.

TABLE 2.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2013 AND THEREAFTER 

[Percent of taxable income] 

Taxable income Income

tax rate 

$0–$50,000 .................................................................................................................................................................... 15

$50,001–$75,000 ........................................................................................................................................................... 25 

$75,001–$20,000,000 .................................................................................................................................................... 32 

Over $20,000,000 ........................................................................................................................................................... 35 

118

The benefit of the graduated rates described above is phased out 

by a three-percent surcharge for corporations with taxable income 

between $20 million and $40,341,667; a corporation with taxable 

income of $40,341,667 or more effectively is subject to a flat rate 

of 35 percent.

TABLE 3.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2011–2012 

[Percent of taxable income] 

Taxable income Income

tax rate 

$0–$50,000 .................................................................................................................................................................... 15 

$50,001–$75,000 ........................................................................................................................................................... 25 

$75,001–$5,000,000 ...................................................................................................................................................... 32 

$5,000,001–$10,000,000 ............................................................................................................................................... 34 

Over $10,000,000 ........................................................................................................................................................... 35 

The benefit of the first three graduated rates described above is 

phased out by a five-percent surcharge for corporations with taxable income between $5,000,000 and $7,205,000. Also, the benefit 

of the 34-percent rate is phased out by a three-percent surcharge 

for corporations with taxable income between $15 million and 

$18,333,333; a corporation with taxable income of $18,333,333 or 

more effectively is subject to a flat rate of 35 percent.

TABLE 4.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2008–2010 

[Percent of taxable income] 

Taxable income Income

tax rate 

$0–$50,000 .................................................................................................................................................................... 15 

$50,001–$75,000 ........................................................................................................................................................... 25 

$75,001–$1,000,000 ...................................................................................................................................................... 32 

$1,000,001–$10,000,000 ............................................................................................................................................... 34 

Over $10,000,000 ........................................................................................................................................................... 35 

The benefit of the first three graduated rates described above is 

phased out by a five-percent surcharge for corporations with taxable income between $1,000,000 and $1,605,000. Also, the benefit 

of the 34-percent rate is phased out by a three-percent surcharge 

for corporations with taxable income between $15 million and 

$18,333,333; a corporation with taxable income of $18,333,333 or 

more effectively is subject to a flat rate of 35 percent.

TABLE 5.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2005–2007

[Percent of taxable income] 

Taxable income Income

tax rate 

$0–$50,000 .................................................................................................................................................................... 15 

$50,001–$75,000 ........................................................................................................................................................... 25 

$75,001–$1,000,000 ...................................................................................................................................................... 33 

$1,000,001–$10,000,000 ............................................................................................................................................... 34 

Over $10,000,000 ........................................................................................................................................................... 35 

The benefit of the first three graduated rates described above is 

phased out by a five-percent surcharge for corporations with taxable income between $1,000,000 and $1,420,000. Also, the benefit 

of the 34-percent rate is phased out by a three-percent surcharge 

119

8Pub. L. No. 108–27, sec. 202 (2003). 9 Additional section 179 incentives are provided with respect to a qualified property used by 

a business in the New York Liberty Zone (sec. 1400L(f)), an empowerment zone (sec. 1397A), 

or a renewal community (sec. 1400J). 10Sec. 179(c)(1). 

for corporations with taxable income between $15 million and 

$18,333,333; a corporation with taxable income of $18,333,333 or 

more effectively is subject to a flat rate of 35 percent. 

EFFECTIVE DATE

The provision applies to taxable years beginning after December 

31, 2004.

TITLE II—CORPORATE REFORM AND GROWTH INCENTIVES 

FOR MANUFACTURERS, SMALL BUSINESSES, AND FARMERS 

A. SMALL BUSINESS EXPENSING

1. Extension of increased section 179 expensing (sec. 201 of the bill 

and sec. 179 of the Code) 

PRESENT LAW

Present law provides that, in lieu of depreciation, a taxpayer 

with a sufficiently small amount of annual investment may elect to 

deduct such costs. The Jobs and Growth Tax Relief Reconciliation 

Act (JGTRRA) of 2003 8 increased the amount a taxpayer may deduct, for taxable years beginning in 2003 through 2005, to $100,000 

of the cost of qualifying property placed in service for the taxable 

year.9 In general, qualifying property is defined as depreciable tangible personal property (and certain computer software) that is purchased for use in the active conduct of a trade or business. The 

$100,000 amount is reduced (but not below zero) by the amount by 

which the cost of qualifying property placed in service during the 

taxable year exceeds $400,000. The $100,000 and $400,000 

amounts are indexed for inflation. 

Prior to the enactment of JGTRRA (and for taxable years beginning in 2006 and thereafter) a taxpayer with a sufficiently small 

amount of annual investment could elect to deduct up to $25,000 

of the cost of qualifying property placed in service for the taxable 

year. The $25,000 amount was reduced (but not below zero) by the 

amount by which the cost of qualifying property placed in service 

during the taxable year exceeds $200,000. In general, qualifying 

property is defined as depreciable tangible personal property that 

is purchased for use in the active conduct of a trade or business. 

The amount eligible to be expensed for a taxable year may not 

exceed the taxable income for a taxable year that is derived from 

the active conduct of a trade or business (determined without regard to this provision). Any amount that is not allowed as a deduction because of the taxable income limitation may be carried forward to succeeding taxable years (subject to similar limitations). 

No general business credit under section 38 is allowed with respect 

to any amount for which a deduction is allowed under section 179. 

Under present law, an expensing election is made under rules 

prescribed by the Secretary.10 Applicable Treasury regulations proVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00121 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.002 HR548P1
120

11Treas. Reg. sec. 1.179–5. Under these regulations, a taxpayer may make the election on the 

original return (whether or not the return is timely), or on an amended return filed by the due 

date (including extensions) for filing the return for the tax year the property was placed in service. If the taxpayer timely filed an original return without making the election, the taxpayer 

may still make the election by filing an amended return within six months of the due date of 

the return (excluding extensions). 12Sec. 179(c)(2). 13 Id. 

vide that an expensing election generally is made on the taxpayer’s 

original return for the taxable year to which the election relates.11

Prior to the enactment of JGTRRA (and for taxable years beginning in 2006 and thereafter), an expensing election may be revoked 

only with consent of the Commissioner.12 JGTRRA permits taxpayers to revoke expensing elections on amended returns without 

the consent of the Commissioner with respect to a taxable year beginning after 2002 and before 2006.13

REASONS FOR CHANGE

The Committee believes that section 179 expensing provides two 

important benefits for small businesses. First, it lowers the cost of 

capital for property used in a trade or business. With a lower cost 

of capital, the Committee believes small businesses will invest in 

more equipment and employ more workers. Second, it eliminates 

depreciation recordkeeping requirements with respect to expensed 

property. In JGTRRA, Congress acted to increase the value of these 

benefits and to increase the number of taxpayers eligible for taxable years through 2005. The Committee believes that these 

changes to section 179 expensing will continue to provide important benefits if extended, and the bill therefore extends these 

changes for an additional two years. 

EXPLANATION OF PROVISION

The provision extends the increased amount that a taxpayer may 

deduct, and other changes that were made by JGTRRA, for an additional two years. Thus, the provision provides that the maximum 

dollar amount that may be deducted under section 179 is $100,000 

for property placed in service in taxable years beginning before 

2008 ($25,000 for taxable years beginning in 2008 and thereafter). 

In addition, the $400,000 amount applies for property placed in 

service in taxable years beginning before 2008 ($200,000 for taxable years beginning in 2008 and thereafter). The provision extends, through 2007 (from 2005), the indexing for inflation of both 

the maximum dollar amount that may be deducted and the 

$400,000 amount. The provision also includes off-the-shelf computer software placed in service in taxable years beginning before 

2008 as qualifying property. The provision permits taxpayers to revoke expensing elections on amended returns without the consent 

of the Commissioner with respect to a taxable year beginning before 2008. The Committee expects that the Secretary will prescribe 

regulations to permit a taxpayer to make an expensing election on 

an amended return without the consent of the Commissioner. 

EFFECTIVE DATE

The provision is effective on the date of enactment.

121

14The Tax Reform Act of 1986 modified the Accelerated Cost Recovery System (‘‘ACRS’’) to 

institute MACRS. Prior to the adoption of ACRS by the Economic Recovery Tax Act of 1981, 

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

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

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

MACRS. 15Former sections 168(f)(6) and 178 provided that, in certain circumstances, a lessee could recover the cost of leasehold improvements made over the remaining term of the lease. The Tax 

Reform Act of 1986 repealed these provisions. 16 If the improvement is characterized as tangible personal property, ACRS or MACRS depreciation is calculated using the shorter recovery periods, accelerated methods, and conventions 

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

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

the improvements constitute a ‘‘structural component’’ of a building (as defined by Treas. Reg. 

sec. 1.48–1(e)(1)). See, e.g., Metro National Corp v. Commissioner, 52 TCM (CCH) 1440 (1987); 

King Radio Corp Inc. v. U.S., 486 F.2d 1091 (10th Cir. 1973); Mallinckrodt, Inc. v. Commissioner, 778 F.2d 402 (8th Cir. 1985) (with respect to various leasehold improvements). 17Pub. L. No. 107–147, sec. 101 (2002), as amended by Pub. L. No. 108–27, sec. 201 (2003). 

B. DEPRECIATION

1. Recovery period for depreciation of certain leasehold improvements and restaurant property (sec. 211 of the bill and sec. 168 

of the Code) 

PRESENT LAW

A taxpayer generally must capitalize the cost of property used in 

a trade or business and recover such cost over time through annual 

deductions for depreciation or amortization. Tangible property generally is depreciated under the modified accelerated cost recovery 

system (‘‘MACRS’’), which determines depreciation by applying specific recovery periods, placed-in-service conventions, and depreciation methods to the cost of various types of depreciable property 

(sec. 168). The cost of nonresidential real property is recovered 

using the straight-line method of depreciation and a recovery period of 39 years. Nonresidential real property is subject to the midmonth placed-in-service convention. Under the mid-month convention, the depreciation allowance for the first year property is placed 

in service is based on the number of months the property was in 

service, and property placed in service at any time during a month 

is treated as having been placed in service in the middle of the 

month. 

Depreciation of leasehold improvements 

Depreciation allowances for improvements made on leased property are determined under MACRS, even if the MACRS recovery 

period assigned to the property is longer than the term of the lease 

(sec. 168(i)(8)).14 This rule applies regardless of whether the lessor 

or the lessee places the leasehold improvements in service.15 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), (d)(2), and (i)(6)).16

Qualified leasehold improvement property 

The Job Creation and Worker Assistance Act of 2002 17

(‘‘JCWAA’’), as amended by JGTRRA, generally provides an additional first-year depreciation deduction equal to either 30 percent 

or 50 percent of the adjusted basis of qualified property placed in 

122

service before January 1, 2005. Qualified property includes qualified leasehold improvement property. For this purpose, qualified 

leasehold improvement property is any improvement to an interior 

portion of a building that is nonresidential real property, provided 

certain requirements are met. The improvement must be made 

under or pursuant to a lease either by the lessee (or sublessee), or 

by the lessor, of that portion of the building to be occupied exclusively by the lessee (or sublessee). The improvement must be 

placed in service more than three years after the date the building 

was first placed in service. Qualified leasehold improvement property does not include any improvement for which the expenditure 

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

escalator, any structural component benefiting a common area, or 

the internal structural framework of the building. 

Treatment of dispositions of leasehold improvements 

A lessor of leased property that disposes of a leasehold improvement that was made by the lessor for the lessee of the property 

may take the adjusted basis of the improvement into account for 

purposes of determining gain or loss if the improvement is irrevocably disposed of or abandoned by the lessor at the termination 

of the lease. This rule conforms the treatment of lessors and lessees 

with respect to leasehold improvements disposed of at the end of 

a term of lease. 

REASONS FOR CHANGE

The Committee believes that taxpayers should not be required to 

recover the costs of certain leasehold improvements beyond the 

useful life of the investment. The present law 39-year recovery period for leasehold improvements extends well beyond the useful life 

of such investments. Although lease terms differ, the Committee 

believes that lease terms for commercial real estate typically are 

shorter than the present-law 39-year recovery period. In the interests of simplicity and administrability, a uniform period for recovery of leasehold improvements is desirable. The Committee bill 

therefore shortens the recovery period for leasehold improvements 

to a more realistic 15 years. 

The Committee also believes that unlike other commercial buildings, restaurant buildings generally are more specialized structures. Restaurants also experience considerably more traffic, and 

remain open longer than most retail properties. This daily assault 

causes rapid deterioration of restaurant properties and forces restaurateurs to constantly repair and upgrade their facilities. As 

such, restaurant facilities have a much shorter life span than other 

commercial establishments. The Committee bill reduces the 39-year 

recovery period for improvements made to restaurant buildings and 

more accurately reflects the true economic life of the properties by 

reducing the recovery period to 15 years. 

EXPLANATION OF PROVISION

The provision provides a statutory 15-year recovery period for 

qualified leasehold improvement property placed in service before 

123

18Qualified leasehold improvement property continues to be eligible for the additional firstyear depreciation deduction under sec. 168(k). 19Qualified restaurant property would become eligible for the additional first-year depreciation deduction under sec. 168(k) by virtue of the assigned 15-year recovery period. 20The additional first-year depreciation deduction is subject to the general rules regarding 

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

or section 263A. 

January 1, 2006.18 The provision requires that qualified leasehold 

improvement property be recovered using the straight-line method. 

Qualified leasehold improvement property is defined as under 

present law for purposes of the additional first-year depreciation 

deduction (sec. 168(k)), with the following modification. If a lessor 

makes an improvement that qualifies as qualified leasehold improvement property such improvement shall not qualify as qualified leasehold improvement property to any subsequent owner of 

such improvement. An exception to the rule applies in the case of 

death and certain transfers of property that qualify for non-recognition treatment. 

The provision also provides a statutory 15-year recovery period 

for qualified restaurant property placed in service before January 

1, 2006.19 For purposes of the provision, qualified restaurant property means any improvement to a building if such improvement is 

placed in service more than three years after the date such building was first placed in service and more than 50 percent of the 

building’s square footage is devoted to the preparation of, and seating for, on-premises consumption of prepared meals. The provision 

requires that qualified restaurant property be recovered using the 

straight-line method. 

EFFECTIVE DATE

The provision is effective for property placed in service after the 

date of enactment. 

2. Modification of depreciation allowance for aircraft (sec. 212 of 

the bill and sec. 168 of the Code) 

PRESENT LAW

In general 

A taxpayer is allowed to recover, through annual depreciation deductions, the cost of certain property used in a trade or business 

or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year 

is determined under the modified accelerated cost recovery system 

(‘‘MACRS’’). Under MACRS, different types of property generally 

are assigned applicable recovery periods and depreciation methods. 

The recovery periods applicable to most tangible personal property 

range from 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. 

Thirty-percent additional first year depreciation deduction 

JCWAA allows an additional first-year depreciation deduction 

equal to 30 percent of the adjusted basis of qualified property.20

124

21 However, the additional first-year depreciation deduction is not allowed for purposes of computing earnings and profits. 22 A taxpayer may elect out of the 50-percent additional first-year depreciation (discussed 

below) for any class of property and still be eligible for the 30-percent additional first-year depreciation. 23 A special rule precludes the additional first-year depreciation deduction for any property 

that is required to be depreciated under the alternative depreciation system of MACRS. 24The term ‘‘original use’’ means the first use to which the property is put, whether or not 

such use corresponds to the use of such property by the taxpayer. If, in the normal course of 

its business, a taxpayer sells fractional interests in property to unrelated third parties, then the 

original use of such property begins with the first user of each fractional interest (i.e., each fractional owner is considered the original user of its proportionate share of the property). 25 In order for property to qualify for the extended placed-in-service date, the property must 

be subject to section 263A by reason of having a production period exceeding two years or an 

estimated production period exceeding one year and a cost exceeding $1 million. 26Property does not fail to qualify for the additional first-year depreciation merely because 

a binding written contract to acquire a component of the property is in effect prior to September 

11, 2001. 

The amount of the additional first-year depreciation deduction is 

not affected by a short taxable year. The additional first-year depreciation deduction is allowed for both regular tax and alternative 

minimum tax purposes for the taxable year in which the property 

is placed in service.21 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. In addition, there are generally no adjustments to the allowable amount of depreciation for purposes of computing a taxpayer’s alternative minimum taxable income with respect to property to which the provision applies. A taxpayer is allowed to elect 

out of the additional first-year depreciation for any class of property for any taxable year.22

In order for property to qualify for the additional first-year depreciation deduction, it must meet all of the following requirements. First, the property must be (1) property to which MACRS 

applies with an applicable recovery period of 20 years or less, (2) 

water utility property (as defined in section 168(e)(5)), (3) computer 

software other than computer software covered by section 197, or 

(4) qualified leasehold improvement property (as defined in section 

168(k)(3)).23 Second, the original use 24 of the property must commence with the taxpayer on or after September 11, 2001. Third, the 

taxpayer must acquire the property within the applicable time period. Finally, the property must be placed in service before January 

1, 2005. 

An extension of the placed-in-service date of one year (i.e., January 1, 2006) is provided for certain property with a recovery period 

of ten years or longer and certain transportation property.25 Transportation property is defined as tangible personal property used in 

the trade or business of transporting persons or property. 

The applicable time period for acquired property is (1) after September 10, 2001 and before January 1, 2005, but only if no binding 

written contract for the acquisition is in effect before September 11, 

2001, or (2) pursuant to a binding written contract which was entered into after September 10, 2001, and before January 1, 2005.26

For property eligible for the extended placed-in-service date, a special rule limits the amount of costs eligible for the additional first 

year depreciation. With respect to such property, only the portion 

of the basis that is properly attributable to the costs incurred beVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00126 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.003 HR548P1
125

27For purposes of determining the amount of eligible progress expenditures, it is intended 

that rules similar to sec. 46(d)(3) as in effect prior to the Tax Reform Act of 1986 shall apply. 28Property does not fail to qualify for the additional first-year depreciation merely because 

a binding written contract to acquire a component of the property is in effect prior to May 6, 

2003. However, no 50-percent additional first-year depreciation is permitted on any such component. No inference is intended as to the proper treatment of components placed in service under 

the 30-percent additional first-year depreciation provided by the JCWAA. 29For purposes of determining the amount of eligible progress expenditures, it is intended 

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

fore January 1, 2005 (‘‘progress expenditures’’) is eligible for the additional first-year depreciation.27

Fifty-percent additional first year depreciation 

JGTRRA provides an additional first-year depreciation deduction 

equal to 50 percent of the adjusted basis of qualified property. 

Qualified property is defined in the same manner as for purposes 

of the 30-percent additional first-year depreciation deduction provided by the JCWAA except that the applicable time period for acquisition (or self construction) of the property is modified. Property 

eligible for the 50-percent additional first-year depreciation deduction is not eligible for the 30-percent additional first-year depreciation deduction. 

In order to qualify, the property must be acquired after May 5, 

2003, and before January 1, 2005, and no binding written contract 

for the acquisition can be in effect before May 6, 2003.28 With respect to property that is manufactured, constructed, or produced by 

the taxpayer for use by the taxpayer, the taxpayer must begin the 

manufacture, construction, or production of the property after May 

5, 2003. For property eligible for the extended placed-in-service 

date (i.e., certain property with a recovery period of ten years or 

longer and certain transportation property), a special rule limits 

the amount of costs eligible for the additional first-year depreciation. With respect to such property, only progress expenditures 

properly attributable to the costs incurred before January 1, 2005 

are eligible for the additional first-year depreciation.29

REASONS FOR CHANGE

The Committee believes that certain non-commercial aircraft represent property having characteristics that should qualify for the 

extended placed-in-service date accorded under present law for 

property having long production periods. This treatment should be 

available only if the purchaser makes a substantial deposit, the expected cost exceeds certain thresholds, and the production period is 

sufficiently long. 

EXPLANATION OF PROVISION

Due to the extended production period, the provision provides criteria under which certain non-commercial aircraft can qualify for 

the extended placed-in-service date. Qualifying aircraft would be eligible for the additional first-year depreciation deduction if placed 

in service before January 1, 2006. In order to qualify, the aircraft 

must: 

(a) Be acquired by the taxpayer during the applicable time 

period as under present law; 

(b) Meet the appropriate placed-in-service date requirements; 

126

30For this purpose, the Committee intends that the term ‘‘purchase’’ be interpreted as it is 

defined in sec. 179(d)(2). 

(c) Not be tangible personal property used in the trade or 

business of transporting persons or property (except for agricultural or firefighting purposes); 

(d) Be purchased 30 by a purchaser who, at the time of the 

contract for purchase, has made a nonrefundable deposit of the 

lesser of ten percent of the cost or $100,000; and 

(e) Have an estimated production period exceeding four 

months and a cost exceeding $200,000. 

EFFECTIVE DATE

The provision is effective as if included in the amendments made 

by section 101 of JCWAA, which applies to property placed in service after September 10, 2001. However, because the property described by the provision qualifies for the additional first-year depreciation deduction under present law if placed in service prior to 

January 1, 2005, the provision will modify the treatment only of 

property placed in service during calendar year 2005. 

3. Modification of placed in service rule for bonus depreciation 

property (sec. 213 of the bill and sec. 168 of the Code) 

PRESENT LAW

Section 101 of JCWAA provides generally for 30-percent additional first-year depreciation, and provides a binding contract rule 

in determining property that qualifies for it. The requirements that 

must be satisfied in order for property to qualify include that (1) 

the original use of the property must commence with the taxpayer 

on or after September 11, 2001, (2) the taxpayer must acquire the 

property after September 10, 2001 and before September 11, 2004, 

and (3) no binding written contract for the acquisition of the property is in effect before September 11, 2001 (or, in the case of selfconstructed property, manufacture, construction, or production of 

the property does not begin before September 11, 2001). In addition, JCWAA provides a special rule in the case of certain leased 

property. In the case of any property that is originally placed in 

service by a person and that is sold to the taxpayer and leased 

back to such person by the taxpayer within three months after the 

date that the property was placed in service, the property is treated as originally placed in service by the taxpayer not earlier than 

the date that the property is used under the leaseback. JCWAA did 

not specifically address the syndication of a lease by the lessor. 

JGTRRA provides an additional first-year depreciation deduction 

equal to 50 percent of the adjusted basis of qualified property. 

Qualified property is defined in the same manner as for purposes 

of the 30-percent additional first-year depreciation deduction provided by the JCWAA except that the applicable time period for acquisition (or self construction) of the property is modified. Property 

with respect to which the 50-percent additional first-year depreciation deduction is claimed is not also eligible for the 30-percent additional first-year depreciation deduction. In order to qualify, the 

property must be acquired after May 5, 2003 and before January 

1, 2005, and no binding written contract for the acquisition can be 

127

in effect before May 6, 2003. With respect to property that is manufactured, constructed, or produced by the taxpayer for use by the 

taxpayer, the taxpayer must begin the manufacture, construction, 

or production of the property after May 5, 2003. 

REASONS FOR CHANGE

The Committee believes that the rules relating to 30-percent additional first-year depreciation should be clarified to reflect the legislative intent that syndicated property, if sold within three months 

of the date it was originally placed in service, be eligible for the additional first-year depreciation deduction. Further, the Committee 

is aware that certain syndication arrangements are entered into 

with respect to multiple units of property (such as rail cars) that, 

for logistical reasons, must be placed in service over a period of 

time that exceeds three months. In such cases, it would be impractical for the sale of the earlier produced units to occur within three 

months of its placed-in-service date. Thus, the Committee deems it 

appropriate to provide a special rule with respect to the syndication 

of multiple units of property that will be placed in service over a 

period of up to twelve months. 

EXPLANATION OF PROVISION

The provision provides that if property is originally placed in 

service by a lessor (including by operation of the special rule for 

self-constructed property), such property is sold within three 

months after the date that the property was placed in service, and 

the user of such property does not change, then the property is 

treated as originally placed in service by the taxpayer not earlier 

than the date of such sale. The provision also provides a special 

rule in the case of multiple units of property subject to the same 

lease. In such cases, property will qualify as placed in service on 

the date of sale if it is sold within three months after the final unit 

is placed in service, so long as the period between the time the first 

and last units are placed in service does not exceed 12 months. 

EFFECTIVE DATE

The provision is generally effective as if included in the amendments made by section 101 of JCWAA (i.e., generally for property 

placed in service after September 10, 2001, in taxable years ending 

after that date). However, the special rule in the case of multiple 

units of property subject to the same lease applies to property sold 

after June 4, 2004.

C. S CORPORATION REFORM AND SIMPLIFICATION

(Secs. 221–231 of the bill and secs. 1361–1379 and 4975 of the 

Code) 

OVERVIEW

In general, an S corporation is not subject to corporate-level income tax on its items of income and loss. Instead, an S corporation 

passes through its items of income and loss to its shareholders. The 

shareholders take into account separately their shares of these 

items on their individual income tax returns. To prevent double 

taxation of these items when the stock is later disposed of, each 

128

31See, for example, GAO/GGD–00–159, Banking Taxation, Implications of Proposed Revisions 

Governing S-Corporations on Community Banks (June 23, 2000). 32 If a qualified retirement plan (other than an employee stock ownership plan) or a charity 

holds stock in an S corporation, the interest held is treated as an interest in an unrelated trade 

or business, and the plan or charity’s share of the S corporation’s items of income, loss, or deduction, and gain or loss on the disposition of the S corporation stock, are taken into account in 

computing unrelated business taxable income. 

shareholder’s basis in the stock of the S corporation is increased by 

the amount included in income (including tax-exempt income) and 

is decreased by the amount of any losses (including nondeductible 

losses) taken into account. A shareholder’s loss may be deducted 

only to the extent of his or her basis in the stock or debt of the 

S corporation. To the extent a loss is not allowed due to this limitation, the loss generally is carried forward with respect to the shareholder. 

REASONS FOR CHANGE

The bill contains a number of general provisions relating to S 

corporations. The Committee adopted these provisions that modernize the S corporation rules and eliminate undue restrictions on 

S corporations in order to expand the application of the S corporation provisions so that more corporations and their shareholders 

will be able to enjoy the benefits of subchapter S status. 

The Committee is aware of obstacles that have prevented banks 

from electing subchapter S status.31 The bill contains provisions 

that apply specifically to banks in order to remove these obstacles 

and make S corporation status more readily available to banks. 

The bill also revises the prohibited transaction rules applicable 

to employee stock ownership plans (‘‘ESOPs’’) maintained by S corporations in order to expand the ability to use distributions made 

with respect to S corporation stock held by an ESOP to repay a 

loan used to purchase the stock, subject to the same conditions that 

apply to C corporation dividends used to repay such a loan. 

1. Members of family treated as one shareholder; increase in number of eligible shareholders to 100

PRESENT LAW

A small business corporation may elect to be an S corporation 

with the consent of all its shareholders, and may terminate its election with the consent of shareholders holding more than 50 percent 

of the stock. A ‘‘small business corporation’’ is defined as a domestic 

corporation which is not an ineligible corporation and which has (1) 

no more than 75 shareholders, all of whom are individuals (and 

certain trusts, estates, charities, and qualified retirement plans)32

who are citizens or residents of the United States, and (2) only one 

class of stock. For purposes of the 75-shareholder limitation, a husband and wife are treated as one shareholder. An ‘‘ineligible corporation’’ means a corporation that is a financial institution using 

the reserve method of accounting for bad debts, an insurance company, a corporation electing the benefits of the Puerto Rico and 

possessions tax credit, or a Domestic International Sales Corporation (‘‘DISC’’) or former DISC. 

129

EXPLANATION OF PROVISION

The bill provides that all family members can elect to be treated 

as one shareholder for purposes of determining the number of 

shareholders in the corporation. A family is defined as the lineal 

descendants (and their spouses) of a common ancestor. The common ancestor cannot be more than three generations removed from 

the youngest generation of shareholder at the time the S election 

is made (or the effective date of this provision, if later). Except as 

provided by Treasury regulations, the election may be made by any 

family member and the election remains in effect until terminated. 

The bill increases the maximum number of eligible shareholders 

from 75 to 100. 

EFFECTIVE DATE

The provision applies to taxable years beginning after December 

31, 2004. 

2. Expansion of bank S corporation eligible shareholders to include 

IRAs 

PRESENT LAW

An individual retirement account (‘‘IRA’’) is a trust or account established for the exclusive benefit of an individual and his or her 

beneficiaries. There are two general types of IRAs: traditional 

IRAs, to which both deductible and nondeductible contributions 

may be made, and Roth IRAs, contributions to which are not deductible. Amounts held in a traditional IRA are includible in income when withdrawn (except to the extent the withdrawal is a return of nondeductible contributions). Amounts held in a Roth IRA 

that are withdrawn as a qualified distribution are not includible in 

income; distributions from a Roth IRA that are not qualified distributions are includible in income to the extent attributable to 

earnings. A qualified distribution is a distribution that (1) is made 

after the five-taxable year period beginning with the first taxable 

year for which the individual made a contribution to a Roth IRA, 

and (2) is made after attainment of age 591⁄2, on account of death 

or disability, or is made for first-time homebuyer expenses of up to 

$10,000.

Under present law, an IRA cannot be a shareholder of an S corporation. 

Certain transactions are prohibited between an IRA and the individual for whose benefit the IRA is established, including a sale of 

property by the IRA to the individual. If a prohibited transaction 

occurs between an IRA and the IRA beneficiary, the account ceases 

to be an IRA, and an amount equal to the fair market value of the 

assets held in the IRA is deemed distributed to the beneficiary. 

EXPLANATION OF PROVISION

The bill allows an IRA (including a Roth IRA) to be a shareholder of a bank that is an S corporation, but only to the extent 

130

33 Under the bill, the present-law rules treating S corporation stock held by a qualified retirement plan (other than an employee stock ownership plan) or a charity as an interest in an unrelated trade or business apply to an IRA holding S corporation stock of a bank. 

of bank stock held by the IRA on the date of enactment of the provision.33

The bill also provides an exemption from prohibited transaction 

treatment for the sale by an IRA to the IRA beneficiary of bank 

stock held by the IRA on the date of enactment of the provision. 

Under the bill, a sale is not a prohibited transaction if: (1) the sale 

is pursuant to an S corporation election by the bank; (2) the sale 

is for fair market value (as established by an independent appraiser) and is on terms at least as favorable to the IRA as the 

terms would be on a sale to an unrelated party; (3) the IRA incurs 

no commissions, costs, or other expenses in connection with the 

sale; and (4) the stock is sold in a single transaction for cash not 

later than 120 days after the S corporation election is made. 

EFFECTIVE DATE

The provision takes effect on the date of enactment of the bill. 

3. Disregard of unexercised powers of appointment in determining 

potential current beneficiaries of ESBT 

PRESENT LAW

An electing small business trust (‘‘ESBT’’) holding stock in an S 

corporation is taxed at the maximum individual tax rate on its ratable share of items of income, deduction, gain, or loss passing 

through from the S corporation. An ESBT generally is an electing 

trust all of whose beneficiaries are eligible S corporation shareholders. For purposes of determining the maximum number of 

shareholders, each person who is entitled to receive a distribution 

from the trust (‘‘potential current beneficiary’’) is treated as a 

shareholder during the period the person may receive a distribution from the trust. 

An ESBT has 60 days to dispose of the S corporation stock after 

an ineligible shareholder becomes a potential current beneficiary to 

avoid disqualification. 

EXPLANATION OF PROVISION

Under the bill, powers of appointment to the extent not exercised 

are disregarded in determining the potential current beneficiaries 

of an electing small business trust. 

The bill increases the period during which an ESBT can dispose 

of S corporation stock, after an ineligible shareholder becomes a potential current beneficiary, from 60 days to one year. 

EFFECTIVE DATE

The provision applies to taxable years beginning after December 

31, 2004. 

4. Transfers of suspended losses incident to divorce, etc. 

PRESENT LAW

Under present law, any loss or deduction that is not allowed to 

a shareholder of an S corporation, because the loss exceeds the 

131

shareholder’s basis in stock and debt of the corporation, is treated 

as incurred by the S corporation with respect to that shareholder 

in the subsequent taxable year. 

EXPLANATION OF PROVISION

Under the bill, if a shareholder’s stock in an S corporation is 

transferred to a spouse, or to a former spouse incident to a divorce, 

any suspended loss or deduction with respect to that stock is treated as incurred by the corporation with respect to the transferee in 

the subsequent taxable year. 

EFFECTIVE DATE

The provision applies to taxable years beginning after December 

31, 2004. 

5. Use of passive activity loss and at-risk amounts by qualified subchapter S trust income beneficiaries 

PRESENT LAW

Under present law, the share of income of an S corporation 

whose stock is held by a qualified subchapter S trust (‘‘QSST’’), 

with respect to which the beneficiary makes an election, is taxed 

to the beneficiary. However, the trust, and not the beneficiary, is 

treated as the owner of the S corporation stock for purposes of determining the tax consequences of the disposition of the S corporation stock by the trust. A QSST generally is a trust with one individual income beneficiary for the life of the beneficiary. 

EXPLANATION OF PROVISION

Under the bill, the beneficiary of a qualified subchapter S trust 

is generally allowed to deduct suspended losses under the at-risk 

rules and the passive loss rules when the trust disposes of the S 

corporation stock.

EFFECTIVE DATE

The provision applies to transfers made after December 31, 2004. 

6. Exclusion of investment securities income from passive investment income test for bank S corporations 

PRESENT LAW

An S corporation is subject to corporate-level tax, at the highest 

corporate tax rate, on its excess net passive income if the corporation has (1) accumulated earnings and profits at the close of the 

taxable year and (2) gross receipts more than 25 percent of which 

are passive investment income. 

Excess net passive income is the net passive income for a taxable 

year multiplied by a fraction, the numerator of which is the 

amount of passive investment income in excess of 25 percent of 

gross receipts and the denominator of which is the passive investment income for the year. Net passive income is defined as passive 

investment income reduced by the allowable deductions that are directly connected with the production of that income. Passive investment income generally means gross receipts derived from royalties, 

rents, dividends, interest, annuities, and sales or exchanges of 

132

34 Notice 97–5, 1997–1 C.B. 352, sets forth guidance relating to passive investment income on 

banking assets. 35 Another provision of the bill increases the maximum number of shareholders to 100. 36Sec. 1361(c)(4). Treasury regulations provide that buy-sell and redemption agreements are 

disregarded in determining whether a corporation’s outstanding shares confer identical distribution and liquidation rights unless (1) a principal purpose of the agreement is to circumvent the 

one class of stock requirement and (2) the agreement establishes a purchase price that, at the 

time the agreement is entered into, is significantly in excess of, or below, the fair market value 

of the stock. Treas. Reg. sec. 1.1361–1(l). 37 12 U.S.C. secs. 71–72. 38See Private Letter Ruling 200217048 (January 24, 2002) describing such an agreement and 

holding that it creates a second class of stock. Nonetheless, the ruling concluded that the election to be an S corporation was inadvertently invalid and that an amended agreement did not 

create a second class of stock so that the corporation’s election was validated. 

stock or securities (to the extent of gains). Passive investment income generally does not include interest on accounts receivable, 

gross receipts that are derived directly from the active and regular 

conduct of a lending or finance business, gross receipts from certain 

liquidations, or gain or loss from any section 1256 contract (or related property) of an options or commodities dealer.34

In addition, an S corporation election is terminated whenever the 

S corporation has accumulated earnings and profits at the close of 

each of three consecutive taxable years and has gross receipts for 

each of those years more than 25 percent of which are passive investment income. 

EXPLANATION OF PROVISION

The bill provides that, in the case of a bank (as defined in section 

581), a bank holding company (as defined in section 2(a) of the 

Bank Holding Company Act of 1956), or a financial holding company (as defined in section 2(p) of that Act), interest income and 

dividends on assets required to be held by the bank or holding company are not treated as passive investment income for purposes of 

the S corporation passive investment income rules. 

EFFECTIVE DATE

The provision applies to taxable years beginning after December 

31, 2004. 

7. Treatment of bank director shares 

PRESENT LAW

An S corporation may have no more than 75 shareholders and 

may have only one outstanding class of stock.35

An S corporation has one class of stock if all outstanding shares 

of stock confer identical rights to distribution and liquidation proceeds. Differences in voting rights are disregarded.36

National banking law requires that a director of a national bank 

own stock in the bank and that a bank have at least five directors.37 A number of States have similar requirements for Statechartered banks. Apparently, it is common practice for a bank director to enter into an agreement under which the bank (or a holding company) will reacquire the stock upon the director’s ceasing 

to hold the office of director, at the price paid by the director for 

the stock.38

133

39 No inference is intended as to the proper tax treatment under present law. 

EXPLANATION OF PROVISION

Under the bill, restricted bank director stock is not taken into account as outstanding stock in applying the provisions of subchapter 

S.39 Thus, the stock is not treated as a second class of stock; a director is not treated as a shareholder of the S corporation by reason of the stock; the stock is disregarded in allocating items of income, loss, etc. among the shareholders; and the stock is not treated as outstanding for purposes of determining whether an S corporation holds 100 percent of the stock of a qualified subchapter S 

subsidiary. 

Restricted bank director stock is stock in a bank (as defined in 

section 581), a bank holding company (within the meaning of section 2(a) of the Bank Holding Company Act of 1956), or a financial 

holding company (as defined in section 2(p) of that Act), registered 

with the Federal Reserve System, if the stock is required to be held 

by an individual under applicable Federal or State law in order to 

permit the individual to serve as a director of the bank or holding 

company and which is subject to an agreement with the bank or 

holding company (or corporation in control of the bank or company) 

pursuant to which the holder is required to sell the stock back 

upon ceasing to be a director at the same price the individual acquired the stock. 

A distribution (other than a payment in exchange for the stock) 

with respect to the restricted stock is includible in the gross income 

of the director and is deductible by the S corporation for the taxable year that includes the last day of the director’s taxable year 

in which the distribution is included in income. 

EFFECTIVE DATE

The provision applies to taxable years beginning after December 

31, 2004. 

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

PRESENT LAW

Under present law, inadvertent invalid subchapter S elections 

and terminations may be waived. 

EXPLANATION OF PROVISION

The bill allows inadvertent invalid qualified subchapter S subsidiary elections and terminations to be waived by the IRS. 

EFFECTIVE DATE

The provision applies to taxable years beginning after December 

31, 2004. 

9. Information returns for qualified subchapter S subsidiaries 

PRESENT LAW

Under present law, a corporation all of whose stock is held by an 

S corporation is treated as a qualified subchapter S subsidiary if 

134

40Sec. 4975. 41Sec. 4975(d)(3). An ESOP that borrows money to purchase employer stock is referred to as a ‘‘leveraged’’ ESOP. 

the S corporation so elects. The assets, liabilities, and items of income, deduction, and credit of the subsidiary are treated as assets, 

liabilities, and items of the parent S corporation. 

EXPLANATION OF PROVISION

The bill provides authority to the Secretary to provide guidance 

regarding information returns of qualified subchapter S subsidiaries. 

EFFECTIVE DATE

The provision applies to taxable years beginning after December 

31, 2004. 

10. Repayment of loans for qualifying employer securities 

PRESENT LAW

An employee stock ownership plan (an ‘‘ESOP’’) is a defined contribution plan that is designated as an ESOP and is designed to 

invest primarily in qualifying employer securities. For purposes of 

ESOP investments, a ‘‘qualifying employer security’’ is defined as: 

(1) publicly traded common stock of the employer or a member of 

the same controlled group; (2) if there is no such publicly traded 

common stock, common stock of the employer (or member of the 

same controlled group) that has both voting power and dividend 

rights at least as great as any other class of common stock; or (3) 

noncallable preferred stock that is convertible into common stock 

described in (1) or (2) and that meets certain requirements. In 

some cases, an employer may design a class of preferred stock that 

meets these requirements and that is held only by the ESOP. Special rules apply to ESOPs that do not apply to other types of qualified retirement plans, including a special exemption from the prohibited transaction rules. 

Certain transactions between an employee benefit plan and a disqualified person, including the employer maintaining the plan, are 

prohibited transactions that result in the imposition of an excise 

tax.40 Prohibited transactions include, among other transactions, 

(1) the sale, exchange or leasing of property between a plan and a 

disqualified person, (2) the lending of money or other extension of 

credit between a plan and a disqualified person, and (3) the transfer to, or use by or for the benefit of, a disqualified person of the 

income or assets of the plan. However, certain transactions are exempt from prohibited transaction treatment, including certain 

loans to enable an ESOP to purchase qualifying employer securities.41 In such a case, the employer securities purchased with the 

loan proceeds are generally pledged as security for the loan. Contributions to the ESOP and dividends paid on employer securities 

held by the ESOP are used to repay the loan. The employer securities are held in a suspense account and released for allocation to 

participants’ accounts as the loan is repaid. 

A loan to an ESOP is exempt from prohibited transaction treatment if the loan is primarily for the benefit of the participants and 

their beneficiaries, the loan is at a reasonable rate of interest, and 

135

42Treas. Reg. sec. 54.4975–7(b)(5). 43Sec. 404(k)(5)(B). 44Sec. 404(k)(2)(B). 

the collateral given to a disqualified person consists of only qualifying employer securities. No person entitled to payments under 

the loan can have the right to any assets of the ESOP other than 

(1) collateral given for the loan, (2) contributions made to the ESOP 

to meet its obligations on the loan, and (3) earnings attributable to 

the collateral and the investment of contributions described in 

(2).42 In addition, the payments made on the loan by the ESOP 

during a plan year cannot exceed the sum of those contributions 

and earnings during the current and prior years, less loan payments made in prior years. 

An ESOP of a C corporation is not treated as violating the qualification requirements of the Code or as engaging in a prohibited 

transaction merely because, in accordance with plan provisions, a 

dividend paid with respect to qualifying employer securities held by 

the ESOP is used to make payments on a loan (including payments 

of interest as well as principal) that was used to acquire the employer securities (whether or not allocated to participants).43 In the 

case of a dividend paid with respect to any employer security that 

is allocated to a participant, this relief does not apply unless the 

plan provides that employer securities with a fair market value of 

not less than the amount of the dividend is allocated to the participant for the year which the dividend would have been allocated to 

the participant.44

EXPLANATION OF PROVISION

Under the provision, an ESOP maintained by an S corporation 

is not treated as violating the qualification requirements of the 

Code or as engaging in a prohibited transaction merely because, in 

accordance with plan provisions, a distribution made with respect 

to S corporation stock that constitutes qualifying employer securities held by the ESOP is used to repay a loan that was used to acquire the securities (whether or not allocated to participants). This 

relief does not apply in the case of a distribution with respect to 

S corporation stock that is allocated to a participant unless the 

plan provides that stock with a fair market value of not less than 

the amount of such distribution is allocated to the participant for 

the year which the distribution would have been allocated to the 

participant. 

EFFECTIVE DATE

The provision is effective for distributions made with respect to 

S corporation stock after December 31, 2004. 

136

D. ALTERNATIVE MINIMUM TAX RELIEF

1. Foreign tax credit under alternative minimum tax; expansion of 

exemption from alternative minimum tax for small corporations; income averaging for farmers not to increase alternative 

minimum tax (secs. 241–243 of the bill and secs. 55–59 of the 

Code) 

PRESENT LAW

In general 

Under present law, taxpayers are subject to an alternative minimum tax (‘‘AMT’’), which is payable, in addition to all other tax 

liabilities, to the extent that it exceeds the taxpayer’s regular income tax liability. The tax is imposed at a flat rate of 20 percent, 

in the case of corporate taxpayers, on alternative minimum taxable 

income (‘‘AMTI’’) in excess of a phased-out exemption amount. 

AMTI is the taxpayer’s taxable income increased for certain tax 

preferences and adjusted by determining the tax treatment of certain items in a manner that limits the tax benefits resulting from 

the regular tax treatment of such items. 

Foreign tax credit 

Taxpayers are permitted to reduce their AMT liability by an 

AMT foreign tax credit. The AMT foreign tax credit for a taxable 

year is determined under principles similar to those used in computing the regular tax foreign tax credit, except that (1) the numerator of the AMT foreign tax credit limitation fraction is foreign 

source AMTI and (2) the denominator of that fraction is total 

AMTI. Taxpayers may elect to use as their AMT foreign tax credit 

limitation fraction the ratio of foreign source regular taxable income to total AMTI. 

The AMT foreign tax credit for any taxable year generally may 

not offset a taxpayer’s entire pre-credit AMT. Rather, the AMT foreign tax credit is limited to 90 percent of AMT computed without 

any AMT net operating loss deduction and the AMT foreign tax 

credit. For example, assume that a corporation has $10 million of 

AMTI, has no AMT net operating loss deduction, and has no regular tax liability. In the absence of the AMT foreign tax credit, the 

corporation’s tax liability would be $2 million. Accordingly, the 

AMT foreign tax credit cannot be applied to reduce the taxpayer’s 

tax liability below $200,000. Any unused AMT foreign tax credit 

may be carried back two years and carried forward five years for 

use against AMT in those years under the principles of the foreign 

tax credit carryback and carryover rules set forth in section 904(c). 

Small corporation exemption 

Corporations with average gross receipts of less than $7.5 million 

for the prior three taxable years are exempt from the corporate 

AMT. The $7.5 million threshold is reduced to $5 million for the 

corporation’s first 3-taxable year period. 

Farmer income averaging 

An individual taxpayer engaged in a farming business (as defined by section 263A(e)(4)) may elect to compute his or her current 

year regular tax liability by averaging, over the prior three-year peVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00138 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.003 HR548P1
137

riod, all or portion of his or her taxable income from the trade or 

business of farming. Because farmer income averaging reduces the 

regular tax liability, the AMT may be increased. Thus, the benefits 

of farmer income averaging may be reduced or eliminated for farmers subject to the AMT. 

REASONS FOR CHANGE

The Committee believes that the AMT is merely a prepayment 

of tax. The corporate AMT requires businesses to prepay their 

taxes when they can least afford it, during a business downturn. 

The Committee believes that increasing the gross receipts cap for 

companies exempt from corporate AMT from $7.5 million of gross 

receipts to $20 million of gross receipts will relieve many taxpayers 

of the financial burden of having to prepay their tax when they can 

least afford it. The provision also will relieve many taxpayers of the 

administrative cost and compliance burden of having to calculate 

their taxes under two separate income tax systems. The Committee 

also believes that taxpayers should be permitted full use of foreign 

tax credits in computing the AMT. The Committee believes that 

farmers should be allowed the full benefits of income averaging 

without incurring liability under the AMT. 

EXPLANATION OF PROVISION

The provision repeals the 90-percent limitation on the utilization 

of the AMT foreign tax credit. 

The provision increases the amount of average gross receipts that 

an exempt corporation may receive from $7.5 million to $20 million. 

The provision provides that, in computing AMT, a farmer’s regular tax liability is determined without regard to farmer income 

averaging. Thus, a farmer receives the full benefit of income averaging because averaging reduces the regular tax while the AMT (if 

any) remains unchanged. 

EFFECTIVE DATE

The provision relating to the foreign tax credit applies to taxable 

years beginning after December 31, 2004. 

The provision relating to the small corporation exemption applies 

to taxable years beginning after December 31, 2005. 

The provision relating to farmers’ income averaging applies to 

taxable years beginning after December 31, 2003.

E. RESTRUCTURING OF INCENTIVES FOR ALCOHOL FUELS, ETC. 

1. Reduced rates of tax on alcohol fuel mixtures replaced with an 

excise tax credit, etc. (secs. 251 and 252 of the bill and secs. 

4041, 4081, 4091, 6427 and 9503 of the Code) 

PRESENT LAW

Alcohol fuels income tax credit 

The alcohol fuels credit is the sum of three credits: the alcohol 

mixture credit, the alcohol credit, and the small ethanol producer 

138

45The alcohol fuels credit is unavailable when, for any period before January 1, 2008, the tax 

rates for gasoline and diesel fuels drop to 4.3 cents per gallon. 46 A special fuel includes any liquid (other than gasoline) that is suitable for use in an internal 

combustion engine. 47 In the case of any alcohol (other than ethanol) with a proof that is at least 150 but less 

than 190, the credit is 45 cents per gallon (the ‘‘low-proof blender amount’’). For ethanol with 

a proof that is at least 150 but less than 190, the low-proof blender amount is 38.52 cents for 

sales or uses during calendar year 2004, and 37.78 cents for calendar years 2005, 2006, and 

2007. 48These fuels are also subject to an additional 0.1 cent-per-gallon excise tax to fund the Leaking Underground Storage Tank Trust Fund. See secs. 4041(d) and 4081(a)(2)(B). In addition, the 

basic fuel tax rate will drop to 4.3 cents per gallon beginning on October 1, 2005.

credit. Generally, the alcohol fuels credit expires after December 

31, 2007.45

A taxpayer (generally a petroleum refiner, distributor, or marketer) who mixes ethanol with gasoline (or a special fuel 46 ) is an 

‘‘ethanol blender.’’ Ethanol blenders are eligible for an income tax 

credit of 52 cents per gallon of ethanol used in the production of 

a qualified mixture (the ‘‘alcohol mixture credit’’). A qualified mixture means a mixture of alcohol and gasoline, (or of alcohol and a 

special fuel) sold by the blender as fuel, or used as fuel by the 

blender in producing the mixture. The term alcohol includes methanol and ethanol but does not include (1) alcohol produced from petroleum, natural gas, or coal (including peat), or (2) alcohol with a 

proof of less than 150. Businesses also may reduce their income 

taxes by 52 cents for each gallon of ethanol (not mixed with gasoline or other special fuel) that they sell at the retail level as vehicle 

fuel or use themselves as a fuel in their trade or business (‘‘the alcohol credit’’). The 52-cents-per-gallon income tax credit rate is 

scheduled to decline to 51 cents per gallon during the period 2005 

through 2007. For blenders using an alcohol other than ethanol, 

the rate is 60 cents per gallon.47

A separate income tax credit is available for small ethanol producers (the ‘‘small ethanol producer credit’’). A small ethanol producer is defined as a person whose ethanol production capacity 

does not exceed 30 million gallons per year. The small ethanol producer credit is 10 cents per gallon of ethanol produced during the 

taxable year for up to a maximum of 15 million gallons. 

The credits that comprise the alcohol fuels tax credit are includible in income. The credit may not be used to offset alternative 

minimum tax liability. The credit is treated as a general business 

credit, subject to the ordering rules and carryforward/carryback 

rules that apply to business credits generally. 

Excise tax reductions for alcohol mixture fuels 

Generally, motor fuels tax rates are as follows: 48

Gasoline ....................................................... 18.3 cents per gallon. 

Diesel fuel and kerosene ............................ 24.3 cents per gallon. 

Special motor fuels ...................................... 18.3 cents per gallon generally. 

Alcohol-blended fuels are subject to a reduced rate of tax. The 

benefits provided by the alcohol fuels income tax credit and the excise tax reduction are integrated such that the alcohol fuels credit 

is reduced to take into account the benefit of any excise tax reduction. 

139

49These rates include the additional 0.1 cent-per-gallon excise tax to fund the Leaking Underground Storage Tank Trust Fund. These special rates will terminate after September 30, 2007 

(sec. 4081(c)(8)). 50Treas. Reg. sec. 48.4081–6(c). A certificate from the buyer assures that the gasoline will be 

used to produce gasohol within 24 hours after purchase. A copy of the registrant’s letter of registration cannot be used as a gasohol blender’s certificate. 51These reduced rates terminate after September 30, 2007. Included in these rates is the 0.05-

cent-per-gallon Leaking Underground Storage Tank Trust Fund tax imposed on such fuel. (sec. 

4041(b)(2)). 52These rates include the additional 0.1 cent-per-gallon excise tax to fund the Leaking Underground Storage Tank Trust Fund (sec. 4041(d)(1)). 

Gasohol 

Registered ethanol blenders may forgo the full income tax credit 

and instead pay reduced rates of excise tax on gasoline that they 

purchase for blending with ethanol. Most of the benefit of the alcohol fuels credit is claimed through the excise tax system. 

The reduced excise tax rates apply to gasohol upon its removal 

or entry. Gasohol is defined as a gasoline/ethanol blend that contains 5.7 percent ethanol, 7.7 percent ethanol, or 10 percent ethanol. For the calendar year 2004, the following reduced rates apply 

to gasohol: 49

5.7 percent ethanol ..................................... 15.436 cents per gallon. 

7.7 percent ethanol ..................................... 14.396 cents per gallon. 

10.0 percent ethanol ................................... 13.200 cents per gallon. 

Reduced excise tax rates also apply when gasoline is purchased 

for the production of ‘‘gasohol.’’ When gasoline is purchased for 

blending into gasohol, the rates above are multiplied by a fraction 

(e.g., 10/9 for 10-percent gasohol) so that the increased volume of 

motor fuel will be subject to tax. The reduced tax rates apply if the 

person liable for the tax is registered with the IRS and (1) produces 

gasohol with gasoline within 24 hours of removing or entering the 

gasoline or (2) gasoline is sold upon its removal or entry and such 

person has an unexpired certificate from the buyer and has no reason to believe the certificate is false.50

Qualified methanol and ethanol fuels 

Qualified methanol or ethanol fuel is any liquid that contains at 

least 85 percent methanol or ethanol or other alcohol produced 

from a substance other than petroleum or natural gas. These fuels 

are taxed at reduced rates.51 The rate of tax on qualified methanol 

is 12.35 cents per gallon. The rate on qualified ethanol in 2004 is 

13.15 cents. From January 1, 2005 through September 30, 2007, 

the rate of tax on qualified ethanol is 13.25 cents. 

Alcohol produced from natural gas 

A mixture of methanol, ethanol, or other alcohol produced from 

natural gas that consists of at least 85 percent alcohol is also taxed 

at reduced rates.52 For mixtures not containing ethanol, the applicable rate of tax is 9.25 cents per gallon before October 1, 2005. In 

all other cases, the rate is 11.4 cents per gallon. After September 

30, 2005, the rate is reduced to 2.15 cents per gallon when the mixture does not contain ethanol and 4.3 cents per gallon in all other 

cases. 

Blends of alcohol and diesel fuel or special motor fuels 

A reduced rate of tax applies to diesel fuel or kerosene that is 

combined with alcohol as long as at least 10 percent of the finished 

140

53These rates include the additional 0.1 cent-per-gallon excise tax to fund the Leaking Underground Storage Tank Trust Fund. 54This rate includes the additional 0.1 cent-per-gallon tax for the Leaking Underground Storage Tank Trust fund. 55Secs. 4041(k)(1) and 4091(c). 56Sec. 4091(c)(1). 

mixture is alcohol. If none of the alcohol in the mixture is ethanol, 

the rate of tax is 18.4 cents per gallon. For alcohol mixtures containing ethanol, the rate of tax in 2004 is 19.2 cents per gallon and 

19.3 cents per gallon for 2005 through September 30, 2007. Fuel 

removed or entered for use in producing a 10 percent diesel-alcohol 

fuel mixture (without ethanol), is subject to a tax of 20.44 cents per 

gallon. The rate of tax for fuel removed or entered for use to 

produce a 10 percent diesel-ethanol fuel mixture is 21.333 cents per 

gallon for 2004 and 21.444 cents per gallon for the period January 

1, 2005 through September 30, 2007.53

Special motor fuel (nongasoline) mixtures with alcohol also are 

taxed at reduced rates. 

Aviation fuel 

Noncommercial aviation fuel is subject to a tax of 21.9 cents per 

gallon.54 Fuel mixtures containing at least 10 percent alcohol are 

taxed at lower rates.55 In the case of 10 percent ethanol mixtures, 

for any sale or use during 2004, the 21.9 cents is reduced by 13.2 

cents (for a tax of 8.7 cents per gallon), for 2005, 2006, and 2007 

the reduction is 13.1 cents (for a tax of 8.8 cents per gallon) and 

is reduced by 13.4 cents in the case of any sale during 2008 or 

thereafter. For mixtures not containing ethanol, the 21.9 cents is 

reduced by 14 cents for a tax of 7.9 cents. These reduced rates expire after September 30, 2007.56

When aviation fuel is purchased for blending with alcohol, the 

rates above are multiplied by a fraction (10/9) so that the increased 

volume of aviation fuel will be subject to tax. 

Refunds and payments 

If fully taxed gasoline (or other taxable fuel) is used to produce 

a qualified alcohol mixture, the Code permits the blender to file a 

claim for a quick excise tax refund. The refund is equal to the difference between the gasoline (or other taxable fuel) excise tax that 

was paid and the tax that would have been paid by a registered 

blender on the alcohol fuel mixture being produced. Generally, the 

IRS pays these quick refunds within 20 days. Interest accrues if 

the refund is paid more than 20 days after filing. A claim may be 

filed by any person with respect to gasoline, diesel fuel, or kerosene 

used to produce a qualified alcohol fuel mixture for any period for 

which $200 or more is payable and which is not less than one 

week. 

Ethyl tertiary butyl ether (ETBE) 

Ethyl tertiary butyl ether (‘‘ETBE’’) is an ether that is manufactured using ethanol. Unlike ethanol, ETBE can be blended with 

gasoline before the gasoline enters a pipeline because ETBE does 

not result in contamination of fuel with water while in transport. 

Treasury regulations provide that gasohol blenders may claim the 

income tax credit and excise tax rate reductions for ethanol used 

in the production of ETBE. The regulations also provide a special 

141

57Sec. 9503(b)(4)(E). 58Sec. 9503(b)(4)(F). 59Sec. 9503(c)(4) and 9503(c)(5). 60The Sport Fish Restoration Account also is funded with receipts from an ad valorem manufacturer’s excise tax on sport fishing equipment. 

election allowing refiners to claim the benefit of the excise tax rate 

reduction even though the fuel being removed from terminals does 

not contain the requisite percentages of ethanol for claiming the excise tax rate reduction.

Highway Trust Fund 

With certain exceptions, the taxes imposed by section 4041 (relating to retail taxes on diesel fuels and special motor fuels) and section 4081 (relating to tax on gasoline, diesel fuel and kerosene) are 

credited to the Highway Trust Fund. In the case of alcohol fuels, 

2.5 cents per gallon of the tax imposed is retained in the General 

Fund.57 In the case of a taxable fuel taxed at a reduced rate upon 

removal or entry prior to mixing with alcohol, 2.8 cents of the reduced rate is retained in the General Fund.58

Taxes from gasoline and special motor fuels used in motorboats and 

gasoline used in the nonbusiness use of small-engine outdoor 

power equipment 

The Aquatic Resources Trust Fund is funded by a portion of the 

receipts from the excise tax imposed on motorboat gasoline and 

special motor fuels, as well as small-engine fuel taxes, that are first 

deposited into the Highway Trust Fund. As a result, transfers to 

the Aquatic Resources Trust Fund are governed in part by Highway Trust Fund provisions.59

A total tax rate of 18.4 cents per gallon is imposed on gasoline 

and special motor fuels used in motorboats. Of this rate, 0.1 cent 

per gallon is dedicated to the Leaking Underground Storage Tank 

Trust Fund. Of the remaining 18.3 cents per gallon, the Code currently transfers 13.5 cents per gallon from the Highway Trust 

Fund to the Aquatics Resources Trust Fund and Land and Water 

Conservation Fund. The remainder, 4.8 cents per gallon, is retained in the General Fund. In addition, the Sport Fish Restoration 

Account of the Aquatics Resources Trust Fund receives 13.5 cents 

per gallon of the revenues from the tax imposed on gasoline used 

as a fuel in the nonbusiness use of small-engine outdoor power 

equipment. The balance of 4.8 cents per gallon is retained in the 

General Fund.60

REASONS FOR CHANGE

Highway vehicles using alcohol-blended fuels contribute to the 

wear and tear of the same highway system used by gasoline or diesel vehicles. Therefore, the Committee believes that alcohol-blended 

fuels should be taxed at rates equal to gasoline or diesel. The Committee believes that present law provides opportunities for fraud 

because individuals can buy gasoline at reduced tax rates for 

blending with alcohol, but never actually use the gasoline to make 

an alcohol fuel blend. The Committee believes that eliminating the 

reduced tax rate on gasoline prior to blending with alcohol will reduce such opportunities for fraud. The Committee also believes 

that providing a tax credit based on the gallons of alcohol used to 

142

make an alcohol fuel and eliminating the various blend tiers associated with reduced tax rates for alcohol-blended fuels will simplify 

present law. 

EXPLANATION OF PROVISION

Overview 

The provision eliminates reduced rates of excise tax for alcoholblended fuels and imposes the full rate of excise tax on alcoholblended fuels (18.4 cents per gallon on gasoline blends and 24.4 

cents per gallon of diesel blended fuel). In place of reduced rates, 

the provision permits the section 40 alcohol mixture credit, with 

certain modifications, to be applied against excise tax liability. The 

credit may be taken against the tax imposed on taxable fuels (by 

section 4081). To the extent a person does not have section 4081 

liability, the provision allows taxpayers to file a claim for payment 

equal to the amount of the credit for the alcohol used to produce 

an eligible mixture. Under certain circumstances, a tax is imposed 

if an alcohol fuel mixture credit is claimed with respect to alcohol 

used in the production of any alcohol mixture, which is subsequently used for a purpose for which the credit is not allowed or 

changed into a substance that does not qualify for the credit. The 

provision eliminates the General Fund retention of certain taxes on 

alcohol fuels, and credits these taxes to the Highway Trust Fund. 

Alcohol fuel mixture excise tax credit and payment provisions 

ALCOHOL FUEL MIXTURE EXCISE TAX CREDIT

The provision eliminates the reduced rates of excise tax for alcohol-blended fuels and taxable fuels used to produce an alcohol fuel 

mixture. Under the provision, the full rate of tax for taxable fuels 

is imposed on both alcohol fuel mixtures and the taxable fuel used 

to produce an alcohol fuel mixture. 

In lieu of the reduced excise tax rates, the provision provides 

that the alcohol mixture credit provided under section 40 may be 

applied against section 4081 excise tax liability (hereinafter referred to as ‘‘the alcohol fuel mixture credit’’). The credit is treated 

as a payment of the taxpayer’s tax liability received at the time of 

the taxable event. The alcohol fuel mixture credit is 52 cents for 

each gallon of alcohol used by a person in producing an alcohol fuel 

mixture for sale or use in a trade or business of the taxpayer. The 

credit declines to 51 cents per gallon after calendar year 2004. For 

mixtures not containing ethanol (renewable source methanol), the 

credit is 60 cents per gallon. As discussed further below, the excise 

tax credit is refundable in order to provide a benefit equivalent to 

the reduced tax rates, which are being repealed under the provision. 

For purposes of the alcohol fuel mixture credit, an ‘‘alcohol fuel 

mixture’’ is a mixture of alcohol and gasoline or alcohol and a special fuel which is sold for use or used as a fuel by the taxpayer producing the mixture. Alcohol for this purpose includes methanol, 

ethanol, and alcohol gallon equivalents of ETBE or other ethers 

produced from such alcohol. It does not include alcohol produced 

from petroleum, natural gas, or coal (including peat), or alcohol 

with a proof of less than 190 (determined without regard to any 

added denaturants). Special fuel is any liquid fuel (other than gasoVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00144 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.003 HR548P1
143

line) which is suitable for use in an internal combustion engine. 

The benefit obtained from the excise tax credit is coordinated with 

the alcohol fuels income tax credit. For refiners making an alcohol 

fuel mixture with ETBE, the mixture is treated as sold to another 

person for use as a fuel only upon removal from the refinery. The 

excise tax credit is available through December 31, 2010. 

Payments with respect to qualified alcohol fuel mixtures 

To the extent the alcohol fuel mixture credit exceeds any section 

4081 liability of a person, the Secretary is to pay such person an 

amount equal to the alcohol fuel mixture credit with respect to 

such mixture. These payments are intended to provide an equivalent benefit to replace the partial exemption for fuels to be blended 

with alcohol and alcohol fuels being repealed by the provision. If 

claims for payment are not paid within 45 days, the claim is to be 

paid with interest. The provision also provides that in the case of 

an electronic claim, if such claim is not paid within 20 days, the 

claim is to be paid with interest. If claims are filed electronically, 

the claimant may make a claim for less than $200. 

The provision does not apply with respect to alcohol fuel mixtures sold after December 31, 2010. 

Alcohol fuel subsidies borne by General Fund 

The provision eliminates the requirement that 2.5 and 2.8 cents 

per gallon of excise taxes be retained in the General Fund with the 

result that the full amount of tax on alcohol fuels is credited to the 

Highway Trust Fund. The provision also authorizes the full 

amount of fuel taxes to be appropriated to the Highway Trust Fund 

without reduction for amounts equivalent to the excise tax credits 

allowed for alcohol fuel mixtures, and the Trust Fund is not required to reimburse any payments with respect to qualified alcohol 

fuel mixtures. 

Motorboat and small engine fuel taxes 

The provision eliminates the General Fund retention of the 4.8 

cents per gallon of the taxes imposed on gasoline and special motor 

fuels used in motorboats and gasoline used as a fuel in the nonbusiness use of small-engine outdoor power equipment. 

EFFECTIVE DATES

The provisions generally are effective for fuel sold or used after 

September 30, 2004. The repeal of the General Fund retention of 

the 2.5/2.8 cents per gallon of tax regarding alcohol fuels and the 

repeal of the 4.8 cents per gallon General Fund retention of the 

taxes imposed on fuels used in motorboats and small engine equipment is effective for taxes imposed after September 30, 2003. The 

provision regarding the crediting of the full amount of tax to the 

Highway Trust Fund without regard to credits and payments is effective for taxes received after September 30, 2004, and payments 

made after September 30, 2004. 

144

61Sec. 421. For purposes of the individual alternative minimum tax, the transfer of stock pursuant to an incentive stock option is generally treated as the transfer of stock pursuant to a 

nonstatutory option. Sec. 56(b)(3). 62Secs. 3101, 3111 and 3301. 63Secs. 3121 and 3306. 64 Notice 2002–47, 2002–28 I.R.B. 97. 

F. STOCK OPTIONS AND EMPLOYEE STOCK PURCHASE PLAN STOCK

OPTIONS

1. Exclusion of incentive stock options and employee stock purchase 

plan stock options from wages (sec. 261 of the bill and secs. 

421(b), 423(c), 3121(a), 3231, and 3306(b) of the Code) 

PRESENT LAW

Generally, when an employee exercises a compensatory option on 

employer stock, the difference between the option price and the fair 

market value of the stock (i.e., the ‘‘spread’’) is includible in income 

as compensation. In the case of an incentive stock option or an option to purchase stock under an employee stock purchase plan (collectively referred to as ‘‘statutory stock options’’), the spread is not 

included in income at the time of exercise.61

If the statutory holding period requirements are satisfied with 

respect to stock acquired through the exercise of a statutory stock 

option, the spread, and any additional appreciation, will be taxed 

as capital gain upon disposition of such stock. Compensation income is recognized, however, if there is a disqualifying disposition 

(i.e., if the statutory holding period is not satisfied) of stock acquired pursuant to the exercise of a statutory stock option. 

Federal Insurance Contribution Act (‘‘FICA’’) and Federal Unemployment Tax Act (‘‘FUTA’’) taxes (collectively referred to as ‘‘employment taxes’’) are generally imposed in an amount equal to a 

percentage of wages paid by the employer with respect to employment.62 The applicable Code provisions 63 do not provide an exception from FICA and FUTA taxes for wages paid to an employee 

arising from the exercise of a statutory stock option. 

There has been uncertainty in the past as to employer withholding obligations upon the exercise of statutory stock options. On 

June 25, 2002, the IRS announced that until further guidance is 

issued, it would not assess FICA or FUTA taxes, or impose Federal 

income tax withholding obligations, upon either the exercise of a 

statutory stock option or the disposition of stock acquired pursuant 

to the exercise of a statutory stock option.64

REASONS FOR CHANGE

To provide taxpayers certainty, the Committee believes that it is 

appropriate to clarify the treatment of statutory stock options for 

employment tax and income tax withholding purposes. The Committee believes that in the past, the IRS has been inconsistent in 

its treatment of taxpayers with respect to this issue and did not 

uniformly challenge taxpayers who did not collect employment 

taxes and withhold income taxes on statutory stock options. 

Until January 2001, the IRS had not published guidance with respect to the imposition of employment taxes and income tax withholding on statutory stock options. Many taxpayers relied on guidance published with respect to qualified stock options (the predecessor to incentive stock options) to take the position that no emVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00146 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.003 HR548P1
145

65The provision also provides a similar exclusion under the Railroad Retirement Tax Act. 

ployment taxes or income tax withholding were required with respect to statutory stock options. It is the Committee’s belief that a 

majority of taxpayers did not withhold employment and income 

taxes with respect to statutory stock options. Thus, proposed IRS 

regulations, if implemented, would have altered the treatment of 

statutory stock options for most employers. 

Because there is a specific income tax exclusion with respect to 

statutory stock options, the Committee believes it is appropriate to 

clarify that there is a conforming exclusion for employment taxes 

and income tax withholding. Statutory stock options are required 

to meet certain Code requirements that do not apply to nonqualified stock options. The Committee believes that such requirements are intended to make statutory stock options a tool of employee ownership rather than a form of compensation subject to 

employment taxes. Furthermore, this clarification will ensure that, 

if further IRS guidance is issued, employees will not be faced with 

a tax increase that will reduce their net paychecks even though 

their total compensation has not changed. 

The clarification will also eliminate the administrative burden 

and cost to employers who, in the absence of the Committee bill, 

could be required to modify their payroll systems to provide for the 

withholding of income and employment taxes on statutory stock options that they are not currently required to withhold. 

EXPLANATION OF PROVISION

The provision provides specific exclusions from FICA and FUTA 

wages for remuneration on account of the transfer of stock pursuant to the exercise of an incentive stock option or under an employee stock purchase plan, or any disposition of such stock. Thus, 

under the provision, FICA and FUTA taxes do not apply upon the 

exercise of a statutory stock option.65 The provision also provides 

that such remuneration is not taken into account for purposes of 

determining Social Security benefits. 

Additionally, the provision provides that Federal income tax 

withholding is not required on a disqualifying disposition, nor 

when compensation is recognized in connection with an employee 

stock purchase plan discount. Present law reporting requirements 

continue to apply. 

EFFECTIVE DATE

The provision is effective for stock acquired pursuant to options 

exercised after the date of enactment. 

G. INCENTIVES TO REINVEST FOREIGN EARNINGS IN THE UNITED

STATES

(Sec. 271 of the bill and new sec. 965 of the Code) 

PRESENT LAW

The United States employs a ‘‘worldwide’’ tax system, under 

which domestic corporations generally are taxed on all income, 

whether derived in the United States or abroad. Income earned by 

a domestic parent corporation from foreign operations conducted by 

146

66Secs. 951–964. 67Secs. 1291–1298. 68Secs. 901, 902, 960, 1291(g). 

foreign corporate subsidiaries generally is subject to U.S. tax when 

the income is distributed as a dividend to the domestic corporation. 

Until such repatriation, the U.S. tax on such income generally is 

deferred, and U.S. tax is imposed on such income when repatriated. 

However, under anti-deferral rules, the domestic parent corporation may be taxed on a current basis in the United States with respect to certain categories of passive or highly mobile income 

earned by its foreign subsidiaries, regardless of whether the income 

has been distributed as a dividend to the domestic parent corporation. The main anti-deferral provisions in this context are the controlled foreign corporation rules of subpart F 66 and the passive foreign investment company rules.67 A foreign tax credit generally is 

available to offset, in whole or in part, the U.S. tax owed on foreign-source income, whether earned directly by the domestic corporation, repatriated as a dividend from a foreign subsidiary, or included in income under the anti-deferral rules.68

REASONS FOR CHANGE

The Committee observes that the residual U.S. tax imposed on 

the repatriation of foreign earnings can serve as a disincentive to 

repatriate these earnings. The Committee believes that a temporary reduction in the U.S. tax on repatriated dividends will stimulate the U.S. domestic economy by triggering the repatriation of 

foreign earnings that otherwise would have remained abroad. The 

Committee emphasizes that this is a temporary economic stimulus 

measure. 

EXPLANATION OF PROVISION

Under the provision, certain dividends received by a U.S. corporation from a controlled foreign corporation are eligible for an 85-

percent dividends-received deduction. At the taxpayer’s election, 

this deduction is available for dividends received either: (1) during 

the first six months of the taxpayer’s first taxable year beginning 

on or after the date of enactment of the bill; or (2) during any sixmonth or shorter period after the date of enactment of the bill, during the taxpayer’s last taxable year beginning before such date. 

Dividends received after the election period will be taxed in the 

normal manner under present law. 

The deduction applies only to dividends and other amounts included in gross income as dividends (e.g., amounts described in section 1248(a)). The deduction does not apply to items that are not 

included in gross income as dividends, such as subpart F inclusions 

or deemed repatriations under section 956. Similarly, the deduction 

does not apply to distributions of earnings previously taxed under 

subpart F, except to the extent that the subpart F inclusions result 

from the payment of a dividend by one controlled foreign corporation to another controlled foreign corporation within a certain chain 

of ownership during the election period. This exception enables 

multinational corporate groups to qualify for the deduction in connection with the repatriation of earnings from lower-tier controlled 

foreign corporations. 

147

The deduction is subject to a number of limitations. First, it applies only to repatriations in excess of the taxpayer’s average repatriation level over three of the five most recent taxable years ending on or before March 31, 2003, determined by disregarding the 

highest-repatriation year and the lowest-repatriation year among 

such five years (the ‘‘base-period average’’). In addition to actual 

dividends, deemed repatriations under section 956 and distributions of earnings previously taxed under subpart F are included in 

the base-period average. 

Second, the amount of dividends eligible for the deduction is limited to the greatest of: (1) $500 million; (2) the amount of earnings 

shown as permanently invested outside the United States on the 

taxpayer’s most recent audited financial statement which is certified on or before March 31, 2003; or (3) in the case of an applicable financial statement that fails to show a specific amount of such 

earnings, but that does show a specific amount of tax liability attributable to such earnings, the amount of such earnings determined in such manner as the Treasury Secretary may prescribe. 

Third, dividends qualifying for the deduction must be invested in 

the United States pursuant to a plan approved by the senior management and board of directors of the corporation claiming the deduction. 

No foreign tax credit (or deduction) is allowed for foreign taxes 

attributable to the deductible portion of any dividend received during the taxable year for which an election under the provision is 

in effect. For this purpose, the taxpayer may specifically identify 

which dividends are treated as carrying the deduction and which 

are not; in the absence of such identification, a pro rata amount of 

foreign tax credits will be disallowed with respect to every dividend 

received during the taxable year. 

In addition, the income attributable to the nondeductible portion 

of a qualifying dividend may not be offset by net operating losses, 

and the tax attributable to such income generally may not be offset 

by credits (other than foreign tax credits and AMT credits) and 

may not reduce the alternative minimum tax otherwise owed by 

the taxpayer. No deduction under sections 243 or 245 is allowed for 

any dividend for which a deduction is allowed under the provision. 

EFFECTIVE DATE

The provision is effective for a taxpayer’s first taxable year beginning on or after the date of enactment of the bill, or the taxpayer’s 

last taxable year beginning before such date, at the taxpayer’s election. 

H. OTHER PROVISIONS

1. Special rules for livestock sold on account of weather-related conditions (sec. 281 of the bill and secs. 1033 and 451 of the Code) 

PRESENT LAW

Generally, a taxpayer realizes gain to the extent the sales price 

(and any other consideration received) exceeds the taxpayer’s basis 

in the property. The realized gain is subject to current income tax 

unless the gain is deferred or not recognized under a special tax 

provision. 

148

Under section 1033, gain realized by a taxpayer from an involuntary conversion of property is deferred to the extent the taxpayer 

purchases property similar or related in service or use to the converted property within the applicable period. The taxpayer’s basis 

in the replacement property generally is the same as the taxpayer’s 

basis in the converted property, decreased by the amount of any 

money or loss recognized on the conversion, and increased by the 

amount of any gain recognized on the conversion. 

The applicable period for the taxpayer to replace the converted 

property begins with the date of the disposition of the converted 

property (or if earlier, the earliest date of the threat or imminence 

of requisition or condemnation of the converted property) and ends 

two years after the close of the first taxable year in which any part 

of the gain upon conversion is realized (the ‘‘replacement period’’). 

Special rules extend the replacement period for certain real property and principle residences damaged by a Presidentially declared 

disaster to three years and four years, respectively, after the close 

of the first taxable year in which gain is realized. 

Section 1033(e) provides that the sale of livestock (other than 

poultry) that is held for draft, breeding, or dairy purposes in excess 

of the number of livestock that would have been sold but for 

drought, flood, or other weather-related conditions is treated as an 

involuntary conversion. Consequently, gain from the sale of such 

livestock could be deferred by reinvesting the proceeds of the sale 

in similar property within a two-year period. 

In general, cash-method taxpayers report income in the year it 

is actually or constructively received. However, section 451(e) provides that a cash-method taxpayer whose principal trade or business is farming who is forced to sell livestock due to drought, flood, 

or other weather-related conditions may elect to include income 

from the sale of the livestock in the taxable year following the taxable year of the sale. This elective deferral of income is available 

only if the taxpayer establishes that, under the taxpayer’s usual 

business practices, the sale would not have occurred but for 

drought, flood, or weather-related conditions that resulted in the 

area being designated as eligible for Federal assistance. This exception is generally intended to put taxpayers who receive an unusually high amount of income in one year in the position they would 

have been in absent the weather-related condition. 

REASONS FOR CHANGE

The Committee is aware of situations in which cattlemen sold 

livestock in excess of their usual business practice as a result of 

weather-related conditions, but have been unable to purchase replacement property because the weather-related conditions have 

continued. The Committee believes it is appropriate to extend the 

time period for cattlemen to purchase replacement property in such 

situations. 

EXPLANATION OF PROVISION

The provision extends the applicable period for a taxpayer to replace livestock sold on account of drought, flood, or other weatherrelated conditions from two years to four years after the close of 

the first taxable year in which any part of the gain on conversion 

is realized. The extension is only available if the taxpayer estabVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00150 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.003 HR548P1
149

69Treas. Reg. sec. 1.1388–1(a)(1). 

lishes that, under the taxpayer’s usual business practices, the sale 

would not have occurred but for drought, flood, or weather-related 

conditions that resulted in the area being designated as eligible for 

Federal assistance. In addition, the Secretary of the Treasury is 

granted authority to further extend the replacement period on a regional basis should the weather-related conditions continue longer 

than three years. Also, for property eligible for the provision’s extended replacement period, the provision provides that the taxpayer can make an election under section 451(e) until the period 

for reinvestment of such property under section 1033 expires. 

EFFECTIVE DATE

The provision is effective for any taxable year with respect to 

which the due date (without regard to extensions) for the return is 

after December 31, 2002. 

2. Payment of dividends on stock of cooperatives without reducing 

patronage dividends (sec. 282 of the bill and sec. 1388 of the 

Code) 

PRESENT LAW

Under present law, cooperatives generally are entitled to deduct 

or exclude amounts distributed as patronage dividends in accordance with Subchapter T of the Code. In general, patronage dividends are comprised of amounts that are paid to patrons (1) on the 

basis of the quantity or value of business done with or for patrons, 

(2) under a valid and enforceable obligation to pay such amounts 

that was in existence before the cooperative received the amounts 

paid, and (3) which are determined by reference to the net earnings 

of the cooperative from business done with or for patrons. 

Treasury Regulations provide that net earnings are reduced by 

dividends paid on capital stock or other proprietary capital interests (referred to as the ‘‘dividend allocation rule’’).69 The dividend 

allocation rule has been interpreted to require that such dividends 

be allocated between a cooperative’s patronage and nonpatronage 

operations, with the amount allocated to the patronage operations 

reducing the net earnings available for the payment of patronage 

dividends. 

REASONS FOR CHANGE

The Committee believes that the dividend allocation rule should 

not apply to the extent that the organizational documents of a cooperative provide that capital stock dividends do not reduce the 

amounts owed to patrons as patronage dividends. To the extent 

that capital stock dividends are in addition to amounts paid under 

the cooperative’s organizational documents to patrons as patronage 

dividends, the Committee believes that those capital stock dividends are not being paid from earnings from patronage business. 

In addition, the Committee believes cooperatives should be able 

to raise needed equity capital by issuing capital stock without dividends paid on such stock causing the cooperative to be taxed on a 

portion of its patronage income, and without preventing the cooperative from being treated as operating on a cooperative basis. 

150

EXPLANATION OF PROVISION

The provision provides a special rule for dividends on capital 

stock of a cooperative. To the extent provided in organizational documents of the cooperative, dividends on capital stock do not reduce 

patronage income and do not prevent the cooperative from being 

treated as operating on a cooperative basis. 

EFFECTIVE DATE

The provision is effective for distributions made in taxable years 

ending after the date of enactment. 

3. Capital gains treatment to apply to outright sales of timber by 

landowner (sec. 283 of the bill and sec. 631(b) of the Code) 

PRESENT LAW

Under present law, a taxpayer disposing of timber held for more 

than one year is eligible for capital gains treatment in three situations. First, if the taxpayer sells or exchanges timber that is a capital asset (sec. 1221) or property used in the trade or business (sec. 

1231), the gain generally is long-term capital gain; however, if the 

timber is held for sale to customers in the taxpayer’s business, the 

gain will be ordinary income. Second, if the taxpayer disposes of 

the timber with a retained economic interest, the gain is eligible 

for capital gain treatment (sec. 631(b)). Third, if the taxpayer cuts 

standing timber, the taxpayer may elect to treat the cutting as a 

sale or exchange eligible for capital gains treatment (sec. 631(a)). 

REASONS FOR CHANGE

The Committee believes that the requirement that the owner of 

timber retain an economic interest in the timber in order to obtain 

capital gain treatment under section 631(b) results in poor timber 

management. Under present law, the buyer, when cutting and removing timber, has no incentive to protect young or other uncut 

trees because the buyer only pays for the timber that is cut and 

removed. Therefore, the Committee bill eliminates this requirement 

and provides for capital gain treatment under section 631(b) in the 

case of outright sales of timber.

EXPLANATION OF PROVISION

Under the provision, in the case of a sale of timber by the owner 

of the land from which the timber is cut, the requirement that a 

taxpayer retain an economic interest in the timber in order to treat 

gains as capital gain under section 631(b) does not apply. Outright 

sales of timber by the landowner will qualify for capital gains treatment in the same manner as sales with a retained economic interest qualify under present law, except that the usual tax rules relating to the timing of the income from the sale of the timber will 

apply (rather than the special rule of section 631(b) treating the 

disposal as occurring on the date the timber is cut). 

EFFECTIVE DATE

The provision is effective for sales of timber after December 31, 

2004. 

151

4. Distributions from publicly traded partnerships treated as qualifying income of regulated investment company (sec. 284 of the 

bill and secs. 851 and 469(k) of the Code) 

PRESENT LAW

Treatment of RICs 

A regulated investment company (‘‘RIC’’) generally is treated as 

a conduit for Federal income tax purposes. In computing its taxable 

income, a RIC deducts dividends paid to its shareholders to achieve 

conduit treatment (sec. 852(b)). In order to qualify for conduit 

treatment, a RIC must be a domestic corporation that, at all times 

during the taxable year, is registered under the Investment Company Act of 1940 as a management company or as a unit investment trust, or has elected to be treated as a business development 

company under that Act (sec. 851(a)). In addition, the corporation 

must elect RIC status, and must satisfy certain other requirements 

(sec. 851(b)). 

One of the RIC qualification requirements is that at least 90 percent of the RIC’s gross income is derived from dividends, interest, 

payments with respect to securities loans, and gains from the sale 

or other disposition of stock or securities or foreign currencies, or 

other income (including but not limited to gains from options, futures, or forward contracts) derived with respect to its business of 

investing in such stock, securities, or currencies (sec. 851(b)(2)). Income derived from a partnership is treated as meeting this requirement only to the extent such income is attributable to items of income of the partnership that would meet the requirement if realized by the RIC in the same manner as realized by the partnership 

(the ‘‘look-through’’ rule for partnership income) (sec. 851(b)). 

Under present law, no distinction is made under this rule between 

a publicly traded partnership and any other partnership. 

The RIC qualification rules include limitations on the ownership 

of assets and on the composition of the RIC’s assets (sec. 851(b)(3)). 

Under the ownership limitation, at least 50 percent of the value of 

the RIC’s total assets must be represented by cash, government securities and securities of other RICs, and other securities; however, 

in the case of such other securities, the RIC may invest no more 

than five percent of the value of the total assets of the RIC in the 

securities of any one issuer, and may hold no more than 10 percent 

of the outstanding voting securities of any one issuer. Under the 

limitation on the composition of the RIC’s assets, no more than 25 

percent of the value of the RIC’s total assets may be invested in 

the securities of any one issuer (other than Government securities), 

or in securities of two or more controlled issuers in the same or 

similar trades or businesses. These limitations generally are applied at the end of each quarter (sec. 851(d)). 

Treatment of publicly traded partnerships 

Present law provides that a publicly traded partnership means a 

partnership, interests in which are traded on an established securities market, or are readily tradable on a secondary market (or the 

substantial equivalent thereof). In general, a publicly traded partnership is treated as a corporation (sec. 7704(a)), but an exception 

to corporate treatment is provided if 90 percent or more of its gross 

152

70 H.R. Rep. No. 100–391, pt. 2 of 2, at 1066 (1987). 71 Id.

income is interest, dividends, real property rents, or certain other 

types of qualifying income (sec. 7704(c) and (d)). 

A special rule for publicly traded partnerships applies under the 

passive loss rules. The passive loss rules limit deductions and credits from passive trade or business activities (sec. 469). Deductions 

attributable to passive activities, to the extent they exceed income 

from passive activities, generally may not be deducted against 

other income. Deductions and credits that are suspended under 

these rules are carried forward and treated as deductions and credits from passive activities in the next year. The suspended losses 

from a passive activity are allowed in full when a taxpayer disposes 

of his entire interest in the passive activity to an unrelated person. 

The special rule for publicly traded partnerships provides that the 

passive loss rules are applied separately with respect to items attributable to each publicly traded partnership (sec. 469(k)). Thus, 

income or loss from the publicly traded partnership is treated as 

separate from income or loss from other passive activities. 

REASONS FOR CHANGE

The Committee understands that publicly traded partnerships 

generally are treated as corporations under rules enacted to address Congress’ view that publicly traded partnerships resemble 

corporations in important respects.70 Publicly traded partnerships 

with specified types of income are not treated as corporations, however, for the reason that if the income is from sources that are commonly considered to be passive investments, then there is less reason to treat the publicly traded partnership as a corporation.71 The 

Committee understands that these types of publicly traded partnerships may have improved access to capital markets if their interests were permitted investments of mutual funds. Therefore, the 

bill treats publicly traded partnership interests as permitted investments for mutual funds (‘‘RICs’’). 

Nevertheless, the Committee believes that permitting mutual 

funds to hold interests in a publicly traded partnership should not 

give rise to avoidance of unrelated business income tax or withholding of income tax that would apply if tax-exempt organizations 

or foreign persons held publicly traded partnership interests directly rather than through a mutual fund. Therefore, the Committee bill requires that present-law limitations on ownership and 

composition of assets of mutual funds apply to any investment in 

a publicly traded partnership by a mutual fund. The Committee believes that these limitations will serve to limit the use of mutual 

funds as conduits for avoidance of unrelated business income tax 

or withholding rules that would otherwise apply with respect to 

publicly traded partnership income. 

EXPLANATION OF PROVISION

The provision modifies the 90-percent test with respect to income 

of a RIC to include income derived from an interest in a publicly 

traded partnership. The provision also modifies the lookthrough 

rule for partnership income of a RIC so that it applies only to income from a partnership other than a publicly traded partnership. 

153

The provision provides that the limitation on ownership and the 

limitation on composition of assets that apply to other investments 

of a RIC also apply to RIC investments in publicly traded partnership interests. 

The provision provides that the special rule for publicly traded 

partnerships under the passive loss rules (requiring separate treatment) applies to a RIC holding an interest in a publicly traded 

partnership, with respect to items attributable to the interest in 

the publicly traded partnership. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after the 

date of enactment. 

5. Improvements related to real estate investment trusts (sec. 285 

of the bill and secs. 856, 857 and 860 of the Code) 

PRESENT LAW

In general 

Real estate investment trusts (‘‘REITs’’) are treated, in substance, as pass-through entities under present law. Pass-through 

status is achieved by allowing the REIT a deduction for dividends 

paid to its shareholders. REITs are generally restricted to investing 

in passive investments primarily in real estate and securities. 

A REIT must satisfy four tests on a year-by-year basis: organizational structure, source of income, nature of assets, and distribution of income. Whether the REIT meets the asset tests is generally 

measured each quarter. 

Organizational structure requirements 

To qualify as a REIT, an entity must be for its entire taxable 

year a corporation or an unincorporated trust or association that 

would be taxable as a domestic corporation but for the REIT provisions, and must be managed by one or more trustees. The beneficial ownership of the entity must be evidenced by transferable 

shares or certificates of ownership. Except for the first taxable year 

for which an entity elects to be a REIT, the beneficial ownership 

of the entity must be held by 100 or more persons, and the entity 

may not be so closely held by individuals that it would be treated 

as a personal holding company if all its adjusted gross income constituted personal holding company income. A REIT is required to 

comply with regulations to ascertain the actual ownership of the 

REIT’s outstanding shares. 

Income requirements 

In order for an entity to qualify as a REIT, at least 95 percent 

of its gross income generally must be derived from certain passive 

sources (the ‘‘95-percent income test’’). In addition, at least 75 percent of its income generally must be from certain real estate 

sources (the ‘‘75-percent income test’’), including rents from real 

property (as defined) and gain from the sale or other disposition of 

real property. 

154

72 A REIT is not treated as providing services that produce impermissible tenant services income if such services are provided by an independent contractor from whom the REIT does not 

derive or receive any income. An independent contractor is defined as a person who does not 

own, directly or indirectly, more than 35 percent of the shares of the REIT. Also, no more than 

35 percent of the total shares of stock of an independent contractor (or of the interests in net 

assets or net profits, if not a corporation) can be owned directly or indirectly by persons owning 

35 percent or more of the interests in the REIT. 73 Rents for certain personal property leased in connection with the rental of real property are 

treated as rents from real property if the fair market value of the personal property does not 

exceed 15 percent of the aggregate fair market values of the real and personal property. 74Sec. 856(d)(2)(B). 75Sec. 856(d)(8). 76Prior to 1999, the rule had applied to the amount by which 95 percent of the income exceeded the items subject to the 95 percent test. 77The ratio of the REIT’s net to gross income is applied to the excess amount, to determine 

the amount of tax (disregarding certain items otherwise subject to a 100-percent tax). In effect, 

the formula seeks to require that all of the REIT net income attributable to the failure of the 

income tests will be paid as tax. Sec. 857(b)(5). 

Qualified rental income 

Amounts received as impermissible ‘‘tenant services income’’ are 

not treated as rents from real property.72 In general, such amounts 

are for services rendered to tenants that are not ‘‘customarily furnished’’ in connection with the rental of real property.73 Special 

rules also permit amounts to be received from certain ‘‘foreclosure 

property’’ treated as such for three years after the property is acquired by the REIT in foreclosure after a default (or imminent default) on a lease of such property or an indebtedness which such 

property secured. 

Rents from real property, for purposes of the 95-percent and 75-

percent income tests, generally do not include any amount received 

or accrued from any person in which the REIT owns, directly or indirectly, 10 percent or more of the vote or value.74 An exception applies to rents received from a taxable REIT subsidiary (‘‘TRS’’) (described further below) if at least 90 percent of the leased space of 

the property is rented to persons other than a TRS or certain related persons, and if the rents from the TRS are substantially comparable to unrelated party rents.75

Certain hedging instruments 

Except as provided in regulations, a payment to a REIT under 

an interest rate swap or cap agreement, option, futures contract, 

forward rate agreement, or any similar financial instrument, entered into by the trust in a transaction to reduce the interest rate 

risks with respect to any indebtedness incurred or to be incurred 

by the REIT to acquire or carry real estate assets, and any gain 

from the sale or disposition of any such investment, is treated as 

income qualifying for the 95-percent income test. 

Tax if qualified income tests not met 

If a REIT fails to meet the 95-percent or 75-percent income tests 

but has set out the income it did receive in a schedule and any 

error in the schedule is due to reasonable cause and not willful neglect, then the REIT does not lose its REIT status but instead pays 

a tax measured by the greater of the amount by which 90 percent 76 of the REIT’s gross income exceeds the amount of items subject to the 95-percent test, or the amount by which 75 percent of 

the REIT’s gross income exceeds the amount of items subject to the 

75-percent test.77

155

78Sec. 1361(c)(5), without regard to paragraph (B)(iii) thereof. 79Sec. 856(c)(7). 

Asset requirements 

75-percent asset test 

To satisfy the asset requirements to qualify for treatment as a 

REIT, at the close of each quarter of its taxable year, an entity 

must have at least 75 percent of the value of its assets invested in 

real estate assets, cash and cash items, and government securities 

(the ‘‘75-percent asset test’’). The term real estate asset is defined 

to mean real property (including interests in real property and 

mortgages on real property) and interests in REITs. 

Limitation on investment in other entities 

A REIT is limited in the amount that it can own in other corporations. Specifically, a REIT cannot own securities (other than 

Government securities and certain real estate assets) in an amount 

greater than 25 percent of the value of REIT assets. In addition, 

it cannot own such securities of any one issuer representing more 

than 5 percent of the total value of REIT assets or more than 10 

percent of the voting securities or 10 percent of the value of the 

outstanding securities of any one issuer. Securities for purposes of 

these rules are defined by reference to the Investment Company 

Act of 1940.

‘‘Straight debt’’ exception 

Securities of an issuer that are within a safe-harbor definition of 

‘‘straight debt’’ (as defined for purposes of subchapter S) 78 are not 

taken into account in applying the limitation that a REIT may not 

hold more than 10 percent of the value of outstanding securities of 

a single issuer, if: (1) the issuer is an individual, (2) the only securities of such issuer held by the REIT or a taxable REIT subsidiary 

of the REIT are straight debt, or (3) the issuer is a partnership and 

the trust holds at least a 20 percent profits interest in the partnership. 

Straight debt for purposes of the REIT provision 79 is defined as 

a written or unconditional promise to pay on demand or on a specified date a sum certain in money if (i) the interest rate (and interest payment dates) are not contingent on profits, the borrower’s 

discretion, or similar factors, and (ii) there is no convertibility (directly or indirectly) into stock. 

Certain subsidiary ownership permitted with income treated 

as income of the REIT 

Under one exception to the rule limiting a REIT’s securities holdings to no more than 10 percent of the vote or value of a single 

issuer, a REIT can own 100 percent of the stock of a corporation, 

but in that case the income and assets of such corporation are 

treated as income and assets of the REIT. 

Special rules for Taxable REIT subsidiaries 

Under another exception to the general rule limiting REIT securities ownership of other entities, a REIT can own stock of a taxable REIT subsidiary (‘‘TRS’’), generally, a corporation other than 

156

80 Certain corporations are not eligible to be a TRS, such as a corporation which directly or 

indirectly operates or manages a lodging facility or a health care facility, or directly or indirectly 

provides to any other person rights to a brand name under which any lodging facility or health 

care facility is operated. Sec. 856(l)(3). 81 If the excise tax applies, then the item is not reallocated back to the TRS under section 

482. 82Secs. 856(c)(6) and 857(b)(5). 

a real estate investment trust 80 with which the REIT makes a 

joint election to be subject to special rules. A TRS can engage in 

active business operations that would produce income that would 

not be qualified income for purposes of the 95-percent or 75-percent 

income tests for a REIT, and that income is not attributed to the 

REIT. For example a TRS could provide noncustomary services to 

REIT tenants, or it could engage directly in the active operation 

and management of real estate (without use of an independent contractor); and the income the TRS derived from these nonqualified 

activities would not be treated as disqualified REIT income. Transactions between a TRS and a REIT are subject to a number of specified rules that are intended to prevent the TRS (taxable as a separate corporate entity) from shifting taxable income from its activities to the pass-through entity REIT or from absorbing more than 

its share of expenses. Under one rule, a 100-percent excise tax is 

imposed on rents, deductions, or interest paid by the TRS to the 

REIT to the extent such items would exceed an arm’s length 

amount as determined under section 482.81

Rents subject to the 100 percent excise tax do not include rents 

for services of a TRS that are for services customarily furnished or 

rendered in connection with the rental of real property. 

They also do not include rents from a TRS that are for real property or from incidental personal property provided with such real 

property. 

Income distribution requirements 

A REIT is generally required to distribute 90 percent of its income before the end of its taxable year, as deductible dividends 

paid to shareholders. This rule is similar to a rule for regulated investment companies (‘‘RICs’’) that requires distribution of 90 percent of income. If a REIT declares certain dividends after the end 

of its taxable year but before the time prescribed for filing its return for that year and distributes those amounts to shareholders 

within the 12 months following the close of that taxable year, such 

distributions are treated as made during such taxable year for this 

purpose. As described further below, a REIT can also make certain 

‘‘deficiency dividends’’ after the close of the taxable year after a determination that it has not distributed the correct amount for qualification as a REIT. 

Consequences of failure to meet requirements 

A REIT loses its status as a REIT, and becomes subject to tax 

as a C corporation, if it fails to meet specified tests regarding the 

sources of its income, the nature and amount of its assets, its structure, and the amount of its income distributed to shareholders. 

In the case of a failure to meet the source of income requirements, if the failure is due to reasonable cause and not to willful 

neglect, the REIT may continue its REIT status if it pays the disallowed income as a tax to the Treasury.82

157

There is no similar provision that allows a REIT to pay a penalty 

and avoid disqualification in the case of other qualification failures. 

A REIT may make a deficiency dividend after a determination is 

made that it has not distributed the correct amount of its income, 

and avoid disqualification. The Code provides only for determinations involving a controversy with the IRS and does not provide for 

a REIT to make such a distribution on its own initiative. Deficiency 

dividends may be declared on or after the date of ‘‘determination’’. A determination is defined to include only (i) a final decision by the 

Tax Court or other court of competent jurisdiction, (ii) a closing 

agreement under section 7121, or (iii) under Treasury regulations, 

an agreement signed by the Secretary and the REIT.

REASONS FOR CHANGE

The Committee believes that a number of simplifying and conforming changes should be made to the ‘‘straight debt’’ provisions 

that exempt certain securities from the rule that a REIT may not 

hold more than 10 percent of the value of securities of a single 

issuer, as well as to the TRS rules, the rules relating to certain 

hedging arrangements, and the computation of tax liability when 

the 95-percent gross income test is not met. 

The Committee also believes it is desirable to provide rules under 

which a REIT that inadvertently fails to meet certain REIT qualification requirements can correct such failure without losing REIT 

status. 

EXPLANATION OF PROVISION

The provision makes a number of modifications to the REIT 

rules. 

Straight debt modification 

The provision modifies the definition of ‘‘straight debt’’ for purposes of the limitation that a REIT may not hold more than 10 percent of the value of the outstanding securities of a single issuer, to 

provide more flexibility than the present law rule. In addition, except as provided in regulations, neither such straight debt nor certain other types of securities are considered ‘‘securities’’ for purposes of this rule. 

Straight debt securities 

As under present law, ‘‘straight-debt’’ is still defined by reference 

to section 1361(c)(5), without regard to subparagraph (B)(iii) thereof (limiting the nature of the creditor). 

Special rules are provided permitting certain contingencies for 

purposes of the REIT provision. Any interest or principal shall not 

be treated as failing to satisfy section 1361(c)(5)(B)(i) solely by reason of the fact that the time of payment of such interest or principal is subject to a contingency, but only if one of several factors 

applies. The first type of contingency that is permitted is one that 

does not have the effect of changing the effective yield to maturity, 

as determined under section 1272, other than a change in the annual yield to maturity, but only if (i) any such contingency does not 

exceed the greater of 1⁄4 of one percent or five percent of the annual 

yield to maturity, or (ii) neither the aggregate issue price nor the 

aggregate face amount of the debt instruments held by the REIT 

158

83The present law rules that limit qualified interest income to amounts the determination of 

which do not depend, in whole or in part, on the income or profits of any person, continue to 

apply to such contingent interest. See, e.g., secs. 856(c)(2)(G), 856(c)(3)(G) and 856(f). 84The provision does not modify any of the standards of section 482 as they apply to REITs 

and to TRSs. 

exceeds $1,000,000 and not more than 12 months of unaccrued interest can be required to be prepaid thereunder. 

Also, the time or amount of any payment is permitted to be subject to a contingency upon a default or the exercise of a prepayment 

right by the issuer of the debt, provided that such contingency is 

consistent with customary commercial practice.83

The provision eliminates the present law rule requiring a REIT 

to own a 20 percent equity interest in a partnership in order for 

debt to qualify as ‘‘straight debt’’. The bill instead provides new 

‘‘look-through’’ rules determining a REIT partner’s share of partnership securities, generally treating debt to the REIT as part of 

the REIT’s partnership interest for this purpose, except in the case 

of otherwise qualifying debt of the partnership. 

Certain corporate or partnership issues that otherwise would be 

permitted to be held without limitation under the special straight 

debt rules described above will not be so permitted if the REIT 

holding such securities, and any of its taxable REIT subsidiaries, 

holds any securities of the issuer which are not permitted securities (prior to the application of this rule) and have an aggregate 

value greater than one percent of the issuer’s outstanding securities. 

Other securities 

Except as provided in regulations, the following also are not considered ‘‘securities’’ for purposes of the rule that a REIT cannot 

own more than 10 percent of the value of the outstanding securities 

of a single issuer: (i) any loan to an individual or an estate, (ii) any 

section 467 rental agreement, (as defined in section 467(d)), other 

than with a person described in section 856(d)(2)(B), (iii) any obligation to pay rents from real property, (iv) any security issued by 

a State or any political subdivision thereof, the District of Columbia, a foreign government, or any political subdivision thereof, or 

the Commonwealth of Puerto Rico, but only if the determination of 

any payment received or accrued under such security does not depend in whole or in part on the profits of any entity not described 

in this category, or payments on any obligation issued by such an 

entity, (v) any security issued by a real estate investment trust; 

and (vi) any other arrangement that, as determined by the Secretary, is excepted from the definition of a security. 

Safe harbor testing date for certain rents 

The provision provides specific safe-harbor rules regarding the 

dates for testing whether 90 percent of a REIT property is rented 

to unrelated persons and whether the rents paid by related persons 

are substantially comparable to unrelated party rents. These testing rules are provided solely for purposes of the special provision 

permitting rents received from a TRS to be treated as qualified 

rental income for purposes of the income tests.84

159

85 Although a REIT could itself provide such service and receive the income without receiving 

any disqualified income, in that case the REIT itself would be bearing the cost of providing the 

service. Under the present law exception for a TRS providing such service, there is no explicit 

requirement that the TRS be reimbursed for the full cost of the service. 86Sec. 856(c)(4)(B)(iii). These rules do not apply to securities of a TRS, or to securities that 

qualify for the 75 percent asset test of section 856(c)(4)(A), such as real estate assets, cash items 

(including receivables), or Government securities. 

Customary services exception 

The provision prospectively eliminates the safe harbor allowing 

rents received by a REIT to be exempt from the 100 percent excise 

tax if the rents are for customary services performed by the TRS 85

or are from a TRS and are for the provision of certain incidental 

personal property. Instead, such payments are free of the excise tax 

if they satisfy the present law safe-harbor that applies if the REIT 

pays the TRS at least 150 percent of the cost to the TRS of providing any services. 

Hedging rules 

The rules governing the tax treatment of arrangements engaged 

in by a REIT to reduce certain interest rate risks are prospectively 

generally conformed to the rules included in section 1221. Also, the 

defined income of a REIT from such a hedging transaction is excluded from gross income for purposes of the 95-percent of gross income requirement. 

95-percent of gross income requirement 

The provision prospectively amends the tax liability owed by the 

REIT when it fails to meet the 95-percent of gross income test by 

applying a taxable fraction based on 95 percent, rather than 90 

percent, of the REIT’s gross income. 

Consequences of failure to meet REIT requirements 

Under the provision, a REIT may avoid disqualification in the 

event of certain failures of the requirements for REIT status, provided that (1) the failure was due to reasonable cause and not willful neglect, (2) the failure is corrected, and (3) except for certain 

failures not exceeding a specified de minimis amount, a penalty 

amount is paid. 

Certain de minimis asset failures of 5-percent or 10-percent 

tests 

One requirement of present law is that, with certain exceptions, 

(i) not more than 5 percent of the value of total REIT assets may 

be represented by securities of one issuer, and (ii) a REIT may not 

hold securities possessing more than 10 percent of the total voting 

power or 10 percent of the total value of the outstanding securities 

of any one issuer.86 The requirements must be satisfied each quarter. 

The provision provides that a REIT will not lose its REIT status 

for failing to satisfy these requirements in a quarter if the failure 

is due to the ownership of assets the total value of which does not 

exceed the lesser of (i) one percent of the total value of the REIT’s 

assets at the end of the quarter for which such measurement is 

done or (ii) 10 million dollars; provided in either case that the 

REIT either disposes of the assets within six months after the last 

day of the quarter in which the REIT identifies the failure (or such 

160

87 A REIT might satisfy the requirements without a disposition, for example, by increasing 

its other assets in the case of the 5 percent rule; or by the issuer modifying the amount or value 

of its total securities outstanding in the case of the 10 percent rule.

other time period prescribed by the Treasury), or otherwise meets 

the requirements of those rules by the end of such time period.87

Larger asset test failures (whether of 5-percent or 10-percent 

tests, or of 75-percent or other asset tests) 

Under the provision, if a REIT fails to meet any of the asset test 

requirements for a particular quarter and the failure exceeds the 

de minimis threshold described above, then the REIT still will be 

deemed to have satisfied the requirements if: (i) following the 

REIT’s identification of the failure, the REIT files a schedule with 

a description of each asset that caused the failure, in accordance 

with regulations prescribed by the Treasury; (ii) the failure was 

due to reasonable cause and not to willful neglect, (iii) the REIT 

disposes of the assets within 6 months after the last day of the 

quarter in which the identification occurred or such other time period as is prescribed by the Treasury (or the requirements of the 

rules are otherwise met within such period), and (iv) the REIT 

pays a tax on the failure. 

The tax that the REIT must pay on the failure is the greater of 

(i) $50,000, or (ii) an amount determined (pursuant to regulations) 

by multiplying the highest rate of tax for corporations under section 11, times the net income generated by the assets for the period 

beginning on the first date of the failure and ending on the date 

the REIT has disposed of the assets (or otherwise satisfies the requirements). 

Such taxes are treated as excise taxes, for which the deficiency 

provisions of the excise tax subtitle of the Code (subtitle F) apply. 

Conforming reasonable cause and reporting standard for failures of income tests 

The provision conforms the reporting and reasonable cause 

standards for failure to meet the income tests to the new asset test 

standards. However, the provision does not change the rule under 

section 857(b)(5) that for income test failures, all of the net income 

attributed to the disqualified gross income is paid as tax. 

Other failures 

The bill adds a provision under which, if a REIT fails to satisfy 

one or more requirements for REIT qualification, other than the 

95-percent and 75-percent gross income tests and other than the 

new rules provided for failures of the asset tests, the REIT may retain its REIT qualification if the failures are due to reasonable 

cause and not willful neglect, and if the REIT pays a penalty of 

$50,000 for each such failure. 

Taxes and penalties paid deducted from amount required to 

be distributed 

Any taxes or penalties paid under the provision are deducted 

from the net income of the REIT in determining the amount the 

REIT must distribute under the 90-percent distribution requirement.

161

Expansion of deficiency dividend procedure 

The provision expands the circumstances in which a REIT may 

declare a deficiency dividend, by allowing such a declaration to 

occur after the REIT unilaterally has identified a failure to pay the 

relevant amount. Thus, the declaration need not await a decision 

of the Tax Court, a closing agreement, or an agreement signed by 

the Secretary of the Treasury. 

EFFECTIVE DATE

The provision is generally effective for taxable years beginning 

after December 31, 2000. 

However, some of the provisions are effective for taxable years 

beginning after the date of enactment. These are: the new ‘‘look 

through’’ rules determining a REIT partner’s share of partnership 

securities for purposes of the ‘‘straight debt’’ rules; the provision 

changing the 90-percent of gross income reference to 95 percent, for 

purposes of the tax liability if a REIT fails to meet the 95-percent 

of gross income test; the new hedging definition; the rule modifying 

the treatment of rents with respect to customary services; and the 

new rules for correction of certain failures to satisfy the REIT requirements. 

6. Treatment of certain dividends of regulated investment companies (sec. 286 of the bill and secs. 871 and 881 of the Code) 

PRESENT LAW

Regulated investment companies 

A regulated investment company (‘‘RIC’’) is a domestic corporation that, at all times during the taxable year, is registered under 

the Investment Company Act of 1940 as a management company 

or as a unit investment trust, or has elected to be treated as a business development company under that Act (sec. 851(a)). 

In addition, to qualify as a RIC, a corporation must elect such 

status and must satisfy certain tests (sec. 851(b)). These tests include a requirement that the corporation derive at least 90 percent 

of its gross income from dividends, interest, payments with respect 

to certain securities loans, and gains on the sale or other disposition of stock or securities or foreign currencies, or other income derived with respect to its business of investment in such stock, securities, or currencies. 

Generally, a RIC pays no income tax because it is permitted to 

deduct dividends paid to its shareholders in computing its taxable 

income. The amount of any distribution generally is not considered 

as a dividend for purposes of computing the dividends paid deduction unless the distribution is pro rata, with no preference to any 

share of stock as compared with other shares of the same class 

(sec. 562(c)). For distributions by RICs to shareholders who made 

initial investments of at least $10,000,000, however, the distribution is not treated as non-pro rata or preferential solely by reason 

of an increase in the distribution due to reductions in administrative expenses of the company. 

A RIC generally may pass through to its shareholders the character of its long-term capital gains. It does this by designating a 

dividend it pays as a capital gain dividend to the extent that the 

162

RIC has net capital gain (i.e., net long-term capital gain over net 

short-term capital loss). These capital gain dividends are treated as 

long-term capital gain by the shareholders. A RIC generally also 

can pass through to its shareholders the character of tax-exempt 

interest from State and local bonds, but only if, at the close of each 

quarter of its taxable year, at least 50 percent of the value of the 

total assets of the RIC consists of these obligations. In this case, 

the RIC generally may designate a dividend it pays as an exemptinterest dividend to the extent that the RIC has tax-exempt interest income. These exempt-interest dividends are treated as interest 

excludable from gross income by the shareholders. 

U.S. source investment income of foreign persons 

In general 

The United States generally imposes a flat 30-percent tax, collected by withholding, on the gross amount of U.S.-source investment income payments, such as interest, dividends, rents, royalties 

or similar types of income, to nonresident alien individuals and foreign corporations (‘‘foreign persons’’) (secs. 871(a), 881, 1441, and 

1442). Under treaties, the United States may reduce or eliminate 

such taxes. Even taking into account U.S. treaties, however, the 

tax on a dividend generally is not entirely eliminated. Instead, 

U.S.-source portfolio investment dividends received by foreign persons generally are subject to U.S. withholding tax at a rate of at 

least 15 percent. 

Interest 

Although payments of U.S.-source interest that is not effectively 

connected with a U.S. trade or business generally are subject to the 

30-percent withholding tax, there are exceptions to that rule. For 

example, interest from certain deposits with banks and other financial institutions is exempt from tax (secs. 871(i)(2)(A) and 881(d)). 

Original issue discount on obligations maturing in 183 days or less 

from the date of original issue (without regard to the period held 

by the taxpayer) is also exempt from tax (sec. 871(g)). An additional exception is provided for certain interest paid on portfolio obligations (secs. 871(h) and 881(c)). ‘‘Portfolio interest’’ generally is 

defined as any U.S.-source interest (including original issue discount), not effectively connected with the conduct of a U.S. trade 

or business, (i) on an obligation that satisfies certain registration 

requirements or specified exceptions thereto (i.e., the obligation is 

‘‘foreign targeted’’), and (ii) that is not received by a 10-percent 

shareholder (secs. 871(h)(3) and 881(c)(3)). With respect to a registered obligation, a statement that the beneficial owner is not a 

U.S. person is required (secs. 871(h)(2), (5) and 881(c)(2)). This exception is not available for any interest received either by a bank 

on a loan extended in the ordinary course of its business (except 

in the case of interest paid on an obligation of the United States), 

or by a controlled foreign corporation from a related person (sec. 

881(c)(3)). Moreover, this exception is not available for certain contingent interest payments (secs. 871(h)(4) and 881(c)(4)). 

163

88The Economic Growth and Tax Relief Reconciliation Act of 2001 (‘‘EGTRRA’’) repealed the 

estate tax for estates of decedents dying after December 31, 2009. However, EGTRRA included 

a ‘‘sunset’’ provision, pursuant to which EGTRRA’s provisions (including estate tax repeal) do 

not apply to estates of decedents dying after December 31, 2010. 

Capital gains 

Foreign persons generally are not subject to U.S. tax on gain realized on the disposition of stock or securities issued by a U.S. person (other than a ‘‘U.S. real property holding corporation,’’ as described below), unless the gain is effectively connected with the 

conduct of a trade or business in the United States. This exemption 

does not apply, however, if the foreign person is a nonresident alien 

individual present in the United States for a period or periods aggregating 183 days or more during the taxable year (sec. 871(a)(2)). 

A RIC may elect not to withhold on a distribution to a foreign person representing a capital gain dividend. (Treas. Reg. sec. 1.1441–

3(c)(2)(D)). 

Gain or loss of a foreign person from the disposition of a U.S. 

real property interest is subject to net basis tax as if the taxpayer 

were engaged in a trade or business within the United States and 

the gain or loss were effectively connected with such trade or business (sec. 897). In addition to an interest in real property located 

in the United States or the Virgin Islands, U.S. real property interests include (among other things) any interest in a domestic corporation unless the taxpayer establishes that the corporation was 

not, during a 5-year period ending on the date of the disposition 

of the interest, a U.S. real property holding corporation (which is 

defined generally to mean a corporation the fair market value of 

whose U.S. real property interests equals or exceeds 50 percent of 

the sum of the fair market values of its real property interests and 

any other of its assets used or held for use in a trade or business). 

Estate taxation 

Decedents who were citizens or residents of the United States 

are generally subject to Federal estate tax on all property, wherever situated.88 Nonresidents who are not U.S. citizens, however, 

are subject to estate tax only on their property which is within the 

United States. Property within the United States generally includes debt obligations of U.S. persons, including the Federal government and State and local governments (sec. 2104(c)), but does 

not include either bank deposits or portfolio obligations, the interest on which would be exempt from U.S. income tax under section 

871 (sec. 2105(b)). Stock owned and held by a nonresident who is 

not a U.S. citizen is treated as property within the United States 

only if the stock was issued by a domestic corporation (sec. 2104(a); 

Treas. Reg. sec. 20.2104–1(a)(5)). 

Treaties may reduce U.S. taxation on transfers by estates of nonresident decedents who are not U.S. citizens. Under recent treaties, 

for example, U.S. tax may generally be eliminated except insofar 

as the property transferred includes U.S. real property or business 

property of a U.S. permanent establishment. 

REASONS FOR CHANGE

Under present law, a disparity exists between foreign persons 

who invest directly in certain interest-bearing and other securities 

164

and a foreign person who invests in such securities indirectly 

through U.S. mutual funds. In general, certain amounts received 

by the direct foreign investor (or a foreign investor through a foreign fund) may be exempt from the U.S. gross-basis withholding 

tax. In contrast, distributions from a RIC generally are treated as 

dividends subject to the withholding tax, notwithstanding that the 

distributions may be attributable to amounts that otherwise could 

qualify for an exemption from withholding tax. U.S. financial institutions often respond to this disparate treatment by forming ‘‘mirror funds’’ outside the United States. The Committee believes that 

such disparate treatment should be eliminated so that U.S. financial institutions will be encouraged to form and operate their mutual funds within the United States rather than outside the United 

States. 

Therefore, the Committee believes that, to the extent a RIC distributes to a foreign person a dividend attributable to amounts that 

would have been exempt from U.S. withholding tax had the foreign 

person received it directly (such as portfolio interest and capital 

gains, including short-term capital gains), such dividend similarly 

should be exempt from the U.S. gross-basis withholding tax. The 

Committee also believes that comparable treatment should be afforded for estate tax purposes to foreign persons who invest in certain assets through a RIC to the extent that such assets would not 

be subject to the estate tax if held directly. 

EXPLANATION OF PROVISION

In general 

Under the bill, a RIC that earns certain interest income that 

would not be subject to U.S. tax if earned by a foreign person directly may, to the extent of such income, designate a dividend it 

pays as derived from such interest income. A foreign person who 

is a shareholder in the RIC generally would treat such a dividend 

as exempt from gross-basis U.S. tax, as if the foreign person had 

earned the interest directly. Similarly, a RIC that earns an excess 

of net short-term capital gains over net long-term capital losses, 

which excess would not be subject to U.S. tax if earned by a foreign 

person, generally may, to the extent of such excess, designate a dividend it pays as derived from such excess. A foreign person who is 

a shareholder in the RIC generally would treat such a dividend as 

exempt from gross-basis U.S. tax, as if the foreign person had realized the excess directly. The bill also provides that the estate of a 

foreign decedent is exempt from U.S. estate tax on a transfer of 

stock in the RIC in the proportion that the assets held by the RIC 

are debt obligations, deposits, or other property that would generally be treated as situated outside the United States if held directly by the estate. 

Interest-related dividends 

Under the bill, a RIC may, under certain circumstances, designate all or a portion of a dividend as an ‘‘interest-related dividend,’’ by written notice mailed to its shareholders not later than 

60 days after the close of its taxable year. In addition, an interestrelated dividend received by a foreign person generally is exempt 

165

from U.S. gross-basis tax under sections 871(a), 881, 1441 and 

1442. 

However, this exemption does not apply to a dividend on shares 

of RIC stock if the withholding agent does not receive a statement, 

similar to that required under the portfolio interest rules, that the 

beneficial owner of the shares is not a U.S. person. The exemption 

does not apply to a dividend paid to any person within a foreign 

country (or dividends addressed to, or for the account of, persons 

within such foreign country) with respect to which the Treasury 

Secretary has determined, under the portfolio interest rules, that 

exchange of information is inadequate to prevent evasion of U.S. 

income tax by U.S. persons. 

In addition, the exemption generally does not apply to dividends 

paid to a controlled foreign corporation to the extent such dividends 

are attributable to income received by the RIC on a debt obligation 

of a person with respect to which the recipient of the dividend (i.e., 

the controlled foreign corporation) is a related person. Nor does the 

exemption generally apply to dividends to the extent such dividends are attributable to income (other than short-term original 

issue discount or bank deposit interest) received by the RIC on indebtedness issued by the RIC-dividend recipient or by any corporation or partnership with respect to which the recipient of the RIC 

dividend is a 10-percent shareholder. However, in these two circumstances the RIC remains exempt from its withholding obligation unless the RIC knows that the dividend recipient is such a 

controlled foreign corporation or 10-percent shareholder. To the extent that an interest-related dividend received by a controlled foreign corporation is attributable to interest income of the RIC that 

would be portfolio interest if received by a foreign corporation, the 

dividend is treated as portfolio interest for purposes of the de minimis rules, the high-tax exception, and the same country exceptions 

of subpart F (see sec. 881(c)(5)(A)). 

The aggregate amount designated as interest-related dividends 

for the RIC’s taxable year (including dividends so designated that 

are paid after the close of the taxable year but treated as paid during that year as described in section 855) generally is limited to the 

qualified net interest income of the RIC for the taxable year. The 

qualified net interest income of the RIC equals the excess of: (1) 

the amount of qualified interest income of the RIC; over (2) the 

amount of expenses of the RIC properly allocable to such interest 

income. 

Qualified interest income of the RIC is equal to the sum of its 

U.S.-source income with respect to: (1) bank deposit interest; (2) 

short term original issue discount that is currently exempt from 

the gross-basis tax under section 871; (3) any interest (including 

amounts recognized as ordinary income in respect of original issue 

discount, market discount, or acquisition discount under the provisions of sections 1271–1288, and such other amounts as regulations 

may provide) on an obligation which is in registered form, unless 

it is earned on an obligation issued by a corporation or partnership 

in which the RIC is a 10-percent shareholder or is contingent interest not treated as portfolio interest under section 871(h)(4); and (4) 

any interest-related dividend from another RIC. 

If the amount designated as an interest-related dividend is greater than the qualified net interest income described above, the porVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00167 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.004 HR548P1
166

tion of the distribution so designated which constitutes an interestrelated dividend will be only that proportion of the amount so designated as the amount of the qualified net interest income bears to 

the amount so designated. 

Short-term capital gain dividends 

Under the bill, a RIC also may, under certain circumstances, designate all or a portion of a dividend as a ‘‘short-term capital gain 

dividend,’’ by written notice mailed to its shareholders not later 

than 60 days after the close of its taxable year. For purposes of the 

U.S. gross-basis tax, a short-term capital gain dividend received by 

a foreign person generally is exempt from U.S. gross-basis tax 

under sections 871(a), 881, 1441 and 1442. This exemption does not 

apply to the extent that the foreign person is a nonresident alien 

individual present in the United States for a period or periods aggregating 183 days or more during the taxable year. However, in 

this circumstance the RIC remains exempt from its withholding obligation unless the RIC knows that the dividend recipient has been 

present in the United States for such period.

The aggregate amount qualified to be designated as short-term 

capital gain dividends for the RIC’s taxable year (including dividends so designated that are paid after the close of the taxable 

year but treated as paid during that year as described in sec. 855) 

is equal to the excess of the RIC’s net short-term capital gains over 

net long-term capital losses. The short-term capital gain includes 

short-term capital gain dividends from another RIC. As provided 

under present law for purposes of computing the amount of a capital gain dividend, the amount is determined (except in the case 

where an election under sec. 4982(e)(4) applies) without regard to 

any net capital loss or net short-term capital loss attributable to 

transactions after October 31 of the year. Instead, that loss is 

treated as arising on the first day of the next taxable year. To the 

extent provided in regulations, this rule also applies for purposes 

of computing the taxable income of the RIC. 

In computing the amount of short-term capital gain dividends for 

the year, no reduction is made for the amount of expenses of the 

RIC allocable to such net gains. In addition, if the amount designated as short-term capital gain dividends is greater than the 

amount of qualified short-term capital gain, the portion of the distribution so designated which constitutes a short-term capital gain 

dividend is only that proportion of the amount so designated as the 

amount of the excess bears to the amount so designated. 

As under present law for distributions from REITs, the bill provides that any distribution by a RIC to a foreign person shall, to 

the extent attributable to gains from sales or exchanges by the RIC 

of an asset that is considered a U.S. real property interest, be 

treated as gain recognized by the foreign person from the sale or 

exchange of a U.S. real property interest. The bill also extends the 

special rules for domestically-controlled REITs to domestically-controlled RICs. 

Estate tax treatment 

Under the bill, a portion of the stock in a RIC held by the estate 

of a nonresident decedent who is not a U.S. citizen is treated as 

property without the United States. The portion so treated is based 

167

upon the proportion of the assets held by the RIC at the end of the 

quarter immediately preceding the decedent’s death (or such other 

time as the Secretary may designate in regulations) that are 

‘‘qualifying assets’’. Qualifying assets for this purpose are bank deposits of the type that are exempt from gross-basis income tax, 

portfolio debt obligations, certain original issue discount obligations, debt obligations of a domestic corporation that are treated as 

giving rise to foreign source income, and other property not within 

the United States. 

EFFECTIVE DATE

The provision generally applies to dividends with respect to taxable years of RICs beginning after December 31, 2004. With respect 

to the treatment of a RIC for estate tax purposes, the provision applies to estates of decedents dying after December 31, 2004. With 

respect to the treatment of RICs under section 897 (relating to U.S. 

real property interests), the provision is effective after December 

31, 2004. 

7. Taxation of certain settlement funds (sec. 287 of the bill and sec. 

468B of the Code) 

PRESENT LAW

In general, section 468B provides that a payment to a designated 

settlement fund that extinguishes a tort liability of the taxpayer 

will result in a deduction to the taxpayer. A designated settlement 

fund means a fund which is established pursuant to a court order, 

extinguishes the taxpayer’s tort liability, is managed and controlled 

by persons unrelated to the taxpayer, and in which the taxpayer 

does not have a beneficial interest in the trust. 

Generally, a designated or qualified settlement fund is taxed as 

a separate entity at the maximum trust rate on its modified income. Modified income is generally gross income less deductions for 

administrative costs and other incidental expenses incurred in connection with the operation of the settlement fund. 

The cleanup of hazardous waste sites is sometimes funded by environmental ‘‘settlement funds’’ or escrow accounts. These escrow 

accounts are established in consent decrees between the Environmental Protection Agency (‘‘EPA’’) and the settling parties under 

the jurisdiction of a Federal district court. The EPA uses these accounts to resolve claims against private parties under Comprehensive Environmental Response, Compensation and Liability Act of 

1980 (‘‘CERCLA’’). 

Present law provides that nothing in any provision of law is to 

be construed as providing that an escrow account, settlement fund, 

or similar fund is not subject to current income tax. 

REASONS FOR CHANGE

The Committee believes that these environmental escrow accounts, established under court consent decrees, are essential for 

the EPA to resolve or satisfy claims under the Comprehensive Environmental Response, Compensation and Liability Act of 1980. 

The tax treatment of these settlement funds may prevent taxpayers from entering into prompt settlements with the EPA for the 

cleanup of Superfund hazardous waste sites and reduce the ultiVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00169 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.004 HR548P1
168

mate amount of funds available for the sites’ cleanup. As these settlement funds are controlled by the government, the Committee believes it is appropriate to establish that these funds are to be treated as beneficially owned by the United States. 

EXPLANATION OF PROVISION

The provision provides that certain settlement funds established 

in consent decrees for the sole purpose of resolving claims under 

CERCLA are to be treated as beneficially owned by the United 

States government and therefore, not subject to Federal income 

tax. 

To qualify the settlement fund must be: (1) established pursuant 

to a consent decree entered by a judge of a United States District 

Court; (2) created for the receipt of settlement payments for the 

sole purpose of resolving claims under CERCLA; (3) controlled (in 

terms of expenditures of contributions and earnings thereon) by the 

government or an agency or instrumentality thereof; and (4) upon 

termination, any remaining funds will be disbursed to such government entity and used in accordance with applicable law. For purposes of the provision, a government entity means the United 

States, any State of political subdivision thereof, the District of Columbia, any possession of the United States, and any agency or instrumentality of the foregoing. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2004. 

8. Expand human clinical trials expenses qualifying for the orphan 

drug tax credit (sec. 288 of the bill and sec. 45C of the Code) 

PRESENT LAW

Taxpayers may claim a 50-percent credit for expenses related to 

human clinical testing of drugs for the treatment of certain rare 

diseases and conditions, generally those that afflict less than 

200,000 persons in the United States. Qualifying expenses are 

those paid or incurred by the taxpayer after the date on which the 

drug is designated as a potential treatment for a rare disease or 

disorder by the Food and Drug Administration (‘‘FDA’’) in accordance with section 526 of the Federal Food, Drug, and Cosmetic Act. 

REASONS FOR CHANGE

The Committee observes that approval for human clinical testing, and designation as a potential treatment for a rare disease or 

disorder, require separate reviews within the FDA. As a result, in 

some cases, a taxpayer may be permitted to begin human clinical 

testing prior to a drug being designated as a potential treatment 

for a rare disease or disorder. If the taxpayer delays human clinical 

testing in order to obtain the benefits of the orphan drug tax credit, 

which currently may be claimed only for expenses incurred after 

the drug is designated as a potential treatment for a rare disease 

or disorder, valuable testing and research time will have been lost 

and Congress’s original intent in enacting the orphan drug tax 

credit will have been partially thwarted. 

169

By submitting an application with the FDA for designation as a 

treatment of certain rare diseases and conditions, the taxpayer is 

indicating that he or she intends to examine the drug as a potential treatment for a qualifying disease or condition in approved 

clinical trials. The FDA is required to approve drugs for human 

clinical testing before testing can commence. The Committee believes the application for designation as a potential treatment for 

a rare disease or disorder can create a starting point from which 

human clinical testing expenses can be measured for purposes of 

the credit. For those cases where the process of filing an application and receiving designation as a potential treatment for a rare 

disease or disorder occurs sufficiently expeditiously to fall entirely 

within the taxpayer’s taxable year plus permitted return filing extension period, the Committee finds it appropriate to eliminate the 

potential financial incentive to delaying clinical testing by permitting testing expenses paid or incurred prior to designation to qualify for the credit. The Committee recognizes that while such an outcome may well describe most applications, in some cases, particularly for applications filed near the close of a taxpayer’s taxable 

year, in other cases the application and designation of the drug will 

not be made within the requisite period. The Committee chooses 

not to expand qualifying expenses to include those expenses paid 

or incurred after the date on which the taxpayer files an application with FDA for designation of the drug as a potential treatment 

for a rare disease or disorder, in the case when the designation is 

approved with respect to a taxable year subsequent to the year in 

which the application is filed, because to do so may create the additional taxpayer burden of requiring the taxpayer to file an amended return to claim credit for qualifying costs related to expenses incurred in a taxable year prior to designation. 

EXPLANATION OF PROVISION

The provision expands qualifying expenses to include those expenses related to human clinical testing paid or incurred after the 

date on which the taxpayer files an application with the FDA for 

designation of the drug under section 526 of the Federal Food, 

Drug, and Cosmetic Act as a potential treatment for a rare disease 

or disorder, if certain conditions are met. Under the provision, 

qualifying expenses include those expenses paid or incurred after 

the date on which the taxpayer files an application with the FDA 

for designation as a potential treatment for a rare disease or disorder if the drug receives FDA designation before the due date (including extensions) for filing the tax return for the taxable year in 

which the application was filed with the FDA. As under present 

law, the credit may only be claimed for such expenses related to 

drugs designated as a potential treatment for a rare disease or disorder by the FDA in accordance with section 526 of such Act. 

EFFECTIVE DATE

The provision is effective for expenditures paid or incurred after 

the date of enactment. 

170

89Sec. 4161(b)(1)(A). 90Sec. 4161(b)(2). 91Sec. 4161(b)(1)(B). 92Draw weight is the maximum force required to bring the bowstring to a full-draw position 

not less than 261⁄4-inches, measured from the pressure point of the hand grip to the nocking 

position on the bowstring. 93 A credit or refund may be obtained when an item was taxed and it is used in the manufacture or production of another taxable item. Sec. 6416(b)(3). As arrow components and finished 

arrows are both taxable, in lieu of a refund of the tax paid on components, the provision suspends the application of sec. 6416(b)(3) and permits the taxpayer to reduce the tax due on the 

finished arrow by the amount of the previous tax paid on the components used in the manufacture of such arrow. 

9. Simplification of excise tax imposed on bows and arrows (sec. 

289 of the bill and sec. 4161 of the Code) 

PRESENT LAW

The Code imposes an excise tax of 11 percent on the sale by a 

manufacturer, producer or importer of any bow with a draw weight 

of 10 pounds or more.89 An excise tax of 12.4 percent is imposed 

on the sale by a manufacturer or importer of any shaft, point, nock, 

or vane designed for use as part of an arrow which after its assembly (1) is over 18 inches long, or (2) is designed for use with a taxable bow (if shorter than 18 inches).90 No tax is imposed on finished arrows. An 11-percent excise tax also is imposed on any part 

of an accessory for taxable bows and on quivers for use with arrows 

(1) over 18 inches long or (2) designed for use with a taxable bow 

(if shorter than 18 inches).91

REASONS FOR CHANGE

Under present law, foreign manufacturers and importers of arrows avoid the 12.4 percent excise tax paid by domestic manufacturers because the tax is placed on arrow components rather than 

finished arrows. As a result, arrows assembled outside of the 

United States have a price advantage over domestically manufactured arrows. The Committee believes it is appropriate to close this 

loophole. The Committee also believes that adjusting the minimum 

draw weight for taxable bows from 10 pounds to 30 pounds will 

better target the excise tax to actual hunting use by eliminating 

the excise tax on instructional (‘‘youth’’) bows. 

EXPLANATION OF PROVISION

The provision increases the draw weight for a taxable bow from 

10 pounds or more to a peak draw weight of 30 pounds or more.92

The provision also imposes an excise tax of 12 percent on arrows 

generally. An arrow for this purpose is defined as a taxable arrow 

shaft to which additional components are attached. The present 

law 12.4-percent excise tax on certain arrow components is unchanged by the bill. In the case of any arrow comprised of a shaft 

or any other component upon which tax has been imposed, the 

amount of the arrow tax is equal to the excess of (1) the arrow tax 

that would have been imposed but for this exception, over (2) the 

amount of tax paid with respect to such components.93 Finally, the 

provision subjects certain broadheads (a type of arrow point) to an 

excise tax equal to 11 percent of the sales price instead of 12.4 percent. 

171

94The Joint Committee on Taxation has cited the tackle box issue as an example of the complexity of the sport fishing excise tax, and has recommended the elimination of the sport fishing 

equipment excise tax. See Joint Committee on Taxation, Study of the Overall State of the Federal Tax System and Recommendations for Simplification, Pursuant to Section 8022(3)(B) of the 

Internal Revenue Code of 1986, (JCS–3–01), Vol. II, Recommendations of the Staff of the Joint 

Committee on Taxation to Simplify the Federal Tax System, at 499–500, April 2001. 

EFFECTIVE DATE

The provision is effective for articles sold by the manufacturer, 

producer, or importer after December 31, 2004. 

10. Repeal excise tax on fishing tackle boxes (sec. 290 of the bill 

and sec. 4162 of the Code) 

PRESENT LAW

Under present law, a 10-percent manufacturer’s excise tax is imposed on specified sport fishing equipment. Examples of taxable 

equipment include fishing rods and poles, fishing reels, artificial 

bait, fishing lures, line and hooks, and fishing tackle boxes. Revenues from the excise tax on sport fishing equipment are deposited 

in the Sport Fishing Account of the Aquatic Resources Trust Fund. 

Monies in the fund are spent, subject to an existing permanent appropriation, to support Federal-State sport fish enhancement and 

safety programs. 

REASONS FOR CHANGE

The Committee observes that fishing ‘‘tackle boxes’’ are little different in design and appearance from ‘‘tool boxes,’’ yet the former 

are subject to a Federal excise tax at a rate of 10-percent, while 

the latter are not subject to Federal excise tax. This excise tax can 

create a sufficiently large price difference that some fishermen will 

choose to use a ‘‘tool box’’ to hold their hooks and lures rather than 

a traditional ‘‘tackle box.’’ The Committee finds that such a distortion of consumer choice places an inappropriate burden on the 

manufacturers and purchasers of traditional tackle boxes, particularly in comparison to the modest amount of revenue raised by the 

present-law provision, and that this burden warrants repeal of the 

tax. The excise tax also adds unwarranted complexity to the Code, 

by requiring taxpayers and the IRS to make highly factual determinations as to which similar-use items are subject to tax and 

which are not.94

EXPLANATION OF PROVISION

The provision repeals the excise tax on fishing tackle boxes. 

EFFECTIVE DATE

The provision is effective for articles sold by the manufacturer, 

producer, or importer after December 31, 2004. 

11. Repeal of excise tax on sonar devices suitable for finding fish 

(sec. 291 of the bill and secs. 4161 and 4162 of the Code) 

PRESENT LAW

In general, the Code imposes a 10 percent tax on the sale by the 

manufacturer, producer, or importer of specified sport fishing 

172

95Sec. 4161(a)(1). 96Sec. 4161(a)(2). 97Sec. 4162(b). 

equipment.95 A three percent rate, however, applies to the sale of 

electric outboard motors and sonar devices suitable for finding 

fish.96 Further, the tax imposed on the sale of sonar devices suitable for finding fish is limited to $30. A sonar device suitable for 

finding fish does not include any device that is a graph recorder, 

a digital type, a meter readout, a combination graph recorder or 

combination meter readout.97

Revenues from the excise tax on sport fishing equipment are deposited in the Sport Fishing Account of the Aquatic Resources 

Trust Fund. Monies in the fund are spent, subject to an existing 

permanent appropriation, to support Federal-State sport fish enhancement and safety programs. 

REASONS FOR CHANGE

The Committee observes that the current exemption for certain 

forms of sonar devices has the effect of exempting almost all of the 

devices currently on the market. The Committee understands that 

only one form of sonar device is not exempt from the tax, those 

units utilizing light-emitting diode (‘‘LED’’) display technology. The 

Committee understands that LED devices are currently not exempt 

from the tax because the technology was developed after the exemption for the other technologies was enacted. In the Committee’s 

view, the application of the tax to LED display devices, and not to 

devices performing the same function with a different technology, 

creates an unfair advantage for the exempt devices. Because most 

of the devices on the market already are exempt, the Committee 

believes it is appropriate to level the playing field by repealing the 

tax imposed on all sonar devices suitable for finding fish. The Committee believes this is a more suitable solution than exempting a 

device from the tax based on the type of technology used. 

EXPLANATION OF PROVISION

The provision repeals the excise tax on all sonar devices suitable 

for finding fish. 

EFFECTIVE DATE

The provision is effective for articles sold by the manufacturer, 

producer, or importer after December 31, 2004. 

12. Income tax credit for cost of carrying tax-paid distilled spirits 

in wholesale inventories (sec. 292 of the bill and new sec. 5011 

of the Code) 

PRESENT LAW

As is true of most major Federal excise taxes, the excise tax on 

distilled spirits is imposed at a point in the chain of distribution 

before the product reaches the retail (consumer) level. Tax on domestically produced and/or bottled distilled spirits arises upon production (receipt) in a bonded distillery and is collected based on removals from the distillery during each semi-monthly period. Distilled spirits that are bottled before importation into the United 

173

98Distilled spirits that are imported in bulk and then bottled domestically qualify as domestically bottled distilled spirits. 

States are taxed on removal from the first U.S. warehouse where 

they are landed (including a warehouse located in a foreign trade 

zone).

No tax credits are allowed under present law for business costs 

associated with having tax-paid products in inventory. Rather, excise tax that is included in the purchase price of a product is treated the same as the other components of the product cost, i.e., deductible as a cost of goods sold. 

REASONS FOR CHANGE

Under current law, wholesale importers of distilled spirits are 

not required to pay the Federal excise tax on imported spirits until 

after the product is removed from a bonded warehouse for sale to 

a retailer. In contrast, the tax on domestically produced spirits is 

included as part of the purchase price and passed on from the supplier to wholesaler. It is the Committee’s understanding that in 

some instances, wholesalers can carry this tax-paid inventory for 

an average of 60 days before selling it to a retailer. To provide 

equivalent tax treatment of domestic and imported product, the 

Committee believes it is appropriate to provide an income tax credit to approximate the interest charge—more commonly referred to 

as float—that results from carrying tax-paid distilled spirits in inventory. 

EXPLANATION OF PROVISION

The provision creates a new income tax credit for eligible wholesale distributors of distilled spirits. An eligible wholesaler is any 

person who holds a permit under the Federal Alcohol Administration Act as a wholesaler of distilled spirits. 

The credit is calculated by multiplying the number of cases of 

bottled distilled spirits by the average tax-financing cost per case 

for the most recent calendar year ending before the beginning of 

such taxable year. A case is 12 80-proof 750-milliliter bottles. The 

average tax-financing cost per case is the amount of interest that 

would accrue at corporate overpayment rates during an assumed 

60-day holding period on an assumed tax rate of $22.83 per case 

of 12 750-milliliter bottles. 

The credit only applies to domestically bottled distilled spirits 98

purchased directly from the bottler of such spirits. The credit is in 

addition to present-law rules allowing tax included in inventory 

costs to be deducted as a cost of goods sold. 

The credit cannot be carried back to a taxable year beginning before January 1, 2005. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2004. 

174

99 A reduced rate of tax in the amount of $500 is imposed on small proprietors. Secs. 5081(b), 

5091(b). 100Secs. 5114, 5124. 101Sec. 5146. 102Sec. 5603. 103Sec. 5117. For example, purchases from a proprietor of a distilled spirits plant at his principal business office would be covered under item (2) since such a proprietor is not subject to 

the special occupational tax on account of sales at his principal business office. Sec. 5113(a). 

Purchases from a State-operated liquor store would be covered under item (3). Sec. 5113(b). 

13. Suspension of occupational taxes relating to distilled spirits, 

wine, and beer (sec. 293 of the bill and new sec. 5148 of the 

Code) 

PRESENT LAW

Under present law, special occupational taxes are imposed on 

producers and others engaged in the marketing of distilled spirits, 

wine, and beer. These excise taxes are imposed as part of a broader 

Federal tax and regulatory engine governing the production and 

marketing of alcoholic beverages. The special occupational taxes 

are payable annually, on July 1 of each year. The present tax rates 

are as follows:

Producers: 99

Distilled spirits and wines (sec. 5081) ............. $1,000 per year, per premise. 

Brewers (sec. 5091) ........................................... $1,000 per year, per premise. 

Wholesale dealers (sec. 5111): 

Liquors, wines, or beer ...................................... $500 per year. 

Retail dealers (sec. 5121): 

Liquors, wines, or beer ...................................... $250 per year. Nonbeverage use of distilled spirits (sec. 5131) ..... $500 per year. 

Industrial use of distilled spirits (sec. 5276) .......... $250 per year. 

The Code requires every wholesale or retail dealer in liquors, 

wine or beer to keep records of their transactions.100 A delegate of 

the Secretary of the Treasury is authorized to inspect the records 

of any dealer during business hours.101 There are penalties for failing to comply with the recordkeeping requirements.102

The Code limits the persons from whom dealers may purchase 

their liquor stock intended for resale. Under the Code, a dealer 

may only purchase from: 

(1) a wholesale dealer in liquors who has paid the special occupational tax as such dealer to cover the place where such 

purchase is made; or 

(2) a wholesale dealer in liquors who is exempt, at the place 

where such purchase is made, from payment of such tax under 

any provision chapter 51 of the Code; or 

(3) a person who is not required to pay special occupational 

tax as a wholesale dealer in liquors.103

In addition, a limited retail dealer (such as a charitable organization selling liquor at a picnic) may lawfully purchase distilled spirits for resale from a retail dealer in liquors.104

Violation of this restriction is punishable by $1,000 fine, imprisonment of one year, or both.105 A violation also makes the alcohol 

subject to seizure and forfeiture.106

REASONS FOR CHANGE

The special occupational tax is not a tax on alcoholic products 

but rather operates as a license fee on businesses. The Committee 

believes that this tax places an unfair burden on business owners. 

However, the Committee recognizes that the recordkeeping and 

175

registration authorities applicable to wholesalers and retailers engaged in such businesses are necessary enforcement tools to ensure 

the protection of the revenue arising from the excise taxes on these 

products. Thus, the Committee believes it appropriate to suspend 

the tax for a three-year period, while retaining present-law recordkeeping and registration requirements. 

EXPLANATION OF PROVISION

Under the provision, the special occupational taxes on producers 

and marketers of alcoholic beverages are suspended for a threeyear period, July 1, 2004 through June 30, 2007. Present law recordkeeping and registration requirements will continue to apply, 

notwithstanding the suspension of the special occupation taxes. In 

addition, during the suspension period, it shall be unlawful for any 

dealer to purchase distilled spirits for resale from any person other 

than a wholesale dealer in liquors who is subject to the recordkeeping requirements, except that a limited retail dealer may purchase distilled spirits for resale from a retail dealer in liquors, as 

permitted under present law. 

EFFECTIVE DATE

The provision is effective on the date of enactment.

14. Exclusion of certain indebtedness of small business investment 

companies from acquisition indebtedness (sec. 294 of the bill 

and sec. 514 of the Code) 

PRESENT LAW

In general, an organization that is otherwise exempt from Federal income tax is taxed on income from a trade or business that 

is unrelated to the organization’s exempt purposes. Certain types 

of income, such as rents, royalties, dividends, and interest, generally are excluded from unrelated business taxable income except 

when such income is derived from ‘‘debt-financed property.’’ Debtfinanced property generally means any property that is held to 

produce income and with respect to which there is acquisition indebtedness at any time during the taxable year. 

In general, income of a tax-exempt organization that is produced 

by debt-financed property is treated as unrelated business income 

in proportion to the acquisition indebtedness on the income-producing property. Acquisition indebtedness generally means the 

amount of unpaid indebtedness incurred by an organization to acquire or improve the property and indebtedness that would not 

have been incurred but for the acquisition or improvement of the 

property. Acquisition indebtedness does not include, however, (1) 

certain indebtedness incurred in the performance or exercise of a 

purpose or function constituting the basis of the organization’s exemption, (2) obligations to pay certain types of annuities, (3) an obligation, to the extent it is insured by the Federal Housing Administration, to finance the purchase, rehabilitation, or construction of 

housing for low and moderate income persons, or (4) indebtedness 

incurred by certain qualified organizations to acquire or improve 

real property. An extension, renewal, or refinancing of an obligation evidencing a pre-existing indebtedness is not treated as the 

creation of a new indebtedness. 

176

Special rules apply in the case of an exempt organization that 

owns a partnership interest in a partnership that holds debt-financed income-producing property. An exempt organization’s share 

of partnership income that is derived from such debt-financed property generally is taxed as debt-financed income unless an exception 

provides otherwise. 

REASONS FOR CHANGE

Small business investment companies obtain financial assistance 

from the Small Business Administration in the form of equity or 

by incurring indebtedness that is held or guaranteed by the Small 

Business Administration pursuant to the Small Business Investment Act of 1958. Tax-exempt organizations that invest in small 

business investment companies who are treated as partnerships 

and who incur indebtedness that is held or guaranteed by the 

Small Business Administration may be subject to unrelated business income tax on their distributive shares of income from the 

small business investment company. The Committee believes that 

the imposition of unrelated business income tax in such cases creates a disincentive for tax-exempt organizations to invest in small 

business investment companies, thereby reducing the amount of investment capital that may be provided by small business investment companies to the nation’s small businesses. The Committee 

believes, however, that ownership limitations on the percentage interests that may be held by exempt organizations are appropriate 

to prevent all or most of a small business investment company’s income from escaping Federal income tax. 

EXPLANATION OF PROVISION

The provision modifies the debt-financed property provisions by 

excluding from the definition of acquisition indebtedness any indebtedness incurred by a small business investment company licensed under the Small Business Investment Act of 1958 that is 

evidenced by a debenture (1) issued by such company under section 

303(a) of said Act, and (2) held or guaranteed by the Small Business Administration. The exclusion shall not apply during any period that any exempt organization (other than a governmental unit) 

owns more than 25 percent of the capital or profits interest in the 

small business investment company, or exempt organizations (including governmental units other than any agency or instrumentality of the United States) own, in the aggregate, 50 percent or 

more of the capital or profits interest in such company. 

EFFECTIVE DATE

The provision is effective for small business investment companies formed after the date of enactment. 

15. Election to determine taxable income from certain international 

shipping activities using per ton rate (sec. 295 of the bill and 

new secs. 1352–1359 of the Code) 

PRESENT LAW

The United States employs a ‘‘worldwide’’ tax system, under 

which domestic corporations generally are taxed on all income, including income from shipping operations, whether derived in the 

177

United States or abroad. In order to mitigate double taxation, a foreign tax credit for income taxes paid to foreign countries is provided to reduce or eliminate the U.S. tax owed on such income, 

subject to certain limitations. 

Generally, the United States taxes foreign corporations only on 

income that has a sufficient nexus to the United States. Thus, a 

foreign corporation is generally subject to U.S. tax only on income, 

including income from shipping operations, which is ‘‘effectively 

connected’’ with the conduct of a trade or business in the United 

States (sec. 882). Such ‘‘effectively connected income’’ generally is 

taxed in the same manner and at the same rates as the income of 

a U.S. corporation. 

The United States imposes a four percent tax on the amount of 

a foreign corporation’s U.S. gross transportation income (sec. 887). 

Transportation income includes income from the use (or hiring or 

leasing for use) of a vessel and income from services directly related to the use of a vessel. Fifty percent of the transportation income attributable to transportation that either begins or ends (but 

not both) in the United States is treated as U.S. source gross transportation income. The tax does not apply, however, to U.S. gross 

transportation income that is treated as income effectively connected with the conduct of a U.S. trade or business. U.S. gross 

transportation income is not treated as effectively connected income unless (1) the taxpayer has a fixed place of business in the 

United States involved in earning the income, and (2) substantially 

all the income is attributable to regularly scheduled transportation.

The taxes imposed by sections 882 and 887 on income from shipping operations may be limited by an applicable U.S. income tax 

treaty or by an exemption of a foreign corporation’s international 

shipping operations income in instances where a foreign country 

grants an equivalent exemption (sec. 883). 

Under present law, there is no provision that provides an alternative to the corporate income tax for taxable income attributable 

to international shipping activities. 

REASONS FOR CHANGE

In general, operators of U.S.-flag vessels in international trade 

are subject to higher taxes than their foreign-based competition. 

The uncompetitive U.S. taxation of shipping income has caused a 

steady and substantial decline of the U.S. shipping industry. The 

Committee believes that this provision will provide operators of 

U.S.-flag vessels in international trade the opportunity to be competitive with their tax-advantaged foreign competitors. 

EXPLANATION OF PROVISION

In general 

The provision generally allows corporations to elect a ‘‘tonnage 

tax’’ on their taxable income from certain shipping activities in lieu 

of the U.S. corporate income tax. Accordingly, a corporation’s income from qualifying shipping activities is no longer taxable under 

sections 11, 55, 882, 887 or 1201(a) under the regime, and electing 

entities are only subject to tax at the maximum corporate income 

tax rate on a notional amount based on the net tonnage of a corporation’s qualifying vessels. However, a foreign corporation is not 

178

107The ‘‘corporate income percentage’’ is the least aggregate share, expressed as a percentage, 

of any item of income or gain of an electing corporation, or an electing group (i.e., a controlled 

group of which one or more members is an electing entity) of which such corporation is a member from qualifying shipping activities that would otherwise be required to be reported on the 

U.S. Federal income tax return of an electing corporation during any taxable period. A ‘‘con- trolled group’’ is any group of trusts and business entities whose members would be treated as 

a single employer under the rules of section 52(a) (without regard to paragraphs (1) and (2) and 

section 52(b)(1)). 108The ‘‘daily notional taxable income’’ from the operation of a qualifying vessel is 40 cents 

for each 100 tons of the net tonnage of the vessel (up to 25,000 net tons), and 20 cents for each 

100 tons of the net tonnage of the vessel, in excess of 25,000 net tons. 109 ‘‘U.S. foreign trade’’ means the transportation of goods or passengers between a place in 

the United States and a foreign place or between foreign places. As a general rule, the temporary operation in the U.S. domestic trade (i.e., the transportation of goods or passengers between places in the United States) of any qualifying vessel is disregarded. However, a vessel 

that is no longer used for operations in U.S. foreign trade (unless such non-use is on a temporary basis) ceases to be a qualifying vessel when such non-use begins. 110 If there are multiple operators of a vessel, the taxable income of such vessel must be allocated among such persons on the basis of their ownership and charter interests or another basis 

that Treasury may prescribe in regulations. 

subject to tax under the tonnage tax regime to the extent its income from qualifying shipping activities is subject to an exclusion 

for certain shipping operations by foreign corporations pursuant to 

section 883(a)(1) or pursuant to a treaty obligation of the United 

States. 

Taxable income from qualifying shipping activities 

Generally, the taxable income of an electing corporation from 

qualifying shipping activities is the corporate income percentage 107

of the sum of the taxable income from each of its qualifying vessels. 

The taxable income from each qualifying vessel is the product of (1) 

the daily notional taxable income 108 from the operation of the 

qualifying vessel in United States foreign trade,109 and (2) the 

number of days during the taxable year that the electing entity operated such vessel as a qualifying vessel in U.S. foreign trade.110

A ‘‘qualifying vessel’’ is described as a self-propelled U.S.-flag vessel 

of not less than 10,000 deadweight tons used in U.S. foreign trade. 

An entity’s qualifying shipping activities consist of its (1) core 

qualifying activities, (2) qualifying secondary activities, and (3) 

qualifying incidental activities. Generally, core qualifying activities 

are activities from operating vessels in U.S. foreign trade and other 

activities of an electing entity and an electing group that are an integral part of the business of operating qualifying vessels in U.S. 

foreign trade. Qualifying secondary activities generally consist of 

the active management or operation of vessels in U.S. foreign trade 

and provisions for vessel, container and cargo-related facilities or 

such other activities as may be prescribed by the Secretary (which 

are not core activities), and may not exceed 20 percent of the aggregate gross income derived from electing entities and other members 

of its electing group from their core qualifying activities. Qualifying 

incidental activities are activities that are incidental to core qualifying activities and are not qualifying secondary activities. The aggregate gross income from qualifying incidental activities cannot 

exceed one-tenth of one percent of the aggregate gross income from 

the core qualifying activities of the electing entities and other 

members of its electing group. 

Items not subject to corporate income tax 

Generally, gross income from an electing entity does not include 

the corporate income percentage of an entity’s (1) income from 

179

111 ‘‘Qualifying shipping assets’’ means any qualifying vessel and other assets which are used 

in core qualifying activities. 112 ‘‘Corporate loss percentage’’ means the greatest aggregate share, expressed as a percentage, of any item of loss, deduction or credit of an electing corporation or electing group of which 

such corporation is a member from qualifying shipping activities that would otherwise be required to be reported on the U.S. Federal income tax return of an electing corporation during 

any taxable period. 

qualifying shipping activities in U.S. foreign trade, (2) income from 

money, bank deposits and other temporary investments which are 

reasonably necessary to meet the working capital requirements of 

its qualifying shipping activities, and (3) income from money or 

other intangible assets accumulated pursuant to a plan to purchase 

qualifying shipping assets.111 Generally, the corporate loss percentage 112 of each item of loss, deduction, or credit is disallowed with 

respect to any activity the income from which is excluded from 

gross income under the provision. The corporate loss percentage of 

an electing entity’s interest expense is disallowed in the ratio that 

the fair market value of its qualifying shipping assets bears to the 

fair market value of its total assets. 

Allocation of credits, income and deductions 

No deductions are allowed against the taxable income of an electing corporation from qualifying shipping activities, and no credit is 

allowed against the tax imposed under the tonnage tax regime. No 

deduction is allowed for any net operating loss attributable to the 

qualifying shipping activities of a corporation to the extent that 

such loss is carried forward by the corporation from a taxable year 

preceding the first taxable year for which such corporation was an 

electing corporation. For purposes of the provision, section 482 applies to a transaction or series of transactions between an electing 

entity and another person or between an entity’s qualifying shipping activities and other activities carried on by it. The qualifying 

shipping activities of an electing entity shall be treated as a separate trade or business activity from all other activities conducted 

by the entity. 

Qualifying shipping assets 

If an electing entity sells or disposes of qualifying shipping assets 

in an otherwise taxable transaction, at the election of the entity no 

gain is recognized if replacement qualifying shipping assets are acquired during a limited replacement period except to the extent 

that the amount realized upon such sale or disposition exceeds the 

cost of the replacement qualifying shipping assets. In the case of 

replacement qualifying shipping assets purchased by an electing 

entity which results in the nonrecognition of any part of the gain 

realized as the result of a sale or other disposition of qualifying 

shipping assets, the basis is the cost of such replacement property 

decreased in the amount of gain not recognized. If the property 

purchased consists of more than one piece of property, the basis is 

allocated to the purchased properties in proportion to their respective costs. 

The election not to recognize gain on the disposition and replacement of qualifying shipping assets is not available if the replacement qualifying shipping assets are acquired from a related person 

except to the extent that the related person (as defined under section 267(b) or 707(b)(1)) acquired the replacement qualifying shipVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00181 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.004 HR548P1
180

113 An entity is generally treated as operating any vessel owned by or chartered to the entity. 

However, an entity is treated as operating a vessel that it has chartered out on bareboat basis 

only if: (1) the vessel is temporarily surplus to the entity’s requirements and the term of the 

charter does not exceed three years or (2) the vessel is bareboat chartered to a member of a 

controlled group which includes such entity or to an unrelated third party that sub-bareboats 

or time charters the vessel to a member of such controlled group (including the owner). Special 

rules apply in an instance in which an electing entity temporarily ceases to operate a qualifying 

vessel. 

ping assets from an unrelated person during a limited replacement 

period. 

Election 

Generally, any qualifying entity may elect into the tonnage tax 

regime by filing an election with the qualifying entity’s income tax 

return for the first taxable year to which the election applies. However, a qualifying entity, which is a member of a controlled group, 

may only make an election into the tonnage tax regime if all qualifying entities that are members of the controlled group make such 

an election. Once made, an election is effective for the taxable year 

in which it was made and for all succeeding taxable years of the 

entity until the election is terminated. An election may be terminated if the entity ceases to be a qualifying entity or if the election 

is revoked. In the event that a qualifying entity elects into the tonnage tax regime and subsequently revokes the election, such entity 

is barred from electing back into the regime until the fifth taxable 

year after the termination is effective, unless the Secretary of the 

Treasury consents to the election. 

A qualifying entity means a trust or business entity that (1) operates one or more qualifying vessels and (2) meets the ‘‘shipping 

activity requirement.’’ 113 The shipping activity requirement is met 

for a taxable year only by an entity that meets one of the following 

requirements: (1) in the first taxable year of its election into the 

tonnage tax regime, for the preceding taxable year on average at 

least 25 percent of the aggregate tonnage of the qualifying vessels 

which were operated by the entity were owned by the entity or 

bareboat chartered to the entity; (2) in the second or any subsequent taxable year of its election into the tonnage tax regime, in 

each of the two preceding taxable years on average at least 25 percent of the aggregate tonnage of the qualifying vessels which were 

operated by the entity were owned by the entity or bareboat chartered to the entity; or (3) requirements (1) or (2) above would be 

met if the 25 percent average tonnage requirement was applied on 

an aggregate basis to the controlled group of which such entity is 

a member, and vessel charters between members of the controlled 

group were disregarded. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after the 

date of enactment. 

181

114Treas. Reg. sec. 1.170A–1(g). 

16. Charitable contribution deduction for certain expenses in support of native Alaskan subsistence whaling (sec. 296 of the bill 

and sec. 170 of the Code) 

PRESENT LAW

In computing taxable income, individuals who do not elect the 

standard deduction may claim itemized deductions, including a deduction (subject to certain limitations) for charitable contributions 

or gifts made during the taxable year to a qualified charitable organization or governmental entity. Individuals who elect the standard 

deduction may not claim a deduction for charitable contributions 

made during the taxable year. 

No charitable contribution deduction is allowed for a contribution 

of services. However, unreimbursed expenditures made incident to 

the rendition of services to an organization, contributions to which 

are deductible, may constitute a deductible contribution.114 Specifically, section 170(j) provides that no charitable contribution deduction is allowed for traveling expenses (including amounts expended 

for meals and lodging) while away from home, whether paid directly or by reimbursement, unless there is no significant element 

of personal pleasure, recreation, or vacation in such travel. 

REASONS FOR CHANGE

The Committee believes that subsistence bowhead whale hunting 

activities are important to certain native peoples of Alaska and further charitable purposes. The Committee believes that certain expenses paid by individuals recognized as whaling captains by the 

Alaska Eskimo Whaling Commission in the conduct of sanctioned 

whaling activities conducted pursuant to the management plan of 

that Commission should be deductible expenses. 

EXPLANATION OF PROVISION

The provision allows individuals to claim a deduction under sec- tion 170 not exceeding $10,000 per taxable year for certain expenses incurred in carrying out sanctioned whaling activities. The 

deduction is available only to an individual who is recognized by 

the Alaska Eskimo Whaling Commission as a whaling captain 

charged with the responsibility of maintaining and carrying out 

sanctioned whaling activities. The deduction is available for reasonable and necessary expenses paid by the taxpayer during the taxable year for: (1) the acquisition and maintenance of whaling boats, 

weapons, and gear used in sanctioned whaling activities; (2) the 

supplying of food for the crew and other provisions for carrying out 

such activities; and (3) the storage and distribution of the catch 

from such activities. The Committee intends that the Secretary 

shall require that the taxpayer substantiate deductible expenses by 

maintaining appropriate written records that show, for example, 

the time, place, date, amount, and nature of the expense, as well 

as the taxpayer’s eligibility for the deduction, and that such substantiation be provided as part of the taxpayer’s income tax return, 

to the extent provided by the Secretary. 

For purposes of the provision, the term ‘‘sanctioned whaling activities’’ means subsistence bowhead whale hunting activities conVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00183 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.004 HR548P1
182

115 However, exceptions to the fungibility principle are provided in particular cases, some of 

which are described below. 

ducted pursuant to the management plan of the Alaska Eskimo 

Whaling Commission. 

EFFECTIVE DATE

The provision is effective for contributions made after December 

31, 2004.

TITLE III—TAX REFORM AND SIMPLIFICATION FOR UNITED 

STATES BUSINESSES 

A. INTEREST EXPENSE ALLOCATION RULES

(Sec. 301 of the bill and sec. 864 of the Code) 

PRESENT LAW

In general 

In order to compute the foreign tax credit limitation, a taxpayer 

must determine the amount of its taxable income from foreign 

sources. Thus, the taxpayer must allocate and apportion deductions 

between items of U.S.-source gross income, on the one hand, and 

items of foreign-source gross income, on the other. 

In the case of interest expense, the rules generally are based on 

the approach that money is fungible and that interest expense is 

properly attributable to all business activities and property of a 

taxpayer, regardless of any specific purpose for incurring an obligation on which interest is paid.115 For interest allocation purposes, 

the Code provides that all members of an affiliated group of corporations generally are treated as a single corporation (the socalled ‘‘one-taxpayer rule’’) and allocation must be made on the 

basis of assets rather than gross income. 

Affiliated group 

In general 

The term ‘‘affiliated group’’ in this context generally is defined by 

reference to the rules for determining whether corporations are eligible to file consolidated returns. However, some groups of corporations are eligible to file consolidated returns yet are not treated as 

affiliated for interest allocation purposes, and other groups of corporations are treated as affiliated for interest allocation purposes 

even though they are not eligible to file consolidated returns. Thus, 

under the one-taxpayer rule, the factors affecting the allocation of 

interest expense of one corporation may affect the sourcing of taxable income of another, related corporation even if the two corporations do not elect to file, or are ineligible to file, consolidated returns. 

Definition of affiliated group—consolidated return rules 

For consolidation purposes, the term ‘‘affiliated group’’ means one 

or more chains of includible corporations connected through stock 

ownership with a common parent corporation which is an includible corporation, but only if: (1) the common parent owns directly 

stock possessing at least 80 percent of the total voting power and 

183

116One such exception is that the affiliated group for interest allocation purposes includes section 936 corporations that are excluded from the consolidated group. 

at least 80 percent of the total value of at least one other includible 

corporation; and (2) stock meeting the same voting power and value 

standards with respect to each includible corporation (excluding the 

common parent) is directly owned by one or more other includible 

corporations. 

Generally, the term ‘‘includible corporation’’ means any domestic 

corporation except certain corporations exempt from tax under section 501 (for example, corporations organized and operated exclusively for charitable or educational purposes), certain life insurance 

companies, corporations electing application of the possession tax 

credit, regulated investment companies, real estate investment 

trusts, and domestic international sales corporations. A foreign corporation generally is not an includible corporation. 

Definition of affiliated group—special interest allocation rules 

Subject to exceptions, the consolidated return and interest allocation definitions of affiliation generally are consistent with each 

other.116 For example, both definitions generally exclude all foreign 

corporations from the affiliated group. Thus, while debt generally 

is considered fungible among the assets of a group of domestic affiliated corporations, the same rules do not apply as between the 

domestic and foreign members of a group with the same degree of 

common control as the domestic affiliated group. 

Banks, savings institutions, and other financial affiliates 

The affiliated group for interest allocation purposes generally excludes what are referred to in the Treasury regulations as ‘‘financial corporations’’ (Treas. Reg. sec. 1.861–11T(d)(4)). These include 

any corporation, otherwise a member of the affiliated group for consolidation purposes, that is a financial institution (described in section 581 or section 591), the business of which is predominantly 

with persons other than related persons or their customers, and 

which is required by State or Federal law to be operated separately 

from any other entity which is not a financial institution (sec. 

864(e)(5)(C)). The category of financial corporations also includes, 

to the extent provided in regulations, bank holding companies (including financial holding companies), subsidiaries of banks and 

bank holding companies (including financial holding companies), 

and savings institutions predominantly engaged in the active conduct of a banking, financing, or similar business (sec. 864(e)(5)(D)). 

A financial corporation is not treated as a member of the regular 

affiliated group for purposes of applying the one-taxpayer rule to 

other non-financial members of that group. Instead, all such financial corporations that would be so affiliated are treated as a separate single corporation for interest allocation purposes. 

REASONS FOR CHANGE

The Committee observes that the United States is the only country that currently imposes harsh and anti-competitive interest expense allocation rules on its businesses and workers. The presentlaw interest expense allocation rules result in U.S. companies allocating a portion of their U.S. interest expense against foreignVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00185 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.004 HR548P1
184

117For purposes of determining the assets of the worldwide affiliated group, neither stock in 

corporations within the group nor indebtedness (including receivables) between members of the 

group is taken into account. It is anticipated that the Treasury Secretary will adopt regulations 

addressing the allocation and apportionment of interest expense on such indebtedness that follow principles analogous to those of existing regulations. Income from holding stock or indebtedness of another group member is taken into account for all purposes under the present-law rules 

of the Code, including the foreign tax credit provisions. 118 Although the interest expense of a foreign subsidiary is taken into account for purposes 

of allocating the interest expense of the domestic members of the electing worldwide affiliated 

group for foreign tax credit limitation purposes, the interest expense incurred by a foreign subsidiary is not deductible on a U.S. return. 119The provision expands the definition of an affiliated group for interest expense allocation 

purposes to include certain insurance companies that are generally excluded from an affiliated 

group under section 1504(b)(2) (without regard to whether such companies are covered by an 

election under section 1504(c)(2)). 120 Indirect ownership is determined under the rules of section 958(a)(2) or through applying 

rules similar to those of section 958(a)(2) to stock owned directly or indirectly by domestic partnerships, trusts, or estates. 

source income, even when the foreign operation has its own debt. 

The tax effect of this rule is that U.S. companies end up paying 

double tax. The practical effect is that the cost for U.S. companies 

to borrow in the United States is increased and it becomes more 

expensive to invest in the United States. The Committee believes 

that these rules should be modified so that U.S. companies are not 

discouraged from investing in the United States. To this end, U.S. 

companies should not be required to allocate U.S. interest expense 

against foreign-source income (and thereby incur double taxation) 

unless their debt-to-asset ratio is higher in the United States than 

in foreign countries. 

EXPLANATION OF PROVISION

In general 

The provision modifies the present-law interest expense allocation rules (which generally apply for purposes of computing the foreign tax credit limitation) by providing a one-time election under 

which the taxable income of the domestic members of an affiliated 

group from sources outside the United States generally is determined by allocating and apportioning interest expense of the domestic members of a worldwide affiliated group on a worldwidegroup basis (i.e., as if all members of the worldwide group were a 

single corporation). If a group makes this election, the taxable income of the domestic members of a worldwide affiliated group from 

sources outside the United States is determined by allocating and 

apportioning the third-party interest expense of those domestic 

members to foreign-source income in an amount equal to the excess 

(if any) of (1) the worldwide affiliated group’s worldwide third-party 

interest expense multiplied by the ratio which the foreign assets of 

the worldwide affiliated group bears to the total assets of the 

worldwide affiliated group,117 over (2) the third-party interest expense incurred by foreign members of the group to the extent such 

interest would be allocated to foreign sources if the provision’s principles were applied separately to the foreign members of the 

group.118

For purposes of the new elective rules based on worldwide 

fungibility, the worldwide affiliated group means all corporations in 

an affiliated group (as that term is defined under present law for 

interest allocation purposes) 119 as well as all controlled foreign corporations that, in the aggregate, either directly or indirectly,120

would be members of such an affiliated group if section 1504(b)(3) 

185

121See Treas. Reg. sec. 1.904–4(e)(2).

did not apply (i.e., in which at least 80 percent of the vote and 

value of the stock of such corporations is owned by one or more 

other corporations included in the affiliated group). Thus, if an affiliated group makes this election, the taxable income from sources 

outside the United States of domestic group members generally is 

determined by allocating and apportioning interest expense of the 

domestic members of the worldwide affiliated group as if all of the 

interest expense and assets of 80-percent or greater owned domestic corporations (i.e., corporations that are part of the affiliated 

group under present-law section 864(e)(5)(A) as modified to include 

insurance companies) and certain controlled foreign corporations 

were attributable to a single corporation. 

In addition, if an affiliated group elects to apply the new elective 

rules based on worldwide fungibility, the present-law rules regarding the treatment of tax-exempt assets and the basis of stock in 

nonaffiliated ten-percent owned corporations apply on a worldwide 

affiliated group basis. 

The common parent of the domestic affiliated group must make 

the worldwide affiliated group election. It must be made for the 

first taxable year beginning after December 31, 2008, in which a 

worldwide affiliated group exists that includes at least one foreign 

corporation that meets the requirements for inclusion in a worldwide affiliated group. Once made, the election applies to the common parent and all other members of the worldwide affiliated 

group for the taxable year for which the election was made and all 

subsequent taxable years, unless revoked with the consent of the 

Secretary of the Treasury. 

Financial institution group election 

The provision allows taxpayers to apply the present-law bank 

group rules to exclude certain financial institutions from the affiliated group for interest allocation purposes under the worldwide 

fungibility approach. The provision also provides a one-time ‘‘financial institution group’’ election that expands the present-law bank 

group. Under the provision, at the election of the common parent 

of the pre-election worldwide affiliated group, the interest expense 

allocation rules are applied separately to a subgroup of the worldwide affiliated group that consists of (1) all corporations that are 

part of the present-law bank group, and (2) all ‘‘financial corporations.’’ For this purpose, a corporation is a financial corporation if 

at least 80 percent of its gross income is financial services income 

(as described in section 904(d)(2)(C)(i) and the regulations thereunder) that is derived from transactions with unrelated persons.121

For these purposes, items of income or gain from a transaction or 

series of transactions are disregarded if a principal purpose for the 

transaction or transactions is to qualify any corporation as a financial corporation. 

The common parent of the pre-election worldwide affiliated group 

must make the election for the first taxable year beginning after 

December 31, 2008, in which a worldwide affiliated group includes 

a financial corporation. Once made, the election applies to the financial institution group for the taxable year and all subsequent 

taxable years. In addition, the provision provides anti-abuse rules 

186

under which certain transfers from one member of a financial institution group to a member of the worldwide affiliated group outside 

of the financial institution group are treated as reducing the 

amount of indebtedness of the separate financial institution group. 

The provision provides regulatory authority with respect to the 

election to provide for the direct allocation of interest expense in 

circumstances in which such allocation is appropriate to carry out 

the purposes of the provision, prevent assets or interest expense 

from being taken into account more than once, or address changes 

in members of any group (through acquisitions or otherwise) treated as affiliated under this provision. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2008. 

B. RECHARACTERIZATION OF OVERALL DOMESTIC LOSS

(Sec. 302 of the bill and sec. 904 of the Code) 

PRESENT LAW

The United States provides a credit for foreign income taxes paid 

or accrued. The foreign tax credit generally is limited to the U.S. 

tax liability on a taxpayer’s foreign-source income, in order to ensure that the credit serves the purpose of mitigating double taxation of foreign-source income without offsetting the U.S. tax on 

U.S.-source income. This overall limitation is calculated by prorating a taxpayer’s pre-credit U.S. tax on its worldwide income between its U.S.-source and foreign-source taxable income. The ratio 

(not exceeding 100 percent) of the taxpayer’s foreign-source taxable 

income to worldwide taxable income is multiplied by its pre-credit 

U.S. tax to establish the amount of U.S. tax allocable to the taxpayer’s foreign-source income and, thus, the upper limit on the foreign tax credit for the year. 

In addition, this limitation is calculated separately for various 

categories of income, generally referred to as ‘‘separate limitation 

categories.’’ The total amount of the foreign tax credit used to offset 

the U.S. tax on income in each separate limitation category may 

not exceed the proportion of the taxpayer’s U.S. tax which the taxpayer’s foreign-source taxable income in that category bears to its 

worldwide taxable income. 

If a taxpayer’s losses from foreign sources exceed its foreignsource income, the excess (‘‘overall foreign loss,’’ or ‘‘OFL’’) may offset U.S.-source income. Such an offset reduces the effective rate of 

U.S. tax on U.S.-source income. 

In order to eliminate a double benefit (that is, the reduction of 

U.S. tax previously noted and, later, full allowance of a foreign tax 

credit with respect to foreign-source income), present law includes 

an OFL recapture rule. Under this rule, a portion of foreign-source 

taxable income earned after an OFL year is recharacterized as 

U.S.-source taxable income for foreign tax credit purposes (and for 

purposes of the possessions tax credit). Unless a taxpayer elects a 

higher percentage, however, generally no more than 50 percent of 

the foreign-source taxable income earned in any particular taxable 

year is recharacterized as U.S.-source taxable income. The effect of 

187

the recapture is to reduce the foreign tax credit limitation in one 

or more years following an OFL year and, therefore, the amount 

of U.S. tax that can be offset by foreign tax credits in the later year 

or years. 

Losses for any taxable year in separate foreign limitation categories (to the extent that they do not exceed foreign income for the 

year) are apportioned on a proportionate basis among (and operate 

to reduce) the foreign income categories in which the entity earns 

income in the loss year. A separate limitation loss recharacterization rule applies to foreign losses apportioned to foreign income 

pursuant to the above rule. If a separate limitation loss was apportioned to income subject to another separate limitation category 

and the loss category has income for a subsequent taxable year, 

then that income (to the extent that it does not exceed the aggregate separate limitation losses in the loss category not previously 

recharacterized) must be recharacterized as income in the separate 

limitation category that was previously offset by the loss. Such recharacterization must be made in proportion to the prior loss apportionment not previously taken into account. 

A U.S.-source loss reduces pre-credit U.S. tax on worldwide income to an amount less than the hypothetical tax that would apply 

to the taxpayer’s foreign-source income if viewed in isolation. The 

existence of foreign-source taxable income in the year of the U.S.-

source loss reduces or eliminates any net operating loss carryover 

that the U.S.-source loss would otherwise have generated absent 

the foreign income. In addition, as the pre-credit U.S. tax on worldwide income is reduced, so is the foreign tax credit limitation. 

Moreover, any U.S.-source loss for any taxable year is apportioned 

among (and operates to reduce) foreign income in the separate limitation categories on a proportionate basis. As a result, some foreign 

tax credits in the year of the U.S.-source loss must be credited, if 

at all, in a carryover year. Tax on U.S.-source taxable income in 

a subsequent year may be offset by a net operating loss 

carryforward, but not by a foreign tax credit carryforward. There 

is currently no mechanism for recharacterizing such subsequent 

U.S.-source income as foreign-source income. For example, suppose a taxpayer generates a $100 U.S.-source loss and earns $100 of foreign-source income in Year 1, and pays 

$30 of foreign tax on the $100 of foreign-source income. Because 

the taxpayer has no net taxable income in Year 1, no foreign tax 

credit can be claimed in Year 1 with respect to the $30 of foreign 

taxes. If the taxpayer then earns $100 of U.S.-source income and 

$100 of foreign-source income in Year 2, present law does not recharacterize any portion of the $100 of U.S.-source income as foreign-source income to reflect the fact that the previous year’s $100 

U.S.-source loss reduced the taxpayer’s ability to claim foreign tax 

credits. 

REASONS FOR CHANGE

The Committee believes that it is important to create parity in 

the treatment of overall foreign losses and overall domestic losses 

in order to prevent the double taxation of income. The Committee 

believes that preventing double taxation will make U.S. businesses 

more competitive and will lead to increased export sales. The Committee believes that this increase in export sales will increase proVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00189 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.004 HR548P1
188

duction in the United States and increase jobs in the United States 

to support the increased exports. 

EXPLANATION OF PROVISION

The provision applies a re-sourcing rule to U.S.-source income in 

cases in which a taxpayer’s foreign tax credit limitation has been 

reduced as a result of an overall domestic loss. Under the provision, a portion of the taxpayer’s U.S.-source income for each succeeding taxable year is recharacterized as foreign-source income in 

an amount equal to the lesser of: (1) the amount of the 

unrecharacterized overall domestic losses for years prior to such 

succeeding taxable year, and (2) 50 percent of the taxpayer’s U.S.-

source income for such succeeding taxable year. 

The provision defines an overall domestic loss for this purpose as 

any domestic loss to the extent it offsets foreign-source taxable income for the current taxable year or for any preceding taxable year 

by reason of a loss carryback. For this purpose, a domestic loss 

means the amount by which the U.S.-source gross income for the 

taxable year is exceeded by the sum of the deductions properly apportioned or allocated thereto, determined without regard to any 

loss carried back from a subsequent taxable year. Under the provision, an overall domestic loss does not include any loss for any taxable year unless the taxpayer elected the use of the foreign tax 

credit for such taxable year. 

Any U.S.-source income recharacterized under the provision is allocated among and increases the various foreign tax credit separate 

limitation categories in the same proportion that those categories 

were reduced by the prior overall domestic losses, in a manner 

similar to the recharacterization rules for separate limitation 

losses. 

It is anticipated that situations may arise in which a taxpayer 

generates an overall domestic loss in a year following a year in 

which it had an overall foreign loss, or vice versa. In such a case, 

it would be necessary for ordering and other coordination rules to 

be developed for purposes of computing the foreign tax credit limitation in subsequent taxable years. The provision grants the Secretary of the Treasury authority to prescribe such regulations as 

may be necessary to coordinate the operation of the OFL recapture 

rules with the operation of the overall domestic loss recapture rules 

added by the provision. 

EFFECTIVE DATE

The provision applies to losses incurred in taxable years beginning after December 31, 2006.

C. REDUCTION TO TWO FOREIGN TAX CREDIT BASKETS

(Sec. 303 of the bill and sec. 904 of the Code) 

PRESENT LAW

In general 

The United States taxes its citizens and residents on their worldwide income. Because the countries in which income is earned also 

may assert their jurisdiction to tax the same income on the basis 

of source, foreign-source income earned by U.S. persons may be 

189

122Subject to certain exceptions, dividends paid by a 10/50 company in taxable years beginning after December 31, 2002 are subject to either a look-through approach in which the dividend is attributed to a particular limitation category based on the underlying earnings which 

gave rise to the dividend (for post-2002 earnings and profits), or a single-basket limitation approach for dividends from all 10/50 companies that are not passive foreign investment companies (for pre-2003 earnings and profits). Under section 304 of the bill, these dividends are subject to a look-through approach, irrespective of when the underlying earnings and profits arose. 123See, e.g., sec. 56(g)(4)(C)(iii)(IV) (relating to certain dividends from corporations eligible for 

the sec. 936 credit); sec. 245(a)(10) (relating to certain dividends treated as foreign source under 

treaties); sec. 865(h)(1)(B) (relating to certain gains from stock and intangibles treated as foreign 

source under treaties); sec. 901(j)(1)(B) (relating to income from certain specified countries); and 

sec. 904(g)(10)(A) (relating to interest, dividends, and certain other amounts derived from U.S.-

owned foreign corporations and treated as foreign source under treaties). 124Treas. Reg. sec. 1.904–4(e)(3)(i) and (2)(i). 

subject to double taxation. In order to mitigate this possibility, the 

United States provides a credit against U.S. tax liability for foreign 

income taxes paid, subject to a number of limitations. The foreign 

tax credit generally is limited to the U.S. tax liability on a taxpayer’s foreign-source income, in order to ensure that the credit 

serves its purpose of mitigating double taxation of cross-border income without offsetting the U.S. tax on U.S.-source income. 

The foreign tax credit limitation is applied separately to the following categories of income: (1) passive income, (2) high withholding tax interest, (3) financial services income, (4) shipping income, (5) certain dividends received from noncontrolled section 902 

foreign corporations (‘‘10/50 companies’’),122 (6) certain dividends 

from a domestic international sales corporation or former domestic 

international sales corporation, (7) taxable income attributable to 

certain foreign trade income, (8) certain distributions from a foreign sales corporation or former foreign sales corporation, and (9) 

any other income not described in items (1) through (8) (so-called 

‘‘general basket’’ income). In addition, a number of other provisions 

of the Code and U.S. tax treaties effectively create additional separate limitations in certain circumstances.123

Financial services income 

In general, the term ‘‘financial services income’’ includes income 

received or accrued by a person predominantly engaged in the active conduct of a banking, insurance, financing, or similar business, 

if the income is derived in the active conduct of a banking, financing or similar business, or is derived from the investment by an insurance company of its unearned premiums or reserves ordinary 

and necessary for the proper conduct of its insurance business (sec. 

904(d)(2)(C)). The Code also provides that financial services income 

includes income, received or accrued by a person predominantly engaged in the active conduct of a banking, insurance, financing, or 

similar business, of a kind which would generally be insurance income (as defined in section 953(a)), among other items. 

Treasury regulations provide that a person is predominantly engaged in the active conduct of a banking, insurance, financing, or 

similar business for any year if for that year at least 80 percent 

of its gross income is ‘‘active financing income.’’ 124 The regulations 

further provide that a corporation that is not predominantly engaged in the active conduct of a banking, insurance, financing, or 

similar business under the preceding definition can derive financial 

services income if the corporation is a member of an affiliated 

group (as defined in section 1504(a), but expanded to include foreign corporations) that, as a whole, meets the regulatory test of 

190

125Treas. Reg. sec. 1.904–4(e)(3)(ii). 126Treas. Reg. sec. 1.904–6. 127Treas. Reg. sec. 1.904–6(a)(1)(iv). 

being ‘‘predominantly engaged.’’ 125 In determining whether an affiliated group is ‘‘predominantly engaged,’’ only the income of members of the group that are U.S. corporations, or controlled foreign 

corporations in which such U.S. corporations own (directly or indirectly) at least 80 percent of the total voting power and value of 

the stock, are counted. 

‘‘Base difference’’ items 

Under Treasury regulations, foreign taxes are allocated and apportioned to the same limitation categories as the income to which 

they relate.126 In cases in which foreign law imposes tax on an 

item of income that does not constitute income under U.S. tax principles (a ‘‘base difference’’ item), the tax is treated as imposed on 

income in the general limitation category.127

REASONS FOR CHANGE

The Committee believes that requiring taxpayers to separate income and tax credits into nine separate tax baskets creates some 

of the most complex tax reporting and compliance issues in the 

Code. Reducing the number of foreign tax credit baskets to two will 

greatly simplify the Code and undo much of the complexity created 

by the Tax Reform Act of 1986. The Committee believes that simplifying these rules will reduce double taxation, make U.S. businesses more competitive, and create jobs in the United States. 

EXPLANATION OF PROVISION

In general 

The provision generally reduces the number of foreign tax credit 

limitation categories to two: passive category income and general 

category income. Other income is included in one of the two categories, as appropriate. For example, shipping income generally 

falls into the general limitation category, whereas high withholding 

tax interest generally could fall into the passive income or the general limitation category, depending on the circumstances. Dividends from a domestic international sales corporation or former domestic international sales corporation, income attributable to certain foreign trade income, and certain distributions from a foreign 

sales corporation or former foreign sales corporation all are assigned to the passive income limitation category. The provision 

does not affect the separate computation of foreign tax credit limitations under special provisions of the Code relating to, for example, treaty-based sourcing rules or specified countries under section 

901(j). 

Financial services income 

In the case of a member of a financial services group or any 

other person predominantly engaged in the active conduct of a 

banking, insurance, financing or similar business, the provision 

treats income meeting the definition of financial services income as 

general category income. Under the provision, a financial services 

group is an affiliated group that is predominantly engaged in the 

191

128See Treas. Reg. sec. 1.904–4(e). 129See H.R. Rep. No. 99–841, 99th Cong., 2d Sess. II–621 (1986); Staff of the Joint Committee 

on Taxation, 100th Cong., 1st Sess., General Explanation of the Tax Reform Act of 1986, at 984 

(1987). 

active conduct of a banking, insurance, financing or similar business. For this purpose, the definition of an affiliated group under 

section 1504(a) is applied, but expanded to include certain insurance companies (without regard to whether such companies are 

covered by an election under section 1504(c)(2)) and foreign corporations. In determining whether such a group is predominantly 

engaged in the active conduct of a banking, insurance, financing, 

or similar business, only the income of members of the group that 

are U.S. corporations or controlled foreign corporations in which 

such U.S. corporations own (directly or indirectly) at least 80 percent of total voting power and value of the stock are taken into account. 

The provision does not alter the present law interpretation of 

what it means to be a ‘‘person predominantly engaged in the active 

conduct of a banking, insurance, financing, or similar business.’’ 128

Thus, other provisions of the Code that rely on this same concept 

of a ‘‘person predominantly engaged in the active conduct of a 

banking, insurance, financing, or similar business’’ are not affected 

by the provision. For example, under the ‘‘accumulated deficit rule’’

of section 952(c)(1)(B), subpart F income inclusions of a U.S. shareholder attributable to a ‘‘qualified activity’’ of a controlled foreign 

corporation may be reduced by the amount of the U.S. shareholder’s pro rata share of certain prior year deficits attributable to 

the same qualified activity. In the case of a qualified financial institution, qualified activity consists of any activity giving rise to foreign personal holding company income, but only if the controlled 

foreign corporation was predominantly engaged in the active conduct of a banking, financing, or similar business in both the year 

in which the corporation earned the income and the year in which 

the corporation incurred the deficit. Similarly, in the case of a 

qualified insurance company, qualified activity consists of activity 

giving rise to insurance income or foreign personal holding company income, but only if the controlled foreign corporation was predominantly engaged in the active conduct of an insurance business 

in both the year in which the corporation earned the income and 

the year in which the corporation incurred the deficit. For this purpose, ‘‘predominantly engaged in the active conduct of a banking, 

insurance, financing, or similar business’’ is defined under present 

law by reference to the use of the term for purposes of the separate 

foreign tax credit limitations.129 The present-law meaning of ‘‘predominantly engaged’’ for purposes of section 952(c)(1)(B) remains 

unchanged under the provision. 

The provision requires the Treasury Secretary to specify the 

treatment of financial services income received or accrued by passthrough entities that are not members of a financial services group. 

The Committee expects these regulations to be generally consistent 

with regulations currently in effect. 

192

130Dividends paid by a 10/50 company in taxable years beginning before January 1, 2003 are 

subject to a separate foreign tax credit limitation for each 10/50 company. 

‘‘Base difference’’ items 

Creditable foreign taxes that are imposed on amounts that do not 

constitute income under U.S. tax principles are treated as imposed 

on general limitation income. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2006. 

Taxes paid or accrued in a taxable year beginning before January 

1, 2007, and carried to any subsequent taxable year are treated as 

if this provision were in effect on the date such taxes were paid or 

accrued. Thus, such taxes are assigned to one of the two foreign tax 

credit limitation categories, as appropriate. 

The Treasury Secretary is given authority to provide by regulations for the allocation of income with respect to taxes carried back 

to pre-effective-date years (in which more than two limitation categories are in effect).

D. LOOK-THROUGH RULES TO APPLY TO DIVIDENDS FROM

NONCONTROLLED SECTION 902 CORPORATIONS

(Sec. 304 of the bill and sec. 904 of the Code) 

PRESENT LAW

U.S. persons may credit foreign taxes against U.S. tax on foreignsource income. In general, the amount of foreign tax credits that 

may be claimed in a year is subject to a limitation that prevents 

taxpayers from using foreign tax credits to offset U.S. tax on U.S.-

source income. Separate limitations are also applied to specific categories of income. 

Special foreign tax credit limitations apply in the case of dividends received from a foreign corporation in which the taxpayer 

owns at least 10 percent of the stock by vote and which is not a 

controlled foreign corporation (a so-called ‘‘10/50 company’’). Dividends paid by a 10/50 company that is not a passive foreign investment company out of earnings and profits accumulated in taxable 

years beginning before January 1, 2003 are subject to a single foreign tax credit limitation for all 10/50 companies (other than passive foreign investment companies).130 Dividends paid by a 10/50 

company that is a passive foreign investment company out of earnings and profits accumulated in taxable years beginning before 

January 1, 2003, continue to be subject to a separate foreign tax 

credit limitation for each such 10/50 company. Dividends paid by 

a 10/50 company out of earnings and profits accumulated in taxable years after December 31, 2002 are treated as income in a foreign tax credit limitation category in proportion to the ratio of the 

10/50 company’s earnings and profits attributable to income in 

such foreign tax credit limitation category to its total earnings and 

profits (a ‘‘look-through’’ approach). 

For these purposes, distributions are treated as made from the 

most recently accumulated earnings and profits. Regulatory authority is granted to provide rules regarding the treatment of disVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00194 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.004 HR548P1
193

131This look-through treatment also applies to dividends that a controlled foreign corporation 

receives from a 10/50 company and then distributes to a U.S. shareholder. 132 It is anticipated that the Treasury Secretary will reconsider the operation of the foreign 

tax credit regulations to ensure that the high-tax income rules apply appropriately to dividends 

treated as passive category income because of inadequate substantiation. 

tributions out of earnings and profits for periods prior to the taxpayer’s acquisition of such stock. 

REASONS FOR CHANGE

The Committee believes that significant simplification can be 

achieved by eliminating the requirement that taxpayers segregate 

the earnings and profits of 10/50 companies on the basis of when 

such earnings and profits arose. 

EXPLANATION OF PROVISION

The provision generally applies the look-through approach to 

dividends paid by a 10/50 company regardless of the year in which 

the earnings and profits out of which the dividend is paid were accumulated.131 If the Treasury Secretary determines that a taxpayer 

has inadequately substantiated that it assigned a dividend from a 

10/50 company to the proper foreign tax credit limitation category, 

the dividend is treated as passive category income for foreign tax 

credit basketing purposes.132

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2002. 

The provision also provides transition rules regarding the use of 

pre-effective-date foreign tax credits associated with a 10/50 company separate limitation category in post-effective-date years. 

Look-through principles similar to those applicable to post-effective-date dividends from a 10/50 company apply to determine the 

appropriate foreign tax credit limitation category or categories with 

respect to carrying forward foreign tax credits into future years. 

The provision allows the Treasury Secretary to issue regulations 

addressing the carryback of foreign tax credits associated with a 

dividend from a 10/50 company to pre-effective-date years.

E. ATTRIBUTION OF STOCK OWNERSHIP THROUGH PARTNERSHIPS TO

APPLY IN DETERMINING SECTION 902 AND 960 CREDITS

(Sec. 305 of the bill and secs. 901, 902, and 960 of the Code) 

PRESENT LAW

Under section 902, a domestic corporation that receives a dividend from a foreign corporation in which it owns ten percent or 

more of the voting stock is deemed to have paid a portion of the 

foreign taxes paid by such foreign corporation. Thus, such a domestic corporation is eligible to claim a foreign tax credit with respect 

to such deemed-paid taxes. The domestic corporation that receives 

a dividend is deemed to have paid a portion of the foreign corporation’s post-1986 foreign income taxes based on the ratio of the 

amount of the dividend to the foreign corporation’s post-1986 undistributed earnings and profits. 

194

133 Under section 901(b)(5), an individual member of a partnership or a beneficiary of an estate or trust generally may claim a direct foreign tax credit with respect to the amount of his 

or her proportionate share of the foreign taxes paid or accrued by the partnership, estate, or 

trust. This rule does not specifically apply to corporations that are either members of a partnership or beneficiaries of an estate or trust. However, section 702(a)(6) provides that each partner 

(including individuals or corporations) of a partnership must take into account separately its 

distributive share of the partnership’s foreign taxes paid or accrued. In addition, under section 

703(b)(3), the election under section 901 (whether to credit the foreign taxes) is made by each 

partner separately. 134 1971–1 C.B. 211. 135T.D. 8708, 1997–1 C.B. 137. 

Foreign income taxes paid or accrued by lower-tier foreign corporations also are eligible for the deemed-paid credit if the foreign 

corporation falls within a qualified group (sec. 902(b)). A ‘‘qualified 

group’’ includes certain foreign corporations within the first six 

tiers of a chain of foreign corporations if, among other things, the 

product of the percentage ownership of voting stock at each level 

of the chain (beginning from the domestic corporation) equals at 

least five percent. In addition, in order to claim indirect credits for 

foreign taxes paid by certain fourth-, fifth-, and sixth-tier corporations, such corporations must be controlled foreign corporations 

(within the meaning of sec. 957) and the shareholder claiming the 

indirect credit must be a U.S. shareholder (as defined in sec. 

951(b)) with respect to the controlled foreign corporations. The application of the indirect foreign tax credit below the third tier is 

limited to taxes paid in taxable years during which the payor is a 

controlled foreign corporation. Foreign taxes paid below the sixth 

tier of foreign corporations are ineligible for the indirect foreign tax 

credit. 

Section 960 similarly permits a domestic corporation with subpart F inclusions from a controlled foreign corporation to claim 

deemed-paid foreign tax credits with respect to foreign taxes paid 

or accrued by the controlled foreign corporation on its subpart F income. 

The foreign tax credit provisions in the Code do not specifically 

address whether a domestic corporation owning ten percent or 

more of the voting stock of a foreign corporation through a partnership is entitled to a deemed-paid foreign tax credit.133 In Rev. Rul. 

71–141,134 the IRS held that a foreign corporation’s stock held indirectly by two domestic corporations through their interests in a domestic general partnership is attributed to such domestic corporations for purposes of determining the domestic corporations’ eligibility to claim a deemed-paid foreign tax credit with respect to the 

foreign taxes paid by such foreign corporation. Accordingly, a general partner of a domestic general partnership is permitted to claim 

deemed-paid foreign tax credits with respect to a dividend distribution from the foreign corporation to the partnership. 

However, in 1997, the Treasury Department issued final regulations under section 902, and the preamble to the regulations states 

that ‘‘[t]he final regulations do not resolve under what circumstances a domestic corporate partner may compute an amount 

of foreign taxes deemed paid with respect to dividends received 

from a foreign corporation by a partnership or other pass-through 

entity.’’ 135 In recognition of the holding in Rev. Rul. 71–141, the 

preamble to the final regulations under section 902 states that a 

‘‘domestic shareholder’’ for purposes of section 902 is a domestic 

corporation that ‘‘owns’’ the requisite voting stock in a foreign corVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00196 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.004 HR548P1
195

poration rather than one that ‘‘owns directly’’ the voting stock. At 

the same time, the preamble states that the IRS is still considering 

under what other circumstances Rev. Rul. 71–141 should apply. 

Consequently, uncertainty remains regarding whether a domestic 

corporation owning ten percent or more of the voting stock of a foreign corporation through a partnership is entitled to a deemed-paid 

foreign tax credit (other than through a domestic general partnership). 

REASONS FOR CHANGE

The Committee believes that a clarification is appropriate regarding the ability of a domestic corporation owning ten percent or 

more of the voting stock of a foreign corporation through a partnership to claim a deemed-paid foreign tax credit. 

EXPLANATION OF PROVISION

The provision clarifies that a domestic corporation is entitled to 

claim deemed-paid foreign tax credits with respect to a foreign corporation that is held indirectly through a foreign or domestic partnership, provided that the domestic corporation owns (indirectly 

through the partnership) ten percent or more of the foreign corporation’s voting stock. No inference is intended as to the treatment of such deemed-paid foreign tax credits under present law. 

The provision also clarifies that both individual and corporate partners (or estate or trust beneficiaries) may claim direct foreign tax 

credits with respect to their proportionate shares of taxes paid or 

accrued by a partnership (or estate or trust). 

EFFECTIVE DATE

The provision applies to taxes of foreign corporations for taxable 

years of such corporations beginning after the date of enactment.

F. FOREIGN TAX CREDIT TREATMENT OF DEEMED PAYMENTS UNDER

SECTION 367(d) 

(Sec. 306 of the bill and sec. 367 of the Code) 

PRESENT LAW

In the case of transfers of intangible property to foreign corporations by means of contributions and certain other nonrecognition 

transactions, special rules apply that are designed to mitigate the 

tax avoidance that may arise from shifting the income attributable 

to intangible property offshore. Under section 367(d), the outbound 

transfer of intangible property is treated as a sale of the intangible 

for a stream of contingent payments. The amounts of these deemed 

payments must be commensurate with the income attributable to 

the intangible. The deemed payments are included in gross income 

of the U.S. transferor as ordinary income, and the earnings and 

profits of the foreign corporation to which the intangible was transferred are reduced by such amounts. 

The Taxpayer Relief Act of 1997 (the ‘‘1997 Act’’) repealed a rule 

that treated all such deemed payments as giving rise to U.S.-source 

income. Because the foreign tax credit is generally limited to the 

U.S. tax imposed on foreign-source income, the prior-law rule reduced the taxpayer’s ability to claim foreign tax credits. As a result 

196

136Secs. 865(d), 862(a). 137Sec. 904(d). 138Sec. 904(d)(3). 139Secs. 951–964. 140Sec. 951(a)(1)(B). 

of the repeal of the rule, the source of payments deemed received 

under section 367(d) is determined under general sourcing rules. 

These rules treat income from sales of intangible property for contingent payments the same as royalties, with the result that the 

deemed payments may give rise to foreign-source income.136

The 1997 Act did not address the characterization of the deemed 

payments for purposes of applying the foreign tax credit separate 

limitation categories.137 If the deemed payments are treated like 

proceeds of a sale, then they could fall into the passive category; 

if the deemed payments are treated like royalties, then in many 

cases they could fall into the general category (under look-through 

rules applicable to payments of dividends, interest, rents, and royalties received from controlled foreign corporations).138

REASONS FOR CHANGE

The Committee believes that it is appropriate to characterize 

deemed payments under section 367(d) as royalties for purposes of 

applying the separate limitation categories of the foreign tax credit, 

and that this treatment should be effective for all transactions subject to the underlying provision of the 1997 Act. 

EXPLANATION OF PROVISION

The provision specifies that deemed payments under section 

367(d) are treated as royalties for purposes of applying the separate limitation categories of the foreign tax credit. 

EFFECTIVE DATE

The provision is effective for amounts treated as received on or 

after August 5, 1997 (the effective date of the relevant provision of 

the 1997 Act). 

G. UNITED STATES PROPERTY NOT TO INCLUDE CERTAIN ASSETS OF

CONTROLLED FOREIGN CORPORATION

(Sec. 307 of the bill and sec. 956 of the Code) 

PRESENT LAW

In general, the subpart F rules 139 require U.S. shareholders with 

a 10-percent or greater interest in a controlled foreign corporation 

(‘‘U.S. 10-percent shareholders’’) to include in taxable income their 

pro rata shares of certain income of the controlled foreign corporation (referred to as ‘‘subpart F income’’) when such income is 

earned, whether or not the earnings are distributed currently to 

the shareholders. In addition, the U.S. 10-percent shareholders of 

a controlled foreign corporation are subject to U.S. tax on their pro 

rata shares of the controlled foreign corporation’s earnings to the 

extent invested by the controlled foreign corporation in certain U.S. 

property in a taxable year.140

A shareholder’s income inclusion with respect to a controlled foreign corporation’s investment in U.S. property for a taxable year is 

197

141Sec. 956(a). 142Secs. 956 and 959. 143Secs. 951(a)(1)(B) and 959. 144Sec. 956(c)(1). 

based on the controlled foreign corporation’s average investment in 

U.S. property for such year. For this purpose, the U.S. property 

held (directly or indirectly) by the controlled foreign corporation 

must be measured as of the close of each quarter in the taxable 

year.141 The amount taken into account with respect to any property is the property’s adjusted basis as determined for purposes of 

reporting the controlled foreign corporation’s earnings and profits, 

reduced by any liability to which the property is subject. The 

amount determined for inclusion in each taxable year is the shareholder’s pro rata share of an amount equal to the lesser of: (1) the 

controlled foreign corporation’s average investment in U.S. property as of the end of each quarter of such taxable year, to the extent that such investment exceeds the foreign corporation’s earnings and profits that were previously taxed on that basis; or (2) the 

controlled foreign corporation’s current or accumulated earnings 

and profits (but not including a deficit), reduced by distributions 

during the year and by earnings that have been taxed previously 

as earnings invested in U.S. property.142 An income inclusion is required only to the extent that the amount so calculated exceeds the 

amount of the controlled foreign corporation’s earnings that have 

been previously taxed as subpart F income.143

For purposes of section 956, U.S. property generally is defined to 

include tangible property located in the United States, stock of a 

U.S. corporation, an obligation of a U.S. person, and certain intangible assets including a patent or copyright, an invention, model or 

design, a secret formula or process or similar property right which 

is acquired or developed by the controlled foreign corporation for 

use in the United States.144

Specified exceptions from the definition of U.S. property are provided for: (1) obligations of the United States, money, or deposits 

with persons carrying on the banking business; (2) certain export 

property; (3) certain trade or business obligations; (4) aircraft, railroad rolling stock, vessels, motor vehicles or containers used in 

transportation in foreign commerce and used predominantly outside of the United States; (5) certain insurance company reserves 

and unearned premiums related to insurance of foreign risks; (6) 

stock or debt of certain unrelated U.S. corporations; (7) moveable 

property (other than a vessel or aircraft) used for the purpose of 

exploring, developing, or certain other activities in connection with 

the ocean waters of the U.S. Continental Shelf; (8) an amount of 

assets equal to the controlled foreign corporation’s accumulated 

earnings and profits attributable to income effectively connected 

with a U.S. trade or business; (9) property (to the extent provided 

in regulations) held by a foreign sales corporation and related to 

its export activities; (10) certain deposits or receipts of collateral or 

margin by a securities or commodities dealer, if such deposit is 

made or received on commercial terms in the ordinary course of the 

dealer’s business as a securities or commodities dealer; and (11) 

certain repurchase and reverse repurchase agreement transactions 

entered into by or with a dealer in securities or commodities in the 

198

145Sec. 956(c)(2). 

ordinary course of its business as a securities or commodities dealer.145

REASONS FOR CHANGE

The Committee believes that the acquisition of securities by a 

controlled foreign corporation in the ordinary course of its business 

as a securities dealer generally should not give rise to an income 

inclusion as an investment in U.S. property under the provisions 

of subpart F. Similarly, the Committee believes that the acquisition 

by a controlled foreign corporation of obligations issued by unrelated U.S. noncorporate persons generally should not give rise to 

an income inclusion as an investment in U.S. property. 

EXPLANATION OF PROVISION

The provision adds two new exceptions from the definition of 

U.S. property for determining current income inclusion by a U.S. 

10-percent shareholder with respect to an investment in U.S. property by a controlled foreign corporation. 

The first exception generally applies to securities acquired and 

held by a controlled foreign corporation in the ordinary course of 

its trade or business as a dealer in securities. The exception applies 

only if the controlled foreign corporation dealer: (1) accounts for the 

securities as securities held primarily for sale to customers in the 

ordinary course of business; and (2) disposes of such securities (or 

such securities mature while being held by the dealer) within a period consistent with the holding of securities for sale to customers 

in the ordinary course of business. 

The second exception generally applies to the acquisition by a 

controlled foreign corporation of obligations issued by a U.S. person 

that is not a domestic corporation and that is not (1) a U.S. 10-percent shareholder of the controlled foreign corporation, or (2) a partnership, estate or trust in which the controlled foreign corporation 

or any related person is a partner, beneficiary or trustee immediately after the acquisition by the controlled foreign corporation of 

such obligation. 

EFFECTIVE DATE

The provision is effective for taxable years of foreign corporations 

beginning after December 31, 2004, and for taxable years of United 

States shareholders with or within which such taxable years of 

such foreign corporations end.

H. ELECTION NOT TO USE AVERAGE EXCHANGE RATE FOR FOREIGN

TAX PAID OTHER THAN IN FUNCTIONAL CURRENCY

(Sec. 308 of the bill and sec. 986 of the Code) 

PRESENT LAW

For taxpayers that take foreign income taxes into account when 

accrued, present law provides that the amount of the foreign tax 

credit generally is determined by translating the amount of foreign 

taxes paid in foreign currencies into a U.S. dollar amount at the 

average exchange rate for the taxable year to which such taxes reVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00200 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.004 HR548P1
199

146Sec. 986(a)(1). 147Sec. 986(a)(2). 148 Electing taxpayers translate foreign income tax payments pursuant to the same presentlaw rules that apply to taxpayers that are required to translate foreign income taxes using the 

exchange rates as of the time such taxes are paid. 

late.146 This rule applies to foreign taxes paid directly by U.S. taxpayers, which taxes are creditable in the year paid or accrued, and 

to foreign taxes paid by foreign corporations that are deemed paid 

by a U.S. corporation that is a shareholder of the foreign corporation, and hence creditable in the year that the U.S. corporation receives a dividend or has an income inclusion from the foreign corporation. This rule does not apply to any foreign income tax: (1) 

that is paid after the date that is two years after the close of the 

taxable year to which such taxes relate; (2) of an accrual-basis taxpayer that is actually paid in a taxable year prior to the year to 

which the tax relates; or (3) that is denominated in an inflationary 

currency (as defined by regulations). 

Foreign taxes that are not eligible for translation at the average 

exchange rate generally are translated into U.S. dollar amounts 

using the exchange rates as of the time such taxes are paid. However, the Secretary is authorized to issue regulations that would 

allow foreign tax payments to be translated into U.S. dollar 

amounts using an average exchange rate for a specified period.147

REASONS FOR CHANGE

The Committee believes that taxpayers generally should be permitted to elect whether to translate foreign income tax payments 

using an average exchange rate for the taxable year or the exchange rate when the taxes are paid, provided the elected method 

continues to be applied consistently unless revoked with the consent of the Treasury Secretary.

EXPLANATION OF PROVISION

For taxpayers that are required under present law to translate 

foreign income tax payments at the average exchange rate, the provision provides an election to translate such taxes into U.S. dollar 

amounts using the exchange rates as of the time such taxes are 

paid, provided the foreign income taxes are denominated in a currency other than the taxpayer’s functional currency.148 Any election 

under the provision applies to the taxable year for which the election is made and to all subsequent taxable years unless revoked 

with the consent of the Secretary. The provision authorizes the Secretary to issue regulations that apply the election to foreign income 

taxes attributable to a qualified business unit. 

EFFECTIVE DATE

The provision is effective with respect to taxable years beginning 

after December 31, 2004.

200

I. REPEAL OF WITHHOLDING TAX ON DIVIDENDS FROM CERTAIN

FOREIGN CORPORATIONS

(Sec. 309 of the bill and sec. 871 of the Code) 

PRESENT LAW

Nonresident individuals who are not U.S. citizens and foreign 

corporations (collectively, foreign persons) are subject to U.S. tax on 

income that is effectively connected with the conduct of a U.S. 

trade or business; the U.S. tax on such income is calculated in the 

same manner and at the same graduated rates as the tax on U.S. 

persons (secs. 871(b) and 882). Foreign persons also are subject to 

a 30-percent gross basis tax, collected by withholding, on certain 

U.S.-source passive income (e.g., interest and dividends) that is not 

effectively connected with a U.S. trade or business. This 30-percent 

withholding tax may be reduced or eliminated pursuant to an applicable tax treaty. Foreign persons generally are not subject to 

U.S. tax on foreign-source income that is not effectively connected 

with a U.S. trade or business. 

In general, dividends paid by a domestic corporation are treated 

as being from U.S. sources and dividends paid by a foreign corporation are treated as being from foreign sources. Thus, dividends paid 

by foreign corporations to foreign persons generally are not subject 

to withholding tax because such income generally is treated as foreign-source income. 

An exception from this general rule applies in the case of dividends paid by certain foreign corporations. If a foreign corporation 

derives 25 percent or more of its gross income as income effectively 

connected with a U.S. trade or business for the three-year period 

ending with the close of the taxable year preceding the declaration 

of a dividend, then a portion of any dividend paid by the foreign 

corporation to its shareholders will be treated as U.S.-source income and, in the case of dividends paid to foreign shareholders, will 

be subject to the 30-percent withholding tax (sec. 861(a)(2)(B)). This 

rule is sometimes referred to as the ‘‘secondary withholding tax.’’

The portion of the dividend treated as U.S.-source income is equal 

to the ratio of the gross income of the foreign corporation that was 

effectively connected with its U.S. trade or business over the total 

gross income of the foreign corporation during the three-year period 

ending with the close of the preceding taxable year. The U.S.-

source portion of the dividend paid by the foreign corporation to its 

foreign shareholders is subject to the 30-percent withholding tax. 

Under the branch profits tax provisions, the United States taxes 

foreign corporations engaged in a U.S. trade or business on 

amounts of U.S. earnings and profits that are shifted out of the 

U.S. branch of the foreign corporation. The branch profits tax is 

comparable to the second-level taxes imposed on dividends paid by 

a domestic corporation to its foreign shareholders. The branch profits tax is 30 percent of the foreign corporation’s ‘‘dividend equivalent amount,’’ which generally is the earnings and profits of a U.S. 

branch of a foreign corporation attributable to its income effectively 

connected with a U.S. trade or business (secs. 884(a) and (b)). 

If a foreign corporation is subject to the branch profits tax, then 

no secondary withholding tax is imposed on dividends paid by the 

foreign corporation to its shareholders (sec. 884(e)(3)(A)). If a forVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00202 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.005 HR548P1
201

149Sec. 861(a)(1). 150Treas. Reg. sec. 1.861–2(a)(2). 151Sec. 884(f)(1). 

eign corporation is a qualified resident of a tax treaty country and 

claims an exemption from the branch profits tax pursuant to the 

treaty, the secondary withholding tax could apply with respect to 

dividends it pays to its shareholders. Several tax treaties (including 

treaties that prevent imposition of the branch profits tax), however, 

exempt dividends paid by the foreign corporation from the secondary withholding tax. 

REASONS FOR CHANGE

The Committee observes that the secondary withholding tax with 

respect to dividends paid by certain foreign corporations has been 

largely superseded by the branch profits tax and applicable income 

tax treaties. Accordingly, the Committee believes that the tax 

should be repealed in the interest of simplification. 

EXPLANATION OF PROVISION

The provision eliminates the secondary withholding tax with respect to dividends paid by certain foreign corporations. 

EFFECTIVE DATE

The provision is effective for payments made after December 31, 

2004.

J. PROVIDE EQUAL TREATMENT FOR INTEREST PAID BY FOREIGN

PARTNERSHIPS AND FOREIGN CORPORATIONS

(Sec. 310 of the bill and sec. 861 of the Code) 

PRESENT LAW

In general, interest income from bonds, notes or other interestbearing obligations of noncorporate U.S. residents or domestic corporations is treated as U.S.-source income.149 Other interest (e.g., 

interest on obligations of foreign corporations and foreign partnerships) generally is treated as foreign-source income. However, 

Treasury regulations provide that a foreign partnership is a U.S. 

resident for purposes of this rule if at any time during its taxable 

year it is engaged in a trade or business in the United States.150

Therefore, any interest received from such a foreign partnership is 

U.S.-source income. 

Notwithstanding the general rule described above, in the case of 

a foreign corporation engaged in a U.S. trade or business (or having gross income that is treated as effectively connected with the 

conduct of a U.S. trade or business), interest paid by such U.S. 

trade or business is treated as if it were paid by a domestic corporation (i.e., such interest is treated as U.S.-source income).151

REASONS FOR CHANGE

The Committee believes that the source of interest income received from a foreign partnership or foreign corporation should be 

consistent. The Committee believes that interest payments from a 

foreign partnership engaged in a trade or business in the United 

202

States should be sourced in the same manner as interest payments 

from a foreign corporation engaged in a trade or business in the 

United States. 

EXPLANATION OF PROVISION

The provision treats interest paid by foreign partnerships in a 

manner similar to the treatment of interest paid by foreign corporations. Thus, interest paid by a foreign partnership is treated 

as U.S.-source income only if the interest is paid by a U.S. trade 

or business conducted by the partnership or is allocable to income 

that is treated as effectively connected with the conduct of a U.S. 

trade or business. The provision applies only to foreign partnerships that are predominantly engaged in the active conduct of a 

trade or business outside the United States. 

EFFECTIVE DATE

This provision is effective for taxable years beginning after December 31, 2003. 

K. LOOK-THROUGH TREATMENT OF PAYMENTS BETWEEN RELATED

CONTROLLED FOREIGN CORPORATIONS UNDER FOREIGN PERSONAL

HOLDING COMPANY INCOME RULES

(Sec. 311 of the bill and sec. 954 of the Code) 

PRESENT LAW

In general, the rules of subpart F (secs. 951–964) require U.S. 

shareholders with a 10-percent or greater interest in a controlled 

foreign corporation to include certain income of the controlled foreign corporation (referred to as ‘‘subpart F income’’) on a current 

basis for U.S. tax purposes, regardless of whether the income is 

distributed to the shareholders. 

Subpart F income includes foreign base company income. One 

category of foreign base company income is foreign personal holding company income. For subpart F purposes, foreign personal 

holding company income generally includes dividends, interest, 

rents and royalties, among other types of income. However, foreign 

personal holding company income does not include dividends and 

interest received by a controlled foreign corporation from a related 

corporation organized and operating in the same foreign country in 

which the controlled foreign corporation is organized, or rents and 

royalties received by a controlled foreign corporation from a related 

corporation for the use of property within the country in which the 

controlled foreign corporation is organized. Interest, rent, and royalty payments do not qualify for this exclusion to the extent that 

such payments reduce the subpart F income of the payor. 

REASONS FOR CHANGE

Most countries allow their companies to redeploy active foreign 

earnings with no additional tax burden. The Committee believes 

that this provision will make U.S. companies and U.S. workers 

more competitive with respect to such countries. By allowing U.S. 

companies to reinvest their active foreign earnings where they are 

most needed without incurring the immediate additional tax that 

companies based in many other countries never incur, the ComVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00204 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.005 HR548P1
203

mittee believes that the provision will enable U.S. companies to 

make more sales overseas, and thus produce more goods in the 

United States. 

EXPLANATION OF PROVISION

Under the provision, dividends, interest, rents, and royalties received by one controlled foreign corporation from a related controlled foreign corporation are not treated as foreign personal holding company income to the extent attributable or properly allocable 

to non-subpart-F income of the payor. For these purposes, a related 

controlled foreign corporation is a controlled foreign corporation 

that controls or is controlled by the other controlled foreign corporation, or a controlled foreign corporation that is controlled by 

the same person or persons that control the other controlled foreign 

corporation. Ownership of more than 50 percent of the controlled 

foreign corporation’s stock (by vote or value) constitutes control for 

these purposes. 

EFFECTIVE DATE

The provision is effective for taxable years of foreign corporations 

beginning after December 31, 2004, and taxable years of U.S. 

shareholders with or within which such taxable years of such foreign corporations end.

L. LOOK-THROUGH TREATMENT UNDER SUBPART F FOR SALES OF

PARTNERSHIP INTERESTS

(Sec. 312 of the bill and sec. 954 of the Code) 

PRESENT LAW

In general, the subpart F rules (secs. 951–964) require U.S. 

shareholders with a 10-percent or greater interest in a controlled 

foreign corporation to include in income currently for U.S. tax purposes certain types of income of the controlled foreign corporation, 

whether or not such income is actually distributed currently to the 

shareholders (referred to as ‘‘subpart F income’’). Subpart F income 

includes foreign personal holding company income. Foreign personal holding company income generally consists of the following: 

(1) dividends, interest, royalties, rents, and annuities; (2) net gains 

from the sale or exchange of (a) property that gives rise to the preceding types of income, (b) property that does not give rise to income, and (c) interests in trusts, partnerships, and REMICs; (3) net 

gains from commodities transactions; (4) net gains from foreign 

currency transactions; (5) income that is equivalent to interest; (6) 

income from notional principal contracts; and (7) payments in lieu 

of dividends. Thus, if a controlled foreign corporation sells a partnership interest at a gain, the gain generally constitutes foreign 

personal holding company income and is included in the income of 

10-percent U.S. shareholders of the controlled foreign corporation 

as subpart F income. 

REASONS FOR CHANGE

The Committee believes that the sale of a partnership interest by 

a controlled foreign corporation that owns a significant interest in 

the partnership should constitute subpart F income only to the exVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00205 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.005 HR548P1
204

tent that a proportionate sale of the underlying partnership assets 

attributable to the partnership interest would constitute subpart F 

income. 

EXPLANATION OF PROVISION

The provision treats the sale by a controlled foreign corporation 

of a partnership interest as a sale of the proportionate share of 

partnership assets attributable to such interest for purposes of determining subpart F foreign personal holding company income. 

This rule applies only to partners owning directly, indirectly, or 

constructively at least 25 percent of a capital or profits interest in 

the partnership. Thus, the sale of a partnership interest by a controlled foreign corporation that meets this ownership threshold constitutes subpart F income under the provision only to the extent 

that a proportionate sale of the underlying partnership assets attributable to the partnership interest would constitute subpart F 

income. The Treasury Secretary is directed to prescribe such regulations as may be appropriate to prevent the abuse of this provision. 

EFFECTIVE DATE

The provision is effective for taxable years of foreign corporations 

beginning after December 31, 2004, and taxable years of U.S. 

shareholders with or within which such taxable years of such foreign corporations end. 

M. REPEAL OF FOREIGN PERSONAL HOLDING COMPANY RULES AND

FOREIGN INVESTMENT COMPANY RULES

(Sec. 313 of the bill and secs. 542, 551–558, 954, 1246, and 1247 

of the Code) 

PRESENT LAW

Income earned by a foreign corporation from its foreign operations generally is subject to U.S. tax only when such income is 

distributed to any U.S. persons that hold stock in such corporation. 

Accordingly, a U.S. person that conducts foreign operations through 

a foreign corporation generally is subject to U.S. tax on the income 

from those operations when the income is repatriated to the United 

States through a dividend distribution to the U.S. person. The income is reported on the U.S. person’s tax return for the year the 

distribution is received, and the United States imposes tax on such 

income at that time. The foreign tax credit may reduce the U.S. tax 

imposed on such income. 

Several sets of anti-deferral rules impose current U.S. tax on certain income earned by a U.S. person through a foreign corporation. 

Detailed rules for coordination among the anti-deferral rules are 

provided to prevent the U.S. person from being subject to U.S. tax 

on the same item of income under multiple rules. 

The Code sets forth the following anti-deferral rules: the controlled foreign corporation rules of subpart F (secs. 951–964); the 

passive foreign investment company rules (secs. 1291–1298); the 

foreign personal holding company rules (secs. 551–558); the personal holding company rules (secs. 541–547); the accumulated earnVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00206 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.005 HR548P1
205

ings tax rules (secs. 531–537); and the foreign investment company 

rules (secs. 1246–1247). 

REASONS FOR CHANGE

The Committee believes that the overlap among the various antideferral regimes results in significant complexity usually with little 

or no ultimate tax consequences. These overlaps require the application of specific rules of priority for income inclusions among the 

regimes, as well as additional coordination provisions pertaining to 

other operational differences among the various regimes. The Committee believes that significant simplification will be achieved by 

streamlining these rules. 

EXPLANATION OF PROVISION

The provision: (1) eliminates the rules applicable to foreign personal holding companies and foreign investment companies; (2) excludes foreign corporations from the application of the personal 

holding company rules; and (3) includes as subpart F foreign personal holding company income personal services contract income 

that is subject to the present-law foreign personal holding company 

rules. 

EFFECTIVE DATE

The provision is effective for taxable years of foreign corporations 

beginning after December 31, 2004, and taxable years of U.S. 

shareholders with or within which such taxable years of foreign 

corporations end.

N. DETERMINATION OF FOREIGN PERSONAL HOLDING COMPANY

INCOME WITH RESPECT TO TRANSACTIONS IN COMMODITIES

(Sec. 314 of the bill and sec. 954 of the Code) 

PRESENT LAW

Subpart F foreign personal holding company income 

Under the subpart F rules, U.S. shareholders with a 10-percent 

or greater interest in a controlled foreign corporation (‘‘U.S. 10-percent shareholders’’) are subject to U.S. tax currently on certain income earned by the controlled foreign corporation, whether or not 

such income is distributed to the shareholders. The income subject 

to current inclusion under the subpart F rules includes, among 

other things, ‘‘foreign personal holding company income.’’

Foreign personal holding company income generally consists of 

the following: dividends, interest, royalties, rents and annuities; 

net gains from sales or exchanges of (1) property that gives rise to 

the foregoing types of income, (2) property that does not give rise 

to income, and (3) interests in trusts, partnerships, and real estate 

mortgage investment conduits (‘‘REMICs’’); net gains from commodities transactions; net gains from foreign currency transactions; income that is equivalent to interest; income from notional principal 

contracts; and payments in lieu of dividends. 

With respect to transactions in commodities, foreign personal 

holding company income does not consist of gains or losses which 

arise out of bona fide hedging transactions that are reasonably necVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00207 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.005 HR548P1
206

152For hedging transactions entered into on or after January 31, 2003, Treasury regulations 

provide that gains or losses from a commodities hedging transaction generally are excluded from 

the definition of foreign personal holding company income if the transaction is with respect to 

the controlled foreign corporation’s business as a producer, processor, merchant or handler of 

commodities, regardless of whether the transaction is a hedge with respect to a sale of commodities in the active conduct of a commodities business by the controlled foreign corporation. The 

regulations also provide that, for purposes of satisfying the requirements for exclusion from the 

definition of foreign personal holding company income, a producer, processor, merchant or handler of commodities includes a controlled foreign corporation that regularly uses commodities in 

a manufacturing, construction, utilities, or transportation business (Treas. Reg. sec. 1.954– 2(f)(2)(v)). However, the regulations provide that a controlled foreign corporation is not a producer, processor, merchant or handler of commodities (and therefore would not satisfy the requirements for exclusion) if its business is primarily financial (Treas. Reg. sec. 1.954–2(f)(2)(v)). 153Treasury regulations provide that substantially all of a controlled foreign corporation’s business is as an active producer, processor, merchant or handler of commodities if: (1) the sum 

of its gross receipts from all of its active sales of commodities in such capacity and its gross 

receipts from all of its commodities hedging transactions that qualify for exclusion from the definition of foreign personal holding company income, equals or exceeds (2) 85 percent of its total 

receipts for the taxable year (computed as though the controlled foreign corporation was a domestic corporation) (Treas. Reg. sec. 1.954–2(f)(2)(iii)(C)). 154Sec. 1221(a)(7). 155Sec. 1221(b)(2)(A). 

essary to the conduct of any business by a producer, processor, 

merchant, or handler of a commodity in the manner in which such 

business is customarily and usually conducted by others.152 In addition, foreign personal holding company income does not consist of 

gains or losses which are comprised of active business gains or 

losses from the sale of commodities, but only if substantially all of 

the controlled foreign corporation’s business is as an active producer, processor, merchant, or handler of commodities.153

Hedging transactions 

Under present law, the term ‘‘capital asset’’ does not include any 

hedging transaction which is clearly identified as such before the 

close of the day on which it was acquired, originated, or entered 

into (or such other time as the Secretary may by regulations prescribe).154 The term ‘‘hedging transaction’’ means any transaction 

entered into by the taxpayer in the normal course of the taxpayer’s 

trade or business primarily: (1) to manage risk of price changes or 

currency fluctuations with respect to ordinary property which is 

held or to be held by the taxpayer; (2) to manage risk of interest 

rate or price changes or currency fluctuations with respect to borrowings made or to be made, or ordinary obligations incurred or to 

be incurred, by the taxpayer; or (3) to manage such other risks as 

the Secretary may prescribe in regulations.155

REASONS FOR CHANGE

The Committee believes that exceptions from subpart F foreign 

personal holding company income for commodities hedging transactions and active business sales of commodities should be modified 

to better reflect current active business practices and, in the case 

of hedging transactions, to conform to recent tax law changes concerning hedging transactions generally. 

EXPLANATION OF PROVISION

The provision modifies the requirements that must be satisfied 

for gains or losses from a commodities hedging transaction to qualify for exclusion from the definition of subpart F foreign personal 

holding company income. Under the provision, gains or losses from 

a transaction with respect to a commodity are not treated as forVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00208 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.005 HR548P1
207

156Sec. 1221(a)(7) and (b)(2)(B). 157For purposes of determining whether substantially all of the controlled foreign corporation’s commodities are comprised of such property, it is intended that the 85-percent requirement provided in the current Treasury regulations (as modified to reflect the changes made by 

the provision) continue to apply. 

eign personal holding company income if the transaction satisfies 

the general definition of a hedging transaction under section 

1221(b)(2). For purposes of this provision, the general definition of 

a hedging transaction under section 1221(b)(2) is modified to include any transaction with respect to a commodity entered into by 

a controlled foreign corporation in the normal course of the controlled foreign corporation’s trade or business primarily: (1) to manage risk of price changes or currency fluctuations with respect to 

ordinary property or property described in section 1231(b) which is 

held or to be held by the controlled foreign corporation; or (2) to 

manage such other risks as the Secretary may prescribe in regulations. Gains or losses from a transaction that satisfies the modified 

definition of a hedging transaction are excluded from the definition 

of foreign personal holding company income only if the transaction 

is clearly identified as a hedging transaction in accordance with the 

hedge identification requirements that apply generally to hedging 

transactions under section 1221(b)(2).156

The provision also changes the requirements that must be satisfied for active business gains or losses from the sale of commodities 

to qualify for exclusion from the definition of foreign personal holding company income. Under the provision, such gains or losses are 

not treated as foreign personal holding company income if substantially all of the controlled foreign corporation’s commodities are 

comprised of: (1) stock in trade of the controlled foreign corporation 

or other property of a kind which would properly be included in the 

inventory of the controlled foreign corporation if on hand at the 

close of the taxable year, or property held by the controlled foreign 

corporation primarily for sale to customers in the ordinary course 

of the controlled foreign corporation’s trade or business; (2) property that is used in the trade or business of the controlled foreign 

corporation and is of a character which is subject to the allowance 

for depreciation under section 167; or (3) supplies of a type regularly used or consumed by the controlled foreign corporation in the 

ordinary course of a trade or business of the controlled foreign corporation.157

For purposes of applying the requirements for active business 

gains or losses from commodities sales to qualify for exclusion from 

the definition of foreign personal holding company income, the provision also provides that commodities with respect to which gains 

or losses are not taken into account as foreign personal holding 

company income by a regular dealer in commodities (or financial 

instruments referenced to commodities) are not taken into account 

in determining whether substantially all of the dealer’s commodities are comprised of the property described above. 

EFFECTIVE DATE

The provision is effective with respect to transactions entered 

into after December 31, 2004. 

208

O. MODIFICATIONS TO TREATMENT OF AIRCRAFT LEASING AND

SHIPPING INCOME

(Sec. 315 of the bill and sec. 954 of the Code) 

PRESENT LAW

In general, the subpart F rules (secs. 951–964) require U.S. 

shareholders with a 10-percent or greater interest in a controlled 

foreign corporation (‘‘CFC’’) to include currently in income for U.S. 

tax purposes certain income of the CFC (referred to as ‘‘subpart F 

income’’), without regard to whether the income is distributed to 

the shareholders (sec. 951(a)(1)(A)). In effect, the Code treats the 

U.S. 10-percent shareholders of a CFC as having received a current 

distribution of their pro rata shares of the CFC’s subpart F income. 

The amounts included in income by the CFC’s U.S. 10-percent 

shareholders under these rules are subject to U.S. tax currently. 

The U.S. tax on such amounts may be reduced through foreign tax 

credits. 

Subpart F income includes foreign base company shipping income (sec. 954(f)). Foreign base company shipping income generally 

includes income derived from the use of an aircraft or vessel in foreign commerce, the performance of services directly related to the 

use of any such aircraft or vessel, the sale or other disposition of 

any such aircraft or vessel, and certain space or ocean activities 

(e.g., leasing of satellites for use in space). Foreign commerce generally involves the transportation of property or passengers between a port (or airport) in the U.S. and a port (or airport) in a 

foreign country, two ports (or airports) within the same foreign 

country, or two ports (or airports) in different foreign countries. In 

addition, foreign base company shipping income includes dividends 

and interest that a CFC receives from certain foreign corporations 

and any gains from the disposition of stock in certain foreign corporations, to the extent the dividends, interest, or gains are attributable to foreign base company shipping income. Foreign base company shipping income also includes incidental income derived in 

the course of active foreign base company shipping operations (e.g., 

income from temporary investments in or sales of related shipping 

assets), foreign exchange gain or loss attributable to foreign base 

company shipping operations, and a CFC’s distributive share of 

gross income of any partnership and gross income received from 

certain trusts to the extent that the income would have been foreign base company shipping income had it been realized directly by 

the corporation. 

Subpart F income also includes foreign personal holding company 

income (sec. 954(c)). For subpart F purposes, foreign personal holding company income generally consists of the following: (1) dividends, interest, royalties, rents and annuities; (2) net gains from 

the sale or exchange of (a) property that gives rise to the preceding 

types of income, (b) property that does not give rise to income, and 

(c) interests in trusts, partnerships, and REMICS; (3) net gains 

from commodities transactions; (4) net gains from foreign currency 

transactions; (5) income that is equivalent to interest; (6) income 

from notional principal contracts; and (7) payments in lieu of dividends. 

209

158 ‘‘Active-leasing expenses’’ are section 162 expenses properly allocable to rental income 

other than (1) deductions for compensation for personal services rendered by the lessor’s shareholders or a related person, (2) deductions for rents, (3) section 167 and 168 expenses, and (4) 

deductions for payments to independent contractors with respect to leased property. Treas. Reg. 

sec. 1.954–2(c)(2)(iii). 159Generally, ‘‘adjusted leasing profit’’ is rental income less the sum of (1) rents paid or incurred by the CFC with respect to such rental income; (2) section 167 and 168 expenses with 

respect to such rental income; and (3) payments to independent contractors with respect to such 

rental income. Treas. Reg. sec. 1.954–2(c)(2)(iv). 

Subpart F foreign personal holding company income does not include rents and royalties received by a CFC in the active conduct 

of a trade or business from unrelated persons (sec. 954(c)(2)(A)). 

The determination of whether rents or royalties are derived in the 

active conduct of a trade or business is based on all the facts and 

circumstances. However, the Treasury regulations provide certain 

types of rents are treated as derived in the active conduct of a 

trade or business. These include rents derived from property that 

is leased as a result of the performance of marketing functions by 

the lessor if the lessor (through its own officers or employees located in a foreign country) maintains and operates an organization 

in such country that regularly engages in the business of marketing, or marketing and servicing, the leased property and that is 

substantial in relation to the amount of rents derived from the 

leasing of such property. An organization in a foreign country is 

substantial in relation to rents if the active leasing expenses 158

equal at least 25 percent of the adjusted leasing profit.159

Also generally excluded from subpart F foreign personal holding 

company income are rents and royalties received by the CFC from 

a related corporation for the use of property within the country in 

which the CFC was organized (sec. 954(c)(3)). However, rent, and 

royalty payments do not qualify for this exclusion to the extent 

that such payments reduce subpart F income of the payor. 

REASONS FOR CHANGE

In general, other countries do not tax foreign shipping income, 

whereas the United States imposes immediate U.S. tax on such income. The uncompetitive U.S. taxation of shipping income has directly caused a steady and substantial decline of the U.S. shipping 

industry. The Committee believes that this provision will provide 

U.S. shippers the opportunity to be competitive with their tax-advantaged foreign competitors. 

In addition, the Committee believes that the current-law exception from foreign base company income for rents and royalties received by a CFC in the active conduct of a trade or business from 

unrelated persons is too narrow in the context of the leasing of an 

aircraft or vessel in foreign commerce. The Committee believes the 

provision of the safe harbor under the bill will improve the competitiveness of U.S.-based multinationals engaging in these activities. 

EXPLANATION OF PROVISION

The provision repeals the subpart F rules relating to foreign base 

company shipping income. The bill also amends the exception from 

foreign personal holding company income applicable to rents or royalties derived from unrelated persons in an active trade or business, by providing a safe harbor for rents derived from leasing an 

210

aircraft or vessel in foreign commerce. Such rents are excluded 

from foreign personal holding company income if the active leasing 

expenses comprise at least 10 percent of the profit on the lease. 

This provision is to be applied in accordance with existing regulations under sec. 954(c)(2)(A) by comparing the lessor’s ‘‘active leasing expenses’’ for its pool of leased assets to its ‘‘adjusted leasing 

profit.’’ The safe harbor will not prevent a lessor from otherwise showing 

that it actively carries on a trade or business. In this regard, the 

requirements of section 954(c)(2)(A) will be met if a lessor regularly 

and directly performs active and substantial marketing, remarketing, management and operational functions with respect to the 

leasing of an aircraft or vessel (or component engines). This will be 

the case regardless of whether the lessor engages in marketing of 

the lease as a form of financing (versus marketing the property as 

such) or whether the lease is classified as a finance lease or operating lease for financial accounting purposes. If a lessor acquires, 

from an unrelated or related party, a ship or aircraft subject to an 

existing FSC or ETI lease, the requirements of section 954(c)(2)(A) 

will be satisfied if, following the acquisition, the lessor performs active and substantial management, operational, and remarketing 

functions with respect to the leased property. If such a lease is 

transferred to a CFC lessor, it will no longer be eligible for FSC 

or ETI benefits. 

An aircraft or vessel will be considered to be leased in foreign 

commerce if it is used for the transportation of property or passengers between a port (or airport) in the United States and one 

in a foreign country or between foreign ports (or airports), provided 

the aircraft or vessel is used predominantly outside the United 

States. An aircraft or vessel will be considered used predominantly 

outside the United States if more than 50 percent of the miles during the taxable year are traversed outside the United States or the 

aircraft or vessel is located outside the United States more than 50 

percent of the time during such taxable year. 

The Committee expects that the Secretary of the Treasury will 

issue timely guidance to make conforming changes to existing regulations, including guidance that aircraft or vessel leasing activity 

that satisfies the requirements of section 954(c)(2)(A) shall also satisfy the requirements for avoiding income inclusion under section 

956 and section 367(a). 

The Committee anticipates that taxpayers now eligible for the 

benefits of the ETI exclusion (or the FSC provisions pursuant to 

the FSC Repeal and Extraterritorial Income Exclusion Act of 2000), 

will find it appropriate, as a matter of sound business judgment, 

to restructure their business operations to take into account the tax 

law changes brought about by the bill. The Committee notes that 

courts have recognized the validity of structuring operations for the 

purpose of obtaining the benefit of tax regimes expressly intended 

by Congress. The Committee intends that structuring or restructuring of operations for the purposes of adapting to the repeal of 

the ETI exclusion (or the FSC regime) will be considered to serve 

a valid business purpose and will not constitute tax avoidance, 

where the restructured operations conform to the requirements expressly mandated by Congress for obtaining tax benefits that remain available. For example, the Committee intends that a restrucVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00212 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.005 HR548P1
211

turing undertaken to transfer aircraft subject to existing FSC or 

ETI leases to a CFC lessor, to take advantange of the amendments 

made by this bill, would serve as a valid business purpose and 

would not constitute tax avoidance, for purposes of determining 

whether a particular tax treatment (such as nonrecognition of gain) 

applies to such restructuring. The Committee intends, for example, 

that if such a restructuring meets the other requirements necessary to qualify as a ‘‘reorganization’’ under section 368, the transaction will also be deemed to meet the ‘‘business purpose’’ requirements under section 368, and thus, qualify as a reorganization 

under that section. 

EFFECTIVE DATE

The provision is effective for taxable years of foreign corporations 

beginning after December 31, 2004, and taxable years of U.S. 

shareholders with or within which such taxable years of foreign 

corporations end.

P. MODIFICATION OF EXCEPTIONS UNDER SUBPART F FOR ACTIVE

FINANCING

(Sec. 316 of the bill and sec. 954 of the Code) 

PRESENT LAW

Under the subpart F rules, U.S. shareholders with a 10-percent 

or greater interest in a controlled foreign corporation (‘‘CFC’’) are 

subject to U.S. tax currently on certain income earned by the CFC, 

whether or not such income is distributed to the shareholders. The 

income subject to current inclusion under the subpart F rules includes, among other things, foreign personal holding company income and insurance income. In addition, 10-percent U.S. shareholders of a CFC are subject to current inclusion with respect to 

their shares of the CFC’s foreign base company services income 

(i.e., income derived from services performed for a related person 

outside the country in which the CFC is organized). 

Foreign personal holding company income generally consists of 

the following: (1) dividends, interest, royalties, rents, and annuities; (2) net gains from the sale or exchange of (a) property that 

gives rise to the preceding types of income, (b) property that does 

not give rise to income, and (c) interests in trusts, partnerships, 

and REMICs; (3) net gains from commodities transactions; (4) net 

gains from foreign currency transactions; (5) income that is equivalent to interest; (6) income from notional principal contracts; and 

(7) payments in lieu of dividends. 

Insurance income subject to current inclusion under the subpart 

F rules includes any income of a CFC attributable to the issuing 

or reinsuring of any insurance or annuity contract in connection 

with risks located in a country other than the CFC’s country of organization. Subpart F insurance income also includes income attributable to an insurance contract in connection with risks located 

within the CFC’s country of organization, as the result of an arrangement under which another corporation receives a substantially equal amount of consideration for insurance of other country 

risks. Investment income of a CFC that is allocable to any insurance or annuity contract related to risks located outside the CFC’s 

212

160Temporary exceptions from the subpart F provisions for certain active financing income applied only for taxable years beginning in 1998. Those exceptions were modified and extended 

for one year, applicable only for taxable years beginning in 1999. The Tax Relief Extension Act 

of 1999 (Pub.L. No. 106–170) clarified and extended the temporary exceptions for two years, applicable only for taxable years beginning after 1999 and before 2002. The Job Creation and 

Worker Assistance Act of 2002 (Pub.L. No. 107–147) extended the temporary exceptions for five 

years, applicable only for taxable years beginning after 2001 and before 2007, with a modification relating to insurance reserves. 

country of organization is taxable as subpart F insurance income 

(Treas. Reg. sec. 1.953–1(a)). 

Temporary exceptions from foreign personal holding company income, foreign base company services income, and insurance income 

apply for subpart F purposes for certain income that is derived in 

the active conduct of a banking, financing, or similar business, or 

in the conduct of an insurance business (so-called ‘‘active financing 

income’’).160

With respect to income derived in the active conduct of a banking, financing, or similar business, a CFC is required to be predominantly engaged in such business and to conduct substantial 

activity with respect to such business in order to qualify for the exceptions. In addition, certain nexus requirements apply, which provide that income derived by a CFC or a qualified business unit 

(‘‘QBU’’) of a CFC from transactions with customers is eligible for 

the exceptions if, among other things, substantially all of the activities in connection with such transactions are conducted directly by 

the CFC or QBU in its home country, and such income is treated 

as earned by the CFC or QBU in its home country for purposes of 

such country’s tax laws. Moreover, the exceptions apply to income 

derived from certain cross border transactions, provided that certain requirements are met. Additional exceptions from foreign personal holding company income apply for certain income derived by 

a securities dealer within the meaning of section 475 and for gain 

from the sale of active financing assets. 

In the case of insurance, in addition to temporary exceptions 

from insurance income and from foreign personal holding company 

income for certain income of a qualifying insurance company with 

respect to risks located within the CFC’s country of creation or organization, temporary exceptions from insurance income and from 

foreign personal holding company income apply for certain income 

of a qualifying branch of a qualifying insurance company with respect to risks located within the home country of the branch, provided certain requirements are met under each of the exceptions. 

Further, additional temporary exceptions from insurance income 

and from foreign personal holding company income apply for certain income of certain CFCs or branches with respect to risks located in a country other than the United States, provided that the 

requirements for these exceptions are met. 

REASONS FOR CHANGE

The Committee believes that the rules for determining whether 

income earned by an eligible CFC or QBU is active financing income should be more consistent with the rules for determining 

whether a CFC or QBU is eligible to earn active financing income. 

213

161 A portion of the child credit may be refundable. 

EXPLANATION OF PROVISION

The provision modifies the present-law temporary exceptions 

from subpart F foreign personal holding company income and foreign base company services income for income derived in the active 

conduct of a banking, financing, or similar business. For purposes 

of determining whether a CFC or QBU has conducted directly in 

its home country substantially all of the activities in connection 

with transactions with customers, the provision provides that an 

activity is treated as conducted directly by the CFC or QBU in its 

home country if the activity is performed by employees of a related 

person and: (1) the related person is itself an eligible CFC the 

home country of which is the same as that of the CFC or QBU; (2) 

the activity is performed in the home country of the related person; 

and (3) the related person is compensated on an arm’s length basis 

for the performance of the activity by its employees and such compensation is treated as earned by such person in its home country 

for purposes of the tax laws of such country. For purposes of determining whether a CFC or QBU is eligible to earn active financing 

income, such activity may not be taken into account by any CFC 

or QBU (including the employer of the employees performing the 

activity) other than the CFC or QBU for which the activities are 

performed. 

EFFECTIVE DATE

The provision is effective for taxable years of foreign corporations 

beginning after December 31, 2004, and taxable years of U.S. 

shareholders with or within which such taxable years of foreign 

corporations end.

TITLE IV—EXTENSION OF CERTAIN EXPIRING PROVISIONS 

A. EXTEND ALTERNATIVE MINIMUM TAX RELIEF FOR INDIVIDUALS

(Sec. 401 of the bill and sec. 26 of the Code) 

PRESENT LAW

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

disabled, the adoption credit, the child tax credit,161 the credit for 

interest on certain home mortgages, the HOPE Scholarship and 

Lifetime Learning credits, the IRA credit, and the D.C. homebuyer’s credit). 

For taxable years beginning in 2003, all the nonrefundable personal credits are allowed to the extent of the full amount of the individual’s regular tax and alternative minimum tax. 

For taxable years beginning after 2003, the credits (other than 

the adoption credit, child credit and IRA credit) are allowed only 

to the extent that the individual’s regular income tax liability exceeds the individual’s tentative minimum tax, determined without 

regard to the minimum tax foreign tax credit. The adoption credit, 

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

214

The alternative minimum tax is the amount by which the tentative minimum tax exceeds the regular income tax. An individual’s tentative minimum tax is an amount equal to (1) 26 percent 

of the first $175,000 ($87,500 in the case of a married individual 

filing a separate return) of alternative minimum taxable income 

(‘‘AMTI’’) in excess of an exemption amount that phases out and (2) 

28 percent of the remaining AMTI. The maximum tax rates on net 

capital gain used in computing the tentative minimum tax are the 

same as under the regular tax. AMTI is the individual’s taxable income adjusted to take account of specified preferences and adjustments. The exemption amounts are: (1) $58,000 ($45,000 in taxable 

years beginning after 2004) in the case of married individuals filing 

a joint return and surviving spouses; (2) $40,250 ($33,750 in taxable years beginning after 2004) in the case of other unmarried individuals; (3) $29,000 ($22,500 in taxable years beginning after 

2004) in the case of married individuals filing a separate return; 

and (4) $22,500 in the case of an estate or trust. The exemption 

amounts are phased out by an amount equal to 25 percent of the 

amount by which the individual’s AMTI exceeds (1) $150,000 in the 

case of married individuals filing a joint return and surviving 

spouses, (2) $112,500 in the case of other unmarried individuals, 

and (3) $75,000 in the case of married individuals filing separate 

returns or an estate or a trust. These amounts are not indexed for 

inflation. 

REASONS FOR CHANGE

The Committee believes that the nonrefundable personal credits 

should be useable without limitation by reason of the alternative 

minimum tax. This will result in significant simplification and will 

enable individuals to fully benefit from the credits. 

EXPLANATION OF PROVISION

The bill extends the provision allowing an individual to offset the 

entire regular tax liability and alternative minimum tax liability by 

the personal nonrefundable credits for taxable years beginning in 

2004 and 2005. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2003.

B. EXTENSION OF THE RESEARCH CREDIT

(Sec. 402 of the bill and sec. 41 of the Code) 

PRESENT LAW

General rule 

Section 41 provides for a research tax credit equal to 20 percent 

of the amount by which a taxpayer’s qualified research expenses 

for a taxable year exceed its base amount for that year. The research tax credit is scheduled to expire and generally will not apply 

to amounts paid or incurred after June 30, 2004. 

A 20-percent research tax credit also applies to the excess of (1) 

100 percent of corporate cash expenses (including grants or conVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00216 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.005 HR548P1
215

162Sec. 41(c)(4). 

tributions) paid for basic research conducted by universities (and 

certain nonprofit scientific research organizations) over (2) the sum 

of (a) the greater of two minimum basic research floors plus (b) an 

amount reflecting any decrease in nonresearch giving to universities by the corporation as compared to such giving during a fixedbase period, as adjusted for inflation. This separate credit computation is commonly referred to as the university basic research credit 

(see sec. 41(e)). 

Computation of allowable credit 

Except for certain university basic research payments made by 

corporations, the research tax credit applies only to the extent that 

the taxpayer’s qualified research expenses for the current taxable 

year exceed its base amount. The base amount for the current year 

generally is computed by multiplying the taxpayer’s fixed-base percentage by the average amount of the taxpayer’s gross receipts for 

the four preceding years. If a taxpayer both incurred qualified research expenses and had gross receipts during each of at least 

three years from 1984 through 1988, then its fixed-base percentage 

is the ratio that its total qualified research expenses for the 1984–

1988 period bears to its total gross receipts for that period (subject 

to a maximum fixed-base percentage of 16 percent). All other taxpayers (so-called start-up firms) are assigned a fixed-base percentage of three percent. In computing the credit, a taxpayer’s base 

amount may not be less than 50 percent of its current-year qualified research expenses. 

Alternative incremental research credit regime 

Taxpayers are allowed to elect an alternative incremental research credit regime.162 If a taxpayer elects to be subject to this alternative regime, the taxpayer is assigned a three-tiered fixed-base 

percentage (that is lower than the fixed-base percentage otherwise 

applicable under present law) and the credit rate likewise is reduced. Under the alternative credit regime, a credit rate of 2.65 

percent applies to the extent that a taxpayer’s current-year research expenses exceed a base amount computed by using a fixedbase percentage of one percent (i.e., the base amount equals one 

percent of the taxpayer’s average gross receipts for the four preceding years) but do not exceed a base amount computed by using 

a fixed-base percentage of 1.5 percent. A credit rate of 3.2 percent 

applies to the extent that a taxpayer’s current-year research expenses exceed a base amount computed by using a fixed-base percentage of 1.5 percent but do not exceed a base amount computed 

by using a fixed-base percentage of two percent. A credit rate of 

3.75 percent applies to the extent that a taxpayer’s current-year research expenses exceed a base amount computed by using a fixedbase percentage of two percent. An election to be subject to this alternative incremental credit regime may be made for any taxable 

year beginning after June 30, 1996, and such an election applies 

to that taxable year and all subsequent years unless revoked with 

the consent of the Secretary of the Treasury. 

216

163 Under a special rule enacted as part of the Small Business Job Protection Act of 1996, 75 

percent of amounts paid to a research consortium for qualified research is treated as qualified 

research expenses eligible for the research credit (rather than 65 percent under the general rule 

under section 41(b)(3) governing contract research expenses) if (1) such research consortium is 

a tax-exempt organization that is described in section 501(c)(3) (other than a private foundation) 

or section 501(c)(6) and is organized and operated primarily to conduct scientific research, and 

(2) such qualified research is conducted by the consortium on behalf of the taxpayer and one 

or more persons not related to the taxpayer. Sec. 41(b)(3)(C). 164Taxpayers may elect 10-year amortization of certain research expenditures allowable as a 

deduction under section 174(a). Secs. 174(f)(2) and 59(e). 

Eligible expenses 

Qualified research expenses eligible for the research tax credit 

consist of: (1) in-house expenses of the taxpayer for wages and supplies attributable to qualified research; (2) certain time-sharing 

costs for computer use in qualified research; and (3) 65 percent of 

amounts paid or incurred by the taxpayer to certain other persons 

for qualified research conducted on the taxpayer’s behalf (so-called 

contract research expenses).163

To be eligible for the credit, the research must not only satisfy 

the requirements of present-law section 174 (described below) but 

must be undertaken for the purpose of discovering information that 

is technological in nature, the application of which is intended to 

be useful in the development of a new or improved business component of the taxpayer, and substantially all of the activities of which 

must constitute elements of a process of experimentation for functional aspects, performance, reliability, or quality of a business 

component. Research does not qualify for the credit if substantially 

all of the activities relate to style, taste, cosmetic, or seasonal design factors (sec. 41(d)(3)). In addition, research does not qualify for 

the credit: (1) if conducted after the beginning of commercial production of the business component; (2) if related to the adaptation 

of an existing business component to a particular customer’s requirements; (3) if related to the duplication of an existing business 

component from a physical examination of the component itself or 

certain other information; or (4) if related to certain efficiency surveys, management function or technique, market research, market 

testing, or market development, routine data collection or routine 

quality control (sec. 41(d)(4)). Research does not qualify for the 

credit if it is conducted outside the United States, Puerto Rico, or 

any U.S. possession. 

Relation to deduction 

Under section 174, taxpayers may elect to deduct currently the 

amount of certain research or experimental expenditures paid or 

incurred in connection with a trade or business, notwithstanding 

the general rule that business expenses to develop or create an 

asset that has a useful life extending beyond the current year must 

be capitalized.164 However, deductions allowed to a taxpayer under 

section 174 (or any other section) are reduced by an amount equal 

to 100 percent of the taxpayer’s research tax credit determined for 

the taxable year (Sec. 280C(c)). Taxpayers may alternatively elect 

to claim a reduced research tax credit amount under section 41 in 

lieu of reducing deductions otherwise allowed (sec. 280C(c)(3)). 

217

REASONS FOR CHANGE

The Committee acknowledges that research is important to the 

economy. Research is the basis of new products, new services, new 

industries, and new jobs for the domestic economy. Therefore the 

Committee believes it is appropriate to extend the present-law research credit. 

EXPLANATION OF PROVISION

The provision extends the present-law research credit to qualified amounts paid or incurred before January 1, 2006. 

EFFECTIVE DATE

The provision is effective for amounts paid or incurred after June 

30, 2004.

C. EXTENSION AND MODIFICATION OF THE SECTION 45 ELECTRICITY

PRODUCTION CREDIT

(Sec. 403 of the bill and sec. 45 of the Code) 

PRESENT LAW

An income tax credit is allowed for the production of electricity 

from either qualified wind energy, qualified ‘‘closed-loop’’ biomass, 

or qualified poultry waste facilities (sec. 45). The amount of the 

credit is 1.5 cents per kilowatt hour (indexed for inflation) of electricity produced. The amount of the credit is 1.8 cents per kilowatt 

hour for 2004. The credit is reduced for grants, tax-exempt bonds, 

subsidized energy financing, and other credits. 

The credit applies to electricity produced by a wind energy facility placed in service after December 31, 1993, and before January 

1, 2004, to electricity produced by a closed-loop biomass facility 

placed in service after December 31, 1992, and before January 1, 

2004, and to a poultry waste facility placed in service after December 31, 1999, and before January 1, 2004. The credit is allowable 

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

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

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

may claim the credit as a lessee/operator of a facility owned by a 

governmental unit. 

Closed-loop biomass is plant matter, where the plants are grown 

for the sole purpose of being used to generate electricity. It does 

not include waste materials (including, but not limited to, scrap 

wood, manure, and municipal or agricultural waste). The credit 

also is not available to taxpayers who use standing timber to 

produce electricity. Poultry waste means poultry manure and litter, 

including wood shavings, straw, rice hulls, and other bedding material for the disposition of manure. 

The credit for electricity produced from wind, closed-loop biomass, or poultry waste is a component of the general business credit (sec. 38(b)(8)). The credit, when combined with all other components of the general business credit, generally may not exceed for 

any taxable year the excess of the taxpayer’s net income tax over 

the greater of (1) 25 percent of net regular tax liability above 

218

$25,000, or (2) the tentative minimum tax. For credits arising in 

taxable years beginning after December 31, 1997, an unused general business credit generally may be carried back one year and 

carried forward 20 years (sec. 39). To coordinate the carryback with 

the period of application for this credit, the credit for electricity 

produced from closed-loop biomass facilities may not be carried 

back to a tax year ending before 1993 and the credit for electricity 

produced from wind energy may not be carried back to a tax year 

ending before 1994 (sec. 39). 

REASONS FOR CHANGE

The Committee recognizes that the section 45 production credit 

has fostered additional electricity generation capacity in the form 

of non-polluting wind power. The Committee believes it is important to continue this tax credit by extending the placed in service 

date for such facilities to bring more wind energy to the U. S. electric grid. The Committee further believes that, to encourage entrepreneurial exploration of alternative sources for electricity generation, it is appropriate to extend the present-law provision relating 

to facilities that use closed-loop biomass as an energy source. 

EXPLANATION OF PROVISION

The provision extends the placed in service date for wind facilities and closed-loop biomass facilities to facilities placed in service 

after December 31, 1993 (December 31, 1992 in the case of closedloop biomass facilities) and before January 1, 2006. The provision 

does not extend the placed in service date for poultry waste facilities. 

EFFECTIVE DATE

The provision is effective for facilities placed in service after December 31, 2003. 

D. INDIAN EMPLOYMENT TAX CREDIT

(Sec. 404 of the bill and sec. 45A of the Code) 

PRESENT LAW

In general, a credit against income tax liability is allowed to employers for the first $20,000 of qualified wages and qualified employee health insurance costs paid or incurred by the employer 

with respect to certain employees (sec. 45A). The credit is equal to 

20 percent of the excess of eligible employee qualified wages and 

health insurance costs during the current year over the amount of 

such wages and costs incurred by the employer during 1993. The 

credit is an incremental credit, such that an employer’s currentyear qualified wages and qualified employee health insurance costs 

(up to $20,000 per employee) are eligible for the credit only to the 

extent that the sum of such costs exceeds the sum of comparable 

costs paid during 1993. No deduction is allowed for the portion of 

the wages equal to the amount of the credit. 

Qualified wages means wages paid or incurred by an employer 

for services performed by a qualified employee. A qualified employee means any employee who is an enrolled member of an Indian tribe or the spouse of an enrolled member of an Indian tribe, 

219

who performs substantially all of the services within an Indian reservation, and whose principal place of abode while performing such 

services is on or near the reservation in which the services are performed. An employee will not be treated as a qualified employee for 

any taxable year of the employer if the total amount of wages paid 

or incurred by the employer with respect to such employee during 

the taxable year exceeds an amount determined at an annual rate 

of $30,000 (adjusted for inflation after 1993). 

The wage credit is available for wages paid or incurred on or 

after January 1, 1994, in taxable years that begin before January 

1, 2005. 

REASONS FOR CHANGE

The Committee believes that extending the wage credit tax incentive will expand employment opportunities for members of Indian tribes. 

EXPLANATION OF PROVISION

The provision extends the Indian employment credit incentive for 

one year (to taxable years beginning before January 1, 2006). 

EFFECTIVE DATE

The provision is effective on the date of enactment.

E. EXTEND THE WORK OPPORTUNITY TAX CREDIT

(Sec. 405 of the bill and sec. 51 of the Code) 

PRESENT LAW

In general 

The work opportunity tax credit (‘‘WOTC’’) is available on an 

elective basis for employers hiring individuals from one or more of 

eight targeted groups. The credit equals 40 percent (25 percent for 

employment of 400 hours or less) of qualified wages. Generally, 

qualified wages are wages attributable to service rendered by a 

member of a targeted group during the one-year period beginning 

with the day the individual began work for the employer. 

The maximum credit per employee is $2,400 (40 percent of the 

first $6,000 of qualified first-year wages). With respect to qualified 

summer youth employees, the maximum credit is $1,200 (40 percent of the first $3,000 of qualified first-year wages). 

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

the Federal Unemployment Tax Act, without regard to the dollar 

cap. 

Targeted groups eligible for the credit 

The eight targeted groups are: (1) families eligible to receive benefits under the Temporary Assistance for Needy Families (‘‘TANF’’) 

Program; (2) high-risk youth; (3) qualified ex-felons; (4) vocational 

rehabilitation referrals; (5) qualified summer youth employees; (6) 

qualified veterans; (7) families receiving food stamps; and (8) persons receiving certain Supplemental Security Income (‘‘SSI’’) benefits. 

220

The employer’s deduction for wages is reduced by the amount of 

the credit. 

Expiration date 

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

individual who begins work for an employer before January 1, 

2004. 

REASONS FOR CHANGE

The Committee believes that a temporary extension of this credit 

will allow the Congress and the Treasury and Labor Departments 

to continue to examine the effectiveness of the credit in expanding 

employment opportunities among the eight targeted groups. 

EXPLANATION OF PROVISION

The bill extends the work opportunity tax credit for two years 

(through December 31, 2005). 

EFFECTIVE DATE

The provision is effective for wages paid or incurred to a qualified individual who begins work for an employer on or after January 1, 2004, and before January 1, 2006.

F. EXTEND THE WELFARE-TO-WORK TAX CREDIT

(Sec. 406 of the bill and sec. 51A of the Code) 

PRESENT LAW

In general 

The welfare-to-work tax credit is available on an elective basis 

for employers for the first $20,000 of eligible wages paid to qualified long-term family assistance recipients during the first two 

years of employment. The credit is 35 percent of the first $10,000 

of eligible wages in the first year of employment and 50 percent of 

the first $10,000 of eligible wages in the second year of employment. The maximum credit is $8,500 per qualified employee. 

Qualified long-term family assistance recipients are: (1) members 

of a family that has received family assistance for at least 18 consecutive months ending on the hiring date; (2) members of a family 

that has received family assistance for a total of at least 18 months 

(whether or not consecutive) after the date of enactment of this 

credit if they are hired within 2 years after the date that the 18–

month total is reached; and (3) members of a family who are no 

longer eligible for family assistance because of either Federal or 

State time limits, if they are hired within two years after the Federal or State time limits made the family ineligible for family assistance. Family assistance means benefits under the Temporary 

Assistance to Needy Families (‘‘TANF’’) program. 

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

Federal Unemployment Tax Act, without regard to the dollar 

amount. In addition, wages include the following: (1) educational 

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

excludable health plan coverage but not more than the applicable 

221

premium defined under section 4980B(f)(4); and (3) dependent care 

assistance excludable under section 129. 

The employer’s deduction for wages is reduced by the amount of 

the credit. 

Expiration date 

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

to a qualified individual who begins work for an employer before 

January 1, 2004. 

REASONS FOR CHANGE

The Committee believes that the welfare-to-work credit should be 

temporarily extended to provide the Congress and Treasury and 

Labor Departments a better opportunity to continue to assess the 

operation and effectiveness of the credit in meeting its goals. These 

goals are: (1) to provide an incentive to hire long-term welfare recipients; (2) to promote the transition from welfare to work by increasing access to employment for these individuals; and (3) to encourage employers to provide these individuals with training, 

health coverage, dependent care and ultimately better job attachment. 

EXPLANATION OF PROVISION

The bill extends the welfare to work credit for two years (through 

December 31, 2005). 

EFFECTIVE DATE

The provision is effective for wages paid or incurred to a qualified individual who begins work for an employer on or after January 1, 2004, and before January 1, 2006.

G. EXTENSION OF THE ABOVE-THE-LINE DEDUCTION FOR CERTAIN

EXPENSES OF ELEMENTARY AND SECONDARY SCHOOL TEACHERS

(Sec. 407 of the bill and sec. 62 of the Code) 

PRESENT LAW

In general, ordinary and necessary business expenses are deductible (sec. 162). However, in general, unreimbursed employee business expenses are deductible only as an itemized deduction and 

only to the extent that the individual’s total miscellaneous deductions (including employee business expenses) exceed two percent of 

adjusted gross income. An individual’s otherwise allowable itemized 

deductions may be further limited by the overall limitation on 

itemized deductions, which reduces itemized deductions for taxpayers with adjusted gross income in excess of $142,700 (for 2004). 

In addition, miscellaneous itemized deductions are not allowable 

under the alternative minimum tax. 

Certain expenses of eligible educators are allowed as an abovethe-line deduction. Specifically, for taxable years beginning in 2002 

and 2003, an above-the-line deduction is allowed for up to $250 annually of expenses paid or incurred by an eligible educator for 

books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment, and 

222

supplementary materials used by the eligible educator in the classroom. To be eligible for this deduction, the expenses must be otherwise deductible under section 162 as a trade or business expense. 

A deduction is allowed only to the extent the amount of expenses 

exceeds the amount excludable from income under section 135 (relating to education savings bonds), 529(c)(1) (relating to qualified 

tuition programs), and section 530(d)(2) (relating to Coverdell education savings accounts). 

An eligible educator is a kindergarten through grade 12 teacher, 

instructor, counselor, principal, or aide in a school for at least 900 

hours during a school year. A school means any school that provides elementary education or secondary education, as determined 

under State law. 

The above-the-line deduction for eligible educators is not allowed 

for taxable years beginning after December 31, 2003. 

REASONS FOR CHANGE

The Committee recognizes that elementary and secondary educators often incur substantial unreimbursed expenses in the course 

of their teaching duties, and believes that an extension of the deduction of such expenses is warranted to continue to provide tax 

relief to educators who incur such expenses on behalf of their students. 

EXPLANATION OF PROVISION

The provision extends the availability of the above-the-line deduction for two years, i.e., for taxable years beginning during 2004 

and 2005. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2003. 

H. EXTENSION OF ACCELERATED DEPRECIATION BENEFIT FOR

PROPERTY ON INDIAN RESERVATIONS

(Sec. 408 of the bill and sec. 168(j) of the Code) 

PRESENT LAW

With respect to certain property used in connection with the conduct of a trade or business within an Indian reservation, depreciation deductions under section 168(j) will be determined using the 

following recovery periods:

Years 

3-year property ....................................................................................................... 2 

5-year property ....................................................................................................... 3 

7-year property ....................................................................................................... 4 

10-year property ..................................................................................................... 6 

15-year property ..................................................................................................... 9 

20-year property ..................................................................................................... 12 

Nonresidential real property ................................................................................. 22

‘‘Qualified Indian reservation property’’ eligible for accelerated 

depreciation includes property which is (1) used by the taxpayer 

predominantly in the active conduct of a trade or business within 

an Indian reservation, (2) not used or located outside the reservation on a regular basis, (3) not acquired (directly or indirectly) by 

223

165Sec. 170(e)(6). 

the taxpayer from a person who is related to the taxpayer (within 

the meaning of section 465(b)(3)(C)), and (4) described in the recovery-period table above. In addition, property is not ‘‘qualified Indian reservation property’’ if it is placed in service for purposes of 

conducting gaming activities. Certain ‘‘qualified infrastructure 

property’’ may be eligible for the accelerated depreciation even if located outside an Indian reservation, provided that the purpose of 

such property is to connect with qualified infrastructure property 

located within the reservation (e.g., roads, power lines, water systems, railroad spurs, and communications facilities). 

The depreciation deduction allowed for regular tax purposes is 

also allowed for purposes of the alternative minimum tax. The accelerated depreciation for Indian reservations is available with respect to property placed in service on or after January 1, 1994, and 

before January 1, 2005. 

REASONS FOR CHANGE

The Committee believes that extending the depreciation incentive will encourage economic development within Indian reservations and expand employment opportunities on such reservations. 

EXPLANATION OF PROVISION

The provision extends the accelerated depreciation incentive for 

one year (to property placed in service before January 1, 2006). 

EFFECTIVE DATE

The provision is effective on the date of enactment.

I. EXTEND ENHANCED CHARITABLE DEDUCTION FOR COMPUTER

TECHNOLOGY AND EQUIPMENT

(Sec. 409 of the bill and sec. 170 of the Code) 

PRESENT LAW

Under present law, a taxpayer’s deduction for charitable contributions of computer technology and equipment generally is limited to the taxpayer’s basis (typically, cost) in the property. However, certain corporations may claim a deduction in excess of basis 

for a qualified computer contribution.165 This enhanced deduction 

is equal to the lesser of (1) basis plus one-half of the item’s appreciated value (i.e., basis plus one half of fair market value minus 

basis) or (2) two times basis. The enhanced deduction for qualified 

computer contributions expires for any contribution made during 

any taxable year beginning after December 31, 2003. 

A qualified computer contribution means a charitable contribution of any computer technology or equipment that meets standards of functionality and suitability as established by the Secretary 

of the Treasury. The contribution must be to certain educational organizations or public libraries and made not later than three years 

after the taxpayer acquired the property or, if the taxpayer constructed the property, not later than the date construction of the 

224

166 If the taxpayer constructed the property and reacquired such property, the contribution 

must be within three years of the date the original construction was substantially completed. 

Sec. 170(e)(6)(D)(i). 167This requirement does not apply if the property was reacquired by the manufacturer and 

contributed. Sec. 170(e)(6)(D)(ii). 

property is substantially completed.166 The original use of the property must be by the donor or the donee,167 and in the case of the 

donee, must be used substantially for educational purposes related 

to the function or purpose of the donee. The property must fit productively into the donee’s education plan. The donee may not transfer the property in exchange for money, other property, or services, 

except for shipping, installation, and transfer costs. Property is 

considered constructed by the taxpayer only if the cost of the parts 

used in the construction of the property (other than parts manufactured by the taxpayer or a related person) does not exceed 50 percent of the taxpayer’s basis in the property. Contributions may be 

made to private foundations under certain conditions. 

REASONS FOR CHANGE

The Committee believes that educational organizations and public libraries continue to have a need for computer equipment and 

that it is appropriate to extend the enhanced deduction for contributions of such equipment to such institutions. 

EXPLANATION OF PROVISION

The provision extends the enhanced deduction for qualified computer contributions to contributions made during any taxable year 

beginning before January 1, 2005. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2003. 

J. EXTENSION OF EXPENSING OF CERTAIN ENVIRONMENTAL

REMEDIATION COSTS

(Sec. 410 of the bill and sec. 198 of the Code) 

PRESENT LAW

Taxpayers can elect to treat certain environmental remediation 

expenditures that would otherwise be chargeable to capital account 

as deductible in the year paid or incurred (sec. 198). The deduction 

applies for both regular and alternative minimum tax purposes. 

The expenditure must be incurred in connection with the abatement or control of hazardous substances at a qualified contaminated site. 

A ‘‘qualified contaminated site’’ generally is any property that (1) 

is held for use in a trade or business, for the production of income, 

or as inventory and (2) is at a site on which there has been a release (or threat of release) or disposal of certain hazardous substances as certified by the appropriate State environmental agency 

(so called ‘‘brownfields’’). However, sites that are identified on the 

national priorities list under the Comprehensive Environmental 

Response, Compensation, and Liability Act of 1980 cannot qualify 

as targeted areas. 

225

168Self-employed individuals include more than two-perent shareholders of S corporations who 

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

Eligible expenditures are those paid or incurred before January 

1, 2004. 

REASONS FOR CHANGE

The Committee observes that by lowering the net capital cost of 

a development project the expensing of brownfields remediation 

costs promotes the goal of environmental remediation and promotes 

new investment and employment opportunities. In addition, the 

Committee believes that the increased investment in the qualifying 

areas has spillover effects that are beneficial to the neighboring 

communities. Therefore, the Committee believes it is appropriate to 

extend the present-law provision permitting the expensing of environmental remediation costs. 

EXPLANATION OF PROVISION

The provision extends the present law expensing provision for 

two years (through December 31, 2005). 

EFFECTIVE DATE

The provision is effective for expenses paid or incurred after December 31, 2003, and before January 1, 2006.

K. EXTENSION OF ARCHER MEDICAL SAVINGS ACCOUNTS (‘‘MSAS’’) 

(Sec. 411 of the bill and sec. 220 of the Code) 

PRESENT LAW

In general 

Within limits, contributions to an Archer MSA are deductible in 

determining adjusted gross income if made by an eligible individual 

and are excludable from gross income and wages for employment 

tax purposes if made by the employer of an eligible individual. 

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

Distributions from an Archer MSA for medical expenses are not includible in gross income. Distributions not used for medical expenses are includible in gross income. In addition, distributions not 

used for medical expenses are subject to an additional 15-percent 

tax unless the distribution is made after age 65, death, or disability. 

Eligible individuals 

Archer MSAs are available to employees covered under an employer-sponsored high deductible plan of a small employer and selfemployed individuals covered under a high deductible health 

plan.168 An employer is a small employer if it employed, on average, no more than 50 employees on business days during either the 

preceding or the second preceding year. An individual is not eligible for an Archer MSA if he or she is covered under any other 

health plan in addition to the high deductible plan. 

226

169These dollar amounts are for 2004. These amounts are indexed for inflation, rounded to 

the nearest $50. 

Tax treatment of and limits on contributions 

Individual contributions to an Archer MSA are deductible (within 

limits) in determining adjusted gross income (i.e., ‘‘above-the-line’’). 

In addition, employer contributions are excludable from gross income and wages for employment tax purposes (within the same 

limits), except that this exclusion does not apply to contributions 

made through a cafeteria plan. In the case of an employee, contributions can be made to an Archer MSA either by the individual 

or by the individual’s employer. 

The maximum annual contribution that can be made to an Archer MSA for a year is 65 percent of the deductible under the high 

deductible plan in the case of individual coverage and 75 percent 

of the deductible in the case of family coverage. 

Definition of high deductible plan 

A high deductible plan is a health plan with an annual deduct- ible of at least $1,700 and no more than $2,600 in the case of individual coverage and at least $3,450 and no more than $5,150 in the 

case of family coverage. In addition, the maximum out-of-pocket expenses with respect to allowed costs (including the deductible) must 

be no more than $3,450 in the case of individual coverage and no 

more than $6,300 in the case of family coverage.169 A plan does not 

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

have a deductible for preventive care as required by State law. A 

plan does not qualify as a high deductible health plan if substantially all of the coverage under the plan is for permitted coverage 

(as described above). In the case of a self-insured plan, the plan 

must in fact be insurance (e.g., there must be appropriate risk 

shifting) and not merely a reimbursement arrangement. 

Cap on taxpayers utilizing Archer MSAs and expiration of pilot program 

The number of taxpayers benefiting annually from an Archer 

MSA contribution is limited to a threshold level (generally 750,000 

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

After 2003, no new contributions may be made to Archer MSAs 

except by or on behalf of individuals who previously had Archer 

MSA contributions and employees who are employed by a participating employer. 

Trustees of Archer MSAs are generally required to make reports 

to the Treasury by August 1 regarding Archer MSAs established by 

July 1 of that year. If any year is a cut-off year, the Secretary is 

required to make and publish such determination by October 1 of 

such year. 

REASONS FOR CHANGE

The Committee believes that individuals should be encouraged to 

save for future medical care expenses and that individuals should 

be allowed to save for such expenses on a tax-favored basis. The 

Committee believes that consumers who spend their own savings 

on health care will make cost-conscious decisions, thus reducing 

227

170Treas. Reg. sec. 1.611–1(b)(1). 

the rising cost of health care. The Committee believes that Archer 

MSAs have been an important tool in allowing certain individuals 

to save for future medical expenses on a tax-favored basis. 

The Committee is aware that recently enacted health savings accounts offer more advantageous tax treatment than Archer MSAs 

and that amounts can be rolled over into a health savings account 

from an Archer MSA on a tax-free basis. Still, the Committee believes that individuals should be allowed the choice to continue the 

use of Archer MSAs. Thus, the Committee believes that it is appropriate to extend Archer MSAs. 

EXPLANATION OF PROVISION

The provision extends Archer MSAs through December 31, 2005. 

The provision also provides that the reports required by MSA trustees for 2004 are treated as timely if made within 90 days after the 

date of enactment. In addition, the determination of whether 2004 

is a cut-off year and the publication of such determination is to be 

made within 120 days of the date of enactment. If 2004 is a cutoff year, the cut-off date will be the last day of such 120-day period. 

EFFECTIVE DATE

The provision is generally effective on January 1, 2004. The provisions relating to reports and the determination by the Secretary 

are effective on the date of enactment.

L. TAXABLE INCOME LIMIT ON PERCENTAGE DEPLETION FOR OIL AND

NATURAL GAS PRODUCED FROM MARGINAL PROPERTIES

(Sec. 412 of the bill and sec. 613A of the Code) 

PRESENT LAW

Overview of depletion 

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

both cases, the taxpayer is allowed a deduction in recognition of the 

fact that an asset—in the case of depletion for oil or gas interests, 

the mineral reserve itself—is being expended in order to produce 

income. Certain costs incurred prior to drilling an oil or gas property are recovered through the depletion deduction. These include 

costs of acquiring the lease or other interest in the property and 

geological and geophysical costs (in advance of actual drilling). 

Depletion is available to any person having an economic interest 

in a producing property. An economic interest is possessed in every 

case in which the taxpayer has acquired by investment any interest 

in minerals in place, and secures, by any form of legal relationship, 

income derived from the extraction of the mineral, to which it must 

look for a return of its capital.170 Thus, for example, both working 

interests and royalty interests in an oil- or gas-producing property 

constitute economic interests, thereby qualifying the interest holders for depletion deductions with respect to the property. A taxpayer who has no capital investment in the mineral deposit does 

not possess an economic interest merely because it possesses an 

228

171Secs. 611–613. 172Sec. 613A. 173Sec. 613A(c). 174Sec. 613(a). 

economic or pecuniary advantage derived from production through 

a contractual relation. 

Cost depletion 

Two methods of depletion are currently allowable under the 

Code: (1) the cost depletion method, and (2) the percentage depletion method.171 Under the cost depletion method, the taxpayer deducts that portion of the adjusted basis of the depletable property 

which is equal to the ratio of units sold from that property during 

the taxable year to the number of units remaining as of the end 

of taxable year plus the number of units sold during the taxable 

year. Thus, the amount recovered under cost depletion may never 

exceed the taxpayer’s basis in the property. 

Percentage depletion and related income limitations 

The Code generally limits the percentage depletion method for oil 

and gas properties to independent producers and royalty owners.172

Generally, under the percentage depletion method, 15 percent of 

the taxpayer’s gross income from an oil- or gas-producing property 

is allowed as a deduction in each taxable year.173 The amount deducted generally may not exceed 100 percent of the net income 

from that property in any year (the ‘‘net-income limitation’’).174 The 

100-percent net-income limitation for marginal wells has been suspended for taxable years beginning after December 31, 1997, and 

before January 1, 2004. 

REASONS FOR CHANGE

Domestic production from marginal wells is an appropriate part 

of establishing national energy security and reducing dependence 

on foreign oil. The Committee believes the suspension of the 100-

percent net-income limitation for marginal wells should be extended to encourage continued operation of such wells. 

EXPLANATION OF PROVISION

The suspension of the 100-percent net-income limitation for marginal wells is extended an additional two years, through taxable 

years beginning before January 1, 2006. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2003.

M. QUALIFIED ZONE ACADEMY BONDS

(Sec. 413 of the bill and sec. 1397E of the Code) 

PRESENT LAW

Tax-exempt bonds 

Interest on State and local governmental bonds generally is excluded from gross income for Federal income tax purposes if the 

229

proceeds of the bonds are used to finance direct activities of these 

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

governmental units. Activities that can be financed with these taxexempt bonds include the financing of public schools (sec. 103). 

Qualified zone academy bonds 

As an alternative to traditional tax-exempt bonds, States and 

local governments are given the authority to issue ‘‘qualified zone 

academy bonds’’ (‘‘QZABs’’) (sec. 1397E). A total of $400 million of 

qualified zone academy bonds may be issued annually in calendar 

years 1998 through 2003. The $400 million aggregate bond cap is 

allocated each year to the States according to their respective populations of individuals below the poverty line. Each State, in turn, 

allocates the credit authority to qualified zone academies within 

such State. 

Financial institutions that hold qualified zone academy bonds are 

entitled to a nonrefundable tax credit in an amount equal to a credit rate multiplied by the face amount of the bond. A taxpayer holding a qualified zone academy bond on the credit allowance date is 

entitled to a credit. The credit is includable in gross income (as if 

it were a taxable interest payment on the bond), and may be 

claimed against regular income tax and AMT liability. 

The Treasury Department sets the credit rate at a rate estimated 

to allow issuance of qualified zone academy bonds without discount 

and without interest cost to the issuer. The maximum term of the 

bond is determined by the Treasury Department, so that the 

present value of the obligation to repay the bond is 50 percent of 

the face value of the bond. 

‘‘Qualified zone academy bonds’’ are defined as any bond issued 

by a State or local government, provided that: (1) at least 95 percent of the proceeds are used for the purpose of renovating, providing equipment to, developing course materials for use at, or 

training teachers and other school personnel in a ‘‘qualified zone 

academy’’, and (2) private entities have promised to contribute to 

the qualified zone academy certain equipment, technical assistance 

or training, employee services, or other property or services with a 

value equal to at least 10 percent of the bond proceeds. 

A school is a ‘‘qualified zone academy’’ if: (1) the school is a public school that provides education and training below the college 

level, (2) the school operates a special academic program in cooperation with businesses to enhance the academic curriculum and 

increase graduation and employment rates, and (3) either (a) the 

school is located in an empowerment zone or enterprise community 

designated under the Code, or (b) it is reasonably expected that at 

least 35 percent of the students at the school will be eligible for 

free or reduced-cost lunches under the school lunch program established under the National School Lunch Act. 

REASONS FOR CHANGE

The Committee believes that the extension of authority to issue 

qualified zone academy bonds is appropriate in light of the educational needs that exist today. 

230

EXPLANATION OF PROVISION

The bill authorizes issuance of up to $400 million of qualified 

zone academy bonds annually for calendar years 2004 and 2005. 

EFFECTIVE DATE

The provision is effective for obligations issued after the date of 

enactment.

N. EXTENSION OF TAX INCENTIVES FOR INVESTMENT IN THE

DISTRICT OF COLUMBIA

(Sec. 414 of the bill and secs. 1400, 1400A, 1400B, and 1400C of 

the Code) 

PRESENT LAW

DC Zone incentives 

The Taxpayer Relief Act of 1997 designated certain economically 

depressed census tracts within the District of Columbia as the District of Columbia Enterprise Zone (the ‘‘D.C. Zone’’), within which 

businesses and individual residents are eligible for special tax incentives. The D.C. Zone designation is in effect for the period from 

January 1, 1998, through December 31, 2003. In addition to the tax 

incentives generally available with respect to empowerment zones, 

the D.C. Zone also has a zero-percent capital gains rate that applies to gain from the sale of certain qualified D.C. Zone assets acquired after December 31, 1997, and held for more than five years. 

With respect to the tax-exempt financing incentives, the D.C. 

Zone generally is treated like a Round I empowerment zone; therefore, the issuance of such tax-exempt bonds is subject to the District of Columbia’s annual private activity bond volume limitation. 

However, the aggregate face amount of all outstanding qualified 

D.C. zone facility bonds per qualified D.C. Zone business may not 

exceed $15 million (rather than $3 million, as is the case for Round 

I empowerment zones). 

Homebuyers tax credit 

First-time homebuyers of a principal residence in the District of 

Columbia are eligible for a nonrefundable tax credit of up to $5,000 

of the amount of the purchase price. The $5,000 maximum credit 

applies both to individuals and married couples. Married individuals filing separately can claim a maximum credit of $2,500 each. 

The credit phases out for individual taxpayers with adjusted gross 

income between $70,000 and $90,000 ($110,000–$130,000 for joint 

filers). For purposes of eligibility, ‘‘first-time homebuyer’’ means 

any individual if such individual did not have a present ownership 

interest in a principal residence in the District of Columbia in the 

one-year period ending on the date of the purchase of the residence 

to which the credit applies. The credit is scheduled to expire for 

property purchased after December 31, 2003. 

REASONS FOR CHANGE

The Committee believes that the incentives should temporarily 

be extended to provide the Congress and the Treasury Department 

a better opportunity to continue to assess the overall operation and 

231

effectiveness of the tax incentives to revitalize the DC Zone and to 

promote homeownership therein. 

EXPLANATION OF PROVISION

DC Zone incentives 

The bill extends the D.C. Zone designation and tax-exempt financing incentives for two years (through December 31, 2005). The 

bill extends the date before which a DC Zone asset must be acquired for purposes of utilizing the zero-percent capital gains rate 

for two years (to January 1, 2006), and extends the period within 

which gain is treated as qualified capital gain for two years 

(through December 31, 2010). 

Homebuyers tax credit 

The bill extends the first-time homebuyer credit for two years 

(through December 31, 2005). 

EFFECTIVE DATE

The provisions are effective on the date of enactment, except that 

the provision relating to tax-exempt financing incentives applies to 

obligations issued after December 31, 2003.

O. EXTEND THE AUTHORITY TO ISSUE LIBERTY ZONE BONDS

(Sec. 415 of the bill and sec. 1400L of the Code) 

PRESENT LAW

In general 

Interest on debt incurred by States or local governments is excluded from income if the proceeds of the borrowing are used to 

carry out governmental functions of those entities or the debt is repaid with governmental funds (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.’’ The term ‘‘private 

person’’ includes the Federal Government and all other individuals 

and entities other than States or local governments. 

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. For calendar year 2004, these annual volume limits are 

equal to the greater of $80 per resident of the State or $234 million. 

Tax-exempt private activity bonds 

Interest on private activity bonds is tax-exempt only for qualified 

bonds. Qualified bonds include: (1) exempt facility bonds; (2) qualified mortgage bonds; (3) qualified veteran mortgage bonds; (4) 

qualified small-issue bonds; (5) qualified student loan bonds; (6) 

qualified redevelopment bonds; and (7) qualified 501(c)(3) bonds. A 

further provision allows tax-exempt financing for ‘‘environmental 

enhancements of hydro-electric generating facilities.’’ Tax-exempt 

232

175 No more than $800 million of the authorized bond amount may be used to finance property 

used for retail sales of tangible property (e.g., department stores, restaurants, etc.) and functionally related and subordinate property. The term nonresidential real property includes structural 

components of such property if the taxpayer treats such components as part of the real property 

structure for all Federal income tax purposes (e.g., cost recovery). The $800 million limit is divided equally between the Mayor and the Governor. 176 No more than $1.6 billion of the authorized bond amount may be used to finance residen- tial rental property. The $1.6 billion limit is divided equally between the Mayor and the Governor. 177 Current refundings of outstanding New York Liberty Bonds bonds do not count against the $8 billion volume limit to the extent that the amount of the refunding bonds does not exceed 

the outstanding amount of the bonds being refunded. In addition, qualified New York Liberty 

Bonds may be issued after December 31, 2004 to refund (other than advance refund) qualified 

New York Liberty Bonds originally issued before January 1, 2005, to the extent the amount of 

the refunding bonds does not exceed the outstanding amount of the refunded bonds. The bonds 

may not be advance refunded. 178Fixtures and equipment that could be removed from the designated zone for use elsewhere 

are not eligible for financing with these bonds. 179Public utility property and residential property located outside the Zone cannot be financed 

with the bonds. 

financing also is authorized for capital expenditures for small manufacturing facilities and land and equipment for first-time farmers 

(‘‘qualified small-issue bonds’’), local redevelopment activities 

(‘‘qualified redevelopment bonds’’), and eligible empowerment zone 

and enterprise community businesses. 

Tax-exempt financing is also allowed for qualified New York Liberty Bonds issued during calendar years 2002, 2003, and 2004. An 

aggregate limit of $8 billion of tax-exempt private activity bonds to 

finance the construction and rehabilitation of nonresidential real 

property 175 and residential rental real property 176 in a newly designated ‘‘Liberty Zone’’ (the ‘‘Zone’’) of New York City is allowed.177

Property eligible for financing with these bonds includes buildings 

and their structural components, fixed tenant improvements,178

and public utility property (e.g., gas, water, electric and telecommunication lines). All business addresses located on or south of 

Canal Street, East Broadway (east of its intersection with Canal 

Street), or Grand Street (east of its intersection with East Broadway) in the Borough of Manhattan are considered to be located 

within the Zone. Issuance of these bonds is limited to projects approved by the Mayor of New York City or the Governor of New 

York State, each of whom may designate up to $4 billion of the 

bonds authorized under the bill. 

If the Mayor or the Governor determines that it is not feasible 

to use all of the authorized bonds that he is authorized to designate 

for property located in the Zone, up to $1 billion of bonds may be 

designated by each to be used for the acquisition, construction, and 

rehabilitation of nonresidential real property (including fixed tenant improvements) located outside the Zone and within New York 

City.179 Bond-financed property located outside the Zone must 

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 acquisition of existing property is applied using a minimum requirement of 50 percent of the cost 

233

180 It is intended that redemptions will occur at least semi-annually beginning at the end of 

10 years after the bonds are issued; however, amounts less than $250,000 are not required to 

be used to redeem bonds at such intervals. 181Sec. 6103(b)(2)(A). 

of acquiring the building being devoted to rehabilitation (sec. 

147(d));

(3) The special arbitrage expenditure rules for certain construction bond proceeds apply to available construction proceeds of the 

bonds (sec. 148(f)(4)(C)); 

(4) The tenant targeting rules applicable to exempt-facility bonds 

for residential rental property (and the corresponding change in 

use penalties for violations of those rules) do not apply to such 

property financed with the bonds (secs. 142(d) and 150(b)(2)); 

(5) Repayments of bond-financed loans may not be used to make 

additional loans, but rather must be used to retire outstanding 

bonds (with the first such retirement occurring 10 years after 

issuance of the bonds); 180 and 

(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)). 

REASONS FOR CHANGE

The Committee is committed to aiding the City of New York’s 

economic recovery from the terrorist attacks of September 11, 2001. 

Therefore, the Committee believes that an extension of the authority to issue New York Liberty Bonds is appropriate. 

EXPLANATION OF PROVISION

The bill extends authority to issue New York Liberty Bonds 

through December 31, 2009. 

EFFECTIVE DATE

The provision is effective for bonds issued after the date of enactment and before January 1, 2010. 

P. DISCLOSURE TO LAW ENFORCEMENT AGENCIES REGARDING

TERRORIST ACTIVITIES

(Sec. 416 of the bill and sec. 6103 of the Code) 

PRESENT LAW

Return information includes a taxpayer’s identity.181 The IRS 

may disclose return information, other than taxpayer return information, to officers and employees of Federal law enforcement upon 

a written request. The request must be made by the head of the 

Federal law enforcement agency (or his delegate) involved in the 

response to or investigation of terrorist incidents, threats, or activities, and set forth the specific reason or reasons why such disclosure may be relevant to a terrorist incident, threat, or activity. 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, 

234

182Sec. 6103(i)(7)(A). 183Sec. 6103(i)(7)(A)(ii). 184Sec. 6103(i)(7)(B). 185Sec. 6103(i)(3)(C). 

threats, or activities. The information is to be used by such officers 

and employees solely for such response or investigation.182

The Federal law enforcement agency may redisclose the information to officers and employees of State and local law enforcement 

personally and directly engaged in the response to or investigation 

of the terrorist incident, threat, or activity. The State or local law 

enforcement agency must be part of an investigative or response 

team with the Federal law enforcement agency for these disclosures to be made.183

If a taxpayer’s identity is taken from a return or other information filed with or furnished to the IRS by or on behalf of the taxpayer, it is taxpayer return information. Since taxpayer return information is not covered by this disclosure authorization, taxpayer 

identity so obtained cannot be disclosed and thus associated with 

the other information being provided. 

The Code also allows the IRS to disclose return information 

(other than taxpayer return information) upon the written request 

of an officer or employee of the Department of Justice or Treasury 

who is appointed by the President with the advice and consent of 

the Senate, or who is the Director of the U.S. Secret Service, if 

such individual is responsible for the collection and analysis of intelligence and counterintelligence concerning any terrorist incident, 

threat, or activity.184 Taxpayer identity information for this purpose is not considered taxpayer return information. Such written 

request must set forth the specific reason or reasons why such disclosure may be relevant to a terrorist incident, threat, or activity. 

Disclosures under this authority may be made to those officers and 

employees of the Department of Justice, Treasury, and Federal intelligence agencies who are personally and directly engaged in the 

collection or analysis of intelligence and counterintelligence information or investigation concerning any terrorist incident, threat, or 

activity. Such disclosures may be made solely for the use of such 

officers and employees in such investigation, collection, or analysis. 

The IRS, on its own initiative, may disclose in writing return information (other than taxpayer return information) that may be related to a terrorist incident, threat, or activity to the extent necessary to apprise the head of the appropriate investigating Federal 

law enforcement agency.185 Taxpayer identity information for this 

purpose is not considered taxpayer return information. The head of 

the agency may redisclose such information to officers and employees of such agency to the extent necessary to investigate or respond 

to the terrorist incident, threat, or activity. 

If taxpayer return information is sought, the disclosure must be 

made pursuant to the ex parte order of a Federal district court 

judge or magistrate. 

No disclosures may be made under these provisions after December 31, 2003. 

REASONS FOR CHANGE

The Committee believes that a renewal of this disclosure authority will provide additional time to evaluate the effectiveness of the 

235

186Sec. 6103. 187Sec. 6103(l)(13). 188Pub. L. No. 108–89, sec. 201 (2003). 189Sec. 6103(c). 190Department of Treasury, Report to the Congress on Scope and Use of Taxpayer Confidentiality and Disclosure Provisions, Volume I: Study of General Provisions (October 2000) at 91. 191Department of Treasury, General Explanations of the Administration’s Fiscal Year 2004 

Revenue Proposals (February 2003) at 133. 

provision and whether any modifications need to be implemented 

to enhance the provision. 

EXPLANATION OF PROVISION

The provision extends the disclosure authority relating to terrorist activities. Under the provision, no disclosures can be made 

after December 31, 2005. 

The provision also makes a technical change to clarify that a taxpayer’s identity is not treated as taxpayer return information for 

purposes of disclosures to law enforcement agencies regarding terrorist activities. 

EFFECTIVE DATE

The provision extending authority is effective for disclosures 

made on or after the date of enactment. The technical change is effective as if included in section 201 of the Victims of Terrorism Tax 

Relief Act of 2001.

Q. DISCLOSURE OF RETURN INFORMATION RELATING TO STUDENT

LOANS

(Sec. 417 of the bill and sec. 6103(l) of the Code) 

PRESENT LAW

Present law prohibits the disclosure of returns and return information, except to the extent specifically authorized by the Code.186

An exception is provided for disclosure to the Department of Education (but not to contractors thereof) of a taxpayer’s filing status, 

adjusted gross income and identity information (i.e., name, mailing 

address, taxpayer identifying number) to establish an appropriate 

repayment amount for an applicable student loan.187 The Department of Education disclosure authority is scheduled to expire after 

December 31, 2004.188

An exception to the general rule prohibiting disclosure is also 

provided for the disclosure of returns and return information to a 

designee of the taxpayer.189 Unlike the specific Department of Education exception, section 6103(c) disclosures are not subject to use 

restrictions nor are they subject to statutory safeguards. Because 

the Department of Education utilizes contractors for the incomecontingent loan verification program, the Department of Education 

obtains taxpayer information by consent under section 6103(c), 

rather than under the specific exception.190 The Department of 

Treasury has reported that the Internal Revenue Service processes 

approximately 100,000 consents per year for this purpose.191

REASONS FOR CHANGE

The Committee believes that the Department of Education 

should be provided with access to tax return information to assist 

236

192 A proof gallon is a liquid gallon consisting of 50 percent alcohol. See sec. 5002(a)(10), (11). 193Sec. 5001(a)(1). 194Secs. 5062(b), 7653(b) and (c). 195Sec. 7652(a)(3), (b)(3), and (e)(1). One percent of the amount of excise tax collected from 

imports into the United States of articles produced in the Virgin Islands is retained by the 

United States under section 7652(b)(3). 196Sec. 7652(e)(2). 197Sec. 7652(a)(3), (b)(3), and (e)(1). 

it in carrying out the income-contingent repayment program. Thus, 

the Committee believes that it is appropriate to provide a further 

extension of this disclosure authority. 

EXPLANATION OF PROVISION

The bill extends the disclosure authority relating to the disclosure of return information to carry out income-contingent repayment of student loans. Under the bill, no disclosures can be made 

after December 31, 2005. 

EFFECTIVE DATE

The provision is effective with respect to disclosures made after 

the date of enactment.

R. EXTENSION OF COVER OVER OF EXCISE TAX ON DISTILLED

SPIRITS TO PUERTO RICO AND VIRGIN ISLANDS

(Sec. 418 of the bill and sec. 7652 of the Code) 

PRESENT LAW

A $13.50 per proof gallon 192 excise tax is imposed on distilled 

spirits produced in or imported (or brought) into the United 

States.193 The excise tax does not apply to distilled spirits that are 

exported from the United States, including exports to U.S. possessions (e.g., Puerto Rico and the Virgin Islands).194

The Code provides for cover over (payment) to Puerto Rico and 

the Virgin Islands of the excise tax imposed on rum imported (or 

brought) into the United States, without regard to the country of 

origin.195 The amount of the cover over is limited under section 

7652(f) to $10.50 per proof gallon ($13.25 per proof gallon during 

the period July 1, 1999 through December 31, 2003). 

Thus, tax amounts attributable to shipments to the United 

States of rum produced in Puerto Rico are covered over to Puerto 

Rico. Tax amounts attributable to shipments to the United States 

of rum produced in the Virgin Islands are covered over to the Virgin Islands. Tax amounts attributable to shipments to the United 

States of rum produced in neither Puerto Rico nor the Virgin Islands are divided and covered over to the two possessions under a 

formula.196 Amounts covered over to Puerto Rico and the Virgin Islands are deposited into the treasuries of the two possessions for 

use as those possessions determine.197 All of the amounts covered 

over are subject to the limitation. 

REASONS FOR CHANGE

The Committee believes that the needs of Puerto Rico and the 

Virgin Islands justify the extension of the cover over amount of 

$13.25 per proof gallon through December 31, 2005. 

237

198The joint review was required to include two members of the majority and one member 

of the minority of the Senate Committees on Finance, Appropriations, and Governmental Affairs, and of the House Committees on Ways and Means, Appropriations, and Government Reform and Oversight. 199Sec. 8021(f). 200Sec. 8022(3)(C). 201 Accordingly, the provision deletes the specific list of matters required to be covered in the 

annual report. 

EXPLANATION OF PROVISION

The provision temporarily suspends the $10.50 per proof gallon 

limitation on the amount of excise taxes on rum covered over to 

Puerto Rico and the Virgin Islands. Under the provision, the cover 

over amount of $13.25 per proof gallon is extended for rum brought 

into the United States after December 31, 2003 and before January 

1, 2006. After December 31, 2005, the cover over amount reverts 

to $10.50 per proof gallon. 

EFFECTIVE DATE

The provision is effective for articles brought into the United 

States after December 31, 2003.

S. EXTENSION OF JOINT REVIEW

(Sec. 419 of the bill and secs. 8021 and 8022 of the Code) 

PRESENT LAW

The Code required the Joint Committee on Taxation to conduct 

a joint review 198 of the strategic plans and budget of the IRS from 

1999 through 2003.199 The Code also required the Joint Committee 

to provide an annual report 200 from 1999 through 2003 with respect to: 

• Strategic and business plans for the IRS; 

• Progress of the IRS in meeting its objectives; 

• The budget for the IRS and whether it supports its objectives; 

• Progress of the IRS in improving taxpayer service and 

compliance; 

• Progress of the IRS on technology modernization; and 

• The annual filing season. 

REASONS FOR CHANGE

The Committee believes that a joint review of the IRS should be 

held for one additional year and that the report provided by the 

Joint Committee on Taxation should be tailored to the specific 

issues addressed in the joint review. 

EXPLANATION OF PROVISION

The provision requires that the Joint Committee conduct a joint 

review before June 1, 2005. The provision requires the Joint Committee to provide an annual report before June 1, 2005, but specifies that the content of the annual report is the matters addressed 

in the joint review.201

EFFECTIVE DATE

The provision is effective on the date of enactment. 

238

202The excise tax does not apply to benefits for services furnished on or after September 30, 

2001, and before January 10, 2002. 

T. PARITY IN THE APPLICATION OF CERTAIN LIMITS TO MENTAL

HEALTH BENEFITS

(Sec. 420 of the bill and sec. 9812 of the Code) 

PRESENT LAW

The Mental Health Parity Act of 1996 amended the Employee 

Retirement Income Security Act of 1974 (‘‘ERISA’’) and the Public 

Health Service Act (‘‘PHSA’’) to provide that group health plans 

that provide both medical and surgical benefits and mental health 

benefits cannot impose aggregate lifetime or annual dollar limits 

on mental health benefits that are not imposed on substantially all 

medical and surgical benefits. The provisions of the Mental Health 

Parity Act were initially effective with respect to plan years beginning on or after January 1, 1998, for a temporary period. Since enactment, the mental health parity requirements in ERISA and the 

PHSA have been extended on more than one occasion and currently 

are scheduled to expire with respect to benefits for services furnished on or after December 31, 2004. 

The Taxpayer Relief Act of 1997 added to the Code the requirements imposed under the Mental Health Parity Act, and imposed 

an excise tax on group health plans that fail to meet the requirements. The excise tax is equal to $100 per day during the period 

of noncompliance and is generally imposed on the employer sponsoring the plan if the plan fails to meet the requirements. The 

maximum tax that can be imposed during a taxable year cannot exceed the lesser of 10 percent of the employer’s group health plan 

expenses for the prior year or $500,000. No tax is imposed if the 

Secretary determines that the employer did not know, and exercising reasonable diligence would not have known, that the failure 

existed. 

The Code provisions were initially effective with respect to plan 

years beginning on or after January 1, 1998, for a temporary period.202 The Code provisions have been extended on a number of 

occasions, and expired with respect to benefits for services furnished after December 31, 2003. 

REASONS FOR CHANGE

The provisions of the Mental Health Parity Act in ERISA and 

the PHSA have been extended to December 31, 2004, while the 

Code provisions have expired. The Committee recognizes that the 

Code provisions relating to mental health parity are important to 

carrying out the purposes of the Mental Health Parity Act. Thus, 

the Committee believes that extending the Code provisions relating 

to mental health parity is warranted. 

EXPLANATION OF PROVISION

The provision extends the Code provisions relating to mental 

health parity to benefits for services furnished after the date of enactment and before January 1, 2006. Thus, the excise tax on failures to meet the requirements imposed by the Code provisions does 

239

203Pub. L. No. 105–34, sec. 976. 

not apply after December 31, 2003, and before the date of enactment. 

EFFECTIVE DATE

The provision is effective for benefits for services furnished after 

the date of enactment.

U. DISCLOSURE OF TAX INFORMATION TO FACILITATE COMBINED

EMPLOYMENT TAX REPORTING

(Sec. 421 of the bill) 

PRESENT LAW

Traditionally, Federal tax forms are filed with the Federal government and State tax forms are filed with individual States. This 

necessitates duplication of items common to both returns. 

The Taxpayer Relief Act of 1997 203 permitted implementation of 

a demonstration project to assess the feasibility and desirability of 

expanding combined Federal and State reporting. There were several limitations on the demonstration project. First, it was limited 

to the sharing of information between the State of Montana and 

the IRS. Second, it was limited to employment tax reporting. Third, 

it was limited to disclosure of the name, address, TIN, and signature of the taxpayer, which is information common to both the 

Montana and Federal portions of the combined form. Fourth, it was 

limited to a period of five years. 

The authority for the demonstration project expired on the date 

five years after the date of enactment (August 5, 2002). 

REASONS FOR CHANGE

The Committee believes that authorizing this pilot project for an 

additional year will provide the Congress with information to assess the usefulness of the program and whether further expansions 

are warranted. 

EXPLANATION OF PROVISION

The provision renews authority for the demonstration project 

through December 31, 2005. 

EFFECTIVE DATE

The provision is effective on the date of enactment. 

V. EXTENSION OF TAX CREDIT FOR ELECTRIC VEHICLES AND TAX

DEDUCTION FOR CLEAN-FUEL VEHICLES

(Sec. 422 of the bill and secs. 30 and 179A of the Code) 

PRESENT LAW

Electric vehicles 

A 10-percent tax credit is provided for the cost of a qualified electric vehicle, up to a maximum credit of $4,000 (sec. 30). A qualified 

electric vehicle is a motor vehicle that is powered primarily by an 

electric motor drawing current from rechargeable batteries, fuel 

240

cells, or other portable sources of electrical current, the original use 

of which commences with the taxpayer, and that is acquired for the 

use by the taxpayer and not for resale. The full amount of the credit is available for purchases prior to 2002. The credit phases down 

in the years 2004 through 2006, and is unavailable for purchases 

after December 31, 2006.

Clean-fuel vehicles 

Certain costs of qualified clean-fuel vehicle may be expensed and 

deducted when such property is placed in service (sec. 179A). 

Qualified clean-fuel vehicle property includes motor vehicles that 

use certain clean-burning fuels (natural gas, liquefied natural gas, 

liquefied petroleum gas, hydrogen, electricity and any other fuel at 

least 85 percent of which is methanol, ethanol, any other alcohol 

or ether). The maximum amount of the deduction is $50,000 for a 

truck or van with a gross vehicle weight over 26,000 pounds or a 

bus with seating capacities of at least 20 adults; $5,000 in the case 

of a truck or van with a gross vehicle weight between 10,000 and 

26,000 pounds; and $2,000 in the case of any other motor vehicle. 

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

deduction. The deduction phases down in the years 2004 through 

2006, and is unavailable for purchases after December 31, 2006. 

REASONS FOR CHANGE

The Committee believes it is necessary to continue to provide the 

full benefit of the tax subsidy to the purchase of these innovative 

vehicles to enable such vehicles to demonstrate their road-worthiness to the consumer. 

EXPLANATION OF PROVISION

The provision suspends the phase down of allowable tax credit 

for electric vehicles and the deduction for clean-fuel vehicles in 

2004 and 2005. Thus, a taxpayer who purchases a qualifying vehicle may claim 100 percent of the otherwise allowable credit or deduction for vehicles purchased in 2004 and 2005. For vehicles purchased in 2006 the credit or deduction remains at 25 percent of the 

otherwise allowable amount as under present law. 

EFFECTIVE DATE

The provision is effective for vehicles placed in service after December 31, 2003.

TITLE V—DEDUCTION OF STATE AND LOCAL GENERAL 

SALES TAXES 

A. DEDUCTION OF STATE AND LOCAL GENERAL SALES TAXES

(Sec. 501 of the bill and sec. 164 of the Code) 

PRESENT LAW

An itemized deduction is permitted for certain taxes paid, including individual income taxes, real property taxes, and personal property taxes. No itemized deduction is permitted for State or local 

general sales taxes. 

241

REASONS FOR CHANGE

The Committee recognizes that not all States rely on income 

taxes as a primary source of revenue, and that allowing a deduction for State and local income taxes, but not sales taxes, may create inequities across States and may also create bias in the types 

of taxes that States and localities choose to impose. The Committee 

believes that the provision of an itemized deduction for State and 

local general sales taxes in lieu of the deduction for State and local 

income taxes provides more equitable Federal tax treatment across 

States, and will cause the Federal tax laws to have a more neutral 

effect on the types of taxes that State and local governments utilize. 

EXPLANATION OF PROVISION

The provision provides that, at the election of the taxpayer, an 

itemized deduction may be taken for State and local general sales 

taxes in lieu of the itemized deduction provided under present law 

for State and local income taxes. 

The term ‘‘general sales tax’’ means a tax imposed at one rate 

with respect to the sale at retail of a broad range of classes of 

items. However, in the case of items of food, clothing, medical supplies, and motor vehicles, the fact that the tax does not apply with 

respect to some or all of such items is not taken into account in 

determining whether the tax applies with respect to a broad range 

of classes of items, and the fact that the rate of tax applicable with 

respect to some or all of such items is lower than the general rate 

of tax is not taken into account in determining whether the tax is 

imposed at one rate. Except in the case of a lower rate of tax applicable with respect to food, clothing, medical supplies, or motor vehicles, no deduction is allowed for any general sales tax imposed with 

respect to an item at a rate other than the general rate of tax. 

However, in the case of motor vehicles, if the rate of tax exceeds 

the general rate, such excess shall be disregarded and the general 

rate is treated as the rate of tax. 

A compensating use tax with respect to an item is treated as a 

general sales tax, provided such tax is complimentary to a general 

sales tax and a deduction for sales taxes is allowable with respect 

to items sold at retail in the taxing jurisdiction that are similar to 

such item. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2003, and prior to January 1, 2006. 

242

TITLE VI—REVENUE PROVISIONS 

A. PROVISIONS TO REDUCE TAX AVOIDANCE THROUGH INDIVIDUAL

AND CORPORATE EXPATRIATION

1. Tax treatment of expatriated entities and their foreign parents 

(sec. 601 of the bill and new sec. 7874 of the Code) 

PRESENT LAW

Determination of corporate residence 

The U.S. tax treatment of a multinational corporate group depends significantly on whether the parent corporation of the group 

is domestic or foreign. For purposes of U.S. tax law, a corporation 

is treated as domestic if it is incorporated under the law of the 

United States or of any State. All other corporations (i.e., those incorporated under the laws of foreign countries) are treated as foreign. 

U.S. taxation of domestic corporations 

The United States employs a ‘‘worldwide’’ tax system, under 

which domestic corporations generally are taxed on all income, 

whether derived in the United States or abroad. In order to mitigate the double taxation that may arise from taxing the foreignsource income of a domestic corporation, a foreign tax credit for income taxes paid to foreign countries is provided to reduce or eliminate the U.S. tax owed on such income, subject to certain limitations. 

Income earned by a domestic parent corporation from foreign operations conducted by foreign corporate subsidiaries generally is 

subject to U.S. tax when the income is distributed as a dividend 

to the domestic corporation. Until such repatriation, the U.S. tax 

on such income generally is deferred, and U.S. tax is imposed on 

such income when repatriated. However, certain anti-deferral regimes may cause the domestic parent corporation to be taxed on a 

current basis in the United States with respect to certain categories of passive or highly mobile income earned by its foreign 

subsidiaries, regardless of whether the income has been distributed 

as a dividend to the domestic parent corporation. The main antideferral regimes in this context are the controlled foreign corporation rules of subpart F (secs. 951–964) and the passive foreign investment company rules (secs. 1291–1298). A foreign tax credit is 

generally available to offset, in whole or in part, the U.S. tax owed 

on this foreign-source income, whether repatriated as an actual 

dividend or included under one of the anti-deferral regimes. 

U.S. taxation of foreign corporations 

The United States taxes foreign corporations only on income that 

has a sufficient nexus to the United States. Thus, a foreign corporation is generally subject to U.S. tax only on income that is ‘‘effectively connected’’ with the conduct of a trade or business in the 

United States. Such ‘‘effectively connected income’’ generally is 

taxed in the same manner and at the same rates as the income of 

a U.S. corporation. An applicable tax treaty may limit the imposition of U.S. tax on business operations of a foreign corporation to 

243

cases in which the business is conducted through a ‘‘permanent establishment’’ in the United States. 

In addition, foreign corporations generally are subject to a grossbasis U.S. tax at a flat 30-percent rate on the receipt of interest, 

dividends, rents, royalties, and certain similar types of income derived from U.S. sources, subject to certain exceptions. The tax generally is collected by means of withholding by the person making 

the payment. This tax may be reduced or eliminated under an applicable tax treaty. 

U.S. tax treatment of inversion transactions 

Under present law, a U.S. corporation may reincorporate in a foreign jurisdiction and thereby replace the U.S. parent corporation of 

a multinational corporate group with a foreign parent corporation. 

These transactions are commonly referred to as inversion transactions. Inversion transactions may take many different forms, including stock inversions, asset inversions, and various combinations of and variations on the two. Most of the known transactions 

to date have been stock inversions. In one example of a stock inversion, a U.S. corporation forms a foreign corporation, which in turn 

forms a domestic merger subsidiary. The domestic merger subsidiary then merges into the U.S. corporation, with the U.S. corporation surviving, now as a subsidiary of the new foreign corporation. The U.S. corporation’s shareholders receive shares of the foreign corporation and are treated as having exchanged their U.S. 

corporation shares for the foreign corporation shares. An asset inversion reaches a similar result, but through a direct merger of the 

top-tier U.S. corporation into a new foreign corporation, among 

other possible forms. An inversion transaction may be accompanied 

or followed by further restructuring of the corporate group. For example, in the case of a stock inversion, in order to remove income 

from foreign operations from the U.S. taxing jurisdiction, the U.S. 

corporation may transfer some or all of its foreign subsidiaries directly to the new foreign parent corporation or other related foreign 

corporations. 

In addition to removing foreign operations from the U.S. taxing 

jurisdiction, the corporate group may derive further advantage 

from the inverted structure by reducing U.S. tax on U.S.-source income through various earnings stripping or other transactions. 

This may include earnings stripping through payment by a U.S. 

corporation of deductible amounts such as interest, royalties, rents, 

or management service fees to the new foreign parent or other foreign affiliates. In this respect, the post-inversion structure enables 

the group to employ the same tax-reduction strategies that are 

available to other multinational corporate groups with foreign parents and U.S. subsidiaries, subject to the same limitations (e.g., 

secs. 163(j) and 482). 

Inversion transactions may give rise to immediate U.S. tax consequences at the shareholder and/or the corporate level, depending 

on the type of inversion. In stock inversions, the U.S. shareholders 

generally recognize gain (but not loss) under section 367(a), based 

on the difference between the fair market value of the foreign corporation shares received and the adjusted basis of the domestic corporation stock exchanged. To the extent that a corporation’s share 

value has declined, and/or it has many foreign or tax-exempt shareVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00245 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.006 HR548P1
244

holders, the impact of this section 367(a) ‘‘toll charge’’ is reduced. 

The transfer of foreign subsidiaries or other assets to the foreign 

parent corporation also may give rise to U.S. tax consequences at 

the corporate level (e.g., gain recognition and earnings and profits 

inclusions under secs. 1001, 311(b), 304, 367, 1248 or other provisions). The tax on any income recognized as a result of these 

restructurings may be reduced or eliminated through the use of net 

operating losses, foreign tax credits, and other tax attributes. 

In asset inversions, the U.S. corporation generally recognizes 

gain (but not loss) under section 367(a) as though it had sold all 

of its assets, but the shareholders generally do not recognize gain 

or loss, assuming the transaction meets the requirements of a reorganization under section 368. 

REASONS FOR CHANGE

The Committee believes that corporate inversion transactions are 

a symptom of larger problems with our current uncompetitive system for taxing U.S.-based global businesses and are also indicative 

of the unfair advantages that our tax laws convey to foreign ownership. The bill addresses the underlying problems with the U.S. system of taxing U.S.-based global businesses and contains provisions 

to remove the incentives for entering into inversion transactions. 

Imposing full U.S. tax on gains of companies undertaking an inversion transaction is one such provision that helps to remove the incentive to enter into an inversion transaction. 

EXPLANATION OF PROVISION

The bill applies special tax rules to corporations that undertake 

certain defined inversion transactions. For this purpose, an inversion is a transaction in which, pursuant to a plan or a series of related transactions: (1) a U.S. corporation becomes a subsidiary of 

a foreign-incorporated entity or otherwise transfers substantially 

all of its properties to such an entity after March 4, 2003; (2) the 

former shareholders of the U.S. corporation hold (by reason of holding stock in the U.S. corporation) 60 percent or more (by vote or 

value) of the stock of the foreign-incorporated entity after the 

transaction; and (3) the foreign-incorporated entity, considered together with all companies connected to it by a chain of greater than 

50-percent ownership (i.e., the ‘‘expanded affiliated group’’) does not 

conduct substantial business activities in the entity’s country of incorporation compared to the total worldwide business activities of 

the expanded affiliated group. 

In such a case, any applicable corporate-level ‘‘toll charges’’ for 

establishing the inverted structure are not offset by tax attributes 

such as net operating losses or foreign tax credits. Specifically, any 

applicable corporate-level income or gain required to be recognized 

under sections 304, 311(b), 367, 1001, 1248, or any other provision 

with respect to the transfer of controlled foreign corporation stock 

or the transfer or license of other assets by a U.S. corporation as 

part of the inversion transaction or after such transaction to a related foreign person is taxable, without offset by any tax attributes 

(e.g., net operating losses or foreign tax credits). This rule does not 

apply to certain transfers of inventory and similar property. These 

measures generally apply for a 10-year period following the inversion transaction. 

245

In determining whether a transaction meets the definition of an 

inversion under the provision, stock held by members of the expanded affiliated group that includes the foreign incorporated entity is disregarded. For example, if the former top-tier U.S. corporation receives stock of the foreign incorporated entity (e.g., so-called 

‘‘hook’’ stock), the stock would not be considered in determining 

whether the transaction meets the definition. Similarly, if a U.S. 

parent corporation converts an existing wholly owned U.S. subsidiary into a new wholly owned controlled foreign corporation, the 

stock of the new foreign corporation would be disregarded. Stock 

sold in a public offering related to the transaction also is disregarded for these purposes. 

Transfers of properties or liabilities as part of a plan a principal 

purpose of which is to avoid the purposes of the provision are disregarded. In addition, the Treasury Secretary is granted authority 

to prevent the avoidance of the purposes of the provision, including 

avoidance through the use of related persons, pass-through or other 

noncorporate entities, or other intermediaries, and through transactions designed to qualify or disqualify a person as a related person or a member of an expanded affiliated group. Similarly, the 

Treasury Secretary is granted authority to treat certain non-stock 

instruments as stock, and certain stock as not stock, where necessary, to carry out the purposes of the provision. 

Under the provision, inversion transactions include certain partnership transactions. Specifically, the provision applies to transactions in which a foreign-incorporated entity acquires substantially all of the properties constituting a trade or business of a domestic partnership, if after the acquisition at least 60 percent of 

the stock of the entity is held by former partners of the partnership 

(by reason of holding their partnership interests), provided that the 

other terms of the basic definition are met. For purposes of applying this test, all partnerships that are under common control within the meaning of section 482 are treated as one partnership, except as provided otherwise in regulations. In addition, the modified 

‘‘toll charge’’ provisions apply at the partner level. 

A transaction otherwise meeting the definition of an inversion 

transaction is not treated as an inversion transaction if, on or before March 4, 2003, the foreign-incorporated entity had acquired directly or indirectly more than half of the properties held directly 

or indirectly by the domestic corporation, or more than half of the 

properties constituting the partnership trade or business, as the 

case may be. 

EFFECTIVE DATE

The provision applies to taxable years ending after March 4, 

2003. 

246

204 Nonstatutory stock options refer to stock options other than incentive stock options and 

employee stock purchase plans, the taxation of which is determined under sections 421–424. 205 If an individual receives a grant of a nonstatutory option that has a readily ascertainable 

fair market value at the time the option is granted, the excess of the fair market value of the 

option over the amount paid for the option is included in the recipient’s gross income as ordinary 

income in the first taxable year in which the option is either transferable or not subject to a 

substantial risk of forfeiture. 206 Under section 83, such amount is includable in gross income in the first taxable year in 

which the rights to the stock are transferable or are not subject to substantial risk of forfeiture. 

2. Excise tax on stock compensation of insiders in expatriated corporations (sec. 602 of the bill and secs. 162(m), 275(a), and new 

sec. 4985 of the Code) 

PRESENT LAW

The income taxation of a nonstatutory 204 compensatory stock option is determined under the rules that apply to property transferred in connection with the performance of services (sec. 83). If 

a nonstatutory stock option does not have a readily ascertainable 

fair market value at the time of grant, which is generally the case 

unless the option is actively traded on an established market, no 

amount is included in the gross income of the recipient with respect to the option until the recipient exercises the option.205 Upon 

exercise of such an option, the excess of the fair market value of 

the stock purchased over the option price is generally included in 

the recipient’s gross income as ordinary income in such taxable 

year.206

The tax treatment of other forms of stock-based compensation 

(e.g., restricted stock and stock appreciation rights) is also determined under section 83. The excess of the fair market value over 

the amount paid (if any) for such property is generally includable 

in gross income in the first taxable year in which the rights to the 

property are transferable or are not subject to substantial risk of 

forfeiture. 

Shareholders are generally required to recognize gain upon stock 

inversion transactions. An inversion transaction is generally not a 

taxable event for holders of stock options and other stock-based 

compensation. 

REASONS FOR CHANGE

The Committee believes that certain inversion transactions are a 

means of avoiding U.S. tax and should be curtailed. The Committee 

is concerned that, while shareholders are generally required to recognize gain upon stock inversion transactions, executives holding 

stock options and certain stock-based compensation are not taxed 

upon such transactions. Since such executives are often instrumental in deciding whether to engage in inversion transactions, the 

Committee believes that, upon certain inversion transactions, it is 

appropriate to impose an excise tax on certain executives holding 

stock options and stock-based compensation. Because shareholders 

are taxed at the capital gains rate upon inversion transactions, the 

Committee believes that it is appropriate to impose the excise tax 

at an equivalent rate. 

EXPLANATION OF PROVISION

Under the provision, specified holders of stock options and other 

stock-based compensation are subject to an excise tax upon certain 

247

207 An expanded affiliated group is an affiliated group (under section 1504) except that such 

group is determined without regard to the exceptions for certain corporations and is determined 

applying a greater than 50 percent threshold, in lieu of the 80 percent test. 208 An officer is defined as the president, principal financial officer, principal accounting officer 

(or, if there is no such accounting officer, the controller), any vice-president in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policymaking functions. 209 Under the provision, any transfer of property is treated as a payment and any right to 

a transfer of property is treated as a right to a payment. 

inversion transactions. The provision imposes a 15-percent excise 

tax on the value of specified stock compensation held (directly or 

indirectly) by or for the benefit of a disqualified individual, or a 

member of such individual’s family, at any time during the 12-

month period beginning six months before the corporation’s expatriation date. Specified stock compensation is treated as held for 

the benefit of a disqualified individual if such compensation is held 

by an entity, e.g., a partnership or trust, in which the individual, 

or a member of the individual’s family, has an ownership interest.

A disqualified individual is any individual who, with respect to 

a corporation, is, at any time during the 12-month period beginning 

on the date which is six months before the expatriation date, subject to the requirements of section 16(a) of the Securities and Exchange Act of 1934 with respect to the corporation, or any member 

of the corporation’s expanded affiliated group,207 or would be subject to such requirements if the corporation (or member) were an 

issuer of equity securities referred to in section 16(a). Disqualified 

individuals generally include officers (as defined by section 

16(a)),208 directors, and 10-percent-or-greater owners of private and 

publicly-held corporations. 

The excise tax is imposed on a disqualified individual of an expatriated corporation (as previously defined in the bill) only if gain 

(if any) is recognized in whole or part by any shareholder by reason 

of a corporate inversion transaction previously defined in the bill. 

Specified stock compensation subject to the excise tax includes 

any payment 209 (or right to payment) granted by the expatriated 

corporation (or any member of the corporation’s expanded affiliated 

group) to any person in connection with the performance of services 

by a disqualified individual for such corporation (or member of the 

corporation’s expanded affiliated group) if the value of the payment 

or right is based on, or determined by reference to, the value or 

change in value of stock of such corporation (or any member of the 

corporation’s expanded affiliated group). In determining whether 

such compensation exists and valuing such compensation, all restrictions, other than a non-lapse restriction, are ignored. Thus, the 

excise tax applies, and the value subject to the tax is determined, 

without regard to whether such specified stock compensation is 

subject to a substantial risk of forfeiture or is exercisable at the 

time of the inversion transaction. Specified stock compensation includes compensatory stock and restricted stock grants, compensatory stock options, and other forms of stock-based compensation, 

including stock appreciation rights, phantom stock, and phantom 

stock options. Specified stock compensation also includes nonqualified deferred compensation that is treated as though it were 

invested in stock or stock options of the expatriating corporation (or 

member). For example, the provision applies to a disqualified individual’s deferred compensation if company stock is one of the acVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00249 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.006 HR548P1
248

tual or deemed investment options under the nonqualified deferred 

compensation plan. 

Specified stock compensation includes a compensation arrangement that gives the disqualified individual an economic stake substantially similar to that of a corporate shareholder. Thus, the excise tax does not apply if a payment is simply triggered by a target 

value of the corporation’s stock or where a payment depends on a 

performance measure other than the value of the corporation’s 

stock. Similarly, the tax does not apply if the amount of the payment is not directly measured by the value of the stock or an increase in the value of the stock. For example, an arrangement 

under which a disqualified individual would be paid a cash bonus 

of $500,000 if the corporation’s stock increased in value by 25 per- cent over two years or $1,000,000 if the stock increased by 33 percent over two years is not specified stock compensation, even 

though the amount of the bonus generally is keyed to an increase 

in the value of the stock. By contrast, an arrangement under which 

a disqualified individual would be paid a cash bonus equal to 

$10,000 for every $1 increase in the share price of the corporation’s 

stock is subject to the provision because the direct connection between the compensation amount and the value of the corporation’s 

stock gives the disqualified individual an economic stake substantially similar to that of a shareholder. 

The excise tax applies to any such specified stock compensation 

previously granted to a disqualified individual but cancelled or 

cashed-out within the six-month period ending with the expatriation date, and to any specified stock compensation awarded in the 

six-month period beginning with the expatriation date. As a result, 

for example, if a corporation cancels outstanding options three 

months before the transaction and then reissues comparable options three months after the transaction, the tax applies both to 

the cancelled options and the newly granted options. It is intended 

that the Secretary issue guidance to avoid double counting with respect to specified stock compensation that is cancelled and then regranted during the applicable twelve-month period. 

Specified stock compensation subject to the tax does not include 

a statutory stock option or any payment or right from a qualified 

retirement plan or annuity, tax-sheltered annuity, simplified employee pension, or SIMPLE. In addition, under the provision, the 

excise tax does not apply to any stock option that is exercised during the six-month period before the expatriation date or to any 

stock acquired pursuant to such exercise, if income is recognized 

under section 83 on or before the expatriation date with respect to 

the stock acquired pursuant to such exercise. The excise tax also 

does not apply to any specified stock compensation that is exercised, sold, exchanged, distributed, cashed-out, or otherwise paid 

during such period in a transaction in which income, gain, or loss 

is recognized in full. 

For specified stock compensation held on the expatriation date, 

the amount of the tax is determined based on the value of the compensation on such date. The tax imposed on specified stock compensation cancelled during the six-month period before the expatriation date is determined based on the value of the compensation 

on the day before such cancellation, while specified stock compensation granted after the expatriation date is valued on the date 

249

granted. Under the provision, the cancellation of a non-lapse restriction is treated as a grant. 

The value of the specified stock compensation on which the excise tax is imposed is the fair value in the case of stock options (including warrants or other similar rights to acquire stock) and stock 

appreciation rights and the fair market value for all other forms of 

compensation. For purposes of the tax, the fair value of an option 

(or a warrant or other similar right to acquire stock) or a stock appreciation right is determined using an appropriate option-pricing 

model, as specified or permitted by the Secretary, that takes into 

account the stock price at the valuation date; the exercise price 

under the option; the remaining term of the option; the volatility 

of the underlying stock and the expected dividends on it; and the 

risk-free interest rate over the remaining term of the option. Options that have no intrinsic value (or ‘‘spread’’) because the exercise 

price under the option equals or exceeds the fair market value of 

the stock at valuation nevertheless have a fair value and are subject to tax under the provision. The value of other forms of compensation, such as phantom stock or restricted stock, is the fair 

market value of the stock as of the date of the expatriation transaction. The value of any deferred compensation that can be valued 

by reference to stock is the amount that the disqualified individual 

would receive if the plan were to distribute all such deferred compensation in a single sum on the date of the expatriation transaction (or the date of cancellation or grant, if applicable). It is expected that the Secretary issue guidance on valuation of specified 

stock compensation, including guidance similar to the revenue procedures issued under section 280G, except that the guidance would 

not permit the use of a term other than the full remaining term 

and would be modified as necessary or appropriate to carry out the 

purposes of the provision. Pending the issuance of guidance, it is 

intended that taxpayers can rely on the revenue procedure issued 

under section 280G (except that the full remaining term must be 

used and recalculation is not permitted). 

The excise tax also applies to any payment by the expatriated 

corporation or any member of the expanded affiliated group made 

to an individual, directly or indirectly, in respect of the tax. Whether a payment is made in respect of the tax is determined under all 

of the facts and circumstances. Any payment made to keep the individual in the same after-tax position that the individual would 

have been in had the tax not applied is a payment made in respect 

of the tax. This includes direct payments of the tax and payments 

to reimburse the individual for payment of the tax. It is expected 

that the Secretary issue guidance on determining when a payment 

is made in respect of the tax and that such guidance include certain factors that give rise to a rebuttable presumption that a payment is made in respect of the tax, including a rebuttable presumption that if the payment is contingent on the inversion transaction, 

it is made in respect to the tax. Any payment made in respect of 

the tax is includible in the income of the individual, but is not deductible by the corporation. 

To the extent that a disqualified individual is also a covered employee under section 162(m), the $1,000,000 limit on the deduction 

allowed for employee remuneration for such employee is reduced by 

the amount of any payment (including reimbursements) made in 

250

210Sec. 845(a). 211See S. Rep. No. 97–494, 97th Cong., 2d Sess., 337 (1982) (describing provisions relating 

to the repeal of modified coinsurance provisions). 

respect of the tax under the provision. As discussed above, this includes direct payments of the tax and payments to reimburse the 

individual for payment of the tax. 

The payment of the excise tax has no effect on the subsequent 

tax treatment of any specified stock compensation. Thus, the payment of the tax has no effect on the individual’s basis in any specified stock compensation and no effect on the tax treatment for the 

individual at the time of exercise of an option or payment of any 

specified stock compensation, or at the time of any lapse or forfeiture of such specified stock compensation. The payment of the 

tax is not deductible and has no effect on any deduction that might 

be allowed at the time of any future exercise or payment. 

Under the provision, the Secretary is authorized to issue regulations as may be necessary or appropriate to carry out the purposes 

of the provision. 

EFFECTIVE DATE

The provision is effective as of March 4, 2003, except that periods 

before March 4, 2003, are not taken into account in applying the 

excise tax to specified stock compensation held or cancelled during 

the six-month period before the expatriation date. 

3. Reinsurance of U.S. risks in foreign jurisdictions (sec. 603 of the 

bill and sec. 845(a) of the Code) 

PRESENT LAW

In the case of a reinsurance agreement between two or more related persons, present law provides the Treasury Secretary with 

authority to allocate among the parties or recharacterize income 

(whether investment income, premium or otherwise), deductions, 

assets, reserves, credits and any other items related to the reinsurance agreement, or make any other adjustment, in order to reflect 

the proper source and character of the items for each party.210 For 

this purpose, related persons are defined as in section 482. Thus, 

persons are related if they are organizations, trades or businesses 

(whether or not incorporated, whether or not organized in the 

United States, and whether or not affiliated) that are owned or 

controlled directly or indirectly by the same interests. The provision may apply to a contract even if one of the related parties is 

not a domestic company.211 In addition, the provision also permits 

such allocation, recharacterization, or other adjustments in a case 

in which one of the parties to a reinsurance agreement is, with respect to any contract covered by the agreement, in effect an agent 

of another party to the agreement, or a conduit between related 

persons. 

REASONS FOR CHANGE

The Committee is concerned that reinsurance transactions are 

being used to allocate income, deductions, or other items inappropriately among U.S. and foreign related persons. The Committee is 

concerned that foreign related party reinsurance arrangements 

may be a technique for eroding the U.S. tax base. The Committee 

251

212The authority to allocate, recharacterize or make other adjustments was granted in connection with the repeal of provisions relating to modified coinsurance transactions. 

believes that the provision of present law permitting the Treasury 

Secretary to allocate or recharacterize items related to a reinsurance agreement should be applied to prevent misallocation, improper characterization, or to make any other adjustment in the 

case of such reinsurance transactions between U.S. and foreign related persons (or agents or conduits). The Committee also wishes 

to clarify that, in applying the authority with respect to reinsurance agreements, the amount, source or character of the items may 

be allocated, recharacterized or adjusted.

EXPLANATION OF PROVISION

The bill clarifies the rules of section 845, relating to authority for 

the Treasury Secretary to allocate items among the parties to a reinsurance agreement, recharacterize items, or make any other adjustment, in order to reflect the proper source and character of the 

items for each party. The bill authorizes such allocation, recharacterization, or other adjustment, in order to reflect the proper 

source, character or amount of the item. It is intended that this authority 212 be exercised in a manner similar to the authority under 

section 482 for the Treasury Secretary to make adjustments between related parties. It is intended that this authority be applied 

in situations in which the related persons (or agents or conduits) 

are engaged in cross-border transactions that require allocation, recharacterization, or other adjustments in order to reflect the proper 

source, character or amount of the item or items. No inference is 

intended that present law does not provide this authority with respect to reinsurance agreements. 

No regulations have been issued under section 845(a). It is expected that the Treasury Secretary will issue regulations under 

section 845(a) to address effectively the allocation of income 

(whether investment income, premium or otherwise) and other 

items, the recharacterization of such items, or any other adjustment necessary to reflect the proper amount, source or character 

of the item. 

EFFECTIVE DATE

The provision is effective for any risk reinsured after the date of 

enactment of the provision. 

4. Revision of tax rules on expatriation of individuals (sec. 604 of 

the bill and secs. 877, 2107, 2501 and 6039G of the Code) 

PRESENT LAW

In general 

U.S. citizens and residents generally are subject to U.S income 

taxation on their worldwide income. The U.S. tax may be reduced 

or offset by a credit allowed for foreign income taxes paid with respect to foreign source income. Nonresident aliens are taxed at a 

flat rate of 30 percent (or a lower treaty rate) on certain types of 

passive income derived from U.S. sources, and at regular graduated 

rates on net profits derived from a U.S. trade or business. The estates of nonresident aliens generally are subject to estate tax on 

252

213 Under present law, an individual’s U.S. residency is considered terminated for U.S. Federal 

tax purposes when the individual ceases to be a lawful permanent resident under the immigration law (or is treated as a resident of another country under a tax treaty and does not waive 

the benefits of such treaty). 214For this purpose, however, U.S.-source income has a broader scope than it does typically 

in the Code. 215The income tax liability and net worth thresholds under section 877(a)(2) for 2004 are 

$124,000 and $622,000, respectively. See Rev. Proc. 2003–85, 2003–49 I.R.B. 1184. 

U.S.-situated property (e.g., real estate and tangible property located within the United States and stock in a U.S. corporation). 

Nonresident aliens generally are subject to gift tax on transfers by 

gift of U.S.-situated property (e.g., real estate and tangible property 

located within the United States, but excluding intangibles, such as 

stock, regardless of where they are located). 

Income tax rules with respect to expatriates 

For the 10 taxable years after an individual relinquishes his or 

her U.S. citizenship or terminates his or her U.S. residency 213 with 

a principal purpose of avoiding U.S. taxes, the individual is subject 

to an alternative method of income taxation than that generally applicable to nonresident aliens (the ‘‘alternative tax regime’’). Generally, the individual is subject to income tax only on U.S.-source 

income 214 at the rates applicable to U.S. citizens for the 10-year 

period. 

An individual who relinquishes citizenship or terminates residency is treated as having done so with a principal purpose of tax 

avoidance and is generally subject to the alternative tax regime if: 

(1) the individual’s average annual U.S. Federal income tax liability for the five taxable years preceding citizenship relinquishment 

or residency termination exceeds $100,000; or (2) the individual’s 

net worth on the date of citizenship relinquishment or residency 

termination equals or exceeds $500,000. These amounts are adjusted annually for inflation.215 Certain categories of individuals 

(e.g., dual residents) may avoid being deemed to have a tax avoidance purpose for relinquishing citizenship or terminating residency 

by submitting a ruling request to the IRS regarding whether the 

individual relinquished citizenship or terminated residency principally for tax reasons. 

Anti-abuse rules are provided to prevent the circumvention of the 

alternative tax regime. 

Estate tax rules with respect to expatriates 

Special estate tax rules apply to individuals who relinquish their 

citizenship or long-term residency within the 10 years prior to the 

date of death, unless he or she did not have a tax avoidance purpose (as determined under the test above). Under these special 

rules, certain closely-held foreign stock owned by the former citizen 

or former long-term resident is includible in his or her gross estate 

to the extent that the foreign corporation owns U.S.-situated assets. 

Gift tax rules with respect to expatriates 

Special gift tax rules apply to individuals who relinquish their 

citizenship or long-term residency within the 10 years prior to the 

date of death, unless he or she did not have a tax avoidance purpose (as determined under the rules above). The individual is subVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00254 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.006 HR548P1
253

ject to gift tax on gifts of U.S.-situated intangibles made during the 

10 years following citizenship relinquishment or residency termination. 

Information reporting 

Under present law, U.S. citizens who relinquish citizenship and 

long-term residents who terminate residency generally are required 

to provide information about their assets held at the time of expatriation. However, this information is only required once. 

REASONS FOR CHANGE

The Committee believes there are several difficulties in administering the present-law alternative tax regime. One such difficulty 

is that the IRS is required to determine the subjective intent of 

taxpayers who relinquish citizenship or terminate residency. The 

present-law presumption of a tax-avoidance purpose in cases in 

which objective income tax liability or net worth thresholds are exceeded mitigates this problem to some extent. However, the 

present-law rules still require the IRS to make subjective determinations of intent in cases involving taxpayers who fall below 

these thresholds, as well for certain taxpayers who exceed these 

thresholds but are nevertheless allowed to seek a ruling from the 

IRS to the effect that they did not have a principal purpose of tax 

avoidance. The Committee believes that the replacement of the 

subjective determination of tax avoidance as a principal purpose for 

citizenship relinquishment or residency termination with objective 

rules will result in easier administration of the tax regime for individuals who relinquish their citizenship or terminate residency. 

Similarly, present-law information-reporting and return-filing 

provisions do not provide the IRS with the information necessary 

to administer the alternative tax regime. Although individuals are 

required to file tax information statements upon the relinquishment of their citizenship or termination of their residency, difficulties have been encountered in enforcing this requirement. The 

Committee believes that the tax benefits of citizenship relinquishment or residency termination should be denied an individual until 

he or she provides the information necessary for the IRS to enforce 

the alternative tax regime. The Committee also believes an annual 

report requirement and a penalty for the failure to comply with 

such requirement are needed to provide the IRS with sufficient information to monitor the compliance of former U.S. citizens and 

long-term residents. 

Individuals who relinquish citizenship or terminate residency for 

tax reasons often do not want to fully sever their ties with the 

United States; they hope to retain some of the benefits of citizenship or residency without being subject to the U.S. tax system as 

a U.S. citizen or resident. These individuals generally may continue 

to spend significant amounts of time in the United States following 

citizenship relinquishment or residency termination—approximately four months every year—without being treated as a U.S. 

resident. The Committee believes that provisions in the bill that 

impose full U.S. taxation if the individual is present in the United 

States for more than 30 days in a calendar year will substantially 

reduce the incentives to relinquish citizenship or terminate resiVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00255 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.006 HR548P1
254

216These provisions reflect recommendations contained in Joint Committee on Taxation, Review of the Present Law Tax and Immigration Treatment of Relinquishment of Citizenship and 

Termination of Long-Term Residency, (JCS–2–03), February 2003. 

dency for individuals who desire to maintain significant ties to the 

United States. 

With respect to the estate and gift tax rules, the Committee is 

concerned that present-law does not adequately address opportunities for the avoidance of tax on the value of assets held by a foreign 

corporation whose stock the individual transfers. Thus, the provision imposes gift tax under the alternative tax regime in the case 

of gifts of certain stock of a closely held foreign corporation. 

EXPLANATION OF PROVISION

In general 

The bill provides: (1) objective standards for determining whether 

former citizens or former long-term residents are subject to the alternative tax regime; (2) tax-based (instead of immigration-based) 

rules for determining when an individual is no longer a U.S. citizen 

or long-term resident for U.S. Federal tax purposes; (3) the imposition of full U.S. taxation for individuals who are subject to the alternative tax regime and who return to the United States for extended periods; (4) imposition of U.S. gift tax on gifts of stock of 

certain closely-held foreign corporations that hold U.S.-situated 

property; and (5) an annual return-filing requirement for individuals who are subject to the alternative tax regime, for each of the 

10 years following citizenship relinquishment or residency termination.216

Objective rules for the alternative tax regime 

The bill replaces the subjective determination of tax avoidance as 

a principal purpose for citizenship relinquishment or residency termination under present law with objective rules. Under the bill, a 

former citizen or former long-term resident would be subject to the 

alternative tax regime for a 10-year period following citizenship relinquishment or residency termination, unless the former citizen or 

former long-term resident: (1) establishes that his or her average 

annual net income tax liability for the five preceding years does not 

exceed $124,000 (adjusted for inflation after 2004) and his or her 

net worth does not exceed $2 million, or alternatively satisfies limited, objective exceptions for dual citizens and minors who have 

had no substantial contact with the United States; and (2) certifies 

under penalties of perjury that he or she has complied with all U.S. 

Federal tax obligations for the preceding five years and provides 

such evidence of compliance as the Secretary of the Treasury may 

require. 

The monetary thresholds under the bill replace the present-law 

inquiry into the taxpayer’s intent. In addition, the bill eliminates 

the present-law process of IRS ruling requests. 

If a former citizen exceeds the monetary thresholds, that person 

is excluded from the alternative tax regime if he or she falls within 

the exceptions for certain dual citizens and minors (provided that 

the requirement of certification and proof of compliance with Federal tax obligations is met). These exceptions provide relief to individuals who have never had substantial connections with the 

255

United States, as measured by certain objective criteria, and eliminate IRS inquiries as to the subjective intent of such taxpayers.

In order to be excepted from the application of the alternative 

tax regime under the bill, whether by reason of falling below the 

net worth and income tax liability thresholds or qualifying for the 

dual-citizen or minor exceptions, the former citizen or former longterm resident also is required to certify, under penalties of perjury, 

that he or she has complied with all U.S. Federal tax obligations 

for the five years preceding the relinquishment of citizenship or 

termination of residency and to provide such documentation as the 

Secretary of the Treasury may require evidencing such compliance 

(e.g., tax returns, proof of tax payments). Until such time, the individual remains subject to the alternative tax regime. It is intended 

that the IRS will continue to verify that the information submitted 

was accurate, and it is intended that the IRS will randomly audit 

such persons to assess compliance. 

Termination of U.S. citizenship or long-term resident status for U.S. 

Federal income tax purposes 

Under the bill, an individual continues to be treated as a U.S. 

citizen or long-term resident for U.S. Federal tax purposes, including for purposes of section 7701(b)(10), until the individual: (1) 

gives notice of an expatriating act or termination of residency (with 

the requisite intent to relinquish citizenship or terminate residency) to the Secretary of State or the Secretary of Homeland Security, respectively; and (2) provides a statement in accordance with 

section 6039G. 

Sanction for individuals subject to the individual tax regime who 

return to the United States for extended periods 

The alternative tax regime does not apply to any individual for 

any taxable year during the 10-year period following citizenship relinquishment or residency termination if such individual is present 

in the United States for more than 30 days in the calendar year 

ending in such taxable year. Such individual is treated as a U.S. 

citizen or resident for such taxable year and therefore is taxed on 

his or her worldwide income. 

Similarly, if an individual subject to the alternative tax regime 

is present in the United States for more than 30 days in any calendar year ending during the 10-year period following citizenship 

relinquishment or residency termination, and the individual dies 

during that year, he or she is treated as a U.S. resident, and the 

individual’s worldwide estate is subject to U.S. estate tax. Likewise, if an individual subject to the alternative tax regime is 

present in the United States for more than 30 days in any year 

during the 10-year period following citizenship relinquishment or 

residency termination, the individual is subject to U.S. gift tax on 

any transfer of his or her worldwide assets by gift during that taxable year. 

For purposes of these rules, an individual is treated as present 

in the United States on any day if such individual is physically 

present in the United States at any time during that day. The 

present-law exceptions from being treated as present in the United 

256

217Secs. 7701(b)(3)(D), 7701(b)(5) and 7701(b)(7)(B)–(D). 218 An individual has such a relationship to a foreign country if the individual becomes a citizen or resident of the country in which (1) the individual becomes fully liable for income tax 

or (2) the individual was born, such individual’s spouse was born, or either of the individual’s parents was born. 219 An individual has a minimal prior physical presence in the United States if the individual 

was physically present for no more than 30 days during each year in the ten-year period ending 

on the date of loss of United States citizenship or termination of residency. However, an individual is not treated as being present in the United States on a day if (1) the individual is a 

teacher or trainee, a student, a professional athlete in certain circumstances, or a foreign government-related individual or (2) the individual remained in the United States because of a 

medical condition that arose while the individual was in the United States. Sec. 7701(b)(3)(D)(ii). 

States for residency purposes 217 generally do not apply for this 

purpose. However, for individuals with certain ties to countries 

other than the United States 218 and individuals with minimal 

prior physical presence in the United States,219 a day of physical 

presence in the United States is disregarded if the individual is 

performing services in the United States on such day for an unrelated employer (within the meaning of sections 267 and 707(b)), 

who meets the requirements the Secretary of the Treasury may 

prescribe in regulations. No more than 30 days may be disregarded 

during any calendar year under this rule. 

Imposition of gift tax with respect to stock of certain closely held foreign corporations 

Gifts of stock of certain closely-held foreign corporations by a 

former citizen or former long-term resident who is subject to the alternative tax regime are subject to gift tax under this bill, if the 

gift is made within the 10-year period after citizenship relinquishment or residency termination. The gift tax rule applies if: (1) the 

former citizen or former long-term resident, before making the gift, 

directly or indirectly owns 10 percent or more of the total combined 

voting power of all classes of stock entitled to vote of the foreign 

corporation; and (2) directly or indirectly, is considered to own 

more than 50 percent of (a) the total combined voting power of all 

classes of stock entitled to vote in the foreign corporation, or (b) the 

total value of the stock of such corporation. If this stock ownership 

test is met, then taxable gifts of the former citizen or former longterm resident include that proportion of the fair market value of 

the foreign stock transferred by the individual, at the time of the 

gift, which the fair market value of any assets owned by such foreign corporation and situated in the United States (at the time of 

the gift) bears to the total fair market value of all assets owned by 

such foreign corporation (at the time of the gift). 

This gift tax rule applies to a former citizen or former long-term 

resident who is subject to the alternative tax regime and who owns 

stock in a foreign corporation at the time of the gift, regardless of 

how such stock was acquired (e.g., whether issued originally to the 

donor, purchased, or received as a gift or bequest).

Annual return 

The bill requires former citizens and former long-term residents 

to file an annual return for each year following citizenship relinquishment or residency termination in which they are subject to 

the alternative tax regime. The annual return is required even if 

no U.S. Federal income tax is due. The annual return requires certain information, including information on the permanent home of 

257

220 Recently issued temporary regulations under section 6043 (relating to information reporting with respect to liquidations, recapitalizations, and changes in control) impose information 

reporting requirements with respect to certain taxable inversion transactions, and proposed regulations would expand these requirements more generally to taxable transactions occurring 

after the proposed regulations are finalized. 

the individual, the individual’s country of residence, the number of 

days the individual was present in the United States for the year, 

and detailed information about the individual’s income and assets 

that are subject to the alternative tax regime. This requirement includes information relating to foreign stock potentially subject to 

the special estate tax rule of section 2107(b) and the gift tax rules 

of this bill. 

If the individual fails to file the statement in a timely manner 

or fails correctly to include all the required information, the individual is required to pay a penalty of $5,000. The $5,000 penalty 

does not apply if it is shown that the failure is due to reasonable 

cause and not to willful neglect. 

EFFECTIVE DATE

The provision applies to individuals who relinquish citizenship or 

terminate long-term residency after June 3, 2004. 

5. Reporting of taxable mergers and acquisitions (sec. 605 of the 

bill and new sec. 6043A of the Code) 

PRESENT LAW

Under section 6045 and the regulations thereunder, brokers (defined to include stock transfer agents) are required to make information returns and to provide corresponding payee statements as 

to sales made on behalf of their customers, subject to the penalty 

provisions of sections 6721–6724. Under the regulations issued 

under section 6045, this requirement generally does not apply with 

respect to taxable transactions other than exchanges for cash (e.g., 

stock inversion transactions taxable to shareholders by reason of 

section 367(a)).220

REASONS FOR CHANGE

The Committee believes that administration of the tax laws 

would be improved by greater information reporting with respect to 

taxable non-cash transactions, and that the Treasury Secretary’s 

authority to require such enhanced reporting should be made explicit in the Code. 

EXPLANATION OF PROVISION

Under the bill, if gain or loss is recognized in whole or in part 

by shareholders of a corporation by reason of a second corporation’s 

acquisition of the stock or assets of the first corporation, then the 

acquiring corporation (or the acquired corporation, if so prescribed 

by the Treasury Secretary) is required to make a return containing: 

(1) A description of the transaction; 

(2) The name and address of each shareholder of the acquired corporation that recognizes gain as a result of the transaction (or would recognize gain, if there was a built-in gain on 

the shareholder’s shares); 

258

221 In the case of a nominee, the nominee must furnish the information to the shareholder 

in the manner prescribed by the Treasury Secretary. 

(3) The amount of money and the value of stock or other consideration paid to each shareholder described above; and 

(4) Such other information as the Treasury Secretary may 

prescribe. 

Alternatively, a stock transfer agent who records transfers of 

stock in such transaction may make the return described above in 

lieu of the second corporation. 

In addition, every person required to make a return described 

above is required to furnish to each shareholder (or the shareholder’s nominee 221) whose name is required to be set forth in such 

return a written statement showing: 

(1) The name, address, and phone number of the information 

contact of the person required to make such return; 

(2) The information required to be shown on that return; and 

(3) Such other information as the Treasury Secretary may 

prescribe. 

This written statement is required to be furnished to the shareholder on or before January 31 of the year following the calendar 

year during which the transaction occurred. 

The present-law penalties for failure to comply with information 

reporting requirements are extended to failures to comply with the 

requirements set forth under this bill. 

EFFECTIVE DATE

The provision is effective for acquisitions after the date of enactment.

6. Studies (sec. 606 of the bill) 

PRESENT LAW

Due to the variation in tax rates and tax systems among countries, a multinational enterprise, whether U.S.-based or foreignbased, may have an incentive to shift income, deductions, or tax 

credits in order to arrive at a reduced overall tax burden. Such a 

shifting of items could be accomplished by establishing artificial, 

non-arm’s-length prices for transactions between group members. 

Under section 482, the Treasury Secretary is authorized to reallocate income, deductions, or credits between or among two or 

more organizations, trades, or businesses under common control if 

he determines that such a reallocation is necessary to prevent tax 

evasion or to clearly reflect income. Treasury regulations adopt the 

arm’s-length standard as the standard for determining whether 

such reallocations are appropriate. Thus, the regulations provide 

rules to identify the respective amounts of taxable income of the related parties that would have resulted if the parties had been uncontrolled parties dealing at arm’s length. Transactions involving 

intangible property and certain services may present particular 

challenges to the administration of the arm’s-length standard, because the nature of these transactions may make it difficult or impossible to compare them with third-party transactions. 

In addition to the statutory rules governing the taxation of foreign income of U.S. persons and U.S. income of foreign persons, biVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00260 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.006 HR548P1
259

lateral income tax treaties limit the amount of income tax that may 

be imposed by one treaty partner on residents of the other treaty 

partner. For example, treaties often reduce or eliminate withholding taxes imposed by a treaty country on certain types of income (e.g., dividends, interest and royalties) paid to residents of the 

other treaty country. Treaties also contain provisions governing the 

creditability of taxes imposed by the treaty country in which income was earned in computing the amount of tax owed to the other 

country by its residents with respect to such income. Treaties further provide procedures under which inconsistent positions taken 

by the treaty countries with respect to a single item of income or 

deduction may be mutually resolved by the two countries. 

REASONS FOR CHANGE

The Committee believes that it is important to evaluate the effectiveness of the current transfer pricing rules and compliance efforts 

with respect to related-party transactions to ensure that income is 

not being shifted outside of the United States. The Committee also 

believes that it is necessary to review current U.S. income tax treaties to identify any inappropriate reductions in withholding tax 

rates that may create opportunities for shifting income outside the 

United States. In addition, the Committee believes that the impact 

of the provisions of this bill on inversion transactions should be 

studied. 

EXPLANATION OF PROVISION

The bill requires the Treasury Secretary to conduct and submit 

to the Congress three studies. The first study will examine the effectiveness of the transfer pricing rules of section 482, with an emphasis on transactions involving intangible property. The second 

study will examine income tax treaties to which the United States 

is a party, with a view toward identifying any inappropriate reductions in withholding tax or opportunities for abuse that may exist. 

The third study will examine the impact of the provisions of this 

bill on inversion transactions. 

EFFECTIVE DATE

The tax treaty study required under the provision is due no later 

than June 30, 2005. The transfer pricing study required under the 

provision is due no later than June 30, 2005. The inversions study 

required under the provision is due no later than December 31, 

2005.

260

222On February 27, 2003, the Treasury Department and the IRS released final regulations 

regarding the disclosure of reportable transactions. In general, the regulations are effective for 

transactions entered into on or after February 28, 2003. 

The discussion of present law refers to the new regulations. The rules that apply with respect 

to transactions entered into on or before February 28, 2003, are contained in Treas. Reg. sec. 

1.6011–4T in effect on the date the transaction was entered into. 223The regulations clarify that the term ‘‘substantially similar’’ includes any transaction that 

is expected to obtain the same or similar types of tax consequences and that is either factually 

similar or based on the same or similar tax strategy. Further, the term must be broadly construed in favor of disclosure. Treas. Reg. sec. 1.6011–4(c)(4). 224Treas. Reg. sec. 1.6011–4(b)(2). 225Treas. Reg. sec. 1.6011–4(b)(3). 226Treas. Reg. sec. 1.6011–4(b)(4). 227Treas. Reg. sec. 1.6011–4(b)(5). Rev. Proc. 2003–24, 2003–11 I.R.B. 599, exempts certain 

types of losses from this reportable transaction category. 228The significant book-tax category applies only to taxpayers that are reporting companies 

under the Securities Exchange Act of 1934 or business entities that have $250 million or more 

in gross assets. 

B. PROVISIONS RELATING TO TAX SHELTERS

1. Penalty for failure to disclose reportable transactions (sec. 611 

of the bill and new sec. 6707A of the Code) 

PRESENT LAW

Regulations under section 6011 require a taxpayer to disclose 

with its tax return certain information with respect to each ‘‘reportable transaction’’ in which the taxpayer participates.222

There are six categories of reportable transactions. The first category is any transaction that is the same as (or substantially similar to) 223 a transaction that is specified by the Treasury Department as a tax avoidance transaction whose tax benefits are subject 

to disallowance under present law (referred to as a ‘‘listed transaction’’).224

The second category is any transaction that is offered under conditions of confidentiality. In general, a transaction is considered to 

be offered to a taxpayer under conditions of confidentiality if the 

advisor who is paid a minimum fee places a limitation on disclosure by the taxpayer of the tax treatment or tax structure of the 

transaction and the limitation on disclosure protects the confidentiality of that advisor’s tax strategies (irrespective if such terms are 

legally binding).225

The third category of reportable transactions is any transaction 

for which (1) the taxpayer has the right to a full or partial refund 

of fees if the intended tax consequences from the transaction are 

not sustained or, (2) the fees are contingent on the intended tax 

consequences from the transaction being sustained.226

The fourth category of reportable transactions relates to any 

transaction resulting in a taxpayer claiming a loss (under section 

165) of at least (1) $10 million in any single year or $20 million 

in any combination of years by a corporate taxpayer or a partnership with only corporate partners; (2) $2 million in any single year 

or $4 million in any combination of years by all other partnerships, 

S corporations, trusts, and individuals; or (3) $50,000 in any single 

year for individuals or trusts if the loss arises with respect to foreign currency translation losses.227

The fifth category of reportable transactions refers to any transaction done by certain taxpayers 228 in which the tax treatment of 

the transaction differs (or is expected to differ) by more than $10 

261

229Treas. Reg. sec. 1.6011–4(b)(6). Rev. Proc. 2003–25, 2003–11 I.R.B. 601, exempts certain 

types of transactions from this reportable transaction category. 230Treas. Reg. sec. 1.6011–4(b)(7). 231Section 6664(c) provides that a taxpayer can avoid the imposition of a section 6662 accuracy-related penalty in cases where the taxpayer can demonstrate that there was reasonable 

cause for the underpayment and that the taxpayer acted in good faith. Regulations under sections 6662 and 6664 provide that a taxpayer’s failure to disclose a reportable transaction is a 

strong indication that the taxpayer failed to act in good faith, which would bar relief under section 6664(c). 232The provision states that, except as provided in regulations, a listed transaction means a 

reportable transaction, which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011. For 

this purpose, it is expected that the definition of ‘‘substantially similar’’ will be the definition 

used in Treas. Reg. sec. 1.6011–4(c)(4). However, the Secretary may modify this definition (as 

well as the definitions of ‘‘listed transaction’’ and ‘‘reportable transactions’’) as appropriate. 

million from its treatment for book purposes (using generally accepted accounting principles) in any year.229

The final category of reportable transactions is any transaction 

that results in a tax credit exceeding $250,000 (including a foreign 

tax credit) if the taxpayer holds the underlying asset for less than 

45 days.230

Under present law, there is no specific penalty for failing to disclose a reportable transaction; however, such a failure can jeopardize a taxpayer’s ability to claim that any income tax understatement attributable to such undisclosed transaction is due to reasonable cause, and that the taxpayer acted in good faith.231

REASONS FOR CHANGE

The Committee believes that the best way to combat tax shelters 

is to be aware of them. The Treasury Department, using the tools 

available, issued regulations requiring disclosure of certain transactions and requiring organizers and promoters of tax-engineered 

transactions to maintain customer lists and make these lists available to the IRS. Nevertheless, the Committee believes that additional legislation is needed to provide the Treasury Department 

with additional tools to assist its efforts to curtail abusive transactions. Moreover, the Committee believes that a penalty for failing 

to make the required disclosures, when the imposition of such penalty is not dependent on the tax treatment of the underlying transaction ultimately being sustained, will provide an additional incentive for taxpayers to satisfy their reporting obligations under the 

new disclosure provisions. 

EXPLANATION OF PROVISION

In general 

The provision creates a new penalty for any person who fails to 

include with any return or statement any required information 

with respect to a reportable transaction. The new penalty applies 

without regard to whether the transaction ultimately results in an 

understatement of tax, and applies in addition to any accuracy-related penalty that may be imposed. 

Transactions to be disclosed 

The provision does not define the terms ‘‘listed transaction’’ 232 or ‘‘reportable transaction,’’ nor does the provision explain the type of 

information that must be disclosed in order to avoid the imposition 

of a penalty. Rather, the provision authorizes the Treasury DepartVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00263 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.006 HR548P1
262

233This does not limit the ability of a taxpayer to challenge whether a penalty is appropriate 

(e.g., a taxpayer may litigate the issue of whether a transaction is a reportable transaction (and 

thus subject to the penalty if not disclosed) or not a reportable transaction (and thus not subject 

to the penalty)). 234Sec. 6662. 235Sec. 6662(d)(2)(B). 

ment to define a ‘‘listed transaction’’ and a ‘‘reportable transaction’’

under section 6011. 

Penalty rate 

The penalty for failing to disclose a reportable transaction is 

$10,000 in the case of a natural person and $50,000 in any other 

case. The amount is increased to $100,000 and $200,000, respectively, if the failure is with respect to a listed transaction. The penalty cannot be waived with respect to a listed transaction. As to reportable transactions, the penalty can be rescinded (or abated) only 

if rescinding the penalty would promote compliance with the tax 

laws and effective tax administration. The authority to rescind the 

penalty can only be exercised by the IRS Commissioner personally. 

Thus, a revenue agent, an Appeals officer, or any other IRS personnel cannot rescind the penalty. The decision to rescind a penalty 

must be accompanied by a record describing the facts and reasons 

for the action and the amount rescinded. There will be no taxpayer 

right to appeal a refusal to rescind a penalty.233 The IRS also is 

required to submit an annual report to Congress summarizing the 

application of the disclosure penalties and providing a description 

of each penalty rescinded under this provision and the reasons for 

the rescission. 

EFFECTIVE DATE

The provision is effective for returns and statements the due date 

for which is after the date of enactment. 

2. Modifications to the accuracy-related penalties for listed transactions and reportable transactions having a significant tax 

avoidance purpose (sec. 612 of the bill and new sec. 6662A of 

the Code) 

PRESENT LAW

The accuracy-related penalty applies to the portion of any underpayment that is attributable to (1) negligence, (2) any substantial 

understatement of income tax, (3) any substantial valuation 

misstatement, (4) any substantial overstatement of pension liabilities, or (5) any substantial estate or gift tax valuation understatement. If the correct income tax liability exceeds that reported by 

the taxpayer by the greater of 10 percent of the correct tax or 

$5,000 ($10,000 in the case of corporations), then a substantial understatement exists and a penalty may be imposed equal to 20 percent of the underpayment of tax attributable to the understatement.234 The amount of any understatement generally is reduced 

by any portion attributable to an item if (1) the treatment of the 

item is or was supported by substantial authority, or (2) facts relevant to the tax treatment of the item were adequately disclosed 

and there was a reasonable basis for its tax treatment.235

263

236Sec. 6662(d)(2)(C). 237Sec. 6664(c). 238Treas. Reg. sec. 1.6662–4(g)(4)(i)(B); Treas. Reg. sec. 1.6664–4(c). 239The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meanings as 

used for purposes of the penalty for failing to disclose reportable transactions. 

Special rules apply with respect to tax shelters.236 For understatements by non-corporate taxpayers attributable to tax shelters, 

the penalty may be avoided only if the taxpayer establishes that, 

in addition to having substantial authority for the position, the taxpayer reasonably believed that the treatment claimed was more 

likely than not the proper treatment of the item. This reduction in 

the penalty is unavailable to corporate tax shelters. 

The understatement penalty generally is abated (even with respect to tax shelters) in cases in which the taxpayer can demonstrate that there was ‘‘reasonable cause’’ for the underpayment 

and that the taxpayer acted in good faith.237 The relevant regulations provide that reasonable cause exists where the taxpayer ‘‘reasonably relies in good faith on an opinion based on a professional 

tax advisor’s analysis of the pertinent facts and authorities [that] 

* * * unambiguously concludes that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld 

if challenged’’ by the IRS.238

REASONS FOR CHANGE

Because disclosure is so vital to combating abusive tax avoidance 

transactions, the Committee believes that taxpayers should be subject to a strict liability penalty on an understatement of tax that 

is attributable to non-disclosed listed transactions or non-disclosed 

reportable transactions that have a significant purpose of tax 

avoidance. Furthermore, in order to deter taxpayers from entering 

into tax avoidance transactions, the Committee believes that a 

more meaningful (but not a strict liability) accuracy-related penalty 

should apply to such transactions even when disclosed. 

EXPLANATION OF PROVISION

In general 

The provision modifies the present-law accuracy-related penalty 

by replacing the rules applicable to tax shelters with a new accuracy-related penalty that applies to listed transactions and reportable transactions with a significant tax avoidance purpose (hereinafter referred to as a ‘‘reportable avoidance transaction’’).239 The 

penalty rate and defenses available to avoid the penalty vary depending on whether the transaction was adequately disclosed. 

Disclosed transactions 

In general, a 20-percent accuracy-related penalty is imposed on 

any understatement attributable to an adequately disclosed listed 

transaction or reportable avoidance transaction. The only exception 

to the penalty is if the taxpayer satisfies a more stringent reasonable cause and good faith exception (hereinafter referred to as the 

‘‘strengthened reasonable cause exception’’), which is described 

below. The strengthened reasonable cause exception is available 

only if the relevant facts affecting the tax treatment are adequately 

disclosed, there is or was substantial authority for the claimed tax 

264

240For this purpose, any reduction in the excess of deductions allowed for the taxable year 

over gross income for such year, and any reduction in the amount of capital losses which would 

(without regard to section 1211) be allowed for such year, shall be treated as an increase in 

taxable income. 241See the previous discussion regarding the penalty for failing to disclose a reportable transaction. 

treatment, and the taxpayer reasonably believed that the claimed 

tax treatment was more likely than not the proper treatment. 

Undisclosed transactions 

If the taxpayer does not adequately disclose the transaction, the 

strengthened reasonable cause exception is not available (i.e., a 

strict-liability penalty applies), and the taxpayer is subject to an increased penalty rate equal to 30 percent of the understatement.

Determination of the understatement amount 

The penalty is applied to the amount of any understatement attributable to the listed or reportable avoidance transaction without 

regard to other items on the tax return. For purposes of this provision, the amount of the understatement is determined as the sum 

of (1) the product of the highest corporate or individual tax rate (as 

appropriate) and the increase in taxable income resulting from the 

difference between the taxpayer’s treatment of the item and the 

proper treatment of the item (without regard to other items on the 

tax return),240 and (2) the amount of any decrease in the aggregate 

amount of credits which results from a difference between the taxpayer’s treatment of an item and the proper tax treatment of such 

item. 

Except as provided in regulations, a taxpayer’s treatment of an 

item shall not take into account any amendment or supplement to 

a return if the amendment or supplement is filed after the earlier 

of when the taxpayer is first contacted regarding an examination 

of the return or such other date as specified by the Secretary. 

Strengthened reasonable cause exception 

A penalty is not imposed under the provision with respect to any 

portion of an understatement if it shown that there was reasonable 

cause for such portion and the taxpayer acted in good faith. Such 

a showing requires (1) adequate disclosure of the facts affecting the 

transaction in accordance with the regulations under section 

6011,241 (2) that there is or was substantial authority for such 

treatment, and (3) that the taxpayer reasonably believed that such 

treatment was more likely than not the proper treatment. For this 

purpose, a taxpayer will be treated as having a reasonable belief 

with respect to the tax treatment of an item only if such belief (1) 

is based on the facts and law that exist at the time the tax return 

(that includes the item) is filed, and (2) relates solely to the taxpayer’s chances of success on the merits and does not take into account the possibility that (a) a return will not be audited, (b) the 

treatment will not be raised on audit, or (c) the treatment will be 

resolved through settlement if raised. 

A taxpayer may (but is not required to) rely on an opinion of a 

tax advisor in establishing its reasonable belief with respect to the 

tax treatment of the item. However, a taxpayer may not rely on an 

opinion of a tax advisor for this purpose if the opinion (1) is proVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00266 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.006 HR548P1
265

242The term ‘‘material advisor’’ (defined below in connection with the new information filing 

requirements for material advisors) means any person who provides any material aid, assistance, or advice with respect to organizing, managing, promoting, selling, implementing, or carrying out any reportable transaction, and who derives gross income in excess of $50,000 in the 

case of a reportable transaction substantially all of the tax benefits from which are provided 

to natural persons ($250,000 in any other case). 243This situation could arise, for example, when an advisor has an arrangement or understanding (oral or written) with an organizer, manager, or promoter of a reportable transaction 

that such party will recommend or refer potential participants to the advisor for an opinion regarding the tax treatment of the transaction. 244 An advisor should not be treated as participating in the organization of a transaction if 

the advisor’s only involvement with respect to the organization of the transaction is the rendering of an opinion regarding the tax consequences of such transaction. However, such an advisor may be a ‘‘disqualified tax advisor’’ with respect to the transaction if the advisor participates 

in the management, promotion or sale of the transaction (or if the advisor is compensated by 

a material advisor, has a fee arrangement that is contingent on the tax benefits of the transaction, or as determined by the Secretary, has a continuing financial interest with respect to 

the transaction).

vided by a ‘‘disqualified tax advisor,’’ or (2) is a ‘‘disqualified opinion.’’

Disqualified tax advisor 

A disqualified tax advisor is any advisor who (1) is a material advisor 242 and who participates in the organization, management, 

promotion or sale of the transaction or is related (within the meaning of section 267(b) or 707(b)(1)) to any person who so participates, 

(2) is compensated directly or indirectly 243 by a material advisor 

with respect to the transaction, (3) has a fee arrangement with respect to the transaction that is contingent on all or part of the intended tax benefits from the transaction being sustained, or (4) as 

determined under regulations prescribed by the Secretary, has a 

disqualifying financial interest with respect to the transaction. 

Organization, management, promotion or sale of a transaction—

A material advisor is considered as participating in the ‘‘organization’’ of a transaction if the advisor performs acts relating to the 

development of the transaction. This may include, for example, preparing documents (1) establishing a structure used in connection 

with the transaction (such as a partnership agreement), (2) describing the transaction (such as an offering memorandum or other 

statement describing the transaction), or (3) relating to the registration of the transaction with any federal, state or local government body.244 Participation in the ‘‘management’’ of a transaction 

means involvement in the decision-making process regarding any 

business activity with respect to the transaction. Participation in 

the ‘‘promotion or sale’’ of a transaction means involvement in the 

marketing or solicitation of the transaction to others. Thus, an advisor who provides information about the transaction to a potential 

participant is involved in the promotion or sale of a transaction, as 

is any advisor who recommends the transaction to a potential participant. 

Disqualified opinion 

An opinion may not be relied upon if the opinion (1) is based on 

unreasonable factual or legal assumptions (including assumptions 

as to future events), (2) unreasonably relies upon representations, 

statements, finding or agreements of the taxpayer or any other person, (3) does not identify and consider all relevant facts, or (4) fails 

to meet any other requirement prescribed by the Secretary. 

266

Coordination with other penalties 

Any understatement upon which a penalty is imposed under this 

provision is not subject to the accuracy-related penalty under section 6662. However, such understatement is included for purposes 

of determining whether any understatement (as defined in sec. 

6662(d)(2)) is a substantial understatement as defined under section 6662(d)(1). 

The penalty imposed under this provision shall not apply to any 

portion of an understatement to which a fraud penalty is applied 

under section 6663. 

EFFECTIVE DATE

The provision is effective for taxable years ending after the date 

of enactment. 

3. Tax shelter exception to confidentiality privileges relating to taxpayer communications (sec. 613 of the bill and sec. 7525 of the 

Code) 

PRESENT LAW

In general, a common law privilege of confidentiality exists for 

communications between an attorney and client with respect to the 

legal advice the attorney gives the client. The Code provides that, 

with respect to tax advice, the same common law protections of 

confidentiality that apply to a communication between a taxpayer 

and an attorney also apply to a communication between a taxpayer 

and a federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it 

were between a taxpayer and an attorney. This rule is inapplicable 

to communications regarding corporate tax shelters. 

REASONS FOR CHANGE

The Committee believes that the rule currently applicable to corporate tax shelters should be applied to all tax shelters, regardless 

of whether or not the participant is a corporation. 

EXPLANATION OF PROVISION

The provision modifies the rule relating to corporate tax shelters 

by making it applicable to all tax shelters, whether entered into by 

corporations, individuals, partnerships, tax-exempt entities, or any 

other entity. Accordingly, communications with respect to tax shelters are not subject to the confidentiality provision of the Code that 

otherwise applies to a communication between a taxpayer and a 

federally authorized tax practitioner.

EFFECTIVE DATE

The provision is effective with respect to communications made 

on or after the date of enactment. 

267

245Sec. 6501(a). 246For this purpose, a return that is filed before the date on which it is due is considered 

to be filed on the required due date (sec. 6501(b)(1)). 247Sec. 6501(e). 248Sec. 6501(c). 249The term ‘‘listed transaction’’ has the same meaning as described in a previous provision 

regarding the penalty for failure to disclose reportable transactions. 250 If the Treasury Department lists a transaction in a year subsequent to the year in which 

a taxpayer entered into such transaction and the taxpayer’s tax return for the year the transaction was entered into is closed by the statute of limitations prior to the date the transaction 

became a listed transaction, this provision does not re-open the statute of limitations with respect to such transaction for such year. However, if the purported tax benefits of the transaction 

are recognized over multiple tax years, the provision’s extension of the statute of limitations 

shall apply to such tax benefits in any subsequent tax year in which the statute of limitations 

had not closed prior to the date the transaction became a listed transaction. 

4. Statute of limitations for unreported listed transactions (sec. 614 

of the bill and sec. 6501 of the Code) 

PRESENT LAW

In general, the Code requires that taxes be assessed within three 

years 245 after the date a return is filed.246 If there has been a substantial omission of items of gross income that totals more than 25 

percent of the amount of gross income shown on the return, the period during which an assessment must be made is extended to six 

years.247 If an assessment is not made within the required time periods, the tax generally cannot be assessed or collected at any future time. Tax may be assessed at any time if the taxpayer files 

a false or fraudulent return with the intent to evade tax or if the 

taxpayer does not file a tax return at all.248

REASONS FOR CHANGE

The Committee has noted that some taxpayers and their advisors 

have been employing dilatory tactics and failing to cooperate with 

the IRS in an attempt to avoid liability because of the expiration 

of the statute of limitations. The Committee accordingly believes 

that it is appropriate to extend the statute of limitations for unreported listed transactions. 

EXPLANATION OF PROVISION

The provision extends the statute of limitations with respect to 

a listed transaction if a taxpayer fails to include on any return or 

statement for any taxable year any information with respect to a 

listed transaction 249 which is required to be included (under section 6011) with such return or statement. The statute of limitations 

with respect to such a transaction will not expire before the date 

which is one year after the earlier of (1) the date on which the Secretary is furnished the information so required, or (2) the date that 

a material advisor (as defined in 6111) satisfies the list maintenance requirements (as defined by section 6112) with respect to a 

request by the Secretary. For example, if a taxpayer engaged in a 

transaction in 2005 that becomes a listed transaction in 2007 and 

the taxpayer fails to disclose such transaction in the manner required by Treasury regulations, then the transaction is subject to 

the extended statute of limitations.250

268

251Sec. 6111(a). 252The tax shelter ratio is, with respect to any year, the ratio that the aggregate amount of 

the deductions and 350 percent of the credits, which are represented to be potentially allowable 

to any investor, bears to the investment base (money plus basis of assets contributed) as of the 

close of the tax year. 253Sec. 6111(c). 254Sec. 6111(d). 255Treas. Reg. sec. 301.6111–2(b)(2). 256Treas. Reg. sec. 301.6111–2(b)(3). 257Treas. Reg. sec. 301.6111–2(b)(4). 258The regulations provide that the determination of whether an arrangement is offered 

under conditions of confidentiality is based on all the facts and circumstances surrounding the 

offer. If an offeree’s disclosure of the structure or tax aspects of the transaction are limited in 

any way by an express or implied understanding or agreement with or for the benefit of a tax 

shelter promoter, an offer is considered made under conditions of confidentiality, whether or not 

such understanding or agreement is legally binding. Treas. Reg. sec. 301.6111–2(c)(1). 

EFFECTIVE DATE

The provision is effective for taxable years with respect to which 

the period for assessing a deficiency did not expire before the date 

of enactment. 

5. Disclosure of reportable transactions by material advisors (sec. 

615 of the bill and secs. 6111 and 6707 of the Code) 

PRESENT LAW

Registration of tax shelter arrangements 

An organizer of a tax shelter is required to register the shelter 

with the Secretary not later than the day on which the shelter is 

first offered for sale.251 A ‘‘tax shelter’’ means any investment with 

respect to which the tax shelter ratio 252 for any investor as of the 

close of any of the first five years ending after the investment is 

offered for sale may be greater than two to one and which is: (1) 

required to be registered under Federal or State securities laws, (2) 

sold pursuant to an exemption from registration requiring the filing of a notice with a Federal or State securities agency, or (3) a 

substantial investment (greater than $250,000 and involving at 

least five investors).253

Other promoted arrangements are treated as tax shelters for 

purposes of the registration requirement if: (1) a significant purpose of the arrangement is the avoidance or evasion of Federal income tax by a corporate participant; (2) the arrangement is offered 

under conditions of confidentiality; and (3) the promoter may receive fees in excess of $100,000 in the aggregate.254

In general, a transaction has a ‘‘significant purpose of avoiding 

or evading Federal income tax’’ if the transaction: (1) is the same 

as or substantially similar to a ‘‘listed transaction,’’ 255 or (2) is 

structured to produce tax benefits that constitute an important 

part of the intended results of the arrangement and the promoter 

reasonably expects to present the arrangement to more than one 

taxpayer.256 Certain exceptions are provided with respect to the 

second category of transactions.257

An arrangement is offered under conditions of confidentiality if: 

(1) an offeree has an understanding or agreement to limit the disclosure of the transaction or any significant tax features of the 

transaction; or (2) the promoter knows, or has reason to know, that 

the offeree’s use or disclosure of information relating to the transaction is limited in any other manner.258

269

259Sec. 6707. 260The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 261See the previous discussion regarding the disclosure requirements under new section 

6707A. 

Failure to register tax shelter 

The penalty for failing to timely register a tax shelter (or for filing false or incomplete information with respect to the tax shelter 

registration) generally is the greater of one percent of the aggregate amount invested in the shelter or $500.259 However, if the tax 

shelter involves an arrangement offered to a corporation under conditions of confidentiality, the penalty is the greater of $10,000 or 

50 percent of the fees payable to any promoter with respect to offerings prior to the date of late registration. Intentional disregard 

of the requirement to register increases the penalty to 75 percent 

of the applicable fees. 

Section 6707 also imposes (1) a $100 penalty on the promoter for 

each failure to furnish the investor with the required tax shelter 

identification number, and (2) a $250 penalty on the investor for 

each failure to include the tax shelter identification number on a 

return. 

REASONS FOR CHANGE

The Committee believes that providing a single, clear definition 

regarding the types of transactions that must be disclosed by taxpayers and material advisors, coupled with more meaningful penalties for failing to disclose such transactions, are necessary tools 

if the effort to curb the use of abusive tax avoidance transactions 

is to be effective. 

EXPLANATION OF PROVISION

Disclosure of reportable transactions by material advisors 

The provision repeals the present law rules with respect to registration of tax shelters. Instead, the provision requires each material advisor with respect to any reportable transaction (including 

any listed transaction) 260 to timely file an information return with 

the Secretary (in such form and manner as the Secretary may prescribe). The return must be filed on such date as specified by the 

Secretary. 

The information return will include (1) information identifying 

and describing the transaction, (2) information describing any potential tax benefits expected to result from the transaction, and (3) 

such other information as the Secretary may prescribe. It is expected that the Secretary may seek from the material advisor the 

same type of information that the Secretary may request from a 

taxpayer in connection with a reportable transaction.261

A ‘‘material advisor’’ means any person (1) who provides material 

aid, assistance, or advice with respect to organizing, managing, 

promoting, selling, implementing, or carrying out any reportable 

transaction, and (2) who directly or indirectly derives gross income 

in excess of $250,000 ($50,000 in the case of a reportable transaction substantially all of the tax benefits from which are provided 

to natural persons) or such other amount as may be prescribed by 

the Secretary for such advice or assistance. 

270

262The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 263The Secretary’s present-law authority to postpone certain tax-related deadlines because of 

Presidentially-declared disasters (sec. 7508A) will also encompass the authority to postpone the 

reporting deadlines established by the provision. 

The Secretary may prescribe regulations which provide (1) that 

only one material advisor has to file an information return in cases 

in which two or more material advisors would otherwise be required to file information returns with respect to a particular reportable transaction, (2) exemptions from the requirements of this 

section, and (3) other rules as may be necessary or appropriate to 

carry out the purposes of this section (including, for example, rules 

regarding the aggregation of fees in appropriate circumstances). 

Penalty for failing to furnish information regarding reportable 

transactions 

The provision repeals the present-law penalty for failure to register tax shelters. Instead, the provision imposes a penalty on any 

material advisor who fails to file an information return, or who 

files a false or incomplete information return, with respect to a reportable transaction (including a listed transaction).262 The amount 

of the penalty is $50,000. If the penalty is with respect to a listed 

transaction, the amount of the penalty is increased to the greater 

of (1) $200,000, or (2) 50 percent of the gross income of such person 

with respect to aid, assistance, or advice which is provided with respect to the transaction before the date the information return that 

includes the transaction is filed. Intentional disregard by a material advisor of the requirement to disclose a listed transaction increases the penalty to 75 percent of the gross income. 

The penalty cannot be waived with respect to a listed transaction. As to reportable transactions, the penalty can be rescinded 

(or abated) only in exceptional circumstances.263 All or part of the 

penalty may be rescinded only if rescinding the penalty would promote compliance with the tax laws and effective tax administration. The authority to rescind the penalty can only be exercised by 

the Commissioner personally. Thus, a revenue agent, an Appeals 

officer, or other IRS personnel cannot rescind the penalty. The decision to rescind a penalty must be accompanied by a record describing the facts and reasons for the action and the amount rescinded. 

There will be no right to appeal a refusal to rescind a penalty. The 

IRS also is required to submit an annual report to Congress summarizing the application of the disclosure penalties and providing 

a description of each penalty rescinded under this provision and 

the reasons for the rescission. 

EFFECTIVE DATE

The provision requiring disclosure of reportable transactions by 

material advisors applies to transactions with respect to which material aid, assistance or advice is provided after the date of enactment. 

The provision imposing a penalty for failing to disclose reportable 

transactions applies to returns the due date for which is after the 

date of enactment. 

271

264Sec. 6112. 265Treas. Reg. sec. 301.6112–1. 266 A special rule applies the list maintenance requirements to transactions entered into after 

February 28, 2000 if the transaction becomes a listed transaction (as defined in Treas. Reg. 

1.6011–4) after February 28, 2003. 267Treas. Reg. sec. 301.6112–1(c)(1). 268Treas. Reg. sec. 301.6112–1(c)(2) and (3). 269Treas. Reg. sec. 301.6112–1(b). 270Sec. 6112(c)(2). 

6. Investor lists and modification of penalty for failure to maintain 

investor lists (secs. 616 and 617 of the bill and secs. 6112 and 

6708 of the Code) 

PRESENT LAW

Investor lists 

Any organizer or seller of a potentially abusive tax shelter must 

maintain a list identifying each person who was sold an interest in 

any such tax shelter with respect to which registration was required under section 6111 (even though the particular party may 

not have been subject to confidentiality restrictions).264 Recently 

issued regulations under section 6112 contain rules regarding the 

list maintenance requirements.265 In general, the regulations apply 

to transactions that are potentially abusive tax shelters entered 

into, or acquired after, February 28, 2003.266

The regulations provide that a person is an organizer or seller 

of a potentially abusive tax shelter if the person is a material advisor with respect to that transaction.267 A material advisor is defined as any person who is required to register the transaction 

under section 6111, or expects to receive a minimum fee of (1) 

$250,000 for a transaction that is a potentially abusive tax shelter 

if all participants are corporations, or (2) $50,000 for any other 

transaction that is a potentially abusive tax shelter.268 For listed 

transactions (as defined in the regulations under section 6011), the 

minimum fees are reduced to $25,000 and $10,000, respectively. 

A potentially abusive tax shelter is any transaction that (1) is required to be registered under section 6111, (2) is a listed transaction (as defined under the regulations under section 6011), or (3) 

any transaction that a potential material advisor, at the time the 

transaction is entered into, knows is or reasonably expects will become a reportable transaction (as defined under the new regulations under section 6011).269

The Secretary is required to prescribe regulations which provide 

that, in cases in which two or more persons are required to maintain the same list, only one person would be required to maintain 

the list.270

Penalty for failing to maintain investor lists 

Under section 6708, the penalty for failing to maintain the list 

required under section 6112 is $50 for each name omitted from the 

list (with a maximum penalty of $100,000 per year). 

REASONS FOR CHANGE

The Committee has been advised that the present-law penalties 

for failure to maintain customer lists are not meaningful and that 

promoters often have refused to provide requested information to 

the IRS. The Committee believes that requiring material advisors 

272

271The term ‘‘material advisor’’ has the same meaning as when used in connection with the 

requirement to file an information return under section 6111. 272The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 273 In no event will failure to maintain a list be considered reasonable cause for failing to 

make a list available to the Secretary. 

to maintain a list of advisees with respect to each reportable transaction, coupled with more meaningful penalties for failing to maintain an investor list, are important tools in the ongoing efforts to 

curb the use of abusive tax avoidance transactions. 

EXPLANATION OF PROVISION

Investor lists 

Each material advisor 271 with respect to a reportable transaction 

(including a listed transaction) 272 is required to maintain a list 

that (1) identifies each person with respect to whom the advisor 

acted as a material advisor with respect to the reportable transaction, and (2) contains other information as may be required by 

the Secretary. In addition, the provision authorizes (but does not 

require) the Secretary to prescribe regulations which provide that, 

in cases in which two or more persons are required to maintain the 

same list, only one person would be required to maintain the list. 

The provision also clarifies that, for purposes of section 6112, the 

identity of any person is not privileged under the common law attorney-client privilege (or, consequently, the section 7525 federally 

authorized tax practitioner confidentiality provision). 

Penalty for failing to maintain investor lists 

The provision modifies the penalty for failing to maintain the required list by making it a time-sensitive penalty. Thus, a material 

advisor who is required to maintain an investor list and who fails 

to make the list available upon written request by the Secretary 

within 20 business days after the request will be subject to a 

$10,000 per day penalty. The penalty applies to a person who fails 

to maintain a list, maintains an incomplete list, or has in fact 

maintained a list but does not make the list available to the Secretary. The penalty can be waived if the failure to make the list 

available is due to reasonable cause.273

EFFECTIVE DATE

The provision requiring a material advisor to maintain an investor list applies to transactions with respect to which material aid, 

assistance or advice is provided after the date of enactment. 

The provision imposing a penalty for failing to maintain investor 

lists applies to requests made after the date of enactment. 

The provision clarifying that the identity of any person is not 

privileged for purposes of section 6112 is effective as if included in 

the amendments made by section 142 of the Deficit Reduction Act 

of 1984. 

273

274Sec. 6700. 

7. Penalty on promoters of tax shelters (sec. 618 of the bill and sec. 

6700 of the Code) 

PRESENT LAW

A penalty is imposed on any person who organizes, assists in the 

organization of, or participates in the sale of any interest in, a 

partnership or other entity, any investment plan or arrangement, 

or any other plan or arrangement, if in connection with such activity the person makes or furnishes a qualifying false or fraudulent 

statement or a gross valuation overstatement.274 A qualified false 

or fraudulent statement is any statement with respect to the allowability of any deduction or credit, the excludability of any income, 

or the securing of any other tax benefit by reason of holding an interest in the entity or participating in the plan or arrangement 

which the person knows or has reason to know is false or fraudulent as to any material matter. A ‘‘gross valuation overstatement’’

means any statement as to the value of any property or services 

if the stated value exceeds 200 percent of the correct valuation, and 

the value is directly related to the amount of any allowable income 

tax deduction or credit. 

The amount of the penalty is $1,000 (or, if the person establishes 

that it is less, 100 percent of the gross income derived or to be derived by the person from such activity). A penalty attributable to 

a gross valuation misstatement can be waived on a showing that 

there was a reasonable basis for the valuation and it was made in 

good faith. 

REASONS FOR CHANGE

The Committee believes that the present-law $1,000 penalty for 

tax shelter promoters is insufficient to deter tax shelter activities. 

The Committee believes that the increased penalties for tax shelter 

promoters are meaningful and will help deter the promotion of tax 

shelters. 

EXPLANATION OF PROVISION

The provision modifies the penalty amount to equal 50 percent 

of the gross income derived by the person from the activity for 

which the penalty is imposed. The new penalty rate applies to any 

activity that involves a statement regarding the tax benefits of participating in a plan or arrangement if the person knows or has reason to know that such statement is false or fraudulent as to any 

material matter. The enhanced penalty does not apply to a gross 

valuation overstatement.

EFFECTIVE DATE

The provision is effective for activities after the date of enactment. 

274

275Sec. 6662(a) and (d)(1)(A). 276Sec. 7408. 

8. Modifications of substantial understatement penalty for nonreportable transactions (sec. 619 of the bill and sec. 6662 of the 

Code) 

PRESENT LAW

An accuracy-related penalty equal to 20 percent applies to any 

substantial understatement of tax. A ‘‘substantial understatement’’

exists if the correct income tax liability for a taxable year exceeds 

that reported by the taxpayer by the greater of 10 percent of the 

correct tax or $5,000 ($10,000 in the case of most corporations).275

REASONS FOR CHANGE

The Committee believes that the present-law definition of substantial understatement allows large corporate taxpayers to avoid 

the accuracy-related penalty on questionable transactions of a significant size. The Committee believes that an understatement of 

more than $10 million is substantial in and of itself, regardless of 

the proportion it represents of the taxpayer’s total tax liability. 

EXPLANATION OF PROVISION

The provision modifies the definition of ‘‘substantial’’ for corporate taxpayers. Under the provision, a corporate taxpayer has a 

substantial understatement if the amount of the understatement 

for the taxable year exceeds the lesser of (1) 10 percent of the tax 

required to be shown on the return for the taxable year (or, if 

greater, $10,000), or (2) $10 million. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after date 

of enactment. 

9. Modification of actions to enjoin certain conduct related to tax 

shelters and reportable transactions (sec. 620 of the bill and 

sec. 7408 of the Code) 

PRESENT LAW

The Code authorizes civil actions to enjoin any person from promoting abusive tax shelters or aiding or abetting the understatement of tax liability.276

REASONS FOR CHANGE

The Committee believes that expanding the authority to obtain 

injunctions against promoters and material advisors that (1) fail to 

file an information return with respect to a reportable transaction 

or (2) fail to maintain, or to timely furnish upon written request 

by the Secretary, a list of investors with respect to reportable 

transactions will discourage tax shelter activity and encourage 

compliance with the tax shelter disclosure requirements. 

275

277Sec. 6707, as amended by other provisions of this bill. 278Sec. 6708, as amended by other provisions of this bill. 279 31 U.S.C. sec. 5314. 280 31 U.S.C. sec. 5321(a)(5). 281 31 U.S.C. sec. 5322. 282 A Report to Congress in Accordance with Sec. 361(b) of the Uniting and Strengthening 

America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 

2001, April 26, 2002. 283Sec. 361(b) of the USA PATRIOT Act of 2001 (Pub. L. No. 107–56). 

EXPLANATION OF PROVISION

The provision expands this rule so that injunctions may also be 

sought with respect to the requirements relating to the reporting 

of reportable transactions 277 and the keeping of lists of investors 

by material advisors.278 Thus, under the provision, an injunction 

may be sought against a material advisor to enjoin the advisor 

from (1) failing to file an information return with respect to a reportable transaction, or (2) failing to maintain, or to timely furnish 

upon written request by the Secretary, a list of investors with respect to each reportable transaction. 

EFFECTIVE DATE

The provision is effective on the day after the date of enactment. 

10. Penalty on failure to report interests in foreign financial accounts (sec. 621 of the bill and sec. 5321 of Title 31, United 

States Code) 

PRESENT LAW

The Secretary must require citizens, residents, or persons doing 

business in the United States to keep records and file reports when 

that person makes a transaction or maintains an account with a 

foreign financial entity.279 In general, individuals must fulfill this 

requirement by answering questions regarding foreign accounts or 

foreign trusts that are contained in Part III of Schedule B of the 

IRS Form 1040. Taxpayers who answer ‘‘yes’’ in response to the 

question regarding foreign accounts must then file Treasury Department Form TD F 90–22.1. This form must be filed with the Department of the Treasury, and not as part of the tax return that 

is filed with the IRS. 

The Secretary may impose a civil penalty on any person who 

willfully violates this reporting requirement. The civil penalty is 

the amount of the transaction or the value of the account, up to a 

maximum of $100,000; the minimum amount of the penalty is 

$25,000.280 In addition, any person who willfully violates this reporting requirement is subject to a criminal penalty. The criminal 

penalty is a fine of not more than $250,000 or imprisonment for not 

more than five years (or both); if the violation is part of a pattern 

of illegal activity, the maximum amount of the fine is increased to 

$500,000 and the maximum length of imprisonment is increased to 

10 years.281

On April 26, 2002, the Secretary submitted to the Congress a report on these reporting requirements.282 This report, which was 

statutorily required,283 studies methods for improving compliance 

with these reporting requirements. It makes several administrative 

recommendations, but no legislative recommendations. A further 

276

284 31 U.S.C. sec. 330. 

report was required to be submitted by the Secretary to the Congress by October 26, 2002. 

REASONS FOR CHANGE

The Committee believes that imposing a new civil penalty for 

failure to report an interest in foreign financial accounts that applies (without regard to willfulness) will increase the reporting of 

foreign financial accounts. 

EXPLANATION OF PROVISION

The provision adds an additional civil penalty that may be imposed on any person who violates this reporting requirement (without regard to willfulness). This new civil penalty is up to $5,000. 

The penalty may be waived if any income from the account was 

properly reported on the income tax return and there was reasonable cause for the failure to report. 

EFFECTIVE DATE

The provision is effective with respect to failures to report occurring on or after the date of enactment.

11. Regulation of individuals practicing before the Department of 

the Treasury (sec. 622 of the bill and sec. 330 of Title 31, 

United States Code) 

PRESENT LAW

The Secretary is authorized to regulate the practice of representatives of persons before the Department of the Treasury.284 The 

Secretary is also authorized to suspend or disbar from practice before the Department a representative who is incompetent, who is 

disreputable, who violates the rules regulating practice before the 

Department, or who (with intent to defraud) willfully and knowingly misleads or threatens the person being represented (or a person who may be represented). The rules promulgated by the Secretary pursuant to this provision are contained in Circular 230. 

REASONS FOR CHANGE

The Committee believes that it is critical that the Secretary have 

the authority to censure tax advisors as well as to impose monetary 

sanctions against tax advisors because of the important role of tax 

advisors in our tax system. Use of these sanctions is expected to 

curb the participation of tax advisors in both tax shelter activity 

and any other activity that is contrary to Circular 230 standards. 

EXPLANATION OF PROVISION

The provision makes two modifications to expand the sanctions 

that the Secretary may impose pursuant to these statutory provisions. First, the provision expressly permits censure as a sanction. 

Second, the provision permits the imposition of a monetary penalty 

as a sanction. If the representative is acting on behalf of an employer or other entity, the Secretary may impose a monetary penalty on the employer or other entity if it knew, or reasonably 

277

285 Helvering v. Horst, 311 U.S. 112 (1940). 286Depending on the facts, the IRS also could determine that a variety of other Code-based 

and common law-based authorities could apply to income stripping transactions, including: (1) 

sections 165, 269, 382, 446(b), 482, 701, or 704 and the regulations thereunder; (2) authorities 

that recharacterize certain assignments or accelerations of future payments as financings; (3) 

business purpose, economic substance, and sham transaction doctrines; (4) the step transaction 

doctrine; and (5) the substance-over-form doctrine. See Notice 2003–55, 2003–34 I.R.B. 395, 

modifying and superseding Notice 95–53, 1995–2 C.B. 334 (accounting for lease strips and other 

stripping transactions). 

should have known, of the conduct. This monetary penalty on the 

employer or other entity may be imposed in addition to any monetary penalty imposed directly on the representative. These monetary penalties are not to exceed the gross income derived (or to be 

derived) from the conduct giving rise to the penalty. These monetary penalties may be in addition to, or in lieu of, any suspension, 

disbarment, or censure of such individual. 

The provision also confirms the present-law authority of the Secretary to impose standards applicable to written advice with respect to an entity, plan, or arrangement that is of a type that the 

Secretary determines as having a potential for tax avoidance or 

evasion. 

EFFECTIVE DATE

The modifications to expand the sanctions that the Secretary 

may impose are effective for actions taken after the date of enactment. 

12. Treatment of stripped interests in bond and preferred stock 

funds, etc. (sec. 631 of the bill and secs. 305 and 1286 of the 

Code) 

PRESENT LAW

Assignment of income in general 

In general, an ‘‘income stripping’’ transaction involves a transaction in which the right to receive future income from income-producing property is separated from the property itself. In such 

transactions, it may be possible to generate artificial losses from 

the disposition of certain property or to defer the recognition of taxable income associated with such property. 

Common law has developed a rule (referred to as the ‘‘assignment of income’’ doctrine) whereby income that is transferred without an accompanying transfer of the underlying property is not respected. A leading judicial decision relating to the assignment of income doctrine involved a case in which a taxpayer made a gift of 

detachable interest coupons before their due date while retaining 

the bearer bond. The U.S. Supreme Court ruled that the donor was 

taxable on the entire amount of interest when paid to the donee on 

the grounds that the transferor had ‘‘assigned’’ to the donee the 

right to receive the income.285

In addition to general common law assignment of income principles, specific statutory rules have been enacted to address certain 

specific types of stripping transactions, such as transactions involving stripped bonds and stripped preferred stock (which are discussed below).286 However, there are no specific statutory rules 

278

287 However, in Estate of Stranahan v. Commissioner, 472 F.2d 867 (6th Cir. 1973), the court 

held that where a taxpayer sold a carved-out interest of stock dividends, with no personal obligation to produce the income, the transaction was treated as a sale of an income interest. 288Sec. 1286. 289Sec. 1286(e). 290Sec. 1286(a). 291Sec. 1286(b). Similar rules apply in the case of any person whose basis in any bond or coupon is determined by reference to the basis in the hands of a person who strips the bond. 

that address stripping transactions with respect to common stock 

or other equity interests (other than preferred stock).287

Stripped bonds 

Special rules are provided with respect to the purchaser and 

‘‘stripper’’ of stripped bonds.288 A ‘‘stripped bond’’ is defined as a 

debt instrument in which there has been a separation in ownership 

between the underlying debt instrument and any interest coupon 

that has not yet become payable.289 In general, upon the disposition of either the stripped bond or the detached interest coupons 

each of the retained portion and the portion that is disposed is 

treated as a new bond that is purchased at a discount and is payable in a fixed amount on a future date. Accordingly, section 1286 

treats both the stripped bond and the detached interest coupons as 

individual bonds that are newly issued with original issue discount 

(‘‘OID’’) on the date of disposition. Consequently, section 1286 effectively subjects the stripped bond and the detached interest coupons 

to the general OID periodic income inclusion rules. 

A taxpayer who purchases a stripped bond or one or more 

stripped coupons is treated as holding a new bond that is issued 

on the purchase date with OID in an amount that is equal to the 

excess of the stated redemption price at maturity (or in the case 

of a coupon, the amount payable on the due date) over the ratable 

share of the purchase price of the stripped bond or coupon, determined on the basis of the respective fair market values of the 

stripped bond and coupons on the purchase date.290 The OID on 

the stripped bond or coupon is includible in gross income under the 

general OID periodic income inclusion rules. 

A taxpayer who strips a bond and disposes of either the stripped 

bond or one or more stripped coupons must allocate his basis, immediately before the disposition, in the bond (with the coupons attached) between the retained and disposed items.291 Special rules 

apply to require that interest or market discount accrued on the 

bond prior to such disposition must be included in the taxpayer’s 

gross income (to the extent that it had not been previously included 

in income) at the time the stripping occurs, and the taxpayer increases his basis in the bond by the amount of such accrued interest or market discount. The adjusted basis (as increased by any accrued interest or market discount) is then allocated between the 

stripped bond and the stripped interest coupons in relation to their 

respective fair market values. Amounts realized from the sale of 

stripped coupons or bonds constitute income to the taxpayer only 

to the extent such amounts exceed the basis allocated to the 

stripped coupons or bond. With respect to retained items (either 

the detached coupons or stripped bond), to the extent that the price 

payable on maturity, or on the due date of the coupons, exceeds the 

portion of the taxpayer’s basis allocable to such retained items, the 

279

292Special rules are provided with respect to stripping transactions involving tax-exempt obligations that treat OID (computed under the stripping rules) in excess of OID computed on the 

basis of the bond’s coupon rate (or higher rate if originally issued at a discount) as income from 

a non-tax-exempt debt instrument (sec. 1286(d)). 293Sec. 305(e)(5). 294Sec. 305(e)(1). 295Sec. 305(e)(3). 

difference is treated as OID that is required to be included under 

the general OID periodic income inclusion rules.292

Stripped preferred stock 

‘‘Stripped preferred stock’’ is defined as preferred stock in which 

there has been a separation in ownership between such stock and 

any dividend on such stock that has not become payable.293 A taxpayer who purchases stripped preferred stock is required to include 

in gross income, as ordinary income, the amounts that would have 

been includible if the stripped preferred stock was a bond issued 

on the purchase date with OID equal to the excess of the redemption price of the stock over the purchase price.294 This treatment 

is extended to any taxpayer whose basis in the stock is determined 

by reference to the basis in the hands of the purchaser. A taxpayer 

who strips and disposes the future dividends is treated as having 

purchased the stripped preferred stock on the date of such disposition for a purchase price equal to the taxpayer’s adjusted basis in 

the stripped preferred stock.295

REASONS FOR CHANGE

The Committee is concerned that taxpayers are entering into tax 

avoidance transactions to generate artificial losses, or defer the recognition of ordinary income and convert such income into capital 

gains, by selling or purchasing stripped interests that are not subject to the present-law rules relating to stripped bonds and preferred stock but that represent interests in bonds or preferred 

stock. Therefore, the Committee believes that it is appropriate to 

provide Treasury with regulatory authority to apply such rules to 

interests that do not constitute bonds or preferred stock but nevertheless derive their economic value and characteristics exclusively 

from underlying bonds or preferred stock. 

EXPLANATION OF PROVISION

The provision authorizes the Treasury Department to promulgate 

regulations that, in appropriate cases, apply rules that are similar 

to the present-law rules for stripped bonds and stripped preferred 

stock to direct or indirect interests in an entity or account substantially all of the assets of which consist of bonds (as defined in section 1286(e)(1)), preferred stock (as defined in section 305(e)(5)(B)), 

or any combination thereof. The provision applies only to cases in 

which the present-law rules for stripped bonds and stripped preferred stock do not already apply to such interests. 

For example, such Treasury regulations could apply to a transaction in which a person effectively strips future dividends from 

shares in a money market mutual fund (and disposes either the 

stripped shares or stripped future dividends) by contributing the 

shares (with the future dividends) to a custodial account through 

which another person purchases rights to either the stripped 

shares or the stripped future dividends. However, it is intended 

280

296 2003–48 I.R.B. 1159. 297 2002–43 I.R.B. 753. 298 2002–9 I.R.B. 572. 

that Treasury regulations issued under this provision would not 

apply to certain transactions involving direct or indirect interests 

in an entity or account substantially all the assets of which consist 

of tax-exempt obligations (as defined in section 1275(a)(3)), such as 

an eligible tax-exempt bond partnership described in Rev. Proc. 

2003–84,296 modifying and superseding Rev. Proc. 2002–68 297 and 

Rev. Proc. 2002–16.298

No inference is intended as to the treatment under the presentlaw rules for stripped bonds and stripped preferred stock, or under 

any other provisions or doctrines of present law, of interests in an 

entity or account substantially all of the assets of which consist of 

bonds, preferred stock, or any combination thereof. The Treasury 

regulations, when issued, would be applied prospectively, except in 

cases to prevent abuse. 

EFFECTIVE DATE

The provision is effective for purchases and dispositions occurring after the date of enactment. 

13. Minimum holding period for foreign tax credit on withholding 

taxes on income other than dividends (sec. 632 of the bill and 

sec. 901 of the Code) 

PRESENT LAW

In general, U.S. persons may credit foreign taxes against U.S. 

tax on foreign-source income. The amount of foreign tax credits 

that may be claimed in a year is subject to a limitation that prevents taxpayers from using foreign tax credits to offset U.S. tax on 

U.S.-source income. Separate limitations are applied to specific categories of income. 

As a consequence of the foreign tax credit limitations of the Code, 

certain taxpayers are unable to utilize their creditable foreign taxes 

to reduce their U.S. tax liability. U.S. taxpayers that are tax-exempt receive no U.S. tax benefit for foreign taxes paid on income 

that they receive. 

Present law denies a U.S. shareholder the foreign tax credits normally available with respect to a dividend from a corporation or a 

regulated investment company (‘‘RIC’’) if the shareholder has not 

held the stock for more than 15 days (within a 30-day testing period) in the case of common stock or more than 45 days (within a 

90-day testing period) in the case of preferred stock (sec. 901(k)). 

The disallowance applies both to foreign tax credits for foreign 

withholding taxes that are paid on the dividend where the dividend-paying stock is held for less than these holding periods, and 

to indirect foreign tax credits for taxes paid by a lower-tier foreign 

corporation or a RIC where any of the required stock in the chain 

of ownership is held for less than these holding periods. Periods 

during which a taxpayer is protected from risk of loss (e.g., by purchasing a put option or entering into a short sale with respect to 

the stock) generally are not counted toward the holding period requirement. In the case of a bona fide contract to sell stock, a special rule applies for purposes of indirect foreign tax credits. The 

281

299Sec. 721. 300Sec. 723. 301Sec. 722. 302Sec. 704(c)(1)(A). 

disallowance does not apply to foreign tax credits with respect to 

certain dividends received by active dealers in securities. If a taxpayer is denied foreign tax credits because the applicable holding 

period is not satisfied, the taxpayer is entitled to a deduction for 

the foreign taxes for which the credit is disallowed. 

REASONS FOR CHANGE

The Committee believes that the present-law holding period requirement for claiming foreign tax credits with respect to dividends 

is too narrow in scope and, in general, should be extended to apply 

to items of income or gain other than dividends, such as interest. 

EXPLANATION OF PROVISION

The provision expands the present-law disallowance of foreign 

tax credits to include credits for gross-basis foreign withholding 

taxes with respect to any item of income or gain from property if 

the taxpayer who receives the income or gain has not held the 

property for more than 15 days (within a 30–day testing period), 

exclusive of periods during which the taxpayer is protected from 

risk of loss. The provision does not apply to foreign tax credits that 

are subject to the present-law disallowance with respect to dividends. The provision also does not apply to certain income or gain 

that is received with respect to property held by active dealers. 

Rules similar to the present-law disallowance for foreign tax credits 

with respect to dividends apply to foreign tax credits that are subject to the provision. In addition, the provision authorizes the 

Treasury Department to issue regulations providing that the provision does not apply in appropriate cases. 

EFFECTIVE DATE

The provision is effective for amounts that are paid or accrued 

more than 30 days after the date of enactment. 

14. Disallowance of certain partnership loss transfers (sec. 633 of 

the bill and secs. 704, 734, and 743 of the Code) 

PRESENT LAW

Contributions of property 

Under present law, if a partner contributes property to a partnership, generally no gain or loss is recognized to the contributing 

partner at the time of contribution.299 The partnership takes the 

property at an adjusted basis equal to the contributing partner’s 

adjusted basis in the property.300 The contributing partner increases its basis in its partnership interest by the adjusted basis 

of the contributed property.301 Any items of partnership income, 

gain, loss and deduction with respect to the contributed property 

are allocated among the partners to take into account any built-in 

gain or loss at the time of the contribution.302 This rule is intended 

to prevent the transfer of built-in gain or loss from the contributing 

partner to the other partners by generally allocating items to the 

282

303 If there is an insufficient amount of an item to allocate to the noncontributing partners, 

Treasury regulations allow for curative or remedial allocations to remedy this insufficiency. 

Treas. Reg. sec. 1.704–3(c) and (d). 304Treas. Reg. 1.704–3(a)(7). 305Sec. 743(a). 306Sec. 743(b). 307Sec. 731(a) and (b). 308Sec. 732(b). 309Sec. 732(a). 310Sec. 734(a). 

noncontributing partners based on the value of their contributions 

and by allocating to the contributing partner the remainder of each 

item.303

If the contributing partner transfers its partnership interest, the 

built-in gain or loss will be allocated to the transferee partner as 

it would have been allocated to the contributing partner.304 If the 

contributing partner’s interest is liquidated, there is no specific 

guidance preventing the allocation of the built-in loss to the remaining partners. Thus, it appears that losses can be ‘‘transferred’’ to other partners where the contributing partner no longer remains 

a partner. 

Transfers of partnership interests 

Under present law, a partnership does not adjust the basis of 

partnership property following the transfer of a partnership interest unless the partnership has made a one-time election under section 754 to make basis adjustments.305 If an election is in effect, 

adjustments are made with respect to the transferee partner to account for the difference between the transferee partner’s proportionate share of the adjusted basis of the partnership property and 

the transferee’s basis in its partnership interest.306 These adjustments are intended to adjust the basis of partnership property to 

approximate the result of a direct purchase of the property by the 

transferee partner. Under these rules, if a partner purchases an interest in a partnership with an existing built-in loss and no election under section 754 is in effect, the transferee partner may be 

allocated a share of the loss when the partnership disposes of the 

property (or depreciates the property). 

Distributions of partnership property 

With certain exceptions, partners may receive distributions of 

partnership property without recognition of gain or loss by either 

the partner or the partnership.307 In the case of a distribution in 

liquidation of a partner’s interest, the basis of the property distributed in the liquidation is equal to the partner’s adjusted basis in 

its partnership interest (reduced by any money distributed in the 

transaction).308 In a distribution other than in liquidation of a 

partner’s interest, the distributee partner’s basis in the distributed 

property is equal to the partnership’s adjusted basis in the property immediately before the distribution, but not to exceed the 

partner’s adjusted basis in the partnership interest (reduced by any 

money distributed in the same transaction).309

Adjustments to the basis of the partnership’s undistributed properties are not required unless the partnership has made the election under section 754 to make basis adjustments.310 If an election 

is in effect under section 754, adjustments are made by a partnership to increase or decrease the remaining partnership assets to reVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00284 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.006 HR548P1
283

311Sec. 734(b). 312 It is intended that a corporation succeeding to attributes of the contributing corporate partner under section 381 shall be treated in the same manner as the contributing partner. 

flect any increase or decrease in the adjusted basis of the distributed properties in the hands of the distributee partner (or gain or 

loss recognized by the distributee partner).311 To the extent the adjusted basis of the distributed properties increases (or loss is recognized) the partnership’s adjusted basis in its properties is decreased by a like amount; likewise, to the extent the adjusted basis 

of the distributed properties decrease (or gain is recognized), the 

partnership’s adjusted basis in its properties is increased by a like 

amount. Under these rules, a partnership with no election in effect 

under section 754 may distribute property with an adjusted basis 

lower than the distributee partner’s proportionate share of the adjusted basis of all partnership property and leave the remaining 

partners with a smaller net built-in gain or a larger net built-in 

loss than before the distribution. 

REASONS FOR CHANGE

The Committee believes that the partnership rules currently 

allow for the inappropriate transfer of losses among partners. This 

has allowed partnerships to be created and used to aid tax-shelter 

transactions. The bill limits the ability to transfer losses among 

partners, while preserving the simplification aspects of the current 

partnership rules for transactions involving smaller amounts. The 

Committee was made aware that certain types of investment partnerships would incur administrative difficulties in making partnership-level basis adjustments in the event of a transfer of a partnership interest, as evidenced by the present practice of a number of 

investment partnerships not to elect partnership basis adjustments 

even when the adjustments would be upward adjustments to the 

basis of partnership property. Accordingly, the bill provides a partner-level loss limitation as an alternative to the partnership basis 

adjustments otherwise required under the bill in the case of transfers of interests in certain investment partnerships that are engaged in investment activities rather than in any trade or business 

activity.

EXPLANATION OF PROVISION

Contributions of property 

Under the provision, a built-in loss may be taken into account 

only by the contributing partner and not by other partners. Except 

as provided in regulations, in determining the amount of items allocated to partners other than the contributing partner, the basis 

of the contributed property is treated as the fair market value at 

the time of contribution. Thus, if the contributing partner’s partnership interest is transferred or liquidated, the partnership’s adjusted basis in the property is based on its fair market value at the 

time of contribution, and the built-in loss is eliminated.312

Transfers of partnership interests 

The provision provides generally that the basis adjustment rules 

under section 743 are mandatory in the case of the transfer of a 

partnership interest with respect to which there is a substantial 

284

313Section 3(a)(1)(A) of the Act provides, ‘‘when used in this title, ‘investment company’ means 

any issuer which is or hold itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities.’’

built-in loss (rather than being elective as under present law). For 

this purpose, a substantial built-in loss exists if the partnership’s 

adjusted basis in its property exceeds by more than $250,000 the 

fair market value of the partnership property. 

Thus, for example, assume that partner A sells his 25-percent partnership interest to B for its fair market value of $1 million. 

Also assume that, immediately after the transfer, the fair market 

value of partnership assets is $4 million and the partnership’s adjusted basis in the partnership assets is $4.3 million. Under the 

bill, section 743(b) applies, so that an adjustment is required to the 

adjusted basis of the partnership assets with respect to B. As a result, B would recognize no gain or loss if the partnership immediately sold all its assets for their fair market value. 

The bill provides that an electing investment partnership is not 

treated as having a substantial built-in loss, and thus is not required to make basis adjustments to partnership property, in the 

case of a transfer of a partnership interest. In lieu of the partnership basis adjustments, a partner-level loss limitation rule applies. 

Under this rule, the transferee partner’s distributive share of losses 

(determined without regard to gains) from the sale or exchange of 

partnership property is not allowed, except to the extent it is established that the partner’s share of such losses exceeds the loss recognized by the transferor partner. In the event of successive transfers, the transferee partner’s distributive share of such losses is not 

allowed, except to the extent that it is established that such losses 

exceed the loss recognized by the transferor (or any prior transferor 

to the extent not fully offset by a prior disallowance under this 

rule). Losses disallowed under this rule do not decrease the transferee partner’s basis in its partnership interest. Thus, on subsequent disposition of its partnership interest, the partner’s gain is 

reduced (or loss increased) because the basis of the partnership interest has not been reduced by such losses. The provision is applied 

without regard to any termination of a partnership under section 

708(b)(1)(B). In the case of a basis reduction to property distributed 

to the transferee partner in a nonliquidating distribution, the 

amount of the transferor’s loss taken into account under this rule 

is reduced by the amount of the basis reduction. 

For this purpose, an electing investment partnership means a 

partnership that satisfies the following requirements: (1) it makes 

an election under the provision that is irrevocable except with the 

consent of the Secretary; (2) it would be an investment company 

under section 3(a)(1)(A) of the Investment Company Act of 1940 313

but for an exemption under paragraph (1) or (7) of section 3(c) of 

that Act; (3) it has never been engaged in a trade or business; (4) 

substantially all of its assets are held for investment; (5) at least 

95 percent of the assets contributed to it consist of money; (6) no 

assets contributed to it had an adjusted basis in excess of fair market value at the time of contribution; (7) all partnership interests 

are issued by the partnership pursuant to a private offering and 

during the 24–month period beginning on the date of the first capital contribution to the partnership; (8) the partnership agreement 

has substantive restrictions on each partner’s ability to cause a reVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00286 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.006 HR548P1
285

314Sec. 721(a). 

demption of the partner’s interest, and (9) the partnership agreement provides for a term that is not in excess of 15 years. 

The provision requires an electing investment partnership to furnish to any transferee partner the information necessary to enable 

the partner to compute the amount of losses disallowed under this 

rule. 

Distributions of partnership property 

The provision provides that a basis adjustment under section 

734(b) is required in the case of a distribution with respect to 

which there is a substantial basis reduction. A substantial basis reduction means a downward adjustment of more than $250,000 that 

would be made to the basis of partnership assets if a section 754 

election were in effect. 

Thus, for example, assume that A and B each contributed $2.5 

million to a newly formed partnership and C contributed $5 million, and that the partnership purchased LMN stock for $3 million 

and XYZ stock for $7 million. Assume that the value of each stock 

declined to $1 million. Assume LMN stock is distributed to C in liquidation of its partnership interest. Under present law, the basis 

of LMN stock in C’s hands is $5 million. Under present law, C 

would recognize a loss of $4 million if the LMN stock were sold for 

$1 million. 

Under the provision, there is a substantial basis adjustment because the $2 million increase in the adjusted basis of LMN stock 

(described in section 734(b)(2)(B)) is greater than $250,000. Thus, 

the partnership is required to decrease the basis of XYZ stock 

(under section 734(b)(2)) by $2 million (the amount by which the 

basis of LMN stock was increased), leaving a basis of $5 million. 

If the XYZ stock were then sold by the partnership for $1 million, 

A and B would each recognize a loss of $2 million.

EFFECTIVE DATE

The provision applies to contributions, distributions and transfers (as the case may be) after the date of enactment. 

In the case of an electing investment partnership in existence on 

June 4, 2004, the requirement that the partnership agreement 

have substantive restrictions on redemptions does not apply, and 

the requirement that the partnership agreement provide for a term 

not exceeding 15 years is modified to permit a term not exceeding 

20 years. 

15. No reduction of basis under section 734 in stock held by partnership in corporate partner (sec. 634 of the bill and sec. 755 

of the Code) 

PRESENT LAW

In general 

Generally, a partner and the partnership do not recognize gain 

or loss on a contribution of property to the partnership.314 Similarly, a partner and the partnership generally do not recognize gain 

286

315Sec. 731(a) and (b). 316Sec. 732(b). 317Sec. 754. 318Sec. 755(a). 319Sec. 755(b).

or loss on the distribution of partnership property.315 This includes 

current distributions and distributions in liquidation of a partner’s 

interest. 

Basis of property distributed in liquidation 

The basis of property distributed in liquidation of a partner’s interest is equal to the partner’s tax basis in its partnership interest 

(reduced by any money distributed in the same transaction).316

Thus, the partnership’s tax basis in the distributed property is adjusted (increased or decreased) to reflect the partner’s tax basis in 

the partnership interest. 

Election to adjust basis of partnership property 

When a partnership distributes partnership property, the basis of 

partnership property generally is not adjusted to reflect the effects 

of the distribution or transfer. However, the partnership is permitted to make an election (referred to as a 754 election) to adjust 

the basis of partnership property in the case of a distribution of 

partnership property.317 The effect of the 754 election is that the 

partnership adjusts the basis of its remaining property to reflect 

any change in basis of the distributed property in the hands of the 

distributee partner resulting from the distribution transaction. 

Such a change could be a basis increase due to gain recognition, 

or a basis decrease due to the partner’s adjusted basis in its partnership interest exceeding the adjusted basis of the property received. If the 754 election is made, it applies to the taxable year 

with respect to which such election was filed and all subsequent 

taxable years. 

In the case of a distribution of partnership property to a partner 

with respect to which the 754 election is in effect, the partnership 

increases the basis of partnership property by (1) any gain recognized by the distributee partner and (2) the excess of the adjusted 

basis of the distributed property to the partnership immediately before its distribution over the basis of the property to the distributee 

partner, and decreases the basis of partnership property by (1) any 

loss recognized by the distributee partner and (2) the excess of the 

basis of the property to the distributee partner over the adjusted 

basis of the distributed property to the partnership immediately before the distribution. 

The allocation of the increase or decrease in basis of partnership 

property is made in a manner that has the effect of reducing the 

difference between the fair market value and the adjusted basis of 

partnership properties.318 In addition, the allocation rules require 

that any increase or decrease in basis be allocated to partnership 

property of a like character to the property distributed. For this 

purpose, the two categories of assets are (1) capital assets and depreciable and real property used in the trade or business held for 

more than one year, and (2) any other property.319

287

320See Joint Committee on Taxation, Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations 

(JCS–3–03), February 2003. 321Sections 860H–860L. 

REASONS FOR CHANGE

The Joint Committee on Taxation staff’s investigative report of 

Enron Corporation320 revealed that certain transactions were being 

undertaken that purported to use the interaction of the partnership 

basis adjustment rules and the rules protecting a corporation from 

recognizing gain on its stock to obtain unintended tax results. 

These transactions generally purported to increase the tax basis of 

depreciable assets and to decrease, by a corresponding amount, the 

tax basis of the stock of a partner. Because the tax rules protect 

a corporation from gain on the sale of its stock (including through 

a partnership), the transactions enable taxpayers to duplicate tax 

deductions at no economic cost. The provision precludes the ability 

to reduce the basis of corporate stock of a partner (or related party) 

in certain transactions. 

EXPLANATION OF PROVISION

The provision provides that in applying the basis allocation rules 

to a distribution in liquidation of a partner’s interest, a partnership 

is precluded from decreasing the basis of corporate stock of a partner or a related person. Any decrease in basis that, absent the provision, would have been allocated to the stock is allocated to other 

partnership assets. If the decrease in basis exceeds the basis of the 

other partnership assets, then gain is recognized by the partnership in the amount of the excess. 

EFFECTIVE DATE

The provision applies to distributions after the date of enactment. 

16. Repeal of special rules for FASITs, etc. (sec. 635 of the bill and 

secs. 860H–860L of the Code) 

PRESENT LAW

Financial asset securitization investment trusts 

In 1996, Congress created a new type of statutory entity called 

a ‘‘financial asset securitization trust’’ (‘‘FASIT’’) that facilitates the 

securitization of debt obligations such as credit card receivables, 

home equity loans, and auto loans.321 A FASIT generally is not taxable. Instead, the FASIT’s taxable income or net loss flows through 

to the owner of the FASIT. The ownership interest of a FASIT generally is required to be held entirely by a single domestic C corporation. In addition, a FASIT generally may hold only qualified 

debt obligations, and certain other specified assets, and is subject 

to certain restrictions on its activities. An entity that qualifies as 

a FASIT can issue one or more classes of instruments that meet 

certain specified requirements and treat those instruments as debt 

for Federal income tax purposes. 

288

322Once an election to be a FASIT is made, the election applies from the date specified in 

the election and all subsequent years until the entity ceases to be a FASIT. If an election to 

be a FASIT is made after the initial year of an entity, all of the assets in the entity at the time 

of the FASIT election are deemed contributed to the FASIT at that time and, accordingly, any 

gain (but not loss) on such assets will be recognized at that time. 

QUALIFICATION AS A FASIT 

To qualify as a FASIT, an entity must: (1) make an election to 

be treated as a FASIT for the year of the election and all subsequent years;322 (2) have assets substantially all of which (including 

assets that the FASIT is treated as owning because they support 

regular interests) are specified types called ‘‘permitted assets;’’ (3) 

have non-ownership interests be certain specified types of debt instruments called ‘‘regular interests’’; (4) have a single ownership interest which is held by an ‘‘eligible holder’’; and (5) not qualify as 

a regulated investment company (‘‘RIC’’). Any entity, including a 

corporation, partnership, or trust may be treated as a FASIT. In 

addition, a segregated pool of assets may qualify as a FASIT. 

An entity ceases qualifying as a FASIT if the entity’s owner 

ceases being an eligible corporation. Loss of FASIT status is treated as if all of the regular interests of the FASIT were retired and 

then reissued without the application of the rule that deems regular interests of a FASIT to be debt. 

Permitted assets 

For an entity or arrangement to qualify as a FASIT, substantially all of its assets must consist of the following ‘‘permitted assets’’: (1) cash and cash equivalents; (2) certain permitted debt instruments; (3) certain foreclosure property; (4) certain instruments 

or contracts that represent a hedge or guarantee of debt held or 

issued by the FASIT; (5) contract rights to acquire permitted debt 

instruments or hedges; and (6) a regular interest in another 

FASIT. Permitted assets may be acquired at any time by a FASIT, 

including any time after its formation. 

‘‘Regular interests’’ of a FASIT 

‘‘Regular interests’’ of a FASIT are treated as debt for Federal income tax purposes, regardless of whether instruments with similar 

terms issued by non-FASITs might be characterized as equity 

under general tax principles. To be treated as a ‘‘regular interest’’, an instrument generally must have fixed terms and must: (1) unconditionally entitle the holder to receive a specified principal 

amount; (2) pay interest that is based on (a) fixed rates, or (b) except as provided by regulations issued by the Secretary, variable 

rates permitted with respect to real estate mortgage investment 

conduit interests under section 860G(a)(1)(B)(i); (3) have a term to 

maturity of no more than 30 years, except as permitted by Treasury regulations; (4) be issued to the public with a premium of not 

more than 25 percent of its stated principal amount; and (5) have 

a yield to maturity determined on the date of issue of less than five 

percentage points above the applicable Federal rate (‘‘AFR’’) for the 

calendar month in which the instrument is issued. Instruments 

that do not satisfy certain of these general requirements nevertheless may be treated as regular interests if they are held by a domestic taxable C corporation that is not a RIC, real estate investment trust (‘‘REIT’’), FASIT, or cooperative. 

289

Transfers to FASITs 

In general, gain (but not loss) is recognized immediately by the 

owner of the FASIT upon the transfer of assets to a FASIT. Where 

property is acquired by a FASIT from someone other than the 

FASIT’s owner (or a person related to the FASIT’s owner), the 

property is treated as being first acquired by the FASIT’s owner for 

the FASIT’s cost in acquiring the asset from the non-owner and 

then transferred by the owner to the FASIT. 

Valuation rules 

In general, except in the case of debt instruments, the value of 

FASIT assets is their fair market value. Similarly, in the case of 

debt instruments that are traded on an established securities market, the market price is used for purposes of determining the 

amount of gain realized upon contribution of such assets to a 

FASIT. However, in the case of debt instruments that are not traded on an established securities market, special valuation rules 

apply for purposes of computing gain on the transfer of such debt 

instruments to a FASIT. Under these rules, the value of such debt 

instruments is the sum of the present values of the reasonably expected cash flows from such obligations discounted over the weighted average life of such assets. The discount rate is 120 percent of 

the AFR, compounded semiannually, or such other rate that the 

Secretary shall prescribe by regulations.

Taxation of a FASIT 

A FASIT generally is not subject to tax. Instead, all of the 

FASIT’s assets and liabilities are treated as assets and liabilities 

of the FASIT’s owner and any income, gain, deduction or loss of the 

FASIT is allocable directly to its owner. Accordingly, income tax 

rules applicable to a FASIT (e.g., related party rules, sec. 871(h), 

sec. 165(g)(2)) are to be applied in the same manner as they apply 

to the FASIT’s owner. The taxable income of a FASIT is calculated 

using an accrual method of accounting. The constant yield method 

and principles that apply for purposes of determining original issue 

discount (‘‘OID’’) accrual on debt obligations whose principal is subject to acceleration apply to all debt obligations held by a FASIT 

to calculate the FASIT’s interest and discount income and premium 

deductions or adjustments. 

Taxation of holders of FASIT regular interests 

In general, a holder of a regular interest is taxed in the same 

manner as a holder of any other debt instrument, except that the 

regular interest holder is required to account for income relating to 

the interest on an accrual method of accounting, regardless of the 

method of accounting otherwise used by the holder. 

Taxation of holders of FASIT ownership interests 

Because all of the assets and liabilities of a FASIT are treated 

as assets and liabilities of the holder of a FASIT ownership interest, the ownership interest holder takes into account all of the 

FASIT’s income, gain, deduction, or loss in computing its taxable 

income or net loss for the taxable year. The character of the income 

to the holder of an ownership interest is the same as its character 

290

323See sections 860A–860G. 

to the FASIT, except tax-exempt interest is included in the income 

of the holder as ordinary income. 

Although the recognition of losses on assets contributed to the 

FASIT is not allowed upon contribution of the assets, such losses 

may be allowed to the FASIT owner upon their disposition by the 

FASIT. Furthermore, the holder of a FASIT ownership interest is 

not permitted to offset taxable income from the FASIT ownership 

interest (including gain or loss from the sale of the ownership interest in the FASIT) with other losses of the holder. In addition, 

any net operating loss carryover of the FASIT owner shall be computed by disregarding any income arising by reason of a disallowed 

loss. Where the holder of a FASIT ownership interest is a member 

of a consolidated group, this rule applies to the consolidated group 

of corporations of which the holder is a member as if the group 

were a single taxpayer. 

Real estate mortgage investment conduits 

In general, a real estate mortgage investment conduit (‘‘REMIC’’) 

is a self-liquidating entity that holds a fixed pool of mortgages and 

issues multiple classes of investor interests. A REMIC is not treated as a separate taxable entity. Rather, the income of the REMIC 

is allocated to, and taken into account by, the holders of the interests in the REMIC under detailed rules.323 In order to qualify as 

a REMIC, substantially all of the assets of the entity must consist 

of qualified mortgages and permitted investments as of the close of 

the third month beginning after the startup day of the entity. A 

‘‘qualified mortgage’’ generally includes any obligation which is 

principally secured by an interest in real property, and which is either transferred to the REMIC on the startup day of the REMIC 

in exchange for regular or residual interests in the REMIC or purchased by the REMIC within three months after the startup day 

pursuant to a fixed-price contract in effect on the startup day. A 

‘‘permitted investment’’ generally includes any intangible property 

that is held for investment and is part of a reasonably required reserve to provide for full payment of certain expenses of the REMIC 

or amounts due on regular interests. 

All of the interests in the REMIC must consist of one or more 

classes of regular interests and a single class of residual interests. 

A ‘‘regular interest’’ is an interest in a REMIC that is issued with 

a fixed term, designated as a regular interest, and unconditionally 

entitles the holder to receive a specified principal amount (or other 

similar amount) with interest payments that are either based on 

a fixed rate (or, to the extent provided in regulations, a variable 

rate) or consist of a specified portion of the interest payments on 

qualified mortgages that does not vary during the period such interest is outstanding. In general, a ‘‘residual interest’’ is any interest in the REMIC other than a regular interest, and which is so 

designated by the REMIC, provided that there is only one class of 

such interest and that all distributions (if any) with respect to such 

interests are pro rata. Holders of residual REMIC interests are 

subject to tax on the portion of the income of the REMIC that is 

not allocated to the regular interest holders. 

291

324See Joint Committee on Taxation, Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations 

(JCS–3–03), February 2003. 325For example, the Committee is aware that FASITs also have been used to facilitate the 

issuance of certain tax-advantaged cross-border hybrid instruments that are treated as indebtedness in the United States but equity in the foreign country of the holder of the instruments. 

Congress did not intend such use of FASITs when it enacted the FASIT rules.

REASONS FOR CHANGE

The Joint Committee on Taxation staff’s investigative report of 

Enron Corporation 324 described two structured tax-motivated 

transactions—Projects Apache and Renegade—that Enron undertook in which the use of a FASIT was a key component in the 

structure of the transactions. The Committee is aware that FASITs 

are not being used widely in the manner envisioned by the Congress and, consequently, the FASIT rules have not served the purpose for which they originally were intended. Moreover, the Joint 

Committee staff’s report and other information indicate that 

FASITs are particularly prone to abuse and likely are being used 

primarily to facilitate tax avoidance transactions.325 Therefore, the 

Committee believes that the potential for abuse that is inherent in 

FASITs far outweighs any beneficial purpose that the FASIT rules 

may serve. Accordingly, the Committee believes that these rules 

should be repealed, with appropriate transition relief for existing 

FASITs and appropriate modifications to the present-law REMIC 

rules to permit the use of REMICs by taxpayers that have relied 

upon FASITs to securitize certain obligations secured by interests 

in real property. 

EXPLANATION OF PROVISION

The provision repeals the special rules for FASITs. The provision 

provides a transition period for existing FASITs, pursuant to which 

the repeal of the FASIT rules generally does not apply to any 

FASIT in existence on the date of enactment to the extent that regular interests issued by the FASIT prior to such date continue to 

remain outstanding in accordance with their original terms. 

For purposes of the REMIC rules, the provision also modifies the 

definitions of REMIC regular interests, qualified mortgages, and 

permitted investments so that certain types of real estate loans and 

loan pools can be transferred to, or purchased by, a REMIC. Specifically, the provision modifies the present-law definition of a 

REMIC ‘‘regular interest’’ to provide that an interest in a REMIC 

does not fail to qualify as a regular interest solely because the specified principal amount of such interest or the amount of interest accrued on such interest could be reduced as a result of the nonoccurrence of one or more contingent payments with respect to one or 

more reverse mortgages loans, as defined below, that are held by 

the REMIC, provided that on the startup day for the REMIC, the 

REMIC sponsor reasonably believes that all principal and interest 

due under the interest will be paid at or prior to the liquidation 

of the REMIC. For this purpose, a reasonable belief concerning ultimate payment of all amounts due under an interest is presumed 

to exist if, as of the startup day, the interest receives an investment grade rating from at least one nationally recognized statistical rating agency. 

292

326Sec. 351. 

In addition, the provision makes three modifications to the 

present-law definition of a ‘‘qualified mortgage.’’ First, the provision 

modifies the definition to include an obligation principally secured 

by real property which represents an increase in the principal 

amount under the original terms of an obligation, provided such increase: (1) is attributable to an advance made to the obligor pursuant to the original terms of the obligation; (2) occurs after the 

REMIC startup day; and (3) is purchased by the REMIC pursuant 

to a fixed price contract in effect on the startup day. Second, the 

provision modifies the definition to generally include reverse mortgage loans and the periodic advances made to obligors on such 

loans. For this purpose, a ‘‘reverse mortgage loan’’ is defined as a 

loan that: (1) is secured by an interest in real property; (2) provides 

for one or more advances of principal to the obligor (each such advance giving rise to a ‘‘balance increase’’), provided such advances 

are principally secured by an interest in the same real property as 

that which secures the loan; (3) may provide for a contingent payment at maturity based upon the value or appreciation in value of 

the real property securing the loan; (4) provides for an amount due 

at maturity that cannot exceed the value, or a specified fraction of 

the value, of the real property securing the loan; (5) provides that 

all payments under the loan are due only upon the maturity of the 

loan; and (6) matures after a fixed term or at the time the obligor 

ceases to use as a personal residence the real property securing the 

loan. Third, the provision modifies the definition to provide that, if 

more than 50 percent of the obligations transferred to, or purchased by, the REMIC are (1) originated by the United States or 

any State (or any political subdivision, agency, or instrumentality 

of the United States or any State) and (2) principally secured by 

an interest in real property, then each obligation transferred to, or 

purchased by, the REMIC shall be treated as secured by an interest in real property. 

In addition, the provision modifies the present-law definition of 

a ‘‘permitted investment’’ to include intangible investment property 

held as part of a reasonably required reserve to provide a source 

of funds for the purchase of obligations described above as part of 

the modified definition of a ‘‘qualified mortgage.’’

EFFECTIVE DATE

Except as provided by the transition period for existing FASITs, 

the provision is effective on January 1, 2005. 

17. Limitation on transfer of built-in losses on REMIC residuals 

(sec. 636 of the bill and sec. 362 of the Code) 

PRESENT LAW

Generally, no gain or loss is recognized when one or more persons transfer property to a corporation in exchange for stock and 

immediately after the exchange such person or persons control the 

corporation.326 The transferor’s basis in the stock of the controlled 

corporation is the same as the basis of the property contributed to 

the controlled corporation, increased by the amount of any gain (or 

dividend) recognized by the transferor on the exchange, and reVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00294 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.007 HR548P1
293

327Sec. 358. 328Sec. 362(a). 329See Joint Committee on Taxation, Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations 

(JCS–3–03), February 2003.

duced by the amount of any money or property received, and by the 

amount of any loss recognized by the transferor.327 The basis of 

property received by a controlled corporation in a tax-free transfer 

to the corporation is the same as the adjusted basis in the hands 

of the transferor, adjusted for gain or loss recognized by the transferor.328

REASONS FOR CHANGE

The Joint Committee on Taxation staff’s investigative report of 

Enron Corporation 329 revealed that Enron was using REMIC residual interests in tax motivated transactions to purportedly duplicate 

a single economic loss and deduct the loss more than once. The 

Committee understands that, under the statutory rules regarding 

the taxation of REMICS, phantom income is allocated to REMIC 

residual interest holders. Because of the associated basis increases 

in the REMIC residual interests, the phantom income allocation inevitably creates built-in losses to the holders of the REMIC residual interests, thus making such interests a natural component of 

transactions designed to duplicate a single economic loss. Congress 

did not intend REMIC residual interests to be used in this manner. 

Therefore, the Committee believes that a corporation’s basis in 

REMIC residual interests acquired in a tax-free transfer should be 

limited to the fair market value of such interests. 

EXPLANATION OF PROVISION

The provision provides that if a residual interest (as defined in 

section 860G(a)(2)) in a real estate mortgage investment conduit 

(‘‘REMIC’’) is contributed to a corporation and the transferee corporation’s adjusted basis in the REMIC residual interest would 

(but for the provision) exceed the fair market value of the REMIC 

residual interest immediately after the contribution, the transferee 

corporation’s adjusted basis in the REMIC residual interest is limited to the fair market value of the REMIC residual interest immediately after the contribution, regardless of whether the fair market value of the REMIC residual interest is less than, equal to, or 

greater than zero (i.e., the provision may result in the transferee 

corporation having a negative adjusted basis in the REMIC residual interest). 

EFFECTIVE DATE

The provision applies to transactions after the date of enactment. 

294

330Secs. 951–964. 331Sec. 951(a)(1)(B). 332Sec. 956(a). 333Secs. 956 and 959. 334Secs. 951(a)(1)(B) and 959. 335Sec. 956(c)(1). 

18. Clarification of banking business for purposes of determining 

investment of earnings in U.S. property (sec. 637 of the bill 

and sec. 956 of the Code) 

PRESENT LAW

In general, the subpart F rules 330 require the U.S. 10-percent 

shareholders of a controlled foreign corporation to include in income currently their pro rata shares of certain income of the controlled foreign corporation (referred to as ‘‘subpart F income’’), 

whether or not such earnings are distributed currently to the 

shareholders. In addition, the U.S. 10-percent shareholders of a 

controlled foreign corporation are subject to U.S. tax currently on 

their pro rata shares of the controlled foreign corporation’s earnings to the extent invested by the controlled foreign corporation in 

certain U.S. property.331

A shareholder’s current income inclusion with respect to a controlled foreign corporation’s investment in U.S. property for a taxable year is based on the controlled foreign corporation’s average 

investment in U.S. property for such year. For this purpose, the 

U.S. property held (directly or indirectly) by the controlled foreign 

corporation must be measured as of the close of each quarter in the 

taxable year.332 The amount taken into account with respect to any 

property is the property’s adjusted basis as determined for purposes of reporting the controlled foreign corporation’s earnings and 

profits, reduced by any liability to which the property is subject. 

The amount determined for current inclusion is the shareholder’s 

pro rata share of an amount equal to the lesser of: (1) the controlled foreign corporation’s average investment in U.S. property as 

of the end of each quarter of such taxable year, to the extent that 

such investment exceeds the foreign corporation’s earnings and 

profits that were previously taxed on that basis; or (2) the controlled foreign corporation’s current or accumulated earnings and 

profits (but not including a deficit), reduced by distributions during 

the year and by earnings that have been taxed previously as earnings invested in U.S. property.333 An income inclusion is required 

only to the extent that the amount so calculated exceeds the 

amount of the controlled foreign corporation’s earnings that have 

been previously taxed as subpart F income.334

For purposes of section 956, U.S. property generally is defined to 

include tangible property located in the United States, stock of a 

U.S. corporation, an obligation of a U.S. person, and certain intangible assets including a patent or copyright, an invention, model or 

design, a secret formula or process or similar property right which 

is acquired or developed by the controlled foreign corporation for 

use in the United States.335

Specified exceptions from the definition of U.S. property are provided for: (1) obligations of the United States, money, or deposits 

with persons carrying on the banking business; (2) certain export 

property; (3) certain trade or business obligations; (4) aircraft, railVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00296 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.007 HR548P1
295

336Sec. 956(c)(2). 337 286 F.3d 324 (6th Cir. 2002), rev’g 113 T.C. 169 (1999).

road rolling stock, vessels, motor vehicles or containers used in 

transportation in foreign commerce and used predominantly outside of the United States; (5) certain insurance company reserves 

and unearned premiums related to insurance of foreign risks; (6) 

stock or debt of certain unrelated U.S. corporations; (7) moveable 

property (other than a vessel or aircraft) used for the purpose of 

exploring, developing, or certain other activities in connection with 

the ocean waters of the U.S. Continental Shelf; (8) an amount of 

assets equal to the controlled foreign corporation’s accumulated 

earnings and profits attributable to income effectively connected 

with a U.S. trade or business; (9) property (to the extent provided 

in regulations) held by a foreign sales corporation and related to 

its export activities; (10) certain deposits or receipts of collateral or 

margin by a securities or commodities dealer, if such deposit is 

made or received on commercial terms in the ordinary course of the 

dealer’s business as a securities or commodities dealer; and (11) 

certain repurchase and reverse repurchase agreement transactions 

entered into by or with a dealer in securities or commodities in the 

ordinary course of its business as a securities or commodities dealer.336

With regard to the exception for deposits with persons carrying 

on the banking business, the U.S. Court of Appeals for the Sixth 

Circuit in The Limited, Inc. v. Commissioner 337 concluded that a 

U.S. subsidiary of a U.S. shareholder was ‘‘carrying on the banking 

business’’ even though its operations were limited to the administration of the private label credit card program of the U.S. shareholder. Therefore, the court held that a controlled foreign corporation of the U.S. shareholder could make deposits with the subsidiary (e.g., through the purchase of certificates of deposit) under 

this exception, and avoid taxation of the deposits under section 956 

as an investment in U.S. property. 

REASONS FOR CHANGE

The Committee believes that further guidance is necessary under 

the U.S. property investment provisions of subpart F with regard 

to the treatment of deposits with persons carrying on the banking 

business. In particular, the Committee believes that the transaction at issue in The Limited case was not contemplated or intended by Congress when it excepted from the definition of U.S. 

property deposits with persons carrying on the banking business. 

Therefore, the Committee believes that it is appropriate and necessary to clarify the scope of this exception so that it applies only 

to deposits with genuine banking businesses and their affiliates. 

EXPLANATION OF PROVISION

The provision provides that the exception from the definition of 

U.S. property under section 956 for deposits with persons carrying 

on the banking business is limited to deposits with persons at least 

80 percent of the gross income of which is derived in the active conduct of a banking business from unrelated persons. For purposes 

of applying this provision, the deposit recipient and all persons reVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00297 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.007 HR548P1
296

338 In 1986, the ceiling was set at $1.2 million and the provision was expanded to apply to 

both stock and mutual property and casualty insurance companies (sec. 1024 of Pub. L. No. 99–

514, the ‘‘Tax Reform Act of 1986’’). 

lated to the deposit recipient are treated as one person in applying 

the 80-percent test. 

No inference is intended as to the meaning of the phrase ‘‘carrying on the banking business’’ under present law. 

EFFECTIVE DATE

This provision is effective on the date of enactment. 

19. Alternative tax for certain small insurance companies (sec. 638 

of the bill and sec. 831 of the Code) 

PRESENT LAW

A property and casualty insurance company generally is subject 

to tax on its taxable income (sec. 831(a)). The taxable income of a 

property and casualty insurance company is determined as the sum 

of its underwriting income and investment income (as well as gains 

and other income items), reduced by allowable deductions (sec. 

832). 

A property and casualty insurance company may elect to be 

taxed only on taxable investment income if its net written premiums or direct written premiums (whichever is greater) do not exceed $1.2 million (sec. 831(b)). For purposes of determining the 

amount of a company’s net written premiums or direct written premiums under this rule, premiums received by all members of a controlled group of corporations (as defined in section 831(b)) of which 

the company is a part are taken into account (including gross receipts of foreign and tax-exempt corporations). 

REASONS FOR CHANGE

The Committee believes that the $1.2 million ceiling on net written premiums or direct written premiums of property and casualty 

insurance companies electing to be taxed only on taxable investment income should be increased to reflect inflation in recent 

years,338 and should be indexed to take account of future inflation. 

EXPLANATION OF PROVISION

Under the provision, the $1.2 million ceiling on net written premiums or direct written premiums for purposes of the election to 

be taxed only on taxable investment income is increased to $1.89 

million, and is indexed for taxable years beginning in a calendar 

year after 2004. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2003. 

297

339Sec. 163(a). 340The definitions of these transactions are the same as those previously described in connection with the provision elsewhere in this bill to modify the accuracy-related penalty for listed 

and certain reportable transactions.

20. Denial of deduction for interest on underpayments attributable 

to nondisclosed reportable transactions (sec. 639 of the bill and 

sec. 163 of the Code) 

PRESENT LAW

In general, corporations may deduct interest paid or accrued 

within a taxable year on indebtedness.339 Interest on indebtedness 

to the Federal government attributable to an underpayment of tax 

generally may be deducted pursuant to this provision. 

REASONS FOR CHANGE

The Committee believes that it is inappropriate for corporations 

to deduct interest paid to the Government with respect to certain 

tax shelter transactions. 

EXPLANATION OF PROVISION

The provision disallows any deduction for interest paid or accrued within a taxable year on any portion of an underpayment of 

tax that is attributable to an understatement arising from an undisclosed listed transaction or from an undisclosed reportable 

avoidance transaction (other than a listed transaction).340

EFFECTIVE DATE

The provision is effective for underpayments attributable to 

transactions entered into in taxable years beginning after the date 

of enactment. 

21. Clarification of rules for payment of estimated tax for certain 

deemed asset sales (sec. 640 of the bill and sec. 338 of the 

Code) 

PRESENT LAW

In certain circumstances, taxpayers can make an election under 

section 338(h)(10) to treat a qualifying purchase of 80 percent of 

the stock of a target corporation by a corporation from a corporation that is a member of an affiliated group (or a qualifying purchase of 80 percent of the stock of an S corporation by a corporation from S corporation shareholders) as a sale of the assets of the 

target corporation, rather than as a stock sale. The election must 

be made jointly by the buyer and seller of the stock and is due by 

the 15th day of the ninth month beginning after the month in 

which the acquisition date occurs. An agreement for the purchase 

and sale of stock often may contain an agreement of the parties to 

make a section 338(h)(10) election. 

Section 338(a) also permits a unilateral election by a buyer corporation to treat a qualified stock purchase of a corporation as a 

deemed asset acquisition, whether or not the seller of the stock is 

a corporation (or an S corporation is the target). In such a case, the 

seller or sellers recognize gain or loss on the stock sale (including 

298

341Sec. 121. 

any estimated taxes with respect to the stock sale), and the target 

corporation recognizes gain or loss on the deemed asset sale. 

Section 338(h)(13) provides that, for purposes of section 6655 (relating to additions to tax for failure by a corporation to pay estimated income tax), tax attributable to a deemed asset sale under 

section 338(a)(1) shall not be taken into account. 

REASONS FOR CHANGE

The Committee is concerned that some taxpayers may inappropriately be taking the position that estimated tax and the penalty 

(computed in the amount of an interest charge) under section 6655 

applies neither to the stock sale nor to the asset sale in the case 

of a section 338(h)(10) election. The Committee believes that estimated tax should not be avoided merely because an election may 

be made under section 338(h)(10). Furthermore, the Committee understands that parties typically negotiate a sale with an understanding as to whether or not an election under section 338(h)(10) 

will be made. In the event there is a contingency in this regard, 

the parties may provide for adjustments to the price to reflect the 

effect of the election. 

EXPLANATION OF PROVISION

The provision clarifies section 338(h)(13) to provide that the exception for estimated tax purposes with respect to tax attributable 

to a deemed asset sale does not apply with respect to a qualified 

stock purchase for which an election is made under section 

338(h)(10). 

Under the provision, if a qualified stock purchase transaction eligible for the election under section 338(h)(10) occurs, estimated tax 

would be determined based on the stock sale unless and until there 

is an agreement of the parties to make a section 338(h)(10) election. 

If at the time of the sale there is an agreement of the parties to 

make a section 338(h)(10) election, then estimated tax is computed 

based on an asset sale, computed from the date of the sale. 

If the agreement to make a section 338(h)(10) election is concluded after the stock sale, such that the original computation was 

based on the stock sale, estimated tax is recomputed based on the 

asset sale election. 

No inference is intended as to present law. 

EFFECTIVE DATE

The provision is effective for qualified stock purchase transactions that occur after the date of enactment. 

22. Exclusion of like-kind exchange property from nonrecognition 

treatment on the sale or exchange of a principal residence (sec. 

641 of the bill and sec. 121 of the Code) 

PRESENT LAW

Under present law, a taxpayer may exclude up to $250,000 

($500,000 if married filing a joint return) of gain realized on the 

sale or exchange of a principal residence.341 To be eligible for the 

299

exclusion, the taxpayer must have owned and used the residence 

as a principal residence for at least two of the five years prior to 

the sale or exchange. A taxpayer who fails to meet these requirements by reason of a change of place of employment, health, or, to 

the extent provided under regulations, unforeseen circumstances is 

able to exclude an amount equal to the fraction of the $250,000 

($500,000 if married filing a joint return) that is equal to the fraction of the two years that the ownership and use requirements are 

met. There are no special rules relating to the sale or exchange of 

a principal residence that was acquired in a like-kind exchange 

within the prior five years. 

REASONS FOR CHANGE

The Committee believes that the present-law exclusion of gain allowable upon the sale or exchange of principal residences serves an 

important role in encouraging home ownership. The Committee 

does not believe that this exclusion is appropriate for properties 

that were recently acquired in like-kind exchanges. Under the likekind exchange rules, a taxpayer that exchanges property that was 

held for productive use or investment for like-kind property may 

acquire the replacement property on a tax-free basis. Because the 

replacement property generally has a low carry-over tax basis, the 

taxpayer will have taxable gain upon the sale or exchange of the 

replacement property. However, when the taxpayer converts the replacement property into the taxpayer’s principal residence, the taxpayer may shelter some or all of this gain from income taxation. 

The Committee believes that this provision balances the concerns 

associated with these provisions to reduce this tax shelter concern 

without unduly limiting the exclusion on sales or exchanges of 

principal residences. 

EXPLANATION OF PROVISION

The bill provides that the exclusion for gain on the sale or exchange of a principal residence does not apply if the principal residence was acquired in a like-kind exchange in which any gain was 

not recognized within the prior five years. 

EFFECTIVE DATE

The provision is effective for sales or exchanges of principal residences after the date of enactment. 

23. Prevention of mismatching of interest and original issue discount deductions and income inclusions in transactions with 

related foreign persons (sec. 642 of the bill and secs. 163 and 

267 of the Code) 

PRESENT LAW

Income earned by a foreign corporation from its foreign operations generally is subject to U.S. tax only when such income is 

distributed to any U.S. person that holds stock in such corporation. 

Accordingly, a U.S. person that conducts foreign operations through 

a foreign corporation generally is subject to U.S. tax on the income 

from such operations when the income is repatriated to the United 

States through a dividend distribution to the U.S. person. The income is reported on the U.S. person’s tax return for the year the 

300

342Sec. 163(e)(1). 343Sec. 163(e)(3). 344Treas. Reg. sec. 1.163–12(b)(3). In the case of a PFIC, the regulations further require that 

the person owing the amount at issue have in effect a qualified electing fund election pursuant 

to section 1295 with respect to the PFIC. 345Sec. 267(a)(2). 346Treas. Reg. sec. 1.267(a)–3(b)(1), –3(c). 347Treas. Reg. sec. 1.267(a)–3(c)(4). 

distribution is received, and the United States imposes tax on such 

income at that time. However, certain anti-deferral regimes may 

cause the U.S. person to be taxed on a current basis in the United 

States with respect to certain categories of passive or highly mobile 

income earned by the foreign corporations in which the U.S. person 

holds stock. The main anti-deferral regimes are the controlled foreign corporation rules of subpart F (secs. 951–964), the passive foreign investment company rules (secs. 1291–1298), and the foreign 

personal holding company rules (secs. 551–558). 

As a general rule, there is allowed as a deduction all interest 

paid or accrued within the taxable year with respect to indebtedness, including the aggregate daily portions of original issue discount (‘‘OID’’) of the issuer for the days during such taxable 

year.342 However, if a debt instrument is held by a related foreign 

person, any portion of such OID is not allowable as a deduction to 

the payor of such instrument until paid (‘‘related-foreign-person 

rule’’). This related-foreign-person rule does not apply to the extent 

that the OID is effectively connected with the conduct by such foreign related person of a trade or business within the United States 

(unless such OID is exempt from taxation or is subject to a reduced 

rate of taxation under a treaty obligation).343 Treasury regulations 

further modify the related-foreign-person rule by providing that in 

the case of a debt owed to a foreign personal holding company 

(‘‘FPHC’’), controlled foreign corporation (‘‘CFC’’) or passive foreign 

investment company (‘‘PFIC’’), a deduction is allowed for OID as of 

the day on which the amount is includible in the income of the 

FPHC, CFC or PFIC, respectively.344

In the case of unpaid stated interest and expenses of related persons, where, by reason of a payee’s method of accounting, an 

amount is not includible in the payee’s gross income until it is paid 

but the unpaid amounts are deductible currently by the payor, the 

amount generally is allowable as a deduction when such amount is 

includible in the gross income of the payee.345 With respect to stated interest and other expenses owed to related foreign corporations, 

Treasury regulations provide a general rule that requires a taxpayer to use the cash method of accounting with respect to the deduction of amounts owed to such related foreign persons (with an 

exception for income of a related foreign person that is effectively 

connected with the conduct of a U.S. trade or business and that is 

not exempt from taxation or subject to a reduced rate of taxation 

under a treaty obligation).346 As in the case of OID, the Treasury 

regulations additionally provide that in the case of stated interest 

owed to a FPHC, CFC, or PFIC, a deduction is allowed as of the 

day on which the amount is includible in the income of the FPHC, 

CFC or PFIC.347

301

348Section 313 of the bill repeals the foreign personal holding company regime, effective for 

taxable years of foreign corporations beginning after December 31, 2004, and taxable years of 

U.S. shareholders with or within which such taxable years of foreign corporations end. 

REASONS FOR CHANGE

The special rules in the Treasury regulations for FPHCs, CFCs 

and PFICs are exceptions to the general rule that OID and unpaid 

interest owed to a related foreign person are deductible when paid 

(i.e., under the cash method). These special rules were deemed appropriate in the case of FPHCs, CFCs and PFICs because it was 

thought that there would be little material distortion in matching 

of income and deductions with respect to amounts owed to a related foreign corporation that is required to determine its taxable 

income and earnings and profits for U.S. tax purposes pursuant to 

the FPHC, subpart F or PFIC provisions. The Committee believes 

that this premise fails to take into account the situation where 

amounts owed to the related foreign corporation are included in the 

income of the related foreign corporation but are not currently included in the income of the related foreign corporation’s U.S. shareholder. Consequently, under the Treasury regulations, both the 

U.S. payors and U.S.-owned foreign payors may be able to accrue 

deductions for amounts owed to related FPHCs, CFCs or PFICs 

without the U.S. owners of such related entities taking into account 

for U.S. tax purposes a corresponding amount of income. These deductions can be used to reduce U.S. income or, in the case of a 

U.S.-owned foreign payor, to reduce earnings and profits which 

could reduce a CFC’s income that would be currently taxable to its 

U.S. shareholders under subpart F.

EXPLANATION OF PROVISION

The provision provides that deductions for amounts accrued but 

unpaid (whether by U.S. or foreign persons) to related FPHCs, 

CFCs, or PFICs are allowable only to the extent that the amounts 

accrued by the payor are, for U.S. tax purposes, currently includible in the income of the direct or indirect U.S. owners of the related foreign corporation under the relevant inclusion rules.348 Deductions that have accrued but are not allowable under this provision are allowed when the amounts are paid. 

For purposes of determining how much of the amount accrued, 

if any, is currently includible in the income of a U.S. person under 

the relevant inclusion rules, properly allowable deductions of the 

related foreign corporation and qualified deficits under section 

952(c)(1)(B) are taken into account. For this purpose, properly allowable deductions of the related foreign corporation are those expenses, losses, or other deductible amounts of the foreign corporation that are properly allocable, under the principles of section 

954(b)(5), to the relevant income of the foreign corporation. 

For example, assume the following facts. A U.S. parent corporation accrues an expense item of 100 to its 60-percent owned CFC. 

The item constitutes foreign base company income in the hands of 

the CFC. An unrelated foreign corporation owns the remaining 40 

percent interest in the CFC. The item is the only potential subpart 

F income of the CFC and has not been paid by the end of the taxable year of the parent. Expenses of 60 are properly allocated or 

apportioned to the 100 of foreign base company income under the 

302

principles of section 954(b)(5). In addition, other income and expense items of the CFC net to a loss of 30, which, when taken together with the 40 (100¥60) of net foreign base company income, 

results in current net income for the CFC of 10. Assuming further 

that the CFC has no current earnings and profits adjustments, the 

CFC’s subpart F income in this case is limited to 10, six of which 

is includible in the gross income of the U.S. parent as its pro rata 

share of subpart F income. Under these facts, the U.S. parent is 

allowed a current deduction of 42 ((10 + 60) × 60%) under this provision. If the other income and expense items of the CFC net to a 

loss of 50 instead of 30, the U.S. parent would instead be allowed 

a current deduction of 30 ((40¥50 + 60) × 60%). 

The provision grants the Secretary regulatory authority to provide exceptions to these rules, including an exception for amounts 

accrued where payment of the amount accrued occurs within a 

short period after accrual, and the transaction giving rise to the 

payment is entered into by the payor in the ordinary course of a 

business in which the payor is predominantly engaged. 

EFFECTIVE DATE

The provision is effective for payments accrued on or after date 

of enactment. 

24. Exclusion from gross income for interest on overpayments of income tax by individuals (sec. 643 of the bill and new sec. 139A 

of the Code) 

PRESENT LAW

Overpayment interest 

Interest is included in the list of items that are required to be 

included in gross income (sec. 61(a)(4)). Interest on overpayments 

of Federal income tax is required to be included in taxable income 

in the same manner as any other interest that is received by the 

taxpayer. 

Cash basis taxpayers are required to report overpayment interest 

as income in the period the interest is received. Accrual basis taxpayers are required to report overpayment interest as income when 

all events fixing the right to the receipt of the overpayment interest 

have occurred and the amount can be estimated with reasonable 

accuracy. Generally, this occurs on the date the appropriate IRS official signs the pertinent schedule of overassessments. 

Underpayment interest 

A corporate taxpayer is allowed to currently take into account interest paid on underpayments of Federal income tax as an ordinary 

and necessary business expense. Typically, this results in a current 

deduction. However, the deduction may be deferred if the interest 

is required to be capitalized or may be disallowed if and to the extent it is determined to be a cost of earning tax exempt income 

under section 265. 

Section 163(h) of the Code prohibits the deduction of personal interest by taxpayers other than corporations. Noncorporate taxpayers, including individuals, generally are not allowed to deduct 

interest on the underpayment of Federal income taxes. 

303

Temporary regulations provide that personal interest includes interest paid on underpayments of individual Federal, State or local 

income taxes, regardless of the source of the income generating the 

tax liability. This is consistent with the statement in the General 

Explanation of the Tax Reform Act of 1986 that ‘‘(p)ersonal interest 

also includes interest on underpayments of individual Federal, 

State, or local income taxes notwithstanding that all or a portion 

of the income may have arisen in a trade or business, because such 

taxes are not considered derived from conduct of a trade or business.’’ The validity of the temporary regulation has been upheld in 

those Circuits that have considered the issue, including the Fourth, 

Fifth, Sixth, Seventh, Eighth, and Ninth Circuits. 

Personal interest also includes interest that is paid by a trust, 

S corporation, or other pass-through entity on underpayments of 

State or local income taxes. Personal interest does not include interest that is paid with respect to sales, excise or similar taxes that 

are incurred in connection with a trade or business or an investment activity. 

REASONS FOR CHANGE

The Committee believes that there should be consistency in the 

treatment of interest paid by the Federal government to an individual taxpayer and interest paid by an individual taxpayer to the 

Federal government. Allowing individual taxpayers to exclude interest on overpayments will treat all individual taxpayers consistently, whether or not they itemize deductions. 

EXPLANATION OF PROVISION

The bill excludes overpayment interest that is paid to individual 

taxpayers on overpayments of Federal income tax from gross income. Interest excluded under the provision is not considered disqualified income that could limit the earned income credit. Interest 

excluded under the provision also is not considered in determining 

what portion of a taxpayer’s social security or tier 1 railroad retirement benefits are subject to tax (sec. 86), whether a taxpayer has 

sufficient taxable income to be required to file a return (sec. 

6012(d)), or for any other computation in which interest exempt 

from tax is otherwise required to be added to adjusted gross income. 

The exclusion from income of overpayment interest does not 

apply if the Secretary determines that the taxpayer’s principal purpose for overpaying his or her tax is to take advantage of the exclusion. 

For example, a taxpayer prepares his return without taking into 

account significant itemized deductions of which he is, or should be, 

aware. Before the expiration of the statute of limitations, the taxpayer files an amended return claiming these itemized deductions 

and requesting a refund with interest. Unless the taxpayer can establish a principal purpose for originally overpaying the tax other 

than collecting excludible interest, the Secretary may determine 

that the principal purpose of waiting to claim the deductions on an 

amended return was to earn interest that would be excluded from 

income. In that case, the interest on the overpayment could not be 

excluded from income. 

304

It is expected that the Secretary will indicate whether the interest is eligible to be excluded from income on the Form 1099 it provides that taxpayer for the taxable year in which the underpayment interest is paid. 

EFFECTIVE DATE

The provision is effective for interest received in calendar years 

beginning after the date of enactment. 

25. Deposits made to suspend the running of interest on potential 

underpayments (sec. 644 of the bill and new sec. 6603 of the 

Code) 

PRESENT LAW

Generally, interest on underpayments and overpayments continues to accrue during the period that a taxpayer and the IRS dispute a liability. The accrual of interest on an underpayment is suspended if the IRS fails to notify an individual taxpayer in a timely 

manner, but interest will begin to accrue once the taxpayer is properly notified. No similar suspension is available for other taxpayers. 

A taxpayer that wants to limit its exposure to underpayment interest has a limited number of options. The taxpayer can continue 

to dispute the amount owed and risk paying a significant amount 

of interest. If the taxpayer continues to dispute the amount and ultimately loses, the taxpayer will be required to pay interest on the 

underpayment from the original due date of the return until the 

date of payment. 

In order to avoid the accrual of underpayment interest, the taxpayer may choose to pay the disputed amount and immediately file 

a claim for refund. Payment of the disputed amount will prevent 

further interest from accruing if the taxpayer loses (since there is 

no longer any underpayment) and the taxpayer will earn interest 

on the resultant overpayment if the taxpayer wins. However, the 

taxpayer will generally lose access to the Tax Court if it follows 

this alternative. Amounts paid generally cannot be recovered by 

the taxpayer on demand, but must await final determination of the 

taxpayer’s liability. Even if an overpayment is ultimately determined, overpaid amounts may not be refunded if they are eligible 

to be offset against other liabilities of the taxpayer. 

The taxpayer may also make a deposit in the nature of a cash 

bond. The procedures for making a deposit in the nature of a cash 

bond are provided in Rev. Proc. 84–58. 

A deposit in the nature of a cash bond will stop the running of 

interest on an amount of underpayment equal to the deposit, but 

the deposit does not itself earn interest. A deposit in the nature of 

a cash bond is not a payment of tax and is not subject to a claim 

for credit or refund. A deposit in the nature of a cash bond may 

be made for all or part of the disputed liability and generally may 

be recovered by the taxpayer prior to a final determination. However, a deposit in the nature of a cash bond need not be refunded 

to the extent the Secretary determines that the assessment or collection of the tax determined would be in jeopardy, or that the deposit should be applied against another liability of the taxpayer in 

the same manner as an overpayment of tax. If the taxpayer recovVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00306 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.007 HR548P1
305

ers the deposit prior to final determination and a deficiency is later 

determined, the taxpayer will not receive credit for the period in 

which the funds were held as a deposit. The taxable year to which 

the deposit in the nature of a cash bond relates must be designated, but the taxpayer may request that the deposit be applied 

to a different year under certain circumstances. 

REASONS FOR CHANGE

The Committee believes that taxpayers should be able to limit 

their underpayment interest exposure in a tax dispute. An improved deposit system will help taxpayers better manage their exposure to underpayment interest without requiring them to surrender access to their funds or requiring them to make a potentially indefinite-term investment in a non-interest bearing account. 

The Committee believes that an improved deposit system that allows for the payment of interest on amounts that are not ultimately needed to offset tax liability when the taxpayer’s position 

is upheld, as well as allowing for the offset of tax liability when the 

taxpayer’s position fails, will provide an effective way for taxpayers 

to manage their exposure to underpayment interest. However, the 

Committee believes that such an improved deposit system should 

be reserved for the issues that are known to both parties, either 

through IRS examination or voluntary taxpayer disclosure.

EXPLANATION OF PROVISION

In general 

The provision allows a taxpayer to deposit cash with the IRS 

that may subsequently be used to pay an underpayment of income, 

gift, estate, generation-skipping, or certain excise taxes. Interest 

will not be charged on the portion of the underpayment that is deposited for the period that the amount is on deposit. Generally, deposited amounts that have not been used to pay a tax may be withdrawn at any time if the taxpayer so requests in writing. The withdrawn amounts will earn interest at the applicable Federal rate to 

the extent they are attributable to a disputable tax. 

The Secretary may issue rules relating to the making, use, and 

return of the deposits. 

Use of a deposit to offset underpayments of tax 

Any amount on deposit may be used to pay an underpayment of 

tax that is ultimately assessed. If an underpayment is paid in this 

manner, the taxpayer will not be charged underpayment interest 

on the portion of the underpayment that is so paid for the period 

the funds were on deposit. 

For example, assume a calendar year individual taxpayer deposits $20,000 on May 15, 2005, with respect to a disputable item on 

its 2004 income tax return. On April 15, 2007, an examination of 

the taxpayer’s year 2004 income tax return is completed, and the 

taxpayer and the IRS agree that the taxable year 2004 taxes were 

underpaid by $25,000. The $20,000 on deposit is used to pay 

$20,000 of the underpayment, and the taxpayer also pays the remaining $5,000. In this case, the taxpayer will owe underpayment 

interest from April 15, 2005 (the original due date of the return) 

to the date of payment (April 15, 2007) only with respect to the 

306

$5,000 of the underpayment that is not paid by the deposit. The 

taxpayer will owe underpayment interest on the remaining $20,000 

of the underpayment only from April 15, 2005, to May 15, 2005, the 

date the $20,000 was deposited. 

Withdrawal of amounts 

A taxpayer may request the withdrawal of any amount of deposit 

at any time. The Secretary must comply with the withdrawal request unless the amount has already been used to pay tax or the 

Secretary properly determines that collection of tax is in jeopardy. 

Interest will be paid on deposited amounts that are withdrawn at 

a rate equal to the short-term applicable Federal rate for the period 

from the date of deposit to a date not more than 30 days preceding 

the date of the check paying the withdrawal. Interest is not payable to the extent the deposit was not attributable to a disputable 

tax. 

For example, assume a calendar year individual taxpayer receives a 30-day letter showing a deficiency of $20,000 for taxable 

year 2004 and deposits $20,000 on May 15, 2006. On April 15, 

2007, an administrative appeal is completed, and the taxpayer and 

the IRS agree that the 2004 taxes were underpaid by $15,000. 

$15,000 of the deposit is used to pay the underpayment. In this 

case, the taxpayer will owe underpayment interest from April 15, 

2005 (the original due date of the return) to May 15, 2006, the date 

the $20,000 was deposited. Simultaneously with the use of the 

$15,000 to offset the underpayment, the taxpayer requests the return of the remaining amount of the deposit (after reduction for the 

underpayment interest owed by the taxpayer from April 15, 2005, 

to May 15, 2006). This amount must be returned to the taxpayer 

with interest determined at the short-term applicable Federal rate 

from the May 15, 2006, to a date not more than 30 days preceding 

the date of the check repaying the deposit to the taxpayer. 

Limitation on amounts for which interest may be allowed 

Interest on a deposit that is returned to a taxpayer shall be allowed for any period only to the extent attributable to a disputable 

item for that period. A disputable item is any item for which the 

taxpayer (1) has a reasonable basis for the treatment used on its 

return and (2) reasonably believes that the Secretary also has a 

reasonable basis for disallowing the taxpayer’s treatment of such 

item. 

All items included in a 30-day letter to a taxpayer are deemed 

disputable for this purpose. Thus, once a 30-day letter has been 

issued, the disputable amount cannot be less than the amount of 

the deficiency shown in the 30-day letter. A 30-day letter is the 

first letter of proposed deficiency that allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals. 

Deposits are not payments of tax 

A deposit is not a payment of tax prior to the time the deposited 

amount is used to pay a tax. Similarly, withdrawal of a deposit will 

not establish a period for which interest was allowable at the shortterm applicable Federal rate for the purpose of establishing a net 

307

zero interest rate on a similar amount of underpayment for the 

same period. 

EFFECTIVE DATE

The provision applies to deposits made after the date of enactment. Amounts already on deposit as of the date of enactment are 

treated as deposited (for purposes of applying this provision) on the 

date the taxpayer identifies the amount as a deposit made pursuant to this provision. 

26. Authorize IRS to enter into installment agreements that provide for partial payment (sec. 645 of the bill and sec. 6159 of 

the Code) 

PRESENT LAW

The Code authorizes the IRS to enter into written agreements 

with any taxpayer under which the taxpayer is allowed to pay 

taxes owed, as well as interest and penalties, in installment payments if the IRS determines that doing so will facilitate collection 

of the amounts owed (sec. 6159). An installment agreement does 

not reduce the amount of taxes, interest, or penalties owed. Generally, during the period installment payments are being made, 

other IRS enforcement actions (such as levies or seizures) with respect to the taxes included in that agreement are held in abeyance.

Prior to 1998, the IRS administratively entered into installment 

agreements that provided for partial payment (rather than full 

payment) of the total amount owed over the period of the agreement. In that year, the IRS Chief Counsel issued a memorandum 

concluding that partial payment installment agreements were not 

permitted. 

REASONS FOR CHANGE

According to the Department of the Treasury, at the end of fiscal 

year 2003, the IRS had not pursued 2.25 million cases totaling 

more than $16.5 billion in delinquent taxes. The Committee believes that clarifying that the IRS is authorized to enter into installment agreements with taxpayers that do not provide for full 

payment of the taxpayer’s liability over the life of the agreement 

will improve effective tax administration. 

The Committee recognizes that some taxpayers are unable or unwilling to enter into a realistic offer-in-compromise. The Committee 

believes that these taxpayers should be encouraged to make partial 

payments toward resolving their tax liability, and that providing 

for partial payment installment agreements will help facilitate this. 

EXPLANATION OF PROVISION

The provision clarifies that the IRS is authorized to enter into installment agreements with taxpayers which do not provide for full 

payment of the taxpayer’s liability over the life of the agreement. 

The provision also requires the IRS to review partial payment installment agreements at least every two years. The primary purpose of this review is to determine whether the financial condition 

of the taxpayer has significantly changed so as to warrant an increase in the value of the payments being made. 

308

349Sec. 1501. 350Sec. 1502. 351 Regulations issued under the authority of section 1502 are considered to be ‘‘legislative’’

regulations rather than ‘‘interpretative’’ regulations, and as such are usually given greater deference by courts in case of a taxpayer challenge to such a regulation. See, S. Rep. No. 960, 70th 

Cong., 1st Sess. at 15 (1928), describing the consolidated return regulations as ‘‘legislative in 

character’’. The Supreme Court has stated that ‘‘. . . legislative regulations are given controlling 

weight unless they are arbitrary, capricious, or manifestly contrary to the statute.’’ Chevron, 

U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844 (1984) (involving an 

environmental protection regulation). For examples involving consolidated return regulations, 

see, e.g., Wolter Construction Company v. Commissioner, 634 F.2d 1029 (6th Cir. 1980); Garvey, 

Inc. v. United States, 1 Ct. Cl. 108 (1983), aff’d 726 F.2d 1569 (Fed. Cir. 1984), cert. denied, 

469 U.S. 823 (1984). Compare, e.g., Audrey J. Walton v. Commissioner, 115 T.C. 589 (2000), describing different standards of review. The case did not involve a consolidated return regulation. 352 255 F.3d 1357 (Fed. Cir. 2001), reh’g denied, 2001 U.S. App. LEXIS 23207 (Fed. Cir. Oct. 

3, 2001). 353Prior to this decision, there had been a few instances involving prior laws in which certain 

consolidated return regulations were held to be invalid. See, e.g., American Standard, Inc. v. United States, 602 F.2d 256 (Ct. Cl. 1979), discussed in the text infra. See also Union Carbide 

Corp. v. United States, 612 F.2d 558 (Ct. Cl. 1979), and Allied Corporation v. United States, 685 F. 2d 396 (Ct. Cl. 1982), all three cases involving the allocation of income and loss within 

a consolidated group for purposes of computation of a deduction allowed under prior law by the 

Code for Western Hemisphere Trading Corporations. See also Joseph Weidenhoff v. Commissioner, 32 T.C. 1222, 1242–1244 (1959), involving the application of certain regulations to the 

excess profits tax credit allowed under prior law, and concluding that the Commissioner had 

applied a particular regulation in an arbitrary manner inconsistent with the wording of the regulation and inconsistent with even a consolidated group computation. Cf. Kanawha Gas & Utilities Co. v. Commissioner, 214 F.2d 685 (1954), concluding that the substance of a transaction 

was an acquisition of assets rather than stock. Thus, a regulation governing basis of the assets 

of consolidated subsidiaries did not apply to the case. See also General Machinery Corporation

EFFECTIVE DATE

The provision is effective for installment agreements entered into 

on or after the date of enactment. 

27. Affirmation of consolidated return regulation authority (sec. 

646 of the bill and sec. 1502 of the Code) 

PRESENT LAW

An affiliated group of corporations may elect to file a consolidated return in lieu of separate returns. A condition of electing to 

file a consolidated return is that all corporations that are members 

of the consolidated group must consent to all the consolidated return regulations prescribed under section 1502 prior to the last day 

prescribed by law for filing such return.349

Section 1502 states:

The Secretary shall prescribe such regulations as he 

may deem necessary in order that the tax liability of any 

affiliated group of corporations making a consolidated return and of each corporation in the group, both during and 

after the period of affiliation, may be returned, determined, computed, assessed, collected, and adjusted, in such 

manner as clearly to reflect the income-tax liability and 

the various factors necessary for the determination of such 

liability, and in order to prevent the avoidance of such tax 

liability.350

Under this authority, the Treasury Department has issued extensive consolidated return regulations.351

In the recent case of Rite Aid Corp. v. United States, 352 the Federal Circuit Court of Appeals addressed the application of a particular provision of certain consolidated return loss disallowance 

regulations, and concluded that the provision was invalid.353 The 

309

v. Commissioner, 33 B.T.A. 1215 (1936); Lefcourt Realty Corporation, 31 B.T.A. 978 (1935); 

Helvering v. Morgans, Inc., 293 U.S. 121 (1934), interpreting the term ‘‘taxable year.’’ 354Treas. Reg. sec. 1.1502–20(c)(1)(iii). 355Treasury Regulation section 1.1502–20, generally imposing certain ‘‘loss disallowance’’ rules on the disposition of subsidiary stock, contained other limitations besides the ‘‘duplicated 

loss’’ rule that could limit the loss available to the group on a disposition of a subsidiary’s stock. 

Treasury Regulation section 1.1502–20 as a whole was promulgated in connection with regulations issued under section 337(d), principally in connection with the so-called General Utilities

repeal of 1986 (referring to the case of General Utilities & Operating Company v. Helvering, 296 

U.S. 200 (1935)). Such repeal generally required a liquidating corporation, or a corporation acquired in a stock acquisition treated as a sale of assets, to pay corporate level tax on the excess 

of the value of its assets over the basis. Treasury regulation section 1.1502–20 principally reflected an attempt to prevent corporations filing consolidated returns from offsetting income 

with a loss on the sale of subsidiary stock. Such a loss could result from the unique upward 

adjustment of a subsidiary’s stock basis required under the consolidated return regulations for 

subsidiary income earned in consolidation, an adjustment intended to prevent taxation of both 

the subsidiary and the parent on the same income or gain. As one example, absent a denial 

of certain losses on a sale of subsidiary stock, a consolidated group could obtain a loss deduction 

with respect to subsidiary stock, the basis of which originally reflected the subsidiary’s value 

at the time of the purchase of the stock, and that had then been adjusted upward on recognition 

of any built-in income or gain of the subsidiary reflected in that value. The regulations also contained the duplicated loss factor addressed by the court in Rite Aid. The preamble to the regulations stated: ‘‘it is not administratively feasible to differentiate between loss attributable to 

built-in gain and duplicated loss.’’ T.D. 8364, 1991–2 C.B. 43, 46 (Sept. 13, 1991). The government also argued in the Rite Aid case that duplicated loss was a separate concern of the regulations. 255 F.3d at 1360. 356For example, the court stated: ‘‘The duplicated loss factor . . . addresses a situation that 

arises from the sale of stock regardless of whether corporations file separate or consolidated returns. With I.R.C. secs. 382 and 383, Congress has addressed this situation by limiting the subsidiary’s potential future deduction, not the parent’s loss on the sale of stock under I.R.C. sec. 

165.’’ 255 F.3d 1357, 1360 (Fed. Cir. 2001). 357S. Rep. No. 960, 70th Cong., 1st Sess. 15 (1928). Though not quoted by the court in Rite 

Aid, the same Senate report also indicated that one purpose of the consolidated return authority 

was to permit treatment of the separate corporations as if they were a single unit, stating ‘‘The 

mere fact that by legal fiction several corporations owned by the same shareholders are separate 

entities should not obscure the fact that they are in reality one and the same business owned 

by the same individuals and operated as a unit.’’ S. Rep. No. 960, 70th Cong., 1st Sess. 29 

(1928). 358 American Standard, Inc. v. United States, 602 F.2d 256, 261 (Ct. Cl. 1979). That case did 

not involve the question of separate returns as compared to a single return approach. It involved 

Continued

particular provision, known as the ‘‘duplicated loss’’ provision,354

would have denied a loss on the sale of stock of a subsidiary by a 

parent corporation that had filed a consolidated return with the 

subsidiary, to the extent the subsidiary corporation had assets that 

had a built-in loss, or had a net operating loss, that could be recognized or used later.355

The Federal Circuit Court opinion contained language discussing 

the fact that the regulation produced a result different than the result that would have obtained if the corporations had filed separate 

returns rather than consolidated returns.356

The Federal Circuit Court opinion cited a 1928 Senate Finance 

Committee Report to legislation that authorized consolidated return regulations, which stated that ‘‘many difficult and complicated 

problems, . . . have arisen in the administration of the provisions 

permitting the filing of consolidated returns’’ and that the committee ‘‘found it necessary to delegate power to the commissioner 

to prescribe regulations legislative in character covering them.’’ 357

The Court’s opinion also cited a previous decision of the Court of 

Claims for the proposition, interpreting this legislative history, that 

section 1502 grants the Secretary ‘‘the power to conform the applicable income tax law of the Code to the special, myriad problems 

resulting from the filing of consolidated income tax returns;’’ but 

that section 1502 ‘‘does not authorize the Secretary to choose a 

method that imposes a tax on income that would not otherwise be 

taxed.’’ 358

310

the computation of a Western Hemisphere Trade Corporation (‘‘WHTC’’) deduction under prior 

law (which deduction would have been computed as a percentage of each WHTC’s taxable income if the corporations had filed separate returns), in a case where a consolidated group included several WHTCs as well as other corporations. The question was how to apportion income 

and losses of the admittedly consolidated WHTCs and how to combine that computation with 

the rest of the group’s consolidated income or losses. The court noted that the new, changed 

regulations approach varied from the approach taken to a similar problem involving public utilities within a group and previously allowed for WHTCs. The court objected that the allocation 

method adopted by the regulation allowed non-WHTC losses to reduce WHTC income. However, 

the court did not disallow a method that would net WHTC income of one WHTC with losses 

of another WHTC, a result that would not have occurred under separate returns. Nor did the 

court expressly disallow a different fractional method that would net both income and losses of 

the WHTCs with those of other corporations in the consolidated group. The court also found that 

the regulation had been adopted without proper notice. 359 Rite Aid, 255 F.3d at 1360. 360See Temp. Reg. Sec. 1.1502–20T(i)(2), Temp. Reg. Sec. 1.337(d)-2T, and Temp. Reg. Sec. 

1.1502–35T. The Treasury Department has also indicated its intention to continue to study all 

the issues that the original loss disallowance regulations addressed (including issues of furthering single entity principles) and possibly issue different regulations (not including the particular approach of Treas. Reg. Sec. 1.1502–20(c)(1)(iii)) on the issues in the future. See Notice 

2002–11, 2002–7 I.R.B. 526 (Feb. 19, 2002); T.D. 8984, 67 F.R. 11034 (March 12, 2002); REG–

102740–02, 67 F.R. 11070 (March 12, 2002); see also Notice 2002–18, 2002–12 I.R.B. 644 (March 

25, 2002); REG–131478–02, 67 F.R. 65060 (October 18, 2002); T.D. 9048, 68 F.R. 12287 (March 

14, 2003); and T.D. 9118, REG–153172–03 (March 17, 2004). 

The Federal Circuit Court construed these authorities and applied them to invalidate Treas. Reg. Sec. 1.1502–20(c)(1)(iii), stating that:

The loss realized on the sale of a former subsidiary’s assets after the consolidated group sells the subsidiary’s 

stock is not a problem resulting from the filing of consolidated income tax returns. The scenario also arises where 

a corporate shareholder sells the stock of a non-consolidated subsidiary. The corporate shareholder could realize 

a loss under I.R.C. sec. 1001, and deduct the loss under 

I.R.C. sec. 165. The subsidiary could then deduct any 

losses from a later sale of assets. The duplicated loss factor, therefore, addresses a situation that arises from the 

sale of stock regardless of whether corporations file separate or consolidated returns. With I.R.C. secs. 382 and 383, 

Congress has addressed this situation by limiting the subsidiary’s potential future deduction, not the parent’s loss 

on the sale of stock under I.R.C. sec. 165.359

The Treasury Department has announced that it will not continue to litigate the validity of the duplicated loss provision of the 

regulations, and has issued interim regulations that permit taxpayers for all years to elect a different treatment, though they may 

apply the provision for the past if they wish.360

REASONS FOR CHANGE

The Committee is concerned that Treasury Department resources 

might be unnecessarily devoted to defending challenges to consolidated return regulations on the mere assertion by a taxpayer that 

the result under the consolidated return regulations is different 

than the result for separate taxpayers. The consolidated return regulations offer many benefits that are not available to separate taxpayers, including generally rules that tax income received by the 

group once and attempt to avoid a second tax on that same income 

when stock of a subsidiary is sold. 

311

361Treas. Reg. sec. 1.1502–20(c)(1)(iii). 362The provision is not intended to overrule the current Treasury Department regulations, 

which allow taxpayers in certain circumstances for the past to follow Treasury Regulations Section 1.1502–20(c)(1)(iii), if they choose to do so. Temp. Reg. Sec. 1.1502–20T(i)(2). 363See, e.g., Notice 2002–11, 2002–7 I.R.B. 526 (Feb. 19, 2002); Temp. Reg. Sec. 1.337(d)–2T, 

(T.D. 8984, 67 F.R. 11034 (March 12, 2002) and T.D. 8998, 67 F.R. 37998 (May 31, 2002)); REG– 102740–02, 67 F.R. 11070 (March 12, 2002); see also Notice 2002–18, 2002–12 I.R.B. 644 (March 

25, 2002); REG–131478–02, 67 F.R. 65060 (October 18, 2002); Temp. Reg. Sec. 1.1502–35T (T.D. 

9048, 68 F.R. 12287 (March 14, 2003)); and T.D. 9118, REG–153172–03 (March 17, 2004). In 

exercising its authority under section 1502, the Secretary is also authorized to prescribe rules 

that protect the purpose of General Utilities repeal using presumptions and other simplifying 

conventions. 

EXPLANATION OF PROVISION

The provision confirms that, in exercising its authority under 

section 1502 to issue consolidated return regulations, the Treasury 

Department may provide rules treating corporations filing consolidated returns differently from corporations filing separate returns. 

Thus, under the statutory authority of section 1502, the Treasury 

Department is authorized to issue consolidated return regulations 

utilizing either a single taxpayer or separate taxpayer approach or 

a combination of the two approaches, as Treasury deems necessary 

in order that the tax liability of any affiliated group of corporations 

making a consolidated return, and of each corporation in the group, 

both during and after the period of affiliation, may be determined 

and adjusted in such manner as clearly to reflect the income-tax 

liability and the various factors necessary for the determination of 

such liability, and in order to prevent avoidance of such liability.

Rite Aid is thus overruled to the extent it suggests that the Secretary is required to identify a problem created from the filing of 

consolidated returns in order to issue regulations that change the 

application of a Code provision. The Secretary may promulgate consolidated return regulations to change the application of a tax code 

provision to members of a consolidated group, provided that such 

regulations are necessary to clearly reflect the income tax liability 

of the group and each corporation in the group, both during and 

after the period of affiliation. 

The provision nevertheless allows the result of the Rite Aid case 

to stand with respect to the type of factual situation presented in 

the case. That is, the bill provides for the override of the regulatory 

provision that took the approach of denying a loss on a 

deconsolidating disposition of stock of a consolidated subsidiary 361

to the extent the subsidiary had net operating losses or built in 

losses that could be used later outside the group.362

Retaining the result in the Rite Aid case with respect to the particular regulation section 1.1502–20(c)(1)(iii) as applied to the factual situation of the case does not in any way prevent or invalidate 

the various approaches Treasury has announced it will apply or 

that it intends to consider in lieu of the approach of that regulation, including, for example, the denial of a loss on a stock sale if 

inside losses of a subsidiary may also be used by the consolidated 

group, and the possible requirement that inside attributes be adjusted when a subsidiary leaves a group.363

EFFECTIVE DATE

The provision is effective for all years, whether beginning before, 

on, or after the date of enactment of the provision. No inference is 

312

364Frank Lyon Co. v. United States, 435 U.S. 561, 583–84 (1978). 365Sec. 168(g)(3)(A). Under present law, section 168(g)(3)(C) states that the recovery period 

of ‘‘qualified technological equipment’’ is five years. 

intended that the results following from this provision are not the 

same as the results under present law.

28. Reform of tax treatment of certain leasing arrangements and 

limitation on deductions allocable to property used by governments or other tax-exempt entities (secs. 647 through 649 of 

the bill, secs. 167 and 168 of the Code, and new sec. 470 of the 

Code) 

PRESENT LAW

Overview of depreciation 

A taxpayer is allowed to recover, through annual depreciation deductions, the cost of certain property used in a trade or business 

or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year 

is determined under the modified accelerated cost recovery system 

(‘‘MACRS’’). Under MACRS, different types of property generally 

are assigned applicable recovery periods and depreciation methods 

based on such property’s class life. The recovery periods applicable 

to most tangible personal property (generally tangible property 

other than residential rental property and nonresidential real property) range from 3 to 25 years and are significantly shorter than 

the property’s class life, which is intended to approximate the economic useful life of the property. In addition, the depreciation 

methods generally applicable to tangible personal property are the 

200-percent and 150-percent declining balance methods, switching 

to the straight-line method for the taxable year in which the depreciation deduction would be maximized. 

Characterization of leases for tax purposes 

In general, a taxpayer is treated as the tax owner and is entitled 

to depreciate property leased to another party if the taxpayer acquires and retains significant and genuine attributes of a traditional owner of the property, including the benefits and burdens of 

ownership. No single factor is determinative of whether a lessor 

will be treated as the owner of the property. Rather, the determination is based on all the facts and circumstances surrounding the 

leasing transaction. 

A sale-leaseback transaction is respected for Federal tax purposes if ‘‘there is a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or 

regulatory realities, is imbued with tax-independent considerations, 

and is not shaped solely by tax-avoidance features that have meaningless labels attached.’’ 364

Recovery period for tax-exempt use property 

Under present law, ‘‘tax-exempt use property’’ must be depreciated on a straight-line basis over a recovery period equal to the 

longer of the property’s class life or 125 percent of the lease 

term.365 For purposes of this rule, ‘‘tax-exempt use property’’ is 

tangible property that is leased (other than under a short-term 

313

366Sec. 168(h)(1). 367Sec. 168(h)(2). 368Sec. 7701(e) provides that a service contract will not be respected, and instead will be 

treated as a lease of property, if such contract is properly treated as a lease taking into account 

all relevant factors. The relevant factors include, among others, the service recipient controls 

the property, the service recipient is in physical possession of the property, the service provider 

does not bear significant risk of diminished receipts or increased costs if there is nonperformance, the property is not used to concurrently provide services to other entities, and the contract 

price does not substantially exceed the rental value of the property. 369Sec. 168(h)(1)(C). 370Sec. 168(h)(3). However, the exception does not apply if part or all of the qualified technological equipment is financed by a tax-exempt obligation, is sold by the tax-exempt entity (or 

related party) and leased back to the tax-exempt entity (or related party), or the tax-exempt 

entity is the United States or any agency or instrumentality of the United States. 371Sec. 168(g)(3)(C). 372Sec. 168(i)(2).

lease) to a tax-exempt entity.366 For this purpose, the term ‘‘taxexempt entity’’ includes Federal, State and local governmental 

units, charities, and, foreign entities or persons.367

In determining the length of the lease term for purposes of the 

125-percent calculation, several special rules apply. In addition to 

the stated term of the lease, the lease term includes options to 

renew the lease or other periods of time during which the lessee 

could be obligated to make rent payments or assume a risk of loss 

related to the leased property. 

Tax-exempt use property does not include property that is used 

by a taxpayer to provide a service to a tax-exempt entity. So long 

as the relationship between the parties is a bona fide service contract, the taxpayer will be allowed to depreciate the property used 

in satisfying the contract under normal MACRS rules, rather than 

the rules applicable to tax-exempt use property.368 In addition, 

property is not treated as tax-exempt use property merely by reason of a short-term lease. In general, a short-term lease means any 

lease the term of which is less than three years and less than the 

greater of one year or 30 percent of the property’s class life.369

Also, tax-exempt use property generally does not include qualified technological equipment that meets the exception for leases of 

high technology equipment to tax-exempt entities with lease terms 

of five years or less.370 The recovery period for qualified technological equipment that is treated as tax-exempt use property, but 

is not subject to the high technology equipment exception, is five 

years.371

The term ‘‘qualified technological equipment’’ is defined as computers and related peripheral equipment, high technology telephone station equipment installed on a customer’s premises, and 

high technology medical equipment.372 In addition, tax-exempt use 

property does not include computer software because it is intangible property. 

REASONS FOR CHANGE

The special rules applicable to the depreciation of tax-exempt use 

property were enacted to prevent tax-exempt entities from using 

leasing arrangements to transfer the tax benefits of accelerated depreciation on property they used to a taxable entity. The Committee is concerned that some taxpayers are attempting to circumvent this policy through the creative use of service contracts 

with the tax-exempt entities. 

More generally, the Committee believes that certain ongoing 

leasing activity with tax-exempt entities and foreign governments 

314

373See H. Rep. 98–432, Pt. 2, pp. 1140–1141 (1984) and S. Prt. 98–169, Vol. I, pp. 125–127 

(1984). 

indicates that the present-law tax rules are not effective in curtailing the ability of a tax-exempt entity to transfer certain tax 

benefits to a taxable entity. The Committee is concerned about this 

activity and the continual development of new structures that purport to minimize or neutralize the effect of these rules. In addition, 

the Committee also is concerned by the increasing use of certain 

leasing structures involving property purported to be qualified 

technological equipment. Although the Committee recognizes that 

leasing plays an important role in ensuring the availability of capital to businesses, it believes that certain transactions of which it 

recently has become aware do not serve this role. These transactions result in little or no accumulation of capital for financing 

or refinancing but, instead, essentially involve an accommodation 

fee paid by a U.S. taxpayer to a tax indifferent party. 

In discussing the reasons for the enactment of rules in 1984 that 

were intended to limit the transfer of tax benefits to taxable entities with respect to property used by tax-exempt entities, Congress 

at the time stated that: (1) the Federal budget was in no condition 

to sustain substantial and growing revenue losses by making additional tax benefits (in excess of tax exemption itself) available to 

tax-exempt entities through leasing transactions; (2) there were 

concerns about possible problems of accountability of governments 

to their citizens, and of tax-exempt organizations to their clientele, 

if substantial amounts of their property came under the control of 

outside parties solely because the Federal tax system made leasing 

more favorable than owning; (3) the tax system should not encourage tax-exempt entities to dispose of assets they own or to forego 

control over the assets they use; (4) there were concerns about 

waste of Federal revenues because in some cases a substantial portion of the tax savings was retained by lawyers, investment bankers, lessors, and investors and, thus, the Federal revenue loss became more of a gain to financial entities than to tax-exempt entities; (5) providing aid to tax-exempt entities through direct appropriations was more efficient and appropriate than providing such 

aid through the Code; and (6) popular confidence in the tax system 

must be sustained by ensuring that the system generally is working correctly and fairly.373

The Committee believes that the reasons stated above for the enactment in 1984 of the present-law rules are as important today as 

they were in 1984. Unfortunately, the present-law rules have not 

adequately deterred taxpayers from engaging in transactions that 

attempt to circumvent the rules enacted in 1984. Therefore, the 

Committee believes that changes to present law are essential to ensure the attainment of the aforementioned Congressional intentions, provided such changes do not inhibit legitimate commercial 

leasing transactions that involve a significant and genuine transfer 

of the benefits and burdens of tax ownership between the taxpayer 

and the tax-exempt lessee. 

315

374The bill defines a tax-exempt entity as under present law. Thus, it includes Federal, State, 

local, and foreign governmental units, charities, foreign entities or persons. 375 A service contract involving property that previously was leased to the tax-exempt entity 

is not part of the same transaction as the preceding leasing arrangement (and, thus, is not included in the lease term of such arrangement) if the service contract was not included in the 

terms and conditions, or contemplated at the inception, of the preceding leasing arrangement. 376For purposes of the bill, a service contract does not include an arrangement for the provision of services if the leased property or substantially similar property is not utilized to provide 

such services. For example, if at the conclusion of a lease term, a tax-exempt lessee purchases 

property from the taxpayer and enters into an agreement pursuant to which the taxpayer maintains the property, the maintenance agreement will not be included in the lease term for purposes of the 125-percent computation.

EXPLANATION OF PROVISION

Overview 

The bill modifies the recovery period of certain property leased 

to a tax-exempt entity, alters the definition of lease term for all 

property leased to a tax-exempt entity, expands the short-term 

lease exception for qualified technological equipment, and establishes rules to limit deductions associated with leases to tax-exempt 

entities if the leases do not satisfy specified criteria. 

Modify the recovery period of certain property leased to a tax-exempt 

entity 

The bill modifies the recovery period for qualified technological 

equipment and computer software leased to a tax-exempt entity 374

to be the longer of the property’s assigned class life (or assigned 

useful life in the case of computer software) or 125 percent of the 

lease term. The bill does not apply to short-term leases, as defined 

under present law with a modification described below for shortterm leases of qualified technological equipment. 

Modify definition of lease term 

In determining the length of the lease term for purposes of the 

125-percent calculation, the bill provides that the lease term includes all service contracts (whether or not treated as a lease under 

section 7701(e)) and other similar arrangements that follow a lease 

of property to a tax-exempt entity and that are part of the same 

transaction (or series of transactions) as the lease.375

Under the bill, service contracts and other similar arrangements 

include arrangements by which services are provided using the 

property in exchange for fees that provide a source of repayment 

of the capital investment in the property.376

This requirement applies to all leases of property to a tax-exempt 

entity. 

Expand short-term lease exception for qualified technological equipment 

For purposes of determining whether a lease of qualified technological equipment to a tax-exempt entity satisfies the present-law 

5-year short-term lease exception for leases of qualified technological equipment, the bill provides that the term of the lease does 

not include an option or options of the lessee to renew or extend 

the lease, provided the rents under the renewal or extension are 

based upon fair market value determined at the time of the renewal or extension. The aggregate period of such renewals or extensions not included in the lease term under this provision may 

316

377Deductions related to a lease of tax-exempt use property include any depreciation or amortization expense, maintenance expense, taxes or the cost of acquiring an interest in, or lease 

of, property. In addition, this provision applies to interest that is properly allocable to tax-exempt use property, including interest on any borrowing by a related person, the proceeds of 

which were used to acquire an interest in the property, whether or not the borrowing is secured 

by the leased property or any other property. 378See Sec. 469(g). 379 Even if a transaction satisfies each of the following requirements, the taxpayer will be 

treated as the owner of the leased property only if the taxpayer acquires and retains significant 

and genuine attributes of an owner of the property under the present-law tax rules, including 

the benefits and burdens of ownership. 380For purposes of this requirement, the adjusted basis of property acquired by the taxpayer 

in a like-kind exchange or involuntary conversion to which section 1031 or section 1033 applies 

is equal to the lesser of (1) the fair market value of the property as of the beginning of the lease 

term, or (2) the amount that would be the taxpayer’s adjusted basis if section 1031 or section 

1033 did not apply to such acquisition. 381 Arrangements to monetize lease obligations include defeasance arrangements, loans by the 

tax-exempt entity (or an affiliate) to the taxpayer (or an affiliate) or any lender, deposit agreements, letters of credit collateralized with cash or cash equivalents, payment undertaking agreements, prepaid rent (within the meaning of the regulations under section 467), sinking fund arrangements, guaranteed investment contracts, financial guaranty insurance, or any similar arrangements. 

not exceed 24 months. In addition, this provision does not apply to 

any period following the failure of a tax-exempt lessee to exercise 

a purchase option if the result of such failure is that the lease renews automatically at fair market value rents. 

Limit deductions for certain leases of property to tax-exempt parties 

The bill also provides that if a taxpayer leases property to a taxexempt entity, the taxpayer may not claim deductions from the 

lease transaction in excess of the taxpayer’s gross income from the 

lease for that taxable year. This provision does not apply to certain 

transactions involving property with respect to which the low-income housing credit or the rehabilitation credit is allowable. 

This provision applies to deductions or losses related to a lease 

to a tax-exempt entity and the leased property.377 Any disallowed 

deductions are carried forward and treated as deductions related to 

the lease in the following taxable year subject to the same limitations. Under rules similar to those applicable to passive activity 

losses (including the treatment of dispositions of property in which 

less than all of the gain or loss from the disposition is recognized),378 a taxpayer generally is permitted to deduct previously 

disallowed deductions and losses when the taxpayer completely disposes of its interest in the property. 

A lease of property to a tax-exempt party is not subject to the 

deduction limitations of this provision if the lease satisfies all of 

the following requirements: 379

(1) Tax-exempt lessee does not monetize its lease obligations 

In general, the tax-exempt lessee may not monetize its lease obligations (including any purchase option) in an amount that exceeds 

20 percent of the taxpayer’s adjusted basis 380 in the leased property at the time the lease is entered into.381 Specifically, a lease 

does not satisfy this requirement if the tax-exempt lessee monetizes such excess amount pursuant to an arrangement, set-aside, or 

expected set-aside, that is to or for the benefit of the taxpayer or 

any lender, or is to or for the benefit of the tax-exempt lessee, in 

order to satisfy the lessee’s obligations or options under the lease. 

This determination shall be made at all times during the lease 

term and shall include the amount of any interest or other income 

or gain earned on any amount set aside or subject to an arrangeVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00318 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.007 HR548P1
317

382 It is anticipated that the customary and budgeted funding by tax-exempt entities of current 

obligations under a lease through unrestricted accounts or funds for general working capital 

needs will not be considered arrangements, set-asides, or expected set-asides under this requirement. 383For purposes of this requirement, the adjusted basis of property acquired by the taxpayer 

in a like-kind exchange or involuntary conversion to which section 1031 or section 1033 applies 

is equal to the lesser of (1) the fair market value of the property as of the beginning of the lease 

term, or (2) the amount that would be the taxpayer’s adjusted basis if section 1031 or section 

1033 did not apply to such acquisition. 384The taxpayer’s at-risk equity investment shall include only consideration paid, and personal liability incurred, by the taxpayer to acquire the property. Cf. Rev. Proc. 2001–28, 2001– 2 C.B. 1156. 

ment described in this provision. For purposes of determining 

whether amounts have been set aside or are expected to be set 

aside, amounts are treated as set aside or expected to be set aside 

only if a reasonable person would conclude that the facts and circumstances indicate that such amounts are set aside or expected 

to be set aside.382

The Secretary may provide by regulations that this requirement 

is satisfied, even if a tax-exempt lessee monetizes its lease obligations or options in an amount that exceeds 20 percent of the taxpayer’s adjusted basis in the leased property, in cases in which the 

creditworthiness of the tax-exempt lessee would not otherwise satisfy the taxpayer’s customary underwriting standards. Such credit 

support would not be permitted to exceed 50 percent of the taxpayer’s adjusted basis in the property. In addition, if the lease provides the tax-exempt lessee an option to purchase the property for 

a fixed purchase price (or for other than the fair market value of 

the property determined at the time of exercise of the option), such 

credit support at the time that such option may be exercised would 

not be permitted to exceed 50 percent of the purchase option price. 

Certain lease arrangements that involve circular cash flows or 

insulation of the taxpayer’s equity investment from the risk of loss 

fail this requirement without regard to the amount in which the 

tax-exempt lessee monetizes its lease obligations or options. Thus, 

a lease does not satisfy this requirement if the tax-exempt lessee 

enters into an arrangement to monetize in any amount its lease obligations or options if such arrangement involves (1) a loan (other 

than an amount treated as a loan under section 467 with respect 

to a section 467 rental agreement) from the tax-exempt lessee to 

the taxpayer or a lender, (2) a deposit that is received, a letter of 

credit that is issued, or a payment undertaking agreement that is 

entered into by a lender otherwise involved in the transaction, or 

(3) in the case of a transaction that involves a lender, any credit 

support made available to the taxpayer in which any such lender 

does not have a claim that is senior to the taxpayer. 

(2) Taxpayer makes and maintains a substantial equity investment in the leased property 

The taxpayer must make and maintain a substantial equity investment in the leased property. For this purpose, a taxpayer generally does not make or maintain a substantial equity investment 

unless (1) at the time the lease is entered into, the taxpayer initially makes an unconditional at-risk equity investment in the 

property of at least 20 percent of the taxpayer’s adjusted basis 383

in the leased property at that time,384 (2) the taxpayer maintains 

such equity investment throughout the lease term, and (3) at all 

times during the lease term, the fair market value of the property 

318

385 Cf. Rev. Proc. 2001–28, sec. 4.01(2), 2001–1 C.B. 1156. The fair market value of the property must be determined without regard to inflation or deflation during the lease term and after 

subtracting the cost of removing the property. 386 Examples of arrangements by which a tax-exempt lessee might assume or retain a risk 

of loss include put options, residual value guarantees, residual value insurance, and service contracts. However, leases do not fail to satisfy this requirement solely by reason of lease provisions 

that require the tax-exempt lessee to pay a contractually stipulated loss value to the taxpayer 

in the event of an early termination due to a casualty loss, a material default by the tax-exempt 

lessee (excluding the failure by the tax-exempt lessee to enter into an arrangement described 

above), or other similar extraordinary events that are not reasonably expected to occur at lease 

inception. 387For purposes of this requirement, residual value protection provided to the taxpayer by a 

manufacturer or dealer of the leased property is not treated as borne by the tax-exempt lessee 

if the manufacturer or dealer provides such residual value protection to customers in the ordinary course of its business. 

at the end of the lease term is reasonably expected to be equal to 

at least 20 percent of such basis.385 For this purpose, the fair market value of the property at the end of the lease term is reduced 

to the extent that a person other than the taxpayer bears a risk 

of loss in the value of the property. 

This requirement does not apply to leases with lease terms of 5 

years or less. 

(3) Tax-exempt lessee does not bear more than a minimal 

risk of loss 

The tax-exempt lessee generally may not assume or retain more 

than a minimal risk of loss, other than the obligation to pay rent 

and insurance premiums, to maintain the property, or other similar 

conventional obligations of a net lease.386 For this purpose, a taxexempt lessee assumes or retains more than a minimal risk of loss 

if, as a result of obligations assumed or retained by, on behalf of, 

or pursuant to an agreement with the tax-exempt lessee, the taxpayer is protected from either (1) any portion of the loss that would 

occur if the fair market value of the leased property were 25 percent less than the leased property’s reasonably expected fair market value at the time the lease is terminated, or (2) an aggregate 

loss that is greater than 50 percent of the loss that would occur if 

the fair market value of the leased property were zero at lease termination.387 In addition, the Secretary may provide by regulations 

that this requirement is not satisfied where the tax-exempt lessee 

otherwise retains or assumes more than a minimal risk of loss. 

Such regulations shall be prospective only. 

This requirement does not apply to leases with lease terms of 5 

years or less. 

Coordination with like-kind exchange and involuntary conversion rules 

Under this provision, neither the like-kind exchange rules (sec. 

1031) nor the involuntary conversion rules (sec. 1033) apply if either (1) the exchanged or converted property is tax-exempt use 

property subject to a lease that was entered into prior to the effective date of this provision and the lease would not have satisfied 

the requirements of this provision had such requirements been in 

effect when the lease was entered into, or (2) the replacement property is tax-exempt use property subject to a lease that does not 

meet the requirements of this provision. 

319

388 Conversely, however, a lease of property that is not tax-exempt use property does not become subject to this provision solely by reason of requisition or seizure by the Federal government in national emergency circumstances. 389 If a lease entered into on or before March 12, 2004, is transferred in a transaction that 

does not materially alter the terms of such lease, the bill shall not apply to the lease as a result 

of such transfer. 

Other rules 

This provision continues to apply throughout the lease term to 

property that initially was tax-exempt use property, even if the 

property ceases to be tax-exempt use property during the lease 

term.388 In addition, this provision is applied before the application 

of the passive activity loss rules under section 469. 

This provision does not alter the treatment of any Qualified 

Motor Vehicle Operating Agreement within the meaning of section 

7701(h). In the case of any such agreement, the second and third 

requirements provided by this provision (relating to taxpayer equity investment and tax-exempt lessee risk of loss, respectively) 

shall be applied without regard to any terminal rental adjustment 

clause. 

EFFECTIVE DATE

The provision generally is effective for leases entered into after 

March 12, 2004.389 However, the provision does not apply to property located in the United States that is subject to a lease with respect to which a formal application (1) was submitted for approval 

to the Federal Transit Administration (an agency of the Department of Transportation) after June 30, 2003, and before March 13, 

2004, (2) is approved by the Federal Transit Administration before 

January 1, 2005, and (3) includes a description and the fair market 

value of such property. 

The provisions relating to coordination with the like-kind exchange and involuntary conversion rules are effective with respect 

to property that is exchanged or converted after the date of enactment. 

No inference is intended regarding the appropriate present-law 

tax treatment of transactions entered into prior to the effective 

date of this provision. In addition, it is intended that this provision 

shall not be construed as altering or supplanting the present-law 

tax rules providing that a taxpayer is treated as the owner of 

leased property only if the taxpayer acquires and retains significant and genuine attributes of an owner of the property, including 

the benefits and burdens of ownership. This provision also is not 

intended to affect the scope of any other present-law tax rules or 

doctrines applicable to purported leasing transactions. 

C. REDUCTION OF FUEL TAX EVASION

1. Exemption from certain excise taxes for mobile machinery vehicles (sec. 651 of the bill, and secs. 4053, 4072, 4082, 4483 and 

6421 of the Code) 

PRESENT LAW

Under present law, the definition of a ‘‘highway vehicle’’ affects 

the application of the retail tax on heavy vehicles, the heavy vehiVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00321 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.007 HR548P1
320

390Secs. 4051, 4071, 4481, 4041 and 4081. 391See Treas. Reg. sec. 48.4061–1(d)). 392Prop. Treas. Reg. sec. 48.4051–1(a), 67 Fed. Reg. 38913, 38914–38915 (2002). 

cle use tax, the tax on tires, and fuel taxes.390 Section 4051 of the 

Code provides for a 12-percent retail sales tax on tractors, heavy 

trucks with a gross vehicle weight (‘‘GVW’’) over 33,000 pounds, 

and trailers with a GVW over 26,000 pounds. Section 4071 provides 

for a tax on highway vehicle tires that weigh more than 40 pounds, 

with higher rates of tax for heavier tires. Section 4481 provides for 

an annual use tax on heavy vehicles with a GVW of 55,000 pounds 

or more, with higher rates of tax on heavier vehicles. All of these 

excise taxes are paid into the Highway Trust Fund. 

Federal excise taxes are also levied on the motor fuels used in 

highway vehicles. Gasoline is subject to a tax of 18.4 cents per gallon, of which 18.3 cents per gallon is paid into the Highway Trust 

Fund and 0.1 cent per gallon is paid into the Leaking Underground 

Storage Tank (‘‘LUST’’) Trust Fund. Highway diesel fuel is subject 

to a tax of 24.4 cents per gallon, of which 24.3 cents per gallon is 

paid into the Highway Trust Fund and 0.1 cent per gallon is paid 

into the LUST Trust Fund. 

The Code does not define a ‘‘highway vehicle.’’ For purposes of 

these taxes, Treasury regulations define a highway vehicle as any 

self-propelled vehicle or trailer or semitrailer designed to perform 

a function of transporting a load over the public highway, whether 

or not also designed to perform other functions. Excluded from the 

definition of highway vehicle are (1) certain specially designed mobile machinery vehicles for non-transportation functions (the ‘‘mobile machinery exception’’); (2) certain vehicles specially designed 

for off-highway transportation for which the special design substantially limits or impairs the use of such vehicle to transport loads 

over the highway (the ‘‘off-highway transportation vehicle’’ exception); and (3) certain trailers and semi-trailers specially designed to 

function only as an enclosed stationary shelter for the performance 

of non-transportation functions off the public highways.391

The mobile machinery exception applies if three tests are met: (1) 

the vehicle consists of a chassis to which jobsite machinery (unrelated to transportation) has been permanently mounted; (2) the 

chassis has been specially designed to serve only as a mobile carriage and mount for the particular machinery; and (3) by reason of 

such special design, the chassis could not, without substantial 

structural modification, be used to transport a load other than the 

particular machinery. An example of a mobile machinery vehicle is 

a crane mounted on a truck chassis that meets the forgoing factors.

On June 6, 2002, the Treasury Department put forth proposed 

regulations that would eliminate the mobile machinery exception.392 The other exceptions from the definition of highway vehicle 

would continue to apply with some modifications. Under the proposed regulations, the chassis of a mobile machinery vehicle would 

be subject to the retail sales tax on heavy vehicles unless the vehicle qualified under the off-highway transportation vehicle exception. Also, under the proposed regulations, mobile machinery vehicles may be subject to the heavy vehicle use tax. In addition, the 

tax credits, refunds, and exemptions from tax may not be available 

for the fuel used in these vehicles. 

321

393Sec. 4093(a). 394 A rack is a mechanism capable of delivering taxable fuel into a means of transport other 

than a pipeline or vessel. Treas. Reg. sec. 48.4081–1(b). 395Sec. 4091(a)(1). 

REASONS FOR CHANGE

The Treasury Department has delayed issuance of final regulations regarding mobile machinery to allow Congressional action on 

a statutory definition of mobile machinery vehicle. The Highway 

Trust Fund is supported by taxes related to the use of vehicles on 

the public highways. The Committee understands that a mobile 

machinery exemption was created by Treasury regulation because 

the Treasury Department believed that mobile machinery used the 

public highways only incidentally to get from one job site to another. However, it has come to the Committee’s attention that certain vehicles are taking advantage of the mobile machinery exemption even though they spend a significant amount of time on public 

highways and, therefore, cause wear and tear to such highways. 

Because the mobile machinery exemption is based on incidental use 

of the public highways, the Committee believes it is appropriate to 

add a use-based test to the design-based test that exists under current regulation. The Committee believes that a use-based test is 

practical to administer only for purposes of the fuel excise tax. 

EXPLANATION OF PROVISION

The provision codifies the present-law mobile machinery exemption for purposes of three taxes: the retail tax on heavy vehicles, 

the heavy vehicle use tax, and the tax on tires. Thus, if a vehicle 

can satisfy the three-part test, it will not be treated as a highway 

vehicle and will be exempt from these taxes. 

For purposes of the fuel excise tax, the three-part design test is 

codified and a use test is added by the provision. Specifically, in addition to the three-part design test, the vehicle must not have traveled more than 7,500 miles over public highways during the owner’s taxable year. Refunds of fuel taxes are permitted on an annual 

basis only. For purposes of this rule, a person’s taxable year is his 

taxable year for income tax purposes. 

EFFECTIVE DATE

The provision generally is effective after the date of enactment. 

As to the fuel taxes, the provision is effective for taxable years beginning after the date of enactment.

2. Taxation of aviation-grade kerosene (sec. 652 of the bill and secs. 

4041, 4081, 4082, 4083, 4091, 4092, 4093, 4101, and 6427 of 

the Code) 

PRESENT LAW

In general 

Aviation fuel is kerosene and any liquid (other than any product 

taxable under section 4081) that is suitable for use as a fuel in an 

aircraft.393 Unlike other fuels that generally are taxed upon removal from a terminal rack,394 aviation fuel is taxed upon sale of 

the fuel by a producer or importer.395 Sales by a registered proVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00323 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.007 HR548P1
322

396Sec. 4091(a)(2). 397Sec. 4091(b). This rate includes a 0.1 cent per gallon Leaking Underground Storage Tank 

(‘‘LUST’’) Trust Fund tax. The LUST Trust Fund tax is set to expire after March 31, 2005, with 

the result that on April 1, 2005, the tax rate is scheduled to be 21.8 cents per gallon. Secs. 

4091(b)(3)(B) and 4081(d)(3). Beginning on October 1, 2007, the rate of tax is reduced to 4.3 

cents per gallon. Sec. 4091(b)(3)(A). 398Sec. 4092(b). The 4.4 cent rate includes 0.1 cent per gallon that is attributable to the LUST 

Trust Fund financing rate. A full exemption, discussed below, applies to aviation fuel that is 

sold for use in commercial aviation as fuel supplies for vessels or aircraft, which includes use 

by certain foreign air carriers and for the international flights of domestic carriers. Secs. 

4092(a), 4092(b), and 4221(d)(3). 399Secs. 4092(b) and 4041(c)(2). 400 Notice 88–132, sec. III(D). See also, Form 637—Application for Registration (For Certain 

Excise Tax Activities). A bond may be required as a condition of registration. 401Sec. 4092(a). 

ducer to another registered producer are exempt from tax, with the 

result that, as a practical matter, aviation fuel is not taxed until 

the fuel is used at the airport (or sold to an unregistered person). 

Use of untaxed aviation fuel by a producer is treated as a taxable 

sale.396 The producer or importer is liable for the tax. The rate of 

tax on aviation fuel is 21.9 cents per gallon.397

The tax on aviation fuel is reported by filing Form 720—Quarterly Federal Excise Tax Return. Generally, semi-monthly deposits 

are required using Form 8109B—Federal Tax Deposit Coupon or by 

depositing the tax by electronic funds transfer. 

Partial exemptions 

In general, aviation fuel sold for use or used in commercial aviation is taxed at a reduced rate of 4.4 cents per gallon.398 Commercial aviation means any use of an aircraft in a business of transporting persons or property for compensation or hire by air (unless 

the use is allocable to any transportation exempt from certain excise taxes).399

In order to qualify for the 4.4 cents per gallon rate, the person 

engaged in commercial aviation must be registered with the Secretary 400 and provide the seller with a written exemption certificate stating the airline’s name, address, taxpayer identification 

number, registration number, and intended use of the fuel. A person that is registered as a buyer of aviation fuel for use in commercial aviation generally is assigned a registration number with a ‘‘Y’’

suffix (a ‘‘Y’’ registrant), which entitles the registrant to purchase 

aviation fuel at the 4.4 cents per gallon rate. 

Large commercial airlines that also are producers of aviation fuel 

qualify for registration numbers with an ‘‘H’’ suffix. As producers 

of aviation fuel, ‘‘H’’ registrants may buy aviation fuel tax free pursuant to a full exemption that applies to sales of aviation fuel by 

a registered producer to a registered producer. If the ‘‘H’’ registrant 

ultimately uses such untaxed fuel in domestic commercial aviation, 

the H registrant is liable for the aviation fuel tax at the 4.4 cents 

per gallon rate. 

Exemptions 

Aviation fuel sold by a producer or importer for use by the buyer 

in a nontaxable use is exempt from the excise tax on sales of aviation fuel.401 To qualify for the exemption, the buyer must provide 

the seller with a written exemption certificate stating the buyer’s 

name, address, taxpayer identification number, registration number (if applicable), and intended use of the fuel. 

323

402 ‘‘Trade’’ includes the transportation of persons or property for hire. Treas. Reg. sec. 

48.4221–4(b)(8). 403Secs. 4041(f)(2), 4041(g), 4041(h), 4041(l), and 4092. 404Sec. 4092(c). 405Sec. 4091(d). 406Treas. Reg. sec. 48.4091–3(b). 407Treas. Reg. sec. 48.4091–3(d)(1). 408Sec. 6427(l)(1). 

Nontaxable uses include: (1) use other than as fuel in an aircraft 

(such as use in heating oil); (2) use on a farm for farming purposes; 

(3) use in a military aircraft owned by the United States or a foreign country; (4) use in a domestic air carrier engaged in foreign 

trade or trade between the United States and any of its possessions;402 (5) use in a foreign air carrier engaged in foreign trade or 

trade between the United States and any of its possessions (but 

only if the foreign carrier’s country of registration provides similar 

privileges to United States carriers); (6) exclusive use of a State or 

local government; (7) sales for export, or shipment to a United 

States possession; (8) exclusive use by a nonprofit educational organization; (9) use by an aircraft museum exclusively for the procurement, care, or exhibition of aircraft of the type used for combat or 

transport in World War II, and (10) use as a fuel in a helicopter 

or a fixed-wing aircraft for purposes of providing transportation 

with respect to which certain requirements are met.403

A producer that is registered with the Secretary may sell aviation fuel tax-free to another registered producer.404 Producers include refiners, blenders, wholesale distributors of aviation fuel, 

dealers selling aviation fuel exclusively to producers of aviation 

fuel, the actual producer of the aviation fuel, and with respect to 

fuel purchased at a reduced rate, the purchaser of such fuel. 

Refunds and credits 

A claim for refund of taxed aviation fuel held by a registered 

aviation fuel producer is allowed 405 (without interest) if: (1) the 

aviation fuel tax was paid by an importer or producer (the ‘‘first 

producer’’) and the tax has not otherwise been credited or refunded; 

(2) the aviation fuel was acquired by a registered aviation fuel producer (the ‘‘second producer’’) after the tax was paid; (3) the second 

producer files a timely refund claim with the proper information; 

and (4) the first producer and any other person that owns the fuel 

after its sale by the first producer and before its purchase by the 

second producer have met certain reporting requirements.406 Refund claims should contain the volume and type of aviation fuel, 

the date on which the second producer acquired the fuel, the 

amount of tax that the first producer paid, a statement by the 

claimant that the amount of tax was not collected nor included in 

the sales price of the fuel by the claimant when the fuel was sold 

to a subsequent purchaser, the name, address, and employer identification number of the first producer, and a copy of any required 

statement of a subsequent seller (subsequent to the first producer 

but prior to the second producer) that the second producer received. 

A claim for refund is filed on Form 8849, Claim for Refund of Excise Taxes, and may not be combined with any other refunds.407

A payment is allowable to the ultimate purchaser of taxed aviation fuel if the aviation fuel is used in a nontaxable use.408 A claim 

for payment may be made on Form 8849 or on Form 720, Schedule 

324

409Treas. Reg. sec. 40.6302(c)-1(a)(3). 410Sec. 34.

C. A claim made on Form 720, Schedule C, may be netted against 

the claimant’s excise tax liability.409 Claims for payment not so 

taken may be allowable as income tax credits 410 on Form 4136, 

Credit for Federal Tax Paid on Fuels. 

REASONS FOR CHANGE

The Committee believes that the present law rules for taxation 

of aviation fuel create opportunities for widespread abuse and evasion of fuels excise taxes. In general, aviation fuel is taxed on its 

sale, whereas other fuel generally is taxed on its removal from a 

refinery or terminal rack. Because the incidence of tax on aviation 

fuel is sale and not removal, under present law, aviation fuel may 

be removed from a refinery or terminal rack tax free if such fuel 

is intended for use in aviation purposes. The Committee is aware 

that unscrupulous persons are removing fuel tax free, purportedly 

for aviation use, but then selling the fuel for highway use, charging 

their customer the full rate of tax that would be owed on highway 

fuel, and keeping the amount of the tax. 

In order to prevent such fraud, the Committee believes that it is 

appropriate to conform the tax treatment of all taxable fuels by 

shifting the incidence of taxation on aviation fuel from the sale of 

aviation fuel to the removal of such fuel from a refinery or terminal 

rack. In general, all removals of aviation fuel will be fully taxed at 

the time of removal, therefore minimizing the cost to the government of the fraudulent diversion of aviation fuel for non-aviation 

uses. If fuel is later used for an aviation use to which a reduced 

rate of tax applies, refunds are available. The Committee notes 

that when the incidence of tax for other fuels (for example, gasoline 

or diesel) was shifted to the rack, collection of the tax increased significantly indicating that fraud had been occurring. 

The provision provides exceptions to the general rule in cases 

where the opportunities for fraud are insignificant. For example, if 

fuel is removed from an airport terminal directly into the wing of 

a commercial aircraft by a hydrant system, it is clear that the fuel 

will be used in commercial aviation and that the reduced rate of 

tax for commercial aviation should apply. In addition, if a terminal 

is located within an secure airport and, except in exigent circumstances, does not fuel highway vehicles, then the Committee 

believes it is appropriate to permit certain airline refueling vehicles 

to transport fuel from the terminal rack directly to the wing of an 

aircraft and have the applicable rate of tax (reduced or otherwise) 

apply upon removal from the refueling vehicle. 

EXPLANATION OF PROVISION

The provision changes the incidence of taxation of aviation fuel 

from the sale of aviation fuel to the removal of aviation fuel from 

a refinery or terminal, or the entry into the United States of aviation fuel. Sales of not previously taxed aviation fuel to an unregistered person also are subject to tax. 

Under the provision, the full rate of tax—21.9 cents per gallon—

is imposed upon removal of aviation fuel from a refinery or terminal (or entry into the United States). Aviation fuel may be reVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00326 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.007 HR548P1
325

411See sec. 4081(a)(1)(B). 412The provision requires that if such delivery of information is provided to a terminal operator (or if a terminal operator collects such information), that the terminal operator provide such 

information to the Secretary. 

moved at a reduced rate—either 4.4 or zero cents per gallon—only 

if the aviation fuel is: (1) removed directly into the wing of an aircraft (i) that is registered with the Secretary as a buyer of aviation 

fuel for use in commercial aviation (e.g., a ‘‘Y’’ registrant under current law), (ii) that is a foreign airline entitled to the present law 

exemption for aviation fuel used in foreign trade, or (iii) for a taxexempt use; or (2) removed or entered as part of an exempt bulk 

transfer.411 An exempt bulk transfer is a removal or entry of aviation fuel transferred in bulk by pipeline or vessel to a terminal or 

refinery if the person removing or entering the aviation fuel, the 

operator of such pipeline or vessel, and the operator of such terminal or refinery are registered with the Secretary. 

Under a special rule, the provision treats certain refueler trucks, 

tankers, and tank wagons as a terminal if certain requirements are 

met. For the special rule to apply, a qualifying truck, tanker, or 

tank wagon must be loaded with aviation fuel from a terminal: (1) 

that is located within an airport, and (2) from which no vehicle licensed for highway use is loaded with aviation fuel, except in exigent circumstances identified by the Secretary in regulations. The 

Committee intends that a terminal is located within an airport if 

the terminal is located in a secure facility on airport grounds. For 

example, if an access road runs between a terminal and an airport’s runways, and the terminal, like the runways, is physically located on airport grounds and is part of a secure facility, the Committee intends that under the provision the terminal is located 

within the airport. The Committee intends that an exigent circumstance under which loading a vehicle registered for highway 

use with fuel would not disqualify a terminal under the special rule 

would include, for example, the unloading of fuel from bulk storage 

tanks into highway vehicles in order to repair the storage tanks. 

In order to qualify for the special rule, a refueler truck, tanker, 

or tank wagon must: (1) deliver the aviation fuel directly into the 

wing of the aircraft at the airport where the terminal is located; 

(2) have storage tanks, hose, and coupling equipment designed and 

used for the purposes of fueling aircraft; (3) not be licensed for 

highway use; and (4) be operated by the terminal operator (who operates the terminal rack from which the fuel is unloaded) or by a 

person that makes a daily accounting to such terminal operator of 

each delivery of fuel from such truck, tanker, or tank wagon.412

The provision does not change the applicable rates of tax under 

present law, 21.9 cents per gallon for use in noncommercial aviation, 4.4 cents per gallon for use in commercial aviation, and zero 

cents per gallon for use by domestic airlines in an international 

flight, by foreign airlines, or other nontaxable use. The provision 

imposes liability for the tax on aviation fuel removed from a refinery or terminal directly into the wing of an aircraft for use in commercial aviation on the person receiving the fuel, in which case, 

such person self-assesses the tax on a return. The provision does 

not change present-law nontaxable uses of aviation fuel, or change 

the persons or the qualifications of persons who are entitled to purchase fuel at a reduced rate, except that a producer is not perVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00327 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.007 HR548P1
326

413 Alternatively, if the aviation fuel in the example is for use in noncommercial aviation, the 

fuel is taxed at 21.9 cents per gallon upon delivery into the wing. Self-assessment of the tax 

would not apply in such case. 

mitted to purchase aviation fuel at a reduced rate by reason of 

such persons’ status as a producer. 

Under the provision, a refund is allowable to the ultimate vendor 

of aviation fuel if such ultimate vendor purchases fuel tax paid and 

subsequently sells the fuel to a person qualified to purchase at a 

reduced rate and who waives the right to a refund. In such a case, 

the provision permits an ultimate vendor to net refund claims 

against any excise tax liability of the ultimate vendor, in a manner 

similar to the present law treatment of ultimate purchaser payment claims. 

As under present law, if previously taxed aviation fuel is used for 

a nontaxable use, the ultimate purchaser may claim a refund for 

the tax previously paid. If previously taxed aviation fuel is used for 

a taxable non aircraft use, the fuel is subject to the tax imposed 

on kerosene (24.4 cents per gallon) and a refund of the previously 

paid aviation fuel tax is allowed. Claims by the ultimate vendor or 

the purchaser that are not taken as refund claims may be allowable as income tax credits. 

For example, for an airport that is not served by a pipeline, aviation fuel generally is removed from a terminal and transported to 

an airport storage facility for eventual use at the airport. In such 

a case, the aviation fuel will be taxed at 21.9 cents per gallon upon 

removal from the terminal. At the airport, if the fuel is purchased 

from a vendor by a person registered with the Secretary to use fuel 

in commercial aviation, the purchaser may buy the fuel at a reduced rate (generally, 4.4 cents per gallon for domestic flights and 

zero cents per gallon for international flights) and waive the right 

to a refund. The ultimate vendor generally may claim a refund for 

the difference between 21.9 cents per gallon of tax paid upon removal and the rate of tax paid to the vendor by the purchaser. To 

obtain a zero rate upon purchase, a registered domestic airline 

must certify to the vendor at the time of purchase that the fuel is 

for use in an international flight; otherwise, the airline must pay 

the 4.4 cents per gallon rate and file a claim for refund to the Secretary if the fuel is used for international aviation. If a zero rate 

is paid and the fuel subsequently is used in domestic and not international travel, the domestic airline is liable for tax at 4.4 cents 

per gallon. A foreign airline eligible under present law to purchase 

aviation fuel tax-free would continue to purchase such fuel tax-free. 

As another example, for an airport that is served by a pipeline, 

aviation fuel generally is delivered to the wing of an aircraft either 

by a refueling truck or by a ‘‘hydrant’’ that runs directly from the 

pipeline to the airplane wing. If a refueling truck that is not licensed for highway use loads fuel from a terminal located within 

the airport (and the other requirements of the provision for such 

truck and terminal are met), and delivers the fuel directly to the 

wing of an aircraft for use in commercial aviation, the aviation fuel 

is taxed at 4.4 cents per gallon upon delivery to the wing and the 

person receiving the fuel is liable for the tax, which such person 

would be able to self-assess on a return.413 If fuel is loaded into a 

refueling truck that does not meet the requirements of the provision, then the fuel is treated as removed from the terminal into the 

327

414Sec. 4081(a)(1)(A). If such fuel is used for a nontaxable purpose, the purchaser is entitled 

to a refund of tax paid, or in some cases, an income tax credit. See sec. 6427. 415Dyeing is not a requirement, however, for certain fuels under certain conditions, i.e., diesel 

fuel or kerosene exempted from dyeing in certain States by the EPA under the Clean Air Act, 

aviation-grade kerosene as determined under regulations prescribed by the Secretary, kerosene 

received by pipeline or vessel and used by a registered recipient to produce substances (other 

than gasoline, diesel fuel or special fuels), kerosene removed or entered by a registrant to 

produce such substances or for resale, and (under regulations) kerosene sold by a registered distributor who sells kerosene exclusively to ultimate vendors that resell it (1) from a pump that 

is not suitable for fueling any diesel-powered highway vehicle or train, or (2) for blending with 

heating oil to be used during periods of extreme or unseasonable cold. Sec. 4082(c), (d). 416Sec. 4082(a). 

refueling truck and tax of 21.9 cents per gallon is paid on such removal. The ultimate vendor is entitled to a refund of the difference 

between 21.9 cents per gallon paid on removal and the rate paid 

by a commercial airline purchaser (assuming the purchaser waived 

the refund right). If fuel is removed from a terminal directly to the 

wing of an aircraft registered to use fuel in commercial aviation by 

a hydrant or similar device, the person removing the aviation fuel 

is liable for a tax of 4.4 cents per gallon (or zero in the case of an 

international flight or qualified foreign airline) and may self-assess 

such tax on a return. 

Under the provision, a floor stocks tax applies to aviation fuel 

held by a person (if title for such fuel has passed to such person) 

on October 1, 2004. The tax is equal to the amount of tax that 

would have been imposed before October 1, 2004, if the provision 

was in effect at all times before such date, reduced by the tax imposed by section 4091, as in effect on the day before the date of enactment. The Secretary shall determine the time and manner for 

payment of the tax, including the nonapplication of the tax on de 

minimis amounts of aviation fuel. Under the provision, 0.1 cents 

per gallon of such tax is transferred to the LUST Trust Fund. The 

remainder is transferred to the Airport and Airway Trust Fund. 

EFFECTIVE DATE

The provision is effective for aviation fuel removed, entered, or 

sold after September 30, 2004. 

3. Mechanical dye injection and related penalties (sec. 653 of the 

bill and sec. 4082 and new sec. 6715A of the Code) 

PRESENT LAW

Statutory rules 

Gasoline, diesel fuel and kerosene are generally subject to excise 

tax upon removal from a refinery or terminal, upon importation 

into the United States, and upon sale to unregistered persons unless there was a prior taxable removal or importation of such 

fuels.414 However, a tax is not imposed upon diesel fuel or kerosene 

if all of the following are met: (1) the Secretary determines that the 

fuel is destined for a nontaxable use, (2) the fuel is indelibly dyed 

in accordance with regulations prescribed by the Secretary,415 and 

(3) the fuel meets marking requirements prescribed by the Secretary.416 A nontaxable use is defined as (1) any use that is exempt 

from the tax imposed by section 4041(a)(1) other than by reason of 

a prior imposition of tax, (2) any use in a train, or (3) certain uses 

328

417Sec. 4082(b). 418Sec. 4082(e). 419Sec. 6715(a). 420Sec. 6715(a). 421Sec. 6715(b). 422Sec. 6715(d). 423Sec. 6715(c)(1). 424Treas. Reg. secs. 48.4082–1, –2. 425 In March 2000, the IRS withdrew its Notice of Proposed Rulemaking PS–6–95 (61 F.R. 

10490 (1996)) relating to dye injection systems. Announcement 2000–42, 2000–1 C.B. 949. The 

proposed regulation established standards for mechanical dye injection equipment and required 

terminal operators to report nonconforming dyeing to the IRS. See also Treas. Reg. sec. 48.4082– 1(c), (d).

in buses for public and school transportation, as described in section 6427(b)(1) (after application of section 6427(b)(3)).417

The Secretary is required to prescribe necessary regulations relating to dyeing, including specifically the labeling of retail diesel 

fuel and kerosene pumps.418

A person who sells dyed fuel (or holds dyed fuel for sale) for any 

use that such person knows (or has reason to know) is a taxable 

use, or who willfully alters or attempts to alter the dye in any dyed 

fuel, is subject to a penalty.419 The penalty also applies to any person who uses dyed fuel for a taxable use (or holds dyed fuel for 

such a use) and who knows (or has reason to know) that the fuel 

is dyed.420 The penalty is the greater of $1,000 per act or $10 per 

gallon of dyed fuel involved. In determining the amount of the penalty, the $1,000 is increased by the product of $1,000 and the number of prior penalties imposed upon such person (or a related person or predecessor of such person or related person).421 The penalty 

may be imposed jointly and severally on any business entity, each 

officer, employee, or agent of such entity who willfully participated 

in any act giving rise to such penalty.422 For purposes of the penalty, the term ‘‘dyed fuel’’ means any dyed diesel fuel or kerosene, 

whether or not the fuel was dyed pursuant to section 4082.423

Regulations 

The Secretary has prescribed certain regulations under this provision, including regulations that specify the allowable types and 

concentration of dye, that the person claiming the exemption must 

be a taxable fuel registrant, that the terminal must be an approved 

terminal (in the case of a removal from a terminal rack), and the 

contents of the notice to be posted on diesel fuel and kerosene 

pumps.424 However, the regulations do not prescribe the time or 

method of adding the dye to taxable fuel.425 Diesel fuel is usually 

dyed at a terminal rack by either manual dyeing or mechanical injection. 

REASONS FOR CHANGE

The Federal government, State governments, and various segments of the petroleum industry have long been concerned with the 

problem of diesel fuel tax evasion. To address this problem, Congress changed the law to require that untaxed diesel fuel be indelibly dyed. The Committee is concerned, however, that tax can still 

be evaded through removals at a terminal of undyed fuel that has 

been designated as dyed. 

Manual dyeing is inherently difficult to monitor. It occurs after 

diesel fuel has been withdrawn from a terminal storage tank, generally requires the work of several people, is imprecise, and does 

329

not automatically create a reliable record. The Committee believes 

that requiring that untaxed diesel fuel be dyed only by mechanical 

injection will significantly reduce the opportunities for diesel fuel 

tax evasion. 

The Committee further believes that security of such mechanical 

dyeing systems will be enhanced by the establishment of standards 

for making such systems tamper resistant, and by the addition of 

new penalties for tampering with such mechanical dyeing systems 

and for failing to maintain the established security standards for 

such systems. In furtherance of the enforcement of these penalties 

in the case of business entities, it is appropriate to impose joint 

and several liability for such penalties upon natural persons who 

have willfully participated in any act giving rise to these penalties 

and upon the parent corporation of an affiliated group of which the 

business entity is a member. 

EXPLANATION OF PROVISION

With respect to terminals that offer dyed fuel, the provision 

eliminates manual dyeing of fuel and requires dyeing by a mechanical system. Not later than 180 days after enactment of this provision, the Secretary of the Treasury is to prescribe regulations establishing standards for tamper resistant mechanical injector dyeing. Such standards shall be reasonable, cost-effective, and establish levels of security commensurate with the applicable facility. 

The provision adds an additional set of penalties for violation of 

the new rules. A penalty, equal to the greater of $25,000 or $10 for 

each gallon of fuel involved, applies to each act of tampering with 

a mechanical dye injection system. The person committing the act 

is also responsible for any unpaid tax on removed undyed fuel. A 

penalty of $1,000 is imposed for each failure to maintain security 

for mechanical dye injection systems. An additional penalty of 

$1,000 is imposed for each day any such violation remains uncorrected after the first day such violation has been or reasonably 

should have been discovered. For purposes of the daily penalty, a 

violation may be corrected by shutting down the portion of the system causing the violation. If any of these penalties are imposed on 

any business entity, each officer, employee, or agent of such entity 

or other contracting party who willfully participated in any act giving rise to such penalty shall be jointly and severally liable with 

such entity for such penalty. If such business entity is part of an 

affiliated group, the parent corporation of such entity shall be jointly and severally liable with such entity for the penalty. 

EFFECTIVE DATE

The provision is effective 180 days after the date that the Secretary issues the required regulations. The Secretary must issue 

such regulations no later than 180 days after enactment.

330

426 ‘‘Taxable fuel’’ means gasoline, diesel fuel, and kerosene. Sec. 4083(a). 427Sec. 4083(c)(1)(A). 428Treas. Reg. sec. 48.4083–1(c)(1). 429Sec. 4081(a)(1)(A). 430Sec. 4081(a)(1)(B). The sale of a taxable fuel to an unregistered person prior to a taxable 

removal or entry of the fuel is subject to tax. Sec. 4081(a)(1)(A). 

4. Authority to inspect on-site records (sec. 654 of the bill and sec. 

4083 of the Code) 

PRESENT LAW

The IRS is authorized to inspect any place where taxable fuel 426

is produced or stored (or may be stored). The inspection is authorized to: (1) examine the equipment used to determine the amount 

or composition of the taxable fuel and the equipment used to store 

the fuel; and (2) take and remove samples of taxable fuel. Places 

of inspection include, but are not limited to, terminals, fuel storage 

facilities, retail fuel facilities or any designated inspection site.427

In conducting the inspection, the IRS may detain any receptacle 

that contains or may contain any taxable fuel, or detain any vehicle 

or train to inspect its fuel tanks and storage tanks. The scope of 

the inspection includes the book and records kept at the place of 

inspection to determine the excise tax liability under section 

4081.428

REASONS FOR CHANGE

The Committee believes it is appropriate to expand the authority 

of the IRS to make on-site inspections of books and records. The 

Committee believes that such expanded authority will aid in the 

detection of fuel tax evasion and the enforcement of Federal fuel 

taxes. 

EXPLANATION OF PROVISION

The provision expands the scope of the inspection to include any 

books, records, or shipping papers pertaining to taxable fuel located 

in any authorized inspection location. 

EFFECTIVE DATE

The provision effective on the date on enactment.

5. Registration of pipeline or vessel operators required for exemption of bulk transfers to registered terminals or refineries (sec. 

655 of the bill and sec. 4081 of the Code) 

PRESENT LAW

In general, gasoline, diesel fuel, and kerosene (‘‘taxable fuel’’) are 

taxed upon removal from a refinery or a terminal.429 Tax also is 

imposed on the entry into the United States of any taxable fuel for 

consumption, use, or warehousing. The tax does not apply to any 

removal or entry of a taxable fuel transferred in bulk (a ‘‘bulk 

transfer’’) to a terminal or refinery if both the person removing or 

entering the taxable fuel and the operator of such terminal or refinery are registered with the Secretary.430

Present law does not require that the vessel or pipeline operator 

that transfers fuel as part of a bulk transfer be registered in order 

for the transfer to be exempt. For example, a registered refiner 

331

431Treas. Reg. sec. 48.4081–3(e)(2). 432Treas. Reg. sec. 48.4081–3(b). 433Sec. 4101; Treas. Reg. sec. 48.4101–1(a) and (c)(1). 434Sec. 7272(a). 435Sec. 7232. 

may transfer fuel to an unregistered vessel or pipeline operator 

who in turn transfers fuel to a registered terminal operator. The 

transfer is exempt despite the intermediate transfer to an unregistered person. 

In general, the owner of the fuel is liable for payment of tax with 

respect to bulk transfers not received at an approved terminal or 

refinery.431 The refiner is liable for payment of tax with respect to 

certain taxable removals from the refinery.432

REASONS FOR CHANGE

The Committee is concerned that unregistered pipeline and vessel operators are receiving bulk transfers of taxable fuel, and then 

diverting the fuel to retailers or end users without the tax ever 

being paid. The Committee believes that requiring that a pipeline 

or vessel operator be registered with the IRS in order for a bulk 

transfer exemption to be valid, in combination with other provisions that impose penalties relating to registration, will help to ensure that transfers of fuel in bulk are delivered as intended to approved refineries and terminals and taxed appropriately. 

EXPLANATION OF PROVISION

The provision requires that for a bulk transfer of a taxable fuel 

to be exempt from tax, any pipeline or vessel operator that is a 

party to the bulk transfer be registered with the Secretary. Transfer to an unregistered party will subject the transfer to tax. 

The Secretary is required to publish periodically a list of all registered persons that are required to register. 

EFFECTIVE DATE

The provision is effective on October 1, 2004, except that the Secretary is required to publish the list of registered persons beginning on July 1, 2004. 

6. Display of registration and penalties for failure to display registration and to register (secs. 656 and 657 of the bill, secs. 

4101, 7232, 7272 and new secs. 6717 and 6718 of the Code) 

PRESENT LAW

Blenders, enterers, pipeline operators, position holders, refiners, 

terminal operators, and vessel operators are required to register 

with the Secretary with respect to fuels taxes imposed by sections 

4041(a)(1) and 4081.433 A non-assessable penalty for failure to reg- ister is $50.434 A criminal penalty of $5,000, or imprisonment of not 

more than five years, or both, together with the costs of prosecution 

also applies to a failure to register and to certain false statements 

made in connection with a registration application.435

REASONS FOR CHANGE

Registration with the Secretary is a critical component of enabling the Secretary to regulate the movement and use of taxable 

332

436Sec. 4010(d); Treas. Reg. sec. 48.4101–2. The reports are required to be filed by the end 

of the month following the month to which the report relates. 437 An approved terminal is a terminal that is operated by a taxable fuel registrant that is 

a terminal operator. Treas. Reg. sec. 48.4081–1(b). 

fuels and ensure that the appropriate excise taxes are being collected. The Committee believes that present law penalties are not 

severe enough to ensure that persons that are required to register 

in fact register. Accordingly, the Committee believes it is appropriate to increase present law penalties significantly and to add a 

new assessable penalty for failure to register. In addition, the Committee believes that persons that do business with vessel operators 

should be able easily to verify whether the vessel operator is registered. Thus, the Committee requires that vessel operators display 

proof of registration on their vessels and imposes an attendant penalty for failure to display such proof. 

EXPLANATION OF PROVISION

The provision requires that every operator of a vessel who is required to register with the Secretary display on each vessel used 

by the operator to transport fuel, proof of registration through an 

electronic identification device prescribed by the Secretary. A failure to display such proof of registration results in a penalty of $500 

per month per vessel. The amount of the penalty is increased for 

multiple prior violations. No penalty is imposed upon a showing by 

the taxpayer of reasonable cause. The provision authorizes 

amounts equivalent to the penalties received to be appropriated to 

the Highway Trust Fund. 

The provision imposes a new assessable penalty for failure to register of $10,000 for each initial failure, plus $1,000 per day that 

the failure continues. No penalty is imposed upon a showing by the 

taxpayer of reasonable cause. In addition, the provision increases 

the present-law non-assessable penalty for failure to register from 

$50 to $10,000 and the present law criminal penalty for failure to 

register from $5,000 to $10,000. The provision authorizes amounts 

equivalent to any of such penalties received to be appropriated to 

the Highway Trust Fund. 

EFFECTIVE DATE

The provision requiring display of registration is effective on October 1, 2004. The provision relating to penalties is effective for 

penalties imposed after September 30, 2004. 

7. Penalties for failure to report (sec. 657 of the bill and new sec. 

6725 of the Code) 

PRESENT LAW

A fuel information reporting program, the Excise Summary Terminal Activity Reporting System (‘‘ExSTARS’’), requires terminal 

operators and bulk transport carriers to report monthly on the 

movement of any liquid product into or out of an approved terminal.436 Terminal operators file Form 720–TO—Terminal Operator Report, which shows the monthly receipts and disbursements 

of all liquid products to and from an approved terminal.437 Bulk 

transport carriers (barges, vessels, and pipelines) that receive liquid product from an approved terminal or deliver liquid product to 

333

438Sec. 6721(a). 439Sec. 4081(a)(1)(A)(iii). 

an approved terminal file Form 720–CS—Carrier Summary Report, 

which details such receipts and disbursements. In general, the penalty for failure to file a report or a failure to furnish all of the required information in a report is $50 per report.438

REASONS FOR CHANGE

The Committee believes that the proper and timely reporting of 

the disbursements of taxable fuels under the ExSTARs system is 

essential to the Treasury Department’s ability to monitor and enforce the excise fuels taxes. Accordingly, the Committee believes it 

is appropriate to provide for significant penalties if required information is not provided accurately, completely, and on a timely 

basis. 

EXPLANATION OF PROVISION

The provision imposes a new assessable penalty for failure to file 

a report or to furnish information required in a report required by 

the ExSTARS system. The penalty is $10,000 per failure with respect to each vessel or facility (e.g., a terminal or other facility) for 

which information is required to be furnished. No penalty is imposed upon a showing by the taxpayer of reasonable cause. The 

provision authorizes amounts equivalent to the penalties received 

to be appropriated to the Highway Trust Fund. 

EFFECTIVE DATE

The provision is effective for penalties imposed after September 

30, 2004. 

8. Collection from Customs bond where importer not registered 

(sec. 658 of the bill and new sec. 4104 of the Code) 

PRESENT LAW

Typically, gasoline, diesel fuel, and kerosene are transferred by 

pipeline or barge in large quantities (‘‘bulk’’) to terminal storage facilities that geographically are located closer to destination retail 

markets. A fuel is taxed when it ‘‘breaks bulk,’’ i.e., when it is removed from the refinery or terminal, typically by truck or rail car, 

for delivery to a smaller wholesale facility or a retail outlet. The 

party liable for payment of the taxes is the ‘‘position holder,’’ i.e., 

the person shown on the records of the terminal facility as owning 

the fuel. 

Tax is also imposed on the entry into the United States of any 

taxable fuel for consumption, use, or warehousing.439 This tax does 

not apply to any entry of a taxable fuel transferred in bulk to a 

terminal or refinery if the person entering the taxable fuel and the 

operator of such terminal or refinery are registered. The ‘‘enterer’’

is liable for the tax. An enterer generally means the importer of 

record (under customs law) with respect to the taxable fuel. However, if the importer of record is acting as an agent (a broker for 

example), the person for whom the agent is acting is the enterer. 

If there is no importer of record for taxable fuel entered into the 

United States, the owner of the taxable fuel at the time it is 

334

440 19 C.F.R. sec. 141.3 (2004). 441Sec. 4481.

brought into the United States is the enterer. An importer’s liability for Customs duties includes a liability for any internal revenue 

taxes that attach upon the importation of merchandise unless otherwise provided by law or regulation.440

As a part of the entry documentation, the importer, consignee, or 

an authorized agent usually is required to file a bond with Customs. The bond, among other things, guarantees that proper entry 

summary, with payment of estimated duties and taxes when due, 

will be made for imported merchandise and that any additional duties and taxes subsequently found to be due will be paid.

As a condition of permitting anyone to be registered with the 

IRS, under section 4101 of the Code, the Secretary may require 

that such person give a bond in such sum as the Secretary determines appropriate. 

REASONS FOR CHANGE

It is the Committee’s understanding that fuel is brought into the 

United States by unregistered parties and the appropriate tax is 

not being remitted. Therefore, the Committee believes it is appropriate to allow the Secretary to recover the tax due from the Customs bond. 

EXPLANATION OF PROVISION

Under the provision, the importer of record is jointly and severally liable for the tax imposed upon entry of fuel into the United 

States if, under regulations, any other person that is not registered 

with the Secretary as a taxable fuel registrant is liable for such 

tax. If the importer of record is liable for the tax and such tax is 

not paid on or before the last date prescribed for payment, the Secretary may collect such tax from the Customs bond posted with respect to the importation of the taxable fuel to which the tax relates. 

For purposes of determining the jurisdiction of any court of the 

United States or any agency of the United States, any action by the 

Secretary to collect the tax from the Customs bond is treated as an 

action to collect tax from a bond authorized by section 4101 of the 

Code, not as an action to collect from a bond relating to the importation of merchandise. 

EFFECTIVE DATE

The provision is effective for fuel entered after September 30, 

2004. 

9. Modification of the use tax on heavy highway vehicles (sec. 659 

of the bill and secs. 4481, 4483 and 6165 of the Code) 

PRESENT LAW

An annual use tax is imposed on heavy highway vehicles, at the 

rates below.441

Under 55,000 pounds ................................ No tax. 

55,000–75,000 pounds ............................... $100 plus $22 per 1,000 pounds over 

55,000. 

Over 75,000 pounds .................................. $550. 

335

442Sec. 6156. 443See generally, sec. 4483. 444Sec. 4483(f): Treas. Reg. sec. 41.4483–7(a). 

The annual use tax is imposed for a taxable period of July 1 

through June 30. Generally, the tax is paid by the person in whose 

name the vehicle is registered. In certain cases, taxpayers are allowed to pay the tax in installments.442 State governments are required to receive proof of payment of the use tax as a condition of 

vehicle registration. 

Exemptions and reduced rates are provided for certain ‘‘transittype buses,’’ trucks used for fewer than 5,000 miles on public highways (7,500 miles for agricultural vehicles), and logging trucks.443

Any highway motor vehicle that is issued a base plate by Canada 

or Mexico and is operated on U.S. highways is subject to the highway use tax whether or not the vehicles are required to be registered in the United States. The tax rate for Canadian and Mexican vehicles is 75 percent of the rate that would otherwise be imposed.444

REASONS FOR CHANGE

The Committee notes that in the case of taxpayers that elect 

quarterly installment payments, the IRS has no procedure for ensuring that installments subsequent to the first one actually are 

paid. Thus, it is possible for taxpayers to receive State registrations 

when only the first quarterly installment is paid with the return. 

Similarly, it is possible for taxpayers repeatedly to pay the first 

quarterly installment and continue to receive State registrations 

because the IRS has no computerized system for checking past 

compliance when it issues certificates of payment for the current 

year. In the case of taxpayers owning only one or a few vehicles, 

it is not cost effective for the IRS to monitor and enforce compliance. Thus, the Committee believes it is appropriate to eliminate 

the ability of taxpayers to pay the use tax in installments. The 

Committee also believes that Canadian and Mexican vehicles operating on U.S. highways should be subject to the full amount of use 

tax, as such vehicles contribute to the wear and tear on U.S. highways. 

EXPLANATION OF PROVISION

The provision eliminates the ability to pay the tax in installments. It also eliminates the reduced rates for Canadian and Mexican vehicles. The provision requires taxpayers with 25 or more vehicles for any taxable period to file their returns electronically. Finally, the provision permits proration of tax for vehicles sold during 

the taxable period. 

EFFECTIVE DATE

The provision is effective for taxable periods beginning after the 

date of enactment.

336

10. Modification of ultimate vendor refund claims with respect to 

farming (sec. 660 of the bill and sec. 6427 of the Code) 

PRESENT LAW

In general, the Code provides that, if diesel fuel, kerosene, or 

aviation fuel on which tax has been imposed is used by any person 

in a nontaxable use, the Secretary is to refund (without interest) 

the amount of tax imposed. The refund is made to the ultimate 

purchaser of the taxed fuel. However, in the case of diesel fuel or 

kerosene used on a farm for farming purposes or by a State or local 

government, refund payments are paid to the ultimate, registered 

vendors (‘‘ultimate vendors’’) of such fuels. 

REASONS FOR CHANGE

The Committee reaffirms its belief that fuel used for farming 

purposes be exempt from tax, but is concerned that, when large 

quantities of undyed, or clear, diesel fuel or kerosene are sold for 

exempt uses and a refund claimed by the ‘‘ultimate vendor,’’ there 

is an increased possibility of diversion of fuel to taxable uses. If 

there were no expense to the provision and storage of dyed fuel, 

and if dyed fuel were easily available at all times and locations, the 

Committee would prefer that only dyed fuel be sold for exempt purposes. However, the Committee recognizes that, to insure sufficient 

quantities of fuel are available in a timely manner for farming purposes, sometimes clear fuel must be sold to the farmer. In such circumstances, a refund for the tax paid in the price of the clear fuel 

is appropriate. The Committee believes that the person engaged in 

farming who purchases the clear fuel is in the best position to certify that the taxed fuel is, in fact, used for farming purposes and 

therefore it is more appropriate for such a person to claim refunds, 

rather than the ‘‘ultimate vendor’’ who, as a dealer in fuels, really 

has no knowledge as to what use the fuel will be put. Notwithstanding this general conclusion, the Committee believes it is appropriate to permit ‘‘ultimate vendor’’ refunds when small amounts 

of fuel are purchased to ease the filing burden on farmers who purchase small quantities of clear fuel. 

EXPLANATION OF PROVISION

In the case of diesel fuel or kerosene used on a farm for farming 

purposes, the provision limits ultimate vendor claims for refund to 

sales of such fuel in amounts less than 250 gallons per farmer per 

claim. 

EFFECTIVE DATE

The provision is effective for fuels sold for nontaxable use after 

the date of enactment. 

11. Dedication of revenue from certain penalties to the Highway 

Trust Fund (sec. 661 of the bill and sec. 9503 of the Code) 

PRESENT LAW

Present law does not dedicate to the Highway Trust Fund any 

penalties assessed and collected by the Secretary. 

337

REASONS FOR CHANGE

The Committee believes it is appropriate to dedicate to the Highway Trust Fund penalties associated with the administration and 

enforcement of taxes supporting the Highway Trust Fund. 

EXPLANATION OF PROVISION

The provision dedicates to the Highway Trust Fund amounts 

equivalent to the penalties paid under sections 6715 (relating to 

dyed fuel sold for use or used in taxable use), 6715A (penalty for 

tampering or failing to maintain security requirements for mechanical dye injection systems), 6717 (penalty for failing to display tax 

registration on vessels), 6718 (penalty for failing to register under 

section 4101), 6725 (penalty for failing to report information required by the Secretary), 7232 (penalty for failing to register and 

false representations of registration status), and 7272 (but only 

with regard to penalties related to failure to register under section 

4101). 

EFFECTIVE DATE

The provision is effective October 1, 2004. 

12. Taxable fuel refunds for certain ultimate vendors (sec. 662 of 

the bill and secs. 6416 and 6427 of the Code) 

PRESENT LAW

The Code provides that, in the case of gasoline on which tax has 

been paid and sold to a State or local government, to a nonprofit 

educational organization, for supplies for vessels or aircraft, for export, or for the production of special fuels, a wholesale distributor 

that sells the gasoline for such exempt purposes is treated as the 

person who paid the tax and thereby is the proper claimant for a 

credit or refund of the tax paid. In the case of undyed diesel fuel 

or kerosene used on a farm for farming purposes or by a State or 

local government, a credit or payment is allowable only to the ultimate, registered vendors (‘‘ultimate vendors’’) of such fuels. 

In general, refunds are paid without interest. However, in the 

case of overpayments of tax on gasoline, diesel fuel, or kerosene 

that is used to produce a qualified alcohol mixture and for refunds 

due ultimate vendors of diesel fuel or kerosene used on a farm for 

farming purposes or by a State or local government, the Secretary 

is required to pay interest on certain refunds. The Secretary must 

pay interest on refunds of $200 or more ($100 or more in the case 

of kerosene) due to the taxpayer arising from sales over any period 

of a week or more, if the Secretary does not make payment of the 

refund within 20 days. 

REASONS FOR CHANGE

The Committee observes that refund procedures for gasoline differ from those for diesel fuel and kerosene. The Committee believes 

that simplification of administration can be achieved for both taxpayers and the IRS by providing a more uniform refund procedure 

applicable to all taxed highway fuels. The Committee further believes that compliance can be increased and administration made 

less costly by increased use of electronic filing.

338

The Committee further observes that often State and local governments find it prudent to monitor and pay for fuel purchases by 

the use of a credit card, fleet buying card, or similar arrangement. 

In such a case the person extending the credit stands between the 

vendor of fuel and purchaser of fuel (the State or local government) 

in an exempt transaction, and the person extending the credit insures payment of the fuel bill thereby paying the amount of any 

tax owed that is embedded in the price of the fuel. In addition, because the person extending credit to the tax-exempt purchaser has 

a contractual relationship with the tax-exempt user, the person extending the credit should be best able to establish that the fuel 

should be sold at a tax-exempt price. The Committee believes that 

in such a situation it is appropriate to deem the person extending 

the credit to hold ultimate vendor status, not withstanding that 

such a person is not actually a vendor of fuel. The Committee observes that the billing service provided by the person extending 

credit to the tax-exempt purchaser creates a ‘‘paper trail’’ that 

should facilitate compliance and aid in any necessary audits that 

the IRS may undertake. 

EXPLANATION OF PROVISION

For sales of gasoline to a State or local government for the exclusive use of a State or local government or to a nonprofit educational organization for its exclusive use on which tax has been 

imposed, the provision conforms the payment of refunds to that 

procedure established under present law in the case of diesel fuel 

or kerosene. That is, the ultimate vendor claims for refund. 

The provision modifies the payment of interest on refunds. Under 

the provision, in the case of overpayments of tax on gasoline, diesel 

fuel, or kerosene that is used to produce a qualified alcohol mixture 

and for refunds due ultimate vendors of diesel fuel or kerosene 

used on a farm for farming purposes or by a State or local government, all refunds unpaid after 45 days must be paid with interest. 

If the taxpayer has filed for his or her refund by electronic means, 

refunds unpaid after 20 days must be paid with interest. 

Lastly, for claims for refund of tax paid on diesel fuel or kerosene 

sold to State and local governments or for sales of gasoline to a 

State or local government for the exclusive use of a State or local 

government or to a nonprofit educational organization for its exclusive use on which tax has been imposed and for which the ultimate 

purchaser utilized a credit card, the provision deems the person extending the credit to the ultimate purchaser to be the ultimate vendor. That is, the person extending credit via a credit card administers claims for refund, and is responsible for supplying all the appropriate documentation currently required from ultimate vendors. 

EFFECTIVE DATE

The provision is effective on October 1, 2004. 

339

445 A ‘‘terminal’’ is a storage and distribution facility that is supplied by pipeline or vessel, 

and from which fuel may be removed at a rack. A ‘‘rack’’ is a mechanism capable of delivering 

taxable fuel into a means of transport other than a pipeline or vessel. 446Such person has a contractual agreement with the terminal operator to store and provide 

services with respect to the fuel. A ‘‘terminal operator’’ is any person who owns, operates, or 

otherwise controls a terminal. A terminal operator can also be a position holder if that person 

owns fuel in its terminal. 447 In the provision, this person is referred to as the ‘‘delivering person.’’

13. Two party exchanges (sec. 663 of the bill and new sec. 4105 of 

the Code) 

PRESENT LAW

Most fuel is taxed when it is removed from a registered terminal.445 The party liable for payment of this tax is the ‘‘position 

holder.’’ The position holder is the person reflected on the records 

of the terminal operator as holding the inventory position in the 

fuel.446

It is common industry practice for oil companies to serve customers of other oil companies under exchange agreements, e.g., 

where Company A’s terminal is more conveniently located for 

wholesale or retail customers of Company B. In such cases, the exchange agreement party (Company B in the example) owns the fuel 

when the motor fuel is removed from the terminal and sold to B’s 

customer. 

REASONS FOR CHANGE

The Committee believes it is appropriate to recognize industry 

practice under exchange agreements by relieving the original position holder of tax liability for the removal of a taxable fuel from 

a terminal if certain circumstances are met. 

EXPLANATION OF PROVISION

The provision permits two registered parties to switch position 

holder status in fuel within a registered terminal (thereby relieving 

the person originally owning the fuel 447 of tax liability as the position holder) if all of the following occur: 

(1) The transaction includes a transfer from the original owner, 

i.e., the person who holds the original inventory position for taxable 

fuel in the terminal as reflected in the records of the terminal operator prior to the transaction. 

(2) The exchange transaction occurs at the same time as completion of removal across the rack from the terminal by the receiving 

person or its customer. 

(3) The terminal operator in its books and records treats the receiving person as the person that removes the product across a terminal rack for purposes of reporting the transaction to the Internal 

Revenue Service.

(4) The transaction is the subject of a written contract. 

EFFECTIVE DATE

The provision is effective on the date of enactment. 

340

14. Simplification of tax on tires (sec. 664 of the bill and sec. 4071 

of the Code) 

PRESENT LAW

A graduated excise tax is imposed on the sale by a manufacturer 

(or importer) of tires designed for use on highway vehicles (sec. 

4071). The tire tax rates are as follows:

Tire weight Tax rate 

Not more than 40 lbs. ............................... No tax. 

More than 40 lbs., but not more than 70 

lbs.

15 cents/lb. in excess of 40 lbs 

More than 70 lbs., but not more than 90 

lbs.

$4.50 plus 30 cents/lb. in excess of 70 

lbs. 

More than 90 lbs. ...................................... $10.50 plus 50 cents/lb. in excess of 90 

lbs. 

No tax is imposed on the recapping of a tire that previously has 

been subject to tax. Tires of extruded tiring with internal wire fastening also are exempt. 

The tax expires after September 30, 2005. 

REASONS FOR CHANGE

Under present law, the tire excise tax is based on the weight of 

each tire. This forces tire manufacturers to weigh sample batches 

of every type of tire made and collect the tax based on that weight. 

This regime also makes it difficult for the IRS to measure and enforce compliance with the tax, as the IRS likewise must weigh sample batches of tires to ensure compliance. The Committee believes 

significant administrative simplification for both tire manufacturers and the IRS will be achieved if the tax were based on the 

weight carrying capacity of the tire, rather than the weight of the 

tire, because Department of Transportation requires the load rating to be stamped on the side of highway tires. Thus, both the 

manufacturer and the IRS will know immediately whether a tire 

is taxable and how much tax should be paid. 

EXPLANATION OF PROVISION

The provision modifies the excise tax applicable to tires. The provision replaces the present-law tax rates based on the weight of the 

tire with a tax rate based on the load capacity of the tire. In general, the tax is 9.4 cents for each 10 pounds of tire load capacity 

in excess of 3,500 pounds. In the case of a biasply tire, the tax rate 

is 4.7 cents for each 10 pounds of tire load capacity in excess of 

3,500 pounds. 

The provision modifies the definition of tires for use on highway 

vehicles to include any tire marked for highway use pursuant to 

certain regulations promulgated by the Secretary of Transportation. The provision also exempts from tax any tire sold for the 

exclusive use of the United States Department of Defense or the 

United States Coast Guard. 

Tire load capacity is the maximum load rating labeled on the tire 

pursuant to regulations promulgated by the Secretary of Transportation. A biasply tire is any tire manufactured primarily for use on 

piggyback trailers. 

341

448See, e.g., Sproull v. Commissioner, 16 T.C. 244 (1951), aff’d per curiam, 194 F.2d 541 (6th 

Cir. 1952); Rev. Rul. 60–31, 1960–1 C.B. 174. 449Treas. Reg. sec. 1.83–3(e). This definition in part reflects previous IRS rulings on nonqualified deferred compensation. 

EFFECTIVE DATE

The provision is effective for sales in calendar years beginning 

more than 30 days after the date of enactment.

D. NONQUALIFIED DEFERRED COMPENSATION PLANS

1. Treatment of nonqualified deferred compensation plans (sec. 671 

of the bill and new sec. 409A and sec. 6051 of the Code) 

PRESENT LAW

In general 

The determination of when amounts deferred under a nonqualified deferred compensation arrangement are includible in the 

gross income of the individual earning the compensation depends 

on the facts and circumstances of the arrangement. A variety of tax 

principles and Code provisions may be relevant in making this determination, including the doctrine of constructive receipt, the economic benefit doctrine,448 the provisions of section 83 relating generally to transfers of property in connection with the performance 

of services, and provisions relating specifically to nonexempt employee trusts (sec. 402(b)) and nonqualified annuities (sec. 403(c)). 

In general, the time for income inclusion of nonqualified deferred 

compensation depends on whether the arrangement is unfunded or 

funded. If the arrangement is unfunded, then the compensation is 

generally includible in income when it is actually or constructively 

received. If the arrangement is funded, then income is includible 

for the year in which the individual’s rights are transferable or not 

subject to a substantial risk of forfeiture. 

Nonqualified deferred compensation is generally subject to social 

security and Medicare taxes when the compensation is earned (i.e., 

when services are performed), unless the nonqualified deferred 

compensation is subject to a substantial risk of forfeiture. If nonqualified deferred compensation is subject to a substantial risk of 

forfeiture, it is subject to social security and Medicare tax when the 

risk of forfeiture is removed (i.e., when the right to the nonqualified deferred compensation vests). Amounts deferred under a 

nonaccount balance plan that are not reasonably ascertainable are 

not required to be taken into account as wages subject to social security and Medicare taxes until the first date that such amounts 

are reasonably ascertainable. Social security and Medicare tax 

treatment is not affected by whether the arrangement is funded or 

unfunded, which is relevant in determining when amounts are includible in income (and subject to income tax withholding). 

In general, an arrangement is considered funded if there has 

been a transfer of property under section 83. Under that section, 

a transfer of property occurs when a person acquires a beneficial 

ownership interest in such property. The term ‘‘property’’ is defined 

very broadly for purposes of section 83.449 Property includes real 

and personal property other than money or an unfunded and unsecured promise to pay money in the future. Property also includes 

342

450Treas. Reg. secs. 1.451–1 and 1.451–2. 451This conclusion was first provided in a 1980 private ruling issued by the IRS with respect 

to an arrangement covering a rabbi; hence the popular name ‘‘rabbi trust.’’ Priv. Ltr. Rul. 

8113107 (Dec. 31, 1980). 452 Rev. Proc. 92–64, 1992–2 C.B. 422, modified in part by Notice 2000–56, 2000–2 C.B. 393. 

a beneficial interest in assets (including money) that are transferred or set aside from claims of the creditors of the transferor, for 

example, in a trust or escrow account. Accordingly, if, in connection 

with the performance of services, vested contributions are made to 

a trust on an individual’s behalf and the trust assets may be used 

solely to provide future payments to the individual, the payment of 

the contributions to the trust constitutes a transfer of property to 

the individual that is taxable under section 83. On the other hand, 

deferred amounts are generally not includible in income if nonqualified deferred compensation is payable from general corporate 

funds that are subject to the claims of general creditors, as such 

amounts are treated as unfunded and unsecured promises to pay 

money or property in the future. 

As discussed above, if the arrangement is unfunded, then the 

compensation is generally includible in income when it is actually 

or constructively received under section 451.450 Income is constructively received when it is credited to an individual’s account, set 

apart, or otherwise made available so that it may be drawn on at 

any time. Income is not constructively received if the taxpayer’s 

control of its receipt is subject to substantial limitations or restrictions. A requirement to relinquish a valuable right in order to 

make withdrawals is generally treated as a substantial limitation 

or restriction. 

Rabbi trusts 

Arrangements have developed in an effort to provide employees 

with security for nonqualified deferred compensation, while still allowing deferral of income inclusion. A ‘‘rabbi trust’’ is a trust or 

other fund established by the employer to hold assets from which 

nonqualified deferred compensation payments will be made. The 

trust or fund is generally irrevocable and does not permit the employer to use the assets for purposes other than to provide nonqualified deferred compensation, except that the terms of the trust 

or fund provide that the assets are subject to the claims of the employer’s creditors in the case of insolvency or bankruptcy. 

As discussed above, for purposes of section 83, property includes 

a beneficial interest in assets set aside from the claims of creditors, 

such as in a trust or fund, but does not include an unfunded and 

unsecured promise to pay money in the future. In the case of a 

rabbi trust, terms providing that the assets are subject to the 

claims of creditors of the employer in the case of insolvency or 

bankruptcy have been the basis for the conclusion that the creation 

of a rabbi trust does not cause the related nonqualified deferred 

compensation arrangement to be funded for income tax purposes.451 As a result, no amount is included in income by reason 

of the rabbi trust; generally income inclusion occurs as payments 

are made from the trust. 

The IRS has issued guidance setting forth model rabbi trust provisions.452 Revenue Procedure 92–64 provides a safe harbor for taxpayers who adopt and maintain grantor trusts in connection with 

343

453The staff of the Joint Committee on Taxation made recommendations similar to the new 

provision in the report on their investigation of Enron Corporation, which detailed how executives deferred millions of dollars in Federal income taxes through nonqualified deferred compensation arrangements. See Joint Committee on Taxation, Report of Investigation of Enron 

Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy 

Recommendations (JCS–3–03), February 2003. 454 A plan includes an agreement or arrangement, including an agreement or arrangement 

that includes one person. 

unfunded deferred compensation arrangements. The model trust 

language requires that the trust provide that all assets of the trust 

are subject to the claims of the general creditors of the company 

in the event of the company’s insolvency or bankruptcy. 

Since the concept of rabbi trusts was developed, arrangements 

have developed which attempt to protect the assets from creditors 

despite the terms of the trust. Arrangements also have developed 

which attempt to allow deferred amounts to be available to individuals, while still purporting to meet the safe harbor requirements 

set forth by the IRS. 

REASONS FOR CHANGE

The Committee is aware of the popular use of deferred compensation arrangements by executives to defer current taxation of 

substantial amounts of income. The Committee believes that many 

nonqualified deferred compensation arrangements have developed 

which allow improper deferral of income. Executives often use arrangements that allow deferral of income, but also provide security 

of future payment and control over amounts deferred. For example, 

nonqualified deferred compensation arrangements often contain 

provisions that allow participants to receive distributions upon request, subject to forfeiture of a minimal amount (i.e., a ‘‘haircut’’

provision). 

The Committee is aware that since the concept of a rabbi trust 

was developed, techniques have been used that attempt to protect 

the assets from creditors despite the terms of the trust. For example, the trust or fund may be located in a foreign jurisdiction, making it difficult or impossible for creditors to reach the assets. 

While the general tax principles governing deferred compensation are well established, the determination whether a particular 

arrangement effectively allows deferral of income is generally made 

on a facts and circumstances basis. There is limited specific guidance with respect to common deferral arrangements. The Committee believes that it is appropriate to provide specific rules regarding whether deferral of income inclusion should be permitted. 

The Committee believes that certain arrangements that allow 

participants inappropriate levels of control or access to amounts deferred should not result in deferral of income inclusion. The Committee also believes that certain arrangements, such as offshore 

trusts, which effectively protect assets from creditors, should be 

treated as funded and not result in deferral of income inclusion.453

EXPLANATION OF PROVISION

Under the provision, all amounts deferred under a nonqualified 

deferred compensation plan 454 for all taxable years are currently 

includible in gross income to the extent not subject to a substantial 

344

455 As under section 83, the rights of a person to compensation are subject to a substantial 

risk of forfeiture if the person’s rights to such compensation are conditioned upon the performance of substantial services by any individual. 456Key employees are defined in section 416(i) and generally include officers having annual 

compensation greater than $130,000 (adjusted for inflation and limited to 50 employees), five 

percent owners, and one percent owners having annual compensation from the employer greater 

than $150,000. 

risk of forfeiture 455 and not previously included in gross income, 

unless certain requirements are satisfied. If the requirements of 

the provision are not satisfied, in addition to current income inclusion, interest at the underpayment rate plus one percentage point 

is imposed on the underpayments that would have occurred had 

the compensation been includible in income when first deferred, or 

if later, when not subject to a substantial risk of forfeiture. Actual 

or notional earnings on amounts deferred are also subject to the 

provision. 

Under the provision, distributions from a nonqualified deferred 

compensation plan may be allowed only upon separation from service (as determined by the Secretary), death, a specified time (or 

pursuant to a fixed schedule), change in control in a corporation (to 

the extent provided by the Secretary), occurrence of an unforeseeable emergency, or if the participant becomes disabled. A nonqualified deferred compensation plan may not allow distributions 

other than upon the permissible distribution events and may not 

permit acceleration of a distribution, except as provided in regulations by the Secretary. 

In the case of a specified employee, distributions upon separation 

from service may not be made earlier than six months after the 

date of the separation from service. Specified employees are key 

employees 456 of publicly-traded corporations. 

Amounts payable at a specified time or pursuant to a fixed 

schedule must be specified under the plan at the time of deferral. 

Amounts payable upon the occurrence of an event are not treated 

as amounts payable at a specified time. For example, amounts payable when an individual attains age 65 are payable at a specified 

time, while amounts payable when an individual’s child begins college are payable upon the occurrence of an event. 

Distributions upon a change in the ownership or effective control 

of a corporation, or in the ownership of a substantial portion of the 

assets of a corporation, may only be made to the extent provided 

by the Secretary. It is intended that the Secretary use a similar, 

but more restrictive, definition of change in control as is used for 

purposes of the golden parachute provisions of section 280G consistent with the purposes of the provision. The provision requires 

the Secretary to issue guidance defining change of control within 

90 days after the date of enactment. 

An unforeseeable emergency is defined as a severe financial 

hardship to the participant resulting from a sudden and unexpected illness or accident of the participant, the participant’s 

spouse, or a dependent (as defined in 152(a)) of the participant; loss 

of the participant’s property due to casualty; or other similar extraordinary and unforeseeable circumstances arising as a result of 

events beyond the control of the participant. The amount of the distribution must be limited to the amount needed to satisfy the emergency plus taxes reasonably anticipated as a result of the distribution. Distributions may not be allowed to the extent that the hardVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00346 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.008 HR548P1
345

ship may be relieved through reimbursement or compensation by 

insurance or otherwise, or by liquidation of the participant’s assets 

(to the extent such liquidation would not itself cause a severe financial hardship). 

A participant is considered disabled if he or she (i) is unable to 

engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous 

period of not less than 12 months; or (ii) is, by reason on any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous 

period of not less than 12 months, receiving income replacement 

benefits for a period of not less than three months under an accident and health plan covering employees of the participant’s employer. 

As previously discussed, except as provided in regulations by the 

Secretary, no accelerations of distributions may be allowed. For example, changes in the form of a distribution from an annuity to a 

lump sum are not permitted. The provision provides the Secretary 

authority to provide, through regulations, limited exceptions to the 

general rule that no accelerations can be permitted. It is intended 

that exceptions be provided only in limited cases where the accelerated distribution is required for reasons beyond the control of the 

participant. For example, it is anticipated that an exception could 

be provided in order to comply with Federal conflict of interest requirements or court-approved settlements. 

The provision requires that the plan must provide that compensation for services performed during a taxable year may be deferred at the participant’s election only if the election to defer is 

made no later than the close of the preceding taxable year, or at 

such other time as provided in Treasury regulations. For example, 

it is expected that Treasury regulations provide that, in appropriate circumstances, elections to defer incentive bonuses earned 

over a period of several years may be made after the beginning of 

the service period, as long as such elections may in no event be 

made later than 12 months before the earliest date on which such 

incentive bonus is initially payable. The Secretary may consider 

other factors in determining the appropriate election period, such 

as when the amount of the bonus payment is determinable. It is 

expected that Treasury regulations will not permit any election to 

defer any bonus or other compensation if the timing of such election would be inconsistent with the purposes of the provision. 

Under the provision, in the first year that an employee becomes eligible for participation in a nonqualified deferred compensation 

plan, the election may be made within 30 days after the date that 

the employee is initially eligible. 

The time and form of distributions must be specified at the time 

of initial deferral. A plan could specify the time and form of payments that are to be made as a result of a distribution event (e.g., 

a plan could specify that payments upon separation of service will 

be paid in lump sum within 30 days of separation from service) or 

could allow participants to elect the time and form of payment at 

the time of the initial deferral election. If a plan allows participants 

to elect the time and form of payment, such election is subject to 

the rules regarding initial deferral elections under the provision. 

346

Under the provision, a plan may allow changes in the time and 

form of distributions subject to certain requirements. A nonqualified deferred compensation plan may allow a subsequent election to delay the timing or form of distributions only if: (1) the plan 

requires that such election cannot be effective for at least 12 

months after the date on which the election is made; (2) except in 

the case of elections relating to distributions on account of death, 

disability or unforeseeable emergency, the plan requires that the 

additional deferral with respect to which such election is made is 

for a period of not less than five years from the date such payment 

would otherwise have been made; and (3) the plan requires that an 

election related to a distribution to be made upon a specified time 

may not be made less than 12 months prior to the date of the first 

scheduled payment. It is expected that in limited cases, the Secretary shall issue guidance, consistent with the purposes of the provision, regarding to what extent elections to change a stream of 

payments are permissible. 

If impermissible distributions or elections are made, or if the 

nonqualified deferred compensation plan allows impermissible distributions or elections, all amounts deferred under the plan (including amounts deferred in prior years) are currently includible in income to the extent not subject to a substantial risk of forfeiture and 

not previously included in income. In addition, interest at the underpayment rate plus one percentage point is imposed on the underpayments that would have occurred had the compensation been 

includible in income when first deferred, or if later, when not subject to a substantial risk of forfeiture. 

Under the provision, in the case of assets set aside (directly or 

indirectly) in a trust (or other arrangement determined by the Secretary) for purposes of paying nonqualified deferred compensation, 

such assets are treated as property transferred in connection with 

the performance of services under section 83 (whether or not such 

assets are available to satisfy the claims of general creditors) at the 

time set aside if such assets are located outside of the United 

States or at the time transferred if such assets are subsequently 

transferred outside of the United States. Any subsequent increases 

in the value of, or any earnings with respect to, such assets are 

treated as additional transfers of property. Interest at the underpayment rate plus one percentage point is imposed on the underpayments that would have occurred had the amounts been includible in income for the taxable year in which first deferred or, if 

later, the first taxable year not subject to a substantial risk of forfeiture. It is expected that the Secretary shall provide rules for 

identifying the deferrals to which assets set aside are attributable, 

for situations in which assets equal to less than the full amount 

of deferrals are set aside. The Secretary has authority to exempt 

arrangements from the provision if the arrangements do not result 

in an improper deferral of U.S. tax and will not result in assets 

being effectively beyond the reach of creditors.

Under the provision, a transfer of property in connection with 

the performance of services under section 83 also occurs with respect to compensation deferred under a nonqualified deferred compensation plan if the plan provides that upon a change in the employer’s financial health, assets will be restricted to the payment 

of nonqualified deferred compensation. The transfer of property ocVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00348 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.008 HR548P1
347

457 A qualified employer plan also includes a section 501(c)(18) trust. 458 A governmental deferred compensation plan that is not an eligible deferred compensation 

plan is not a qualified employer plan. 

curs as of the earlier of when the assets are so restricted or when 

the plan provides that assets will be restricted. It is intended that 

the transfer of property occurs to the extent that assets are restricted or will be restricted with respect to such compensation. For 

example, in the case of a plan that provides that upon a change 

in the employer’s financial health, a trust will become funded to 

the extent of all deferrals, all amounts deferred under the plan are 

treated as property transferred under section 83. If a plan provides 

that deferrals of certain individuals will be funded upon a change 

in financial health, the transfer of property would occur with respect to compensation deferred by such individuals. Any subsequent increases in the value of, or any earnings with respect to, 

such assets are treated as additional transfers of property. Interest 

at the underpayment rate plus one percentage point is imposed on 

the underpayments that would have occurred had the amounts 

been includible in income for the taxable year in which first deferred or, if later, the first taxable year not subject to a substantial 

risk of forfeiture. 

A nonqualified deferred compensation plan is any plan that provides for the deferral of compensation other than a qualified employer plan or any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan. A qualified employer plan means a qualified retirement plan, tax-deferred annuity, simplified employee pension, and SIMPLE.457 A governmental 

eligible deferred compensation plan (sec. 457) is also a qualified 

employer plan under the provision.458 Plans subject to section 457, 

other than governmental eligible deferred compensation plans, are 

subject to both the requirements of section 457 and the provision. 

For example, in addition to the requirements of the provision, an 

eligible deferred compensation plan of a tax-exempt employer 

would still be required to meet the applicable dollar limits under 

section 457. 

Interest imposed under the provision is treated as interest on an 

underpayment of tax. Income (whether actual or notional) attributable to nonqualified deferred compensation is treated as additional deferred compensation and is subject to the provision. The 

provision is not intended to prevent the inclusion of amounts in 

gross income under any provision or rule of law earlier than the 

time provided in the provision. Any amount included in gross income under the provision shall not be required to be included in 

gross income under any provision of law later than the time provided in the provision. The provision does not affect the rules regarding the timing of an employer’s deduction for nonqualified deferred compensation. 

The provision requires annual reporting to the Internal Revenue 

Service of amounts deferred. Such amounts are required to be reported on an individual’s Form W–2 for the year deferred even if 

the amount is not currently includible in income for that taxable 

year. Under the provision, the Secretary is authorized, through regulations, to establish a minimum amount of deferrals below which 

the reporting requirement does not apply. The Secretary may also 

provide that the reporting requirement does not apply with respect 

348

459 It is intended that the exception be similar to that under Treas. Reg. sec. 31.3121(v)(2)–

1(e)(4). 

to amounts of deferrals that are not reasonably ascertainable. It is 

intended that the exception for amounts not reasonable ascertainable only apply to nonaccount balance plans and that amounts be 

required to be reported when they first become reasonably ascertainable.459

The provision provides the Secretary authority to prescribe regulations as are necessary to carry out the purposes of provision, including regulations: (1) providing for the determination of amounts 

of deferral in the case of defined benefit plans; (2) relating to 

changes in the ownership and control of a corporation or assets of 

a corporation; (3) exempting from the provisions providing for 

transfers of property arrangements that will not result in an improper deferral of U.S. tax and will not result in assets being effectively beyond the reach of creditors; (4) defining financial health; 

and (5) disregarding a substantial risk of forfeiture. 

It is intended that substantial risk of forfeitures may not be used 

to manipulate the timing of income inclusion. It is intended that 

substantial risks of forfeiture should be disregarded in cases in 

which they are illusory or are used inconsistent with the purposes 

of the provision. For example, if an executive is effectively able to 

control the acceleration of the lapse of a substantial risk of forfeiture, such risk of forfeiture should be disregarded and income inclusion should not be postponed on account of such restriction. 

EFFECTIVE DATE

The provision is effective for amounts deferred after June 3, 

2004. The provision does not apply to amounts deferred after June 

3, 2004, and before January 1, 2005, pursuant to an irrevocable 

election or binding arrangement made before June 4, 2004. Earnings on amounts deferred before the effective date are subject to 

the provision to the extent that such amounts deferred are subject 

to the provision. 

It is intended that amounts further deferred under a subsequent 

election with respect to amounts originally deferred before June 4, 

2004, are subject to the requirements of the provision. 

No later than 90 days after the date of enactment, the Secretary 

shall issue guidance providing a limited period of time during 

which an individual participating in a nonqualified deferred compensation plan adopted before June 4, 2004, may, without violating 

the requirements of the provision, terminate participation or cancel 

an outstanding deferral election with regard to amounts earned 

after June 3, 2004, if such amounts are includible in income as 

earned.

E. OTHER REVENUE PROVISIONS

1. Qualified tax collection contracts (sec. 681 of the bill and new 

sec. 6306 of the Code) 

PRESENT LAW

In fiscal years 1996 and 1997, the Congress earmarked $13 million for IRS to test the use of private debt collection companies. 

There were several constraints on this pilot project. First, because 

349

460Sec. 7801(a). 461GAO/GGD–97–129R Issues Affecting IRS’ Collection Pilot (July 18, 1997). 462TIRNO–03–H–0001 (February 14, 2003), at www.procurement.irs.treas.gov. The basic request for information is 104 pages, and there are 16 additional attachments. 463GAO–04–492 Tax Debt Collection: IRS Is Addressing Critical Success Factors for Contracting Out but Will Need to Study the Best Use of Resources (May 2004). 464Private collection agencies. 465Page 19 of the May 2004 GAO report. 466 31 U.S.C. sec. 3718. 467 31 U.S.C. sec. 3718(f). 

both IRS and OMB considered the collection of taxes to be an inherently governmental function, only government employees were 

permitted to collect the taxes.460 The private debt collection companies were utilized to assist the IRS in locating and contacting taxpayers, reminding them of their outstanding tax liability, and suggesting payment options. If the taxpayer agreed at that point to 

make a payment, the taxpayer was transferred from the private 

debt collection company to the IRS. Second, the private debt collection companies were paid a flat fee for services rendered; the 

amount that was ultimately collected by the IRS was not taken 

into account in the payment mechanism. 

The pilot program was discontinued because of disappointing results. GAO reported 461 that IRS collected $3.1 million attributable 

to the private debt collection company efforts; expenses were also 

$3.1 million. In addition, there were lost opportunity costs of $17 

million to the IRS because collection personnel were diverted from 

their usual collection responsibilities to work on the pilot. The pilot 

program results were disappointing because ‘‘IRS’ efforts to design 

and implement the private debt collection pilot program were hindered by limitations that affected the program’s results.’’ The limitations included the scope of work permitted to the private debt 

collection companies, the number and type of cases referred to the 

private debt collection companies, and the ability of IRS’ computer 

systems to identify, select, and transmit collection cases to the private debt collectors. 

The IRS has in the last several years expressed renewed interest 

in the possible use of private debt collection companies; for example, IRS recently revised its extensive Request for Information concerning its possible use of private debt collection companies.462

GAO recently reviewed IRS’ planning and preparation for the use 

of private debt collection companies.463 GAO identified five broad 

factors critical to the success of using private debt collection companies to collect taxes. GAO concluded: ‘‘If Congress does authorize 

PCA 464 use, IRS’s planning and preparations to address the critical success factors for PCA contracting provide greater assurance 

that the PCA program is headed in the right direction to meet its 

goals and achieve desired results. Nevertheless, much work and 

many challenges remain in addressing the critical success factors 

and helping to maximize the likelihood that a PCA program would 

be successful.’’ 465

In general, Federal agencies are permitted to enter into contracts 

with private debt collection companies for collection services to recover indebtedness owed to the United States.466 That provision 

does not apply to the collection of debts under the Internal Revenue Code.467

350

468The provision generally applies to any type of tax imposed under the Internal Revenue 

Code. It is anticipated that the focus in implementing the provision will be: (a) taxpayers who 

have filed a return showing a balance due but who have failed to pay that balance in full; and 

(b) taxpayers who have been assessed additional tax by the IRS and who have made several 

voluntary payments toward satisfying their obligation but have not paid in full. 469 An amount of tax reported as due on the taxpayer’s tax return is considered to be selfassessed. If the IRS determines that the assessment or collection of tax will be jeopardized by 

delay, it has the authority to assess the amount immediately (sec. 6861), subject to several procedural safeguards. 470Several portions of the provision require that the IRS disclose confidential taxpayer information to the private debt collection company. Section 6103(n) permits disclosure for ‘‘the providing of other services ... for purposes of tax administration.’’ Accordingly, no amendment to 

section 6103 is necessary to implement the provision. It is intended, however, that the IRS vigorously protect the privacy of confidential taxpayer information by disclosing the least amount 

of information possible to contractors consistent with the effective operation of the provision. 471The private debt collection company is not permitted to accept payment directly. Payments 

are required to be processed by IRS employees. 

The President’s fiscal year 2004 and 2005 budget proposals proposed the use of private debt collection companies to collect Federal 

tax debts. 

REASONS FOR CHANGE

The Committee believes that the use of private debt collection 

agencies will help facilitate the collection of taxes that are owed to 

the Government. The Committee also believes that the safeguards 

it has incorporated will protect taxpayers’ rights and privacy. 

EXPLANATION OF PROVISION

The bill permits the IRS to use private debt collection companies 

to locate and contact taxpayers owing outstanding tax liabilities of 

any type 468 and to arrange payment of those taxes by the taxpayers. There must be an assessment pursuant to section 6201 in 

order for there to be an outstanding tax liability. An assessment is 

the formal recording of the taxpayer’s tax liability that fixes the 

amount payable. An assessment must be made before the IRS is 

permitted to commence enforcement actions to collect the amount 

payable. In general, an assessment is made at the conclusion of all 

examination and appeals processes within the IRS.469

Several steps are involved in the deployment of private debt collection companies. First, the private debt collection company contacts the taxpayer by letter.470 If the taxpayer’s last known address 

is incorrect, the private debt collection company searches for the 

correct address. Second, the private debt collection company telephones the taxpayer to request full payment.471 If the taxpayer 

cannot pay in full immediately, the private debt collection company 

offers the taxpayer an installment agreement providing for full 

payment of the taxes over a period of as long as five years. If the 

taxpayer is unable to pay the outstanding tax liability in full over 

a five-year period, the private debt collection company obtains financial information from the taxpayer and will provide this information to the IRS for further processing and action by the IRS. 

The bill specifies several procedural conditions under which the 

provision would operate. First, provisions of the Fair Debt Collection Practices Act apply to the private debt collection company. Second, taxpayer protections that are statutorily applicable to the IRS 

are also made statutorily applicable to the private sector debt collection companies. In addition, taxpayer protections that are statutorily applicable to IRS employees are also made statutorily applicable to employees of private sector debt collection companies. 

351

472 It is assumed that there will be competitive bidding for these contracts by private sector 

tax collection agencies and that vigorous bidding will drive the overhead costs down. 473 Charitable deductions are provided for income, estate, and gift tax purposes. Secs. 170, 

2055, and 2522, respectively. 474See sec. 1221(a)(3), 1231(b)(1)(C). 

Third, subcontractors are prohibited from having contact with taxpayers, providing quality assurance services, and composing debt 

collection notices; any other service provided by a subcontractor 

must receive prior approval from the IRS. In addition, the Committee intends that the IRS require the private sector debt collection companies to inform every taxpayer they contact of the availability of assistance from the Taxpayer Advocate. 

The bill creates a revolving fund from the amounts collected by 

the private debt collection companies. The private debt collection 

companies will be paid out of this fund. The bill prohibits the payment of fees for all services in excess of 25 percent of the amount 

collected under a tax collection contract.472

EFFECTIVE DATE

The provision is effective on the date of enactment. 

2. Modify charitable contribution rules for donations of patents and 

other intellectual property (sec. 682 of the bill and secs. 170 

and 6050L of the Code) 

PRESENT LAW

In general, a deduction is permitted for charitable contributions, 

subject to certain limitations that depend on the type of taxpayer, 

the property contributed, and the donee organization.473 In the 

case of non-cash contributions, the amount of the deduction generally equals the fair market value of the contributed property on 

the date of the contribution. 

For certain contributions of property, the taxpayer is required to 

reduce the deduction amount by any gain, generally resulting in a 

deduction equal to the taxpayer’s basis. This rule applies to contributions of: (1) Property that, at the time of contribution, would 

not have resulted in long-term capital gain if the property was sold 

by the taxpayer on the contribution date; (2) tangible personal 

property that is used by the donee in a manner unrelated to the 

donee’s exempt (or governmental) purpose; and (3) property to or 

for the use of a private foundation (other than a foundation defined 

in section 170(b)(1)(E)). 

Charitable contributions of capital gain property generally are 

deductible at fair market value. Capital gain property means any 

capital asset or property used in the taxpayer’s trade or business 

the sale of which at its fair market value, at the time of contribution, would have resulted in gain that would have been long-term 

capital gain. Contributions of capital gain property are subject to 

different percentage limitations than other contributions of property. Under present law, certain copyrights are not considered capital assets, in which case the charitable deduction for such copyrights generally is limited to the taxpayer’s basis.474

In general, a charitable contribution deduction is allowed only for 

contributions of the donor’s entire interest in the contributed propVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00353 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.008 HR548P1
352

475Sec. 170(f)(3). 476Sec. 1011(b) and Treas. Reg. sec. 1.1011–2. 477Sec. 170(f)(8). 478Pub. L. No. 98–369, sec. 155(a)(1) through (6) (1984) (providing that not later than December 31, 1984, the Secretary shall prescribe regulations requiring an individual, a closely held 

corporation, or a personal service corporation claiming a charitable deduction for property (other 

than publicly traded securities) to obtain a qualified appraisal of the property contributed and 

attach an appraisal summary to the taxpayer’s return if the claimed value of such property (plus 

the claimed value of all similar items of property donated to one or more donees) exceeds 

$5,000). Under Pub. L. No. 98–369, a qualified appraisal means an appraisal prepared by a 

qualified appraiser that includes, among other things, (1) a description of the property appraised; (2) the fair market value of such property on the date of contribution and the specific 

basis for the valuation; (3) a statement that such appraisal was prepared for income tax purposes; (4) the qualifications of the qualified appraiser; (5) the signature and TIN of such appraiser; and (6) such additional information as the Secretary prescribes in such regulations. 479 In the case of a deduction first claimed or reported on an amended return, the deadline 

is the date on which the amended return is filed. 480Treas. Reg. sec. 1.170A–13(c)(3). 

erty, and not for contributions of a partial interest.475 If a taxpayer 

sells property to a charitable organization for less than the property’s fair market value, the amount of any charitable contribution 

deduction is determined in accordance with the bargain sale 

rules.476 In general, if a donor receives a benefit or quid pro quo 

in return for a contribution, any charitable contribution deduction 

is reduced by the amount of the benefit received. For contributions 

of $250 or more, no charitable contribution deduction is allowed unless the donee organization provides a contemporaneous written acknowledgement of the contribution that describes and provides a 

good faith estimate of the value of any goods or services provided 

by the donee organization in exchange for the contribution.477

Taxpayers are required to obtain a qualified appraisal for donated property with a value of $5,000 or more, and to attach the 

appraisal to the tax return in certain cases.478 Under Treasury regulations, a qualified appraisal means an appraisal document that, 

among other things, (1) relates to an appraisal that is made not 

earlier than 60 days prior to the date of contribution of the appraised property and not later than the due date (including extensions) of the return on which a deduction is first claimed under section 170; 479 (2) is prepared, signed, and dated by a qualified appraiser; (3) includes (a) a description of the property appraised; (b) 

the fair market value of such property on the date of contribution 

and the specific basis for the valuation; (c) a statement that such 

appraisal was prepared for income tax purposes; (d) the qualifications of the qualified appraiser; and (e) the signature and taxpayer 

identification number (‘‘TIN’’) of such appraiser; and (4) does not 

involve an appraisal fee that violates certain prescribed rules.480

REASONS FOR CHANGE

The Committee believes that the value of certain intellectual 

property, such as patents, copyrights, trademarks, trade names, 

trade secrets, know-how, software, similar property, or applications 

or registrations of such property, that is contributed to a charity 

often is highly speculative. Some donated intellectual property may 

prove to be worthless, or the initial promise of worth may be diminished by future inventions, marketplace competition, or other factors. Although in theory, such intellectual property may promise 

significant monetary benefits, the benefits generally will not materialize if the charity does not make the appropriate investments, 

have the right personnel and equipment, or even have sufficient 

353

sustained interest to exploit the intellectual property. The Committee understands that valuation is made yet more difficult in the 

charitable contribution context because the transferee does not provide full, if any, consideration in exchange for the transferred property pursuant to arm’s length negotiations, and there may not be 

a comparable sales market for such property to use as a benchmark 

for valuations.

The Committee is concerned that taxpayers with intellectual 

property are taking advantage of the inherent difficulties in valuing such property and are preparing or obtaining erroneous valuations. In such cases, the charity receives an asset of questionable 

value, while the taxpayer receives a significant tax benefit. The 

Committee believes that the excessive charitable contribution deductions enabled by inflated valuations is best addressed by ensuring that the amount of the deduction for charitable contributions 

of such property may not exceed the taxpayer’s basis in the property. The Committee notes that for other types of charitable contributions for which valuation is especially problematic—charitable 

contributions of property created by the personal efforts of the taxpayer and charitable contributions to certain private foundations— a basis deduction generally is the result under present law. 

Although the Committee believes that a deduction of basis is appropriate in this context, the Committee recognizes that some contributions of intellectual property may prove to be of economic benefit to the charity and that donors may need an economic incentive 

to make such contributions. Accordingly, the Committee believes 

that it is appropriate to permit donors of intellectual property to 

receive certain additional charitable contribution deductions in the 

future but only if the contributed property generates qualified income for the charitable organization. 

EXPLANATION OF PROVISION

The provision provides that if a taxpayer contributes a patent or 

other intellectual property (other than certain copyrights or inventory) to a charitable organization, the taxpayer’s initial charitable 

deduction is limited to the lesser of the taxpayer’s basis in the contributed property or the fair market value of the property. In addition, the taxpayer is permitted to deduct, as a charitable deduction, 

certain additional amounts in the year of contribution or in subsequent taxable years based on a specified percentage of the qualified 

donee income received or accrued by the charitable donee with respect to the contributed property. For this purpose, ‘‘qualified donee 

income’’ includes net income received or accrued by the donee that 

properly is allocable to the intellectual property itself (as opposed 

to the activity in which the intellectual property is used). 

The amount of any additional charitable deduction is calculated 

as a sliding-scale percentage of qualified donee income received or 

accrued by the charitable donee that properly is allocable to the 

contributed property to the applicable taxable year of the donor, determined as follows:

Taxable year of donor Deduction permitted for such taxable year 

1st year ending on or after contribution ................................. 100 percent of qualified donee income. 

2nd year ending on or after contribution ................................ 100 percent of qualified donee income. 

3rd year ending on or after contribution ................................. 90 percent of qualified donee income. 

354

481The net income taken into account by the taxpayer may not exceed the amount of qualified 

donee income reported by the donee to the taxpayer and the IRS under the provision’s substantiation and reporting requirements. 

Taxable year of donor Deduction permitted for such taxable year 

4th year ending on or after contribution ................................. 80 percent of qualified donee income. 

5th year ending on or after contribution ................................. 70 percent of qualified donee income. 

6th year ending on or after contribution ................................. 60 percent of qualified donee income. 

7th year ending on or after contribution ................................. 50 percent of qualified donee income. 

8th year ending on or after contribution ................................. 40 percent of qualified donee income. 

9th year ending on or after contribution ................................. 30 percent of qualified donee income. 

10th year ending on or after contribution ............................... 20 percent of qualified donee income. 

11th year ending on or after contribution ............................... 10 percent of qualified donee income. 

12th year ending on or after contribution ............................... 10 percent of qualified donee income. 

Taxable years thereafter ........................................................... No deduction permitted. 

An additional charitable deduction is allowed only to the extent 

that the aggregate of the amounts that are calculated pursuant to 

the sliding-scale exceed the amount of the deduction claimed upon 

the contribution of the patent or intellectual property. 

No charitable deduction is permitted with respect to any revenues or income received or accrued by the charitable donee after 

the expiration of the legal life of the patent or intellectual property, 

or after the tenth anniversary of the date the contribution was 

made by the donor. 

The taxpayer is required to inform the donee at the time of the 

contribution that the taxpayer intends to treat the contribution as 

a contribution subject to the additional charitable deduction provisions of the provision. In addition, the taxpayer must obtain written substantiation from the donee of the amount of any qualified 

donee income properly allocable to the contributed property during 

the charity’s taxable year.481 The donee is required to file an annual information return that reports the qualified donee income 

and other specified information relating to the contribution. In instances where the donor’s taxable year differs from the donee’s taxable year, the donor bases its additional charitable deduction on 

the qualified donee income of the charitable donee properly allocable to the donee’s taxable year that ends within the donor’s taxable year. 

Under the provision, additional charitable deductions are not 

available for patents or other intellectual property contributed to a 

private foundation (other than a private operating foundation or 

certain other private foundations described in section 170(b)(1)(E)). 

Under the provision, the Secretary may prescribe regulations or 

other guidance to carry out the purposes of the provision, including 

providing for the determination of amounts to be treated as qualified donee income in certain cases where the donee uses the donated property to further its exempt activities or functions, or as 

may be necessary or appropriate to prevent the avoidance of the 

purposes of the provision.

EFFECTIVE DATE

The provision is effective for contributions made after June 3, 

2004. 

355

482 Charitable deductions are provided for income, estate, and gift tax purposes. Secs. 170, 

2055, and 2522, respectively. 483Pub. L. No. 98–369, sec. 155(a)(1) through (6) (1984) (providing that not later than December 31, 1984, the Secretary shall prescribe regulations requiring an individual, a closely held 

corporation, or a personal service corporation claiming a charitable deduction for property (other 

than publicly traded securities) to obtain a qualified appraisal of the property contributed and 

attach an appraisal summary to the taxpayer’s return if the claimed value of such property (plus 

the claimed value of all similar items of property donated to one or more donees) exceeds 

$5,000). Under Pub. L. No. 98–369, a qualified appraisal means an appraisal prepared by a 

qualified appraiser that includes, among other things, (1) a description of the property appraised; (2) the fair market value of such property on the date of contribution and the specific 

basis for the valuation; (3) a statement that such appraisal was prepared for income tax purposes; (4) the qualifications of the qualified appraiser; (5) the signature and taxpayer identification number of such appraiser; and (6) such additional information as the Secretary prescribes 

in such regulations. 484 In the case of a deduction first claimed or reported on an amended return, the deadline 

is the date on which the amended return is filed. 485Treas. Reg. sec. 1.170A–13(c)(3). 

3. Require increased reporting for noncash charitable contributions 

(sec. 683 of the bill and sec. 170 of the Code) 

PRESENT LAW

In general, a deduction is permitted for charitable contributions, 

subject to certain limitations that depend on the type of taxpayer, 

the property contributed, and the donee organization.482 In the 

case of non-cash contributions, the amount of the deduction generally equals the fair market value of the contributed property on 

the date of the contribution. 

In general, if the total charitable deduction claimed for non-cash property exceeds $500, the taxpayer must file IRS Form 8283 

(Noncash Charitable Contributions) with the IRS. C corporations 

(other than personal service corporations and closely-held corporations) are required to file Form 8283 only if the deduction claimed 

exceeds $5,000. 

Taxpayers are required to obtain a qualified appraisal for donated property (other than money and publicly traded securities) 

with a value of more than $5,000.483 Corporations (other than a 

closely-held corporation, a personal service corporation, or an S corporation) are not required to obtain a qualified appraisal. Taxpayers are not required to attach a qualified appraisal to the taxpayer’s return, except in the case of contributed art-work valued at more than $20,000. Under Treasury regulations, a qualified appraisal means an appraisal document that, among other things, (1) 

relates to an appraisal that is made not earlier than 60 days prior 

to the date of contribution of the appraised property and not later 

than the due date (including extensions) of the return on which a 

deduction is first claimed under section 170; 484 (2) is prepared, 

signed, and dated by a qualified appraiser; (3) includes (a) a description of the property appraised; (b) the fair market value of 

such property on the date of contribution and the specific basis for 

the valuation; (c) a statement that such appraisal was prepared for 

income tax purposes; (d) the qualifications of the qualified appraiser; and (e) the signature and taxpayer identification number 

of such appraiser; and (4) does not involve an appraisal fee that 

violates certain prescribed rules.485

REASONS FOR CHANGE

Under present law, an individual who contributes property to a 

charity and claims a deduction in excess of $5,000 must obtain a 

356

486 Charitable deductions are provided for income, estate, and gift tax purposes. Secs. 170, 

2055, and 2522, respectively. 

qualified appraisal, but a C corporation (other than a closely-held 

corporation or a personal services corporation) that donates property in excess of $5,000 is not required to obtain such an appraisal. 

Present law does not require that appraisals, even for large gifts, 

be attached to a taxpayer’s return. The Committee believes that requiring C corporations to obtain a qualified appraisal for charitable 

contributions of certain property in excess of $5,000, and requiring 

that appraisals be attached to a taxpayer’s return for large gifts, 

will reduce valuation abuses. 

EXPLANATION OF PROVISION

The provision requires increased donor reporting for certain charitable contributions of property other than cash, inventory, or publicly traded securities. The provision extends to all C corporations 

the present law requirement, applicable to an individual, closelyheld corporation, personal service corporation, partnership, or S 

corporation, that the donor must obtain a qualified appraisal of the 

property if the amount of the deduction claimed exceeds $5,000. 

The provision also provides that if the amount of the contribution 

of property other than cash, inventory, or publicly traded securities 

exceeds $500,000, then the donor (whether an individual, partnership, or corporation) must attach the qualified appraisal to the donor’s tax return. For purposes of the dollar thresholds under the 

provision, property and all similar items of property donated to one 

or more donees are treated as one property. 

The provision provides that a donor that fails to substantiate a 

charitable contribution of property, as required by the Secretary, is 

denied a charitable contribution deduction. If the donor is a partnership or S corporation, the deduction is denied at the partner or 

shareholder level. The denial of the deduction does not apply if it 

is shown that such failure is due to reasonable cause and not to 

willful neglect. 

The provision provides that the Secretary may prescribe such 

regulations as may be necessary or appropriate to carry out the 

purposes of the provision, including regulations that may provide 

that some or all of the requirements of the provision do not apply 

in appropriate cases. 

EFFECTIVE DATE

The provision is effective for contributions made after June 3, 

2004.

4. Require qualified appraisals for charitable contributions of vehicles (sec. 684 of the bill and sec. 170 of the Code) 

PRESENT LAW

In general, a deduction is permitted for charitable contributions, 

subject to certain limitations that depend on the type of taxpayer, 

the property contributed, and the donee organization.486 In the 

case of non-cash contributions, the amount of the deduction generally equals the fair market value of the contributed property on 

the date of the contribution. 

357

487Pub. L. No. 98–369, sec. 155(a)(1) through (6) (1984) (providing that not later than December 31, 1984, the Secretary shall prescribe regulations requiring an individual, a closely held 

corporation, or a personal service corporation claiming a charitable deduction for property (other 

than publicly traded securities) to obtain a qualified appraisal of the property contributed and 

attach an appraisal summary to the taxpayer’s return if the claimed value of such property (plus 

the claimed value of all similar items of property donated to one or more donees) exceeds 

$5,000). Under Pub. L. No. 98–369, a qualified appraisal means an appraisal prepared by a 

qualified appraiser that includes, among other things, (1) a description of the property appraised; (2) the fair market value of such property on the date of contribution and the specific 

basis for the valuation; (3) a statement that such appraisal was prepared for income tax purposes; (4) the qualifications of the qualified appraiser; (5) the signature and TIN of such appraiser; and (6) such additional information as the Secretary prescribes in such regulations. 488 In the case of a deduction first claimed or reported on an amended return, the deadline 

is the date on which the amended return is filed. 

For certain contributions of property, the taxpayer is required to 

determine the deductible amount by subtracting any gain from fair 

market value, generally resulting in a deduction equal to the taxpayer’s basis. This rule applies to contributions of: (1) property 

that, at the time of contribution, would not have resulted in longterm capital gain if the property was sold by the taxpayer on the 

contribution date; (2) tangible personal property that is used by the 

donee in a manner unrelated to the donee’s exempt (or governmental) purpose; and (3) property to or for the use of a private 

foundation (other than a foundation defined in section 

170(b)(1)(E)). 

Charitable contributions of capital gain property generally are 

deductible at fair market value. Capital gain property means any 

capital asset or property used in the taxpayer’s trade or business 

the sale of which at its fair market value, at the time of contribution, would have resulted in gain that would have been long-term 

capital gain. Contributions of capital gain property are subject to 

different percentage limitations than other contributions of property. 

A taxpayer who donates a used automobile to a charitable donee 

generally deducts the fair market value (rather than the taxpayer’s 

basis) of the automobile. A taxpayer who donates a used automobile generally is permitted to use an established used car pricing 

guide to determine the fair market value of the automobile, but 

only if the guide lists a sales price for an automobile of the same 

make, model and year, sold in the same area, and in the same condition as the donated automobile. Similar rules apply to contributions of other types of vehicles and property, such as boats. 

Charities are required to provide donors with written substan- tiation of donations of $250 or more. Taxpayers are required to report non-cash contributions totaling $500 or more and the method 

used for determining fair market value. 

Taxpayers are required to obtain a qualified appraisal for do- nated property with a value of $5,000 or more, and to attach the 

appraisal to the tax return in certain cases.487 Under Treasury regulations, a qualified appraisal means an appraisal document that, 

among other things, (1) relates to an appraisal that is made not 

earlier than 60 days prior to the date of contribution of the appraised property and not later than the due date (including extensions) of the return on which a deduction is first claimed under section 170; 488 (2) is prepared, signed, and dated by a qualified appraiser; (3) includes (a) a description of the property appraised; (b) 

the fair market value of such property on the date of contribution 

and the specific basis for the valuation; (c) a statement that such 

358

489Treas. Reg. sec. 1.170A–13(c)(3). 490 Rev. Rul. 67–461, 1967–2 C.B. 125. 491Sec. 197. 

appraisal was prepared for income tax purposes; (d) the qualifications of the qualified appraiser; and (e) the signature and taxpayer 

identification number (‘‘TIN’’) of such appraiser; and (4) does not 

involve an appraisal fee that violates certain prescribed rules.489

Appraisal fees paid by an individual to determine the fair market 

value of donated property are deductible as miscellaneous expenses 

subject to the 2 percent of adjusted gross income limit.490

REASONS FOR CHANGE

The Committee is aware that in recent years, charitable organizations increasingly have been soliciting charitable contributions of 

vehicles, which are promptly sold (by the charity or the charity’s 

agent) at auctions for prices far less than the value claimed by taxpayers for purposes of taking a charitable contribution deduction. 

The Committee believes that requiring taxpayers to obtain a qualified appraisal of a vehicle at the time of the contribution will help 

to ensure that the value claimed for a vehicle properly takes into 

account the vehicle’s condition and will prevent donors from making excessive claims of value based on generic pricing guides for vehicles. 

EXPLANATION OF PROVISION

The provision allows a charitable deduction for contributions of 

vehicles for which the taxpayer claims a deduction of more than 

$250 only if the taxpayer obtains a qualified appraisal of the vehicle. The provision applies to automobiles and other types of motor 

vehicles manufactured primarily for use on public streets, roads, 

and highways; boats; and aircraft. The provision does not affect 

contributions of inventory property. The definition of qualified appraisal generally follows the definition contained in present law, 

subject to additional regulations or guidance provided by the Secretary. The qualified appraisal of a donated vehicle must be obtained by the taxpayer by the time the contribution is made. Under 

the provision, the Secretary shall prescribe such regulations or 

other guidance as may be necessary to carry out the purposes of 

the provision. 

EFFECTIVE DATE

The provision is effective for contributions made after June 3, 

2004. 

5. Extend the present-law intangible amortization provisions to acquisitions of sports franchises (sec. 685 of the bill and sec. 197 

of the Code) 

PRESENT LAW

The purchase price allocated to intangible assets (including franchise rights) acquired in connection with the acquisition of a trade 

or business generally must be capitalized and amortized over a 15-

year period.491 These rules were enacted in 1993 to minimize disputes regarding the proper treatment of acquired intangible assets. 

359

492Sec. 197(e)(6). 493P.D.B. Sports, Ltd. v. Comm., 109 T.C. 423 (1997). 

The rules do not apply to a franchise to engage in professional 

sports and any intangible asset acquired in connection with such 

a franchise.492 However, other special rules apply to certain of 

these intangible assets. 

Under section 1056, when a franchise to conduct a sports enterprise is sold or exchanged, the basis of a player contract acquired 

as part of the transaction is generally limited to the adjusted basis 

of such contract in the hands of the transferor, increased by the 

amount of gain, if any, recognized by the transferor on the transfer 

of the contract. Moreover, not more than 50 percent of the consideration from the transaction may be allocated to player contracts unless the transferee establishes to the satisfaction of the Commissioner that a specific allocation in excess of 50 percent is proper. 

However, these basis rules may not apply if a sale or exchange of 

a franchise to conduct a sports enterprise is effected through a 

partnership.493 Basis allocated to the franchise or to other valuable 

intangible assets acquired with the franchise may not be amortizable if these assets lack a determinable useful life. 

In general, section 1245 provides that gain from the sale of certain property is treated as ordinary income to the extent depreciation or amortization was allowed on such property. Section 

1245(a)(4) provides special rules for recapture of depreciation and 

deductions for losses taken with respect to player contracts. The 

special recapture rules apply in the case of the sale, exchange, or 

other disposition of a sports franchise. Under the special recapture 

rules, the amount recaptured as ordinary income is the amount of 

gain not to exceed the greater of (1) the sum of the depreciation 

taken plus any deductions taken for losses (i.e., abandonment 

losses) with respect to those player contracts which are initially acquired as a part of the original acquisition of the franchise or (2) 

the amount of depreciation taken with respect to those player contracts which are owned by the seller at the time of the sale of the 

sports franchise. 

REASONS FOR CHANGE

The present-law rules under section 197 were enacted to minimize disputes regarding the measurement of acquired intangible 

assets. Prior to the enactment of the rules, there were many disputes regarding the value and useful life of various intangible assets acquired together in a business acquisition. Furthermore, in 

the absence of a showing of a reasonably determinable useful life, 

an asset could not be amortized. Taxpayers tended to identify and 

allocate large amounts of purchase price to assets said to have 

short useful lives, while the IRS would allocate a large amount of 

value to intangible assets for which no determinable useful life 

could be shown (e.g., goodwill), and would deny amortization for 

that amount of purchase price. 

The present-law rules for acquisitions of sports franchises do not 

eliminate the potential for disputes, because they address only 

player contracts, while a sports franchise acquisition can involve 

many intangibles other than player contracts. In addition, disputes 

may arise regarding the appropriate period for amortization of parVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00361 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.008 HR548P1
360

494 Notice and demand is the notice given to a person liable for tax stating that the tax has 

been assessed and demanding that payment be made. The notice and demand must be mailed 

to the person’s last known address or left at the person’s dwelling or usual place of business 

(Code sec. 6303). 495 Code sec. 6331. 496 Code secs. 6335–6343. 497 Code sec. 6331(h). 498Some DOD Contractors Abuse the Federal Tax System with Little Consequence, GAO–04–

95, February 2004. 

ticular player contracts. The Committee believes expending taxpayer and government resources disputing these items is an unproductive use of economic resources. The Committee further believes 

that the section 197 rules should apply to all types of businesses 

regardless of the nature of their assets. 

EXPLANATION OF PROVISION

The provision extends the 15–year recovery period for intangible 

assets to franchises to engage in professional sports and any intangible asset acquired in connection with the acquisition of such a 

franchise (including player contracts). Thus, the same rules for amortization of intangibles that apply to other acquisitions under 

present law will apply to acquisitions of sports franchises. The provision also repeals the special rules under section 1245(a)(4) and 

makes other conforming changes. 

EFFECTIVE DATE

The provision is effective for property acquired after the date of 

enactment. The amendment to section 1245(a)(4) applies to franchises acquired after the date of enactment. 

6. Increase continuous levy for certain Federal payments (sec. 686 

of the bill and sec. 6331 of the Code) 

PRESENT LAW

If any person is liable for any internal revenue tax and does not 

pay it within 10 days after notice and demand 494 by the IRS, the 

IRS may then collect the tax by levy upon all property and rights 

to property belonging to the person,495 unless there is an explicit 

statutory restriction on doing so. A levy is the seizure of the person’s property or rights to property. Property that is not cash is 

sold pursuant to statutory requirements.496

A continuous levy is applicable to specified Federal payments.497

This includes any Federal payment for which eligibility is not 

based on the income and/or assets of a payee. Thus, a Federal payment to a vendor of goods or services to the government is subject 

to continuous levy. This continuous levy attaches up to 15 percent 

of any specified payment due the taxpayer. 

REASONS FOR CHANGE

There have recently been reports 498 of abuses of the Federal tax 

system by some Federal contractors. Consequently, the Committee 

believes that it is appropriate to increase the permissible percentage of Federal payments subject to levy. 

361

499Sec. 1092. 500 However, if the option written by the taxpayer is a qualified covered call option that is 

in-the-money, then (1) any loss with respect to such option is treated as long-term capital loss 

if, at the time such loss is realized, gain on the sale or exchange of the offsetting stock held 

by the taxpayer would be treated as long-term capital gain, and (2) the holding period of such 

stock does not include any period during which the taxpayer is the grantor of the option (sec. 

1092(f)). 

EXPLANATION OF PROVISION

The provision permits a levy of up to 100 percent of a Federal 

payment to a vendor of goods or services to the Government.

EFFECTIVE DATE

The provision is effective on the date of enactment. 

7. Modification of straddle rules (sec. 687 of the bill and sec. 1092 

of the Code) 

PRESENT LAW

Straddle rules 

In general 

A ‘‘straddle’’ generally refers to offsetting positions (sometimes 

referred to as ‘‘legs’’ of the straddle) with respect to actively traded 

personal property. Positions are offsetting if there is a substantial 

diminution in the risk of loss from holding one position by reason 

of holding one or more other positions in personal property. A ‘‘position’’ is an interest (including a futures or forward contract or option) in personal property. When a taxpayer realizes a loss with respect to a position in a straddle, the taxpayer may recognize that 

loss for any taxable year only to the extent that the loss exceeds 

the unrecognized gain (if any) with respect to offsetting positions 

in the straddle.499 Deferred losses are carried forward to the succeeding taxable year and are subject to the same limitation with 

respect to unrecognized gain in offsetting positions. 

Positions in stock 

The straddle rules generally do not apply to positions in stock. 

However, the straddle rules apply where one of the positions is 

stock and at least one of the offsetting positions is: (1) an option 

with respect to the stock, (2) a securities futures contract (as defined in section 1234B) with respect to the stock, or (3) a position 

with respect to substantially similar or related property (other than 

stock) as defined in Treasury regulations. In addition, the straddle 

rules apply to stock of a corporation formed or availed of to take 

positions in personal property that offset positions taken by any 

shareholder. 

Although the straddle rules apply to offsetting positions that consist of stock and an option with respect to stock, the straddle rules 

generally do not apply if the option is a ‘‘qualified covered call option’’ written by the taxpayer.500 In general, a qualified covered call 

option is defined as an exchange-listed option that is not deep-inthe-money and is written by a non-dealer more than 30 days before 

expiration of the option. 

The stock exception from the straddle rules has been largely curtailed by statutory amendment and regulatory interpretation. 

362

501Prop. Treas. Reg. sec. 1.1092(d)–2(c). 502Sec. 1092(c)(2)(B). 503Priv. Ltr. Rul. 199925044 (Feb. 3, 1999). 504 A costless collar generally is comprised of the purchase of a put option and the sale of a 

call option with the same trade dates and maturity dates and set such that the premium paid 

substantially equals the premium received. The collar can be considered as economically similar 

to a short position in the stock.

Under proposed Treasury regulations, the application of the stock 

exception essentially would be limited to offsetting positions involving direct ownership of stock and short sales of stock.501

Unbalanced straddles 

When one position with respect to personal property offsets only 

a portion of one or more other positions (‘‘unbalanced straddles’’), 

the Treasury Secretary is directed to prescribe by regulations the 

method for determining the portion of such other positions that is 

to be taken into account for purposes of the straddle rules.502 To 

date, no such regulations have been promulgated. 

Unbalanced straddles can be illustrated with the following example: Assume the taxpayer holds two shares of stock (i.e., is long) in 

XYZ stock corporation—share A with a $30 basis and share B with 

a $40 basis. When the value of the XYZ stock is $45, the taxpayer 

pays a $5 premium to purchase a put option on one share of the 

XYZ stock with an exercise price of $40. The issue arises as to 

whether the purchase of the put option creates a straddle with respect to share A, share B, or both. Assume that, when the value 

of the XYZ stock is $100, the put option expires unexercised. Taxpayer incurs a loss of $5 on the expiration of the put option, and 

sells share B for a $60 gain. On a literal reading of the straddle 

rules, the $5 loss would be deferred because the loss ($5) does not 

exceed the unrecognized gain ($70) in share A, which is also an offsetting position to the put option—notwithstanding that the taxpayer recognized more gain than the loss through the sale of share 

B. This problem is exacerbated when the taxpayer has a large portfolio of actively traded personal property that may be offsetting the 

loss leg of the straddle. 

Although Treasury has not issued regulations to address unbalanced straddles, the IRS issued a private letter ruling in 1999 that 

addressed an unbalanced straddle situation.503 Under the facts of 

the ruling, a taxpayer entered into a costless collar with respect to 

a portion of the shares of a particular stock held by the taxpayer.504 Other shares were held in an account as collateral for a 

loan and still other shares were held in excess of the shares used 

as collateral and the number of shares specified in the collar. The 

ruling concluded that the collar offset only a portion of the stock 

(i.e., the number of shares specified in the costless collar) because 

that number of shares determined the payoff under each option 

comprising the collar. The ruling further concluded that: 

In the absence of regulations under section 1092(c)(2)(B), 

we conclude that it is permissible for Taxpayer to identify 

which shares of Corporation stock are part of the straddles 

and which shares are used as collateral for the loans using 

appropriately modified versions of the methods of section 

1.1012–1(c)(2) and (3) [providing rules for adequate identification of shares of stock sold or transferred by a taxpayer] or section 1.1092(b)–3T(d)(4) [providing requireVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00364 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.009 HR548P1
363

505Sec. 243. The amount of the deduction is 70 percent of dividends received if the recipient 

owns less than 20 percent (by vote and value) of stock of the payor. If the recipient owns more 

than 20 percent of the stock, the deduction is increased to 80 percent. If the recipient owns more 

than 80 percent of the stock, the deduction is further increased to 100 percent for qualifying 

dividends. 506Sec. 246(c). 507Sec. 246(c)(4). 

ments and methods for identification of positions that are 

part of a section 1092(b)(2) identified mixed straddle]. 

Holding period for dividends-received deduction 

If an instrument issued by a U.S. corporation is classified for tax 

purposes as stock, a corporate holder of the instrument generally 

is entitled to a dividends-received deduction for dividends received 

on that instrument.505 The dividends-received deduction is allowed 

to a corporate shareholder only if the shareholder satisfies a 46-day 

holding period for the dividend-paying stock (or a 91-day holding 

period for certain dividends on preferred stock).506 The holding period must be satisfied for each dividend over a period that is immediately before and immediately after the taxpayer becomes entitled 

to receive the dividend. The 46- or 91-day holding period generally 

does not include any time during which the shareholder is protected (other than by writing a qualified covered call) from the risk 

of loss that is otherwise inherent in the ownership of any equity 

interest.507

REASONS FOR CHANGE

The Committee believes that the straddle rules should be modified in several respects. While the present-law rules provide authority for the Secretary to issue guidance concerning unbalanced 

straddles, the Committee is of the view that such guidance is not 

forthcoming. Therefore, the Committee believes that it is necessary 

at this time to provide such guidance by statute. The Committee 

further believes that it is appropriate to repeal the exception from 

the straddle rules for positions in stock, particularly in light of 

statutory changes in the straddle rules and elsewhere in the Code 

that have significantly diminished the continuing utility of the exception. In addition, the Committee believes that the present-law 

treatment of physically settled positions under the straddle rules 

requires clarification. 

EXPLANATION OF PROVISION

Straddle rules 

The bill modifies the straddle rules in three respects: (1) permits 

taxpayers to identify offsetting positions of a straddle; (2) provides 

a special rule to clarify the present-law treatment of certain physically settled positions of a straddle; and (3) repeals the stock exception from the straddle rules. 

Identified straddles 

Under the bill, taxpayers generally are permitted to identify the 

offsetting positions that are components of a straddle at the time 

the taxpayer enters into a transaction that creates a straddle, inVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00365 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.009 HR548P1
364

508 However, to the extent provided by Treasury regulations, taxpayers are not permitted to 

identify offsetting positions of a straddle if the fair market value of the straddle position already 

held by the taxpayer at the creation of the straddle is less than its adjusted basis in the hands 

of the taxpayer. 509For this purpose, ‘‘unrecognized gain’’ is the excess of the fair market value of an identified 

position that is part of an identified straddle at the time the taxpayer incurs a loss with respect 

to another identified position in the identified straddle, over the fair market value of such position when the taxpayer identified the position as a position in the identified straddle. 510For example, although the provision does not require taxpayers to identify any positions 

of a straddle as an identified straddle, it may be necessary to provide rules requiring all balanced offsetting positions to be included in an identified straddle if a taxpayer elects to identify 

any of the offsetting positions as an identified straddle. 511 It is intended that Treasury regulations defining substantially similar or related property 

for this purpose will continue to apply subsequent to repeal of the stock exception and generally 

will constitute the exclusive definition of a straddle with respect to offsetting positions involving 

stock. See Prop. Treas. Reg. sec. 1.1092(d)–2(b). However, the general straddles rules regarding 

substantial diminution in risk of loss will continue to apply to stock of corporations formed or 

availed of to take positions in personal property that offset positions taken by the shareholder. 

cluding an unbalanced straddle.508 If there is a loss with respect 

to any identified position that is part of an identified straddle, the 

general straddle loss deferral rules do not apply to such loss. Instead, the basis of each of the identified positions that offset the 

loss position in the identified straddle is increased by an amount 

that bears the same ratio to the loss as the unrecognized gain (if 

any) with respect to such offsetting position bears to the aggregate 

unrecognized gain with respect to all positions that offset the loss 

position in the identified straddle.509 Any loss with respect to an 

identified position that is part of an identified straddle cannot otherwise be taken into account by the taxpayer or any other person 

to the extent that the loss increases the basis of any identified positions that offset the loss position in the identified straddle. 

In addition, the provision provides authority to issue Treasury 

regulations that would specify (1) the proper methods for clearly 

identifying a straddle as an identified straddle (and identifying positions as positions in an identified straddle), (2) the application of 

the identified straddle rules for a taxpayer that fails to properly 

identify the positions of an identified straddle,510 and (3) provide 

an ordering rule for dispositions of less than an entire position that 

is part of an identified straddle. 

Physically settled straddle positions 

The bill also clarifies the present-law straddle rules with respect 

to taxpayers that settle a position that is part of a straddle by delivering property to which the position relates. Specifically, the provision clarifies that the present-law straddle loss deferral rules 

treat as a two-step transaction the physical settlement of a straddle position that, if terminated, would result in the realization of 

a loss. With respect to the physical settlement of such a position, 

the taxpayer is treated as having terminated the position for its 

fair market value immediately before the settlement. The taxpayer 

then is treated as having sold at fair market value the property 

used to physically settle the position. 

Stock exception repeal 

The bill also eliminates the exception from the straddle rules for 

stock (other than the exception relating to qualified covered call options). Thus, offsetting positions comprised of actively traded stock 

and a position with respect to substantially similar or related property generally constitute a straddle.511

365

512Sec. 4131. 513The Committee recognizes that, to become covered under the Vaccine Injury Compensation 

Program, the Secretary of Health and Human Services also must list the hepatitis A vaccine 

on the Vaccine Injury Table. 

Dividends-received deduction holding period 

The bill also modifies the required 46- or 91–day holding period 

for the dividends-received deduction by providing that the holding 

period does not include any time during which the shareholder is 

protected from the risk of loss otherwise inherent in the ownership 

of any equity interest if the shareholder obtains such protection by 

writing an in-the-money call option on the dividend-paying stock. 

EFFECTIVE DATE

The provision is effective for positions established on or after the 

date of enactment that substantially diminish the risk of loss from 

holding offsetting positions (regardless of when such offsetting position was established). 

8. Add vaccines against hepatitis A to the list of taxable vaccines 

(sec. 688 of the bill and sec. 4132 of the Code) 

PRESENT LAW

A manufacturer’s excise tax is imposed at the rate of 75 cents per 

dose 512 on the following vaccines routinely recommended for administration to children: diphtheria, pertussis, tetanus, measles, 

mumps, rubella, polio, HIB (haemophilus influenza type B), hepatitis B, varicella (chicken pox), rotavirus gastroenteritis, and streptococcus pneumoniae. The tax applied to any vaccine that is a combination of vaccine components equals 75 cents times the number 

of components in the combined vaccine. 

Amounts equal to net revenues from this excise tax are deposited 

in the Vaccine Injury Compensation Trust Fund to finance compensation awards under the Federal Vaccine Injury Compensation 

Program for individuals who suffer certain injuries following administration of the taxable vaccines. This program provides a substitute Federal, ‘‘no fault’’ insurance system for the State-law tort 

and private liability insurance systems otherwise applicable to vaccine manufacturers. All persons immunized after September 30, 

1988, with covered vaccines must pursue compensation under this 

Federal program before bringing civil tort actions under State law. 

REASONS FOR CHANGE

The Committee is aware that the Centers for Disease Control 

and Prevention have recommended that children in 17 highly endemic States be inoculated with a hepatitis A vaccine. The population of children in the affected States exceeds 20 million. Several 

of the affected States mandate childhood vaccination against hepatitis A. The Committee is aware that the Advisory Commission on 

Childhood Vaccines has recommended that the vaccine excise tax 

be extended to cover vaccines against hepatitis A. For these reasons, the Committee believes it is appropriate to include vaccines 

against hepatitis A as part of the Vaccine Injury Compensation 

Program. Making the hepatitis A vaccine taxable is a first step.513

In the unfortunate event of an injury related to this vaccine, famiVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00367 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.009 HR548P1
366

514Sec. 4131. 515The Committee recognizes that, to become covered under the Vaccine Injury Compensation 

Program, the Secretary of Health and Human Services also must list each trivalent vaccine 

against influenza on the Vaccine Injury Table. 

lies of injured children are eligible for the no-fault arbitration system established under the Vaccine Injury Compensation Program 

rather than going to Federal Court to seek compensatory redress. 

EXPLANATION OF PROVISION

The provision adds any vaccine against hepatitis A to the list of 

taxable vaccines. 

EFFECTIVE DATE

The provision is effective for vaccines sold beginning on the first 

day of the first month beginning more than four weeks after the 

date of enactment. 

9. Add vaccines against influenza to the list of taxable vaccines 

(sec. 689 of the bill and sec. 4132 of the Code)

PRESENT LAW

A manufacturer’s excise tax is imposed at the rate of 75 cents per 

dose 514 on the following vaccines routinely recommended for administration to children: diphtheria, pertussis, tetanus, measles, 

mumps, rubella, polio, HIB (haemophilus influenza type B), hepatitis B, varicella (chicken pox), rotavirus gastroenteritis, and streptococcus pneumoniae. The tax applied to any vaccine that is a combination of vaccine components equals 75 cents times the number 

of components in the combined vaccine. 

Amounts equal to net revenues from this excise tax are deposited 

in the Vaccine Injury Compensation Trust Fund to finance compensation awards under the Federal Vaccine Injury Compensation 

Program for individuals who suffer certain injuries following administration of the taxable vaccines. This program provides a substitute Federal, ‘‘no fault’’ insurance system for the State-law tort 

and private liability insurance systems otherwise applicable to vaccine manufacturers. All persons immunized after September 30, 

1988, with covered vaccines must pursue compensation under this 

Federal program before bringing civil tort actions under State law. 

REASONS FOR CHANGE

The Committee understands that on October 15, 2003, the Advisory Committee on Immunization Practices of the Centers for Disease Control and Prevention issued a recommendation for the routine annual vaccination of infants six to 23 months of age with an 

inactivated influenza vaccine licensed by FDA. This is the first recommendation for ‘‘routine use’’ in children although trivalent influenza vaccine products have long been available and approved for 

use in children of varying ages and these vaccines have long been 

recommended for use by seniors. For these reasons, the Committee 

believes it is appropriate to include trivalent vaccines against influenza as part of the Vaccine Injury Compensation Program. Making 

an influenza vaccine taxable is a first step.515 In the unfortunate 

event of an injury related to these vaccines, an injured individual 

is eligible for the no-fault arbitration system established under the 

367

516These user fees were originally enacted in section 10511 of the Revenue Act of 1987 (Pub. 

Law No. 100–203, December 22, 1987). Public Law 104–117 (An Act to provide that members 

of the Armed Forces performing services for the peacekeeping efforts in Bosnia and Herzegovina, 

Croatia, and Macedonia shall be entitled to tax benefits in the same manner as if such services 

were performed in a combat zone, and for other purposes (March 20, 1996)) extended the statutory authorization for these user fees through September 30, 2003. 517 117 Stat. 1131; H.R. 3146, signed by the President on October 1, 2003. 518That Public Law also moved into the Code the user fee provision relating to pension plans 

that was enacted in section 620 of the Economic Growth and Tax Relief Reconciliation Act of 

2001 (Pub. L. 107–16, June 7, 2001). 

Vaccine Injury Compensation Program rather than going to Federal Court to seek compensatory redress. 

EXPLANATION OF PROVISION

The provision adds any trivalent vaccine against influenza to the 

list of taxable vaccines. 

EFFECTIVE DATE

The provision is effective for vaccines sold or used beginning on 

the later of the first day of the first month beginning more than 

four weeks after the date of enactment or the date on which the 

Secretary of Health and Human Services lists any such vaccine for 

purpose of compensation for any vaccine-related injury or death 

through the Vaccine Injury Compensation Trust Fund. 

10. Extension of IRS user fees (sec. 690 of the bill and sec. 7528 

of the Code)

PRESENT LAW

The IRS provides written responses to questions of individuals, 

corporations, and organizations relating to their tax status or the 

effects of particular transactions for tax purposes. The IRS generally charges a fee for requests for a letter ruling, determination 

letter, opinion letter, or other similar ruling or determination.516

Public Law 108–89 517 extended the statutory authorization for 

these user fees through December 31, 2004, and moved the statutory authorization for these fees into the Code.518

REASONS FOR CHANGE

The Committee believes that it is appropriate to provide a further extension of the applicability of these user fees. 

EXPLANATION OF PROVISION

The provision extends the statutory authorization for these user 

fees through September 30, 2014. 

EFFECTIVE DATE

The provision is effective for requests made after the date of enactment. 

11. Extension of customs user fees (sec. 691 of the bill)

PRESENT LAW

Section 13031 of the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) (P.L. 99–272), authorized the Secretary 

of the Treasury to collect certain service fees. Section 412 (P.L 107–

368

519Sec. 201; 117 Stat. 1335. 

296) of the Homeland Security Act of 2002 authorized the Secretary of the Treasury to delegate such authority to the Secretary 

of Homeland Security. Provided for under 19 U.S.C. 58c, these fees 

include: processing fees for air and sea passengers, commercial 

trucks, rail cars, private aircraft and vessels, commercial vessels, 

dutiable mail packages, barges and bulk carriers, merchandise, and 

Customs broker permits. COBRA was amended on several occasions but most recently by P.L. 108–121 which extended authorization for the collection of these fees through March 1, 2005.519

REASONS FOR CHANGE

The Committee believes it is important to extend these fees to 

cover the expenses of the services provided. However, the Committee also believes it is important that any fee imposed be a true 

user fee. That is, the Committee believes that when the Congress 

authorizes the executive branch to assess user fees, those fees must 

be determined to reflect only the cost of providing the service for 

which the fee is assessed.

EXPLANATION OF PROVISION

The provision extends the passenger and conveyance processing 

fees and the merchandise processing fees authorized under the 

Consolidated Omnibus Budget Reconciliation Act of 1985 through 

September 30, 2014. For fiscal years after September 30, 2005, the 

Secretary is to charge fees in amount that are reasonably related 

to the costs of providing customs services in connection with the activity or item for which the fee is charged. 

The provision also includes a Sense of the Congress that the fees 

set forth in paragraphs (1) through (8) of subsection (a) of section 

13031 of the Consolidated Omnibus Budget Reconciliation Act of 

1985 have been reasonably related to the costs of providing customs services in connection with the activities or items for which 

the fees have been charged under such paragraphs. The Sense of 

Congress also states that the fees collected under such paragraphs 

have not exceeded, in the aggregate, the amounts paid for the costs 

described in subsection (f)(3)(A) incurred in providing customs services in connection with the activities or items for which the fees 

were charged under such paragraphs. 

The provision further provides that the Secretary conduct a 

study of all the fees collected by the Department of Homeland Security, and shall submit to the Congress, not later than September 

30, 2005, a report containing the recommendations of the Secretary 

on what fees should be eliminated, what the rate of fees retains 

should be, and any other recommendations with respect to the fees 

that the Secretary considers appropriate. 

EFFECTIVE DATE

The provisions are effective upon the date of enactment. 

369

520Pub. L. No. 97–218 (1982). 

TITLE VII—MARKET REFORM FOR TOBACCO GROWERS 

(Secs. 701–725 of the bill)

PRESENT LAW

The current tobacco program has two main components: a supply 

management component and a price support component. In addition, in 1982, Congress passed the ‘‘No-Net-Cost Tobacco Program 

Act’’ 520 that assured the tobacco program would run at no-net cost 

to the Federal government. 

Supply management 

The supply management component limits and stabilizes the 

quantity of tobacco marketed by farmers. This is achieved through 

marketing quotas. The Secretary of Agriculture raises or lowers the 

national marketing quota on an annual basis. The Secretary establishes the national marketing quota for each type of tobacco based 

upon domestic and export demand, but at a price above the government support price. The purpose of matching supply with demand 

is to keep the price of tobacco high. There is a secondary market 

in tobacco quota. Tobacco growers who do not have sufficient quota 

may purchase or rent one. 

Support price 

Given the numerous variables that affect tobacco supply and demand, marketing quotas alone have not always been able to guarantee tobacco prices. Therefore, in addition to marketing quotas, 

Federal support prices are established and guaranteed through the 

mechanism of nonrecourse loans available on each farmer’s marketed crop. The loan price for each type of tobacco is announced 

each year by the Department of Agriculture using the formula 

specified in the law to calculate loan levels. This system guarantees 

minimum prices for the different types of tobacco. 

The national loan price on 2004 crop flue-cured tobacco is $1.69 

per pound; the burley loan price is $1.873 per pound. 

No-net-cost assessment 

In 1982, Congress passed the ‘‘No-Net-Cost Tobacco Program 

Act.’’ The purpose of this program is to ensure that the nonrecourse 

loan program is run at no-net-cost to the Federal government. 

When tobacco is not contracted, it is sold at an auction sale barn. 

At the auction sale barn, each lot of tobacco goes to the highest bidder, unless that bid does not exceed the government’s loan price. 

When the bid does not exceed this price, the farmer may choose to 

be paid the loan price by a cooperative, with money borrowed from 

the Commodity Credit Corporation (‘‘CCC’’). In such cases, the tobacco is consigned to the cooperative (known as a price stabilization cooperative), which redries, packs, and stores the tobacco as 

collateral for the CCC. The cooperative, acting as an agent for the 

CCC, later sells the tobacco, with the proceeds going to repay the 

loan plus interest. If the cooperative does not recover the cost of 

the loan plus interest, the Secretary of Agriculture assesses growers, purchasers and importers of tobacco in order to repay the difVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00371 Fmt 6659 Sfmt 6602 E:\HR\OC\HR548P1.009 HR548P1
370

521Secs. 711–712 of the bill. 

ference. All growers, purchasers and importers of tobacco participate in paying these assessments, regardless of whether or not 

they participate in the loan program. 

The no-net-cost assessment on 2004 crop flue-cured is 10 cents 

per pound; the burley assessment is 2 cents per pound. The no-netcost assessment funds are deposited in an escrow account that is 

held to reimburse the government for any financial losses resulting 

from tobacco loan operations. 

Currently, over 80 percent of growers market their tobacco 

through contracts with tobacco companies, and thus these growers 

do not participate in the loan program. However, they must still 

pay the no-net-cost assessment when the Secretary levies it. The 

remaining 20 percent of growers market their tobacco through the 

auction system, and are eligible for participation in the loan program. Of this group, over 60 percent have consistently participated 

in the loan program during the past several years. 

REASONS FOR CHANGE

The tobacco price support program was first created in the 1930s. 

Almost seventy years later, this depression era program is no 

longer achieving its stated mission of helping to support tobacco 

farmers through support prices and marketing quotas. 

There are two main reasons for the current failure of the tobacco 

price support system to achieve its stated goals. First, consumption 

of tobacco products has declined substantially in recent years. For 

example, cigarette consumption has declined nearly 36 percent in 

the United States since 1981, from 640 billion to an estimated 410 

billion in 2003. 

Second, the current program prevents U.S. tobacco from being 

price competitive on the domestic and world market. For example, 

the share of U.S. tobacco in U.S cigarettes has declined from 90 

percent in 1960 to 45 percent in 2003. Exports of U.S. tobacco have 

also declined. At the same time, imports of foreign tobacco have increased to fill the void. 

The combined result of declining consumption and the increasing 

price of U.S. tobacco has been the steady reduction of tobacco quota 

available to farmers in recent years. Since 1998, the Secretary of 

Agriculture has cut the national marketing quota by approximately 

50 percent. As quota levels have been reduced, so has the volume 

of domestically-produced tobacco sales. At the same time, quota 

rental rates have risen, as has the no-net-cost assessment partially 

paid by growers. This has led to an overall decrease in farm revenue from tobacco production. 

The provision eliminates the tobacco program, ending government participation in the growing and marketing of tobacco. Producers are provided transition assistance and quota holders are 

provided a payment to buy out the asset value of the quota. 

EXPLANATION OF PROVISION

The provision repeals the Federal tobacco support program, including marketing quotas and nonrecourse marketing loans.521

371

522Sec. 722 of the bill. 523Sec. 723 of the bill. 524Sec. 725 of the bill. 

The provision also provides quota holders $7.00 per pound on 

their 2002 quota allotment paid in equal installments over five 

years.522

Additionally, the provision provides producers transition payments of $3.00 per pound based on their 2002 quota levels paid in 

equal installments over five years.523

The provision caps payments to quota holders and growers at 

$9.6 billion over fiscal years 2005 through 2009.524

EFFECTIVE DATE

The provision is effective on the date of enactment. 

TITLE VIII—TRADE PROVISIONS 

A. SUSPENSION OF DUTIES ON CEILING FANS

(Sec. 801 of the bill) 

PRESENT LAW

A 4.7-percent ad valorem customs duty is collected on imported 

ceiling fans from all sources. 

REASONS FOR CHANGE

The Committee observes that ceiling fans are an energy efficient 

method of cooling and heating residences and commercial buildings. However, because there is a lack of U.S. production of ceiling 

fans, the Committee notes that a tariff only serves to increase the 

cost of ceiling fans to the U.S. consumer. Reducing the tariff on imported ceiling fans is expected to reduce the costs to consumers and 

encourage energy conservation. 

EXPLANATION OF PROVISION

The provision agreement suspends the present customs duty applicable to ceiling fans through December 31, 2006. 

EFFECTIVE DATE

The provision is effective on the fifteenth day after the date of 

enactment.

B. SUSPENSION OF DUTIES ON NUCLEAR STEAM GENERATORS

(Sec. 802 of the bill) 

PRESENT LAW

Nuclear steam generators, as classified under heading 9902.84.02 

of the Harmonized Tariff Schedule of the United States, enter the 

United States duty free until December 31, 2006. After December 

31, 2006, the duty on nuclear steam generators returns to the column 1 rate of 5.2 percent under subheading 8402.11.00 of the Harmonized Tariff Schedule of the United States. 

372

REASONS FOR CHANGE

The Committee notes that nuclear steam generators are essential 

components to nuclear electricity plants, but at the present time, 

there is a lack of U.S. production of nuclear steam generators. 

Therefore the Committee concludes that a tariff only serves to increase the cost of these products to the U.S. purchasers. Reducing 

the tariff on imported nuclear steam generators is expected to encourage installation of more modern and energy efficient equipment 

and to reduce the costs to consumers of electricity. 

EXPLANATION OF PROVISION

The provision extends the present-law suspension of customs 

duty applicable to nuclear steam generators through December 31, 

2008. 

EFFECTIVE DATE

The provision is effective on the date of enactment. 

C. SUSPENSION OF DUTIES ON NUCLEAR REACTOR VESSEL HEADS

(Sec. 802 of the bill) 

PRESENT LAW

According to section 5202 of the Trade Act of 2002, nuclear reactor vessel heads are classified under subheading 8401.40.00 of the 

Harmonized Tariff Schedule of the United States and enter the 

United States with a column 1 duty rate of 3.3 percent. 

REASONS FOR CHANGE

The Committee notes that nuclear reactor vessel heads are essential components to nuclear electricity plants, but at the present 

time, there is a lack of U.S. production of nuclear reactor vessel 

heads. Therefore the Committee concludes that a tariff only serves 

to increase the cost of these products to the U.S. purchasers. Reducing the tariff on imported nuclear reactor vessel heads is expected to encourage installation of more modern and energy efficient equipment and to reduce the costs to consumers of electricity. 

EXPLANATION OF PROVISION

The provision temporarily suspends the present customs duty applicable to nuclear reactor vessel heads for column 1 countries 

through December 31, 2008. 

EFFECTIVE DATE

The provision is effective on the fifteenth day after the date of 

enactment.

II. VOTES OF THE COMMITTEE 

In compliance with clause 3(b) of rule XIII of the Rules of the 

House of Representatives, the following statements are made concerning the votes of the Committee on Ways and Means in its consideration of the bill, H.R. 4520. 

373

MOTION TO REPORT THE BILL

The bill, H.R. 4520, as amended, was ordered favorably reported 

by a rollcall vote of 27 yeas to 9 nays (with a quorum being 

present). The vote was as follows:

Representatives Yea Nay Present Representatives Yea Nay Present 

Mr. Thomas ........................... X .... .... Mr. Rangel ........................... .... X ..... 

Mr. Crane .............................. X .... .... Mr. Stark .............................. .... ........... ..... 

Mr. Shaw ............................... X .... .... Mr. Matsui ............................ .... ........... ..... 

Mrs. Johnson ......................... X .... .... Mr. Levin .............................. .... X ..... 

Mr. Houghton ........................ X .... .... Mr. Cardin ............................ .... X ..... 

Mr. Herger ............................. X .... .... Mr. McDermott ..................... .... X ..... 

Mr. McCrery ........................... X .... .... Mr. Kleczka ........................... .... ........... ..... 

Mr. Camp .............................. X .... .... Mr. Lewis (GA) ..................... .... X ..... 

Mr. Ramstad ......................... X .... .... Mr. Neal ............................... .... ........... ..... 

Mr. Nussle ............................. X .... .... Mr. McNulty .......................... .... ........... ..... 

Mr. Johnson ........................... X .... .... Mr. Jefferson ........................ X ........... ..... 

Ms. Dunn .............................. X .... .... Mr. Tanner ............................ X ........... ..... 

Mr. Collins ............................ X .... .... Mr. Becerra .......................... .... X ..... 

Mr. Portman .......................... X .... .... Mr. Doggett .......................... .... X ..... 

Mr. English ........................... X .... .... Mr. Pomeroy ......................... .... X ..... 

Mr. Hayworth ......................... X .... .... Mr. Sandlin .......................... X ........... ..... 

Mr. Weller .............................. X .... .... Ms. Tubbs Jones .................. .... X ..... 

Mr. Hulshof ........................... X .... ............. .............................................. ........... ...........

Mr. McInnis ........................... X .... ............. .............................................. ........... ...........

Mr. Lewis (KY) ...................... X .... ............. .............................................. ........... ...........

Mr. Foley ............................... X .... ............. .............................................. ........... ...........

Mr. Brady .............................. X .... ............. .............................................. ........... ...........

Mr. Ryan ............................... X .... ............. .............................................. ........... ...........

Mr. Cantor ............................. X .... ............. .............................................. ........... ...........

VOTES ON AMENDMENTS

A rollcall vote was conducted on the following amendments to the 

Chairman’s amendment in the nature of a substitute. 

An amendment by Mr. Rangel, which would strike all of the 

Chairman’s amendment in the nature of a substitute, except for 

Title VII, and insert new provisions, was defeated by a rollcall vote 

of 11 yeas to 25 nays. The vote was as follows:

Representatives Yea Nay Present Representatives Yea Nay Present 

Mr. Thomas ........................... ........... X ............. Mr. Rangel ........................... X ........... .............

Mr. Crane .............................. ........... X ............. Mr. Stark .............................. ........... ........... .............

Mr. Shaw ............................... ........... X ............. Mr. Matsui ............................ ........... ........... .............

Mrs. Johnson ......................... ........... X ............. Mr. Levin .............................. X ........... .............

Mr. Houghton ........................ ........... X ............. Mr. Cardin ............................ X ........... .............

Mr. Herger ............................. ........... X ............. Mr. McDermott ..................... X ........... .............

Mr. McCrery ........................... ........... X ............. Mr. Kleczka ........................... ........... ........... .............

Mr. Camp .............................. ........... X ............. Mr. Lewis (GA) ..................... X ........... .............

Mr. Ramstad ......................... ........... X ............. Mr. Neal ............................... ........... ........... .............

Mr. Nussle ............................. ........... X ............. Mr. McNulty .......................... ........... ........... .............

Mr. Johnson ........................... ........... X ............. Mr. Jefferson ........................ X ........... .............

Ms. Dunn .............................. ........... X ............. Mr. Tanner ............................ X ........... .............

Mr. Collins ............................ ........... X ............. Mr. Becerra .......................... X ........... .............

Mr. Portman .......................... ........... X ............. Mr. Doggett .......................... X ........... .............

Mr. English ........................... ........... X ............. Mr. Pomeroy ......................... ........... X .............

Mr. Hayworth ......................... ........... X ............. Mr. Sandlin .......................... X ........... .............

Mr. Weller .............................. ........... X ............. Ms. Tubbs Jones .................. X ........... .............

Mr. Hulshof ........................... ........... X .............

Mr. McInnis ........................... ........... X .............

Mr. Lewis (KY) ...................... ........... X .............

Mr. Foley ............................... ........... X .............

Mr. Brady .............................. ........... X .............

Mr. Ryan ............................... ........... X .............

374

Representatives Yea Nay Present Representatives Yea Nay Present 

Mr. Cantor ............................. ........... X .............

An amendment by Mr. McDermott, which would strike Section 

681, which would have permitted private sector debt collection companies to collect taxes, was defeated by a rollcall vote of 12 yeas 

to 24 nays. The vote was as follows:

Representatives Yea Nay Present Representatives Yea Nay Present 

Mr. Thomas ........................... ........... X ............. Mr. Rangel ........................... X ........... .............

Mr. Crane .............................. ........... X ............. Mr. Stark .............................. ........... ........... .............

Mr. Shaw ............................... ........... X ............. Mr. Matsui ............................ ........... ........... .............

Mrs. Johnson ......................... ........... X ............. Mr. Levin .............................. X ........... .............

Mr. Houghton ........................ ........... X ............. Mr. Cardin ............................ X ........... .............

Mr. Herger ............................. ........... X ............. Mr. McDermott ..................... X ........... .............

Mr. McCrery ........................... ........... X ............. Mr. Kleczka ........................... ........... ........... .............

Mr. Camp .............................. ........... X ............. Mr. Lewis (GA) ..................... X ........... .............

Mr. Ramstad ......................... ........... X ............. Mr. Neal ............................... ........... ........... .............

Mr. Nussle ............................. ........... X ............. Mr. McNulty .......................... ........... ........... .............

Mr. Johnson ........................... ........... X ............. Mr. Jefferson ........................ X ........... .............

Ms. Dunn .............................. ........... X ............. Mr. Tanner ............................ X ........... .............

Mr. Collins ............................ ........... X ............. Mr. Becerra .......................... X ........... .............

Mr. Portman .......................... ........... X ............. Mr. Doggett .......................... X ........... .............

Mr. English ........................... ........... X ............. Mr. Pomeroy ......................... X ........... .............

Mr. Hayworth ......................... ........... X ............. Mr. Sandlin .......................... X ........... .............

Mr. Weller .............................. ........... X ............. Ms. Tubbs Jones .................. X ........... .............

Mr. Hulshof ........................... ........... X .............

Mr. McInnis ........................... ........... X .............

Mr. Lewis (KY) ...................... ........... X .............

Mr. Foley ............................... ........... X .............

Mr. Brady .............................. ........... X .............

Mr. Ryan ............................... ........... X .............

Mr. Cantor ............................. ........... X .............

An amendment by Mr. Sandlin, which would strike Title III and 

replace Title V with a new Title V that would create a permanent 

deduction for State and local general retail sales taxes, was defeated by a rollcall vote of 8 yeas to 28 nays. The vote was as follows:

Representatives Yea Nay Present Representatives Yea Nay Present 

Mr. Thomas ........................... ........... X ............. Mr. Rangel ........................... X ........... .............

Mr. Crane .............................. ........... X ............. Mr. Stark .............................. ........... ........... .............

Mr. Shaw ............................... ........... X ............. Mr. Matsui ............................ ........... ........... .............

Mrs. Johnson ......................... ........... X ............. Mr. Levin .............................. ........... X .............

Mr. Houghton ........................ ........... X ............. Mr. Cardin ............................ ........... X .............

Mr. Herger ............................. ........... X ............. Mr. McDermott ..................... X ........... .............

Mr. McCrery ........................... ........... X ............. Mr. Kleczka ........................... ........... ........... .............

Mr. Camp .............................. ........... X ............. Mr. Lewis (GA) ..................... X ........... .............

Mr. Ramstad ......................... ........... X ............. Mr. Neal ............................... ........... ........... .............

Mr. Nussle ............................. ........... X ............. Mr. McNulty .......................... ........... ........... .............

Mr. Johnson ........................... ........... X ............. Mr. Jefferson ........................ X ........... .............

Ms. Dunn .............................. ........... X ............. Mr. Tanner ............................ X ........... .............

Mr. Collins ............................ ........... X ............. Mr. Becerra .......................... ........... X .............

Mr. Portman .......................... ........... X ............. Mr. Doggett .......................... X ........... .............

Mr. English ........................... ........... X ............. Mr. Pomeroy ......................... ........... X .............

Mr. Hayworth ......................... ........... X ............. Mr. Sandlin .......................... X ........... .............

Mr. Weller .............................. ........... X ............. Ms. Tubbs Jones .................. X ........... .............

Mr. Hulshof ........................... ........... X 

Mr. McInnis ........................... ........... X 

Mr. Lewis (KY) ...................... ........... X 

Mr. Foley ............................... ........... X 

Mr. Brady .............................. ........... X 

Mr. Ryan ............................... ........... X 

375

Representatives Yea Nay Present Representatives Yea Nay Present 

Mr. Cantor ............................. ........... X 

III. BUDGET EFFECTS OF THE BILL 

A. COMMITTEE ESTIMATE OF BUDGETARY EFFECTS

In compliance with clause 3(d)(2) of the rule XIII of the Rules of 

the House of Representatives, the following statement is made concerning the effects on the budget of the revenue provisions of the 

bill, H.R. 4520 as reported. 

The bill is estimated to have the following effects on budget receipts for fiscal years 2003–2008:

376


Insert offset folio 435 here HR548.001
377


Insert offset folio 436 here HR548.002
378


Insert offset folio 437 here HR548.003
379


Insert offset folio 438 here HR548.004
380


Insert offset folio 439 here HR548.005
381


Insert offset folio 440 here HR548.006
382


Insert offset folio 441 here HR548.007
383


Insert offset folio 442 here HR548.008
384


Insert offset folio 443 here HR548.009
385


Insert offset folio 444 here HR548.010
386


Insert offset folio 445 here HR548.011
387

B. STATEMENT REGARDING NEW BUDGET AUTHORITY AND TAX

EXPENDITURES BUDGET AUTHORITY

In compliance with clause 3(c)(2) of rule XIII of the Rules of the 

House of Representatives, the Committee states that the bill involves no new or increased budget authority. The Committee further states that the revenue reducing income tax provisions involve 

increased tax expenditures, and the revenue increasing provisions 

involve reduced tax expenditures (See amounts in table in Part 

III.A., above.) 

C. COST ESTIMATE PREPARED BY THE CONGRESSIONAL BUDGET

OFFICE

In compliance with clause 3(c)(3) of rule XIII of the Rules of the 

House of Representatives, requiring a cost estimate prepared by 

the CBO, the following statement by CBO is provided.

U.S. CONGRESS, 

CONGRESSIONAL BUDGET OFFICE, 

Washington, DC, June 16, 2004. 

Hon. WILLIAM ‘‘BILL’’ M. THOMAS, 

Chairman, Committee on Ways and Means 

House of Representatives, Washington, DC. 

DEAR MR. CHAIRMAN: The Congressional Budget Office has prepared the enclosed cost estimate for H.R. 4520, the American Jobs 

Creation Act of 2004, which was ordered reported by the House 

Committee on Ways and Means on June 14, 2004. 

If you wish further details on this estimate, we will be pleased 

to provide them. The CBO staff contact is Annabelle Bartsch. 

DOUGLAS HOLTZ-EAKIN, 

Director. 

Enclosure. 

H.R. 4520—American Jobs Creation Act of 2004

Summary: H.R. 4520 would repeal the exclusion from taxation 

for a portion of income earned by U.S. exporters, reduce tax rates 

on certain corporate income, extend various expiring tax provisions, 

and make numerous other changes to tax law. In addition, H.R. 

4520 would extend Internal Revenue Service (IRS) and customs 

user fees. The bill also would repeal the federal tobacco production 

quota program and provide direct payments through 2009 to both 

holders of tobacco quotas and tobacco growers. The provisions of 

the bill have various effective dates. 

The Congressional Budget Office (CBO) and the Joint Committee 

on Taxation (JCT) estimate that enacting the bill would increase 

federal revenues by about $1.5 billion in 2004 and decrease revenues by about $29.2 billion over the 2004–2009 period and $42.2 

billion over the 2004–2014 period. CBO estimates that enacting the 

bill would increase direct spending by $45 million in 2004 and 

about $4.1 billion over the 2004–2009 period, and reduce direct 

spending by about $5.4 billion over the 2004–2014 period. Finally, 

CBO estimates that implementing the bill would increase discretionary spending by $43 million over the 2004–2014 period, assuming appropriation of the necessary sums. 

388

JCT and CBO have determined that the provisions of H.R. 4520 

contain no intergovernmental mandates as defined in the Unfunded Mandates Reform Act (UMRA). The provisions of the bill 

that would subject vaccines for hepatitis A and influenza to taxation would increase state spending for Medicaid by about $140 

million over the 2004–2009 period. 

JCT has determined that H.R. 4520 contains seven private-sector 

mandates as defined by UMRA. CBO has reviewed the non-tax provisions and determined that the extension of the customs user fees 

and the extension of provisions in the Mental Health Parity Act are 

private-sector mandates as defined in UMRA. In aggregate, the 

costs of all the mandates in the bill would greatly exceed the annual threshold established by UMRA for private-sector mandates 

($120 million in 2004, adjusted annually for inflation) in each of 

the first five years the mandates are in effect. 

Estimated Cost to the Federal Government: The estimated budgetary impact of H.R. 4520 is shown in the following table. The 

spending impact of the legislation falls within budget functions 300 

(natural resources and environment), 350 (agriculture), 550 

(health), 570 (Medicare), 750 (administration of justice) and 800 

(general government).

389

By fiscal year, in millions of dollars

—

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

CHANGES IN REVENUES

Title I: Provisions relating to trade compliance and reduction in corporate income 

tax rates ...................................................................................................................... 0 ¥1,645 ¥1,697 ¥1,282 ¥2,267 ¥2,670 ¥2,509 ¥3,310 ¥3,533 ¥4,688 ¥5,282

Title II: Provisions relating to job creation tax incentives for manufacturers, small 

business, and farmers ................................................................................................ 2,665 ¥1,757 ¥7,222 ¥8,226 ¥1,830 2,670 1,421 1,673 1,486 1,075 808

Title III: Provisions relating to tax reform and simplification for United States businesses ......................................................................................................................... ¥608 ¥262 ¥399 ¥925 ¥1,768 ¥2,523 ¥4,250 ¥4,440 ¥4,641 ¥4,845 ¥5,060

Title IV: Extension of certain expiring provisions ........................................................... ¥946 ¥4,962 ¥4,205 ¥1,269 ¥844 ¥517 ¥232 ¥179 ¥197 ¥246 ¥235

Title V: Deduction of state and local general sales taxes ............................................. 0 ¥2,208 1,373 0 0 0 0 0 0 0 0Title VI: Revenue provisions ............................................................................................ 405 3,324 2,747 3,176 3,481 3,822 4,103 4,487 4,839 5,167 5,529Title VIII: Trade provisions .............................................................................................. ¥4 ¥19 ¥21 ¥8 ¥3 ¥100000

Estimated revenues ......................................................................................................... 1,512 ¥7,529 ¥12,170 ¥8,534 ¥3,231 781 ¥1,467 ¥1,769 ¥2,046 ¥3,537 ¥4,240

CHANGES IN DIRECT SPENDING

Payments in lieu of excise tax credits for alcohol fuels: 

Estimated budget authority ................................................................................... 0 105 114 116 117 119 121 38 0 0 0Estimated outlays ................................................................................................... 0 105 114 116 117 119 121 38 0 0 0

Expiration of special tax treatment for ethanol: 

Estimated budget authority ................................................................................... 0 0 0 0 0 0 0 19 32 54 66Estimated outlays ................................................................................................... 0 0 0 0 0 0 0 19 32 54 66

Cover over of tax on distilled spirits: 

Estimated budget authority ................................................................................... 35 115 18 0 0 0 0 0 0 0 0Estimated outlays ................................................................................................... 35 115 18 0 0 0 0 0000

Spending of conservation-relateed excise taxes: 

Estimated budget authority ................................................................................... 0 111 114 122 126 131 135 137 141 144 148Estimated outlays ................................................................................................... 0 28 62 93 109 121 127 132 133 137 140

IRS contracting for debt collection: 

Estimated budget authority ................................................................................... 0 0 19 50 45 40 37 37 37 37 37Estimated outlays ................................................................................................... 0 0 19 50 45 40 37 37 37 37 37

Taxation of hepatitis A and influenza vaccines: 

Estimated budget authority ................................................................................... 10 56 54 56 58 59 59 60 62 63 63Estimated outlays ................................................................................................... 10 56 54 56 58 59 59 60 62 63 63

Extension of customers user fees: 

Estimated budget authority ................................................................................... 0 ¥784 ¥1,565 ¥1,656 ¥1,751 ¥1,893 ¥1,960 ¥2,074 ¥2,194 ¥2,321 ¥2,456

Estimated outlays ................................................................................................... 0 ¥784 ¥1,565 ¥1,656 ¥1,751 ¥1,893 ¥1,960 ¥2,074 ¥2,194 ¥2,321 ¥2,456

390

By fiscal year, in millions of dollars

—

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Market reform for tobacco growers: 

Estimated budget authority ................................................................................... 0 1,927 1,927 1,927 1,927 1,892 0 0 0 0 0Estimated outlays ................................................................................................... 0 1,927 1,927 1,927 1,927 1,892 0 0 0 0 0

Termination of no-net-cost tobacco price support program: 

Estimated budget authority ................................................................................... 0 500 0 0 0 0 0 0 0 0 0Estimated outlays ................................................................................................... 0 500 0 0 0 0 0 0 0 0 0

Total changes in direct spending: 

Estimated budget authority ................................................................................... 45 2,030 681 615 522 388 ¥1,608 ¥1,783 ¥1,922 ¥2,023 ¥2,143

Estimated outlays ................................................................................................... 45 1,947 629 586 505 378 ¥1,616 ¥1,788 ¥1,930 ¥2,030 ¥2,150

CHANGES IN SPENDING SUBJECT TO APPROPRIATION

Studies: 

Estimated authorization level ................................................................................ 0 2 0 0 0 0 0 0 0 0 0Estimated outlays ................................................................................................... 0 2 0 0 0 0 0 0 0 0 0

Spending from IRS user fees: 

Estimated authorization level ................................................................................ 0 3 3 4 4 4 4 4 5 5 5Estimated outlays ................................................................................................... 0 3 3 4 4 4 4 4 5 5 5

Total changes in discretionary spending: 

Authorization level .................................................................................................. 0 5 3 4 4 4 4 4 5 5 5

Estimated outlays ................................................................................................... 0 5 3 4 4 4 4 4 5 5 5

Note.

—Details may not sum to totals due to rounding.

Sources: CBO and the Joint Committee on Taxation. 

391

Basis of Estimate: This estimate assumes the bill would be enacted in the summer of 2004. 

Revenues 

With the exception of the provisions relating to mental health 

parity, IRS user fees, and customs duty suspensions, JCT provided 

all the revenue estimates for this legislation. CBO and JCT estimate that the provisions of H.R. 4520 would increase federal revenues by about $1.5 billion in 2004 and decrease revenues by about 

$29.2 billion over the 2004–2009 period and $42.2 billion over the 

2004–2014 period. 

Title I. This title would repeal the exclusion for a portion of income earned by U.S. exporters beginning in 2005, and would provide transition relief in the first two years. JCT estimates that 

doing so would increase federal revenues by about $16.8 billion 

over the 2005–2009 period and about $49.6 billion over the 2005– 2014 period. Title I also would lower the tax rate on corporations 

for income from certain manufacturing and other activities, and for 

taxable income from nonmanufacturing activities below certain 

amounts. JCT estimates that those tax rate reductions would decrease governmental receipts by about $26.4 billion over the 2005– 2009 period and $78.5 billion over the 2005–2014 period. On net, title I would reduce revenues by about $9.6 billion over the 2005– 2009 period and by $28.9 billion over the 2005–2014 period.

Title II. The provisions of title II would make numerous changes 

to existing tax law relating primarily to domestic business activity. 

On net, JCT estimates that those provisions would increase governmental receipts by about $2.7 billion in 2004, and decrease receipts 

by about $13.7 billion over the 2004–2009 period and $7.2 billion 

over the 2004–2014 period. Those provisions include, but are not 

limited to: • Extending for two years the increased expensing of fixed investments by small businesses; • Altering depreciation rules for various types of property; 

• Providing relief from the alternative minimum tax; 

• Restructuring tax laws for alcohol fuels; and 

• Temporarily reducing the effective rate of tax on certain dividends paid by foreign corporations. 

One provision would repeal the existing exemptions from the gasoline tax for alcohol fuels and replace those exemptions with an excise tax credit worth the same amount. JCT estimates that the increased compliance from doing so would increase federal revenues 

by $113 million over the 2005–2009 period and $220 million over 

the 2005–2014 period if the excise tax credit for alcohol fuels were 

extended beyond the provision’s 2010 expiration. 

Budget law (the Balanced Budget and Emergency Deficit Control 

Act of 1985) requires CBO to treat excise taxes dedicated to trust 

funds as permanent, even if they expire during the projection period. CBO’s baseline includes permanent extension of the reduced 

rates of taxation on alcohol fuels beyond their expiration because 

they reduce amounts credited to the Highway Trust Fund (HTF). 

However, the excise tax credit for alcohol fuels, as established by 

the bill, would not reduce amounts credited to the HTF. Therefore, 

CBO and JCT do not assume the credit would be extended and estimate that repealing the existing exemptions from the gasoline tax 

392

rate for alcohol fuels would increase governmental receipts by an 

additional $5.9 billion between 2011 and 2014, after the new tax 

credit would expire. 

Title III. The provisions of title III would makes changes to tax 

law relating to U.S. businesses with foreign operations. Roughly 

half of the effect on revenues would result from altering interest 

expense allocation rules beginning in 2009, which JCT estimates 

would reduce federal revenues by about $14.4 billion over the 

2009–2004 period. 

Title IV. This title would temporarily extend numerous provisions set to expire under current law. Some of those provisions include the tax credit for research and experimentation expenses, the 

work opportunity and welfare-to-work tax credits, the treatment of 

nonrefundable personal credits under the individual alternative 

minimum tax, and parity in the application of certain limits to 

mental health. CBO and JCT estimate that those extensions would 

reduce federal revenues by $946 million in 2004, about $12.7 billion over the 2004–2009 period, and $13.8 billion over the 2004– 2014 period. 

Title V. Section 501 would allow taxpayers to elect to deduct 

state and local sales taxes in lieu of state and local income taxes. 

The provision would apply to tax years 2004 and 2005 and would 

reduce governmental receipts by an estimated $3.6 billion over fiscal years 2005 and 2006. 

Title VI. All of the numerous provisions in title VI would increase revenues. CBO and JCT estimate that revenues would increase by $405 million in 2004, about $17.0 billion over the 2004– 2009 period, and about $41.1 billion over the 2004–2014 period. 

Roughly half of the increase would come from reforming the tax 

treatment for leasing transactions with parties generally exempt 

from tax, which JCT estimates would result in additional revenues 

of about $19.6 billion between 2004 and 2014. Title VI also includes 

an extension of IRS user fees through September 30, 2014. Currently, the fees are set to expire on December 31, 2004. CBO estimates that this provision would increase revenues by $170 million 

over the 2005–2009 period and $396 million over the 2005–2014 

period. 

Title VII. Title VII would affect the Department of Agriculture’s 

tobacco program and would have no effect on federal revenue collections. 

Title VIII. Sections 801 and 802 would temporarily suspend the 

duties on certain ceiling fans and nuclear reactor vessel heads 

through December 31, 2006, and December 31, 2008, respectively. 

In addition, section 802 would extend the duty-free treatment of 

nuclear steam generators for two years beyond its current December 31, 2006, expiration date. CBO estimates that enacting those 

duty suspensions would reduce governmental receipts by $4 million 

in 2004 and $56 million over the 2004–2009 period. 

Direct spending 

Providing Direct Payments in Lieu of Excise Credits for Alcohol 

Fuels. Title II would provide for payments to recipients of the tax 

credits who have insufficient tax liability to use them otherwise. 

CBO estimates that outlays would increase by $571 million over 

the 2005–2009 period and $730 million over the 2005–2011 period. 

393

Because these payments would replace the existing reduced tax 

rate on alcohol fuels, these amounts exactly equal the increase in 

revenues estimated for this provision.

Expiration of Special Tax Treatment for Ethanol. Replacing the 

gasoline tax exemption for alcohol fuels with an excise tax credit 

would result in increased spending for farm price and income support payments after 2010 because the former is assumed to continue after 2010, but the latter is assumed to expire. Because the 

alcohol in such fuels is primarily derived from corn, demand for 

corn rises and falls with the demand for ethanol. The higher aftertax price of alcohol fuels resulting from expiration of the tax credit 

in 2010 would slightly reduce demand for ethanol and corn prices 

relative to those projected in the CBO baseline. As a result, CBO 

estimates that federal spending for farm price and income support 

payments would increase by $171 million over the 2011–2014 period. 

Cover Over of Tax on Distilled Spirits. Under current law, an excise tax of $13.50 per proof gallon is assessed on distilled spirits 

produced in or brought into the United States. The U.S. Treasury 

pays the treasuries of Puerto Rico and the Virgin Islands $10.50 

per proof gallon of rum imported into the U.S. from any country 

or those possessions. A higher payment rate of $13.25 expired on 

December 31, 2003. Under H.R. 4520, the governments of Puerto 

Rico and the Virgin Islands would receive payments of $13.25 per 

proof gallon for tax assessments made between January 1, 2004, 

and December 31, 2005. Those payments are recorded as outlays 

in the budget. Based on recent tax and payment data, CBO estimates that increasing the possessions’ share of the excise tax would 

increase direct spending by $168 million over fiscal years 2004–

2006. 

Spending of Conservation-Related Excise Taxes. Title VI of the 

bill would eliminate a requirement in current law that a portion of 

fuel excise taxes used by motorboats and small engines be deposited in the general fund. Those amounts would instead be deposited 

into the Aquatic Resources Trust Fund (ARTF). The bill also would 

eliminate or reduce excise taxes on certain fishing and hunting 

products, including archery equipment, which are deposited into either the ARTF or the Federal Aid-Wildlife Fund. Amounts in the 

two funds are used primarily for grants to states for the conservation of wildlife, sport fish, and coastal wetlands. CBO estimates 

that the net effect of enacting these two provisions would be an increase in direct spending from those funds of $1.1 billion over the 

2005–2014 period. 

Installment Agreements for Tax Payments. Under current law, 

taxpayers can elect to pay their full tax liability through installments. Section 645 would allow the IRS to enter into agreements 

for the partial payment of tax liabilities. That change would result 

in more installment agreements and additional revenue collections. 

The IRS charges a fee of $43 for each installment agreement, 

which it can spend without further appropriation. CBO estimates 

that allowing installment agreements providing for the partial payment of tax liabilities would increase IRS collections of installment 

fees by about $1 million over the 2004–2006 period. Because the 

IRS has the authority to retain and spend such collections without 

394

further appropriation, the change would have no significant net 

budgetary impact. 

IRS Contracting for Debt Collection. H.R. 4520 would allow the 

IRS to contract with private collection agencies (PCAs) to collect 

payments of tax liabilities. JCT estimates that this provision would 

increase revenues by about $1.4 billion over the 2006–2014 period. 

The IRS would be allowed to retain and spend up to 25 percent of 

the amount collected by the PCAs to pay for the services they provide. CBO estimates that allowing the IRS to retain and spend 25 

percent of the amounts collected would increase direct spending by 

$339 million over the 2006–2014 period. 

Taxation of Hepatitis A and Influenza Vaccines. Sections 688 and 

689 would require buyers of hepatitis A and influenza vaccines to 

pay an excise tax on each dose purchased. Medicaid is a major purchaser of vaccines through the Vaccines for Children program, administered through the Centers for Disease Control and Prevention 

(CDC). Medicare is a major purchaser of the vaccines for the elderly. CBO estimates that Medicaid and Medicare pay for approximately half of the hepatitis A and influenza vaccines sold annually. 

Based on estimates provided by JCT, CBO expects that implementing the bill would cost the Medicaid and Medicare programs 

about $10 million in 2004 and $556 million over the 2004–2014 period. (Those amounts are reflected in the estimates of the revenues 

resulting from the bill.) 

Receipts from the tax would go to the Vaccine Injury Compensation Fund (VICF), which is administered by the Health Resources 

and Services Administration (HRSA). The fund uses tax revenues 

to pay compensation to claimants injured by vaccines. Once a vaccine becomes taxable, injuries attributed to its use become compensable through this fund. Based on information provided by HRSA 

and CDC, we expect there would be few compensable claims related to the hepatitis A and influenza vaccines. CBO estimates that 

the provisions of H.R. 4520 would increase outlays from the VICF 

by $46 million over the 2005–2014 period. Thus, we estimate that 

outlays resulting from the vaccine provisions would total $10 million in 2004 and $602 million over the 2004–2014 period. 

Extension of Customs User Fees. Under current law, customs 

user fees expire after March 1, 2005. H.R. 4520 would extend these 

fees through September 30, 2014. CBO estimates that this provision would increase offsetting receipts by about $18.6 billion over 

the 2005–2014 period. 

Market Reform for Tobacco Growers. Title VII would repeal laws 

implemented by the Department of Agriculture (USDA) to control 

the supply and price of tobacco grown in the U.S. by granting individuals rights (known as quotas) to produce and market specific 

quantities of tobacco. Under the bill, this system of control through 

quotas and acreage allotments would be replaced by a series of direct federal payments to domestic tobacco growers and owners of 

tobacco quotas. (Because those holding tobacco quotas to produce 

and market tobacco can lease that right to others, the quota owners 

and growers may be different individuals.) 

The bill would provide a direct payment to individuals of $1.49 

per pound of tobacco quota owned and $0.60 per pound of tobacco 

quota grown for each year over the 2005–2009 period. Based on information from USDA on the volume of tobacco quotas and the use 

395

of those quotas, CBO estimates payments under the bill would be 

$1,927 million a year. Because the bill would limit the new direct 

payments under this title to $9.6 billion, payments would have to 

be reduced slightly in 2009 to comply with this limitation. 

In addition to the direct federal payments authorized by this 

title, CBO estimates that tobacco growers and buyers would be relieved of paying a federal assessment of about $500 million in 2005 

due to the termination of USDA’s No-Net-Cost Tobacco program. 

The No-Net-Cost Tobacco program is operated under current law to 

provide a support price (also known as loan rate) to growers of the 

many varieties of domestic tobacco. This program is administered 

through the Commodity Credit Corporation (CCC) and is separate 

and in addition to the tobacco quota system discussed above. Support prices for the various tobacco varieties are set by a formula 

specified in current law, and USDA is charged with attempting to 

control the supply of tobacco through quotas so that the actual 

market price of tobacco is at or above the support price. In the 

event that USDA cannot manage supply to achieve the support 

price in the market, growers are guaranteed the support price by 

USDA. Any net cost incurred by USDA to maintain the support 

price, however, is offset by an assessment imposed on all tobacco 

growers and buyers. Thus, the price support program operates at 

no net cost to the federal government. 

Under the bill, the CCC price support for tobacco would be effective for the 2004 crop, but not for future crops. CBO expects that 

after enactment of this bill the market price for domestic tobacco 

would drop precipitously because USDA’s quota and acreage allotment systems would not longer restrict the supply of tobacco. We 

estimate the price support program would cost the CCC about $500 

million in 2005 as more growers would accept the support price for 

tobacco and forfeit crops from 2004 and previous years to the government. Because the bill would terminate the No-Net-Cost Tobacco program for future years’ crops, USDA would have no opportunity to collect assessments from tobacco producers and buyers to 

offset this cost. That loss of receipts to USDA would bring the total 

estimated coast of enacting this title to $10.1 billion over the 2005–

2009 period. 

Spending subject to appropriation 

Studies. Section 606 would require the Treasury Department to 

complete studies on transfer pricing rules, income tax treaties, and 

corporate expatriation. Assuming the appropriations of the necessary amounts, CBO estimates that performing these studies 

would cost about $2 million in fiscal year 2005. 

Extension of IRS User Fees. Section 690 would extend the authority of the IRS to charge taxpayers fees for certain rulings, opinion letters, and determinations through September 30, 2014. The 

bill would authorize the IRS to retain and spend a portion of the 

fees collected, subject to appropriation. Based on the historical level 

of fees spent, CBO estimates that implementing this provision 

would cost $18 million over the 2005–2009 period and about $41 

million over the 2005–2014 period, subject to the appropriation of 

the necessary amounts. 

Estimated Impact on State, Local, and Tribal Governments: JCT 

and CBO have determined that the provisions of H.R. 4520 contain 

396

no intergovernmental mandates as defined in UMRA. The provisions of the bill that would subject vaccines for hepatitis A and influenza to taxation would increase state spending for Medicaid by 

about $140 million over the 2004–2009 period. 

Estimated Impact on the Private Sector: JCT and CBO have determined that H.R. 4520 contains several private-sector mandates 

as defined in UMRA. In aggregate, the costs of those mandates 

would greatly exceed the annual threshold established by UMRA 

for private-sector mandates ($120 million in 2004, adjusted annually for inflation) in each of the first five years the mandates are 

in effect. 

Tax Mandates 

JCT has determined that the following tax provisions of H.R. 

4520 contain private-sector mandates as defined in UMRA: (1) repealing the exclusion for extraterritorial income; (2) altering tax 

law relating to reportable transactions and tax shelters; (3) reforming the tax treatment for leasing transactions with parties that are 

generally exempt from tax; (4) taxing aviation-grade kerosene; (5) 

requiring registration of pipeline and vessel operators for exemption of bulk transfers and imposing a penalty for failure to display 

such registration; (6) modifying the heavy vehicle use tax; and (7) 

modifying the charitable contribution rules for donations of patents 

and other intellectual property.

Other Mandates 

CBO has determined that the non-tax provisions of the bill contain two private-sector mandates as defined in UMRA—an extension of customs user fees and an extension of provisions in the 

Mental Health Parity Act. 

Customs User Fees. Section 691 would extend through 2014 the 

customs user fees that are scheduled to expire after March 1, 2005. 

CBO estimates that the cost of the private-sector mandate in section 691 relative to the case where the mandate is allowed to expire would be more than $70 million in fiscal year 2005 and larger 

in later years. 

Mental Health Parity. Section 420 would extend the provisions 

of the Mental Health Parity Act of 1996, which expires on December 31, 2004, through the end of calendar year 2005. That act prohibits group health plans that provide both medical and surgical 

benefits and mental health benefits from imposing aggregate lifetime limits or annual limits for coverage of mental health benefits 

that are different from those used for medical and surgical benefits. 

CBO estimates that the cost of the private-sector mandate in section 420 relative to the case where the mandates is allowed to expire would be $39 million in fiscal year 2005 and $41 million in fiscal year 2006. 

Previous CBO Estimates: On November 5, 2003, CBO transmitted a cost estimate for H.R. 2896, the American Jobs Creation 

Act of 2003, as ordered reported by the House Committee on Ways 

and Means on October 28, 2003. Many of the provisions in the two 

bills are different, and the assumed enactment dates differ as well. 

The estimated budgetary impact of the two bills reflects those differences. 

397

On November 6, 2003, CBO transmitted a cost estimate for S. 

1637, the Jumpstart Our Business Strength (JOBS) Act, as ordered 

reported by the Senate Committee on Finance on October 2, 2003. 

Again, many of the provisions in the two bills are different, and the 

assumed enactment dates differ as well. The estimated budgetary 

impact of the two bills reflects those differences. 

Estimated Prepared by: Federal Revenues: Annabelle Bartsch. 

Federal Spending: Deborah Reis, Mark Grabowicz, David Hull, and 

Matthew Pickford; Margaret Nowak. Impact on State, Local and 

Tribal Governments: Leo Lex. Impact on the Private Sector: Paige 

Piper/Bach. 

Estimate Approved by: G. Thomas Woodward, Assistant Director 

for Tax Analysis; Robert A. Sunshine, Assistant Director for Budget 

Analysis.

D. MACROECONOMIC IMPACT ANALYSIS

In compliance with clause 3(h)(2) of rule XIII of the Rules of the 

House of Representatives, the following statement is made by the 

Joint Committee on Taxation with respect to the provisions of the 

bill amending the Internal Revenue Code of 1986: 

This bill contains provisions that have partially offsetting effects 

on business tax rates. Among the major provisions, it lowers marginal and average tax rates on corporate manufacturing income 

and some other specified corporate income. It also repeals the 

extraterritorial income exclusion, and includes additional provisions that increase taxes for some corporations. There are many 

smaller provisions affecting corporate and non-corporate businesses, some of which increase marginal or average rates, and 

some of which decrease rates. 

The net reductions in taxation of U.S. corporations provided for 

in this bill will provide some incentive for additional investment in 

corporate capital by the corporations that experience net reductions 

in their corporate tax rates. However, some firms may experience 

an increase in taxes due to the repeal of the extraterritorial income 

exclusion, the limitations placed on certain leasing transactions, 

and other provisions. Because the rate reductions in this bill are 

not uniformly provided to all corporations, this proposal is likely to 

result in a reallocation of investment resources across different corporate sectors both within the U.S. and internationally. Provisions 

affecting both corporate and non-corporate businesses in small subsectors of the economy would be likely to result in the reallocation 

of the tax burden across these sectors, which could have positive 

or negative implications for economic efficiency, and hence, longrun growth. In addition, certain export activity may increase if repeal of the extraterritorial exclusion leads to the elimination of tariffs currently imposed by the European Union. Finally, the net increase in the U.S. Federal government deficit may crowd out some 

domestic investment in the long run. 

In light of these considerations, the effects of the bill on total economic activity within the six-year budget horizon are so small as 

to be incalculable within the context of our current models of the 

aggregate economy. In order to produce a complete quantitative 

analysis of the effects of this proposal on specific sectors of the 

economy, it would be necessary to model separately the effects of 

the bill on the average and marginal tax rates of corporations and 

398

other businesses of different sizes, and with varying amounts of domestic and international activities. However, current modeling capabilities do not allow for these specific changes to be explicitly 

modeled at this level of detail. 

IV. OTHER MATTERS TO BE DISCUSSED UNDER THE 

RULES OF THE HOUSE 

A. COMMITTEE OVERSIGHT FINDINGS AND RECOMMENDATIONS

With respect to clause 3(c)(1) of rule XIII of the Rules of the 

House of Representatives (relating to oversight findings), the Committee advises that it was a result of the Committee’s oversight review concerning the tax burden on American taxpayers that the 

Committee concluded that it is appropriate and timely to enact the 

revenue provisions included in the bill as reported. 

B. STATEMENT OF GENERAL PERFORMANCE GOALS AND OBJECTIVES

With respect to clause 3(c)(4) of rule XIII of the Rules of the 

House of Representatives, the Committee advises that the bill contains no measure that authorizes funding, so no statement of general performance goals and objectives for which any measure authorizes funding is required. 

C. CONSTITUTIONAL AUTHORITY STATEMENT

With respect to clause 3(d)(1) of the rule XIII of the Rules of the 

House of Representatives (relating to Constitutional Authority), the 

Committee states that the Committee’s action in reporting this bill 

is derived from Article I of the Constitution, Section 8 (‘‘The Congress shall have Power To lay and collect Taxes, Duties, Imposts 

and Excises . . .’’), and from the 16th Amendment to the Constitution. 

D. INFORMATION RELATING TO UNFUNDED MANDATES

This information is provided in accordance with section 423 of 

the Unfunded Mandates Act of 1995 (Pub. L. No. 104–4). 

The Committee has determined that the bill contains seven Federal mandates on the private sector: (1) the provision to repeal the 

exclusion for extraterritorial income; (2) the provision relating to 

reportable transactions and tax shelters; (3) the provision relating 

to the reform of the tax treatment for leasing transactions with 

tax-indifferent parties; (4) the provision relating to the taxation of 

aviation grade kerosene; (5) the provision requiring registration of 

pipeline and vessel operators for exemption of bulk transfers and 

imposing a penalty for failure to display such registration; (6) the 

provision to modify the heavy vehicle use tax; and (7) the provision 

to modify the charitable contribution rules for donations of patents 

and other intellectual property. The costs required to comply with 

each Federal private sector mandate generally are no greater than 

the aggregate estimated budget effects of the provision. Benefits 

from the provision include improved administration of the tax laws 

and a more accurate measurement of income for Federal tax purposes. 

399

The Committee has determined that the bill does not impose a 

Federal intergovernmental mandate on State, local, or tribal governments. 

E. APPLICABILITY OF HOUSE RULE XXI 5(B) 

Rule XXI 5(b) of the Rules of the House of Representatives provides, in part, that ‘‘A bill or joint resolution, amendment, or conference report carrying a Federal income tax rate increase may not 

be considered as passed or agreed to unless so determined by a 

vote of not less than three-fifths of the Members voting, a quorum 

being present.’’ The Committee has carefully reviewed the provisions of the bill, and states that the provisions of the bill do not 

involve any Federal income tax rate increases within the meaning 

of the rule. 

F. TAX COMPLEXITY ANALYSIS

Section 4022(b) of the Internal Revenue Service Reform and Restructuring Act of 1998 (the ‘‘IRS Reform Act’’) requires the Joint 

Committee on Taxation (in consultation with the Internal Revenue 

Service and the Department of the Treasury) to provide a tax complexity analysis. The complexity analysis is required for all legislation reported by the House Committee on Ways and Means, the 

Senate Committee on Finance, or any committee of conference if 

the legislation includes a provision that directly or indirectly 

amends the Internal Revenue Code and has widespread applicability to individuals or small businesses. 

The staff of the Joint Committee on Taxation has determined 

that a complexity analysis is not required under section 4022(b) of 

the IRS Reform Act because the bill contains no provisions that 

amend the Internal Revenue Code and that have ‘‘widespread applicability’’ to individuals or small businesses. 

V. CHANGES IN EXISTING LAW MADE BY THE BILL, AS 

REPORTED 

Legislative Counsel has not prepared a Ramseyer at the time of 

the filing of this report (June 16, 2004). 

(400)

VI. DISSENTING AND ADDITIONAL VIEWS 

DISSENTING VIEWS 

The bill reported by the Committee is the fourth legislative proposal from Chairman Thomas addressing the World Trade Organization ruling concerning the FSC/ETI export related tax benefits. 

The only consistent theme in all of those proposals has been the 

inclusion of tax incentives for companies to move operations and 

jobs offshore. • The first proposal, H.R. 5095 from the 107th Congress, was introduced almost two years ago. It included large domestic tax increases to finance $86 billion of overseas tax benefits. As a result, 

the bill was never scheduled for markup. • The second bill, H.R. 2896, was introduced a year later on July 25, 2003. The fiscal cost of that bill ($128 billion over 10 years) and 

the lack of any general domestic replacement for the FSC/ETI benefit meant that there were not sufficient votes in the Committee to 

report the legislation in its introduced form. • Chairman Thomas’ third proposal came when he announced 

his substitute in connection with the markup of H.R. 2896 on October 28, 2003. For the first time, the Chairman was willing to include elements of the bipartisan Crane-Rangel-Manzullo-Levin bill. 

Those modifications were sufficient to allow the bill to be reported 

on a straight party-line vote. However, the bill never was scheduled 

for Floor consideration, presumably because it did not have sufficient votes. • Finally, the Chairman has brought forth a fourth version, essentially unchanged in its basic structure from the bill reported 

last year. The major significant change is the addition of extraneous items designed to buy votes. 

At no time during the almost 2-year period that began with the 

introduction of his first bill did the Chairman attempt to bring the 

Committee on Ways and Means together on a bipartisan basis to 

reach a consensus on how to respond to the European challenge to 

our FSC/ETI program. The 2-year delay was not necessary and has 

resulted in U.S. products being subjected to European retaliatory 

tariffs. Congressmen Crane, Rangel, Manzullo, and Levin introduced legislation during that period, which demonstrated that a bipartisan consensus could have been reached on this issue, avoiding 

trade sanctions. 

Now the Chairman has abandoned any pretext of justifying his 

approach to the FSC/ETI issue on policy grounds. He is adopting 

the crude and perhaps effective approach of simply buying the 

votes with unrelated, and, often, special interest provisions, many 

of which have never borne the scrutiny of a Committee hearing or 

markup. 

401

We hope that those who are being offered blandishments to support the Chairman’s bill will consider the following: 

1. First, the blandishments being offered can quickly disappear 

in conference. There will be extraordinary pressure to shrink the 

size of the bill, because the Senate will insist that the bill be revenue neutral. Few should be surprised if the conference report reflects the priorities of the Chairman and does not include many of 

the ornaments being attached to the bill in order to buy votes. 

2. Second, Members should not just focus on the blandishments 

being offered to buy votes. They should examine the rest of the 

Committee bill and make sure they would be comfortable defending 

its provisions. The Committee bill provides tremendous incentives 

for companies to move jobs offshore. Even its ‘‘domestic rate cut’’

will reward companies that purchase cheap, imported parts or 

outsource services overseas. It permits companies to put profits 

above patriotism and move their corporate charters offshore for tax 

avoidance. 

3. Third, while this bill includes some offsets, it still increases 

deficits over the next ten years by $34 billion. This number is deceptive, however, because the delayed effective dates and other accounting gimmicks indicate the long-term effect on the national 

debt will be much greater. In addition, some of the offsets, like authorizing the IRS to outsource collections to private debt collectors, 

are simply bad policy. It is bad enough to be promoting the offshore outsourcing of American jobs through enhanced corporate tax 

subsidies. It is totally indefensible to pay for such subsidies by increasing deficits that have already proven a drag on our economy, 

and will eventually have to be paid through higher taxes on future 

generations of Americans. 

4. Finally, Members should understand that farmers and other 

small businesses will be large losers if the Committee bill prevails. 

Both corporate and noncorporate taxpayers are eligible for exportrelated benefits under current law. As a result, the bill passed by 

the Senate and the amendment offered by Congressman Rangel 

provide across-the-board rate reductions for all domestic producers, 

whether organized as taxable corporations or as subchapter S corporations, partnerships, or sole proprietorships. Only the Committee bill limits the general rate reductions to corporations and it 

provides the largest rate reduction for the biggest corporations. 

Following is an elaboration of some of the provisions in the Committee bill that make it a bad choice: 

COMMITTEE BILL PROVIDES INCREASED INCENTIVES FOR MOVING

JOBS OFFSHORE

PRESENT LAW

A recent study published by the American Enterprise Institute 

noted that our current international tax rules already provide significant incentives for U.S. companies to move jobs and operations 

offshore. That study concluded that federal tax receipts would rise 

by $7 billion per year if the United States provided a tax exemption 

for the overseas business income of our multinationals. 

402

The Joint Committee on Taxation reached a similar conclusion in 

a preliminary revenue estimate that indicated that such a territorial system would raise approximately $60 billion over 10 years. 

Any doubt over the accuracy of those estimates was removed 

when the National Foreign Trade Council (a group of large, U.S.-

based multinationals) issued a press report stating that moving to 

a territorial system ‘‘would put U.S. companies at a significant disadvantage in the global market.’’

These facts suggest that our current system, in many circumstances, provides a negative tax overseas, i.e., benefits greater 

than the exemption under a territorial system. The fact that U.S. 

multinationals oppose adoption of a territorial system is stark evidence of the liberal nature of our system. 

The Congressional Research Service concluded that our current 

international tax rules provide incentives for U.S. firms to move 

overseas. In a recent report, they stated—‘‘We begin by looking at 

the incentive effects of the current U.S.-international system, with 

the deferral system and indirect foreign tax credit described above. 

Economic theory is relatively clear on the basic incentive impact of 

the system: it encourages U.S. firms to invest more capital than 

they otherwise would in overseas locations where local taxes are 

low. * * * Deferral poses an incentive for U.S. firms to invest 

abroad in countries with low tax rates over investment in the 

United States.’’

COMMITTEE BILL

The Committee reported bill provides a dramatic increase in the 

incentives to more offshore. Moreover, the bill deliberately attempts 

to hide the size of the tax cuts on offshore operations through delayed effective dates. 

When the bill is fully effective, the annual cost of the international benefits is approximately $5 billion. The Committee bill 

almost doubles the size of the negative tax overseas. 

Though billed as reform, a number of the international provisions do not constitute reform, they include some very large overseas benefits and a larger number of small special interest provisions. 

The Committee bill provides some new, significant tax benefits 

that would encourage companies to move jobs and operations offshore. Following are examples. 

A. Increased Cross-Crediting 

The Committee bill (sec. 303) reduces the number of foreign tax 

credit baskets to two. This may seem like a technical change but 

it would cost over $1 billion per year, and increase incentives to 

move offshore. 

The provision repeals current law limitations on cross-crediting, 

i.e., using taxes paid in one country at rates exceeding U.S. rates 

to offset U.S. tax on income from other countries. 

The provision effectively subsidizes high-tax foreign countries. 

Companies could locate in a high-tax country and have the United 

States government bear the cost of that country’s tax above the 

U.S. rate if they also have income in low-tax countries. 

403

Companies would receive no tax advantage from locating in the 

United States rather than a higher tax country overseas, since they 

could use the higher foreign taxes to reduce tax on other income. 

Also, the provision creates incentives to shift operations from the 

United States into low-tax jurisdictions to take advantage of the 

cross-crediting. 

B. Liberalized Deferral 

The Committee bill (sec. 311) contains modifications to subpart 

F (anti-deferral regime) that would also increase incentives to move 

jobs offshore. 

The modifications would permit amounts earned by one offshore 

subsidiary to be reinvested in any other location (other than the 

United States) without tax. 

The modifications also would permit U.S. companies to avoid tax 

on their income from operations in developed countries through 

earnings stripping transactions. This would provide a substantial 

incentive to move offshore; companies could get the benefits of operating in a developed country without tax. 

If U.S. companies can get the benefits of low tax rates for investments located in high-tax countries, one economist suggested that 

the United States is ‘‘likely to lose capital and jobs, as well as all 

of the taxable profits associated with them.’’ The Committee bill also includes a series of narrowly targeted 

benefits for companies operating overseas, such as benefits for 

overseas commodity traders, companies leasing aircraft overseas, 

and security dealers. 

THOMAS BILL’S DOMESTIC MANUFACTURING BENEFIT IS DEEPLY

FLAWED

1. Small corporations and unincorporated small businesses need not 

apply 

The bipartisan H.R. 1769 would provide an effective 10% across 

the board rate reduction for all corporations, regardless of size, engaged in domestic manufacturing. The Senate bill extends the rate 

reduction to businesses, like subchapter S corporations, partnerships, farms, and other proprietorships not subject to the corporate 

tax. Extension of the rate cut to those businesses was among the 

improvements to H.R. 1769 that were included in the amendment 

that Congressman Rangel offered in the Committee. 

In contrast, Chairman Thomas’ ‘‘manufacturing rate cut’’ provides its largest benefit to large corporations and little or no benefit 

to other corporations or businesses. According to the nonpartisan 

Joint Committee on Taxation, 82% of all profitable corporations do 

not have incomes large enough to benefit from the rate adjustment 

contained in the Committee bill. The Committee rate reduction 

does not apply to businesses that are not taxed as corporations. 

Therefore, all subchapter S corporations, partnerships, farms and 

other proprietorships engaged in manufacturing activities will receive no rate adjustment whatsoever from the Committee bill. 

Again, we would like to emphasize that 82% of all profitable corporations will receive no tax benefit from the Committee bill because they are too small. No business engaged in manufacturing, 

404

but not organized as a taxable corporation, will receive any benefit. 

All of those businesses, regardless of size or organizational structure, would receive a tax reduction under Congressman Rangel’s 

amendment. 

2. Alternative minimum tax (AMT) clawback 

Republicans have often described the corporate alternative minimum tax as the ‘‘anti-manufacturing tax.’’ that rhetoric is fairly 

hypocritical when one views the substance of the Committee’s manufacturing tax cut. 

The Committee bill reduces the regular tax on manufacturing income but not the minimum tax. As a result, all corporations affected by the minimum tax under current law will receive no benefit from the rate reduction contained in the Committee bill. Other 

manufacturers may find that the name of the tax they pay has 

changed, but the amount stays the same. The Committee bill promises a three-point rate reduction, but some corporations will find 

that much, if not all, of their rate reduction is taken back by the 

corporate minimum tax. Capital-intensive manufacturers will be 

among those most adversely by this aspect of the Committee bill. 

In contrast, the Senate bill and the amendment offered by Congressman Rangel provides an effective 10% across the board reduction in both corporate and minimum tax rates. No portion of the 

benefit promised in those proposals will be clawed back through 

the minimum tax.

3. Tax incentives for outsourcing labor force and parts 

The Committee bill will provide substantial tax benefits for the 

income of domestic companies that is attributable to outsourcing 

technical and administrative services overseas, or is that is attributable to cost-savings from using cheap imported parts. If a domestic manufacturer is able to reduce its cost by conducting research, 

testing, computer programming, or other service functions overseas, it will receive a rate reduction for the income resulting from 

those cost savings. If a domestic manufacturer assembles a product 

in the United States using cheap imported parts, it will receive a 

rate reduction for the income resulting from the cost-savings. Effectively, even the portion of the Committee bill which is advertised 

as helping U.S. manufacturers provides incentives for outsourcing 

overseas. 

Last Thursday, The Wall Street Journal published an article 

which gives an idea of how large the potential loophole in the Committee bill may be. It described how auto manufacturers were forcing their suppliers to outsource parts manufacturing overseas. All 

of the cost savings from that offshoring will receive tax benefits 

under the Committee bill. 

This aspect of the Committee bill is deliberate, not accidental. 

The provision passed by the Senate and the amendment offered by 

Mr. Rangel, both contain provisions designed to ensure that the 

‘‘U.S. manufacturing benefit’’ only be allowed for income earned 

from productive activities in the United States. Both of those proposals explicitly make clear that income resulting from offshoring 

will not be eligible for the new rate reduction. It is difficult to unVerDate jul 14 2003 05:28 Jun 18, 2004 Jkt 029006 PO 00000 Frm 00406 Fmt 6604 Sfmt 6602 E:\HR\OC\HR548P1.009 HR548P1
405

derstand what could motivate Republican members of this Committee to endorse a proposal incentivizing offshoring. 

Previously, most of the jobs moved by U.S. companies overseas 

were manufacturing jobs. Now, increasingly, we are seeing U.S. 

companies moving technical work, computer programming, call centers, and other service jobs to take advantage of cheap labor rates 

overseas. That trend will be accelerated by the tax benefits provided by the Committee bill for income resulting from the cost saving of hiring cheaper foreign labor. 

For example, if a software company hires foreign computer programmers to produce parts of its software because of lower wage 

rates overseas, it will receive a rate reduction for the cost saving 

so long as the final computer program is assembled in the United 

States. Manufacturers that move call centers or technical assistance services overseas similarly will get rate reductions for the income derived by hiring cheap, foreign labor. Importers of cheap foreign goods will receive benefits if there is some assembly here. 

PATRIOTISM JUST HAS TO TAKE A BACK SEAT TO PROFITS

A spokesperson for a major accounting firm which was promoting 

the tax avoidance device of moving the corporate charter offshore 

was asked whether there was any downside to these transactions. 

The response was stark. The spokesperson suggested that the 9/11 

tragedies placed an emphasis on patriotism. That concern was dismissed with the statement that the profits from the transaction 

were so large that ‘‘the patriotism issue needs to take a back seat.’’ The Thomas bill is totally consistent with the view expressed by 

that person. It contains no meaningful restrictions on the ability of 

corporations to move their corporate charters offshore for tax avoidance purposes. The Bush Treasury Department representative at 

the markup acknowledged that the Committee bill did little to stop 

these transactions. Remarkably, he supported the bill anyway, arguing that the Bush Administration opposes ‘‘putting up walls’’

that prevent businesses from moving their corporate charters offshore.

COMMITTEE BILL IMPOSES COSTS ON STATE AND LOCAL

GOVERNMENTS TO FUND CORPORATE TAX BENEFITS

Increasingly, the Bush Administration, and the Republican Congress, have increased the burdens on State and local governments. 

They have imposed new mandates without providing needed resources. Some of the tax policies promoted by the Bush Administration have had the indirect impact of increasing the burden of State 

and local taxes. 

Budget crises faced by State and local governments have caused 

some of them to engage in leasing transactions from which they receive some monetary benefits. We recognize that many of these 

transactions are abusive, and that the amount received by the 

State and local government is a relatively small portion of the overall federal revenue loss. Therefore, we would support reform in this 

area, but cannot support the Committee bill that merely increases 

the burden on State and local governments, and makes no attempt 

to replace the benefit. 

406

IRS USE OF PRIVATE COLLECTORS FOR FEDERAL TAX DEBTS

The bill’s provision to ‘‘privatize’’ IRS debt collection should be an 

affront to taxpayers nationwide. Federal tax collection is and 

should continue to be the job of the IRS and the Department of 

Treasury—it is an inherently governmental function. The collection 

of Federal taxes should not be a profitable business venture for corporate America looking to expand their debt collection market 

share. The very notion of unleashing a small army of bill collectors 

on the taxpayers of this Nation should give major pause to everyone. 

The Committee bill specifically rewards private debt collectors up 

to 25% of amounts collected from taxpayers. It is offensive and a 

failure of responsibility for the Committee to give companies and 

their employees—who are not directly accountable to the Treasury 

Department Secretary and IRS Commissioner—‘‘a bounty’’ for getting money from taxpayers. The IRS’s earlier project to use private 

debt collectors resulted in numerous violations of the Fair Debt 

Collection Act and was abandoned, in large part, because the companies were not able to collect taxes from the taxpayers assigned 

to them—cases having large and old tax delinquencies. Now, the 

Treasury Department plans to given these firms small and recent 

cases so they can make profit. This ‘‘cherry picking’’ means that 

private tax collectors will be able to work on average taxpayer 

cases—those who, in fact, filed a return in 2001, 2002 or 2003 and 

were unable to enclose a balance due check of $40–$600. 

Clearly, the IRS could do this collection work if it had more resources. The Republican Leadership just plain refuses to give the 

IRS the resources it needs and wants to do its job of properly administering our tax laws. There is no question that the IRS could 

efficiently and effectively collect additional taxes due and do so for 

about 3–5% of the amount collected. The notice and letter machines, the telephone lines, the know-how, the entire process is 

there and ready to go at the IRS. All that is needed are staff and 

resources to do the work under the existing system. Why would we 

pay someone 25% of a $1,000 tax bill for making a phone call or 

sending a letter to a taxpayer, when the IRS could send that some 

letter or make that same phone call at little cost? 

The proposal is unfair, inefficient, and a threat to taxpayer confidentiality. The fact that the provision specifically prevents a lawsuit against the United States in the event a taxpayer is abused 

by a tax collection company clearly shows that the Committee’s 

plan does include taking responsibility for how the private debt collection plan turns out.

(407)

ADDITIONAL VIEWS OF REPRESENTATIVE EARL POMEROY 

The road to reporting H.R. 4520 has been long and tortured. It 

began with various legislative efforts to assist domestic manufacturers, including the Domestic International Sales Corporation 

(DISC) provisions, Foreign Sales Corporation (FSC) provisions, and 

ultimately the provisions of the Extraterritorial Income Exclusion 

(ETI) Act. Unfortunately, the World Trade Organization has found 

ETI unlawful and authorized billions of dollars of sanctions until 

such time as ETI is repealed. 

Presently, our companies and products are facing tariffs of 8 percent, with this rising by 1 percentage point a month until repeal 

is affected. This situation is untenable and we must therefore pass 

legislation that at a minimum repeals ETI. I also believe that it is 

appropriate to find a WTO-compliant way of providing an equivalent benefit for our domestic manufacturers. This was the purpose 

behind the bipartisan Crane-Rangel proposal, which I supported. 

Ultimately, I find myself unable to wholly support either the underlying bill or the substitute amendment that was offered. While 

my concerns are many, I am most concerned about the fact that the 

Chairman’s bill has chosen to exclude non-C corporation taxpayers 

from the tax reductions that are provided. Small businesses, 

whether they are S corporations or sole proprietorships, farmers or 

other small manufacturers, should not be excluded from the effort 

to solidify our domestic production activities. 

Similarly, while I am concerned that the Chairman’s mark has 

a minimum cost of $35 billion dollars, and likely much more once 

the various gimmicks are accounted for, I am equally concerned 

that in the rush to find offsets, we are continuing a trend that has 

been underway for the last several years, that being shifting our 

tax burdens from the federal level to our state and local governments. Specifically, I am concerned that efforts to curb leasing 

transactions, which are most often used by state and local governmental entities, are being undertaken without ensuring that there 

is a viable financing alternative left to fund infrastructure projects 

at our universities, water treatment facilities, and transit systems. 

I support the vast majority of the provisions contained in the 

substitute amendment. Unfortunately, the substitute has, I believe, 

itself overreached with its provisions on corporate inversion. I do 

not support the actions of those companies that have chosen to invert. I believe, however, that the inversion provisions in the substitute amendment would have an unfair retroactive effect. The 

substitute would reach back and punish those companies who legally, though still unwisely in my view, inverted before March of 

2002, when Congress first gave notice that it might change the applicable tax laws. 

The inversions that were finalized before 2002 were approved by 

corporate shareholders that paid tens of millions of dollars in U.S. 

408

taxes as a result of the transactions. The substitute does not address how to undo this. Additionally, had the inverting corporations 

been given notice of impending Congressional action, they might 

not have inverted and may have made other decisions regarding 

their corporate structures and business activities. This logic is supported by the lack of companies inverting after March 2002, once 

Congress gave fair warning. Making a retroactive change going 

back to before March 2002 could threaten over 2,000 manufacturing jobs in North Dakota and likely even more across the rest 

of the country. Therefore, despite my concerns about the act of inverting, I cannot support the manner in which the substitute addresses the issue. 

I am also concerned that neither of the bills before the committee 

addressed the issue of energy tax incentives. In its bill, the Senate 

included a thoughtful array of energy tax provisions, including important provisions relating to the wind energy tax credit and ethanol and biodiesel. As with the proposed tax rate reductions for our 

domestic manufacturers, these energy provisions can play a significant role in employing Americans while also reducing our energy 

dependence. I support these measures and I am hopeful that the 

Senate’s energy provisions will be retained in conference. 

I remain hopeful that we can quickly pass legislation repealing 

ETI and that in conference a fair resolution will be made relating 

to the scope of any tax benefits and the handling of leasing transactions and corporate inverters. 

EARL POMEROY.

Æ