TECHNICAL EXPLANATION OF TITLE III 

(TAX PROVISIONS) OF DIVISION A OF H.R. 1424, THE 

“EMERGENCY ECONOMIC STABILIZATION ACT OF 2008” 

SCHEDULED FOR CONSIDERATION 

BY THE 

SENATE ON OCTOBER 1, 2008 

Prepared by the Staff 

of the 

JOINT COMMITTEE ON TAXATION 

 

October 1, 2008 

JCX-79-08
i 

CONTENTS 

Page

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

A. Treat Gain or Loss from Sale or Exchange of Certain Preferred Stock by Applicable 

Financial Institutions as Ordinary Income or Loss (sec. 301 of the bill) ............................ 2

B. Special Rules for Tax Treatment of Executive Compensation of Employers 

Participating in the Troubled Assets Relief Program (sec. 302 of the bill and 

secs. 162(m) and 280G of the Code) .................................................................................. 5

C. Exclude Discharges of Acquisition Indebtedness on Principal Residences from 

Gross Income (sec. 303 of the bill and sec. 108 of the Code) .......................................... 14
1 

INTRODUCTION 

This document,1

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

technical explanation of Title III (Tax Provisions) of Division A of H.R. 1424, the “Emergency 

Economic Stabilization Act of 2008,” scheduled for consideration by the Senate on October 1, 

2008. 

 1

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

of Title III (Tax Provisions) of Division A of H.R. 1424, the “Emergency Economic Stabilization Act of 

2008” (JCX-79-08), October 1, 2008. This document can also be found on our website at www.jct.gov. 
2 

A. Treat Gain or Loss from Sale or Exchange of Certain Preferred Stock 

by Applicable Financial Institutions as Ordinary Income or Loss 

(sec. 301 of the bill) 

Present Law

Under section 582(c)(1),2

 the sale or exchange of a bond, debenture, note, or certificate or 

other evidence of indebtedness by a financial institution described in section 582(c)(2) is not 

considered a sale or exchange of a capital asset. The financial institutions described in section 

582(c)(2) are (i) any bank (including any corporation which would be a bank except for the fact 

that it is a foreign corporation), (ii) any financial institution referred to in section 591, which 

includes mutual savings banks, cooperative banks, domestic building and loan associations, and 

other savings institutions chartered and supervised as savings and loan or similar associations 

under Federal or State law, (iii) any small business investment company operating under the 

Small Business Investment Act of 1958, and (iv) any business development corporation, defined 

as a corporation which was created by or pursuant to an act of a State legislature for purposes of 

promoting, maintaining, and assisting the economy and industry within such State on a regional 

or statewide basis by making loans to be used in trades and businesses which would generally 

not be made by banks within such region or State in the ordinary course of their business (except 

on the basis of a partial participation) and which is operated primarily for such purposes. In the 

case of a foreign corporation, section 582(c)(1) applies only with respect to gains or losses that 

are effectively connected with the conduct of a banking business in the United States. 

Preferred stock issued by the Federal National Mortgage Corporation (“Fannie Mae”) or 

the Federal Home Loan Mortgage Corporation (“Freddie Mac”) is not treated as indebtedness for 

Federal income tax purposes, and therefore is not treated as an asset to which section 582(c)(1) 

applies. Accordingly, a financial institution described in section 582(c)(2) that holds Fannie Mae 

or Freddie Mac preferred stock as a capital asset generally will recognize capital gain or loss 

upon the sale or taxable exchange of that stock. Section 1211 provides that, in the case of a 

corporation, losses from sales or exchanges of capital assets are allowed only to the extent of 

gains from such sales or exchanges.3

 Thus, in taxable years in which a corporation does not 

recognize gain from the sale of capital assets, its capital losses do not reduce its income. 

 2

 Unless otherwise specified, all section references herein are to sections of the Internal Revenue 

Code of 1986, as amended. 

3

 In general, corporations (other than S corporations) may carry capital losses back to each of the 

three taxable years preceding the loss year and forward to each of the five taxable years succeeding the 

loss year. Sec. 1212(a). In the case of an S corporation, net capital losses flow through to the 

corporation’s shareholders. Banks hold a wide range of financial assets in the ordinary course of their 

banking business. For convenience, those assets often are described as “loans” or “investments,” but both 

serve the same overall purpose (to earn a return on the bank’s capital and borrowings consistent with 

prudent banking practices). A bank’s investments are subject to the same regulatory capital adequacy 

supervision as are its loans, and a bank may acquire only certain types of financial assets as permitted 

investments. Banks determine how much of their assets to hold as loans or as investments based on the 

exercise of their commercial and financial judgment, taking into account such factors as return on the 
3 

Explanation of Provision

Under the provision, gain or loss recognized by an “applicable financial institution” from 

the sale or exchange of “applicable preferred stock” is treated as ordinary income or loss. An 

applicable financial institution is a financial institution referred to in section 582(c)(2) or a 

depository institution holding company (as defined in section 3(w)(1) of the Federal Deposit 

Insurance Act (12 U.S.C. 1813(w)(1)). Applicable preferred stock is preferred stock of Fannie 

Mae or Freddie Mac that was (i) held by the applicable financial institution on September 6, 

2008, or (ii) was sold or exchanged by the applicable financial institution on or after January 1, 

2008, and before September 7, 2008.4

In the case of a sale or exchange of applicable preferred stock on or after January 1, 2008, 

and before September 7, 2008, the provision applies only to taxpayers that were applicable 

financial institutions at the time of such sale or exchange. In the case of a sale or exchange of 

applicable preferred stock after September 6, 2008, by a taxpayer that held such preferred stock 

on September 6, 2008, the provision applies only where the taxpayer was an applicable financial 

institution at all times during the period beginning on September 6, 2008, and ending on the date 

of the sale or exchange of the applicable preferred stock. Thus, the provision is generally 

inapplicable to any Fannie Mae or Freddie Mac preferred stock held by a taxpayer that was not 

an applicable financial institution on September 6, 2008 (even if such taxpayer subsequently 

became an applicable financial institution). 

The provision grants the Secretary authority to extend the provision to cases in which 

gain or loss is recognized on the sale or exchange of applicable preferred stock acquired in a 

carryover basis transaction by an applicable financial institution after September 6, 2008. For 

example, if after September 6, 2008, Bank A, an entity that was an applicable financial 

 

asset, relative liquidity, and diversification objectives. As a result, for Federal income tax purposes, gains 

and losses on a bank’s investment portfolio ordinarily would be considered an integral part of the 

business operations of the bank, and ordinary losses that pass through to the shareholder of a bank that is 

an S corporation therefore could comprise part of such shareholder’s net operating loss for the year 

attributable to that banking business. 

Section 1366(d) provides that losses that flow through to an S corporation shareholder are limited 

to the sum of (i) the shareholder’s adjusted basis in his S corporation stock and (ii) the shareholder’s 

adjusted basis in any indebtedness of the S corporation to the shareholder; losses in excess of basis are 

suspended (and allowed to the extent of basis in subsequent years). An S corporation shareholder's ability 

to utilize any flow-through capital loss is subject to all limitations otherwise imposed by the Code on such 

shareholder. In general, under section 1211, an individual (including an individual S corporation 

shareholder) may deduct capital losses only against capital gains plus up to $3,000 of ordinary income; in 

addition, an individual may carry excess capital losses forward but not back. 

4

 On September 7, 2008, the Federal Housing Finance Agency (“FHFA”) placed both Fannie 

Mae and Freddie Mac in a conservatorship. Also on September 7, 2008, FHFA and the Treasury 

Department entered into Preferred Stock Purchase Agreements, contractual agreements between the 

Treasury and the conserved entities. Under these agreements, the Treasury Department received senior 

preferred stock in the two companies and warrants to buy 79.9% of the common stock of such companies. 
4 

institution at all times during the period beginning on September 6, 2008, acquired assets of 

Bank T, an entity that also was an applicable financial institution at all times during the period 

beginning on September 6, 2008, in a transaction in which no gain or loss was recognized under 

section 368(a)(1), regulations could provide that Fannie Mae and Freddie Mac stock that was 

applicable preferred stock in the hands of Bank T will continue to be applicable preferred stock 

in the hands of Bank A. 

In addition, the Secretary may, through regulations, extend the provision to cases in 

which the applicable financial institution is a partner in a partnership that (i) held preferred stock 

of Fannie Mae or Freddie Mac on September 6, 2008, and later sold or exchanged such stock, or 

(ii) sold or exchanged such preferred stock on or after January 1, 2008, and before September 7, 

2008. It is intended that Treasury guidance will provide that loss (or gain) attributable to Fannie 

Mae or Freddie Mac preferred stock of a partnership is characterized as ordinary in the hands of 

a partner only if the partner is an applicable financial institution, and only if the institution would 

have been eligible for ordinary treatment under section 301 of the bill had the institution held the 

underlying preferred stock directly for the time period during which both (i) the partnership 

holds the preferred stock and (ii) the institution holds substantially the same partnership interest. 

 In particular, substantial amounts of the preferred stock of Fannie Mae and Freddie Mac 

are held through “pass-through trusts” analyzed as partnerships for Federal income tax purposes. 

Substantially all the assets of such a pass-through trust comprise Fannie Mae or Freddie Mac 

preferred stock, and the trust in turn passes through dividends received on such stock to its two 

outstanding classes of certificates (partnership interests): an auction-rate class, where the share of 

the underlying preferred stock dividend is determined by periodic auctions, and a residual class, 

which receives the remainder of any dividends received on the underlying stock. The bill’s 

delegation of authority to the Secretary anticipates that regulations will promptly be issued 

confirming in general that losses recognized by such a trust on or after January 1, 2008, in 

respect of the preferred stock of Fannie Mae or Freddie Mac that it acquired before September 6, 

2008, will be characterized as ordinary loss in the hands of a certificate holder that is an 

applicable financial institution and that would be eligible for the relief contemplated by this 

provision if the applicable financial institution had held the underlying preferred stock directly 

for the same period that it held the pass-through certificate. In light of the substantial amount of 

such pass-through certificates in the marketplace, and the importance of the prompt resolution of 

the character of any resulting losses allocated to certificate holders that are applicable financial 

institutions for purposes of their regulatory and investor financial statement filings, unnecessary 

disruptions to the marketplace could best be avoided if the Secretary were to exercise the 

regulatory authority granted under the provision to address this case as soon as possible and, in 

any event, by October 31, 2008. 

Effective Date

This provision applies to sales or exchanges occurring after December 31, 2007, in 

taxable years ending after such date. 
5 

B. Special Rules for Tax Treatment of Executive Compensation of Employers 

Participating in the Troubled Assets Relief Program 

(sec. 302 of the bill and secs. 162(m) and 280G of the Code) 

Present Law

In general

An employer generally may deduct reasonable compensation for personal services as an 

ordinary and necessary business expense. Sections 162(m) and 280G provide explicit limitations 

on the deductibility of compensation expenses in the case of corporate employers. 

Section 162(m)

In general

The otherwise allowable deduction for compensation paid or accrued with respect to a 

covered employee of a publicly held corporation5 is limited to no more than $1 million per year.6 

The deduction limitation applies when the deduction would otherwise be taken. Thus, for 

example, in the case of compensation resulting from a transfer of property in connection with the 

performance of services, such compensation is taken into account in applying the deduction 

limitation for the year for which the compensation is deductible under section 83 (i.e., generally 

the year in which the employee’s right to the property is no longer subject to a substantial risk of 

forfeiture). 

Covered employees

Section 162(m) defines a covered employee as (1) the chief executive officer of the 

corporation (or an individual acting in such capacity) as of the close of the taxable year and (2) 

the four most highly compensated officers for the taxable year (other than the chief executive 

officer). Treasury regulations under section 162(m) provide that whether an employee is the 

chief executive officer or among the four most highly compensated officers should be 

determined pursuant to the executive compensation disclosure rules promulgated under the 

Securities Exchange Act of 1934 (“Exchange Act”). 

In 2006, the Securities and Exchange Commission amended certain rules relating to 

executive compensation, including which executive officers’ compensation must be disclosed 

under the Exchange Act. Under the new rules, such officers consist of (1) the principal executive 

officer (or an individual acting in such capacity), (2) the principal financial officer (or an 

individual acting in such capacity), and (3) the three most highly compensated executive officers, 

other than the principal executive officer or financial officer. 

 5

 A corporation is treated as publicly held if it has a class of common equity securities that is 

required to be registered under section 12 of the Securities Exchange Act of 1934. 

6

 Sec. 162(m). This deduction limitation applies for purposes of the regular income tax and the 

alternative minimum tax. 
6 

In response to the Securities and Exchange Commission’s new disclosure rules, the 

Internal Revenue Service issued updated guidance on identifying which employees are covered 

by section 162(m).7 The new guidance provides that “covered employee” means any employee 

who is (1) the principal executive officer (or an individual acting in such capacity) defined in 

reference to the Exchange Act, or (2) among the three most highly compensated officers for the 

taxable year (other than the principal executive officer), again defined by reference to the 

Exchange Act. Thus, under current guidance, only four employees are covered under section 

162(m) for any taxable year. Under Treasury regulations, the requirement that the individual 

meet the criteria as of the last day of the taxable year applies to both the principal executive 

officer and the three highest compensated officers.8 

Compensation subject to the deduction limitation

In general.−Unless specifically excluded, the deduction limitation applies to all 

remuneration for services, including cash and the cash value of all remuneration (including 

benefits) paid in a medium other than cash. If an individual is a covered employee for a taxable 

year, the deduction limitation applies to all compensation not explicitly excluded from the 

deduction limitation, regardless of whether the compensation is for services as a covered 

employee and regardless of when the compensation was earned. The $1 million cap is reduced 

by excess parachute payments (as defined in sec. 280G, discussed below) that are not deductible 

by the corporation. 

Certain types of compensation are not subject to the deduction limit and are not taken 

into account in determining whether other compensation exceeds $1 million. The following 

types of compensation are not taken into account: (1) remuneration payable on a commission 

basis; (2) remuneration payable solely on account of the attainment of one or more performance 

goals if certain outside director and shareholder approval requirements are met 

(“performance-based compensation”); (3) payments to a tax-qualified retirement plan (including 

salary reduction contributions); (4) amounts that are excludable from the executive’s gross 

income (such as employer-provided health benefits and miscellaneous fringe benefits (sec. 132)); 

and (5) any remuneration payable under a written binding contract which was in effect on 

February 17, 1993. In addition, remuneration does not include compensation for which a 

deduction is allowable after a covered employee ceases to be a covered employee. Thus, the 

deduction limitation often does not apply to deferred compensation that is otherwise subject to 

the deduction limitation (e.g., is not performance-based compensation) because the payment of 

compensation is deferred until after termination of employment. 

Performance-based compensation.−Compensation qualifies for the exception for 

performance-based compensation only if (1) it is paid solely on account of the attainment of one 

or more performance goals, (2) the performance goals are established by a compensation 

 7

 Notice 2007-49, 2007-25 I.R.B. 1429. 

8

 Treas. Reg. sec. 1.162-27(c)(2). 
7 

committee consisting solely of two or more outside directors,9

 (3) the material terms under which 

the compensation is to be paid, including the performance goals, are disclosed to and approved 

by the shareholders in a separate vote prior to payment, and (4) prior to payment, the 

compensation committee certifies that the performance goals and any other material terms were 

in fact satisfied. 

Compensation (other than stock options or other stock appreciation rights) is not treated 

as paid solely on account of the attainment of one or more performance goals unless the 

compensation is paid to the particular executive pursuant to a pre-established objective 

performance formula or standard that precludes discretion. Stock options or other stock 

appreciation rights generally are treated as meeting the exception for performance-based 

compensation, provided that the requirements for outside director and shareholder approval are 

met (without the need for certification that the performance standards have been met), because 

the amount of compensation attributable to the options or other rights received by the executive 

would be based solely on an increase in the corporation’s stock price. Stock-based compensation 

is not treated as performance-based if it is dependent on factors other than corporate 

performance. For example, if a stock option is granted to an executive with an exercise price 

that is less than the current fair market value of the stock at the time of grant, then the executive 

would have the right to receive compensation on the exercise of the option even if the stock price 

decreases or stays the same. In contrast to options or other stock appreciation rights, grants of 

restricted stock are not inherently performance-based because the executive may receive 

compensation even if the stock price decreases or stays the same. Thus, a grant of restricted 

stock does not satisfy the definition of performance-based compensation unless the grant or 

vesting of the restricted stock is based upon the attainment of a performance goal and otherwise 

satisfies the standards for performance-based compensation. 

Section 280G

In general

In some cases, a compensation agreement for a corporate executive may provide for 

payments to be made if there is a change in control of the executive’s employer, even if the 

executive does not lose his or her job as part of the change in control. Such payments are 

sometimes referred to as “golden parachute payments.” The Code contains limits on the amount 

of certain types of such payments, referred to as “excess parachute payments.” Excess parachute 

 9

 A director is considered an outside director if he or she is not a current employee of the 

corporation (or related entities), is not a former employee of the corporation (or related entities) who is 

receiving compensation for prior services (other than benefits under a tax-qualified retirement plan), was 

not an officer of the corporation (or related entities) at any time, and is not currently receiving 

compensation for personal services in any capacity (e.g., for services as a consultant) other than as a 

director. 
8 

payments are not deductible by a corporation.10 In addition, an excise tax is imposed on the 

recipient of any excess parachute payment equal to 20 percent of the amount of such payment.11 

Definition of parachute payment

A “parachute payment” is any payment in the nature of compensation to (or for the 

benefit of) a disqualified individual which is contingent on a change in the ownership or 

effective control of a corporation or on a change in the ownership of a substantial portion of the 

assets of a corporation (“acquired corporation”), if the aggregate present value of all such 

payments made or to be made to the disqualified individual equals or exceeds three times the 

individual’s “base amount.” 

The individual’s base amount is the average annual compensation payable by the 

acquired corporation and includible in the individual’s gross income over the five-taxable years 

of such individual preceding the individual’s taxable year in which the change in ownership or 

control occurs. 

The term parachute payment also includes any payment in the nature of compensation to 

a disqualified individual if the payment is made pursuant to an agreement which violates any 

generally enforced securities laws or regulations. 

Certain amounts are not considered parachute payments, including payments under a 

qualified retirement plan, and payments that are reasonable compensation for services rendered 

on or after the date of the change in control. In addition, the term parachute payment does not 

include any payment to a disqualified individual with respect to a small business corporation or a 

corporation no stock of which was readily tradable, if certain shareholder approval requirements 

are satisfied. 

Disqualified individual

A disqualified individual is any individual who is an employee, independent contractor, 

or other person specified in Treasury regulations who performs personal services for the 

corporation and who is an officer, shareholder, or highly compensated individual of the 

corporation. Personal service corporations and similar entities generally are treated as 

individuals for this purpose. A highly compensated individual is defined for this purpose as an 

employee (or a former employee) who is among the highest-paid one percent of individuals 

performing services for the corporation (or an affiliated corporation) or the 250 highest paid 

individuals who perform services for a corporation (or affiliated group). 

 10 Sec. 280G. 

11 Sec. 4999. 
9 

Excess parachute payments

In general, excess parachute payments are any parachute payments in excess of the base 

amount allocated to the payment. The amount treated as an excess parachute payment is reduced 

by the portion of the payment that the taxpayer establishes by clear and convincing evidence is 

reasonable compensation for personal services actually rendered before the change in control. 

Explanation of Provision

Section 162(m)

In general

Under the provision, the section 162(m) limit is reduced to $500,000 in the case of 

otherwise deductible compensation of a covered executive for any applicable taxable year of an 

applicable employer. 

An applicable employer means any employer from which one or more troubled assets are 

acquired under the “troubled assets relief program” (“TARP”) established by the bill if the 

aggregate amount of the assets so acquired for all taxable years (including assets acquired 

through a direct purchase by the Treasury Department, within the meaning of section 113(c) of 

Title I of the bill) exceeds $300,000,000. However, such term does not include any employer 

from which troubled assets are acquired by the Treasury Department solely through direct 

purchases (within the meaning of section 113(c) of Title I of the bill). For example, if a firm 

sells $250,000,000 in assets through an auction system managed by the Treasury Department, 

and $100,000,000 to the Treasury Department in direct purchases, then the firm is an applicable 

employer. Conversely, if all $350,000,000 in sales take the form of direct purchases, then the 

firm would not be an applicable employer. 

Unlike section 162(m), an applicable employer under this provision is not limited to 

publicly held corporations (or even limited to corporations). For example, an applicable 

employer could be a partnership if the partnership is an employer from which a troubled asset is 

acquired. The aggregation rules of Code section 414(b) and (c) apply in determining whether an 

employer is an applicable employer. However, these rules are applied disregarding the rules for 

brother-sister controlled groups and combined groups in sections 1563(a)(2) and (3). Thus, this 

aggregation rule only applies to parent-subsidiary controlled groups. A similar controlled group 

rule applies for trades and businesses under common control. 

The result of this aggregation rule is that all corporations in the same controlled group are 

treated as a single employer for purposes of identifying the covered executives of that employer 

and all compensation from all members of the controlled group are taken into account for 

purposes of applying the $500,000 deduction limit. Further, all sales of assets under the TARP 

from all members of the controlled group are considered in determining whether such sales 

exceed $300,000,000. 

An applicable taxable year with respect to an applicable employer means the first taxable 

year which includes any portion of the period during which the authorities for the TARP 

established under the bill are in effect (the “authorities period”) if the aggregate amount of 
10 

troubled assets acquired from the employer under that authority during the taxable year (when 

added to the aggregate amount so acquired for all preceding taxable years) exceeds 

$300,000,000, and includes any subsequent taxable year which includes any portion of the 

authorities period. 

A special rule applies in the case of compensation that relates to services that a covered 

executive performs during an applicable taxable year but that is not deductible until a later year 

(“deferred deduction executive remuneration”), such as nonqualified deferred compensation. 

Under the special rule, the unused portion (if any) of the $500,000 limit for the applicable tax 

year is carried forward until the year in which the compensation is otherwise deductible, and the 

remaining unused limit is then applied to the compensation. 

For example, assume a covered executive is paid $400,000 in cash salary by an 

applicable employer in 2008 (assuming 2008 is an applicable taxable year) and the covered 

executive earns $100,000 in nonqualified deferred compensation (along with the right to future 

earnings credits) payable in 2020. Assume further that the $100,000 has grown to $300,000 in 

2020. The full $400,000 in cash salary is deductible under the $500,000 limit in 2008. In 2020, 

the applicable employer’s deduction with respect to the $300,000 will be limited to $100,000 

(the lesser of the $300,000 in deductible compensation before considering the special limitation, 

and $500,000 less $400,000, which represents the unused portion of the $500,000 limit from 

2008). 

Deferred deduction executive remuneration that is properly deductible in an applicable 

taxable year (before application of the limitation under the provision) but is attributable to 

services performed in a prior applicable taxable year is subject to the special rule described 

above and is not double-counted. For example, assume the same facts as above, except that the 

nonqualified deferred compensation is deferred until 2009 and that 2009 is an applicable taxable 

year. The employer’s deduction for the nonqualified deferred compensation for 2009 would be 

limited to $100,000 (as in the example above). The limit that would apply under the provision 

for executive remuneration that is in a form other than deferred deduction executive 

remuneration and that is otherwise deductible for 2009 is $500,000. For example, if the covered 

executive is paid $500,000 in cash compensation for 2009, all $500,000 of that cash 

compensation would be deductible in 2009 under the provision. 

Covered executive

The term covered executive means any individual who is the chief executive officer or 

the chief financial officer of an applicable employer, or an individual acting in that capacity, at 

any time during a portion of the taxable year that includes the authorities period. It also includes 

any employee who is one of the three highest compensated officers of the applicable employer 

for the applicable taxable year (other than the chief executive officer or the chief financial officer 

and only taking into account employees employed during any portion of the taxable year that 

includes the authorities period). 
11 

The determination of the three highest compensated officers is made on the basis of the 

shareholder disclosure rules for compensation under the Exchange Act, except to the extent that 

the shareholder disclosure rules are inconsistent with the provision.12 Such shareholder 

disclosure rules are applied without regard to whether those rules actually apply to the employer 

under the Exchange Act. If an employee is a covered executive with respect to an applicable 

employer for any applicable taxable year, the employee will be treated as a covered executive for 

all subsequent applicable taxable years (and will be treated as a covered executive for purposes 

of any subsequent taxable year for purposes of the special rule for deferred deduction executive 

remuneration). 

Executive remuneration

The provision generally incorporates the present law definition of applicable employee 

remuneration. However, the present law exceptions for remuneration payable on commission 

and performance-based compensation do not apply for purposes of the new $500,000 limit. In 

addition, the new $500,000 limit only applies to executive remuneration which is attributable to 

services performed by a covered executive during an applicable taxable year. For example, 

assume the same facts as in the example above, except that the covered executive also receives in 

2008 a payment of $300,000 in nonqualified deferred compensation that was attributable to 

services performed in 2006. Such payment is not treated as executive remuneration for purposes 

of the new $500,000 limit. 

Other rules

The modification to section 162(m) provides the same coordination rules with disallowed 

parachute payment and stock compensation of insiders in expatriated corporations as exist under 

present law section 162(m). Thus, the $500,000 deduction limit under this section is reduced 

(but not below zero) by any parachute payments (including parachute payments under the 

expanded definition under this provision) paid during the authorities period and any payment of 

the excise tax under section 4985 for stock compensation of insiders in expatriated corporations. 

 12 For example, the shareholder disclosure rules require the reporting of the compensation of the 

three most highly compensated executive officers (other than the principal executive officer and the 

principal financial officer) who were serving as executive officers at the end of the last completed fiscal 

year and up to two additional individuals from whom disclosure would have been provided but for the 

fact that the individual was not serving as an executive officer at the end of the last completed fiscal year. 

17 C.F.R. sec. 229.402(a)(3)(iii), (iv). For purposes of the provision, the term “officer” is intended to 

mean those “executive officers” whose compensation is subject to reporting under the Exchange Act. 

Under the provision, however, an individual’s status as one of the three most highly compensated officers 

takes into account only executive officers employed during the authorities period, regardless of whether 

the individual serves as an executive officer at year end. Additionally, the shareholder disclosure rules 

measure compensation for purposes of determining “high three” status by reference to total compensation 

for the last completed fiscal year, and compensation is measured without regard to whether the 

compensation is includible in an executive officer’s gross income. It is intended that this broad 

measurement of compensation apply for purposes of the provision; however, the measurement period for 

purposes of the provision is the applicable taxable year for which “high three” status is being determined. 
12 

The modification authorizes the Secretary of the Treasury to prescribe such guidance, 

rules, or regulations as are necessary to carry out the purposes of the $500,000 deduction limit, 

including the application of the limit in the case of any acquisition, merger, or reorganization of 

an applicable employer. 

Section 280G

The provision also modifies section 280G by expanding the definition of parachute 

payment in the case of a covered executive of an applicable employer. For this purpose, the 

terms “covered executive,” “applicable taxable year,” and “applicable employer” have the same 

meaning as under the modifications to section 162(m) (described above). 

Under the modification, a parachute payment means any payments in the nature of 

compensation to (or for the benefit of) a covered executive made during an applicable taxable 

year on account of an applicable severance from employment during the authorities period if the 

aggregate present value of such payments equals or exceeds an amount equal to three times the 

covered executive’s base amount. An applicable severance from employment is any severance 

from employment of a covered executive (1) by reason of an involuntary termination of the 

executive by the employer or (2) in connection with a bankruptcy, liquidation, or receivership of 

the employer. 

Whether a payment is on account of the employee’s severance from employment is 

generally determined in the same manner as under present law. Thus, a payment is on account of 

the employee’s severance from employment if the payment would not have been made at that 

time if the severance from employment had not occurred. Such payments include amounts that 

are payable upon severance from employment (or separation from service), vest or are no longer 

subject to a substantial risk of forfeiture on account of such a separation, or are accelerated on 

account of severance from employment. As under present law, the modified definition of 

parachute payment does not include amounts paid to a covered executive from certain tax 

qualified retirement plans. 

A parachute payment during an applicable taxable year that is paid on account of a 

covered executive’s applicable severance from employment is nondeductible on the part of the 

employer (and the covered executive is subject to the section 4999 excise tax) to the extent of the 

amount of the payment that is equal to the excess over the employee’s base amount that is 

allocable to such payment. For example, assume that a covered executive’s annualized 

includible compensation is $1 million and the covered executive’s only parachute payment under 

the provision is a lump sum payment of $5 million. The covered executive’s base amount is $1 

million and the excess parachute payment is $4 million. 

The modifications to section 280G do not apply in the case of a payment that is treated as 

a parachute payment under present law. The modifications further authorize the Secretary of 

Treasury to issue regulations to carry out the purposes of the provision, including the application 

of the provision in the case of a covered executive who receives payments some of which are 

treated as parachute payments under present law section 280G and others of which are treated as 

parachute payments on account of this provision, and the application of the provision in the event 

of any acquisition, merger, or reorganization of an applicable employer. The regulations shall 
13 

also prevent the avoidance of the application of the provision through the mischaracterization of 

a severance from employment as other than an applicable severance from employment. It is 

intended that the regulations prevent the avoidance of the provision through the acceleration, 

delay, or other modification of payment dates with respect to existing compensation 

arrangements. 

Effective Date

The provision is effective for taxable years ending on or after date of enactment, except 

that the modifications to section 280G are effective for payments with respect to severances 

occurring during the authorities period. 
14 

C. Exclude Discharges of Acquisition Indebtedness on Principal 

Residences from Gross Income 

(sec. 303 of the bill and sec. 108 of the Code) 

Present Law

In general

Gross income includes income that is realized by a debtor from the discharge of 

indebtedness, subject to certain exceptions for debtors in Title 11 bankruptcy cases, insolvent 

debtors, certain student loans, certain farm indebtedness, and certain real property business 

indebtedness (secs. 61(a)(12) and 108).13 In cases involving discharges of indebtedness that are 

excluded from gross income under the exceptions to the general rule, taxpayers generally reduce 

certain tax attributes, including basis in property, by the amount of the discharge of indebtedness. 

The amount of discharge of indebtedness excluded from income by an insolvent debtor 

not in a Title 11 bankruptcy case cannot exceed the amount by which the debtor is insolvent. In 

the case of a discharge in bankruptcy or where the debtor is insolvent, any reduction in basis may 

not exceed the excess of the aggregate bases of properties held by the taxpayer immediately after 

the discharge over the aggregate of the liabilities of the taxpayer immediately after the discharge 

(sec. 1017). 

For all taxpayers, the amount of discharge of indebtedness generally is equal to the 

difference between the adjusted issue price of the debt being cancelled and the amount used to 

satisfy the debt. These rules generally apply to the exchange of an old obligation for a new 

obligation, including a modification of indebtedness that is treated as an exchange (a debt-fordebt exchange). 

Qualified principal residence indebtedness

An exclusion from gross income is provided for any discharge of indebtedness income by 

reason of a discharge (in whole or in part) of qualified principal residence indebtedness. 

Qualified principal residence indebtedness means acquisition indebtedness (within the meaning 

of section 163(h)(3)(B), except that the dollar limitation is $2,000,000) with respect to the 

taxpayer’s principal residence. Acquisition indebtedness with respect to a principal residence 

generally means indebtedness which is incurred in the acquisition, construction, or substantial 

improvement of the principal residence of the individual and is secured by the residence. It also 

includes refinancing of such indebtedness to the extent the amount of the indebtedness resulting 

from such refinancing does not exceed the amount of the refinanced indebtedness. For these 

purposes, the term “principal residence” has the same meaning as under section 121 of the Code. 

If, immediately before the discharge, only a portion of a discharged indebtedness is 

qualified principal residence indebtedness, the exclusion applies only to so much of the amount 

 13 A debt cancellation which constitutes a gift or bequest is not treated as income to the donee 

debtor (sec. 102). 
15 

discharged as exceeds the portion of the debt which is not qualified principal residence 

indebtedness. Thus, assume that a principal residence is secured by an indebtedness of $1 

million, of which $800,000 is qualified principal residence indebtedness. If the residence is sold 

for $700,000 and $300,000 debt is discharged, then only $100,000 of the amount discharged may 

be excluded from gross income under the qualified principal residence indebtedness exclusion. 

The basis of the individual’s principal residence is reduced by the amount excluded from 

income under the provision. 

The qualified principal residence indebtedness exclusion does not apply to a taxpayer in a 

Title 11 case; instead the general exclusion rules apply. In the case of an insolvent taxpayer not 

in a Title 11 case, the qualified principal residence indebtedness exclusion applies unless the 

taxpayer elects to have the general exclusion rules apply instead. 

The exclusion does not apply to the discharge of a loan if the discharge is on account of 

services performed for the lender or any other factor not directly related to a decline in the value 

of the residence or to the financial condition of the taxpayer. 

The exclusion for qualified principal residence indebtedness is effective for discharges of 

indebtedness before January 1, 2010. 

Explanation of Provision

The provision extends for three additional years the exclusion from gross income for 

discharges of qualified principal residence indebtedness. 

Effective Date

The provision is effective for discharges of indebtedness on or after January 1, 2010, and 

before January 1, 2013.