I

104TH CONGRESS

1ST SESSION H. R. 2692

To amend the Internal Revenue Code of 1986 to provide for deductible

contributions to medical finance accounts and to reform the earned

income credit.

IN THE HOUSE OF REPRESENTATIVES

NOVEMBER 30, 1995

Mr. ROYCE introduced the following bill; which was referred to the Committee

on Ways and Means

A BILL

To amend the Internal Revenue Code of 1986 to provide

for deductible contributions to medical finance accounts

and to reform the earned income credit.

1 Be it enacted by the Senate and House of Representa2 tives of the United States of America in Congress assembled,

3 TITLE I—MEDICAL FINANCE

4 ACCOUNTS

5 SEC. 101. MEDICAL FINANCE ACCOUNTS.

6 (a) IN GENERAL.—Part VII of subchapter B of chap7 ter 1 of the Internal Revenue Code of 1986 (relating to

8 additional itemized deductions for individuals) is amended
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1 by redesignating section 220 as section 221 and by insert2 ing after section 219 the following new section:

3 ‘‘SEC. 220. MEDICAL FINANCE ACCOUNTS.

4 ‘‘(a) DEDUCTION ALLOWED.—In the case of an indi5 vidual, there shall be allowed as a deduction for the tax6 able year an amount equal to the aggregate amount paid

7 in cash by such individual during such taxable year to a

8 medical finance account of such individual.

9 ‘‘(b) LIMITATIONS.—

10 ‘‘(1) IN GENERAL.—Except as otherwise pro11 vided in this subsection, the amount allowable as a

12 deduction under subsection (a) to an individual for

13 any taxable year shall not exceed the greater of—

14 ‘‘(A) $3,000 or, in the case of an individ15 ual who is married, has a dependent (as defined

16 in section 152), or is a dependent (as so de17 fined) for the taxable year, the amount deter18 mined under paragraph (3),

19 ‘‘(B) in the case of an individual who is

20 covered by a catastrophic health plan, the de21 ductible under such plan, or

22 ‘‘(C) the excess of—

23 ‘‘(i) the limitation under this para24 graph (determined without regard to this
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1 subparagraph) for the taxable year and

2 each of the preceding 4 taxable years, over

3 ‘‘(ii) the sum of the amounts allowed

4 as a deduction under this section for each

5 of such 4 taxable years.

6 For purposes of subparagraph (C), any of such pre7 ceding 4 taxable years during which the individual

8 did not have a medical finance account shall not be

9 taken into account, and any taxable year beginning

10 before January 1, 1996, shall not be taken into ac11 count.

12 ‘‘(2) COORDINATION WITH EXCLUSION FOR EM13 PLOYER CONTRIBUTIONS.—The limitation which

14 would (but for this paragraph) apply under this sub15 section to any individual for any taxable year shall

16 be reduced (but not below zero) by the amount

17 which would (but for section 106(b)) be includible in

18 such individual’s gross income for such taxable year.

19 ‘‘(3) SPECIAL RULES FOR MARRIED INDIVID20 UALS AND FAMILIES.—For purposes of paragraph

21 (1)(A)—

22 ‘‘(A) IN GENERAL.—Subject to subpara23 graphs (B) and (C), the amount determined

24 under this paragraph, with respect to an indi25 vidual who is married or has a dependent (as
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1 defined in section 152) for the taxable year, is

2 $5,000.

3 ‘‘(B) TREATMENT OF FAMILY AS ONE IN4 DIVIDUAL.—For purposes of subparagraph (A),

5 an individual, the spouse (if any) of such indi6 vidual, and all dependents of such individual or

7 such spouse shall be treated as 1 individual.

8 ‘‘(C) DIVISION OF AMOUNTS BETWEEN

9 FAMILY MEMBERS.—Individuals who are mar10 ried to each other may allocate the amount ap11 plicable under subparagraph (A) between them

12 in any proportion on which they agree. If there

13 is no such agreement, such amount shall be al14 located equally between such individuals. Any

15 individual may allocate to any dependent (as

16 defined in section 152) of such individual any

17 portion of the amount otherwise allocable to

18 such individual under this paragraph.

19 ‘‘(4) SPECIAL RULE IF ONE DEDUCTIBLE AP20 PLIES TO FAMILY.—For purposes of paragraph

21 (1)(B), rules similar to the rules of subparagraphs

22 (B) and (C) of paragraph (3) shall apply with re23 spect to any catastrophic health plan which applies

24 one deductible to—

25 ‘‘(A) an individual, and
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1 ‘‘(B)(i) the spouse (if any) of such individ2 ual, or

3 ‘‘(ii) any dependent of such individual or

4 such spouse.

5 ‘‘(c) MEDICAL FINANCE ACCOUNT.—For purposes of

6 this section—

7 ‘‘(1) MEDICAL FINANCE ACCOUNT.—The term

8 ‘medical finance account’ means a trust created or

9 organized in the United States exclusively for the

10 purpose of paying the qualified medical expenses of

11 the account holder, but only if the written governing

12 instrument creating the trust meets the following re13 quirements:

14 ‘‘(A) Except in the case of a rollover con15 tribution described in subsection (f)(3), con16 tributions will be accepted—

17 ‘‘(i) only in cash, and

18 ‘‘(ii) only to the extent not in excess

19 of the limitation under subsection (b) (de20 termined without regard to paragraph (2)

21 thereof).

22 ‘‘(B) The trustee is a bank (as defined in

23 section 408(n)), an insurance company (as de24 fined in section 816), or another person who

25 demonstrates to the satisfaction of the Sec-
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1 retary that the manner in which such person

2 will administer the trust will be consistent with

3 the requirements of this section.

4 ‘‘(C) No part of the trust assets will be in5 vested in life insurance contracts.

6 ‘‘(D) The assets of the trust will not be

7 commingled with other property except in a

8 common trust fund or common investment

9 fund.

10 ‘‘(E) The interest of an individual in the

11 balance in his account is nonforfeitable.

12 ‘‘(2) QUALIFIED MEDICAL EXPENSES.—The

13 term ‘qualified medical expenses’ means, with re14 spect to an account holder, amounts paid by such

15 holder for medical care (as defined in section

16 213(d)), or long-term care, for—

17 ‘‘(A) such individual, the spouse of such

18 individual, and any dependent (as defined in

19 section 152) of such individual, or

20 ‘‘(B) any member of the family of such in21 dividual or spouse who has attained age 65,

22 but only to the extent such amounts are not com23 pensated for by insurance or otherwise, and
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1 ‘‘(3) ACCOUNT HOLDER.—The term ‘account

2 holder’ means the individual on whose behalf the

3 medical finance account was established.

4 ‘‘(4) CERTAIN RULES TO APPLY.—Rules similar

5 to the following rules shall apply for purposes of this

6 section:

7 ‘‘(A) Section 219(d)(2) (relating to no de8 duction for rollovers).

9 ‘‘(B) Section 219(f)(3) (relating to time

10 when contributions deemed made).

11 ‘‘(C) Except as provided in section 106(b),

12 section 219(f)(5) (relating to employer pay13 ments).

14 ‘‘(D) Section 408(h) (relating to custodial

15 accounts).

16 ‘‘(d) TAX TREATMENT OF ACCOUNTS.—

17 ‘‘(1) IN GENERAL.—A medical finance account

18 is exempt from taxation under this subtitle, unless

19 such account has ceased to be a medical finance ac20 count by reason of the rules referred to in paragraph

21 (2). Notwithstanding the preceding sentence, any

22 such account is subject to the taxes imposed by sec23 tion 511 (relating to imposition of tax on unrelated

24 business income of charitable, etc., organizations).
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1 ‘‘(2) ACCOUNT ASSETS TREATED AS DISTRIB2 UTED IN THE CASE OF PROHIBITED TRANSACTIONS

3 OR ACCOUNT PLEDGED AS SECURITY FOR LOAN.—

4 Rules similar to the rules of paragraphs (2) and (4)

5 of section 408(e) shall apply to medical finance ac6 counts, and any amount treated as distributed under

7 such rules shall be treated as not used to pay quali8 fied medical expenses.

9 ‘‘(e) TAX TREATMENT OF DISTRIBUTIONS.—

10 ‘‘(1) INCLUSION OF AMOUNTS NOT USED FOR

11 QUALIFIED MEDICAL EXPENSES.—Any amount paid

12 or distributed out of a medical finance account shall

13 be included in the gross income of the account hold14 er unless such amount is used exclusively to pay the

15 qualified medical expenses of such holder.

16 ‘‘(2) PENALTY FOR AMOUNTS NOT USED FOR

17 QUALIFIED MEDICAL EXPENSES.—

18 ‘‘(A) IN GENERAL.—The tax imposed by

19 this chapter for any taxable year in which any

20 amount is included in gross income by reason

21 of paragraph (1) shall be increased by 10 per22 cent of such amount.

23 ‘‘(B) EXCEPTIONS.—Subparagraph (A)

24 shall not apply with respect to any amount paid
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1 or distributed on or after the date the account

2 holder—

3 ‘‘(i) becomes disabled within the

4 meaning of section 72(m)(7), or

5 ‘‘(ii) dies.

6 ‘‘(3) EXCESS CONTRIBUTIONS RETURNED BE7 FORE DUE DATE OF RETURN.—Paragraph (1) shall

8 not apply to the distribution of any contribution paid

9 during a taxable year to a medical finance account

10 to the extent that such contribution exceeds the limi11 tation under subsection (b) (determined without re12 gard to paragraph (3) thereof) if—

13 ‘‘(A) such distribution is received by the

14 account holder on or before the last day pre15 scribed by law (including extensions of time) for

16 filing such individual’s return for such taxable

17 year, and

18 ‘‘(B) such distribution is accompanied by

19 the amount of net income attributable to such

20 excess contribution.

21 Any net income described in subparagraph (B) shall

22 be included in the gross income of the account hold23 er for the taxable year in which it is received.

24 ‘‘(4) ROLLOVERS AND TRANSFERS AT

25 DEATH.—Paragraph (1) shall not apply to any
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1 amount paid or distributed out of a medical finance

2 account if the entire amount received (including

3 money and any other property) is paid into another

4 medical finance account for the benefit of—

5 ‘‘(A) such holder,

6 ‘‘(B) the spouse of such holder,

7 ‘‘(C) any dependent of such holder who has

8 attained age 21 as of the date of the payment

9 or distribution, or

10 ‘‘(D) in the case of a payment or distribu11 tion made by reason of the death of such hold12 er, the beneficiary designated by such holder,

13 not later than the 60th day after the date of such

14 payment or distribution.

15 ‘‘(5) COORDINATION WITH MEDICAL EXPENSE

16 DEDUCTION.—For purposes of section 213, any pay17 ment or distribution out of a medical finance ac18 count for qualified medical expenses shall not be

19 treated as an expense paid for medical care.

20 ‘‘(6) TRANSFER OF ACCOUNT INCIDENT TO DI21 VORCE.—The transfer of an individual’s interest in

22 a medical finance account to his spouse or former

23 spouse under a divorce or separation instrument de24 scribed in subparagraph (A) of section 71(b)(2) is

25 not to be considered a taxable transfer made by such
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1 individual notwithstanding any other provision of

2 this subtitle, and such interest at the time of the

3 transfer is to be treated as a medical finance ac4 count of such spouse, and not of such individual.

5 Thereafter such account for purposes of this subtitle

6 is to be treated as maintained for the benefit of such

7 spouse.

8 ‘‘(f) REPORTS.—The trustee of a medical finance ac9 count shall make such reports regarding such account to

10 the Secretary and to the account holder with respect to

11 contributions, distributions, and such other matters as the

12 Secretary may require under regulations. The reports re13 quired by this subsection shall be filed at such time and

14 in such manner and furnished to such individuals at such

15 time and in such manner as may be required by those reg16 ulations.’’

17 (b) DEDUCTION ALLOWED WHETHER OR NOT INDI18 VIDUAL ITEMIZES OTHER DEDUCTIONS.—Subsection (a)

19 of section 62 of such Code is amended by inserting after

20 paragraph (15) the following new paragraph:

21 ‘‘(16) MEDICAL FINANCE ACCOUNTS.—The de22 duction allowed by section 220.’’

23 (c) EXCLUSIONS FOR EMPLOYER CONTRIBUTIONS

24 TO MEDICAL FINANCE ACCOUNTS.—
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1 (1) EXCLUSION FROM INCOME TAX.—The text

2 of section 106 of such Code (relating to contribu3 tions by employer to accident and health plans) is

4 amended to read as follows:

5 ‘‘(a) GENERAL RULE.—Gross income of an employee

6 does not include employer-provided coverage under an ac7 cident or health plan.

8 ‘‘(b) CONTRIBUTIONS TO MEDICAL FINANCE AC9 COUNTS.—

10 ‘‘(1) IN GENERAL.—In the case of an employee,

11 gross income does not include amounts contributed

12 by such employee’s employer to any medical finance

13 account (as defined in section 220(c)) of such em14 ployee.

15 ‘‘(2) NO CONSTRUCTIVE RECEIPT.—No amount

16 shall be included in the gross income of any em17 ployee solely because the employee may choose be18 tween the contributions referred to in paragraph (1)

19 and employer contributions to another health plan of

20 the employer.

21 ‘‘(3) COORDINATION WITH DEDUCTION LIMITA22 TION.—The amount excluded from the gross income

23 of an employee under this subsection for any taxable

24 year shall not exceed the limitation under section

25 220(b)(1) (determined without regard to this sub-
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1 section) which is applicable to such employee for

2 such taxable year.’’

3 (2) EXCLUSION FROM EMPLOYMENT TAXES.—

4 (A) SOCIAL SECURITY TAXES.—

5 (i) Subsection (a) of section 3121 of

6 such Code is amended by striking ‘‘or’’ at

7 the end of paragraph (20), by striking the

8 period at the end of paragraph (21) and

9 inserting ‘‘; or’’, and by inserting after

10 paragraph (21) the following new para11 graph:

12 ‘‘(22) any payment made to or for the benefit

13 of an employee if at the time of such payment it is

14 reasonable to believe that the employee will be able

15 to exclude such payment from income under section

16 106(b).’’

17 (ii) Subsection (a) of section 209 of

18 the Social Security Act is amended by

19 striking ‘‘or’’ at the end of paragraph (17),

20 by striking the period at the end of para21 graph (18) and inserting ‘‘; or’’, and by in22 serting after paragraph (18) the following

23 new paragraph:

24 ‘‘(19) any payment made to or for the benefit

25 of an employee if at the time of such payment it is
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1 reasonable to believe that the employee will be able

2 to exclude such payment from income under section

3 106(b) of the Internal Revenue Code of 1986.’’

4 (B) RAILROAD RETIREMENT TAX.—Sub5 section (e) of section 3231 of such Code is

6 amended by adding at the end the following

7 new paragraph:

8 ‘‘(10) MEDICAL FINANCE ACCOUNT CONTRIBU9 TIONS.—The term ‘compensation’ shall not include

10 any payment made to or for the benefit of an em11 ployee if at the time of such payment it is reason12 able to believe that the employee will be able to ex13 clude such payment from income under section

14 106(b).’’

15 (C) UNEMPLOYMENT TAX.—Subsection (b)

16 of section 3306 of such Code is amended by

17 striking ‘‘or’’ at the end of paragraph (15), by

18 striking the period at the end of paragraph (16)

19 and inserting ‘‘; or’’, and by inserting after

20 paragraph (16) the following new paragraph:

21 ‘‘(17) any payment made to or for the benefit

22 of an employee if at the time of such payment it is

23 reasonable to believe that the employee will be able

24 to exclude such payment from income under section

25 106(b).’’
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1 (D) WITHHOLDING TAX.—Subsection (a)

2 of section 3401 of such Code is amended by

3 striking ‘‘or’’ at the end of paragraph (19), by

4 striking the period at the end of paragraph (20)

5 and inserting ‘‘; or’’, and by inserting after

6 paragraph (20) the following new paragraph:

7 ‘‘(21) any payment made to or for the benefit

8 of an employee if at the time of such payment it is

9 reasonable to believe that the employee will be able

10 to exclude such payment from income under section

11 106(b).’’

12 (d) EXCLUSION OF MEDICAL FINANCE ACCOUNTS

13 FROM ESTATE TAX.—Part IV of subchapter A of chapter

14 11 of such Code is amended by adding at the end the fol15 lowing new section:

16 ‘‘SEC. 2057. MEDICAL FINANCE ACCOUNTS.

17 ‘‘For purposes of the tax imposed by section 2001,

18 the value of the taxable estate shall be determined by de19 ducting from the value of the gross estate an amount

20 equal to the value of any medical finance account (as de21 fined in section 220(c)) included in the gross estate.’’

22 (e) TAX ON EXCESS CONTRIBUTIONS.—Section 4973

23 of such Code (relating to tax on excess contributions to

24 individual retirement accounts, certain section 403(b) con-
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1 tracts, and certain individual retirement annuities) is

2 amended—

3 (1) by inserting ‘‘MEDICAL FINANCE AC4 COUNTS,’’ after ‘‘ACCOUNTS,’’ in the heading of

5 such section,

6 (2) by redesignating paragraph (2) of sub7 section (a) as paragraph (3) and by inserting after

8 paragraph (1) the following:

9 ‘‘(2) a medical finance account (within the

10 meaning of section 220(c)),’’,

11 (3) by striking ‘‘or’’ at the end of paragraph

12 (1) of subsection (a), and

13 (4) by adding at the end thereof the following

14 new subsection:

15 ‘‘(d) EXCESS CONTRIBUTIONS TO MEDICAL FINANCE

16 ACCOUNTS.—For purposes of this section, in the case of

17 a medical finance account (within the meaning of section

18 220(c)), the term ‘excess contributions’ means the amount

19 by which the amount contributed for the taxable year to

20 the account exceeds the limitation under section 220(b)

21 for such taxable year. For purposes of this subsection, any

22 contribution which is distributed out of the medical fi23 nance account in a distribution to which section 220(e)(3)

24 applies shall be treated as an amount not contributed.’’
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1 (f) TAX ON PROHIBITED TRANSACTIONS.—Section

2 4975 of such Code (relating to tax on prohibited trans3 actions) is amended—

4 (1) by adding at the end of subsection (c) the

5 following new paragraph:

6 ‘‘(4) SPECIAL RULE FOR MEDICAL FINANCE AC7 COUNTS.—An individual for whose benefit a medical

8 finance account (within the meaning of section

9 220(c)) is established shall be exempt from the tax

10 imposed by this section with respect to any trans11 action concerning such account (which would other12 wise be taxable under this section) if, with respect

13 to such transaction, the account ceases to be a medi14 cal finance account by reason of the application of

15 section 220(d)(2) to such account.’’, and

16 (2) by inserting ‘‘or a medical finance account

17 described in section 220(c)’’ in subsection (e)(1)

18 after ‘‘described in section 408(a)’’.

19 (g) FAILURE TO PROVIDE REPORTS ON MEDICAL FI20 NANCE ACCOUNTS.—Section 6693 of such Code (relating

21 to failure to provide reports on individual retirement ac22 counts or annuities) is amended—

23 (1) by inserting ‘‘OR ON MEDICAL FINANCE

24 ACCOUNTS’’ after ‘‘ANNUITIES’’ in the heading of

25 such section, and
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1 (2) by adding at the end of subsection (a) the

2 following: ‘‘The person required by section 220(f) to

3 file a report regarding a medical finance account at

4 the time and in the manner required by such section

5 shall pay a penalty of $50 for each failure to so file

6 unless it is shown that such failure is due to reason7 able cause.’’

8 (h) CLERICAL AMENDMENTS.—

9 (1) The table of sections for part VII of sub10 chapter B of chapter 1 of such Code is amended by

11 striking the last item and inserting the following:

‘‘Sec. 220. Medical finance accounts.

‘‘Sec. 221. Cross reference.’’

12 (2) The table of sections for subchapter B of

13 chapter 68 of such Code is amended by inserting ‘‘or

14 on medical finance accounts’’ after ‘‘annuities’’ in

15 the item relating to section 6693.

16 (3) The table of sections for part IV of sub17 chapter A of chapter 11 of such Code is amended by

18 adding at the end the following new item:

‘‘Sec. 2057. Medical finance accounts.’’

19 (i) EFFECTIVE DATE.—The amendments made by

20 this section shall apply to taxable years beginning after

21 December 31, 1995.
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1 TITLE II—REFORM OF THE

2 EARNED INCOME CREDIT

3 SEC. 201. AMENDMENT OF 1986 CODE.

4 Except as otherwise expressly provided, whenever in

5 this title an amendment or repeal is expressed in terms

6 of an amendment to, or repeal of, a section or other provi7 sion, the reference shall be considered to be made to a

8 section or other provision of the Internal Revenue Code

9 of 1986.

10 SEC. 202. EARNED INCOME CREDIT DENIED TO INDIVID11 UALS NOT AUTHORIZED TO BE EMPLOYED IN

12 THE UNITED STATES.

13 (a) IN GENERAL.—Section 32(c)(1) (relating to indi14 viduals eligible to claim the earned income credit) is

15 amended by adding at the end the following new subpara16 graph:

17 ‘‘(F) IDENTIFICATION NUMBER REQUIRE18 MENT.—The term ‘eligible individual’ does not

19 include any individual who does not include on

20 the return of tax for the taxable year—

21 ‘‘(i) such individual’s taxpayer identi22 fication number, and

23 ‘‘(ii) if the individual is married (with24 in the meaning of section 7703), the tax-
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1 payer identification number of such indi2 vidual’s spouse.’’.

3 (b) SPECIAL IDENTIFICATION NUMBER.—Section 32

4 is amended by adding at the end the following new sub5 section:

6 ‘‘(l) IDENTIFICATION NUMBERS.—Solely for pur7 poses of subsections (c)(1)(F) and (c)(3)(D), a taxpayer

8 identification number means a social security number is9 sued to an individual by the Social Security Administra10 tion (other than a social security number issued pursuant

11 to clause (II) (or that portion of clause (III) that relates

12 to clause (II)) of section 205(c)(2)(B)(i) of the Social Se13 curity Act).’’.

14 (c) EXTENSION OF PROCEDURES APPLICABLE TO

15 MATHEMATICAL OR CLERICAL ERRORS.—Section

16 6213(g)(2) (relating to the definition of mathematical or

17 clerical errors) is amended by striking ‘‘and’’ at the end

18 of subparagraph (D), by striking the period at the end

19 of subparagraph (E) and inserting a comma, and by in20 serting after subparagraph (E) the following new subpara21 graphs:

22 ‘‘(F) an omission of a correct taxpayer

23 identification number required under section 32

24 (relating to the earned income credit) to be in25 cluded on a return, and
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1 ‘‘(G) an entry on a return claiming the

2 credit under section 32 with respect to net

3 earnings from self-employment described in sec4 tion 32(c)(2)(A) to the extent the tax imposed

5 by section 1401 (relating to self-employment

6 tax) on such net earnings has not been paid.’’.

7 (d) EFFECTIVE DATE.—The amendments made by

8 this section shall apply to taxable years beginning after

9 December 31, 1995.

10 SEC. 203. REPEAL OF EARNED INCOME CREDIT FOR INDI11 VIDUALS WITHOUT CHILDREN.

12 (a) IN GENERAL.—Subparagraph (A) of section

13 32(c)(1) (defining eligible individual) is amended to read

14 as follows:

15 ‘‘(A) IN GENERAL.—The term ‘eligible in16 dividual’ means any individual who has a quali17 fying child for the taxable year.’’.

18 (b) CONFORMING AMENDMENTS.—Each of the tables

19 contained in paragraphs (1) and (2) of section 32(b) are

20 amended by striking the items relating to no qualifying

21 children.

22 (c) EFFECTIVE DATE.—The amendments made by

23 this section shall apply to taxable years beginning after

24 December 31, 1995.
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1 SEC. 204. MODIFICATION OF EARNED INCOME CREDIT

2 AMOUNT AND PHASEOUT.

3 (a) MODIFICATION OF PHASEOUT.—Subparagraph

4 (B) of section 32(a)(2) is amended to read as follows:

5 ‘‘(B) the sum of—

6 ‘‘(i) the initial phaseout percentage of

7 so much of the adjusted gross income (or,

8 if greater, the earned income) of the tax9 payer for the taxable year as exceeds the

10 initial phaseout amount but does not ex11 ceed the final phaseout amount, plus

12 ‘‘(ii) the final phaseout percentage of

13 so much of the adjusted gross income (or,

14 if greater, the earned income) of the tax15 payer for the taxable year as exceeds the

16 final phaseout amount.’’

17 (b) PERCENTAGES AND AMOUNTS.—

18 (1) IN GENERAL.—Subsection (b) of section 32,

19 as amended by section 203(b), is amended to read

20 as follows:

21 ‘‘(b) PERCENTAGES AND AMOUNTS.—

22 ‘‘(1) PERCENTAGES.—The credit percentage,

23 the initial phaseout percentage, and the final phase24 out percentage shall be determined as follows:
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‘‘In the case of an eligible individual

with:

The credit percentage is:The initial phaseout percentage is:The final phaseout percentage is:

1 qualifying child ......................... 34 15.98 20

2 or more qualifying children ....... 36 21.06 25

1 ‘‘(2) AMOUNTS.—The earned income amount,

2 the initial phaseout amount, and the final phaseout

3 amount shall be determined as follows:

‘‘In the case of an eligible individual

with:

The earned income amount is:The initial phaseout amount is:The final phaseout amount is:

1 qualifying child ......................... $6,340 $11,630 $14,850

2 or more qualifying children ....... $8,910 $11,630 $17,750’’.

4 (2) INCREASE IN CREDIT FOR LOWER-INCOME

5 FAMILIES HAVING 2 OR MORE QUALIFYING CHIL6 DREN.—Subsection (d) of section 32 is amended to

7 read as follows:

8 ‘‘(d) INCREASE IN CREDIT FOR LOWER-INCOME

9 FAMILIES HAVING 2 OR MORE QUALIFYING CHILDREN.—

10 ‘‘(1) IN GENERAL.—If an eligible individual has

11 2 or more qualifying children, for purposes of apply12 ing paragraphs (1) and (2)(A) of subsection (a)—

13 ‘‘(A) the amount of the taxpayer’s earned

income shall be treated as being equal to 10 14 ⁄9 of

15 such income (determined without regard to this

16 paragraph), and

17 ‘‘(B) the earned income amount shall be

treated as being equal to 10 18 ⁄9 of such amount

19 (determined without regard to this paragraph).
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1 ‘‘(2) PHASEOUT OF BENEFIT.—If the applicable

2 income of the taxpayer for the taxable year exceeds

3 $14,000 ($17,000 in the case of a joint return), the

4 amount of each increase under paragraph (1) shall

5 be reduced (but not below zero) by an amount which

6 bears the same ratio to such increase (determined

7 without regard to this subparagraph) as such excess

8 bears to $4,000.

9 ‘‘(3) APPLICABLE INCOME.—For purposes of

10 this subsection, the term ‘applicable income’ means

11 adjusted gross income or, if greater, earned in12 come.’’

13 (3) CONFORMING AMENDMENTS.—

14 (A) Subsection (j) of section 32 is amend15 ed—

16 (i) by striking ‘‘subsection (b)(2)(A)’’

17 and inserting ‘‘subsection (b)(2) or (d)’’,

18 (ii) by striking ‘‘1994’’ and inserting

19 ‘‘1996’’, and

20 (iii) by striking ‘‘1993’’ and inserting

21 ‘‘1995’’.

22 (B) Subsection (e) of section 32 is amend23 ed to read as follows:

24 ‘‘(e) OTHER SPECIAL RULES.—
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1 ‘‘(1) MARRIED INDIVIDUALS.—In the case of an

2 individual who is married (within the meaning of

3 section 7703), this section shall apply only if a joint

4 return is filed for the taxable year.

5 ‘‘(2) TAXABLE YEAR MUST BE FULL TAXABLE

6 YEAR.—Except in the case of a taxable year closed

7 by reason of the death of an individual, no credit

8 shall be allowable under this section in the case of

9 a taxable year covering a period of less than 12

10 months.’’

11 (c) EFFECTIVE DATE.—The amendments made by

12 this section shall apply to taxable years beginning after

13 December 31, 1995.

14 SEC. 205. RULES RELATING TO DENIAL OF EARNED IN15 COME CREDIT ON BASIS OF DISQUALIFIED

16 INCOME.

17 (a) DEFINITION OF DISQUALIFIED INCOME.—Para18 graph (2) of section 32(i) (defining disqualified income)

19 is amended by striking ‘‘and’’ at the end of subparagraph

20 (B), by striking the period at the end of subparagraph

21 (C) and inserting ‘‘, and’’, and by adding at the end the

22 following new subparagraph:

23 ‘‘(D) the excess (if any) of—

24 ‘‘(i) the aggregate income from all

25 passive activities for the taxable year (de-
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1 termined without regard to any amount de2 scribed in a preceding subparagraph), over

3 ‘‘(ii) the aggregate losses from all pas4 sive activities for the taxable year (as so

5 determined).

6 For purposes of subparagraph (D), the term

7 ‘passive activity’ has the meaning given such

8 term by section 469.’’.

9 (b) EFFECTIVE DATE.—The amendments made by

10 this section shall apply to taxable years beginning after

11 December 31, 1995.

12 SEC. 206. MODIFICATION OF ADJUSTED GROSS INCOME

13 DEFINITION FOR EARNED INCOME CREDIT.

14 (a) IN GENERAL.—Subsections (a)(2), (c)(1)(C), (d),

15 and (f)(2)(B) of section 32, as amended by the preceding

16 sections of this title, are each amended by striking ‘‘ad17 justed gross income’’ each place it appears and inserting

18 ‘‘modified adjusted gross income’’.

19 (b) MODIFIED ADJUSTED GROSS INCOME DE20 FINED.—Section 32(c) (relating to definitions and special

21 rules) is amended by adding at the end the following new

22 paragraph:

23 ‘‘(5) MODIFIED ADJUSTED GROSS INCOME.—
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1 ‘‘(A) IN GENERAL.—The term ‘modified

2 adjusted gross income’ means adjusted gross in3 come—

4 ‘‘(i) increased by the sum of the

5 amounts described in subparagraph (B),

6 and

7 ‘‘(ii) determined without regard to—

8 ‘‘(I) the amounts described in

9 subparagraph (C), or

10 ‘‘(II) the deduction allowed under

11 section 172.

12 ‘‘(B) NONTAXABLE INCOME TAKEN INTO

13 ACCOUNT.—Amounts described in this subpara14 graph are—

15 ‘‘(i) social security benefits (as defined

16 in section 86(d)) received by the taxpayer

17 during the taxable year to the extent not

18 included in gross income,

19 ‘‘(ii) amounts which—

20 ‘‘(I) are received during the tax21 able year by (or on behalf of) a spouse

22 pursuant to a divorce or separation

23 instrument (as defined in section

24 71(b)(2)), and
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1 ‘‘(II) under the terms of the in2 strument are fixed as payable for the

3 support of the children of the payor

4 spouse (as determined under section

5 71(c)),

6 but only to the extent such amounts exceed

7 $6,000,

8 ‘‘(iii) interest received or accrued dur9 ing the taxable year which is exempt from

10 tax imposed by this chapter, and

11 ‘‘(iv) amounts received as a pension or

12 annuity, and any distributions or payments

13 received from an individual retirement

14 plan, by the taxpayer during the taxable

15 year to the extent not included in gross in16 come.

17 Clause (iv) shall not include any amount which

18 is not includible in gross income by reason of

19 section 402(c), 403(a)(4), 403(b)(8), 408(d)

20 (3), (4), or (5), or 457(e)(10).

21 ‘‘(C) CERTAIN AMOUNTS DISREGARDED.—

22 An amount is described in this subparagraph if

23 it is—

24 ‘‘(i) the amount of losses from sales

25 or exchanges of capital assets in excess of
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1 gains from such sales or exchanges to the

2 extent such amount does not exceed the

3 amount under section 1211(b)(1),

4 ‘‘(ii) the net loss from the carrying on

5 of trades or businesses, computed sepa6 rately with respect to—

7 ‘‘(I) trades or businesses (other

8 than farming) conducted as sole pro9 prietorships,

10 ‘‘(II) trades or businesses of

11 farming conducted as sole proprietor12 ships, and

13 ‘‘(III) other trades or business,

14 ‘‘(iii) the net loss from estates and

15 trusts, and

16 ‘‘(iv) the excess (if any) of amounts

17 described in subsection (i)(2)(C)(ii) over

18 the amounts described in subsection

19 (i)(2)(C)(i) (relating to nonbusiness rents

20 and royalties).

21 For purposes of clause (ii), there shall not be

22 taken into account items which are attributable

23 to a trade or business which consists of the per24 formance of services by the taxpayer as an em25 ployee.’’.
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1 (c) EFFECTIVE DATE.—The amendments made by

2 this section shall apply to taxable years beginning after

3 December 31, 1995.

4 SEC. 207. PROVISIONS TO IMPROVE TAX COMPLIANCE.

5 (a) INCREASE IN PENALTIES FOR RETURN PREPAR6 ERS.—

7 (1) UNDERSTATEMENT PENALTY.—Section

8 6694 (relating to understatement of income tax li9 ability by income tax return preparer) is amended—

10 (A) by striking ‘‘$250’’ in subsection (a)

11 and inserting ‘‘$500’’, and

12 (B) by striking ‘‘$1,000’’ in subsection (b)

13 and inserting ‘‘$2,000’’.

14 (2) OTHER ASSESSABLE PENALTIES.—Section

15 6695 (relating to other assessable penalties) is

16 amended—

17 (A) by striking ‘‘$50’’ and ‘‘$25,000’’ in

18 subsections (a), (b), (c), (d), and (e) and insert19 ing ‘‘$100’’ and ‘‘$50,000’’, respectively, and

20 (B) by striking ‘‘$500’’ in subsection (f)

21 and inserting ‘‘$1,000’’.

22 (b) AIDING AND ABETTING PENALTY.—Section

23 6701(b) (relating to amount of penalty) is amended—

24 (1) by striking ‘‘$1,000’’ in paragraph (1) and

25 inserting ‘‘2,000’’, and
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1 (2) by striking ‘‘10,000’’ in paragraph (2) and

2 inserting ‘‘20,000’’.

3 (c) EFFECTIVE DATE.—The amendments made by

4 this section shall apply to penalties with respect to taxable

5 years beginning after December 31, 1995.

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