The ownership interest of a FASIT generally is required to be entirely held by a single
domestic C corporation. In addition, a FASIT generally must 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 instruments (called "regular interests")
that meet certain specified requirements and treat those instruments as debt for Federal income
tax purposes. In general, those requirements must be met “after the startup date." Instruments
bearing yields to maturity over 5 percentage points above the yield to maturity on specified
United States government obligations (i.e., "high-yield interests") may be held only by domestic
C corporations that are not exempt from income tax.

Income from prohibited transactions

The owner of a FASIT is required to pay a penalty excise tax equal to 100 percent of net
income derived from (1) an asset that is not a permitted asset, (2) any disposition of an asset
other than a permitted disposition, (3) any income attributable to loans originated by the FASIT,
and (4) compensation for services (other than fees for a waiver, amendment, or consent under
permitted assets not acquired through foreclosure). A permitted disposition is any disposition of
any permitted asset (1) arising from complete liquidation of a class of regular interests (.e., a
qualified liquidation)*; (2) incident to the foreclosure, default, or imminent default of the asset;
(3) incident to the bankruptcy or insolvency of the FASIT; (4) necessary to avoid a default on
any indebtedness of the FASIT attributable to a default (or imminent default) on an asset of the
FASIT; (5) to facilitate a clean-up call; (6) to substitute a permitted debt instrument for another
such instrument; or (7) in order to reduce over-collateralization where a principal purpose of the
disposition was not to avoid recognition of gain arising from an increase in its market value after
its acquisition by the FASIT.

Definition of "FASIT"

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
Tepresent a hedge or guarantee of debt held or issued by the FASIT; (5) contract rights to
acquire permitted debt instruments or hedges; (6) a regular interest in another FASIT; and (7a
regular interest ina REMIC. A FASIT must meet the asset test at the 90th day after its
formation and at all times thereafter. Permitted assets may be acquired at any time by a FASIT,
including any time after its formation.

* For this purpose, a "qualified liquidation" has the same meaning as it does purposes of
the exemption from the tax on prohibited transactions of a real estate mortgage investment
conduit ("REMIC”) in section 860F(a)(4).

-16-



IV. TECHNICAL CORRECTIONS TO OTHER ACTS

1. Related parties determined by reference to section 267

Present Law

Section 267 disallows loses arising in transactions between certain defined related
parties. In the case of related corporations, such losses may be deferred. Several Code
provisions, in defining related parties, often incorporate the relationships described in section
267 by cross-reference to such section.

- Description of Proposal

.__ Any provision of the Internal Revenue Code of 1986 that refers to a relationship that
would resuit in loss disallowance under section-267 also refers to relationships where loss is
deferred, where such relationship is applicable to the provision.

Effective Date
The proposal would be applicable as if included in the Tax Reform Act of 1984.

2. Clarify definition of Indian reservation under section 168(j)(6)

Present Law

Section 168(j)(6) provides for accelerated depreciation for certain property located on
Indian reservations. For this Purpose, provides that the term “Indian reservation” means a
Teservation as defined in either (a) section 3(d) of the Indian Financing Act of 1974 (25 U.S.C.
1452(d)), or (b) section 4(10) of the Indian Child Welfare Act of 1978 (25 U.S.C. 1903(10)). In
addition, section 45A (which provides for an incremental Indian employment credit)
incorporates by reference the same definition of “Indian reservation” contained in section
168(j)(6). Section 3(d) of the Indian Financing Act of 1974 includes not only officially
designated Indian reservations and public domain Indian allotments, but also all “former Indian
reservations in Oklahoma,” which covers most of the State of Oklahoma even though parts of
such “former Indian reservations” may no longer have a significant nexus to an Indian tribe.

Description of. I

For purposes of the section 168G)(6) definition of “Indian reservation,” the term “former
Teservations in Oklahoma” would mean lands that are (1) within the jurisdictional area of an
Oklahoma Indian tribe as determined by the Secretary of the Interior, and (2) recognized by such
Secretary as an area eligible for trust land Status under 25 C.F.R. Part 51.

-33-



Description of Proposal

The proposal would clarify that a minister may participate in the denominational plan,
whether or not the minister is employed by a tax-exempt employer or a taxable employer.

The proposal would clarify that the exclusion amount is determined by taking into

account the minister’s self-employed earnings with respect to years of service taken into account
in calculating the exclusion amount.

-10-



Il. HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996

1. Medical savings accounts

a. Additional tax on distributions not used for medical purposes

Present Law

Under present law, distributions from a medical.savings account (“MSA”) that are not
used for medical expenses are includible in gross income and subject to a 15-percent additional
tax unless the distribution is after age 65 or death or on account of disability. A similar
additional 10-percent tax is imposed on early withdrawals from individual retirement
arrangements and qualified pension plans. The 10-percent additional tax on early withdrawals is
not treated as tax liability for purposes of the minimum tax. No such rule applies to the 15-
percent additional tax applicable to MSAs.

Description of Proposal

The proposal would provide that the 15-percent tax on nonmedical withdrawals from an
MSA is not treated as tax liability for purposes of the minimum tax.

b. Definition of permitted coverage

Present Law

Under present law, in order to be eligible to have a medical savings account (“MSA”) an
individual must be covered under a high deductible health plan and no other health plan, except
for plans that provide certain permitted coverage. Medicare supplemental plans are one of the
types of permitted coverage, even though an individual covered by Medicare is not eligible to
have an MSA.

Description of Proposal

Under the proposal, Medicare supplemental plans would be deleted from the types of
permitted coverage an individual may have and still qualify for an MSA.

c. Taxation of distributions
Present Law
Under present law, in order to be eligible to have a medical savings account (“MSA”) an
individual must be covered under a high deductible health plan and no other health plan, except

for plans that provide certain permitted coverage and must be either (1) a self-employed
individual, or (2) employed by a small employer. Distributions from an MSA for the medical

-20-



INTRODUCTION

The Senate Committee on Finance has scheduled a markup of revenue reconciliation
provisions, beginning on June 19, 1997. This document,’ prepared by the staff of the Joint
Committee on Taxation, provides a description of the Chairman’s mark for various technical
corrections to previously enacted tax legislation, including the Small Business Job Protection
Act of 1996 (P.L. 104-188), Health Insurance Portability and Accountability Act of 1996
(P.L.104-191), Taxpayer Bill of Rights 2 (P.L. 104-268), and other recent tax acts. Except as
otherwise noted, these technical corrections are Proposed to be effective as if included in the
original provisions to which they relate. Proposed technical corrections that are clerical in nature
are not described in this document.

Separate documents provide descriptions of revenue reconciliation and simplification
provisions of the Chairman’s mark.

' This document may be cited as follows: Joint Committee on Taxation, Description of
Senate Finance Committee Chairman’s Mark Relating to Technical Correction Provisions
(JCX-31-97), June 17, 1997. :

-l-


2. Reporting by public charities with respect to intermediate sanctions and certain other
excise tax penalties

Present Law

Section 4958 imposes penalty excise taxes as an intermediate sanction in cases where .
organizations exempt from tax under sections 501(c)(3) or 501(c)(4) (other than private
foundations) engage in an “excess benefit transaction.” The excise tax may be imposed on
certain disqualified persons (i.e., insiders) who improperly benefit from an excess benefit
transaction and on organization managers who participate in such a transaction knowing that it is
improper. No tax is imposed on the organization itself with respect-under section 4958.

Section 4911 imposes an excise tax penalty on excess lobbying expenditures made by
public charities. The tax is imposed on the organization itself. Section 4912 imposes a penalty
excise tax on certain public charities that make disqualifying lobbying expenditures and section
4955 imposes a penalty excise tax on political expenditures of section 501(c)(3) organizations.
Both of these penalty taxes are imposed not only on the affected organization, but also on
organization managers who agree to an expenditure knowing that it is improper.

Under section 4962, the IRS has the authority to abate certain first-tier taxes if the
taxable event was due to reasonable cause and not to willful neglect and the event was corrected
within the applicable correction period. First-tier taxes which may be abated include, among
others, the taxes imposed under section 4955.6

Under section 6033(b)(10), 501(c)(3) organizations are Tequired to report annually on
Form 990 any amounts paid by the organization under section 491 1, 4912, and 4955. Thus,
although sections 4912 and 4955 impose excise taxes on organization managers, organizations
technically are not required to Teport any such excise taxes paid by such managers.

by the organization, or any disqualified person with Tespect to such organization, during the
taxable year. The Code does not explicitly require the reporting of any excess benefit excise
taxes paid by an organization manager solely in his or her capacity as such (i.e., an organization
manager might also be a disqualified person with respect to an excess benefit transaction, in
which case any tax paid would be reported).

© A separate Provision (III.1., above) would make a technical correction to section
4962(b) to permit the abatement of first-tier penalty excise taxes imposed under section 4958.

-3)-



Description of Proposal
Definition of regular interest

The proposal would provide that the requirement of a "regular interest" must be met "on
or after the startup date," instead of just "after the startup date."

Correction of cross reference

The proposal would Correct an incorrect cross reference in section 860L(d)from section
860L(c)(2) to section 860L(b)(2).

Tax on prohibited transactions

The proposal would provide that the tax on prohibited transactions would not apply to
dispositions of foreclosure property or hedges using the similar exception applicable to REMICs.

3. Qualified State tuition plans

P Tesent Law

Section 529 provides tax-exempt status to certain qualified State tuition programs and
provides rules for the tax treatment of distributions from such programs. Section 529 was
effective on the date of enactment of the Small Business Act, but a special transition mule
provides that if (1) a State maintains (on the date of enactment) a Program under which persons
may purchase tuition credits on behalf of, or make contributions for educational expenses of: a
designated beneficiary, and (2) such program meets the requirements of a qualified State tuition
program before the later of (a) one year after the date of enactment, or (b) the first day of the first
calendar quarter after the close of the first regular session of the State legislature that begins after
the date of enactment, then the provisions of the Small Business Act will apply to contributions
(and earings allocable thereto) made before the date the Program meets the requirements of a
qualified State tuition program, without regard to whether the requirements of a qualified State
tuition program are satisfied with Tespect to such contributions and earnings (e.g., even if the
interest in the tuition or educational savings program covers not only qualified higher education
expenses but also room and board expenses).

Description of Proposal

The proposal would clarify that, if a State program under which persons may purchase
tuition credits comes into compliance with the requirements of a “qualified State tuition
program” as defined in section 529 within a specified time period, then such program would be
treated as a qualified State tuition program with respect to any contributions (and earnings
allocable thereto) made pursuant to a contract entered into under the program before the date on

-17-



Present law provides that amounts (other than policyholder dividends or premium
refunds) received under a long-term care insurance contract generally are excludable as amounts
received for personal injuries and sickness, subject to a dollar cap on per diem contracts only. If
the aggregate amount of periodic payments under all qualified long-term care contracts exceeds
the dollar cap for the period, then the amount of such excess payments is excludable only to the
extent of the individual's costs (that are not otherwise compensated for by insurance or
otherwise) for long-term care services during the period.

Present law also provides an exclusion from gross income as an amount paid by reason of
the death of an insured for (1) amounts received under a life insurance contract and (2) amounts
received for the sale or assignment of any portion of the death benefit under a life insurance
contract to a qualified viatical settlement provider, provided that the insured under the life
insurance contract is either terminally ill or chronically ill (the accelerated death benefit Tules).

A payor of long-term care benefits (defined for this purpose to include any amount paid
under a product advertised, marketed or offered as long-term care insurance), and a payor of
amounts treated as subject to reporting under the accelerated death benefit rules, is required to
report to the IRS the aggregate amount of such benefits paid to any individual during any
calendar year, and the name, address and taxpayer identification number of such individual. A
payor is also required to report the name, address, and taxpayer identification number of. the
chronically ill individual on account of whose condition the amounts are paid, and whether the
contract under which the amount is paid is a per diem-type contract. A copy of the report must
be provided to the payee by January 31 following the year of payment, showing the name of the
payor and the aggregate amount of benefits paid to the individual during the calendar year.
Failure to file the report or provide the copy to the payee is subject to the generally applicable
penalties for failure to file similar information reports.

Description of Proposal

The technical correction would clarify that the reporting requirements include the need to
report the address and phone number of the information Contact. This conforms these reporting
requirements to the requirements of the Taxpayer Bill of Rights 2.

5. Consumer protection provisions for long-term care insurance contracts

Present Law

The long-term care insurance rules of Present law include consumer protection provisions
(sec. 7702B(g)). Among these provisions is a Tequirement that the issuer of a contract offer to
the policyholder a nonforfeiture provision that meets certain requirements. The requirements
include a rule that the nonforfeiture provision shall provide for a benefit available in the event of
a default in the payment of any premiums and the amount of the benefit may be adjusted
subsequent to being initially granted only as necessary to reflect changes in claims, persistency,

-23-



b. Application of leased employee rules

Present Law

In order for employer-provided adoption assistance to be excludable from income, certain
requirements must be satisfied, including a requirement that the adoption assistance plan does
not discriminate in favor of highly compensated employees. For purposes of similar
nondiscrimination requirements, leased employees are treated as employees of the employer.

Description of Proposal

The proposal would provide that the leased employee rules apply to employer-provided
adoption assistance.

-19.



Description of Proposal

The proposal would make the reporting requirements of section 6033(b)(10) and (11)
consistent with the excise tax penalty provisions to which they relate. Thus, section 6033(b)(10)
would be amended to require 501(c)(3) organizations to report any amounts of tax imposed
under sections 4911, 4912, and 4955 on the organization or any organization manager of the
organization. In addition, the proposal would require reporting with respect to any
reimbursements paid by an organization with respect to taxes imposed under sections 4912 or
4955 on any organization manager of the organization. Section 6033(b)(11) would be amended
to require 501(c)(3) organizations to report any amounts of tax imposed under section 4958 on
any organization manager or any disqualified person, as well as any reimbursements of section
4958 excise tax liability paid by the organization to such organization managers or disqualified
persons.

In addition, the proposal would clarify that no reporting is required under sections

6033(b)(10) or (11) in the event a first-tier penalty excise tax imposed under section 4955 or
section 4958 is abated by the IRS pursuant to its authority under section 4962.

-32-



3. Clarify effective date of technical correction related to ethanol refunds

Present Law

Present law includes a 54-cents-per-gallon income tax credit for ethanol used as a motor
fuel. This tax benefit may be claimed through reduced-rate gasoline sales or expedited refunds
of gasoline tax paid when the ethanol is blended with gasoline. The Small Business Act
corrected a previous technical error in the expiration date of the expedited refund provision, but
the correction inadvertently failed to include refunds for periods before its enactment.

Description of Proposal

The proposal would clarify that the technical correction relating to the expedited ethanol
refunds was retroactive to the provision's expiration after September 30, 1995. Claims for
refunds of tax paid during the period October 1, 1995, through the date of enactment of the Small
Business Act would have to be filed before 60 days after enactment of the proposal.

4. Clarify scope of aviation excise tax exemption for emergency medical aircraft

Present Law

The Small Business Act provided that fixed-wing aircraft that are equipped for and
exclusively dedicated to the provision of emergency medical services (ie., air ambulances) are
exempt from the aviation excise taxes.

Description of Proposal
The proposal would clarify that this exemption is applied on a flight-by-flight basis.



b. Notification requirement for SIMPLE IRAs

Present Law

The trustee of any SIMPLE IRA is required to provide the employer maintaining the
arrangement a summary plan description containing basic information about the plan. At least
once a year, the trustee is also required to furnish an account statement to each individual
maintaining a SIMPLE account. In addition, the trustee is required to file an annual report with
the Secretary. A trustee who fails to provide any of such reports or descriptions will be subject to
a penalty of $50 per day until such failure is corrected, unless the failure is due to reasonable
cause.

Description of Proposal

The proposal would provide that insurers offering annuities for SIMPLE IRAs have the
same reporting requirements as SIMPLE IRA trustees.

c. Reporting requirements for SIMPLE IRAs

Present Law

A trustee of an individual retirement account and the issuer of an individual retirement
annuity must furnish reports regarding the account or annuity to the individual for whom the
account or annuity is maintained not later than January 31 of the calendar year following the year
to which the reports relate. In the case of a SIMPLE IRA, such Teports are to be furnished within
30 days after each calendar year.

Description of Proposal

The proposal would conform the time for providing reports for SIMPLE IRAs to that for
IRA reports generally. Thus, the proposal would provide that the report required to be furnished
to the individual under a SIMPLE IRA would be provided within 31 days after each calendar
year.

d. Application of exclusive plan requirement for SIMPLE IRAs to
noncollectively bargained employees

Present Law

A SIMPLE IRA will be treated as a qualified salary reduction arrangement provided the
employer does not maintain a qualified plan during the same time period the SIMPLE IRA is
maintained. Collectively bargained employees can be excluded from participation in the
SIMPLE IRA and may be covered under a plan established by the employer as a result of a good
faith bargaining agreement.

6-


credit against the U.S. estate tax for foreign estate taxes paid with respect to property that is
includible in the decedent’s U.S. estate solely by reason of the expatriation estate tax provisions.

Description of Proposal

The proposal would clarify the formula for determining the amount of the foreign tax
credit allowable against U.S. estate taxes on property that is includible in the decedent’s U.S.
estate solely by reason of the expatriation estate tax provisions.

-29.



9. Effective date of interest rate cap on key persons and pre-1986 contracts under the
COLI rule

Present Law

No deduction is allowed for interest paid or accrued on any indebtedness with respect to
one or more life insurance policies or annuity or endowment contracts owned by the taxpayer
covering any individual who is (1) an officer or employee of, or (2) is financially interested in,
any trade or business carried on by the taxpayer. An exception is provided for interest on
indebtedness with respect to life insurance policies covering up to 20 key persons, subject to an
interest rate cap.

This provision generally does not apply to interest on debt with respect to contracts
purchased on or before June 20, 1986. If the policy loan interest rate under such a contract does
not provide for a fixed rate of interest, then interest on such a contract paid or accrued after
December 31, 1995, is allowable only to the extent the rate of interest for each fixed period
selected by the taxpayer does not exceed Moody's Corporate Bond Yield Average--Monthly
Average Corporates, for the third month preceding the first month of the fixed period. The fixed
period must be 12 months or less.

The interest rate cap on key persons and pre-1986 contracts is effective with respect to
interest paid or accrued for any month beginning after December 31, 1995. Another part of the
provision provides that the interest rate cap on key employees and pre-1986 contracts applies to
interest paid or accrued after October 13, 1995.

Description of Proposal

The technical correction would clarify that, under the COLI tule, the interest rate cap on
key persons and pre-1986 contracts applies to interest paid or accrued for any month beginning
after December 31, 1995. This would conform conflicts in the effective date provisions.

10. Clarification of contract lapses under effective date provisions of the COLI rule

Present Law

No deduction is allowed for interest paid or accrued on any indebtedness with respect to
one or more life insurance policies or annuity or endowment contracts owned by the taxpayer
covering any individual who is (1) an officer or employee of, or (2) is financially interested in,
any trade or business carried on by the taxpayer. An exception is provided for interest on
indebtedness with respect to life insurance policies covering up to 20 key persons, subject to an
interest rate cap.

Additional limitations are imposed on the deductibility of interest with respect to single
Premium contracts, and interest on debt incurred or continued to purchase or carry a life

-26-



3. Clarify the effective date for post-termination transition period provision
Present Law

Distributions made by a former S corporation during its post-termination period are
treated in the same manner as if the distributions were made by an S corporation (e.g., treated by
shareholders as nontaxable distributions to the extent of the accumulated adjustment account).
Distributions made after the post-termination period are generally treated as made byaC
Corporation (i.e., treated by shareholders as taxable dividends to the extent of earnings and

profits).

The “post-termination period" is the period beginning on the day after the last day of the
last taxable year of the S corporation and ending on the later of: (1) a date that is one year later,
or (2) the due date for filing the return for the last taxable year and the 120-day period beginning
on the date of a determination that the corporation's S corporation election had terminated fora
previous taxable year.

The Small Business Act expanded the Post-termination period to include the 120-day
period beginning on the date of any determination pursuant to an audit of the taxpayer that
follows the termination of the S corporation's election and that adjusts a subchapter S item of
income, loss or deduction of the S corporation during the S period. In addition, the definition of
"determination" was expanded to include a final disposition of the Secretary of the Treasury of a
claim for refund and, under regulations, certain agreements between the Secretary and any
person, relating to the tax liability of the person. The Small Business Act provision was
effective for taxable years beginning after December 31, 1996.

Description of Proposal

The technical correction would clarify that the effective date for the Small Business Act
provision affecting the post-termination transition period is for determinations after December
31, 1996, not for determinations with Tespect to taxable years beginning after December 3 1,
1996. However, in no event would the post-termination transition period expanded by the Small
Business Act end before the end of the 120-day period beginning after the date of enactment of
this Act.

4. Treatment of qualified subchapter S subsidiaries

Present Law

Pursuant to a provision of the Small Business Act, an S corporation is allowed toowna
qualified subchapter S subsidiary. The term "qualified subchapter S subsidiary” means a
domestic corporation that (1) is not an ineligible corporation (ie., a corporation that would be
eligible to be an S corporation if the stock of the corporation were held directly by the
shareholders of its parent S corporation) if 100 percent of the stock of the subsidiary were held

3-


I. TECHNICAL CORRECTIONS TO THE SMALL BUSINESS
JOB PROTECTION ACT OF 1996?

A. Small Business-Related Provisions

1. Returns relating to purchases of. fish

Present Law

Every person engaged in the trade or business of purchasing fish for resale must file an
informational return reporting its purchases from any person that is engaged in the trade or
business of catching fish which are in excess of $600 for any calendar year. Persons filing such
an informational return relating to the purchase of fish must furnish a statement showing the
name and address of the person filing the return, as well as the amount shown on the return, to
each person whose name is required to be disclosed on the return,

Description of Proposal

Every person filing an informational return relating to the purchase of fish would be
Tequired to furnish a statement showing the name, address and phone number of the person filing
the return, as well as the amount shown on the return, to each person whose name is required to
be disclosed on the return.

2. Charitable remainder trusts not eligible to be electing small business trusts

Present Law

Under present:law, an electing small businéss trust may be a shareholder in an S
corporation. In order to qualify for this treatment, all beneficiaries of the electing small business
trust generally must be individuals or estates eligible to be S corporation shareholders. An
exempt trust may not qualify as an electing small business trust.

Description of Proposal

The technical correction would clarify that charitable remainder annuity trusts and
charitable remainder unitrusts may not be electing small business trusts.

? Referred to herein as the “Small Business Act.”
-2-


E. Other Provisions

1. Treatment of certain reserves of thrift institutions

Present Law

A provision of the Small Business Act Tepealed the percentage-of-taxable income method
for deducting bad debts applicable to thrift institutions. The portion of the section 481(a)
adjustment applicable to pre-1988 reserves of an institution required to change its method of
accounting generally is not restored to income unless the institution makes a distribution to
which section 593(e) applies. Section 593(e) provides that if a institution makes a
nonliquidating distribution in an amount in excess of its Post-1951 accumulated earnings and
profits, such excess will be treated as a distribution of the post-1987 reserve for bad debts,
requiring recapture of such amount.

Another provision of the Small Business Act allows a bank or a thrift institution to elect
to be treated as an S corporation so long as the entity does not use a reserve method of
accounting for bad debts. The earnings of an S corporation increase the corporation's
accumulated adjustments account, but do not increase its accumulated earnings and profits (sec.
1368). In addition, any net unrealized built-in gains of a C corporation that converts to S
corporation status that are recognized during the 10-year period beginning with the date of such
Conversion generally are subject to corporate-level tax (sec. 1374). Section 481(a) adjustments
taken into account during the 10-year period generally are subject to section 1374.

Description of Proposal

The proposal would provide rules to clarify the section 593 (e) treatment of pre-1988 bad
debt reserves of thrift and former thrift institutions that become S corporations. The proposed
technical corrections would provide that (1) the accumulated adjustments account of an S
Corporation would be treated the same as post-1951] earnings and profits for Purposes of section
593(e) and (2) section 593(e) would apply irrespective of section 1374 (e.g., distributions that
trigger section 593(e) would be subject to corporate-level recapture even if such distributions
occur after the 10-year period of section 1374).

2. “FASIT" technical corrections
Present Law
ene
A "financial asset securitization investment trust” ("FASIT") is designed to facilitate the
securitization of debt obligations such as credit card receivables, home equity loans, and auto

loans. A FASIT generally is not taxable; the FASIT's taxable income or net loss flows through
to the owner of the FASIT.

-15-



B. Pension Provisions
1. Salary reduction simplified employee pensions (““SARSEPS”)

Present Law

SARSEPs were repealed for years beginning after December 31, 1996, unless the
SARSEP was established before January 1, 1997. Consequently, an employer was not permitted
to establish a SARSEP after December 3 1, 1996. SARSEPs established before January 1, 1997,
may continue to receive contributions under the rules in effect prior to January 1, 1997.

Description of Proposal

The proposal would clarify that new employees of an employer hired after December 3 1,
1996, may participate in a SARSEP of an employer established before January 1, 1997.

2. SIMPLE retirement plans

a. Maximum dollar limitation for SIMPLE IRAs

Present Law

The Small Business Act created a simplified retirement plan for small business called the
savings incentive match plan for employees (“SIMPLE”) retirement plan. A SIMPLE plan can
be either an individual retirement arrangement (“IRA”) for each employee or part of a qualified
cash or deferred arrangement (“a 401(k) plan”). A SIMPLE IRA permits employees to make
elective contributions up to $6,000 per year to their IRA. The employer is required to satisfy one
of two contribution formulas. Under the matching contribution formula, the employer generally
is required to match employee elective contributions on a dollar-for-dollar basis up to 3 percent
of the employee’s compensation, unless the employer elects a lower percentage matching
contribution (but not less than 1 percent of each employee’s compensation). Alternatively, an
employer is permitted to elect, in lieu of making matching contributions, to make a 2 percent of
compensation nonelective contribution on behalf of each eligible employee. The employer
contribution amounts are contributed to the employee’s IRA. The maximum contribution
limitation to an IRA is $2,000.

Description of Proposal

The proposal would provide that in the case of a SIMPLE IRA, the $2,000 maximum
limitation applicable to IRAs would be increased to the limitations in effect for contributions
made under a qualified salary reduction arrangement. This would include employee elective
contributions and required employer contributions.

5-


expenses of the MSA account holder and his or her spouse or dependents are generally
excludable from income. However, in any year for which a contribution is made to an MSA,
withdrawals from the MSA are excludable from income only if the individual for whom the
expenses were incurred was an eligible individual for the month in which the expenses were
incurred. This rule is designed to ensure that MSAs are used in conjunction with a high
deductible plan and that they are not primarily used by other individuals who have health plans
that are not high deductible plans.

Description of Proposal

The proposal would clarify that, in any year for which a contribution is made to an MSA,
withdrawals from the MSA are excludable from income only if the individual for whom the
expenses were incurred was covered under a high deductible health plan (and no other health
plan except for plans that provide certain permitted coverage) in the month in which the
expenses were incurred. That is, the individual for whom the expenses were incurred does not
have to be self employed or employed by a small employer in order for a withdrawal for medical
expenses to be excludible.

d. Penalty for failure to provide required reports

Present Law

Trustees of an MSA are required to provide such reports to the Secretary and the account
holder as the Secretary may require. A penalty of $50 applies with respect to each failure to
provide a required report. Under present law, separate penalties apply to information returns
required by the Code.

Description of Proposal
The proposal would provide that the $50 penalty does not apply to information returns,

2. Definition of chronically ill individual under a qualified long-term care insurance
contract

Present La
Under the long-term care insurance tules, a chronically ill individual is one who has been
certified within the previous 12 months by a licensed health care practitioner as (1) being unable

to perform (without substantial assistance) at least 2 activities of daily living for at least 90 days
due to a loss of functional capacity, (2) having a level of disability similar (as determined under

-21-



DESCRIPTION OF SENATE FINANCE COMMITTEE
CHAIRMAN’S MARK
RELATING TO
TECHNICAL CORRECTION PROVISIONS

Scheduled for Markup
Before the
SENATE COMMITTEE ON FINANCE

on June 19, 1997

Prepared by the Staff
of the

JOINT COMMITTEE ON TAXATION

June 17, 1997

JCX-31-97



g. Top-heavy exemption for SIMPLE 401(k) arrangements
Present Law

A plan meeting the SIMPLE 401(k) requirements for any year is not treated as a top-
heavy plan under section 416 for the year. This rule was intended to apply only to SIMPLE
401(k)s, and not other plans maintained by the employer.

escription of Proposal

The proposal would provide that the top-heavy exemption would apply to a plan which
permits only contributions required to satisfy the SIMPLE 401(k) requirements.

h. Employer deduction for SIMPLE 401(k) arrangements

Present Law

Contributions paid by an employer to a profit sharing or stock bonus plan are deductible
by the employer for a taxable year to the extent the contributions do not exceed 15-percent of the
compensation otherwise paid or accrued during the taxable year to the participants under the
plan. Contributions paid by an employer to a profit sharing or stock bonus plan that are not
deductible because they are in excess of the 15-percent limitation are subject to a 10-percent
excise tax payable by the employer making the contribution.

Description of Proposal

The proposal would provide that to the extent that contributions paid by an employer to a
SIMPLE 401(k) arrangement satisfy the contribution requirements of section 401(k)(11)(B),
such contributions will be deductible by the employer for the taxable year.

i. Notification and election periods for SIMPLE 401(k) arrangements

Present Law

An employer maintaining a SIMPLE 401(k) arrangement is required to make a matching
contribution for employees making elective deferrals of up to 3-percent of compensation (or,
alternatively, elect to make a 2-percent of compensation nonelective contribution on behalf of all
eligible employees). An employer electing to make a 2-percent nonelective contribution
is required to notify all employees of such election within a reasonable period of time before the
60th day before the beginning of the year.

An employer maintaining a SIMPLE IRA is required to notify each employee of the

employee’s opportunity to make or modify salary reduction contributions as well as the
contribution alternative chosen by the employer within a reasonable period of time before the

8.



Description of Proposal

The proposal would provide that an employer who maintains a plan for collectively
bargained employees is permitted to maintain a SIMPLE IRA for noncollectively bargained
employees.

e. Application of exclusive plan requirement for SIMPLE IRAs
in the case of mergers and acquisitions

Present Law

Only employers who employ 100 or fewer employees who received compensation for the
preceding year of at least $5,000 are eligible to establish a SIMPLE IRA. An eligible employer
maintaining a SIMPLE IRA who fails to be an eligible employer due to an acquisition,
disposition or similar transaction will be treated as an eligible employer for the 2 years following
the last year the employer was eligible provided rules similar to the special coverage rules of
section 410(b)(6)(C)(1) apply. There is no parallel provision with respect to an employer who,
because of an acquisition, disposition or similar transaction, maintains a qualified plan and a
SIMPLE IRA at the same time.

Description of Proposal

The proposal would provide that if an employer maintains a qualified plan and a SIMPLE
IRA in the same year due to an acquisition, disposition or similar transaction the SIMPLE IRA
will be treated as a qualified salary reduction arrangement for the year of the transaction and the
following calendar year.

f. Cost of living adjustments for SIMPLE 401(k) arrangements

Present Law

The $6,000 limit on deferrals to a SIMPLE IRA is subject to a cost-of-living adjustment.
There is no parallel provision applicable to a SIMPLE 401(k) arrangement.

Description of Proposal

The proposal would provide that the 36,000 limit on elective deferrals under a SIMPLE
401(k) arrangement would be adjusted at the same time and in the same manner as for SIMPLE
TRAs.

-7-


residency status, any gain required to be recognized under regulations would be recognized
immediately after the date of such loss of citizenship or residency status.

12. Suspension of 10-year period in case of substantial diminution of risk of loss

Present Law

Under the expatriation tax provisions in section 877, special tax treatment applies to
certain former U.S. citizens and former long-term U.S. residents for 10 years following the date
of loss of U.S. citizenship or U.S. residency status. The Tunning of this period with respect to
gain on the sale or exchange of any property is suspended for any period during which the
individual’s risk of loss with respect to the property is substantially diminished.

Description of Proposal

The proposal would clarify that the period to which the mule suspending such period in
the case of a substantial diminution of risk of loss applies is the 10-year period that begins on the
date of loss of U.S. citizenship or U.S. residency status.

13. Treatment of property contributed to certain foreign corporations

Present Law

Under the expatriation tax provisions in section 877, special tax treatment applies to
certain former U.S. citizens and former long-term U.S. residents for 10 years following the date
of loss of U.S. citizenship or U.S. residency status. Special rules apply in the case of certain
contributions of U.S. property by such an individual to a foreign corporation during such period.

‘ion of
The proposal would clarify that the period to which the rule regarding certain
contributions to foreign corporations applies is the 10-year period that begins on the date of loss
of U.S. citizenship or U.S. residency status. The proposal also would clarify that the rule applies

in the case of property the income from which, immediately before the contribution, was from
U.S. sources.

14. Credit for foreign estate tax

Present Law

Under the expatriation tax provisions in section 2107, special estate tax treatment applies
to certain former U.S. citizens and former long-term U.S. residents who die within 10 years
following the date of loss of U.S. citizenship or U.S. residency status. Special rules provide a

-28-



insurance, endowment, or annuity contract pursuant to a plan of purchase that contemplates the
systematic direct or indirect borrowing of part or all of the increases in the cash value of the
contract. An exception to the latter rule is provided, permitting deductibility of interest on bona
fide debt that is part of such a plan, if no part of 4 of the annual premiums due during the first 7
years is paid by means of debt (the "4-out-of-7" tule),

Present law provides that the COLI rule is phased in. In connection with the phase-in
tule, a transition rule provides that any amount included in income during 1996, 1997, or 1998,
that is received under a contract described in the provision on the complete surrender,
redemption or maturity of the contract or in full discharge of the obligation under the contract
that is in the nature of a refund of the consideration paid for the contract, is includable ratably
Over the first 4 taxable years beginning with the taxable year the amount would otherwise have
been includable. The lapse of a contract after October 13, 1995, due to nonpayment of premiums
does not cause interest paid or accrued Prior to January 1, 1999, to be nondeductible solely by
reason of (1) failure to meet the 4-out-of-7 mule of present law, or (2) causing the contract to be
treated as a single premium contract within the meaning of section 264(b)(1). This lapse
provision states that the relief is provided in the following case: solely by reason of no additional
premiums being received by reason of a lapse.

cripti re I

The technical correction would clarify that, under the transition relief provided under the
COLI rule, the 4-out-of-7 rule and the single premium mule of present law are not to apply solely
by reason of a lapse occurring by reason of no additional premiums being received under the
contract after October 13, 1995.

11. Requirement of gain recognition on certain exchanges

Present Law

Under the expatriation tax provisions in section 877, special tax treatment applies to
certain former U.S. citizens and former long-term U.S. residents for 10 years following the date
of loss of U.S. citizenship or U.S. residency status. Gain recognition is required on certain
exchanges of property following loss of U.S. citizenship or U.S. residency status, unless a gain
recognition agreement is entered into. In addition, regulatory authority is granted to apply this
rule to the 15-year period beginning 5 years before the loss of U.S. citizenship or U.S. residency
status.

Description of Proposal

The proposal would clarify that the period to which the general rule requiring gain
Tecognition on certain exchanges applies is the 10-year period that begins on the date of loss of
US. citizenship or U.S. residency status. In addition, the Proposal would clarify that in the case
of an exchange occurring during the 5-year period before the loss of USS. citizenship or U.S.

-27-



by its S corporation parent and (2) which the parent elects to treat as a qualified subchapter S
subsidiary. Under the election, for all purposes of the Code, the qualified subchapter S
subsidiary is not treated as a separate corporation and all the assets, liabilities, and items of
income, deduction, and credit of the subsidiary are treated as the assets, liabilities, and items of
income, deduction, and credit of the parent S corporation.

The legislative history of the provision provides that if an election is made to treat an
existing corporation as a qualified subchapter S subsidiary, the subsidiary will be deemed to
have liquidated under sections 332 and 337 immediately before the election is effective.

Description of Proposal

The technical correction would provide that the Secretary of the Treasury may provide,
by regulations, instances where the separate corporate existence of a qualified subchapter S
subsidiary may be taken into account for purposes of the Code. Thus, if an S corporation owns
100 percent of the stock of a bank (as defined in sec. 581) and elects to treat the bank as a
qualified subchapter S subsidiary, it is expected that Treasury regulations would treat the bank as
a separate legal entity for purposes of those Code provisions that apply specifically to banks
(e.g., sec. 582).

Treasury regulations also may provide exceptions to the general rule that the qualified
subchapter S subsidiary election is treated as a deemed section 332 liquidation of the subsidiary
in appropriate cases. In addition, if the effect of a qualified subchapter S subsidiary election is to
invalidate an election to join in the filing of a consolidated return for a group of subsidiaries that
formerly joined in such filing, Treasury regulations may provide guidance as to the consolidated
return effects of the S election.

4.


which the program comes into compliance with the present-law requirements of a qualified State
tuition program under section 529.

4. Adoption tax credit

Present Law

Taxpayers are allowed a maximum nonrefundable tax credit against income tax liability
of $5,000 per child for qualified adoption expenses ($6,000 in the case of certain domestic
adoptions) paid or incurred by the taxpayer. Qualified adoption expenses are reasonable and
necessary adoption fees, court costs, attorneys’ fees, and other expenses that are directly related
to the legal adoption of an eligible child.

Otherwise qualified adoption expenses paid or incurred in one taxable year are not taken
into account for purposes of the credit until the next taxable year unless the expenses are paid or
incurred in the year the adoption becomes final.

Description of Proposal

The technical correction would conform the treatment of otherwise qualified adoption
expenses paid or incurred in years after the year the adoption becomes final to the treatment of
expenses paid or incurred in the year the adoption becomes final. Another technical correction
would repeal as "deadwood" an ordering rule inadvertently included in the credit.

5. Adoption assistance exclusion

a. Phaseout of adoption assistance exclusion

Present Law

The adoption tax credit and the exclusion for employer provided adoption assistance are
generally phased out ratably for taxpayers with modified adjusted gross income (AGI) above
$75,000, and are fully phased out at $115,000 of modified AGI. For these purposes modified
AGI is computed by increasing the taxpayer's AGI by the amount otherwise excluded from gross
income under sections 911, 931, or 933 (relating to the exclusion of income of U.S. citizens or
residents living abroad; residents of Guam, American Samoa, and the Northern Mariana Islands,
and residents of Puerto Rico, respectively).

Description of Proposal

The technical correction would conform the phaseout range of the adoption assistance
exclusion to the phaseout range of the credit for qualified adoption expenses.

-18-



7, 1994 and the provisions of the plan as in effect on December 7, 1994, but only if such
provisions of the plan meet the requirements of such section (as so in effect).

-35-



and interest as reflected in changes in rates for premium paying policies approved by the
Secretary for the same contract form.

escription of Proposal

The technical correction would clarify that the nonforfeiture provision shall provide for a
benefit available in the event of a default in the payment of any premiums and the amount of the
benefit may be adjusted subsequent to being initially granted only as necessary to reflect changes
in claims, persistency, and interest as reflected in changes in rates for premium paying policies
approved by the appropriate State regulatory authority (not by the Secretary) for the same
contract form.

6. Insurable interests under the COLI provision

Present Law

No deduction is allowed for interest paid or accrued on any indebtedness with respect to
one or more life insurance policies or annuity or endowment contracts owned by the taxpayer
covering any individual who is (1) an officer or employee of, or (2) is financially interested in,
any trade or business carried on by the taxpayer (the COLI mule). An exception is provided for
interest on indebtedness with respect to life insurance policies covering up to 20 key persons,
subject to an interest rate cap.

Description of Proposal

The technical correction would prevent unintended avoidance of. the COLI rule by
clarifying that the rule relates to life insurance policies or annuity or endowment contracts
covering any individual-who (1) is or was an officer or employee of, or (2) is or was financially
interested in, any trade or business carried on currently or formerly by the taxpayer. Thus, for
example, the provision would clarify the treatment of interest on debt with respect to contracts
covering former employees of the taxpayer. As another example, the provision would clarify the
treatment of interest on debt with respect to a business formerly conducted by the taxpayer and
transferred to an affiliate of the taxpayer.

7. Applicable period for purposes of applying the interest rate for a variable rate contract
under the COLI rules

Present Law

No deduction is allowed for interest paid or accrued on any indebtedness with respect to
one or more life insurance policies or annuity or endowment contracts owned by the taxpayer
covering any individual who is (1) an officer or employee of, or (2) is financially interested in,
any trade or business carried on by the taxpayer. An exception is provided for interest on

-24-



9.

10.

11.
12.

13.
14.

Effective date of interest rate cap on key persons and pre-1996
contracts under the COLI nle...... 2.0.00... . eee eee,
Clarification of contract lapse under effective date provisions of

the COLI rule... 2... ele, see
Requirement of gain recognition on certain exchanges............
Suspension of 10-year period in case of substantial diminution of

Tisk Of loss 262. cece ccc cece ceece.
Treatment of property contributed to certain foreign corporations . .
Credit for foreign estate tax 2.6... 00.

MI. TECHNICAL CORRECTIONS TO THE TAXPAYER BILL OF
RIGHTS 2 2... cce cece.

1,

2.

Reasonable cause abatement for first-tier intermediate sanctions
ORCHSE AX eee ccc cece cece eee
Reporting by public charities with respect to intermediate

sanctions and certain other excise tax penalties .................

IV. TECHNICAL CORRECTIONS TO OTHERACTS................

Related parties determined by reference to section 267 ...........
Clarify definition of Indian reservation under section 168G)(6) .....
Correction of GATT interest and mortality rate provisions in the

Retirement Protection Act ........ Lette cece cece eee cease

ii)

26

26
27

28

28
28

30

30

31

33

33
33

34


C. Foreign Provisions
1. Measurement of earnings of controlled foreign corporations

Present Law

U.S. 10-percent shareholders of a controlled foreign corporation (CFC) are subject to
current U.S. tax on their pro rata shares of the CFC’s earnings invested in United States property.
For this purpose, earnings include both current and accumulated earnings and profits.

escription of Proposal

The proposal would clarify that accumulated earnings and profits of a CFC taken into
account for purposes of | determining the CFC’'s earnings invested in United States property do not
include current earnings (which are taken into account separately).

2. Transfers to foreign trusts at fair market value

Present Law

AUS. person who transfers Property to a foreign trust which has U.S. beneficiaries
generally is treated as the owner of such trust. However, this rule does not apply where the U.S.
person transfers property to a trust in exchange for fair market value consideration. In
determining whether the U.S. Person receives fair market value consideration, obligations of
certain related persons are not taken into account, For this purpose, related persons include any
grantor or beneficiary of the trust and certain Persons who are related to any such grantor or
beneficiary.

Description of Proposal

The proposal would clarify that, for purposes of determining whether a U.S. person’s
transfer to a trust is for fair market value consideration, the related persons whose obligations are
disregarded include any owner of the trust and certain persons who are related to any such
owner.

3. Treatment of trust as United States person

Present Law

A trust is considered to be a U.S. Person if two criteria are met. First, a court within the
United States must be able to exercise primary supervision over the administration of the trust.
Second, one or more U.S. fiduciaries must have the authority to control all substantial decisions
of the trust.

-1]-


D. Excise Tax Provisions
1. Phaseout and expiration of excise tax on luxury automobiles

Present Law

Present law imposes an excise tax on the sale of automobiles whose price exceeds a
designated threshold, currently $34,000. The excise tax was imposed at a rate of 8-percent on
the excess of the sales price above the designated threshold. The 8-percent rate declines by one
percentage point per year until reaching three percent in 2002. The $34,000 threshold is indexed
for inflation.

The tax generally applies only to the first retail sale after manufacture, production, or
importation of an automobile. It does not apply to subsequent sales of taxable automobiles.
However, under section 4003, a 10-percent tax is imposed on the "separate purchase of vehicle
and parts and accessories therefor" when the sum of the Separate purchases exceeds the luxury
tax threshold. The rate of tax under section 4003 is not determined by reference to section 4001.

The tax under section 4001 applies to sales before January 1, 2003. The tax under
section 4003 has no termination date.

Description of Proposal

The technical correction would clarify that the phased reduction in luxury excise tax rates
and the expiration date of December 31, 2002, enacted as part of the Small Business Act, apply
both for the tax imposed on the purchase of new automobiles under section 4001 and for the tax
imposed for the separate purchase of vehicles and parts and accessories therefor under section
4003. or

2. Repeal "deadwood" provisions relating to previous allowance of advance refunds of
diesel fuel tax

Present Law

The Small Business Act repealed a provision allowing purchasers of diesel-powered
automobiles and light trucks to claim a tax credit equal to an assumed amount of diesel fuel tax
that they would pay over the life of the vehicle. Several accounting provisions in the Code's
Highway Trust Fund rules that relate to this repealed provision were inadvertently retained.

Description of Proposal

The proposal would repeal the Highway Trust Fund provisions relating to the diesel fuel
advance refunds, as “deadwood.”

-13-



D. Excise Tax Provisions ...................... Fo NEE Ee oad

Phaseout and expiration of excise tax on luxury automobiles ......
Repeal “deadwood” provisions relating to previous allowance of
advance refunds of diesel fueltax ..........................
Clarify effective date of technical correction related to ethanol
refunds ccc eee.
Clarify scope of aviation excise tax exemption for emergency
medical aircraft 202

E. Other Provisions 02. e cee cce ee,

Ul. HEALTH INSURANCE PORTAB

. Adoption tax credit ........... an
- Adoption assistance exclusion .........0.00.00.0000

1. Treatment of certain reserves of thrift institutions ...............
2. “FASIT” technical corrections .............................
3.

4
5

Qualified State tuition plans... . .

a. Phaseout of adoption assistance exclusion ..............._
b. Application of leased employee mules ..................,.,

OF 1996 2.

1.

No

Medical savings accounts 6.02...
a. Additional tax on distributions not used for medical purposes . .
b. Definition of permitted coverage
c. Taxation of distributions ....................0...«, .
d. Penalty for failure to provide required reports ............,.
Definition of chronically ill individual under a qualified long-term
care insurance contract... 6...
Deduction for long-term care insurance of self-employed

individuals 2,
Applicability of reporting requirements of long-term care contracts
and accelerated death benefits 6.0.0...
Consumer protection provisions for long-term care insurance
Contracts «eee.
Insurable interests under the COLI Provision................0.,
Applicable period for purposes of applying the interest rate for a
Variable rate contract under the COLI rules..............
Definition of 20-percent owner of purposes of key period exception
under COLT rule 2.

ILITY AND ACCOUNTABILITY ACT

15
15
15
17
18
18
19
20
20
20
20
20
21
21
22
22

23
24

24

25


Effective Date

The proposal generally would be effective as if included in the Omnibus Budget
Reconciliation Act of 1993 (i.e., the technical correction would apply to property placed in
service and wages paid on or after January 1, 1994). However, the proposal would not apply to
wages claimed on any original return filed prior to March 18, 1997, nor would it apply to
property placed in service with a 10-year life or less (without regard to section 168(j)) if
accelerated depreciation under section 168(j) was claimed with Tespect to such property on an
original return filed prior to March 18, 1997.

3. Correction of GATT interest and mortality rate provisions in the Retirement Protection

Act
Present Law

The Retirement Protection Act of 1994, enacted as part of the implementing legislation
for the General Agreements on Tariffs and Trade (“GATT”), modified the actuarial assumptions
that must be used in adjusting benefits and limitations under section 415. In general, in adjusting
a benefit that is payable in a form other than a straight life annuity and in adjusting the dollar
limitation if benefits begin before age 62, the interest rate to be used cannot be less than the
greater of 5 percent or the rate specified by the plan. Under GATT, the benefit is payable in a
form subject to the requirements of section 417(e)(3), then the interest rate on 30-year Treasury
securities is substituted for 5 percent. Also under GATT, for purposes of adjusting any limit or
benefit, the mortality table prescribed by the Secretary must be used. This provision of GATT
was generally effective as of the first day of the limitation year beginning in 1995,

The Small Business Act conformed the effective date of these changes to the effective
date of similar changes by providing generally that, in the case of a plan that was adopted and in
effect before December, 8, 1994, the GATT change is not effective with Tespect to benefits
accrued before the earlier of (1) the later of the date a plan amendment applying the amendments
is adopted or made effective or (2) the first day of the first limitation year beginning after
December 31, 1999. The Small Business Act provides that “Determinations under section
415(b)(2)(E) before such earlier date are to be made with Tespect to such benefits on the basis of
such section as in effect on December 7, 1994 (except that the modification made by section
1449(b) of the Small Business Job Protection Act of 1996 shall be taken into account), and the
provisions of the plan as in effect on December 7, 1994, but only if such provisions of the plan
meet the requirements of such section (as so in effect).”

Description of Proposal

The provision in the Small Business Act was intended to permit plans to apply pre-GATT
law under section 415(b)(2)(E) for a transition period. The proposal would conforms the statute
to this intent by providing that determinations under section 415(b)(2)(E) before such earlier date
are to be made with respect to such benefits on the basis of such section as in effect on December

34.



of whether an individual is a chronically ill individual takes into account at least 5 of such
activities,

Description of Proposal

The technical correction would clarify that the five-activity requirement--i.e., that the
number of activities of daily living that are taken into account not be less than five-applies only
for purposes of the first of three alternative definitions of a chronically ill individual (sec.
7702B(c)(2)(A)(1)), that is, by reason of the individual being unable to perform (without
substantial assistance) at least 2 activities of daily living for at least 90 days due to a loss of
functional capacity. Thus, the requirement would not apply to the determination of whether an
individual is a chronically ill individual either (1) by virtue of severe cognitive impairment, or
(2) if the insured satisfies a standard (if any) that is not based upon activities of daily living, as
determined under regulations.

3. Deduction for long-term care insurance of self-employed individuals

Present Law

Present law provides that the deduction for health insurance expenses of a self-employed
individual is not available for a month for which the individual is eligible to participate in any
subsidized health plan maintained by any employer of the individual or the individual's spouse.
Present law also provides that in the case of a qualified long-term care insurance contract, only
eligible long-term care premiums (as defined for purposes of the medical expense deduction) are
taken into account in determining the deduction for health insurance expenses of a self-employed
individual.

Description of Proposal

The technical correction would apply the rules for the deduction for health insurance
expenses of a self-employed individual separately with respect to (1) plans that include coverage
for qualified long-term care services or that are qualified long-term care insurance contracts, and
(2) plans that do not include such coverage and are not such contracts. Thus, the technical
correction would clarify that the fact that an individual is eligible for employer-subsidized health
insurance does not affect the ability of such an individual to deduct long-term care insurance
premiums, so long as the individual is not eligible for employer-subsidized long-term care
insurance.

4. Applicability of reporting requirements of long-term care contracts and accelerated
death benefits

Present Law

-22-



ONTENTS

INTRODUCTION ................... Meee cece eee e erences

I. TECHNICAL CORRECTIONS TO THE SMALL BUSINESS JOB
JOB PROTECTION ACT OF 1996 ....0 02.2000.

A. Small Business-Related Provisions ......................0-..,

1. Returns relating to purchases of fish ........................
2. Charitable remainder trusts not eligible to be electing small
business trusts 0. eee cece
3. Clarify the effective date for post-termination transition period
PFOVISION 2c cece cece cece ceeeee
4. Treatment of qualified subchapter S subsidiaries ..............,

1. Salary reduction simplified employee pensions (“SARSEPS”) .....
2. SIMPLE retirement plans ............................ see

a.
b. Notification requirement for SIMPLE IRAs................
c.

d. Application of exclusive plan requirement for SIMPLE IRAs

@

£
g.
h.
i,

3. Treatment of Indian tribal governments under section 403(b) ..

Maximum dollar limitation for SIMPLE IRAs .
Reporting requirements for SIMPLE IRAs ...............,

to noncollectively bargained employees ...................
Application of exclusive plan requirement for SIMPLE IRAs

in the case of mergers and acquisitions....................
Cost of living adjustments for SIMPLE 401(k) arrangements . . .
Top-heavy exemption for SIMPLE 401(k) arrangements ......

. Employer deduction for SIMPLE 401(k) arrangements .......

Notification and election periods for SIMPLE 401(k)
arrangements ... 2... eee ee eee

4. Special rules for chaplains and self-employed ministers ..........

C. Foreign Provisions ..... 2.00... 0 occ cece cece cceeeee

1, Measurement of earnings of controlled foreign corporations ......

2. Transfers to foreign trusts at fair market value

3. Treatment of trust as United States person ...................

@

eo an ANUUY

0 00

11

11
11
11


Il. TECHNICAL CORRECTIONS TO THE TAXPAYER BILL OF RIGHTS 2

1. Reasonable cause abatement for first-tier intermediate sanctions excise tax

Present Law

Section 4958 imposes penalty excise taxes as an intermediate sanction in cases where
organizations exempt from tax under sections 501(c)(3) or 501(c)(4) (other than private
foundations) engage in an “excess benefit transaction.” The excise tax may be imposed on
certain disqualified persons (i.e., insiders) who improperly benefit from an excess benefit
transaction and on organization managers who participate in such a transaction knowing that it is
improper.

A disqualified person who benefits from an excess benefit transaction is subject to a first-
tier penalty tax equal to 25 percent of the amount of the excess benefit. Organization managers
who participate in an excess benefit transaction knowing that it is improper are subject to a first-
tier penalty tax of 10 percent of the amount of the excess benefit. Additional second-tier taxes
equal to 200 percent of the amount of the excess benefit may be imposed on a disqualified
person if there is no correction of the transaction within a specified time period.

Under section 4962, the IRS has the authority to abate certain first-tier taxes if the
taxable event was due to reasonable cause and not to willful neglect and the event was corrected
within the applicable correction period. First-tier taxes which may be abated include, among
others, the taxes imposed under sections 4941 (on acts of self-dealing between private
foundations and disqualified persons), 4942 (for failure by private foundations to distribute a
minimum amount of income), and 4943 (on private foundations with excess business holdings).

In enacting the new excise taxes on excess benefit transactions, Congress explicitly
intended to provide the IRS with abatement authority under section 4962.5 However, the
abatement rules of section 4962 apply only to qualified first-tier taxes imposed by subchapter A
or C of Chapter 42. The section 4958 excise tax is located in subchapter D of Chapter 42. The
failure to cross reference subchapter D in section 4962 means that IRS does not have such
abatement authority with respect to the section 4958 excise taxes.

Description of Proposal

The proposal would amend section 4962(b) to include a cross-reference to first-tier taxes
imposed by subchapter D (i.e., the section 4958 excise taxes on excess benefit transactions).
Thus, the IRS would have authority to abate the first-tier excise taxes on excess benefit
transactions in cases where it is established that the violation was due to Teasonable cause and
not due to willful neglect and the transaction at issue was corrected within the specified period.

* See Ways and Means Committee Report 104-506 accompanying H.R. 2377, p. 59.
-30-



indebtedness with respect to life insurance policies covering up to 20 key persons, subject to an
interest rate cap.

This provision generally does not apply to interest on debt with Tespect to contracts
purchased on or before June 20, 1986. If the policy loan interest rate under such a contract does
not provide for a fixed rate of interest, then interest on such a contract paid or accrued after
December 31, 1995, is allowable only to the extent the rate of interest for each fixed period
selected by the taxpayer does not exceed Moody's Corporate Bond Yield Average--Monthly
Average Corporates, for the third month preceding the. first month of the fixed period. The fixed
period must be 12 months or less.

Description of Proposal

The technical correction would provide that an election of an applicable period for
purposes of applying the interest rate for a variable rate contract can be made no later than the
90th date after the date of enactment of the proposal, and would apply to the taxpayer's first
taxable year ending on or after October 13, 1995. If no election is made, the applicable period
would be the policy year. me

8. Definition of 20-percent owner for purposes of key person exception under COLI rule
. Pri Law

No deduction is allowed for interest paid or accrued on any indebtedness with respect to
one or more life insurance policies or annuity or endowment contracts owned by the taxpayer
Covering any individual who is (1) an officer or employee of, or (2) is financially interested in,
any trade or business carried on by the taxpayer. An exception is provided for interest on

indebtedness with respect to life insurance policies covering up to 20 key persons, subject to an
interest rate cap,

A key person is an individual who is either an officer or a 20-percent owner of the
taxpayer. The number of individuals that can be treated as key persons may not exceed the
greater of (1) 5 individuals, or (2) the lesser of 5 percent of the total number of officers and
employees of the taxpayer, or 20 individuals, Employees are to be full-time employees, for this
Purpose. A 20-percent owner is an individual who directly owns 20 percent or more of the total
combined voting power of the corporation. If the taxpayer is not a corporation, the statute states
that a 20-percent owner is an individual who directly owns 20 percent or more of the capital or
profits interest of the employer.

Description of Proposal

The technical correction would clarify that, in determining a key person, if the taxpayer
is not a corporation, a 20-percent owner is an individual who directly owns 20 percent or more of
the capital or profits interest of the taxpayer.

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employee’s election period. The employee’s election period is the 60-day period before the
beginning of any year (and the 60-day period before the first day such employee is eligible to
Participate).

Description of Proposal

The proposal would extend the employer notice and employee election requirements of
SIMPLE IRAs to SIMPLE 401(k) arrangements.

Effective Date

The proposal would be effective with Tespect to calendar years beginning after the date of
enactment.

3. Treatment of Indian tribal governments under section 403(b)

Present Law

Any 403(b) annuity contract purchased in a plan year beginning before January 1, 1995,
by an Indian tribal government is treated as purchased by an entity permitted to maintain a tax-
sheltered annuity plan. Such contracts may be rolled over into a section 401(k) plan maintained
by the Indian tribal government in accordance with the rollover rules of section 403(b)(8).

Description of Proposal

The proposal would clarify that an employee participating in a 403(b) annuity contract of
the Indian tribal government would be permitted to roll over amounts from such contract toa

section 401(k) plan maintained by the Indian tribal government whether or not the annuity
contract is terminated.

4. Special rules for chaplains and self-employed ministers
Present Law

Present law permits ministers employed by an employer other than a church may
Participate in their denominational church plan.

Present law provides that certain service of a self-employed minister is treated as years of

service for purposes of calculating the exclusion allowance applicable to section 403(b)
annuities.


These criteria regarding the treatment of a trust as a United States person are effective for
taxable years beginning after December 31, 1996. The Internal Revenue Service announced
procedures under which a U.S. trust in existence on August 20, 1996 may continue to file returns
as a U.S. trust for taxable years beginning after December 31, 1996. To qualify for such
treatment, the trustee (1) must initiate modification of the trust to conform to the new criteria by
the due date for filing the trust’s return for its first taxable year beginning after 1996, (2) must
complete the modification within two years of such date, and (3) must attach the required
Statement to the trust returns for the taxable years beginning after 1996.3

Description of Proposal

The proposal would clarify that a trust would be treated as a U.S. person as long as one or
more U.S. persons have the authority to control all substantial decisions of the trust (anda U.S.
court can exercise primary supervision). In addition, the proposal would clarify that a trust that
is a foreign trust under these criteria would not be considered to be present or resident in the
United States at any time. Finally, the proposal would provide the Secretary of Treasury with
authority to allow reasonable time for U.S. trusts in existence on August 20, 1996 to make
modifications in order to comply with the new criteria for treatment of a trust as a U.S. person.

3 Notice 96-65, LR.B. 1996-52. See Joint Committee on Taxation, General Explanation

of Tax Legislation Enacted in the 104th Congress (JCS-12-96), December 12, 1996, pp. 277-

278.

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