1

DESCRIPTION OF CHAIRMAN’S MODIFICATION 

TO THE “ENERGY TAX INCENTIVES ACT OF 2003”1

A. Modifications to the Provisions of the Energy Tax Incentives Act of 2003 

1. Section 45 credit at 1.8 cents per kilowatt hour 

The chairman’s mark is modified to provide a credit rate of 1.8 cents per kilowatt hour, 

rather than 1.5 cents per kilowatt hour, with no adjustment for inflation for production in years 

after 2003 from facilities placed in service after the date of enactment. 

2. Modifications to alternative fuel vehicle credits, electric vehicle credits, refueling 

property credits, and credits for the retail sale of alternative fuels 

Fuel cell vehicles

The Chairman’s modification changes the credit amount for fuel cell vehicles. 

 

1

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

Chairman’s Modification to the “Energy Tax Incentives Act of 2003,” (JCX-28-03), April 2, 

2003. 

Joint Committee on Taxation 

April 2, 2003 

JCX-28-03 
2

Table 1, below, is substituted for Table 1 of the Chairman’s mark. 

Table 1.–Base Credit Amount for Fuel Cell Vehicles 

Vehicle Gross Weight Rating in Pounds Credit Amount 

Vehicle ≤ 8,500................................................. $4,000 

8,500 < vehicle ≤ 14,000................................... $10,000 

14,000 < vehicle ≤ 26,000................................. $20,000 

26,000 < vehicle................................................ $40,000 

Automobiles and light trucks

The Chairman’s modification changes the proposed base credit amounts for automobiles 

and light trucks. 

Table 2, below, is substituted for Table 3 of the Chairman’s mark. 

Table 2.–Hybrid Vehicle Base Credit Amount for Automobiles and Light Trucks, 

Dependent Upon the Power Available from the Rechargeable Energy Storage 

System as a Percentage of the Vehicles Maximum Available Power 

 If Rechargeable Energy Storage System Provides: 

Base Credit 

Amount at least but less than 

$250 4% of maximum available power 10% of maximum available power 

$500 10% of maximum available power 20% of maximum available power 

$750 20% of maximum available power 30% of maximum available power 

$1,000 30% of maximum available power 

Heavy duty hybrid vehicles

The Chairman’s modification defines a heavy duty hybrid vehicle as a vehicle weighing 

more than 8,500 pounds.2

 The Chairman’s modification also changes the proposed credit 

amounts for heavy duty hybrid vehicles weighing 14,000 pounds or less. 

Table 3, below, is substituted for Table 5 of the Chairman’s mark. 

 2

 Medium duty passenger vehicles as defined in 40 CFR 86.1830-01 are treated as a 

passenger automobile or light truck for the purpose of determining the allowable credit. 
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Table 3.–Hybrid Vehicle Base Credit Amount for Heavy Duty Vehicles 

Weighing Not More Than 14,000 pounds 

 If Rechargeable Energy Storage System Provides: 

Base Credit 

Amount at least but less than 

$1,000 20% of maximum available power 30% of maximum available power 

$1,750 30% of maximum available power 40% of maximum available power 

$2,000 40% of maximum available power 50% of maximum available power 

$2,250 50% of maximum available power 60% of maximum available power 

$2,500 60% of maximum available power 

The Chairman’s modification changes the proposed base credit amounts for heavy duty 

hybrid vehicles weighing more than 14,000 pounds but not more than 26,000 pounds. 

Table 4, below, is substituted for Table 6 of the Chairman’s mark. 

Table 4.–Hybrid Vehicle Base Credit Amount for Heavy Duty Hybrid Vehicles 

Weighing More Than 14,000 Pounds, But Not More Than 26,000 Pounds 

 If Rechargeable Energy Storage System Provides: 

Base Credit Amount at least but less than 

$4,000 20% of maximum available power 30% of maximum available power 

$4,500 30% of maximum available power 40% of maximum available power 

$5,000 40% of maximum available power 50% of maximum available power 

$5,500 50% of maximum available power 60% of maximum available power 

$6,000 60% of maximum available power 

The Chairman’s modification changes the proposed base credit amounts for heavy duty 

hybrid vehicles weighing more than 26,000 pounds. 

Table 5, below, is substituted for Table 7 of the Chairman’s mark. 
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Table 5.–Hybrid Vehicle Base Credit Amount for Heavy Duty Hybrid 

Vehicles Weighing More Than 26,000 Pounds 

 If Rechargeable Energy Storage System Provides: 

Base Credit Amount at least but less than 

$6,000 20% of maximum available power 30% of maximum available power

$7,000 30% of maximum available power 40% of maximum available power

$8,000 40% of maximum available power 50% of maximum available power

$9,000 50% of maximum available power 60% of maximum available power

$10,000 60% of maximum available power 

Alternative fuel vehicles

The Chairman’s modification changes the maximum allowable incremental cost for the 

purchase of a new alternative fuel vehicle to not more than between $5,000 and $40,000 

depending upon the weight of the vehicle weight class. 

Table 6, below, is substituted for Table 8 of the Chairman’s mark. 

Table 6.–Maximum Allowable Incremental Cost for Calculation 

of Alternative Fuel Vehicle Credit 

Vehicle Gross Weight Rating in Pounds Maximum Allowable Incremental Cost 

vehicle ≤ 8,500.................................................. $5,000 

8,500 < vehicle ≤ 14,000................................... $10,000 

14,000 < vehicle ≤ 26,000................................. $25,000 

26,000 < vehicle................................................ $40,000 

Battery electric vehicles

The Chairman’s modification changes present law to provide for a credit equal to the 

lesser of $1,500 or 10 percent of the manufacturer’s suggested retail price of certain vehicles that 

conform to the Motor Vehicle Safety Standard 500. The Chairman’s modification also changes 

the credit amount for qualifying battery electric vehicles. 

Table 7, below, is substituted for Table 10 of the Chairman’s mark. 
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Table 7.–Credit for Qualifying Battery Electric Vehicles 

Vehicle Gross Weight Rating in Pounds Credit Amount 

Vehicle ≤ 8,500................................................. $3,500 

8,500 < vehicle ≤ 14,000................................... $10,000 

14,000 < vehicle ≤ 26,000................................. $20,000 

26,000 < vehicle................................................ $40,000 

If an electric vehicle weighing not more than 8,500 pounds has an estimated driving 

range of at least 100 miles on a single charge of the vehicle’s batteries or if it is capable of a 

payload capacity of at least 1,000 pounds, then the Chairman’s modification changes the credit 

amount to $6,000. 

Extension of present-law section 179A

The Chairman’s modification adds an extension for the deduction for costs to qualified 

clean-fuel vehicle property and clean-fuel vehicle refining property through December 31, 2007 

(December 31, 2011 in the case of property relating to hydrogen). The phase-down of present 

law for clean fuel vehicles is modified such that the taxpayer may claim 75 percent of the 

otherwise allowable deduction in 2004 and 2005 (2004 through 2009 in the case of property 

relating to hydrogen), 50 percent of the otherwise allowable deduction in 2006 (2010 in the case 

of property relating to hydrogen), and 25 percent of the otherwise allowable deduction in 2007 

(2011 in the case of property relating to hydrogen). 

Credit for installation of alternative fueling stations

The Chairman’s modification changes the allowable credit amount of retail clean-fuel 

vehicle refueling property to not exceed $30,000 and also changes the credit amount of 

residential clean-fuel vehicle refueling property to not exceed $1,000. 

Credit for retail sale of alternative fuels

The Chairman’s modification changes the credit equal to the gasoline gallon equivalent to 

30 cents per gallon of alternative fuel sold in 2003, 40 cents per gallon in 2004, 50 cents per 

gallon in 2005, and 50 cents per gallon in 2006. 

3. Credit for residential energy efficient property 

The Chairman’s modification provides that oil and propane furnaces and water heaters 

that meet the same efficiency standards as their natural gas counterparts are eligible for the same 

credit. 
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4. Three-year applicable recovery period for depreciation of qualified energy management 

devices 

The Chairman’s modification clarifies that a qualified energy management device is not 

required to record or communicate price data. 

5. Modification to investment and production credits for advanced clean coal technology 

units 

The Chairman’s mark is modified to provide that pressurized fluidized bed combustion 

technology is a qualifying advanced clean coal technology. A qualifying pressurized fluidized 

bed combustion technology unit is a unit placed in service after the date of enactment and before 

2017 and having a design net heat rate of not more than 7,720 Btu (8,900 Btu if the unit is placed 

in service before 2009 and 8,500 Btu if the unit is placed in service after 2008 and before 2013). 

The Chairman’s mark is modified to provide that a qualifying integrated gasification 

combined cycle technology unit must have a design net heat rate of not more than 8,500 Btu if 

the unit is placed in service after 2008 and before 2013. 

The Chairman’s mark also is modified so that in the case of units placed in service after 

2008 and before 2013 for which the unit net heat rate, Btu/kWh adjusted for the heat content for 

the design coal, is more than 8,125 Btu but less than 8,500 Btu, the production credit will be 

$0.0075 for the first five years of production and $0.0055 for the second five years of 

production. (This modifies the last line of Table 12 of the Chairman’s mark.) 

Lastly, the Chairman’s mark is modified to provide that the Secretary of the Treasury 

may grant certificates to investments in advanced clean coal technology units to the point the 

4,000 megawatts of electricity production capacity qualifies for the investment credit and 

production credit. From the potential pool of 4,000 megawatts of capacity, not more than 500 

megawatts in total and not more than 250 megawatts in years prior to 2009 shall be allocated to 

units using pressurized fluidized bed combustion technology. 

6. Amortization of geological and geophysical expenditures 

The Chairman’s mark is modified to provide that the amortization of geological and 

geophysical costs is changed from four years to two years. 

7. Extension and modification of credit for producing fuel from a non-conventional source 

The Chairman’s modification increases the section 29 credit for oil from shale or tar 

sands, and gas from geopressured brine, Devonian shale, coal seams, a tight formation, or 

biomass to $3.00. 
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B. New Energy Provisions 

1. Ethanol excise tax credit 

Present Law

Alcohol fuels income tax credit

The alcohol fuels credit is the sum of three credits: the alcohol mixture credit, the alcohol 

credit and the small ethanol producer credit. Generally, the alcohol fuels credit expires after 

December 31, 2007.3

A taxpayer (generally a petroleum refiner, distributor, or marketer) who mixes ethanol 

with gasoline (or a special fuel4

) is an “ethanol blender.” Ethanol blenders are eligible for an 

income tax credit of 52 cents per gallon of ethanol used in the production of a qualified mixture 

(the “alcohol mixture credit”). A qualified mixture means a mixture of alcohol and gasoline, (or 

of alcohol and a special fuel) sold by the blender as fuel, or used as fuel by the blender in 

producing the mixture. Businesses also may reduce their income taxes by 52 cents for each 

gallon of ethanol (not mixed with gasoline or other special fuel) that they sell at the retail level as 

vehicle fuel or use themselves as a fuel in their trade or business (“the alcohol credit”). The 52-

cents-per-gallon income tax credit rate is scheduled to decline to 51 cents per gallon during the 

period 2005 through 2007. 

A separate income tax credit is available for small ethanol producers (the “small ethanol 

producer credit”). A small ethanol producer is defined as a person whose ethanol production 

capacity does not exceed 30 million gallons per year. The small ethanol producer credit is 10 

cents per gallon of ethanol produced during the taxable year for up to a maximum of 15 million 

gallons. 

The credits that comprise alcohol fuels tax credit are includible in income. The credit 

may not be used to offset alternative minimum tax liability. The credit is a treated as a general 

business credit, subject to the ordering rules and carryforward/carryback rules that apply to 

business credits generally. 

Excise tax reduction

Registered ethanol blenders may forgo the full income tax credit and instead pay reduced 

rates of excise tax on gasoline that they purchase for blending with ethanol. Most of the benefit 

of the alcohol fuels credit is claimed through the excise tax system. 

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 The alcohol fuels credit is unavailable when, for any period before January 1, 2008, the 

tax rates for gasoline and diesel fuels drop to 4.3 cents per gallon. 

4

 A special fuel includes any liquid (other than gasoline) that is suitable for use in an 

internal combustion engine. 
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The reduced excise tax rates apply when gasoline is being purchased for the production 

of “gasohol.” Gasohol is defined as a gasoline/ethanol blend that contains 5.7 percent ethanol, 

7.7 percent ethanol, or 10 percent ethanol. The Federal excise tax on gasoline is 18.4 cents per 

gallon. For the calendar year 2003, the following reduced rates apply to gasohol:5

 

5.7 percent ethanol 15.436 cents per gallon 

7.7 percent ethanol 14.396 cents per gallon 

10.0 percent ethanol 13.200 cents per gallon 

The person liable for the tax is required to be registered with the IRS and (1) produces 

gasohol with gasoline within 24 hours of removing or entering the gasoline or (2) at the time the 

gasoline was sold, has an unexpired certificate from the buyer and has no reason to believe the 

certificate is false.6

If an ethanol blender is not registered with the IRS, the blender must pay the full excise 

tax of 18.4 cents per gallon on all gasoline that is blended with ethanol. The blender may claim 

the income tax credit for the ethanol. In addition, in lieu of the credit, the blender may file for a 

quick excise tax refund. The refund is equal to the difference between the gasoline excise tax 

that was paid and the tax that would have been paid by a registered blender on the 

gasoline/ethanol mixture being produced. Generally, the IRS pays these quick refunds within 20 

days. Interest accrues if the refund is paid more than 20 days after filing. 

The benefits provided by the alcohol fuels income tax credit and the excise tax exemption 

are integrated such that the alcohol fuels credit is reduced to take into account the benefit of any 

excise tax reduction. 

Highway Trust Fund

In general, 18.3 cents per gallon of the gasoline excise tax is deposited in the Highway 

Trust Fund and 0.1 cent per gallon is deposited in the Leaking Underground Storage Tank Trust 

Fund (the “LUST” rate). In the case of gasohol with respect to which a reduced excise tax is 

paid, 2.5 cents per gallon of the reduced tax is retained in the General Fund.7

 In the case of 

 5

 These special rates will terminate on September 30, 2007 (sec. 4081(c)(8)). In 

addition, the basic fuel tax rate will drop to 4.3 cents per gallon beginning on October 1, 2005. 

6

 Treas. Reg. sec. 48.4081-6(c). A certificate from the buyer assures that the gasoline 

will be used to produce gasohol within 24 hours after purchase. A copy of the registrant’s letter 

of registration cannot be used as a gasohol blender’s certificate. 

7

 Sec. 9503(b)(4)(E). 
9

gasoline taxed at a reduced rate prior to mixing, 2.8 cents of the reduced rate is retained in the 

General Fund.8 The balance of the reduced rate (less the LUST rate) is deposited in the Highway 

Trust Fund. 

Description of Proposal

In lieu of the reduced excise tax rates on gasoline used to produce gasohol, the proposal 

provides for an excise tax credit equal to the alcohol mixture credit. The alcohol fuel mixture 

credit is 52 cents and will decline at the same rate as the current alcohol fuels income tax credit 

to 51 cents in 2005, 2006, and 2007 for each gallon of alcohol used by a person in producing an 

alcohol fuel mixture. For mixtures not containing ethanol (renewable source methanol), the 

credit is 60 cents per gallon. This excise tax credit may be taken against excise tax liability. The 

excise tax credit is to be coordinated with the income tax credit. The proposal extends both the 

present-law alcohol fuels income tax credit and the new excise tax credit through December 31, 

2010. 

The proposal eliminates the alcohol blend rate tiers (i.e. 5.7 percent, 7.7 percent and 10 

percent) for reduced rates of tax. Under the proposal the full rate of tax for gasoline is imposed 

on both alcohol fuel mixtures and gasoline used to produce an alcohol fuel mixture. Equivalent 

amounts of this tax are to be credited to the Highway Trust Fund. Registered ultimate vendors of 

gasoline used to produce an alcohol fuel mixture could seek a refund equal to the alcohol fuels 

mixture credit. If such claims are not paid within 45 days, the claim is to be paid with interest. 

The proposal also provides that in the case of an electronic claim, if such claim is not paid within 

20 days, the claim is to be paid with interest. 

The proposal eliminates the requirement that 2.5 and 2.8 cents per gallon of excise taxes 

be retained in the General Fund so that the full amount of tax is credited to the Highway Trust 

Fund. 

Effective Date

The proposal is effective September 30, 2003. 

2. Modify income tax and excise tax rules governing treatment of ETBE 

Present Law

An 18.4 cents-per-gallon excise tax is imposed on gasoline. The tax is imposed when the 

fuel is removed from a refinery unless the removal is to a bulk transportation facility (e.g., 

removal by pipeline or barge to a registered terminal). In the case gasoline removed in bulk by 

registered parties, tax is imposed when the gasoline is removed from the terminal facility, 

typically by truck (i.e., “breaks bulk”). If gasoline is sold to an unregistered party before it is 

removed from a terminal, tax is imposed on that sale. When the gasoline subsequently breaks 

bulk, a second tax is imposed. The payor of the second tax may file a refund claim if it can 

 8

 Sec. 9503(b)(4)(F). 
10

prove payment of the first tax. The party liable for payment of the gasoline excise tax is called a 

“position holder,” defined as the owner of record inside the refinery or terminal facility. 

A 52-cents-per-gallon income tax credit is allowed for ethanol used as a motor fuel (the 

“alcohol fuels credit”). The benefit of the alcohol fuels tax credit may be claimed as a reduction 

in excise tax payments when the ethanol is blended with gasoline (“gasohol”). The reduction is 

based on the amount of ethanol contained in the gasohol. The excise tax benefits apply to 

gasohol blends of 90 percent gasoline/10 percent ethanol, 92.3 percent gasoline/7.7 percent 

ethanol, or 94.3 percent gasoline/5.7 percent ethanol. The income tax credit is based on the 

amount of alcohol contained in the blended fuel. 

ETBE is an ether that is manufactured using ethanol. Unlike ethanol, ETBE can be 

blended with gasoline before the gasoline enters a pipeline because ETBE does not result in 

contamination of fuel with water while in transport. Treasury Department regulations provide 

that gasohol blenders may claim the income tax credit and excise tax rate reductions for ethanol 

used in the production of ETBE. The regulations also provide a special election allowing 

refiners to claim the benefit of the excise tax rate reduction even though the fuel being removed 

from terminals does not contain the requisite percentages of ethanol for claiming the excise tax 

rate reduction. 

Description of Proposal

The proposal replaces the present-law regulatory procedures enabling refiners to claim 

excise tax benefits on ETBE-blended gasohol with a new excise tax credit alternative to the 

alcohol fuels income tax credit. Under the provision, in lieu of excise tax rate reductions for 

specified gasohol blends, a refiner blending ETBE and gasoline accrues an excise tax credit 

equal to the amount of the alcohol fuels credit or excise tax rate reduction otherwise available for 

the ETBE blended fuel. The refiner may use this credit to offset its excise tax liability for 

highway motor fuels under Code section 4081. Alternatively, the credit may be transferred to a 

registered position holder that is a member of the same controlled group of corporations as the 

refiner, and the position holder may use the excise tax credit to offset its liability for excise taxes 

under Code section 4081. 

Effective Date

The proposal is effective for fuels blended after date of enactment. 

3. Sale of gasoline and diesel fuel at duty-free sales enterprises 

Present Law

A duty-free sales enterprise that meets certain conditions may sell and deliver for export 

from the customs territory of the United States duty-free merchandise. Duty-free merchandise is 

merchandise sold by a duty-free sales enterprise on which neither federal duty nor federal tax has 

been assessed pending exportation from the customs territory of the United States. Conditions 

for qualifying as a duty-free enterprise include (but are limited to) locations within a specified 

distance from a port of entry, establishment of procedures for ensuring that merchandize is 

exported from the United States, and prominent posting of rules concerning duty-free treatment 
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of merchandise. The duty-free statute does not contain any limitation on what goods may qualify 

for duty-free treatment. 

Description of Proposal

The proposal amends Section 555(b) of the Tariff Act of 1930 (19 U.S.C. 1555(b)) to 

provide that gasoline or diesel fuel sold at duty-free enterprises shall be considered to entered for 

consumption into the United States and thus ineligible for classification as duty-free 

merchandise. 

Effective Date

The proposal is effective on the date of enactment. 

4. Exempt certain prepayments for natural gas from tax-exempt bond arbitrage rules 

Present Law

Interest on bonds issued by States or local governments to finance activities carried out or 

paid for by those entities generally is exempt from income tax.9 Restrictions are imposed on the 

ability of States or local governments to invest the proceeds of these bonds for profit (the 

“arbitrage restrictions”). One such restriction limits the use of bond proceeds to acquire 

“investment-type property.” The term investment-type property includes the acquisition of 

property in a transaction involving a prepayment. A prepayment can produce prohibited 

arbitrage profits when the discount received for prepaying the costs exceeds the yield on the taxexempt bonds. In general, prohibited prepayments include all prepayments that are not 

customary in an industry by both beneficiaries of tax-exempt bonds and other persons using 

taxable financing for the same transaction. 

On April 17, 2002, the Department of the Treasury issued proposed regulations regarding 

arbitrage and private activity restrictions applicable to tax-exempt bonds issued by State and 

local governments. The proposed regulations add an exception to the definition of investmenttype property for certain natural gas prepayments that are made by or for one or more utilities 

that are owned by a governmental person.10 The exception applies if at least 95 percent of the 

natural gas purchased with the prepayment is to be (1) consumed by retail customers in the 

service area of a municipal gas utility, or (2) used to produce electricity that will be furnished to 

retain customers that a municipal electric utility is obligated to serve under State or Federal law. 

An obligation that arises solely because of a contract is not an obligation to serve under State or 

Federal law. For this purpose, the service area of a municipal gas utility is defined as (1) any 

area throughout which the municipal utility provided (at all times during the five-year period 

ending on the issue date) gas transmission or distribution service, and any area that is contiguous 

to such an area, or (2) any area where the municipal utility is obligated under State or Federal 

 9

 Sec. 103. 

10 Prop. Treas. Reg. sec. 1.148-1(e)(2)(ii). 
12

law to provide gas distribution services as provided in such law. Issuers may apply principles 

similar to the rules governing private use to cure a violation of the 95 percent requirement.11 

A prepayment will not fail to meet the requirements for prepaid gas contracts by reason 

of any commodity swap contract that may be entered into between the issuer and an unrelated 

party (other than the gas supplier), or between the gas supplier and an unrelated party (other than 

the issuer), so long as each swap contract is an independent contract. A swap contract is an 

independent contract if it is not dependent on performance by any person (other than the party to 

the swap contract) under another contract (for example, a gas contract or another swap contract). 

A natural gas commodity swap contract will not fail to be an independent contract solely because 

the swap contract may terminate in the event of a failure of a gas supplier to deliver gas for 

which the swap contract is a hedge.12 The Commissioner may, by published guidance, set forth 

additional circumstances in which a prepayment does not give rise to investment-type property. 

Description of Proposal

In general 

The proposal creates a safe harbor exception to the general rule that tax-exempt bondfinanced prepayments violate the arbitrage restrictions. The term “investment type property” 

does not include a prepayment under a qualified natural gas supply contract. The proposal also 

provides such prepayments are not treated as private loans for purposes of the private business 

tests. 

Under the proposal, a prepayment financed with tax-exempt bond proceeds for the 

purpose of obtaining a supply of natural gas for service area customers of a governmental utility 

is not treated as the acquisition of investment-type property. A contract is a qualified natural gas 

contract if the volume of natural gas secured for any year covered by the prepayment does not 

exceed the sum of (1) the average annual natural gas purchased (other than for resale) by 

customers of the utility within the service area of the utility (“retail natural gas consumption”) 

during the testing period, and (2) the amount of natural gas that is needed to fuel transportation 

of the natural gas to the governmental utility. The testing period is the 5-calendar-year period 

immediately preceding the calendar year in which the bonds are issued. A retail customer is one 

who does not purchase natural gas for resale. Natural gas used to generate electricity by a 

governmental utility is counted as retail natural gas consumption if the electricity was sold to 

retail customers within the service area of the governmental electric utility. 

Adjustments

The volume of gas permitted by the general rule is reduced by natural gas otherwise 

available on the date of issuance. Specifically, the amount of natural gas permitted to be 

 11 See Treas. Reg. 1.141-12. 

12 Internal Revenue Service, Clarification of Proposed Regulations Relating to TaxExempt Bonds Issued by State or Local Governments, Notice 2002-52, 2002-30 IRB 1 (July 03, 

2002). 
13

acquired under a qualified natural gas contract for any period is to be reduced by natural gas held 

by the utility on the date of issuance of the bonds and natural gas that the utility has a right to 

acquire for the prepayment period (determined as of the date of issuance).13 For purposes of the 

preceding sentence, applicable share means, with respect to any period, the natural gas allocable 

to such period if the gas were allocated ratably over the period to which the prepayment relates. 

For purposes of the safe harbor, if after the close of the testing period and before the issue 

date of the bonds (1) the government utility enters into a contract to supply natural gas (other 

than for resale) for a commercial person for use at a property within the service area of such 

utility and (2) the gas consumption for such property was not included in the testing period or the 

ratable amount of natural gas to be supplied under the contract is significantly greater than the 

ratable amount of gas supplied to such property during the testing period, then the amount of gas 

permitted to be purchased may be increased to accommodate the contract. 

The average annual retail natural gas consumption calculation for purposes of the safe 

harbor, however, is not to exceed the annual amount of natural gas reasonably expected to be 

purchased (other than for resale) by persons who are located within the service area of such 

utility and who, as of the date of issuance of the issue, are customers of such utility. 

Intentional acts

The safe harbor does not apply if the utility engages in intentional acts to render (1) the 

volume of natural gas covered by the prepayment to be in excess of that needed for retail natural 

gas consumption, and (2) the amount of natural gas that is needed to fuel transportation of the 

natural gas to the governmental utility. 

Definition of service area

Service area is defined as (1) any area throughout which the governmental utility 

provided (at all times during the testing period) in the case of a natural gas utility, natural gas 

transmission or distribution service, or in the case of an electric utility, electric distribution 

service; (2) limited areas contiguous to such areas, and (3) any area recognized as the service 

area of the governmental utility under State or Federal law. Contiguous areas are limited to any 

area within a county contiguous to the area described in (1) in which retail customers of the 

utility are located if such area is not also served by another utility providing the same service. 

Ruling request for higher prepayment amounts

Upon written request, the Secretary may allow an issuer to prepay for an amount of gas 

greater than that allowed by the safe harbor based on objective evidence of growth in gas 

 13 For example, natural gas otherwise available on the date the bonds are issued includes 

supply covered by other prepayment contracts for the period, and supply held in storage or 

subject to an option to purchase by such utility that is available for retail natural gas consumption 

during the period covered by the prepayment. It does not include supply that could be purchased 

on the open market during the prepayment period. 
14

consumption or population that demonstrates that amount permitted by the exception is 

insufficient. 

Effective Date

The proposal is effective for obligations issued after the date of enactment. 
15

C. Provisions to Discourage Corporate Expatriation 

1. Tax treatment of inversion transactions 

Present Law

Determination of corporate residence

The U.S. tax treatment of a multinational corporate group depends significantly on 

whether the top-tier “parent” corporation of the group is domestic or foreign. For purposes of 

U.S. tax law, a corporation is treated as domestic if it is incorporated under the law of the United 

States or of any State. All other corporations (i.e., those incorporated under the laws of foreign 

countries) are treated as foreign. Thus, place of incorporation determines whether a corporation 

is treated as domestic or foreign for purposes of U.S. tax law, irrespective of other factors that 

might be thought to bear on a corporation’s “nationality,” such as the location of the 

corporation’s management activities, employees, business assets, operations, or revenue sources, 

the exchanges on which the corporation’s stock is traded, or the residence of the corporation’s 

managers and shareholders. 

U.S. taxation of domestic corporations

The United States employs a “worldwide” tax system, under which domestic corporations 

generally are taxed on all income, whether derived in the United States or abroad. In order to 

mitigate the double taxation that may arise from taxing the foreign-source income of a domestic 

corporation, a foreign tax credit for income taxes paid to foreign countries is provided to reduce 

or eliminate the U.S. tax owed on such income, subject to certain limitations. 

Income earned by a domestic parent corporation from foreign operations conducted by 

foreign corporate subsidiaries generally is subject to U.S. tax when the income is distributed as a 

dividend to the domestic corporation. Until such repatriation, the U.S. tax on such income is 

generally deferred. However, certain anti-deferral regimes may cause the domestic parent 

corporation to be taxed on a current basis in the United States with respect to certain categories 

of passive or highly mobile income earned by its foreign subsidiaries, regardless of whether the 

income has been distributed as a dividend to the domestic parent corporation. The main antideferral regimes in this context are the controlled foreign corporation rules of subpart F14 and the 

passive foreign investment company rules.15 A foreign tax credit is generally available to offset, 

in whole or in part, the U.S. tax owed on this foreign-source income, whether repatriated as an 

actual dividend or included under one of the anti-deferral regimes. 

U.S. taxation of foreign corporations

The United States taxes foreign corporations only on income that has a sufficient nexus to 

the United States. Thus, a foreign corporation is generally subject to U.S. tax only on income 

 14 Secs. 951-964. 

15 Secs. 1291-1298. 
16

that is “effectively connected” with the conduct of a trade or business in the United States. Such 

“effectively connected income” generally is taxed in the same manner and at the same rates as 

the income of a U.S. corporation. An applicable tax treaty may limit the imposition of U.S. tax 

on business operations of a foreign corporation to cases in which the business is conducted 

through a “permanent establishment” in the United States. 

In addition, foreign corporations generally are subject to a gross-basis U.S. tax at a flat 

30-percent rate on the receipt of interest, dividends, rents, royalties, and certain similar types of 

income derived from U.S. sources, subject to certain exceptions. The tax generally is collected 

by means of withholding by the person making the payment. This tax may be reduced or 

eliminated under an applicable tax treaty. 

U.S. tax treatment of inversion transactions

Under present law, U.S. corporations may reincorporate in foreign jurisdictions and 

thereby replace the U.S. parent corporation of a multinational corporate group with a foreign 

parent corporation. These transactions are commonly referred to as “inversion” transactions. 

Inversion transactions may take many different forms, including stock inversions, asset 

inversions, and various combinations of and variations on the two. Most of the known 

transactions to date have been stock inversions. In one example of a stock inversion, a U.S. 

corporation forms a foreign corporation, which in turn forms a domestic merger subsidiary. The 

domestic merger subsidiary then merges into the U.S. corporation, with the U.S. corporation 

surviving, now as a subsidiary of the new foreign corporation. The U.S. corporation’s 

shareholders receive shares of the foreign corporation and are treated as having exchanged their 

U.S. corporation shares for the foreign corporation shares. An asset inversion reaches a similar 

result, but through a direct merger of the top-tier U.S. corporation into a new foreign corporation, 

among other possible forms. An inversion transaction may be accompanied or followed by 

further restructuring of the corporate group. For example, in the case of a stock inversion, in 

order to remove income from foreign operations from the U.S. taxing jurisdiction, the U.S. 

corporation may transfer some or all of its foreign subsidiaries directly to the new foreign parent 

corporation or other related foreign corporations. 

In addition to removing foreign operations from the U.S. taxing jurisdiction, the 

corporate group may derive further advantage from the inverted structure by reducing U.S. tax 

on U.S.-source income through various “earnings stripping” or other transactions. This may 

include earnings stripping through payment by a U.S. corporation of deductible amounts such as 

interest, royalties, rents, or management service fees to the new foreign parent or other foreign 

affiliates. In this respect, the post-inversion structure enables the group to employ the same taxreduction strategies that are available to other multinational corporate groups with foreign 

parents and U.S. subsidiaries, subject to the same limitations. These limitations under present 

law include section 163(j), which limits the deductibility of certain interest paid to related 

parties, if the payor’s debt-equity ratio exceeds 1.5 to 1 and the payor’s net interest expense 

exceeds 50 percent of its “adjusted taxable income.” More generally, section 482 and the 

regulations thereunder require that all transactions between related parties be conducted on terms 

consistent with an “arm’s length” standard, and permit the Secretary of the Treasury to reallocate 

income and deductions among such parties if that standard is not met. 
17

Inversion transactions may give rise to immediate U.S. tax consequences at the 

shareholder and/or the corporate level, depending on the type of inversion. In stock inversions, 

the U.S. shareholders generally recognize gain (but not loss) under section 367(a), based on the 

difference between the fair market value of the foreign corporation shares received and the 

adjusted basis of the domestic corporation stock exchanged. To the extent that a corporation’s 

share value has declined, and/or it has many foreign or tax-exempt shareholders, the impact of 

this section 367(a) “toll charge” is reduced. The transfer of foreign subsidiaries or other assets to 

the foreign parent corporation also may give rise to U.S. tax consequences at the corporate level 

(e.g., gain recognition and earnings and profits inclusions under sections 1001, 311(b), 304, 367, 

1248 or other provisions). The tax on any income recognized as a result of these restructurings 

may be reduced or eliminated through the use of net operating losses, foreign tax credits, and 

other tax attributes. 

In asset inversions, the U.S. corporation generally recognizes gain (but not loss) under 

section 367(a) as though it had sold all of its assets, but the shareholders generally do not 

recognize gain or loss, assuming the transaction meets the requirements of a reorganization under 

section 368. 

Description of Proposal

In general

The proposal defines two different types of corporate inversion transactions and 

establishes a different set of consequences for each type. Certain partnership transactions also 

are covered. 

Transactions involving at least 80 percent identity of stock ownership

The first type of inversion is a transaction in which, pursuant to a plan or a series of 

related transactions: (1) a U.S. corporation becomes a subsidiary of a foreign-incorporated entity 

or otherwise transfers substantially all of its properties to such an entity;16 (2) the former 

shareholders of the U.S. corporation hold (by reason of holding stock in the U.S. corporation) 80 

percent or more (by vote or value) of the stock of the foreign-incorporated entity after the 

transaction; and (3) the foreign-incorporated entity, considered together with all companies 

connected to it by a chain of greater than 50 percent ownership (i.e., the “expanded affiliated 

group”), does not have substantial business activities in the entity’s country of incorporation, 

compared to the total worldwide business activities of the expanded affiliated group. The 

provision denies the intended tax benefits of this type of inversion by deeming the top-tier 

foreign corporation to be a domestic corporation for all purposes of the Code.17 

 16 It is expected that the Treasury Secretary will issue regulations applying the term 

“substantially all” in this context and will not be bound in this regard by interpretations of the 

term in other contexts under the Code. 

17 Since the top-tier foreign corporation is treated for all purposes of the Code as 

domestic, the shareholder-level “toll charge” of sec. 367(a) does not apply to these inversion 

transactions. However, regulated investment companies and certain similar entities are allowed 
18

Except as otherwise provided in regulations, the provision does not apply to a direct or 

indirect acquisition of the properties of a U.S. corporation no class of the stock of which was 

traded on an established securities market at any time within the four-year period preceding the 

acquisition. In determining whether a transaction would meet the definition of an inversion 

under the provision, stock held by members of the expanded affiliated group that includes the 

foreign incorporated entity is disregarded. For example, if the former top-tier U.S. corporation 

receives stock of the foreign incorporated entity (e.g., so-called “hook” stock), the stock would 

not be considered in determining whether the transaction meets the definition. Stock sold in a 

public offering (whether initial or secondary) or private placement related to the transaction also 

is disregarded for these purposes. Acquisitions with respect to a domestic corporation or 

partnership are deemed to be “pursuant to a plan” if they occur within the four-year period 

beginning on the date which is two years before the ownership threshold under the provision is 

met with respect to such corporation or partnership. 

Transfers of properties or liabilities as part of a plan a principal purpose of which is to 

avoid the purposes of the provision are disregarded. In addition, the Treasury Secretary is 

granted authority to prevent the avoidance of the purposes of the provision, including avoidance 

through the use of related persons, pass-through or other noncorporate entities, or other 

intermediaries, and through transactions designed to qualify or disqualify a person as a related 

person, a member of an expanded affiliated group, or a publicly traded corporation. Similarly, 

the Treasury Secretary is granted authority to treat certain non-stock instruments as stock, and 

certain stock as not stock, where necessary to carry out the purposes of the provision. 

Transactions involving greater than 50 percent but less than 80 percent identity of stock 

ownership

The second type of inversion is a transaction that would meet the definition of an 

inversion transaction described above, except that the 80-percent ownership threshold is not met. 

In such a case, if a greater-than-50-percent ownership threshold is met, then a second set of rules 

applies to the inversion. Under these rules, the inversion transaction is respected (i.e., the foreign 

corporation is treated as foreign), but: (1) any applicable corporate-level “toll charges” for 

establishing the inverted structure may not be offset by tax attributes such as net operating losses 

or foreign tax credits; (2) the IRS is given expanded authority to monitor related-party 

transactions that may be used to reduce U.S. tax on U.S.-source income going forward; and (3) 

section 163(j), relating to “earnings stripping” through related-party debt, is strengthened. These 

measures generally apply for a 10-year period following the inversion transaction. In addition, 

inverting entities are required to provide information to shareholders or partners and the IRS with 

respect to the inversion transaction. 

With respect to “toll charges,” any applicable corporate-level income or gain required to 

be recognized under sections 304, 311(b), 367, 1001, 1248, or any other provision with respect to 

the transfer of controlled foreign corporation stock or other assets by a U.S. corporation as part 

of the inversion transaction or after such transaction to a related foreign person is taxable, 

 

to elect to recognize gain as if sec. 367(a) did apply. This election is available for the calendar 

year of enactment and, if enactment occurs after October 31, the succeeding calendar year. 
19

without offset by any tax attributes (e.g., net operating losses or foreign tax credits). To the 

extent provided in regulations, this rule will not apply to certain transfers of inventory and 

similar transactions conducted in the ordinary course of the taxpayer’s business. 

In order to enhance IRS monitoring of related-party transactions, the provision 

establishes a new pre-filing procedure. Under this procedure, the taxpayer will be required 

annually to submit an application to the IRS for an agreement that all return positions to be taken 

by the taxpayer with respect to related-party transactions comply with all relevant provisions of 

the Code, including sections 163(j), 267(a)(3), 482, and 845. The Treasury Secretary is given the 

authority to specify the form, content, and supporting information required for this application, 

as well as the timing for its submission. 

The IRS will be required to take one of the following three actions within 90 days of 

receiving a complete application from a taxpayer: (1) conclude an agreement with the taxpayer 

that the return positions to be taken with respect to related-party transactions comply with all 

relevant provisions of the Code; (2) advise the taxpayer that the IRS is satisfied that the 

application was made in good faith and substantially complies with the requirements set forth by 

the Treasury Secretary for such an application, but that the IRS reserves substantive judgment as 

to the tax treatment of the relevant transactions pending the normal audit process; or (3) advise 

the taxpayer that the IRS has concluded that the application was not made in good faith or does 

not substantially comply with the requirements set forth by the Treasury Secretary. 

In the case of a compliance failure described in (3) above (and in cases in which the 

taxpayer fails to submit an application), the following sanctions will apply for the taxable year 

for which the application was required: (1) no deductions or additions to basis or cost of goods 

sold for payments to foreign related parties will be permitted; (2) any transfers or licenses of 

intangible property to related foreign parties will be disregarded; and (3) any cost-sharing 

arrangements will not be respected. In such a case, the taxpayer may seek direct review by the 

U.S. Tax Court of the IRS’s determination of compliance failure. 

If the IRS fails to act on the taxpayer’s application within 90 days of receipt, then the 

taxpayer will be treated as having submitted in good faith an application that substantially 

complies with the above-referenced requirements. Thus, the deduction disallowance and other 

sanctions described above will not apply, but the IRS will be able to examine the transactions at 

issue under the normal audit process. The IRS is authorized to request that the taxpayer extend 

this 90-day deadline in cases in which the IRS believes that such an extension might help the 

parties to reach an agreement. 

The “earnings stripping” rules of section 163(j), which deny or defer deductions for 

certain interest paid to foreign related parties, are strengthened for inverted corporations. With 

respect to such corporations, the provision eliminates the debt-equity threshold generally 

applicable under section 163(j) and reduces the 50-percent thresholds for “excess interest 

expense” and “excess limitation” to 25 percent. 

In cases in which a U.S. corporate group acquires subsidiaries or other assets from an 

unrelated inverted corporate group, the provisions described above generally do not apply to the 

acquiring U.S. corporate group or its related parties (including the newly acquired subsidiaries or 
20

assets) by reason of acquiring the subsidiaries or assets that were connected with the inversion 

transaction. The Treasury Secretary is given authority to issue regulations appropriate to carry 

out the purposes of this provision and to prevent its abuse. 

Partnership transactions

Under the proposal, both types of inversion transactions include certain partnership 

transactions. Specifically, both parts of the provision apply to transactions in which a foreignincorporated entity acquires substantially all of the properties constituting a trade or business of a 

domestic partnership (whether or not publicly traded), if after the acquisition at least 80 percent 

(or more than 50 percent but less than 80 percent, as the case may be) of the stock of the entity is 

held by former partners of the partnership (by reason of holding their partnership interests), and 

the “substantial business activities” test is not met. For purposes of determining whether these 

tests are met, all partnerships that are under common control within the meaning of section 482 

are treated as one partnership, except as provided otherwise in regulations. In addition, the 

modified “toll charge” provisions apply at the partner level. 

Effective Date

The regime applicable to transactions involving at least 80 percent identity of ownership 

applies to inversion transactions completed after March 20, 2002. The rules for inversion 

transactions involving greater-than-50-percent identity of ownership apply to inversion 

transactions completed after 1996 that meet the 50-percent test and to inversion transactions 

completed after 1996 that would have met the 80-percent test but for the March 20, 2002 date. 

2. Excise tax on stock compensation of insiders of inverted corporations 

Present Law

The income taxation of a nonstatutory18 compensatory stock option is determined under 

the rules that apply to property transferred in connection with the performance of services (sec. 

83). If a nonstatutory stock option does not have a readily ascertainable fair market value at the 

time of grant, which is generally the case unless the option is actively traded on an established 

market, no amount is included in the gross income of the recipient with respect to the option until 

the recipient exercises the option.19 Upon exercise of such an option, the excess of the fair 

market value of the stock purchased over the option price is included in the recipient’s gross 

income as ordinary income in such taxable year. 

 18 Nonstatutory stock options refer to stock options other than incentive stock options 

and employee stock purchase plans, the taxation of which is determined under sections 421-424. 

19 If an individual receives a grant of a nonstatutory option that has a readily 

ascertainable fair market value at the time the option is granted, the excess of the fair market 

value of the option over the amount paid for the option is included in the recipient’s gross 

income as ordinary income in the first taxable year in which the option is either transferable or 

not subject to a substantial risk of forfeiture. 
21

The tax treatment of other forms of stock-based compensation (e.g., restricted stock and 

stock appreciation rights) is also determined under section 83. The excess of the fair market 

value over the amount paid (if any) for such property is generally includable in gross income in 

the first taxable year in which the rights to the property are transferable or are not subject to 

substantial risk of forfeiture. 

Shareholders are generally required to recognize gain upon stock inversion transactions. 

An inversion transaction is generally not a taxable event for holders of stock options and other 

stock-based compensation. 

Description of Proposal

Under the provision, specified holders of stock options and other stock-based 

compensation are subject to an excise tax upon certain inversion transactions. The provision 

imposes a 20 percent excise tax on the value of specified stock compensation held (directly or 

indirectly) by or for the benefit of a disqualified individual, or a member of such individual’s 

family, at any time during the 12-month period beginning six months before the corporation’s 

inversion date. Specified stock compensation is treated as held for the benefit of a disqualified 

individual if such compensation is held by an entity, e.g., a partnership or trust, in which the 

individual, or a member of the individual’s family, has an ownership interest. 

A disqualified individual is any individual who, with respect to a corporation, is, at any 

time during the 12-month period beginning on the date which is six months before the inversion 

date, subject to the requirements of section 16(a) of the Securities and Exchange Act of 1934 

with respect to the corporation, or any member of the corporation’s expanded affiliated group,20

or would be subject to such requirements if the corporation (or member) were an issuer of equity 

securities referred to in section 16(a). Disqualified individuals generally include officers (as 

defined by section 16(a)),21 directors, and 10-percent owners of private and publicly-held 

corporations. 

The excise tax is imposed on a disqualified individual of an inverted corporation only if 

gain (if any) is recognized in whole or part by any shareholder by reason of either the 80 percent 

or 50 percent identity of stock ownership corporate inversion transactions previously described 

in the provision. 

 20 An expanded affiliated group is an affiliated group (under section 1504) except that 

such group is determined without regard to the exceptions for certain corporations and is 

determined applying a greater than 50 percent threshold, in lieu of the 80 percent test. 

21 An officer is defined as the president, principal financial officer, principal accounting 

officer (or, if there is no such accounting officer, the controller), any vice-president in charge of 

a principal business unit, division or function (such as sales, administration or finance), any other 

officer who performs a policy-making function, or any other person who performs similar 

policy-making functions. 
22

Specified stock compensation subject to the excise tax includes any payment22 (or right to 

payment) granted by the inverted corporation (or any member of the corporation’s expanded 

affiliated group) to any person in connection with the performance of services by a disqualified 

individual for such corporation (or member of the corporation’s expanded affiliated group) if the 

value of the payment or right is based on, or determined by reference to, the value or change in 

value of stock of such corporation (or any member of the corporation’s expanded affiliated 

group). In determining whether such compensation exists and valuing such compensation, all 

restrictions, other than non-lapse restrictions, are ignored. Thus, the excise tax applies, and the 

value subject to the tax is determined, without regard to whether such specified stock 

compensation is subject to a substantial risk of forfeiture or is exercisable at the time of the 

inversion transaction. Specified stock compensation includes compensatory stock and restricted 

stock grants, compensatory stock options, and other forms of stock-based compensation, 

including stock appreciation rights, phantom stock, and phantom stock options. Specified stock 

compensation also includes nonqualified deferred compensation that is treated as though it were 

invested in stock or stock options of the inverting corporation (or member). For example, the 

provision applies to a disqualified individual’s deferred compensation if company stock is one of 

the actual or deemed investment options under the nonqualified deferred compensation plan. 

Specified stock compensation includes a compensation arrangement that gives the 

disqualified individual an economic stake substantially similar to that of a corporate shareholder. 

Thus, the excise tax does not apply where a payment is simply triggered by a target value of the 

corporation’s stock or where a payment depends on a performance measure other than the value 

of the corporation’s stock. Similarly, the tax does not apply if the amount of the payment is not 

directly measured by the value of the stock or an increase in the value of the stock. For example, 

an arrangement under which a disqualified individual is paid a cash bonus of $500,000 if the 

corporation’s stock increased in value by 25 percent over two years or $1,000,000 if the stock 

increased by 33 percent over two years is not specified stock compensation, even though the 

amount of the bonus generally is keyed to an increase in the value of the stock. By contrast, an 

arrangement under which a disqualified individual is paid a cash bonus equal to $10,000 for 

every $1 increase in the share price of the corporation’s stock is subject to the provision because 

the direct connection between the compensation amount and the value of the corporation’s stock 

gives the disqualified individual an economic stake substantially similar to that of a shareholder. 

The excise tax applies to any such specified stock compensation previously granted to a 

disqualified individual but cancelled or cashed-out within the six-month period ending with the 

inversion transaction, and to any specified stock compensation awarded in the six-month period 

beginning with the inversion transaction. As a result, for example, if a corporation were to 

cancel outstanding options three months before the transaction and then reissue comparable 

options three months after the transaction, the tax applies both to the cancelled options and the 

newly granted options. It is intended that the Treasury Secretary issue guidance to avoid double 

counting with respect to specified stock compensation that is cancelled and then regranted during 

the applicable twelve-month period. 

 22 Under the provision, any transfer of property is treated as a payment and any right to a 

transfer of property is treated as a right to a payment. 
23

Specified stock compensation subject to the tax does not include a statutory stock option 

or any payment or right from a qualified retirement plan or annuity, a tax-sheltered annuity, a 

simplified employee pension, or a simple retirement account. In addition, under the provision, 

the excise tax does not apply to any stock option that is exercised during the six-month period 

before the inversion or to any stock acquired pursuant to such exercise. The excise tax also does 

not apply to any specified stock compensation which is sold, exchanged, distributed or cashedout during such period in a transaction in which gain or loss is recognized in full. 

For specified stock compensation held on the inversion date, the amount of the tax is 

determined based on the value of the compensation on such date. The tax imposed on specified 

stock compensation cancelled during the six-month period before the inversion date is 

determined based on the value of the compensation on the day before such cancellation, while 

specified stock compensation granted after the inversion date is valued on the date granted. 

Under the provision, the cancellation of a non-lapse restriction is treated as a grant. 

The value of the specified stock compensation on which the excise tax is imposed is the 

fair value in the case of stock options (including warrants and other similar rights to acquire 

stock) and stock appreciation rights and the fair market value for all other forms of 

compensation. For purposes of the tax, the fair value of an option (or a warrant or other similar 

right to acquire stock) or a stock appreciation right is determined using an appropriate optionpricing model, as specified or permitted by the Treasury Secretary, that takes into account the 

stock price at the valuation date; the exercise price under the option; the remaining term of the 

option; the volatility of the underlying stock and the expected dividends on it; and the risk-free 

interest rate over the remaining term of the option. Options that have no intrinsic value (or 

“spread”) because the exercise price under the option equals or exceeds the fair market value of 

the stock at valuation nevertheless have a fair value and are subject to tax under the provision. 

The value of other forms of compensation, such as phantom stock or restricted stock, are the fair 

market value of the stock as of the date of the inversion transaction. The value of any deferred 

compensation that could be valued by reference to stock is the amount that the disqualified 

individual would receive if the plan were to distribute all such deferred compensation in a single 

sum on the date of the inversion transaction (or the date of cancellation or grant, if applicable). It 

is expected that the Treasury Secretary issue guidance on valuation of specified stock 

compensation, including guidance similar to the revenue procedures issued under section 280G, 

except that the guidance would not permit the use of a term other than the full remaining term. 

Pending the issuance of guidance, it is intended that taxpayers could rely on the revenue 

procedures issued under section 280G (except that the full remaining term must be used). 

The excise tax also applies to any payment by the inverted corporation or any member of 

the expanded affiliated group made to an individual, directly or indirectly, in respect of the tax. 

Whether a payment is made in respect of the tax is determined under all of the facts and 

circumstances. Any payment made to keep the individual in the same after-tax position that the 

individual would have been in had the tax not applied is a payment made in respect of the tax. 

This includes direct payments of the tax and payments to reimburse the individual for payment 

of the tax. It is expected that the Treasury Secretary issue guidance on determining when a 

payment is made in respect of the tax and that such guidance would include certain factors that 

give rise to a rebuttable presumption that a payment is made in respect of the tax, including a 

rebuttable presumption that if the payment is contingent on the inversion transaction, it is made 
24

in respect to the tax. Any payment made in respect of the tax is includible in the income of the 

individual, but is not deductible by the corporation. 

To the extent that a disqualified individual is also a covered employee under section 

162(m), the $1,000,000 limit on the deduction allowed for employee remuneration for such 

employee is reduced by the amount of any payment (including reimbursements) made in respect 

of the tax under the provision. As discussed above, this includes direct payments of the tax and 

payments to reimburse the individual for payment of the tax. 

The payment of the excise tax has no effect on the subsequent tax treatment of any 

specified stock compensation. Thus, the payment of the tax has no effect on the individual’s 

basis in any specified stock compensation and no effect on the tax treatment for the individual at 

the time of exercise of an option or payment of any specified stock compensation, or at the time 

of any lapse or forfeiture of such specified stock compensation. The payment of the tax is not 

deductible and has no effect on any deduction that might be allowed at the time of any future 

exercise or payment. 

Under the provision, the Treasury Secretary is authorized to issue regulations as may be 

necessary or appropriate to carry out the purposes of the section. 

Effective Date

The provision is effective as of July 11, 2002, except that periods before July 11, 2002, 

are not taken into account in applying the tax to specified stock compensation held or cancelled 

during the six-month period before the inversion date. 

3. Reinsurance agreements 

Present Law

In the case of a reinsurance agreement between two or more related persons, present law 

provides the Treasury Secretary with authority to allocate among the parties or recharacterize 

income (whether investment income, premium or otherwise), deductions, assets, reserves, credits 

and any other items related to the reinsurance agreement, or make any other adjustment, in order 

to reflect the proper source and character of the items for each party.23 For this purpose, related 

persons are defined as in section 482. Thus, persons are related if they are organizations, trades 

or businesses (whether or not incorporated, whether or not organized in the United States, and 

whether or not affiliated) that are owned or controlled directly or indirectly by the same interests. 

The provision may apply to a contract even if one of the related parties is not a domestic 

company.

24 In addition, the provision also permits such allocation, recharacterization, or other 

adjustments in a case in which one of the parties to a reinsurance agreement is, with respect to 

 23 Sec. 845(a). 

24 See S. Rep. No. 97-494, “Tax Equity and Fiscal Responsibility Act of 1982,” July 12, 

1982, 337 (describing provisions relating to the repeal of modified coinsurance provisions). 
25

any contract covered by the agreement, in effect an agent of another party to the agreement, or a 

conduit between related persons. 

Description of Proposal

The proposal clarifies the rules of section 845, relating to authority for the Treasury 

Secretary to allocate items among the parties to a reinsurance agreement, recharacterize items, or 

make any other adjustment, in order to reflect the proper source and character of the items for 

each party. The proposal authorizes such allocation, recharacterization, or other adjustment, in 

order to reflect the proper source, character or amount of the item. It is intended that this 

authority25 be exercised in a manner similar to the authority under section 482 for the Treasury 

Secretary to make adjustments between related parties. It is intended that this authority be 

applied in situations in which the related persons (or agents or conduits) are engaged in crossborder transactions that require allocation, recharacterization, or other adjustments in order to 

reflect the proper source, character or amount of the item or items. No inference is intended that 

present law does not provide this authority with respect to reinsurance agreements. 

No regulations have been issued under section 845(a). It is expected that the Treasury 

Secretary will issue regulations under section 845(a) to address effectively the allocation of 

income (whether investment income, premium or otherwise) and other items, the 

recharacterization of such items, or any other adjustment necessary to reflect the proper amount, 

source or character of the item. 

Effective Date

The provision is effective for any risk reinsured after April 11, 2002. 

 25 The authority to allocate, recharacterize or make other adjustments was granted in 

connection with the repeal of provisions relating to modified coinsurance transactions. 
26

D. Provisions Relating to Alaska Natural Gas 

1. Credit for production of Alaska natural gas 

Present Law

Present law does not provide a credit for conventional production of natural gas or 

delivery of fuels to a pipeline. However, certain fuels produced from “non-conventional 

sources” and sold to unrelated parties are eligible for an income tax credit equal to $3 (generally 

adjusted for inflation) per barrel or BTU oil barrel equivalent (sec. 29). Qualified fuels must be 

produced within the United States. 

Qualified fuels include: 

(1) gas produced from geopressured brine, Devonian shale, coal seams, tight 

formations (“tight sands”), or biomass; and 

(2) liquid, gaseous, or solid synthetic fuels produced from coal (including lignite). 

In general, the credit is available only with respect to fuels produced from wells drilled or 

facilities placed in service after December 31, 1979, and before January 1, 1993. An exception 

extends the January 1, 1993 expiration date for facilities producing gas from biomass and 

synthetic fuel from coal if the facility producing the fuel is placed in service before July 1, 1998, 

pursuant to a binding contract entered into before January 1, 1997. 

The credit may be claimed for qualified fuels produced and sold before January 1, 2003 

(in the case of non-conventional sources subject to the January 1, 1993 expiration date) or 

January 1, 2008 (in the case of biomass gas and synthetic fuel facilities eligible for the extension 

period). 

Description of Proposal

The proposal provides a credit per million British thermal units (Btu) of natural gas for 

Alaska natural gas entering a pipeline during the 15-year period beginning the later of January 1, 

2010 or the initial date for the interstate transportation of Alaska natural gas. Taxpayers may 

claim the credit against both the regular and minimum tax. 

The credit amount for any month is a maximum of 52 cents (indexed for inflation) per 

million Btu of natural gas. The credit phases out as the price at the wellhead rises above 83 cents 

per million Btu. The credit is not available if the price at the wellhead rises above $1.35 

(indexed for inflation) per million Btu. 

Alaska natural gas is any gas derived from an area of the State of Alaska lying north of 

64 degrees North latitude generally from the area known as the “North Slope of Alaska,” but not 

including the Alaska National Wildlife Refuge. 
27

Effective date 

The proposal is effective on the date of enactment. 

2. Treat certain Alaska pipeline property as seven-year property 

Present Law

The applicable recovery period for assets placed in service under the Modified 

Accelerated Cost Recovery System is based on the “class life of the property.” The class lives of 

assets placed in service after 1986 are generally set forth in Revenue Procedure 87-56.26 Asset 

class 46.0, describing pipeline transportation, provides a class life of 22 years and a recovery 

period of 15 years. 

Description of Proposal

The proposal establishes a statutory seven-year recovery period and a class life of 10 

years for any natural gas pipeline system, located in Alaska, that has a capacity greater than five 

hundred billion Btu of natural gas per day and is placed in service after 2014. For purposes of 

the proposal, a natural gas pipeline system is defined as any system used in the carrying of 

natural gas by means of pipes, including pipe, trunk lines, related equipment, and appurtenances. 

It does not include any natural gas processing plant related to the pipeline itself. 

Effective Date

The proposal is effective on the date of enactment. 

 26 1987-2 C.B. 674 (as clarified and modified by Rev. Proc. 88-22, 1988-1 C.B. 785). 
28

E. Extension of IRS User Fees 

Present Law

The IRS provides written responses to questions of individuals, corporations, and 

organizations relating to their tax status or the effects of particular transactions for tax purposes. 

The IRS generally charges a fee for requests for a letter ruling, determination letter, opinion 

letter, or other similar ruling or determination. Public Law 104-11727 extended the statutory 

authorization for these user fees28 through September 30, 2003. 

Description of Proposal

The proposal extends the statutory authorization for these user fees through September 

30, 2013. The proposal also moves the statutory authorization for these fees into the Code.29

Effective Date

The proposal, including moving the statutory authorization for these fees into the Code and 

repealing the off-Code statutory authorization for these fees, is effective through September 30, 

2007. 

 27 An Act to provide that members of the Armed Forces performing services for the 

peacekeeping efforts in Bosnia and Herzegovina, Croatia, and Macedonia shall be entitled to tax 

benefits in the same manner as if such services were performed in a combat zone, and for other 

purposes (March 20, 1996). 

28 These user fees were originally enacted in section 10511 of the Revenue Act of 1987 

(Pub. Law No. 100-203, December 22, 1987). 

29 The provision also moves into the Code the user fee provision relating to pension 

plans that was enacted in section 620 of the Economic Growth and Tax Relief Reconciliation Act 

of 2001 (Pub. L. 107-16, June 7, 2001).