" COMMITTEE PRINT ! 108TH CONGRESS

1st Session 

S. PRT. 

108–32 

TECHNICAL EXPLANATION OF THE ENERGY TAX 

INCENTIVES ACT OF 2003

TO ACCOMPANY SENATE AMENDMENT 1424

COMMITTEE ON FINANCE 

UNITED STATES SENATE

CHARLES E. GRASSLEY, Chairman

JULY 2003

Printed for the use of the Committee on Finance 


E:\Seals\Congress.#13
TECHNICAL EXPLANATION OF THE ENERGY TAX INCENTIVES ACT OF 2003 

U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

1

88–682 

" COMMITTEE PRINT ! 108TH CONGRESS

1st Session 

S. PRT. 

2003

108–32 

TECHNICAL EXPLANATION OF THE ENERGY TAX 

INCENTIVES ACT OF 2003

TO ACCOMPANY SENATE AMENDMENT 1424

COMMITTEE ON FINANCE 

UNITED STATES SENATE

CHARLES E. GRASSLEY, Chairman

JULY 2003

Printed for the use of the Committee on Finance 


E:\Seals\Congress.#13
COMMITTEE ON FINANCE 

CHARLES E. GRASSLEY, Iowa, Chairman 

ORRIN G. HATCH, Utah 

DON NICKLES, Oklahoma 

TRENT LOTT, Mississippi 

OLYMPIA J. SNOWE, Maine 

JON KYL, Arizona 

CRAIG THOMAS, Wyoming 

RICK SANTORUM, Pennsylvania 

BILL FRIST, Tennessee 

GORDON SMITH, Oregon 

JIM BUNNING, Kentucky 

MAX BAUCUS, Montana 

JOHN D. ROCKEFELLER IV, West Virginia 

TOM DASCHLE, South Dakota 

JOHN BREAUX, Louisiana 

KENT CONRAD, North Dakota 

BOB GRAHAM, Florida 

JAMES M. JEFFORDS (I), Vermont 

JEFF BINGAMAN, New Mexico 

JOHN F. KERRY, Massachusetts 

BLANCHE L. LINCOLN, Arkansas

KOLAN DAVIS, Staff Director and Chief Counsel 

JEFF FORBES, Democratic Staff Director 

(II) 

(III)

C O N T E N T S 

Page 

I. Legislative Background .................................................................................... 1

Title I—Renewable Electricity Production Tax Credit .................................. 1 

A. Extension and Modification of the Section 45 Electricity Production Credit (sec. 101 of the bill and sec. 45 of the Code) ................ 1 

Title II—Alternative Motor Vehicles and Fuel Incentives ............................ 5 

A. Modifications and Extensions of Provisions Relating to Electric 

Vehicles, Clean-Fuel Vehicles, and Clean-Fuel Vehicle Refueling 

Property (secs. 201, 202, 203, and 204 of the bill and secs. 

30 and 179A and new secs. 30B, 30C, and 40A of the Code) ......... 5 

B. Modifications to Small Producer Ethanol Credit (sec. 205 of the 

bill and secs. 38, 40, 87, and 469 of the Code) ................................. 13 

C. Increased Flexibility in Alcohol Fuels Income Tax Credit (sec. 

206 of the bill and sec. 40 of the Code) ............................................ 14

D. Income Tax Credit for Biodiesel Fuel Mixtures (sec. 207 of the 

bill and new sec. 40B of the Code) .................................................... 15 

E. Alcohol Fuel and Biodiesel Mixtures Excise Tax Credit (sec. 208 

of the bill, secs. 40, 4081, 6427, 9503, and new sec. 6426 of 

the Code) ............................................................................................. 17 

F. Sale of Gasoline and Diesel Fuel at Duty-Free Sales Enterprises 

(sec. 209 of the bill) ............................................................................ 23

Title III—Conservation and Energy Efficiency Provisions ........................... 24

A. Credit for Construction of New Energy-Efficient Home (sec. 301 

of the bill and new sec. 45G of the Code) ......................................... 24

B. Credit for Energy-Efficient Appliances (sec. 302 of the bill and 

new sec. 45H of the Code) ................................................................. 26 

C. Credit for Residential Energy Efficient Property (sec. 303 of the 

bill and new sec. 25C of the Code) .................................................... 27 

D. Credit for Business Installation of Qualified Fuel Cells and Stationary Microturbine Power Plants (sec. 304 of the bill and sec. 

48 of the Code) .................................................................................... 29 

E. Energy-Efficient Commercial Buildings Deduction (sec. 305 of the 

bill and new sec. 179B of the Code) .................................................. 31 

F. Three-Year Applicable Recovery Period for Depreciation of Qualified Energy Management Devices (sec. 306 of the bill and sec. 

168 of the Code) .................................................................................. 33 

G. Three-Year Applicable Recovery Period for Depreciation of Qualified Water Submetering Devices (sec. 307 of the bill and sec. 

168 of the Code) .................................................................................. 34 

H. Energy Credit for Combined Heat and Power System Property 

(sec. 308 of the bill and sec. 48 of the Code) .................................... 34 

I. Credit for Energy Efficiency Improvements to Existing Homes (sec. 

309 of the bill and new sec. 25D of the Code) .................................. 36 

Title IV—Clean Coal Incentives ...................................................................... 38

A. Investment and Production Credits for Clean Coal Technology 

(secs. 401, 411, and 412 of the bill and new secs. 45I, 45J, 

and 48A of the Code) ......................................................................... 38 

Title V—Oil and Gas Provisions ..................................................................... 43 

A. Tax Credit for Oil and Gas Production From Marginal Wells 

(sec. 501 of the bill and sec. 45K of the Code) ................................. 43 

B. Natural Gas Gathering Lines Treated as Seven-Year Property 

(sec. 502 of the bill and sec. 168 of the Code) .................................. 44 

Page

IV

C. Expensing of Capital Costs Incurred and Credit for Production 

in Complying With Environmental Protection Agency Sulfur Regulations (secs. 503 and 504 of the bill and new secs. 179C and 

45L of the Code) ................................................................................. 45 

D. Determination of Small Refiner Exception to Oil Depletion Deduction (sec. 505 of the bill and sec. 613A of the Code) ........................ 46 

E. Extension of Suspension of Taxable Income Limit With Respect 

to Marginal Production (sec. 506 of the bill and sec. 613A of 

the Code) ............................................................................................. 47 

F. Amortization of Delay Rental Payments (sec. 507 of the bill and 

new sec. 199A of the Code) ................................................................ 49 

G. Amortization of Geological and Geophysical Expenditures (sec. 

508 of the bill and new sec. 199 of the Code) .................................. 50 

H. Extension and Modification of Credit for Producing Fuel From 

a Non-Conventional Source (sec. 509 of the bill and new sec. 

45J of the Code) .................................................................................. 52 

I. Natural Gas Distribution Lines Treated as 15–Year Property (sec. 

510 of the bill and sec. 168 of the Code) .......................................... 56 

J. Credit for Alaska Natural Gas (sec. 511 of the bill and new sec. 

45M of the Code) ................................................................................ 57 

K. Certain Alaska Pipeline Systems Treated as Seven-Year Property 

(sec. 512 of the bill and sec. 168 of the Code) .................................. 59 

L. Exempt Certain Prepayments for Natural Gas From Tax-Exempt 

Bond Arbitrage Rules (sec. 513 of the bill and sec. 148 of the 

Code) ................................................................................................... 60 

Title VI—Electric Utility Restructuring Provisions ...................................... 63 

A. Modifications to Special Rules for Nuclear Decommissioning Costs 

(sec. 601 of the bill and sec. 468A of the Code) ............................... 63 

B. Treatment of Certain Income of Cooperatives (sec. 602 of the 

bill and sec. 501 of the Code) ............................................................ 66 

C. Sales or Dispositions To Implement Federal Energy Regulatory 

Commission or State Electric Restructuring Policy (sec. 603 of 

the bill and sec. 451 of the Code) ...................................................... 71 

Title VII—Additional Provisions ..................................................................... 72 

A. Extension of Accelerated Depreciation and Wage Credit Benefits 

on Indian Reservations (sec. 701 of the bill and secs. 45A and 

168(j) of the Code) .............................................................................. 72 

B. GAO Study (sec. 702 of the bill) ......................................................... 74

C. Repeal Certain Excise Taxes on Rail Diesel Fuel and Inland Waterway Barge Fuels (sec. 703 of the bill and secs. 4041 and 

4042 of the Code) ................................................................................ 75 

D. Modify Research Credit for Research Relating to Energy (sec. 

704 of the bill and sec. 41 of the Code) ............................................ 76 

Title VIII—Revenue Provisions ....................................................................... 78

A. Provisions Designed To Curtail Tax Shelters ................................... 78

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

801 of the bill and new sec. 6707A of the Code) ....................... 78 

2. Modifications to the accuracy-related penalties for listed 

transactions and reportable transactions having a significant 

tax avoidance purpose (sec. 802 of the bill and new sec. 

6662A of the Code) ...................................................................... 81 

3. Tax shelter exception to confidentiality privileges relating to 

taxpayer communications (sec. 803 of the bill and sec. 7525 

of the Code) .................................................................................. 85 

4. Disclosure of reportable transactions by material advisors 

(secs. 804 and 805 of the bill and secs. 6111 and 6707 of 

the Code) ...................................................................................... 86 

5. Investor lists and modification of penalty for failure to maintain investor lists (secs. 804 and 806 of the bill and secs. 

6112 and 6708 of the Code) ........................................................ 89 

6. Penalties on promoters of tax shelters (sec. 807 of the bill 

and sec. 6700 of the Code) .......................................................... 91 

B. Provisions to Discourage Corporate Expatriation ............................. 92

Page

V

1. Tax treatment of inversion transactions (sec. 821 of the bill 

and new sec. 7874 of the Code) .................................................. 92 

2. Excise tax on stock compensation of insiders of inverted corporations (sec. 822 of the bill and new sec. 5000A and sec. 

275(a) of the Code) ...................................................................... 98 

3. Reinsurance agreements (sec. 823 of the bill and sec. 845(a) 

of the Code) .................................................................................. 102 

C. Extension of IRS User Fees (sec. 831 of the bill and new sec. 

7529 of the Code) ................................................................................ 104 

D. Add Vaccines Against Hepatitis A to the List of Taxable Vaccines 

(sec. 832 of the bill and sec. 4132 of the Code) ................................ 104 

E. Individual Expatriation To Avoid Tax (sec. 833 of the bill and 

secs. 877, 2107, 2501, and 6039 of the Code) ................................... 105 

II. Budget Effects of the Bill ................................................................................. 111 

A. Committee Estimates .......................................................................... 111 

B. Budget Authority and Tax Expenditures .......................................... 124

C. Consultation With Congressional Budget Office ............................... 124 

III. Votes of the Committee .................................................................................... 129 

IV. Regulatory Impact and Other Matters ........................................................... 130

A. Regulatory Impact ............................................................................... 130

B. Unfunded Mandates Statement .......................................................... 131

C. Tax Complexity Analysis ..................................................................... 131 

V. Changes in Existing Law Made by the Bill, as Reported ............................. 131

(1)

I. LEGISLATIVE BACKGROUND 

The Senate Committee on Finance Marked up an original bill, S. 

ll the ‘‘Energy Tax Incentives Act of 2003’’), on April 2, 2003, 

and, with a quorum present, ordered the bill favorably reported by 

a voice vote on that date.

[Note.—This bill was converted into Senate Amendment 1424] 

TITLE I—RENEWABLE ELECTRICITY PRODUCTION TAX 

CREDIT 

A. EXTENSION AND MODIFICATION OF THE SECTION 45 ELECTRICITY

PRODUCTION CREDIT

(Sec. 101 of the Bill and Sec. 45 of the Code) 

PRESENT LAW

An income tax credit is allowed for the production of electricity 

from either qualified wind energy, qualified ‘‘closed-loop’’ biomass, 

or qualified poultry waste facilities (sec. 45). The amount of the 

credit is 1.5 cents per kilowatt hour (indexed for inflation) of electricity produced. The amount of the credit was 1.8 cents per kilowatt hour for 2002. The credit is reduced for grants, tax-exempt 

bonds, subsidized energy financing, and other credits. 

The credit applies to electricity produced by a wind energy facility placed in service after December 31, 1993, and before January 

1, 2004, to electricity produced by a closed-loop biomass facility 

placed in service after December 31, 1992, and before January 1, 

2004, and to a poultry waste facility placed in service after December 31, 1999, and before January 1, 2004. The credit is allowable 

for production during the 10-year period after a facility is originally 

placed in service. In order to claim the credit, a taxpayer must own 

the facility and sell the electricity produced by the facility to an unrelated party. In the case of a poultry waste facility, the taxpayer 

may claim the credit as a lessee/operator of a facility owned by a 

governmental unit. 

Closed-loop biomass is plant matter, where the plants are grown 

for the sole purpose of being used to generate electricity. It does 

not include waste materials (including, but not limited to, scrap 

wood, manure, and municipal or agricultural waste). The credit 

also is not available to taxpayers who use standing timber to 

produce electricity. Poultry waste means poultry manure and litter, 

including wood shavings, straw, rice hulls, and other bedding material for the disposition of manure. 

The credit for electricity produced from wind, closed-loop biomass, or poultry waste is a component of the general business credit (sec. 38(b)(8)). The credit, when combined with all other compoVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 E:\HR\OC\A682.XXX A682
2

nents of the general business credit, generally may not exceed for 

any taxable year the excess of the taxpayer’s net income tax over 

the greater of (1) 25 percent of net regular tax liability above 

$25,000, or (2) the tentative minimum tax. For credits arising in 

taxable years beginning after December 31, 1997, an unused general business credit generally may be carried back one year and 

carried forward 20 years (sec. 39). To coordinate the carryback with 

the period of application for this credit, the credit for electricity 

produced from closed-loop biomass facilities may not be carried 

back to a tax year ending before 1993 and the credit for electricity 

produced from wind energy may not be carried back to a tax year 

ending before 1994 (sec. 39). 

REASONS FOR CHANGE

The Committee recognizes that the section 45 production credit 

has fostered additional electricity generation capacity in the form 

of non-polluting wind power. The Committee believes it is important to continue this tax credit by extending the placed in service 

date for such facilities to bring more wind energy to the United 

States electric grid. The Committee also believes it is important to 

extend the placed in service date for closed-loop biomass facilities 

to give those potential fuel sources an opportunity in the market 

place. The Committee also believes it is appropriate to include in 

qualifying facilities those facilities that co-fire closed-loop biomass 

fuels with coal, with other biomass, or with coal and other biomass. 

Based on the success of the section 45 credit in the development 

of wind power as an alternative source of electricity generation, the 

committee further believes the country will benefit from the expansion of the production credit to certain other ‘‘environmentally 

friendly’’ sources of electricity generation such as open-loop biomass 

and agricultural waste nutrients, geothermal power, solar power, 

biosolids and sludge, small irrigation systems, and trash combustion. While not all of these additional facilities are pollution free, 

they do address environmental concerns related to waste disposal. 

In addition, these potential power sources further diversify the nation’s energy supply. 

In the current electricity market, the Committee believes that a 

subsidy via a tax credit of 1.8 cents per kilowatt-hour should provide sufficient incentive to investors to enter the market with alternative sources of electricity. Therefore the Committee believes indexing of the credit amounts for years after 2003 is unwarranted. 

Because tax-exempt persons such as public power systems and 

cooperatives provide a significant percentage of electricity in the 

United States, the Committee believes it is important to provide 

the incentive for production from renewable resources to these persons in addition to taxable persons. 

Lastly, the Committee believes that certain pre-existing facilities 

should qualify for the section 45 production credit, albeit at a reduced rate. These facilities previously received explicit subsidies, or 

implicit subsidies provided through rate regulation. In a deregulated electricity market, these facilities, and the environmental 

benefits they yield, may be uneconomic without additional economic incentive. The Committee believes the benefits provided by 

3

1 As is the case for the 1.8 cents-per-kilowatt-hour credit, the 1.2 cents-per-kiowatt-hour credit 

is not indexed for future inflation. 

such existing facilities warrant their inclusion in the section 45 

production credit. 

EXPLANATION OF PROVISION

The provision extends the placed in service date for wind facilities, and closed-loop biomass facilities to facilities placed in service 

after December 31, 1993 (December 31, 1992 in the case of closedloop biomass) and before January 1, 2007. 

The provision provides that, for facilities placed in service after 

the date of enactment, the amount of the credit will be 1.8 cents 

per kilowatt hour with no adjustment for inflation for production 

in years after 2003. 

The provision also defines six new qualifying energy resources: 

biomass (including agricultural livestock waste nutrients), geothermal energy, solar energy, small irrigation power, biosolids and 

sludge, and municipal solid waste. 

Qualifying biomass facilities are facilities using biomass to 

produce electricity that are placed in service prior to January 1, 

2005. Qualifying agricultural livestock waste nutrient facilities are 

facilities using agricultural livestock waste nutrients to produce 

electricity that are placed in service after the date of enactment 

and before January 1, 2007.

For a facility placed in service after the date of enactment, the 

ten-year credit period commences when the facility is placed in 

service. In the case of a biomass facility originally placed in service 

before the date of enactment, the ten-year credit period is reduced 

to a five-year period and commences after December 31, 2003 and 

the otherwise allowable 1.8 cent-per-kilowatt-hour credit is reduced 

to a 1.2 cent-per-kilowatt-hour credit.1

The provision modifies present law to provide that qualifying 

closed-loop biomass facilities include any facility originally placed 

in service before December 31, 1992 and modified to use closed-loop 

biomass to co-fire with coal, to co-fire with other biomass, or to cofire with coal and other biomass, before January 1, 2007. The taxpayer may claim credit for electricity produced at such qualifying 

facilities with the credit amount equal to the otherwise allowable 

credit multiplied by the ratio of the thermal content of the closedloop biomass fuel burned in the facility to the thermal content of 

all fuels burned in the facility. 

Qualifying geothermal energy facilities are facilities using geothermal deposits to produce electricity that are placed in service 

after the date of enactment and before January 1, 2007. Qualifying 

solar energy facilities are facilities using solar energy to generate 

electricity that are placed in service after the date of enactment 

and before January 1, 2007. In the case of qualifying geothermal 

energy facilities and qualifying solar energy facilities, taxpayers 

may claim the otherwise allowable credit for the five-year period 

commencing when the facility is placed in service. 

A qualified small irrigation power facility is a facility originally 

placed in service after the date of enactment and before January 

1, 2007. A small irrigation power facility is a facility that generates 

4

2For this purpose a unit eligible under the bill would comprise a new burner, boiler and turbine system installed on the site of an existing municipal solid waste facility. 3 No credit is permitted during the taxable year if, during any portion of the taxable year, 

there is a certification in effect by the Administrator of the Environmental Protection Agency 

that the facility was permitted to operate in a manner inconsistent with section 4003(d) of the 

Solid Waste Disposal Act. 4The provision deletes poultry litter as a separate qualifying facility for facilities placed in 

service after the effective date. Poultry litter facilities remain qualifying facilities as agricultural 

waste nutrient facilities. Any poultry litter facility placed in service on or prior to the date of 

enactment is unaffected by the modifications made by this provision. For example, the value 

of the credit that may be claimed for production from such a facility would continue to be indexed for inflation. 

electric power through an irrigation system canal or ditch without 

any dam or impoundment of water. The installed capacity of a 

qualified facility is less than five megawatts. 

A qualified biosolids and sludge facility is a facility originally 

placed in service after the date of enactment and before January 

1, 2007. A biosolids and sludge facility is a facility that uses the 

waste heat from the incineration of biosolids and sludge to produce 

electricity. For example, if the taxpayer conveys biosolids and 

sludge into a glass furnace for the purpose of stabilizing the inorganic contents of the biosolids and sludge in an amorphous glass 

matrix (and potentially selling the resulting glass aggregates), and 

the taxpayer uses the waste heat from the glass furnace to generate steam to power a turbine and produce electricity, the electricity produced would be from a qualified biosolids and sludge facility. In addition, a qualifying biosolids and sludge facility is a facility for which the taxpayer has not claimed credit as a combined 

heat and power system property as defined elsewhere in this bill. 

Municipal solid waste facilities (or units) are facilities (or units) 

that burn municipal solid waste (garbage) to produce steam to 

drive a turbine for the production of electricity. Qualifying municipal solid waste facilities (or units) include facilities (or units 2) 

placed in service after the date of enactment and before January 

1, 2007. In the case of qualifying municipal solid waste facilities (or 

units), taxpayers may claim the otherwise allowable credit for the 

five-year period commencing when the facility (or unit) is placed in 

service.3

Biomass is defined as any solid, nonhazardous, cellulosic waste 

material which is segregated from other waste materials and which 

is derived from any of forest-related resources, solid wood waste 

materials, or agricultural sources. Eligible forest-related resources 

are mill and harvesting residues, precommercial thinnings, slash, 

and brush. Solid wood waste materials include waste pallets, 

crates, dunnage, manufacturing and construction wood wastes 

(other than pressure-treated, chemically-treated, or painted wood 

wastes), and landscape or right-of-way tree trimmings. Agricultural 

sources include orchard tree crops, vineyard, grain, legumes, sugar, 

and other crop by-products or residues. However, qualifying biomass for purposes of this provision does not include municipal solid 

waste (garbage), gas derived from biodegradation of solid waste, or 

paper that is commonly recycled. Agricultural waste nutrients are 

defined as livestock manure and litter, including bedding material 

for the disposition of manure. Agricultural livestock comprise bovine, swine, poultry,4 and sheep among others. 

Geothermal energy is energy derived from a geothermal deposit 

which is a geothermal reservoir consisting of natural heat which is 

5

stored in rocks or in an aqueous liquid or vapor (whether or not 

under pressure). 

Biosolids and sludge are the residue or solids removed during the 

treatment of commercial, industrial, or municipal wastewater. 

Municipal solid waste is ‘‘solid waste’’ as defined in section 2(27) 

of the Solid Waste Disposal Act. 

The provision provides that certain persons (public power systems, electric cooperatives, rural electric cooperatives, and Indian 

tribes) may sell, trade, or assign to any taxpayer any credits that 

would otherwise be allowable to that person, if that person were a 

taxpayer, for production of electricity from a qualified facility 

owned by such person. However, any credit sold, traded, or assigned may only be sold, traded, or assigned once. Subsequent 

transfers are not permitted. In addition, any credits that would 

otherwise be allowable to such person, to the extent provided by 

the Administrator of the Rural Electrification Administration, may 

be applied as a prepayment to certain loans or obligations undertaken by such person under the Rural Electrification Act of 1936. 

In the case of qualifying open-loop biomass facilities, qualifying 

closed-loop biomass facilities modified to use closed-loop biomass to 

co-fire with coal, with other biomass, or with coal and other biomass, and qualifying municipal solid waste facilities, the provision 

permits a lessee or operator to claim the credit in lieu of the owner 

of the facilities. 

Lastly, the provision repeals the present-law reduction in allowable credit for facilities financed with tax-exempt bonds or with 

certain loans received under the Rural Electrification Act of 1936. 

In the case of qualifying closed-loop biomass facilities modified to 

use closed-loop biomass to co-fire with coal, with other biomass, or 

with coal and other biomass, the provision repeals the present-law 

reduction in allowable credit for facilities that receive any subsidy. 

EFFECTIVE DATE

The provision generally is effective for electricity produced and 

sold from qualifying facilities after the date of enactment. For electricity produced from qualifying open-loop biomass facilities originally placed in service prior to the date of enactment, the provision 

is effective January 1, 2004.

TITLE II—ALTERNATIVE MOTOR VEHICLES AND FUEL 

INCENTIVES 

A. MODIFICATIONS AND EXTENSIONS OF PROVISIONS RELATING TO

ELECTRIC VEHICLES, CLEAN FUEL VEHICLES, AND CLEAN-FUEL

VEHICLE REFUELING PROPERTY

(Secs. 201, 202, 203, and 204 of the Bill and Secs. 30 and 179A and 

new Secs. 30B, 30C, and 40A of the Code) 

PRESENT LAW

Electric vehicles 

A 10-percent tax credit is provided for the cost of a qualified elec- tric vehicle, up to a maximum credit of $4,000 (sec. 30). A qualified 

electric vehicle is a motor vehicle that is powered primarily by an 

6

electric motor drawing current from rechargeable batteries, fuel 

cells, or other portable sources of electrical current, the original use 

of which commences with the taxpayer, and that is acquired for the 

use by the taxpayer and not for resale. The full amount of the credit is available for purchases prior to 2002. The credit phases down 

in the years 2004 through 2006, and is unavailable for purchases 

after December 31, 2006. 

Clean-fuel vehicles 

Certain costs of qualified clean-fuel vehicles may be expensed 

and deducted when such property is placed in service (sec. 179A). 

Qualified clean fuel vehicle property includes motor vehicles that 

use certain clean-burning fuels (natural gas, liquefied natural gas, 

liquefied petroleum gas, hydrogen, electricity and any other fuel at 

least 85 percent of which is methanol, ethanol, any other alcohol 

or ether). The maximum amount of the deduction is $50,000 for a 

truck or van with a gross vehicle weight over 26,000 pounds or a 

bus with seating capacities of at least 20 adults; $5,000 in the case 

of a truck or van with a gross vehicle weight between 10,000 and 

26,000 pounds; and $2,000 in the case of any other motor vehicle. 

Qualified electric vehicles do not qualify for the clean-fuel vehicle 

deduction. The deduction phases down in the years 2004 through 

2006, and is unavailable for purchases after December 31, 2006. 

Clean-fuel vehicle refueling property 

Clean-fuel vehicle refueling property may be expensed and deducted when such property is placed in service (sec. 179A). Cleanfuel vehicle refueling property comprises property for the storage or 

dispensing of a clean-burning fuel, if the storage or dispensing is 

the point at which the fuel is delivered into the fuel tank of a 

motor vehicle. Clean-fuel vehicle refueling property also includes 

property for the recharging of electric vehicles, but only if the property is located at a point where the electric vehicle is recharged. 

Up to $100,000 of such property at each location owned by the taxpayer may be expensed with respect to that location. The deduction 

is unavailable for costs incurred after December 31, 2006. 

REASONS FOR CHANGE

The Committee believes that further investments in alternative 

fuel and advanced technology vehicles are necessary to transform 

automotive transportation in the United States to be cleaner, more 

fuel efficient, and less reliant on petroleum fuels. 

Tax benefits provided directly to the consumer to lower the cost 

of new technology and alternative-fueled vehicles can help lower 

consumer resistance to these technologies by making the vehicles 

more price competitive with purely petroleum-based fuel vehicles 

and creating increased demand for manufacturers to produce the 

technologies. The eventual goal is mass production and mass-market acceptance of new technology vehicles. The Committee recognizes that creating a number of different credits tailored to each 

different automotive technology adds complexity to the Internal 

Revenue Code, but no one technology has established that it alone 

provides the solution. Therefore, it is appropriate to provide tax 

benefits tailored to specific vehicle technologies, as long as the veVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00014 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
7

hicle’s engine technology directly replaces gasoline and diesel fuel 

with an alternative energy source. 

The Committee expects that hybrid motor vehicles and dedicated 

alternative fuel vehicles are the near-term technological advancement that will replace gasoline- and diesel-burning engines with alternative-powered engines, and electrical and fuel cell vehicles will 

be the long-term technological advancement. 

Applying these technologies to medium and heavy-duty trucks 

and buses is also important for transforming the transportation 

sector to a cleaner, more fuel-efficient sector less reliant on petroleum-based fuels. Therefore, it is appropriate to use tax incentives 

to encourage the introduction of advanced vehicle technologies in 

large trucks and buses. 

In addition, because new vehicle technologies require new fuels 

and infrastructure to deliver those fuels, investments in new technology automobiles alone are not sufficient to transform the market 

to accept these vehicles. Therefore, substantial investments in new 

refueling stations and new fuels are also necessary to make alternative vehicle technologies feasible. 

EXPLANATION OF PROVISION

Alternative motor vehicle credits 

The bill provides a credit for the purchase of a new qualified fuel 

cell motor vehicle, a new qualified hybrid motor vehicle, and a new 

qualified alternative fuel motor vehicle. In general the provision 

provides that the buyer claims the credit, unless the buyer is a taxexempt entity in which case the seller or lessor of the vehicle may 

claim the credit. The taxpayer may carry forward unused credits 

for 20 years or carry unused credits back for three years (but not 

to any taxable year beginning before the date of enactment). Qualified vehicles are vehicles placed in service before 2007 (2012 in the 

case of fuel cell vehicles). Any deduction otherwise allowable under 

sec. 179A is reduced by the amount of credit allowable.

Fuel cell vehicles 

A qualifying fuel cell vehicle is a motor vehicle that is propelled 

by power derived from one or more cells which convert chemical energy directly into electricity by combining oxygen with hydrogen 

fuel which is stored on board the vehicle and may or may not require reformation prior to use. The amount of credit for the purchase of a fuel cell vehicle is determined by a base credit amount 

that depends upon the weight class of the vehicle and, in the case 

of automobiles or light trucks, an additional credit amount that depends upon the rated fuel economy of the vehicle compared to a 

base fuel economy. For these purposes the base fuel economy is the 

2002 model year city fuel economy rating for vehicles of various 

weight classes (see below). Table 1, below, shows the base credit 

amounts.

TABLE 1.—BASE CREDIT AMOUNT FOR FUEL CELL VEHICLES 

Vehicle gross weight rating in pounds Credit 

amount 

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

8

5Medium 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. However, medium 

duty passenger vehicles are only eligible for the base credit amount. There is not an additional 

fuel economy credit for medium duty passenger vehicles. 

TABLE 1.—BASE CREDIT AMOUNT FOR FUEL CELL VEHICLES—Continued

Vehicle gross weight rating in pounds Credit 

amount 

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

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

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

Table 2, below, shows the additional credits for passenger automobiles or light trucks.

TABLE 2.—CREDIT FOR QUALIFYING FUEL CELL VEHICLES 

Credit 

If fuel economy of the fuel cell vehicle is: 

at least but less than 

$1,000 .................................................. 150% of base fuel economy .................. 175% of base fuel economy. 

$1,500 .................................................. 175% of base fuel economy .................. 200% of base fuel economy. 

$2,000 .................................................. 200% of base fuel economy .................. 225% of base fuel economy. 

$2,500 .................................................. 225% of base fuel economy .................. 250% of base fuel economy. 

$3,000 .................................................. 250% of base fuel economy .................. 275% of base fuel economy. 

$3,500 .................................................. 275% of base fuel economy .................. 300% of base fuel economy. 

$4,000 .................................................. 300% of base fuel economy. 

Hybrid vehicles 

A qualifying hybrid vehicle is a motor vehicle that draws propulsion energy from on-board sources of stored energy which include 

both an internal combustion engine or heat engine using combustible fuel and a rechargeable energy storage system (e.g., batteries). 

The amount of credit for the purchase of a hybrid vehicle is the 

sum of two components. In the case of an automobile or light truck, 

the amount of credit is the sum of a base credit amount that varies 

with the amount of power available from the rechargeable storage 

system and a fuel economy credit amount that varies with the 

rated fuel economy of the vehicle compared to a 2002 model year 

standard. In addition, the vehicle must meet or exceed the EPA 

Tier II, bin 5 emissions standards. In the case of a heavy duty hybrid motor vehicle (a vehicle weighing more than 8,500 pounds),5

the amount of credit is the sum of a base credit amount that varies, by vehicle weight class, with the amount of power available 

from the rechargeable storage system and an additional credit for 

early adoption of the technology that varies with the model year of 

the vehicle purchased. 

For these purposes, a vehicle’s power available from its rechargeable energy storage system as a percentage of maximum available 

power is calculated as the maximum value available from the battery or other energy storage device during a standard power test, 

divided by the sum of the battery or other energy storage device 

and the SAE net power of the heat engine. 

Table 3, below, shows the base credit amounts for automobiles 

and light trucks.

9

TABLE 3.—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 VEHICLE’S MAXIMUM AVAILABLE POWER 

Base credit amount 

If rechargeable energy storage system provides: 

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. 

Table 4, below, shows the additional fuel economy credit available to a hybrid passenger automobile or light truck whose fuel 

economy (on a gasoline gallon equivalent basis) exceeds that of a 

base fuel economy. For these purposes the base fuel economy is the 

2002 model year city fuel economy rating for vehicles of various 

weight classes (see below).

TABLE 4.—ADDITIONAL FUEL ECONOMY CREDIT FOR HYBRID VEHICLES 

Credit 

If fuel economy of the hybrid vehicle is: 

at least but less than 

$500 ..................................................... 125% of base fuel economy .................. 150% of base fuel economy. 

$1,000 .................................................. 150% of base fuel economy .................. 175% of base fuel economy. 

$1,500 .................................................. 175% of base fuel economy .................. 200% of base fuel economy. 

$2,000 .................................................. 200% of base fuel economy .................. 225% of base fuel economy. 

$2,500 .................................................. 225% of base fuel economy .................. 250% of base fuel economy. 

$3,000 .................................................. 250% of base fuel economy 

Table 5 below, shows the base credit amounts for heavy duty hybrid vehicles weighing 14,000 pounds or less.

TABLE 5.—HYBRID VEHICLE BASE CREDIT AMOUNT FOR HEAVY DUTY VEHICLES WEIGHING NOT 

MORE THAN 14,000 POUNDS 

Base credit amount 

If rechargeable energy storage system provides: 

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 

In the case of heavy duty hybrid vehicles weighing not more than 

14,000 pounds, the additional credit amount for early adoption of 

the 2007 enission standards technology is $3,000 for model year 

2003 vehicles, $2,500 for model year 2004 vehicles, $2,000 for 

model year 2005 vehicles, and $1,500 or model year 2006 vehicles. 

Table 6, below, shows the base credit amounts for heavy duty hybrid vehicles weighing more than 14,000 pounds but not more than 

26,000 pounds.

10

TABLE 6.—HYBRID VEHICLE BASE CREDIT AMOUNT FOR HEAVY DUTY HYBRID VEHICLES 

WEIGHING MORE THAN 14,000 POUNDS, BUT NOT MORE THAN 26,000 POUNDS 

Base credit amount 

If rechargeable energy storage system provides: 

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 

In the case of heavy duty hybrid vehicles weighing more than 

14,000 pounds but not more than 26,000 pounds, the additional 

credit amount for early adoption of the 2007 emission standards 

technology is $7,750 for model year 2003 vehicles, $6,500 for model 

year 2004 vehicles, $5,250 for model year 2005 vehicles, and $4,000 

for model year 2006 vehicles. 

Table 7, below, shows the base credit amounts for heavy duty hybrid vehicles weighing more than 26,000 pounds.

TABLE 7.—HYBRID VEHICLE BASE CREDIT AMOUNT FOR HEAVY DUTY HYBRID VEHICLES 

WEIGHING MORE THAN 26,000 POUNDS 

Base credit amount 

If rechargeable energy storage system provides: 

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 

In the case of heavy duty hybrid vehicles weighing more than 

26,000 pounds, the additional credit amount for early adoption of 

the 2007 emission standards technology is $12,000 for model year 

2003 vehicles, $10,000 for model year 2004 vehicles, $8,000 for 

model year 2005 vehicles, and $6,000 for model year 2006 vehicles. 

Alternative fuel vehicle 

The credit for the purchase of a new alternative fuel vehicle is 

40 percent of the incremental cost of such vehicle, plus an additional 30 percent if the vehicle meets certain emissions standards, 

but not more than between $5,000 and $40,000 depending upon the 

weight of the vehicle. Table 8, below, shows the maximum permitted incremental cost for the purpose of calculating the credit for 

alternative fuel vehicles by vehicle weight class.

TABLE 8.—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 

11

Alternative fuels comprise compressed natural gas, liquefied natural gas, liquefied petroleum gas, hydrogen, and any liquid fuel 

that is at least 85 percent methanol. Qualifying alternative fuel 

motor vehicles are vehicles that operate only on qualifying alternative fuels and are incapable of operating on gasoline or diesel 

(except in the extent gasoline or diesel fuel is part of a qualified 

mixed fuel, described below). 

Certain mixed fuel vehicles, that is vehicles that use a combination of an alternative fuel and a petroleum-based fuel, are eligible 

for a reduced credit. If the vehicle operates on a mixed fuel that 

is at least 75 percent alternative fuel, the vehicle is eligible for 70 

percent of the otherwise allowable alternative fuel vehicle credit. If 

the vehicle operates on a mixed fuel that is at least 90 percent alternative fuel, the vehicle is eligible for 90 percent of the otherwise 

allowable alternative fuel vehicle credit. 

Base fuel economy 

The base fuel economy is the Environmental Protection Agency’s 

unadjusted 2002 model year city fuel economy for vehicles by inertia weight class by vehicle type. The ‘‘vehicle inertia weight class’’ 

is that defined in regulations prescribed by the Environmental Protection Agency for purposes of Title II of the Clean Air Act. Table 

9, below, shows the 2002 model year city fuel economy for vehicles 

by type and by inertia weight class.

TABLE 9.—2002 MODEL YEAR CITY FUEL ECONOMY 

Vehicle inertia weight class (pounds) 

Passenger 

automobile 

(miles per 

gallon) 

Light truck 

(miles per 

gallon) 

1,500 ................................................................................................................................................ 45.2 39.4 

1,750 ................................................................................................................................................ 45.2 39.4 

2,000 ................................................................................................................................................ 39.6 35.2 

2,250 ................................................................................................................................................ 35.2 31.8 

2,500 ................................................................................................................................................ 31.7 29.0 

2,750 ................................................................................................................................................ 28.8 26.8 

3,000 ................................................................................................................................................ 26.4 24.9 

3,500 ................................................................................................................................................ 22.6 21.8 

4,000 ................................................................................................................................................ 19.8 19.4 

4,500 ................................................................................................................................................ 17.6 17.6 

5,000 ................................................................................................................................................ 15.9 16.1 

5,500 ................................................................................................................................................ 14.4 14.8 

6,000 ................................................................................................................................................ 13.2 13.7 

6,500 ................................................................................................................................................ 12.2 12.8 

7,000 ................................................................................................................................................ 11.3 12.1 

8,500 ................................................................................................................................................ 11.3 12.1 

Modification of credit for qualified electric vehicles 

The bill repeals the phaseout of the credit for electric vehicles 

under present law. The provision also modifies 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. For all other electric vehicles, Table 10, below describes the credit.

12

6For the purpose of the credit for refueling property, refueling property is defined as in 

present-law section 179A as modified by this bill to include property for the production of hydrogen. 

TABLE 10.—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 credit amount in Table 10 is 

$6,000. 

In the case of property purchased by tax-exempt persons, the 

seller may claim the credit. The provision allows taxpayers to carry 

forward unused credits for 20 years or carry unused credits back 

for three (but not to any taxable year before the date of enactment). 

Extension of present-law section 179A 

The bill extends the sunset date of the present law deduction for 

costs of qualified clean-fuel vehicle and clean-fuel vehicle refueling 

property through December 31, 2007 (December 31, 2011 in the 

case of property relating to hydrogen). The provision modifies the 

definition of refueling property in the case of property relating to 

hydrogen to include property for the production of 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 deductible 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 bill permits taxpayers to claim a 50-percent credit for the 

cost of installing clean-fuel vehicle refueling property 6 to be used 

in a trade or business of the taxpayer or installed at the principal 

residence of the taxpayer. In the case of retail clean-fuel vehicle refueling property the allowable credit may not exceed $30,000. In 

the case of residential clean-fuel vehicle refueling property the allowable credit may not exceed $1,000. The taxpayer’s basis in the 

property is reduced by the amount of the credit and the taxpayer 

may not claim deductions under section 179A with respect to property for which the credit is claimed. In the case of refueling property installed on property owned or used by a tax-exempt person, 

the taxpayer that installs the property may claim the credit. To be 

eligible for the credit, the property must be placed in service before 

January 1, 2008 (January 1, 2012 in the case of hydrogen). The 

credit allowable in the taxable year cannot exceed the difference 

between the taxpayer’s regular tax (reduced by certain other credVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00020 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
13

its) and the taxpayer’s tentative minimum tax. The taxpayer may 

carry forward unused credits for 20 years. 

Credit for retail sale of alternative fuels 

The bill permits taxpayers to claim a credit equal to the gasoline 

gallon equivalent of 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. Qualifying alternative fuels are compressed natural gas, liquefied natural gas, liquefied petroleum gas, 

hydrogen, and any liquid mixture consisting of at least 85 percent 

methanol or ethanol. The gasoline gallon equivalency of any alternative fuel is determined by reference to the British thermal unit 

content of the alternative fuel compared to a gallon of gasoline. The 

credit may be claimed for sales prior to January 1, 2007. Under the 

provision, the credit is part of the general business credit. 

EFFECTIVE DATE

The provisions relating to the credit for new fuel cell motor vehicles, hybrid motor vehicles, and alternative fuel motor vehicles, the 

credit for battery electric vehicles, the credit for alternative fuel vehicle refueling property, and deductions for clean fuel vehicles and 

clean fuel refueling property are effective for property placed in 

service after the date of enactment, in taxable years ending after 

the date of enactment. The credit for retail sales of alternative 

fuels is effective for sales of fuels after the date of enactment, in 

taxable years ending after the date of enactment.

B. MODIFICATIONS TO SMALL PRODUCER ETHANOL CREDIT

(Sec. 205 of the Bill and Secs. 38, 40, 87, and 469 of the Code) 

PRESENT LAW

Small producer credit 

Present law provides several tax benefits for ethanol and methanol produced from renewable sources (e.g., biomass) that are used 

as a motor fuel or that are blended with other fuels (e.g., gasoline) 

for such a use. In the case of ethanol, a separate 10-cents-per-gallon credit for small producers, defined generally as persons whose 

production does not exceed 15 million gallons per year and whose 

production capacity does not exceed 30 million gallons per year. 

The alcohol fuels tax credits are includible in income. This credit, 

like tax credits generally, may not be used to offset alternative 

minimum tax liability. The credit is treated as a general business 

credit, subject to the ordering rules and carryforward/carryback 

rules that apply to business credits generally. The alcohol fuels tax 

credit is scheduled to expire after December 31, 2007. 

Taxation of cooperatives and their patrons 

Under present law, cooperatives in essence are treated as passthrough entities in that the cooperative is not subject to corporate 

income tax to the extent the cooperative timely pays patronage 

dividends. Under present law, the only excess credits that may be 

flowed-through to cooperative patrons are the rehabilitation credit 

14

(sec. 47), the energy property credit (sec. 48(a)), and the reforestation credit (sec. 48(b)). 

REASONS FOR CHANGE

The Committee believes provisions allowing greater flexibility in 

utilizing the benefits of the small ethanol producer credit are consistent with the objective of the bill to increase availability of alternative fuels. 

EXPLANATION OF PROVISION

The provision makes several modifications to the rules governing 

the small producer ethanol credit. First, the provision liberalizes 

the definition of an eligible small producer to include persons 

whose production capacity does not exceed 60 million gallons. Second, the provision allows cooperatives to elect to pass-through the 

small ethanol producer credits to its patrons. The credit allowed to 

a particular patron is that proportion of the credit that the cooperative elects to pass-through for that year as the amount of patronage 

of that patron for that year bears to total patronage of all patrons 

for that year. 

Third, the provision repeals the rule that includes the small producer credit in income of taxpayers claiming it and liberalizes the 

ordering and carryforward/carryback rules for the small producer 

ethanol credit. Fourth, the provision allows the small producer 

credit to be claimed against the alternative minimum tax. Finally, 

the provision provides that the small producer ethanol credit is not 

treated as derived from a passive activity under the Code rules restricting credits and deductions attributable to such activities. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after date 

of enactment. 

C. INCREASED FLEXIBILITY IN ALCOHOL FUELS INCOME TAX CREDIT

(Sec. 206 of the Bill and Sec. 40 of the Code) 

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 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 

15

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. 

Ethyl tertiary butyl ether (‘‘ETBE’’) is an ether that is manufactured using ethanol. Unlike ethanol, ETBE can be blended with 

gasoline before the gasoline enters a pipeline because ETBE does 

not result in contamination of fuel with water while in transport. 

Treasury 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. 

REASONS FOR CHANGE

The Committee believes the tax benefits currently available to 

ethanol used in the production of ETBE should be clarified statutorily. In addition, the Committee believes it appropriate to increase the flexibility by which the alcohol fuels credit may be 

claimed for alcohol used in the production of ETBE. 

EXPLANATION OF PROVISION

The provision permits a taxpayer to transfer the alcohol fuels 

credit with respect to alcohol used in the production of ETBE to 

any registered position holder liable for excise taxes imposed under 

section 4081. Such position holder also must obtain from the transferor taxpayer a certificate that identifies the amount of alcohol 

used in the production of ETBE. The Secretary is to prescribe regulations as necessary to ensure that the credit is claimed once and 

not reassigned by the position holder. 

EFFECTIVE DATE

The provision is effective date of enactment.

D. INCOME TAX CREDIT FOR BIODIESEL FUEL MIXTURES

(Sec. 207 of the Bill and new Sec. 40B of the Code) 

PRESENT LAW

No income tax credit or excise tax rate reduction is provided for 

biodiesel fuels under present law. However, a 52-cents-per-gallon 

income tax credit (the ‘‘alcohol fuels credit’’) is allowed for ethanol 

and methanol (derived from renewable sources) when the alcohol is 

used as a highway motor fuel. The benefit of this income tax credit 

may be claimed through reductions in excise taxes paid on alcohol 

fuels. In the case of alcohol blended with other fuels (e.g., gasoline), 

the excise tax rate reductions are allowable only for blends of 90 

percent gasoline/ 10 percent alcohol, 92.3 percent gasoline/7.7 perVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00023 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
16

cent alcohol, or 94.3 percent gasoline/5.7 percent alcohol. These 

present law provisions are scheduled to expire in 2007. 

REASONS FOR CHANGE

The Committee believes that providing a new income tax credit 

for biodiesel fuel will promote energy self-sufficiency and also is 

consistent with the environmental objectives of the bill. 

EXPLANATION OF PROVISION

The provision provides a new income tax credit for qualified biodiesel mixtures. A qualified biodiesel mixture is a mixture of diesel 

fuel and biodiesel that (1) is sold by the taxpayer producing such 

mixture to any person for use as a fuel, or (2) is used as a fuel by 

the taxpayer producing such mixture. Biodiesel is monoalkyl esters 

of long chain fatty acids for use in diesel-powered engines and 

which meet the registration requirements of the Environmental 

Protection Agency under section 211 of the Clean Air Act (42 

U.S.C. sec. 7545) and the American Society of Testing and Materials D6751. Agri-biodiesel means biodiesel derived solely from virgin oils, including esters derived from corn, soybeans, sunflower 

seeds, cottonseeds, canola, crambe, rapeseeds, safflowers, flaxseeds, 

rice bran, mustard seeds, or animal fats. Recycled biodiesel is biodiesel derived from nonvirgin vegetable oils or nonvirgin animal 

fats. Virgin vegetable oils or animal fats mixed with recycled biodiesel will be treated as recycled biodiesel. 

The biodiesel mixture credit is the sum of the products of the biodiesel mixture rate for each qualified biodiesel mixture and the 

number of gallons of such mixture of the taxpayer for the taxable 

year. The per gallon biodiesel mixture rate for agri-biodiesel equals 

one cent for each percentage point of biodiesel in the qualified biodiesel mixture, subject to a maximum credit of 20 cents per blended gallon of fuel. Agri-biodiesel used in the production of a qualified 

biodiesel mixture is taken into account only if a certification from 

the producer of the agribiodiesel which identifies the product produced is obtained. The per gallon biodiesel mixture rate for recycled biodiesel equals 0.5 cent for each percentage point of biodiesel 

in the qualified biodiesel mixture, subject to a maximum credit of 

10 cents per blended gallon of fuel. 

The amount of the biodiesel mixture credit is includible in income. The credit may not be carried back to a taxable year beginning before date of enactment. 

EFFECTIVE DATE

The biodiesel mixture credit is effective for biodiesel fuel sold 

after date of enactment, and before January 1, 2006. 

17

7The 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. 8 A special fuel includes any liquid (other than gasoline) that is suitable for use in an internal 

combustion engine. 9 In the case of any alcohol (other than ethanol) with a proof that is at least 150 but less than 

190, the credit is 45 cents per gallon (the ‘‘low-proof blender amount’’). For ethanol with a proof 

that is at least 150 but less than 190, the low-proof blender amount is 38.52 cents for sales 

or uses during calendar year 2003 and 2004, and 37.78 cents for calendar years 2005, 2006, and 

2007. 10These rates include an additional 0.1 cent-per-gallon excise tax to fund the Leaking Underground Storage Tank Trust Fund. See secs. 4041(d) and 4081(a)(2)(B). In addition, the basic fuel 

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

E. ALCOHOL FUEL AND BIODIESEL MIXTURES EXCISE TAX CREDIT

(Sec. 208 of the Bill, Secs. 40, 4081, 6427, 9503, and new Sec. 6426 

of the Code) 

PRESENT LAW

Alcohol fuels income tax credit 

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

mixture credit, the alcohol credit and the small ethanol producer 

credit. Generally, the alcohol fuels credit expires after December 

31, 2007.7

A taxpayer (generally a petroleum refiner, distributor, or marketer) who mixes ethanol with gasoline (or a special fuel 8 ) is an 

‘‘ethanol blender.’’ Ethanol blenders are eligible for an income tax 

credit of 52 cents per gallon of ethanol used in the production of 

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

special fuel) sold by the blender as fuel, or used as fuel by the 

blender in producing the mixture. The term alcohol includes methanol and ethanol but does not include (1) alcohol produced from petroleum, natural gas, or coal (including peat), or (2) alcohol with a 

proof of less than 150. Businesses also may reduce their income 

taxes by 52 cents for each gallon of ethanol (not mixed with gasoline or other special fuel) that they sell at the retail level as vehicle 

fuel or use themselves as a fuel in their trade or business (‘‘the alcohol credit’’). The 52-cents-per-gallon income tax credit rate is 

scheduled to decline to 51 cents per gallon during the period 2005 

through 2007. For blenders using an alcohol other than ethanol, 

the rate is 60 cents per gallon.9

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 treated as a general business credit, subject to the ordering rules and carryforward/carryback rules 

that apply to business credits generally. 

Excise tax reductions for alcohol mixture fuels 

Generally, motor fuels tax rates are as follows: 10

18

11These rates include the additional 0.1 cent-per-gallon excise tax to fund the Leaking Underground Storage Tank Trust Fund. These special rates will terminate on September 30, 2007 

(sec. 4081(c)(8)). 12Treas. 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. 13 A 0.05–cent-per-gallon Leaking Underground Storage Tank Trust Fund tax is imposed on 

such fuel. This provision expires on October 1, 2007 (sec. 4041(b)(2)). 14These reduced rates terminate after September 30, 2007. 

Gasoline ....................................................... 18.4 cents per gallon. 

Diesel fuel and kerosene ............................ 24.4 cents per gallon. 

Special motor fuels ...................................... 18.4 cents per gallon generally. 

Alcohol-blended fuels are subject to a reduced rate of tax. The 

benefits provided by the alcohol fuels income tax credit and the excise tax reduction are integrated such that the alcohol fuels credit 

is reduced to take into account the benefit of any excise tax reduction. 

Gasohol 

Registered ethanol blenders may forgo the full income tax credit 

and instead pay reduced rates of excise tax on gasoline that they 

purchase for blending with ethanol. Most of the benefit of the alcohol fuels credit is claimed through the excise tax system. 

The reduced excise tax rates apply to gasohol upon its removal 

or entry. Gasohol is defined as a gasoline/ethanol blend that contains 5.7 percent ethanol, 7.7 percent ethanol, or 10 percent ethanol. The Federal excise tax on gasoline is 18.4 cents per gallon. 

For the calendar year 2003, the following reduced rates apply to 

gasohol: 11

5.7 percent ethanol ....................................................... 15.436 cents per gallon. 

7.7 percent ethanol ....................................................... 14.396 cents per gallon. 

10.0 percent ethanol ..................................................... 13.200 cents per gallon. 

Reduced excise tax rates also apply when gasoline is being purchased for the production of ‘‘gasohol.’’ When gasoline is purchased 

for blending into gasohol, the rates above are multiplied by a fraction (e.g., 10/9 for 10-percent gasohol) so that the increased volume 

of motor fuel will be subject to tax. The reduced tax rates apply if 

the person liable for the tax is registered with the IRS and (1) produces gasohol with gasoline within 24 hours of removing or entering the gasoline or (2) gasoline is sold upon its removal or entry 

and such person has an unexpired certificate from the buyer and 

has no reason to believe the certificate is false.12

Qualified methanol and ethanol fuels 

Alcohol produced from a substance other than petroleum or 

natural gas 

Qualified methanol or ethanol fuel is any liquid that contains at 

least 85 percent methanol or ethanol or other alcohol produced 

from a substance other than petroleum or natural gas. These fuels 

are taxed at reduced rates.13 The rate of tax on qualified methanol 

is 12.35 cents per gallon. The rate on qualified ethanol in 2003 and 

2004 is 13.15 cents. From January 1, 2005 through September 30, 

2007, the rate of tax on qualified ethanol is 13.25 cents.14

19

15These rates include the additional 0.1 cent-per-gallon excise tax to fund the Leaking Underground Storage Tank Trust Fund (sec. 4041(d)(1)). 16This rate includes the additional 0.1 cent-per-gallon tax for the Leaking Underground Storage Tank Trust fund. 17Sec. 4041(k)(1) and 4091(c). 18Sec. 4091(c)(1). In the case of aviation fuel for use in producing an aviation alcohol fuel mixture, the rate of tax is 10/9 of the rate that would have been applicable to such mixture had 

such mixture been created prior to sale. 

Alcohol produced from natural gas 

A mixture of methanol, ethanol, or other alcohol produced from 

natural gas that consists of at least 85 percent alcohol is also taxed 

at reduced rates.15 For mixtures not containing ethanol, the applicable rate of tax is 9.25 cents per gallon before October 1, 2005. In 

all other cases, the rate is 11.4 cents per gallon. After September 

31, 2005, the rate is reduced to 2.15 cents per gallon when the mixture does not contain ethanol and 4.3 cents per gallon in all other 

cases. 

Blends of alcohol and diesel fuel or special motor fuels 

A reduced rate of tax applies to diesel fuel or kerosene that is 

combined with alcohol as long as at least 10 percent of the finished 

mixture is alcohol. If none of the alcohol in the mixture is ethanol, 

the rate of tax is 18.4 cents per gallon. For alcohol mixtures containing ethanol, the rate of tax in 2003 and 2004 is 19.2 cents per 

gallon and for 2005 through September 30, 2007, the rate for ethanol mixtures is 19.3 cents per gallon. Fuel removed or entered for 

use in producing a 10 percent diesel-alcohol fuel mixture (without 

ethanol), is subject to a tax of 20.44 cents. The rate of tax for fuel 

removed or entered to produce a 10 percent diesel-ethanol fuel mixture is 21.333 cents per gallon for 2003 and 2004 and 21.444 cents 

per gallon for the period January 1, 2005 through September 30, 

2007.

Special motor fuel (nongasoline) mixtures with alcohol also are 

taxed at reduced rates. 

Aviation fuel 

Noncommercial aviation fuel is subject to a tax of 21.9 cents per 

gallon.16 Fuel mixtures containing at least 10 percent alcohol are 

taxed at lower rates.17 In the case of 10 percent ethanol mixtures, 

any sale or use during 2003 and 2004, the 21.9 cents is reduced 

by 13.2 cents (for a tax of 8.7 cents per gallon), for 2005, 2006, and 

2007 the reduction is 13.1 cents (for a tax of 8.8 cents per gallon) 

and is reduced by 13.4 cents in the case of any sale during 2008 

or thereafter. For mixtures not containing ethanol, the 21.9 cents 

is reduced by 14 cents for a tax of 7.9 cents. These reduced rates 

expire after September 30, 2007.18

When aviation fuel is purchased for blending with alcohol, the 

rates above are multiplied by a fraction (10/9) so that the increased 

volume of aviation fuel will be subject to tax. 

Refunds and payments 

If fully taxed gasoline (or other taxable fuel) is used to produce 

a qualified alcohol mixture, the Code permits the blender to file a 

claim for a quick excise tax refund. The refund is equal to the difference between the gasoline (or other taxable fuel) excise tax that 

20

19Sec. 9503(b)(4)(E). 20Sec. 9503(b)(4)(F). 21Sec. 4081(b); Rev. Rul. 2002–76, 2002–46 I.R.B. 841 (2002). ‘‘Taxable fuels’’ are gasoline, diesel and kerosene (sec. 4083). Biodiesel, although suitable for use as a fuel in a diesel-powered 

highway vehicle or diesel-powered train, contains less than four percent normal paraffins and, 

therefore, is not treated as diesel fuel under the applicable Treasury regulations. Treas. Reg. 

secs. 48.4081–1(c)(2)(i) and (ii), and 48.4081–1(b); Rev. Rul. 2002–76, 2002–46 I.R.B. 841 (2002). 

As a result, biodiesel alone is not a taxable fuel for purposes of section 4081. As noted above, 

however, tax is imposed upon the removal or entry of blended taxable fuel made with biodiesel. 22Sec. 4041. The tax imposed under section 4041 also will not apply if an exemption from 

tax applies. 23 Rev. Rul. 2002–76, 2002–46 I.R.B. 841 (2002). 

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

blender on the alcohol fuel mixture being produced. Generally, the 

IRS pays these quick refunds within 20 days. Interest accrues if 

the refund is paid more than 20 days after filing. A claim may be 

filed by any person with respect to gasoline, diesel fuel, or kerosene 

used to produce a qualified alcohol fuel mixture for any period for 

which $200 or more is payable and which is not less than one 

week. 

Ethyl tertiary butyl ether (ETBE) 

Ethyl tertiary butyl ether (‘‘ETBE’’) is an ether that is manufactured using ethanol. Unlike ethanol, ETBE can be blended with 

gasoline before the gasoline enters a pipeline because ETBE does 

not result in contamination of fuel with water while in transport. 

Treasury 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. 

Highway Trust Fund 

With certain exceptions, the taxes imposed by section 4041 (relating to retail taxes on diesel fuels and special motor fuels) and section 4081 (relating to tax on gasoline, diesel fuel and kerosene) are 

credited to the Highway Trust Fund. In the case of alcohol fuels, 

2.5 cents per gallon of the tax imposed is retained in the General 

Fund.19 In the case of a taxable fuel taxed at a reduced rate upon 

removal or entry prior to mixing with alcohol, 2.8 cents of the reduced rate is retained in the General Fund.20

Biodiesel 

If biodiesel is used in the production of blended taxable fuel, the 

Code imposes tax on the removal or sale of the blended taxable 

fuel.21 In addition, the Code imposes tax on any liquid other than 

gasoline sold for use or used as a fuel in a diesel-powered highway 

vehicle or diesel powered train unless tax was previously imposed 

and not refunded or credited.22 If biodiesel that was not previously 

taxed or exempt is sold for use or used as a fuel in a diesel-powered 

highway vehicle or a diesel-powered train, tax is imposed.23 There 

are no reduced excise tax rates for biodiesel. 

21

24The provision does not change the present-law treatment of alcohol aviation fuels, fuels 

blended with alcohol derived from natural gas (under sec. 4041(m)) or alcohol derived from coal 

or peat (under sec. 4041(b)(2)). In general, the provision does not change the taxes imposed to 

fund the Leaking Underground Storage Tank Trust Fund. 

REASONS FOR CHANGE

The United States seeks to reduce its dependence on foreign oil 

through, among other means, the use of alternative fuels. The 

Committee believes that the goal of promoting the use of alternative fuels can be achieved without decreasing the revenues available for improving the nation’s highway and bridge network. As a 

result, the Committee believes that it is appropriate that the entire 

amount of alcohol fuel taxes be devoted to the Highway Trust 

Fund. Highway vehicles using alcohol-blended fuels contribute to 

the wear and tear of the same highway system used by gasoline 

or diesel vehicles. Therefore, the Committee believes that alcoholblended fuels should be taxed at rates equal to gasoline or diesel.

EXPLANATION OF PROVISION

Overview 

The provision eliminates reduced rates of excise tax for most alcohol-blended fuels. In place of reduced rates, the provision creates 

two new credits: the alcohol fuel mixture credit and the biodiesel 

mixture credit. The sum of these credits may be taken against the 

tax imposed on taxable fuels (by section 4081). Alternatively, in 

lieu of a credit against tax, the provision allows taxpayers to file 

a claim for payment equal to the amount of these credits. The provision also eliminates the General Fund retention of certain taxes 

on alcohol fuels, and credits these taxes to the Highway Trust 

Fund and extends the present-law alcohol fuels credit through December 31, 2010. 

Alcohol fuel mixture excise tax credit 

The provision eliminates the reduced rates of excise tax for most 

alcohol-blended fuels.24 Under the provision, the full rate of tax for 

taxable fuels is imposed on both alcohol fuel mixtures and the taxable fuel used to produce an alcohol fuel mixture. 

In lieu of the reduced excise tax rates, the provision provides for 

an excise tax credit, the alcohol fuel mixture credit. The alcohol 

fuel mixture credit is 52 cents for each gallon of alcohol used by 

a person in producing an alcohol fuel mixture. The credit declines 

to 51 cents per gallon after calendar year 2004. For mixtures not 

containing ethanol (renewable source methanol), the credit is 60 

cents per gallon. Equivalent amounts of these credits are to be 

credited to the Highway Trust Fund. 

For purposes of the alcohol fuel mixture credit, an ‘‘alcohol fuel 

mixture’’ is (1) a mixture of alcohol and a taxable fuel and (2) sold 

for use or used as a fuel by the taxpayer producing the mixture. 

Alcohol for this purpose includes methanol, ethanol, and alcohol 

gallon equivalents of ETBE or other ethers produced from such alcohol. It does not include alcohol produced from petroleum, natural 

gas or coal (including peat), or alcohol with a proof of less than 190 

22

25Sec. 4083(a)(1). 26 Agri-biodiesel is monoalkyl esters of long chain fatty acids for use in diesel-powered engines 

that is derived from virgin oils, including that from corn, soybeans, sunflower seeds, cottonseeds, 

canola, crambe, rapeseeds, safflowers, flaxseeds, rice bran, mustard seeds, or animal fats. The 

excise tax credit employs the same definitions as the biodiesel income tax credit created by section 207 of the bill. 

(determined without regard to any added denaturants). Taxable 

fuel is gasoline, diesel and kerosene.25

The excise tax credit is coordinated with the alcohol fuels income 

tax credit and is available through December 31, 2010. 

Biodiesel mixture excise tax credit 

The provision provides an excise tax credit for agri-biodiesel mixtures. The credit is one dollar for the first gallon of agri-biodiesel 

used by the taxpayer in producing at least five gallons of qualified 

biodiesel mixture.26 The credit is not available for any sale or use 

for any period after December 31, 2005. This excise tax credit is coordinated with income tax credit for biodiesel such that credit for 

the same biodiesel cannot be claimed for both income and excise 

tax purposes. 

Payments with respect to tax-paid fuel used to produce qualified 

mixtures 

When tax-paid fuel is used to produce an alcohol fuel mixture or 

qualified biodiesel mixture that is sold or used in the trade or business of the person who makes such a mixture, a payment in an 

amount equal to the alcohol fuel mixture credit or biodiesel mixture 

credit is available. This refund provision is available to persons 

using gasoline, diesel fuel or kerosene to make an alcohol fuel mixture or qualified biodiesel mixture. Specifically, if any gasoline, diesel fuel, or kerosene on which tax was imposed by section 4081 is 

used by any person in producing an alcohol fuel mixture or qualified biodiesel mixture which is sold or used in such person’s trade 

or business, the Secretary is to pay to such person an amount 

equal to the alcohol fuel mixture credit or the biodiesel mixture 

credit with respect to such gasoline, diesel fuel or kerosene. 

If such claims are not paid within 45 days, the claim is to be paid 

with interest. The provision also provides that in the case of an 

electronic claim, if such claim is not paid within 20 days, the claim 

is to be paid with interest. The refund provision is coordinated with 

other refund provisions and the excise tax credits for alcohol fuel 

mixtures and biodiesel mixtures. The provision does not apply with 

respect to alcohol fuel mixtures sold or used after December 31, 

2010 or qualified biodiesel mixtures sold or used after December 

31, 2005. 

Highway Trust Fund 

The provision 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 on alcohol fuels is credited to the Highway 

Trust Fund. The provision also authorizes the full amount of fuel 

taxes to be appropriated to the Highway Trust Fund without reduction for amounts equivalent to the excise tax credits allowed for alcohol fuel mixtures and biodiesel mixtures. 

23

Alcohol fuels income tax credit 

The provision extends the alcohol fuels credit (sec. 40) through 

December 31, 2010. 

EFFECTIVE DATE

The provision is effective for fuel sold or used after September 

30, 2003.

F. SALE OF GASOLINE AND DIESEL FUEL AT DUTY-FREE SALES

ENTERPRISES

(Sec. 209 of the Bill) 

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 merchandise is exported from the 

United States, and prominent posting of rules concerning duty-free 

treatment of merchandise. The duty-free statute does not contain 

any limitation on what goods may qualify for duty-free treatment. 

REASONS FOR CHANGE

The Committee understands that in some circumstances individuals purchase motor fuels at a duty free facility that is located in 

the United States, drive briefly outside of the United States, and 

return to the United States. The Committee believes that motor 

fuel sold at duty-free enterprises should support the financing of 

the U.S. highway system as do other motor fuel sales in the United 

States. 

EXPLANATION OF PROVISION

The provision 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 dutyfree enterprises shall be considered to be entered for consumption 

into the United States and thus ineligible for classification as dutyfree merchandise. 

EFFECTIVE DATE

The provision is effective on the date of enactment. 

24

TITLE III—CONSERVATION AND ENERGY EFFICIENCY 

PROVISIONS 

A. CREDIT FOR CONSTRUCTION OF NEW ENERGY-EFFICIENT HOME

(Sec. 301 of the Bill and new Sec. 45G of the Code) 

PRESENT LAW

A nonrefundable, 10-percent business energy credit is allowed for 

the cost of new property that is equipment (1) that uses solar energy to generate electricity, to heat or cool a structure, or to provide solar process heat, or (2) used to produce, distribute, or use 

energy derived from a geothermal deposit, but only, in the case of 

electricity generated by geothermal power, up to the electric transmission stage. 

The business energy tax credits are components of the general 

business credit (sec. 38(b)(1)). The business energy tax credits, 

when combined with all other components of the general business 

credit, generally may not exceed for any taxable year the excess of 

the taxpayer’s net income tax over the greater of (1) 25 percent of 

net regular tax liability above $25,000 or (2) the tentative minimum tax. For credits arising in taxable years beginning after December 31, 1997, an unused general business credit generally may 

be carried back one year and carried forward 20 years (sec. 39). 

A taxpayer may exclude from income the value of any subsidy 

provided by a public utility for the purchase or installation of an 

energy conservation measure. An energy conservation measure 

means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the 

management of energy demand with respect to a dwelling unit (sec. 

136). 

There is no present-law credit for the construction of new energyefficient homes. 

REASONS FOR CHANGE

The Committee recognizes that residential energy use for heating 

and cooling represents a large share of national energy consumption, and accordingly believes that measures to reduce heating and 

cooling energy requirements have the potential to substantially reduce national energy consumption. The Committee further recognizes that the most cost-effective time to properly insulate a home 

is when it is under construction and that the most effective mechanism to encourage the utilization of energy-efficient components in 

the construction of new homes is through an incentive to the builder. Accordingly, the Committee believes that a tax credit for the 

use of energy-efficiency components in a home’s envelope (exterior 

windows (including skylights) and doors and insulation) or heating 

and cooling appliances will encourage contractors to produce highly 

energy-efficient homes, which in turn will reduce national energy 

consumption. Reduced energy consumption will in turn reduce reliance on foreign suppliers of oil and will reduce pollution in general.

25

EXPLANATION OF PROVISION

The provision provides a credit to an eligible contractor of an 

amount equal to the aggregate adjusted bases of all energy-efficient 

property installed in a qualified new energy-efficient home during 

construction. The credit cannot exceed $1,000 ($2,000) in the case 

of a new home that has a projected level of annual heating and 

cooling costs that is 30 percent (50 percent) less than a comparable 

dwelling constructed in accordance with Chapter 4 of the 2000 

International Energy Conservation Code. 

The eligible contractor is the person who constructed the home, 

or in the case of a manufactured home, the producer of such home. 

Energy efficiency property is any energy-efficient building envelope 

component (insulation materials or system designed to reduce heat 

loss or gain, and exterior windows, including skylights, and doors) 

and any energy-efficient heating or cooling appliance that can, individually or in combination with other components, meet the standards for the home. 

To qualify as an energy-efficient new home, the home must be: 

(1) a dwelling located in the United States; (2) the principal residence of the person who acquires the dwelling from the eligible 

contractor; and (3) certified to have a projected level of annual 

heating and cooling energy consumption that meets the standards 

for either the 30-percent or 50-percent reduction in energy usage. 

The home may be certified according to a component-based method 

or an energy performance based method. Additionally, manufactured homes certified by the Environmental Protection Agency’s 

Energy Star Labeled Homes program are eligible for the $1,000 

credit provided criteria (1) and (2) are met. 

The component-based method of certification shall be based on 

applicable energy-efficiency specifications or ratings, including current product labeling requirements. The Secretary shall develop 

component-based packages that are equivalent in energy performance to properties that qualify for the credit. The standard for certifying homes through the component based method shall be based 

on the same standards for plan check and physical inspections as 

are used for energy code compliance. The certification shall be provided by a local building regulatory authority, a utility, a manufactured home primary inspection agency, or a home energy rating organization. Such provider of the certification must be financially 

independent of the eligible contractor. 

The performance-based method of certification shall be based on 

an evaluation of the home in reference to a home which uses the 

same energy source and system heating type, and is constructed in 

accordance with Chapter 4 of the 2000 International Energy Conservation Code. The certification shall be provided by an individual 

recognized by the Secretary for such purposes. 

The certification process requires that energy savings to the consumer be measured in terms of energy costs. To ensure consistent 

and reasonable energy cost analyses, the Department of Energy 

shall include in its rulemaking related to this bill specific reference 

data to be used for qualification for the credit. 

In the case of manufactured homes, certification shall be by the 

Energy Star Labeled Homes program. 

26

The credit will be part of the general business credit. No credits 

attributable to energy efficient homes may be carried back to any 

taxable year ending on or before the effective date of the credit. 

EFFECTIVE DATE

The credit applies to homes whose construction is substantially 

completed after the date of enactment and which are purchased 

during the period beginning on the date of enactment and ending 

on December 31, 2007 (December 31, 2005 in the case of the $1,000 

credit).

B. CREDIT FOR ENERGY-EFFICIENT APPLIANCES

(Sec. 302 of the Bill and new Sec. 45H of the Code) 

PRESENT LAW

A nonrefundable, 10-percent business energy credit is allowed for 

the cost of new property that is equipment: (1) that uses solar energy to generate electricity, to heat or cool a structure, or to provide solar process heat; or (2) used to produce, distribute, or use 

energy derived from a geothermal deposit, but only, in the case of 

electricity generated by geothermal power, up to the electric transmission stage. 

The business energy tax credits are components of the general 

business credit (sec. 38(b)(1)). The business energy tax credits, 

when combined with all other components of the general business 

credit, generally may not exceed for any taxable year the excess of 

the taxpayer’s net income tax over the greater of: (1) 25 percent of 

net regular tax liability above $25,000 or (2) the tentative minimum tax. For credits arising in taxable years beginning after December 31, 1997, an unused general business credit generally may 

be carried back one year and carried forward 20 years (sec. 39). 

A taxpayer may exclude from income the value of any subsidy 

provided by a public utility for the purchase or installation of an 

energy conservation measure. An energy conservation measure 

means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the 

management of energy demand with respect to a dwelling unit (sec. 

136). 

There is no present-law credit for the manufacture of energy-efficient appliances. 

REASONS FOR CHANGE

The Committee believes that providing a tax credit for the production of energy-efficient clothes washers and refrigerators will 

encourage manufacturers to produce such products currently and to 

invest in technologies to achieve higher energy-efficiency standards 

for the future. In addition, the Committee intends to encourage 

those manufacturers already producing energy-efficient clothes 

washers and refrigerators to accelerate production. 

EXPLANATION OF PROVISION

The provision provides a credit for the production of certain energy-efficient clothes washers and refrigerators. The credit would 

27

equal $50 per appliance for energy-efficient clothes washers produced with a modified energy factor (‘‘MEF’’) of 1.42 MEF or greater for washers produced before 2007 and for refrigerators produced 

before 2005 that consume 10 percent less kilowatt-hours per year 

than the energy conservation standards promulgated by the Department of Energy that took effect on July 1, 2001. The credit 

equals $100 for energy-efficient clothes washers produced with a 

MEF of 1.5 or greater and for refrigerators produced that consume 

at least 15 percent less kilowatt-hours per year (at least 20 percent 

less for production in 2007) than the energy conservation standards 

promulgated by the Department of Energy that took effect on July 

1, 2001. The credit is $150 in the case of a refrigerator that consumes at least 20 percent less kilowatt-hours per year than such 

standards and is produced before 2007. A refrigerator must be an 

automatic defrost refrigerator-freezer with an internal volume of at 

least 16.5 cubic feet to qualify for the credit. A clothes washer is 

any residential clothes washer, including a residential style coin 

operated washer, that satisfies the relevant efficiency standard. 

For each category of appliances (e.g., washers that meet the 

lower MEF standard, washers that meet the higher MEF standard, 

refrigerators that meet the 10 percent standard, refrigerators that 

meet the 15 percent standard), only production in excess of average 

production for each such category during calendar years 2000–2002 

would be eligible for the credit. For 2003, only production after the 

date of enactment is eligible for the credit, and special rules apply 

to determine if production exceeds the average of the base period. 

The taxpayer may not claim credits in excess of $60 million for all 

taxable years, and may not claim credits in excess of $30 million 

with respect to appliances that only qualify for the $50 credit. Additionally, the credit allowed for all appliances may not exceed two 

percent of the average annual gross receipts of the taxpayer for the 

three taxable years preceding the taxable year in which the credit 

is determined. 

The credit will be part of the general business credit. No credits 

attributable to energy-efficient appliances may be carried back to 

taxable years ending before January 1, 2003. 

EFFECTIVE DATE

The credit applies to appliances produced after the date of enactment and prior to January 1, 2008.

C. CREDIT FOR RESIDENTIAL ENERGY EFFICIENT PROPERTY

(Sec. 303 of the Bill and new Sec. 25C of the Code) 

PRESENT LAW

A taxpayer may exclude from income the value of any subsidy 

provided by a public utility for the purchase or installation of an 

energy conservation measure. An energy conservation measure 

means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the 

management of energy demand with respect to a dwelling unit (sec. 

136). 

28

There is no present-law personal tax credit for energy efficient 

residential property. 

REASONS FOR CHANCE

The Committee believes that allowing a credit for the purchase 

of certain energy efficient appliances and systems that generate 

electricity through renewable and pollution-free alternative energy 

sources will encourage the purchase of these products. The Committee believes that the use of these products will help reduce reliance on conventional energy sources and reduce atmospheric pollutants. The Committee believes that the on-site generation of electricity and solar hot water will reduce reliance on the United 

States’ electricity grid and on natural gas pipelines. Furthermore, 

the Committee believes that the use of highly efficient residential 

equipment will lead to decreased energy consumption in households, resulting in significant energy savings. 

EXPLANATION OF PROVISION

The provision provides a personal tax credit for the purchase of 

qualified wind energy property, qualified photovoltaic property, and 

qualified solar water heating property that is used exclusively for 

purposes other than heating swimming pools and hot tubs. The 

credit is equal to 15 percent for solar water heating property and 

photovoltaic property, and 30 percent for wind energy property. 

The maximum credit for each of these systems of property is 

$2,000. The provision also provides a 30 percent credit for the purchase of qualified fuel cell power plants. The credit for any fuel cell 

may not exceed $500 for each 0.5 kilowatt of capacity. 

Qualifying solar water heating property means an expenditure 

for property to heat water for use in a dwelling unit located in the 

United States and used as a residence if at least half of the energy 

used by such property for such purpose is derived from the sun. 

Qualified photovoltaic property is property that uses solar energy 

to generate electricity for use in a dwelling unit. Solar panels are 

treated as qualified photovoltaic property. Qualified wind energy 

property is property that uses wind energy to generate electricity 

for use in a dwelling unit. A qualified fuel cell power plant is an 

integrated system comprised of a fuel cell stack assembly and associated balance of plant components that converts a fuel into electricity using electrochemical means, and which has an electricityonly generation efficiency of greater than 30 percent and that generates at least 0.5 kilowatts of electricity. The qualified fuel cell 

power plant must be installed on or in connection with a dwelling 

unit located in the United States and used by the taxpayer as a 

principal residence. 

The provision also provides a credit for the purchase of other 

qualified energy efficient property, as described below: 

Electric heat pump hot water heaters with an Energy Factor of at least 1.7. The maximum credit is $75 per unit. 

Electric heat pumps with a heating efficiency of at least 9 HSPF 

(Heating Seasonal Performance Factor) and a cooling efficiency of 

at least 15 SEER (Seasonal Energy Efficiency Rating) and an energy efficiency ratio (EER) of 12.5 or greater. The maximum credit 

is $250 per unit. 

29

Natural gas, oil, or propane furnace which achieves 95 percent 

annual fuel utilization efficiency. The maximum credit is $250 per 

unit. 

Central air conditioners with an efficiency of at least 15 SEER 

and an EER of 12.5 or greater. The maximum credit is $250 per 

unit. 

Natural gas, oil, or propane water heaters with an Energy Factor 

of at least 0.8. The maximum credit is $75 per unit. 

Geothermal heat pumps which have an EER of at least 21. The 

maximum credit is $250 per unit. 

The credit is nonrefundable, and the depreciable basis of the 

property is reduced by the amount of the credit. Expenditures for 

labor costs allocable to onsite preparation, assembly, or original installation of property eligible for the credit are eligible expenditures. The credit is allowed against the regular and alternative 

minimum tax. 

Certain equipment safety requirements need to be met to qualify 

for the credit. Special proration rules apply in the case of jointly 

owned property, condominiums, and tenant-stockholders in cooperative housing corporations. With the exception of wind energy property, if less than 80 percent of the property is used for nonbusiness 

purposes, only that portion of expenditures that is used for nonbusiness purposes is taken into account. 

EFFECTIVE DATE

The credit applies to purchases after the date of enactment and 

before January 1, 2008.

D. CREDIT FOR BUSINESS INSTALLATION OF QUALIFIED FUEL CELLS

AND STATIONARY MICROTURBINE POWER PLANTS

(Sec. 304 of the Bill and Sec. 48 of the Code) 

PRESENT LAW

A nonrefundable, 10-percent business energy credit is allowed for 

the cost of new property that is equipment (1) that uses solar energy to generate electricity, to heat or cool a structure, or to provide solar process heat, or (2) used to produce, distribute, or use 

energy derived from a geothermal deposit, but only, in the case of 

electricity generated by geothermal power, up to the electric transmission stage. 

The business energy tax credits are components of the general 

business credit (sec. 38(b)(1)). The business energy tax credits, 

when combined with all other components of the general business 

credit, generally may not exceed for any taxable year the excess of 

the taxpayer’s net income tax over the greater of (1) 25 percent of 

net regular tax liability above $25,000 or (2) the tentative minimum tax. An unused general business credit generally may be carried back one year and carried forward 20 years (sec. 39). 

A taxpayer may exclude from income the value of any subsidy 

provided by a public utility for the purchase or installation of an 

energy conservation measure. An energy conservation measure 

means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the 

30

management of energy demand with respect to a dwelling unit (sec. 

136). 

There is no present-law credit for fuel cell power plant or microturbine property. 

REASONS FOR CHANGE

The Committee believes that investments in qualified fuel cell 

power plants represent a promising means to produce electricity 

through non-polluting means and from nonconventional energy 

sources. Furthermore, the on-site generation of electricity provided 

by fuel cell power plants, as well as that by microturbines, will reduce reliance on the United States’ electricity grid. The Committee 

believes that providing a tax credit for investment in qualified fuel 

cell and microturbine power plants will encourage investments in 

such systems. 

EXPLANATION OF PROVISION

The provision provides a 30 percent business energy credit for 

the purchase of qualified fuel cell power plants for businesses. A 

qualified fuel cell power plant is an integrated system comprised of 

a fuel cell stack assembly and associated balance of plant components that converts a fuel into electricity using electrochemical 

means, and which has an electricity-only generation efficiency of 

greater than 30 percent and generates at least 0.5 kilowatts of electricity using an electrochemical process. The credit for any fuel cell 

may not exceed $500 for each 0.5 kilowatts of capacity. 

Additionally, the provision provides a 10 percent credit for the 

purchase of qualifying stationary microturbine power plants. A 

qualified stationary microturbine power plant is an integrated system comprised of a gas turbine engine, a combustor, a recuperator 

or regenerator, a generator or alternator, and associated balance of 

plant components which converts a fuel into electricity and thermal 

energy. Such system also includes all secondary components located between the existing infrastructure for fuel delivery and the 

existing infrastructure for power distribution, including equipment 

and controls for meeting relevant power standards, such as voltage, 

frequency and power factors. Such system must have an electricityonly generation efficiency of not less that 26 percent at International Standard Organization conditions and a capacity of less 

than 2,000 kilowatts. The credit is limited to the lesser of 10 percent of the basis of the property or $200 for each kilowatt of capacity. 

The credit is nonrefundable. The taxpayer’s basis in the property 

is reduced by the amount of the credit claimed. 

EFFECTIVE DATE

The credit for businesses applies to property placed in service 

after the date of enactment and before January 1, 2008 (January 

1, 2007 in the case of microturbines), under rules similar to rules 

of section 48(m) of the Internal Revenue Code of 1986 (as in effect 

on the day before the date of enactment of the Revenue Reconciliation Act of 1990).

31

E. ENERGY-EFFICIENT COMMERCIAL BUILDINGS DEDUCTION

(Sec. 305 of the Bill and new Sec. 179B of the Code) 

PRESENT LAW

No special deduction is currently provided for expenses incurred 

for energy-efficient commercial building property. 

REASONS FOR CHANGE

The Committee recognizes that commercial buildings consume a 

significant amount of energy resources and that reductions in commercial energy use have the potential to significantly reduce national energy consumption. Accordingly, the Committee believes 

that a special deduction for commercial building property (lighting, 

heating, cooling, ventilation, and hot water supply systems) that 

meets a high energy-efficiency standard will encourage construction 

of buildings that are significantly more energy efficient than the 

norm. The Committee further believes that the special deduction 

will encourage innovation to reduce the costs of meeting the energy-efficiency standard. 

EXPLANATION OF PROVISION

The provision provides a deduction equal to energy-efficient commercial building property expenditures made by the taxpayer. Energy-efficient commercial building property expenditures are defined as amounts paid or incurred for energy-efficient property installed in connection with the new construction or reconstruction of 

property: (1) which is depreciable property; (2) which is located in 

the United States, and (3) which is the type of structure to which 

the Standard 90.1–2001 of the American Society of Heating, Refrigerating, and Air Conditioning Engineers and the Illuminating Engineering Society of North America (‘‘ASHRAE/IESNA’’) is applicable. The deduction is limited to an amount equal to $2.25 per 

square foot of the property for which such expenditures are made. 

The deduction is allowed in the year in which the property is 

placed in service. 

Energy-efficient commercial building property generally means 

any property that reduces total annual energy and power costs 

with respect to the lighting, heating, cooling, ventilation, and hot 

water supply systems of the building by 50 percent or more in comparison to a building which minimally meets the requirements of 

Standard 90.1–2001 of ASHRAE/IESNA. Because of the requirement that in order to qualify, a building must fall within the scope 

of the ASHRAE/IESNA Standard 90.1–2001, residential rental 

property that is less than four stories does not qualify. 

Certain certification requirements must be met in order to qualify for the deduction. The Secretary, in consultation with the Secretary of Energy, will promulgate regulations that describe methods of calculating and verifying energy and power costs. The methods for calculation shall be fuel neutral, such that the same energy 

efficiency features shall qualify a building for the deduction under 

this subsection regardless of whether the heating source is a gas 

or oil furnace or an electric heat pump. To allow proper calculations of cost, the Secretary shall prescribe the costs per unit of enVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00039 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
32

ergy and power, such as kilowatt hour, kilowatt, gallon of fuel oil, 

and cubic foot or Btu of natural gas, which may be dependent on 

time of usage. If a State has developed annual energy usage and 

cost reduction procedures based on time of usage costs for use in 

the performance standards of the State’s building energy code before the effective date of this section, the Secretary may allow taxpayers in that State to use those annual energy usage and cost reduction procedures in lieu of those adopted by the Secretary. 

The Secretary shall promulgate procedures for the inspection and 

testing for compliance of buildings that are comparable, given the 

difference between commercial and residential buildings, to the requirements in the Mortgage Industry National Home Energy Rating Standards. Individuals qualified to determine compliance shall 

only be those recognized by one or more organizations certified by 

the Secretary for such purposes. In order that the deduction is 

available immediately, it is expected that the Secretary will 

promptly issue interim guidance with respect to the methods of calculating and verifying energy and power costs that relies on provisions of ASHRAE/IESNA Standard 90.1–2001 and of the 2001 California Nonresidential Alternative Calculation Method Approval 

Manual or the 2001 California Residential Alternative Calculation 

Method Approval Manual. The methods for calculation need not 

comply fully with section 11 of ASHRAE/IESNA Standard 90.1–

2001. Such interim guidance will include interim guidance as to 

the qualified computer software and qualified individuals necessary 

to certify eligibility for the deduction. 

When final regulations are adopted, such regulations additionally 

may, with respect to methods of calculating and verifying energy 

and power costs, take into consideration appropriate energy savings from design methodologies and technologies not otherwise 

credited in ASHRAE/IESNA Standard 90.1–2001, the 2001 California Nonresidential Alternative Calculation Method Approval 

Manual, or the 2001 California Residential Alternative Calculation 

Method Approval Manual, including the following: (1) natural ventilation, (2) evaporative cooling, (3) automatic lighting controls such 

as occupancy sensors, photocells, and timeclocks, (4) daylighting, 

(5) designs utilizing semi-conditioned spaces which maintain adequate comfort conditions without air conditioning or without heating, (6) improved fan system efficiency, including reductions in 

static pressure, and (7) advanced unloading mechanisms for mechanical cooling, such as multiple or variable speed compressors. 

Additionally, the calculation methods may take into account the extent of commissioning in the building, and allow the taxpayer to 

take into account measured performance which exceeds typical performance. 

For energy-efficient commercial building property public property 

expenditures made by a public entity, such as public schools, the 

interim guidance, as well as final regulations, will allow the value 

of the deduction (determined without regard to the tax-exempt status of such entity) to be allocated to the person primarily responsible for designing the property in lieu of the public entity. 

33

EFFECTIVE DATE

The provision is effective for taxable years beginning after the 

date of enactment for expenditures in connection with a building 

whose construction is completed on or before December 31, 2009.

F. THREE-YEAR APPLICABLE RECOVERY PERIOD FOR DEPRECIATION

OF QUALIFIED ENERGY MANAGEMENT DEVICES

(Sec. 306 of the Bill and Sec. 168 of the Code) 

PRESENT LAW

No special recovery period is currently provided for depreciation 

of qualified energy management devices. 

REASONS FOR CHANGE

The Committee believes that consumers could better manage 

their electricity use if they had better information concerning their 

usage habits by time of day. In the case of electricity, if time-ofday pricing is used, energy management devices that provide information to consumers regarding their peak electrical use could encourage consumers to defer certain electrical use, such as use of a 

washing machine, to periods of the day when electricity prices are 

lower. In addition to potentially reducing consumers’ electricity bill, 

spreading the demand for electricity more evenly throughout the 

day will reduce the need for utility investments in generation capacity to satisfy peak demand periods. 

The Committee believes that providing a 3-year recovery period 

for qualified energy management devices will provide sufficient incentive for utilities to establish time-of-day pricing options that will 

encourage consumers to adjust their electricity usage in such a 

manner to dampen utilities’ peak load capacity needs and thus reduce the need for investment in new capacity to meet peak load demand. 

EXPLANATION OF PROVISION

The provision provides a three-year recovery period for qualified 

new energy management devices placed in service by any taxpayer 

who is a supplier of electric energy or is a provider of electric energy services. A qualified energy management device is any meter 

or metering device eligible for accelerated depreciation under code 

section 168 and which is used by the taxpayer 

(1) To measure and record electricity usage data on a timedifferentiated basis in at least 4 separate time segments per 

day, and 

(2) To provide such data on at least a monthly basis to both 

consumers and the taxpayer. 

EFFECTIVE DATE

The provision is effective for any qualified energy management 

device placed in service after the date of enactment of the Act and 

before January 1, 2008. 

34

G. THREE-YEAR APPLICABLE RECOVERY PERIOD FOR DEPRECIATION

OF QUALIFIED WATER SUBMETERING DEVICES

(Sec. 307 of the Bill and Sec. 168 of the Code) 

PRESENT LAW

No special recovery period is currently provided for depreciation 

of qualified water submetering devices. 

REASONS FOR CHANGE

The Committee believes that consumers would better manage 

their water use if they paid for water in proportion to the water 

that they actually used. In many cases in multi-unit properties, 

there is not unit by unit metering of water use. Rather, the landlord’s average per-unit costs for water are reflected in rental rates. 

Thus, individual units have virtually no financial incentive to conserve on water use, as the cost of any individual’s increased water 

usage is borne by all dwellers. The Committee believes that a tax 

incentive for the installation of submeters to enable unit by unit 

charges that reflect water usage will rationalize water use and help 

to conserve water resources. 

EXPLANATION OF PROVISION

The provision provides a three-year recovery period for qualified 

new water submetering devices placed in service by any taxpayer 

who is an eligible resupplier. An eligible resupplier is any taxpayer 

who purchases and installs qualified water submetering devices in 

every unit in any multi-unit property. A qualified water submetering device is anywater submetering device eligible for accelerated depreciation under code section 168 and which is used by the 

taxpayer 

(1) To measure and record water usage data, and 

(2) To provide such data on at least a monthly basis to both 

consumers and the taxpayer. 

EFFECTIVE DATE

The provision is effective for any qualified water submetering device placed in service after the date of enactment of the Act and 

before January 1, 2008.

H. ENERGY CREDIT FOR COMBINED HEAT AND POWER SYSTEM

PROPERTY

(Sec. 308 of the Bill and Sec. 48 of the Code) 

PRESENT LAW

A nonrefundable, 10-percent business energy credit is allowed for 

the cost of new property that is equipment (1) that uses solar energy to generate electricity, to heat or cool a structure, or to provide solar process heat, or (2) used to produce, distribute, or use 

energy derived from a geothermal deposit, but only, in the case of 

electricity generated by geothermal power, up to the electric transmission stage. 

35

The business energy tax credits are components of the general 

business credit (sec. 38(b)(1)). The business energy tax credits, 

when combined with all other components of the general business 

credit, generally may not exceed for any taxable year the excess of 

the taxpayer’s net income tax over the greater of (1) 25 percent of 

net regular tax liability above $25,000 or (2) the tentative minimum tax. For credits arising in taxable years beginning after December 31, 1997, an unused general business credit generally may 

be carried back one year and carried forward 20 years (sec. 39). 

A taxpayer may exclude from income the value of any subsidy 

provided by a public utility for the purchase or installation of an 

energy conservation measure. An energy conservation measure 

means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the 

management of energy demand with respect to a dwelling unit (sec. 

136). 

There is no present-law credit for combined heat and power 

(‘‘CHP’’) property. 

REASONS FOR CHANGE

The Committee believes that investments in combined heat and 

power systems represent a promising means to achieve greater national energy efficiency by encouraging the dual use of the energy 

from the burning of fossil fuels. Furthermore, the on-site generation of electricity provided by CHP systems will reduce reliance on 

the United States’ electricity grid. The Committee believes that 

providing a tax credit for investment in combined heat and power 

property will encourage investments in such systems. 

EXPLANATION OF PROVISION

The provision provides a 10-percent credit for the purchase of 

combined heat and power property. CHP property as defined as 

property: (1) which uses the same energy source for the simultaneous or sequential generation of electrical power, mechanical shaft 

power, or both, in combination with the generation of steam or 

other forms of useful thermal energy (including heating and cooling 

applications); (2) which has an electrical capacity of more than 50 

kilowatts or a mechanical energy capacity of more than 67 horsepower or an equivalent combination of electrical and mechanical 

energy capacities; (3) which produces at least 20 percent of its total 

useful energy in the form of thermal energy and at least 20 percent 

in the form of electrical or mechanical power (or a combination 

thereof); and (4) the energy efficiency percentage of which exceeds 

60 percent (70 percent in the case of a system with an electrical 

capacity in excess of 50 megawatts or a mechanical energy capacity 

in excess of 67,000 horsepower, or an equivalent combination of 

electrical and mechanical capacities.) Also, for purposes of determining whether CHP property includes technologies which generate electricity or mechanical power using backpressure steam 

turbines in place of existing pressure-reducing valves, or which 

make use of waste heat from industrial processes such as by using 

organic rankine, stirling, or kalina heat engine systems, the general requirements of clause (1), the energy output requirements reVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00043 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
36

lated to heat versus power described under (3), and the energy efficiency requirements of (4), above, may be disregarded. 

CHP property does include property used to transport the energy 

source to the generating facility or to distribute energy produced by 

the facility. 

If a taxpayer is allowed a credit for CHP property, and the property would ordinarily have a depreciation class life of 15 years or 

less, the depreciation period for the property is treated as having 

a 22-year class life. The present-law carry back rules of the general 

business credit generally would apply except that no credits attributable to combined heat and power property may be carried back 

before the effective date of this provision. 

EFFECTIVE DATE

The credit applies to property placed in service after the date of 

enactment and before January 1, 2007.

I. CREDIT FOR ENERGY EFFICIENCY IMPROVEMENTS TO EXISTING

HOMES

(Sec. 309 of the Bill and new Sec. 25D of the Code) 

PRESENT LAW

A taxpayer may exclude from income the value of any subsidy 

provided by a public utility for the purchase or installation of an 

energy conservation measure. An energy conservation measure 

means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the 

management of energy demand with respect to a dwelling unit (sec. 

136). 

There is no present law credit for energy efficiency improvements 

to existing homes. 

REASONS FOR CHANGE

Since residential energy consumption represents a large fraction 

of national energy use, the Committee believes that energy savings 

in this sector of the economy have the potential to significantly impact national energy consumption, which will reduce reliance on 

foreign suppliers of oil and reduce pollution in general. The Committee further recognizes that many existing homes are inadequately insulated. Accordingly, the Committee believes that a tax 

credit for certain energy-efficiency improvements related to a 

home’s envelope (exterior windows (including skylights) and doors, 

insulation, and certain roofing systems) will encourage homeowners 

to improve the insulation of their homes, which in turn will reduce 

national energy consumption. 

EXPLANATION OF PROVISION

The provision would provide a 10-percent nonrefundable credit 

for the purchase of qualified energy efficiency improvements. The 

maximum credit for a taxpayer with respect to the same dwelling 

for all taxable years is $300. A qualified energy efficiency improvement would be any energy efficiency building envelope component 

that is certified to meet or exceed the prescriptive criteria for such 

37

a component established by the 2000 International Energy Conservation Code, or any combination of energy efficiency measures 

that is certified to achieve at least a 30-percent reduction in heating and cooling energy usage for the dwelling and (1) that is installed in or on a dwelling located in the United States; (2) owned 

and used by the taxpayer as the taxpayer’s principal residence; (3) 

the original use of which commences with the taxpayer; and (4) 

such component can reasonably be expected to remain in use for at 

least five years. 

Building envelope components would be: (1) insulation materials 

or systems which are specifically and primarily designed to reduce 

the heat loss or gain for a dwelling, and (2) exterior windows (including skylights) and doors. 

Homes shall be certified according to a component-based method 

or a performance-based method. The component-based method 

shall be based on applicable energy-efficiency ratings, including 

current product labeling requirements. Certification by the component method shall be provided by a third party, such as a local 

building regulatory authority, a utility, a manufactured home production inspection primary inspection agency, or a home energy 

rating organization. 

The performance-based method shall be based on a comparison 

of the projected energy consumption of the dwelling in its original 

condition and after the completion of energy efficiency measures. 

The performance-based method of certification shall be conducted 

by an individual or organization recognized by the Secretary of the 

Treasury for such purposes. 

The certification process requires that energy savings to the consumer be measured in terms of energy costs. To ensure consistent 

and reasonable energy cost analyses, the Department of Energy 

shall include in its rulemaking related to this bill specific reference 

data to be used for qualification for the credit. 

The taxpayer’s basis in the property would be reduced by the 

amount of the credit. Special rules would apply in the case of condominiums and tenant-stockholders in cooperative housing corporations. 

The credit is allowed against the regular and alternative minimum tax. 

EFFECTIVE DATE

The credit is effective for qualified energy efficiency improvements installed on or after the date of enactment and before January 1, 2007.

38

TITLE IV—CLEAN COAL INCENTIVES 

A. INVESTMENT AND PRODUCTION CREDITS FOR CLEAN COAL

TECHNOLOGY

(Secs. 401, 411, and 412 of the Bill and new Secs. 451, 45J, and 

48A of the Code) 

PRESENT LAW

Present law does not provide an investment credit for electricity 

generating units that use coal as a fuel. Nor does present law provide a production credit for electricity generated at units that use 

coal as a fuel. However, a nonrefundable, 10-percent investment 

tax credit (‘‘business energy credit’’) is allowed for the cost of new 

property that is equipment (1) that uses solar energy to generate 

electricity, to heat or cool a structure, or to provide solar process 

heat, or (2) that is used to produce, distribute, or use energy derived from a geothermal deposit, but only, in the case of electricity 

generated by geothermal power, up to the electric transmission 

stage (sec. 48). Also, an income tax credit is allowed for the production of electricity from either qualified wind energy, qualified 

‘‘closed-loop’’ biomass, or qualified poultry waste units placed in 

service prior to January 1, 2004 (sec. 45). The credit allowed equals 

1.5 cents per kilowatt-hour of electricity sold. The 1.5 cent figure 

is indexed for inflation and equaled 1.8 cents for 2002. The credit 

is allowable for production during the 10-year period after a unit 

is originally placed in service. The business energy tax credits and 

the production tax credit are components of the general business 

credit (sec. 38(b)(1)). 

REASONS FOR CHANGE

The Committee recognizes that coal is the nation’s most abundant fuel source. The Committee is also sensitive to the environmental impact of burning coal for the production of electricity. For 

coal to continue to be a viable fuel source, the Committee seeks to 

encourage ways to burn coal in a more efficient and environmentally friendly manner. Therefore, the Committee supports the 

development and deployment of the most advanced technologies for 

generating electricity from coal by providing investment and production credits to a limited number of experimental productionscale electricity generating units to reduce the cost of building and 

operating units that represent the frontier of thermal efficiency and 

pollution control. 

Tax-exempt organizations make up a significant percentage of 

the electricity industry in the United States. The Committee believes it is important to provide the incentives for investment in, 

and production from, clean coal technologies to all producers. 

EXPLANATION OF PROVISION

In general 

The bill creates three new credits: a production credit for electricity produced from qualifying clean coal technology units; a production credit for electricity produced from qualifying advanced 

clean coal technology units; and a credit for investments in qualiVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00046 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
39

fying advanced clean coal technology units. Certain persons (public 

utilities, electric cooperatives, Indian tribes, and the Tennessee 

Valley Authority) will be eligible to obtain certifications from the 

Secretary of the Treasury (as described below) for each of these 

credits and sell, trade, or assign the credit to any taxpayer. However, any credit sold, traded, or assigned may only be sold, traded, 

or assigned once. Subsequent transfers are not permitted. 

Credit for investments in qualifying advanced clean coal technology 

units 

The bill provides a 10-percent investment tax credit for qualified 

investments in advanced clean coal technology units. A qualified 

investment is that amount that would otherwise be a qualified investment multiplied by a fraction equal to the amount of national 

megawatt capacity allocated to the taxpayer (as described below) 

divided by the megawatt capacity of the qualifying unit. Qualifying 

advanced clean coal technology units must utilize advanced pulverized coal or atmospheric fluidized bed combustion technology, pressurized fluidized bed combustion technology, integrated gasification 

combined cycle technology, or some other technology certified by 

the Secretary of Energy. Any qualifying advanced clean coal technology unit must meet certain capacity standards, thermal efficiency standards, and emissions standards for SO2, nitrous oxides, 

particulate emissions, and source emissions standards as provided 

in the Clean Air Act. In addition, a qualifying advanced clean coal 

technology unit must meet certain carbon emissions requirements. 

The proposal defines four types of qualifying advanced clean coal 

technology units: (1) advanced pulverized coal or atmospheric fluidized bed combustion technology units (2) qualifying pressurized fluidized bed combustion technology units; (3) integrated gasification 

combined cycle technology units; and (3) other technology units. 

(1) A qualifying advanced pulverized coal or atmospheric fluidized bed combustion technology unit is a unit placed in service 

after the date of enactment and before 2013 and having a design 

net heat rate of not more than 8,500 Btu (8,900 Btu if the unit is 

placed in service before 2009). 

(2) 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). 

(3) A qualifying integrated gasification combined cycle 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). 

(4) A qualifying other technology unit use any other technology 

and is placed in service after the date of enactment and before 

2017. 

The provision provides that qualifying advanced clean coal units 

must satisfy carbon emissions standards. For units using design 

coal with a heat content of not more than 9,000 Btu per pound, the 

40

27 Each 3,413 Btu of heat content of the fuel or chemical is treated as equivalent to one kilowatt-hour of electricity. 

carbon emission rate must be less than 0.60 pound of carbon per 

kilowatt hour (0.51 if the unit qualifies as an other technology 

unit). For units using design coal with a heat content in excess of 

9,000 Btu per pound, the carbon emission rate must be less than 

0.54 pound of carbon per kilowatt hour (0.459 if the unit qualifies 

as an other technology unit). 

To be a qualified investment in advanced clean coal technology, 

the taxpayer must receive a certificate from the Secretary of the 

Treasury. The Secretary may grant certificates to investments only 

to the point that 4,000 megawatts of electricity production capacity 

qualifies for the credit. From the potential pool of 4,000 megawatts 

of capacity, not more than 1,000 megawatts in total and not more 

than 500 megawatts in years prior to 2009 shall be allocated to 

units using advanced pulverized coal or atmospheric fluidized bed 

combustion technology. 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. From 

the potential pool of 4,000 megawatts of capacity, not more than 

2,000 megawatts in total and not more than 750 megawatts in 

years prior to 2009 shall be allocated to units using integrated gasification combined cycle technology, with or without fuel or chemical co-production. From the potential pool of 4,000 megawatts of 

capacity, not more than 500 in total and not more than 250 

megawatts in years prior to 2009 shall be allocated to any other 

technology certified by the Secretary of Energy. 

Production credit for electricity produced from qualifying clean coal 

technology units 

The bill provides a production credit for electricity produced from 

certain units that have been retrofitted, repowered, or replaced 

with a clean coal technology within ten years of the date of enactment. The value of the credit is 0.34 cents per kilowatt-hour of 

electricity and the heat value of other fuels or chemicals produced 

at the unit 27 multiplied by the fraction equal to the amount of national megawatt capacity limitation (see below) allocated to the 

qualifying unit divided by the total megawatt capacity of the unit. 

The value of the credit is indexed for inflation occurring after 2003 

with the first potential adjustment in 2005. The taxpayer may 

claim the credit throughout the 10-year period commencing from 

the date on which the qualifying unit is placed in service. 

A qualifying clean coal technology unit is a clean coal technology 

unit that meets certain capacity standards, thermal efficiency 

standards, and emissions standards for SO2, nitrous oxides, particulate emissions, and source emissions standards as provided in the 

Clean Air Act. In addition, a qualifying clean coal technology unit 

cannot be a unit that is receiving or is scheduled to receive funding 

under the Clean Coal Technology Program, the Power Plant Improvement Initiative, or the Clean Coal Power Initiative administered by the Secretary of the Department of Energy. Lastly, to be 

a qualified clean coal technology unit, the taxpayer must receive a 

41

28 In the case of a taxpayer who received a megawatt allocation for a qualifying advanced 

clean coal technology unit that is less than the rated capacity of such unit, the taxpayer may 

claim credit on a percentage of the electricity produced from the unit. The percentage is the 

percentage that the taxpayer’s megawatt allocation represents as a percentage of the rated capacity of the unit. 29 Each 3,413 Btu of heat content of the fuel or chemical is treated as equivalent to one kilowatt-hour of electricity. 30Some of the tables in the bill, and below, express the unit’s efficiency in terms of the units 

net heat rate and other tables express the unit’s efficiency in percentage term. In practice, there 

is no difference as one kilowhatt-hour of electricity generally is equivalent to 3,413 Btu of heat. 

Therefore, if one divides 3,413 Btu by the efficiency rate one obtains the heat rate. Likewise, 

given a heat rate, the one calculates the efficiency by dividing 3,413 Btu by the heat rate.

certificate from the Secretary of the Treasury. The Secretary may 

grant certificates to units only to the point that 4,000 megawatts 

of electricity production capacity qualifies for the credit. However, 

no qualifying unit would be eligible if the unit’s capacity exceeded 

300 megawatts prior to having been retrofitted, repowered, or replaced. The maximum eligible allocation to any qualifying unit may 

not exceed 300 megawatts. 

Production credit for electricity produced from qualifying advanced 

clean coal technology 

The bill also provides a production credit for electricity produced 

from any qualified advanced clean coal technology electricity generation unit that qualifies for the investment credit for qualifying 

clean coal technology units, as described above.28 The taxpayer 

may claim a production credit on the sum of each kilowatt-hour of 

electricity produced and the heat value of other fuels or chemicals 

produced by the taxpayer at the unit.29 The taxpayer may claim 

the production credit for the 10-year period commencing with the 

date the qualifying unit is placed in service (or the date on which 

a conventional unit was retrofitted or repowered). The value of the 

credit varies depending upon the year the unit is placed in service, 

whether the unit produces solely electricity or electricity and fuels 

or chemicals, and the rated thermal efficiency of the unit.30 In addition, the value of the credit is reduced for the second five years 

of eligible production. If a unit meets the more stringent qualification standards of post-2008 in years before 2009, the taxpayer may 

claim the higher post-2008 credit amounts. The value of the credit 

is indexed for inflation occurring after 2003 with the first potential 

adjustment in 2005. The tables below specify the value of the credit 

(before indexing is applied). 

Advanced clean coal technology units producing solely electricity

TABLE 11.—UNITS PLACED IN SERVICE BEFORE 2009 

The unit net heat rate, Btu/kWh adjusted for the heat content for the design coal is equal to: 

Credit amount per kilowatt-hour 

For the 

first five 

years 

For the 

second five 

years 

Not more than 8,500 ............................................................................................................................... $.0060 $.0038 

More than 8,500 but not more than 8,750 ............................................................................................ $.0025 $.0010 

More than 8,750 but less than 8,900 .................................................................................................... $.0010 $.0010 

42

TABLE 12.—UNITS PLACED IN SERVICE AFTER 2008 AND BEFORE 2013 

The unit net heat rate, Btu/kWh adjusted for the heat content for the design coal is equal to: 

Credit amount per kilo- watt-hour 

For the 

first five 

years 

For the 

second five years 

Not more than 7,770 ............................................................................................................................... $.0105 $.0090 

More than 7,770 but not more than 8,125 ............................................................................................ $.0085 $.0068 

More than 8,125 but less than 8,500 .................................................................................................... $.0075 $.0055 

TABLE 13.—UNITS PLACED IN SERVICE AFTER 2012 AND BEFORE 2017 

The unit net heat rate, Btu/kWh adjusted for the heat content for the design coal is equal to: 

Credit amount per kilowatt-hour 

For the 

first five 

years 

For the 

second five 

years 

Not more than 7,380 ............................................................................................................................... $.0140 $.0115 

More than 7,380 but not more than 7,720 ............................................................................................ $.0120 $.0090 

Advanced clean coal technology units producing electricity 

and a fuel or chemical

TABLE 14.—UNITS PLACED IN SERVICE BEFORE 2009

The unit design net thermal efficiency is equal to: 

Credit amount per kilowatt-hour 

For the 

first five 

years 

For the 

second five years 

Not less than 40.6% ............................................................................................................................... $.0060 $.0038 

Less than 40.6% but not less than 40% .............................................................................................. $.0025 $.0010 

Less than 40% but not less than 38.4% .............................................................................................. $.0010 $.0010

TABLE 15.—UNITS PLACED IN SERVICE AFTER 2008 AND BEFORE 2013 

The unit design net thermal efficiency is equal to: 

Credit amount per kilowatt-hour 

For the 

first five 

years 

For the 

second five 

years 

Not less than 43.6% ............................................................................................................................... $.0105 $.0090 

Less than 43.6% but not less than 42% .............................................................................................. $.0085 $.0068 

Less than 42% but not less than 40.2% .............................................................................................. $.0075 $.0055 

TABLE 16.—UNITS PLACED IN SERVICE AFTER 2012 AND BEFORE 2017 

The unit design net thermal efficiency is equal to: 

Credit amount per kilowatt-hour 

For the 

first five 

years 

For the 

second five 

years 

Not less than 44.2% ............................................................................................................................... $.0140 $.0115 

Less than 44.2% but not less than 43.9% ........................................................................................... $.0120 $.0090

The credits are part of the general business credit. No credit may 

be carried back to taxable years ending on or before the date of enactment. 

43

EFFECTIVE DATE

The provision relating to investment credits for advanced clean 

coal technology units is effective after the date of enactment. The 

provisions relating to production credits are effective after the date 

of enactment.

TITLE V—OIL AND GAS PROVISIONS 

A. TAX CREDIT FOR OIL AND GAS PRODUCTION FROM MARGINAL

WELLS

(Sec. 501 of the Bill and Sec. 45K of the Code) 

PRESENT LAW

There is no credit for the production of oil and gas from marginal 

wells. The costs of such production may be recovered under the 

Code’s depreciation and depletion rules and in other cases as a deduction for ordinary and necessary business expenses. 

REASONS FOR CHANGE

The highly volatile price of oil and gas can result in lost production during periods when prices are low. The Committee has 

learned that once a marginally producing well is shut down, that 

source of supply may be forever lost. To increase domestic supply, 

the Committee determined that a tax credit will help ensure that 

supply is not lost as a result of low market prices. 

EXPLANATION OF PROVISION

The provision would create a new, $3 per barrel credit for quali- fied crude oil production and a $0.50 credit per 1,000 cubic feet of 

qualified natural gas production. The maximum amount of production on which credit could be claimed is 1,095 barrels or barrel 

equivalents. In both cases, the credit is available only for qualified 

production from a ‘‘qualified marginal well.’’ The credit is not available to production occurring if the reference price of oil exceeded 

$18 ($2.00 for natural gas). The credit is reduced proportionately 

as for reference prices between $15 and $18 ($1.67 and $2.00 for 

natural gas). Reference prices are determined on a one-year 

lookback basis. 

The terms ‘‘qualified crude oil production’’ and ‘‘qualified natural 

gas production’’ mean domestic crude oil or natural gas which is 

produced from a qualified marginal well. Production from a marginal well that is not in compliance with the applicable Federal pollution prevention, control and permit requirements for any period 

of time is not considered qualified crude oil production or qualified 

natural gas production. A qualified marginal well is defined as (1) 

a well production from which was marginal production for purposes 

of the Code percentage depletion rules or (2) a well that during the 

taxable year had (a) average daily production of not more than 25 

barrel equivalents and (b) produced water at a rate of not less than 

95 percent of total well effluent. 

The credit is treated as part of the general business credit. The 

credit cannot be carried back to a taxable year ending on or before 

the date of enactment of the provision. 

44

31 1987–2 C.B. 674 (as clarified and modified by Rev. Proc. 88–22, 1988–1 C.B. 785). 32Duke Energy v. Commissioner, 172 F.3d 1255 (10th Cir. 1999), rev’g 109 T.C. 416 (1997). 

See also True v. United States, 97–2 U.S. Tax Cas. (CCH) par. 50,946 (D. Wyo. 1997). 33 Clajon Gas Co., L.P. v. Commissioner, 119 T.C. 197 (2002) and Saginaw Bay Pipeline Co.

v. United States, 124 F. Supp. 2d 465 (E.D. Mich. 2001). 

EFFECTIVE DATE

The provision is effective for production in taxable years beginning after the date of enactment. 

B. NATURAL GAS GATHERING LINES TREATED AS SEVEN-YEAR

PROPERTY

(Sec. 502 of the Bill and Sec. 168 of the Code) 

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–

56.31 Revenue Procedure 87–56 includes two asset classes that 

could describe natural gas gathering lines owned by nonproducers 

of natural gas. Asset class 46.0, describing pipeline transportation, 

provides a class life of 22 years and a recovery period of 15 years. 

Asset class 13.2, describing assets used in the exploration for and 

production of petroleum and natural gas deposits, provides a class 

life of 14 years and a depreciation recovery period of seven years. 

The uncertainty regarding the appropriate recovery period of natural gas gathering lines has resulted in litigation between taxpayers and the IRS. The 10th Circuit Court of Appeals held that 

natural gas gathering lines owned by nonproducers falls within the 

scope of Asset class 13.2 (i.e., seven-year recovery period).32 More 

recently, the Tax Court and the U.S. District Court for the Eastern 

District of Michigan, Southern Division, held that natural gas gathering lines owned by nonproducers falls within the scope of Asset 

class 46.0 (i.e., 15-year recovery period).33

REASONS FOR CHANGE

The Committee believes the appropriate recovery period for natural gas gathering lines is seven years. 

EXPLANATION OF PROVISION

The provision establishes a statutory seven-year recovery period 

and a class life of 10 years for natural gas gathering lines. A natural gas gathering line is defined to include any pipe, equipment, 

and appurtenance that is (1) determined to be a gathering line by 

the Federal Energy Regulatory Commission, or (2) used to deliver 

natural gas from the wellhead or a common point to the point at 

which such gas first reaches (a) a gas processing plant, (b) an interconnection with an interstate transmission line, (c) an interconnection with an intrastate transmission line, or (d) a direct interconnection with a local distribution company, a gas storage facility, 

or an industrial consumer. 

45

EFFECTIVE DATE

The provision is effective for property placed in service after the 

date of enactment. No inference is intended as to the proper treatment of natural gas gathering lines placed in service before the 

date of enactment.

C. EXPENSING OF CAPITAL COSTS INCURRED AND CREDIT FOR PRODUCTION IN COMPLYING WITH ENVIRONMENTAL PROTECTION

AGENCY SULFUR REGULATIONS

(Secs. 503 and 504 of the Bill and new Secs. 179C and 45L of the 

Code) 

PRESENT LAW

Taxpayers generally may recover the costs of investments in refinery property through annual depreciation deductions. Present 

law does not provide a credit for the production of lowsulfur diesel 

fuel. 

REASONS FOR CHANGE

The Committee believes it is important for all refiners to meet 

applicable pollution control standards. However, the Committee is 

concerned that the cost of complying with the Highway Diesel Fuel 

Sulfur Control Requirement of the Environmental Protection Agency may force some small refiners out of business. To maintain this 

refining capacity and to foster compliance with pollution control 

standards the Committee believes it is appropriate to modify cost 

recovery provisions for small refiners to reduce their capital costs 

of complying with the Highway Diesel Fuel Sulfur Control Requirement of the Environmental Protection Agency. 

EXPLANATION OF PROVISION

The provision generally permits small business refiners to claim 

an immediate deduction (i.e., expensing) for up to 75 percent of the 

qualified capital costs paid or incurred for the purpose of complying 

with the Highway Diesel Fuel Sulfur Control Requirements of the 

Environmental Protection Agency. Qualified capital costs are those 

costs paid or incurred and otherwise chargeable to the taxpayer’s 

capital account that are necessary for the refinery to come into 

compliance with the EPA diesel fuel requirements. 

In addition, the provision provides that a small business refiner 

may claim a credit equal to five cents per gallon for each gallon of 

low sulfur diesel fuel produced at a facility of a small business refiner. The total production credit claimed by the taxpayer generally 

is limited to 25 percent of the qualified capital costs incurred with 

respect to expenditures at the refinery during the period beginning 

after the date of enactment and ending with the date that is one 

year after the date on which the taxpayer must comply with applicable EPA regulations. No deduction is allowed to the taxpayer for 

expenses otherwise allowable as a deduction in an amount equal to 

the amount of production credit claimed during the taxable year. 

For these purposes a small business refiner is a taxpayer who 

within the business of refining petroleum products employs not 

46

34The refining capacities of all persons that are part of a related group are aggregated for 

purposes of this definition. In addition, in any case where refinery through-put or retained production of the refinery differs substantially from its average daily output of refined product, the 

Committee intends that capacity be measured by reference to the average daily output of refined 

product. 

more than 1,500 employees directly in refining on business days 

during a taxable year in which the deduction or production credit 

is claimed and had an average daily refinery run (or retained production) not exceeding 205,000 barrels per day 34 for the year prior 

to enactment. 

For taxpayers with an average daily refinery run in the year 

prior to enactment in excess of 155,000 and not greater than 

205,000 barrels per day, the provision limits otherwise qualifying 

small business refiners to an immediate deduction for a percentage 

of qualifying capital costs equal to 75 percent less the percentage 

points determined by the excess of the average daily refinery runs 

over 155,000 barrels per day divided by 50,000 barrels per day. In 

addition, for these taxpayers, the limitation on the total production 

credit that may be claimed also is reduced proportionately. 

In the case of a qualifying small business refiner that is owned 

by a cooperative, the cooperative is allowed to elect to pass any production credits to patrons of the organization. 

EFFECTIVE DATE

The provision is effective for expenses paid or incurred after December 31, 2002. 

D. DETERMINATION OF SMALL REFINER EXCEPTION TO OIL

DEPLETION DEDUCTION

(Sec. 505 of the Bill and Sec. 613A of the Code) 

PRESENT LAW

Present law classifies oil and gas producers as independent producers or integrated companies. The Code provides numerous special tax rules for operations by independent producers. One such 

rule allows independent producers to claim percentage depletion 

deductions rather than deducting the costs of their asset, a producing well, based on actual production from the well (i.e., cost depletion). 

A producer is an independent producer only if its refining and retail operations are relatively small. For example, an independent 

producer may not have refining operations the runs from which exceed 50,000 barrels on any day in the taxable year during which 

independent producer status is claimed. 

REASONS FOR CHANGE

The Committee believes that the goal of present law, to identify 

producers without significant refining capacity, can be achieved 

while permitting more flexibility to refinery operations. 

EXPLANATION OF PROVISION

The provision increases the current 50,000-barrel-per-day limitation to 60,000. In addition, the provision changes the refinery limiVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00054 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
47

35Treas. Reg. sec. 1.611–1(b)(1). 

tation on claiming independent producer status from a limit based 

on actual daily production to a limit based on average daily production for the taxable year. Accordingly, the average daily refinery 

run for the taxable year cannot exceed 60,000 barrels. For this purpose, the taxpayer calculates average daily refinery run by dividing 

total production for the taxable year by the total number of days 

in the taxable year. 

EFFECTIVE DATE

The provision is effective for taxable years ending after the date 

of enactment.

E. EXTENSION OF SUSPENSION OF TAXABLE INCOME LIMIT WITH

RESPECT TO MARGINAL PRODUCTION

(Sec. 506 of the Bill and Sec. 613A of the Code) 

PRESENT LAW

In general 

Depletion, like depreciation, is a form of capital cost recovery. In 

both cases, the taxpayer is allowed a deduction in recognition of the 

fact that an asset—in the case of depletion for oil or gas interests, 

the mineral reserve itself—is being expended in order to produce 

income. Certain costs incurred prior to drilling an oil or gas property are recovered through the depletion deduction. These include 

costs of acquiring the lease or other interest in the property and 

geological and geophysical costs (in advance of actual drilling). 

Depletion is available to any person having an economic interest 

in a producing property. An economic interest is possessed in every 

case in which the taxpayer has acquired by investment any interest 

in minerals in place, and secures, by any form of legal relationship, 

income derived from the extraction of the mineral, to which it must 

look for a return of its capital.35 Thus, for example, both working 

interests and royalty interests in an oil- or gasproducing property 

constitute economic interests, thereby qualifying the interest holders for depletion deductions with respect to the property. A taxpayer who has no capital investment in the mineral deposit does 

not possess an economic interest merely because it possesses an 

economic or pecuniary advantage derived from production through 

a contractual relation. 

Cost depletion 

Two methods of depletion are currently allowable under the Internal Revenue Code (the ‘‘Code’’): (1) the cost depletion method, 

and (2) the percentage depletion method (secs. 611–613). Under the 

cost depletion method, the taxpayer deducts that portion of the adjusted basis of the depletable property which is equal to the ratio 

of units sold from that property during the taxable year to the 

number of units remaining as of the end of taxable year plus the 

number of units sold during the taxable year. Thus, the amount recovered under cost depletion may never exceed the taxpayer’s basis 

in the property. 

48

36Sec. 613A. 37 Amounts disallowed as a result of this rule may be carried forward and deducted in subsequent taxable years, subject to the 65-percent taxable income limitation for those years. 38This exception is limited to wells, the drilling of which began between September 30, 1978, 

and January 1, 1984. 

Percentage depletion and related income limitations 

The Code generally limits the percentage depletion method for oil 

and gas properties to independent producers and royalty owners.36

Generally, under the percentage depletion method 15 percent of the 

taxpayer’s gross income from an oil- or gas-producing property is 

allowed as a deduction in each taxable year (sec. 613A(c)). The 

amount deducted generally may not exceed 100 percent of the net 

income from that property in any year (the ‘‘net income limitation’’) 

(sec. 613(a)). By contrast, for any other mineral qualifying for the 

percentage depletion deduction, such deduction may not exceed 50 

percent of the taxpayer’s taxable income from the depletable property. A similar 50-percent net income limitation applied to oil and 

gas properties for taxable years beginning before 1991. Section 

11522(a) of the Omnibus Budget Reconciliation Act of 1990 prospectively changed the net-income limitation threshold to 100 percent only for oil and gas properties, effective for taxable years beginning after 1990. The 100-percent net-income limitation for marginal wells has been suspended for taxable years beginning after 

December 31, 1997, and before January 1, 2004. 

Additionally, the percentage depletion deduction for all oil and 

gas properties may not exceed 65 percent of the taxpayer’s overall 

taxable income (determined before such deduction and adjusted for 

certain loss carrybacks and trust distributions) (sec. 613A(d)(1)).37

Because percentage depletion, unlike cost depletion, is computed 

without regard to the taxpayer’s basis in the depletable property, 

cumulative depletion deductions may be greater than the amount 

expended by the taxpayer to acquire or develop the property. 

A taxpayer is required to determine the depletion deduction for 

each oil or gas property under both the percentage depletion method (if the taxpayer is entitled to use this method) and the cost depletion method. If the cost depletion deduction is larger, the taxpayer must utilize that method for the taxable year in question 

(sec. 613(a)). 

Limitation of oil and gas percentage depletion to independent producers and royalty owners 

Generally, only independent producers and royalty owners (as 

contrasted to integrated oil companies) are allowed to claim percentage depletion. Percentage depletion for eligible taxpayers is allowed only with respect to up to 1,000 barrels of average daily production of domestic crude oil or an equivalent amount of domestic 

natural gas (sec. 613A(c)). For producers of both oil and natural 

gas, this limitation applies on a combined basis. 

In addition to the independent producer and royalty owner exception, certain sales of natural gas under a fixed contract in effect on 

February 1, 1975, and certain natural gas from geopressured 

brine,38 are eligible for percentage depletion, at rates of 22 percent 

and 10 percent, respectively. These exceptions apply without regard to the 1,000-barrel-per-day limitation and regardless of 

49

39 65 Fed. Reg, 6090 (2000). 

whether the producer is an independent producer or an integrated 

oil company. 

REASONS FOR CHANGE

The Committee is concerned that, while current oil and gas operations may be profitable, the highly volatile nature of oil and gas 

prices could quickly create economic hardships in the industry. 

Thus, to help minimize the adverse effects of future price fluctuations, the Committee believes it is appropriate to extend the suspension of the 100-percent net-income limitation for marginal 

wells. 

EXPLANATION OF PROVISION

The suspension of the 100-percent net income limitation for marginal wells is extended through taxable years beginning before January 1, 2007. 

EFFECTIVE DATE

The provision is effective on date of enactment.

F. AMORTIZATION OF DELAY RENTAL PAYMENTS

(Sec. 507 of the Bill and new Sec. 199A of the Code) 

PRESENT LAW

Present law generally requires costs associated with inventory 

and property held for resale to be capitalized rather than currently 

deducted as they are incurred. (sec. 263). Oil and gas producers 

typically contract for mineral production in exchange for royalty 

payments. If mineral production is delayed, these contracts provide 

for ‘‘delay rental payments’’ as a condition of their extension. In 

proposed regulations issued in 2000, the Treasury Department took 

the position that the uniform capitalization rules of section 263A 

require delay rental payments to be capitalized.39

REASONS FOR CHANGE

The Committee believes that substantial simplification for taxpayers and significant gains in taxpayer compliance and reductions 

in administrative cost can be contained by establishing the simple 

rule that all delay rental payments may be amortized over two 

years, including the basis of abandoned property. 

EXPLANATION OF PROVISION

The provision allows delay rental payments incurred in connection with the development of oil or gas within the United States 

to be amortized over two years. In the case of abandoned property, 

remaining basis may no longer be recovered in the year of abandonment of a property as all basis is recovered over the two-year 

amortization period. 

50

40Under section 263, capital expenditures are defined generally as any amount paid for new 

buildings or for permanent improvements or betterments made to increase the value of any 

property or estate. Treasury regulations define capital expenditures to include amounts paid or 

incurred (1) to add to the value, or substantially prolong the useful life, of property owned by 

the taxpayer or (2) to adapt property to a new or different use. Treas. Reg. sec. 1.263(a)–1(b). 41 ‘‘Property’’ means an interest in a property as defined in section 614 of the Code, and includes an economic interest in a tract or parcel of land notwithstanding that a mineral deposit 

has not been established or proved at the time the costs are incurred. 42See, e.g., Schermerhorn Oil Corporation v. Commissioner, 46 B.T.A. 151 (1942). By contrast, 

section 617 of the Code permits a taxpayer to elect to deduct certain expenditures incurred for 

the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or 

other mineral (but not oil and gas). These deductions are subject to recapture if the mine with 

respect to which the expenditures were incurred reaches the producing stage. 43 1977–1 C.B. 76. 

EFFECTIVE DATE

The provision applies to delay rental payments paid or incurred 

in taxable years beginning after the date of enactment. No inference is intended from the prospective effective date of this proposal 

as to the proper treatment of pre-effective date delay rental payments. 

G. AMORTIZATION OF GEOLOGICAL AND GEOPHYSICAL EXPENDITURES

(Sec. 508 of the Bill and new Sec. 199 of the Code) 

PRESENT LAW

In general 

Geological and geophysical expenditures are costs incurred by a 

taxpayer for the purpose of obtaining and accumulating data that 

will serve as the basis for the acquisition and retention of mineral 

properties by taxpayers exploring for minerals. A key issue with respect to the tax treatment of such expenditures is whether or not 

they are capital in nature. Capital expenditures are not currently 

deductible as ordinary and necessary business expenses, but are allocated to the cost of the property.40

Courts have held that geological and geophysical costs are capital, and therefore are allocable to the cost of the property 41 acquired or retained.42 The costs attributable to such exploration are 

allocable to the cost of the property acquired or retained. As described further below, IRS administrative rulings have provided 

further guidance regarding the definition and proper tax treatment 

of geological and geophysical costs. 

Revenue Ruling 77–188 

In Revenue Ruling 77–188 43 (hereinafter referred to as the ‘‘1977 

ruling’’), the IRS provided guidance regarding the proper tax treatment of geological and geophysical costs. The ruling describes a 

typical geological and geophysical exploration program as containing the following elements: 

• It is customary in the search for mineral producing properties 

for a taxpayer to conduct an exploration program in one or more 

identifiable project areas. Each project area encompasses a territory that the taxpayer determines can be explored advantageously 

in a single integrated operation. This determination is made after 

analyzing certain variables such as (1) the size and topography of 

the project area to be explored, (2) the existing information availVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00058 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
51

able with respect to the project area and nearby areas, and (3) the 

quantity of equipment, the number of personnel, and the amount 

of money available to conduct a reasonable exploration program 

over the project area. 

• The taxpayer selects a specific project area from which geological and geophysical data are desired and conducts a reconnaissance-type survey utilizing various geological and geophysical exploration techniques. These techniques are designed to yield data 

that will afford a basis for identifying specific geological features 

with sufficient mineral potential to merit further exploration. 

• Each separable, noncontiguous portion of the original project 

area in which such a specific geological feature is identified is a 

separate ‘‘area of interest.’’ The original project area is subdivided 

into as many small projects as there are areas of interest located 

and identified within the original project area. If the circumstances 

permit a detailed exploratory survey to be conducted without an 

initial reconnaissance-type survey, the project area and the area of 

interest will be coextensive. 

• The taxpayer seeks to further define the geological features 

identified by the prior reconnaissance-type surveys by additional, 

more detailed, exploratory surveys conducted with respect to each 

area of interest. For this purpose, the taxpayer engages in more intensive geological and geophysical exploration employing methods 

that are designed to yield sufficiently accurate sub-surface data to 

afford a basis for a decision to acquire or retain properties within 

or adjacent to a particular area of interest or to abandon the entire 

area of interest as unworthy of development by mine or well. 

The 1977 ruling provides that if, on the basis of data obtained 

from the preliminary geological and geophysical exploration operations, only one area of interest is located and identified within the 

original project area, then the entire expenditure for those exploratory operations is to be allocated to that one area of interest and 

thus capitalized into the depletable basis of that area of interest. 

On the other hand, if two or more areas of interest are located and 

identified within the original project area, the entire expenditure 

for the exploratory operations is to be allocated equally among the 

various areas of interest. 

If no areas of interest are located and identified by the taxpayer 

within the original project area, then the 1977 ruling states that 

the entire amount of the geological and geophysical costs related to 

the exploration is deductible as a loss under section 165. The loss 

is claimed in the taxable year in which that particular project area 

is abandoned as a potential source of mineral production. 

A taxpayer may acquire or retain a property within or adjacent 

to an area of interest, based on data obtained from a detailed survey that does not relate exclusively to any discrete property within 

a particular area of interest. Generally, under the 1977 ruling, the 

taxpayer allocates the entire amount of geological and geophysical 

costs to the acquired or retained property as a capital cost under 

section 263(a). If more than one property is acquired, it is proper 

to determine the amount of the geological and geophysical costs allocable to each such property by allocating the entire amount of the 

costs among the properties on the basis of comparative acreage. 

52

441983–2 C.B. 51. 45The value of the section 29 credit for production in 2002 was $6.35 per barrel of oil equivalent. 

If, however, no property is acquired or retained within or adjacent to that area of interest, the entire amount of the geological 

and geophysical costs allocable to the area of interest is deductible 

as a loss under section 165 for the taxable year in which such area 

of interest is abandoned as a potential source of mineral production. 

In 1983, the IRS issued Revenue Ruling 83–105,44 which elaborates on the positions set forth in the 1977 ruling by setting forth 

seven factual situations and applying the principles of the 1977 ruling to those situations. In addition, Revenue Ruling 83–105 explains what constitutes ‘‘abandonment as a potential source of mineral production.’’ 

REASONS FOR CHANGE

The Committee believes that substantial simplification for taxpayers, significant gains in taxpayer compliance, and reductions in 

administrative cost can be obtained by establishing the simple rule 

that all geological and geophysical costs may be amortized over two 

years, including the basis of abandoned property. 

The Committee recognizes that, on average, a two-year amortization period accelerates recovery of geological and geophysical expenses. The Committee believes that more rapid recovery of such 

expenses will foster increased exploration for new sources of supply. 

EXPLANATION OF PROVISION

The provision allows geological and geophysical costs incurred in 

connection with oil and gas exploration in the United States to be 

amortized over two years. In the case of abandoned property, remaining basis may no longer be recovered in the year of abandonment of a property as all basis is recovered over the two-year amortization period. 

EFFECTIVE DATE

The provision is effective for geological and geophysical costs paid 

or incurred in taxable years beginning after the date of enactment. 

No inference is intended from the prospective effective date of this 

proposal as to the proper treatment of pre-effective date geological 

and geophysical costs.

H. EXTENSION AND MODIFICATION OF CREDIT FOR PRODUCING FUEL

FROM A NON-CONVENTIONAL SOURCE

(Sec. 509 of the Bill and new Sec. 45J of the Code) 

PRESENT LAW

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) 45 per barrel or BTU oil barrel 

53

equivalent (sec. 29). Qualified fuels must be produced within the 

United States. 

Qualified fuels include: 

(5) Oil produced from shale and tar sands; as produced from 

geopressured brine, Devonian shale, coal seams, tight formations (‘‘tight sands’’), or biomass; and 

(6) 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). 

REASONS FOR CHANGE

The Committee concludes that the section 29 credit, on the margins, has increased production of oil and natural gas from domestic 

sources and that in the absence of these non-conventional sources 

the demand for imported fuels may have increased. To increase domestic sources of supply, the Committee believes it is appropriate 

to extend the section 29 credit to help foster new domestic fuel 

sources. The Committee is also concerned that, without the implicit 

subsidy of the production credit due to the higher extraction costs 

of certain ‘‘viscous oil,’’ entrepreneurs would not otherwise exploit 

this domestic energy source. Therefore, the Committee believes it 

is appropriate to extend the credit for viscous oil produced from 

new wells or facilities. 

The Committee also recognizes that the credit for production of 

synthetic fuels from coal has been interpreted to include fuels that 

are merely chemical changes to coal that do not necessarily enhance the value or environmental performance of the feedstock 

coal. Therefore, the Committee believes it is appropriate to extend 

the section 29 credit only to fuels produced from coal that achieve 

significant environmental and value-added improvements. Methane 

in coal mines is a serious safety hazard. In many coal mining operations, the cost of collection exceeds the value of the recovered 

methane so the methane is vented directly into the atmosphere. 

Methane is an extremely potent and long-lived greenhouse gas. 

Therefore, the Committee seeks to encourage capture of methane 

from coal mines in particular. 

The Committee recognizes that the world price of oil as the nation enters the 21st century has not risen to levels forecast in 1978. 

Therefore, the Committee believes it is appropriate to restart the 

section 29 credit at a level lower than that currently available to 

existing production. 

54

46The daily average would be computed as total production divided by the total number of 

days the well or facility was in production during the year. 47The provision does not apply to liquid, gaseous, or solid synthetic fuels produced from coal 

as described under present law section 29(c)(1)(C), but does provide credit for a new category, 

refined coal, described below. 

The Committee believes it is important to study the efficacy of 

the section 29 credit in the case of methane recovered from coal 

seams or so-called ‘‘coal beds.’’ 

EXPLANATION OF PROVISION

The provision extends the placed in service date for certain facilities that would otherwise qualify for the section 29 credit under 

present law and modifies the amount of the credit to equal $3.00 

unindexed for inflation. The provision also expands the class of facilities that are eligible for the credit. In addition, under the provision, the taxpayer would not be able to claim any credit for production in excess of a daily average of 200,000 cubic feet of gas (or barrel of oil equivalent) from a qualifying well or facility.46

Clarification of definition of when a facility is placed in service 

The provision clarifies the definition of when a landfill gas facility is placed in service, both for facilities originally placed in service on or before the date of enactment and for facilities placed in 

service after the date of enactment. In general, a landfill gas facility includes wells, pipes, and the related components to collect 

landfill gas (i.e., the gas produced from biomass and derived from 

the bio-degradation on municipal solid waste). The production of 

landfill gas attributable to wells, pipes, and related components 

placed in service after the date of enactment is considered produced 

from a facility placed in service after the date of enactment. Production of landfill gas attributable to those wells, pipes, and related 

components placed in service on or before the date of enactment is 

considered produced from a facility placed in service on or before 

the date of enactment. That is, all of the landfill gas produced from 

a landfill is not considered to be from a facility placed in service 

on the date on which the first set of wells, pipes, and related components drew gas from the landfill. Rather, as a landfill expands 

and additional integrated sets of wells, pipes, and related components are installed to draw off landfill gas, the landfill gas drawn 

from each additional integrated set of wells, pipes, and related 

components is to be considered to be produced from a facility 

placed in service on the date each additional integrated set of 

wells, pipes, and related components is placed in service. Thus, a 

single landfill may have several ‘‘facilities’’ eligible for the section 

29 credit, each placed in service on a different date.

Extension for certain non-conventional fuels 

The provision permits taxpayers to claim the section 29 credit for 

production of certain non-conventional fuels produced at wells 

placed in service after the date of enactment and before January 

1, 2007.47 Under the provision, qualifying fuels are oil from shale 

or tar sands, and gas from geopressured brine, Devonian shale, coal 

seams, a tight formation, or biomass. The value of the credit is rebased to $3.00 and the amount is not indexed for inflation. TaxVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00062 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
55

48 No inference is intended that high-carbon fly ash qualified previous to the date of enactment. 

payers may claim the credit for production from the well for each 

of the first three years of production from the qualifying well. 

Expansion for fuels from agricultural and animal waste 

The provision adds facilities producing liquid, gaseous, or solid 

fuels, from agricultural and animal waste placed in service after 

the date of enactment and before January 1, 2007, to the list of 

qualified facilities for purposes of the non-conventional fuel credit. 

The amount of the credit is equal to $3.00 (unindexed) per barrel 

or Btu oil barrel equivalent, for three years of production commencing on the date the facility is placed in service. Agricultural 

and animal waste includes by-products, packaging, and any materials associated with processing, feeding, selling, transporting, or 

disposal of agricultural or animal products or wastes. 

Expansion for ‘‘viscous oil’’ 

The provision expands section 29 to permit taxpayers to claim 

the section 29 credit for production of certain viscous oil produced 

at wells placed in service after the date of enactment and before 

January 1, 2007. The provision defines ‘‘viscous oil’’ as domestic 

crude oil produced from any property if the crude oil has a weighted average gravity of 22 degrees API or less (corrected to 60 degrees Fahrenheit). The value of the credit for viscous oil also is 

$3.00 per barrel. Taxpayers may claim the credit for production 

from the well for each of the first three years of production from 

the time the well is placed in service. The provision provides that 

qualifying sales to related parties for consumption not in the immediate vicinity of the wellhead qualify for the credit. 

Expansion for ‘‘refined coal’’ 

The provision also expands section 29 to include certain ‘‘refined 

coal’’ as a qualified non-conventional fuel. ‘‘Refined coal’’ is a qualifying liquid, gaseous, or solid synthetic fuel produced from coal (including lignite) from facilities placed in service after date of enactment and before January 1, 2007. Refined coal also would include 

a qualifying fuel derived from high carbon fly ash produced from 

facilities placed in service after the date of enactment and before 

January 1, 2007.48 A qualifying fuel is a fuel that when burned 

emits 20 percent less nitrogen oxide and either sulfur dioxide or 

mercury than the burning of feedstock coal or comparable coal predominantly available in the marketplace as of January 1, 2003, and 

if the fuel sells at prices at least 50 percent greater than the prices 

of the feedstock coal or comparable coal. However, no fuel produced 

at a qualifying advanced clean coal facility (as defined elsewhere in 

the committee bill) would be a qualifying fuel. The amount of credit 

for refined coal also is $3.00 per barrel equivalent. Taxpayers may 

claim the credit for fuel produced during the five-year period beginning on the date the facility is placed in service. 

56

Expansion for coalmine gas 

In addition, the provision permits taxpayers to claim credit for 

coalmine gas captured by the taxpayer and utilized as a fuel source 

or sold by or on behalf of the taxpayer to an unrelated person. The 

term ‘‘coalmine gas’’ means any methane gas which is being liberated during qualified coal mining operations or as a result of past 

qualified coal mining operations, or which is captured 10 years in 

advance of qualified coal mining operations as part of specific plan 

to mine a coal deposit. In the case of coalmine gas that is captured 

in advance of qualified coal mining operations, the credit is allowed 

only after the date the coal extraction occurs in the immediate area 

where the coalmine gas was removed. The value of the credit for 

coalmine methane also is $3.00 per Btu oil barrel equivalent (51.7 

cents per million Btu of heat value in the gas) for gas captured and 

utilized or sold. Taxpayers may claim the credit for gas captured 

and utilized or sold after the date of enactment and before January 

1, 2007. 

Extension of credit for certain existing facilities 

The provision extends the present-law credit through December 

31, 2005 for production from existing facilities producing coke, coke 

gas, or natural gas and by-products produced by coal gasification 

from lignite. The provision provides that the credit amount will be 

$3.00 per Btu oil barrel equivalent for production from such facilities after December 31, 2002. 

Study of coal bed methane gas 

Lastly, the provision directs the Secretary of the Treasury to undertake a study of the effect section 29 has had on the production 

of coal bed methane. The study should estimate the total amount 

of credit claimed annually and in aggregate related to the production of coal bed methane since the enactment of section 29. The 

study should report the annual value of the credit allowable for 

coal bed methane compared to the average annual wellhead price 

of natural gas (per thousand cubic feet of natural gas). The study 

should estimate the incremental increase in production of coal bed 

methane that has resulted from the enactment of section 29. The 

study should estimate the cost to the Federal government, in terms 

of the net tax benefits claimed, per thousand cubic feet of incremental coal bed methane produced annually and in aggregate since 

the enactment of section 29. 

EFFECTIVE DATE

The provisions apply to fuels sold from qualifying wells and facilities after the date of enactment.

I. NATURAL GAS DISTRIBUTION LINES TREATED AS 15-YEAR

PROPERTY

(Sec. 510 of the Bill and Sec. 168 of the Code) 

PRESENT LAW

The applicable recovery period for assets placed in service under 

the Modified Accelerated Cost Recovery System is based on the 

57

49 1987–2 C.B. 674 (as clarified and modified by Rev. Proc. 88–22, 1988–1 C.B. 785). 

‘‘class life of the property.’’ The class lives of assets placed in service after 1986 are generally set forth in Revenue Procedure 87–

56.49 Natural gas distribution pipelines are assigned a 20-year recovery period and a class life of 35 years. 

REASONS FOR CHANGE

The Committee recognizes the importance of modernizing our 

aging energy infrastructure to meet the demands of the twentyfirst century, and the Committee also recognizes that both shortterm and long-term solutions are required to meet this challenge. 

The Committee understands that investment in our energy infrastructure has not kept pace with the nation’s needs. In light of this, 

the Committee believes it is appropriate to reduce the recovery period for investment in certain energy infrastructure property to encourage investment in such property. 

EXPLANATION OF PROVISION

The provision establishes a statutory 15-year recovery period and 

a class life of 20 years for natural gas distribution lines. 

EFFECTIVE DATE

The provision is effective for property placed in service after the 

date of enactment. 

J. CREDIT FOR ALASKA NATURAL GAS

(Sec. 511 of the Bill and new Sec. 45M of the Code) 

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 

58

50 Natural gas entering a gas processing facility is not considered to have entered a pipeline. 

Rather, the credit applies only to pipeline quality gas at the time of entry into the pipeline. 51 In practice, the $1.35 figure also is indexed for inflation, as $1.35 is the sum of the 52-cent 

credit and the 83-cent price. 

The bill provides that the Secretary can compute the inflation adjustment factor for a calendar 

year in the fourth quarter of the preceding year. For example, the adjustment for 2004 is calculated as the 2003 GDP deflator over the 2002 GDP deflator, where the 2002 GDP deflator 

is the value of the GDP deflator on June 30, 2002 (as determined by the latest available revision 

from the Department of Commerce prior to October 1, 2002). Likewise, the 2003 deflator is the 

value of the GDP deflator on June 30, 2003. 

(in the case of biomass gas and synthetic fuel facilities eligible for 

the extension period). 

REASONS FOR CHANGE

The Committee recognizes the natural gas in Alaska is an important natural resource that can expand domestic energy supplies. 

However, due to the volatility of energy prices, the private sector 

may be unwilling to make the substantial investment in a pipeline 

to bring some of the natural gas to the lower 48 States. The Committee believes it is important to make this natural gas resource 

available to the lower 48 States and to provide an economic stimulus to the Alaskan economy. The Committee believes that a credit 

against income taxes for delivery of natural gas to a transmission 

pipeline will provide a minimum return and the reduced volatility 

necessary to induce the private sector to invest in the pipeline to 

bring Alaska natural gas to the rest of the U.S. market.

EXPLANATION OF PROVISION

The provision provides a credit per million British thermal units 

(Btu) of natural gas for Alaska natural gas entering a pipelines 50

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 per 

million Btu of natural gas. The credit phases out as the reference 

price of Alaska natural gas rises above 83 cents per million Btu, 

at a rate of one cent of credit lost per each cent by which the reference price of Alaska natural gas exceeds 83 cents per million Btu. 

The credit is not available if the reference price of Alaska natural 

gas rises above $1.35 per million Btu. The 52-cent and 83-cent figures are indexed for inflation after 2002, with the first adjustment 

for calendar year 2004.51

The bill provides that the Secretary of the Treasury calculate the 

reference price of Alaska natural gas as the average price of natural gas delivered in the lower 48 States less certain transportation 

costs and gas processing costs. The Committee intends that an appropriate measure of the price of natural gas delivered to the lower 

48 States be the monthly Chicago city gate price for natural gas 

as reliably reported in one or more trade publications or as reported by the Secretary of Energy. Because qualifying natural gas 

is likely to be transported across both the United States and Canada, the Committee intends that transportation costs be measured 

as such costs as determined (pursuant to approved tariffs) by the 

appropriate national regulatory body. At the present time, the apVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00066 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
59

52 1987–2 C.B. 674 (as clarified and modified by Rev. Proc. 88–22, 1988–1 C.B. 785). 

propriate national regulatory body for transportation of natural gas 

in the United States is the Federal Energy Regulatory Commission. 

At the present time, the Committee understands the appropriate 

national regulatory body for transportation of natural gas in Canada is the Canadian National Energy Board. The Committee further intends that gas processing costs include all rates and charges 

of whatever kind for firm service assessed with respect to the processing of Alaska natural gas as calculated pursuant to approved 

tariffs under the Natural Gas Act (15 U.S.C. 717), if such costs are 

regulated by the Federal government, or as calculated under the 

principles of sec. 482 of the Code, if such costs are not regulated 

by the Federal government. 

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

of Alaska lying north of 64 degrees North latitude, but not including the Alaska National Wildlife Refuge. 

The credit is part of the general business credit. 

EFFECTIVE DATE

The proposal is effective on the date of enactment. 

K. CERTAIN ALASKA PIPELINE SYSTEMS TREATED AS SEVEN-YEAR

PROPERTY

(Sec. 512 of the Bill and Sec. 168 of the Code) 

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–

56.52 Assets used in the private, commercial, and contract carrying 

of petroleum, gas and other products by means of pipes and conveyors are assigned a 15-year recovery period and a class life of 22 

years. 

REASONS FOR CHANGE

The Committee recognizes that, on our present course, the nation 

will be ever more reliant on foreign governments, that do not always have America’s interest at heart, for oil and natural gas. The 

Committee recognizes that even with conservation efforts and alternative sources of energy that our nation’s long-term security depends on reducing our reliance on foreign energy sources. In light 

of this, the Committee believes it is appropriate to reduce the recovery period, and thus the cost of capital, for investment in natural gas pipeline systems in Alaska that meet certain requirements. 

EXPLANATION OF PROVISION

The provision 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. 

60

53Prop. Treas. Reg. sec. 1.148–1(e)(2)(ii). 54See Treas. Reg. 1.141–12. 

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 gas treatment plant related to 

such pipeline. 

EFFECTIVE DATE

The proposal is effective on the date of enactment.

L. EXEMPT CERTAIN PREPAYMENTS FOR NATURAL GAS FROM TAX- EXEMPT BOND ARBITRAGE RULES

(Sec. 513 of the Bill and Sec. 148 of the Code) 

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 (sec. 103). 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.’’ A prepayment for property or services may give rise 

to investment-type property. A prepayment can produce prohibited 

arbitrage profits when the discount received for prepaying the costs 

exceeds the yield on the tax-exempt 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 investment type property for certain natural gas prepayments that are made by or for one or more utilities that are owned 

by a governmental person.53 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 retail 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 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.54

A prepayment will not fail to meet the requirements for prepaid 

gas contracts by reason of any commodity swap contract that may 

61

55 Internal Revenue Service, Clarification of Proposed Regulations Relating to Tax-Exempt 

Bonds Issued by State or Local Governments, Notice 2002–52, 2002–30 IRB 1 (July 03, 2002). 

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 the obligation of each party to perform under the swap contract is not dependent on performance by any person (other than 

the other 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.55 The Commissioner may, by published guidance, 

set forth additional circumstances in which a prepayment does not 

give rise to investment type property. 

REASONS FOR CHANGE

The Committee determined that it was appropriate to complement the proposed Treasury regulations with a safe harbor that 

provides certainty on the date of issuance that prepayments for 

natural gas within the safe harbor will not violate the arbitrage 

rules. This provision will ensure adequate supplies of natural gas 

at predictable prices for natural gas utility customers without sacrificing to a great degree the appropriate present-law limitations 

regarding tax-exempt bond issuance for the purchase of investment 

property. The Committee believes that this proposal strikes an appropriate balance between these two competing policies. The creation of this safe harbor is not intended to limit the Secretary’s regulatory authority to identify other situations in which prepayments 

do not give rise to investment type property. 

EXPLANATION OF PROVISION

In general 

The provision 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 

provision also provides that such prepayments are not treated as 

private loans for purposes of the private business tests. 

Under the provision, 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 supply 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 

62

56For 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. 

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. 

With respect to qualified natural gas supply contracts entered 

into by joint action agencies acting for or on behalf of one or more 

governmental utilities, the requirements of the safe harbor are 

tested at the utility level. A joint action agency shall be treated as 

the agent of the utility when selling directly to a retail customer 

within that utility’s service area.

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 acquired under a 

qualified natural gas supply contract for any period is to be reduced by the applicable share of 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).56 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 governmental 

utility enters into a contract to supply natural gas (other than for 

resale) for use by a business 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 the volume of natural gas covered by the prepayment to be in excess of that needed for (1) 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. 

Sales to dispose of excess gas outside the service area that are necessitated by circumstances beyond the control of the utility, such 

63

as weather conditions, are not considered intentional acts to render 

the prepaid gas supply in excess of the utility’s needs. 

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 consumption or 

population that demonstrates that the amount permitted by the exception is insufficient. 

EFFECTIVE DATE

The provision is effective for obligations issued after the date of 

enactment.

TITLE VI—ELECTRIC UTILITY RESTRUCTURING 

PROVISIONS 

A. MODIFICATIONS TO SPECIAL RULES FOR NUCLEAR

DECOMMISSIONING COSTS

(Sec. 601 of the Bill and Sec. 468A of the Code) 

PRESENT LAW

Overview 

Special rules dealing with nuclear decommissioning reserve 

funds were adopted by Congress in the Deficit Reduction Act of 

1984 (‘‘1984 Act’’), when tax issues regarding the time value of 

money were addressed generally. Under general tax accounting 

rules, a deduction for accrual basis taxpayers is deferred until 

there is economic performance for the item for which the deduction 

is claimed. However, the 1984 Act contains an exception under 

which a taxpayer responsible for nuclear powerplant decommissioning may elect to deduct contributions made to a qualified nuclear decommissioning fund for future decommissioning costs. Taxpayers who do not elect this provision are subject to general tax accounting rules. 

Qualified nuclear decommissioning fund 

A qualified nuclear decommissioning fund (a ‘‘qualified fund’’) is 

a segregated fund established by a taxpayer that is used exclusively for the payment of decommissioning costs, taxes on fund income, management costs of the fund, and for making investments. 

64

57 As originally enacted in 1984, a qualified fund paid tax on its earnings at the top corporate 

rate and, as a result, there was no present-value tax benefit of making deductible contributions 

to a qualified fund. Also, as originally enacted, the funds in the trust could be invested only 

in certain low risk investments. Subsequent amendments to the provision have reduced the rate 

of tax on a qualified fund to 20 percent and removed the restrictions on the types of permitted 

investments that a qualified fund can make. 58Taxpayers are required to include in gross income customer charges for decommissioning 

costs (sec. 88). 59Treas. reg. sec. 1.468A–6. 60Treas. reg. sec. 1.468A–6(f). 61These funds are generally referred to as ‘‘nonqualified funds.’’ 

The income of the fund is taxed at a reduced rate of 20 percent for 

taxable years beginning after December 31, 1995.57

Contributions to a qualified fund are deductible in the year made 

to the extent that these amounts were collected as part of the cost 

of service to ratepayers (the ‘‘cost of service requirement’’).58 Funds 

withdrawn by the taxpayer to pay for decommissioning costs are 

included in the taxpayer’s income, but the taxpayer also is entitled 

to a deduction for decommissioning costs as economic performance 

for such costs occurs. 

Accumulations in a qualified fund are limited to the amount required to fund decommissioning costs of a nuclear powerplant for 

the period during which the qualified fund is in existence (generally post-1984 decommissioning costs of a nuclear powerplant). 

For this purpose, decommissioning costs are considered to accrue 

ratably over a nuclear powerplant’s estimated useful life. In order 

to prevent accumulations of funds over the remaining life of a nuclear powerplant in excess of those required to pay future decommissioning costs of such nuclear powerplant and to ensure that 

contributions to a qualified fund are not deducted more rapidly 

than level funding (taking into account an appropriate discount 

rate), taxpayers must obtain a ruling from the IRS to establish the 

maximum annual contribution that may be made to a qualified 

fund (the ‘‘ruling amount’’). In certain instances (e.g., change in estimates), a taxpayer is required to obtain a new ruling amount to 

reflect updated information. 

A qualified fund may be transferred in connection with the sale, 

exchange or other transfer of the nuclear powerplant to which it relates. If the transferee is a regulated public utility and meets certain other requirements, the transfer will be treated as a nontaxable transaction. No gain or loss will be recognized on the transfer of the qualified fund and the transferee will take the transferor’s basis in the fund.59 The transferee is required to obtain a 

new ruling amount from the IRS or accept a discretionary determination by the IRS.60

Nonqualified nuclear decommissioning funds 

Federal and State regulators may require utilities to set aside 

funds for nuclear decommissioning costs in excess of the amount allowed as a deductible contribution to a qualified fund. In addition, 

taxpayers may have set aside funds prior to the effective date of 

the qualified fund rules.61 The treatment of amounts set aside for 

decommissioning costs prior to 1984 varies. Some taxpayers may 

have received no tax benefit while others may have deducted such 

amounts or excluded such amounts from income. Since 1984, taxpayers have been required to include in gross income customer 

65

62The ability to transfer property into a qualified fund under this special rule is available only 

to the extent the taxpayer has not obtained a new ruling amount incorporating the repeal of 

Continued

charges for decommissioning costs (sec. 88), and a deduction has 

not been allowed for amounts set aside to pay for decommissioning 

costs except through the use of a qualified fund. Income earned in 

a nonqualified fund is taxable to the fund’s owner as it is earned. 

REASONS FOR CHANGE

The Committee does not believe a utility should be denied the opportunity to contribute to a qualified fund simply because it operates in a deregulated environment. The Committee also believes 

that it is appropriate to permit all decommissioning costs associated with a nuclear powerplant to be funded through a qualified 

fund. In addition, the Committee recognizes the importance of providing clear and concise rules to minimize disputes between taxpayers and the IRS.

EXPLANATION OF PROVISION

Repeal of cost of service requirement 

The provision repeals the cost of service requirement for deductible contributions to a nuclear decommissioning fund. Thus, all taxpayers, including unregulated taxpayers, would be allowed a deduction for amounts contributed to a qualified fund. 

Permit contributions to a qualified fund for pre-1984 decommissioning costs 

The proposal also repeals the limitation that a qualified fund 

only accumulate an amount sufficient to pay for a nuclear powerplant’s decommissioning costs incurred during the period that the 

qualified fund is in existence (generally post-1984 decommissioning 

costs). Thus, any taxpayer is permitted to accumulate an amount 

sufficient to cover the present value of 100 percent of a nuclear 

powerplant’s estimated decommissioning costs in a qualified fund. 

The proposal does not change the requirement that contributions 

to a qualified fund not be deducted more rapidly than level funding. 

Clarify treatment of transfers of qualified funds 

The provision clarifies the Federal income tax treatment of the 

transfer of a qualified fund. No gain or loss would be recognized to 

the transferor or the transferee (or the qualified fund) as a result 

of the transfer of a qualified fund in connection with the transfer 

of the powerplant with respect to which such fund was established. 

Exception to ruling amount for certain decommissioning costs 

The provision permits a taxpayer to make contributions to a 

qualified fund in excess of the ruling amount in one circumstance. 

Specifically, a taxpayer is permitted to contribute up to the present 

value of the amount required to fund a nuclear powerplant’s decommissioning costs which under present law section 468A(d)(2)(A) 

is not permitted to be accumulated in a qualified fund (generally 

pre-1984 decommissioning costs).62 It is anticipated that an 

66

the limitation that a qualified fund only accumulate an amount sufficient to pay for decommissioning costs of a nuclear powerplant incurred during the period that the fund is in existence 

(generally post 1984 decommissioning costs). 63 A taxpayer recognizes no gain or loss on the contribution of property to a qualified fund 

under this special rule. The qualified fund will take a transferred (carryover) basis in such property. Correspondingly, a taxpayer’s deduction (over the estimated life of the nuclear powerplant) 

is to be based on the adjusted tax basis of the property contributed rather than the fair market 

value of such property. 64 Announcement 96–24, Proposed Examination Guidelines Regarding Rural Electric Cooperatives, 1996–16 I.R.B. 35. 

amount that is permitted to be contributed under this special rule 

shall be determined using the estimate of total decommissioning 

costs used for purposes of determining the taxpayer’s most recent 

ruling amount. Any amount transferred to the qualified fund under 

this special rule that has not previously been deducted, or excluded 

from gross income is allowed as a deduction over the remaining 

useful life of the nuclear powerplant.63 If a qualified fund that has 

received amounts under this rule is transferred to another person, 

that person will be entitled to the deduction at the same time and 

in the same manner as the transferor. Thus, if the transferor was 

not subject to tax at the time and thus would have been unable to 

use the deduction, the transferee will similarly not be able to utilize the deduction. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after date 

of enactment.

B. TREATMENT OF CERTAIN INCOME OF COOPERATIVES

(Sec. 602 of the Bill and Sec. 501 of the Code) 

PRESENT LAW

In general 

Under present law, an entity must be operated on a cooperative 

basis in order to be treated as a cooperative for Federal income tax 

purposes. Although not defined by statute or regulation, the two 

principal criteria for determining whether an entity is operating on 

a cooperative basis are: (1) ownership of the cooperative by persons 

who patronize the cooperative; and (2) return of earnings to patrons in proportion to their patronage. The IRS requires that cooperatives must operate under the following principles: (1) subordination of capital in control over the cooperative undertaking and in 

ownership of the financial benefits from the cooperative; (2) democratic control by the members of the cooperative; (3) vesting in and 

allocation among the members of all excess of operating revenues 

over the expenses incurred to generate revenues in proportion to 

their participation in the cooperative (patronage); and (4) operation 

at cost (not operating for profit or below cost).64

In general, cooperative members are those who participate in the 

management of the cooperative and who share in patronage capital. As described below, income from the sale of electric energy by 

an electric cooperative may be member or non-member income to 

the cooperative, depending on the membership status of the purchaser. A municipal corporation may be a member of a cooperative. 

67

65See Rev. Rul. 83–135, 1983–2 C.B. 149. 66 Rev. Rul. 72–36, 1972–1 C.B. 151. 

For Federal income tax purposes, a cooperative generally computes its income as if it were a taxable corporation, with one exception—the cooperative may exclude from its taxable income distributions of patronage dividends. In general, patronage dividends are 

the profits of the cooperative that are rebated to its patrons pursuant to a pre-existing obligation of the cooperative to do so. The rebate must be made in some equitable fashion on the basis of the 

quantity or value of business done with the cooperative. 

Except for tax-exempt farmers’ cooperatives, cooperatives that 

are subject to the cooperative tax rules of subchapter T of the Code 

(sec. 1381, et seq.) are permitted a deduction for patronage dividends from their taxable income only to the extent of net income 

that is derived from transactions with patrons who are members of 

the cooperative (sec. 1382). The availability of such deductions from 

taxable income has the effect of allowing the cooperative to be 

treated like a conduit with respect to profits derived from transactions with patrons who are members of the cooperative. 

Cooperatives that qualify as tax-exempt farmers’ cooperatives are 

permitted to exclude patronage dividends from their taxable income 

to the extent of all net income, including net income that is derived 

from transactions with patrons who are not members of the cooperative, provided the value of transactions with patrons who are not 

members of the cooperative does not exceed the value of transactions with patrons who are members of the cooperative (sec. 521). 

Taxation of electric cooperatives exempt from subchapter T 

In general, the cooperative tax rules of subchapter T apply to any 

corporation operating on a cooperative basis (except mutual savings 

banks, insurance companies, other tax-exempt organizations, and 

certain utilities), including tax-exempt farmers’ cooperatives (described in sec. 521(b)). However, subchapter T does not apply to an 

organization that is ‘‘engaged in furnishing electric energy, or providing telephone service, to persons in rural areas’’ (sec. 

1381(a)(2)(C)). Instead, electric cooperatives are taxed under rules 

that were generally applicable to cooperatives prior to the enactment of subchapter T in 1962. Under these rules, an electric cooperative can exclude patronage dividends from taxable income to the 

extent of all net income of the cooperative, including net income derived from transactions with patrons who are not members of the 

cooperative.65

Tax exemption of rural electric cooperatives 

Section 501(c)(12) provides an income tax exemption for rural 

electric cooperatives if at least 85 percent of the cooperative’s income consists of amounts collected from members for the sole purpose of meeting losses and expenses of providing service to its 

members. The IRS takes the position that rural electric cooperatives also must comply with the fundamental cooperative principles 

described above in order to qualify for tax exemption under section 

501(c)(12).66 The 85-percent test is determined without taking into 

account any income from qualified pole rentals and cancellation of 

68

indebtedness income from the prepayment of a loan under sections 

306A, 306B, or 311 of the Rural Electrification Act of 1936 (as in 

effect on January 1, 1987). The exclusion for cancellation of indebtedness income applies to such income arising in 1987, 1988, or 

1989 on debt that either originated with, or is guaranteed by, the 

Federal Government. Rural electric cooperatives generally are subject to the tax on unrelated trade or business income under section 

511. 

REASONS FOR CHANGE

The purpose of the 85-percent test under section 501(c)(12) is to 

ensure that the primary activities of a tax-exempt electric cooperative fulfill the statutory purpose of providing electricity services to 

the members of the cooperative. Similarly, the fundamental cooperative principles described above are the defining characteristics of 

a cooperative upon which the Federal tax rules condition conduit 

treatment. 

The Committee believes that the nature of an electric cooperative’s activities does not change because it has income from open 

access transactions with non-members or from nuclear decommissioning transactions (as these terms are defined in the bill). Accordingly, the Committee believes that the 85-percent test for tax exemption under present law should be applied without regard to 

such income. The Committee intends that the term ‘‘open access 

transaction’’ shall be applied in a manner that allows an electric 

cooperative to carry out its statutory purpose in a restructured 

electric energy market environment without adversely impacting 

its tax-exempt status. 

For similar reasons, the Committee believes that the 85-percent 

test for tax exemption under present law should be applied without 

regard to cancellation of indebtedness income from the prepayment 

of certain loans that are provided, insured, or guaranteed by the 

Federal government, as well as income from certain transactions 

that would otherwise qualify for deferred gain recognition under 

section 1031 or 1033. 

The Committee further believes that electric energy sales to nonmembers should not result in a loss of tax-exempt status or cooperative status to the extent that such sales are necessary to replace 

lost sales of electric energy to members as a result of restructuring 

of the electric energy industry. Accordingly, the Committee believes 

that replacement electric energy sales to nonmembers (defined as 

‘‘load loss transactions’’ in the bill) should be treated, for a limited 

period of time, as member income in applying the 85-percent test 

for tax exemption of rural electric cooperatives. The Committee believes that such treatment also should apply for purposes of determining whether tax-exempt and taxable electric cooperatives comply with the fundamental cooperative principles. Finally, the Committee believes that income from replacement electric energy sales 

should not be subject to the tax on unrelated trade or business income under Code section 511. 

69

67 Under this provision, references to FERC are treated as including references to the Public 

Utility Commission of Texas or the Rural Utilities Service. 

EXPLANATION OF PROVISION

Treatment of income from open access transactions 

The bill provides that income received or accrued by a rural electric cooperative from any ‘‘open access transaction’’ (other than income received or accrued directly or indirectly from a member of 

the cooperative) is excluded in determining whether a rural electric 

cooperative satisfies the 85-percent test for tax exemption under 

section 501(c)(12). The term ‘‘open access transaction’’ is defined 

as— 

(1) The provision or sale of electric energy transmission services or ancillary services on a nondiscriminatory open access 

basis: (i) pursuant to an open access transmission tariff filed 

with and approved by the Federal Energy Regulatory Commission (‘‘FERC’’) (including acceptable reciprocity tariffs), but 

only if (in the case of a voluntarily filed tariff) the cooperative 

files a report with FERC within 90 days of enactment of this 

provision relating to whether or not the cooperative will join a 

regional transmission organization (‘‘RTO’’); or (ii) under an 

RTO agreement approved by FERC (including an agreement 

providing for the transfer of control—but not ownership—of 

transmission facilities); 67

(2) The provision or sale of electric energy distribution services or ancillary services on a nondiscriminatory open access 

basis to end-users served by distribution facilities owned by the 

cooperative or its members; or 

(3) The delivery or sale of electric energy on a nondiscriminatory open access basis, provided that such electric energy is 

generated by a generation facility that is directly connected to 

distribution facilities owned by the cooperative (or its members) which owns the generation facility. 

For purposes of the 85-percent test, the bill also provides that income received or accrued by a rural electric cooperative from any 

‘‘open access transaction’’ is treated as an amount collected from 

members for the sole purpose of meeting losses and expenses if the 

income is received or accrued indirectly from a member of the cooperative. 

Treatment of income from nuclear decommissioning transactions 

The bill provides that income received or accrued by a rural electric cooperative from any ‘‘nuclear decommissioning transaction’’ 

also is excluded in determining whether a rural electric cooperative 

satisfies the 85-percent test for tax exemption under section 

501(c)(12). The term ‘‘nuclear decommissioning transaction’’ is defined as— 

(1) Any transfer into a trust, fund, or instrument established 

to pay any nuclear decommissioning costs if the transfer is in 

connection with the transfer of the cooperative’s interest in a 

nuclear powerplant or nuclear powerplant unit; 

(2) Any distribution from a trust, fund, or instrument established to pay any nuclear decommissioning costs; or 

70

(3) Any earnings from a trust, fund, or instrument established to pay any nuclear decommissioning costs. 

Treatment of income from asset exchange or conversion transactions 

The bill provides that gain realized by a tax-exempt rural electric 

cooperative from a voluntary exchange or involuntary conversion of 

certain property is excluded in determining whether a rural electric 

cooperative satisfies the 85-percent test for tax exemption under 

section 501(c)(12). This provision only applies to the extent that: (1) 

the gain would qualify for deferred recognition under section 1031 

(relating to exchanges of property held for productive use or investment) or section 1033 (relating to involuntary conversions); and (2) 

the replacement property that is acquired by the cooperative pursuant to section 1031 or section 1033 (as the case may be) constitutes 

property that is used, or to be used, for the purpose of generating, 

transmitting, distributing, or selling electricity or methane-based 

natural gas. 

Treatment of cancellation of indebtedness income from prepayment 

of certain loans 

The bill provides that income from the prepayment of any loan, 

debt, or obligation of a tax-exempt rural electric cooperative that is 

originated, insured, or guaranteed by the Federal Government 

under the Rural Electrification Act of 1936 is excluded in determining whether the cooperative satisfies the 85-percent test for tax 

exemption under section 501(c)(12) 

Treatment of income from load loss transactions 

Tax-exempt rural electric cooperatives.—The bill provides that income received or accrued by a tax-exempt rural electric cooperative 

from a ‘‘load loss transaction’’ is treated under 501(c)(12) as income 

collected from members for the sole purpose of meeting losses and 

expenses of providing service to its members. Therefore, income 

from load loss transactions is treated as member income in determining whether a rural electric cooperative satisfies the 85-percent 

test for tax exemption under section 501(c)(12). The bill also provides that income from load loss transactions does not cause a taxexempt electric cooperative to fail to be treated for Federal income 

tax purposes as a mutual or cooperative company under the fundamental cooperative principles described above. 

The term ‘‘load loss transaction’’ is generally defined as any 

wholesale or retail sale of electric energy (other than to a member 

of the cooperative) to the extent that the aggregate amount of such 

sales during a seven-year period beginning with the ‘‘start-up year’’ 

does not exceed the reduction in the amount of sales of electric energy during such period by the cooperative to members. The ‘‘startup year’’ is defined as the calendar year which includes the date 

of enactment of this provision or, if later, at the election of the cooperative: (1) the first year that the cooperative offers nondiscriminatory open access; or (2) the first year in which at least 10 percent of the cooperative’s sales of electric energy are to patrons who 

are not members of the cooperative. 

71

The bill also excludes income received or accrued by rural electric 

cooperatives from load loss transactions from the tax on unrelated 

trade or business income. 

Taxable electric cooperatives.—The bill provides that the receipt 

or accrual of income from load loss transactions by taxable electric 

cooperatives is treated as income from patrons who are members 

of the cooperative. Thus, income from a load loss transaction is excludible from the taxable income of a taxable electric cooperative 

if the cooperative distributes such income pursuant to a pre-existing contract to distribute the income to a patron who is not a member of the cooperative. The bill also provides that income from load 

loss transactions does not cause a taxable electric cooperative to 

fail to be treated for Federal income tax purposes as a mutual or 

cooperative company under the fundamental cooperative principles 

described above. 

EFFECTIVE DATE

This provision is effective for taxable years beginning after the 

date of enactment. 

C. SALES OR DISPOSITIONS TO IMPLEMENT FEDERAL ENERGY REGU- LATORY COMMISSION OR STATE ELECTRIC RESTRUCTURING POLICY

(Sec. 603 of the Bill and Sec. 451 of the Code) 

PRESENT LAW

Generally, a taxpayer recognizes gain to the extent the sales 

price (and any other consideration received) exceeds the seller’s 

basis in the property. The recognized gain is subject to current income tax unless the gain is deferred or not recognized under a special tax provision. 

REASONS FOR CHANGE

The Committee recognizes that electric deregulation has been occurring, and is continuing to occur, at both the Federal and State 

level. Federal and state energy regulators are calling for the 

‘‘unbundling’’ of electric transmission assets held by vertically integrated utilities, with the transmission assets ultimately placed 

under the ownership or control of independent transmission providers (or other similarly-approved operators). This policy is intended to improve transmission management and facilitate the formation of competitive markets. To facilitate the implementation of 

these policy objectives, the Committee believes it is appropriate to 

assist taxpayers in moving forward with industry restructuring by 

providing a tax deferral for gain associated with certain dispositions of electric transmission assets. 

EXPLANATION OF PROVISION

The provision permits a taxpayer to elect to recognize gain from 

a qualifying electric transmission transaction ratably over an eightyear period beginning in the year of sale. A qualifying electric 

transmission transaction is the sale or other disposition of property 

used by the taxpayer in the trade or business of providing electric 

transmission services, or an ownership interest in such an entity, 

72

68 In general, an independent transmission company is defined as: (1) a regional transmission 

organization approved by the FERC; (2) a person (i) who the FERC determines under section 

203 of the Federal Power Act is not a ‘‘market participant’’ and (ii) whose transmission facilities 

are placed under the operational control of a FERC-approved regional transmission organization 

before the close of the period specified in such authorization, but not later than January 1, 2008; 

or (3) in the case of facilities subject to the exclusive jurisdiction of the Public Utility Commission of Texas, a person who is approved by that commission as consistent with Texas state law 

regarding an independent transmission organization. 69The provision also provides that the installment sale rules shall not apply to any qualifying 

electric transmission transaction that elects the application of this provision. 

to an independent transmission company 68 prior to January 1, 

2008. 

A taxpayer electing the application of the provision is required 

to attach a statement to that effect in the tax return for the taxable 

year in which the transaction takes place in the manner as the 

Secretary shall prescribe. The election shall be binding for that taxable year and all subsequent taxable years.69

EFFECTIVE DATE

The provision is effective for transactions occurring after the date 

of enactment.

TITLE VII—ADDITIONAL PROVISIONS 

A. EXTENSION OF ACCELERATED DEPRECIATION AND WAGE CREDIT

BENEFITS ON INDIAN RESERVATIONS

(Sec. 701 of the Bill and Secs. 45A and 168(j) of the Code) 

PRESENT LAW

Present law includes the following tax incentives for businesses 

located within Indian reservations. 

Accelerated depreciation 

With respect to certain property used in connection with the conduct of a trade or business within an Indian reservation, depreciation deductions under section 168(j) will be determined using the 

following recovery periods:

3-year property ................................................................................................ 2 years 

5-year property ................................................................................................ 3 years 

7-year property ................................................................................................ 4 years 

10-year property .............................................................................................. 6 years 

15-year property .............................................................................................. 9 years 

20-year property .............................................................................................. 12 years 

Nonresidential real property .......................................................................... 22 years

‘‘Qualified Indian reservation property’’ eligible for accelerated 

depreciation includes property which is (1) used by the taxpayer 

predominantly in the active conduct of a trade or business within 

an Indian reservation, (2) not used or located outside the reservation on a regular basis, (3) not acquired (directly or indirectly) by 

the taxpayer from a person who is related to the taxpayer (within 

the meaning of section 465(b)(3)(C)), and (4) described in the recovery-period table above. In addition, property is not ‘‘qualified Indian reservation property’’ if it is placed in service for purposes of 

conducting gaming activities. Certain ‘‘qualified infrastructure 

property’’ may be eligible for the accelerated depreciation even if located outside an Indian reservation, provided that the purpose of 

73

such property is to connect with qualified infrastructure property 

located within the reservation (e.g., roads, power lines, water systems, railroad spurs, and communications facilities). 

The depreciation deduction allowed for regular tax purposes is 

also allowed for purposes of the alternative minimum tax. The accelerated depreciation for Indian reservations is available with respect to property placed in service on or after January 1, 1994, and 

before January 1, 2005. 

Indian employment credit 

In general, a credit against income tax liability is allowed to employers for the first $20,000 of qualified wages and qualified employee health insurance costs paid or incurred by the employer 

with respect to certain employees (sec. 45A). The credit is equal to 

20 percent of the excess of eligible employee qualified wages and 

health insurance costs during the current year over the amount of 

such wages and costs incurred by the employer during 1993. The 

credit is an incremental credit, such that an employer’s currentyear qualified wages and qualified employee health insurance costs 

(up to $20,000 per employee) are eligible for the credit only to the 

extent that the sum of such costs exceeds the sum of comparable 

costs paid during 1993. No deduction is allowed for the portion of 

the wages equal to the amount of the credit. 

Qualified wages means wages paid or incurred by an employer 

for services performed by a qualified employee. A qualified employee means any employee who is an enrolled member of an Indian tribe or the spouse of an enrolled member of an Indian tribe, 

who performs substantially all of the services within an Indian reservation, and whose principal place of abode while performing such 

services is on or near the reservation in which the services are performed. An employee will not be treated as a qualified employee for 

any taxable year of the employer if the total amount of wages paid 

or incurred by the employer with respect to such employee during 

the taxable year exceeds an amount determined at an annual rate 

of $30,000 (adjusted for inflation after 1993). 

The wage credit is available for wages paid or incurred on or 

after January 1, 1994, in taxable years that begin before December 

31, 2004. 

REASONS FOR CHANGE

The Committee recognizes the significant potential on Indian 

lands for development of energy resources and other projects. The 

special nature of Native American tribes and high poverty rates in 

certain areas in some circumstances create unique barriers to development that these incentives help overcome. The Committee understands that a significant portion of these incentives are used in 

development of energy projects. 

The Committee concluded that extending the accelerated depreciation and wage credit tax incentives within Indian reservations 

will both increase the supply of energy and expand business and 

employment opportunities in these areas. 

74

EXPLANATION OF PROVISION

Accelerated depreciation 

The provision extends the accelerated depreciation incentive for 

one year (to property placed in service before January 1, 2006). 

Indian employment credit 

The provision extends the Indian employment credit incentive for 

one year (to taxable years beginning before January 1, 2006). 

EFFECTIVE DATE

The provision is effective on the date of enactment.

B. GAO STUDY

(Sec. 702 of the Bill) 

PRESENT LAW

Present law does not require study of the present law provisions 

relating to clean fuel vehicles and electric vehicles. 

REASONS FOR CHANGE

The Committee believes it is important to gain information on 

the value of benefits compared to costs in order to make informed 

decisions regarding the propriety of special tax treatment of various products or technologies designed to reduce dependence on petroleum, reduce emissions of pollutants, or to promote energy conservation. The Committee believes it is important to have measures 

of the amount of conservation or reduction in pollution that results 

from provisions designed to achieve such results. 

EXPLANATION OF PROVISION

The bill directs the Comptroller General to undertake an ongoing 

analysis of the effectiveness of the tax credits allowed to alternative motor vehicles and the tax credits allowed to various alternative fuels under Title II of the bill and the tax credits and enhanced deductions allowed for energy conservation and efficiency 

under Title III of the bill. The studies should estimate the energy 

savings and reductions in pollutants achieved from taxpayer utilization of these provisions. The studies should estimate the dollar 

value of the benefits of reduced energy consumption and reduced 

air pollution in comparison to estimates of the revenue cost of these 

provisions to the U.S. Treasury. The studies should include an 

analysis of the distribution of the taxpayers who utilize these provisions by income and other relevant characteristics. 

The bill directs the Comptroller General to submit annual reports to Congress beginning not later than December 31, 2004. 

EFFECTIVE DATE

The provision is effective on the date of enactment. 

75

70The 0.1 cent per gallon for the LUST Trust Fund applies so long as there is a tax imposed 

on rail diesel and the LUST Trust Fund tax is in effect (secs. 4041(d)(1) and (3), and 4081(d)(3)). 

C. REPEAL CERTAIN EXCISE TAXES ON RAIL DIESEL FUEL AND

INLAND WATERWAY BARGE FUELS

(Sec. 703 of the Bill and Secs. 4041 and 4042 of the Code) 

PRESENT LAW

Under present law, diesel fuel used in trains is subject to a 4.4-

cents-per-gallon excise tax. Revenues from 4.3 cents per gallon of 

this excise tax are retained in the General Fund of the Treasury. 

The remaining 0.1 cent per gallon is deposited in the Leaking Underground Storage Tank (‘‘LUST’’) Trust Fund.70

Similarly, fuel used in barges operating on the designated inland 

waterways system is subject to a 4.3-cents-per-gallon General Fund 

excise tax. This tax is in addition to the 20.1-cents-per-gallon tax 

rates that is imposed on fuels used in these barges to fund the Inland Waterways Trust Fund and the Leaking Underground Storage 

Tank Trust Fund. 

In both cases, the 4.3-cents-per-gallon excise tax rates are permanent. The LUST Trust Fund tax is scheduled to expire after March 

31, 2005. 

REASONS FOR CHANGE

The Committee notes that in 1993, the Congress enacted the 

present-law 4.3-cents-per-gallon excise tax on motor fuels as a deficit reduction measure, with the receipts payable to the General 

Fund. Since that time, the Congress has diverted the 4.3-cents-pergallon excise tax for most uses to specified trust funds that provide 

benefits for those motor fuel users who ultimately bear the burden 

of these taxes. As a result, the Committee finds that generally only 

rail and barge operators remain as motor fuel users subject to the 

4.3-cents-per-gallon excise tax who receive no benefits from a dedicated trust fund as a result of their tax burden. The Committee observes that rail and barge operators compete with other transportation service providers who benefit from expenditures paid from 

dedicated trust funds. The Committee concludes that it is inequitable and distortive of transportation decisions to continue to impose the 4.3-cents-per-gallon excise tax on diesel fuel used in trains 

and barges. 

EXPLANATION OF PROVISION

The 4.3-cents-per-gallon General Fund excise tax rate on diesel 

fuel used in trains and fuels used in barges operating on the designated inland waterways system is repealed. The 0.1 cent per gallon for the Leaking Underground Storage Tank (‘‘LUST’’) Trust 

Fund is unchanged by the provision. 

EFFECTIVE DATE

The proposal is effective on January 1, 2004.

76

71Sec. 41(c)(4). 

D. MODIFY RESEARCH CREDIT FOR RESEARCH RELATING TO ENERGY

(Sec. 704 of the Bill and Sec. 41 of the Code) 

PRESENT LAW

General rule 

Section 41 provides for a research tax credit equal to 20 percent 

of the amount by which a taxpayer’s qualified research expenses 

for a taxable year exceed its base amount for that year. The research tax credit is scheduled to expire and generally will not apply 

to amounts paid or incurred after June 30, 2004. 

A 20-percent research tax credit also applied to the excess of (1) 

100 percent of corporate cash expenses (including grants or contributions) paid for basic research conducted by universities (and 

certain nonprofit scientific research organizations) over (2) the sum 

of (a) the greater of two minimum basic research floors plus (b) an 

amount reflecting any decrease in nonresearch giving to universities by the corporation as compared to such giving during a fixedbase period, as adjusted for inflation. This separate credit computation is commonly referred to as the university basic research credit 

(see sec. 41(e)). 

Alternative incremental research credit regime 

Taxpayers are allowed to elect an alternative incremental research credit regime.71 If a taxpayer elects to be subject to this alternative regime, the taxpayer is assigned a three-tiered fixed-base 

percentage (that is lower than the fixed-base percentage otherwise 

applicable under present law) and the credit rate likewise is reduced. Under the alternative credit regime, a credit rate of 2.65 

percent applies to the extent that a taxpayer’s current-year research expenses exceed a base amount computed by using a fixedbase percentage of one percent (i.e., the base amount equals one 

percent of the taxpayer’s average gross receipts for the four preceding years) but do not exceed a base amount computed by using 

a fixed-base percentage of 1.5 percent. A credit rate of 3.2 percent 

applies to the extent that a taxpayer’s current-year research expenses exceed a base amount computed by using a fixed-base percentage of 1.5 percent but do not exceed a base amount computed 

by using a fixed-base percentage of two percent. A credit rate of 

3.75 percent applies to the extent that a taxpayer’s current-year research expenses exceed a base amount computed by using a fixedbase percentage of two percent. An election to be subject to this alternative incremental credit regime may be made for any taxable 

year beginning after June 30, 1996, and such an election applies 

to that taxable year and all subsequent years unless revoked with 

the consent of the Secretary of the Treasury. 

Eligible expenses 

Qualified research expenses eligible for the research tax credit 

consist of: (1) in-house expenses of the taxpayer for wages and supplies attributable to qualified research; (2) certain time-sharing 

costs for computer use in qualified research; and (3) 65 percent of 

77

72 Allowable expenditures for the purpose of the credit include contributions to an energy research consortium. 

amounts paid or incurred by the taxpayer to certain other persons 

for qualified research conducted on the taxpayer’s behalf (so-called 

contract research expenses). In the case of amounts paid to a research consortium, 75 percent of amounts paid for qualified research is treated as qualified research expenses eligible for the research credit (rather than 65 percent under the general rule) if (1) 

such research consortium is a tax-exempt organization that is described in section 501(c)(3) (other than a private foundation) or section 501(c)(6) and is organized and operated primarily to conduct 

scientific research, and (2) such qualified research is conducted by 

the consortium on behalf of the taxpayer and one or more persons 

not related to the taxpayer. 

To be eligible for the credit, the research must not only satisfy 

the requirements of present-law section 174 for the deduction for 

research expenses, but must be undertaken for the purpose of discovering information that is technological in nature, the application 

of which is intended to be useful in the development of a new or 

improved business component of the taxpayer, and substantially all 

of the activities of which must constitute elements of a process of 

experimentation for functional aspects, performance, reliability, or 

quality of a business component. 

REASONS FOR CHANGE

The Committee believes that research into energy production and 

energy conservation will help reduce pollution and enhance energy 

independence in the future. 

EXPLANATION OF PROVISION

The bill modifies the present-law research credit as it applies to 

qualified energy research. In particular, the provision provides that 

the taxpayer may claim a credit equal to 20 percent of the taxpayer’s expenditures on qualified energy research undertaken by 

an energy research consortium.72 The amount of credit claimed is 

determined only by regard to such expenditures by the taxpayer 

within the taxable year. Unlike the general rule for the research 

credit, the 20-percent credit for research by an energy research consortium applies to all such expenditures, not only those in excess 

of a base amount however determined. An energy research consortium is a qualified research consortium as under present law that 

also is organized and operated primarily to conduct energy research and development in the public interest and to which at least 

five unrelated persons paid, or incurred amounts, to such organization within the calendar year. In addition, to be a qualified energy 

research consortium no single person shall pay or incur more than 

50 percent of the total amounts received by the research consortium during the calendar year. 

The bill also provides that 100 percent of amounts paid or incurred by the taxpayer to eligible small businesses, universities, 

and Federal for qualified energy research would constitute qualified research expenses as contract research expenses, rather than 

65 percent of qualified research expenditures allowed under 

78

73On February 27, 2003, the Treasury Department and the IRS released final regulations regarding the disclosure of reportable transactions. In general, the regulations are effective for 

transactions entered into on or after February 28, 2003. 

The discussion of present law refers to the new regulations. The rules that apply with respect 

to transactions entered into on or before February 28, 2003, are contained in Treas. Reg. sec. 

1.6011–4T in effect on the date the transaction was entered into. 74The regulations clarify that the term ‘‘substantially similar’’ includes any transaction that 

is expected to obtain the same or similar types of tax consequences and that is either factually 

similar or based on the same or similar tax strategy. Further, the term must be broadly construed in favor of disclosure. Treas. Reg. sec. 1–6011–4(c)(4). 75Treas. Reg. sec. 1.6011–4(b)(2). 76Treas. Reg. sec. 1.6011–4(b)(3). 

present law. An eligible small business for this purpose is a business in which the taxpayer does not own a 50 percent or greater 

interest and the business has employed, on average, 500 or fewer 

employees in the two preceding calendar years. 

Qualified energy research expenditures are expenditures that 

would otherwise qualify for the research credit under present law 

and relate to the production, supply, and conservation of energy, 

including otherwise qualifying research expenditures related to alternative energy sources or the use of alternative energy sources. 

For example, research relating to hydrogen fuel cell vehicles would 

qualify under this provision, if the research expenditures otherwise 

satisfy the criteria of present-law sec. 41. Likewise, otherwise 

qualifying research undertaken to improve the energy-efficiency of 

lighting would qualify under this provision. 

EFFECTIVE DATE

The provision is effective for amounts paid or incurred after the 

date of enactment in taxable years ending after such date.

TITLE VIII—REVENUE PROVISIONS 

A. PROVISIONS DESIGNED TO CURTAIL TAX SHELTERS

1. Penalty for failure to disclose reportable transactions (Sec. 801 

of the Bill and new Sec. 6707A of the Code) 

PRESENT LAW

Regulations under section 6011 require a taxpayer to disclose 

with its tax return certain information with respect to each ‘‘reportable transaction’’ in which the taxpayer participates.73

There are six categories of reportable transactions. The first category is any transaction that is the same as (or substantially similar to) 74 a transaction that is specified by the Treasury Department as a tax avoidance transaction whose tax benefits are subject 

to disallowance under present law (referred to as a ‘‘listed transaction’’).75

The second category is any transaction that is offered under conditions of confidentiality. In general, if a taxpayer’s disclosure of 

the structure or tax aspects of the transaction is limited in any way 

by an express or implied understanding or agreement with or for 

the benefit of any person who makes or provides a statement, oral 

or written, as to the potential tax consequences that may result 

from the transaction, it is considered offered under conditions of 

confidentiality (whether or not the understanding is legally binding).76

79

77Treas. Reg. sec. 1.6011–4(b)(4). 78Treas. Reg. sec. 1.6011–4(b)(5). IRS Rev. Proc. 2003–24, 2003–11 I.R.B. 599, exempts certain 

types of losses from this reportable transaction category. 79The significant book-tax category applies only to taxpayers that are reporting companies under the Securities Exchange Act of 1934 or business entities that have $250 million or more 

in gross assets. 80Treas. Reg. sec. 1.6011–4(b)(6). IRS Rev. Proc. 2003–25, 2003–11 I.R.B. 601, exempts certain 

types of transactions from this reportable transition category. 81Treas. Reg. sec. 1.6011–4(b)(7). 82Section 6664(c) provides that a taxpayer can avoid the imposition of a section 6662 accuracy-related penalty in cases where the taxpayer can demonstrate that there was reasonable 

cause for the underpayment and that the taxpayer acted in good faith. On December 31, 2002, 

the Treasury Department and IRS issued proposed regulations under sections 6662 and 6664 

(REG–126016–01) that limit the defenses available to the imposition of an accuracy-related penalty in connection with a reportable transaction when the transaction is not disclosed. 83 In this regard, the Committee has concerns with the outcomes and rationales used by courts 

in some recent decisions involving tax-motivated transactions. For a more detailed discussion 

of recent court decisions and other developments regarding tax shelters, see Joint Committee 

on Taxation, Background and Present Law Relating to Tax Shelters (JCX 19–02), March 19, 

2002. 

The third category of reportable transactions is any transaction 

for which (1) the taxpayer has the right to a full or partial refund 

of fees if the intended tax consequences from the transaction are 

not sustained or, (2) the fees are contingent on the intended tax 

consequences from the transaction being sustained.77

The fourth category of reportable transactions relates to any 

transaction resulting in a taxpayer claiming a loss (under section 

165) of at least (1) $10 million in any single year or $20 million 

in any combination of years by a corporate taxpayer or a partnership with only corporate partners; (2) $2 million in any single year 

or $4 million in any combination of years by all other partnerships, 

S corporations, trusts, and individuals; or (3) $50,000 in any single 

year for individuals or trusts if the loss arises with respect to foreign currency translation losses.78

The fifth category of reportable transactions refers to any transaction done by certain taxpayers 79 in which the tax treatment of 

the transaction differs (or is expected to differ) by more than $10 

million from its treatment for book purposes (using generally accepted accounting principles) in any year.80

The final category of reportable transactions is any transaction that results in a tax credit exceeding $250,000 (including a foreign 

tax credit) if the taxpayer holds the underlying asset for less than 

45 days.81

Under present law, there is no specific penalty for failing to disclose a reportable transaction; however, such a failure may jeopardize a taxpayer’s ability to claim that any income tax understatement attributable to such undisclosed transaction is due to reasonable cause, and that the taxpayer acted in good faith.82

REASONS FOR CHANGE

The Committee is aware that individuals and corporations are 

increasingly using sophisticated transactions to avoid or evade Federal income tax.83 Such a phenomenon could pose a serious threat 

to the efficacy of the tax system because of both the potential loss 

of revenue and the potential threat to the integrity and perceived 

fairness of the self-assessment system. 

The Committee over two years ago began working on legislation 

to address this significant compliance problem. In addition, the 

Treasury Department, using the tools available, issued regulations 

80

84The provision states that, except as provided in regulations, a listed transaction means a 

reportable transaction, which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011. For 

this purpose, it is expected that the definition of ‘‘substantially similar’’ will be the definition 

used in Treas. Reg. sec. 1.6011–4(c)(4). However, the Secretary may modify this definition (as 

well as the definitions of ‘‘listed transaction’’ and ‘‘reportable transactions’’) as appropriate. 

requiring disclosure of certain transactions and requiring organizers and promoters of tax-engineered transactions to maintain 

customer lists and make these lists available to the IRS. Nevertheless, the Committee believes that additional legislation is needed to 

provide the Treasury Department with additional tools to assist its 

efforts to curtail abusive transactions. Moreover, the Committee believes that a penalty for failing to make the required disclosures, 

when the imposition of such penalty is not dependent on the tax 

treatment of the underlying transaction ultimately being sustained, 

will provide an additional incentive for taxpayers to satisfy their 

reporting obligations under the new disclosure provisions. 

EXPLANATION OF PROVISION

In general 

The bill creates a new penalty for any person who fails to include 

with any return or statement any required information with respect to a reportable transaction. The new penalty applies without 

regard to whether the transaction ultimately results in an understatement of tax, and applies in addition to any accuracy-related 

penalty that may be imposed. 

Transactions to be disclosed 

The bill does not define the terms ‘‘listed transaction’’ 84 or ‘‘reportable transaction,’’ nor does the bill explain the type of information that must be disclosed in order to avoid the imposition of a 

penalty. Rather, the bill authorizes the Treasury Department to define a ‘‘listed transaction’’ and a ‘‘reportable transaction’’ under section 6011. 

Penalty rate 

The penalty for failing to disclose a reportable transaction is 

$50,000. The amount is increased to $100,000 if the failure is with 

respect to a listed transaction. For large entities and high net 

worth individuals, the penalty amount is doubled (i.e., $100,000 for 

a reportable transaction and $200,000 for a listed transaction). The 

penalty cannot be waived with respect to a listed transaction. As 

to reportable transactions, the penalty can be rescinded (or abated) 

only if: (1) the taxpayer on whom the penalty is imposed has a history of complying with the Federal tax laws, (2) it is shown that 

the violation is due to an unintentional mistake of fact, (3) imposing the penalty would be against equity and good conscience, and 

(4) rescinding the penalty would promote compliance with the tax 

laws and effective tax administration. The authority to rescind the 

penalty can only be exercised by the IRS Commissioner personally 

or the head of the Office of Tax Shelter Analysis. Thus, the penalty 

cannot be rescinded by a revenue agent, an Appeals officer, or any 

other IRS personnel. The decision to rescind a penalty must be accompanied by a record describing the facts and reasons for the acVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00088 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
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85 A reportable avoidance transaction is a reportable transaction with a significant tax avoidance purpose. 86Sec. 6662. 

tion and the amount rescinded. There will be no taxpayer right to 

appeal a refusal to rescind a penalty. The IRS also is required to 

submit an annual report to Congress summarizing the application 

of the disclosure penalties and providing a description of each penalty rescinded under this provision and the reasons for the rescission. 

A ‘‘large entity’’ is defined as any entity with gross receipts in excess of $10 million in the year of the transaction or in the preceding year. A ‘‘high net worth individual’’ is defined as any individual whose net worth exceeds $2 million, based on the fair market value of the individual’s assets and liabilities immediately before entering into the transaction. 

A public entity that is required to pay a penalty for failing to disclose a listed transaction (or is subject to an understatement penalty attributable to a non-disclosed listed transaction or a non-disclosed reportable avoidance transaction) 85 must disclose the imposition of the penalty in reports to the Securities and Exchange 

Commission for such period as the Secretary shall specify. The bill 

applies without regard to whether the taxpayer determines the 

amount of the penalty to be material to the reports in which the 

penalty must appear, and treats any failure to disclose a transaction in such reports as a failure to disclose a listed transaction. 

A taxpayer must disclose a penalty in reports to the Securities and 

Exchange Commission once the taxpayer has exhausted its administrative and judicial remedies with respect to the penalty (or if 

earlier, when paid). 

EFFECTIVE DATE

The bill is effective for returns and statements the due date for 

which is after the date of enactment.

2. Modifications to the accuracy-related penalties for listed transactions and reportable transactions having a significant tax 

avoidance purpose (Sec. 802 of the Bill and new Sec. 6662A of 

the Code) 

PRESENT LAW

The accuracy-related penalty applies to the portion of any underpayment that is attributable to (1) negligence, (2) any substantial 

understatement of income tax, (3) any substantial valuation 

misstatement, (4) any substantial overstatement of pension liabilities, or (5) any substantial estate or gift tax valuation understatement. If the correct income tax liability exceeds that reported by 

the taxpayer by the greater of 10 percent of the correct tax or 

$5,000 ($10,000 in the case of corporations), then a substantial understatement exists and a penalty may be imposed equal to 20 percent of the underpayment of tax attributable to the understatement.86 The amount of any understatement generally is reduced by 

any portion attributable to an item if (1) the treatment of the item 

is supported by substantial authority, or (2) facts relevant to the 

82

87Sec. 6662(d)(2)(B). 88Sec. 6662(d)(2)(C). 89Sec. 6664(c). 90Treas. Reg. sec. 1.6662–4(g)(4)(i)(B); Treas. Reg. sec. 1.6664–4(c). 91The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meanings as 

used for purposes of the penalty for failing to disclose reportable transactions. 

tax treatment of the item were adequately disclosed and there was 

a reasonable basis for its tax treatment.87

Special rules apply with respect to tax shelters.88 For understatements by non-corporate taxpayers attributable to tax shelters, the 

penalty may be avoided only if the taxpayer establishes that, in addition to having substantial authority for the position, the taxpayer 

reasonably believed that the treatment claimed was more likely 

than not the proper treatment of the item. This reduction in the 

penalty is unavailable to corporate tax shelters. 

The understatement penalty generally is abated (even with respect to tax shelters) in cases in which the taxpayer can demonstrate that there was ‘‘reasonable cause’’ for the underpayment 

and that the taxpayer acted in good faith.89 The relevant regulations provide that reasonable cause exists where the taxpayer ‘‘reasonably relies in good faith on an opinion based on a professional 

tax advisor’s analysis of the pertinent facts and authorities [that] 

* * * unambiguously concludes that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld 

if challenged’’ by the IRS.90

REASONS FOR CHANGE

Because the Treasury shelter initiative emphasizes combating 

abusive tax avoidance transactions by requiring increased disclosure of such transactions by all parties involved, the Committee believes that taxpayers should be subject to a strict liability penalty 

on an understatement of tax that is attributable to non-disclosed 

listed transactions or non-disclosed reportable transactions that 

have a significant purpose of tax avoidance. Furthermore, in order 

to deter taxpayers from entering into tax avoidance transactions, 

the Committee believes that a more meaningful (but less stringent) 

accuracy-related penalty should apply to such transactions even 

when disclosed. 

EXPLANATION OF PROVISION

In general 

The bill modifies the present-law accuracy related penalty by replacing the rules applicable to tax shelters with a new accuracy-related penalty that applies to listed transactions and reportable 

transactions with a significant tax avoidance purpose (hereinafter 

referred to as a ‘‘reportable avoidance transaction’’).91 The penalty 

rate and defenses available to avoid the penalty vary depending on 

whether the transaction was adequately disclosed. 

Disclosed transactions 

In general, a 20-percent accuracy-related penalty is imposed on 

any understatement attributable to an adequately disclosed listed 

transaction or reportable avoidance transaction. The only exception 

to the penalty is if the taxpayer satisfies a more stringent reasonVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00090 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
83

92For this purpose, any reduction in the excess of deductions allowed for the taxable year over 

gross income for such year, and any reduction in the amount of capital losses which would (without regard to section 1211) be allowed for such year, shall be treated as an increase in taxable 

income. 

able cause and good faith exception (hereinafter referred to as the 

‘‘strengthened reasonable cause exception’’), which is described 

below. The strengthened reasonable cause exception is available 

only if the relevant facts affecting the tax treatment are adequately 

disclosed, there is or was substantial authority for the claimed tax 

treatment, and the taxpayer reasonably believed that the claimed 

tax treatment was more likely than not the proper treatment. 

Undisclosed transactions 

If the taxpayer does not adequately disclose the transaction, the 

strengthened reasonable cause exception is not available (i.e., a 

strict-liability penalty applies), and the taxpayer is subject to an increased penalty rate equal to 30 percent of the understatement. 

In addition, a public entity that is required to pay the 30-percent 

penalty must disclose the imposition of the penalty in reports to 

the SEC for such periods as the Secretary shall specify. The disclosure to the SEC applies without regard to whether the taxpayer determines the amount of the penalty to be material to the reports 

in which the penalty must appear, and any failure to disclose such 

penalty in the reports is treated as a failure to disclose a listed 

transaction. A taxpayer must disclose a penalty in reports to the 

SEC once the taxpayer has exhausted its administrative and judicial remedies with respect to the penalty (or if earlier, when paid). 

Once the 30-percent penalty has been included in the Revenue 

Agent Report, the penalty cannot be compromised for purposes of 

a settlement without approval of the Commissioner personally or 

the head of the Office of Tax Shelter Analysis. Furthermore, the 

IRS is required to submit an annual report to Congress summarizing the application of this penalty and providing a description of 

each penalty compromised under this provision and the reasons for 

the compromise. 

Determination of the understatement amount 

The penalty is applied to the amount of any understatement attributable to the listed or reportable avoidance transaction without 

regard to other items on the tax return. For purposes of this bill, 

the amount of the understatement is determined as the sum of (1) 

the product of the highest corporate or individual tax rate (as appropriate) and the increase in taxable income resulting from the 

difference between the taxpayer’s treatment of the item and the 

proper treatment of the item (without regard to other items on the 

tax return),92 and (2) the amount of any decrease in the aggregate 

amount of credits which results from a difference between the taxpayer’s treatment of an item and the proper tax treatment of such 

item. 

Except as provided in regulations, a taxpayer’s treatment of an 

item shall not take into account any amendment or supplement to 

a return if the amendment or supplement is filed after the earlier 

of when the taxpayer is first contacted regarding an examination 

of the return or such other date as specified by the Secretary. 

84

93See the previous discussion regarding the penalty for failing to disclose a reportable transaction. 94The term ‘‘material advisor’’ (defined below in connection with the new information filing 

requirements for material advisors) means any person who provides any material aid, assistance, or advice with respect to organizing, promoting, selling, implementing, or carrying out any 

reportable transaction, and who derives gross income in excess of $50,000 in the case of a reportable transaction substantially all of the tax benefits from which are provided to natural persons ($250,000 in any other case). 95This situation could arise, for example, when an advisor has an arrangement or understanding (oral or written) with an organizer, manager, or promoter of a reportable transaction 

that such party will recommend or refer potential participants to the advisor for an opinion regarding the tax treatment of the transaction. 

Strengthened reasonable cause exception 

A penalty is not imposed under the bill with respect to any portion of an understatement if it shown that there was reasonable 

cause for such portion and the taxpayer acted in good faith. Such 

a showing requires (1) adequate disclosure of the facts affecting the 

transaction in accordance with the regulations under section 

6011,93 (2) that there is or was substantial authority for such treatment, and (3) that the taxpayer reasonably believed that such 

treatment was more likely than not the proper treatment. For this 

purpose, a taxpayer will be treated as having a reasonable belief 

with respect to the tax treatment of an item only if such belief (1) 

is based on the facts and law that exist at the time the tax return 

(that includes the item) is filed, and (2) relates solely to the taxpayer’s chances of success on the merits and does not take into account the possibility that (a) a return will not be audited, (b) the 

treatment will not be raised on audit, or (c) the treatment will be 

resolved through settlement if raised. 

A taxpayer may (but is not required to) rely on an opinion of a 

tax advisor in establishing its reasonable belief with respect to the 

tax treatment of the item. However, a taxpayer may not rely on an 

opinion of a tax advisor for this purpose if the opinion (1) is provided by a ‘‘disqualified tax advisor,’’ or (2) is a ‘‘disqualified opinion.’’ 

Disqualified tax advisor 

A disqualified tax advisor is any advisor who (1) is a material advisor 94 and who participates in the organization, management, promotion or sale of the transaction or is related (within the meaning 

of section 267 or 707) to any person who so participates, (2) is compensated directly or indirectly 95 by a material advisor with respect 

to the transaction, (3) has a fee arrangement with respect to the 

transaction that is contingent on all or part of the intended tax 

benefits from the transaction being sustained, or (4) as determined 

under regulations prescribed by the Secretary, has a continuing financial interest with respect to the transaction. 

Organization, management, promotion or sale of a transaction.—

A material advisor is considered as participating in the ‘‘organization’’ of a transaction if the advisor performs acts relating to the 

development of the transaction. This may include, for example, preparing documents (1) establishing a structure used in connection 

with the transaction (such as a partnership agreement), (2) describing the transaction (such as an offering memorandum or other 

statement describing the transaction), or (3) relating to the registration of the transaction with any federal, state or local governVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00092 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
85

96 An advisor should not be treated as participating in the organization of a transaction if the 

advisor’s only involvement with respect to the organization of the transaction is the rendering 

of an opinion regarding the tax consequences of such transaction. However, such an advisor may 

be a ‘‘disqualified tax advisor’’ with respect to the transaction if the advisor participates in the 

management, promotion or sale of the transaction (or if the advisor is compensated by a material advisor, has a fee arrangement that is contingent on the tax benefits of the transaction, 

or as determined by the Secretary, has a continuing financial interest with respect to the transaction).

ment body.96 Participation in the ‘‘management’’ of a transaction 

means involvement in the decision-making process regarding any 

business activity with respect to the transaction. Participation in 

the ‘‘promotion or sale’’ of a transaction means involvement in the 

marketing or solicitation of the transaction to others. Thus, an advisor who provides information about the transaction to a potential 

participant is involved in the promotion or sale of a transaction, as 

is any advisor who recommends the transaction to a potential participant. 

Disqualified opinion 

An opinion may not be relied upon if the opinion (1) is based on 

unreasonable factual or legal assumptions (including assumptions 

as to future events), (2) unreasonably relies upon representations, 

statements, finding or agreements of the taxpayer or any other person, (3) does not identify and consider all relevant facts, or (4) fails 

to meet any other requirement prescribed by the Secretary. 

Coordination with other penalties 

Any understatement upon which a penalty is imposed under this 

bill is not subject to the accuracy-related penalty under section 

6662. However, such understatement is included for purposes of determining whether any understatement (as defined in sec. 

6662(d)(2)) is a substantial understatement as defined under section 6662(d)(1). 

The penalty imposed under this provision shall not apply to any 

portion of an understatement to which a fraud penalty is applied 

under section 6663. 

EFFECTIVE DATE

The bill is effective for taxable years ending after the date of enactment. 

3. Tax shelter exception to confidentiality privileges relating to taxpayer communications (Sec. 803 of the Bill and Sec. 7525 of the 

Code) 

PRESENT LAW

In general, a common law privilege of confidentiality exists for 

communications between an attorney and client with respect to the 

legal advice the attorney gives the client. The Code provides that, 

with respect to tax advice, the same common law protections of 

confidentiality that apply to a communication between a taxpayer 

and an attorney also apply to a communication between a taxpayer 

and a federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it 

86

97Sec. 6111(a). 98The tax shelter ratio is, with respect to any year, the ratio that the aggregate amount of 

the deductions and 350 percent of the credits, which are represented to be potentially allowable 

to any investor, bears to the investment base (money plus basis of assets contributed) as of the 

close of the tax year. 99Sec. 6111(c). 100Sec. 6111(d). 101Treas. Reg. sec. 301.6111–2(b)(2). 

were between a taxpayer and an attorney. This rule is inapplicable 

to communications regarding corporate tax shelters. 

REASONS FOR CHANGE

The Committee believes that the rule currently applicable to corporate tax shelters should be applied to all tax shelters, regardless 

of whether or not the participant is a corporation. 

EXPLANATION OF PROVISION

The bill modifies the rule relating to corporate tax shelters by 

making it applicable to all tax shelters, whether entered into by 

corporations, individuals, partnerships, tax-exempt entities, or any 

other entity. Accordingly, communications with respect to tax shelters are not subject to the confidentiality provision of the Code that 

otherwise applies to a communication between a taxpayer and a 

federally authorized tax practitioner. 

EFFECTIVE DATE

The bill is effective with respect to communications made on or 

after the date of enactment. 

4. Disclosure of reportable transactions by material advisors (Secs. 

804 and 805 of the Bill and Secs. 6111 and 6707 of the Code) 

PRESENT LAW

Registration of tax shelter arrangements 

An organizer of a tax shelter is required to register the shelter 

with the Secretary not later than the day on which the shelter is 

first offered for sale.97 A ‘‘tax shelter’’ means any investment with 

respect to which the tax shelter ratio 98 for any investor as of the 

close of any of the first five years ending after the investment is 

offered for sale may be greater than two to one and which is: (1) 

required to be registered under Federal or State securities laws, (2) 

sold pursuant to an exemption from registration requiring the filing of a notice with a Federal or State securities agency, or (3) a 

substantial investment (greater than $250,000 and at least five investors).99

Other promoted arrangements are treated as tax shelters for 

purposes of the registration requirement if: (1) a significant purpose of the arrangement is the avoidance or evasion of Federal income tax by a corporate participant; (2) the arrangement is offered 

under conditions of confidentiality; and (3) the promoter may receive fees in excess of $100,000 in the aggregate.100

In general, a transaction has a ‘‘significant purpose of avoiding 

or evading Federal income tax’’ if the transaction: (1) is the same 

as or substantially similar to a ‘‘listed transaction,’’ 101 or (2) is 

87

102Treas. Reg. sec. 301.6111–2(b)(3). 103Treas. Reg. sec. 301.6111–2(b)(4). 104The regulations provide that the determination of whether an arrangement is offered 

under conditions of confidentiality is based on all the facts and circumstances surrounding the 

offer. If an offeree’s disclosure of the structure or tax aspects of the transaction are limited in 

any way by an express or implied understanding or agreement with or for the benefit of a tax 

shelter promoter, an offer is considered made under conditions of confidentiality, whether or not 

such understanding or agreement is legally binding. Treas. Reg. sec. 301.6111–2(c)(1). 105Sec. 6707. 

structured to produce tax benefits that constitute an important 

part of the intended results of the arrangement and the promoter 

reasonably expects to present the arrangement to more than one 

taxpayer.102 Certain exceptions are provided with respect to the 

second category of transactions.103

An arrangement is offered under conditions of confidentiality if: 

(1) an offeree has an understanding or agreement to limit the disclosure of the transaction or any significant tax features of the 

transaction; or (2) the promoter knows, or has reason to know that 

the offeree’s use or disclosure of information relating to the transaction is limited in any other manner.104

Failure to register tax shelter 

The penalty for failing to timely register a tax shelter (or for filing false or incomplete information with respect to the tax shelter 

registration) generally is the greater of one percent of the aggregate amount invested in the shelter or $500.105 However, if the tax 

shelter involves an arrangement offered to a corporation under conditions of confidentiality, the penalty is the greater of $10,000 or 

50 percent of the fees payable to any promoter with respect to offerings prior to the date of late registration. Intentional disregard 

of the requirement to register increases the penalty to 75 percent 

of the applicable fees. Section 6707 also imposes (1) a $100 penalty on the promoter for 

each failure to furnish the investor with the required tax shelter 

identification number, and (2) a $250 penalty on the investor for 

each failure to include the tax shelter identification number on a 

return. 

REASONS FOR CHANGE

The Committee has been advised that the current promoter registration rules have not proven particularly effective, in part because the rules are not appropriate for the kinds of abusive transactions now prevalent, and because the limitations regarding confidential corporate arrangements have proven easy to circumvent. 

The Committee believes that providing a single, clear definition 

regarding the types of transactions that must be disclosed by taxpayers and material advisors, coupled with more meaningful penalties for failing to disclose such transactions, are necessary tools 

if the effort to curb the use of abusive tax avoidance transactions 

is to be effective. 

EXPLANATION OF PROVISION

Disclosure of reportable transactions by material advisors 

The bill repeals the present law rules with respect to registration 

of tax shelters. Instead, the bill requires each material advisor with 

88

106The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 107See the previous discussion regarding the disclosure requirements under new section 

6707A. 108The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 109The Secretary’s present-law authority to postpone certain tax-related deadlines because of 

Presidentially-declared disasters (sec. 7508A) will also encompass the authority to postpone the 

reporting deadlines established by the provision. 

respect to any reportable transaction (including any listed transaction)106 to timely file an information return with the Secretary 

(in such form and manner as the Secretary may prescribe). The return must be filed on such date as specified by the Secretary. 

The information return will include (1) information identifying 

and describing the transaction, (2) information describing any potential tax benefits expected to result from the transaction, and (3) 

such other information as the Secretary may prescribe. It is expected that the Secretary may seek from the material advisor the 

same type of information that the Secretary may request from a 

taxpayer in connection with a reportable transaction.107

A ‘‘material advisor’’ means any person (1) who provides material 

aid, assistance, or advice with respect to organizing, promoting, 

selling, implementing, or carrying out any reportable transaction, 

and (2) who directly or indirectly derives gross income in excess of 

$250,000 ($50,000 in the case of a reportable transaction substantially all of the tax benefits from which are provided to natural persons) for such advice or assistance. 

The Secretary may prescribe regulations which provide (1) that 

only one material advisor has to file an information return in cases 

in which two or more material advisors would otherwise be required to file information returns with respect to a particular reportable transaction, (2) exemptions from the requirements of this 

section, and (3) other rules as may be necessary or appropriate to 

carry out the purposes of this section (including, for example, rules 

regarding the aggregation of fees in appropriate circumstances). 

Penalty for failing to furnish information regarding reportable 

transactions 

The bill repeals the present law penalty for failure to register tax 

shelters. Instead, the bill imposes a penalty on any material advisor who fails to file an information return, or who files a false or 

incomplete information return, with respect to a reportable transaction (including a listed transaction).108 The amount of the pen- alty is $50,000. If the penalty is with respect to a listed transaction, the amount of the penalty is increased to the greater of (1) 

$200,000, or (2) 50 percent of the gross income of such person with 

respect to aid, assistance, or advice which is provided with respect 

to the transaction before the date the information return that includes the transaction is filed. Intentional disregard by a material 

advisor of the requirement to disclose a listed transaction increases 

the penalty to 75 percent of the gross income. 

The penalty cannot be waived with respect to a listed transaction. As to reportable transactions, the penalty can be rescinded 

(or abated) only in exceptional circumstances.109 All or part of the 

penalty may be rescinded only if: (1) the material advisor on whom 

the penalty is imposed has a history of complying with the Federal 

89

110Sec. 6112. 111Treas. Reg. sec. 301–6112–1. 112 A special rule applies the list maintenance requirements to transactions entered into after 

February 28, 2000 if the transaction becomes a listed transaction (as defined in Treas. Reg. 

1.6011–4) after February 28, 2003. 113Treas. Reg. sec. 301.6112–1(c)(1). 

tax laws, (2) it is shown that the violation is due to an unintentional mistake of fact, (3) imposing the penalty would be against 

equity and good conscience, and (4) rescinding the penalty would 

promote compliance with the tax laws and effective tax administration. The authority to rescind the penalty can only be exercised by 

the Commissioner personally or the head of the Office of Tax Shelter Analysis; this authority to rescind cannot otherwise be delegated by the Commissioner. Thus, the penalty cannot be rescinded 

by a revenue agent, an Appeals officer, or other IRS personnel. The 

decision to rescind a penalty must be accompanied by a record describing the facts and reasons for the action and the amount rescinded. There will be no right to appeal a refusal to rescind a penalty. The IRS also is required to submit an annual report to Congress summarizing the application of the disclosure penalties and 

providing a description of each penalty rescinded under this provision and the reasons for the rescission. 

EFFECTIVE DATE

The provision requiring disclosure of reportable transactions by 

material advisors applies to transactions with respect to which material aid, assistance or advice is provided after the date of enactment. 

The provision imposing a penalty for failing to disclose reportable 

transactions applies to returns the due date for which is after the 

date of enactment. 

5. Investor lists and modification of penalty for failure to maintain 

investor lists (Secs. 804 and 806 of the Bill and Secs. 6112 and 

6708 of the Code) 

PRESENT LAW

Investor lists 

Any organizer or seller of a potentially abusive tax shelter must 

maintain a list identifying each person who was sold an interest in 

any such tax shelter with respect to which registration was required under section 6111 (even though the particular party may 

not have been subject to confidentiality restrictions).110 Recently 

issued regulations under section 6112 contain rules regarding the 

list maintenance requirements.111 In general, the regulations apply 

to transactions that are potentially abusive tax shelters entered 

into, or acquired after, February 28, 2003.112

The regulations provide that a person is an organizer or seller 

of a potentially abusive tax shelter if the person is a material advisor with respect to that transaction.113 A material advisor is defined as any person who is required to register the transaction 

under section 6111, or expects to receive a minimum fee of (1) 

$250,000 for a transaction that is a potentially abusive tax shelter 

if all participants are corporations, or (2) $50,000 for any other 

90

114Treas. Reg. sec. 301.6112–1(c)(2) and (3). 115Treas. Reg. sec. 301.6112–1(b). 116Sec. 6112(c)(2). 117The term ‘‘material advisor’’ has the same meaning as when used in connection with the 

requirement to file an information return under section 6111. 118The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 

transaction that is a potentially abusive tax shelter.114 For listed 

transactions (as defined in the regulations under section 6011), the 

minimum fees are reduced to $25,000 and $10,000, respectively. 

A potentially abusive tax shelter is any transaction that (1) is required to be registered under section 6111, (2) is a listed transaction (as defined under the regulations under section 6011), or (3) 

any transaction that a potential material advisor, at the time the 

transaction is entered into, knows is or reasonably expects will become a reportable transaction (as defined under the new regulations under section 6011).115

The Secretary is required to prescribe regulations which provide 

that, in cases in which two or more persons are required to maintain the same list, only one person would be required to maintain 

the list.116

Penalties for failing to maintain investor lists 

Under section 6708, the penalty for failing to maintain the list required under section 6112 is $50 for each name omitted from the 

list (with a maximum penalty of $100,000 per year). 

REASONS FOR CHANGE

The Committee has been advised that the present-law penalties 

for failure to maintain customer lists are not meaningful and that 

promoters often have refused to provide requested information to 

the IRS. The Committee believes that requiring material advisors 

to maintain a list of advisees with respect to each reportable transaction, coupled with more meaningful penalties for failing to maintain an investor list, are important tools in the ongoing efforts to 

curb the use of abusive tax avoidance transactions. 

EXPLANATION OF PROVISION

Investor lists 

Each material advisor 117 with respect to a reportable transaction 

(including a listed transaction) 118 is required to maintain a list 

that (1) identifies each person with respect to whom the advisor 

acted as a material advisor with respect to the reportable transaction, and (2) contains other information as may be required by 

the Secretary. In addition, the bill authorizes (but does not require) 

the Secretary to prescribe regulations which provide that, in cases 

in which 2 or more persons are required to maintain the same list, 

only one person would be required to maintain the list. 

Penalty for failing to maintain investor lists 

The bill modifies the penalty for failing to maintain the required 

list by making it a time-sensitive penalty. Thus, a material advisor 

who is required to maintain an investor list and who fails to make 

the list available upon written request by the Secretary within 20 

91

119 In no event will failure to maintain a list be considered reasonable cause for failing to 

make a list available to the Secretary. 120Sec. 6700. 

business days after the request will be subject to a $10,000 per day 

penalty. The penalty applies to a person who fails to maintain a 

list, maintains an incomplete list, or has in fact maintained a list 

but does not make the list available to the Secretary. The penalty 

can be waived if the failure to make the list available is due to reasonable cause.119

EFFECTIVE DATE

The provision requiring a material advisor to maintain an investor list applies to transactions with respect to which material aid, 

assistance or advice is provided after the date of enactment. 

The provision imposing a penalty for failing to maintain investor 

lists applies to requests made after the date of enactment. 

6. Penalties on promoters of tax shelters (Sec. 807 of the Bill and 

Sec. 6700 of the Code) 

PRESENT LAW

A penalty is imposed on any person who organizes, assists in the 

organization of, or participates in the sale of any interest in, a 

partnership or other entity, any investment plan or arrangement, 

or any other plan or arrangement, if in connection with such activity the person makes or furnishes a qualifying false or fraudulent 

statement or a gross valuation overstatement.120 A qualified false 

or fraudulent statement is any statement with respect to the allowability of any deduction or credit, the excludability of any income, 

or the securing of any other tax benefit by reason of holding an interest in the entity or participating in the plan or arrangement 

which the person knows or has reason to know is false or fraudulent as to any material matter. A ‘‘gross valuation overstatement’’ 

means any statement as to the value of any property or services 

if the stated value exceeds 200 percent of the correct valuation, and 

the value is directly related to the amount of any allowable income 

tax deduction or credit. 

The amount of the penalty is $1,000 (or, if the person establishes 

that it is less, 100 percent of the gross income derived or to be derived by the person from such activity). A penalty attributable to 

a gross valuation misstatement can be waived on a showing that 

there was a reasonable basis for the valuation and it was made in 

good faith. 

REASONS FOR CHANGE

The Committee believes that the present-law penalty rate is insufficient to deter the type of conduct that gives rise to the penalty. 

EXPLANATION OF PROVISION

The bill modifies the penalty amount to equal 50 percent of the 

gross income derived by the person from the activity for which the 

penalty is imposed. The new penalty rate applies to any activity 

that involves a statement regarding the tax benefits of particiVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00099 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
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121Secs. 951–964. 

pating in a plan or arrangement if the person knows or has reason 

to know that such statement is false or fraudulent as to any material matter. The enhanced penalty does not apply to a gross valuation overstatement. 

EFFECTIVE DATE

The bill is effective for activities after the date of enactment. 

B. PROVISIONS TO DISCOURAGE CORPORATE EXPATRIATION

1. Tax treatment of inversion transactions (Sec. 821 of the Bill and 

new Sec. 7874 of the Code) 

PRESENT LAW

Determination of corporate residence 

The U.S. tax treatment of a multinational corporate group depends significantly on whether the 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 foreignsource income of a domestic corporation, a foreign tax credit for income taxes paid to foreign countries is provided to reduce or eliminate the U.S. tax owed on such income, subject to certain limitations. 

Income earned by a domestic parent corporation from foreign operations conducted by foreign corporate subsidiaries generally is 

subject to U.S. tax when the income is distributed as a dividend 

to the domestic corporation. Until such repatriation, the U.S. tax 

on such income 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 F 121 and the passive foreign investment 

93

122Secs. 1291–1298. 

company rules. 122 A foreign tax credit is generally available to offset, in whole or in part, the U.S. tax owed on this foreign-source 

income, whether repatriated as an actual dividend or included 

under one of the anti-deferral regimes. 

U.S. taxation of foreign corporations 

The United States taxes foreign corporations only on income that 

has a sufficient nexus to the United States. Thus, a foreign corporation is generally subject to U.S. tax only on income that is ‘‘effectively connected’’ with the conduct of a trade or business in the 

United States. Such ‘‘effectively connected income’’ generally is 

taxed in the same manner and at the same rates as the income of 

a U.S. corporation. An applicable tax treaty may limit the imposition of U.S. tax on business operations of a foreign corporation to 

cases in which the business is conducted through a ‘‘permanent establishment’’ in the United States. 

In addition, foreign corporations generally are subject to a grossbasis U.S. tax at a flat 30-percent rate on the receipt of interest, 

dividends, rents, royalties, and certain similar types of income derived from U.S. sources, subject to certain exceptions. The tax generally is collected by means of withholding by the person making 

the payment. This tax may be reduced or eliminated under an applicable tax treaty. 

U.S. tax treatment of inversion transactions 

Under present law, 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 inVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00101 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
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come through various ‘‘earnings stripping’’ or other transactions. 

This may include earnings stripping through payment by a U.S. 

corporation of deductible amounts such as interest, royalties, rents, 

or management service fees to the new foreign parent or other foreign affiliates. In this respect, the post-inversion structure enables 

the group to employ the same tax reduction strategies that are 

available to other multinational corporate groups with foreign parents and U.S. subsidiaries, subject to the same limitations. 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. 

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. 

REASONS FOR CHANGE

The Committee believes that inversion transactions resulting in 

a minimal presence in a foreign country of incorporation are a 

means of avoiding U.S. tax and should be curtailed. In particular, 

these transactions permit corporations and other entities to continue to conduct business in the same manner as they did prior to 

the inversion, but with the result that the inverted entity avoids 

U.S. tax on foreign operations and may engage in earnings-stripping techniques to avoid U.S. tax on domestic operations. The Committee believes that certain inversion transactions (involving 80 

percent or greater identity of stock ownership) have little or no 

non-tax effect or purpose and should be disregarded for U.S. tax 

purposes. The Committee believes that other inversion transactions 

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

ownership) may have sufficient non-tax effect and purpose to be reVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00102 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
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123 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. 124Since 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, with respect to inversion transactions completed before 2004, regulated investment 

companies and certain similar entities are allowed to elect to recognize gain as if sec. 367(a) 

did apply. 

spected, but warrant heightened scrutiny and other restrictions to 

ensure that the U.S. tax base is not eroded through related-party 

transactions. 

EXPLANATION OF PROVISION

In general 

The provision 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; 123 (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.124

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. 

96

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, 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 taxVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00104 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
97

payer: (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 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 foreign-incorporated 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 

98

125 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. 126 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. 

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 (Sec. 822 of the Bill and new Sec. 5000A and Sec. 275(a) 

of the Code) 

PRESENT LAW

The income taxation of a nonstatutory 125 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.126 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. 

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. 

99

127 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. 128 An officer is defined as the president, principal financial officer, principal accounting officer 

(or, if there is no such accounting officer, the controller), any vice-president in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policymaking functions. 129 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. 

REASONS FOR CHANGE

The Committee believes that certain inversion transactions are a 

means of avoiding U.S. tax and should be curtailed. The Committee 

is concerned that, while shareholders are generally required to recognize gain upon stock inversion transactions, executives holding 

stock options and certain stock-based compensation are not taxed 

upon such transactions. Since such executives are often instrumental in deciding whether to engage in inversion transactions, the 

Committee believes that, upon certain inversion transactions, it is 

appropriate to impose an excise tax on certain executives holding 

stock options and stock-based compensation. 

EXPLANATION OF PROVISION

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,127 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)) 128 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. 

Specified stock compensation subject to the excise tax includes 

any payment 129 (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 

100

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. 

101

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 cashed-out 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 option-pricing 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 

102

130Sec. 845(a). 

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 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 em- ployee 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 sixmonth period before the inversion date.

3. Reinsurance agreements (Sec. 823 of the Bill and Sec. 845(a) of 

the Code) 

PRESENT LAW

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

authority to allocate among the parties or recharacterize income 

(whether investment income, premium or otherwise), deductions, 

assets, reserves, credits and any other items related to the reinsurance agreement, or make any other adjustment, in order to reflect 

the proper source and character of the items for each party.130 For 

this purpose, related persons are defined as in section 482. Thus, 

persons are related if they are organizations, trades or businesses 

103

131See 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). 132The authority to allocate, recharacterize or make other adjustments was granted in connection with the repeal of provisions relating to modified coinsurance transactions. 

(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.131 In addition, the provision also permits 

such allocation, recharacterization, or other adjustments in a case 

in which one of the parties to a reinsurance agreement is, with respect to any contract covered by the agreement, in effect an agent 

of another party to the agreement, or a conduit between related 

persons. 

REASONS FOR CHANGE

The Committee is concerned that reinsurance transactions are 

being used to allocate income, deductions, or other items inappropriately among U.S. and foreign related persons. The Committee is 

concerned that foreign related party reinsurance arrangements 

may be a technique for eroding the U.S. tax base. The Committee 

believes that the provision of present law permitting the Treasury 

Secretary to allocate or recharacterize items related to a reinsurance agreement should be applied to prevent misallocation, improper characterization, or to make any other adjustment in the 

case of such reinsurance transactions between U.S. and foreign related persons (or agents or conduits). The Committee also wishes 

to clarify that, in applying the authority with respect to reinsurance agreements, the amount, source or character of the items may 

be allocated, recharacterized or adjusted. 

EXPLANATION OF PROVISION

The provision 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 authority 132 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 adjustVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00111 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
104

133 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). 134These user fees were originally enacted in section 10511 of the Revenue Act of 1987 (Pub. 

Law No. 100–203, December 22, 1987). 135The proposal 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). 136Sec. 4131 

ment 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.

C. EXTENSION OF IRS USER FEES

(Sec. 831 of the Bill and new Sec. 7529 of the Code) 

PRESENT LAW

The IRS provides written responses to questions of individuals, 

corporations, and organizations relating to their tax status or the 

effects of particular transactions for tax purposes. The IRS generally charges a fee for requests for a letter ruling, determination 

letter, opinion letter, or other similar ruling or determination. Public Law 104–117 133 extended the statutory authorization for these 

user fees 134 through September 30, 2003. 

REASONS FOR CHANGE

The Committee believes that it is appropriate to provide a further extension of these user fees. 

EXPLANATION OF PROVISION

The bill extends the statutory authorization for these user fees 

through September 30, 2013. The bill also moves the statutory authorization for these fees into the Code.135

EFFECTIVE DATE

The provision, including moving the statutory authorization for 

these fees into the Code and repealing the off-Code statutory authorization for these fees, is effective for requests made after the 

date of enactment. 

D. ADD VACCINES AGAINST HEPATITIS A TO THE LIST OF TAXABLE

VACCINES

(Sec. 842 of the Bill and Sec. 4132 of the Code) 

PRESENT LAW

A manufacturer’s excise tax is imposed at the rate of 75 cents per 

dose 136 on the following vaccines routinely recommended for administration to children: diphtheria, pertussis, tetanus, measles, 

mumps, rubella, polio, HIB (haemophilus influenza type B), hepatitis B, varicella (chicken pox), rotavirus gastroenteritis, and strepVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00112 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
105

137The Committee recognizes that, to become covered under the Vaccine Injury Compensation 

Program, the Secretary of Health and Human Services also must list the hepatitis A vaccine 

on the Vaccine Injury Table. 

tococcus pneumoniae. The tax applied to any vaccine that is a combination of vaccine components equals 75 cents times the number 

of components in the combined vaccine. 

Amounts equal to net revenues from this excise tax are deposited 

in the Vaccine Injury Compensation Trust Fund to finance compensation awards under the Federal Vaccine Injury Compensation 

Program for individuals who suffer certain injuries following administration of the taxable vaccines. This program provides a substitute Federal, ‘‘no fault’’ insurance system for the State-law tort 

and private liability insurance systems otherwise applicable to vaccine manufacturers. All persons immunized after September 30, 

1988, with covered vaccines must pursue compensation under this 

Federal program before bringing civil tort actions under State law. 

REASONS FOR CHANGE

The Committee is aware that the Centers for Disease Control 

and Prevention have recommended that children in 17 highly endemic States be inoculated with a hepatitis A vaccine. The population of children in the affected States exceeds 20 million. Several 

of the affected States mandate childhood vaccination against hepatitis A. The Committee is aware that the Advisory Commission on 

Childhood Vaccines has recommended that the vaccine excise tax 

be extended to cover vaccines against hepatitis A. For these reasons, the Committee believes it is appropriate to include vaccines 

against hepatitis A as part of the Vaccine Injury Compensation 

Program. Making the hepatitis A vaccine taxable is a first step.137

In the unfortunate event of an injury related to this vaccine, families of injured children are eligible for the no-fault arbitration system established under the Vaccine Injury Compensation Program 

rather than going to Federal Court to seek compensatory redress. 

EXPLANATION OF PROVISION

The bill adds any vaccine against hepatitis A to the list of taxable vaccines. The bill also makes a conforming amendment to the 

trust fund expenditure purposes. 

EFFECTIVE DATE

The provision is effective for vaccines sold beginning on the first 

day of the first month beginning more than four weeks after the 

date of enactment.

E. INDIVIDUAL EXPATRIATION TO AVOID TAX

(Sec. 833 of the Bill and Secs. 877, 2107, 2501, and 6039 of the 

Code) 

PRESENT LAW

U.S. citizens and residents generally are subject to U.S income 

taxation on their worldwide income. The U.S. tax may be reduced 

or offset by a credit allowed for foreign income taxes paid with respect to foreign source income. Nonresidents who are not U.S. citiVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00113 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
106

138The alternative tax regime applies to long-term residents of the United States that have 

terminated their residency with a principal purpose of avoiding U.S. tax. A ‘‘long-term resident’’ 

is any individual who was a lawful permanent resident of the United States for at least 8 out 

of the 15 taxable years ending with the year in which such termination occurs. In applying the 

8-year test, an individual is not considered to be a lawful permanent resident for any year in 

which the individual is treated as a resident of another country under a treaty tiebreaker rule 

(and the individual does not elect to waive the benefits of such treaty). 

zens are taxed at a flat rate of 30 percent (or a lower treaty rate) 

on certain types of passive income derived from U.S. sources, and 

at regular graduated rates on net profits derived from a U.S. trade 

or business. 

An individual who relinquishes his or her U.S. citizenship or terminates his or her U.S. residency 138 with a principal purpose of 

avoiding U.S. taxes is subject to an alternative method of income 

taxation for the 10 taxable years ending after the citizenship relinquishment or residency termination (the ‘‘alternative tax regime’’). 

The alternative tax regime modifies the rules generally applicable 

to the taxation of nonresident noncitizens. For the 10-year period, 

the individual is subject to tax only on U.S.-source income at the 

rates applicable to U.S. citizens, rather than the rates applicable 

to nonresident noncitizens. However, for this purpose, U.S.-source 

income has a broader scope than it does for normal U.S. Federal 

tax purposes and includes, for example, gain from the sale of U.S. 

corporate stock or debt obligations. The alternative tax regime applies only if it results in a higher U.S. tax liability than the liability that would result if the individual were taxed as a nonresident 

noncitizen. 

In addition, the alternative tax regime includes special estate 

and gift tax rules. Under present law, estates of nonresident noncitizens are subject to U.S. estate tax on U.S.-situated property. 

For these purposes, stock in a foreign corporation generally is not 

treated as U.S.-situated property, even if the foreign corporation 

itself owns U.S.-situated property. However, a special estate tax 

rule (sec. 2107) applies to former citizens and former long-term 

residents who are subject to the alternative tax regime. Under this 

rule, certain closely-held foreign stock owned by the former citizen 

or former long-term resident is includible in his or her gross estate 

to the extent that the foreign corporation owns U.S.-situated assets, if the former citizen or former long-term resident dies within 

10 years of citizenship relinquishment or residency termination. 

This rule prevents former citizens and former long-term residents 

who are subject to the alternative tax regime from avoiding U.S. 

estate tax through the expedient of transferring U.S.-situated assets to a foreign corporation (subject to income tax on any appreciation under section 367). In addition, under the alternative tax regime, the individual is subject to gift tax on gifts of U.S.-situated 

intangibles, such as U.S. stock, made during the 10 years following 

citizenship relinquishment or residency termination. 

Anti-abuse rules are provided to prevent the circumvention of the 

alternative tax regime. Accordingly, the alternative tax regime generally applies to exchanges of property that give rise to U.S.-source 

income for property that gives rise to foreign source income. In addition, amounts earned by former citizens and former long-term 

residents through controlled foreign corporations are subject to the 

alternative tax regime, and the 10-year liability period is susVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00114 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
107

139The penalty applies for each year of the 10-year period beginning on the date the individual ceases to be a U.S. citizen or resident. 

pended during any time at which a former citizen’s or former longterm resident’s risk of loss with respect to property subject to the 

alternative tax regime is substantially diminished, among other 

measures. 

A U.S. citizen who relinquishes citizenship or a long-term resident who terminates residency is treated as having done so with 

a principal purpose of tax avoidance (and, thus, generally is subject 

to the alternative tax regime described above) if: (1) the individual’s average annual U.S. Federal income tax liability for the five 

taxable years preceding citizenship relinquishment or residency 

termination exceeds $100,000; or (2) the individual’s net worth on 

the date of citizenship relinquishment or residency termination 

equals or exceeds $500,000. These amounts are adjusted annually 

for inflation. Certain categories of individuals may avoid being 

deemed to have a tax avoidance purpose for relinquishing citizenship or terminating residency by submitting a ruling request to the 

IRS regarding whether the individual relinquished citizenship or 

terminated residency principally for tax reasons. 

Under present law, the Immigration and Nationality Act governs 

the determination of when a U.S. citizen is treated for U.S. Federal 

tax purposes as having relinquished citizenship. Similarly, an individual’s U.S. residency is considered terminated for U.S. Federal 

tax purposes when the individual ceases to be a lawful permanent 

resident under the immigration law (or is treated as a resident of 

another country under a tax treaty and does not waive the benefits 

of such treaty). In view of this reliance on immigration-law status, 

it is possible in many instances for a U.S. citizen or resident to convert his or her Federal tax status to that of a nonresident noncitizen without notifying the IRS. 

Individuals subject to the alternative tax regime are required to 

provide certain tax information, including tax identification numbers, upon relinquishment of citizenship or termination of residency (on IRS Form 8854, Expatriation Initial Information Statement). In the case of an individual with a net worth of at least 

$500,000, the individual also must provide detailed information 

about the individual’s assets and liabilities. The penalty for the 

failure to provide the required tax information is the greater of 

$1,000 or five percent of the tax imposed under the alternative tax 

regime for the year.139 In addition, the U.S. Department of State 

and other governmental agencies are required to provide this information to the IRS. 

Former citizens and former long-term residents who are subject 

to the alternative tax regime also are required to file annual income tax returns, but only in the event that they owe U.S. Federal 

income tax. If a tax return is required, the former citizen or former 

long-term resident is required to provide the IRS with a statement 

setting forth (generally by category) all items of U.S.-source and 

foreign-source gross income, but no detailed information with respect to all assets held by the individual. 

108

REASONS FOR CHANGE

There are several difficulties in administering the present-law alternative tax regime. One such difficulty is that the IRS is required 

to determine the subjective intent of taxpayers who relinquish citizenship or terminate residency. The present-law presumption of a 

tax avoidance purpose in cases in which objective income tax liability or net worth thresholds are exceeded mitigates this problem to 

some extent. However, the present-law rules still require the IRS 

to make subjective determinations of intent in cases involving taxpayers who fall below these thresholds, as well for certain taxpayers who exceed these thresholds but are nevertheless allowed to 

seek a ruling from the IRS to the effect that they did not have a 

principal purpose of tax avoidance. The Committee believes that 

the replacement of the subjective determination of tax avoidance as 

a principal purpose for citizenship relinquishment or residency termination with objective rules will result in easier administration of 

the tax regime for individuals who relinquish their citizenship or 

terminate residency. 

Similarly, present-law information-reporting and return-filing 

provisions do not provide the IRS with the information necessary 

to administer the alternative tax regime. Although individuals are 

required to file tax information statements upon the relinquishment of their citizenship or termination of their residency, difficulties have been encountered in enforcing this requirement. The 

Committee believes that the tax benefits of citizenship relinquishment or residency termination should be denied an individual until 

he or she provides the information necessary for the IRS to enforce 

the alternative tax regime. The Committee also believes an annual 

report requirement and a penalty for the failure to comply with 

such requirement are needed to provide the IRS with sufficient information to monitor the compliance of former U.S. citizens and 

long-term residents. 

Individuals who relinquish citizenship or terminate residency for 

tax reasons often do not want to fully sever their ties with the 

United States; they hope to retain some of the benefits of citizenship or residency without being subject to the U.S. tax system as 

a U.S. citizen or resident. These individuals generally may continue 

to spend significant amounts of time in the United States following 

citizenship relinquishment or residency termination—approximately four months every year—without being treated as a U.S. 

resident. The Committee believes that provisions in the bill that 

impose full U.S. taxation if the individual is present in the United 

States for more than 30 days in a calendar year will substantially 

reduce the incentives to relinquish citizenship or terminate residency for individuals who desire to maintain significant ties to the 

United States. 

With respect to the estate and gift tax rules, the Committee is 

concerned that present-law does not adequately address opportunities for the avoidance of tax on the value of assets held by a foreign 

corporation whose stock the individual transfers. Thus, the provision imposes gift tax under the alternative tax regime in the case 

of gifts of certain stock of a closely held foreign corporation. 

109

140These provisions reflect recommendations contained in Joint Committee on Taxation, Review of the Present Law Tax and Immigration Treatment of Relinquishment of Citizenship and 

Termination of Long-Term Residency, (JCS–2–03), February 2003. 

EXPLANATION OF PROVISION

In general 

The provision provides: (1) objective standards for determining 

whether former citizens or former long-term residents are subject 

to the alternative tax regime; (2) tax based (instead of immigrationbased) rules for determining when an individual is no longer a U.S. 

citizen or long term resident for U.S. Federal tax purposes; (3) the 

imposition of full U.S. taxation for individuals who are subject to 

the alternative tax regime and who return to the United States for 

extended periods; (4) imposition of U.S. gift tax on gifts of stock of 

certain closely-held foreign corporations that hold U.S.-situated 

property; and (5) an annual return-filing requirement for individuals who are subject to the alternative tax regime, for each of the 

10 years following citizenship relinquishment or residency termination.140

Objective rules for the alternative tax regime 

The provision replaces the subjective determination of tax avoidance as a principal purpose for citizenship relinquishment or residency termination under present law with objective rules. Under 

the provision, a former citizen or former long-term resident would 

be subject to the alternative tax regime for a 10-year period following citizenship relinquishment or residency termination, unless 

the former citizen or former long-term resident: (1) establishes that 

his or her average annual net income tax liability for the five preceding years does not exceed $122,000 (adjusted for inflation) and 

his or her net worth does not exceed $2 million, or alternatively 

satisfies limited, objective exceptions for dual citizens and minors 

who have had no substantial contact with the United States; and 

(2) certifies under penalties of perjury that he or she has complied 

with all U.S. Federal tax obligations for the preceding five years 

and provides such evidence of compliance as the Secretary of the 

Treasury may require. 

The monetary thresholds under the provision replace the 

present-law inquiry into the taxpayer’s intent. In addition, the provision eliminates the present-law process of IRS ruling requests. 

If a former citizen exceeds the monetary thresholds, that person 

is excluded from the alternative tax regime if he or she falls within 

the exceptions for certain dual citizens and minors (provided that 

the requirement of certification and proof of compliance with Federal tax obligations is met). These exceptions provide relief to individuals who have never had substantial connections with the 

United States, as measured by certain objective criteria, and eliminate IRS inquiries as to the subjective intent of such taxpayers. 

In order to be excepted from the application of the alternative 

tax regime under the provision, whether by reason of falling below 

the net worth and income tax liability thresholds or qualifying for 

the dual-citizen or minor exceptions, the former citizen or former 

long-term resident also is required to certify, under penalties of 

perjury, that he or she has complied with all U.S. Federal tax obliVerDate jul 14 2003 03:53 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00117 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
110

141Sections 7701(b)(3)(D), 7701(b)(5) and 7701(b)(7)(B)–(D). 

gations for the five years preceding the relinquishment of citizenship or termination of residency and to provide such documentation 

as the Secretary of the Treasury may require evidencing such compliance (e.g., tax returns, proof of tax payments). Until such time, 

the individual remains subject to the alternative tax regime. It is 

intended that the IRS should continue to verify that the information submitted was accurate, and it is intended that the IRS should 

randomly audit such persons to assess compliance. 

Termination of U.S. citizen or long-term resident status for U.S. 

Federal income tax purposes 

Under the provision, an individual continues to be treated as a 

U.S. citizen or long-term resident for U.S. Federal tax purposes, including for purposes of section 7701(b)(10), until the individual: (1) 

gives notice of an expatriating act or termination of residency (with 

the requisite intent to relinquish citizenship or terminate residency) to the Secretary of State or the Secretary of Homeland Security, respectively; and (2) provides a statement in accordance with 

section 6039G. 

Sanction for individuals subject to the individual tax regime who 

return to the United States for extended periods 

The alternative tax regime does not apply to any individual for 

any taxable year during the 10-year period following citizenship relinquishment or residency termination if such individual is present 

in the United States for more than 30 days in the calendar year 

ending in such taxable year. Such individual is treated as a U.S. 

citizen or resident for such taxable year. 

Similarly, if an individual subject to the alternative tax regime 

is present in the United States for more than 30 days in any calendar year ending during the 10-year period following citizenship 

relinquishment or residency termination, and the individual dies 

during that year, he or she is treated as a U.S. resident, and the 

individual’s worldwide estate is subject to U.S. estate tax. Likewise, if an individual subject to the alternative tax regime is 

present in the United States for more than 30 days in any year 

during the 10-year period following citizenship relinquishment or 

residency termination, the individual is subject to U.S. gift tax on 

any transfer of his or her worldwide assets by gift during that taxable year. 

For purposes of these rules, an individual is treated as present 

in the United States on any day if such individual is physically 

present in the United States at any time during that day, with no 

exceptions. The present-law exceptions from being treated as 

present in the United States for residency purposes141 do not apply 

for this purpose. 

Imposition of gift tax with respect to stock of certain closely held foreign corporations 

Gifts of stock of certain closely-held foreign corporations by a 

former citizen or former long-term resident who is subject to the alternative tax regime are subject to gift tax under this provision, if 

111

the gift is made within the 10-year period after citizenship relinquishment or residency termination. The gift tax rule applies if: (1) 

the former citizen or former long-term resident, before making the 

gift, directly or indirectly owns 10 percent or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation; and (2) directly or indirectly, is considered to own 

more than 50 percent of (a) the total combined voting power of all 

classes of stock entitled to vote in the foreign corporation, or (b) the 

total value of the stock of such corporation. If this stock ownership 

test is met, then taxable gifts of the former citizen or former longterm resident include that proportion of the fair market value of 

the foreign stock transferred by the individual, at the time of the 

gift, which the fair market value of any assets owned by such foreign corporation and situated in the United States (at the time of 

gift) bears to the total fair market value of all assets owned by 

such foreign corporation (at the time of gift). 

This gift tax rule applies to a former citizen or former long-term 

resident who is subject to the alternative tax regime and who owns 

stock in a foreign corporation at the time of the gift, regardless of 

how such stock was acquired (e.g., whether issued originally to the 

donor, purchased, or received as a gift or bequest). 

Annual return 

The provision requires former citizens and former long-term residents to file an annual return for each year following citizenship 

relinquishment or residency termination in which they are subject 

to the alternative tax regime. The annual return is required even 

if no U.S. Federal income tax is due. The annual return requires 

certain information, including information on the permanent home 

of the individual, the individual’s country of residency, the number 

of days the individual was present in the United States for the 

year, and detailed information about the individual’s income and 

assets that are subject to the alternative tax regime. This requirement includes information relating to foreign stock potentially subject to the special estate tax rule of section 2107(b) and the gift tax 

rules of this provision. 

If the individual fails to file the statement in a timely manner 

or fails correctly to include all the required information, the individual is required to pay a penalty of $5,000. The $5,000 penalty 

does not apply if it is shown that the failure is due to reasonable 

cause and not to willful neglect. 

EFFECTIVE DATE

The provisions apply to individuals who relinquish citizenship or 

terminate long-term residency after February 27, 2003. 

II. BUDGET EFFECTS OF THE BILL 

A. COMMITTEE ESTIMATES

In compliance with paragraph 11(a) of rule XXVI of the Standing 

Rules of the Senate, the following statement is made concerning 

the estimated budget effects of the revenue provisions of the ‘‘Energy Tax Incentives Act of 2003’’ as reported.

ESTIMATED REVENUE EFFECTS OF MODIFICATIONS TO S. 1149, THE ‘‘ENERGY TAX INCENTIVES ACT OF 2003,’’ FOR CONSIDERATION ON THE SENATE FLO

[Fiscal years 2004–2013, in millions of dollars] 

Provision Effective 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2004–08 

Extension and Modification of Renewable 

Electricity Production Tax Credit—Extend (property placed in service before 1/1/07 (1/1/05 in the case of open-loop)) and modify the section 45 credit for producing electricity from certain sources (credit is equal to 1.8 cents per kilowatt hour for production from post-enactment facilities after 12/31/03).

esfqfa DOE ¥111 ¥205 ¥298 ¥387 ¥384 ¥354 ¥326 ¥303 ¥287 ¥277 ¥1,381 

Alternative Motor Vehicles and Fuel Incentives: 

1. Credits for purchase of alternative 

motor vehicles, modifications to credit for electric vehicles, and extension of deduction for qualified clean fuel vehicles and property (deduction for property placed in service before 1/1/08 (1/1/12 in the case of hydrogen fuel)); credit for alternative and electric vehicles purchased before 1/1/07 (1/1/12 in the case of hydrogen).

ppisa DOE ¥151 ¥428 ¥649 ¥550 ¥17 38 ¥19 ¥2 ¥11 ¥19 ¥1,795 

2. Credit for installation of alternative 

fueling stations credit for property placed in service before 1/1/08 (1/1/12 in the case of hydrogen).

ppisa DOE ¥2 ¥3 ¥3 ¥3 ¥1 (1) (1) (1) (1) (1) ¥11 

3. Credit for retail 

sale of alternative fuels (30 cents/gallon in 2003, 40 cents in 2004, 50 cents in 2005 and 2006).

DOE ¥83 ¥169 ¥215 ¥90 ¥1 ¥1 ¥1 ¥1 .............. .............. ¥558 

ESTIMATED REVENUE EFFECTS OF MODIFICATIONS TO S. 1149, THE ‘‘ENERGY TAX INCENTIVES ACT OF 2003,’’ FOR CONSIDERATION ON THE SENATE FLOO

Continued

[Fiscal years 2004–2013, in millions of dollars] 

Provision Effective 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2004–08 

4. Modifications to 

small ethanol producer credit and extension of section 40 credit (through 12/31/10).

tyba DOE ¥16 ¥34 ¥34 ¥34 ¥41 ¥49 ¥50 ¥29 ¥3 .............. ¥159 

5. Tax incentives for 

biodiesel (sunset 12/31/05) 3 4.

fsa DOE ¥20 ¥29 ¥8 .............. .............. .............. .............. .............. .............. .............. ¥57 

6. Alcohol fuel and 

biodiesel mixtures excise tax credit 4.

fsa 9/30/03 31 46 49 48 45 43 40 36 33 30 221 

7. Sale of gasoline and 

diesel fuel at dutyfree sales enterprises.

DOE No Revenue Effect

Total of Alternative 

Motor Vehicles and Fuel Incentives.

.............................. ¥241 ¥617 ¥860 ¥629 ¥15 29 8 8 19 11 ¥2,359 

Conservation and Energy Efficiency Provisions: 

1. Business credit for 

construction of new energy efficient homes.

ppb DOE & 12/31/

07

¥63 ¥102 ¥98 ¥108 ¥68 ¥21 ¥4 .............. .............. .............. ¥440 

2. Credit for energy efficient appliances. apb DOE & 12/31/ 07

¥58 ¥82 ¥68 ¥46 ¥23 ¥8 ¥2 (2) .............. .............. ¥277 

3. Credit for residential fuel cell, solar, 

and other energy efficient property.

ppb 1/1/04 & 12/

31/07

¥30 ¥54 ¥61 ¥71 ¥62 .............. .............. .............. .............. .............. ¥278 

4. Business tax incentives for qualifying 

fuel cells and microturbines (sunset 12/31/06).

ppisb DOE & 12/

31/07

¥5 ¥9 ¥14 ¥9 ¥4 ¥3 ¥1 (5) (5) (5) ¥43 

5. Allowance of deduction for certain energy efficient commercial building 

property.

tyba DOE & ccb 

1/1/10

¥28 ¥51 ¥74 ¥101 ¥130 ¥139 ¥41 10 9 8 ¥385 

6. Three-year applicable recovery period

for qualified energy management devices (excluding ancillary equipment):.a. Electric devices 

(sunset for property placed in service after 12/31/07).

ppsia DOE ¥9 ¥20 ¥42 ¥70 ¥61 ¥13 16 26 22 14 ¥202 

b. Water submetering devices 

(sunset for property placed in service after 12/31/07).

ppisa DOE ¥4 ¥11 ¥21 ¥31 ¥24 ¥1 12 15 11 5 ¥91 

7. Energy credit for 

combined heat and power system property.

ppisa DOE & 

ppisb 1/1/07

¥68 ¥79 ¥78 ¥51 ¥24 ¥11 ¥1466 ¥300 

8. Credit for energy efficiency improvements to existing 

homes.

tyba DOE & tybb 

1/1/07

¥55 ¥78 ¥78 ¥63 ¥62 .............. .............. .............. .............. .............. ¥274 

ESTIMATED REVENUE EFFECTS OF MODIFICATIONS TO S. 1149, THE ‘‘ENERGY TAX INCENTIVES ACT OF 2003,’’ FOR CONSIDERATION ON THE SENATE FLOO

Continued

[Fiscal years 2004–2013, in millions of dollars] 

Provision Effective 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2004–08 

Total of Conservation and Energy 

Efficiency Provisions.

.............................. ¥320 ¥486 ¥534 ¥550 ¥396 ¥196 ¥21 55 48 33 ¥2,290 

Clean Coal Incentives—

Investment and Production Credits for Clean Coal Technology: 1. Credit for production from qualifying 

clean coal technology units.

pa DOE ¥31 ¥58 ¥70 ¥80 ¥87 ¥90 ¥92 ¥94 ¥97 ¥97 ¥326 

2. Credit for investment in qualifying 

advanced clean coal technology (for property placed in service after the date of enactment and before 1/1/17 (1/1/13 in the case of advanced pulverized coal or atmospheric fluidized bed)).

ppsia DOE ¥20 ¥47 ¥49 ¥41 ¥27 ¥111 ¥94 ¥39 ¥28 ¥18 ¥184 

3. Credit for production of electricity 

from qualifying advanced clean coal technology units.

pa DOE ¥4 ¥17 ¥36 ¥55 ¥70 ¥96 ¥132 ¥153 ¥162 ¥168 ¥183 

Total of Clean Coal 

Incentives—Investment and Production Credit for Clean Coal Technology.

.............................. ¥55 ¥122 ¥155 ¥176 ¥184 ¥297 ¥318 ¥286 ¥287 ¥283 ¥693 

Oil and Gas Provisions: 

1. Credit for marginal 

domestic oil and natural gas well production.

DOE No Revenue Effect

2. Natural gas gathering pipelines 

treated as 7–year property.

ppsia DOE ¥3 ¥5 ¥8 ¥12 ¥41 ¥49 ¥58 ¥66 ¥77 ¥88 ¥69 

3. Expensing of capital 

costs incurred and credit for production in complying with Environmental Protection Agency sulfur regulations for small refiners.

epoia 1/1/03 ¥9 ¥7 ¥8 ¥12 ¥27 ¥52 ¥21 3 4 5 ¥63 

4. Determination of 

small refiner exception to oil depletion deduction—modify definition of independent refiner from daily maximum run less than 50,000 barrels to average daily run less than 60,000 barrels.

tyea DOE ¥6 ¥7 ¥8 ¥8 ¥8 ¥8 ¥8 ¥8 ¥9 ¥9 ¥37 

ESTIMATED REVENUE EFFECTS OF MODIFICATIONS TO S. 1149, THE ‘‘ENERGY TAX INCENTIVES ACT OF 2003,’’ FOR CONSIDERATION ON THE SENATE FLOO

Continued

[Fiscal years 2004–2013, in millions of dollars] 

Provision Effective 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2004–08 

5. Extension of suspension of 100% of 

taxable income limit with respect to marginal production (through 12/31/06).

DOE ¥22 ¥35 ¥36 ¥13 .............. .............. .............. .............. .............. .............. ¥106 

6. Amortize all geological and geophysical (‘‘G&G’’) 

expenditures over 2 years.

cpoii tyba DOE 234 ¥212 ¥449 ¥428 ¥320 ¥261 ¥226 ¥194 ¥188 ¥194 ¥1,175 

7. Amortize all delay 

rental payments over 2 years.

apoii tyba DOE 85 11 ¥64 ¥62 ¥35 ¥9 ¥1 ¥1 ¥1 ¥1 ¥65 

8. Extension and 

modification of section 27 credit for facilities placed in service after the date of enactment and before 1/1//07, including viscous oil, coalmine gas, agricultural and animal waste, and refined coal; extension and modification of section 29 credit certain coal gasification and coke production from 1/1/02 through 12/31/05; clarification of definition of landfill gas facility; study of coal bed methane; for new facilities described in section 29 (c)(1)(A) & (B), credit rate is equal to $3.00 Barrel of Oil Equivalent; and 200,000 cubic feet per day limit 6.

DOE ¥189 ¥134 ¥509 ¥601 ¥469 ¥230 ¥50 (2) .............. .............. ¥2,083 

9. Natural gas distribution lines treated as 15–year property. ppisa DOE ¥16 ¥38 ¥60 ¥90 ¥119 ¥145 ¥171 ¥200 ¥228 ¥242 ¥323 

10. Provisions Relating to Alaska Natural Gas:.

ESTIMATED REVENUE EFFECTS OF MODIFICATIONS TO S. 1149, THE ‘‘ENERGY TAX INCENTIVES ACT OF 2003,’’ FOR CONSIDERATION ON THE SENATE FLOO

Continued

[Fiscal years 2004–2013, in millions of dollars] 

Provision Effective 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2004–08 

a. Credit for Alaska 

Natural Gas:.

(7) No Revenue Effect

b. Treat certain 

Alaska pipeline property as 7–year property.

generally 

ppisa 12/31/12

.............. .............. .............. .............. .............. .............. .............. .............. .............. ¥150 ................ 

11. Exempt certain 

prepayments for natural gas from tax-exempt arbitrage rules.

oia DOE (2) ¥1 ¥1 ¥2 ¥3 ¥3 ¥4 ¥5 ¥5 ¥6 ¥7 

Total of Oil and Gas 

Provisions.

.............................. 74 ¥608 ¥1,143 ¥1,228 ¥1,022 ¥757 ¥539 ¥472 ¥504 ¥685 ¥3,928 

Electric Utility Restructuring Provisions: 

1. Modification to special rules for nuclear decommissioning costs—

transfer of nonqualified funds (buyer gets deduction over life of plant); eliminate cost of service requirement; and clarify treatment of fund transfers.

tyba DOE ¥47 ¥69 ¥76 ¥85 ¥94 ¥103 ¥113 ¥125 ¥137 ¥151 ¥371 

2. Treatment of certain income of electric cooperatives. tyba DOE ¥8 ¥18 ¥21 ¥23 ¥25 ¥27 ¥30 ¥33 ¥35 ¥38 ¥95 

3. Sales or dispositions to Implement 

Federal Energy Regulatory Commission or State electric restructuring policy prior to 1/1/08.

ta DOE ¥1,321 ¥1,183 ¥1,273 ¥817 476 1,013 1,033 1,012 818 580 ¥4,118 

Total of Electric 

Utility Restructuring Provisions.

.............................. ¥1,376 ¥1,270 ¥1,370 ¥925 357 883 890 854 646 391 ¥4,584 

Additional Provisions: 

1. Extension of accelerated depreciation 

and wage credit benefits for businesses on Indian reservations (through 12/31/05).

DOE 2 ¥172 ¥290 ¥104 21 72 113 92 50 6 ¥543 

2. Study of effectiveness of certain provisions by GAO. DOE No Revenue Effect

3. Repeal of the 4.3 

cent tax on rail and barge diesel 8.

1/1/04 ¥107 ¥156 ¥161 ¥166 ¥171 ¥176 ¥182 ¥187 ¥192 ¥197 ¥761 

4. Modify research 

credit with respect to energy research.

ea DOE ¥3 ¥7 ¥4 ¥2 ¥1 ¥1 (2) .............. .............. .............. ¥18 

Total of Additional 

Provisions.

.............................. ¥108 ¥335 ¥455 ¥272 ¥151 ¥105 ¥69 ¥95 ¥142 ¥191 ¥1,322 

Revenue Provisions: 

1. Provisions relating 

to reportable transactions and tax shelters.

various dates 

after DOE 9

92 115 119 120 124 131 139 150 164 179 570 

ESTIMATED REVENUE EFFECTS OF MODIFICATIONS TO S. 1149, THE ‘‘ENERGY TAX INCENTIVES ACT OF 2003,’’ FOR CONSIDERATION ON THE SENATE FLOO

Continued

[Fiscal years 2004–2013, in millions of dollars] 

Provision Effective 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2004–08 

2. Provisions to Discourage Corporate 

Expatriation: a. Tax treatment of 

inversion transactions.

(10) 193 117 140 168 202 242 290 348 418 493 820 

b. Excise tax on 

stock compensation of insiders in inverted corporations.

generally 7/11/02 35 10 10 10 10 10 10 10 10 10 75 

c. Reinsurance 

agreements.

rra 4/11/02 (1) (1) (1) (1) (1) (1) (1) (1) (1) (1) 2 

3. Extend IRS User 

Fee (through 9/30/13) 11.

DOE 33 34 35 36 38 39 41 42 44 45 176 

4. Add Hepatitis A 

to the list of taxable vaccines (including outlay effects).

(12) 8 9 9 9 9 9 9 9 9 9 44 

5. Modification of 

the tax treatment of individual expatriation and residency termination.

(13) 19 18 21 24 28 32 37 43 49 56 100 

Total of Revenue 

Provisions.

.............................. 380 303 334 367 411 463 526 602 694 792 1,797 

Net total .................. .............................. ¥1,757 ¥3,340 ¥4,481 ¥3,800 ¥1,384 ¥334 151 363 187 ¥209 ¥14,760 

1Gain of less than $1 million. 

2Loss of less than $500,000. 3This provision may also have indirect effects on Federal outlays for certain farm programs. Outlay effects will be estimated by the Congressional Budget Office. 4This is a preliminary estimate of the revenue effects of this provision. This preliminary estimate assumes that all of the ethanol and biodiesel subsidies would be provided th

cise tax credits and refunds and income tax credits. If a portion of the subsidies is obtained in the form of outlay payments, the overall budget effect could be significantly greater preliminary estimate of revenue effects. The outlay effects of this provision will be estimated by the Congressional Budget Office. 5Gain of less than $500,000. 

6Qualified facilities would be given credit for three years of production (five years in the case of refined coal). 7 Effective the later of January 1, 2010, or initial date of interstate transportation of qualifying gas. 8 Estimate assumes that the rail diesel LUST tax of 0.1 cents per gallon would be retained. 9 Effective dates for provisions relating to reportable transactions and tax shelters: the penalty for failure to disclose reportable transactions is effective for returns and statem

due date of which is after the date of enactment; the modification to the accuracy-related penalty for listed or reportable transactions is effective for taxable years ending after thenactment; the tax shelter exception to confidentiality privileges is effective for communications made on or after the date of enactment; the material advisor disclosure provision transactions with respect to which material aid, assistance or advice is provided after the date of enactment; the investor list provision applies to transactions with respect to whrial aid, assistance or advice is provided after the date of enactment, and the penalty on promoters of tax shelters is effective for activities after the date of enactment. 

10 Effective for certain transactions completed after March 20, 2002, and would also affect certain taxpayers who completed transactions before March 21, 2002. 11 Estimate provided by the Congressional Budget Office. 12 Effective for vaccines sold beginning on the first day of the first month beginning more than four weeks after the date of enactment. 13 Effective for individuals who expatriate or terminate long-term residency after February 27, 2003.

Legend for ‘‘Effective’’ column: apoii=amounts paid or incurred in; apb=appliances produced between; ccb=construction completed by; cpoii=costs paid or incurred in; DOE=date 

ment; ea=expenditure after; epoia=expenses paid or incurred after; esfqfa=electricity sold from qualifying facilities after; fsa=fuel sold after; oia=obligation issued after; pa=producppb=property purchased between; ppisa=property placed in service after; ppisb=property placed in service between; rra=risk reinsured after; ta=transactions after; tyba=taxable yening after; tybb=taxable years beginning before.

Note.—Details may not add to totals due to rounding. Date of enactment is assumed to be November 1, 2003. 

124

B. BUDGET AUTHORITY AND TAX EXPENDITURES

Budget authority 

In compliance with section 308(a)(1) of the Budget Act, the Committee states that the revenue provisions of the bill as reported involve no new or increased budget authority. 

Tax expenditures 

In compliance with section 308(a)(2) of the Budget Act, the Committee states that the revenue-reducing provisions of the bill involve increased tax expenditures (see revenue table in Part III. A., 

above). 

C. CONSULTATION WITH CONGRESSIONAL BUDGET OFFICE

In accordance with section 403 of the Budget Act, the Committee 

advises that the Congressional Budget Office submitted the following statement on this bill:

U.S. CONGRESS, 

CONGRESSIONAL BUDGET OFFICE, 

Washington, DC, June 10, 2003. 

Hon. CHARLES E. GRASSLEY, 

Chairman, Committee on Finance, 

U.S. Senate, Washington, DC. 

DEAR MR. CHAIRMAN: At the request of the Senate Budget Committee, the Congressional Budget Office has prepared the enclosed 

revised cost estimate for S. 1149, the Energy Tax Incentives Act of 

2003. This revised estimate supersedes the estimate transmitted on 

May 23, 2003, and it reflects a change in estimated revenues that 

was provided by the Joint Committee on Taxation on June 6, 2003, 

as well as a revision to CBO’s estimate of direct spending. 

If you wish further details on this estimate, we will be pleased 

to provide them. The CBO staff contacts are Annie Bartsch (for 

revenues) and Lisa Cash Driskill (for spending) 

Sincerely, 

DOUGLAS HOLTZ-EAKIN, 

Director. 

Enclosure. 

S. 1149—Energy Tax Incentives Act of 2003

Summary: The Energy Tax Incentives Act would amend numerous provisions of tax law mainly relating to energy. The bill would 

enhance and create credits for the use and development of energyefficient technologies, amend tax rules to provide deductions for 

certain devices and credits for businesses that provide energy, and 

enhance and create credits and deductions for the production of oil, 

gas, and other types of fuel. The bill also would provide tax credits 

for production of biodiesel fuels, which would result in changes in 

the subsidies provided through the U.S. Department of Agriculture 

(USDA) for certain crops. Certain tax credits would be available to 

the Tennessee Valley Authority (TVA) and rural electric cooperatives in the form of credits that could be used as payments owed 

to the Treasury. The bill also would raise revenue by changing the 

125

tax treatment of inversion transactions and altering requirements 

for reportable transactions and tax shelters. Provisions of the bill 

would generally take effect upon enactment (assumed to be July 1, 

2003). 

The Congressional Budget Office (CBO) and the Joint Committee 

on Taxation (JCT) estimate that enacting the bill would decrease 

governmental receipts by $457 million in 2003, by about $15.8 billion over the 2003–2008 period, and by about $15.7 billion over the 

2003–2013 period. CBO estimates that provisions in the bill affecting TVA, rural electric cooperatives, and USDA would result in an 

increase in direct spending of $20 million in 2003, an increase of 

$11 million over the 2003–2008 period, and a decrease of $80 million over the 2003–2013 period. CBO also estimates that extending 

IRS user fees would increase spending subject to appropriation by 

$18 million over the 2003–2008 period and by $39 million over the 

2003–2013 period. 

CBO has reviewed section 702 and found no intergovernmental 

mandates as defined in the Unfunded Mandates Reform Act 

(UMRA). That section would require the General Accounting Office 

(GAO) to analyze the effectiveness of alternative vehicle and fuel 

credits and would impose no costs on state, local, or tribal governments. JCT has determined that the remaining provisions contain 

no intergovernmental mandates as defined in UMRA. 

JCT has determined that the provisions relating to the tax treatment of corporate inversion transactions, tax shelters, the alternative tax regime for individuals who expatriate, reinsurance 

agreements, the excise tax on stock compensation of insiders of inverted corporations, and the excise tax on vaccines against hepatitis A all contain private sector mandates as defined in UMRA. 

The cost of complying with the mandates would not exceed the 

threshold established by UMRA ($117 million in 2003, adjusted annually for inflation). CBO has determined that sections 702 and 

831 of the bill contain no new private-sector mandates as defined 

in UMRA. 

Estimated cost to the Federal Government: The estimated budgetary impact of S. 1149 is shown in the table on the following page. 

These estimates are based on an assumption that the bill will be 

enacted on July 1, 2003; however, if the bill is enacted after this 

date, the revenue effects could be smaller. All revenue estimates 

were provided by JCT except for two provisions. For the years after 

2006, CBO estimated the revenue effects of the provision providing 

income and excise tax credits for biodiesel fuel mixtures. In addition, CBO estimated the effect of the provision extending IRS user 

fees. 

Basis of estimate 

Revenues 

Several provisions would compose a significant portion of the effect on revenues if enacted. Those provisions would extend the 

credit for producing energy from certain sources, extend the credit 

for purchase of alternative motor vehicles, and modify the credit for 

purchase of electric vehicles. They also would allow geological and 

geophysical expenditures to be amortized over two years, establish 

126

a statutory 15-year recovery period for natural gas distribution 

lines, expand the credit for certain qualifying fuels produced from 

coal to fuels produced in facilities placed in service after the date 

of enactment, provide credits for biodiesel fuel purchases, and modify the rules governing certain requirements for contributions to, 

and transfers of, qualified nuclear decommissioning funds. The bill 

also contains several provisions relating to tax shelters and reportable transactions. JCT estimates that these provisions would, if enacted, reduce revenues by $457 million in 2002, about $15.8 billion 

over the 2003–2008 period, and by about $15.5 billion over the 

2003–2013 period.

By fiscal year, in millions of dollars—

2003 2004 2005 2006 2007 2008

CHANGES IN REVENUES

Estimated Revenues .................................................................... ¥457 ¥2,187 ¥3,619 ¥4,519 ¥3,692 ¥1,299

CHANGES IN DIRECT SPENDING

Tax Credits for TVA: 

Estimated Budget Authority ............................................... 0 0 10 10 10 10

Estimated Outlays .............................................................. 0 0 10 10 10 10

Tax Credits for Rural Electric Cooperatives: 

Estimated Budget Authority ............................................... 20 0 0 0 0 0

Estimated Outlays .............................................................. 20 0 0 0 0 0

Biodiesel Farm Program Savings: 

Estimated Budget Authority ............................................... 0 ¥2 ¥4 ¥11 ¥14 ¥18

Estimated Outlays .............................................................. 0 ¥2 ¥4 ¥11 ¥14 ¥18

Total Changes in Direct Spending: 

Estimated Budget Authority ............................................... 20 ¥2 6 ¥1 ¥4 ¥8

Estimated Outlays .............................................................. 20 ¥2 6 ¥1 ¥4 ¥8

SPENDING SUBJECT TO APPROPRIATION 1

Extension of IRS User Fees: 

Estimated Authorization Level ........................................... 0 3 3 4 4 4

Estimated Outlays .............................................................. 0 3 3 4 4 4

1 S. 1149 would also require in preparation of certain annual reports by GAO and the Department of the Treasury, which CBO estimates would cost less than $500,000 per year.

Sources: CBO and the Joint Committee on Taxation. 

The bill would provide income and excise tax credits for purchases of biodiesel fuel mixtures (a combination of diesel fuel and 

vegetable oil or animal fat). The provision would expire on December 31, 2005, and JCT estimated the effects of the provision assuming that expiration date. However, budget law requires CBO to 

treat excise taxes dedicated to trust funds as permanent, even if 

they expire during the projection period. Thus, CBO estimates that 

the provision would reduce revenues by an additional $522 million 

from 2006 through 2013. 

In addition, the bill would extend the period during which IRS 

may charge fees on businesses for providing ruling, opinion, and 

determination letters. Under current law, IRS’s authority to charge 

such fees will expire at the end of fiscal year 2003. The bill would 

extend the authority to charge such fees until September 30, 2013. 

Based on the amount of fees collected in recent years and on information from IRS, CBO estimates that extending the fees would increase governmental receipts by $176 million over the 2004–2008 

period and $386 million over the 2004–2013 period. 

127

Direct spending 

Effect of Biodiesel Tax Credits on Farm Programs. Because of the 

bill’s incentives to sell and use biodiesel fuels, JCT and CBO have 

estimated that use of these fuel mixtures would increase. Because 

the vegetable oil in the mixtures is expected to be primarily derived 

from soybeans and a few other oilseeds, the price of these oilseeds 

would increase. (Qualifying vegetable oils may be derived from 

corn, soybeans, and a list of other oil seeds.) Higher commodity 

prices would result in lower costs of farm price-support and income-support programs administered by USDA. CBO estimates 

these changes in the demand for soybeans and other sources of vegetable oils would reduce federal spending by about $50 million over 

the 2004–2008 period, and by $190 million over the 2004–2013 period. 

Use of Credits for Federal Payments by TVA and Rural Electric 

Cooperatives. The bill would establish tax credits for electric power 

producers using certain clean coal and renewable technologies. Although exempt from taxation, TVA and rural electric cooperatives 

would be eligible to take such credits in the form of cash-equivalent 

credits that could be used to repay amounts they owe to the Treasury. We estimate that the provisions would cost $20 million in 

2003, $100 million over the 2003–2008 period, and $110 million 

over the 2003–2013 period. 

CBO expects that TVA will make significant investments in pollution control and clean coal technologies over the next 10 years 

and thus would be eligible for the cash-equivalent credits authorized by the bill. TVA could use such credits to reduce its payment 

to the Treasury for past appropriations. TVA could then pass such 

savings on to its customers by lowering the price it charges for 

electricity. We estimate that this price adjustment would reduce 

TVA’s power revenues by an average of $10 million a year beginning in 2005, when we expect the agency would revise its rates. 

Hence, CBO estimates that this provision would cost a total of 

about $90 million over the 2003–2013 period. 

Rural electric cooperatives would be eligible for both the clean 

coal technology and renewable energy tax credits offered under the 

bill. Based on information from industry analysts, CBO expects 

that rural electric cooperatives would make investments in technologies that would qualify for such credits over the next several 

years. The bill would allow the credits to be sold or traded to certain other taxable entities, or used to prepay loans held by the federal government. For this estimate, we assume that around 15 percent of eligible cooperatives would prepay their federal loans with 

the Rural Utilities Service, rather than trade the credits. 

The authority provided by the bill to prepay federal loans with 

non-cash credits would be considered a loan modification. Under 

the Federal Credit Reform Act, the cost of a loan modification is 

the change in the subsidy cost of the loan (on a present-value basis) 

because of the modified loan terms. CBO estimates that the cost of 

this provision would be about $20 million and would be recorded 

in 2003, the assumed year of enactment. 

128

Spending subject to appropriation 

Section 831 would adjust and extend the authority of the IRS to 

charge taxpayers fees for certain rulings, opinion letters, and determinations through September 30, 2013. The bill would authorize 

the IRS to retain and spend a small portion of the fees collected, 

subject to appropriation. CBO estimates that implementing this 

provision would cost $18 million over the 2004–2008 period and 

$39 million over the 2004–2013 period, subject to the appropriation 

of the estimated amounts. 

The bill also would require GAO and the Department of the 

Treasury to provide annual reports on energy tax incentives. Based 

on information from these agencies, CBO expects that preparing 

the reports would cost less than $500,000 per year, assuming availability of appropriated funds. 

Summary of the effect on revenues and direct spending: The 

overall effects of the bill on revenues and direct spending over the 

2003–2013 period are shown in the following table.

By fiscal year, in millions of dollars—

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Changes in receipts ............ ¥457 ¥2,187 ¥3,619 ¥4,519 ¥3,692 ¥1,299 ¥275 177 283 82 ¥147

Changes in outlays ............. 20 ¥2 6 ¥1 ¥4 ¥8 ¥12 ¥15 ¥18 ¥22 ¥24

Sources: CBO and the Joint Committee on Taxation. 

Impact on state, local, and tribal governments: CBO has reviewed section 702 and found no intergovernmental mandates as 

defined in UMRA. That section would require GAO to analyze the 

effectiveness of alternative vehicle and fuel credits and would impose no costs on state, local, or tribal governments. JCT has determined that the remaining provisions contain no intergovernmental 

mandates as defined in UMRA. 

Impact on the private sector: JCT has determined that the provisions relating to the tax treatment of corporate inversion transactions, tax shelters, the alternative tax regime for individuals who 

expatriate, agreements, the excise tax on stock compensation of insiders of inverted corporations, reinsurance, and the excise tax on 

vaccines against hepatitis A all contain private-sector mandates as 

defined in UMRA. The cost of complying with the mandates would 

not exceed the threshold established by UMRA ($117 million in 

2003, adjusted annually for inflation). CBO has determined that 

sections 702 and 831 of the bill contain no new private-sector mandates as defined in UMRA. 

Previous CBO estimate: On May 23, 2003, CBO transmitted a 

cost estimate for an unnumbered version of the Energy Tax Incentives Act of 2003, as ordered reported by the Senate Committee on 

Finance on April 2, 2003. This revised cost estimate supersedes 

that previous estimate, and it reflects a change in the estimated effect on federal revenues for the provision pertaining to the sale of 

gasoline and diesel fuel at duty-free sales enterprises as provided 

by JCT on June 6, 2003. The previous estimate included a $9 million increase in federal revenues over the 2003–2013 period resulting from this provision; however, JCT now estimates this provision 

to have a negligible effect on revenues. In addition, this estimate 

reflects a revision to CBO’s estimate of direct spending. The preVerDate jul 14 2003 05:44 Sep 16, 2003 Jkt 088682 PO 00000 Frm 00136 Fmt 6633 Sfmt 6602 E:\HR\OC\A682.XXX A682
129

vious estimate included a $39 million increase in direct spending 

over the 2003–2013 period as a result of the provision extending 

IRS user fees. This revised estimate shows that spending as subject 

to appropriation. 

Estimate prepared by: Federal Revenues: Annie Bartsch. Federal 

Spending: Lisa Cash Driskill, Dave Hull, and Matthew Pickford. 

Impact on State, Local, and Tribal Governments: Greg Waring. Impact on the Private Sector: Paige Piper/Bach. 

Estimate approved by: G. Thomas Woodward, Assistant Director 

for Tax Analysis; and Peter H. Fontaine, Deputy Assistant Director 

for Budget Analysis.

III. VOTES OF THE COMMITTEE 

In compliance with paragraph 7(b) of Rule XXVI of the standing 

rules of the Senate, the following statements are made concerning 

the roll call votes in the Committee’s consideration of the ‘‘Energy 

Tax Incentives Act of 2003.’’ 

Motion to report the Bill 

An original bill, the ‘‘Energy Tax Incentives Act of 2003,’’ was ordered favorably reported, by a record vote on April 2, 2003. 

Yeas.—Senators Grassley, Hatch, Lott, Snowe, Thomas, 

Santorum (proxy), Frist (proxy), Smith, Bunning, Baucus, Rockefeller (proxy), Daschle (proxy), Breaux, Conrad (proxy), Jeffords 

(proxy), Bingaman (proxy), Kerry (proxy), Lincoln. 

Nays.—Senators Nickles, Kyl. 

Votes on other amendments 

The Committee accepted an amendment by Senator Bingaman to 

expand the research credit to 100 percent of expenses for energy 

related research by universities and 20 percent for payments to research consortiums for energy research. The Committee rejected a 

motion by Senators Baucus and Graham, to extend Superfund 

taxes, by record vote. 

Yeas.—Senators Snowe, Baucus, Rockefeller, Daschle, Conrad, 

Graham (proxy), Jeffords, Bingaman, Kerry (proxy). 

Nays.—Senators Grassley, Hatch, Nickles, Lott, Kyl, Thomas, 

Santorum, Frist (proxy), Smith, Bunning, Breaux, Lincoln. 

The Committee rejected a motion by Senators Baucus, Rockefeller, Daschle, Breaux, Conrad, Graham, Jeffords, Bingaman, 

Kerry and Lincoln regarding tax shelter transparency and enforcement, by record vote. 

Yeas.—Baucus, Rockefeller, Daschle, Breaux, Conrad, Graham 

(proxy), Jeffords, Bingaman, Kerry (proxy), Lincoln. 

Nays.—Senators Grassley, Hatch, Nickles, Lott, Snowe, Kyl, 

Thomas, Santorum, Frist (proxy), Smith, Bunning. 

The Committee rejected a modified amendment by Senator Jeffords, regarding the motor fuel excise tax on diesel fuel used by 

railroads, by record vote. 

Yeas.—Baucus, Rockefeller (proxy), Jeffords, Kerry (proxy). 

Nays.—Grassley, Hatch (proxy), Nickles, Lott, Snowe, Kyl, 

Thomas, Santorum (proxy), Frist (proxy), Smith, Bunning, Daschle, 

Breaux, Conrad, Bingaman, Lincoln. 

130

The Committee accepted an amendment by Senator Lott regarding the immediate repeal of 4.3 cents tax on diesel used by rails 

and barges, by voice vote. 

The Committee accepted an amendment by Senator Conrad to 

provide credit for business installations of stationary microturbine 

power plants. (Senator Kyl objected.) 

The Committee rejected an amendment by Senator Nickles to 

strike section 29 of the Chairman’s mark, by roll call vote. 

Ayes.—Senators Nickles, Lott, Kyl, Bunning. 

Nays.—Senators Grassley, Hatch (proxy), Snowe, Thomas, 

Santorum (proxy), Frist (proxy), Smith, Baucus, Rockefeller (proxy), 

Daschle (proxy), Breaux, Conrad (proxy), Graham (proxy), Jeffords 

(proxy), Bingaman (proxy), Kerry (proxy), Lincoln. 

The Committee accepted an amendment by Senator Lincoln to 

modify section 29 of the Internal Revenue Code with respect to the 

definition of a landfill gas facility and to modify section 45 of the 

Internal Revenue Code for the production of electricity to include 

electricity produced from facilities that burn municipal solid waste. 

The amendment was modified to include the President’s Budget 

Proposal of definition change for landfill gas placed in service date 

and to amend the extension of Internal Revenue Service user fees.

IV. REGULATORY IMPACT AND OTHER MATTERS 

A. REGULATORY IMPACT

Pursuant to paragraph 11(b) of Rule XXVI of the Standing Rules 

of the Senate, the Committee makes the following statement concerning the regulatory impact that might be incurred in carrying 

out the provisions of the bill as amended. 

Impact on individuals and businesses 

With respect to individuals and businesses, the bill modifies the 

rules relating to (1) tax benefits for alternative fuels; (2) coal production; (3) oil and gas production; (4) energy conservation; and (5) 

electric industry participants involved in industry restructuring activities. Taxpayers may elect whether to avail themselves of the 

provisions of the bill. Thus, the provisions do not impose increased 

regulatory burdens on individuals or businesses. Certain provisions 

of the bill, such as the provision relating to transfers of decommissioning funds associated with nuclear generating facilities, simplify 

the present-law rules and, therefore, reduce burdens on taxpayers 

electing to utilize the provision. Thus, the bill does not impose increased regulatory burdens on individuals and businesses. 

Impact on personal privacy and paperwork 

The provisions of the bill do not impact personal privacy. Individuals may elect whether to avail themselves of the provisions of the 

bill. Thus, the bill does not impose increased paperwork burdens on 

individuals. Individuals who elect to take advantage of the bill may 

in some cases need to keep records in order to demonstrate that 

they qualify for the tax treatment provided by the bill. In some 

cases the bill simplifies present law, thus reducing recordkeeping 

requirements. 

131

B. UNFUNDED MANDATES STATEMENT

This information is provided in accordance with section 423 of 

the Unfunded Mandates Reform Act of 1995 (P.L. 104–4). 

The Committee has determined that four of the revenue provisions of the bill impose Federal mandates on the private sector. 

The four provisions are (1) the provisions to curtail tax shelters; (2) 

tax treatment of corporate inversion transactions; (3) the excise tax 

on stock compensation of insiders of inverted corporations; and (4) 

the revisions to the alternative tax regime for individuals who expatriate. The Committee has determined that the remaining revenue provisions of the bill do not impose a Federal intergovernmental mandate on State, local, or tribal governments. 

C. TAX COMPLEXITY ANALYSIS

Section 4022(b) of the Internal Revenue Service Reform and Restructuring Act of 1998 (the ‘‘IRS Reform Act’’) requires the Joint 

Committee on Taxation (in consultation with the Internal Revenue 

Service and the Department of the Treasury) to provide a tax complexity analysis. The complexity analysis is required for all legislation reported by the Senate Committee on Finance, the House 

Committee on Ways and Means, or any committee of conference if 

the legislation includes a provision that directly or indirectly 

amends the Internal Revenue Code (the ‘‘Code’’) and has widespread applicability to individuals or small businesses. 

The staff of the Joint Committee on Taxation has determined 

that a complexity analysis is not required under section 4022(b) of 

the IRS Reform Act because the bill contains no provisions that 

amend the Internal Revenue Code and that have ‘‘widespread applicability’’ to individuals or small businesses. 

V. CHANGES IN EXISTING LAW MADE BY THE BILL, AS 

REPORTED 

In the opinion of the Committee, it is necessary in order to expedite the business of the Senate, to dispense with the requirements 

of paragraph 12 of Rule XXVI of the Standing Rules of the Senate 

(relating to the showing of changes in existing law made by the bill 

as reported by the Committee).

Æ