19–010

Calendar No. 22

108TH CONGRESS REPORT " SENATE ! 1st Session 108–11

CARE ACT OF 2003

FEBRUARY 27, 2003.—Ordered to be printed 

Mr. GRASSLEY, from the Committee on Finance, 

submitted the following 

R E P O R T 

[To accompany S. 476] 

[Including cost estimate of the Congressional Budget Office] 

The Committee on Finance reported an original bill S. 476, to 

provide incentives for charitable contributions by individuals and 

businesses, to improve the public disclosure of activities of exempt 

organizations, and to enhance the ability of low-income Americans 

to gain financial security by building assets, and for other purposes, having considered the same, reports favorably thereon and 

recommends that the bill do pass.

CONTENTS 

Page 

I. Legislative Background .................................................................................... 5

II. Explanation of the Bill ..................................................................................... 5 

Title I. Charitable Giving Incentives ..............................................................

A. Charitable Deduction for Nonitemizers (sec. 101 of the bill and 

sec. 63 and 170 of the Code) .............................................................. 5 

B. Tax-Free Distributions From Individual Retirement Arrangements 

for Charitable Purposes (sec. 102 of the bill and secs. 408 and 

6034 of the Code) ................................................................................ 8 

C. Charitable Deduction for Contributions of Food Inventory (sec. 

103 of the bill and sec. 170 of the Code) .......................................... 15 

D. Charitable Deduction for Contributions of Book Inventory (sec. 

104 of the bill and sec. 170 of the Code) .......................................... 17 

E. Expand Charitable Contribution Allowed for Scientific Property 

Used for Research and for Computer Technology and Equipment 

(sec. 105 of the bill and sec. 170 of the Code) .................................. 19

F. Encourage Contributions of Capital Gain Real Property Made 

for Conservation Purposes (sec. 106 of the bill and sec. 170 

of the Code) ......................................................................................... 21 

2

G. Exclusion of 25 Percent of Capital Gain for Certain Sales Made 

for Qualifying Conservation Purposes (sec. 107 of the bill and 

new sec. 121A of the Code) ................................................................ 24 

H. Cost Sharing Payments under the Partners for Fish and Wildlife 

Program (sec. 108 of the bill and sec. 126 of the Code) .................. 30 

I. Basis Adjustment to Stock of S Corporation Contributing Property 

(sec. 109 of the bill and sec. 1367 of the Code) ................................ 31 

J. Enhanced Deduction for Charitable Contributions of Literary, Musical, Artistic, and Scholarly Compositions (sec. 110 of the bill 

and sec. 170 of the Code) ................................................................... 32 

K. Exclusion for Certain Mileage Reimbursements to Charitable Volunteers (sec. 111 of the bill and new sec. 139A of the Code) ......... 34 

L. Extend Enhanced Deduction for Inventory to Include Public 

Schools (sec. 112 of the bill and sec. 170 of the Code) .................... 35 

Title II. Provisions Improving the Oversight of Tax-Exempt Organizations 37 

A. Disclosure of Written Determinations (sec. 201 of the bill and 

sec. 6110 of the Code) ........................................................................ 37 

B. Disclosure of Internet Web Site and Name Under Which Organization Does Business sec. 202 of the bill and sec. 6033 of the 

Code) ................................................................................................... 39 

C. Modification to Reporting of Capital Transactions (sec. 203 of 

the bill and secs. 6033 and 6104 of the Code) ................................. 40 

D. Disclosure that Form 990 is Publicly Available (sec. 204 of the 

bill) ...................................................................................................... 42 

E. Disclosure to State Officials of Proposed Actions Related to Section 501(c) Organizations (sec. 205 of the bill and sec. 6104 

of the Code) ......................................................................................... 42 

F. Expansion of Penalties to Preparers of Form 990 (sec. 206 of 

the bill and sec. 6695 of the Code) .................................................... 45 

G. Notification Requirement for Exempt Entities not Currently Required to File an Annual Information Return (sec. 207 of the 

bill and sec. 6033 of the Code) .......................................................... 46 

H. Suspension of Tax-Exempt Status of Terrorist Organizations (sec. 

208 of the bill and sec. 501 of the Code) .......................................... 48 

Title III. Other Charitable and Exempt Organization Provisions ................ 50 

A. Modify Tax on Unrelated Business Taxable Income of Charitable 

Remainder Trusts (sec. 301 of the bill and sec. 664 of the Code) .. 50 

B. Modify Tax Treatment of Certain Payments to Controlling Exempt Organizations (sec. 302 of the bill and sec. 512 of the 

Code) ................................................................................................... 52 

C. Simplification of Lobbying Expenditure Limitation (sec. 303 of 

the bill and secs. 501 and 4911 of the Code) ................................... 53 

D. Expedited Review Process for Certain Tax-Exemption Applications (sec. 304 of the bill) ................................................................... 57 

E. Clarification of Definition of Church Tax Inquiry (sec. 305 of 

the bill and sec. 7611 of the Code) .................................................... 59 

F. Extension of Declaratory Judgment Procedures to Non–501(c)(3) 

Tax-Exempt Organizations (sec. 306 of the bill and sec. 7428 

of the Code) ......................................................................................... 60 

G. Definition of Convention or Association of Churches (sec. 307 

of the bill and sec. 7701 of the Code) ............................................... 61 

H. Payments by Charitable Organizations to Victims of War on Terrorism and Families of Astronauts (sec. 308 of the bill) ................. 63 

I. Increase Percentage Limits for Certain Employer-Related Scholarship Programs (sec. 309 of the bill) .................................................. 64 

J. Treatment of Certain Hospital Support Organizations in Determining Acquisition Indebtedness (sec. 310 of the bill and sec. 

514 of the Code) .................................................................................. 67 

K. Charitable Contribution Deduction for Certain Expenses in Support of Native Alaskan Subsistence Whaling (sec. 311 of the 

bill and sec. 170 of the Code) ............................................................ 68 

L. Matching grants to low-income taxpayer clinics for return preparation (sec. 312 of the bill and new sec. 7526A of the Code) .......... 69 

Title IV. Social Services Block Grant (Secs 401–403 of the Bill) ................. 70 

Title V. Individual Development Accounts (Sec. 501–512 of the Bill) ......... 71 

Title VI. Management of Exempt Organizations (Sec. 601 of the Bill) 75 

Title VII. Revenue Provisions .......................................................................... 76 

A. Provisions Designed to Curtail Tax Shelters .................................... 76 

3

1. Clarification of the economic substance doctrine (sec. 701 of 

the bill and sec. 7701 of the Code) ............................................ 76 

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

702 of the bill and new sec. 6707A of the Code) ....................... 81 

3. Modifications to the accuracy-related penalties for listed 

transactions and reportable transactions having a significant 

tax avoidance purpose (sec. 703 of the bill and new sec. 

6662A of the Code) ...................................................................... 84

4. Penalty for understatements from transactions lacking economic substance (sec. 704 of the bill and new sec. 6662B 

of the Code) .................................................................................. 89 

5. Modifications to the substantial understatement penalty (sec. 

705 of the bill and sec. 6662 of the Code) ................................. 91 

6. Tax shelter exception to confidentiality privileges relating to 

taxpayer communications (sec. 706 of the bill and sec. 7525 

of the Code) .................................................................................. 93

7. Disclosure of reportable transactions by material advisors 

(secs. 707 and 708 of the bill and secs. 6111 and 6707 of 

the Code) ...................................................................................... 93

8. Investor lists and modification of penalty for failure to maintain investor lists (secs. 707 and 709 of the bill and secs. 

6112 and 6708 of the Code) ........................................................ 97

9. Actions to enjoin conduct with respect to tax shelters and 

reportable transactions (sec. 710 of the bill and sec. 7408 

of the Code) .................................................................................. 99

10. Understatement of taxpayer’s liability by income tax return 

preparer (sec. 711 of the bill and sec. 6694 of the Code) ......... 99

11. Penalty for failure to report interests in foreign financial 

accounts (sec. 712 of the bill and sec. 5321 of Title 31, 

United States Code) .................................................................... 100

12. Frivolous tax returns and submissions (sec. 713 of the bill 

and sec. 67021 of the Code) ........................................................ 102

13. Regulation of individuals practicing before the Department 

of the Treasury (sec. 714 of the bill and sec. 330 of Title 

31, United States Code) .............................................................. 103

14. Penalties on promoters of tax shelters (sec. 715 of the bill 

and sec. 6700 of the Code) .......................................................... 104

15. Extend statute of limitations for certain undisclosed transactions (sec. 716 of the bill and sec. 6501 of the Code) ............ 105

16. Deny deduction for interest paid to IRS on underpayments 

involving certain tax-motivated transactions (sec. 717 of the 

bill and sec. 163 of the Code) ..................................................... 106

17. Authorize additional $300 million per year to the IRS to 

combat abusive tax avoidance transactions (sec. 718 of the 

bill) ............................................................................................... 106

B. Other Provisions .................................................................................. 107

1. Affirmation of consolidated return regulation authority (sec. 

721 of the bill and sec. 1502 of the Code) ................................. 107

2. Chief Executive Officer Required To Sign Corporate Income 

Tax Returns (sec. 722 of the bill and sec. 6062 of the Code) .. 111

III. Budget Effects of the Bill ................................................................................. 112

A. Committee Estimates .......................................................................... 112

B. Budget Authority and Tax Expenditures .......................................... 116

C. Consultation with Congressional Budget Office ................................ 116

IV. Votes of the Committee .................................................................................... 121

V. Regulatory Impact and Other Matters ........................................................... 122

A. Regulatory Impact ............................................................................... 122

B. Unfunded Mandates Statement .......................................................... 122

C. Tax Complexity Analysis ..................................................................... 123

VI. Changes in Existing Law Made by the Bill as Reported .............................. 125

(5)

1 All section references are to the Internal Revenue Code of 1986, unless otherwise indicated. 

2Secs. 170(c)(3)–(5). 3Sec. 170(c)(1). 

4Secs. 170(b) and (e). 

5Sec. 170(a). The Economic Recovery Tax Act of 1981 adopted a temporary provision that permitted individual taxpayers who did not itemize income tax deductions to claim a deduction 

from gross income for a specified percentage of their charitable contributions. The maximum deduction was $25 for 1982 and 1983, $75 for 1984, 50 percent of the amount of the contribution 

for 1985, and 100 percent of the amount of the contribution for 1986. The nonitemizer deduction 

terminated for contributions made after 1986. 

I. LEGISLATIVE BACKGROUND 

The ‘‘CARE Act of 2003’’ was referred to the Senate Committee 

on Finance on January 30, 2003. The Senate Committee on Finance marked up an original bill the ‘‘CARE Act of 2003’’ on February 5, 2003, and ordered the bill, as amended, favorably reported 

by voice vote.

II. EXPLANATION OF THE BILL 

TITLE I. CHARITABLE GIVING INCENTIVES 

A. CHARITABLE DEDUCTION FOR NONITEMIZERS

(Sec. 101 of the bill and sec. 63 and 170 of the Code) 

PRESENT LAW

In computing taxable income, an individual taxpayer who 

itemizes deductions generally is allowed to deduct the amount of 

cash and up to the fair market value of property contributed to a 

charity described in section 501(c)(3),1 to certain veterans’ organizations, fraternal societies, and cemetery companies,2 or to a Federal, State, or local governmental entity for exclusively public purposes3 The deduction also is allowed for purposes of calculating alternative minimum taxable income. 

The amount of the deduction allowable for a taxable year with 

respect to a charitable contribution of property may be reduced depending on the type of property contributed, the type of charitable 

organization to which the property is contributed, and the income 

of the taxpayer.4

A taxpayer who takes the standard deduction (i.e., who does not 

itemize deductions) may not take a separate deduction for charitable contributions.5

A payment to a charity (regardless of whether it is termed a ‘‘contribution’’) in exchange for which the donor receives an economic benefit is not deductible, except to the extent that the donor 

can demonstrate that the payment exceeds the fair market value 

of the benefit received from the charity. To facilitate distinguishing 

charitable contributions from purchases of goods or services from 

charities, present law provides that no charitable contribution deduction is allowed for a separate contribution of $250 or more unVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00005 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
6

6Sec. 170(f)(8). 

7Sec. 6115. 

less the donor obtains a contemporaneous written acknowledgement of the contribution from the charity indicating whether the 

charity provided any good or service (and an estimate of the value 

of any such good or service) to the taxpayer in consideration for the 

contribution.6 In addition, present law requires that any charity 

that receives a contribution exceeding $75 made partly as a gift 

and partly as consideration for goods or services furnished by the 

charity (a ‘‘quid pro quo’’ contribution) is required to inform the 

contributor in writing of an estimate of the value of the goods or 

services furnished by the charity and that only the portion exceeding the value of the goods or services is deductible as a charitable 

contribution.7

Under present law, total deductible contributions of an individual 

taxpayer to public charities, private operating foundations, and certain types of private nonoperating foundations may not exceed 50 

percent of the taxpayer’s contribution base, which is the taxpayer’s 

adjusted gross income for a taxable year (disregarding any net operating loss carryback). To the extent a taxpayer has not exceeded 

the 50–percent limitation, (1) contributions of capital gain property 

to public charities generally may be deducted up to 30 percent of 

the taxpayer’s contribution base, (2) contributions of cash to private 

foundations and certain other charitable organizations generally 

may be deducted up to 30 percent of the taxpayer’s contribution 

base, and (3) contributions of capital gain property to private foundations and certain other charitable organizations generally may 

be deducted up to 20 percent of the taxpayer’s contribution base. 

Contributions by individuals in excess of the 50–percent, 30–percent, and 20–percent limit may be carried over and deducted over 

the next five taxable years, subject to the relevant percentage limitations on the deduction in each of those years. 

In addition to the percentage limitations imposed specifically on 

charitable contributions, present law imposes a reduction on most 

itemized deductions, including charitable contribution deductions, 

for taxpayers with adjusted gross income in excess of a threshold 

amount, which is indexed annually for inflation. The threshold 

amount for 2003 is $139,500 ($69,750 for married individuals filing 

separate returns). For those deductions that are subject to the 

limit, the total amount of itemized deductions is reduced by three 

percent of adjusted gross income over the threshold amount, but 

not by more than 80 percent of itemized deductions subject to the 

limit. Beginning in 2006, the overall limitation on itemized deductions phases-out for all taxpayers. The overall limitation on 

itemized deductions is reduced by one-third in taxable years beginning in 2006 and 2007, and by two-thirds in taxable years beginning in 2008 and 2009. The overall limitation on itemized deductions is eliminated for taxable years beginning after December 31, 

2009; however, this elimination of the limitation sunsets on December 31, 2010. 

7

REASONS FOR CHANGE

The Committee recognizes that the Administration believes that 

providing a charitable deduction for taxpayers who do not itemize 

deductions will result in an increase in charitable giving. In addition, the Committee appreciates that the charitable deduction is an 

important part of the President’s faith-based initiative. The provision is for a two-year period. To provide Congress adequate information in considering extending the provision, the Committee requires the Secretary of the Treasury to submit a report on the effectiveness of the provision. The report should consider the extent 

to which charitable giving has increased, the burdens of complexity 

to taxpayers, and the impact on tax compliance. 

EXPLANATION OF PROVISION

In the case of an individual taxpayer who does not itemize deductions, the provision allows a ‘‘direct charitable deduction’’ from adjusted gross income for charitable contributions paid in cash during 

the taxable year. This deduction is allowed in addition to the 

standard deduction. The deduction is available only for that portion 

of contributions actually made during the year that in the aggregate exceed $250 ($500 in the case of a joint return). The maximum 

deduction is $250 ($500 in the case of a joint return). Contributions 

that are below the minimum amount or that exceed the maximum 

deduction may not be carried over for purposes of a subsequent 

taxable year’s calculation of the direct charitable deduction. Under 

the provision, an individual is not entitled to a charitable deduction 

for the first $250 of cash contributions made during the tax year, 

is entitled to a deduction on a dollar-for-dollar basis for contributions of $251 to $500 (e.g., a $1 contribution deduction in the case 

of $251 of contributions, and a $250 deduction in the case of $500 

of contributions), and is not entitled to a deduction for contributions exceeding $500. 

The provision does not alter present-law rules regarding the carryover of contributions to or from a taxable year, including a taxable year in which the taxpayer elects the standard deduction. The 

direct charitable deduction generally is subject to the tax rules normally governing charitable contribution deductions, such as the 

substantiation requirements. The deduction is allowed in computing alternative minimum taxable income. 

The provision requires the Secretary of the Treasury to complete 

a study by December 31, 2004, of the effect of the provision on increased charitable giving, and of taxpayer compliance, for example, 

by comparing compliance by taxpayers who itemize their charitable 

contributions with compliance by those who claim the direct charitable deduction. The Secretary shall report on the study to the 

Committee on Finance of the Senate and the Committee on Ways 

and Means of the House of Representatives. 

EFFECTIVE DATE

The direct charitable deduction is effective for taxable years beginning after December 31, 2002, and before January 1, 2005. The 

Treasury study is required by December 31, 2004. 

8

8 All section references are to the Internal Revenue Code of 1986, unless otherwise indicated. 

9Secs. 170(c)(3)–(5). 10Sec. 170(c)(1). 11Secs. 170(b) and (e). 12Sec. 170(a). The Economic Recovery Tax Act of 1981 adopted a temporary provision that 

permitted individual taxpayers who did not itemize income tax deductions to claim a deduction 

from gross income for a specified percentage of their charitable contributions. The maximum deduction was $25 for 1982 and 1983, $75 for 1984, 50 percent of the amount of the contribution 

for 1985, and 100 percent of the amount of the contribution for 1986. The nonitemizer deduction 

terminated for contributions made after 1986. 13Sec. 170(f)(8). 

B. TAX-FREE DISTRIBUTIONS FROM INDIVIDUAL RETIREMENT

ARRANGEMENTS FOR CHARITABLE PURPOSES

(Sec. 102 of the bill and secs. 408 and 6034 of the Code) 

PRESENT LAW

In general 

If an amount withdrawn from a traditional individual retirement 

arrangement (‘‘IRA’’) or a Roth IRA is donated to a charitable organization, the rules relating to the tax treatment of withdrawals 

from IRAs apply to the amount withdrawn and the charitable contribution is subject to the normally applicable limitations on deductibility of such contributions. 

Charitable contributions 

In computing taxable income, an individual taxpayer who 

itemizes deductions generally is allowed to deduct the amount of 

cash and up to the fair market value of property contributed to a 

charity described in section 501(c)(3),8 to certain veterans’ organizations, fraternal societies, and cemetery companies,9 or to a Federal, State, or local governmental entity for exclusively public purposes.10 The deduction also is allowed for purposes of calculating 

alternative minimum taxable income. 

The amount of the deduction allowable for a taxable year with 

respect to a charitable contribution of property may be reduced depending on the type of property contributed, the type of charitable 

organization to which the property is contributed, and the income 

of the taxpayer.11

A taxpayer who takes the standard deduction (i.e., who does not 

itemize deductions) may not take a separate deduction for charitable contributions.12

A payment to a charity (regardless of whether it is termed a 

‘‘contribution’’) in exchange for which the donor receives an economic benefit is not deductible, except to the extent that the donor 

can demonstrate that the payment exceeds the fair market value 

of the benefit received from the charity. To facilitate distinguishing 

charitable contributions from purchases of goods or services from 

charities, present law provides that no charitable contribution deduction is allowed for a separate contribution of $250 or more unless the donor obtains a contemporaneous written acknowledgement of the contribution from the charity indicating whether the 

charity provided any good or service (and an estimate of the value 

of any such good or service) to the taxpayer in consideration for the 

contribution.13 In addition, present law requires that any charity that receives a contribution exceeding $75 made partly as a gift 

9

14Sec. 6115. 15Secs. 170(f), 2055(e)(2), and 2522(c)(2). 

and partly as consideration for goods or services furnished by the 

charity (a ‘‘quid pro quo’’ contribution) is required to inform the 

contributor in writing of an estimate of the value of the goods or 

services furnished by the charity and that only the portion exceeding the value of the goods or services is deductible as a charitable 

contribution.14

Under present law, total deductible contributions of an individual 

taxpayer to public charities, private operating foundations, and certain types of private nonoperating foundations may not exceed 50 

percent of the taxpayer’s contribution base, which is the taxpayer’s 

adjusted gross income for a taxable year (disregarding any net operating loss carryback). To the extent a taxpayer has not exceeded 

the 50-percent limitation, (1) contributions of capital gain property 

to public charities generally may be deducted up to 30 percent of 

the taxpayer’s contribution base, (2) contributions of cash to private 

foundations and certain other charitable organizations generally 

may be deducted up to 30 percent of the taxpayer’s contribution 

base, and (3) contributions of capital gain property to private foundations and certain other charitable organizations generally may 

be deducted up to 20 percent of the taxpayer’s contribution base. 

Contributions by individuals in excess of the 50-percent, 30-percent, and 20-percent limit may be carried over and deducted over 

the next five taxable years, subject to the relevant percentage limitations on the deduction in each of those years. 

In addition to the percentage limitations imposed specifically on 

charitable contributions, present law imposes a reduction on most 

itemized deductions, including charitable contribution deductions, 

for taxpayers with adjusted gross income in excess of a threshold 

amount, which is indexed annually for inflation. The threshold 

amount for 2003 is $139,500 ($69,750 for married individuals filing 

separate returns). For those deductions that are subject to the 

limit, the total amount of itemized deductions is reduced by three 

percent of adjusted gross income over the threshold amount, but 

not by more than 80 percent of itemized deductions subject to the 

limit. Beginning in 2006, the overall limitation on itemized deductions phases-out for all taxpayers. The overall limitation on 

itemized deductions is reduced by one-third in taxable years beginning in 2006 and 2007, and by two-thirds in taxable years beginning in 2008 and 2009. The overall limitation on itemized deductions is eliminated for taxable years beginning after December 31, 

2009; however, this elimination of the limitation sunsets on December 31, 2010. 

In general, a charitable deduction is not allowed for income, estate, or gift tax purposes if the donor transfers an interest in property to a charity (e.g., a remainder) while also either retaining an 

interest in that property (e.g., an income interest) or transferring 

an interest in that property to a noncharity for less than full and 

adequate consideration.15 Exceptions to this general rule are provided for, among other interests, remainder interests in charitable 

remainder annuity trusts, charitable remainder unitrusts, and 

pooled income funds, and present interests in the form of a guaranVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00009 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
10

16Sec. 170(f)(2). 17 Conversion contributions refer to conversions of amounts in a traditional IRA to a Roth IRA. 18Sec. 6034. This requirement applies to all split-interest trusts described in section 

4947(a)(2). 19Sec. 642(c). 20Sec. 6104(b). 

teed annuity or a fixed percentage of the annual value of the property.16 For such interests, a charitable deduction is allowed to the 

extent of the present value of the interest designated for a charitable organization. 

IRA rules 

Within limits, individuals may make deductible and nondeductible contributions to a traditional IRA. Amounts in a traditional 

IRA are includible in income when withdrawn (except to the extent 

the withdrawal represents a return of nondeductible contributions). 

Individuals also may make nondeductible contributions to a Roth 

IRA. Qualified withdrawals from a Roth IRA are excludable from 

gross income. Withdrawals from a Roth IRA that are not qualified 

withdrawals are includible in gross income to the extent attributable to earnings. Includible amounts withdrawn from a traditional IRA or a Roth IRA before attainment of age 591⁄2 are subject 

to an additional 10-percent early withdrawal tax, unless an exception applies. 

If an individual has made nondeductible contributions to a traditional IRA, a portion of each distribution from an IRA is nontaxable, until the total amount of nondeductible contributions has 

been received. In general, the amount of a distribution that is nontaxable is determined by multiplying the amount of the distribution by the ratio of the remaining nondeductible contributions to 

the account balance. In making the calculation, all traditional IRAs 

of an individual are treated as a single IRA, all distributions during any taxable year are treated as a single distribution, and the 

value of the contract, income on the contract, and investment in 

the contract are computed as of the close of the calendar year. 

In the case of a distribution from a Roth IRA that is not a qualified distribution, in determining the portion of the distribution attributable to earnings, contributions and distributions are deemed 

to be distributed in the following order: (1) regular Roth IRA contributions; (2) taxable conversion contributions;17 (3) nontaxable 

conversion contributions; and (4) earnings. In determining the 

amount of taxable distributions from a Roth IRA, all Roth IRA distributions in the same taxable year are treated as a single distribution, all regular Roth IRA contributions for a year are treated as 

a single contribution, and all conversion contributions during the 

year are treated as a single contribution. 

Split-interest trust filing requirements 

Split-interest trusts, including charitable remainder annuity 

trusts, charitable remainder unitrusts, and pooled income funds, 

are required to file an annual information return 18 (Form 1041A). 

Trusts that are not split-interest trusts but that claim a charitable 

deduction for amounts permanently set aside for a charitable purpose 19 also are required to file Form 1041A. The returns are required to be made publicly available.20 A trust that is required to 

11

21Sec. 6011; Treas. Reg. sec. 53.6011–1(d). 

distribute all trust net income currently to trust beneficiaries in a 

taxable year is exempt from this return requirement for such taxable year. A failure to file the required return may result in a penalty on the trust of $10 a day for as long as the failure continues, 

up to a maximum of $5,000 per return. 

In addition, split-interest trusts are required to file annually 

Form 5227.21 Form 5227 requires disclosure of information regarding a trust’s noncharitable beneficiaries. The penalty for failure to 

file this return is calculated based on the amount of tax owed. A 

split-interest trust generally is not subject to tax and therefore, in 

general, a penalty may not be imposed for the failure to file Form 

5227. Form 5227 is not required to be made publicly available. 

REASONS FOR CHANGE

Under present law, an individual who wants to use IRA proceeds 

to make charitable contributions must treat the IRA distribution as 

a withdrawal subject to IRA income recognition rules and is subject 

to deduction limitation provisions on the contributions made to the 

charity. In some cases, this can result in taxable income even 

though the individual used the entire IRA distribution to make the 

charitable contribution. The Committee believes that taxpayers 

who want to make charitable contributions from IRAs generally 

should be permitted to do so without recognizing income because 

of the distribution from the IRA, whether such contribution is 

made directly to the charitable organization or indirectly through 

the use of a split-interest entity. The Committee believes that facilitating charitable contributions from IRAs will help increase giving to charitable organizations. 

EXPLANATION OF PROVISION

Qualified charitable distributions from IRAs 

The provision provides an exclusion from gross income for otherwise taxable IRA distributions from a traditional or a Roth IRA in 

the case of qualified charitable distributions. Special rules apply in 

determining the amount of an IRA distribution that is otherwise 

taxable. The present-law rules regarding taxation of IRA distributions and the deduction of charitable contributions continue to 

apply to distributions from an IRA that are not qualified charitable 

distributions. 

A qualified charitable distribution is defined as any distribution 

from an IRA that is made directly by the IRA trustee either to (1) 

an organization to which deductible contributions can be made (a 

‘‘direct distribution’’) or (2) a ‘‘split-interest entity.’’ A split-interest 

entity means a charitable remainder annuity trust or charitable remainder unitrust (together referred to as a ‘‘charitable remainder 

trust’’), a pooled income fund, or a charitable gift annuity. Direct 

distributions are eligible for the exclusion only if made on or after 

the date the IRA owner attains age 701⁄2. Distributions to a split 

interest entity are eligible for the exclusion only if made on or after 

the date the IRA owner attains age 591⁄2 (or, if later, January 1, 

2004). In the case of split-interest distributions, no person may 

12

hold an income interest in the amounts in the split-interest entity 

attributable to the charitable distribution other than the IRA 

owner, his or her spouse, or a charitable organization. 

The exclusion applies to direct distributions only if a charitable 

contribution deduction for the entire distribution otherwise would 

be allowable, determined without regard to the generally applicable 

percentage limitations. Thus, for example, if the deductible amount 

is reduced because of a benefit received in exchange, or if a deduction is not allowable because the donor did not obtain sufficient 

substantiation, the exclusion is not available with respect to any 

part of the IRA distribution. Similarly, the exclusion applies in the 

case of a distribution directly to a split-interest entity only if a 

charitable contribution deduction for the entire present value of the 

charitable interest (for example, a remainder interest) otherwise 

would be allowable, determined without regard to the generally applicable percentage limitations. 

If the IRA owner has any IRA that includes nondeductible contributions, a special rule applies in determining the portion of a 

distribution that is includible in gross income (but for the provision) and thus is eligible for qualified charitable distribution treatment. In such case, the IRA owner aggregates all IRAs to determine eligibility for the exclusion. Under the special rule, the distribution is treated as consisting of income first, up to the aggregate amount that would be includible in gross income (but for the 

provision) if the aggregate balance of all IRAs having the same 

owners were distributed during the same year. In determining the 

amount of subsequent IRA distributions includible in income, proper adjustments are made to reflect the amount treated as a qualified charitable distribution under the special rule. 

Special rules apply for distributions to split-interest entities. For 

distributions to charitable remainder trusts, the provision provides 

that subsequent distributions from the charitable remainder trust 

are treated as ordinary income in the hands of the beneficiary, notwithstanding how such amounts normally are treated under section 664(b). In addition, for a charitable remainder trust to be eligible to receive qualified charitable distributions, the charitable remainder trust has to be funded exclusively by such distributions. 

For example, an IRA owner may not make qualified charitable distributions to an existing charitable remainder trust any part of 

which was funded with assets that were not qualified charitable 

distributions. 

Under the provision, a pooled income fund is eligible to receive 

qualified charitable distributions only if the fund accounts separately for amounts attributable to such distributions. In addition, 

all distributions from the pooled income fund that are attributable 

to qualified charitable distributions are treated as ordinary income 

to the beneficiary. Qualified charitable distributions to a pooled income fund are not includible in the fund’s gross income. 

In determining the amount includible in gross income by reason 

of a payment from a charitable gift annuity purchased with a qualified charitable distribution from an IRA, the portion of the distribution from the IRA used to purchase the annuity is not an investment in the annuity contract. 

13

Any amount excluded from gross income by reason of the provision is not taken into account in determining the deduction for 

charitable contributions under section 170. 

Qualified charitable distribution examples 

The following examples illustrate the determination of the portion of an IRA distribution that is a qualified charitable distribution and the application of the special rules for a qualified charitable distribution to a split-interest entity. In each example, it is 

assumed that the requirements for qualified charitable distribution 

treatment are otherwise met (e.g., the applicable age requirement 

and the requirement that contributions are otherwise deductible) 

and that no other IRA distributions occur during the year. 

Example 1. Individual A has a traditional IRA with a balance of 

$100,000, consisting solely of deductible contributions and earnings. Individual A has no other IRA. The entire IRA balance is distributed in a direct distribution to a charitable organization. Under 

present law, the entire distribution of $100,000 would be includible 

in Individual A’s income. Accordingly, under the provision, the en- tire distribution of $100,000 is a qualified charitable distribution. 

As a result, no amount is included in Individual A’s income as a 

result of the distribution and the distribution is not taken into account in determining the amount of Individual A’s charitable deduction for the year. 

Example 2. The facts are the same as in Example 1, except that the entire IRA balance of $100,000 is distributed to a charitable remainder unitrust, which contains no other assets and which must 

be funded exclusively by qualified charitable distributions. Under 

the terms of the trust, Individual A is entitled to receive five percent of the value of the trust each year. As explained in Example 

l, the entire $100,000 distribution is a qualified charitable distribution, no amount is included in Individual A’s income as a result of 

the distribution, and the distribution is not taken into account in 

determining the amount of Individual A’s charitable deduction for 

the year. In addition, under a special rule in the provision for charitable remainder trusts, any distribution from the charitable remainder unitrust to Individual A is includible in gross income as 

ordinary income, regardless of the character of the distribution 

under the usual rules for the taxation of distributions from such a 

trust. 

Example 3. Individual B has a traditional IRA with a balance of 

$100,000, consisting of $20,000 of nondeductible contributions and 

$80,000 of deductible contributions and earnings. Individual B has 

no other IRA. In a direct distribution to a charitable organization, 

$80,000 is distributed from the IRA. Under present law, a portion 

of the distribution from the IRA would be treated as a nontaxable 

return of nondeductible contributions. The nontaxable portion of 

the distribution would be $16,000, determined by multiplying the 

amount of the distribution ($80,000) by the ratio of the nondeductible contributions to the account balance ($20,000/$100,000). Accordingly, under present law, $64,000 of the distribution ($80,000 

minus $16,000) would be includible in Individual B’s income. 

Under the provision, notwithstanding the present-law tax treatment of IRA distributions, the distribution is treated as consisting 

14

22Sec. 6652(c)(4)(C). 

of income first, up to the total amount that would be includible in 

gross income (but for the provision) if all amounts were distributed 

from all IRAs otherwise taken into account in determining the 

amount of IRA distributions. The total amount that would be includible in income if all amounts were distributed from the IRA is 

$80,000. Accordingly, under the provision, the entire $80,000 distributed to the charitable organization is treated as includible in 

income (before application of the provision) and is a qualified charitable distribution. As a result, no amount is included in Individual 

B’s income as a result of the distribution and the distribution is not 

taken into account in determining the amount of Individual B’s 

charitable deduction for the year. In addition, for purposes of determining the tax treatment of other distributions from the IRA, 

$20,000 of the amount remaining in the IRA is treated as Individual B’s nondeductible contributions. 

Split-interest trust filing requirements 

The provision increases the penalty on split-interest trusts for 

failure to file a return and for failure to include any of the information required to be shown on such return and to show the correct 

information. The penalty is $20 for each day the failure continues 

up to $10,000 for any one return. In the case of a split-interest 

trust with gross income in excess of $250,000, the penalty is $100 

for each day the failure continues up to a maximum of $50,000. In 

addition, if a person (meaning any officer, director, trustee, employee, or other individual who is under a duty to file the return 

or include required information) 22 knowingly failed to file the return or include required information, then that person is personally 

liable for such a penalty, which would be imposed in addition to the 

penalty that is paid by the organization. Information regarding 

beneficiaries that are not charitable organizations as described in 

section 170(c) is exempt from the requirement to make information 

publicly available. In addition, the provision repeals the presentlaw exception to the filing requirement for split-interest trusts that 

are required in a taxable year to distribute all net income currently 

to beneficiaries. Such exception remains available to trusts other 

than split-interest trusts that are otherwise subject to the filing requirement. 

EFFECTIVE DATE

The provision relating to qualified charitable distributions is effective for distributions made after the date of enactment. The provision relating to information returns of split-interest trusts is effective for returns for taxable years beginning after December 31, 

2003.

15

23Sec. 170(e)(3). In general, a C corporation’s charitable contribution deductions for a year 

may not exceed 10 percent of the corporation’s taxable income. Sec. 170(b)(2). 24Lucky Stores Inc. v. Commissioner, 105 T.C. 420 (1995). 

C. CHARITABLE DEDUCTION FOR CONTRIBUTIONS OF FOOD

INVENTORY

(Sec. 103 of the bill and sec. 170 of the Code) 

PRESENT LAW

Under present law, a taxpayer’s deduction for charitable contributions of inventory generally is limited to the taxpayer’s basis 

(typically, cost) in the inventory. 

However, for certain contributions of inventory, C corporations 

may claim an enhanced deduction equal to the lesser of (1) basis 

plus one-half of the item’s appreciated value (i.e., basis plus one 

half of fair market value in excess of basis) or (2) two times basis.23

To be eligible for the enhanced deduction, the contributed property 

generally must be inventory of the taxpayer, contributed to a charitable organization described in section 501(c)(3) (except for private 

nonoperating foundations), and the donee must (1) use the property 

consistent with the donee’s exempt purpose solely for the care of 

the ill, the needy, or infants, (2) not transfer the property in exchange for money, other property, or services, and (3) provide the 

taxpayer a written statement that the donee’s use of the property 

will be consistent with such requirements. In the case of contributed property subject to the Federal Food, Drug, and Cosmetic Act, 

the property must satisfy the applicable requirements of such Act 

on the date of transfer and for 180 days prior to the transfer. 

To use the enhanced deduction, the taxpayer must establish that 

the fair market value of the donated item exceeds basis. The valuation of food inventory has been the subject of ongoing disputes between taxpayers and the IRS. In one case, the Tax Court held that 

the value of surplus bread inventory donated to charity was the full 

retail price of the bread rather than half the retail price, as the 

IRS asserted.24

REASONS FOR CHANGE

The Committee believes that expanding the present-law enhanced deduction for contributions of food inventory to non-C corporations and raising the amount of the enhanced deduction will 

increase charitable contributions of food to those in need. By clarifying the definition of fair market value, the Committee believes 

that taxpayers will be better able to avoid disputes with the IRS 

about the valuation of food and receive an appropriate deduction 

for their contribution. In addition, the Committee believes that providing certain low-basis taxpayers with a deemed basis equal to 

one quarter of the fair market value of the food will increase food 

donations, thus further providing needed nourishment to the nation’s hungry. 

EXPLANATION OF PROVISION

Under the provision, any taxpayer, whether or not a C corporation, engaged in a trade or business is eligible to claim the enhanced deduction for donations of food inventory. For taxpayers 

16

25This includes, for example, taxpayers who are eligible for administrative relief under Revenue Procedures 2002–28 and 2001–10. 

other than C corporations, the total deduction for donations of food 

inventory in a taxable year generally may not exceed 10 percent of 

the taxpayer’s net income for such year from its trade or business 

(or interest therein) from which contributions are made. For example, if a taxpayer is a sole proprietor, a shareholder in an S corporation, and a partner in a partnership, and each business makes 

charitable contributions of food inventory, the taxpayer’s deduction 

for donations of food inventory is limited to 10 percent of the taxpayer’s net income from the sole proprietorship and the taxpayer’s 

interests in the S corporation and partnership. However, if only the 

sole proprietorship and the S corporation made charitable contributions of food inventory, the taxpayer’s deduction would be limited 

to 10 percent of the net income from the trade or business of the 

sole proprietorship and the S corporation, but not the partnership. 

The 10 percent limitation does not affect the application of the 

generally applicable percentage limitations. For example, if 10 percent of a sole proprietor’s net income from the proprietor’s trade or 

business was greater than 50 percent of the proprietor’s contribution base, the available deduction for the taxable year (with respect 

to contributions to public charities) would be 50 percent of the proprietor’s contribution base. Consistent with present law, such contributions may be carried forward because they exceed the 50 percent limitation. Contributions of food inventory by a taxpayer that 

is not a C corporation that exceed the 10 percent limitation but not 

the 50 percent limitation could not be carried forward. 

For purposes of calculating the enhanced deduction, taxpayers 

who do not account for inventories under section 471 and who are 

not required to capitalize indirect costs under section 263A are able 

to elect to treat the basis of the contributed food as being equal to 

25 percent of the food’s fair market value.25

The provision changes the amount of the present-law enhanced 

deduction for eligible contributions of food inventory to the lesser 

of fair market value or twice the taxpayer’s basis in the inventory. 

For example, a taxpayer who makes an eligible donation of food 

that has a fair market value of $10 and a basis of $4 could take 

a deduction of $8 (twice basis). If the taxpayer’s basis was $6 instead of $4, then the deduction would be $10 (fair market value). 

By contrast, under present law, a C corporation’s deduction in the 

first example would be $7 (fair market value less half the appreciation) and in the second example would be $8. (Under present law, 

taxpayers other than C corporations generally could take a deduction for a contribution of food inventory only for the $4 basis in either example.) Taxpayers that do not account for inventories under 

section 471 and who are not required to capitalize indirect costs 

under section 263A would be able to elect to treat the basis of the 

contributed food as being equal to 25 percent of the food’s fair market value. 

Under the provision, the enhanced deduction is available only for 

food that qualifies as ‘‘apparently wholesome food.’’ ‘‘Apparently 

wholesome food’’ is defined as food intended for human consumption that meets all quality and labeling standards imposed by FedVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00016 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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26Sec. 170(e)(3). 

eral, State, and local laws and regulations even though the food 

may not be readily marketable due to appearance, age, freshness, 

grade, size, surplus, or other conditions. 

In addition, the provision provides that the fair market value of 

donated apparently wholesome food that cannot or will not be sold 

solely due to internal standards of the taxpayer or lack of market 

is determined without regard to such internal standards or lack of 

market and by taking into account the price at which the same or 

substantially the same food items (as to both type and quality) are 

sold by the taxpayer at the time of the contribution or, if not so 

sold at such time, in the recent past. 

EFFECTIVE DATE

The provision is effective for contributions made after the date of 

enactment.

D. CHARITABLE DEDUCTION FOR CONTRIBUTIONS OF BOOK

INVENTORY

(Sec. 104 of the bill and sec. 170 of the Code) 

PRESENT LAW

Under present law, a taxpayer’s deduction for charitable contributions of inventory generally is limited to the taxpayer’s basis 

(typically, cost) in the inventory. 

However, for certain contributions of inventory, C corporations 

may claim an enhanced deduction equal to the lesser of (1) basis 

plus one-half of the item’s appreciated value (i.e., basis plus one 

half of fair market value in excess of basis) or (2) two times basis.26

To be eligible for the enhanced deduction, the contributed property 

generally must be inventory of the taxpayer, contributed to a charitable organization described in section 501(c)(3) (except for private 

nonoperating foundations), and the donee must: (1) use the property consistent with the donee’s exempt purpose solely for the care 

of the ill, the needy, or infants, (2) not transfer the property in exchange for money, other property, or services, and (3) provide the 

taxpayer a written statement that the donee’s use of the property 

will be consistent with such requirements. 

REASONS FOR CHANGE

Under present law, taxpayers sometimes are prohibited from receiving an enhanced deduction for charitable contributions of their 

book inventory, in part because of the requirement that the inventory be used for care of the ill, the needy, or infants. For example, 

such requirement generally prohibits donations to public libraries 

and adult literacy programs. The Committee believes that suitable 

book inventory should be eligible for an enhanced deduction in 

cases where a contribution is made to an appropriate educational 

organization. To minimize disputes between taxpayers and the IRS 

about the value of books and to encourage contributions of books 

that are suitable in terms of currency, content, and quantity, the 

Committee provides a special rule for determining the amount of 

18

the contribution of such books. A clear rule is needed so that taxpayers know that if they donate books to schools, libraries, and literacy programs, they will receive an enhanced deduction that more 

adequately reflects the costs of the donation. 

EXPLANATION OF PROVISION

The provision modifies the present-law enhanced deduction for C 

corporations so that it is equal to the lesser of fair market value 

or twice the taxpayer’s basis in the case of qualified book contributions. The provision provides that the fair market value for this 

purpose is determined by reference to a bona fide published market 

price for the book. Under the provision, a bona fide published market price of a book means a price: (1) determined using the same 

printing and edition; (2) determined in the usual market in which 

such a book has been customarily sold by the taxpayer; and (3) for 

which the taxpayer can demonstrate to the satisfaction of the Secretary that the taxpayer customarily sold such books in arm’s 

length transactions within 7 years preceding the contribution. For 

example, a publisher’s listed retail price for a book would not meet 

the standard if the publisher could not demonstrate to the satisfaction of the Secretary that the price was one at which the publisher 

customarily sold the book in its usual market in arm’s length 

transactions occurring within the 7-year period prior to the contribution. If a publisher entered into a contract with a local school 

district to sell newly published textbooks six years prior to making 

a qualified book contribution of such textbooks, the publisher could 

use as a bona fide published market price, the price at which such 

books regularly were sold to the school district under the contract. 

By contrast, if a publisher listed in a catalogue or elsewhere a ‘‘suggested retail price,’’ but the publisher did not in fact customarily 

sell the books at such price, the publisher could not use the ‘‘suggested retail price’’ to determine the fair market value of the book 

for purposes of the enhanced deduction. Thus, in general, a bona 

fide published market price must be independently verifiable by 

reference to actual sales within the seven-year period preceding the 

contribution, and not to a publisher’s own price list. 

As an illustration of the mechanics of calculating the enhanced 

deduction under the provision, a C corporation that made a qualified book contribution with a bona fide published market price of 

$10 and a basis of $4 could take a deduction of $8 (twice basis). 

If the taxpayer’s basis is $6 instead of $4, then the deduction is 

$10. Also, in such latter case, if the book’s bona fide market pub- lished market price was $5 at the time of the contribution but was 

$10 five years before the contribution, then the deduction is $10. 

A qualified book contribution means a charitable contribution of 

books to: (1) an educational organization that normally maintains 

a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where 

its educational activities are regularly carried on; (2) a public library; or (3) an organization described in section 501(c)(3) (except 

for private nonoperating foundations), that is organized primarily 

to make books available to the general public at no cost or to operate a literacy program. The donee must: (1) use the property consistent with the donee’s exempt purpose; (2) not transfer the propVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00018 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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27Sec. 170(e)(1). 28Secs. 170(e)(4) and 170(e)(6). 

erty in exchange for money, other property, or services; and (3) provide the taxpayer a written statement that the donee’s use of the 

property will be consistent with such requirements and also that 

the books are suitable, in terms of currency, content, and quantity, 

for use in the donee’s educational programs and that the donee will 

use the books in such educational programs. 

EFFECTIVE DATE

The provision is effective for contributions made after the date of 

enactment.

E. EXPAND CHARITABLE CONTRIBUTION ALLOWED FOR SCIENTIFIC

PROPERTY USED FOR RESEARCH AND FOR COMPUTER TECHNOLOGY

AND EQUIPMENT

(Sec. 105 of the bill and sec. 170 of the Code) 

PRESENT LAW

In the case of a charitable contribution of inventory or other ordinary-income or short-term capital gain property, the amount of the 

charitable deduction generally is limited to the taxpayer’s basis in 

the property. In the case of a charitable contribution of tangible 

personal property, the deduction is limited to the taxpayer’s basis 

in such property if the use by the recipient charitable organization 

is unrelated to the organization’s tax-exempt purpose. In cases involving contributions to a private foundation (other than certain 

private operating foundations), the amount of the deduction is limited to the taxpayer’s basis in the property.27

Under present law, a taxpayer’s deduction for charitable contributions of scientific property used for research and for contributions of computer technology and equipment generally is limited to 

the taxpayer’s basis (typically, cost) in the property. However, certain corporations may claim a deduction in excess of basis for a 

‘‘qualified research contribution’’ or a ‘‘qualified computer contribution.’’ 28 This enhanced deduction is equal to the lesser of (1) basis 

plus one-half of the item’s appreciated value (i.e., basis plus one 

half of fair market value minus basis) or (2) two times basis. The 

enhanced deduction for qualified computer contributions expires for 

any contribution made during any taxable year beginning after December 31, 2003. 

A qualified research contribution means a charitable contribution 

of inventory that is tangible personal property. The contribution 

must be to a qualified educational or scientific organization and be 

made not later than two years after construction of the property is 

substantially completed. The original use of the property must be 

by the donee, and be used substantially for research or experimentation, or for research training, in the U.S. in the physical or biological sciences. The property must be scientific equipment or apparatus, constructed by the taxpayer, and may not be transferred by 

the donee in exchange for money, other property, or services. The 

donee must provide the taxpayer with a written statement representing that it will use the property in accordance with the condiVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00019 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
20

29 If the taxpayer constructed the property and reacquired such property, the contribution 

must be within three years of the date the original construction was substantially completed. 

Sec. 170(e)(6)(D)(i). 30This requirement does not apply if the property was reacquired by the manufacturer and 

contributed. Sec. 170(e)(6)(D)(ii). 31Sec. 170(e)(6)(C). 

tions for the deduction. For purposes of the enhanced deduction, 

property is considered constructed by the taxpayer only if the cost 

of the parts used in the construction of the property (other than 

parts manufactured by the taxpayer or a related person) do not exceed 50 percent of the taxpayer’s basis in the property. 

A qualified computer contribution means a charitable contribution of any computer technology or equipment, which meets standards of functionality and suitability as established by the Secretary 

of the Treasury. The contribution must be to certain educational organizations or public libraries and made not later than three years 

after the taxpayer acquired the property or, if the taxpayer constructed the property, not later than the date construction of the 

property is substantially completed.29 The original use of the property must be by the donor or the donee,30 and in the case of the 

donee, must be used substantially for educational purposes related 

to the function or purpose of the donee. The property must fit productively into the donee’s education plan. The donee may not transfer the property in exchange for money, other property, or services, 

except for shipping, installation, and transfer costs. To determine 

whether property is constructed by the taxpayer, the rules applicable to qualified research contributions apply. Contributions may be 

made to private foundations under certain conditions.31

REASONS FOR CHANGE

The Committee believes that extension of the enhanced deduction to include property assembled by the taxpayer will lead to increased charitable contributions of scientific property used for research and computer technology and equipment and will help to 

eliminate confusion in determining whether property is ‘‘constructed’’ or ‘‘assembled’’ for purposes of claiming the enhanced deduction. The Committee believes it is appropriate to extend temporarily the enhanced deduction for qualified computer contributions. 

EXPLANATION OF PROVISION

Under the provision, property assembled by the taxpayer, in addition to property constructed by the taxpayer, is eligible for either 

enhanced deduction. The Committee does not intend that old or 

used components assembled by the taxpayer into scientific property 

or computer technology or equipment are eligible for the enhanced 

deduction. 

The provision extends the enhanced deduction for qualified computer contributions to contributions made during any taxable year 

beginning before January 1, 2006. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2002.

21

32Secs. 170, 2055, and 2522, respectively. 

F. ENCOURAGE CONTRIBUTIONS OF CAPITAL GAIN REAL PROPERTY

MADE FOR CONSERVATION PURPOSES

(Sec. 106 of the bill and sec. 170 of the Code) 

PRESENT LAW

Charitable contributions generally 

In general, a deduction is permitted for charitable contributions, 

subject to certain limitations that depend on the type of taxpayer, 

the property contributed, and the donee organization. The amount 

of deduction generally equals the fair market value of the contributed property on the date of the contribution. Charitable deductions are provided for income, estate, and gift tax purposes.32

In general, in any taxable year, charitable contributions by a corporation are not deductible to the extent the aggregate contributions exceed 10 percent of the corporation’s taxable income computed without regard to net operating or capital loss carrybacks. 

For individuals, the amount deductible is a percentage of the taxpayer’s contribution base, which is the taxpayer’s adjusted gross income computed without regard to any net operating loss carryback. 

The applicable percentage of the contribution base varies depending on the type of donee organization and property contributed. 

Cash contributions of an individual taxpayer to public charities, 

private operating foundations, and certain types of private nonoperating foundations may not exceed 50 percent of the taxpayer’s 

contribution base. Cash contributions to private foundations and 

certain other organizations generally may be deducted up to 30 

percent of the taxpayer’s contribution base. 

In general, a charitable deduction is not allowed for income, estate, or gift tax purposes if the donor transfers an interest in property to a charity while also either retaining an interest in that 

property or transferring an interest in that property to a noncharity for less than full and adequate consideration. Exceptions to 

this general rule are provided for, among other interests, remainder interests in charitable remainder annuity trusts, charitable remainder unitrusts, and pooled income funds, present interests in 

the form of a guaranteed annuity or a fixed percentage of the annual value of the property, and qualified conservation contributions. 

Capital gain property 

Capital gain property means any capital asset or property used 

in the taxpayer’s trade or business the sale of which at its fair market value, at the time of contribution, would have resulted in gain 

that would have been long-term capital gain. Contributions of capital gain property to a qualified charity are deductible at fair market value within certain limitations. Contributions of capital gain 

property to charitable organizations described in section 

170(b)(1)(A) (e.g., public charities, private foundations other than 

private non-operating foundations, and certain governmental units) 

generally are deductible up to 30 percent of the taxpayer’s contribution base. An individual may elect, however, to bring all these 

22

contributions of capital gain property for a taxable year within the 

50-percent limitation category by reducing the amount of the contribution deduction by the amount of the appreciation in the capital 

gain property. Contributions of capital gain property to charitable 

organizations described in section 170(b)(1)(B) (e.g., private non-operating foundations) are deductible up to 20 percent of the taxpayer’s contribution base. 

For purposes of determining whether a taxpayer’s aggregate 

charitable contributions in a taxable year exceed the applicable 

percentage limitation, contributions of capital gain property are 

taken into account after other charitable contributions. Contributions of capital gain property that exceed the percentage limitation 

may be carried forward for five years. 

Qualified conservation contributions 

Qualified conservation contributions are not subject to the ‘‘partial interest’’ rule, which generally bars deductions for charitable 

contributions of partial interests in property. A qualified conservation contribution is a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. A qualified real property interest is defined as: (1) the entire 

interest of the donor other than a qualified mineral interest; (2) a 

remainder interest; or (3) a restriction (granted in perpetuity) on 

the use that may be made of the real property. Qualified organizations include certain governmental units, public charities that meet 

certain public support tests, and certain supporting organizations. 

Conservation purposes include: (1) the preservation of land areas 

for outdoor recreation by, or for the education of, the general public; (2) the protection of a relatively natural habitat of fish, wildlife, 

or plants, or similar ecosystem; (3) the preservation of open space 

(including farmland and forest land) where such preservation will 

yield a significant public benefit and is either for the scenic enjoyment of the general public or pursuant to a clearly delineated Federal, State, or local governmental conservation policy; and (4) the 

preservation of an historically important land area or a certified 

historic structure. 

Qualified conservation contributions of capital gain property are 

subject to the same limitations and carryover rules of other charitable contributions of capital gain property. 

REASONS FOR CHANGE

The Committee desires to provide additional incentives for charitable donations of real property made for qualified conservation 

purposes. The Committee believes that increasing the percentage 

limitations applicable to qualified conservation contributions of real 

property, and increasing the carryover period applicable to such 

contributions from five to fifteen years, will increase donations 

made for qualified conservation purposes. The Committee also believes that special incentives are required to encourage qualified 

conservation contributions of farm and ranch properties. 

23

EXPLANATION OF PROVISION

In general 

Under the provision, the 30-percent contribution base limitation 

on contributions of capital gain property by individuals does not 

apply to qualified conservation contributions (as defined under 

present law). Thus, individuals may include the fair market value 

of any qualified conservation contribution of capital gain property 

in determining the amount of the charitable contributions subject 

to the 50-percent contribution base limitation. 

Individuals are allowed to carryover any qualified conservation 

contributions that exceed the 50-percent limitation for up to 15 

years. The 50-percent contribution base limitation applies first to 

contributions other than qualified conservation contributions and 

then to qualified conservation contributions. For example, assume 

an individual with a contribution base of $100 makes a qualified 

conservation contribution of property with a fair market value of 

$80 and makes other charitable contributions of $60. The individual is allowed a deduction of $50 in the current taxable year for 

the other contributions (50 percent of the $100 contribution base) 

and is allowed to carryover the excess $10 for up to 5 years. No 

current deduction is allowed for the qualified conservation contribution but the entire $80 qualified conservation contribution 

may be carried forward for up to 15 years. 

Farmers and ranchers 

In the case of an eligible farmer or rancher, a qualified conservation contribution is allowable up to 100 percent of the taxpayer’s 

contribution base (after taking into account other charitable contributions). This rule applies both to individuals and corporations. 

In addition, corporate (as well as non-corporate) eligible farmers 

and ranchers are allowed to carryover any excess qualified conservation contributions for up to 15 years. The 100-percent contribution base limitation applies first to contributions other than 

qualified conservation contributions (to the extent allowable under 

other percentage limitations) and then to qualified conservation 

contributions. For example, assume an individual farmer or rancher with a contribution base of $100 makes a qualified conservation 

contribution of property with a fair market value of $80 and makes 

other charitable contributions of $60. The individual is allowed a 

deduction of $50 in the current taxable year for the other contributions (50 percent of the $100 contribution base) and is allowed to 

carryover the excess $10 for up to 5 years. The individual also is 

allowed a deduction of $50 in the current taxable year for the 

qualified charitable contribution (the amount of the remaining contribution base). The remaining $30 qualified conservation contribution may be carried forward for up to 15 years. 

For this purpose, an eligible farmer or rancher means a taxpayer 

(other than a publicly traded C corporation) whose gross income 

from the trade of business of farming is at least 51 percent of the 

taxpayer’s gross income for the taxable year. 

24

33Ltr. Rul. 8626029. 

EFFECTIVE DATE

The provision is effective for contributions made after the date of 

enactment. 

G. EXCLUSION OF 25 PERCENT OF CAPITAL GAIN FOR CERTAIN SALES

MADE FOR QUALIFYING CONSERVATION PURPOSES

(Sec. 107 of the bill and new sec. 121A of the Code) 

PRESENT LAW

Sales of capital gain property 

Gain from the sale or exchange of land held more than one year 

generally is treated as long-term capital gain. Generally, the net 

capital gain of an individual (i.e., long-term capital gain less shortterm capital loss) is subject to a maximum tax rate of 20 percent. 

Charitable contributions of capital gain property for conservation 

purposes 

Special rules apply to charitable contributions of qualified conservation contributions. Qualified conservation contributions are 

not subject to the ‘‘partial interest’’ rule, which generally bars deductions for charitable contributions of partial interests in property. A qualified conservation contribution is a contribution of a 

qualified real property interest to a qualified organization exclusively for conservation purposes. A qualified real property interest 

is defined as: (1) the entire interest of the donor other than a qualified mineral interest; (2) a remainder interest; or (3) a restriction 

(granted in perpetuity) on the use that may be made of the real 

property. Charitable contributions of interests that constitute the 

taxpayer’s entire interest in the property are not regarded as qualified real property interests within the meaning of section 170(h),33

but instead are subject to the general rules applicable to charitable 

contributions of entire interests of the taxpayer. Qualified organizations include certain governmental units, public charities that meet 

certain public support tests, and certain supporting organizations. 

Conservation purposes include: (1) the preservation of land areas 

for outdoor recreation by, or for the education of, the general public; (2) the protection of a relatively natural habitat of fish, wildlife, 

or plants, or similar ecosystem; (3) the preservation of open space 

(including farmland and forest land) where such preservation will 

yield a significant public benefit and is either for the scenic enjoyment of the general public or pursuant to a clearly delineated Federal, State, or local governmental conservation policy; and (4) the 

preservation of an historically important land area or a certified 

historic structure. 

Treasury regulations provide that a deduction for a qualified conservation contribution is allowed only if the donor prohibits in the 

instrument of conveyance the donee from subsequently transferring 

the qualified real property interest, whether or not for consideration, unless the donee organization, as a condition of the subsequent transfer, requires that the conservation purpose which the 

contribution was originally intended to advance continues to be carVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00024 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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34Treas. Reg. sec. 1.170A–14(c)(2). 35 Id. 36The exclusion is mandatory if all of the requirements of the provision are satisfied, and a 

taxpayer need not file an election to take advantage of the exclusion. A taxpayer who transfers 

qualifying property to a qualified organization may opt out of the 25-percent exclusion by choosing not to satisfy one or more of the provision’s requirements without having to file a formal 

election with the Secretary, such as by failing to obtain the requisite letter of intent from the 

qualified organization. 

ried out.34 Moreover, subsequent transfers of such interests are restricted to organizations that are qualified conservation organizations.35

REASONS FOR CHANGE

Some landowners may want their land to be protected for conservation purposes but cannot afford simply to donate either the 

land or an easement on the land, especially if the land is the landowner’s primary asset. The Committee desires to encourage the 

sale of appreciated, environmentally sensitive land and real property interests in land or water, as well as controlling stock interests in certain land corporations, to qualified conservation organizations and governments, thus achieving conservation goals 

through voluntary sales of property. The Committee believes that 

providing taxpayers a partial exclusion of capital gain derived from 

the voluntary sale of properties for conservation purposes will increase the number of properties dedicated to conservation purposes. 

The Committee desires to facilitate the transfers of properties to 

conservation organizations in a manner that will, to the extent 

practicable, preserve the value of the properties once they are acquired by the conservation organizations, while providing safeguards designed to ensure the protection of the conservation purposes for which the properties are intended to be used. 

EXPLANATION OF PROVISION

In general 

The provision provides a 25-percent exclusion from gross income 

of long-term capital gain from the qualifying sale or exchange of 

land, or an interest in land or water rights, provided that the land 

or interest in land or water rights constitutes an interest in real 

property that has been held by the taxpayer or the taxpayer’s family at all times during the five years preceding the date of sale. The 

qualifying sale must be made to a qualified organization that intends that the acquired property be used for qualified conservation 

purposes in perpetuity.36

Qualifying interests 

The exclusion applies only to sales or exchanges of real property 

interests in land or water rights that constitute the entire interest 

of the taxpayer in such land or water rights, or that constitute 

qualified real property interests as defined in section 170(h), specifically: (1) the entire interest of the taxpayer other than a qualified mineral interest; (2) a remainder interest; or (3) a restriction 

(granted in perpetuity) on the use which may be made of the real 

property. Partial interests in property that are not the entire interest of the taxpayer or a qualified real property interest do not qualVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00025 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
26

37The Committee intends that soil and water conservation expenditures in the nature of those 

described in section 175, determined without regard to whether the taxpayer is engaged in a 

farming business and that the land be used for farming, generally shall be treated as furthering 

a qualified conservation purpose.

ify for the exclusion. For example, a taxpayer who owns land and 

related mineral rights but who sells only the mineral rights is not 

eligible for the exclusion. However, a taxpayer who owns only mineral rights is eligible for the 25-percent exclusion if the taxpayer 

sells his or her entire interest in the mineral rights and satisfies 

the other requirements of the provision. 

Generally, an undivided interest that constitutes the taxpayer’s 

entire interest in the property is eligible for the exclusion. A partial 

interest that constitutes the taxpayer’s entire interest in the property, however, does not qualify for the exclusion if the property in 

which such partial interest exists was divided in an attempt to 

avoid the partial interest rules. The Committee intends that the 

partial interest rules contained in Treasury Regulations section 

1.170A–7(a)(2)(i) and generally applicable to contributions of partial interests be applied similarly for purposes of this provision. For 

example, if a taxpayer transfers an undivided interest in property 

to a spouse and immediately thereafter sells the remaining undivided interest to a qualified organization, the exclusion will not 

apply to the taxpayer’s sale to the qualified organization. 

Under the provision, the exclusion is available for long-term capital gain from certain sales or exchanges of stock in a C corporation 

if the qualified organization ultimately obtains a controlling stock 

interest (generally a stock interest that provides the qualified organization at least 90 percent of the total voting power and total 

value of the corporation’s stock) and if at least 90 percent of the 

fair market value of the C corporation’s assets at the time of the 

sale or exchange consists of land or water rights, or interests in 

land or water rights, that were held by the corporation at all times 

during the five years preceding the sale. Stock in a corporation will 

not qualify if at the time of the sale or exchange the fair market 

value of water rights and infrastructure relating to the delivery of 

water constitutes more than 50 percent of the fair market value of 

all of the corporation’s assets. Only a stock interest held by the taxpayer or the taxpayer’s family at all times during the five years 

preceding the sale qualifies for the 25-percent exclusion. The Committee intends that in appropriate circumstances a controlling 

stock interest may be acquired by the qualified organization from 

multiple persons in multiple transactions, and authorizes the Secretary to issue guidance regarding the availability of the exclusion 

in such cases. 

Qualifying gain 

The exclusion applies only to long-term capital gain. Gain treated 

as ordinary income, such as under depreciation recapture provisions, is not eligible for the exclusion. Gain attributable to certain 

improvements, such as buildings or structures that do not further 

a qualified conservation purpose (‘‘disqualified improvements’’), also 

does not qualify for the exclusion.37 The provision provides that the 

maximum amount of gain that may be excluded by a shareholder 

in the case of a sale or exchange of a controlling stock interest is 

27

38The Committee intends that the taxpayer be required to use this gain allocation rule unless 

the taxpayer has adequate records to substantiate the adjusted basis and fair market value to 

support a separate calculation. 39 A sale or exchange made prior to the issuance of an order, but that is the result of a threat 

of condemnation or eminent domain, may qualify for the exclusion. 

25 percent of the shareholder’s proportionate share of the C corporation’s underlying gain attributable to qualifying land, water 

rights, or interests therein held by the C corporation. 

Consistent with present law, the determination of gain or loss is 

to be calculated on an asset-by-asset basis whenever that is required for other purposes of the Code (such as for purposes of section 1245 or section 1250). To minimize administrative complexity 

and assist taxpayers in the preparation of their returns, the Committee intends that in those cases where the Code does not otherwise require a separate determination of gain or loss for the disqualified improvement, the gain allocable to the disqualified improvement shall be determined by reference to the fair market 

value of the disqualified improvement relative to the fair market 

value of all assets for which a gain or loss determination is not otherwise required by the Code.38

For example, if a taxpayer sells a qualifying land interest with 

a fair market value of $100 and a basis of $30, that includes a 

building or structure that does not further a conservation purpose 

(a disqualified improvement) and that has a fair market value of 

$40, the taxpayer must determine the portion of the gain that is 

attributable to the eligible land and to the disqualified improvement. If determination of gain or loss on the sale of the improvement is required for other purposes of the Code, then the gain or 

loss determined for those purposes governs, and the taxpayer must 

determine his or her basis of the disqualified improvement (in this 

case, assumed to be zero), with the result that the $40 gain on the 

disqualified improvement is not eligible for the 25-percent exclusion and the gain of $30 on the land is eligible for the 25-percent 

exclusion. On the other hand, if the determination of gain or loss 

on the sale of the improvement is not required for other purposes 

of the Code, then the Committee intends that the taxpayer allocate 

the aggregate gain of $70 attributable to the land and the disqualified improvement between the land and the improvement on the 

basis of their respective fair market values (i.e., 40 percent to the 

improvement and 60 percent to the land). Under this gain allocation rule, the $28 of gain allocable to the improvement is not eligible for the 25-percent exclusion, and the $42 of gain allocable to the 

land qualifies for the 25-percent exclusion. 

Eligible sales 

An eligible sale is a sale or exchange (excluding a transfer made 

by order of condemnation or eminent domain) 39 that may be made 

only to a qualified organization, defined as a Federal, State, or 

local government, or an agency or department thereof or a section 

501(c)(3) organization that is organized and operated primarily to 

meet a qualified conservation purpose. In addition, to be an eligible 

sale, the organization acquiring the property interest must provide 

the taxpayer with a letter stating that the intent of such organization in acquiring the property is to further a qualified conservation 

28

purpose and that any subsequent transfer of the acquired interest 

will be to a qualified organization and made to protect the conservation purpose in perpetuity. A qualified conservation purpose 

is: (1) the preservation of land areas for outdoor recreation by, or 

the education of, the general public; (2) the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem; or (3) the preservation of open space (including farmland 

and forest land) where the preservation is for the scenic enjoyment 

of the general public or pursuant to a clearly delineated Federal, 

State, or local governmental conservation policy and will yield a 

significant public benefit. 

Protection of conservation purposes 

The provision provides for the imposition of penalty excise taxes 

in appropriate cases where a qualified organization fails to take 

steps consistent with the protection of conservation purposes. Because the penalty taxes are imposed on an organization that fails 

to protect the conservation purpose, and do not serve to encumber 

the property in the same manner as a restriction contained in an 

instrument of conveyance, the Committee believes that the penalty 

taxes will adequately protect conservation purposes without decreasing the value of the property in the hands of the conservation 

organizations. 

If ownership or possession of the property is transferred by a 

qualified organization other than to another qualified organization 

that provides the requisite letter of intent, or a legal restriction 

contained in an instrument of conveyance that protects the qualified conservation purpose is removed, then: (1) a 20-percent excise 

tax applies to the proceeds or fair market value of the property; (2) 

any realized gain or income is subject to an additional excise tax 

imposed at the highest income tax rate applicable to C corporations; and (3) any otherwise applicable non-recognition provisions 

of the Code shall not apply to the transferor. The Committee intends that the excise taxes apply to all cases involving the transfer 

of ownership or possession of the property to a transferee that is 

not a qualified organization unless the transferring qualified organization demonstrates to the satisfaction of the Secretary that 

qualified conservation purposes will be protected in perpetuity. In 

the case of a removal of a legal restriction contained in an instrument of conveyance, the qualified organization must demonstrate 

to the satisfaction of the Secretary that a later unexpected change 

in the conditions surrounding the property makes retaining the 

conservation restriction impossible or impractical and that any proceeds derived from the removal of the restriction will be used to 

further qualified conservation purposes. The Committee authorizes 

the Secretary to provide guidance to identify appropriate cases 

where transfers to persons other than qualified organizations are 

regarded as protecting a conservation purpose in perpetuity. The 

Committee intends, for example, that a qualified organization may 

acquire a fee simple interest in real property operated as a farm 

and then transfer, without imposition of the penalty taxes, the real 

property subject to a conservation easement that constitutes a 

qualified real property interest if, in a recorded instrument of conveyance, the transferor prohibits the transferee from subsequently 

29

40Sec. 1011(b) and Treas. Reg. sec. 1.1011–2. 

transferring the real property unless the transferee, as a condition 

of the subsequent transfer, requires that the qualified conservation 

purpose of preserving the property as open space farmland will 

continue to be carried out. 

In the case of a transfer by a qualified organization to another 

qualified organization, the transferee must provide the transferor 

at the time of the transfer a letter stating that the intent of the 

transferee is to further a qualified conservation purpose and that 

any subsequent transfer of the acquired interest will be made to 

protect the conservation purpose in perpetuity, and the transferee 

becomes subject to the excise tax provisions for subsequent transfers. The Committee intends that in the case of a sale or exchange 

of stock of a C corporation in which a qualified organization acquires a controlling stock interest, all of the stock of such corporation acquired by the qualified organization (including any stock 

which did not qualify for the exclusion), as well as the property 

held by such C corporation, becomes subject to the penalty tax provisions. 

The provision provides that the Secretary may require such reporting as may be necessary or appropriate to further the purpose 

that any conservation use be in perpetuity. 

Relationship with other provisions 

In the case of an individual, the exclusion applies both for purposes of the regular tax and the alternative minimum tax. In the 

case of a corporation, the present-law alternative minimum tax provisions apply without modification. 

If a taxpayer sells a real property interest to a qualified organization for less than the property’s fair market value, the amount 

of any charitable contribution deduction is determined in accordance with the bargain sale rules,40 and the taxpayer shall not fail 

to qualify for a contribution deduction under those rules solely because the taxpayer derives a tax benefit from the partial exclusion 

of long-term capital gain from the sale. For example, if a taxpayer 

sells qualifying land with a fair market value of $100 and an adjusted basis of $10 to a qualified organization for a sales price of 

$95 (or alternatively, for a sale price of $50), the taxpayer’s basis 

of $10 shall be allocated between the sale and the contribution 

components of the transfer under the bargain sale rules, and the 

tax savings resulting from the 25-percent exclusion of long-term 

capital gain on the sale will not reduce the portion of the transfer 

treated as a charitable contribution under the bargain sale rules. 

The present-law requirements applicable to the charitable contribution component of the transfer, including, for example, the recordkeeping, substantiation, and appraisal provisions of Treasury Regulations section 1.170A–13, must be satisfied. 

EFFECTIVE DATE

The provision is effective for sales or exchanges occurring after 

the date of enactment.

30

H. COST SHARING PAYMENTS UNDER THE PARTNERS FOR FISH AND

WILDLIFE PROGRAM

(Sec. 108 of the bill and sec. 126 of the Code) 

PRESENT LAW

Under present law, gross income does not include the excludable 

portion of payments made to taxpayers by federal and state governments for a share of the cost of improvements to property under 

certain conservation programs. These programs include payments 

received under (1) the rural clean water program authorized by section 208(j) of the Federal Water Pollution Control Act, (2) the rural 

abandoned mine program authorized by section 406 of the Surface 

Mining Control and Reclamation Act of 1977, (3) the water bank 

program authorized by the Water Bank Act, (4) the emergency conservation measures program authorized by title IV of the Agricultural Credit Act of 1978, (5) the agriculture conservation program 

authorized by the Soil Conservation and Domestic Allotment Act, 

(6) the great plains conservation program authorized by section 16 

of the Soil Conservation and Domestic Policy Act, (7) the resource 

conservation and development program authorized by the 

Bankhead-Jones Farm Tenant Act and by the Soil Conservation 

and Domestic Allotment Act, (8) the forestry incentives program 

authorized by section 4 of the Cooperative Forestry Assistance Act 

of 1978, (9) any small watershed program administered by the Secretary of Agriculture which is determined by the Secretary of the 

Treasury or his delegate to be substantially similar to the type of 

programs described in items (1) through (8), and (10) any program 

of a State, possession of the United States, a political subdivision 

of any of the foregoing, or the District of Columbia under which 

payments are made to individuals primarily for the purpose of conserving soil, protecting or restoring the environment, improving forests, or providing a habitat for wildlife. 

REASONS FOR CHANGE

The Committee believes that payments received by taxpayers 

under the Partners for Fish and Wildlife Program are similar to 

payments made under other government programs that are excludable from gross income under present law. Accordingly, the Committee believes it is appropriate to extend the present-law exclusion to payments under this program. 

EXPLANATION OF PROVISION

The provision expands the types of qualified cost-sharing payments to include payments under the Partners for Fish and Wildlife Program. 

EFFECTIVE DATE

The provision applies to payments received after the date of enactment. 

31

41Sec. 1366(a)(1)(A). 42Sec. 1367(a)(2)(B). 43See Rev. Rul. 96–11 (1996–1 C.B. 140) for a rule reaching a similar result in the case of 

charitable contributions made by a partnership. 

I. BASIS ADJUSTMENT TO STOCK OF S CORPORATION CONTRIBUTING

PROPERTY

(Sec. 109 of the bill and sec. 1367 of the Code) 

PRESENT LAW

Under present law, if an S corporation contributes money or 

other property to a charity, each shareholder takes into account the 

shareholder’s pro rata share of the contribution in determining its 

own income tax liability.41 A shareholder of an S corporation reduces the basis in the stock of the S corporation by the amount of 

the charitable contribution that flows through to the shareholder.42

REASONS FOR CHANGE

Under present law, if an S corporation makes a charitable contribution of appreciated property, the shareholder may be taxed on 

an amount equal to the appreciation in the contributed property 

when the S corporation stock is sold. Thus, under present law, a 

charitable contribution of appreciated property made by an S corporation receives less favorable tax treatment than other contributions of appreciated property. 

The Committee wishes to preserve the benefit of providing a 

charitable contribution deduction for contributions of property by 

an S corporation with a fair market value in excess of its adjusted 

basis. Thus, the bill provides that the basis adjustment to the stock 

of an S corporation for charitable contributions made by the corporation will be in an amount equal to the shareholder’s pro rata 

share of the adjusted basis of the property contributed. This adjustment will prevent the later recognition of gain attributable to the 

appreciation in the contributed property on the disposition of the 

S corporation stock. 

EXPLANATION OF PROVISION

The provision provides that the amount of a shareholder’s basis 

reduction in the stock of an S corporation by reason of a charitable 

contribution made by the corporation will be equal to the shareholder’s pro rata share of the adjusted basis of the contributed 

property.43

Thus, for example, assume an S corporation with one individual 

shareholder makes a charitable contribution of stock with a basis 

of $200 and a fair market value of $500. The shareholder will be 

treated as having made a $500 charitable contribution (or a lesser 

amount if the special rules of section 170(e) apply), and will reduce 

the basis of the S corporation stock by $200. 

EFFECTIVE DATE

The provision applies to contributions made after the date of enactment.

32

44Sec. 170(e)(1). 45Sec. 170(e)(1)(B)(ii). 46Sec. 170(f)(3). 

J. ENHANCED DEDUCTION FOR CHARITABLE CONTRIBUTIONS OF

LITERARY, MUSICAL, ARTISTIC, AND SCHOLARLY COMPOSITIONS

(Sec. 110 of the bill and sec. 170 of the Code) 

PRESENT LAW

In the case of a charitable contribution of inventory or other ordinary-income or short-term capital gain property, the amount of the 

deduction generally is limited to the taxpayer’s basis in the property.44 In the case of a charitable contribution of tangible personal 

property, the deduction is limited to the taxpayer’s basis in such 

property if the use by the recipient charitable organization is unrelated to the organization’s tax-exempt purpose. In cases involving 

contributions of tangible personal property to a private foundation 

(other than certain private foundations),45 the amount of the deduction is limited to the taxpayer’s basis in the property. 

Under present law, charitable contributions of literary, musical, 

and artistic compositions created or prepared by the donor are considered ordinary income property and a taxpayer’s deduction of 

such property is limited to the taxpayer’s basis (typically, cost) in 

the property. A charitable contribution of a literary, musical, or artistic composition by a person other than the person who created 

or prepared the work generally is eligible for a fair market value 

deduction if the donee organization’s use of the property is related 

to such organization’s exempt purposes. 

To be eligible for the deduction, the contribution must be of an 

undivided portion of the donor’s entire interest in the property.46

For purposes of the charitable income tax deduction, the copyright 

and the work in which the copyright is embodied are not treated 

as separate property interests. Accordingly, if a donor owns a work 

of art and the copyright to the work of art, a gift of the artwork 

without the copyright or the copyright without the artwork will 

constitute a gift of a ‘‘partial interest’’ and will not qualify for the 

income tax charitable deduction. 

REASONS FOR CHANGE

The Committee believes that it is appropriate to provide an enhanced deduction for charitable contributions of certain literary, 

musical, artistic, and scholarly compositions created by the personal efforts of the donor. In many cases, such works have a low 

basis, and because present law generally limits the deduction for 

such contributions to basis, the creators of literary, musical, artistic, and scholarly compositions do not have an appropriate incentive to contribute their works to charity. In addition, the Committee believes that the present-law rule that a charitable contribution deduction generally is not available for contributions of 

less than the taxpayer’s entire property interest is an inappropriate 

disincentive for contributions of such works. 

33

EXPLANATION OF PROVISION

The provision provides that a deduction for ‘‘qualified artistic 

charitable contributions’’ generally is increased from the value 

under present law (generally, basis) to the fair market value of the 

property contributed, measured at the time of the contribution. 

However, the amount of the increase of the deduction provided by 

the provision may not exceed the amount of the donor’s adjusted 

gross income for the taxable year attributable to: (1) income from 

the sale or use of property created by the personal efforts of the 

donor that is of the same type as the donated property; and (2) income from teaching, lecturing, performing, or similar activities with 

respect to such property. In addition, the increase to the presentlaw deduction provided by the provision may not be carried over 

and deducted in other taxable years. 

The provision defines a qualified artistic charitable contribution 

to mean a charitable contribution of any literary, musical, artistic, 

or scholarly composition, or similar property, or the copyright 

thereon (or both) that meets certain requirements. First, the contributed property must have been created by the personal efforts 

of the donor at least 18 months prior to the date of contribution. 

Second, the donor must obtain a qualified appraisal of the contributed property, a copy of which is required to be attached to the donor’s income tax return for the taxable year in which such contribution is made. The appraisal must include evidence of the extent (if any) to which property created by the personal efforts of the 

taxpayer and of the same type as the donated property is or has 

been owned, maintained, and displayed by certain charitable organizations and sold to or exchanged by persons other than the taxpayer, donee, or any related person. Third, the contribution must 

be made to a public charity or to certain limited types of private 

foundations. Finally, the use of donated property by the recipient 

organization must be related to the organization’s charitable purpose or function, and the donor must receive a written statement 

from the organization verifying such use. 

Under the provision, the tangible property and the copyright on 

such property are treated as separate properties for purposes of the 

‘‘partial interest’’ rule; thus, a gift of artwork without the copyright 

or a copyright without the artwork does not constitute a gift of a 

partial interest and is deductible. Contributions of letters, memoranda, or similar property that are written, prepared, or produced 

by or for an individual while the individual is an officer or employee of any person (including a government agency or instrumentality) do not qualify for a fair market value deduction unless the 

contributed property is entirely personal. 

EFFECTIVE DATE

The deduction for qualified artistic charitable contributions applies to contributions made after the date of enactment.

34

47Treas. Reg. sec. 1.170A–1(g). 48Sec. 170(j). 49Sec. 170(i). 

K. EXCLUSION FOR CERTAIN MILEAGE REIMBURSEMENTS TO

CHARITABLE VOLUNTEERS

(Sec. 111 of the bill and new sec. 139A of the Code) 

PRESENT LAW

Unreimbursed out-of-pocket expenditures made incident to providing donated services to a qualified charitable organization—such 

as out-of-pocket transportation expenses necessarily incurred in 

performing donated services—may constitute an itemized deduction 

for charitable contributions.47 No charitable contribution deduction 

is allowed for traveling expenses (including expenses for meals and 

lodging) while away from home, whether paid directly or by reimbursement, unless there is no significant element of personal pleasure, recreation, or vacation in such travel.48 In determining the 

amount treated as a charitable contribution where a taxpayer operates a vehicle in providing services to a charity, the taxpayer either 

may deduct actual out-of-pocket expenditures or may use the charitable standard mileage rate. The taxpayer may also deduct (under 

either computation method), any parking fees and tolls incurred in 

rendering the services, but may not deduct any amount (regardless 

of the computation method used) for general repair or maintenance 

expenses, depreciation, insurance, registration fees, etc. 

The charitable standard mileage rate is set by statute at 14 cents 

per mile.49 The standard mileage rate for charitable purposes is 

lower than the standard business rate because the charitable rate 

covers only the out-of-pocket operating expenses (including gasoline 

and oil) directly related to the use of the car in performing the donated services that a taxpayer may deduct as a charitable contribution. The charitable rate does not include costs that are not deductible as a charitable contribution such as general repair or maintenance expenses, depreciation, insurance, and registration fees. 

Such costs are, however, included in computing the business standard mileage rate (the rate allowed for business use of an automobile), which is 36 cents per mile. 

Volunteer drivers who are reimbursed for mileage expenses have 

taxable income to the extent the reimbursement exceeds deductible 

travel expenses. Employees who are reimbursed for mileage expenses under a qualified arrangement that pays a mileage allowance in lieu of reimbursing actual expenses generally have taxable 

income to the extent the reimbursement exceeds the amount of the 

business standard mileage rate multiplied by the actual business 

miles. 

REASONS FOR CHANGE

The Committee believes that it is important to recognize the valuable contributions made by volunteers to charitable organizations 

by providing an exclusion from income up to the applicable business standard mileage rate for volunteers who receive reimbursements for the costs of using their automobiles while performing 

services for charitable organizations. 

35

50Sec. 170(e)(3). In general, a C corporation’s charitable contribution deductions for a year 

may not exceed 10 percent of the corporation’s taxable income. Sec. 170(b)(2). 

EXPLANATION OF PROVISION

Under the provision, reimbursement by an organization described in section 170(c) (including public charities and private 

foundations) to a volunteer for the costs of using an automobile in 

connection with providing donated services is excludable from the 

gross income of the volunteer, provided that (1) the reimbursement 

does not exceed the business standard mileage rate prescribed for 

business use (as periodically adjusted), and (2) recordkeeping requirements applicable to deductible business expenses are satisfied. 

The provision does not permit a volunteer to claim a deduction or 

credit with respect amounts excluded under the provision. Information reporting required by section 6041 is not required with respect 

to reimbursements excluded under the provision. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after the 

date of enactment.

L. EXTEND ENHANCED DEDUCTION FOR INVENTORY TO INCLUDE

PUBLIC SCHOOLS

(Sec. 112 of the bill and sec. 170 of the Code) 

PRESENT LAW

Under present law, a taxpayer’s deduction for charitable contributions of inventory generally is limited to the taxpayer’s basis 

(typically, cost) in the inventory. 

However, for certain contributions of inventory, C corporations 

may claim an enhanced deduction equal to the lesser of (1) basis 

plus one-half of the item’s appreciated value (i.e., basis plus one 

half of fair market value in excess of basis) or (2) two times basis.50

To be eligible for the enhanced deduction, the contributed property 

generally must be inventory of the taxpayer, contributed to a charitable organization described in section 501(c)(3) (except for private 

nonoperating foundations), and the donee must: (1) use the property consistent with the donee’s exempt purpose solely for the care 

of the ill, the needy, or infants, (2) not transfer the property in exchange for money, other property, or services, and (3) provide the 

taxpayer a written statement that the donee’s use of the property 

will be consistent with such requirements. In the case of contributed property subject to the Federal Food, Drug, and Cosmetic Act, 

the property must satisfy the applicable requirements of such Act 

on the date of transfer and for 180 days prior to the transfer. 

Donations to educational organizations described in section 

170(b)(1)(A)(ii) (and that are not described in section 501(c)(3) and 

exempt under section 501(a)) are not eligible to receive the enhanced deduction. An organization is described in section 

170(b)(1)(A)(ii) if it normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or 

students in attendance at the place where its educational activities 

are regularly carried on. Donations to such organizations are eligiVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00035 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
36

51Sec. 170(e)(6). 

ble to receive an enhanced deduction if the donation qualifies as a 

qualified computer contribution.51

REASONS FOR CHANGE

The Committee believes that charitable contributions of inventory to public schools should receive the same treatment as charitable contributions of inventory to private schools and therefore 

should be eligible for the enhanced deduction. The Committee intends that contributions to a public school, like contributions to any 

other eligible donee, must be used solely for the care of the ill, the 

needy, or infants in order to qualify for the enhanced deduction. 

EXPLANATION OF PROVISION

The provision would extend the enhanced deduction for inventory 

property to donations to educational organizations described in section 170(b)(1)(A)(ii) (to the extent such organizations are not described in section 501(c)(3) and exempt under section 501(a)). Charitable contributions of computer technology and equipment continue to be covered by the present law enhanced deduction of section 170(e)(6) and are not eligible property for an enhanced deduction under the provision. 

The provision retains present law requirements: (1) that use of 

the donated property by the donee is related to the donee’s exempt 

purposes (or, in the case of a section 170(b)(1)(A)(ii) organization, 

to educational purposes) and is used solely for the care of the ill, 

the needy, or infants, (2) that the organization not transfer the 

property in exchange for money, other property, or services, and (3) 

that the organization provide the taxpayer a written statement 

that the donee’s use of the property will be consistent with such requirements. 

The Committee believes that the enhanced deduction continues 

to provide a useful incentive for charitable contributions of inventory, but also emphasizes that the enhanced deduction is available 

only for inventory that is used by the donee in the direct provision 

of care to the ill, the needy or infants. Thus, for example, the Committee does not intend that inventory property that may be useful 

to a school in maintaining its physical plant (e.g., paint, electrical 

supplies, equipment not used directly for educational purposes) or 

administrative offices but that is not used directly for the educational benefit of the ill, the needy, or infants is eligible for the 

enhanced deduction. 

EFFECTIVE DATE

The provision is effective for contributions made after December 

31, 2003.

37

52Sec. 6103(a). 53Sec. 6110(l)(1). 54Section 6104(a)(1)(A) provides that ‘‘any papers submitted in support of’’ an application for 

tax-exempt status must be available for inspection. Treasury regulations limit the definition of 

supporting documents to papers submitted by the organization. Treas. Reg. sec. 301.6104(a)–

1(e). 55Sec. 6104(a)(1)(D). 56Treas. Reg. sec. 301.6104(a)–5(a)(1). 57Sec. 6110(a). A background file document includes the request for a written determination, 

any written material submitted by the taxpayer in support of the request, and any communicaContinued

TITLE II. PROVISIONS IMPROVING THE OVERSIGHT OF TAXEXEMPT ORGANIZATIONS 

A. DISCLOSURE OF WRITTEN DETERMINATIONS

(Sec. 201 of the bill and sec. 6110 of the Code) 

PRESENT LAW

In general 

Three provisions of present law govern the disclosure of information relating to tax-exempt organizations. First, section 6103 provides a general rule that tax returns and return information generally are not subject to disclosure unless authorized by the Code.52

Second, in order to allow the public to scrutinize the activities of 

tax-exempt organizations, section 6104 grants an exception to the 

confidentiality rule of section 6103 for certain categories of tax-exempt organization documents and information. Third, section 6110 

provides that written determinations by the IRS and related background file documents generally are open to public inspection in redacted form. Section 6110 does not apply to any matter to which 

section 6104 applies.53

Disclosure of applications for recognition of tax exemption and annual information returns 

Under present law, the IRS is required to make approved applications for recognition of tax-exempt status (and certain related 

documents) 54 and annual information returns (Form 990 or Form 

990–PF) available for public inspection, except that the IRS is not 

authorized to disclose the names and addresses of contributors 

(other than contributors to a private foundation). 

The Secretary may withhold disclosure of certain information described in an organization’s application for tax-exempt status if disclosure would: (1) divulge a trade secret, patent, process, style of 

work, or apparatus of the organization, and the Secretary determines that such disclosure would harm the organization; or (2) that 

the Secretary determines would harm the national defense.55 The 

organization must apply to the Commissioner for a determination 

that the disclosure would violate one of these criteria. The organization will be given 15 days to contest an adverse determination 

before the information is made available for public inspection.56

Disclosure of written determinations 

Section 6110 provides that the text of any written determination 

by the IRS and related background file document is open to public 

inspection.57 The term ‘‘written determination’’ means a ruling, deVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00037 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
38

tions between the IRS and other persons in connection with the written determination received 

before issuance of the written determination. Sec. 6110(b)(2). 58Sec. 6103(b)(2)(D); sec. 6110(b)(1)(B). 59Sec. 6110(c). 60Treas. Reg. sec. 301.6110–1(a). 61Treas. Reg. sec. 301.6104(a)–1(i). 

termination letter, technical advice memorandum, or Chief Counsel 

advice. Closing agreements, which are final and conclusive written 

agreements entered into by the IRS and a taxpayer in order to settle the taxpayer’s tax liability with respect to a taxable year, do not 

constitute written determinations.58

Before releasing any written determination or background file 

document, the IRS must delete identifying details of the person 

about whom the written determination pertains and certain other 

private information.59

The application of section 6110 to guidance relating to tax-exempt organizations is limited to written determinations unrelated 

to an organization’s tax-exempt status. Section 6110(l)(1) provides, 

‘‘this section shall not apply to any matter to which section 6104 

applies.’’ The regulations under section 6110 clarify which matters 

are within the ambit of section 6104 and, therefore, are not subject 

to disclosure under section 6110:

[a]ny application filed with the Internal Revenue Service 

with respect to the qualification or exempt status of an organization * * *; any document issued by the Internal 

Revenue Service in which the qualification or exempt status of an organization is * * * granted, denied or revoked 

or the portion of any document in which technical advice 

with respect thereto is given to a district director; * * * 

the portion of any document issued by the Internal Revenue Service in which is discussed the effect on the qualification or exempt status of an organization * * * of proposed transactions by such organization * * *; and any 

document issued by the Internal Revenue Service in which 

is discussed the qualification or status of a [private foundation or private operating foundation].60

In addition, the regulations under section 6104 provide that some 

documents relating to tax exemption that are not open to public inspection under section 6104(a)(1)(A) are nevertheless ‘‘within the 

ambit’’ of section 6104 for purposes of the disclosure provisions of 

section 6110.61 The regulation explains that the following documents are, therefore, not available for public inspection under either section 6104 or 6110: 

(1) Unfavorable rulings or determination letters issued in response to applications for tax exemption; 

(2) Rulings or determination letters revoking or modifying a 

favorable determination letter; 

(3) Technical advice memoranda relating to a disapproved 

application for tax exemption or the revocation or modification 

of a favorable determination letter; 

(4) Any letter or document filed with or issued by the IRS 

relating to whether a proposed or accomplished transaction is 

a prohibited transaction under section 503; 

39

62 Id. 63Sec. 6033(a). See, e.g., Form 990—Return of Organization Exempt From Income Tax. An 

organization that is required to file Form 990, but that has gross receipts of less than $100,000 

during its taxable year, and total assets of less than $250,000 at the end of its taxable year, 

may file Form 990–EZ instead of Form 990. Private foundations are required to file Form 990– PF rather than Form 990. 

(5) Any letter or document filed with or issued by the IRS 

relating to an organization’s status as a private foundation or 

private operating foundation, unless the letter or document relates to the organization’s application for tax exemption; and 

(6) Any other letter or document filed with or issued by the 

IRS which, although it relates to an organization’s tax exempt 

status as an organization described in section 501(c), does not 

relate to that organization’s application for tax exemption.62

The effect of these limitations is that written determinations relating to exempt status issues are not released, even in redacted 

form. The IRS does, however, release under section 6110 written 

determinations issued to tax-exempt organizations that include 

issues that clearly are not within the ambit of section 6104, such 

as the application of the unrelated business income tax to a particular proposed transaction. 

REASONS FOR CHANGE

The Committee believes that written determinations and background file documents that ordinarily would be disclosed under section 6110 but for the nondisclosure provided by section 6104 should 

be disclosed in redacted form, and that such disclosure will provide 

additional guidance to taxpayers as to the views of the IRS on certain issues. 

EXPLANATION OF PROVISION

The provision provides that the provisions of section 6110 apply 

to written determinations and related background file documents 

relating to an organization described in section 501(c) or (d) (including any written determination denying an organization exempt 

status under such subsection), or to a political organization described in section 527, that are not required to be disclosed by section 6104(a)(1)(A). 

EFFECTIVE DATE

The provision is effective for written determinations issued after 

the date of enactment.

B. DISCLOSURE OF INTERNET WEB SITE AND NAME UNDER WHICH

ORGANIZATION DOES BUSINESS

(Sec. 202 of the bill and sec. 6033 of the Code) 

PRESENT LAW

Most types of tax-exempt organizations are required to file annually an information return.63 The Internal Revenue Code does not 

specifically require an exempt organization to furnish on the applicable information return any name under which the organization 

operates or does business, if such name differs from the legal name 

40

64The IRS requires disclosure of an organization’s Internet web site address on Forms 990 

and 990–EZ. 65The staff of the Joint Committee on Taxation recommended the adoption of this provision. 

Joint Committee on Taxation, Study of Present-Law Taxpayer Confidentiality and Disclosure 

Provisions as Required by Section 3802 of the Internal Revenue Service Restructuring and Reform Act of 1998, Volume II: Study of Disclosure Provisions Relating to Tax-Exempt Organizations (JCS–1–00), January 28, 2000 at 96–97. 66Sec. 6033(a). 

of the organization, or the organization’s Internet web site address, 

if any.64

REASONS FOR CHANGE

Some tax-exempt organizations do business and solicit contributions under a name that is different from the organization’s legal 

name. This can cause confusion to individuals and others seeking 

information about the organization. Further, although much information regarding the operations and activities of tax-exempt organizations is available on the Internet web sites of such organizations, some members of the public might experience difficulties obtaining access to an organization’s web site if they do not know the 

organization’s web site address. The Committee believes that reducing confusion and increasing public access to relevant information regarding a tax-exempt organization would be achieved by requiring a tax-exempt organization to report on its annual return 

any name under which such organization operates or does business, and the Internet web site address (if any) of such organization.65

EXPLANATION OF PROVISION

The provision requires a tax-exempt organization subject to reporting requirements under section 6033(a) to include on its annual 

return any name under which such organization operates or does 

business, and the Internet web site address (if any) of such organization. 

EFFECTIVE DATE

The provision applies to returns filed after December 31, 2003. 

C. MODIFICATION TO REPORTING OF CAPITAL TRANSACTIONS

(Sec. 203 of the bill and secs. 6033 and 6104 of the Code) 

PRESENT LAW

Private foundations are required to file an annual information return (Form 990–PF).66 Part IV of the Form 990–PF requires that 

private foundations report detailed information regarding the gain 

or loss from the sale or other disposition of property, including a 

description of the property sold, how it was acquired (purchase or 

donation), the date acquired, the date sold, the gross sales price, 

the amount of depreciation allowed or allowable, and the cost or 

other basis plus expenses of the sale. Such information generally 

is required for the IRS to calculate the tax on the private foundation’s net investment income. The Form 990–PF is required to be 

made available to the public. 

41

67The staff of the Joint Committee on Taxation recommended the adoption of this provision. 

Joint Committee on Taxation, Study of Present-Law Taxpayer Confidentiality and Disclosure 

Provisions as Required by Section 3802 of the Internal Revenue Service Restructuring and Reform Act of 1998, Volume II: Study of Disclosure Provisions Relating to Tax-Exempt Organizations (JCS–1–00), January 28, 2000 at 99. 

REASONS FOR CHANGE

Under present law, private foundations that engage in capital 

transactions must report detailed information about each transaction on Form 990–PF, which is filed with the IRS and available 

to the public. For some foundations, listing these transactions involves hundreds of pages. The Committee believes that automatic 

disclosure of such voluminous information does not necessarily benefit the public, and may in fact reduce the level of meaningful disclosure by obscuring other important information. The Committee 

believes that meaningful disclosure to the public will be increased 

if the version of the Form 990–PF that automatically is available 

to the public summarizes rather than lists the securities transactions that affect the calculation of the organization’s net investment income. In order to preserve the public’s access to more specific information regarding such securities transactions, the Committee believes that the more detailed information provided to the 

IRS on the Form 990–PF should be made available to those members of the public that explicitly request such information.67

EXPLANATION OF PROVISION

The provision requires that any information regarding capital 

gains and losses from the sale or disposition of stock or securities 

that are listed on an established securities market that is required 

to be furnished by private foundations in order to calculate the tax 

on net investment income be furnished also in summary form. 

In addition, information regarding capital gains and losses from 

the sale or disposition of stock or securities that are listed on an 

established securities market that is required to be filed with the 

IRS but that is not in summary form is not required to be made 

available to the public by the IRS or by the private foundation except by the explicit request of a member of the public to the IRS 

or to the foundation. A member of the public may request disclosure of such information from the Secretary, who shall prescribe 

the manner of making such request and the manner of disclosure. 

A member of the public also may request disclosure of the private 

foundation, which must be made in person or in writing. If the request is made in person, the foundation shall provide a copy of the 

information immediately and, if the request is made in writing, the 

foundation shall provide the information within 30 days. 

The provision also provides that private foundations are required 

to state on the furnished summary that the more detailed description is available upon request. 

EFFECTIVE DATE

The provision applies to returns filed after December 31, 2003.

42

68The applicable taxes include the termination tax on private foundations; taxes on public 

charities for certain excess lobbying expenses; taxes on a private foundation’s net investment 

income, self-dealing activities, undistributed income, excess business holdings, investments that 

jeopardize charitable purposes, and taxable expenditures (some of these taxes also apply to certain non-exempt trusts); taxes on the political expenditures and excess benefit transactions of 

section 501(c)(3) organizations; and certain taxes on black lung benefit trusts and foreign organizations. 

D. DISCLOSURE THAT FORM 990 IS PUBLICLY AVAILABLE

(Sec. 204 of the bill) 

PRESENT LAW

Under present law, there is no requirement that the IRS notify 

the public that the Form 990 is publicly available. 

REASONS FOR CHANGE

The information provided on Forms 990 is useful to the public 

only to the extent that the public is aware that the forms are publicly available. The Committee believes that the availability of 

Forms 990 that have been filed by exempt organizations will be increased by requiring the IRS to inform the public regarding the 

availability of such forms. 

EXPLANATION OF PROVISION

The provision requires the IRS to notify the public in appropriate 

publications and other materials of the extent to which Form 990, 

Form 990–EZ, or Form 990–PF are publicly available. 

EFFECTIVE DATE

The provision applies to publications or other materials issued or 

revised after the date of enactment. 

E. DISCLOSURE TO STATE OFFICIALS OF PROPOSED ACTIONS

RELATED TO SECTION 501(c) ORGANIZATIONS

(Sec. 205 of the bill and sec. 6104 of the Code) 

PRESENT LAW

In the case of organizations that are described in section 

501(c)(3) and exempt from tax under section 501(a) or that have 

applied for exemption as an organization so described, present law 

(sec. 6104(c)) requires the Secretary to notify the appropriate State 

officer of (1) a refusal to recognize such organization as an organization described in section 501(c)(3), (2) a revocation of a section 

501(c)(3) organization’s tax-exempt status, and (3) the mailing of a 

notice of deficiency for any tax imposed under section 507, chapter 

41, or chapter 42.68 In addition, at the request of such appropriate 

State officer, the Secretary is required to make available for inspection and copying, such returns, filed statements, records, reports, 

and other information relating to the above-described disclosures, 

as are relevant to any State law determination. An appropriate 

State officer is the State attorney general, State tax officer, or any 

State official charged with overseeing organizations of the type described in section 501(c)(3). 

43

69Sec. 6103(a). 70Sec. 6103(p)(3). 71Sec. 6103(p)(4). 72Secs. 7213 and 7213A. 73Sec. 7431. 74The staff of the Joint Committee on Taxation recommended the adoption of a similar provision. Joint Committee on Taxation, Study of Present-Law Taxpayer Confidentiality and Disclosure Provisions as Required by Section 3802 of the Internal Revenue Service Restructuring and 

Reform Act of 1998, Volume II: Study of Disclosure Provisions Relating to Tax-Exempt Organizations (JCS–1–00), January 28, 2000 at 101–105. 

In general, return and return information (as such terms are defined in sec. 6103(b)) is confidential and may not be disclosed or inspected unless expressly provided by law.69 Present law requires 

the Secretary to keep records of disclosures and requests for inspection 70 and requires that persons authorized to receive return and 

return information maintain various safeguards to protect such information against unauthorized disclosure.71 Willful unauthorized 

disclosure or inspection of return or return information is subject 

to a fine and/or imprisonment.72 The knowing or negligent unauthorized inspection or disclosure of returns or return information 

gives the taxpayer a right to bring a civil suit.73 Such present-law 

protections against unauthorized disclosure or inspection of return 

and return information do not apply to the disclosures or inspections, described above, that are authorized by section 6104(c). 

REASONS FOR CHANGE

The Committee believes that State officials that are charged with 

oversight of certain organizations described in section 501(c) have 

an important and legitimate interest in receiving certain information about such organizations’ tax-exempt status and tax filings, in 

some cases before the IRS has made a final determination with respect to an organization’s tax-exempt status or liability for tax. By 

providing appropriate State officials with earlier access to information about the activities of certain section 501(c) organizations, 

State officials will be able to monitor such organizations more effectively and better protect the public’s interest in assuring that organizations that have been given the benefit of tax-exemption operate 

consistently with their exempt purposes.74

The Committee stresses the importance of maintaining the confidentiality of taxpayer return and return information and believes 

it is important to extend existing protections against unauthorized 

disclosure or inspection of return and return information to disclosures made or inspections allowed by the Secretary of return and 

return information regarding such section 501(c) organizations. 

EXPLANATION OF PROVISION

The provision provides that upon written request by an appropriate State officer, the Secretary may disclose: (1) a notice of proposed refusal to recognize an organization as a section 501(c)(3) organization; (2) a notice of proposed revocation of tax-exemption of 

a section 501(c)(3) organization; (3) the issuance of a proposed deficiency of tax imposed under section 507, chapter 41, or chapter 42; 

(4) the names, addresses, and taxpayer identification numbers of 

organizations that have applied for recognition as section 501(c)(3) 

organizations; and (5) returns and return information of organizaVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00043 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
44

75Such returns and return information also may be open to inspection by an appropriate State 

officer. 

tions with respect to which information has been disclosed under 

(1) through (4) above.75 Disclosure or inspection is permitted for 

the purpose of, and only to the extent necessary in, the administration of State laws regulating section 501(c)(3) organizations, such 

as laws regulating tax-exempt status, charitable trusts, charitable 

solicitation, and fraud. Disclosure or inspection may be made only 

to or by designated representatives of the appropriate State officer, 

which does not include any contractor or agent. The Secretary also 

is permitted to disclose or open to inspection the return and return 

information of an organization that is recognized as tax-exempt 

under section 501(c)(3), or that has applied for such recognition, to 

an appropriate State officer if the Secretary determines that disclosure or inspection may facilitate the resolution of Federal or State 

issues relating to the tax-exempt status of the organization. For 

this purpose, appropriate State officer means the State attorney 

general or any other State official charged with overseeing organizations of the type described in section 501(c)(3). 

In addition, the provision provides that upon the written request 

by an appropriate State officer, the Secretary may make available 

for inspection or disclosure returns and return information of an 

organization described in section 501(c)(2) (certain title holding 

companies), 501(c)(4) (certain social welfare organizations), 

501(c)(6) (certain business leagues and similar organizations), 

501(c)(7) (certain recreational clubs), 501(c)(8) (certain fraternal organizations), 501(c)(10) (certain domestic fraternal organizations 

operating under the lodge system), and 501(c)(13) (certain cemetery 

companies). Such return and return information is available for inspection or disclosure only for the purpose of, and to the extent necessary in, the administration of State laws regulating the solicitation or administration of the charitable funds or charitable assets 

of such organizations. Disclosure or inspection may be made only 

to or by designated representatives of the appropriate State officer, 

which does not include any contractor or agent. For this purpose, 

appropriate State officer means the State attorney general and the 

head of an agency designated by the State attorney general as having primary responsibility for overseeing the solicitation of funds 

for charitable purposes of such organizations. 

In addition, the provision provides that any return and return information disclosed under section 6104(c) may be disclosed in civil 

administrative and civil judicial proceedings pertaining to the enforcement of State laws regulating the applicable tax-exempt organization in a manner prescribed by the Secretary. Returns and return information are not to be disclosed under section 6104(c), or 

in such an administrative or judicial proceeding, to the extent that 

the Secretary determines that such disclosure would seriously impair Federal tax administration. The provision makes disclosures of 

returns and return information under section 6104(c) subject to the 

disclosure, recordkeeping, and safeguard provisions of section 6103, 

including the requirements that such information remain confidential (sec. 6103(a)(2)), that the Secretary maintain a permanent system of records of requests for disclosure (sec. 6103(p)(3)), and that 

45

76Sec. 6694(a). 77Sec. 6694(b). 78The staff of the Joint Committee on Taxation recommended the adoption of this provision. 

Joint Committee on Taxation, Study of Present-Law Taxpayer Confidentiality and Disclosure 

Provisions as Required by Section 3802 of the Internal Revenue Service Restructuring and Reform Act of 1998, Volume II: Study of Disclosure Provisions Relating to Tax-Exempt Organizations (JCS–1–00), January 28, 2000 at 99–101. 

the appropriate State officer maintain various safeguards that protect against unauthorized disclosure (sec. 6103(p)(4)). The provision 

provides that the willful unauthorized disclosure of returns or return information described in section 6104(c) is a felony subject to 

a fine of up to $5,000 and/or imprisonment of up to five years (sec. 

7213(a)(2)), the willful unauthorized inspection of returns or return 

information described in section 6104(c) is subject to a fine of up 

to $1,000 and/or imprisonment of up to one year (sec. 7213A), and 

provides the taxpayer the right to bring a civil action for damages 

in the case of knowing or negligent unauthorized disclosure or inspection of such information (sec. 7431(a)(2)). 

EFFECTIVE DATE

The provision is effective on the date of enactment but does not 

apply to requests made before such date.

F. EXPANSION OF PENALTIES TO PREPARERS OF FORM 990 

(Sec. 206 of the bill and sec. 6695 of the Code) 

PRESENT LAW

Under present law, income tax return preparers are subject to a 

penalty of $250 with respect to any return if a portion of an understatement of tax liability is due to a position for which there was 

not a realistic possibility of success on the merits, the preparer 

knew or reasonably should have known of the position, and the position was not disclosed or was frivolous.76 In addition, present law 

imposes a penalty on income tax return preparers of $1,000 with 

respect to a tax return if a portion of an understatement of tax liability is due to a willful attempt to understate liability or to reckless or intentional disregard of rules or regulations.77

REASONS FOR CHANGE

The Committee believes that information returns play a critical 

role in the oversight of exempt organizations, but that many returns are not filed with complete and accurate information. The 

Committee believes that imposing a penalty on paid preparers of 

information returns will help to improve the accuracy of the return.78

EXPLANATION OF PROVISION

The provision provides that a preparer (for compensation) of an 

information return of an exempt organization is subject to a penalty of $250 if the preparer omits or misrepresents any information 

with respect to such return that was known or should have been 

known by the preparer. The penalty does not apply to minor, inadvertent omissions. 

46

79Sec. 6033(a)(2); Treas. Reg. sec. 1.6033–2(a)(2)(i); Treas. Reg. sec. 1.6033–2(g)(1). Sec. 6033(a)(2)(A)(ii) provides a $5,000 annual gross receipts exception from the annual reporting requirements for certain exempt organizations. In Announcement 82–88, 1982–25 I.R.B. 23, the 

IRS exercised its discretionary authority under section 6033 to increase the gross receipts exception to $25,000, and enlarge the category of exempt organizations that are not required to file 

Form 990. 

In addition, a preparer of such an information return is subject to a penalty of $1,000 if the preparer recklessly or intentionally 

misrepresents any information or recklessly or intentionally disregards any rule or regulation with respect to such return. With respect to any return, the $1,000 penalty is reduced by the amount 

of any penalty paid by such person with respect to the return for 

omissions and misrepresentations (the $250 penalty imposed by the 

provision) or a penalty imposed by section 6694. 

EFFECTIVE DATE

The provision is effective for documents prepared after the date 

of enactment. 

G. NOTIFICATION REQUIREMENT FOR EXEMPT ENTITIES NOT

CURRENTLY REQUIRED TO FILE AN ANNUAL INFORMATION RETURN

(Sec. 207 of the bill and sec. 6033 of the Code) 

PRESENT LAW

Under present law, the requirement that an exempt organization 

file an annual information return does not apply to several categories of exempt organizations. Organizations excepted from the 

filing requirement include organizations (other than private foundations), the gross receipts of which in each taxable year normally 

are not more than $25,000.79 Also exempt from the requirement 

are churches, their integrated auxiliaries, and conventions or associations of churches; the exclusively religious activities of any religious order; section 501(c)(1) instrumentalities of the United 

States; section 501(c)(21) trusts; an interchurch organization of 

local units of a church; certain mission societies; certain church-affiliated elementary and high schools; certain state institutions 

whose income is excluded from gross income under section 115; certain governmental units and affiliates of governmental units; and 

other organizations that the IRS has relieved from the filing requirement pursuant to its statutory discretionary authority. 

REASONS FOR CHANGE

The Committee believes that it is appropriate under present law 

that certain small exempt organizations not be required to file an 

annual information return. However, as a result, the Secretary of 

the Treasury is not able to maintain a record of the continuing existence of such organizations and the public is unable to easily obtain basic information about the organization, such as the organization’s current address. The absence of a record is especially problematic for charitable exempt organizations. Although the Secretary publishes the names of organizations to which charitable 

contributions may be made, if the organization is not required to 

file with the Secretary and alert the Secretary of its termination, 

the Secretary does not know when to omit the organization from 

47

80The staff of the Joint Committee on Taxation recommended the adoption of a similar provision. Joint Committee on Taxation, Study of Present-Law Taxpayer Confidentiality and Disclosure Provisions as Required by Section 3802 of the Internal Revenue Service Restructuring and 

Reform Act of 1998, Volume II: Study of Disclosure Provisions Relating to Tax-Exempt Organizations (JCS–1–00), January 28, 2000 at 98. 

its list of names. Accordingly, the Committee believes that exempt 

organizations that do not have to file an annual information return 

by virtue of the amount of their gross receipts should file with the 

Secretary a simple, short annual notice. The Committee does not 

intend that the annual filing be burdensome and does not believe 

that a monetary penalty is appropriate for a failure to file the notice. However, if an organization is unable to file a notice with the 

Secretary for three consecutive years, the Committee believes that 

revocation of the organization’s exempt status is an appropriate 

sanction under the circumstances. In addition, to ensure equitable 

treatment among exempt organizations, the sanction of loss of exempt status is extended to consecutive failures to file a required information return. 80

EXPLANATION OF PROVISION

The provision provides that organizations that are excused from 

filing an information return by reason of normally having gross receipts below a certain specified amount (generally, under $25,000) 

shall furnish to the Secretary annually the legal name of the organization, any name under which the organization operates or does 

business, the organization’s mailing address and Internet web site 

address (if any), the organization’s taxpayer identification number, 

the name and address of a principal officer, and evidence of the organization’s continuing basis for its exemption from the generally 

applicable information return filing requirements. Upon such organization’s termination of existence, the organization is required to 

furnish notice of such termination. 

The provision provides that if an organization fails to provide the 

required notice for three consecutive years, the organization’s taxexempt status is revoked. In addition, if an organization that is required to file an annual information return under section 6033(a) 

(Form 990) fails to file such an information return for three consecutive years, the organization’s tax-exempt status is revoked. If 

an organization fails to meet its filing obligation to the IRS for 

three consecutive years in cases where the organization is subject 

to the information return filing requirement in one or more years 

during a three-year period and also is subject to the notice requirement for one or more years during the same three-year period, the 

organization’s tax-exempt status is revoked. 

A revocation under the provision is effective from the date that 

the Secretary determines was the last day the organization could 

have timely filed the third required information return or notice. 

To again be recognized as tax-exempt, the organization must apply 

to the Secretary for recognition of tax-exemption, irrespective of 

whether the organization was required to make an application for 

recognition of tax-exemption in order to gain tax-exemption originally. 

If upon application for tax-exempt status after a revocation 

under the provision, the organization shows to the satisfaction of 

48

the Secretary reasonable cause for failing to file the required annual notices or returns, the organization’s tax-exempt status may, 

in the discretion of the Secretary, be reinstated retroactive to the 

date of revocation. An organization may not challenge under the 

Code’s declaratory judgment procedures (section 7428) a revocation 

of tax-exemption made pursuant to the provision. 

There is no monetary penalty for failure to file the notice. The 

provision does not require that the notices be made available to the 

public under the public disclosure and inspection rules generally 

applicable to exempt organizations. The provision does not affect an 

organization’s obligation under present law to file required information returns or existing penalties for failure to file such returns. 

The Secretary is required to notify in a timely manner every organization that is subject to the notice filing requirement of the 

new filing obligation. Notification by the Secretary shall be by mail, 

in the case of any organization the identity and address of which 

is included in the list of exempt organizations maintained by the 

Secretary, and by Internet or other means of outreach, in the case 

of any other organization. In addition, the Secretary is required to 

publicize in a timely manner in appropriate forms and instructions 

and other means of outreach the new penalty imposed for consecutive failures to file the information return. 

The Secretary is authorized to publish a list of organizations 

whose exempt status is revoked under the provision. 

EFFECTIVE DATE

The provision is effective for notices with respect to annual periods beginning after 2003.

H. SUSPENSION OF TAX-EXEMPT STATUS OF TERRORIST

ORGANIZATIONS

(Sec. 208 of the bill and sec. 501 of the Code) 

PRESENT LAW

Under present law, the Internal Revenue Service generally issues 

a letter revoking recognition of an organization’s tax-exempt status 

only after (1) conducting an examination of the organization, (2) 

issuing a letter to the organization proposing revocation, and (3) allowing the organization to exhaust the administrative appeal rights 

that follow the issuance of the proposed revocation letter. In the 

case of an organization described in section 501(c)(3), the revocation letter immediately is subject to judicial review under the declaratory judgment procedures of section 7428. To sustain a revocation of tax-exempt status under section 7428, the IRS must demonstrate that the organization is no longer entitled to exemption. 

There is no procedure under current law for the IRS to suspend the 

tax-exempt status of an organization. 

To combat terrorism, the Federal government has designated a 

number of organizations as terrorist organizations or supporters of 

terrorism under the Immigration and Nationality Act, the International Emergency Economic Powers Act, and the United Nations 

Participation Act of 1945. 

49

REASONS FOR CHANGE

An organization that has been designated or otherwise identified 

by the Federal government as a terrorist organization pursuant to 

certain authority should not be exempt from Federal income tax 

and contributions to such organizations should not be deductible 

for Federal income tax purposes. The Committee believes that the 

Federal government’s designation or identification of an organization as a terrorist organization is grounds for suspension of tax-exempt status, and that in such cases a separate investigation of the 

organization by the Internal Revenue Service is not necessary. Further, because a terrorist organization may challenge the Federal 

government’s designation or identification of the organization 

under the law authorizing the designation or identification, recourse to the declaratory judgment procedures of the Internal Revenue Code to challenge the suspension of tax-exemption is not appropriate. 

EXPLANATION OF PROVISION

The provision suspends the tax-exempt status of an organization 

that is exempt from tax under section 501(a) for any period during 

which the organization is designated or identified by U.S. Federal 

authorities as a terrorist organization or supporter of terrorism. 

The provision also makes such an organization ineligible to apply 

for tax exemption under section 501(a). The period of suspension 

runs from the date the organization is first designated or identified 

(or from the date of enactment of the provision, whichever is later) 

to the date when all designations or identifications with respect to 

the organization have been rescinded pursuant to the law or Executive order under which the designation or identification was made. 

The provision describes a terrorist organization as an organization that has been designated or otherwise individually identified 

(1) as a terrorist organization or foreign terrorist organization 

under the authority of section 212(a)(3)(B)(vi)(II) or section 219 of 

the Immigration and Nationality Act; (2) in or pursuant to an Executive order that is related to terrorism and issued under the authority of the International Emergency Economic Powers Act or 

section 5 of the United Nations Participation Act for the purpose 

of imposing on such organization an economic or other sanction; or 

(3) in or pursuant to an Executive order that refers to the provision 

and is issued under the authority of any Federal law if the organization is designated or otherwise individually identified in or pursuant to such Executive order as supporting or engaging in terrorist activity (as defined in section 212(a)(3)(B) of the Immigration 

and Nationality Act) or supporting terrorism (as defined in section 

140(d)(2) of the Foreign Relations Authorization Act, Fiscal Years 

1988 and 1989). During the period of suspension, no deduction for 

any contribution to a terrorist organization is allowed under the 

Code, including under sections 170, 545(b)(2), 556(b)(2), 642(c), 

2055, 2106(a)(2), or 2522. 

No organization or other person may challenge, under section 

7428 or any other provision of law, in any administrative or judicial proceeding relating to the Federal tax liability of such organization or other person, the suspension of tax-exemption, the ineligiVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00049 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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81Treas. Reg. sec. 1.664–1(d)(2). 

bility to apply for tax-exemption, a designation or identification described above, the timing of the period of suspension, or a denial 

of deduction described above. The suspended organization may 

maintain other suits or administrative actions against the agency 

or agencies that designated or identified the organization, for the 

purpose of challenging such designation or identification (but not 

the suspension of tax-exempt status under this provision). 

If the tax-exemption of an organization is suspended and each 

designation and identification that has been made with respect to 

the organization is determined to be erroneous pursuant to the law 

or Executive order making the designation or identification, and 

such erroneous designation results in an overpayment of income 

tax for any taxable year with respect to such organization, a credit 

or refund (with interest) with respect to such overpayment shall be 

made. If the operation of any law or rule of law (including res judicata) prevents the credit or refund at any time, the credit or refund 

may nevertheless be allowed or made if the claim for such credit 

or refund is filed before the close of the one-year period beginning 

on the date that the last remaining designation or identification 

with respect to the organization is determined to be erroneous. 

The provision directs the IRS to update the listings of tax-exempt 

organizations to take account of organizations that have had their 

exemption suspended and to publish notice to taxpayers of the suspension of an organization’s tax-exemption and the fact that contributions to such organization are not deductible during the period 

of suspension. 

EFFECTIVE DATE

The provision is effective for designations made before, on, or 

after the date of enactment.

TITLE III. OTHER CHARITABLE AND EXEMPT 

ORGANIZATION PROVISIONS 

A. MODIFY TAX ON UNRELATED BUSINESS TAXABLE INCOME OF

CHARITABLE REMAINDER TRUSTS

(Sec. 301 of the bill and sec. 664 of the Code) 

PRESENT LAW

Charitable remainder annuity trusts and charitable remainder 

unitrusts are exempt from Federal income tax for a tax year unless 

the trust has any unrelated business taxable income for the year. 

Unrelated business taxable income includes certain debt financed 

income. A charitable remainder trust that loses exemption from income tax for a taxable year is taxed as a regular complex trust. As 

such, the trust is allowed a deduction in computing taxable income 

for amounts required to be distributed in a taxable year, not to exceed the amount of the trust’s distributable net income for the 

year. Taxes imposed on the trust are required to be allocated to 

corpus.81

Distributions from a charitable remainder annuity trust or charitable remainder unitrust are treated in the following order as: (1) 

51

82Sec. 664(b). 83Treas. Reg. sec. 1.664–1(d)(4). 84Sec. 664(d). 

ordinary income to the extent of the trust’s current and previously 

undistributed ordinary income for the trust’s year in which the distribution occurred, (2) capital gains to the extent of the trust’s current capital gain and previously undistributed capital gain for the 

trust’s year in which the distribution occurred, (3) other income 

(e.g., tax-exempt income) to the extent of the trust’s current and 

previously undistributed other income for the trust’s year in which 

the distribution occurred, and (4) corpus.82

In general, distributions to the extent they are characterized as 

income are includible in the income of the beneficiary for the year 

that the annuity or unitrust amount is required to be distributed 

even though the annuity or unitrust amount is not distributed 

until after the close of the trust’s taxable year.83

A charitable remainder annuity trust is a trust that is required 

to pay, at least annually, a fixed dollar amount of at least five percent of the initial value of the trust to a noncharity for the life of 

an individual or for a period of 20 years or less, with the remainder 

passing to charity. A charitable remainder unitrust is a trust that 

generally is required to pay, at least annually, a fixed percentage 

of at least five percent of the fair market value of the trust’s assets 

determined at least annually to a noncharity for the life of an individual or for a period 20 years or less, with the remainder passing 

to charity.84

A trust does not qualify as a charitable remainder annuity trust 

if the annuity for a year is greater than 50 percent of the initial 

fair market value of the trust’s assets. A trust does not qualify as 

a charitable remainder unitrust if the percentage of assets that are 

required to be distributed at least annually is greater than 50 percent. A trust does not qualify as a charitable remainder annuity 

trust or a charitable remainder unitrust unless the value of the remainder interest in the trust is at least 10 percent of the value of 

the assets contributed to the trust. 

REASONS FOR CHANGE

The Committee believes that in years that a charitable remainder trust has unrelated business income, an excise tax of 100 percent on such income is a more appropriate remedy than loss of tax 

exemption for the year. 

EXPLANATION OF PROVISION

The provision imposes a 100-percent excise tax on the unrelated 

business taxable income of a charitable remainder trust. This replaces the present-law rule that takes away the income tax exemption of a charitable remainder trust for any year in which the trust 

has any unrelated business taxable income. Consistent with 

present law, the tax is treated as paid from corpus. The unrelated 

business taxable income is considered income of the trust for purposes of determining the character of the distribution made to the 

beneficiary. 

52

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2002.

B. MODIFY TAX TREATMENT OF CERTAIN PAYMENTS TO

CONTROLLING EXEMPT ORGANIZATIONS

(Sec. 302 of the bill and sec. 512 of the Code) 

PRESENT LAW

In general, interest, rents, royalties, and annuities are excluded 

from the unrelated business income of tax-exempt organizations. 

However, section 512(b)(13) generally treats otherwise excluded 

rent, royalty, annuity, and interest income as unrelated business 

income if such income is received from a taxable or tax-exempt subsidiary that is 50 percent controlled by the parent tax-exempt organization. In the case of a stock subsidiary, ‘‘control’’ means ownership by vote or value of more than 50 percent of the stock. In the 

case of a partnership or other entity, control means ownership of 

more than 50 percent of the profits, capital or beneficial interests. 

In addition, present law applies the constructive ownership rules of 

section 318 for purposes of section 512(b)(13). Thus, a parent exempt organization is deemed to control any subsidiary in which it 

holds more than 50 percent of the voting power or value, directly 

(as in the case of a first-tier subsidiary) or indirectly (as in the case 

of a second-tier subsidiary). 

Under present law, interest, rent, annuity, or royalty payments 

made by a controlled entity to a tax-exempt organization are includable in the latter organization’s unrelated business income and 

are subject to the unrelated business income tax to the extent the 

payment reduces the net unrelated income (or increases any net 

unrelated loss) of the controlled entity (determined as if the entity 

were tax exempt). 

The Taxpayer Relief Act of 1997 (the ‘‘1997 Act’’) made several 

modifications to the control requirement of section 512(b)(13). In 

order to provide transitional relief, the changes made by the 1997 

Act do not apply to any payment received or accrued during the 

first two taxable years beginning on or after the date of enactment 

of the 1997 Act (August 5, 1997) if such payment is received or accrued pursuant to a binding written contract in effect on June 8, 

1997, and at all times thereafter before such payment (but not pursuant to any contract provision that permits optional accelerated 

payments). 

REASONS FOR CHANGE

The present-law rule that requires a controlling entity to include 

as unrelated business income certain payments made by a controlled entity applies without regard to whether the amount of the 

payment is fair and reasonable under the circumstances or would 

otherwise constitute unrelated business income if paid by an organization not controlled by the exempt organization. The Committee 

believes that the controlling organization should not be subject to 

the unrelated business income tax if the amount of the payment 

from the controlled entity is determined in accordance with estabVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00052 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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85Sec. 501(c)(3). 

lished arm’s-length principles. The Committee intends that the controlling organization be subject to the present-law rule only to the 

extent that a payment made by a controlled entity exceeds the 

amount that would have been paid if the payment had been determined under established arm’s-length principles. In order to discourage controlled entities from claiming deductions in excess of 

the arm’s-length amount, the Committee believes that it is appropriate to subject the controlling organization to a penalty tax for 

making excess payments. 

EXPLANATION OF PROVISION

The provision provides that the general rule of section 512(b)(13), 

which includes interest, rent, annuity, or royalty payments made 

by a controlled entity to a tax-exempt organization in the latter organization’s unrelated business income to the extent the payment 

reduces the net unrelated income (or increases any net unrelated 

loss) of the controlled entity, applies only to the portion of payments received or accrued in a taxable year that exceed the amount 

of the specified payment that would have been paid or accrued if 

such payment had been determined under the principles of section 

482. Thus, if a payment of rent by a controlled subsidiary to its 

tax-exempt parent organization exceeds fair market value, the excess amount of such payment over fair market value (as determined in accordance with section 482) is included in the parent organization’s unrelated business income, to the extent that such excess reduced the net unrelated income (or increased any net unrelated loss) of the controlled entity (determined as if the entity were 

tax exempt). In addition, the provision imposes a 20-percent penalty on the larger of such excess determined without regard to any 

amendment or supplement to a return of tax, or such excess determined with regard to all such amendments and supplements. 

The provision provides that if modifications to section 512(b)(13) 

made by the 1997 Act did not apply to a contract because of the 

transitional relief provided by the 1997 Act, then such modifications also do not apply to amounts received or accrued under such 

contract before January 1, 2001. 

EFFECTIVE DATE

The provision applies to payments received or accrued after December 31, 2000.

C. SIMPLIFICATION OF LOBBYING EXPENDITURE LIMITATION

(Sec. 303 of the bill and secs. 501 and 4911 of the Code) 

PRESENT LAW

In general 

An organization does not qualify for tax-exempt status under section 501(c)(3) unless ‘‘no substantial part’’ of the activities of the organization is ‘‘carrying on propaganda, or otherwise attempting, to 

influence legislation,’’ except as provided by section 501(h). 85 CarVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00053 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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86Organizations that do not make a section 501(h) election are subject to the ‘‘no substantial 

part’’ test. 87Secs. 501(h)(2)(A), 4911(c)(1), 4911(d). 88 Exempt purpose expenditures generally are expenses incurred for exempt purposes, such as 

amounts paid to accomplish exempt purposes, administrative expenses such as overhead, lobbying expenses, and certain fundraising expenses. Exempt purpose expenditures do not include, 

for example, expenses not for exempt purposes, payments of unrelated business income tax, or 

capital expenses in connection with an unrelated business. See Treas. Reg. sec. 56.4911–4. 89Sec. 501(h)(1). 90Treas. Reg. sec. 1.501(h)–3. 

rying on propaganda and attempting to influence legislation commonly are referred to as ‘‘lobbying’’ activities. Thus, section 

501(c)(3) permits a limited amount of lobbying activity without loss 

of tax-exempt status. 

For purposes of determining whether lobbying activities are a 

substantial part of an organization’s overall functions, an organization generally may choose between two standards, the ‘‘no substantial part’’ test of section 501(c)(3) or the ‘‘expenditure’’ test of section 501(h). 

Whether an organization meets the ‘‘no substantial part’’ test is 

based on all the facts and circumstances. There is no statutory or 

regulatory guidance, and it is not clear whether the determination 

is based on the organization’s activities, its expenditures, or both. 

Alternatively, under section 501(h), certain organizations described 

in section 501(c)(3) can elect to be subject to the expenditure test, 86

which consists of bright-line rules that specify the dollar amount 

of permitted expenditures on lobbying activities. 

Consequences of excess lobbying under section 501(h) 

Organizations that make a section 501(h) election (‘‘electing charities’’) are subject to tax if the electing charity makes either ‘‘lobbying expenditures’’ or ‘‘grass roots expenditures’’ in excess of a certain amount established for each type of expenditure for each taxable year. Lobbying expenditures are the sum of grass-roots expenditures and ‘‘direct lobbying’’ expenditures. 87

The expenditure limits are based on a ‘‘lobbying nontaxable 

amount’’ for the taxable year and a ‘‘grass roots nontaxable 

amount’’ for the taxable year. The lobbying nontaxable amount is 

the lesser of $1 million or an amount determined as a percentage 

of an organization’s exempt purpose expenditures. 88 The grassroots nontaxable amount is 25 percent of the organization’s lobbying nontaxable amount. An electing charity that exceeds either 

of the spending limitations is subject to a 25 percent tax on the excess. An electing charity that exceeds both of the spending limitations is subject to a 25 percent tax on the greater of the excess of 

the lobbying expenditures or the grass-roots expenditures. 

An electing charity that normally exceeds either of two ‘‘ceiling 

amounts,’’ which are based on the expenditure limits, will lose its 

tax exemption. 89 The ‘‘lobbying ceiling amount’’ is 150 percent of 

the electing charity’s lobbying nontaxable amount for the taxable 

year and the ‘‘grass roots ceiling amount’’ is 150 percent of the 

grass-roots nontaxable amount for the taxable year. For this purpose, ‘‘normal’’ expenditures are calculated based on a four-year 

averaging mechanism. 90

55

91Secs. 501(h)(2)(C) & 4911(d)(1)(A) 92Treas. Reg. sec. 56.4911–2(b)(2)(i). 93Treas. Reg. sec. 56.4911–2(b)(2)(iii). The regulations provide that the first three elements 

constitute ‘‘direct’’ encouragement, whereas the fourth element is ‘‘indirect’’ encouragement. This 

distinction becomes relevant in determining whether a communication meets one of the prescribed exceptions to lobbying, i.e., an indirect call to action in a grass-roots communication may 

qualify as ‘‘nonpartisan analysis, study or research’’ (Treas. Reg. sec. 56.4911–2(b)(2)(iv)), and 

in determining the proper allocation of expenses between grass-roots and direct lobbying. Treas. 

Reg. sec. 56.4911–5(e). 94Treas. Reg. sec. 56.4911–2(b)(5)(ii). 95 Id. 96Sec. 501(h)(2)(A) and 4911(d)(1)(B) and Treas. Reg. sec. 56.4911–2(b)(1). 

Definitions 

Grass-roots expenditures are defined as ‘‘any attempt to influence any legislation through an attempt to affect the opinions of 

the general public or any segment thereof.’’ 91 For a communication 

to constitute grass-roots lobbying, it must refer to ‘‘specific legislation,’’ reflect a view on such legislation, and encourage the recipient 

of the communication to take action with respect to such legislation 

(a ‘‘call to action’’). 92 A communication includes a call to action if 

it incorporates one of four elements: (1) it urges the recipient to 

contact a legislator, employee of a government body, or any other 

government official or employee who may participate in the formulation of legislation with the principal purpose of influencing legislation; (2) it states the address, telephone number, or similar information of a legislator or an employee of a legislative body; (3) it 

provides a petition, tear-off postcard, or similar device for the recipient to communicate with government officials or employees who 

participate in the formulation of legislation with the principal purpose of influencing legislation; or (4) it states the position of one 

or more legislators on the legislation, except that a communication 

may name the main sponsors of legislation for purposes of identifying the legislation without constituting a call to action. 93 In addition, a communication is presumed to be grass-roots lobbying if the 

communication is a paid advertisement that: (1) appears in the 

mass media within two weeks before a vote by a legislative body 

or committee (but not a subcommittee) on a highly publicized piece 

of legislation; (2) reflects a view on the general subject of the legislation; and (3) either refers to the legislation or encourages the 

public to communicate with legislators on the general subject of 

such legislation. 94 The presumption is rebuttable if the electing 

charity demonstrates that the timing of the communication was not 

related to the legislation or that the advertisement was of a type 

regularly made by the electing charity without regard to the timing 

of the legislation (a customary course of business exception). 95

Direct lobbying expenditures are ‘‘any attempt to influence any 

legislation through communication with any member or employee 

of a legislative body, or with any government official or employee 

who may participate in the formulation of the legislation’’ if the 

principal purpose of the communication is to influence legislation. 96 A communication would constitute direct lobbying only if 

the communication ‘‘refers to specific legislation’’ and reflects a 

view on such legislation. 

Certain specified activities do not constitute attempts to influence legislation and therefore expenditures for such activities are 

not subject to the expenditure limits for lobbying expenditures or 

56

97Sec. 4911(d)(2). 98Treas. Reg. sec. 56.4911–5(e). 99See Treas. Reg. sec. 56.4911–6. 

grass-roots expenditures. In general, such activities include: (1) 

making available the results of nonpartisan analysis, study, or research; (2) providing technical advice or assistance to a governmental body or to a committee in response to a written request; (3) 

appearances before, or communications to, any legislative body 

with respect to a possible decision of such body that might affect 

the existence of the organization, its powers and duties, tax-exempt 

status, or the deduction of contributions to the organization (socalled ‘‘self-defense’’ expenditures); (4) certain communications to 

members of the electing charity; and (5) communications with governmental officials or employees that are not intended to influence 

legislation. 97

Special rules for mixed lobbying expenditures 

Expenses that serve both direct and grass-roots lobbying purposes, e.g., communications that are sent to members and nonmembers, or ‘‘mixed lobbying’’ expenditures, are subject to special rules. 

The regulations specify how an electing charity is to allocate mixed 

lobbying expenditures between direct and grass-roots lobbying purposes. 98 For example, for a mixed lobbying communication that is 

designed primarily for members (i.e., more than half the recipients 

are members) and that directly encourages grass-roots lobbying 

(even if it also encourages direct lobbying), the grass-roots expenditure amount includes all the costs of preparing the material used 

for purposes of grass-roots lobbying plus the mechanical and distributional costs associated with the communication. If a mixed lobbying communication encourages direct lobbying, but only indirectly encourages grass-roots lobbying, then the entire costs of the 

communication are allocated based on the proportion of members 

and nonmembers receiving the communication. 

Disclosure of lobbying expenditures 

An electing charity must disclose lobbying expenditures annually 

on Schedule A of Form 990. In order to meet disclosure requirements, electing charities are required to keep detailed records of direct and grass-roots lobbying expenditures. Required records of 

grass-roots expenditures include: (1) all amounts directly paid or 

incurred for grass-roots lobbying; (2) payments to other organizations earmarked for grass-roots lobbying; (3) fees and expenses paid 

for grass-roots lobbying; (4) the printing, mailing, and other costs 

of reproducing and distributing materials used in grass-roots lobbying; (5) the portion of amounts paid or incurred as current or deferred compensation for an employee’s grass-roots lobbying services; (6) any amount paid for out-of-pocket expenditures incurred 

on behalf of the electing charity for grass-roots lobbying; (7) the allocable portion of administrative, overhead and other general expenditures attributable to grass-roots lobbying; and (8) expenditures for grass-roots lobbying of a controlled organization. 99

57

100Sec. 508(a). 

REASONS FOR CHANGE

The Committee believes that the separate limitation on grassroots lobbying expenditures is an unnecessary complication for 

electing charities. The Committee believes that the overall limit on 

lobbying expenditures is a sufficient ceiling on the lobbying activities of electing charities, irrespective of the proportion of lobbying 

activities that are grass-roots lobbying or direct lobbying. 

EXPLANATION OF PROVISION

The provision eliminates the separate limitation for grass-roots 

lobbying expenditures applicable to electing charities. Electing 

charities remain subject to the overall limitation on lobbying expenditures, which does not change in amount, but electing charities 

are not required to limit grass roots expenditures as a percentage 

of overall lobbying. Thus, an electing charity is able to make taxfree any combination of grass-roots and direct lobbying expenditures up to the lobbying non-taxable amount and does not risk loss 

of tax-exemption as a result of such expenditures until total lobbying expenditures normally exceed the lobbying ceiling amount. 

For purposes of the section 501(h) election, electing charities are 

not required to distinguish between grass-roots lobbying and direct 

lobbying, whether for mixed lobbying expenditures or otherwise. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2002. 

D. EXPEDITED REVIEW PROCESS FOR CERTAIN TAX-EXEMPTION

APPLICATIONS

(Sec. 304 of the bill) 

PRESENT LAW

Most organizations that seek tax-exempt status as a charitable 

organization are required to file an Application for Recognition of 

Exemption (Form 1023) with the IRS.100 Organizations that are 

not required to file Form 1023 include churches, their integrated 

auxiliaries, and conventions or associations of churches, and any 

organization (other than a private foundation) that normally has 

gross receipts of $5,000 or less in a taxable year. Organizations 

that file Form 1023 within 15 months of the end of the month of 

the organization’s formation will, if the application is approved, be 

recognized as tax-exempt from the date of formation. The IRS will 

automatically grant an organization’s request for an additional 12-

month extension of the 15-month period. Otherwise, exemption normally will be recognized as of the date the application was received 

by the IRS. In appropriate circumstances, upon written request, 

the IRS will expedite consideration of applications for tax-exemption. For example, organizations formed to provide relief to victims 

of disasters or other emergencies often receive expedited consideration. 

58

REASONS FOR CHANGE

Many social service organizations that want to apply for government funding through grants or contracts are required as a condition of application to have been recognized as an exempt charitable 

organization. The Committee wishes to facilitate the formation of 

charitable organizations that intend to work with Federal, State 

and local governments to provide vital social services to many of 

the neediest members of society by implementing an expedited review procedure for exempt status applications, and by waiving IRS 

user fees pertaining to such applications filed by smaller social 

service organizations. 

EXPLANATION OF PROVISION

The provision provides that the Secretary or his delegate shall 

adopt procedures to expedite consideration of applications for exempt status by organizations that are organized and operated for 

the primary purpose of providing social services. To be eligible, the 

organization must: (1) be seeking a contract or grant under a Federal, State, or local program that provides funding for social service 

programs; (2) establish that tax-exempt status is a condition of applying for such contract or grant; (3) include a completed copy of 

the contract or grant application with the application for exemption; and (4) meet such other criteria as the Secretary may provide. 

Organizations that meet the eligibility requirements described 

above (except for the requirement that tax-exempt status is a condition of the contract or grant application), and that certify that the 

organization’s average annual gross receipts over the four-year period preceding the application was not more than $50,000 (or, in 

the case of an organization in existence less than four years, is not 

expected to be more than $50,000 during the organization’s first 

four years) are entitled to a waiver of any fee for application of taxexempt status. 

For this purpose, social services is defined as services directed at 

helping people in need, reducing poverty, improving outcomes of 

low-income children, revitalizing low-income communities, and empowering low-income families and low-income individuals to become self-sufficient, including: (1) child care services, protective 

services for children and adults, services for children and adults in 

foster care, adoption services, services related to the management 

and maintenance of the home, day care services for adults, and 

services to meet the special needs of children, older individuals, 

and individuals with disabilities (including physical, mental, or 

emotional disabilities); (2) transportation services; (3) job training 

and related services, and employment services; (4) information, referral, and counseling services; (5) the preparation and delivery of 

meals, and services related to soup kitchens or food banks; (6) 

health support services; (7) literacy and mentoring programs; (8) 

services for the prevention and treatment of juvenile delinquency 

and substance abuse, services for the prevention of crime and the 

provision of assistance to the victims and the families of criminal 

offenders, and services related to the intervention in, and prevention of, domestic violence; and (9) services related to the provision 

of assistance for housing under Federal law. Social services does 

59

101Sec. 7611. Prior to the year 2000 IRS restructuring, the lowest level official who could initiate a church tax inquiry was an IRS Regional Commissioner. 

not include a program having the purpose of delivering educational 

assistance under the Elementary and Secondary Education Act of 

1965 or under the Higher Education Act of 1965. 

EFFECTIVE DATE

The provision applies to applications for tax-exempt status filed 

after December 31, 2003. 

E. CLARIFICATION OF DEFINITION OF CHURCH TAX INQUIRY

(Sec. 305 of the bill and sec. 7611 of the Code) 

PRESENT LAW

Under present law, the IRS may begin a church tax inquiry only 

if an appropriate high-level Treasury official reasonably believes, 

on the basis of the facts and circumstances recorded in writing, 

that an organization (1) may not qualify for tax exemption as a 

church, (2) may be carrying on an unrelated trade or business, or 

(3) otherwise may be engaged in taxable activities.101 A church tax 

inquiry is defined as any inquiry to a church (other than an examination) that serves as a basis for determining whether the organization qualified for tax exemption as a church or whether it is carrying on an unrelated trade or business or otherwise is engaged in 

taxable activities. An inquiry is considered to commence when the 

IRS requests information or materials from a church of a type contained in church records, other than routine requests for information or inquiries regarding matters that do not primarily concern 

the tax status or liability of the church itself. 

REASONS FOR CHANGE

The Committee believes that the present-law church tax inquiry 

procedures provide important safeguards against the IRS engaging 

in unnecessary and intrusive examinations of churches. However, 

the church tax inquiry procedures also have the effect of hampering 

IRS efforts to educate churches with respect to actions that are not 

permissible under section 501(c)(3). The Committee believes that a 

clarification of the scope of the church tax inquiry procedures to 

make it clear that the IRS may undertake educational outreach efforts with respect to specific churches (e.g., initiating meetings with 

representatives of a particular church to discuss the rules that 

apply to such church) will improve compliance with the law by 

churches. 

EXPLANATION OF PROVISION

The provision clarifies that the church tax inquiry procedures do 

not apply to contacts made by the IRS for the purpose of educating 

churches with respect to the Federal income tax law governing taxexempt organizations. For example, the IRS does not violate the 

church tax inquiry procedures when written materials are provided 

to a church or churches for the purpose of educating such church 

60

or churches with respect to the types of activities that are not permissible under section 501(c)(3). 

EFFECTIVE DATE

The provision is effective on the date of enactment. 

F. EXTENSION OF DECLARATORY JUDGMENT PROCEDURES TO NON–

501(c)(3) TAX-EXEMPT ORGANIZATIONS

(Sec. 306 of the bill and sec. 7428 of the Code) 

PRESENT LAW

In order for an organization to be granted tax exemption as a 

charitable entity described in section 501(c)(3), it generally must 

file an application for recognition of exemption with the IRS and 

receive a favorable determination of its status. Similarly, for most 

organizations, a charitable organization’s eligibility to receive taxdeductible contributions is dependent upon its receipt of a favorable determination from the IRS. In general, a section 501(c)(3) organization can rely on a determination letter or ruling from the 

IRS regarding its tax-exempt status, unless there is a material 

change in its character, purposes, or methods of operation. In cases 

in which an organization violates one or more of the requirements 

for tax exemption under section 501(c)(3), the IRS is authorized to 

revoke an organization’s tax exemption, notwithstanding an earlier 

favorable determination. 

In situations in which the IRS denies an organization’s application for recognition of exemption under section 501(c)(3) or fails to 

act on such application, or in which the IRS informs a section 

501(c)(3) organization that it is considering revoking or adversely 

modifying its tax-exempt status, present law authorizes the organization to seek a declaratory judgment regarding its tax status (sec. 

7428). Section 7428 provides a remedy in the case of a dispute involving a determination by the IRS with respect to: (1) the initial 

qualification or continuing qualification of an organization as a 

charitable organization for tax exemption purposes or for charitable 

contribution deduction purposes; (2) the initial classification or continuing classification of an organization as a private foundation; (3) 

the initial classification or continuing classification of an organization as a private operating foundation; or (4) the failure of the IRS 

to make a determination with respect to (1), (2), or (3). A ‘‘determination’’ in this context generally means a final decision by the 

IRS affecting the tax qualification of a charitable organization, although it also can include a proposed revocation of an organization’s tax-exempt status or public charity classification. Section 

7428 vests jurisdiction over controversies involving such a determination in the U.S. District Court for the District of Columbia, 

the U.S. Court of Federal Claims, and the U.S. Tax Court. 

Prior to utilizing the declaratory judgment procedure, an organization must have exhausted all administrative remedies available 

to it within the IRS. An organization is deemed to have exhausted 

its administrative remedies at the expiration of 270 days after the 

date on which the request for a determination was made if the orVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00060 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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102This limitation currently applies to declaratory judgments relating to tax qualification for 

certain employee retirement plans (sec. 7476). 

ganization has taken, in a timely manner, all reasonable steps to 

secure such determination. 

If an organization (other than a section 501(c)(3) organization) 

files an application for recognition of exemption and receives a favorable determination from the IRS, the determination of tax-exempt status is usually effective as of the date of formation of the 

organization if its purposes and activities during the period prior 

to the date of the determination letter were consistent with the requirements for exemption. However, if the organization files an application for recognition of exemption and later receives an adverse 

determination from the IRS, the IRS may assert that the organization is subject to tax on some or all of its income for open taxable 

years. In addition, as with charitable organizations, the IRS may 

revoke or modify an earlier favorable determination regarding an 

organization’s tax-exempt status. 

Under present law, a non-charity (i.e., an organization not described in section 501(c)(3)) may not seek a declaratory judgment 

with respect to an IRS determination regarding its tax-exempt status. The only remedies available to such an organization are to petition the U.S. Tax Court for relief following the issuance of a notice of deficiency or to pay any tax owed and sue for refund in federal district court or the U.S. Court of Federal Claims. 

REASONS FOR CHANGE

The Committee believes that it is important to provide certainty 

for organizations that have sought a determination of their tax-exempt status. Thus, the Committee finds it appropriate to extend 

the present-law declaratory judgment procedures to all organizations that apply for tax-exempt status as organizations described in 

section 501(c) or 501(d). 

EXPLANATION OF PROVISION

The provision extends declaratory judgment procedures similar 

to those currently available only to charities under section 7428 to 

other section 501(c) and 501(d) determinations. The provision limits 

jurisdiction over controversies involving such other determinations 

to the United States Tax Court.102

EFFECTIVE DATE

The extension of the declaratory judgment procedures to organizations other than section 501(c)(3) organizations is effective for 

pleadings filed with respect to determinations (or requests for determinations) made after December 31, 2002.

G. DEFINITION OF CONVENTION OR ASSOCIATION OF CHURCHES

(Sec. 307 of the bill and sec. 7701 of the Code) 

PRESENT LAW

Under present law, an organization that qualifies as a ‘‘convention or association of churches’’ (within the meaning of sec. 

62

103Sec. 6033(a)(2)(A)(i). 104Sec. 7611(h)(1)(B). 105See, e.g., Sec. 402(g)(8)(B) (limitation on elective deferrals); sec. 403(b)(9)(B) (definition of 

retirement income account); sec. 410(d) (election to have participation, vesting, funding, and certain other provisions apply to church plans); sec. 414(e) (definition of church plan); sec. 415(c)(7) 

(certain contributions by church plans); sec. 501(h)(5) (disqualification of certain organizations 

from making the sec. 501(h) election regarding lobbying expenditure limits); sec. 501(m)(3) (definition of commercial-type insurance); sec. 508(c)(1)(A) (exception from requirement to file application seeking recognition of exempt status); sec. 512(b)(12) (allowance of up to $1,000 deduction 

for purposes of determining unrelated business taxable income); sec. 514(b)(3)(E) (definition of 

debt-financed property); sec. 3121(w)(3)(A) (election regarding exemption from social security 

taxes); sec. 3309(b)(1) (application of federal unemployment tax provisions to services performed 

in the employ of certain organizations); sec. 6043(b)(1) (requirement to file a return upon liquidation or dissolution of the organization); and sec. 7702(j)(3)(A) (treatment of certain death 

benefit plans as life insurance). 

170(b)(1)(A)(i)) is not required to file an annual return,103 is subject 

to the church tax inquiry and church tax examination provisions 

applicable to organizations claiming to be a church,104 and is subject to certain other provisions generally applicable to churches.105

The Internal Revenue Code does not define the term ‘‘convention 

or association of churches.’’

REASONS FOR CHANGE

The term ‘‘convention or association of churches’’ was added to 

the Code to ensure that hierarchical churches and congregational 

churches would not be treated dissimilarly for Federal income tax 

purposes merely because of their organizational and governance 

structures. The Committee understands that some congregational 

church organizations have only churches as members, and that others have both churches and individuals as members. The Committee is concerned that an organization with the characteristics of 

a convention or association of churches, including having a substantial number of churches as members, might fail to be regarded 

as a convention or association of churches merely because it includes individuals in its membership. The Committee intends that 

a congregational church organization that otherwise constitutes a 

convention or association of churches not be denied recognition as 

such merely because its membership includes individuals as well as 

churches. 

EXPLANATION OF PROVISION

The provision provides that an organization that otherwise is a 

convention or association of churches does not fail to so qualify 

merely because the membership of the organization includes individuals as well as churches, or because individuals have voting 

rights in the organization. 

EFFECTIVE DATE

The provision is effective on the date of enactment.

63

106Sec. 170. 107Sec. 4941. 

H. PAYMENTS BY CHARITABLE ORGANIZATIONS TO VICTIMS OF WAR

ON TERRORISM AND FAMILIES OF ASTRONAUTS

(Sec. 308 of the bill) 

PRESENT LAW

In general, organizations described in section 501(c)(3) of the 

Code are exempt from taxation. Contributions to such organizations generally are tax deductible.106 Section 501(c)(3) organizations must be organized and operated exclusively for exempt purposes and no part of the net earnings of such organizations may 

inure to the benefit of any private shareholder or individual. An organization is not organized or operated exclusively for one or more 

exempt purposes unless the organization serves a public rather 

than a private interest. Thus, an organization described in section 

501(c)(3) generally must serve a charitable class of persons that is 

indefinite or of sufficient size. 

Tax-exempt private foundations are a type of organization described in section 501(c)(3) and are subject to special rules. Private 

foundations are subject to excise taxes on acts of self-dealing between the private foundation and a disqualified person with respect 

to the foundation.107 For example, it is self-dealing if assets of a 

private foundation are used for the benefit of a disqualified person, 

such as a substantial contributor to the foundation or a person in 

control of the foundation, and the benefit is not incidental or tenuous. 

REASONS FOR CHANGE

The Committee believes that payments by charities to members 

of the Armed Forces of the United States (and their immediate 

families) made by reason of death, injury, wounding or illness and 

incurred as a result of our nation’s military response to the terrorist attacks of September 11, 2001, and to individuals of the immediate families of astronauts killed in the line of duty after December 31, 2002, should be treated as consistent with the charity’s 

exempt purpose, to the extent the payments are made in good faith 

and pursuant to a reasonable and objective formula that is consistently applied. 

EXPLANATION OF PROVISION

The provision provides that organizations described in section 

501(c)(3) that make certain payments are not required to make a 

specific assessment of need for the payments to be related to the 

purpose or function constituting the basis for the organization’s exemption, provided that the organization makes the payments in 

good faith and uses an objective formula that is consistently applied in making the payments. 

The provision applies to payments to a member of the Armed 

Forces of the United States (as defined in section 7701(a)(15)), or 

to a member of such person’s immediate family (including spouses, 

parents, children, and foster children), by reason of the death, inVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00063 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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108Treas. Reg. sec. 1.117–3(a). 

jury, wounding, or illness of a member of the Armed Forces of the 

United States that was incurred as a result of the military response of the United States to the terrorist attacks against the 

United States on September 11, 2001. The provision also applies to 

payments to an individual of an astronaut’s immediate family by 

reason of the death of such astronaut occurring in the line of duty 

after December 31, 2002. 

As under present law, such payments must be for public and not 

private benefit and therefore must serve a charitable class. For example, a charitable organization that assists the families of members of the Armed Forces killed in the line of duty may make prorata distributions to the families of those killed, even though the 

specific financial needs of each family are not directly considered. 

Similarly, if the amount of a distribution is based on the number 

of dependents of a charitable class of persons killed in the military 

response to the attacks and this standard is applied consistently 

among distributions, the specific needs of each recipient do not 

have to be taken into account. However, it is not appropriate for 

a charity to make pro-rata payments based on the recipients’ living 

expenses before the harm occurred if the result generally provides 

significantly greater assistance to persons in a better position to 

provide for themselves than to persons with fewer financial resources. Although such a distribution might be based on objective 

criteria, it is not a reasonable formula for distributing assistance 

in an equitable manner. Similarly, although specific assessments of 

need are not required, payments that do not further public purposes are not permitted. The provision does not change the substantive standards for exemption under section 501(c)(3), including 

the prohibition on private inurement. The provision also provides 

that if a private foundation makes payments under the conditions 

described above, the payment is not treated as made to a disqualified person for purposes of section 4941. 

EFFECTIVE DATE

For payments related to members of the Armed Forces, the provision applies to payments made after the date of enactment and before September 11, 2004. For payments related to astronauts, the 

provision applies to payments made after December 31, 2002.

I. INCREASE PERCENTAGE LIMITS FOR CERTAIN EMPLOYER-RELATED

SCHOLARSHIP PROGRAMS

(Sec. 309 of the bill) 

PRESENT LAW

Gross income does not include any amount received as a qualified scholarship by an individual who is a candidate for a degree 

at an educational organization (sec. 117(a)). For this purpose, a 

scholarship generally means an amount paid or allowed to, or for 

the benefit of, a student to aid that student in pursuing studies.108

However, an amount paid or allowed to, or on behalf of, an individual to enable the individual to pursue studies is not treated as 

65

109Treas. Reg. sec. 1.117–4(c). 110Secs. 4945(a) and (b). 111Secs. 4945(d)(3) and (g). 112For the purpose of section 4945(g), the term ‘‘scholarship or fellowship’’ refers to the provisions of section 117(a) as in effect before the Tax Reform Act of 1986. Sec. 4945(g)(1). 113Secs. 4945(g)(1) and 170(b)(1)(A)(ii). 114 Rev. Proc. 76–47, 1976–2 C.B. 670. The revenue procedure defines an employer-related program as a program that treats some or all of the employees, or children of some or all of the 

employees, of an employer as a group from which grantees of some or all of the grants will be 

selected, limits the potential grantees for some or all of the grants to individuals who are employees or children of employees of an employer, or otherwise gives such individuals a preference 

or priority over others in being selected as grantees. 115Treas. Reg. sec. 53.4941(d)–2(f)(2). 116The seven conditions include: (1) the program must not be used to recruit employees, to 

induce employees to continue their employment, or to compel a course of action sought by the 

employer; (2) the selection of grant recipients must be made by a committee consisting of indeContinued

a scholarship if the amount represents compensation for past, 

present, or future services.109 The determination of whether an 

amount is properly treated as a scholarship or compensation for 

services is made in light of all the relevant facts and circumstances. 

Present law imposes excise taxes on the taxable expenditures of 

a private foundation.110 A taxable expenditure includes, among 

other things, any amount paid or incurred by a private foundation 

as a grant to an individual for travel, study, or other similar purposes by such individual, unless such grant is awarded on an objective and nondiscriminatory basis pursuant to a procedure approved 

in advance by the Secretary.111 In the case of individual grants to 

be made as scholarships or fellowships, the private foundation 

must demonstrate to the satisfaction of the Secretary that the 

grant: (1) constitutes a scholarship or fellowship which would be 

subject to the provisions of section 117(a),112 and (2) is to be used 

for study at an educational organization which normally maintains 

a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where 

its educational activities are regularly carried on.113

Private foundations may in the course of their activities make 

scholarship or fellowship grants to individuals to be used for educational purposes. However, a private foundation’s grant program 

may not provide compensation, an employment incentive, or an employee fringe benefit to persons employed by the foundation or by 

another employer (including, for example, employees of a ‘‘related’’ employer organization). Revenue Procedure 76–47 provides advance 

approval guidelines to determine whether grants made by private 

foundations under employer-related grant programs to an employee 

or to a child of an employee of the employer to which the program 

relates is considered a scholarship or fellowship grant subject to 

the provisions of section 117(a).114 To the extent that such grants 

are considered scholarships or fellowships under these guidelines, 

the Secretary will assume the grants are not taxable expenditures 

subject to section 4945 taxes. Educational grants that are not 

scholarships or fellowships under these guidelines might, depending upon the circumstances, be taxable under Chapter 42 of the 

Code.115

Under Revenue Procedure 76–47, a grant made under an employer-related grant program that satisfies seven conditions and a 

percentage test is considered a scholarship or fellowship.116 Grants 

66

pendent individuals; (3) the program must impose identifiable minimum requirements for grant 

eligibility; (4) the selection of grant recipients must be based solely upon substantial objective 

standards that are completely unrelated to employment and to the employer’s line of business; 

(5) a grant may not be terminated because the recipient or the recipient’s parent terminates 

employment with the employer; (6) the courses of study for which grants are available must not 

be limited to those would be of particular benefit to the employer or the foundation; and (7) 

the terms of the grant and the courses of study for which grants are available must meet all 

other requirements of section 117 and must be consistent with the disinterested purpose of education for personal benefit rather than for the benefit of the employer or the foundation. 117 Rev. Proc. 80–39, 1980–2 C.B. 772. 118 Id. 

awarded to children of employees and to employees are considered 

as having been awarded under separate programs for purposes of 

the revenue procedure, regardless of whether they are awarded 

under separately administered programs. All such grants must satisfy each of the seven conditions to obtain advance approval of the 

grant program. The percentage test applicable to grants to children 

of employees requires that the number of grants awarded not exceed either 25 percent of the eligible applicants considered by the 

selection committee in selecting grant recipients or 10 percent of 

those eligible for grants (regardless of whether they submitted 

grant applications). The percentage test applicable to grants to employees requires that the number of grants awarded not exceed 10 

percent of eligible applicants considered by the selection committee 

in selecting grant recipients. If the seven conditions are met, but 

the relevant percentage test is not satisfied, then the question of 

whether the grants constitute scholarships or fellowships is based 

upon all of the facts and circumstances. 

Similar requirements and percentage limits apply to determine 

whether educational loans made by a private foundation under an 

employer-related loan program are taxable expenditures.117 If an 

employer-related program encompasses educational loans and 

scholarship or fellowship grants to the same group of eligible employees or employees’ children, the percentage tests applicable to 

the loan program apply to the total number of individuals receiving 

combined grants of scholarships, fellowships, and educational 

loans.118

REASONS FOR CHANGE

The Committee believes that the quantitative limits set forth in 

Revenue Procedure 76–47 are too low for employer-related grant 

programs that provide scholarships or fellowships to children of 

employees. The Committee believes that higher percentage limits 

will encourage increases in grants made for educational purposes. 

The Committee also believes that the higher percentage limits 

should be available only in cases where the foundation maintains 

a comparable grant program for children who are not affiliated 

with the employer to which the employer-related grant program relates. 

EXPLANATION OF PROVISION

The percentage limits set forth in Revenue Procedure 76–47 for 

grants to children of employees are increased to 35 percent of eligible applicants considered by the selection committee or 20 percent 

of those eligible for the grants. However, the higher percentage limits are available only if the private foundation meets the other reVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00066 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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quirements of the Revenue Procedure and demonstrates that the 

foundation provides a comparable number and aggregate amount of 

grants during the same grant-program year to individuals who are 

not such employees, children or dependents of such employees, or 

affiliated with the employer of such employees. The provision does 

not amend the percentage limits for grants to employees, or the 

percentage limits of Revenue Procedure 80–39 relating to loan programs or programs which encompass both loans and grants. 

EFFECTIVE DATE

Revenue Procedure 76–47 is to be amended effective for grants 

awarded after the date of enactment. 

J. TREATMENT OF CERTAIN HOSPITAL SUPPORT ORGANIZATIONS IN

DETERMINING ACQUISITION INDEBTEDNESS

(Sec. 310 of the bill and sec. 514 of the Code) 

PRESENT LAW

In general, income of a tax-exempt organization that is produced 

by debt-financed property is treated as unrelated business income 

in proportion to the acquisition indebtedness on the income-producing property. Acquisition indebtedness generally means the 

amount of unpaid indebtedness incurred by an organization to acquire or improve the property and indebtedness that would not 

have been incurred but for the acquisition or improvement of the 

property. However, under an exception, acquisition indebtedness 

does not include indebtedness incurred by certain qualified organizations to acquire or improve real property. Qualified organizations 

include pension trusts, educational institutions, and title-holding 

companies. 

REASONS FOR CHANGE

The Committee believes that certain indebtedness of qualified 

hospital support organizations should not be considered acquisition 

indebtedness for purposes of the tax on debt-financed income. 

EXPLANATION OF PROVISION

The provision expands the exception to the definition of acquisition indebtedness in the case of a qualified hospital support organization. The exception applies to eligible indebtedness (or the qualified refinancing thereof) of the qualified hospital support organization. 

A qualified hospital support organization is a supporting organization (under section 509(a)(3)) of a hospital that is an academic 

health center (under section 119(d)(4)(B)). The assets of the supporting organization have to meet certain requirements. First, 

more than half of the value of the organization’s assets at any time 

since its organization (1) have to have been acquired, directly or indirectly, by testamentary gift or devise, and (2) have to consist of 

real property. In addition, the fair market value of the organization’s real estate acquired by gift or devise has to exceed 25 percent 

of the fair market value of all investment assets held by the organization immediately prior to the time that the eligible indebtedness 

68

119Sec. 170. Section references are to the Internal Revenue Code of 1986 unless otherwise indicated. 120Treas. Reg. sec. 1.170A–1(g). 

was incurred. These requirements have to be met each time eligible 

indebtedness was incurred or a qualified refinancing thereof occurs. 

Eligible indebtedness means indebtedness secured by real property acquired directly or indirectly by gift or devise, the proceeds 

of which are used exclusively to acquire a leasehold interest in or 

to improve or repair the property. A qualified refinancing of eligible 

indebtedness occurs if the refinancing does not exceed the amount 

of refinanced eligible indebtedness immediately before the refinancing. 

EFFECTIVE DATE

The provision applies to indebtedness incurred after December 

31, 2003. 

K. CHARITABLE CONTRIBUTION DEDUCTION FOR CERTAIN EXPENSES

IN SUPPORT OF NATIVE ALASKAN SUBSISTENCE WHALING

(Sec. 311 of the bill and sec. 170 of the Code) 

PRESENT LAW

In computing taxable income, individuals who do not elect the 

standard deduction may claim itemized deductions, including a deduction (subject to certain limitations) for charitable contributions 

or gifts made during the taxable year to a qualified charitable organization or governmental entity.119 Individuals who elect the 

standard deduction may not claim a deduction for charitable contributions made during the taxable year. 

No charitable contribution deduction is allowed for a contribution 

of services. However, unreimbursed expenditures made incident to 

the rendition of services to an organization, contributions to which 

are deductible, may constitute a deductible contribution.120 Specifically, section 170(j) provides that no charitable contribution deduction is allowed for traveling expenses (including amounts expended 

for meals and lodging) while away from home, whether paid directly or by reimbursement, unless there is no significant element 

of personal pleasure, recreation, or vacation in such travel. 

REASONS FOR CHANGE

The Committee believes that subsistence bowhead whale hunting 

activities are important to certain native peoples of Alaska and further charitable purposes. The Committee believes that certain expenses paid by individuals recognized as whaling captains by the 

Alaska Eskimo Whaling Commission in the conduct of sanctioned 

whaling activities conducted pursuant to the management plan of 

that Commission should be deductible as charitable contributions 

even though they are paid other than directly to a charitable organization. 

EXPLANATION OF PROVISION

The provision allows individuals to claim a deduction under sec- tion 170 not exceeding $10,000 per taxable year for certain exVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00068 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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121 Eligible clinics must be either: (1) part of an accredited law, business, or accounting school; 

or (2) a tax-exempt organization. 

penses incurred in carrying out sanctioned whaling activities. The 

deduction would be available only to an individual who is recognized by the Alaska Eskimo Whaling Commission as a whaling 

captain charged with the responsibility of maintaining and carrying out sanctioned whaling activities. The deduction would be 

available for reasonable and necessary expenses paid by the taxpayer during the taxable year for: (1) the acquisition and maintenance of whaling boats, weapons, and gear used in sanctioned 

whaling activities, (2) the supplying of food for the crew and other 

provisions for carrying out such activities, and (3) storage and distribution of the catch from such activities. The Committee intends 

that the Secretary shall require that the taxpayer substantiate deductible expenses by maintaining appropriate written records that 

show, for example, the time, place, date, amount, and nature of the 

expense, as well as the taxpayer’s eligibility for the deduction. In 

addition, the Committee believes that it is appropriate for the taxpayer to provide such substantiation as part of the taxpayer’s income tax return, to the extent provided by the Secretary. 

For purposes of the provision, the term ‘‘sanctioned whaling activities’’ means subsistence bowhead whale hunting activities conducted pursuant to the management plan of the Alaska Eskimo 

Whaling Commission. 

EFFECTIVE DATE

The provision is effective for contributions made after December 

31, 2003.

L. MATCHING GRANTS TO LOW-INCOME TAXPAYER CLINICS FOR

RETURN PREPARATION

(Sec. 312 of the bill and new sec. 7526A of the Code) 

PRESENT LAW

The Code provides that the Secretary is authorized to provide up 

to $6 million per year in matching grants to certain low-income 

taxpayer clinics. Eligible clinics 121 are those that charge no more 

than a nominal fee to either represent low-income taxpayers in controversies with the IRS or provide tax information to individuals 

for whom English is a second language. No clinic can receive more 

than $100,000 per year. 

REASONS FOR CHANGE

The Committee believes that the existing low-income taxpayer 

clinics provide an invaluable service to taxpayers and have increased compliance with the Code by providing representation and 

guidance to taxpayers who might otherwise be uncertain about 

their rights and obligations under the Code. Therefore, the Committee believes that creating a new matching grant program, focused entirely on assisting taxpayers with the preparation of their 

Federal tax returns, will also increase compliance with our tax 

laws. 

70

EXPLANATION OF PROVISION

The bill authorizes up to $10 million annually in matching 

grants for low-income taxpayer assistance clinics. These clinics may 

provide routine tax return preparation and filing services to low income taxpayers. 

EFFECTIVE DATE

The provision is effective for grants made after the date of enactment. 

TITLE IV. SOCIAL SERVICES BLOCK GRANT 

(Secs. 401–403 of the bill) 

PRESENT LAW

Social Services Block Grant Funding (‘‘SSBG’’), also known as 

‘‘Title XX’’ (because it is Title XX of the Social Security Act), is a 

flexible funding stream, providing states with resources to support 

a variety of social services. SSBG funds can be used to assist the 

elderly and disabled so that they do not need to enter institutions, 

to prevent child and elder abuse, to provide child care, to promote 

and support adoption, and for several other services. There are certain specified limitations so that SSBG cannot fund most medical 

care, for example, or cash welfare payments. It is a mandatory 

capped entitlement, distributed by a population-based formula 

among the states. 

States use SSBG in differing ways. Much of the funding supports 

local social service providers, including faith-related organizations, 

through contracts with state and local governments. Overall, in fiscal year 1999, SSBG spending was as follows: 13.4 percent for ‘‘prevention’’ and case management; 13 percent for day care; 12.4 percent for child and adult protective services; 10.9 percent for foster 

care; 7.4 percent for home-based services. There are several other 

categories in the expenditure data as well. 

Prior to the 1996 welfare reform law, SSBG was funded at $2.8 

billion. That legislation reduced SSBG to $2.38 billion, as part of 

achieving budgetary savings, and permitted states to transfer up to 

10 percent of their new Temporary Assistance for Needy Families 

(TANF) welfare block grant allocations to SSBG. (Any transferred 

funds are required to be spent on behalf of families below 200 percent of poverty.) In 1998, as part of the TEA–21 highway legislation, SSBG funding as further reduced, declining to $1.7 billion for 

fiscal year 2001 and fiscal year 2002. The TANF transfer was further limited to 4.25 percent. 

REASONS FOR CHANGE

The Committee believes that an increase in funding for SSBG 

will allow social service organizations to provide more assistance to 

families in need and disadvantaged individuals. The flexible nature 

of SSBG permits states and localities to choose their own priorities 

for the uses of the increased funding. 

71

122 Rev. Rul. 99–44, 1999–2 C.B. 549. 

EXPLANATION OF PROVISION

The provision increases SSBG funding to $1.975 billion for fiscal 

year 2003 and $2.8 billion for fiscal year 2004. In addition, the 

TANF transfer limit is restored to 10 percent. These two measures 

provide additional resources to faith-related social service organizations. Finally, the Secretary of HHS is required to submit annual 

reports on SSBG expenditures to the Congress. 

EFFECTIVE DATE

The provision is effective for amounts made available for fiscal 

year 2003 and for amounts made available each fiscal year thereafter. The provision requiring annual reports applies to such reports with respect to fiscal year 2002 and each fiscal year thereafter. 

TITLE V. INDIVIDUAL DEVELOPMENT ACCOUNTS 

(Sec. 501–512 of the bill) 

PRESENT LAW

Individual development accounts were first authorized by the 

Personal Work and Responsibility Act of 1996. In 1998, the Assets 

for Independence Act established a five-year $125 million demonstration program to permit certain eligible individuals to open 

and make contributions to an individual development account. Contributions by an individual to an individual development account 

do not receive a tax preference but are matched by contributions 

from a State program, a participating nonprofit organization, or 

other ‘‘qualified entity.’’ The IRS has ruled that matching contributions by a qualified entity are a gift and not taxable to the account 

owner.122 The qualified entity chooses a matching rate, which must 

be between 50 and 400 percent. Withdrawals from individual development accounts can be made for certain higher education expenses, a first home purchase, or small-business capitalization expenses. Matching contributions (and earnings thereon) typically are 

held separately from the individuals’ contributions (and earnings 

thereon) and must be paid directly to a mortgage provider, university, or business capitalization account at a financial institution. 

The Department of Health and Human Services administers the individual development account program. 

REASONS FOR CHANGE

The Committee recognizes that the rate of private savings in the 

United States is too low. In particular, many low-income individuals either have inadequate savings or no savings at all. The Committee believes that a tax-subsidized match by financial institutions may help encourage more savings by low-income working individuals. The program is intended to encourage a pattern of individual savings and wealth accumulation. Finally, the Committee 

believes that the program will allow individuals to use their savings for three important purposes: (1) to afford better educations; 

72

123 If less than 100,000 accounts are opened before January 1, 2008, then the number of accounts that can be opened after December 31, 2007 and before January 1, 2010 will be reduced 

to the lesser of 75,000 accounts or three times the number of accounts opened before January 

1, 2007. 

(2) to achieve home ownership; and (3) to start their own businesses. 

EXPLANATION OF PROVISION

The provision provides for a nonrefundable tax credit for an eligible entity (i.e., a qualified financial institution) that has an individual development account program in a taxable year. The tax 

credit equals the amount of matching contributions made by the eligible entity under the program (up to $500 per taxable year) plus 

$50 for each individual development account maintained during the 

taxable year under the program. Except in the first year that each 

account is open, the $50 credit is available only for accounts with 

a balance of more than $100 at year-end (including matching 

funds). The $50 credit is limited to seven years (the year the account is created and the six years immediately thereafter). The 

credit for matching funds is not allowed with respect to an individual’s account if such individual has outstanding student loans, 

child support payments, or Federal tax liability. No deduction or 

other credit is available with respect to the amount of matching 

funds taken into account in determining the credit. 

The credit applies with respect to the first 300,000 individual development accounts opened before January 1, 2012, and with respect to matching funds for participant contributions that are made 

after December 31, 2004, and before January 1, 2012. An account 

is considered open if at any time the balance in the account exceeds 

$100 (including matching amounts). The maximum amount of annual contributions to an individual development account by an otherwise eligible individual is limited to three times the maximum 

credit amount for matching contributions for such year. The individual development accounts will be available on the following 

basis: (1) a maximum of 100,000 accounts may be opened after December 31, 2004 and before January 1, 2008; (2) a second 100,000 

accounts may be opened after December 31, 2007 and before January 1, 2010, if the entire 100,000 of authorized accounts are opened 

after December 31, 2004 and before January 1, 2008 and the Secretary of the Treasury determines that these accounts are being 

reasonably and responsibly administered; 123 and (3) a third 

100,000 accounts may be opened after December 31, 2009 and before January 1, 2012 if the previous cohorts of 100,000 accounts 

have been opened under the schedule described above and the Secretary of the Treasury makes a four-part determination. Specifically, the Secretary will have to determine: (1) that all previously 

opened accounts have been reasonably and responsibly administered to date; (2) that the individual development account program 

has increased net savings of participants in the program; (3) 

whether participants in the individual development account program have increased Federal income tax liability and decreased 

utilization of Federal assistance programs (e.g., Temporary Assistance to Needy Families and Food Stamps) relative to similarly situated individuals that did not participate in the individual developVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00072 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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124Married taxpayers filing separate returns are not eligible to open an IDA or to receive 

matching funds for an IDA that is already open. 

ment account program; and (4) that the sum of the increased Federal tax liability and reduction of Federal assistance program benefits to participants in the individual development account program 

is greater than the cost of the individual development account program to the Federal government. If the Secretary finds that any of 

the four determinations has not been satisfied, the Congress will 

have the discretion to authorize the third 100,000 accounts after 

the Secretary makes his or her report to the Congress regarding 

the four determinations. The third 100,000 accounts must be equally divided among the States. For all accounts, the Secretary will 

take steps to encourage use of individual development accounts in 

rural areas. 

Nonstudent U.S. citizens or lawful permanent residents between 

the ages of 18 and 60 (inclusive) who meet certain income requirements are eligible to open and contribute to an individual development account. The income limit for participation is modified adjusted gross income of $18,000 for single filers, $38,000 for joint filers, and $30,000 for head-of-household filers.124 Eligibility in a taxable year generally is based on the previous year’s modified adjusted gross income and circumstances (e.g., status as a student). 

Modified adjusted gross income is adjusted gross income plus certain items that are not includible in gross income. The items added 

are tax-exempt interest and the amounts otherwise excluded from 

gross income under Code sections 86, 893, 911, 931, and 933 (relating to the exclusion of certain social security and Tier 1 railroad 

retirement benefits; the exclusion of compensation of employees of 

foreign governments and international organizations; the exclusion 

of income of U.S. citizens or residents living abroad; the exclusion 

of income for residents of Guam, American Samoa, and the Northern Mariana Islands; and the exclusion of income for residents of 

Puerto Rico). The income limits are adjusted for inflation after 

2003. These amounts are rounded to the nearest multiple of 50 dollars. 

Under the provision, an individual development account must: 

(1) be owned by the eligible individual for whom the account was 

established; (2) consist only of cash contributions; (3) be held by a 

person authorized to be a trustee of any individual retirement account under section 408(a)(2); and (4) not commingle account assets 

with other property (except in a common trust fund or common investment fund). These requirements must be reflected in the written governing instrument creating the account. The entity establishing the program is required to maintain separate accounts for 

the individual’s contributions (and earnings thereon) and for 

matching funds and earnings thereon (a ‘‘parallel account’’). 

Contributions to individual development accounts by individuals 

are not deductible and earnings thereon are taxable to the account 

holder. Matching contributions and earnings thereon are not taxable to the account holder. Any amount (including earnings) in an 

individual development account and matching contributions are 

disregarded for purposes of any means-tested Federal programs. 

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The provision permits individuals to withdraw amounts from an 

individual development account for qualified expenses of the account owner, owner’s spouse, or dependents as well as for nonqualified expenses, subject to certain restrictions. Qualified expenses include qualified: (1) higher education expenses (as generally defined in section 529(e)(3)); (2) first-time homebuyer costs 

(as generally provided in section 72 (t)(8)); (3) business capitalization or expansion costs (expenditures made pursuant to a business 

plan that has been approved by the financial institution); (4) rollovers of the balance of the account (including the parallel account) 

to another individual development account for the benefit of the 

same owner; and (5) final distributions in the case of a deceased 

account owner. Withdrawals for qualified expenses must be made 

from funds that have been in the account for at least one year and 

must be paid directly to the unrelated third party to whom the 

amount is due, except in the case of expenses under a qualified 

business plan, rollover, or final distribution. Such withdrawals generally are not permitted until the account owner completes a financial education course offered by a qualified financial institution. 

The Secretary of the Treasury (the ‘‘Secretary’’) is required to establish minimum standards for such courses. Withdrawals for nonqualified expenses may result in the account owner’s forfeiture of 

matching funds. The amount of the forfeiture is the lesser of: (1) 

an amount equal to the nonqualified withdrawal; or (2) the excess 

of the amount in the parallel account (excluding earnings on 

matching funds) over the amount remaining in the individual development account after the nonqualified withdrawal. If the individual development account (or a portion thereof) is pledged as security for a loan, then the portion so used will be treated as a nonqualified withdrawal and will result in the loss of an equal amount 

of matching funds from the parallel account. At age 65, an individual may withdraw the balance of his or her individual development account for nonqualified purposes without losing matching 

amounts.

The qualified entity administering the individual development 

account program generally is required to make quarterly payments 

of matching funds to a parallel account on a dollar-for-dollar basis 

for the first $500 contributed by the account owner in a taxable 

year. Matching funds also may be provided by State, local, or private sources. Balances of the individual development account and 

parallel account must be reported annually to the account owner. 

If an account owner ceases to meet eligibility requirements, matching funds generally may not be contributed during the period of ineligibility. Any amount withdrawn from a parallel account is not 

includible in an eligible individual’s gross income or the account 

sponsor’s gross income. 

Qualified entities administering a qualified program are required 

to report to the Secretary that the program is administered in accordance with legal requirements. If the Secretary determines that 

the program was not so operated, the Secretary would have the 

power to terminate the program. Qualified entities also are required to report annually to the Secretary information about: (1) 

the number of individuals making contributions to individual development accounts; (2) the amounts contributed by such individuals; 

75

(3) the amount of matching funds contributed; (4) the amount of 

funds withdrawn and for what purpose; (5) balance information; 

and (6) any other information that the Secretary deems necessary. 

The fiduciary requirements of Title 12 of the United States Code 

with respect to insured depository institutions and insured credit 

unions (as defined therein) continue to apply to those financial institutions participating in the individual development account program. Qualified entities are prohibited from charging any fees with 

regard to the individual development accounts. 

The Secretary is authorized to prescribe necessary regulations, 

including rules to permit individual development account program 

sponsors to verify eligibility of individuals seeking to open accounts 

and rules to allow a financial institution (e.g., a tax-exempt credit 

union) to transfer those credits to another taxpayer. The Secretary 

also is authorized to provide rules to recapture credits claimed with 

respect to individuals who forfeit matching funds. 

The Secretary must submit annual reports to Congress on the 

status of the qualified individual account program. 

EFFECTIVE DATE

The provision is effective for taxable years ending after December 

31, 2004, and beginning before January 1, 2012. 

TITLE VI. MANAGEMENT OF EXEMPT ORGANIZATIONS 

(Sec. 601 of the bill) 

EXPLANATION OF PROVISION

The provision authorizes $80 million to be appropriated to the 

Secretary of the Treasury for each fiscal year to carry out the administration of exempt organizations by the IRS. 

The provision authorizes $3 million to be appropriated to the 

Secretary of the Treasury to carry out the provisions of Public 

Laws 106–230 and 107–276, relating to section 527. 

REASONS FOR CHANGE

The Committee believes that the oversight and administration of 

exempt organizations by the IRS is critical to ensuring that exempt 

organizations operate consistent with their exempt purposes and do 

not abuse the public trust. The Committee believes that the IRS 

currently is underfunded in this regard. 

Public Laws 106–230 and 107–276 imposed substantial new filing requirements on section 527 organizations and required the 

IRS to establish and maintain electronic filing capability and a 

searchable on-line database for public use. The Committee believes 

that the efficient and successful completion of this task requires 

separate funding by the Congress. 

EFFECTIVE DATE

The authorizations are effective on the date of enactment. 

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125See, e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d Cir. 1998), aff’g 73 T.C.M. 

(CCH) 2189 (1997), cert. denied 526 U.S. 1017 (1999). 126 Closely related doctrines also applied by the courts (sometimes interchangeable with the 

economic substance doctrine) include the ‘‘sham transaction doctrine’’ and the ‘‘business purpose 

doctrine’’. See, e.g., Knetsch v. United States, 364 U.S. 361 (1960) (denying interest deductions on a ‘‘sham transaction’’ whose only purpose was to create the deductions). 

TITLE VII. REVENUE PROVISIONS 

A. PROVISIONS DESIGNED TO CURTAIL TAX SHELTERS

1. Clarification of the Economic Substance Doctrine 

(Sec. 701 of the bill and sec. 7701 of the Code) 

PRESENT LAW

In general 

The Code provides specific rules regarding the computation of 

taxable income, including the amount, timing, source, and character of items of income, gain, loss and deduction. These rules are 

designed to provide for the computation of taxable income in a 

manner that provides for a degree of specificity to both taxpayers 

and the government. Taxpayers generally may plan their transactions in reliance on these rules to determine the federal income 

tax consequences arising from the transactions. 

In addition to the statutory provisions, courts have developed 

several doctrines that can be applied to deny the tax benefits of tax 

motivated transactions, notwithstanding that the transaction may 

satisfy the literal requirements of a specific tax provision. The common-law doctrines are not entirely distinguishable, and their application to a given set of facts is often blurred by the courts and the 

IRS. Although these doctrines serve an important role in the administration of the tax system, invocation of these doctrines can be 

seen as at odds with an objective, ‘‘rule-based’’ system of taxation. 

Nonetheless, courts have applied the doctrines to deny tax benefits 

arising from certain transactions.125

A common-law doctrine applied with increasing frequency is the 

‘‘economic substance’’ doctrine. In general, this doctrine denies tax 

benefits arising from transactions that do not result in a meaningful change to the taxpayer’s economic position other than a purported reduction in federal income tax.126

Economic substance doctrine 

Courts generally deny claimed tax benefits if the transaction that 

gives rise to those benefits lacks economic substance independent 

of tax considerations—notwithstanding that the purported activity 

actually occurred. The tax court has described the doctrine as follows: 

The tax law . . . requires that the intended transactions 

have economic substance separate and distinct from economic benefit achieved solely by tax reduction. The doctrine of economic substance becomes applicable, and a judicial remedy is warranted, where a taxpayer seeks to claim 

tax benefits, unintended by Congress, by means of transVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00076 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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127 ACM Partnership v. Commissioner, 73 T.C.M. at 2215. 128 ACM Partnership v. Commissioner, 157 F.3d at 256 n.48. 129See, e.g., Pasternak v. Commissioner, 990 F.2d 893, 898 (6th Cir. 1993) (‘‘The threshold 

question is whether the transaction has economic substance. If the answer is yes, the question 

becomes whether the taxpayer was motivated by profit to participate in the transaction.’’) 130See, e.g., Rice’s Toyota World v. Commissioner, 752 F.2d 89, 91–92 (4th Cir. 1985) (‘‘To 

treat a transaction as a sham, the court must find that the taxpayer was motivated by no business purposes other than obtaining tax benefits in entering the transaction, and, second, that 

the transaction has no economic substance because no reasonable possibility of a profit exists.’’); 

IES Industries v. United States, 253 F.3d 350, 358 (8th Cir. 2001) (‘‘In determining whether a 

transaction is a sham for tax purposes [under the Eighth Circuit test], a transaction will be 

characterized as a sham if it is not motivated by any economic purpose out of tax considerations 

(the business purpose test), and if it is without economic substance because no real potential 

for profit exists’’ (the economic substance test).’’) As noted earlier, the economic substance doctrine and the sham transaction doctrine are similar and sometimes are applied interchangeably. 

For a more detailed discussion of the sham transaction doctrine, see, e.g., Joint Committee on 

Taxation, Study of Present-Law Penalty and Interest Provisions as Required by Section 3801 

of the Internal Revenue Service Restructuring and Reform Act of 1998 (including Provisions Relating to Corporate Tax Shelters) (JCS–3–99) at 182. 131See, e.g., ACM Partnership v. Commissioner, 157 F.3d at 247; James v. Commissioner, 899 

F.2d 905, 908 (10th Cir. 1995); Sacks v. Commissioner, 69 F.3d 982, 985 (9th Cir. 1995) (‘‘Instead, the consideration of business purpose and economic substance are simply more precise 

factors to consider * * *. We have repeatedly and carefully noted that this formulation cannot 

be used as a ’rigid two-step analysis’.’’). 

actions that serve no economic purpose other than tax savings.127

Business purpose doctrine 

Another common law doctrine that overlays and is often considered together with (if not part and parcel of) the economic substance doctrine is the business purpose doctrine. The business purpose test is a subjective inquiry into the motives of the taxpayer— that is, whether the taxpayer intended the transaction to serve 

some useful non-tax purpose. In making this determination, some 

courts have bifurcated a transaction in which independent activities with non-tax objectives have been combined with an unrelated 

item having only tax-avoidance objectives in order to disallow the 

tax benefits of the overall transaction.128

Application by the courts 

Elements of the doctrine 

There is a lack of uniformity regarding the proper application of 

the economic substance doctrine. Some courts apply a conjunctive 

test that requires a taxpayer to establish the presence of both economic substance (i.e., the objective component) and business purpose (i.e., the subjective component) in order for the transaction to 

sustain court scrutiny.129 A narrower approach used by some 

courts is to invoke the economic substance doctrine only after a determination that the transaction lacks both a business purpose and 

economic substance (i.e., the existence of either a business purpose 

or economic substance would be sufficient to respect the transaction).130 A third approach regards economic substance and business purpose as ‘‘simply more precise factors to consider’’ in determining whether a transaction has any practical economic effects 

other than the creation of tax benefits.131

Profit potential 

There also is a lack of uniformity regarding the necessity and 

level of profit potential necessary to establish economic substance. 

Since the time of Gregory, several courts have denied tax benefits 

78

132See, e.g., Knetsch, 364 U.S. at 361; Goldstein v. Commissioner, 364 F.2d 734 (2d Cir. 1966) 

(holding that an unprofitable, leveraged acquisition of Treasury bills, and accompanying prepaid 

interest deduction, lacked economic substance); Ginsburg v. Commissioner, 35 T.C.M. (CCH) 860 

(1976) (holding that a leveraged cattle-breeding program lacked economic substance). 133See, e.g., Goldstein v. Commissioner, 364 F.2d at 739–40 (disallowing deduction even 

though taxpayer had a possibility of small gain or loss by owning Treasury bills); Sheldon v. 

Commissioner, 94 T.C. 738, 768 (1990) (stating, ‘‘potential for gain * * * is infinitesimally nominal and vastly insignificant when considered in comparison with the claimed deductions’’). 134See, e.g., Rice’s Toyota World v. Commissioner, 752 F.2d at 94 (the economic substance inquiry requires an objective determination of whether a reasonable possibility of profit from the 

transaction existed apart from tax benefits); Compaq Computer Corp. v. Commissioner, 277 F.3d 

at 781 (applied the same test, citing Rice’s Toyota World); IES Industries v. United States, 253 

F.3d at 354 (the application of the objective economic substance test involves determining 

whether there was a ‘‘reasonable possibility of profit * * * apart from tax benefits.’’). 

on the grounds that the subject transactions lacked profit potential.132 In addition, some courts have applied the economic substance doctrine to disallow tax benefits in transactions in which a 

taxpayer was exposed to risk and the transaction had a profit potential, but the court concluded that the economic risks and profit 

potential were insignificant when compared to the tax benefits.133

Under this analysis, the taxpayer’s profit potential must be more 

than nominal. Conversely, other courts view the application of the 

economic substance doctrine as requiring an objective determination of whether a ‘‘reasonable possibility of profit’’ from the transaction existed apart from the tax benefits.134 In these cases, in assessing whether a reasonable possibility of profit exists, it is sufficient if there is a nominal amount of pre-tax profit as measured 

against expected net tax benefits. 

REASONS FOR CHANGE

The Committee is concerned that many taxpayers are engaging 

in tax avoidance transactions that rely on the interaction of highly 

technical tax law provisions. These transactions usually produce 

surprising results that were not contemplated by Congress. Whether these transactions are respected usually hinges on whether the 

transaction had sufficient economic substance. The Committee is 

concerned that in addressing these transactions the courts, in some 

cases, are reaching conclusions inconsistent with Congressional intent. In addition, the Committee is concerned that in determining 

whether a transaction has economic substance, taxpayers are subject to different legal standards based on the circuit that the taxpayer is located. Thus, the Committee believes it is appropriate to 

clarify for the courts the appropriate standards to use in determining whether a transaction has economic substance. 

EXPLANATION OF PROVISION

In general 

The bill clarifies and enhances the application of the economic 

substance doctrine. The bill provides that a transaction has economic substance (and thus satisfies the economic substance doctrine) only if the taxpayer establishes that (1) the transaction 

changes in a meaningful way (apart from Federal income tax consequences) the taxpayer’s economic position, and (2) the taxpayer 

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135 If the tax benefits are clearly contemplated and expected by the language and purpose of 

the relevant authority, it is not intended that such tax benefits be disallowed if the only reason 

for such disallowance is that the transaction fails the economic substance doctrine as defined 

in this provision. 136See, Martin McMahon Jr., Economic Substance, Purposive Activity, and Corporate Tax 

Shelters, 94 Tax Notes 1017, 1023 (Feb. 25, 2002) (advocates ‘‘confining the most rigorous application of business purpose, economic substance, and purposive activity tests to transactions outside the ordinary course of the taxpayer’s business—those transactions that do not appear to 

contribute to any business activity or objective that the taxpayer may have had apart from tax 

planning but are merely loss generators.’’); Mark P. Gergen, The Common Knowledge of Tax 

Abuse, 54 SMU L. Rev. 131, 140 (Winter 2001) (‘‘The message is that you can pick up tax gold 

if you find it in the street while going about your business, but you cannot go hunting for it.’’). 137 However, if the tax benefits are clearly contemplated and expected by the language and 

purpose of the relevant authority, such tax benefits should not be disallowed solely because the 

transaction results in a favorable accounting treatment. An example is the repealed foreign 

sales corporation rules. 

action and the transaction is a reasonable means of accomplishing 

such purpose.135

The bill does not change current law standards used by courts 

in determining when to utilize an economic substance analysis. 

Also, the bill does not alter the court’s ability to aggregate or 

disaggregate a transaction when applying the doctrine. The bill 

provides a uniform definition of economic substance, but does not 

alter court flexibility in other respects. 

Conjunctive analysis 

The bill clarifies that the economic substance doctrine involves a 

conjunctive analysis—there must be an objective inquiry regarding 

the effects of the transaction on the taxpayer’s economic position, 

as well as a subjective inquiry regarding the taxpayer’s motives for 

engaging in the transaction. Under the bill, a transaction must satisfy both tests—i.e., it must change in a meaningful way (apart 

from Federal income tax consequences) the taxpayer’s economic position, and the taxpayer must have a substantial non-tax purpose 

for entering into such transaction (and the transaction is a reasonable means of accomplishing such purpose)—in order to satisfy the 

economic substance doctrine. This clarification eliminates the disparity that exists among the circuits regarding the application of 

the doctrine, and modifies its application in those circuits in which 

either a change in economic position or a non-tax business purpose 

(without having both) is sufficient to satisfy the economic substance 

doctrine. 

Non-tax business purpose 

The bill provides that a taxpayer’s non-tax purpose for entering 

into a transaction (the second prong in the analysis) must be ‘‘substantial,’’ and that the transaction must be ‘‘a reasonable means’’ of accomplishing such purpose. Under this formulation, the non-tax 

purpose for the transaction must bear a reasonable relationship to 

the taxpayer’s normal business operations or investment activities.136

In determining whether a taxpayer has a substantial non-tax 

business purpose, it is intended that an objective of achieving a favorable accounting treatment for financial reporting purposes will 

not be treated as having a substantial non-tax purpose.137 Furthermore, a transaction that is expected to increase financial accounting income as a result of generating tax deductions or losses without a corresponding financial accounting charge (i.e., a permanent 

80

138This includes tax deductions or losses that are anticipated to be recognized in a period subsequent to the period the financial accounting benefit is recognized. For example, FAS 109 in 

some cases permits the recognition of financial accounting benefits prior to the period in which 

the tax benefits are recognized for income tax purposes. 139 Claiming that a financial accounting benefit constitutes a substantial non-tax purpose fails 

to consider the origin of the accounting benefit (i.e., reduction of taxes) and significantly diminishes the purpose for having a substantial non-tax purpose requirement. See, e.g., American 

Electric Power, Inc. v. U.S., 136 F. Supp. 2d 762, 791–92 (S.D. Ohio, 2001) (‘‘AEP’s intended 

use of the cash flows generated by the [corporate-owned life insurance] plan is irrelevant to the 

subjective prong of the economic substance analysis. If a legitimate business purpose for the use 

of the tax savings ’were sufficient to breathe substance into a transaction whose only purpose 

was to reduce taxes, [then] every sham tax-shelter device might succeed,’’’ citing Winn-Dixie v. 

Commissioner, 113 T.C. 254, 287 (1999)). 140Thus, a ‘‘reasonable possibility of profit’’ will not be sufficient to establish that a transaction has economic substance. 

book-tax difference) 138 should not be considered to have a substantial non-tax purpose unless a substantial non-tax purpose exists 

apart from the financial accounting benefits.139

By requiring that a transaction be a ‘‘reasonable means’’ of accomplishing its non-tax purpose, the bill broadens the ability of the 

courts to bifurcate a transaction in which independent activities 

with non-tax objectives are combined with an unrelated item having only tax-avoidance objectives in order to disallow the tax benefits of the overall transaction. 

Profit potential 

Under the bill, a taxpayer may rely on factors other than profit 

potential to demonstrate that a transaction results in a meaningful 

change in the taxpayer’s economic position; the bill merely sets 

forth a minimum threshold of profit potential if that test is relied 

on to demonstrate a meaningful change in economic position. If a 

taxpayer relies on a profit potential, however, the present value of 

the reasonably expected pre-tax profit must be substantial in relation to the present value of the expected net tax benefits that 

would be allowed if the transaction were respected.140 Moreover, 

the profit potential must exceed a risk-free rate of return. In addition, in determining pre-tax profit, fees and other transaction expenses and foreign taxes are treated as expenses. 

In applying the profit test to the lessor of tangible property, certain deductions and other applicable tax credits (such as the rehabilitation tax credit and the low income housing tax credit) are not 

taken into account in measuring tax benefits. Thus, a traditional 

leveraged lease is not affected by the bill to the extent it meets the 

present law standards. 

Transactions with tax-indifferent parties 

The bill also provides special rules for transactions with tax-indifferent parties. For this purpose, a tax-indifferent party means 

any person or entity not subject to Federal income tax, or any person to whom an item would have no substantial impact on its income tax liability. Under these rules, the form of a financing transaction will not be respected if the present value of the tax deductions to be claimed is substantially in excess of the present value 

of the anticipated economic returns to the lender. Also, the form of 

a transaction with a tax-indifferent party will not be respected if 

it results in an allocation of income or gain to the tax-indifferent 

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141On October 17, 2002, Treasury Department and the IRS released new temporary and proposed regulations regarding the disclosure of reportable transactions. The regulations are effective for transactions entered into on or after January 1, 2003. Subsequent to the issuance of 

the new regulations, the IRS announced that, in light of the numerous comments received regarding the new regulations, the revised regulations under section 6011 will permit taxpayers 

who entered into transactions on or after January 1, 2003 (and before the filing date of the revised regulations) to elect to apply the revised regulations. Notice 2003–11, 2003–6 I.R.B. 1 

(January 17, 2003). 

The discussion of present law refers to the new regulations. The rules that apply with respect 

to transactions entered into on or before December 31, 2002, are contained in Treas. Reg. sec. 

1.6011–4T in effect prior to January 1, 2003. 142The regulations clarify that the term ‘‘substantially similar’’ includes any transaction that 

is expected to obtain the same or similar types of tax benefits and that is either factually similar 

or based on the same or similar tax strategy. Also, the term must be broadly construed in favor 

of disclosureTemp. Treas. Reg. sec. 1–6011–4T(c)(4). 143Temp. Treas. Reg. sec. 1.6011–4T(b)(2). 

come or if the transaction results in the shifting of basis on account 

of overstating the income or gain of the tax-indifferent party. 

Other rules 

The Secretary may prescribe regulations which provide (1) exemptions from the application of this bill, and (2) other rules as 

may be necessary or appropriate to carry out the purposes of the 

bill.

No inference is intended as to the proper application of the economic substance doctrine under present law. In addition, except 

with respect to the economic substance doctrine, the provision shall 

not be construed as altering or supplanting any other common law 

doctrine (including the sham transaction doctrine), and this provision shall be construed as being additive to any such other doctrine. 

EFFECTIVE DATE

The bill applies to transactions entered into after the date of enactment. 

2. Penalty for Failure To Disclose Reportable Transactions 

(Sec. 702 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.141

There are six categories of reportable transactions. The first category is any transaction that is the same as (or substantially similar to) 142 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’’).143

The second category is any transaction that is offered under conditions of confidentiality. 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 

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144Temp. Treas. Reg. sec. 1.6011–4T(b)(3). 145Temp. Treas. Reg. sec. 1.6011–4T(b)(4). 146Temp. Treas. Reg. sec. 1.6011–4T(b)(5). 147The significant book-tax category applies only to taxpayers that are reporting companies under the Securities Exchange Act of 1934 or business entities that have $100 million or more 

in gross assets. 148Temp. Treas. Reg. sec. 1.6011–4T(b)(6). The regulations exempt 13 types of transactions 

from the book-tax reportable transaction category. See Temp. Treas. Reg. sec. 1.6011– 4T(b)(6)(iii)(A)–(M). 149Temp. Treas. Reg. sec. 1.6011–4T(b)(7). 150Section 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. 151 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. 

transaction, it is considered offered under conditions of confidentiality (whether or not the understanding is legally binding).144

The third category of reportable transaction is any transaction 

for which the taxpayer has obtained or been provided with contractual protection against the possibility that part or all of the intended tax consequences from the transaction will not be sustained. 

Such protection can include recission rights, the right to a refund 

of fees, contingent fees, insurance protection with respect to the tax 

treatment, or a tax indemnity or similar agreement.145

The fourth category of reportable transactions relates to any 

transaction resulting in, or that is reasonably expected to result 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; (2) $5 million in any single year or 

$10 million in any combination of years by a partnership or S corporation; (3) $2 million in any single year or $4 million in any combination of years by an individual or trust; or (4) $50,000 in any 

single year for individuals or trusts if the loss arises with respect 

to foreign currency translation losses.146

The fifth category of reportable transactions refers to any transaction done by certain taxpayers 147 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.148

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.149

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.150

REASONS FOR CHANGE

The Committee is aware that individuals and corporations are 

increasingly using sophisticated transactions to avoid or evade Federal income tax.151 Such a phenomenon could pose a serious threat 

83

152The 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 Temp. Treas. Reg. sec. 1.6011–4T(b)(2). However, the Secretary may modify this definition (as well as the definitions of ‘‘listed transaction’’ and ‘‘reportable transactions’’) as appropriate. 

to the efficacy of the tax system because of both the potential loss 

of revenue and the potential threat to the integrity 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 

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 believed that additional legislation was 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’’ 152 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 

84

153These categories of transactions are described in greater detail below in connection with 

the provisions modifying the accuracy-related penalty for listed and certain reportable transactions and a penalty for understatements attributable to transactions that lack economic substance. 

(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 action 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 ex- cess of $10 million in the year of the transaction or in the preceding year. A ‘‘high net worth individual’’ is defined as any indi- vidual 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, a non-disclosed reportable avoidance transaction, or a transaction that lacks 

economic substance 153) 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. 

3. Modifications to the Accuracy-Related Penalties for Listed Transactions and Reportable Transactions Having a Significant Tax 

Avoidance Purpose 

(Sec. 703 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 understateVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00084 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
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154Sec. 6662. 155Sec. 6662(d)(2)(B). 156Sec. 6662(d)(2)(C). 157Sec. 6664(c). 158Treas. Reg. sec. 1.6662–4(g)(4)(i)(B); Treas. Reg. sec. 1.6664–4(c). 

ment. 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.154 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 tax treatment of the item were adequately disclosed and there 

was a reasonable basis for its tax treatment.155

Special rules apply with respect to tax shelters.156 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.157 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.158

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 

86

159The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meanings as 

previously described in connection with the penalty for failing to disclose reportable transactions. 

referred to as a ‘‘reportable avoidance transaction’’).159 The penalty 

rate and defenses available to avoid the penalty vary depending on 

the category of the transaction (i.e., listed or reportable avoidance 

transaction) and 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 reasonable 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 

87

160For 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. 161See the previous discussion regarding the penalty for failing to disclose a reportable transaction. 162The 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). 163This 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. 

tax return) 160, 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. 

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 

6011,161 (2) there is or was substantial authority for such treatment, and (3) 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 162 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 163 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 

88

164 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). 

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 government body.164 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 to 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. 

89

165Sec. 6662. 166Sec. 6662(d)(2)(C). 167Sec. 6664(c). 168Treas. Reg. sec. 1.6662–4(g)(4)(i)(B); Treas. Reg. sec. 1.6664–4(c). 

4. Penalty for Understatements From Transactions Lacking 

Economic Substance 

(Sec. 704 of the bill and new sec. 6662B of the Code) 

PRESENT LAW

An 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.165 The amount of any understatement 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 tax 

treatment of the item were adequately disclosed and there was a 

reasonable basis for its tax treatment. 

Special rules apply with respect to tax shelters.166 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 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.167 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.168

REASONS FOR CHANGE

The Committee is concerned that many taxpayers are engaging 

in tax avoidance transactions that rely on the interaction of highly 

technical tax law provisions. These transactions usually produce 

surprising results that were not contemplated by Congress. Whether these transactions are respected usually hinges on whether the 

transaction had sufficient economic substance. The Committee believes that the benefits that taxpayers potentially obtain from these 

transactions significantly outweigh the potential costs of engaging 

in such transactions. In addition, the Committee believes taxpayers 

will continue to engage in tax avoidance transactions until the risk 

90

169Thus, unlike the new accuracy-related penalty under section 6662A (which applies only to 

listed and reportable avoidance transactions), the new penalty under this provision applies to 

any transaction that lacks economic substance. 170The provision provides that a transaction has economic substance only if: (1) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s eco- nomic position, and (2) the transaction has a substantial non-tax purpose for entering into such 

transaction and is a reasonable means of accomplishing such purpose. 171The provision provides that the form of a transaction that involves a tax-indifferent party 

will not be respected in certain circumstances. 172For 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 that would 

(without regard to section 1211) be allowed for such year, would be treated as an increase in 

taxable income. 

and cost to the taxpayer of engaging in the transactions is increased. Thus, the Committee believes that taxpayers should be 

subject to the imposition of a substantial strict liability penalty for 

transactions that are determined not have economic substance. 

EXPLANATION OF PROVISION

The bill imposes a penalty for an understatement attributable to 

any transaction that lacks economic substance (referred to in the 

statute as a ‘‘non-economic substance transaction understatement’’).169 The penalty rate is 40 percent (reduced to 20 percent if 

the taxpayer adequately discloses the relevant facts in accordance 

with regulations prescribed under section 6011). No exceptions (including the reasonable cause or rescission rules) to the penalty 

would be available under the bill (i.e., the penalty is a strict-liability penalty). 

A ‘‘non-economic substance transaction’’ means any transaction if 

(1) the transaction lacks economic substance (as defined in the earlier provision regarding the economic substance doctrine),170 (2) the 

transaction was not respected under the rules relating to transactions with tax-indifferent parties (as described in the earlier provision regarding the economic substance doctrine),171 or (3) any 

similar rule of law. For this purpose, a similar rule of law would 

include, for example, an understatement attributable to a transaction that is determined to be a sham transaction. 

For purposes of this provision, the calculation of an ‘‘understatement’’ is made in the same manner as in the separate provision relating to accuracy-related penalties for listed and reportable avoidance transactions (new sec. 6662A). Thus, the amount of the understatement under this provision would be 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),172 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. In essence, the penalty will apply to the amount of any understatement attributable solely to a non-economic substance 

transaction. 

Except as provided in regulations, the taxpayer’s treatment of an 

item will not take into account any amendment or supplement to 

a return if the amendment or supplement is filed after the earlier 

of the date the taxpayer is first contacted regarding an examination of the return or such other date as specified by the Secretary. 

91

173Sec. 6662(a) and (d)(1)(A). 

A public entity that is required to pay a penalty under this provision (regardless of whether the transaction was disclosed) 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 a penalty (regardless of whether the transaction was disclosed) 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. 

Any understatement to which a penalty is imposed under this 

provision will not be subject to the accuracy-related penalty under 

section 6662 or under new 6662A (accuracy-related penalties for 

listed and reportable avoidance transactions). However, an understatement under this provision would be taken into account 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 will 

not apply to any portion of an understatement to which a fraud 

penalty is applied under section 6663. 

EFFECTIVE DATE

The bill applies to transactions after the date of enactment. 

5. Modifications to the Substantial Understatement Penalty 

(Sec. 705 of the bill and sec. 6662 of the Code) 

PRESENT LAW

Definition of substantial understatement 

An accuracy-related penalty equal to 20 percent applies to any 

substantial understatement of tax. A ‘‘substantial understatement’’

exists if the correct income tax liability for a taxable year 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 most corporations).173

Reduction of understatement for certain positions 

For purposes of determining whether a substantial understatement penalty applies, 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 

92

174Sec. 6662(d)(2)(B). 175Sec. 6662(d)(2)(D). 

relevant to the tax treatment of the item were adequately disclosed 

and there was a reasonable basis for its tax treatment.174

The Secretary is required to publish annually in the Federal Register a list of positions for which the Secretary believes there is not 

substantial authority and which affect a significant number of taxpayers.175

REASONS FOR CHANGE

The Committee believes that the present-law definition of substantial understatement allows large corporate taxpayers to avoid 

the accuracy-related penalty on questionable transactions of a significant size. The Committee believes that an understatement of 

more than $10 million is substantial in and of itself, regardless of 

the proportion it represents of the taxpayer’s total tax liability. 

The Committee believes that a higher compliance standard 

should be imposed on any taxpayer in order to reduce the amount 

of an understatement resulting from a transaction that the taxpayer did not adequately disclose. The Committee further believes 

that a taxpayer should not take a position on a tax return that 

could give rise to a substantial understatement penalty that the 

taxpayer does not believe is more likely than not the correct tax 

treatment unless this information is disclosed to the IRS. 

EXPLANATION OF PROVISION

Definition of substantial understatement 

The bill modifies the definition of ‘‘substantial’’ for corporate taxpayers. Under the bill, a corporate taxpayer has a substantial understatement if the amount of the understatement for the taxable 

year exceeds the lesser of (1) 10 percent of the tax required to be 

shown on the return for the taxable year (or, if greater, $10,000), 

or (2) $10 million. 

Reduction of understatement for certain positions 

The bill elevates the standard that a taxpayer must satisfy in 

order to reduce the amount of an understatement for undisclosed 

items. With respect to the treatment of an item whose facts are not 

adequately disclosed, a resulting understatement is reduced only if 

the taxpayer had a reasonable belief that the tax treatment was 

more likely than not the proper treatment. The bill also authorizes 

(but does not require) the Secretary to publish a list of positions 

for which it believes there is not substantial authority or there is 

no reasonable belief that the tax treatment is more likely than not 

the proper treatment (without regard to whether such positions affect a significant number of taxpayers). The list shall be published 

in the Federal Register or the Internal Revenue Bulletin. 

EFFECTIVE DATE

The bill is effective for taxable years beginning after date of enactment. 

93

176Sec. 6111(a). 177The 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. 

6. Tax Shelter Exception to Confidentiality Privileges Relating to 

Taxpayer Communications 

(Sec. 706 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 

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. 

7. Disclosure of Reportable Transactions by Material Advisors 

(Secs. 707 and 708 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.176 A ‘‘tax shelter’’ means any investment with 

respect to which the tax shelter ratio 177 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 filVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00093 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
94

178Sec. 6111(c). 179Sec. 6111(d). 180Temp. Treas. Reg. sec. 301.6111–2T(b)(2). 181Temp. Treas. Reg. sec. 301.6111–2T(b)(3). 182Temp. Treas. Reg. sec. 301.6111–2T(b)(4). 183The 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. 301.6111–2T(c)(1). 184Sec. 6707. 

ing of a notice with a Federal or State securities agency, or (3) a 

substantial investment (greater than $250,000 and at least five investors).178

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.179

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,’’ 180 or (2) is 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.181

Certain exceptions are provided with respect to the second category 

of transactions.182

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 claims, knows, or has reason to 

know that a party other than the potential participant claims that 

the transaction (or any aspect of it) is proprietary to the promoter 

or any party other than the offeree, or is otherwise protected from 

disclosure or use.183

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 $500.184 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. 

95

185The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 186See the previous discussion regarding the disclosure requirements under new section 

6707A. 

REASONS FOR CHANGE

The Committee has been advised that the current promoter registration rules have not proven particularly helpful, 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 

respect to any reportable transaction (including listed transaction) 185 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.186

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 

96

187The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 188The 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. 

incomplete information return, with respect to a reportable transaction (including a listed transaction).187 The amount of the penalty 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 reportable 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 reportable 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.188 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 

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. 

97

189Sec. 6112. 190Temp. Treas. Reg. sec. 301–6112–1T. 191Subsequent to the issuance of the new regulations, the IRS announced that, in order to 

provide necessary clarification of the list maintenance regulations, the effective date will be 

changed to the date that revised regulations under section 6112 are filed. The delayed effective 

date, however, will not apply to listed transactions or transactions that are section 6111 shelters 

(as defined in Treas. Reg. sec. 301.6112–1T(b)(1)). Notice 2003–11, 2003–6 I.R.B. 1 (January 17, 

2003). 192Temp. Treas. Reg. sec. 301.6112–1T(c)(1). 193Temp. Treas. Reg. sec. 301.6112–1T(b). 194Temp. Treas. Reg. sec. 301.6112–1T(c)(1) and (2). 195Sec. 6112(c)(2). 

8. Investor Lists and Modification of Penalty for Failure To 

Maintain Investor Lists 

(Secs. 707 and 709 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).189 Recentlyissued temporary regulations under section 6112 contain elaborate 

rules regarding the list maintenance requirements.190 The regulations apply to transactions that are potentially abusive tax shelters 

entered into, or acquired after, January 1, 2003.191

The temporary regulations, issued in October 2002, 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.192 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 new temporary regulations under 

section 6011), or (3) any transaction that a potential material advisor knows or has reason to know, at the time the transaction is entered into, is a reportable transaction (as defined under the new 

temporary regulations under section 6011).193

The temporary regulations define an organizer or a seller of an 

interest with respect to a potentially abusive tax shelter if that person is a ‘‘material advisor.’’ A material advisor is defined any person who (directly or indirectly) receives, or is expected 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 transaction that is a potentially abusive tax 

shelter.194

The Secretary is required 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.195

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). 

98

196The term ‘‘material advisor’’ has the same meaning as when used in connection with the 

requirement to file an information return under section 6111. 197The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 198 In no event will failure to maintain a list be considered reasonable cause for failing to 

make a list available to the Secretary. 

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 196 that is required to file an information 

return with respect to a reportable transaction (including a listed 

transaction) 197 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 request by the Secretary within 20 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.198

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. 

99

199Sec. 7408. 200Sec. 6707, as amended by other provisions of this bill. 201Sec. 6708, as amended by other provisions of this bill. 

9. Actions To Enjoin Conduct With Respect to Tax Shelters and 

Reportable Transactions 

(Sec. 710 of the bill and sec. 7408 of the Code) 

PRESENT LAW

The Code authorizes civil action to enjoin any person from promoting abusive tax shelters or aiding or abetting the understatement of tax liability.199

REASONS FOR CHANGE

The Committee understands that some promoters are blatantly 

ignoring the rules regarding registration and list maintenance regardless of the penalties. An injunction would place these promoters in a public proceeding under court order. Thus, the Committee believes that the types of tax shelter activities with respect 

to which an injunction may be sought should be expanded. 

EXPLANATION OF PROVISION

The bill expands this rule so that injunctions may also be sought 

with respect to the requirements relating to the reporting of reportable transactions 200 and the keeping of lists of investors by material advisors.201 Thus, under the bill, an injunction may be sought 

against a material advisor to enjoin the advisor from (1) failing to 

file an information return with respect to a reportable transaction, 

or (2) failing to maintain, or to timely furnish upon written request 

by the Secretary, a list of investors with respect to each reportable 

transaction. 

EFFECTIVE DATE

The bill is effective on the day after the date of enactment. 

10. Understatement of Taxpayer’s Liability by Income Tax Return 

Preparer 

(Sec. 711 of the bill and sec. 6694 of the Code) 

PRESENT LAW

An income tax return preparer who prepares a return with respect to which there is an understatement of tax that is due to a 

position for which there was not a realistic possibility of being sustained on its merits and the position was not disclosed (or was frivolous) is liable for a penalty of $250, provided that the preparer 

knew or reasonably should have known of the position. An income 

tax return preparer who prepares a return and engages in specified 

willful or reckless conduct with respect to preparing such a return 

is liable for a penalty of $1,000.

100

202 31 U.S.C. 5314. 

REASONS FOR CHANGE

The Committee believes that the standards of conduct applicable 

to income tax return preparers should be the same as the standards applicable to taxpayers. Accordingly, the minimum standard 

for each undisclosed position on a tax return would be that the preparer must reasonably believe that the tax treatment is more likely 

than not the proper tax treatment. The Committee believes that 

this standard is appropriate because the tax return is signed under 

penalties of perjury, which implies a high standard of diligence in 

determining the facts and substantial accuracy in determining and 

applying the rules that govern those facts. The Committee believes 

that it is both appropriate and vital to the tax system that both 

taxpayers and their return preparers file tax returns that they reasonably believe are more likely than not correct. In addition, conforming the standards of conduct applicable to income tax return 

preparers to the standards applicable to taxpayers will simplify the 

law by reducing confusion inherent in different standards applying 

to the same behavior. 

EXPLANATION OF PROVISION

The bill alters the standards of conduct that must be met to 

avoid imposition of the first penalty. The bill replaces the realistic 

possibility standard with a requirement that there be a reasonable 

belief that the tax treatment of the position was more likely than 

not the proper treatment. The bill also replaces the not frivolous 

standard with the requirement that there be a reasonable basis for 

the tax treatment of the position. 

In addition, the bill increases the amount of these penalties. The 

penalty relating to not having a reasonable belief that the tax 

treatment was more likely than not the proper tax treatment is increased from $250 to $1,000. The penalty relating to willful or reckless conduct is increased from $1,000 to $5,000. 

EFFECTIVE DATE

The bill is effective for documents prepared after the date of enactment. 

11. Penalty for Failure To Report Interests in Foreign Financial 

Accounts 

(Sec. 712 of the bill and sec. 5321 of Title 31, United States Code) 

PRESENT LAW

The Secretary of the Treasury must require citizens, residents, or 

persons doing business in the United States to keep records and 

file reports when that person makes a transaction or maintains an 

account with a foreign financial entity.202 In general, individuals 

must fulfill this requirement by answering questions regarding foreign accounts or foreign trusts that are contained in Part III of 

Schedule B of the IRS Form 1040. Taxpayers who answer ‘‘yes’’ in 

response to the question regarding foreign accounts must then file 

Treasury Department Form TD F 90–22.1. This form must be filed 

101

203 31 U.S.C. 5321(a)(5). 204 31 U.S.C. 5322. 205 A Report to Congress in Accordance with Sec. 361(b) of the Uniting and Strengthening 

America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 

2001, April 26, 2002. 206Sec. 361(b) of the USA PATRIOT Act of 2001 (Pub. L. 107–56). 

with the Department of the Treasury, and not as part of the tax 

return that is filed with the IRS. 

The Secretary of the Treasury may impose a civil penalty on any 

person who willfully violates this reporting requirement. The civil 

penalty is the amount of the transaction or the value of the account, up to a maximum of $100,000; the minimum amount of the 

penalty is $25,000.203 In addition, any person who willfully violates 

this reporting requirement is subject to a criminal penalty. The 

criminal penalty is a fine of not more than $250,000 or imprisonment for not more than five years (or both); if the violation is part 

of a pattern of illegal activity, the maximum amount of the fine is 

increased to $500,000 and the maximum length of imprisonment is 

increased to 10 years.204

On April 26, 2002, the Secretary of the Treasury submitted to 

the Congress a report on these reporting requirements.205 This report, which was statutorily required,206 studies methods for improving compliance with these reporting requirements. It makes 

several administrative recommendations, but no legislative recommendations. A further report was required to be submitted by 

the Secretary of the Treasury to the Congress by October 26, 2002. 

REASONS FOR CHANGE

The Committee understands that the number of individuals involved in using offshore bank accounts to engage in abusive tax 

scams has grown significantly in recent years. For one scheme 

alone, the IRS estimates that there may be one to two million taxpayers with offshore bank accounts attempting to conceal income 

from the IRS. The Committee is concerned about this activity and 

believes that improving compliance with this reporting requirement 

is vitally important to sound tax administration, to combating terrorism, and to preventing the use of abusive tax schemes and 

scams. Adding a new civil penalty that applies without regard to 

willfulness will improve compliance with this reporting requirement. 

EXPLANATION OF PROVISION

The bill adds an additional civil penalty that may be imposed on 

any person who violates this reporting requirement (without regard 

to willfulness). This new civil penalty is up to $5,000. The penalty 

may be waived if any income from the account was properly reported on the income tax return and there was reasonable cause 

for the failure to report. 

EFFECTIVE DATE

The bill is effective with respect to failures to report occurring on 

or after the date of enactment.

102

207 Because in general the Tax Court is the only pre-payment forum available to taxpayers, 

it deals with most of the frivolous, groundless, or dilatory arguments raised in tax cases. 

12. Frivolous Tax Returns and Submissions 

(Sec. 713 of the bill and sec. 6702 of the Code) 

PRESENT LAW

The Code provides that an individual who files a frivolous income 

tax return is subject to a penalty of $500 imposed by the IRS (sec. 

6702). The Code also permits the Tax Court 207 to impose a penalty 

of up to $25,000 if a taxpayer has instituted or maintained proceedings primarily for delay or if the taxpayer’s position in the proceeding is frivolous or groundless (sec. 6673(a)). 

REASONS FOR CHANGE

The IRS has been faced with a significant number of tax filers 

who are filing returns based on frivolous arguments or who are 

seeking to hinder tax administration by filing returns that are patently incorrect. In addition, taxpayers are using existing procedures for collection due process hearings, offers-in-compromise, installment agreements, and taxpayer assistance orders to impede or 

delay tax administration by raising frivolous arguments. These procedures were intended to provide assistance to taxpayers genuinely 

seeking to resolve legitimate disputes with the IRS, and the use of 

these procedures for impeding or delaying tax administration diverts scarce IRS resources away from resolving genuine disputes. 

Allowing the IRS to assert more substantial penalties for frivolous 

submissions and to dismiss frivolous requests without the need to 

follow otherwise mandated procedures will deter frivolous taxpayer 

behavior and enable the IRS to use its resources to better assist 

taxpayers in resolving genuine disputes. 

EXPLANATION OF PROVISION

The bill modifies the IRS-imposed penalty by increasing the 

amount of the penalty to up to $5,000 and by applying it to all taxpayers and to all types of Federal taxes. 

The bill also modifies present law with respect to certain submissions that raise frivolous arguments or that are intended to delay 

or impede tax administration. The submissions to which this provision applies are requests for a collection due process hearing, installment agreements, offers-in-compromise, and taxpayer assistance orders. First, the bill permits the IRS to dismiss such requests. Second, the bill permits the IRS to impose a penalty of up 

to $5,000 for such requests, unless the taxpayer withdraws the request after being given an opportunity to do so. 

The bill requires the IRS to publish a list of positions, arguments, requests, and submissions determined to be frivolous for 

purposes of these provisions. 

EFFECTIVE DATE

The bill is effective for submissions made and issues raised after 

the date on which the Secretary first prescribes the required list. 

103

208 31 U.S.C. 330. 

13. Regulation of Individuals Practicing Before the Department of 

the Treasury 

(Sec. 714 of the bill and sec. 330 of Title 31, United States Code) 

PRESENT LAW

The Secretary of the Treasury is authorized to regulate the practice of representatives of persons before the Department of the 

Treasury.208 The Secretary is also authorized to suspend or disbar 

from practice before the Department a representative who is incompetent, who is disreputable, who violates the rules regulating practice before the Department, or who (with intent to defraud) willfully and knowingly misleads or threatens the person being represented (or a person who may be represented). The rules promulgated by the Secretary pursuant to this provision are contained in 

Circular 230. 

REASONS FOR CHANGE

The Committee believes that it is critical that the Secretary have 

the authority to censure tax advisors as well as to impose monetary 

sanctions against tax advisors because of the important role of tax 

advisors in our tax system. Use of these sanctions is expected to 

curb the participation of tax advisors in both tax shelter activity 

and any other activity that is contrary to Circular 230 standards. 

EXPLANATION OF PROVISION

The bill makes two modifications to expand the sanctions that 

the Secretary may impose pursuant to these statutory provisions. 

First, the bill expressly permits censure as a sanction. Second, the 

bill permits the imposition of a monetary penalty as a sanction. If 

the representative is acting on behalf of an employer or other entity, the Secretary may impose a monetary penalty on the employer 

or other entity if it knew, or reasonably should have known, of the 

conduct. This monetary penalty on the employer or other entity 

may be imposed in addition to any monetary penalty imposed directly on the representative. These monetary penalties are not to 

exceed the gross income derived (or to be derived) from the conduct 

giving rise to the penalty. These monetary penalties may be in addition to, or in lieu of, any suspension, disbarment, or censure. 

The bill also confirms the present-law authority of the Secretary 

to impose standards applicable to written advice with respect to an 

entity, plan, or arrangement that is of a type that the Secretary determines as having a potential for tax avoidance or evasion. 

EFFECTIVE DATE

The modifications to expand the sanctions that the Secretary 

may impose are effective for actions taken after the date of enactment.

104

209Sec. 6700. 

14. Penalties on Promoters of Tax Shelters 

(Sec. 715 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.209 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 participating 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. 

105

210Sec. 6501(a). 211For this purpose, a return that is filed before the date on which it is due is considered 

to be filed on the required due date (sec. 6501(b)(1)). 212Sec. 6501(e). 213Sec. 6501(c). 214The tax year extended is the tax year the transaction is entered into. 215The term ‘‘listed transaction’’ has the same meaning as described in a previous provision 

regarding the penalty for failure to disclose reportable transactions. 216 However, if the Treasury Department lists a transaction in a year subsequent to the year 

a taxpayer entered into such transaction, and the taxpayer’s tax return for the year the transaction was entered into is closed by the statute of limitations prior to the transaction becoming 

a listed transaction, this provision does not re-open the statute of limitations for such year.

15. Extend Statute of Limitations for Certain Undisclosed 

Transactions 

(Sec. 716 of the bill and sec. 6501 of the Code) 

PRESENT LAW

In general, the Code requires that taxes be assessed within three 

years 210 after the date a return is filed.211 If there has been a substantial omission of items of gross income that total more than 25 

percent of the amount of gross income shown on the return, the period during which an assessment must be made is extended to six 

years.212 If an assessment is not made within the required time periods, the tax generally cannot be assessed or collected at any future time. Tax may be assessed at any time if the taxpayer files 

a false or fraudulent return with the intent to evade tax or if the 

taxpayer does not file a tax return at all.213

REASONS FOR CHANGE

The Committee believes that extending the statute of limitations 

if a taxpayer required to disclose a listed transaction fails to do so 

will encourage taxpayers to provide the required disclosure and 

will afford the IRS additional time to discover the transaction if the 

taxpayer does not disclose it. 

EXPLANATION OF PROVISION

The bill extends the statute of limitations to six years with respect to the entire tax return 214 if a taxpayer required to disclose 

a listed transaction 215 fails to do so in the manner required. For 

example, if a taxpayer entered into a transaction in 2005 that becomes a listed transaction in 2006 and the taxpayer fails to disclose 

such transaction in the manner required by Treasury regulations, 

the 2005 tax return will be subject to a six-year statute of limitations.216

EFFECTIVE DATE

The bill is effective for transactions entered into in taxable years 

beginning after the date of enactment. 

106

217Sec. 163(a). 218The definitions of these transactions are the same as those previously described in connection with the provision to modify the accuracy-related penalty for listed and certain reportable 

transactions and the provision to impose a penalty on understatements attributable to transactions that lack economic substance. 

16. Deny Deduction for Interest Paid to IRS on Underpayments 

Involving Certain Tax-Motivated Transactions 

(Sec. 717 of the bill and sec. 163 of the Code) 

PRESENT LAW

In general, corporations may deduct interest paid or accrued 

within a taxable year on indebtedness.217 Interest on indebtedness 

to the Federal government attributable to an underpayment of tax 

generally may be deducted pursuant to this provision. 

REASONS FOR CHANGE

The Committee believes that it is inappropriate for corporations 

to deduct interest paid to the Government with respect to certain 

tax shelter transactions. 

EXPLANATION OF PROVISION

The bill disallows any deduction for interest paid or accrued 

within a taxable year on any portion of an underpayment of tax 

that is attributable to an understatement arising from (1) an undisclosed reportable avoidance transaction, (2) an undisclosed listed 

transaction, or (3) a transaction that lacks economic substance.218

EFFECTIVE DATE

The bill is effective for underpayments attributable to transactions entered into in taxable years beginning after the date of enactment. 

17. Authorize Additional $300 Million Per Year to the IRS To 

Combat Abusive Tax Avoidance Transactions 

(Sec. 718 of the bill) 

PRESENT LAW

There is no explicit authorization of appropriations to the Internal Revenue Service to be used to combat abusive tax avoidance 

transactions. 

REASONS FOR CHANGE

The Committee believes that authorizing an additional $300 million to the Internal Revenue Service to be used to combat abusive 

tax avoidance transactions will aid in the implementation of the 

tax shelter measures the Committee is simultaneously approving. 

EXPLANATION OF PROVISION

The bill includes an authorization of an additional $300 million 

to the Internal Revenue Service to be used to combat abusive tax 

avoidance transactions. 

107

219Sec. 1501. 220Sec. 1502. 221 Regulations issued under the authority of section 1502 are considered to be ‘‘legislative’’ regulations rather than ‘‘interpretative’’ regulations, and as such are usually given greater deference by courts in case of a taxpayer challenge to such a regulation. See, S. Rep. No. 960, 70th 

Cong., 1st Sess. at 15, describing the consolidated return regulations as ‘‘legislative in character’’. The Supreme Court has stated that ‘‘* * * legislative regulations are given controlling 

weight unless they are arbitrary, capricious, or manifestly contrary to the statute.’’ Chevron, 

U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844 (1984) (involving an 

environmental protection regulation). For examples involving consolidated return regulations, 

see, e.g., Wolter Construction Company v. Commissioner, 634 F.2d 1029 (6th Cir. 1980); Garvey, 

Inc. v. United States, 1 Ct. Cl. 108 (1983), aff’d 726 F.2d 1569 (Fed. Cir. 1984), cert. denied 469 

U.S. 823 (1984). Compare, e.g., Audrey J. Walton v. Commissioner, 115 T.C. 589 (2000), describing different standards of review. The case did not involve a consolidated return regulation. 222 255 F.3d 1357 (Fed. Cir. 2001), reh’g denied, 2001 U.S. App. LEXIS 23207 (Fed. Cir. Oct. 

3, 2001). 223Prior to this decision, there had been a few instances involving prior laws in which certain 

consolidated return regulations were held to be invalid. See, e.g., American Standard, Inc. v. United States, 602 F.2d 256 (Ct. Cl. 1979), discussed in the text infra. see also Union Carbide 

Corp. v. United States, 612 F.2d 558 (Ct. Cl. 1979), and Allied Corporation v. United States, 685 F. 2d 396 (Ct. Cl. 1982), all three cases involving the allocation of income and loss within 

a consolidated group for purposes of computation of a deduction allowed under prior law by the 

Code for Western Hemisphere Trading Corporations. See also Joseph Weidenhoff v. Commissioner, 32 T.C. 1222, 1242–1244 (1959), involving the application of certain regulations to the 

excess profits tax credit allowed under prior law, and concluding that the Commissioner had 

applied a particular regulation in an arbitrary manner inconsistent with the wording of the regulation and inconsistent with even a consolidated group computation. Cf. Kanawha Gas & UtiliContinued

EFFECTIVE DATE

The provision is effective on the date of enactment. 

B. OTHER PROVISIONS

1. Affirmation of Consolidated Return Regulation Authority 

(Sec. 721 of the bill and sec. 1502 of the Code) 

PRESENT LAW

An affiliated group of corporations may elect to file a consolidated return in lieu of separate returns. A condition of electing to 

file a consolidated return is that all corporations that are members 

of the consolidated group must consent to all the consolidated return regulations prescribed under section 1502 prior to the last day 

prescribed by law for filing such return.219

Section 1502 states:

The Secretary shall prescribe such regulations as he 

may deem necessary in order that the tax liability of any 

affiliated group of corporations making a consolidated return and of each corporation in the group, both during and 

after the period of affiliation, may be returned, determined, computed, assessed, collected, and adjusted, in such 

manner as clearly to reflect the income-tax liability and 

the various factors necessary for the determination of such 

liability, and in order to prevent the avoidance of such tax 

liability.220

Under this authority, the Treasury Department has issued extensive consolidated return regulations.221

In the recent case of Rite Aid Corp. v. United States,222 the Federal Circuit Court of Appeals addressed the application of a particular provision of certain consolidated return loss disallowance 

regulations, and concluded that the provision was invalid.223 The 

108

ties Co. v. Commissioner, 214 F.2d 685 (1954), concluding that the substance of a transaction 

was an acquisition of assets rather than stock. Thus, a regulation governing basis of the assets 

of consolidated subsidiaries did not apply to the case. See also General Machinery Corporation v. Commissioner, 33 B.T.A. 1215 (1936); Lefcourt Realty Corporation, 31 B.T.A. 978 (1935); 

Helvering v. Morgans, Inc., 293 U.S. 121 (1934), interpreting the term ‘‘taxable year.’’ 224Treas. Reg. Sec. 1.1502–20(c)(1)(iii). 225Treasury Regulation section 1.1502–20, generally imposing certain ‘‘loss disallowance’’ rules on the disposition of subsidiary stock, contained other limitations besides the ‘‘duplicated 

loss’’ rule that could limit the loss available to the group on a disposition of a subsidiary’s stock. 

Treasury Regulation section 1.1502–20 as a whole was promulgated in connection with regulations issued under section 337(d), principally in connection with the so-called General Utilities

repeal of 1986 (referring to the case of General Utilities & Operating Company v. Helvering, 296 

U.S. 200 (1935)). Such repeal generally required a liquidating corporation, or a corporation acquired in a stock acquisition treated as a sale of assets, to pay corporate level tax on the excess 

of the value of its assets over the basis. Treasury regulation section 1.1502–20 principally reflected an attempt to prevent corporations filing consolidated returns from offsetting income 

with a loss on the sale of subsidiary stock. Such a loss could result from the unique upward 

adjustment of a subsidiary’s stock basis required under the consolidated return regulations for 

subsidiary income earned in consolidation, an adjustment intended to prevent taxation of both 

the subsidiary and the parent on the same income or gain. As one example, absent a denial 

of certain losses on a sale of subsidiary stock, a consolidated group could obtain a loss deduction 

with respect to subsidiary stock, the basis of which originally reflected the subsidiary’s value 

at the time of the purchase of the stock, and that had then been adjusted upward on recognition 

of any built-in income or gain of the subsidiary reflected in that value. The regulations also contained the duplicated loss factor addressed by the court in Rite Aid. The preamble to the regulations stated: ‘‘it is not administratively feasible to differentiate between loss attributable to 

built-in gain and duplicated loss.’’ T.D. 8364, 1991–2 C.B. 43, 46 (Sept. 13, 1991). The government also argued in the Rite Aid case that duplicated loss was a separate concern of the regulations. 255 F.3d at 1360. 226For example, the court stated: ‘‘The duplicated loss factor * * * addresses a situation that 

arises from the sale of stock regardless of whether corporations file separate or consolidated returns. With I.R.C. secs. 382 and 383, Congress has addressed this situation by limiting the subsidiary’s potential future deduction, not the parent’s loss on the sale of stock under I.R.C. sec. 

165.’’ 255 F.3d 1357, 1360 (Fed. Cir. 2001). 227S. Rep. No. 960, 70th Cong., 1st Sess. 15 (1928). Though not quoted by the court in Rite 

Aid, the same Senate report also indicated that one purpose of the consolidated return authority 

was to permit treatment of the separate corporations as if they were a single unit, stating ‘‘The 

mere fact that by legal fiction several corporations owned by the same shareholders are separate 

entities should not obscure the fact that they are in reality one and the same business owned 

by the same individuals and operated as a unit.’’ S. Rep. No. 960, 70th Cong., 1st Sess. 29 

(1928). 

particular provision, known as the ‘‘duplicated loss’’ provision,224

would have denied a loss on the sale of stock of a subsidiary by a 

parent corporation that had filed a consolidated return with the 

subsidiary, to the extent the subsidiary corporation had assets that 

had a built-in loss, or had a net operating loss, that could be recognized or used later.225

The Federal Circuit Court opinion contained language discussing 

the fact that the regulation produced a result different than the result that would have obtained if the corporations had filed separate 

returns rather than consolidated returns.226

The Federal Circuit Court opinion cited a 1928 Senate Finance 

Committee Report to legislation that authorized consolidated return regulations, which stated that ‘‘many difficult and complicated 

problems, * * * have arisen in the administration of the provisions 

permitting the filing of consolidated returns’’ and that the committee ‘‘found it necessary to delegate power to the commissioner 

to prescribe regulations legislative in character covering them.’’ 227

The Court’s opinion also cited a previous decision of the Court of 

Claims for the proposition, interpreting this legislative history, that 

section 1502 grants the Secretary ‘‘the power to conform the applicable income tax law of the Code to the special, myriad problems 

resulting from the filing of consolidated income tax returns;’’ but 

that section 1502 ‘‘does not authorize the Secretary to choose a 

109

228 American Standard, Inc. v. United States, 602 F.2d 256, 261 (Ct. Cl. 1979). That case did 

not involve the question of separate returns as compared to a single return approach. It involved 

the computation of a Western Hemisphere Trade Corporation (‘‘WHTC’’) deduction under prior 

law (which deduction would have been computed as a percentage of each WHTC’s taxable income if the corporations had filed separate returns), in a case where a consolidated group included several WHTCs as well as other corporations. The question was how to apportion income 

and losses of the admittedly consolidated WHTCs and how to combine that computation with 

the rest of the group’s consolidated income or losses. The court noted that the new, changed 

regulations approach varied from the approach taken to a similar problem involving public utilities within a group and previously allowed for WHTCs. The court objected that the allocation 

method adopted by the regulation allowed non-WHTC losses to reduce WHTC income. However, 

the court did not disallow a method that would net WHTC income of one WHTC with losses 

of another WHTC, a result that would not have occurred under separate returns. Nor did the 

court expressly disallow a different fractional method that would net both income and losses of 

the WHTCs with those of other corporations in the consolidated group. The court also found that 

the regulation had been adopted without proper notice. 229Rite Aid, 255 F.3d at 1360. 230See Temp. Reg. 1.1502–20T(i)(2). The Treasury Department has also indicated its intention 

to continue to study all the issues that the original loss disallowance regulations addressed (including issues of furthering single entity principles) and possibly issue different regulations (not 

including the particular approach of Treas. Reg. Sec. 1.1502–20(c)(1)(iii)) on the issues in the 

future. See Notice 2002–11, 2002–7 I.R.B. 526 (Feb. 19, 2002); T.D. 8984, 67 F.R. 11034 (March 

12, 2002); REG–102740–02, 67 F.R. 11070 (March 12, 2002); see also Notice 2002–18, 2002–12 

I.R.B. 644 (March 25, 2002). 

method that imposes a tax on income that would not otherwise be 

taxed.’’ 228

The Federal Circuit Court construed these authorities and applied them to invalidate Treas. Reg. Sec. 1.1502–20(c)(1)(iii), stating that: 

The loss realized on the sale of a former subsidiary’s assets after the consolidated group sells the subsidiary’s 

stock is not a problem resulting from the filing of consolidated income tax returns. The scenario also arises where 

a corporate shareholder sells the stock of a non-consolidated subsidiary. The corporate shareholder could realize 

a loss under I.R.C. sec. 1001, and deduct the loss under 

I.R.C. sec. 165. The subsidiary could then deduct any 

losses from a later sale of assets. The duplicated loss factor, therefore, addresses a situation that arises from the 

sale of stock regardless of whether corporations file separate or consolidated returns. With I.R.C. secs. 382 and 383, 

Congress has addressed this situation by limiting the subsidiary’s potential future deduction, not the parent’s loss 

on the sale of stock under I.R.C. sec. 165.229

The Treasury Department has announced that it will not continue to litigate the validity of the duplicated loss provision of the 

regulations, and has issued interim regulations that permit taxpayers for all years to elect a different treatment, though they may 

apply the provision for the past if they wish.230

REASONS FOR CHANGE

The Committee is concerned that the language and analysis in 

the Rite Aid decision might lead taxpayers to attempt to challenge 

other Treasury consolidated return regulations that prescribe a tax 

result different from the result that would occur if separate returns 

were filed. 

The Committee is concerned that any such challenges may lead 

to protracted litigation and commitment of Internal Revenue Service resources to defending the consolidated return provisions. 

110

231Treas. Reg. Sec. 1.1502–20(c)(1)(iii). 232The provision is not intended to overrule the current Treasury Department regulations, 

which allow taxpayers for the past to follow Treasury Regulations Section 1.1502–20(c)(1)(iii), 

if they choose to do so. Temp. Reg. Sec. 1.1502–20T(i)(2). 

The Committee wishes to clarify that the fact that a result under 

the consolidated return regulations differs from the result under 

separate returns does not provide a basis to challenge a Treasury 

consolidated return regulation. 

The Committee believes that the result of the case with respect 

to the type of factual situation in Rite Aid, involving the ‘‘duplicated loss factor’’ portion of Treasury Regulation section 1.1502–20, 

which Treasury has announced that taxpayers need not follow, 

should not be overturned. Therefore, the committee legislatively allows the specific result of the case to stand for the taxpayer in Rite 

Aid or any similarly situated taxpayers. 

Apart from that specific result, the Committee disagrees with the 

reasoning of the case and believes it should not be applied to support any challenge to other consolidated return regulations. The 

Committee also wishes to reaffirm the broad authority of the 

Treasury Department to issue consolidated return regulations. 

EXPLANATION OF PROVISION

The bill confirms that, in exercising its authority under section 

1502 to issue consolidated return regulations, the Treasury Department may provide rules treating corporations filing consolidated returns differently from corporations filing separate returns. 

Thus, under the statutory authority of section 1502, the Treasury 

Department is authorized to issue consolidated return regulations 

utilizing either a single taxpayer or separate taxpayer approach or 

a combination of the two approaches, as Treasury deems necessary 

in order that the tax liability of any affiliated group of corporations 

making a consolidated return, and of each corporation in the group, 

both during and after the period of affiliation, may be determined 

and adjusted in such manner as clearly to reflect the income-tax 

liability and the various factors necessary for the determination of 

such liability, and in order to prevent avoidance of such liability. 

Rite Aid is thus overruled to the extent it suggests that there is 

not a problem that can be addressed in consolidated return regulations if application of a particular Code provision on a separate taxpayer basis would produce a result different from single taxpayer 

principles that may be used for consolidation. 

The bill nevertheless allows the result of the Rite Aid case to 

stand with respect to the type of factual situation presented in the 

case. That is, the legislation provides for the override of the regulatory provision that took the approach of denying a loss on a 

deconsolidating disposition of stock of a consolidated subsidiary 231

to the extent the subsidiary had net operating losses or built in 

losses that could be used later outside the group.232

Retaining the result in the Rite Aid case with respect to the particular regulation section 1.1502–20(c)(1)(iii) as applied to the factual situation of the case does not in any way prevent or invalidate 

the various approaches Treasury has announced it will apply or 

that it intends to consider in lieu of the approach of that regulation, including, for example, the denial of a loss on a stock sale if 

111

233See, e.g., Notice 2002–11, 2002–7 I.R.B. 526 (Feb. 19, 2002); T.D. 8984, 67 F.R. 11034 (Mar. 

12, 2002); REG–102740–02, 67 F.R. 11070 (Mar. 12, 2002); see also Notice 2002–18, 2002–12 

I.R.B. 644 (Mar. 25, 2002). In exercising its authority under section 1502, the Secretary is also 

authorized to prescribe rules that protect the purpose of General Utilities repeal using presumptions and other simplifying conventions. 234Sec. 6062. 235Sec. 7206. 236Pursuant to 18 U.S.C. 3571, the maximum fine for an individual convicted of a felony is 

$250,000. 

inside losses of a subsidiary may also be used by the consolidated 

group, and the possible requirement that inside attributes be adjusted when a subsidiary leaves a group.233

EFFECTIVE DATE

The bill is effective for all years, whether beginning before, on, 

or after the date of enactment of the bill. 

No inference is intended that the results following from this provision are not the same as the results under present law. 

2. Chief Executive Officer Required To Sign Corporate Income Tax 

Returns 

(Sec. 722 of the bill and sec. 6062 of the Code) 

PRESENT LAW

The Code requires 234 that the income tax return of a corporation 

must be signed by either the president, the vice-president, the 

treasurer, the assistant treasurer, the chief accounting officer, or 

any other officer of the corporation authorized by the corporation 

to sign the return. 

The Code also imposes 235 a criminal penalty on any person who 

willfully signs any tax return under penalties of perjury that that 

person does not believe to be true and correct with respect to every 

material matter at the time of filing. If convicted, the person is 

guilty of a felony; the Code imposes a fine of not more than 

$100,000 236 ($500,000 in the case of a corporation) or imprisonment of not more than three years, or both, together with the costs 

of prosecution. 

REASONS FOR CHANGE

The Committee believes that the filing of accurate tax returns is 

essential to the proper functioning of the tax system. The Committee believes that requiring that the chief executive officer of a 

corporation sign its corporate income tax returns will elevate the 

level of care given to the preparation of those returns. 

EXPLANATION OF PROVISION

The bill requires that the chief executive officer of a corporation 

sign that corporation’s income tax returns. If the corporation does 

not have a chief executive officer, the IRS may designate another 

officer of the corporation; otherwise, no other person is permitted 

to sign the income tax return of a corporation. The Committee intends that the IRS issue general guidance, such as a revenue procedure, to (1) address situations when a corporation does not have 

a chief executive officer, and (2) define who the chief executive offiVerDate Jan 31 2003 04:53 Mar 04, 2003 Jkt 019010 PO 00000 Frm 00111 Fmt 6601 Sfmt 6602 E:\HR\OC\SR011.XXX SR011
112

237The provision does, however, apply to the income tax returns of mutual fund management 

companies and advisors. 

cer is, in situations (for example) when the primary official bears 

a different title or when a corporation has multiple chief executive 

officers. The Committee intends that, in every instance, the highest 

ranking corporate officer (regardless of title) sign the tax return. 

The provision does not apply to the income tax returns of mutual 

funds; 237 they are required to be signed as under present law. 

EFFECTIVE DATE

The provision is effective for returns filed after the date of enactment. 

III. 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 provisions of the bill as reported.

ESTIMATED BUDGET EFFECTS OF THE ‘‘CARE ACT OF 2003,’’ AS REPORTED BY THE COMMITTEE ON FINANCE 

[Fiscal years 2003–2013, millions of dollars] 

Provision Effective 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2003–08 

I. Charitable Giving Incentive Provisions

1. Provide charitable contribution deduction for non-itemizers with 

cash contributions in excess of $250 for individuals and $500 for joint returns; cap on deduction of $250 for individuals and $500 for joint returns.

tyba 12/31/02 & 

tybb 1/1/05 

¥204 ¥1,368 ¥1,218 ................ ................ ................ ................ ................ ................ ................ ................ ¥2,790 

2. Tax-free distributions from IRAs for charitable purposes—taxpayer must have attained age 701

⁄2 for contributions made directly to a charitable organization and age 591

⁄2 for contributions to a split-interest entity.

DOE & 

tyba 12/31/03 ¥48 ¥156 ¥248 ¥270 ¥258 ¥244 ¥231 ¥247 ¥352 ¥450 ¥471 ¥1,223 

3. Extend present-law section 170(e)(3) deduction for food inventory to all businesses and provide special basis rule for certain 

taxpayers; modify the enhanced deduction for charitable contributions of donations of food inventory to equal the lesser of the item’s fair market value or twice basis.

cma DOE ¥59 ¥154 ¥173 ¥185 ¥193 ¥201 ¥209 ¥217 ¥225 ¥234 ¥246 ¥965 

4. Enhanced charitable deduction for contributions of book inventories, with special fair market value rule. cma DOE ¥8 ¥17 ¥19 ¥21 ¥23 ¥25 ¥28 ¥31 ¥33 ¥37 ¥41 ¥113 

5. Expand charitable contribution allowed for scientific property 

used for research and for computer technology and equipment; and temporary extension of enhanced deduction for qualified computer contributions (through 12/31/05).

generally 

tyba 12/31/02 ¥1 ¥67 ¥133 ¥63 ¥1 ¥1 ¥1 ¥1 ¥1 ¥1 ¥1 ¥266 

6. Encourage contributions of capital gain real property made for 

conservation purposes.

cma DOE ¥3 ¥5 ¥9 ¥13 ¥16 ¥23 ¥32 ¥41 ¥51 ¥62 ¥75 ¥70 

7. 25% capital gain exclusion for sales or exchanges of land or 

interest in land or water to eligible entities for conservation purposes.

soeoa DOE ¥4 ¥21 ¥40 ¥59 ¥62 ¥65 ¥69 ¥72 ¥76 ¥80 ¥84 ¥251 

8. Exclusion for government payments under Partners for Fish and 

Wildlife Program.

pra DOE ¥1 ¥2 ¥2 ¥3 ¥3 ¥3 ¥3 ¥3 ¥3 ¥3 ¥3 ¥12 

9. Adjustment to basis of S corporation stock for certain charitable 

contributions.

cma DOE ¥8 ¥22 ¥30 ¥33 ¥37 ¥41 ¥45 ¥50 ¥55 ¥62 ¥68 ¥172 

10. Enhanced deduction for certain charitable contributions of literary, musical, artistic, and scholarly compositions. cma DOE ¥2 ¥4 ¥4 ¥5 ¥5 ¥6 ¥6 ¥6 ¥7 ¥7 ¥7 ¥26 

11. Certain mileage reimbursements to charitable volunteers excluded from gross income. tyba DOE (1) (1) (1) (1) (1) (1) (1) (1) (1) (1) (1) ¥1 

12. Provide an equal enhanced deduction for qualified corporate 

contributions of inventory to public schools as currently allowed for contributions to private schools; computer technology and equipment are not eligible property.

cma 12/31/03 ................ ¥17 ¥28 ¥31 ¥34 ¥38 ¥41 ¥46 ¥50 ¥55 ¥59 ¥148 

Total of Charitable Giving Incentive Provisions ................... ................................. ¥338 ¥1,833 ¥1,904 ¥683 ¥632 ¥647 ¥665 ¥714 ¥853 ¥991 ¥1,055 ¥6,037 

II. Provisions to Improve Oversight of Tax-Exempt Organizations

1. Disclosure of written determinations ............................................. wdia DOE Negligible Revenue Effect 2. Disclosure of name under which an organization does business 

and its Internet Web site.

rfa 12/31/03 Negligible Revenue Effect 

3. Modification to private foundation reporting of capital transactions. rfa 12/31/03 Negligible Revenue Effect 

ESTIMATED BUDGET EFFECTS OF THE ‘‘CARE ACT OF 2003,’’ AS REPORTED BY THE COMMITTEE ON FINANCE

—Continued

[Fiscal years 2003–2013, millions of dollars] 

Provision Effective 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2003–08 

4. Disclosure that Form 990 is publicly available ............................ pomiora DOE Negligible Revenue Effect 5. Disclosure to State officials of certain tax information related to 

certain section 501(c) organizations.

DOE Negligible Revenue Effect 

6. Expansion of penalties to preparers of Form 990 ........................ dpa DOE Negligible Revenue Effect 7. Notification requirement for exempt entities not currently required to file. fapba 12/31/03 Negligible Revenue Effect 8. Suspension of tax-exempt status of terrorist organizations ......... (2) Negligible Revenue Effect Total Rule

Total of Provisions to Improve Oversight of Tax-Exempt Organizations. ................................. Negligible Revenue Effect 

III. Other Charitable and Exempt Organization Provisions

1. Modify tax on unrelated business taxable income of charitable 

remainder trusts.

tyba 12/31/02 ¥ ¥4 ¥4 ¥5 ¥5 ¥5 ¥5 ¥6 ¥6 ¥6 ¥7 ¥23 

2. Modify tax treatment of certain payments to controlling exempt 

organizations.

proaa 12/31/00 ¥32 ¥12 ¥13 ¥13 ¥14 ¥15 ¥16 ¥17 ¥18 ¥20 ¥21 ¥99 

3. Simplification of lobbying expenditure limitation ......................... tyba 12/31/02 ¥1 ¥1 ¥1 ¥1 ¥1 ¥1 ¥2 ¥2 ¥2 ¥2 ¥3 ¥7 

4. Expedited review process for certain tax-exemption applications afa 12/31/03 Negligible Revenue Effect 5. Clarification of definition of church tax inquiry ........................... DOE No Revenue Effect 6. Extension of declaratory judgment procedures to non-501(c)(3) 

tax-exempt organizations.

dma 12/31/03 Negligible Revenue Effect 

7. Definition of convention or association of churches ..................... DOE Negligible Revenue Effect 8. Provide that certain payments by charitable organizations made 

by reason of the death, injury, wounding, or illness of military personnel incurred as a result of the war on terrorism and astronauts killed in the line of duty (no sunset) are deemed consistent with exempt purposes.

pma DOE & pmb 

9/11/04; 3

Negligible Revenue Effect 

9. Increase percentage limits for certain employer-related scholarship programs under Revenue Procedure 76–47 to 35% of eligible applicants or 20% of eligible students. gma DOE ................ ¥6 ¥9 ¥11 ¥12 ¥14 ¥15 ¥17 ¥19 ¥22 ¥25 ¥52 

10. Treatment of certain hospital organizations as qualified organizations for purposes of determining acquisition indebtedness. iia 12/31/03 ................ ¥8 ¥16 ¥18 ¥19 ¥20 ¥20 ¥21 ¥22 ¥23 ¥23 ¥80 

11. Charitable contribution deduction for certain expenses in support of Native Alaska subsistence whaling. cma 12/31/03 ................ (1) (1) (1) (1) (1) (1) (1) (1) (1) (1) ¥1 

12. Matching grants to low-income taxpayer clinics for return 

preparation.

DOE No Revenue Effect

Total of Other Charitable and Exempt Organization Provisions. ................................. ¥33 ¥31 ¥43 ¥48 ¥51 ¥55 ¥58 ¥63 ¥67 ¥73 ¥79 ¥262 

IV. Restoration of Social Services Block Grant Funding (outlays) 4 .. (5) ¥238 ¥946 ¥278 23 16 27 20 ................ ................ ................ ................ ¥1,395 

V. Individual Development Accounts

—provide a tax credit to eligible entities with respect to the first 300,000 individual development accounts established for low-income workers. tyea 12/31/04 & tybb 1/1/12 ................ ................ ¥24 ¥44 ¥39 ¥61 ¥76 ¥90 ¥104 ¥48 (1) ¥169 

VI. Management of Exempt Organizations ......................................... DOE No Revenue Effect 

VII. Revenue Provisions

A. Provisions to Curtail Tax Shelters: 

1. Clarification of the economic substance doctrine and 

related penalty provisions.

ta 2/15/04 ¥258 552 1,119 1,042 927 965 1,079 1,213 1,395 1,607 1,848 4,347 

2. Provisions relating to reportable transactions and tax 

shelters.

various dates 

after DOE 6

35 92 115 119 120 124 131 139 150 164 179 604 

3. Modification to the substantial understatement penalty 7. ta DOE ................ ................ 4 11 19 23 26 30 34 38 38 57 

4. Actions to enjoin conduct with respect to tax shelters DOE Negligible Revenue Effect 5. Understatement of taxpayer’s liability by income tax 

return preparer.

dpa DOE Negligible Revenue Effect 

6. Impose a civil penalty (of up to $5,000) on failure to 

report interest in foreign financial accounts.

DOE (8) (8) (8) (8) (8) (8) (8) (8) (8) (8) (8) 1 

7. Frivolous tax submissions ............................................ (9) 1 3 3 3 3 3 3 3 3 3 3 16 

8. Regulation of individuals practicing before the Department of Treasury. ata DOE No Revenue Effect 9. Amend Code section 6501 to provide for 6-year statute of limitations for undisclosed listed transactions. tyba DOE ................ ................ ................ 1 1 1 1 1 1 1 1 3 10. Amend Code section 163 to disallow a deduction 

for deficiency interest paid to the IRS on underpayments involving tax motivated transactions.

tyba DOE ................ ................ ................ 1 1 3 4 4 4 4 4 5 

11. Additional $300 million tax law enforcement authorization for the IRS 4. DOE No Revenue Effect 

B. Other Provisions: 

1. Affirmation of consolidated return regulation authority.

(10) Negligible Revenue Effect 

2. Require CEO signatures on income tax returns .......... rfa DOE Negligible Revenue Effect

Total of Revenue Provisions ......................................... ................................. ¥222 647 1,241 1,177 1,071 1,119 1,244 1,390 1,587 1,817 2,073 5,033 

Net Total ................................................................................ ................................. ¥831 ¥2,163 ¥1,008 425 365 383 465 523 563 705 939 ¥2,830 

1 Loss of less than $500,000. 2 Effective for organizations that are designated or identified as a terrorist organization prior to, on, or after the date of enactment. 3 Effective for payments made after December 31, 2002, with respect to astronauts killed in the line of duty after December 31, 2002. 4 Estimate provided by the Congressional Budget Office. 5 Effective for amounts made available for fiscal year 2003 and for amounts made available each fiscal year thereafter. The proposal requiring annual reports would be with respect to fiscal year 2002 and each fiscal year thereafte6 Effective dates for provisions relating to reportable transactions and tax shelters: the penalty for failure to disclose reportable transactions is effective for returns and statements the due date of which is after the date of en

modification to the accuracy-related penalty for listed or reportable transactions is effective for taxable years ending after the date of enactment; the tax shelter exception to confidentiality privileges is effective for communications after the date of enactment; the material advisor disclosure provisions applies to transactions with respect to which material aid, assistance or advice is provided after the date of enactment; the investor list provision applies to tranrespect to which material 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. 7 Failure or substantial delay of forthcoming regulations for section 6011 of the Internal Revenue Code and other administrative actions to be taken by the Treasury Department or the Internal Revenue Service would reduce the es

enue effects of these provisions. 8 Gain of less than $1 million. 

9 Effective for submissions made and issues raised after the first list is prescribed under section 6702(c). 10 Effective for all taxable years, whether beginning before, with, or after the date of enactment.

Legend for ‘‘Effective’’ column: afa = applications filed after; ata = actions taken after; bia = bonds issued after; cma = contributions made after; dma = determinations made after; DOE = date of enactment; dpa = docume

after; fapba = for annual periods beginning after; gma = grants made after; iia = indebtedness incurred after; pma = payments made after; pmb = payments made before; pra = payments received after; pomiora = publications issued or revised after; proaa = payments received or accrued after; rfa = returns filed after; soeoa = sales or exchanges occurring after; ta = transactions after; tyba = taxable years beginning after; tybb = taxable years beginning = taxable years ending after; and wdia = written determinations issued after.

Note.

—Details may not add to totals due to rounding.

Source: Joint Committee on Taxation. 

116

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 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). The revenue increasing provisions of the bill involve reduced 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, February 20, 2003. 

Hon. CHARLES E. GRASSLEY, 

Chairman, Committee on Finance, 

U.S. Senate, Washington, DC. 

DEAR MR. CHAIRMAN: The Congressional Budget Office has prepared the enclosed cost estimate for S. 256, the CARE Act of 2003. 

If you wish further details on this estimate, we will be pleased 

to provide them. The CBO staff contacts are Annabelle Bartsch (for 

federal revenues) and Sheila Dacey (for federal spending). 

Sincerely, 

DOUGLAS HOLTZ-EAKIN, 

Director. 

Enclosure. 

U.S. CONGRESS, 

CONGRESSIONAL BUDGET OFFICE, 

Washington, DC, February 25, 2003. 

Hon. CHARLES E. GRASSLEY, Chairman, Committee on Finance, 

U.S. Senate, Washington, DC. 

DEAR MR. CHAIRMAN: The Congressional Budget Office has prepared the enclosed cost estimate for the CARE Act of 2003 as ordered reported by the Senate Committee on Finance. This estimate 

supersedes the one CBO provided on February 20, 2003, which 

identified the bill as S. 256. Because the Committee is now planning to report an original bill, this estimate deletes any reference 

to S. 256. CBO’s estimate of the budgetary impact of the Care Act 

is unchanged. 

117

If you wish further details on this estimate, we will be pleased 

to provide them. The CBO staff contacts are Annabelle Bartsch (for 

federal revenues) and Sheila Dacey (for federal spending. 

Sincerely, 

DOUGLAS HOLTZ-EAKIN, 

Director. 

Enclosure.

CARE Act of 2003

Summary: The Care Act would provide taxpayers with several incentives for charitable giving, restrict tax-shelter activity, increase 

funding for the Social Services Block Grant (SSBG), and increase 

the amount that could be transferred from the Temporary Assistance to Needy Families (TANF) program to SSBG. 

CBO and the Joint Committee on Taxation (JCT) estimate that 

enacting the bill would decrease governmental receipts by $596 

million in 2003 and by about $1.7 billion over the 2003–2008 period. Over the 2003–2013 period, however, enacting the legislation 

would increase governmental receipts by about $1.5 billion. The bill 

also would increase direct spending by $76 million in 2003, and 

$1.4 billion over the 2003–2008 period (with a comparable total for 

the 2003–2013 period). 

The bill also would authorize the appropriation of $83 million in 

2003 and $491 million over the 2003–2008 period for administering 

an expanded Individual Development Account (IDA) program and 

handling filing of tax-exempt organizations. Assuming that those 

amounts are appropriated, CBO estimates that the resulting outlays would be $439 million over the 2003–2008 period. 

CBO has reviewed title IV of the bill and has determined that 

it contains no intergovernmental mandates as defined in the Unfunded Mandates Reform Act (UMRA). That title would benefit 

states by increasing their ability to transfer TANF funds to SSBG 

and also by increasing funding for SSBG in 2003 and 2004. JCT 

has determined that the remaining provisions of the bill contain no 

intergovernmental mandates as defined in UMRA and would not 

affect the budgets of state, local, or tribal governments. 

JCT has determined that the provisions relating to tax shelters 

contain private-sector mandates. The total cost of complying with 

those mandates would exceed the threshold established by UMRA 

($117 million in 2003, adjusted annually for inflation). CBO has determined that title IV of the bill contains no private-sector mandates as defined in UMRA. 

Estimated cost to the Federal Government: The estimated budgetary impact of the Care Act is shown in Table 1. All revenue estimates were provided by JCT. The spending under the bill falls in 

budget functions 500 (education, training, employment, and social 

services), 600 (income security), and 800 (general government). 

Basis of estimate: For this estimate, CBO assumes the CARE Act 

will be enacted in the spring of 2003 and that the authorized 

amounts will be appropriated for each year. These estimates would 

change if the bill were enacted later in the year. We estimated the 

bill’s budgetary effect using CBO’s January 2003 baseline assumptions, updated to reflect legislation that has cleared the Congress, 

118

particularly the Consolidated Appropriations Resolution, 2003 

(Public Law 108–10). 

Revenues 

All estimates were provided by JCT. A number of provisions 

would reduce revenues, and several would increase revenues. All 

together, the bill’s provisions would reduce governmental receipts by $596 million in 2003 and by about $1.7 billion over the 2003– 2008 period. Over the 2003–2013 period, however, enacting the leg- islation would increase revenues by about $1.5 billion. 

Most of the revenue reductions would occur from the provisions 

that allow tax-free distributions from individual retirement accounts (IRAs) for charitable purposes, a 25 percent exclusion of 

capital gains for sales of land or water for conservation purposes, 

and the deduction of a certain amount of charitable contributions 

by taxpayers who do not itemize. Other provisions that would reduce revenues include enhancing deductions for contributions of 

food inventories, adjusting the tax basis of certain stock for charitable contributions, and providing a tax credit to eligible financial 

entities for matching contributions to Individual Development Accounts made by certain low-income workers. These provisions together would reduce revenues by $326 million in 2003, by about 

$5.7 billion over the 2003–2008 period, and by about $9.6 billion 

over the 2003–2013 period. The remaining provisions to provide incentives to increase charitable giving would decrease receipts by 

$48 million in 2003, by about $1.0 billion over the 2003–2008 pe- riod, and by about $2.1 billion over the 2003–2013 period.

TABLE 1.—ESTIMATED BUDGETARY IMPACT OF THE CARE ACT OF 2003

By fiscal year, in millions of dollars—

2003 2004 2005 2006 2007 2008

Changes in Revenue

Estimated Revenues ............................................. ¥596 ¥1,252 ¥750 310 277 347

Changes in Direct Spending

Increased SSBG Funding: 

Budget Authority .......................................... 275 1,100 0 0 0 0

Estimated Outlays ....................................... 110 990 231 44 0 0

TANF Effect of New SSBG Funding: 

Budget Authority .......................................... 0 0 0 0 0 0

Estimated Outlays ....................................... ¥34 ¥114 25 41 46 36

Increased Transfer Authority from TANF to SSBG: 

Budget Authority .......................................... 0 0 0 0 0 0

Estimated Outlays ....................................... 0 114 84 ¥82 ¥49 ¥50

Total Changes in Direct Spending: 

Budget Authority ................................. 275 1,100 0 0 0 0

Estimated Outlays .............................. 76 990 340 3 ¥3 ¥14

Changes in Spending Subject to Appropriations

Individual Development Accounts: 

Authorization Level ...................................... 0 4 1 1 1 1

Estimated Outlays ....................................... 0 1 1 1 1 2

Tax-Exempt Organizations: 

Authorization Level ...................................... 83 80 80 80 80 80

Estimated Outlays ....................................... 23 90 80 80 80 80

Total: 

Authorization Level ...................................... 83 84 81 81 81 81

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TABLE 1.—ESTIMATED BUDGETARY IMPACT OF THE CARE ACT OF 2003—Continued

By fiscal year, in millions of dollars—

2003 2004 2005 2006 2007 2008

Estimated Outlays ....................................... 23 91 81 81 81 82

Notes.—SSBG=Social Services Block Grant. TANF=Temporary Assistance to Needy Families. 

Most of the revenue increases would result from provisions restricting tax-shelter activity. The provision clarifying the economic 

substance doctrine and the related penalty provisions would decrease revenues by $258 million in 2003, but would increase revenues by about $4.3 billion over the 2003–2008 period and $11.5 billion over the 2003–2013 period. The remaining provisions, which 

relate to reportable transactions and tax shelters and modifications 

of the substantial understatement penalty and certain other penalties, would increase revenues by $36 million in 2003, by $686 

million over the 2003–2008 period, and by about $1.7 billion over 

the 2003–2013 period.

TABLE 2.—ESTIMATED REVENUE EFFECTS OF THE CARE ACT OF 2003

By fiscal year, in millions of dollars—

2003 2004 2005 2006 2007 2008

Major Revenue Reducers

Charitable Contribution Deduction for Nonitemizers ........................................................... ¥204 ¥1,368 ¥1,218 0 0 0

Tax-Free Distributions from IRAs for Charitable 

Purposes ........................................................... ¥48 ¥156 ¥248 ¥270 ¥258 ¥244

Enhanced Deductions for Contributions to Food 

Inventories ........................................................ ¥59 ¥154 ¥173 ¥185 ¥193 ¥201

25 percent Exclusion of Capital Gains Taxes for 

Sales of Land or Water for Conservation purposes ................................................................ ¥7 ¥56 ¥60 ¥67 ¥70 ¥74

Adjustment to Basis of S Corporation Stock for 

Certain Charitable Contributions ..................... ¥8 ¥22 ¥30 ¥33 ¥37 ¥41

Tax Credit for IDA Program Expansion ................ 0 0 ¥24 ¥44 ¥39 ¥61

Other Provisions ................................................... ¥48 ¥143 ¥238 ¥268 ¥197 ¥151

Subtotal ................................................... ¥374 ¥1,899 ¥1,991 ¥867 ¥794 ¥772

Major Revenue Raisers

Clarification of the Economic Substance Doctrine and Related Penalty Provisions .............. ¥258 552 1,119 1,042 927 965

Provisions Relating to Reportable Transactions 

and Tax Shelters .............................................. 35 92 115 119 120 124

Other Provisions ................................................... 1 3 7 16 24 30

Subtotal ................................................... ¥222 647 1,241 1,177 1,071 1,119

Net Effect on Revenues

Estimated Revenues ............................................. ¥596 ¥1,252 ¥750 ¥310 ¥277 ¥347

Notes.—components may not sum to totals because of rounding. IRA = Individual Retirement Account. IDA = Individual Development Ac- count. 

Direct Spending 

Title IV would increase the funding level for the Social Services 

Block Grant in 2003 and 2004 and raise the percentage of the 

TANF grant that states could transfer to SSBG. SSBG is permanently authorized at $1.7 billion annually. Title IV would increase 

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funding for 2003 to $1.975 billion and for 2004 to $2.8 billion. 

Funding would return to $1.7 billion in 2005 and later. CBO estimates that states would spend the new funds a little more slowly 

than regular SSBG funds, raising outlays by $76 million in 2003 

and about $1.4 billion over the 2003–2008 period. Title IV also 

would allow states to maintain the authority to transfer up to 10 

percent of TANF funds to SSBG. That authority is scheduled to fall 

to 4.25 percent in 2004 and after. In recent years, states have 

transferred about $1 billion annually. 

Those provisions would affect TANF spending in two ways. First, 

the additional SSBG spending would tend to reduce the incentives 

for TANF transfers to SSBG. CBO estimates that change would 

lower TANF spending by $148 million over the 2003–2004 period, 

but raise it by a similar amount over the 2005–2008 period. Second, maintaining the transfer authority at the higher level would 

make it easier for states to spend their TANF grants and would 

tend to accelerate spending relative to current law. (Based on recent state transfers, CBO expects that states would transfer an additional $400 million in 2004 under the provision, but because 

some of this money would have been spent within the TANF program anyway, only $114 million of additional spending would occur 

in 2004.) The combined effect of the provisions would be to increase 

net TANF spending over the 2003–2008 period by $17 million, but 

lower it by 417 million over the 2009–2013 period. Thus, there 

would be no net impact on TANF spending over the 11-year period 

as a whole. 

Spending Subject to Appropriation 

Title V would augment the existing Individual Development Account program by providing an IDA tax credit to qualified financial 

institutions for matching the IDA savings of low-income individuals. The effect of those tax credits on reducing federal revenues 

is estimated to total $168 million over the 2005–2008 period. 

(Those effects were included in the totals discussed in the earlier 

section on revenues.) The bill also would authorize the appropriation of $2.5 million for a report on cost and outcomes of IDAs and 

$1 million in each year 2004 through 2011 for other administrative 

activities. Assuming appropriation of the authorized amounts, CBO 

estimates outlays of $1 million in 2004, $6 million over the 2004–

2008 period, and $10 million over the eight-year period. 

The bill also would disregard any funds in IDA accounts for purposes of qualifying individuals for federal means-tested programs. 

It is possible that expanding the IDA program could allow certain 

people with assets to participate in means-tested programs who 

would otherwise be ineligible, but CBO estimates that would have 

an insignificant effect (less than $500,000 a year) on federal spending. While there are limited data on current IDA participants, the 

available information indicates most participants would not deposit 

enough into their accounts to disqualify themselves from any federal means-tested program. 

Title VI would authorize the annual appropriation of $80 million 

for the Internal Revenue Service for its administrative costs related 

to filing of tax-exempt organizations. it would authorize $3 million 

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in fiscal year 2003 for the Department of Treasury for its administrative costs related to filing of section 527 political organizations. 

Assuming the appropriation of the authorized amounts, CBO estimates that implementing those provisions would cost $23 million 

in 2003 and $433 million over the 2003–2008 period. 

Estimated Impact on state, local, and tribal governments: CBO 

has reviewed title IV of the bill and has determined that it contains no intergovernmental mandates as defined in UMRA. That 

title would benefit states by increasing their ability to transfer 

TANF funds to SSBG and also by increasing funding for SSBG in 

2003 and 2004. 

JCT has determined that the remaining provisions of the bill 

contain no intergovernmental mandates as defined in UMRA and 

would not affect the budgets of state, local, or tribal governments. 

Estimated impact on the private sector: JCT has determined that 

the provisions relating to tax shelters contain private-sector mandates, and that the direct cost of complying with those mandates 

would exceed the threshold established by UMRA ($117 million in 

2003, adjusted annually for inflation), in 2003 and thereafter. CBO 

has determined that title IV of the bill contains no private-sector 

mandates as defined in UMRA.

Previous CBO estimate: On February 20, 2003, CBO transmitted 

a cost estimate for the CARE Act of 2003 as ordered reported by 

the Senate Committee on Finance on February 5, 2003. CBO’s estimate of the budgetary impact of the CARE Act of 2003 is unchanged. This estimate deletes any reference to S. 256 as the bill 

number of the CARE Act ordered reported by the Senate Finance 

Committee. 

Estimate prepared by: Federal Revenues: Annabelle Bartsch. 

Federal Spending: Social Services Block Grant: Sheila Dacy; Individual Development Accounts: Donna Wong; and Department of 

Treasury: Matthew Pickford. Impact on State, Local, and Tribal 

Governments: Leo Lex. Impact on the Private Sector: Kate 

Bloniarz. 

Estimate approved by: Peter H. Fontaine, Deputy Director for 

Budget Analysis; and G. Thomas Woodward, Assistant Director for 

Tax Analysis. 

IV. 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 votes taken on the Committee’s consideration of the bill. 

Motion to report the bill 

The bill was ordered favorably reported by a voice vote, a 

quorum being present, on February 5, 2003. 

Votes on amendments 

An amendment by Senator Baucus to require the chief executive 

officer of a corporation to sign that corporation’s income tax return 

was agreed to by a voice vote.

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V. 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 the provisions that do not increase revenue, the 

committee amendment to the bill modifies the rules relating to (1) 

certain charitable giving incentives; (2) disclosure of information 

relating to tax-exempt organizations; (3) tax treatment and procedures relating to exempt organizations; (4) restoration of funds for 

the Social Services Block Grant; and (5) individual development accounts. Under these provisions, taxpayers may elect whether to 

avail themselves of the provisions. The Social Services Block Grant 

provisions provide increased funding to States to support a variety 

of social services, the low-income taxpayer clinic provision authorize grants by the Secretary of the Treasury, and the management 

of exempt organization provisions authorize certain appropriations. 

Thus, the provisions do not impose increased regulatory burdens on 

individuals or businesses. 

With respect to the revenue-increasing provisions, the committee 

amendment to the bill modifies the rules relating to (1) the disclosure of reportable transactions and tax shelters; (2) the substantial 

understatement penalty; (3) actions to enjoin conduct with respect 

to tax shelters; (4) an understatement of a taxpayer’s liability by 

an income tax return preparer; (5) the imposition of a civil penalty 

(of up to $5,000) on a failure to report interest in foreign financial 

accounts; and (6) frivolous tax submissions. These provisions relate 

to taxpayers that engage in certain tax avoidance transactions. 

Taxpayers that have not undertaken or planned to undertake such 

transactions generally are not affected by the provisions of the bill. 

Thus, the revenue provisions generally do not impose increased 

regulatory burdens on individuals or businesses. 

Impact on personal privacy and paperwork 

The provisions of the bill do not impact personal privacy. Individuals either elect whether to avail themselves of the provisions of 

the bill or are subject to the bill for engaging in certain tax avoidance transactions. The bill does not impose increased paperwork 

burdens on individuals. Individuals who elect to take advantage of 

provisions in the bill may in some cases need to keep records in 

order to demonstrate that they qualify for the treatment provided. 

Individuals who elect to engage in tax avoidance transactions, and 

certain advisors who provide material aid, assistance, or advice 

with respect to such transactions, may in some cases need to file 

certain disclosure statements with the IRS. 

B. UNFUNDED MANDATES STATEMENT

The information is provided in accordance with section 423 of the 

Unfunded Mandates Reform Act of 1995 (P.L. 104–4). 

123

The Committee has determined that the following provisions of 

the bill contain Federal mandates on the private sector: (1) provisions relating to reportable transactions and tax shelters; (2) modifications to the substantial understatement penalty; (3) actions to 

enjoin conduct with respect to tax shelters; (4) understatement of 

taxpayer’s liability by an income tax return preparer; (5) the imposition of a civil penalty (of up to $5,000) on a failure to report interest in foreign financial accounts; and (6) frivolous tax submissions. 

The costs required to comply with each Federal private sector 

mandate generally are no greater than the estimated budget effect 

of the provision. Benefits from the provisions include improved administration of the Federal income tax laws and a more accurate 

measurement of income for Federal income tax purposes.

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. For each 

such provision identified by the staff of the Joint Committee on 

Taxation, a summary description of the provision is provided, along 

with an estimate of the number and type of affected taxpayers, and 

a discussion regarding the relevant complexity and administrative 

issues. Following the analysis of the staff of the Joint Committee 

on Taxation are the comments of the IRS regarding each provision 

included in the complexity analysis, including a discussion of the 

likely effect on IRS forms and any expected impact on the IRS. 

Direct charitable deduction for nonitemizers (sec. 101 of the bill) 

Summary description of provision 

In the case of an individual taxpayer who does not itemize deductions, the bill would allow a direct charitable deduction from adjusted gross income for charitable contributions paid in cash. This 

deduction would be allowed in addition to the standard deduction. 

The deduction would be available only for that portion of contributions that in the aggregate exceed $250 ($500 in the case of a joint 

return). The maximum deduction would be $250 ($500 in the case 

of a joint return). The direct charitable deduction generally would 

be subject to the tax rules normally governing charitable contribution deductions, such as the substantiation requirements. The deduction would be allowed in computing alternative minimum taxable income. The direct charitable deduction would be effective for 

taxable years beginning after December 31, 2002, and before January 1, 2005. 

124

Number of affected taxpayers 

It is estimated that the provision will affect approximately 30 

million individual income tax returns each year the deduction is in 

effect. 

Discussion 

Individuals who do not itemize their deductions will need to keep 

additional records (e.g., canceled checks, a receipt from the donee 

organization, or other reliable written records) in order to substantiate that a contribution was made to a qualified charitable organization. The information necessary to implement the provision 

should be readily available to taxpayers (in the form of new tax return forms and instructions). The direct charitable deduction is expected to require an additional line on the individual income tax 

return forms. The provision might result in an increase in disputes 

with the IRS for taxpayers who are unable to substantiate a 

claimed deduction. Additional regulatory guidance will not be necessary to implement this provision. Any increase in tax preparation 

costs is expected be negligible.

DEPARTMENT OF THE TREASURY, 

INTERNAL REVENUE SERVICE, 

Washington, DC, February 10, 2003. 

Ms. LINDY L. PAULL, Chief of Staff, Joint Committee on Taxation, 

Washington, DC. 

DEAR MS. PAUL: Enclosed are the combined comments of the Internal Revenue Service and the Treasury Department on the provision for a charitable deduction for non-itemizers from the Senate 

Finance Committee’s markup of the ‘‘CARE Act of 2003,’’ that you 

identified for complexity analysis in your letter of February 5, 

2003. Our comments are based on the description of that provision 

in you letter and in JCX–04–03, Joint Committee on Taxation, Description of the CARE Act of 2003, February 3, 2003. 

Due to the short turnaround time, our comments are provisional 

and subject to change upon a more complete and in-depth analysis 

of the provision. 

Sincerely, 

BOB WENZEL, 

Acting Commissioner. 

Enclosure.

COMPLEXITY ANALYSIS OF PROVISION FROM THE CARE ACT OF 2003

CHARITABLE DEDUCTION FOR NON-ITEMIZERS

Provision: A taxpayer who does not itemize deductions would be 

allowed a direct charitable deduction from adjusted gross income 

for charitable contributions paid in cash. This deduction would be 

available only for that portion of contributions that in the aggregate exceed $250 ($500 in the case of a joint return). The maximum 

deduction would be $250 ($500 in the case of a joint return). The 

direct charitable deduction generally would be subject to the tax 

rules normally governing charitable contribution deductions, and 

125

would be allowed in computing alternative minimum taxable income. The provision would be effective for taxable years beginning 

after December 31, 2002, and before January 1, 2005. 

IRS and Treasury Comments 

• Two lines would have to be added to Forms 1040, 1040A, 

1040EZ, 1040NR, and 1040NR–EZ for 2003 and 2004; one for the 

allowable deduction and one to reflect the total of the standard deduction and the charitable contribution deduction. One line would 

be added to the TeleFile Tax Record for 2003 and 2004 (taxpayers 

would enter their total contributions on the new line and TeleFile 

would calculate the allowable deduction). No new forms would be 

required. • The new deduction would also have to be reflected on Form 

1040–ES for 2004 and in the instructions for Forms 1040X and 

1045 for 2003 and 2004. Subsequent to enactment, the IRS may 

have to advise taxpayers who make estimated tax payments for 

2003 how they can adjust their estimated tax payments for 2003 

to reflect the new deduction. • Information necessary for taxpayers to determine their eligibility for the deduction, including the AGI limitation applicable to 

cash contributions, and the substantiation requirements, would 

have to be reflected in the 2003 and 2004 instructions for Forms 

1040, 1040A, 1040EZ, 1040NR, and 1040NR–EZ and for TeleFile. • A worksheet (consisting of four lines) for taxpayers to calculate 

their allowable deduction would have to be reflected in the 2003 

and 2004 instructions for Forms 1040, 1040A, 1040EZ, 1040NR, 

and 1040NR–EZ. • Changes to the TeleFile script for 2003 and 2004 would be required to allow the deduction to taxpayers who use TeleFile. • All of the above changes would have to be reversed for tax 

years beginning after December 31, 2004, to reflect the termination 

of the charitable deduction for non-itemizers (e.g., the lines would 

be removed from the Form 1040 series of returns, the worksheet 

would be removed from the instructions for these returns, and programming and script changes would be necessary to eliminate the 

deduction). 

• Ensuring compliance with the new charitable deduction would 

be difficult. The only means of verifying amounts deducted would 

be through examination, and the normal examination rate for such 

returns is relatively low. 

• Programming changes would be required to reflect the new deduction on the tax returns. 

VI. 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