DESCRIPTION OF THE CHAIRMAN’S MARK 

OF H.R. 6049 

THE “ENERGY AND TAX EXTENDERS ACT OF 2008” 

Scheduled for Markup 

by the 

HOUSE COMMITTEE ON WAYS AND MEANS 

on May 15, 2008 

Prepared by the Staff 

of the 

JOINT COMMITTEE ON TAXATION 

May 14, 2008 

JCX-39-08 
i 

CONTENTS 

Page

INTRODUCTION .......................................................................................................................... 1 

I. ENERGY TAX INCENTIVES.............................................................................................. 2 

A. Clean Renewable Energy Production Incentives............................................................. 2 

1. Extension and modification of the credit for the production of electricity from 

renewable resources................................................................................................... 2 

2. Extension and modification of energy credit........................................................... 11 

3. Credit for residential energy efficient property ....................................................... 13 

4. Extension and modification of special rule to implement FERC and State 

electric restructuring policy ..................................................................................... 15 

5. New clean renewable energy bonds......................................................................... 17 

6. Expansion and modification of the advanced coal project credit ............................ 20 

7. Expansion and modification of the coal gasification investment credit .................. 23 

8. Extend excise tax on coal at current rates................................................................ 24 

9. Temporary procedures for excise tax refunds on exported coal.............................. 25 

10. Carbon audit of provisions of the Internal Revenue Code of 1986 ......................... 29 

B. Transportation and Domestic Fuel Security Provisions................................................. 31 

1. Credit for production of cellulosic biofuel............................................................... 31 

2. Inclusion of cellulosic biofuel in bonus depreciation for biomass ethanol plant 

property.................................................................................................................... 32 

3. Extension of credits for biodiesel and extension and modification of renewable 

diesel credit .............................................................................................................. 34 

4. Modification of alcohol credit ................................................................................. 37 

5. Calculation of volume of alcohol for fuel credits .................................................... 39 

6. Clarification that credits for fuel are designed to provide an incentive for 

United States production.......................................................................................... 39 

7. Alternative motor vehicle credit and plug-in electric vehicle credit........................ 40 

8. Exclusion from heavy vehicle excise tax for idling reduction units and 

advanced insulation.................................................................................................. 48 

9. Restructure New York Liberty Zone tax incentives ................................................ 49 

10. Extension of transportation fringe benefit to bicycle commuters............................ 52 

11. Extension and modification of alternative fuel vehicle refueling property credit ... 53 

12. Comprehensive study of biofuels............................................................................. 54 

C. Energy Conversation and Efficiency Provisions ........................................................... 56 

1. Qualified energy conservation bonds....................................................................... 56 

2. Extension and modification of energy efficient existing homes credit.................... 62 

3. Energy efficient commercial buildings deduction ................................................... 63 

4. Extension and modification of energy efficient appliance credit ............................ 65 

5. Accelerated recovery period for depreciation of smart meters and smart grid 

systems..................................................................................................................... 68 

6. Extension of issuance authority for qualified green building and sustainable 

design project bonds ................................................................................................ 69 
ii 

II. ONE YEAR EXTENDERS ................................................................................................. 72 

A. Extenders Primarily Affecting Individuals .................................................................... 72 

1. Deduction of State and local general sales taxes ..................................................... 72 

2. Above-the-line deduction for higher education expenses........................................ 73 

3. Extension of special withholding tax rule for interest-related dividends paid 

by regulated investment companies......................................................................... 74 

4. Extend the special rule encouraging contributions of capital gain real property 

for conservation purposes ........................................................................................ 76 

5. Tax-free distributions from individual retirement plans for charitable purposes .... 79 

6. Educator expense deduction .................................................................................... 83 

7. One year extension of the election to treat combat pay as earned income for 

purposes of the earned income credit....................................................................... 84 

8. Extension of qualified mortgage bond program rules for veterans.......................... 85 

9. Treatment of distributions to individuals called to active duty for at least 180 

days .......................................................................................................................... 86 

10. Extension of special rule for regulated investment company stock held in the 

estate of a nonresident non-citizen........................................................................... 87 

11. Extend RIC qualified investment entity treatment under FIRPTA.......................... 88 

12. Modify tax treatment of offshore nonqualified deferred compensation .................. 90 

B. Extenders Primarily Affecting Businesses................................................................... 101 

1. Extend the research and experimentation tax credit .............................................. 101 

2. Indian employment tax credit ................................................................................ 105 

3. Extend the new markets tax credit......................................................................... 106 

4. Extend railroad track maintenance credit .............................................................. 108 

5. Fifteen-year straight-line cost recovery for qualified leasehold improvements 

and qualified restaurant improvements.................................................................. 109 

6. 7-year recovery period for motorsports racetrack property ................................... 111 

7. Accelerated depreciation for business property on Indian reservations ................ 112 

8. Extend expensing of brownfields remediation costs ............................................. 113 

9. Extension of deduction for income attributable to domestic production 

activities in Puerto Rico......................................................................................... 115 

10. Modify tax treatment of certain payments to controlling exempt organizations... 117 

11. Extend and modify qualified zone academy bonds ............................................... 118 

12. Tax incentives for investment in the District of Columbia.................................... 120 

13. Extension of economic development credit for American Samoa......................... 124 

14. Extend the enhanced charitable deduction for contributions of food inventory.... 126 

15. Extend the enhanced deduction for charitable contributions of book inventory ... 128 

16. Extend the enhanced charitable deduction for computer technology and 

equipment............................................................................................................... 130 

17. Basis adjustment to stock of S corporation contributing property......................... 131 

18. Extension of the Hurricane Katrina work opportunity tax credit .......................... 132 

19. Subpart F exception for active financing income .................................................. 135 

20. Look-through treatment of payments between related controlled foreign 

corporations under foreign personal holding company income rules.................... 137 

21. Extension of treatment of certain qualified film and television productions......... 138
iii 

C. Other Extenders ........................................................................................................... 141 

1. Authority to disclose information related to terrorist activity made permanent.... 141 

2. IRS authority to fund undercover operations made permanent ............................. 144 

3. Authority to disclose return information for certain veterans programs 

made permanent..................................................................................................... 145 

4. Suspend limitation on rate of rum excise tax cover over to Puerto Rico and 

Virgin Islands......................................................................................................... 145 

III. ADDITIONAL INDIVIDUAL TAX RELIEF .................................................................. 147 

A. Additional Standard Deduction for State and Local Real Property Taxes .................. 147 

B. Refundable Child Credit .............................................................................................. 148 

C. Increase of AMT Refundable Credit Amount for Individuals with Long-Term 

Unused Credits, Etc. .................................................................................................... 149 

D. Uniform Treatment of Attorney-Advanced Expenses and Court Costs in 

Contingency Fee Cases................................................................................................ 152 

E. Modification of Domestic Production Activities Deduction for Film Production ...... 154 

F. Modification of Treatment of Certain Qualified Film and Television Productions .... 159 

G. Modified Standard for Imposition of Tax Return Preparer Penalties.......................... 161 

H. Election to Amend Returns for Hurricane-Related Casualty Losses........................... 163 

I. Waiver of Deadline on Construction of GO Zone Property Eligible for Bonus 

Depreciation................................................................................................................. 165 

J. Expansion of Gulf Opportunity Zone for Purposes of Tax-Exempt Bond 

Financing...................................................................................................................... 168 

IV. REVENUE PROVISIONS ................................................................................................ 171 

A. Modify Tax Treatment of Offshore Nonqualified Deferred Compensation................ 171 

B. Delay Implementation of Worldwide Interest Allocation ........................................... 183 

C. Modifications to Corporate Estimated Tax Payments ................................................. 187 
1 

INTRODUCTION 

The House Committee on Ways and Means has scheduled a markup of H.R. 6049, the 

“Energy and Tax Extenders Act of 2008.” This document,1 prepared by the staff of the Joint 

Committee on Taxation, provides a description of the Chairman’s Mark. 

 1

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

Chairman’s Mark of H.R. 6049, the “Energy and Tax Extenders Act of 2008,” May 14, 2008, 

(JCX-39-08). This document can also be found on our website at www.house.gov/jct. 
2 

I. ENERGY TAX INCENTIVES 

A. Clean Renewable Energy Production Incentives 

1. Extension and modification of the credit for the production of electricity from renewable 

resources 

Present Law

In general

An income tax credit is allowed for the production of electricity from qualified energy 

resources at qualified facilities.2 Qualified energy resources comprise wind, closed-loop 

biomass, open-loop biomass, geothermal energy, solar energy, small irrigation power, municipal 

solid waste, and qualified hydropower production. Qualified facilities are, generally, facilities 

that generate electricity using qualified energy resources. To be eligible for the credit, electricity 

produced from qualified energy resources at qualified facilities must be sold by the taxpayer to 

an unrelated person. 

Credit amounts and credit period

In general

The base amount of the electricity production credit is 1.5 cents per kilowatt-hour 

(indexed annually for inflation) of electricity produced. The amount of the credit was 2 cents per 

kilowatt-hour for 2007.3

 A taxpayer may generally claim a credit during the 10-year period 

commencing with the date the qualified facility is placed in service. The credit is reduced for 

grants, tax-exempt bonds, subsidized energy financing, and other credits. 

Credit phaseout

The amount of credit a taxpayer may claim is phased out as the market price of electricity 

exceeds certain threshold levels. The electricity production credit is reduced over a 3 cent 

phaseout range to the extent the annual average contract price per kilowatt-hour of electricity 

sold in the prior year from the same qualified energy resource exceeds 8 cents (adjusted for 

inflation; 10.7 cents for 2007). 

 2

 Sec. 45. In addition to the electricity production credit, section 45 also provides income tax 

credits for the production of Indian coal and refined coal at qualified facilities. Unless otherwise stated, 

all section references are to the Internal Revenue Code of 1986, as amended (the “Code”). 

3

 The Internal Revenue Service (“IRS”) is expected to announce the 2008 inflation adjustment 

factor in the spring of 2008. 
3 

Reduced credit periods and credit amounts

Generally, in the case of open-loop biomass facilities (including agricultural livestock 

waste nutrient facilities), geothermal energy facilities, solar energy facilities, small irrigation 

power facilities, landfill gas facilities, and trash combustion facilities placed in service before 

August 8, 2005, the 10-year credit period is reduced to five years commencing on the date the 

facility was originally placed in service. However, for qualified open-loop biomass facilities 

(other than a facility described in sec. 45(d)(3)(A)(i) that uses agricultural livestock waste 

nutrients) placed in service before October 22, 2004, the five-year period commences on 

January 1, 2005. In the case of a closed-loop biomass facility modified to co-fire with coal, to 

co-fire with other biomass, or to co-fire with coal and other biomass, the credit period begins no 

earlier than October 22, 2004. 

In the case of open-loop biomass facilities (including agricultural livestock waste nutrient 

facilities), small irrigation power facilities, landfill gas facilities, trash combustion facilities, and 

qualified hydropower facilities the otherwise allowable credit amount is 0.75 cent per kilowatthour, indexed for inflation measured after 1992 (1 cent per kilowatt-hour for 2007). 

Other limitations on credit claimants and credit amounts

In general, in order to claim the credit, a taxpayer must own the qualified facility and sell 

the electricity produced by the facility to an unrelated party. A lessee or operator may claim the 

credit in lieu of the owner of the qualifying facility in the case of qualifying open-loop biomass 

facilities and in the case of closed-loop biomass facilities modified to co-fire with coal, to co-fire 

with other biomass, or to co-fire with coal and other biomass. In the case of a poultry waste 

facility, the taxpayer may claim the credit as a lessee or operator of a facility owned by a 

governmental unit. 

For all qualifying facilities, other than closed-loop biomass facilities modified to co-fire 

with coal, to co-fire with other biomass, or to co-fire with coal and other biomass, the amount of 

credit a taxpayer may claim is reduced by reason of grants, tax-exempt bonds, subsidized energy 

financing, and other credits, but the reduction cannot exceed 50 percent of the otherwise 

allowable credit. In the case of closed-loop biomass facilities modified to co-fire with coal, to 

co-fire with other biomass, or to co-fire with coal and other biomass, there is no reduction in 

credit by reason of grants, tax-exempt bonds, subsidized energy financing, and other credits. 

The credit for electricity produced from renewable sources is a component of the general 

business credit.4

 Generally, the general business credit for any taxable year may not exceed the 

amount by which the taxpayer’s net income tax exceeds the greater of the tentative minimum tax 

or so much of the net regular tax liability as exceeds $25,000. Excess credits may be carried 

back one year and forward up to 20 years. 

A taxpayer’s tentative minimum tax is treated as being zero for purposes of determining 

the tax liability limitation with respect to the section 45 credit for electricity produced from a 

 4

 Sec. 38(b)(8). 
4 

facility (placed in service after October 22, 2004) during the first four years of production 

beginning on the date the facility is placed in service. 

Qualified facilities

Wind energy facility

A wind energy facility is a facility that uses wind to produce electricity. To be a qualified 

facility, a wind energy facility must be placed in service after December 31, 1993, and before 

January 1, 2009. 

Closed-loop biomass facility

A closed-loop biomass facility is a facility that uses any organic material from a plant 

which is planted exclusively for the purpose of being used at a qualifying facility to produce 

electricity. In addition, a facility can be a closed-loop biomass facility if it is a facility that is 

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

and other biomass, but only if the modification is approved under the Biomass Power for Rural 

Development Programs or is part of a pilot project of the Commodity Credit Corporation. 

To be a qualified facility, a closed-loop biomass facility must be placed in service after 

December 31, 1992, and before January 1, 2009. In the case of a facility using closed-loop 

biomass but also co-firing the closed-loop biomass with coal, other biomass, or coal and other 

biomass, a qualified facility must be originally placed in service and modified to co-fire the 

closed-loop biomass at any time before January 1, 2009. 

Open-loop biomass (including agricultural livestock waste nutrients) facility

An open-loop biomass facility is a facility that uses open-loop biomass to produce 

electricity. For purposes of the credit, open-loop biomass is defined as (1) any agricultural 

livestock waste nutrients or (2) any solid, nonhazardous, cellulosic waste material or any lignin 

material that is segregated from other waste materials and which is derived from: 

• forest-related resources, including mill and harvesting residues, precommercial 

thinnings, slash, and brush; 

• solid wood waste materials, including waste pallets, crates, dunnage, manufacturing 

and construction wood wastes, and landscape or right-of-way tree trimmings; or 

• agricultural sources, including orchard tree crops, vineyard, grain, legumes, sugar, 

and other crop by-products or residues. 

Agricultural livestock waste nutrients are defined as agricultural livestock manure and 

litter, including bedding material for the disposition of manure. Wood waste materials do not 

qualify as open-loop biomass to the extent they are pressure treated, chemically treated, or 

painted. In addition, municipal solid waste, gas derived from the biodegradation of solid waste, 

and paper which is commonly recycled do not qualify as open-loop biomass. Open-loop 

biomass does not include closed-loop biomass or any biomass burned in conjunction with fossil 

fuel (co-firing) beyond such fossil fuel required for start up and flame stabilization. 
5 

In the case of an open-loop biomass facility that uses agricultural livestock waste 

nutrients, a qualified facility is one that was originally placed in service after October 22, 2004, 

and before January 1, 2009, and has a nameplate capacity rating which is not less than 150 

kilowatts. In the case of any other open-loop biomass facility, a qualified facility is one that was 

originally placed in service before January 1, 2009. 

Geothermal facility

A geothermal facility is a facility that uses geothermal energy to produce electricity. 

Geothermal energy is energy derived from a geothermal deposit that is a geothermal reservoir 

consisting of natural heat that is stored in rocks or in an aqueous liquid or vapor (whether or not 

under pressure). To be a qualified facility, a geothermal facility must be placed in service after 

October 22, 2004, and before January 1, 2009. 

Solar facility

A solar facility is a facility that uses solar energy to produce electricity. To be a qualified 

facility, a solar facility must be placed in service after October 22, 2004, and before January 1, 

2006. 

Small irrigation facility

A small irrigation power facility is a facility that generates electric power through an 

irrigation system canal or ditch without any dam or impoundment of water. The installed 

capacity of a qualified facility must be at least 150 kilowatts but less than five megawatts. To be 

a qualified facility, a small irrigation facility must be originally placed in service after 

October 22, 2004, and before January 1, 2009. 

Landfill gas facility

A landfill gas facility is a facility that uses landfill gas to produce electricity. Landfill gas 

is defined as methane gas derived from the biodegradation of municipal solid waste. To be a 

qualified facility, a landfill gas facility must be placed in service after October 22, 2004, and 

before January 1, 2009. 

Trash combustion facility

Trash combustion facilities are facilities that burn municipal solid waste (garbage) to 

produce steam to drive a turbine for the production of electricity. To be a qualified facility, a 

trash combustion facility must be placed in service after October 22, 2004, and before January 1, 

2009. A qualified trash combustion facility includes a new unit, placed in service after 

October 22, 2004, that increases electricity production capacity at an existing trash combustion 

facility. A new unit generally would include a new burner/boiler and turbine. The new unit may 

share certain common equipment, such as trash handling equipment, with other pre-existing units 

at the same facility. Electricity produced at a new unit of an existing facility qualifies for the 

production credit only to the extent of the increased amount of electricity produced at the entire 

facility. 
6 

Hydropower facility

A qualifying hydropower facility is (1) a facility that produced hydroelectric power (a 

hydroelectric dam) prior to August 8, 2005, at which efficiency improvements or additions to 

capacity have been made after such date and before January 1, 2009, that enable the taxpayer to 

produce incremental hydropower or (2) a facility placed in service before August 8, 2005, that 

did not produce hydroelectric power (a nonhydroelectric dam) on such date, and to which 

turbines or other electricity generating equipment have been added after such date and before 

January 1, 2009. 

At an existing hydroelectric facility, the taxpayer may claim credit only for the 

production of incremental hydroelectric power. Incremental hydroelectric power for any taxable 

year is equal to the percentage of average annual hydroelectric power produced at the facility 

attributable to the efficiency improvement or additions of capacity determined by using the same 

water flow information used to determine an historic average annual hydroelectric power 

production baseline for that facility. The Federal Energy Regulatory Commission will certify the 

baseline power production of the facility and the percentage increase due to the efficiency and 

capacity improvements. 

At a nonhydroelectric dam, the facility must be licensed by the Federal Energy 

Regulatory Commission and meet all other applicable environmental, licensing, and regulatory 

requirements and the turbines or other generating devices must be added to the facility after 

August 8, 2005 and before January 1, 2009. In addition, there must not be any enlargement of 

the diversion structure, construction or enlargement of a bypass channel, or the impoundment or 

any withholding of additional water from the natural stream channel. 
7 

Summary of credit rate and credit period by facility type

Table 1.–Summary of Section 45 Credit for Electricity Produced from 

Certain Renewable Resources 

Eligible electricity 

production activity 

Credit amount for 

2007 (cents per 

kilowatt-hour) 

Credit period for 

facilities placed 

in service on or 

before August 8, 

2005 (years from 

placed-in-service 

date) 

Credit period for 

facilities placed in 

service after 

August 8, 2005 

(years from 

placed-in-service 

date) 

Wind 2 10 10 

Closed-loop biomass 2 101 10 

Open-loop biomass 

 (including agricultural 

 livestock waste nutrient 

 facilities) 

1 52 10 

Geothermal 

Solar (pre-2006 facilities only) 

Small irrigation power 

Municipal solid waste 

 (including landfill gas 

 facilities and trash 

 combustion facilities) 

Qualified hydropower 

2 

2 

1 

1 

1 

 5 

 5 

 5 

 5 

N/A 

10 

10 

10 

10 

10 

1 In the case of certain co-firing closed-loop facilities, the credit period begins no earlier than October 22, 

2004. 

2

 For certain facilities placed in service before October 22, 2004, the five-year credit period commences 

on January 1, 2005. 

Taxation of cooperatives and their patrons

For Federal income tax purposes, a cooperative generally computes its income as if it 

were a taxable corporation, with one exception: the cooperative may exclude from its taxable 

income distributions of patronage dividends. Generally, a cooperative that is subject to the 

cooperative tax rules of subchapter T of the Code5

 is permitted a deduction for patronage 

dividends paid only to the extent of net income that is derived from transactions with patrons 

who are members of the cooperative.6

 The availability of such deductions from taxable income 

 5

 Secs. 1381-1383. 

6

 Sec. 1382. 
8 

has the effect of allowing the cooperative to be treated like a conduit with respect to profits 

derived from transactions with patrons who are members of the cooperative. 

Eligible cooperatives may elect to pass any portion of the credit through to their patrons. 

An eligible cooperative is defined as a cooperative organization that is owned more than 50 

percent by agricultural producers or entities owned by agricultural producers. The credit may be 

apportioned among patrons eligible to share in patronage dividends on the basis of the quantity 

or value of business done with or for such patrons for the taxable year. The election must be 

made on a timely filed return for the taxable year and, once made, is irrevocable for such taxable 

year. 

Description of Proposal

The proposal extends and modifies the electricity production credit. 

Extension of placed-in-service date for qualifying facilities

The proposal extends for three years (through 2011) the period during which qualified 

facilities producing electricity from closed-loop biomass, open-loop biomass, geothermal energy, 

small irrigation power, municipal solid waste, and qualified hydropower may be placed in 

service for purposes of the electricity production credit. The proposal extends for one year 

(through 2009) the placed-in-service period for qualified wind facilities. 

Addition of marine and hydrokinetic renewable energy as a qualified resource

The proposal adds marine and hydrokinetic renewable energy as a qualified energy 

resource and marine and hydrokinetic renewable energy facilities as qualified facilities. Marine 

and hydrokinetic renewable energy is defined as energy derived from (1) waves, tides, and 

currents in oceans, estuaries, and tidal areas; (2) free flowing water in rivers, lakes, and streams; 

(3) free flowing water in an irrigation system, canal, or other man-made channel, including 

projects that utilize nonmechanical structures to accelerate the flow of water for electric power 

production purposes; or (4) differentials in ocean temperature (ocean thermal energy 

conversion). The term does not include energy derived from any source that uses a dam, 

diversionary structure (except for irrigation systems, canals, and other man-made channels), or 

impoundment for electric power production. A qualified marine and hydrokinetic renewable 

energy facility is any facility owned by the taxpayer and placed in service after the date of 

enactment and before 2012 that produces electric power from marine and hydrokinetic renewable 

energy and that has a nameplate capacity rating of at least 150 kilowatts. 

Under the proposal, marine and hydrokinetic renewable energy facilities subsume small 

irrigation power facilities. The proposal, therefore, terminates as a separate category of qualified 

facility small irrigation power facilities placed in service on or after the date of enactment. Such 

facilities qualify for the electricity production credit as marine and hydrokinetic renewable 

energy facilities. 
9 

Phaseout replaced by limitation based on investment in facility

The proposal replaces the electricity production credit phaseout with an annual limit on 

the total credits that may be claimed with respect to any qualified facility placed in service after 

2009 based on the investment in the facility. Under the limitation, the electricity production 

credit determined for any taxable year may not exceed the eligible basis of the facility multiplied 

by a limitation percentage (the “applicable percentage”) determined by the Secretary for the 

month during which the facility is originally placed in service. The applicable percentage for 

any month is the percentage that yields over a 10-year period amounts of limitation that have a 

present value equal to 35 percent of the eligible basis of the facility. The discount rate for 

purposes of this calculation is the greater of 4.5 percent or 110 percent of the long-term Federal 

rate. 

Generally, the eligible basis of a facility is the basis of such facility at the time it is 

originally placed in service. However, certain special rules apply. Since each wind turbine 

generally qualifies as a separate facility under section 45, the basis of shared qualified property at 

a wind project composed of multiple separate wind facilities may be allocated in proportion to 

the projected generation from such facilities. For this purpose, shared qualified property is 

property that is eligible for five-year depreciation under section 168(e)(3)(B)(vi) but which is not 

part of a qualified facility. In the case of a qualified geothermal facility, the eligible basis for 

purposes of the limitation includes intangible drilling and development costs described in section 

263(c). 

At the election of the taxpayer, all qualified facilities which are part of the same project 

and which are placed in service during the same calendar year may be treated for as a single 

facility placed in service at either the mid-point of such year or the first day of the following 

calendar year. 

Special rules apply for the first and last year of a facility’s 10-year credit period to 

allocate the limitation across a taxpayer's taxable years. In addition, if a facility’s production is 

less than the limitation amount for any taxable year, the limitation with respect to such facility 

for the next taxable year is increased by the amount of the unused limitation. Similarly, if the 

electricity production credit exceeds the limitation amount for any taxable year, but falls under 

the limit the following year, the credit for the following taxable year is increased, up to that 

year’s limitation amount, by the amount of such excess, but not beyond the facility’s 10-year 

credit eligibility period. 

Clarification of the definition of trash combustion facility

The proposal modifies the definition of qualified trash combustion facilities to permit 

facilities that gasify municipal solid waste and then burn such gas as part of an electricity 

generation process to qualify for the electricity production credit. 

Modification of the definitions of open-loop biomass facility and closed-loop biomass 

facility to include new units added to existing qualified facilities

The definitions of qualified open-loop biomass facility and qualified closed-loop biomass 

facility are modified to include new power generation units placed in service at existing qualified 
10 

facilities, but only to the extent of the increased amount of electricity produced at such facilities 

by reason of such new units. 

Modification of the third party sale rule for sales to regulated public utilities

The proposal modifies the requirement that qualified electricity be sold to a third party. 

Under the proposal, net sales of electricity to a regulated public utility are treated as sold to an 

unrelated person. Thus, under the proposal, a partnership controlled by a regulated public utility 

may sell power otherwise eligible for the electricity production credit to its controlling partner 

without failing the third party sale rule. 

Modification to definition of nonhydroelectric dam for purposes of qualified hydropower 

production

The proposal modifies the definition of nonhydroelectric dam for purposes of qualified 

hydropower production. Under the new definition, the nonhydroelectric dam must have been 

operated for flood control, navigation, or water supply purposes. 

The proposal replaces the requirement that the project not enlarge the diversion structure 

or bypass channel, or impound additional water from the natural stream channel, with a 

requirement that the project be operated so that the water surface elevation at any given location 

and time be the same as would occur in absence of the project, subject to any license 

requirements aimed at improving the environmental quality of the affected waterway. 

The hydroelectric project installed on the nonhydroelectric dam must still be licensed by 

the Federal Energy Regulatory Commission and meet all other applicable environmental, 

licensing, and regulatory requirements, including applicable fish passage requirements. 

Effective Date

The extension of the electricity production credit is effective for facilities originally 

placed in service after 2008. The addition of marine and hydrokinetic renewable energy as a 

qualified energy resource is effective for electricity produced at qualified facilities and sold after 

the date of enactment in taxable years ending after such date. The repeal of the credit phaseout 

adjustment is effective for taxable years ending after 2008. The limitation based on investment 

is effective for facilities originally placed in service after 2009. The clarification of the 

definition of trash combustion facility and the modification to the third party sale rule are 

effective for electricity produced and sold after the date of enactment. The modifications to the 

definitions of open-loop biomass facility, closed-loop biomass facility, and nonhydroelectric dam 

are effective for property placed in service after the date of enactment. 
11 

2. Extension and modification of energy credit 

Present Law

In general

A nonrefundable, 10-percent business energy credit7 is allowed for the cost of new 

property that is equipment that either (1) uses solar energy to generate electricity, to heat or cool 

a structure, or to provide solar process heat, or (2) is used to produce, distribute, or use energy 

derived from a geothermal deposit, but only, in the case of electricity generated by geothermal 

power, up to the electric transmission stage. Property used to generate energy for the purposes of 

heating a swimming pool is not eligible solar energy property. 

The energy credit is a component of the general business credit8

 and as such is subject to 

the alternative minimum tax. An unused general business credit generally may be carried back 

one year and carried forward 20 years.9 The taxpayer’s basis in the property is reduced by onehalf of the amount of the credit claimed. For projects whose construction time is expected to 

equal or exceed two years, the credit may be claimed as progress expenditures are made on the 

project, rather than during the year the property is placed in service. Similarly, the credit only 

applies to expenditures made after the effective date of the provision. 

In general, property that is public utility property is not eligible for the credit. Public 

utility property is property that is used predominantly in the trade or business of the furnishing or 

sale of (1) electrical energy, water, or sewage disposal services, (2) gas through a local 

distribution system, or (3) telephone service, domestic telegraph services, or other 

communication services (other than international telegraph services), if the rates for such 

furnishing or sale have been established or approved by a State or political subdivision thereof, 

by an agency or instrumentality of the United States, or by a public service or public utility 

commission. This rule is waived in the case of telecommunication companies’ purchases of fuel 

cell and microturbine property. 

Special rules for solar energy property 

The credit for solar energy property is increased to 30 percent in the case of periods after 

December 31, 2005 and prior to January 1, 2009. Additionally, equipment that uses fiber-optic 

distributed sunlight to illuminate the inside of a structure is solar energy property eligible for the 

30-percent credit. 

 7

 Sec. 48. 

8

 Sec. 38(b)(1). 

9

 Sec. 39. 
12 

Fuel cells and microturbines

The business energy credit also applies for the purchase of qualified fuel cell power 

plants, but only for periods after December 31, 2005 and prior to January 1, 2009. The credit 

rate is 30 percent. 

A qualified fuel cell power plant is an integrated system composed of a fuel cell stack 

assembly and associated balance of plant components that (1) converts a fuel into electricity 

using electrochemical means, and (2) has an electricity-only generation efficiency of greater than 

30 percent and a capacity of at least on-half kilowatt. The credit may not exceed $500 for each 

0.5 kilowatt of capacity. 

The business energy credit also applies for the purchase of qualifying stationary 

microturbine power plants, but only for periods after December 31, 2005 and prior to January 1, 

2009. The credit is limited to the lesser of 10 percent of the basis of the property or $200 for 

each kilowatt of capacity. 

A qualified stationary microturbine power plant is an integrated system comprised of a 

gas turbine engine, a combustor, a recuperator or regenerator, a generator or alternator, and 

associated balance of plant components that converts a fuel into electricity and thermal energy. 

Such system also includes all secondary components located between the existing infrastructure 

for fuel delivery and the existing infrastructure for power distribution, including equipment and 

controls for meeting relevant power standards, such as voltage, frequency and power factors. 

Such system must have an electricity-only generation efficiency of not less that 26 percent at 

International Standard Organization conditions and a capacity of less than 2,000 kilowatts. 

Additionally, for purposes of the fuel cell and microturbine credits, and only in the case 

of telecommunications companies, the general present-law section 48 restriction that would 

otherwise prohibit telecommunication companies from claiming the new credit due to their status 

as public utilities is waived. 

Description of Proposal

The proposal extends the otherwise expiring credits and credit rates for six years, through 

December 31, 2014. The proposal raises the $500 per half kilowatt of capacity credit cap with 

respect to fuel cells to $1500 per half kilowatt of capacity. Also, the restrictions on public utility 

property being eligible for the credit are repealed. The proposal makes the energy credit 

allowable against the alternative minimum tax. 

The proposal makes combined heat and power (“CHP”) property eligible for the 10-

percent energy credit through December 31, 2014. 

CHP property is property: (1) that uses the same energy source for the simultaneous or 

sequential generation of electrical power, mechanical shaft power, or both, in combination with 

the generation of steam or other forms of useful thermal energy (including heating and cooling 

applications); (2) that has an electrical capacity of not more than 50 megawatts or a mechanical 

energy capacity of no more than 67,000 horsepower or an equivalent combination of electrical 

and mechanical energy capacities; (3) that produces at least 20 percent of its total useful energy 
13 

in the form of thermal energy that is not used to produce electrical or mechanical power, and 

produces at least 20 percent of its total useful energy in the form of electrical or mechanical 

power (or a combination thereof); and (4) the energy efficiency percentage of which exceeds 60 

percent. CHP property does not include property used to transport the energy source to the 

generating facility or to distribute energy produced by the facility. 

The otherwise allowable credit with respect to CHP property is reduced to the extent the 

property has an electrical capacity or mechanical capacity in excess of any applicable limits. 

Property in excess of the applicable limit (15 megawatts or a mechanical energy capacity of 

more than 20,000 horsepower or an equivalent combination of electrical and mechanical energy 

capacities) is permitted to claim a fraction of the otherwise allowable credit. The fraction is equal 

to the applicable limit divided by the capacity of the property. For example, a 45 megawatt 

property would be eligible to claim 15/45ths, or one third, of the otherwise allowable credit. 

Again, no credit is allowed if the property exceeds the 50 megawatt or 67,000 horsepower 

limitations described above. 

Additionally, the proposal provides that systems whose fuel source is at least 90 percent 

open-loop biomass and that would qualify for the credit but for the failure to meet the efficiency 

standard are eligible for a credit that is reduced in proportion to the degree to which the system 

fails to meet the efficiency standard. For example, a system that would otherwise be required to 

meet the 60-percent efficiency standard, but which only achieves 30-percent efficiency, would be 

permitted a credit equal to one-half of the otherwise allowable credit (i.e., a 5-percent credit). 

Effective Date

The proposal is generally effective on the date of enactment. 

The proposal relating to combined heat and power property applies to periods after the 

date of enactment, in taxable years ending after such date, under rules similar to the rules of 

section 48(m) of the Code (as in effect on the day before the enactment of the Revenue 

Reconciliation Act of 1990). 

The proposal relating to the restrictions on public utility property applies to periods after 

February 13, 2008, in taxable years ending after such date, under rules similar to the rules of 

section 48(m) of the Code (as in effect on the day before the enactment of the Revenue 

Reconciliation Act of 1990). 

The allowance of the credit against the alternative minimum tax is effective for credits 

determined in taxable years beginning after the date of enactment. 

3. Credit for residential energy efficient property 

Present Law

Code section 25D provides a personal tax credit for the purchase of qualified solar 

electric property and qualified solar water heating property that is used exclusively for purposes 

other than heating swimming pools and hot tubs. The credit is equal to 30 percent of qualifying 

expenditures, with a maximum credit for each of these systems of property of $2,000. Section 
14 

25D also provides a 30 percent credit for the purchase of qualified fuel cell power plants. The 

credit for any fuel cell may not exceed $500 for each 0.5 kilowatt of capacity. 

Qualifying solar water heating property means an expenditure for property to heat water 

for use in a dwelling unit located in the United States and used as a residence if at least half of 

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

electric property is property that uses solar energy to generate electricity for use in a dwelling 

unit. A qualified fuel cell power plant is an integrated system comprised of a fuel cell stack 

assembly and associated balance of plant components that (1) converts a fuel into electricity 

using electrochemical means, (2) has an electricity-only generation efficiency of greater than 30 

percent. The qualified fuel cell power plant must be installed on or in connection with a dwelling 

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

The credit is nonrefundable, and the depreciable basis of the property is reduced by the 

amount of the credit. Expenditures for labor costs allocable to onsite preparation, assembly, or 

original installation of property eligible for the credit are eligible expenditures. 

Certain equipment safety requirements need to be met to qualify for the credit. Special 

proration rules apply in the case of jointly owned property, condominiums, and tenantstockholders in cooperative housing corporations. If less than 80 percent of the property is used 

for nonbusiness purposes, only that portion of expenditures that is used for nonbusiness purposes 

is taken into account. 

The credit applies to property placed in service prior to January 1, 2009. 

Description of Proposal

The proposal extends the credit for six years (through December 31, 2014) and allows the 

credit to be claimed against the alternative minimum tax. Additionally, the credit cap for solar 

electric property is raised to $4,000. 

The proposal provides a new 30 percent credit for qualified small wind energy property 

expenses made by the taxpayer during the taxable year. The credit is limited to $500 with 

respect to each half kilowatt of capacity, not to exceed $4,000. The credit for qualified small 

wind energy property is allowed for expenditures after December 31, 2007, for property placed 

in service prior to January 1, 2015. 

Qualified small wind energy property expenditures are expenditures for property that 

uses a wind turbine to generate electricity for use in a dwelling unit located in the U.S. and used 

as a residence by the taxpayer. 

The proposal also provides a 30 percent credit for qualified geothermal heat pump 

property expenditures, not to exceed $2,000. The term “qualified geothermal heat pump 

property expenditure” means an expenditure for qualified geothermal heat pump property 

installed on or in connection with a dwelling unit located in the United States and used as a 

residence by the taxpayer. Qualified geothermal heat pump property means any equipment which 

(1) uses the ground or ground water as a thermal energy source to heat the dwelling unit or as a 

thermal energy sink to cool such dwelling unit, and (2) meets the requirements of the Energy 
15 

Star program which are in effect at the time that the expenditure for such equipment is made. The 

credit for qualified geothermal heat pump property is allowed for expenditures after December 

31, 2007, for property placed in service prior to January 1, 2015. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2007, for 

property placed in service prior to January 1, 2015. 

4. Extension and modification of special rule to implement FERC and State electric 

restructuring policy 

Present Law

Generally, a taxpayer selling property recognizes gain to the extent the sales price (and 

any other consideration received) exceeds the seller’s basis in the property. The recognized gain 

is subject to current income tax unless the gain is deferred or not recognized under a special tax 

provision. 

One such special tax provision permits taxpayers to elect to recognize gain from 

qualifying electric transmission transactions ratably over an eight-year period beginning in the 

year of sale if the amount realized from such sale is used to purchase exempt utility property 

within the applicable period10 (the “reinvestment property”). If the amount realized exceeds the 

amount used to purchase reinvestment property, any realized gain is recognized to the extent of 

such excess in the year of the qualifying electric transmission transaction. 

A qualifying electric transmission transaction is the sale or other disposition of property 

used by the taxpayer in the trade or business of providing electric transmission services, or an 

ownership interest in such an entity, to an independent transmission company prior to January 1, 

2008. In general, an independent transmission company is defined as: (1) an independent 

transmission provider11 approved by the FERC; (2) a person (i) who the FERC determines under 

section 203 of the Federal Power Act (or by declaratory order) is not a “market participant” and 

(ii) whose transmission facilities are placed under the operational control of a FERC-approved 

independent transmission provider before the close of the period specified in such authorization, 

but not later than December 31, 2007; or (3) in the case of facilities subject to the jurisdiction of 

the Public Utility Commission of Texas, (i) a person which is approved by that Commission as 

consistent with Texas State law regarding an independent transmission organization, or (ii) a 

political subdivision, or affiliate thereof, whose transmission facilities are under the operational 

control of an organization described in (i). 

 10 The applicable period for a taxpayer to reinvest the proceeds is four years after the close of the 

taxable year in which the qualifying electric transmission transaction occurs. 

11 For example, a regional transmission organization, an independent system operator, or an 

independent transmission company. 
16 

Exempt utility property is defined as: (1) property used in the trade or business of 

generating, transmitting, distributing, or selling electricity or producing, transmitting, 

distributing, or selling natural gas, or (2) stock in a controlled corporation whose principal trade 

or business consists of the activities described in (1). 

If a taxpayer is a member of an affiliated group of corporations filing a consolidated 

return, the reinvestment property may be purchased by any member of the affiliated group (in 

lieu of the taxpayer). 

Description of Proposal

The proposal extends the treatment under the present-law deferral provision to sales or 

dispositions by a qualified electric utility prior to January 1, 2010. A qualified electric utility is 

defined as an electric utility, which as of the date of the qualifying electric transmission 

transaction, is vertically integrated in that it is both (1) a transmitting utility (as defined in the 

Federal Power Act) 12 with respect to the transmission facilities to which the election applies, and 

(2) an electric utility (as defined in the Federal Power Act).13

The definition of an independent transmission company is modified for taxpayers whose 

transmission facilities are placed under the operational control of a FERC-approved independent 

transmission provider, which under the proposal must take place no later than four years after the 

close of the taxable year in which the transaction occurs. 

The proposal also changes the definition of exempt utility property to exclude property 

that is located outside the United States. 

Effective Date

The extension proposal applies transactions after December 31, 2007. The change in the 

definition of an independent transmission company is effective as if included in section 909 of 

the American Jobs Creation Act of 2004. The exclusion for property located outside the United 

States applies to transactions after the date of enactment. 

 12 Sec. 3(23), 16 U.S.C. 796, defines “transmitting utility” as any electric utility, qualifying 

cogeneration facility, qualifying small power production facility, or Federal power marketing agency 

which owns or operates electric power transmission facilities which are used for the sale of electric 

energy at wholesale. 

13 Sec. 3(22), 16 U.S.C. 796, defines “electric utility” as any person or State agency (including 

any municipality) which sells electric energy; such term includes the Tennessee Valley Authority, but 

does not include any Federal power marketing agency. 
17 

5. New clean renewable energy bonds 

Present law

Tax-exempt bonds

Subject to certain Code restrictions, interest on bonds issued by State and local 

government generally is excluded from gross income for Federal income tax purposes. Bonds 

issued by State and local governments may be classified as either governmental bonds or private 

activity bonds. Governmental bonds are bonds the proceeds of which are primarily used to 

finance governmental functions or which are repaid with governmental funds. Private activity 

bonds are bonds in which the State or local government serves as a conduit providing financing 

to nongovernmental persons. For this purpose, the term “nongovernmental person” generally 

includes the Federal Government and all other individuals and entities other than States or local 

governments. The exclusion from income for interest on State and local bonds does not apply to 

private activity bonds, unless the bonds are issued for certain permitted purposes (“qualified 

private activity bonds”) and other Code requirements are met. 

In most cases, the aggregate volume of tax-exempt qualified private activity bonds is 

restricted by annual aggregate volume limits imposed on bonds issued by issuers within each 

State. For calendar year 2008, the State volume limit, which is indexed for inflation, equals $85 

per resident of the State, or $262.09 million, if greater. 

The exclusion from income for interest on State and local bonds also does not apply to 

any arbitrage bond.14 An arbitrage bond is defined as any bond that is part of an issue if any 

proceeds of the issue are reasonably expected to be used (or intentionally are used) to acquire 

higher yielding investments or to replace funds that are used to acquire higher yielding 

investments.15 In general, arbitrage profits may be earned only during specified periods (e.g., 

defined “temporary periods”) before funds are needed for the purpose of the borrowing or on 

specified types of investments (e.g., “reasonably required reserve or replacement funds”). 

Subject to limited exceptions, investment profits that are earned during these periods or on such 

investments must be rebated to the Federal Government. 

An issuer must file with the IRS certain information about the bonds issued by them in 

order for that bond issue to be tax-exempt.16 Generally, this information return is required to be 

filed no later the 15th day of the second month after the close of the calendar quarter in which 

the bonds were issued. 

 14 Sec. 103(a) and (b)(2). 

15 Sec. 148. 

16 Sec. 149(e). 
18 

Clean renewable energy bonds

As an alternative to traditional tax-exempt bonds, States and local governments may issue 

clean renewable energy bonds (“CREBs”). CREBs are defined as any bond issued by a qualified 

issuer if, in addition to the requirements discussed below, 95 percent or more of the proceeds of 

such bonds are used to finance capital expenditures incurred by qualified borrowers for qualified 

projects. “Qualified projects” are facilities that qualify for the tax credit under section 45 (other 

than Indian coal production facilities), without regard to the placed-in-service date requirements 

of that section.17 The term “qualified issuers” includes (1) governmental bodies (including 

Indian tribal governments); (2) mutual or cooperative electric companies (described in section 

501(c)(12) or section 1381(a)(2)(C), or a not-for-profit electric utility which has received a loan 

or guarantee under the Rural Electrification Act); and (3) clean renewable energy bond lenders. 

The term “qualified borrower” includes a governmental body (including an Indian tribal 

government) and a mutual or cooperative electric company. A clean renewable energy bond 

lender means a cooperative which is owned by, or has outstanding loans to, 100 or more 

cooperative electric companies and is in existence on February 1, 2002. 

Unlike tax-exempt bonds, CREBs are not interest-bearing obligations. Rather, the 

taxpayer holding CREBs on a credit allowance date is entitled to a tax credit. The amount of the 

credit is determined by multiplying the bond’s credit rate by the face amount on the holder’s 

bond. The credit rate on the bonds is determined by the Secretary and is to be a rate that permits 

issuance of CREBs without discount and interest cost to the qualified issuer. The credit accrues 

quarterly and is includible in gross income (as if it were an interest payment on the bond), and 

can be claimed against regular income tax liability and alternative minimum tax liability. 

CREBs are subject to a maximum maturity limitation. The maximum maturity is the 

term which the Secretary estimates will result in the present value of the obligation to repay the 

principal on a CREBs being equal to 50 percent of the face amount of such bond. The discount 

rate used to determine the present value amount is the average annual interest rate of tax-exempt 

obligations having a term of 10 years or more which are issued during the month the CREBs are 

issued. In addition, the Code requires level amortization of CREBs during the period such bonds 

are outstanding. 

CREBs also are subject to the arbitrage requirements of section 148 that apply to 

traditional tax-exempt bonds. Principles under section 148 and the regulations thereunder apply 

for purposes of determining the yield restriction and arbitrage rebate requirements applicable to 

CREBs. 

In addition to the above requirements, at least 95 percent of the proceeds of CREBs must 

be spent on qualified projects within the five-year period that begins on the date of issuance. To 

the extent less than 95 percent of the proceeds are used to finance qualified projects during the 

 17 In addition, Notice 2006-7 provides that qualified projects include any facility owned by a 

qualified borrower that is functionally related and subordinate to any facility described in sections 

45(d)(1) through (d)(9) and owned by such qualified borrower. 
19 

five-year spending period, bonds will continue to qualify as CREBs if unspent proceeds are used 

within 90 days from the end of such five-year period to redeem bonds. The five-year spending 

period may be extended by the Secretary upon the qualified issuer’s request demonstrating that 

the failure to satisfy the five-year requirement is due to reasonable cause and the projects will 

continue to proceed with due diligence. 

Issuers of CREBs are required to report issuance to the IRS in a manner similar to the 

information returns required for tax-exempt bonds. There is a national CREB limitation of $1.2 

billion. The maximum amount of CREBs that may be allocated to qualified projects of 

governmental bodies is $750 million. CREBs must be issued before January 1, 2009. 

Description of Proposal

The proposal creates a new category of clean renewable energy bonds (“New CREBs”) 

that may be issued by qualified issuers to finance qualified renewable energy facilities. 

Qualified renewable energy facilities are facilities: (1) that qualify for the tax credit under 

section 45 (other than Indian coal and refined coal production facilities), without regard to the 

placed-in-service date requirements of that section; and (2) that are owned by a public power 

provider, governmental bodies, or cooperative electric company. 

The term “qualified issuers” includes: (1) public power providers; (2) a governmental 

body; (3) cooperative electric companies; (4) a not-for-profit electric utility that has received a 

loan or guarantee under the Rural Electrification Act; and (5) clean renewable energy bond 

lenders. The term “public power provider” means a State utility with a service obligation, as 

such terms are defined in section 217 of the Federal Power Act (as in effect on the date of the 

enactment of this paragraph). A “governmental body” means any State or Indian tribal 

government, or any political subdivision thereof. The term “cooperative electric company” 

means a mutual or cooperative electric company (described in section 501(c)(12) or section 

1381(a)(2)(C)). A clean renewable energy bond lender means a cooperative that is owned by, or 

has outstanding loans to, 100 or more cooperative electric companies and is in existence on 

February 1, 2002. 

There is a national limitation for New CREBs of $2 billion. Under the proposal, no more 

than one-third of the national limit may be allocated to projects of public power providers, 

governmental bodies, or cooperative electric companies. Allocations to governmental bodies 

and cooperative electric companies may be made in the manner the Secretary determines 

appropriate. Allocations to projects of public power providers shall be made, to the extent 

practicable, in such manner that the amount allocated to each such project bears the same ratio to 

the cost of such project as the maximum allocation limitation to projects of public power 

providers bears to the cost of all such projects. 

Under the proposal, 100 percent of the available project proceeds of New CREBs must be 

used within the three-year period that begins on the date of issuance. The proposal defines 

available project proceeds as proceeds from the sale of the bond issue less issuance costs (not to 

exceed two percent) and any investment earnings on such sale proceeds. To the extent less than 

100 percent of the available project proceeds are used to finance qualified projects during the 

three-year spending period, bonds will continue to qualify as New CREBs if unspent proceeds 
20 

are used within 90 days from the end of such three-year period to redeem bonds. The three-year 

spending period may be extended by the Secretary upon the qualified issuer’s request 

demonstrating that the failure to satisfy the three-year requirement is due to reasonable cause and 

the projects will continue to proceed with due diligence. 

New CREBs generally are subject to the arbitrage requirements of section 148. 

However, available project proceeds invested during the three-year spending period are not 

subject to the arbitrage restrictions (i.e., yield restriction and rebate requirements). In addition, 

amounts invested in a reserve fund are not subject to the arbitrage restrictions to the extent: (1) 

such fund is funded at a rate not more rapid than equal annual installments; (2) such fund is 

funded in a manner reasonably expected to result in an amount not greater than an amount 

necessary to repay the issue; and (3) the yield on such fund is not greater than the average annual 

interest rate of tax-exempt obligations having a term of 10 years or more that are issued during 

the month the New CREBs are issued. 

The maturity of New CREBs is the term that the Secretary estimates will result in the 

present value of the obligation to repay the principal on such bonds being equal to 50 percent of 

the face amount of such bonds, using as a discount rate the average annual interest rate of taxexempt obligations having a term of 10 years or more which are issued during the month the 

qualified energy conservation bonds are issued. 

As with present-law CREBs, the taxpayer holding New CREBs on a credit allowance 

date is entitled to a tax credit. Unlike present-law CREBs, however, the credit rate on New 

CREBs is set by the Secretary at a rate that is 70 percent of the rate that would permit issuance of 

such bonds without discount and interest cost to the issuer. The amount of the tax credit is 

determined by multiplying the bond’s credit rate by the face amount on the holder’s bond. The 

credit accrues quarterly, is includible in gross income (as if it were an interest payment on the 

bond), and can be claimed against regular income tax liability and alternative minimum tax 

liability. Unused credits may be carried forward to succeeding taxable years. In addition, credits 

may be separated from the ownership of the underlying bond similar to how interest coupons can 

be stripped for interest-bearing bonds. 

Issuers of New CREBs are required to certify that the financial disclosure requirements 

that apply to State and local bonds offered for sale to the general public are satisfied with respect 

to any Federal, State, or local government official directly involved with the issuance of New 

CREBs. The proposal authorizes the Secretary to impose additional financial reporting 

requirements by regulation. 

Effective Date

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

6. Expansion and modification of the advanced coal project credit 

Present Law

An investment tax credit is available for power generation projects that use integrated 

gasification combined cycle (“IGCC”) or other advanced coal-based electricity generation 
21 

technologies. The credit amount is 20 percent for investments in qualifying IGCC projects and 

15 percent for investments in qualifying projects that use other advanced coal-based electricity 

generation technologies. 

To qualify, an advanced coal project must be located in the United States and use an 

advanced coal-based generation technology to power a new electric generation unit or to retrofit 

or repower an existing unit. Generally, an electric generation unit using an advanced coal-based 

technology must be designed to achieve a 99 percent reduction in sulfur dioxide and a 90 percent 

reduction in mercury, as well as to limit emissions of nitrous oxide and particulate matter.18

The fuel input for a qualifying project, when completed, must use at least 75 percent coal. 

The project, consisting of one or more electric generation units at one site, must have a 

nameplate generating capacity of at least 400 megawatts, and the taxpayer must provide evidence 

that a majority of the output of the project is reasonably expected to be acquired or utilized. 

Credits are available only for projects certified by the Secretary of Treasury, in 

consultation with the Secretary of Energy. Certifications are issued using a competitive bidding 

process. The Secretary of Treasury must establish a certification program no later than 180 days 

after August 8, 2005,19 and each project application must be submitted during the three-year 

period beginning on the date such certification program is established. An applicant for 

certification has two years from the date the Secretary accepts the application to provide the 

Secretary with evidence that the requirements for certification have been met. Upon 

certification, the applicant has five years from the date of issuance of the certification to place 

the project in service. 

The Secretary of Treasury may allocate $800 million of credits to IGCC projects and 

$500 million to projects using other advanced coal-based electricity generation technologies. 

Qualified projects must be economically feasible and use the appropriate clean coal technologies. 

With respect to IGCC projects, credit-eligible investments include only investments in property 

associated with the gasification of coal, including any coal handling and gas separation 

equipment. Thus, investments in equipment that could operate by drawing fuel directly from a 

natural gas pipeline do not qualify for the credit. 

In determining which projects to certify that use IGCC technology, the Secretary must 

allocate power generation capacity in relatively equal amounts to projects that use bituminous 

coal, subbituminous coal, and lignite as primary feedstock. In addition, the Secretary must give 

 18 For advanced coal project certification applications submitted after October 2, 2006, an 

electric generation unit using advanced coal-based generation technology designed to use subbituminous 

coal can meet the performance requirement relating to the removal of sulfur dioxide if it is designed either 

to remove 99 percent of the sulfur dioxide or to achieve an emission limit of 0.04 pounds of sulfur 

dioxide per million British thermal units on a 30-day average. 

19 The Secretary issued guidance establishing the certification program on February 21, 2006 

(IRS Notice 2006-24). 
22 

high priority to projects which include greenhouse gas capture capability, increased by-product 

utilization, and other benefits. 

Description of Proposal

The proposal increases to 30 percent the credit rate for IGCC and other advanced coal 

projects. In addition, the proposal permits the Secretary to allocate an additional $1.25 billion of 

credits to qualifying projects. 

The proposal modifies the definition of qualifying projects to require that projects include 

equipment which separates and sequesters at least 65 percent of the project’s total carbon dioxide 

emissions. This percentage increases to 70 percent if the credits are later reallocated by the 

Secretary. The Secretary is required to recapture the benefit of any allocated credit if a project 

fails to attain or maintain these carbon dioxide separation and sequestration requirements. 

In selecting projects, the proposal requires the Secretary to give high priority to 

applicants who have a research partnership with an eligible educational institution. In addition, 

the Secretary must give the highest priority to projects with the greatest separation and 

sequestration percentage of total carbon dioxide emissions. The proposal also requires that the 

Secretary disclose which projects receive credit allocations, including the identity of the taxpayer 

and the amount of the credit awarded. 

In implementing either section 48A (relating to the credit described above) or section 

48B (relating to the coal gasification credit), the proposal directs the Secretary to modify the 

terms of any competitive certification award and any associated closing agreements in certain 

cases. Specifically, modification is required when it (1) is consistent with the objectives of such 

section, (2) is requested by the recipient of the award, and (3) involves moving the project site to 

improve the potential to capture and sequester carbon dioxide emissions, reduce costs of 

transporting feedstock, and serve a broader customer base. However, no modification is required 

if the Secretary determines that the dollar amount of tax credits available to the taxpayer under 

the applicable section would increase as a result of the modification or such modification would 

result in such project not being originally certified. In considering any such modification, the 

Secretary must consult with other relevant Federal agencies, including the Department of 

Energy. 

Effective Date

The proposal authorizing the Secretary to allocate additional credits is effective on the 

date of enactment. The increased credit rate along with the carbon dioxide sequestration and 

other rules (other than the term modification proposal) are effective with respect to these 

additional credit allocations. The proposal directing the Secretary to modify the terms of certain 

competitive certification awards and associated closing agreements is effective for awards issued 

before, on, or after the date of enactment. 
23 

7. Expansion and modification of the coal gasification investment credit 

Present Law

A 20 percent investment tax credit is available for investments in certain qualifying coal 

gasification projects. Only property which is part of a qualifying gasification project and 

necessary for the gasification technology of such project is eligible for the gasification credit. 

Qualified gasification projects convert coal, petroleum residue, biomass, or other 

materials recovered for their energy or feedstock value into a synthesis gas composed primarily 

of carbon monoxide and hydrogen for direct use or subsequent chemical or physical conversion. 

Qualified projects must be carried out by an eligible entity, defined as any person whose 

application for certification is principally intended for use in a domestic project which employs 

domestic gasification applications related to (1) chemicals, (2) fertilizers, (3) glass, (4) steel, (5) 

petroleum residues, (6) forest products, and (7) agriculture, including feedlots and dairy 

operations. 

Credits are available only for projects certified by the Secretary of Treasury, in 

consultation with the Secretary of Energy. Certifications are issued using a competitive bidding 

process. The Secretary of Treasury must establish a certification program no later than 180 days 

after August 8, 2005,20 and each project application must be submitted during the 3-year period 

beginning on the date such certification program is established. The Secretary of Treasury may 

not allocate more than $350 million in credits. In addition, the Secretary may certify a maximum 

of $650 million in qualified investment as eligible for credit with respect to any single project. 

 20 The Secretary issued guidance establishing the certification program on February 21, 2006 

(IRS Notice 2006-25). 
24 

Description of Proposal

The proposal expands and modifies the coal gasification investment credit. The proposal 

increases gasification project credit rate to 30 percent and permits the Secretary to allocate an 

additional $250 million of credits to qualified projects. 

The proposal modifies the definition of qualified projects to require that such projects 

include equipment which separates and sequesters at least 75 percent of total carbon dioxide 

emissions. The Secretary is required to recapture the benefit of any allocated credit if a project 

fails to attain or maintain these carbon dioxide separation and sequestration requirements. 

In selecting projects, the proposal requires the Secretary to give high priority to 

applicants who have a research partnership with an eligible educational institution. In addition, 

the Secretary must give the highest priority to projects with the greatest separation and 

sequestration percentage of total carbon dioxide emissions. The proposal also requires that the 

Secretary disclose which projects receive credit allocations, including the identity of the taxpayer 

and the amount of the credit awarded. 

Effective Date

The proposal authorizing the Secretary to allocate additional credits is effective on the 

date of enactment. The increased credit rate along with the carbon dioxide sequestration and 

other rules are effective with respect to these additional credit allocations. 

8. Extend excise tax on coal at current rates 

Present Law

A $1.10 per ton excise tax is imposed on coal sold by the producer from underground 

mines in the United States. The rate is 55 cents per ton on coal sold by the producer from 

surface mining operations. In either case, the tax cannot exceed 4.4 percent of the coal 

producer's selling price. No tax is imposed on lignite. 

Gross receipts from the excise tax are dedicated to the Black Lung Disability Trust Fund 

to finance benefits under the Federal Black Lung Benefits Act. Currently, the Black Lung 

Disability Trust Fund is in a deficit position because previous spending was financed with 

interest-bearing advances from the General Fund. 

The coal excise tax rates are scheduled to decline to 50 cents per ton for undergroundmined coal and 25 cents per ton for surface-mined coal (and the cap is scheduled to decline to 

two percent of the selling price) for sales after January 1, 2014, or after any earlier January 1 on 

which there is no balance of repayable advances from the Black Lung Disability Trust Fund to 

the General Fund and no unpaid interest on such advances. 

Description of Proposal

The proposal retains the excise tax on coal at the current rates until the earlier of the 

following dates: (1) January 1, 2019, and (2) the day after the first December 31 after 2007 on 
25 

which the Black Lung Disability Trust Fund has repaid, with interest, all amounts borrowed from 

the General Fund. On and after that date, the reduced rates of $.50 per ton for coal from 

underground mines and $.25 per ton for coal from surface mines will apply and the tax per ton of 

coal will be capped at two percent of the amount for which it is sold by the producer. 

Effective Date

The proposal is effective on the date of enactment. 

9. Temporary procedures for excise tax refunds on exported coal 

Present Law

In general

Excise tax is imposed on coal, except lignite, produced from mines located in the United 

States.21 The producer of the coal is liable for paying the tax to the IRS. Producers generally 

recover the tax from their purchasers. 

The Export Clause of the U.S. Constitution provides that “no Tax or Duty shall be laid on 

Articles exported from any State.”22 Courts have determined that the Export Clause applies to 

excise tax on exported coal, and therefore such taxes are subject to a claim for refund.23 The 

Supreme Court has ruled that taxpayers seeking a refund of such taxes must proceed under the 

rules of the Internal Revenue Code.24

 21 Sec. 4121(a). Throughout the relevant period, the rate of tax on coal from underground mines 

has been $1.10 per ton and the rate of tax on coal from surface mines has been $0.55 per ton. These rates 

are subject to a limitation of 4.4 percent of the producer’s sale price. Sec. 4121(b). 

22 U.S. Const., art. I, sec. 9, cl. 5. 

23 See Ranger Fuel Corp. v. United States, 33 F. Supp. 2d 466 (E.D. Va. 1998). The IRS 

subsequently provided guidance regarding how taxpayers may assure that exported coal would not be 

subject to excise tax. Notice 2000-28, 2000-1 C.B. 1116. 

24 United States v. Clintwood Elkhorn Mining Co., 76 U.S.L.W. 4189 (U.S. April 15, 2008). 

Prior to the Court’s decision, a refund could be claimed in the Court of Federal Claims under the Export 

Clause and the Tucker Act, which confers jurisdiction upon such court “to render judgment upon any 

claim against the United States founded either upon the Constitution, or any Act of Congress or any 

regulation of an executive department ....” See 28 U.S.C. sec. 1491(a). Lower courts had held that such 

a Tucker Act claim was subject to the Tucker Act’s six-year statute of limitations and was not subject to 

the requirements of the Code. Venture Coal Sales Co. v. U.S., 93 AFTR 2d 2004-2495 (Fed. Cir. 2004); 

Cyprus Amax Coal Co. v. U.S., 205 F.3d 1369 (Fed. Cir. 2000). The Supreme Court held that the stricter 

Code rules apply to these refund claims. 
26 

Claims under the Code

In order to obtain a refund of taxes on exported coal, a claimant must satisfy the 

following requirements of the Code and case law: 

1. A claim for refund must be filed within three years from the time the return was filed, 

or within two years from the time the tax was paid, whichever period expires later;25

2. The person must establish that the goods were in the stream of export when the excise 

tax was imposed;26

3. The claimant must establish that it has borne the tax. More specifically, the claimant 

must establish that the tax was neither included in the price of the article nor collected 

from the purchaser (or if so, that the claimant has repaid the amount of tax to the 

ultimate purchaser), that the claimant has repaid or agreed to repay the tax to the 

ultimate vendor or has obtained the written consent of such ultimate vendor to the 

allowance of the claim, or that the claimant has filed the written consent of the 

ultimate purchaser to the allowance of the claim;27 

4. In the case of an exporter or shipper of an article exported to a foreign country or 

shipped to a possession, the amount of tax may be refunded to the exporter or shipper 

if the person who paid the tax waives its claim to such amount;28 and 

5. A civil action for refund must not be begun before the expiration of six months from 

the date of filing the claim (unless the claim has been disallowed during that time), nor 

after the expiration of two years from the date of mailing the notice of claim 

disallowance.29

In 2000, the Internal Revenue Service (“IRS”) issued Notice 2000-28,30 which 

summarizes the IRS position regarding claims for credits or refunds of excise taxes on exported 

coal and sets forth procedural rules relating to such claims. Under Notice 2000-28, a coal 

producer or exporter must provide the following information as part of its claim: 

 25 Sec. 6511(a). 

26 See Ranger Fuel Corp. v. United States, 33 F. Supp. 2d 466 (E.D. Va. 1998). See also United 

States v. International Business Machines Corp., 517 U.S. 843 (1996); Joy Oil, Ltd. v. State Tax 

Commission, 337 U.S. 286 (1949). 

27 Sec. 6416(a)(1). 

28 Sec. 6416(c). 

29 Sec. 6532(a). 

30 Notice 2000-28, 2001-1 C.B. 1116. 
27 

1. A statement by the person that paid the tax to the government that provides the quarter 

and the year for which the tax was reported on Form 720, the line number on such 

Form, the amount of tax paid on the coal, and the date of payment; 

2. In the case of an exporter, a statement by the person that paid the tax to the 

government that such person has waived the right to claim a refund; 

3. A statement that the claimant has evidence that the coal was in the stream of export 

when sold by the producer; 

4. In the case of an exporter, proof of exportation; 

5. In the case of a coal producer, a statement that the coal actually was exported; and 

A statement that the claimant: 

a. has neither included the tax in the price of the coal nor collected the amount of the 

tax from its buyer, 

b. has repaid the amount of the tax to the ultimate purchaser of the coal, or 

c. has obtained the written consent of the ultimate purchaser of the coal to the 

allowance of the claim. 

If the IRS disallows the claim, the claimant may proceed in a Federal district court or the 

Court of Federal Claims under 28 U.S.C. sec. 1346(a)(1), which grants these courts concurrent 

jurisdiction over “[a]ny civil action against the United States for the recovery of any internal 

revenue tax alleged to have been erroneously or illegally assessed or collected ... or any sum 

alleged to have been excessive or in any manner wrongfully collected under the internal-revenue 

laws.” 

With respect to claims under the Code allowed by the IRS or by a court, prejudgment 

interest is generally allowed.31

Description of Proposal

The proposal creates a new procedure under which certain coal producers and exporters 

may claim a refund of excise taxes imposed on coal exported from the United States. Coal 

producers or exporters that exported coal during the period beginning on or after October 1, 1990 

and ending on or before the date of enactment of the proposal, with respect to which a return was 

filed on or after October 1, 1990, and on or before the date of enactment, and that file a claim for 

refund not later than the close of the 30-day period beginning on the day of enactment, may 

obtain a refund from the Secretary of the Treasury of excise taxes paid on such exported coal and 

any interest accrued from the date of overpayment. Interest on such claims is computed under 

 31 See sec. 6611; 28 U.S.C. sec. 2411. 
28 

the Code.32 The Secretary of the Treasury is required to determine whether to approve the claim 

within 180 days after such claim is filed, and to pay such claim not later than 180 days after 

making such determination. 

In order to qualify for a refund under the proposal, a coal producer must establish that it, 

or a party related to such coal producer, exported coal produced by such coal producer to a 

foreign country or shipped coal produced by such coal producer to a U.S. possession, the export 

or shipment of which was other than through an exporter that has filed a valid and timely claim 

for refund under the proposal. An exporter must establish that it exported coal to a foreign 

country, shipped coal to a U.S. possession, or caused such coal to be so exported or shipped. 

Refunds to producers are to be made in an amount equal to the tax paid on exported coal. 

Exporters are to receive a payment equal to $0.825 per ton of exported coal. 

Special rules apply if a court has rendered a judgment. If a coal producer or a party 

related to a coal producer has received, from a court of competent jurisdiction in the United 

States, a judgment in favor of such coal producer (or party related to such coal producer) that 

relates to the constitutionality of Federal excise tax paid on exported coal, then such coal 

producer is deemed to have established the export of coal to a foreign country or shipment of 

coal to a possession of the United States. If such coal producer is entitled to a payment under 

this proposal, the amount of such payment is reduced by any amount awarded under such court 

judgment. In the event such judgment is later overturned, the coal producer must pay to the 

Secretary the amount of any payment received under the proposal unless the coal producer 

establishes the export of the coal to a foreign country or shipment of coal to a possession of the 

United States. Subject to the rules below, a coal exporter may file a claim notwithstanding that a 

coal producer or a party related to a coal producer has received a court judgment relating to the 

same coal. 

Under the proposal, the term “coal producer” means the person that owns the coal 

immediately after the coal is severed from the ground, without regard to the existence of any 

contractual arrangement for the sale or other disposition of the coal or the payment of any 

royalties between the producer and third parties. The term also includes any person who extracts 

coal from coal waste refuse piles or from the silt waste product which results from the wet 

washing or similar processing of coal. The term “exporter” means a person, other than a coal 

producer, that does not have an agreement with a producer or seller of such coal to sell or export 

such coal to a third party on behalf of such producer or seller, and that is indicated as the 

exporter of record in the shipper’s export declaration or other documentation, or actually 

exported such coal to a foreign country, shipped such coal to a U.S. possession, or caused such 

coal to be so exported or shipped. The term “a party related to such coal producer” means a 

person that is related to such coal producer through any degree of common management, stock 

ownership, or voting control, is related, within the meaning of section 144(a)(3), to such coal 

producer, or has a contract, fee arrangement, or any other agreement with such coal producer to 

sell such coal to a third party on behalf of such coal producer. 

 32 See sec. 6621. 
29 

The proposal does not apply with respect to excise tax on exported coal if a credit or 

refund of such tax has been allowed or made, or if a “settlement with the Federal Government” 

has been made with and accepted by the coal producer, a party related to such coal producer, or 

the exporter of such coal, as of the date that the claim is filed under the proposal. The term 

“settlement with the Federal Government” does not include a settlement or stipulation entered 

into as of the date of enactment, if such settlement or stipulation contemplates a judgment with 

respect to which any party has filed an appeal or has reserved the right to file an appeal. In 

addition, the proposal does not apply to the extent that a credit or refund of tax on exported coal 

has been paid to any person, regardless of whether such credit or refund occurs prior to, or after, 

the date of enactment. 

The proposal does not confer standing upon an exporter to commence, or intervene in, 

any judicial or administrative proceeding concerning a claim for refund by a coal producer of 

any Federal or State tax, fee, or royalty paid by the coal producer. The proposal does not confer 

standing upon a coal producer to commence, or intervene in, any judicial or administrative 

proceeding concerning a claim for refund by an exporter of any Federal or State tax, fee, or 

royalty paid by the producer and alleged to have been passed on to an exporter. 

Effective Date

The proposal applies to claims on coal exported on or after October 1, 1990 through the 

date of enactment, with respect to amounts of tax for which a return was filed on or after October 

1, 1990, and on or before the date of enactment, and for which a claim for refund is filed not later 

than the close of the 30-day period beginning on the date of enactment. 

10. Carbon audit of provisions of the Internal Revenue Code of 1986 

Present Law

Present law does not require a review of the Code for provisions that affect carbon 

emissions and climate. The National Research Council is part of the National Academies. The 

National Academy of Sciences serves to investigate, examine, experiment and report upon any 

subject of science whenever called upon to do so by any department of the government. The 

National Research Council was organized by the National Academy of Sciences in 1916 and is 

its principal operating agency for conducting science policy and technical work. 

Description of Proposal

The proposal directs the Secretary to request that the National Academy of Sciences 

undertake a comprehensive review of the Code to identify the types of and specific tax 

provisions that have the largest effects on carbon and other greenhouse gas emissions and to 

generally estimate the magnitude of those effects.33 The report should identify the provisions of 

the Code that are most likely to have significant effects on carbon emissions and discuss the 

 33 A detailed quantitative analysis is not required. It is envisioned that the review will catalogue 

and provide a general analysis of the effect of each identified provision. 
30 

importance of controlling carbon and greenhouse gas emissions as part of a comprehensive 

national strategy for reducing U.S. contributions to global climate change.34 The report will 

describe the processes by which the tax provisions affect emissions (both directly and indirectly), 

assess the relative influence of the identified provisions, and evaluate the potential for changes in 

the Code to reduce carbon emissions. The report also will identify other provisions of the Code 

that may have significant influence on other factors affecting climate change. 

The Secretary is to submit to Congress a report containing the results of the National 

Academy of Sciences review within two years of the date of enactment. The proposal authorizes 

the appropriation of $1,500,000 to carry out the review. 

Effective Date

The proposal is effective on the date of enactment. 

 34 “Greenhouse gas emissions” include, but are not limited to, methane, nitrous oxide, ozone, and 

fluorinated hydrocarbons. 
31 

B. Transportation and Domestic Fuel Security Provisions 

1. Credit for production of cellulosic biofuel 

Present Law

In the case of ethanol, the Code provides a separate 10-cents-per-gallon credit for up to 

15 million gallons per year for small producers, defined generally as persons whose production 

capacity does not exceed 60 million gallons per year. The ethanol must (1) be sold by such 

producer to another person (a) for use by such other person in the production of a qualified 

alcohol fuel mixture in such person’s trade or business (other than casual off-farm production), 

(b) for use by such other person as a fuel in a trade or business, or, (c) who sells such ethanol at 

retail to another person and places such ethanol in the fuel tank of such other person; or (2) used 

by the producer for any purpose described in (a), (b), or (c). A cooperative may pass through the 

small ethanol producer credit to its patrons. The credit is includible in income and is treated as a 

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

to business credits generally. The alcohol fuels tax credit, of which the small producer credit is a 

part, is scheduled to expire after December 31, 2010. 

Description of Proposal

The proposal adds a new component to section 40 of the Code, the “cellulosic biofuel 

producer credit.” This credit is a nonrefundable income tax credit for each gallon of qualified 

cellulosic fuel production of the producer for the taxable year. The amount of the credit per 

gallon is $1.01, except in the case of cellulosic biofuel that is alcohol. In the case of cellulosic 

biofuel that is alcohol, the $1.01 credit amount is reduced by (1) the credit amount applicable for 

such alcohol under the alcohol mixture credit as in effect at the time cellulosic biofuel is 

produced and (2) in the case of cellulosic biofuel that is ethanol, the credit amount for small 

ethanol producers as in effect at the time the cellulosic biofuel fuel is produced. The reduction 

applies regardless of whether the producer claims the alcohol mixture credit or small ethanol 

producer credit with respect to the cellulosic alcohol. When the alcohol mixture credit and small 

ethanol producer credit expire after December 31, 2010, cellulosic biofuel will receive the $1.01 

without reduction. 

“Qualified cellulosic biofuel production” is any cellulosic biofuel which is produced by 

the taxpayer and which is sold by the taxpayer to another person (a) for use by such other person 

in the production of a qualified biofuel fuel mixture in such person’s trade or business (other than 

casual off-farm production), (b) for use by such other person as a fuel in a trade or business, or, 

(c) who sells such biofuel at retail to another person and places such biofuel in the fuel tank of 

such other person; or (2) used by the producer for any purpose described in (a), (b), or (c). 

“Cellulosic biofuel” means any liquid fuel that (1) is produced in the United States35 for 

consumption in the United States, (2) is derived from any lignocellulosic or hemicellulosic 

matter that is available on a renewable or recurring basis and (3) meets the registration 

 35 For this purpose, “United States” includes any possession of the United States. 
32 

requirements for fuels and fuel additives established by the Environmental Protection Agency 

under section 211 of the Clean Air Act. Thus, to qualify for the credit the fuel must be approved 

by the Environmental Protection Agency. Cellulosic biofuel does not include any alcohol with a 

proof of less than 150. Examples of lignocellulosic or hemicellulosic matter that is available of 

a renewable or recurring basis include dedicated energy crops and trees, wood and wood 

residues, plants, grasses, agricultural residues, fibers, animal wastes and other waste materials, 

and municipal solid waste. 

A “qualified cellulosic biofuel mixture” is a mixture of cellulosic biofuel and a special 

fuel or of cellulosic biofuel and gasoline, which is sold by the person producing such mixture to 

any person for use as a fuel, or is used as a fuel by the person producing such mixture. The term 

“special fuel” includes any liquid fuel (other than gasoline) which is suitable for use in an 

internal combustion engine. 

The cellulosic biofuel producer credit terminates on December 31, 2015. The proposal 

requires cellulosic biofuel producers to be registered with the IRS. The cellulosic biofuel 

producer credit cannot be claimed unless the taxpayer is registered with the IRS as a producer of 

cellulosic biofuel. 

With respect to the small ethanol producer credit, the proposal also waives the 15 million 

gallon limitation for cellulosic biofuel that is ethanol. Thus the small ethanol producer credit 

may be claimed for cellulosic ethanol in excess of 15 million gallons. The other requirements 

for the small ethanol producer credit continue to apply for ethanol other than cellulosic ethanol, 

including the 15 million gallon limitation. 

Under the proposal, cellulosic biofuel and alcohols cannot qualify as biodiesel, renewable 

diesel, or alternative fuel for purposes of the credit and payment provisions relating to those 

fuels. 

Effective Date

The proposal is effective for fuel produced after December 31, 2008. 

2. Inclusion of cellulosic biofuel in bonus depreciation for biomass ethanol plant property 

Present Law

Section 168(l) allows an additional first-year depreciation deduction equal to 50 percent 

of the adjusted basis of qualified cellulosic biomass ethanol plant property. In order to qualify, 

the property generally must be placed in service before January 1, 2013.

Qualified cellulosic biomass ethanol plant property means property used in the U.S. 

solely to produce cellulosic biomass ethanol. For this purpose, cellulosic biomass ethanol means 

ethanol derived from any lignocellulosic or hemicellulosic matter that is available on a 

renewable or recurring basis. For example, lignocellulosic or hemicellulosic matter that is 

available on a renewable or recurring basis includes bagasse (from sugar cane), corn stalks, and 

switchgrass. 
33 

The additional first-year depreciation deduction is allowed for both regular tax and 

alternative minimum tax purposes for the taxable year in which the property is placed in service. 

The additional first-year depreciation deduction is subject to the general rules regarding whether 

an item is deductible under section 162 or subject to capitalization under section 263 or section 

263A. The basis of the property and the depreciation allowances in the year of purchase and 

later years are appropriately adjusted to reflect the additional first-year depreciation deduction. 

In addition, there is no adjustment to the allowable amount of depreciation for purposes of 

computing a taxpayer’s alternative minimum taxable income with respect to property to which 

the provision applies. A taxpayer is allowed to elect out of the additional first-year depreciation 

for any class of property for any taxable year. 

In order for property to qualify for the additional first-year depreciation deduction, it 

must meet the following requirements. The original use of the property must commence with the 

taxpayer on or after December 20, 2006. The property must be acquired by purchase (as defined 

under section 179(d)) by the taxpayer after December 20, 2006, and placed in service before 

January 1, 2013. Property does not qualify if a binding written contract for the acquisition of 

such property was in effect on or before December 20, 2006. 

Property that is manufactured, constructed, or produced by the taxpayer for use by the 

taxpayer qualifies if the taxpayer begins the manufacture, construction, or production of the 

property after December 20, 2006, and the property is placed in service before January 1, 2013 

(and all other requirements are met). Property that is manufactured, constructed, or produced for 

the taxpayer by another person under a contract that is entered into prior to the manufacture, 

construction, or production of the property is considered to be manufactured, constructed, or 

produced by the taxpayer. 

Property any portion of which is financed with the proceeds of a tax-exempt obligation 

under section 103 is not eligible for the additional first-year depreciation deduction. Recapture 

rules apply if the property ceases to be qualified cellulosic biomass ethanol plant property. 

Property with respect to which the taxpayer has elected 50 percent expensing under 

section 179C is not eligible for the additional first-year depreciation deduction.

Description of Proposal

The proposal changes the definition of qualified property. Under the proposal, qualified 

property includes cellulosic biofuel, which is defined as any liquid fuel which is produced from 

any lignocellulosic or hemicellulosic matter that is available on a renewable or recurring basis. 

Effective Date

The proposal is effective for property placed in service after the date of enactment, in 

taxable years ending after such date. 
34 

3. Extension of credits for biodiesel and extension and modification of renewable diesel 

credit 

Present Law

Income tax credit 

Overview

The Code provides an income tax credit for biodiesel fuels (the “biodiesel fuels credit”).36 

The biodiesel fuels credit is the sum of three credits: (1) the biodiesel mixture credit, (2) the 

biodiesel credit, and (3) the small agri-biodiesel producer credit. The biodiesel fuels credit is 

treated as a general business credit. The amount of the biodiesel fuels credit is includable in 

gross income. The biodiesel fuels credit is coordinated to take into account benefits from the 

biodiesel excise tax credit and payment provisions discussed below. The credit does not apply to 

fuel sold or used after December 31, 2008. 

Biodiesel is monoalkyl esters of long chain fatty acids derived from plant or animal 

matter that meet (1) the registration requirements established by the Environmental Protection 

Agency under section 211 of the Clean Air Act and (2) the requirements of the American Society 

of Testing and Materials ("ASTM") D6751. Agri-biodiesel is biodiesel derived solely from 

virgin oils including oils from corn, soybeans, sunflower seeds, cottonseeds, canola, crambe, 

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

Biodiesel may be taken into account for purposes of the credit only if the taxpayer 

obtains a certification (in such form and manner as prescribed by the Secretary) from the 

producer or importer of the biodiesel that identifies the product produced and the percentage of 

biodiesel and agri-biodiesel in the product. 

Biodiesel mixture credit

The biodiesel mixture credit is 50 cents for each gallon of biodiesel (other than agribiodiesel) used by the taxpayer in the production of a qualified biodiesel mixture. For agribiodiesel, the credit is $1.00 per gallon. A qualified biodiesel mixture is a mixture of biodiesel 

and diesel fuel that is (1) sold by the taxpayer producing such mixture to any person for use as a 

fuel, or (2) is used as a fuel by the taxpayer producing such mixture. The sale or use must be in 

the trade or business of the taxpayer and is to be taken into account for the taxable year in which 

such sale or use occurs. No credit is allowed with respect to any casual off-farm production of a 

qualified biodiesel mixture. 

Biodiesel credit

The biodiesel credit is 50 cents for each gallon of biodiesel that is not in a mixture with 

diesel fuel (100 percent biodiesel or B-100) and which during the taxable year is (1) used by the 

 36 Sec. 40A. 
35 

taxpayer as a fuel in a trade or business or (2) sold by the taxpayer at retail to a person and 

placed in the fuel tank of such person’s vehicle. For agri-biodiesel, the credit is $1.00 per gallon. 

Small agri-biodiesel producer credit

The Code provides a small agri-biodiesel producer income tax credit, in addition to the 

biodiesel and biodiesel fuel mixture credits. The credit is a 10-cents-per-gallon credit for up to 

15 million gallons of agri-biodiesel produced by small producers, defined generally as persons 

whose agri-biodiesel production capacity does not exceed 60 million gallons per year. The agribiodiesel must (1) be sold by such producer to another person (a) for use by such other person in 

the production of a qualified biodiesel mixture in such person’s trade or business (other than 

casual off-farm production), (b) for use by such other person as a fuel in a trade or business, or, 

(c) who sells such agri-biodiesel at retail to another person and places such agri-biodiesel in the 

fuel tank of such other person; or (2) used by the producer for any purpose described in (a), (b), 

or (c). 

Biodiesel mixture excise tax credit

The Code also provides an excise tax credit for biodiesel mixtures.37 The credit is 50 

cents for each gallon of biodiesel used by the taxpayer in producing a biodiesel mixture for sale 

or use in a trade or business of the taxpayer. In the case of agri-biodiesel, the credit is $1.00 per 

gallon. A biodiesel mixture is a mixture of biodiesel and diesel fuel that (1) is sold by the 

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

taxpayer producing such mixture. No credit is allowed unless the taxpayer obtains a certification 

(in such form and manner as prescribed by the Secretary) from the producer of the biodiesel that 

identifies the product produced and the percentage of biodiesel and agri-biodiesel in the 

product.38 

The credit is not available for any sale or use for any period after December 31, 2008. 

This excise tax credit is coordinated with the income tax credit for biodiesel such that credit for 

the same biodiesel cannot be claimed for both income and excise tax purposes. 

Payments with respect to biodiesel fuel mixtures 

If any person produces a biodiesel fuel mixture in such person’s trade or business, the 

Secretary is to pay such person an amount equal to the biodiesel mixture credit.39 To the extent 

the biodiesel fuel mixture credit exceeds the section 4081 liability of a person, the Secretary is to 

pay such person an amount equal to the biodiesel fuel mixture credit with respect to such 

mixture.40 Thus, if the person has no section 4081 liability, the credit is refundable. The 

 37 Sec. 6426(c). 

38 Sec. 6426(c)(4). 

39 Sec. 6427(e). 

40 Sec. 6427(e)(1) and (e)(3). 
36 

Secretary is not required to make payments with respect to biodiesel fuel mixtures sold or used 

after December 31, 2008. 

Renewable diesel

“Renewable diesel” is diesel fuel that (1) is derived from biomass (as defined in section 

45K(c)(3)) using a thermal depolymerization process; (2) meets the registration requirements for 

fuels and fuel additives established by the Environmental Protection Agency (“EPA”) under 

section 211 of the Clean Air Act (42 U.S.C. sec. 7545); and (3) meets the requirements of the 

ASTM D975 or D396. ASTM D975 provides standards for diesel fuel suitable for use in diesel 

engines. ASTM D396 provides standards for fuel oil intended for use in fuel-oil burning 

equipment, such as furnaces. 

For purposes of the Code, renewable diesel is generally treated the same as biodiesel. 

Like biodiesel, the incentive may be taken as an income tax credit, an excise tax credit, or as a 

payment from the Secretary.41 The incentive for renewable diesel is $1.00 per gallon. There is 

no small producer credit for renewable diesel. The incentives for renewable diesel expire after 

December 31, 2008. 

Pursuant to IRS Notice 2007-37, the Secretary provided that fuel produced as a result of 

co-processing biomass and petroleum feedstock (“co-produced fuel”) qualifies for the renewable 

diesel incentives to the extent of the fuel attributable to the biomass in the mixture. In coproduced fuel, the fuel attributable to the biomass does not exist as a distinct separate quantity 

prior to mixing. 

Description of Proposal

The proposal extends an additional year (through December 31, 2009) the income tax 

credit, excise tax credit, and payment provisions for biodiesel (including agri-biodiesel) and 

renewable diesel. The proposal provides that both biodiesel and agri-biodiesel are entitled to a 

credit of $1.00 per gallon. 

The proposal modifies the definition of renewable diesel. The proposal eliminates the 

requirement that the fuel be made using a thermal depolymerization process. The proposal also 

permits the Secretary to identify standards equivalent to ASTM D975 and ASTM D396 for 

renewable diesel. Thus, under the proposal, renewable diesel is liquid fuel derived from biomass 

which meets (a) the registration requirements for fuels and fuel additives established by the EPA 

under section 211 of the Clean Air Act, and (b) the requirements of the ASTM D975, ASTM 

D396, or other equivalent standard approved by the Secretary. The proposal also provides that 

renewable diesel includes biomass fuel that meets a Department of Defense military specification 

for jet fuel or an ASTM for aviation turbine fuel. 

 The proposal also overrides IRS Notice 2007-37 with respect to co-produced fuel, providing 

that renewable diesel does not include any fuel derived from co-processing biomass with a 

 41 Secs. 40A(f), 6426(c), and 6427(e). 
37 

feedstock that is not biomass. The de minimis use of catalysts, such as hydrogen, is permitted 

under the proposal. 

Effective Date

The proposal is generally effective for fuel produced, and sold or used, after December 

31, 2008. The proposal making co-produced fuel ineligible for the renewable diesel incentives is 

effective for fuel produced, and sold or used, after February 13, 2008. 

4. Modification of alcohol credit 

Present Law

Income tax credit

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

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

December 31, 2010.42

Taxpayers are eligible for an income tax credit of 51 cents per gallon of ethanol (60 

cents in the case of alcohol other than ethanol) used in the production of a qualified mixture (the 

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

alcohol and a special fuel) sold by the taxpayer as fuel, or used as fuel by the taxpayer producing 

such mixture. The term “alcohol” includes methanol and ethanol but does not include 

(1) alcohol produced from petroleum, natural gas, or coal (including peat), or (2) alcohol with a 

proof of less than 150. 

Taxpayers may reduce their income taxes by 51 cents for each gallon of ethanol, which is 

not in a mixture with gasoline or other special fuel, that they sell at the retail level as vehicle fuel 

or use themselves as a fuel in their trade or business (“the alcohol credit”). For alcohol other 

than ethanol, the rate is 60 cents per gallon.43 

In the case of ethanol, the Code provides an additional 10-cents-per-gallon credit for up 

to 15 million gallons per year for small producers. Small producer is defined generally as 

persons whose production capacity does not exceed 60 million gallons per year. The ethanol 

must (1) be sold by such producer to another person (a) for use by such other person in the 

production of a qualified alcohol fuel mixture in such person’s trade or business (other than 

casual off-farm production), (b) for use by such other person as a fuel in a trade or business, or, 

(c) who sells such ethanol at retail to another person and places such ethanol in the fuel tank of 

 42 The alcohol fuels credit is unavailable when, for any period before January 1, 2011, the tax 

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

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

190, the credit is 45 cents per gallon (the “low-proof blender amount”). For ethanol with a proof that is at 

least 150 but less than 190, the low-proof blender amount is 37.78 cents. 
38 

such other person; or (2) used by the producer for any purpose described in (a), (b), or (c). A 

cooperative may pass through the small ethanol producer credit to its patrons. 

The alcohol fuels credit is includible in income and is treated as a general business credit, 

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

generally. The credit is allowable against the alternative minimum tax. 

Excise tax credit and payment provision for alcohol fuel mixtures

The Code also provides an excise tax credit and payment provision for alcohol fuel 

mixtures. Like the income tax credit, the amount of the credit is 60 cents per gallon of alcohol 

used as part of a qualified mixture (51 cents in the case of ethanol). For purposes of the excise 

tax credit and payment provisions, alcohol includes methanol and ethanol but does not include 

(1) alcohol produced from petroleum, natural gas, or coal (including peat), or (2) alcohol with a 

proof of less than 190. Such term also includes an alcohol gallon equivalent of ethyl tertiary 

butyl either or other ethers produced from alcohol. In lieu of a tax credit, a person making a 

qualified mixture eligible for the credit may seek a payment from the Secretary in the amount of 

the credit. The payment provisions and credits are coordinated such that the incentive is not 

claimed more than once for each gallon of alcohol used as part of qualified mixture. 

Description of Proposal

The proposal extends an additional year (through December 31, 2009) the income tax 

credit, excise tax credit, and payment provisions for biodiesel (including agri-biodiesel) and 

renewable diesel. The proposal provides that both biodiesel and agri-biodiesel are entitled to a 

credit of $1.00 per gallon. 

The proposal modifies the definition of renewable diesel. The proposal eliminates the 

requirement that the fuel be made using a thermal depolymerization process. The proposal also 

permits the Secretary to identify standards equivalent to ASTM D975 and ASTM D396 for 

renewable diesel. Thus, under the proposal, renewable diesel is liquid fuel derived from biomass 

which meets (a) the registration requirements for fuels and fuel additives established by the EPA 

under section 211 of the Clean Air Act, and (b) the requirements of the ASTM D975, ASTM 

D396, or other equivalent standard approved by the Secretary. The proposal also provides that 

renewable diesel includes biomass fuel that meets a Department of Defense military specification 

for jet fuel or an ASTM for aviation turbine fuel. 

 The proposal also overrides IRS Notice 2007-37 with respect to co-produced fuel, providing 

that renewable diesel does not include any fuel derived from co-processing biomass with a 

feedstock that is not biomass. The de minimis use of catalysts, such as hydrogen, is permitted 

under the proposal. 

Effective Date

The proposal is effective on the date of enactment. 
39 

5. Calculation of volume of alcohol for fuel credits 

Present Law

The Code provides a per-gallon credit for the volume of alcohol used as a fuel or in a 

qualified mixture. For purposes of determining the number of gallons of alcohol with respect to 

which the credit is allowable, the volume of alcohol includes any denaturant, including 

gasoline.44 The denaturant must be added under a formula approved by the Secretary and the 

denaturant cannot exceed five percent of the volume of such alcohol (including denaturants). 

Description of Proposal

The proposal provides that in calculating the volume of alcohol eligible for the credit the 

amount of denaturants cannot exceed two percent. 

Effective Date

The proposal is effective for fuel sold or used after December 31, 2008. 

6. Clarification that credits for fuel are designed to provide an incentive for United States 

production 

Present Law

The Code provides per-gallon incentives relating to the following qualified fuels: alcohol 

(including ethanol), biodiesel (including agri-biodiesel), renewable diesel, and certain alternative 

fuels.45 The incentives may be taken as an income tax credit, excise tax credit or payment. The 

provisions are coordinated so that a gallon of qualified fuel is only taken into account once. If 

the qualified fuel is part of a qualified fuel mixture, the incentives apply only to the amount of 

qualified fuel in the mixture. 

For alcohol, other than ethanol, the amount of the credit is 60 cents per gallon. For 

ethanol, the credit is generally 51 cents per gallon, an extra 10 cents per gallon available for 

small ethanol producers. The alcohol incentives expire after December 31, 2010. The amount of 

the credit for biodiesel is 50 cents. For agri-biodiesel and renewable diesel, the credit amount is 

$1.00 per gallon. An extra 10 cents per gallon is available for small producers of agri-biodiesel. 

The biodiesel, agri-biodiesel and renewable diesel incentives expire after December 31, 2008. 

The credit amount for alternative fuels is 50 cents per gallon. The incentives for alternative fuels 

expire after September 30, 2009 (after September 30, 2014, in the case of liquefied hydrogen). 

 44 Sec. 40(d)(4). 

45 See secs. 40, 40A, 6426, and 6427(e). 
40 

The Code is silent as to the geographic limitations on where the fuel must be produced, 

used, or sold. For imported ethanol, there is an offsetting tariff of 54 cents per gallon. This tariff 

expires January 1, 2009. 

Description of Proposal

The proposal provides that fuel that is produced outside the United States for use as a fuel 

outside the United States is ineligible for the per-gallon tax incentives relating to alcohol, 

biodiesel, renewable diesel, and alternative fuel. For example, fuel in the following situations is 

ineligible for incentives: (1) biodiesel, which is not in a mixture, that is both produced and used 

outside the United States, (2) foreign-produced biodiesel that is used to make a qualified mixture 

outside of the United States for foreign use, and (3) foreign-produced biodiesel that is used to 

make a qualified mixture in the United States that is then exported for foreign use. 

Effective Date

The proposal is effective for claims for credit or payment made on or after May 15, 2008. 

7. Alternative motor vehicle credit and plug-in electric vehicle credit 

Present Law

In general

A credit is available for each new qualified fuel cell vehicle, hybrid vehicle, advanced 

lean burn technology vehicle, and alternative fuel vehicle placed in service by the taxpayer 

during the taxable year.46 In general, the credit amount varies depending upon the type of 

technology used, the weight class of the vehicle, the amount by which the vehicle exceeds 

certain fuel economy standards, and, for some vehicles, the estimated lifetime fuel savings. The 

credit generally is available for vehicles purchased after 2005. The credit terminates after 2009, 

2010, or 2014, depending on the type of vehicle. 

In general, the credit is allowed to the vehicle owner, including the lessor of a vehicle 

subject to a lease. If the use of the vehicle is described in paragraphs (3) or (4) of section 50(b) 

(relating to use by tax-exempt organizations, governments, and foreign persons) and is not 

subject to a lease, the seller of the vehicle may claim the credit so long as the seller clearly 

discloses to the user in a document the amount that is allowable as a credit. A vehicle must be 

used predominantly in the United States to qualify for the credit. 

Fuel cell vehicles

A qualified fuel cell vehicle is a motor vehicle that is propelled by power derived from 

one or more cells that convert chemical energy directly into electricity by combining oxygen 

with hydrogen fuel that is stored on board the vehicle and may or may not require reformation 

 46 Sec. 30B. 
41 

prior to use. A qualified fuel cell vehicle must be purchased before January 1, 2015. The amount 

of credit for the purchase of a fuel cell vehicle is determined by a base credit amount that 

depends upon the weight class of the vehicle and, in the case of automobiles or light trucks, an 

additional credit amount that depends upon the rated fuel economy of the vehicle compared to a 

base fuel economy. For these purposes the base fuel economy is the 2002 model year city fuel 

economy rating for vehicles of various weight classes.47 Table 2, below, shows the base credit 

amounts. 

Table 2.–Base Credit Amount for Fuel Cell Vehicles 

Vehicle Gross Weight Rating (pounds) Credit Amount 

Vehicle ≤ 8,500 $8,000 

8,500 < vehicle ≤ 14,000 $10,000 

14,000 < vehicle ≤ 26,000 $20,000 

26,000 < vehicle $40,000 

In the case of a fuel cell vehicle weighing less than 8,500 pounds and placed in service 

after December 31, 2009, the $8,000 amount in Table 2, above is reduced to $4,000. 

Table 3, below, shows the additional credits for passenger automobiles or light trucks. 

Table 3.–Credit for Qualified Fuel Cell Vehicles 

If Fuel Economy of the Fuel Cell Vehicle Is: 

Credit 

at least but less than 

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

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

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

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

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

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

$4,000 300% of base fuel economy 

 47 See discussion surrounding Table 7, below. 
42 

Hybrid vehicles and advanced lean burn technology vehicles

Qualified hybrid vehicle

A qualified hybrid vehicle is a motor vehicle that draws propulsion energy from on-board 

sources of stored energy that include both an internal combustion engine or heat engine using 

combustible fuel and a rechargeable energy storage system (e.g., batteries). A qualified hybrid 

vehicle must be placed in service before January 1, 2011 (January 1, 2010 in the case of a hybrid 

vehicle weighing more than 8,500 pounds). 

Hybrid vehicles that are automobiles and light trucks

In the case of an automobile or light truck (vehicles weighing 8,500 pounds or less), the 

amount of credit for the purchase of a hybrid vehicle is the sum of two components: (1) a fuel 

economy credit amount that varies with the rated fuel economy of the vehicle compared to a 

2002 model year standard and (2) a conservation credit based on the estimated lifetime fuel 

savings of the qualified vehicle compared to a comparable 2002 model year vehicle that is 

powered solely by a gasoline or diesel internal combustion engine. A qualified hybrid 

automobile or light truck must have a maximum available power48 from the rechargeable energy 

storage system of at least four percent. In addition, the vehicle must meet or exceed certain 

Environmental Protection Agency (“EPA”) emissions standards. For a vehicle with a gross 

vehicle weight rating of 6,000 pounds or less the applicable emissions standards are the Bin 5 

Tier II emissions standards. For a vehicle with a gross vehicle weight rating greater than 6,000 

pounds and less than or equal to 8,500 pounds, the applicable emissions standards are the Bin 8 

Tier II emissions standards. 

Table 4, below, shows the fuel economy credit available to a hybrid passenger 

automobile or light truck whose fuel economy (on a gasoline gallon equivalent basis) exceeds 

that of a base fuel economy. 

Table 4.–Fuel Economy Credit 

 If Fuel Economy of the Hybrid Vehicle Is: 

Credit at least but less than 

 $400 125% of base fuel economy 150% of base fuel economy 

 $800 150% of base fuel economy 175% of base fuel economy 

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

 $1,600 200% of base fuel economy 225% of base fuel economy 

 $2,000 225% of base fuel economy 250% of base fuel economy 

 $2,400 250% of base fuel economy 

 48 For hybrid passenger vehicles and light trucks, the term “maximum available power” means 

the maximum power available from the rechargeable energy storage system, during a standard 10 second 

pulse power or equivalent test, divided by such maximum power and the SAE net power of the heat 

engine. Sec. 30B(d)(3)(C)(i). 
43 

Table 5, below, shows the conservation credit. 

Table 5.–Conservation Credit 

Estimated Lifetime Fuel Savings 

(gallons of gasoline) Conservation Amount 

At least 1,200 but less than 1,800 $250 

At least 1,800 but less than 2,400 $500 

At least 2,400 but less than 3,000 $750 

At least 3,000 $1,000 

Advanced lean burn technology vehicles

The amount of credit for the purchase of an advanced lean burn technology vehicle is the 

sum of two components: (1) a fuel economy credit amount that varies with the rated fuel 

economy of the vehicle compared to a 2002 model year standard as described in Table 4, above, 

and (2) a conservation credit based on the estimated lifetime fuel savings of a qualified vehicle 

compared to a comparable 2002 model year vehicle as described in Table 5, above. The amounts 

of the credits are determined after an adjustment is made to account for the different BTU 

content of gasoline and the fuel utilized by the lean burn technology vehicle. 

A qualified advanced lean burn technology vehicle is a passenger automobile or a light 

truck that incorporates direct injection, achieves at least 125 percent of the 2002 model year city 

fuel economy, and for 2004 and later model vehicles meets or exceeds certain Environmental 

Protection Agency emissions standards. For a vehicle with a gross vehicle weight rating of 

6,000 pounds or less the applicable emissions standards are the Bin 5 Tier II emissions standards. 

For a vehicle with a gross vehicle weight rating greater than 6,000 pounds and less than or equal 

to 8,500 pounds, the applicable emissions standards are the Bin 8 Tier II emissions standards. A 

qualified advanced lean burn technology vehicle must be placed in service before January 1, 

2011.Limitation on number of qualified hybrid and advanced lean burn technology vehicles 

eligible for the credit 

There is a limitation on the number of qualified hybrid vehicles and advanced lean burn 

technology vehicles sold by each manufacturer of such vehicles that are eligible for the credit. 

Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar 

quarter after the quarter in which the manufacturer records the 60,000th hybrid and advanced 

lean burn technology vehicle sale occurring after December 31, 2005. Taxpayers may claim one 

half of the otherwise allowable credit during the two calendar quarters subsequent to the first 

quarter after the manufacturer has recorded its 60,000th such sale. In the third and fourth 

calendar quarters subsequent to the first quarter after the manufacturer has recorded its 60,000th 

such sale, the taxpayer may claim one quarter of the otherwise allowable credit. 

Thus, for example, summing the sales of qualified hybrid vehicles of all weight classes 

and all sales of qualified advanced lean burn technology vehicles, if a manufacturer records the 

sale of its 60,000th qualified vehicle in February of 2007, taxpayers purchasing such vehicles 
44 

from the manufacturer may claim the full amount of the credit on their purchases of qualified 

vehicles through June 30, 2007. For the period July 1, 2007, through December 31, 2007, 

taxpayers may claim one half of the otherwise allowable credit on purchases of qualified vehicles 

of the manufacturer. For the period January 1, 2008, through June 30, 2008, taxpayers may 

claim one quarter of the otherwise allowable credit on the purchases of qualified vehicles of the 

manufacturer. After June 30, 2008, no credit may be claimed for purchases of hybrid vehicles or 

advanced lean burn technology vehicles sold by the manufacturer. 

Hybrid vehicles that are medium and heavy trucks

In the case of a qualified hybrid vehicle weighing more than 8,500 pounds, the amount of 

credit is determined by the estimated increase in fuel economy and the incremental cost of the 

hybrid vehicle compared to a comparable vehicle powered solely by a gasoline or diesel internal 

combustion engine and that is comparable in weight, size, and use of the vehicle. For a vehicle 

that achieves a fuel economy increase of at least 30 percent but less than 40 percent, the credit is 

equal to 20 percent of the incremental cost of the hybrid vehicle. For a vehicle that achieves a 

fuel economy increase of at least 40 percent but less than 50 percent, the credit is equal to 30 

percent of the incremental cost of the hybrid vehicle. For a vehicle that achieves a fuel economy 

increase of 50 percent or more, the credit is equal to 40 percent of the incremental cost of the 

hybrid vehicle. 

The credit is subject to certain maximum applicable incremental cost amounts. For a 

qualified hybrid vehicle weighing more than 8,500 pounds but not more than 14,000 pounds, the 

maximum allowable incremental cost amount is $7,500. For a qualified hybrid vehicle weighing 

more than 14,000 pounds but not more than 26,000 pounds, the maximum allowable incremental 

cost amount is $15,000. For a qualified hybrid vehicle weighing more than 26,000 pounds, the 

maximum allowable incremental cost amount is $30,000. 

A qualified hybrid vehicle weighing more than 8,500 pounds but not more than 14,000 

pounds must have a maximum available power from the rechargeable energy storage system of 

at least 10 percent. A qualified hybrid vehicle weighing more than 14,000 pounds must have a 

maximum available power from the rechargeable energy storage system of at least 15 percent.49

Alternative fuel vehicle

The credit for the purchase of a new alternative fuel vehicle is 50 percent of the 

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

emissions standards. The incremental cost of any new qualified alternative fuel vehicle is the 

 49 In the case of such heavy-duty hybrid motor vehicles, the percentage of maximum available 

power is computed by dividing the maximum power available from the rechargeable energy storage 

system during a standard 10-second pulse power test, divided by the vehicle’s total traction power. A 

vehicle’s total traction power is the sum of the peak power from the rechargeable energy storage system 

and the heat (e.g., internal combustion or diesel) engine’s peak power. If the rechargeable energy storage 

system is the sole means by which the vehicle can be driven, then the total traction power is the peak 

power of the rechargeable energy storage system. 
45 

excess of the manufacturer’s suggested retail price for such vehicle over the price for a gasoline 

or diesel fuel vehicle of the same model. To be eligible for the credit, a qualified alternative fuel 

vehicle must be purchased before January 1, 2011. 

The amount of the credit varies depending on the weight of the qualified vehicle. The 

credit is subject to certain maximum applicable incremental cost amounts. Table 6, below, 

shows the maximum permitted incremental cost for the purpose of calculating the credit for 

alternative fuel vehicles by vehicle weight class as well as the maximum credit amount for such 

vehicles. 

Table 6.–Maximum Allowable Incremental Cost for Calculation 

of Alternative Fuel Vehicle Credit 

Vehicle Gross Weight Rating (pounds) Maximum Allowable 

Incremental Cost 

Maximum 

Allowable Credit 

Vehicle ≤ 8,500 $5,000 $4,000 

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

14,000 < vehicle ≤ 26,000 $25,000 $20,000 

26,000 < vehicle $40,000 $32,000 

Alternative fuels comprise compressed natural gas, liquefied natural gas, liquefied 

petroleum gas, hydrogen, and any liquid fuel that is at least 85 percent methanol. Qualified 

alternative fuel vehicles are vehicles that operate only on qualified alternative fuels and are 

incapable of operating on gasoline or diesel (except to the extent gasoline or diesel fuel is part of 

a qualified mixed fuel, described below). 

Certain mixed fuel vehicles, that is vehicles that use a combination of an alternative fuel 

and a petroleum-based fuel, are eligible for a reduced credit. If the vehicle operates on a mixed 

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

otherwise allowable alternative fuel vehicle credit. If the vehicle operates on a mixed fuel that is 

at least 90 percent alternative fuel, the vehicle is eligible for 90 percent of the otherwise 

allowable alternative fuel vehicle credit. 

Base fuel economy

The base fuel economy is the 2002 model year city fuel economy by vehicle type and 

vehicle inertia weight class. For this purpose, “vehicle inertia weight class” has the same 

meaning as when defined in regulations prescribed by the EPA for purposes of Title II of the 

Clean Air Act. Table 7, below, shows the 2002 model year city fuel economy for vehicles by 

type and by inertia weight class. 
46 

Table 7.–2002 Model Year City Fuel Economy 

Vehicle Inertia 

Weight Class 

(pounds) 

Passenger Automobile 

(miles per gallon) 

Light Truck 

(miles per gallon) 

1,500 45.2 39.4 

1,750 45.2 39.4 

2,000 39.6 35.2 

2,250 35.2 31.8 

2,500 31.7 29.0 

2,750 28.8 26.8 

3,000 26.4 24.9 

3,500 22.6 21.8 

4,000 19.8 19.4 

4,500 17.6 17.6 

5,000 15.9 16.1 

5,500 14.4 14.8 

6,000 13.2 13.7 

6,500 12.2 12.8 

7,000 11.3 12.1 

8,500 11.3 12.1 

Other rules

The portion of the credit attributable to vehicles of a character subject to an allowance for 

depreciation is treated as a portion of the general business credit; the remainder of the credit is 

allowable to the extent of the excess of the regular tax (reduced by certain other credits) over the 

alternative minimum tax for the taxable year. 

Description of Proposal

Treatment of alternative motor vehicle credit as a personal credit

The proposal modifies the alternative motor vehicle credit by treating the nonbusiness 

portion of that credit as a personal credit. As a result, in the event Congress extends the proposal 

allowing personal credits to offset the alternative minimum tax, the alternative motor vehicle 

credit will be allowable against the alternative minimum tax. 
47 

Plug-in electric drive motor vehicle credit

The proposal allows a credit for each qualified plug-in electric drive motor vehicle placed 

in service. A qualified plug-in electric drive motor vehicle is a motor vehicle that meets certain 

emissions standards and is propelled to a significant extent by an electric motor that draws 

electricity from a battery that (1) has a capacity of at least four kilowatt-hours and (2) is capable 

of being recharged from an external source of electricity. Qualified vehicles must have a gross 

weight of less than 14,000 pounds. In addition, qualified vehicles weighing less than 8,500 

pounds must be passenger automobiles or light trucks. 

The base amount of the plug-in electric drive motor vehicle credit is $3,000. If the 

qualified vehicle draws propulsion from a battery with at least five kilowatt-hours of capacity, 

the credit amount is increased by $200, plus another $200 for each kilowatt-hour of battery 

capacity in excess of five kilowatt-hours, up to a maximum additional credit of $2,000. 

In general, the credit is available to the vehicle owner, including the lessor of a vehicle 

subject to lease. If the qualified vehicle is used by certain tax-exempt organizations, 

governments, or foreign persons and is not subject to a lease, the seller of the vehicle may claim 

the credit so long as the seller clearly discloses to the user in a document the amount that is 

allowable as a credit. A vehicle must be used predominantly in the United States to qualify for 

the credit. 

There is a limitation on the number of qualified plug-in electric drive motor vehicles sold 

by each manufacturer of such vehicles that are eligible for the credit. Taxpayers may claim the 

full amount of the allowable credit up to the end of the first calendar quarter after the quarter in 

which the manufacturer records the 60,000th plug-in electric drive motor vehicle sale. 

Taxpayers may claim one half of the otherwise allowable credit during the two calendar quarters 

subsequent to the first quarter after the manufacturer has recorded its 60,000th such sale. In the 

third and fourth calendar quarters subsequent to the first quarter after the manufacturer has 

recorded its 60,000th such sale, the taxpayer may claim one quarter of the otherwise allowable 

credit. 

The basis of any qualified vehicle is reduced by the amount of the credit. To the extent a 

vehicle is eligible for credit as a qualified plug-in electric drive motor vehicle, it is not eligible 

for credit as a qualified hybrid vehicle under section 30B. The portion of the credit attributable 

to vehicles of a character subject to an allowance for depreciation is treated as part of the general 

business credit; the nonbusiness portion of the credit is allowable to the extent of the excess of 

the regular tax and the alternative minimum tax (reduced by certain other credits) for the taxable 

year. 

Effective Date

The plug-in electric drive motor vehicle credit proposal is effective for taxable years 

beginning after December 31, 2008. The proposal treating the nonbusiness portion of the 

alternative motor vehicle credit as a personal credit is effective for taxable years beginning after 

December 31, 2007. 
48 

8. Exclusion from heavy vehicle excise tax for idling reduction units and advanced 

insulation 

Present Law

A 12 percent excise tax (the “heavy vehicle excise tax”) is imposed on the first retail sale 

of automobile truck chassis and bodies, truck trailer and semitrailer chassis and bodies, and 

tractors of the kind chiefly used for highway transportation in combination with a trailer or 

semitrailer.50 The heavy vehicle excise tax does not apply to automobile truck chassis and 

bodies suitable for use with a vehicle which has a gross vehicle weight of 33,000 pounds or less. 

The tax also does not apply to truck trailer and semitrailer chassis and bodies suitable for use 

with a trailer or semitrailer which has a gross vehicle weight of 26,000 pounds or less, or to 

tractors having a gross vehicle weight of 19,500 pounds or less if such tractor in combination 

with a trailer or semitrailer has a gross combined weight of 33,000 pounds or less. 

If the owner, lessee, or operator of a taxable article installs any part or accessory within 

six months after the date such vehicle was first placed in service, a 12 percent tax applies on the 

price of such part or accessory and its installation. 

Description of Proposal

The proposal provides an exemption from the heavy vehicle excise tax for the cost of 

qualifying idling reduction devices. A qualifying idling reduction device means any device or 

system of devices that (1) is designed to provide to a vehicle those services (such as heat, air 

conditioning, or electricity), which would otherwise require the operation of the main drive 

engine while the vehicle is temporarily parked or remains stationary, by using one or more 

devices affixed to a tractor, and (2) is certified by the Secretary of Energy, in consultation with 

the Administrator of the Environmental Protection Agency and the Secretary of Transportation, 

to reduce idling of such vehicle at a motor vehicle rest stop or other location where such vehicles 

are temporarily parked or remain stationary. 

The proposal also provides an exemption for the installation of “advanced insulation” in a 

commercial refrigerated truck or trailer that is subject to the heavy vehicle excise tax. Advanced 

insulation means insulation that has an R value of not less than R35 per inch. 

Both exemptions apply regardless of whether the device or insulation is factory installed 

or later added as an accessory. 

Effective Date

The proposal is effective for retail sales or installations made after the date of enactment.

 50 Sec. 4051. 
49 

9. Restructure New York Liberty Zone tax incentives 

Present Law

In general

Present law includes a number of incentives to invest in property located in the New 

York Liberty Zone (“NYLZ”), which is the area located on or south of Canal Street, East 

Broadway (east of its intersection with Canal Street), or Grand Street (east of its intersection with 

East Broadway) in the Borough of Manhattan in the City of New York, New York. These 

incentives were enacted following the terrorist attack in New York City on September 11, 

2001.51

Special depreciation allowance for qualified New York Liberty Zone property

Section 1400L(b) allows an additional first-year depreciation deduction equal to 30 

percent of the adjusted basis of qualified NYLZ property. 52 In order to qualify, property 

generally must be placed in service on or before December 31, 2006 (December 31, 2009 in the 

case of nonresidential real property and residential rental property). 

The additional first-year depreciation deduction is allowed for both regular tax and 

alternative minimum tax purposes for the taxable year in which the property is placed in service. 

A taxpayer is allowed to elect out of the additional first-year depreciation for any class of 

property for any taxable year. 

In order for property to qualify for the additional first-year depreciation deduction, it 

must meet all of the following requirements. First, the property must be property to which the 

general rules of the Modified Accelerated Cost Recovery System (“MACRS”)53 apply with (1) 

an applicable recovery period of 20 years or less, (2) water utility property (as defined in section 

168(e)(5)), (3) certain nonresidential real property and residential rental property, or (4) 

computer software other than computer software covered by section 197. A special rule 

precludes the additional first-year depreciation under this provision for (1) qualified NYLZ 

 51 In addition to the NYLZ provisions described above, other NYLZ incentives are provided: (1) 

$8 billion of tax-exempt private activity bond financing for certain nonresidential real property, 

residential rental property and public utility property is authorized to be issued after March 9, 2002, and 

before January 1, 2010; and (2) $9 billion of additional tax-exempt advance refunding bonds is available 

after March 9, 2002, and before January 1, 2006, with respect to certain State or local bonds outstanding 

on September 11, 2001. 

52 The amount of the additional first-year depreciation deduction is not affected by a short 

taxable year. 

53 A special rule precludes the additional first-year depreciation deduction for property that is 

required to be depreciated under the alternative depreciation system of MACRS. 
50 

leasehold improvement property54 and (2) property eligible for the additional first-year 

depreciation deduction under section 168(k) (i.e., property is eligible for only one 30 percent 

additional first-year depreciation). Second, substantially all of the use of such property must be 

in the NYLZ. Third, the original use of the property in the NYLZ must commence with the 

taxpayer on or after September 11, 2001. Finally, the property must be acquired by purchase55

by the taxpayer after September 10, 2001 and placed in service on or before December 31, 2006. 

For qualifying nonresidential real property and residential rental property the property must be 

placed in service on or before December 31, 2009 in lieu of December 31, 2006. Property will 

not qualify if a binding written contract for the acquisition of such property was in effect before 

September 11, 2001. 56

Nonresidential real property and residential rental property are eligible for the additional 

first-year depreciation only to the extent such property rehabilitates real property damaged, or 

replaces real property destroyed or condemned as a result of the terrorist attacks of September 

11, 2001. 

Property that is manufactured, constructed, or produced by the taxpayer for use by the 

taxpayer qualifies for the additional first-year depreciation deduction if the taxpayer begins the 

manufacture, construction, or production of the property after September 10, 2001, and the 

property is placed in service on or before December 31, 200657 (and all other requirements are 

met). Property that is manufactured, constructed, or produced for the taxpayer by another person 

under a contract that is entered into prior to the manufacture, construction, or production of the 

property is considered to be manufactured, constructed, or produced by the taxpayer. 

 54 Qualified NYLZ leasehold improvement property is defined in another provision. Leasehold 

improvements that do not satisfy the requirements to be treated as “qualified NYLZ leasehold 

improvement property” may be eligible for the 30 percent additional first-year depreciation deduction 

(assuming all other conditions are met). 

55 For purposes of this provision, purchase is defined as under section 179(d). 

56 Property is not precluded from qualifying for the additional first-year depreciation merely 

because a binding written contract to acquire a component of the property is in effect prior to September 

11, 2001. 

57 December 31, 2009 with respect to qualified nonresidential real property and residential rental 

property. 
51 

Description of Proposal

Repeal of certain NYLZ incentives

The proposal repeals the NYLZ incentive for the additional first-year depreciation 

allowance of 30 percent for nonresidential real property and residential rental property as of the 

date of enactment of this proposal.58

Creation of New York Liberty Zone Tax Credits

The proposal provides a credit against tax imposed for any payroll period by section 3402 

(related to withholding for wages paid) for which a New York Liberty Zone governmental unit is 

liable under section 3403. The credit is equal to such portion of the qualifying project 

expenditure amounts allocated to the governmental unit for the calendar year that such 

governmental unit allocates to such period. The amount of the credit allowed for any payroll 

period shall be treated as a payment to the Secretary on the day on which the wages were paid to 

the employee, but only to the extent the governmental unit actually deducted and withheld such 

wages for the applicable period. A New York Liberty Zone governmental unit is the State of 

New York, the City of New York, or any agency or instrumentality of such State or city. 

Qualifying project expenditure amount means, with respect to any calendar year, the sum 

of (1) the total expenditures paid or incurred during such calendar year by all New York Liberty 

Zone governmental units and the Port Authority of New York and New Jersey for any portion of 

qualifying projects located wholly within the City of New York, and (2) any such expenditures 

paid or incurred in any preceding calendar year beginning after the date of enactment of this 

proposal and not previously allocated. 

A qualifying project is any transportation infrastructure project, including highways, 

mass transit systems, railroads, airports, ports, and waterways, in or connecting with the New 

York Liberty Zone, which is designated as a qualifying project by the Governor of the State of 

New York and the Mayor of the City of New York. 

The Governor of the State of New York and the Mayor of the City of New York are to 

jointly allocate to each New York Liberty Zone governmental unit the portion of the qualifying 

expenditure amount that may be taken into account by such governmental unit to determine the 

credit for any calendar year in the credit period. The credit period is the 12-year period 

beginning on January 1, 2009. Aggregate amounts allocated may not exceed $2 billion during 

the credit period. There is also an annual limit on allocations equal to (1) $115 million for each 

year in the first ten years of the credit period, plus (2) any amounts in (1) that were authorized to 

be allocated for prior calendar years in the credit period but not so allocated. The annual limit for 

each of the last two years of the credit period is $425 million, plus any amounts that were 

authorized to be allocated for prior calendar years in the credit period but not so allocated. 

 58 In the case of nonresidential real property and residential rental property acquired pursuant to a 

binding contract in effect on such enactment date, provision terminates on December 31, 2009. 
52 

If amounts allocated to a New York Liberty Zone governmental unit exceed the 

aggregate taxes for which such unit is liable under section 3403, the excess may be carried to the 

succeeding calendar year and added to the allocation for that calendar year. If a New York 

Liberty Zone governmental unit does not use an amount allocated to it within the time prescribed 

by the Governor of the State of New York and the Mayor of the City of New York, such amounts 

will be treated as if never allocated, and thus they may be reallocated by the Governor and 

Mayor. 

Under the proposal, any expenditure for a qualifying project taken into account for 

purposes of the credit shall be considered State and local funds for the purpose of any Federal 

program. 

The Governor of the State of New York and the Mayor of the City of New York must 

jointly submit to the Secretary an annual report that certifies the qualifying project expenditure 

amounts for the calendar year, the amount allocated to each New York Liberty Zone 

governmental unit, and any other such information as the Secretary may require. 

Effective Date

The proposal is effective on the date of enactment. 

10. Extension of transportation fringe benefit to bicycle commuters 

Present Law

Qualified transportation fringe benefits provided by an employer are excluded from an 

employee's gross income.59 Qualified transportation fringe benefits include parking, transit 

passes, and vanpool benefits. In addition, no amount is includible in income of an employee 

merely because the employer offers the employee a choice between cash and qualified 

transportation fringe benefits. Up to $220 (for 2008) per month of employer-provided parking is 

excludable from income. Up to $115 (for 2008) per month of employer-provided transit and 

vanpool benefits are excludable from gross income. These amounts are indexed annually for 

inflation, rounded to the nearest multiple of $5. 

Under present law, qualified transportation fringe benefits include a cash reimbursement 

by an employer to an employee. However, in the case of transit passes, a cash reimbursement is 

considered a qualified transportation fringe benefit only if a voucher or similar item which may 

be exchanged only for a transit pass is not readily available for direct distribution by the 

employer to the employee. 

Description of Proposal

The proposal adds a qualified bicycle commuting reimbursement fringe benefit as a 

qualified transportation fringe benefit. A qualified bicycle commuting reimbursement fringe 

 59 Code sec. 132(f). 
53 

benefit means, with respect to a calendar year, any employer reimbursement during the 15-month 

period beginning with the first day of such calendar year of an employee for reasonable expenses 

incurred by the employee during the calendar year for the purchase and repair of a bicycle, 

bicycle improvements, and bicycle storage, provided that the bicycle is regularly used for travel 

between the employee’s residence and place of employment. 

The maximum amount that can be excluded from an employee’s gross income for a 

calendar year on account of a bicycle commuting reimbursement fringe benefit is the applicable 

annual limitation for the employee for that calendar year. The applicable annual limitation for an 

employee for a calendar year is equal to the product of $20 multiplied by the number of the 

employee’s qualified bicycle commuting months for the year. The $20 amount is not indexed for 

inflation. A qualified bicycle commuting month means with respect to an employee any month 

for which the employee does not receive any other qualified transportation fringe benefit and 

during which the employee regularly uses a bicycle for a substantial portion of travel between 

the employee’s residence and place of employment. Thus, no amount is credited towards an 

employee’s applicable annual limitation for any month in which an employee’s usage of a 

bicycle is infrequent or constitutes an insubstantial portion of the employee’s commute. 

A bicycle commuting reimbursement fringe benefit cannot be funded by an elective 

salary contribution on the part of an employee. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2008. 

11. Extension and modification of alternative fuel vehicle refueling property credit 

Present Law

Taxpayers may claim a 30-percent credit for the cost of installing qualified clean-fuel 

vehicle refueling property to be used in a trade or business of the taxpayer or installed at the 

principal residence of the taxpayer.60 The credit may not exceed $30,000 per taxable year, per 

location, in the case of qualified refueling property used in a trade or business and $1,000 per 

taxable year per location in the case of qualified refueling property installed on property which is 

used as a principal residence. 

Qualified refueling property is property (not including a building or its structural 

components) for the storage or dispensing of a clean-burning fuel into the fuel tank of a motor 

vehicle propelled by such fuel, but only if the storage or dispensing of the fuel is at the point 

where such fuel is delivered into the fuel tank of the motor vehicle. The use of such property 

must begin with the taxpayer. 

Clean-burning fuels are any fuel at least 85 percent of the volume of which consists of 

ethanol, natural gas, compressed natural gas, liquefied natural gas, liquefied petroleum gas, or 

 60 Sec. 30C. 
54 

hydrogen. In addition, any mixture of biodiesel and diesel fuel, determined without regard to 

any use of kerosene and containing at least 20 percent biodiesel, qualifies as a clean fuel. 

Credits for qualified refueling property used in a trade or business are part of the general 

business credit and may be carried back for one year and forward for 20 years. Credits for 

residential qualified refueling property cannot exceed for any taxable year the difference between 

the taxpayer’s regular tax (reduced by certain other credits) and the taxpayer’s tentative 

minimum tax. Generally, in the case of qualified refueling property sold to a tax-exempt entity, 

the taxpayer selling the property may claim the credit. 

A taxpayer’s basis in qualified refueling property is reduced by the amount of the credit. 

In addition, no credit is available for property used outside the United States or for which an 

election to expense has been made under section 179. 

The credit is available for property placed in service after December 31, 2005, and 

(except in the case of hydrogen refueling property) before January 1, 2010. In the case of 

hydrogen refueling property, the property must be placed in service before January 1, 2015. 

Description of Proposal

The proposal extends and modifies the credit for installing alternative fuel refueling 

property. The proposal extends for one year (through 2010) the credit for installing nonhydrogen alternative fuel refueling property. The proposal also increases the credit amount to 50 

percent of the cost of the qualified property and raises to $50,000 per taxable year, per location, 

the limit with respect to depreciable qualified property. 

Effective Date

The proposal is effective for property placed in service after the date of enactment, in 

taxable years ending after such date. 

12. Comprehensive study of biofuels 

Present Law

The National Academy of Sciences serves to investigate, examine, experiment and report 

upon any subject of science whenever called upon to do so by any department of the 

government. The National Research Council is part of the National Academies. The National 

Research Council was organized by the National Academy of Sciences in 1916 and is its 

principal operating agency for conducting science policy and technical work. 

Description of Proposal

The proposal requires the Secretary, in consultation with the Department of Energy and 

the Department of Agriculture and the Environmental Protection Agency, to enter into an 

agreement with the National Academy of Sciences to produce an analysis of current scientific 

findings to determine: 
55 

1. Current biofuels production, as well as projections for future production; 

2. The maximum amount of biofuels production capable on U.S. forests and farmlands, 

including the current quantities and character of the feedstocks and inclusing such 

information as regional forest inventories that are commercially available, used in the 

production of biofuels; 

3. The domestic effects of an increase in biofuels production on, for example, (a) the 

price of fuel, (b) the price of land in rural and suburban communities, (c) crop acreage 

and other land use, (d) the environment, due to changes in crop acreage, fertilizer use, 

runoff, water use, emissions from vehicles utilizing biofuels, and other factors, (e) the 

price of feed, (f) the selling price of grain crops, and unprocessed wood-based fiber, 

(g) exports and imports of grains and unprocessed wood-based fiber, (h) taxpayers, 

through cost or savings to commodity crop payments, and (i) the expansion of refinery 

capacity; 

4. The ability to convert corn ethanol plants for other uses, such as cellulosic ethanol or 

biodiesel; 

5. A comparative analysis of corn ethanol versus other biofuels and renewable energy 

sources, considering cost, energy output, and ease of implementation; 

6. The impact of the credit for production of cellulosic biofuel (as established by this 

Act) on the regional agricultural and silvicultural capabilities of commercially 

available forest inventories; and 

7. The need for additional scientific inquiry, and specific areas of interest for future 

research. 

The Secretary shall submit an initial report of the findings to the Congress not later than 

six months after the date of enactment, and a final report not later than 12 months after the date 

of enactment. In the case of information relating to the impact of the tax credits established by 

the Act on the regional agricultural and silvicultural capabilities of commercially available forest 

inventories, the initial report is due 36 months after the date of enactment and the final report is 

due 42 months after the date of enactment. 

Effective Date

The proposal is effective on the date of enactment. 
56 

C. Energy Conversation and Efficiency Provisions 

1. Qualified energy conservation bonds 

Present law

Tax-exempt bonds

In general

Subject to certain Code restrictions, interest on bonds issued by State and local 

government generally is excluded from gross income for Federal income tax purposes. Bonds 

issued by State and local governments may be classified as either governmental bonds or private 

activity bonds. Governmental bonds are bonds the proceeds of which are primarily used to 

finance governmental functions or which are repaid with governmental funds. Private activity 

bonds are bonds in which the State or local government serves as a conduit providing financing 

to nongovernmental persons. For this purpose, the term “nongovernmental person” generally 

includes the Federal Government and all other individuals and entities other than States or local 

governments. The exclusion from income for interest on State and local bonds does not apply to 

private activity bonds, unless the bonds are issued for certain permitted purposes (“qualified 

private activity bonds”) and other Code requirements are met. 

Private activity bond tests

Present law provides two tests for determining whether a State or local bond is in 

substance a private activity bond, the private business test and the private loan test.61 

Private business tests

Private business use and private payments result in State and local bonds being private 

activity bonds if both parts of the two-part private business test are satisfied– 

• More than 10 percent of the bond proceeds is to be used (directly or indirectly) by a 

private business (the “private business use test”); and 

• More than 10 percent of the debt service on the bonds is secured by an interest in 

property to be used in a private business use or to be derived from payments in 

respect of such property (the “private payment test”).62 

 61 Sec. 141(b) and (c). 

62 The 10-percent private business use and payment threshold is reduced to five percent for 

private business uses that are unrelated to a governmental purpose also being financed with proceeds of 

the bond issue. In addition, as described more fully below, the 10-percent private business use and 

private payment thresholds are phased-down for larger bond issues for the financing of certain “output” 

facilities. The term output facility includes electric generation, transmission, and distribution facilities. 
57 

Private business use generally includes any use by a business entity (including the 

Federal government), which occurs pursuant to terms not generally available to the general 

public. For example, if bond-financed property is leased to a private business (other than 

pursuant to certain short-term leases for which safe harbors are provided under Treasury 

regulations), bond proceeds used to finance the property are treated as used in a private business 

use, and rental payments are treated as securing the payment of the bonds. Private business use 

also can arise when a governmental entity contracts for the operation of a governmental facility 

by a private business under a management contract that does not satisfy Treasury regulatory safe 

harbors regarding the types of payments made to the private operator and the length of the 

contract.63 

Private loan test

The second standard for determining whether a State or local bond is a private activity 

bond is whether an amount exceeding the lesser of (1) five percent of the bond proceeds or (2) $5 

million is used (directly or indirectly) to finance loans to private persons. Private loans include 

both business and other (e.g., personal) uses and payments by private persons; however, in the 

case of business uses and payments, all private loans also constitute private business uses and 

payments subject to the private business test. Present law provides that the substance of a 

transaction governs in determining whether the transaction gives rise to a private loan. In 

general, any transaction which transfers tax ownership of property to a private person is treated 

as a loan. 

Qualified private activity bonds

As stated, interest on private activity bonds is taxable unless the bonds meet the 

requirements for qualified private activity bonds. Qualified private activity bonds permit States 

or local governments to act as conduits providing tax-exempt financing for certain private 

activities. The definition of qualified private activity bonds includes an exempt facility bond, or 

qualified mortgage, veterans’ mortgage, small issue, redevelopment, 501(c)(3), or student loan 

bond (sec. 141(e)). The definition of exempt facility bond includes bonds issued to finance 

certain transportation facilities (airports, ports, mass commuting, and high-speed intercity rail 

facilities); qualified residential rental projects; privately owned and/or operated utility facilities 

(sewage, water, solid waste disposal, and local district heating and cooling facilities, certain 

private electric and gas facilities, and hydroelectric dam enhancements); public/private 

educational facilities; qualified green building and sustainable design projects; and qualified 

highway or surface freight transfer facilities (sec. 142(a)). 

In most cases, the aggregate volume of these tax-exempt private activity bonds is 

restricted by annual aggregate volume limits imposed on bonds issued by issuers within each 

State. For calendar year 2008, the State volume cap, which is indexed for inflation, equals $85 

per resident of the State, or $262.09 million, if greater. 

 63 See Treas. Reg. sec. 1.141-3(b)(4) and Rev. Proc. 97-13, 1997-1 C.B. 632. 
58 

Arbitrage restrictions

The exclusion from income for interest on State and local bonds also does not apply to 

any arbitrage bond.64 An arbitrage bond is defined as any bond that is part of an issue if any 

proceeds of the issue are reasonably expected to be used (or intentionally are used) to acquire 

higher yielding investments or to replace funds that are used to acquire higher yielding 

investments.65 In general, arbitrage profits may be earned only during specified periods (e.g., 

defined “temporary periods”) before funds are needed for the purpose of the borrowing or on 

specified types of investments (e.g., “reasonably required reserve or replacement funds”). 

Subject to limited exceptions, investment profits that are earned during these periods or on such 

investments must be rebated to the Federal Government. 

Indian tribal governments

Indian tribal governments are provided with a tax status similar to State and local 

governments for specified purposes under the Code.66 Among the purposes for which a tribal 

government is treated as a State is the issuance of tax-exempt bonds. However, bonds issued by 

tribal governments are subject to limitations not imposed on State and local government issuers. 

Tribal governments are authorized to issue tax-exempt bonds only if substantially all of the 

proceeds are used for essential governmental functions or certain manufacturing facilities.67 

Clean renewable energy bonds

As an alternative to traditional tax-exempt bonds, States and local governments may issue 

clean renewable energy bonds (“CREBs”). CREBs are defined as any bond issued by a qualified 

issuer if, in addition to the requirements discussed below, 95 percent or more of the proceeds of 

such bonds are used to finance capital expenditures incurred by qualified borrowers for qualified 

projects. “Qualified projects” are facilities that qualify for the tax credit under section 45 (other 

than Indian coal production facilities), without regard to the placed-in-service date requirements 

of that section.68 The term “qualified issuers” includes (1) governmental bodies (including 

Indian tribal governments); (2) mutual or cooperative electric companies (described in section 

501(c)(12) or section 1381(a)(2)(C), or a not-for-profit electric utility which has received a loan 

or guarantee under the Rural Electrification Act); and (3) clean renewable energy bond lenders. 

The term “qualified borrower” includes a governmental body (including an Indian tribal 

 64 Sec. 103(a) and (b)(2). 

65 Sec. 148. 

66 Sec. 7871. 

67 Sec. 7871(c). 

68 In addition, Notice 2006-7 provides that qualified projects include any facility owned by a 

qualified borrower that is functionally related and subordinate to any facility described in section 45(d)(1) 

through (d)(9) and owned by such qualified borrower. 
59 

government) and a mutual or cooperative electric company. A clean renewable energy bond 

lender means a cooperative which is owned by, or has outstanding loans to, 100 or more 

cooperative electric companies and is in existence on February 1, 2002. 

Unlike tax-exempt bonds, CREBs are not interest-bearing obligations. Rather, the 

taxpayer holding CREBs on a credit allowance date is entitled to a tax credit. The amount of the 

credit is determined by multiplying the bond’s credit rate by the face amount on the holder’s 

bond. The credit rate on the bonds is determined by the Secretary and is to be a rate that permits 

issuance of CREBs without discount and interest cost to the qualified issuer. The credit accrues 

quarterly and is includible in gross income (as if it were an interest payment on the bond), and 

can be claimed against regular income tax liability and alternative minimum tax liability. 

CREBs are subject to a maximum maturity limitation. The maximum maturity is the 

term which the Secretary estimates will result in the present value of the obligation to repay the 

principal on a CREBs being equal to 50 percent of the face amount of such bond. In addition, 

the Code requires level amortization of CREBs during the period such bonds are outstanding. 

CREBs also are subject to the arbitrage requirements of section 148 that apply to 

traditional tax-exempt bonds. Principles under section 148 and the regulations thereunder apply 

for purposes of determining the yield restriction and arbitrage rebate requirements applicable to 

CREBs. 

In addition to the above requirements, at least 95 percent of the proceeds of CREBs must 

be spent on qualified projects within the five-year period that begins on the date of issuance. To 

the extent less than 95 percent of the proceeds are used to finance qualified projects during the 

five-year spending period, bonds will continue to qualify as CREBs if unspent proceeds are used 

within 90 days from the end of such five-year period to redeem any “nonqualified bonds.” The 

five-year spending period may be extended by the Secretary upon the qualified issuer’s request 

demonstrating that the failure to satisfy the five-year requirement is due to reasonable cause and 

the projects will continue to proceed with due diligence. 

Issuers of CREBs are required to report issuance to the IRS in a manner similar to the 

information returns required for tax-exempt bonds. There is a national CREB limitation of $1.2 

billion. The maximum amount of CREBs that may be allocated to qualified projects of 

governmental bodies is $750 million. CREBs must be issued before January 1, 2009. 

Description of Proposal

The proposal creates a new category of tax-credit bonds, qualified energy conservation 

bonds. Qualified energy conservation bonds may be used to finance qualified conservation 

purposes. 

The term “qualified conservation purpose” means: 

1. Capital expenditures incurred for purposes of reducing energy consumption in 

publicly owned buildings by at least 20 percent; implementing green community 

programs; rural development involving the production of electricity from renewable 
60 

energy resources; or any facility eligible for the production tax credit under section 45 

(other than Indian coal and refined coal production facilities); 

2. Expenditures with respect to facilities or grants that support research in: (A) 

development of cellulosic ethanol or other nonfossil fuels; (B) technologies for the 

capture and sequestration of carbon dioxide produced through the use of fossil fuels; 

(C) increasing the efficiency of existing technologies for producing nonfossil fuels; 

(D) automobile battery technologies and other technologies to reduce fossil fuel 

consumption in transportation; and (E) technologies to reduce energy use in buildings; 

3. Mass commuting facilities and related facilities that reduce the consumption of 

energy, including expenditures to reduce pollution from vehicles used for mass 

commuting; 

4. Demonstration projects designed to promote the commercialization of: (A) green 

building technology; (B) conversion of agricultural waste for use in the production of 

fuel or otherwise; (C) advanced battery manufacturing technologies; (D) technologies 

to reduce peak-use of electricity; and (D) technologies for the capture and 

sequestration of carbon dioxide emitted from combusting fossil fuels in order to 

produce electricity; and 

5. Public education campaigns to promote energy efficiency (other than movies, 

concerts, and other events held primarily for entertainment purposes). 

There is a national limitation on qualified energy conservation bonds of $3 billion. 

Allocations of qualified energy conservation bonds are made to the States with sub-allocations to 

large local governments. Allocations are made to the States according to their respective 

populations, reduced by any sub-allocations to large local governments (defined below) within 

the States. Sub-allocations to large local governments shall be an amount of the national 

qualified energy conservation bond limitation that bears the same ratio to the amount of such 

limitation that otherwise would be allocated to the State in which such large local government is 

located as the population of such large local government bears to the population of such State. 

The term large local government means: any municipality or county if such municipality or 

county has a population of 100,000 or more. Indian tribal governments also are treated as large 

local governments for these purposes (without regard to population). 

Each State or large local government receiving an allocation of qualified energy 

conservation bonds may further allocate issuance authority to issuers within such State or large 

local government. However, any allocations to issuers within the State or large local government 

shall be made in a manner that results in not less than 70 percent of the allocation of qualified 

energy conservation bonds to such State or large local government being used to designate bonds 

that are not private activity bonds (i.e., the bond cannot meet the private business tests or the 

private loan test of section 141). 

Under the proposal, 100 percent of the available project proceeds of qualified energy 

conservation bonds must be used for qualified conservation purposes. In the case of qualified 

conservation bonds issued as private activity bonds, 100 percent of the available project proceeds 
61 

must be used for capital expenditures. In addition, qualified energy conservation bonds only 

may be issued by Indian tribal governments to the extent such bonds are issued for purposes that 

satisfy the present law requirements for tax-exempt bonds issued by Indian tribal governments 

(i.e., essential governmental functions and certain manufacturing purposes). 

The proposal requires 100 percent of the available project proceeds of qualified energy 

conservation bonds to be used within the three-year period that begins on the date of issuance. 

The proposal defines available project proceeds as proceeds from the sale of the issue less 

issuance costs (not to exceed two percent) and any investment earnings on such sale proceeds. 

To the extent less than 100 percent of the available project proceeds are used to finance qualified 

conservation purposes during the three-year spending period, bonds will continue to qualify as 

qualified energy conservation bonds if unspent proceeds are used within 90 days from the end of 

such three-year period to redeem bonds. The three-year spending period may be extended by the 

Secretary upon the issuer’s request demonstrating that the failure to satisfy the three-year 

requirement is due to reasonable cause and the projects will continue to proceed with due 

diligence. 

Qualified energy conservation bonds generally are subject to the arbitrage requirements 

of section 148. However, available project proceeds invested during the three-year spending 

period are not subject to the arbitrage restrictions (i.e., yield restriction and rebate requirements). 

In addition, amounts invested in a reserve fund are not subject to the arbitrage restrictions to the 

extent: (1) such fund is funded at a rate not more rapid than equal annual installments; (2) such 

fund is funded in a manner reasonably expected to result in an amount not greater than an 

amount necessary to repay the issue; and (3) the yield on such fund is not greater than the 

average annual interest rate of tax-exempt obligations having a term of 10 years or more that are 

issued during the month the qualified energy conservation bonds are issued. 

The maturity of qualified energy conservation bonds is the term that the Secretary 

estimates will result in the present value of the obligation to repay the principal on such bonds 

being equal to 50 percent of the face amount of such bonds, using as a discount rate the average 

annual interest rate of tax-exempt obligations having a term of 10 years or more that are issued 

during the month the qualified energy conservation bonds are issued. 

As with present-law tax credit bonds, the taxpayer holding qualified energy conservation 

bonds on a credit allowance date is entitled to a tax credit. The credit rate on the bonds is set by 

the Secretary at a rate that is 70 percent of the rate that would permit issuance of such bonds 

without discount and interest cost to the issuer. The amount of the tax credit is determined by 

multiplying the bond’s credit rate by the face amount on the holder’s bond. The credit accrues 

quarterly, is includible in gross income (as if it were an interest payment on the bond), and can 

be claimed against regular income tax liability and alternative minimum tax liability. Unused 

credits may be carried forward to succeeding taxable years. In addition, credits may be separated 

from the ownership of the underlying bond similar to how interest coupons can be stripped for 

interest-bearing bonds. 

Issuers of qualified energy conservation bonds are required to certify that the financial 

disclosure requirements that apply to State and local bonds offered for sale to the general public 

are satisfied with respect to any Federal, State, or local government official directly involved 
62 

with the issuance of such bonds. The proposal authorizes the Secretary to impose additional 

financial reporting requirements by regulation. 

Effective Date

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

2. Extension and modification of energy efficient existing homes credit 

Present Law

Code section 25C provides a 10-percent credit for the purchase of qualified energy 

efficiency improvements to existing homes. A qualified energy efficiency improvement is any 

energy efficiency building envelope component that meets or exceeds the prescriptive criteria for 

such a component established by the 2000 International Energy Conservation Code as 

supplemented and as in effect on August 8, 2005 (or, in the case of metal roofs with appropriate 

pigmented coatings, meets the Energy Star program requirements), and (1) that is installed in or 

on a dwelling located in the United States; (2) owned and used by the taxpayer as the taxpayer’s 

principal residence; (3) the original use of which commences with the taxpayer; and (4) such 

component reasonably can be expected to remain in use for at least five years. The credit is 

nonrefundable. 

Building envelope components are: (1) insulation materials or systems which are 

specifically and primarily designed to reduce the heat loss or gain for a dwelling; (2) exterior 

windows (including skylights) and doors; and (3) metal roofs with appropriate pigmented 

coatings which are specifically and primarily designed to reduce the heat loss or gain for a 

dwelling. 

Additionally, code section 25C provides specified credits for the purchase of specific 

energy efficient property. The allowable credit for the purchase of certain property is (1) $50 for 

each advanced main air circulating fan, (2) $150 for each qualified natural gas, propane, or oil 

furnace or hot water boiler, and (3) $300 for each item of qualified energy efficient property. 

 An advanced main air circulating fan is a fan used in a natural gas, propane, or oil 

furnace originally placed in service by the taxpayer during the taxable year, and which has an 

annual electricity use of no more than two percent of the total annual energy use of the furnace 

(as determined in the standard Department of Energy test procedures). 

A qualified natural gas, propane, or oil furnace or hot water boiler is a natural gas, 

propane, or oil furnace or hot water boiler with an annual fuel utilization efficiency rate of at 

least 95. 

Qualified energy-efficient property is: (1) an electric heat pump water heater which yields 

an energy factor of at least 2.0 in the standard Department of Energy test procedure, (2) an 

electric heat pump which has a heating seasonal performance factor (HSPF) of at least 9, a 

seasonal energy efficiency ratio (SEER) of at least 15, and an energy efficiency ratio (EER) of at 

least 13, (3) a geothermal heat pump which (i) in the case of a closed loop product, has an energy 

efficiency ratio (EER) of at least 14.1 and a heating coefficient of performance (COP) of at least 
63 

3.3, (ii) in the case of an open loop product, has an energy efficiency ratio (EER) of at least 16.2 

and a heating coefficient of performance (COP) of at least 3.6, and (iii) in the case of a direct 

expansion (DX) product, has an energy efficiency ratio (EER) of at least 15 and a heating 

coefficient of performance (COP) of at least 3.5, (4) a central air conditioner with energy 

efficiency of at least the highest efficiency tier established by the Consortium for Energy 

Efficiency as in effect on Jan. 1, 2006, and (5) a natural gas, propane, or oil water heater which 

has an energy factor of at least 0.80. 

Under section 25C, the maximum credit for a taxpayer with respect to the same dwelling 

for all taxable years is $500, and no more than $200 of such credit may be attributable to 

expenditures on windows. 

The taxpayer’s basis in the property is reduced by the amount of the credit. Special rules 

apply in the case of condominiums and tenant-stockholders in cooperative housing corporations. 

The credit applies to property placed in service prior to January 1, 2008. 

Description of Proposal

The proposal extends the credit for one year, through December 31, 2008. The proposal 

adds biomass fuel property to the list of qualified energy efficient building property eligible for a 

$300 credit. Biomass fuel property is a stove that burns biomass fuel to heat a dwelling unit 

located in the United States and used as a principal residence by the taxpayer, or to heat water for 

such dwelling unit, and that has a thermal efficiency rating of at least 75 percent. Biomass fuel is 

any plant-derived fuel available on a renewable or recurring basis, including agricultural crops 

and trees, wood and wood waste and residues (including wood pellets), plants (including aquatic 

plants, grasses, residues, and fibers. 

The credit for geothermal heat pumps is eliminated. 

Effective Date

The proposal is effective for expenditures after December 31, 2007, for property placed 

in service prior to January 1, 2009. 

3. Energy efficient commercial buildings deduction 

Present Law

In general

Code section 179D provides a deduction equal to energy-efficient commercial building 

property expenditures made by the taxpayer. Energy-efficient commercial building property 

expenditures is defined as property (1) which is installed on or in any building located in the 

United States that is within the scope of Standard 90.1-2001 of the American Society of Heating, 

Refrigerating, and Air Conditioning Engineers and the Illuminating Engineering Society of 

North America (“ASHRAE/IESNA”), (2) which is installed as part of (i) the interior lighting 

systems, (ii) the heating, cooling, ventilation, and hot water systems, or (iii) the building 
64 

envelope, and (3) which is certified as being installed as part of a plan designed to reduce the 

total annual energy and power costs with respect to the interior lighting systems, heating, 

cooling, ventilation, and hot water systems of the building by 50 percent or more in comparison 

to a reference building which meets the minimum requirements of Standard 90.1-2001 (as in 

effect on April 2, 2003). The deduction is limited to an amount equal to $1.80 per square foot of 

the property for which such expenditures are made. The deduction is allowed in the year in 

which the property is placed in service. 

Certain certification requirements must be met in order to qualify for the deduction. The 

Secretary, in consultation with the Secretary of Energy, will promulgate regulations that describe 

methods of calculating and verifying energy and power costs using qualified computer software 

based on the provisions of the 2005 California Nonresidential Alternative Calculation Method 

Approval Manual or, in the case of residential property, the 2005 California Residential 

Alternative Calculation Method Approval Manual. 

The Secretary shall prescribe procedures for the inspection and testing for compliance of 

buildings that are comparable, given the difference between commercial and residential 

buildings, to the requirements in the Mortgage Industry National Accreditation Procedures for 

Home Energy Rating Systems. Individuals qualified to determine compliance shall only be those 

recognized by one or more organizations certified by the Secretary for such purposes. 

For energy-efficient commercial building property expenditures made by a public entity, 

such as public schools, the Secretary shall promulgate regulations that allow the deduction to be 

allocated to the person primarily responsible for designing the property in lieu of the public 

entity. 

If a deduction is allowed under this section, the basis of the property shall be reduced by 

the amount of the deduction. 

The deduction is effective for property placed in service after December 31, 2005 and 

prior to January 1, 2009. 

Partial allowance of deduction

In the case of a building that does not meet the overall building requirement of a 50-

percent energy savings, a partial deduction is allowed with respect to each separate building 

system that comprises energy efficient property and which is certified by a qualified professional 

as meeting or exceeding the applicable system-specific savings targets established by the 

Secretary of the Treasury. The applicable system-specific savings targets to be established by 

the Secretary are those that would result in a total annual energy savings with respect to the 

whole building of 50 percent, if each of the separate systems met the system specific target. The 

separate building systems are (1) the interior lighting system, (2) the heating, cooling, ventilation 

and hot water systems, and (3) the building envelope. The maximum allowable deduction is 

$0.60 per square foot for each separate system. 
65 

Interim rules for lighting systems

In the case of system-specific partial deductions, in general no deduction is allowed until 

the Secretary establishes system-specific targets69. However, in the case of lighting system 

retrofits, until such time as the Secretary issues final regulations, the system-specific energy 

savings target for the lighting system is deemed to be met by a reduction in Lighting Power 

Density of 40 percent (50 percent in the case of a warehouse) of the minimum requirements in 

Table 9.3.1.1 or Table 9.3.1.2 of ASHRAE/IESNA Standard 90.1-2001. Also, in the case of a 

lighting system that reduces lighting power density by 25 percent, a partial deduction of 30 cents 

per square foot is allowed. A pro-rated partial deduction is allowed in the case of a lighting 

system that reduces lighting power density between 25 percent and 40 percent. Certain lighting 

level and lighting control requirements must also be met in order to qualify for the partial 

lighting deductions under the interim rule. 

Description of Proposal

The proposal extends the energy efficient commercial buildings deduction for five years, 

through December 31, 2013. 

Effective Date

The proposal is effective on the date of enactment. 

4. Extension and modification of energy efficient appliance credit 

Present Law

A credit is allowed for the eligible production of certain energy-efficient dishwashers, 

clothes washers, and refrigerators. 

The credit for dishwashers applies to dishwashers produced in 2006 and 2007 that meet 

the Energy Star standards for 2007, and equals $32.31 per eligible dishwasher70. 

The credit for clothes washers equals $100 for clothes washers manufactured in 2006-

2007 that meet the requirements of the Energy Star program that are in effect for clothes washers 

in 2007. 

 69 IRS Notice 2008-40 has set a target of a 10 percent reduction in total energy and power costs 

with respect to the building envelope, and 20 percent each with respect to the interior lighting system and 

the heating, cooling, ventilation and hot water systems. 

70 The credit amount equals $3 multiplied by 100 times the “energy savings percentage,” but may 

not exceed $100 per dishwasher. The energy saving percentage is defined as the change in the energy 

factor (EF) required by the Energy Star program between 2007 and 2005 divided by the EF requirement 

for 2007. The EF required for the Energy Star program was 0.58 in 2005 and 0.65 in 2007, for a change 

of 0.07. The energy saving percentage is thus 0.07 / 0.65, which when multiplied by 100 times $3 equals 

$32.31 per refrigerator. 
66 

The credit for refrigerators is based on energy savings and year of manufacture. The 

energy savings are determined relative to the energy conservation standards promulgated by the 

Department of Energy that took effect on July 1, 2001. Refrigerators that achieve a 15 to 20 

percent energy saving and that are manufactured in 2006 receive a $75 credit. Refrigerators that 

achieve a 20 to 25 percent energy saving receive a (i) $125 credit if manufactured in 2006-2007. 

Refrigerators that achieve at least a 25 percent energy saving receive a (i) $175 credit if 

manufactured in 2006-2007. 

Appliances eligible for the credit include only those produced in the United States and 

that exceed the average amount of U.S. production from the three prior calendar years for each 

category of appliance. In the case of refrigerators, eligible production is U.S. production that 

exceeds 110 percent of the average amount of U.S. production from the three prior calendar 

years. 

A dishwasher is any a residential dishwasher subject to the energy conservation standards 

established by the Department of Energy. A refrigerator must be an automatic defrost 

refrigerator-freezer with an internal volume of at least 16.5 cubic feet to qualify for the credit. A 

clothes washer is any residential clothes washer, including a residential style coin operated 

washer, that satisfies the relevant efficiency standard. 

The taxpayer may not claim credits in excess of $75 million for all taxable years, and 

may not claim credits in excess of $20 million with respect to clothes washers eligible for the 

$50 credit and refrigerators eligible for the $75 credit. A taxpayer may elect to increase the $20 

million limitation described above to $25 million provided that the aggregate amount of credits 

with respect to such appliances, plus refrigerators eligible for the $100 and $125 credits, is 

limited to $50 million for all taxable years. 

Additionally, the credit allowed in a taxable year for all appliances may not exceed two 

percent of the average annual gross receipts of the taxpayer for the three taxable years preceding 

the taxable year in which the credit is determined. 

The credit is part of the general business credit. 

Description of Proposal

The proposal extends and modifies the energy efficient appliance credit. The proposal 

provides modified credits for eligible production as follows: 

Dishwashers

1. $45 in the case of a dishwasher that is manufactured in calendar year 2008 or 2009 

that uses no more than 324 kilowatt hours per year and 5.8 gallons per cycle, and 

2. $75 in the case of a dishwasher that is manufactured in calendar year 2008, 2009, or 

2010 and that uses no more than 307 kilowatt hours per year and 5.0 gallons per cycle 

(5.5 gallons per cycle for dishwashers designed for greater than 12 place settings). 
67 

Clothes washers

1. $75 in the case of a residential top-loading clothes washer manufactured in calendar 

year 2008 that meets or exceeds a 1.72 modified energy factor and does not exceed a 

8.0 water consumption factor, and 

2. $125 in the case of a residential top-loading clothes washer manufactured in calendar 

year 2008 or 2009 that meets or exceeds a 1.8 modified energy factor and does not 

exceed a 7.5 water consumption factor, 

3. $150 in the case of a residential or commercial clothes washer manufactured in 

calendar year 2008, 2009 or 2010 that meets or exceeds a 2.0 modified energy factor 

and does not exceed a 6.0 water consumption factor, and 

4. $250 in the case of a residential or commercial clothes washer manufactured in 

calendar year 2008, 2009, or 2010 that meets or exceeds a 2.2 modified energy factor 

and does not exceed a 4.5 water consumption factor. 

Refrigerators

1. $50 in the case of a refrigerator manufactured in calendar year 2008 that consumes at 

least 20 percent but not more than 22.9 percent less kilowatt hours per year than the 

2001 energy conservation standards, 

2. $75 in the case of a refrigerator that is manufactured in calendar year 2008 or 2009 

that consumes at least 23 percent but no more than 24.9 percent less kilowatt hours per 

year than the 2001 energy conservation standards, 

3. $100 in the case of a refrigerator that is manufactured in calendar year 2008, 2009 or 

2010 that consumes at least 25 percent but not more than 29.9 percent less kilowatt 

hours per year than the 2001 energy conservation standards, and 

4. $200 in the case of a refrigerator manufactured in calendar year 2008, 2009 or 2010 

that consumes at least 30 percent less energy than the 2001 energy conservation 

standards. 

Appliances eligible for the credit include only those that exceed the average amount of 

production from the two prior calendar years for each category of appliance, rather than the 

present law three prior calendar years. Additionally, the special rule with respect to refrigerators 

is eliminated. 

The aggregate credit amount allowed with respect to a taxpayer for all taxable years 

beginning after December 31, 2007 may not exceed $75 million, with the exception that the $200 

refrigerator credit and the $250 clothes washer credit are not limited. 

The term “modified energy factor” means the modified energy factor established by the 

Department of Energy for compliance with the Federal energy conservation standard. 
68 

The term “gallons per cycle” means, with respect to a dishwasher, the amount of water, 

expressed in gallons, required to complete a normal cycle of a dishwasher. 

The term “water consumption factor” means, with respect to a clothes washer, the 

quotient of the total weighted per-cycle water consumption divided by the cubic foot (or liter) 

capacity of the clothes washer. 

Effective Date

The proposal applies to appliances produced after December 31, 2007. 

5. Accelerated recovery period for depreciation of smart meters and smart grid systems 

Present Law

A taxpayer generally must capitalize the cost of property used in a trade or business and 

recover such cost over time through annual deductions for depreciation or amortization. 

Tangible property generally is depreciated under the modified accelerated cost recovery system 

(“MACRS”), which determines depreciation by applying specific recovery periods, placed-inservice conventions, and depreciation methods to the cost of various types of depreciable 

property.71 The class lives of assets placed in service after 1986 are generally set forth in 

Revenue Procedure 87-56.72 Assets included in class 49.14, describing assets used in the 

transmission and distribution of electricity for sale and related land improvements, are assigned a 

class life of 30 years and a recovery period of 20 years. 

Description of Proposal

The proposal provides a 10-year recovery period and 150 percent declining balance 

method for any qualified smart electric meter and any qualified smart electric grid system. For 

purposes of the proposal, a qualified smart electric meter means any time-based meter and 

related communication equipment which is placed in service by a taxpayer who is a supplier of 

electric energy or a provider of electric energy services and which is capable of being used by 

the taxpayer as part of a system that (1) measures and records electricity usage data on a timedifferentiated basis in at least 24 separate time segments per day; (2) provides for the exchange 

of information between the supplier or provider and the customer’s smart electric meter in 

support of time-based rates or other forms of demand response; and (3) provides data to such 

supplier or provider so that the supplier or provider can provide energy usage information to 

customers electronically; and (4) provides all commercial and residential customers of such 

supplier or provider with net metering. The term “net metering” means allowing a customer a 

credit, if any, as complies with applicable Federal and State laws and regulations, for providing 

electricity to the supplier or provider. 

 71 Sec. 168. 

72 1987-2 C.B. 674 (as clarified and modified by Rev. Proc. 88-22, 1988-1 C.B. 785). 
69 

For purposes of the proposal, a qualified smart electric grid system means any smart grid 

property used as part of a system for electric distribution grid communications, monitoring, and 

management placed in service by a taxpayer who is a supplier of electric energy or a provider of 

electric energy services. Smart grid property includes electronics and related equipment that is 

capable of (1) sensing, collecting, and monitoring data of or from all portions of a utility’s 

electric distribution grid; (2) providing real-time, two-way communications to monitor to 

manage such grid; and (3) providing real-time analysis of an event prediction based upon 

collected data that can be used to improve electric distribution system reliability, quality, and 

performance. 

Effective Date

The proposal is effective for property placed in service after the date of enactment. 

6. Extension of issuance authority for qualified green building and sustainable design 

project bonds 

Present Law

In general

Private activity bonds are bonds that nominally are issued by States or local governments, 

but the proceeds of which are used (directly or indirectly) by a private person and payment of 

which is derived from funds of such private person. The exclusion from income for State and 

local bonds does not apply to private activity bonds, unless the bonds are issued for certain 

permitted purposes (“qualified private activity bonds”). The definition of a qualified private 

activity bond includes exempt facility bonds. 

In most cases, the aggregate volume of tax-exempt qualified private activity bonds, 

including most exempt facility bonds, is restricted by annual aggregate volume limits imposed on 

bonds issued by issuers within each State. For calendar year 2008, the State volume cap, which 

is indexed for inflation, equals $85 per resident of the State, or $262.09 million, if greater. 

Qualified green building and sustainable design project bonds

The definition of exempt facility bond includes qualified green building and sustainable 

design project bonds (“qualified green bond”). A qualified green bond is defined as any bond 

issued as part of an issue that finances a project designated by the Secretary, after consultation 

with the Administrator of the Environmental Protection Agency (the “Administrator”) as a green 

building and sustainable design project that meets the following eligibility requirements: (1) at 

least 75 percent of the square footage of the commercial buildings that are part of the project is 

registered for the U.S. Green Building Council’s LEED73 certification and is reasonably expected 

 73 The LEED (“Leadership in Energy and Environmental Design) Green Building 

Rating System is a voluntary, consensus-based national standard for developing highperformance sustainable buildings. Registration is the first step toward LEED certification. 

Actual certification requires that the applicant project satisfy a number of requirements. 
70 

(at the time of designation) to meet such certification; (2) the project includes a brownfield site;74 

(3) the project receives at least $5 million dollars in specific State or local resources; and (4) the 

project includes at least one million square feet of building or at least 20 acres of land. 

Qualified green bonds are not subject to the State bond volume limitations. Rather, there 

is a national limitation of $2 billion of qualified green bonds that the Secretary may allocate, in 

the aggregate, to qualified green building and sustainable design projects. Qualified green bonds 

may be currently refunded if certain conditions are met, but cannot be advance refunded. The 

authority to issue qualified green bonds terminates after September 30, 2009. 

Under present law, each green building and sustainable design project project must 

certify to the Secretary, no later than 30 days after the completion of the project, that the net 

benefit of the tax-exempt financing was used for the purposes described in the project 

application. Issuers are required to maintain, on behalf of each project, an interest bearing 

reserve account equal to one percent of the net proceeds of any qualified green bond issued for 

such project. Not later than five years after the date of issuance of bonds with respect to the 

project, the Secretary, after consultation with the Administrator, shall determine whether the 

project financed with the proceeds of qualified green bonds has substantially complied with the 

requirements and goals of the project. If the Secretary, after such consultation, certifies that the 

project has substantially complied with the requirements and goals, amounts in the reserve 

account, including all interest, shall be released to the project. If the Secretary determines that 

the project has not substantially complied with such requirements and goals, amounts in the 

reserve account, including all interest, shall be paid to the United States Treasury. 

Description of Proposal

The proposal extends the authority to issue qualified green bonds through September 30, 

2012. 

The proposal also clarifies that the date for determining whether amounts in a reserve 

account may be released to the project is the date that is five years after the date of issuance of 

the last bond issue issued with respect to the project. 

 

Commercial buildings, as defined by standard building codes are eligible for certification. 

Commercial occupancies include, but are not limited to, offices, retail and service 

establishments, institutional buildings (e.g. libraries, schools, museums, churches, etc.), hotels, 

and residential buildings of four or more habitable stories. 

74 For this purpose, a brownfield site is defined by section 101(39) of the Comprehensive 

Environmental Response, Compensation, and Liability Act of 1980 (42 U.S.C. 9601), including 

a site described in subparagraph (D)(ii)(II)(aa) thereof (relating to a site that is contaminated by 

petroleum or a petroleum product excluded from the definition of ‘hazardous substance’ under 

section 101). 
71 

Effective Date

The proposal applies on the date of enactment. 
72 

II. ONE YEAR EXTENDERS 

A. Extenders Primarily Affecting Individuals 

1. Deduction of State and local general sales taxes 

Present Law

For purposes of determining regular tax liability, an itemized deduction is permitted for 

certain State and local taxes paid, including individual income taxes, real property taxes, and 

personal property taxes. The itemized deduction is not permitted for purposes of determining a 

taxpayer’s alternative minimum taxable income. For taxable years beginning in 2004 and 2005, 

at the election of the taxpayer, an itemized deduction may be taken for State and local general 

sales taxes in lieu of the itemized deduction provided under present law for State and local 

income taxes. As is the case for State and local income taxes, the itemized deduction for State 

and local general sales taxes is not permitted for purposes of determining a taxpayer’s alternative 

minimum taxable income. Taxpayers have two options with respect to the determination of the 

sales tax deduction amount. Taxpayers may deduct the total amount of general State and local 

sales taxes paid by accumulating receipts showing general sales taxes paid. Alternatively, 

taxpayers may use tables created by the Secretary of the Treasury that show the allowable 

deduction. The tables are based on average consumption by taxpayers on a State-by-State basis 

taking into account number of dependents, modified adjusted gross income and rates of State and 

local general sales taxation. Taxpayers who live in more than one jurisdiction during the tax 

year are required to pro-rate the table amounts based on the time they live in each jurisdiction. 

Taxpayers who use the tables created by the Secretary may, in addition to the table amounts, 

deduct eligible general sales taxes paid with respect to the purchase of motor vehicles, boats and 

other items specified by the Secretary. Sales taxes for items that may be added to the tables are 

not reflected in the tables themselves. 

The term “general sales tax” means a tax imposed at one rate with respect to the sale at 

retail of a broad range of classes of items. However, in the case of items of food, clothing, 

medical supplies, and motor vehicles, the fact that the tax does not apply with respect to some or 

all of such items is not taken into account in determining whether the tax applies with respect to 

a broad range of classes of items, and the fact that the rate of tax applicable with respect to some 

or all of such items is lower than the general rate of tax is not taken into account in determining 

whether the tax is imposed at one rate. Except in the case of a lower rate of tax applicable with 

respect to food, clothing, medical supplies, or motor vehicles, no deduction is allowed for any 

general sales tax imposed with respect to an item at a rate other than the general rate of tax. 

However, in the case of motor vehicles, if the rate of tax exceeds the general rate, such excess 

shall be disregarded and the general rate is treated as the rate of tax. 

A compensating use tax with respect to an item is treated as a general sales tax, provided 

such tax is complementary to a general sales tax and a deduction for sales taxes is allowable with 

respect to items sold at retail in the taxing jurisdiction that are similar to such item. 
73 

Description of Proposal

The present-law provision allowing taxpayers to elect to deduct State and local sales 

taxes in lieu of State and local income taxes is extended for one year (through December 31, 

2008). 

Effective Date

The proposal applies to taxable years beginning after December 31, 2007. 

2. Above-the-line deduction for higher education expenses 

Present Law

An individual is allowed an above-the-line deduction for qualified tuition and related 

expenses for higher education paid by the individual during the taxable year.75 Qualified tuition 

and related expenses are defined in the same manner as for the Hope and Lifetime Learning 

credits, and includes tuition and fees required for the enrollment or attendance of the taxpayer, 

the taxpayer’s spouse, or any dependent of the taxpayer with respect to whom the taxpayer may 

claim a personal exemption, at an eligible institution of higher education for courses of 

instruction of such individual at such institution.76 The expenses must be in connection with 

enrollment at an institution of higher education during the taxable year, or with an academic 

period beginning during the taxable year or during the first three months of the next taxable year. 

The deduction is not available for tuition and related expenses paid for elementary or secondary 

education. 

The maximum deduction is $4,000 for an individual whose adjusted gross income for the 

taxable year does not exceed $65,000 ($130,000 in the case of a joint return), or $2,000 for other 

individuals whose adjusted gross income does not exceed $80,000 ($160,000 in the case of a 

joint return). No deduction is allowed for an individual whose adjusted gross income exceeds 

the relevant adjusted gross income limitations, for a married individual who does not file a joint 

return, or for an individual with respect to whom a personal exemption deduction may be 

claimed by another taxpayer for the taxable year. The deduction is not available for taxable 

years beginning after December 31, 2007. 

The amount of qualified tuition and related expenses must be reduced by certain 

scholarships, educational assistance allowances, and other amounts paid for the benefit of such 

individual,77 and by the amount of such expenses taken into account for purposes of determining 

 75 Sec. 222. 

76 The deduction generally is not available for expenses with respect to a course or education 

involving sports, games, or hobbies, and is not available for student activity fees, athletic fees, insurance 

expenses, or other expenses unrelated to an individual’s academic course of instruction. 

77 Secs. 222(d)(1) and 25A(g)(2). 
74 

any exclusion from gross income of: (1) income from certain U.S. savings bonds used to pay 

higher education tuition and fees; and (2) income from a Coverdell education savings account.78 

Additionally, such expenses must be reduced by the earnings portion (but not the return of 

principal) of distributions from a qualified tuition program if an exclusion under section 529 is 

claimed with respect to expenses eligible for the qualified tuition deduction. No deduction is 

allowed for any expense for which a deduction is otherwise allowed or with respect to an 

individual for whom a Hope or Lifetime Learning credit is elected for such taxable year. 

Description of Proposal 

The proposal extends the qualified tuition deduction for one year so that it is available for 

taxable years beginning before January 1, 2009. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2007. 

3. Extension of special withholding tax rule for interest-related dividends paid by 

regulated investment companies 

Present Law

In general

Under present law, a regulated investment company (“RIC”) that earns certain interest 

income that would not be subject to U.S. tax if earned by a foreign person directly may, to the 

extent of such income, designate a dividend it pays as derived from such interest income. A 

foreign person who is a shareholder in the RIC generally would treat such a dividend as exempt 

from gross-basis U.S. tax, as if the foreign person had earned the interest directly. 

Interest-related dividends

Under present law, a RIC may, under certain circumstances, designate all or a portion of 

a dividend as an “interest-related dividend,” by written notice mailed to its shareholders not later 

than 60 days after the close of its taxable year. In addition, an interest-related dividend received 

by a foreign person generally is exempt from U.S. gross-basis tax under sections 871(a), 881, 

1441 and 1442. 

However, this exemption does not apply to a dividend on shares of RIC stock if the 

withholding agent does not receive a statement, similar to that required under the portfolio 

interest rules, that the beneficial owner of the shares is not a U.S. person. The exemption does 

not apply to a dividend paid to any person within a foreign country (or dividends addressed to, or 

for the account of, persons within such foreign country) with respect to which the Treasury 

 78 Sec. 222(c). These reductions are the same as those that apply to the Hope and Lifetime 

Learning credits. 
75 

Secretary has determined, under the portfolio interest rules, that exchange of information is 

inadequate to prevent evasion of U.S. income tax by U.S. persons. 

In addition, the exemption generally does not apply to dividends paid to a controlled 

foreign corporation to the extent such dividends are attributable to income received by the RIC 

on a debt obligation of a person with respect to which the recipient of the dividend (i.e., the 

controlled foreign corporation) is a related person. Nor does the exemption generally apply to 

dividends to the extent such dividends are attributable to income (other than short-term original 

issue discount or bank deposit interest) received by the RIC on indebtedness issued by the RICdividend recipient or by any corporation or partnership with respect to which the recipient of the 

RIC dividend is a 10-percent shareholder. However, in these two circumstances the RIC remains 

exempt from its withholding obligation unless the RIC knows that the dividend recipient is such 

a controlled foreign corporation or 10-percent shareholder. To the extent that an interest-related 

dividend received by a controlled foreign corporation is attributable to interest income of the RIC 

that would be portfolio interest if received by a foreign corporation, the dividend is treated as 

portfolio interest for purposes of the de minimis rules, the high-tax exception, and the same 

country exceptions of subpart F (see sec. 881(c)(5)(A)). 

The aggregate amount designated as interest-related dividends for the RIC’s taxable year 

(including dividends so designated that are paid after the close of the taxable year but treated as 

paid during that year as described in section 855) generally is limited to the qualified net interest 

income of the RIC for the taxable year. The qualified net interest income of the RIC equals the 

excess of: (1) the amount of qualified interest income of the RIC; over (2) the amount of 

expenses of the RIC properly allocable to such interest income. 

Qualified interest income of the RIC is equal to the sum of its U.S.-source income with 

respect to: (1) bank deposit interest; (2) short term original issue discount that is currently 

exempt from the gross-basis tax under section 871; (3) any interest (including amounts 

recognized as ordinary income in respect of original issue discount, market discount, or 

acquisition discount under the provisions of sections 1271-1288, and such other amounts as 

regulations may provide) on an obligation which is in registered form, unless it is earned on an 

obligation issued by a corporation or partnership in which the RIC is a 10-percent shareholder or 

is contingent interest not treated as portfolio interest under section 871(h)(4); and (4) any 

interest-related dividend from another RIC. 

If the amount designated as an interest-related dividend is greater than the qualified net 

interest income described above, the portion of the distribution so designated which constitutes 

an interest-related dividend will be only that proportion of the amount so designated as the 

amount of the qualified net interest income bears to the amount so designated. 

This withholding tax rule for interest-related dividends received from a RIC does not 

apply to any taxable year of a RIC beginning after December 31, 2007. 

Description of Proposal

The proposal extends the exemption from withholding tax of interest-related dividends 

received from a RIC to taxable years of a RIC beginning before January 1, 2009. 
76 

Effective Date

The proposal applies to estates of decedents dying after December 31, 2007. 

4. Extend the special rule encouraging contributions of capital gain real property for 

conservation purposes 

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. 

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 contributions 

of capital gain property for a taxable year within the 50-percent limitation category by reducing 
77 

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. 

Special rule regarding contributions of capital gain real property for conservation 

purposes

In general

Under a temporary provision that is effective for contributions made in taxable years 

beginning after December 31, 2005,79 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). Instead, individuals may deduct the fair market 

value of any qualified conservation contribution to an organization described in section 

170(b)(1)(A) to the extent of the excess of 50 percent of the contribution base over the amount of 

all other allowable charitable contributions. These contributions are not taken into account in 

determining the amount of other allowable charitable contributions. 

 79 Sec. 170(b)(1)(E). 
78 

Individuals are allowed to carry over any qualified conservation contributions that exceed 

the 50-percent limitation for up to 15 years. 

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 subject to the 50-percent limitation of $60. The individual is allowed a deduction 

of $50 in the current taxable year for the non-conservation 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 individual who is a qualified farmer or rancher for the taxable year in 

which the contribution is made, a qualified conservation contribution is allowable up to 100 

percent of the excess of the taxpayer’s contribution base over the amount of all other allowable 

charitable contributions. 

In the above example, if the individual is a qualified farmer or rancher, in addition to the 

$50 deduction for non-conservation contributions, an additional $50 for the qualified 

conservation contribution is allowed and $30 may be carried forward for up to 15 years as a 

contribution subject to the 100-percent limitation. 

In the case of a corporation (other than a publicly traded corporation) that is a qualified 

farmer or rancher for the taxable year in which the contribution is made, any qualified 

conservation contribution is allowable up to 100 percent of the excess of the corporation’s 

taxable income (as computed under section 170(b)(2)) over the amount of all other allowable 

charitable contributions. Any excess may be carried forward for up to 15 years as a contribution 

subject to the 100-percent limitation.80

As an additional condition of eligibility for the 100 percent limitation, with respect to any 

contribution of property in agriculture or livestock production, or that is available for such 

production, by a qualified farmer or rancher, the qualified real property interest must include a 

restriction that the property remain generally available for such production. (There is no 

requirement as to any specific use in agriculture or farming, or necessarily that the property be 

used for such purposes, merely that the property remain available for such purposes.) Such 

additional condition does not apply to contributions made on or before August 17, 2006. 

A qualified farmer or rancher means a taxpayer whose gross income from the trade or 

business of farming (within the meaning of section 2032A(e)(5)) is greater than 50 percent of the 

taxpayer’s gross income for the taxable year. 

 80 Sec. 170(b)(2)(B). 
79 

Termination

The special rule regarding contributions of capital gain real property for conservation 

purposes does not apply to contributions made in taxable years beginning after December 31, 

2007. 

Description of Proposal

The proposal extends the special rule regarding contributions of capital gain real property 

for conservation purposes for contributions made in taxable years beginning before January 1, 

2009. 

Effective Date

The proposal is effective for contributions made in taxable years beginning after 

December 31, 2007. 

5. Tax-free distributions from individual retirement plans for charitable purposes 

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. An exception 

applies in the case of a qualified charitable distribution. 

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), to certain veterans’ organizations, fraternal societies, 

and cemetery companies,81 or to a Federal, State, or local governmental entity for exclusively 

public purposes.82 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.83

 81 Secs. 170(c)(3)-(5). 

82 Sec. 170(c)(1). 

83 Secs. 170(b) and (e). 
80 

A taxpayer who takes the standard deduction (i.e., who does not itemize deductions) may 

not take a separate deduction for charitable contributions.84

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, among other things, 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.85 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 may be deductible as a charitable contribution.86

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 

limits 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 2006 is $150,500 ($75,250 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. 

 84 Sec. 170(a). 

85 Sec. 170(f)(8). 

86 Sec. 6115. 
81 

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.87 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 guaranteed annuity or a fixed percentage of the annual value of the property.88 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 59-1⁄2 are 

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

present law, minimum distributions are required to be made from tax-favored retirement 

arrangements, including IRAs. Minimum required distributions from a traditional IRA must 

generally begin by the April 1 of the calendar year following the year in which the IRA owner 

attains age 70-1⁄2.89

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. 

 87 Secs. 170(f), 2055(e)(2), and 2522(c)(2). 

88 Sec. 170(f)(2). 

89 Minimum distribution rules also apply in the case of distributions after the death of a 

traditional or Roth IRA owner. 
82 

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;90 (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. 

Distributions from an IRA (other than a Roth IRA) are generally subject to withholding 

unless the individual elects not to have withholding apply.91 Elections not to have withholding 

apply are to be made in the time and manner prescribed by the Secretary. 

Qualified charitable distributions

Present law 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.92 

The exclusion may not exceed $100,000 per taxpayer per taxable year. Special rules apply in 

determining the amount of an IRA distribution that is otherwise taxable. The otherwise 

applicable 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. Qualified charitable distributions are taken into account for purposes of the 

minimum distribution rules applicable to traditional IRAs to the same extent the distribution 

would have been taken into account under such rules had the distribution not been directly 

distributed under the qualified charitable distribution provision. An IRA does not fail to qualify 

as an IRA merely because qualified charitable distributions have been made from the IRA. 

A qualified charitable distribution is any distribution from an IRA directly by the IRA 

trustee to an organization described in section 170(b)(1)(A) (other than an organization described 

in section 509(a)(3) or a donor advised fund (as defined in section 4966(d)(2)). Distributions are 

eligible for the exclusion only if made on or after the date the IRA owner attains age 70-1⁄2. 

The exclusion applies only if a charitable contribution deduction for the entire 

distribution otherwise would be allowable (under present law), 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. 

 90 Conversion contributions refer to conversions of amounts in a traditional IRA to a Roth IRA. 

91 Sec. 3405. 

92 The exclusion does not apply to distributions from employer-sponsored retirements plans, 

including SIMPLE IRAs and simplified employee pensions (“SEPs”). 
83 

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 

qualified charitable distribution provision) and thus is eligible for qualified charitable 

distribution treatment. 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 qualified 

charitable distribution provision) if the aggregate balance of all IRAs having the same owner 

were distributed during the same year. In determining the amount of subsequent IRA 

distributions includible in income, proper adjustments are to be made to reflect the amount 

treated as a qualified charitable distribution under the special rule. 

Distributions that are excluded from gross income by reason of the qualified charitable 

distribution provision are not taken into account in determining the deduction for charitable 

contributions under section 170. 

The exclusion for qualified charitable distributions applies to distributions made in 

taxable years beginning after December 31, 2005. Under present law, the exclusion does not 

apply to distributions made in taxable years beginning after December 31, 2007. 

Description of Proposal

 The proposal would extend the exclusion for qualified charitable distributions to 

distributions made in taxable years beginning after December 31, 2007, and before January 1, 

2009. 

Effective Date

The proposal is effective for distributions made in taxable years beginning after 

December 31, 2007. 

6. Educator expense deduction 

Present Law

In general, ordinary and necessary business expenses are deductible. However, 

unreimbursed employee business expenses generally are deductible only as an itemized 

deduction and only to the extent that the individual’s total miscellaneous deductions (including 

employee business expenses) exceed two percent of adjusted gross income. An individual’s 

otherwise allowable itemized deductions may be further limited by the overall limitation on 

itemized deductions, which reduces itemized deductions for taxpayers with adjusted gross 

income in excess of $159,950 (for 2008).93 In addition, miscellaneous itemized deductions are 

not allowable under the alternative minimum tax. 

 93 The adjusted gross income threshold is $79,975 in the case of a married individual filing a 

separate return (for 2008). 
84 

Eligible educators are allowed an above-the-line deduction for certain expenses.94 

Specifically, for taxable years beginning after December 31, 2001, and prior to January 1, 2008, 

an above-the-line deduction is allowed for up to $250 annually of expenses paid or incurred by 

an eligible educator for books, supplies (other than nonathletic supplies for courses of instruction 

in health or physical education), computer equipment (including related software and services) 

and other equipment, and supplementary materials used by the eligible educator in the 

classroom. To be eligible for this deduction, the expenses must be otherwise deductible under 

section 162 as a trade or business expense. A deduction is allowed only to the extent the amount 

of expenses exceeds the amount excludable from income under section 135 (relating to education 

savings bonds), 529(c)(1) (relating to qualified tuition programs), and section 530(d)(2) (relating 

to Coverdell education savings accounts). 

An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, 

principal, or aide in a school for at least 900 hours during a school year. A school means any 

school that provides elementary education or secondary education, as determined under State 

law. 

The above-the-line deduction for eligible educators is not allowed for taxable years 

beginning after December 31, 2007.

Description of Proposal

The proposal extends the deduction for eligible educator expenses for one year so that it 

is available for taxable years beginning before January 1, 2009. 

Effective Date

The proposal is effective for expenses paid or incurred in taxable years beginning after 

December 31, 2007. 

7. One year extension of the election to treat combat pay as earned income for purposes of 

the earned income credit 

Present Law

In general

Subject to certain limitations, military compensation earned by members of the Armed 

Forces while serving in a combat zone may be excluded from gross income. In addition, for up 

to two years following service in a combat zone, military personnel may also exclude 

compensation earned while hospitalized from wounds, disease, or injuries incurred while serving 

in the combat zone. 

 94 Sec. 62(a)(2)(D). 
85 

Child credit 

Combat pay that is otherwise excluded from gross income under section 112 is treated as 

earned income which is taken into account in computing taxable income for purposes of 

calculating the refundable portion of the child credit. 

Earned income credit

Any taxpayer may elect to treat combat pay that is otherwise excluded from gross income 

under section 112 as earned income for purposes of the earned income credit. This election is 

available with respect to any taxable year ending after the date of enactment and before 

January 1, 2008. 

Description of Proposal

The proposal extends for one year the availability of the election to treat combat pay that 

is otherwise excluded from gross income under section 112 as earned income for purposes of the 

earned income credit. 

Effective Date

The proposal is effective in taxable years beginning after December 31, 2007 and before 

January 1, 2009. 

8. Extension of qualified mortgage bond program rules for veterans 

Present Law

Private activity bonds are bonds that nominally are issued by States or local governments, 

but the proceeds of which are used (directly or indirectly) by a private person and payment of 

which is derived from funds of such private person. The exclusion from income for State and 

local bonds does not apply to private activity bonds, unless the bonds are issued for certain 

permitted purposes (“qualified private activity bonds”). The definition of a qualified private 

activity bond includes both qualified mortgage bonds and qualified veterans’ mortgage bonds. 

Qualified mortgage bonds are issued to make mortgage loans to qualified mortgagors for 

owner-occupied residences. The Code imposes several limitations on qualified mortgage bonds, 

including income limitations for homebuyers and purchase price limitations for the home 

financed with bond proceeds. In addition, qualified mortgage bonds generally cannot be used to 

finance a mortgage for a homebuyer who had an ownership interest in a principal residence in 

the three years preceding the execution of the mortgage (the “first-time homebuyer” 

requirement). 

Under a special rule, qualified mortgage bonds may be issued to finance mortgages for 

veterans who served in the active military without regard to the first-time homebuyer 

requirement. Present-law income and purchase price limitations apply to loans to veterans 

financed with the proceeds of qualified mortgage bonds. Veterans are eligible for the exception 

from the first-time homebuyer requirement without regard to the date they last served on active 
86 

duty or the date they applied for a loan after leaving active duty. However, veterans may only 

use the exception one time. This provision applies to bonds issued before January 1, 2008. 

Description of Proposal

The proposal extends for one year the first-time homebuyer exception for veterans under 

the qualified mortgage bond program. 

Effective Date

The proposal applies to bonds issued after December 31, 2007 and before January 1, 

2009. 

9. Treatment of distributions to individuals called to active duty for at least 180 days 

Present Law

Under present law, a taxpayer who receives a distribution from a qualified retirement 

plan prior to age 591⁄2, death, or disability generally is subject to a 10-percent early withdrawal 

tax on the amount includible in income, unless an exception to the tax applies. Among other 

exceptions, the early distribution tax does not apply to distributions made to an employee who 

separates from service after age 55, or to distributions that are part of a series of substantially 

equal periodic payments made for the life (or life expectancy) of the employee or the joint lives 

(or life expectancies) of the employee and his or her beneficiary. 

Certain amounts held in a qualified cash or deferred arrangement (a “section 401(k) 

plan”) or in a tax-sheltered annuity (a “section 403(b) annuity”) may not be distributed before 

severance from employment, age 591⁄2, death, disability, or financial hardship of the employee. 

Pursuant to amendments to section 72(t) made by the Pension Protection Act of 2006,95

the 10-percent early withdrawal tax does not apply to a qualified reservist distribution. A 

qualified reservist distribution is a distribution (1) from an IRA or attributable to elective 

deferrals under a section 401(k) plan, section 403(b) annuity, or certain similar arrangements, (2) 

made to an individual who (by reason of being a member of a reserve component as defined in 

section 101 of title 37 of the U.S. Code) was ordered or called to active duty for a period in 

excess of 179 days or for an indefinite period, and (3) that is made during the period beginning 

on the date of such order or call to duty and ending at the close of the active duty period. A 

section 401(k) plan or section 403(b) annuity does not violate the distribution restrictions 

applicable to such plans by reason of making a qualified reservist distribution. 

An individual who receives a qualified reservist distribution may, at any time during the 

two-year period beginning on the day after the end of the active duty period, make one or more 

contributions to an IRA of such individual in an aggregate amount not to exceed the amount of 

such distribution. The dollar limitations otherwise applicable to contributions to IRAs do not 

 95 Pub. L. No. 109-280. 
87 

apply to any contribution made pursuant to this special repayment rule. No deduction is allowed 

for any contribution made under the special repayment rule. 

The special rules applicable to a qualified reservist distribution apply to individuals 

ordered or called to active duty after September 11, 2001, and before December 31, 2007. 

Description of Proposal 

The proposal extends the rules applicable to qualified reservist distributions to 

individuals ordered or called to active duty before January 1, 2009. 

Effective Date

The proposal applies to individuals ordered or called to active duty after December 31, 

2007. 

10. Extension of special rule for regulated investment company stock held in the estate of a 

nonresident non-citizen 

Present Law

The gross estate of a decedent who was a U.S. citizen or resident generally includes all 

property -- real, personal, tangible, and intangible -- wherever situated.96 The gross estate of a 

nonresident non-citizen decedent, by contrast, generally includes only property that at the time of 

the decedent’s death is situated within the United States.97 Property within the United States 

generally includes debt obligations of U.S. persons, including the Federal government and State 

and local governments, but does not include either bank deposits or portfolio obligations the 

interest on which would be exempt from U.S. income tax under section 871.98 Stock owned and 

held by a nonresident non-citizen generally is treated as property within the United States if the 

stock was issued by a domestic corporation.99

Treaties may reduce U.S. taxation of transfers of the estates of nonresident non-citizens. 

Under recent treaties, for example, U.S. tax generally may be eliminated except insofar as the 

property transferred includes U.S. real property or business property of a U.S. permanent 

establishment. 

 96 Sec. 2031. The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) 

repealed the estate tax for estates of decedents dying after December 31, 2009. EGTRRA, however, 

included a termination provision under which EGTRRA’s rules, including estate tax repeal, do not apply 

to estates of decedents dying after December 31, 2010. 

97 Sec. 2103. 

98 Secs. 2104(c), 2105(b). 

99 Sec. 2104(a); Treas. Reg. sec. 20.2104-1(a)(5)). 
88 

Although stock issued by a domestic corporation generally is treated as property within 

the United States, stock of a regulated investment company (“RIC”) that was owned by a 

nonresident non-citizen is not deemed property within the United States in the proportion that, at 

the end of the quarter of the RIC’s taxable year immediately before a decedent’s date of death, 

the assets held by the RIC are debt obligations, deposits, or other property that would be treated 

as situated outside the United States if held directly by the estate (the “estate tax look-through 

rule for RIC stock”).100 This estate tax look-through rule for RIC stock does not apply to estates 

of decedents dying after December 31, 2007. 

Description of Proposal

The proposal permits the estate tax look-through rule for RIC stock to apply to estates of 

decedents dying before January 1, 2009. 

Effective Date

The proposal applies to estates of decedents dying after December 31, 2007. 

11. Extend RIC qualified investment entity treatment under FIRPTA 

Present law

Special U.S. tax rules apply to capital gains of foreign persons that are attributable to 

dispositions of interests in U.S. real property. In general, a foreign person (a foreign corporation 

or a nonresident alien individual) is not generally taxed on U.S. source capital gains unless 

certain personal presence or effectively connected business requirements are met. However, 

under the Foreign Investment in Real Property Tax Act ("FIRPTA") provisions codified in 

section 897 of the Code, a foreign person who sells a U.S. real property interest (USRPI) is 

treated as if the gain from such a sale is effectively connected with a U.S. business, and is subject 

to tax at the same rates as a U.S. person. Withholding tax is also imposed under section 1445. 

A USPRI, the sale of which is subject to FIRPTA tax, includes stock or a beneficial 

interest in any U.S. real property holding corporation (as defined), unless the stock is regularly 

traded on an established securities market and the selling foreign corporation or nonresident alien 

individual held no more than 5 percent of that stock within the 5-year period ending on date of 

disposition (or, if shorter, during the period in which the entity was in existence). There is an 

exception, however, for stock of a domestically controlled "qualified investment entity." 

However, if stock of a domestically controlled qualified investment entity is disposed of within 

the 30 days preceding a dividend distribution in an “applicable wash sale transaction,” in which 

an amount that would have been a taxable distribution (as described below) is instead treated as 

nontaxable sales proceeds, but substantially similar stock is reacquired (or an option to obtain it 

is acquired) within a 61 day period, then the amount that would have been a taxable distribution 

continues to be taxed. 

 100 Sec. 2105(d). 
89 

A distribution from a "qualified investment entity" that is attributable to the sale of a 

USRPI is subject to tax under FIRPTA unless the distribution is with respect to an interest that is 

regularly traded on an established securities market located in the United Sates and the recipient 

foreign corporation or nonresident alien individual held no more than 5 percent of that class of 

stock or beneficial interest within the 1-year period ending on the date of distribution. Special 

rules apply to situations involving tiers of qualified investment entities. 

The term "qualified investment entity" includes a regulated investment company ("RIC") 

that meets certain requirements, although the inclusion of a RIC in that definition is scheduled to 

expire, for certain purposes, on December 31, 2007.101 The definition does not expire for 

purposes of taxing distributions from the RIC that are attributable directly or indirectly to a 

distribution to the entity from a real estate investment trust, nor for purposes of the applicable 

wash sale rules. 

Description of Proposal

The proposal would extend the inclusion of a regulated investment company (RIC) within 

the definition of a "qualified investment entity" under section 897 of the Code through December 

31, 2008, for those situations in which that that inclusion would otherwise expire at the end of 

2007. However, such extension would not apply to then application of withholding requirements 

with respect to any payments made on or before date of enactment. 

Effective Date 

The proposal would take effect on January 1, 2008. 

 101 Section 897(h). 
90 

12. Modify tax treatment of offshore nonqualified deferred compensation 

Present Law

In general

Under present law, the determination of when amounts deferred under a nonqualified 

deferred compensation arrangement are includible in the gross income of the person earning the 

compensation depends on the facts and circumstances of the arrangement. A variety of tax 

principles and Code provisions may be relevant in making this determination, including the 

doctrine of constructive receipt, the economic benefit doctrine,102 the provisions of section 83 

relating generally to transfers of property in connection with the performance of services, 

provisions relating specifically to nonexempt employee trusts (sec. 402(b)) and nonqualified 

annuities (sec. 403(c)), and the requirements of section 409A. 

In general, the time for income inclusion of nonqualified deferred compensation depends 

on whether the arrangement is unfunded or funded. If the arrangement is unfunded, then the 

compensation generally is includible in income by a cash-basis taxpayer when it is actually or 

constructively received. If the arrangement is funded, then income is includible for the year in 

which the individual’s rights are transferable or not subject to a substantial risk of forfeiture. 

An arrangement generally is considered funded if there has been a transfer of property 

under section 83. Under that section, a transfer of property occurs when a person acquires a 

beneficial ownership interest in such property. The term “property” is defined very broadly for 

purposes of section 83.103 Property includes real and personal property other than money or an 

unfunded and unsecured promise to pay money in the future. Property also includes a beneficial 

interest in assets (including money) that are transferred or set aside from claims of the creditors 

of the transferor; for example, in a trust or escrow account. Accordingly, if, in connection with 

the performance of services, vested contributions are made to a trust on an individual’s behalf 

and the trust assets may be used solely to provide future payments to the individual, the payment 

of the contributions to the trust constitutes a transfer of property to the individual that is taxable 

under section 83. On the other hand, deferred amounts generally are not includible in income if 

nonqualified deferred compensation is payable from general corporate funds that are subject to 

the claims of general creditors, as such amounts are treated as unfunded and unsecured promises 

to pay money or property in the future. 

As discussed above, if the arrangement is unfunded, then the compensation generally is 

includible in income by a cash-basis taxpayer when it is actually or constructively received under 

section 451.104 Income is constructively received when it is credited to a person’s account, set 

 102 See, e.g., Sproull v. Commissioner, 16 T.C. 244 (1951), aff’d, per curiam, 194 F.2d 541 (6th 

Cir. 1952); Rev. Rul. 60-31, 1960-1 C.B. 174. 

103 Treas. Reg. sec. 1.83-3(e). This definition, in part, reflects previous IRS rulings on 

nonqualified deferred compensation. 

104 Treas. Reg. secs. 1.451-1 and 1.451-2. 
91 

apart, or otherwise made available so that it may be drawn on at any time. Income is not 

constructively received if the taxpayer’s control of its receipt is subject to substantial limitations 

or restrictions. A requirement to relinquish a valuable right in order to make withdrawals is 

generally treated as a substantial limitation or restriction. 

Prior to the enactment of section 409A, arrangements had developed in an effort to 

provide employees with security for nonqualified deferred compensation, while still allowing 

deferral of income inclusion under the constructive receipt doctrine (which applies to unfunded 

arrangements). One such arrangement is a “rabbi trust.” A rabbi trust is a trust or other fund 

established by the employer to hold assets from which nonqualified deferred compensation 

payments will be made. The trust or fund is generally irrevocable and does not permit the 

employer to use the assets for purposes other than to provide nonqualified deferred 

compensation, except that the terms of the trust or fund provide that the assets are subject to the 

claims of the employer’s creditors in the case of insolvency or bankruptcy. In the case of a rabbi 

trust, these terms have been the basis for the conclusion that the creation of a rabbi trust does not 

cause the related nonqualified deferred compensation arrangement to be funded for income tax 

purposes.105 As a result, no amount is included in income by reason of the rabbi trust; generally 

income inclusion occurs as payments are made from the trust. 

Section 409A

Reason for enactment

The Congress enacted section 409A106 because it was concerned that many nonqualified 

deferred compensation arrangements had developed which allowed improper deferral of income. 

Executives often used arrangements that allowed deferral of income, but also provided security 

of future payment and control over amounts deferred. For example, nonqualified deferred 

compensation arrangements often contained provisions that allowed participants to receive 

distributions upon request, subject to forfeiture of a minimal amount (i.e., a “haircut” provision). 

In addition, Congress was aware that since the concept of a rabbi trust was developed, techniques 

had been used that attempted to protect the assets from creditors despite the terms of the trust. 

For example, the trust or fund would be located in a foreign jurisdiction, making it difficult or 

impossible for creditors to reach the assets. 

Prior to the enactment of section 409A, while the general tax principles governing 

deferred compensation were well established, the determination whether a particular 

arrangement effectively allowed deferral of income was generally made on a facts and 

circumstances basis. There was limited specific guidance with respect to common deferral 

arrangements. The Congress believed that it was appropriate to provide specific rules regarding 

 105 This conclusion was first provided in a 1980 private ruling issued by the IRS with respect to 

an arrangement covering a rabbi; hence, the popular name “rabbi trust.” Priv. Ltr. Rul. 8113107 (Dec. 31, 

1980). 

106 Section 409A was added to the Code by sec. 885 of the American Job Creation Act of 2004, 

Pub. L. No. 108-357. 
92 

whether deferral of income inclusion should be permitted and to provide a clear set of rules that 

would apply to these arrangements. The Congress believed that certain arrangements that allow 

participants inappropriate levels of control or access to amounts deferred should not result in 

deferral of income inclusion. The Congress also believed that certain arrangements, such as 

offshore trusts, which effectively protect assets from creditors of the employer, should be treated 

as funded and not result in deferral of income inclusion to the extent the amounts are vested. 

General requirements of section 409A

In general.–Under section 409A, all amounts deferred by a service provider under a 

nonqualified deferred compensation plan107 for all taxable years are currently includible in gross 

income of the service provider to the extent such amounts are not subject to a substantial risk of 

forfeiture108 and not previously included in gross income, unless certain requirements are 

satisfied. If the requirements of section 409A are not satisfied, in addition to current income 

inclusion, interest at the rate applicable to underpayments of tax plus one percentage point is 

imposed on the underpayments that would have occurred had the compensation been includible 

in income when first deferred, or if later, when not subject to a substantial risk of forfeiture. The 

amount required to be included in income is also subject to a 20-percent additional tax. 

Section 409A does not limit the amount that may be deferred under a nonqualified 

deferred compensation plan. The Secretary of the Treasury is authorized to prescribe regulations 

as are necessary or appropriate to carry out the purposes of section 409A. The Secretary of the 

Treasury published final regulations under section 409A on April 17, 2007.109 

Under these regulations, the term “service provider” includes an individual, corporation, 

subchapter S corporation, partnership, personal service corporation (as defined in section 

269A(b)(1)), noncorporate entity that would be a personal service corporation if it were a 

corporation, or qualified personal service corporation (as defined in section 448(d)(2)) for any 

taxable year in which such individual or entity accounts for gross income from the performance 

of services under the cash receipts and disbursements method of accounting.110 Section 409A 

does not apply to a service provider that provides significant services to at least two service 

recipients that are not related to each other or the service provider. This exclusion does not apply 

 107 A plan includes an agreement or arrangement, including an agreement or arrangement that 

includes one person. Amounts deferred also include actual or notional earnings. 

108 The rights of a person to compensation are subject to a substantial risk of forfeiture if the 

person’s rights to such compensation are conditioned upon the performance of substantial services by any 

individual. 

109 On October 22, 2007, the IRS announced that during 2008, taxpayers are not required to 

comply with the final regulations. Instead, taxpayers must operate a plan in compliance with section 

409A and the otherwise applicable guidance. To the extent an issue is not addressed, a reasonable, good 

faith interpretation of the statute must be used. Notice 2007-86. 

110 Treas. Reg. sec. 1.409A-1(f)(1). 
93 

to a service provider who is an employee or a director of a corporation (or similar position in the 

case of an entity that is not a corporation).111 In addition, the exclusion does not apply to an 

entity that operates as the manager of a hedge fund or private equity fund. This is because the 

exclusion does not apply to the extent that a service provider provides management services to a 

service recipient. Management services for this purpose means services that involve the actual 

or de facto direction or control of the financial or operational aspects of a trade or business of the 

service recipient or investment management or advisory services provided to a service recipient 

whose primary trade or business includes the investment of financial assets, such as a hedge 

fund.112

Permissible distribution events.–Under section 409A, distributions from a nonqualified 

deferred compensation plan may be allowed only upon separation from service (as determined 

by the Secretary of the Treasury), death, a specified time (or pursuant to a fixed schedule), 

change in control of a corporation (to the extent provided by the Secretary of the Treasury), 

occurrence of an unforeseeable emergency, or if the service provider becomes disabled. A 

nonqualified deferred compensation plan may not allow distributions other than upon the 

permissible distribution events and, except as provided in regulations by the Secretary of the 

Treasury, may not permit acceleration of a distribution. In the case of a specified employee who 

separates from service, distributions may not be made earlier than six months after the date of the 

separation from service or upon death. Specified employees are key employees113 of publiclytraded corporations. 

Elections.–Section 409A requires that a plan must provide that compensation for services 

performed during a taxable year may be deferred at the service provider’s election only if the 

election to defer is made no later than the close of the preceding taxable year, or at such other 

time as provided in Treasury regulations. In the case of any performance-based compensation 

based on services performed over a period of at least 12 months, such election may be made no 

later than six months before the end of the service period. The time and form of distributions 

must be specified at the time of initial deferral. A plan may allow changes in the time and form 

of distributions subject to certain requirements. 

Back-to-back arrangements.–Back-to-back service recipients (i.e., situations under which 

an entity receives services from a service provider such as an employee, and the entity in turn 

provides services to a client) that involve back-to-back nonqualified deferred compensation 

arrangements (i.e., the fees payable by the client are deferred at both the entity level and the 

employee level) are subject to special rules under section 409A. For example, the final 

regulations generally permit the deferral agreement between the entity and its client to treat as a 

permissible distribution event those events that are specified as distribution events in the deferral 

 111 Treas. Reg. sec. 1.409A-1(f)(2). 

112 Treas. Reg. sec. 1.409A-1(f)(2)(iv). 

113 Key employees are defined in section 416(i) and generally include officers (limited to 50 

employees) having annual compensation greater than $145,000 (for 2007), five percent owners, and one 

percent owners having annual compensation from the employer greater than $150,000. 
94 

agreement between the entity and its employee. Thus, if separation from employment is a 

specified distribution event between the entity and the employee, the employee’s separation 

generally is a permissible distribution event for the deferral agreement between the entity and its 

client.114

Offshore funding arrangements.–Section 409A requires current income inclusion in the 

case of certain offshore funding of nonqualified deferred compensation. Under section 409A, in 

the case of assets set aside (directly or indirectly) in a trust (or other arrangement determined by 

the Secretary of the Treasury) for purposes of paying nonqualified deferred compensation, such 

assets are treated as property transferred in connection with the performance of services under 

section 83 (whether or not such assets are available to satisfy the claims of general creditors) at 

the time set aside if such assets (or trust or other arrangement) are located outside of the United 

States or at the time transferred if such assets (or trust or other arrangement) are subsequently 

transferred outside of the United States. Any subsequent increases in the value of, or any 

earnings with respect to, such assets are treated as additional transfers of property. 

Interest at the underpayment rate plus one percentage point is imposed on the 

underpayments of tax that would have occurred had the amounts set aside been includible in 

income for the taxable year in which first deferred or, if later, the first taxable year not subject to 

a substantial risk of forfeiture. The amount required to be included in income also is subject to 

an additional 20-percent tax. 

The special funding rule does not apply to assets located in a foreign jurisdiction if 

substantially all of the services to which the nonqualified deferred compensation relates are 

performed in such foreign jurisdiction. The Secretary of the Treasury has authority to exempt 

arrangements from the provision if the arrangements do not result in an improper deferral of U.S. 

tax and will not result in assets being effectively beyond the reach of creditors. 

Definition of substantial risk of forfeiture

Under the Treasury regulations, compensation is subject to a substantial risk of forfeiture 

if entitlement to the amount is conditioned upon either the performance of substantial future 

services by any person or the occurrence of a condition related to a purpose of the compensation, 

provided that the possibility of forfeiture is substantial.115 

Definition of nonqualified deferred compensation

Under section 409A, a nonqualified deferred compensation plan generally includes any 

plan that provides for the deferral of compensation other than a qualified employer plan or any 

bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan. A 

qualified employer plan means a qualified retirement plan, tax-deferred annuity, simplified 

 114 Treas. Reg. sec. 1.409A-3(i)(6). 

115 Treas. Reg. sec. 1.409A-1(d)(1). 
95 

employee pension, and SIMPLE. A qualified governmental excess benefit arrangement (sec. 

415(m)) and an eligible deferred compensation plan (sec. 457(b)) is a qualified employer plan. 

The Treasury regulations also provide that certain other types of plans are not considered 

deferred compensation, and thus are not subject to section 409A. For example, if a service 

recipient transfers property to a service provider, there is no deferral of compensation merely 

because the value of the property is either not includible in income under section 83 by reason of 

the property being substantially nonvested or is includible in income because of a valid section 

83(b) election.116 Special rules apply in the case of stock options.117 Another exception applies 

to amounts that are not deferred beyond a short period of time after the amount is no longer 

subject to a substantial risk of forfeiture.118 Under this exception, there generally is no deferral 

for purposes of section 409A if the service provider actually or constructively receives the 

amount on or before the last day of the applicable 21⁄2 month period. The applicable 21⁄2 month 

period is the period ending on the later of the 15th day of the third month following the end of: 

(1) the service provider’s first taxable year in which the right to the payment is no longer subject 

to a substantial risk of forfeiture; or (2) the service recipient’s first taxable year in which the right 

to the payment is no longer subject to a substantial risk of forfeiture. 

Special rules apply in the case of stock appreciation rights ("SARs").119 Under the final 

Treasury regulations, a SAR is a right to compensation based on the appreciation in value of a 

specified number of shares of service recipient stock occurring between the date of grant and the 

date of exercise of such right. The final regulations generally provide that a SAR does not result 

in a deferral of compensation for purposes of section 409A (and thus is not subject to section 

409A) if the compensation payable under the SAR is not greater than the excess of the fair 

market value of the underlying stock on the date the SAR is exercised over the fair market value 

of the underlying stock on the date the SAR is granted.120 

The Treasury regulations provide exclusions from the definition of nonqualified deferred 

compensation in the case of services performed by individuals who participate in certain foreign 

plans, including plans covered by an applicable treaty and broad-based foreign retirement 

plans.121 In the case of a U.S. citizen or lawful permanent alien, nonqualified deferred 

compensation plan does not include a broad-based foreign retirement plan, but only with respect 

to the portion of the plan that provides for nonelective deferral of foreign earned income and 

subject to limitations on the annual amount deferred under the plan or the annual amount payable 

 116 Treas. Reg. Sec. 1.409A-1(b)(6). 

117 Treas. Reg. Sec. 1.409A-1(b)(5). 

118 Treas. Reg. sec. 1.409A-1(b)(4). 

119 Treas. Reg. sec. 1.409A-1(b)(5). 

120 Treas. Reg. sec. 1.409A-1(b)(5)(i)(B). 

121 Treas. Reg. sec. 1.409A-1(a)(3). 
96 

under the plan. In general, foreign earned income refers to amounts received by an individual 

from sources within a foreign country that constitutes earned income attributable to services. 

Timing of the service recipient’s deduction

Special statutory provisions govern the timing of the deduction for nonqualified deferred 

compensation, regardless of whether the arrangement covers employees or nonemployees and 

regardless of whether the arrangement is funded or unfunded.122 Under these provisions, the 

amount of nonqualified deferred compensation that is includible in the income of the service 

provider is deductible by the service recipient for the taxable year in which the amount is 

includible in the service provider’s income.123 Thus, for example, in the case of an unfunded 

nonqualified deferred compensation plan, a deduction to the taxable service recipient is deferred 

until the deferred compensation is actually paid or made available to the service provider. 

Section 457

Special income recognition rules apply in the case of a participant in a deferred 

compensation plan that is sponsored by a State or local government or an organization that is 

exempt from Federal income tax under section 501(a). Section 457 provides for different 

income inclusion rules for two basic types of deferred compensation arrangements: (1) 

arrangements that limit the amount of compensation that may be deferred (generally, $15,500 in 

2007) and that meet certain other requirements specified in section 457(b) (referred to as a 

“section 457(b) plan” or an “eligible deferred compensation plan”); and (2) arrangements that do 

not satisfy the requirements of section 457(b) (referred to as a “section 457(f) plan” or an 

“ineligible deferred compensation plan”). Section 457 does not provide a limit on the amount of 

compensation that may be deferred under a section 457(f) plan. 

A participant in a section 457(b) plan does not recognize income with respect to the 

participant’s interest in such plan until the time of actual distribution (or, if earlier, the time the 

 122 Secs. 404(a)(5), (b) and (d) and sec. 83(h). 

123 In the case of a publicly held corporation, no deduction is allowed for a taxable year for 

remuneration with respect to a covered employee to the extent that the remuneration exceeds $1 million. 

Code sec. 162(m). The Code defines the term “covered employee” in part by reference to Federal 

securities law. In light of changes to Federal securities law, the Internal Revenue Service interprets the 

term covered employee as the principal executive officer of the taxpayer as of the close of the taxable 

year or the 3 most highly compensated employees of the taxpayer for the taxable year whose 

compensation must be disclosed to the taxpayer’s shareholders (other than the principal executive officer 

or the principal financial officer). Notice 2007-49, 2007-25 I.R.B. 1429. For purposes of the deduction 

limit, remuneration generally includes all remuneration for which a deduction is otherwise allowable, 

although commission-based compensation and certain performance-based compensation are not subject to 

the limit. Remuneration does not include compensation for which a deduction is allowable after a 

covered employee ceases to be a covered employee. Thus, the deduction limitation often does not apply 

to deferred compensation that is otherwise subject to the deduction limitation (e.g., is not performancebased compensation) because the payment of the compensation is deferred until after termination of 

employment. 
97 

participant’s interest is made available to the participant, but only in the case of a section 457(b) 

plan maintained by a tax-exempt sponsor other than a State or local government). In contrast, a 

participant in a section 457(f) plan must include amounts deferred under such a plan in gross 

income for the first taxable year in which there is no substantial risk of forfeiture of the rights to 

such compensation. 

Description of Proposal

In general

Under the proposal, any compensation that is deferred under a nonqualified deferred 

compensation plan of a nonqualified entity is includible in gross income by the service provider 

when there is no substantial risk of forfeiture of the service provider’s rights to such 

compensation. The proposal applies in addition to the requirements of section 409A (or any 

other provision of the Code or general tax law principle) with respect to nonqualified deferred 

compensation. 

Nonqualified deferred compensation

For purposes of the proposal, the term nonqualified deferred compensation plan is 

defined in the same manner as for purposes of section 409A. As under section 409A, the term 

nonqualified deferred compensation includes earnings with respect to previously deferred 

amounts. Earnings are treated in the same manner as the amount deferred to which the earnings 

relate. 

Under the proposal, nonqualified deferred compensation includes any arrangement under 

which compensation is based on the increase in value of a specified number of equity units of the 

service recipient. Thus, stock appreciation rights (SARs) are treated as nonqualified deferred 

compensation under the proposal, regardless of the exercise price of the SAR. It is not intended 

that the term nonqualified deferred compensation plan include an arrangement taxable under 

section 83 providing for the grant of an option on employer stock with an exercise price that is 

not less than the fair market value of the underlying stock on the date of grant if such 

arrangement does not include a deferral feature other than the feature that the option holder has 

the right to exercise the option in the future. The proposal is not intended to change the tax 

treatment of incentive stock options meeting the requirements of 422 or options granted under an 

employee stock purchase plan meeting the requirements of section 423. Similarly, nonqualified 

deferred compensation for purposes of the proposal does not include a transfer of property to 

which section 83 is applicable (such as a transfer of restricted stock), provided that the 

arrangement does not include a deferral feature. 

Compensation is not treated as deferred for purposes of the proposal if the service 

provider receives payment of the compensation not later than 12 months after the end of the 

taxable year of the service recipient during which the right to the payment of such compensation 

is no longer subject to a substantial risk of forfeiture. 
98 

Nonqualified entity

The term nonqualified entity includes certain foreign corporations and certain 

partnerships (either domestic or foreign). A foreign corporation is a nonqualified entity unless 

substantially all of such income is effectively connected with the conduct of a United States trade 

or business or is subject to a comprehensive foreign income tax. A partnership is a nonqualified 

entity unless substantially all of such income is allocated to persons other than foreign persons 

with respect to whom such income is not subject to a comprehensive income tax and 

organizations which are exempt from U.S. income tax. 

The term comprehensive foreign income tax means with respect to a foreign person, the 

income tax of a foreign country if (1) such person is eligible for the benefits of a comprehensive 

income tax treaty between such foreign county and the United States, or (2) such person 

demonstrates to the satisfaction of the Secretary of the Treasury that such foreign country has a 

comprehensive income tax. 

In the case of a foreign corporation with income that is taxable under section 882, the 

proposal does not apply to compensation which, had such compensation been paid in cash on the 

date that such compensation ceased to be subject to a substantial risk of forfeiture, would have 

been deductible by such foreign corporation against such income. 

Additional rules

For purposes of the proposal, compensation of a service provider is subject to a 

substantial risk of forfeiture only if such person’s right to the compensation is conditioned upon 

the future performance of substantial services by any person. Thus, compensation is subject to a 

substantial risk of forfeiture only if entitlement to the compensation is conditioned on the 

performance of substantial future services and the possibility of forfeiture is substantial. 

Substantial risk of forfeiture does not include a condition related to a purpose of the 

compensation (other than future performance of substantial services), regardless of whether the 

possibility of forfeiture is substantial. 

To the extent provided in regulations prescribed by the Secretary, if compensation is 

determined solely by reference to the amount of gain recognized on the disposition of an 

investment asset, such compensation is treated as subject to a substantial risk of forfeiture until 

the date of such disposition. Investment asset means any single asset (other than an investment 

fund or similar entity) (1) acquired directly by an investment fund or similar entity, (2) with 

respect to which such entity does not (nor does any person related to such entity) participate in 

the active management of such asset (or if such asset is an interest in an entity, in the active 

management of the assets of such entity), and (3) substantially all of any gain on the disposition 

of which (other than the nonqualified deferred compensation) is allocated to investors of such 

entity. The rule only applies if the compensation is determined solely by reference to the gain 

upon the disposition of an investment asset. Thus, for example, the rule does not apply in the 

case of an arrangement under which the amount of this compensation is reduced for losses on the 

disposition of any other asset. With respect to any gain before the asset is treated as no longer 

subject to a substantial risk of forfeiture under these provisions, it is intended that Treasury 
99 

regulations will limit the application of this rule to gain attributable to the period that the service 

provider is performing services. 

The rule is intended to apply to compensation contingent on the disposition of a single 

asset held as a long-term investment, provided that the service provider does not actively manage 

the asset (other than the decision to purchase or sell the investment). If the asset is an interest in 

an entity (such as a company that produces products or services), the rule does not apply if the 

service provider actively participates in the management of the entity. Active management is 

intended to include participation in the day-to-day activities of the asset, but does not include the 

election of a director or other voting rights exercised by shareholders. 

The rule is intended to apply solely to compensation arrangements relating to passive 

investments by an investment fund in a single asset. For example, if an investment fund acquires 

XYZ operating corporation, the rule is intended to apply to an arrangement that the fund 

manager receive 20 percent of the gain from the disposition of XYZ operating corporation if the 

fund manager does not actively participate in the management of XYZ operating corporation. In 

contrast, the rule does not apply if the investment fund holds two or more operating corporations 

and the fund manger’s compensation is based on the net gain resulting from the disposition of the 

operating corporations. The rule does not apply to the disposition of a foreign subsidiary which 

holds a variety of assets the investment of which is managed by the service provider. 

Under the proposal, if the amount of any deferred compensation is not determinable at 

the time that such compensation is otherwise required to be taken into account into income under 

the proposal, the amount is taken into account when such amount becomes determinable. This 

rule applies in lieu of the general rule of the proposal, under which deferred compensation is 

taken into account in income when such compensation is no longer subject to a substantial risk of 

forfeiture. In addition, the income tax with respect to such amount is increased by the sum of (1) 

an interest charge, and (2) an amount equal to 20 percent of such compensation. The interest 

charge is equal to the interest at the rate applicable to underpayments of tax plus one percentage 

point imposed on the underpayments that would have occurred had the compensation been 

includible in income when first deferred, or if later, when not subject to a substantial risk of 

forfeiture. 

Treasury regulations

It is intended that the Secretary of the Treasury issue regulations as to when an amount is 

not determinable for purposes of the proposal. It is intended that an amount of deferred 

compensation is not determinable at the time the amount is no longer subject to a substantial risk 

of forfeiture if the amount varies depending on the satisfaction of an objective condition. For 

example, if a deferred amount varies depending on the satisfaction of an objective condition at 

the time the amount is no longer subject to substantial risk of forfeiture (e.g., no amount is paid 

unless a certain threshold is achieved, 100 percent is paid the threshold is achieved, and 200 

percent is paid if a higher threshold is achieved), the amount deferred is not determinable. 

The Secretary of the Treasury is also authorized to issue such regulations as may be 

necessary or appropriate to carry out the purposes of the proposal, including regulations 

disregarding a substantial risk of forfeiture as necessary to carry out such purposes. 
100 

Under the proposal, aggregation rules similar to those that apply under section 409A 

apply for purposes of determining whether a plan sponsor is a nonqualified entity. It is intended, 

however, that such aggregation rules are limited by the Secretary to operate in accordance with 

the purposes of the proposal. For example, it is intended that the aggregation rules do not result 

in the application of the proposal to employees of a U.S. subsidiary C corporation that is wholly 

owned by a nonqualified entity when the U.S. subsidiary sponsors the nonqualified deferred 

compensation plan in which the employees of the subsidiary participate. This is because the 

subsidiary is subject to the timing rule with respect to its deduction of its employees’ 

nonqualified deferred compensation. 

Effective Date

The proposal is effective with respect to amounts deferred which are attributable to 

services performed after December 31, 2008. In the case of an amount deferred which is 

attributable to services performed on or before December 31, 2008, to the extent such amount is 

not includible in gross income in a taxable year beginning before 2018, then such amount is 

includible in gross income in the later of (1) the last taxable year beginning before 2018, or (2) 

the taxable year in which there is no substantial risk of forfeiture of the rights to such 

compensation. Earnings on amounts deferred which are attributable to services performed on or 

before December 31, 2008, are subject to the proposal only to the extent that the amounts to 

which such earnings relate are subject to the proposal. 

No later than 120 days after date of enactment, the Secretary shall issue guidance 

providing a limited period of time during which a nonqualified deferred compensation 

arrangement attributable to services performed on or before December 31, 2008, may, without 

violating the requirements of section 409A(a), be amended to conform the date of distribution to 

the date the amounts are required to be included in income. If the taxpayer is also a service 

recipient and maintains one or more nonqualified deferred compensation arrangements for its 

service providers under which any amount is attributable to services performed on or before 

December 31, 2008, the guidance shall permit such arrangements to be amended to conform the 

dates of distribution under the arrangement to the date amounts are required to be included in 

income of the taxpayer under the proposal. An amendment made pursuant to the Treasury 

guidance will not be treated as a material modification of the arrangement for purposes of section 

409A.
101

B. Extenders Primarily Affecting Businesses 

1. Extend the research and experimentation tax credit 

Present Law

General rule

A taxpayer may claim a research credit equal to 20 percent of the amount by which the 

taxpayer’s qualified research expenses for a taxable year exceed its base amount for that year.124 

Thus, the research credit is generally available with respect to incremental increases in qualified 

research. 

A 20-percent research tax credit is also available with respect to the excess of (1) 100 

percent of corporate cash expenses (including grants or contributions) paid for basic research 

conducted by universities (and certain nonprofit scientific research organizations) over (2) the 

sum of (a) the greater of two minimum basic research floors plus (b) an amount reflecting any 

decrease in nonresearch giving to universities by the corporation as compared to such giving 

during a fixed-base period, as adjusted for inflation. This separate credit computation is 

commonly referred to as the university basic research credit.125

Finally, a research credit is available for a taxpayer’s expenditures on research 

undertaken by an energy research consortium. This separate credit computation is commonly 

referred to as the energy research credit. Unlike the other research credits, the energy research 

credit applies to all qualified expenditures, not just those in excess of a base amount. 

The research credit, including the university basic research credit and the energy research 

credit, has expired and does not apply to amounts paid or incurred after December 31, 2007.126

Computation of allowable credit

Except for energy research payments and certain university basic research payments 

made by corporations, the research tax credit applies only to the extent that the taxpayer’s 

qualified research expenses for the current taxable year exceed its base amount. The base 

amount for the current year generally is computed by multiplying the taxpayer’s fixed-base 

percentage by the average amount of the taxpayer’s gross receipts for the four preceding years. 

If a taxpayer both incurred qualified research expenses and had gross receipts during each of at 

least three years from 1984 through 1988, then its fixed-base percentage is the ratio that its total 

 124 Sec. 41. 

125 Sec. 41(e). 

126 The research tax credit was initially enacted in the Economic Recovery Tax Act of 1981. It 

has been subsequently extended and modified numerous times. Most recently, the Tax Relief and Health 

Care Act of 2006 extended the research credit through December 31, 2007, modified the alternative 

incremental research credit, and added an election to claim an alternative simplified credit. 
102

qualified research expenses for the 1984-1988 period bears to its total gross receipts for that 

period (subject to a maximum fixed-base percentage of 16 percent). All other taxpayers (socalled start-up firms) are assigned a fixed-base percentage of three percent.127 

In computing the credit, a taxpayer’s base amount can not be less than 50 percent of its 

current-year qualified research expenses. 

To prevent artificial increases in research expenditures by shifting expenditures among 

commonly controlled or otherwise related entities, a special aggregation rule provides that all 

members of the same controlled group of corporations are treated as a single taxpayer.128 Under 

regulations prescribed by the Secretary, special rules apply for computing the credit when a 

major portion of a trade or business (or unit thereof) changes hands, under which qualified 

research expenses and gross receipts for periods prior to the change of ownership of a trade or 

business are treated as transferred with the trade or business that gave rise to those expenses and 

receipts for purposes of recomputing a taxpayer’s fixed-base percentage.129 

Alternative incremental research credit regime

Taxpayers are allowed to elect an alternative incremental research credit regime.130 If a 

taxpayer elects to be subject to this alternative regime, the taxpayer is assigned a three-tiered 

fixed-base percentage (that is lower than the fixed-base percentage otherwise applicable under 

present law) and the credit rate likewise is reduced. 

Generally, for amounts paid or incurred prior to 2007, under the alternative incremental 

credit regime, a credit rate of 2.65 percent applies to the extent that a taxpayer’s current-year 

research expenses exceed a base amount computed by using a fixed-base percentage of one 

percent (i.e., the base amount equals one percent of the taxpayer’s average gross receipts for the 

four preceding years) but do not exceed a base amount computed by using a fixed-base 

percentage of 1.5 percent. A credit rate of 3.2 percent applies to the extent that a taxpayer’s 

 127 The Small Business Job Protection Act of 1996 expanded the definition of start-up firms 

under section 41(c)(3)(B)(i) to include any firm if the first taxable year in which such firm had both gross 

receipts and qualified research expenses began after 1983. A special rule (enacted in 1993) is designed to 

gradually recompute a start-up firm’s fixed-base percentage based on its actual research experience. 

Under this special rule, a start-up firm is assigned a fixed-base percentage of three percent for each of its 

first five taxable years after 1993 in which it incurs qualified research expenses. A start-up firm’s fixedbase percentage for its sixth through tenth taxable years after 1993 in which it incurs qualified research 

expenses is a phased-in ratio based on the firm’s actual research experience. For all subsequent taxable 

years, the taxpayer’s fixed-base percentage is its actual ratio of qualified research expenses to gross 

receipts for any five years selected by the taxpayer from its fifth through tenth taxable years after 1993. 

Sec. 41(c)(3)(B). 

128 Sec. 41(f)(1). 

129 Sec. 41(f)(3). 

130 Sec. 41(c)(4). 
103

current-year research expenses exceed a base amount computed by using a fixed-base percentage 

of 1.5 percent but do not exceed a base amount computed by using a fixed-base percentage of 

two percent. A credit rate of 3.75 percent applies to the extent that a taxpayer’s current-year 

research expenses exceed a base amount computed by using a fixed-base percentage of two 

percent. Generally, for amounts paid or incurred after 2006, the credit rates listed above are 

increased to three percent, four percent, and five percent, respectively.131

An election to be subject to this alternative incremental credit regime can be made for 

any taxable year beginning after June 30, 1996, and such an election applies to that taxable year 

and all subsequent years unless revoked with the consent of the Secretary of the Treasury. 

Alternative simplified credit

Generally, for amounts paid or incurred after 2006, taxpayers may elect to claim an 

alternative simplified credit for qualified research expenses.132 The alternative simplified 

research credit is equal to 12 percent of qualified research expenses that exceed 50 percent of the 

average qualified research expenses for the three preceding taxable years. The rate is reduced to 

six percent if a taxpayer has no qualified research expenses in any one of the three preceding 

taxable years. 

An election to use the alternative simplified credit applies to all succeeding taxable years 

unless revoked with the consent of the Secretary. An election to use the alternative simplified 

credit may not be made for any taxable year for which an election to use the alternative 

incremental credit is in effect. A transition rule applies which permits a taxpayer to elect to use 

the alternative simplified credit in lieu of the alternative incremental credit if such election is 

made during the taxable year which includes January 1, 2007. The transition rule applies only to 

the taxable year which includes that date. 

Eligible expenses

Qualified research expenses eligible for the research tax credit consist of: (1) in-house 

expenses of the taxpayer for wages and supplies attributable to qualified research; (2) certain 

time-sharing costs for computer use in qualified research; and (3) 65 percent of amounts paid or 

incurred by the taxpayer to certain other persons for qualified research conducted on the 

taxpayer’s behalf (so-called contract research expenses).133 Notwithstanding the limitation for 

 131 A special transition rule applies for fiscal year 2006-2007 taxpayers. 

132 A special transition rule applies for fiscal year 2006-2007 taxpayers. 

133 Under a special rule, 75 percent of amounts paid to a research consortium for qualified 

research are treated as qualified research expenses eligible for the research credit (rather than 65 percent 

under the general rule under section 41(b)(3) governing contract research expenses) if (1) such research 

consortium is a tax-exempt organization that is described in section 501(c)(3) (other than a private 

foundation) or section 501(c)(6) and is organized and operated primarily to conduct scientific research, 

and (2) such qualified research is conducted by the consortium on behalf of the taxpayer and one or more 

persons not related to the taxpayer. Sec. 41(b)(3)(C). 
104

contract research expenses, qualified research expenses include 100 percent of amounts paid or 

incurred by the taxpayer to an eligible small business, university, or Federal laboratory for 

qualified energy research. 

To be eligible for the credit, the research does not only have to satisfy the requirements of 

present-law section 174 (described below) but also must be undertaken for the purpose of 

discovering information that is technological in nature, the application of which is intended to be 

useful in the development of a new or improved business component of the taxpayer, and 

substantially all of the activities of which constitute elements of a process of experimentation for 

functional aspects, performance, reliability, or quality of a business component. Research does 

not qualify for the credit if substantially all of the activities relate to style, taste, cosmetic, or 

seasonal design factors.134 In addition, research does not qualify for the credit: (1) if conducted 

after the beginning of commercial production of the business component; (2) if related to the 

adaptation of an existing business component to a particular customer’s requirements; (3) if 

related to the duplication of an existing business component from a physical examination of the 

component itself or certain other information; or (4) if related to certain efficiency surveys, 

management function or technique, market research, market testing, or market development, 

routine data collection or routine quality control.135 Research does not qualify for the credit if it 

is conducted outside the United States, Puerto Rico, or any U.S. possession. 

Relation to deduction

Under section 174, taxpayers may elect to deduct currently the amount of certain research 

or experimental expenditures paid or incurred in connection with a trade or business, 

notwithstanding the general rule that business expenses to develop or create an asset that has a 

useful life extending beyond the current year must be capitalized.136 However, deductions 

allowed to a taxpayer under section 174 (or any other section) are reduced by an amount equal to 

100 percent of the taxpayer’s research tax credit determined for the taxable year.137 Taxpayers 

may alternatively elect to claim a reduced research tax credit amount under section 41 in lieu of 

reducing deductions otherwise allowed.138

 134 Sec. 41(d)(3). 

135 Sec. 41(d)(4). 

136 Taxpayers may elect 10-year amortization of certain research expenditures allowable as a 

deduction under section 174(a). Secs. 174(f)(2) and 59(e). 

137 Sec. 280C(c). 

138 Sec. 280C(c)(3). 
105

Description of Proposal

The proposal extends the research credit for one year, through December 31, 2008. The 

proposal also clarifies the computation of the alternative incremental research credit and the 

alternative simplified credit for the taxable year in which the credit terminates. 

Effective Date

The proposal is effective for amounts paid or incurred after December 31, 2007. 

2. Indian employment tax credit 

Present Law

In general, a credit against income tax liability is allowed to employers for the first 

$20,000 of qualified wages and qualified employee health insurance costs paid or incurred by the 

employer with respect to certain employees (sec. 45A). The credit is equal to 20 percent of the 

excess of eligible employee qualified wages and health insurance costs during the current year 

over the amount of such wages and costs incurred by the employer during 1993. The credit is an 

incremental credit, such that an employer’s current-year qualified wages and qualified employee 

health insurance costs (up to $20,000 per employee) are eligible for the credit only to the extent 

that the sum of such costs exceeds the sum of comparable costs paid during 1993. No deduction 

is allowed for the portion of the wages equal to the amount of the credit. 

Qualified wages means wages paid or incurred by an employer for services performed by 

a qualified employee. A qualified employee means any employee who is an enrolled member of 

an Indian tribe or the spouse of an enrolled member of an Indian tribe, who performs 

substantially all of the services within an Indian reservation, and whose principal place of abode 

while performing such services is on or near the reservation in which the services are performed. 

An “Indian reservation” is a reservation as defined in section 3(d) of the Indian Financing Act of 

1974 or section 4(1) of the Indian Child Welfare Act of 1978. For purposes of the preceding 

sentence, section 3(d) is applied by treating “former Indian reservations in Oklahoma” as 

including only lands that are (1) within the jurisdictional area of an Oklahoma Indian tribe as 

determined by the Secretary of the Interior, and (2) recognized by such Secretary as an area 

eligible for trust land status under 25 C.F.R. Part 151 (as in effect on August 5, 1997). 

An employee is not treated as a qualified employee for any taxable year of the employer 

if the total amount of wages paid or incurred by the employer with respect to such employee 

during the taxable year exceeds an amount determined at an annual rate of $30,000 (which after 

adjustment for inflation is currently $40,000).139 In addition, an employee will not be treated as 

a qualified employee under certain specific circumstances, such as where the employee is related 

to the employer (in the case of an individual employer) or to one of the employer’s shareholders, 

partners, or grantors. Similarly, an employee will not be treated as a qualified employee where 

the employee has more than a 5 percent ownership interest in the employer. Finally, an 

 139 See Form 8845, Indian Employment Credit (Rev. December 2006). 
106

employee will not be considered a qualified employee to the extent the employee’s services 

relate to gaming activities or are performed in a building housing such activities. 

The Indian employment tax credit is not available for taxable years beginning after 

December 31, 2007. 

Description of Proposal

The proposal extends for one year the present-law employment credit provision (through 

taxable years beginning on or before December 31, 2008). 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2007. 

3. Extend the new markets tax credit 

Present Law

Section 45D provides a new markets tax credit for qualified equity investments made to 

acquire stock in a corporation, or a capital interest in a partnership, that is a qualified community 

development entity (“CDE”).140 The amount of the credit allowable to the investor (either the 

original purchaser or a subsequent holder) is (1) a five-percent credit for the year in which the 

equity interest is purchased from the CDE and for each of the following two years, and (2) a sixpercent credit for each of the following four years. The credit is determined by applying the 

applicable percentage (five or six percent) to the amount paid to the CDE for the investment at 

its original issue, and is available for a taxable year to the taxpayer who holds the qualified 

equity investment on the date of the initial investment or on the respective anniversary date that 

occurs during the taxable year. The credit is recaptured if at any time during the seven-year 

period that begins on the date of the original issue of the investment the entity ceases to be a 

qualified CDE, the proceeds of the investment cease to be used as required, or the equity 

investment is redeemed. 

A qualified CDE is any domestic corporation or partnership: (1) whose primary mission 

is serving or providing investment capital for low-income communities or low-income persons; 

(2) that maintains accountability to residents of low-income communities by their representation 

on any governing board of or any advisory board to the CDE; and (3) that is certified by the 

Secretary as being a qualified CDE. A qualified equity investment means stock (other than 

nonqualified preferred stock) in a corporation or a capital interest in a partnership that is acquired 

directly from a CDE for cash, and includes an investment of a subsequent purchaser if such 

investment was a qualified equity investment in the hands of the prior holder. Substantially all 

of the investment proceeds must be used by the CDE to make qualified low-income community 

investments. For this purpose, qualified low-income community investments include: (1) capital 

 140 Section 45D was added by section 121(a) of the Community Renewal Tax Relief Act of 2000, 

Pub. L. No. 106-554 (December 21, 2000). 
107

or equity investments in, or loans to, qualified active low-income community businesses; (2) 

certain financial counseling and other services to businesses and residents in low-income 

communities; (3) the purchase from another CDE of any loan made by such entity that is a 

qualified low-income community investment; or (4) an equity investment in, or loan to, another 

CDE. 

A “low-income community” is a population census tract with either (1) a poverty rate of 

at least 20 percent or (2) median family income which does not exceed 80 percent of the greater 

of metropolitan area median family income or statewide median family income (for a nonmetropolitan census tract, does not exceed 80 percent of statewide median family income). In 

the case of a population census tract located within a high migration rural county, low-income is 

defined by reference to 85 percent (rather than 80 percent) of statewide median family income. 

For this purpose, a high migration rural county is any county that, during the 20-year period 

ending with the year in which the most recent census was conducted, has a net out-migration of 

inhabitants from the county of at least 10 percent of the population of the county at the beginning 

of such period. 

The Secretary has the authority to designate “targeted populations” as low-income 

communities for purposes of the new markets tax credit. For this purpose, a “targeted 

population” is defined by reference to section 103(20) of the Riegle Community Development 

and Regulatory Improvement Act of 1994 (12 U.S.C. 4702(20)) to mean individuals, or an 

identifiable group of individuals, including an Indian tribe, who (A) are low-income persons; or 

(B) otherwise lack adequate access to loans or equity investments. Under such Act, “lowincome” means (1) for a targeted population within a metropolitan area, less than 80 percent of 

the area median family income; and (2) for a targeted population within a non-metropolitan area, 

less than the greater of 80 percent of the area median family income or 80 percent of the 

statewide non-metropolitan area median family income.141 Under such Act, a targeted 

population is not required to be within any census tract. In addition, a population census tract 

with a population of less than 2,000 is treated as a low-income community for purposes of the 

credit if such tract is within an empowerment zone, the designation of which is in effect under 

section 1391, and is contiguous to one or more low-income communities. 

A qualified active low-income community business is defined as a business that satisfies, 

with respect to a taxable year, the following requirements: (1) at least 50 percent of the total 

gross income of the business is derived from the active conduct of trade or business activities in 

any low-income community; (2) a substantial portion of the tangible property of such business is 

used in a low-income community; (3) a substantial portion of the services performed for such 

business by its employees is performed in a low-income community; and (4) less than five 

percent of the average of the aggregate unadjusted bases of the property of such business is 

attributable to certain financial property or to certain collectibles. 

 141 12 U.S.C. 4702(17) (defines “low-income” for purposes of 12 U.S.C. 4702(20)). 
108

The maximum annual amount of qualified equity investments is capped at $2.0 billion 

per year for calendar years 2004 and 2005, and at $3.5 billion per year for calendar years 2006, 

2007, and 2008. 

Description of Proposal

The proposal extends the new markets tax credit for one year, through 2009, permitting 

up to $3.5 billion in qualified equity investments for that calendar year. 

Effective Date

The proposal is effective on the date of enactment. 

4. Extend railroad track maintenance credit 

Present Law

Present law provides a 50-percent business tax credit for qualified railroad track 

maintenance expenditures paid or incurred by an eligible taxpayer during the taxable year.142 

The credit is limited to the product of $3,500 times the number of miles of railroad track (1) 

owned or leased by an eligible taxpayer as of the close of its taxable year, and (2) assigned to the 

eligible taxpayer by a Class II or Class III railroad that owns or leases such track at the close of 

the taxable year.143 Each mile of railroad track may be taken into account only once, either by 

the owner of such mile or by the owner's assignee, in computing the per-mile limitation. Under 

the provision, the credit is limited in respect of the total number of miles of track (1) owned or 

leased by the Class II or Class III railroad and (2) assigned to the Class II or Class III railroad for 

purposes of the credit. 

Qualified railroad track maintenance expenditures are defined as gross expenditures 

(whether or not otherwise chargeable to capital account) for maintaining railroad track (including 

roadbed, bridges, and related track structures) owned or leased as of January 1, 2005, by a Class 

II or Class III railroad (determined without regard to any consideration for such expenditure 

given by the Class II or Class III railroad which made the assignment of such track).144

An eligible taxpayer means any Class II or Class III railroad, and any person who 

transports property using the rail facilities of a Class II or Class III railroad or who furnishes 

railroad-related property or services to a Class II or Class III railroad, but only with respect to 

miles of railroad track assigned to such person by such railroad under the provision.145

 142 Sec. 45G(a). 

143 Sec. 45G(b)(1). 

144 Sec. 45G(d). 

145 Sec. 45G(c). 
109

The terms Class II or Class III railroad have the meanings given by the Surface 

Transportation Board.146 

The provision applies to qualified railroad track maintenance expenditures paid or 

incurred during taxable years beginning after December 31, 2004, and before January 1, 2008. 

Description of Proposal

The proposal extends the present law provision for one year, for qualified railroad track 

maintenance expenditures paid or incurred before January 1, 2009. 

Effective Date

The proposal is effective for expenditures paid or incurred after December 31, 2007. 

5. Fifteen-year straight-line cost recovery for qualified leasehold improvements and 

qualified restaurant improvements 

Present Law

In general

A taxpayer generally must capitalize the cost of property used in a trade or business and 

recover such cost over time through annual deductions for depreciation or amortization. 

Tangible property generally is depreciated under the modified accelerated cost recovery system 

(“MACRS”), which determines depreciation by applying specific recovery periods, placed-inservice conventions, and depreciation methods to the cost of various types of depreciable 

property.147 The cost of nonresidential real property is recovered using the straight-line method 

of depreciation and a recovery period of 39 years. Nonresidential real property is subject to the 

mid-month placed-in-service convention. Under the mid-month convention, the depreciation 

allowance for the first year property is placed in service is based on the number of months the 

property was in service, and property placed in service at any time during a month is treated as 

having been placed in service in the middle of the month. 

Depreciation of leasehold improvements

Generally, depreciation allowances for improvements made on leased property are 

determined under MACRS, even if the MACRS recovery period assigned to the property is 

longer than the term of the lease. This rule applies regardless of whether the lessor or the lessee 

places the leasehold improvements in service. If a leasehold improvement constitutes an 

addition or improvement to nonresidential real property already placed in service, the 

improvement generally is depreciated using the straight-line method over a 39-year recovery 

 146 Sec. 45G(e)(1). 

147 Sec. 168. 
110

period, beginning in the month the addition or improvement was placed in service. However, 

exceptions exist for certain qualified leasehold improvements and qualified restaurant property. 

Qualified leasehold improvement property

Section 168(e)(3)(E)(iv) provides a statutory 15-year recovery period for qualified 

leasehold improvement property placed in service before January 1, 2008. Qualified leasehold 

improvement property is recovered using the straight-line method and a half-year convention. 

Leasehold improvements placed in service in 2008 and later will be subject to the general rules 

described above. 

Qualified leasehold improvement property is any improvement to an interior portion of a 

building that is nonresidential real property, provided certain requirements are met. The 

improvement must be made under or pursuant to a lease either by the lessee (or sublessee), or by 

the lessor, of that portion of the building to be occupied exclusively by the lessee (or sublessee). 

The improvement must be placed in service more than three years after the date the building was 

first placed in service. Qualified leasehold improvement property does not include any 

improvement for which the expenditure is attributable to the enlargement of the building, any 

elevator or escalator, any structural component benefiting a common area, or the internal 

structural framework of the building. 

If a lessor makes an improvement that qualifies as qualified leasehold improvement 

property, such improvement does not qualify as qualified leasehold improvement property to any 

subsequent owner of such improvement. An exception to the rule applies in the case of death 

and certain transfers of property that qualify for non-recognition treatment. 

Qualified restaurant property

Section 168(e)(3)(E)(v) provides a statutory 15-year recovery period for qualified 

restaurant property placed in service before January 1, 2008. For purposes of the provision, 

qualified restaurant property means any improvement to a building if such improvement is 

placed in service more than three years after the date such building was first placed in service 

and more than 50 percent of the building’s square footage is devoted to the preparation of, and 

seating for on-premises consumption of, prepared meals. Qualified restaurant property is 

recovered using the straight-line method and a half-year convention. Restaurant property placed 

in service in 2008 and later will be subject to the general rules described above. 

Description of Proposal

The present-law provisions for qualified leasehold improvement property and qualified 

restaurant property are extended for one year (through December 31, 2008). 

Effective Date

The proposal applies to property placed in service after December 31, 2007. 
111

6. 7-year recovery period for motorsports racetrack property 

Present Law

A taxpayer generally must capitalize the cost of property used in a trade or business and 

recover such cost over time through annual deductions for depreciation or amortization. Tangible 

property generally is depreciated under the modified accelerated cost recovery system 

(“MACRS”), which determines depreciation by applying specific recovery periods, placed-inservice conventions, and depreciation methods to the cost of various types of depreciable 

property.148 The cost of nonresidential real property is recovered using the straight-line method 

of depreciation and a recovery period of 39 years. Nonresidential real property is subject to the 

mid-month placed-in-service convention. Under the mid-month convention, the depreciation 

allowance for the first year property is placed in service is based on the number of months the 

property was in service, and property placed in service at any time during a month is treated as 

having been placed in service in the middle of the month. Land improvements (such as roads 

and fences) are recovered over 15 years. An exception exists for the theme and amusement park 

industry, whose assets are assigned a recovery period of seven years. Additionally, a 

motorsports entertainment complex placed in service before December 31, 2007 is assigned a 

recovery period of seven years.149 For these purposes, a motorsports entertainment complex 

means a racing track facility which is permanently situated on land that during the 36 month 

period following its placed in service date it hosts a racing event.150 The term motorsports 

entertainment complex also includes ancillary facilities, land improvements (e.g., parking lots, 

sidewalks, fences), support facilities (e.g., food and beverage retailing, souvenir vending), and 

appurtenances associated with such facilities (e.g., ticket booths, grandstands). 

Description of Proposal

The proposal extends the present law seven year recovery period for one year through 

December 31, 2008. 

Effective Date

The proposal is effective for property placed in service after December 31, 2007. 

 148 Sec. 168. 

149 Sec. 168(e)(3)(C)(ii). 

150 Sec. 168(i)(15). 
112

7. Accelerated depreciation for business property on Indian reservations 

Present Law

With respect to certain property used in connection with the conduct of a trade or 

business within an Indian reservation, depreciation deductions under section 168(j) are 

determined using the following recovery periods: 

3-year property 2 years 

5-year property 3 years 

7-year property 4 years 

10-year property 6 years 

15-year property 9 years 

20-year property 12 years 

Nonresidential real 

property 22 years 

“Qualified Indian reservation property” eligible for accelerated depreciation includes 

property described in the table above which is: (1) used by the taxpayer predominantly in the 

active conduct of a trade or business within an Indian reservation; (2) not used or located outside 

the reservation on a regular basis; (3) not acquired (directly or indirectly) by the taxpayer from a 

person who is related to the taxpayer;151 and (4) is not property placed in service for purposes of 

conducting gaming activities.152 Certain “qualified infrastructure property” may be eligible for 

the accelerated depreciation even if located outside an Indian reservation, provided that the 

purpose of such property is to connect with qualified infrastructure property located within the 

reservation (e.g., roads, power lines, water systems, railroad spurs, and communications 

facilities).153 

An “Indian reservation” means a reservation as defined in section 3(d) of the Indian 

Financing Act of 1974 or section 4(10) of the Indian Child Welfare Act of 1978. For purposes of 

the preceding sentence, section 3(d) is applied by treating “former Indian reservations in 

Oklahoma” as including only lands that are (1) within the jurisdictional area of an Oklahoma 

Indian tribe as determined by the Secretary of the Interior, and (2) recognized by such Secretary 

as an area eligible for trust land status under 25 C.F.R. Part 151 (as in effect on August 5, 1997). 

 151 For these purposes, related persons is defined in Sec. 465(b)(3)(C). 

152 Sec. 168(j)(4)(A). 

153 Sec. 168(j)(4)(C). 
113

The depreciation deduction allowed for regular tax purposes is also allowed for purposes 

of the alternative minimum tax. The accelerated depreciation for Indian reservations is available 

with respect to property placed in service on or after January 1, 1994, and before January 1, 

2008. 

Description of Proposal

The proposal extends for one year the present-law incentive relating to depreciation of 

qualified Indian reservation property (to apply to property placed in service through 

December 31, 2008). 

Effective Date

The proposal applies to property placed in service after December 31, 2007. 

8. Extend expensing of brownfields remediation costs 

Present Law

Present law allows a deduction for ordinary and necessary expenses paid or incurred in 

carrying on any trade or business.154 Treasury regulations provide that the cost of incidental 

repairs that neither materially add to the value of property nor appreciably prolong its life, but 

keep it in an ordinarily efficient operating condition, may be deducted currently as a business 

expense. Section 263(a)(1) limits the scope of section 162 by prohibiting a current deduction for 

certain capital expenditures. Treasury regulations define “capital expenditures” as amounts paid 

or incurred to materially add to the value, or substantially prolong the useful life, of property 

owned by the taxpayer, or to adapt property to a new or different use. Amounts paid for repairs 

and maintenance do not constitute capital expenditures. The determination of whether an 

expense is deductible or capitalizable is based on the facts and circumstances of each case. 

Taxpayers may elect to treat certain environmental remediation expenditures that would 

otherwise be chargeable to capital account as deductible in the year paid or incurred.155 The 

deduction applies for both regular and alternative minimum tax purposes. The expenditure must 

be incurred in connection with the abatement or control of hazardous substances at a qualified 

contaminated site. In general, any expenditure for the acquisition of depreciable property used in 

connection with the abatement or control of hazardous substances at a qualified contaminated 

site does not constitute a qualified environmental remediation expenditure. However, 

depreciation deductions allowable for such property, which would otherwise be allocated to the 

site under the principles set forth in Commissioner v. Idaho Power Co.156 and section 263A, are 

treated as qualified environmental remediation expenditures. 

 154 Sec. 162. 

155 Sec. 198. 

156 418 U.S. 1 (1974). 
114

A “qualified contaminated site” (a so-called “brownfield”) generally is any property that 

is held for use in a trade or business, for the production of income, or as inventory and is 

certified by the appropriate State environmental agency to be an area at or on which there has 

been a release (or threat of release) or disposal of a hazardous substance. Both urban and rural 

property may qualify. However, sites that are identified on the national priorities list under the 

Comprehensive Environmental Response, Compensation, and Liability Act of 1980 

(“CERCLA”)157 cannot qualify as targeted areas. Hazardous substances generally are defined by 

reference to sections 101(14) and 102 of CERCLA, subject to additional limitations applicable to 

asbestos and similar substances within buildings, certain naturally occurring substances such as 

radon, and certain other substances released into drinking water supplies due to deterioration 

through ordinary use, as well as petroleum products defined in section 4612(a)(3) of the Code. 

In the case of property to which a qualified environmental remediation expenditure 

otherwise would have been capitalized, any deduction allowed under section 198 is treated as a 

depreciation deduction and the property is treated as section 1245 property. Thus, deductions for 

qualified environmental remediation expenditures are subject to recapture as ordinary income 

upon a sale or other disposition of the property. In addition, sections 280B (demolition of 

structures) and 468 (special rules for mining and solid waste reclamation and closing costs) do 

not apply to amounts that are treated as expenses under this provision. 

Eligible expenditures are those paid or incurred before January 1, 2008. 

The Gulf Opportunity Zone Act of 2005158 added section 1400N(g) to the Code, which 

extended for two years (through December 31, 2007) the expensing of environmental 

remediation expenditures paid or incurred to abate contamination at qualified contaminated sites 

located in the Gulf Opportunity Zone. As a result of the extension of section 198 contained in 

the Tax Relief and Health Care Act of 2006,159 eligible expenditures covered under both section 

1400N(g) and section 198 must be paid or incurred prior to January 1, 2008. 

Description of Proposal

The proposal extends the present law expensing provision under section 198 for one year 

through December 31, 2008. 

Effective Date

The proposal is effective for expenditures paid or incurred after December 31, 2007. 

 157 Pub. L. No. 96-510 (1980). 

158 Pub. L. No. 109-135 (2005). 

159 Pub. L. No. 109-432 (2006). 
115

9. Extension of deduction for income attributable to domestic production activities in 

Puerto Rico 

Present Law

In general

Present law provides a deduction from taxable income (or, in the case of an individual, 

adjusted gross income) that is equal to a portion of the taxpayer’s qualified production activities 

income. For taxable years beginning after 2009, the deduction is nine percent of that income. 

For taxable years beginning in 2005 and 2006, the deduction is three percent of qualified 

production activities income and for taxable years beginning in 2007, 2008, and 2009, the 

deduction is six percent of qualified production activities income. For taxpayers subject to the 

35-percent corporate income tax rate, the nine-percent deduction effectively reduces the 

corporate income tax rate to just under 32 percent on qualified production activities income. 

Qualified production activities income

In general, qualified production activities income is equal to domestic production gross 

receipts (defined by section 199(c)(4)), reduced by the sum of: (1) the costs of goods sold that 

are allocable to those receipts and (2) other expenses, losses, or deductions which are properly 

allocable to those receipts. 

Domestic production gross receipts

Domestic production gross receipts generally are gross receipts of a taxpayer that are 

derived from (1) any sale, exchange, or other disposition, or any lease, rental, or license, of 

qualifying production property160 that was manufactured, produced, grown or extracted by the 

taxpayer in whole or in significant part within the United States; (2) any sale, exchange, or other 

disposition, or any lease, rental, or license, of qualified film161 produced by the taxpayer; (3) any 

lease, rental, license, sale, exchange, or other disposition of electricity, natural gas, or potable 

water produced by the taxpayer in the United States; (4) construction of real property performed 

in the United States by a taxpayer in the ordinary course of a construction trade or business; or 

(5) engineering or architectural services performed in the United States for the construction of 

real property located in the United States. 

 160 Qualifying production property generally includes any tangible personal property, computer 

software, and sound recordings. 

161 Qualified film includes any motion picture film or videotape (including live or delayed 

television programming, but not including certain sexually explicit productions) if 50 percent or more of 

the total compensation relating to the production of the film (including compensation in the form of 

residuals and participations) constitutes compensation for services performed in the United States by 

actors, production personnel, directors, and producers. 
116

Wage limitation

For taxable years beginning after May 17, 2006, the amount of the deduction for a 

taxable year is limited to 50 percent of the wages paid by the taxpayer, and properly allocable to 

domestic production gross receipts, during the calendar year that ends in such taxable year.162 

Wages paid to bona fide residents of Puerto Rico generally are not included in the wage 

limitation amount.163

Rules for Puerto Rico

When used in the Code in a geographical sense, the term “United States” generally 

includes only the States and the District of Columbia.164 A special rule for determining domestic 

production gross receipts, however, provides that in the case of any taxpayer with gross receipts 

from sources within the Commonwealth of Puerto Rico, the term “United States” includes the 

Commonwealth of Puerto Rico, but only if all of the taxpayer’s gross receipts are taxable under 

the Federal income tax for individuals or corporations.165 In computing the 50-percent wage 

limitation, that taxpayer is permitted to take into account wages paid to bona fide residents of 

Puerto Rico for services performed in Puerto Rico.166

The special rules for Puerto Rico apply only with respect to the first two taxable years of 

a taxpayer beginning after December 31, 2005 and before January 1, 2008. 

Description of Proposal

The proposal allows the special rules for Puerto Rico to apply for one additional taxable 

year of a taxpayer. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2007.

 162 For purposes of the provision, “wages” include the sum of the amounts of wages as defined in 

section 3401(a) and elective deferrals that the taxpayer properly reports to the Social Security 

Administration with respect to the employment of employees of the taxpayer during the calendar year 

ending during the taxpayer’s taxable year. For taxable years beginning before May 18, 2006, the 

limitation is based upon all wages paid by the taxpayer, rather than only wages properly allocable to 

domestic production gross receipts. 

163 Sec. 3401(a)(8)(C). 

164 Sec. 7701(a)(9). 

165 Sec. 199(d)(8)(A). 

166 Sec. 199(d)(8)(B). 
117 

10. Modify tax treatment of certain payments to controlling exempt organizations 

Present Law

In general, organizations exempt from Federal income tax are subject to the unrelated 

business income tax on income derived from a trade or business regularly carried on by the 

organization that is not substantially related to the performance of the organization’s tax-exempt 

functions.167 In general, interest, rents, royalties, and annuities are excluded from the unrelated 

business income of tax-exempt organizations.168 

Section 512(b)(13) provides special rules regarding income derived by an exempt 

organization from a controlled subsidiary. In general, section 512(b)(13) 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 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). 

However, a special rule enacted as part of the Pension Protection Act of 2006 provides that, for 

payments made pursuant to a binding written contract in effect on August 17, 2006 (or renewal 

of such a contract on substantially similar terms), the general rule of section 512(b)(13) applies 

only to the portion of payments received or accrued (before January 1, 2008) in a taxable year 

that exceeds the amount of the payment that would have been paid or accrued if the amount of 

such payment had been determined under the principles of section 482 (i.e., at arm’s length).169 

In addition, the special rule 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. 

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). 

Description of Proposal

The proposal extends the special rule of the Pension Protection Act to payments received 

or accrued before January 1, 2009. Accordingly, under the proposal, payments of rent, royalties, 

annuities, or interest income by a controlled organization to a controlling organization pursuant 

to a binding written contract in effect on August 17, 2006 (or renewal of such a contract on 

 167 Sec. 511. 

168 Sec. 512(b). 

169 Sec. 512(b)(13)(E). 
118 

substantially similar terms), may be includible in the unrelated business taxable income of the 

controlling organization only to the extent the payment exceeds the amount of the payment 

determined under the principles of section 482 (i.e., at arm’s length). Any such excess is subject 

to 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. 

Effective Date

The proposal is effective for payments received or accrued after December 31, 2007. 

11. Extend and modify qualified zone academy bonds 

Present Law

Tax-exempt bonds

Interest on State and local governmental bonds generally is excluded from gross income 

for Federal income tax purposes if the proceeds of the bonds are used to finance direct activities 

of these governmental units or if the bonds are repaid with revenues of the governmental units. 

Activities that can be financed with these tax-exempt bonds include the financing of public 

schools.170 An issuer must file with the IRS certain information about the bonds issued by them 

in order for that bond issue to be tax-exempt.171 Generally, this information return is required to 

be filed no later the 15th day of the second month after the close of the calendar quarter in which 

the bonds were issued. 

The tax exemption for State and local bonds does not apply to any arbitrage bond.172 An 

arbitrage bond is defined as any bond that is part of an issue if any proceeds of the issue are 

reasonably expected to be used (or intentionally are used) to acquire higher yielding investments 

or to replace funds that are used to acquire higher yielding investments.173 In general, arbitrage 

profits may be earned only during specified periods (e.g., defined “temporary periods”) before 

funds are needed for the purpose of the borrowing or on specified types of investments (e.g., 

“reasonably required reserve or replacement funds”). Subject to limited exceptions, investment 

profits that are earned during these periods or on such investments must be rebated to the Federal 

Government. 

 170 Sec. 103. 

171 Sec. 149(e). 

172 Sec. 103(a) and (b)(2). 

173 Sec. 148. 
119 

Qualified zone academy bonds

As an alternative to traditional tax-exempt bonds, States and local governments were 

given the authority to issue “qualified zone academy bonds.”174 A total of $400 million of 

qualified zone academy bonds is authorized to be issued annually in calendar years 1998 through 

2007. The $400 million aggregate bond cap is allocated each year to the States according to their 

respective populations of individuals below the poverty line. Each State, in turn, allocates the 

credit authority to qualified zone academies within such State. 

Financial institutions that hold qualified zone academy bonds are entitled to a 

nonrefundable tax credit in an amount equal to a credit rate multiplied by the face amount of the 

bond. A taxpayer holding a qualified zone academy bond on the credit allowance date is entitled 

to a credit. The credit is includable in gross income (as if it were a taxable interest payment on 

the bond), and may be claimed against regular income tax and alternative minimum tax liability. 

The Treasury Department sets the credit rate at a rate estimated to allow issuance of 

qualified zone academy bonds without discount and without interest cost to the issuer. The 

maximum term of the bond is determined by the Treasury Department, so that the present value 

of the obligation to repay the bond was 50 percent of the face value of the bond. 

“Qualified zone academy bonds” are defined as any bond issued by a State or local 

government, provided that (1) at least 95 percent of the proceeds are used for the purpose of 

renovating, providing equipment to, developing course materials for use at, or training teachers 

and other school personnel in a “qualified zone academy” and (2) private entities have promised 

to contribute to the qualified zone academy certain equipment, technical assistance or training, 

employee services, or other property or services with a value equal to at least 10 percent of the 

bond proceeds. 

A school is a “qualified zone academy” if (1) the school is a public school that provides 

education and training below the college level, (2) the school operates a special academic 

program in cooperation with businesses to enhance the academic curriculum and increase 

graduation and employment rates, and (3) either (a) the school is located in an empowerment 

zone or enterprise community designated under the Code, or (b) it is reasonably expected that at 

least 35 percent of the students at the school will be eligible for free or reduced-cost lunches 

under the school lunch program established under the National School Lunch Act. 

The Tax Relief and Health Care Act of 2006 (“TRHCA”)175 imposed the arbitrage 

requirements that generally apply to interest-bearing tax-exempt bonds to qualified zone 

academy bonds. In addition, an issuer of qualified zone academy bonds must reasonably expect 

to and actually spend 95 percent or more of the proceeds of such bonds on qualified zone 

academy property within the five-year period that begins on the date of issuance. To the extent 

less than 95 percent of the proceeds are used to finance qualified zone academy property during 

 174 Sec. 1397E. 

175 Pub. L. No. 109-432. 
120 

the five-year spending period, bonds will continue to qualify as qualified zone academy bonds if 

unspent proceeds are used within 90 days from the end of such five-year period to redeem any 

nonqualified bonds. The five-year spending period may be extended by the Secretary if the 

issuer establishes that the failure to meet the spending requirement is due to reasonable cause and 

the related purposes for issuing the bonds will continue to proceed with due diligence. Issuers of 

qualified zone academy bonds are required to report issuance to the IRS in a manner similar to 

the information returns required for tax-exempt bonds. 

Description of Proposal

The proposal extends and modifies the present-law qualified zone academy bond 

program. The proposal authorizes issuance of up to $400 million of qualified zone academy 

bonds annually through 2008. 

For bonds issued after the date of enactment, the proposal also modifies the spending and 

arbitrage rules that apply to qualified zone academy bonds. The proposal modifies the spending 

rule by requiring 100 percent of available project proceeds to be spent on qualified zone 

academy property. In addition, the proposal modifies the arbitrage rules by providing that 

available project proceeds invested during the five-year period beginning on the date of issue are 

not subject to the arbitrage restrictions (i.e., yield restriction and rebate requirements). The 

proposal defines “available project proceeds” as proceeds from the sale of an issue of qualified 

zone academy bonds, less issuance costs (not to exceed two percent) and any investment 

earnings on such proceeds. Thus, available project proceeds invested during the five-year 

spending period may be invested at unrestricted yields, but the earnings on such investments 

must be spent on qualified zone academy property. 

The proposal provides that amounts invested in a reserve fund are not subject to the 

arbitrage restrictions to the extent: (1) such fund is funded at a rate not more rapid than equal 

annual installments; (2) such fund is funded in a manner reasonably expected to result in an 

amount not greater than an amount necessary to repay the issue; and (3) the yield on such fund is 

not greater than the average annual interest rate of tax-exempt obligations having a term of 10 

years or more that are issued during the month the qualified zone academy bonds are issued. 

Effective Date

The proposal applies to bonds issued after the date of enactment. 

12. Tax incentives for investment in the District of Columbia 

Present Law

In general

The Taxpayer Relief Act of 1997 designated certain economically depressed census tracts 

within the District of Columbia as the District of Columbia Enterprise Zone (the “D.C. Zone”), 

within which businesses and individual residents are eligible for special tax incentives. The 

census tracts that compose the D.C. Zone are (1) all census tracts that presently are part of the 

D.C. enterprise community designated under section 1391 (i.e., portions of Anacostia, Mt. 
121 

Pleasant, Chinatown, and the easternmost part of the District), and (2) all additional census tracts 

within the District of Columbia where the poverty rate is not less than 20 percent. The D.C. 

Zone designation remained in effect for the period from January 1, 1998, through December 31, 

2007. In general, the tax incentives available in connection with the D.C. Zone are a 20-percent 

wage credit, an additional $35,000 of section 179 expensing for qualified zone property, 

expanded tax-exempt financing for certain zone facilities, and a zero-percent capital gains rate 

from the sale of certain qualified D.C. zone assets. 

Wage credit

A 20-percent wage credit is available to employers for the first $15,000 of qualified 

wages paid to each employee (i.e., a maximum credit of $3,000 with respect to each qualified 

employee) who (1) is a resident of the D.C. Zone, and (2) performs substantially all employment 

services within the D.C. Zone in a trade or business of the employer. 

Wages paid to a qualified employee who earns more than $15,000 are eligible for the 

wage credit (although only the first $15,000 of wages is eligible for the credit). The wage credit 

is available with respect to a qualified full-time or part-time employee (employed for at least 90 

days), regardless of the number of other employees who work for the employer. In general, any 

taxable business carrying out activities in the D.C. Zone may claim the wage credit, regardless of 

whether the employer meets the definition of a “D.C. Zone business.”176

An employer’s deduction otherwise allowed for wages paid is reduced by the amount of 

wage credit claimed for that taxable year.177 Wages are not to be taken into account for purposes 

of the wage credit if taken into account in determining the employer’s work opportunity tax 

credit under section 51 or the welfare-to-work credit under section 51A.178 In addition, the 

$15,000 cap is reduced by any wages taken into account in computing the work opportunity tax 

credit or the welfare-to-work credit.179 The wage credit may be used to offset up to 25 percent of 

alternative minimum tax liability.180

 176 However, the wage credit is not available for wages paid in connection with certain business 

activities described in section 144(c)(6)(B) or certain farming activities. In addition, wages are not 

eligible for the wage credit if paid to (1) a person who owns more than five percent of the stock (or capital 

or profits interests) of the employer, (2) certain relatives of the employer, or (3) if the employer is a 

corporation or partnership, certain relatives of a person who owns more than 50 percent of the business. 

177 Sec. 280C(a). 

178 Secs. 1400H(a), 1396(c)(3)(A) and 51A(d)(2). 

179 Secs. 1400H(a), 1396(c)(3)(B) and 51A(d)(2). 

180 Sec. 38(c)(2). 
122 

Section 179 expensing

In general, a D.C. Zone business is allowed an additional $35,000 of section 179 

expensing for qualifying property placed in service by a D.C. Zone business.181 The section 179 

expensing allowed to a taxpayer is phased out by the amount by which 50 percent of the cost of 

qualified zone property placed in service during the year by the taxpayer exceeds $200,000 

($500,000 for taxable years beginning after 2006 and before 2011). The term “qualified zone 

property” is defined as depreciable tangible property (including buildings), provided that (1) the 

property is acquired by the taxpayer (from an unrelated party) after the designation took effect, 

(2) the original use of the property in the D.C. Zone commences with the taxpayer, and (3) 

substantially all of the use of the property is in the D.C. Zone in the active conduct of a trade or 

business by the taxpayer.182 Special rules are provided in the case of property that is 

substantially renovated by the taxpayer. 

Tax-exempt financing

A qualified D.C. Zone business is permitted to borrow proceeds from tax-exempt 

qualified enterprise zone facility bonds (as defined in section 1394) issued by the District of 

Columbia.183 Such bonds are subject to the District of Columbia’s annual private activity bond 

volume limitation. Generally, qualified enterprise zone facility bonds for the District of 

Columbia are bonds 95 percent or more of the net proceeds of which are used to finance certain 

facilities within the D.C. Zone. The aggregate face amount of all outstanding qualified 

enterprise zone facility bonds per qualified D.C. Zone business may not exceed $15 million and 

may be issued only while the D.C. Zone designation is in effect. 

Zero-percent capital gains

A zero-percent capital gains rate applies to capital gains from the sale of certain qualified 

D.C. Zone assets held for more than five years.184 In general, a qualified “D.C. Zone asset” 

means stock or partnership interests held in, or tangible property held by, a D.C. Zone business. 

For purposes of the zero-percent capital gains rate, the D.C. Enterprise Zone is defined to include 

all census tracts within the District of Columbia where the poverty rate is not less than 10 

percent. 

In general, gain eligible for the zero-percent tax rate means gain from the sale or 

exchange of a qualified D.C. Zone asset that is (1) a capital asset or property used in the trade or 

business as defined in section 1231(b), and (2) acquired before January 1, 2008. Gain that is 

attributable to real property, or to intangible assets, qualifies for the zero-percent rate, provided 

 181 Sec. 1397A. 

182 Sec. 1397D. 

183 Sec. 1400A. 

184 Sec. 1400B. 
123 

that such real property or intangible asset is an integral part of a qualified D.C. Zone business.185 

However, no gain attributable to periods before January 1, 1998, and after December 31, 2012, is 

qualified capital gain. 

District of Columbia homebuyer tax credit

First-time homebuyers of a principal residence in the District of Columbia are eligible for 

a nonrefundable tax credit of up to $5,000 of the amount of the purchase price. The $5,000 

maximum credit applies both to individuals and married couples. Married individuals filing 

separately can claim a maximum credit of $2,500 each. The credit phases out for individual 

taxpayers with adjusted gross income between $70,000 and $90,000 ($110,000-$130,000 for 

joint filers). For purposes of eligibility, “first-time homebuyer” means any individual if such 

individual did not have a present ownership interest in a principal residence in the District of 

Columbia in the one-year period ending on the date of the purchase of the residence to which the 

credit applies. The credit expired for purchases after December 31, 2007.186

Description of Proposal

The proposal extends the designation of the D.C. Zone for one year (through December 

31, 2008), thus extending the wage credit and section 179 expensing for one year. 

The proposal extends the tax-exempt financing authority for one year, applying to bonds 

issued during the period beginning on January 1, 1998, and ending on December 31, 2008. 

The proposal extends the zero-percent capital gains rate applicable to capital gains from 

the sale of certain qualified D.C. Zone assets for one year. 

The proposal extends the first-time homebuyer credit for one year, through December 31, 

2008. 

Effective Date

The proposal is effective for periods beginning after, bonds issued after, acquisitions 

after, and property purchased after December 31, 2007. 

 185 However, sole proprietorships and other taxpayers selling assets directly cannot claim the 

zero-percent rate on capital gain from the sale of any intangible property (i.e., the integrally related test 

does not apply). 

186 Sec. 1400C(i). 
124 

13. Extension of economic development credit for American Samoa 

Present and Prior Law

In general

For taxable years beginning before January 1, 2006, certain domestic corporations with 

business operations in the U.S. possessions were eligible for the possession tax credit.187 This 

credit offset the U.S. tax imposed on certain income related to operations in the U.S. 

possessions.188 For purposes of the credit, possessions included, among other places, American 

Samoa. Subject to certain limitations described below, the amount of the possession tax credit 

allowed to any domestic corporation equaled the portion of that corporation’s U.S. tax that was 

attributable to the corporation’s non-U.S. source taxable income from (1) the active conduct of a 

trade or business within a U.S. possession, (2) the sale or exchange of substantially all of the 

assets that were used in such a trade or business, or (3) certain possessions investment.189 No 

deduction or foreign tax credit was allowed for any possessions or foreign tax paid or accrued 

with respect to taxable income that was taken into account in computing the credit under section 

936.190 The section 936 credit generally expired for taxable years beginning after December 31, 

2005, but a special credit, described below, was allowed with respect to American Samoa. 

To qualify for the possession tax credit for a taxable year, a domestic corporation was 

required to satisfy two conditions. First, the corporation was required to derive at least 80 

percent of its gross income for the three-year period immediately preceding the close of the 

taxable year from sources within a possession. Second, the corporation was required to derive at 

least 75 percent of its gross income for that same period from the active conduct of a possession 

business. 

The possession tax credit was available only to a corporation that qualified as an existing 

credit claimant. The determination of whether a corporation was an existing credit claimant was 

made separately for each possession. The possession tax credit was computed separately for 

each possession with respect to which the corporation was an existing credit claimant, and the 

credit was subject to either an economic activity-based limitation or an income-based limitation. 

 187 Secs. 27(b), 936. 

188 Domestic corporations with activities in Puerto Rico are eligible for the section 30A economic 

activity credit. That credit is calculated under the rules set forth in section 936. 

189 Under phase-out rules described below, investment only in Guam, American Samoa, and the 

Northern Mariana Islands (and not in other possessions) now may give rise to income eligible for the 

section 936 credit. 

190 Sec. 936(c). 
125 

Qualification as existing credit claimant

A corporation was an existing credit claimant with respect to a possession if (1) the 

corporation was engaged in the active conduct of a trade or business within the possession on 

October 13, 1995, and (2) the corporation elected the benefits of the possession tax credit in an 

election in effect for its taxable year that included October 13, 1995.191 A corporation that added 

a substantial new line of business (other than in a qualifying acquisition of all the assets of a 

trade or business of an existing credit claimant) ceased to be an existing credit claimant as of the 

close of the taxable year ending before the date on which that new line of business was added. 

Economic activity-based limit

Under the economic activity-based limit, the amount of the credit determined under the 

rules described above was not permitted to exceed an amount equal to the sum of (1) 60 percent 

of the taxpayer’s qualified possession wages and allocable employee fringe benefit expenses, (2) 

15 percent of depreciation allowances with respect to short-life qualified tangible property, plus 

40 percent of depreciation allowances with respect to medium-life qualified tangible property, 

plus 65 percent of depreciation allowances with respect to long-life qualified tangible property, 

and (3) in certain cases, a portion of the taxpayer’s possession income taxes. 

Income-based limit

As an alternative to the economic activity-based limit, a taxpayer was permitted elect to 

apply a limit equal to the applicable percentage of the credit that otherwise would have been 

allowable with respect to possession business income; in taxable years beginning in 1998 and 

subsequent years, the applicable percentage was 40 percent. 

Repeal and phase out

In 1996, the section 936 credit was repealed for new claimants for taxable years 

beginning after 1995 and was phased out for existing credit claimants over a period including 

taxable years beginning before 2006. The amount of the available credit during the phase-out 

period generally was reduced by special limitation rules. These phase-out period limitation rules 

did not apply to the credit available to existing credit claimants for income from activities in 

Guam, American Samoa, and the Northern Mariana Islands. As described previously, the 

section 936 credit generally was repealed for all possessions, including Guam, American Samoa, 

and the Northern Mariana Islands, for all taxable years beginning after 2005, but a modified 

credit was allowed for activities in American Samoa. 

 191 A corporation will qualify as an existing credit claimant if it acquired all the assets of a trade 

or business of a corporation that (1) actively conducted that trade or business in a possession on 

October 13, 1995, and (2) had elected the benefits of the possession tax credit in an election in effect for 

the taxable year that included October 13, 1995. 
126 

American Samoa economic development credit

A domestic corporation that was an existing credit claimant with respect to American 

Samoa and that elected the application of section 936 for its last taxable year beginning before 

January 1, 2006 is allowed a credit based on the economic activity-based limitation rules 

described above. The credit is not part of the Code but is computed based on the rules secs. 30A 

and 936. The credit is allowed for the first two taxable years of a corporation that first two 

taxable years of a corporation that begin after December 31, 2005, and before January 1, 2008. 

The amount of the credit allowed to a qualifying domestic corporation under the 

provision is equal to the sum of the amounts used in computing the corporation’s economic 

activity-based limitation (described previously) with respect to American Samoa, except that no 

credit is allowed for the amount of any American Samoa income taxes. Thus, for any qualifying 

corporation the amount of the credit equals the sum of (1) 60 percent of the corporation’s 

qualified American Samoa wages and allocable employee fringe benefit expenses and (2) 15 

percent of the corporation’s depreciation allowances with respect to short-life qualified 

American Samoa tangible property, plus 40 percent of the corporation’s depreciation allowances 

with respect to medium-life qualified American Samoa tangible property, plus 65 percent of the 

corporation’s depreciation allowances with respect to long-life qualified American Samoa 

tangible property. 

The section 936(c) rule denying a credit or deduction for any possessions or foreign tax 

paid with respect to taxable income taken into account in computing the credit under section 936 

does not apply with respect to the credit allowed by the provision. 

The credit is not available for taxable years beginning after December 31, 2007. 

Description of Proposal

The proposal allows the American Samoa economic development credit for one 

additional taxable year of a taxpayer. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2007. 

14. Extend the enhanced charitable deduction for contributions of food inventory 

Present Law

General rules regarding contributions of food inventory

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, or if less the fair 

market value of the inventory. 

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 appreciation (i.e., basis plus one-half of 
127 

fair market value in excess of basis) or (2) two times basis.192 In general, a C corporation’s 

charitable contribution deductions for a year may not exceed 10 percent of the corporation’s 

taxable income.193 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. 

A donor making a charitable contribution of inventory must make a corresponding 

adjustment to the cost of goods sold by decreasing the cost of goods sold by the lesser of the fair 

market value of the property or the donor’s basis with respect to the inventory.194 Accordingly, 

if the allowable charitable deduction for inventory is the fair market value of the inventory, the 

donor reduces its cost of goods sold by such value, with the result that the difference between the 

fair market value and the donor’s basis may still be recovered by the donor other than as a 

charitable contribution. 

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 disputes 

between taxpayers and the IRS.195

Temporary rule expanding and modifying the enhanced deduction for contributions of 

food inventory

Under a temporary provision enacted as part of the Katrina Emergency Tax Relief Act of 

2005 and extended by the Pension Protection Act of 2006, 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.196 For taxpayers 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 taxable year from all sole proprietorships, S corporations, or 

partnerships (or other non C corporation) from which contributions of apparently wholesome 

 192 Sec. 170(e)(3). 

193 Sec. 170(b)(2). 

194 Treas. Reg. sec. 1.170A-4A(c)(3). 

195 Lucky Stores Inc. v. Commissioner, 105 T.C. 420 (1995) (holding 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). 

196 Sec. 170(e)(3)(C). 
128 

food 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 taxpayer’s 

interest in the S corporation, but not the taxpayer’s interest in the partnership.197 

Under the temporary provision, the enhanced deduction for food 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 

Federal, 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. 

The temporary provision does not apply to contributions made after December 31, 2007. 

Description of Proposal

The proposal extends the expansion of, and modifications to, the enhanced deduction for 

charitable contributions of food inventory to contributions made before January 1, 2009. 

Effective Date

The proposal is effective for contributions made after December 31, 2007. 

15. Extend the enhanced deduction for charitable contributions of book inventory 

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, or, if less, the fair 

market value of the inventory. 

In general, 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 appreciation (i.e., basis plus 

one-half of fair market value in excess of basis) or (2) two times basis.198 In general, a C 

 197 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. 

198 Sec. 170(e)(3). 
129 

corporation’s charitable contribution deductions for a year may not exceed 10 percent of the 

corporation’s taxable income.199 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. 

A donor making a charitable contribution of inventory must make a corresponding 

adjustment to the cost of goods sold by decreasing the cost of goods sold by the lesser of the fair 

market value of the property or the donor’s basis with respect to the inventory.200 Accordingly, 

if the allowable charitable deduction for inventory is the fair market value of the inventory, the 

donor reduces its cost of goods sold by such value, with the result that the difference between the 

fair market value and the donor’s basis may still be recovered by the donor other than as a 

charitable contribution. 

To use the enhanced deduction, the taxpayer must establish that the fair market value of 

the donated item exceeds basis. 

The Katrina Emergency Tax Relief Act of 2005 expanded the generally applicable 

enhanced deduction for C corporations to certain qualified book contributions made after August 

28, 2005, and before January 1, 2006. The Pension Protection Act of 2006 extended the 

deduction for qualified book contributions to contributions made before January 1, 2008. A 

qualified book contribution means a charitable contribution of books to a public school that 

provides elementary education or secondary education (kindergarten through grade 12) and that 

is 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. The enhanced deduction for qualified book 

contributions is not allowed unless the donee organization certifies in writing that the contributed 

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. The donee also 

must make the certifications required for the generally applicable enhanced deduction, i.e., the 

donee will (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. 

 199 Sec. 170(b)(2). 

200 Treas. Reg. sec. 1.170A-4A(c)(3). 
130 

Description of Proposal

The proposal extends the enhanced deduction for contributions of book inventory to 

contributions made before January 1, 2009. 

Effective Date

The proposal is effective for contributions made after December 31, 2007. 

16. Extend the enhanced charitable deduction for computer technology and equipment 

Present Law

In the case of a charitable contribution of inventory or other ordinary-income or shortterm 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.201

Under present law, a taxpayer’s deduction for charitable 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 computer contribution.”202 This enhanced deduction is equal to the lesser of (1) basis 

plus one-half of the item’s appreciation (i.e., basis plus one half of fair market value in excess of 

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, 2007. 

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 or assembled the property, not later than the date construction or 

assembly of the property is substantially completed.203 The original use of the property must be 

by the donor or the donee,204 and in the case of the donee, must be used substantially for 

 201 Sec. 170(e)(1). 

202 Secs. 170(e)(4) and 170(e)(6). 

203 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). 

204 This requirement does not apply if the property was reacquired by the manufacturer and 

contributed. Sec. 170(e)(6)(D)(ii).
131 

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 or assembled by the taxpayer, the rules 

applicable to qualified research contributions apply. Contributions may be made to private 

foundations under certain conditions.205 

Description of Proposal

The proposal extends the enhanced deduction for computer technology and equipment for 

one year to apply to contributions made during any taxable year beginning after December 31, 

2007, and before January 1, 2009. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2007. 

17. Basis adjustment to stock of S corporation contributing property 

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.206 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.207

In the case of contributions made in taxable years beginning after December 31, 2005, 

and before January 1, 2008, 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 is equal to the 

shareholder’s pro rata share of the adjusted basis of the contributed property. For contributions 

made in taxable years beginning after December 31, 2007, the amount of the reduction is the 

shareholder’s pro rata share of the fair market value of the contributed property. 

Description of Proposal

The proposal extends the rule relating to the basis reduction on account of charitable 

contributions of property for one year to contributions made in taxable years beginning before 

January 1, 2009. 

 205 Sec. 170(e)(6)(C). 

206 Sec. 1366(a)(1)(A). 

207 Sec. 1367(a)(2)(B). 
132 

Effective Date

The proposal applies to contributions made in taxable years beginning after December 

31, 2007. 

18. Extension of the Hurricane Katrina work opportunity tax credit 

Present Law

Work opportunity tax credit

In general

The work opportunity tax credit is available on an elective basis for employers hiring 

individuals from one or more of nine targeted groups. The amount of the credit available to an 

employer is determined by the amount of qualified wages paid by the employer. Generally, 

qualified wages consist of wages attributable to service rendered by a member of a targeted 

group during the one-year period beginning with the day the individual begins work for the 

employer (two years in the case of an individual in the long-term family assistance recipient 

category). 

Targeted groups eligible for the credit

Generally an employer is eligible for the credit only for qualified wages paid to members 

of a targeted group. There are nine targeted groups: (1) families receiving Temporary Assistance 

for Needy Families Program (“TANF”); (2) qualified veterans; (3) qualified ex-felons; (4) 

designated community residents; (5) vocational rehabilitation referrals; (6) qualified summer 

youth employees; (7) qualified food stamp recipients; (8) qualified supplemental security income 

(“SSI”) benefit recipients; and (9) qualified long-term family assistance recipients. 

Qualified wages

Generally, qualified wages are defined as cash wages paid by the employer to a member 

of a targeted group. The employer’s deduction for wages is reduced by the amount of the credit. 

For purposes of the credit, generally, wages are defined by reference to the FUTA 

definition of wages contained in sec. 3306(b) (without regard to the dollar limitation therein 

contained). Special rules apply in the case of certain agricultural labor and certain railroad labor. 

Calculation of the credit

The credit available to an employer for qualified wages paid to members of all targeted 

groups except for long-term family assistance recipients equals 40 percent (25 percent for 

employment of 400 hours or less) of qualified first-year wages. Generally, qualified first-year 

wages are qualified wages (not in excess of $6,000) attributable to service rendered by a member 

of a targeted group during the one-year period beginning with the day the individual began work 

for the employer. Therefore, the maximum credit per employee is $2,400 (40 percent of the first 

$6,000 of qualified first-year wages). There are two exceptions to this general rule. First, with 
133 

respect to qualified summer youth employees, the maximum credit is $1,200 (40 percent of the 

first $3,000 of qualified first-year wages). Second, with respect to qualified veterans who are 

entitled to compensation for a service-connected disability, the maximum credit is $4,800 

because qualified first-year wages are $12,000 rather than $6,000 for such individuals.208 Except 

for long-term family assistance recipients, no credit is allowed for second-year wages. 

In the case of long-term family assistance recipients, the credit equals 40 percent (25 

percent for employment of 400 hours or less) of $10,000 for qualified first-year wages and 50 

percent of the first $10,000 of qualified second-year wages. Generally, qualified second-year 

wages are qualified wages (not in excess of $10,000) attributable to service rendered by a 

member of the long-term family assistance category during the one-year period beginning on the 

day after the one-year period beginning with the day the individual began work for the employer. 

Therefore, the maximum credit per employee is $9,000 (40 percent of the first $10,000 of 

qualified first-year wages plus 50 percent of the first $10,000 of qualified second-year wages). 

Certification rules

An individual is not treated as a member of a targeted group unless: (1) on or before the 

day on which an individual begins work for an employer, the employer has received a 

certification from a designated local agency that such individual is a member of a targeted group; 

or (2) on or before the day an individual is offered employment with the employer, a prescreening notice is completed by the employer with respect to such individual, and not later than 

the 28th day after the individual begins work for the employer, the employer submits such 

notice, signed by the employer and the individual under penalties of perjury, to the designated 

local agency as part of a written request for certification. For these purposes, a pre-screening 

notice is a document (in such form as the Secretary may prescribe) which contains information 

provided by the individual on the basis of which the employer believes that the individual is a 

member of a targeted group. 

Minimum employment period

No credit is allowed for qualified wages paid to employees who work less than 120 hours 

in the first year of employment. 

Other rules

The work opportunity tax credit is not allowed for wages paid to a relative or dependent 

of the taxpayer. No credit is allowed for wages paid to an individual who is a more than fiftypercent owner of the entity. Similarly, wages paid to replacement workers during a strike or 

lockout are not eligible for the work opportunity tax credit. Wages paid to any employee during 

any period for which the employer received on-the-job training program payments with respect 

to that employee are not eligible for the work opportunity tax credit. The work opportunity tax 

 208 The expanded definition of qualified first-year wages does not apply to the veterans qualified 

with reference to a food stamp program, as defined under present law. 
134 

credit generally is not allowed for wages paid to individuals who had previously been employed 

by the employer. In addition, many other technical rules apply. 

Expiration

The work opportunity tax credit is not available for individuals who begin work for an 

employer after August 31, 2011. 

Work Opportunity Tax Credit for Hurricane Katrina Employees

In general

The Katrina Emergency Tax Relief Act of 2005 provided that a Hurricane Katrina 

employee is treated as a member of a targeted group for purposes of the work opportunity tax 

credit. A Hurricane Katrina employee was: (1) an individual who on August 28, 2005, had a 

principal place of abode in the core disaster area and was hired during the two-year period 

beginning on such date for a position, the principal place of employment of which was located in 

the core disaster area; and (2) an individual who on August 28, 2005, had a principal place of 

abode in the core disaster area, who was displaced from such abode by reason of Hurricane 

Katrina and was hired during the period beginning on such date and ending on December 31, 

2005 without regard to whether the new principal place of employment is in the core disaster 

area. 

The present-law WOTC certification requirement was waived for such individuals. In 

lieu of the certification requirement, an individual may have provided to the employer reasonable 

evidence that the individual is a Hurricane Katrina employee. 

The present-law rule that denies the credit with respect to wages of employees who had 

been previously employed by the employer was waived for the first hire of such employee as a 

Hurricane Katrina employee unless such employee was an employee of the employer on 

August 28, 2005. 

Definitions

The term “Hurricane Katrina disaster area” means an area with respect to which a major 

disaster has been declared by the President before September 14, 2005 under section 401 of the 

Robert T. Stafford Disaster Relief and Emergency Assistance Act. 

The term “core disaster area” means that portion of the Hurricane Katrina disaster area 

determined by the President to warrant individual or individual and public assistance from the 

Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance 

Act. 

Description of Proposal

The proposal extends through August 28, 2008, the work opportunity tax credit for 

certain Hurricane Katrina employees employed within the core disaster area. For this purpose, a 

Hurricane Katrina employee employed within the core disaster area is an individual who on 
135 

August 28, 2005, had a principal place of abode in the core disaster area and is hired on or after 

August 28, 2005 and before August 29, 2008 for a position, the principal place of employment of 

which was located in the core disaster area.209 The other special rules (e.g., certification and 

previous employment) for Hurricane Katrina employees apply. 

Effective Date

The proposal is effective for individuals hired after August 28, 2007. 

19. Subpart F exception for active financing income 

Present Law

Under the subpart F rules,210 10-percent-or-greater U.S. shareholders of a controlled 

foreign corporation (“CFC”) are subject to U.S. tax currently on certain income earned by the 

CFC, whether or not such income is distributed to the shareholders. The income subject to 

current inclusion under the subpart F rules includes, among other things, insurance income and 

foreign base company income. Foreign base company income includes, among other things, 

foreign personal holding company income and foreign base company services income (i.e., 

income derived from services performed for or on behalf of a related person outside the country 

in which the CFC is organized). 

Foreign personal holding company income generally consists of the following: (1) 

dividends, interest, royalties, rents, and annuities; (2) net gains from the sale or exchange of (a) 

property that gives rise to the preceding types of income, (b) property that does not give rise to 

income, and (c) interests in trusts, partnerships, and REMICs; (3) net gains from commodities 

transactions; (4) net gains from certain foreign currency transactions; (5) income that is 

equivalent to interest; (6) income from notional principal contracts; (7) payments in lieu of 

dividends; and (8) amounts received under personal service contracts. 

Insurance income subject to current inclusion under the subpart F rules includes any 

income of a CFC attributable to the issuing or reinsuring of any insurance or annuity contract in 

connection with risks located in a country other than the CFC’s country of organization. Subpart 

F insurance income also includes income attributable to an insurance contract in connection with 

risks located within the CFC’s country of organization, as the result of an arrangement under 

which another corporation receives a substantially equal amount of consideration for insurance 

of other country risks. Investment income of a CFC that is allocable to any insurance or annuity 

contract related to risks located outside the CFC’s country of organization is taxable as subpart F 

insurance income.211

 209 The prior-law work opportunity tax credit for Katrina employees hired to a new place of 

employment outside of the core disaster area is not extended by this proposal. 

210 Secs. 951-964. 

211 Prop. Treas. Reg. sec. 1.953-1(a). 
136 

Temporary exceptions from foreign personal holding company income, foreign base 

company services income, and insurance income apply for subpart F purposes for certain income 

that is derived in the active conduct of a banking, financing, or similar business, as a securities 

dealer, or in the conduct of an insurance business (so-called “active financing income”).212 

With respect to income derived in the active conduct of a banking, financing, or similar 

business, a CFC is required to be predominantly engaged in such business and to conduct 

substantial activity with respect to such business in order to qualify for the active financing 

exceptions. In addition, certain nexus requirements apply, which provide that income derived by 

a CFC or a qualified business unit (“QBU”) of a CFC from transactions with customers is 

eligible for the exceptions if, among other things, substantially all of the activities in connection 

with such transactions are conducted directly by the CFC or QBU in its home country, and such 

income is treated as earned by the CFC or QBU in its home country for purposes of such 

country’s tax laws. Moreover, the exceptions apply to income derived from certain cross border 

transactions, provided that certain requirements are met. Additional exceptions from foreign 

personal holding company income apply for certain income derived by a securities dealer within 

the meaning of section 475 and for gain from the sale of active financing assets. 

In the case of a securities dealer, the temporary exception from foreign personal holding 

company income applies to certain income. The income covered by the exception is any interest 

or dividend (or certain equivalent amounts) from any transaction, including a hedging transaction 

or a transaction consisting of a deposit of collateral or margin, entered into in the ordinary course 

of the dealer’s trade or business as a dealer in securities within the meaning of section 475. In 

the case of a QBU of the dealer, the income is required to be attributable to activities of the QBU 

in the country of incorporation, or to a QBU in the country in which the QBU both maintains its 

principal office and conducts substantial business activity. A coordination rule provides that this 

exception generally takes precedence over the exception for income of a banking, financing or 

similar business, in the case of a securities dealer. 

In the case of insurance, a temporary exception from foreign personal holding company 

income applies for certain income of a qualifying insurance company with respect to risks 

located within the CFC’s country of creation or organization. In the case of insurance, 

temporary exceptions from insurance income and from foreign personal holding company 

income also apply for certain income of a qualifying branch of a qualifying insurance company 

with respect to risks located within the home country of the branch, provided certain 

 212 Temporary exceptions from the subpart F provisions for certain active financing income 

applied only for taxable years beginning in 1998 (Taxpayer Relief Act of 1997, Pub. L. No. 105-34). 

Those exceptions were modified and extended for one year, applicable only for taxable years beginning in 

1999 (the Tax and Trade Relief Extension Act of 1998, Pub. L. No. 105-277). The Tax Relief Extension 

Act of 1999 (Pub. L. No. 106-170) clarified and extended the temporary exceptions for two years, 

applicable only for taxable years beginning after 1999 and before 2002. The Job Creation and Worker 

Assistance Act of 2002 (Pub. L. No. 107-147) modified and extended the temporary exceptions for five 

years, for taxable years beginning after 2001 and before 2007. The Tax Increase Prevention and 

Reconciliation Act of 2005 (Pub. L. No. 109-222) extended the temporary provisions for two years, for 

taxable years beginning after 2006 and before 2009. 
137 

requirements are met under each of the exceptions. Further, additional temporary exceptions 

from insurance income and from foreign personal holding company income apply for certain 

income of certain CFCs or branches with respect to risks located in a country other than the 

United States, provided that the requirements for these exceptions are met. In the case of a life 

insurance or annuity contract, reserves for such contracts are determined under rules specific to 

the temporary exceptions. Present law also permits a taxpayer in certain circumstances, subject 

to approval by the IRS through the ruling process or in published guidance, to establish that the 

reserve of a life insurance company for life insurance and annuity contracts is the amount taken 

into account in determining the foreign statement reserve for the contract (reduced by 

catastrophe, equalization, or deficiency reserve or any similar reserve). IRS approval is to be 

based on whether the method, the interest rate, the mortality and morbidity assumptions, and any 

other factors taken into account in determining foreign statement reserves (taken together or 

separately) provide an appropriate means of measuring income for Federal income tax purposes. 

Description of Proposal

The proposal extends for one year (for taxable years beginning before 2010) the presentlaw temporary exceptions from subpart F foreign personal holding company income, foreign 

base company services income, and insurance income for certain income that is derived in the 

active conduct of a banking, financing, or similar business, or in the conduct of an insurance 

business. 

Effective Date

The proposal is effective for taxable years of foreign corporations beginning after 

December 31, 2008, and for taxable years of U.S. shareholders with or within which such taxable 

years of such foreign corporations end. 

20. Look-through treatment of payments between related controlled foreign corporations 

under foreign personal holding company income rules 

Present Law

In general

In general, the rules of subpart F (secs. 951-964) require U.S. shareholders with a 10-

percent or greater interest in a controlled foreign corporation (“CFC”) to include certain income 

of the CFC (referred to as “subpart F income”) on a current basis for U.S. tax purposes, 

regardless of whether the income is distributed to the shareholders. 

Subpart F income includes foreign base company income. One category of foreign base 

company income is foreign personal holding company income. For subpart F purposes, foreign 

personal holding company income generally includes dividends, interest, rents, and royalties, 

among other types of income. There are several exceptions to these rules. For example, foreign 

personal holding company income does not include dividends and interest received by a CFC 

from a related corporation organized and operating in the same foreign country in which the CFC 

is organized, or rents and royalties received by a CFC from a related corporation for the use of 

property within the country in which the CFC is organized. Interest, rent, and royalty payments 
138 

do not qualify for this exclusion to the extent that such payments reduce the subpart F income of 

the payor. In addition, subpart F income of a CFC does not include any item of income from 

sources within the United States which is effectively connected with the conduct by such CFC of 

a trade or business within the United States (“ECI”) unless such item is exempt from taxation (or 

is subject to a reduced rate of tax) pursuant to a tax treaty. 

The “look-through rule”213

Under the “look-through rule” (sec. 954(c)(6)), dividends, interest (including factoring 

income which is treated as equivalent to interest under section 954(c)(1)(E)), rents, and royalties 

received by one CFC from a related CFC are not treated as foreign personal holding company 

income to the extent attributable or properly allocable to income of the payor that is neither 

subpart F nor treated as ECI. For this purpose, a related CFC is a CFC that controls or is 

controlled by the other CFC, or a CFC that is controlled by the same person or persons that 

control the other CFC. Ownership of more than 50 percent of the CFC’s stock (by vote or value) 

constitutes control for these purposes. 

The Secretary is authorized to prescribe regulations that are necessary or appropriate to 

carry out the look-through rule, including such regulations as are appropriate to prevent the 

abuse of the purposes of such rule. 

The look-through rule is effective for taxable years of foreign corporations beginning 

after December 31, 2005, but before January 1, 2009, and for taxable years of U.S. shareholders 

with or within which such taxable years of such foreign corporations end. 

Description of Proposal

The proposal extends for one year the application of the look-through rule, to taxable 

years of foreign corporations beginning before January 1, 2010, and for taxable years of U.S. 

shareholders with or within which such taxable years of such foreign corporations end. 

Effective Date

The proposal is effective for taxable years of foreign corporations beginning after 

December 31, 2008 (but before January 1, 2010), and for taxable years of U.S. shareholders with 

or within which such taxable years of such foreign corporations end. 

21. Extension of treatment of certain qualified film and television productions 

Present Law

The modified Accelerated Cost Recovery System (“MACRS”) does not apply to certain 

property, including any motion picture film, video tape, or sound recording, or to any other 

 213 The look-through rule was enacted by the Tax Increase Prevention and Reconciliation Act of 

2005, Pub. L. No. 109-222, sec. 103(b)(1) (2006). 
139 

property if the taxpayer elects to exclude such property from MACRS and the taxpayer properly 

applies a unit-of-production method or other method of depreciation not expressed in a term of 

years. Section 197 does not apply to certain intangible property, including property produced by 

the taxpayer or any interest in a film, sound recording, video tape, book or similar property not 

acquired in a transaction (or a series of related transactions) involving the acquisition of assets 

constituting a trade or business or substantial portion thereof. Thus, the recovery of the cost of a 

film, video tape, or similar property that is produced by the taxpayer or is acquired on a “standalone” basis by the taxpayer may not be determined under either the MACRS depreciation 

provisions or under the section 197 amortization provisions. The cost recovery of such property 

may be determined under section 167, which allows a depreciation deduction for the reasonable 

allowance for the exhaustion, wear and tear, or obsolescence of the property. A taxpayer is 

allowed to recover, through annual depreciation deductions, the cost of certain property used in a 

trade or business or for the production of income. Section 167(g) provides that the cost of 

motion picture films, sound recordings, copyrights, books, and patents are eligible to be 

recovered using the income forecast method of depreciation. 

Under section 181, taxpayers may elect214 to deduct the cost of any qualifying film and 

television production, commencing prior to January 1, 2009, in the year the expenditure is 

incurred in lieu of capitalizing the cost and recovering it through depreciation allowances.215 A 

qualified film or television production is one in which the aggregate cost is $15 million or less.216 

The threshold is increased to $20 million if a significant amount of the production expenditures 

are incurred in areas eligible for designation as a low-income community or eligible for 

designation by the Delta Regional Authority as a distressed county or isolated area of distress.217

A qualified film or television production means any production of a motion picture 

(whether released theatrically or directly to video cassette or any other format) or television 

program if at least 75 percent of the total compensation expended on the production is for 

services performed in the United States by actors, directors, producers, and other relevant 

production personnel.218 The term “compensation” does not include participations and residuals 

(as defined in section 167(g)(7)(B)).219 With respect to property which is one or more episodes 

in a television series, each episode is treated as a separate production and only the first 44 

 214 See Treas. Reg. section 1.181-2T for rules on making an election under this section. 

215 For this purpose, a production is treated as commencing on the first date of principal 

photography. 

216 Sec. 181(a)(2)(A). A qualifying film or television production that is co-produced is eligible 

for the benefits of the provision only if its aggregate cost, regardless of funding source, does not exceed 

the threshold. 

217 Sec. 181(a)(2)(B). 

218 Sec. 181(d)(3)(A). 

219 Sec. 181(d)(3)(B). 
140 

episodes qualify under the provision.220 Qualified property does not include sexually explicit 

productions as defined by section 2257 of title 18 of the U.S. Code.221

For purposes of recapture under section 1245, any deduction allowed under section 181 is 

treated as if it were a deduction allowable for amortization.222

Description of Proposal

The proposal extends the provision for one year, to qualified film and television 

productions commencing prior to January 1, 2010. 

Effective Date

The proposal applies to qualified film and television productions commencing after 

December 31, 2008. 

 220 Sec. 181(d)(2)(B). 

221 Sec. 181(d)(2)(C). 

222 Sec. 1245(a)(2)(C). 
141 

C. Other Extenders 

1. Authority to disclose information related to terrorist activity made permanent 

Present Law

In general

Section 6103 provides that returns and return information may not be disclosed by the 

IRS, other Federal employees, State employees, and certain others having access to the 

information except as provided in the Internal Revenue Code. Section 6103 contains a number 

of exceptions to this general rule of nondisclosure that authorize disclosure in specifically 

identified circumstances (including nontax criminal investigations) when certain conditions are 

satisfied. 

Disclosure provisions relating to emergency circumstances

The IRS is authorized to disclose return information to apprise Federal law enforcement 

agencies of danger of death or physical injury to an individual or to apprise Federal law 

enforcement agencies of imminent flight of an individual from Federal prosecution.223 This 

authority has been used in connection with the investigation of terrorist activity.224

Disclosure provisions relating specifically to terrorist activity 

Also among the disclosures permitted under the Code is disclosure of returns and return 

information for purposes of investigating terrorist incidents, threats, or activities, and for 

analyzing intelligence concerning terrorist incidents, threats, or activities. The term “terrorist 

incident, threat, or activity” is statutorily defined to mean an incident, threat, or activity 

involving an act of domestic terrorism or international terrorism.225 

The term “international terrorism” means activities that involve violent acts or acts 

dangerous to human life that are a violation of the criminal laws of the United States or of any 

State, or that would be a criminal violation if committed within the jurisdiction of the United 

States or of any State; appear to be intended to intimidate or coerce a civilian population, to 

influence the policy of a government by intimidation or coercion, or to affect the conduct of a 

government by mass destruction, assassination, or kidnapping; and occur primarily outside the 

territorial jurisdiction of the United States, or transcend national boundaries in terms of the 

means by which they are accomplished, the persons they appear intended to intimidate or coerce, 

 223 Sec. 6103(i)(3)(B). 

224 See, Joint Committee on Taxation, Disclosure Report for Public Inspection Pursuant to 

Internal Revenue Code Section 6103(p)(3)(C) for Calendar Year 2002 (JCX 29-04) April 6, 2004. 

225 Sec. 6103(b)(11). For this purpose, “domestic terrorism” is defined in 18 U.S.C. sec. 2331(5) 

and “international terrorism” is defined in 18 U.S.C. sec. 2331(1). 
142 

or the locale in which their perpetrators operate or seek asylum. The term “domestic terrorism” 

means activities that involve acts dangerous to human life that are a violation of the criminal 

laws of the United States or of any State; appear to be intended to intimidate or coerce a civilian 

population, to influence the policy of a government by intimidation or coercion or to affect the 

conduct of a government by mass destruction, assassination, or kidnapping; and occur primarily 

within the territorial jurisdiction of the United States. 

 In general, returns and taxpayer return information must be obtained pursuant to an ex 

parte court order. Return information, other than taxpayer return information, generally is 

available upon a written request meeting specific requirements. The IRS also is permitted to 

make limited disclosures of such information on its own initiative to the appropriate Federal law 

enforcement agency. 

No disclosures may be made under these provisions after December 31, 2007. The 

procedures applicable to these provisions are described in detail below. 

Disclosure of returns and return information - by ex parte court order

Ex parte court orders sought by Federal law enforcement and Federal intelligence 

agencies

The Code permits, pursuant to an ex parte court order, the disclosure of returns and return 

information (including taxpayer return information) to certain officers and employees of a 

Federal law enforcement agency or Federal intelligence agency. These officers and employees 

are required to be personally and directly engaged in any investigation of, response to, or 

analysis of intelligence and counterintelligence information concerning any terrorist incident, 

threat, or activity. These officers and employees are permitted to use this information solely for 

their use in the investigation, response, or analysis, and in any judicial, administrative, or grand 

jury proceeding, pertaining to any such terrorist incident, threat, or activity. 

The Attorney General, Deputy Attorney General, Associate Attorney General, an 

Assistant Attorney General, or a United States attorney, may authorize the application for the ex 

parte court order to be submitted to a Federal district court judge or magistrate. The Federal 

district court judge or magistrate would grant the order if based on the facts submitted he or she 

determines that: (1) there is reasonable cause to believe, based upon information believed to be 

reliable, that the return or return information may be relevant to a matter relating to such terrorist 

incident, threat, or activity; and (2) the return or return information is sought exclusively for the 

use in a Federal investigation, analysis, or proceeding concerning any terrorist incident, threat, or 

activity. 

Special rule for ex parte court ordered disclosure initiated by the IRS

If the Secretary of the Treasury (or his delegate) possesses returns or return information 

that may be related to a terrorist incident, threat, or activity, the Secretary may, on his own 

initiative, authorize an application for an ex parte court order to permit disclosure to Federal law 

enforcement. In order to grant the order, the Federal district court judge or magistrate must 

determine that there is reasonable cause to believe, based upon information believed to be 

reliable, that the return or return information may be relevant to a matter relating to such terrorist 
143 

incident, threat, or activity. The information may be disclosed only to the extent necessary to 

apprise the appropriate Federal law enforcement agency responsible for investigating or 

responding to a terrorist incident, threat, or activity and for officers and employees of that agency 

to investigate or respond to such terrorist incident, threat, or activity. Further, use of the 

information is limited to use in a Federal investigation, analysis, or proceeding concerning a 

terrorist incident, threat, or activity. Because the Department of Justice represents the Secretary 

in Federal district court, the Secretary is permitted to disclose returns and return information to 

the Department of Justice as necessary and solely for the purpose of obtaining the special IRS ex 

parte court order. 

Disclosure of return information other than by ex parte court order

Disclosure by the IRS without a request

The Code permits the IRS to disclose return information, other than taxpayer return 

information, related to a terrorist incident, threat, or activity to the extent necessary to apprise the 

head of the appropriate Federal law enforcement agency responsible for investigating or 

responding to such terrorist incident, threat, or activity. The IRS on its own initiative and 

without a written request may make this disclosure. The head of the Federal law enforcement 

agency may disclose information to officers and employees of such agency to the extent 

necessary to investigate or respond to such terrorist incident, threat, or activity. A taxpayer’s 

identity is not treated as return information supplied by the taxpayer or his or her representative. 

Disclosure upon written request of a Federal law enforcement agency

The Code permits the IRS to disclose return information, other than taxpayer return 

information, to officers and employees of Federal law enforcement upon a written request 

satisfying certain requirements. The request must: (1) be made by the head of the Federal law 

enforcement agency (or his delegate) involved in the response to or investigation of terrorist 

incidents, threats, or activities, and (2) set forth the specific reason or reasons why such 

disclosure may be relevant to a terrorist incident, threat, or activity. The information is to be 

disclosed to officers and employees of the Federal law enforcement agency who would be 

personally and directly involved in the response to or investigation of terrorist incidents, threats, 

or activities. The information is to be used by such officers and employees solely for such 

response or investigation. 

The Code permits the redisclosure by a Federal law enforcement agency to officers and 

employees of State and local law enforcement personally and directly engaged in the response to 

or investigation of the terrorist incident, threat, or activity. The State or local law enforcement 

agency must be part of an investigative or response team with the Federal law enforcement 

agency for these disclosures to be made. 

Disclosure upon request from the Departments of Justice or the Treasury for 

intelligence analysis of terrorist activity

Upon written request satisfying certain requirements discussed below, the IRS is to 

disclose return information (other than taxpayer return information) to officers and employees of 

the Department of Justice, Department of the Treasury, and other Federal intelligence agencies, 
144 

who are personally and directly engaged in the collection or analysis of intelligence and 

counterintelligence or investigation concerning terrorist incidents, threats, or activities. Use of 

the information is limited to use by such officers and employees in such investigation, collection, 

or analysis. 

The written request is to set forth the specific reasons why the information to be disclosed 

is relevant to a terrorist incident, threat, or activity. The request is to be made by an individual 

who is: (1) an officer or employee of the Department of Justice or the Department of the 

Treasury, (2) appointed by the President with the advice and consent of the Senate, and (3) 

responsible for the collection, and analysis of intelligence and counterintelligence information 

concerning terrorist incidents, threats, or activities. The Director of the United States Secret 

Service also is an authorized requester. 

Description of Proposal

The proposal makes permanent the present-law disclosure authority relating to terrorist 

activities. 

Effective Date

The proposal is effective for disclosures made on or after the date of enactment. 

2. IRS authority to fund undercover operations made permanent 

Present Law

IRS undercover operations are statutorily226 exempt from the generally applicable 

restrictions controlling the use of Government funds (which generally provide that all receipts 

must be deposited in the general fund of the Treasury and all expenses be paid out of 

appropriated funds). In general, the Code permits the IRS to use proceeds from an undercover 

operation to pay additional expenses incurred in the undercover operation, through 2007. The 

IRS is required to conduct a detailed financial audit of large undercover operations in which the 

IRS is churning funds and to provide an annual audit report to the Congress on all such large 

undercover operations. 

Description of Proposal

The proposal makes permanent the IRS’s authority to use proceeds from an undercover 

operation to pay additional expenses incurred in the undercover operation. 

Effective Date

The proposal is effective on January 1, 2008. 

 226 Sec. 7608(c). 
145 

3. Authority to disclose return information for certain veterans programs made permanent 

Present Law

The Code prohibits disclosure of returns and return information, except to the extent 

specifically authorized by the Code (sec. 6103). Unauthorized disclosure is a felony punishable 

by a fine not exceeding $5,000 or imprisonment of not more than five years, or both (sec. 7213). 

An action for civil damages also may be brought for unauthorized disclosure (sec. 7431). No tax 

information may be furnished by the Internal Revenue Service (“IRS”) to another agency unless 

the other agency establishes procedures satisfactory to the IRS for safeguarding the tax 

information it receives (sec. 6103(p)). 

Among the disclosures permitted under the Code is disclosure of certain tax information 

to the Department of Veterans Affairs. Disclosure is permitted to assist the Department of 

Veterans Affairs in determining eligibility for, and establishing correct benefit amounts under, 

certain of its needs-based pension, health care, and other programs (sec. 6103(1)(7)(D)(viii)). 

The Department of Veterans Affairs disclosure provisions do not apply after September 30, 

2008. 

Description of Proposal

The proposal makes permanent the authority to make disclosures to the Department of 

Veteran’s Affairs. The proposal also corrects the cross-references to Title 38. 

Effective Date

The proposal is effective for requests made after September 30, 2008.

4. Suspend limitation on rate of rum excise tax cover over to Puerto Rico and Virgin 

Islands 

Present Law

A $13.50 per proof gallon227 excise tax is imposed on distilled spirits produced in or 

imported (or brought) into the United States.228 The excise tax does not apply to distilled spirits 

that are exported from the United States, including exports to U.S. possessions (e.g., Puerto Rico 

and the Virgin Islands).229

The Code provides for cover over (payment) to Puerto Rico and the Virgin Islands of the 

excise tax imposed on rum imported (or brought) into the United States, without regard to the 

 227 A proof gallon is a liquid gallon consisting of 50 percent alcohol. See sec. 5002(a)(10) and 

(11). 

228 Sec. 5001(a)(1). 

229 Secs. 5062(b), 7653(b) and (c). 
146 

country of origin.230 The amount of the cover over is limited under Code section 7652(f) to 

$10.50 per proof gallon ($13.25 per proof gallon during the period July 1, 1999 through 

December 31, 2007). 

Tax amounts attributable to shipments to the United States of rum produced in Puerto 

Rico are covered over to Puerto Rico. Tax amounts attributable to shipments to the United 

States of rum produced in the Virgin Islands are covered over to the Virgin Islands. Tax 

amounts attributable to shipments to the United States of rum produced in neither Puerto Rico 

nor the Virgin Islands are divided and covered over to the two possessions under a formula.231 

Amounts covered over to Puerto Rico and the Virgin Islands are deposited into the treasuries of 

the two possessions for use as those possessions determine.232 All of the amounts covered over 

are subject to the limitation. 

Description of Proposal

The proposal suspends for one year the $10.50 per proof gallon limitation on the amount 

of excise taxes on rum covered over to Puerto Rico and the Virgin Islands. Under the proposal, 

the cover over amount of $13.25 per proof gallon is extended for rum brought into the United 

States after December 31, 2007 and before January 1, 2009. After December 31, 2008, the cover 

over amount reverts to $10.50 per proof gallon. 

Effective Date

The change in the cover over rate is effective for articles brought into the United States 

after December 31, 2007. 

 230 Secs. 7652(a)(3), (b)(3), and (e)(1). One percent of the amount of excise tax collected from 

imports into the United States of articles produced in the Virgin Islands is retained by the United States 

under section 7652(b)(3). 

231 Sec. 7652(e)(2). 

232 Secs. 7652(a)(3), (b)(3), and (e)(1). 
147 

III. ADDITIONAL INDIVIDUAL TAX RELIEF 

A. Additional Standard Deduction for State and Local Real Property Taxes 

Present Law

An individual taxpayer’s taxable income is computed by reducing adjusted gross income 

either by a standard deduction or, if the taxpayer elects, by the taxpayer’s itemized deductions. 

Unless an individual taxpayer elects, no itemized deduction is allowed for the taxable year. The 

deduction for certain taxes, including income taxes, real property taxes, and personal property 

taxes, generally is an itemized deduction.233 

Desciption of Proposal

The proposal increases an individual taxpayer’s standard deduction for a taxable year 

beginning in 2008 by the lesser of (1) the amount allowable to the taxpayer as a deduction for 

State and local taxes described in section 164(a)(1) (relating to real property taxes), or (2) $350 

($700 in the case of married individuals filing a joint return). The increased standard deduction 

is determined by taking into account real estate taxes for which a deduction is allowable to the 

taxpayer under section 164 and, in the case of a tenant-stockholder in a cooperative housing 

corporation, real estate taxes for which a deduction is allowable to the taxpayer under section 

216. No taxes deductible in computing adjusted gross income are taken into account in 

computing the increased standard deduction. 

Effective Date

The proposal applies to taxable years beginning in 2008. 

 233 If the deduction for State and local taxes is attributable to business or rental income, the 

deduction is allowed in computing adjusted gross income and therefore is not an itemized deduction. 
148 

B. Refundable Child Credit 

Present Law

An individual may claim a tax credit for each qualifying child under the age of 17. The 

amount of the credit per child is $1,000 through 2010, and $500 thereafter. A child who is not a 

citizen, national, or resident of the United States cannot be a qualifying child. 

The credit is phased out for individuals with income over certain threshold amounts. 

Specifically, the otherwise allowable child tax credit is reduced by $50 for each $1,000 (or 

fraction thereof) of modified adjusted gross income over $75,000 for single individuals or heads 

of households, $110,000 for married individuals filing joint returns, and $55,000 for married 

individuals filing separate returns. For purposes of this limitation, modified adjusted gross 

income includes certain otherwise excludable income earned by U.S. citizens or residents living 

abroad or in certain U.S. territories. 

The credit is allowable against the regular tax and the alternative minimum tax. To the 

extent the child credit exceeds the taxpayer’s tax liability, the taxpayer is eligible for a 

refundable credit (the additional child tax credit) equal to 15 percent of earned income in excess 

of a threshold dollar amount (the “earned income” formula). The threshold dollar amount is 

$12,050 (2008), and is indexed for inflation. 

Families with three or more children may determine the additional child tax credit using 

the “alternative formula,” if this results in a larger credit than determined under the earned 

income formula. Under the alternative formula, the additional child tax credit equals the amount 

by which the taxpayer's social security taxes exceed the taxpayer's earned income credit (“EIC”). 

Earned income is defined as the sum of wages, salaries, tips, and other taxable employee 

compensation plus net self-employment earnings. Unlike the EIC, which also includes the 

preceding items in its definition of earned income, the additional child tax credit is based only on 

earned income to the extent it is included in computing taxable income. For example, some 

ministers’ parsonage allowances are considered self-employment income, and thus are 

considered earned income for purposes of computing the EIC, but the allowances are excluded 

from gross income for individual income tax purposes, and thus are not considered earned 

income for purposes of the additional child tax credit since the income is not included in taxable 

income. 

Description of Proposal

The proposal modifies the earned income formula for the determination of the refundable 

child credit to apply to 15 percent of earned income in excess of $8,500 for taxable years 

beginning in 2008. 

Effective Date

The proposal is effective for taxable years beginning in 2008. 
149 

C. Increase of AMT Refundable Credit Amount for Individuals 

with Long-Term Unused Credits, Etc. 

Present Law

In general

Present law imposes an alternative minimum tax (“AMT”) on an individual taxpayer to 

the extent the taxpayer’s tentative minimum tax liability exceeds his or her regular income tax 

liability. An individual’s tentative minimum tax is the sum of (1) 26 percent of so much of the 

taxable excess as does not exceed $175,000 ($87,500 in the case of a married individual filing a 

separate return) and (2) 28 percent of the remaining taxable excess. The taxable excess is the 

amount by which the alternative minimum taxable income (“AMTI”) exceeds an exemption 

amount. 

An individual’s AMTI is the taxpayer’s taxable income increased by certain preference 

items and adjusted by determining the tax treatment of certain items in a manner that negates the 

deferral of income resulting from the regular tax treatment of those items. 

The individual AMT attributable to deferral adjustments generates a minimum tax credit 

that is allowable to the extent the regular tax (reduced by other nonrefundable credits) exceeds 

the tentative minimum tax in a future taxable year. Unused minimum tax credits are carried 

forward indefinitely. 

AMT treatment of incentive stock options

One of the adjustments in computing AMTI is the tax treatment of the exercise of an 

incentive stock option. An incentive stock option is an option granted by a corporation in 

connection with an individual’s employment, so long as the option meets certain specified 

requirements.234 Under the regular tax, the exercise of an incentive stock option is tax-free if the 

stock is not disposed of within one year of exercise of the option or within two years of the grant 

of the option.235 The individual then computes the long-term capital gain or loss on the sale of 

the stock using the amount paid for the stock as the cost basis. If the holding period 

requirements are not satisfied, the individual generally takes into account at the exercise of the 

option an amount of ordinary income equal to the excess of the fair market value of the stock on 

the date of exercise over the amount paid for the stock. The cost basis of the stock is increased 

by the amount taken into account.236 

 234 Sec. 422. 

235 Sec. 421. 

236 If the stock is sold at a loss before the required holding periods are met, the amount taken into 

account may not exceed the amount realized on the sale over the adjusted basis of the stock. If the stock 

is sold after the taxable year in which the option was exercised but before the required holding periods are 

met, the required inclusion is made in the year the stock is sold. 
150 

Under the individual alternative minimum tax, the exercise of an incentive stock option is 

treated as the exercise of an option other than an incentive stock option. Under this treatment, 

generally the individual takes into account as ordinary income for purposes of computing AMTI 

the excess of the fair market value of the stock at the date of exercise over the amount paid for 

the stock.237 When the stock is later sold, for purposes of computing capital gain or loss for 

purposes of AMTI, the adjusted basis of the stock includes the amount taken into account as 

AMTI. 

The adjustment relating to incentive stock options is a deferral adjustment and therefore 

generates an AMT credit in the year the stock is sold.238

Allowance of long-term unused credits

Under present law, an individual’s minimum tax credit allowable for any taxable year 

beginning after December 31, 2006, and beginning before January 1, 2013, is not less than the 

“AMT refundable credit amount”. The “AMT refundable credit amount” is the amount (not in 

excess of the long-term unused minimum tax credit) equal to the greatest of (1) $5,000, (2) 20 

percent of the long-term unused minimum tax credit for the taxable year, or (3) the amount (if 

any) of the AMT refundable credit amount for the preceding taxable year before any reduction 

by reason of the reduction for adjusted gross income described below. The long-term unused 

minimum tax credit for any taxable year means the portion of the minimum tax credit 

attributable to the adjusted net minimum tax for taxable years before the 3rd taxable year 

immediately preceding the taxable year (assuming the credits are used on a first-in, first-out 

basis). 

In the case of an individual whose adjusted gross income for a taxable year exceeds the 

threshold amount (within the meaning of section 151(d)(3)(C)), the AMT refundable credit 

amount is reduced by the applicable percentage (within the meaning of section 151(d)(3)(B)). 

The additional credit allowable by reason of this provision is refundable. 

Description of Proposal

The proposal generally allows the long-term unused minimum tax credit to be claimed 

over a two-year period (rather than a five-year period) and eliminates the AGI phase-out. 

The proposal provides that any underpayment of tax outstanding on the date of enactment 

which is attributable to the application of the minimum tax adjustment for incentive stock 

options (including any interest or penalty relating thereto) is abated. No tax which is abated is 

taken into account in determining the minimum tax credit. 

 237 If the stock is sold in the same taxable year the option is exercised, no adjustment in 

computing AMTI is required. 

238 If the stock is sold for less than the amount paid for the stock, the loss may not be allowed in 

full in computing AMTI by reason of the $3,000 limit on the deductibility of net capital losses. Thus, the 

excess of the regular tax over the tentative minimum tax may not reflect the full amount of the loss. 
151 

The proposal provides that the AMT refundable credit amount for each of the first two 

taxable years beginning after December 31, 2007, is increased by one-half of the amount of any 

interest and penalty paid before the date of enactment on account of the application of the 

minimum adjustment for incentive stock options. 

Effective Date

The proposal generally applies to taxable years beginning after December 31, 2007. 

The proposal relating to the abatement of tax, interest, and penalties takes effect on date 

of enactment. 
152 

D. Uniform Treatment of Attorney-Advanced Expenses and Court Cost 

in Contingency Fee Cases 

Present Law

 In general, a deduction is allowed for ordinary and necessary expenses paid or incurred 

during the taxable year in carrying on any trade or business.239 For advanced litigation costs in 

contingency fee cases, the tax treatment is determined based on the type of arrangement that 

exists between the attorney and client. The contingent fee arrangements generally take two 

forms: (1) net fee arrangements, whereby the attorney's compensation is based on a percentage of 

the gross recovery net of the advanced litigation costs, and (2) gross fee arrangements, whereby 

the attorney's compensation is based on a percentage of the gross recovery without regard to the 

amount of advanced litigation costs. The advanced litigation costs typically include travel 

expenses, witness fees, deposition costs, court filing fees, expert witness fees, and other case 

related costs. When these costs are paid by the attorney, effectively on behalf of the client, they 

are generally considered to be advanced litigation costs. 

The advanced litigation costs incurred as part of net fee arrangements have been viewed 

by the IRS and the Courts as a loan from the attorney to the client. A current deduction under 

section 162 is not permitted; however, the attorney may claim a bad debt deduction under section 

166 at such time as the loan becomes worthless.240 This conclusion has primarily been reached 

based on the attorney's expectation of reimbursement based on the screening process used to 

accept cases with a high probability of victory (e.g., the rate of collection on the advances is 

typically in excess of 90%). In the case of a gross fee arrangement, the Ninth Circuit Court of 

Appeals has ruled that the costs are deductible by the attorney in the year incurred and the 

payment of such costs cannot be described as an advance or a loan when there is no obligation on 

the part of the client to repay the money expended.241

Description of Proposal

The provision ensures a uniform set of rules for attorney-advanced expenses and court 

costs in contingency fee cases by providing that in the case of any expense or court costs which 

is paid or incurred in the course of the trade or business of practicing law and the repayment of 

which is contingent on a recovery by judgment or settlement in the action to which such expense 

or cost relates, the deduction of an ordinary and necessary business expense is determined as if 

such expense or cost is not subject to repayment. Thus, the amounts paid or incurred by the 

attorney are not considered to be a loan to the client, and the attorney is entitled to an otherwise 

permissible deduction in the taxable year in which the expense or cost is paid or incurred. 

 239 Sec. 162(a). 

240 Burnett v. Commissioner, 356 F.2d 755 (5th Cir. 1966); Hearn v. Commissioner, 309 F.2d 

431 (9th Cir. 1962); Canelo v. Commissioner, 447 F.2d 484 (9th Cir. 1971); Boccardo v. United States, 

12 Cl. Ct. 184 (1987). 

241 Boccardo v. Commissioner, 56 F.3d 1016 (9th Cir. 1995). 
153 

Effective Date

The provision applies to expenses and costs paid or incurred in taxable years beginning 

after date of enactment. 
154 

E. Modification of Domestic Production Activities 

Deduction for Film Production 

Present Law

In general

Section 199 of the Code provides a deduction from taxable income (or, in the case of an 

individual, adjusted gross income) that is equal to a portion of the taxpayer’s qualified 

production activities income. For taxable years beginning after 2009, the deduction is nine 

percent of such income. For taxable years beginning in 2008 and 2009, the deduction is six 

percent of such income. The deduction for a taxable year is limited to 50 percent of the wages 

properly allocable to domestic production gross receipts paid by the taxpayer during the calendar 

year that ends in such taxable year.242

Qualified production activities income

In general, qualified production activities income (“QPAI”) is equal to domestic 

production gross receipts (“DPGR”), reduced by the sum of: (1) the costs of goods sold that are 

allocable to such receipts; (2) other expenses, losses, or deductions which are properly allocable 

to such receipts.243

Domestic production gross receipts

DPGR generally are gross receipts of a taxpayer that are derived from: (1) any sale, 

exchange or other disposition, or any lease, rental or license, of qualifying production property 

(“QPP”) that was manufactured, produced, grown or extracted (“MPGE”) by the taxpayer in 

whole or in significant part within the United States;244 (2) any sale, exchange or other 

disposition, or any lease, rental or license, of qualified film produced by the taxpayer; (3) any 

sale, exchange or other disposition of electricity, natural gas, or potable water produced by the 

taxpayer in the United States; (4) in the case of a taxpayer engaged in the active conduct of a 

construction trade or business, construction of real property performed in the United States by 

 242 For purposes of the provision, “wages” include the sum of the amounts of wages as defined in 

section 3401(a) and elective deferrals that the taxpayer properly reports to the Social Security 

Administration with respect to the employment of employees of the taxpayer during the calendar year 

ending during the taxpayer’s taxable year. Elective deferrals include elective deferrals as defined in 

section 402(g)(3), amounts deferred under section 457, and, designated Roth contributions (as defined in 

section 402A). 

243 Sec. 199(c)(1). 

244 Domestic production gross receipts include gross receipts of a taxpayer derived from any sale, 

exchange or other disposition of agricultural products with respect to which the taxpayer performs 

storage, handling or other processing activities (other than transportation activities) within the United 

States, provided such products are consumed in connection with, or incorporated into, the manufacturing, 

production, growth or extraction of qualifying production property (whether or not by the taxpayer).
155 

the taxpayer in the ordinary course of such trade or business;245 or (5) in the case of a taxpayer 

engaged in the active conduct of an engineering or architectural services trade or business, 

engineering or architectural services performed in the United States by the taxpayer in the 

ordinary course of such trade or business with respect to the construction of real property in the 

United States.246

Domestic production gross receipts do not include any gross receipts of the taxpayer that 

are derived from: (1) the sale of food or beverages prepared by the taxpayer at a retail 

establishment; (2) the transmission or distribution of electricity, natural gas, or potable water; or 

(3) the lease, rental, license, sale, exchange, or other disposition of land.247

A special rule for government contracts provides that property that is manufactured or 

produced by the taxpayer pursuant to a contract with the Federal Government is considered to be 

DPGR even if title or risk of loss is transferred to the Federal Government before the 

manufacture or production of such property is complete to the extent required by the Federal 

Acquisition Regulation.248

For purposes of determining DPGR of a partnership and its partners, provided all of the 

interests in the capital and profits of the partnership are owned by members of the same 

expanded affiliated group (“EAG”) at all times during the taxable year of the partnership, then 

the partnership and all members of that EAG are treated as a single taxpayer during such 

period.249

Qualifying production property and qualified film

QPP generally includes any tangible personal property, computer software, or sound 

recordings. “Qualified film” includes any motion picture film or videotape250 (including live or 

delayed television programming, but not including certain sexually explicit productions) if 50 

percent or more of the total compensation relating to the production of such film (including 

 245 For this purpose, construction activities include activities that are directly related to the 

erection or substantial renovation of residential and commercial buildings and infrastructure. Substantial 

renovation would include structural improvements, but not mere cosmetic changes, such as painting, that 

is not performed in connection with activities that otherwise constitute substantial renovation. 

246 Sec. 199(c)(4)(A). 

247 Sec. 199(c)(4)(B). 

248 Sec. 199(c)(4)(C). 

249 Sec. 199(c)(4)(D). 

250 The nature of the material on which properties described in section 168(f)(3) are embodied 

and the methods and means of distribution of such properties does not affect their qualification under this 

provision. 
156 

compensation in the form of residuals and participations)251 constitutes compensation for 

services performed in the United States by actors, production personnel, directors, and 

producers.252

Other rules

Qualified production activities income of partnerships and S corporations

With respect to the domestic production activities of a partnership or S corporation, the 

deduction under section 199 is determined at the partner or shareholder level.253 In performing 

the calculation, each partner or shareholder generally will take into account such person’s 

allocable share of the components of the calculation (including domestic production gross 

receipts; the cost of goods sold allocable to such receipts; and other expenses, losses, or 

deductions allocable to such receipts) from the partnership or S corporation as well as any items 

relating to the partner or shareholder’s own qualified production activities, if any.254 Each 

partner or shareholder is treated as having W-2 wages for the taxable year in an amount equal to 

such person’s allocable share of the W-2 wages of the partnership or S corporation for the 

taxable year.255

The Treasury regulations provide that, except for certain qualifying in-kind partnerships 

and EAG partnerships, an owner of a pass-thru entity is not treated as conducting the qualified 

production activities of the of the pass-thru entity, and vice versa.256

Alternative minimum tax

The deduction under section 199 is allowed for purposes of computing alternative 

minimum taxable income (including adjusted current earnings), without regard to alternative 

minimum tax adjustments.257 The deduction in computing alternative minimum taxable income 

is determined by reference to the lesser of the qualified production activities income (as 

determined for the regular tax) or the alternative minimum taxable income (in the case of an 

 251 To the extent that a taxpayer has included an estimate of participations and/or residuals in its 

income forecast calculation under section 167(g), the taxpayer must use the same estimate of 

participations and/or residuals for purposes of determining total compensation. 

252 Sec. 199(c)(6). 

253 Sec. 199(d)(1)(A)(i). 

254 Sec. 199(d)(1)(A)(ii). 

255 Sec. 199(d)(1)(A)(iii). 

256 Treas. Reg. sec. 1.199-5T(g). 

257 Sec. 199(d)(6)(A). 
157 

individual, adjusted gross income as determined for the regular tax) without regard to this 

deduction.258

Description of Proposal

The proposal provides that a qualified film includes any copyrights, trademarks, and 

other intangibles with respect to the film. 

The proposal provides that the deduction under section 199 for qualified films is not 

affected by the methods and means of distributing an otherwise qualified film.259 For example, 

the distribution of a qualified film via the internet (whether the film is viewed online or 

downloaded or whether or not there is a fee charged) is considered to be a disposition of the film 

for purposes of determining DPGR. Likewise, the distribution of a qualified film through an 

open air (free of charge) broadcast is considered a disposition of the film for these purposes. 

The proposal modifies the application of section 199 to partnerships and S corporations. 

First, the proposal provides that each partner with at least a 20 percent capital interest or 

shareholder with at least a 20 percent ownership interest, either directly or indirectly, in such 

entity is treated as having engaged directly in any film produced by the partnership or S 

corporation. For example, Studio A and Studio B form a partnership in which each is a 50-

percent partner to produce a qualified film. Studio A has the rights to distribute the film 

domestically and Studio B has the rights to distribute the film outside the United States. Under 

the proposal, the production activities of the partnership are attributed to each partner, and thus 

each partner’s revenue from the distribution of the qualified film is not treated as non-DPGR 

solely because neither Studio A nor Studio B produced the qualified film itself. Additionally, a 

partnership or S corporation is treated as having engaged directly in any film produced by any 

partner with at least a 20 percent capital interest or shareholder with at least a 20 percent 

ownership interest, either directly or indirectly, in the partnership or S corporation. For example, 

Studio A and Studio B form a partnership in which each is a 50-percent partner to distribute a 

qualified film. Studio A produced the film and contributes it to the partnership and Studio B 

contributes distribution services to the partnership. Under the proposal, the production activities 

of Studio A are attributed to the partnership, and thus the partnership’s revenue from the 

distribution of the qualified film is not treated as non-DPGR solely because the partnership did 

not produce the qualified film. Thus, the Treasury regulation providing that an owner of a passthru entity is not treated as conducting the qualified production activities of the of the pass-thru 

entity, and vice versa,260 does not apply to situations to which this provision applies. 

The proposal modifies the W-2 wage limitation by defining the term “W-2 wages” for 

qualified films to include any compensation for services performed in the United States by 

 258 Sec. 199(d)(6)(A). 

259 This proposal is consistent with H.R. Conf. Rep. No. 108-755, at 262, Footnote 30 (2004). 

260 Treas. Reg. sec. 1.199-5T(g). 
158 

actors, production personnel, directors, and producers. Thus, compensation is not restricted to 

W-2 wages for the limitation of qualified films. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2007. 
159 

F. Modification of Treatment of Certain Qualified Film 

and Television Productions 

Present Law

The modified Accelerated Cost Recovery System (“MACRS”) does not apply to certain 

property, including any motion picture film, video tape, or sound recording, or to any other 

property if the taxpayer elects to exclude such property from MACRS and the taxpayer properly 

applies a unit-of-production method or other method of depreciation not expressed in a term of 

years. Section 197 does not apply to certain intangible property, including property produced by 

the taxpayer or any interest in a film, sound recording, video tape, book or similar property not 

acquired in a transaction (or a series of related transactions) involving the acquisition of assets 

constituting a trade or business or substantial portion thereof. Thus, the recovery of the cost of a 

film, video tape, or similar property that is produced by the taxpayer or is acquired on a “standalone” basis by the taxpayer may not be determined under either the MACRS depreciation 

provisions or under the section 197 amortization provisions. The cost recovery of such property 

may be determined under section 167, which allows a depreciation deduction for the reasonable 

allowance for the exhaustion, wear and tear, or obsolescence of the property. A taxpayer is 

allowed to recover, through annual depreciation deductions, the cost of certain property used in a 

trade or business or for the production of income. Section 167(g) provides that the cost of 

motion picture films, sound recordings, copyrights, books, and patents are eligible to be 

recovered using the income forecast method of depreciation. 

Under section 181, taxpayers may elect261 to deduct the cost of any qualifying film and 

television production, commencing prior to January 1, 2009, in the year the expenditure is 

incurred in lieu of capitalizing the cost and recovering it through depreciation allowances.262 A 

qualified film or television production is one in which the aggregate cost is $15 million or less.263 

The threshold is increased to $20 million if a significant amount of the production expenditures 

are incurred in areas eligible for designation as a low-income community or eligible for 

designation by the Delta Regional Authority as a distressed county or isolated area of distress.264

A qualified film or television production means any production of a motion picture 

(whether released theatrically or directly to video cassette or any other format) or television 

program if at least 75 percent of the total compensation expended on the production is for 

services performed in the United States by actors, directors, producers, and other relevant 

 261 See Treas. Reg. section 1.181-2T for rules on making an election under this section. 

262 For this purpose, a production is treated as commencing on the first date of principal 

photography. 

263 Sec. 181(a)(2)(A). A qualifying film or television production that is co-produced is eligible 

for the benefits of the provision only if its aggregate cost, regardless of funding source, does not exceed 

the threshold. 

264 Sec. 181(a)(2)(B). 
160 

production personnel.265 The term “compensation” does not include participations and residuals 

(as defined in section 167(g)(7)(B)).266 With respect to property which is one or more episodes 

in a television series, each episode is treated as a separate production and only the first 44 

episodes qualify under the provision.267 Qualified property does not include sexually explicit 

productions as defined by section 2257 of title 18 of the U.S. Code.268

For purposes of recapture under section 1245, any deduction allowed under section 181 is 

treated as if it were a deduction allowable for amortization.269

Description of Proposal

The proposal modifies the dollar limitation so that the first $15 million ($20 million for 

productions in low income communities or distressed area or isolated area of distress) of an 

otherwise qualified film or television production may be treated as an expense in cases where the 

aggregate cost of the production exceeds the dollar limitation. The cost of the production in 

excess of the dollar limitation is capitalized and recovered under the taxpayer’s method of 

accounting for the recovery of such property. 

Effective Date

The proposal applies to qualified film and television productions commencing after 

December 31, 2007. 

 265 Sec. 181(d)(3)(A). 

266 Sec. 181(d)(3)(B). 

267 Sec. 181(d)(2)(B). 

268 Sec. 181(d)(2)(C). 

269 Sec. 1245(a)(2)(C). 
161 

G. Modified Standard for Imposition of Tax Return Preparer Penalties 

Present Law

Taxpayer standards

Present law imposes accuracy-related penalties on a taxpayer at a rate of 20 percent of the 

portion of any underpayment that is attributable to any substantial understatement of income tax. 

In determining whether a substantial understatement exists, the amount of the 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. 

In the case of a tax shelter item of a non-corporate taxpayer, the substantial 

understatement penalty does not apply if the taxpayer had substantial authority for the tax 

position and the taxpayer can demonstrate that he or she had a reasonable belief that the position 

is “more likely than not” the proper treatment. A taxpayer will be considered to have a 

reasonable belief that the treatment is more likely than not the proper treatment if the taxpayer 

relies upon the opinion of a professional advisor and the opinion is based upon the pertinent facts 

and authorities analyzed similar to the manner described in the substantial authority standard.270

Tax return preparer standards

Prior to enactment of the Small Business and Work Opportunity Tax Act of 2007, an 

income tax return preparer who prepared a tax return with respect to which there was an 

understatement of tax that was due to an undisclosed position for which there was not a realistic 

possibility of being sustained on its merits was liable for a $250 penalty. For a disclosed 

position, the preparer was liable only if the position was frivolous. 

Legislation enacted as part of the Small Business and Work Opportunity Tax Act of 2007 

broadened the scope of the preparer penalty by applying it to all tax return preparers and altered 

the standards of conduct a tax return preparer is required to meet in order to avoid the imposition 

of penalties for the preparation of a return with respect to which there is an understatement of 

tax. A tax return preparer now can be penalized for preparing a return on which there is an 

understatement of tax liability as a result of an “unreasonable position.” Any position that a 

return preparer does not reasonably believe is more likely than not to be sustained on its merits is 

an “unreasonable position” unless the position is disclosed on the return and there is a reasonable 

basis for the position. 

In general, the term “tax return preparer” is broadly defined as any person who prepares 

for compensation, or who employs one or more persons to prepare for compensation, any return 

 270 Treas. Reg. sec. 1.6662-4(g). 
162 

of tax or any claim for refund of tax.271 Preparation of a substantial portion of a return is treated 

as if it were the preparation of such return. 

Description of Proposal

The proposal changes the standards for imposition of the tax return preparer penalty. The 

preparer standard for undisclosed positions is reduced to “substantial authority.” The preparer 

standard for disclosed positions is “reasonable basis.” For tax shelters and reportable 

transactions to which section 6662A applies (i.e., listed transactions and reportable transactions 

with significant avoidance or evasion purposes), a tax return preparer is required to have a 

reasonable belief that such a transaction was more likely than not to be sustained on its merits. 

Effective Date

The proposal generally is effective with respect to returns prepared after May 25, 2007. 

In the case of tax shelters and reportable transactions, the proposal is effective for returns 

prepared for taxable years ending after the date of enactment. 

 271 Sec. 7701(a)(36)(A). 
163 

H. Election to Amend Returns for Hurricane-Related Casualty Losses 

Present Law

Under present law, a taxpayer may generally claim a deduction for any loss sustained 

during the taxable year and not compensated by insurance or otherwise.272 For individual 

taxpayers, deductible losses must be incurred in a trade or business or other profit-seeking 

activity or consist of property losses arising from fire, storm, shipwreck, or other casualty, or 

from theft.273 Generally, personal casualty or theft losses are deductible only if they exceed $100 

per casualty or theft and net casualty and theft losses are deductible only to the extent it exceeds 

10 percent of adjusted gross income.274 However, for hurricane-related casualty losses, these 

two casualty loss limitations are removed.275 

Casualty losses are generally allowed for the taxable year of the loss. However, in the 

case of a disaster loss arising in an area determined by the President of the United States to 

warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and 

Emergency Assistance Act, the taxpayer may elect to take the loss into account for the taxable 

year immediately before the taxable year in which the disaster occurred.276

When a taxpayer is reimbursed for such loss in a subsequent taxable year, the deductible 

loss is not recomputed for the taxable year in which the deduction was taken; instead, the 

reimbursed amount is taken into income in the taxable year received.277

Description of Proposal

The proposal allows a taxpayer who claimed a casualty loss to a principal residence 

(within the meaning of section 121) resulting from Hurricane Katrina, Hurricane Rita, or 

Hurricane Wilma and in a subsequent year receives a grant as reimbursement of such loss to 

elect to file an amended return for the taxable year to which such deduction was allowed.278 The 

casualty loss deduction is reduced, but not below zero, by the amount of such reimbursement. 

The time for filing such amended return is the later of three years after the original due date for 

filing the tax return or one year after the date of enactment of this Act. Any underpayment of tax 

 272 Sec. 165. 

273 Sec. 165(c)(3). 

274 Sec. 165(h). 

275 Sec. 1400S(b). 

276 Sec. 165(i). 

277 Treas. Reg. sec. 165-1(d)(2)(iii) 

278 To qualify the grant must be received under Public Law 109-148, 109-234, or 110-116. 
164 

shall not be subject to penalty or interest if paid not later than one year after the filing of the 

amended return. 

Effective Date

The proposal is effective on the date of enactment.
165 

I. Waiver of Deadline on Construction of GO Zone Property 

Eligible for Bonus Depreciation 

Present Law

 In general

A taxpayer is allowed to recover, through annual depreciation deductions, the cost of 

certain property used in a trade or business or for the production of income. The amount of the 

depreciation deduction allowed with respect to tangible property for a taxable year is determined 

under the modified accelerated cost recovery system (“MACRS”). Under MACRS, different 

types of property generally are assigned applicable recovery periods and depreciation methods. 

The recovery periods applicable to most tangible personal property (other than residential rental 

property and nonresidential real property) range from three to 25 years. The depreciation 

methods generally applicable to tangible personal property are the 200-percent and 150-percent 

declining balance methods, switching to the straight-line method for the taxable year in which 

the depreciation deduction would be maximized. 

Gulf Opportunity Zone

The “Gulf Opportunity Zone” is defined as that portion of the Hurricane Katrina Disaster 

Area determined by the President to warrant individual or individual and public assistance from 

the Federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance 

Act by reason of Hurricane Katrina. The term “Hurricane Katrina disaster area” means an area 

with respect to which a major disaster has been declared by the President before September 14, 

2005, under section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act 

by reason of Hurricane Katrina. 

Gulf Opportunity Zone property

Present law provides an additional first-year depreciation deduction equal to 50 percent 

of the adjusted basis of qualified Gulf Opportunity Zone property. In order to qualify, property 

generally must be placed in service on or before December 31, 2007 (December 31, 2008 in the 

case of nonresidential real property and residential rental property).

The additional first-year depreciation deduction is allowed for both regular tax and 

alternative minimum tax purposes for the taxable year in which the property is placed in service. 

The additional first-year depreciation deduction is subject to the general rules regarding whether 

an item is deductible under section 162 or subject to capitalization under section 263 or section 

263A. The basis of the property and the depreciation allowances in the year of purchase and 

later years are appropriately adjusted to reflect the additional first-year depreciation deduction. 

In addition, the provision provides that there is no adjustment to the allowable amount of 

depreciation for purposes of computing a taxpayer’s alternative minimum taxable income with 

respect to property to which the provision applies. A taxpayer is allowed to elect out of the 

additional first-year depreciation for any class of property for any taxable year. 

In order for property to qualify for the additional first-year depreciation deduction, it 

must meet all of the following requirements. First, the property must be property (1) to which 
166 

the general rules of the Modified Accelerated Cost Recovery System (“MACRS”) apply with an 

applicable recovery period of 20 years or less, (2) computer software other than computer 

software covered by section 197, (3) water utility property (as defined in section 168(e)(5)), (4) 

certain leasehold improvement property, or (5) certain nonresidential real property and 

residential rental property. Second, substantially all of the use of such property must be in the 

Gulf Opportunity Zone and in the active conduct of a trade or business by the taxpayer in the 

Gulf Opportunity Zone. Third, the original use of the property in the Gulf Opportunity Zone 

must commence with the taxpayer on or after August 28, 2005. (Thus, used property may 

constitute qualified property so long as it has not previously been used within the Gulf 

Opportunity Zone. In addition, it is intended that additional capital expenditures incurred to 

recondition or rebuild property the original use of which in the Gulf Opportunity Zone began 

with the taxpayer would satisfy the “original use” requirement. See Treasury Regulation 1.48-2 

Example 5.) Finally, the property must be acquired by purchase (as defined under section 

179(d)) by the taxpayer on or after August 28, 2005 and placed in service on or before 

December 31, 2007. For qualifying nonresidential real property and residential rental property, 

the property must be placed in service on or before December 31, 2008, in lieu of December 31, 

2007. Property does not qualify if a binding written contract for the acquisition of such property 

was in effect before August 28, 2005. However, property is not precluded from qualifying for 

the additional first-year depreciation merely because a binding written contract to acquire a 

component of the property is in effect prior to August 28, 2005. 

Property that is manufactured, constructed, or produced by the taxpayer for use by the 

taxpayer qualifies if the taxpayer begins the manufacture, construction, or production of the 

property on or after August 28, 2005 and before January 1, 2008, and the property is placed in 

service on or before December 31, 2007 (and all other requirements are met). In the case of 

qualified nonresidential real property and residential rental property, the property must be placed 

in service on or before December 31, 2008. Property that is manufactured, constructed, or 

produced for the taxpayer by another person under a contract that is entered into prior to the 

manufacture, construction, or production of the property is considered to be manufactured, 

constructed, or produced by the taxpayer. 

Under a special rule, property any portion of which is financed with the proceeds of a 

tax-exempt obligation under section 103 is not eligible for the additional first-year depreciation 

deduction. Recapture rules apply under the provision if the property ceases to be qualified Gulf 

Opportunity Zone property. 

Gulf Opportunity Zone extension property

The placed-in-service deadline is extended for specified Gulf Opportunity Zone extension 

property to qualify for the additional first-year depreciation deduction. Specified Gulf 

Opportunity Zone extension property is defined as property substantially all the use of which is 

in one or more specified portions of the Gulf Opportunity Zone and which is either: (1) 

nonresidential real property or residential rental property which is placed in service by the 

taxpayer on or before December 31, 2010, or (2) in the case of a taxpayer who places in service a 
167 

building described in (1), property described in section 168(k)(2)(A)(i)279 placed in service on or 

before December 31, 2010, if substantially all the use of such property is in such building and 

such property is placed in service within 90 days of the date the building is placed in service. 

However, in the case of nonresidential real property or residential rental property, only the 

adjusted basis of such property attributable to manufacture, construction, or production before 

January 1, 2010 (“progress expenditures”) is eligible for the additional first-year depreciation. 

The specified portions of the Gulf Opportunity Zone are defined as those portions of the 

Gulf Opportunity Zone which are in a county or parish which is identified by the Secretary of the 

Treasury (or his delegate) as being a county or parish in which hurricanes occurring in 2005 

damaged (in the aggregate) more than 60 percent of the housing units in such county or parish 

which were occupied (determined according to the 2000 Census). These areas include the 

Louisiana parishes of Calcasieu, Cameron, Orleans, Plaquemines, St. Bernard, St. Tammany, and 

Washington, and the Mississippi counties of Hancock, Harrison, Jackson, Pearl River, and 

Stone.280

Description of Proposal

The proposal removes the commencement date of January 1, 2008, for self-constructed 

Gulf Opportunity Zone extension property. The placed in service date of December 31, 2010 

and the progress expenditure date of January 1, 2010 are not modified. 

Effective Date

The provision applies to property placed in service after December 31, 2007.

 279 Property described in section 168(k)(2)(A)(i) includes (1) property to which the general rules 

of the Modified Accelerated Cost Recovery System (“MACRS”) apply with an applicable recovery 

period of 20 years or less, (2) computer software other than computer software covered by section 197, 

(3) water utility property (as defined in section 168(e)(5)), and (4) certain leasehold improvement 

property. 

280 Notice 2007-36, 2007-17 I.R.B. 1000. 
168 

J. Expansion of Gulf Opportunity Zone for Purposes 

of Tax-Exempt Bond Financing 

Present Law

In general

Under present law, gross income generally does not include interest on State or local 

bonds. State and local bonds are classified generally as either governmental bonds or private 

activity bonds. Governmental bonds are bonds which are primarily used to finance 

governmental functions or are repaid with governmental funds. Private activity bonds are bonds 

with respect to which the State or local government serves as a conduit providing financing to 

nongovernmental persons (e.g., private businesses or individuals). The exclusion from income 

for State and local bonds does not apply to private activity bonds, unless the bonds are issued for 

certain permitted purposes (“qualified private activity bonds”). 

Gulf Opportunity Zone Bonds

The Gulf Opportunity Zone Act authorized the issuance of qualified private activity 

bonds to finance the construction and rehabilitation of residential and nonresidential property 

located in the Gulf Opportunity Zone (“Gulf Opportunity Zone Bonds”). Gulf Opportunity Zone 

Bonds must be before January 1, 2011. 

Gulf Opportunity Zone Bonds may be issued by the State of Alabama, Louisiana, or 

Mississippi, or any political subdivision thereof. Issuance of bonds authorized under the 

provision is limited to projects approved by the Governor of the State (or the State bond 

commission in the case of a bond which is required under State law to be approved by such 

commission) in which the financed project shall be located. The maximum aggregate face 

amount of Gulf Opportunity Zone Bonds that may be issued in any State is limited to $2,500 

multiplied by the population of the respective State within the Gulf Opportunity Zone. Current 

refundings of outstanding bonds issued under the provision do not count against the aggregate 

volume limit to the extent that the principal amount of the refunding bonds does not exceed the 

outstanding principal amount of the bonds being refunded. Gulf Opportunity Zone Bonds may 

not be advance refunded. 

Depending on the purpose for which such bonds are issued, Gulf Opportunity Zone 

Bonds are treated as either exempt facility bonds or qualified mortgage bonds. Gulf Opportunity 

Zone Bonds are treated as exempt facility bonds if 95 percent or more of the net proceeds of such 

bonds are to be used for qualified project costs located in the Gulf Opportunity Zone. Qualified 

project costs include the cost of acquisition, construction, reconstruction, and renovation of 

nonresidential real property (including buildings and their structural components and fixed 

improvements associated with such property), qualified residential rental projects (as defined in 

section 142(d) with certain modifications), and public utility property. For purposes of the 

provision, costs associated with improving a facility (e.g., installing equipment that enhances the 

pollution control of a manufacturing facility) may be permitted project costs if such costs are 

chargeable to the capital account of the facility or would be so chargeable either with a proper 

election by a taxpayer or but for a proper election by a taxpayer to deduct the costs. 
169 

Bond proceeds may not be used to finance movable fixtures and equipment. The purpose 

of this limitation is to ensure that property financed with the bonds will remain in the Gulf 

Opportunity Zone. “Movable fixtures and equipment” does not include components that are 

assembled to construct an industrial plant. Such term also does not include consumer appliances 

installed in owner-occupied residences and residential rental property financed with the proceeds 

of Gulf Opportunity Zone Bonds. 

Rather than applying the 20-50 and 40-60 test under present law, a project is a qualified 

residential rental project under the provision if 20 percent or more of the residential units in such 

project are occupied by individuals whose income is 60 percent or less of area median gross 

income or if 40 percent or more of the residential units in such project are occupied by 

individuals whose income is 70 percent or less of area median gross income. 

Gulf Opportunity Zone Bonds are treated as qualified mortgage bonds if the bonds of 

such issue meet the requirements of a qualified mortgage issue (as defined in section 143 and 

modified by this provision) and the residences financed with such bonds are located in the Gulf 

Opportunity Zone. For these purposes, residences located in the Gulf Opportunity Zone are 

treated as targeted area residences. Thus, the first-time homebuyer rule is waived and purchase 

and income rules for targeted area residences apply to residences financed with bonds issued 

under the provision. Under the provision, 100 percent of the mortgages must be made to 

mortgagors whose family income is 140 percent or less of the applicable median family income. 

Thus, the present law rule allowing one-third of the mortgages to be made without regard to any 

income limits does not apply. In addition, the provision increases from $15,000 to $150,000 the 

amount of a qualified home-improvement loan that may be financed with bond proceeds. 

Subject to the following exceptions and modifications, issuance of Gulf Opportunity 

Zone Bonds is subject to the general rules applicable to issuance of qualified private activity 

bonds: 

(1) Except as otherwise permitted for a qualified mortgage issue, repayments of bondfinanced loans may not be used to make additional loans; 

(2) Issuance of the bonds is not subject to the aggregate annual State private activity 

bond volume limits (sec. 146); 

(3) The restriction on acquisition of existing property is applied using a minimum 

requirement of 50 percent of the cost of acquiring the building being devoted to 

rehabilitation (sec. 147(d)); 

(4) The special arbitrage expenditure rules for certain construction bond proceeds apply 

to available construction proceeds of Gulf Opportunity Zone Bonds issued to 

finance qualified project costs, treating such bonds as a construction issue (sec. 

148(f)(4)(C)); 

(5) Interest on the bonds is not a preference item for purposes of the alternative 

minimum tax preference for private activity bond interest (sec. 57(a)(5)); and 
170 

(6) No portion of the proceeds of the bonds may be used to provide any property 

described in section 144(c)(6)(B) (i.e., any private or commercial golf course, 

country club, massage parlor, hot tub facility, suntan facility, racetrack or other 

facility used for gambling, or any store the principal purpose of which is the sale 

alcoholic beverages for consumption off premises). 

Description of Proposal

The proposal adds Colbert County, Alabama and Dallas County, Alabama to the Gulf 

Opportunity Zone for the purpose of issuing Gulf Opportunity Zone Bonds. 

Effective Date

The proposal is effective as if included in the Gulf Opportunity Zone Act. 
171 

IV. REVENUE PROVISIONS 

A. Modify Tax Treatment of Offshore Nonqualified Deferred Compensation 

Present Law

In general

Under present law, the determination of when amounts deferred under a nonqualified 

deferred compensation arrangement are includible in the gross income of the person earning the 

compensation depends on the facts and circumstances of the arrangement. A variety of tax 

principles and Code provisions may be relevant in making this determination, including the 

doctrine of constructive receipt, the economic benefit doctrine,281 the provisions of section 83 

relating generally to transfers of property in connection with the performance of services, 

provisions relating specifically to nonexempt employee trusts (sec. 402(b)) and nonqualified 

annuities (sec. 403(c)), and the requirements of section 409A. 

In general, the time for income inclusion of nonqualified deferred compensation depends 

on whether the arrangement is unfunded or funded. If the arrangement is unfunded, then the 

compensation generally is includible in income by a cash-basis taxpayer when it is actually or 

constructively received. If the arrangement is funded, then income is includible for the year in 

which the individual’s rights are transferable or not subject to a substantial risk of forfeiture. 

An arrangement generally is considered funded if there has been a transfer of property 

under section 83. Under that section, a transfer of property occurs when a person acquires a 

beneficial ownership interest in such property. The term “property” is defined very broadly for 

purposes of section 83.282 Property includes real and personal property other than money or an 

unfunded and unsecured promise to pay money in the future. Property also includes a beneficial 

interest in assets (including money) that are transferred or set aside from claims of the creditors 

of the transferor; for example, in a trust or escrow account. Accordingly, if, in connection with 

the performance of services, vested contributions are made to a trust on an individual’s behalf 

and the trust assets may be used solely to provide future payments to the individual, the payment 

of the contributions to the trust constitutes a transfer of property to the individual that is taxable 

under section 83. On the other hand, deferred amounts generally are not includible in income if 

nonqualified deferred compensation is payable from general corporate funds that are subject to 

the claims of general creditors, as such amounts are treated as unfunded and unsecured promises 

to pay money or property in the future. 

As discussed above, if the arrangement is unfunded, then the compensation generally is 

includible in income by a cash-basis taxpayer when it is actually or constructively received under 

 281 See, e.g., Sproull v. Commissioner, 16 T.C. 244 (1951), aff’d, per curiam, 194 F.2d 541 (6th 

Cir. 1952); Rev. Rul. 60-31, 1960-1 C.B. 174. 

282 Treas. Reg. sec. 1.83-3(e). This definition, in part, reflects previous IRS rulings on 

nonqualified deferred compensation. 
172 

section 451.283 Income is constructively received when it is credited to a person’s account, set 

apart, or otherwise made available so that it may be drawn on at any time. Income is not 

constructively received if the taxpayer’s control of its receipt is subject to substantial limitations 

or restrictions. A requirement to relinquish a valuable right in order to make withdrawals is 

generally treated as a substantial limitation or restriction. 

Prior to the enactment of section 409A, arrangements had developed in an effort to 

provide employees with security for nonqualified deferred compensation, while still allowing 

deferral of income inclusion under the constructive receipt doctrine (which applies to unfunded 

arrangements). One such arrangement is a “rabbi trust.” A rabbi trust is a trust or other fund 

established by the employer to hold assets from which nonqualified deferred compensation 

payments will be made. The trust or fund is generally irrevocable and does not permit the 

employer to use the assets for purposes other than to provide nonqualified deferred 

compensation, except that the terms of the trust or fund provide that the assets are subject to the 

claims of the employer’s creditors in the case of insolvency or bankruptcy. In the case of a rabbi 

trust, these terms have been the basis for the conclusion that the creation of a rabbi trust does not 

cause the related nonqualified deferred compensation arrangement to be funded for income tax 

purposes.284 As a result, no amount is included in income by reason of the rabbi trust; generally 

income inclusion occurs as payments are made from the trust. 

Section 409A

Reason for enactment

The Congress enacted section 409A285 because it was concerned that many nonqualified 

deferred compensation arrangements had developed which allowed improper deferral of income. 

Executives often used arrangements that allowed deferral of income, but also provided security 

of future payment and control over amounts deferred. For example, nonqualified deferred 

compensation arrangements often contained provisions that allowed participants to receive 

distributions upon request, subject to forfeiture of a minimal amount (i.e., a “haircut” provision). 

In addition, Congress was aware that since the concept of a rabbi trust was developed, techniques 

had been used that attempted to protect the assets from creditors despite the terms of the trust. 

For example, the trust or fund would be located in a foreign jurisdiction, making it difficult or 

impossible for creditors to reach the assets. 

Prior to the enactment of section 409A, while the general tax principles governing 

deferred compensation were well established, the determination whether a particular 

 283 Treas. Reg. secs. 1.451-1 and 1.451-2. 

284 This conclusion was first provided in a 1980 private ruling issued by the IRS with respect to 

an arrangement covering a rabbi; hence, the popular name “rabbi trust.” Priv. Ltr. Rul. 8113107 (Dec. 31, 

1980). 

285 Section 409A was added to the Code by sec. 885 of the American Job Creation Act of 2004, 

Pub. L. No. 108-357. 
173 

arrangement effectively allowed deferral of income was generally made on a facts and 

circumstances basis. There was limited specific guidance with respect to common deferral 

arrangements. The Congress believed that it was appropriate to provide specific rules regarding 

whether deferral of income inclusion should be permitted and to provide a clear set of rules that 

would apply to these arrangements. The Congress believed that certain arrangements that allow 

participants inappropriate levels of control or access to amounts deferred should not result in 

deferral of income inclusion. The Congress also believed that certain arrangements, such as 

offshore trusts, which effectively protect assets from creditors of the employer, should be treated 

as funded and not result in deferral of income inclusion to the extent the amounts are vested. 

General requirements of section 409A

In general.–Under section 409A, all amounts deferred by a service provider under a 

nonqualified deferred compensation plan286 for all taxable years are currently includible in gross 

income of the service provider to the extent such amounts are not subject to a substantial risk of 

forfeiture287 and not previously included in gross income, unless certain requirements are 

satisfied. If the requirements of section 409A are not satisfied, in addition to current income 

inclusion, interest at the rate applicable to underpayments of tax plus one percentage point is 

imposed on the underpayments that would have occurred had the compensation been includible 

in income when first deferred, or if later, when not subject to a substantial risk of forfeiture. The 

amount required to be included in income is also subject to a 20-percent additional tax. 

Section 409A does not limit the amount that may be deferred under a nonqualified 

deferred compensation plan. The Secretary of the Treasury is authorized to prescribe regulations 

as are necessary or appropriate to carry out the purposes of section 409A. The Secretary of the 

Treasury published final regulations under section 409A on April 17, 2007.288 

Under these regulations, the term “service provider” includes an individual, corporation, 

subchapter S corporation, partnership, personal service corporation (as defined in section 

269A(b)(1)), noncorporate entity that would be a personal service corporation if it were a 

corporation, or qualified personal service corporation (as defined in section 448(d)(2)) for any 

taxable year in which such individual or entity accounts for gross income from the performance 

of services under the cash receipts and disbursements method of accounting.289 Section 409A 

 286 A plan includes an agreement or arrangement, including an agreement or arrangement that 

includes one person. Amounts deferred also include actual or notional earnings. 

287 The rights of a person to compensation are subject to a substantial risk of forfeiture if the 

person’s rights to such compensation are conditioned upon the performance of substantial services by any 

individual. 

288 On October 22, 2007, the IRS announced that during 2008, taxpayers are not required to 

comply with the final regulations. Instead, taxpayers must operate a plan in compliance with section 

409A and the otherwise applicable guidance. To the extent an issue is not addressed, a reasonable, good 

faith interpretation of the statute must be used. Notice 2007-86. 

289 Treas. Reg. sec. 1.409A-1(f)(1). 
174 

does not apply to a service provider that provides significant services to at least two service 

recipients that are not related to each other or the service provider. This exclusion does not apply 

to a service provider who is an employee or a director of a corporation (or similar position in the 

case of an entity that is not a corporation).290 In addition, the exclusion does not apply to an 

entity that operates as the manager of a hedge fund or private equity fund. This is because the 

exclusion does not apply to the extent that a service provider provides management services to a 

service recipient. Management services for this purpose means services that involve the actual 

or de facto direction or control of the financial or operational aspects of a trade or business of the 

service recipient or investment management or advisory services provided to a service recipient 

whose primary trade or business includes the investment of financial assets, such as a hedge 

fund.291

Permissible distribution events.–Under section 409A, distributions from a nonqualified 

deferred compensation plan may be allowed only upon separation from service (as determined 

by the Secretary of the Treasury), death, a specified time (or pursuant to a fixed schedule), 

change in control of a corporation (to the extent provided by the Secretary of the Treasury), 

occurrence of an unforeseeable emergency, or if the service provider becomes disabled. A 

nonqualified deferred compensation plan may not allow distributions other than upon the 

permissible distribution events and, except as provided in regulations by the Secretary of the 

Treasury, may not permit acceleration of a distribution. In the case of a specified employee who 

separates from service, distributions may not be made earlier than six months after the date of the 

separation from service or upon death. Specified employees are key employees292 of publiclytraded corporations. 

Elections.–Section 409A requires that a plan must provide that compensation for services 

performed during a taxable year may be deferred at the service provider’s election only if the 

election to defer is made no later than the close of the preceding taxable year, or at such other 

time as provided in Treasury regulations. In the case of any performance-based compensation 

based on services performed over a period of at least 12 months, such election may be made no 

later than six months before the end of the service period. The time and form of distributions 

must be specified at the time of initial deferral. A plan may allow changes in the time and form 

of distributions subject to certain requirements. 

Back-to-back arrangements.–Back-to-back service recipients (i.e., situations under which 

an entity receives services from a service provider such as an employee, and the entity in turn 

provides services to a client) that involve back-to-back nonqualified deferred compensation 

arrangements (i.e., the fees payable by the client are deferred at both the entity level and the 

employee level) are subject to special rules under section 409A. For example, the final 

 290 Treas. Reg. sec. 1.409A-1(f)(2). 

291 Treas. Reg. sec. 1.409A-1(f)(2)(iv). 

292 Key employees are defined in section 416(i) and generally include officers (limited to 50 

employees) having annual compensation greater than $145,000 (for 2007), five percent owners, and one 

percent owners having annual compensation from the employer greater than $150,000. 
175 

regulations generally permit the deferral agreement between the entity and its client to treat as a 

permissible distribution event those events that are specified as distribution events in the deferral 

agreement between the entity and its employee. Thus, if separation from employment is a 

specified distribution event between the entity and the employee, the employee’s separation 

generally is a permissible distribution event for the deferral agreement between the entity and its 

client.293

Offshore funding arrangements.–Section 409A requires current income inclusion in the 

case of certain offshore funding of nonqualified deferred compensation. Under section 409A, in 

the case of assets set aside (directly or indirectly) in a trust (or other arrangement determined by 

the Secretary of the Treasury) for purposes of paying nonqualified deferred compensation, such 

assets are treated as property transferred in connection with the performance of services under 

section 83 (whether or not such assets are available to satisfy the claims of general creditors) at 

the time set aside if such assets (or trust or other arrangement) are located outside of the United 

States or at the time transferred if such assets (or trust or other arrangement) are subsequently 

transferred outside of the United States. Any subsequent increases in the value of, or any 

earnings with respect to, such assets are treated as additional transfers of property. 

Interest at the underpayment rate plus one percentage point is imposed on the 

underpayments of tax that would have occurred had the amounts set aside been includible in 

income for the taxable year in which first deferred or, if later, the first taxable year not subject to 

a substantial risk of forfeiture. The amount required to be included in income also is subject to 

an additional 20-percent tax. 

The special funding rule does not apply to assets located in a foreign jurisdiction if 

substantially all of the services to which the nonqualified deferred compensation relates are 

performed in such foreign jurisdiction. The Secretary of the Treasury has authority to exempt 

arrangements from the provision if the arrangements do not result in an improper deferral of U.S. 

tax and will not result in assets being effectively beyond the reach of creditors. 

Definition of substantial risk of forfeiture

Under the Treasury regulations, compensation is subject to a substantial risk of forfeiture 

if entitlement to the amount is conditioned upon either the performance of substantial future 

services by any person or the occurrence of a condition related to a purpose of the compensation, 

provided that the possibility of forfeiture is substantial.294 

Definition of nonqualified deferred compensation

Under section 409A, a nonqualified deferred compensation plan generally includes any 

plan that provides for the deferral of compensation other than a qualified employer plan or any 

bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan. A 

 293 Treas. Reg. sec. 1.409A-3(i)(6). 

294 Treas. Reg. sec. 1.409A-1(d)(1). 
176 

qualified employer plan means a qualified retirement plan, tax-deferred annuity, simplified 

employee pension, and SIMPLE. A qualified governmental excess benefit arrangement (sec. 

415(m)) and an eligible deferred compensation plan (sec. 457(b)) is a qualified employer plan. 

The Treasury regulations also provide that certain other types of plans are not considered 

deferred compensation, and thus are not subject to section 409A. For example, if a service 

recipient transfers property to a service provider, there is no deferral of compensation merely 

because the value of the property is either not includible in income under section 83 by reason of 

the property being substantially nonvested or is includible in income because of a valid section 

83(b) election.295 Special rules apply in the case of stock options.296 Another exception applies 

to amounts that are not deferred beyond a short period of time after the amount is no longer 

subject to a substantial risk of forfeiture.297 Under this exception, there generally is no deferral 

for purposes of section 409A if the service provider actually or constructively receives the 

amount on or before the last day of the applicable 21⁄2 month period. The applicable 21⁄2 month 

period is the period ending on the later of the 15th day of the third month following the end of: 

(1) the service provider’s first taxable year in which the right to the payment is no longer subject 

to a substantial risk of forfeiture; or (2) the service recipient’s first taxable year in which the right 

to the payment is no longer subject to a substantial risk of forfeiture. 

Special rules apply in the case of stock appreciation rights ("SARs").298 Under the final 

Treasury regulations, a SAR is a right to compensation based on the appreciation in value of a 

specified number of shares of service recipient stock occurring between the date of grant and the 

date of exercise of such right. The final regulations generally provide that a SAR does not result 

in a deferral of compensation for purposes of section 409A (and thus is not subject to section 

409A) if the compensation payable under the SAR is not greater than the excess of the fair 

market value of the underlying stock on the date the SAR is exercised over the fair market value 

of the underlying stock on the date the SAR is granted.299 

The Treasury regulations provide exclusions from the definition of nonqualified deferred 

compensation in the case of services performed by individuals who participate in certain foreign 

plans, including plans covered by an applicable treaty and broad-based foreign retirement 

plans.300 In the case of a U.S. citizen or lawful permanent alien, nonqualified deferred 

compensation plan does not include a broad-based foreign retirement plan, but only with respect 

to the portion of the plan that provides for nonelective deferral of foreign earned income and 

 295 Treas. Reg. Sec. 1.409A-1(b)(6). 

296 Treas. Reg. Sec. 1.409A-1(b)(5). 

297 Treas. Reg. sec. 1.409A-1(b)(4). 

298 Treas. Reg. sec. 1.409A-1(b)(5). 

299 Treas. Reg. sec. 1.409A-1(b)(5)(i)(B). 

300 Treas. Reg. sec. 1.409A-1(a)(3). 
177 

subject to limitations on the annual amount deferred under the plan or the annual amount payable 

under the plan. In general, foreign earned income refers to amounts received by an individual 

from sources within a foreign country that constitutes earned income attributable to services. 

Timing of the service recipient’s deduction

Special statutory provisions govern the timing of the deduction for nonqualified deferred 

compensation, regardless of whether the arrangement covers employees or nonemployees and 

regardless of whether the arrangement is funded or unfunded.301 Under these provisions, the 

amount of nonqualified deferred compensation that is includible in the income of the service 

provider is deductible by the service recipient for the taxable year in which the amount is 

includible in the service provider’s income.302 Thus, for example, in the case of an unfunded 

nonqualified deferred compensation plan, a deduction to the taxable service recipient is deferred 

until the deferred compensation is actually paid or made available to the service provider. 

Section 457

Special income recognition rules apply in the case of a participant in a deferred 

compensation plan that is sponsored by a State or local government or an organization that is 

exempt from Federal income tax under section 501(a). Section 457 provides for different 

income inclusion rules for two basic types of deferred compensation arrangements: (1) 

arrangements that limit the amount of compensation that may be deferred (generally, $15,500 in 

2007) and that meet certain other requirements specified in section 457(b) (referred to as a 

“section 457(b) plan” or an “eligible deferred compensation plan”); and (2) arrangements that do 

not satisfy the requirements of section 457(b) (referred to as a “section 457(f) plan” or an 

“ineligible deferred compensation plan”). Section 457 does not provide a limit on the amount of 

compensation that may be deferred under a section 457(f) plan. 

 301 Secs. 404(a)(5), (b) and (d) and sec. 83(h). 

302 In the case of a publicly held corporation, no deduction is allowed for a taxable year for 

remuneration with respect to a covered employee to the extent that the remuneration exceeds $1 million. 

Code sec. 162(m). The Code defines the term “covered employee” in part by reference to Federal 

securities law. In light of changes to Federal securities law, the Internal Revenue Service interprets the 

term covered employee as the principal executive officer of the taxpayer as of the close of the taxable 

year or the 3 most highly compensated employees of the taxpayer for the taxable year whose 

compensation must be disclosed to the taxpayer’s shareholders (other than the principal executive officer 

or the principal financial officer). Notice 2007-49, 2007-25 I.R.B. 1429. For purposes of the deduction 

limit, remuneration generally includes all remuneration for which a deduction is otherwise allowable, 

although commission-based compensation and certain performance-based compensation are not subject to 

the limit. Remuneration does not include compensation for which a deduction is allowable after a 

covered employee ceases to be a covered employee. Thus, the deduction limitation often does not apply 

to deferred compensation that is otherwise subject to the deduction limitation (e.g., is not performancebased compensation) because the payment of the compensation is deferred until after termination of 

employment. 
178 

A participant in a section 457(b) plan does not recognize income with respect to the 

participant’s interest in such plan until the time of actual distribution (or, if earlier, the time the 

participant’s interest is made available to the participant, but only in the case of a section 457(b) 

plan maintained by a tax-exempt sponsor other than a State or local government). In contrast, a 

participant in a section 457(f) plan must include amounts deferred under such a plan in gross 

income for the first taxable year in which there is no substantial risk of forfeiture of the rights to 

such compensation. 

Charitable contributions

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. 

In general, 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 by 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. 

Charitable contributions in excess of applicable percentage limits generally may be carried over 

to the five succeeding taxable years. 

Description of Proposal

In general

Under the proposal, any compensation that is deferred under a nonqualified deferred 

compensation plan of a nonqualified entity is includible in gross income by the service provider 

when there is no substantial risk of forfeiture of the service provider’s rights to such 

compensation. The proposal applies in addition to the requirements of section 409A (or any 

other provision of the Code or general tax law principle) with respect to nonqualified deferred 

compensation. 

Nonqualified deferred compensation

For purposes of the proposal, the term nonqualified deferred compensation plan is 

defined in the same manner as for purposes of section 409A. As under section 409A, the term 

nonqualified deferred compensation includes earnings with respect to previously deferred 

amounts. Earnings are treated in the same manner as the amount deferred to which the earnings 

relate. 

Under the proposal, nonqualified deferred compensation includes any arrangement under 

which compensation is based on the increase in value of a specified number of equity units of the 

service recipient. Thus, stock appreciation rights (SARs) are treated as nonqualified deferred 

compensation under the proposal, regardless of the exercise price of the SAR. It is not intended 
179 

that the term nonqualified deferred compensation plan include an arrangement taxable under 

section 83 providing for the grant of an option on employer stock with an exercise price that is 

not less than the fair market value of the underlying stock on the date of grant if such 

arrangement does not include a deferral feature other than the feature that the option holder has 

the right to exercise the option in the future. The proposal is not intended to change the tax 

treatment of incentive stock options meeting the requirements of 422 or options granted under an 

employee stock purchase plan meeting the requirements of section 423. Similarly, nonqualified 

deferred compensation for purposes of the proposal does not include a transfer of property to 

which section 83 is applicable (such as a transfer of restricted stock), provided that the 

arrangement does not include a deferral feature. 

Compensation is not treated as deferred for purposes of the proposal if the service 

provider receives payment of the compensation not later than 12 months after the end of the 

taxable year of the service recipient during which the right to the payment of such compensation 

is no longer subject to a substantial risk of forfeiture. 

Nonqualified entity

The term nonqualified entity includes certain foreign corporations and certain 

partnerships (either domestic or foreign). A foreign corporation is a nonqualified entity unless 

substantially all of such income is effectively connected with the conduct of a United States trade 

or business or is subject to a comprehensive foreign income tax. A partnership is a nonqualified 

entity unless substantially all of such income is allocated to persons other than foreign persons 

with respect to whom such income is not subject to a comprehensive income tax and 

organizations which are exempt from U.S. income tax. 

The term comprehensive foreign income tax means with respect to a foreign person, the 

income tax of a foreign country if (1) such person is eligible for the benefits of a comprehensive 

income tax treaty between such foreign county and the United States, or (2) such person 

demonstrates to the satisfaction of the Secretary of the Treasury that such foreign country has a 

comprehensive income tax. 

In the case of a foreign corporation with income that is taxable under section 882, the 

proposal does not apply to compensation which, had such compensation been paid in cash on the 

date that such compensation ceased to be subject to a substantial risk of forfeiture, would have 

been deductible by such foreign corporation against such income. 

Additional rules

For purposes of the proposal, compensation of a service provider is subject to a 

substantial risk of forfeiture only if such person’s right to the compensation is conditioned upon 

the future performance of substantial services by any person. Thus, compensation is subject to a 

substantial risk of forfeiture only if entitlement to the compensation is conditioned on the 

performance of substantial future services and the possibility of forfeiture is substantial. 

Substantial risk of forfeiture does not include a condition related to a purpose of the 

compensation (other than future performance of substantial services), regardless of whether the 

possibility of forfeiture is substantial. 
180 

To the extent provided in regulations prescribed by the Secretary, if compensation is 

determined solely by reference to the amount of gain recognized on the disposition of an 

investment asset, such compensation is treated as subject to a substantial risk of forfeiture until 

the date of such disposition. Investment asset means any single asset (other than an investment 

fund or similar entity) (1) acquired directly by an investment fund or similar entity, (2) with 

respect to which such entity does not (nor does any person related to such entity) participate in 

the active management of such asset (or if such asset is an interest in an entity, in the active 

management of the assets of such entity), and (3) substantially all of any gain on the disposition 

of which (other than the nonqualified deferred compensation) is allocated to investors of such 

entity. The rule only applies if the compensation is determined solely by reference to the gain 

upon the disposition of an investment asset. Thus, for example, the rule does not apply in the 

case of an arrangement under which the amount of this compensation is reduced for losses on the 

disposition of any other asset. With respect to any gain before the asset is treated as no longer 

subject to a substantial risk of forfeiture attributable to the period it is intended that Treasury 

regulations will limit the application of this rule to gain attributable to the period that the service 

provider is performing services. 

The rule is intended to apply to compensation contingent on the disposition of a single 

asset held as a long-term investment, provided that the service provider does not actively manage 

the asset (other than the decision to purchase or sell the investment). If the asset is an interest in 

an entity (such as a company that produces products or services), the rule does not apply if the 

service provider actively participates in the management of the entity. Active management is 

intended to include participation in the day-to-day activities of the asset, but does not include the 

election of a director or other voting rights exercised by shareholders. 

The rule is intended to apply solely to compensation arrangements relating to passive 

investments by an investment fund in a single asset. For example, if an investment fund acquires 

XYZ operating corporation, the rule is intended to apply to an arrangement that the fund 

manager receive 20 percent of the gain from the disposition of XYZ operating corporation if the 

fund manager does not actively participate in the management of XYZ operating corporation. In 

contrast, the rule does not apply if the investment fund holds two or more operating corporations 

and the fund manger’s compensation is based on the net gain resulting from the disposition of the 

operating corporations. The rule does not apply to the disposition of a foreign subsidiary which 

holds a variety of assets the investment of which is managed by the service provider. 

Under the proposal, if the amount of any deferred compensation is not determinable at 

the time that such compensation is otherwise required to be taken into account into income under 

the proposal, the amount is taken into account when such amount becomes determinable. This 

rule applies in lieu of the general rule of the proposal, under which deferred compensation is 

taken into account in income when such compensation is no longer subject to a substantial risk of 

forfeiture. In addition, the income tax with respect to such amount is increased by the sum of (1) 

an interest charge, and (2) an amount equal to 20 percent of such compensation. The interest 

charge is equal to the interest at the rate applicable to underpayments of tax plus one percentage 

point imposed on the underpayments that would have occurred had the compensation been 

includible in income when first deferred, or if later, when not subject to a substantial risk of 

forfeiture. 
181 

Treasury regulations

It is intended that the Secretary of the Treasury issue regulations as to when an amount is 

not determinable for purposes of the proposal. It is intended that an amount of deferred 

compensation is not determinable at the time the amount is no longer subject to a substantial risk 

of forfeiture if the amount varies depending on the satisfaction of an objective condition. For 

example, if a deferred amount varies depending on the satisfaction of an objective condition at 

the time the amount is no longer subject to substantial risk of forfeiture (e.g., no amount is paid 

unless a certain threshold is achieved, 100 percent is paid the threshold is achieved, and 200 

percent is paid if a higher threshold is achieved), the amount deferred is not determinable. 

The Secretary of the Treasury is also authorized to issue such regulations as may be 

necessary or appropriate to carry out the purposes of the proposal, including regulations 

disregarding a substantial risk of forfeiture as necessary to carry out such purposes. 

Under the proposal, aggregation rules similar to those that apply under section 409A 

apply for purposes of determining whether a plan sponsor is a nonqualified entity. It is intended, 

however, that such aggregation rules are limited by the Secretary to operate in accordance with 

the purposes of the proposal. For example, it is intended that the aggregation rules do not result 

in the application of the proposal to employees of a U.S. subsidiary C corporation that is wholly 

owned by a nonqualified entity when the U.S. subsidiary sponsors the nonqualified deferred 

compensation plan in which the employees of the subsidiary participate. This is because the 

subsidiary is subject to the timing rule with respect to its deduction of its employees’ 

nonqualified deferred compensation. 

Increase in charitable percentage limit for qualified contributions 

In the case of certain qualified contributions, the proposal increases the limit on 

charitable contributions of cash to public charities above the otherwise applicable 50-percent 

limit. A qualified contribution is: (1) a charitable contribution of cash (2) made during the last 

taxable year beginning before 2018 (3) to an organization described in section 170(b)(1)(A) (in 

general, a public charity), other than a supporting organization described in section 509(a) or a 

donor advised fund described in section 4966(d)(2). Under the proposal, qualified contributions 

are allowable as charitable contributions to the extent the aggregate of such contributions for the 

taxable year exceeds the excess of (1) the amount includable in gross income under the proposal 

during such year attributable to services performed on or before December 31, 2008, over (2) the 

amount of all other allowable charitable contributions for such year. Therefore, if the includable 

amount described in the preceding sentences is greater than 50 percent of the taxpayer’s 

contribution base for the year (i.e., the present-law percentage limit), the proposal will result in 

an increase in the taxpayer’s charitable contribution limit for such year. Contributions in excess 

of the limit may be carried over to the five succeeding taxable years under generally applicable 

charitable contributions carryover rules. 

Effective Date

The proposal is effective with respect to amounts deferred which are attributable to 

services performed after December 31, 2008. In the case of an amount deferred which is 
182 

attributable to services performed on or before December 31, 2008, to the extent such amount is 

not includible in gross income in a taxable year beginning before 2018, then such amount is 

includible in gross income in the later of (1) the last taxable year beginning before 2018, or (2) 

the taxable year in which there is no substantial risk of forfeiture of the rights to such 

compensation. Earnings on amounts deferred which are attributable to services performed on or 

before December 31, 2008, are subject to the proposal only to the extent that the amounts to 

which such earnings relate are subject to the proposal. 

No later than 120 days after date of enactment, the Secretary shall issue guidance 

providing a limited period of time during which a nonqualified deferred compensation 

arrangement attributable to services performed on or before December 31, 2008, may, without 

violating the requirements of section 409A(a), be amended to conform the date of distribution to 

the date the amounts are required to be included in income. If the taxpayer is also a service 

recipient and maintains one or more nonqualified deferred compensation arrangements for its 

service providers under which any amount is attributable to services performed on or before 

December 31, 2008, the guidance shall permit such arrangements to be amended to conform the 

dates of distribution under the arrangement to the date amounts are required to be included in 

income of the taxpayer under the proposal. An amendment made pursuant to the Treasury 

guidance will not be treated as a material modification of the arrangement for purposes of section 

409A.
183 

B. Delay Implementation of Worldwide Interest Allocation 

Present Law

In general

In order to compute the foreign tax credit limitation, a taxpayer must determine the 

amount of its taxable income from foreign sources. Thus, the taxpayer must allocate and 

apportion deductions between items of U.S.-source gross income, on the one hand, and items of 

foreign-source gross income, on the other. 

In the case of interest expense, the rules generally are based on the approach that money 

is fungible and that interest expense is properly attributable to all business activities and property 

of a taxpayer, regardless of any specific purpose for incurring an obligation on which interest is 

paid.303 For interest allocation purposes, all members of an affiliated group of corporations 

generally are treated as a single corporation (the so-called “one-taxpayer rule”) and allocation 

must be made on the basis of assets rather than gross income. The term “affiliated group” in this 

context generally is defined by reference to the rules for determining whether corporations are 

eligible to file consolidated returns. 

For consolidation purposes, the term “affiliated group” means one or more chains of 

includible corporations connected through stock ownership with a common parent corporation 

which is an includible corporation, but only if: (1) the common parent owns directly stock 

possessing at least 80 percent of the total voting power and at least 80 percent of the total value 

of at least one other includible corporation; and (2) stock meeting the same voting power and 

value standards with respect to each includible corporation (excluding the common parent) is 

directly owned by one or more other includible corporations. 

Generally, the term “includible corporation” means any domestic corporation except 

certain corporations exempt from tax under section 501 (for example, corporations organized and 

operated exclusively for charitable or educational purposes), certain life insurance companies, 

corporations electing application of the possession tax credit, regulated investment companies, 

real estate investment trusts, and domestic international sales corporations. A foreign 

corporation generally is not an includible corporation. 

Subject to exceptions, the consolidated return and interest allocation definitions of 

affiliation generally are consistent with each other.304 For example, both definitions generally 

exclude all foreign corporations from the affiliated group. Thus, while debt generally is 

considered fungible among the assets of a group of domestic affiliated corporations, the same 

 303 However, exceptions to the fungibility principle are provided in particular cases, some of 

which are described below. 

304 One such exception is that the affiliated group for interest allocation purposes includes section 

936 corporations that are excluded from the consolidated group. 
184 

rules do not apply as between the domestic and foreign members of a group with the same 

degree of common control as the domestic affiliated group. 

Banks, savings institutions, and other financial affiliates

The affiliated group for interest allocation purposes generally excludes what are referred 

to in the Treasury regulations as “financial corporations” (Treas. Reg. sec. 1.861-11T(d)(4)). 

These include any corporation, otherwise a member of the affiliated group for consolidation 

purposes, that is a financial institution (described in section 581 or section 591), the business of 

which is predominantly with persons other than related persons or their customers, and which is 

required by State or Federal law to be operated separately from any other entity which is not a 

financial institution (sec. 864(e)(5)(C)). The category of financial corporations also includes, to 

the extent provided in regulations, bank holding companies (including financial holding 

companies), subsidiaries of banks and bank holding companies (including financial holding 

companies), and savings institutions predominantly engaged in the active conduct of a banking, 

financing, or similar business (sec. 864(e)(5)(D)). 

A financial corporation is not treated as a member of the regular affiliated group for 

purposes of applying the one-taxpayer rule to other non-financial members of that group. 

Instead, all such financial corporations that would be so affiliated are treated as a separate single 

corporation for interest allocation purposes. 

Worldwide interest allocation

In general

The American Jobs Creation Act of 2004 (“AJCA”)305 modifies the interest expense 

allocation rules described above (which generally apply for purposes of computing the foreign 

tax credit limitation) by providing a one-time election (the “worldwide affiliated group election”) 

under which the taxable income of the domestic members of an affiliated group from sources 

outside the United States generally is determined by allocating and apportioning interest expense 

of the domestic members of a worldwide affiliated group on a worldwide-group basis (i.e., as if 

all members of the worldwide group were a single corporation). If a group makes this election, 

the taxable income of the domestic members of a worldwide affiliated group from sources 

outside the United States is determined by allocating and apportioning the third-party interest 

expense of those domestic members to foreign-source income in an amount equal to the excess 

(if any) of (1) the worldwide affiliated group’s worldwide third-party interest expense multiplied 

by the ratio which the foreign assets of the worldwide affiliated group bears to the total assets of 

the worldwide affiliated group,306 over (2) the third-party interest expense incurred by foreign 

members of the group to the extent such interest would be allocated to foreign sources if the 

 305 Pub. L. No. 108-357, sec. 401 (2004). 

306 For purposes of determining the assets of the worldwide affiliated group, neither stock in 

corporations within the group nor indebtedness (including receivables) between members of the group is 

taken into account. 
185 

principles of worldwide interest allocation were applied separately to the foreign members of the 

group.307

For purposes of the new elective rules based on worldwide fungibility, the worldwide 

affiliated group means all corporations in an affiliated group as well as all controlled foreign 

corporations that, in the aggregate, either directly or indirectly,308 would be members of such an 

affiliated group if section 1504(b)(3) did not apply (i.e., in which at least 80 percent of the vote 

and value of the stock of such corporations is owned by one or more other corporations included 

in the affiliated group). Thus, if an affiliated group makes this election, the taxable income from 

sources outside the United States of domestic group members generally is determined by 

allocating and apportioning interest expense of the domestic members of the worldwide affiliated 

group as if all of the interest expense and assets of 80-percent or greater owned domestic 

corporations (i.e., corporations that are part of the affiliated group, as modified to include 

insurance companies) and certain controlled foreign corporations were attributable to a single 

corporation. 

The common parent of the domestic affiliated group must make the worldwide affiliated 

group election. It must be made for the first taxable year beginning after December 31, 2008, in 

which a worldwide affiliated group exists that includes at least one foreign corporation that 

meets the requirements for inclusion in a worldwide affiliated group. Once made, the election 

applies to the common parent and all other members of the worldwide affiliated group for the 

taxable year for which the election was made and all subsequent taxable years, unless revoked 

with the consent of the Secretary of the Treasury. 

Financial institution group election

Taxpayers are allowed to apply the bank group rules to exclude certain financial 

institutions from the affiliated group for interest allocation purposes under the worldwide 

fungibility approach. The rules also provides a one-time “financial institution group” election 

that expands the bank group. At the election of the common parent of the pre-election 

worldwide affiliated group, the interest expense allocation rules are applied separately to a 

subgroup of the worldwide affiliated group that consists of (1) all corporations that are part of the 

bank group, and (2) all “financial corporations.” For this purpose, a corporation is a financial 

corporation if at least 80 percent of its gross income is financial services income (as described in 

section 904(d)(2)(C)(i) and the regulations thereunder) that is derived from transactions with 

unrelated persons.309 For these purposes, items of income or gain from a transaction or series of 

 307 Although the interest expense of a foreign subsidiary is taken into account for purposes of 

allocating the interest expense of the domestic members of the electing worldwide affiliated group for 

foreign tax credit limitation purposes, the interest expense incurred by a foreign subsidiary is not 

deductible on a U.S. return. 

308 Indirect ownership is determined under the rules of section 958(a)(2) or through applying 

rules similar to those of section 958(a)(2) to stock owned directly or indirectly by domestic partnerships, 

trusts, or estates. 

309 See Treas. Reg. sec. 1.904-4(e)(2). 
186 

transactions are disregarded if a principal purpose for the transaction or transactions is to qualify 

any corporation as a financial corporation. 

The common parent of the pre-election worldwide affiliated group must make the 

election for the first taxable year beginning after December 31, 2008, in which a worldwide 

affiliated group includes a financial corporation. Once made, the election applies to the financial 

institution group for the taxable year and all subsequent taxable years. In addition, anti-abuse 

rules are provided under which certain transfers from one member of a financial institution group 

to a member of the worldwide affiliated group outside of the financial institution group are 

treated as reducing the amount of indebtedness of the separate financial institution group. 

Regulatory authority is provided with respect to the election to provide for the direct allocation 

of interest expense in circumstances in which such allocation is appropriate to carry out the 

purposes of these rules, to prevent assets or interest expense from being taken into account more 

than once, or to address changes in members of any group (through acquisitions or otherwise) 

treated as affiliated under these rules. 

Effective date of worldwide interest allocation under AJCA

The worldwide interest allocation rules under AJCA are effective for taxable years 

beginning after December 31, 2008. 

Description of Proposal

The proposal delays the effective date of worldwide interest allocation rules for ten years, 

until taxable years beginning after December 31, 2018. The required dates for making the 

worldwide affiliated group election and the financial institution group election are changed 

accordingly. 

Effective Date

The proposal is effective on the date of enactment.
187 

C. Modifications to Corporate Estimated Tax Payments 

Present Law

In general

In general, corporations are required to make quarterly estimated tax payments of their 

income tax liability. For a corporation whose taxable year is a calendar year, these estimated tax 

payments must be made by April 15, June 15, September 15, and December 15. 

Tax Increase Prevention and Reconciliation Act of 2005 (“TIPRA”) 

TIPRA provided the following special rules: 

In case of a corporation with assets of at least $1 billion, the payments due in July, 

August, and September, 2012, shall be increased to 106.25 percent of the payment otherwise due 

and the next required payment shall be reduced accordingly. 

In case of a corporation with assets of at least $1 billion, the payments due in July, 

August, and September, 2013, shall be increased to 100.75 percent of the payment otherwise due 

and the next required payment shall be reduced accordingly. 

Subsequent legislation

Several public laws have been enacted since TIPRA which further increase the 

percentage of payments due under each of the two special rules enacted by TIPRA described 

above. 

Description of Proposal

The provision makes two modifications to the corporate estimated tax payment rules. 

First, in case of a corporation with assets of at least $1 billion, the payments due in July, 

August, and September, 2013, are increased by 36 3⁄4 percentage points of the payment otherwise 

due and the next required payment shall be reduced accordingly. 

Second, in case of a corporation with assets of at least $1 billion, the increased payments 

due in July, August, and September, 2012 under the special rules in TIPRA and subsequent 

legislation are repealed. In effect the general rule is applied (i.e., such corporations are required 

to make quarterly estimated tax payments based on their income tax liability.) 

Effective Date

The proposal is effective on the date of enactment.