DESCRIPTION OF TITLE I OF H.R. 598, THE 

“AMERICAN RECOVERY AND REINVESTMENT 

TAX ACT OF 2009” 

Scheduled for Markup 

by the 

HOUSE COMMITTEE ON WAYS AND MEANS 

on January 22, 2009 

Prepared by the Staff 

of the 

JOINT COMMITTEE ON TAXATION 

January 21, 2009 

JCX-5-09 
i 

CONTENTS 

Page

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

A. Making Work Pay Credit ................................................................................................. 2 

B. Additional Tax Relief for Families With Children .......................................................... 6 

1. Increase in the earned income tax credit .................................................................... 6 

2. Increase of refundable portion of the child credit ...................................................... 8 

C. American Opportunity Tax Credit ................................................................................. 10 

D. Housing Incentives ......................................................................................................... 13 

1. Waiver of requirement to repay first-time homebuyer credit .................................. 13 

2. Election to substitute grants to states for low-income housing projects in lieu 

of low-income housing credit allocation for 2009 ................................................... 14 

E. Tax Incentives for Business ........................................................................................... 17 

1. Special allowance for certain property acquired during 2009 ................................. 17 

2. Temporary increase in limitations on expensing of certain depreciable business 

assets ........................................................................................................................ 19 

3. Five-year carryback of operating losses .................................................................. 21 

4. Modification of work opportunity tax credit ........................................................... 23 

5. Clarification of regulations related to limitations on certain built in losses 

following an ownership change ............................................................................... 28 

F. Fiscal Relief for State and Local Governments ............................................................. 34 

1. De minimis safe harbor exception for tax-exempt interest expense of financial 

institutions and modification of small issuer exception to tax-exempt interest 

expense allocation rules for financial institutions .................................................... 34 

2. Temporary modification of alternative minimum tax limitations on tax-exempt 

bonds ........................................................................................................................ 37 

3. Qualified school construction bonds ........................................................................ 37 

4. Extend and expand qualified zone academy bonds ................................................. 42 

5. Taxable bond option for governmental bonds ......................................................... 45 

6. Recovery Zone Bonds .............................................................................................. 49 

7. Tribal Economic Development Bonds ..................................................................... 55 

8. Repeal of withholding on government contractors .................................................. 57 

G. Energy Incentives ........................................................................................................... 58 

1. Extension of the renewable electricity credit ........................................................... 58 
ii 

2. Election of investment credit in lieu of production tax credits ................................ 65 

3. Modification of energy credit .................................................................................. 66 

4. Expand New Clean Renewable Energy Bonds ........................................................ 69 

5. Expand qualified energy conservation bonds .......................................................... 71 

6. Extension and modification of credit for nonbusiness energy property .................. 73 

7. Credit for residential energy efficient property. ...................................................... 75 

8. Temporary increase in credit for alternative fuel vehicle refueling property .......... 77 

9. Energy research credit .............................................................................................. 78 

H. Other Provisions ............................................................................................................. 83 

1. Application of certain labor standards to projects financed with certain 

tax-favored bonds..................................................................................................... 83 

2. Grants for specified energy property in lieu of tax credits ...................................... 83 
1 

INTRODUCTION 

The House Committee on Ways and Means has scheduled a markup of H.R. 598, the 

“American Recovery and Reinvestment Tax Act of 2009.” 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 Title I of 

H.R. 598, the “American Recovery and Reinvestment Tax Act of 2009,” January 21, 2009, (JCX-5-09). 

This document can also be found on our website at www.jct.gov. 
2 

A. Making Work Pay Credit 

Present Law

Earned income tax credit

Low- and moderate-income workers may be eligible for the refundable earned income tax 

credit (EITC). Eligibility for the EITC is based on earned income, adjusted gross income, 

investment income, filing status, and immigration and work status in the United States. The 

amount of the EITC is based on the presence and number of qualifying children in the worker’s 

family, as well as on adjusted gross income and earned income. 

The EITC generally equals a specified percentage of earned income2 up to a maximum 

dollar amount. The maximum amount applies over a certain income range and then diminishes 

to zero over a specified phaseout range. For taxpayers with earned income (or adjusted gross 

income (AGI), if greater) in excess of the beginning of the phaseout range, the maximum EITC 

amount is reduced by the phaseout rate multiplied by the amount of earned income (or AGI, if 

greater) in excess of the beginning of the phaseout range. For taxpayers with earned income (or 

AGI, if greater) in excess of the end of the phaseout range, no credit is allowed. 

The EITC is a refundable credit, meaning that if the amount of the credit exceeds the 

taxpayer’s Federal income tax liability, the excess is payable to the taxpayer as a direct transfer 

payment. Under an advance payment system, eligible taxpayers may elect to receive the credit 

in their paychecks, rather than waiting to claim a refund on their tax returns filed by April 15 of 

the following year. 

Child credit

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. 

 2

 Earned income is defined as (1) wages, salaries, tips, and other employee compensation, but 

only if such amounts are includible in gross income, plus (2) the amount of the individual’s net selfemployment earnings. 
3 

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 

$12,550 (for 2009), 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 tax credit 

(“EITC”). 

Earned income is defined as the sum of wages, salaries, tips, and other taxable employee 

compensation plus net self-employment earnings. Unlike the EITC, 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 EITC, 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. 

Description of Proposal

In general

The proposal provides eligible individuals a refundable income tax credit for two years 

(taxable years beginning in 2009 and 2010). 

The credit is the lesser of (1) 6.2 percent of an individual’s earned income or (2) $500 

($1,000 in the case of a joint return). For these purposes, the earned income definition is the 

same as for the earned income tax credit with two modifications. First, earned income for these 

purposes does not include net earnings from self-employment which are not taken into account in 

computing taxable income. Second, earned income for these purposes includes combat pay 

excluded from gross income under section 112.3

The credit is phased out at a rate of two percent of the eligible individual’s modified 

adjusted gross income above $75,000 ($150,000 in the case of a joint return). For these purposes 

an eligible individual’s modified adjusted gross income is the eligible individual’s adjusted gross 

income increased by any amount excluded from gross income under sections 911, 931, or 933. 

An eligible individual means any individual other than: (1) a nonresident alien; (2) an individual 

with respect to whom another individual may claim a dependency deduction for a taxable year 

beginning in a calendar year in which the eligible individual’s taxable year begins; and (3) an 

estate or trust. 

 3

 Unless otherwise stated, all section references are to the Internal Revenue Code of 1986, as 

amended (the “Code”). 
4 

Treatment of the U.S. possessions

Mirror code possessions4

The U.S. Treasury will make two payments (for 2009 and 2010, respectively) to each 

mirror code possession in an amount equal to the aggregate amount of the credits allowable by 

reason of the proposal to that possession’s residents against its income tax. This amount will be 

determined by the Treasury Secretary based on information provided by the government of the 

respective possession. For purposes of this payment, a possession is a mirror code possession if 

the income tax liability of residents of the possession under that possession’s income tax system 

is determined by reference to the U.S. income tax laws as if the possession were the United 

States. 

Non-mirror code possessions5

To each possession that does not have a mirror code tax system, the U.S. Treasury will 

make two payments (for 2009 and 2010, respectively) in an amount estimated by the Secretary as 

being equal to the aggregate credits that would have been allowed to residents of that possession 

if a mirror code tax system had been in effect in that possession. Accordingly, the amount of 

each payment to a non-mirror Code possession will be an estimate of the aggregate amount of 

the credits that would be allowed to the possession’s residents if the credit provided by the 

proposal to U.S. residents were provided by the possession to its residents. This payment will 

not be made to any U.S. possession unless that possession has a plan that has been approved by 

the Secretary under which the possession will promptly distribute the payment to its residents. 

General rules

No credit against U.S. income tax is permitted under the proposal for any person to 

whom a credit is allowed against possession income taxes as a result of the proposal (for 

example, under that possession’s mirror income tax). Similarly, no credit against U.S. income 

tax is permitted for any person who is eligible for a payment under a non-mirror code 

possession’s plan for distributing to its residents the payment described above from the U.S. 

Treasury. 

For purposes of the payments to the possessions, the Commonwealth of Puerto Rico and 

the Commonwealth of the Northern Mariana Islands are considered possessions of the United 

States. 

For purposes of the rule permitting the Treasury Secretary to disburse appropriated 

amounts for refunds due from certain credit proposals of the Internal Revenue Code of 1986, the 

 4

 Possessions with mirror code tax systems are the United States Virgin Islands, Guam, and the 

Commonwealth of the Northern Mariana Islands. 

5

 Possessions that do not have mirror code tax systems are Puerto Rico and American Samoa. 
5 

payments required to be made to possessions under the proposal are treated in the same manner 

as a refund due from the credit allowed under the proposal. 

Federal programs or Federally-assisted programs

Any credit or refund allowed or made to an individual under this proposal (including to 

any resident of a U.S. possession) is not taken into account as income and shall not be taken into 

account as resources for the month of receipt and the following two months for purposes of 

determining eligibility of such individual or any other individual for benefits or assistance, or the 

amount or extent of benefits or assistance, under any Federal program or under any State or local 

program financed in whole or in part with Federal funds. 

Income tax withholding

It is anticipated that taxpayers’ reduced tax liability under the proposal shall be 

expeditiously implemented through revised income tax withholding schedules produced by the 

Internal Revenue Service. These revised income tax withholding schedules should be designed 

to reduce taxpayers’ income tax withheld for each remaining pay period in the remainder of 2009 

by an amount equal to the amount that withholding would have been reduced had the proposal 

been reflected in the income tax withholding schedules for the entire taxable year. 

Effective Date

The proposal applies to taxable years beginning after December 31, 2008. 
6 

B. Additional Tax Relief for Families With Children 

1. Increase in the earned income tax credit 

Present Law

Overview

Low- and moderate-income workers may be eligible for the refundable earned income tax 

credit (“EITC”). Eligibility for the EITC is based on earned income, adjusted gross income, 

investment income, filing status, and immigration and work status in the United States. The 

amount of the EITC is based on the presence and number of qualifying children in the worker’s 

family, as well as on adjusted gross income and earned income. 

The EITC generally equals a specified percentage of earned income6 up to a maximum 

dollar amount. The maximum amount applies over a certain income range and then diminishes 

to zero over a specified phaseout range. For taxpayers with earned income (or adjusted gross 

income (AGI), if greater) in excess of the beginning of the phaseout range, the maximum EITC 

amount is reduced by the phaseout rate multiplied by the amount of earned income (or AGI, if 

greater) in excess of the beginning of the phaseout range. For taxpayers with earned income (or 

AGI, if greater) in excess of the end of the phaseout range, no credit is allowed. 

An individual is not eligible for the EITC if the aggregate amount of disqualified income 

of the taxpayer for the taxable year exceeds $3,100 (for 2009). This threshold is indexed for 

inflation. Disqualified income is the sum of: (1) interest (taxable and tax exempt); (2) dividends; 

(3) net rent and royalty income (if greater than zero); (4) capital gains net income; and (5) net 

passive income (if greater than zero) that is not self-employment income. 

The EITC is a refundable credit, meaning that if the amount of the credit exceeds the 

taxpayer’s Federal income tax liability, the excess is payable to the taxpayer as a direct transfer 

payment. Under an advance payment system, eligible taxpayers may elect to receive the credit 

in their paychecks, rather than waiting to claim a refund on their tax returns filed by April 15 of 

the following year. 

Filing status

An unmarried individual may claim the EITC if he or she files as a single filer or as a 

head of household. Married individuals generally may not claim the EITC unless they file 

jointly. An exception to the joint return filing requirement applies to certain spouses who are 

separated. Under this exception, a married taxpayer who is separated from his or her spouse for 

the last six months of the taxable year shall not be considered as married (and, accordingly, may 

file a return as head of household and claim the EITC), provided that the taxpayer maintains a 

 6

 Earned income is defined as (1) wages, salaries, tips, and other employee compensation, but 

only if such amounts are includible in gross income, plus (2) the amount of the individual’s net selfemployment earnings. 
7 

household that constitutes the principal place of abode for a dependent child (including a son, 

stepson, daughter, stepdaughter, adopted child, or a foster child) for over half the taxable year,7

and pays over half the cost of maintaining the household in which he or she resides with the child 

during the year. 

Presence of qualifying children and amount of the earned income credit

Three separate credit schedules apply: one schedule for taxpayers with no qualifying 

children, one schedule for taxpayers with one qualifying child, and one schedule for taxpayers 

with more than one qualifying child.8

Taxpayers with no qualifying children may claim a credit if they are over age 24 and 

below age 65. The credit is 7.65 percent of earnings up to $5,970, resulting in a maximum credit 

of $457 for 2009. The maximum is available for those with incomes between $5,970 and $7,470 

($10,590 if married filing jointly). The credit begins to phase down at a rate of 7.65 percent of 

earnings above $7,470 ($10,590 if married filing jointly) resulting in a $0 credit at $13,440 of 

earnings ($16,560 if married filing jointly). 

Taxpayers with one qualifying child may claim a credit in 2009 of 34 percent of their 

earnings up to $8,950, resulting in a maximum credit of $3,043. The maximum credit is 

available for those with earnings between $8,950 and $16,420 ($19,540 if married filing jointly). 

The credit begins to phase down at a rate of 15.98 percent of earnings above $16,420 ($19,540 if 

married filing jointly). The credit is phased down to $0 at $35,463 of earnings ($38,583 if 

married filing jointly). 

Taxpayers with more than one qualifying child may claim a credit in 2009 of 40 percent 

of earnings up to $12,570, resulting in a maximum credit of $5,028. The maximum credit is 

available for those with earnings between $12,570 and $16,420 ($19,540 if married filing 

jointly). The credit begins to phase down at a rate of 21.06 percent of earnings above $16,420 

($19,540 if married filing jointly). The credit is phased down to $0 at $40,295 of earnings 

($43,415 if married filing jointly). 

If more than one taxpayer lives with a qualifying child, only one of these taxpayers may 

claim the child for purposes of the EITC. If multiple eligible taxpayers actually claim the same 

qualifying child, then a tiebreaker rule determines which taxpayer is entitled to the EITC with 

respect to the qualifying child. Any eligible taxpayer with at least one qualifying child who does 

not claim the EITC with respect to qualifying children due to failure to meet certain 

identification requirements with respect to such children (i.e., providing the name, age and 

taxpayer identification number of each of such children) may not claim the EITC for taxpayers 

without qualifying children. 

 7

 A foster child must reside with the taxpayer for the entire taxable year. 

8

 All income thresholds are indexed for inflation annually. 
8 

Description of Proposal

Three or more qualifying children

The proposal increases the EITC credit percentage for families with three or more 

qualifying children to 45 percent for 2009 and 2010. For example, in 2009 taxpayers with three 

or more qualifying children may claim a credit of 45 percent of earnings up to $12,570, resulting 

in a maximum credit of $5,656.50. 

Provide additional marriage penalty relief through higher threshold phase-out amounts for 

married couples filing joint returns

The proposal increases the threshold phase-out amounts for married couples filing joint 

returns to $5,0009 above the threshold phase-out amounts for singles, surviving spouses, and 

heads of households) for 2009 and 2010. For example, in 2009 the maximum credit of $3,043 

for one qualifying child is available for those with earnings between $8,950 and $16,420 

($21,420 if married filing jointly). The credit begins to phase down at a rate of 15.98 percent of 

earnings above $16,420 ($21,420 if married filing jointly). The credit is phased down to $0 at 

$35,463 of earnings ($40,463 if married filing jointly). 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2008. 

2. Increase of refundable portion of the 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 

 9

 The $5,000 is indexed for inflation in the case of taxable years beginning in 2010. 
9 

of a threshold dollar amount (the “earned income” formula). The threshold dollar amount is 

$12,550 (for 2009), 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 tax credit 

(“EITC”). 

Earned income is defined as the sum of wages, salaries, tips, and other taxable employee 

compensation plus net self-employment earnings. Unlike the EITC, 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 EITC, 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. 

Any credit or refund allowed or made to an individual under this proposal (including to 

any resident of a U.S. possession) is not taken into account as income and shall not be taken into 

account as resources for the month of receipt and the following two months for purposes of 

determining eligibility of such individual or any other individual for benefits or assistance, or the 

amount or extent of benefits or assistance, under any Federal program or under any State or local 

program financed in whole or in part with Federal funds. 

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 $0 for taxable years beginning 

in 2009 and 2010. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2008. 
10 

C. American Opportunity Tax Credit 

Present Law

Individual taxpayers are allowed to claim a nonrefundable credit, the Hope credit, against 

Federal income taxes of up to $1,800 (for 2009) per eligible student per year for qualified tuition 

and related expenses paid for the first two years of the student’s post-secondary education in a 

degree or certificate program.10 The Hope credit rate is 100 percent on the first $1,200 of 

qualified tuition and related expenses, and 50 percent on the next $1,200 of qualified tuition and 

related expenses; these dollar amounts are indexed for inflation, with the amount rounded down 

to the next lowest multiple of $100. Thus, for example, a taxpayer who incurs $1,200 of 

qualified tuition and related expenses for an eligible student is eligible (subject to the adjusted 

gross income phaseout described below) for a $1,200 Hope credit. If a taxpayer incurs $2,400 of 

qualified tuition and related expenses for an eligible student, then he or she is eligible for a 

$1,800 Hope credit. 

The Hope credit that a taxpayer may otherwise claim is phased out ratably for taxpayers 

with modified adjusted gross income between $50,000 and $60,000 ($100,000 and $120,000 for 

married taxpayers filing a joint return) for 2009. The adjusted gross income phaseout ranges are 

indexed for inflation, with the amount rounded down to the next lowest multiple of $1,000. 

The qualified tuition and related expenses must be incurred on behalf of the taxpayer, the 

taxpayer’s spouse, or a dependent of the taxpayer. The Hope credit is available with respect to 

an individual student for two taxable years, provided that the student has not completed the first 

two years of post-secondary education before the beginning of the second taxable year. 

The Hope credit is available in the taxable year the expenses are paid, subject to the 

requirement that the education is furnished to the student during that year or during an academic 

period beginning during the first three months of the next taxable year. Qualified tuition and 

related expenses paid with the proceeds of a loan generally are eligible for the Hope credit. The 

repayment of a loan itself is not a qualified tuition or related expense. 

A taxpayer may claim the Hope credit with respect to an eligible student who is not the 

taxpayer or the taxpayer’s spouse (e.g., in cases in which the student is the taxpayer’s child) only 

if the taxpayer claims the student as a dependent for the taxable year for which the credit is 

claimed. If a student is claimed as a dependent, the student is not entitled to claim a Hope credit 

for that taxable year on the student’s own tax return. If a parent (or other taxpayer) claims a 

student as a dependent, any qualified tuition and related expenses paid by the student are treated 

as paid by the parent (or other taxpayer) for purposes of determining the amount of qualified 

tuition and related expenses paid by such parent (or other taxpayer) under the proposal. In 

addition, for each taxable year, a taxpayer may elect either the Hope credit, the Lifetime 

 10 Sec. 25A. The Hope credit generally may not be claimed against a taxpayer’s alternative 

minimum tax liability. However, the credit may be claimed against a taxpayer’s alternative minimum tax 

liability for taxable years beginning prior to January 1, 2009. 
11 

Learning credit, or an above-the-line deduction for qualified tuition and related expenses with 

respect to an eligible student. 

The Hope credit is available for “qualified tuition and related expenses,” which include 

tuition and fees (excluding nonacademic fees) required to be paid to an eligible educational 

institution as a condition of enrollment or attendance of an eligible student at the institution. 

Charges and fees associated with meals, lodging, insurance, transportation, and similar personal, 

living, or family expenses are not eligible for the credit. The expenses of education involving 

sports, games, or hobbies are not qualified tuition and related expenses unless this education is 

part of the student’s degree program. 

Qualified tuition and related expenses generally include only out-of-pocket expenses. 

Qualified tuition and related expenses do not include expenses covered by employer-provided 

educational assistance and scholarships that are not required to be included in the gross income 

of either the student or the taxpayer claiming the credit. Thus, total qualified tuition and related 

expenses are reduced by any scholarship or fellowship grants excludable from gross income 

under section 117 and any other tax-free educational benefits received by the student (or the 

taxpayer claiming the credit) during the taxable year. The Hope credit is not allowed with 

respect to any education expense for which a deduction is claimed under section 162 or any other 

section of the Code. 

An eligible student for purposes of the Hope credit is an individual who is enrolled in a 

degree, certificate, or other program (including a program of study abroad approved for credit by 

the institution at which such student is enrolled) leading to a recognized educational credential at 

an eligible educational institution. The student must pursue a course of study on at least a halftime basis. A student is considered to pursue a course of study on at least a half-time basis if the 

student carries at least one half the normal full-time work load for the course of study the student 

is pursuing for at least one academic period that begins during the taxable year. To be eligible 

for the Hope credit, a student must not have been convicted of a Federal or State felony 

consisting of the possession or distribution of a controlled substance. 

Eligible educational institutions generally are accredited post-secondary educational 

institutions offering credit toward a bachelor’s degree, an associate’s degree, or another 

recognized post-secondary credential. Certain proprietary institutions and post-secondary 

vocational institutions also are eligible educational institutions. To qualify as an eligible 

educational institution, an institution must be eligible to participate in Department of Education 

student aid programs. 

Effective for taxable years beginning after December 31, 2010, the changes to the Hope 

credit made by the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) 

no longer apply. The principal EGTRRA change scheduled to expire is the change that 

permitted a taxpayer to claim a Hope credit in the same year that he or she claimed an exclusion 

from a Coverdell education savings account. Thus, after 2010, a taxpayer cannot claim a Hope 

credit in the same year he or she claims an exclusion from a Coverdell education savings 

account. 
12 

Description of Proposal

The proposal modifies the Hope credit for taxable years beginning in 2009 or 2010. The 

modified credit is referred to as the American opportunity tax credit. The allowable modified 

credit is up to $2,500 per eligible student per year for qualified tuition and related expenses paid 

for each of the first four years of the student’s post-secondary education in a degree or certificate 

program. The modified credit rate is 100 percent on the first $2,000 of qualified tuition and 

related expenses, and 25 percent on the next $2,000 of qualified tuition and related expenses. 

For purposes of the modified credit, the definition of qualified tuition and related expenses is 

expanded to include course materials. 

Under the proposal, the modified credit is available with respect to an individual student 

for four years, provided that the student has not completed the first four years of post-secondary 

education before the beginning of the fourth taxable year. Thus, the modified credit, in addition 

to other modifications, extends the application of the Hope credit to two more years (up to four 

years) of post-secondary education. 

The modified credit that a taxpayer may otherwise claim is phased out ratably for 

taxpayers with modified adjusted gross income between $80,000 and $90,000 ($160,000 and 

$180,000 for married taxpayers filing a joint return). The modified credit may be claimed 

against a taxpayer’s alternative minimum tax liability. 

Forty percent of a taxpayer’s otherwise allowable modified credit is refundable. 

However, no portion of the modified credit is refundable if the taxpayer claiming the credit is a 

child to whom section 1(g) applies for such taxable year (generally, any child under age 18 or 

any child under age 24 who is a student providing less than one-half of his or her own support, 

who has at least one living parent and does not file a joint return). 

In addition, the proposal requires the Secretary of the Treasury to conduct two studies 

and submit a report to Congress on the results of those studies within one year after the date of 

enactment. The first study shall examine how to coordinate the Hope and Lifetime Learning 

credits with the Pell grant program. The second study shall examine requiring students to 

perform community service as a condition of taking their tuition and related expenses into 

account for purposes of the Hope and Lifetime Learning credits. 

Effective Date

The proposal is effective with respect to taxable years beginning after December 31, 

2008. 
13 

D. Housing Incentives 

1. Waiver of requirement to repay first-time homebuyer credit 

Present Law

A taxpayer who is a first-time homebuyer is allowed a refundable tax credit equal to the 

lesser of $7,500 ($3,750 for a married individual filing separately) or 10 percent of the purchase 

price of a principal residence. The credit is allowed for the tax year in which the taxpayer 

purchases the home unless the taxpayer makes an election as described below. The credit is 

allowed for qualifying home purchases on or after April 9, 2008 and before July 1, 2009 (without 

regard to whether there was a binding contract to purchase prior to April 9, 2008). 

The credit phases out for individual taxpayers with modified adjusted gross income 

between $75,000 and $95,000 ($150,000 and $170,000 for joint filers) for the year of purchase. 

A taxpayer is considered a first-time homebuyer if such individual had no ownership 

interest in a principal residence in the United States during the 3-year period prior to the 

purchase of the home to which the credit applies. 

No credit is allowed if the D.C. homebuyer credit is allowable for the taxable year the 

residence is purchased or a prior taxable year. A taxpayer is not permitted to claim the credit if 

the taxpayer’s financing is from tax-exempt mortgage revenue bonds, if the taxpayer is a 

nonresident alien, or if the taxpayer disposes of the residence (or it ceases to be a principal 

residence) before the close of a taxable year for which a credit otherwise would be allowable. 

The credit is recaptured ratably over fifteen years with no interest charge beginning in the 

second taxable year after the taxable year in which the home is purchased. For example, if the 

taxpayer purchases a home in 2008, the credit is allowed on the 2008 tax return, and repayments 

commence with the 2010 tax return. If the taxpayer sells the home (or the home ceases to be 

used as the principal residence of the taxpayer or the taxpayer’s spouse) prior to complete 

repayment of the credit, any remaining credit repayment amount is due on the tax return for the 

year in which the home is sold (or ceases to be used as the principal residence). However, the 

credit repayment amount may not exceed the amount of gain from the sale of the residence to an 

unrelated person. For this purpose, gain is determined by reducing the basis of the residence by 

the amount of the credit to the extent not previously recaptured. No amount is recaptured after 

the death of a taxpayer. In the case of an involuntary conversion of the home, recapture is not 

accelerated if a new principal residence is acquired within a two year period. In the case of a 

transfer of the residence to a spouse or to a former spouse incident to divorce, the transferee 

spouse (and not the transferor spouse) will be responsible for any future recapture. 

An election is provided to treat a home purchased in the eligible period in 2009 as if 

purchased on December 31, 2008 for purposes of claiming the credit on the 2008 tax return and 

for establishing the beginning of the recapture period. Taxpayers may amend their returns for 

this purpose. 
14 

Description of Proposal

The proposal waives the recapture of the credit for qualifying home purchases after 

December 31, 2008 and before July 1, 2009. This waiver of recapture applies without regard to 

whether the taxpayer elects to treat the purchase in 2009 as occurring on December 31, 2008. If 

the taxpayer disposes of the home or the home otherwise ceases to be the principal residence of 

the taxpayer within 36 months from the date of purchase, the present law rules for recapture of 

the credit will still apply. 

Effective Date

The proposal applies to residences purchased after December 31, 2008. 

2. Election to substitute grants to states for low-income housing projects in lieu of lowincome housing credit allocation for 2009 

Present Law

In general

The low-income housing credit may be claimed over a 10-year period by owners of 

certain residential rental property for the cost of rental housing occupied by tenants having 

incomes below specified levels.11 The amount of the credit for any taxable year in the credit 

period is the applicable percentage of the qualified basis of each qualified low-income building. 

The qualified basis of any qualified low-income building for any taxable year equals the 

applicable fraction of the eligible basis of the building. 

Volume limits

A low-income housing credit is allowable only if the owner of a qualified building 

receives a housing credit allocation from the State or local housing credit agency. Generally, the 

aggregate credit authority provided annually to each State for calendar year 2009 is $2.30 per 

resident, with a minimum annual cap of $2,665,000 for certain small population States.12 These 

amounts are indexed for inflation. Projects that also receive financing with proceeds of taxexempt bonds issued subject to the private activity bond volume limit do not require an 

allocation of the low-income housing credit. 

Description of Proposal

Low-income housing grant election amount

The Secretary of the Treasury shall make a grant to the State housing credit agency of 

each State in an amount equal to the low-income housing grant election amount. 

 11 Sec. 42. 

12 Rev. Proc. 2008-66. 
15 

The low-income housing grant election amount for a State is an amount elected by the 

State subject to certain limits. The maximum low-income housing grant election amount for a 

State may not exceed 85 percent of the product of ten and the sum of the State’s: (1) unused 

housing credit ceiling for 2008; (2) any returns to the State during 2009 of credit allocations 

previously made by the State; (3) 40 percent of the State’s 2009 credit allocation; and (4) 40 

percent of the State’s share of the national pool allocated in 2009, if any). 

Grants under this proposal are not taxable income to recipients. 

Subawards to low-income housing credit buildings

A State receiving a grant under this proposal is to use these monies to make subawards to 

finance the construction, or acquisition and rehabilitation of qualified low-income buildings as 

defined under the low-income housing credit. A subaward may be made to finance a qualified 

low-income building regardless of whether the building has an allocation of low-income housing 

credit. However, in the case of qualified low-income buildings without allocations of the lowincome housing credit, the State housing credit agency must make a determination that the 

subaward with respect to such building will increase the total funds available to the State to build 

and rehabilitate affordable housing. In conjunction with this determination the State housing 

credit agency must establish a process in which applicants for the subawards must demonstrate 

good faith efforts to obtain investment commitments before the agency makes such subawards. 

Any building receiving grant money from a subaward is required to satisfy the lowincome housing credit rules. The State housing credit agency shall perform asset management 

functions to ensure compliance with the low-income housing credit rules and the long-term 

viability of buildings financed with these subawards.13 Failure to satisfy the low-income housing 

credit rules will result in recapture enforced by means of liens or other methods that the 

Secretary of the Treasury (or delegate) deems appropriate. Any such recapture will be payable to 

the Secretary of the Treasury for deposit in the general fund of the Treasury. 

 Any grant funds not used to make subawards before January 1, 2011 and any grant 

monies from subawards returned on or after January 1, 2011 must be returned to the Secretary of 

the Treasury. 

Reduction in low-income housing credit volume limit for 2009

The otherwise applicable volume limit for any State for 2009 is reduced by the amount 

taken into account in determining the low-income housing grant election amount. 

 13 The State housing credit agency may collect reasonable fees from subaward recipients to cover 

the expenses of the agency’s asset management duties. Alternatively, the State housing credit agency 

may retain a thirdparty to perform these asset management duties. 
16 

Appropriations

The proposal appropriates to the Secretary of the Treasury such sums as may be 

necessary to carry out this proposal. 

Effective Date

The proposal is effective on the date of enactment. 
17 

E. Tax Incentives for Business 

1. Special allowance for certain property acquired during 2009 

Present Law

Present law permits an additional first-year depreciation deduction equal to 50 percent of 

the adjusted basis of qualified property.14 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.15 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 are no adjustments to the allowable amount of 

depreciation for purposes of computing a taxpayer’s alternative minimum taxable income with 

respect to property to which the proposal applies. The amount of the additional first-year 

depreciation deduction is not affected by a short taxable year. The taxpayer may elect out of 

additional first-year depreciation for any class of property for any taxable year. 

The interaction of the additional first-year depreciation allowance with the otherwise 

applicable depreciation allowance may be illustrated as follows. Assume that in 2008, a taxpayer 

purchases new depreciable property and places it in service.16 The property’s cost is $1,000, and 

it is 5-year property subject to the half-year convention. The amount of additional first-year 

depreciation allowed is $500. The remaining $500 of the cost of the property is deductible under 

the rules applicable to 5-year property. Thus, 20 percent, or $100, is also allowed as a 

depreciation deduction in 2008. The total depreciation deduction with respect to the property for 

2008 is $600. The remaining $400 cost of the property is recovered under otherwise applicable 

rules for computing depreciation. 

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 (1) property to which 

MACRS applies with an applicable recovery period of 20 years or less, (2) water utility property 

(as defined in section 168(e)(5)), (3) computer software other than computer software covered by 

section 197, or (4) qualified leasehold improvement property (as defined in section 168(k)(3)).17 

 14 Sec. 168(k). The additional first-year depreciation deduction is subject to the general rules 

regarding whether an item is deductible under section 162 or instead is subject to capitalization under 

section 263 or section 263A. 

15 However, the additional first-year depreciation deduction is not allowed for purposes of 

computing earnings and profits. 

16 Assume that the cost of the property is not eligible for expensing under section 179. 

17 A special rule precludes the additional first-year depreciation deduction for any property that is 

required to be depreciated under the alternative depreciation system of MACRS. 
18 

Second, the original use18 of the property must commence with the taxpayer after December 31, 

2007.19 Third, the taxpayer must purchase the property within the applicable time period. 

Finally, the property must be placed in service after December 31, 2007, and before January 1, 

2009. An extension of the placed in service date of one year (i.e., to January 1, 2010) is provided 

for certain property with a recovery period of ten years or longer and certain transportation 

property.20 Transportation property is defined as tangible personal property used in the trade or 

business of transporting persons or property. 

The applicable time period for acquired property is (1) after December 31, 2007, and 

before January 1, 2009, but only if no binding written contract for the acquisition is in effect 

before January 1, 2008, or (2) pursuant to a binding written contract which was entered into after 

December 31, 2007, and before January 1, 2009.21 With respect to property that is 

manufactured, constructed, or produced by the taxpayer for use by the taxpayer, the taxpayer 

must begin the manufacture, construction, or production of the property after December 31, 

2007, and before January 1, 2009. 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. For property eligible for the extended placed in service date, a special 

rule limits the amount of costs eligible for the additional first-year depreciation. With respect to 

such property, only the portion of the basis that is properly attributable to the costs incurred 

 18 The term “original use” means the first use to which the property is put, whether or not such 

use corresponds to the use of such property by the taxpayer. 

If in the normal course of its business a taxpayer sells fractional interests in property to unrelated 

third parties, then the original use of such property begins with the first user of each fractional interest 

(i.e., each fractional owner is considered the original user of its proportionate share of the property). 

19 A special rule applies in the case of certain leased property. In the case of any property that is 

originally placed in service by a person and that is sold to the taxpayer and leased back to such person by 

the taxpayer within three months after the date that the property was placed in service, the property would 

be treated as originally placed in service by the taxpayer not earlier than the date that the property is used 

under the leaseback. 

If property is originally placed in service by a lessor (including by operation of section 

168(k)(2)(D)(i)), such property is sold within three months after the date that the property was placed in 

service, and the user of such property does not change, then the property is treated as originally placed in 

service by the taxpayer not earlier than the date of such sale. 

20 In order for property to qualify for the extended placed in service date, the property is required 

to have an estimated production period exceeding one year and a cost exceeding $1 million. 

21 Property does not fail to qualify for the additional first-year depreciation merely because a 

binding written contract to acquire a component of the property is in effect prior to January 1, 2008. 
19 

before January 1, 2009 (“progress expenditures”) is eligible for the additional first-year 

depreciation.22 

Property does not qualify for the additional first-year depreciation deduction when the 

user of such property (or a related party) would not have been eligible for the additional firstyear depreciation deduction if the user (or a related party) were treated as the owner. For 

example, if a taxpayer sells to a related party property that was under construction prior to 

January 1, 2008, the property does not qualify for the additional first-year depreciation 

deduction. Similarly, if a taxpayer sells to a related party property that was subject to a binding 

written contract prior to January 1, 2008, the property does not qualify for the additional firstyear depreciation deduction. As a further example, if a taxpayer (the lessee) sells property in a 

sale-leaseback arrangement, and the property otherwise would not have qualified for the 

additional first-year depreciation deduction if it were owned by the taxpayer-lessee, then the 

lessor is not entitled to the additional first-year depreciation deduction. 

The limitation on the amount of depreciation deductions allowed with respect to certain 

passenger automobiles (sec. 280F) is increased in the first year by $8,000 for automobiles that 

qualify (and do not elect out of the increased first year deduction). The $8,000 increase is not 

indexed for inflation. 

Description of Proposal

The proposal extends the additional first-year depreciation deduction for one year, 

generally through 2009 (through 2010 for certain longer-lived and transportation property).23

Effective Date

The proposal is effective for property placed in service after December 31, 2008. 

2. Temporary increase in limitations on expensing of certain depreciable business assets 

Present Law

In lieu of depreciation, a taxpayer with a sufficiently small amount of annual investment 

may elect to deduct (or “expense”) such costs under section 179. Present law provides that the 

maximum amount a taxpayer may expense for taxable years beginning in 2008 is $250,000 of 

 22 For purposes of determining the amount of eligible progress expenditures, it is intended that 

rules similar to sec. 46(d)(3) as in effect prior to the Tax Reform Act of 1986 shall apply. 

23 The proposal does not modify the property eligible for the election to accelerate AMT and 

research credits in lieu of bonus depreciation under section 168(k)(4). However, the proposal includes a 

technical amendment to section 168(k)(4)(D) providing that no written binding contract for the 

acquisition of eligible qualified property may be in effect before April 1, 2008 (effective for taxable years 

ending after March 31, 2008). 
20 

the cost of qualifying property placed in service for the taxable year.24 For taxable years 

beginning in 2009 and 2010, the limitation is $125,000. In general, qualifying property is 

defined as depreciable tangible personal property that is purchased for use in the active conduct 

of a trade or business. Off-the-shelf computer software placed in service in taxable years 

beginning before 2011 is treated as qualifying property. For taxable years beginning in 2008, the 

$250,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying 

property placed in service during the taxable year exceeds $800,000. For taxable years 

beginning in 2009 and 2010, the $125,000 amount is reduced (but not below zero) by the amount 

by which the cost of qualifying property placed in service during the taxable year exceeds 

$500,000. The $125,000 and $500,000 amounts are indexed for inflation in taxable years 

beginning in 2009 and 2010. 

The amount eligible to be expensed for a taxable year may not exceed the taxable income 

for a taxable year that is derived from the active conduct of a trade or business (determined 

without regard to this proposal). Any amount that is not allowed as a deduction because of the 

taxable income limitation may be carried forward to succeeding taxable years (subject to similar 

limitations). No general business credit under section 38 is allowed with respect to any amount 

for which a deduction is allowed under section 179. An expensing election is made under rules 

prescribed by the Secretary.25

For taxable years beginning in 2011 and thereafter (or before 2003), the following rules 

apply. A taxpayer with a sufficiently small amount of annual investment may elect to deduct up 

to $25,000 of the cost of qualifying property placed in service for the taxable year. The $25,000 

amount is reduced (but not below zero) by the amount by which the cost of qualifying property 

placed in service during the taxable year exceeds $200,000. The $25,000 and $200,000 amounts 

are not indexed for inflation. In general, qualifying property is defined as depreciable tangible 

personal property that is purchased for use in the active conduct of a trade or business (not 

including off-the-shelf computer software). An expensing election may be revoked only with 

consent of the Commissioner.26

 24 Additional section 179 incentives are provided with respect to qualified property meeting 

applicable requirements that is used by a business in an empowerment zone (sec. 1397A) or a renewal 

community (sec. 1400J), qualified section 179 Gulf Opportunity Zone property (sec. 1400N(e)), qualified 

Recovery Assistance property placed in service in the Kansas disaster area (Pub. L. No. 110-234, sec. 

15345 (2008)), and qualified disaster assistance property (sec. 179(e)). 

25 Sec. 179(c)(1). Under Treas. Reg. sec. 1.179-5, applicable to property placed in service in 

taxable years beginning after 2002 and before 2008, a taxpayer is permitted to make or revoke an election 

under section 179 without the consent of the Commissioner on an amended Federal tax return for that 

taxable year. This amended return must be filed within the time prescribed by law for filing an amended 

return for the taxable year. T.D. 9209, July 12, 2005. 

26 Sec. 179(c)(2). 
21 

Description of Proposal

The proposal extends the $250,000 and $800,000 amounts to taxable years beginning in 

2009. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2008. 

3. Five-year carryback of operating losses 

Present Law

Under present law, a net operating loss (“NOL”) generally means the amount by which a 

taxpayer’s business deductions exceed its gross income. In general, an NOL may be carried 

back two years and carried over 20 years to offset taxable income in such years.27 NOLs offset 

taxable income in the order of the taxable years to which the NOL may be carried.28 

The alternative minimum tax rules provide that a taxpayer’s NOL deduction cannot 

reduce the taxpayer’s alternative minimum taxable income (“AMTI”) by more than 90 percent of 

the AMTI. 

Different rules apply with respect to NOLs arising in certain circumstances. A three-year 

carryback applies with respect to NOLs (1) arising from casualty or theft losses of individuals, or 

(2) attributable to Presidentially declared disasters for taxpayers engaged in a farming business 

or a small business. A five-year carryback applies to NOLs (1) arising from a farming loss 

(regardless of whether the loss was incurred in a Presidentially declared disaster area), (2) certain 

amounts related to Hurricane Katrina, Gulf Opportunity Zone, and Midwestern Disaster Area, or 

(3) qualified disaster losses.29 Special rules also apply to real estate investment trusts (no 

carryback), specified liability losses (10-year carryback), and excess interest losses (no carryback 

to any year preceding a corporate equity reduction transaction). Additionally, a special rule 

applies to certain electric utility companies. 

In the case of a life insurance company, present law allows a deduction for the operations 

loss carryovers and carrybacks to the taxable year, in lieu of the deduction for net operating 

losses allowed to other corporations.30 A life insurance company is permitted to treat a loss from 

operations (as defined under section 810(c)) for any taxable year as an operations loss carryback 

to each of the three taxable years preceding the loss year and an operations loss carryover to each 

 27 Sec. 172(b)(1)(A). 

28 Sec. 172(b)(2). 

29 Sec. 172(b)(1)(J). 

30 Secs. 810, 805(a)(5). 
22 

of the 15 taxable years following the loss year.31 Special rules apply to new life insurance 

companies. 

Description of Proposal

The proposal increases the general NOL carryback period from two years to five years in 

the case of an NOL for any taxable year ending during 2008 or 2009. The proposal also 

suspends the 90-percent limitation on the use of any alternative tax NOL deduction attributable 

to carrybacks from taxable years ending during 2008 or 2009, and carryovers to taxable years 

ending during 2008 and 2009. 

A taxpayer may elect to have the carryback period determined without regard to the 

special five year period or may use any whole number of years less than five in its place. For 

example, a taxpayer incurring a net operating loss in 2008 may elect to carry the loss back to 

2004 (i.e., four years). 

For life insurance companies, the proposal increases the carryback period for losses from 

operations from three years to any whole amount of years less than six in the case of losses from 

operations for any taxable year ending during 2008 or 2009. 

For a net operating loss for a taxable year ending during 2008, the proposal includes three 

transition rules: (1) any election to waive the carryback period under either sections 172(b)(3) or 

810(b)(3) with respect to such loss may be revoked before the applicable date; (2) any election to 

disregard the five year carryback period in favor of a shorter carryback period under section 

172(k) or to use a carryback period under section 810(b)(4) with respect to such loss is treated as 

timely made if made before the applicable date; and (3) any application for a tentative carryback 

adjustment under section 6411(a) with respect to such loss is treated as timely filed if filed before 

the applicable date. For purposes of the transition rules, the applicable date is the date which is 

60 days after the date of the enactment of the proposal. 

The proposal does not apply to: (1) any taxpayer if (a) the Federal Government acquires, 

at any time, an equity interest in the taxpayer pursuant to the Emergency Economic Stabilization 

Act of 2008, or (b) the Federal Government acquires, at any time, any warrant (or other right) to 

acquire any equity interest with respect to the taxpayer pursuant to such Act; (2) the Federal 

National Mortgage Association and the Federal Home Loan Mortgage Corporation; and (3) any 

taxpayer that in 2008 or 2009 is a member of the same affiliated group (as defined in section 

1504 without regard to subsection (b) thereof) as a taxpayer to which the proposal does not 

otherwise apply. 

Effective Date

The proposal is generally effective for net operating losses arising in taxable years ending 

after December 31, 2007. The modification to the alternative tax NOL deduction applies to 

taxable years ending after 1997. The modification with respect to operating loss deductions of 

 31 Sec. 810(b)(1). 
23 

life insurance companies applies to losses from operations arising in taxable years ending after 

December 31, 2007. 

4. Modification of work opportunity tax credit 

Present Law

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. 

(1) Families receiving TANF

An eligible recipient is an individual certified by a designated local employment agency 

(e.g., a State employment agency) as being a member of a family eligible to receive benefits 

under the Temporary Assistance for Needy Families Program (“TANF”) for a period of at least 

nine months part of which is during the 18-month period ending on the hiring date. For these 

purposes, members of the family are defined to include only those individuals taken into account 

for purposes of determining eligibility for the TANF. 

(2) Qualified veteran

There are two subcategories of qualified veterans related to eligibility for Food stamps 

and compensation for a service-connected disability. 

Food stamps 

A qualified veteran is a veteran who is certified by the designated local agency as a 

member of a family receiving assistance under a food stamp program under the Food Stamp Act 

of 1977 for a period of at least three months part of which is during the 12-month period ending 

on the hiring date. For these purposes, members of a family are defined to include only those 

individuals taken into account for purposes of determining eligibility for a food stamp program 

under the Food Stamp Act of 1977. 
24 

Entitled to compensation for a service-connected disability

A qualified veteran also includes an individual who is certified as entitled to 

compensation for a service-connected disability and: (1) having a hiring date which is not more 

than one year after having been discharged or released from active duty in the Armed Forces of 

the United States, or (2) having been unemployed for six months or more (whether or not 

consecutive) during the one-year period ending on the date of hiring. 

Definitions

 For these purposes, being entitled to compensation for a service-connected disability is 

defined with reference to section 101 of Title 38, U.S.Code, which means having a disability 

rating of 10-percent or higher for service connected injuries. 

For these purposes, a veteran is an individual who has served on active duty (other than 

for training) in the Armed Forces for more than 180 days or who has been discharged or released 

from active duty in the Armed Forces for a service-connected disability. However, any 

individual who has served for a period of more than 90 days during which the individual was on 

active duty (other than for training) is not a qualified veteran if any of this active duty occurred 

during the 60-day period ending on the date the individual was hired by the employer. This latter 

rule is intended to prevent employers who hire current members of the armed services (or those 

departed from service within the last 60 days) from receiving the credit. 

(3) Qualified ex-felon

A qualified ex-felon is an individual certified as: (1) having been convicted of a felony 

under any State or Federal law, and (2) having a hiring date within one year of release from 

prison or the date of conviction. 

(4) Designated community residents

A designated community resident is an individual certified as being at least age 18 but 

not yet age 40 on the hiring date and as having a principal place of abode within an 

empowerment zone, enterprise community, renewal community or a rural renewal community. 

For these purposes, a rural renewal county is a county outside a metropolitan statistical area (as 

defined by the Office of Management and Budget) which had a net population loss during the 

five-year periods 1990-1994 and 1995-1999. Qualified wages do not include wages paid or 

incurred for services performed after the individual moves outside an empowerment zone, 

enterprise community, renewal community or a rural renewal community. 

(5) Vocational rehabilitation referral

A vocational rehabilitation referral is an individual who is certified by a designated local 

agency as an individual who has a physical or mental disability that constitutes a substantial 

handicap to employment and who has been referred to the employer while receiving, or after 

completing: (a) vocational rehabilitation services under an individualized, written plan for 

employment under a State plan approved under the Rehabilitation Act of 1973; (b) under a 

rehabilitation plan for veterans carried out under Chapter 31 of Title 38, U.S. Code; or (c) an 
25 

individual work plan developed and implemented by an employment network pursuant to 

subsection (g) of section 1148 of the Social Security Act. Certification will be provided by the 

designated local employment agency upon assurances from the vocational rehabilitation agency 

that the employee has met the above conditions. 

(6) Qualified summer youth employee

A qualified summer youth employee is an individual: (a) who performs services during 

any 90-day period between May 1 and September 15, (b) who is certified by the designated local 

agency as being 16 or 17 years of age on the hiring date, (c) who has not been an employee of 

that employer before, and (d) who is certified by the designated local agency as having a 

principal place of abode within an empowerment zone, enterprise community, or renewal 

community (as defined under Subchapter U of Subtitle A, Chapter 1 of the Internal Revenue 

Code). As with designated community residents, no credit is available on wages paid or incurred 

for service performed after the qualified summer youth moves outside of an empowerment zone, 

enterprise community, or renewal community. If, after the end of the 90-day period, the 

employer continues to employ a youth who was certified during the 90-day period as a member 

of another targeted group, the limit on qualified first year wages will take into account wages 

paid to the youth while a qualified summer youth employee. 

(7) Qualified food stamp recipient

A qualified food stamp recipient is an individual at least age 18 but not yet age 40 

certified by a designated local employment agency as being a member of a family receiving 

assistance under a food stamp program under the Food Stamp Act of 1977 for a period of at least 

six months ending on the hiring date. In the case of families that cease to be eligible for food 

stamps under section 6(o) of the Food Stamp Act of 1977, the six-month requirement is replaced 

with a requirement that the family has been receiving food stamps for at least three of the five 

months ending on the date of hire. For these purposes, members of the family are defined to 

include only those individuals taken into account for purposes of determining eligibility for a 

food stamp program under the Food Stamp Act of 1977. 

(8) Qualified SSI recipient

A qualified SSI recipient is an individual designated by a local agency as receiving 

supplemental security income (“SSI”) benefits under Title XVI of the Social Security Act for any 

month ending within the 60-day period ending on the hiring date. 

(9) Long-term family assistance recipients

A qualified long-term family assistance recipient is an individual certified by a 

designated local agency as being: (a) a member of a family that has received family assistance 

for at least 18 consecutive months ending on the hiring date; (b) a member of a family that has 

received such family assistance for a total of at least 18 months (whether or not consecutive) 
26 

after August 5, 1997 (the date of enactment of the welfare-to-work tax credit)32 if the individual 

is hired within two years after the date that the 18-month total is reached; or (c) a member of a 

family who is no longer eligible for family assistance because of either Federal or State time 

limits, if the individual is hired within two years after the Federal or State time limits made the 

family ineligible for family assistance. 

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). With respect to qualified summer youth employees, the 

maximum credit is $1,200 (40 percent of the first $3,000 of qualified first-year wages). 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). 

In the case of a qualified veteran who is entitled to compensation for a service connected 

disability, the credit equals 40 percent of $12,000 of qualified first-year wages. This 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. 

 32 The welfare-to-work tax credit was consolidated into the work opportunity tax credit in the 

Tax Relief and Health Care Act of 2006, for qualified individuals who begin to work for an employer 

after December 31, 2006. 
27 

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 

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. 

Description of Proposal

The proposal creates a new targeted group for the work opportunity tax credit. That new 

category is unemployed veterans and disconnected youth who begin work for the employer in 

2009 or 2010. 

An unemployed veteran is defined as an individual certified by the designated local 

agency as someone who: (1) has served on active duty (other than for training) in the Armed 

Forces for more than 180 days or who has been discharged or released from active duty in the 

Armed Forces for a service-connected disability; (2) has been discharged or released from active 

duty in the Armed Forces during 2008, 2009, or 2010; and (3) has received unemployment 

compensation under State or Federal law for not less than four weeks during the one-year period 

ending on the hiring date. 
28 

A disconnected youth is defined as an individual certified by the designated local agency 

as someone: (1) at least age 16 but not yet age 25 on the hiring date; (2) not regularly attending 

any secondary, technical, or post-secondary school during the six-month period preceding the 

hiring date; (3) not regularly employed during the six-month period preceding the hiring date; 

and (4) not readily employable by reason of lacking a sufficient number of skills. 

Effective Date

The proposals are effective for individuals who begin work for an employer after 

December 31, 2008. 

5. Clarification of regulations related to limitations on certain built in losses following an 

ownership change 

Present Law

Section 382 limits the extent to which a “loss corporation” that experiences an 

“ownership change” may offset taxable income in any post-change taxable year by pre-change 

net operating losses, certain built-in losses, and deductions attributable to the pre-change 

period.33 In general, the amount of income in any post-change year that may be offset by such 

net operating losses, built-in losses and deductions is limited to an amount (referred to as the 

“section 382 limitation”) determined by multiplying the value of the loss corporation 

immediately before the ownership change by the long-term tax-exempt interest rate.34 

A “loss corporation” is defined as a corporation entitled to use a net operating loss 

carryover or having a net operating loss carryover for the taxable year in which the ownership 

change occurs. Except to the extent provided in regulations, such term includes any corporation 

with a “net unrealized built-in loss” (or NUBIL),35 defined as the amount by which the fair 

market value of the assets of the corporation immediately before an ownership change is less 

than the aggregate adjusted basis of such assets at such time. However, if the amount of the 

 33 Section 383 imposes similar limitations, under regulations, on the use of carryforwards of 

general business credits, alternative minimum tax credits, foreign tax credits, and net capital loss 

carryforwards. Section 383 generally refers to section 382 for the meanings of its terms, but requires 

appropriate adjustments to take account of its application to credits and net capital losses. 

34 If the loss corporation had a “net unrealized built in gain” (or NUBIG) at the time of the 

ownership change, then the section 382 limitation for any taxable year may be increased by the amount of 

the “recognized built-in gains” (discussed further below) for that year. A NUBIG is defined as the 

amount by which the fair market value of the assets of the corporation immediately before an ownership 

change exceeds the aggregate adjusted basis of such assets at such time. However, if the amount of the 

NUBIG does not exceed the lesser of (i) 15 percent of the fair market value of the corporation’s assets or 

(ii) $10,000,000, then the amount of the NUBIG is treated as zero. Sec. 382(h)(1). 

35 Sec. 382(k)(1). 
29 

NUBIL does not exceed the lesser of (i) 15 percent of the fair market value of the corporation’s 

assets or (ii) $10,000,000, then the amount of the NUBIL is treated as zero.36

An ownership change is defined generally as an increase by more than 50 percentage 

points in the percentage of stock of a loss corporation that is owned by any one or more fivepercent (or greater) shareholders (as defined) within a three year period.37 Treasury regulations 

provide generally that this measurement is to be made as of any “testing date,” which is any date 

on which the ownership of one or more persons who were or who become five-percent 

shareholders increases.38 

Section 382(h) governs the treatment of certain built-in losses and built-in gains 

recognized with respect to assets held by the loss corporation at the time of the ownership 

change. In the case of a loss corporation that has a NUBIL (measured immediately before an 

ownership change), section 382(h)(1) provides that any “recognized built-in loss” (or RBIL) for 

any taxable year during a “recognition period” (consisting of the five years beginning on the 

 36 Sec. 382(h)(3). 

37 Determinations of the percentage of stock of any corporation held by any person are made on 

the basis of value. Sec. 382(k)(6)(C). 

38 See Treas. Reg. sec. 1.382-2(a)(4) (providing that “a loss corporation is required to determine 

whether an ownership change has occurred immediately after any owner shift, or issuance or transfer 

(including an issuance or transfer described in Treas. Reg. sec. 1.382-4(d)(8)(i) or (ii)) of an option with 

respect to stock of the loss corporation that is treated as exercised under Treas. Reg. sec. 1.382-4(d)(2)” 

and defining a “testing date” as “each date on which a loss corporation is required to make a 

determination of whether an ownership change has occurred”) and Temp. Treas. Reg. sec. 1.382-2T(e)(1) 

(defining an “owner shift” as “any change in the ownership of the stock of a loss corporation that affects 

the percentage of such stock owned by any 5-percent shareholder”). Treasury regulations under section 

382 provide that, in computing stock ownership on specified testing dates, certain unexercised options 

must be treated as exercised if certain ownership, control, or income tests are met. These tests are met 

only if “a principal purpose of the issuance, transfer, or structuring of the option (alone or in combination 

with other arrangements) is to avoid or ameliorate the impact of an ownership change of the loss 

corporation.” Treas. Reg. sec. 1.382-4(d). Compare prior temporary regulations, Temp. Reg. sec. 1.382-

2T(h)(4) (“Solely for the purpose of determining whether there is an ownership change on any testing 

date, stock of the loss corporation that is subject to an option shall be treated as acquired on any such date, 

pursuant to an exercise of the option by its owner on that date, if such deemed exercise would result in an 

ownership change.”). Internal Revenue Service Notice 2008-76, I.R.B. 2008-39 (September 29, 2008), 

released September 7, 2008, provides that the Treasury Department intends to issue regulations modifying 

the term “testing date” under section 382 to exclude any date on or after which the United States acquires 

stock or options to acquire stock in certain corporations with respect to which there is a “Housing Act 

Acquisition” pursuant to the Housing and Economic Recovery Act of 2008 (P.L. 110-289). The Notice 

states that the regulations will apply on and after September 7, 2008, unless and until there is additional 

guidance. Internal Revenue Service Notice 2008-84, I.R.B. 2008-41 (October 14, 2008), provides that the 

Treasury Department intends to issue regulations modifying the term “testing date” under section 382 to 

exclude any date as of the close of which the United States owns, directly or indirectly, a more than 50 

percent interest in a loss corporation, which regulations will apply unless and until there is additional 

guidance. 
30 

ownership change date) is subject to the section 382 limitation in the same manner as if it were a 

pre-change net operating loss.39 An RBIL is defined for this purpose as any loss recognized 

during the recognition period on the disposition of any asset held by the loss corporation 

immediately before the ownership change date, to the extent that such loss is attributable to an 

excess of the adjusted basis of the asset on the change date over its fair market value on that 

date.40 An RBIL also includes any amount allowable as depreciation, amortization or depletion 

during the recognition period, to the extent that such amount is attributable to the excess of the 

adjusted basis of the asset over its fair market value on the ownership change date.41 In addition, 

any amount that is allowable as a deduction during the recognition period (determined without 

regard to any carryover) but which is attributable to periods before the ownership change date is 

treated as an RBIL for the taxable year in which it is allowable as a deduction.42 

As indicated above, section 382(h)(1) provides in the case of a loss corporation that has a 

NUBIG that the section 382 limitation may be increased for any taxable year during the 

recognition period by the amount of recognized built-in gains (or RBIGs) for such taxable year.43 

An RBIG is defined for this purpose as any gain recognized during the recognition period on the 

disposition of any asset held by the loss corporation immediately before the ownership change 

date, to the extent that such gain is attributable to an excess of the fair market value of the asset 

on the change date over its adjusted basis on that date.44 In addition, any item of income that is 

properly taken into account during the recognition period but which is attributable to periods 

before the ownership change date is treated as an RBIG for the taxable year in which it is 

properly taken into account.45 

Internal Revenue Service Notice 2003-6546 provides two alternative safe harbor 

approaches for the identification of built-in items for purposes of section 382(h): the “1374 

approach” and the “338 approach.” 

Under the 1374 approach,47 NUBIG or NUBIL is the net amount of gain or loss that 

would be recognized in a hypothetical sale of the assets of the loss corporation immediately 

 39 Sec. 382(h)(2). The total amount of the loss corporation’s RBILs that are subject to the section 

382 limitation cannot exceed the amount of the corporation’s NUBIL. 

40 Sec. 382(h)(2)(B). 

41 Sec. 382(h)(2)(B). 

42 Sec. 382(h)(6)(B). 

43 The total amount of such increases cannot exceed the amount of the corporation’s NUBIG. 

44 Sec. 382(h)(2)(A). 

45 Sec. 382(h)(6)(A). 

46 2003-2 C.B. 747. 
31 

before the ownership change.48 The amount of gain or loss recognized during the recognition 

period on the sale or exchange of an asset held at the time of the ownership change is RBIG or 

RBIL, respectively, to the extent it is attributable to a difference between the adjusted basis and 

the fair market value of the asset on the change date, as described above. However, the 1374 

approach generally relies on the accrual method of accounting to identify items of income or 

deduction as RBIG or RBIL, respectively. Generally, items of income or deduction properly 

included in income or allowed as a deduction during the recognition period are considered 

attributable to period before the change date (and thus are treated as RBIG or RBIL, 

respectively), if a taxpayer using an accrual method of accounting would have included the item 

in income or been allowed a deduction for the item before the change date. However, the 1374 

approach includes a number of exceptions to this general rule, including a special rule dealing 

with bad debt deductions under section 166. Under this special rule, any deduction item properly 

taken into account during the first 12 months of the recognition period as a bad debt deduction 

under section 166 is treated as RBIL if the item arises from a debt owed to the loss corporation at 

the beginning of the recognition period (and deductions for such items properly taken into 

account after the first 12 months of the recognition period are not RBILs).49 

The 338 approach identifies items of RBIG and RBIL generally by comparing the loss 

corporation’s actual items of income, gain, deduction and loss with those that would have 

resulted if a section 338 election had been made with respect to a hypothetical purchase of all of 

the outstanding stock of the loss corporation on the change date. Under the 338 approach, 

NUBIG or NUBIL is calculated in the same manner as it is under the 1374 approach.50 The 338 

approach identifies RBIG or RBIL by comparing the loss corporation’s actual items of income, 

gain, deduction and loss with the items of income, gain, deduction and loss that would result if a 

section 338 election had been made for the hypothetical purchase. The loss corporation is treated 

for this purpose as using those accounting methods that the loss corporation actually uses. The 

338 approach does not include any special rule with regard to bad debt deductions under section 

166. 

 47 The 1374 approach generally incorporates rules similar to those of section 1374(d) and the 

Treasury regulations thereunder in calculating NUBIG and NUBIL and identifying RBIG and RBIL. 

48 More specifically, NUBIG or NUBIL is calculated by determining the amount that would be 

realized if immediately before the ownership change the loss corporation had sold all of its assets, 

including goodwill, at fair market value to a third party that assumed all of its liabilities, decreased by the 

sum of any deductible liabilities of the loss corporation that would be included in the amount realized on 

the hypothetical sale and the loss corporation’s aggregate adjusted basis in all of its assets, increased or 

decreased by the corporation’s section 481 adjustments that would be taken into account on a hypothetical 

sale, and increased by any RBIL that would not be allowed as a deduction under section 382, 383 or 384 

on the hypothetical sale. 

49 Notice 2003-65, section III.B.2.b. 

50 Accordingly, unlike the case in which a section 338 election is actually made, contingent 

consideration (including a contingent liability) is taken into account in the initial calculation of NUBIG or 

NUBIL, and no further adjustments are made to reflect subsequent changes in deemed consideration. 
32 

Section 166 generally allows a deduction in respect of any debt that becomes worthless, 

in whole or in part, during the taxable year.51 The determination of whether a debt is worthless, 

in whole or in part, is a question of fact. However, in the case of a bank or other corporation that 

is subject to supervision by Federal authorities, or by State authorities maintaining substantially 

equivalent standards, the Treasury regulations under section 166 provide a presumption of 

worthlessness to the extent that a debt is charged off during the taxable year pursuant to a 

specific order of such an authority or in accordance with established policies of such an authority 

(and in the latter case, the authority confirms in writing upon the first subsequent audit of the 

bank or other corporation that the charge-off would have been required if the audit had been 

made at the time of the charge-off). The presumption does not apply if the taxpayer does not 

claim the amount so charged off as a deduction for the taxable year in which the charge-off takes 

place. In that case, the charge-off is treated as having been involuntary; however, in order to 

claim the section 166 deduction in a later taxable year, the taxpayer must produce sufficient 

evidence to show that the debt became partially worthless in the later year or became recoverable 

only in part subsequent to the taxable year of the charge-off, as the case may be, and to the extent 

that the deduction claimed in the later year for a partially worthless debt was not involuntarily 

charged off in prior taxable years, it was charged off in the later taxable year.52 

The Treasury regulations also permit a bank (generally as defined for purposes of section 

581, with certain modifications) that is subject to supervision by Federal authorities, or State 

authorities maintaining substantially equivalent standards, to make a “conformity election” under 

which debts charged off for regulatory purposes during a taxable year are conclusively presumed 

to be worthless for tax purposes to the same extent, provided that the charge-off results from a 

specific order of the regulatory authority or corresponds to the institution’s classification of the 

debt as a “loss asset” pursuant to loan loss classification standards that are consistent with those 

of certain specified bank regulatory authorities. The conformity election is treated as the 

adoption of a method of accounting.53

Internal Revenue Service Notice 2008-83,54 released on October 1, 2008, provides that 

“[f]or purposes of section 382(h), any deduction properly allowed after an ownership change (as 

defined in section 382(g)) to a bank with respect to losses on loans or bad debts (including any 

deduction for a reasonable addition to a reserve for bad debts) shall not be treated as a built-in 

loss or a deduction that is attributable to periods before the change date.”55 The Notice further 

 51 Section 166 does not apply, however, to a debt which is evidenced by a security, defined for 

this purpose (by cross-reference to section 165(g)(2)(C)) as a bond, debenture, note or certificate or other 

evidence of indebtedness issued by a corporation or by a government or political subdivision thereof, with 

interest coupons or in registered form. Sec. 166(e). 

52 See Treas. Reg. sec. 1.166-2(d)(1) and (2). 

53 See Treas. Reg. sec. 1.166-2(d)(3); cf. Priv. Let. Rul. 9248048 (July 7, 1992); Tech. Ad. Mem. 

9122001 (Feb. 8, 1991). 

54 2008-42 I.R.B. 2008-42 (Oct. 20, 2008). 

55 Notice 2008-83, section 2. 
33 

states that the Internal Revenue Service and the Treasury Department are studying the proper 

treatment under section 382(h) of certain items of deduction or loss allowed after an ownership 

change to a corporation that is a bank (as defined in section 581) both immediately before and 

after the change date, and that any such corporation may rely on the treatment set forth in Notice 

2008-83 unless and until there is additional guidance. 

Description of Proposal

The proposal states that Congress finds as follows: (1) The delegation of authority to the 

Secretary of the Treasury, or his delegate, under section 382(m)56 does not authorize the 

Secretary to provide exemptions or special rules that are restricted to particular industries or 

classes of taxpayers, (2) Internal Revenue Service Notice 2008-83 is inconsistent with the 

congressional intent in enacting such section 382(m), (3) the legal authority to prescribe Notice 

2008-83 is doubtful, (4) however, as taxpayers should generally be able to rely on guidance 

issued by the Secretary of the Treasury, legislation is necessary to clarify the force and effect of 

Notice 2008-83 and restore the proper application under the Internal Revenue Code of the 

limitation on built-in losses following an ownership change of a bank. 

Under the proposal, Treasury Notice 2008-83 shall be deemed to have the force and 

effect of law with respect to any ownership change (as defined in section 382(g)) occurring on or 

before January 16, 2009, and with respect to any ownership change (as so defined) which occurs 

after January 16, 2009, if such change (1) is pursuant to a written binding contract entered in to 

on or before such date or (2) was described on or before such date in a public announcement or 

in a filing with the Securities and Exchange Commission required by reason of such ownership 

change, but shall otherwise have no force or effect with respect to any ownership change after 

such date. 

 56 Section 382(m) authorizes the Secretary to prescribe such regulations as may be necessary or 

appropriate to carry out the purposes of sections 382 and 383. 
34 

F. Fiscal Relief for State and Local Governments 

1. De minimis safe harbor exception for tax-exempt interest expense of financial 

institutions and modification of small issuer exception to tax-exempt interest expense 

allocation rules for financial institutions 

Present Law

Present law disallows a deduction for interest on indebtedness incurred or continued to 

purchase or carry obligations the interest on which is exempt from tax.57 In general, an interest 

deduction is disallowed only if the taxpayer has a purpose of using borrowed funds to purchase 

or carry tax-exempt obligations; a determination of the taxpayer’s purpose in acquiring taxexempt obligations is made based on all of the facts and circumstances.58

Two-percent rule for individuals and certain nonfinancial corporations

In the absence of direct evidence linking an individual taxpayer’s indebtedness with the 

purchase or carrying of tax-exempt obligations, the Internal Revenue Service takes the position 

that it ordinarily will not infer that a taxpayer’s purpose in borrowing money was to purchase or 

carry tax-exempt obligations if the taxpayer’s investment in tax-exempt obligations is 

“insubstantial.”59 An individual’s holdings of tax-exempt obligations are presumed to be 

insubstantial if during the taxable year the average adjusted basis of the individual’s tax-exempt 

obligations is two percent or less of the average adjusted basis of the individual’s portfolio 

investments and assets held by the individual in the active conduct of a trade or business. 

Similarly, in the case of a corporation that is not a financial institution or a dealer in taxexempt obligations, where there is no direct evidence of a purpose to purchase or carry taxexempt obligations, the corporation’s holdings of tax-exempt obligations are presumed to be 

insubstantial if the average adjusted basis of the corporation’s tax-exempt obligations is two 

percent or less of the average adjusted basis of all assets held by the corporation in the active 

conduct of its trade or business. 

Financial institutions

In the case of a financial institution, the Code generally disallows that portion of the 

taxpayer’s interest expense that is allocable to tax-exempt interest.60 The amount of interest that 

is disallowed is an amount which bears the same ratio to such interest expense as the taxpayer’s 

 57 Sec. 265(a). 

58 See Rev. Proc. 72-18, 1972-1 C.B. 740. 

59 Id. 

60 Sec. 265(b)(1). A “financial institution” is any person that (1) accepts deposits from the public 

in the ordinary course of such person’s trade or business and is subject to Federal or State supervision as a 

financial institution or (2) is a corporation described in section 585(a)(2). Sec. 265(b)(5). 
35 

average adjusted bases of tax-exempt obligations acquired after August 7, 1986, bears to the 

average adjusted bases for all assets of the taxpayer. 

Exception for certain obligations of qualified small issuers

The general rule in section 265(b), denying financial institutions’ interest expense 

deductions allocable to tax-exempt obligations, does not apply to “qualified tax-exempt 

obligations.”61 Instead, as discussed in the next section, only 20 percent of the interest expense 

allocable to “qualified tax-exempt obligations” is disallowed.62 A “qualified tax-exempt 

obligation” is a tax-exempt obligation that (1) is issued after August 7, 1986, by a qualified small 

issuer, (2) is not a private activity bond, and (3) is designated by the issuer as qualifying for the 

exception from the general rule of section 265(b). 

A “qualified small issuer” is an issuer that reasonably anticipates that the amount of taxexempt obligations that it will issue during the calendar year will be $10 million or less.63 The 

Code specifies the circumstances under which an issuer and all subordinate entities are 

aggregated.64 For purposes of the $10 million limitation, an issuer and all entities that issue 

obligations on behalf of such issuer are treated as one issuer. All obligations issued by a 

subordinate entity are treated as being issued by the entity to which it is subordinate. An entity 

formed (or availed of) to avoid the $10 million limitation and all entities benefiting from the 

device are treated as one issuer. 

Composite issues (i.e., combined issues of bonds for different entities) qualify for the 

“qualified tax-exempt obligation” exception only if the requirements of the exception are met 

with respect to (1) the composite issue as a whole (determined by treating the composite issue as 

a single issue) and (2) each separate lot of obligations that is part of the issue (determined by 

treating each separate lot of obligations as a separate issue).65 Thus a composite issue may 

qualify for the exception only if the composite issue itself does not exceed $10 million, and if 

each issuer benefitting from the composite issue reasonably anticipates that it will not issue more 

than $10 million of tax-exempt obligations during the calendar year, including through the 

composite arrangement. 

Treatment of financial institution preference items

Section 291(a)(3) reduces by 20 percent the amount allowable as a deduction with respect 

to any financial institution preference item. Financial institution preference items include 

interest on debt to carry tax-exempt obligations acquired after December 31, 1982, and before 

 61 Sec. 265(b)(3). 

62 Secs. 265(b)(3)(A), 291(a)(3) and 291(e)(1). 

63 Sec. 265(b)(3)(C). 

64 Sec. 265(b)(3)(E). 

65 Sec. 265(b)(3)(F). 
36 

August 8, 1986.66 Section 265(b)(3) treats qualified tax-exempt obligations as if they were 

acquired on August 7, 1986. As a result, the amount allowable as a deduction by a financial 

institution with respect to interest incurred to carry a qualified tax-exempt obligation is reduced 

by 20 percent. 

Description of Proposals

Two-percent safe harbor for financial institutions

The proposal provides that tax-exempt obligations issued during 2009 or 2010 and held 

by a financial institution, in an amount not to exceed two percent of the adjusted basis of the 

financial institution’s assets, are not taken into account for the purpose of determining the 

portion of the financial institution’s interest expense subject to the pro rata interest disallowance 

rule of section 265(b). For purposes of this rule, a refunding bond (whether a current or advance 

refunding) is treated as issued on the date of the issuance of the refunded bond (or in the case of 

a series of refundings, the original bond). 

The proposal also amends section 291(e) to provide that tax-exempt obligations issued 

during 2009 and 2010, and not taken into account for purposes of the calculation of a financial 

institution’s interest expense subject to the pro rata interest disallowance rule, are treated as 

having been acquired on August 7, 1986. As a result, such obligations are financial institution 

preference items, and the amount allowable as a deduction by a financial institution with respect 

to interest incurred to carry such obligations is reduced by 20 percent. 

Modifications to qualified small issuer exception

With respect to tax-exempt obligations issued during 2009 and 2010, the proposal 

increases from $10 million to $30 million the annual limit for qualified small issuers. 

In addition, in the case of a “pooled financing issue” issued in 2009 or 2010, the proposal 

applies the $30 million annual volume limitation at the borrower level (rather than at the level of 

the pooled financing issuer). Thus, for the purpose of applying the requirements of the section 

265(b)(3) qualified small issuer exception, the portion of the proceeds of a pooled financing 

issue that are loaned to a “qualified borrower” that participates in the issue are treated as a 

separate issue with respect to which the qualified borrower is deemed to be the issuer. 

A “pooled financing issue” is any issue the proceeds of which are used directly or 

indirectly to make or finance loans to two or more ultimate borrowers all of whom are qualified 

borrowers. A “qualified borrower” means (1) a State or political subdivision of a State or (2) an 

organization described in section 501(c)(3) and exempt from tax under section 501(a). Thus, for 

example, a $100 million pooled financing issue that was issued in 2009 could qualify for the 

section 265(b)(3) exception if the proceeds of such issue were used to make four equal loans of 

$25 million to four qualified borrowers. However, if (1) more than $30 million were loaned to 

any qualified borrower, (2) any borrower were not a qualified borrower, or (3) any borrower 

 66 Sec. 291(e)(1). 
37 

would, if it were the issuer of a separate issue in an amount equal to the amount loaned to such 

borrower, fail to meet any of the other requirements of section 265(b)(3), the entire $100 million 

pooled financing issue would fail to qualify for the exception. 

Effective Date

The proposals are effective for obligations issued after December 31, 2008. 

2. Temporary modification of alternative minimum tax limitations on tax-exempt bonds 

Present Law

Present law imposes an alternative minimum tax (“AMT”) on individuals and 

corporations. AMT is the amount by which the tentative minimum tax exceeds the regular 

income tax. The tentative minimum tax is computed based upon a taxpayer’s alternative 

minimum taxable income (“AMTI”). AMTI is the taxpayer’s taxable income modified to take 

into account certain preferences and adjustments. One of the preference items is tax-exempt 

interest on certain tax-exempt bonds issued for private activities (sec. 57(a)(5)). Also, in the case 

of a corporation, an adjustment based on current earnings is determined, in part, by taking into 

account 75 percent of items, including tax-exempt interest, that are excluded from taxable 

income but included in the corporation’s earnings and profits (sec. 56(g)(4)(B)). 

Description of Proposal

The proposal provides that tax-exempt interest on private activity bonds issued in 2009 

and 2010 is not an item of tax preference for purposes of the alternative minimum tax and 

interest on tax exempt bonds issued in 2009 and 2010 is not included in the corporate adjustment 

based on current earnings. For these purposes, a refunding bond is treated as issued on the date 

of the issuance of the refunded bond (or in the case of a series of refundings, the original bond). 

 Effective Date

The proposal applies to interest on bonds issued after December 31, 2008. 

3. Qualified school construction 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. 

These can include tax-exempt bonds which finance public schools.67 An issuer must file with the 

 67 Sec. 103. 
38 

Internal Revenue Service certain information about the bonds issued in order for that bond issue 

to be tax-exempt.68 Generally, this information return is required to be filed no later than 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.69 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.70 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. 

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.”71 A total of $400 million of 

qualified zone academy bonds is authorized to be issued annually in calendar years 1998 through 

2009. 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. Eligible financial institutions are limited to: (a) a bank (within the meaning of section 581 

of the Code); (b) an insurance company to which subchapter L of the Code applies; and (c) a 

corporation actively engaged in the business of lending money. A taxpayer holding a qualified 

zone academy bond on the credit allowance date is entitled to a credit. The credit is includible 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.72 The 

 68 Sec. 149(e). 

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

70 Sec. 148. 

71 Sec. 1397E. 

72 Given the differences in credit quality and other characteristics of individual issuers, the 

Secretary cannot set credit rates in a manner that will allow each issuer to issue tax credit bonds at par. 
39 

Secretary determines credit rates for tax credit bonds based on general assumptions about credit 

quality of the class of potential eligible issuers and such other factors as the Secretary deems 

appropriate. The Secretary may determine credit rates based on general credit market yield 

indexes and credit ratings. The maximum term of the bond is determined by the Treasury 

Department, so that the present value of the obligation to repay the principal on the bond is 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 arbitrage requirements which generally apply to interest-bearing tax-exempt bonds 

also generally apply to qualified zone academy bonds. In addition, an issuer of qualified zone 

academy bonds must reasonably expect to and actually spend 100 percent of the proceeds of 

such bonds on qualified zone academy property within the three years period that begins on the 

date of issuance. To the extent less than 100 percent of the proceeds are used to finance 

qualified zone academy property during the three years 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 three years period to redeem any nonqualified bonds. The three years 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. 

Two special arbitrage rules apply to qualified zone academy bonds. First, available 

project proceeds invested during the three-year period beginning on the date of issue are not 

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

project proceeds are 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 three-year spending period may be invested at 

unrestricted yields, but the earnings on such investments must be spent on qualified zone 

academy property. Second, 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 
40 

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. 

Issuers of qualified zone academy bonds are required to report issuance to the Internal 

Revenue Service in a manner similar to the information returns required for tax-exempt bonds. 

Description of Proposal

In general

The proposal creates a new category of tax-credit bonds: qualified school construction 

bonds. Qualified school construction bonds must meet three requirements: (1) 100 percent of the 

available project proceeds of the bond issue is used for the construction, rehabilitation, or repair 

of a public school facility or for the acquisition of land on which such a bond-financed facility is 

to be constructed; (2) the bond is issued by a State or local government within which such school 

is located; and (3) the issuer designates such bonds as a qualified school construction bond. 

National limitation

There is a national limitation on qualified school construction bonds of $10 billion for 

calendar years 2009 and 2010, respectively. Allocations of the national limitation of qualified 

school construction bonds are divided between the States and certain large school districts. The 

States receive 60 percent of the national limitation for a calendar year and the remaining 40 

percent of the national limitation for a calendar year is allocated to certain of the largest school 

districts. 

Allocation to the States

Generally allocations are made to the States under the 60 percent allocation according to 

their respective populations of children aged five through seventeen. However, the Secretary of 

the Treasury shall adjust the annual allocations among the States to ensure that for each State the 

sum of its allocations under the 60 percent allocation plus any allocations to large educational 

agencies within the States is not less than a minimum percentage. A State’s minimum 

percentage for a calendar year is a product of 1.68 and the minimum percentage described in 

section 1124(d) of the Elementary and Secondary Education Act of 1965 for such State for the 

most recent fiscal year ending before such calendar year. 

For allocation purposes, a State includes the District of Columbia and any possession of 

the United States. The proposal provides a special allocation for possessions of the United States 

other than Puerto Rico under the 60 percent share of the national limitation for States. Under this 

special rule an allocation to a possession other than Puerto Rico is made on the basis of the 

respective populations of individuals below the poverty line (as defined by the Office of 

Management and Budget) rather than respective populations of children aged five through 

seventeen. This special allocation reduces the State allocation share of the national limitation 

otherwise available for allocation among the States. Under another special rule the Secretary of 

the Interior may allocate $200 million of school construction bonds for 2009 and 2010, 

respectively, to Indian schools. This special allocation for Indian schools is to be used for 

purposes of the construction, rehabilitation, and repair of schools funded by the Bureau of Indian 
41 

Affairs. For purposes of such allocations Indian tribal governments are qualified issuers. The 

special allocation for Indian schools does not reduce the State allocation share of the national 

limitation otherwise available for allocation among the States. 

If an amount allocated under this allocation to the States is unused for a calendar year it 

may be carried forward by the State to the next calendar year. 

Allocation to large school districts

The remaining 40 percent of the national limitation for a calendar year is allocated by the 

Secretary of the Treasury among local educational agencies which are large local educational 

agencies for such year. This allocation is made in proportion to the respective amounts each 

agency received for Basic Grants under subpart 2 of Part A of Title I of the Elementary and 

Secondary Education Act of 1965 for the most recent fiscal year ending before such calendar 

year. Any unused allocation of any agency within a State may be allocated by the agency to 

such State. With respect to a calendar year, the term large local educational agency means any 

local educational agency if such agency is: (1) among the 100 local educational agencies with the 

largest numbers of children aged 5 through 17 from families living below the poverty level, or 

(2) one of not more than 25 local educational agencies (other than in 1, immediately above) that 

the Secretary of Education determines are in particular need of assistance, based on a low level 

of resources for school construction, a high level of enrollment growth, or other such factors as 

the Secretary of Education deems appropriate. If any amount allocated to large local educational 

agency is unused for a calendar year the agency may reallocate such amount to the State in 

which the agency is located. 

The proposal makes qualified school construction bonds a type of qualified tax credit 

bond for purposes of section 54A. In addition, qualified school construction bonds may be 

issued by Indian tribal governments only 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 school 

construction bonds to be used within the three-year period that begins on the date of issuance. 

Available project proceeds are 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 purposes during the 

three-year spending period, bonds will continue to qualify as qualified school construction 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 school construction 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 
42 

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 school construction bonds are issued. 

The maturity of qualified school construction 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 school construction bonds are issued. 

As with present-law tax credit bonds, the taxpayer holding qualified school construction 

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 50 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 in a manner similar to the manner in which interest 

coupons can be stripped from interest-bearing bonds. 

Issuers of qualified school construction bonds are required to certify that the financial 

disclosure requirements and applicable State and local law requirements governing conflicts of 

interest are satisfied with respect to such issue, as well as any other additional conflict of interest 

rules prescribed by the Secretary with respect to any Federal, State, or local government official 

directly involved with the issuance of qualified school construction bonds. 

Effective Date

The proposal is effective for bonds issued after December 31, 2008. 

4. Extend and expand 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. 

These can include tax-exempt bonds which finance public schools.73 An issuer must file with the 

Internal Revenue Service certain information about the bonds issued in order for that bond issue 

 73 Sec. 103. 
43 

to be tax-exempt.74 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.75 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.76 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. 

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.”77 A total of $400 million of 

qualified zone academy bonds is authorized to be issued annually in calendar years 1998 through 

2009. 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. Eligible financial institutions are limited to: (a) a bank (within the meaning of section 581 

of the Code); (b) an insurance company to which subchapter L of the Code applies; and (c) a 

corporation actively engaged in the business of lending money. A taxpayer holding a qualified 

zone academy bond on the credit allowance date is entitled to a credit. The credit is includible 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.78 The 

Secretary determines credit rates for tax credit bonds based on general assumptions about credit 

quality of the class of potential eligible issuers and such other factors as the Secretary deems 

 74 Sec. 149(e). 

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

76 Sec. 148. 

77 Sec. 1397E. 

78 Given the differences in credit quality and other characteristics of individual issuers, the 

Secretary cannot set credit rates in a manner that will allow each issuer to issue tax credit bonds at par. 
44 

appropriate. The Secretary may determine credit rates based on general credit market yield 

indexes and credit ratings. The maximum term of the bond is determined by the Treasury 

Department, so that the present value of the obligation to repay the principal on the bond is 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 arbitrage requirements which generally apply to interest-bearing tax-exempt bonds 

also generally apply to qualified zone academy bonds. In addition, an issuer of qualified zone 

academy bonds must reasonably expect to and actually spend 100 percent or more of the 

proceeds of such bonds on qualified zone academy property within the three-year period that 

begins on the date of issuance. To the extent less than 100 percent of the proceeds are used to 

finance qualified zone academy property during the three-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 three-year period to redeem any nonqualified bonds. The three-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. 

Two special arbitrage rules apply to qualified zone academy bonds. First, available 

project proceeds invested during the three-year period beginning on the date of issue are not 

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

project proceeds are 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 three-year spending period may be invested at 

unrestricted yields, but the earnings on such investments must be spent on qualified zone 

academy property. Second, 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. 
45 

Issuers of qualified zone academy bonds are required to report issuance to the Internal 

Revenue Service in a manner similar to the information returns required for tax-exempt bonds. 

Description of Proposal

The proposal extends and expands the present-law qualified zone academy bond 

program. The proposal authorizes issuance of up to $1.4 billion of qualified zone academy 

bonds annually for 2009 and 2010, respectively. 

Effective Date

The proposal applies to bonds issued after December 31, 2008. 

5. Taxable bond option for governmental bonds 

Present Law

In general

Under present law, gross income 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 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 (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”) and other Code requirements are 

met. 

Private activity bonds

The Code defines a private activity bond as any bond that satisfies (1) the private 

business use test and the private security or payment test (“the private business test”); or (2) “the 

private loan financing test.”79

Private business test

Under the private business test, a bond is a private activity bond if it is part of an issue in 

which: 

1. More than 10 percent of the proceeds of the issue (including use of the bond-financed 

property) are to be used in the trade or business of any person other than a 

governmental unit (“private business use”); and 

 79 Sec. 141. 
46 

2. More than 10 percent of the payment of principal or interest on the issue is, directly or 

indirectly, secured by (a) property used or to be used for a private business use or (b) 

to be derived from payments in respect of property, or borrowed money, used or to be 

used for a private business use (“private payment test”).80

A bond is not a private activity bond unless both parts of the private business test (i.e., the 

private business use test and the private payment test) are met. Thus, a facility that is 100 

percent privately used does not cause the bonds financing such facility to be private activity 

bonds if the bonds are not secured by or paid with private payments. For example, land 

improvements that benefit a privately-owned factory may be financed with governmental bonds 

if the debt service on such bonds is not paid by the factory owner or other private parties. 

Private loan financing test

A bond issue satisfies the private loan financing test if proceeds exceeding the lesser of 

$5 million or five percent of such proceeds are used directly or indirectly to finance loans to one 

or more nongovernmental 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. 

Arbitrage restrictions

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

arbitrage bond.81 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.82 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. 

Qualified tax credit bonds

In lieu of interest, holders of qualified tax credit bonds receive a tax credit that accrues 

quarterly. The following bonds are qualified tax credit bonds: qualified forestry conservation 

 80 The 10 percent private business test is reduced to five percent in the case of private business 

uses (and payments with respect to such uses) that are unrelated to any governmental use being financed 

by the issue. 

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

82 Sec. 148. 
47 

bonds, new clean renewable energy bonds, qualified energy conservation bonds, and qualified 

zone academy bonds.83 

Section 54A of the Code sets forth general rules applicable to qualified tax credit bonds. 

These rules include requirements regarding credit allowance dates, the expenditure of available 

project proceeds, reporting, arbitrage, maturity limitations, and financial conflicts of interest, 

among other special rules. 

A taxpayer who holds a qualified tax credit bond on one or more credit allowance dates 

of the bond during the taxable year shall be allowed a credit against the taxpayer’s income tax 

for the taxable year. In general, the credit amount for any credit allowance date is 25 percent of 

the annual credit determined with respect to the bond. The annual credit is determined by 

multiplying the applicable credit rate by the outstanding face amount of the bond. The applicable 

credit rate for the bond is the rate that the Secretary estimates will permit the issuance of the 

qualified tax credit bond with a specified maturity or redemption date without discount and 

without interest cost to the qualified issuer.84 The Secretary determines credit rates for tax credit 

bonds based on general assumptions about credit quality of the class of potential eligible issuers 

and such other factors as the Secretary deems appropriate. The Secretary may determine credit 

rates based on general credit market yield indexes and credit ratings. 

The credit is included in gross income and, under regulations prescribed by the Secretary, 

may be stripped (a separation (including at issuance) of the ownership of a qualified tax credit 

bond and the entitlement to the credit with respect to such bond). 

Section 54A of the Code requires that 100 percent of the available project proceeds of 

qualified tax credit bonds must be used within the three-year period that begins on the date of 

issuance. Available project proceeds are 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 qualified tax 

credit 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 tax credit 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 

 83 See secs. 54B, 54C, 54D, and 54E. 

84 Given the differences in credit quality and other characteristics of individual issuers, the 

Secretary cannot set credit rates in a manner that will allow each issuer to issue tax credit bonds at par. 
48 

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 tax credit bonds are issued. 

The maturity of qualified tax credit 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 tax credit bonds are issued. 

Description of Proposal

In general

The proposal permits an issuer to elect to have an otherwise tax-exempt bond treated as a 

“taxable governmental bond.” A “taxable governmental bond” is any obligation (other than a 

private activity bond) if the interest on such obligation would be (but for this proposal) 

excludable from gross income under section 103 and the issuer makes an irrevocable election to 

have the proposal apply. In determining if an obligation would be tax-exempt under section 

103, the credit (or the payment discussed below for qualified bonds) is not treated as a Federal 

guarantee. Further, the yield on a taxable governmental bond is determined without regard to the 

credit. A taxable governmental bond does not include any bond if the issue price has more than 

a de minimis amount of premium over the stated principal amount of the bond. 

The holder of a taxable governmental bond will accrue a tax credit in the amount of 35 

percent of the interest payable on the interest payment dates of the bond during the calendar year. 

The interest payment date is any date on which the holder of record of the taxable governmental 

bond is entitled to a payment of interest under such bond. The sum of the accrued credits is 

allowed against regular and alternative minimum tax. Unused credit may be carried forward to 

succeeding taxable years. The credit, as well as the interest paid by the issuer, is included in 

gross income and the credit may be stripped under rules similar to those provided in section 54A 

regarding qualified tax credit bonds. Rules similar to those that apply for S corporations, 

partnerships and regulated investment companies with respect to qualified tax credit bonds also 

apply to the credit. 

Special rule for qualified bonds issued during 2009 and 2010

A “qualified bond” is any taxable governmental bond issued as part of an issue if 100 

percent of the available project proceeds of such issue are to be used for capital expenditures.85 

 85 Under Treas. Reg. sec. 150-1(b), capital expenditure means any cost of a type that is properly 

chargeable to capital account (or would be so chargeable with a proper election or with the application of 

the definition of placed in service under Treas. Reg. sec. 1.150-2(c)) under general Federal income tax 

principles. For purposes of applying the “general Federal income tax principles” standard, an issuer 

should generally be treated as if it were a corporation subject to taxation under subchapter C of chapter 1 

of the Code. An example of a capital expenditure would include expenditures made for the purchase of 

fiber-optic cable to provide municipal broadband service. 
49 

The bond must be issued after the date of enactment of the proposal and before January 1, 2011. 

The issuer must make an irrevocable election to have the special rule for qualified bonds apply. 

Under the special rule for qualified bonds, in lieu of the tax credit to the holder, the issuer 

is allowed a credit equal to 35 percent of each interest payment made under such bond. Under 

the proposal, the Secretary will pay to the issuer the amount of the credit accrued with respect to 

an interest payment date. The payment by the Secretary is to be made contemporaneously with 

the interest payment made by the issuer, and may be made either in advance or as 

reimbursement. In lieu of payment to the issuer, the payment may be made to a person making 

interest payments on behalf of the issuer. For purposes of the arbitrage rules, the yield on a 

qualified bond is reduced by the amount of the credit/payment. 

Transitional coordination with State law

As noted above, interest on a taxable governmental bond and the related credit are 

includible in gross income to the holder for Federal tax purposes. The proposal provides that 

until a State provides otherwise, the interest on any taxable governmental bond and the amount 

of any credit determined with respect to such bond shall be treated as being exempt from Federal 

income tax for purposes of State income tax laws. 

Effective Date

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

6. Recovery Zone Bonds 

Present Law

In general

Under present law, gross income 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 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 (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”) and other Code requirements are 

met. 
50 

Private activity bonds

The Code defines a private activity bond as any bond that satisfies (1) the private 

business use test and the private security or payment test (“the private business test”); or (2) “the 

private loan financing test.”86

Private business test

Under the private business test, a bond is a private activity bond if it is part of an issue in 

which: 

1. More than 10 percent of the proceeds of the issue (including use of the bond-financed 

property) are to be used in the trade or business of any person other than a 

governmental unit (“private business use”); and 

2. More than 10 percent of the payment of principal or interest on the issue is, directly or 

indirectly, secured by (a) property used or to be used for a private business use or (b) 

to be derived from payments in respect of property, or borrowed money, used or to be 

used for a private business use (“private payment test”).87

A bond is not a private activity bond unless both parts of the private business test (i.e., the 

private business use test and the private payment test) are met. Thus, a facility that is 100 

percent privately used does not cause the bonds financing such facility to be private activity 

bonds if the bonds are not secured by or paid with private payments. For example, land 

improvements that benefit a privately-owned factory may be financed with governmental bonds 

if the debt service on such bonds is not paid by the factory owner or other private parties and 

such bonds are not secured by the property. 

Private loan financing test

A bond issue satisfies the private loan financing test if proceeds exceeding the lesser of 

$5 million or five percent of such proceeds are used directly or indirectly to finance loans to one 

or more nongovernmental persons. Private loans include both business and other (e.g., personal) 

uses and payments to 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. 

 86 Sec. 141. 

87 The 10 percent private business test is reduced to five percent in the case of private business 

uses (and payments with respect to such uses) that are unrelated to any governmental use being financed 

by the issue. 
51 

Arbitrage restrictions

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

arbitrage bond.88 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.89 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. 

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 an 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 qualified private activity bonds is restricted by 

annual aggregate volume limits imposed on bonds issued by issuers within each State (“State 

volume cap”). For calendar year 2007, the State volume cap, which is indexed for inflation, 

equals $85 per resident of the State, or $256.24 million, if greater. Exceptions to the State 

volume cap are provided for bonds for certain governmentally owned facilities (e.g., airports, 

ports, high-speed intercity rail, and solid waste disposal) and bonds which are subject to separate 

local, State, or national volume limits (e.g., public/private educational facility bonds, enterprise 

zone facility bonds, qualified green building bonds, and qualified highway or surface freight 

transfer facility bonds). 

Qualified private activity bonds generally are subject to restrictions on the use of 

proceeds for the acquisition of land and existing property. In addition, qualified private activity 

bonds generally are subject to restrictions on the use of proceeds to finance certain specified 

facilities (e.g., airplanes, skyboxes, other luxury boxes, health club facilities, gambling facilities, 

and liquor stores), and use of proceeds to pay costs of issuance (e.g., bond counsel and 

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

89 Sec. 148. 
52 

underwriter fees). Small issue and redevelopment bonds also are subject to additional 

restrictions on the use of proceeds for certain facilities (e.g., golf courses and massage parlors). 

Moreover, the term of qualified private activity bonds generally may not exceed 120 

percent of the economic life of the property being financed and certain public approval 

requirements (similar to requirements that typically apply under State law to issuance of 

governmental debt) apply under Federal law to issuance of private activity bonds. 

Qualified tax credit bonds

In lieu of interest, holders of qualified tax credit bonds receive a tax credit that accrues 

quarterly. The following bonds are qualified tax credit bonds: qualified forestry conservation 

bonds, new clean renewable energy bonds, qualified energy conservation bonds, and qualified 

zone academy bonds.90 

Section 54A of the Code sets forth general rules applicable to qualified tax credit bonds. 

These rules include requirements regarding the expenditure of available project proceeds, 

reporting, arbitrage, maturity limitations, and financial conflicts of interest, among other special 

rules. 

A taxpayer who holds a qualified tax credit bond on one or more credit allowance dates 

of the bond during the taxable year shall be allowed a credit against the taxpayer’s income tax 

for the taxable year. In general, the credit amount for any credit allowance date is 25 percent of 

the annual credit determined with respect to the bond. The annual credit is determined by 

multiplying the applicable credit rate by the outstanding face amount of the bond. The applicable 

credit rate for the bond is the rate that the Secretary estimates will permit the issuance of the 

qualified tax credit bond with a specified maturity or redemption date without discount and 

without interest cost to the qualified issuer.91 The Secretary determines credit rates for tax credit 

bonds based on general assumptions about credit quality of the class of potential eligible issuers 

and such other factors as the Secretary deems appropriate. The Secretary may determine credit 

rates based on general credit market yield indexes and credit ratings. 

The credit is included in gross income and, under regulations prescribed by the Secretary, 

may be stripped (a separation (including at issuance) of the ownership of a qualified tax credit 

bond and the entitlement to the credit with respect to such bond). 

Section 54A of the Code requires that 100 percent of the available project proceeds of 

qualified tax credit bonds must be used within the three-year period that begins on the date of 

issuance. Available project proceeds are 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 

 90 See secs. 54B, 54C, 54D, and 54E. 

91 Given the differences in credit quality and other characteristics of individual issuers, the 

Secretary cannot set credit rates in a manner that will allow each issuer to issue tax credit bonds at par. 
53 

projects during the three-year spending period, bonds will continue to qualify as qualified tax 

credit 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 tax credit 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 tax credit bonds are issued. 

The maturity of qualified tax credit 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 tax credit bonds are issued. 

The credit with respect to a qualified tax credit bond is included in the gross income of 

the holder. Under regulations prescribed by the Secretary, may be stripped (a separation 

(including at issuance) of the ownership of a qualified tax credit bond and the entitlement to the 

credit with respect to such bond). 

Description of Proposal

In general

The proposal permits an issuer to designate one or more areas as recovery zones. The 

area must have significant poverty, unemployment, or rate of home foreclosures, or be any area 

for which a designation as an empowerment zone or renewal community is in effect. Issuers 

may issue recovery zone economic development bonds and recovery zone facility bonds with 

respect to these zones. 

There is a national recovery zone economic development bond limitation of $10 billion. 

In addition, there is a separate national recovery zone facility bond limitation of $15 billion. 

The Secretary is to separately allocate the bond limitations among the States in the proportion 

that each State’s employment decline bears to the aggregate 2008 State employment declines for 

all States. In turn each State is to reallocate its allocation among the counties (parishes) and 

large municipalities in such State in the proportion that each such county or municipality’s 2008 

employment decline bears to the aggregate employment declines for all counties and 

municipalities in such State. In calculating the local employment decline with respect to a 

county, the portion of such decline attributable to a large municipality is disregarded for 
54 

purposes of determining the county’s portion of the State employment decline and is attributable 

to the large municipality only. 

For purposes of the proposal “2008 State employment decline” means, with respect to 

any State, the excess (if any) of (i) the number of individuals employed in such State as 

determined for December 2007, over (ii) the number of individuals employed in such State as 

determined for December 2008. The term “large municipality” means a municipality with a 

population of more than 100,000. 

Recovery Zone Economic Development Bonds

New section 54AA(h) of the proposal creates a special rule for qualified bonds (a type of 

taxable governmental bond) issued before January 1, 2011, that entitles the issuer of such bonds 

to receive an advance tax credit equal to 35 percent of the interest payable on an interest payment 

date.92 For taxable governmental bonds that are designated recovery zone economic 

development bonds, the applicable percentage is 40 percent. 

A recovery zone economic development bond is a taxable governmental bond issued as 

part of an issue if 100 percent of the available project proceeds of such issue are to be used for 

one or more qualified economic development purposes and the issuer designates such bond for 

purposes of this section. A qualified economic development purpose means expenditures for 

purposes of promoting development or other economic activity in a recovery zone, including (1) 

capital expenditures paid or incurred with respect to property located in such zone, (2) 

expenditures for public infrastructure and construction of public facilities located in a recovery 

zone. 

The aggregate face amount of bonds which may be designated by any issuer cannot 

exceed the amount of the recovery zone economic development bond limitation allocated to such 

issuer. 

Recovery Zone Facility Bonds

The proposal creates a new category of exempt facility bonds, “recovery zone facility 

bonds.” A recovery zone facility bond means any bond issued as part of an issue if: (1) 95 

percent or more of the net proceeds of such issue are to be used for recovery zone property and 

(2) such bond is issued before January 1, 2011, and (3) the issuer designates such bond as a 

recovery zone facility bond. The aggregate face amount of bonds which may be designated by 

any issuer cannot exceed the amount of the recovery zone facility bond limitation allocated to 

such issuer. 

Under the proposal, the term “recovery zone property” means any property subject to 

depreciation to which section 168 applies (or would apply but for section 179) if (1) such 

property was acquired by the taxpayer by purchase after the date on which the designation of the 

recovery zone took effect; (2) the original use of such property in the recovery zone commences 

 92 See “Taxable Bond Option for Governmental Bonds” discussed above. 
55 

with the taxpayer; and (3) substantially all of the use of such property is in the recovery zone and 

is in the active conduct of a qualified business by the taxpayer in such zone. The term “qualified 

business” means any trade or business except that the rental to others of real property located in a 

recovery zone shall be treated as a qualified business only if the property is not residential rental 

property (as defined in section 168(e)(2)) and does not include any trade or business consisting 

of the operation of any facility 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 of alcoholic 

beverages for consumption off premises). 

Subject to the following exceptions and modifications, issuance of recovery zone facility 

bonds is subject to the general rules applicable to issuance of qualified private activity bonds: 

1. Issuance of the bonds is not subject to the aggregate annual State private activity bond 

volume limits (sec. 146); 

2. The restriction on acquisition of existing property does not apply (sec. 147(d)); 

Effective Date

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

7. Tribal Economic Development Bonds 

Present Law

Under present law, gross income does not include interest on State or local bonds.93 State 

and local bonds are classified generally as either governmental bonds or private activity bonds. 

Governmental bonds are bonds the proceeds of which are primarily used to finance 

governmental facilities or the debt is 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 these purposes, the term “nongovernmental person” includes the 

Federal government and all other individuals and entities other than States or local 

governments.94 Interest on private activity bonds is taxable, unless the bonds are issued for 

certain purposes permitted by the Code and other requirements are met.95 

Although not States or subdivisions of States, Indian tribal governments are provided 

with a tax status similar to State and local governments for specified purposes under the Code.96

 93 Sec. 103. 

94 Sec. 141(b)(6); Treas. Reg. sec. 1.141-1(b). 

95 Secs. 103(b)(1) and 141. 

96 Sec. 7871. 
56 

Among the purposes for which a tribal government is treated as a State is the issuance of taxexempt bonds. Under section 7871(c), tribal governments are authorized to issue tax-exempt 

bonds only if substantially all of the proceeds are used for essential governmental functions.97 

The term essential governmental function does not include any function that is not customarily 

performed by State and local governments with general taxing powers. Section 7871(c) further 

prohibits Indian tribal governments from issuing tax-exempt private activity bonds (as defined in 

section 141(a) of the Code) with the exception of certain bonds for manufacturing facilities. 

Description of Proposal

Tribal Economic Development Bonds

The proposal allows Indian tribal governments to issue “tribal economic development 

bonds.” There is a national bond limitation of $2 billion, to be allocated as the Secretary 

determines appropriate, in consultation with the Secretary of the Interior. Tribal economic 

development bonds issued by an Indian tribal government are treated as if such bond were issued 

by a State except that section 146 (relating to State volume limitations) does not apply. 

A tribal economic development bond is any bond issued by an Indian tribal government 

(1) the interest on which would be tax-exempt if issued by a State or local government but would 

be taxable under section 7871(c), and (2) that is designated by the Indian tribal government as a 

tribal economic development bond. The aggregate face amount of bonds that may be designated 

by any Indian tribal government cannot exceed the amount of national tribal economic 

development bond limitation allocated to such government. 

Tribal economic development bonds cannot be used to finance any portion of a building 

in which class II or class III gaming (as defined in section 4 of the Indian Gaming Regulatory 

Act) is conducted, or housed, or any other property used in the conduct of such gaming. Nor can 

tribal economic development bonds be used to finance any facility located outside of the Indian 

reservation. 

Treasury Study

The proposal requires that the Treasury Department study the effects of tribal economic 

development bonds. One year after the date of enactment, a report is to be submitted to 

Congress providing the results of such study along with any recommendations, including 

whether the restrictions of section 7871(c) should be eliminated or otherwise modified. 

Effective Date

The proposal applies to obligations issued after the date of enactment. 

 97 Sec. 7871(c). 
57 

8. Repeal of withholding on government contractors 

Present law 

For payments made after December 31, 2010, the Code requires withholding at a threepercent rate on certain payments to persons providing property or services made by the 

Government of the United States, every State, every political subdivision thereof, and every 

instrumentality of the foregoing (including multi-State agencies). The withholding requirement 

applies regardless of whether the government entity making such payment is the recipient of the 

property or services. Political subdivisions of States (or any instrumentality thereof) with less 

than $100 million of annual expenditures for property or services that would otherwise be subject 

to withholding under this proposal are exempt from the withholding requirement. 

Payments subject to the three-percent withholding include any payment made in 

connection with a government voucher or certificate program which functions as a payment for 

property or services. For example, payments to a commodity producer under a government 

commodity support program are subject to the withholding requirement. The proposal imposes 

information reporting requirements on the payments that are subject to withholding under the 

proposal. 

The three-percent withholding requirement does not apply to any payments made through 

a Federal, State, or local government public assistance or public welfare program for which 

eligibility is determined by a needs or income test. The three-percent withholding requirement 

also does not apply to payments of wages or to any other payment with respect to which 

mandatory (e.g., U.S.-source income of foreign taxpayers) or voluntary (e.g., unemployment 

benefits) withholding applies under present law. Although the proposal applies to payments that 

are potentially subject to backup withholding under section 3406, it does not apply to those 

payments from which amounts are actually being withheld under backup withholding rules. 

The three-percent withholding requirement also does not apply to the following: 

payments of interest; payments for real property; payments to tax-exempt entities or foreign 

governments; intra-governmental payments; payments made pursuant to a classified or 

confidential contract (as defined in section 6050M(e)(3)), and payments to government 

employees that are not otherwise excludable from the new withholding proposal with respect to 

the employees’ services as employees. 

Description of Proposal

The proposal repeals the three-percent withholding requirement on government 

payments. 

Effective Date

The proposal is effective on the date of enactment. 
58 

G. Energy Incentives 

1. Extension of the renewable electricity credit 

Present Law

In general

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

resources at qualified facilities.98 Qualified energy resources comprise wind, closed-loop 

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

solid waste, qualified hydropower production, and marine and hydrokinetic renewable energy. 

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 2.1 cents 

per kilowatt-hour for 2008. 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; 11.8 cents for 2008). 

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 section 45(d)(3)(A)(i) that uses agricultural livestock waste 

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

 98 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. 
59 

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 2008). 

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 resources is a component of the 

general business credit.99 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 25 percent of so much of the net regular tax liability as exceeds $25,000. 

However, this limitation does not apply to section 45 credits for electricity or refined coal 

produced from a 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. 100 Excess credits may be 

carried back one year and forward up to 20 years. 

 99 Sec. 38(b)(8). 

100 Sec. 38(c)(4)(B)(ii). 
60 

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, 2010. 

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, 2011. 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, 2011. 

A qualified facility includes a new power generation unit placed in service after October 

3, 2008, at an existing closed-loop biomass facility, but only to the extent of the increased 

amount of electricity produced at the existing facility by reason of such new unit. 

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 
61 

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. 

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, 2011. A qualified facility includes a new power 

generation unit placed in service after October 3, 2008, at an existing open-loop biomass facility, 

but only to the extent of the increased amount of electricity produced at the existing facility by 

reason of such new unit. 

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, 2011. 

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 October 3, 2008. Marine and hydrokinetic renewable energy 

facilities, described below, subsume small irrigation power facilities after October 2, 2008. 

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, 2011. 

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, 

2011. A qualified trash combustion facility includes a new unit, placed in service after 
62 

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. 

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, 2011, 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, 2011. 

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. 

Nonhydroelectric dams converted to produce electricity must be licensed by the Federal 

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

regulatory requirements. 

For a nonhydroelectric dam converted to produce electric power before January 1, 2009, 

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. 

For a nonhydroelectric dam converted to produce electric power after December 31, 

2008, the nonhydroelectric dam must have been (1) placed in service before October 3, 2008, (2) 

operated for flood control, navigation, or water supply purposes and (3) did not produce 

hydroelectric power on October 3, 2008. In addition, the hydroelectric project must be operated 

so that the water surface elevation at any given location and time that would have occurred in the 

absence of the hydroelectric project is maintained, subject to any license requirements imposed 

under applicable law that change the water surface elevation for the purpose of improving 

environmental quality of the affected waterway. The Secretary, in consultation with the Federal 

Energy Regulatory Commission, shall certify if a hydroelectric project licensed at a 

nonhydroelectric dam meets this criteria. 
63 

Marine and hydrokinetic renewable energy facility

A qualified marine and hydrokinetic renewable energy facility is any facility that 

produces electric power from marine and hydrokinetic renewable energy, has a nameplate 

capacity rating of at least 150 kilowatts, and is placed in service after October 2, 2008, and 

before January 1, 2012. 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 manmade 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. 

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 

2008 (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 2.1 10 10 

Closed-loop biomass 2.1 101 10 

Open-loop biomass 

 (including agricultural 

 livestock waste nutrient 

 facilities) 

1.0 52 10 

Geothermal 

Solar (pre-2006 facilities only) 

Small irrigation power 

Municipal solid waste 

 (including landfill gas 

 facilities and trash 

 combustion facilities) 

Qualified hydropower 

2.1 

2.1 

1.0 

1.0 

1.0 

 5 

 5 

 5 

 5 

 N/A 

10 

10 

10 

10 

10 

Marine and hydrokinetic 1.0 N/A 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. 
64 

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 Code101 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.102 The availability of such deductions from taxable income 

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

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

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 for three years (generally, through 2013; through 2012 for wind 

facilities) the period during which qualified facilities producing electricity from wind, closedloop biomass, open-loop biomass, geothermal energy, municipal solid waste, and qualified 

hydropower may be placed in service for purposes of the electricity production credit. The 

proposal extends for two years (through 2013) the placed-in-service period for marine and 

hydrokinetic renewable energy resources. 

The proposal also makes a technical amendment to the definition of small irrigation 

power facility to clarify its integration into the definition of marine and hydrokinetic renewable 

energy facility. 

Effective Date

The extension of the electricity production credit is effective for property placed in 

service after the date of enactment. The technical amendment is effective as if included in 

section 102 of the Energy Improvement and Extension Act of 2008. 

 101 Secs. 1381-1383. 

102 Sec. 1382. 
65 

2. Election of investment credit in lieu of production tax credits 

Present Law

Renewable Electricity Credit

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

resources at qualified facilities.103 Qualified energy resources comprise wind, closed-loop 

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

solid waste, qualified hydropower production, and marine and hydrokinetic renewable energy. 

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. The credit amounts, 

credit periods, definitions of qualified facilities, and other rules governing this credit are 

described more fully in section G.1. of this document. 

Energy Credit

An income tax credit is also allowed for certain energy property placed in service. 

Qualifying property includes certain fuel cell property, solar property, geothermal power 

production property, small wind energy property, combined heat and power system property, and 

geothermal heat pump property.104 The amounts of credit, definitions of qualifying property, and 

other rules governing this credit are described more fully in section G.3. of this document. 

Description of Proposal

The proposal allows the taxpayer to make an irrevocable election to have certain 

qualified facilities placed in service in 2009 and 2010 be treated as energy property eligible for a 

30 percent investment credit under section 48. For this purpose, qualified facilities are facilities 

otherwise eligible for the section 45 production tax credit (other than refined coal, Indian coal, 

and solar facilities) with respect to which no credit under section 45 has been allowed. A 

taxpayer electing to treat a facility as energy property may not claim the production credit under 

section 45. 

Effective Date

The proposal applies to facilities placed in service after December 31, 2008. 

 

 103 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. 

104 Sec. 48. 
66 

3. Modification of energy credit105 

Present Law

In general

A nonrefundable, 10-percent business energy credit106 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 credit.107 An unused general 

business credit generally may be carried back one year and carried forward 20 years.108 The 

taxpayer’s basis in the property is reduced by one-half 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. The credit is allowed against the alternative minimum tax for 

credits determined in taxable years beginning after October 3, 2008. 

Property financed by subsidized energy financing or with proceeds from private activity 

bonds is subject to a reduction in basis for purposes of claiming the credit. The basis reduction is 

proportional to the share of the basis of the property that is financed by the subsidized financing 

or proceeds. The term “subsidized energy financing” means financing provided under a Federal, 

State, or local program a principal purpose of which is to provide subsidized financing for 

projects designed to conserve or produce energy.

 105 Additional proposals that (1) allow section 45 facilities to elect to be treated as section 48 

energy property, and (2) allow section 48 facilities to elect to receive a grant from the Department of 

Energy rather than the section 48 energy credit, are described in sections G.2. and H.2. of this document. 

106 Sec. 48. 

107 Sec. 38(b)(1). 

108 Sec. 39. 
67 

Special rules for solar energy property

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

to January 1, 2017. 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. 

Fuel cells and microturbines

The energy credit applies to qualified fuel cell power plants, but only for periods prior to 

January 1, 2017. 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 one-half kilowatt. The credit may not exceed $1,500 for 

each 0.5 kilowatt of capacity. 

The energy credit applies to qualifying stationary microturbine power plants for periods 

prior to January 1, 2017. 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 than 26 percent at 

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

Geothermal heat pump property

The energy credit applies to qualified geothermal heat pump property placed in service 

prior to January 1, 2017. The credit rate is 10 percent. Qualified geothermal heat pump property 

is equipment that uses the ground or ground water as a thermal energy source to heat a structure 

or as a thermal energy sink to cool a structure. 

Small wind property

The energy credit applies to qualified small wind energy property placed in service prior 

to January 1, 2017. The credit rate is 30 percent. The credit is limited to $4,000 per year with 

respect to all wind energy property of any taxpayer. Qualified small wind energy property is 

property that uses a qualified wind turbine to generate electricity. A qualifying wind turbine 

means a wind turbine of 100 kilowatts of rated capacity or less. 
68 

Combined heat and power property

The energy credit applies to combined heat and power (“CHP”) property placed in 

service prior to January 1, 2017. The credit rate is 10 percent. 

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 

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). 

Description of Proposal

The proposal eliminates the credit cap applicable to qualified small wind energy property. 

The proposal also removes the rule that reduces the basis of the property for purposes of 

claiming the credit if the property is financed in whole or in part by subsidized energy financing 

or with proceeds from private activity bonds. 

Effective Date

The proposal applies to periods after December 31, 2008, 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). 
69 

4. Expand New Clean Renewable Energy Bonds 

Present Law

New Clean Renewable Energy Bonds

New clean renewable energy bonds (“New CREBs”) may be issued by qualified issuers 

to finance qualified renewable energy facilities. Qualified renewable energy facilities are 

facilities that: (1) 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) are owned by a public power provider, governmental body, 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 (including any affiliated entity which is controlled by such lender). 

There is a national limitation for New CREBs of $800 million. 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. 

New CREBs are a type of qualified tax credit bond for purposes of section 54A of the 

Code. As such, 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. Available project proceeds are 

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 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. 
70 

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. 

As with other tax credit bonds, a taxpayer holding New CREBs on a credit allowance 

date is entitled to a tax credit. Unlike 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 applicable credit rate for the bond is the rate 

that the Secretary estimates will permit the issuance of the qualified tax credit bond with a 

specified maturity or redemption date without discount and without interest cost to the qualified 

issuer.109 The Secretary determines credit rates for tax credit bonds based on general 

assumptions about credit quality of the class of potential eligible issuers and such other factors as 

the Secretary deems appropriate. The Secretary may determine credit rates based on general 

credit market yield indexes and credit ratings. 

The amount of the tax credit is determined by multiplying the bond’s credit rate by the 

face amount of 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. 

An issuer of New CREBs is treated as meeting the “prohibition on financial conflicts of 

interest” requirement in section 54A(d)(6) if it certifies that it satisfies (i) applicable State and 

local law requirements governing conflicts of interest and (ii) any additional conflict of interest 

rules prescribed by the Secretary with respect to any Federal, State, or local government official 

directly involved with the issuance of New CREBs. 

Description of Proposal

The proposal expands the New CREBs program. The proposal authorizes issuance of up 

to an additional $1.6 billion of New CREBs. 

Effective Date

The proposal applies to bonds issued after date of enactment. 

 109 Given the differences in credit quality and other characteristics of individual issuers, the 

Secretary cannot set credit rates in a manner that will allow each issuer to issue tax credit bonds at par. 
71 

5. Expand qualified energy conservation bonds 

Present Law

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 

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 $800 million. 

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). 
72 

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). 

Qualified energy conservations bonds are a type of qualified tax credit bond for purposes 

of section 54A of the Code. As a result, 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 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). 

Under present law, 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. 

Available project proceeds are 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 other 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 
73 

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.110 The Secretary determines credit rates for tax credit 

bonds based on general assumptions about credit quality of the class of potential eligible issuers 

and such other factors as the Secretary deems appropriate. The Secretary may determine credit 

rates based on general credit market yield indexes and credit ratings. 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 applicable State and local law requirements governing conflicts of 

interest are satisfied with respect to such issue, as well as any other additional conflict of interest 

rules prescribed by the Secretary with respect to any Federal, State, or local government official 

directly involved with the issuance of qualified energy conservation bonds. 

Description of Proposal

The proposal expands the present-law qualified energy conservation bond program. The 

proposal authorizes issuance of an additional $2.4 billion of qualified energy conservation bonds. 

Effective Date

The proposal is bonds issued after the date of enactment. 

6. Extension and modification of credit for nonbusiness energy property 

Present Law

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 (1) 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); (2) that is installed in or on a 

dwelling located in the United States and owned and used by the taxpayer as the taxpayer’s 

principal residence; (3) the original use of which commences with the taxpayer; and (4) that 

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 

 110 Given the differences in credit quality and other characteristics of individual issuers, the 

Secretary cannot set credit rates in a manner that will allow each issuer to issue tax credit bonds at par. 
74 

windows (including skylights) and doors; and (3) metal or asphalt roofs with appropriate 

pigmented coatings or cooling granules that are specifically and primarily designed to reduce the 

heat gain for a dwelling. 

Additionally, 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 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, 2006,111 (4) a natural 

gas, propane, or oil water heater which has an energy factor of at least 0.80 or thermal efficiency 

of at least 90 percent, and (5) biomass fuel property. 

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. 

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 

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 

 111 The highest tier in effect at this time was tier 2, requiring SEER of at least 15 and EER of at 

least 12.5 for split central air conditioning systems and SEER of at least 14 and EER of at least 12 for 

packaged central air conditioning systems. 
75 

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

is taken into account. 

For purposes of determining the amount of expenditures made by any individual with 

respect to any dwelling unit, there shall not be taken into account expenditures which are made 

from subsidized energy financing The term “subsidized energy financing” means financing 

provided under a Federal, State, or local program a principal purpose of which is to provide 

subsidized financing for projects designed to conserve or produce energy. 

The credit applies to expenditures made after December 31, 2008 for property placed in 

service after December 31, 2008, and prior to January 1, 2010. 

Description of Proposal

The proposal raises the 10 percent credit rate to 30 percent. Additionally, all energy 

property otherwise eligible for the $50, $100, or $150 credits is instead eligible for a 30 percent 

credit on expenditures for such property. 

The proposal additionally extends the proposal for one year, through December 31, 2010. 

Finally, the $500 lifetime cap (and the $200 lifetime cap with respect to windows) is eliminated 

and replaced with an aggregate cap of $1,500 in the case of property placed in service after 

December 31, 2008 and prior to January 1, 2011. 

The present law rule related to subsidized energy financing is eliminated. 

Effective Date

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

2008, for property placed in service prior to January 1, 2011. 

7. Credit for residential energy efficient property.

Present Law

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 of $2,000 with respect to qualified solar water heating 

property. There is not cap with respect to qualified solar electric property. 

Section 25D also provides a 30 percent credit for the purchase of qualified geothermal 

heat pump property, qualified small wind energy property, and qualified fuel cell power plants. 

The credit for geothermal heat pump property is capped at $2,000, the credit for qualified small 

wind energy property is limited to $500 with respect to each half kilowatt of capacity, not to 

exceed $4,000, and the credit for any fuel cell may not exceed $500 for each 0.5 kilowatt of 

capacity. 
76 

The credit with respect to all qualifying property may be claimed against the alternative 

minimum tax. 

Qualified solar electric property is property that uses solar energy to generate electricity 

for use in a dwelling unit. Qualifying solar water heating property is property used 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. 

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. 

Qualified small wind energy property is 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. 

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, (2) meets the requirements of the Energy Star program 

which are in effect at the time that the expenditure for such equipment is made, and (3) is 

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

residence by the taxpayer. 

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. 

Special proration rules apply in the case of jointly owned property, condominiums, and 

tenant-stockholders 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. 

For purposes of determining the amount of expenditures made by any individual with 

respect to any dwelling unit, there shall not be taken into account expenditures which are made 

from subsidized energy financing. The term “subsidized energy financing” means financing 

provided under a Federal, State, or local program a principal purpose of which is to provide 

subsidized financing for projects designed to conserve or produce energy. 

The credit applies to property placed in service prior to January 1, 2017. 

Description of Proposal

The proposal eliminates the credit caps for solar hot water, geothermal, and wind 

property and eliminates the reduction in credits for property using subsidized energy financing. 
77 

Effective Date

The proposal applies to taxable years beginning after December 31, 2008. 

8. Temporary increase in credit for alternative fuel vehicle refueling property 

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.112 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 or electricity into the fuel tank 

or battery of a motor vehicle propelled by such fuel or electricity, but only if the storage or 

dispensing of the fuel or electricity is at the point of delivery into the fuel tank or battery 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 

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, 2011. In the case of 

hydrogen refueling property, the property must be placed in service before January 1, 2015. 

 112 Sec. 30C. 
78 

Description of Proposal

For property placed in service in 2009 or 2010, the proposal increases the maximum 

credit available for business property to $200,000 for qualified hydrogen refueling property and 

to $50,000 for other qualified refueling property. For nonbusiness property, the maximum credit 

is increased to $2,000. In addition, the credit rate is increased from 30 percent to 50 percent, 

except in the case of hydrogen refueling property. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2008. 

9. Energy research 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.113 

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.114

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, expires for amounts paid or incurred after December 31, 2009.115

 113 Sec. 41. 

114 Sec. 41(e). 

115 Sec. 41(h). 
79 

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 

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.116 

In computing the credit, a taxpayer’s base amount cannot 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.117 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.118 

Alternative incremental research credit regime

Taxpayers are allowed to elect an alternative incremental research credit regime.119 If a 

taxpayer elects to be subject to this alternative regime, the taxpayer is assigned a three-tiered 

 116 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). 

117 Sec. 41(f)(1). 

118 Sec. 41(f)(3). 

119 Sec. 41(c)(4). 
80 

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 

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.120

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. The 

alternative incremental credit regime terminates for taxable years beginning after December 31, 

2008. 

Alternative simplified credit

Generally, for amounts paid or incurred after 2006, taxpayers may elect to claim an 

alternative simplified credit for qualified research expenses.121 The alternative simplified 

research credit is equal to 12 percent (14 percent for taxable years beginning after December 31, 

2008) 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. 

 120 A special transition rule applies for fiscal year 2006-2007 taxpayers. 

121 A special transition rule applies for fiscal year 2006-2007 taxpayers. 
81 

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).122 Notwithstanding the limitation for 

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 not only has 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.123 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.124 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 

 122 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). 

123 Sec. 41(d)(3). 

124 Sec. 41(d)(4). 
82 

useful life extending beyond the current year must be capitalized.125 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.126 Taxpayers 

may alternatively elect to claim a reduced research tax credit amount under section 41 in lieu of 

reducing deductions otherwise allowed.127

Description of Proposal

The proposal creates a new 20 percent credit for all qualified energy research expenses 

paid or incurred in 2009 or 2010. Qualified energy research expenses are qualified research 

expenses related to the fields of fuel cells and battery technology, renewable energy, energy 

conservation technology, efficient transmission and distribution of electricity, and carbon capture 

and sequestration. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2008. 

 125 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). 

126 Sec. 280C(c). 

127 Sec. 280C(c)(3). 
83 

H. Other Provisions 

1. Application of certain labor standards to projects financed with certain tax-favored 

bonds 

Present Law

The United States Code (Subchapter IV of Chapter 31 of Title 40) applies a prevailing 

wage requirement to certain contracts to which the Federal Government is a party. 

Description of Proposal

The proposal provides that Subchapter IV of Chapter 31 of Title 40 of the U.S. Code 

shall apply to projects financed with the proceeds of: 

1. any qualified clean renewable energy bond (as defined in sec. 54C of the Code) issued 

after the date of enactment; 

2. any qualified energy conservation bond (as defined in sec. 54D of the Code) issued 

after the date of enactment; ; 

3. any qualified zone academy bond (as defined in sec. 54E of the Code) issued after the 

date of enactment; 

4. any qualified school construction bond (as defined in sec. 54F of the Code) issued; and 

5. any recovery zone economic development bond (as defined in sec. 1400U-2 of the 

Code). 

Effective Date

The proposal is effective on the date of enactment. 

2. Grants for specified energy property in lieu of tax credits 

Present Law

Renewable electricity credit

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

resources at qualified facilities.128 Qualified energy resources comprise wind, closed-loop 

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

solid waste, qualified hydropower production, and marine and hydrokinetic renewable energy. 

 128 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. 
84 

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. The credit amounts, 

credit periods, definitions of qualified facilities, and other rules governing this credit are 

described more fully in section G.1. of this document. 

Energy credit

An income tax credit is also allowed for certain energy property placed in service. 

Qualifying property includes certain fuel cell property, solar property, geothermal power 

production property, small wind energy property, combined heat and power system property, and 

geothermal heat pump property.129 The amounts of credit, definitions of qualifying property, and 

other rules governing this credit are described more fully in section G.3. of this document. 

Description of Proposal

The proposal authorizes the Secretary of Energy to provide a grant to each person who 

places in service during 2009 or 2010 energy property that is either (1) an electricity production 

facility otherwise eligible for the renewable electricity credit or (2) qualifying property otherwise 

eligible for the energy credit. In general, the grant amount is 30 percent of the basis of the 

property. For qualified microturbine, combined heat and power system, and geothermal heat 

pump property, the amount is 10 percent of the basis of the property. The basis of the property is 

reduced by fifty percent of the amount of the grant. Some or all of each grant is subject to 

recapture if the grant eligible property is disposed of by the grant recipient within five years of 

being placed in service. 

Under the proposal, if a grant is paid, no renewable electricity credit or energy credit may 

be claimed with respect to the grant eligible property. In addition, no grant may be awarded to 

any Federal, State, or local government or any section 501(c) tax-exempt entity. 

The proposal appropriates to the Secretary of Energy the funds necessary to make the 

grants. No grant may be made unless the application for the grant has been received before 

October 1, 2011. 

Effective Date

The proposal is effective on date of enactment. 

 129 Sec. 48.