General Explanations 

of the 

Administration’s Fiscal Year 2008

Revenue Proposals

Department of the Treasury 

February 2007
General Explanations 

of the 

Administration’s Fiscal Year 2008 

Revenue Proposals 

Department of the Treasury 

February 2007 

This document is available in Adobe Acrobat format on the Internet at: 

http://www.treas.gov/offices/tax-policy/library/bluebk07.pdf

The free Adobe Acrobat Reader is available at: http://www.adobe.com/products/acrobat/readstep2.html
Table of Contents 

GENERAL EXPLANATIONS OF THE ADMINISTRATION’S FISCAL YEAR 2008 REVENUE

PROPOSALS ...............................................................................................................................................................1

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

IMPROVE THE TAX SYSTEM TO MAKE THE U.S. MORE COMPETITIVE ......................................................................1

A DYNAMIC ANALYSIS DIVISION WITHIN THE OFFICE OF TAX POLICY .....................................................................1

MAKE PERMANENT CERTAIN TAX RELIEF ENACTED IN 2001 AND 2003 ..............................................3

PERMANENTLY EXTEND CERTAIN PROVISIONS OF THE 2001 TAX RELIEF AND THE 2003 JOBS AND GROWTH TAX

RELIEF.......................................................................................................................................................................3

TAX INCENTIVES.....................................................................................................................................................5

SIMPLIFY AND ENCOURAGE SAVING .........................................................................................................................5

Expand tax-free savings opportunities...................................................................................................................5

Consolidate employer-based savings accounts ....................................................................................................11

ENCOURAGE ENTREPRENEURSHIP AND INVESTMENT ..............................................................................................16

Increase expensing for small business..................................................................................................................16

INVEST IN HEALTH CARE.........................................................................................................................................18

Provide a new Standard deduction for health insurance (SDHI) ($15,000 for family coverage and $7,500 for

single coverage) ............................................................................................................................................18

Expand and make health savings accounts (HSAs) more flexible ........................................................................21

Improve the Health Coverage Tax Credit ............................................................................................................25

Allow the orphan drug tax credit for certain pre-designation expenses...............................................................27

PROVIDE INCENTIVES FOR CHARITABLE GIVING .....................................................................................................28

Permanently extend tax-free withdrawals from IRAs for charitable contributions..............................................28

Permanently extend the enhanced charitable deduction for contributions of food inventory ..............................30

Permanently extend the enhanced deduction for corporate contributions of computer equipment for

educational purposes.....................................................................................................................................32

Permanently extend increased limits on contributions of partial interests in real property for conservation

purposes ........................................................................................................................................................33

Permanently extend the basis adjustment to stock of S corporations contributing appreciated property............35

Reform excise tax based on investment income of private foundations................................................................36

Repeal the $150 million limitation on qualified 501(c)(3) bonds.........................................................................38

Repeal certain restrictions on the use of qualified 501(c)(3) bonds for residential rental property ....................39

STRENGTHEN EDUCATION .......................................................................................................................................41

Permanently extend the above-the-line deduction for qualified out-of-pocket classroom expenses.....................41

Allow the Saver’s Credit for contributions to qualified tuition programs (section 529 plans).............................42

PROTECT THE ENVIRONMENT ..................................................................................................................................44

Permanently extend expensing of brownfields remediation costs ........................................................................44

Eliminate the volume cap for private activity bonds for water infrastructure......................................................46

RESTRUCTURE ASSISTANCE TO NEW YORK CITY....................................................................................................48

Provide tax incentives for transportation infrastructure......................................................................................48

SIMPLIFY THE TAX LAWS FOR FAMILIES ....................................................................................................51

Clarify uniform definition of a child.....................................................................................................................51

Simplify EITC eligibility requirement regarding filing status, presence of children, and work and immigrant 

status .............................................................................................................................................................55

Reduce computational complexity of refundable child tax credit.........................................................................59

IMPROVE TAX COMPLIANCE............................................................................................................................61

INTRODUCTION........................................................................................................................................................61

EXPAND INFORMATION REPORTING ........................................................................................................................63

Require information reporting on payments to corporations...............................................................................63

Require basis reporting on security sales.............................................................................................................64

Expand broker information reporting ..................................................................................................................65

Require information reporting on merchant payment card reimbursements........................................................66

Require a certified Taxpayer Identification Number from contractors................................................................67

i 
Require increased information reporting for certain government payments for property and services...............69

Increase information return penalties..................................................................................................................70

IMPROVE COMPLIANCE BY BUSINESSES ..................................................................................................................71

Require e-filing by certain large organizations....................................................................................................71

Implement standards clarifying when employee leasing companies can be held liable for their clients’ 

Federal employment taxes.............................................................................................................................73

Amend collection due process procedures for employment tax liabilities............................................................75

STRENGTHEN TAX ADMINISTRATION ......................................................................................................................77

Expand IRS access to information in the national directory of new hires for tax administration purposes.........77

Permit disclosure of prison tax scams..................................................................................................................78

Make repeated willful failure to file a tax return a felony....................................................................................79

PENALTIES...............................................................................................................................................................80

Expand preparer penalties...................................................................................................................................80

Impose penalty on failure to comply with electronic filing requirements.............................................................81

Create an erroneous refund claim penalty ...........................................................................................................82

IMPROVE TAX ADMINISTRATION AND OTHER MISCELLANEOUS PROPOSALS..............................83

Make Section 1203 of the IRS Restructuring and Reform Act of 1998 more effective and fair............................83

Allow for the termination of installment agreements for failure to file returns and for failure to make 

deposits..........................................................................................................................................................85

Eliminate the monetary threshold for counsel review of offers in compromise....................................................86

Allow the Financial Management Service to impose and retain transaction fees................................................87

Extend IRS authority to fund undercover operations ...........................................................................................88

Eliminate the special exclusion from unrelated business taxable income for gain or loss on the sale or

exchange of certain brownfields....................................................................................................................89

Limit related party interest deductions.................................................................................................................91

Repeal telephone excise tax on local service........................................................................................................93

Modify financing of the Airport and Airway Trust Fund......................................................................................95

IMPROVE UNEMPLOYMENT INSURANCE.....................................................................................................97

Strengthen the financial integrity of the unemployment insurance system by reducing improper benefit 

payments and tax avoidance..........................................................................................................................97

Extend unemployment insurance surtax ...............................................................................................................99

ENERGY PROVISIONS ........................................................................................................................................101

Repeal reduced recovery period for natural gas distribution lines....................................................................101

Modify amortization for certain geological and geophysical expenditures........................................................102

EXTEND EXPIRING PROVISIONS....................................................................................................................103

Minimum tax relief for individuals.....................................................................................................................103

Permanently extend the Research & Experimentation (R&E) tax credit ...........................................................105

Work Opportunity Tax Credit.............................................................................................................................107

First-time homebuyer credit for the District of Columbia..................................................................................109

Authority to issue Qualified Zone Academy Bonds ............................................................................................110

Deferral of gains from the sale of electric transmission property......................................................................112

Disclosure of tax return information related to terrorist activity.......................................................................114

Excise tax on coal...............................................................................................................................................115

Qualified retirement plan distributions to individuals called to active duty ......................................................116

Include combat pay as earned income for EITC ................................................................................................118

REVENUE ESTIMATES TABLE.........................................................................................................................119

ii 
GENERAL EXPLANATIONS OF THE ADMINISTRATION’S FISCAL YEAR 2008 

REVENUE PROPOSALS

Introduction

This report summarizes the revenue proposals in the Administration’s Fiscal Year 2008 Budget. 

These proposals include making permanent the tax relief enacted in 2001 and 2003, which is 

essential for promoting economic growth and higher living standards in the future. The other 

proposals, also intended to strengthen the American economy, affect a wide range of areas, 

including simplifying and encouraging saving, encouraging entrepreneurship and investment, 

investing in health care, providing incentives for charitable giving, strengthening education, and 

protecting the environment. Additionally included are proposals to simplify the tax law for 

families, improve tax compliance, improve tax administration, improve unemployment 

insurance, modify energy provisions, and extend expiring tax provisions. 

Improve the Tax System to Make the U.S. More Competitive

Americans deserve a tax system that is simple, fair, and pro-growth – in tune with our dynamic, 

21st century economy. The tax system should allow taxpayers to make decisions based on 

economic merit, free of tax-induced distortions. The tax system should promote the 

competitiveness of American workers and businesses in the global economy. The Report of the 

President’s Advisory Panel on Federal Tax Reform has helped lay groundwork on ways to 

ensure that our tax system better meets the needs of today’s economy. 

The President’s tax relief enacted in 2001 and 2003 helped move the tax Code in this direction 

and the Administration has proposed changes that would improve the Code yet further. The FY 

2008 Budget includes proposals to make health care more affordable and consumer-driven, to 

promote savings for all Americans, and to encourage investment by entrepreneurs. The FY 2008 

Budget also recognizes that tax policy analysis needs to account fully for the economic benefits 

of policy changes on our economy. In the coming months, the Treasury Department will engage

in a public dialogue on how our tax system can be improved to make the United States more 

competitive in the global economy. 

A Dynamic Analysis Division within the Office of Tax Policy

Dynamic analysis emphasizes the potential economic benefits of tax changes for increasing and 

promoting economic growth and is particularly important for evaluating broad reforms of the tax 

system. Dynamic analysis recognizes a more comprehensive range of behavioral responses to 

tax changes, including how tax changes affect the size of the economy. 

The FY 2008 Budget includes funds for a Dynamic Analysis Division within the Treasury 

Department’s Office of Tax Policy, as proposed in the FY 2007 Budget, to conduct dynamic 

analysis of tax policy proposals. 

1
MAKE PERMANENT CERTAIN TAX RELIEF ENACTED IN 2001 AND 2003

Permanently Extend Certain Provisions of the 2001 Tax Relief and the 2003 Jobs and 

Growth Tax Relief

Current Law

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) created a new 

10-percent individual income tax rate bracket, reduced marginal income tax rates for individuals, 

doubled the child credit and extended its refundability, reduced marriage penalties, eliminated 

the phase-out of personal exemptions and the limitation on certain itemized deductions for 

higher-income taxpayers, provided additional incentives for education, increased IRA and 

pension incentives, provided relief from the alternative minimum tax (AMT), eliminated the 

estate and generation-skipping transfer taxes, and modified the gift tax. These and several other 

provisions of EGTRRA sunset on December 31, 2010. 

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) increased the amount of 

qualifying property that can be expensed in the year of purchase rather than being depreciated 

and lowered the tax rates on qualifying dividends and on capital gains. The liberalized 

expensing provision, as extended by the Tax Increase Prevention and Reconciliation Act of 2005 

(TIPRA), sunsets on December 31, 2009. The dividend and capital gains provisions, as extended 

by TIPRA, sunset on December 31, 2010. 

Reasons for Change

The tax relief and incentives to work, save, and invest provided by EGTRRA and JGTRRA are 

essential to the long-run performance of the economy. All taxpayers should have the certainty of

knowing that the provisions of EGTRRA will extend beyond 2010. Taxpayers plan for periods 

far beyond the scheduled sunset dates of the EGTRRA and JGTRRA provisions when saving for 

their children’s education, undertaking new business ventures, planning for retirement, and 

planning future contributions to charity and bequests for their children. Taxpayers require the 

certainty that can be provided today by permanently extending the provisions of EGTRRA and 

JGTRRA. Permanent extension of the provisions is essential for promoting growth and higher 

levels of income in the future. 

Proposal

The provisions of JGTRRA that sunset on December 31, 2009 and December 31, 2010 (as 

extended) would be permanently extended. The provisions of EGTRRA that sunset on 

December 31, 2010 would be permanently extended. 

3
Revenue Estimate1

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

188 -690 -1,595 -13,789 -146,193 -224,918 -387,185 -1,696,789

 1

 The estimate includes both receipts and outlay effects. The outlay effect is $79,618 million for 2008-2017. 

4
TAX INCENTIVES

Simplify and Encourage Saving

EXPAND TAX-FREE SAVINGS OPPORTUNITIES 

Current Law

Current law provides multiple tax-preferred individual savings accounts to encourage saving for 

retirement, education, and health expenses. The accounts have overlapping goals but are subject 

to different sets of rules regulating eligibility, contribution limits, tax treatment, and withdrawal 

restrictions. Individual Retirement Accounts (IRAs), including traditional, nondeductible, and 

Roth IRAs, are primarily intended to encourage retirement saving, but can also be used for 

certain education, medical, and other non-retirement expenses. Each of the three types of IRAs 

is subject to a different set of rules regulating eligibility and tax treatment. Coverdell Education 

Savings Accounts (ESAs) and Section 529 Qualified Tuition Programs (QTPs) are both intended 

to encourage saving for education, but each is subject to different rules. Archer Medical Savings 

Accounts (MSAs) and Health Savings Accounts (HSAs) are intended to encourage saving for 

medical expenses. 

Individual Retirement Accounts: Under current law, individuals under age 701⁄2 may make 

contributions to a traditional IRA, subject to certain limits. The contributions are generally 

deductible; however, the deduction is phased out for workers with incomes above certain levels 

who are covered by an employer-sponsored retirement plan. For taxpayers covered by employer 

plans in 2007, the deduction is phased out for single and head-of-household filers with modifiedadjusted gross income2

 (AGI) between $52,000 and $62,000, for married filing jointly filers with 

modified-AGI between $83,000 and $103,000, and for married filing separately filers with 

modified-AGI between $0 and $10,000. For a married, filing jointly taxpayer who is not 

covered, but whose spouse is covered by an employer-sponsored retirement plan, the deduction 

is phased out with modified-AGI between $156,000 and $166,000. Account earnings are not 

includible in gross income until distributed. Distributions (including both contributions and 

account earnings) are includible in gross income for income tax purposes. 

To the extent a taxpayer cannot or does not make deductible contributions to a traditional IRA, a 

taxpayer under age 701⁄2 may make nondeductible contributions. In this case, distributions 

representing a return of basis are not includible in gross income, while distributions representing 

account earnings are includible in gross income. There is no income limit for nondeductible 

contributions to a traditional IRA. 

Individuals of any age may make contributions to a Roth IRA. The contributions are not 

deductible. Allowable contributions are phased out for workers with incomes above certain 

levels. In 2007, contributions are phased out for single or head-of-household filers with 

modified-AGI between $99,000 and $114,000, for married filing jointly filers with modified-

 2

 AGI plus income from education savings bonds, interest paid on education loans, employer-provided adoption 

assistance benefits, IRA deductions, deductions for qualified higher education expenses, and certain other 

adjustments. 

5
AGI between $156,000 and $166,000, and for married filing-separate filers with modified-AGI 

between $0 and $10,000. Account earnings accumulate tax free, and qualified distributions 

(including account earnings) are not included in gross income for income tax purposes. 

Nonqualified distributions from Roth IRAs are included in income (to the extent they exceed 

basis) and subject to an additional tax. Distributions are deemed to come from basis first. 

The annual aggregate limit on contributions to all of a taxpayer’s IRAs (traditional, 

nondeductible, and Roth) is the lesser of earnings or $4,000 for 2007. The contribution limit is 

scheduled to increase to $5,000 in 2008 and will be indexed for inflation after 2008. Individuals 

age 50 and over may make an additional “catch-up” contribution of up to $1,000. 

Taxpayers with AGI of $100,000 or less and who are not married filing separately can convert a 

traditional IRA to a Roth IRA. In general, the conversion amount is included in gross income

(but not for purposes of the $100,000 limit). The Tax Increase Prevention and Reconciliation 

Act of 2005 repealed the income limitation for conversions from a traditional IRA to a Roth IRA 

made after December 31, 2009. Taxpayers who make such conversions in 2010 may include 

half of the conversion amount in income in each year, 2011 and 2012, and none of the amount in 

income in 2010. Conversions made on or after January 1, 2011 will be included in gross income

in the year of the conversion. 

Early distributions from IRAs are generally subject to an additional 10 percent tax. The tax is 

imposed on the portion of an early distribution that is includible in gross income. It applies in 

addition to ordinary income taxes on the distribution. The additional tax does not apply to a 

rollover to an employer plan or IRA, or if the distribution is made in the cases of death or 

disability, certain medical expenses, first-time homebuyer expenses, qualified higher-education 

expenses, health insurance expenses of unemployed individuals, or as part of a series of 

substantially equal periodic payments. 

Minimum distribution rules require that, beginning at age 701⁄2, the entire amount of a traditional 

IRA be distributed over the expected life of the individual (or the joint lives of the individual and 

a designated beneficiary). Roth IRAs are not subject to minimum distribution rules during the 

account owner’s lifetime. 

Coverdell Education Savings Accounts: Taxpayers may elect to contribute up to $2,000 per year 

to an ESA for beneficiaries under age 18. The contribution limit is phased out for single filers 

with modified-AGI between $95,000 and $110,000 and for joint filers with modified-AGI 

between $190,000 and $220,000. Contributions are not deductible, but earnings on contributions 

accumulate tax-free. Distributions are excludable from gross income to the extent they do not 

exceed qualified education expenses that are incurred during the year the distributions are made 

and that are not used to claim another tax benefit (such as an education tax credit or a tax-free 

distribution from a qualified tuition program). The earnings portion of a distribution not used to 

cover qualified education expenses is includible in the gross income of the beneficiary and is 

generally subject to an additional 10 percent tax. 

Except in the case of a special needs beneficiary, when a beneficiary reaches age 30, the account 

balance is deemed to have been distributed for nonqualified purposes. However, prior to the 

6
beneficiary reaching age 30, tax-free (and penalty-free) rollovers of account balances may be 

made to an ESA benefiting another family member. 

Section 529 Qualified Tuition Programs: Contributions to a QTP are not deductible from income

for Federal tax purposes, but earnings on contributions accumulate tax-free. Taxpayers may 

exclude from gross income amounts distributed from a QTP and used for qualified higher 

education expenses, so long as the distribution is not used for the same educational expenses for 

which another tax benefit (such as an education tax credit or a tax-free distribution from an ESA) 

is claimed. Nonqualified distributions are subject to an additional tax. A change in the 

designated beneficiary of an account is not treated as a distribution, and therefore is not subject 

to income tax, if the new beneficiary is a member of the family of the prior beneficiary. Neither 

contributors nor beneficiaries may direct the investment of the account. 

There is no specific dollar cap on annual contributions to a QTP. In addition, there is no limit on

contributions to a QTP account based on the contributor’s income, contributions are allowed at 

any time during the beneficiary’s lifetime, and the account can remain open after the beneficiary 

reaches age 30. However, a QTP must provide adequate safeguards to prevent contributions on 

behalf of a designated beneficiary in excess of amounts necessary to provide for the qualified 

higher education expenses of the beneficiary. 

Some States allow contributions to be excluded from income for State income tax purposes. 

Health Savings Accounts: Individuals who are covered by a qualifying high deductible health 

plan and not covered by any non-high deductible health plan other than certain permitted or

disregarded coverage may contribute to a Health Savings Account (HSA) that can be used to 

reimburse the individuals’ and their dependents’ health expenses. Employers may also make 

contributions to employees’ HSAs. The high deductible health plan may be provided by an 

employer or purchased in the individual insurance market. Individuals who are eligible for 

Medicare or to be claimed as a dependent on someone else’s return may not contribute to an 

HSA. Contributions to HSAs are deductible and qualified distributions are excluded from gross 

income. Nonqualified distributions are subject to income tax and, if taken prior to age 65, an 

additional 10 percent tax. 

Archer Medical Savings Accounts: Self-employed individuals and individuals employed by 

small employers maintaining a high deductible health plan (defined more restrictively than under 

the HSA provisions) are allowed to accumulate funds in an Archer Medical Savings Account 

(MSA) on a tax-preferred basis to pay for medical expenses. An individual is eligible to 

establish an MSA only if the employee (or the employee’s spouse) is covered by a highdeductible health plan (and not covered by any non-high deductible health plan). Although 

individuals with MSAs can continue to contribute to them as long as they are with an MSA 

participating employer, no new MSAs are permitted after the end of 2007 except with respect to 

individuals being hired after 2007 by an MSA-participating employer. Contributions to MSAs 

are deductible and qualified distributions are excluded from gross income. Nonqualified 

distributions are subject to income tax and, if taken prior to age 65, an additional 15 percent tax. 

7
Reasons for Change

The plethora of individual savings accounts, each subject to different rules regarding eligibility, 

contributions, tax treatment, and withdrawal, creates complexity and redundancy in the Code. 

Taxpayers must determine their eligibility for each account separately and then must decide 

which plan or plans are best for them given their circumstances. Furthermore, as their 

circumstances change over time, taxpayers must continually re-evaluate their eligibility for each 

plan and which best meets their needs. The current list of non-retirement exceptions within IRAs

weakens the focus on retirement saving, and the IRA exceptions and special purpose savings 

vehicles place a burden on taxpayers to document that withdrawals are used for certain purposes 

that Congress has deemed qualified. In addition, the restrictions on withdrawals and additional 

tax on early distributions discourage many taxpayers from making contributions because they are 

concerned about the inability to access the funds should they need them. Consolidating the three 

types of IRAs under current law into one account dedicated solely to retirement, and creating a 

new account that could be used to save for any reason would simplify the taxpayer’s decisionmaking process while further encouraging savings. 

Savings will be further simplified and encouraged by administrative changes to the tax filing 

process that, beginning in the 2007 filing season, will allow taxpayers to direct that their tax 

refunds be directly deposited into more than one account. Consequently, taxpayers will be able, 

for example, to direct that a portion of their tax refunds be deposited into a Retirement Savings 

Account or Lifetime Savings Account described below. Simplifying the rules, making savings 

opportunities universally available, and making it easier for people to set money aside through 

direct deposit will complement the Administration’s commitment to programs focusing on 

financial education and, specifically, retirement planning. 

Proposal

The proposal would consolidate the three types of current law IRAs into a single account: a 

Retirement Savings Account (RSA). RSAs would be dedicated solely to retirement savings; 

other withdrawals would be subject to tax and penalty as described below. Instead of a list of 

exceptions for penalty-free early withdrawals, a new account, a Lifetime Savings Account (LSA) 

would be created that could be used to save for any purpose, including retirement savings, health 

care, emergencies, and education. 

 

Individuals could contribute up to $5,000 per year (or earnings includible in gross income, if 

less) to their RSA. As under current law IRAs, for an individual who is married filing a joint 

return, the compensation limitation will only be binding if the combined includible compensation 

of the spouses is less than $10,000. No income limits would apply to RSA contributions. 

Contributions would have to be in cash. Contributions would be nondeductible, but earnings 

would accumulate tax-free, and qualified distributions would be excluded from gross income. 

The RSA contribution limit would be indexed for inflation. 

Qualified distributions from the RSA would be distributions made after age 58 or in the event of 

death or disability. Any other distribution would be a nonqualified distribution and, as with 

current non-qualified distributions from Roth IRAs, would be includible in income (to the extent 

8
it exceeds basis) and subject to a 10 percent additional tax. Distributions would be deemed to 

come from basis first. As with current law Roth IRAs, no minimum required distribution rules 

would apply to RSAs during the account owner’s lifetime. Married individuals could roll 

amounts from their RSA over to their spouses’ RSA. 

Existing Roth IRAs would be renamed RSAs and be made subject to the new rules for RSAs. 

Existing traditional and nondeductible IRAs could be converted into an RSA by taking the 

conversion amount into gross income, similar to a current-law Roth conversion. However, no 

income limit would apply to the ability to convert. Taxpayers who convert IRAs to RSAs before 

January 1, 2009, could include the conversion amount in income ratably over 4 years. 

Conversions made on or after January 1, 2009, would be included in income in the year of the 

conversion. Existing traditional or nondeductible IRAs that are not converted to RSAs could not 

accept any new contributions. New traditional IRAs could be created to accommodate rollovers 

from employer plans, but they could not accept any new individual contributions. Individuals 

wishing to roll an amount directly from an employer plan to an RSA could do so by taking the 

rollover amount (excluding basis) into gross income (i.e., “converting” the rollover, similar to a 

current law Roth conversion). 

Amounts converted to an RSA from a traditional IRA or from an Employer Retirement Savings 

Account (ERSA) would be subject to a 5-year holding period. Distributions attributable to a 

conversion from a traditional IRA or ERSA (other than amounts attributable to a Roth-type 

account in an ERSA) prior to the end of the 5-year period starting with the year the conversion 

was made or, if earlier, the date on which the individual turns 58, becomes disabled, or dies 

would be subject to an additional 10 percent early distribution tax on the entire amount. The 5-

year period is separately determined for each conversion contribution. To determine the amount 

attributable to a conversion, a distribution is treated as made in the following order: regular 

contributions; conversion contributions (on a first-in-first-out basis); earnings. To the extent a 

distribution is treated as made for a conversion contribution, it is treated as made first from the 

portion, if any, that was required to be included in gross income because of the conversion. 

Individuals could contribute up to $2,000 per year to their LSA, regardless of wage income. No 

income limits would apply to LSA contributions. Contributions would have to be in cash. The 

time period for which the contribution limit applies is the calendar year. Contributions would be 

nondeductible, but earnings would accumulate tax-free, and all distributions would be excluded 

from gross income, regardless of the individual’s age or use of the distribution. As with current 

law Roth IRAs, no minimum required distribution rules would apply to LSAs during the account 

owner’s lifetime. 

Contribution limits would apply to all accounts held in an individual’s name, rather than to 

contributors. Thus, contributors could make annual contributions of up to $2,000 each to the 

accounts of other individuals, but the aggregate of all contributions to all accounts held in a 

given individual’s name could not exceed $2,000. The LSA contribution limit would be indexed 

for inflation. 

Control over an account in a minor’s name would be exercised exclusively for the benefit of the 

minor, until the minor reached the age of majority (determined under applicable State law), by 

9
the minor's parent or legal guardian acting in that capacity. Married individuals could roll 

amounts from their LSAs over to their spouses’ LSAs. 

Taxpayers would be able to convert balances in ESAs and QTPs to LSA balances. All 

conversions made before January 1, 2009, would be on a tax-free basis, subject to the following 

limitations. An amount can be rolled into an individual’s LSA from a QTP only if that 

individual was the beneficiary of the QTP or ESA as of December 31, 2006. The amount that 

can be rolled over to an LSA from an ESA is limited to the sum of the amount in the accounts as 

of December 31, 2006, plus any contributions to and earnings on the accounts in 2007. The 

amount that can be rolled over to any LSA from a QTP is limited to the sum of (i) the lesser of 

$50,000 or the amount in the QTP as of December 31, 2006, plus (ii) any contributions and 

earnings to the QTP during 2007. Total rollovers to an individual’s LSA attributable to 2007 

contributions from the individual’s ESAs and QTPs cannot exceed $2,000 (plus any earnings on 

those contributions). 

QTPs would continue to exist as separate types of accounts, but could be offered inside an LSA. 

For example, State agencies that administer QTPs could offer LSAs with the same investment 

options available under the QTP. The plan administrator would be freed from the additional 

reporting requirements of a QTP for investments in an LSA, but investors would be subject to 

the annual LSA contribution limit. Distributions for purposes other than education would not be 

subject to Federal income tax or penalties. However, States would be free to provide State tax 

incentives, and administrators would be free to provide investment incentives, for savings used 

for educational purposes. 

The Saver’s Credit would apply to contributions to an RSA but would not apply to contributions 

to an LSA. 

Both LSAs and RSAs would become effective beginning on January 1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 1,527 3,545 3,023 1,075 -1,314 7,856 -592

10
CONSOLIDATE EMPLOYER-BASED SAVINGS ACCOUNTS 

Current Law

Qualified Retirement Plans: Under Code section 401, employers may establish for the benefit of 

employees a retirement plan that may qualify for tax benefits, including a tax deduction to the 

employer for contributions, a tax deferral to the employee for elective contributions and their 

earnings, and a tax exemption for the fund established to pay benefits. To qualify for tax 

benefits, the plan must satisfy multiple requirements. Among the requirements, the plan may not 

discriminate in favor of highly-compensated employees (HCEs) with regard either to coverage or

to amount or availability of contributions or benefits. The following cover some, but not all, of 

the defined-contribution plan rules. 

Contribution Limits. For 2007, the total annual contribution to a participant’s account may not 

exceed the lesser of $45,000 (adjusted annually for inflation) or 100 percent of compensation. 

General Nondiscrimination Requirement. Qualified plans, both defined-benefit and definedcontribution, must comply with the section 401(a)(4) prohibition on contributions or benefits that 

discriminate in favor of HCEs. Detailed regulations spell out the calculations required for 

satisfying this provision, including optional safe harbors and a general test for nondiscrimination. 

Contribution Tests. In addition to the general nondiscrimination requirement, definedcontribution plans that have after-tax contributions or matching contributions are subject to the 

actual contribution percentage (ACP) test. This test measures the contribution rate to HCEs’ 

accounts relative to the contribution rate to non-highly-compensated employees’ (NHCEs’) 

accounts. To satisfy the test, the ACP of HCEs generally cannot exceed the following limits: 

200 percent of the NHCEs’ ACP if the NHCEs’ ACP is 2 percent or less; 2 percentage points 

over the NHCEs’ ACP if the NHCEs’ ACP is between 2 percent and 8 percent; or 125 percent of 

the NHCEs’ ACP if the NHCEs’ ACP is 8 percent or more. 

Three “safe-harbor” designs are deemed to satisfy the ACP test automatically for employer 

matching contributions (up to 6 percent of compensation) that do not increase with an 

employee’s rate of contributions or elective deferrals. In the first, vested employer matching 

contributions on behalf of NHCEs are equal to 100 percent of elective deferrals up to 3 percent 

of compensation, and 50 percent of elective deferrals between 3 and 5 percent of compensation. 

In the second, vested employer matching contributions follow an alternative matching formula 

such that the aggregate amount of matching contributions is no less than it would be under the 

first design. In the third, vested employer non-elective contributions are at least 3 percent of 

compensation made on behalf of all eligible NHCEs. 

Vesting. In general, employer contributions must vest at least as quickly as under one of the 

following schedules. Under graded vesting, 20 percent of the benefit is vested after three years 

of service and an additional 20 percent vests with each additional year of service, so that the 

employee is fully vested after seven years of service. Under cliff vesting, the employee has no 

vested interest until five years of service has been completed, but is then fully vested. However, 

matching contributions must vest more quickly: under graded vesting, the first 20 percent must 

11
vest after two years of service, so that the employee is fully vested after six years of service, and 

under cliff vesting, the employee becomes fully vested after three years of service. 

401(k) plans. Private employers may establish 401(k) plans, which allow participants to choose 

to take compensation in the form of cash or a contribution to a defined-contribution plan 

(“elective deferral”). In addition to the rules applying to qualified defined-contribution plans, 

401(k) plans are subject to additional requirements. 

Annual deferrals under a 401(k) plan may not exceed $15,500 in 2007. Participants aged 50 or 

over may make additional “catch-up” deferrals of up to $5,000. These contribution limits are 

indexed annually for inflation. Elective deferrals are immediately fully vested. 

401(k) plans are subject to an actual deferral percentage (ADP) test, which generally measures 

employees’ elective-deferral rates. In applying the ADP test, the same numerical limits are used 

as under the ACP test. Three 401(k)-plan “safe-harbor” designs (similar to the safe-harbor 

designs for the ACP test described above) are deemed to satisfy the ADP test automatically. 

SIMPLE 401(k) plans. Employers with 100 or fewer employees and no other retirement plan 

may establish SIMPLE 401(k) plans. Deferrals of SIMPLE participants may not exceed 

$10,500. SIMPLE participants aged 50 or over may make additional “catch-up” deferrals of up 

to $2,500. All contributions are immediately fully vested. In lieu of the ADP test, SIMPLE 

plans are subject to special contribution requirements, including a lower annual elective deferral 

limit and either a matching contribution not exceeding 3 percent of compensation or non-elective 

contribution of 2 percent of compensation.3

Thrift plans. Employers may establish thrift plans under which participants may choose to make 

after-tax cash contributions. Such after-tax contributions, along with any matching contributions 

that an employer elects to make, are subject to the ACP test (without the availability of an ACP 

safe harbor). Employee contributions under a thrift plan are not subject to the $15,500 limit that 

applies to employee pre-tax deferrals. 

Roth-treatment of contributions. Effective after December 31, 2005, participants in 401(k) and 

403(b) plans can elect Roth treatment for their contributions. That is, contributions would not be 

excluded from income and distributions would not be included in income. Roth contributions 

must be accounted for in a separate account. There are no required minimum distributions 

during an employee’s lifetime, but heirs, other than a spouse, are subject to required minimum

distributions. 

Salary reduction simplified employee pensions (SARSEPs). Employees can elect to have 

contributions made to a SARSEP or to receive the amount in cash. The amount the employee 

elects to have contributed to the SARSEP is not currently includible in income and is limited to 

the dollar limit applicable to employee deferrals in a 401(k) plan. SARSEPs are available only 

for employers who had 25 or fewer eligible employees at all times during the prior taxable year

and are subject to a special nondiscrimination test. The rules permitting SARSEPs were repealed 

 3

 Employer contributions and employee deferrals may be made to SIMPLE IRAs under rules very similar to those 

applicable to SIMPLE 401(k) plans. 

12
in 1996, but employee deferral contributions can still be made to SARSEPs that were established 

prior to January 1, 1997. 

403(b) plans: Section 501(c)(3) organizations and public schools may establish tax-sheltered 

annuity plans, also called 403(b) plans. The rules applicable to these plans are different in 

certain respects than rules applicable to qualified plans under section 401. Benefits may 

generally only be provided through the purchase of annuities or contributions to a custodial 

account invested in mutual funds. Contribution limits (including catch-ups), deferral limits, and 

minimum distribution rules are generally the same as for 401(k) plans. However, certain 

employees with 15 years of service may defer additional amounts according to a complicated 

three-part formula. Some 403(b) plans are subject to some nondiscrimination rules. 

Governmental 457(b) plans: State and local governments may establish eligible plans under 

section 457(b).4 In general, these plans are subject to different rules than qualified plans that are 

defined under section 401. Contributions and plan earnings are tax-deferred until withdrawal. 

Contributions may not exceed the lesser of 100 percent of compensation or $15,500 in 2007. 

However, participants may make additional contributions of up to twice the standard amount are 

permitted in the last three years before normal retirement age. Additional “catch-up” 

contributions of up to $5,000 may be made for participants age 50 or over.

Reasons for Change

The rules covering employer retirement plans are among the lengthiest and most complicated 

sections of the Code and associated regulations. The extreme complexity imposes substantial 

compliance, administrative, and enforcement costs on employers, participants, and the 

government (and hence, taxpayers in general). Moreover, because employer sponsorship of a 

retirement plan is voluntary, the complexity discourages many employers from offering a plan at 

all. This is especially true of the small employers who together employ about two-fifths of 

American workers. Complexity is often cited as a reason the coverage rate under an employer 

retirement plan has not grown above about 50 percent overall, and has remained under 25 

percent among employees of small firms. Reducing unnecessary complexity in the employer 

plan area would save significant compliance costs and would encourage additional coverage and 

retirement saving. 

Proposal

The proposal would consolidate those types of defined-contribution accounts that permit 

employee deferrals or employee after-tax contributions, including 401(k), SIMPLE 401(k), 

Thrift, 403(b), and Governmental 457(b) plans, as well as SIMPLE IRAs and SARSEPs, into 

Employer Retirement Savings Accounts (ERSAs), which would be available to all employers 

and have simplified qualification requirements. 

The proposal would become effective for years beginning after December 31, 2007. 

 4

 Tax-exempt organizations are also permitted to establish eligible section 457(b) plans, but such plans are not 

funded arrangements and are generally limited to management or highly compensated employees. 

13
ERSAs would follow the existing rules for 401(k) plans, subject to the plan qualification 

simplifications described below. Thus, employees could defer wages of up to $15,500 annually, 

with employees aged 50 and older able to defer an additional $5,000 in 2007. The maximum 

deferral amounts, as under current law, would be adjusted annually for inflation. The maximum 

total contribution (including employer contributions) to ERSAs would be the lesser of 100 

percent of compensation or $45,000 in 2007 (adjusted annually for inflation). The taxability of 

contributions and distributions from an ERSA would be the same as contributions and 

distributions from the plans that the ERSA would be replacing. Thus, contributions could be 

pre-tax deferrals or after-tax employee contributions or Roth contributions, depending on the 

design of the plan. Distributions of Roth and non-Roth after-tax employee contributions and 

qualified distributions of earnings on Roth contributions would not be included in income. All 

other distributions would be included in the participants’ income. 

Existing 401(k) and Thrift plans would be renamed ERSAs and could continue to operate as 

before, subject to the simplification described below. Existing SIMPLE 401(k) plans, SIMPLE 

IRAs, SARSEPs, 403(b) plans, and governmental 457(b) plans could be renamed ERSAs and be 

subject to ERSA rules, or could continue to be held separately, but if held separately could not 

accept any new contributions after December 31, 2008, with a special transition for collectively 

bargained plans and plans sponsored by State and local governments. 

Special Rule for Small Employers. Employers that had 10 or fewer employees making at least 

$5,000 during the prior year would be able to fund an ERSA by contributing to a custodial 

account, similar to a current-law IRA, provided the employer’s contributions satisfy the designbased ERSA safe harbor described below. This custodial account would provide annual 

reporting relief for small employers as well as relief from most of the ERISA fiduciary rules 

under circumstances similar to the fiduciary relief currently provided to sponsors of SIMPLE 

IRAs.

ERSA Nondiscrimination Testing. The following single test would apply for satisfying the 

nondiscrimination requirements with respect to contributions for ERSAs: the average 

contribution percentage of HCEs could not exceed 200 percent of NHCEs’ percentage if the 

NHCEs’ average contribution percentage is 6 percent or less. In cases in which the NHCEs’ 

average contribution percentage exceeds 6 percent, the goal of increasing contributions among 

NHCEs would be deemed satisfied, and no nondiscrimination testing would apply. For this 

purpose, “contribution percentage” would be calculated for each employee as the sum of all 

employee and employer contributions divided by the employee’s compensation. The ACP and 

ADP tests would be repealed. Plans sponsored by State and local governments or churches 

would not be subject to this test. A plan sponsored by a section 501(c)(3) organization would not 

be subject to this nondiscrimination test (unless the plan permits after-tax or matching 

contributions) but would be required to permit all employees of the organization to participate. 

ERSA Safe Harbor. The design-based safe harbor described below would be sufficient to satisfy 

the nondiscrimination test for ERSAs described above. The design of the plan must be such that 

all eligible NHCEs are eligible to receive fully vested employer contributions (including 

matching or non-elective contributions, but not including employee elective deferrals or after-tax 

contributions) of at least 3 percent of compensation. To the extent that the employer 

14
contributions of 3 percent of compensation for NHCEs are matching contributions rather than 

non-elective contributions, the match formula must be one of two qualifying formulas. The first 

formula would be a 50 percent employer match for the elective contributions of the employee up 

to 6 percent of the employee’s compensation. The second would be any alternative formula such 

that the rate of an employer’s matching contribution does not increase as the rate of an 

employee’s elective contributions increases, and the aggregate amount of matching contributions 

at such rate of elective contribution is at least equal to the aggregate amount of matching 

contributions which would be made if matching contributions were made on the basis of the 

percentages described in the first formula. In addition, the rate of matching contribution with 

respect to an HCE at any rate of elective contribution cannot be greater than that with respect to 

an NHCE. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -80 -120 -132 -141 -150 -623 -1,484

15
Encourage Entrepreneurship and Investment

INCREASE EXPENSING FOR SMALL BUSINESS 

Current Law

Section 179 provides that, in place of capitalization and subsequent depreciation, certain 

taxpayers may elect to deduct up to $100,000 of the cost of qualifying property placed in service 

each taxable year. The $100,000 amount is reduced (but not below zero) by the amount by 

which the cost of qualifying property exceeds $400,000. Both limitations are indexed annually 

for inflation for taxable years beginning after 2003 and before 2010. (For taxable years 

beginning after December 31, 2009, the maximum deduction amount reverts back to $25,000, 

and the phase-out of the deductible amount begins at $200,000). Higher expensing amounts are 

allowed for investments in an empowerment zone or renewal community, or in the Gulf 

Opportunity (GO) Zone. 

In general, qualifying property is defined as depreciable tangible personal property and certain 

depreciable real property that is purchased for use in the active conduct of a trade or business. 

For taxable years beginning after 2002 and before 2010, off-the-shelf computer software is 

considered qualifying property even though it is intangible property. An election for the section 

179 deduction can be revoked on an amended return for taxable years beginning after 2002 and 

before 2010. In other years, elections can only be revoked with the consent of the 

Commissioner. 

Reasons for Change

The temporary expansion of section 179 provides a number of benefits to small business 

taxpayers and the economy. Expensing encourages investment by lowering the after-tax cost of 

capital purchases, relative to claiming regular depreciation deductions. Expensing is also simpler 

than claiming regular depreciation deductions, which is particularly helpful for small businesses. 

Including off-the-shelf computer software in section 179 means that purchased software is not 

disadvantaged relative to developed software (for which development costs can generally be 

expensed). Allowing revocations of section 179 elections to be made on amended returns helps 

less sophisticated taxpayers, who may not always be aware of the implications of section 179 

expensing when they file their initial tax return. Inflation-adjusting the specified dollar amounts 

ensures that the benefits of section 179 do not apply to an ever-shrinking share of business 

taxpayers. 

A further expansion of section 179 would extend the benefits of expensing to more taxpayers and 

would also simplify tax accounting for them. Making the expansion permanent would allow 

these businesses to improve their planning of future investments. 

Proposal

The proposal would expand the expensing provisions of section 179. Specifically, the proposal 

would increase the maximum amount of qualified property that a taxpayer may deduct under 

16
section 179 to $200,000, raise the amount of total qualifying investment at which the phase-out 

begins to $800,000 per year, and permanently include off-the-shelf computer software as 

qualifying property. Both the deduction limit and phase-out threshold would be indexed 

annually for inflation. In addition, the proposal would allow expensing elections to be made or 

revoked on amended returns. Furthermore, the Administration also proposes to make the higher 

amounts under section 179 permanent. 

The proposal would be effective for property placed in service in taxable years beginning on or 

after January 1, 2008. The $200,000 and $800,000 amounts would be indexed for inflation for 

any taxable year beginning in a calendar year after 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -1,597 -2,180 -1,541 -1,135 -847 -7,300 -10,095

17
Invest in Health Care

PROVIDE A NEW STANDARD DEDUCTION FOR HEALTH INSURANCE (SDHI) 

($15,000 FOR FAMILY COVERAGE AND $7,500 FOR SINGLE COVERAGE) 

Current Law

The cost of health coverage paid by an employer on behalf of employees is excludible for 

income and employment tax purposes. The employee’s portion of the cost of employersponsored coverage is also excludible for income and employment tax purposes if it is paid 

through a cafeteria plan. Out-of-pocket expenses can also be excluded from income and 

employment taxes if they are paid through a health flexible spending arrangement (FSA) under a 

cafeteria plan. 

Taxpayers’ health insurance premiums paid outside of the employment context (or paid outside 

of a cafeteria plan) as well as other medical expenses generally are not deductible except by 

taxpayers who itemize their deductions and only to the extent they exceed 7.5 percent of adjusted

gross income. Medical expenses and insurance premiums paid outside of the employment 

context are never excludible for employment tax purposes. 

Medical costs paid through a health savings account (HSA) or medical savings account (MSA) 

are generally excludible for income tax purposes, although the ability to pay health insurance 

premiums through an HSA is limited. 

Premiums for health insurance paid by self-employed individuals who are not eligible for 

subsidized employer coverage are deductible in computing adjusted gross income. 

Reason for Change

There are a number of ways the current exclusion for employer-based health coverage 

encourages employers to provide more coverage than necessary and has resulted in higher and 

less efficient health spending. The value of the current exclusion rises with the amount of 

insurance an employee purchases. This creates a tax bias in favor of more expensive insurance. 

Such insurance often has low deductibles or first dollar coverage, which reduces consumers’ 

sensitivity to the cost of health insurance because they are not exposed to the true cost of health 

care. The tax bias also creates an incentive for workers to channel more of their routine health 

expenses through their employer-based insurance. Coverage tends to be broader and include 

more incidental expenses. 

Workers who do not receive insurance through their employer but who purchase health insurance 

directly typically receive no tax benefit for buying health insurance. They pay for insurance after 

paying income and payroll taxes on their wages. In contrast, the health insurance premiums for 

workers who receive insurance through their jobs are subject to neither income nor payroll taxes. 

This disparate tax treatment can increase the after-tax cost of insurance purchased directly by 

individuals by as much as 50 percent. The after-tax cost of purchasing insurance is also higher 

18
for the self-employed who receive an income tax deduction, but no deduction for payroll tax 

purposes. 

Proposal

A standard deduction for health insurance (SDHI) of $15,000 for family coverage ($7,500 for 

single coverage) would be provided to all families who purchase health insurance that meets 

minimum requirements, whether directly or through an employer. 

One-twelfth of the full SDHI would apply for each month that an individual has qualifying 

coverage (determined on the first of the month), regardless of how much a family or individual 

spends on health insurance. A family or individual that spends less on health insurance than the 

full SDHI would still receive the full SDHI. The SDHI would apply for purposes of both the 

income and payroll taxes. 

The new SDHI would replace the existing exclusion for employer-based health insurance, the 

self-employed premium deduction, and the medical itemized deduction for those not enrolled in 

Medicare (typically those under 65 years of age). The current exclusion or deduction from 

income of health care spending, whether for insurance premiums or out-of-pocket expenses, 

except under a Health Savings Account, also would be repealed. Itemized medical deductions 

would still be available for taxpayers enrolled in Medicare. 

Employers would be required to report the value of health insurance coverage to their employees 

on their annual Form W-2 and such amounts would be subject to withholding and employment 

taxes. Employers would exclude a pro-rated portion of the SDHI for employment tax purposes 

for their employees who have qualifying coverage. Withholding and estimated taxes could be 

adjusted to reflect the SDHI. Businesses would continue to deduct employer-based health 

insurance as a business expense. In addition, the phase-out rate for the EITC for taxpayers with 

qualifying children would be reduced to 15 percent. 

 

Insurance coverage that qualifies a taxpayer for the SDHI, must meet certain minimum coverage 

requirements, including: 

• A limit on out-of-pocket exposure for covered expenses that is not higher than that 

currently allowable for HSAs (e.g., for 2007, those limits would be $5,500 for single 

coverage and $11,000 for family coverage). 

• A reasonable annual and/or lifetime benefit maximum. 

• Coverage for inpatient and outpatient care, emergency benefits, and physician care. 

• Guaranteed renewability by the provider. 

This minimum level of coverage is not intended to pre-empt State laws mandating certain 

coverage. Thus, eligible coverage would be subject to applicable State minimum coverage rules. 

Under regulations promulgated by the Treasury Department, the SDHI would be denied for 

19
coverage under policies that do not meaningfully limit individual economic exposure to 

extraordinary medical expenses. Long-term care insurance and Medicare would not qualify for 

the SDHI. 

Generally, individuals (including dependents) enrolled in Medicare, Medicaid or SCHIP would 

not qualify for the SDHI. As with the current exclusion for employer-based insurance, 

individuals would not be eligible to claim the SDHI if they claim the HCTC or use tax-preferred 

distributions from HSAs or MSAs to pay for premiums. An individual who can be claimed as a 

dependent on another filer’s return would not be eligible to claim the SDHI. 

The new SDHI would address the rising cost of health insurance by removing the tax bias for 

more expensive insurance, while also providing a potent incentive for the uninsured to purchase 

insurance. The proposal would break the link between the value of the tax subsidy and the 

amount of insurance a worker purchases. The proposal also would level the playing field 

between less expensive and more expensive health insurance, and between wages and employerprovided health insurance. 

Individuals and families would have a strong incentive to purchase insurance under the proposal. 

However, the insurance they choose to purchase would be based on their needs and 

circumstances rather than the tax bias in favor of health insurance and against wages. The tax 

bias for overly generous insurance would be eliminated. This change would translate into 

greater price sensitivity for health care consumers. Many of those with employer-based 

insurance would take advantage of the level playing field between wages and health insurance by 

receiving higher wages in exchange for less expensive health insurance. 

Treasury estimates that about 3 to 5 million more people would have health insurance under the 

proposal. 

The provision would be effective for tax years after December 31, 2008. 

Revenue Estimate5

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 0 -31,664 -43,521 -35,548 -24,748 -135,480 -32,735

 5

 The estimate includes both receipt and outlay effects. The outlay effect is $37,886 million for 2008-2017. 

20
EXPAND AND MAKE HEALTH SAVINGS ACCOUNTS (HSAs) MORE FLEXIBLE 

Current Law

Eligible individuals are allowed to accumulate funds in a Health Savings Account (HSA) on a 

tax-preferred basis to pay for medical expenses and retiree health coverage. 

Eligibility: In order to contribute to an HSA, an individual must be covered by a high-deductible 

health plan (HDHP) and generally no other health plan except for certain permitted or 

disregarded coverage. Individuals who can be claimed as a dependent on someone else’s return 

or who are enrolled in Medicare may not contribute to an HSA. An HSA may only be 

established on or after the first day of the first month that an individual is an eligible individual 

with HDHP coverage on the first day. 

Tax Treatment of Contributions and Earnings: Employer contributions to HSAs are excluded 

from employee income for income and employment tax purposes. Individual contributions to 

HSAs are deductible in computing the individual’s adjusted gross income (AGI), but are not 

deductible from payroll taxes. Earnings in an HSA accumulate tax-free. 

Tax Treatment of Distributions: Withdrawals for qualified medical expenses of the HSA owner, 

the owner’s spouse or dependent are not taxable. Qualified medical expenses are generally 

medical expenses as defined for the itemized medical expense deduction, with the addition of 

nonprescription drugs. However, qualified medical expenses do not include payments for 

insurance except in certain limited situations – a health plan during any period of continuation 

coverage under COBRA or other Federal law; qualified long-term care insurance, a health plan 

while an individual is receiving unemployment compensation under Federal or State law, or 

individuals who have reached age 65 (other than Medicare supplemental policies). Thus, most 

purchases of insurance with HSA funds are included in income and subject to the 10 percent tax 

on non-medical withdrawals to the extent applicable. There is no limit on the time for 

reimbursing qualified medical expenses that are incurred after the HSA is established. 

Nonmedical withdrawals are subject to an additional 10 percent tax if made before age 65 and 

are includable in income regardless of age. Reimbursements of qualified medical expenses that 

are excluded from income only include medical expenses incurred after the HSA is established. 

Consequently, where HDHP coverage begins after the first day of the month, any expenses 

incurred prior to the first day of the next month may not be reimbursed by the HSA on a taxfavored basis. 

HDHPs: In order to be an HDHP, a plan in 2007 must have a deductible of at least $1,100 for 

self-only coverage or $2,200 for family coverage. An HDHP in 2006 may not have a total outof-pocket exposure of more than $5,500 for self-only coverage or $11,000 for family coverage. 

The deductible minimums and out-of-pocket maximums are indexed for inflation. The out-ofpocket amount includes the deductible as well as copays and other amounts a covered individual 

must pay for covered benefits. For network plans, the out-of-pocket requirement only includes 

the out-of-pocket amounts for benefits provided in network. Out-of-pocket expenses do not 

include amounts paid by covered individuals for benefits excluded by reasonable benefit 

restrictions or exclusions. 

21
Contribution Limits: Annual contributions to HSAs are limited to $2,850 (for self-only coverage 

in 2007) or $5,650 (for family coverage in 2007). For network plans, only the deductible for 

benefits provided in-network is taken into account for purposes of determining the HSA 

maximum contribution. Maximum contributions are based on the sum of monthly limits, with 

contributions pro rated for individuals who are not eligible individuals for the entire year. For 

the initial year of HDHP coverage, however, an individual will be entitled to an entire year’s 

contribution limit, subject to a recapture of some that contribution (plus an additional 10 percent 

tax on that amount) if the individual does not remain in an HDHP for the 12-month period 

following the end of that first year. 

A special rule applies for determining HSA contributions by married individuals with family 

HDHP coverage. If one spouse has family coverage, both spouses are generally treated as 

having family coverage. The maximum annual family HSA contribution is divided between the 

spouses equally unless they agree on a different division, which can include allocating the entire 

contribution to one spouse. For this purpose, family coverage is defined as anything that is not 

self-only coverage; thus, family HDHP coverage (supporting a family-level contribution) is 

health coverage that covers one eligible individual and at least one other individual, regardless of 

the other individual’s coverage. A married individual with individual HDHP coverage may not 

make contributions to his or her spouse’s HSA based on the married individual’s self-only 

HDHP coverage. 

In addition to the annual contribution, individuals who attain age 55 during the year are allowed 

to make an additional catch up contribution. The catch up amount increases in $100 increments 

from $800 in year 2007 to $1000 for years after 2008. Catch up contributions are pro rated for 

the number of months that the HSA owner is an eligible individual. If both spouses qualify for 

the catch up contribution, both spouses are allowed the additional HSA contribution amount. 

However, one spouse is not permitted to have his or her catch up contribution made to the HSA 

owned by the other spouse. 

Employer Contributions: Employer contributions to HSAs are subject to comparability rules that 

generally require that if the employer contributes to one employee’s HSA, the employer must 

contribute the same amount or percentage of the HDHP deductible to all employees who are 

eligible individuals with comparable (i.e., self-only or family) coverage. The comparability rules 

do not apply to contributions made through a cafeteria plan. 

HRAs: Health Reimbursement Arrangements (HRAs) are employer-sponsored plans which 

allow employers to reimburse substantiated employee medical expenses up to a maximum

amount. Unlike a flexible spending arrangement (FSA) under section 125, unused HRA 

amounts may be used in later years. HRAs may not be funded by salary reduction. Employers 

may also provide health coverage through an FSA. HRAs are employer-provided health 

coverage that disqualify individuals from contributing to HSAs unless the HRA is designed to be 

compatible with HSA, such as being limited to reimbursing certain permitted or disregarded 

coverage and preventive care (limited purpose HRAs), reimbursing expenses after the deductible 

of the HDHP is satisfied (post-deductible HRAs), or combinations. The disqualification from

HSA contributions applies regardless of whether the HRA coverage is provided by the employer 

of the individual or spouse of the individual. 

22
Reasons for Change

Health care costs continue to rise rapidly in the United States. Empowering health care 

consumers to play a more direct role in their health care decisions, rather than third party payers, 

would help to stem this trend. A health care system that is more market-oriented and consumer 

driven will help control costs and result in health care that is more affordable and accessible. 

This goal can be facilitated by making HSAs more flexible and increasing the incentive for 

individuals to change to HSA-eligible coverage. 

Proposal

1. Plans with 50 percent coinsurance would qualify as HDHPs. Health plans would be 

considered HSA-eligible if they meet all the existing requirements of an HDHP except 

that, in lieu of satisfying the minimum deductible requirement, they have at least a 50

percent or higher coinsurance requirement and a minimum out-of-pocket exposure that, 

under guidelines established by the Secretary, would result in the same (or lower) 

premium as coverage under a high deductible health plan under the current requirements 

for the same family or individual. 

2. For HSA purposes, include as qualified medical expenses any medical expense incurred 

on or after the first day of HSA eligibility in a year. The existing rule that denies tax-free 

treatment for HSA funds used to pay medical expenses incurred prior to the 

establishment of the HSA would be changed so that HSA funds could be used to pay 

medical expenses incurred on or after the first day of eligibility in a particular year, as 

long as the HSA is established no later than the date for filing the return for that taxable 

year. This will provide more time for newly eligible taxpayers to set up their HSAs. 

3. Allow larger employer contributions for the chronically ill. Contributions to HSAs on 

behalf of employees who are chronically ill or employees who have spouses or 

dependents who are chronically ill would be excluded from the comparability rules to the 

extent the contributions exceed the comparable contributions for other employees. 

4. Allow family coverage to include coverage where each individual in the family can 

receive benefits once they have reached the minimum deductible for an individual 

HDHP. Many types of family coverage provide for an overall deductible that meets the 

requirements for family HDHP coverage, but include embedded deductibles for each

family member below the family deductible. Under current law this does not constitute 

an HDHP. Under the proposal, such coverage would constitute a family HDHP if each 

individual embedded deductible is at least the minimum deductible for individual HDHP 

coverage and the overall deductible is at least the minimum deductible for family HDHP 

coverage. 

5. If both spouses are eligible individuals, allow both spouses to contribute the catch-up 

contribution to a single HSA owned by one spouse. 

23
6. Allow contributions to HSAs to be made by individuals covered by an FSA or HRA, but 

offset the maximum allowable HSA contribution by the level of FSA or HRA coverage. 

Currently, FSA or HRA participation generally disqualifies individuals from contribution 

to HSAs because of the first dollar nature of FSAs and HRAs. This proposal would make 

it much easier for individuals who change from a non-HDHP to an HDHP when they 

have HRA or FSA coverage. 

All of the changes described above would apply for tax years beginning after December 31, 

2007. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

High coinsurance policies eligible for HSAs 

0 -253 -488 -663 -804 -895 -3,103 -8,898

Other HSA enhancements 

0 -65 -105 -121 -133 -142 -566 -1,468

Total 

0 -318 -593 -784 -937 -1,037 -3,669 -10,366

24
IMPROVE THE HEALTH COVERAGE TAX CREDIT 

Current Law

The Health Coverage Tax Credit (HCTC) was created under the Trade Adjustment Assistance 

Reform Act of 2002 (TAA) for the purchase of qualified health insurance for eligible individuals 

and for their family members. The HCTC is refundable and equal to 65 percent of the cost of 

qualified health insurance paid by eligible individuals, including certain recipients of the TAA or 

Alternative TAA (ATAA) benefits and certain individuals between the ages of 55 and 64 who 

are receiving pension benefits from the Pension Benefit Guaranty Corporation (PBGC). 

Individuals can claim the HCTC as part of the tax-filing process or through an advance payment 

program at the time qualified insurance is purchased. The HCTC is not available (either for the 

eligible individual or the eligible individual’s family) once the eligible individual becomes 

entitled to Medicare coverage. 

Since 1997, the Health Insurance Portability and Accountability Act (HIPAA) has provided 

protections for individuals who have 12 months of creditable coverage (generally continuous 

health coverage without a gap of more than 63 days). To be a qualified State-based HCTC plan, 

however, a plan must provide protections similar to the HIPAA protections for individuals who 

have only 3 months of creditable coverage. 

Reasons for Change

Making the requirements for qualified State-based coverage under the HCTC more consistent

with the HIPAA rules encourages plans to participate in the HCTC program. Also, there are 

many cases in which the eligible individual is (or becomes) entitled to Medicare coverage but 

has a spouse who is younger. In these cases, the younger spouse is not entitled to the credit, even 

though the younger spouse would be entitled to the credit if he or she were receiving benefit 

checks from the PBGC (as a survivor or divorcee). Finally, a number of issues should be 

clarified in order to facilitate the administration of the HCTC. 

Proposal

First, the proposal would subject State-based HCTC coverage to rules more like the HIPAA rules 

by allowing State-based coverage to impose a pre-existing condition restriction for a period of up 

to 12 months, provided the plan reduces the restriction period by the length of the eligible 

individual’s creditable coverage (as of the date they apply for the State-based coverage). This 

provision would be effective for eligible individuals applying for coverage after December 31, 

2007. Second, effective for taxable years beginning after December 31, 2007, the proposal 

would permit spouses of HCTC-eligible individuals to claim the HCTC when the HCTC-eligible 

individual becomes entitled to Medicare coverage. The spouse, however, would have to be at 

least 55 years old and meet the other HCTC eligibility requirements. Third, the proposal would 

provide the following clarifications: 

1. Clarify that individuals who elect to receive one-time lump sum payments from the 

PBGC and certain alternative PBGC payees would be eligible for the HCTC. 

25
2. For purposes of the State-based coverage rules, deem the Commonwealths of Puerto Rico 

and the Northern Mariana Islands as well as American Samoa, Guam, and the U.S. Virgin 

Islands to be States. 

3. Clarify that State continuation coverage provided under a State law would automatically 

qualify as “qualified health insurance,” as Federally mandated COBRA continuation 

coverage, without meeting the requirements relating to State-based qualified coverage. 

4. Apply the same list of “other specified coverage” to all eligible individuals by changing 

the definition of “other specified coverage” for “eligible ATAA recipients” to conform to 

the definition applied to other eligible individuals. 

Revenue Estimate6

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -5 -13 -16 -19 -20 -73 -190

 6

 The estimate includes both receipt and outlay effects. The outlay effect is $139 million for 2008-2017. 

26
ALLOW THE ORPHAN DRUG TAX CREDIT FOR CERTAIN PRE-DESIGNATION 

EXPENSES 

Current Law

Taxpayers may claim a 50-percent credit for expenses related to human clinical testing of drugs 

for the treatment of certain rare diseases and conditions, generally those that afflict less than 

200,000 persons in the United States (orphan drug credit). Qualifying expenses are those paid or 

incurred by the taxpayer after the date on which the drug is designated as a potential treatment 

for a rare disease or disorder by the Food and Drug Administration (FDA) in accordance with the 

section 526 of the Federal Food, Drug, and Cosmetic Act. Research expenses claimed for the 

orphan drug credit are not eligible for the credit for increasing research under section 41 of the 

Code. 

Reasons for Change

Currently, expenditures for human clinical trials are eligible for the credit only after the FDA 

designates the drug as a potential treatment for a rare disease or condition. Expenses for clinical 

trials that the taxpayer undertakes while the FDA reviews the taxpayer’s application for 

designation are ineligible. This creates an incentive to defer clinical testing for orphan drugs 

until the taxpayer receives the FDA’s approval and complexity for taxpayers by treating predesignation and post-designation clinical expenses differently. The proposal would reduce the 

incentive to defer clinical testing while the FDA reviews the taxpayer’s application for

designation of a drug as an orphan drug and simplify the credit by treating pre-designation 

expenses and post-designation expenses equally. 

Proposal

Taxpayers that incur expenses prior to FDA designation would be permitted to claim the orphan 

drug credit for these expenses if the drug receives FDA designation as a potential treatment for a 

rare disease or condition before the due date (including extensions) for filing the tax return for 

the year in which the FDA application was filed. 

The proposal would be effective for qualified expenses incurred after December 31, 2006. 

Revenue Estimate

[No revenue effect] 

27
Provide Incentives for Charitable Giving

PERMANENTLY EXTEND TAX-FREE WITHDRAWALS FROM IRAs FOR 

CHARITABLE CONTRIBUTIONS 

Current Law

Eligible individuals may make deductible contributions to a traditional individual retirement 

arrangement (traditional IRA). Other individuals with taxable income may make nondeductible 

contributions to a traditional IRA. Earnings and pre-tax contributions in a traditional IRA are 

includible in income when withdrawn. Withdrawals made before age 591⁄2 are subject to an 

additional 10-percent excise tax, unless an exception applies.

Individuals with adjusted gross incomes (AGI) below certain levels may make nondeductible 

contributions to a Roth IRA. Amounts withdrawn from a Roth IRA as a qualified distribution 

are not includible in income. A qualified distribution is a distribution made (1) after 5 years and 

(2) after the holder has attained age 591⁄2, died, or become disabled or is made for first-time 

homebuyer expenses of up to $10,000. Distributions from a Roth IRA that are not qualified 

distributions are includible in income to the extent the distributions are attributable to earnings, 

and are also subject to the additional 10-percent excise tax, unless an exception applies. 

Individual taxpayers who itemize their deductions may claim a deduction for contributions made 

to qualified charitable organizations. Total deductible contributions may not exceed 50 percent 

of the taxpayer’s AGI, and lower deductibility limits apply in the case of contributions of 

appreciated property and contributions to certain private foundations. Excess amounts may be 

carried forward and deducted in future years. In addition, the total of most categories of itemized 

deductions, including charitable contributions, is reduced by 2 percent of AGI in excess of a 

certain threshold ($156,400 for joint filers in 2007). Taxpayers who elect the standard deduction 

(“non-itemizers”) may not claim a deduction for charitable contributions. 

Through December 31, 2007, individuals may exclude from gross income (and thus from AGI 

for all purposes under the Code) distributions made after age 701⁄2 from a traditional or Roth IRA 

(but not a SIMPLE IRA or SEP IRA) directly to a qualified charitable organization. The 

exclusion may not exceed $100,000 per taxpayer per taxable year and is available without regard 

to the percentage of AGI limits that apply to deductible contributions. 

The exclusion does not apply to distributions to certain private foundations, supporting 

organizations, or donor advised funds. The exclusion applies only if a charitable contribution 

deduction for the entire distribution would otherwise be allowed under current law, determined 

without regard to the percentage-of-AGI limitation. No charitable deduction is allowed with 

respect to any amount that is excludable from income under this provision. If an amount 

transferred from the IRA would otherwise be nontaxable, such as a qualified distribution from a 

Roth IRA or the return of nondeductible contributions from a traditional IRA, the normal 

charitable contribution deduction rules apply. 

28
Reasons for Change

Allowing taxpayers who are at the stage in their life when they are already required to take 

distributions from their IRAs to exclude from income direct transfers to qualified charities will 

stimulate additional charitable giving by simplifying the required tax calculations and 

eliminating the current-law tax disincentives. Permanency will maintain this incentive.

Proposal

The exclusion from income of qualified distributions made after age 701⁄2 from a traditional or 

Roth IRA directly to a qualified charitable organization would be made permanent. 

Revenue Estimate 

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

--- -120 -255 -235 -171 -147 -928 -1,867

29
PERMANENTLY EXTEND THE ENHANCED CHARITABLE DEDUCTION FOR 

CONTRIBUTIONS OF FOOD INVENTORY 

Current Law

A taxpayer’s deduction for charitable contributions of inventory property generally is limited to 

the taxpayer’s basis (typically, cost) in the inventory. However, for certain contributions of 

inventory, C corporations may claim an enhanced deduction equal to the lesser of (1) the 

taxpayer’s basis in the contributed property, plus one-half of the gain that would have been 

realized had the property been sold or (2) two times basis. To be eligible for the enhanced 

deduction, the inventory must be contributed to a charitable organization (other than a private 

nonoperating foundation), and the donee must (1) use the property consistent with the donee’s 

exempt purpose solely for the care of the ill, the needy, or infants, (2) not transfer the property in 

exchange for money, other property, or services, and (3) provide the taxpayer a written statement 

that the donee’s use of the property will be consistent with these requirements. To claim the 

enhanced deduction, the taxpayer must establish that the fair market value of the donated item

exceeds basis. 

Through December 31, 2007, for donations of food inventory, all businesses, and not just C 

corporations, are eligible for the enhanced deduction. For all businesses, the enhanced deduction 

is available only for donations of “apparently wholesome food” (food intended for human 

consumption that meets all quality and labeling standards imposed by Federal, State, and local 

laws and regulations, even though the food may not be readily marketable due to appearance, 

age, freshness, grade, size, surplus, or other conditions). 

In the case of a taxpayer other than a C corporation, the total deduction for donated food 

inventory for any taxable year may not exceed 10 percent of the taxpayer’s net income from the 

related trade or business.

Reasons for Change

The enhanced deduction for contributions of food inventory increases donations of food by all 

types of businesses. Permanent extension of this provision supports charities working to combat 

hunger. 

Proposal

The proposal would make permanent the expansion of the enhanced deduction for donations of 

food inventory to all types of businesses and the clarification of the definition of eligible food. 

30
Revenue Estimate 

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -44 -96 -106 -116 -127 -489 -1,345

31
PERMANENTLY EXTEND THE ENHANCED DEDUCTION FOR CORPORATE 

CONTRIBUTIONS OF COMPUTER EQUIPMENT FOR EDUCATIONAL PURPOSES 

Current Law

A taxpayer’s deduction for charitable contributions of inventory property generally is limited to 

the taxpayer’s basis (typically, cost) in the inventory property. The Taxpayer Relief Act of 1997 

provided an enhanced deduction for a three-year period for charitable contributions by certain 

corporations of computer technology or equipment to elementary and secondary schools and 

charities formed for the purpose of supporting elementary and secondary education. In 2000, 

this provision was extended for an additional three-year period and expanded to apply to 

charitable contributions of computer technology or equipment to post-secondary educational 

institutions and public libraries. It was extended again in 2004. In 2006, this provision was 

extended for an additional two-year period. In addition, the definition of property eligible for the 

enhanced deduction was expanded to include property assembled by the taxpayer. 

For contributions made in taxable years beginning before January 1, 2008, the amount of the 

deduction is equal to the lesser of (1) the taxpayer’s basis in the contributed property, plus onehalf of the gain that would have been realized had the property been sold, or (2) two times basis. 

To qualify for the enhanced deduction, the contribution must satisfy various requirements. This 

provision does not apply to contributions made in taxable years beginning after December 31, 

2007. 

Reasons for Change

This provision provides an incentive for businesses to contribute computer equipment and 

software for the benefit of local communities and students at the elementary, secondary, and 

post-secondary school levels, by providing public libraries and educational institutions with 

needed technology resources. Because the need for technology resources is ongoing, this 

provision should be made permanent. 

Proposal

The enhanced deduction for corporate donations of computer equipment would be made 

permanent. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -50 -118 -147 -154 -162 -631 -1,570

32
PERMANENTLY EXTEND INCREASED LIMITS ON CONTRIBUTIONS OF 

PARTIAL INTERESTS IN REAL PROPERTY FOR CONSERVATION PURPOSES 

Current Law

In general, a deduction is permitted for charitable contributions, subject to certain limitations that 

depend on the type of taxpayer, the property contributed, and the donee organization. The 

amount of the deduction generally equals the fair market value of the contributed property on the 

date of the contribution.

Corporations generally are allowed to deduct charitable contributions up to a limit of 10 percent 

of taxable income (computed without regard to net operating or capital loss carrybacks). 

Individual taxpayers who itemize their deductions may claim a deduction for charitable 

contributions up to a percentage of the taxpayer’s adjusted gross income (AGI) (computed 

without regard to any net operating loss carryback). The percentage limit for individuals varies 

depending on the type of donee organization and the type of property contributed. In general, the 

deduction for charitable contributions may not exceed 50 percent of AGI. However, lower 

percentage limits apply to contributions of capital gain property and contributions to certain 

private foundations. For example, the deduction for contributions of capital gain property to 

public charities, private operating foundations, and certain non-operating foundations generally 

may not exceed 30 percent of AGI. In general, in the case of both individuals and corporations, 

charitable contributions in excess of the percentage limits may be carried forward for up to five 

years. 

Gifts of partial interests in property generally are not deductible as charitable contributions. 

However, to encourage donations for conservation purposes, the tax law provides an exception to 

the “partial interest” rule for qualified conservation contributions. A qualified conservation 

contribution is a contribution of a qualified real property interest (such as a remainder interest or

a restriction (granted in perpetuity) on the use that may be made of the real property) to a 

qualified organization exclusively for conservation purposes. Qualified conservation 

contributions generally are subject to the same limitations and carryover rules as apply to other 

charitable contributions of capital gain property.

For 2006 and 2007, special percentage limits and carryover rules apply to contributions of partial 

interests in real property for conservation purposes. In 2006 and 2007, an individual taxpayer 

may deduct the fair market value of any qualified conservation contributions up to a limit equal 

to the excess of (i) 50 percent of AGI over (ii) the amount of all other allowable charitable 

contributions (determined under the general rules described above, but not taking into account 

the qualified conservation contributions). In the case of a qualified farmer or rancher, the limit is 

100 percent of the excess of the individual taxpayer’s AGI (or 100 percent of the corporation’s 

taxable income) over the amount of all other allowable charitable contributions. In addition, for 

both individuals and corporations, the number of years that qualified conservation contributions 

in excess of these limits may be carried forward is increased to 15 years from five years. 

33
Reasons for Change

Increasing the limits on the allowable deduction for qualified conservation contributions will 

stimulate charitable giving for conservation purposes by increasing the incentives to donors. 

Permanency will maintain the incentives. 

Proposal

The increased limits on the deduction for qualified conservation contributions would be made 

permanent. 

Revenue Estimate 

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -48 -35 -22 -18 -21 -144 -265

34
PERMANENTLY EXTEND THE BASIS ADJUSTMENT TO STOCK OF S 

CORPORATIONS CONTRIBUTING APPRECIATED PROPERTY

Current Law

If an S corporation contributes money or other property to a charity, each shareholder takes into 

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

income tax liability. Prior to the enactment of the Pension Protection Act of 2006 (PPA), a 

shareholder of an S corporation reduced the basis in the stock or indebtedness of the S 

corporation by the amount of the charitable contribution that flowed through to the shareholder. 

In many cases, a shareholder’s basis in S corporation stock reflects the basis of the contributed 

property, whereas the charitable contribution deduction reflects the fair market value of the 

contributed property. As a result, pre-PPA law deprived some S corporation shareholders of the 

full benefit of the charitable contribution deduction. 

Reasons for Change

PPA modified the rules for adjusting the basis of S corporation stock to preserve the benefit of 

providing a charitable contribution deduction for contributions of appreciated property by an S 

corporation. S corporation shareholders are allowed to adjust their basis in the stock by their pro 

rata share of the adjusted basis (not fair market value) of the contributed property. The provision 

only applies to charitable contributions made by an S corporation in taxable years beginning after 

December 31, 2005, and before January 1, 2008. 

Proposal

The proposal would permanently extend the rule allowing S corporation shareholders to adjust 

their stock basis by their pro rate share of the adjusted basis of contributed property. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -3 -15 -21 -25 -28 -92 -301

35
REFORM EXCISE TAX BASED ON INVESTMENT INCOME OF PRIVATE 

FOUNDATIONS 

Current Law

Private foundations that are exempt from Federal income tax generally are subject to a twopercent excise tax on their net investment income. The excise tax rate is reduced to one percent 

in any year in which the foundation’s distributions for charitable purposes exceed the average 

level of the foundation’s charitable distributions over the five preceding taxable years (with 

certain adjustments). Private foundations that are not exempt from Federal income tax, including 

certain charitable trusts, must pay an excise tax equal to the excess (if any) of the sum of the 

excise tax on net investment income and the amount of the unrelated business income tax that 

would have been imposed if the foundation were tax exempt, over the income tax imposed on the 

foundation. Under current law, private nonoperating foundations generally are required to make 

annual distributions for charitable purposes equal to at least five percent of the fair market value 

of the foundation’s noncharitable use assets (with certain adjustments). The amount that a 

foundation is required to distribute annually for charitable purposes is reduced by the amount of 

the excise tax paid by the foundation. 

Reasons for Change

The current “two-tier” structure of the excise tax on private foundation net investment income

may discourage foundations from significantly increasing their distributions for charitable 

purposes in any particular year. Under the current formula, any increase in the foundation’s 

percentage payout in a given year (by increasing the average percentage payout) makes it more 

difficult for the foundation to qualify for the reduced one percent excise tax rate in subsequent 

years. Eliminating the “two-tier” structure of this excise tax would ensure that private 

foundations do not suffer adverse excise tax consequences if they increase their grant-making in 

a particular year to respond to charitable needs. Such a change would also simplify tax planning 

and the calculation of the excise tax for private foundations. In addition, lowering the excise tax 

rate for all foundations would make additional funds available for charitable purposes. 

Proposal

This proposal would replace the two rates of tax on private foundations that are exempt from

Federal income tax with a single tax rate of one percent. The tax on private foundations not 

exempt from Federal income tax would be equal to the excess (if any) of the sum of the onepercent excise tax on net investment income and the amount of the unrelated business income tax 

that would have been imposed if the foundation were tax exempt, over the income tax imposed 

on the foundation. The special reduced excise tax rate available to tax-exempt private 

foundations that maintain their historic level of charitable distributions would be repealed. 

The proposal would be effective for taxable years beginning after December 31, 2007.

36
Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -61 -91 -97 -103 -110 -462 -1,163

37
REPEAL THE $150 MILLION LIMITATION ON QUALIFIED 501(C)(3) BONDS 

Current Law

The Tax Reform Act of 1986 established a $150 million limit on the volume of outstanding, nonhospital, tax-exempt bonds for the benefit of any one 501(c)(3) organization. The provision was 

repealed in 1997 with respect to bonds issued after August 5, 1997, at least 95 percent of the net 

proceeds of which are used to finance capital expenditures incurred after that date. Thus, the 

limitation continues to apply to bonds more than five percent of the net proceeds of which 

finance or refinance (1) working capital expenditures or (2) capital expenditures incurred on or 

before August 5, 1997. 

Reasons for Change

The $150 million limitation results in complexity and provides disparate treatment depending on 

the nature and timing of bond-financed expenditures. Issuers must determine whether an issue 

consists of non-hospital bonds, and must calculate the amount of non-hospital bonds that are 

allocable to a particular tax-exempt organization. In addition, issuers must determine whether 

more than five percent of the net proceeds of each issue of non-hospital bonds finances working 

capital expenditures, or capital expenditures incurred on or before August 5, 1997, in order to 

determine whether the issue is subject to the limitation. Complete repeal of the limitation would 

enable private universities to utilize tax-exempt financing on a basis comparable to public 

universities.

Proposal

The $150 million limit on the volume of outstanding, non-hospital, tax-exempt bonds for the 

benefit of any one 501(c)(3) organization would be repealed in its entirety, effective for bonds 

issued after the date of enactment. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -2 -3 -9 -13 -14 -41 -104

38
REPEAL CERTAIN RESTRICTIONS ON THE USE OF QUALIFIED 501(C)(3) BONDS 

FOR RESIDENTIAL RENTAL PROPERTY

Current Law

Interest on State or local bonds is generally excluded from gross income. However, this 

exclusion does not apply to private activity bonds unless a specific exemption is provided in the 

Code. 

One type of tax-exempt private activity bond is a qualified 501(c)(3) bond. In general, an issue 

consists of qualified 501(c)(3) bonds if, among other things, at least 95 percent of its net 

proceeds are used by no person other than a 501(c)(3) organization or a State or local 

governmental unit. For this purpose, any activity of a 501(c)(3) organization that constitutes an 

unrelated trade or business is a non-qualifying use. 

Current law contains a special limitation (the residential rental property limitation) under which, 

in general, an issue does not consist of qualified 501(c)(3) bonds if any of its net proceeds are 

used to provide residential rental property for family units. However, this limitation does not 

apply if: (1) the first use of the financed property is pursuant to the issue; (2) the property meets 

the low-income set-aside requirements described below for qualified residential rental projects 

under the exempt facility bond rules; or (3) the property is substantially rehabilitated (i.e., in 

general, rehabilitation expenditures must equal or exceed the owner’s adjusted basis in the 

property) during the two-year period ending one year after the acquisition. 

In addition to qualified 501(c)(3) bonds, current law authorizes the issuance of tax-exempt 

private activity bonds for certain exempt facilities that are owned or operated by private, forprofit entities. One type of exempt facility is a qualified residential rental project. A qualified 

residential rental project is a project for residential rental property if, at all times during a 

specified project period, the project meets one of the following requirements elected by the 

issuer: (1) at least 20 percent of the residential units are occupied by individuals whose income

is 50 percent or less of area median gross income; or (2) at least 40 percent of the residential 

units are occupied by individuals whose income is 60 percent or less of area median gross 

income. 

Reasons for Change

The residential rental property limitation results in complexity, and provides disparate treatment 

for new and existing property used by 501(c)(3) organizations. In applying the residential rental 

property limitation, issuers must first determine whether existing property is residential rental

property. For example, an assisted living facility may or may not constitute residential rental

property, depending in part on the amount of nursing services provided. Issuers must also 

determine whether existing property satisfies the low-income set-aside or rehabilitation

requirements. Failure to meet the requirements could result in a loss of tax-exemption on the 

bonds, retroactive to the date of issue. Simplification would be achieved if the residential rental 

property limitation were repealed. 

39
Proposal

The residential rental property limitation would be repealed, effective for bonds issued after the 

date of enactment. As under current law, the use of residential rental property by a 501(c)(3) 

organization would be a qualifying use only to the extent it did not constitute an unrelated trade 

or business.

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -2 -5 -10 -17 -24 -58 -286

40
Strengthen Education

PERMANENTLY EXTEND THE ABOVE-THE-LINE DEDUCTION FOR QUALIFIED 

OUT-OF-POCKET CLASSROOM EXPENSES 

Current Law 

Individual taxpayers who itemize their deductions may claim a deduction for unreimbursed, jobrelated expenses to the extent those expenses and other miscellaneous deductions exceed 2 

percent of adjusted gross income. Such deductions may not be allowed for purposes of the 

alternative minimum tax. 

For taxable years 2002 through 2007, taxpayers who are K-12 teachers and certain other school 

personnel in a school for at least 900 hours during a school year may deduct, whether or not they 

itemize, up to $250 paid or incurred in connection with books, supplies, computer equipment and 

other equipment and supplemental materials used in the classroom. 

Reasons for Change

Teachers and other school personnel often incur expenses related to classroom activities that are 

not reimbursed. These expenditures enhance the quality of education received by students but 

diminish a teacher’s properly measured ability to pay taxes. Allowing school personnel to 

deduct such expenditures on their Federal income tax return encourages dedicated personnel who 

supplement available school resources at their own expense. 

Proposal 

The proposal would extend this provision to apply to expenses incurred in taxable years 

beginning after December 31, 2007. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -18 -180 -183 -185 -188 -754 -1,739

41
ALLOW THE SAVER’S CREDIT FOR CONTRIBUTIONS TO QUALIFIED TUITION 

PROGRAMS (SECTION 529 PLANS) 

Current Law

Under current law, taxpayers may receive a nonrefundable credit – the Saver’s Credit – on up to 

$2,000 contributed to elective deferral plans or individual retirement accounts (IRAs). An 

eligible taxpayer must be at least 18 years old, must not be eligible to be claimed as a dependent 

by another taxpayer, and must not be a full-time student. Taxpayers must have compensation to 

be eligible to contribute to an elective deferral plan or IRA. 

The credit is nonrefundable and is equal to a percentage of the amount contributed to elective 

deferral plans or IRAs. The applicable percentage is based on AGI (adjusted for inflation) and 

filing status and is determined according to the following table for 2007: 

Adjusted Gross Income

Joint Return Head of a Household All other cases 

Over Not Over Over Not Over Over Not

Over 

Applicable 

percentage 

$31,000 $23,250 $15,500 50

$31,000 $34,000 $23,250 $25,500 $15,500 $17,000 20

$34,000 $52,000 $25,500 $39,000 $17,000 $26,000 10

$52,000 $39,000 $26,000 0

Qualified contributions in determining the credit are reduced by any distributions from an 

elective deferral plan or IRA during the current tax year, the two preceding tax years, and the 

following year up to the due date of the return including extensions. 

Taxpayers may contribute to a Section 529 Qualified Tuition Program (QTP) to save for higher 

education expenses of a designated beneficiary. Contributions to a QTP are not deductible from

income for Federal tax purposes, but earnings on contributions accumulate tax-free. Taxpayers 

may exclude from gross income amounts distributed from a QTP and used for qualified higher 

education expenses, so long as the distribution is not used for the same educational expenses for 

which another tax benefit (such as an education tax credit or a tax-free distribution from a 

Coverdell Education Savings Account) is claimed. Nonqualified distributions are subject to an 

additional tax. Some States allow contributions to be excluded from income for State income tax 

purposes. 

There is no specific dollar cap on annual contributions to a QTP and no limit on contributions to 

a QTP account based on the contributor’s income. However, a QTP must provide adequate 

safeguards to prevent contributions on behalf of a designated beneficiary in excess of amounts 

necessary to provide for the qualified higher education expenses of the beneficiary. 

42
Reasons for Change

Almost one-third of American households have no financial assets and another fifth have only 

negligible assets available for investment. Many Americans are kept from entering the economic 

mainstream because they lack the financial resources to invest for long-term goals. Recent 

evidence suggests that low-income households respond to financial incentives in making savings 

decisions. Allowing the Saver’s Credit for contributions to a QTP provides an incentive for lowincome taxpayers to save for higher education. 

Proposal

The proposal would allow the Saver’s Credit for contributions to QTPs. As under current law, a 

taxpayer must be at least 18 years old, must not be eligible to be claimed as a dependent by 

another taxpayer, and must not be a full-time student in order to be eligible to receive the 

matching credit. 

Adjusted gross income in determining the applicable rate for the Saver’s Credit would be 

modified to include the excludable portion of the taxpayer’s Social Security benefits. The credit 

would apply to an annual aggregate contribution of up to $2,000 (or earnings includible in gross 

income, if less) to the taxpayer’s elective deferral plans, IRAs, and QTPs. For a married couple 

filing a joint return, the maximum allowable credit would be constrained by earnings only if the 

combined includible compensation of the spouses was less than $4,000. For purposes of the 

credit, qualified contributions to a QTP must be made to an account over which the taxpayer is 

the person with the power to authorize distributions and to otherwise administer the account. 

Qualified contributions would be reduced by any distributions from an elective deferral plan, 

IRA, or QTP during the current tax year, the two preceding tax years, and the following tax year 

up to the due date of the return including extensions. 

The credit would be available for contributions to QTPs beginning on or after January 1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

--- -63 -163 -176 -189 -200 -791 -1,966

43
Protect the Environment

PERMANENTLY EXTEND EXPENSING OF BROWNFIELDS REMEDIATION COSTS

Current Law

Taxpayers can elect to treat certain environmental remediation expenditures that would 

otherwise be chargeable to a capital account as deductible in the year paid or incurred. The 

deduction applies for both regular and alternative minimum tax purposes. The expenditure must 

be incurred in connection with the abatement of hazardous substances at a qualified 

contaminated site (so-called “brownfields”). This provision applies only to expenditures paid or 

incurred before January 1, 2008. 

Hazardous substances are defined generally for purposes of the brownfields provision by 

reference to sections 101(14) and 102 of the Comprehensive Environmental Response, 

Compensation, and Liability Act of 1980 (CERCLA). A qualified contaminated site generally is 

any property that (1) is held for use in a trade or business, for the production of income, or as 

inventory; (2) contains (or potentially contains) a hazardous substance; and (3) is certified by the 

appropriate State environmental agency as to the presence (or potential presence) of a hazardous 

substance. However, sites that are identified on the national priorities list under CERCLA do not 

qualify as qualified contaminated sites. 

The Tax Relief and Health Care Act of 2006 expanded the definition of hazardous substance to 

include petroleum products (including crude oil) for remediation expenditures paid or incurred 

after December 31, 2005, and before January 1, 2008. 

Reasons for Change

Encouraging environmental remediation is an important national goal. The brownfields 

provision encourages the cleanup of contaminated brownfields, thereby enabling them to be 

brought back into productive use in the economy and mitigating potential harms to public health. 

Extending the special treatment accorded to brownfields on a permanent basis would remove 

doubt among taxpayers as to the deductibility of future remediation expenditures and would 

promote the goal of encouraging environmental remediation. 

Proposal

The expensing of brownfield remediation expenditures would be made permanent. 

44
Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

61 -244 -400 -352 -342 -331 -1,669 -2,851

45
ELIMINATE THE VOLUME CAP FOR PRIVATE ACTIVITY BONDS FOR WATER 

INFRASTRUCTURE 

Current Law

In general, the interest on bonds issued by State or local governments is excludable from gross 

income if the bonds meet certain eligibility requirements. State or local governments issue taxexempt bonds to finance a wide range of public infrastructure projects. There are two basic 

kinds of tax-exempt bonds: governmental bonds and qualified private activity bonds. Bonds 

generally are treated as governmental bonds if the proceeds are used to carry out governmental 

purposes and the bonds are repaid with governmental funds. Bonds are classified as 

governmental bonds under a definition that limits private business use and private business 

sources of payment and also limits private loans. Governmental bonds are subject to various 

general restrictions, including arbitrage investment restrictions, registration and reporting 

requirements, Federal guarantee restrictions, advance refunding limitations, spending period 

limitations, and pooled bond limitations. Governmental bonds, however, are not subject to 

specific volume limitations. 

Bonds that have excessive private business involvement or private loans are classified as “private 

activity bonds.” In particular, bonds are classified as “private activity bonds” if more than 10 

percent (reduced to 5 percent in the case of certain unrelated or disproportionate private business 

use) of the bond proceeds are both: (1) used for private business use; and (2) payable or secured 

from private sources. Bonds also are treated as private activity bonds if more than the lesser of 

$5 million or 5 percent of the bond proceeds are used to finance private loans, including business 

and consumer loans. 

Private activity bonds may be issued on a tax-exempt basis only if they meet the general 

requirements for governmental bonds and the additional requirements necessary for “qualified 

private activity bonds.” Qualified private activity bonds include exempt facility bonds, qualified 

mortgage bonds for single-family housing, qualified veterans’ mortgage bonds, qualified small 

issue bonds, qualified student loan bonds, qualified redevelopment bonds, and qualified 

501(c)(3) bonds. Eligible facilities for which exempt facility bonds may be issued include 

facilities for the furnishing of water and sewage facilities. Most qualified private activity bonds 

are subject to an annual unified State volume cap. 

Reasons for Change

The nation’s water and wastewater infrastructure facilities serve important national public policy 

interests in ensuring clean and safe drinking water and sanitation. There is a significant need for 

capital funding to upgrade the nation’s water and wastewater infrastructure facilities. Removing 

the volume cap on tax-exempt qualified private activity bonds for water and wastewater 

infrastructure facilities would encourage additional needed private investment and public-private 

partnerships in these needed water infrastructure facilities. 

46
Proposal

The proposal would provide an exception to the unified annual State volume cap on tax-exempt 

qualified private activity bonds for exempt facilities for the “furnishing of water” or “sewage 

facilities.” The proposal would be effective for bonds issued after December 31, 2007 to finance 

water or sewer facilities.

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -1 -3 -5 -9 -13 -31 -184

47
Restructure Assistance to New York City

PROVIDE TAX INCENTIVES FOR TRANSPORTATION INFRASTRUCTURE 

Current Law

The Job Creation and Worker Assistance Act of 2002 (the Act) provided tax incentives for the 

area of New York City damaged or affected by the terrorist attacks on September 11, 2001. The 

Act created the “New York Liberty Zone,” defined as the area located on or south of Canal 

Street, East Broadway (east of its intersection with Canal Street), or Grand Street (east of its 

intersection with East Broadway) in the Borough of Manhattan in the City of New York, New 

York. New York Liberty Zone tax incentives included: (1) an expansion of the work 

opportunity tax credit (WOTC) for New York Liberty Zone business employees; (2) a special 

depreciation allowance for qualified New York Liberty Zone property; (3) a five-year recovery 

period for depreciation of qualified New York Liberty Zone leasehold improvement property; (4) 

$8 billion of tax-exempt private activity bond financing for certain nonresidential real property, 

residential rental property and public utility property; (5) $9 billion of additional tax-exempt, 

advance refunding bonds; (6) increased section 179 expensing; and (7) an extension of the 

replacement period for nonrecognition of gain for certain involuntary conversions.7

The expanded WOTC credit provided a 40 percent subsidy on the first $6,000 of annual wages 

paid to New York Liberty Zone business employees for work performed during 2002 or 2003. 

The special depreciation allowance for qualified New York Liberty Zone property equals 30 

percent of the adjusted basis of the property for the taxable year in which the property is placed 

in service. Qualified nonresidential real property and residential rental property must be 

purchased by the taxpayer after September 10, 2001, and placed in service before January 1, 

2010. Such property is qualified property only to the extent it rehabilitates real property 

damaged, or replaces real property destroyed or condemned, as a result of the September 11, 

2001, terrorist attack. The provision is no longer applicable for other property. 

The five-year recovery period for qualified leasehold improvement property applied, in general, 

to buildings located in the New York Liberty Zone if the improvement was placed in service 

after September 10, 2001, and before January 1, 2007, and no written binding contract for the 

improvement was in effect before September 11, 2001. 

The $8 billion of tax-exempt private activity bond financing is authorized to be issued by the 

State of New York or any political subdivision thereof after March 9, 2002, and before January 

1, 2010. 

The $9 billion of additional tax-exempt, advance refunding bonds was available after March 9, 

2002, and before January 1, 2006, with respect to certain State or local bonds outstanding on 

September 11, 2001. 

 7

 The Working Families Tax Relief Act of 2004 amended certain of the New York Liberty Zone provisions relating 

to tax-exempt bonds. 

48
Businesses were allowed to expense the cost of certain qualified New York Liberty Zone 

property placed in service prior to 2007, up to an additional $35,000 above the amounts 

generally available under section 179.8

 In addition, only 50 percent of the cost of such qualified 

New York Liberty Zone property counted toward the limitation under which section 179 

deductions are reduced to the extent the cost of section 179 property exceeds a specified amount. 

A taxpayer may elect not to recognize gain with respect to property that is involuntarily 

converted if the taxpayer acquires within an applicable period (the replacement period) property 

similar or related in service or use. In general, the replacement period begins with the date of the 

disposition of the converted property and ends two years (three years if the converted property is 

real property held for the productive use in a trade or business or for investment) after the close 

of the first taxable year in which any part of the gain upon conversion is realized. The Act 

extended the replacement period to five years for property in the New York Liberty Zone that 

was involuntarily converted as a result of the terrorist attacks on September 11, 2001, if 

substantially all of the use of the replacement property is in New York City. 

Reasons for Change

Some of the tax benefits that were provided to New York following the attacks of September 11, 

2001, likely will not be usable in the form in which they were originally provided. State and 

local officials in New York have concluded that improvements to transportation infrastructure 

and connectivity in the Liberty Zone would have a greater impact on recovery and continued 

development than would some of the existing tax incentive provisions. 

Proposal

The proposal would sunset certain existing New York Liberty Zone tax benefits and to provide 

in their place tax credits to New York State and New York City for expenditures relating to the 

construction or improvement of transportation infrastructure in or connecting to the New York 

Liberty Zone. New York State and New York City each would be eligible for a tax credit for 

expenditures relating to the construction or improvement of transportation infrastructure in or 

connecting to the New York Liberty Zone. The tax credit would be allowed in each year from

2008 to 2017, inclusive, subject to an annual limit of $200 million (for a total of $2 billion in tax 

credits), and would be divided evenly between the State and the city. Any unused credits below 

the annual limit would be added to the $200 million annual limit for the following year, 

including years after 2017. Similarly, expenditures that exceed the annual limit would be carried 

forward and subtracted from the annual limit in the following year. The credit would be allowed 

against any payments (other than payments of excise taxes and social security and Medicare 

payroll taxes) made by the city and State under any provision of the Code, including income tax 

withholding. The Treasury Department would prescribe such rules as are necessary to ensure 

that the expenditures are made for the intended purposes. The amount of the credit received 

would be considered State and local funds for the purpose of any Federal program. 

 8

 Section 179 provides that, in place of depreciation, certain taxpayers, typically small businesses, may elect to

deduct up to $100,000 of the cost of section 179 property placed in service each year. In general, section 179 

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

or business. 

49
Repeal Certain New York City Liberty Zone Incentives 

The special depreciation allowance for qualified New York Liberty Zone property that is either

nonresidential real property or residential rental property would be terminated as of the date of 

enactment. Property placed in service after the date of enactment would be ineligible for this 

incentive unless a binding written contract is in effect on the date of enactment and the property 

is placed in service before the original sunset dates set forth in the Act. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -200 -200 -200 -200 -200 -1,000 -2,000

50
SIMPLIFY THE TAX LAWS FOR FAMILIES

CLARIFY UNIFORM DEFINITION OF A CHILD 

Current Law

A taxpayer may be eligible to claim a qualifying child for various tax benefits, including the 

dependent exemption, head of household filing status, the child tax credit, the child and 

dependent care tax credit, and the earned income tax credit (EITC). A qualifying child must 

meet the following three tests:

• Relationship – The child generally must be the taxpayer’s son, daughter, grandchild, 

sibling, niece or nephew, or foster child. 

• Residence – The child must live with the taxpayer in the same principal place of abode 

for over half the year. 

• Age – The child must be under the age of 19, a full-time student if over age 18 and under 

age 24, or totally and permanently disabled. However, the child must be under age 13 for 

the child and dependent care tax credit and under age 17 for purposes of the child tax 

credit. 

Additional requirements may apply to specific child-related tax benefits. For example, a 

taxpayer may claim a married child for the child tax credit, assuming the child meets the criteria 

listed above. However, for purposes of the dependent exemption and EITC, an individual 

generally cannot be a qualifying child if he or she is married and filing a joint return (unless that 

return is filed only as a claim for a refund). 

A taxpayer may not claim a qualifying child if the taxpayer is a qualifying child of another 

taxpayer. Further, a taxpayer who is a dependent of another taxpayer may not claim a qualifying 

child for purposes of the personal exemption, head of household filing status, or the child and 

dependent care tax credit. 

Under some circumstances (e.g., a three-generation household), two or more taxpayers may be 

eligible to claim the same child for tax benefits. Current law allows the eligible taxpayers to 

decide among themselves who will claim the child-related tax benefits. If more than one eligible 

taxpayer actually claims the same qualifying child, then the following tiebreaker tests determine 

which taxpayer is entitled to the child-related tax benefits. 

• An eligible parent’s claim supersedes all other claims. 

• If the child’s parents do not file a joint return and both claim the child on separate returns, 

then the tax benefits accrue to the parent with whom the child resides the longest. If both 

parents reside with the child for the same length of time, then the benefits accrue to the 

parent with the highest adjusted gross income (AGI). 

51
• If the child’s parents do not claim the child, then the tax benefits accrue to the claimant 

with the highest AGI. 

Reasons for Change 

The Working Families Tax Relief Act of 2004 (WFTRA) created a uniform definition of 

qualifying child, allowing, in many circumstances, a taxpayer to claim the same child for five 

different child-related tax benefits. WFTRA also simplified eligibility rules, making it easier for 

both taxpayers and the IRS to determine if an individual is a qualifying child. By eliminating a 

burdensome support test, WFTRA also reduced recording-keeping requirements. 

However, WFTRA may have some unintended consequences. Under prior law, a taxpayer could 

not claim a sibling for certain child-related tax benefits unless the taxpayer could demonstrate 

that he or she cared for the sibling as if the sibling were the taxpayer’s own child. Congress 

repealed this factual test, responding to concern that it was difficult to administer. However, this 

change also effectively denied assistance to some low-income taxpayers who are the sole 

guardians of their siblings while giving higher-income families an opportunity to avoid income

limitations on child tax benefits. 

 

For example, a 20-year-old taxpayer works 30 hours a week while going to school full-time. The 

taxpayer’s parents are dead, and she is the legal guardian of her 15-year-old brother, with whom

she resides for over half the year. She provides over half of her own and her brother’s support. 

Under pre-WFTRA law, the young woman could not be claimed as a dependent by another 

taxpayer, since she provided more than half of her own support. Further, the young woman 

could claim her brother as a dependent and receive the tax benefits associated with the dependent 

exemption, head of household filing status, and the child tax credit. She could also claim her 

brother for the EITC because, in addition to meeting other requirements, she cared for him as if 

he were her own child. 

WFTRA recognizes that this taxpayer is self-supporting, and thus she is still able to claim

exemptions both for herself and her brother, file as a head of household, and claim the child tax 

credit. Her brother is also still considered her qualifying child for purposes of the EITC. 

However, eliminating the “care for” test means that the 20-year-old is now the qualifying child 

of her 15-year-old brother: she meets the relationship, residency, and age tests. Unlike the other 

child-related tax benefits, there is no rule prohibiting self-supporting individuals from being 

considered the qualifying children of other taxpayers. Because a qualifying child cannot claim

another qualifying child, the older sister is no longer eligible for the EITC under WFTRA. 

(Similarly, the younger brother could not claim his older sister for the EITC, if he worked and 

had earnings.) 

In other cases, the elimination of the “care for” test makes it possible for some taxpayers to avoid 

income limitations on certain child-related tax benefits by allowing other family members, who 

have lower incomes, to claim the taxpayers’ sons and daughters as qualifying children. For 

example, a couple lives with their 26-year-old son and 16-year-old daughter. The son is not a 

qualifying child because of his age (assuming that he does not have a permanent and total 

52
disability). In addition, the son earns less than $30,000 a year, placing him in the EITC income

range. If the parents have moderate income, they may find that the family could receive larger 

child tax benefits if their son claims his sister as a qualifying child and receives the EITC. If the 

parents have very high income, the gains to the family of allowing the son to claim the sister as a 

dependent may be even greater, because the parent’s income is too high to benefit from the 

dependent exemption and child tax credits, as well as the EITC. 

Current law thus allows some families to obtain certain child tax benefits, even when the parents’

income is too high to qualify, while denying the EITC to some low-income working taxpayers 

who are the sole guardians of their siblings. Current law also creates complexity by encouraging 

families to engage in multiple computations in order to determine how to maximize tax benefits. 

WFTRA had other unintended consequences, which made some of the eligibility rules less 

uniform. For example, WFTRA allowed dependent filers to claim the child tax credit, even 

though they are generally ineligible for most other child-related tax benefits. WFTRA also 

allowed taxpayers to claim the child tax credit on behalf of a married child who files a joint 

return with his or her spouse, even though the taxpayer cannot generally claim other tax benefits 

for this child. These exceptions not only create confusion, but have led to the creation of a new 

tax form – Form 8901 – solely to deal with these issues. 

Proposal 

The proposal clarifies the definition of a qualifying child and who is eligible to claim these 

children. 

Definition of Qualifying Child. The proposal would stipulate that a taxpayer is not a qualifying 

child of another individual if the taxpayer is older than that individual unless the other individual 

is a sibling and the taxpayer is permanently and totally disabled. In addition, an individual who 

is married and files a joint return (unless that return is filed only as a claim for a refund) would 

not be a qualifying child for any child-related tax benefits, including the child tax credit. 

Eligibility of Taxpayer for Child-Related Tax Benefits. If a parent resides with his or her child 

for over half the year, only the parent would be eligible to claim the child as a qualifying child. 

However, the parent could waive the child-related tax benefits to another member of the 

household who has higher AGI and is otherwise eligible for the child tax benefits. In addition, 

dependent filers would not be eligible to claim any child-related tax benefits. 

The proposal would be effective for tax years beginning after December 31, 2007. 

53
Revenue Estimate9

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

17 246 244 280 276 256 1,302 2,959

 9

 The estimate includes both receipt and outlay effects. The outlay effect is -$2,609 million for 2008-2017. 

54
SIMPLIFY EITC ELIGIBILITY REQUIREMENT REGARDING FILING STATUS, 

PRESENCE OF CHILDREN, AND WORK AND IMMIGRANT STATUS 

Current Law

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

(EITC). Eligibility for the EITC is based on 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 income. The rules regarding filing 

status, presence of children, and work and immigration status are particularly complicated and 

are described below. 

Filing Status: An unmarried individual can claim the EITC if he or she files as a single filer or as 

a head of household. Married individuals generally cannot claim the EITC unless they file 

jointly. However, there is an exception for estranged spouses who meet three requirements. 

First, an estranged spouse must live apart from his or her spouse for the last six months of the 

year. Second, the estranged spouse must maintain a household that constitutes the principal 

place of abode for a dependent child for over half the year. Third, the estranged spouse must pay 

over half the cost of maintaining the home in which he or she resides with the child during the 

year. If the estranged spouse meets these conditions, he or she may file a tax return as a head of 

household and claim the EITC. 

Presence of Qualifying Children: A taxpayer who resides with a qualifying child may be eligible

for an EITC of up to $2,853 ($4,716 for two or more children). A taxpayer who does not reside 

with a qualifying child may be eligible for a smaller credit of up to $428. A taxpayer may claim

the EITC for workers without qualifying children only if the taxpayer does not reside with a 

qualifying child. 

To be considered an EITC qualifying child, a child must meet residency, relationship, and age 

tests. Even if the child meets the three qualifying child tests, the taxpayer may not be able to 

claim the child or the EITC. For example, if more than one taxpayer lives with a qualifying 

child, only one of those taxpayers can claim the child for purposes of the EITC.10 If a taxpayer 

lives with a qualifying child, but is not allowed to claim the child because the child is properly 

claimed by someone else, the taxpayer is not eligible for the EITC. Because the taxpayer resides 

with a qualifying child, he or she is ineligible for the EITC for workers without qualifying 

children. 

A similar situation arises when a taxpayer resides with a qualifying child who does not have a 

valid social security number. The taxpayer is not eligible for the EITC for workers with 

 10 If more than one taxpayer claims the same qualifying child for purposes of the EITC, then only the claimant with

the highest adjusted gross income (AGI) is deemed eligible. However, a parent’s claim supersedes the claims of 

other taxpayers, regardless of the outcome of the AGI tiebreaker test. If both parents file separate returns claiming

the child, then the parent who resides with the child the longest is deemed entitled to the EITC. In the event that 

both parents reside with the child for the same amount of time, then the parent with the highest AGI is entitled to the 

EITC. 

55
qualifying children because the child lacks a valid social security number. The taxpayer also is 

ineligible for the EITC for workers without qualifying children because he or she lives with a 

qualifying child. 

Work and Immigration Status: To claim the EITC, the taxpayer (including his or her spouse, if 

married) and qualifying child must have valid social security numbers. A social security number 

is considered invalid for EITC purposes if it was issued by the Social Security Administration 

solely to allow an individual to obtain Federal benefits. Thus, an individual who is not 

authorized to work in the United States but who obtained a social security number in order to 

receive Medicaid or another Federal benefit is not eligible for the EITC. However, an individual 

who is not authorized to work in the United States but who obtained a social security number for 

a reason other than to obtain Federal benefits (e.g., to obtain a driver’s license under State law or 

for tax purposes prior to the creation of the ITIN) is eligible for the EITC. 

The IRS may deny EITC claims if the taxpayer does not provide valid social security numbers 

under statutory authority to asses amounts claimed due to mathematical or clerical errors. 

Reasons for Change 

According to the IRS, between $8.5 and $9.9 billion of EITC claims (27 percent to 31.7 percent 

of total claims) were erroneously paid with respect to tax year 1999 returns. Many of these 

errors related to taxpayers who failed to meet eligibility criteria concerning family and income

status. Since 1999, a number of steps have been taken to improve compliance. Most notably, 

the Economic Growth and Tax Relief Reconciliation Act of 2001 contained several provisions 

that simplified the EITC eligibility rules and reduced non-compliance.11 As a result of these 

efforts, the EITC error rate is estimated to fall to between 23 and 28 percent in 2006. Further 

simplification is needed to reduce these erroneous claims. 

Some of the EITC errors may have been caused by taxpayer confusion over unusual family 

situations and the complicated tax rules that were created to address these situations. For 

example, an individual who has separated from his or her spouse is required to understand a 

complicated three-part test to determine his or her filing status under current law. Separated 

spouses may have to consult two IRS publications (Publication 596 on the EITC and Publication 

501 on filing status) in order to determine if they are eligible for the EITC. They must compile 

and retain documentation showing that they provided over half the cost of maintaining the home 

in which they and their children reside. In tax year 1999, nearly $1 billion of EITC overclaims

were due solely to married taxpayers claiming single or head of household filing status when 

they should have claimed married-filing-separately status. Many of these claims would not be 

erroneous if separated spouses were not required to document that they provide over half the cost 

of maintaining the household in which they reside with their children. 

 11 These provisions include a simplified tiebreaker test to resolve duplicate claims and to apply the same definitions

of earned income and adjusted gross income used elsewhere in the Code to the EITC. The recent adoption of a 

uniform definition of qualifying child will further reduce the complexity of the EITC eligibility criteria. In addition

to these simplification efforts, the IRS has been implementing a new five-point initiative, which seeks to better 

detect erroneous claims before refunds are paid. 

56
Other types of complicated family situations result in complicated tax rules. For example, if a 

child lives with her mother in her grandmother’s home for over half the year, the child is a 

qualifying child of both her mother and grandmother. If the mother claims the child for the 

EITC, the grandmother is not eligible for the EITC for workers without qualifying children 

because she is still considered to have a qualifying child (her granddaughter). However, the 

grandmother may erroneously claim the EITC for workers who do not reside with qualifying 

children, not realizing that she is ineligible to claim the credit because she lives with her 

daughter and granddaughter. Taxpayers may be confused by the subtle difference between 

having a qualifying child one cannot claim for the EITC and having no qualifying child at all. 

 

Efforts to target the EITC to specific populations also give rise to complexity. In some cases, 

targeting provisions may be more complicated than they were intended to be. A provision of the 

Personal Responsibility and Work Opportunity Reconciliation Act of 1996 (the “1996 Act”) was 

intended to deny the EITC to any person (including his or her spouse) who is not authorized to 

work in the United States. Individuals may obtain a social security number if they are citizens or

permanent residents or other persons authorized to work in the United States. Individuals not 

authorized to work in the United States may also obtain a social security number in order to 

receive certain Federal benefits. In addition, until recently, it was possible for some individuals 

to receive social security numbers for other reasons – e.g., to obtain a driver’s license in some

States or, before the adoption of ITINs, to file a tax return or claim certain tax benefits. As 

drafted, the 1996 Act denied the EITC to taxpayers who receive a social security number solely 

to receive Federal benefits. The 1996 Act did not deny the EITC to individuals who are not 

authorized to work in the United States and who received social security numbers for reasons 

other than to obtain Federal benefits. Thus, the statutory language in the 1996 Act did not have 

its intended effect. The disparate treatment of individuals with non-work-related social security 

numbers is confusing, inequitable, and difficult to administer.

Proposal 

Allow separated spouses to claim the EITC. Married taxpayers who file separate returns would 

be allowed to claim the EITC if they live with a qualifying child for over half the year. They 

must also live apart from their spouse for the last six months of the tax year. However, they 

would not be required to provide over half the cost of maintaining the household in which they 

reside. The proposal would be effective for tax years beginning after December 31, 2007. 

Simplify rules regarding presence of qualifying child. A taxpayer with a qualifying child who 

lives in an extended family would be eligible to claim the EITC for workers without qualifying 

children even if another member of the family claims the taxpayer’s qualifying child. However, 

if unmarried parents reside together with their child, then one parent could claim the EITC for 

qualifying children, but neither could claim the EITC for workers without qualifying children. 

Taxpayers would be eligible to receive the EITC for workers without qualifying children if their 

child does not have a valid social security number. As under current law, the taxpayer (and 

spouse, if married) must have a valid social security number. The proposal would be effective 

for tax years beginning after December 31, 2007.

57
Clarify when a social security number is valid for EITC purposes. To qualify for the EITC, a 

taxpayer (including his or her spouse, if married) must have a social security number that is valid 

for employment in the United States (that is, they are U.S. citizens, permanent residents, or have 

certain types of temporary visas that allow them to work in the United States).12 The Treasury 

Department and the IRS will develop an outreach strategy to ensure that taxpayers, including 

those whose immigration and work status has changed since they received social security 

numbers, are aware of the new requirements. The proposal would be effective January 1, 2008. 

Revenue Estimate13

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 241 -58 -39 -39 -35 70 -60

 12 Taxpayers who initially received a social security number for non-work reasons, but who subsequently became

authorized to work in the United States (i.e., they became permanent residents or U.S. citizens), would be eligible to

receive the EITC. 13 The estimate includes both receipt and outlay effects. The outlay effect is -$104 million for 2008-2017.

58
REDUCE COMPUTATIONAL COMPLEXITY OF REFUNDABLE CHILD TAX 

CREDIT 

Current Law

An individual may claim a $1,000 tax credit for each qualifying child. A qualifying child must 

meet the following three tests:

• Relationship – The child generally must be the taxpayer’s son, daughter, grandchild, 

sibling, niece or nephew, or foster child. 

• Residence – The child must live with the taxpayer in the same principal place of abode 

for over half the year. 

• Age – The child must be under the age of 17. 

For purposes of the child tax credit, a qualifying child must be a citizen, national, or resident of 

the United States. The child tax credit is phased out for individuals with income over certain 

thresholds,14 and is partially refundable. 

Taxpayers may be eligible for a refundable amount (the additional child tax credit) equal to 15 

percent of earned income in excess of $11,750.15 Earned income is defined as the sum of wages, 

salaries, tips, and other taxable employee compensation plus net self-employment earnings. 

Unlike the earned income tax credit (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.16 

Families with three or more children may determine the additional child tax credit using an 

alternative formula. A taxpayer can claim an additional child tax credit equal to the amount by 

which the taxpayer’s social security taxes exceed the taxpayer’s EITC, if that amount is greater 

than the additional child tax credit based on the taxpayer’s earned income in excess of $11,750. 

Reasons for Change 

The additional child tax credit is difficult to compute and unduly complicated. To compute the 

credit amount, low and moderate-income taxpayers must attach a separate form to their tax 

return. Many taxpayers with three or more children must compute the additional child tax credit 

twice to determine which formula yields the larger credit. 

 14 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.

15 The earned income threshold amount is indexed for inflation. 

16 For example, some ministers add parsonage allowances to self-employment income when computing the EITC, 

but such allowances are excluded from taxable income for purposes of the additional child tax credit. 

59
In addition, the eligibility criteria for the additional child tax credit differ from those used for the 

EITC. (Over 70 percent of taxpayers who are eligible for the additional child tax credit also can 

claim the EITC.) Although both credits are based on earned income and the number of children 

in the family, they use different definitions of earned income and qualifying children. For 

example, when computing the additional child tax credit, taxpayers may count earned income

only to the extent that it is included in taxable income; however, when computing the EITC, 

other types of income that are not included in computing taxable income are counted. Another 

example is that the additional child tax credit may be claimed by taxpayers who reside with 

children outside the United States, while the child-based EITC may be claimed only by taxpayers 

who reside with children in the United States. 

Proposal 

Eliminate Multiple Computations. Taxpayers with three or more children would no longer have 

the option to compute the additional child tax credit using an alternative formula that compares 

social security taxes paid to the amount of the EITC received. The additional child tax credit 

would be based solely on the formula that uses earned income, regardless of the number of 

children in a taxpayer’s family. 

Conform the Definition of Earned Income. The definition of earned income for purposes of the 

additional child tax credit would be conformed to that currently used for the EITC. Thus, earned 

income for both credits would equal the sum of wages, salaries, tips, and other taxable employee 

compensation plus net self-employment earnings. The proposal would eliminate the requirement 

that earned income be included in taxable income in order to be included in computing the 

additional child tax credit. 

Require Taxpayers to Reside in the United States. The proposal would require taxpayers to 

reside with a child in the United States to claim the additional child tax credit. The principal 

place of abode for members of the U.S. Armed Forces would be treated as in the United States 

for any period the member is stationed outside the United States while serving on extended 

active duty. Extended active duty would include a call or order to such duty for a period in 

excess of 90 days. 

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

Revenue Estimate17

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 0 375 388 400 417 1,580 3,773

 17 The estimate includes both receipt and outlay effects. The outlay effect is -$3,773 million for 2008-2017. 

60
IMPROVE TAX COMPLIANCE

Introduction

The Federal tax system is based on voluntary compliance with the tax laws. Under this system, 

taxpayers report and pay their taxes voluntarily with minimal interaction with the IRS. While the 

vast majority of Americans pay their taxes in a timely and accurate manner, there remains a 

difference between what taxpayers should pay and what they actually pay. In 2001, the overall 

compliance rate was estimated at over 86 percent, after including late payments and recoveries 

from IRS enforcement activities. While this rate of compliance is high, a large amount of the tax 

that should be paid is not paid, resulting in the so-called “tax gap.” 

In September 2006, the Treasury Department released a comprehensive strategy to improve tax 

compliance.18 The strategy builds upon the demonstrated experience and current efforts of the 

Treasury Department and IRS to improve compliance. 

Four key principles guided the development of this strategy: 

• Unintentional taxpayer errors and intentional taxpayer evasion should both be addressed. 

• Sources of non-compliance should be targeted with specificity. 

• Enforcement activities should be combined with a commitment to taxpayer service. 

• Tax policy and compliance proposals should be sensitive to taxpayer rights and maintain 

an appropriate balance between enforcement activity and imposition of taxpayer burden. 

These principles point to the need for a comprehensive, integrated, multi-year strategy to 

improve tax compliance. Components of this strategy must include: (1) legislative proposals to 

reduce opportunities for evasion; (2) a multi-year commitment to compliance research; (3) 

continued improvements in information technology; (4) improvements in IRS compliance 

activities; (5) enhancements of taxpayer service; (6) simplification of the tax law; and (7) 

coordination between the government and its partners and stakeholders. 

The IRS has taken a number of steps to improve compliance. To enhance the IRS’ efforts, the 

Administration’s FY 2008 Budget includes a number of legislative proposals intended to 

improve tax compliance with minimum taxpayer burden. The Administration proposes to 

expand information reporting, improve compliance by businesses, strengthen tax administration, 

and expand penalties. 

The Treasury Department and IRS continue to consider additional approaches to reducing the tax 

gap that are consistent with the four principles outlined above. Some approaches under 

consideration, are, for example, improvements in coordination with State governments, including 

coordination concerning licensing activities, and further expansions of information reporting 

 18 Treasury Department, A Comprehensive Strategy for Reducing the Tax Gap (September 26, 2006).

61
requirements, including reporting of financial activity that may not currently be subject to 

information reporting. 

62
Expand Information Reporting

REQUIRE INFORMATION REPORTING ON PAYMENTS TO CORPORATIONS 

Current Law

Generally, a taxpayer making payments to a recipient aggregating to $600 or more for services or

determinable gains in the course of a trade or business in a calendar year is required to send an 

information return to the IRS setting forth the amount, as well as name and address of the 

recipient of the payment (generally on Form 1099). Under a longstanding regulatory regime, 

there are certain exceptions for payments to corporations, as well as tax-exempt and government 

entities. 

Reasons for Change

Generally, compliance increases significantly for payments that a third party reports to the IRS. 

In the case of tax-exempt or government entities that are generally not subject to income tax, 

information returns may not be necessary. On the other hand, during the decades in which the 

regulatory exception for payments to corporations has become established, the number and 

complexity of corporate taxpayers have increased. Moreover, the longstanding regulatory 

exception from information reporting for payments to corporations has created compliance 

issues. Although the exception for information reporting to corporations is set forth in existing 

regulations, because it has been in place for many years and because Congress, during that time 

period, has made numerous changes to the information reporting rules, elimination of the 

exception should be made by legislative change. 

Proposal

A business would be required to file an information return for payments aggregating to $600 or 

more in a calendar year to a corporation (except a tax-exempt corporation). 

The proposal would be effective for payments made to corporations on or after January 1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 69 421 609 769 832 2,700 7,736

63
REQUIRE BASIS REPORTING ON SECURITY SALES 

Current Law

Brokers (including mutual funds and certain other persons) file information returns with the IRS 

setting forth the amount of sales proceeds from the sale of securities, as well as the name, 

Taxpayer Identification Number, and address of the recipient (generally on Form 1099-B). 

Reasons for Change

Generally, compliance increases significantly for payments that a third party reports to the IRS. 

The potential for non-compliance on sales of securities is considerable under current law, 

because the taxpayer’s basis is not reported to the IRS. Requiring brokers to maintain records of 

the adjusted basis of securities sold by their customers and report this information to the IRS 

would increase compliance with capital gains reporting. In addition, such a requirement would 

provide significant simplification benefits by relieving taxpayers from the often complicated task 

of calculating adjusted basis to determine gain or loss on the sale of securities. 

Proposal

Certain brokers (including brokerage houses, mutual funds, asset managers and fiduciaries) 

would be required to report information regarding adjusted basis in connection with the sale of

certain publicly traded securities. The IRS and Treasury Department would be granted 

regulatory authority to promulgate specific rules, including exceptions, to implement this 

mandate. Brokers also would be required to report acquisition or disposition dates for securities 

to determine short-term or long-term gain or loss for taxpayers. To facilitate accurate basis 

reporting if a customer transfers securities from an account with one broker to an account with 

another, the transferor broker would be required to provide the relevant information to the 

transferee. Under regulations, a broker would be exempt from reporting items of information 

that the broker is unable to obtain with reasonable efforts. Regulations may establish a regime

under which customers provide information to their brokers about customer transactions that 

produce adjustments to basis and about the customers’ initial basis in securities when the broker 

has no other way of knowing this information. Information about basis adjustments that are 

applicable to all holders of securities of a particular class would be available to brokers either

directly from the relevant issuer or indirectly from the issuer through a central repository of 

information. 

The reporting provisions would apply to securities acquired after December 31, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 0 31 178 328 498 1,035 6,709

64
EXPAND BROKER INFORMATION REPORTING 

Current Law

Generally, a broker files an information return with the IRS showing customer name and address 

as well as gross proceeds. For example, stock and bond brokers generally report gross proceeds 

on Form 1099-B. However, existing law does not clearly impose the information return 

requirement on businesses that, with respect to sales of tangible personal property, may not be 

acting as agents of the customers (i.e., the sellers of the property). 

Reasons for Change

Generally, compliance increases significantly for amounts that a third party reports to the IRS. 

Some taxpayers fail to report income derived from the sale of tangible personal property through 

brokers. 

Proposal

In certain circumstances, a broker would be required to make an information return showing 

its customer’s name, address, and Taxpayer Identification Number, as well as gross proceeds 

from the sale of tangible personal property. The requirement would apply only with respect to a 

customer for whom the broker has handled 100 or more separate transactions generating at least 

$5,000 in gross proceeds in a year. There would be an exception from the proposed requirement 

(and the sale would not be taken into account for the 100 transactions/$5,000 gross proceeds test) 

if the sale is required to be reported by other information return requirements (such as payment 

card sales the gross proceeds of which would be reported under the payment card reporting 

proposal). The IRS and Treasury Department would have regulatory authority to allow 

additional exceptions in appropriate situations in which the benefit of information reporting 

is outweighed by the cost of compliance. In a case in which a broker may not have required 

information because another person handles gross proceeds for a customer, a regulatory 

exception for such broker may be accompanied by imposition of the reporting requirement on 

that other person. 

The proposal would be effective for sales of property on or after January 1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 20 77 136 186 220 639 1,974

65
REQUIRE INFORMATION REPORTING ON MERCHANT PAYMENT CARD 

REIMBURSEMENTS

Current Law

Generally, a taxpayer making payments to a recipient aggregating to $600 or more for services or

determinable gains in the course of a trade or business in a calendar year is required to send an 

information return to the IRS setting forth the amount, as well as the name and address of the 

recipient of the payment (generally on Form 1099). For example, any service recipient engaged 

in a trade or business is required to file an information return if the aggregate amount of 

payments for services is $600 or more in a calendar year. 

Reasons for Change

Payment cards (both credit cards and debit cards) are an increasingly common form of payment 

for many merchant transactions. Some merchants fail to report accurately their gross income, 

including income derived from payment card transactions. Generally, compliance increases 

significantly for amounts that a third party reports to the IRS. 

Proposal

The proposal would provide the IRS with authority to promulgate regulations requiring merchant 

acquiring banks (i.e., organizations that process card payments for merchants who accept 

payment cards) to report to the IRS annually the gross reimbursement payments made to 

merchants in a calendar year. The IRS and Treasury Department would have regulatory 

authority to provide exceptions from the requirements where the benefit of improved compliance 

from information reporting is outweighed by the cost of compliance. 

The proposal would be effective for payments made on or after January 1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 113 404 694 949 1,174 3,334 10,745

66
REQUIRE A CERTIFIED TAXPAYER IDENTIFICATION NUMBER FROM 

CONTRACTORS 

Current Law

In the course of a trade or business, service recipients (“businesses”) making payments 

aggregating to $600 or more in a calendar year to any non-employee service provider 

(“contractor”) that is not a corporation are required to send an information return to the IRS 

setting forth the amount, as well as name and address of the contractor. The information returns, 

required annually after the end of the year, are made on Form 1099-MISC based on identifying 

information furnished by the contractor but not verified by the IRS. Copies are provided both to 

the contractor and to the IRS. Withholding is not required or permitted for payments to 

contractors. Since contractors are not subject to withholding, they may be required to make 

quarterly payments of estimated income taxes and self-employment taxes (SECA) near the end 

of each calendar quarter. The contractor is required to pay any balance due when the annual 

income tax return is subsequently filed. 

Reasons for Change

Estimated tax filing is relatively burdensome, especially for less sophisticated and lower-income 

taxpayers. Moreover, by the time estimated tax payments (or final tax payments) are due, some

contractors will not have put aside the necessary funds. Given that the SECA tax rate is 15.3 

percent (up to certain income limits), the required tax payments can be more than 25 percent of a 

contractor’s gross receipts, even for a contractor with modest income. 

An optional withholding method for contractors would reduce the burdens of having to make 

quarterly payments, would help contractors automatically set aside funds for tax payments, and 

would help increase compliance. 

Proposal

A contractor receiving payments of $600 or more in a calendar year from a particular business 

would be required to furnish to the business (on Form W-9) the contractor’s certified Taxpayer 

Identification Number (TIN). A business would be required to verify the contractor’s TIN with 

the IRS, which would be authorized to disclose, solely for this purpose, whether the certified 

TIN-name combination matches IRS records. If a contractor fails to furnish an accurate certified 

TIN, the business would be required to withhold a flat rate percentage of gross payments. 

Contractors receiving payments of $600 or more in a calendar year from a particular business 

could require the business to withhold a flat rate percentage of their gross payments, with the flat 

rate percentage of 15, 25, 30, or 35 percent being selected by the contractor. 

The proposal would be effective for payments made to contractors on or after January 1, 2008. 

67
Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 5 42 72 76 80 275 749

68
REQUIRE INCREASED INFORMATION REPORTING FOR CERTAIN 

GOVERNMENT PAYMENTS FOR PROPERTY AND SERVICES 

Current Law

Businesses, governments, and other taxpayers are subject to a number of information reporting 

and withholding requirements. Generally, a taxpayer making payments aggregating to $600 or 

more for services or determinable gains in the course of a trade or business in a calendar year is 

required to send an information return to the IRS (except if the recipient is a corporation) setting 

forth the amount, as well as the name and address of the recipient of the payment (generally on 

Form 1099). In addition, any service recipient engaged in a trade or business is required to file 

an information return if the aggregate of payments for services is $600 or more in a calendar 

year. This requirement specifically applies to government agencies, even if the service provider 

is a corporation. Moreover, Federal agencies must file information returns with respect to 

contractors, generally on Form 8596 (Information Return for Federal Contracts) and Form

8596A (Quarterly Transmittal of Information Returns for Federal Contracts). Under recently 

enacted legislation that will take effect in 2011, Federal, State and local government agencies 

generally must withhold 3 percent of payments for goods and services. Exceptions will apply to

certain payments such as those actually subjected to backup withholding, wages and public 

assistance. 

Reasons for Change

Generally, compliance increases significantly for payments that a third party reports to the IRS. 

Some government vendors fail to meet their tax filing and payment obligations. 

Proposal

The IRS and Treasury Department would be authorized to promulgate regulations requiring 

information reporting on all non-wage payments by Federal, State and local governments to 

procure property and services. It is expected that certain categories of payments would be 

excluded from the new information reporting requirements, including payments of interest, 

payments for real property, payments to tax-exempt entities or foreign governments, 

intergovernmental payments, and payments made pursuant to a classified or confidential 

contract. The proposal would be effective for payments made on or after January 1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 25 100 130 108 27 390 390

69
INCREASE INFORMATION RETURN PENALTIES

Current Law

Taxpayers are subject to a number of information reporting requirements under the Code. When 

these requirements are not adhered to, penalties may apply. Generally, there is a penalty of $50, 

not to exceed $250,000 in a calendar year, for each failure to file timely an accurate information 

return. For certain small filers whose average annual gross receipts do not exceed $5,000,000, 

the limit is $100,000 instead of $250,000. If a failure is due to intentional disregard of a filing 

requirement, the minimum penalty for each failure is $100, with no calendar year limit. 

Reasons for Change

Generally, compliance increases significantly with respect to amounts reported on information 

returns. In some cases, taxpayers may have failed to comply with existing information reporting 

requirements because the amount of the potentially applicable penalties is too small to 

discourage non-compliance. Increasing the penalty amounts, which were established in 1989 

and have not been increased, will help to ensure the timely filing of accurate information returns. 

Proposal

The $50 and $100 penalty amounts would be increased to $100 and $250, respectively. The 

$250,000 and $100,000 caps would be increased to $1,500,000 and $500,000. 

The proposal would be effective for information returns required to be filed on or after January 

1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 0 0 29 72 72 173 546

70
Improve Compliance by Businesses

REQUIRE E-FILING BY CERTAIN LARGE ORGANIZATIONS 

Current Law

Effective for tax years ending on or after December 31, 2005, corporations with assets of $10 

million or more filing Form 1120 are required to file Schedule M-3 (Net Income (Loss) 

Reconciliation for Corporations with Total Assets of $10 Million or More). Effective for tax 

years ending on or after December 31, 2006, this Schedule M-3 filing requirement also applies to 

S corporations, life insurance corporations, property and casualty insurance corporations and 

cooperative associations filing various versions of Form 1120 and having $10 million or more in 

assets. Schedule M-3 is also required for partnerships with assets of $10 million or more and 

certain other partnerships. 

Corporations and tax-exempt organizations that have assets of $10 million or more and file at 

least 250 returns during a calendar year, including income tax, information, excise tax, and 

employment tax returns, are required to file electronically their Form 1120/1120S income tax 

returns and Form 990 information returns for tax years ending on or after December 31, 2006. In 

addition, private foundations and charitable trusts that file at least 250 returns during a calendar 

year are required to file electronically their Form 990-PF information returns for tax years ending 

on or after December 31, 2006, regardless of their asset size. Taxpayers can request waivers of 

the electronic filing requirement if they cannot meet that requirement due to technology 

constraints, or where compliance with the requirement would result in undue financial burden on 

the taxpayer. Although electronic filing is required of certain corporations and other taxpayers, 

others may voluntarily convert to electronic filing. 

Generally, regulations may require electronic filing by taxpayers (other than individuals, estates 

and trusts) that file at least 250 returns annually. Before requiring electronic filing, the IRS and 

Treasury Department must take into account the ability of taxpayers to comply at a reasonable 

cost. 

Reasons for Change

Generally, compliance increases when taxpayers are required to provide better information to the 

IRS in usable form. Large organizations with assets of $10 million or more generally maintain 

financial records in electronic form, and generally either hire tax professionals who use tax 

preparation software or use tax preparation software themselves although they may not currently 

file electronically. 

Electronic filing supports the IRS’ broader goals of improving service to taxpayers, enhancing 

compliance, and modernizing tax administration. Overall, increased electronic filing of returns 

may improve customer satisfaction and confidence in the filing process, and it may be more cost 

effective for affected entities. Expanding electronic filing to include all businesses required to 

file Schedule M-3 will provide tax return information in a more uniform electronic form. This 

71
will enhance the ability of the IRS to more productively focus its audit activities. This can 

reduce burdens on businesses where the need for an audit can be avoided. 

In the case of a large business, adopting the same standard for electronic filing as for filing 

Schedule M-3 provides simplification benefits. 

Proposal

All corporations and partnerships required to file Schedule M-3 would be required to file their 

income tax returns electronically. In the case of large taxpayers not required to file Schedule M3 (such as exempt organizations), the regulatory authority to require electronic filing would be 

expanded beyond the current 250-return minimum. Nevertheless, any new regulations would 

balance the benefits of electronic filing against any burden that might accrue to taxpayers, and 

implementation would take place incrementally to afford adequate time for transition to

electronic filing. Taxpayers would be able to request waivers of this requirement if they cannot 

meet the requirement due to technology constraints, if compliance with the requirement would 

result in undue financial burden, or if other criteria specified in regulations are met. 

The provision would be effective for tax years ending on or after December 31, 2008.

Revenue Estimate

[No revenue effect] 

72
IMPLEMENT STANDARDS CLARIFYING WHEN EMPLOYEE LEASING 

COMPANIES CAN BE HELD LIABLE FOR THEIR CLIENTS’ FEDERAL 

EMPLOYMENT TAXES 

Current Law

Employers are required to withhold and pay Federal Insurance Contribution Act (FICA) and 

income taxes, and are required to pay Federal Unemployment Tax Act (FUTA) taxes 

(collectively “Federal employment taxes”) with respect to wages paid to their employees. 

Liability for Federal employment taxes generally lies with the taxpayer that is determined to be 

the employer under a multi-factor common law test or under specific statutory provisions. For 

example, a third party that is not the common law employer can be a statutory employer if the 

third party has control over the payment of wages. In addition, certain designated agents are 

jointly and severally liable with their principals for employment taxes with respect to wages paid 

to the principals’ employees. These designated agents prepare and file employment tax returns 

using their own name and employer identification number. In contrast, reporting agents (often 

referred to as payroll service providers) are generally not liable for the employment taxes 

reported on their clients’ returns. Reporting agents prepare and file employment tax returns for 

their clients using the client’s name and employer identification number. 

Employee leasing is the practice of contracting with an outside business to handle certain 

administrative, personnel, and payroll matters for a taxpayer’s employees. Employee leasing 

companies (often referred to as professional employer organizations) typically prepare and file 

employment tax returns for their clients using the leasing company’s name and employer 

identification number, often taking the position that the leasing company is the statutory or 

common law employer of their clients’ workers.

Reasons for Change

Under present law, there is often uncertainty as to whether the employee leasing company or its 

client is liable for unpaid Federal employment taxes arising with respect to wages paid to the 

client’s workers. Thus, when an employee leasing company files employment tax returns using 

its own name and employer identification number, but fails to pay some or all of the taxes due, or 

when no returns are filed with respect to wages paid by a taxpayer that uses an employee leasing 

company, there can be uncertainty as to how the Federal employment taxes are assessed and 

collected. 

Providing standards for when an employee leasing company and its clients will be held liable for 

Federal employment taxes will facilitate the assessment, payment and collection of those taxes 

and will preclude taxpayers who have control over withholding and payment of those taxes from

denying liability when the taxes are not paid. 

Proposal

Under the proposal, standards would be set forth for holding employee leasing companies jointly 

and severally liable with their clients for Federal employment taxes. The proposal would also 

73
provide standards for holding employee leasing companies solely liable for such taxes if they 

meet specified requirements. 

The provision would be effective for employment tax returns required to be filed with respect to 

wages paid on or after January 1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 3 5 5 5 6 24 57

74
AMEND COLLECTION DUE PROCESS PROCEDURES FOR EMPLOYMENT TAX 

LIABILITIES 

Current Law

Employers are required to withhold and pay Federal Insurance Contribution Act (FICA) taxes 

and income taxes, and are required to pay Federal Unemployment Tax Act (FUTA) taxes 

(collectively “Federal employment taxes”) with respect to wages paid to their employees. 

Generally, employers are required to file annual returns (Form 940) reporting FUTA taxes and 

quarterly returns (Form 941) reporting FICA taxes and income tax withholding. For small 

employers, the taxes reported on Form 941 generally are required to be deposited on a monthly 

or semi-weekly basis. Beginning in calendar year 2006, certain small employers are permitted to 

file employment tax returns (Form 944) and pay the related tax on an annual, rather than a 

quarterly basis. 

In order to ensure the payment and collection of employment taxes, the IRS is authorized to take 

various collection actions, including issuing Federal tax levies. Before a tax levy can be issued, 

however, the IRS generally must provide the taxpayer with notice and an opportunity for an 

administrative collection due process (CDP) hearing, and for judicial review. An exception to 

the requirement for pre-levy CDP proceedings applies to levies issued to collect a Federal tax 

liability from a State tax refund. In this context, the taxpayer is provided an opportunity for a 

CDP hearing within a reasonable period of time after the levy.

Reasons for Change

Frequently, an employer that fails to satisfy its Federal employment tax liabilities for one period 

will also fail to satisfy its liabilities for later periods, resulting in a “pyramiding” of unpaid 

employment taxes. Some employers who request a CDP hearing and judicial review for one tax 

period will continue to accrue, or pyramid, their employment tax liabilities during the CDP 

proceedings. Liabilities for these subsequent periods cannot be collected by levy until after the 

employer has been given notice and opportunity for hearing and judicial review for each period. 

The existing CDP framework compounds the pyramiding problem by allowing employers to 

continue to accrue Federal employment tax obligations without risk of collection action. 

Proposal

The proposal would expand the exception to the requirement for pre-levy CDP proceedings to 

include levies issued to collect Federal employment taxes. As with the current procedures 

applicable to levies issued to collect a Federal tax liability from State tax refunds, the taxpayer 

would be provided an opportunity for a CDP hearing within a reasonable period of time after the 

levy. Collection by levy would be allowed to continue during the CDP proceedings. Taxpayers 

would retain their current right to seek managerial appeal of a proposed levy and to participate in 

the formal Collection Appeals Process before a levy is issued.

The proposal would be effective for collection actions initiated on or after January 1, 2008. 

75
Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 140 86 33 16 14 289 364

76
Strengthen Tax Administration

EXPAND IRS ACCESS TO INFORMATION IN THE NATIONAL DIRECTORY OF 

NEW HIRES FOR TAX ADMINISTRATION PURPOSES 

Current Law

The Office of Child Support Enforcement of the Department of Health and Human Services 

(HHS) maintains the National Directory of New Hires (NDNH), which is a database that 

contains newly-hired employee data from Form W-4, quarterly wage data from State and Federal 

employment security agencies and unemployment benefit data from State unemployment 

insurance agencies. The NDNH was created to help State child support enforcement agencies 

enforce obligations of parents across State lines. 

Under current provisions of the Social Security Act, the IRS may obtain data from the NDNH, 

but only for the purpose of administering the Earned Income Tax Credit (EITC) and verifying 

employment reported on a tax return. 

Generally, the IRS obtains employment and unemployment data less frequently than quarterly, 

and there are significant internal costs of preparing these data for use. Under various State laws, 

the IRS may negotiate for access to employment and unemployment data directly from State 

agencies that maintain these data. 

Reasons for Change

Employment data are useful to the IRS in administering a wide range of tax provisions beyond 

the EITC, including verifying taxpayer claims and identifying levy sources. Currently, the IRS 

may obtain employment and unemployment data on a State-by-State basis, which is a costly and 

time-consuming process. NDNH data are timely, uniformly compiled, and electronically 

accessible. Access to the NDNH would increase the productivity of the IRS by reducing the 

amount of IRS resources dedicated to obtaining and processing data without reducing the current 

levels of taxpayer privacy. 

Proposal

The Social Security Act would be amended to expand IRS access to NDNH data for general tax 

administration purposes, including data matching, verification of taxpayer claims during return 

processing, preparation of substitute returns for non-compliant taxpayers, and identification of 

levy sources. Data obtained by the IRS from the NDNH would be protected by existing taxpayer 

privacy law, including civil and criminal sanctions. The proposal would be effective upon 

enactment. 

Revenue Estimate

[No revenue effect] 

77
PERMIT DISCLOSURE OF PRISON TAX SCAMS 

Current Law

Generally, tax return information is confidential, unless a specific exception in the Code applies. 

None of the exceptions currently in the Code permit the IRS to refer inmate tax violations to 

prison officials for imposition of administrative sanctions. Thus, if the IRS has information 

about tax violations by inmates, the IRS cannot disclose return information to prison officials to 

impose administrative sanctions for tax-related misconduct. 

Reason for Change

There are an increasing number of fraudulent refund claims filed by prisoners. Tax violations by 

inmates create a broad perception regarding non-compliance and are a significant tax 

enforcement problem. Prison officials can take administrative steps to curtail such conduct if the 

IRS were authorized to disclose information about fraudulent tax schemes advanced by inmates. 

Criminal prosecutions or injunction suits against prisoners are resource-intensive and often not as 

effective at curtailing tax violations by inmates through administrative sanctions imposed by 

prison officials. 

Proposal

The IRS would be authorized to disclose certain limited return information about tax violations 

by inmates so that prison officials could punish and deter such conduct through administrative 

sanctions. 

The proposal would authorize disclosures on or after January 1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 0 0 0 0 0 0 5

 

78
MAKE REPEATED WILLFUL FAILURE TO FILE A TAX RETURN A FELONY 

Current Law

Current law provides that willful failure to file a tax return is a misdemeanor punishable by a 

term of imprisonment for not more than one year, a fine of not more than $25,000 ($100,000 in 

the case of a corporation), or both. A taxpayer who fails to file returns for multiple years 

commits a separate misdemeanor offense for each year. 

Reasons for Change

Increased criminal penalties would help to deter multiple willful failures to file tax returns. 

Proposal

Any person who willfully fails to file tax returns in any three years within any five consecutive 

year period, if the aggregated tax liability for such period is at least $50,000, would be subject to 

a new aggravated failure to file criminal penalty. The proposal would classify such failure as a 

felony and, upon conviction, impose a fine of not more than $250,000 ($500,000 in the case of a 

corporation) or imprisonment for not more than five years, or both. 

The proposal would be effective for returns required to be filed on or after January 1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 0 0 1 1 1 3 12

79
Penalties

EXPAND PREPARER PENALTIES 

Current Law

Generally, an income tax return preparer is subject to a monetary penalty for certain failures, 

unless a failure was due to reasonable cause and not willful neglect. The amount (set in 1989) of 

the penalty for a type of failure is $50 per failure, not to exceed $25,000 in a calendar year. The 

income tax return preparer conduct subject to this penalty includes failure to furnish a copy of a 

return to the taxpayer, failure to sign a return, failure to furnish a preparer taxpayer identification 

number, failure to retain a copy of a return, and failure to file a correct information return. An 

income tax return preparer is subject to a $250 penalty if he or she knew, or reasonably should 

have known, of an understatement of liability, on a return or refund claim, due to a position that 

did not have a realistic possibility of being sustained on its merits, and was frivolous or not 

disclosed, unless there was reasonable cause, and the preparer acted in good faith. An income

tax return preparer is subject to a $1,000 penalty if an understatement of liability, on a return or 

refund claim, is due to the income tax return preparer’s willful, reckless or intentional disregard 

of rules. The $1,000 penalty may be reduced by any $250 penalty paid. 

Reasons for Change

Unscrupulous preparers facilitate the reporting of unreasonable and unrealistic positions on 

various types of returns in addition to income tax returns. Expanding the penalty to other types 

of returns and increasing the amount of applicable penalties will help to ensure the accountability 

of preparers. 

Proposal

The scope of the existing preparer penalties would be expanded from income tax returns to 

include employment, excise, exempt organization, estate and gift tax returns and related 

documents. The per failure penalty would be increased from $50 to $150. The $250 penalty 

would be increased to the greater of $1,000 or 50 percent of the preparer’s fee. The $1,000 

penalty would be increased to the greater of $5,000 or 50 percent of the preparer’s fee.

The proposal would be effective for returns filed on or after January 1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 3 5 6 8 9 31 80

 

80
IMPOSE PENALTY ON FAILURE TO COMPLY WITH ELECTRONIC FILING 

REQUIREMENTS 

Current Law

Certain corporations and tax-exempt organizations (including certain charitable trusts and private 

foundations) are required to file their returns electronically. Generally, filing on paper instead of 

electronically is treated as a failure to file if electronic filing is required. Additions to tax are 

imposed for the failure to file tax returns reporting a liability. For failure to file a corporate 

return, the addition to tax is 5 percent on the amount required to be shown as tax due on the 

return, for the first month of failure, and an additional 5 percent for each month or part of a 

month thereafter, up to a maximum of 25 percent. 

For failure to file a tax-exempt organization return, the addition to tax is $20 a day for each day 

the failure continues. The maximum amount per return is $10,000 or 5 percent of the 

organization’s gross receipts for the year, whichever is less. Organizations with annual gross 

receipts exceeding $1 million, however, are subject to an addition to tax of $100 per day, with a 

maximum of $50,000. 

 

Reasons for Change

Although there are additions to tax for the failure to file returns, there is no specific penalty in 

the Code for a failure to comply with a requirement to file electronically. Because the addition 

to tax for failure to file a corporate return is based on an underpayment of tax, no addition is 

imposed if the corporation is in a refund or credit status. Thus, the existing addition to tax may 

not provide an adequate incentive for certain corporations to file electronically. Generally, 

electronic filing increases efficiency of tax administration because the provision of tax return 

information in an electronic form enables the IRS to focus audit activities where they can have 

the greatest impact. This also assists taxpayers where the need for audit is reduced. 

Proposal

An assessable penalty would be established for a failure to comply with a requirement of

electronic (or other machine-readable) format for a return that is filed. The amount of the 

penalty would be $25,000 for a corporation or $5,000 for a tax-exempt organization. For failure 

to file in any format, the existing penalty would remain, and the proposed penalty would not 

apply. 

The proposal would be effective for returns required to be electronically filed on or after January 

1, 2008. 

Revenue Estimate

[No revenue effect] 

81
CREATE AN ERRONEOUS REFUND CLAIM PENALTY 

Current Law

Negligence and substantial understatement accuracy-related penalties apply only in the case of 

an underpayment of tax required to be shown on a return. The amount of an accuracy-related 

penalty is 20 percent of the underpayment of tax resulting from a substantial valuation 

misstatement and is 40 percent for a gross valuation misstatement. No substantial 

understatement penalty is imposed unless the portion of the underpayment attributable to the 

valuation misstatement exceeds $5,000 ($10,000 in the case of a corporation other than an S 

corporation or a personal holding company). Additional and alternative accuracy-related 

penalties can apply in the case of an understatement of tax attributable to a transaction required 

to be reported to the IRS under the reporting regime for potentially abusive transactions. 

A taxpayer who is denied the earned income tax credit (EITC) as a result of a deficiency 

procedure must recertify eligibility before claiming the credit again in a subsequent year. Failure 

to recertify will result in a denial of the subsequent EITC claim. EITC claims are disallowed for 

two years if a prior year erroneous claim of the EITC was found to be due to reckless or 

intentional disregard of rules and regulations. The length of the EITC denial is increased to 10 

years if the prior year erroneous claim was due to fraud. 

Reasons for Change

Disallowing a refund or credit claim does not result in an underpayment. Absent a frivolous 

position evident on the face of the return, there is no accuracy-related penalty applicable to 

disallowance of a refund or credit claim. 

Proposal

A penalty would be imposed in the amount of up to 20 percent of a disallowed portion of a claim

for refund or credit for which there is no reasonable basis for the claimed tax treatment or for 

which the taxpayer did not have reasonable cause. A minimum penalty amount would apply, 

regardless of the percentage calculation. However, no penalty would apply to erroneous claims

for an EITC (given the existing procedures designed to deter such claims). 

The proposal would be effective for returns filed on or after January 1, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 0 0 5 10 11 26 98

82
IMPROVE TAX ADMINISTRATION AND OTHER MISCELLANEOUS PROPOSALS

MAKE SECTION 1203 OF THE IRS RESTRUCTURING AND REFORM ACT OF 1998 

MORE EFFECTIVE AND FAIR 

Current Law

Section 1203 of the IRS Restructuring and Reform Act of 1998 (RRA98) requires the 

Commissioner of Internal Revenue to terminate an employee for certain specifically enumerated 

violations committed by the employee in connection with the performance of the employee’s 

official duties. The Commissioner has non-delegable authority to determine whether mitigating 

factors support a personnel action other than termination for a covered violation. 

Reasons for Change

The proposal would enhance the IRS’ effectiveness by more carefully tailoring the types of 

conduct by IRS employees that are subject to sanctions, by reinforcing the seriousness with 

which covered violations will be handled, by providing clear guidance to IRS employees 

regarding covered conduct and associated penalties, and by allowing the imposition of penalties 

that are commensurate with specific violations. 

Current law requires the termination of an IRS employee for the failure to timely file tax returns, 

except when such failure is due to reasonable cause and not due to willful neglect. An IRS 

employee who fails to timely file a refund return (i.e., for a tax year in which the employee is 

entitled to a refund) is subject to termination even though a taxpayer who files a refund return 

late generally is not subject to any penalty. Late-filed refund return cases constitute a significant 

percentage of the section 1203 cases handled to date. These cases do not represent the type of 

serious conduct for which termination under section 1203 should apply. In addition, a number of 

section 1203 cases have involved allegations of wrongful conduct by IRS employees against 

other IRS employees. The Treasury Inspector General for Tax Administration has recommended 

that these types of cases be removed from the list of violations covered by section 1203. Such 

allegations can be addressed by existing administrative and statutory procedures. The proposal 

would eliminate late refund returns and employee versus employee acts from the list of covered 

violations. The proposal also would strengthen taxpayer protections by enhancing the 

Commissioner’s ability to punish the unauthorized access of taxpayer return information. 

Current law requires termination for any covered violation unless the Commissioner personally 

determines that mitigating factors justify some other personnel action. The proposal would 

require the Commissioner to establish guidelines outlining specific penalties, up to and including 

termination, for specific types of covered violations. These guidelines will provide notice to IRS 

employees of the punishment that would result from specific violations. This change would 

improve IRS employee morale and enhance the fundamental fairness of the statute. 

83
Proposal

The proposal would modify section 1203 of RRA98 by (i) removing the late filing of refund 

returns from the list of violations; (ii) removing employee versus employee acts (i.e., for 

violation of an employee’s, rather than a taxpayer’s, Constitutional or civil rights) from the list of 

violations; and (iii) adding the unauthorized inspection of returns or return information to the list 

of violations. In addition, the proposal would require the Commissioner to establish guidelines 

outlining specific penalties, up to and including termination, for specific types of wrongful 

conduct covered by section 1203 of RRA98. The Commissioner would retain the nondelegable 

authority to determine whether mitigating factors support a personnel action other than that 

specified in the guidelines for a covered violation. 

The proposal would be effective upon enactment. 

Revenue Estimate

[No revenue effect] 

84
ALLOW FOR THE TERMINATION OF INSTALLMENT AGREEMENTS FOR 

FAILURE TO FILE RETURNS AND FOR FAILURE TO MAKE DEPOSITS 

Current Law

The IRS may terminate an agreement with a taxpayer to pay a tax liability in installments only 

for specific statutory reasons. These statutory reasons do not include a taxpayer’s failure to file 

required returns or a taxpayer’s failure to make required tax deposits. 

Reasons for Change

IRS administrative procedures specify that installment agreements contain a provision requiring 

taxpayers to meet all return filing and deposit obligations during the term of the agreement. This 

provision is intended to ensure that the privilege of paying a tax liability in installments is 

extended only to those taxpayers willing to commit to future compliance. The installment 

agreement statute, however, does not allow the IRS to terminate an agreement even if a taxpayer 

fails to file required returns or fails to make required Federal tax deposits. Thus, the taxpayer 

may incur significant additional unpaid tax liability before the IRS can terminate the agreement. 

Proposal

The proposal would permit the IRS to terminate an installment agreement if the taxpayer fails to 

timely file tax returns or if a taxpayer fails to timely make required Federal tax deposits. 

The proposal would be effective for failures occurring on or after the date of enactment. 

Revenue Estimate

[No revenue effect] 

85
ELIMINATE THE MONETARY THRESHOLD FOR COUNSEL REVIEW OF OFFERS 

IN COMPROMISE 

Current Law

Whenever a compromise is reached between the IRS and a taxpayer under section 7122, a record 

of the compromise must be placed on file along with an opinion from the IRS Office of Chief 

Counsel. The opinion of Chief Counsel is not required when the total liability, including 

penalties and interest, is less than $50,000. All compromises, regardless of amount, are subject 

to continuous quality review by the Secretary. 

Reasons for Change

The proposal would allow the IRS to more efficiently direct resources for offer in compromise 

(OIC) cases while retaining existing quality review procedures. Many OIC cases do not present 

any significant legal issues, and the required legal review for cases meeting the statutory 

threshold can delay the acceptance process under current administrative procedures. The 

proposal would require the establishment of criteria for determining when review by Chief 

Counsel is appropriate. By retaining the requirement of continuous quality review by the 

Secretary, this proposal would insure that the overall quality of case dispositions does not 

decline. 

Proposal

The proposal would eliminate the requirement that the opinion of Chief Counsel be placed on 

file for any accepted offer in compromise involving unpaid taxes, penalties, and interest equal to 

or exceeding $50,000. This proposal would require the Secretary to establish standards for 

determining when an opinion of Chief Counsel must be obtained. The proposal would be 

effective for offers in compromise submitted or pending on or after the date of enactment. 

Revenue Estimate

[No revenue effect] 

86
ALLOW THE FINANCIAL MANAGEMENT SERVICE TO IMPOSE AND RETAIN 

TRANSACTION FEES 

Current Law

The IRS may continuously levy up to 100 percent of certain Federal payments to a delinquent 

taxpayer under the Federal Payment Levy Program (FPLP). The FPLP is administered by the 

Financial Management Service (FMS) of the Department of the Treasury. FMS charges the IRS 

the costs incurred in developing and operating the FPLP. 

Reasons for Change

The IRS pays the FPLP fees to FMS out of the IRS’ own appropriations. The FPLP fees have 

increased since the inception of the program due to increased FMS costs and increased use of the 

FPLP program. The proposal would alter internal government accounting to effectively 

eliminate accounting costs. 

Proposal

The proposal would allow FMS to add the cost of collection services to the liability being 

recovered from the taxpayer and retain that portion of the levied funds as payment for FMS’ 

collection services, thereby shifting the cost of collection to the delinquent taxpayer. The 

proposal would be effective upon enactment. 

Revenue Estimate

[No revenue effect] 

87
EXTEND IRS AUTHORITY TO FUND UNDERCOVER OPERATIONS 

Current Law

The IRS is authorized to use proceeds it receives from undercover operations to offset necessary 

and reasonable expenses incurred in such operations. The IRS’ authority to use proceeds from

undercover operations is scheduled to expire on December 31, 2007. 

Reasons for Change

The IRS’ authority to use proceeds from undercover operations places the IRS on equal footing 

with other Federal law enforcement agencies. The IRS uses this authority to facilitate long-term, 

complicated criminal investigations, including investigations of international money laundering 

activities that often are connected to terrorism. The expiration of this authority would disrupt 

ongoing investigations. An extension would preserve the IRS’ ability to pursue these important 

criminal investigations. 

Proposal

The proposal would extend the IRS’ authority to use the proceeds received from undercover 

operations through December 31, 2012. 

Revenue Estimate

[No revenue effect] 

88
ELIMINATE THE SPECIAL EXCLUSION FROM UNRELATED BUSINESS TAXABLE 

INCOME FOR GAIN OR LOSS ON THE SALE OR EXCHANGE OF CERTAIN 

BROWNFIELDS 

Current Law

In general, an organization that is otherwise exempt from Federal income tax is taxed on income

from any trade or business regularly carried on by the organization that is not substantially 

related to the organization’s exempt purposes. Gains or losses from the sale, exchange or other 

disposition of property (other than stock in trade, inventory, or property held primarily for sale to 

customers in the ordinary course of the trade or business) generally are excluded from unrelated 

business taxable income. However, such amounts may be taxable if they are derived from 

property that is debt-financed. The amount of income that is taxable is determined based on the 

ratio of the outstanding indebtedness incurred by the organization in acquiring or improving the 

property to the adjusted basis of the property. The debt-financed income rules do not apply in 

the case of certain indebtedness, such as indebtedness that is incurred in the performance or 

exercise of the purpose or function constituting the basis for the organization’s exemption. 

The American Jobs Creation Act of 2004 (the Act) created a special exclusion from unrelated 

business taxable income of gain or loss from the sale or exchange of certain brownfield 

properties by a tax-exempt organization, whether the properties are held directly or indirectly 

through a partnership. For property to qualify for the exclusion, the property must be acquired 

during a five-year period beginning January 1, 2005 and ending December 31, 2009, although 

the property may be disposed of after that date. Certain certification requirements must be met. 

In addition, the exempt organization (or the partnership of which it is a partner) must spend a 

minimum amount on remediation expenses, which may be determined by averaging expenses 

across multiple qualifying brownfield properties for a period of up to eight years. 

The Act also created a special exception to the debt-financed property rules for qualifying 

brownfield properties. Thus, gain or loss from the sale or exchange of qualifying brownfield 

properties is not taxed even if the exempt organization (or partnership) incurred debt to acquire 

or improve the property. 

Reasons for Change

The special exclusion adds considerable complexity to the Code and is difficult to administer. In 

addition, there are concerns about the effectiveness of the provision because there is no limit on 

the amount of gain that is exempt from unrelated business income tax. The special exclusion 

could exempt from income tax real estate development considerably beyond mere environmental 

remediation. 

Proposal

The proposal would eliminate this special exclusion effective for taxable years beginning after 

December 31, 2007. 

89
Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 2 14 28 28 23 95 126

90
LIMIT RELATED PARTY INTEREST DEDUCTIONS 

Current Law

Section 163(j) of the Code applies to limit the deductibility of certain interest paid by a

corporation to related persons (“disqualified interest”). Disqualified interest for these purposes 

generally means interest paid or accrued by a corporation to a related person if such interest

income is not subject to Federal income tax. Disqualified interest also includes interest paid or

accrued by a corporation to an unrelated person if the underlying indebtedness is guaranteed by a 

related foreign person or tax exempt organization and such interest is not subject to U.S. 

withholding tax. The limitations of section 163(j) only apply to a corporation with a debt-to 

equity ratio that exceeds 1.5 to 1. If such a corporation has net interest expense that exceeds 50 

percent of its adjusted taxable income (computed by adding back net interest expense, 

depreciation, amortization and depletion, and any net operating loss deduction), no deduction is 

allowed for disqualified interest in excess of the 50-percent limit. Interest that is disallowed in a 

taxable year under section 163(j) may be carried forward for deduction in a future year; there is 

no time limit on this carryforward. In addition, excess limitation (i.e., the amount by which the 

corporation’s 50-percent limit exceeds its net interest expense for a taxable year) may be carried 

forward up to three years.

Reasons for Change

Under current law, opportunities are available to reduce inappropriately the U.S. tax on income

earned from U.S. operations through the use of foreign related-party debt. Amending the rules of 

section 163(j) is necessary to prevent these inappropriate income-reduction opportunities. 

Proposal

Section 163(j) would be revised to tighten the limitation on the deductibility of interest paid to 

related persons. The current law 1.5 to 1 debt-to-equity safe harbor would be eliminated. The 

adjusted taxable income threshold for the limitation would be reduced from 50 percent to 25 

percent of adjusted taxable income with respect to disqualified interest other than interest paid to

unrelated parties on debt that is subject to a related-party guarantee (hereinafter referred to as 

“guaranteed debt”). Interest on guaranteed debt generally would be subject to the current law 50 

percent of adjusted taxable income threshold. The indefinite carryforward for disallowed interest 

under the adjusted taxable income limitation of current law would be limited to ten years. The 3-

year carryforward of excess limitation would be eliminated. 

Pursuant to section 424 of the American Jobs Creation Act of 2004, the Treasury Department is 

conducting a study of the effectiveness of and deficiencies in the current section 163(j) rules for 

addressing these income-reduction opportunities. Congress has requested a report regarding this 

issue. Such report may include recommendations for further modifications to these rules to 

ensure the elimination of inappropriate income-reduction opportunities. 

The proposal would be effective on the date of enactment. 

91
Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

86 148 155 163 171 180 817 1,859

92
REPEAL TELEPHONE EXCISE TAX ON LOCAL SERVICE 

Current Law

The Code imposes a three-percent excise tax on amounts paid for taxable communications 

services, which include local telephone service and toll telephone service. Local telephone 

service is defined as access to a local telephone system and the privilege of telephonic 

communication with substantially all persons having telephones in the local system. Toll 

telephone service is defined to include both (1) telephonic quality communication for which 

there is a toll charge that varies in amount with the distance and elapsed transmission time of 

each individual call, and (2) telephone service that (a) provides the right to an unlimited number 

of telephone calls to points in a specified area that is outside the local telephone system and (b) is 

subject to a periodic charge determined either as a flat amount or upon the basis of total elapsed 

transmission time. 

Until the mid-1990’s, most long-distance charges were based on the time and distance of each 

call. Since then, the industry has shifted to charges based solely on time. The longstanding 

position of the IRS was that charges based solely on time were subject to tax. Service providers 

followed this position and collected the tax from their customers who began filing claims for 

refunds. When these claims for refunds were denied, taxpayers brought refund suits against the 

IRS. 

The government was uniformly unsuccessful in this litigation at the appellate level. Am. 

Bankers Ins. Group v. United States, 408 F.3d 1328 (11th Cir. 2005); OfficeMax, Inc. v. United 

States, 428 F.3d 583 (6th Cir. 2005); Nat’l R.R. Passenger Corp. v. United States, 431 F.3d 374 

(D.C. Cir. 2005); Fortis v. United States, 447 F.3d 190 (2d Cir. 2006) and Reese Bros., Inc. v 

United States, 447 F.3d 229 (3d Cir. 2006) all hold that a telephonic communication for which 

there is a toll charge that varies with elapsed transmission time and not distance (time-only 

service) is not taxable toll telephone service. 

 

The IRS has announced that it will no longer litigate this issue. As a result, amounts paid for the 

service at issue in the litigation are not subject to tax. The IRS has also announced that, under 

the analysis in the cases cited above, taxpayers are no longer required to pay tax on similar 

services, such as plans that provide bundled local and long distance service for either a flat 

monthly fee or a charge that varies with the elapsed transmission time for which the service is 

used. As a result, the only communications services that remain subject to the tax are purely 

local telephone services. 

Reasons for Change 

It is likely that purely local telephone service will be replaced over time by nontaxable services 

and that, as this occurs, the poor and elderly will be the primary users of purely local service and 

will bear most of the burden of the telephone excise tax. 

93
Proposal 

All taxes on communications services, including the tax on local telephone service, would be 

repealed. The proposal would be effective for amounts paid pursuant to bills first rendered more 

than 90 days after enactment of legislation repealing the tax.

Revenue Estimate 

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

-552 -463 -148 -74 -74 -74 -833 -1,211

94
MODIFY FINANCING OF THE AIRPORT AND AIRWAY TRUST FUND 

Current Law

The Airport and Airway Trust Fund is supported by taxes on air passenger transportation, 

domestic air freight transportation, and aviation fuel. The tax on domestic air passenger 

transportation is 7.5 percent of the amount paid for the transportation plus a segment fee of $3.40 

per segment. The tax on international air transportation is $15.10 on each international arrival or

departure. Both the segment fee and the international arrival and departure fee are adjusted 

annually for inflation. The tax on domestic air freight transportation is 6.25 percent of the 

amount paid for the transportation. The tax on aviation fuel, to the extent dedicated to the 

Airport and Airway Trust Fund, is 4.3 cents per gallon for kerosene used in commercial aviation, 

21.8 cents per gallon for kerosene used in non-commercial (general) aviation, and 19.8 cents per 

gallon for aviation gasoline. The tax is generally imposed when the fuel is removed from a 

terminal. 

The taxes that support the Airport and Airway Trust Fund expire on September 30, 2007. The 

taxes on air transportation do not apply to amounts paid after September 30, 2007. The taxes on 

aviation fuel do not apply to fuel removed from a terminal after September 30, 2007. The 

authority to make expenditures from the Trust Fund for airport and airway programs also expires 

on September 30, 2007. 

Reasons for Change 

The Federal Aviation Administration’s (FAA’s) financing system should be more cost based. 

The current excise tax system, to the extent based on taxes on the amount paid for air 

transportation, does not provide a direct relationship between the taxes paid by users and the air 

traffic control services provided by the FAA. 

For non-commercial aviation, a fuel tax provides an appropriate method of recovering FAA costs 

for air traffic control services. In addition, fuel taxes are an appropriate source of support for 

FAA’s Airport Improvement Program. 

To provide for necessary Federal airport and airway expenditures until a cost-based system is 

developed, the aviation excise taxes and the expenditure authority from the Airport and Airway 

Trust Fund should be temporarily extended. 

Proposal 

The taxes on air transportation would be extended through September 30, 2008. Beginning on 

October 1, 2008, FAA would collect user fees for air traffic control services provided to 

commercial aviation. In addition, the international arrival and departure fees would remain in 

effect, at reduced rates, from October 1, 2008, through September 30, 2017. The aviation fuel 

taxes would be extended through September 30, 2017. Beginning on October 1, 2008, the rates 

of tax on aviation fuel would be adjusted to provide appropriate levels of support for FAA air 

traffic control services that benefit general aviation and for FAA’s Airport Improvement 

95
Program. Expenditure authority from the Airport and Airway Trust Fund would be extended 

through September 30, 2017. 

Revenue Estimate 

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 0 -6,407 -6,705 -7,005 -7,326 -27,443 -69,732

96
IMPROVE UNEMPLOYMENT INSURANCE

STRENGTHEN THE FINANCIAL INTEGRITY OF THE UNEMPLOYMENT 

INSURANCE SYSTEM BY REDUCING IMPROPER BENEFIT PAYMENTS AND TAX 

AVOIDANCE 

Current Law

The Federal Unemployment Tax Act (FUTA) currently imposes a Federal payroll tax on 

employers of 6.2 percent of the first $7,000 paid annually to each employee. Generally, these 

funds support the administrative costs of the unemployment insurance system. Employers in 

States that meet certain Federal requirements are allowed a credit against FUTA taxes of up to 

5.4 percent, making the minimum net Federal rate 0.8 percent. States also impose an 

unemployment tax on employers. A State’s unemployment insurance taxes are first placed in the 

State’s own clearing account and then deposited into its Federal unemployment insurance trust 

fund from which the State pays unemployment benefits. State recoveries of overpayments of 

unemployment insurance benefits must be similarly deposited and used exclusively to pay 

unemployment benefits.

While States may enact penalties for overpayments, amounts collected as penalties or interest on 

benefit overpayments may be treated as general receipts by the States. 

Reasons for Change 

States’ abilities to reduce overpayments and increase overpayment recoveries are limited by 

funding. The mandatory redeposit of the collection of unemployment benefits overpayments 

prevents States from redirecting these amounts to future recovery activity. The mandatory 

redeposit rule also limits the ability of States to use private collection agencies. Although States 

might use penalties or interest on overpayments to increase collections, there is no requirement 

that such amounts be directed for additional enforcement activities. 

Proposal 

The proposal would increase incentives for the recovery of State unemployment benefit 

overpayments and delinquent employer taxes. The proposal would allow States to redirect up to 

5 percent of overpayment recoveries to additional enforcement activity. The proposal would 

require States to impose a penalty of at least 15 percent on recipients of fraudulent 

overpayments, and penalty revenue would be used exclusively for additional enforcement 

activity. States would be prohibited from relieving an employer of benefit charges due to a 

benefit overpayment if the employer had caused the overpayment. In certain circumstances 

relating to fraudulent overpayment of delinquent employer taxes, States would be allowed to 

permit private collection agencies to retain a portion (up to 25 percent) of any amounts collected. 

At the request of a State, the Secretary of the Treasury would collect benefit overpayments due 

to a State from any income tax refund owed to a benefit recipient. The proposal would allow 

States to deposit up to 5 percent of moneys recovered in the course of a UI tax investigation into 

a special fund dedicated to implementing the State Unemployment Tax Act (SUTA) Dumping 

97
Prevention Act of 2004 or enforcing State laws relating to employer fraud or tax evasion. The 

proposal would require employers to report a “start work date” to the National Directory of New 

Hires for all new hires. Finally, the proposal would authorize the Secretary of Labor to waive 

certain requirements to allow States to conduct Demonstration Projects geared to reemployment 

of individuals eligible for unemployment benefits. 

The provisions of the act would be effective as of the date of enactment. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 0 29 29 -16 -64 -22 -1,469

98
EXTEND UNEMPLOYMENT INSURANCE SURTAX 

Current Law

The Federal Unemployment Tax Act (FUTA) currently imposes a Federal payroll tax on 

employers of 6.2 percent of the first $7,000 paid annually to each employee. The tax funds a 

portion of the Federal/State unemployment benefits system. This 6.2 percent rate includes a 

temporary surtax of 0.2 percent. States also impose an unemployment tax on employers. 

Employers in States that meet certain Federal requirements are allowed a credit for State 

unemployment taxes of up to 5.4 percent, making the minimum net Federal tax rate 0.8 percent. 

Generally, Federal and State unemployment taxes are collected quarterly and deposited in 

Federal trust fund accounts. 

In 1976, Congress passed a temporary surtax of 0.2 percent of taxable wages to be added to the 

permanent FTA tax rate. Thus, the current 0.8 percent FUTA tax rate has two components: a 

permanent tax rate of 0.6 percent, and temporary surtax rate of 0.2 percent. The surtax has been 

extended several times, the most recently through 2007, to build up reserves in the Federal trust 

accounts and thus to help avoid future funding problems in these accounts. 

Reasons for Change

Extending the surtax will support the continued solvency of the Federal unemployment trust 

funds and maintain the ability of the unemployment system to adjust to any economic

downturns. 

Proposal

The proposal would extend the 0.2 percent surtax through December 31, 2012. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 1,073 1,542 1,580 1,617 1,633 7,445 1,526

99
ENERGY PROVISIONS

REPEAL REDUCED RECOVERY PERIOD FOR NATURAL GAS DISTRIBUTION 

LINES 

Current Law

Pipelines used by utilities to distribute natural gas to their customers (natural gas distribution 

lines) placed in service before January 1, 2011, are assigned a statutory recovery period of 

15 years for purposes of the Modified Accelerated Cost Recovery System (MACRS) and a 

statutory class life of 35 years for purposes of the alternative depreciation system applicable to 

certain property and for purposes of computing the alternative minimum tax. Natural gas 

distribution lines placed in service after December 31, 2010, are assigned a 20-year recovery 

period for purposes of MACRS and a 35-year class life for purposes of the alternative 

depreciation system. 

Reasons for Change 

Because the 15-year MACRS recovery period for natural gas distribution lines benefits gas 

utilities rather than gas producers, it does not significantly add to our nation’s energy supplies 

over what the market would provide if the recovery period were 20 years. Moreover, the 15-year 

recovery period provides natural gas utilities with an unwarranted advantage over competitors 

such as electric utilities. 

Proposal 

The proposal would assign natural gas distribution lines a statutory recovery period of 20 years 

for purposes of the MACRS. The 35-year class life for purposes of the alternative depreciation 

system would be retained. The proposal would be effective for natural gas distribution lines 

placed in service after December 31, 2007. 

Revenue Estimate 

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 52 88 107 119 106 472 906

101
MODIFY AMORTIZATION FOR CERTAIN GEOLOGICAL AND GEOPHYSICAL 

EXPENDITURES 

Current Law

Geological and geophysical expenditures are costs incurred for the purpose of obtaining and 

accumulating data that will serve as the basis for the acquisition and retention of mineral 

properties. The amortization period for geological and geophysical expenditures incurred in 

connection with oil and gas exploration in the United States is two years for independent 

producers and five years for integrated oil and gas producers. 

Reasons for Change 

Current high energy prices provide significant incentives for investments in oil and gas 

exploration. Additional incentives in the form of accelerated amortization of geological and 

geophysical expenditures are not necessary. In addition, increasing the amortization period for 

geological and geophysical expenditures incurred by independent oil and gas producers from two

years to five years would provide more consistent tax treatment for all oil and gas producers. 

Proposal 

The proposal would increase the amortization period from two years to five years for geological 

and geophysical expenditures incurred by independent producers in connection with all oil and 

gas exploration in the United States. Five-year amortization would apply even if the property is 

abandoned and any remaining basis of the abandoned property would be recovered over the 

remainder of the five-year period. The proposal would be effective for amounts paid or incurred 

in taxable years beginning after December 31, 2007. 

Revenue Estimate 

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 15 55 81 67 56 274 582

102
EXTEND EXPIRING PROVISIONS

MINIMUM TAX RELIEF FOR INDIVIDUALS 

Current Law

An individual is subject to an alternative minimum tax (AMT) to the extent the individual’s 

tentative minimum tax is greater than the regular tax liability. In computing the tentative 

minimum tax, taxable income is calculated differently than for regular tax purposes. Under the 

AMT, certain income items are included that are not included for regular tax purposes. Also, 

certain deductions, including State and local tax deductions, miscellaneous itemized deductions, 

and the standard deduction, are not permitted. A specified exemption amount, which varies by 

filing status but not by the number of personal exemptions and which phases out at higher 

income levels, is allowed. The regular tax personal exemptions for taxpayers and their 

dependents are not allowed in computing the AMT. Under the AMT, the tax rate is 26 percent 

on the first $175,000 ($87,500 if married filing separately) of AMT income, and 28 percent on 

any excess. 

Generally, for AMT purposes taxpayers are allowed to use most tax credits only to the extent 

their regular tax liability exceeds their tentative minimum tax. However, under provisions of the 

Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), before 2011, the child 

tax credit, the adoption credit, and the saver’s credit are not limited by the AMT, and the AMT 

does not reduce the earned income tax credit and the additional child tax credit. A temporary 

provision, which permitted an individual to reduce tax liability by the full amount of 

nonrefundable personal credits (such as the child and dependent care credit and the higher 

education credits) even if tax liability is reduced to an amount that is less than the individual’s 

tentative minimum tax, expired after taxable year 2001 but was extended for taxable years 2002 

and 2003 by the Job Creation and Worker Assistance Act of 2002, for 2004 and 2005 by the 

Working Families Tax Relief Act of 2004, and for 2006 by the Tax Increase Prevention and 

Reconciliation Act of 2005. 

EGTRRA increased the alternative minimum tax (AMT) exemption amounts for taxable years 

2001 through 2004, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) 

further increased the exemptions for 2003 and 2004, and the Working Families Tax Relief Act of

2004 extended the higher exemption amount through 2005. Under the Tax Increase Prevention 

and Reconciliation Act of 2005, the exemptions were increased further for 2006 to $42,500 for 

single and head of household filers, $62,550 for married taxpayers filing joint returns, and 

$31,275 for married taxpayers filing separate returns. Beginning in taxable year 2007, the 

exemption levels revert to their pre-EGTRRA levels of $33,750, $45,000, and $22,500, 

respectively.

Reasons for Change

The Administration is concerned that the individual AMT may impose substantial burdens upon 

taxpayers who were not the originally intended targets of the individual AMT. Providing higher 

AMT exemption levels and allowing nonrefundable personal credits to be used in full for an 

103
additional year would avoid a significant increase in the number of taxpayers subject to the AMT 

in the near term. Substantially fewer taxpayers would need to perform the complex and tedious 

AMT computations. The Administration believes the longer term solution to the problems

associated with the individual AMT is best addressed within the context of other reforms to the 

tax system. 

Proposal

The proposal would increase the AMT exemption levels for 2007 to $43,900 for single and head 

of household filers, $65,350 for married taxpayers filing joint returns, and $32,675 for married 

taxpayers filing separate returns. In addition, the proposal would allow an individual to reduce 

2007 tax liability by the full amount of nonrefundable personal credits even if tax liability is 

reduced to an amount that is less than the individual’s tentative minimum tax. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

-9,123 -47,922 11,431 0 0 0 -36,491 -36,491

104
PERMANENTLY EXTEND THE RESEARCH & EXPERIMENTATION (R&E) TAX 

CREDIT 

Current Law

The research and experimentation (R&E) tax credit is 20 percent of qualified research expenses 

above a base amount. The base amount is the product of the taxpayer’s “fixed base percentage” 

and the average of the taxpayer’s gross receipts for the four preceding years. The taxpayer’s 

fixed base percentage generally is the ratio of its research expenses to gross receipts for the 

1984-88 period. The base amount cannot be less than 50 percent of the taxpayer’s qualified 

research expenses for the taxable year. Taxpayers can elect into a three-tiered alternative credit 

that has lower credit rates (ranging from 2.65 to 3.75 percent) and lower statutory fixed base 

percentages (ranging from 1 to 2 percent). 

The Tax Relief and Health Care Act of 2006 extended the R&E credit, which expired on 

December 31, 2005, for two years (through December 31, 2007) and modified the credit for 

qualified research expenses incurred after December 31, 2006. The first modification increases 

the range of rates for the alternative credit from 2.65 to 3.75 percent to 3 percent to 5 percent. 

The second modification provides a new simplified research credit equal to 12 percent of 

qualified research expenses that exceed 50 percent of the average qualified research expenses for 

the three preceding taxable years. The rate is reduced to 6 percent if a taxpayer has no qualified 

research expenses in any one of the three preceding taxable years. An election to use the new 

credit applies to all succeeding taxable years unless revoked with the consent of the Secretary. 

Reasons for Change

The R&E tax credit encourages technological developments that are an important component of 

economic growth. However, uncertainty about the future availability of the R&E tax credit 

diminishes the incentive effect of the credit because it is difficult for taxpayers to factor the 

credit into decisions to invest in research projects that will not be initiated and completed prior to

the credit’s expiration. To improve the credit’s effectiveness, the R&E tax credit should be made 

permanent. 

Proposal

The proposal would make the R&E credit permanent. 

In addition, the Administration is concerned that features of the R&E tax credit may limit its 

effectiveness in encouraging taxpayers to invest in R&E. The Administration will work closely 

with the Congress to develop and enact reforms to rationalize the R&E tax credit and improve its 

incentive effect. 

105
Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -3,221 -7,071 -9,145 -10,601 -11,799 -41,837 -117,309

106
WORK OPPORTUNITY TAX CREDIT 

Current Law

The Tax Relief and Health Care Act of 2006 consolidated the former work opportunity tax credit 

and the former welfare-to-work credit with modifications into a combined work opportunity tax 

credit (WOTC), effective for wages paid to eligible workers who begin work in 2007. In 

general, the WOTC is now available to employers who hire qualified workers from nine eligible 

targeted groups of economically disadvantaged or handicapped workers. The current eligible 

targeted groups for purposes of the WOTC include: (1) recipients of Temporary Assistance to 

Needy Families (TANF); (2) qualified veterans; (3) qualified ex-felons; (4) high-risk youth at 

least 18 years old but not yet 25 years old; (5) qualified referrals from State-sponsored vocational 

rehabilitation programs for the mentally and physically disabled ; (6) qualified summer youth; 

(7) qualified food stamp recipients at least 18 years old but not yet 40 years old; (8) 

Supplemental Security Income (SSI) recipients, and (9) long-term family assistance recipients. 

In general, the amount of the WOTC available to an employer is based on the amount of 

qualified wages paid to an employee within an eligible targeted group during the first year of 

employment (the first two years of employment for employees who are long-term family 

assistance recipients). In general, for all targeted groups except summer youth employees and 

long-term family assistance recipients, the WOTC is equal to 40 percent (25 percent for 

employment of between 120 hours and 400 hours) of qualified first-year wages for the first 

$6,000 of wages. Thus, the maximum credit generally is equal to 40 percent of $6,000 of 

qualified first-year wages per eligible worker or $2,400. For the summer youth target group, the 

maximum credit is 40 percent of $3,000 of qualified first-year wages per eligible worker or 

$1,200. For long-term family assistance recipients, the credit is equal to 40 percent of qualified 

first-year wages for the first $10,000 of first-year wages and 50 percent of qualified second-year 

wages for the first $10,000 of second-year wages, which results in a maximum WOTC credit for 

long-term family assistance recipients of $9,000 per eligible worker. 

The WOTC is subject to various limitations, including a requirement by employers to reduce 

their deduction for wages paid by the amount of the credit claimed and tax liability limitations 

governing the general business credit. 

Membership in most eligible target groups for purposes of the WOTC requires eligible persons 

to be members of families that benefit from means-tested government programs, to live in areas 

with high poverty rates, or to have participated in government programs that provide benefits to 

handicapped workers. Designated local agencies are responsible for certifying that individuals 

hired are members of eligible target groups. Employers must have certifications of worker 

eligibility from designated local agencies in order to claim the credit. For workers hired without 

appropriate documentation of eligibility, employers must request certification documents within 

28 days of the hiring date in order to obtain the necessary certification documents. 

The WOTC is unavailable to employers for wages paid to workers in the nine targeted groups 

who begin work after December 31, 2007. 

107
Reasons for Change

The WOTC provides appropriate tax incentives to employers for hiring and training 

economically disadvantaged workers. 

Proposal

The proposal would extend the WOTC to employers for qualified wages paid to eligible target 

group employees who begin work after December 31, 2007 and before January 1, 2009. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -71 -192 -162 -80 -51 -556 -582

108
FIRST-TIME HOMEBUYER CREDIT FOR THE DISTRICT OF COLUMBIA

Current Law

A one-time, nonrefundable $5,000 credit is available to purchasers of a principal residence in the 

District of Columbia who have not owned a residence in the District during the year preceding 

the purchase. The credit phases out for taxpayers with modified adjusted gross income between 

$70,000 and $90,000 ($110,000 and $130,000 for joint returns). 

The credit does not apply to purchases after December 31, 2007. 

Reasons for Change

The homeownership rate in the District of Columbia is significantly below the rate for 

neighboring States and the nation as a whole. Homeownership fosters healthy, vibrant 

communities and is a key to revitalizing the Nation’s capital. Extending the credit would 

enhance the District’s ability to attract new homeowners and establish a stable residential base. 

Proposal

The first-time homebuyer credit for the District of Columbia would be extended for one year, 

making the credit available with respect to purchases through December 31, 2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -1 -19 0 0 0 -20 -20

109
AUTHORITY TO ISSUE QUALIFIED ZONE ACADEMY BONDS 

Current Law

During 1998-2007, State and local governments have been able to issue qualified zone academy 

bonds (QZABs) for qualified purposes to fund the improvement of certain eligible public 

schools. In general, QZABs are not interest-bearing obligations. Rather, an eligible holder of a 

QZAB receives annual Federal income tax credits in lieu of interest. These annual credits 

compensate the holder for lending money and, therefore, are treated like taxable interest

payments for Federal tax purposes. Eligible holders are banks, insurance companies, and 

corporations actively engaged in the business of lending money. The credit rate for a QZAB is 

set on its day of sale by reference to credit rates established by the Department of the Treasury 

and is a rate that is intended to permit the issuance of the QZAB without discount and without 

interest cost to the issuer. The credit accrues annually and is includible in gross income (as if it 

were an interest payment on a taxable bond) and can be claimed against regular income tax 

liability. The maximum term of a QZAB is determined by reference to a percentage of the 

adjusted applicable Federal rate (AFR) published by IRS for the month in which the QZAB is 

issued. This maturity restriction results in a Federal subsidy which is approximately equal to half 

the face amount of the bond. 

A national volume cap of $400 million annually applies to QZABs. The annual national volume 

cap is allocated among the States in proportion to their respective populations of individuals with 

incomes below the poverty line. Unused authority to issue QZABs can be carried forward for 

two years. 

A number of requirements must be met for a bond to be treated as a QZAB. First, the bond must 

be issued pursuant to an allocation of bond authority from the issuer's State educational agency. 

Second, at least 95 percent of the bond proceeds must be used for an eligible purpose at a 

qualified zone academy. Eligible purposes include rehabilitating school facilities, acquiring 

equipment, developing course materials, or training teachers. A qualified zone academy is a 

public school (or an academic program within a public school) that is designed in cooperation 

with business and is either (1) located in an empowerment zone or enterprise community, or (2) 

attended by students at least 35 percent of whom are estimated to be eligible for free or reducedcost lunches under the National School Lunch Act. Third, private entities must have promised to 

contribute to the qualified zone academy certain property or services with a present value equal 

to at least 10 percent of the bond proceeds. 

For QZABs issued from volume cap authority arising in 2006 and thereafter, several additional 

program restrictions apply. A new spending rule applies which requires an issuer to spend at 

least 95 percent of the proceeds of an issue of QZABs within five years (and to redeem bonds 

from unspent proceeds upon failure to meet that spending requirement). In addition, an IRS 

information reporting requirement applies to these QZABs similar to one applicable to taxexempt bonds. Finally, arbitrage investment restrictions apply to these QZABs similar to those 

applicable to tax-exempt bonds. 

110
Reasons for Change

Aging school buildings and new educational technologies create a need to renovate older school 

buildings and to develop new curricula. Many school systems have insufficient fiscal capacity to 

finance needed renovation and programs. The QZAB provision encourages the development of 

innovative school programs through public/private partnerships. 

 

Proposal

The authority to issue $400 million of QZABs per year would be extended for one year through 

2008. 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 -3 -8 -13 -18 -20 -62 -162

111
DEFERRAL OF GAINS FROM THE SALE OF ELECTRIC TRANSMISSION 

PROPERTY 

Current Law

Generally, the gain on the sale of business assets is subject to current income tax unless a special 

rule provides for nonrecognition or deferral of the gain. One such special rule applies to 

qualifying electric transmission transactions. Under this rule, a taxpayer may elect to recognize 

the gain from a qualifying electric transmission transaction ratably over the eight-year period 

beginning with the year of the transaction. Deferral is allowed only with respect to proceeds that 

are used to purchase other gas or electric utility property during the four-year period beginning 

on the date of the transaction (the reinvestment period). If the amount realized exceeds the 

amount used to purchase other gas or electric utility property during the reinvestment period, the 

realized gain to the extent of such excess is recognized in the year of the qualifying electric 

transmission transaction. 

A sale or other disposition of property is a qualifying electric transmission transaction if (i) the 

property is used in the trade or business of providing electric transmission services or is an 

ownership interest in an entity whose principal trade or business is providing electric 

transmission services and (ii) the sale or other disposition is to an independent transmission 

company and occurs before January 1, 2008. 

In general, whether the purchaser qualifies as an independent transmission company depends on 

determinations by the Federal Energy Regulatory Commission (FERC) or, in the case of 

facilities subject to the jurisdiction of the Public Utility Commission of Texas, by that 

Commission. In certain cases, a person’s qualification as an independent transmission company 

also depends on whether the person’s transmission facilities are under the operational control of 

a FERC-approved independent transmission provider before January 1, 2008.

Reasons for Change

To improve transmission management and facilitate the formation of competitive energy

markets, Federal and State energy regulators are calling for vertically integrated utilities to place 

their transmission assets under the ownership or control of independent transmission companies. 

An extension of the special rule allowing limited deferral of the tax on gain from the dispositions 

to independent transmission companies would facilitate electric deregulation and encourage 

investment in modernization of the country’s energy infrastructure. 

Proposal

The special rule allowing the deferral of tax on the gain from the sale or disposition of electric 

transmission property would be extended for one year, allowing taxpayers to elect deferral with 

respect to sales or dispositions that occur before January 1, 2009. In addition, for cases in which 

qualification as an independent transmission company depends on operational control of 

transmission facilities by a FERC-approved independent transmission provider, the deadline for 

112
achieving such control would be extended for one year (i.e., qualification would depend on 

whether the transmission facilities were under such control before January 1, 2009). 

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

-63 -48 -52 -65 -39 5 -199 41

113
DISCLOSURE OF TAX RETURN INFORMATION RELATED TO TERRORIST 

ACTIVITY 

Current Law

Current law permits disclosure by the IRS of return information to aid the investigation or 

response to terrorism in two situations. First, if a specified official of a Federal law enforcement 

or intelligence agency submits a written request, the IRS may disclose a taxpayer’s identity and 

return information to such agency’s officers and employees involved with a terrorist incident, 

threat, or activity. The head of a Federal law enforcement agency in turn may make disclosures 

to State or local law enforcement agencies working as part of a team on the investigation or 

response. Second, if the IRS wishes to apprise a Federal law enforcement agency of a terrorist 

incident, threat, or activity, the IRS may disclose a taxpayer’s identity and return information to 

the agency’s head (who in turn may disclose the information to agency officers and employees as 

necessary). With respect to returns and return information that the taxpayer supplied (other than 

taxpayer identity information), the IRS cannot make the disclosure to Federal law enforcement or 

intelligence agency officers and employees without a court order indicating there is reasonable 

cause to believe the returns and return information at issue are relevant to the terrorist incident, 

threat or activity. If a Federal law enforcement or intelligence agency seeks taxpayer return 

information, specified officials in the Department of Justice may apply for an ex parte court 

order. If the IRS wishes to disclose taxpayer return information, the IRS may apply for an ex 

parte court order and may make disclosures to the Department of Justice as necessary to prepare 

such application on behalf of the IRS. 

Reasons for Change

The disclosure authority relating to terrorist activities expires on December 31, 2007. The 

Administration believes that extension would help provide continued support for investigations 

and responses relating to terrorism. 

Proposal

The proposal would extend this authority until December 31, 2008. 

Revenue Estimate

[No revenue effect] 

114
EXCISE TAX ON COAL 

Current Law

An excise tax is imposed on coal at a rate of $1.10 per ton for coal from underground mines and 

$0.55 per ton for coal from surface mines. In either case, the tax imposed with respect to a ton of 

coal may not exceed 4.4 percent of the amount for which it is sold by the producer. Receipts 

from the tax are deposited in the Black Lung Disability Trust Fund. Amounts in the Fund are 

used to pay compensation, medical, and survivor benefits to eligible miners and their survivors 

and to cover costs of program administration. Miners and survivors qualify for benefits from the 

Fund only if the miner’s mine employment terminated before 1970 or no mine operator is liable 

for the payment of benefits. The Fund is also permitted to borrow from the general fund any 

amounts necessary to make authorized expenditures if excise tax receipts do not provide

sufficient funding. 

Reduced rates of tax apply after the earlier of December 31, 2013, or the date on which the Black 

Lung Disability Trust Fund has repaid, with interest, all amounts borrowed from the general fund 

of the Treasury. The reduced rates of tax are $0.50 per ton for coal from underground mines and 

$0.25 per ton for coal from surface mines. In addition, the maximum tax imposed with respect to 

a ton of coal is reduced from 4.4 percent of the amount for which it is sold by the producer to 2 

percent of that amount. 

Reasons for Change

To reduce the duration of the general fund subsidy for black lung disability programs, excise tax 

rates on coal should remain at their current levels until all amounts borrowed from the general 

fund of the Treasury have been repaid with interest. 

Proposal

The proposal would retain the excise tax on coal at the current rates until the date on which the 

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

general fund of the Treasury. After repayment of the Fund’s debt, the reduced rates of $0.50 per 

ton for coal from underground mines and $0.25 per ton for coal from surface mines would apply 

and the tax per ton of coal would be capped at 2 percent of the amount for which it is sold by the 

producer. The proposal would be effective for coal sales after December 31, 2006.

Revenue Estimate

Fiscal Years

2007 2008 2009 2010 2011 2012 2008-2012 2008-2017

($ in millions) 

0 0 0 0 0 0 0 1,081

115
QUALIFIED RETIREMENT PLAN DISTRIBUTIONS TO INDIVIDUALS CALLED TO

ACTIVE DUTY 

Current Law

Taxpayers who receive distributions from a qualified retirement plan prior to age 591⁄2 , death, or 

disability generally are subject to a 10 percent tax, in addition to regular income tax, on the 

amount includible in income as a result of the distribution, unless an exception applies. 

Examples of distributions that are excepted from this additional tax include early distributions 

made to an employee who separates from service after age 55, or to distributions that are part of 

a series of substantially equal periodic payments over the life (or life expectancy) of the 

employee or the joint lives (or life expectancies) of the employee and his or her beneficiary. 

Employee deferrals in a section 401(k) plan or section 403(b) annuity may not be distributed at 

all before severance from employment, age 591⁄2, death, disability, or financial hardship of the 

individual. 

The Pension Protection Act of 2006 provided that “qualified reservist distributions” are an 

additional exception to the 10 percent additional tax on early withdrawals. A qualified reservist 

distribution is a distribution (1) from an IRA or attributable to elective deferrals under a section 

401(k) plan, section 403(b) annuity, or certain similar arrangements, (2) made to an individual 

who (by reason of being a member of a reserve component, which includes national guard units) 

was ordered or called to active duty after September 11, 2001, for a period in excess of 179 days 

or for an indefinite period, and (3) that is made during the period beginning on the date of such 

order or call to duty and ending at the close of the active duty period. A section 401(k) plan or 

section 403(b) annuity does not violate the distribution restrictions applicable to such plans by 

reason of making a qualified reservist distribution. An individual who receives a qualified 

reservist distribution may, at any time during the two-year period beginning on the day after the 

end of the active duty period, make one or more contributions to an IRA of such individual in an 

aggregate amount not greater than the amount of the distribution. The dollar limitations 

otherwise applicable to contributions to IRAs do not apply to any contribution made pursuant to 

this rule. No deduction is allowed for any contribution made under this rule. This exception to 

the 10 percent early withdrawal penalty does not apply to individuals called to active duty after 

December 31, 2007. 

Reasons for Change

Americans commonly incur economic hardship as a result of being called to active military 

service. They should not be penalized if they need to draw on their qualified retirement funds to 

address these hardships. 

Proposal

The exception to the 10 percent early withdrawal tax on distributions to individuals called to 

active duty for at least 179 days would be extended to individuals called to active duty on or 

before December 31, 2008. 

116
Revenue Estimate 

[No revenue effect] 

117
INCLUDE COMBAT PAY AS EARNED INCOME FOR EITC 

Current Law

Subject to certain limitations, compensation earned by members of the Armed Forces while 

serving in combat zones may be excluded from gross income. Enlisted personnel and warrant 

officers may exclude the full amount of compensation earned in combat zones. Commissioned 

officers also may exclude compensation earned in combat zones, but only to the extent of the 

maximum amount that enlisted personnel receive. For up to two years following service in a 

combat zone, military personnel also may exclude compensation earned while hospitalized from

wounds, disease, or injuries incurred while serving in a combat zone. 

Nontaxable compensation is not includable in earned income for purposes of computing the 

earned income tax credit (EITC). However, a taxpayer may elect to treat combat pay otherwise 

excluded from gross income as earned income for purposes of the EITC, effective for taxable 

years ending after October 4, 2004, and before January 1, 2008. 

Reasons for Change

Excluding combat pay from earned income can decrease or increase the amount of the EITC 

received by military personnel serving in combat zones. The effect of the exclusion varies 

depending on a number of factors, including the taxpayer’s rank, number of years of service in 

the military, number of months in a combat zone, marital status, and number of children. The 

effects of the exclusion are most adverse among very low-ranking enlisted personnel who serve 

in combat zones for most or all of the tax year. However, in 2006, the exclusion likely increased 

the EITC for most military personnel.

Extending the availability of the election to include combat pay as earned income for purposes of 

the EITC would assist very low-ranking enlisted personnel who serve long periods in combat 

zones, without disadvantaging other military personnel also serving in combat zones.

Proposal

The election to treat combat pay otherwise excluded from gross income as earned income for 

purposes of the EITC would be extended through December 31, 2008. 

118
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008-2012 2008-2017

Dividends tax rate structure................................................... 344 683 695 -3,595 -13,789 1,491 -4,389 -12,826 -18,392 -19,400 -20,451 -14,515 -89,973

Capital gains tax rate structure.............................................. 0 0 0 -3,405 -17,477 -7,269 -7,599 -9,565 -10,890 -11,215 -11,639 -28,151 -79,059

Expensing for small business................................................ 0 0 0 -3,728 -4,947 -3,376 -2,454 -1,826 -1,429 -1,242 -1,156 -12,051 -20,158

Marginal individual income tax rate reductions...................... 0 0 0 0 -71,892 -113,251 -116,044 -119,209 -122,054 -124,798 -126,532 -185,143 -793,780

Child tax credit 1/................................................................... 0 0 0 0 -5,311 -33,065 -33,248 -33,431 -33,535 -33,660 -33,782 -38,376 -206,032

Marriage penalty relief 2/....................................................... 0 0 0 0 -5,014 -9,594 -8,680 -7,843 -7,026 -6,306 -5,820 -14,608 -50,283

Education incentives.............................................................. 0 0 0 0 -739 -1,336 -1,402 -1,459 -1,519 -1,578 -1,640 -2,075 -9,673

Repeal of estate and generation-skipping transfer taxes, and modification of gift taxes.............................................. -156 -1,373 -2,290 -3,067 -26,845 -57,652 -60,012 -65,184 -70,077 -75,385 -80,605 -91,227 -442,490Other incentives for families and children.............................. 0 0 0 6 -179 -866 -860 -859 -861 -861 -861 -1,039 -5,341 Total make permanent the tax relief enacted in  2001 and 2003....................................................... 188 -690 -1,595 -13,789 -146,193 -224,918 -234,688 -252,202 -265,783 -274,445 -282,486 -387,185 -1,696,789

Tax Incentives:

Simplify and encourage saving:

Expand tax-free savings opportunities.................................. 0 1,527 3,545 3,023 1,075 -1,314 -1,634 -866 -1,505 -2,011 -2,432 7,856 -592

Consolidate employer-based savings accounts.................... 0 -80 -120 -132 -141 -150 -159 -169 -178 -187 -168 -623 -1,484

 Total simplify and encourage savings......................... 0 1,447 3,425 2,891 934 -1,464 -1,793 -1,035 -1,683 -2,198 -2,600 7,233 -2,076

Encourage entrepreneurship and investment:

Increase expensing for small business.................................. 0 -1,597 -2,180 -1,541 -1,135 -847 -659 -567 -527 -521 -521 -7,300 -10,095

Invest in health care:

Provide a flat $15,000 deduction for family coverage ($7,500 for individual coverage) for those with health insurance 3/........................................................................ 0 0 -31,664 -43,521 -35,548 -24,748 -11,048 4,059 19,930 36,034 53,770 -135,480 -32,735

Expand and make health savings accounts (HSA's) more flexible................................................................................ 0 -318 -593 -784 -937 -1,037 -1,130 -1,225 -1,329 -1,439 -1,574 -3,669 -10,366

Improve the Health Coverage Tax Credit 4/.......................... 0 -5 -13 -16 -19 -20 -21 -22 -23 -25 -26 -73 -190

Allow the orphan drug tax credit for certain pre- designation expenses......................................................... 0 0 0 0 0 0 0 0 0 0 -1 0 -1

 Total invest in health care............................................ 0 -323 -32,270 -44,321 -36,504 -25,805 -12,199 2,812 18,578 34,570 52,170 -139,222 -43,292

Provide incentives for charitable giving:

Permanently extend tax-free withdrawals from IRAs for charitable contributions....................................................... 0 -120 -255 -235 -171 -147 -161 -177 -190 -200 -211 -928 -1,867

Permanently extend the enhanced charitable deduction for contributions of food inventory...................................... 0 -44 -96 -106 -116 -127 -140 -154 -169 -187 -206 -489 -1,345Permanently extend the enhanced deduction for corporate contributions of computer equipment for educational purposes......................................................... 0 -50 -118 -147 -154 -162 -170 -178 -187 -197 -207 -631 -1,570Permanently extend increased limits on contributions of  partial interests in real property for conservation  purposes............................................................................. 0 -48 -35 -22 -18 -21 -22 -23 -24 -25 -27 -144 -265

Permanently extend the basis adjustment to stock of S corporations contributing appreciated property.................. 0 -3 -15 -21 -25 -28 -32 -37 -42 -47 -51 -92 -301

Reform excise tax based on investment income of private foundations......................................................................... 0 -61 -91 -97 -103 -110 -119 -130 -142 -151 -159 -462 -1,163

Repeal the $150 million limitation on qualified 501(c)(3) bonds.................................................................................. 0 -2 -3 -9 -13 -14 -14 -13 -13 -12 -11 -41 -104

Repeal certain restrictions on the use of qualified 501(c)(3) bonds for residential rental property................... 0 -2 -5 -10 -17 -24 -32 -39 -46 -52 -59 -58 -286

 Total incentives for charitable giving........................... 0 -330 -618 -647 -617 -633 -690 -751 -813 -871 -931 -2,845 -6,901

Revenue Estimates */

FY 2008 Budget Tax Proposals Affecting Receipts

Fiscal Years

(in millions of dollars)

Make Permanent Certain Tax Relief Enacted in 2001 and 2003:

119
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008-2012 2008-2017

Revenue Estimates */

FY 2008 Budget Tax Proposals Affecting Receipts

Fiscal Years

(in millions of dollars)

Strengthen education:

Permanently extend the above-the-line deduction for qualified out-of-pocket classroom expenses...................... 0 -18 -180 -183 -185 -188 -191 -194 -197 -200 -203 -754 -1,739Allow the saver's credit for contributions to qualified tuition programs (section 529 plans).................................. 0 -63 -163 -176 -189 -200 -208 -221 -236 -249 -261 -791 -1,966

 Total strengthen education.......................................... 0 -81 -343 -359 -374 -388 -399 -415 -433 -449 -464 -1,545 -3,705

Protect the environment:

Permanently extend expensing of brownfields remediation costs............................................................... 61 -244 -400 -352 -342 -331 -292 -256 -236 -207 -191 -1,669 -2,851Eliminate the volume cap for private activity bonds for water infrastructure............................................................. 0 -1 -3 -5 -9 -13 -18 -24 -30 -37 -44 -31 -184 Total protect the environment...................................... 61 -245 -403 -357 -351 -344 -310 -280 -266 -244 -235 -1,700 -3,035

Restructure Assistance to New York City

Provide tax incentives for transportation infrastructure......... 0 -200 -200 -200 -200 -200 -200 -200 -200 -200 -200 -1,000 -2,000 Subtotal: Tax Incentives................................................... 61 -1,329 -32,589 -44,534 -38,247 -29,681 -16,250 -436 14,656 30,087 47,219 -146,379 -71,104

Simplify the Tax Law for Families:

Clarify uniform definition of a child 5/..................................... 17 246 244 280 276 256 282 310 332 356 377 1,302 2,959

Simplify EITC eligibility requirement regarding filing status, presence of children, and work and immigrant status 6/.............................................................................. 0 241 -58 -39 -39 -35 -32 -29 -26 -23 -20 70 -60Reduce computational complexity of refundable child tax credit 7/............................................................................... 0 0 375 388 400 417 426 435 436 446 450 1,580 3,773

 Subtotal: Simplify Tax Law for Families............................ 17 487 561 629 637 638 676 716 742 779 807 2,952 6,672

Improve Tax Compliance:

Expand information reporting:

Require information reporting on payments to corporations........................................................................ 0 69 421 609 769 832 893 951 1,008 1,061 1,123 2,700 7,736

Require basis reporting on security sales.............................. 0 0 31 178 328 498 771 1,023 1,186 1,289 1,405 1,035 6,709Expand broker information reporting..................................... 0 20 77 136 186 220 240 254 267 280 294 639 1,974Require information reporting on merchant payment card reimbursements.......................................................... 0 113 404 694 949 1,174 1,309 1,406 1,490 1,564 1,642 3,334 10,745Require a certified taxpayer identification number from contractors.......................................................................... 0 5 42 72 76 80 85 90 94 100 105 275 749Require increased information reporting for certain government payments for property and services............... 0 25 100 130 108 27 0 0 0 0 0 390 390Increase information return penalties.................................... 0 0 0 29 72 72 73 74 75 75 76 173 546

 Total expand information reporting.............................. 0 232 1,075 1,848 2,488 2,903 3,371 3,798 4,120 4,369 4,645 8,546 28,849

Improve compliance by businesses:

Require e-filing by certain large businesses..........................

Implement standards clarifying when employee leasing  companies can be held liable for their clients' federal  employment taxes.............................................................. 0 3 5 5 5 6 6 6 7 7 7 24 57Amend collection due process procedures for employment tax liabilities.................................................... 0 140 86 33 16 14 14 14 15 16 16 289 364 Total improve compliance by business........................ 0 143 91 38 21 20 20 20 22 23 23 313 421

Strengthen tax administration:

Expand IRS access to information in the National Directory of New Hires for tax administration purposes.....Permit disclosure of prison tax scams................................... 0 0 0 0 0 0 1 1 1 1 1 0 5Make repeated willful failure to file a tax return a felony........ 0 0 0 1 1 1 1 2 2 2 2 3 12

 Total strengthen tax administration............................. 0 0 0 1 1 1 2 3 3 3 3 3 17

No Revenue EffectNo Revenue Effect

120
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008-2012 2008-2017

Revenue Estimates */

FY 2008 Budget Tax Proposals Affecting Receipts

Fiscal Years

(in millions of dollars)

Penalties:

Expand preparer penalties.................................................... 0 3 5 6 8 9 9 9 10 10 11 31 80

Impose penalty on failure to comply with electronic filing requirements....................................................................... 000 0 0 0 0 0 0 0 0 0 0

Create an erroneous refund claim penalty............................ 0 0 0 5 10 11 12 13 14 16 17 26 98

 Total penalties............................................................. 0 3 5 11 18 20 21 22 24 26 28 57 178

 Subtotal: Improve Tax Compliance................. 0 378 1,171 1,898 2,528 2,944 3,414 3,843 4,169 4,421 4,699 8,919 29,465

Make Section 1203 of the IRS Restructuring and Reform Act of 1998 more effective and fair.....................................Allow for the termination of installment agreements for failure to file returns and for failure to make depositsÖÖÖEliminate the monetary threshold for counsel review of offers in compromise..........................................................Allow the Financial Management Service to impose and retain transaction fees........................................................Extend IRS authority to fund undercover operations.............Eliminate the special exclusion from unrelated business taxable income for gain or loss on the sale or exchange of certain brownfields.......................................................... 0 2 14 28 28 23 18 10 3 0 0 95 126

Limit related party interest deductions................................... 86 148 155 163 171 180 189 198 208 218 229 817 1,859

 Total tax administration............................................... 86 150 169 191 199 203 207 208 211 218 229 912 1,985

Repeal telephone excise tax on local service........................ -552 -463 -148 -74 -74 -74 -75 -75 -76 -76 -76 -833 -1,211

Modify financing of the Airport and Airway Trust Fund.......... 0 0 -6,407 -6,705 -7,005 -7,326 -7,663 -8,036 -8,427 -8,857 -9,306 -27,443 -69,732

 Total other................................................................... -552 -463 -6,555 -6,779 -7,079 -7,400 -7,738 -8,111 -8,503 -8,933 -9,382 -28,276 -70,943 Subtotal: Improve Tax Administration and Other............................................................. -466 -313 -6,386 -6,588 -6,880 -7,197 -7,531 -7,903 -8,292 -8,715 -9,153 -27,364 -68,958

Improve Unemployment Insurance:

Strengthen the financial integrity of the unemployment insurance system by reducing improper benefit  payments and tax avoidance.............................................. 0 0 29 29 -16 -64 -210 -1,170 -697 468 162 -22 -1,469

Extend unemployment insurance surtax............................... 0 1,073 1,542 1,580 1,617 1,633 -54 -843 -1,754 -2,290 -978 7,445 1,526

 Subtotal: Improve Unemployment Insurance................... 0 1,073 1,571 1,609 1,601 1,569 -264 -2,013 -2,451 -1,822 -816 7,423 57

Energy Provisions: 8/

Repeal reduced recovery period for natural gas distribution lines.................................................................. 0 52 88 107 119 106 89 81 81 87 96 472 906

Modify amortization for certain geological and geophysical expenditures................................................... 0 15 55 81 67 56 58 60 61 64 65 274 582

 Subtotal: Energy Provisions............................................. 0 67 143 188 186 162 147 141 142 151 161 746 1,488

Extend Expiring Provisions:

Minimum tax relief for individuals....................................... -9,123 -47,922 11,431 0 0 0 0 0 0 0 0 -36,491 -36,491

Permanently extend the Research and Experimentation (R&E) Tax Credit................................................................ 0 -3,221 -7,071 -9,145 -10,601 -11,799 -12,833 -13,875 -15,002 -16,222 -17,540 -41,837 -117,309Work Opportunity Tax Credit................................................. 0 -71 -192 -162 -80 -51 -22 -4 0 0 0 -556 -582First-time homebuyer credit for the District of Columbia....... 0 -1 -19 0 0 0 0 0 0 0 0 -20 -20

Authority to issue Qualified Zone Academy Bonds............... 0 -3 -8 -13 -18 -20 -20 -20 -20 -20 -20 -62 -162

No Revenue EffectNo Revenue EffectNo Revenue Effect

 Miscellaneous Proposals:

No Revenue EffectNo Revenue Effect

Improve Tax Administration and Other

121
122

Revenue Estimates */

FY 2008 Budget Tax Proposals Affecting Receipts

Fiscal Years

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008-2012 2008-2017 

(in millions of dollars)

Deferral of gains from the sale of electric transmission

property.............................................................................. -63 -48 -52 -65 -39 5 27 43 117 57 -4 -199 41 

Disclosure of tax return information related to terrorist

activity................................................................................. No Revenue Effect

Excise tax on coal.................................................................. 0 0 0 0 0 0 0 202 289 293 297 0 1,081 

Qualified retirement plan distributions to individuals called

to active duty...................................................................... 0 0 0 0 0 0 0 0 0 0 0 0 0

 Subtotal: Expiring Provisions............................................ -9,186 -51,266 4,089 -9,385 -10,738 -11,865 -12,848 -13,654 -14,616 -15,892 -17,267 0 -79,165 -153,442

Trade:

Implement free trade agreements and modify other trade

related agreements............................................................. 0 -241 -502 -760 -994 -1,240 -1,511 -1,699 -1,860 -2,036 -2,229 -3,737 -13,072

 Total Effect of FY 2008 Budget Tax Proposals -9,386 -51,834 -33,537 -70,732 -198,100 -269,588 -268,855 -273,207 -273,293 -267,472 -259,065 -623,790 -1,965,683 

*/ Estimates presented for certain provisions identified in the table include the effects of both receipts and outlays. For these provisions, estimates differ from those presented in Table 17-3 of the Analytical Perspectives of the President's Budget, which presents only the effect on receipts of the Administration's legislative proposals.1/ Affects both receipts and outlays. The outlay effect is $46 million in 2011, $11,937 million in 2012, $11,849 million in 2013, $11,784 million in 2014, $11,685 million in 2015, $11,658 million in 2016, $11,693 million in 2017, $11,983 million in 2008-

$70,652 million in 2008-2017.

2/ Affects both receipts and outlays. The outlay effect is -$366 million in 2011, $1,623 million in 2012, $1,590 million in 2013, $1,561 million in 2014, $1,536 million in 2015, $1,517 million in 2016, $1,505 million in 2017, $1,257 million in 2008-2012, 

$8,966 million in 2008-2017.

3/ Affects both receipts and outlays. The outlay effect is $231 million in 2009, $4,629 million in 2010, $4,705 million in 2011, $4,715 million in 2012, $4,737 million in 2013, $4,742 million in 2014, $4,715 million in 2015, $4,711 million in 2016, $4,701

million in 2017, $14,280 million in 2008-2012, $37,886 million in 2008-2017.

4/ Affects both receipts and outlays. The outlay effect is $4 million in 2008, $10 million in 2009, $12 million in 2010, $14 million in 2011, $15 million in 2012, $15 million in 2013, $16 million in 2014, $17 million in 2015, $18 million in 2016, $18 million in 

2017, $55 million in 2008-2012, $139 million in 2008-2017.

5/ Affects both receipts and outlays. The outlay effect is -$182 million in 2008, -$196 million in 2009, -$249 million in 2010, -$236 million in 2011, -$241 million in 2012, -$259 million in 2013, -$282 million in 2014, -$302 million in 2015, -$322 million in 

2016, -$340 million in 2017, -$1,104 million 2008-2012, -$2,609 million in 2008-2017.

6/ Affects both receipts and outlays. The outlay effect is -$210 million in 2008, $33 million in 2009, $17 million in 2010, $17 million in 2011, $14 million in 2012, $10 million in 2013, $8 million in 2014, $6 million in 2015, $2 million in 2016, -$1 million in 

-$129 million in 2008-2012, -$104 million in 2008-2017.

7/ Affects both receipts and outlays. The outlay effect is -$375 million in 2009, -$388 million in 2010, -$400 million in 2011, -$417 million in 2012, -$426 million in 2013, -$435 million in 2014, -$436 million in 2015, -$446 million in 2016, -$450 million in 

2017, -$1,580 million in 2008-2012, -$3,773 million in 2008-2017.

8/ Table 17-3 of the Analytical Perspectives section of the President's Budget includes taxes lost as a result of proposals to impose renewable fuels and fleet fuel efficiency standards. These tax losses total $45 million in 2008, $93 million in 2009,

$163 million in 2010, $92 million in 2011, $98 million in 2012, $123 million in 2013, $133 million in 2014, $141 million in 2015, $112 million in 2016, and $19 million in 2017. 

Office of Tax Analysis