General Explanations 

of the 

Administration=s Revenue Proposals

Department of the Treasury 

February 1998 
-- 

TABLE OF CONTENTS 

MAKE CHILD CARE MORE AFFORDABLE 

EXPANDING THE CHILDAND DEPENDENTCARETAXCREDIT. . .. . I . .. . , . .,, ., ., . . . . 1 

EMPLOYER CREDIT FOR EXPENSES OF SUPPORTING EMPLOYEECHILD CARE . ... ., ., " I I 3 

PROMOTE ENERGY EFFICIENCY AND IMPROVE THE ENVIRONMENT

PROVIDE TAX CREDIT FOR ENERGY-EFFICIENT BUILDING EQUIPMENT. . . . . I I . I . I . . .5 

PROVIDE TAX CREDIT FOR PURCHASE OF NEW ENERGY EFFICIENTHOMES ., ., ., . I , . . . . 7 

PROVIDE TAXCREDITFOR HIGH-FUEL-ECONOMY VEHICLESI . I I I I . . .. I I I . . .8 

EQUALIZE TREATMENT OF PARKING AND TRANSIT BENEFITS, . ,, .. ., ,, " I . . . ., ,, ., , , . I 10 

PROVIDEINVESTMENTTAXCREDITFOR 

COMBINED %AT AND POWER (Cm)SYSTEMS 11 

PROVIDE TAX CREDIT FOR REPLACEMENT OF 

CERTAIN CIRCUIT BREAKEREQUIPMENT. . . 13 

PROVIDE TAX CREDIT FOR CERTAIN PERFLUOROCOMPOUND (PFC) 

AND HYDROFLUOROCARBON (HFC) RECYCLING EQUIPMENT. I . . .. . . ,, , . 1 . I . . ., , .14 

. PROVIDE TAXCREDIT FOR ROOFTOP SOLAR EQUIPMENTI . . . ... .. .. I I I .. ... . . .. . " 15 

EXTEND Wm AND Biomss TAXCREDIT ., . ~ ,, , I . I . ,, ., .. , ~ " , . ,. ., I ... . . 16 

PROMOTE EXPANDED RETIRMENTSAVINGS 

EXPANDED ACCESS TO PAYROLL DEDUCTION FOR RETIREMENTSAVINGS .. . .. I .. I . . ., 17 

SlVIALL BUSINESS TAXCREDIT FOR RETIREMENT PLAN START-UP EXPENSES I . . ., . I 18 

THE SMART PLAN A SIMPLIFIED PENSIONPLANFOR SMALL BUSMESS .I I .. . . ., . 19 

FASTER VESTING OF EMPLOYERMATCHING CONTRIBUTIONS . . .. .., ., ,. .. ... . I . ... I 24 
PENSIONFUGHT?'OKNOWP~oposars.. . .. I I. ........~ ............. ~.......(25 

SIMPLIFIED METHOD FOR IMPROVING BENEFITS OF NONHIGHLY COMPENSATED

EMPLOYEESUNDER THE SAFE HARBOR FOR 40 1(K) PLANS . I. . .... I ..... (.(.I . I .... 28 

SIMPLIFY DEFINITION OF HIGHLYCOMPENSATED EMPLOYEE ... I. (................30 

SIMPLIFY BENEFIT LIMIrS FOR MULTIEMPLOYER PLANS UNDER SECTION 415 ......... 31

SIMPLIFY FULLFUNDING LIMITATION FOR MULTIEMPLOYER PLANS ......... .......... 32

ELIMINATE PAR?IAL TERMINATION RULESFOR MULTIEMPLOYER PLANS ............33 

EDUCATIONINITIATIVES 

TAXCREDITS FOR HOLDERS OF QUALIFIED SCHOOL MODERNIZATION BONDS

AND QUALIFIED ZONEACADEMYBONDS.. I .. .... I ....I . I . I .... I .. I .."34 

EXCLUSION FOR EMPLOYER-PROVIDED EDUCATIONALASSISI ANCE .(... ......... 37 

ELIMINATING TAX ON FORGIVENESS OF DIRECT STUDENT LOANSSUBJECT TO INCOME

CONTINGENTREPAYME" ....................................................... 38 

Low INCOME HOUSING CREDIT

INCREASE LOW-INCOME HOUSING TAXCREDITPER CAPITA CAP ..................39

EXTENDEXPIRINGPROVISIONS 

EXTEND THE WORK OPPORTUNITY TAX CREDIT . ... ~ .. ~ (........... ........ ...40 

EXTEND THEWELFARE-TO-WORKTAXCREDIT................................ 41 

EXTEND THER&E TAXCREDIT............................................. 42

EXTEND THE DEDUCTIONPROVIDED FORcONTRIBLlTlONS OF 

APPRECIATED STOCKTO PRIVA'IEFOUNDATIONS ........................... 43 

MA& PERMANENTTHE EXPENSING OF BROWNFIELDSREMEDIATION COSTS ......... 44 
MISCELLANEOUSPROVISIONS 

EXTEND AND MODIFYPUERTO RICOTAXCREDIT(SECTION30A) . . I ... . I I I I ., I . ,, 45 

SPECIALIZED SMALLBUSINESS INVESTMENT COMPANYTAXINCENTIVES. I ,, ,, , ,, 46 

ACCELERATE AND EXPANDINCENTIVES AVAILABLE TO TWO

NEWEMPOWERMENT ZONES. ...I I .I . . . . I I . . . . . . I . . 48 

MAKE FIRST$2,000 OF SEVERANCE PAY EXEMPT FROM INCOMETAX . . . .. . . I I I I I 49 

SIMPLIFYTHETAXLAWS 

OPTIONAL SELF-EMPLOYMENT CONTRIBUTIONS ACT(SECA) COMPUTATIONS ... .. . . .50 

PROVIDE STATUTORY HEDGING AND OTHER RULESTO ENSURE 

BUSINESS PROPERTY Is TREATED AS ORDINARY PROPERTY. .. . . . . I . .. . ....I .. I . . .52 

CLARIFY RULES&L.ATING TO CERTAIN DISCLAIMERS I I I I I I I .. I I ~ . I ,, I I I 54 

SIMPLIFY THE FOREIGNTAXCREDIT LIMITATION 

FOR DIVIDENDSFROM 10/50 COMPANIES ... . .. . .. . I . . I I . . . . I . . . ... . . ... . .55 

INTEREST TREATMENT FOR DIVIDENDS PAID BY CERTAIN REGULATED

INVESTMENT COMPANIES TO FOREIGNPERSONS... .. ~ " I I .I ., . . . . . .. I .... .. .57 

ENHANCE TAXPAYERS' RIGHTS

SUSPEND COLLECTION BY LEVYDURINGREFUNDSUIT. ~ .. I ~ I .. . . I I . ... . . .58 

SUSPEND COLLECTION BY LEVYWHILE OFFER IN COMPROMISE IS PENDING . .. . . , . . .59 

SUSPEND COLLECTION TO PERMIT RESOLUTIONOF DISPUTESAS TO LIABILITY . . . . ..60 

REQUIRE DISTRICT COUNSEL APPROVAL OF CERTAIN THIRD-PARTY COLLECTION

ACTIVITIES.................... 61 

REQUIRE MANAGEMENT APPROVAL OF LEVIES ON CERTAM ASSETSI . . I ~ . .. .. .62 

REQUIRE DISTRICTCOUNSEL REVIEW OF JEOPARDY 

AND TERMINATION ASSESSMENTS AND JEOPARDYLEVIES..I .I I . 63 

REQUIRE MANAGEMENT APPROVAL OF SALES OF PERISHABLE GOODS.... . .. . ~ . . .64 
CODIFY CERTAIN FAIRDEBTCOLLECTION PROCEDURES ......................... 65 

MODIFY PAYMENTOF TAXES................................................ 66 

REQUIRE DISCLOSURES RELATING TO EXTENSION OF STAI'UTES OF LIMITATIONBY 

AGREEMENT........................................................... 67 

PUBLISH LMNGALLOWANCE SCHEDULES RELATING TO OFFERSIN COMPROMISE.I . . 68 

ENSURE AVAILABILITY OF INSTALLMENT AGREEMENTS........................... 69 

INCREASE SUPERPRIORITYDOLLARLIMITS .................................... 70 

PERMIT PERSONAL DELIVERY OFSECTION6672(B) NOTICES ...................... 71 

ALLOW TAXPAYERS TO QUASHALL "-PARTY SUMMONSES .................... 72 

WQUIRE DISCLOSURE OFCNTERIA FOR EXAMINATION SELECTION ..................73

PROHIBIT mAT OF AUDITTO COERCE TIPREPORTING 

ALERNATIVECOMMITMENTAGREEMENTS................................... 74 

PERMITSERVICEOF SUMMONSES BY MAIL..................................... 75 

ALLOW SUITS FOR DAMAGESIF THE IRs VIOLATES 

CERTAINBANKRUPTCYPROCEDURES ........................................ 76 

INCREASE TAX COURT'S "SMALL CASE" LIMI'T ................................ 77 

PROVIDE EQUIT~BLE TOLLING............................................. 78 

REQUIRENOTICE OF DEFICIENCYTO SPECIFY TAX COURT FILINGDEADLINES........79 

ALLOW ACTIONSFOR &FUND WITH RESPECT TO CERTAIN ESTATES 

Wmm HAVEELECTED THE INSTALLMENT METHODOF PAYMENT.................80

EXPAND AUTHORITYTO AWARDCOSTSAND FEES.............................. 81 

EXPAN!3 AUTHORITY TO ISSUE TAWnYER ASSISTANCE ORDERS .. ~ .. ~ ..... I .. ...82

PROVIDE NEWWhtEDY FOR THIRD PARTIES WHO CLAIM THAT 

THEIRSHASFILEDANERRONEOUSLLEN .................................... 83 

ALLOWDAMAGE SUITSBY PERSONS OTHERTHANTHE TAXPAYER................. 85 
SUSPEND COLLECI'ION IN CERTAIN JOINT LIABILITYCASES . . .I " . .I I ., I .. . . . .. . . . 86 

REQUIREEXPLANATION OF JOINT AND SEVERALIABILITY., ,, I .., I .. . ~ . . .. I . I I .. . I 87 

RELIEVE INNOCENT SPOUSE OF LIABILITYIN CERTAIN CASES I . . . ... I . I I I I . I I ., , , 88 

&LOW "GLOBAL" INTEREST NETTINGOF UNDER- AND OVER-PAYMENTS I . . I .., ,, ., ., 90 

FACILITATEARCHIVING OF IRS RECORDS ... ~ . . . . . I . . ., . .. . .... I I ,, I I ., .. .. .. 91 

CLARIFY AUTHORITYTO PRESCRIBE IVIAM*IER OF MAKING ELECTIONS.. . I ,. I ,, . .. I .92 

GRANTIRS BROADAUTHORIT( TO ENTERINTO COOPERATIVE 

AGREEMENTS WITH STATE TAXINGAGENCIES... . . ... . . . I . 93 

PROVIDE CL.INICS FOR LOW-INCOME TAXPAYERSI I . . ,, . . I I I I ,. I I I I I I ,. ., ., ., .,. ., , . . .94 

PROVIDE PROCEDURES FOR RELEASE OF FIELDSERVICE ADVICE.. ,, .,, .. I ., ., ., . ., . .., . . .95 

REVENUEMEASURES 

DEFERDEDUCTION FOR INTEREST AND ORIGINAL ISSUE DlSCOLNI

ON CONVERTIBLEDEBT I . I . . I . . ., . . .I , . , I , . . . .. ., ., . . 97 

ELIMINATE DIVIDENDS-RECEIVED DEDUCTIONFOR CERTAIN PREFERRED STOCK . . I ~ .98 

REPEAL PERCENTAGE DEPLETION FOR NON-FUEL MINERALSMINED ON 

FEDERAL AND FORMERLY FEDERALANDS .. . . . .. . I ... ..... .... .... .. I I ~ I 100 

REPEAL. TAX-FEE CONVERSIONS OF LARGEC CORPORATIONSTO s CORPORATIONS 101 

REPLACESALESSOURCE RULESWITH ACTIVTY-BASEDRULE I I .. I I I . . I . .. .lo3 

MODIFYRULESREL.ATING TO FOREIGN OIL AND GASEXTRACTIONINCOME ... . ...lo4 

REPEALLOWEROF COST OR WRKET INVENTORY ACCOUNTING"OD . . . . . I .lo6 

INCREASE PENALTIES FOR FAILURETO FILECORRECT INFORMATION &TURNS I I I I , 107 

TIGHTENTHE SUBSTANTIAL UNDERSTATEMENT PENALN FOR LARGECORPORATIONS I 108 

REPEAL EXEMPTION FOR WITHHOLDING ON GAMBLING WINNINGS

FROM BINGO AM) KENO IN EXCESS OF $5,000 . ~ .. .... . ~ ...I ~ ... I .. I . .. 109 
REINSTATE OILSPILLEXCISETAX (................I .................. I .. I ... 110 

MODIFYDEPOSIT REQUIRE~T' FOR FUTA .. (....I ...........(... (... .........(... 

EXEND PRO RATA DISALLOWANCE OF TAX-EXEMPT INTERESTEXPENSE

THAT &'PLIES TO BANKS TO ALL FINANCIALINTERMEDIARIES ....................... 112 

INCREASE THE PRORATION PERCENTAGE FOR PROPERTY CASUALTY 

(P&C) INSURANCE COMPANIES...(.......... I ...............I I ................. I .113

PRECLUDE CEKTAIN TAXPAYERS FROM PREMATURELY CLAIMINGLOSSES FROM RECEIVABLES

OR FROM CREATING RESERVESFOR BADDEBTS .....(.I ................. I .. (.. . .. 114

RESTRICT SPECIAL NE1 OPERATING LOSS CARRYBACKRULESFOR 

SPECIFIED LIABILITYLOSSES.I(.(....... . I ...... . .... I ............ (... .116 

FREEZEGRANDFATHERED STATUS OF STAPLED OR PAIRED SHAREREITS .. (.(.I I (. . 118 

RESTRICI IMPERMISSIBLE BUSINESSESbJLWJX"LY CONDUCTED BY REITS .. I .... " 119 

MODIFY TREATMENI OF CLOSELY HELD REITS I . I .......... . .........(. . (. . 120 

MODIFYDEPRECIA'IION METHODFOR TAX-EXEMPTUSEPROPERTY. .... I ........ 121 

IMPOSEXCISETAXON PURCHASE OF S'IRUCTURED SETTLEMENTS .......... I ........ 122 

CLARIFYAND EXPANDM~TH ERRORPROCEDURES...... ............(.I ..............123 

CLARIFY THE MEANING OF "SUBJECT TO"LIABILITIESUNDER SECTION 357(C) .....(... 125 

SIMPLIFY FOSTER CHILDDEFINITIONUNDER EITC . I ..................... I . . 127 

CLARIFYTIE-BREAKERRULEUNDER EITC I ....... . .. I .................... 128 

ELIMINA'ENON-BUSINESS VALUATIONDISCOUNTS..... I . ... (.(.I .. I (.......... 129 

ELIMINATE"CRUMMEY"RULE ....(...... (....I ............. I .. (.. I .. I II .).).130 

ELIMINATE GIFTTAXEXEMPTION FOR PERSONALRESIDENCETRUSTS. ...... I I (. I 131 

INCLUDE QUALIFIED TERMINABLE INTEREST PROPERTY(QTIP) 

TRUST ASSETS IN SURVIVING SPOUSE'S ESTATE .....I (. I ........................ 132 

&PLY 7.7 PERCENT CAPITALIZATION RATE TO CREDIT LIFEINSURANCE PREMIUMS .. I 133 
MODIFY CORPORATE-OWNED LIFEINSURANCE(COLI) RULES.. I . .,, . ,, ,, I ,, ., ,, I I ,. 134 

MODIFY RESERVERULESFOR ANNUITY CONTRACTS . . . . . ... . I I I I I ,, I ,, I I . .. I ,, ,, 136

TAXCERTAIN EXCHANGES OF INSURANCE CONTRACTS AND

&AL.L.OCATIONS OF ASSETSWITHIN VARIABLE INSURANCE CONTRACTS I I . . I I 138 

REDUCE “INVESTMENT IN THE CONTRACT” FOR MORTALITY 

AND EXPENSE CHARGES ON CERTAIN INSURANCE CONTRACTS., ,. I I , . . , . ,, ,. ,. . . ,, ,. ,. ., 140 

PRESCRIBE REGULATORY DIRECTIVETO ADDRESS TAXAVOIDANCE 

INVOL.VING FOREIGN BUILT-INLOSSESI I . ” . . , . I . I I . I I .. . . . . . . I .. . I I . . 143 

PRESCRIBE REGULATORY DIRECTIVETO ADDRESS TAX 

AVOIDANCE THROUGH USE OF HYBRIDSI I I , . . ., ., . ,, I . ., I . ,. ., I I I ., I ,, . ,. I I , . .,, . I .144 

MODIFY FOREIGN OFFICE MATERIAL PARTICIPATION EXCEPTIONAPPLICABLE 

TO INVENTORY SALESATTRIBUTABLE TO NONRESIDENT’SU.S. OFFICE . . . I . . . .. . . , 147 

STOP ABUSE OF CFC EXCEPTIONTO OWNERSHIP REQUIREMENTS OF SECTION 883 . . 148 

OTHERMEASURES AFFECTING RECEIPTS

REINSTATE ENVIRONMENTAL TAXIMPOSED ON CORPORATE TAXABLE 

INCOME AND nEPOSITED IN THE HAZARDOUSSUBSTANCE SUPERFUND TRUSTFUND .. 150 

REINSTATEEXCISE TAXESDEPOSITEDIN THEHAZARDOUS 

SUESTANCESUPERFUND TR~JSTFUND I I .. . I I .. .. ,, .I I .I I . . ,, .,, .. 151 

EXTEND EXCISETAXESON GASOLINE, DIESEL FUEL,AND SPECIALMOTORFUELS I . 152 

CONVERT EXCISE TAXES DEPOSITED IN THE AIRPORT AND AIRWAY TRUST

FUND TO COST-BASED USER FEESASSESSED FOR FEDERALAVIATION 

ADMINISTRATION(FAA) SERVICESI I I . , . . I I I I ,, ,, I I .. ., ., I . I ., .. I ,, ,, .. ., I . I 153 
EXPANDING THECHILD AND DEPENDENT CARE TAX CREDIT 

Current Law 

A taxpayer may be eligible for a nonrefundable tax credit if he or she pays for the care of 

a qualifying individual in order to work. Qualifjmg individuals include children under the age 

of 13 and disabled dependents or spouses. The credit is equal to a percentage of the taxpayer’s 

employment-relatedexpendimes for child or dependent care. A taxpayer must provide over half 

the costs of maintaining the household in which the taxpayer and the qualifying dependent 

reside. 

The credit rate depends on the taxpayer’s adjusted gross income. The credit rate is 

phased-down &om 30 percent (for taxpayers with adjusted gross incomes of $10,000 or less) to 

20 percent (for taxpayers with adjusted gross incomes above $28,000). The maximum amounts 

of qualifying expenses for which credits can be claimed are limited to $2,400 for one qualifying 

individual and $4,800 for two or more qualifying individuals. Thus, the maximum credit ranges 

from $480 to $720 for a taxpayer with one qualifying individual and $960 to $1,440 for a 

taxpayer with two or more qualifying individuals. 

Employees may exclude from their taxable income (and their earnings for social security 

tax purposes) amounts their employers provide as child and dependent care benefits, including 

cafeteria plan contributions. The exclusion is limited to $5,000 of child care expenses per year 

and does not vary with the number of qualifying dependents. The amount of a taxpayer’s 

expenses eligible for the child and dependent care credit is reduced dollar for dollar by the 

amount of excludable benefits provided by the employer. 

Reasons for Chanoe 

Many working parents cannot find affordable and safe child care. In the FY 1999 budget, 

the Administration is proposing a comprehensiveinitiative to address the child care needs of 

both low- and moderate-income working families. Low-income families will receive additional 

assistance through an expansion of the Child Care and Development Block Grant. The needs of 

moderate-income families can be best served through an expansion of the child and dependent 

care tax credit, which was last increased in 1982.. 

Pro~osal 

The maximum child and dependent care tax credit rate would be increased from 30 

percent to 50 percent. Taxpayers would be eligible for the 50 percent credit rate if their adjusted 

gross income is $30,000 or less. For taxpayers with adjusted gross incomes between $30,000 

and $59,000, the credit rate would be reduced by one percentage point for each additional 

$1,000, or Eaction thereof, of adjusted gross income in excess of $30,000. Taxpayers with 

adjusted gross incomes over $59,000 would be eligible for a 20 percent credit rate. 

1 
Taxpayers generally would no longer be required to provide over half the costs of 

maintaining the home Ui which the taxpayer and the qualifying individual reside to claim the 

child and dependent care taxcredit, but would still be required to demonstratethat they resided 

in the same household asthe qualifyiig individual. A married taxpayer who files a separate 

return, however, would still have to meet the current law household maintenance test in order to 

qualify for the credit. 

The provision would be effective for taxyears beginning after December 31, 1998. 

Be,.inning in the year 2000, the starting point for the phase-down range would be indexed for 

inflation. The maxi" amounts of qualifying child and dependent care expenses that could be 

claimed for the credit would also be indexed, beginning in 2000. 

2 
EMPLOYER CREDIT FOR EXPENSES OF SUPPORTING EMPLOYEE CJXILD CARE 

Current Law 

If an employer incurs expenses to assist employees in obtaining child care, either by 

acquiring or constructing a child care facility for their use or arranging for third parties to provide 

child care services, those expenses generally are either immediately deductible under section 162 

as ordinary and necessary business expenses or capitalized and then recovered over time through 

depreciation deductions. Employers may also treat up to $5,000 per year in dependent care 

assistance provided to an employee who is a long-term family assistance recipient as wages for 

purposes of the Welfare-to-Work Tax Credit provided under section 51A. Otherwise, an 

employer is not eligible to take a credit against Federal income tax for expenses incurred that 

relate to child care for its employees. 

Reasons for Change 

As part of the Administration's comprehensive initiative to address the child care needs of 

both low.-and moderate-income working families, the Administration intends to provide private 

sector employers with an incentive to make quality child care services available to their 

employees. 

ProDosa1 

Taxpayers would receive a credit againsttheir Federal income tax equal to 25 percent of 

qualified expenses for employee child care. These expenses would include costs incurred 

(1) to acquire, construct, rehabilitate or expand property that is to be used as part 

of a taxpayer's qualified child care facility; 

(2) for the operation of a taxpayer's qualified child care facility, including the 

costs of training and continuing education for employees of the child care facility; 

or 

(3)under a contract with a qualified child care facility to provide child care 

services to employees of the taxpayer. 

To be a qualified child care facility, the principal use of the facility must be for child care, and 

the facility must be duly licensed by the State agency with jurisdiction over its operations. Also, 

if the facility is owned or operated by the taxpayer, at least 30 percent of the children enrolled in 

the center (based on an annualaverage of the enrollment measured at the beginning of each 

month) must be children of the taxpayer's employees. If a taxpayer opens a new facility, it must 

meet the 30 percent employee enrollment requirement withintwo years of commencing 

3 
operations If a new facility failed to meet this requirement, the credit would be subject to 

recapture. 

To qualify for the credit, the taxpayer must offer child care services, either at its own 

facility or through third parties, on a basis that does not discriminate in favor of highly 

compensated employees. 

A taxpayer would also be entitled to a credit for ten percent of expenses incurred to 

provide employees with child care resource and referral services. 

A taxpayer’s total credit under this proposal would be limited to $150,000 per year. Any 

deduction the taxpayer would otherwise be entitled to take for the qualified expenses shall be 

reduced by the amount of the credit. Similarly, if the credit is taken for expenses of acquiring, 

constructing, rehabilitating, or expanding a facility, the taxpayer’s basis in the facility would be 

reduced by the amount of the credit. 

The credit would be effective for taxable years beginning after December 3 1,1998 

4 
PROVIDE TAX CREDIT FOR ENERGY-EFFICIENT BUJLDING EQUIPMENT 

Current Law 

No income tax credit is provided currently for investment in energy-efficientbuilding 

equipment. 

Reasons for Charye 

A credit for types of equipment that have substantially increased energy efficiency oveI 

conventional equipment will help to accelerate the development and distribution of energyefficient technologies. A credit would reduce costs to consumers, increasing demand for the 

equipment and reducing manufacturing costs, while also spurring technological innovation. 

Proposal 

A credit would be provided for the purchase of certain types of highly efficient building 

equipment: fuel cells, electric heat pump water heaters, advanced natural gas and residential size 

electric heat pumps, and advanced central air conditioners. The credit would equal 20 percent of 

the purchase price, subject to a cap. The credit would be nonrefundable. For businesses, it 

would be subject to the limitations an the general business credit and would reduce the basis of 

the equipment. The credit would generally be available for final purchases from unrelated third 

parties between January 1, 1999 and December 31, 2003 for use within the United States. 

(Because of the current state of technology, the credit for fuel cells would be available for 

purchases between January 1,2000 and December 31,2004.) 

To be eligible for the credit, the specific technologies would have to meet the following 

criteria: 

Fuel cells generate electricity and heat ~~ing an electrochemicalprocess. To qualify for 

the credit, fuel cell technologies would be required to have an electricity-only generation 

efficiency greater than 35 percent. Fuel cells with a minimum generating capacity of 50 

kilowatts would be eligible for the credit. 

Electric heat pump hot water heaters use electrically powered vapor compression cycles 

to extract heat from air and deliver it to a hot water storage tank. Qualifyingheat pump 

water heaters would be required to yield an Energy Factor greater than or equal to 1.7 in 

the standard Department of Energy (DOE) test procedure. 

Electric heat Dumps use electrically powered vapor compression cycles to extract heat 

from airin one space and deliver it to air in another space. EHP technologies witha 

heatihg efficiency greater thanor equal to 9 HSPF and a coaling efficiency greater than or 

equal to 15 SEER would qualify for the credit. 

5 
Natural gasheat pumps use either a gas-absorption cycle or a gas-driven engine to power 

the vapor compression cycle to extract heat from one source and deliver it to another. 

Qualifying natural gas heat pumps would be those with a coefficient of performance for 

heating of at least 1.25 and for cooling of at least 0.70. 

Central air conditioners would be required to have an efficiency equal to or greater than 

15 SEER to qualify for the credit. 

Advanced natural gas water,heatersuse a variety of mechanisms to increase steady state 

efficiency and reduce standby and vent losses. Only natural gas water heaters with an 

energy factor of at least 0.80 in DOE test procedures would qualify for the credit. 

6 
PROVIDE TAX CREDIT FOR PURCHASE OF NEW ENERGY EFFICIENT HOMES 

Current Law 

No deductions or credits are provided currently for the purchase of energy efficient new 

homes. 

Reasons for Change 

Residences, which account for about ane-sixth of all US.greenhouse gases, offer one of 

the largest single sources of carbon-saving potential. Some States and certain Federal programs 

require new houses to meet Model Energy Code standards for insulation and related construction 

standards, and for heating, cooling and hot water equipment. By the use of cost-effective means, 

many new homes could reduce energy consumption by 50 percent or mare as compared to the 

Model Energy Code standard. A targeted credit for such highly energy efficient new housing 

could increase the use of energy efficient building practices and efficient heating and cooling 

equipment In addition, it could help spur innovation in house design and construction, thereby 

providing significant environmental benefits over the long term 

Proposal 

A tax credit of up to $2,000 would be available to purchasers of highly energy efficient 

new homes. To claim the credit, the taxpayer must use the new home as the taxpayer’sprincipal 

residence, and the new home must use at least 50 percent less energy for heating, cooling and hot 

water than the Model Energy Code standard for single family residences. The tax credit would 

be one percent of the purchase price of the home up to a maximum credit of $2,000 for eligible 

homes purchased in the five-year peIiad beginning January 1, 1999 and ending December 31, 

2003 The credit would be available for an additional two years, i.e., for homes purchased 

January 1,2004 through December 3 1,2005, with a maximum credit of $1,000. 
PROVIDE TAX CEDIT FOR HIGH-FUEL-ECONOMYVEHICLES 

Current Law 

No generally available income tax credit for purchases of fuel-efficient vehicles is 

provided currently. A 10 percent tax credit is provided for the cost of a qualified electric vehicle, 

up to a maximum credit of $4,000. A qualified electric vehicle is a motor vehicle that is powered 

primarily by an electric motor &awing current fiom rechargeable batteries, fuel cells, or other 

portable sources of electrical current, the original use of which commences with the taxpayer, 

and that is acquired for the use by the taxpayer and not for resale. The full amount of the credit 

is available for purchases prior to 2002. The credit begins to phase down in 2002 and phases out 

in 2005. 

Certain costs of qualified clean-fuel vehicle property may be deducted when such 

property is placed in service. Qualified electric vehicles do not qualify for the clean-fuel vehicle 

deduction. The deduction phases down in the years 2002 through 2004. 

Reasons for Chanoe 

The transportation sector now accounts for one-third of greenhouse gas emissions in the 

United States. Cars, sport utility vehicles, light trucks and minivans alone account for 20 percent 

of our greenhouse gas emissions. 

The proposed credits will encourage the early introduction and purchase of highly fuelefficient vehicles and will help to move ultra fuel efficient vehicles with three times the fuel 

efficiency of today's vehicles fiom the laboratory to the highway. These vehicles can 

significantly reduce emissions of carbon dioxide, the most prevalent greenhouse gas. 

Proposal 

The proposal would provide two temporary tax credits for the purchase of fuel efficient 

vehicles: 

(1) Credit for vehicles with triDle the base fuel economv, Thiscredit would be $4,000 

for each vehicle that has three times the base fuel economy for its class. The $4,000 

credit would be available for purchases of qualifying vehicles after December 3 1,2002, 

and before January 1,2007. The credit amount would phase down to $3,000 in 2007, 

$2,000 in 2008, and $1,000 in 2009, and would phase out in 2010. 

(2) Credit for vehicles with twice the base fuel economv. This credit would be $3,000 

for each vehicle that has twice the base fuel economy for its class. The $3,000 credit 

woula be available for purchases of qualifyiig vehicles after December 31,1999 and 

8 
before January 1,2004. The credit amount would phase down to $2,000 in 2004, $1,000 

in 2005, and would phase out in 2006. 

These credits would be available for all qualifying light vehicles, including cars, 

minivans, sport utility vehicles, light trucks, and hybrid and electric vehicles Taxpayers who 

claim one of these credits would not be able to claim the qualified electric vehicle credit or the 

deduction for clean-fuel vehicle property for the same vehicle. 

9 
EQUALIZE TREATMENT OF PARKING AND TRANSIT BENEFITS 

Current Law 

Under current law, qualified transpoitationfringe benefits provided by an employer are 

excluded from income. Qualified transportation fringe benefits include parking, transit passes, 

and vanpool benefits. For taxable years beginning after December 31, 1997, parking is 

excludable from gross income even when provided in lieu of other compensation payable to an 

employee. Transit passes and vanpool benefits, however, are only excludable if' provided in 

addition to, and not in lieu of; any compensation otherwise payable to an employee. 

Under. current law, up to $155 (in 1993 dollars) per month of employer-provided parking 

benefits is excludable from income; in 1998 the limit is $175 per month. Up to $60 (in 1993 

dollars) per month of employer-provided transit and vanpool benefits is excludable from income; 

in 1998 the limit is $65 per month. 

Reasons for Change 

'The tax treatment of transit and vanpool benefits should be equalized with the tax 

treatment of parking benefits. This equalization would eliminate the tax disincentives for 

providing transit and vanpool benefits relative to parking benefits. 

Prooosal 

Under the proposal, employers would be allowed to offer their employees transit and 

vanpool benefits in lieu of compensation, beginning January 1, 1999. The proposal would enact 

the same change for transit and vanpool benefits that the Taxpayer Relief Act of 1997 enacted for 

parking benefits. 

The proposal also would raise the monthly limit on employer-provided transit and 

vanpool benefits excludable from income to $155 (m 1993 dollars) per month, Le., the limit on 

parking benefits. As under current law, the amount of the benefits would be indexed for 

inflation. 

10 
PROVIDE INVESTMENT TAX CREDIT FOR 

COMBINED HEAT AND POWER (CHP) SYSTEMS 

Current Law 

Combined heat and power (CHP) systems are used to produce electricity and process heat 

andor mechanical power fIom a single primary energy source. A taxcredit is currently not 

available for investments in CHP systems. 

Depreciation allowances for depreciation for CHP property vary by asset use and 

capacity. Assets employed in the production of electricity with rated total capacity in excess of 

500 kilowatts, or employed in the production of steam with rated total capacity in excess of 

12,500 pounds per hour, and used by the taxpayer in an industrial manufacturing process or plant 

activity (and not ordinarily available for sale to others), have a general cost recovery period of 15 

years. Electricity or steam production assets of lesser rated capacity generally are classified with 

other manufacturing assets and have cost recovery periods of five to ten years. Assets used in the 

steam power production of electricity for sale, including combustion turbines operated in a 

combined cycle with a conventional steam unit, have a 20 year recovery period. Other turbines 

and engines used to produce electricity for sale have a 15 year recovery period. Assets that are 

structural components of buildings have a recovery period of either 39 years (if nonresidential) or 

27.5 years (if residential). For assets with recovery periods of 10 years or less, the 200 percent 

declining balance method may be used to compute depreciation allowances. The 150 percent 

declining balance method may be used for assets with recovery periods of 15 or 20 years. The 

straight-line method must be used for buildings and their structural components. 

Reasons for Chanee 

Combined heat and power systems utilize thermal energy that is otherwise wasted in the 

process of producing electricity by more conventional methods CHP systems achieve greater 

energy efficiency, lessen the consumption of primary fossil fuels, lower total energy costs, and 

reduce carbon emissions. An investment tax credit for CHP assets is expected to encourage and 

accelerate investment in such systems. The increased demand for CHP equipment should, in 

tum,reduce manufacturing costs and spur technological innovation in improved CHP systems. 

Proposal 

The proposal would establish a 10 percent investment credit for certain CHP systems 

with an electrical capacity in excess of 50 kilowatts (or with a capacity to produce mechanical 

power equivalent to 50 kilowatts). Investments in qualified CHP systems that are assigned cost 

recovery periods of less than 15 years would be eligible for the credit, provided that a 15 year 

recovery period and 150 percent declining balance method are utilized to calculate depreciation 

allowances. Property placed in service outside the United States would be ineligible for the 

credit. 

11 
A qualified CKP system would be defined as equipment used in the simultaneous or 

sequential production of electricity, thermal energy (includingheating and cooling and/or 

mechanical power), and mechanical power. A qualified CHP system would be required to 

produce at least 20 percent of its total useN energy in the form ofboth (i) thermal energy, and 

(ii) electric and/or mechanical power. For CHP systems with an electrical capacity of 

50 megawatts or less, the total energy efficiency of the system would have to be greater than 

60 percent. For larger systems, the total energy efficiency would have to exceed 70 percent. For 

this purpose, total energy efficiency would be calculated as the sum of the useful electrical, 

thermal, and mechanical power produced, measured in Btus, divided by the lower heating value 

of the primary energy supplied. Taxpayers would be required to obtain proper certification by 

qualified engineers for meeting the energy efficiency and percentage-of-energy tests, pursuant to 

regulations to be issued by the Secretary of the Treasury. 

The credit would be subject to the 1iInitationson the general business credits. The 

depreciable basis of qualified propeQ for which the credit is taken would be reduced.by the 

amount of the credit. Regulated public utilities claiming the credit would be required to use a 

normalization method of accounting with respect to the credit. Taxpayers using the credit for 

CHP systems would not be entitled to any other tax credit for the same equipment. The credit 

would apply to investments in CHP systems placed in service after December 31, 1998, but 

before January 1,2004. 

12 
PROVIDE TAX CREDIT FOR REPLACEMENT OF 

CERTAIN CIRCUIT BREAKER EQTJIPMENT 

Current Law 

No tax credits are provided currently for the purchase of large power circuit breakers used 

in the transmission and distribution of electricity. 

Reasons for Chanee 

Some power circuit breakers used in the .transmission and distribution of electric power 

use sulfur hexaflouride (SF6). Certain older circuit breakers that use a dual pressure technology 

are especially prone to leak SF6 gas. Of all greenhouse gases, SF6 is among the most potent 

because it has an expected atmospheric lifetime of over three thousand years, and a global 

warming potential 23,900 times that of carbon dioxide, the most abundant greenhouse gas. 

Proposal 

A tax credit would be available for the installation of new power circuit breaker 

equipment to replace certain older power circuit breakers. The tax credit would be 10 percent of 

qualified inveshnent. To be eligible for the credit, the replaced power circuit breakers must be 

dual pressure circuit breakers that contain SF6, have a capacity of at least 115kV, and have been 

installed by December 31,1985. The replaced circuit breaker equipment must be destroyed so as 

to prevent its fider use. The credit would be subject to the limitations on the general business 

credits. The depreciable basis of qualified property for which the credit is taken would be 

reduced by the amount of the credit claimed. The new equipment must be placed in service in 

the five year period beginning Janw 1, 1999 and ending December 31,2003. 

13 
PROVIDE TAX CREDIT FOR CERTAIN PERFLUOROCOMPOUNI) (PFC) 

AND HYDROFLUOROCARBON (RFC) RECYCLING EQUIPMENT 

Current Law 

No taxcredits are provided currently for the purchase of perfluorocompound (PFC) and 

hydrofluorocarbon (HFC) recycling equipment. Semiconductor manufacturers who install 

equipment to recover or recycle PFC and HFC gases used in the production of semiconductors 

may depreciate the cost ofthat equipment over 6 years. 

Reasons for Change 

Of all greenhouse gases, PFCs and certain HFCs are among the most potent because of 

their extreme stability in the atmosphere and strong absorption of radiation. PFCs commonly 

have expected atmospheric lifetimes of thousands of years, and a global warming potential 

thousands of times greater than that of carbon dioxide, which is the most abundant greenhouse 

gas. PFCs and certain HFCs are used extensively in the semiconductor manufacturing industry. 

Because of the anticipated rapid growth of the semiconductor industry, annual emissions of PFCs 

would grow from 0.2 dlion metric tons of carbon equivalent (MMTCE) in 1990 to as much as 

26 MMTCE by 2010 if no control measures wefe undertaken. Anticipated voluntary measures 

by the semiconductor industry to reduce emissions are expected to limit annual emissions to 13 

MMTCE by 2010. Installation of additional equipment to recover and recycle PFC and HFC 

gases could eliminate most of the remaining emissions. While new methods of manufacturing 

semiconductors are expected ultimately to eliminate PFC and HFC emissions, emissions from 

existing plants would continue until the plants were eventually replaced or recycling equipment 

is installed. 

Proposal 

A tax credit would be available for the installation of PFC and HFC recoveryhecycling 

equipment in semiconductor manufacturing plants. The tax credit would be 10 percent of 

qualified investment. The credit would be subject to the limitations on the general business 

credits. The depreciable basis of qualified propem for which the credit is taken would be 

reduced by the amount of the credit claimed. Equipment would qualify for the credit only if it 

recovers at least 99 percent of PFCs and HFCs, and the equipment is placed in service in the 

five-year period beginning January 1, 1999 and ending December 3 1,2003. 

14 
PROVIDE TAX CREDIT FOR ROOFTOP SOLAR EQUIPMENT 

Current Law 

A 10 percent business energy investment tax credit is provided for qualifying equipment 

that uses solar energy to generate electricity,to heat or cool or provide hot water for use in a 

structure, or to provide solar process heat. 

Reasons for Chanze 

An investment tax credit for rooftop solar photovoltaic systems and solar water heating 

systems will reduce the cost of these investments and encourage individuals and businesses to 

adopt these systems. Heat and electricity from these sources produce no greenhouse gasses 

Prooosal 

Under this proposal, a tax credit would be available for purchasers of rooftop 

photovoltaic systems and solar water heating systems located on or adjacent to the building for 

uses other than heating swimmirig pools. The credit would be equal to 15 percent of qualified 

investment up to a maximum of $1,000 for solar water heating systems and $2,000 for rooftop 

photovoltaic systems This credit would be nonrefundable. For businesses, this credit would be 

subject to the limitations of the general business credit. The depreciable basis of the qualified 

property would be reduced by the amount of the credit claimed The credit would apply ody to 

equipment placed in service in the five year period after December 31, 1998 and before January 

1,2004 for solar water heating systems and for the seven year period beginning after December 

31,1998 and before January 1,2006 for rooftop photovoltaic systems. Taxpayers would have to 

choose between the proposed credit and the present tax credit for each investment. 

15 
EX”D WIND AND BIOMASS TAX CREDIT 

Current Law 

Current law provides taxpayers a 1.5 cent per kilowatt hour tax credit, for electricity 

produced from wind or “closed-loop” biomass. The electricity must be sold to an unrelated third 

party and the credit is limited to the first 10 years of production. The credit applies only to 

facilities placed in service before July 1, 1999, after which it expires. The credit amount is 

indexed for inflation after 1992. 

Reasons for Chanee 

The tax credit helps make such electricity produced from wind and closed-loop biomass 

competitive with other forms of electricity. Electricity from these sources produces no 

greenhouse gases. 

Proposal 

‘ne proposal would extend the current credit for five years, to facilities placed in service 

before July 1,2004. 

16 
EXPANDED ACCESS TO PAYROLL DEDUCTION 

FOR RETIREMENT SAVINGS 

Current Law 

Individuals who contribute to an individual retirement account or annuity (“IRA”) 

typically do so by depositing funds into IRAs However, an employee whose employer permits 

such an arrangement may contribute to an IRA by electing to have the employer withhold 

requested amounts from the employee’s paycheck and forward them ta the employee’s IRA 

These payroll deduction contributions to an IRA appear as wages an the employee’s Form W-2, 

but the employee is allowed to deduct the contributions on the employee’s tax retum, subject to 

the normal rules governing IRA contributions 

Reasons for Chanze 

Payroll deduction contributions to IRAs could be an important means of increasing 

retirement savings among employees The advantages of saving through payroll deduction -- the 

convenience of contributions continuing after the employee’s initial election, reinforcement of 

the value of savings by peer groups in the workplace, and the incentive of tax-favored treatment 

of contributions -- encourage employees to save more for retirement One way to encourage 

employers to offer, and employees to make, payroll deduction contributionsto IRAs would be to 

provide employees with a convenient way to receive an immediate tax benefit for these 

contributions that eliminates the need for most employees to report the contributions on their tax 

retums and enables some employees to use simpler tax forms 

Proposal 

Contributions of up to $2,000 made to an IRA through payroll deduction generally would 

be excluded from an employee’s income and, accordingly, would not be reported as income an 

the employee’s Form W-2. However, the amounts would be subject to employment taxes and 

would be reported as a contribution to an IRA an the employee’s Form W.-2. In the event the 

amounts would not have been deductible had the employee contributed directly to an IRA, the 

employee would be required to include the amounts in income on the employee’s taxreturn. 

The proposal would be effective for years beginning after December 3 1,1998. 

17 
SMALL BUSINESS TAX CREDIT 

FOR RETIREMENT PLAN START-UP EXPENSES 

Current Law 

An employer's costs related to the establishment of a retirement plan (e.g., payroll system 

changes, investment vehicle set-up fees, consulting fees, etc.) generally are deductible as 

business expenses. 

Reasons for Change 

Plan start-up, plan administration, and retirement education costs may pose a banier to 

the establishnient of new retirement plans, especially for smaller employers. Providing a tax 

credit for creating new plans could promote their adoption, not only by defraying some of these 

costs, but also by providing a marketing tool for financial institutions or advisors to use in 

promoting new plan adoption and by increasing awareness of retirement savings options. 

Prooosal 

The proposal would provide a three-year tax credit, in lieu of a deduction, for 50 percent 

of the administrative and retirement-education expenses for any small business that adopts a new 

qualified defined benefit or defined contribution plan (including a section 401(k) plan), 

SIMPLE, SEP, or payroll deduction IRA arrangement. The credit would cover 50 percent of the 

first $2,000 in administrative and retirement-education expenses for the plan or arrangement for 

the first year of the plan or arrangement and 50 percent of the first $1,000 of administrative and 

retirement-education expenses for each of the second and third years. 

The credit would be available to employers that did not employ, in the preceding year, 

more than 100 employees with compensation in excess of $5,000, but only if the employer did 

not have a plan or payroll deduction IRA arrangement during any part of 1997. In order for an 

employer to get the credit, the plan would have to cover at least 2 individuals. In addition, if the 

credit is for the cost of a payroll deduction IRA arrangement, the arrangement would have to be 

made available to all employees ofthe employer who have worked with the employer for at least 

3 months. 

The credit would be effective beginning in the year of enactment and would be available 

only for plans established on or before December 31,2000. For example, if an eligible employer 

adopted a plan in the year 2000, the credit would be available for the years 2000,2001 and 2002. 

18 
THE SMART PLAN - A SIMPLIFIED PENSION PLAN FOR SMALL BUSINESS 

Current Law 

Under current law, small business employers that wish to sponsor a tax-favored 

retirement savingsplan, yet seek to avoid the administrative cost and complexity associated with 

traditional qualified retirement plans, may instead establish a SIMPLE plan SIMPLE IRA and 

SIMPLE 401(k) plans are defined contributionplans that are not subject to many of the rules 

applicable to qualified retirement plans, and are subject to only minimal reporting and disclosure 

requirements. SIMPLE plans allow employees to make salary reduction contributionsup to a 

lower limit ($6,000 a year) than 401(k) plans. SIMPLE plans must provide for certain specified 

employer contributions. 

Alternatively, small business employers may offer their employees a simplified employee 

pension (SEP). SEPs are employer-sponsored plans under which employer contributions are 

made to IRAs established by employees Contributions under a SEP generally must bear a 

uniform relationship to the compensation of each employee covered under the SEP (e.g., each 

employee receives a contribution to the employee’s IRA equal to 5 percent of the employee’s 

compensation for the year). 

Reasons for Chanve 

There is no alternative, similar to SIMPLE plans or SEPs, that is available for small 

business employers seeking to provide their employees with a simplified, tax-favored defined 

benefit pension plan. The need for complex actuarial calculations, administrative costs, and the 

unpredictability of funding requirements may inhibit these employers from adopting such plans. 

ProDosa1 

The proposal would allow small employers to adopt a new simplified, tax-favored 

pension plan that combines attractive features of both defined benefit and defined contribution 

plans. The new plan would be known as the SMART (Secure Money Annuity or Retirement 

Trust) Plan As in the case of other qualified plans, contributions to the SMART Plan would be 

excludable from income, eamings would accumulate tax-he, and distributions would be subject 

to income tax(unless rolled over) 

SMART Plans would provide participants with a minimumguaranteed benefit at 

retirement that provides payments over the course of an employee’s retirement years, and 

Pension Benefit Guaranty Corporationinsurance, together with the potential for additional 

investment retum and the portability of individual accounts. 

19 
Emplover Elioibilitv 

An employer generally would be eligible to maintain a SMART Plan if the employer did 

not employ more than 100 employees who received at least $5,000 in compensation in the prior 

year, the employer is not a professional sexvice employer (Le., an employer substantially all of 

the activities of which involve the performance of services in the fields of health, law, 

engineering, architecture, accounting, actuarial sciences, performing arts, or consulting), and the 

employer has not maintained a defined benefit pension plan or a money purchase pension plan 

within the preceding five years. 

Emplovee Eligibiiitv and Vestinc 

If an employer establishes a SMART Plan, all employees who have completed two years 

of service with at least $5,000 in compensation and who are reasonably expected to receive 

$5,000 in compensation in the current year would participate in the Plan. An employee’s benefit 

would be 100 percent vested at all times. 

Benefits and Fundinp 

Minimum Defined Benefit 

SMART Plans would provide a Nly funded minimum defined benefit, with a possible 

higher benefit if cumulative investment returns exceed 5 percent. 

Each year the employee participates, the employee would earn a minimum annual benefit 

at retirement equal to 1percent or 2 percent of compensation for that year. For example, if an 

employee participated for 25 years in a SMART Plan of an employer that elected a 2 percent 

benefit, and the employee’s average salary over the enhe period was $50,000, the employee 

would accrue a minimum benefit of $25,000 per year at age 65. Moreover, an employer could 

elect, for each of the first 5 years the SMART Plan is in existence, to provide all employees with 

a benefit equal to 3 percent of compensation (in lieu of 1 percent or 2 percent of Compensation). 

The maxi” compensation that could be taken into account in determining an employee’s 

benefit for a year would be $100,000 (indexed for inflation). 

Funding and Investment Returns 

Funding would be provided either through a SMART Plan individual retirement annuity 

(“SMART Annuity”)issued by an insurance company, or through a trust (“SMART Trust”) that 

invests only in readily tradable securities and insurance company products regulated by State 

law. Each year, an employer would be required to contribute an amount sufficient to provide the 

annualbenefit accrued for that year payable at age 65, using actuarial assumptions specified in 

the statute (icluding a 5 percent annual interest rate). 

20 
In the case of a SMART Trust, each employee would have an account to which actual 

investment returns would be credited If a participant’s account balance were less than the total 

of past employer contributions credited with 5 percent interest per year, the employer would be 

required to contribute an additional amount for the year to make up for any shortfall. Moreover, 

the employer would be required to contribute an additional amount for the year to make up for 

any shortfall between the balance in the employee’s account and the purchase price of an annuity 

paying the minimum -guaranteed benefit when an employee retires and takes a life annuity“ On 

the other hand, if the investment returns exceeded the 5 percent assumption, the employee would 

be entitled to the larger account balance. If the employee elected to receive an annuity, the larger 

account balance would translate to a larger annuity. 

In the case of a SMART Annuity, each year an employer would be required to contribute 

the amount necessary to purchase an annuity that provides the benefit accrual for that year on a 

guaranteed basis. 

The required contributions would be deductible under the rules applicable to qualified 

defined benefit pension plans. An excise taxwould apply if the employer failed to make the 

required contributions for a year. 

Distributions 

Timin,o 

No distributions would be allowed from a SMART Plan prior to an employee’s 

attainment of age 65, except in the event of death or disability, or where the account balance of a 

terminated employee was not more than $5,000. However, an employer could allow a 

terminated employee who has not yet attained age 65 to directly transfer the individual’s account 

balance from a SMART Trust to either a SMART Annuity or a special individual retirement 

account (“SMART Account”) that is subject to the same distribution restrictions as the SMART 

Trust. 

If a terminated employee’s account balance did not exceed $5,000, the SMART Plan 

would be allowed to make a cashout of the account balance. The employee would be allowed to 

transfer any such distribution tax-free to a SMART Annuity, a SMAkTAccount, or a regular 

IRA. 

Form 

SMART Plans would be subject to the qualifiedjoint and survivor annuity rules that 

apply to qualified defined benefit pension plans. Lump sum payments also could be made 

available. In addition, an employer could allow the transfer of a terminated employee’s account 

balance from a SMART Trust to either a SMART Annuity or a SMART Account. 

21 
Taration 

Distributions from SMART Plans would be subject to tax under current rules applicable 

to the taxation of annuities under Code section 72. 

A 20 percent additional taxwould be imposed for violating the pre-age 65 distribution 

restrictions under a SMART Annuityor SMART Account. 

PBGC Guarantee and Premiums 

The minimumguaranteed benefit under the SMART Trust would be guaranteed by the 

PBGC. Reduced PBGC premiums would apply to the SMART Trust. Neither the PBGC 

guarantee, nor PBGC premiums, would apply to the SWT Annuityor SMART Account. 

Reportine and Disclosure 

Because SMART Plans do not have complex actuarial calculations, they would be subject 

to simplified reporting requirements. 

Nondiscrimination Requirements and-BenefitLimitations 

SMART Plans would not be subject to the nondiscriminationor top-heavy rules 

applicable to qualified retirement plans. SMART Plans also would not be subject to the 

limitations on benefits under section 415. However, if an employer maintained a SMART Plan, 

and then terminated it and established a qualified defined benefit plan, the SMART Plan accruals 

would be taken into account for purposes of the section 415 limitations applicable to the defined 

benefit plan. 

Miscellaneous 

Otherplans maintained bv the emplover. An employer that maintained a SMART Plan 

could not maintain additional tax-qualified plans, other than a SIMPLE plan, or a 401(k) plan or 

403(b) tax-sheltered annuity plan under which the only contributions that are pexmitted are 

elective contributions and matching contributions that are not greater thanthose provided for 

under the design-based safe harbor for 401(k) plans described in section 401(k)(12)(B)(I). 

Emulovee contributions. No employee contributions would be permitted to a SMART 

Plan. 

IRS model. The IRS would be directed to issue model SMART Plan provisions or a 

model SMART Plan document. Vendors and employers would have the option of using their 

own documents instead of the models. 

22 
Coordination with IRA deduction rules. SMART Plans would be treated as qualified 

plans for purposes of the IRA deduction phase-out rules. Thus, employees who participated in a 

SMART Plan and had modified AGI in excess of the applicable thresholds would be phased out 

of making deductible IRA contributions. This is the same rule that currently applies to SEPs and 

SIMPLE plans. 

CalendarpZan vear. The plan year for all SMART Plans would be the calendar year, 

which would be used in applying SMART Plan contribution limits, eligibility, and other 

requirements. 

These provisions would be effective for calendar years beginning after 1998. 

23 
FASTER VESTING OF EMPLOYER MATCHING CONTRIBUTIONS 

Current Law 

Generally, employer matching contributions on behalf of an employee under a section 

401(k) plan (or other type of plan) either must be fully vested after the employee has completed 

five years of service, or must become vested in increments of 20 percent for each year beginning 

after the employee has completed three years of service, with full vesting after the employee has 

completed seven years of service. If a plan is a “top-heavy plan” within the meaning of section 

416, employer matching contributions either must be Nly vested after an employee has 

completed three years of service, or must become vested in increments of 20 percent for each 

year beginning der the employee has completed two years of service, with full vesting after the 

employee has completed six years of service. Employer matching contributions that are treated 

as elective contributions for purposes of the actual deferral percentage test under section 401(k) 

(“qualified matching contributions”)must be fully vested immediately. 

Reasons for Chance 

The popularity and importance of 401(k) plans has grown substantially over the years. 

Employers often choose to contribute to 401(k) plans by matching the salary reduction 

contributions made by employees. Given the mobile nature of today’s workforce, there is a 

significant risk that many participants will leave employment before Nly vesting in employer 

matching contributionsunder 401(k)plans. One way to increase the portability of benefits for 

401Q plan participants is to require faster vesting for employer matching contributions. 

Prooosal 

Employer matching contributions under 401(k) plans (or other qualified plans) would be 

required either to be fully vested after an employee has completed three years of service, or to 

become vested in increments of 20 percent for each year beginning after the employee has 

completed two years of service, with full vesting after the employee has completed six years of 

service. Qualified matching contributions would continue to be Nly vested immediately, as 

under current law. 

These provisions would be effective for plan years beginning after December 31,1998, 

with an extended effective date for plans maintained pursuant to a collective bargaining 

agreement” 

24 
. 

PENSION RIGHT TO KNOW PROPOSALS 

A. Spouse’s Right to Know Distribution Information 

Current Law 

In general, when a tax-qualified pension plan commences a distribution of retirement 

benefits to a participant in the plan, the benefits must be distributed as an annuity over the life of 

the participant. If the participant is married on the annuity starting date, the annuity must 

continue to pay at least one-half of these monthly amounts to the surviving spouse following the 

participant’s death (a form of benefit known as a “qualifiedjoint and survivor annuity”). If the 

participant dies before the ann~6tystarting date, the surviving spouse generally must be paid an 

annuity mown as a “qualified preretirement survivor annuity”)that is not less than what the 

spouse would have been paid under the survivor portion of the qualifiedjoint and survivor 

annuity. Most defined contribution plans (such as 401(k) plans) are not required to provide these 

annuities if certain conditions are satisfied, including the condition that, upon the participant’s 

death, the participant’s vested account balance is payable in full to the surviving spouse 

A plan may allow a participant to waive the right to receive these survivor annuities if 

certain conditions are satisfied. In particttlar, the spouse generally must provide a written 

consent to the waiver, witnessed by a plan representative or a notary public, which acknowledges 

the effect of the waiver. Further, the participant must have been provided witha written 

explanation of the terms and conditions of the survivor annuity, the participant’s right to make, 

and the effect of, a waiver of the survivor annuity,the rights of the spouse to waive the survivor 

annuity, and the right of a participant to revoke the waiver. (Similar waiver and explanation 

rulesapply concerning the death benefit payable to the spouse under a defined contribution plan.) 

Reasons for Change 

Although the survivor des provide important rights to spouses, these rules do not require 

plans to fumish spouses a copy of the written explanation of survivor benefits that is required to 

be furnished to participant.. In order to help spouses understand their rights and the implications 

of waiving these survivor benefits, spouses should be able to receive a copy of the explanation of 

survivor benefits 

Proposal 

When an explanation of a plan’s survivor benefits is provided to participants, a copy of 

the explanation would be required to be provided to the participant’s spouse. If the last known 

mailing address of the participant and spouse is the same, then the explanation and a copy of the 

explanation can be provided in a single mailing addressed to the participant and the spouse. 

The proposal would be effective for plan years beginning after December 3 1, 1998. 

25 
B. Election Periods and Right to Know Employer ContributionFormula 

Current Law 

The actual defexxd percentage (ADP) test generally applies to the elective contributions 

(typically made by salary reduction) of all ernployees eligible to participate in a 401(k) plan. The 

ADP test is satisfied if the average percentage of elective contributions for highly compensated 

employees does not exceed the average percentage of elective contributions for nonhighly 

compensated employees by a specified percentage. Because the ADP test looks to the actual 

pattem of deferrals by the highly compensated and nonhighly compensated employees, the 

employer has an incentive to increase participation by the nonhighly compensated employees and 

will take steps (such as publicizing the ease of saving through the plan and providing matching 

contributions) in order to encourage employees to contribute. 

As an alternative to annual testing under the ADP test (and the similar ACP test that 

applies to matching contributions and after-tax employee contributions), the Small Business Job 

Protection Act of 1996 provides two altemative “design-based” 401(k) safe harbors, effective 

beginning in 1999. If the employees are provided a specified matching contribution (or a 

specified nonelective contribution), the employer can avoid all ADP and ACP testing of 

employee elective contributions and employer matching contributions. Unlike the similar safeharbor desigm under the SIMPLE plan and the SIMPLE 401(k) plan that require annual 60-day 

election periods and notification tied to those election periods, for 401(k) plans using a safe 

harbor, there are no specific requirements that prescribe the len-4 and frequency of the election 

period or that tie the timing of the notice describing employee rights and obligations under the 

plan to the election period. 

Reasons for Chanoe 

Employers that use the safe harbor plan design have no built-in incentive to make it easy 

for employees to elect to make contributions and to notify employees of the employer matching 

contribution in connection with that election period. In order for the safe harbor plan design to 

be an adequate substitute for nondiscrimination tests, employees need to have reasonable 

opportuuities to start making elective deferrals and need to receive information about the 

employer contribution formula in connection with these opportunities. 

Proposat 

Employers that use either one of the safe harbor plan designs to avoid ADP and ACP 

testing would be required to provide notice and contribution opportunities comparable to those 

provided under SIMPLE plans. Thus, employees would have to be offered an opportunity to 

elect to make contributions (or modify a prior election) during a 60-day period before the 

beginning of each year and a 60-day period when they first become eligible. In addition, the 

current law requirement that employers provide employees with notice of their rights to make 

26 
contributions and notice of the safe harbor contribution formula the employer is currently using 

(in order to notify employees oftheir rights and obligations) would be modified to require the 

notice within a reasonable period of time before the 60-day periods begin rather than before the 

beginning of the year. 

The proposal would be effective for years beginning after December 31, 1998, when the 

safe harbors themselves take effect. 

27 
SIMPLIFIED METHOD FOR IMPROVLNG BENEFITS OF NONHIGHLY 

COMPENSATED EMPLOYEES UNDER THE SAFE HARBOR FOR 4010 PLANS 

Current Law 

The actual deferral percentage (ADP) test generally applies to the elective contributions 

(typically made by salary reduction) of all employees eligible to participate in a 401(k) plan. The 

test requires the calculation of each eligible employee’s elective contributions as a percentage of 

the employee’s pay. ‘TheADP test is satisfied if the average percentage of elective contributions 

for highly compensated employees does not exceed the average percentage of elective 

contributions for nonhighly compensated employees by a specified percentage. Thus, the ADP 

tests looks to the actual pattem of deferrals by the highly compensated and nonhighly 

compensated employees who are eligible to make elective contributions. The actual contribution 

percentage (ACP) test is almost identical to the ADP test, but generally applies to employer 

matching contributions and after-tax employee contributions under any qualified employer 

retirement plan,. 

As an altemative to annual testing under the ADP and ACP tests, the Small Business Job 

Protection Act of 1996 provided two altemative “design-based’’ safe harbors, effective beginning 

in 1999. If a plan were designed to use one of these safe harbors, the employer could avoid all 

ADP and ACP testing of employee elective contributions and employer matching contributions,. 

Under the fist safe harbor, the employer would have to make nonelective contributions of at 

least three percent of compensation for each nonhighly compensated employee eligible to 

participate in the plan,. Altematively, under the second safe harbor, the employer would have to 

make a 100 percent matchirig contribution on an employee’s elective contributions up to the first 

3 percent of compensation and a matching contribution of at least 50 percent on the employee’s 

elective contributions up to the next 2 percent of compensation. 

Reasons for Chance 

Under the section 401(k) safe harbor plan design, employers need not perform 

nondiscrimination tests and may not have adequate incentives to educate nonhighly compensated 

employees about the value of tax-deferred savings for retirement. Providing a one percent 

nonelective contribution to all eligible nonhighly compensated employees, in addition to the 

matching contribution, would help demonstrate the value of tax-deferred compounding to those 

employees who initially might not malie deferrals. This one percent contribution would also help 

ensure that more low- and moderate-wage workers begin accumulating savings for retirement 

and acquire the saving habit. 

Prouosal 

The proposal would modify the section 401(k) matching formula safe harbor by requiring 

that, in addition to the matching contribution, employers would make a contribution of one 

28 
percent of compensation for each eligible nonhighly compensated employee, regardless of 

whether the employee makes elective contributions. 

The new safe harbor formula would be effective for years beginning after December 3 1, 

1998, when the safe harbors themselves take effect. 

29 
SIMPLIFY DEFINITION OF HIGHLYCOMPENSATED EMPLOYEE 

Current Law 

A qualified retirement plan must satisfy various nondiscrimination tests to ensure that it 

does not discriminate in favor of “highly compensated employees.” In order to apply these tests, 

the employer must identify its “highly compensated employees.” Under current law, effective 

for plan years beginning after December 3 1,1996, an employee is treated as a highly 

compensated employee if the employee (1) was a five-percent owner of the employer at any time 

during the year or the preceding year, or (2) for the preceding year, had compensation in excess 

of $80,000 (indexed for inflation), and, if the employer elects, was in the top-paid group of 

employees for the preceding year. For this purpose, an employee is in the top-paid group if the 

employee was among the top 20 percent of employees of the employer when ranked on the basis 

of compensation paid to the employees during the preceding year. 

Reasons for Change 

The definition of highly compensated employee, while simpler than the seven-part test 

that applied under prior law, could be further simplified by elimination of the top-paid group 

election. Permitting elections that may vary from year to year increases complexity. In addition, 

under the current definition, it is possible for employees eaming very high Compensation (of 

several hundred thousand dollars or more) to be treated as nonhighly compensated for testing 

purposes if the employer has a suftcient percentage of high-paid employees in its workforce. 

This would allow some employers to effectively eliminate benefits for low- and moderate-wage 

workers without violating the nondiscrimination rules. The simplified definition of highly 

compensated employee should better reflect the purpose of promoting meaningful benefits for 

low- and moderate-wage workers, not only the high-paid. 

Prnnosal 

The top-paid group election would be eliminated from the definition of highly 

compensated employee. Under the new definition, an employee would be treated as a highly 

compensated employee if the employee (1) was a five-percent owner of the employer at any time 

during the year or the preceding year, or (2) for the preceding year, had compensation in excess 

of $80,00O (indexed for inflation). 

The proposal would be effective for years beginning after December 3 1,1998 

30 
SIMPLIFY BENEFIT LIMITS FOR MULTIEMPLOYER PLANS 

UNDER SECTION 415 

Current Law 

Annual benefits payable under a defined benefit plan are liited to the lesser of $130,000 

(for 1998) or 100percent of “three-year-high average compensation.” (Reductions in the dollar 

or percentage limit for defined benefit plans may be required if the employee has fewer than ten 

years of plan participation or service.) If benefits under a defined benefit plan begin before the 

social security retirement age, the dollar limit must be actuarially reduced to compensate for the 

earlier commencement. Certain special rules apply to govemmental plans. 

Reasons for Chanve 

The qualified plan limitations present significant administrative problems for many 

multiemployer plans. These plans typically base benefits on years of credited service, not an a 

participant’s compensation. In addition, the 100percent-of-compensation limit is based on an 

employee‘saverage compensation for the three highest consecutive years. This rule often 

produces an artificially low limit for employees in certain industries, such as building and 

construction, where wages vary significantly from year to year. 

Proposal 

The section 415 limits applicable to multiemployer plans would be modified to eliminate 

the 100 percent-of-compensation limit (but not the $130,000 limit) for such plans, and to exempt 

certain survivor and disability benefits from the adjustments for early commencement and for 

participation and service of less than 10 years. This would be comparable to the changes made to 

the section 415 limits for govemmental plans in the Small Business Job Protection Act of 1996. 

The proposals would be effective for years beginning after December 31, 1998. 

31 
SIMPLIFY FULL FUNDINGLIMITATION FOR MULTIEMPLOYER PLANS 

Current Law 

An employer’s annual deduction for contributions to a defined benefit plan may not 

exceed the plan’s full funding limitation. The full funding limitation is generally defined as the 

excess of the plan’s accrued liability (or, if less, a specified percentage ofthe plan’s current 

liability) over the value of the plan’s assets. The specified percentage is 150 percent for plan 

years beginning before January 1,1999 and it increases by 5 percent every other year beginning 

in 1999, until it reaches 170 percent for plan years beginning on or after January 1,2005. 

Whenever the specified percentage of current liability is less than the plan’s acerued liability, the 

full funding limitation restricts the extent to which an employer can deduct contributions for 

benefits that have not yet accrued. 

Defined benefit plans are required to have an actuarial valuation no less fiequently than 

mually. 

Reasons for Chanoe 

An employer has little, if any, incentive to make “excess” contributions to a 

multiemployer plan, yet, under curTent law, the employer must perform the calculations to apply 

this lit. ‘Theamount an employer contributes to a multiemployer plan is determined by the 

collective bargaining agreement, and aparticular employer’s contributions are not set aside to pay 

benefits solely to the employees of that employer. 

Proposal 

The limit on deductible contributions based on a specified percentage of current liability 

would be eliminated for multiemployer plans. Therefore, the annualdeduction for contributions 

to such a plan would be limited to the amount by which the plan’s acerued liability exceeds the 

value of the plan’s assets. In addition, actuarial valuations would be required under the Code no 

less fiequently thanevery three years for multiemployer plans. Parallel changes would be made 

to the Employee Retirement Income Security Act of 1974, as amended. 

The proposal would be effective for years beginning after December 3 1, 1998. 

32 
ELIMINATE PARTIAL TERMINATION RULES 

FOR MULTIEMPLOYER PLANS 

Current Law 

When a qualified retirement plan is terminated, all plan participants are required to 

become 100 percent vested in their acciued benefits to the extent those benefits are funded. In 

the case of certain “partial terminations” that are not actual plan terminations (e.g., a large 

reduction in the work force), all affected employees must become 100 percent vested in their 

benefits accrued to the date of the termination, to the extent the benefits are funded. 

Whether a partial termination has occurred in a particular situation is generally based on 

specific facts and circumstances, including the exclusion from the plan of a group of employees 

who have previously been covered by the plan by reason of a plan amendment or severance by 

the employer. In addition, if a defined benefit plan stops or reduces future benefit accruals under 

the plan, a partial termination is deemed to occur under certain circumstances. 

Reasons for Chanve 

Over the years, court decisions have left unanswered many key questions as to how to 

apply the partial termination rules. Accordingly, applying the rules can often be difficult and 

uncertain, especially for multiemployer plans. For example, multiemployer plans experience 

frequent fluctuations in participation levels caused by the commencement and completion of 

projects that involve significantnumbers of union members, Many of these terminated 

participants are soon rehired for another project that resumes their active coverage under the 

plan. In addition, it is common for participants leaving one multiemployer plan’s coverage to 

maintain service credit under a reciprocal agreement if they move to the coverage of another plan 

sponsored by the same union. As a result, these participants do not suffer the interruption of 

their progress along the plan‘s vesting schedule that ordinarily occurs when an employee stops 

being covered by a plan. Given these factors, the difficulties associated withapplying the partial 

termination rules to multiemployer plans outweigh the benefits. 

Prooosal 

The requirement that affected participants become 100 percent vested in their accrued 

benefits (to the extent funded) upcin the partial termination of a qualified employer retirement 

plan would be repealed with respect to multiemployer plans. 

The proposal would be effective for partial terminations that begin after December 3 1, 

199s” 

33 
TAX CREDITS FOR HOLDERS OF QUALIFIED SCHOOL 

MODERNIZATION BONDS AND QUALIFIED ZONE ACADEMY BONDS 

Current Law 

Under cment law, State and local governments fund public school consiruction by 

issuing bonds the interest on which generally is exempt from Federal income tax. In addition, 

State and local governments can issue “qualified zone academy bonds” to fund the improvement 

of certain eligible public schools. An eligible holder of a qualified zone academy bond receives 

annual Federal income tax credits. 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” on a qualified zone academy bond is used to 

determine the amount of the annual taxcredit and is set at 110 percent of the applicable Federal 

rate (AFR) for the month in which the bond is issued. The maximum term of a qualified zone 

academy bond issued during any month is determined by reference to the “adjusted” AFR for the 

month in which the bond is issued. 

A total of $400 million of qualified zone academy bonds may be issued in each of 1998 

and 1999. The annual cap is allocated among the States in proportion to their respective 

populations of individuals with incomes below the poverty line. Unused authority to issue 

qualified zone academy bonds may be carried forward to subsequent years. 

There are a number of requirements that must be met for a bond to be treated as a 

qualified zone academy bond. 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 renovating school facilities, acquiring equipment, developing course materials, or 

training teachers. A qualified zone academy is a public school (or an academic program withh a 

public school) that is designed in cooperation with business and is either (1) located in an 

empowermentzone or enterprise community, or (2) attended by students at least 35 percent of 

whom are estimated to be eligible for free or reduced-cost lunches under the Federal school lunch 

promoram. Third, private business entities must have promised to contribute to the qualified zone 

academy certain property or services witha present value equal to at least 10 percent of the bond 

proceeds. 

Reasons for ChangeAging school buildings, new educational technologies, growing enrollments, the need for 

smaller class sizes, and changing demographics have created a need to renovate older school 

buildings and build new ones. Many school systems have insufficient fiscal capacity to finance 

needed renoGation and new construction. The proposal would leverage Federal support to spur 

new State and local investment in public schools. 

34 
Proaosal 

Qualified school modemiation bonds 

State and local govemments would be able to issue “qualified school modernization 

bonds” to fund the construction or rehabilitation of public schools. Much like the holder of a 

qualified zone academy bond, the holder of a qualified school modernization bond would receive 

annual Federal income tax credits in lieu of interest payments. Because the annual credits 

compensate the holder for lending money, they would be treated as payments of interest for 

Federal income tax purposes, and accord.ingly would be included in the holder’s gross income. 

As is the case with qualified zone academy bonds, the “credit rate” for qualified school 

modernization bonds would be set by the Secretary of the Treasury so that, an average, bonds 

would be issued without interest, discount or premium. The maximum term of the bonds would 

be 15 years. Importantly, unlike qualified zone academy bonds, any person, not just financial 

institutions, would be able to hold a qualified school modernization bond and thereby claim the 

tax credit. The proposal would require information returns to be provided with respect to holders 

(including corporations) that are entitled to credits. 

Under the proposal, a total of $9 7 billion of authority to issue qualified school 

modernization bonds would be allocated among States and the 100 largest school districts in 

each of 1999 and 2000. Half of this annual cap would be allocated among the 100 school 

districts with the largest number of low-income children The cap will be allocated among these 

districts based an the amounts of Federal assistance each district receives under the Basic Grant 

Formula for Title I of the Elementary and Secondary Education Act of 1965. This assistance is 

based primarily upon the number of low-income children residing in the district, with an 

adjustment for differences in per pupil expenditures. The other half of the annual cap would be 

divided among States and Puerto Rico in proportion to their shares of Federal assistance under 

the Basic Grant Formula, adjusted for amounts allocated to the 100 large districts. A small 

portion of the total cap would be set aside for each U.S. possession (other than Puerto Rico) 

based on its share of the total US. poverty population. The relative shares of assistance provided 

under the Basic Grant Fomula would be determined by the Secretary based on the most recent 

data available from the Department of Education on November 1 of the year prior to the year for 

which the allocation of authority to issue qualified school modernization bonds is made. A State, 

possession, or eligible school district would be permitted to cany forward any unused portion of 

its allocation until September 30,2003. 

Under the proposal, a bond would be b-eated as a qualified school modernization bond if 

three requirements are met. First, the Department of Education must approve the school 

construction plan of the State or eligible school district. The school constructionplan must (1) 

demonstrate that a comprehensive survey has been undertaken of the construction and renovation 

needs in the jurisdiction, and (2) describe how the jurisdiction will assure that bond proceeds are 

used for the purposes of this proposal. Second, the issuing govemment must receive an 

35 
allocation for the bond from the State educational agency or the eligible school district. Third, 

95 percent or more ofthe bond proceeds must be used to construct or rehabilitate public school 

facilities. In determining whether this third requirement is met, taxpayers may rely on principles 

used to determine satisfaction of similar requirements with respect to tax-exempt obligations. 

Unlike qualified zone academy bonds, qualified school modernization bonds would not be 

subject to a requirement that private business entities contribute a specified amount of goods or 

services to the school. 

Qualified zone academv bonds 

The proposal would make three changes to the existing qualified zone academy bond 

statute. First, the proposal would increase the bond cap for 1999 from $400 million to $1.4 

billion and add an additional $1.4 billion of bond cap in 2000. Second, the proposal would 

expand the list of permissible uses ofproceeds to include new school construction. Third, the 

proposal would set the maximum term of qualified zone academy bonds at 15 years. 

36 
EXCLUSIONFOR EMPLOYER-PROVIDEDEDUCATIONALASSISTANCE 

Current Law 

Section 127 provides that an employee’s gross income and wages do not include mounts 

paid or incurred by the employer for educational assistanceprovided to the employee if such 

amounts are paid ar incurred pursuant to a qualified educational assistance program. This 

exclusion is limited to $5,250 of educational assistance with respect to an individual during a 

calendar year. The exclusion applies whether or not the education isjob-related. In the absence 

of this exclusion, educational assistance is excludable from income only if it is related to the 

employee’s current job 

The exclusion applies with respect to undergraduate courses beginning before June I, 

2000. The exclusion does not apply to gradduae level courses beginning after June 30, 1996. 

Reasons for Chanve 

Well-educated workers are essential to an economy experiencing technological change 

and facing global competition. Extension of section 127, including reinstatement of its 

application to graduate courses, will e@and educational opportunity and increase productivity. 

In addition, these provisions will encourage the retraining of current and former employees to 

reflect the changing needs of the workplace. The extension of section 127 also will simplify 

the rules for employers and workers by eliminating the need to distinguish between job-related 

expenses and other employer-provided educational assistance 

Proposal 

The current law exclusion would be extended by one year to apply to undergraduate 

courses beginning before June 1,2001 In addition, the exclusion would be reinstated for 

graduate education, effective for courses beginning after June 30, 1998 and before June 1,2001. 

37 
ELIMINATING TAX ON FORGIVENJCSSOF DIRECTSTUDENTLOANS 

SUBJECTTO INCOME CONTINGENTREPAYMENT 

CurrentLaw 

Generally, when a lender forgives a borrower’s loan, the borrower has income equal to 

the loan balance that is forgiven In the case of student loans, an exception is provided when the 

lender is a governmental agency or tax-exempt charitable or educational organization, and the 

lender forgives all or part of the loan in return for the borrower’s providing professional services 

for a certain period of time to certain employers for the benefit of the community. 

Individuals who borrow money to pay for postsecondary education through the Federal 

government’s Direct Loan program may elect income contingent repayment of their loans. If 

they elect income contingent repayment, the size of their repayment installments is adjusted in 

accordance with their income. If an individual who has elected income contingent repayment 

still has an outstanding loan balance after having been in income contingent repayment status for 

twenty-five years, the loan balance is forgiven. 

Reasons for ChanqeWhen taxpayers who have elected income contingent repayment qualify for loan 

forgiveness after having been in income contingent repayment status for twenty-five years, the 

taxpayers should be able to take advantage of the loan forgiveness without undertaking a 

substantial new obligation for income tax to the Federal government. 

Prooosal 

A taxpayer would exclude from income any amount the taxpayer would otherwise 

include as a result of the forgiveness of a student loan made under the Direct Loan program. The 

proposal would be effective for loan cancellations after December 31,1998. 

38 
INCREASELOW-INCOME HOUSING TAX CREDIT PER CAPITA CAP 

CurrentLaw 

A taxcredit is allowed in annual installments over 10 years for qualifying low-income 

rental housing, which may be newly constructed or substantiallyrehabilitated residential units. 

In order for a credit to be claimed with respect to a building, the building owner must receive a 

credit allocation from a State or local housing authority. The low-income housing credit is 

allocated by State or local govemment authorities subject to an annual limitation for each State. 

The annual State housing credit limitation, expressed in terms of first-year credits, is currently 

equal to the sum of $1.25 per capita, the amount of unused housing credit (if any) for the 

preceding calendar year, the amount of housing credits (if any) returned to the State or local 

authority in the calendar year, and the housing credit amounts (if any) allocated to such State by 

the Secretary of the Treasury out of a pool of returned credits The $1“25per capita amount, used 

in determining a State’s total amount of available first-year credits, was set in 1986. 

Reasonsfor Change 

The need for decent low-iicome housing exceeds the amount markets provide at 

affordable rents. Most State agencies receive qualified proposals fox far moxe low-income rental 

housing than they can support with available credits. Without the tax credits, these projects will 

not be undertaken. A modest increase in the per capita amount will allow additional low-income 

housing to be provided but still will require that State agencies choose projects that meet specific 

housing needs. 

ProDosa1 

The annual State low-income housing credit limitation would be increased to $1.75 per 

capita, effective for calender years beginning after 1998. 

39 
EXTEND THE WORK OPPORTWTY TAX CREDIT 

CurrentLaw 

A work opportunity tax credit (WOTC) currently is provided for hiring individuals fiom 

certain targeted groups. The credit equals a percentage of qualified wages paid during the first 

year of the individual's employment with the employer. The credit percentage is 25 percent for 

employment of at least 120 hours but less than 400 hours and 40 percent for employment of400 

or more hours. The maxi" amount of qualified wages paid to an individual is $6,000. The 

credit expires with respect to employees who begin work after June 30, 1998. 

Reasonsfor Change 

The goal of the Work Opportunity Tax Credit is to provide employers with a tax 

incentive to hire individuals who have traditionally had difficulty entering and remaining in the 

work force. An extended wage credit would continue to serve as an inducement for employers to 

hire these individuals and to invest in their training. 

Proposal 

The Work OppoicUnty Tax Credit would be extended so that the credit would apply with 

respect to employees who begin work before May 1,2000. 

40 
EXTEND THE WELFAFU3-TO-WORK TAX CREDIT 

CurrentLaw 

The welfare-to-work credit enables employersto claim a tax credit for eligible wages 

paid to certain long-term family assistance recipients The credit is 35 percent of the first 

$10,000 of eligible wages in the first year of employment and 50 percent of the first $10,000 of 

eligible wages in the second year of employment. Thus, the maxi" credit is $8,500 per 

qualified employee. 

For purposes of qualifying for the credit, the long-term family assistance recipients are 

defined to include: (1) members of families that have received family assistance (AFDC or its 

successor program) for at least 18 consecutive months ending an the hiring date; (2) members of 

families that have received family assistance for a total of at least 18 months beginning on the 

date of enactment, provided that they are hired within two years of the date that the 18-month 

total is reached; and (3) members of families who are no longer eligible for family assistance 

because of Federal or State time limits, provided that they are hired withintwo years of the date 

that they became ineligible for family assistance. 

Eligible wages would be defmed to include amounts paid by the employer for the 

following: (1) educational assistance excludable under a section 127 program (or that would 

meet the requirements of Section 127 but for the expiration of that provision); (2) health plan 

coverage for the employee, but not more than the applicable premium defined under section 

4980B(f)(4); and (3) dependent care assistance excludable under section 129 

The credit is effective for individuals who begin work before May 1, 1999. 

Reasons for Chanee 

Extending the welfare-to-work credit would continue to encourage employers to hire, 

invest in training, and provide certain benefits and more permanent employment, to longer-term 

welfare recipients. 

Proposal 

The welfare-to-work credit would be extended for one year, so that the credit would be 

effective for individuals who begin work before May 1,2000. 

41 
EXTEND THER&E TAX CREDIT 

Current Law 

The research tax credit generally applies on an incremental basis to a *payer’s “qualified 

research” expenses for a taxable year. The credit generally is equal to 20 percent of the amount 

by which the taxpayer’s qualified research expenses for the taxable year exceed a base amount,. 

The base amount is the product of the taxpayer’s “fixed base percentage” and the average of the 

taxpayer’sgross receipts for the four preceding years. The base amount cannot be less than 50 

percent of the taxpayer’s qualified research expenses for the taxable year. 

Under the Small Business lob Protection Act of 1996 (SBJPA), taxpayers are allowed to 

elect an alternative incremental research credit regime for the first taxable year of the taxpayer 

beginning after June 30, 1996. If a taxpayer elects to be subject to this altemative regime, the 

taxpayer is assigned a three-tiered fixed-base percentage (that is lower than the fixed-base 

percentage otherwise applicable under present law) and the credit rate likewise is reduced. 

‘Theresearch credit expired on June 30, 1995. In the SBJPA, the research credit was 

extended (in modified form) for eleven months, from July 1, 1996 to May 31, 1997. The credit 

was subsequently extended by the Taxpayer Relief Act of 1997 (TRA 97) to apply to expenses 

generally incurred from June 1,1997 to June 30,1998. TRA 97 also modified the alternative 

incremental research credit regime to pennit taxpayers to elect the regime for any taxable year 

beginning after June 30,1996. 

Reasons for Chan-e 

The Administration supports the extension of the research tax credit,. The Administration 

recognizes the importance of technology to our national ability to compete in the global 

marketplace, and the research credit is useN in supporting and fostering technology. The credit 

provides incentives for private-sector investment in research and innovation that can help 

increase America’s economic competitiveness and enhance U.S.productivity. 

Proposal 

The research tax credit would be extended for twelve months, from July 1,1998, through 

June 30, 1999. 

42 
EXTEND THE DEDUCTION PROVIDEDFOR 

CONTRIBUTIONS OF APPRECIATED STOCK TO PRIVATEFOUNDATIONS 

Current Law 

Generally, when donors contribute property to a private foundation, they are allowed to 

deduct no more than their adjusted basis in the property. However, section 170(e)(5) provides a 

full fair market value deduction for gifts of publicly traded stock to private foundations. This 

provision expires after June 30, 1998. For gifts of such stock to private foundations made after 

that date, donors will be allowed to deduct only their basis in the stock. Donors will still be able 

to deduct the full fair market value of the publicly traded stock if it is contributed to a public 

charity. 

Reasons for ChanFe 

Private foundationsprovide financial support for many essential and innovative charitable 

and educational activities. Allowing donors to deduct the full fair market value of publicly 

traded stock given to private foundations encourages taxpayers to devote the stock exclusively to 

charitablepurposes. 

Proposal 

The proposal would extend for one year, from July 1,1998, through .June 30,1999, the 

provision allowing a full fair market value deduction for gifts of publicly traded stock to private 

foundations. 

43 
MAKE PERMANENT’rmEXPENSING OF BROWNFIELDS REMEDIATION COSTS 

Current Law 

Generally, costs incurred to clean up land and groundwater increase the value of any 

property and are not currently deductible, but must be capitalized. In a ruling issued in 1994 

(Revenue Ruling 94-38), the IRS concluded that certain costs incurred are currently deductible as 

business expenses. That ruling only addressed cleanup costs incurred by the same taxpayer that 

contaminated the land, rather than someone who acquired previously contaminated property. 

As part ofthe Taxpayer Relief Act of 1997, certain remediation costs are currently 

deductible if incurred with respect to a qualified containment site. Generally, these expenses are 

limited to those paid or incurred in connection with the abatement or control of environmental 

contaminants. For example, expenses incurred with respect to the demolition of existing 

buildings and their structural components do not qualifL for this treatment except in the unusual 

circumstance where the demolition is required as part of ongoing remediation. This deduction 

applies for alternative minimumtax purposes as well as for regular tax purposes. 

A ‘‘qualified containment 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) is certified by the appropriate State 

environmental agency to be located within a targeted area; and (3) contains (or potentially 

contains) a hazardous substance (so-called “brownfields”). Targeted areas are defined as: (1) 

empowerment zones and enterprise communities; (2) sites that were announced before February 

1997 as being subject to one of the 76 Environmental Protection Agency (“EPA”) Brownfields 

Pilots; (3) any population census tract with a poverty rate of20 percent or more; and (4) certain 

industrial and commercial areas that are adjacent to tracts described in (3) above. 

Thisspecial treatment does not apply to expenditures paid or incurred after December 3 1, 

2000” 

Reasons for Chanve 

The Administration believes that encouraging environmental remediation is an important 

national goal. Extending special treatment on a permanent basis would remove doubt among 

taxpayers as to the future deductibility of remediation expenditures and would promote the goal 

of encouraging environmental remediation. 

Proposal 

The proposal would eliminate the restriction requiring that expenditures must be paid or 

incurred on or before December 31,2000 in order to be deductible as environmentalremediation 

expenditurei. 

44 
EXTEND AND MODIFY PUERTORICO TAX CREDIT (SECTION 30A) 

CurrentLaw 

Domestic corporations with business operations that were established by October 13, 

1995 in U.S.possessions (including, for this purpose, Puerto Rico and the US.Virgin Islands) 

may continue to elect the benefits available under Code section 936 or 30A to reduce or 

eliminate the U.S. tax on certain income which is related to their possession-based operations. 

The credit available under Code section 936 or 30A may offset the U.X tax on income arising 

from the active conduct of a bade or business wirhin a US.possession or from the sale or 

exchange of substantially all of the assets used by the taxpayer in the active conduct of such trade 

or business. The credit offsets the beneficiary corporation’s U.S. tax whether or not it pays 

income tax to the possession. 

Limitations on the credit were enacted in 1993, and a phaseout of the credit was enacted 

in 1996. Beneficiary companies may elect either (1) a reduced percentage of the income-based 

credit as allowed under pre-1993 law (45 percent in 1997 and 40 percent beginning in 1998), 

subject beginning in 1998 to a cap based on pre-1996 possessions income, or (2) a limitation 

based on the company’s economic activity in the possessions (measured by wages and other 

compensation, depreciation, and certain taxes paid), subject beginning in 2002 to a cap based on 

pre-1996 possessions income. (Inthe case of Puerto Rico, the credit under the economic-activity 

limitation is provided under section 30A of the Code.) No credit is available in taxable years 

beginning after December 31,2005. No credit is available for business operations established in 

Puerto Rico or the possessions after October 13, 1995. 

-Reasonsfor Chanoe 

The Administration proposed to reformulate the credit in 1993 and again in 1996 to make 

it a more efficient incentive for job creation and economic activity in Puerto Rico; the 

amendments enacted in 1993 moved part way toward the Administration’s proposals, but the 

phase-out enacted in 1996 eliminated all incentives for new investment in Puerto Rico. The 

Administration continues to believe that the credit should provide an incentive for increased 

economic activity in Puerto Rico rather than merely an incentive to attribute profits there. 

Proposal 

To provide a more efficient and effective tax incentive for the economic development of 

Puerto Rico and to continue the shift from an income-based credit to an economic-activity credit 

that was begun in the 1993 Act, the proposal would modify the economic-activity credit under 

section 30A by (1) extending it indefinitely, (2) opening it to newly established business 

operations, effective for taxable years beginning after December 31, 1998, and (3) removing the 

income cap.-

45 
SPECIALIZEDSMALLBUSINESSINVESTMENT COMPANYTAX INCENTIVES 

Current Law 

Certain existing tax incentives are intended to encourage investment in specialized small 

business investment companies (“SSBICs”). SSBICs are partnerships or corporations that are 

licensed by the Small Business Administration to make long-term loans to, or equity investments 

in, small businesses owned by persons who are socially or economically disadvantaged. 

One such incentive allows any C coIporation or individual to elect to roll over without 

payment oftax any capital gains realized upon the sale of publicly-traded securities where the 

corporation or individual uses the proceeds from the sale to purchase common stock or a 

partnership interest in a SSBIC within 60 days of the sale of the securities. The amount of gain 

that an individual may elect to roll over under this provision for a taxable year is limited to the 

lesser of (1) $50,000 or (2) $500,000 reduced by the gain previously excluded under this 

provision. For corporations, these limits are $250,000 and $1,000,000. 

Another incentive provides favorable qualification requirements, relative to other small 

businesses, for purposes of section 1202. Under section 1202,50 percent of the gain realized by 

an individual upon the sale of qualifying small business stock is excluded from income. The 

incentive provides that a SSBIC automatically is deemed to satisfy the active business 

requirement, which must be satisfied by other small business corporations to qualify their stock 

for the exclusion. 

Reasons for Chanee 

Additional tax incentives would mer encourage investment in SSBICs, thereby 

incre’asingthe amount of equity capital available to small businesses owned by persons who are 

socially or economically disadvantaged. 

Proposal 

Tke proposal expands the tax-free rollover incentive in three ways. First, the 60 day 

rollover period is extended to 180 days. Second, a taxpayer who uses the proceeds of the sale of 

publicly-traded securities to purchase preferred stock inthe SSBIC is also eligible for the 

exclusion. Third, the proposal increases the lifebe cap on the SSBIC rollover gain exclusion 

from $500,000 to $750,000 in the case of an individual, and from $1,000,000 to $2,000,000 in 

the case of a corporation. The annual caps on gain exclusion of $50,000 per individual and 

$250,000 per corporation are eliminated. 

The proposal also provides that a SSBIC that is organized as a corporation may convert to 

a partnership within 180days of enactment, without giving rise to tax at either the corporate or 

46 
shareholder levels (although the shareholderswould be taxed on gain to the extent of boot 

received in addition to partnership interests). To qualify for this treatment, the corporation must 

contribute its assets to a partnership (in which it holds an interest of at least 80-percent 

immediately after the contribution), distribute the partnership interests to its shareholders, and 

immediately liquidate. The shareholders’ basis in the partnership interests generally would cany 

over from their basis in the SSBIC stock. The partnership would remain subject to an entity 

level tax at any time that it later disposed of assets that were held at the time of conversion on the 

amount of “built-in” gains inherent in such assets at the time of conversion. 

Finally, in the case of a direct or indirect sale of SSBIC stock that qualifies for treatment 

under section 1202,the proposal raises the exclusion of gain from 50-percent to 60-percent. 

The tax-free rollover and section 1202 provisions are effective for sales occurring after 

the date of enactment. 

47 
ACCELERATE AND EXPAND INCENTIVES AVAILABLE TO 

TWO NEW EMPOWERMENT ZONES 

Current Law 

The Omnibus Budget Reconciliation Act of 1993 (OBRA ‘93) authorized a Federal 

demonstration project in which nine empowerment zones and 95 enterprise communities would 

be designated in a competitive application process. Of the nine empowerment zones, six were to 

be located in urban areas and three were to be located in rural areas. State and local governments 

would nominate distressed areas and propose strategic plans to stimulate economic and social 

revitalization. 

Among other benefits, businesses located in the nine original empowerment zones are 

eligible for three Federal taxincentives: an employment and training credit; an additional 

$20,000 per year of section 179 expensing; and a new category oftax-exempt private activity 

bonds. Businesses located in enterprise communities are eligible for the new category of 

tax-exempt bonds,. OBRA ‘93 also provided that Federal grants would be made to designated 

areas. 

The Taxpayer Relief Act of 1997authorized the designation of two additional 

empowerment zones located in urban areas (the “additional empowerment zones”) which 

generally are eligible for the same tax incentives as are available withinthe empowerment zones 

authorized by OBRA ‘93. The designations of these two additional empowerment zones will be 

made in early 1998, but the tax incentives provided for them do not take effect until January 1, 

2000. These incentives generally remain in effect for 10 years. The wage credit, however, is 

phased down beginning in 2005 and expires after 2007. 

Reasons for Chanee 

The Administration believes that the availability of the tax incentives for the two 

additional empowerment zones should be accelerated and expanded in order to help combat the 

pervasive poverty and stimulate the revitalization of these areas. 

Proposal 

The proposal would accelerate the start-up date of the taxincentives for the two 

additional empowerment zones to January 1,1999. The proposal also would provide that the 

wage credit would remain in effect for 10 years from that date and would be phased down using 

the same percentages that apply to the ori,&al empowerment zones designated under OBRA ‘93. 

48 
MAKE FIRST $2,000 OF SEVERANCE PAY EXEMPT FROM INCOME TAX 

Current Law 

Severance payments are includible in the gross income of the recipient 

Reasons for Change 

The taxan severance payments places an additional burden an displaced workers, 

especially if theworker is separated from service because of a reduction in work force by the 

employer, in which case it may be difficult for the worker to find new, comparable employment. 

Prouosai 

Under the proposal, up to $2,000 of certain severance payments would be excludable 

from the income of the recipient. This exclusion would apply to payments received by an 

individual who was separated from service in connection with a reduction in the employer's 

work force. The exclusion is not available if theindividual attains employment within six 

months ofthe separation from service at a compensationlevel that is 95 percent of the 

compensation the individual received before the separation from service. The exclusion does not 

apply if the total severance payments received by the individual exceed $125,000. 

The proposal would be effective for severancepay received in taxable years beginning 

after December 31, 1998 and before January 1,2004. 

49 
OPTIONAL SELF-EMPLOYMENT CONTRIBUTIONS ACT (SECA) 

COMPUTATIONS 

Current Law 

The SelfEmployment Contributions Act (SECA) imposes taxes on net eamings from 

self-employment to provide social security coverage to self-employed workers. The maximum 

amount ofeamings subject to the self-employment (or SECA) tax is coordinated with, and is set 

at the same level as, the maximum level of wages and salaries subject to FICA taxes ($68,400 for 

OASDI taxes in 1998 and indexed annually, and without liiit for the Hospital Insurance tax). 

Special rules allow certain self-employed individuals to continue to maintain social 

security coverage during a period of low income. "he method applicable to farmers is slightly 

more favorable than the method applicableto other self-employed persons,. A famer may 

increase his or her self-employment income, for purposes of obtaining social security coverage, 

by reporting two thirds of the first $2,400 of gross income as net earnings from self-employment, 

i.e., the optional amount of net earnings from self-employmentwould not exceed $1,600. 'Ihere 

is no limit to the number of times a farmer may use this method. The optional method for nonfm income is similar, also permitting two thirds of the first $2,400 of gross income to be 

treated as self-employment income. However, the optional non-fam method may not be used 

more than five times by any individual, and may only be used ifthe taxpayer had net earnings 

from self-employment of$400 or more in at least two ofthe three years immediately preceding 

the year in which the optional method is elected. 

Reasons �or Chanee 

Combining the two different optional methods of computing self-employment income for 

self-employment taxpurposes into a single combiued optional method will simplify the selfemployment tax for the approximately 45,000 taxpayers (in 1994) who use one of these methods. 

Forms and instructions will also be simplified for the millions of self-employed workers who do 

not use the optional methods. 

There is no policy reason for providing different methods for farm and non-farm selfemployed workers,. By permitting non-farm self-employed workers to use the more liberal 

requirements that currently apply to the farm optional method, more non-farm self-employed 

persons would be expected to use the combined optional method and, thereby, to obtain 

additional social security and Medicare coverage and, eventually, to receive higher social 

security benefits. 

50 
Proposal 

The two current optional methods would be combined inta a single combined optional 

method under which self-employment income for SECA taupurposes wauld be two-thirds of the 

first $2,400 of gross income. A self-emplayed worker could elect the proposed combined 

optional method an unlimited number of times. If it is used, it would have to be applied to all 

self-employment earnings for the year, both farm and non-farm. As under current law, the 

$2,400 amaunt would not be indexed for inflation. 

The proposal would be effective far tax years beginning after December 3 1,1998. 

51 
PROVIDE STATUTORY HEDGING AND OTHER RULES TO ENSURE 

BUSINESS PROPERTY IS TREATED AS ORDINARYPROPERTY 

Current Law 

Under current law, there is a si,&mificgt issue of whether income from hedging 

transactions is capital or ordinary. The Supreme Court in Arkansas Best established a restrictive 

definition of ordinary assets that resulted in certain business hedges being treated as capital 

assets. The decision and subsequent IRS interpretation caused considerable efforts by affected 

industries to change the rules legislatively. 

In 1993, the Department of the Treasury issued temporary regulations (fmalized in 1994) 

that were similar to industry proposals.. The regulations provide ordinary character for most 

business hedges and provide timing rules to ensure that hedging transactions are taken into 

account in a manner that matches the income or loss from hedged items. 

The straddle rules of section 1092 limit the ability of taxpayers to claim losses on 

offsetting positions in personal property. 

Reasons for Change 

The hedging regulations issued by the Department ofthe Treasury do not eliminate the 

possibility that a business hedge can be improperly characterized for taxpurposes. The rules 

under which assets are treated as ordinary assets and under which hedging transactions are 

accounted for need to be modemized,. In addition, the loss deferral provision under the straddle 

rules can be punitive and sometimes results in a total disallowance of losses,. 

Proposal 

The proposal generally would codify the approach taken by the Treasury regulations and 

make some modifications to help clarify the rules.. The proposal would add three categories of 

ordinary assets to section 1221: (1) derivative contracts entered into by derivative dealers; (2) 

supplies of a type regularly used by the taxpayer in the provision of services or the production of 

ordinary property; and (3) hedges. A new provision would define a hedging transaction as a 

transaction entered into primarily to manage the risk of ordinary property held or to be held, or 

certain liabilities incurred or to be incurred, and identified as a hedge of specified property. If a 

transaction was improperly identified as a hedging transaction, losses would retain their usual 

character (Le., usually capital), but gains would be ordinary. If a hedging transaction was not 

identified (and there was no reasonable basis for the failure), gains would be ordinary but losses 

would retain their non-hedging character. Other rationales for ordinary treatment (such as 

surrogacy for a non-capital asset or insurance against a business risk) generally would not be 

allowed, and the proposed provisions would be the exclusive means to obtain ordinary treatment. 

Treasury would have authority to apply these rules to related parties. 
The proposal would require that the timing of income, gain, deduction, or loss from a 

hedging transaction must reasonably match the income, gain, deduction, or loss from the item(s) 

being hedged. Taxpayers could, to the extent allowed in regulations, elect this timing for 

straddles as well, provided the positions in the straddles are identified by the taxpayer, instead of 

being subject to the nde that defers losses on straddles to the extent of unrecognized gain in the 

offsetting position. The proposal would repeal the exception from the straddle rules for stock. 

Further, Treasury would have regulatory authority to integrate offsetting positions in a straddle 

The proposal would be effective after the date of enactment, with the effective date for 

the hedging identification requirements deferred until 60 days after date of enactment. Treasury 

would be given authority to issue regulations governing transactions entered into prior to the 

effective date. The regulations would provide treatment similar to that provided in the statute. 

53 
CLARIFY RULES RELATING TO CERTAIN DISCLAIMERS 

Current Law 

State laws permit donees of gifts and bequests to refuse to accept (ie., disclaim) such 

transfers prior to acceptance. In that event, State laws typically provide that the disclaimed 

property passes as if the intended recipient died before the transfer was made. Under section 

25 18, a State law type disclaimer is effectivefor Federal transfer taxpurposes if it is an 

irrevocable and unqualified refusal to accept an interest in property, the disclaimer is made in 

Writing not later than nine months after the transfer creating the interest occurs, and certain other 

requirements are satisfied. Disclaimers are permitted for an “undivided portion” of the 

disclaimant’s interest. Also, a spouse is permitted to disclaim even when the result of the 

disclaimer is that the disclaimed property will pass to a trust of which the spouse is a beneficiary. 

When a qualified disclaimer is made, the property passes in accordancewith State law and the 

transfer tax provisions apply as if no transfer had been made to the disclaiming person. The 

effect of a qualified disclaimer for Federal income tax purposes is unclear. 

Certain transfers of property also can be treated as qualified disclaimers under section 

25 18(c)(3). In order to qualify, these transfer-type disclaimers must be a witten transfer of the 

disclaimant’s “entire interest in the property” to the person who would have received the 

property had there been a valid disclaimer under State law. Like other disclaimers, the 

transfer-type disclaimer generally must be made within nine months of the transfer creating the 

interest. 

Reasons for Chawe 

The Administration wishes to clarify that transfer-type disclaimers should be treated the 

same as non-transfer-type disclaimers. In addition, qualified disclaimers should be effective foI 

income tax purposes as well as for transfer tax purposes, so that if a person disclaims property 

that is income in respect of a decedent (IRD), the income tax liability for the IRD goes with the 

disclaimed property. 

Proposal 

The proposal would amend the disclaimer rules to state that, in the case of a transfer-type 

disclaimer, partial disclaimers are permitted and a spouse can make a disclaimerthat is effective 

for gift tax purposes even where the disclaimed property passes to a oxst in which the surviving 

spouse has an income interest. The proposal also would clarify that disclaimers are effective for 

income tax purposes. This proposal would apply to disclaimers made after the date of 

enactment. 

54 
SIMPLIFY THE FOREIGN TAX CREDIT LIMITATION 

FOR DIVIDENDS FROM 10/50COMPANIES 

Current Law 

US. persons may credit foreign taxes against US. tax on foreign source income., The 

amount of foreign tax credits that can be claimed in a year is subject to a limitation that prevents 

taxpayers from using foreign tax credits to offset US. tax on US. source income. Separate 

limitations are applied to specific categories of income. 

Special foreign tax credit limitation rules apply in the case of dividends received from a 

foreign corporation in which the taxpayer owns at least 10 percent ofthe stock by vote and which 

is neither a controlled foreign corporation nor a passive foreign investment company (a so-called 

“10/50 company”). Dividends paid by a 10/50 company in taxable years beginning before 

January 1,2003, are subject to a separate foreign tax credit limitation for each 1060 company. 

Dividends paid by a 10/50 company in taxable years beginning after December 31,2002, from 

earnings and profits accumulated in taxable years beginning before January 1,2003, are subject 

to a single foreign tax credit limitation for all 10150 companies. Dividends paid by a 10/50 

company in taxable years beginning after December 31,2002, from earnings and profits 

accumulated in taxable years beginning after December 31,2002, are treated as income in a 

foreign tax credit limitation category in proportion to the ratio of the eamings and profits 

attributable to income in such foreign tax credit limitation category to the total earnings and 

profits (a so-called “look-through” approach). Regulatory authority is granted to provide des 

regarding the treatment of distributions out of eamings and profits for periods prior to the 

taxpayer’s acquisition of such stock. 

Reasons for Chan-e 

With respect to dividends paid by a 10/50 company in taxable years beginning after 

December 31,2002, the concurrent application of both the single basket approach (for pre.2003 

earnings and profits) and the look-through approach (for post-2002 earnings and profits) will 

result in significant complexity to taxpayers. A reduction in complexity and compliance burdens 

will reduce the bias against US. participation in foreignjoint ventures and foreign investment by 

U.S. companies through affiliates that are not majority owned. 

Proposal 

The proposal would simplify the application of the foreign tax credit limitation by 

applying the look-through approach immediately to dividends paid by a 10/50 company, 

regardless of the year in which the earnings and profits out of which the dividend is paid were 

accumulated. The proposal would grant re,datory authority to provide rules regarding the 

treatment of-distributionsout of earnings and profits for periods prior to the taxpayer’s 

acquisition of the stock, including rules to disregard preacquisition earnings and profits, and 

55 
foreign taxes, inappropriate circumstances.. .The proposal would be effective for taxable years 

beginning afier December 31,1997. 

56 
INTEREST TREATMENT FOR DMDENDS PAID BY CERTAIN REGULATED 

INVESTMENT COMPANIES TO FOREIGN PERSONS 

Current Law 

Interest income and short-term capital gains received by a U.S. money market or bond 

mutual fund are recharacterized as dividend income that is subject to US. withholding tax when 

distributed to foreign investors. However, in general, no US. withholding taxis imposed, on 

interest income and short-term capital gains received by foreign investors from direct 

investments or investments through foreign funds in U.S. bonds and money market instruments. 

Reasons for ChanPe 

Imposition of US. withholding tax on investments through US. money market or bond 

mutual funds, when tax is not imposed on comparable investments through foreign funds, puts 

U.S. mutual funds at a significant competitive disadvantage in attracting foreign investors. The 

proposal would eliminate this disadvantage as well as needless complications now associated 

with structuring vehicles for foreign investment in US. debt securities. 

Proposal 

The proposal generally would treat all income received by a US. mutual fimd that invests 

substantially all of its assets in US. debt securities or cash as interest that is exempt from US. 

withholding tax. In determining whether a fhd invests substantially all of its assets in U.S. debt 

securities or cash, a fund generally will not fail to meet this test if it also invests some of its 

assets in foreign debt instruments that are free from foreign taxpursuant to the domestic laws of 

the relevant foreign countries. 

57 
SUSPEND COLLECTION BY LEVY DTJlUNG REFUND SUIT 

Current Law 

Neither the Intemal Revenue Code nor the regulations contains any provision that 

prohibits the IRS from levying to collect tax liabilities that are the subject of a refund suit during 

the pendency of the litigation. Generally, full payment of the tax at issue is a prerequisite to a 

refund suit, Flora v. United States, 357 U.S. 63 (1958), aff’d on reh’g, 362 U.S. 145 (1960), but 

this rule does not apply in the case of “divisible” taxes (such as employment taxes or the “1 00 

percent penalty” under section 6672). The Service’s policy and the Intemal Revenue Manual 

generally provide, however, that when a refund suit is pending on a divisible assessment, the IRS 

will exercise forbearance with respect to collection, so long as the interests of the Government 

are adequately protected (s,by the filing of a notice of Federal tax lien) and collection is not in 

jeopardy. Any refunds due the taxpayer may be credited to the unpaid portion of the liability 

pending the outcome of the suit. 

Reasons for Change 

Taxpayers who are litigating a refund action over divisible taxes should be protected from 

collection of the full assessed amount, for whicli they may not be liable, so long as the 

Government’s ultimate ability to collect the amount determined by the court to be properly due is 

preserved. 

Prooosal 

This proposal would require the IRS to withhold collection by levy of liabilities that are 

the subject of a refund suit during the pendency of the litigation. This would only apply when 

refund suits can be brought without the full payment ofthe tax,is., in the case of divisible taxes. 

Collection by levy would be withheld unless jeopardy exists or the taxpayer waives the 

suspension of collection in writing. This proposal would not affect the IRS’s ability to collect 

other assessments that are not the subject of the refund suit, to offset refunds, or to file a notice of 

Federal tax lien. The statute of limitations on collection would be stayed for the period during 

which the IRS is prohibited from collecting by levy. The proposal would be effective for refund 

suits brought with respect to tax years beginning after December 31, 1998. 

58 
SUSPEND COLLECTIONBY LEVY WHILE OFFER IN COMPROMISE IS PENDING 

Current Law 

The Code and re-dations do not preclude collection of a taw liability while an offer in 

compromise with respect to that liability is pending. The regulations and IRS policy statements 

do, however, provide that collection may be deferred while an offer in compromise is pending, 

unless the interests of the United States are jeopardized or the offer was filed solely for the 

purpose of delaying collection. Collection is ordinarily barred, pursuant to the parties’ 

agreement, if an offer in compromise is accepted 

Reasons for ChanPe 

If a taxpayer is making a legitimate effort to resolve a tax liability through an offer in 

compromise, and the interests of the United States are adequately protected, it is appropriate to 

preclude enforced collection of the liability. 

Proposal 

The IRS would be barred iiom collecting a taxliability by levy during any period that a 

taxpayer’s offer incompromise of that liability is being processed, during the 30 days following 

rejection of an offer, and for any period during which an appeal of a rejected offer is being 

considered. Levy would not be precluded if the IRS determines that collection is in jeopardy or 

that the offer is submitted solely to delay collection. This proposal would not affect liabilities or 

assessments that are not the subject of the offer in compromise, the IRS’s ability to make refund 

offsets under section 6402, or its ability to file a notice of Federal tax lien. The proposal would 

not require the IRS to stop any levy action that was initiated, or withdraw any lien that was filed, 

prior to the taxpayer’s making an offer in compromise. The statute of limitations on collection 

would be stayed for the period during which collection by levy is barred. The proposal would be 

effective with respect to taxes assessed 60 days after the date of enactment. 

59 
SUSPENDCOLLECTION'roPERMIT 

RESOLUTION OF DISPUTES AS TO LIABILITY 

Current Law 

Under current law, once a valid assessment is made the IRS is not required to suspend 

collection if the taxpayer claims not to owe the taxes. This is true even if the assessment was 

made as a result of the taxpayer's failure to respond to a statutory notice of deficiency sent to the 

taxpayer's last known address. However, the Intemal Revenue Code allows a taxpayer to submit 

an offer in compromise based on doubt as to the taxpayer's liability, except when the issue has 

been determined previously by a court. The IRS's policy is to suspend collection while an offer 

in compromise is pending, except in cases ofjeopardy or if the IRS determines that the offer is 

submitted solely to delay collection. 

Reasons for Change 

Some taxpayers who fail to receive or respond to a proper statutory notice of deficiency 

are not actually liable for the tax. If such a taxpayer is making a legitimate effort to resolve a tax 

liability through an offer in compromise, and the interests of the United States are adequately 

protected, it is appropriate to preclude enforced collection of @e liability. 

Proposal 

This proposal would permit an individual taxpayer to request that collection be suspended 

temporarily with regard to aiincome tax liability that is assessed based upon a statutory notice 

of deficiency that the taxpayer failed to receive or to which the taxpayer failed to respond. The 

IRS would suspend collection for a 60-day period, during which the taxpayer may dispute the 

merits of the underlying assessment. The 60-day period would be extended in appropriate cases 

where progress is being made in resolving the liability. Collection by refund offset and jeopardy 

levies would be exempted. The statute of litations on collection would be stayed while the 

taxpayer's claim is pending. The proposal also would not affect the IRS's ability to file a notice 

of Federal tax lien. The proposal would be effective for taxes assessed with respect to taxable 

years beginning after December 31,1998. 

60 
REQUIRE DISTRICT COUNSEL 

APPROVAL OF CERTAIN THIRD PARTY COLLECTION ACTMTIES 

Current Law 

Circumstances may exist where property nominally held in a name other than the 

taxpayer is in fact the taxpayer's property or is deemed to be the taxpayer's property. For 

instance, where a corporation is the alter ego of an individual taxpayer, the IRS may treat the 

corporation's assets as those of the taxpayer and can properly take administrative collection 

action against those assets. Similarly, it is sometimes possible to show that property held in the 

name of a third party individual is being held in a nominal or representative capacity for a 

taxpayer. In such situations, IRS policy is to require written advice by District Counsel as to the 

need for a supplemental assessment, a new notice and demand, and the language to be 

incorporated in the notices of lien and levy on such property. However, District Counsel 

approval is not presently required before a notice of Federal tax lien can be filed in connection 

with property held by a nominee, transferee, or alter ego of the taxpayer, or before the seizure of 

property to which a Federal tax lien attaches but which is presently neither owned by the 

taxpayer nor titled in the name of the taxpayer. 

Reasons for Change 

The collection of tax liabilities from property held by nominees, transferees, or alter egos 

of the taxpayer often involves difficult legal issues. Similar issues may arise whenever the IRS 

seizes property that is not currently owned by the taxpayer nor titled in the taxpayer's name. 

These issues should be reviewed by District Counsel before the IRS files a notice of Federal tax 

lien against, or levies on, such property. 

ProDosal 

This proposal would require IRS District Counsef approval before a notice of Federal tax 

lien can be filed or levy is made in connection with property held by a nominee, transferee, or 

alter ego of the taxpayer. District Counsel approval would also be required before the IRS seizes 

property encumbered by a Federal tax lien if the property is presently neither owned nor titled in 

the name of the taxpayer. The only exception would be in jeopardy situations.. If District 

Counsel's approval was not obtained, the property-owner would be entitled to obtain release of 

the lien or levy, and, if the IRS failed to make such release, to appeal fkst to the Collections 

Appeals process and then to the US.District Court.. The proposal would be effective with 

respect to taxes assessed after the date of enactment. 

61 
REQUIRE MANAGEMENT 

APPROVAL OF LEVDES ON CERTAIN ASSETS 

Current Law 

'The Secretary of the Treasury is authorized to collect taxes by kvying on property or 

rights to property of the taxpayer. This authority has been delegated to various IRS officials, and 

different levels of IRS review are required before a levy is made on certain kinds of taxpayer 

assets. Under section 6334(e), the IRS can levy on a taxpayer's personal residence only after the 

District Director or Assistant District Director approves such a levy (or in jeopardy situations).. 

Reasons for Change 

Potential levies on other kinds of important personal assets should be subject to the sgme 

level of review and scrutiny as levies on personal residences. 

ProDosa1 

This p~oposalwould require the personal approval of a District Director or Assistant 

District Director of any levy against non-Federal pensions or the cash value of life insurance 

policies. The proposal would thus place these assets in the same class as principal residences 

pursuant to section 6334(e). The only exception would be in jeopardy situations. If the requisite 

approval was not obtained, the taxpayer would be entitled to obtain release of the levy, and, if the 

IRS failed to make such release, to appeal first to the Collections Appeals process and then to the 

US.District Court. The proposal would be effective with respect to taxes assessed after the date 

of enactment. 

62 
REQUIRE DISTRICT COUNSEL REVIEW OF 

JEOPARDY AND TERMINATION ASSESSMENTS AND JEOPARDY LEVIES 

Current Law 

The Internal Revenue Code provides special procedures that allow the IRS to make 

jeopardy assessments or termination assessments in certain extraordinary circumstances, for 

instance if the taxpayer is leaving or removing property fiom the United States or if assessment 

or collection would be jeopardized by delay. In jeopardy situations, a levy may also be made 

without the 30 days’ notice of intent to levy that is ordinarily required. The Code and regulations 

do not presently require District Counsel to review jeopardy assessments, termination 

assessments, or jeopardy levies, although the Intemal Revenue Manual does require District 

Counsel review before such actions and it is current practice to make such a review. The 

Government bears the burden of proof with respect to the reasonableness of a jeopardy or 

termination assessment or a jeopardy levy 

Reasons for Change 

Jeopardy and termination assessments and jeopardy levies often involve difficult legal 

issues. These issues should be reviewed by District Counsel before the IRS takes such action, 

particularly as the Government may bear the burden of proof on the reasonableness of the IRS 

action if the taxpayer contests it in court 

Proposal 

The proposal would require IRS District Counsel review and approval before the IRS 

could make a jeopardy assessment, a termination assessment, or a jeopardy levy. If District 

Counsel’s approval was not obtained,the taxpayer would be entitled to obtain abatement of the 

assessment or release of the levy, and, if the IRS failed to offer such relief, to appeal first to the 

Collections Appeals process and then to the U S. District Court. The proposal would be effective 

with respect to taxes assessed after the date of enactment. 

63 
REQUIRE MANAGEMENT APPROVAL 

OF SALES OF PERISHABLE GOODS 

Current Law 

Under section 6336 of the Internal Revenue Code, if it is determined that any property 

seized to satisfy unpaid taxes is liable to pexish or become greatly reduced inprice or value by 

keeping, or that the property cannot be kept without great expense, the property may be sold after 

it has been appraised and the owner has been given an opportunity to pay the appraised value or 

furnish bond for payment. The procedures governing the sale of seized property that are set forth 

in section 6335 (a,requiring ten-days notice before sale and the determination of a minimum 

bid) are not applicable to sales of perishables Rather, different procedures set forth in section 

6336 and the regulations thereunder apply to the sale of perishable goods. 

Reasons for Change 

Because ofthe nature ofthe property at issue, it is appropriate that special, accelerated 

procedures apply to the sale of perishable goods that have been seized. However, a revenue 

officer’s determination that the perishable goods procedures apply should be subject to higher 

level management review. 

ProDosaI 

The proposal would require approval by the IRS District Director or Assistant District 

Director before the IRS sells perishable goods pursuant to section 6336. The proposal would 

also clarify what a “perishable” good is for these purposes. The proposal would be effective with 

respect to taxes assessed after the date of enactment. 

64 
CODIFY CERTAIN FAIR DEBT COLLECTION PROCEDURES 

Current Law 

Government agencies, including the IRS, are generally exempt from the Fair Debt 

Collection Practices Act, 15 U.S.C. 1692. In the past, however, appropriations legislation 

funding the IRS has required IRS officers and employees to comply with sections 805(a) 

(relating to communications in connection with debt collection) and 806 (relating to harassment 

or abuse) of the Fair Debt Collection Practices Act. The first provision prohibits a creditor from 

commtlnicating with a debtor at any unusual time and place, generally prohibiting telephone calls 

other than between the hours of 8:00 a.m. to 9:OO p"m.local time. The second provision 

prohibits creditors from harassing or abusing debtors in attempts to collect. 

Reasons for Change 

The IRS should be required to comply withsections 805(a) and 806 of the Fair Debt 

collection Practices Act, which impose reasonable constraints on debt collection activities. 

Placing these requirements in the Intemal Revenue Code would ensure that both taxpayers and 

employees of the IRS are fully aware of these requirements. 

Proposal 

The proposal would add to the Intemal Revenue Code the provisions ofthe Fair Debt 

Collection Procedure Act concerning communications in connection with debt collection (section 

805) and the prohibition on harassment or abuse (section 806) (15 U.S..C.$5 1692c and 1692d). 

The proposal would be effective on the date of enactment. 

65 
MODIFY PAYMENT OF TAXES 

Current Law 

The Secretary of the Treasury is authorized to accept payments by stamps, check, or 

money orders, as provided in readations Under the regulations, see Treas. Reg. Sec. 301.631 1-

1(a)(I), checks or money orders are currently made payable to the “Internal Revenue Service.” 

Reasons for Chanye 

Allowing checks to be made payable to the United States Treasury will make it 

clearer to taxpayers that their tax payments support the entire US. Government, not just the IRS. 

Proposal 

The proposal would require the Secretary ofthe Treasury or his delegate to establish such 

rules, regulations, and procedures as are necessary to allow payment of taxes by check or money 

order to be made payable to the order of “United States Treasury.” The proposal would be 

effective on the date ofenactment. 

66 
REQUIRE DISCLOSURES RELATING TO EXTENSION 

OF STATUTES OF LIMITATION BY AGREEMENT 

Current Law 

Under section 6501, the statute of limitations within which the IRS may assess additional 

taxes is generally three years from the date a retum is filed. The statute of limitations within 

which a tax may be collected after assessment is generally 10 years after assessment, see section 

6502. Prior to the expiration ofthese periods of limitations, the taxpayer and the IRS may agree 

in writing to extend the statutory period, either for a specified period or for an indefinite period. 

Reasons for Change 

Taxpayers should be fully informed of their rights with respect to extending, or refusing 

to extend, the applicable statute of limitations. 

Proposal 

The proposal would require that, on each occasion on which the taxpayer is requested by 

the IRS to extend the statutory period of limitations on assessment or collection, either for a 

specified period or for an indefinite period, the IRS mint notify the taxpayer of the taxpayer’s 

right to refuse to extend the statute of limitations or to limit the extension to particular issues. 

The proposal would apply to requests to extend the statute of limitations made after the date of 

enactment. 

67 
PUBLISH LIVING ALLOWANCE SCIDEDULES 

RELATING TO OFFERS IN COMPROMISE 

Current Law 

Section 7122 permits the IRS to compromise a taxpayer's tax liability for less than the 

full amount due. In general, there are two grounds on which an offer can be made: doubt as to 

the taxpayer's liability for the full amount, or doubt as to the taxpayer's ability to pay in full the 

amount owed. 

Reasons for Change 

In evaluating the sufficiency of an offer in compromise, the IRS should take into 

consideration a taxpayer's need to provide for the basic living expenses of his or her farnily, 

based on the cost of living in the taxpayer's locality. 

Proaosal 

'The proposal would require the IRS to develop and publish schedules of national and 

local living allowances, taking into account variations in the cost of living in different areas. 

These schedules would be designed to provide taxpayers entering into an offer in compromise 

withadequate means to provide for basic living expenses. The IRS would be expected to use this 

information in evaluating the sufficiency of offers in compromise. The schedules required by 

this provision would be published as soon as practicable, but no later than 180 days after the date 

of enactment. 

68 
ENSURE AVAIZABILITY OF INSTALLMENTAGREEMENTS 

Current Law 

The IRS is authorized under.Code section 6159 to enter into agreements with taxpayers 

under which taxpayers are permitted to pay taxes in installments “if the Secretary determines that 

such agreement will facilitate collection of such liability.” The Secretary of the Treasury has 

discretion to determine when such an agreement is appropriate; installment agreements generally 

require extensive and ongoing financial disclosures by taxpayers, the continued filing of notices 

of Federal tax liens, and a plan for full payment of the taxes due Treas. Reg. 8 301.6159-1. 

Reasons for Change 

The IRS generally permits a taxpayer with an outstanding liability of less than $10,000 to 

enter an installment payment agreement, under certain conditions. The proposal would 

essentially codify the IRS’s cwent practice. 

Proposal 

The proposal would require the Secretary to enter an installment agreement, at the 

taxpayer’s option, if: 

(1) the liability is $10,000 or less; 

(2) witbin the previous 5 years, the taxpayer has not failed to file or to pay, nor 

entered an installment agreement under this provision; 

(3) if requested by the Secretary, the taxpayer submits financial statements that 

demonstrate an inability to pay the tax due in full; 

(4) the installment agreementprovides for full payment of the liability within3 years, 

with installment payments made by direct debit of the taxpayer’s bank account; 

(5) the taxpayer extends the statute of limitations on collection during the term of the 

agreement; and 

(6) the taxpayer agrees to continue to comply with the tax laws and the terms ofthe 

agreement for the period (up to 3 years) that the agreement is in place. 

The proposal would be effective on the date of enactment. 

69 
INCREASE SWERPRIORITY DOLLAR LIMITS 

Current Law 

Section 6323(b) provides protection to certain interests even though a Notice of Federal 

Tax Lien has been filed before those competing interests arise. These interests are said to have 

"superpriorities." 

Two of these interests are limited by a specific dollar amount. Under section 6323(b)(4), 

purchasers of personal property at a casual sale are currently protected to the extent the sale is for 

less than $250. Section 6323@)(7)provides protection to mechanic's lienors with respect to the 

repairs or improvements made to owner-occupied personal residences, but only to the extent that 

the contract for Iepair or improvement is for not more than $1,000. 

In addition, a superpriority is granted under section 6323@)(10)to banks and building 

and loan associations which make passbook loans to their customers, provided that those 

institutions retain the passbooks in their possession until the loan is completely paid off. 

Reasons for Chanve 

The dollar limits on the superpriority amounts have not been increased for decades and do 

not reflect current prices or values. Increasing these limits would provide superpriority 

protection against the Federal tax lien for more competing claimants to the property of debtow. 

Similarly, the passbook loan requirement does not reflect current banking practices. 

Proposal 

The proposal would increase the dollar limit in section 6323@)(4) for purchasers at a 

casual sale from $250 to $1,000, and it would increase the dollar limit in section 6323(b)(7) from 

$1,000 to $5,000 for mechanics lienors providing home improvement work for owner-occupied 

personal residences. The proposal also would clarify section 6323(b)(10) to reflect current 

banking practices, where a passbook-type loan may be made even though an actual passbook is 

not used. The proposal would be effective on the date of enactment. 

70 
PERMIT PERSONAL DELIVERY OF SECTION 6672(b) NOTICES 

Current Law 

Section 6672(b)(l) requires that before the IRS may assess a “100 percent penalty” 

against a taxpayer, the IRS must mail to that taxpayer’s last known address a Written preliiary 

notice informing the taxpayer of the proposed penalty. Prior to this change in section 6672, the 

IRS ofien conducted personal meetings with taxpayers against whom a IO0 percent penalty was 

proposed and delivered a written preliminary notice informing them of the proposed assessment 

and their appeal rights during that meeting. It is not clear, however, whether the Intemal 

Revenue Code permits such delivery. 

Reasons for Chan-e 

Permitting personal service of the preliminary notice required by section 6672(b)(1) of 

the Code may eliminate unnecessary disputes over whether the notice was properly addressed or 

received, and may additionally afford taxpayers and IRS employees the opportunity to resolve 

some 100percent penalty cases at an earlier stage. 

Prooosal 

The proposal would permit personal delivery, in addition to the Code’s cwent 

requirement of mail delivery, of a preliminary notice that the IRS intends to assess a 100 percent 

penalty against the taxpayer. The proposal would be effective on the date of enactment. 

71 
ALLOW TAXPAYERS TO QUASH ALL THIRD-PARTY SUMMONSES 

Current Law 

When the IRS issues a summons to a “third-party recordkeeper” relating to the business 

transactions or aflkirs of a taxpayer, section 7609 requires that notice of the summons be given to 

the taxpayer within three days by certified or registered mail. The taxpayer is thereafter given up 

to 23 days to begin a court proceeding to quash the summons. Third-party recordkeepers are 

prohibited fiom complying with the summons until the court rules on the taxpayer’s petition to 

quash, but the statute of limitations for assessment and collection with respect to the taxpayer is 

stayed during the pendency of such a proceeding. Third-party recordkeepers are generally 

persons who hold financial information about the taxpayer, such as banks, brokers, attomeys, and 

accountants. 

Reasons for Chanye 

A taxpayer should have notice when the IRS utilizes its summons power to gather 

information in an effort to determine the taxpayer‘s liability. While the current definition of 

third-party recordkeeper probably encompasses the vast majority of third-party summonses that 

are issued each year, expanding the definitionto include all third parties would have the 

beneficial effect of ensuring taxpayers willreceive notice and an opportunity to contest any 

summons issued to a third party in connection with the determinationof their liability. It will 

not, however, seriously impair IRSinvestigations. 

-Pr& 

The proposal would generally expand the current “third-party recordkeeper” procedures 

to apply to all summonses issued to persons other than the taxpayer. Thus, for example, the 

taxpayer whose liability is being investigated would receive notice of the summons and would be 

entitled to bring an action in the appropriateU.S. District Court to quash the summons, although 

(as under the current third-party recordkeeperprovision) the statute of limitations on assessment 

and collection would be stayed pending the litigation, and certain kinds of summonses specified 

under current law would not be subject to these requirements. The provision would be effective 

for summonses served after the date of enactment. 

72 
REQUIRE DISCLOSURE OF CRITERIA FOR EXAMINATION SELECTION 

Current Law 

The IRSexamines Federal tax returns to determine the correct liability of taxpayers. 

Returns are selected for examination in a number of ways, such as through “matching” of tax 

returns and information returns or through the use of a computerized classification system (the 

discriminant function or “DIP system). 

Reasons for Change 

Taxpayers should better understand the reasons why they may be selected for 

examination. 

Proposal 

The proposal would require the IRS to add to Publication 1 (“Your Rights as a 

Taxpayer”) a statement setting forth, in simple and nontechnical terms, the criteria and 

procedures for selecting taxpayers for examination The statement would not include any 

information the disclosure of which would be detrimentalto law enforcement, but it must specify 

the general procedures used by the IRS, including whether taxpayers are selected for examination 

on the basis of information in the media or kom informants. Drafts of the statement would be 

required to be submitted to the House Committee on Ways and Means, the Senate Committee on 

Finance, anddhe Joint Committee on Taxation prior to publication. The addition to Publication 1 

would have to be made not later than 180 days after the date of enactment. 

73 
PROHIBIT THREAT OF AUDIT TO COERCE 

TIP REPORTING ALTERNATNE COMMITMENT AGREEMENTS 

Current Law 

Restaurants may enter into Tip Reporting Alternative Commitment (TRAC) agreements. 

A restaurant entering into a TRAC agreement is obligated to educate its employees on their tip 

reporting obligations, to institute formal tip reporting procedures, to fulfill all filing and 

recordkeeping requirements, and to pay and deposit taxes. In retum, the IRS agrees to base the 

restaurant's liability for employment taxes solely on reported tips and any unreported tips 

discovered during an IRS audit of anemployee. 

Reasons for Change 

It is inappropriate for IRS agents or employees to use the threat of an audit to induce 

participation in a voluntary program such as a TRAC agreement. 

Prooosal 

The proposal would require the IRS to instruct its employees that they may not threaten 

to audit any taxpayer in an attempt to coerce the taxpayer to enter into a TRAC agreement. The 

proposal would be effective on the date of enactment 

14 
PERMIT SERVICE OF SUMMONSES BY MAIL 

Current Law 

Section 7603 requires that a-summonsshall be served “by an attested copy delivered in 

hand to the person to whom it is directed or left at his last and usual place of abode.” By 

contrast, if a third-party recordkeeper summons is served pursuant to section 7609, the taxpayer 

may be given notice of the summons via certified or registered mail. Moreover, Rule 4 of the 

Federal Rules of Civil Procedure permits service of process by mail even in summons 

enforcement proceedings. 

Reasons for Chanee 

Most IRS summonses are used to obtain financial data from large corporate financial 

institutions such as banks and brokers Under current law, IRS officialsmust appear personally 

and serve the summons on an officer of the corporation designated to receive service of process. 

This intrusion can prove to be unnecessarily disruptive to the financial institution. Moreover, 

since notice of the summons can be given to the taxpayer by mail, it makes administrative sense 

to permit service of the summons itself by mail as well. 

Prooosal 

This proposal would permit the IRS to serire summonses by mail, in addition to the 

present law requirement that all summonses be personally served The proposal would thus 

bring the service of the actual summons into line with the notice requirements regarding third 

party recordkeeper summonses and the service of process requirements of the Federal Rules of 

Civil Procedure. The provision would be effective for summonses served after the date of 

enactment. 

75 
ALLOW SUITSFOR DAMAGES IPTHE 

IRS VIOLATES CERTAIN BANKRUPTCY PROCEDURES 

Current Law 

No remedy exists under the Intemal Revenue Code if the IRS wilfully violates the 

automatic stay provision of the Bankruptcy Code. Section 362(h) of the Bankruptcy Code 

permits individuals to obtain attomey’s fees and damages fiom the IRS for such violations, but it 

offers no such remedies for corporations, partnerships, or other entities. Thus, courts have to 

devise creative remedies under their equitable and contempt powers in order to compensate some 

debtors and bankruptcy estates. 

Present law is similarly unclear as to whether an IRS violation of the discharge provisions 

ofthe Bankruptcy Code creates a cause of action for damages under section 7433 of the Intemal 

Revenue Code. Furthermore, the Bankruptcy Code provides no statutory remedy for damages 

and attomey fees for violation ofthe discharge order. As a result, courts have relied on their 

contempt powers to compensate debtors for such violations. 

Reasons for ChangeThe IRS should be held responsible when it willfully violates the automatic stay or 

discharge provisions of the Bankruptcy Code. The law should be clarified to permit taxpayers 

who are injured by such IRS actions to recover their damages and attomey’s fees and costs. 

Prooosal 

This proposal would amend section 7433 of the Internal Revenue Code to provide for 

payment of damages, plus attomey’s fees and costs, for willful violations by officers or 

employees of the IRS of either the automatic stay under section 362 of the Bankruptcy Code or 

the discharge injunction under section 524 of the Bankrvptcy Code. Jurisdiction over such cases 

would lie with the Bankruptcy Court, but the claimant would be required to exhaust 

administrative remedies at the IRS to the same extent as for other claims under section 7433. 

The provision would be effective with respect to violations occurring after the date of enactment. 

76 
INCREASE TAX COURT’S ‘‘SMALL CASE” LIMIT 

Current Law 

Taxpayers may choose to contest many taxdisputes in the Tax Court. Under section 

7463 of the Internal Revenue Code, special “small case procedures” apply to certain disputes 

involving $10,000 or less, if the taxpayer chooses to utilize these procedures (and the Tax Court 

concurs). 

Reasons for Chanpe 

The small case procedures, which are simpler and less expensive than ordinary litigation, 

should be accessible to taxpayers in more cases. 

Proposal 

The proposal would increase the cap for small case treatment in the Tax Court from 

$10,000 to $25,000. The proposal would apply to proceedings commenced after the date of 

enactment 
PROVIDE EQUITABLE TOLLING 

Current Law 

Section 6511 sets forth the limitations periods for claiming refunds of Federal taxes. The 

general rule is that a rehd claim is timely if it is made within three years of the date of filing the 

return or two years of the date ofpayment, whichever is later. A refund claim that is not filed 

within certain specified time periods is rejected as untimely. The Supreme Court recently held in 

United States v. Brockamp, 117 S.Ct. 849 (1997), that these limitations periods cannot be 

extended, or “tolled,” for equitable reasons. 

Reasons for Chan-e 

The law at times may reach harsh results for some taxpayers, particularly when they fail 

to seek a refund because a well-documented disability or similar compelling circumstance 

prevents them from doing so. 

Proposal 

The proposal would permit “eq~tabletolling” ofthe limitation period on claims for 

refund for the period of time during which an individual taxpayer is under a sufficient medically 

determined physical or mental disability as to be unable to manage his or her financial affairs. 

Tolling would not apply during periods in which the taxpayer’s spouse or another person is 

authorized to act on the taxpayer’s behalf in financial matters. The proposal would apply with 

respect to taxable years ending after the date of enactment. 

78 
REQUZRE NOTICE OF DEFICIENCY 

TO SPECIFY TAX COURT FILING DEADLINES 

Current Law 

Under section 6213, taxpayers must file a petition with the Tax Court within 90 days after 

the notice of deficiency is mailed (150 days if the person is outside the United States). If the 

petition is not filed within that time period, the Tax Court does not have jurisdiction to consider 

the petition. Because timely filing in Tax Court is ajurisdictional prerequisit, the IRS cannot 

extend the filing period, nor can the Tax Court hear the case of a taxpayer who relies on 

erraneous information from the IRS and files too late. 

Reasons for Chanoe 

Taxpayers should receive better assistance from the IRS in determining the time period 

within which they must file a petition in Tax Court. Taxpayers should also be able to rely on the 

computation of the appropriate filing period by the IRS. 

Proposal 

The proposal would require the IRS to include on each notice of deficiency the date 

determined by the IRS as the last day on which the taxpayer may file a petition with the Tax 

Court. The last day on which a taxpayer who is outside the United States may file a petition with 

the Tax Court would be shown as an alternative. Any petition filed with the Tax Court by the 

later of the statutory date or the date shown on the deficiency notice would be timely. The 

proposal would apply to notices mailed after December 31,1998. 

79 
ALLOW ACTIONS FOR REFUND WITH RESPECT TO CERTAIN ESTATES 

WCH HAVE ELECTED THE INSTALLMENT METHOD OF PAYMENT 

Current Law 

Under section 7422, the US. Court of Federal Claims and the U.S. district courts have 

jurisdiction over suits for the refund oftaxes, as long as full payment ofthe assessed tax liability 

has been made. See Flora v. United States, 357 U.S. 63 (1958), ad on rehk, 362 U.S. 145 

(1960). However, under section 6166 of the Code, if certain conditions are met, the executor of 

a decedent's estate may elect to pay the estate tax atnibutable to certain closely-held businesses 

over a 14-year period Courts have held that U.S. district courts and the US. Court of Federal 

Claims do not have jurisdiction over claims for refunds by taxpayers that defer estate tax 

payments pursuant to section 6166 unless the entire estate tax liability has been paid (k,timely 

payment of the installments due prior to the bringing of an action is not sufficient to invoke 

jurisdiction). See. e.%, Rocovich v. United States, 933 F.2d 991 (Fed. Cir. 1991); Abruzzo v. 

U- 24 Ct. C1.668 (1991). 

Reasons for Change 

The refund jurisdiction of the U.S. Court ofFederal Claims and the U.S. district courts 

should apply without regard to whether the taxpayer has elected, and the Secretary has accepted, 

the payment of the estate tax in installments. 

Proposa1 

The proposal would @ant to the U.S. Court of Federal Claims and the U.S. district courts 

jurisdiction to determine the correct amount of estate tax liability (or for any refund) in actions 

brought by taxpayers that defer estate tax payments under section 6166, so long as certain 

conditions are met. In order to qualify, the estate must have made an election pursuant to section 

6166 and fully paid each installment of principal and/or interest due before the date the suit is 

filed (as long as one or more installments are still remaining), and no portion ofthe payments 

due may have been accelerated. The proposal would also provide that, once a finaljudgment has 

been entered by a district court or the US. Court of Federal Claims, the IRS would not be 

permitted to collect any amount disallowed by the court, and any amounts paid by the taxpayer in 

excess of the amount found to be currently due and payable would be refunded to the taxpayer. 

Finally, the proposal would provide that the two-year statute of limitationsfor filing a refund 

action would be suspended during the pendency of any action brought by a taxpayer pursuant to 

section 7479 for a declaratoryjudgment as to an estate's eligibility for section 6166 installment 

payment treatment. The proposal would be effective for claims for refunds filed after the date of 

enactment. 

80 
EXPAND AUTHORITY TO AWARD COSTS AND FEES 

Current Law 

Any person who substantially prevails in any action by or against the United States in 

connection with the determination, collection, or refund of any tax, interest, or penalty may be 

awarded reasonable administrativecosts incurred before the IRS and reasonable litigation costs 

incurred in connection with any court proceeding. In general, only an individual whose net 

worth does not exceed $2 million is eligible for an award, and only a Corporation or partnership 

whose net worth does not exceed $7 million is eligible for an award. However, awards of 

reasonable litigation costs and reasonable administrative costs cannot exceed amounts actually 

paid or incurred, and cannot exceed a statutorily limited rate ($1 10 per hour, indexed for 

inflation) 

Reasons for Change 

The pro bono representation of taxpayers should be encouraged and the value of the legal 

services rendered in these situations should be recognized. Where the IRS takes positions that are 

not substantiallyjustified, it should not be relieved of its obligation to bear reasonable 

administrative and litigation costs becauscrepresentationwas provided to the taxpayer on a pro 

bono basis. 

Proposal 

The proposal would permit the award of attomey's fees (in amounts up to the statutory 

limit) to specified persons who represent a prevailing taxpayer for no more than a nominal fee. 

This would encoilrage specialists to take pro bono cases and thereby ensure that low-income 

taxpayers are able to obtain necessary assistance. The proposal would be effective with respect 

to costs incurred and services performed after the date of enactment 

81 
EXPAND AUTHORITY 

TO ISSUE TAXPAYER ASSISTANCE ORDERS 

Current Law 

Under section 7811 of the InteInal Revenue Code, taxpayers can request that the 

Taxpayer Advocate issue a taxpayer assistance order (TAO) if they are suffering or about to 

suffer a significant hardship as a result ofthe manner in which the intemal revenue laws are 

being administered. A TAO may require the IRS to release property of the taxpayer that has 

been levied upon, or to cease any action, take any action as permitted by law, or refrain &om 

taking any action with respect to the taxpayer. 

Reasons for Chanoe 

The Taxpayer Advocate program is an effective mechanism for resolving taxpayer 

complaints. Last year, nearly 300,000 cases were brought to the attention of Taxpayer Advocate 

offices around the country, and cases were resolved in an average of 38 days. Strengthening the 

Taxpayer Advocate will allow the Taxpayer Advocate to provide even greater assistance to 

taxpayers. 

Prooosal 

The proposal would provide that in determining whether to issue a TAO, the Taxpayer 

Advocate will be authorized to consider, among other factors, the following: unreasonable 

delays in resolving the taxpayer's accourit problems; immediate threats of substantial adverse 

action (such as the seizure of a residence to pay overdue taxes); the likelihood of irreparable 

harm if relief is not granted; whether the taxpayer will have to pay significant professional fees if 

relief is not granted; and the possibility of long-term adverse impact on the taxpayer The 

proposal would be effective on the date of enactment. 

82 
PROVIDE NE,W REMEDY FOR THIRD PARTIES 

WHO CLAIM THAT THE IRS HAS FILED AN ERRONEOUS LIEN 

Current Law 

Prior to 1995, the provisions governing jurisdiction over refund suits had generally been 

interpreted to apply only if an action was brought by the taxpayer against whom tax was 

assessed. Remedies for third parties from whom tax was collected (rather than assessed) were 

found in other provisions of the Internal Revenue Code. The Supreme Court held in Williams v. 

United States, 115 S.Ct. 1611 (1995), however, that a third party who paid another person's tax 

under protest to remove a lien on the third party's property could bring a refund suit, because she 

had no other adequate administrative or judicial remedy. In Williams, the IRS had filed a 

nominee lien against property that was owned by the taxpayer's former spouse and that was 

under a contract for sale In order to complete the sale, the former spouse paid the amount of the 

lien under protest, and then sued in district court to recover the amount paid The Supreme Court 

held that parties who are forced to pay another's tax under duress could bring a refund suit, 

because no other judicial remedy was adequate 

Reasons for Chanoe 

The Williams Court left many important questions unresolved, such as: the class of third 

parties who have standing; what administrative procedure is required before litigation; the 

applicable statutes of limitations; the IRS's authority to pay interest on such a refund; and how to 

prevent expiration of the collection period on the taxpayer while the third party from whom the 

tax was collected challenges the IRS. These questions should be resolved statutorily rather than 

through litigation. 

Proposal 

The proposal would create an administrative procedure similar to the wrongful levy 

remedy for third parties in section 7426. Under this procedure, a record owner of property 

against which a Federal tax lien had been filed could obtain a certificate of discharge of property 

from the lien as a matter of right. The third party would be required to apply to the Secretary of 

the Treasury for such a certificate and either to deposit cash or to fumish a bond sufficient to 

protect the lien interest of the United States. Although the Secretary would determine the 

amount necessary to protect the Government's lien interest, if this procedure was fallowed the 

Secretary would have no discretion to refuse to issue a certificate of discharge, thus curing the 

defect in this remedy that the Supreme Court found in Williams.. A certificate of discharge of 

property from a lien issued pursuant to the procedure would enable the record owner to sell the 

property free and clear of the Federal tax lien in all circumstances. The proposal also would 

authorize the refund of all or part of the amount deposited, plus interest at the same rate that 

wouild be made on an overpayment of tax by the taxpayer, or the release of all or part of the 

83 
bond, if the Secietary otherwise satisfies the tax liability 01determines that the United States 

does not have a lien interest or has a lesser lien interest than the amount initially determined. 

The proposal would also establish a judicial cause of action for third parties challenging a 

lien that is similar to the wrongful levy xemedy in section 7426 The period withinwhich such 

an action must be commenced would be a short period (120 days) to ensure an early resolution of 

the parties’ interests. The statute of limitations on collecting from the taxpayer would be stayed 

while a third party challenged a lien in court under these procedures. Upon conclusion of the 

litigation, the IRS would be authorized to apply the deposit or bond to the assessed liability and 

to rehd to the third party any amount in excess of the liability, plus interest, or to release the 

bond. Actions for quiet title under 28 U.S.C. cj 2410 would still be available to persons who did 

not seek the expedited review permitted under the new statutory procedure 

The proposal would be effective on the date of enactment 

84 
ALLOW DAMAGE SUITS BY 

PERSONS OTHER THAN THE TAXPAYER 

Current Law 

Section 7433 of the Internal Revenue Code provides a right to taxpayers to sue for 

damages if, in connection with any collection of Federal tax, any officer or employee of the IRS 

recklessly or intentionally disregards any provision of the Internal Revenue Code or any 

regulation thereunder. Recoverable damages are the lesser of actual, direct economic damages 

sustained as a proximate result of the reckless or intentional act, plus attomeys' fees, or $1 

million. Actions under tbis provision may only be brought by an injured taxpayer, however, and 

not by an injured third party. 

Under section 7426(a), by contrasf a person other than the taxpayer may bring an action 

in district court for the return of property that has been wrongfully levied upon. 

Reasons for Chan-e 

Persons other than the taxpayer who have been harmed by reckless or intentionally 

wrongfid actions by IRS officers or employees should have the same remedies as taxpayers who 

are harmed by such actions. The remedies available to such third parties should not be limited to 

the wrongful levy situation. 

Proposal 

The proposal would provide persons other than the taxpayer &omwhom collection is 

sought a right to sue for damages under sectian 7433. Thus if, in connection with any collection 

of Federal tax, any officer or employee of the IRS recNessly or intentionally disregards any 

provision of the Code or any regulations thereunder, and a person other than the taxpayer is 

injured, that person could bring an action pursuant to section 7433. The current law limitations 

on awards for damages would apply to third party plaintiffs as well. The proposal would be 

effective with respect to collection actions taken after the date of enactment. 

85 
SUSPEND COLLECTION IN CERTAIN JOINT "xry CASES 

Current Law 

When one spouse files a petition in the Tax Court concerning a joint retum, there are no 

provisions in the Intemal Revenue Code or the re,dations addressing administrative collection 

action against a nonpetitioning spouse during the pendency of the Tax Court. The IRS's policy 

is generally to forebear from administrative collection where there is reasonable doubt that the 

assessment is correct, provided that adjustment of the claim is within the control ofthe IRS and 

the interests of the Government will not be jeopardized. There are some circumstanceswhen 

collection action may be appropriate, however, such as when the petitioning spouse is seeking 

relief solely as an innocent spouse, or it is anticipated that the nonpetitioning spouse may file a 

bankruptcy petition, or when the majority ofthe assets are held in the name ofthe nonpetitioning 

spouse, or there is reason to believe that jeopardy exists with respect to collection from the 

nonpetitioning spouse. 

Reasons for Chanve 

A nonpetitioning spouse should generally receive the same protection against IRS 

collection action as the spouse who has filed a petition in Tax Court contesting a proposed 

deficiency. 

Pronosal 

When a married couple's joint return is the subject of a laxCourt proceeding, this 

proposal would require the IRS to withhold collection by levy against a nonpetitioning spouse 

during the pendency of a Tax Court proceeding involving the other spouse. This would treat the 

nonpetitioning spouse the same as the petitioning spouse in most situations. Certain exceptions 

would be provided, including in jeopardy situations, when the taxpayer waives this protection

(k,agrees to the collection action), or for some other, !.kited but automatic kinds of collection 

activity, such as automatic refund offset, filiig of protective notices of Federal tax lien, or in 

certain other circumstances. The statute of limitations on assessment and collection would be 

stayed for the period during which collection is barred. If there is a final decision that reduces 

the proposed assessment against the petitioning spouse, the assessment against the nonpetitioning 

spouse would likewise be reduced. The proposal would not affect the IRS's ability to collect 

other liabilities or assessments that are not the subject of the Tax Court proceeding. The 

proposal would be effective for taxes assessed with respect to taxable years beginning after 

December 31,1998. 

86 
REQUIRE EXPLANATION OF JOINT AND SEVERAL LIABILITY 

Current Law 

In general, spouses who file a joint tax return are jointly and severally liable for the tax 

due. Thus each is fully responsible for the accuracy of the return and the full amount of the 

liability, even if only one spouse eamed the wages or income which is shown on the return. 

Spouses who wish to avoid joint and several liability may file as a married person filing 

separately. Special rules apply in the case of innocent spouses pursuant to section 6013(e) 

Reasons for Chanre 

Married taxpayers need to better understand the legal implications of signing a joint 

retum. The IRS should provide sufficient information concerningjoint and several liability that 

such taxpayers fully understand their potential liability. 

Proposal 

The proposal would require that the IRS establish procedures to alert married taxpayers 

clearly of their joint and several liability on appropriate tax publications and instructions. The 

proposal would require that such procedures be established no later than 180 days after the date 

of enaciment. 

87 
RELIEVE INNOCENT SPOUSE 

OF LIABILITY IN CERTAIN CASES 

Current Law 

Spouses who file a joint tax return are each Nly responsible for the accuracy of the 

return and for the fulltaxliability, even if only one spouse earned the wages or income shown on 

the return. This is “joint and several” liability. A spouse who wishes to avoid joint liability may 

file as a “married person fhg separately.” Relief from liability for tax, interest, and penalties is 

available for “innocent spouses” in certain limited circumstances. To qualify for such relief, the 

innocent spouse must establish (1) that a joint retum was made; (2) that an understatement of 

tax, which exceeds the greater of $500 or a specified percentage of the innocent spouse’s adjusted 

gross income for the preadjustment (most recent) year, is attributable to a “grossly erroneous 

item” of the other spouse (defined as items of gross income that are omitted from reported 

income and claims of deductions, credits, or basis in an amount for which there is no basis in fact 

of law); (3) that in signing the return, the innocent spouse did not know, and had no reason to 

know, that there was an understatement of tax; and (4)that taking into account all the facts and 

circumstances, it is inequitable to hold the innocent spouse liable for the deficiency in tax. The 

specified percentage of adjusted gross income is 10 percent if adjusted gross income is $20,000 

or less. Otherwise, the specified percentage is 25 percent. 

The proper forum for contesting a denial by the Secretary of the Treasury of innocent 

spouse relief is determined by whether an underpayment is asserted or the taxpayer is seeking a 

refund of overpaid taxes. Accordingly, the Tax Court may not have jurisdiction to review all 

denials of innocent spouse relief. The IRS currently does not provide a form to assist taxpayers 

in applying for innocent spouse relief. 

Reasons for Chanee 

The innocent spouse provisions of present law are too narrowly liited. Furthermore, all 

taxpayers should have access to the Tax Court in resolving disputes concerning their status as an 

innocent spouse. Finally, taxpayers need to be better informed of their right to apply for innocent 

spouse relief in appropriate cases, and the IRS is the best source of that information. 

Proaosal 

The proposal generally would make innocent spouse status easier to obtain. It would first 

eliminate all of the dollar amount thresholds for understatements of tax, and make the rules 

applicable in community property states and common law states parallel. 

The proposal also would specifically provide the Tax Court with jurisdiction to review 

any denial (or failure to rule) by the Secretary regarding an application for innocent spouse relief. 

Under this proposal, the taxpayer must file a petition for review with the Tax Court during the 

88 
90-day period that begins on the earlier of (1) 6 months after the date the taxpayer filed his or her 

claim for innacent spouse relief with the Secretary, or (2) the date a notice denying innocent 

spouse relief was mailed by the Secretary The TaxCourt would be authorized to order refunds 

as appropriate where it determines the spouse qualifies for relief and an overpayment exists as a 

result of the innocent spouse qualifying for such relief. Except for termination and jeopardy 

assessments (sections 6851 and 6861), the Secretary would not be allowed to levy or proceed in 

court to collect any tax from a taxpayer claiming innocent spouse statLls with regard to such tax 

until the expiration of the 90-day period in which such taxpayer may petition the Tax Court or, if 

the Tax Court considers such petition, before the decision of the TaxCourt has become final. 

The statute of limitations on collections would be stayed in such situations with respect to the 

spouse claiming innocent spouse status. 

The proposal would also require the Secretary to dewlap a separate form with 

instructions for taxpayers to use in applying for innocent spouse relief. The form must be made 

available within 180 days from the date of enactment. 

The proposal would be effective for understatements with respect to taxable years 

beginning after the date of enactment. With respect to overpayments, effective on or after the 

date of enactment an innocent spouse seeking relief under this provision would be required to 

claim innocent spouse status with regard to any assessment not later than two years after the date 

of such assessment. 

89 
ALLOW “GLOBAL” INTEREST NETTING OF UNDER- AND OVER-PAYMENTS 

Current Law 

Under section 6621, interest on underpayments differs kom interest on overpayments by 

as much as 4.5 percent. The IRS ameliorates the effect ofthis interest rate differential in two 

situations.. If a taxpayer previously paid undetpayment interest and is now due a refund for the 

same tax period, the excess interest is refunded pursuant to Rev. Proc. 94-60. Further, ifthe IRS 

credits an overpayment against any other outstanding taxliability pursuant to section 6402(a) and 

Treas. Reg. $301.6402-1, underpayment interest is not charged to the extent of the credit, 

pursuant to section 6601(f),. There is, however, no authority to net in a third situation: netting an 

overpayment, or interest thereon, against a prior deficiency of tax or interest that has already 

been paid in full by the taxpayer, or conversely netting an underpayment (of tax or interest) 

against a prior refurid (of tax or interest) that has already been paid by the IRS. See Northem 

States Power Co. v. United States, 73 F.3d 764,765 (8th Cir”),cert. denied, 117 S. Ct. 168 

(1996). This third situation is refened to as “global” netting. 

Reasons for Change 

Treasury’s study of interest netting issues concluded that the IRS has not performed 

“global” netting for two reasons. First, there is no clear authority to credit an overpayment 

against any tax debt other than one that is still outstanding when the credit arises, nor to refund 

excess underpayment interest in global situations. Second, very complex interest netting 

computations across taxperiods are done by hand, and they cannot be automated within the 

IRS’s current systems capabilities. There is no policy reason, however, for netting interest only 

in some situations but not in others. 

Proposal 

Global interest netting for income taxes would be implemented by adding a new interest 

rate to section 6621 When the taxpayer reasonably identifies and establishes an appropriate 

situation for such netting -- an overlapping period of mutual indebtedness with respect to tax 

periods that are not barred by the expiration ofthe statute of limitations -- interest would be 

equalized (k,the net interest rate would be zero) to the extent and for the time of the 

overlapping amount. The proposal would apply prospectively to periods of overlapping mutual 

indebtedness that occur after the date of enactment. 

90 
FACILITATE ARCHIVING OF IRS RECORDS 

Current Law 

The IRS, like all other Federal agencies, must create, maintain, and preserve agency 

records, and must transfer significant and historical records to the National,Archives and Records 

Administration (NARA) for retention or disposal. NARA has general authority to inspect 

records for the purpose of making recommendations for the improvement of records management 

practices. However, tax returns and return information can only be disclosed under the authority 

provided in section 6103 of the Internal Revenue Code. There is no exception to section 6103 

that would authorize the disclosure of confidential return information to NARA. See American 

Friends Service Committee v. Webster, 720 F.2d 29 @.C. Cir 1983); Tax Analysts v. Intemal 

Revenue Service, No. 97-0260 0.D.C. August 21,1997). Unauthorized disclosure is a felony 

punishable by a fine not exceeding $5,000 or imprisonment of not more than five years, or both, 

and a taxpayer whose records are disclosed without authorization may also bring an action for 

civil damages. 

Reasons for Chanw 

It is appropriate to permit Iimited disclosure of retums and retum information to NARA 

for purposes of scheduling records for destruction or retention, while at the same time preserving 

the confidentiality of the taxpayer information in those documents. 

Proposal 

The proposal would provide an exception to the disclosure rules to authorize the IRS to 

disclose tax returns and return information to officers or employees of NARA, upon written 

request from the Archivist, for purposes of the appraisal of such records for destruction ox 

retention in the National Archives. The present-law prohibitions on, and penalties for, 

unauthorized redisclosure of tax information would apply to NARA. The proposal would be 

effective for requests made by the Archivist after the date of enactment. 

91 
CLARIFY AUTHORITYfroPRESCRIBE 

MANNER OF MAKWG ELECTIONS 

Current Law 

Except as otherwise provided by statute, section 7805(d) requires elections under the 

Intemal Revenue Code to be made in such manner as the Secretary of the Treaswy “shall by 

regulations or forms prescribe.” 

Reasons for Change 

The question has arisen whether the Secretary can prescribe the manner of required 

elections other than by regulations or forms, for instance in revenue rulings or revenue 

procedures.. Any confusion over the type of guidance in which the Secretary may prescribe the 

manner of making any election should be eliminated. 

Proposal 

The proposal would clarify that, except as otherwise provided, the Secretary may 

prescribe the manner of making of‘any election by any reasonable means. The proposal would 

be effective as of the date of enactment. No inference regarding the proper interpretation of 

section 7805(d) under current law is intended by the proposal. 

92 
GRANT IRSBROAD AUTHORITY TO ENTER INTO 

COOPERATIVE AGREEMENTS WITH STATE TAXING AGENCIES 

Current 

The IRS is generally not authorized to provide services to nan-Federal agencies even if 

the cost is reimbursed. Taxpayers currently must file returns with both their State taxing agency 

and the RS, and sequently must resolve issues with the agencies at different times. 

Reasons for Change 

If appropriate statutory authority were enacted, taxpayers could file only one return for 

both State and Federal taxes. Then, pursuant to a cooperative agreement between the IRS and 

the State, the information could be processed by one tax administrator and shared between the 

two. This would substantially simplify filing requirements and reduce taxpayer burden. 

Proposa1 

The proposal would permit the IRS to enter agreements with the States to provide for 

joint filing and processing of returns, jointcollection of taxes (other than Federal income taxes), 

and such other provisions as may enhancejoint tax administration. It would further amend 

sections 6103 and 743 1 of the Intemal Revenue Code (relating to confidentiality of tax 

information) to permit sharing of common tax data; it would contain a number of statutory 

limitations on the effect of joint agreements; and it would include a thorough list of conforming 

amendments. The proposal would be effective on the date of enactment 

93 
PROVIL)E CLINICS FOR LOW-INCOME TAXPAYERS 

Current Law 

There are no provisions in present law authorizing legal clinics that assist low-income 

taxpayers. 

Reasons for Chanoe 

Providing tax services to low-income individuals through accredited clinics that offer 

such services for a nominal fee would improve compliance with the Federal tax laws and should 

be encouraged.. 

ProDosa1 

The proposal would authorize the Legal Services Corporation to make up to $3,000,000 

in grants for the development, expansion, or continuation of certain low-income taxpayer clinics. 

Eligible clinics are those that charge no more than a nominal fee to represent low-income 

taxpayers in controversies with the IRS. The term “clinic” includes (1) a clinical program at an 

accredited law school in which students represent low-income taxpayers, and (2) an organization 

exempt from tax provides referral to qualified representatives. A clinic is treated as representing 

low,.incometaxpayers if at least 90 percent of the taxpayers represented by the clinic have 

incomes that do not exceed 250 percent ofthe poverty level and have amounts in controversy of 

$25,000 or less. 

No taxpayer cliic could receive more than $100,000 per year. The clinic must provide 

matching funds on a dollar-for-dollar basis. Matching funds could include the allocable portion 

of both the salary (including fiinge benefits) of individuals performing services for the clinic and 

clinic equipment costs, but not general institutional overhead. The following criteria would be 

considered in making awards: (1) the number of taxpayers served by the clinic; (2) the existence 

of other taxpayer clinics serving the same population; (3) the quality of the program; and (4) 

altemative funding sources available to the clinic. 

The proposal would be effective on the date of enactment 

94 
PROVIDE PROCEDURES FOR 

RELEASE OF FIELD SERVICE ADVICE 

Current Law 

Returns and return information are generally confidential and may be disclosed only as 

specifically authorized in the Intemal Revenue Code. “Return information’’ is broadly defined in 

section 6103@)(2)to include, inter alia, “any other data, received by, recorded by, prepared by, 

furnished to, or collected by the Secretary with respect to a retum or with respect to the 

determination of‘ a tax liability Unauthorized disclosure is a felony punishable by a fine not 

exceeding $5,000 or imprisonmentof not more than five years, or both, and a taxpayer whose 

records are disclosed without authorization may also bring a civil action for damages. 

Certain kinds of retum information (“written determinations,” k,rulings, determination 

letters, technical advice memoranda, and background Ne documents relating to such written 

determinations)are subject to disclosure under section 6110 of the Code.. However, the taxpayer 

who is the subject of the written determinationhas the right to participate in the process of 

redacting certain specific taxpayer information, and procedures governing this redaction process 

are set forth in section 6110. 

In Tax Analvsts v. Intemal Revenue Service, 117 F.3d 607 @.C. Cir. July 8, 1997),the 

court generally held that portions of IRS Field Service Advice Memoranda (“FSAs”) are not 

return information and are to be disclosed pursuant to a Freedom of Information Act request. 

However, the court did not specify what standards should govem the process of redacting the 

FSAs when they are to be released 

Reasons for Chanw 

Taxpayers who are the subject of FSAshave a significantinterest in protecting their 

confidential tax information. They should have the right to participate in the redaction of their 

confidential information before the FSAs are released. Without taxpayer participation in the 

redaction process, taxpayer rights to confidentiality of their tax information could be jeopardized. 

Moreover, without legislation,there is a risk that taxpayers in jurisdictions other than the District 

of Columbia whose FSAs are released pursuant to the court’s order might bring suit for damages 

resulting &om the unauthorized disclosure of such information. 

Prooosal 

The proposal would clarify that FSAs are retum information in their entirety, thus 

prohibiting their unauthorized disclosure. Also, however, it would provide a structured 

mechanism for public inspection of FSAs, subject to a redaction process similar to that under 

present section 6110, in which the taxpayer whose liability is the subject of the FSA would 

participate. The proposal would be effective on the date of enactment, but it would include a 

95 
schedule of time over which the IRS would make the FSAs subject to the lawsuit available under 

the taxpayer participation and redaction procedure. 

96 
Revenue Offsets 

DEFER DEDTJCTION FOR INTEREST AND 

ORIGINAL, ISSUE DISCOUNT ON COWERTIBLE DEBT 

Current Law 

If a financial instrument qualifies as a debt instrument, the issuer of the instrument may 

deduct stated interest as it economically accrues. In addition, if the instrument is issued at a 

discount, the issuer may deduct original issue discount (“OID) as it economically accrues, even 

though the OID may not be paid until the instrument matures. The holder of a debt instrument 

includes stated interest under its regular method of accounting and O D as it economically 

accrues. 

In the case of a debt instrument that is convertible into stock of the issuer or a related 

-party,an issuer may deduct accrued interest and OID up until the time of the conversion, even if 

the accrued interest and OID is never paid because the instrument is converted. 

Reasons for Chanae 

In many cases, the issuance of convertible debt instrument is viewed by market 

participants as a de facto issuance of equity. Allowing issuers to deduct accrued interest and OID 

is inconsistent with this market view. 

Proposal 

The proposal would defer the deduction for accrued stated interest and OID on 

convertible debt until actual payment Conversion into the stock of the issuer or a related party 

(within the meaning of sections 267(b) and 707(b)) would not be .treated as a payment of accrued 

OID or interest. Payments in equity of the issuer or a related party, and payments in cash, the 

amount of which is determined by reference to the value of such equity, would also be 

disregarded for this purpose. For purposes of this proposal, convertible debt would include (i) 

debt exchangeable for the stock of the issuer or a related party, (ii) debt that provides for 

cash-settlement Conversion features, or (iii) debt issued with warrants (or similar instruments) as 

part of an investment unit in which the debt component may be used to satisfy the exercise price 

for the warrant. This proposal would not apply to any debt that would be convertible solely 

because a fixed payment of principal or interest is payable, at the election of the holder, in an 

amount of the issuer’s or related party’s equity that has a value equal to the amount of the fixed 

payment The proposal would not affect the treatment of holders. 

The proposal would be effective generally for convertible debt issued on or after the date 

of first cormbittee action 

97 
ELIMINATE DIVIDENDS-RECEIVED DEDUCTION 

FOR CERTAIN PREFERRED STOCK 

Current Law 

A corporate taxpayer is entitled to a deduction of 70 percent of the dividends it receives 

from a domestic corporation. The percentage deduction is generally increased to 80 percent if 

the taxpayer owns at least 20 percent (by vote and value) of the stock of the dividend-paying 

corporation, and to 100 percent for ‘‘qualifying dividends,” which generally are from members of 

the same aKiliated group as the taxpayer. 

The dividends-received deduction is disallowed if the taxpayer has held the stock for 45 

days or less during the 90-day period beginning on the date that is 45 days before the date on 

which such shqe becomes ex-dividend with respect to such dividend. In the case of certain 

preferred stock, the dividends-received deduction is disallowed if the taxpayer has held the stock 

for 90 days or less during the 180-day period beginning on the date which is 90 days before the 

date on which such share becomes ex-dividend with respect to such dividend. The holding 

period generally does not include any period during which the taxpayer has a right 01 obligation 

to sell the stock, or is otherwise protected from the risk of loss otherwise inherent in the 

ownership of an equity interest. When an insnurnent is treated as stock for tax purposes, but 

provides for payment of a fixed amount on a specified maturity date and affords holders the 

rights of creditors to enforce such payment, no dividends-received deduction is allowed for 

distributions on the instnunent. Rev. Rul. 94-28. 

The Taxpayer Relief Act of 1997 amended sections 351,354,355,356, and 1036 to treat 

“nonqualified preferred stock” as boot in corporate transactions, subject to certain exceptions.. 

Nonqualified preferred stock is defined in section 35l(g) as preferred stock that does not 

participate (through a conversion privilege or otherwise) in corporate growth to any significant 

extent, if‘(i) the holder has the right to require the issuer or a related person to redeem or 

purchase the stock, (ii) the issuer or a related person is required to redeem or purchase the stock, 

(iii) the issuer or a related person has the right to redeem or purchase the stock and, as of the 

issue date, it is more liely than not that such right will be exercised, or (iv) the dividend rate on 

the stock varies in whole or in part (directly or indirectly) with reference to interest rates, 

commodity prices, or similar indices, regardless of whether such varying rate is provided as an 

express term of the stock (as in the case of an adjustable rate stock) or as a practical result of 

other aspects of the stock (as in the case of auction rate stock). For this purpose, clauses (i), (ii), 

and (ii) apply if the right or obligation may be exercised with 20 years of the issue date and is 

not subject to a contingency which, as of the issue date, makes remote the likelihood of the 

redemption or purchase. 

98 
Reasons for Chan-e 

Taxpayers have taken advantage of the benefit of the dividends received deduction for 

payments on instruments that, while treated as stock for taxpurposes, economically perform as 

debt instruments and have debt-like characteristics (e.g., enhanced likelihood of recovery of 

principal or of maintaining a dividend over the term of the instrument, or both). 

Proposal 

Except in the case of “qualifying dividends”, the dividends-received deduction would be 

eliminated for dividends on nonqualified preferred stock (as defined in section 351(g)). 

No inference regarding the tax treatment of the above-described stock under current law 

is intended by this proposal. 

The proposal would apply to stock issued after the date of enactment 

99 
REPEAL PERCENTAGE DEPLETION FOR 

NON-FUEL MINEWS MINED ON FEDEJUL AND FORMERLY FEDERAL LANDS 

Current Law 

Taxpayers are allowed to deduct a reasonable allowance for depletion relating to certain 

hard mineral deposits. The depletion deduction for any taxable year is calculated under either the 

cost depletion method or the percentage depletion method, whichever results in the greater 

depletion allowance for the year. 

Under the cost depletion method, the taxpayer deducts that portion of the adjusted basis 

of the property that is equal to the ratio of the units sold from that property during the taxable 

year, to the estimated total units remaining at the beginning of that year. 

Under the percentage depletion method, a deduction is allowed in each taxable year for a 

statutory percentage of the taxpayer's gross income from the property. The percentage depletion 

deduction for these minerals may not exceed 50 percent of the net income from the property for 

the taxable year (computed without allowance for depletion). Percentage depletion is not limited 

to the taxpayer's basis in the property; thus, the aggregate amount of percentage depletion 

deductions claimed may exceed the amount expended by the taxpayer to acquire and develop the 

property. 

The 1872 xnining act has allowed investors to acquire mining rights on Federal lands at 

the cost of $5.00 per acre or less. 

Reasons for Change 

Tbe percentage depletion provisions under present law generally are viewed as an 

incentive for mineral production rather than as a normative rule for recovering the taxpayer's 

investment in the property. This incentive, however, is excessive with respect to minerals 

acquired under the 1872 mining act, in light of the minimal costs of acquiring these mining 

rights. In addition, the measurement of income in the affected industries will be improved by the 

repeal of these percentage depletion provisions. 

Proaosal 

The proposal would repeal percentage depletion provisions under present law for non-he1 

minerals mined on Federal lands where the mining rights were originally acquired under the 

1872 law, and on private lands acquired under the 1872 law. The proposal would be effective for 

taxable years beginning after the date of enactment. 

100 
REPEAL TAX-FmE CONVERSIONS OF LARGE C CORPORATIONS 

TO S CORPORATIONS 

Current Law 

C corporations generally are subject to a two-tier tax. A corporation can avoid this twotier tax by electing to be treated as an S corporation or by converting to a phership. 

Converting to a partnership is a taxable event that generally requires the corporation to recognize 

any built-in gain on its assets and requires the shareholders of the corporation to reco-~zeany 

built-in gain in their corporate stock. The conversion of a C corporation to an S corporation, 

however, generally is tax-free for both the Corporation and its shareholders, except that the S 

corporation must recognize the built-in gain on assets held at the time of conversion if the assets 

are sold within ten years under section 1374. 

A corporation generally can also avoid the two-tier tax if it can qualify as a regdated 

investment company @.IC) or a real estate investment tmst (REIT) (by deducting dividends paid 

to its shareholders) The conversion of a C Corporation ta a RIC or REIT, however, is treated as 

if the corporation had sold all of its assets at their fair market value and immediately liquidated, 

thereby requiring the corporation to recognize any built-in gain in its assets at the time of the 

conversion. Notice 88-19, 1988-1 C.B 486 The IRS, however, permits the corporation to avoid 

the immediate recognition of its built-in gain if the corporation elects to be subject to rules 

similar to section 1374. 

Reasons for Chanoe 

The tax treatment of the conversion of a C corporation to an S corporation generally 

should be consistent with the treatment of its conversion of a C corporation to a partnership. In 

particular, any appreciation in corporate assets that occurred during the time the corporation is a 

C corporation should be subject to the corporate-level tax. 

Proposal 

The proposal would repeal section 1374 for large corporations. A C-to-S corporation 

conversion (whether by a C corporation electing S corporation status or by a C corporation 

merging into an S corporation) would be treated as a liquidation of the C corporation followed by 

a contribution of the assets to an Scorporation by the recipient shareholders. Thus, the proposal 

would require immediate gain recognition by both the corporation (with respect to its appreciated 

assets) and its shareholders (with respect to their stock) upon the conversion to S corporation 

Status. 

For this purpose, a large corporation is one with a value of more than $5 million at the 

time of conv'ersion. The value of the corporation would be the fair market value of all the stock 

of the corporation on the date of conversion. 

101 
The proposal would be effective for subchapter S elections that are first effective for a 

taxable year beginning after January 1,1999. The proposal also would apply to acquisitions 

(e.g ,the merger ofa C corporation into an S corpoxation) after December 31, 1998. Thus,C 

corporations would continue to be permitted to elect S corporation status effective for taxable 

years beginning in 1998 or on January 1,1999 without incurring the taxon conversion. 

In addition, the Intemal Revenue Service would revise Notice 88-19 to conform to the 

proposed amendment to section 1374, with an effective date similar to the statutory proposal. As 

a result, the conversion of a large C corporation to a RIC or a REIT after the revisions would 

result in immediate recognition by the C corporation of the net built-in gain in its assets 

102 
REPLACE SALES SOURCE RULES WITH ACTIVITY-BASED RULE 

-Current Law 

The foreign tax credit generally reduces U.S. tax on foreign source income, but does not 

reduce U.S tax on US.source income. Where products are manufactured in the United States 

and sold abroad, Treasury regulations provide that 50 percent of such income generally is treated 

as earned in production activities, and sourced on the basis of the location of assets held or used 

to produce income which is derived fiam the export sales. The remaining 50 percent of the 

income is treated as earned in sales activities and sourced based on where title to the inventory 

transfers. Thus,if a U.S. manufacturer sells inventory abroad, half of the income generally is 

treated as derived fiom domestic sources, and half of the income generally is treated as deIived 

&om foreign sources. However, the taxpayer may use a mole favorable method if it can establish 

to the satisfaction of the IRS that mare than half of its economic activity occurred in a foreign 

country. Different rules apply to the export of natural resources 

Reasons for Change 

The existing 50hO rule provides a benefit for U.S. exporters that also operate in high-tax 

foreign countries. Thus, US.multinational exporters have a competitive advantage over U S. 

exporters that conduct all their business activities in the United States. Different categories of 

exporters should be treated equally. 

In addition, the United States has established an income tax treaty program that 

encompasses more than 50 countries during the 70 years since the 50150 nde of present law has 

been in place. These treaties protect export sales income from local taxation in the country 

where the goods are sold. Now that export sales income generally is not subject to foreign tax, it 

is not appropriate to maintain the existing allowance of foreign tax credits against that income. 

Proposal 

Under the proposal, if a US. manufacturer sells inventory abroad, the apportionment of 

its income between production activities and sales activities would be based on actual economic 

activity. The proposal would not change the taxrules that apply to the export of natural 

resources. 

The proposal would be effective for taxable years beginning after the date of enactment. 

103 
MODIFY RULES RELATING TO FOREIGN OIL AND GAS EXTRACTION INCOME 

Current Law 

The United States taxes US.persons on their worldwide income. A credit against U.S.. 

tax on foreign income is allowed for foreign income taxes paid by the US. person. In addition, a 

credit is allowed to a U.S. corporation for foreign taxes paid by certain foreign subsidiary 

corporations upon payment of an actual or deemed dividend by the subsidiary (the “deemed 

paid” or “indirect” foreign tax credit). 

To be a creditable income tax, a foreign levy must be the substantial equivalent of an 

income tax in the U.S.sense, regardless of the label the foreign government attaches to it,. Under 

regulations, a foreign levy is a tax if it is a compulsory payment under the authority of a foreign 

government to levy taxes and is not compensation for a specific economic benefit provided by 

the foreign country. Taxpayers that are subject to a foreign levy and that also receive (directly or 

indirectly) a specific economic benefit from the levying country are referred to as “dual capacity” 

taxpayers and may not claim a credit for that portion of the foreign levy paid as compensation for 

the specific economic benefit received. Under a regulatory safe-harbor test, if a country has a 

generally imposed income tax, the dual-capacity taxpayer may treat as a creditable tax the 

portion of the levy that application ofthe generally imposed income tax would yield (to the 

extent the levy otherwise constitutes an income tax or an “in lieu of” tax); the balance is treated 

as compensation for the specific economic benefit. Ifthere is no generally imposed income tax, 

the regulation treats as a creditable tax that portion of the payment that does not exceed the 

applicable US.tax rate applied to net income. A foreign tax is treated as “generally imposed” 

even if it applies only to persons who are not residents or nationals of that country. 

There is no separate section 904 foreign tax credit “basket” for oil and gas income. 

However, under section 907, the amount of creditable foreign taxes imposed on FOGEI is limited 

in any year to the applicable US.tax on that income. 

Reasons for Chan-e 

The purpose of the foreign tax credit is to avoid double taxation of income by both the 

United States and a foreignjurisdiction. When a payment to a foreign government is made as 

compensation for a specific economic benefit, there is no incidence of double taxation. Current 

law recognizes the distinction between creditable taxes and non-creditable payments for a 

specific economic benefit but fails to achieve the appropriate split between the two in a case 

where a foreign country imposes a levy on, for example, oil and gas income only, but has no 

generally imposed income tax. 
ProDosal 

The proposal would treat payments by a dual-capacity taxpayer to a foreign country that 

would otherwise quali~as income taxes or “in lieu of‘ taxes as taxes only if there is a “generally 

applicable income tax” in that country For this purpose, a generally applicable income tax is an 

income tax (or a series of income taxes) that applies to trade or business income from sources in 

that country, so long as the levy has substantial application both to non-dual-capacity taxpayers 

and to persons who are citizens or residents of that country. The proposal thus would replace 

that part of the regulatory safe harbor that treats a foreign levy as a taxup to the amount of the 

U.S tax where the foreign country has no generally applicable income tax. The proposal 

generally would retain the rule of present law where the foreign country does generally impose 

an income tax. In that case, credits would be allowed up to the level of taxation that would be 

imposed under that general tax, so long as the tax satisfiesthe statutory definition of a “generally 

applicable income tax.” 

The proposal also would convert the special foreign tax credit limitation rules of presentlaw section 907 into a new foreign tax credit basket withinsection 904 for foreign oil and gas 

income. 

The proposal would be effective for taxable years beginning after the date of enactment. 

The proposal would yield to US.treaty obligations that allow a credit for taxes paid or accrued 

on certain oil or gas income. 

105 
REPEAL LOWER OF COST OR MARKET INVENTORY ACCOUNTING METHOD 

Current Law 

Taxpayers required to maintain inventories are permitted to use a variety of methods to 

determine the cost oftheir ending inventories, including the last-in, first-out (“LIFO) method, 

the first-in, first-out (“FIFO”) method, and the retail method. Taxpayers not using a LIFO 

method may determine the carrying values of their inventories by applying the lower of cost or 

market (“LCM) method and by writing down the cost of goods that are unsalable at normal 

prices or unusable in the normal way because of damage, imperfection or other causes (the 

“subnormal goods” method). 

Reasons for Change 

The allowance of write-downs under the LCM and subnormal goods methods is an 

inappropriate exception from the realization principle and is essentially a one-way mark-tomarket method that understates taxable income. 

ProDosaI 

The proposal would repeal the LCM and subnormal goods methods. Appropriate washsale rules also would be included The proposal would be treated as a change in the method of 

accounting for inventories, and any resulting section 48 I(a) adjustment would be included in 

income ratably over a four-year period beginning with the year of change. These changes would 

not apply to taxpayers with average annual gross receipts over a three-year period of $5 million 

or less, with appropIiate aggregation rules. 

The proposal would be effective for taxable years beginning after the date of enactment 

106 
INCREASE PENUTIES FOR FAILURF:TO FILE 

CORRECT INFORMATION RETURNS 

Current Law 

Any person who fails to file required information returns in a timely manner or 

incorrectly Ieports such information is subject to penalties. The amount of the penalty is 

generally $50 for each retum with respect to which a penalty is incurred, not to exceed $250,000 

during any calendar year. If any failure or error is corrected within 30 days after the required 

filing date, the penalty imposed is $15 per return, not to exceed $75,000. Failures corrected more 

than 30 days after the required filing date but before August 1 are subject to a $30 per retum 

penalty, not to exceed $150,000 in any calendar year. 

Reasons for Chanee 

For taxpayers filing large volumes of information returns or reporting significant 

payments, the general penalty provisions may not be sufficient to encourage timely and accurate 

reporting. By basing the penalty amount on either the number of returns or amount to be 

reported, the proposal encourages taxpayers to assure both the accuracy and timeliness of 

information on each retum and in the aggregate. 

Proposal 

The proposal would increase the general penalty amount for any failure to the greater of 

$50 per return or 5 percent of the total amount required to be reported, subject to the overall 

dollar limitations. The increased penalty would not apply if the aggregate amount actually 

reported by the taxpayer on all returns filed for that calender year was at least 97 percent of the 

amount required to be reported. The proposal would be effective for retums the due date for 

which (without regard to extensions) is more than 90 days after the date of enactment of the 

proposal. 

107 
TIGHTEN THE SUBSTANTIAL UNDERSTATEMENT PENALTY 

FOR LARGE CORPORATIONS 

Current Law 

Currently, taxpayers may be penalized for erroneous, but non-negligent, return positions 

only if the taxpayer did not have “substantial authority” for the claimed position, the taxpayer did 

not disclose the position in a statement or return, and the amount of the understatement is 

“substantial.” (Special rules apply in the case of tax shelters.) “Substantial” is defined for this 

purpose as the greater of $5,000 ($10,000 for certain corporations) or 10 percent of the taxpayer’s 

total tax liability, which for large taxpayers can be a very sizeable amount. 

Reasons for Chanoe 

The current definition of “substantial” has led some large corporations to take very 

aggressive reporting positions for transactions with respect to which the potential tax liability 

does not exceed 10 percent of the company’s total tax bill. In effect, they can “play the audit 

lottery” without any downside risk of a penalty if they are caught, even if huge amounts of 

potential tax liability are at stake. 

ProDosal 

The proposal would treat a corporation’s deficiency of more than $1 0 million as 

substantial for purposes of the substantial understatement penalty, whether or not it exceeds 10 

percent of the taxpayer’s total tax liability This proposal should help to deter aggressive tax 

planrling by large corporate taxpayers that have corrected tax liabilities of $100 million or more 

The proposal would be effective for taxable years beginning after date of enactment. 

108 
REPEAL EXEMPTION FOR WITHHOLDING ON GAMBLING W"GS 

FROM BINGO AND KENO IN EXCESS OF $5,000 

Current Law 

Proceeds of most wagers with odds af less than 300 to 1 are exempt from withholding, as 

are all bingo and keno winnings. 

Reasons for Chanoe 

Withholding on gambling winnings would improve compliance and enforcement. 

Proposal 

The proposal would impose withholding on proceeds of bingo or keno in excess of 

$5,000 at a rate of28 percent, regardless of the odds ofthe wager. The proposal would be 

effective for payments made after the beginning of the %st month that begins at least 10 days 

after the date of enactment. 

109 
REINSTATE OIL SPILL EXCISE TAX 

Current Law 

Before January 1, 1995, a five-cents-per-barrel excise tax was imposed on domestic crude 

oil and imported petroleum products. The tax was dedicated to the Oil Spill Liability Trust Fund 

to finance the cleanup of oil spills and pay other costs associated with oil pollution. The tax was 

not imposed for a calendar quarter if the unobligated balance in the Trust Fund exceeded $1 

billion at the close ofthe preceding quarter. 

Reasons for Chan-e 

It is essential that the Oil Spill Liability Trust Fund remain funded because of the 

continuingpotential for oil spills and the magnitude of damages such spills can cause. 

Moreover, the N1funding level was last changed by the Omnibus Budget Reconciliation Act of 

1989 and is no longer adequate. After the enactment of the current $1 billion limitation, the Oil 

Pollution Act of 1990 permitted the use of amounts in the 'Trust Fund for additional expenditwe 

purposes and doubled the limits on Trust Fund expenditures with respect to a single incident 

(increasing the overall limit from $500 million to $1 billion and the lit for natural resource 

damages payments from $250 million to $500 million). In addition, the Department ofthe 

Treasury's authority to advance up to $1 billion to the Trust Fund expired in 1994. 

Pronosal 

The Oil Spill Liability Trust Fund excise tax would be reinstated for the period after the 

date of enactment and before October 1,2008. In addition, the full funding limitation would be 

increased from $1 billion to $5 billion, effective on the date of enactment. 

110 
MODIFY DEPOSIT REQUIREMENT FOR FUTA 

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 federdstate unemployment benefits system. 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 5.4percent, 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. 

Reasons for Change 

Accelerating collections may reduce losses to the federal unemployment trust funds 

caused by employer delinquencies and provide a regular inflow of money into State funds to 

offset the regular payment of benefits. Limiting the application of acceleration to larger 

employers would avoid imposing additional burdens on small businesses. 

Proposal 

The proposal would require an employer topay federal and state unemployment taxes on 

a monthly basis in a given year if the employer’s FUTA tax liability in the prior year was $1,100 

or more (reflecting approximately 20 employees earning at least $7,000). A safe harbor would be 

provided for the required deposits for the first two months of each calendar quarter. For the first 

month in each quarter, the payment would be required to be the lesser of 30 percent of the actual 

FUTA liability for the quarter or 90 percent of the actual FUTA liability for the month. The 

cumulative deposits paid in the first two months of each quarter would be required to be the 

lesser of 60 percent of the actual FUTA liability for the quarter or 90 percent of the actual FUTA 

liability for the two months. The employer would be required to pay the balance of the actual 

FUTA liability for each quarter by the last day of the month following the quarter. States would 

be allowed to pravide a similar mechanism for paying state unemployment taxes 

The collection proposal would be effective for months beginning after December 3 1, 

2003, 

111 
EXTEND PRO RATA DISALLOWANCE OF TAX-EXEMPT INTEREST EXPENSE 

THAT APPLIES TO BANKS TO ALL FINANCIAL INTERMEDIARIES 

Current Law 

No income tax deduction is allowed for inteIest on debt used directly or indirectly to 

acquire or hold investments that produce tax-exempt income. The determination of whether debt 

is used to acquire or hold tax-exempt investnients differs depending on the holder of the 

instrument. For banks and a limited class of other financial institutions, debt generally is treated 

as financing all of the taxpayer‘s assets proportionately. For other corporations, and for 

individuals, however, a tracing rule is employed. Under this approach, deductions are disallowed 

only when indebtedness is incurred or continued for the purpose of purchasing or carrying 

tax-exempt investments. Securities dealers are not included in the definition of “financial 

institution,” and although they are subject to a case-law-based, pro-rata rule similar to the one 

that applies to other financial institutions, they benefit from a special exception to which 

financial institutions are not entitled. Securities dealers are allowed to trace borrowings to 

non-exempt purposes and to exclude the interest on those borrowings from the interest that is 

subject to the pro-rata disallowance rule. Thus, in general, the portion of a securities dealer’s 

interest subject to possible disallowance under the pro-rata rule is generally much smaller than, 

for example, a bank‘s portion. Other financial intermediaries, such as finance companies, are 

also excluded &om the delinition of “financial institution,” and therefore are subject only to the 

direct tracing rule, even though they operate similarly to banks. 

Reasons for Chanye 

The current rules applicable to securities dealers and financial intermediaries other than 

banks permit them to reduce their tax liabilities inappropriately through double Federal tax 

benefits of interest expense deductions and tax-exempt interest income, notwithstanding that they 

operate similarly to banks. The treatment of banks should be applicable to other taxpayers 

engaged in the business of financial intermediation, such as securities dealers. There is no reason 

to distinguish between banks and other financial intermediaries in this context. Inboth cases it is 

difficult to trace funds within the institution and nearly impossible to assess the taxpayer’s 

purpose in accepting deposits or making other borrowings. 

Proposal 

Under the proposal, the definition of “financial institution” under section 265(b) should 

be amended to include any person engaged in the active conduct of a banking, financing, or 

similar business, such as securities dealers and other financial intermediaries. Thus, a financial 

intermediary investing in tax-exempt obligations would be disallowed deductions for a portion of 

its interest expense equal to the portion of its total assets that is comprised of tax-exempt 

investments-. The proposal would be effective for taxable years beginning after the date of 

enactment with respect to obligations acquired on or after. the date of first committee action 

112 
INCREASE THE PRORATION PERCENTAGE FOR PROPERTY CASUALTY 

Cp&C) INSURANCE COMPANIES 

Current Law 

Property casualty insurance companies generally are taxable on the sum of their 

underwriting income, investment income and other income. In computing their undenniting 

income, property casualty companies deduct reserves for losses and lass expenses incurred from 

their premiums earned. These loss reserves are funded in part with the property casualty 

company’s investment income. The taxable investment income of property casualty companies 

generally does not include interest on tax-exempt bonds, the deductible portion of certain 

dividends received, or inside buildup on most insurance policies. 

In 1986, Congress concluded that it was inappropriate for property casualty companies to 

fund fully deductible loss reserves with investment income that might be exempt from tax, such 

as interest on tax-exempt bonds or the deductibleportion of certain dividends received. Thus, 

Congressreduced the reserve deductions of property casualty companies by I5 percent of the 

tax-exempt interest or the deductible portion of certain dividends received, for stock or 

obligations acquired after August 7, 1986 

In 1997, Congress concluded that it also was inappropriatefor property casualty 

companies to fund fully deductible loss reserves with investment income that might be 

tax-exempt or tax-deferred under certain types of insurance contracts. Given this conclusion, 

Congressexpanded the 15 percent proration rule to apply to the inside buildup on certain 

annuity,endowment, or life insurance contracts. 

Reasons for Chance 

The existing 15 percent proration rule still enables property casualty insurance companies 

to fund a substantial portion of their deductible reserves with tax-exempt or tax-deferred income. 

Other financial intermediaries, such as life insurance companies and banks, are subject to more 

stringent proration rules that substantiallyreduce or eliminate their ability to use tax-exempt or 

tax-deferred investments to fund currently deductible reserves or interest on loans. 

Proposal 

The proration percentage would be increased from 15 percent to 30 percent, for taxable 

years beginning after the date of enactment with respect to investments acquired on or after the 

date of first committee action. 

113 
PRECLUDE CERTAIN TAXPAYERS FROM PREMATURELY CLAIMING LOSSES 

FROM RECEIVABLES OR FROM CREATING RESERVES FOR BAD DEBTS 

Current Law 

An accrual method taxpayer generally must recognize income when all events have 

occurred which fix the right to its receipt and its amount can be determined with reasonable 

accuracy. In the event that a receivable arising in the ordinary course of the taxpayer’s trade or 

business becomes uncollectible, the accrual method taxpayer may deduct the account receivable 

as a business bad debt in the year in which it becomes wholly or partially worthless. 

Accrual method service providers are provided a special exception to the general rule 

requiring an accrual method taxpayer to deduct an uncollectible account receivable only in the 

year in which it becomes wholly or partially worthless. Under the exception, a taxpayer using an 

accrual method with respect to amounts to be received for the performance of services is not 

required to accrue any portion of such amounts which (on the basis of experience) will not be 

collected (9“-accrual experiencemethod”). This exception applies as long as the taxpayer 

does not charge interest or a penalty for failure to timely pay on such amounts. 

In general, dealers in securities are required to use a mark-to-market method of 

accounting for securities. Exceptio& to the mark-to-market rule are provided for securities 

held for investment, certain debt instruments and obligations to acquire debt instruments, and 

certain securities that hedge securities. A dealer in securities is a taxpayer who regularly 

purchases securities from or sells securities to customers in the ordinary course of a trade or 

business, 01 who regularly offers to enter into, assume, offset, assign, or otherwise terminate 

positions in certain types of securities with customers in the ordinary course of a trade or 

business. A security includes (i) a share of stock, (ii) an interest in a widely held or publicly 

traded partnership or trust, (iii) an evidence of indebtedness, (iv) an interest rate, currency, or 

equity notional principal contract, (v) an evidence of an interest in, or derivative fmcial 

instrument in, any of the foregoing securities, or any currency, including any option, forward 

contract, short position, or similar fmcial instrument in such a security or currency, or (vi) a 

position that is an identified hedge with respect to any of the foregoing securities. 

Under Treasury regulations, if a taxpayer would not be a dealer in securities but for its 

purchases and sales of debt instruments that, at the time of purchase or sale, are customer 

paper with respect to either the taxpayer or a corporation that is a member of the same 

consolidated group as the taxpayer, then the taxpayer is not a dealer in securities, unless the 

taxpayer elects out of this exception to dealer status (the “customer paper election”). For this 

purpose, a debt instrument is “customer paper” with respect to a person at a point in time if (i) 

the person’s principal activity is selling nonfinancial goods or providing nonfinancial services; 

(ii) the debt-instrumentwas issued by the purchaser of the goods or services at the time of the 

purchase of those goods and services in order to finance the purchase; and (iii) at all times 

114 
since the debt instrUment was issued, it has been held either by the person selling those goods 

or services or by a corporation that is a member of the same consolidated group as that person. 

The Taxpayer Relief Act of 1997 extended, on an elective basis, mark-to-market 

treatment to traders in securities and dealers and traders in commodities. 

Reasons for Chanoe 

The Administration believes that the non-accrual experience method is an inappropriate 

method of accounting for tax purposes. The Administration also is aware that taxpayers are using 

the customer paper election to obtain certain inappropriate results for tax purposes. 

The non-accnlal experience method permits a taxpayer to reduce current taxable income 

by an estimate of its future bad debt losses. Thus, this method is the equivalent of establishing a 

bad debt reserve. The reserve method of accounting for bad debts has repeatedly been 

determined an unacceptable method of accounting for taxpurposes because it results in a 

mismeasurement of economic income. Accordingly, it is inappropriate to continue to provide 

this tax benefit to service providers. In addition, because the taxbenefit only applies to amounts 

to be received for performance of services, it promotes controversy over whether a taxpayer’s 

receivables represent amounts to be received for the performance of services or for the provision 

of goods. 

Similarly, significant number of taxpayers whose principal activities are selling 

nonfinancial goods or providing nonfinancial services are making the customer paper election as 

a means of restoring bad debt reserves. The use of the customer paper election to mark-tomarket trade receivables bearing little or no interest in order to recognize loss is inappropriate 

and inconsistent with the repeal of reserves for bad debts. 

Proposal 

Under the proposal, the non-accrual experience method would be repealed for taxable 

years ending after the date of enactment. A taxpayer required to change its method of 

accounting would treat such change as a change initiated by the taxpayer, and having been made 

with the consent ofthe Secretary of the Treasury. Any required section 481(a) adjustment would 

be taken into account ratably over a four-year period. 

In addition, the proposal would provide that certain trade receivables would not be 

eligible for mark-to-market treatment. Trade receivables excluded from mark-to-market 

treatment would include non-interest bearing receivables, and account, note, and trade 

receivables unrelated to an active business of a securities dealer. The Secretary ofthe Treasury 

would be granted regulatory authority to cany out the purposes of the proposal. The proposal 

would be effective for taxable years ending after the date of enactment. No inference regarding 

the tax treatment of receivable under current law is intended by this proposal.. 

115 
RESTRICT SPECIAL NET OPERATING LOSS CARRYBACK RULES FOR 

SPECIFIED LIABILITY LOSSES 

Current Law 

Under current law, that portion ofa net operating loss that qualifies as a “specified 

liability loss” may be carried back 10 years rather than being limited to the general two-year 

carryback period. A specified liability loss includes amounts allowable as a deduction with 

respect to product liability, and also certain liabilities that arise under Federal or State law or out 

of any tort of the taxpayer’. In the case of a liability arising out of a Federal or State law, the act 

(or failure to act) giving rise to the liability must occur at least 3 years before the beginning of 

the taxable year. In the case ofa liability arising out of a tort, the liability must arise out of a 

series of actions (or failures to act) over’an extended period of time a substantial portion of which 

occurred at least 3 years before the beginning of the taxable year. A specified liability loss 

cannot exceed the amount of the net operating loss, and is only available to taxpayers that used 

the accrual method throughout the period that the acts (orfailures to act) giving rise to the 

liability occurred. 

Reasons for Chanee 

The proper interpretation of the specified liability loss provisions as they apply to 

liabilities arising under Federal or State law or out of any tort of the taxpayer has been the subject 

of significant controversy. Although the legislative history suggests that these specified liability 

loss rules apply only to liabilities for which a deduction is deferred as a result of the economic 

performance rules of section 461(h), many taxpayers have not limited their claimed specified 

liability losses to such deductions. In addition, many taxpayers have interpreted the 3-year 

requirement and the requirement that the liability arises out of a Federal or State law in a manner 

that is plainly contrary to the intent and purpose of the specified liability loss provisions.. (See, 

for example, ‘Notice97-36, 1997-26 I.R.B. 6, June 1, 1997.) In a recent decision, Sealv Cop v. 

Commissioner, 107 T.C. 177 (1996), the Tax Court determined that based on the legislative 

history Congress intended the specified liability loss provisions to apply only to liabilities for 

which a deduction is deferred as a result of the economic performance rules. The court further 

concluded that Congress intended the 10-year carryback provisions to apply to a relatively 

narrow class of liabilities similar to those identified in the statute. The court did not specify what 

types of liabilities satisfied the narrow class of liabilities intended by Congress. 

To “ize future controversy, the specified liability loss provisions should be clarified 

to provide that only a liiiited class of liabilities qualify as a specified liability loss. This change 

should also ensure that only the types of liabilities that truly warrant relief are subject to the 

specified liability loss provisions. 

116 
Proposal 

Under the proposal, specified liability losses would include (in addition to product 

liability losses), any amount allowable as a deduction that is attributable to a liability that arises 

under Federal or State law for reclamation of land, decommissioning of a nuclear power plant (or 

any unit thereof), dismantlement of an offshore oil drilling platform, remediation of 

environmental contamination, or payments arising under a workers’ compensation statute, if the 

act (or failure to act) giving rise to such liability occurs at least 3 years before the beginning of 

the taxable year. The proposal would be effective for taxable years beginning after the date of 

enactment. No inference regarding the interpretation ofthe specified liability loss carryback 

rules under current law is intended by this proposal. 

117 
FREEZE GRANDFATHERED STATUS OF 

STAPLED OR PAIREDSHARE REITS 

CurrentLaw 

Real Estate Investment Trusts (“REITS”) are conduit-like entities that generally are 

limited to making passive investments in real estate and certain securities. ‘TheIntemal Revenue 

Code places significant constraints on the types of services that a REIT may provide in running 

its properties, and these limitations often discourage REITs from holding certain types of 

property. 

“Stapled REITs” were designed to largely circumvent these limitations: Under a stapled 

REIT structure, the stock of two corporations, one a REIT and a subchapter C corporation, trade 

as a single unit. The REI? acquires properties, such as hotels, retirement homes, or race-tracks, 

that generally cannot be operated directly by a REIT. The REIT then leases the properties to the 

stapled subchapter C corporation, which is free to operate the properties unconstrained by the 

limitations that apply to REITs. As an altemative, in some situations the operating company 

may own and operate the properties but may pay a portion of the income from the properties to 

the REIT in the form of interest on a loan secured by the property. 

In the Deficit Reduction Act of 1984, Congress restricted REITs’ ability to avoid the 

investment limitations by providing that stapled entities must be treated as one entity for 

purposes ofdeterminjng qualification under the REIT des. However, Congress provided 

indefinite grandfather relief for a few existing stapled REITs. 

Reasonsfor Chance 

While the market largely ignored the grandfathered entities for a significant period of 

time after 1984, recently promoters have begun exploiting these stapled REITs to accumulate 

large holdings of properties that could not be operated directly by a REIT. These entities have 

used their tax-favored grandfathered status to obtain a competitive advantage over others and to 

expand their operations greatly beyond the levels and types ofbusinesses conducted in 1984. 

Prooosal 

The proposal would lit the grandfathered status of the existing stapled REITs. Under 

the proposal, for purposes of determining whether any grandfathered entity is a REIT, the stapled 

entities would be Qeated as one entity with respect to properties acquired on or after the date of 

first committee action and withrespect to activities or services relating to such properties (i.e.. 

properties acquired on or after the effective date) that are undertaken or performed by one of the 

stapled entities on or after such date. 

118 
RESTRICT IMPEFMISSIBLEBUSINESSES INDIRECTLY CONDUCTED BY REITS 

Current Law 

Real Estate Investment Trusts (“REITs”) generally are restricted to makiig passive 

investments in real estate and certain securities. In furtherance of this stated purpose, REITs 

generally are limited under the 95 percent gross income test to receiving income that qualifies as 

rents from real property and, to a more limited degree, portfolio income. 

The REIT provisions also contain a number of rules that limit a REIT’s ownership of 

other corporations in order to prevent REITSfrom becoming active in the management and 

operations of companies that engage in activitiesthat are not permissible activities for a REIT. 

One of these rules provides that a REIT may not own more than 10 percent of the outstanding 

voting securities of any issuer 

Reasons for Chanee 

The Administration understands that REITs are conducting businesses through subsidiary 

corporations that, if operated directly, would generate nonqualifying income under the 95 percent 

gross income test. The impermissible business generally is a third-party development or 

management business and often is conducted using many of the REIT’s employees and officers. 

In order to avoid running afoul of the 10 percent voting securities limitation, the business is 

operated through a Corporation with two classes of stock. Non-voting stock that entitles the 

holder to a disproportionatelylarge amount of the corporation’s income is issued to the REIT 

At least 90 percent of the voting stock, which entitlesthe holder to a comparatively insignificant 

amount of the Corporation’s income, is issued to parties that are filiated with the REIT, and the 

remainder is issued to the REIT. The corporation often is significantly leveraged with debt held 

by the WIT, which generates interest deductions intended to greatly reduce or eliminate the 

taxable income of the corporation. Through the retention of non-voting stock and debt, the REIT 

is able to retain most, if not all, of the income generated by the impermissiblebusiness and, due 

to the transmuting of operating income into interest paid to the REIT, that income often is not 

subject to any corporate level tax. 

Proposal 

The proposal would amend section 856(c)(5)@)to prohibit WITSfrom holding stock 

possessing more than 10 percent of the vote or value of all classes of stock of a corporation. 

The proposal would be effectivewith respect to stock acquired on or after the date of first 

committee action. Jnaddition, to the extent that a REIT’s stock ownership is grandfathered by 

virtue of this effective date, that grandfathered status will terminate if the subsidiary Corporation 

engages in atrade or business that it is not engaged in on the date of first committee action or 

acquires substantial new assets on or after that date. 

119 
MODIFY TREAThXENTOF CLOSELY HELD REITS 

Current Law 

When originally enacted, the Real Estate Investment Trust (“REIT”) legislation was 

intended to provide a tax-favoled vehicle through which small investors could invest in a 

professionally managed real estate portfolio. REITs are intended to be widely held entities, and 

certain requirements of the REIT rules are designed to ensure this result Among other 

requirements, in order for an entity to qualify for REIT status, the beneficial ownership of the 

entity must be held by 100 or more persons In addition, a REIT cannot be closely held, which is 

determined by reference to the stock ownership requirement in the personal holding company 

Ides. Under these rules, generally no more than 50 percent of the value of the REITSstock can 

be owned by five or fewer individuals during the last half of the taxable yea. Certain attribution 

rules apply in making this determination. 

Reasonsfor Chanre 

The Administrationhas become aware of a number of tax avoidance transactions 

involving the use of closely held REITS In order to meet the 100 or more shareholder 

requirement, the REIT generally issues common stock and a separate class of non-voting 

preferred stock. The common stock, which reflects virtually all of the REIT’s economic value, is 

acquired by a single shareholder, and the preferred stock is acquired by 99 other ‘‘kiendly” 

shareholders (generally employees of the majority shareholder). The closely held limitation does 

not disqualify the REI’Is that are utilizing this ownership structure because the majority 

shareholder of these REITs is not an individual. 

Proposal 

The proposal would impose as an additional requirement for REI?’ qualificationthat no 

person can own stock ofa REIT possessing more than 50 percent of the total combined voting 

power of all classes of voting stock or more than 50 percent of the total value of shares of all 

classes of stock. For purposes of determining a person’s stock ownership, rules similar to the 

attributionrules contained in section 856(d)(5) would apply. 

The proposal would be effective for entities electing REIT status for taxable years 

beginning on or after the date of first committee action. 

120 
MODIFY DEPRECIATION METHOD FOR TAX-EXEMPT USE PROPERTY 

Current Law 

Accelerated depreciation generally is unavailable for property that is tax-exempt use 

property, including leased property used by a foreign or tax-exempt entity. Instead, such 

property is depreciated using the straight-linemethod over a period equal to the greater of (1) the 

pIoperty's class life, or (2) 125 percent of the lease term. 

Reasons for Chance 

The purpose of the special depreciation rules for tax-exempt use property is to prevent the 

benefits of accelerated depreciation hm accruing to users of property who do not pay 1J.S. 

income taxes. However, because the class life of an asset may be shorter than the economic 

useful life of the asset and because taxpayers have control over the term of a lease, current law 

may continue to provide depreciation that is accelerated as compared to economic depreciation" 

Proposal 

Tax-exempt use property would be depreciated using the straight-line method over a 

period equal to 150 percent of the class life of the property. This is expected to prevent 

depreciation deductions from accruing more rapidly than economic depreciation. The proposal 

would not affect the depreciation of property other than tax-exempt use property. 

The proposal would be effective for property placed in service after December 31, 1998. 

The proposal would also be effective for property that first becomes tax-exempt use property 

after December 31, 1998, or becomes subject to a new lease after that date. 

121 
IMPOSE EXCISETAX ON PURCHASE OF STRUCTUREDSETTLEMENTS 

Current Law 

Current law facilitates the use of structured personal injury settlements by permitting a 

defendant to assign to a structured settlement company (“SSC”) the liability to make periodic 

payments to an injured person, such that the defendant can deduct the payment immediately, but 

the SSC does not include the amount received from the defendant in income. This favorable 

treatment is conditioned on a requirement that the periodic payments cannot be accelerated, 

deferred, increased or decreased by the injured person. If the SSC purchases a deferred annuity 

contract to fund the liability, it is exempted from the section 72(u) inclusion of inside buildup, 

and is subject to the more favorabie rules of annuity taxation usually applicable only to 

individual owners. As a result, the income under the annuity is taxable to the SSC only upon 

receipt by the SSC, at which time the SSC is entitled to an offsetting deduction for corresponding 

payments to the injured person. The exclusion for physical personal injury damages applies also 

to amounts received periodically, thus effectively exempting the interest income in the hands of 

the injured person from tax as well 

Reasons for Chanye 

Congress enacted favorable taxrules intended to encourage the use of structured 

settlements -- and conditioned such tax treatment on the injured person’s inability to accelerate, 

defer, increase or decrease the periodic payments -- because recipients of structured settlements 

are less likely than recipients of lump sum awards to consume their awards too quickly and 

require public assistance. 

Consistent with the condition that the injured person not be able to accelerate, defer, 

increase or decrease the periodic payments, SSC agreements with injured persons uniformly 

contain anti-assignment clauses. Nohvithstanding these contractual provisions, however, many 

injured persons are willing to accept heavily discounted lump sum payments from certain 

“factoring” companies in consideration for their payment streams. These “factoring” 

transactions directly undermine the Congressional objective to create an incentive for injured 

persons to receive periodic payments as settlements of personal injury claims. 

Proposal 

Under the proposal, any person purchasing (or otherwise acquiring for consideration) a 

structured settlement payment stream would be subject to a 20 percent excise tax on the purchase 

price, unless such purchase is pursuant to a court order fmding that the extraordinary and 

unanticipated needs of the original intended recipient render such a transaction desirable. The 

proposal would apply to purchases occurring after the date of enactment. No inference is 

intended as io the contractual validity of the factoring transaction or its effect on the tax 

treatment of any party other than the purchaser. 

122 
CLARIFY AND EXPAND MATH ERROR PROCEDURES 

CurrentLaw 

In order to claim certain tax benefits, taxpayers are required to include correct taxpayer 

identification numbers (TINS)on their tax returns for themselves, and in certain cases, their 

children. For example, taxpayers are required to include a TIN on their tax returns in order to 

claim a personal exemption, eamed income tax credit (EITC), and child and dependent care tax 

credit. For most individual taxpayers, their Social Security Number (SSN) is their TIN. 

A failure to provide a correct TIN in connection with a claim for certain tax benefits, e.g., 

EITC, is treated as a mathematical or clerical error. Mathematical or clerical error treatment 

permits the IRS to assess additional tax due without sending the individual a notice of deficiency 

Generally, taxpayers have 60 days in which they can either provide a correct TINor request that 

the IRS follow the current-law deficiency procedures. If the taxpayer fails to respond within this 

period, he or she must file an amended retum with a comct TIN in order to obtain the tax benefit 

originally claimed. The Taxpayer Relief Act of 1997 extended math error procedures to 

taxpayers who fail to provide correct TINSwhen claiming the child tax credit, the Hope 

Scholarship Credif and the Lifetime Learning Credit. 

In determining whether a taxpayer who claims the EITC, child and dependent care tax 

credit, child tax credit, the Hope Scholarship Credit, or Lifetime Learning Credit has provided a 

correct TIN, the IRS matches the number shown on the taxretam with information the IRS 

receives eom the Social Security Administration (SSA). If a comparison between the TIN 

shown on the taxpayer’s return and the data the IRS receives from the SSA shows that the 

taxpayer has provided an incorrect SSN, the incorrect number is treated as a mathematical or 

clerical error. 

Reasonsfor Change 

Current law does not provide the IRS with clear guidance on what constitutes a correct 

TIN. Under current practice, the IRS may determine that an SSN is invalid if there is a mismatch 

between the name and TINon the retum with the name and TIN on SSA or IRS records. Thus, 

the IRS might deny the EITC to a taxpayer who claims a child with either a nonexistent SSN or 

an SSN belonging to an individual with a different name. In some cases, taxpayers claim 

children who are not their own for the EITC with the correct SSN and name information; 

however, because the taxpayers do not know the children whom they claim, they provide age 

information on the taxreturn that is inconsistent with date-of-birth information in the SSA 

records.. The IRS should be able to treat an age discrepancy as an indicator that the SSN is 

invalid. 

Eligibility for the EITC, the child tax credit, and the child and dependent care tax credit is 

based on the age of the qualifying child or, in some cases, the taxpayer’s age. Date-of-birth data 

123 
from SSA records can also be used to identifj taxpayers who do not qualify for these tax benefits 

because of age restrictions. 

Proposal 

For purposes of the mathematical or clerical enor procedures, the term “correct TIN” 

would be defined as the TIN assigned by the SSA (or in certain liited cases, the IRS) to the 

individual identified on the return. The IRS would be authorized to use data obtained from SSA 

(including name, age, date of birth, and SSN) to detemine whether the individual identified on 

the return corresponds in every respect to the individual to whom the TIN has been assigned. 

Thus, for example, if an individual is identified on the return as having an age that does not 

correspond to the SSA’s record of the age of the individual with that TIN, then the TIN is not 

correct, even if the SSA’s data shows that the taxpayer has matched the correct name to that TIN 

Further, the IRS would be authorized to use mathematical or clerical error procedures to 

deny eligibility for the child tax credit, the child and dependent care tax credit, and the EITC if 

the taxpayer provides a TIN for either the taxpayer or qualifying child, and the IRS determines, 

using data &om SSA, that the recipient does not meet the statutory age restrictions. 

Thus, if a taxpayer claims the child and dependent care tax credit with respect to a child 

and the IRS determines, using data obtained from the SSA, that the claimed child is too old to 

qualify the taxpayer for the credit, the IRS may deny the taxpayer’s claim under the 

mathematical or clerical error procedures. Similarly, a taxpayer who claims the EITC as a lowincome worker without qualifying children, but who is determined to be 70 as a result of a 

comparison of the SSN included on the taxpayer’s return and data obtained from the SSA (even 

though the taxpayer is not required to report his or her age on the return), the IRS may deny the 

taxpayer’s claim under the mathematical or clerical error procedures. 

The proposal would be effective for taxable years ending after the date of enactment. 

124 
CLARIFY THE MEANING OF “SUBJECTTO” LIABILITIES 

UNDER SECTION357(c) 

Current Law 

Section 351 provides that no gain or loss shall be recognized if property is exchanged 

solely for stock of a controlled corporation. If the sum of the amount of liabilities assumed by 

the transferor, plus the amount of the liabilitiesto which the transferred property is subject, 

exceeds the total adjusted basis of the property transferred pursuant to a section 351exchange, 

the transferor must recognize gain from the sale or exchange of the property (with certain 

exceptions) pursuant to section 357(c). 

The basis of property transferred equals the transferor’s basis in such property increased 

by the amount of gain recognized by the transferor, including section 357(c) gain. 

Where a recourse liability is secured by multiple assets, the tax treatment is unclear 

under present law whether a transfer of one asset where the transferor remains liable is a transfer 

“subject to” the liability. As a result, many taxpayers lack the certainty necessary to engage in 

legitimate transactions while others have structured transactions to take advantage of different 

interpretations. For example, if a foreign transferor transfers an asset that partially secures a line 

of credit, taxpayers have taken the position that gain would be computed under section 357(c) by 

treating the entire liability as an amount realized and the transferee’s basis in the asset would be 

increased accordingly. Alternatively, under this interpretation, if a transferor transfers the assets 

securing a single liability to several different subsidiaries, taxpayers have taken the position that 

each asset has a basis increased by the entire liability. Similar issues arise with respect to 

nonrecourse liabilities. 

ProDosai 

The distinction between the assumption of a liability and the acquisition of an asset 

subject to a liability would be eliminated. Instead, the extent to which a liability (including a 

nonrecourse liability) is treated as assumed for Federal income tax purposes in connection with a 

transfer of property shall be determined on the basis of all the facts and circumstances. Thus, for 

example, a transferee shall not be treated as assuming a 1iabilit)rif the transferor indemnifies the 

transferee against the possibility of foreclosure. Similarly, the fact that a lender retains a security 

interest in property securing a recourse liability shall not cause the transferee to be treated as 

assuming the liability if the transferor remains solely liable on the indebtedness without a right of 

contribution against the transferee. In general, if nonrecourse indebtedness is secured by more 

than one asset, and any assets securing the indebtedness are transferred subject to the 

indebtedness without any indemnity agreements, then for all Federal income taxpurposes the 

transferee shall be treated as assuming an allocable portion of the liability based upon the relative 

125 
fair market values (determined without regard to section 7701(g)) of the assets securing the 

liability. The proposal would authorize the Secretary of the Treasury to issue regulations to carry 

out the purposes of this proposal, including anti-abuse rules. 

No inference regarding the taxtreatment under current law is intended by this proposal. 

The proposal would apply for transfers after the date of first committee action. 

126 
SIMPLIFYFOSTER CHILDDEFINITION UNDER EITC 

CurrentLaw 

A taxpayer is eligible to claim the earned income tax credit (EITC) if he or she resides 

with a son, daughter, or grandchild for over half the year. EITC qualifying children also include 

foster children, defmed to mean individuals who reside with a taxpayer for a full year and whom 

the taxpayer “cares for as the taxpayer’s own child.” All EITC qualifying children (including 

foster children) must either be under the age of 19 (24 if a full-time student) or permanently and 

totally disabled. 

When more than one taxpayer can meet the eligibility criteria with respect to the same 

child, only the taxpayer with the highest modified adjusted gross income may claim the credit 

Reasonsfor Chanze 

The foster child rule is difficult to administer. For example, some taxpayers claim 

unrelated children for EITC purposes, by arguing that they lived with the child’s parent and 

“cared for the child as if the child was their own.” Without more objective standards regarding 

the definition of a foster child, the IRS cannot easily determine whether, in fact, these taxpayers 

are eligible for the EITC. 

Clarifying the definition of a foster child would prevent unintentional errors by confused 

taxpayers, reduce potential abuse by noncompliant taxpayers, and provide better guidance to the 

IRS when investigating questionable claims. 

Proposal 

In addition to the existing requirement that the foster child be a child who is cared for by 

the taxpayer as if he or she were the taxpayer’s own child, the proposal requires that a foster 

child, for purposes of claiming the EITC, also meet a specified relationship test. Under this test, 

the foster child must be the taxpayer’s sibling (or descendant of the taxpayer’s sibling), or be 

placed in the taxpayer’s home by an agency of a State or one of its political subdivisions or a taxexempt child placement agency licensed by a State. The proposal would be effective for taxable 

years beginning after December 3 1,1998. 

127 
CLARIFY TIE-BREAKER RULE UNDER EITC 

Current Law 

If two or more taxpayers are eligible to claim the earned income tax credit (EITC) with 

respect to the same qualifying child, then only the individual with the highest modified adjusted 

gross income (“AGI”)may claim the credit with respect to that child. 

Historically, the IRS has interpreted this tie-breaker rule to deny the EITC to the 

lower-income taxpayer, regardless of whether the higher-income taxpayer has claimed the EITC 

on his or her tax return. Last year, however, the Tax Court held that the tie-breaker rule does not 

apply if the higher-income individual did not actually claim the credit with respect to the child in 

question on his or her tax return. &g Leseanoe v. Commissioner, T.C.M. 1997-428 (1997) 

(holding that the definition of “qualifying child” is satisfied only if the child is identified on the 

taxreturn). Under this view, if the higher-income individual does not satisfy this “identification 

requirement,” the child is not a qualifying child with respect to that individual, and the 

tie-breaker rule does not apply to prevent the lower-income individual &om claiming the child 

for purposes of the credit. 

Reasons for Change 

The Omnibus Budget Reconciliation Act of 1990 simplified eligibility for the EITC by 

replacing a complicated and unverifiable support test with the tie-breaker rule. The tie-breaker 

rule was intended to serve the same purpose as the support test: to ensure that only the most 

needy and deserving families are eligible for the EITC. Thus,a taxpayer with a child should not 

qualify for the EITC because his or her own income is low, if, for example, the taxpayer also 

shares a household with his or her own higher-income parent. 

The rule was not and is not intended to become operative only inthe event that two 

individuals actually claim the child in question on their respective tax retums. 

Proposal 

The proposal clarifies that the identification requirement is a requirement for claiming the 

credit, rather than an element of the definition of “qualifying child.” Thus, the tie-breaker rule 

would apply where more than one individual otherwise could claim the same child as a 

qualifying child on their respective taxreturns, regardless of whether the child is actually listed 

on any tax rem. A similar change would be made to the definition of “eligible individual.” 

The proposal is effective with respect to taxable years ending after the date of enactment. 

No Serence is intended as to the operation of the tie-breaker rule under current law. 

128 
ELIMINATE NON,-BUSINESSVALUATIONDISCOUNTS 

CurrentLaw 

IJnder current law, taxpayers making gratuitous transfers of fractional interests in entities 

routinely claim discounts on the valuation of such interests. The concept of valuation discounts 

originated in the context of active businesses, where it has long been accepted that a willing 

buyer would not pay a willing selleI a proportionate share of the value of the entire business 

when purchasing a minority interest in a non-publicly traded business. 

Without legislation in this area, tax planners have carried this concept over into the 

family estate planing area, where a now common planning technique is to contribute marketable 

assets to a family limited partnership or limited liability company and make gifts of minority 

interests in the entity to other family members. Taxpayers then claim large discounts on the 

valuation of these gifts. 

Reasons for Change 

The use of family limited partnerships and similar devices is eroding the transfer tax base. 

Taxpayers take the position that they can make value disappear by making contributions of 

marketable assets to an entity, and then making gifts of interests in such entity to family 

members. ?his disappearing value is illusory, because family members are not minority interest 

holders in any meaningful sense. Moreover, it is implausible that the donor would intentionally 

take an action (contribution of the property to an entity) if the donor really believed that such 

action would cause the family’s wealth to decline substantially 

Prooosal 

The proposal would eliminate valuation discounts except as they apply to active 

businesses. Interests in entities would be required to be valued for transfer tax purposes at a 

proportional share of the net asset value of the entity to the extent that the entity holds readily 

marketable assets (including cash, cash equivalents, foreign currency, publicly traded securities, 

real property, annuities, royalty-producing assets, non-income producing property such as art or 

collectibles, commodities, options and swaps) at the time of the gin or death. To the extent the 

entity conducts an active business, the reasonable working capital needs ofthe business would be 

treated as part of the active business (Le., not subject to the limits on valuation discounts). No 

inference is intended as to the propriety of these discounts under current law 

This proposal would be effective for transfers made after the date of enactment. 

129 
ELIMINATE“CRUMMEY”RULE 

Current Law 

Under section 2503(c), gifts of “present interests” of a value of up to $10,000 (indexed 

for inflation beginning in 1999) per donor per donee each year are excepted from the gift tax. 

Generally, a aansfer in trust is not considered a transfer of a present interest to the beneficiary of 

the trust. Under the decision in Crummev v. Commissioner, 397 F.2d 82 (9th Cir 1968), 

however, a transfer in trust is considered a transfer of a present interest if the trust instrument 

permits the beneficiary to withdraw the transferred amount for a limited period of time (often 30 

days or less). Thus, so-called “Crummey powers” are often used to enable a transfer of a 

$10,000 gift to a trust to qualify for the annual exclusion under section 2503(c). 

In the Cmey case, the holder of the withdrawal power was the ultimate beneficiary of 

the trust. In more recent cases, such as Estate of Cristofani v. Commissioner, 97 TC 74 (1991), 

and Estate of Kohlsaat v. Commissioner, 73 TCM 2732 (1997), the trust agreement has been 

drafted to give withdrawal rights to individuals who do not have substantial economic interests in 

the trust. Typically, by pre-arrangement or understanding, none of these withdrawal rights will 

be exercised 

Reasons for Chanee 

The use of the Crummey power is essentially a legal fiction. It is extremely rare for a 

Cmiey power to be exercised. The continued existence and expansion of the Cmev 

decision undermines the statutory requirement of a present interest. 

Proposal 

The proposal would overrule the Crummev decision by amending Section 2503(c) to 

apply only to outright gifts of present interests. Gifts to minors under a uniform act would be 

deemed to be outright gifts. 

The proposal would be effective for gifts completed after December 31, 1998. 

130 
ELIMINATE GIFTTAX EXEMPTION FOR PERSONAL RESIDENCE TRUSTS 

CurrentLaw 

Under section 2702, if an interest retained by a grantor in a trust when other interests are 

transferred to fdly members, the retained interest is valued at zero for gift tax purposes unless 

it takes the form of an annuity(a GRAT), a unitrust (a GRUT), or a remainder interest after a 

GRAT or a GRUT. However, section 2702(a)(3)(A)(ii)provides an exception for a trust “all the 

property in which consists of a residence to be used as a personal residence by persons holding 

term interests in such tfust ” As written, this exemption completely removes personal residence 

trusts from the purview of section 2702. 

Reasons for Chanye 

Because the exemption under section 2702 completely removes personal residence trusts 

from section 2702, such trusts receive more favorable gift tax treatment than that given to the 

statutorily authorized GRATs and GRUTs Specifically, when valuing the gift made to the 

remainderman in a personal residence trust, the value of any reversionary interest in the grantor 

can be taken into account, and such value reduces the amount of the taxable gift. In contrast, 

even if the grantor has a reversionary interest in a GRAT or a GRUT, section 2702 prohibits the 

actuarial value of that interest from being taken into account in valuing the gift. 

Furthermore, by requiring a grantor’s retained interest in a trust to take the form of an 

annuity or aunitrust, section 2702 was attempting to make sure that the grantor would actually 

receive the interest valued by the actuarial tables. This requirement was designed to prohibit the 

pre-2702 grantor retained income trusts (GRITS), in which the actuarial tables were used to value 

the grantor’s retained income interest even when the projected income was zero or minimal. 

Experience has shown that the use value of the residence retained by the grantor is a poor 

substitute for an annuityor unitrust interest In the personal residence trust, the grantor 

ordinarily remains responsible for the insurance, maintenance and property taxes on the 

residence. Therefore, the true rental value of the house should be less than fair market rent. In 

these circumstances, the actuarial tables overstate the value of the grantor’s retained interest in 

the house. 

Prooosal 

The proposal would repeal the personal residence exception of section 2702(a)(3)(A)(ii). 

If a residence is used to fund a GUT or a GRUT, the trust would be required to pay out the 

required annuity or unitrust amount; otherwise the grantor’s retained interest would be valued at 

zero for gift tax purposes. 

The proposal would be effective for transfers in trust after the date of enactment. 

131 
INCLUDE QUALIFLEI) TERMINABLEINTERESTPROPERTY (QTIP) 

TRUST ASSETS IN SURVIVINGSPOUSE'S ESTATE 

Current Law 

A marital deduction is allowed for qualified terminable interest property (QTIP) passing 

to a qualifying trust for a spouse either by gift or by bequest. Under Section 2044, the value of 

the recipient spouse's estate includes the value of any such property in which the decedent had a 

qualifying income interest for life and a deduction was allowed under the gifi or estate tax. 

Reasons for Change 

The marital deduction is intended to defer the estate tax until the death of the surviving 

spouse, not to excuse payment of the taxpermanently. In some cases, taxpayers have attempted 

to whipsaw the govemment by claiming the marital deduction for QTIP property in the first 

estate and then after the statute of limitations for assessing tax on the first estate has elapsed, 

arguing against inclusion under section 2044 in the second estate due to some technical flaw in 

the QTIP eligibility or election in the first estate. Since the surviving spouse has benefitted from 

the deferral of estate tax due to the marital deduction taken in the first estate, the property should 

be includible in the surviving spouse's estate even if the surviving spouse later discovers that the 

marital trust did not in fact qualify for the QTIP election in the first estate. 

Proposal 

The proposal would amend section 2044 to provide that if amarital deduction is allowed 

with respect to QTIP property under section 2523(f) or 2056(b)(7), inclusion is required inthe 

beneficiary spouse's estate under section 2044. 

The proposal would be effective for decedents (Le",surviving spouses) dying after the 

date of enactment. 

132 
APPLY 7.7 PERCENT CAPITALIZATION RATE TO CREDITLEE 

INSURANCEPREMIUMS 

CurrentLaw 

Insurance companies are required to capitalize different percentages of their total 

premiums for various lines of business as a proxy for their capitalizable acquisition expenses 

such as commissions. Under current law, companies capitalize 1.75 percent of the net premiums 

for specified insurance contractsthat are annuity contracts, 2.05 percent of net premiums for 

specified insurance contracts that are group life insurance contracts, and 7 7 percent of net 

premiums for specified insurance contracts, such as individual life insurance contracts. These 

capitalied amounts generally are amortized over 10 years A company that issues group credit 

life inshance contracts is required to capitalize 2.05 percent of its net premiums for such 

contracts. 

Reasons for Chanoe 

Credit life insurance contracts generally have acquisition expenses that are substantially 

higher than most group life insurance contracts. In general, commissions and other policy 

acquisition expenses for credit life insurance contracts are comparable to or higher than policy 

acquisition expenses for individual life insurance contracts. Thus, the statutory proxy rate for an 

insurance company's policy acquisition costs an credit life insurance does not accurately reflect 

the level of commissions and other policy acquisition expenses for credit life insurance. 

Proposal 

Insurance companies would be required to capitalize 7.7 percent of their net premium for 

a taxable year with respect to all credit life insurance contracts. 

The proposal would be effective for taxable years beginning after the date of enactment. 

133 

P 
MODIFY CORPORATE-OWMEDLIFE INSURANCE(COLI)RULES 

CurrentLaw 

In general, no Federal income tax is imposed on a policyholder with respect to earnings 

under a life insurance contract or endowment contract, and Federal income tax generally is 

deferred with respect to the earnings under an annuity contract. In addition, amounts received 

under a life insurance contract paid by reason of death of the insured are excluded fiom gross 

income. 

Interest on policy loans or other indebtedness with respect to life insurance, endowment 

or annuity contracts generally is not deductible unless the insurance contract insures the lives of a 

key person of a business. A key person includes a 20 percent owner of the business, as well as a 

limited number of the business’ officers or employees However, this interest disallowance rule 

applies to businesses only to the extent that the indebtedness can be traced to a life insurance, 

endowment or annuity contract. 

In addition, the interest deductions of a business other than an insurance company are 

reduced under a proration rule if the business owns or is a direct or indirect beneficiary with 

respect to certain life insurance, endowriient or annuity contracts. This proration rule generally 

does not apply if the contract covers an individual who is a 20 percent owner of the business, or 

an officer, director, or employee of such business. This proration rule also does not apply if the 

contract is a joint life policy covering a 20 percent owner of the business and his or her spouse. 

Special pioration rules apply to life insurance companies and property casualty insurance 

companies if such insurance companies own or are direct or indirect beneficiaries under the same 

types of life insurance, endowment and annuity contracts. Under the special lie insurance 

company proration rules, the life insurance company’s reserve and policyholdex dividend 

deductions are reduced to the extent that such reserves or dividends are funded by the inside 

buildup on certain life insurance, endowment and annuity contracts. Under the special rules, the 

losses incurred deductions of a property casualty insurance company are reduced by 15 percent 

of the inside buildup on certain life insurance, endowment and annuity contracts. 

Reasonsfor ChanPe 

Leveraged businesses can still fid deductible interest expenses with tax-exempt or 

tax-deferred inside buildup on lie insurance, endowment or annuity contracts insuring certain 

types of individuals.. For example, banks, commercial credit companies and other leveraged 

businesses frequently invest in single premium or other investment-oriented insurance policies 

covering the lives of their employees, officers, directors or owners. These entities do not take 

out policy loans or other indebtedness that is secured by, or otherwise traceable to, the insurance 

contracts. head, they borrow from depositors or other lenders, or issue bonds. 

134 
Similar tax arbitrage benefits result when insurance companies invest in certain insurance 

contracts that cover the lives of their employees, officers, directors or 20 percent shareholders. 

Life insurance companies can still fund deductible reserves or policyholder dividends with 

tax-exempt or tax-deferred investment income on insurance contracts with respect to their 

employees, officers, directors or 20 percent owners. Similarly, property casualty insurance 

companies can still fund deductible loss reserves with tax-exempt or tax-deferred investment 

income on insurance contractswithrespect to their employees, officers, directors or 20 percent 

owners. 

Proposal 

The proposal would repeal the exception under the COLI proration rules for contracts 

covering employees, officers or directors, other than 20 percent owners of the business that is the 

owner or beneficiary of an annuity,endowment or life insurance contract. The proposal would 

be effective for taxable years beginning after the date of enactment. 

135 
MODIFY RESERVE RULES FOR ANNUITY CONTRACTS 

Current Law 

A life insurance company that issues an annuity contract claims a reserve deduction equal 

to the greater of the net surrender value of the contract and an amount that is based on the 

Commissioner’s Annuities Reserve Valuation Method (“CARVM”) in effect on the date that the 

annuity contract is issued, subject to the requirement that tax reserves cannot exceed annual 

statement reserves. In computing the CARVM reserve for taxpurposes, the life insurance 

company is required to use the prevailing commissioners’ standard tables for mortality and 

morbidiry. 

In 1997, the NAIC adopted new actuarial guidelines interpreting CARVM. According to 

the guidelines, life insurance companies previously interpreted CARVM inconsistently, and 

some companies assumed that the CARVM reserve was equal to cash surrender value. The 

,pidelines generally require life insurance companies to compute CARVM reserves by 

determining the greatest possible present value of all guaranteed benefits, using a number of 

worst-case ro conservative assumptions. The guidelines are effective on December 31,1998, and 

apply to contracts issued on or after January 1, 1981I Inaddition, the NAIC is developing new 

mortality tables to be used in computing annuity reserves, which will assume that annuity holders 

will live substantiallylonger thantheir actual current life expectancies 

Under the new CARVM guidelines,life insurance companies generally will increase their 

CARVM reserves substantially for previously issued annuity contracts. The use of the new 

CARVM guidelines is a change in the basis for determining reserves. Thus, any deduction 

arising fiom increased annuity reserves that result fiom this change in the company’s basis for 

determining its annuity reserves will be taken into account over a IO-year period. 

Reasons for ChanPe 

The “conservative” assumptions that the NAIC iequires companies to use in computing 

their annuity CARVM reserves may be appropriate in the regulatory context, which is intended 

to minimize the risk that companies will become insolvent and unable to pay policyholders 

Howevex, these “conservative” assumptionsresult in excessive reserves, which cause a material 

understatement in the economic income of life insurance companies issuing annuities. 

Prooosal 

Reserves for all annuity contracts with cash surrender values would equal the lesser of the 

CARVM reserve or the contract’s adjusted account value, subject to the current law requirement 

that reserves cannot exceed annual statement reserves. The adjusted account value for a contmct 

would eqdthe net cash surrender value plus a percentage of the contract’s net cash surrender 

value, which would be set at 5.5 percent in the taxable year in which the contract was issued, 5.0 

136 
percent in the second year, 4.0 percent in the third year, 3.0 percent in the fourth year, 2.5 percent 

in the fifthyear, 1.5 percent in the 6th year, 0..5percent in the seventh year, and 0.0 percent in all 

subsequent years. The proposal would be effective for taxable years ending on or after the date 

of enactment. 

137 
TAX CERTAINEXCHANGES OF INSURANCE CONTRACTSAND 

REALLOCATIONSOF ASSETS WITHIN VAFUABLEINSURANCE CONTRACTS 

Current Law 

Generally, investors are taxed upon the sale or exchange of assets. For example, an 

individual who owns a share of a mutual fund generally will pay Federal income tax on any gain 

realized from the sale of that share ofthe mutual fund, in addition to paying Federal income taxes 

each year on distributions fkom the mutual fund. 

Special rules apply to investors in life insurance, endowment, and annuity contracts who 

exchange their contracts for certain other insurance contracts. Holders of life insurance contracts 

generally may exchange their contracts for other life insurance, endowment, or annuity contracts 

tax-free. Holders of endowment contracts generally may exchange their contracts for other 

endowment contracts or annuity contracts tax-free. Holders of annuity contracts generally may 

exchange their contracts for other annuity contractstax-free. 

Special rules also apply to holders of variable life insurance and variable annuity 

contracts. A holder of a variable contract can choose to invest his funds in any ofa number of 

different mutual funds offered (but not necessarily managed) by the insurance company that 

issues the variable contract. An investor in a variable contract who liquidates part or all of his 

investment in one fund, and reallocates the proceeds to a different fund within a variable 

contract, is not treated as having exchanged any property. 

Reasons for Change 

Variable contracts are used substantiallyas investment vehicles. Some variable contracts 

give holders the ability to choose fkom over 30 mutual fund options and Wly all variable 

contracts give holders the ability to choose from over 10 mutual fund options. The mutual funds 

are increasingly managed by well-known independent mutual fund companies, rather thanby the 

insurance company issuing the contract. The legal rights granted to holders of variable contracts 

also differ j?om the legal rights granted holders of traditional insurance contracts where 

premiums are invested in an insurance company's general account. Variable contract assets 

invested in mutual funds through an insurance company separate account are not at risk if the 

insurance company becomes insolvenf and variable contracts are regulated as securities by the 

Securities and Exchange Commission. 

The special tax-free treatment for exchanges of insurance policies originated before 

people could direct the insurance company to invest in various mutual funds. Policyholders who 

purchased cash value contracts could only invest in the insuran'ce company's general account, 

which in tum was invested primarily in fixed-income securities. Because most insurance 

companies invested their general account assets in similar types of securities, investments 

through insurance contracts were economically similar. After the development of variable 

138 
contracts, however, investment options for life insurance, endowment, and annuity contracts 

became less similar. In addition, the ability to select from a range of mutual funds with different 

investment objectives meant that the reallocation of assets within a single variable contract or the 

ability to exchange one variable contract for another insurance contract could be used to 

exchange one investment for a significantly different investment. 

Proposal 

Any exchange of a life insurance, endowment or annuity contract for a variable contract 

would be a taxable exchange. Similarly, any exchange of a variable contract for a life insurance, 

endowment, or annuitycontract would be a taxable exchange. In addition, each investment in a 

separate account mutual fund or in the insurance company’s general account pursuant to a 

variable contract would be treated as a separate contract. 

These rules would apply to contracts issued after the date of fxst committee action. A 

material change in an existing contract would be treated as the issuance of a new contract. 

139 
REDUCEc~~~~~~~ IN ‘rmCONTRACT” FOR MORTALITY 

AND EXPENSE CHARGES ON CERTAIN INSURANCE CONTRACTS 

Current Law 

Investors in cash value life insurance generally pay no tax on their investment income, 

unless the contract is surrendered for cash before the insured person dies. Investors in cash value 

life insurance contracts that are surrendered before the insured person dies and investors in 

annuity contracts issued by insurance companies can defer tax on investment income until the 

investment income is deemed distributed. In general, cash withdrawals or other taxable 

distributions from cash value life insurance contracts are assumed to be paid first from basis, and 

second from investment income. Cash withdrawals and other taxable distributions from annuity 

contracts and certain highly investment-orientedcash value life insurance contracts generally are 

assumed to be paid first fiom investment income. 

For purposes of computing the amount of taxable investment income under section 72 

fiom distributions under cash value life insurance or annuity contracts, the holder’s basis 

includes premiums used to pay mortality and associated expense charges. These charges can be 

used to purchase term life insurance, other types of insurance coverage, or to pay for an option to 

buy a life annuity at rates guaranteed in 2 deferred annuity contract. 

Except for limited amounts of employer-provided group term life insurance, premiums 

for term life insurance generally are not deductible and must be paid with after-tax dollars. The 

special basis rules under section 72 pernrit investors in cash value insurance contractsto use 

pre-tax dollars to purchase term life insurance coverage, even if such coverage is not provided by 

the employer. 

A portion of the mortality and expense charges for deferred annuity contracts is used to 

pay for an option to purchase a life annuity at guaranteedrates specified in the deferred annuity 

contract. If an investor surrenders a deferred annuity contract for cash, the investor cannot 

exercise its option to obtain a life annuity at guaranteed rates. However, the special basis rules 

cause the mortality and expense charge associated with the life annuitization option to be 

included in the holder’s basis under section 72, even if the option was not exercised. The 

average annual mortality and expense charge on a deferred annuity contract is approximately 125 

basis points. 

In determining whether a contract with a death benefit qualiies as a life insurance 

contract under section 7702, insurance companies are required to use reasonable mortality charge 

assumptions. These mortality charge assumptions also are used to determine when a contract is a 

modified endowment contract under section 7702A. 

140 
Reasons for Chance 

Existing rules used to determine a holder’s basis in a cash value life insurance or annuity 

contract for purposes of section 72 overstate basis, and thus understate the amount of 

tax-deferred income associated with investments in such Contracts. If premiums are used to buy 

current insurance coverage, these amounts should not be included in the holder’s taxbasis if the 

contract is surrendered for cash. If premiums are used to buy an option to purchase a life annuity 

at ,wanteed rates, such amounts should only be included in basis if the option is exercised. To 

the extent that holders withdraw cash or receive other distributions under cash value life 

insurance or annuity contracts, the holders’ basis in their contracts generally should be limited to 

the portion of their premiums not used to purchase term life insurance, other current insurance 

protection, or options that are not exercised. 

ProDosaI 

The Administrationproposes to conform the computation of investment in the cantract 

under section 72 for cash value life insurance contracts and certain annuity contracts to the 

general tax defurttion of basis for other purposes by subtracting mortality and associated expense 

charges. 

For cash value life insurance contracts, the holder’s investment in the contract would 

equal the investment in the contract as currently defined under section 72, less any mortality 

charges that the company assumes purposes of section 7702 and section 7702A. In addition, the 

Secretary of the Treasury would have authority to issue guidance requiring the subtraction of 

appropriate expense charges for cash value life insurance contracts. 

For any annuity contract other than an immediate life annuity contract that is described in 

section 72(u)(4), the holder’s investment in the contract generally would equal the investment in 

the contract as currently defmed under section 72 less the contract’s assumed mortality and 

expense charges. The assumed mortality and expense charges would equal the contract’s average 

cash value during the year multiplied by 1.25 percent. The assumed moxtality and expense 

charges on deferred annuity contracts would be added back to the holder’s investment in the 

contract only if and to the extent that the holder exercised his or her contractual option in the 

deferred annuity contract to use the accumulated funds to purchase a life annuity at specific rates 

guaranteed in the deferred annuity contract. This proposal would apply to contracts issued after 

the date of fust committee action. 

141 
AMEND 80/20 COMPANY RULES 

CurrentLaw 

A portion of interest and dividends paid by a domestic corporation is effectively exempt 

from U.S. withholding tax provided the corporation qualifies as a so-called 80/20 corporation,. In 

general, interest or dividends paid by a domestic corporation will be treated as interest or 

dividends from an 8OL?0 corporation if at least 80 percent of the gross income of the corporation 

for the testing period is foreign source income attributable to the active conduct of a foreign trade 

or business (or the foreign business of a subsidiary). The testing period is the three year period 

preceding the year ofthe dividend. 

Reasonsfor Change 

The testing period relevant for determining 80/20 company status is subject to 

manipulation such that certain foreign persons may utilize the 80Q0 company rules in order to 

improperly avoid U.S. withholding tax with respect to certain distributions attributable to U.S. 

source eamings of a US. subsidiary. 

Prooosal 

The proposal would prevent taxpayers from manipulating the testing period in order to 

avoid US. withholding tax on certain distributions attributable to US. source eamings by 

applying the 80/20 test on a group-wide basis. 

The proposal would apply to interest or dividends paid or accrued more than30 days after 

the date of enactment. 

142 
PRESCRIBE REGULATORY DIRECTIVETO ADDRESSTAX AVOIDANCE 

INVOLMNG FOREIGN BUILT-IN LOSSES 

CurrentLaw 

Under current law, no specific provisions prevent taxpayers from “importing” built-in 

losses incurred outside U.S. taxing jurisdiction to offset income or gain that would otherwise be 

subject to 1J.S. tax. General anti-abuse provisions such as sections 269,446@) and 482, and loss 

limitation provisions such as section 382, prevent abusive loss trafficking in certain 

circumstances, but other similar abuses are not specifically addressed under current law.. 

Section 367(a) generally limits a U.S.,taxpayer’s ability to transfer built-in gain outside 

the U.S. taxing jurisdiction and escape paying U.S..tax on the gain. Similarly, section 864(c)(7) 

limits the ability of a foreign person to remove built-in gain property used in a US. trade or 

business from U.S. taxing jurisdiction without paying US. tax on the gain. Also, section 877 

limits a U.S. citizen’sability to avoid paying U.S. tax on built-in gain by expatriating. There are 

no analogous Code provisions, however, that prevent built-in lossesfrom being injected &Q US 

taxing jurisdiction to shelter income otherwise subject to U.,S.tax. 

Reasons for ChanPe 

Some taxpayers are acquiring built-in losses incurred outside U.S. taxing jurisdiction ar 

are seeking to generate related income and loss in circumstanceswhere the income is athibutable 

to a foreign entity that is not subject to U.S. tax and the related loss can be utilized to reduce U.S. 

taxable income (collectively, “built-in loss” transactions). U.S. taxpayers may seek to use losses 

from these transactions to avoid Subpart F inclusions or capital gains tax and foreign taxpayers 

investing in the US. may seek to utilize such losses to avoid U.S. tax on U.S. operations. 

Although certain built-in-loss transactions can be curtailed under existing authority, 

additional regulatory authority is necessary to provide the Secretary the flexibility to address a 

broader range of potential abuses and to deal with built-in-loss abuses in a simple, 

comprehensive manner. 

Proposal 

The provision would require that the Secretary prescribe regulations to determine the 

basis of assets held directly or indirectly by a person other than a United States person and the 

amount of built-in deductions with respect to a person other than a 1J.S. person or an entity held 

directly or indirectly by such a non-US. person, as may be necessary or appropriate to prevent 

the avoidance of tax.No inference is intended as to the treatment under present law of 

transactions that purport to result in the use for U.S. tax purposes of losses arising outside the 

US. taxing jurisdiction. The proposal would be effective on the date of enactment. 

143 
PRESCRIBE REGULATORY DIRECTIVETO ADDRESS TAX 

AVOIDANCE TFIROUGH USE OFHYBRIDS 

Current Law 

Certain foreign and U.S. persons are entering into transactions (collectively, “hybrid 

transactions”) that utilize so-called hybrid entities (i.e., entities that are treated as corporations in 

one jurisdiction and as branches or partnerships in anotherjurisdiction), so-called hybrid 

securities (e.g., securities that are treated as debt or royalty rights for U.S. tax purposes and as 

equity interests for foreign tax purposes) or other types of hybrid structures, including hybrid 

transactions involving repurchase arrangements that are characterized as loans in one jurisdiction 

and as non-taxable exchanges in another jurisdiction. Certain hybrid transactions are used to 

generate tax results that are inconsistent with the purposes 0fU.S. tax law (including tax 

treaties). Taxpayers entering into these transactions may be interpreting U.S. law in an overly 

aggressive manner. Other hybrid transactions do not attempt to generate tax results that are 

inconsistent with the purposes ofU.S. tax law. Taxpayers contemplating entering into these 

transactions may not have adequate ,pidance to enable them to conclude with sufficient certainty 

that they can achieve their intended results 

Reasons for Chanze 

The extent to which hybrids are featured in transactions used to circunivent the puqposes 

0fU.S. law (including tax treaty provisions) indicates that it is appropriate to scrutinize carefidly 

hybrid transactions for consistency with the purposes of the substantive provisions of U.S. law 

that are implicated in such transactions. The consequences of these transactions should be 

clarified in promptly issued administrative guidance both to prevent inappropriate results and to 

provide taxpayers with greater certainty regarding ttie U.S. tax consequences of hybrid 

transactions. 

Proaosal 

The proposal would direct the Secretary to prescribe re,plations clarifying the tax 

consequences of hybrid transactions. The regulations would set forth the appropriate tax results 

under hybrid transactions in which the intended results are inconsistent with the purposes of U.S. 

tax law (including treaties), and would make clear that such results ob^ in hybrid transactions 

in which the intended results are not inconsistent with the purposes of U.S. law. In particular, the 

regulations would not be authorized to deny tax benefits or results that arise in connection with 

hybrid transactions solely because such transactions involve the inconsistent treatment of entities, 

items and transactions (i.e., ‘‘tax arbitrage”). 

For example, where U.S. tax law considers a U.S. person the owner of a leased asset (and 

the U.S. person contemporaneously and consistently reports the transaction accordingly), and 

foreign law applied to the same facts nevertheless characterizes a foreign person as the owner of 

144 
the same asset, US. depreciation deductions claimed by the US. person generally would not be 

denied on the basis that such deductions are inconsistent with the purposes of Code section 168. 

See Tech. Adv. Mem. 9748005 (Auig. 19,1997). Similarly, interest deductions of a U.S. person 

with respect to a hybrid debt security that is treated as equity in the jurisdiction of the security 

holder generally are consistent with the purposes of Code section 163, and thus should be 

allowed unless such deductions are inconsistent with the purposes of other US.law (inchding 

US. treaty obligations) (e&, because application of a treaty to the hybrid security would 

inappropriatelyeliminate worldwide tax rather than serve to alleviate double taxation). 

Conversely, it is anticipated that the Secretary may utilize its re,platory authority under 

the proposal to deny taxbenefits or results arising in connection with various types of tax 

arbitrage transactions, including transactions that circumvent the purposes of the U.S. Subpart F 

rules, U.S. tax treaty provisions, and the U.S.. foreign tax credit rules. For example, in the 

Subpart F area, the Secretary would be expected to issue regulations that prevent the use of 

hybrid entities and hybrid securities that, contrary to the purposes of the Subpart F rules, result in 

deductions for foreign tax purposes with respect to certain cross-border payments that do not 

generate Subpart F income. See Notice 98-11 relating to the use of hybrid branch structures to 

obtain such a result. Similarly, the Secretary would be expected to prescribe readations that 

would prevent the use of hybrid securities and other hybrid transactions in order to achieve 

results that can not be achieved through the use of hybrid entities (see Code section 894(c) and 

Regulations section L894-1T), as well as regulations that would deny inappropriate foreign tax 

credits not otherwise denied pursuant to the rules to be issued pursuant to Notice 98-5, that arise 

in connection with certain hybrid transactions. 

As applied to many cases, the proposal merely makes the Secretary’s current general 

regulatory authority more specific, and directs the Secretary to promulgate regulations pursuant 

to such authority. In many of these cases, it has not been suggested that the Secretary’s authority 

is in question. In other cases, however, such as was the case regarding the hybrid entity 

transactions ultimately covered by the regulations under section 894(c), the Secretary’s authority 

may be questioned and should be clarified. In yet other cases, the Secretary may not have 

sufficient authority under current law to provide for the appropriate results and the proposal 

provides this authority. 

For example, the proposal authorizes the Secretary to prescribe regulations to deny 

interest deductions of a U.S. person with respect to a hybrid debt security that is treated as equity 

in thejurisdiction of the security holder where such deductions are incompatible with the 

purposes of U.S. treaty obligations (e.g., because application of a treaty to the hybrid security 

would inappropriately eliminate worldwide tax rather than serve to alleviate double taxation). 

Similarly, the proposal authorizes the Secretary to prescribe regulations to require a deemed 

income inclusion by a U.S. person in the following case: Assume that a controlled foreign 

corporation (ACo) issues an instrument to its US. parent corporation (PCo) in exchange for cash. 

Assume that the instrument is viewed as debt for purposes of the laws of country A but as equity 

for US. purposes. Assume further that country A has original issue discount rules similar to our 

145 
own. ACo can use its OID accruals to reduce its country A effective tax rate without PCo or its 

affiliates recopking any income, achieving inappropriatetax results similar to those described 

in Notice 98-11. Although the authority for regulations requiring an income inclusion by PCo in 

this transaction is unclear under current law, such re,dations would be authorized under the 

proposal. It is intended that the proposal generally would create no inference regarding the 

Secretary’s current re,gAatory authority to address hybrid transactions or the general treatment 

under present law of hybrid transactions.. 

It is intended that any regulations issued pursuant to the proposal would lead to results 

consistent with purposes of the provisions of all US.taxtreaties. 

The proposal would be effective as of the date of enactment. 

146 
MODIFY FOREIGN OFFICE MATERIAL PARTICIPATION EXCEPTION 

APPLICABLE TO INVENTORY SALES 

ATTRIBUTABLE TO NONRESIDENT’S U.S. OFFICE 

Current Law 

Foreign corporations and nonresident alien individuals engaged in a trade or business 

within the United States are taxable on a net basis on their taxable income that is effectively 

connected with the conduct of the U.S. trade or business. The determination of whether income 

is effectively connected depends in part on whether the income is from sources withinthe United 

States or without the United States. In general, if a nonresident maintains an office or other tixed 

place of business in the United States, income from any sale of personal property (including 

inventory property) attributable to such place of business is sourced in the United States. As a 

result, such income is treated as effectively connected with the conduct of the US trade or 

business and is subject to net basis taxation. 

However, this general rule does not apply to any sale of inventory property that is sold for 

use, disposition, or consumption outside the United States if an office or other fixed place of 

business of the taxpayer in a foreign country materially participates in the sale. Under these 

circumstances, the source of the income depends on where title to the inventory property passes. 

As a result, iftitle passes outside the United States the income is not treated as effectively 

connected with the conduct of a US. trade or business, and is not subject to tax by the United 

States. 

Reasons for Change 

As a result of this material participation exception, the sale of inventory property for use, 

disposition, or consumption outside the United States may not be subject to United States 

taxation even though the sale is attributable to an office or fixed place of business in the United 

States. Moreover, the sale may not be subject to taxation in any other jurisdiction. The United 

States should not cede its jurisdiction to tax sales of inventory property that are attributableto an 

office or fixed place of business in the United States unless the sale is actually taxed by a foreign 

country at some minimal level. 

Proposal 

The proposal would provide that the source rule exception for sales of inventory property 

for use, disposition, or consumption outside the IJnited States in which the nonresident’s foreign 

office or other fixed place of business materially participates shall apply only if an income tax 

equal to at least 10 percent of the income from the sale is actually paid to a foreign counm with 

respect to such income. The proposal would be effective for transactions occurring on or after 

the date of enactment. 

147 
STOP ABUSE OF CFC EXCEPTION TO OWNERSHIP REQUIREMENTS OF 

SECTION 883 

Current Law 

Section 887 of the Code imposes a 4 percent tax on the United States source gross 

transportation income of nonresident alien individuals and foreign corporations,if the income is 

not effectively connected with a United States trade or business. Sections 871 and 882 impose 

tax on income that is effectively connected with a United States trade or business at the 

graduated rates that apply to U.S persons. However, sections 872(b)(1) and (2) and section 883 

provide that the gross income of nonresident alien individuals and foreign corporations is not to 

include income from the international operation of ships or aircraft derived by such foreign 

persons resident in a foreign country that grants an equivalent exemptionto US. persons, either 

by agreement or under domestic law. To prevent abusive use of “exemption”-country 

corporationsby residents of non-exemption countries, section 883(c) denies the exclusion from 

gross income to corporationsthat are 50 percent or more owned by individuals who are not 

residents of an exemption country. That exception to the exclusion does not apply, however, to a 

foreign corporation that is a controlled foreign corporation (a “CFC”). Code section 883(c)(2). 

That is, ifa foreign corporation is a CFC, there are no (further) restrictions placed on its 

ownershipwith respect to eligibility for the exclusion. Thus, a CFC fofmed in an exemption 

country may exclude its international shipping income from gross income, regardless of the 

nationality of its ultimate owners. 

In general, a CFC is a foreign corporation that is more than 50 percent owned by US. 

persons that each own 10 percent or more ofthe foreign corporation. A partnership organized in 

the US. 01 under US. law is a U.S person for these purposes, regardless of nationality of its 

owners. Thus, a foreign corporation that is wholly owned by non-resident aliens through a U.S. 

partnership is a CFC Such a corporation is thereby eligible for the exemption regardless of 

whether its ultimate individual owners are residents of exemption countries. 

Reasons for Change 

Foreign persons from non-exemption countries are forming U.S.partnerships and then 

having the partnerships formcorporations resident in exemption countries. The foreign 

corporationsare CFCs because they are wholly-owned by U.S. persons (the U.S. partnerships), 

and therefore the anti-abuse rule of section 883(c) requiring exemption country ownership does 

not apply. In this manner, the foreign persons achieve exemption of their foreign corporations’ 

international ship and aircraft transportation income &om the section 887 tax of 4 percent of 

gross and &omthe taxon effectively connected income. Thus,interposing the U.S. partnership 

eliminates an otherwise applicableU.S. tax by circumventingan anti-abuserule. Besides 

allowing foreign persons to avoid U.S. tax,the provisions as currently drafied provide a 

disincentive for countries to enter into reciprocal exemption agreements with the United States, 

148 
as the exemption from United States tax is already easily and generally availableto their 

residents. 

ProposaI 

The Code would be amended to provide that the anti-abuse rule of Code section 883(c)(2) 

requiring at least 50 percent ownership by foreign individuals who are residents of an exemption 

country shall apply unless the CFC is owned more than 50 percent by US.shareholders that are 

individuals or corpaiations. This narrows the exception and assures that it is available only when 

U.S. persons subject to U.S. taxown the CFC. That should prevent the abuse and, in addition, 

encourage countries to negotiate reciprocal exemptions with the United States. It is intended that 

no inference be drawn from this proposal regarding the authority of the Secretary to achieve the 

same result through the issuance of re,dations. The provision would be effective for taxable 

years beginning after the date of enactment. 

149 
REINSTATE ENVIRONMENTAL TAX IMPOSED ON CORPORATE 

TAXABLE INCOME AND DEPOSITED IN THE 

HAZARDOUS SUBSTANCE SUPERFUND TRUST FUND 

Current Law 

For taxable years beginning before January 1, 1996, a corporate environmental income 

tax was imposed at a late of 0 12 percent on the mount by which the modified altemative 

mini"taxable income of a corporation exceeded $2 million. Modified altemative mini" 

taxable income was defined as a corporation's altemative minimum taxable income, determined 

without regard to the altemative tax net operating loss deduction and the deduction for the 

corporate environmental income tax. 

The tax was dedicated to the Hazardous Substance Superfund Trust Fund (the Superfund 

Trust Fund). Amounts in the Superfund Trust Fund are available for expenditures incurred in 

connection with releases or threats of releases of hazardous substances into the environment 

under specified provisions of the ComprehensiveEnvkmnental Response, Compensation, and 

Liability Act of 1980 (as amended). Spending from the Superfund Trust Fund is classified as 

discretionary domestic spending for Federal budget purposes. 

Reasons for Chanee 

The corporate environmental income tax should be reinstated because of the continuing 

need for funds to remedy damages caused by releases of hazardous substances. 

Proposal 

The corporate enviroumental income taxwould be reinstated for taxable years beginning 

after December 31, 1997, and before Jauuary 1,2009 

150 
REINSTATE EXCISE TAXES DEPOSITED IN THE 

HAZARDOUS SUBSTANCE SUPERFUNDTRUST FUND 

Current Law 

The following Superfund excise taxes were imposed before .January 1, 1996: 

(1) An excise tax on domestic crude oil and on imported petroleum products at a rate of 

9.7 cents per barrel; 

(2) An excise taxon listed hazardous chemicals at a rate that varied from $0.22 to $4.87 

per ton; and 

(3) An excise tax on imported substancesthat use as materials in their manufacture or 

praduction one or more of the hazardous chemicals subject to the excise tax described in (2) 

above. 

Amounts equivalent to the revenues from these taxes were dedicated to the Hazardous 

Substance Superfund Trust Fund (the Superfund Trust Fund) Amounts in the Superfund Trust 

Fund are available for expenditures incurred in connection with releases or threats of releases of 

hazardous substances into the environment under specified provisions of the Comprehensive 

Environmental Response, Compensation, and Liability Act of 1980 (as amended). Spending 

&om the Superfund TrustFund is classified as discretionary domestic spending for Federal 

budget purposes. 

Reasons for Change 

The Superfund excise taxes should be reinstated because of the continning need for funds 

to remedy damages caused by releases of hazardous substances. 

Prooosal 

The three Superfund excise taxes would be reinstated for the period after the date of 

enactment and before October 1,2008. 

151 
EXTEND EXCISE TAXES ON GASOLINE, DIESEL FUEL, 

Ah'D SPECIAL MOTOR FUELS 

Current Law 

Excise taxes are imposed on gasoline (other than aviation gasoline) at a rate of 18.4 cents 

per gallon, diesel fuel at a rate of24.4 cents per gallon, and special motor fuels at rates varying 

from 9.25 to 18.4 cents per gallon. The revenues from these taxes, except to the extent 

attributable to the 0.1-cent-per-gallon Leaking Underground Storage Tank (LUST) tax, are 

generally dedicated to the Highway Trust Fund. Revenues from the LUST tax are dedicated to a 

separate LUST trust fund. Special rules apply to revenues from taxes on fuel used for certain 

off-highway purposes, such as in trains, recreational motorboats, and small engines. Depending 

on the purpose, part or all of the revenues from these taxes is retained in the general fund and the 

balance, if any, is dedicated to trust funds other than the Highway Trust Fund. In addition, part 

ofthe revenue amibutable to the tax on certain alcohol fuels is retained in the general fund. 

The tax rates are scheduled to fall to 4.4 cents per gallon (or comparable rates in the case 

of special motor fuels) on Septembex 30, 1999. In addition, the LUST tax is scheduled to expire 

on March 3 1,2005. 

Reasons for Change 

The extension of the taxes on nonaviation gasoline, diesel fuel, and special motor fuels is 

necessary to provide for the continued Federal investment in the improvement of the Nation's 

transportation infrastructure. The Administration's proposed National Economic Crossroads 

TransportationEfficiency Act (NEmA) describes these investments and also provides for the 

extension of these taxes at their current rates 

Prooosai 

The proposal would extend the current rates of tax on nonaviation gasoline, diesel fuel, 

and special motor fuels (with a 0.1 cent per gallon reduction, reflecting the expiration of the 

LUST tax,on April 1,2005). 

152 
CONVERT EXCISE TAXES DEPOSITED IN THE AIRPORT AND AlRWAY 

TRUST FUND TO COST-BASED USER FEES ASSESSED FOR FEDERAL 

AVIATION ADMINISTRATION (FAA) SERVICES 

Current Law 

The Anport and Airway Trust Fund is supported by taxes on airpassenger transportation, 

domestic airfreight transportation, and noncommercial aviation fuel. The current tax on 

domestic air passenger transportation is 9 percent of the amount paid for the transportation plus 

$1.00 for each segment of the transportation, the current taxon international departures and 

arrivals is $12 per person, the tax on domestic air freight transportation is 6 25 percent of the 

amount paid for the transportation, and the tax on noncommercial aviation fuel, to the extent 

dedicated to the Trust Fund, is 17.5 cents per gallon (15 cents per gallon in the case of gasoline) 

The rate of taxon amounts paid for domestic airtransportation is phased down to 8 percent after 

September 30, 1998, and to 7.5 percent after September 30, 1999. The domestic segment fee is 

phased up in five steps to a Nly phased-in fee of $3.00 per segment after December 3 1,2001. In 

addition, the segment fee is indexed for inflation beginning in calendar year 2003 and the 

international anival and departure fees are indexed for inflation beginning in calendar year 1999 

Reasons for Change 

As part of the Administration's effort to create a more business-like Federal Aviation 

Administration, the aviation excise taxes should be replaced with cost-based user fees. 

Prooosal 

The Administration will propose legislation to phase out the aviation excise taxes and 

replace them with cost-based user fees. Under this proposal, the aviation excise taxes would be 

phased out over the period FY 1999through FY 2003 (withthe first reduction on October 1, 

1999, and fig1phase out on October 14,2002) and the FAA would be entirely funded by costbased user fees by 2003. 

153