General Explanations

of the

Administration’s Fiscal Year 2002

Tax Relief Proposals

Department of the Treasury

April 2001
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THE PRESIDENT’S AGENDA FOR TAX RELIEF PRESENTED TO CONGRESS ON FEBRUARY 8TH....1

Create New 10-Percent Individual Income Tax Rate Bracket................................................................................1

Reduce Individual Income Tax Rates .....................................................................................................................2

Increase the Child Tax Credit ................................................................................................................................3

Reduce the Marriage Penalty.................................................................................................................................5

Provide Charitable Contribution Deduction for Non-itemizers .............................................................................6

Permit Tax-free Withdrawals from Individual Retirement Accounts (IRA’s) for Charitable Contributions ..........7

Raise the Cap on Corporate Charitable Contributions..........................................................................................9

Increase and Expand Education Savings Accounts..............................................................................................10

Permanently Extend the Research and Experimentation (R&E) Tax Credit........................................................11

Phase Out Death Tax ...........................................................................................................................................12

ADDITIONAL TAX INCENTIVES ........................................................................................................................17

STRENGTHEN AND REFORM EDUCATION .................................................................................................................17

Allow Teachers to Deduct Out-of-Pocket Classroom Expenses ...........................................................................17

Allow Tax-Free Distributions From Qualified State Tuition Plans (QSTP's) For Certain Higher Education

Expenses And Allow Private Colleges To Offer Prepaid Tuition Plans........................................................18

Allow States to Issue Tax-Exempt Private Activity Bonds for School Construction.............................................21

INVEST IN HEALTH CARE.........................................................................................................................................23

Refundable Tax Credit for the Purchase of Health Insurance .............................................................................23

Provide an Above-the-Line Deduction for Long-Term Care Insurance Premiums..............................................25

Allow up to $500 in Unused Benefits in a Health Flexible Spending Arrangement to be Carried Forward to

the Next Year .................................................................................................................................................27

Provide Additional Choice with Regard to Unused Benefits in a Health Flexible Spending Arrangement .........28

Permanently Extend and Reform Archer MSA’s ..................................................................................................29

Provide an Additional Personal Exemption to Home Caretakers of Family Members ........................................31

Provide Tax Relief for Awards under Certain Health Education Programs........................................................33

ASSIST AMERICANS WITH DISABILITIES ..................................................................................................................34

Exclude from Income the Value of Employer-Provided Computers, Software, and Peripherals .........................34

STRENGTHEN FAMILIES ...........................................................................................................................................36

Permanently Extend and Increase the Adoption Tax Credit ................................................................................36

HELP FARMERS AND FISHERMEN MANAGE ECONOMIC DOWNTURNS .....................................................................37

Establish Farm, Fish, and Ranch Risk Management (FFARRM) Savings Accounts............................................37

INCREASE HOUSING OPPORTUNITIES.......................................................................................................................39

Provide Tax Credit for Developers of Affordable Single-Family Housing ..........................................................39

ENCOURAGE SAVING...............................................................................................................................................41

Establish Individual Development Accounts (IDA’s) ...........................................................................................41

PROTECT THE ENVIRONMENT ..................................................................................................................................43

Permanently Extend Expensing of Brownfields Remediation Costs.....................................................................43

Exclude 50 Percent of Gains from the Sale of Property for Conservation Purposes ...........................................44

ENERGY POLICY PROPOSALS...................................................................................................................................46

Extend and Modify the Tax Credit for Producing Electricity from Certain Sources............................................46

Provide Tax Credit for Residential Solar Energy Systems ...................................................................................48

Modify Treatment of Nuclear Decommissioning Funds .......................................................................................49

ONE-YEAR EXTENSION OF PROVISIONS EXPIRING IN 2001 ....................................................................52

Extend the Work Opportunity Tax Credit.............................................................................................................52

Extend the Welfare-To-Work Tax Credit..............................................................................................................53

Extend Exclusion for Employer-Provided Educational Assistance ......................................................................54

Extend Minimum Tax Relief for Individuals.........................................................................................................55

Extend Exceptions Provided under Subpart F for Certain Active Financing Income..........................................56

Extend Suspension of Net Income Limitation on Percentage Depletion from Marginal Oil and Gas Wells........57

Extend Authority to Issue Qualified Zone Academy Bonds ..................................................................................58

REVENUE ESTIMATES .........................................................................................................................................59
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THE PRESIDENT’S AGENDA FOR TAX RELIEF PRESENTED TO CONGRESS ON

FEBRUARY 8TH

CREATE NEW 10-PERCENT INDIVIDUAL INCOME TAX RATE BRACKET

Current Law

The tax rate on the first amounts of income of individuals that become taxable is 15 percent. The

15-percent tax bracket covers the first $27,050 of taxable income (for calendar year 2001) for

single taxpayers, the first $36,250 for taxpayers who file as heads of household, and the first

$45,200 for married taxpayers filing joint returns ($22,600 for married taxpayers filing separate

returns). The widths of each of the tax brackets are adjusted annually for the effects of inflation.

Reasons for Change

Families often need additional resources to help pay for education, child care, and other costs

associated with supporting children and maintaining a family. An income tax reduction would

provide families with additional resources which could be used to meet the specific needs of

each family.

Low- and moderate-income families are particularly burdened by high marginal tax rates that

result from the combined effect of income taxes, payroll taxes, and the phaseout of the earned

income tax credit. Reducing the marginal income tax rate from 15 percent to 10 percent, in

combination with the proposed doubling of the child tax credit, would significantly reduce the

marginal Federal tax rate faced by low-income families with children.

Proposal

The current 15-percent tax rate bracket would be divided into two rate brackets, 10 percent and

15 percent. The 10-percent tax rate would apply to the first $6,000 of taxable income for single

taxpayers (and married taxpayers filing separate returns), the first $10,000 for unmarried heads

of household, and the first $12,000 for married taxpayers filing jointly. Taxable income above

those amounts which is currently taxed at the 15-percent rate would continue to be taxed at the

15-percent rate. The new rate bracket would be phased in. The rate would be 14 percent in 2002

and would decline by one percentage point per year until it reached 10 percent in 2006 and

thereafter. The width of the 10-percent rate bracket would be indexed for inflation beginning in

2007.
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REDUCE INDIVIDUAL INCOME TAX RATES

Current Law

There are five statutory marginal tax rate brackets, ranging from 15 percent to 39.6 percent,

applicable to individual taxpayers. Generally, the widths of the tax rate brackets depend on the

filing status of the taxpayer. For married taxpayers filing joint returns, tax brackets are wider,

but not twice as wide, as for single taxpayers. The widths of the brackets for unmarried heads of

household fall between the widths of the brackets for single and joint filers. The bracket widths

for married taxpayers filing separately are exactly one-half as wide as for married taxpayers

filing jointly. However, the 39.6 percent tax bracket begins at the same level of taxable income

for single, unmarried head of household, and joint returns. The beginning and ending points of

the tax brackets are adjusted annually for the effects of inflation. Individual income tax rates

also apply to estates and trusts.

Reasons for Change

Lower tax burdens will enable taxpayers to spend or invest more of what they earn, will promote

a healthy economy, and will provide resources for additional investment which, in turn, will

increase income levels in the future. High marginal tax rates tend to reduce the incentives to

work and invest and distort economic decisions. Lowering tax rates will reduce such impacts

and promote more rapid economic growth, entrepreneurship and higher income levels.

Proposal

The five current tax rate brackets ranging from 15 percent to 39.6 percent would be replaced

with four tax brackets ranging from 10 percent to 33 percent. The lower tax rates would be

phased in between 2002 and 2006.

The current 15-percent tax rate bracket would be split into two rate brackets, 10 percent and 15

percent. The 10-percent tax rate would apply to the first $6,000 of taxable income for single

taxpayers, the first $10,000 for unmarried heads of household, and the first $12,000 for married

taxpayers filing jointly. The tax rate in the new bracket would be 14 percent in 2002 and decline

by one percentage point per year until it reached 10 percent in 2006 and thereafter.

The tax rates in the current 28-percent and 31-percent brackets would be reduced to 25 percent

between 2002 and 2006. The 31-percent rate would be reduced to 30 percent in 2002, 29 percent

in 2003, 28 percent in 2004, 27 percent in 2005, and 25 percent in 2006 and thereafter. The 28-

percent rate would be reduced to 27 percent in 2002 and 2003, 26 percent in 2004 and 2005, and

25 percent in 2006 and thereafter.

The tax rates in the current 36-percent and 39.6-percent brackets would be reduced to 33 percent

between 2002 and 2006. The 36-percent rate would be reduced to 35 percent in 2002 and 2003,

34 percent in 2004 and 2005, and 33 percent in 2006 and thereafter. The 39.6-percent rate would

be reduced to 38 percent in 2002, 37 percent in 2003, 36 percent in 2004, 35 percent in 2005, and

33 percent in 2006. The tax rate reductions would also apply to estates and trusts.
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INCREASE THE CHILD TAX CREDIT

Current Law

Taxpayers may be eligible for a tax credit for qualifying children of up to $500 per child. The

credit is reduced by $50 for each $1,000 (or fraction thereof) by which the taxpayer’s modified

adjusted gross income exceeds $110,000 ($75,000 if the taxpayer is not married and $55,000 if

the taxpayer is married but filing a separate return).

The credit is generally nonrefundable. However, taxpayers may be eligible for an additional

refundable child tax credit if they have little or no income tax liability. To qualify, taxpayers

must have three or more children. The additional credit cannot exceed the taxpayer’s share of

social security taxes, net of the refundable portion of the earned income tax credit (EITC).

Beginning in 2002, the child tax credit, along with other personal nonrefundable tax credits, will

be allowed only to the extent that an individual’s regular income tax liability exceeds his or her

tentative alternative minimum tax. Also beginning in 2002, the refundable child tax credit and

the earned income tax credit will be reduced by the amount of the individual’s alternative

minimum tax.

To qualify, children must meet four tests. First, they must be a dependent of the taxpayer.

Second, they must be under the age of 17. Third, they must be a son or daughter of the taxpayer,

or a descendant of either, or an eligible foster child. Fourth, the child dependent must be a U.S.

citizen or national. Taxpayers must provide a valid taxpayer identification number (typically, a

social security number) for each qualifying child.

Reasons for Change

Many families with children need additional resources to help pay for education, child care, and

the other costs associated with child rearing. Increasing the child tax credit would reduce

families’ tax burdens and allow each family to determine how best to use the additional

resources to meet their particular needs.

Low- and moderate-income families are particularly burdened by high marginal tax rates that

result from the combined effect of income taxes, payroll taxes, and the phase-out of the earned

income tax credit. Doubling the child tax credit, in combination with the establishment of the

new 10-percent income tax bracket, would significantly reduce the marginal Federal tax rate

faced by low-income families with children.

Proposal

The amount of the child tax credit would be doubled to $1,000 per child, and the credit would

phase out more slowly and at higher incomes. The credit would be reduced by $20 for each

$1,000 (or fraction thereof) by which the taxpayer’s modified adjusted gross income exceeds the

income threshold. For unmarried filers and married couples filing joint returns, the income

threshold would be increased to $200,000. The threshold would increase to $100,000 if the

taxpayer is married but filing a separate return. The taxpayer would be allowed to offset both the
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regular tax and minimum tax by the child tax credit. In addition, refundable credits would no

longer be reduced by the amount of the alternative minimum tax.

The proposal generally would be effective for taxable years beginning after December 31, 2001.

The increase in the amount of the child tax credit would be phased in over five years, rising to

$600 in 2002, $700 in 2003, $800 in 2004, $900 in 2005, and $1,000 in 2006 and thereafter. The

increase in the modified adjusted gross income threshold would be gradually implemented in

$18,000 annual increments ($25,000 annual increments if the taxpayer is not married and $9,000

annual increments if the taxpayer is married and filing a separate return) between 2002 and 2006.

The reduction in the credit phase-out rate would be effective for taxable years beginning after

December 31, 2005.
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REDUCE THE MARRIAGE PENALTY

Current Law

A couple has a marriage penalty if they owe more income tax filing a joint return than the

spouses would pay if they were unmarried and each filed a separate return. Marriage penalties

often arise because the standard deduction and rate brackets for joint filers are less than twice the

corresponding amounts for single filers or head of household filers.

Reasons for Change

Under the current tax system, two-earner couples often pay higher income taxes filing joint

returns than if each spouse were taxed on his or her income. Marriage penalties tend to be

greatest when the division of earnings between the spouses is relatively even. Moreover, twoearner couples may also be subject to higher marginal tax rates on their combined income than

each spouse would face if they were unmarried and filing separate returns. Higher marginal tax

rates discourage participation in the work force, particularly by the second earner in a family.

Proposal

To reduce marriage penalties, the two-earner deduction that was in effect between 1982 and

1986 would be restored. Joint filers would be allowed to deduct 10 percent of the first $30,000

of the earned income of the lower paid spouse.

Earned income would be defined as the sum of wages, salaries, and net income from selfemployment less certain deductions for IRA, Keogh, SEP, and SIMPLE plan contributions, selfemployed health insurance, MSA contributions, one half of self-employment taxes, supplemental

unemployment compensation, and certain trade and business expenses.

The proposal would be effective for taxable years beginning after December 31, 2001. The

limitation on eligible earnings would be phased in over five years, increasing from $6,000 in

2002 to $12,000 in 2003, $18,000 in 2004, $24,000 in 2005, and $30,000 in 2006 and thereafter.
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PROVIDE CHARITABLE CONTRIBUTION DEDUCTION FOR NON-ITEMIZERS

Current Law

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

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

of the taxpayer’s adjusted gross income (AGI), and lower deductibility limits apply in the case of

contributions of appreciated property and contributions to certain private foundations. Under

current law, taxpayers who elect the standard deduction (“non-itemizers”) may not claim a

deduction for charitable contributions.

Reasons for Change

A combination of government and private efforts is needed to help people in need. It is important

that government not discourage support for the activities of charitable organizations in dealing

with important community problems. Approximately two-thirds of tax filers are non-itemizers,

and thus are not allowed to claim tax deductions for their charitable contributions. Allowing nonitemizers to deduct their charitable contributions would help increase support for charitable

organizations by rewarding and encouraging giving by all taxpayers.

Proposal

Taxpayers who do not itemize would be allowed to deduct charitable contributions in addition to

their standard deduction. The non-itemizer deduction would not be a preference item for

alternative minimum tax purposes, and would not affect the calculation of AGI. Deductible

contributions of non-itemizers would be limited to the amount of a taxpayer's standard

deduction. Charitable contributions in excess of the standard deduction could not be carried

forward to future years. Deductions of contributions by non-itemizers would be subject to the

existing rules governing itemized charitable contributions, such as substantiation requirements

and the percentage-of-AGI limitations. The proposal would be effective for charitable

contributions in taxable years beginning after December 31, 2001, and would be phased in

between 2002 and 2006. Non-itemizers would be allowed to deduct 20 percent of contributions

in 2002, 40 percent in 2003, 60 percent in 2004, 80 percent in 2005, and 100 percent of

contributions in 2006 and thereafter.
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PERMIT TAX-FREE WITHDRAWALS FROM INDIVIDUAL RETIREMENT

ACCOUNTS (IRA’S) FOR CHARITABLE CONTRIBUTIONS

Current Law

Eligible individuals may make deductible contributions to a traditional individual retirement

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

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

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

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

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

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

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

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

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

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

and are also subject to the 10-percent early withdrawal tax (unless an exception applies).

Individuals who itemize their deductions may claim a deduction for contributions made to

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

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

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

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

deductions, including charitable contributions, is reduced by 3 percent of AGI in excess of a

certain threshold ($132,950 for most filers in 2001).

Reasons for Change

Under current law, a taxpayer who wishes to donate otherwise taxable IRA assets to charity must

first include the taxable amounts in income and then claim a deduction for charitable

contributions. Because not all taxpayers can deduct the full amount of their charitable

contributions, current law effectively discourages some taxpayers from contributing their IRA

assets to charity. Allowing taxpayers to exclude from income direct transfers from IRAs to

qualified charities will stimulate additional charitable giving by simplifying the required tax

calculations and eliminating the current-law tax disincentives.

Proposal

Individuals would be allowed to exclude from gross income (and thus from AGI for all purposes

under the Code) distributions made after age 59 1⁄2 from a traditional or Roth IRA directly to a

qualified charitable organization. The exclusion would be available without regard to the

percentage of AGI limits that apply to deductible contributions. An amount transferred directly

to a charitable organization would be counted as a distribution for purposes of the required

minimum distribution rules. The exclusion for transfers to charitable organizations would apply

only to the extent the individual does not receive any benefit in exchange for the transfer. No

charitable deduction would be allowed with respect to any amount that is excludable from
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income under this provision. If an amount transferred from the IRA would otherwise be

nontaxable, such as a qualified distribution from a Roth IRA or the return of nondeductible

contributions from a traditional IRA, the normal charitable contribution deduction rules would

apply.

The proposal would be effective for distributions after December 31, 2001.
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RAISE THE CAP ON CORPORATE CHARITABLE CONTRIBUTIONS

Current Law

Corporations are allowed to deduct charitable contributions up to a limit equal to 10 percent of

net income calculated before the deduction of the charitable contributions and certain other

deductions. The limit was increased in 1982 from the previous level of 5 percent of net income.

Contributions in excess of the limit can be carried forward for up to five years.

Reasons for Change

A combination of efforts by the government, non-profit and private sectors is needed to help

people in need and to deal with community problems. Corporate charitable donations are an

important source of support for charitable and other non-profit organizations that deal with

important community problems and interests. Raising the limit on the charitable deduction

would provide an incentive for corporations to increase their support for charitable organizations.

Proposal

The limit on corporate deductions for charitable contributions would be increased from 10

percent to 15 percent. The proposal would be effective for contributions deductible in taxable

years beginning after December 31, 2001.
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INCREASE AND EXPAND EDUCATION SAVINGS ACCOUNTS

Current Law

Taxpayers may elect to contribute up to $500 per year to an education savings account for

beneficiaries under age 18. The contribution limit is phased out for taxpayers with modified AGI

between $95,000 and $110,000 ($150,000 and $160,000 for joint filers). Contributions are not

deductible, but earnings on contributions accumulate tax-free. Distributions are excludable from

gross income to the extent they do not exceed qualified higher education expenses incurred

during the year the distributions are made. The earnings portion of a distribution not used to

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

generally subject to an additional 10-percent tax. When a beneficiary reaches age 30, the

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

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

made to an education savings account benefiting another family member. If any portion of a

distribution from an education savings account is excluded from gross income, an education tax

credit may not be claimed with respect to the same student in the same taxable year.

Reasons for Change

Encouraging parents to save on a tax-free basis for education expenses at the elementary and

secondary level will help ensure that children get the best education possible and promote

accountability in education. In addition, the low annual contribution limits and restrictions on

availability of the education tax credits under current law discourage the use of education savings

accounts to save for higher education.

Proposal

Education savings accounts would be expanded to allow tax-free and penalty-free distributions

for certain elementary, secondary, and after-school program expenses. Eligible expenses would

include tuition, fees, academic tutoring, special needs services, books, supplies, and computer

equipment incurred in connection with the enrollment of the beneficiary as an elementary or

secondary school student at a public, private, or religious school, as well as any expenses for

room and board, uniforms, and transportation required or provided by the school in connection

with such enrollment. The annual contribution limit would also be raised, to $1,000 in 2002,

$2,000 in 2003, $3,000 in 2004, $4,000 in 2005 and $5,000 in 2006 and thereafter. In addition,

an education tax credit and a tax-free distribution from an education savings account would be

allowable with respect to the same student in the same taxable year, provided the distribution is

not used for the same qualified higher education expenses for which an education tax credit is

claimed.

The proposal would be effective for contributions and distributions made after December 31,

2001.
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PERMANENTLY EXTEND THE RESEARCH AND EXPERIMENTATION (R&E) TAX

CREDIT

Current Law

The research and experimentation (R&E) tax credit is 20 percent of qualified research expenses

above a base amount. The base amount is the product of the taxpayer’s “fixed base percentage”

and the average of the taxpayer’s gross receipts for the four preceding years. The taxpayer’s

fixed base percentage generally is the ratio of its research expenses to gross receipts for the

1984-88 period. The base amount cannot be less than 50 percent of the taxpayer’s qualified

research expenses for the taxable year. Taxpayers can elect into a three-tiered alternative credit

that has lower credit rates (ranging from 2.65 to 3.75 percent) and lower statutory fixed base

percentages (ranging from 1 to 2 percent). The R&E credit is scheduled to expire on June 30,

2004.

Reasons for Change

The R&E credit encourages technological developments that are an important component of

economic growth. However, uncertainty about the future availability of the R&E credit

diminishes the incentive effect of the credit because it is difficult for taxpayers to factor the

credit into decisions to invest in research projects that will not be initiated and completed prior to

the credit’s expiration. To improve the credit’s effectiveness, the R&E credit should be made

permanent.

Proposal

The proposal would make the R&E credit permanent.
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PHASE OUT DEATH TAX

Current Law

The estate, gift and generation-skipping taxes form a unified system of taxes on the transfer of

property, directly or in trust, during life and at death.

Estate Tax. The estate tax is levied on property owned by the decedent at the time of death. In

computing the taxable estate, deductions are allowed for funeral and administrative expenses,

debts and mortgages, certain losses, charitable bequests, bequests to the surviving spouse and

qualifying family-owned business interests.

The statutory marginal tax rate ranges from 18 percent on the first $10,000 of the taxable estate

to 55 percent on the taxable estate in excess of $3,000,000. In addition, there is a 5-percent

surtax levied on amounts between $10,000,000 and $17,184,000. The surtax phases out the

benefit of the graduated rate schedule. The estate tax rate brackets are not indexed.

Every estate is allowed a unified credit. For persons dying in 2001, the unified credit is

$220,550. At that value, the unified credit effectively exempts the first $675,000 of property

from tax. The unified credit is not indexed. However, under the Tax Reform Act of 1997, the

unified credit is scheduled to increase, so that property of $700,000 will be exempt from tax in

2002 and 2003, $850,000 will be exempt in 2004, $950,000 will be exempt in 2005 and

$1,000,000 will be exempt for persons dying in 2006 and thereafter. Other credits against estate

tax include credits for state and foreign death taxes and for taxes on certain prior transfers.

There are a number of provisions designed to ease the burden of the estate tax on family- owned

farms and businesses. These provisions include the qualified family-owned business interest

(QFOBI) deduction, which, together with the unified credit, can be used to exempt up to

$1,300,000 in assets from tax. The special use valuation provision allows eligible farm and

business owners to reduce the value of real property by up to $800,000 (in 2001, indexed), if the

value of the property when it is used in the farm or business is less than the fair market value.

Business owners also may be eligible to defer the estate tax and pay it in installments over a

period of 14 years, at favorable interest rates.

An inherited asset receives a new basis equal to the fair market value of the asset on the date of

the decedent's death (or, if the alternative valuation date is elected, the earlier of the date that the

property is sold or distributed by the estate or six months after the date of death). Although this

is commonly referred to as a “stepped-up” basis, market conditions could result in a steppeddown basis. Thus, when an inherited asset is sold, only capital gains (or losses) realized between

the time of the transferor’s death and the time of sale by the transferee are subject to federal

income taxation.

Gift Tax. The gift tax rate schedule and unified credit are the same as the estate tax provisions.

Annual gifts of up to $10,000 (in 2001, indexed) per donor, per donee are exempt from tax.

Each year, the current year’s taxable gifts (that is, those in excess of the annual exclusion) are

added to taxable gifts made in prior years. The tax on the cumulative gifts is then computed, and

gift taxes payable for prior-year gifts are subtracted from the total tax (to eliminate double
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taxation). When the donor dies, taxable lifetime gifts are added to the property owned at death.

The estate tax is computed on that base, and gift taxes payable for prior gifts are again subtracted

from the total tax. Gifts receive a partial step-up in basis to reflect gift tax paid on the unrealized

appreciation in the property.

Generation-Skipping Transfer (GST) Tax. Property transferred to individuals two or more

generations younger than the transferor is subject to the GST tax, in addition to estate or gift tax.

Each taxpayer has a $1,060,000 (in 2001, indexed) lifetime exemption from GST. The GST tax

rate is set equal to the highest estate tax rate, currently 55 percent. Gifts subject to GST tax

receive a partial step-up in basis to reflect GST tax paid on the unrealized appreciation in the

property.

Reasons for Change

The Administration believes that death should not trigger a tax, and the existence of an estate tax

raises issues of fairness. Income that is saved rather than consumed may be taxed twice under

the current system, once when it is earned and again when the owner dies. For example, income

invested in bonds or dividend paying stocks or deposited into savings accounts is taxed when it is

initially earned, and it produces interest or dividend income that also is taxable under the income

tax system. The estate or gift tax is a second tax levied on both the principal and the interest or

dividend income. Capital gains income that is not realized before death is not taxed under the

current income tax system. However, the basis of the investment (that is, the funds used to

purchase the asset) may have been taxed under the income tax system. Thus the estate tax

amounts to double taxation on the basis. Income should be taxed once–when it is earned–and

not again when it is passed on to the next generation.

In addition, combined federal income and estate or gift tax rates can approach 70 percent. High

marginal tax rates reduce the benefits of working, saving and investing, and can thereby reduce

economic efficiency. High tax rates also increase the incentive to engage in economically

unproductive avoidance techniques.

The estate tax reduces the amount of capital available to smaller businesses. There are

provisions in current law designed to reduce the burden of the estate tax on family-owned farms

and businesses. However, these provisions require the heirs who inherit the property to meet

certain requirements for up to ten years after inheriting the business, or face additional estate

taxes. During this period, the business is subject to a lien for potential estate taxes, which can

reduce the value of the business and make it more difficult for the business to raise capital.

Proposal

The estate, gift and generation-skipping transfer taxes would be phased out between 2002 and

2008 and repealed in 2009.

Provisions in Effect During Phase-Out Period. Each estate and gift tax rate would be reduced by

5 percentage points in 2002, 10 percentage points in 2004, 15 percentage points in 2005, 20

percentage points in 2006, 30 percentage points in 2007, and 40 percentage points in 2008;

however, no estate tax rate applicable to amounts of taxable estate in excess of $1.3 million
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would fall below the highest statutory individual income tax rate generally applicable to longterm capital gains (20 percent).1

 In addition to the rate reductions, the exemption equivalent for

U.S. citizens and residents would be increased to $1.3 million in 2008. Since the GST tax is set

equal to the highest statutory estate tax rate, it would be phased down automatically along with

the estate tax, and repealed in 2009.

Technical changes would be made to the GST tax. These changes are designed to ensure that a

taxpayer does not unfairly or inadvertently lose the benefit of the exemption from GST tax

provided under current law.

The 5-percent surtax would be repealed in 2002. State death tax and GST tax credit rates would

be reduced to maintain the current relationship between the credit rates and the federal tax rates.

Provisions in Effect After December 31, 2008. Effective for decedents dying after, and gifts

made after, December 31, 2008, the estate, gift and GST taxes would be repealed.

After repeal of the estate tax, the basis of property acquired from or passed from a decedent, in

the hands of the person acquiring or receiving it, generally would be the lower of the fair market

value on the date of the decedent's death or the adjusted basis of the property immediately before

the death of the decedent. For purposes of recapture, the character of the gain on the sale of the

inherited assets would remain the same as it was in the hands of the decedent. Thus, real estate

that has been depreciated and would be subject to recapture tax if sold by the decedent would be

subject to recapture tax if sold by the heir.

For every estate of a U.S. citizen or resident, there would be three potential adjustments to basis,

so that taxpayers who are not currently subject to estate tax generally would not be subject to

capital gains tax on assets held until death. First, each estate would receive $1.3 million of basis

to be added to the carryover basis of any one or more of the assets held at death. Second, an

estate generally would receive additional basis equal to the sum of (1) the decedent's unused

capital loss carryforwards, (2) the decedent's unused net operating loss carryforwards, and (3) the

difference between the decedent's basis and fair market value on assets that are assigned a fair

market value basis. Other than with respect to net operating losses, this additional basis could

not be assigned to depreciable or ordinary income assets. Third, estates would be allowed an

additional $3 million of basis, to be allocated among the assets passing to a surviving spouse.

No addition to basis could increase the new basis of any asset beyond its fair market value on the

date of death. The allowable amounts of additional basis would be indexed for inflation after

2009.2

In addition, the current-law exclusion of gain on the sale of a principal residence would be

extended to heirs. Thus, an heir who sells the decedent’s principal residence within 3 years of

 

1

 For nonresident aliens, the 20-percent rate floor would apply to taxable estates in excess of $60,000.

2

 Estates of nonresident aliens would be given additional basis on U.S. property of $60,000 (rather than $1.3

million), corresponding to the exemption amount of nonresident aliens under current law. Surviving spouses of

nonresident aliens would be entitled to the additional basis of $3 million only if the spouse is a U.S. citizen.
- 15 -

the decedent’s death could use the 2-out-of-5-years rule with respect to the decedent’s use of the

residence while alive, and claim a capital gain exclusion.

Property would be considered to pass to the surviving spouse and be eligible to receive an

additional basis allocation if it passes outright to the surviving spouse, or if it passes in a

“qualified marital trust.” A qualified marital trust would be a trust in which the surviving spouse

is entitled to all of the income from the trust property, payable annually or at more frequent

intervals, and no person has a power to appoint any part of the property to any person other than

the surviving spouse during the surviving spouse's lifetime. This provision would adopt the

definition of “qualified terminable interest property” under current law; however, no election to

treat property as passing to the spouse would be required. In addition, the qualified domestic

trust (QDOT) rules would be repealed so that a non-citizen surviving spouse (of a decedent who

died before repeal) would not owe any estate tax upon death or a withdrawal from the QDOT.

Basis could be added to property acquired from the decedent only if the property was owned by

the decedent. Property owned by the decedent and another person as joint tenants, tenancy by

the entireties, or community property, would be considered “owned” by the decedent, but only to

the extent of 50 percent of the property if the co-owner is the spouse, or in proportion to the

amount attributable to contributions by the decedent, if the co-owner is other than the spouse.

Property transferred by the decedent during life to a revocable trust, to pay the income for life to

or on the direction of the decedent would also be considered “owned” by the decedent.

However, property over which the decedent had only a power of appointment would not be

considered “owned” by the decedent. Powers, rights or interests of another person in the

decedent's property would be taken into account when determining the fair market value (beyond

which basis could not be stepped up) of the decedent's property. In no event could basis be

added to (1) property acquired by the decedent by gift (other than from a spouse) during the 3-

year period ending on the date of the decedent's death, (2) property that constitutes a right to

receive income in respect of a decedent under section 691, or (3) stock of certain foreign entities

(for example, foreign personal holding companies and domestic international sales corporations).

A donor would be required to report to the IRS the basis and character of any gifted property

with a value in excess of $25,000, along with the name and social security number of the donee.

The donor also would be required to report the basis to the donee. Gifts of cash would be

excluded from this requirement, as would gifts to charity (other than split-interest gifts). For

transfers at death of non-cash assets in excess of $1.3 million, the executor of the estate would

report to the IRS the basis in each property, the character of the property, any additional basis

allocated to the property, the fair market value of the property on the decedent’s date of death,

and the name and social security number of the heir receiving the property. Basis information

would also have to be reported to the heir. For estates with non-cash assets of less than $1.3

million, this reporting generally would not be required (unless the decedent had received a noncash gift in excess of $25,000 within 3 years of death). The filing requirements would be

indexed for inflation after 2009. The reporting to the IRS would be done in connection with the

filing of the decedent’s final income tax return, with liberal extensions of time available.

Penalties would apply if a donor or executor failed to meet the reporting requirements with

respect to the IRS or recipients.
- 16 -

Upon the sale of inherited or gifted property, the taxpayer would be required to substantiate the

basis of the property. If the basis is unknown but the date of acquisition by the decedent is

known, then the basis would be presumed to be the fair market value at the time of acquisition

(with any appropriate adjustments, for example, due to improvements or depreciation).

In the absence of a gift tax, and with a general rule of carryover basis, there are many potential

circumstances in which the income or capital gains tax and related rules could be avoided. The

proposal would include several provisions to limit the potential for avoidance of the income tax.

First, the proposal would modify the treatment of transfers to nonresident aliens. Second, the

proposal would amend the application of the private foundation rules to non-exempt trusts.

Third, the proposal would include a general anti-abuse rule.

The proposal also would include technical and conforming changes, including an amendment to

provide that distribution by an estate of an asset secured by indebtedness would not be a

disposition, limitations on income tax deductions of the estate, elimination of the disparate

treatment of pecuniary, fractional and formula bequests, provision for disclaimer of bequests

within 9 months of death, and treatment of art inherited from the artist as a capital asset.
- 17 -

ADDITIONAL TAX INCENTIVES

Strengthen and Reform Education

ALLOW TEACHERS TO DEDUCT OUT-OF-POCKET CLASSROOM EXPENSES

Current Law

Individual taxpayers who itemize their deductions may claim a deduction for unreimbursed, jobrelated expenses to the extent those expenses and other miscellaneous deductions exceed 2

percent of adjusted gross income. Such deductions may not be allowed for purposes of the

alternative minimum tax.

Reasons for Change

Teachers and other school professionals often incur expenses related to classroom activities or

for professional training that are not reimbursed. These expenditures enhance the quality of

education received by students but diminish a teacher's properly-measured ability to pay taxes.

Allowing school professionals to deduct such expenditures on their federal income tax return

would encourage dedicated teachers who supplement available school resources at their own

expense.

Proposal

An above-the-line deduction, not subject to the alternative minimum tax, would be allowed for

up to $400 of out-of-pocket expenses incurred by schoolteachers during a taxable year. Eligible

teachers would be defined as those employed full time for an academic year ending during the

taxable year and who teach in the United States at grade levels K through 12, including

elementary and secondary school professionals such as principals, counselors, teacher's aides,

librarians and coaches. The provision would apply to teachers employed by public entities or

private schools (as determined under State law). Eligible, unreimbursed expenses would include

the purchase of books, supplies, and equipment related to classroom instruction that become

school property. Teacher training expenses related to current teaching positions also would

qualify. Neither travel nor lodging expenses nor expenditures related to religious instruction or

activities would be eligible. Expenses claimed as an above-the-line deduction could not be

claimed as an itemized deduction. Taxpayers would be required to retain receipts for eligible

expenditures along with a certification from a principal or other school official that the

expenditures qualified.

The provision would be effective for expenditures made after December 31, 2001.
- 18 -

ALLOW TAX-FREE DISTRIBUTIONS FROM QUALIFIED STATE TUITION PLANS

(QSTP'S) FOR CERTAIN HIGHER EDUCATION EXPENSES AND ALLOW PRIVATE

COLLEGES TO OFFER PREPAID TUITION PLANS

Current Law

Current law provides tax-exempt status to qualified State tuition programs (QSTPs). These

State-sponsored programs generally take one of two forms (a State may sponsor both):

(1) prepaid tuition plans, under which an individual may purchase tuition credits or certificates

on behalf of a designated beneficiary which entitle the beneficiary to the waiver or payment of

qualified higher education expenses at participating educational institutions; and (2) tuition

savings plans, under which an individual may make contributions to an account which is

established for the purpose of meeting the qualified higher education expenses of a designated

beneficiary. Qualified higher education expenses include expenses for tuition, fees, books,

supplies, and equipment required for the enrollment or attendance at an eligible educational

institution, as well as certain room and board expenses for any period during which the student is

at least a half-time student.

Current law provides two basic tax benefits to contributors to, and beneficiaries of, QSTPs:

(1) amounts invested in a QSTP are not subject to tax until a distribution is made (or educational

benefits are provided) and (2) distributions made on behalf of a beneficiary are taxed at the

beneficiary’s (rather than the contributor’s) income tax rate. Distributions made from QSTPs for

nonqualified expenses generally are subject to a more than de minimis penalty (typically 10

percent of the earnings portion of the distribution). The penalty inures to the benefit of the Statesponsored plan. A change in the designated beneficiary of an account is not treated as a

distribution, and therefore is not subject to income tax, if the new beneficiary is a member of the

family of the old beneficiary. Neither contributors nor beneficiaries may direct the investment of

account balances.

Current law also allows individuals to contribute up to $500 per year to an education savings

account on behalf of beneficiaries under age 18. The contribution limit is phased out for

taxpayers with modified AGI between $95,000 and $110,000 ($150,000 and $160,000 for joint

filers). Contributions to education savings accounts are not deductible, but earnings on

contributions accumulate tax-free. Distributions are excludable from gross income to the extent

they do not exceed qualified higher education expenses of the beneficiary in the year the

distributions are made. The earnings portion of a distribution not used to cover qualified

education expenses is includible in the gross income of the beneficiary and is generally subject to

an additional 10-percent tax. When a beneficiary reaches age 30, the account balance is deemed

to have been distributed for nonqualified purposes. However, prior to the beneficiary reaching

age 30, tax-free (and penalty-free) rollovers of account balances may be made to an education

savings account benefiting another family member. If any portion of a distribution from an

education savings account is excluded from gross income, neither the Hope Credit nor the

Lifetime Learning Credit may be claimed with respect to the same student in the same taxable

year. (See page 10 for a description of the Administration's proposal to expand education

savings accounts.)
- 19 -

Unlike education savings accounts, which limit annual contributions, there is no specific dollar

cap on annual contributions to a QSTP. In addition, there is no limit on contributions to a QSTP

account based on the contributor’s income, contributions are allowed at any time during the

beneficiary’s lifetime, and, unlike education savings accounts, the account can remain open after

the beneficiary reaches age 30. However, a QSTP must provide adequate safeguards to prevent

contributions on behalf of a designated beneficiary in excess of amounts necessary to provide for

the qualified higher education expenses of the beneficiary. In addition, no contributor or

designated beneficiary may exercise investment discretion with respect to the investment of

amounts contributed to the QSTP.

Reasons for Change

Providing an exclusion from gross income for distributions from qualified tuition plans for

qualified higher education expenses, and permitting private colleges and universities to offer

prepaid tuition plans, will encourage families and students to save for future education expenses.

Proposal

Distributions from qualified tuition programs would be excludable from the gross income of the

designated beneficiary to the extent that such distributions are used to pay qualified higher

education expenses of the beneficiary as in the current law treatment of distributions from

education savings accounts. The definition of “qualified higher education expenses” would be

limited to: (1) tuition and fees required for the enrollment or attendance of a designated

beneficiary at an eligible educational institution; (2) expenses for books, supplies, and equipment

incurred in connection with such enrollment or attendance (but not in excess of the allowance for

books and supplies included in the “cost of attendance” as determined by the eligible educational

institution for purposes of Federal financial aid programs); and (3) room and board expenses of a

student enrolled at least half time (but not in excess of the applicable allowance for room and

board included in the cost of attendance, as determined by the eligible educational institution for

such period). “Qualified higher education expenses” would not include expenses for education

involving sports, games, or hobbies, unless the education is part of the student’s degree program

or is taken to acquire or improve job skills of the individual.

The definition of a “qualified tuition program” would be expanded to allow private educational

institutions to establish prepaid tuition (but not savings account) programs. Such institutions

would be limited to post-secondary educational institutions that are eligible to participate in

Federal financial aid programs under Title IV of the Higher Education Act of 1965. The

Secretary of the Treasury would be authorized to require such programs to obtain a ruling

regarding qualification.

The proposal would allow a qualified tuition program to permit up to three qualified account

transfers (with or without a change in designated beneficiaries) with respect to any account

without violating the prohibition on investment direction. A “qualified account transfer” is any

transfer of credits (or other amounts) between (1) a prepaid tuition program and a State savings

program, (2) a savings program in one State and a savings program in a different State, or (3)

two investment options offered within the same State savings program. A mere change in the

designated beneficiary of an account, without any change in programs or investment options, is
- 20 -

not subject to this limit. In the case of a transfer from one account to another account in the

same qualified tuition program or a different program, the transferee account would assume the

lesser of the number of qualified account transfers remaining in the transferor account or number

of qualified account transfers remaining in the transferee account.

A first cousin of the original designated beneficiary would be defined as a “member of the

family” eligible to benefit from a tax-free “rollover” of a qualified tuition program account.

The proposal would provide tax-free treatment for amounts distributed from a qualified tuition

program for qualified higher education expenses of the designated beneficiary, and allow an

education tax credit and a tax-free distribution from an education savings account to be claimed

for the same taxable year with respect to the same student, as long as the distribution from the

qualified tuition program is not used for the same expenses for which either a credit or a tax-free

distribution from an education savings account is claimed.

Following current law with respect to education savings accounts, the proposal generally would

impose an additional tax (equal to 10 percent of the earnings portion) on any distribution not

used for qualified higher education expenses. This tax would be collected by the qualified

tuition programs and remitted to the IRS. If taxable earnings from nonqualified distributions

exceed $5,000 in any year, the excess taxable earnings would be subject to a second 10-percent

additional tax collected by the IRS (for a total 20 percent additional tax on such amounts).

The proposal would limit the aggregate amount of earnings (taxable and tax-free) received by

any beneficiary from one or more qualified tuition program accounts. For any beneficiary, the

cumulative lifetime earnings limit would equal 50 times the maximum grant authorized under the

Federal Pell Grant Program, determined for the year in which the distribution is made. All

distributions of account earnings in excess of this cumulative lifetime earnings limit would be

taxable to the beneficiary even if used for qualified higher education expenses (though not, if so

used, subject to the additional tax described above). Beginning with the first distribution on

behalf of a designated beneficiary, a qualified tuition program would report annually to the IRS

both the amount of earnings distributed and cumulative earnings distributions. This reporting

would be required with respect to each designated beneficiary for which distributions have been

made.

This proposal would be effective for taxable years beginning after December 31, 2001.
- 21 -

ALLOW STATES TO ISSUE TAX-EXEMPT PRIVATE ACTIVITY BONDS FOR

SCHOOL CONSTRUCTION

Current Law

Interest on State or local bonds is generally excluded from gross income. However, this

exclusion generally does not apply to “private activity bonds.” In general, a bond is a private

activity bond if either: (1) more than ten percent of its proceeds is used for a private business use

and more than ten percent of its debt service is secured by or payable from property used for a

private business use; or (2) more than the lesser of $5 million or five percent of the proceeds is

loaned to a nongovernmental person.

The Code contains several exceptions under which interest on private activity bonds is excluded

from gross income. For example, eligible activities of educational and other charitable

organizations described in section 501(c)(3) may be financed with tax-exempt private activity

bonds known as “qualified 501(c)(3) bonds.” Another category of tax-exempt private activity

bonds is “exempt facility bonds,” which includes, for example, bonds for airports, small

manufacturing facilities, and low-income rental housing. Under current law, exempt facility

bonds may not be issued to finance school facilities.

The volume of most tax-exempt private activity bonds is restricted by per-State limits. The

annual volume limits for 2001 are the greater of $62.50 per resident of the State or $187.5

million. In 2002, the volume limits will increase to the greater of $75 per resident or $225

million. Beginning in 2003, the annual limits will be adjusted for inflation. Qualified 501(c)(3)

bonds and certain exempt facility bonds are not subject to these volume limitations.

Reasons for Change

Some public school systems may find it desirable to enter into agreements with private entities

under which a private entity agrees to build, own, and maintain school facilities. Under some

circumstances, those agreements might render any bonds issued by a State or local government

to finance the facilities to be non-exempt private activity bonds under current law. Allowing a

limited amount of tax-exempt private activity bonds to be issued for these purposes outside the

current law volume cap will encourage innovative public/private partnerships for the provision of

school facilities.

Proposal

A new category of exempt facility bond would be authorized to finance “qualified public

educational facilities.” The facilities would be owned by a for-profit entity under a publicprivate partnership agreement with a State or local educational agency. The private entity would

construct, rehabilitate, refurbish or equip an elementary or secondary public school facility, and

would agree to transfer the facility to the State or local educational agency at the end of the

agreement for no additional consideration. Facilities eligible to be financed with these bonds

would consist of school buildings, including functionally related and subordinate facilities and

land, and depreciable personal property used at the facilities. The facilities would have to be

operated by a public educational agency as part of a system of public schools.
- 22 -

Issuance of these bonds would be subject to a separate annual per-State volume limit equal to the

greater of $10 per resident or $5 million. States would allocate bond authority to State and local

government agencies that would issue the bonds. Issuers could carry forward any unused

limitation for up to two years after the year in which the authority arose.

The proposal would be effective for bonds issued after December 31, 2001.
- 23 -

Invest in Health Care

REFUNDABLE TAX CREDIT FOR THE PURCHASE OF HEALTH INSURANCE

Current Law

Under present law, the tax treatment of health insurance premiums depends on whether an

individual has medical expenses that exceed a certain threshold, whether the individual is

covered under a health plan paid for by an employer, and whether an individual has selfemployment income.

Individuals who purchase their own health insurance may claim an itemized deduction for the

premiums only to the extent that the premiums, when combined with other unreimbursed

medical care expenses, exceed 7.5 percent of AGI. Other medical care expenses include

expenses of the taxpayer, a spouse, or a dependent for basic medical care, qualified long-term

care services, and premiums for qualified long-term care insurance (subject to a dollar limit).

Employer-provided health coverage and reimbursements for medical care are generally excluded

from gross income for income tax and from wages for employment tax purposes. Active

employees participating in a cafeteria plan may pay their employee share of premiums and other

medical care expenses on the same tax-preferred basis.

Premiums for health insurance (or an arrangement having the effect of health insurance) paid by

self-employed individuals are deductible in computing their AGI. For self-employed individuals

who are not eligible for subsidized employer coverage, premiums for health insurance are 60

percent deductible for 2001, 70 percent deductible for 2002, and 100 percent deductible for 2003

and thereafter.

Reimbursements made to an individual from accident or health insurance (or an arrangement

having the effect of accident or health insurance) for injuries or sickness are excluded from gross

income.

Reasons for Change

An additional incentive is needed to encourage individuals who do not have public or employerprovided health coverage to purchase health insurance. Any incentive should assist low-income

individuals and families with little or no income tax liability to purchase health insurance, but

should not discourage earning additional income. In addition, incentives need to be made

available in advance so that uninsured individuals receive financial help at the time of purchase

of health insurance.

Proposal

The proposal would create a refundable income tax credit for health insurance purchased for

individuals under age 65. The credit would equal 90 percent of the health insurance premium.

However, the maximum credit would be $1,000 per individual covered by a policy, up to a

maximum of $2,000. Individuals participating in public or employer-provided health plans
- 24 -

would not be eligible for the tax credit. Eligible health insurance plans would be required to

meet minimum coverage standards, including coverage for high medical expenses. 

Individuals without dependents filing a single return with AGI up to $15,000 would be eligible

for the maximum credit. Above that income level, the maximum credit would be phased out

ratably for individuals without dependents filing a single return who have AGI between $15,000

and $30,000. All other filers with AGI up to $30,000 would be eligible for the maximum credit

and, above that income level, the maximum credit for these other filers would be phased out

ratably between $30,000 and $45,000 of AGI in the case of a policy covering only one individual

and would be phased out ratably between $30,000 and $60,000 of AGI in the case of a policy or

policies covering more than one individual. These dollar amounts would be indexed by the

Consumer Price Index for all-urban consumers.

Individuals could claim the tax credit for premiums paid as part of the normal tax-filing process.

As an alternative to claiming the tax credit on the individual’s tax return, the tax credit would be

available at the time the individual purchases health insurance through a credit that could be

applied to the purchase. A mechanism would be developed to allow the health insurance issuer

to realize the value of the credits it receives in payment of premiums. Eligibility for a credit that

could be applied to the purchase of insurance would be based on the individual’s prior year tax

return.

The health insurance tax credit would be effective for taxable years beginning after December

31, 2001. The credit would be phased in by limiting the credit to $750 per individual up to a

maximum of $1,500 for 2002 and 2003. The full $1,000 credit for individuals and the $2,000

credit for families would be effective for taxable years beginning after December 31, 2003.
- 25 -

PROVIDE AN ABOVE-THE-LINE DEDUCTION FOR LONG-TERM CARE

INSURANCE PREMIUMS

Current Law

Under present law, the tax treatment of long-term care insurance premiums depends on whether

an individual has medical expenses that exceed a certain threshold, whether the individual is

covered under a qualified long-term care insurance plan paid for by an employer, and whether an

individual has self-employment income.

Individuals who purchase their own qualified long-term care insurance may claim an itemized

deduction for the premiums, up to certain dollar limits that are based on age, but only to the

extent that the premiums, when combined with other unreimbursed medical care expenses,

exceed 7.5 percent of AGI.

For self-employed individuals who are not eligible for subsidized employer long-term care

insurance coverage, premiums for qualified long-term care insurance (up to the applicable dollar

limit) are 60 percent deductible for 2001, 70 percent deductible for 2002, and 100 percent

deductible for 2003 and thereafter. Contributions by self-employed individuals are deductible in

determining AGI and, thus, are not limited by the 7.5 percent of AGI applying to other

individuals.

Employer-provided qualified long-term care insurance coverage and reimbursements for

qualified long-term care services generally are excluded from gross income for income and

employment tax purposes.

Reimbursements made to an individual from qualified long-term care insurance are generally

excluded from gross income, regardless of whether the insurance is purchased by the individual

or by the individual’s employer.

Reasons for Change

Favorable tax treatment for the purchase of long-term care insurance generally provides an

incentive for individuals to take greater financial responsibility for their long-term care needs.

Allowing all individuals to deduct the cost of purchasing long-term care insurance will

encourage the use of long-term care insurance. With the incorporation of tax deductibility for

policies that meet eligibility standards, quality long-term care insurance will play a larger role in

the financial security of older Americans.

Proposal

The proposal would allow individuals purchasing qualified long-term care insurance a deduction

in determining AGI up to the annual dollar limitations that currently apply to the deductibility of

long-term care insurance. The deduction would be available for the employee’s share of the cost

of employer-provided coverage if the employee pays at least 50 percent of the cost. In addition,

qualified long-term care insurance policies would be required to meet new minimum standards

for quality coverage.
- 26 -

The deduction would be effective for taxable years beginning on or after January 1, 2002, but

would be phased in so that 25 percent of the premium would be deductible for 2002 through

2004, 35 percent for 2005, 65 percent for 2006, and 100 percent for 2007 and thereafter.
- 27 -

ALLOW UP TO $500 IN UNUSED BENEFITS IN A HEALTH FLEXIBLE SPENDING

ARRANGEMENT TO BE CARRIED FORWARD TO THE NEXT YEAR

Current Law

A flexible spending arrangement ("FSA") is a reimbursement account or other arrangement

under which an employee is reimbursed for qualified benefits. An FSA for medical care (or

other qualified benefits) may be part of a salary reduction cafeteria plan. Under such a plan, an

employee reduces current compensation and the employer agrees to provide the employee with

qualified benefits. If the arrangement meets the cafeteria plan requirements of section 125, the

compensation that was available is not included in the employee’s gross income or wages for

employment tax purposes. Section 125 prohibits cafeteria plans from providing deferred

compensation. Proposed regulations under section 125 include rules that prevent FSAs from

being used to provide deferred compensation, and require that FSAs have risk-shifting and riskdistribution characteristics similar to traditional health insurance. These rules include a "use it or

lose it" provision that prevents the carry forward to future years of amounts in a cafeteria plan

that are not used for medical expenses incurred by the end of a year.

Reasons for Change

Participation in FSAs can help employees to save for unexpected medical expenses. Requiring

employees to forfeit the entire FSA account balance that has not been used at the end of the year

discourages the use of FSAs. Further, without the ability to carry forward small amounts,

employees may accelerate expenses or incur unnecessary costs (e.g., extra eyeglasses) as year

end approaches in order to avoid forfeiting benefits. Modifying the “use it or lose it” rule to

allow a limited carryforward will encourage saving for unexpected medical expenses and reduce

the incentive to accelerate expenses or incur unnecessary costs, while preserving the character of

a cafeteria plan health FSA as an arrangement that provides current health insurance coverage.

Proposal

An employer’s cafeteria plan health FSA could permit up to $500 in amounts available for an

employee’s medical expenses but not used during the plan year to be carried forward to the

employee’s account for the next plan year of the health FSA. The proposal would be effective

for plan years beginning after December 31, 2001.
- 28 -

PROVIDE ADDITIONAL CHOICE WITH REGARD TO UNUSED BENEFITS IN A

HEALTH FLEXIBLE SPENDING ARRANGEMENT

Current Law

A flexible spending arrangement ("FSA") is a reimbursement account or other arrangement

under which an employee is reimbursed for qualified benefits. An FSA for medical care (or

other qualified benefits) may be part of a salary reduction cafeteria plan. Under such a plan, an

employee reduces current compensation and the employer agrees to provide the employee with

qualified benefits. If the arrangement meets the cafeteria plan requirements of section 125, the

compensation that was available is not included in the employee’s gross income or wages for

employment tax purposes. Section 125 prohibits cafeteria plans from providing deferred

compensation. Proposed regulations under section 125 include rules that prevent FSAs from

being used to provide deferred compensation, and require that FSAs have risk-shifting and riskdistribution characteristics similar to traditional health insurance. These rules include a "use it or

lose it" provision that prevents the carry forward to future years of amounts in a cafeteria plan

that are not used for medical expenses incurred by the end of a year.

Reasons for Change

Participation in FSAs can help employees to save appropriately for unexpected medical

expenses. Requiring employees to forfeit the FSA account balance that has not been used at the

end of the year discourages the use of FSAs. A related proposal would allow cafeteria plans to

permit employees to carry forward up to $500 in unused amounts within the FSA. Also allowing

employers to give participants the option of receiving a distribution of up to $500 in unused

amounts or the option of contributing this amount to the employer’s retirement plan or to an

Archer Medical Savings Account (MSA) will further encourage participation. These options

provide additional flexibility for employees participating in FSAs who would not benefit from

the carryforward, such as participants terminating employment with the employer.

Proposal

An employer’s cafeteria plan could permit up to $500 in amounts available but not used for

medical expenses during the plan year to be distributed to the employee or contributed to a

401(k) plan, 403(b) plan, governmental 457(b) plan, or MSA. Amounts distributed would be

subject to income tax withholding and employment taxes. Amounts the participant chooses to

contribute to a 401(k) or other plan or MSA would be subject to the normal rules (e.g.,

contribution limits, discrimination tests, withdrawal restrictions, employment taxes) applicable to

elective contributions to the receiving plan or MSA.

The proposal would be effective for plan years beginning after December 31, 2001.
- 29 -

PERMANENTLY EXTEND AND REFORM ARCHER MSA’S

Current Law

An MSA is a trust or custodial account used to accumulate funds on a tax-preferred basis to pay

for medical expenses. An individual is eligible to establish an MSA only if the employee (or the

employee's spouse) is covered by a high deductible health plan (and no other health plan) and is

either self-employed or employed by a small employer maintaining the high deductible health

plan. Generally, if more than 750,000 individuals establish an MSA before 2002, no additional

MSAs may be established.

A high deductible health plan is defined as a health plan with an annual deductible in the range

of $1,550 to $2,350 in the case of individual coverage and in the range of $3,100 to $4,650 in all

other cases. A high deductible health plan must also have an out-of-pocket limit that is no higher

than $3,100 in the case of individual coverage and $5,700 in all other cases.

Individual contributions to an MSA that do not exceed specified limits are deductible in

determining AGI and employer contributions to an MSA are excludable up to those same limits.

An individual who receives an employer contribution for a year is not allowed to make a

deductible contribution for the same year. In addition, contributions to an MSA are not

permitted under a cafeteria plan. The annual limit on MSA contributions is 65 percent of the

annual deductible in the case of individual coverage and 75 percent of the annual deductible all

other cases.

Earnings on an MSA are not includible in income. Distributions from an MSA that are used to

pay medical expenses are generally excludable for income. If a distribution is not for purposes

of paying medical expenses, the distribution is includible in income and subject to a 15-percent

additional tax. Amounts distributed after an account holder reaches age 65, dies or becomes

disabled are not subject to this 15-percent additional tax.

Reasons for Change

MSAs provide an additional option for individuals, including those currently without health

insurance, to purchase coverage, and give them more control over spending on medical expenses.

This control provides an incentive for individuals to become more cost conscious purchasers of

medical services, potentially reducing the growth of health care costs. Eliminating restrictions

on the availability of MSAs and easing some of the restrictions on MSA plan features will

simplify the rules and make the use of these accounts attractive to more individuals.

Proposal

MSAs would be made permanent and liberalized. The 750,000 cap on the number of MSAs and

the restriction related to employer size would be removed. All employees and individuals

covered by a high deductible health plan, other than a health plan for which the individual is

eligible to claim a refundable health care credit, would be eligible for MSAs. The definition of

high deductible health plan would be modified to permit an annual deductible as low as $1,000

for individual coverage and $2,000 in all other cases.
- 30 -

MSA contributions would be allowed up to 100 percent of the maximum deductible and could be

made by the employee, the individual or both up to the applicable limit for the individual for that

particular year. Contributions to MSAs could be made through a cafeteria plan.

The proposal would be effective for taxable years beginning after December 31, 2001.
- 31 -

PROVIDE AN ADDITIONAL PERSONAL EXEMPTION TO HOME CARETAKERS

OF FAMILY MEMBERS

Current Law

Taxpayers are allowed to claim exemptions for themselves, their spouses and their dependents.

To qualify as a dependent, an individual must (1) be a specified relative or member of the

taxpayer’s household for a full year,3 (2) receive over half of his or her support from the

taxpayer,4

 (3) not have gross income in excess of the exemption amount,5 (4) be a citizen or

resident of the United States or resident of Canada or Mexico, and (5) not be required to file a

joint tax return with his or her spouse.

In 2001, the amount of the exemption is $2,900. Personal exemptions are phased-out by two

percentage points for each $2,500 ($1,250 if married filing separately) or fraction thereof by

which adjusted gross income exceeds certain thresholds ($132,950 for single filers, $199,450 for

joint filers, $166,200 for heads of households, and $99,725 for married couples filing separate

returns). Both the amount of the exemption and the income thresholds at which the exemption

begins to phase out are indexed for inflation.

Reasons for Change

A parent's long illness or disability can impose significant burdens on their adult children who

choose to care for them at home. Similar burdens are incurred by taxpayers who are the primary

caregivers for their ill or disabled spouses or grandparents. Taxpayers who provide long-term

care in their own home for close family members incur significant costs, and therefore do not

have the same ability to pay as other taxpayers. Providing an additional exemption adjusts for

differences in ability to pay between caregivers and other taxpayers and recognizes the formal

and informal costs of providing long-term care.

Proposal

Taxpayers would be eligible to claim an additional personal exemption for certain qualified

family members residing with the taxpayer in the household the taxpayer maintains. A taxpayer

would be treated as maintaining the household for the year only if over half the cost of

maintaining the household for the year is furnished by the taxpayer. Qualified family members

would include any individual with long-term care needs who (1) is the spouse of the taxpayer or

an ancestor of the taxpayer or the spouse of such an ancestor and (2) is a member of the

taxpayer’s household for the entire year. An individual would be considered to have long-term

care needs if he or she were certified by a licensed physician (prior to the filing of a return

claiming the exemption) as being unable for at least 180 consecutive days to perform at least two

activities of daily living (ADLs) without substantial assistance from another individual, due to a

 

3

 Specified relatives include the taxpayer’s sons, daughters, grandchildren, siblings, parents, aunts, uncles, nieces

and nephews.

4

 For purposes of determining whether a taxpayer provides over half of an individual’s support, public assistance

payments are taken into account as support payments made by a governmental authority.

5

 This test does not apply if the dependent is the taxpayer’s child (son, daughter, stepson, or stepdaughter or foster

child) and is under the age of 19 at the close of the calendar year (24 if a full-time student).
- 32 -

loss of functional capacity.6

 As under section 7702B(c)(2)(B), ADLs would be eating, toileting,

transferring, bathing, dressing, and continence. Substantial assistance would include both handson assistance (that is, the physical assistance of another person without which the individual

would be unable to perform the ADL) and stand-by assistance (that is, the presence of another

person within arm’s reach of the individual that is necessary to prevent, by physical intervention,

injury to the individual when performing the ADL).

As an alternative to the two-ADL test described above, an individual would be considered to

have long-term care needs if he or she were certified by a licensed physician as, for at least 180

consecutive days, (1) requiring substantial supervision to be protected from threats to health and

safety due to severe cognitive impairment and (2) being unable to perform at least one ADL or,

to the extent provided in regulations prescribed by the Secretary of the Treasury (in consultation

with the Secretary of Health and Human Services) being unable to engage in age appropriate

activities.

The taxpayer would be required to provide a correct taxpayer identification number for the

individual with long-term care needs, as well as a correct physician identification number (e.g.,

the Unique Physician Identification Number that is currently required for Medicare billing) for

the certifying physician. Failure to provide correct taxpayer and physician identification

numbers would be subject to mathematical error procedures (enabling the Internal Revenue

Service to summarily assess additional tax without issuing a notice of deficiency). Further, the

taxpayer could be required to provide other proof of the existence of long-term care needs in

such form and manner, and at such times, as the Secretary requires.

The proposal would be effective for taxable years beginning after December 31, 2001.

 

6 A portion of the period certified by the physician must occur within the taxable year for which the exemption is

claimed. After the initial certification, individuals must be re-certified by their physician within three years or such

other period as the Secretary prescribes.
- 33 -

PROVIDE TAX RELIEF FOR AWARDS UNDER CERTAIN HEALTH EDUCATION

PROGRAMS

Current Law

Section 117 provides tax-free treatment for certain scholarship and fellowship grants used to pay

qualified tuition and related expenses, but not to the extent that any grant represents

compensation for services. The National Health Service Corps (NHSC) Scholarship Program

and the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial

Assistance Program provide certain education awards to participants on condition that the

participants provide certain services. These education awards generally involve the payment of

higher education expenses (under the NHSC program, the awards also may be used for the

repayment or cancellation of existing or future student loans). Because the recipients are

required to perform services in exchange for the education awards, the awards used to pay higher

education expenses are taxable income to the recipient.

Reasons for Change

Imposing a tax liability on education awards under these Federal programs undercuts the

objective of providing an incentive for health professionals to serve in medically underserved

geographic areas, in the case of the NHSC Scholarship Program, or the Armed Forces, in the

case of the Armed Forces Health Professions Program.

Proposal

Amounts received by an individual under the National Health Service Corps Scholarship

Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program

would be "qualified scholarships" excludable from income, without regard to any service

obligation by the recipient.

The proposal would be effective for education awards received after December 31, 2001.
- 34 -

Assist Americans with Disabilities

EXCLUDE FROM INCOME THE VALUE OF EMPLOYER-PROVIDED COMPUTERS,

SOFTWARE, AND PERIPHERALS

Current Law

The value of computers, software and other office equipment provided by an employer to an

employee for use at the employee’s home is generally excludable from income to the extent that

the employee uses the equipment to perform work for the employer, and includible in income to

the extent that the employee uses the equipment for personal purposes or to carry on a trade or

business other than working as an employee of the employer.

Taxpayers with disabilities may claim an itemized deduction for impairment-related work

expenses. The deduction is not subject to the two-percent of adjusted gross income (AGI) floor

applicable to miscellaneous itemized deductions.

An individual with a disability is defined as any individual who has a physical or mental

disability (including, but not limited, to blindness or deafness), which for such individual

constitutes or results in a functional limitation to employment, or who has any physical or mental

impairment (including, but not limited to, a sight or hearing impairment), which substantially

limits one or more major life activities.

Impairment-related work expenses are defined as expenses for attendant care services at the

individual’s place of employment and other expenses in connection with such place of

employment which are necessary for the individual to be able to work. Impairment-related work

expenses must be ordinary and necessary. Depreciable capital items are not included under the

definition of impairment-related work expenses. Depreciation attributable to these items,

however, may be deductible, subject to certain limitations (such as, for example, the two-percent

AGI floor).

Reasons for Change

Disabled individuals may incur additional costs in order to work and earn taxable income. For

example, they may require special equipment in order to work, particularly to enable them to

telecommute. However, employees cannot exclude the entire value of such equipment provided

by an employer if they use the equipment for personal use as well as work. This restriction can

impose significant recordkeeping requirements on employers and workers. Removing this

restriction would lower the costs of telecommuting by disabled individuals.

Proposal

An individual with a disability would be allowed to exclude from income the value of any

computers, software or other office equipment provided by such individual’s employer which are
- 35 -

necessary for the individual to perform work for the employer at home.7

 In order to qualify for

the exclusion, the employee would be required to make substantial use of the equipment to

perform work for the employer. The exclusion would apply to all use of such equipment,

including use by the employee for personal purposes or to carry on a trade or business other than

working as an employee of the employer.

The proposal would adopt the current-law definition of individuals with disabilities. Employees

would be required to provide their employer with a certification from a licensed physician

showing that they meet the criteria to be considered an individual with a disability in such form

and manner, and at such times, as the Secretary requires.

The proposal would be effective for taxable years beginning after December 31, 2001.

 

7 If the employer provided the employee with use of equipment after the end of the equipment’s depreciable life, the

value of such use to the employee would be deemed to be zero.
- 36 -

Strengthen Families

PERMANENTLY EXTEND AND INCREASE THE ADOPTION TAX CREDIT

Current Law

Families who adopt children are provided a nonrefundable tax credit of 100 percent of the first

$5,000 per adoption ($6,000 for adoptions of children with special needs) of qualified expenses

paid in the adoption process. Tax credits in excess of tax liability may be carried forward for up

to five years. The tax credit does not apply to adoptions by stepparents.

Qualified expenses for an adoption may be incurred in a single year or in more than one year, but

the maximum qualifying amounts for the credit are cumulative for an adoption. Qualified

expenses do not include any expenses which are paid or reimbursed under any other government

or non-government program.

The credit is phased out ratably for taxpayers with incomes between $75,000 and $115,000.

The tax credit generally sunsets after 2001, but is permanent with respect to adoptions of

children with special needs.

Reasons for Change

In 1998, the latest year for which data are available, the tax provisions for adoption provided

financial assistance to about 50,400 adoptions. Without legislation, such assistance would

terminate after 2001 for over 90 percent of such adoptions. Continuing to provide tax benefits

for adoptions would reduce the financial burden for taxpayers undertaking adoptions, would

permit some adoptions that would not otherwise be undertaken, and, in conjunction with Federal

expenditure programs, would help promote the movement of children from foster care into

permanent homes.

Proposal

The adoption tax credit for the adoptions of children without special needs would be made

permanent and the limit on qualified expenses would be increased to $7,500 per adoption. The

limit for adoptions of children with special needs would be increased to $8,500 per adoption for

expenses paid or incurred after December 21, 2001.
- 37 -

Help Farmers and Fishermen Manage Economic Downturns

ESTABLISH FARM, FISH, AND RANCH RISK MANAGEMENT (FFARRM) SAVINGS

ACCOUNTS

Current Law

There is no provision in present law allowing the elective deferral of farm or fishing income.

However, farmers can elect to average their farming income over a three-year period, and

farmers may carry back net operating losses over the five previous years. In addition, taxes can

be deferred on certain forms of income, including disaster payments, crop insurance, and

proceeds from emergency livestock sales. Farmers are also permitted to use the cash receipts

and disbursement and the installment methods of accounting.

Reasons for Change

The income of an individual engaged in farming, commercial fishing, or ranching can fluctuate

significantly from year to year depending on the weather, agricultural markets, and other factors

beyond the individual’s control. The income averaging and net operating loss rules of current

law provide tax relief in good years, but there are no provisions encouraging farmers, fishermen,

and ranchers to put aside part of their income in good years to provide a cushion when harvests

fail or prices fall.

Proposal

Individuals engaged in an eligible business would be allowed to establish Farm, Fish, and Ranch

Risk Management (FFARRM) accounts. Eligible businesses for this purpose would be farming,

ranching, or commercial fishing businesses that are not passive activities of the taxpayer.

All FFARRM accounts would be domestic trusts for the exclusive benefit of the farmer,

fisherman, or rancher who establishes the trust. The trust would be required to satisfy certain

other requirements, including a requirement that the governing instrument of the trust limit trust

assets to cash and certain interest-bearing obligations. A FFARRM account would be treated as

a grantor trust and income earned in the account would be taxed currently to the individual who

established the account.

In each year, a taxpayer would be permitted to make contributions to a FFARRM account equal

to 20 percent of taxable income from eligible businesses. The taxable income from eligible

businesses would be determined without regard to amounts deducted or included in gross income

under the FFARRM account rules but otherwise in the manner prescribed for purposes of the

income averaging rules. Only cash contributions would be permitted, and the amount of the

contribution during a taxable year would be allowed as a deduction for that year. For this

purpose, contributions made on or before the due date (without regard to extensions) of the

taxpayer’s return for a taxable year would be treated as having been made on the last day of the

year. A six-percent excise tax would be imposed on excess contributions.
- 38 -

The deduction for FFARRM account contributions would be taken into account in determining

adjusted gross income and would reduce income attributable to the eligible business for all

income tax purposes other than determining the maximum permitted FFARRM account

contribution for the taxable year. Contributions to a FFARRM account would not reduce

earnings from self employment.

Distributions from a FFARRM account, except to the extent attributable to income earned in the

account or nondeductible contributions, would be included in gross income (but not selfemployment income) of the individual who established the account. Any amount that has not

been distributed by the close of the fifth year following the year of deposit would be deemed to

be distributed in the fifth year. The deemed distribution would be included in gross income of

the account owner and would be subject to a 10-percent excise tax. For purposes of these rules,

distributions during a year would be treated as made first from account earnings that have not

been previously distributed and then from deposits in the order made beginning with the earliest.

In addition, distributions made on or before the due date (without regard to extensions) of the

taxpayer’s return for a taxable year would be treated as having been made on the last day of the

year.

Other deemed distribution rules would apply if the account owner ceases to engage in an eligible

business or dies. If the account owner does not engage in an eligible business during two

consecutive taxable years, the balance of the FFARRM account would deemed to be distributed

to the owner on the last day of the two-year period. In addition, if the individual who established

the FFARRM account dies and the individual’s surviving spouse is not designated as the

beneficiary, the account would cease to be a FFARRM account on the date of the owner’s death

and the balance of the account would be deemed to be distributed to the owner on the date of

death. A surviving spouse designated as the beneficiary of a FFARRM account would, on the

other hand, “step into the shoes” of the deceased owner with respect to the account. The deemed

distributions under these rules would be included in gross income of the owner but would not be

subject to an additional excise tax.

The proposal would be effective for taxable years beginning after December 31, 2001.
- 39 -

Increase Housing Opportunities

PROVIDE TAX CREDIT FOR DEVELOPERS OF AFFORDABLE SINGLE-FAMILY

HOUSING

Current Law

No tax credits are available to developers of new or rehabilitated, affordable single-family

housing. Current law does provide tax credits to owners of qualified low-income rental units

through the low-income housing tax credit (LIHTC). The LIHTC may be claimed over a 10-year

period for a portion of the cost of rental housing occupied by tenants having incomes below

specified levels. The credit percentage for newly constructed or substantially rehabilitated

housing that is not federally subsidized is adjusted monthly by the Internal Revenue Service so

that generally the 10 annual credit amounts have a present value of 70 percent of qualifying

costs. The credit percentage for substantially rehabilitated housing that is federally subsidized

and for existing buildings is calculated to have a present value of 30 percent of qualified

expenditures. In general, the aggregate first-year credit authority allocated to each State is $1.50

per capita in 2001 and $1.75 per capita in 2002. Per capita amounts are indexed for inflation

beginning in 2003. Tax credits are allocated to particular projects by State or local housing

agencies pursuant to publicly announced plans for allocation. Authority to allocate credits may

be carried forward by agencies to the following calendar year. Unused credit allocations may be

returned to an agency for reallocation. Credit allocations may revert to the agency if less than 10

percent of the taxpayer's reasonably expected qualifying basis is expended within 6 months of

receiving the allocation. Authority not used in a timely manner reverts to a national pool for

distribution to States requesting additional authority. Agencies may award less than the

maximum credits generally applicable. Generally, a qualifying building must be placed in

service in the year the credit is allocated unless at least 10 percent of the taxpayer's reasonably

expected basis in the property is expended in the year of allocation or within 6 months of the

allocation date. Rules are provided for the allocation of costs to individual units in multi-unit

projects and to property that is part of a project but used for purposes other than rental housing.

The tax credit period begins with the taxable year in which qualified buildings are placed in

service (or, in certain circumstances, the succeeding taxable year). Credits are recaptured if the

required number of units is not rented to qualifying tenants for a period of 15 years.

Current law allows tax-exempt bonds (mortgage revenue bonds) to be issued by State and local

governments to finance mortgages at interest rates that are below-market for homebuyers who

meet certain income and purchase price limits. In general, eligible individuals must be first-time

homebuyers and have incomes of 115 percent (100 percent for families with less than 3

members) or less of the greater of area or statewide median gross income (applicable median

family income). The subsidy is recaptured under certain conditions if the home is sold within 9

years of the date of purchase.

Reasons for Change

The quality of life in distressed neighborhoods can be improved by increasing home ownership.

Existing buildings in these neighborhoods often need extensive renovation before they can

provide decent owner-occupied housing. Renovation may not occur because the costs involved

exceed the prices at which the housing units could be sold. Similarly, the costs of new
- 40 -

construction may exceed their market value. Properties will sit vacant and neighborhoods will

remain blighted unless the gap between development costs and market prices can be filled.

Proposal

The proposal would create a single-family housing tax credit (SFHTC). First-year credit

authority of $1.75 per resident would be made available annually to States (including U.S.

possessions) beginning in calendar year 2002. The per capita amount would be indexed for

inflation beginning in 2003. Pursuant to a plan of allocation, State or local housing credit

agencies would award first-year credits to housing units comprising a project for the

development of single-family housing in census tracts with median incomes of 80 percent or less

of area median income, based initially upon 2000 census data. Rules similar to the current law

rules for the LIHTC would apply regarding carry forward and return of unused credits and a

national pool for unused credits. Credits allocated to a project would revert to the agency unless

expenditures equal to 10 percent or more of reasonably expected qualifying costs were made

within 6 months of receipt of the allocation. Units in condominiums and cooperatives could

qualify as single-family housing. Credits would be awarded as a fixed amount for individual

units comprising a project. The present value of the credits with respect to a unit, as of the

beginning of the credit period (described below), could not exceed 50 percent of the qualifying

costs of the unit. For these purposes, present value would be determined based on the mid-term

Applicable Federal Rate in effect for the date the agency allocated credits to the project. Rules

similar to the current law rules for the LIHTC would apply to determine eligible costs of

individual units. The Treasury Department would have the authority to promulgate necessary

reporting requirements.

The taxpayer (developer or investor partnership) owning the housing unit immediately prior to

the date of sale to a qualified buyer (or, if later, the date a certificate of occupancy was issued)

would be eligible to claim SFHTCs over a 5-year period beginning on that date. No credits with

respect to a housing unit would be available unless the unit was sold within a 1-year period

beginning on the date a certificate of occupancy is issued with respect to that unit.

Eligible homebuyers would have incomes at 80 percent (70 percent for families with less than 3

members) or less of applicable median family income. They would not have to be first-time

homebuyers. Rules similar to the mortgage revenue bond provisions would apply to determine

applicable median family income. As in the case of mortgage revenue bonds, homebuyers would

be subject to recapture provisions in certain circumstances. In particular, recapture rules would

apply if the homebuyer (or a subsequent buyer) sold the property to a nonqualified buyer within

3 years of the date of initial sale of the unit. The recapture tax would equal the lesser of (1) 80

percent of the gain upon resale and (2) a recapture amount. The recapture amount would equal

the value of the credits allocated to the housing unit being resold, reduced by 1/36th of that value

for each month between the initial sale and the sale to a nonqualified buyer. No recapture

provision would apply to taxpayers eligible to claim SFHTCs. If a housing unit for which any

credit is claimed were converted to rental property within the first 5 years following the initial

purchase, no deductions for depreciation or property taxes could be claimed with respect to that

unit during that time period.

The proposal would be effective beginning with first-year credit allocations for calendar year

2002.
- 41 -

Encourage Saving

ESTABLISH INDIVIDUAL DEVELOPMENT ACCOUNTS (IDA’S)

Current Law

There is no tax provision under current law specifically targeted to low-income families to

encourage them to save and develop a pool of capital to be used for such purposes as a first-time

home purchase, higher education expenses or small business capitalization.

IDAs were first authorized under the Personal Work and Responsibility Act of 1996. The Assets

for Independence Act of 1998 established a five-year IDA demonstration program, with an

appropriation of $25 million per year. Under the program, certain individuals eligible for

Temporary Assistance for Needy Families (TANF, the successor to AFDC), or eligible for the

Earned Income Tax Credit (EITC) and who meet a net worth test, could open an IDA.

Individuals’ contributions receive no tax preference, but are matched by contributions from a

state program or a participating nonprofit organization. The matching contributions and their

earnings are not taxable to the individual. Withdrawals can be made for higher education, first

home purchase, or small business capitalization. Matching amounts are typically held separately

and, upon withdrawal, must be paid directly to a mortgage provider, university, or business

capitalization account at a financial institution. Match rates are chosen by the state or nonprofit

and must be between 50 and 400 percent. The IDA program is administered by the Department

of Health and Human Services.

Reasons for Change

One third of all Americans have no assets available for investment, and another twenty percent

have only negligible assets. The household savings rate of the United States lags far behind

other industrial nations, constraining national economic growth and preventing many Americans

from entering the economic mainstream by buying a house, obtaining an adequate education, or

starting a business.

Absent some inducement, financial institutions may not encourage the establishment of IDAs

because the administrative cost associated with the establishment and maintenance of small

accounts is large as a fraction of the account balance. In addition, financial education is an

essential component of a policy to assist lower-income persons in building assets. By helping

financial institutions and their non-profit partners to defray the costs associated with both

account administration and providing financial education, the credit will both stimulate savings

and encourage a sensible approach to lifetime financial planning.

Proposal

The Administration’s proposal would create a tax credit, subject to the provisions of the General

Business Credit, to defray the cost to financial institutions of establishing IDAs, contributing

matching funds to these accounts and providing financial education to account holders. The

range of financial institutions eligible to participate includes all those institutions eligible under

current law to serve as the custodian of IRAs. The goals and broad outline of this program are
- 42 -

similar to those of the IDA demonstration program; however, certain specific design features are

intended to facilitate administration through the tax system.

Individuals between the ages of 18 and 60, who are not students and meet certain income

requirements, would be eligible to establish and contribute to an IDA. For single filers, the

income limit would be $15,000 in AGI, while the corresponding thresholds for head-ofhousehold and joint filers would be $22,500 and $30,000 in AGI respectively. In all cases,

eligibility would be determined by the previous year’s AGI.

The credit provided to a financial institution sponsoring an IDA program would consist of three

components: First, a $70 per account credit could be claimed to offset in part the cost to the

financial institution of establishing the account and providing basic financial literacy training. A

second credit component, consisting of $30 per account per year, would offset the ongoing costs

to the financial institution of maintaining and administering the account. Finally, the financial

institution would be eligible to claim a 90-percent credit for up to $300 contributed to each

account annually, for a maximum credit of $270. Sponsoring financial institutions, in order to be

eligible for the credit, would be required to match account holder contributions on a dollar-fordollar basis and provide earnings on such amounts. Matching contributions and earnings thereon

would be tracked separately by the financial institution.

Individuals could withdraw their contributions and matching funds, along with earnings thereon,

for qualified purposes including certain higher education expenses, first-time home purchase,

and business start-up expenses. The financial institution at which the IDA is held would be

required to disburse the funds directly to another financial institution (in cases of home purchase

or business start-up) or to an institution of higher education. Non-qualified distributions would

result in the forfeiture of matching funds and earnings thereon. Matching funds and earnings

thereon would be available, without penalty, to the account holder for any purpose after he or she

attains the age of 62.

Contributions to IDAs by individuals would not be deductible and the earnings on such

contributions would be taxable to the account holder. Matching contributions and earnings on

such contributions would not be taxable to the account holder at any time.

The proposal would provide explicit regulatory authority to Treasury to adopt rules that will

permit financial institutions sponsoring IDA programs to verify the eligibility of individuals

seeking to open accounts and ensure that such individuals do not already possess accounts at

other institutions. Furthermore, the authority would extend to rules governing the recapture of

credits claimed by financial institutions with respect to non-eligible individuals and individuals

who, by virtue of making a non-qualified withdrawal of their contributions, forfeit matching

funds and earnings thereon.

The credit would be provided with respect to IDAs established between 2003 and 2007. The

annual maintenance credit as well as the credit for matching funds advanced by financial

institutions would be available for years between 2003 and 2009.
- 43 -

Protect the Environment

PERMANENTLY EXTEND EXPENSING OF BROWNFIELDS REMEDIATION COSTS

Current Law

Taxpayers can elect to treat certain environmental remediation expenditures that would

otherwise be chargeable to a capital account as deductible in the year paid or incurred. The

deduction applies for both regular and alternative minimum tax purposes. The expenditure must

be incurred in connection with the abatement of hazardous substances at a qualified

contaminated site (so-called “brownfields”).

Hazardous substances are defined generally for purposes of the brownfields provision by

reference to sections 101(14) and 102 of the Comprehensive Environmental Response,

Compensation, and Liability Act of 1980 (CERCLA). A qualified contaminated site generally is

any property that (1) is held for use in a trade or business, for the production of income, or as

inventory; (2) contains (or potentially contains) a hazardous substance; and (3) is certified by the

appropriate state environmental agency as to the presence (or potential presence) of a hazardous

substance. However, sites that are identified on the national priorities list under CERCLA do not

qualify as qualified contaminated sites.

The Community Renewal Tax Relief Act of 2000 extended the brownfields provision to

expenditures paid or incurred before January 1, 2004. In addition, the bill eliminated the targeted

area requirement included in the original provision, which generally restricted eligible sites to

areas with low median income as well as those within the boundaries of designated

empowerment zones and enterprise communities.

Reasons for Change

The Administration believes that encouraging environmental remediation is an important

national goal. The brownfields provision encourages the cleanup of contaminated brownfields,

thereby enabling them to be brought back into productive use in the economy and mitigating

potential harms to public health. Extending the special treatment accorded to brownfields on a

permanent basis would remove doubt among taxpayers as to the future deductibility of

remediation expenditures and would promote the goal of encouraging environmental

remediation.

Proposal

The expensing of brownfield remediation expenditures would be made permanent by eliminating

the restriction that qualified expenditures must be paid or incurred on or before December 31,

2003.
- 44 -

EXCLUDE 50 PERCENT OF GAINS FROM THE SALE OF PROPERTY FOR

CONSERVATION PURPOSES

Current Law

A taxpayer who sells property must generally recognize, and pay taxes on, the full amount of any

gain realized, even if the property is an interest in environmentally sensitive land or water and

the sale is to an entity that will protect the land or water from development. By contrast, to

encourage donations for conservation purposes, tax law provides a charitable contribution

deduction not only for gifts to charity of a taxpayer’s entire interest in property but also for

conservation-oriented donations of partial interests, such as remainder interests and conservation

easements. A charitable contribution deduction may also be available in certain cases where the

property is sold to a charity for less than its fair market value (that is, a “bargain sale”). In some

cases, if a qualified conservation easement has been donated, land burdened by that easement

may receive a reduced valuation for estate tax purposes.

Reasons for Change

Some landowners would take steps to preserve their land preserved in its undeveloped state or

protect special features of the land from development but may not be able to afford to simply

donate the land for conservation purposes, especially if the land is their primary salable asset.

For these taxpayers, the tax incentive for charitable contributions is ineffective in encouraging

preservation of the land. Land preservation would be encouraged, however, by reducing capital

gains taxes on sales of land or conservation easements to conservation charities or to

governments for conservation purposes. This would be a non-regulatory approach to

conservation and protection of the environment.

Proposal

When land (or an interest in land or water) is voluntarily sold for conservation purposes (as

defined below), only 50 percent of any capital gain would be included in the seller’s income.

The exclusion would be computed without regard to improvements. To be eligible for the partial

exclusion, the sale must be to a qualified conservation organization. A qualified conservation

organization is either a governmental unit or a charity that is a qualified organization under

section 170(h)(3) and that is organized and operated primarily for conservation purposes.

Conservation purposes means the preservation of land areas for outdoor recreation by, or the

education of, the general public; the protection of a relatively natural habitat of fish, wildlife, or

plants, or similar ecosystem; or the preservation of open space where the preservation is for the

scenic enjoyment of the general public or pursuant to a clearly delineated Federal, State, or local

governmental conservation policy.

The buyer must provide a written statement representing that it is a qualified conservation

organization and that it intends to hold the property exclusively for conservation purposes and

not to transfer it for valuable consideration other than to a qualified conservation organization in

a transaction that would qualify for this 50 percent exclusion if the buyer/transferor were taxable.

The partial exclusion would not be available for sales pursuant to a condemnation order but

would apply to any gain recognized in a sale that is made in response to the threat or imminence
- 45 -

of such an order. If the property sold is less than the taxpayer’s entire interest in the property, it

must satisfy requirements like those applicable to qualified conservation contributions under

section 170(h). In addition, the property sold must have been owned by the taxpayer or a

member of the taxpayer’s family for the three years immediately preceding the date of the sale.

The provision would be effective for sales taking place on or after the date of first committee

action.
- 46 -

Energy Policy Proposals

EXTEND AND MODIFY THE TAX CREDIT FOR PRODUCING ELECTRICITY

FROM CERTAIN SOURCES

Current Law

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

from wind, “closed-loop” biomass (organic material from a plant that is planted exclusively for

purposes of being used at a qualified facility to produce electricity), and poultry waste. The

credit amount is indexed for inflation after 1992 and is 1.7 cents per kilowatt hour in 2001. The

electricity must be sold to an unrelated third party and the credit is limited to the first 10 years of

production. In addition, the credit is reduced if the facility producing the electricity is financed

by governmental grants or subsidized energy financing, tax-exempt bonds, or other tax credits

(governmental financing). The percentage reduction in the credit is the same as the

governmental financing percentage of the total capital cost of the facility. The credit applies

only to facilities that are owned by the taxpayer claiming the credit and that are placed in service

before January 1, 2002.

Reasons for Change

The tax credit helps make electricity produced from wind and biomass competitive with other

forms of electricity. These renewable energy sources will be an important part of the Nation’s

long-term energy supply. Expanding eligible biomass sources would increase the production of

electricity from biomass.

Proposal

The credit for electricity produced from wind and biomass (but not poultry waste) would be

extended for three years to facilities placed in service before January 1, 2005. In addition,

eligible biomass sources would be expanded to include (i) closed-loop biomass and (ii) any solid,

nonhazardous, cellulosic waste material that is segregated from other waste materials and is

derived from: (a) any of the following forest-related resources: mill residues, pre-commercial

thinnings, slash and brush, but not including old growth timber or wood waste incidental to pulp

and paper production; (b) waste pallets, crates, and dunnage, and landscape or right-of-way tree

trimmings, but not including unsegregated municipal solid waste (garbage) and post-consumer

waste paper; or (c) agricultural sources, including orchard tree crops, vineyard, grain, legumes,

sugar, and other crop byproducts or residues. In addition, the rules relating to governmental

financing would be modified. There would be no percentage reduction in the credit for

governmental financing attributable to tax-exempt bonds. Instead, such financing would reduce

the credit only to the extent necessary to offset the value of the tax exemption.

Special rules would apply to facilities placed in service before January 1, 2002. Electricity

produced at such facilities from newly eligible sources would be eligible for the credit only from

January 1, 2002, through December 31, 2004. The credit for such electricity would be computed

at a rate equal to 60 percent of the generally applicable rate.
- 47 -

Electricity produced from newly eligible biomass co-fired in coal plants would be eligible for the

credit only from January 1, 2002, through December 31, 2004. The credit for such electricity

would be computed at a rate equal to 30 percent of the generally applicable rate.

In the case of a wind or biomass facility operated by a lessee, the proposal would permit the

lessee, rather than the owner, to claim the credit. This rule would apply to production under

leases entered into after the date on which the proposal is enacted.
- 48 -

PROVIDE TAX CREDIT FOR RESIDENTIAL SOLAR ENERGY SYSTEMS

Current Law

A 10-percent investment tax credit is provided to businesses 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. No credit is available for nonbusiness purchases of solar energy

equipment.

Reasons for Change

A tax credit for solar energy equipment used to generate electricity (photovoltaic equipment) or

heat water (solar water heating equipment) will reduce the cost of these investments and

encourage individuals to adopt these systems. Solar energy will be an important part of the

Nation’s long-term energy supply. Increasing the demand for these systems should also increase

private-sector research to reduce costs further and increase efficiency.

Proposal

Individuals that purchase photovoltaic equipment or solar water heating equipment for use in a

dwelling unit that the individual uses as a residence would be allowed a nonrefundable personal

credit equal to 15 percent of the cost of the equipment and its installation. Equipment would

qualify for the credit only if it is used exclusively for purposes other than heating swimming

pools. The Secretary of the Treasury would be authorized to prescribe regulations providing for

recapture of the credit if the equipment is used in a manner inconsistent with this requirement.

An individual would be allowed a cumulative maximum credit of $2,000 per residence for

photovoltaic equipment and $2,000 per residence for solar water heating equipment. The credit

would apply only to solar water heating equipment placed in service after December 31, 2001,

and before January 1, 2006, and to photovoltaic systems placed in service after December 31,

2001, and before January 1, 2008.
- 49 -

MODIFY TREATMENT OF NUCLEAR DECOMMISSIONING FUNDS

Current Law

Although accrual basis taxpayers generally may not deduct an item until economic performance

occurs, a taxpayer responsible for nuclear power plant decommissioning may elect to deduct

contributions made to a qualified nuclear decommissioning fund.

A qualified nuclear decommissioning fund is a segregated fund that is established by the

taxpayer, restricted to certain types of investments, and used exclusively for the payment of

decommissioning costs, taxes on fund income, and management costs. Contributions to the fund

are deductible in the year made to the extent they were collected as part of the cost of service to

ratepayers. Withdrawals from the fund to pay for decommissioning expenses are included in

income at the time of withdrawal, but the taxpayer also is entitled to a deduction for

decommissioning expenses as economic performance for those costs occurs. A 20-percent tax

rate applies to the taxable income of the fund.

Nuclear decommissioning costs are otherwise deductible (without regard to section 280B)

expenses to be incurred in connection with the entombment, decontamination, dismantlement,

removal, and disposal of a nuclear plant that has permanently ceased the production of

electricity.

Accumulations in a qualified fund are limited to the amount necessary to pay post-1983 nuclear

decommissioning costs (determined as if decommissioning costs accrued ratably over the

estimated useful life of the plant). To prevent accumulations of funds in excess of those required

to pay post-1983 decommissioning costs and to ensure that contributions to the fund are not

deducted more rapidly than level funding, taxpayers are required to obtain a ruling from the IRS

to establish the maximum annual contribution that may be made to the fund. Taxpayers are

required to obtain subsequent rulings setting new ruling amounts in certain instances.

A qualified fund may be transferred in connection with the sale, exchange, or other transfer of

the nuclear power plant to which it relates. If the transferee is eligible to maintain a qualified

fund and continues to maintain the fund after the transfer while satisfying certain other

conditions, the regulations treat the transfer as a nontaxable transaction. No gain or loss is

recognized on the transfer of the qualified decommissioning fund and the transferee takes the

transferor’s basis in the fund. The regulations also permit the IRS to treat a transfer that does not

satisfy these conditions as a nontaxable transaction (with continued qualification of the fund)

when that is necessary and appropriate to carry out the purposes of the statutory and regulatory

provisions relating to qualified funds.

Regulators may also require utilities to set aside amounts for nuclear decommissioning in excess

of the amount allowed as a deductible contribution. In addition, pursuant to regulatory

requirements, taxpayers may have set aside amounts for nuclear decommissioning prior to the

enactment of the qualified fund rules in 1984. The treatment of these pre-1984 amounts varies.

Some taxpayers may have received no tax benefit while others may have deducted the amounts

or excluded the amounts from gross income.
- 50 -

Reasons for Change

The Administration is concerned that appropriate incentives be provided to insure adequate funds

are available for the decommissioning of nuclear power plants. The favorable tax treatment of

contributions to nuclear decommissioning funds recognizes the national importance of the

establishment of segregated reserve funds for paying nuclear decommissioning costs. Although

the favorable tax treatment was adopted at a time when nuclear power plants were operated by

regulated public utilities, deregulation will not reduce the need for such funds. Deregulation

will, however, generally eliminate traditional cost of service determinations for ratemaking

purposes. In many cases, a line charge or other fee will be imposed by a State or local

government or a public utility commission to ensure that adequate funds will be available for

decommissioning, but there is no assurance that this will be the case under all State deregulation

plans.

State deregulation plans frequently require utilities to divest electricity generation assets,

including nuclear power plants and related nuclear decommissioning funds. The transferor of a

nuclear power plant also may be required to fund the full amount of the plant’s decommissioning

costs in connection with the transfer. The policy of limiting fund accumulations to the amount

necessary to pay post-1983 nuclear decommissioning costs may discourage these transactions

and increase the risk that decommissioning costs will not be adequately funded.

Deregulation has also made it increasingly common for nuclear decommissioning funds to be

transferred in transactions that do not satisfy the generally applicable regulatory conditions for

nontaxability. Uncertainty concerning the tax treatment of these transfers may be impeding the

transition to deregulated electricity markets.

Proposal

The cost of service limitation would be eliminated. Thus, unregulated taxpayers would be

allowed a deduction for amounts contributed to a qualified nuclear decommissioning fund.

The maximum contribution and deduction for a taxable year generally would be limited to the

ruling amount obtained from the IRS, but taxpayers would be permitted to make contributions in

excess of the ruling amount in two cases. First, taxpayers would be permitted to make transfers

to a qualified fund of amounts held in certain nonqualified nuclear decommissioning funds to the

extent such amounts do not exceed the present value of the amount required to pay the plant’s

pre-1984 decommissioning costs. Transfers would be permitted from a fund in which amounts

are irrevocably set aside pursuant to the requirements of a State or Federal agency exclusively

for the purpose of funding the decommissioning of the nuclear power plant. Second, if the

present value of the amount required to pay the plant’s pre-1984 decommissioning costs exceeds

the amount held in such nonqualified funds, the taxpayer would be permitted to contribute an

amount equal to the excess. Any portion of the amount transferred under these rules that exceeds

the amount previously deducted (other than under the qualified fund rules) or excluded from the

taxpayer’s gross income on account of the taxpayer’s liability for decommissioning costs would

be allowed as a deduction ratably over the remaining useful life of the nuclear power plant. If

the qualified fund is subsequently transferred, deductions under this rule for periods subsequent

to the transfer will be allowed to the transferee rather than the transferor unless the transferor is
- 51 -

tax exempt. Accumulations in the fund attributable to amounts contributed under these rules

would not be taken into account in determining the ruling amount for the fund.

The treatment of transfers of qualified funds would be clarified. Any transfer of a qualified fund

in connection with the transfer of the power plant with respect to which the fund was established

would be nontaxable and no gain or loss will be recognized by the transferor or transferee as a

result of the transfer.

The proposal would also permit taxpayers to make deductible contributions to a qualified fund

after the end of the nuclear power plant’s estimated useful life and would provide that nuclear

decommissioning costs are deductible when paid.

The proposal would be effective for taxable years beginning after December 31, 2001.
- 52 -

ONE-YEAR EXTENSION OF PROVISIONS EXPIRING IN 2001

EXTEND THE WORK OPPORTUNITY TAX CREDIT

Current Law

Under current law, employers are generally entitled to a Work Opportunity Tax Credit (WOTC)

for the first $6,000 of wages paid to several target groups of economically disadvantaged

workers or workers with disabilities. The maximum WOTC credit is generally $2,400 per

worker. For workers employed between 120 and 400 hours, the WOTC credit rate is 25 percent

of qualified wages. For workers employed over 400 hours, the WOTC credit rate is 40 percent.

Employers must reduce their deduction for wages paid by the amount of the credit claimed. The

minimum employment period that employees must work before employers can claim the WOTC

credit is 120 hours.

Current WOTC target groups include qualified: (1) recipients of Temporary Assistance to Needy

Families (TANF), (2) veterans, (3) ex-felons, (4) high-risk youth, (5) participants in Statesponsored vocational rehabilitation programs, (6) summer youth, (7) food stamp recipients, and

(8) Supplemental Security Income (SSI) recipients.

The credit is effective for workers hired before January 1, 2002.

Reasons for Change

The goal of the Work Opportunity Tax Credit is to provide employers with a tax incentive to hire

and retain individuals who want to work but are likely to have 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 provide them with on-the-job training that will improve

their labor market skills.

Proposal

The Work Opportunity Tax Credit would be extended for one year, so that the credit would be

effective for individuals who begin work before January 1, 2003.
- 53 -

EXTEND THE WELFARE-TO-WORK TAX CREDIT

Current Law

The Welfare-to-Work (WTW) Tax Credit enables employers to claim a tax credit for eligible

wages paid to certain long-term welfare 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 maximum credit is $8,500 per qualified

employee. Employers must reduce their deduction for eligible wages paid to qualified employees

by the amount of WTW credits claimed. The minimum employment period that employees must

work before employers can claim the WTW credit is 400 hours.

A qualified long-term welfare recipient is: (1) a member of a family that has received

Temporary Assistance for Needy Families (TANF) for at least 18 consecutive months ending on

the hiring date; (2) a member of a family that has received TANF for a total of 18 months after

August 5, 1997, provided the hiring date is within two years of the date when the 18 month total

is reached; or (3) a member of a family ineligible for TANF because of any Federal- or Stateimposed time limit, if the family member is hired within two years of the date of benefit

cessation.

Eligible wages are defined to include amounts paid by the employer for: (1) educational

assistance excludable under a section 127 program; (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 Welfare-to-Work Tax Credit is effective for individuals who begin work before January 1,

2002.

Reasons for Change

Extending the Welfare-to-Work Tax Credit would continue to encourage employers to hire,

invest in training, and provide certain benefits and more permanent employment to long-term

welfare recipients who need stable jobs to support their families.

Proposal

The Welfare-to-Work Tax Credit would be extended for one year, so that the credit would be

effective for individuals who begin work before January 1, 2003.
- 54 -

EXTEND EXCLUSION FOR EMPLOYER-PROVIDED EDUCATIONAL ASSISTANCE

Current Law

Section 127 provides that an employee’s gross income and wages do not include amounts paid or

incurred by the employer for educational assistance provided to the employee if such amounts

are paid or 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 is job-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 January 1, 2002.

Reasons for Change

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

facing global competition. Extension of section 127 will expand educational opportunity,

increase productivity, and encourage retraining of current and former employees to reflect the

changing needs of the workplace. In addition, extending section 127 will simplify the rules for

employers and workers by eliminating the need to distinguish between job-related training and

other employer-provided educational assistance.

Proposal

The current law exclusion would be extended through December 31, 2002.
- 55 -

EXTEND MINIMUM TAX RELIEF FOR INDIVIDUALS

Current Law

Taxpayers are subject to an alternative minimum tax (AMT) if their tentative minimum tax is

greater than their regular tax liability. Taxable income for AMT purposes is calculated

differently than for regular tax purposes. Under the AMT, certain income items are included that

are not included for regular tax purposes. Also, certain deductions, including state and local tax

deductions, miscellaneous itemized deductions, and the standard deduction, are not permitted. In

addition, for AMT purposes, taxpayers may not deduct the personal exemptions they are allowed

under the regular income tax. The AMT does has an exclusion amount, which differs by filing

status but not by the number of persons in the tax-filing unit.

Under a temporary provision that expires after 2001, non-refundable personal tax credits can be

used to reduce both regular tax liability (regardless of the AMT) and AMT liability. Beginning

in 2002, taxpayers are allowed to use these credits only to the extent their regular tax liability

exceeds their tentative minimum tax.

Reasons for Change

The original individual minimum tax was enacted to ensure that taxpayers with substantial

amounts of economic income did not avoid significant tax liability by using exclusions,

deductions, and credits. The Administration believes that allowing middle-income families to

use non-refundable personal tax credits in full would not undermine the policy of the AMT and

would promote the important social policies underlying the credits.

Moreover, the Administration believes that allowing these credits to be used in full would result

in significant simplification. Substantially fewer taxpayers would need to perform complex and

tedious computations to determine whether their personal credits were affected by the AMT.

Proposal

The temporary provision allowing non-refundable personal tax credits other than the child tax

credit to reduce both regular tax liability (regardless of the AMT) and AMT liability would be

extended for one year. A separate proposal, included with the proposal to increase the child tax

credit, would permanently allow the child tax credit to reduce both regular tax liability

(regardless of the AMT) and AMT liability and would provide that refundable credits would no

longer be reduced by AMT liability.
- 56 -

EXTEND EXCEPTIONS PROVIDED UNDER SUBPART F FOR CERTAIN ACTIVE

FINANCING INCOME

Current Law

Under the subpart F rules, certain U.S. shareholders of a controlled foreign corporation (CFC)

are subject to current U.S. tax on certain income earned by the CFC, whether or not the income

is distributed to the shareholders. The income subject to current U.S. tax under the subpart F

rules includes, among other things, foreign personal holding company income and insurance

income. Foreign personal holding company income generally includes many types of income

derived by a financial services company, such as dividends, interest, royalties, rents and

annuities; net gains from the sale of certain property, including securities, commodities and

foreign currency; and income from notional principal contracts and securities lending activities.

A temporary exception from subpart F for certain income that is derived in the active conduct of

a banking, financing, insurance or similar business applies only for taxable years beginning on or

before December 31, 2001.

Reasons for Change

The subpart F rules are designed to subject to current U.S. tax the income earned by CFCs that is

either passive or easily moveable. However, without the exception, the rules will subject certain

active financing income to current U.S. tax when the income is neither passive nor easily

moveable.

Proposal

The proposal would extend the exclusion of certain active financing income from the subpart F

rules to taxable years beginning in 2002.
- 57 -

EXTEND SUSPENSION OF NET INCOME LIMITATION ON PERCENTAGE

DEPLETION FROM MARGINAL OIL AND GAS WELLS

Current Law

Taxpayers are allowed a deduction for depletion of oil and gas wells. Independent oil and gas

producers and royalty owners may determine part or all of this deduction using the percentage

depletion method. (Percentage depletion is also allowed with respect to certain fixed-price gas

contracts and natural gas from geopressured brine.) For any taxable year, the amount deducted

under the percentage depletion method with respect to an oil or gas property generally may not

exceed 100 percent of the net income from the property. For domestic production from marginal

wells, however, the 100-percent-of-net-income limitation has been suspended for taxable years

beginning after December 31, 1997, and before January 1, 2002.

Reasons for Change

A further extension of the tax incentive and relief provision relating to marginal wells that is

scheduled to expire in calendar year 2000 would avoid production disruptions and allow the

Administration and Congress to evaluate the need for additional extensions or other

modifications of the provision.

Proposal

The suspension of the 100-percent-of-net-income limitation for marginal wells would be

extended for one year. Thus, the limitation would not apply for taxable years beginning in 2002.
- 58 -

EXTEND AUTHORITY TO ISSUE QUALIFIED ZONE ACADEMY BONDS

Current Law

Under current law, State and local governments can issue qualified zone academy bonds

(QZABs) to fund the improvement of certain eligible public schools. An eligible holder of a

QZAB 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 for a QZAB is set on its day of sale by reference

to credit rates established by the Department of the Treasury. The maximum term of a QZAB

issued during any month is determined by reference to the adjusted applicable Federal rate

(AFR) published by the Internal Revenue Service for the month in which the bond is issued. The

higher the AFR, the shorter the maximum term (rounded to whole years) so as to keep the extent

of the Federal subsidy approximately equal to half the face amount of the bond.

Current law establishes authority to issue $400 million of QZABs for each year from 1998

through 2001. 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

QZABs may be carried forward for two years (three years for authority arising in 1998 and 1999)

after the year for which the authority was established.

A number of requirements must be met for a bond to be treated as a QZAB. First, the bond must

be issued pursuant to an allocation of bond authority from the issuer's State educational agency.

Second, at least 95 percent of the bond proceeds must be used for an eligible purpose at a

qualified zone academy. Eligible purposes include rehabilitating school facilities, acquiring

equipment, developing course materials, or training teachers. A qualified zone academy is a

public school (or an academic program within a public school) that is designed in cooperation

with business and is either (1) located in an empowerment zone or enterprise community, or (2)

attended by students at least 35 percent of whom are estimated to be eligible for free or reducedcost lunches under the National School Lunch Act. Third, private entities must have promised to

contribute to the qualified zone academy certain property or services with a present value equal

to at least 10 percent of the bond proceeds.

Reasons for Change

Aging school buildings and new educational technologies create a need to renovate older school

buildings and to develop new curricula. Many school systems have insufficient fiscal capacity to

finance needed renovation and programs. The QZAB provision encourages the development of

innovative school programs through public/private partnerships.

Proposal

An additional $400 million of authority to issue QZABs would be provided for 2002.
05-Apr-01 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2001-2006 2001-2011

Provision:

President's Agenda for Tax Relief Presented To Congress On February 8th

Create new 10-percent individual income tax bracket -- -5,678 -13,847 -21,932 -29,849 -37,407 -39,734 -40,281 -40,602 -40,685 -40,603 -108,713 -310,618

Reduce individual income tax rates -- -11,793 -21,047 -33,493 -42,306 -57,299 -63,741 -65,454 -67,020 -68,550 -69,963 -165,938 -500,666

Increase the child tax credit 2/ -- -1,238 -7,720 -11,908 -17,057 -21,923 -26,506 -27,422 -28,164 -28,875 -29,535 -59,846 -200,348

Reduce the marriage penalty -- -1,435 -4,844 -7,773 -10,343 -12,675 -14,125 -14,645 -15,154 -15,657 -16,183 -37,070 -112,834

Provide charitable contribution deduction for nonitemizers -- -482 -1,690 -2,963 -4,448 -6,065 -6,988 -7,087 -7,306 -7,500 -7,642 -15,648 -52,171

Permit tax-free withdrawals from IRAs for charitable contributions -- -53 -181 -195 -210 -225 -241 -258 -277 -299 -322 -864 -2,261

Raise the cap on corporate charitable contributions -- -85 -136 -136 -143 -149 -159 -169 -178 -202 -222 -649 -1,579

Increase and expand education savings accounts -- -3 -25 -88 -204 -373 -593 -829 -1,037 -1,206 -1,287 -693 -5,645

Permanently extend the R&E tax credit -- -- -- -1,055 -3,431 -5,415 -6,543 -7,388 -8,019 -8,567 -9,158 -9,901 -49,576

Phase out death tax -152 -4,899 -10,405 -11,455 -13,517 -16,534 -21,757 -31,747 -40,291 -58,397 -62,346 -56,962 -271,500

Total President's Agenda for Tax Relief Presented To Congress February 8th -152 -25,666 -59,895 -90,998 -121,508 -158,065 -180,387 -195,280 -208,048 -229,938 -237,261 -456,284 -1,507,198

Additional Tax Incentives

Strengthen and Reform Education

Allow teachers to deduct out-of-pocket classroom expenses -- -21 -214 -249 -268 -286 -287 -289 -290 -292 -293 -1,038 -2,489

Allow tax-free distributions from Qualified State Tuition plans for

 certain higher education expenses and allow private colleges to

 offer prepaid tuition plans -- -4 -20 -42 -66 -90 -114 -136 -160 -189 -214 -222 -1,035

Allow states to issue tax-exempt private activity bonds for

 school construction -- -1 -4 -10 -15 -20 -26 -31 -36 -42 -47 -50 -232

Invest in Health Care

Provide refundable tax credit for the purchase of health

 insurance 3/ -- -300 -3,427 -5,187 -7,705 -8,170 -8,991 -9,285 -9,420 -9,496 -9,552 -24,789 -71,533

Provide above-the-line deduction for long-term care insurance

 premiums -- -273 -378 -404 -560 -1,097 -1,937 -2,362 -2,644 -2,944 -3,285 -2,712 -15,884

Allow up to $500 in unused benefits in a health flexible spending

 arrangement to be carried forward to the next year -- -200 -600 -700 -750 -800 -850 -900 -950 -1,000 -1,070 -3,050 -7,820

Provide additional choice with regard to unused benefits in a

 health flexible spending arrangement -- -10 -30 -36 -41 -47 -54 -63 -73 -85 -101 -164 -540

Permanently extend and reform Archer MSAs -- -100 -400 -425 -446 -469 -492 -517 -542 -570 -598 -1,840 -4,559

Provide an additional personal exemption to home caretakers of 

 family members -- -305 -432 -460 -502 -525 -533 -554 -568 -567 -559 -2,224 -5,005

Provide tax relief for awards under certain health education

 programs -- 0 -1 -2 -1 0 0 0 0 -1 -1 -4 -6

($'s in millions)

Revenue Estimates 1/

FY 2002 President's Budget

Preliminary

Fiscal Years
05-Apr-01 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2001-2006 2001-2011

Provision:

($'s in millions)

Fiscal Years

Assist Americans With Disabilities

Exclude from income the value of employer-provided computers,

 software and peripherals -- -2 -5 -5 -6 -6 -6 -6 -6 -6 -7 -24 -55

Strengthen Families

Permanently extend and increase the adoption tax credit -- -20 -197 -204 -212 -221 -230 -232 -234 -236 -238 -854 -2,024

Help Farmers and Fisherman Manage Economic Downturns

Establish Farm, Fish and Ranch Risk Management (FFARRM)

 savings accounts -- -79 -216 -154 -113 -86 -70 -60 -50 -43 -38 -648 -909

Increase Housing Opportunities

Provide tax credit for developers of affordable single-family

 housing -- -4 -45 -198 -516 -970 -1,487 -1,986 -2,365 -2,572 -2,643 -1,733 -12,786

Encourage Saving

Establish Individual Development Accounts (IDAs) -- -- -155 -270 -288 -305 -312 -151 -39 -15 -1 -1,018 -1,536

Promote Trade

Expand and extend Andean trade preferences 4/ -- -190 -198 -205 -214 -55 0 0 0 0 0 -862 -862

Protect the Environment

Permanently extend expensing of brownfields remediation costs -- -- -- -235 -372 -363 -354 -343 -331 -321 -309 -970 -2,628

Exclude 50 percent of gains from the sale of property for

 conservation purposes -18 -81 -89 -95 -104 -117 -136 -160 -195 -245 -314 -504 -1,554

Energy Policy Proposals

Extend and modify the tax credit for producing electricity

 from certain sources -- -116 -203 -222 -125 -58 -59 -57 -55 -56 -57 -724 -1,008

Provide tax credit for residential solar energy systems -- -7 -15 -19 -25 -31 -20 -16 -7 0 0 -97 -140

Modify treatment of nuclear decommissioning funds -- -54 -104 -124 -137 -151 -164 -179 -194 -210 -227 -570 -1,544

Total Additional Tax Incentives -18 -1767 -6733 -9246 -12466 -13867 -16122 -17327 -18159 -18890 -19554 -44097 -134149
05-Apr-01 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2001-2006 2001-2011

Provision:

($'s in millions)

Fiscal Years

One-Year Extension of Provisions Expiring In 2001

Extend the work opportunity tax credit -- -60 -154 -118 -52 -31 -9 0 0 0 0 -415 -424

Extend the welfare-to-work tax credit -- -12 -36 -36 -24 -17 -10 -2 0 0 0 -125 -137

Extend exclusion for employer-provided educational assistance -- -247 -110 0 0 0 0 0 0 0 0 -357 -357

Extend minimum tax relief for individuals -- -119 -477 0 0 0 0 0 0 0 0 -596 -596

Extend exceptions provided under subpart F for certain

 active financing income -- -807 -556 0 0 0 0 0 0 0 0 -1,363 -1,363

Extend suspension of net income limitation on percentage

 depletion from marginal oil and gas wells -- -20 -13 0 0 0 0 0 0 0 0 -33 -33

Extend Generalized System of Preferences (GSP) 4/ -- -346 0 0 0 0 0 0 0 0 0 -346 -346

Extend authority to issue Qualified Zone Academy Bonds -- -3 -9 -16 -18 -18 -18 -18 -18 -18 -18 -64 -154

Total One-Year Extension of Provisions Expiring In 2001 0 -1614 -1355 -170 -94 -66 -37 -20 -18 -18 -18 -3299 -3410

Total Effect on Receipts -170 -29,047 -67,983 -100,414 -134,068 -171,998 -196,546 -212,627 -226,225 -248,846 -256,833 -503,680 -1,644,757

Department of the Treasury

Office of Tax Analysis

1/ Estimates for several provisions differ from estimates included in Table 3-3 of the Analytical Perspectives of the President's Budget, which presents only the effect on receipts of the Administration's

legislative proposals. Estimates presented here for certain provisions identified below, include the effects on both receipts and outlays. Moreover, estimates were revised as proposals were finalized.

2/ The proposal to increase the child credit has both receipts and outlay effects. The outlay effect for the proposal is $215 million, $453 million, $710 million, $960 million,

$1,210 million, $1,145 million, $1,066 million, $999 million and $933 million in fiscal years 2003 - 2011, respectively.

3/ The proposal to provide a refundable credit for the purchase of health insurance has both receipts and outlay effects. The outlay effect for the proposal is $300 million,

$3,427 million, $5,187 million, $7,705 million, $8,170 million, $8,991 million, $9,285 million, $9,420 million $9,496 million and $9,552 million in fiscal years 2002 - 2011, respectively.

4/ These proposals are included in the FY 2002 Budget, but not described in these General Explanations. The estimates are net of income tax offsets.