General Explanations 

of the 

Administration’s Fiscal Year 2005 

Revenue Proposals

Department of the Treasury 

February 2004 
GENERAL EXPLANATIONS OF THE ADMINISTRATION’S FISCAL YEAR 2005 REVENUE

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

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

MAKE PERMANENT THE TAX CUTS ENACTED IN 2001 AND 2003 ............................................................3

EXTEND THROUGH 2010 CERTAIN PROVISIONS OF THE 2003 JOBS AND GROWTH TAX CUT.....................................3

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

..................................................................................................................................................................................5

TAX INCENTIVES.....................................................................................................................................................7

SIMPLIFY AND ENCOURAGE SAVING .........................................................................................................................7

Expand tax-free savings opportunities ...................................................................................................................7

Consolidate employer-based savings accounts ....................................................................................................13

Establish Individual Development Accounts (IDAs) ............................................................................................18

INVEST IN HEALTH CARE.........................................................................................................................................21

Provide refundable tax credit for the purchase of health insurance ....................................................................21

Provide an above-the-line deduction for high deductible insurance premiums ...................................................25

Provide an above-the-line deduction for long-term care insurance premiums ....................................................27

Provide an additional personal exemption to home caregivers of family members .............................................29

Allow the orphan drug tax credit for certain pre-designation expenses...............................................................31

Clarify the Health Coverage Tax Credit ..............................................................................................................32

PROVIDE INCENTIVES FOR CHARITABLE GIVING .....................................................................................................33

Provide charitable contribution deduction for non-itemizers ..............................................................................33

Permit tax-free withdrawals from IRAs for charitable contributions...................................................................34

Expand and increase the enhanced charitable deduction for contributions of food inventory ............................36

Reform excise tax based on investment income of private foundations................................................................38

Modify tax on unrelated business taxable income of charitable remainder trusts ...............................................40

Modify basis adjustment to stock of S corporations contributing appreciated property ......................................42

Repeal the $150 million limitation on qualified 501(c)(3) bonds.........................................................................43

Repeal certain restrictions on the use of qualified 501(c)(3) bonds for residential rental property ....................44

STRENGTHEN EDUCATION .......................................................................................................................................46

Extend, increase and expand the above-the-line deduction for qualified out-of-pocket classroom expenses ......46

ENCOURAGE TELECOMMUTING ...............................................................................................................................48

Exclude from income the value of employer-provided computers, software and peripherals..............................48

INCREASE HOUSING OPPORTUNITIES.......................................................................................................................49

Provide tax credit for developers of affordable single-family housing ................................................................49

PROTECT THE ENVIRONMENT ..................................................................................................................................52

Permanently extend expensing of brownfields remediation costs ........................................................................52

Exclude 50 percent of gains from the sale of property for conservation purposes...............................................53

INCREASE ENERGY PRODUCTION AND PROMOTE ENERGY CONSERVATION ............................................................55

Extend and modify the tax credit for producing electricity from certain sources ................................................55

Provide tax credit for residential solar energy systems........................................................................................57

Modify treatment of nuclear decommissioning funds...........................................................................................58

Provide tax credit for purchase of certain hybrid and fuel cell vehicles..............................................................61

Provide tax credit for energy produced from landfill gas ....................................................................................65

Provide tax credit for combined heat and power property...................................................................................67

Extend excise tax exemption (credit) for ethanol..................................................................................................69

Permit electric utilities to defer gain from sales of electric transmission property..............................................70

Modify tax treatment of certain income of electric cooperatives..........................................................................72

SIMPLIFY THE TAX LAWS FOR FAMILIES ....................................................................................................73

Establish uniform definition of a qualifying child ................................................................................................73

Simplify adoption tax benefits...............................................................................................................................80

Eliminate household maintenance test for head-of-household filing status .........................................................82

Reduce computational complexity of refundable child tax credit.........................................................................84

Simplify EITC eligibility requirements regarding filing status, presence of children, investment income and 

work and immigrant status............................................................................................................................86

i 
Simplify the taxation of dependents......................................................................................................................91

Consolidate rules for lifetime learning credit, HOPE credit and education expense deductions, and simplify 

other higher education provisions.................................................................................................................93

Allow annual reporting and payment of combined State and federal unemployment insurance taxes by

employers of household employees ...............................................................................................................99

Simplify taxation of capital gains on collectibles, small business stock and other assets ..................................101

STRENGTHEN THE EMPLOYER BASED PENSION SYSTEM....................................................................103

Ensure fair treatment of older workers in cash balance conversions and protect defined benefit plans ...........103

Improve the accuracy of pension liability measures ..........................................................................................107

CLOSE LOOPHOLES AND IMPROVE TAX COMPLIANCE........................................................................111

Combat abusive tax avoidance transactions ......................................................................................................111

Limit related party interest deductions...............................................................................................................115

Modify qualification rules for tax-exempt property casualty insurance companies...........................................116

Increase penalties for false or fraudulent statements made to promote abusive tax shelters.............................119

Prevent abusive overvaluations on donations of patents and other intellectual property..................................120

Prevent overvaluations and other abuses in charitable donations of used vehicles...........................................122

Reform the tax treatment for leasing transactions with tax-indifferent parties..................................................124

Ensure foreign subsidiaries of U.S. companies cannot inappropriately avoid U.S. tax on foreign earnings 

invested in U.S. property through use of the exceptions for bank deposits .................................................129

Modify tax rules for individuals who give up U.S. citizenship or green card status...........................................130

Expand tax shelter exception for federal practitioner privilege.........................................................................132

Extend the statute of limitations for reportable transactions where a taxpayer fails to disclose on return as

required.......................................................................................................................................................133

Require increased reporting for noncash charitable contributions....................................................................134

Clarify the consequences of changing the benficiary of a qualified tuition program.........................................136

TAX ADMINISTRATION AND UNEMPLOYMENT INSURANCE ...............................................................139

IMPROVE TAX ADMINISTRATION...........................................................................................................................139

Implement IRS administrative reforms ...............................................................................................................139

Make Section 1203 of the IRS Restructuring and Reform Act of 1998 more effective and fair......................................... 139

Curb the use of frivolous submissions and filings made to impede or delay tax administration ........................................ 141

Authorize partial-liability installment agreements.............................................................................................................. 142

Allow for the termination of installment agreements for failure to file returns and for failure to make tax deposits ......... 143

Consolidate judicial review of collection due process cases in the United States Tax Court ............................................. 144

Eliminate the monetary threshold for counsel review of offers in compromise ................................................................. 146

Initiate IRS Cost Saving Measures .....................................................................................................................147

Allow the Financial Management Service to retain transaction fees from levied amounts ................................................ 147

Extend the due date for electronically filed returns ............................................................................................................ 148

Repeal section 132 of the Revenue Act of 1978 and amend the tax code to authorize the Secretary of the 

Treasury to issue rules to address inappropriate nonqualified deferred compensation arrangements ......149

Permit private collection agencies to engage in specific, limited activities to support IRS collection efforts....151

Increase continuous levy for certain federal payments ......................................................................................154

STRENGTHEN FINANCIAL INTEGRITY OF UNEMPLOYMENT INSURANCE ................................................................155

Strengthen the financial integrity of the unemployment insurance system by reducing tax avoidance and

improper benefit payments ..........................................................................................................................155

REAUTHORIZE FUNDING FOR THE HIGHWAY TRUST FUND ...............................................................157

Deposit full amount of excise tax imposed on gasohol in the Highway Trust Fund...........................................157

Impose additional registration requirements on the transfer of tax-exempt fuel by pipeline, vessel, or barge..158

Repeal installment method for payment of heavy highway vehicle use tax ........................................................160

Allow tax-exempt financing for private highway projects and rail-truck transfer facilities...............................161

EXPIRING PROVISIONS .....................................................................................................................................163

Extend minimum tax relief for individuals..........................................................................................................163

Permanently extend research and experimentation (R&E) tax credit................................................................165

Repeal the disallowance of certain deductions of mutual life insurance companies..........................................167

Permanently extend and expand disclosure of tax return information for administration of student loans.......169

ii 
Extend and modify work opportunity tax credit and welfare-to-work tax credit................................................170

Extend the District of Columbia Enterprise Zone ..............................................................................................173

Extend the first-time homebuyer credit for the District of Columbia .................................................................174

Extend authority to issue Qualified Zone Academy Bonds.................................................................................175

Extend deduction for corporate donations of computer technology...................................................................177

Extend allowance of net operating loss offset of 100 percent of alternative minimum taxable income .............178

Permanently extend IRS user fees ......................................................................................................................179

Extend provisions permitting disclosure of return information relating to terrorism ........................................180

Extend authority to issue Liberty Zone Bonds....................................................................................................181

Extend excise tax on coal at current rates..........................................................................................................183

EXPAND PROTECTIONS FOR MEMBERS OF THE ARMED FORCES.....................................................185

RESPOND TO FOREIGN SALES CORPORATION/EXTRATERRITORIAL INCOME DECISIONS .....187

REVENUE ESTIMATES TABLE.........................................................................................................................191

iii 
GENERAL EXPLANATIONS OF THE ADMINISTRATION’S FISCAL YEAR 2005 

REVENUE PROPOSALS 

Introduction 

This report summarizes the revenue proposals in the Administration’s Fiscal Year 2005 Budget. 

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

essential for promoting economic growth and higher levels of income in the future. The other 

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

including encouraging saving, investing in health care, providing incentives for charitable giving, 

strengthening education, encouraging telecommuting, increasing housing opportunities, 

protecting the environment, and increasing energy production and promoting energy 

conservation as well as simplifying the tax laws. Additionally included are proposals to 

strengthen the employer based pension system, close loopholes and improve tax compliance, 

improve tax administration as well as proposals related to highway reauthorization and proposals 

to extend expiring tax provisions. 

The Administration’s ongoing tax simplification project, which is focusing on immediately 

achievable reforms of the current tax system, has produced several proposals that appear in this 

year’s Budget. In addition to the nine proposals appearing under the heading, Simplify the Tax 

Laws for Families, the simplification proposals include expanding tax-free savings opportunities, 

consolidating employer based savings accounts, simplifying use of the orphan drug tax credit for 

pre-designation costs, repealing the $150 million limitation on qualified 501(c)(3) bonds, 

repealing restrictions on the use of qualified 501(c)(3) bonds in providing residential rental 

housing, exclusion from income of the value of employer-provided computers, and conforming 

and simplifying the Work Opportunity Tax Credit and the Welfare to Work Tax Credit. 

1 
 2 
MAKE PERMANENT THE TAX CUTS ENACTED IN 2001 AND 2003 

Extend Through 2010 Certain Provisions of the 2003 Jobs and Growth Tax Cut 

Current Law 

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) gradually phased 

in the reduction in individual income tax rates and other tax benefits for individuals and families. 

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) accelerated 

implementation of the major EGTRRA provisions, but some provisions (described below) were 

accelerated only for 2003 and 2004. Beginning in 2005, these provisions will revert to the lower 

levels specified by EGTRRA’s phase-in schedule. 

Child Tax Credit. EGTRRA increased the child tax credit from $500 to $1,000 over a period of 

ten years. The credit was increased to $600 for 2001 through 2004, $700 for 2005 through 2008, 

$800 for 2009, and $1,000 for 2010. JGTRRA increased the child tax credit to $1,000 in 2003 

and 2004. The credit will revert to $700 in 2005 and phase-up to $1,000 by 2010. 

10-Percent Rate Bracket. EGTRRA created a 10-percent rate bracket. Effective in 2001, the 10-

percent rate bracket applies to the first $6,000 of taxable income for single taxpayers, $10,000 of 

taxable income for heads of households, and $12,000 of taxable income for married couples 

filing joint returns. In 2008, the top of the 10-percent rate bracket will increase to $7,000 for 

single taxpayers and $14,000 for joint filers. In 2009 and 2010, these levels will be indexed for 

inflation. JGTRRA increased the thresholds to $7,000 for single taxpayers and $14,000 for joint 

taxpayers in 2003 and adjusted the thresholds for inflation in 2004 (to $7,150 for single filers, 

$10,200 for heads of households, and $14,300 for joint filers). In 2005, the thresholds for the 10-

percent rate bracket will revert back to $6,000 for single filers, $10,000 for heads of households, 

and $12,000 for joint filers, 

Standard Deduction for Married Couples. Over a five-year period beginning in 2005, EGTRRA 

increased the standard deduction for married couples filing joint returns to double the standard 

deduction for single filers. The standard deduction for joint filers was increased from 167 

percent of the standard deduction for single filers to 174 percent in 2005, 184 percent in 2006, 

187 percent in 2007, 190 percent in 2008, and 200 percent in 2009 and 2010. JGTRRA 

increased the standard deduction for joint filers to 200 percent of the standard deduction for 

single filers in 2003 and 2004. In 2005, the standard deduction for joint filers will revert to the 

level specified in EGTRRA (174 percent of the standard deduction for single filers). 

15-Percent Rate Bracket for Married Couples. Over a four-year period beginning in 2004, 

EGTRRA increased the width of the 15-percent rate bracket for joint filers to twice the width for 

single filers. The top of the 15-percent rate bracket for joint filers was increased from 167 

percent of the corresponding amount for single filers to 180 percent in 2005, 187 percent in 

2006, 193 percent in 2007, and 200 percent in 2008, 2009, and 2010. JGTRRA increased the 

width of the 15-percent rate bracket for joint filers to twice the width for single filers in 2003 and 

2004. In 2005, the top of the 15-percent rate bracket will revert to the level specified in 

EGTRRA (180 percent of the amount for single filers). 

3 
Reasons for Change 

Last year, the Administration worked with Congress to enact tax relief to provide additional 

support for the economic recovery and promote long-term growth. The quick passage of 

JGTRRA meant that millions of taxpayers began to receive tax relief by July. Paychecks 

increased because withholding tables were adjusted immediately following the enactment of 

JGTRRA to reflect the lower tax rates and the expanded 10- and 15-percent tax rate brackets. 

Beginning in July, 24 million taxpayers with children received checks containing an increase in 

the child tax credit (of up to $400 per qualifying child). 

Continuation of this tax relief is needed to ensure sustained strong economic growth in the 

future. 

Proposal 

The provisions of JGTRRA that revert to their EGTRRA levels on December 31, 2004 would be 

extended through 2010. 

(As described in a later section, the Administration is also proposing to permanently extend the 

provisions of EGTRRA and JGTRRA that sunset.) 

Revenue Estimate

1 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-2009 2005-2014

($ in millions) 

0 -11,489 -25,810 -23,472 -18,956 -15,640 -95,367 -106,436 

1 The estimate includes both receipt and outlay effects. The outlay effect is $4,265 million for 2006, $4,131 million 

for 2007, $4,003 million for 2008, $3,936 million for 2009, $4,568 million for 2010, $16,335 million for 2005-2009 

and $18,906 million for 2005-2014. 

4 
Permanently Extend Certain Provisions of the 2001 Tax Cut and the 2003 Jobs and 

Growth Tax Cut 

Current Law 

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

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

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

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

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

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

estate tax. These and several other provisions of EGTRRA sunset on December 31, 2010. 

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

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

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

expensing provision sunsets on December 31, 2005. The dividend and capital gains provisions 

sunset on December 31, 2008. 

Reasons for Change 

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

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

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

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

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

retirement, and when planning future contributions to charity and bequests for their children. 

Taxpayers require the certainty that can be provided today by permanently extending the 

provisions of EGTRRA and JGTRRA. 

Proposal 

The provisions of EGTRRA that sunset on December 31, 2010 would be permanently extended. 

The provisions of JGTRRA that sunset on December 31, 2005 and December 31, 2008 would be 

permanently extended. 

Revenue Estimate2 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-2009 2005-2014

($ in millions) 

0 -287 -4,475 -6,980 -10,729 -30,124 -52,595 -883,312 

2 The estimate includes both receipt and outlay effects. There is no outlay effect for fiscal years 2005-2009. The 

outlay effect is $34,579 million for 2005-2014. 

5 
 6 
TAX INCENTIVES 

Simplify and Encourage Saving 

EXPAND TAX-FREE SAVINGS OPPORTUNITIES 

Current Law 

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

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

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

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

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

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

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

Education Savings Accounts (ESAs) and Section 529 Qualified Tuition Plans (QTPs) are both 

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

Medical Savings Accounts (MSAs) and Health Savings Accounts (HSAs) are intended to 

encourage saving for medical expenses. 

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

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

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

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

employer-plans in 2004, the deduction is phased out for single and head-of-household filers with 

modified-AGI3 between $45,000 and $55,000 (increasing to $50,000 to $60,000 in 2005), for 

married filing jointly filers with modified-AGI between $65,000 and $75,000 (increasing in 

stages to $80,000 to $100,000 in 2007), and for married filing separately filers with modifiedAGI between $0 and $10,000. For a married, filing jointly taxpayer who is not covered, but 

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

with modified-AGI between $150,000 and $160,000. Account earnings are not includible in 

gross income until distributed. Distributions (including both contributions and account earnings) 

are includible in gross income. 

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

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

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

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

contributions to a traditional IRA. 

Individuals of any age may make contributions to a Roth IRA. Allowable contributions are 

phased out for workers with incomes above certain levels. Contributions are phased out for 

3

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

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

adjustments. 

7 
single or head-of-household filers with modified-AGI between $95,000 and $110,000, for 

married filing jointly filers with modified-AGI between $150,000 and $160,000, and for married 

filing-separate filers with modified-AGI between $0 and $10,000. Account earnings accumulate 

tax free, and qualified distributions (including account earnings) are not included in gross income 

for income tax purposes. Nonqualified distributions from Roth IRAs are included in income (to 

the extent they exceed basis) and subject to an additional tax. Distributions are deemed to come 

from basis first. 

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

nondeductible, and Roth) is the lesser of earnings or $3,000 for 2004 ($3,500 for individuals age 

50 and over). The contribution limit is scheduled to increase in stages to $5,000 ($6,000 for 

individuals age 50 and over) in 2008. 

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

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

(but not for purposes of the $100,000 limit). 

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

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

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

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

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

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

substantially equal periodic payments. 

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

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

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

account owner’s lifetime. 

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

to a Coverdell Education Savings Account (ESA) for beneficiaries under age 18. The 

contribution limit is phased out for single filers with modified-AGI between $95,000 and 

$110,000 and for joint filers with modified-AGI between $150,000 and $160,000. Contributions 

are not deductible, but earnings on contributions accumulate tax-free. Distributions are 

excludable from gross income to the extent they do not exceed qualified education expenses that 

are incurred during the year the distributions are made and that are not used to claim another tax 

benefit (such as an education tax credit or a tax-free distribution from a qualified tuition 

program). The earnings portion of a distribution not used to cover qualified education expenses 

is includible in the gross income of the beneficiary and is generally subject to an additional 10 

percent tax. 

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

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

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

made to an ESA benefiting another family member. 

8 
Section 529 Qualified Tuition Programs: Contributions to a QTP are not deductible from income 

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

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

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

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

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

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

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

contributors nor beneficiaries may direct the investment of the account. 

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

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

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

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

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

higher education expenses of the beneficiary. 

Some states allow contributions to be excluded from income for state income tax purposes. 

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

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

disregarded coverage may contribute to a health savings account (HSA) that can be used to 

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

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

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

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

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

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

additional 10 percent tax. 

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

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

the HSA) are allowed to accumulate funds in an Archer Medical Savings Account (MSA) on a 

tax-preferred basis to pay for medical expenses. An individual is eligible to establish an MSA 

only if the employee (or the employee's spouse) is covered by a high-deductible health plan (and 

not covered by any non-high deductible health plan). Although individuals with MSAs can 

continue to contribute to them as long as they are with an MSA participating employer, no new 

MSAs are permitted after the end of 2003 except with respect to individuals being hired after 

2003 by an MSA-participating employer. Contributions to MSAs are deductible and qualified 

distributions are excluded from gross income. Nonqualified distributions are subject to income 

tax and, if taken prior to age 65, an additional 15 percent tax. 

Reasons for Change 

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

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

9 
Taxpayers must determine their eligibility for each account separately and then must decide 

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

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

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

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

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

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

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

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

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

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

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

process that will allow taxpayers to direct that their tax refunds be directly deposited into more 

than one account. Consequently, taxpayers will be able, for example, to direct that a portion of 

their tax refunds be deposited into a Lifetime Savings Account or Retirement Savings Account 

described below. Simplifying the rules, making savings opportunities universally available, and 

making it easier for people to set money aside through direct deposit will complement the 

Administration’s commitment to programs focusing on financial education and, specifically, 

retirement planning. 

Proposal 

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

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

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

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

would be created that could be used for savings for any purpose, including augmenting 

retirement savings, health care, covering emergencies, and education. 

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

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

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

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

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

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

The RSA contribution limit would be indexed for inflation. 

Qualified distributions from the retirement account would be distributions made after age 58 or 

in the event of death or disability. Any other distribution would be a nonqualified distribution 

and, as with current non-qualified distributions from Roth IRAs, would be includible in income 

(to the extent it exceeds basis) and subject to a 10 percent additional tax. Distributions would be 

deemed to come from basis first. As with current law Roth IRAs, no minimum required 

distribution rules would apply to RSAs during the account owner’s lifetime. Married individuals 

could roll amounts from their RSA over to their spouses’ RSA. 

10 
Existing Roth IRAs would be renamed RSAs and be made subject to the new rules for RSAs. 

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

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

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

January 1, 2006, could include the conversion amount in income ratably over 4 years. 

Conversions made on or after January 1, 2006, would be included in income in the year of the 

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

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

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

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

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

current law Roth conversion). 

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

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

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

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

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

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

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

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

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

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

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

Individuals could contribute up to $5,000 per year to their LSA, regardless of wage income. No 

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

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

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

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

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

owner’s lifetime. 

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

contributors. Thus, contributors could make annual contributions of up to $5,000 each to the 

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

given individual’s name could not exceed $5,000. The LSA contribution limit would be indexed 

for inflation. 

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

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

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

amounts from their LSAs over to their spouses’ LSAs. 

11 
Taxpayers would be able to convert balances in Coverdell Education Savings Accounts (ESAs) 

and Section 529 Qualified Tuition Plans (QTPs) to LSA balances. All conversions must be made 

before January 1, 2006, and would be subject to the following limitations. An amount can be 

rolled into an individual’s LSA from a QTP only if that individual was the beneficiary of the 

QTP or ESA as of December 31, 2003. The amount that can be rolled over to an LSA from an 

ESA is limited to the sum of the amount in the accounts as of December 31, 2003, plus any 

contributions to and earnings on the accounts in 2004. The amount that can be rolled over to any 

LSA from a QTP is limited to the sum of (i) the lesser of $50,000 or the amount in the QTP as of 

December 31, 2003, plus (ii) any contributions and earnings to the QTP during 2004. Total 

rollovers to an individual’s LSA attributable to 2004 contributions to the individual’s ESAs and 

QTPs cannot exceed $5,000 (plus any earnings on those contributions). 

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

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

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

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

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

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

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

for educational purposes. 

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

to an LSA. 

Both LSAs and RSAs would become effective beginning on January 1, 2005. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-2009 2005-2014

($ in millions) 

0 3,949 8,192 5,488 2,798 685 21,112 5,558

12 
CONSOLIDATE EMPLOYER-BASED SAVINGS ACCOUNTS 

Current Law 

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

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

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

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

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

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

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

the defined-contribution plan rules. 

Contribution Limits. The total annual contribution to a participant’s account may not exceed the 

lesser of $41,000 or 100 percent of compensation. 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

compensation made on behalf of all eligible NHCEs. 

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

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

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

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

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

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

13 
vest after two years of service, so that the employee is fully vested after six years of service, and 

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

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

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

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

401(k) plans are subject to additional requirements. 

Annual deferrals under a 401(k) plan may not exceed $13,000 in 2004 (increasing to $15,000 by 

2006). Participants aged 50 or over may make additional “catch-up” deferrals of up to $3,000 

(increasing to $5,000 by 2006). Elective deferrals are immediately fully vested. 

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

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

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

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

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

may establish SIMPLE 401(k) plans. Deferrals of SIMPLE participants may not exceed $9,000 

in 2004 (increasing to $10,000 in 2005). SIMPLE participants aged 50 or over may make 

additional “catch-up” deferrals of up to $1,500 (increasing to $2,500 by 2006). All contributions 

are immediately fully vested. In lieu of the ADP test, SIMPLE plans are subject to special 

contribution requirements, including a lower annual elective deferral limit and either a matching 

contribution not exceeding 3 percent of compensation or non-elective contribution of 2 percent 

of compensation.4 

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

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

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

safe harbor). Employee contributions under a thrift plan are not subject to the $13,000 limit that 

applies to employee pre-tax deferrals. 

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

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

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

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

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

distributions. 

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

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

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

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

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

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

applicable to SIMPLE 401(k) plans. 

14 
and are subject to a special nondiscrimination test. The rules permitting SARSEPs were repealed 

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

prior to January 1, 1997. 

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

annuity plans, also called 403(b) plans. In general these plans are subject to different rules than 

qualified plans under section 401. Benefits may be provided through the purchase of annuities or 

contributions to a custodial account invested in mutual funds. Contribution limits (including 

catch-ups), deferral limits, and minimum distribution rules are generally the same as for 401(k) 

plans. However, certain employees with 15 years of service may defer additional amounts 

according to a complicated three-part formula. Some 403(b) plans are subject to some 

nondiscrimination rules. 

Governmental 457 plans: State and local governments may establish Section 457 plans.5 In 

general, these plans are subject to different rules than qualified plans that are defined under 

section 401. Participant contributions are tax-deferred until substantially vested, and plan 

earnings are tax-deferred until withdrawal, due to the exemption enjoyed by state and local 

governments. Participant elective contributions may not exceed the lesser of 100 percent of 

compensation or $13,000 in 2004 (increasing to $15,000 by 2006). However, participants may 

make additional contributions of up to twice the standard amount in the last three years before 

normal retirement age. Participants aged 50 or over may make additional “catch-up” 

contributions of up to $3,000 (increasing to $5,000 by 2006). 

Reasons for Change 

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

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

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

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

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

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

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

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

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

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

retirement saving. 

Proposal 

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

employee deferrals or employee after-tax contributions and simplify defined-contribution plan 

qualification rules. 

The proposal would become effective for years beginning after December 31, 2004. 

5

 Tax-exempt organizations are permitted to establish section 457 plans, but such plans are not funded arrangements 

and are generally limited to management or highly compensated employees. 

15 
Consolidate 401(k), SIMPLE 401(k), Thrift, 403(b), and Governmental 457 plans, as well as 

SIMPLE IRAs and SARSEPs, into Employer Retirement Savings Accounts (ERSAs), 

which would be available to all employers and have simplified qualification requirements. 

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

simplifications described below. Thus, employees could defer wages of up to $13,000 annually 

(increasing to $15,000 by 2006), with employees aged 50 and older able to defer an additional 

$3,000 (increasing to $5,000 by 2006). The maximum total contribution (including employer 

contributions) to ERSAs would be the lesser of 100 percent of compensation or $41,000. The 

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

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

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

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

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

other distributions would be included in the participants’ income. 

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

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

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

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

accept any new contributions after December 31, 2005, with a special transition for collectively 

bargained plans and plans sponsored by state and local governments. 

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

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

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

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

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

IRAs. 

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

nondiscrimination requirements with respect to contributions for ERSAs: the average 

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

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

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

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

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

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

ADP tests would be repealed. Plans sponsored by state and local governments would not be 

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

this nondiscrimination test (unless the plan permits after-tax or matching contributions) but 

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

16 
ERSA Safe Harbor. The design-based safe harbor described below would be sufficient to satisfy 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

an NHCE. 

Roth ERSAs. The effective date for Roth contributions to ERSAs would be after December 31, 

2004 (changed from after December 31, 2005, under current law). 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -214 -318 -337 -358 -380 -1,607 -11,763 

17 
ESTABLISH INDIVIDUAL DEVELOPMENT ACCOUNTS (IDAS) 

Current Law 

Under section 25B, certain low-income taxpayers are allowed a non-refundable credit for 

qualified retirement savings contributions up to $2,000. The maximum credit rate is 50 percent 

and is phased out for single filers with adjusted gross income between $15,000 and $25,000 

($22,500 and $37,500 for head of households and $30,000 and $50,000 for joint returns). The 

credit does not apply to contributions made after December 31, 2006. No other current tax 

provision is specifically targeted to encourage low-income families to save and develop a pool of 

capital to be used for purposes such 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 

annual appropriation of $25 million. Under the program, which the Department of Health and 

Human Services administers, an IDA can be opened by certain individuals who meet a net worth 

test and are eligible for the Earned Income Tax Credit or for Temporary Assistance for Needy 

Families (the successor to AFDC). Individuals’ contributions are not deductible but are matched 

by contributions from a program run by a state 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 withdrawals must be paid directly to a mortgage 

provider, institution of higher education, or business capitalization account at a financial 

institution. Match rates chosen by the state or nonprofit must be between 50 and 400 percent. 

Reasons for Change 

One third of all Americans have no assets in savings or investments, and another fifth have only 

negligible assets. The United States household savings rate lags far behind other industrial 

nations, constraining national economic growth and keeping many Americans from entering the 

economic mainstream by buying a house, obtaining an adequate education, or starting a business. 

To ameliorate this situation by establishing IDA programs more broadly, federal support is 

needed both for the matching funds and for the administrative costs of the programs. In addition, 

financial education is an essential component of a policy to assist lower-income persons in 

building assets. By helping program sponsors defray the costs associated with matching 

participants’ contributions, administering the accounts, 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 of establishing and running IDA programs, contributing 

matching funds to the appropriate accounts, and providing financial education to account 

holders. Program sponsors could be qualified financial institutions, qualified nonprofits, or 

18 
qualified Indian tribes, but the accounts would have to be held by an institution eligible under 

current law to serve as the custodian of IRAs. The goals and broad outline of this program are 

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 dependents or students and meet certain 

income requirements would be eligible to establish and contribute to an IDA. For single filers, 

the income limit would be $20,000 in modified AGI. The corresponding thresholds for head-ofhousehold and joint filers would be $30,000 and $40,000 respectively. (Married individuals 

filing separately could not participate.) Modified AGI is AGI as ordinarily computed, plus 

certain exempt items. In all cases eligibility would be determined by the individual’s 

circumstances for the previous taxable year. Eligibility limits would be indexed annually for 

inflation beginning in 2006. Sponsors would match contributions from eligible account holders 

on a dollar-for-dollar basis up to $500 per year. The main account (including earnings) and an 

account containing the matching amounts (including earnings) would be tracked separately by 

the sponsor. 

Program sponsors (and, if the sponsor is exempt, other persons as provided in regulations) could 

claim a tax credit for an IDA program. The credit would have two components: First, a $50-peraccount credit could be claimed each year to offset the ongoing costs of maintaining and 

administering each account and providing financial education to participants. Except for the first 

year that an account is open, the credit would be available only for accounts with a balance at 

year’s end of more than $100. In addition, there is a credit for the dollar-for-dollar matching 

amounts. 

Participants could generally withdraw their contributions and matching funds (including 

earnings) for qualified purposes, which include certain higher education expenses, first-time 

home purchase expenditures, and small business capitalization. The financial institution at 

which the IDA is held would generally 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 could not be made from the account containing the 

matching funds (including earnings). Non-qualified withdrawals from the account containing the 

participant's contributions could result in the forfeiture of some or all of the amounts in the 

matching-fund account. Matching funds and earnings would generally be available, without 

penalty, to the account holder for any purpose after he or she attains the age of 61. 

Contributions to IDAs by individuals would not be deductible, and the earnings on the 

contributions would be taxable to the account holder. Matching amounts and earnings on those 

amounts would not be taxable to the account holder at any time. 

The proposal includes explicit regulatory authority for Treasury to adopt rules to permit IDA 

program sponsors to verify the eligibility of individuals seeking to open accounts and to ensure 

that these individuals have not previously opened such an IDA. The authority would also extend 

to rules governing the recapture of credits claimed with respect to non-eligible individuals and 

with respect to matching amounts and earnings that are forfeited. 

19 
The credit would apply with respect to the first 900,000 IDA accounts opened before January 1, 

2010, and with respect to matching funds for participant contributions that are made after 

December 31, 2004, and before January 1, 2012. The credit could generally be claimed for 

taxable years ending after December 31, 2004, and beginning before January 1, 2012. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -134 -286 -326 -300 -255 -1,301 -1,380 

20 
Invest in Health Care 

PROVIDE REFUNDABLE TAX CREDIT FOR THE PURCHASE OF HEALTH 

INSURANCE 

Current Law 

Under present law, 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 medical care, qualified long-term 

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

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

from gross income for income tax purposes 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 pre-tax basis. 

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

self-employed individuals who are not eligible for subsidized employer coverage are deductible 

in computing AGI. 

In addition, individuals are allowed to accumulate funds in a health savings account (HSA) or in 

more limited circumstances in a medical savings account (Archer MSA) on a tax-preferred basis 

to pay for medical expenses, provided they are covered by a high-deductible health plan (and no 

other health plan). 

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. 

Finally, under the Trade Adjustment Assistance Reform Act of 2002, a refundable tax credit is 

provided to eligible individuals for the cost of qualified health coverage. The credit is equal to 

65 percent of the amount paid by certain individuals receiving (or eligible to receive) a trade 

readjustment allowance or by certain individuals between the ages of 55 and 64 who are 

receiving pension benefits from the Pension Benefit Guaranty Corporation. 

Reasons for Change 

According to some estimates, more than 43 million Americans are currently without health 

insurance coverage. These uninsured individuals require an incentive to assist them in 

purchasing health insurance. The incentive must provide assistance to low-income individuals 

and families with little or no income tax liability. At the same time, the incentive should not 

discourage individuals from entering the labor force or from earning additional income. The 

incentive also needs to be made available in advance and with certainty, so that uninsured 

individuals receive financial assistance at the same time they purchase health insurance. A 

health tax credit made available in advance for individuals who are not covered by public or 

21 
employer-provided health plans will provide these incentives. In addition, allowing the credit to 

be applied to health insurance purchased through private and state purchasing groups and at state 

option to certain state insurance programs will enhance the tax credit’s purchasing power and 

improve coverage options. 

Proposal 

The proposal would create a refundable income tax credit for the cost of health insurance 

purchased by individuals under age 65. The credit would provide a subsidy of up to 90 percent 

of the health insurance premium, up to a maximum credit of $1,000 per adult and $500 per child 

for up to two children. The maximum subsidy percentage of 90 percent would apply for lowincome taxpayers and would be phased down at higher incomes. Individuals participating in 

public or employer-provided health plans would generally not be eligible for the tax credit. In 

addition, individuals would not be allowed to claim the credit and make a contribution to an 

HSA or an Archer MSA for the same taxable year. 

Individuals with no dependents who file a single return and have modified AGI up to $15,000 

would be eligible for the maximum subsidy rate of 90 percent and a maximum tax credit of 

$1,000. The subsidy percentage for these individuals would be phased down ratably from 90 

percent to 50 percent between $15,000 and $20,000 of modified AGI, and then phased out 

completely at $30,000 of modified AGI. 

All other filers with modified AGI up to $25,000 would be eligible for the maximum subsidy 

rate of 90 percent, and the maximum credit of $1,000 per adult and $500 per child for up to two 

children. The subsidy percentage would be phased out ratably between $25,000 and $40,000 of 

modified AGI in the case of a policy covering only one adult, and between $25,000 and $60,000 

of modified AGI in the case of a policy or policies covering more than one adult. The maximum 

credit for these other filers would vary by income and the number of adults and children covered 

by a policy. For example, the maximum tax credit would equal $3,000 for families with 

modified AGI up to $25,000 who obtain a policy covering two adults and two or more children. 

The maximum allowable premium for credit purposes would be $1,111 for an adult and $556 for 

a child at all income levels. These dollar amounts would be indexed by the medical care 

component of the Consumer Price Index based on all urban consumers. 

Examples of the maximum credit: 

(1) Individuals with No Dependents Filing a Single Return 

Modified AGI $15,000 $20,000 $30,000 

Maximum Credit $1,000 $556 $0 

(2) Other Filers Obtaining a Policy Covering Only One Adult 

Modified AGI $25,000 $30,000 $40,000 

Maximum Credit $1,000 $667 $0 

22 
(3) Other Filers Obtaining a Policy Covering Two Adults 

Modified AGI $25,000 $40,000 $60,000 

Maximum Credit $2,000 $1,143 $0 

(4) Other Filers Obtaining a Policy Covering Two Adults and One Child 

Modified AGI $25,000 $40,000 $60,000 

Maximum Credit $2,500 $1,429 $0 

(5) Other Filers Obtaining a Policy Covering Two Adults and Two or More Children 

Modified AGI $25,000 $40,000 $60,000 

Maximum Credit $3,000 $1,714 $0 

Individuals could claim the tax credit for health insurance premiums paid as part of the normal 

tax-filing process. Alternatively, the tax credit would be available in advance at the time the 

insurance is purchased. Individuals would reduce their premium payment by the amount of the 

credit and the health insurer would be reimbursed by the Department of the Treasury for the 

amount of the advance credit. Eligibility for the advance credit would be based on the 

individual’s prior year tax return. 

Eligible health insurance plans would be required to meet minimum coverage standards, 

including coverage for high medical expenses. In addition to the non-group insurance market, 

qualifying health insurance could also be purchased through private purchasing groups, statesponsored insurance purchasing pools and state high-risk pools. At state option, effective after 

December 31, 2005, the tax credit would be allowed for certain individuals not otherwise eligible 

for public health insurance programs to buy into privately contracted state sponsored purchasing 

groups (such as Medicaid or SCHIP purchasing pools for private insurance or state government 

employee programs for states in which Medicaid or SCHIP does not contract with private plans.) 

States could, under limited circumstances, provide additional contributions to individuals who 

purchased private insurance through such purchasing groups. The maximum state contribution 

would be $2,000 per adult for up to two adults for individuals with incomes up to 133 percent of 

poverty. The maximum state contribution would phase down ratably reaching $500 per adult at 

200 percent of poverty. Individuals with income above 200 percent of poverty would not be 

eligible for a state contribution. States would not be allowed to provide any other explicit or 

implicit cross subsidies. 

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

31, 2004, and would be available in advance beginning July 1, 2006. 

23 
Revenue Estimate6 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -106 -5,177 -6,100 -7,242 -7,765 -26,390 -70,055 

6 The estimate includes both receipt and outlay effects. The outlay effects are $82 million for 2005, $3,760 million 

for 2006, $5,041 million for 2007, $6,388 million for 2008, $7,133 million for 2009, $22,404 million for 2005-2009,

and $65,355 million for 2005-2014. 

24 
PROVIDE AN ABOVE-THE-LINE DEDUCTION FOR HIGH DEDUCTIBLE 

INSURANCE PREMIUMS 

Current Law 

Individuals who are covered by a qualifying high deductible health plan and not covered by any 

non-high deductible health plan other than certain permitted or disregarded coverage may 

contribute to a health savings account (HSA) that can be used to reimburse the individuals’ and 

their dependents’ health expenses. Employers may also make contributions to an individual's 

HSA. The high deductible health plan may be provided by an employer or purchased in the 

individual insurance market. Individuals who are eligible for Medicare or to be claimed as a 

dependent on someone else’s return may not contribute to an HSA. 

Individuals who purchase health insurance in the individual market 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. Self-employed individuals are 

entitled to deduct (for purposes of federal income tax but not for purposes of the selfemployment tax) the full amount of their health insurance coverage, whether or not they itemize 

deductions. Employer contributions for health insurance generally are excluded from gross 

income for income and employment tax purposes. Reimbursements made to an individual from 

health 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 

Allowing all individuals to deduct the cost of high deductible health plans will encourage the use 

of those plans. Providing a deduction for the premium "above-the-line" will generally level the 

playing field for a segment of the population that does not have employer-sponsored coverage 

and encourage cost consciousness in the purchase of health care through greater reliance on high 

deductible health plans. 

Proposal 

Individuals who contribute to an HSA because they are covered under high deductible health 

insurance in the individual insurance market would be allowed a deduction in the amount of the 

premium in determining AGI (i.e, whether or not the person itemizes deductions). Similar to 

HSA rules, an individual would not qualify for the deduction if, in addition to the high deductible 

plan for which the deduction is claimed, he or she is covered by other health insurance, except 

for health insurance that provides only certain benefits. Individuals covered by employer plans or 

public plans or otherwise not eligible to contribute to an HSA would not qualify for the 

deduction. 

The deduction would be available for tax years beginning after December 31, 2004. 

25 
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -173 -1,764 -2,014 -2,292 -2,501 -8,744 -24,775 

26 
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 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. The deduction only applies to qualified long-term care insurance, which is required to 

satisfy certain standards set forth in the models published by the National Association of 

Insurance Commissioners (NAIC). 

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

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

dollar limit) are deductible in determining AGI and, thus, are not limited by the 7.5 percent of 

AGI threshold that applies 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, 

the Secretary of the Treasury would be authorized to require qualified long-term care insurance 

27 
policies to meet consumer protection standards for quality coverage, for example, to reflect 

changes in the NAIC model standards. 

The deduction would be effective for taxable years beginning on or after January 1, 2005, but 

would be phased in so that 25 percent of the premium would be deductible for 2005, 35 percent 

for 2006, 65 percent for 2007, and 100 percent for 2008 and thereafter. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -68 -489 -805 -1,572 -2,435 -5,369 -21,428 

28 
PROVIDE AN ADDITIONAL PERSONAL EXEMPTION TO HOME CAREGIVERS 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,7 (2) receive over half of his or her support from the 

taxpayer,8

 (3) not have gross income in excess of the exemption amount,9 (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 2004, the amount of the exemption is $3,100. 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 ($142,700 for single filers, $214,050 for 

joint filers, $178,350 for heads of households, and $107,025 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 his or her adult children 

who choose to care for the parent 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 homes 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 

A taxpayer 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, if married, the taxpayer’s spouse) 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 

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

and nephews. 8 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. 9 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). 

29 
assistance from another individual, due to a loss of functional capacity.10 As under Internal 

Revenue Code section 7702B(c)(2)(B), ADLs would be eating, toileting, transferring, bathing, 

dressing, and continence. Substantial assistance would include both hands-on 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, 2004. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -71 -460 -398 -398 -415 -1,742 -3,759 

10 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. 

30 
ALLOW THE ORPHAN DRUG TAX CREDIT FOR CERTAIN PRE-DESIGNATION 

EXPENSES 

Current Law 

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

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

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

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

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

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

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

Internal Revenue Code. 

Reasons for Change 

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

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

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

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

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

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

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

expenses and post-designation expenses equally. 

Proposal 

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

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

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

the year in which the FDA application was filed. 

The proposal would be effective for qualified expenses incurred after December 31, 2003. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

-* -* -* -* -* -* -1 -2 

* less than .5 million. 

31 
-- -- -- -- -- -- -- --

CLARIFY THE HEALTH COVERAGE TAX CREDIT 

Current Law 

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

(TAA) Reform Act of 2002 for the purchase of qualified health insurance. The HCTC is 

refundable and equal to 65 percent of the cost of qualified health insurance paid by eligible 

individuals, including certain recipients of the TAA or Alternative TAA (ATAA) benefits and 

certain individuals between the ages of 55 and 64 who are receiving pension benefits from the 

Pension Benefit Guaranty Corporation (PBGC). Individuals can claim the HCTC as part of the 

tax-filing process or through an advance payment program at the time qualified insurance is 

purchased. 

Reasons for Change 

The statute is unclear on a number of issues that need to be clarified in order to facilitate the 

administration of the HCTC. The proposal would clarify eligibility of several groups of PBGC 

pension recipients, the status of the U.S. possessions and territories to elect a state-based 

coverage option, the application of the confidentiality and disclosure rules to the administration 

of the advance payment program, and the qualification of state continuation coverage provided 

under a state law. In addition, the proposal would reduce the complexity in administering 

eligibility exclusion under “other specified coverage.” 

Proposal 

The Administration proposes a number of modifications to the current law. First, the proposal 

would clarify that individuals who elect to receive one-time lump sum payments from the PBGC 

and certain alternative PBGC payees would be eligible for the HCTC. Second, for purposes of 

the state-based coverage rules, the proposal would deem the Commonwealths of Puerto Rico and 

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

be states. Third, the proposal would clarify that providers of health insurance could include 

employers and administrators of health plans and would allow disclosure of certain information 

necessary to carry out the advance payment program to providers of health insurance or their 

contractors. Fourth, the proposal would clarify that state continuation coverage provided under a 

state law would automatically qualify as “qualified health insurance,” as federally mandated 

COBRA continuation coverage, without meeting the requirements relating to state-based 

qualified coverage. Finally, the proposal would apply the same list of “other specified coverage” 

to all eligible individuals by changing the definition of “other specified coverage” for “eligible 

ATAA recipients” to conform to the definition applied to other eligible individuals. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

32 
Provide Incentives for Charitable Giving 

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 

Approximately two-thirds of tax filers are non-itemizers, and thus are not allowed to claim tax 

deductions for their charitable contributions. Allowing non-itemizers 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 cash contributions to qualified 

charitable organizations in addition to claiming the standard deduction, effective for tax years 

beginning after December 31, 2003. Taxpayers would be allowed to deduct aggregate 

contributions that exceed $250 ($500 for married taxpayers filing joint returns) up to a maximum 

deduction of $250 ($500 for married taxpayers filing joint returns). The deduction floors and 

limits would be indexed for inflation after 2004.11 Deductible contributions would be subject to 

existing rules governing itemized charitable contributions, such as the substantiation 

requirements and the percentage-of-AGI limitations. The non-itemizer deduction would not be a 

preference item for alternative minimum tax purposes, and would not affect the calculation of 

AGI. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -1,248 -1,103 -1,111 -1,144 -1,173 -5,779 -12,036 

11 In order to maintain the fixed relationship between the deduction floors and ceilings for single taxpayers and 

married taxpayers filing jointly, the dollar amounts for joint returns would be twice the indexed values for single 

returns. 

33 
PERMIT TAX-FREE WITHDRAWALS FROM IRAS FOR CHARITABLE 

CONTRIBUTIONS 

Current Law 

Eligible individuals may make deductible contributions to a traditional individual retirement 

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

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

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

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

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

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

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

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

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

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

and are also subject to the 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 ($142,700 for most filers in 2004). 

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 65 from a traditional or Roth IRA directly to a 

qualified charitable organization. The exclusion would not apply to indirect gifts through a split 

interest entity such as a charitable remainder trust or pooled income fund, or through the 

purchase of a charitable gift annuity. 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 

34 
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 

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, 2003. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

-68 -450 -341 -327 -330 -329 -1,777 -3,498 

35 
EXPAND AND INCREASE THE ENHANCED CHARITABLE DEDUCTION FOR 

CONTRIBUTIONS OF FOOD INVENTORY 

Current Law 

A taxpayer’s deduction for charitable contributions of inventory property generally is limited to 

the taxpayer’s basis (typically, cost) in the inventory. However, for certain contributions of 

inventory, C corporations may claim an enhanced deduction equal to the lesser of (1) the 

taxpayer’s basis in the contributed property, plus one-half of the gain that would have been 

realized had the property been sold or (2) two times basis. To be eligible for the enhanced 

deduction, the inventory must be contributed to a charitable organization (other than a private 

nonoperating foundation), and the donee must (1) use the property consistent with the donee’s 

exempt purpose solely for the care of the ill, the needy, or infants, (2) not transfer the property in 

exchange for money, other property, or services, and (3) provide the taxpayer a written statement 

that the donee’s use of the property will be consistent with these requirements. To claim the 

enhanced deduction, the taxpayer must establish that the fair market value of the donated item 

exceeds basis. 

Reasons for Change 

The lack of incentives for businesses other than C corporations (including many farmers and 

small businesses) to donate food inventory to charity reduces the ability of charities to combat 

hunger. Increasing the amount of the enhanced deduction for contributions of food inventory, 

making it available to any taxpayer engaged in a trade or business, and clarifying the method of 

determining fair market value in the case of surplus food will increase donations of food 

inventory. 

Proposal 

Eligibility for the enhanced deduction for donations of food inventory would be expanded to 

include businesses other than C corporations. The amount of the enhanced deduction for 

donations of food inventory would be increased to the lesser of: (1) fair market value, or (2) two 

times basis. To ensure consistent treatment of all businesses claiming an enhanced deduction for 

donations of food inventory, the enhanced deduction for qualified food donations by S 

corporations and non-corporate taxpayers would be limited to 10 percent of net income from the 

associated trade or business. A special provision would allow taxpayers with a zero or low basis 

in the qualified food donation (e.g., taxpayers that use the cash method of accounting for 

purchases and sales, and taxpayers that are not required to capitalize indirect costs) to assume a 

basis equal to 25 percent of fair market value. The enhanced deduction would be available only 

for donations of “apparently wholesome food” (food intended for human consumption that 

meets all quality and labeling standards imposed by federal, State, and local laws and 

regulations, even though the food may not be readily marketable due to appearance, age, 

freshness, grade, size, surplus, or other conditions). The fair market value of “apparently 

wholesome food” that cannot or will not be sold solely due to internal standards of the taxpayer 

or lack of market, would be determined by taking into account the price at which the same or 

substantially the same food items (taking into account both type and quality) are sold by the 

taxpayer at the time of the contribution or, if not so sold at such time, in the recent past. 

36 
These proposed changes in the enhanced deduction for donations of food inventory would be 

effective for taxable years beginning after December 31, 2003. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -42 -87 -96 -106 -116 -447 -1,224 

37 
REFORM EXCISE TAX BASED ON INVESTMENT INCOME OF PRIVATE 

FOUNDATIONS 

Current Law 

Private foundations that are exempt from federal income tax generally are subject to a twopercent excise tax on their net investment income. The excise tax rate is reduced to one percent 

in any year in which the foundation’s distributions for charitable purposes exceed the average 

level of the foundation’s charitable distributions over the five preceding taxable years (with 

certain adjustments). Private foundations that are not exempt from federal income tax, including 

certain charitable trusts, must pay an excise tax equal to the excess (if any) of the sum of the 

excise tax on net investment income and the amount of the unrelated business income tax that 

would have been imposed if the foundation were tax exempt, over the income tax imposed on the 

foundation. Under current law, private nonoperating foundations generally are required to make 

annual distributions for charitable purposes equal to at least five percent of the fair market value 

of the foundation’s noncharitable use assets (with certain adjustments). The amount that a 

foundation is required to distribute annually for charitable purposes is reduced by the amount of 

the excise tax paid by the foundation. 

Reasons for Change 

The current “two-tier” structure of the excise tax on private foundation net investment income 

may discourage foundations from significantly increasing their distributions for charitable 

purposes in any particular year. Under the current formula, any increase in the foundation’s 

percentage payout in a given year (by increasing the average percentage payout) makes it more 

difficult for the foundation to qualify for the reduced one percent excise tax rate in subsequent 

years. Eliminating the “two-tier” structure of this excise tax would ensure that private 

foundations do not suffer adverse excise tax consequences if they increase their grantmaking in a 

particular year to respond to charitable needs. Such a change would also simplify tax planning 

and the calculation of the excise tax for private foundations. In addition, lowering the excise tax 

rate for all foundations would make additional funds available for charitable purposes. 

Proposal 

This proposal would replace the two rates of tax on private foundations that are exempt from 

federal income tax with a single tax rate of one percent. The tax on private foundations not 

exempt from federal income tax would be equal to the excess (if any) of the sum of the onepercent excise tax on net investment income and the amount of the unrelated business income tax 

that would have been imposed if the foundation were tax exempt, over the income tax imposed 

on the foundation. The special reduced excise tax rate available to tax-exempt private 

foundations that maintain their historic level of charitable distributions would be repealed. 

The proposal would be effective for taxable years beginning after December 31, 2003. 

38 
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -133 -83 -84 -86 -90 -476 -1,009 

39 
MODIFY TAX ON UNRELATED BUSINESS TAXABLE INCOME OF CHARITABLE 

REMAINDER TRUSTS 

Current law 

A charitable remainder annuity trust is a trust that is required to pay, at least annually, a fixed 

dollar amount of at least five percent of the initial value of the trust to a noncharity for the life of 

an individual or for a period of 20 years or less, with the remainder passing to charity. A 

charitable remainder unitrust is a trust that generally is required to pay, at least annually, a fixed 

percentage of at least five percent of the fair market value of the trust’s assets determined at least 

annually to a non-charity for the life of an individual or for a period of 20 years or less, with the 

remainder passing to charity. A trust does not qualify as a charitable remainder annuity trust if 

the annuity for a year is greater than 50 percent of the initial fair market value of the trust’s 

assets. A trust does not qualify as a charitable remainder unitrust if the percentage of assets that 

are required to be distributed at least annually is greater than 50 percent. A trust does not qualify 

as a charitable remainder annuity trust or a charitable remainder unitrust unless the value of the 

remainder interest in the trust is at least 10 percent of the value of the assets contributed to the 

trust. 

Distributions from a charitable remainder trust, which are included in the income of the 

beneficiary for the year that the annuity or unitrust amount is required to be distributed, are 

treated in the following order as: (1) ordinary income to the extent of the trust’s current and 

previously undistributed ordinary income for the trust’s year in which the distribution occurred; 

(2) capital gains to the extent of the trust’s current capital gain and previously undistributed 

capital gain for the trust’s year in which the distribution occurred; (3) other income to the extent 

of the trust’s current and previously undistributed other income for the trust’s year in which the 

distribution occurred; and (4) corpus (trust principal). 

Charitable remainder trusts are exempt from federal income tax. However, charitable remainder 

trusts lose their income tax exemption for any year in which they have unrelated business taxable 

income. Any taxes imposed on the trust are required to be allocated to trust corpus. 

Reasons for Change 

Under current law, a charitable remainder trust that has any unrelated business taxable income 

loses its tax-exempt status for the year. The Administration believes that imposing a tax equal to 

100 percent of any unrelated business taxable income received by a charitable remainder trust is 

a more appropriate remedy than loss of tax exemption for the year. 

Proposal 

The Administration proposes to levy a 100-percent excise tax on the unrelated business taxable 

income of a charitable remainder trust, in lieu of removing the trust’s federal income tax 

exemption for any year in which unrelated business taxable income is received. The amount of 

the tax would be treated as paid from corpus. Therefore, the unrelated business taxable income 

would be considered income of the trust for purposes of determining the character of the 

distribution made to the beneficiary. 

40 
The proposal would be effective for taxable years beginning after December 31, 2003, regardless 

of when the trust was created. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -8 -5 -6 -6 -6 -31 -68

41 
MODIFY BASIS ADJUSTMENT TO STOCK OF S CORPORATIONS CONTRIBUTING 

APPRECIATED PROPERTY 

Current Law 

If an S corporation contributes money or other property to a charity, each shareholder takes into 

account the shareholder’s pro rata share of the contribution in determining income tax liability. 

A shareholder of an S corporation reduces the basis in the stock of the S corporation by the 

amount of the charitable contribution that flows through to the shareholder. In many cases, a 

shareholder’s basis in S corporation stock reflects the basis of the contributed property, whereas 

the charitable contribution deduction reflects the value of the contributed property. As a result, 

current law deprives some S corporation shareholders from obtaining the full benefit of the 

charitable contribution deduction. 

Reasons for Change 

The proposal modifies the rules for adjusting the basis of S corporation stock to preserve the 

benefit of providing a charitable contribution deduction for contributions of appreciated property 

by an S corporation. 

Proposal 

The proposal would allow an S corporation shareholder to increase the basis of the S corporation 

stock by an amount equal to the excess of the charitable contribution deduction that flows 

through to the shareholder over the shareholder’s pro rata share of the adjusted basis of the 

contributed property. 

The proposal would be effective for taxable years beginning after December 31, 2003. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -21 -13 -15 -18 -21 -88 -239

42 
REPEAL THE $150 MILLION LIMITATION ON QUALIFIED 501(C)(3) BONDS 

Current Law 

The Tax Reform Act of 1986 established a $150 million limit on the volume of outstanding, nonhospital, tax-exempt bonds for the benefit of any one 501(c)(3) organization. The provision was 

repealed in 1997 with respect to bonds issued after August 5, 1997, at least 95 percent of the net 

proceeds of which are used to finance capital expenditures incurred after that date. Thus, the 

limitation continues to apply to bonds more than five percent of the net proceeds of which 

finance or refinance (1) working capital expenditures or (2) capital expenditures incurred on or 

before August 5, 1997. 

Reasons for Change 

The $150 million limitation results in complexity and provides disparate treatment depending on 

the nature and timing of bond-financed expenditures. Issuers must determine whether an issue 

consists of non-hospital bonds, and must calculate the amount of non-hospital bonds that are 

allocable to a particular tax-exempt organization. In addition, issuers must determine whether 

more than five percent of the net proceeds of each issue of non-hospital bonds finances working 

capital expenditures, or capital expenditures incurred on or before August 5, 1997, in order to 

determine whether the issue is subject to the limitation. Complete repeal of the limitation would 

enable private universities to utilize tax-exempt financing on a basis comparable to public 

universities. 

Proposal 

The $150 million limit on the volume of outstanding, non-hospital, tax-exempt bonds for the 

benefit of any one 501(c)(3) organization would be repealed in its entirety, effective for bonds 

issued after the date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -8 -10 -11 -10 -10 -49 -94

43 
REPEAL CERTAIN RESTRICTIONS ON THE USE OF QUALIFIED 501(C)(3) BONDS 

FOR RESIDENTIAL RENTAL PROPERTY 

Current Law 

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

exclusion does not apply to private activity bonds unless a specific exemption is provided in the 

Code. 

One type of tax-exempt private activity bond is a qualified 501(c)(3) bond. In general, an issue 

consists of qualified 501(c)(3) bonds if, among other things, at least 95 percent of its net 

proceeds are used by no person other than a 501(c)(3) organization or a State or local 

governmental unit. For this purpose, any activity of a 501(c)(3) organization that constitutes an 

unrelated trade or business is a non-qualifying use. 

Current law contains a special limitation (the residential rental property limitation) under which, 

in general, an issue does not consist of qualified 501(c)(3) bonds if any of its net proceeds are 

used to provide residential rental property for family units. However, this limitation does not 

apply if: (1) the first use of the financed property is pursuant to the issue; (2) the property meets 

the low-income set-aside requirements described below for qualified residential rental projects 

under the exempt facility bond rules; or (3) the property is substantially rehabilitated (i.e., in 

general, rehabilitation expenditures must equal or exceed the owner’s adjusted basis in the 

property) during the two-year period ending one year after the acquisition. 

In addition to qualified 501(c)(3) bonds, current law authorizes the issuance of tax-exempt 

private activity bonds for certain exempt facilities that are owned or operated by private, forprofit entities. One type of exempt facility is a qualified residential rental project. A qualified 

residential rental project is a project for residential rental property if, at all times during a 

specified project period, the project meets one of the following requirements elected by the 

issuer: (1) at least 20 percent of the residential units are occupied by individuals whose income 

is 50 percent or less of area median gross income; or (2) at least 40 percent of the residential 

units are occupied by individuals whose income is 60 percent or less of area median gross 

income. 

Reasons for Change 

The residential rental property limitation results in complexity, and provides disparate treatment 

for new and existing property used by 501(c)(3) organizations. In applying the residential rental 

property limitation, issuers must first determine whether existing property is residential rental 

property. For example, an assisted living facility may or may not constitute residential rental 

property, depending in part on the amount of nursing services provided. Issuers must also 

determine whether existing property satisfies the low-income set-aside or rehabilitation 

requirements. Failure to meet the requirements could result in a loss of tax-exemption on the 

bonds, retroactive to the date of issue. Simplification would be achieved if the residential rental 

property limitation were repealed. 

44 
Proposal 

The residential rental property limitation would be repealed, effective for bonds issued after the 

date of enactment. As under current law, the use of residential rental property by a 501(c)(3) 

organization would be a qualifying use only to the extent it did not constitute an unrelated trade 

or business. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -5 -6 -12 -18 -25 -66 -299

45 
 Strengthen Education 

EXTEND, INCREASE AND EXPAND THE ABOVE-THE-LINE DEDUCTION FOR 

QUALIFIED OUT-OF-POCKET CLASSROOM EXPENSES 

Current Law 

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

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

alternative minimum tax. 

For taxable years 2002 and 2003, taxpayers who were K-12 teachers and certain other school 

personnel in a school for at least 900 hours during a school year were allowed to deduct, whether 

or not they itemize, up to $250 incurred in connection with books, supplies, computer equipment 

and other equipment and supplemental materials used in the classroom. 

Reasons for Change 

Teachers and other school 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 

encourages dedicated teachers who supplement available school resources at their own expense. 

Proposal 

The 2003 law provision would be made permanent and the maximum deduction increased to 

$400. As under current law, the provision would apply to teachers and other school personnel 

employed by public entities, charter schools or private schools (as determined under State law). 

The current-law 900-hour rule would be clarified to refer to a school year ending during the 

taxable year. Eligible, unreimbursed expenses would be expanded to include teacher training 

expenses related to current teaching positions. 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 or taken into account 

in determining any other tax benefit such as Hope or lifetime learning credits. 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 expenses incurred in taxable years beginning after 

December 31, 2003. 

46 
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

-23 -229 -240 -249 -260 -263 -1,241 -2,611

47 
Encourage Telecommuting 

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. 

Reasons for Change 

Current law imposes significant recordkeeping requirements on employers and their workers 

who use employer-provided computer equipment and services to telecommute. These 

requirements encourage noncompliance and raise the cost of telecommuting. Removing these 

requirements would lower the costs of telecommuting, benefiting workers, their families and the 

environment. 

Proposal 

An individual would be allowed to exclude from income the value of any computers, software or 

other office equipment provided by such individual’s employer if the equipment is necessary for 

the individual to perform work for the employer at home.12 The employee would be required to 

make substantial business use of the equipment to perform work for the employer. Substantial 

business use would include standby use for periods when work from home may be required by 

the employer, such as during work closures caused by the treat of terrorism, inclement weather, 

or natural disasters. 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 be effective for taxable years beginning after December 31, 2004. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -27 -45 -43 -48 -55 -218 -668 

12 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. 

48 
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. For 2004, the aggregate first-year credit authority allocated to each State will be 

the greater of $2.075 million or $1.80 per capita. This limit is indexed annually. 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 

49 
exceed the prices at which the housing units could be sold. Similarly, the costs of new 

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 amounts equal to LIHTC allocations would be made available annually to States 

(including U.S. possessions) beginning in calendar year 2005. Pursuant to a plan of allocation, 

State or local housing credit agencies would award first-year credits to new or rehabilitated 

housing units comprising a project for the development of single-family housing in census tracts 

with median incomes of 80 percent or less of the greater of area or statewide median income, or 

in areas of chronic economic distress (following rules similar to those used in connection with 

mortgage revenue bonds) designated within the 5 years prior to allocation. 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. 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 eligible 

basis 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 basis of 

individual units. Neither land nor existing structures would be included in eligible basis. Units 

in rehabilitated structures would qualify only if rehabilitation expenditures exceeded $25,000. 

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 amount would equal half the gain 

resulting from the resale, reduced by 1/36th of that gain for each month between the initial sale 

and the sale to a nonqualified buyer. The recapture amount would be paid to the agency making 

the credit allocation pursuant to a lien for this purpose recorded at the time of initial purchase. 

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 by the initial homebuyer within the 

first 3 years following the purchase, no deductions could be claimed. 

The proposal would be effective beginning with first-year credit allocations for calendar year 

2005. The Treasury Department would have the authority to promulgate necessary reporting 

requirements. 

50 
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -7 -81 -327 -776 -1,352 -2,543 -16,409 

51 
Protect the Environment 

PERMANENTLY EXTEND EXPENSING OF BROWNFIELDS REMEDIATION COSTS 

Current Law 

Taxpayers can elect to treat certain environmental remediation expenditures that would 

otherwise be chargeable to a capital account as deductible in the year paid or incurred. The 

deduction applies for both regular and alternative minimum tax purposes. The expenditure must 

be incurred in connection with the abatement of hazardous substances at a qualified 

contaminated site (so-called “brownfields”). This provision applies only to expenditures paid or 

incurred before January 1, 2004. 

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. 

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 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 before January 1, 2004. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

-178 -243 -212 -201 -191 -181 -1,028 -1,858

52 
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, the 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 may want their land to be protected for conservation purposes but cannot 

afford simply to donate either the land or an easement on the land, especially if the land is the 

landowner's primary salable asset. By adding an incentive for sales to qualified conservation 

groups, the current proposal complements the existing provisions that encourage charitable 

donations. This proposal would encourage the sale of appreciated, environmentally sensitive 

land and land rights to qualified conservation groups, thus achieving conservation goals through 

voluntary sales of property, rather than imposing government regulation on land use. The 

proposal would achieve this goal by strengthening the ability of conservation groups to compete 

with other potential buyers of appreciated, environmentally sensitive land. 

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 

53 
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 taxpayer or a member of the taxpayer’s family must have owned 

the property sold for the three years immediately preceding the date of the sale. 

To prevent abuse, significant penalties would be imposed on any subsequent transfer or use of 

the property other than exclusively for conservation purposes, or any subsequent removal of a 

conservation restriction contained in an instrument of conveyance of the property. 

Sales of property under this provision at a price that is less than the fair market value of the 

property may qualify as bargain sales, but only to the extent that the proceeds of the sale, net of 

capital gains taxes under this provision, are lower than the after-tax proceeds that would have 

resulted if the property had been sold at fair market value and the seller had paid tax on the full 

amount of the resulting gain. 

The provision would be effective for sales taking place on or after January 1, 2005 and before 

January 1, 2008. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -45 -88 -101 -58 0 -292 -292

54 
Increase Energy Production and Promote Energy Conservation 

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 was 1.8 cents per kilowatt-hour in 2003. 

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, 2004. 

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, 2007. 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, 2004. Electricity 

produced at such facilities from newly eligible sources would be eligible for the credit only from 

January 1, 2004, through December 31, 2008. The credit for such electricity would be computed 

at a rate equal to 60 percent of the generally applicable rate. 

55 
Electricity produced from newly eligible biomass co-fired in coal plants would be eligible for the 

credit only from January 1, 2004, through December 31, 2006. 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. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -401 -337 -305 -278 -139 -1,460 -2,175 

56 
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, 2003, and before January 1, 2007, and to photovoltaic systems placed in service after 

December 31, 2003, and before January 1, 2009. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -12 -11 -17 -23 -10 -73 -73

57 
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. 

58 
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 

59 
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, 2003. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -193 -147 -154 -162 -169 -825 -1,767 

60 
PROVIDE TAX CREDIT FOR PURCHASE OF CERTAIN HYBRID AND FUEL CELL 

VEHICLES 

Current Law 

No generally available income tax credit for purchases of hybrid vehicles is available currently. 

A 10-percent tax credit is provided for the cost of a qualified electric vehicle, up to a maximum 

credit of $4,000. A qualified electric vehicle is a motor vehicle that is powered primarily by an 

electric motor drawing current from rechargeable batteries, fuel cells, or other portable sources 

of electric current, the original use of which commences with the taxpayer, and that is acquired 

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

purchases prior to 2004. The credit begins to phase down in 2004 and does not apply to vehicles 

placed in service after 2006. 

Certain costs of qualified clean-fuel property, including clean-fuel vehicles, may be deducted 

when such property is placed in service. Qualified electric vehicles do not qualify for the cleanfuel vehicle deduction. The deduction for clean-fuel vehicles begins to phase down in 2004 and 

does not apply to property placed in service after 2006. 

Reasons for Change 

The transportation sector now accounts for 67 percent of U.S. oil consumption. Cars, sport 

utility vehicles, light trucks, and minivans alone account for 42 percent of U.S. oil consumption, 

about 20 to 40 percent of all urban smog-forming emissions, and 16 percent of greenhouse gas 

emissions. Almost all of these vehicles use a single gasoline-fueled engine. 

Hybrid vehicles, which have more than one source of power on board the vehicle, and electric 

vehicles have the potential to reduce petroleum consumption, air pollution, and greenhouse gas 

emissions. The proposed credits will encourage the purchase of highly fuel-efficient vehicles 

that incorporate advanced automotive technologies and will help to move hybrid and fuel cell 

vehicles from the laboratory to the highway. These vehicles can significantly reduce oil 

consumption, emissions of air pollutants, and emissions of carbon dioxide, the most prevalent 

greenhouse gas. 

Proposal 

The proposal would provide temporary tax credits for certain hybrid and fuel cell vehicles: 

(1) Credit for qualified hybrid vehicles. A credit, of up to $4,000, would be available for 

purchases of qualified hybrid vehicles after December 31, 2003, and before January 1, 2009. 

The credit would be: 

(a) $250 if the rechargeable energy storage system provides at least 5 percent but less than 

10 percent of the maximum available power; 

(b) $500 if the rechargeable energy storage system provides at least 10 percent and less than 

20 percent of the maximum available power; 

61 
(c) $750 if the rechargeable energy storage system provides at least 20 percent and less than 

30 percent of the maximum available power; and 

(d) $1,000 if the rechargeable energy storage system provides 30 percent or more of the 

maximum available power. 

If the vehicle’s fuel economy exceeds the 2000 model year city fuel economy, the amount of 

credit shown in (a) through (d) above would be increased by the following amounts: 

(i) $500 if the vehicle achieves at least 125 percent but less than 150 percent of the 

2000 model year city fuel economy: 

(ii) $1,000 if the vehicle achieves at least 150 percent but less than 175 percent of the 

2000 model year city fuel economy; 

(iii) $1,500 if the vehicle achieves at least 175 percent but less than 200 percent of the 

2000 model year city fuel economy; 

(iv) $2,000 if the vehicle achieves at least 200 percent but less than 225 percent of the 

2000 model year city fuel economy; 

(v) $2,500 if the vehicle achieves at least 225 percent but less than 250 percent of the 

2000 model year city fuel economy; and 

(vi) $3,000 if the vehicle achieves at least 250 percent of the 2000 model year city fuel 

economy. 

(2) Credit for qualified fuel cell vehicles. A credit of up to $8,000 would be available for the 

purchase of new qualified fuel cell vehicles after December 31, 2003, and before January 1, 

2013. The credit would be $4,000, but, if the vehicle’s fuel economy exceeds the 2000 model 

year city fuel economy, the credit would increase by the following amounts: 

(i) $1,000 if the vehicle achieves at least 150 percent but less than 175 percent of the 

2000 model year city fuel economy; 

(ii) $1,500 if the vehicle achieves at least 175 percent but less than 200 percent of the 

2000 model year city fuel economy; 

(iii) $2,000 if the vehicle achieves at least 200 percent but less than 225 percent of the 

2000 model year city fuel economy; 

(iv) $2,500 if the vehicle achieves at least 225 percent but less than 250 percent of the 

2000 model year city fuel economy; 

(v) $3,000 if the vehicle achieves at least 250 percent but less than 275 percent of the 

2000 model year city fuel economy; 

(vi) $3,500 if the vehicle achieves at least 275 percent but less than 300 percent of the 

2000 model year city fuel economy; and 

(vii) $4,000 if the vehicle achieves at least 300 percent of the 2000 model year city fuel 

economy. 

62 
The 2000 model year city fuel economy would be the following: 

If the vehicle inertia The 2000 model year city fuel economy is: 

weight class is: For a passenger automobile: For a light truck: 

1,500 or 1,750 lbs 

2,000 lbs 

2,250 lbs 

2,500 lbs 

2,750 lbs 

3,000 lbs 

3,500 lbs 

4,000 lbs 

4,500 lbs 

5,000 lbs 

5,500 lbs 

6,000 lbs 

6,500 lbs 

7,000 or 8,500 lbs 

43.7 mpg 37.6 mpg 

38.3 mpg 33.7 mpg 

34.1 mpg 30.6 mpg 

30.7 mpg 28.0 mpg 

27.9 mpg 25.9 mpg 

25.6 mpg 24.1 mpg 

22.0 mpg 21.3 mpg 

19.3 mpg 19.0 mpg 

17.2 mpg 17.3 mpg 

15.5 mpg 15.8 mpg 

14.1 mpg 14.6 mpg 

12.9 mpg 13.6 mpg 

11.9 mpg 12.8 mpg 

11.1 mpg 12.0 mpg 

The “vehicle inertia weight class” is defined in regulations prescribed by the Environmental 

Protection Agency for purposes of title II of the Clean Air Act. 

A qualifying hybrid vehicle is a motor vehicle that draws propulsion energy from on-board 

sources of stored energy which include both: (1) an internal combustion engine or heat engine 

using combustible fuel, and (2) a rechargeable energy storage system. A qualifying fuel cell 

vehicle is a motor vehicle that is propelled by power derived from one or more cells which 

convert chemical energy directly into electricity by combining oxygen with hydrogen fuel which 

is stored on board the vehicle and may or may not require reformation prior to use. A qualifying 

vehicle must meet all applicable regulatory requirements. 

The percentage of maximum available power provided by the rechargeable energy storage 

system means the maximum value available from the battery or other energy storage device, 

during a standard power test, divided by the sum of the battery or other energy storage device 

and the SAE net power of the heat engine. 

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

utility vehicles, and light trucks. Taxpayers would be able to claim only one of the credits per 

vehicle and taxpayers who claim either credit would not be able to claim the qualified electric 

vehicle credit or the deduction for clean-fuel vehicle property for the same vehicle. Business 

taxpayers claiming either credit would be subject to the limitations on the general business credit 

and would be required to reduce the basis of the vehicle by the amount of the credit. 

63 
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -79 -223 -376 -556 -542 -1,776 -2,211 

64 
PROVIDE TAX CREDIT FOR ENERGY PRODUCED FROM LANDFILL GAS 

Current Law 

Taxpayers that produce gas from biomass (including landfill methane) are eligible for a tax credit 

(“the section 29 credit”) equal to $3 per barrel-of-oil equivalent. For this purpose, a barrel-of-oil 

equivalent is the amount of gas that has a Btu (British thermal unit) content of 5.8 million. To 

qualify for the credit, the gas must be produced domestically from a facility placed in service by 

the taxpayer before July 1, 1998, pursuant to a written binding contract in effect before January 

1, 1997. In addition, the gas must be sold to an unrelated person before January 1, 2008. 

The amount of the section 29 credit generally is adjusted by an inflation adjustment factor for the 

calendar year in which the sale occurs. The inflation adjustment factor for the 2002 calendar 

year was 2.1169, and the inflation-adjusted amount of the credit for that year was $6.35 per 

barrel or barrel equivalent. The credit begins to phase out if the annual average unregulated 

wellhead price per barrel of domestic crude oil exceeds $23.50 multiplied by the inflation 

adjustment factor. For 2002, the inflation adjusted threshold for onset of the phaseout was 

$49.75 ($23.50 x 2.1169) and the average wellhead price for that year was $22.51. 

The amount of the section 29 credit allowable with respect to a project is reduced by any 

unrecaptured business energy tax credit or enhanced oil recovery credit claimed with respect to 

such project. 

The section 29 credit may not be used to offset alternative minimum tax liability. Any unused 

section 29 credit generally may not be carried back or forward to another taxable year; however, 

a taxpayer receives a credit for prior year minimum tax liability to the extent that a section 29 

credit is disallowed as a result of the operation of the alternative minimum tax. The credit is 

limited to what would have been the regular tax liability but for the alternative minimum tax. 

Reasons for Change 

The tax credit helps make fuel produced from landfill methane competitive with other fuels. 

Extending the credit would continue the important contribution of this renewable energy source 

to the Nation’s long-term energy supply. 

Proposal 

The credit would be allowed for fuel produced from landfill methane if the fuel is produced from 

a facility (or portion of a facility) placed in service after December 31, 2003, and before January 

1, 2012, and is sold (or used to produce electricity that is sold) before January 1, 2012. The 

credit for fuel produced at landfills subject to EPA’s 1996 New Source Performance 

Standards/Emissions Guidelines would be limited to two-thirds of the otherwise applicable 

amount beginning on January 1, 2008, if any portion of the facility for producing fuel at the 

landfill was placed in service before July 1, 1998, and beginning on January 1, 2004, in all other 

cases. The proposal would clarify, for purposes of determining the extent to which a facility is 

placed in service after December 31, 2003, that the facility includes the wells, pipes, and related 

components used to collect landfill methane and that only production attributable to wells, pipes, 

65 
and related components placed in service after December 31, 2003, is treated as produced from 

the portion of the facility placed in service after that date. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -34 -67 -91 -104 -117 -413 -737 

66 
PROVIDE TAX CREDIT FOR COMBINED HEAT AND POWER PROPERTY 

Current Law 

Combined heat and power (CHP) systems are used to produce electricity (and/or mechanical 

power) and usable thermal energy from a single primary energy source. No income tax credit is 

currently provided for investments in CHP property. 

Depreciation allowances for CHP property vary by asset use and capacity. Assets used to 

produce electricity with a capacity of 500 kilowatts or less are classified with other 

manufacturing assets, and generally have cost recovery periods of five to ten years. Other assets 

employed in the production of electricity have either a 15-year or 20-year recovery period. For 

assets that are structural components of buildings, however, the recovery period is either 39 years 

(if nonresidential real property) or 27.5 years (if residential rental property). 

Reasons for Change 

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

producing electricity by more conventional methods. CHP systems achieve a greater level of 

overall energy efficiency, and thereby lessen the consumption of primary fossil fuels. They can 

lower total energy costs and reduce carbon emissions. An investment tax credit for CHP assets 

is expected to encourage increased energy efficiency by accelerating planned investment and 

inducing additional investment in CHP systems. The increased demand for such equipment 

should, in turn, reduce CHP production costs and spur additional technological innovations in 

improved CHP systems. 

Proposal 

The proposal would establish a 10-percent investment credit for qualified CHP systems with an 

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

excess of 67 horsepower (or an equivalent combination of electrical and mechanical energy 

capacities). CHP property would be defined as property comprising a system that uses the same 

energy source for the simultaneous or sequential generation of (1) electricity or mechanical shaft 

power (or both) and (2) steam or other forms of useful thermal energy (including heating and 

cooling applications). A qualified CHP system would be required to produce at least 20 percent 

of its total useful energy in the form of thermal energy and at least 20 percent of its total useful 

energy in the form of electrical or mechanical power (or a combination thereof) and would also 

be required to satisfy an energy-efficiency standard. For CHP systems with an electrical 

capacity in excess of 50 megawatts (or a mechanical energy capacity in excess of 67,000 

horsepower), the total energy efficiency of the system would have to exceed 70 percent. For 

smaller systems, the total energy efficiency would have to exceed 60 percent. For this purpose, 

total energy efficiency would be calculated as the sum of the useful electrical, thermal, and 

mechanical power produced by the system at normal operating rates, measured on a Btu basis, 

divided by the lower heating value of the primary fuel source for the system. The eligibility of 

qualified CHP property would be verified under regulations prescribed by the Secretary of the 

Treasury. 

67 
Qualified CHP assets that are assigned cost recovery periods of less than 15 years would be 

eligible for the credit, but only if the taxpayer elects to treat such property as having a 22-year 

class life. Thus, for such property, regular tax depreciation allowances would be calculated 

using a 15-year recovery period and the 150 percent declining balance method. 

The credit would be treated as an energy credit under the investment credit component of the 

section 38 general business credit, and would be subject to the rules and limitations governing 

that credit. Taxpayers using the credit for CHP equipment would not be entitled to any other tax 

credit for the same equipment. 

The credit would apply to investments in CHP equipment placed in service after December 31, 

2003, but before January 1, 2009. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -154 -107 -64 -62 -13 -400 -349

68 
-- -- -- -- -- -- -- --

EXTEND EXCISE TAX EXEMPTION (CREDIT) FOR ETHANOL 

Current Law 

Current law provides an income tax credit and an excise tax exemption for ethanol and 

renewable source methanol used as a fuel. In general, the income tax credit for ethanol is 52 

cents per gallon, but small ethanol producers (i.e., those producing less than 30 million gallons of 

ethanol per year) qualify for a credit of 62 cents per gallon on the first 15 million gallons of 

ethanol produced in a year. A credit of 60 cents per gallon is allowed for renewable source 

methanol. 

As an alternative to the income tax credit, gasohol blenders may claim a gasoline tax exemption 

of 52 cents for each gallon of ethanol and 60 cents for each gallon of renewable source methanol 

that is blended into qualifying gasohol. 

The income tax credit expires on December 31, 2007, and the excise tax exemption expires on 

September 30, 2007. In addition, the ethanol credit and exemption are each reduced by 1 cent 

per gallon in 2005. Neither the credit nor the exemption applies during any period in which 

motor fuel taxes dedicated to the Highway Trust Fund are limited to 4.3 cents per gallon. Under 

current law, the motor fuel tax dedicated to the Highway Trust Fund will be limited to 4.3 cents 

per gallon beginning on October 1, 2005. 

Reasons for Change 

The tax credit and excise tax exemption help make ethanol and renewable source methanol 

competitive with other fuels. Extending the credit and exemption would continue the important 

contribution of these renewable energy sources to the Nation’s long-term energy supply. 

Proposal 

The income tax credit and the excise tax exemption would be extended through December 31, 

2010. The current law rule providing that neither the credit nor the exemption applies during any 

period in which motor fuel taxes dedicated to the Highway Trust Fund are limited to 4.3 cents 

per gallon would be retained. As under current law, the credit and the exemption would each be 

reduced by 1 cent per gallon in 2005. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

69 
PERMIT ELECTRIC UTILITIES TO DEFER GAIN FROM SALES OF ELECTRIC 

TRANSMISSION PROPERTY 

Current Law 

Gain on the sale of business assets is subject to current income tax unless a special rule provides 

for nonrecognition or deferral of the gain. 

Reasons for Change 

To improve transmission management and facilitate the formation of competitive energy 

markets, federal and State energy regulators are calling for vertically integrated utilities to place 

their transmission assets under the ownership or control of independent transmission providers 

(or other similarly approved operators). The current tax on gain from the sale of business assets 

may, however, inhibit the dispositions that energy regulators are attempting to encourage. A 

limited deferral of the tax on gain from these dispositions, available only to the extent proceeds 

of the disposition are reinvested in utility property, would facilitate electric deregulation and 

encourage investment in modernization of the country’s energy infrastructure. 

Proposal 

Electric utilities would be permitted to defer the gain from sales of electric transmission property 

(or an ownership interest in an entity providing electric transmission services) to an independent 

transmission company. For this purpose, an independent transmission company would be 

defined as (1) any FERC-approved regional transmission organization, independent system 

operator, or independent transmission company; (2) any person that FERC determines under 

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

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

regional transmission organization, independent system operator, or independent transmission 

company; and (3) in the case of facilities subject to the jurisdiction of the Public Utility 

Commission of Texas (i) any entity approved by that Commission as consistent with Texas law 

regarding an independent transmission organization or (ii) a political subdivision, or affiliate 

thereof, whose transmission facilities are under the operational control of such an entity. A 

taxpayer electing deferral under the proposal would recognize the gain ratably over the eightyear period beginning with the year of sale. Deferral would be available only to the extent the 

taxpayer (or an affiliate) reinvests the amount received for the transmission property in other 

electric or gas utility property during the period ending four years after the end of the taxable 

year in which the disposition occurs. The period for assessing a deficiency with respect to the 

deferred gain of an electing taxpayer would not expire until three years after the IRS is notified 

of the reinvestment or of the taxpayer’s intent not to reinvest. The proposal would apply to sales 

or other dispositions occurring after the date of enactment and before January 1, 2007. 

70 
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

-11 -475 -615 -532 -227 100 -1,749 361

71 
MODIFY TAX TREATMENT OF CERTAIN INCOME OF ELECTRIC 

COOPERATIVES 

Current law 

Mutual or cooperative electric companies (electric cooperatives) are generally exempt from 

federal income tax if at least 85 percent of the cooperative’s income consists of amounts 

collected from members for the sole purpose of meeting losses and expenses (the 85-percent 

test). Taxable electric cooperatives may exclude from taxable income certain profits rebated to 

patrons. 

Reasons for Change 

Competitive electricity markets will benefit consumers and enhance economic growth. Certain 

rules governing the taxation of electric cooperatives should be modified to facilitate participation 

by electric cooperatives in electric industry restructuring. 

Proposal 

Income of electric cooperatives from the following activities would be excluded from the 85-

percent test: (1) providing open access transmission service under a tariff filed with the Federal 

Energy Regulatory Commission (FERC) (or, if applicable, the Public Utility Commission of 

Texas) or an independent transmission provider agreement approved or accepted by FERC (or, if 

applicable, the Public Utility Commission of Texas); (2) providing open access distribution 

service (i) to deliver electricity to end-users served by distribution facilities not owned by the 

cooperative or any of its members, or (ii) to deliver to third parties electricity generated by a 

facility that is not owned or leased by the cooperative or any of its members and is directly 

connected to distribution facilities owned by the cooperative or any of its members; (3) certain 

transfers into (and distributions and earnings from) a trust, fund or instrument established to pay 

nuclear decommissioning costs; and (4) certain voluntary exchanges or involuntary conversions 

of property related to generating, transmitting, distributing or selling electric energy. The 

Administration also proposes that income from sales of electric energy to non-members be 

treated as qualifying member income (and, in the case of certain taxable electric cooperatives, 

excluded from taxable income whether or not profits are rebated to patrons) to the extent such 

sales do not exceed the cooperative’s load losses during a specified ten-year recovery period. 

The proposal would be effective for taxable years beginning after the date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -14 -20 -21 -22 -23 -100 -235 

72 
SIMPLIFY THE TAX LAWS FOR FAMILIES 

ESTABLISH UNIFORM DEFINITION OF A QUALIFYING CHILD 

Current Law 

The tax code provides assistance to families with children through the dependent exemption, 

head-of-household filing status, child tax credit, child and dependent care tax credit, and earned 

income tax credit (EITC). However, each of these provisions has a unique definition of eligible 

child. These are described below. 

Dependent Exemption: To qualify as a dependent, an individual must satisfy five tests. First, he 

or she must either be a qualifying relative or meet certain residency requirements. Qualifying 

relatives include the taxpayer’s (1) son or daughter or a descendant of either (e.g., grandchildren, 

great-grandchildren); (2) stepson or stepdaughter; (3) sibling or stepsibling; (4) parent or 

ancestor of a parent (e.g., grandparent, great-grandparent); (5) stepparent; (6) son or daughter of 

a sibling; (7) parent’s sibling; or (8) father-in-law, mother-in-law, son-in-law, daughter-in-law, 

brother-in-law, or sister-in-law. If the individual is not a qualifying relative, the taxpayer’s home 

must be his or her principal place of abode for the full tax year, and the individual must be a 

member of the taxpayer’s household.13 

Second, the individual also must receive more than half of his or her support from the taxpayer.14 

Third, he or she must be a citizen or resident of the United States or a resident of a contiguous 

country (Canada or Mexico). Fourth, if the individual is married, he or she cannot file a joint tax 

return with his or her spouse, except to receive a refund of withheld taxes. Fifth, a taxpayer 

cannot claim a dependent if the dependent’s gross income exceeds the exemption amount 

($3,100 in 2004). This test does not apply if the dependent is the taxpayer’s child (son, daughter, 

stepson, stepdaughter, or foster child) and is under the age of 19 at the close of the calendar year 

(under 24 if a full-time student). A foster child is defined to mean an individual for whom the 

taxpayer “cares for as the taxpayer’s own child.” A foster child must reside with the taxpayer for 

the entire year. 

Special rules apply to more complicated family situations. For example, in the event of divorce 

or separation, the custodial parent generally is entitled to the dependent exemption if the parents, 

in combination, provide over half the support of the child. To qualify as the custodial parent, the 

taxpayer must reside with his or her child for over half the year. The noncustodial parent may 

claim the exemption only if the custodial parent provides him or her with a written waiver to be 

attached to the tax return. 

There are other circumstances, in addition to divorce or separation, when more than one taxpayer 

helps support an individual. If each taxpayer provides less than half of the person’s support, but 

in combination, the taxpayers provide over half of the person’s support, then one of the taxpayers 

can claim the dependent exemption if three additional tests are met. First, the taxpayer meets all 

13 A taxpayer or another individual may still be considered to be a member of the household despite a temporary 

absence due to special circumstances, such as illness, education, work, military service, or vacation. 14 Public assistance payments are taken into account as support payments made by a government entity. 

73 
the requirements, other than support, for claiming the person as a dependent. Second, the 

taxpayer contributes over ten percent of the person’s support. Third, each of the other taxpayers 

who provide at least ten percent of the person’s support signs a waiver, which the taxpayer 

claiming the exemption then attaches to his or her tax return. 

An exemption is not allowed for any dependent unless a taxpayer identification number for the 

dependent is included on the taxpayer’s tax return. 

Head of Household Filing Status: An unmarried taxpayer may be considered a head of 

household if the taxpayer maintains as his or her home a household that constitutes for more than 

half of the tax year the principal place of abode for (1) unmarried sons, daughters, stepchildren, 

or descendants of the taxpayer’s sons or daughters; (2) married sons, daughters, stepchildren, or 

descendants of the taxpayer’s sons or daughters, whom the taxpayer can claim as dependents; or 

(3) relatives whom the taxpayer can claim as dependents (as defined above). An unmarried 

taxpayer also may claim head of household filing status if he or she maintains a separate 

household for dependent parents for the tax year. 

Child Tax Credit: Taxpayers can claim the child tax credit for qualifying individuals who meet 

three tests, in addition to the five tests that qualify them as dependents. The qualifying 

individual must be under the age of 17. Further, the child must be the taxpayer’s son, daughter, 

grandchild, sibling, niece, nephew, or foster child. Stepchildren, stepsiblings, and their 

descendants are also qualifying children. If the child is the taxpayer’s sibling, niece or nephew, 

the taxpayer must care for the child as if the child were his or her own child. Finally, the child 

must be a citizen or resident of the United States (that is, the contiguous country rule, which 

applies to the dependent exemption, does not pertain to the child tax credit). 

The definition of foster child for the child tax credit differs from that used for dependents. As 

under the definition of a dependent, a foster child is an individual for whom the taxpayer “cares 

for as the taxpayer’s own child” and who resides with the taxpayer for the entire year. However, 

the foster child also must be placed with the taxpayer by an authorized placement agency. 

Tax Benefits Related to Child Care: A taxpayer may be eligible for the child and dependent care 

tax credit and the exclusion for employer-provided child care if the taxpayer provides over half 

the costs of maintaining a home in which the taxpayer and a qualifying individual reside. 

Qualifying individuals include dependents (as defined above) under the age of 13. Custodial 

parents also may claim children under the age of 13 whom they would be entitled to claim as 

dependents if they had not waived the exemption to the noncustodial parents. Qualifying 

individuals can include dependents (of any age) or spouses who are physically or mentally 

incapable of caring for themselves. 

To qualify for the credit, a taxpayer must maintain the household in which the taxpayer and the 

qualifying individual reside. The household maintenance test applies to both married and 

unmarried filers. A taxpayer must provide over half the cost of maintaining the household for 

the period during the year in which he or she resides in the home with the qualifying individual. 

74 
Earned Income Tax Credit (EITC): A child is a qualifying child if the following three 

requirements are met: (1) the child must be the taxpayer’s son, daughter, grandchild, sibling, 

niece, nephew, or foster child; (2) the child generally must reside with the taxpayer in the same 

principal place of abode in the United States for over half the year; and (3) the child must be 

under the age of 19 (or under 24 if a full-time student). Stepchildren, stepsiblings, and their 

descendants are also qualifying children. If the child is the taxpayer’s sibling, niece or nephew, 

the taxpayer must care for the child as if the child were his or her own child. The definition of 

foster child is the same as under the child tax credit, except that the residency test is over six 

months rather than twelve months. 

If more than one taxpayer claims the same child for purposes of the EITC, the following rules 

apply. If each claimant satisfies the age, relationship, and residence tests with respect to the 

same child, only the taxpayer with the highest adjusted gross income (AGI) can claim the child. 

However, the parent’s claim supercedes the claims of other taxpayers, regardless of the outcome 

of the AGI tiebreaker test. If both parents file separate returns claiming the child, then the parent 

who resides with the child the longest is deemed entitled to the EITC. In the event that both 

parents reside with the child for the same amount of time, then the parent with the highest AGI is 

entitled to the credit. 

Both the taxpayer (and his or her spouse, if married) and qualifying child must have a social 

security number that is valid for employment in the United States (that is, they must be U.S. 

citizens, permanent residents, or have certain types of temporary visas that allow them to work in 

the United States). 

Reasons for Change 

Taxpayers with children may receive a number of tax benefits to help offset the costs of raising a 

family. In tax year 2005, there will be over 53 million taxpayers with children. Of these, 50 

million taxpayers will claim child dependents and tens of millions will claim one or more other 

child-related tax benefits. 

Tax Year 2005 

Child-Related Tax Benefit 

Dependent Exemption 

With Child 

Head of Household Filing Status 

With Child 

Child Tax Credit 

Child and Dependent Care Tax Credit 

Earned Income Tax Credit 

With Child 

Number of Returns (millions) 

53.8 

50.3 

24.4 

22.2 

32.0 

6.4 

21.6 

17.7 

In many cases, taxpayers will claim more than one of these benefits. For example, 32.0 million 

taxpayers will claim both child dependent exemptions and the child tax credit, 16.5 million 

taxpayers will claim both child dependent exemptions and the EITC, and 10.7 million taxpayers 

will claim all three. Over a million taxpayers will claim all five of the child-related tax benefits. 

75 
But to obtain these benefits, taxpayers must wade through pages of bewildering rules and 

instructions because each provision defines an eligible “child” differently. For example, to claim 

the dependent exemption and the child tax credit, a taxpayer must demonstrate that he or she 

provides most of the support of the child. To claim the EITC, the taxpayer must demonstrate that he 

or she resides with the child for a specified period of time. Having different definitions for as 

simple a concept as one’s child may confuse taxpayers and lead to erroneous claims of one or more 

child-related tax benefits. As a recent EITC compliance study found, nearly one in five children 

claimed as dependents and EITC qualifying children in 1999 were disallowed for one, but not both, 

tax benefits. 

Taxpayer confusion and errors also may be linked to some of the criteria used to determine 

eligibility for the child-related tax benefits. A 1993 General Accounting Office study found that 

in 1988, taxpayers erroneously claimed exemptions for an estimated nine million dependents.15 

Nearly three-quarters of erroneous claims were attributable to taxpayers’ failure to meet the 

dependent support test. Among those who did not meet the support test, taxpayers did not 

provide financial support for 57 percent of the claimed dependents. In the remaining cases, 

taxpayers lacked adequate records to demonstrate that they had met the support test. Replacing 

the support test, which is difficult to understand and to administer in the absence of an intrusive 

audit, with a uniform residency test would reduce both compliance and administrative costs. 

Proposal 

A uniform definition of qualifying child would be adopted for purposes of determining eligibility 

for the dependency exemption, the child tax credit, the child and dependent care tax credit, head 

of household filing status, and the EITC. A qualifying child would have to meet the following 

three tests: 

• Relationship – The child must be the taxpayer’s son, daughter, stepchild, sibling, stepsibling, 

or a descendant of such individuals. Foster children placed with the taxpayer by authorized 

placement agencies would satisfy the relationship test. If the child is the taxpayer’s sibling or 

stepsibling or a descendant of any such individual, the taxpayer must care for the child as if 

the child were his or her own child. 

• Residence – The child must live with the taxpayer in the same principal place of abode in the 

United States for over half the year. Military personnel on extended active duty outside the 

United States would be considered to be residing in the United States. As under current law, 

the taxpayer and child are considered to live together even if one or both are temporarily 

absent due to special circumstances such as illness, education, business, vacation, or military 

service. 

• Age – The child must be under the age of 19, a full-time student if over age 18 and under age 

24, or totally and permanently disabled. However, as under current law, qualifying children 

15 United States General Accounting Office, Tax Administration: Erroneous Dependent and Filing Status Claims, 

Report GAO/GGD-93-60, March 1993. 

76 
(who are not disabled) must be under age 13 for purposes of the child and dependent care tax 

credit and under 17 (whether or not disabled) to qualify for the child tax credit. 

Neither the support nor gross income tests would apply to qualifying children who meet the 

relationship, residence, and age tests. In addition, taxpayers would no longer be required to meet 

a household maintenance test when claiming the child and dependent care tax credit. 

If more than one taxpayer claims the same qualifying child, then the following tiebreaker rules 

would apply: 

• If only one of the claimants is the child’s parent, then he or she would receive the tax benefit. 

• If the child’s parents do not file a joint return and both claim the child on separate returns, 

then the tax benefit would accrue to the parent with whom the child resides the longest. If 

both parents reside with the child for the same length of time, then the benefit would accrue 

to the parent with the highest AGI. 

• If the child’s parents do not claim the child, then the tax benefit would accrue to the claimant 

with the highest AGI. 

The proposal repeals the current law provision that allows a custodial parent to release the claim 

to a dependent exemption to a noncustodial parent if the parents, in combination, provide over 

half the support of a child. However, if there is a child support instrument between the parents 

that applies to the dependent and that is in effect as of the date of the announcement of a 

legislative proposal, then current law would pertain. That is, in such cases, a custodial parent 

could release the claim to a dependent exemption (and, by extension, the child tax credit) to the 

noncustodial parent. 

Taxpayers could continue to claim individuals who do not meet the proposed relationship, 

residency, or age tests as dependents if the current law dependency requirements are met.16 

Thus, a taxpayer would still be able to claim a parent as a dependent if the taxpayer provides 

over half the support of the parent and the parent’s gross income is less than the exemption 

amount. As under current law, taxpayers would also be able to claim a distantly related or 

unrelated child as a dependent if the child resides in the taxpayer’s home for the full year and 

meets the current law dependency tests. Further, such children would still not qualify the 

taxpayer for the child tax credit or the EITC unless placed in the home by an authorized 

placement agency. However, if more than one taxpayer claims a child as a dependent, then the 

proposed residency-based tests would supercede current law. The current law dependency tests 

would also continue to apply to children who are U.S. citizens living abroad or non-U.S. citizens 

living in Canada and Mexico. 

Taxpayers would be required to provide a valid taxpayer identification number for each 

qualifying child. An EITC qualifying child, however, would be required to have a social security 

16 Under the proposal, a child who provides over half of his or her own support would not be considered a 

dependent of another taxpayer. This is consistent with current law. 

77 
number that is valid for employment in the United States (that is, EITC qualifying children must 

be U.S. citizens, permanent residents, or have certain types of temporary visas). 

The proposal would be effective for tax years beginning after December 31, 2004. 

Revenue Estimate17 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 -38 -70 -65 -56 -46 -275 -475 

17 The estimate includes both receipt and outlay effects. The outlay effect is $36 million for 2006, $36 million for 

2007, $36 million for 2008, $37 million for 2009, $145 million for 2005-2009 and $333 million for 2005-2014. 

78 
Comparison of Key Provisions Relating to Qualifying Children 

Dependency Exemption Head of Household Filing 

Status 

Child Tax Credit Child and Dependent 

Care Tax Credit 

Earned Income 

Credit 

1. Relationship test 

Sons, daughters, grandchildren 

Yes Yes Yes Yes Yes 

Brothers, sisters, nieces, nephews 

Yes Yes, if qualifies as a 

dependent 

Yes, if qualifies as a dependent and taxpayer cares for child as his or her 

own 

Same as dependency exemption 

Yes, if taxpayer carchild as his or her o

Foster children 

(which may 

include relatives 

and unrelated 

children) 

Any child may be treated as 

own child if lives with 

taxpayer for entire year and 

the taxpayer cares for the child as his or her own 

Yes, if qualifies as a dependent 

Yes, if lives with taxpayer 

for entire year, is placed by 

an authorized placement 

agency, and taxpayer cares 

for the child as his or her 

own 

Same as dependency exemption 

Yes, if lives with tafor over half the yeplaced by an author

placement agency, taxpayer cares for t

as his or her own 

2. Age limit Under 19 or under 24 if 

full-time student 

No age limit for unmarried sons, daughters, grandchildren, and stepchildren. Otherwise, 

same as dependency exemption. 

Under 17 Under 13 (no age limit for 

disabled dependent) 

Same as dependencexemption, but no afor disabled childre

3. Gross income limit 

Individual cannot be claimed as a dependent if 

earns more than the exemption amount, except if son, daughter, stepson, stepdaughter, or foster child under age limit 

No limit for unmarried 

sons, daughters, grandchildren, and stepchildren regardless of 

age; otherwise, same as dependency exemption 

Same as dependency exemption 

Same as dependency exemption 

No limit 

4. Residency requirements 

Certain related children do 

not have to live with the taxpayer, otherwise entire year 

Child must live with the 

taxpayer for over one half 

of the year 

Same as dependency exemption 

Child must live with the taxpayer for the period during which the expenses were incurred 

Child must live wit

taxpayer for over o

of the year 

5. Support test Taxpayer must provide 

over one half of the child’s support. 

No support test for unmarried sons, daughters, grandchildren, and stepchildren; otherwise, 

same as dependency exemption 

Same as dependency exemption 

Same as dependency exemption 

None 

6. Household maintenance test 

None Taxpayer must provide 

over one half of the costs of maintaining the household 

None Taxpayer must provide 

over one half of the costs of maintaining the household for the period during which child lived with taxpayer 

None 

79 
SIMPLIFY ADOPTION TAX BENEFITS 

Current Law 

Under current law, for taxable years through 2010, two tax benefits are provided to taxpayers 

who adopt children: (1) a nonrefundable 100 percent tax credit for a limited amount of qualified 

expenses incurred in the adoption of a child; and (2) an exclusion from gross income of a limited 

amount of qualified adoption expenses paid or reimbursed by an employer under an adoption 

assistance program. In 2004, the separate limits on qualified adoption expenses for the credit 

and the exclusion are $10,390. Taxpayers may use both adoption tax benefits, but the same 

expenses cannot be used for both benefits. Taxpayers who adopt children with special needs 

may claim the full $10,390 credit or exclusion even if adoption expenses are less than that 

amount. Taxpayers may carry forward unused credit amounts for up to five years. If modified 

adjusted gross income exceeds $155,860 (in 2004), both the credit amount and the amount 

excluded from gross income are reduced pro-rata over the next $40,000 of modified adjusted 

gross income. The maximum credit and exclusion and the income at which the phase-out range 

begins are indexed annually for inflation. The limits for the tax credit and the exclusion are per 

adoption, so that benefits for a given adoption may be claimed over several years. 

For taxable years after 2010, taxpayers will be able to claim the adoption credit only for the 

adoption of a child with special needs, only for qualified expenses they actually incur, the 

qualified expense limit will be $6,000, the credit will be reduced pro-rata between $75,000 and 

$115,000 of modified adjusted gross income, and the credit amount and beginning of the phaseout range will not be indexed annually for inflation. The exclusion of employer-provided 

adoption assistance from gross income is not available to taxpayers for taxable years beginning 

after 2010. However, as a result of the Administration’s separate proposal to permanently extend 

all provisions of EGTRRA, both the adoption tax credit and the exclusion for employer-provided 

adoption assistance would remain in effect with all of their current, pre-2011 provisions and 

limits. 

Reasons for Change 

The phase-out provisions of both adoption tax benefits increase complexity for all taxpayers who 

use the adoption tax benefits, including the vast majority who are not affected by the phase-outs. 

Moreover, the phase-outs increase marginal tax rates very substantially for taxpayers with 

incomes in the phase-out range. For example, a family that, in 2004, has $10,390 of adoption 

expenses eligible for the tax credit and that is in the phase-out range has its marginal tax rate 

increased by 26.0 percentage points over what its marginal tax rate would otherwise be. 

Proposal 

The Administration proposes to eliminate the income-related phase-outs of the adoption tax 

credit and exclusion. The proposal would be effective for taxable years beginning after 

December 31, 2004. 

80
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -4 -39 -40 -42 -43 -168 -411

81
ELIMINATE HOUSEHOLD MAINTENANCE TEST FOR HEAD-OF-HOUSEHOLD 

FILING STATUS 

Current Law 

Taxpayers who qualify as heads of households may claim a standard deduction that is equal to 

147 percent of the standard deduction claimed by single filers. Their income is taxed under a 

separate rate structure that is more generous than the rate structure that applies to single filers. 

An unmarried taxpayer may be considered a head of household if the taxpayer maintains as his 

or her home a household that constitutes for more than half of the taxable year the principal place 

of abode for (1) an unmarried son, daughter, stepchild, or a descendant of the taxpayer’s son or 

daughter; (2) a married son, daughter, stepchild, or a descendant of the taxpayer’s son or 

daughter, whom the taxpayer can claim as a dependent; or (3) a relative whom the taxpayer can 

claim as a dependent. An unmarried taxpayer also may claim head of household filing status if 

he or she maintains a separate household for a dependent parent for the tax year. 

Taxpayers who qualify as surviving spouses may use the standard deduction and rate brackets 

that are applicable to married couples filing jointly, which are more generous than the standard 

deduction and rate brackets that apply to single filers. 

A taxpayer may qualify as a surviving spouse if his or her spouse died during either of the two 

years immediately preceding the current taxable year. In addition, the taxpayer must maintain as 

his or her home the household that constitutes for the taxable year the principal place of abode 

for a dependent who is the taxpayer’s son, daughter, or stepchild. 

Reasons for Change 

In 2005, 24.5 million taxpayers will claim either head of household or surviving spouse filing 

status on their tax returns. To qualify for either filing status, these taxpayers will have to 

demonstrate that they provide over half the cost of maintaining the home in which they reside. 

(An unmarried taxpayer also can qualify as a head of household if he or she provides over half 

the cost of maintaining the home in which the taxpayer’s dependent parent resides.) This 

household maintenance test is difficult to understand and administer. 

First, taxpayers must read a separate page of instructions in Publication 501 to determine if they 

qualify as a head of household. Then, they must complete an eleven-line worksheet to determine 

if they provide over half the cost of maintaining their home. Taxpayers also must compile and 

retain records to prove they meet the household maintenance test. 

Second, taxpayers can easily be confused by the subtle distinctions between the household 

maintenance test and the similar, but not identical, support test used to determine whether 

someone is a dependent (a separate 22-line worksheet in Publication 501). For example, 

mortgage interest expenses and property taxes are counted toward the cost of maintaining a 

household, but the taxpayer is instructed to factor in the “fair rental value of a home” toward 

support. To compute household maintenance, taxpayers must measure the cost of food 

82
consumed on the premises. But for the support test, the taxpayer must include the cost of all 

food, regardless of where it is eaten. 

Third, the IRS does not receive independent information to verify that taxpayers have met the 

household maintenance test. As a consequence, the IRS cannot verify that an unmarried 

taxpayer is a head of household in the absence of a burdensome audit. 

Proposal 

An unmarried taxpayer would no longer be required to meet a household maintenance test in 

order to claim head of household filing status. An unmarried taxpayer would be considered a 

head of household if he or she resides with a qualifying child or a related dependent for more 

than half the year. An unmarried taxpayer also may qualify as a head of household if he or she 

claims a parent as a dependent, regardless of where the parent resides. 

A special rule would apply to unmarried parents who reside together with their child for more 

than half the year. In this instance, only one parent would be allowed to claim head of household 

filing status. If both parents claim head of household filing status, only the taxpayer with the 

higher adjusted gross income (AGI) would be deemed eligible. For purposes of this rule, a child 

is defined as the taxpayer’s son or daughter. 

To qualify as a surviving spouse, a taxpayer would no longer have to meet a household 

maintenance test. A taxpayer would be considered a surviving spouse if his or her spouse died 

during either of the two years immediately preceding the current taxable year. In addition, the 

taxpayer must reside with his or her dependent child for over half the taxable year. For purposes 

of this provision, a child is defined as the taxpayer’s son, daughter, or stepchild. 

The proposal is effective for taxable years beginning after December 31, 2004. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -123 -297 -284 -285 -281 -1,270 -2,555

83
REDUCE COMPUTATIONAL COMPLEXITY OF REFUNDABLE CHILD TAX 

CREDIT 

Current Law 

An individual may claim a $1,000 tax credit for each qualifying child under the age of 17.18 A 

qualifying child must be a citizen, national, or resident of the United States. The child tax credit 

is phased out for individuals with income over certain thresholds,19 and is partially refundable. 

Taxpayers may be eligible for a refundable amount (the additional child tax credit) equal to 10 

percent of earned income in excess of $10,750.20 Earned income is defined as the sum of wages, 

salaries, tips, and other taxable employee compensation plus net self-employment earnings. 

Unlike the EITC, which also includes the preceding items in its definition of earned income, the 

additional child tax credit is based only on earned income to the extent it is included in 

computing taxable income.

21 

Families with three or more children may determine the additional child tax credit using an 

alternative formula. A taxpayer can claim an additional child tax credit equal to the amount by 

which the taxpayer's social security taxes exceed the taxpayer's earned income tax credit, if that 

amount is greater than the additional child tax credit based on the taxpayer's earned income in 

excess of $10,750. 

Reasons for Change 

The additional child tax credit is difficult to compute and unduly complicated. To compute the 

credit amount, low and moderate-income taxpayers must attach a separate form to their tax 

return. Many taxpayers with three or more children must compute the additional child tax credit 

twice to determine which formula yields the larger credit. 

In addition, the eligibility criteria for the additional child tax credit differ from those used for the 

similar EITC. (About 75 percent of taxpayers who are eligible for the additional child tax credit 

also can claim the EITC.) Although both credits are based on earned income and the number of 

children in the family, they use different definitions of earned income and qualifying children. 

For example, when computing the additional child tax credit, taxpayers may count earned 

income only to the extent that it is included in taxable income; however, when computing the 

EITC, other types of income that are not included in computing taxable income are counted. 

18 The amount of the child tax credit will be $700 in 2005, $800 in 2008, and $1,000 in 2010. The Administration 

is proposing that the child tax credit be increased to $1,000 in 2005. 

19 Specifically, the otherwise allowable child tax credit is reduced by $50 for each $1,000 (or fraction thereof) of 

modified adjusted gross income over $75,000 for single individuals or heads of households, $110,000 for married 

individuals filing joint returns, and $55,000 for married individuals filing separate returns. 

20 The percentage is increased to 15 percent for calendar years 2005 and thereafter. The earned income threshold 

amount is indexed for inflation. 

21 For example, some ministers add parsonage allowances to self-employment income when computing the EITC, 

but such allowances are excluded from taxable income for purposes of the additional child tax credit. 

84 
Another example is that the additional child tax credit may be claimed by taxpayers who reside 

with children outside the United States, while the child-based EITC may be claimed only by 

taxpayers who reside with children in the United States. 

Proposal 

Eliminate Multiple Computations. Taxpayers with three or more children would no longer have 

the option to compute the additional child tax credit using an alternative formula that compares 

social security taxes paid to the amount of the EITC received. The additional child tax credit 

would be based solely on the formula that uses earned income, regardless of the number of 

children in a taxpayer’s family. 

Conform the Definition of Earned Income. The definition of earned income for purposes of the 

additional child tax credit would be conformed to that currently used for the EITC. Thus, earned 

income for both credits would equal the sum of wages, salaries, tips, and other taxable employee 

compensation plus net self-employment earnings. The proposal would eliminate the requirement 

that earned income be included in taxable income in order to be included in computing the 

additional child tax credit. 

Require Taxpayers to Reside in the United States. The proposal would require taxpayers to 

reside with a child in the United States to claim the additional child tax credit. The principal 

place of abode for members of the U.S. Armed Forces would be treated as in the United States 

for any period the member is stationed outside the United States while serving on extended 

active duty. Extended active duty would include a call or order to such duty for a period in 

excess of 90 days. 

The proposal would be effective for tax years beginning after December 31, 2004. 

Revenue Estimate22 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 0 181 183 185 187 736 1,722 

22 The estimate includes both receipt and outlay effects. The outlay effect is -$181 million for 2006, -$183 million 

for 2007, -$185 million for 2008, -$187 million for 2009, -$736 million for 2005-2009 and -$1,701 million for 

2005-2014. 

85 
SIMPLIFY EITC ELIGIBILITY REQUIREMENTS REGARDING FILING STATUS, 

PRESENCE OF CHILDREN, INVESTMENT INCOME AND WORK AND 

IMMIGRANT STATUS 

Current Law 

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

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

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

EITC is based on the presence and number of qualifying children in the worker’s family, as well 

as on adjusted gross income and earned income. The rules regarding filing status, presence of 

children, investment income, and work and immigration status are particularly complicated and 

are described below. 

Filing Status: An unmarried individual can claim the EITC if he or she files as a single filer or as 

a head of household. Married individuals generally cannot claim the EITC unless they file 

jointly. However, there is an exception for estranged spouses who meet three requirements. 

First, an estranged spouse must live apart from his or her spouse for the last six months of the 

year. Second, the estranged spouse must maintain a household that constitutes the principal 

place of abode for a dependent child for over half the year. Third, the estranged spouse must pay 

over half the cost of maintaining the home in which he or she resides with the child during the 

year. If the estranged spouse meets these conditions, he or she may file a tax return as a head of 

household and claim the EITC. 

Presence of Qualifying Children: A taxpayer who resides with a qualifying child may be eligible 

for an EITC of up to $2,604 ($4,300 for two or more children). A taxpayer who does not reside 

with a qualifying child may be eligible for a smaller credit of up to $390. A taxpayer may claim 

the EITC for workers without children only if the taxpayer does not reside with a qualifying 

child. 

To be considered an EITC qualifying child, a child must meet residency, relationship, and age 

tests. Even if the child meets the three qualifying child tests, the taxpayer may not be able to 

claim the EITC. For example, if more than one taxpayer lives with a qualifying child, only one 

of those taxpayers can claim the child for purposes of the EITC.23 If a taxpayer lives with a 

qualifying child, but is not allowed to claim the child because the child is properly claimed by 

someone else, the taxpayer is not eligible for the EITC. Because the taxpayer resides with a 

qualifying child, he or she is ineligible for the EITC for workers without children. 

A similar situation arises when a taxpayer resides with a qualifying child who does not have a 

valid social security number. The taxpayer is not eligible for the EITC for taxpayers with 

23 If more than one taxpayer claims the same qualifying child for purposes of the EITC, then only the claimant with 

the highest adjusted gross income (AGI) is deemed eligible. However, a parent’s claim supercedes the claims of 

other taxpayers, regardless of the outcome of the AGI tiebreaker test. If both parents file separate returns claiming 

the child, then the parent who resides with the child the longest is deemed entitled to the EITC. In the event that 

both parents reside with the child for the same amount of time, then the parent with the highest AGI is entitled to the 

EITC. 

86
children because the child lacks a valid social security number. The taxpayer also is ineligible 

for the EITC for workers without children because he or she lives with a qualifying child. 

Investment Income: To qualify for the EITC, a taxpayer must meet an investment income test, in 

addition to two other tests for earned income and adjusted gross income. 

A taxpayer cannot have disqualified investment income in excess of $2,650. Disqualified 

investment income includes interest (including tax-exempt interest), dividends, net capital gains, 

net income from rents or royalties, and net income from passive activities. 

Work and Immigration Status: To claim the EITC, the taxpayer (including his or her spouse, if 

married) and qualifying child must have valid social security numbers. A social security number 

is considered invalid for EITC purposes if it was issued by the Social Security Administration 

solely to allow an individual to obtain federal benefits. Thus, an individual who is not authorized 

to work in the United States but who obtained a social security number in order to receive 

Medicaid or another federal benefit is not eligible for the EITC. However, an individual who is 

not authorized to work in the United States but who obtained a social security number for a 

reason other than to obtain federal benefits (e.g., a driver’s license or for tax purposes prior to the 

creation of the ITIN) is eligible for the EITC. 

The IRS may use math error authority to deny EITC claims when the taxpayer does not provide 

valid social security numbers. 

Reason for Change 

A recent IRS report found that between $8.5 and $9.9 billion of EITC claims (27 percent to 31.7 

percent of total claims) were erroneously paid with respect to tax year 1999 returns. Many of 

these errors related to taxpayers who failed to meet eligibility criteria concerning family and 

income status. Simplifying the eligibility requirements for the EITC should help to reduce these 

erroneous claims.

24 

Some of these errors may have been caused by taxpayer confusion over unusual family situations 

and the complicated tax rules that were created to address these situations. For example, an 

individual who has separated from his or her spouse, but who cannot afford a lawyer to obtain a 

divorce or legal separation, is required to understand a complicated three-part test to determine 

his or her filing status under current law. Separated spouses may have to consult two IRS 

publications (Publication 596 on the EITC and Publication 501 on filing status) in order to 

determine if they are eligible for the EITC. They must compile and retain documentation 

showing that they provided over half the cost of maintaining the home in which they and their 

24 The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) contains several provisions that 

significantly simplified the EITC eligibility criteria and instructions. These provisions include a simplified 

tiebreaker test to resolve duplicate claims and conforming the definitions of earned income and adjusted gross 

income to those used elsewhere in the tax code. The proposal to adopt a uniform definition of qualifying child, 

included in the Budget, would further reduce the complexity of the EITC eligibility criteria. In addition to these 

simplification efforts, the IRS is implementing a new five-point initiative during the 2004 filing season, which seeks 

to better detect erroneous claims before refunds are paid. 

87 
children reside. In tax year 1999, nearly $1 billion of EITC overclaims were due solely to 

married taxpayers claiming single or head of household filing status when they should have filed 

as married-filing-separately. Many of these claims would not be erroneous if separated spouses 

were not required to document that they provide over half the cost of maintaining the household 

in which they reside with their children. 

Other types of complicated family situations result in complicated tax rules. For example, if a 

child lives with her mother in her grandmother’s home for over half the year, the child is a 

qualifying child of both her mother and grandmother. If the mother claims the child for the 

EITC, the grandmother is not eligible for the EITC for workers without children because she is 

still considered to have a qualifying child (her granddaughter). However, the grandmother may 

erroneously claim the childless EITC, not realizing that she is ineligible to claim the credit 

because she lives with her daughter and granddaughter. Taxpayers may be confused by the 

subtle difference between having a qualifying child one cannot claim for the EITC and having no 

qualifying child at all. 

Efforts to target the EITC to specific populations also give rise to complexity. To determine if 

they are eligible for the EITC, low-income workers must meet three different income tests. The 

most complicated of these tests concerns investment income, including capital gains, properties 

sales, rents, and royalties. Most EITC claimants do not have income from any of these sources, 

but they have to read through 22 lines of complicated instructions in the Schedule EIC in order to 

learn that the disqualified investment income test does not affect their eligibility for the EITC. 

Those who think the disqualified investment income test applies to them must complete a 14-line 

worksheet in Publication 596. 

The disqualified investment income test may have other undesirable effects, in addition to its 

effects on complexity. It may discourage saving by working families trying to move into the 

middle class. The disqualified investment income test contains a cliff, whereby an individual 

with $2,650 of investment income is qualified to receive an EITC of up to $4,300 while an 

individual with $2,651 of investment income would receive no EITC at all. The test favors some 

types of assets over others. For example, owning a home or car does not affect a taxpayer’s 

eligibility for the EITC, but other forms of investments could generate income that would result 

in the denial of the EITC. Eliminating the disqualified investment income test would encourage 

both saving and an efficient allocation of resources. 

In some cases, targeting provisions may be more complicated than they were intended to be. A 

provision of the Personal Responsibility and Work Opportunity Reconciliation Act of 1996 (the 

“1996 Act”) was intended to deny the EITC to any person (including his or her spouse and 

children) who is not authorized to work in the United States. Individuals may obtain a social 

security number if they are citizens or permanent residents or other persons authorized to work in 

the United State. Individuals not authorized to work in the United States may also obtain a social 

security number in order to receive certain federal benefits. In addition, until recently, it was 

possible for some individuals to receive social security numbers for themselves or their children 

for other reasons – e.g., to obtain a driver’s license in some states or, before the adoption of 

ITINs, to file a tax return or claim certain tax benefits. As drafted, the 1996 Act denied the EITC 

to taxpayers who receive a social security number solely to receive federal benefits. The 1996 

88 
Act did not deny the EITC to individuals who are not authorized to work in the United States and 

who received social security numbers for reasons other than to obtain federal benefits. Thus, the 

statutory language in the 1996 Act did not have its intended effect. The disparate treatment of 

individuals with non-work-related social security numbers is confusing, inequitable, and difficult 

to administer. In tax year 1999, about $500 million of EITC overclaims were attributable to 

returns filed by taxpayers who did not provide valid social security numbers for themselves, their 

spouses, or their children. In most of these cases, the taxpayer was not eligible for the EITC for 

additional reasons. Typically, they failed to demonstrate that they resided with a child in the 

United States. 

Proposal 

Allow separated spouses to claim EITC. Married taxpayers who file separate returns would be 

allowed to claim the EITC if they live with a qualifying child for over half the year. They must 

also live apart from their spouse for the last six months of the tax year. However, they would not 

be required to provide over half the cost of maintaining the household in which they reside. 

Simplify rules regarding presence of qualifying child. A taxpayer with a qualifying child who 

lives in an extended family would be eligible to claim the EITC for workers without children 

even if another member of the family claims the taxpayer’s qualifying child. However, if 

unmarried parents reside together with their child, then one parent can claim the EITC for 

qualifying children, but neither can claim the EITC for workers without children. 

Taxpayers would be eligible to receive the EITC for workers without children if their child does 

not have a valid social security number. As under current law, the taxpayer (and spouse, if 

married) must have a valid social security number. 

Eliminate disqualified investment income test. The disqualified investment income test would be 

eliminated. 

Clarify when a social security number is valid for EITC purposes. Both the taxpayer (including 

his or her spouse, if married) and qualifying child must have a social security number that is 

valid for employment in the United States (that is, they are U.S. citizens, permanent residents, or 

have certain types of temporary visas that allow them to work in the United States).25 

25 Taxpayers who initially received a social security number for non-work reasons, but who subsequently became 

authorized to work in the United States (i.e., they became permanent residents or U.S. citizens), would be eligible to 

receive the EITC. 

89 
Revenue Estimate

26 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 504 -167 -165 -151 -167 -146 -915 

26 The estimate includes both receipt and outlay effects. The outlay effects are -$440 million for 2005, $131 million 

for 2006, $130 million for 2007, $119 million for 2008, $134 million for 2009, $74 million for 2005-2009 and $643 

million for 2005-2014. 

90
SIMPLIFY THE TAXATION OF DEPENDENTS 

Current Law 

The standard deduction of taxpayers who may be claimed as dependents of another taxpayer is 

the lesser of: (1) the standard deduction for single taxpayers ($4,850 for 2004, indexed annually 

thereafter for the effects of inflation); or (2) the larger of $800 (for 2004) or the individual's 

earned income plus $250 (for 2004). 

For minors under age 14 with taxable investment income, special rules (often called the "kiddie 

tax") apply. Only the first $800 (in 2004) of the child's taxable investment income over the 

standard deduction is taxed at the child's tax rate. Taxable investment income in excess of $800 

is taxed as the marginal income of the parents (or guardian).27 28 In certain cases, the parents (or 

guardian) may elect to include the dependent's income on their own tax return.29 

Reasons for Change 

The current standard deduction for dependents requires dependents with earnings of $550 or 

more to file a tax return if their interest and dividend income exceeds $250. This necessitates the 

filing of a significant number of tax returns with very small amounts of tax liability. Eliminating 

such tax returns would benefit both taxpayers and the IRS. 

The special "kiddie tax" provisions are extremely complex and lead to uncertainty about the tax 

rate that will apply to a minor child's investment income. In addition, the parental election 

option increases the number of required decisions as well as adding to the complexity and length 

of instructions and tax forms. This complexity may cause a misunderstanding of the rules and 

has caused considerable frustration among taxpayers. This, in turn, may discourage use of even 

the limited tax benefits of holding savings under the child's name permitted under current law. 

Subsequent to enactment of the "kiddie tax," three tax provisions have been enacted that allow 

tax-free accumulation of savings for educational purposes: the exclusion of the interest on 

education savings bonds; Coverdell education savings accounts; and section 529 college savings 

27 For a child with no earned income who uses the standard deduction, the first $800 of investment income is not 

subject to tax (because of the standard deduction), the next $800 is taxed at the child’s tax rate (generally, 10 

percent), and amounts above that are taxed as the marginal income of the parents or guardian. 

28 If there is more than one child under 14 with taxable investment income exceeding $800, the incremental tax 

from adding the total taxable investment income of all such children to the parents’ taxable income is allocated 

among all affected children in proportion to each child’s taxable investment income. (The tax on any capital gains is 

calculated through similar, but separate, incremental calculations.) 

29 If (1) the gross income of a dependent under age 14 is solely from interest, dividends, capital gains distributions, 

and Alaska Permanent Fund dividends, (2) if the total amount of the child’s income is less than $8,000 (in 2004), 

and (3) no prepayments of tax (estimated tax payments or backup withholding) have been made for this income, 

then the parents (or guardian) may elect to include the dependent’s income on their own tax return. (The parents’ 

return can include the income of more than one eligible dependent.) The computations used generally result in the 

tax being the same as if a separate return were filed for the dependent, although interactions with certain incomebased phaseouts, limitations, and floors may affect the tax liability on the dependent’s (and parents’) income. 

91 
or prepayment plans. It is anomalous to provide such benefits while imposing significantly 

higher taxes on families who choose to save for education without using these special provisions. 

Proposal 

The standard deduction for all dependents would be $800 (indexed) plus the amount of the 

dependent's earned income, but not to exceed the standard deduction for a non-dependent single 

filer. 

For dependents under age 14, the first $2,500 (indexed after 2005) of taxable investment income 

and all earned income would be taxed at the child's own tax rate. Any taxable investment 

income above $2,500 would be taxed at the highest regular income tax rate (regardless of the 

parent's tax rate). Any dividends or capital gains included in taxable investment income above 

$2,500 would be taxed at the highest dividends or capital gains tax rates, respectively, generally 

applicable. The election to include the child's investment income on the parents' tax return 

would be eliminated. 

These changes would be effective for taxable years beginning after December 31, 2004. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -11 -25 -20 -25 -43 -124 -498

92
CONSOLIDATE RULES FOR LIFETIME LEARNING CREDIT, HOPE CREDIT AND 

EDUCATION EXPENSE DEDUCTIONS, AND SIMPLIFY OTHER HIGHER 

EDUCATION PROVISIONS 

Consolidate Higher Education Credits and Deductions 

Current Law 

A taxpayer may deduct up to $2,500 of interest on student loans. This deduction is phased out 

between $50,000 and $65,000 of modified adjusted gross income (“AGI”) for single taxpayers 

($100,000 and $130,000 for joint returns). The phase-out thresholds are indexed for inflation 

subject to a $5,000 rounding convention. 

A taxpayer may deduct up to $4,000 of qualifying higher education expenses. Single taxpayers 

whose modified AGI does not exceed $65,000 ($130,000 for joint returns) may deduct up to 

$4,000 of qualified expenses. Taxpayers with modified AGI between $65,000 and $80,000 

(between $130,000 and $160,000 for joint returns) may deduct up to $2,000 of qualified 

expenses. This provision was enacted on a temporary basis in 2001 and expires after 2005. 

A taxpayer may claim one or both of the following nonrefundable tax credits for qualified tuition 

and fees for enrollment of the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependent in a 

postsecondary degree or certificate program. To be eligible for the Hope credit, the student must 

be enrolled on at least a half-time basis. The Hope Credit is equal to 100 percent of the first 

$1,000 of qualified expenses and 50 percent of the next $1,000 of qualified expenses, for a 

maximum credit of $1,500 per student. The Hope Credit is only available for the first two years 

of a student’s postsecondary education. 

A taxpayer may claim a nonrefundable lifetime learning credit for all postsecondary education, 

including graduate education and programs not leading to a degree or certificate. The credit is 

equal to 20 percent of up to $10,000 of qualified tuition and required fees paid during the taxable 

year on behalf of the taxpayer, the taxpayer’s spouse, or a dependent of the taxpayer. There is no 

limit on the number of years for which the lifetime learning credit may be claimed. The $10,000 

amount is not indexed for inflation. 

For calendar year 2004, the income phase-outs for the Hope credit and the lifetime learning 

credit begin at $42,000 of modified AGI ($85,000 for joint returns). The threshold amounts are 

indexed for inflation subject to a $1,000 rounding convention. In addition, the amount of the 

allowable Hope credit is indexed for inflation in future years (subject to a $100 rounding 

convention). Taxpayers may claim the Hope credit for more than one qualifying student. In 

contrast, the lifetime learning credit, is applied on a per-taxpayer, rather than a per-student, basis. 

Reasons for Change 

Taxpayers may be easily confused by the potential application of multiple provisions relating to 

higher education expenses. Taxpayers are likely to become confused by the per-student rules of 

the Hope credit and the per-taxpayer rules of the lifetime learning credit, or to be unaware that 

they can claim the Hope credit for one student and the lifetime learning credit for another. Some 

93 
taxpayers have to make detailed computations to determine which provision gives the best result 

for each student. 

Proposal 

Under the Administration’s proposal, the lifetime learning credit would be revised to subsume 

the deductions for student loan interest and qualified higher education expenses by allowing the 

credit on a per-student basis and treating up to $2,500 of interest on student loans as a qualified 

expense. The temporary above-the-line deduction for higher education expenses and the 

deduction for student loan interest would be repealed. The beginning of the phase-out range 

would be raised to $50,000 ($100,000 for joint returns) and a new phase-out rule would be added 

that would reduce the otherwise allowed credits by 5 percent of the extent to which modified 

AGI exceeds the new limits. The phase-out rules for the Hope credit would be conformed to 

those of the revised lifetime learning credit. 

The dollar limits of the revised lifetime learning credit and the Hope credit would be indexed for 

inflation after 2005 using a $100 rounding convention. The phase-out rules for the Hope credit 

and the lifetime learning credit would be indexed for inflation after 2005 using a $1,000 

rounding convention. 

Simplify the Definitions of a Qualifying Higher Educational Institution and Qualified 

Educational Expenses 

Current Law 

Seven provisions define a qualifying higher education institution to include institutions eligible 

to participate in federal student aid programs under Title IV of the Higher Education Act of 

1965.30 Four provisions use the broader section 170(b)(1)(A)(ii) definition, which includes “an 

organization which normally maintains a regular faculty and curriculum and normally has a 

regularly enrolled body of pupils or students in attendance at the place where its educational 

activities are regularly carried on.”

31 

30 These provisions are: (i) the Hope credit, (ii) the lifetime learning credit, (iii) the exclusion from gross income for 

distributions from Coverdell accounts, (iv) the exclusion from gross income for distributions from qualified tuition 

programs, (v) the exclusion from gross income for Savings Bond interest, (vi) the deduction for interest on 

educational loans, and (vii) the temporary above-the-line deduction for higher education expenses. The deduction 

for interest on educational loans also applies with respect to institutions “conducting an internship or residency 

program leading to a degree or certificate awarded by an institution of higher education, a hospital, or a health care 

facility which offers postgraduate training.” 

31 These provisions are: (i) the personal exemption for full time dependent children aged 19 through 23, (ii) the 

exclusion from gross income of scholarships and fellowships, (iii) the exclusion from gross income of qualified 

tuition reductions, and (iv) the exclusion from the gift tax of amounts paid as tuition to an educational institution. 

The personal exemption also covers students who are “pursuing a full-time course of institutional on-farm training 

under the supervision of an accredited agent of an educational organization described in section 170(b)(1)(A)(ii) or 

of a State or a political subdivision of a State.” 

94 
Seven higher education provisions treat tuition and required fees as qualifying expenses.32 Four 

of these seven provisions exclude tuition and required fees with respect to any course or other 

education involving sports, games, or hobbies, unless such course or other education is part of 

the individual’s degree program.

33 Three of the seven provisions exclude non-academic fees.34 

Two additional provisions treat only tuition as a qualifying expense.35 

Three higher education provisions treat books, supplies and equipment as qualifying expenses. 

Scholarship and fellowship income spent on books, supplies and equipment is treated as a 

qualifying expense (and therefore exempt from tax) if the books, supplies and equipment are 

required for courses of instruction. Distributions received from a Coverdell account or a 

qualified tuition program for books, supplies, and other equipment are treated as made for 

qualifying expenses (and therefore exempt from tax) if the books, supplies and equipment are 

required for enrollment or attendance. There is currently no limit on the amount that can be 

received tax-free for required books, supplies and equipment under these provisions. The 

remaining higher education provisions do not treat books, supplies and equipment as qualifying 

expenses. 

A beneficiary of a Coverdell educational savings account or a qualified tuition program may 

receive distributions tax-free from the account or program for expenses for “special needs 

services in the case of a special needs beneficiary” which are incurred in connection with the 

enrollment or attendance of the beneficiary. “Special needs services” are not defined under 

current law. 

Students who are enrolled at least half time can receive distributions tax-free from a Coverdell 

account or a qualified tuition program for room and board expenses. The amount that can be 

received tax-free, however, cannot exceed the greater of (i) the room and board amount included 

in the institution’s cost of attendance for federal student aid purposes36 or (ii) the actual invoiced 

amount for students residing in housing owned and operated by the institution. 

32 The seven provisions are: (i) the exclusion from gross income or scholarships and fellowships, (ii) the Hope 

credit, (iii) the lifetime learning credit, (iv) the exclusion from gross income of distributions from Coverdell 

accounts, (v) the exclusion from gross income of distributions from qualified tuition plans, (vi) the temporary abovethe-line deduction for higher education expenses, and (vii) the exclusion from gross income of Savings Bond 

interest. 

33 The four provisions are: (i) the Hope credit, (ii) the lifetime learning credit, (iii) the temporary above-the-line 

deduction for higher education expenses, and (iv) the exclusion from gross income for Savings Bond interest. 

34 The three provisions are (i) the Hope credit, (ii) the lifetime learning credit, (iii) the temporary above-the-line 

deduction for higher education expenses. 

35 The two provisions are: (i) the exclusion from gift tax and (ii) the exclusion from gross income for tuition 

reductions. 

36 The cost of attendance amounts are established separately by each institution. In addition, these amounts are 

widely available for student aid purposes and therefore easily accessible to taxpayers. See the following U.S. 

Department of Education web site for the cost of attendance data for individual institutions: 

http://www.nces.ed.gov/ipeds/cool. 

95 
Reasons for Change 

Taxpayers may be easily confused by the different definitions of a qualifying higher education 

institution and by the different definitions of qualifying higher education expenses for tuition and 

fees, or for books, supplies and equipment. As a result, taxpayers may erroneously claim tax 

benefits or fail to claim tax benefits for which they are eligible. 

The lack of defined limits on the amounts that can be received tax-free from scholarships and 

fellowships and for books, supplies and equipment causes numerous disputes between taxpayers 

and the IRS. It also provides opportunities for non-compliance because some taxpayers overstate 

these costs. 

The lack of a definition of “special needs services” may cause similar disputes between 

taxpayers and the IRS. In addition, taxpayers making similar expenditures are likely to treat 

them differently. 

The two part test to determine limits on room and board distributions from Coverdell education 

savings accounts or a qualified tuition program adds unnecessary complexity in calculating 

benefits. In addition, the second part of this test is difficult to administer given the wide variety 

of student housing arrangements regarding ownership and operation. 

Proposal 

The proposal would define qualifying higher education institutions for purposes of the higher 

education provisions by reference to institutions eligible to participate in federal student aid 

programs under Title IV of the Higher Education Act of 1965, and not Code section 

170(b)(1)(A)(ii) 

Under the proposal, tuition and fees required for enrollment or attendance would be treated as 

qualifying expenses for purposes of the higher education provisions. However, qualifying 

expenses for tuition or fees would exclude: (i) expenses with respect to any course or other 

education involving sports, games, or hobbies, unless such course or other education is part of 

the individual’s degree program, (ii) nonacademic fees, and (iii) tuition or fees that entitle the 

student to any services for room or board. 

The proposal would also conform the treatment of books, supplies and equipment for Coverdell 

educational savings accounts, qualified tuition programs, and scholarships and fellowships (the 

remaining provisions do not treat these items as qualifying expenses). For purposes of these 

provisions, qualifying expenses would be defined to include expenses for books, supplies, and 

equipment required for enrollment or attendance. The definition would exclude such expenses 

with respect to any course or other education involving sports, games, or hobbies, unless such 

course or other education is part of the individual’s degree program. In addition, the amount of 

qualifying expenses for books, supplies, and equipment could not exceed the allowance 

(applicable to the student) for books and supplies included in the “cost of attendance” as 

determined by the institution for purposes of federal financial aid programs.37 

37 See footnote 36. 

96 
“Special needs services” would be defined as expenses incurred with respect to personal 

attendants (such as readers for the blind) and adaptive equipment, including adaptive computer 

software, incurred in connection with a student's enrollment, attendance or courses of instruction. 

The two part test for determining how much can be received tax-free for room and board for 

postsecondary education would be eliminated. Distributions for room and board would be 

excluded only to the extent they do not exceed the allowance (applicable to the student) for room 

and board included in the cost of attendance as determined by the institution for federal student 

aid purposes.38 

Repeal Coverdell Income Limits 

Current Law 

Individuals who make contributions to Coverdell education savings accounts are subject to an 

income limitation regarding the maximum contribution of $2,000 per year. The allowable 

contribution phases out between $95,000 and $110,000 of modified AGI ($190,000 to $220,000 

for joint returns). There is, however, no limit on the number of accounts that may be established 

for a single beneficiary and persons other than individuals, e.g., corporations or charities, can 

also make contributions up to the $2,000 per year limit with respect to any single beneficiary. 

Reason for Change 

The current income phase-out rule for Coverdell education savings accounts adds complexity 

and compliance burdens but has little effect on limiting the tax benefits available to beneficiaries 

because contributions can be made by multiple individuals with respect to the same beneficiary 

(as long as aggregate annual contributions do not exceed $2,000). For example, grandparents 

and other relatives, who may not be affected by the income-related limitations, may contribute to 

Coverdell education savings accounts for a given beneficiary even if the parents’ income 

precludes them from making such contributions themselves. Also, there are no similar income 

limitations with respect to contributions to qualified tuition programs that serve the same 

objective as that of Coverdell accounts with respect to higher education. 

Proposal 

This proposal would repeal the current-law phase out of the maximum contribution that could be 

made to a Coverdell education savings account by individuals. Contributions could continue to 

be made by corporations, charitable organizations, and other entities without regard to their 

income. Multiple accounts could continue to be established for the same beneficiary (as long as 

aggregate annual contributions do not exceed $2,000). 

The proposals would be effective for taxable years beginning after December 31, 2004. 

38 This proposal would not affect the two part test with respect to elementary and secondary education. 

97 
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -19 -94 -311 -294 -282 -1,000 -2,558 

98
ALLOW ANNUAL REPORTING AND PAYMENT OF COMBINED STATE AND 

FEDERAL UNEMPLOYMENT INSURANCE TAXES BY EMPLOYERS OF 

HOUSEHOLD EMPLOYEES 

Current Law 

Household employees generally are covered by unemployment insurance, and household 

employers must pay separate federal and state unemployment insurance taxes. The federal 

portion of the unemployment tax (FUTA) — together with social security and Medicare taxes — 

for household employees is calculated on Schedule H and is paid with the employer’s form 1040, 

if not already prepaid through estimated tax payments or withholding.39 State unemployment 

insurance tax returns are filed quarterly, along with tax payments, directly to each state in which 

the employment occurred. The state thresholds for coverage, the state tax rates that apply, the 

forms used, and benefit qualifications and amounts are determined by each state. 

Reasons for Change 

Household employers express concern about the burdens of complying with the various 

employment tax requirements for household employees. Those burdens are often blamed for the 

failure of household employers to report the income of household employees, or otherwise 

comply with employment tax requirements. In 1993, statutory changes eliminated for household 

employers the requirements for separate federal tax returns for social security and Medicare 

taxes and for the FUTA tax. The reporting and payment of those taxes were incorporated into 

the federal income tax return of the employer, although employers still are required to provide 

Forms W-2 (Wage and Tax Statements) to their employees and to file the W-2s and a covering 

return (Form W-3) with the Social Security Administration. 

The 1993 changes, however, did not address the burdens on household employers from quarterly 

filing of state unemployment insurance returns and the need to make separate, typically very 

small, payments for state unemployment insurance premiums. Household employers typically 

complain that, when they become a household employer for the first time, it is difficult to obtain 

the required information to enable them to begin filing returns and making payments on a timely 

basis. The administrative burdens of such returns and payments (and the penalties for 

inadvertent failures) are often disproportionate to the size of the required payments. Similarly, 

the administrative costs for state unemployment insurance agencies of maintaining accounts, 

collecting the taxes, and processing the tax returns are very large relative to the taxes collected. 

Such costs are ultimately borne by the Federal Government since most administrative costs are 

paid through allocations from the FUTA trust funds. 

The difficulties with, and the burdens from, state unemployment insurance reporting and 

payments may tend to increase noncompliance. Moreover, noncompliance with state 

unemployment insurance requirements may lead to, or be associated with, noncompliance for 

social security and Medicare taxes. The lack of such reporting then results in widespread failures 

by workers to report the income for income tax purposes. Changes in unemployment insurance 

39 Household employers are subject to FUTA if they pay total cash wages to all household employees of $1,000 or 

more in any calendar quarter of the current or preceding year. 

99 
reporting that would reduce employer burdens would promote compliance by household 

employers and the reporting of income by household employees. 

Proposal 

For household employers, the separate reporting of wages and the payment of taxes for 

unemployment insurance purposes to state unemployment insurance agencies would be 

eliminated. Instead, household employers would pay a single, combined state and federal 

unemployment insurance tax to the Federal Government, with reporting combined with social 

security and Medicare taxes on a schedule to be filed annually with the employer’s annual 

individual income tax return. The combined annual reporting would be on a slightly expanded 

Schedule H of Form 1040, which is currently used to report social security earnings, Medicare 

earnings, and FUTA earnings of household workers. Actual payment of unemployment 

insurance taxes for household employees would be combined with the payment of other tax 

liabilities reported on Form 1040. The income threshold for requiring unemployment insurance 

coverage, the ceiling on each employee’s covered wages, and the tax rate would be uniform 

nationally. The unemployment insurance tax rate of household employers would not be 

experience-rated, but the tax rate would be subject to annual adjustment based on overall 

experience so that revenues collected were sufficient to cover all, or a pre-determined fraction of, 

aggregate benefit payments and administrative costs. 

As under the current system, unemployment insurance benefits would be paid by state 

unemployment insurance agencies, with benefit eligibility and benefit levels determined by state 

laws. Benefit payments and administrative costs would be reimbursed by the Federal 

Government from the combined federal-state tax collected from household employers. 

The proposal would be effective for tax years beginning after December 31, 2004. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -20 -1 -1 -1 -1 -24 -30

100
SIMPLIFY TAXATION OF CAPITAL GAINS ON COLLECTIBLES, SMALL 

BUSINESS STOCK AND OTHER ASSETS 

Current Law 

Short-term capital gains of individual taxpayers are taxed at ordinary rates. Long-term capital 

gains (generally 1 year or more) are taxed separately from other income, generally at rates of 5 

percent (for gains that would otherwise be taxed at the 10 or 15 percent rates) and 15 percent (for 

gains otherwise taxed at higher rates). In 2008, taxpayers in the 10 and 15 percent brackets will 

qualify for a zero percent tax rate on long-term gains. Capital gains are generally taxed at the 

same rates under the alternative minimum tax (AMT) as under the regular tax. Special rates 

apply to capital gains on certain small business stock, collectibles, and certain real property. 

Gains from the sale of certain small business stock qualify for a 50-percent exclusion subject to a 

28 percent maximum rate, resulting in a maximum effective rate of 14 percent (Section 1202). 

However, the AMT preference on excluded small business stock gains results in an effective rate 

of 14.98 percent. To be eligible for the exclusion, the stockholder must have been the original 

purchaser of the stock and have held the stock for at least 5 years. In addition, the total assets of 

the corporation, including the proceeds of the stock sale, cannot exceed $50 million through the 

time of issue. The business must have met various requirements on eligible types of business 

activities, stock redemptions, working capital, holdings of real estate, and active business assets 

throughout the stockholder’s holding period. A provision enacted in 1997 allows capital gains 

from the sale of small business stock held more than 6 months to be rolled over into new 

investments in other qualified small business stock (Section 1045). 

Long-term gains on collectibles are taxed at ordinary tax rates subject to a 28 percent maximum 

rate. Collectibles include works of art, antiques, stamps and coins, metal or gems, alcoholic 

beverages, and other tangible personal property defined in regulations. 

For non-corporate taxpayers, gain on Section 1250 real property is allocated into three parts: 

ordinary gain, unrecaptured Section 1250 gain, and capital gain. Ordinary gain, generally the 

portion previously deducted as accelerated depreciation (i.e., depreciation in excess of straightline depreciation), is recaptured by treating it as ordinary gain rather than capital gain. 

Unrecaptured Section 1250 gain, generally the portion previously deducted as straight-line 

depreciation, is taxed at ordinary tax rates up to a maximum rate of 25 percent. Capital gain, 

generally the increase in value above original cost, is taxed at capital gains tax rates. 

Reasons for Change 

Schedule D and the associated forms and instructions are more complicated than necessary 

because of the special 25 percent and 28 percent rates that apply in only a small fraction of cases. 

For example, the 28 percent rate requires an extra column on Schedule D and two worksheets of 

51 and 7 lines, but affects only about 1 percent of taxpayers with capital gains (about 240,000 

taxpayers). There are also complicated rules for calculating how these provisions interact with 

other capital gains and losses in particular cases. Eliminating the 25 and 28 percent special rates 

would simplify capital gains forms and calculations. About one in five taxpayers (more than 20 

million) report capital gain or loss in a given year, and more than twice as many taxpayers report 

101 
capital gain or loss over time. Thus a large fraction of taxpayers would benefit from 

simplification of capital gains taxes. 

Because of complicated eligibility rules, the 50 percent exclusion and rollover provision for 

gains on certain small business stock create compliance problems for taxpayers and enforcement 

problems for the IRS. Corporations with eligible stock are not required to register with the IRS 

or inform their shareholders whether gains on their stock are eligible for the exclusion. Thus, 

neither shareholders nor the IRS are likely to know whether particular shares of small business 

stock are eligible. In addition, taxpayers receive little benefit from the exclusion under current 

law, because the tax rate for eligible stock is only slightly below the regular capital gains tax 

rate, particularly if the taxpayer is subject to the AMT. 

Collectibles are taxed at ordinary rates with a maximum rate of 28 percent because Congress did 

not extend the 1997 capital gains tax cuts to collectibles, as doing so was considered inconsistent 

with the goal of increasing incentives for productive investment. Unrecaptured Section 1250 

gains are taxed at ordinary rates with a maximum rate of 25 percent because such gains result 

from previous depreciation deductions at higher ordinary tax rates. While based on tax policy 

considerations, these special provisions create complexity for all taxpayers with capital gains by 

creating two additional tax rates, requiring additional instructions and worksheet calculations, 

and adding lines and an additional column to Schedule D. Despite adding complexity, these two 

provisions provide no benefit for taxpayers in the 10 percent, 15 percent and (for collectibles) 25 

percent ordinary income-tax brackets. 

Proposal 

The proposal would eliminate the 25 percent and 28 percent capital gains tax rates, greatly 

simplifying capital gains tax calculations and forms. The 28 percent rate would be eliminated by 

repealing the 50 percent exclusion and rollover provision for small business stock (Sections 1202 

and 1045), and by taxing 50 percent of the capital gains on collectibles as long-term capital gains 

and 50 percent as short-term capital gains. For collectibles, this produces a maximum effective 

rate of 25 percent in the 35 percent tax bracket (i.e., 25% = 0.50*15% + 0.50*35%) and lower 

rates in lower tax brackets. Similarly, the 25 percent rate would be eliminated by taxing 50 

percent of Section 1250 gain as long-term capital gain and 50 percent as ordinary income. The 

maximum effective rate for unrecaptured Section 1250 gain remains 25 percent and rates are 

reduced in lower tax brackets. For assets with unrecaptured Section 1250 gain, the gain reflecting 

an increase in value over original cost would continue to be taxed at regular capital gains tax 

rates. The proposals would be effective for tax years beginning after December 31, 2003. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-2009 2005-2014

($ in millions) 

-* -4 5 11 -1 -17 -6 -35 

* Less than one million 

102 
STRENGTHEN THE EMPLOYER BASED PENSION SYSTEM 

ENSURE FAIR TREATMENT OF OLDER WORKERS IN CASH BALANCE 

CONVERSIONS AND PROTECT DEFINED BENEFIT PLANS 

Current Law 

Qualified retirement plans consist of defined benefit plans, which allocate investment risk to the 

plan sponsor, and defined contribution plans, which allocate investment risk to plan participants. 

In recent years, many plan sponsors have adopted cash balance and other “hybrid” plans that 

combine features of defined benefit and defined contribution plans. A cash balance plan is a 

defined benefit plan that provides for annual “pay credits” to a participant’s “hypothetical 

account” and “interest credits” on the balance in the hypothetical account. As with traditional 

defined benefit plans, the sponsor of a cash balance plan bears investment risk (as well as some 

mortality risk), and benefits are guaranteed by the Pension Benefit Guaranty Corporation. 

Otherwise, the cash balance plan functions like a defined contribution plan from the perspective 

of a participant. 

Questions have been raised regarding whether and how cash balance plans satisfy the rules 

relating to age discrimination and the calculation of lump sum distributions. 

Age Discrimination. Code section 411(b)(1)(H) provides that a defined benefit plan fails to 

satisfy the benefit-accrual rules if, under the plan, a participant’s benefit accrual is ceased, or the 

rate of a participant’s benefit accrual is reduced, because of the attainment of any age. Section 

204(b)(1)(H) of the Employee Retirement Income Security Act of 1974 (ERISA) and section 

4(i)(1)(A) of the Age Discrimination in Employment Act (ADEA) set forth similar rules. 

Age-discrimination questions have been raised regarding two aspects of cash balance plans. 

First, some have argued that pay credits for younger participants provide higher benefits than the 

same pay credits for older participants because the pay credits for younger participants accrue 

interest credits over longer periods. Although one federal district court has agreed with this 

analysis, others have rejected it. Compare Cooper v. IBM Personal Pension Plan, 274 F. Supp. 

2d 1010 (S.D. Ill. 2003) (cash balance plan found age-discriminatory) with Campbell v. 

BankBoston, N.A., 206 F. Supp. 2d 70 (D. Mass. 2002) (cash balance plan found not agediscriminatory), aff’d, 327 F.3d 1 (1st Cir. 2003), and Eaton v. Onan Corp., 117 F. Supp. 2d 812 

(S.D. Ind. 2000) (same). 

Second, some have argued that “conversions” of traditional defined benefit plans to cash balance 

plans disadvantage older participants. A conversion occurs when a plan sponsor amends a 

traditional plan to make it a cash balance plan. A conversion can result in lower future accrual 

rates for some or all participants. If this occurs, ERISA section 204(h) and Code section 4980F 

require that participants receive advance notice. The conversion can also result in “wear-away” 

– a period following the conversion during which a participant’s prior accrued benefits under the 

traditional plan exceed the benefits payable under the cash balance plan. Thus, during wearaway, the benefits under the cash balance formula of some or all participants must “catch up” 

with benefits accrued under the traditional plan. Wear-away may occur for the normal 

retirement benefit, the early retirement benefit, or both. However, under Code section 411(d)(6) 

103 
and ERISA section 204(g), the conversion may not reduce the accrued normal or early retirement 

benefit of any participant. 

Some have argued that the adverse effects of cash balance conversions fall more heavily on older 

participants than on younger participants because traditional plans usually provide more valuable 

accruals to older and longer-service participants. Many plan sponsors have adopted strategies to 

mitigate these effects, including protection of participant expectations through “choice” and 

“grandfathering” as well as avoidance of wear-away. However, these strategies have been 

voluntary, as current law generally gives the plan sponsor broad authority to amend a plan for 

any reason at any time. Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 443 (1999). 

In December of 2002, Treasury and the IRS proposed regulations to address these and other agediscrimination issues. 67 Fed. Reg. 76123 (Dec. 11, 2002). The proposed regulations provide 

that a cash balance formula is not discriminatory as long as pay credits for older participants are 

equal to or greater than pay credits for younger participants. The proposed regulations also 

provide that cash balance conversions are not discriminatory as long as the conversions satisfy 

one of three permissible methods specified in the regulations. The proposed regulations do not 

prohibit reductions in future accrual rates or benefit wear-away because, under the conditions 

specified in the proposed regulations, those effects are not inherently age-discriminatory. 

Calculation of Lump Sum Distributions. Three federal appellate courts have addressed the 

calculation of lump sum distributions under cash balance plans. Berger v. Xerox Corp. 

Retirement Income Guarantee Plan, 338 F.3d 755 (7th Cir. 2003); Esden v. Bank of Boston, 229 

F.3d 154 (2d Cir. 2000), cert. dismissed, 531 U.S. 1061 (2001); Lyons v. Georgia-Pacific 

Salaried Employees Retirement Plan, 221 F.3d 1235 (11th Cir. 2000), cert. denied, 532 U.S. 967 

(2001). All three courts held that a participant’s hypothetical account balance must be projected 

to normal retirement age using the plan’s interest crediting rate, converted to an annuity, and 

then discounted to a lump sum using the section 417(e) interest rate. If the plan’s interest 

crediting rate is the section 417(e) rate, the present value of the normal retirement age annuity 

will be the same as the hypothetical account balance. However, if the plan’s interest crediting 

rate is higher than the section 417(e) rate, the present value of the normal retirement age annuity 

– and the amount of any lump sum distribution – will be greater than the hypothetical account 

balance. This result is sometimes referred to as “whipsaw.” 

These federal court decisions have followed an analysis set out in IRS Notice 96-8. Many plan 

sponsors have responded to whipsaw by limiting the interest crediting rate to the section 417(e) 

rate (or a deemed equivalent). This response effectively makes the section 417(e) rate a ceiling 

on plan interest credits. 

Reasons for Change 

Although cash balance plans and cash balance conversions are not inherently age-discriminatory, 

current law does not provide adequate protection for older workers in every conversion. For 

example, the statutory age-discrimination rules do not prevent a plan sponsor from changing 

future benefit accruals. Also, current law does not prevent a plan sponsor from imposing wearaway of normal or early retirement benefits. (Current law actually restricts certain transition 

practices, such as preserving the value of early retirement subsidies through additions to 

104 
participant account balances.) Many plan sponsors have voluntarily tried to mitigate any adverse 

effects that cash balance conversions may have on older and longer-service participants.40 

However, ensuring the fair treatment of older and longer-service participants in conversions 

requires strengthening current law to guarantee reasonable transition protections and to prohibit 

benefit wear-away. 

Inconsistent federal court decisions make it necessary to clarify that cash balance plans are not 

inherently discriminatory as long as older participants are treated at least as well as younger 

participants. Removing uncertainty about the basic legality of cash balance plans is critical to 

preserving the vitality of the defined benefit system, which provides retirement income security 

for millions of American workers and their families. 

As applied by the courts, the whipsaw effect under Notice 96-8 has harmed participants by 

leading plan sponsors to limit interest credits to the section 417(e) rate. This results in lower 

retirement accumulations for participants. The whipsaw effect should be eliminated so that plan 

sponsors can give participants higher interest credits. 

Proposal 

The proposal would accomplish three major objectives: 

1. Ensure fairness for older workers in cash balance conversions. 

2. Protect the defined benefit system by clarifying the status of cash balance plans. 

3. Remove the effective ceiling on interest credits in cash balance plans. 

Ensure fairness for older workers in cash balance conversions. The proposal would provide 

new protections for participants in cash balance conversions that would ensure fair transitions 

from traditional plans to cash balance plans. For each of the first five years after a conversion, 

the benefits earned by any current participant under the cash balance plan would have to be at 

least as valuable as the benefits the participant would have earned under the traditional plan if the 

conversion had not occurred. Additionally, there could be no wear-away of normal or early 

retirement benefits for any current participant at any time. 

To prohibit violations of the new transition protections, there would be a 100 percent excise tax, 

payable by the plan sponsor, on any difference between the benefits required under the proposal 

and the benefits actually provided by the cash balance plan. In recognition of the fact that some 

plan sponsors may be experiencing adverse business conditions, the amount of the excise tax 

could not exceed the greater of the plan’s surplus assets at the time of the conversion or the plan 

sponsor’s taxable income. Failure to implement the new transition protections would not result 

in disqualification of the plan. 

40 The General Accounting Office reported that 84 percent of the employers that it surveyed provided full or partial 

transition relief in cash balance conversions. General Accounting Office, Private Pensions: Implications of 

Conversions to Cash Balance Plans at 33 (GAO/HEHS-00-185, Sept. 29, 2000); General Accounting Office, Cash 

Balance Plans: Implications for Retirement Income at 34-5 (GAO/HEHS-00-207, Sept. 29, 2000). 

105 
The excise tax would not apply if participants were given a choice between the traditional 

formula and the cash balance formula or if the cash balance conversion grandfathered current 

participants under the traditional formula. This would preserve flexibility of plan sponsors to 

implement other provisions that protect older and longer-service participants. 

Protect the defined benefit system by clarifying the status of cash balance plans. The proposal 

would clarify that a cash balance plan satisfies the age-discrimination rules if the plan provides 

pay credits for older participants that are not less than the pay credits for younger participants, in 

the same manner as any defined contribution plan. The proposal would also clarify that certain 

transition strategies used in conversions (such as preserving the value of early retirement 

subsidies) do not violate the age-discrimination or other qualification rules. The proposal would 

provide similar rules for other types of hybrid plans and for conversions from traditional plans to 

other types of hybrid plans. 

Remove the effective ceiling on interest credits in cash balance plans. The proposal would 

eliminate whipsaw, providing that a cash balance plan may distribute a participant’s account 

balance as a lump sum distribution as long as the plan does not credit interest in excess of a 

market rate of return. The Secretary would be authorized to provide safe harbors for what 

constitutes a market rate of return and to prescribe appropriate conditions regarding the 

calculation of plan distributions. This would permit plan sponsors to give higher interest credits 

to participants, resulting in larger retirement accumulations. 

Conforming amendments and effective date. There would be conforming amendments under 

ERISA and the ADEA for statutory changes to the existing age-discrimination and distribution 

rules (but not for the new excise tax). 

All changes under the proposal would be effective prospectively. The legislative history would 

state that there would be no inference as to the status of cash balance plans or cash balance 

conversions under current law. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 0 0 0 0 0 0 2,373

106
IMPROVE THE ACCURACY OF PENSION LIABILITY MEASURES 

Current Law 

Defined benefit pension plans are subject to minimum funding requirements and limits on 

maximum deductible contributions. In the case of a single-employer defined benefit plan 

maintained by an employer who has more than 100 employees participating under defined 

benefit plans sponsored by that employer, the minimum funding requirements established under 

ERISA are supplemented by a deficit reduction contribution. 

The deficit reduction contribution is based on the plan’s current liability. For plan years 

beginning in 2004, current liability is required to be calculated using an interest rate that is 

within 90-105 percent of the weighted average of the rate of interest on 30-year Treasury 

securities, where the average is determined for the 48 months ending with the month preceding 

the first day of the plan year. Current liability is calculated using a statutorily specified mortality 

table. 

Current liability is also relevant in determining the maximum deductible contribution to a 

defined benefit pension plan. Under section 401(a)(1)(D), an employer’s contributions to a 

defined benefit plan do not exceed the maximum deductible amount so long as they are less than 

the amount necessary to bring the plan’s assets up to the current liability (determined without 

regard to plan amendments made in the last 2 years in the case of a plan which has 100 or fewer 

participants for the plan year). 

Under section 401(a)(29), an employer sponsoring a single employer plan with assets less than 

60 percent of current liability (determined without regard to the unamortized portion of pre-1989 

unfunded current liability) that amends the plan to increase benefits is required to post security 

before the plan amendment can take effect. The amount of the security is the excess of the assets 

needed to increase the plan’s funded current liability percentage to 60 percent (or, if less, the 

amount of increases in current liability attributable to all post-1988 benefit increases) over $10 

million. 

Under section 401(a)(33), an amendment to a defined benefit plan sponsored by an employer in 

bankruptcy improving the benefits under the plan generally may not be made effective until the 

reorganization is complete. Under section 412(f), if an employer has an outstanding minimum 

funding waiver for a defined benefit plan, the plan generally may not be amended to improve 

benefits until the waiver is fully amortized. 

In the case of a distribution of a lump sum (and certain other benefit forms that do not provide 

for lifetime payments), the amount of the distribution must be no less than the amount 

determined using a statutorily specified interest rate and mortality table. The interest rate is the 

average of the rate of interest on 30-year Treasury securities for the month preceding the 

distribution or, in accordance with regulations, at some earlier time as established under the plan. 

Reasons for Change 

Interest rates used for determining an employer’s pension funding obligations should accurately 

107 
reflect the cost of settling its pension liability. Changes in the financial markets have 

fundamentally altered the relationship between the interest rate on the 30-year Treasury bond and 

interest rates on other fixed income securities. As a result of those changes, while 105 percent of 

the interest rate on 30-year Treasury securities may have been an appropriate interest rate to be 

used in discounting pension liabilities in the past, this is no longer the case today. The continued 

use of 105 percent of the interest rate on 30-year Treasury securities overstates the cost of 

settling an employer’s pension liability. This in turn dramatically increases the funding 

requirements for sponsors of many plans at a critical phase in the economic expansion. 

The interest rates used for current liability purposes should be based on market-determined 

interest rates for similar obligations. An employer’s pension promise need not be quite as 

secure as the full faith and credit guaranty of the Treasury security, but should be as safe as a 

high-quality corporate bond. Accordingly, the interest rates for determining current liability 

should be based on interest rates on high-quality corporate bonds. 

The interest rates used to determine current liability should also reflect the timing of future 

benefit payments under the plan. To the extent that a plan will be making the bulk of its benefit 

payments in the next few years, the interest rates used to discount those payments should be the 

market yields for shorter-term bonds. Conversely, to the extent a plan will be making most of its 

payments far into the future, it is appropriate to use longer-term yields to discount those 

payments. These steps would improve the accuracy of the liability measurement. 

The interest rates used to determine pension liabilities should reflect current market conditions, 

rather than the potentially stale interest rates of 2 years ago. Any smoothing in interest rates 

should be just sufficient to reduce short term market volatility without reducing measurement 

accuracy. Calculations of pension liability using current market conditions would enable plan 

sponsors to make a realistic assessment of their plans’ funded status. 

The current use of the rate of interest on 30-year Treasury securities for purposes of determining 

lump sums creates a mismatch between the amount of an employee’s lump sum and the value of 

the annuity that the employee would otherwise receive. This mismatch may create an incentive 

for retirees to select one form of benefit payment (a lump sum) rather than an annuity. Changing 

the interest rate used to determine lump sums to market-determined interest rates that reflect the 

timing of expected benefit payments would remove this bias and ensure that the amount of the 

lump sum is the same as the value of the annuity. Any such change should provide a transition 

period, so that employees who are expecting to retire in the near future are not subject to an 

abrupt change in the amount of their lump sums as a result of changes in law. 

Proposal 

For plan years beginning in 2004 and 2005, current liability would be determined using a 

weighted average of the yields on high-quality long-term corporate bonds. The average would 

be determined for the 48 months ending with the month preceding the first day of the plan year. 

Beginning in 2008, current liability would be determined using a series of interest rates drawn 

from a yield curve of high-quality zero-coupon bonds with various maturities. The maturities 

would be selected to match the amounts and timing of when benefit payments are expected to be 

108 
made from the plan. The yield curve would be issued monthly by the Secretary of Treasury and 

would be based on the 90-day average of interest rates for high quality corporate bonds. 

For plan years beginning in 2006 and 2007, current liability would be determined as the 

weighted average of the value of the current liability determined using the methodology 

applicable to 2004 and 2005 and the value of the current liability determined using the 

methodology applicable to 2008 and beyond. For 2006, the weighting factor would be 2/3 for 

the “old” methodology and 1/3 for the new methodology; and for 2007, the weighting factors 

would be reversed. 

For plan years beginning in 2004 and 2005, there would be no change in the law relating to 

determination of lump sums from defined benefit plans. However, beginning in 2008, lump sum 

calculations would also be calculated using rates drawn from the zero-coupon corporate bond 

yield curve. Thus, the interest rate that would apply would depend on how many years in the 

future a participant’s annuity payment will be made. Typically, a higher interest rate would 

apply for payments made further out in the future. 

For distributions in 2006 and 2007, lump sum calculations would be determined as the weighted 

average of the value of the lump sum determined using current law and the value of the current 

liability determined using the methodology applicable to 2008 and beyond. For 2006, the 

weighting factor would be 2/3 for the “old” methodology and 1/3 for the new methodology; and 

for 2007, the weighting factors would be reversed. 

If a plan sponsored by an employer with a below investment grade credit rating has assets less 

than 50 percent of termination liability, the plan would be required to be frozen (i.e., no 

additional accruals would be permitted), but service would continue to be earned for purposes of 

vesting and eligibility for benefits. In addition, such a plan would be required to suspend lump 

sums (and other forms of accelerated benefit payments, including the purchase of annuities). 

The proposal generally would be effective for plan years beginning in 2004. The requirement for 

a freeze of accruals and the suspension of lump sums for a plan that is funded less than 50 

percent of termination liability that is sponsored by an employer with a below investment grade 

credit rating would be effective for plan years beginning in 2005. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

8,537 12,297 7,340 3,042 -1,586 -5,467 15,626 -15,869 

109
110
CLOSE LOOPHOLES AND IMPROVE TAX COMPLIANCE 

COMBAT ABUSIVE TAX AVOIDANCE TRANSACTIONS 

Current Law 

There is no specific penalty for the failure to disclose a transaction required by regulations to be 

disclosed on a return (a reportable transaction), although such failure may affect a taxpayer’s 

ability to establish a defense to the accuracy-related penalty with respect to any resulting 

underpayment. Reportable transactions include transactions specifically identified as tax 

avoidance transactions (listed transactions). 

Promoters of certain transactions satisfying a ratio test and certain confidential corporate 

transactions are required to register these transactions with the IRS. The penalty for failing to 

timely register these transactions (or for filing false or incomplete information with respect to the 

registration) generally is the greater of one percent of the aggregate amount invested in the 

shelter or $500. With respect to confidential corporate transactions that must be registered, the 

penalty is the greater of $10,000 or 50 percent of the fees payable to any promoter with respect 

to offerings prior to the date of late registration. Intentional disregard of the requirement to 

register increases the penalty to 75 percent of the applicable fees. Promoters also must maintain 

lists of investors with respect to transactions that must be registered and specified transactions 

with the potential for the tax avoidance or evasion. The penalty for failing to maintain such lists 

is $50 for each name omitted (with a maximum penalty of $100,000 per year). 

A person who willfully fails to report a transaction or an account with a foreign financial entity is 

subject to civil and criminal penalties. The civil penalty is the amount of the transaction or the 

value of the account, up to a maximum of $100,000; the minimum amount of the penalty is 

$25,000. 

In order to prevent the double taxation of a taxpayer’s foreign source income – taxation of the 

same income by the source country where the income is earned and by the United States – 

taxpayers are permitted a credit for certain foreign taxes. The amount of foreign taxes that may 

be credited each year generally is limited to the U.S. tax liability on a taxpayer’s foreign-source 

income, in order to ensure that the credit serves its purpose of mitigating double taxation of 

cross-border income without offsetting the U.S. tax on U.S.-source income. A foreign tax credit 

for foreign taxes paid with respect to dividends from a corporation is not permitted unless the 

taxpayer meets certain holding period requirements: 15 days (within a 30-day testing period) in 

the case of common stock and 45 days (within a 90-day testing period) in the case of preferred 

stock. Periods during which the shareholder is protected from risk of loss (e.g., by purchasing a 

put option or entering into a short sale with respect to the stock) generally are not counted toward 

the holding period requirement. 

Existing provisions prohibit taxpayers from using bonds and preferred stock to engage in 

“income-separation” transactions that are structured to create immediate tax losses or to convert 

current ordinary income into deferred capital gain. Taxpayers, however, are using other types of 

assets that provide for relatively stable, periodic income with substantial future value, such as 

111
shares in a money-market mutual fund or a lease contract, to engage in similar income-separation 

transactions. 

Reasons for Change 

The Treasury Department and the IRS can most effectively address abusive tax avoidance 

transactions through early identification and analysis of potentially questionable transactions and 

appropriate enforcement action. Changes to regulations and other forms of published guidance 

might be required to address an abusive transaction; in other cases, a statutory change may be 

required. 

Current rules provide for the disclosure and registration of certain potentially abusive 

transactions, and the maintenance of lists of participants in such transactions. The specific rules 

and definitions applicable to disclosure, registration, and list maintenance, however, are not 

consistent and the existing penalties (which currently do not apply to the failure to disclose a 

transaction) are insufficient to effectively reinforce these rules. 

Proposal 

The proposal would permit Treasury to provide a consistent definition of a transaction that must 

be disclosed by a taxpayer and registered by a promoter, and for which lists of participants must 

be maintained by a promoter. The proposal also would strengthen the IRS’ enforcement 

capability with respect to potentially abusive transactions and would modify substantive rules to 

address areas of identified potential abuse. 

A taxpayer failing to disclose a reportable transaction on a return would be subject to a penalty 

for each failure in the following amounts: (i) for corporate taxpayers with respect to listed 

transactions, $200,000 and 5 percent of any underpayment resulting from the listed transaction; 

(ii) for corporate taxpayers with respect to other reportable transactions, $50,000; (iii) for 

partnerships, S corporations, and trusts, $200,000 with respect to listed transactions and $50,000 

with respect to other reportable transactions; (iv) for individual taxpayers with respect to listed 

transactions, $100,000 and 5 percent of any underpayment resulting from the listed transaction; 

and (v) for individual taxpayers with respect to other reportable transactions, $10,000. Corporate 

taxpayers would be required to disclose, in their filings with the Securities and Exchange 

Commission, any penalty for the failure to disclose a listed transaction and any accuracy-related 

penalty resulting from an undisclosed listed transaction. 

The provisions regarding registration with the IRS of certain transactions would be modified to 

require the registration of any entity, investment plan or arrangement or other plan or 

arrangement that is of a type determined by the Treasury Department to have the potential for tax 

avoidance or evasion. The provisions also would be modified to confirm that the requirements 

and penalties may apply to all organizers and sellers of covered transactions, including persons 

who assist such persons. With respect to listed transactions, the penalty for the failure to register 

a transaction would be increased to an amount equal to the greater of 50 percent of the fees paid 

to the promoter or $200,000. This penalty would be increased to 75 percent for the intentional 

failure to register a transaction or the intentional failure to provide complete or true information 

112
as part of a registration. For other reportable transactions, the penalty would be increased to 

$50,000. 

The provisions regarding the maintenance of lists of investors would be modified to confirm that 

the requirements and penalties may apply to all organizers and sellers of covered transactions, 

including persons who assist such persons, and that the Treasury Department would not be 

required to permit one person to maintain a list on behalf of a group of persons required to 

maintain a list. If a promoter fails to provide the IRS with a list of investors within 20 business 

days after receipt of the IRS’ written request, the promoter would be subject to a penalty of 

$10,000 for each additional business day that the requested information is not provided. This 

penalty would be imposed for each investor list that a promoter fails to maintain or delays in 

providing to the IRS. The IRS would have the discretion to extend the deadline or waive all or a 

portion of the penalty for good cause shown. 

The IRS would be given explicit authority to seek an injunction against promoters who disregard 

the rules requiring the registration of transactions and the maintenance of investor lists. 

A penalty of $5,000 would be imposed for non-willful failures to report a transaction or an 

account with a foreign financial entity. The penalty may be waived if the taxpayer paid all U.S. 

tax due with respect to the taxpayer’s foreign accounts or transactions and the taxpayer 

demonstrates that the failure to report the transaction or account was due to reasonable cause. 

The minimum holding period requirement for obtaining a foreign tax credit for foreign taxes paid 

with respect to dividends would be expanded to disallow any foreign tax credit with respect to 

any item of income or gain from property if the taxpayer that receives the income or gain has not 

held the property for more than 15 days (within a 30-day testing period), exclusive of periods 

during which the taxpayer is protected from risk of loss. Regulatory authority would be granted 

to the Treasury Department to issue regulations providing exceptions in appropriate cases. 

In addition, the proposal would grant regulatory authority to the Treasury Department in order to 

address transactions that involve the inappropriate separation of foreign taxes from the related 

foreign income in cases where taxes are imposed on any person in respect of income of an entity. 

Because the types of transactions involved are varied, the regulations could provide for either the 

disallowance of a credit for all or a portion of the foreign taxes, or the allocation of the foreign 

taxes among the participants to the transaction in a manner that is more consistent with the 

underlying economics of the transaction. 

An income-separation transaction would be treated as a secured borrowing, not a separation of 

ownership. Debt characterization would ensure that the parties’ ongoing tax treatment of the 

transaction clearly reflects income. 

The proposal generally would be effective after enactment. 

113
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 46 63 85 113 128 435 1,071 

114
LIMIT RELATED PARTY INTEREST DEDUCTIONS 

Current Law 

Section 163(j) of the Code applies to limit the deductibility of certain interest paid by a 

corporation to related persons (“disqualified interest”). Disqualified interest for these purposes 

generally means interest paid or accrued by a corporation to a related person if such interest 

income is not subject to federal income tax. Disqualified interest also includes interest paid or 

accrued by a corporation to an unrelated person if the underlying indebtedness is guaranteed by a 

related foreign person or tax exempt organization and such interest is not subject to U.S. 

withholding tax. The limitations of section 163(j) only apply to a corporation with a debt-toequity ratio that exceeds 1.5 to 1. If such a corporation has net interest expense that exceeds 50 

percent of its adjusted taxable income (computed by adding back net interest expense, 

depreciation, amortization and depletion, and any net operating loss deduction), no deduction is 

allowed for disqualified interest in excess of the 50-percent limit. Interest that is disallowed in a 

taxable year under section 163(j) may be carried forward for deduction in a future year; there is 

no time limit on this carryforward. In addition, excess limitation (i.e., the amount by which the 

corporation’s 50-percent limit exceeds its net interest expense for a taxable year) may be carried 

forward up to three years. 

Reasons for Change 

Under current law, opportunities are available to reduce inappropriately the U.S. tax on income 

earned from U.S. operations through the use of foreign related-party debt. Tightening the rules 

of section 163(j) is necessary to eliminate these inappropriate income-reduction opportunities. 

Proposal 

Section 163(j) would be revised to tighten the limitation on the deductibility of interest paid to 

related persons. The current law 1.5 to 1 debt-to-equity safe harbor would be eliminated. The 

adjusted taxable income threshold for the limitation would be reduced from 50 percent to 25 

percent of adjusted taxable income with respect to disqualified interest other than interest paid to 

unrelated parties on debt that is subject to a related-party guarantee (hereinafter referred to as 

“guaranteed debt”). Interest on guaranteed debt generally would be subject to the current law 50 

percent of adjusted taxable income threshold. The indefinite carryforward for disallowed interest 

under the adjusted taxable income limitation of current law would be limited to ten years. The 3-

year carryforward of excess limitation would be eliminated. 

The proposal would be effective on the date of first committee action. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14 

($'s in millions) 

0 -51 93 146 203 265 656 3,116 

115 
MODIFY QUALIFICATION RULES FOR TAX-EXEMPT PROPERTY CASUALTY 

INSURANCE COMPANIES 

Current Law 

Section 501(c)(15) provides that an insurance company that is not a life insurance company (a 

“property-casualty insurance company”), and which has $350,000 or less of net written 

premiums (or direct written premiums, if greater) during the taxable year, is tax-exempt. The 

only limit on the amount of investment income or assets that the insurance company may hold is 

the requirement that the entity be primarily engaged in the insurance business to qualify as an 

insurance company. Section 501(c)(15)(A), section 831(a), section 1.801-3(a). Section 816(a) 

provides that a company is an insurance company only if more than half of its business is the 

insurance business, but this test only applies for purposes of determining whether an insurance 

company is a life insurance company for federal tax purposes. 

Section 831(b) allows a property-casualty insurance company with annual written premiums (as 

defined above) that exceed $350,000, but which do not exceed $1,200,000, to elect to be taxed 

on its taxable investment income. 

In determining whether a property casualty insurance company is tax-exempt under section 

501(c)(15) or qualifies for the elective tax regime in section 831(b), premiums of companies in 

the same controlled group are aggregated. For purposes of these provisions, a controlled group 

is defined in accordance with the rules contained in section 1563, as modified by section 

831(b)(2)(B) to include life insurance companies and to use a lower 50 percent ownership 

standard rather than the 80 percent standard set forth in section 1563. The definition of a 

controlled group does not, however, include other related tax-exempt insurance companies or 

foreign insurance companies, and, therefore, premiums received by these entities are not 

aggregated for purposes of determining whether an insurance company qualifies for exemption 

under section 501(c)(15). 

Section 4371 imposes a four percent excise tax on property-casualty insurance policies directly 

insuring U.S. risks and issued by a foreign company to a domestic corporation or partnership, a 

U.S. resident, or a foreign entity or individual engaged in a trade or business within the United 

States. Section 4371 also imposes a one percent excise tax on premiums paid for propertycasualty reinsurance or life insurance contracts issued by a foreign company with respect to U.S. 

risks. 

Section 953(d) allows a 25 percent U.S.-owned foreign insurance company to elect to be taxed as 

a domestic insurance company if it meets certain requirements, including the requirement that 

the foreign insurance company would qualify for taxation as an insurance company under Part I 

or II of subchapter L for the taxable year if it were a domestic corporation. 

Reason for Change 

Section 501(c)(15) originally was designed to provide a tax exemption for small bona fide 

mutual property-casualty insurance companies (such as entities formed to insure farmers) with 

116
gross receipts of $150,000 or less. Similarly, only small mutual companies with gross receipts 

between $150,000 and $500,000 were eligible to make the section 831(b) election. 

In 1986, Congress expanded section 501(c)(15) to provide tax-exemption to stock as well as 

mutual property-casualty insurance companies with written premiums, rather than gross receipts, 

of $350,000 or less. Treasury has become aware that, since enactment of the 1986 changes, the 

section 501(c)(15) tax exemption has been used inappropriately to accumulate investment 

income tax-free. Several companies have been established as foreign insurance companies in 

tax- and regulatory-friendly jurisdictions, and, in order to avoid the excise tax on foreign-issued 

insurance and reinsurance policies, have elected to be treated as tax-exempt domestic insurance 

companies. 

Proposal 

The proposal would modify section 501(c)(15) to provide that tax exemption is available only for 

a domestic mutual property-casualty insurance company (not including a foreign company that 

has made an election under section 953(d)), which is organized within, and subject to regulation 

in, a single state, and which only writes insurance or reinsurance contracts on risks located 

within that same state. The proposal would further modify section 501(c)(15) so that the tax 

exemption would apply only to such a company with gross income of no more than $350,000. 

For purposes of section 501(c)(15), gross income would include premiums earned, investment 

income, and other types of gross income. For purposes of determining eligibility of the 

insurance company for tax-exempt status under section 501(c)(15), the proposal would modify 

the applicable controlled group rules to aggregate the gross income of U.S. and foreign taxable 

and tax-exempt insurance companies, as well as the gross income of any related non-insurance 

companies. 

The proposal would modify section 831(b) so that the election to be taxed on taxable investment 

income is available to any property-casualty insurance company with net written premiums (or 

direct written premiums, if greater) of $1,200,000 or less. For purposes of determining the 

eligibility of the insurance company to make an election under section 831(b), the proposal 

would modify the applicable controlled group rules to aggregate premiums of U.S. and foreign 

insurance companies, including the premiums of any related tax-exempt insurance companies. 

The proposal would also clarify the rules for determining whether a property-casualty insurance 

company is an insurance company for U.S. tax purposes. Specifically, the proposal would 

conform the definition of a property-casualty insurance company to the definition set forth in 

section 816(a) by requiring that more than half of the business of a property-casualty insurance 

company be the issuing of insurance or annuity contracts or the reinsuring of risks underwritten 

by insurance companies. Finally, the proposal would grant the Secretary discretion to develop 

appropriate reporting requirements to assure compliance with these rules. 

The proposal would be effective for taxable years beginning after the date of enactment. 

No inference should be drawn regarding whether existing companies claiming to be insurance 

companies eligible for tax exemption or to be treated as small companies eligible to make the 

117
election under section 831(b) are insurance companies for federal tax purposes under current 

law. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 67 114 116 119 121 537 1,184

118
-- -- -- -- -- -- --

INCREASE PENALTIES FOR FALSE OR FRAUDULENT STATEMENTS MADE TO 

PROMOTE ABUSIVE TAX SHELTERS 

Current Law 

A penalty is imposed on any person making or furnishing a false or fraudulent statement in 

connection with the organization, participation, or sale of an interest in a tax shelter, such as a 

partnership or other entity, investment plan, or any other plan or arrangement. The amount of 

the penalty is the lesser of $1,000 or 100 percent of the gross income derived by the person from 

the organization, participation, or promotion of the tax shelter. The penalty applies to any 

statement that the person knows or has reason to know is false or fraudulent as to any material 

matter relating to the allowability of any deduction or credit, the excludability of any income, or 

the securing of any other tax benefit by reason of holding an interest or participating in the tax 

shelter. The penalty also applies to certain statements regarding the value of any property or 

services if stated value exceeds 200 percent of the correct valuation. 

Reasons for Change 

The current penalty amount is insufficient to deter tax shelter promoters from making false or 

fraudulent statements regarding the purported benefits of an abusive transaction. 

Proposal 

The Administration’s proposal would increase the penalty to 50 percent of the income derived by 

the person making or furnishing the false statement in connection with the promotion of a tax 

shelter. The enhanced penalty would not apply to valuation overstatements. 

The proposal would be effective for activities after the date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

41--

41 Included in combat abusive tax avoidance transactions 

119 
PREVENT ABUSIVE OVERVALUATIONS ON DONATIONS OF PATENTS AND 

OTHER INTELLECTUAL PROPERTY 

Current Law 

In general, a taxpayer may claim a deduction for charitable contributions, subject to certain 

limitations based on the type of taxpayer, the property contributed and the type of donee 

organization. In the case of non-cash contributions, the amount of the deduction generally 

equals the fair market value of the contributed property on the date of the contribution. There 

are, however, several exceptions to the general fair market value deduction rule. For example, in 

the case of certain contributions of inventory and other tangible personal property the amount of 

the deduction is limited to the lesser of the taxpayer’s basis (typically cost) in the donated 

property or fair market value. In the case of a contribution of a copyright that is not a capital 

asset,42 the deduction is limited to the taxpayer’s basis. 

Reasons for Change 

Some taxpayers are claiming substantially inflated deductions for donations of patents and 

similar intellectual property to charities. Typically, the valuations for these deductions are based 

on income projections that far exceed the actual income potential of the patent or other 

intangible.43 Most often, the taxpayer no longer plans to use the intangible in its trade or 

business, and the intangible would have little market value if the taxpayer attempted to sell the 

intangible. 

The IRS faces significant administrative burdens in examining valuation issues, because the IRS 

must employ outside valuation experts and because the nature of the property interests 

transferred, the actual rights given to the transferee to exploit the property and the restrictions 

placed on those rights all have an impact on the value of the property. 

Proposal 

If a taxpayer contributes a patent or other intellectual property (other than certain copyrights) to 

charity, the taxpayer’s initial deduction would be limited to the lesser of the taxpayer’s basis in 

the donated property or the fair market value of the property. In addition, the taxpayer would be 

permitted to deduct certain additional amounts based on the amount of royalties or other revenue, 

if any, actually received by the donee charity from the donated property. The amount of the 

additional deduction would be calculated as a sliding-scale percentage of revenues actually 

received by the donee charity from the donated property. The taxpayer would be permitted to 

claim a deduction equal to 100 percent of any revenue from the donated property received by the 

donee charity from the date of the contribution through the end of the charity’s first complete 

taxable year following the date of the contribution. The applicable percentage would be reduced 

annually thereafter. The taxpayer would be permitted to claim a deduction equal to 90 percent of 

42 Sections 1221(a)(3) and 1231(b)(1)(C). 43 For example, the New York Times reported on March 17, 2003, that one corporation claimed a deduction for

$83.5 million and, three years later, the donee university's licensing revenue from the donated property totaled only 

$335,000. 

120 
any revenue from the donated property received by the donee charity in the second taxable year 

beginning after the date of the contribution, 80 percent in the third taxable year, 70 percent in the 

fourth taxable year, 60 percent in the fifth taxable year, 50 percent in the sixth taxable year, 40 

percent in the seventh taxable year, 30 percent in the eighth taxable year, 20 percent in the ninth 

taxable year, and 10 percent in the tenth taxable year. No additional deduction would be 

permitted for any revenues received by the donee charity more than 10 years after the date of the 

contribution or after the expiration of a patent. The taxpayer would be required to obtain written 

substantiation from the donee charity of the amount of any revenue derived from the donated 

property during the charity’s taxable year. 

The proposed changes would be effective for taxable years beginning after December 31, 2003. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 432 270 273 277 287 1,539 3,207

121
PREVENT OVERVALUATIONS AND OTHER ABUSES IN CHARITABLE 

DONATIONS OF USED VEHICLES 

Current Law 

In general, a taxpayer may claim a deduction for charitable contributions of tangible personal 

property subject to certain limitations based on the type of taxpayer, the type of donee 

organization and the use of the property by the donee organization. The amount of the deduction 

generally equals the fair market value of the contributed property if the use of the property by the 

donee is related to its exempt purpose or function. However, the amount of the deduction is 

limited to the lesser of the taxpayer’s basis in the property (typically, cost) or fair market value 

when the use of the property by the donee is unrelated to the donee’s exempt purposes. As a 

practical matter, taxpayers generally are permitted to deduct the fair market value of donated 

vehicles, regardless of whether the vehicle is actually used for a charitable purpose or re-sold 

with the charity receiving some revenue from the sale of the vehicle. 

A taxpayer who donates a used car to charity is permitted to use an established used car pricing 

guide to determine fair market value, but only if the guide lists a sales price for a car of the same 

make, model and year, sold in the same area, and in the same condition as the donated car. 

Taxpayers are required to report non-cash contributions totaling $500 or more and the method 

used for determining fair market value. Taxpayers are required to obtain a qualified appraisal for 

donated property with a value of $5,000 or more, and to attach the appraisal in certain cases. 

Charities are required to provide donors with written substantiation of donations of $250 or 

more. 

Reasons for Change 

In recent years, charities and their agents have actively solicited donations of used vehicles. In 

most cases, the vehicles are not used for a charitable purpose, but are resold shortly after the 

donation. Typically, the donated vehicles are sold at auction for wholesale or liquidation prices 

or to salvage yards for parts. According to a recent report issued by the General Accounting 

Office, the amounts of deductions claimed by taxpayers often substantially exceed the fair 

market values of the donated vehicles because taxpayers often use published values for cars in 

better condition than the donated vehicles. 

Proposal 

To curtail the problem of excessive donations being claimed for donated vehicles, the proposal 

would allow a charitable deduction for contributions of vehicles only if the taxpayer obtains a 

qualified appraisal of the vehicle. Treasury would be permitted to establish an administrative 

safe harbor in published guidance. 

The proposal would not affect the rules governing charitable contributions of inventory property. 

The proposal would be effective for taxable years beginning after December 31, 2003. 

122
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 158 102 105 108 112 585 1,197

123
REFORM THE TAX TREATMENT FOR LEASING TRANSACTIONS WITH TAXINDIFFERENT PARTIES 

Current Law 

Under current law, a taxpayer is treated as the tax owner and is entitled to depreciate property 

leased to another party if the taxpayer acquires and retains significant and genuine attributes of a 

traditional owner of the property, including the benefits and burdens of ownership. A saleleaseback transaction is respected for federal tax purposes if “there is a genuine multiple-party 

transaction with economic substance which is compelled or encouraged by business or regulatory 

realities, is imbued with tax-independent considerations, and is not shaped solely by taxavoidance features that have meaningless labels attached.” Frank Lyon Co. v. United States, 435 

U.S. 561, 583-84 (1978). In addition, a sale-leaseback transaction involving “limited use” 

property for which there is no likely potential lessee or buyer at the end of the lease term other 

than the original lessee is not respected for federal tax purposes. No single factor is determinative 

of whether a lessor will be treated as the owner of the property. Rather, the determination is 

based on all the facts and circumstances surrounding the leasing transaction. 

Special rules provide that depreciation deductions relating to property leased to a tax-exempt 

entity (“tax-exempt use property”) must be computed on a straight-line basis, using the longer of 

the property's assigned class life or 125 percent of the lease term. The length of the lease term 

for purposes of the 125-percent calculation includes options to renew the lease or other periods 

of time during which the lessee could be obligated to make rent payments or assume a risk of 

loss related to the leased property by agreeing to locate a party to enter into a replacement lease 

of the property. Tax-exempt entities include federal, state, local, and foreign governmental units, 

charities, and foreign entities or persons. Tax-exempt use property does not include property 

subject to leases of less than three years, certain computer software, certain qualified 

technological equipment, and certain property that is used by a taxpayer to provide services to a 

tax-exempt entity. 

Reasons for Change 

Leasing plays an important role as an affordable source of capital. Recently, arrangements have 

been entered into with tax-indifferent parties, such as foreign and domestic municipalities and 

tax-exempt organizations, that purport to be leasing transactions but, in substance, provide no 

financing to the tax-indifferent party aside from a fee. These arrangements have no meaningful 

financial or economic utility other than the transfer of tax benefits to a U.S. taxpayer (by means 

of a purported “sale” of property) in exchange for the payment of an accommodation fee to the 

tax-indifferent party. These arrangements are known as SILOs, or sale-in/lease out 

arrangements. 

For example, a U.S. taxpayer (“Lessor”) may purport to “purchase” an existing asset, such as a 

subway line, stadium, or waste water facility, from a tax-indifferent party for $100 million and 

124
simultaneously lease the property back to the tax-indifferent party.44 No interruption or change 

occurs in the actual use, operation, or control of the property. Under the terms of the 

arrangement, the tax-indifferent party has an option to “repurchase” the property from the Lessor 

for a predetermined price at the end of the lease. 

Approximately 85 percent of the Lessor’s $100 million “purchase” price is financed with nonrecourse debt. Virtually all (in this example $96 million) of the “purchase” price is set aside in 

defeasance arrangements and other investments for the benefit of the Lessor and the nonrecourse 

lender (often in an account at a bank related to the lender). These arrangements are structured to 

provide the necessary funds to pay the rent due under the lease and to fund the exercise by the 

tax-indifferent party of its “purchase option” at the end of the lease term. Thus, without any 

further cost or expenditure, the tax-indifferent party may continue to use the property for the 

entire lease term and retain all rights to the property at the end of that term. In return for its 

participation, the tax-indifferent party receives the $4 million difference between the “purchase” 

price and the amount set aside for the benefit of the Lessor. In essence, the $4 million amount is 

an accommodation fee received by the tax-indifferent party for selling tax benefits (depreciation 

on the $100 million “purchase” price) to the Lessor. 

In addition to the defeasance arrangements described above, Lessors have used other 

arrangements, including “loop debt” or “loan backs” by the tax-indifferent party to the Lessor (or 

an affiliate), collateralized letters of credit, payment undertakings, lease prepayments, deposit 

agreements, and sinking funds, that are designed to eliminate the Lessor’s risk and monetize the 

tax-indifferent party’s tax benefits. Although nominally different, in each case the taxindifferent party sets aside the capital normally provided or made available to the lessee by a 

lease transaction. The only capital retained by the tax-indifferent party is the $4 million 

accommodation fee. 

These arrangements also include features designed to ensure that the Lessor will not lose money 

if the property declines in value. As discussed above, the tax-indifferent party has an option to 

“reacquire” the property for a predetermined price that is funded as a result of the defeasance 

arrangements. If the “purchase option” is exercised, the Lessor will recover its equity investment 

and a fixed return on that investment. It is reasonable to expect a municipality to exercise a 

funded “purchase option” to prevent the transfer of a public asset, such as a subway line, 

stadium, or waste water facility, to a private party. Moreover, from a practical and political 

standpoint, the tax-indifferent party is unlikely to surrender control of an asset such as a subway. 

Nevertheless, the parties take the position that the “purchase option” is not likely to be exercised. 

If the “purchase option” is not exercised by the tax-indifferent party, the Lessor has two other 

alternatives under the terms of the arrangement. First, the Lessor may take possession of the 

property. Second, the Lessor may require the tax-indifferent party to locate a third party to enter 

into a service contract, the terms of which were agreed to at the inception of the arrangement. 

The third party must agree to receive services to be provided by the Lessor using the leased 

44 Because of the nature of the asset, the tax-indifferent party may not be able to transfer title to the asset to the 

Lessor. In that case, the “sale” takes the form of a lease by the tax-indifferent party to the Lessor for a period in 

excess of the expected useful life of the asset, which is treated as a sale for federal tax purposes. 

125 
property.45 In return, the third party must agree to make payments to the Lessor. The payments 

required by the service contract provide the Lessor with funds to repay the remaining balances of 

the nonrecourse loans and to enable the Lessor to recoup its equity investment and a return on 

that investment. If the tax-indifferent party does not locate a third party, the tax-indifferent party 

(or, in certain cases, an affiliate) must agree to receive services and make the required payments. 

The service contract is used to shorten the lease term, which results in a shorter tax depreciation 

recovery period. Whether the “purchase option” or the service contract is selected, the practical 

effect is that the Lessor recovers its investment plus a return and the Lessor’s risk of loss is 

eliminated.46 

Considering the totality of the circumstances, the substance of the arrangement is the payment of 

a small fee to the tax-indifferent party in exchange for tax benefits. No real financing occurs and 

there is no change in the control, use, operation of, or beneficial interest in, the asset. 

Many of these arrangements involve foreign property and provide no benefits to state or local 

governments or charities in the United States. Even when the arrangement involves U.S. 

property, the tax benefits purchased by the Lessor, and the corresponding cost to U.S. taxpayers 

in lost tax revenues, exceed the fee paid to the tax-indifferent party. 

Existing rules have proved ineffective in preventing U.S. taxpayers from entering into these and 

similar arrangements that result in the monetization of tax benefits rather than financing for the 

tax-indifferent party. Additional rules are necessary to expand the types of assets covered by the 

existing rules and to limit the ability of a U.S. taxpayer to acquire tax benefits through such 

arrangements. At the same time, leasing arrangements that provide real financing to taxindifferent parties should be permitted to continue. 

Proposal 

Modify the Rules for Depreciation of Tax-Exempt Use Property. The proposal would expand 

existing rules applicable to tax-exempt use property. The recovery period for property leased to 

a tax-indifferent party, which is the longer of the property's assigned class life or 125 percent of 

the lease term, would apply to qualified technological equipment and computer software. Except 

as provided in regulations, service contracts and other similar arrangements following a lease of 

property to a tax-indifferent party would be included in the length of the lease term for purposes 

of the 125-percent calculation. A tax-indifferent party would include federal, state, local, and 

45 As part of any service contract arrangement, it is contemplated that the Lessor will enter into an operating 

agreement engaging a third party to operate the leased property. The service recipient will be required to reimburse 

the Lessor for monthly operating expenses in addition to making the minimum payments required under the service 

contract. 

46 Similar arrangements take advantage of the shorter depreciation periods available for computer software and 

qualified technological equipment, which comprise a growing proportion of the assets involved in these leasing 

arrangements. In these arrangements, the Lessor purports to “purchase” equipment having a useful life substantially 

longer than the recovery period for qualified technological equipment and related software. The terms of these 

arrangements are similar to the example discussed above. In lieu of a service contact, however, the tax-indifferent 

party may be required to purchase residual value insurance if it fails to exercise an early buyout option. The residual 

value insurance requirement, like the service contract, ensures that the Lessor will recoup its equity investment and a 

return on that investment. 

126 
foreign governmental units, charities, foreign entities or persons, and any transferee or 

accommodation party who enters into a lease of such property with a taxpayer. 

Limit Deductions for Leases to Tax-Indifferent Parties. The proposal would limit a taxpayer’s 

deductions or losses related to a lease to a tax-indifferent party to the taxpayer’s income from the 

lease for that taxable year. This limit would apply to all deductions related to a lease to a taxindifferent party and the leased property. Any disallowed deductions would be carried forward 

and treated as deductions related to the lease in the next taxable year subject to the same 

limitations. A taxpayer would be allowed to take previously disallowed deductions and losses 

when the taxpayer completely disposes of its interest in the property subject to a lease to a taxindifferent party. 

A lease to a tax-indifferent party would not be subject to the limit described in the preceding 

paragraph if the lease satisfies all of the following five requirements. First, the lease is not a 

lease of property financed with tax-exempt bonds. 

Second, the tax-indifferent party does not enter into an arrangement to monetize its lease 

obligations, including any purchase option, in an amount that exceeds 20 percent of the 

taxpayer’s cost of the leased property. Arrangements to monetize lease obligations would 

include a defeasance arrangement, a loan by the tax-indifferent party to the taxpayer (or an 

affiliate), a deposit agreement, a letter of credit collateralized with cash or cash equivalents, a 

payment undertaking agreement, a lease prepayment, a sinking fund arrangement, any similar 

arrangement, and any other arrangement identified by the Secretary in regulations. The 

Secretary would be authorized to promulgate regulations permitting qualified lease treatment 

even if a tax-indifferent party provides cash-equivalent credit support in excess of 20 percent if 

the creditworthiness of the tax-indifferent party would not otherwise satisfy the lessor’s 

customary underwriting standards. Such credit support would not be permitted to exceed 50 

percent of the taxpayer’s cost of the property. In addition, on the purchase option exercise date, if 

any, such credit support would not be permitted to exceed 50 percent of the lessee’s purchase 

option price. 

Third, the taxpayer makes and maintains a substantial equity investment in the leased property. 

For this purpose, a taxpayer would not have made or maintained a substantial equity investment 

unless: (1) the taxpayer makes an unconditional initial equity investment in the property of at 

least 20 percent of the cost of the leased property; (2) the taxpayer maintains a 20-percent equity 

investment at all times throughout the term of the lease; and (3) the taxpayer’s 20-percent equity 

investment remains at the end of the lease term. 

Fourth, the tax-indifferent party does not assume or retain more than a minimal risk of loss (other 

than the obligation to pay rent and insurance premiums, to maintain the property or other similar 

conventional obligations of a net lease) through a put option, a residual value guarantee, residual 

value insurance, any similar agreement, or any other arrangement identified by the Secretary in 

regulations. For this purpose, a tax-indifferent party would have assumed or retained more than 

a minimal risk of loss if: (1) as a result of obligations assumed or retained by, on behalf of, or 

pursuant to an agreement with the tax-indifferent party, the taxpayer is insulated from any 

portion of the loss that would occur if the value of the leased property is 25 percent less than the 

127 
leased property’s projected fair market value at lease termination; (2) as a result of obligations 

assumed or retained by, on behalf of, or pursuant to an agreement with the tax-indifferent party, 

the taxpayer is insulated from a risk of loss in the aggregate that is greater than 50 percent of the 

loss that would occur if the value of the leased property were zero at lease termination; or (3) the 

tax-indifferent party assumes or retains a risk of loss described by the Secretary in regulations. 

Fifth, the lease is not described by the Secretary in regulations. 

The proposal would be effective for leases entered into after December 31, 2003. No inference 

should be drawn regarding the appropriate tax treatment of similar transactions entered into prior 

to January 1, 2004. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

340 1,591 2,712 3,285 3,565 3,766 14,919 33,385

128
ENSURE FOREIGN SUBSIDIARIES OF U.S. COMPANIES CANNOT 

INAPPROPRIATELY AVOID U.S. TAX ON FOREIGN EARNINGS INVESTED IN U.S. 

PROPERTY THROUGH USE OF THE EXCEPTIONS FOR BANK DEPOSITS 

Current Law 

A U.S. shareholder of a foreign corporation generally is subject to U.S. tax on earnings of that 

foreign corporation only when such income is repatriated. Under the subpart F rules, 10-percent 

U.S. shareholders of a controlled foreign corporation are subject to U.S. tax on their pro rata 

share of the corporation’s investments in certain U.S. property. U.S. property for this purpose 

generally includes debt obligations of U.S. persons. However, deposits with persons “carrying 

on the banking business” are excluded from the definition of U.S. property subject to this general 

rule. In The Limited, Inc. v. Commissioner, 286 F.2d 324 (6th Cir., 2002), the Court of Appeals 

held that a U.S. affiliate was “carrying on the banking business” even though its operations were 

limited to administering the U.S. group’s private-label credit-card program. Therefore, the court 

held that certificates of deposit issued by the U.S. affiliate and held by the controlled foreign 

corporation were covered by the exception and so were not taxable repatriations. 

Reasons for Change 

The result in The Limited is inconsistent with the policy underlying the exception from U.S. 

property of deposits with a person carrying on the banking business. This exception is one of 

several exceptions from the definition of U.S. property that generally were designed to ensure 

that property held by a controlled foreign corporation for business purposes will not be 

characterized as a disguised repatriation. The result in The Limited inappropriately extends the 

exception for deposits with persons carrying on the banking business to cases in which the 

deposits should be characterized as a repatriation. 

Proposal 

The Administration proposes to limit the exception for foreign earnings invested in U.S. property 

as bank deposits to deposits with institutions regulated as banks. The proposal would be 

effective after the date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 24 21 22 22 23 112 234

129
MODIFY TAX RULES FOR INDIVIDUALS WHO GIVE UP U.S. CITIZENSHIP OR 

GREEN CARD STATUS 

Current Law 

Under Section 877, for 10 years after an individual’s loss of U.S. citizenship or termination of 

long-term U.S. residency with a principal purpose of avoiding U.S. tax, the individual is subject 

to an alternative tax regime. Generally, the individual is subject to regular U.S. income tax on an 

expanded class of income, taxed on certain transfers that otherwise would get non-recognition 

treatment, and subject to special estate and gift tax rules covering an expanded class of assets. 

An individual is presumed to have lost citizenship or terminated long-term residency with a 

principal purpose of tax avoidance if he meets an average annual net income tax liability test or a 

net worth test. Certain individuals (e.g., dual citizens) may rebut this presumption by submitting 

a ruling request within one year of the date of loss of U.S. citizenship asking the IRS for a 

determination as to whether the loss of citizenship had for one of its principal purposes the 

avoidance of U.S. tax. 

Reasons for Change 

The current-law alternative tax regime applicable to former citizens and long-term residents 

frequently requires a determination of a taxpayer’s motive for expatriation. This subjective test 

can be difficult to administer. Replacing this and other administratively difficult tests with 

clearer and objective tests and expanding information reporting by individuals who expatriate 

should help to improve compliance with the alternative tax regime. 

Proposal 

An individual losing U.S. citizenship or residency would be subject to the alternative tax regime 

of section 877 if the individual’s average annual net income tax liability for the 5 taxable years 

preceding expatriation exceeds $124,000 (indexed for inflation), the individual’s net worth on 

the date of expatriation exceeds $2 million (indexed for inflation), or the individual fails to 

certify under penalty of perjury that he complied with his U.S. tax liabilities for the 5 taxable 

years preceding expatriation. Exceptions would be provided for certain dual citizens and certain 

U.S. citizens who relinquish citizenship prior to age 181⁄2. 

An individual who expatriates would continue to be taxed as a U.S. citizen or resident until the 

individual gives notice of an expatriating act or termination of residency to the Secretary of State 

or the Secretary of Homeland Security and provides the statement required by section 6039G 

(information on individuals losing U.S. citizenship). 

Except to the extent provided in regulations, individuals who are subject to the alternative tax 

regime in a calendar year during the 10-year period following expatriation but who are 

physically present in the U.S. for more than 30 days in that calendar year generally would be 

subject to U.S. tax on their worldwide income as though they were U.S. citizens or residents in 

that taxable year. 

130 
Certain gifts of stock of closely-held foreign corporations by a former citizen or former longterm resident would be subject to U.S. gift tax. 

Annual reporting would be required for individuals subject to the alternative tax regime, even if 

they have no U.S. tax liability that year. 

The changes would apply to individuals losing U.S. citizenship or long-term residency on or 

after date of first committee action. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

1 23 20 22 24 25 114 272

131
-- -- -- -- -- -- --

EXPAND TAX SHELTER EXCEPTION FOR FEDERAL PRACTITIONER PRIVILEGE 

Current Law 

In general, a common law privilege of confidentiality exists for attorney-client communications 

with respect to legal advice. Communications relating to federal tax advice between a taxpayer 

and a federally authorized tax practitioner (who may not be an attorney) are protected by a 

statutory confidentiality privilege to the same extent that the communication would be 

considered a privileged communication if it were between a taxpayer and an attorney. Written 

communications relating to corporate tax shelters are not covered by the statutory privilege. 

Reasons for Change 

The exception to the privilege for communications relating to corporate tax shelters should be 

expanded to all tax shelters, regardless of whether or not the participant is a corporation. 

Proposal 

The Administration’s proposal would modify the federal tax practitioner privilege by expanding 

the tax shelter exception to cover written communication relating to any tax shelter, regardless of 

whether the participant is a corporation, individual, partnership, tax-exempt entity, or any other 

type of entity. 

The Administration’s proposal also would confirm that for purposes of the list maintenance 

requirements of section 6112, the identity of any person is not privileged. 

The proposal to amend the federal tax practitioner privilege would be effective with respect to 

communications made on or after the date of enactment. The proposal with respect to section 

6112 would be effective as if included in the amendments made by section 142 of the Deficit 

Reduction Act of 1984. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

47--

47 Included in combat abusive tax avoidance transactions 

132 
-- -- -- -- -- -- --

EXTEND THE STATUTE OF LIMITATIONS FOR REPORTABLE TRANSACTIONS 

WHERE A TAXPAYER FAILS TO DISCLOSE ON RETURN AS REQUIRED 

Current Law 

In general, taxes must be assessed within three years after the date on which a return is filed. If a 

taxpayer omits an item of gross income totaling more than 25 percent of the amount of gross 

income shown on the return, the statute of limitations is extended to six years. Taxes generally 

cannot be assessed or collected unless an assessment is made before the statute of limitations 

expires. Taxes may be assessed at any time if the taxpayer files a false or fraudulent return, or if 

the taxpayer fails to file a tax return. 

Reasons for Change 

Extending the statute of limitations for reportable transactions that are not disclosed properly will 

encourage taxpayers to make the required disclosures and will provide the IRS with the time 

necessary to examine these transactions. 

Proposal 

The Administration’s proposal would extend the statute of limitations with respect to a 

reportable transaction if a taxpayer fails to disclose that transaction properly on a return. The 

statute of limitations with respect to any underpayment of tax arising from the reportable 

transaction will not expire until one year after the earlier of the date on which taxpayer provides 

the required disclosures regarding the reportable transaction or the date on which a material 

advisor satisfies its list maintenance requirements with respect to the taxpayer’s transaction in 

response to an IRS request. This provision does not operate to shorten an otherwise applicable 

statute of limitation. 

The proposal would be effective for taxable years with respect to which the period for assessing 

a deficiency had not expired on the date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

48--

48 Included in combat abusive tax avoidance transactions 

133 
REQUIRE INCREASED REPORTING FOR NONCASH CHARITABLE 

CONTRIBUTIONS 

Current Law 

In general, a taxpayer may claim a deduction for charitable contributions, subject to certain 

limitations based on the type of taxpayer, the property contributed and the type of donee 

organization. The amount of the deduction generally equals the fair market value of the 

contributed property on the date of the contribution. In the case of contributions of inventory 

property and certain tangible personal property, the amount of the deduction generally is limited 

to lesser of the taxpayer’s basis in the property (typically, cost) or fair market value. 

In general, if the total deduction claimed for all contributed property is over $500, the taxpayer 

must file Form 8283 (Noncash Charitable Contributions) with the IRS. C corporations (other 

than personal service corporations and closely-held corporations) are required to file Form 8283 

only if the deduction claimed exceeds $5,000. 

Any individual, closely-held corporation, or personal service corporation claiming a charitable 

contribution deduction for a contribution of property (other than publicly-traded securities) 

valued at more than $5,000 ($10,000 in the case of nonpublicly traded stock) must obtain a 

qualified appraisal for the property contributed. C corporations (other than personal service 

corporations and closely-held corporations) are not required to obtain a qualified appraisal. In 

the case of donated art work valued at more than $20,000, a taxpayer that is required to obtain a 

qualified appraisal must attach a copy of the qualified appraisal itself to Form 8283. 

Reasons for Change 

Under current law, although an individual who contributes property to charity and claims a 

deduction of $5,001 must obtain a qualified appraisal, a C corporation (other than a closely-held 

corporation or a personal services corporation) that donates property to charity is not required to 

obtain a qualified appraisal, even if the corporation claims a deduction far in excess of $5,000. 

Requiring all taxpayers to obtain a qualified appraisal before claiming large charitable 

deductions for donated property (other than publicly traded stock) would reduce valuation 

abuses. In addition, requiring that a copy of the qualified appraisal be submitted to the IRS in the 

case of large deductions would assist the IRS in administering the law. 

Proposal 

Require all taxpayers to obtain a qualified appraisal for property (other than inventory property 

and publicly traded securities) donated to charity, if the deduction claimed exceeds $5,000. In 

addition, require the taxpayer to attach a copy of the qualified appraisal or an executive summary 

of the qualified appraisal to Form 8283 if the deduction claimed exceeds $500,000. Any 

executive summary attached to Form 8283 must be prepared by the qualified appraiser, and must 

contain a description of the donated property, the methodology used by the appraiser, a 

description of the critical facts relied upon, and such additional information as the Secretary may 

require by form or regulations. The limits would be indexed for inflation after December 31, 

134
2003. The $5,000 limit would be indexed in $1,000 increments and the $500,000 requirement 

would be increased in $50,000 increments using the rounding rules in IRC Section 1(f). 

This proposal would be effective for taxable years beginning after December 31, 2003. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 49 31 32 33 34 179 367

135
CLARIFY THE CONSEQUENCES OF CHANGING THE BENFICIARY OF A 

QUALIFIED TUITION PROGRAM 

Current Law 

A section 529 program may be a prepaid tuition program or a savings program. Under either 

type of program, a contributor creates an account for the benefit of a particular designated 

beneficiary (DB) to provide for the DB’s higher education expenses. 

Income tax. Earnings in a section 529 account accumulate tax-free until a distribution is 

made. If a distribution is used to pay qualified higher education expenses (qualified expenses), 

the distribution is tax-free. If a distribution is not used to pay qualified expenses, the earnings 

portion of the distribution is subject to federal income tax, plus a 10 percent additional tax 

(subject to exceptions, including death, disability or receipt of a scholarship). A change in the 

DB of a section 529 account is not treated as a “distribution” for income tax purposes if the new 

DB is a member of the old DB’s family. 

Gift and Generation-Skipping Transfer (GST) Taxes on Contributions. A contribution to a 

section 529 account is treated as a completed gift of a present interest from the contributor to the 

DB. Therefore, contributions to a section 529 account qualify for the per-donee annual gift tax 

exclusion (currently $11,000); gifts sheltered by this exclusion are also exempt from GST tax. A 

contributor may contribute up to five times the per-donee annual gift tax exclusion to a section 

529 account and, for gift and GST tax purposes, treat the contribution as having been made 

ratably over five years, beginning in the year the contribution is made. 

Gift and GST Taxes on Distributions. Because a contribution to a section 529 account is 

treated as a completed gift, a distribution from a section 529 account generally is not subject to 

gift or GST tax. Those taxes may, however, apply to a change of DB. Gift or GST tax (or both) 

may be imposed if the new DB is in a generation below that of the former DB, or if the new DB 

is not a family member of the former DB.49 

Estate Tax. Section 529 accounts generally are excluded from the gross estate of the 

contributor (unless the contributor is also the DB). If, however, the contributor elected the 

special five-year allocation rule for gift tax annual exclusion purposes, any amounts contributed 

that are allocable to the years following the year of the contributor’s death are includible in the 

contributor’s gross estate. Amounts distributed on account of the death of the DB are includible 

in the DB’s gross estate. 

Reasons for Change 

Current law regarding the transfer tax treatment of section 529 accounts is unclear and in some 

situations imposes tax in a manner inconsistent with generally applicable transfer tax provisions. 

The law should be clarified to provide taxpayers with certainty as to the tax consequences of a 

transfer and to eliminate the inappropriate imposition of transfer taxes. 

49 A technical correction has been introduced to add the same family requirement to the statute, in accordance with 

the legislative history (H.R. Rep. 148 at 327-328). 

136 
In addition, the lack of any limits on who can be named a DB creates opportunities for the 

unintended and inappropriate use of section 529 plans. For example, taxpayers may seek to use 

section 529 accounts as retirement accounts, with all the tax benefits but none of the restrictions 

and requirements of qualified retirement accounts, or to avoid gift and GST taxes by changing 

the DB of existing section 529 accounts. This proposal would simplify the tax consequences of 

section 529 accounts, facilitate utilization of the accounts for educational purposes, and eliminate 

opportunities for abuse. 

Proposal 

As under current law, contributions to section 529 accounts would be treated as completed gifts 

to the DB, subject to applicable gift and GST taxes but eligible for the special five-year 

allocation rule. Also as under current law, a contributor’s gross estate would include only the 

per-donee annual gift tax exclusion used for calendar years after the year of the contributor’s 

death. The DB’s gross estate would include only amounts (if any) paid to the DB’s estate or 

pursuant to the DB’s general power of appointment. No transfer taxes would be imposed on a 

change in DB. 

Distributions used for the DB’s qualified expenses would not trigger income tax, regard-less of 

the DB’s identity. As under current law, the recipient of a distribution not used for qualified 

expenses (a nonqualified distribution) would be subject to income tax on the accrued income 

portion of the nonqualified distribution. The income portion of the first $50,000 in cumulative 

nonqualified distributions to a DB also would be subject to a 10 percent penalty unless the 

penalty would not have applied under current law (which exempts distributions made for reasons 

including the DB’s death, disability or receipt of a scholarship). 

In addition, each nonqualified distribution in excess of $50,000 (computed on a cumulative basis 

for each DB) would be subject to a new excise tax payable from the account, unless the 

distribution was made as a result of the DB’s death, disability or receipt of a scholarship. The 

excise tax would eliminate the economic incentive to use a section 529 account for purposes 

other than that intended by the statute. The excise tax would be imposed at the rate of 35 percent 

on the first $100,000 of cumulative nonqualified distributions in excess of $50,000, and at the 

rate of 50 percent on cumulative nonqualified distributions in excess of $150,000. The excise 

tax would be withheld by the program administrator. 

Only an individual under age 35 would be permitted to be the DB of a section 529 account. 

When the DB reaches age 35, either the account would be distributed to the DB or a new DB 

would be named. Similarly, if a DB dies, the account would be distributed to the DB’s estate or 

a new DB would be named. The custodian of the account could have no beneficial interest in the 

account. The rules applicable to trusts contributing to section 529 accounts would be clarified, 

reporting requirements would be modified, and the Secretary would be granted broad regulatory 

authority to ensure that section 529 accounts are used in a manner consistent with Congressional 

intent. 

The proposal generally would be effective for section 529 accounts (including prepaid tuition 

contracts) established after the date of enactment. Modified reporting requirements would apply 

137 
after the date of enactment to all section 529 accounts. Additional contributions to existing 

section 529 savings accounts would be prohibited unless those accounts elect to be governed by 

the new rules. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 7 12 13 13 17 62 194

138
TAX ADMINISTRATION AND UNEMPLOYMENT INSURANCE 

Improve Tax Administration 

IMPLEMENT IRS ADMINISTRATIVE REFORMS 

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

fair 

Current Law 

Section 1203 of the IRS Restructuring and Reform Act of 1998 (RRA98) requires the 

Commissioner of Internal Revenue to terminate an employee for certain specifically enumerated 

violations committed by the employee in connection with the performance of the employee’s 

official duties. The Commissioner has non-delegable authority to determine whether mitigating 

factors support a personnel action other than termination for a covered violation. 

Reasons for Change 

The Administration’s proposal would enhance the IRS’ effectiveness by more carefully tailoring 

the types of conduct by IRS employees that are subject to sanctions, by reinforcing the 

seriousness with which covered violations will be handled, by providing clear guidance to IRS 

employees regarding covered conduct and associated penalties, and by allowing the imposition 

of penalties that are commensurate with specific violations. 

Current law requires the termination of an IRS employee for the failure to timely file tax returns, 

except when such failure is due to reasonable cause and not due to willful neglect. An IRS 

employee who fails to timely file a refund return (i.e., for a year for which the employee is 

entitled to a refund) is subject to termination even though a taxpayer who files a refund return 

late generally is not subject to any penalty. Late-filed refund return cases have constituted a 

significant percentage of the section 1203 cases to date, and these cases do not represent the type 

of serious conduct for which the penalties imposed by the statute should apply. In addition, a 

number of section 1203 cases have involved allegations of wrongful conduct by IRS employees 

against other IRS employees. The Treasury Inspector General for Tax Administration has 

recommended that these types of cases be removed from the list of violations covered by section 

1203 of RRA98. Such allegations can be addressed by existing administrative and statutory 

procedures. The Administration’s proposal would eliminate late refund returns and employee vs. 

employee acts from the list of covered violations. The proposal also would strengthen taxpayer 

protections by enhancing the Commissioner’s ability to punish the unauthorized access of 

taxpayer return information. 

Current law requires termination for any covered violation unless the Commissioner personally 

determines that mitigating factors justify some other personnel action. The proposal would 

require the Commissioner to establish guidelines outlining specific penalties, up to and including 

termination, for specific types of covered violations. These guidelines will provide notice to IRS 

employees of the punishment that would result from specific violations. This change would 

improve IRS employee morale and enhance the fundamental fairness of the statute. 

139 
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Proposal 

The Administration’s proposal would modify section 1203 of RRA1998 by (i) removing the latefiling of refund returns from the list of violations; (ii) removing employee vs. employee acts (i.e., 

for violation of an employee’s, rather than a taxpayer’s, Constitutional or civil rights) from the 

list of violations; and (iii) adding the unauthorized inspection of returns or return information to 

the list of violations. In addition, the proposal would require the Commissioner to establish 

guidelines outlining specific penalties, up to and including termination, for specific types of 

wrongful conduct covered by section 1203 of RRA 98. The Commissioner would retain the nondelegable authority to determine whether mitigating factors support a personnel action other than 

that specified in the guidelines for a covered violation. 

The proposal would be effective upon enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

140
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Curb the use of frivolous submissions and filings made to impede or delay tax 

administration 

Current Law 

The IRS may assert a penalty of $500 on an individual who files a return that, first, either does 

not contain sufficient information to allow the IRS to determine whether the tax shown on the 

return is correct or contains information indicating that the tax shown is substantially incorrect 

and, second, was filed based on a position that is frivolous or, based on information on the 

return, was intended to delay or impede tax administration. 

Reasons for Change 

The IRS has been faced with a significant number of tax filers who are filing returns based on 

frivolous arguments or who are seeking to hinder tax administration by filing returns that are 

patently incorrect. In addition, taxpayers are using existing procedures for Collection Due 

Process hearings, offers in compromise, and installment agreements to impede or delay tax 

administration by raising frivolous arguments. The IRS generally must address such frivolous 

arguments through mandated procedures, which results in delay and additional administrative 

burden and expense. Allowing the IRS to assert more substantial penalties for frivolous 

submissions, and to dismiss frivolous requests without the need to follow otherwise mandated 

procedures, would deter egregious taxpayer behavior and enable the IRS to utilize its resources 

more efficiently. 

Proposal 

The Administration’s proposal would increase the penalty for frivolous tax returns from $500 to 

$5,000. In addition, the proposal would permit the IRS to dismiss requests for Collection Due 

Process hearings, installment agreements, and offers in compromise if they are based on 

frivolous arguments or are intended to delay or impede tax administration. Individuals 

submitting such requests would be subject to a $5,000 penalty for repeat behavior or failure to 

withdraw the request after being given the opportunity to do so. The IRS would be permitted to 

maintain administrative records of frivolous submissions by taxpayers. The IRS, however, 

would be required to remove the designation of a taxpayer if, after a reasonable period of time, 

no further frivolous submissions are made by the taxpayer. Finally, the proposal would require 

the IRS to publish, at least annually, a listing of positions, arguments, requests, and proposals 

deemed frivolous for purposes of non-return submissions covered by the provision. 

The proposal would be effective for submissions made on or after the date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

141 
Authorize partial-liability installment agreements 

Current Law 

The IRS may enter into an agreement to allow a taxpayer to pay a tax liability in installments. 

The IRS, however, generally may enter into an installment agreement only if the agreement 

provides for the full payment of the liability. 

Reasons for Change 

The Administration’s proposal would provide the IRS with an additional option for entering into 

agreements with taxpayers for the voluntary repayment of delinquent tax liabilities. Currently, 

the IRS may enter into an installment agreement for full payment of the taxes or may accept an 

offer in compromise resulting in final settlement of the account for less than full payment. For 

taxpayers unable to pay in full through an installment agreement, an offer in compromise may 

not be a practical alternative. For example, a taxpayer may have limited assets, such as a modest 

amount of equity in a home or business, but the taxpayer is unable to make payments equal to 

the amount of that equity. At the same time, the equity may not be sufficient to justify the costs 

of enforced collection, and seizure of the asset may leave the taxpayer with an even lesser ability 

to make future payments. 

For a taxpayer who is unable to pay in full through monthly payments and unable to propose an 

acceptable compromise, but who desires to make some payment, a partial-liability installment 

agreement would allow the taxpayer to make payments towards the taxpayer’s liability and also 

would permit the IRS to collect a larger amount, including the entire liability, if the taxpayer’s 

circumstances change. Moreover, such an agreement would protect the taxpayer from other IRS 

collection action while the agreement was in effect (i.e., the taxpayer continues to comply with 

the payment obligations, and the taxpayer’s financial circumstances have not improved to a 

degree allowing the collection of a greater amount). 

Proposal 

The Administration’s proposal would allow the IRS to enter into installment agreements for 

amounts less than the full liability owed by taxpayers. 

The proposal would be effective for agreements entered into on or after the date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

0 52 47 46 47 49 241 505

142
-- -- -- -- -- -- -- --

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

failure to make tax deposits 

Current Law 

The IRS may terminate an agreement with a taxpayer to pay a tax liability in installments only 

for specific statutory grounds. These statutory grounds do not include a taxpayer’s failure to file 

required returns or a taxpayer’s failure to make required tax deposits. 

Reasons for Change 

The IRS administrative procedures specify that installment agreements contain a provision 

requiring taxpayers to meet all return filing and deposit obligations during the term of the 

agreement. This provision is intended to ensure that the privilege of paying a tax liability in 

installments is extended only to those taxpayers willing to commit to future compliance. The 

installment agreement statute, however, does not allow the IRS to terminate an agreement even if 

a taxpayer fails to file required returns or fails to make required federal tax deposits, and the 

taxpayer may incur significant additional unpaid tax liability before the IRS can terminate the 

agreement. 

Proposal 

The Administration’s proposal would permit the IRS to terminate an installment agreement if a 

taxpayer fails to timely file tax returns or if a taxpayer fails to timely make required federal tax 

deposits. 

The proposal would be effective for failures occurring on or after the date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

143
Consolidate judicial review of collection due process cases in the United States Tax Court 

Current Law 

The Collection Due Process (CDP) statutes entitle taxpayers to notice and a right to a CDP 

hearing with the IRS Office of Appeals after the filing of a notice of federal tax lien and prior to 

an intended levy. The taxpayer may request judicial review of a determination by the IRS Office 

of Appeals. The CDP statutes currently provide that venue for the review of an Appeals 

determination in a CDP case depends on which court (i.e., Tax Court or district court) would 

have jurisdiction over the underlying tax. Under this rule, the Tax Court reviews CDP cases 

involving deficiency-type taxes, generally income and estate taxes. The district court reviews 

cases involving nondeficiency-type taxes, generally employment and excise taxes. 

Reasons for Change 

The current statute, which divides responsibility for judicial review between the Tax Court and 

district courts, was intended to give jurisdiction to the court that would have the most expertise 

over the underlying tax. In practice, however, taxpayer challenges in CDP cases have focused 

primarily on collection issues rather than liability issues. In particular, relatively few district 

court cases have involved challenges to the underlying tax liability. 

The division of jurisdiction between the Tax Court and the district courts has needlessly 

complicated the CDP process by making it more confusing and expensive for taxpayers. A 

taxpayer who mistakenly files a request for review with the wrong court must incur the expense 

of refiling the case. In certain circumstances, a taxpayer may be required to seek judicial review 

in both the Tax Court and a district court. In addition, there are indications that some taxpayers 

are using the venue provisions to delay collection activity by deliberately filing the case with the 

wrong court. 

Most cases seeking judicial review of Appeals determinations in CDP cases already are handled 

by the Tax Court. This proposal not only will simplify and streamline the CDP process for 

taxpayers, but will also enable the Government and taxpayers to benefit from the Tax Court’s 

expertise in CDP issues. 

Proposal 

The Administration’s proposal would provide that the United States Tax Court shall be the 

exclusive venue for suits to obtain judicial review of any determination issued by Appeals after a 

CDP hearing. 

The proposal would be effective for IRS Office of Appeals determinations made after the date of 

enactment. 

144
-- -- -- -- -- -- -- --

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

145
-- -- -- -- -- -- -- --

Eliminate the monetary threshold for counsel review of offers in compromise 

Current Law 

Whenever a compromise is reached between the IRS and a taxpayer under section 7122, a record 

of the compromise must be placed on file along with an opinion from the IRS Chief Counsel. 

The opinion of Chief Counsel is not required when the total liability, including penalties and 

interest, is less than $50,000. All compromises, regardless of amount, are subject to continuous 

quality review by the Secretary. 

Reasons for Change 

The Administration’s proposal would allow the IRS to more efficiently direct resources for offer 

in compromise (OIC) cases while retaining existing quality review procedures. Many OIC cases 

do not present any significant legal issues, and the required legal review for cases meeting the 

statutory threshold can delay the acceptance process under current administrative procedures. 

The proposal would require the establishment of criteria for determining when review by Chief 

Counsel is appropriate. By retaining the requirement of continuous quality review by the 

Secretary, this proposal would insure that the overall quality of case dispositions does not 

decline. 

Proposal 

The Administration’s proposal would eliminate the requirement that the opinion of Chief 

Counsel be placed on file for any accepted offer in compromise involving unpaid tax, penalty, 

and interest equal to or exceeding $50,000. This proposal would require the Secretary to 

establish standards for determining when an opinion of Counsel must be obtained. 

The proposal would be effective for offers in compromise submitted or pending on or after the 

date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

146
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INITIATE IRS COST SAVING MEASURES 

Allow the Financial Management Service to retain transaction fees from levied amounts 

Current Law 

The IRS may continuously levy 15 percent of a delinquent taxpayer’s federal payments under the 

Federal Payment Levy Program (FPLP). The FPLP is administered by the Financial 

Management Service (FMS) of the Department of the Treasury. By statute, FMS must charge 

the IRS the costs incurred by FMS in developing and operating the FPLP. For the current fiscal 

year, the IRS expects that the FPLP fees charged by FMS will be between $8 and $9 million. 

Reasons for Change 

The IRS pays the FPLP fees to FMS out of the IRS’ own appropriations. The FPLP fees have 

increased since the inception of the program due to increased FMS costs and increased use of the 

FPLP program. The proposal would alter internal government accounting to effectively 

eliminate accounting costs. 

Proposal 

The Administration’s proposal would allow FMS to retain directly a portion of the levied funds 

as payment for FMS’s fees. A delinquent taxpayer, however, would receive full credit for the 

amount levied upon – i.e., the amount credited to a taxpayer’s account would not be reduced by 

FMS’s fee. 

The proposal would be effective upon enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

147
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Extend the due date for electronically filed returns 

Current Law 

Individual taxpayers must file their income tax returns, and pay any tax balance due, on or before 

April 15 following the close of the calendar year. (A taxpayer may request an extension of time 

to file a return, but no extension is available for the making of tax payments.) A variety of filing 

methods may be used by taxpayers, including electronic filing, mailing with the U.S. Postal 

Service, and delivery by certain private carriers. A taxpayer’s failure to timely file a return or 

timely pay a tax liability is subject to penalties and/or interest. 

Reasons for Change 

In the IRS Restructuring and Reform Act of 1998 (RRA98), Congress established a goal of 

having at least 80 percent of all federal tax and information returns filed electronically by 2007. 

Although the number of taxpayers filing returns electronically has increased each year, the 

current rate of growth is not sufficient to meet this goal. In addition, most taxpayers filing 

returns electronically are taxpayers who are claiming refunds, as opposed to taxpayers having 

balances due. The proposal would provide an incentive to file electronically, particularly for 

taxpayers who have a balance due and refund filers who file later in the filing season. By 

extending the due date for electronic returns, this proposal also would extend the due date for 

any tax balance due as that due date is keyed to the return due date. The extended due date for 

tax payments, however, would apply only if the payments are made by electronic funds transfer. 

This proposal would encourage additional taxpayers to file returns electronically. Increased use 

of electronic filing and electronic payment will reduce processing costs for the Federal 

Government. 

Proposal 

The Administration’s proposal would extend the return filing and payment date for the filing of 

individual income tax returns from April 15 to April 30, if the return is filed electronically. In 

order to qualify for this extended return due date, any balance due must be paid electronically by 

the extended return due date. The due date for returns filed on paper would remain April 15. 

The proposal would be effective for taxable years beginning after December 31, 2003. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

$'s in millions 

148
REPEAL SECTION 132 OF THE REVENUE ACT OF 1978 AND AMEND THE TAX 

CODE TO AUTHORIZE THE SECRETARY OF THE TREASURY TO ISSUE RULES 

TO ADDRESS INAPPROPRIATE NONQUALIFIED DEFERRED COMPENSATION 

ARRANGEMENTS 

Current Law 

Amounts received by an individual as compensation for services are income under section 61, 

and property received in connection with the performance of services is income under section 83. 

Under the rules of section 451, an individual has income in the year in which the compensation is 

actually or constructively received. An individual is in constructive receipt of income unless 

there is a substantial limitation on the individual’s ability to receive the income currently. The 

amount and timing of income attributable to amounts payable under a funded employee trust are 

determined under section 402(b). 

Nonqualified deferred compensation plans are arrangements, other than tax-qualified retirement 

plans, under which an employer promises to pay compensation in the future. An individual will 

have current income with respect to amounts payable under such an arrangement unless the 

ability to receive payments is subject to a substantial limitation, the arrangement is unfunded, 

and the individual’s right to receive future payment is not assignable or otherwise transferable. 

In order for a plan to be considered unfunded, any assets held in connection with the 

arrangement must remain the property of the employer and must be within the reach of the 

employer’s creditors if the employer becomes insolvent. If the assets cannot be reached by the 

employer’s creditors, the arrangement is considered funded and the individual is subject to 

immediate taxation. 

Under section 404(a)(5), the employer’s deduction for nonqualified deferred compensation is 

deferred until the individual includes the amount in income. 

In 1978, the Department of the Treasury and the Internal Revenue Service (IRS) issued Proposed 

Treasury Regulations section 1.61-16, providing for current inclusion of compensation deferred 

“at the taxpayer’s individual option.” Section 132 of the Revenue Act of 1978, which was 

enacted to prevent finalization of section 1.61-16, provides that the taxable year of inclusion of 

any amount under a private deferred compensation plan “shall be determined in accordance with 

the principles set forth in regulations, rulings, and judicial decisions relating to deferred 

compensation which were in effect on February 1, 1978.” The broad rule-making moratorium 

imposed by section 132 currently prohibits Treasury and the IRS from issuing new regulations or 

other guidance on many aspects of nonqualified deferred compensation arrangements (other 

than, for example, under section 83 or 402(b), to which section 132 does not apply). 

Reasons for Change 

Section 132 restricts the ability of Treasury and the IRS to respond effectively to arrangements 

designed to allow individuals to avoid current income for compensation that is, in practice, 

readily accessible or sheltered from the employer’s creditors. Since the enactment of section 132 

over 25 years ago, deferred compensation arrangements have become increasingly aggressive, in 

large part because of the prohibition on issuance of new guidance to deal with such aggressive 

149 
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techniques. These arrangements include ones in which the limitations on an individual’s access 

to the compensation are not substantial as well as arrangements that effectively limit creditor 

access to assets through restrictions or payout provisions triggered, for example, by financial 

distress of the employer or through the use of offshore funding vehicles. 

Proposal 

The Administration’s proposal would repeal section 132 of the Revenue Act of 1978 and amend 

the tax code to authorize the Secretary to issue rules to address inappropriate nonqualified 

deferred compensation arrangements (i.e., arrangements under which the availability of deferred 

payments is not actually subject to a substantial limitation, under which assets are in effect 

placed beyond the reach of the employer's general creditors, or under which the individual 

otherwise attempts to defer tax on amounts with respect to which he realizes current economic 

value). 

It is expected that new guidance would address when an individual’s access to compensation is 

considered subject to substantial limitation, the extent to which company assets may be 

designated as available to meet deferred compensation obligations, and when an arrangement is 

treated as funded. The new guidance would not include finalization of Proposed Treasury 

Regulation section 1.61-16. 

The proposal would be effective after the date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

150
PERMIT PRIVATE COLLECTION AGENCIES TO ENGAGE IN SPECIFIC, LIMITED 

ACTIVITIES TO SUPPORT IRS COLLECTION EFFORTS 

Current Law 

Federal tax liabilities generally must be collected by the IRS and cannot be referred to a private 

collection agency (PCA) for collection. 

Reasons for Change 

As of November 2003, the IRS designated over $16.1 billion in delinquent tax liabilities as 

uncollectible due to IRS collection and resource priorities, and this amount continues to increase. 

Many of these accounts represent taxpayers who have filed a tax return showing an amount of 

tax due, but who have failed to pay the tax. Other accounts represent taxpayers who have been 

assessed additional tax by the IRS and have made three or more voluntary payments to satisfy 

that additional tax, but who have stopped making payments. These taxpayers are aware of their 

outstanding liabilities. The IRS, however, is unable to continuously pursue each taxpayer with 

an outstanding tax liability. 

Many taxpayers with outstanding tax liabilities would make payment if contacted by telephone 

and, if necessary, offered the ability to make payment of the full amount in installments. If 

PCAs could perform these tasks for this group of taxpayers, without affecting any taxpayer 

protection, the IRS would be able to focus its resources on more complex cases and issues. 

Proposal 

Under the proposal, the IRS would be permitted to use PCAs to support IRS collection efforts by 

having the PCAs locate and contact taxpayers with outstanding tax liabilities. The PCAs would 

be permitted to request payment of the liability, either in full or in installments, but would not be 

permitted to take any enforcement action against a taxpayer. The PCAs would be governed by 

all of the same rules by which the IRS is governed, thus ensuring that taxpayer rights would be 

safeguarded 

Under the proposal, PCAs would first contact each taxpayer by a letter meeting the requirements 

of the Fair Debt Collection Practices Act (FDCPA) as well as the requirements for comparable 

notices issued by the IRS. If a taxpayer’s last known address is incorrect, and in order to verify 

the taxpayer’s telephone number, PCAs would be permitted to obtain current contact information 

by using automated database matching (e.g., running a name against an on-line or electronic 

“white pages”) and, if necessary, contacting sources of information such as directory assistance. 

PCAs, however, would not be permitted to contact individuals (such as relatives and neighbors) 

or employers to locate a taxpayer. 

A PCA would be permitted under the proposal to contact a taxpayer by telephone to request 

payment of an outstanding tax liability. PCAs would be given specific, limited information 

regarding an outstanding tax liability (e.g., type of tax, amount of the outstanding liability, tax 

years affected, and prior payments) to answer basic, but important, questions that a taxpayer may 

have regarding the liability. If a taxpayer is unable to make full payment, the PCA would be 

151 
authorized to offer the taxpayer the ability to pay pursuant to an installment agreement providing 

for full payment of the liability over three years (a “3-year installment agreement”). All 3-year 

installment agreements would be between the taxpayer and the IRS and would be subject to all of 

the protections currently provided to taxpayers making payments pursuant to an installment 

agreement. 

If a taxpayer contacted by a PCA requests to pay the outstanding tax liability over more than 

three years or indicates that the taxpayer is unable to pay the liability in full even over time, the 

PCA would be permitted under the proposal to obtain from the taxpayer financial information in 

the same manner that the IRS currently does through its Automated Collection System (ACS). 

The IRS would be required to provide PCAs with specific training regarding this process, and the 

information received would be forwarded to the IRS. For special circumstances, such as those 

involving a deceased or bankrupt taxpayer, the IRS also would be permitted to develop specific 

procedures allowing PCAs to gather information that would enable the IRS to resolve the 

account administratively. PCAs would not be permitted to subcontract any taxpayer-contact 

(including the composition of written communications) or quality monitoring activities. 

Under this proposal, existing taxpayer protections would be fully preserved. PCAs would be 

subject to careful monitoring by the IRS, including live monitoring of telephonic 

communications between PCA employees and taxpayers, review of recorded conversations, 

taxpayer-satisfaction surveys, audits of PCA records, and periodic reviews of PCA performance. 

In addition, the IRS would be specifically required to monitor PCA compliance with 

confidentiality requirements and the restrictions contained in section 1203 of RRA98. 

Under existing law, the FDCPA would apply to PCAs and would prohibit, for instance, 

communications with taxpayers at an unusual or inconvenient time or place, and conduct that is 

harassing, oppressive or abusive. Similarly, PCAs would be subject to existing disclosure 

restrictions, and the proposal would require annual reports outlining the safeguards in place at 

the PCAs to protect taxpayer confidentiality and PCA compliance with the confidentiality 

requirements. The proposal would require PCAs to inform taxpayers of their right to obtain 

assistance from the Office of the National Taxpayer Advocate and to immediately refer any case 

in which such assistance is requested to the local Taxpayer Advocate office. PCAs would be 

prohibited from making contacts with third-parties with respect to a taxpayer’s liability absent 

specific, written authorization from the IRS. All existing Code provisions governing taxpayer 

notices and taxpayer interviews by IRS employees would apply to PCA contacts with taxpayers. 

Taxpayers would be permitted under the proposal to pursue claims against a PCA for 

unauthorized collection actions by the PCA. The Government would have the right to intervene 

in any action brought by a taxpayer against a PCA, although in no case would the government be 

liable for a wrongful act of a PCA. 

An IRS support unit and a PCA oversight team would work with, monitor, and evaluate each 

PCA. PCAs would be evaluated based on a number of factors, including quality of service, 

taxpayer satisfaction, and case resolution, in addition to collection results. The proposal would 

create a revolving fund from the tax revenue collected under the program, and the amounts in 

this fund would be used to compensate the PCAs. Taxpayers’ accounts would be credited with 

152
the gross amounts collected, which is the same procedure for taxes collected by an IRS 

employee. 

The proposal would be effective after the date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 0 47 151 190 153 541 1,531

153
INCREASE CONTINUOUS LEVY FOR CERTAIN FEDERAL PAYMENTS 

Current Law 

The Taxpayer Relief Act of 1997 authorizes the IRS to continuously levy 15 percent of a 

delinquent taxpayer’s federal payments under the Federal Payment Levy Program (FPLP). The 

FPLP is administered by the Financial Management Service (FMS) of the Department of the 

Treasury. 

Reasons for Change 

Many federal payments, such as salary, retirement, and benefit payments, are regularly recurring 

payments that can be continuously levied until the outstanding tax obligation is satisfied. 

Vendor payments (i.e., payments to vendors that provide goods or services to the Government), 

however, are not regularly recurring payments and present fewer opportunities for collection. 

Withholding more of the vendor payment will allow FMS to recoup a greater percentage of the 

outstanding tax debt. 

Proposal 

The Administration’s proposal would increase the amount of a vendor payment that may be 

withheld under the FPLP to satisfy outstanding tax debts to 100 percent of the payment. 

The proposal would be effective upon enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 10 18 19 20 20 87 202

154
Strengthen Financial Integrity of Unemployment Insurance 

STRENGTHEN THE FINANCIAL INTEGRITY OF THE UNEMPLOYMENT 

INSURANCE SYSTEM BY REDUCING TAX AVOIDANCE AND IMPROPER 

BENEFIT PAYMENTS 

Current Law 

The Federal Employment Tax Act (FUTA) currently imposes a federal payroll tax on employers 

of 6.2 percent of the first $7,000 paid annually to each employee. States also impose an 

unemployment tax on employers. Employers in States that meet certain federal requirements are 

allowed a credit against FUTA taxes of up to 5.4 percent, making the minimum net federal rate 

0.8 percent. State Unemployment Insurance taxes are deposited into the State's Federal 

Unemployment Insurance Trust Fund and are used by the State to pay unemployment benefits. 

Employer eligibility for the full FUTA rate reduction requires that the State assess 

unemployment tax rates on an employer in part according to the unemployment experience of 

that employer. This feature of State law is commonly known as "experience rating." Generally, 

the more unemployment benefits paid to former employees, the higher the State unemployment 

tax rate of the employer. 

Reasons for Change 

Some employers manipulate their experience rating, for example, by transferring employees to 

shell companies with little or no unemployment history to take advantage of the shell company’s 

lower rate. Restricting the ability of employers to artificially lower their experience ratings will 

prevent tax avoidance in this area. 

Some individuals continue to collect State unemployment benefits illegally after returning to 

work and therefore not remaining eligible for the benefits. 

Proposal 

The proposal would modify the requirements for State unemployment tax laws to deter schemes 

used by employers to manipulate experience rates so that they pay lower state taxes than they 

should based on their benefit experience. The proposal also allows the States access to the 

National Directory of New Hires, allowing them to more quickly determine those who are no 

longer eligible for benefit payments due to new employment. These changes would be effective 

beginning January 1, 2005. 

155
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 0 -2 108 142 120 368 -216

156
REAUTHORIZE FUNDING FOR THE HIGHWAY TRUST FUND 

DEPOSIT FULL AMOUNT OF EXCISE TAX IMPOSED ON GASOHOL IN THE 

HIGHWAY TRUST FUND 

Current Law 

Excise taxes are imposed at various rates on highway motor fuels. In general, receipts from 

these taxes (except for the 0.1-cent-per-gallon Leaking Underground Storage Tank (LUST) Trust 

Fund excise tax) are transferred to the Highway Trust Fund. In the case of the tax on gasohol 

and other fuels containing specified percentages of ethanol or renewable source methanol, 

however, receipts attributable to a rate of 2.5 cents per gallon are retained in the general fund and 

only the remainder, less the amount transferred to the LUST Trust Fund, is transferred to the 

Highway Trust Fund. 

Reasons for Change 

The full amount of any excise tax on a highway motor fuel, less the amount dedicated to the 

LUST Trust Fund, is an appropriate source of funding for highway expenditures. The 

elimination of the rule providing for reduced transfers to the Highway Trust Fund in the case of 

gasohol and other fuels containing alcohol and renewable source methanol would provide needed 

additional funding for highway programs. 

Proposal 

All receipts from excise taxes on gasohol and other highway motor fuels containing ethanol or 

renewable source methanol, less the amount dedicated to the LUST Trust Fund, would be 

transferred to the Highway Trust Fund, effective for collections after September 30, 2003. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 0 648 666 691 699 2,694 6,443

157
IMPOSE ADDITIONAL REGISTRATION REQUIREMENTS ON THE TRANSFER OF 

TAX-EXEMPT FUEL BY PIPELINE, VESSEL, OR BARGE 

Current Law 

An excise tax is imposed on taxable fuel at a rate of 18.4 cents per gallon in the case of gasoline 

(other than aviation gasoline), 19.4 cents per gallon in the case of aviation gasoline, and 24.4 

cents per gallon in the case of diesel fuel or kerosene. Tax is generally imposed on the removal 

of taxable fuel from a terminal. Tax is also imposed on the removal of taxable fuel from a 

refinery or the entry of taxable fuel into the United States, but an exemption applies if the fuel is 

transferred in bulk to a terminal or refinery and both the person removing or entering the fuel and 

the operator of the terminal or refinery receiving the bulk transfer are registered with the Internal 

Revenue Service. This exemption applies even if the bulk carrier transporting the fuel between 

the point of removal or entry and the registered terminal or refinery is not registered. Refiners, 

taxable fuel importers, terminal operators, and bulk carriers are required to register with the 

Internal Revenue Service. Persons that fail to register when required to do so are subject to a 

$50 penalty and, in the case of unregistered refiners, importers, and terminal operators, are 

unable to take advantage of the bulk transfer exemption. Registrants are not required to display 

proof of registration. 

Reasons for Change 

The current law rule permitting an exemption for bulk transport of untaxed fuel by unregistered 

carriers makes it more difficult for the IRS to track bulk transfers of taxable fuel between the 

refinery or point of entry into the country and the point of taxation and expands opportunities to 

divert the fuel to retailers or end users before tax is paid. Moreover, the absence of any 

requirement to display proof of registration makes it difficult for the IRS to determine whether a 

vessel or barge transporting taxable fuel is registered. In addition, the current law penalty for 

failure to register is not sufficient to ensure compliance. 

Proposal 

The proposal would limit the exemption for bulk transfers of taxable fuel to transfers by 

registered bulk carriers. In addition, vessel and barge operators transporting taxable fuel would 

also be required to display proof of registration in the manner prescribed by the IRS. New 

penalties would be imposed for failure to comply with registration and display of proof of 

registration requirements. The penalty for failure to register would be $1,000 per day and the 

penalty for failure to display proof of registration would be $500 per day. The proposal would 

apply to bulk transfers (in the case of limits on the exemption) and failures (in the case of the 

new penalties) occurring after October 31, 2004. 

158
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 76 93 96 91 87 443 747

159
REPEAL INSTALLMENT METHOD FOR PAYMENT OF HEAVY HIGHWAY 

VEHICLE USE TAX 

Current Law 

An annual tax is imposed on the use of heavy (at least 55,000 pounds) highway vehicles. The 

amount of tax increases from $100 (for a 55,000 pound vehicle) to $550 (for vehicles over 

75,000 pounds). The tax year is July 1 through June 30 and the tax return is generally due on 

August 31 of the year to which it relates. A taxpayer may, however, elect to pay the tax in 

installments. The installment option generally permits payment of one quarter of the tax on each 

of the following dates: August 31, December 31, March 31, and June 30. States are required to 

obtain evidence, before issuing tags for a vehicle, that the use tax return has been filed and any 

tax due with the return has been paid. 

Reasons for Change 

The requirement that States obtain evidence of tax payment before issuing tags is the most costeffective method of enforcing the heavy vehicle use tax. Under current law, however, tags can 

be issued if the tax due with the return (the first installment) has been paid even if the taxpayer is 

delinquent with respect to subsequent installments. 

Proposal 

The installment option would be eliminated for tax years beginning after June 30, 2004. Thus, 

heavy vehicle owners would be required to pay the entire tax with their returns and would be 

unable to obtain State tags without providing proof of full payment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

407 30 31 32 31 32 156 341

160
ALLOW TAX-EXEMPT FINANCING FOR PRIVATE HIGHWAY PROJECTS AND 

RAIL-TRUCK TRANSFER FACILITIES 

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. One category of tax-exempt private activity bonds is “exempt facility 

bonds.” Facilities eligible for exempt facility bond financing include airports, docks and 

wharves, mass commuting facilities, water, sewage and solid waste disposal facilities, qualified 

residential rental projects, facilities for the local furnishing of electric energy or gas, local district 

heating or cooling facilities, qualified hazardous waste facilities, high-speed intercity rail 

facilities, environmental enhancements of hydro-electric generating facilities, and qualified 

public educational facilities. The volume of most tax-exempt private activity bonds is restricted 

by per-State limits. The annual volume limits are $75 per resident of the State or $225 million, if 

greater, and are indexed for inflation beginning in 2003. 

Reasons for Change 

Economic growth and productivity depend on a modern, well-connected national transportation 

network. Allowing a limited amount of tax-exempt private activity bonds to be issued for 

highway projects and surface freight transfer facilities would encourage private sector 

investment in these projects. 

Proposal 

Two new categories of exempt facility bonds would be authorized to finance highway facilities 

and surface freight transfer facilities. Issuance of the bonds would not be subject to the general 

private activity bond volume cap, but rather would be subject to a separate volume limitation of 

$15 billion in the aggregate. The Secretary of Transportation would allocate the $15 billion of 

authority among eligible projects. 

Highway facilities eligible for financing under the program would consist of any surface 

transportation project eligible for federal assistance under title 23 of the United States Code, or 

any project for an international bridge or tunnel for which an international entity authorized 

under federal or State law is responsible. Surface freight transfer facilities would consist of 

facilities for the transfer of freight from truck to rail or rail to truck, including any temporary 

storage facilities directly related to those transfers. Examples of eligible surface freight transfer 

facilities would include cranes, loading docks and computer-controlled equipment that are 

integral to such freight transfers. Examples of non-qualifying facilities would include lodging, 

retail, industrial or manufacturing facilities. 

161 
The proposal would be effective for bonds issued after the date of enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -20 -49 -77 -94 -97 -337 -619

162
EXPIRING PROVISIONS 

EXTEND MINIMUM TAX RELIEF FOR INDIVIDUALS 

Current Law 

An individual is subject to an alternative minimum tax (AMT) to the extent the individual’s 

tentative minimum tax is greater than the regular tax liability. In computing the tentative 

minimum tax, taxable income is calculated differently than for regular tax purposes. Under the 

AMT, certain income items are included that are not included for regular tax purposes. Also, 

certain deductions, including state and local tax deductions, miscellaneous itemized deductions, 

and the standard deduction, are not permitted. A specified exemption amount, which varies by 

filing status but not by the number of personal exemptions and which phases out at higher 

income levels, is allowed, but the regular tax personal exemptions for taxpayers and their 

dependents are not allowed in computing the AMT. Generally, taxpayers are allowed to use 

most tax credits only to the extent their regular tax liability exceeds their tentative minimum tax. 

However, under provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 

(EGTRRA), before 2011, the child tax credit, the adoption credit, and the new saver credit are 

not limited by the AMT, and the earned income tax credit and the additional child tax credit are 

not reduced by the amount of the AMT. 

EGTRRA increased the alternative minimum tax (AMT) exemption amounts for taxable years 

2001 through 2004, and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) 

further increased the exemptions for 2003 and 2004. For 2004, the exemption level is $40,250 

for single and head of household filers, $58,000 for married taxpayers filing joint returns, and 

$29,000 for married taxpayers filing separate returns. EGTRRA and JGTRRA did not alter the 

AMT tax rates of 26 percent and 28 percent, the income level at which the 28 percent tax rate 

begins to apply, nor the income levels at which the AMT exemption is phased-out. After taxable 

year 2004, the exemption levels revert to their pre-EGTRRA levels of $33,750, $45,000, and 

$22,500, respectively. 

A temporary provision, which permitted an individual to reduce tax liability by the full amount 

of nonrefundable personal credits even if tax liability is reduced to an amount that is less than the 

individual’s tentative minimum tax, expired after taxable year 2001 but was extended for taxable 

years 2002 and 2003 by the Job Creation and Worker Assistance Act of 2002. The extension did 

not apply to the child credit, earned income tax credit, the adoption credit, and the refundable 

portions of the child credit and the earned income credit, all of which were provided AMT relief 

through taxable year 2010 under EGTRRA. 

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 is concerned that the individual AMT may impose 

financial and compliance burdens upon taxpayers who were not the originally intended targets of 

the individual AMT. The Administration believes that allowing full use of nonrefundable 

personal credits, all of which are limited in amount and which are generally limited to lower- and 

163 
middle-income families, would not undermine the policy of the individual AMT and would 

promote the important social policies underlying the credits. 

The Administration believes that allowing nonrefundable personal credits to be used in full and 

allowing the larger AMT exemption would avoid a significant increase in compliance burdens. 

Substantially fewer taxpayers would need to perform complex and tedious computations to 

determine whether the AMT limited the use of these credits. 

Proposal 

The proposal would allow an individual to reduce tax liability by the full amount of 

nonrefundable personal credits even if tax liability is reduced to an amount that is less than the 

individual’s tentative minimum tax. The larger AMT exemption levels provided temporarily by 

JGTRRA would continue. The proposal would be effective for taxable years through 2005. 

The adoption credit and both the regular and refundable portions of the child credit and the 

earned income tax credit would remain refundable for taxable years after 2010 as the result of the 

Administration’s proposal to permanently extend all provisions of EGTRRA. 

Although these temporary changes will continue to ameliorate the AMT problem in the shortrun, long-term change is needed. The Treasury Department has been directed to study the AMT 

with the goal of producing a long-term solution. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

-86 -9,383 -13,881 0 0 0 -23,264 -23,264

164
PERMANENTLY EXTEND 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. 

In addition, the principles that guided the development of the R&E credit statute in the past need 

to be reconsidered to determine whether modifications should be made to improve the credit’s 

incentive effect. Ongoing uncertainty over the interpretation of the statutory requirements for 

credit eligibility has generated controversy between taxpayers and the IRS. Although 

administrative guidance has addressed much of this uncertainty, a number of the statutory 

requirements are inherently subjective. As a result, taxpayers often are not certain whether 

particular activities will qualify for the credit and taxpayer and IRS resources are needlessly 

consumed by controversy. 

Further, in its current form the research credit results in disparate tax treatment of researchperforming firms that is difficult to justify. Some taxpayers can receive large credits while others 

receive none for the same amount of qualifying research. The credit also can create a competitive 

disadvantage among firms in the same industry. 

The complexity of the credit, and particularly the fixed base period, is an issue as well. 

Taxpayers, for example, who have sold or acquired other businesses face documentation and 

substantiation difficulties as time passes since the years comprising the fixed-base percentage 

(1984-1988). These difficulties relate to not only research spending but also gross receipts. 

165
Proposal 

The proposal would make the R&E credit permanent. The Administration is concerned that 

features of the R&E credit may limit its incentive effect. Consequently, the Treasury 

Department has been directed to study the credit and ways to improve its effectiveness. The 

Administration intends to work closely with the Congress to develop and enact the reforms that 

will rationalize the R&E credit and improve its incentive effect. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

-672 -3,610 -5,187 -6,291 -7,129 -7,775 -29,992 -78,351 

166
REPEAL THE DISALLOWANCE OF CERTAIN DEDUCTIONS OF MUTUAL LIFE 

INSURANCE COMPANIES 

Current Law 

Life insurance companies may generally deduct policyholder dividends, while dividends to 

stockholders are not deductible. Section 809 of the Internal Revenue Code, enacted in 1984, was 

intended to address a long-standing question regarding whether a portion of the policyholder 

dividends paid by a mutual life insurance company should be more appropriately characterized 

as a payment of non-deductible stockholder dividends. Section 809 identifies such an amount, 

and reduces the deduction for mutual company policyholder dividends (or otherwise increases 

taxable income by reducing the amount of end-of-year reserves) in an equal amount. 

The amount of the deduction disallowed by Section 809 is termed the company’s differential 

earnings amount. The differential earnings amount equals the product of the individual 

company’s average equity base and an industry-wide computed differential earnings rate. The 

average equity base is computed using the company’s surplus and capital, adjusted for nonadmitted financial assets, the excess of statutory reserves over tax reserves, certain other 

reserves, and by 50 percent of the provision for policyholder dividends payable in the following 

year. The differential earnings rate equals the excess of an imputed stock earnings rate (the 

average stock earnings rate for the prior three years of the 50 largest domestic stock life 

insurance companies, adjusted by a factor roughly equal to 0.90555) over the average earnings 

rate of all domestic mutual life insurance companies. The differential earnings rate equals zero if 

the average mutual earnings rate exceeds the imputed stock earnings rate. The differential 

earnings rate is initially computed using the average mutual earnings rate for the second year 

preceding the current taxable year, but is later recomputed using the current year’s average 

mutual earnings rate. Any difference between the differential earnings amount and the 

recomputed differential earnings amount is taken into account in computing taxable income for 

the following taxable year. 

Section 809 was temporarily suspended by the Job Creation and Work Assistance Act of 2002 

(Public Law 107-147). For taxable years beginning in 2001, 2002 and 2003, the differential 

earnings rate is treated as zero for purposes of computing the differential earnings amount and 

the recomputed differential earnings amount. 

Reasons for Change 

Section 809 has never effectively achieved the purpose for which it was intended. In fact, the 

differential earnings amount has been zero for seven of the last ten years, thus permitting mutual 

life insurance companies a full deduction for policyholder dividends in those seven years. 

Section 809 has been criticized as being theoretically unsound because capital contributions 

made to a stock company are untaxed to the company, while mutual company capital 

contributions in the form of life insurance premiums are fully taxed. In essence, mutual 

companies prepay the tax on income later distributed to policyholders as policyholder dividends. 

The computations necessary to determine the differential earnings amount are overly complex. 

They are flawed because an individual company’s tax is based on industry-wide results. 

Moreover, the computations incorrectly measure the differential earnings rate by comparing a 

167 
current year mutual earnings rate with a stock earnings rate averaged over three prior years. In 

addition, the correction attempted by calculating a recomputed differential earnings rate ignores 

the time value of money. Furthermore, section 809 imposes an additional data reporting burden 

on both stock and mutual life insurers, but raises relatively little revenue. 

Finally, section 809 has become less relevant in recent years, because the mutual life insurance 

industry has demutualized to a significant degree. 

Proposal 

The proposal would repeal section 809, effective for taxable years beginning in 2004. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -85 -51 -48 -45 -43 -272 -471

168
-- -- -- -- -- -- -- --

PERMANENTLY EXTEND AND EXPAND DISCLOSURE OF TAX RETURN 

INFORMATION FOR ADMINISTRATION OF STUDENT LOANS 

Current Law 

The IRS may disclose a taxpayer’s filing status, adjusted gross income, and identity information 

to the Department of Education – but not to contractors of the Department of Education – only 

for purposes of establishing income contingent repayment amounts for certain student loans. 

This provision is scheduled to expire on December 31, 2004. 

Reasons for Change 

The Department of Education’s student financial aid application requires applicants (and their 

parents) to provide information on adjusted gross income, earnings from employment, income 

tax liability, and type of tax return filed. Financial aid applications are processed by Department 

of Education contractors, and neither the Department of Education nor its contractors are 

permitted to receive return information from the IRS to verify the information on the financial 

aid applications. Allowing the Department of Education to use return information from the IRS 

to verify financial aid applications would significantly reduce fraud and error and allow financial 

aid to be directed to those students who are truly in need. In particular, statistical studies indicate 

that Pell Grant overpayments could be reduced by hundreds of millions of dollars each year if 

this type of verification were permitted. 

Proposal 

The Administration’s proposal would permit the IRS to disclose to the Department of Education 

and its contractors identity information, filing status, adjusted gross income, earnings from 

employment, income tax liability, and type of tax return filed for purposes of verifying student 

financial aid applications, as well as establishing repayment amounts. The Department of 

Education and its contractors would remain subject to confidentiality restrictions and safeguards 

with respect to return information. The legislation would help to reduce fraud and error in 

student financial aid programs. 

The expanded disclosure authority would apply to requests for disclosures made after the date of 

enactment. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

169
EXTEND AND MODIFY WORK OPPORTUNITY TAX CREDIT AND WELFARE-TOWORK TAX CREDIT 

Current Law 

Under current law, employers are generally entitled to a work opportunity tax credit (WOTC) for 

the first $6,000 of cash wages paid to several target groups of economically disadvantaged or 

handicapped workers. The maximum WOTC credit is generally $2,400 per worker. For the 

summer youth target group, the credit is limited to the first $3,000 of cash wages and the 

maximum credit is $1,200. 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. 

The welfare-to-work (WTW) tax credit enables employers to claim a tax credit for eligible wages 

paid to certain qualified long-term welfare recipients. The WTW 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 wages paid by the amount of the 

credit claimed. The minimum employment period that employees must work before employers 

can claim the WTW credit is 400 hours. 

Other limitations, including the tax liability limitations governing the general business credit, 

restrict the amount of WOTC and WTW credits that can be claimed. 

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 

State-sponsored vocational rehabilitation programs; (6) summer youth; (7) food stamp recipients; 

and (8) Supplemental Security Income (SSI) recipients. A qualified long-term welfare recipient 

for purposes of the WTW credit is: (1) a member of a family that has received 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 family ineligible for TANF 

because of any federal- or State-imposed time limit, if the family member is hired within two 

years of the date of benefit cessation. 

For the WOTC credit, eligible wages include only cash wages. For the WTW credit, eligible 

wages 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. 

Membership in most WOTC and WTW target groups requires eligible persons to be members of 

families that benefit from means-tested government programs, to live in areas with high poverty 

rates, or to have participated in government programs that provide benefits to handicapped 

170
workers.50 However, ex-felons are required to be members of families which have incomes for a 

specified 6-month period that, when annualized, do not exceed 70 percent of the Lower Living 

Standard published by the Bureau of Labor Statistics. State employment security agencies 

(SESAs) are responsible for certifying that individuals are eligible for the credits. 

Many workers eligible for the WTW credit are also eligible for WOTC. Employers of such 

workers may claim either the WOTC or WTW credit, but not both, in any taxable year. The 

WOTC and WTW credits are effective for workers hired before January 1, 2004. 

Reasons for Change 

The WOTC and WTW credits provide tax incentives to employers for hiring economically 

disadvantaged workers, but the rules for computing the credits differ in ways that are hard to 

justify. Employers of WTW-eligible long-term welfare recipients, who generally are more costly 

to employ than WOTC workers, receive lower credits in the initial phase of employment than 

employers of WOTC workers. Because many WTW employees are also eligible for WOTC, 

employers of these workers compute credits under both sets of rules to determine which credit is 

most advantageous. To compute WTW credits, employers have to calculate the value of certain 

fringe benefits paid to each WTW worker hired, which is difficult and costly relative to the 

expected tax benefits. The family-income test for the WOTC credit’s ex-felon target group is 

burdensome for administrative agencies and reduces employer incentives for hiring ex-felons. 

Proposal 

The proposal would simplify the employment incentives by combining the credits into one credit 

and making the rules for computing the combined credit simpler. The credits would be 

combined by creating a new welfare-to-work target group under the work opportunity tax credit. 

The minimum employment periods and credit rates for the first year of employment under the 

present work opportunity tax credit would apply to welfare-to-work employees. The maximum 

amount of eligible wages would continue to be $10,000 for welfare-to-work employees and 

generally $6,000 for other target groups ($3,000 for summer youth). In addition, the second-year 

50-percent credit currently available under the welfare-to-work credit would continue to be 

available for welfare-to-work employees under the modified work opportunity tax credit. 

Qualified wages would be limited to cash wages. The work opportunity tax credit would also be 

simplified by eliminating the requirement to determine family income for ex-felons. The 

modified work opportunity tax credit would apply to individuals who begin work after December 

31, 2003, and before January 1, 2006 (including individuals who begin work after December 31, 

2003, and before the date of enactment). 

50 A provision of The Job Creation and Worker Assistance Act of 2002 provides a wage credit for New York 

Liberty Zone Employees by temporarily treating them as members of a WOTC target group. 

171 
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

-12 -187 -268 -162 -86 -46 -749 -768

172
EXTEND THE DISTRICT OF COLUMBIA ENTERPRISE ZONE 

Current Law 

The DC Zone includes the D.C. Enterprise Community and District of Columbia census tracts 

with a poverty rate of at least 20 percent. Certain businesses in the zone are eligible for (1) a 

wage credit equal to 20 percent of the first $15,000 in annual wages paid to qualified employees 

who reside within the District of Columbia; (2) $35,000 in increased section 179 expensing;51 

and (3) in certain circumstances, tax-exempt bond financing. In addition, gross income does not 

include capital gain from the sale of qualified DC Zone assets held more than 5 years. For 

purposes of the capital gain exclusion, the DC Zone includes all DC census tracts with a poverty 

rate of at least 10 percent. Gain on DC Zone assets attributable to the periods before January 1, 

1998, and after December 31, 2008, is not eligible for the exclusion. 

The DC Zone incentives apply for the period from January 1, 1998, through December 31, 2003, 

and with respect to bonds issued and DC Zone assets acquired during that period. 

Reasons for Change 

Despite recent economic growth in the region, certain portions of the District of Columbia are 

still characterized by high levels of poverty, unemployment and other indicators of economic 

distress. Extending the DC Zone incentives would encourage the continued economic 

redevelopment of these areas. 

Proposal 

The DC Zone incentives would be extended for two years, making the incentives applicable 

through December 31, 2005, and with respect to bonds issued and DC Zone assets acquired 

during 2004 and 2005. The capital gain eligible for the exclusion would also be expanded to 

include gain attributable to the period from January 1, 2009, through December 31, 2010. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

-46 -79 -37 -7 -9 -24 -156 -328 

51 Section 179 provides that, in place of depreciation, certain taxpayers, typically small businesses, may elect to 

deduct up to $100,000 of the cost of qualifying property placed in service each year. In general, qualifying property 

is defined as depreciable tangible personal property that is purchased for use in the active conduct of a trade or 

business. 

173 
EXTEND THE FIRST-TIME HOMEBUYER CREDIT FOR THE DISTRICT OF 

COLUMBIA 

Current Law 

A one-time, non-refundable $5,000 credit is available to purchasers of a principal residence in 

the District of Columbia who have not owned a residence in the District during the year 

preceding the purchase. The credit phases out for taxpayers with modified adjusted gross 

income between $70,000 and $90,000 ($110,000 and $130,000 for joint returns). 

The credit does not apply to purchases after December 31, 2003. 

Reasons for Change 

The homeownership rate in the District of Columbia is significantly below the rate for 

neighboring states and the nation as a whole. Homeownership fosters healthy, vibrant 

communities and is a key to revitalizing the Nation’s capital. Extending the credit would 

enhance the District’s ability to attract new homeowners and establish a stable residential base. 

Proposal 

The first-time homebuyer credit for the District of Columbia would be extended for two years, 

making the credit available with respect to purchases through December 31, 2005. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

-1 -18 -17 0 0 0 -35 -35

174
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 is 

determined by reference to the adjusted applicable federal rate (AFR) published by the Internal 

Revenue Service. 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 2003. 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. There is no requirement that issuers of QZABs 

report issuance to the Internal Revenue Service (IRS). Issuers of tax-exempt bonds must report 

issuance to the IRS by filing information returns. 

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. A reporting requirement would 

facilitate evaluation of this provision and assist in its administration by the IRS. 

175
Proposal 

The authority to issue $400 million of QZABs per year would be extended for two years to 2004 

and 2005. For QZABs issued after the date of enactment, issuers would be required to report 

issuance to the IRS in a manner similar to the information returns required for tax-exempt bonds. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

-2 -9 -15 -22 -28 -30 -104 -254

176
EXTEND DEDUCTION FOR CORPORATE DONATIONS OF COMPUTER 

TECHNOLOGY 

Current Law 

The deduction for charitable contributions of ordinary income property is generally limited to the 

lesser of the taxpayer’s cost basis in the property or fair market value. The Taxpayer Relief Act 

of 1997 provided an enhanced deduction for a three-year period for charitable contributions of 

computer technology or equipment to elementary and secondary schools and charities formed for 

the purpose of supporting elementary and secondary education. In 2000, this provision was 

extended for an additional three-year period and expanded to apply to charitable contributions of 

computer technology or equipment to post-secondary educational institutions and public 

libraries. For contributions made in taxable years beginning before January 1, 2004, the amount 

of the deduction is equal to the taxpayer's basis in the donated property plus one-half of the 

amount of ordinary income that would have been realized if the property had been sold. The 

enhanced deduction is limited to twice the taxpayer’s basis in the donated property. To qualify 

for the enhanced deduction, the contribution must satisfy various requirements. This provision 

does not apply to contributions made in taxable years beginning after December 31, 2003. 

Reasons for Change 

This provision provides an incentive for businesses to contribute computer equipment and 

software for the benefit of local communities and students at the elementary, secondary, and 

post-secondary school levels, by providing public libraries and educational institutions with 

needed technological resources. Because the need for technological resources is continuing, this 

provision should be extended. 

Proposal 

The Administration proposes to extend the deduction, which expired with respect to donations 

made in taxable years beginning after December 31, 2003, to apply to donations made in taxable 

years beginning before January 1, 2006. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -180 -46 0 0 0 -226 -226

177
EXTEND ALLOWANCE OF NET OPERATING LOSS OFFSET OF 100 PERCENT OF 

ALTERNATIVE MINIMUM TAXABLE INCOME 

Current Law 

A net operating loss (NOL) generally is the amount by which a taxpayer’s allowable deductions 

exceed the taxpayer’s gross income. NOLs generally may be carried back two years, resulting in 

a refund of taxes paid in the carryback year, or carried forward for twenty years, resulting in 

lower tax payments for the carryforward year. However, NOL deductions may not reduce a 

taxpayer’s alternative minimum taxable income (AMTI) by more than 90 percent. The Job 

Creation and Worker Assistance Act of 2002 temporarily waived the AMTI limitation for NOL 

carrybacks arising in taxable years ending in 2001 and 2002 as well as for NOL carryforwards to 

those years. 

Reasons for Change 

The AMTI limitation is inconsistent with measuring net income, is overly burdensome, and 

prevents appropriate tax relief to firms in difficult financial straits. 

Proposal 

The Administration’s proposal would waive the AMTI limitation for NOL carrybacks 

originating in taxable years ending in 2003, 2004, and 2005, as well as for NOLs carried forward 

into those years. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

-1,326 -755 -101 203 154 129 -370 82 

178
PERMANENTLY EXTEND IRS USER FEES 

Current Law 

The IRS is authorized to charge user fees for written responses to questions from individuals, 

corporations, and organizations related to their tax status or the effects of particular transactions 

for tax purposes. Under current law, these fees are scheduled to expire effective with requests 

made after December 31, 2004. 

Reasons for Change 

The existing provision permits the IRS to recover its costs for providing written responses to 

taxpayer questions that, with certain exceptions, are binding upon the IRS. Preparing such 

written responses typically requires significant IRS resources and, in the absence of authority to 

charge user fees, would require the IRS to reduce its resources devoted to other priorities. 

Proposal 

The proposal would extend permanently the IRS’s authority to charge user fees for written 

responses to questions from individuals, corporations, and organizations related to their tax status 

or the effects of particular transactions for tax purposes. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 32 44 45 46 47 214 464

179
-- -- -- -- -- -- -- --

EXTEND PROVISIONS PERMITTING DISCLOSURE OF RETURN INFORMATION 

RELATING TO TERRORISM 

Current Law 

Current law permits disclosure by the IRS of return information to aid the investigation or 

response to terrorism in two situations. First, if a specified official of a federal law enforcement 

or intelligence agency submits a written request, the IRS may disclose a taxpayer’s identity and 

return information to such agency’s officers and employees involved with a terrorist incident, 

threat, or activity. The head of a federal law enforcement agency in turn may make disclosures 

to State or local law enforcement agencies working as part of a team on the investigation or 

response. Second, if the IRS wishes to apprise a federal law enforcement agency of a terrorist 

incident, threat, or activity, the IRS may disclose a taxpayer’s identity and return information to 

the agency’s head (who in turn may disclose the information to agency officers and employees as 

necessary). 

With respect to returns and return information that the taxpayer himself or herself filed, the IRS 

cannot make the disclosure to federal law enforcement or intelligence agency officers and 

employees without a court order indicating there is reasonable cause to believe the returns and 

return information at issue are relevant to the terrorist incident, threat or activity. If a federal law 

enforcement or intelligence agency seeks returns or return information, specified officials in the 

Department of Justice may apply for an ex parte court order. If the IRS wishes to apprise a 

federal law enforcement agency of a terrorist incident, threat, or activity, the IRS may apply for 

an ex parte court order and may make disclosures to the Department of Justice as necessary to 

prepare such application on behalf of the IRS. 

Reasons for Change 

This disclosure authority relating to terrorist activities expired on December 31, 2003. The 

Administration believes that extension would help provide continued support for investigations 

and responses relating to terrorism. 

Proposal 

The Administration proposes to extend this authority until December 31, 2004. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

180
EXTEND AUTHORITY TO ISSUE LIBERTY ZONE BONDS 

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. One category of tax-exempt private activity bonds is “exempt facility 

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

The annual volume limits are $75 per resident of the State or $225 million, if greater, and are 

indexed for inflation beginning in 2003. 

Current law authorizes the issuance of $8 billion of qualified New York Liberty Bonds (Liberty 

Bonds). Liberty Bonds are generally treated as exempt facility bonds, but are not subject to the 

general private activity bond volume cap. A Liberty Bond is a bond issued as part of an issue if: 

(1) 95 percent or more of the net proceeds of the issue are to be used for qualified project costs; 

(2) the bond is issued by the State of New York or any political subdivision thereof; (3) the 

Governor of the State of New York or the Mayor of The City of New York designates the bond 

as a Liberty Bond; and (4) the bond is issued after March 9, 2002, and before January 1, 2005. 

Qualified project costs are the cost of acquisition, construction, reconstruction, and renovation of 

certain nonresidential real property, residential rental property and public utility property located 

in a specified area of New York City known as the “New York Liberty Zone.” Qualified project 

costs also include the cost of acquisition, construction, reconstruction, and renovation of certain 

nonresidential real property located outside the New York Liberty Zone but within New York 

City, if the property is part of a project that consists of at least 100,000 square feet of usable 

office or other commercial space located in a single building or multiple adjacent buildings. No 

more than $2 billion of Liberty Bonds may be issued for property located outside the New York 

Liberty Zone. 

Reasons for Change 

Liberty Bonds provide assistance in the rebuilding and recovery of the area of New York City 

damaged or affected by the terrorist attack on September 11, 2001. Extending the authority to 

issue Liberty Bonds will assist in the planning and utilization of Liberty Bonds. 

Proposal 

Authority to issue Liberty Bonds would be extended through calendar year 2009. 

181
Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

0 -8 -27 -45 -62 -79 -221 -616

182
-- -- -- -- -- -- --

EXTEND EXCISE TAX ON COAL AT CURRENT RATES 

Current Law 

An excise tax is imposed on coal at a rate of $1.10 per ton for coal from underground mines and 

$.55 per ton for coal from surface mines. In either case, the tax imposed with respect to a ton of 

coal may not exceed 4.4 percent of the amount for which it is sold by the producer. Receipts 

from the tax are deposited in the Black Lung Disability Trust Fund. Amounts in the Fund are 

used to pay compensation, medical, and survivor benefits to eligible miners and their survivors 

and to cover costs of program administration. Miners and survivors qualify for benefits from the 

Fund only if the miner’s mine employment terminated before 1970 or no mine operator is liable 

for the payment of benefits. The Fund is also permitted to borrow from the general fund any 

amounts necessary to make authorized expenditures if excise tax receipts do not provide 

sufficient funding. 

Reduced rates of tax apply after the earlier of December 31, 2013, or the date on which the Black 

Lung Disability Trust Fund has repaid, with interest, all amounts borrowed from the general fund 

of the Treasury. The reduced rates of tax are $.50 per ton for coal from underground mines and 

$.25 per ton for coal from surface mines. In addition, the maximum tax imposed with respect to 

a ton of coal is reduced from 4.4 percent of the amount for which it is sold by the producer to 2 

percent of that amount. 

Reasons for Change 

To reduce the duration of the general fund subsidy for black lung disability programs, excise tax 

rates on coal should remain at their current levels until all amounts borrowed from the general 

fund of the Treasury have been repaid with interest. 

Proposal 

The proposal would retain the excise tax on coal at the current rates until the date on which the 

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

general fund of the Treasury. After repayment of the Fund’s debt, the reduced rates of $.50 per 

ton for coal from underground mines and $.25 per ton for coal from surface mines would apply 

and the tax per ton of coal would be capped at 2 percent of the amount for which it is sold by the 

producer. The proposal would be effective for coal sales after December 31, 2003. 

Revenue Estimate 

Fiscal Years 

2004 2005 2006 2007 2008 2009 2005-09 2005-14

($'s in millions) 

180 

183
184
EXPAND PROTECTIONS FOR MEMBERS OF THE ARMED FORCES 

Current Law 

Under section 7508 of the Code, when a member of the Armed Forces is serving in a designated 

combat zone, the period spent in the combat zone, plus 180 days, is ignored in determining the 

timeliness of a variety of actions taken by either the IRS or the servicemember with respect to a 

federal tax liability. (Special rules apply to servicemembers who are hospitalized as a result of 

an injury sustained while serving in a combat zone.) Interest and penalties do not accrue during 

this period. Although the IRS is permitted to pursue certain assessment and collection actions 

during this time, the IRS suspends all assessment and collection actions against a member of the 

Armed Forces serving in a designated combat zone. Section 510 of the Servicemembers Civil 

Relief Act provides that if a servicemember’s ability to pay a federal or state income tax liability 

arising before or during military service is materially affected by military service (whether or not 

in a combat zone), collection action with respect to the tax liability is deferred for the period of 

military service and up to 180 days after the servicemember’s termination or release from 

military service. (The statute of limitation for the collection of tax affected by the deferral also is 

extended.) The deferral does not apply to certain Social Security taxes. No interest or penalties 

accrue on the unpaid income tax liability during the period of deferment. 

Reasons for Change 

Armed Forces reservists and National Guardsmen called to active duty often experience 

significant decreases in income and disruptions to their businesses. These disruptions increase 

the longer that these servicemembers remain on active duty. Current law provides these 

servicemembers additional time to address tax liabilities, including liabilities resulting from the 

disruption of being called to active duty, if the servicemember is in a designated combat zone or 

if the servicemember can demonstrate that his or her ability to pay an outstanding tax liability 

has been materially affected by military service. Even outside these situations, Armed Forces 

reservists and National Guardsmen called to active duty still experience significant personal and 

financial disruption and, in addition, may not be able to respond fully to tax assessment or 

collection actions. Extending existing protections will improve the morale and effectiveness of 

our Armed Forces while providing the IRS, state taxing authorities and servicemembers 

sufficient time to address outstanding tax liabilities. 

Proposal 

The Administration’s proposal would extend the protections of section 7508 to all Armed Forces 

reservists and National Guardsmen called to active duty. Thus, the changes would result in the 

suspension of IRS assessment and collection action against Armed Forces reservists and National 

Guardsmen on active duty and would extend the time that these individuals would have to 

comply with their tax obligations, such as the filing of returns. While these individuals are on 

active duty, interest and penalties would not accrue on any federal tax liability owed. In 

addition, the proposal would extend the protections in Section 510 of the Servicemembers Civil 

Relief Act to suspend the assessment and collection of any state income tax liability for all 

servicemembers (including Armed Forces reservists and National Guardsmen) serving in a 

185
designated combat zone and for all other Armed Forces reservists and National Guardsmen 

called to active duty. 

The proposal would be effective upon enactment. 

186
RESPOND TO FOREIGN SALES CORPORATION/EXTRATERRITORIAL INCOME 

DECISIONS 

Current Law 

The extraterritorial income exclusion (ETI) provisions provide a partial exemption from tax for 

income from certain foreign sales and leasing transactions. The ETI provisions were enacted in 

2000 to replace the foreign sales corporation (FSC) provisions of prior law. In January 2002, the 

WTO Dispute Settlement Body adopted a final report finding that the ETI provisions, like the 

prior-law FSC provisions, provide an illegal export subsidy and thus are inconsistent with WTO 

rules. The WTO has authorized the imposition of trade sanctions against U.S. exports up to the 

level of $4 billion per year, which may be imposed at any time as long as the ETI provisions 

remain in the law. In December 2003, the EU Council of Foreign Affairs Ministers adopted a 

proposal providing for sanctions against U.S. exports to be phased in beginning in March 2004 if 

the United States has not come into compliance with the WTO decision by repealing the ETI 

provisions. 

Reasons for Change 

The ETI provisions must be repealed to comply with the WTO rulings regarding the FSC and 

ETI provisions. The ETI provisions should be replaced with tax law changes that preserve and 

enhance the global competitiveness of U.S.-based businesses and American workers. The 

Administration intends to work with the Congress on prompt enactment of legislation that 

satisfies the twin goals of honoring our WTO obligations and making changes to our tax law to 

promote the competitiveness of American manufacturers and other job creating sectors of the 

U.S. economy. 

Changes to the tax law should reflect today’s highly-competitive, highly-globalized, knowledgedriven economy. To ensure the ability of U.S. workers to achieve higher living standards, the 

tax laws should help, not hinder, the U.S. businesses that employ those workers to compete in 

markets around the world. The key to rising standards of living is focusing on the fundamentals 

for growth domestically and abroad. 

Proposal 

The ETI provisions would be repealed and replaced with changes to our tax law that increase the 

competitiveness of American manufacturers and other job creating sectors of the U.S. economy. 

There are a number of changes to the tax laws that would improve the competitiveness of these 

vital contributors to the U.S. economy. Described below are some of the alternatives deserving 

consideration. 

Among the proposals included in the Administration’s FY 2005 budget are permanent extensions 

of both the R&E tax credit and increased expensing for small businesses as well as extension 

through 2005 of the waiver on the use of NOLs under the AMT. Extension of these provisions 

will provide certainty to job creating businesses and encourage investment and growth. In 

addition to extension, modifications to these provisions should be considered. The R&E tax 

187 
credit rules could be reformed and improved to make the credit easier for taxpayers to apply and 

easier for the IRS to administer. Giving taxpayers greater certainty regarding the availability of 

the credit would enhance its incentive effect and encourage more taxpayers to perform research 

in the United States. The NOL carryback period could be extended as well. Such a change 

would measure more accurately net income by providing appropriate tax relief for losses and 

increase the cash flow of taxpayers that incur losses by allowing a refund of taxes previously 

paid. 

More broadly, a corporate income tax rate reduction would provide significant tax relief to 

American businesses and increase the attractiveness of the United States as a place to invest. A 

corporate rate cut would help to reduce the current tax burden on income from investment in 

corporate shares relative to income from other investments such as partnerships and bonds. 

Alternative minimum tax reform would encourage greater business investment, reduce 

paperwork burdens, and provide relief for cyclical businesses, such as manufacturers. One 

potential AMT reform would be to conform depreciation methods under the AMT to the 

depreciation methods used for regular tax purposes. This would eliminate the AMT disincentive 

for new investment by allowing the regular tax depreciation allowances under AMT. This 

reform would benefit capital intensive businesses, encouraging them to continue to invest and 

grow. Another possible AMT reform would be repeal of the limitation on the use of foreign tax 

credits. The current-law limitation is inconsistent with the principle that foreign income should 

not be subject to double tax. Likewise, increasing and indexing the AMT exemption for small 

businesses would significantly reduce the number of small and medium sized businesses subject 

to the burdens of the AMT. Eliminating the AMT limitation on the use of NOLs would provide 

simplification and cash-flow benefits to taxpayers experiencing economic distress. 

The depreciation rules could be re-examined, with particular consideration given to a shorter 

recovery period for nonresidential buildings. This would reduce the tax cost of such 

investments, including investments by manufacturing businesses, thereby stimulating aggregate 

investment and improving the neutrality of the tax system by reducing the tax bias that favors 

investment in equipment over structures. A shorter recovery period also would reduce the 

controversies that arise from the treatment of improvements and components. 

Business tax rules could be simplified. The challenge for businesses trying to comply with the 

law - or the IRS trying to administer and enforce it - is enormous. In particular, small and 

medium-sized businesses often find this complexity to be nearly overwhelming. For example, 

the uniform capitalization rules are extremely complex and impose a significant compliance 

burden on small companies. Increasing the number of small businesses exempt from these rules 

would provide meaningful simplification. Another area of needed simplification, especially for 

small businesses, is the method for calculating tax on income received from long-term contracts. 

The international tax rules are especially in need of simplification and rationalization. Relative 

to the tax systems of the United States’ major trading partners, the U.S. international tax rules 

can impose significantly heavier burdens on domestically based companies, thereby hindering 

the ability of U.S. businesses to compete in today’s global marketplace. The U.S. international 

tax rules are unique in their breadth and complexity. The complexity represents a significant 

188 
burden. One example is the interest expense allocation rules for foreign tax credit purposes. By 

understating foreign income and reducing the foreign tax credit limitation, these rules can deny 

U.S.-based companies the full ability to credit foreign taxes paid against U.S. tax liability, 

resulting in the double taxation that the foreign tax credit rules are intended to eliminate and 

reducing the competitiveness of the U.S. company relative to companies organized in other 

jurisdictions. 

The Administration looks forward to working closely with the Congress on prompt enactment of 

legislation that brings our tax law into compliance with WTO rules with changes that will 

enhance the competitiveness of American businesses and the workers they employ. 

189
190
--- --- --- --- ---

--- --- --- --- --- ---

--- --- --- ---

--- --- --- ---

------ --- --- ---

---

--- --- --- --- --- --- --- ---

--- --- --- --- --- --- ---

--- --- --- --- --- --- --- ---

---

---

--- --- --- --- --- --- --- ---

--- --- --- --- --- --- ---

---

---

---

------

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---

------

---

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---

---

---

2005-14 

-60,985 

-18,108 

-27,343 

-106,436 

-81,280 

-49,970 

-24,798 

-395,269 

-101,689 

-38,102 

-6,758 

-180,111 

-1,804 

-3,531 

-883,312 

-989,748 

5,558 

-11,763 

-1,380 

-7,585 

-70,055 

-24,775 

-21,428 

-3,759 

-2 

-120,017 

-12,036 

-3,498 

-1 

No revenue effect 

-1,224 

2005-09 

-53,846 

-18,108 

-23,413 

-95,367 

-15,161 

-12,634 

-16,128 

-110 

-8,562 

-52,595 

-147,962 

21,112 

-1,607 

-1,301 

18,204 

-26,390 

-8,744 

-5,369 

-1,742 

-42,245 

-5,779 

-1,777 

-447 

2014 

-22,158 

-9,425 

-1,056 

-110,948 

-32,250 

-10,154 

-2,016 

-53,835 

-503 

-1,122 

-243,467 

-243,467 

-4,704 

-2,997 

3 

-7,698 

-9,075 

-3,668 

-3,807 

-379 

-16,929 

-1,307 

-353 

-187 

2013 

-21,009 

-9,023 

-1,295 

-109,163 

-32,103 

-10,752 

-1,896 

-49,642 

-487 

-1,112 

-236,482 

-236,482 

-4,259 

-2,684 

3 

-6,940 

-9,045 

-3,431 

-3,574 

-392 

-16,442 

-1,248 

-354 

-169 

-11,472 

2012 

-15,741 

-7,789 

-1,614 

-106,215 

-32,003 

-1,782 

-46,482 

-468 

-1,098 

-224,664 

-224,664 

-3,806 

-2,478 

3 

-6,281 

-8,889 

-3,209 

-3,152 

-410 

-15,660 

-1,251 

-358 

-154 

2011 

-913 

-913 

-68,943 

-5,724 

-19,498 

-346 

-260 

-116,253 

-117,166 

-2,050 

3 

-3,638 

-337 

-140 

-6,959 

-6,193 

-2,093 

-5,334 

-903 

-1,591 

-8,609 

-2,994 

-2,878 

-422 

-14,903 

-1,245 

2010 

-3,017 

-10,156 

-2,612 

1 

-2,092 

61 

-9,851 

-735 

-1,232 

-2,648 

-319 

-127 

-7,139 

-252 

-4,906 

-51 

-20,007 

-406 

-91 

-8,047 

-2,729 

-414 

-13,838 

-1,206 

2009 

-423 

-2,956 

-15,640 

-3,205 

-2,244 

-30,124 

-45,764 

685 

-380 

-255 

50 

-2,501 

-2,435 

-329 

-116 

-12,261 

-17,272 

-7,366 

-37 

-7,765 

-415 

-13,116 

-1,173 

Revenue Estimates */ 

FY 2005 Budget Proposals Affecting Receipts 

(in millions of dollars) 

2008 

-1,850 

-4,036 

-18,956 

642 

-4,102 

-1,977 

-10,729 

-29,685 

2,798 

-358 

-300 

2,140 

-7,242 

-2,292 

-1,572 

-330 

-106 

-13,070 

-5,268 

-24 

-398 

-11,504 

-1,144 

-30,452 

-6,100 

2007 

-805 

-327 

-13,154 

-3,883 

-6,435 

-23,472 

485 

-5,711 

-22 

-1,732 

-6,980 

5,488 

-337 

-326 

4,825 

-2,014 

-398 

-9,317 

-1,111 

-96 

2006 

-13,195 

-6,634 

-5,981 

-25,810 

486 

-3,336 

-1,609 

-4,475 

-30,285 

8,192 

-318 

-286 

7,588 

-5,177 

-1,764 

-489 

-460 

-341 

-16 

-87 

-7,890 

-1,103 

226 

-11,776 

-106 

-173 

-68 

2005 

-450 

-2,166 

-5,318 

-4,005 

-11,489 

498 

-11 

-1,000 

-287 

3,949 

-214 

-134 

3,601 

-71 

-418 

-1,248 

-42 

2004 

-68 

Marriage penalty relief............................................................... Expensing for small business.................................................... Marriage penalty relief 3/........................................................... 

tax cut and the 2003 jobs and growth tax cut.................... 

insurance 4/........................................................................... 

10-percent individual income tax rate bracket........................... Provide charitable contribution deduction for nonitemizers....... 

transfer taxes, and modification of gift taxes......................... 

Total simplify and encourage saving................................. 

insurance premiums ............................................................. insurance premiums ............................................................. 

expenses............................................................................... contributions.......................................................................... 

Child tax credit 1/......................................................................Consolidate employer-based savings accounts........................ 

. 

Dividends tax rate structure....................................................... 

Capital gains tax rate structure.................................................. Child tax credit 2/....................................................................... Education incentives.................................................................. 

givers of family members....................................................... 

Total invest in health care.................................................. 

Modifications of pension plans.................................................. 

for contributions of food inventory......................................... 

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

2003 jobs and growth tax cut............................................ 

2001 and 2003.......................................................... 

Marginal individual income tax rate reductions......................... Other incentives for families and children................................. 

Establish Individual Development Accounts (IDAs).................. 

Allow the orphan drug tax credit for certain pre-designation 

Total permanently extend certain provisions of the 2001 

Make Permanent The Tax Cuts Enacted in 2001 and 2003: 

Extend through 2010 certain provisions of the 2003 jobs 

and growth tax cut: 

Provide an above-the-line deduction for high deductible Provide an additional personal exemption to home careExpand and increase the enhanced charitable deduction 

Invest in health care: 

Provide refundable tax credit for the purchase of health Provide an above-the-line deduction for long-term care 

Permanently extend certain provisions of the 2001 tax 

cut and the 2003 jobs and growth tax cut: 

Total extend through 2010 certain provisions of the 

Total make permanent the tax cuts enacted in 

Repeal of estate and generation-skipping Permit tax-free withdrawals from IRAs for charitable 

Provide incentives for charitable giving: 

Clarify the Health Coverage Tax Credit 

Simplify and encourage saving: 

Tax Incentives: 

191
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2005-14 

-1,009 

-68 

-239 

-18,467 

-2,611 

-16,409 

-1,858 

-2,150 

-2,175 

-1,767 

-2,211 

-7,186 

-175,093 

-475 

-411 

-2,555 

No revenue effect 

1,722 

2005-09 

-476 

-31 

-88 

-49 

-66 

-8,713 

-1,241 

-218 

-2,543 

-1,028 

-292 

-1,320 

-1,460 

-73 

-825 

-1,776 

-413 

-400 

-1,749 

-100 

-6,796 

-44,872 

-275 

-168 

-1,270 

736 

2014 

-119 

-8 

-36 

-8 

-60 

-2,078 

-282 

-117 

-3,248 

-156 

-156 

-137 

-202 

-179 

196 

-30 

-352 

-30,860 

-45 

-52 

-237 

205 

507 

2013 

-112 

-8 

-34 

-8 

-54 

-1,987 

-278 

-103 

-3,154 

-161 

-161 

-148 

-195 

-121 

5 

-28 

20 

-29,045 

-39 

-50 

-250 

201 

540 

2012 

-106 

-7 

-30 

-9 

-47 

-1,962 

-274 

-89 

-2,947 

-166 

-166 

-146 

-188 

-77 

-56 

10 

-27 

56 

-27,323 

-37 

-49 

-261 

198 

2011 

-100 

-7 

-27 

-10 

-270 

-76 

-171 

-143 

-182 

15 

512 

193 

-40 

-1,906 

-2,545 

-171 

-43 

-138 

-26 

-5 

-23,514 

-39 

-47 

-264 

2010 

-96 

-7 

-24 

-10 

-266 

-65 

-176 

-141 

-175 

-15 

21 

355 

-109 

189 

-32 

-1,821 

-1,972 

-176 

-130 

-24 

-19,479 

-40 

-45 

-273 

2009 

-90 

-6 

-21 

-10 

-1,770 

-263 

-55 

-1,352 

-181 

-139 

-169 

-542 

-117 

100 

-913 

-46 

187 

-25 

-181 

-10 

-13 

-23 

-17,600 

-43 

-281 

185 

2008 

-86 

-6 

-18 

-10 

-1,718 

-260 

-48 

-776 

-191 

-278 

-23 

-162 

-556 

-104 

-227 

-1,434 

-18 -58 

-56 

-249 

-62 

-22 

-13,849 

-42 

-285 

-84 

-11 

-327 

-201 

-305 

-376 

-532 

183 

2007 

-6 

-15 

-12 

-1,662 

-249 

-43 

-101 

-302 

-17 

-154 

-91 

-64 

-21 

-1,560 

-8,635 

-65 

-40 

-284 

181 

2006 

-83 

-5 

-13 

-10 

-1,648 

-240 

-45 

-81 

-212 

-300 

-337 

-11 

-147 

-223 

-67 

-107 

-615 

-1,527 

-70 

-297 

-6 

-88 -20 

-4,143 

-39 

-133 

-8 

-7 

-243 

-401 

-79 

2005 

-475 

-8 

-21 

-5 

-1,915 

-229 

-27 

-45 

-288 

-12 

-193 

-34 

-154 

-14 

-1,362 

-645 

-38 

-4 

-123 

2004 

-68 

-23 

-178 

-178 

-11 

-11 

-280 

foundations............................................................................ charitable remainder trusts ................................................... contributing appreciated property ......................................... housing.................................................................................. from certain sources.............................................................. operatives.............................................................................. 

Provide tax credit for combined heat and power property......... 

tax credit 6/................................................................................ 

Establish uniform definition of a qualifying child 5/........................ 

501(c)(3) bonds..................................................................... costs...................................................................................... cell vehicles........................................................................... transmission property............................................................ 

energy conservation...................................................... 

for qualified out-of-pocket classroom expenses.................... 

Provide tax credit for residential solar energy systems............. 

Total protect the environment............................................ 

Total tax incentives.................................................... 

Simplify adoption tax benefits........................................................ 

filing status................................................................................. 

501(c)(3) bonds for residential rental property...................... computers, software and peripherals.................................... conservation purposes ......................................................... 

Modify treatment of nuclear decommissioning funds................ Provide tax credit for energy produced from landfill gas........... 

Total provide incentives for charitable giving.................... 

Extend excise tax exemption (credit) for ethanol ..................... Permit electric utilities to defer gain from sales of electric 

Increase housing opportunities: 

Provide tax credit for developers of affordable single-family 

Strengthen education: 

Extend, increase and expand the above-the-line deduction 

Protect the environment: 

Eliminate household maintenance test for head of household 

Reform excise tax based on investment income of private Permanently extend expensing of brownfields remediation Exclude 50 percent of gains from the sale of property for Extend and modify the tax credit for producing electricity Provide tax credit for purchase of certain hybrid and fuel 

Encourage telecommuting: 

Modify tax on unrelated business taxable income of Exclude from income the value of employer-provided Modify tax treatment of certain income of electric coTotal increase energy production and promote Modify basis adjustment to stock of S corporations 

Increase energy production and promote energ

Reduce computational complexity of refundable child 

y 

Repeal the $150 million limitation on qualified Repeal certain restrictions on the use of qualified 

Simplify the Tax Laws for Families: 

conservation: 

-94 

-299 

-668 

-292 

-73 

-737 

-349 

361 

-235 

192
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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2005-09 2005-14 

Simplify EITC eligibility requirements regarding filing status, 

presence of children, investment income, and work and immigrant status 7/.................................................................... 504 -167 -165 -151 -167 -157 -175 -154 -152 -131 -146 -915 

Simplify the taxation of dependents.............................................. -11 -25 -20 -25 -43 -48 -59 -82 -89 -96 -124 -498 

Consolidate rules for lifetime learning credit, Hope credit and 

education expense deductions, and simplify other higher education provisions.................................................................. -19 -94 -311 -294 -282 -279 -289 -344 -326 -320 -1,000 -2,558 

Allow annual reporting and payment of combined State and 

Federal unemployment insurance taxes by employers of household employees........................................................... -20 -1 -1 -1 -1 -1 -2 -1 -1 -1 -24 -30 

Simplify taxation of capital gains on collectibles, small 

business stock and other assets............................................... -4 5 11 -1 -17 -13 -10 -7 -1 2 -6 -35 

Total simplify the tax laws for families................................... 285 -507 -692 -670 -693 -667 -692 -737 -707 -675 -2,277 -5,755 

Strengthen the Employer Based Pension System: 

Ensure fair treatment of older workers in cash balance 

conversions and protect defined benefit plans.......................... 339 512 510 507 505 2,373 

Improve the accuracy of pension liability measures...................... 8,537 12,297 7,340 3,042 -1,586 -5,467 -7,322 -6,569 -5,781 -5,833 -5,990 15,626 -15,869 

Total strengthen the employer based pension system.......... 8,537 12,297 7,340 3,042 -1,586 -5,467 -6,983 -6,057 -5,271 -5,326 -5,485 15,626 -13,496 

Close Loopholes and Improve Tax Compliance: 

Combat abusive tax avoidance transactions................................. 46 63 85 113 128 130 128 127 126 125 435 1,071 Limit related party interest deductions........................................... -51 93 146 203 265 333 407 486 571 663 656 3,116 

Modify qualification rules for tax-exempt property casualty 

insurance companies................................................................. 67 114 116 119 121 124 127 129 132 135 537 1,184 

Increase penalties for false or fraudulent statements made 

to promote abusive tax shelters..................................... Included in combat abusive tax avoidance transactions 

Prevent abusive overvaluations on donations of patents and 

other intellectual property.......................................................... 432 270 273 277 287 302 317 333 349 367 1,539 3,207 

Prevent overvaluations and other abuses in charitable 

donations of used vehicles........................................................ 158 102 105 108 112 115 119 122 126 130 585 1,197 

Reform the tax treatment for leasing transactions with 

tax-indifferent parties.................................................... 340 1,591 2,712 3,285 3,565 3,766 3,833 3,799 3,683 3,581 3,570 14,919 33,385 

Ensure foreign subsidiaries of U.S. companies cannot 

inappropriately avoid U.S. tax on foreign earnings invested in U.S. property through use of the exception for bank deposits..................................................................................... 24 21 22 22 23 23 24 24 25 26 112 234 

Modify tax rules for individuals who give up U.S. citizenship 

or green card status................................................................... 1 23 20 22 24 25 27 29 32 34 36 114 272 

Expand tax shelter exception for federal practitioner 

privilege.................................................................... Included in combat abusive tax avoidance transactions 

Extend the statute of limitations for reportable transactions 

where a taxpayer fails to disclose on return as required..... Included in combat abusive tax avoidance transactions 

Require increased reporting for noncash charitable 

contributions.............................................................................. 49 31 32 33 34 35 36 38 39 40 179 367 

Clarify the consequences of changing the beneficiary of a 

qualified tuition program............................................................ 7 12 13 13 17 23 12 30 33 34 62 194 

Total close loopholes and improve tax compliance............... 341 2,346 3,438 4,099 4,477 4,778 4,945 4,998 5,004 5,016 5,126 19,138 44,227 

Tax Administration, Unemployment Insurance and Other: 

Improve tax administration: 

Implement IRS administrative reforms......................................... 52 47 46 47 49 50 51 53 54 56 241 505 

No revenue effect Initiate IRS cost saving measures 

193
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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2005-09 2005-14 

Repeal section 132 of the Revenue Act of 1978 and amend 

the tax code to authorize the Secretary of the Treasury to issue rules to address inappropriate nonqualified deferred compensation arrangements............................. No revenue effect 

Permit private collection agencies to engage in specific, 

limited activities to support IRS collection efforts..................... 47 151 190 153 166 181 197 214 232 541 1,531 

Increase continuous levy for certain Federal payments 10 18 19 20 20 21 22 23 24 25 87 202 

Total improve tax administration........................................ 62 112 216 257 222 237 254 273 292 313 869 2,238 

Strengthen financial integrity of unemployment 

insurance: 

Strengthen the financial integrity of the unemployment 

insurance system by reducing tax avoidance and improper benefit payments 8/................................................ -2 108 142 120 101 -790 335 101 -331 368 -216 

Other proposals: 

Increase Indian gaming activity fees 9/..................................... 4 4 5 5 5 5 5 5 5 18 43 

Total other proposals............................................................. 4 4 5 5 5 5 5 5 5 18 43 

Total tax administration, unemployment insurance 

and other....................................................................... 62 114 328 404 347 343 -531 613 398 -13 1,255 2,065 

Reauthorize Funding for the Highway Trust Fund: 

Deposit full amount of excise tax imposed on gasohol in the 

Highway Trust Fund 8/.............................................................. 648 666 681 699 716 732 750 766 785 2,694 6,443 

Impose additional registration requirements on the 

transfer of tax-exempt fuel by pipeline, vessel, or barge 8/................................................................................. 76 93 96 91 87 80 71 62 52 39 443 747 

Repeal installment method for payment of heavy highway 

vehicle use tax 8/....................................................................... 407 30 31 32 31 32 34 36 38 38 39 156 341 

Allow tax-exempt financing for private highway projects and 

rail-truck transfer facilities.......................................................... -20 -49 -77 -94 -97 -100 -94 -61 -21 -6 -337 -619 

Total reauthorize funding for the highway trust fund............. 407 86 723 717 709 721 730 745 789 835 857 2,956 6,912 

Expiring Provisions: 

Extend minimum tax relief for individuals..................................... -86 -9,383 -13,881 -23,264 -23,264 Permanently extend research & experimentation (R&E) ............. 

tax credit -672 -3,610 -5,187 -6,291 -7,129 -7,775 -8,347 -8,961 -9,619 -10,330 -11,102 -29,992 -78,351 

Repeal the disallowance of certain deductions 

of mutual life insurance companies.......................................... -85 -51 -48 -45 -43 -42 -41 -39 -38 -39 -272 -471 

Permanently extend and expand disclosure of tax return 

information for administration of student loans.................. No revenue effect 

Extend and modify work opportunity tax credit and 

welfare-to-work tax credit............................................... -12 -187 -268 -162 -86 -46 -16 -3 -749 -768 

Extend the District of Columbia enterprise zone.................... -46 -79 -37 -7 -9 -24 -42 -40 -33 -30 -27 -156 -328 

Extend the first-time homebuyer credit for the District of 

Columbia...................................................................... -1 -18 -17 -35 -35 

Extend authority to issue Qualified Zone Academy Bonds.......... -2 -9 -15 -22 -28 -30 -30 -30 -30 -30 -30 -104 -254 

Extend deduction for corporate donations of computer 

technology.................................................................... -180 -46 -226 -226 

Extend allowance of net operating loss offset of 100 percent 

of alternative minimum taxable income.................................... -1,326 -755 -101 203 154 129 111 100 89 80 72 -370 82 

Permanently extend IRS user fees............................................... 32 44 45 46 47 48 49 50 51 52 214 464 

Extend provisions permitting IRS to disclose return 

information relating to terrorist activity...................................... No revenue effect 

194
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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2005-09 2005-14 

Extend provision permitting disclosure of information relating 

to terrorist activities upon request of federal law enforcement or intelligence agency No revenue effect 

Extend abandoned mine reclamation fees 9/............................... 239 245 252 256 262 252 257 260 262 265 1,254 2,550 Extend authority to issue Liberty Zone Bonds.............................. -8 -27 -45 -62 -79 -88 -84 -79 -74 -70 -221 -616 

Extend excise tax on coal at current rates 8/............................... 180 180 

Total extend other expiring provisions .............................. -2,145 -14,043 -19,341 -6,075 -6,903 -7,559 -8,154 -8,753 -9,401 -10,109 -10,699 -53,921 -101,037 

Promote Trade: 

Implement free trade agreements with Morocco, 

Australia and Central American countries 8/ 9/..................... -389 -583 -675 -749 -831 -897 -967 -1,009 -1,073 -1,132 -3,227 -8,305 

Total budget proposals............................................................... 6,860 -11,777 -43,244 -38,343 -47,852 -72,068 -50,169 -151,937 -261,999 -276,493 -286,348 -213,284 -1,240,230 

*/ Estimates for several provisions differ from estimates included in Table 16-3 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. 

1/ Affects both receipts and outlays. The outlay effect is $4,265 million for 2006, $4,131 million for 2007, $4,003 million for 2008, $3,936 million for 2009 

$4,568 million for 2010, $16,335 million for 2005-2009 and $18,906 million for 2005-2014. 

2/ Affects both receipts and outlays. The outlay effect is $9,887 million for 2012, $9,599 million for 2013, $9,417 million for 2014 and $28,903 million for 2005-2014. 3/ Affects both receipts and outlays. The outlay effect is -$320 million for 2011, $2,006 million for 2012, $1,997 million for 2013, $1,993 for 2014 and $5,676 million for 2005-2014. 4/ Affects both receipts and outlays. The outlay effect is $82 million for 2005, $3,760 million for 2006, $5,041 million for 2007, $6,388 million for 2008, $7,133 million for 2009, 

$7,814 million for 2010, $8,401million for 2011, $8,698 million for 2012, $8,920 million for 2013, $9,091 million for 2014, $22,404 million for 2005-2009 and $65,355 million for 2005-2014. 

5/ Affects both receipts and outlays. The outlay effect is $36 million for 2006, $36 million for 2007, $36 million for 2008, $37 million for 2009, $37 million for 2010, $37 million for 2011, 

$38 million for 2012, $38 million for 2013, $38 million for 2014, $145 million for 2005-2009 and $333 million for 2005-2014. 

6/ Affects both receipts and outlays. The outlay effect is -$181million for 2006, -$183 million for 2007, -$185 million for 2008, -$187 million for 2009, -$189 million for 2010, 

-$191 million for 2011, -$193 million for 2012, -$195 million for 2013, -$197 million for 2014, -$736 million for 2005-2009 and -$1,701million for 2005-2014. 

7/ Affects both receipts and outlays. The outlay effect is -$440 million for 2005, $131 million for 2006, $130 million for 2007, $119 million for 2008, $134 million for 2009, $123 million for 2010, 

$140 million for 2011, $112 million for 2012, $107 million for 2013, $87 for 2014, $74 million for 2005-2009 and $643 million for 2005-2014. 

8/ Net of income offsets. 9/ The proposal affects receipts and is included in the FY 2005 Budget, but is not described in these General Explanations. 

195