I 

110TH CONGRESS 

1ST SESSION H. R. 4912 

To amend the Internal Revenue Code of 1986 with respect to the treatment 

of prepaid derivative contracts. 

IN THE HOUSE OF REPRESENTATIVES 

DECEMBER 19, 2007 

Mr. NEAL of Massachusetts introduced the following bill; which was referred 

to the Committee on Ways and Means 

A BILL 

To amend the Internal Revenue Code of 1986 with respect 

to the treatment of prepaid derivative contracts. 

1 Be it enacted by the Senate and House of Representa2 tives of the United States of America in Congress assembled, 

3 SECTION 1. TREATMENT OF PREPAID DERIVATIVE CON4 TRACTS. 

5 (a) IN GENERAL.—Part V of subchapter P of chapter 

6 1 of the Internal Revenue Code of 1986 (relating to spe7 cial rules for bonds and other debt instruments) is amend8 ed by adding at the end the following new subpart: 

9 ‘‘Subpart E—Prepaid Derivative Contracts 

‘‘Sec. 1289. Treatment of prepaid derivative contracts. 

‘‘Sec. 1289A. Definitions. 


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1 ‘‘SEC. 1289. TREATMENT OF PREPAID DERIVATIVE CON2 TRACTS. 

3 ‘‘(a) CURRENT INCLUSION IN INCOME.—For pur4 poses of this title, there shall be included in the gross in5 come of the holder of a prepaid derivative contract an 

6 amount equal to the holder’s interest accrual amount with 

7 respect to such contract for the taxable year. Any amount 

8 included in gross income under the preceding sentence 

9 shall be treated as interest. 

10 ‘‘(b) BASIS ADJUSTMENTS.—If any interest accrual 

11 amount is included in the gross income of the holder of 

12 a prepaid derivative contract under subsection (a), such 

13 holder’s basis in such contract shall be increased by the 

14 amount so included. 

15 ‘‘(c) LOSS TREATED AS ORDINARY TO EXTENT OF

16 BASIS INCREASES.—In the case of any loss recognized on 

17 the disposition of any prepaid derivative contract, so much 

18 of such loss as does not exceed the aggregate increases 

19 in the basis of such contract under subsection (b) shall 

20 be treated as an ordinary loss. 

21 ‘‘(d) TREATMENT OF DISTRIBUTIONS.—In the case 

22 of any distribution under a prepaid derivative contract— 

23 ‘‘(1) except as provided in paragraph (3), such 

24 distribution shall not be includible in gross income, 


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1 ‘‘(2) the adjusted basis of such contract shall be 

2 reduced (but not below zero) by the amount of such 

3 distribution, and 

4 ‘‘(3) the excess (if any) of such distribution 

5 over such adjusted basis (determined before any re6 duction under paragraph (2)) shall be treated as 

7 gain from the sale of such contract. 

8 For purposes of this subsection, adjusted basis shall be 

9 determined after any adjustment to such basis under sub10 section (b) for the taxable year. 

11 ‘‘(e) INTEREST ACCRUAL AMOUNT.— 

12 ‘‘(1) IN GENERAL.—For purposes of this sec13 tion, the interest accrual amount with respect to any 

14 prepaid derivative contract for any taxable year is 

15 the product of— 

16 ‘‘(A) the holder’s adjusted basis in such 

17 contract as of the beginning of such taxable 

18 year, multiplied by 

19 ‘‘(B) the greater of— 

20 ‘‘(i) the monthly Federal short-term 

21 rate determined under section 1274(d) for 

22 the first month ending during such taxable 

23 year, or 


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1 ‘‘(ii) in the case of a contract under 

2 which notional amounts are credited, the 

3 rate at which such amounts are credited. 

4 ‘‘(2) PRORATION OF INTEREST ACCRUAL

5 AMOUNT.—In the case of a taxpayer who acquires or 

6 disposes of any prepaid derivative contract during 

7 the taxable year, the interest accrual amount deter8 mined under paragraph (1) with respect to such con9 tract for such year shall be an amount which bears 

10 the same ratio to— 

11 ‘‘(A) the amount which would be so deter12 mined without regard to this subparagraph, as 

13 ‘‘(B) the portion of such taxable year dur14 ing which such contract was held by such tax15 payer bears to the entire taxable year. 

16 ‘‘(3) ADJUSTED BASIS DETERMINED AT ACQUI17 SITION.—In the case of the acquisition of any pre18 paid derivative contract during the taxable year, 

19 paragraph (1) shall be applied by substituting ‘the 

20 acquisition of such contract’ for ‘the beginning of 

21 such taxable year’. 

22 ‘‘(f) SPECIAL RULES FOR PUBLICLY TRADED PRE23 PAID DERIVATIVE CONTRACTS.— 

24 ‘‘(1) LIMITATION ON INCLUSION.—The amount 

25 includible under subsection (a) with respect to the 


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1 holder of any publicly traded prepaid derivative con2 tract for any taxable year shall not exceed the excess 

3 (if any) of— 

4 ‘‘(A) the sum of— 

5 ‘‘(i) the fair market value of such con6 tract as of the close of such taxable year 

7 (or, in the case of the disposition of such 

8 contract during the taxable year, as of 

9 such disposition), plus 

10 ‘‘(ii) any distributions to the holder 

11 under such contract during such taxable 

12 year, over 

13 ‘‘(B) the holder’s adjusted basis in such 

14 contract as of the close of the preceding taxable 

15 year (or, in the case of the acquisition of the 

16 contract during the taxable year, as of such ac17 quisition). 

18 ‘‘(2) EXCESS CARRIED FORWARD.—If the inter19 est accrual amount with respect to any publicly trad20 ed prepaid derivative contract for any taxable year 

21 exceeds the limitation determined under paragraph 

22 (1) with respect to the holder of such contract for 

23 such year, the interest accrual amount of such hold24 er with respect to such contract for the succeeding 

25 taxable year shall be increased by such excess. 


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1 ‘‘(3) INTEREST ACCRUAL AMOUNT IN SUC2 CEEDING YEARS UNAFFECTED BY LIMITATION.— 

3 Solely for purposes of subsection (e)(1), the adjusted 

4 basis in a publicly traded prepaid derivative contract 

5 shall be determined without regard to paragraph (1). 

6 ‘‘(g) EXCEPTION FOR SHORT HOLDING PERIODS

7 AND INSTRUMENTS MARKED TO MARKET.—This section 

8 shall not apply to any prepaid derivative contract for any 

9 taxable year if such contract— 

10 ‘‘(1) has been held for less than 1 year and is 

11 disposed of in the taxable year in which acquired or 

12 on or before the due date for the return of income 

13 tax for such taxable year (without regard to any ex14 tension of time for filing such return), or 

15 ‘‘(2) is marked to market with respect to the 

16 taxpayer for such taxable year under section 475 or 

17 1256 or any other provision of this title. 

18 ‘‘(h) REGULATIONS.—The Secretary shall issue such 

19 regulations as are necessary or appropriate to carry out 

20 the purposes of this section, including regulations to pre21 vent the avoidance of the purposes of this section. 

22 ‘‘SEC. 1290. DEFINITIONS. 

23 ‘‘For purposes of this subpart— 

24 ‘‘(1) PREPAID DERIVATIVE CONTRACT.— 


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1 ‘‘(A) IN GENERAL.—The term ‘prepaid de2 rivative contract’ means any prepaid contract 

3 with a term of longer than 1 year from the date 

4 of issue which is a derivative financial instru5 ment with respect to— 

6 ‘‘(i) any security (as defined in section 

7 475(c)(2), determined without regard to 

8 subparagraph (F) and the last sentence 

9 thereof) or group of securities (as so de10 fined), 

11 ‘‘(ii) any commodity (as defined in 

12 section 475(e)(2), determined without re13 gard to subparagraph (D) thereof) or 

14 group of commodities (as so defined), or 

15 ‘‘(iii) any financial index. 

16 ‘‘(B) EXCEPTIONS.—Such term shall not 

17 include any instrument which is treated (for 

18 purposes of this title) as— 

19 ‘‘(i) stock or debt, 

20 ‘‘(ii) an interest in a partnership, 

21 ‘‘(iii) part of a constructive ownership 

22 transaction to which section 1260 applies, 

23 ‘‘(iv) a hedging transaction (as de24 fined in section 1256(e)(2)), 

25 ‘‘(v) a notional principal contract, or 


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1 ‘‘(vi) an option. 

2 ‘‘(C) CERTAIN OPTIONS ECONOMICALLY

3 SIMILAR TO OWNERSHIP.—To the extent pro4 vided by the Secretary in regulations or other 

5 guidance, any option which by reason of such 

6 option’s term and strike price is economically 

7 similar to a prepaid contract described in sub8 paragraph (A) shall not be treated as an option 

9 for purposes of subparagraph (B)(vi). 

10 ‘‘(2) PREPAID CONTRACT.—The term ‘prepaid 

11 contract’ means any contract under which there is 

12 no substantial likelihood that the taxpayer will be re13 quired to pay any additional amount under the con14 tract. For purposes of the preceding sentence, a tax15 payer shall not be treated as having a substantial 

16 likelihood of being required to pay any additional 

17 amount if those additional amounts have been set 

18 aside (or are expected to be set aside) with respect 

19 to such payment or are subject to a defeasance ar20 rangement or other arrangement similar to an ar21 rangement described in section 470(d)(1)(B). 

22 ‘‘(3) PUBLICLY TRADED PREPAID DERIVATIVE

23 CONTRACT.—The term ‘publicly traded prepaid de24 rivative contract’ means any prepaid derivative con25 tract— 


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1 ‘‘(A) which is traded on or subject to the 

2 rules of a qualified board or exchange, or 

3 ‘‘(B) with respect to which the issuer (or 

4 any person acting on behalf of the issuer) regu5 larly makes available to the public (including 

6 customers or subscribers) bid or offer quotes 

7 and stands ready to effect buy or sell trans8 actions at the quoted prices for itself or on be9 half of others.’’. 

10 (b) CONFORMING AMENDMENTS.— 

11 (1) The table of subparts for part V of sub12 chapter P of chapter 1 of such Code is amended by 

13 adding at the end the following new item: 

‘‘SUBPART E—PREPAID DERIVATIVE CONTRACTS.’’. 

14 (2) The heading of part V of subchapter P of 

15 chapter 1 of such Code, and the item relating to 

16 such part in the table of parts for subchapter P of 

17 chapter 1 of such Code, are each amended by strik18 ing ‘‘debt’’. 

19 (c) EFFECTIVE DATE.—The amendments made by 

20 this section shall apply to contracts acquired after the date 

21 of the enactment of this Act. 

Æ 


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