I
104TH CONGRESS
1ST SESSION
H. R. 2692
To amend the Internal Revenue Code of 1986 to provide for deductible
contributions to medical finance accounts and to reform the earned
income credit.
IN THE HOUSE OF REPRESENTATIVES
NOVEMBER 30, 1995
Mr. ROYCE introduced the following bill; which was referred to the Committee
on Ways and Means
A BILL
To amend the Internal Revenue Code of 1986 to provide
for deductible contributions to medical finance accounts
and to reform the earned income credit.
Be it enacted by the Senate and House of Representa-
tives of the United States of America in Congress assembled,
TITLE I—MEDICAL FINANCE
ACCOUNTS
SEC. 101. MEDICAL FINANCE ACCOUNTS.
(a) IN GENERAL.—Part VII of subchapter B of chap-
ter 1 of the Internal Revenue Code of 1986 (relating to
additional itemized deductions for individuals) is amended
by redesignating section 220 as section 221 and by insert-
ing after section 219 the following new section:
‘‘SEC. 220. MEDICAL FINANCE ACCOUNTS.
‘‘(a) DEDUCTION ALLOWED.—In the case of an indi-
vidual, there shall be allowed as a deduction for the tax-
able year an amount equal to the aggregate amount paid
in cash by such individual during such taxable year to a
medical finance account of such individual.
‘‘(b) LIMITATIONS.—
‘‘(1) IN GENERAL.—Except as otherwise pro-
vided in this subsection, the amount allowable as a
deduction under subsection (a) to an individual for
any taxable year shall not exceed the greater of—
‘‘(A) $3,000 or, in the case of an individ-
ual who is married, has a dependent (as defined
in section 152), or is a dependent (as so de-
fined) for the taxable year, the amount deter-
mined under paragraph (3),
‘‘(B) in the case of an individual who is
covered by a catastrophic health plan, the de-
ductible under such plan, or
‘‘(C) the excess of—
‘‘(i) the limitation under this para-
graph (determined without regard to this
defined in section 152) for the taxable year, is
$5,000.
‘‘(B) TREATMENT OF FAMILY AS ONE IN-
DIVIDUAL.—For purposes of subparagraph (A),
an individual, the spouse (if any) of such indi-
vidual, and all dependents of such individual or
such spouse shall be treated as 1 individual.
‘‘(C) DIVISION
OF
AMOUNTS
BETWEEN
FAMILY MEMBERS.—Individuals who are mar-
ried to each other may allocate the amount ap-
plicable under subparagraph (A) between them
in any proportion on which they agree. If there
is no such agreement, such amount shall be al-
located equally between such individuals. Any
individual may allocate to any dependent (as
defined in section 152) of such individual any
portion of the amount otherwise allocable to
such individual under this paragraph.
‘‘(4) SPECIAL RULE IF ONE DEDUCTIBLE AP-
PLIES
TO
FAMILY.—For purposes of paragraph
(1)(B), rules similar to the rules of subparagraphs
(B) and (C) of paragraph (3) shall apply with re-
spect to any catastrophic health plan which applies
one deductible to—
‘‘(A) an individual, and
‘‘(B)(i) the spouse (if any) of such individ-
ual, or
‘‘(ii) any dependent of such individual or
such spouse.
‘‘(c) MEDICAL FINANCE ACCOUNT.—For purposes of
this section—
‘‘(1) MEDICAL FINANCE ACCOUNT.—The term
‘medical finance account’ means a trust created or
organized in the United States exclusively for the
purpose of paying the qualified medical expenses of
the account holder, but only if the written governing
instrument creating the trust meets the following re-
quirements:
‘‘(A) Except in the case of a rollover con-
tribution described in subsection (f)(3), con-
tributions will be accepted—
‘‘(i) only in cash, and
‘‘(ii) only to the extent not in excess
of the limitation under subsection (b) (de-
termined without regard to paragraph (2)
thereof).
‘‘(B) The trustee is a bank (as defined in
section 408(n)), an insurance company (as de-
fined in section 816), or another person who
demonstrates to the satisfaction of the Sec-
retary that the manner in which such person
will administer the trust will be consistent with
the requirements of this section.
‘‘(C) No part of the trust assets will be in-
vested in life insurance contracts.
‘‘(D) The assets of the trust will not be
commingled with other property except in a
common trust fund or common investment
fund.
‘‘(E) The interest of an individual in the
balance in his account is nonforfeitable.
‘‘(2) QUALIFIED
MEDICAL
EXPENSES.—The
term ‘qualified medical expenses’ means, with re-
spect to an account holder, amounts paid by such
holder for medical care (as defined in section
213(d)), or long-term care, for—
‘‘(A) such individual, the spouse of such
individual, and any dependent (as defined in
section 152) of such individual, or
‘‘(B) any member of the family of such in-
dividual or spouse who has attained age 65,
but only to the extent such amounts are not com-
pensated for by insurance or otherwise, and
‘‘(3) ACCOUNT
HOLDER.—The term ‘account
holder’ means the individual on whose behalf the
medical finance account was established.
‘‘(4) CERTAIN RULES TO APPLY.—Rules similar
to the following rules shall apply for purposes of this
section:
‘‘(A) Section 219(d)(2) (relating to no de-
duction for rollovers).
‘‘(B) Section 219(f)(3) (relating to time
when contributions deemed made).
‘‘(C) Except as provided in section 106(b),
section 219(f)(5) (relating to employer pay-
ments).
‘‘(D) Section 408(h) (relating to custodial
accounts).
‘‘(d) TAX TREATMENT OF ACCOUNTS.—
‘‘(1) IN GENERAL.—A medical finance account
is exempt from taxation under this subtitle, unless
such account has ceased to be a medical finance ac-
count by reason of the rules referred to in paragraph
(2). Notwithstanding the preceding sentence, any
such account is subject to the taxes imposed by sec-
tion 511 (relating to imposition of tax on unrelated
business income of charitable, etc., organizations).
‘‘(2) ACCOUNT ASSETS TREATED AS DISTRIB-
UTED IN THE CASE OF PROHIBITED TRANSACTIONS
OR ACCOUNT PLEDGED AS SECURITY FOR LOAN.—
Rules similar to the rules of paragraphs (2) and (4)
of section 408(e) shall apply to medical finance ac-
counts, and any amount treated as distributed under
such rules shall be treated as not used to pay quali-
fied medical expenses.
‘‘(e) TAX TREATMENT OF DISTRIBUTIONS.—
‘‘(1) INCLUSION OF AMOUNTS NOT USED FOR
QUALIFIED MEDICAL EXPENSES.—Any amount paid
or distributed out of a medical finance account shall
be included in the gross income of the account hold-
er unless such amount is used exclusively to pay the
qualified medical expenses of such holder.
‘‘(2) PENALTY FOR AMOUNTS NOT USED FOR
QUALIFIED MEDICAL EXPENSES.—
‘‘(A) IN GENERAL.—The tax imposed by
this chapter for any taxable year in which any
amount is included in gross income by reason
of paragraph (1) shall be increased by 10 per-
cent of such amount.
‘‘(B) 
EXCEPTIONS.—Subparagraph 
(A)
shall not apply with respect to any amount paid
or distributed on or after the date the account
holder—
‘‘(i) becomes disabled within the
meaning of section 72(m)(7), or
‘‘(ii) dies.
‘‘(3) EXCESS CONTRIBUTIONS RETURNED BE-
FORE DUE DATE OF RETURN.—Paragraph (1) shall
not apply to the distribution of any contribution paid
during a taxable year to a medical finance account
to the extent that such contribution exceeds the limi-
tation under subsection (b) (determined without re-
gard to paragraph (3) thereof) if—
‘‘(A) such distribution is received by the
account holder on or before the last day pre-
scribed by law (including extensions of time) for
filing such individual’s return for such taxable
year, and
‘‘(B) such distribution is accompanied by
the amount of net income attributable to such
excess contribution.
Any net income described in subparagraph (B) shall
be included in the gross income of the account hold-
er for the taxable year in which it is received.
‘‘(4) 
ROLLOVERS
AND
TRANSFERS
AT
DEATH.—Paragraph (1) shall not apply to any
section) which is applicable to such employee for
such taxable year.’’
(2) EXCLUSION FROM EMPLOYMENT TAXES.—
(A) SOCIAL SECURITY TAXES.—
(i) Subsection (a) of section 3121 of
such Code is amended by striking ‘‘or’’ at
the end of paragraph (20), by striking the
period at the end of paragraph (21) and
inserting ‘‘; or’’, and by inserting after
paragraph (21) the following new para-
graph:
‘‘(22) any payment made to or for the benefit
of an employee if at the time of such payment it is
reasonable to believe that the employee will be able
to exclude such payment from income under section
106(b).’’
(ii) Subsection (a) of section 209 of
the Social Security Act is amended by
striking ‘‘or’’ at the end of paragraph (17),
by striking the period at the end of para-
graph (18) and inserting ‘‘; or’’, and by in-
serting after paragraph (18) the following
new paragraph:
‘‘(19) any payment made to or for the benefit
of an employee if at the time of such payment it is
reasonable to believe that the employee will be able
to exclude such payment from income under section
106(b) of the Internal Revenue Code of 1986.’’
(B) RAILROAD
RETIREMENT
TAX.—Sub-
section (e) of section 3231 of such Code is
amended by adding at the end the following
new paragraph:
‘‘(10) MEDICAL FINANCE ACCOUNT CONTRIBU-
TIONS.—The term ‘compensation’ shall not include
any payment made to or for the benefit of an em-
ployee if at the time of such payment it is reason-
able to believe that the employee will be able to ex-
clude such payment from income under section
106(b).’’
(C) UNEMPLOYMENT TAX.—Subsection (b)
of section 3306 of such Code is amended by
striking ‘‘or’’ at the end of paragraph (15), by
striking the period at the end of paragraph (16)
and inserting ‘‘; or’’, and by inserting after
paragraph (16) the following new paragraph:
‘‘(17) any payment made to or for the benefit
of an employee if at the time of such payment it is
reasonable to believe that the employee will be able
to exclude such payment from income under section
106(b).’’
(D) WITHHOLDING
TAX.—Subsection (a)
of section 3401 of such Code is amended by
striking ‘‘or’’ at the end of paragraph (19), by
striking the period at the end of paragraph (20)
and inserting ‘‘; or’’, and by inserting after
paragraph (20) the following new paragraph:
‘‘(21) any payment made to or for the benefit
of an employee if at the time of such payment it is
reasonable to believe that the employee will be able
to exclude such payment from income under section
106(b).’’
(d) EXCLUSION OF MEDICAL FINANCE ACCOUNTS
FROM ESTATE TAX.—Part IV of subchapter A of chapter
11 of such Code is amended by adding at the end the fol-
lowing new section:
‘‘SEC. 2057. MEDICAL FINANCE ACCOUNTS.
‘‘For purposes of the tax imposed by section 2001,
the value of the taxable estate shall be determined by de-
ducting from the value of the gross estate an amount
equal to the value of any medical finance account (as de-
fined in section 220(c)) included in the gross estate.’’
(e) TAX ON EXCESS CONTRIBUTIONS.—Section 4973
of such Code (relating to tax on excess contributions to
individual retirement accounts, certain section 403(b) con-
tracts, and certain individual retirement annuities) is
amended—
(1) by inserting ‘‘MEDICAL
FINANCE
AC-
COUNTS,’’ after ‘‘ACCOUNTS,’’ in the heading of
such section,
(2) by redesignating paragraph (2) of sub-
section (a) as paragraph (3) and by inserting after
paragraph (1) the following:
‘‘(2) a medical finance account (within the
meaning of section 220(c)),’’,
(3) by striking ‘‘or’’ at the end of paragraph
(1) of subsection (a), and
(4) by adding at the end thereof the following
new subsection:
‘‘(d) EXCESS CONTRIBUTIONS TO MEDICAL FINANCE
ACCOUNTS.—For purposes of this section, in the case of
a medical finance account (within the meaning of section
220(c)), the term ‘excess contributions’ means the amount
by which the amount contributed for the taxable year to
the account exceeds the limitation under section 220(b)
for such taxable year. For purposes of this subsection, any
contribution which is distributed out of the medical fi-
nance account in a distribution to which section 220(e)(3)
applies shall be treated as an amount not contributed.’’
(f) TAX ON PROHIBITED TRANSACTIONS.—Section
4975 of such Code (relating to tax on prohibited trans-
actions) is amended—
(1) by adding at the end of subsection (c) the
following new paragraph:
‘‘(4) SPECIAL RULE FOR MEDICAL FINANCE AC-
COUNTS.—An individual for whose benefit a medical
finance account (within the meaning of section
220(c)) is established shall be exempt from the tax
imposed by this section with respect to any trans-
action concerning such account (which would other-
wise be taxable under this section) if, with respect
to such transaction, the account ceases to be a medi-
cal finance account by reason of the application of
section 220(d)(2) to such account.’’, and
(2) by inserting ‘‘or a medical finance account
described in section 220(c)’’ in subsection (e)(1)
after ‘‘described in section 408(a)’’.
(g) FAILURE TO PROVIDE REPORTS ON MEDICAL FI-
NANCE ACCOUNTS.—Section 6693 of such Code (relating
to failure to provide reports on individual retirement ac-
counts or annuities) is amended—
(1) by inserting ‘‘OR ON MEDICAL FINANCE
ACCOUNTS’’ after ‘‘ANNUITIES’’ in the heading of
such section, and
SEC. 204. MODIFICATION OF EARNED INCOME CREDIT
AMOUNT AND PHASEOUT.
(a) MODIFICATION
OF PHASEOUT.—Subparagraph
(B) of section 32(a)(2) is amended to read as follows:
‘‘(B) the sum of—
‘‘(i) the initial phaseout percentage of
so much of the adjusted gross income (or,
if greater, the earned income) of the tax-
payer for the taxable year as exceeds the
initial phaseout amount but does not ex-
ceed the final phaseout amount, plus
‘‘(ii) the final phaseout percentage of
so much of the adjusted gross income (or,
if greater, the earned income) of the tax-
payer for the taxable year as exceeds the
final phaseout amount.’’
(b) PERCENTAGES AND AMOUNTS.—
(1) IN GENERAL.—Subsection (b) of section 32,
as amended by section 203(b), is amended to read
as follows:
‘‘(b) PERCENTAGES AND AMOUNTS.—
‘‘(1) PERCENTAGES.—The credit percentage,
the initial phaseout percentage, and the final phase-
out percentage shall be determined as follows:
‘‘In the case of an eligible individual
with:
The credit per-
centage is:
The initial phase-
out percentage is:
The final phase-
out percentage is:
1 qualifying child .........................
15.98
2 or more qualifying children .......
21.06
‘‘(2) AMOUNTS.—The earned income amount,
the initial phaseout amount, and the final phaseout
amount shall be determined as follows:
‘‘In the case of an eligible individual
with:
The earned in-
come amount is:
The initial phase-
out amount is:
The final phase-
out amount is:
1 qualifying child .........................
$6,340
$11,630
$14,850
2 or more qualifying children .......
$8,910
$11,630
$17,750’’.
(2) INCREASE IN CREDIT FOR LOWER-INCOME
FAMILIES
HAVING
OR
MORE
QUALIFYING
CHIL-
DREN.—Subsection (d) of section 32 is amended to
read as follows:
‘‘(d) INCREASE
IN CREDIT
FOR LOWER-INCOME
FAMILIES HAVING 2 OR MORE QUALIFYING CHILDREN.—
‘‘(1) IN GENERAL.—If an eligible individual has
2 or more qualifying children, for purposes of apply-
ing paragraphs (1) and (2)(A) of subsection (a)—
‘‘(A) the amount of the taxpayer’s earned
income shall be treated as being equal to 10⁄9 of
such income (determined without regard to this
paragraph), and
‘‘(B) the earned income amount shall be
treated as being equal to 10⁄9 of such amount
(determined without regard to this paragraph).
‘‘(2) PHASEOUT OF BENEFIT.—If the applicable
income of the taxpayer for the taxable year exceeds
$14,000 ($17,000 in the case of a joint return), the
amount of each increase under paragraph (1) shall
be reduced (but not below zero) by an amount which
bears the same ratio to such increase (determined
without regard to this subparagraph) as such excess
bears to $4,000.
‘‘(3) APPLICABLE
INCOME.—For purposes of
this subsection, the term ‘applicable income’ means
adjusted gross income or, if greater, earned in-
come.’’
(3) CONFORMING AMENDMENTS.—
(A) Subsection (j) of section 32 is amend-
ed—
(i) by striking ‘‘subsection (b)(2)(A)’’
and inserting ‘‘subsection (b)(2) or (d)’’,
(ii) by striking ‘‘1994’’ and inserting
‘‘1996’’, and
(iii) by striking ‘‘1993’’ and inserting
‘‘1995’’.
(B) Subsection (e) of section 32 is amend-
ed to read as follows:
‘‘(e) OTHER SPECIAL RULES.—
‘‘(1) MARRIED INDIVIDUALS.—In the case of an
individual who is married (within the meaning of
section 7703), this section shall apply only if a joint
return is filed for the taxable year.
‘‘(2) TAXABLE YEAR MUST BE FULL TAXABLE
YEAR.—Except in the case of a taxable year closed
by reason of the death of an individual, no credit
shall be allowable under this section in the case of
a taxable year covering a period of less than 12
months.’’
(c) EFFECTIVE DATE.—The amendments made by
this section shall apply to taxable years beginning after
December 31, 1995.
SEC. 205. RULES RELATING TO DENIAL OF EARNED IN-
COME CREDIT ON BASIS OF DISQUALIFIED
INCOME.
(a) DEFINITION OF DISQUALIFIED INCOME.—Para-
graph (2) of section 32(i) (defining disqualified income)
is amended by striking ‘‘and’’ at the end of subparagraph
(B), by striking the period at the end of subparagraph
(C) and inserting ‘‘, and’’, and by adding at the end the
following new subparagraph:
‘‘(D) the excess (if any) of—
‘‘(i) the aggregate income from all
passive activities for the taxable year (de-
termined without regard to any amount de-
scribed in a preceding subparagraph), over
‘‘(ii) the aggregate losses from all pas-
sive activities for the taxable year (as so
determined).
For purposes of subparagraph (D), the term
‘passive activity’ has the meaning given such
term by section 469.’’.
(b) EFFECTIVE DATE.—The amendments made by
this section shall apply to taxable years beginning after
December 31, 1995.
SEC. 206. MODIFICATION OF ADJUSTED GROSS INCOME
DEFINITION FOR EARNED INCOME CREDIT.
(a) IN GENERAL.—Subsections (a)(2), (c)(1)(C), (d),
and (f)(2)(B) of section 32, as amended by the preceding
sections of this title, are each amended by striking ‘‘ad-
justed gross income’’ each place it appears and inserting
‘‘modified adjusted gross income’’.
(b) MODIFIED
ADJUSTED
GROSS
INCOME
DE-
FINED.—Section 32(c) (relating to definitions and special
rules) is amended by adding at the end the following new
paragraph:
‘‘(5) MODIFIED ADJUSTED GROSS INCOME.—
‘‘(A) IN
GENERAL.—The term ‘modified
adjusted gross income’ means adjusted gross in-
come—
‘‘(i) increased by the sum of the
amounts described in subparagraph (B),
and
‘‘(ii) determined without regard to—
‘‘(I) the amounts described in
subparagraph (C), or
‘‘(II) the deduction allowed under
section 172.
‘‘(B) NONTAXABLE INCOME TAKEN INTO
ACCOUNT.—Amounts described in this subpara-
graph are—
‘‘(i) social security benefits (as defined
in section 86(d)) received by the taxpayer
during the taxable year to the extent not
included in gross income,
‘‘(ii) amounts which—
‘‘(I) are received during the tax-
able year by (or on behalf of) a spouse
pursuant to a divorce or separation
instrument (as defined in section
71(b)(2)), and
‘‘(II) under the terms of the in-
strument are fixed as payable for the
support of the children of the payor
spouse (as determined under section
71(c)),
but only to the extent such amounts exceed
$6,000,
‘‘(iii) interest received or accrued dur-
ing the taxable year which is exempt from
tax imposed by this chapter, and
‘‘(iv) amounts received as a pension or
annuity, and any distributions or payments
received from an individual retirement
plan, by the taxpayer during the taxable
year to the extent not included in gross in-
come.
Clause (iv) shall not include any amount which
is not includible in gross income by reason of
section 402(c), 403(a)(4), 403(b)(8), 408(d)
(3), (4), or (5), or 457(e)(10).
‘‘(C) CERTAIN AMOUNTS DISREGARDED.—
An amount is described in this subparagraph if
it is—
‘‘(i) the amount of losses from sales
or exchanges of capital assets in excess of
gains from such sales or exchanges to the
extent such amount does not exceed the
amount under section 1211(b)(1),
‘‘(ii) the net loss from the carrying on
of trades or businesses, computed sepa-
rately with respect to—
‘‘(I) trades or businesses (other
than farming) conducted as sole pro-
prietorships,
‘‘(II) trades or businesses of
farming conducted as sole proprietor-
ships, and
‘‘(III) other trades or business,
‘‘(iii) the net loss from estates and
trusts, and
‘‘(iv) the excess (if any) of amounts
described in subsection (i)(2)(C)(ii) over
the 
amounts 
described 
in 
subsection
(i)(2)(C)(i) (relating to nonbusiness rents
and royalties).
For purposes of clause (ii), there shall not be
taken into account items which are attributable
to a trade or business which consists of the per-
formance of services by the taxpayer as an em-
ployee.’’.
(c) EFFECTIVE DATE.—The amendments made by
this section shall apply to taxable years beginning after
December 31, 1995.
SEC. 207. PROVISIONS TO IMPROVE TAX COMPLIANCE.
(a) INCREASE IN PENALTIES FOR RETURN PREPAR-
ERS.—
(1) 
UNDERSTATEMENT
PENALTY.—Section
6694 (relating to understatement of income tax li-
ability by income tax return preparer) is amended—
(A) by striking ‘‘$250’’ in subsection (a)
and inserting ‘‘$500’’, and
(B) by striking ‘‘$1,000’’ in subsection (b)
and inserting ‘‘$2,000’’.
(2) OTHER ASSESSABLE PENALTIES.—Section
6695 (relating to other assessable penalties) is
amended—
(A) by striking ‘‘$50’’ and ‘‘$25,000’’ in
subsections (a), (b), (c), (d), and (e) and insert-
ing ‘‘$100’’ and ‘‘$50,000’’, respectively, and
(B) by striking ‘‘$500’’ in subsection (f)
and inserting ‘‘$1,000’’.
(b) AIDING
AND
ABETTING
PENALTY.—Section
6701(b) (relating to amount of penalty) is amended—
(1) by striking ‘‘$1,000’’ in paragraph (1) and
inserting ‘‘2,000’’, and
(2) by striking ‘‘10,000’’ in paragraph (2) and
inserting ‘‘20,000’’.
(c) EFFECTIVE DATE.—The amendments made by
this section shall apply to penalties with respect to taxable
years beginning after December 31, 1995.
Æ
HR 2692 IH——2
HR 2692 IH——3