‘‘(i) the amount of the refinanced in-
debtedness, plus 
‘‘(ii) the lesser of $10,000 or the 
points paid in respect of the indebtedness 
resulting from the refinancing to the ex-
tent that the indebtedness resulting from 
the refinancing does not exceed the refi-
nanced indebtedness.’’. 
(b) CONFORMING AMENDMENT.—The heading of 
paragraph (2) of section 461(g) is amended by inserting 
‘‘BASED ON BUSINESS PRACTICE’’ after ‘‘EXCEPTION’’. 
(c) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003. 
SEC. 107. TAXATION OF MINOR CHILDREN. 
(a) APPLICATION OF TRUST RATE SCHEDULE TO 
NET UNEARNED INCOME OF MINOR CHILDREN.—Sub-
section (g) of section 1 (relating to certain unearned in-
come of minor children taxed as if parent’s income) is 
amended—
(1) by striking paragraphs (1), (3) and (5), 
(2) by redesignating paragraphs (4), (6), and 
(7) as paragraphs (3), (4), and (5), respectively, and 
(3) by inserting before paragraph (2) the fol-
lowing new paragraph:
‘‘(1) IN GENERAL.—In the case of a child to 
whom this subsection applies, the tax imposed by 
this section shall be the sum of—
‘‘(A) a tax computed at the rates and in 
the same manner as if this subsection had not 
been enacted on taxable income reduced by net 
unearned income, plus 
‘‘(B) the excess (if any) of the tax deter-
mined under subsection (e) on total taxable in-
come over the tax determined under subsection 
(e) on taxable income reduced by net unearned 
income.’’. 
(b) EXPANSION
OF PARENTAL ELECTION.—Para-
graph (5) of section 1(g) (as redesignated under sub-
section (a)) is amended to read as follows: 
‘‘(5) ELECTION TO CLAIM INCOME OF CHILD ON 
PARENT’S RETURN.—
‘‘(A) IN GENERAL.—If the parent of any 
child to whom this subsection applies elects the 
application of subparagraph (B), such child—
‘‘(i) shall be treated (other than for 
purposes of this paragraph)—
‘‘(I) as having no gross income 
for such year, and
‘‘(II) as not being entitled to any 
deductions or credits for such year, 
and 
‘‘(ii) shall not be required to file a re-
turn under section 6012 for such year. 
‘‘(B) INCOME INCLUDED ON PARENT’S RE-
TURN.—In the case of a parent making the 
election under this paragraph—
‘‘(i) the gross income of each child to 
whom such election applies shall be in-
cluded in such parent’s gross income for 
the taxable year, 
‘‘(ii) the deductions to which such 
child would be entitled without regard to 
such election shall be allowed to such par-
ent but only to the extent the aggregate of 
such deductions does not exceed the gross 
income of such child, 
‘‘(iii) any estimated tax payment, and 
any amount which has been deducted and 
withheld under chapter 24, for such year 
that is made in the name and TIN of such 
child shall be treated as an estimated tax 
payment or as an amount deducted and 
withheld in the name and TIN of such par-
ent for such year (including for purposes 
of section 31), and 
‘‘(iv) any interest which is an item of 
tax preference under section 57(a)(5) of 
the child shall be treated as an item of tax 
preference of such parent (and not of such 
child). 
‘‘(C) SPECIAL
RULE
FOR
DETERMINING 
WHICH
PARENT
MAY
MAKE
ELECTION.—For 
purposes of this paragraph, the parent of a 
child to whom this subsection applies who may 
make an election under this paragraph shall 
be—
‘‘(i) in the case of parents who are not 
married (within the meaning of section 
7703), the custodial parent (within the 
meaning of section 151(c)(7)) of the child, 
and 
‘‘(ii) in the case of married individuals 
filing separately, the individual with the 
greater taxable income. 
‘‘(D) CARRYOVERS
ALLOWED.—Subpara-
graph (A)(i)(II) shall not prohibit the carryover
of any amount that the child would be entitled
to carryover without regard to the election 
under this paragraph. 
‘‘(E) REGULATIONS.—The Secretary shall 
prescribe such regulations as may be necessary 
or appropriate to carry out the purposes of this 
paragraph.’’. 
(c) CONFORMING AMENDMENT.—The heading for 
subsection (g) of section 1 is amended to read as follows: 
‘‘(g) TREATMENT OF CERTAIN INCOME OF MINOR 
CHILDREN.—’’. 
(d) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003. 
SEC. 108. SIMPLIFICATION OF DEPENDENT CARE TAX BEN-
EFITS. 
(a) REPEAL OF REDUCTION OF CREDIT BASED ON 
ADJUSTED GROSS INCOME.—Subsection (a) of section 21 
(relating to allowance of credit) is amended—
(1) in paragraph (1), by striking ‘‘applicable 
percentage’’ and inserting ‘‘35 percent’’, 
(2) by striking paragraph (2), and 
(3) by striking ‘‘(1) IN GENERAL.—’’ and mov-
ing the text 2 ems to the left.
(b) DOLLAR LIMIT ON AMOUNT CREDITABLE MADE 
$5,500 REGARDLESS OF NUMBER OF QUALIFYING INDI-
VIDUALS.—
(1) IN GENERAL.—Subsection (c) of section 21 
(relating to dollar limit on amount creditable) is 
amended to read as follows: 
‘‘(c) DOLLAR LIMIT ON AMOUNT CREDITABLE.—The 
amount of employment-related expenses incurred during 
any taxable year which may be taken into account under 
subsection (a) shall not exceed $5,500, reduced by the ag-
gregate amount excludable from gross income under sec-
tion 129 for the taxable year.’’. 
(2) EXCLUSION.—Subparagraph (A) of section 
129(a)(2) is amended by striking ‘‘$5,000 ($2,500’’ 
and inserting ‘‘$5,500 ($2,750’’.
(c) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003. 
SEC. 109. ACCELERATION OF PHASEOUT OF PHASEOUT OF 
OVERALL LIMITATION ON ITEMIZED DEDUC-
TIONS. 
(a) IN GENERAL.—Section 68 (relating to overall 
limitation on itemized deductions) is hereby repealed. 
(b) CONFORMING AMENDMENTS.—
(1) Section 1(f)(6)(A) is amended by striking ‘‘, 
section 68(b)(2)’’. 
(2) Section 773(a)(3)(B) is amended by strik-
ing clause (i) and redesignating clauses (ii), (iii), 
and (iv) as clauses (i), (ii), and (iii), respectively. 
(3) The table of sections for part I of sub-
chapter B of chapter 1 is amended by striking the 
item relating to section 68. 
(c) EFFECTIVE DATE.—The amendments by this sec-
tion shall apply to taxable years beginning after December 
31, 2003. 
SEC. 110. ACCELERATION OF REPEAL OF PHASEOUT OF 
PERSONAL EXEMPTIONS. 
(a) IN GENERAL.—Subsection (e) of section 151 (re-
lating to phaseout of exemption amount), as amended by 
the preceding sections of this Act, is amended by striking 
paragraph (3) and redesignating paragraph (4) as para-
graph (3). 
(b) CONFORMING AMENDMENTS.—
(1) Paragraph (3) of section 151(e), as amend-
ed by subsection (a), is amended to read as follows: 
‘‘(3) INFLATION ADJUSTMENT.—In the case of 
any taxable year beginning in a calendar year after 
1989, the dollar amount contained in paragraph (1) 
shall be increased by an amount equal to—
‘‘(A) such dollar amount, multiplied by 
‘‘(B) the cost-of-living adjustment deter-
mined under section 1(f)(3) for the calendar 
year in which the taxable year begins, by sub-
stituting ‘calendar year 1988’ for ‘calendar year 
1992’ in subparagraph (B) thereof.’’. 
(2) Section 1(f)(6) is amended—
(A) in subparagraph (A) by striking 
‘‘151(e)(4)’’ and inserting ‘‘151(e)(3)’’, and 
(B) in subparagraph (B), both as in effect 
on the date of the enactment of this Act and as 
amended by the Economic Growth and Tax Re-
lief Reconciliation Act of 2001, by striking 
‘‘151(e)(4)(A)’’ and inserting ‘‘151(e)(3)’’. 
(3) Subparagraph (C) of section 642(b)(2), as 
amended by the preceding sections of this Act, is 
amended by striking ‘‘, determined by treating such 
trust 
as 
an 
individual 
described 
in 
section 
151(e)(3)(C)(ii)’’. 
(c) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003.
SEC. 111. REPEAL OF PERSONAL HOLDING COMPANY TAX. 
(a) IN GENERAL.—Part II of subchapter G of chap-
ter 1 (relating to personal holding companies) is hereby 
repealed. 
(b) CONFORMING AMENDMENTS.—
(1) Section 12(2) is amended to read as follows:
‘‘(2) For accumulated earnings tax, see part I 
of subchapter G (sec. 531 and following).’’. 
(2) Section 26(b)(2) is amended by striking 
subparagraph (G) and by redesignating the suc-
ceeding subparagraphs accordingly. 
(3) Section 30A(c) is amended by striking para-
graph (3) and by redesignating paragraph (4) as 
paragraph (3). 
(4) Section 41(e)(7)(E) is amended by adding 
‘‘and’’ at the end of clause (i), by striking clause 
(ii), and by redesignating clause (iii) as clause (ii). 
(5) Section 56(b)(2) is amended by striking 
subparagraph (C) and by redesignating subpara-
graph (D) as subparagraph (C). 
(6) Section 170(e)(4)(D) is amended by adding 
‘‘and’’ at the end of clause (i), by striking clause 
(ii), and by redesignating clause (iii) as clause (ii). 
(7) Section 111(d) is amended to read as fol-
lows:
‘‘(d) SPECIAL RULES FOR ACCUMULATED EARNINGS 
TAX.—In applying subsection (a) for the purpose of deter-
mining the accumulated earnings tax under section 531—
‘‘(1) any excluded amount under subsection (a) 
allowed for purposes of this subtitle (other than sec-
tion 531) shall be allowed whether or not such 
amount resulted in a reduction of the tax under sec-
tion 531 for the prior taxable year, and 
‘‘(2) where any excluded amount under sub-
section (a) was not allowed as a deduction for the 
prior taxable year for purposes of this subtitle other 
than section 531 but was allowable for the same tax-
able year under section 531, then such excluded 
amount shall be allowable if it did not result in a re-
duction of the tax under section 531.’’. 
(8)(A) Section 316(b) is amended by striking 
paragraph (2) and by redesignating paragraph (3) 
as paragraph (2). 
(B) Section 331(b) is amended by striking 
‘‘(other than a distribution referred to in paragraph 
(2)(B) of section 316(b))’’. 
(9) Section 341(d) is amended—
(A) by striking ‘‘section 544(a)’’ and in-
serting ‘‘section 465(f)’’, and
(B) by inserting before the period at the 
end of the next to the last sentence ‘‘and such 
paragraph (2) shall be applied by inserting ‘by 
or for his partner’ after ‘his family’ ’’. 
(10) Section 381(c) is amended by striking 
paragraphs (14) and (17). 
(11) Section 443(e) is amended by striking 
paragraph (2) and by redesignating paragraphs (3), 
(4), and (5) as paragraphs (2), (3), and (4), respec-
tively. 
(12) Section 447(g)(4)(A) is amended by strik-
ing ‘‘other than—’’ and all that follows and insert-
ing ‘‘other than an S corporation.’’
(13)(A) Section 465(a)(1)(B) is amended to 
read as follows: 
‘‘(B) a C corporation which is closely 
held,’’. 
(B) Section 465(a)(3) is amended to read as 
follows:
‘‘(3) CLOSELY
HELD
DETERMINATION.—For 
purposes of paragraph (1), a corporation is closely 
held if, at any time during the last half of the tax-
able year, more than 50 percent in value of its out-
standing stock is owned, directly or indirectly, by or 
for not more than 5 individuals. For purposes of this
paragraph, an organization described in section 
401(a), 501(c)(17), or 509(a) or a portion of a trust 
permanently set aside or to be used exclusively for 
the purposes described in section 642(c) shall be 
considered an individual.’’
(C) Section 465 is amended by adding at the 
end the following new subsection: 
‘‘(f) CONSTRUCTIVE OWNERSHIP RULES.—For pur-
poses of subsection (a)(3)—
‘‘(1) STOCK
NOT
OWNED
BY
INDIVIDUAL.—
Stock owned, directly or indirectly, by or for a cor-
poration, partnership, estate, or trust shall be con-
sidered as being owned proportionately by its share-
holders, partners, or beneficiaries. 
‘‘(2) FAMILY OWNERSHIP.—An individual shall 
be considered as owning the stock owned, directly or 
indirectly, by or for his family. For purposes of this 
paragraph, the family of an individual includes only 
his brothers and sisters (whether by the whole or 
half blood), spouse, ancestors, and lineal descend-
ants. 
‘‘(3) OPTIONS.—If any person has an option to 
acquire stock, such stock shall be considered as 
owned by such person. For purposes of this para-
graph, an option to acquire such an option, and each
one of a series of such options, shall be considered 
as an option to acquire such stock. 
‘‘(4) APPLICATION
OF
FAMILY
AND
OPTION 
RULES.—Paragraphs (2) and (3) shall be applied if, 
but only if, the effect is to make the corporation 
closely held under subsection (a)(3). 
‘‘(5) CONSTRUCTIVE
OWNERSHIP
AS
ACTUAL 
OWNERSHIP.—Stock constructively owned by a per-
son by reason of the application of paragraph (1) or 
(3), shall, for purposes of applying paragraph (1) or 
(2), be treated as actually owned by such person; 
but stock constructively owned by an individual by 
reason of the application of paragraph (2) shall not 
be treated as owned by him for purposes of again 
applying such paragraph in order to make another 
the constructive owner of such stock. 
‘‘(6) OPTION
RULE
IN
LIEU
OF
FAMILY 
RULE.—If stock may be considered as owned by an 
individual under either paragraph (2) or (3) it shall 
be considered as owned by him under paragraph (3). 
‘‘(7) CONVERTIBLE SECURITIES.—Outstanding 
securities convertible into stock (whether or not con-
vertible during the taxable year) shall be considered 
as outstanding stock if the effect of the inclusion of 
all such securities is to make the corporation closely
held under subsection (a)(3). The requirement under 
the preceding sentence that all convertible securities 
must be included if any are to be included shall be 
subject to the exception that, where some of the out-
standing securities are convertible only after a later 
date than in the case of others, the class having the 
earlier conversion date may be included although the 
others are not included, but no convertible securities 
shall be included unless all outstanding securities 
having a prior conversion date are also included.’’
(D) Section 465(c)(7)(B) is amended by strik-
ing clause (i) and by redesignating clauses (ii) and 
(iii) as clauses (i) and (ii), respectively. 
(E) Section 465(c)(7)(G) is amended to read as 
follows: 
‘‘(G) LOSS OF 1 MEMBER OF AFFILIATED 
GROUP MAY NOT OFFSET INCOME OF PERSONAL 
SERVICE CORPORATION.—Nothing in this para-
graph shall permit any loss of a member of an 
affiliated group to be used as an offset against 
the income of any other member of such group 
which is a personal service corporation (as de-
fined in section 269A(b) but determined by sub-
stituting ‘5 percent’ for ‘10 percent’ in section 
269A(b)(2)).’’
(14) Sections 508(d), 4947, and 4948(c)(4) are 
each amended by striking ‘‘545(b)(2),’’ each place it 
appears. 
(15) Section 532(b) is amended by striking 
paragraph (1) and by redesignating paragraphs (2), 
(3), and (4) as paragraphs (1), (2), and (3), respec-
tively. 
(16) Sections 535(b)(1) and 556(b)(1) are each 
amended by striking ‘‘section 541’’ and inserting 
‘‘section 541 (as in effect before its repeal)’’. 
(17)(A) Section 553(a)(1) is amended by strik-
ing ‘‘section 543(d)’’ and inserting ‘‘subsection (c)’’. 
(B) Section 553 is amended by adding at the 
end the following new subsection:
‘‘(c) ACTIVE BUSINESS COMPUTER SOFTWARE ROY-
ALTIES.—
‘‘(1) IN GENERAL.—For purposes of subsection 
(a), the term ‘active business computer software roy-
alties’ means any royalties—
‘‘(A) received by any corporation during 
the taxable year in connection with the licensing 
of computer software, and 
‘‘(B) with respect to which the require-
ments of paragraphs (2), (3), (4), and (5) are 
met.
‘‘(2) ROYALTIES MUST BE RECEIVED BY COR-
PORATION ACTIVELY ENGAGED IN COMPUTER SOFT-
WARE BUSINESS.—The requirements of this para-
graph are met if the royalties described in paragraph 
(1)—
‘‘(A) are received by a corporation engaged 
in the active conduct of the trade or business 
of developing, manufacturing, or producing 
computer software, and 
‘‘(B) are attributable to computer software 
which—
‘‘(i) is developed, manufactured, or 
produced by such corporation (or its prede-
cessor) in connection with the trade or 
business described in subparagraph (A), or 
‘‘(ii) is directly related to such trade 
or business. 
‘‘(3) ROYALTIES MUST CONSTITUTE AT LEAST 
50 PERCENT OF INCOME.—The requirements of this 
paragraph are met if the royalties described in para-
graph (1) constitute at least 50 percent of the ordi-
nary gross income of the corporation for the taxable 
year.
‘‘(4) DEDUCTIONS UNDER SECTIONS 162 AND 
174 RELATING TO ROYALTIES MUST EQUAL OR EX-
CEED 25 PERCENT OF ORDINARY GROSS INCOME.—
‘‘(A) IN GENERAL.—The requirements of 
this paragraph are met if—
‘‘(i) the sum of the deductions allow-
able to the corporation under sections 162, 
174, and 195 for the taxable year which 
are properly allocable to the trade or busi-
ness described in paragraph (2) equals or 
exceeds 25 percent of the ordinary gross 
income of such corporation for such tax-
able year, or 
‘‘(ii) the average of such deductions 
for the 5-taxable year period ending with 
such taxable year equals or exceeds 25 per-
cent of the average ordinary gross income 
of such corporation for such period. 
If a corporation has not been in existence dur-
ing the 5-taxable year period described in clause 
(ii), then the period of existence of such cor-
poration shall be substituted for such 5-taxable 
year period. 
‘‘(B) DEDUCTIONS
ALLOWABLE
UNDER 
SECTION 162.—For purposes of subparagraph
(A), a deduction shall not be treated as allow-
able under section 162 if it is specifically allow-
able under another section. 
‘‘(C) LIMITATION ON ALLOWABLE DEDUC-
TIONS.—For purposes of subparagraph (A), no 
deduction shall be taken into account with re-
spect to compensation for personal services ren-
dered by the 5 individual shareholders holding 
the largest percentage (by value) of the out-
standing stock of the corporation. For purposes 
of the preceding sentence individuals holding 
less than 5 percent (by value) of the stock of 
such corporation shall not be taken into ac-
count.’’
(18) Section 561(a) is amended by striking 
paragraph (3), by inserting ‘‘and’’ at the end of 
paragraph (1), and by striking ’’, and’’ at the end 
of paragraph (2) and inserting a period. 
(19) Section 562(b) is amended to read as fol-
lows: 
‘‘(b) DISTRIBUTIONS IN LIQUIDATION.—Except in 
the case of a foreign personal holding company described 
in section 552—
‘‘(1) in the case of amounts distributed in liq-
uidation, the part of such distribution which is prop-
erly chargeable to earnings and profits accumulated 
after February 28, 1913, shall be treated as a divi-
dend for purposes of computing the dividends paid 
deduction, and 
‘‘(2) in the case of a complete liquidation occur-
ring within 24 months after the adoption of a plan 
of liquidation, any distribution within such period 
pursuant to such plan shall, to the extent of the 
earnings and profits (computed without regard to 
capital losses) of the corporation for the taxable year 
in which such distribution is made, be treated as a 
dividend for purposes of computing the dividends 
paid deduction. 
For purposes of paragraph (1), a liquidation includes a 
redemption of stock to which section 302 applies. Except 
to the extent provided in regulations, the preceding sen-
tence shall not apply in the case of any mere holding or 
investment company which is not a regulated investment 
company.’’
(20) Section 563 is amended by striking sub-
section (b). 
(21) Section 564 is hereby repealed. 
(22) Section 631(c) is amended by striking ‘‘or 
section 545(b)(5)’’.
(23) Section 852(b)(1) is amended by striking 
‘‘which is a personal holding company (as defined in 
section 542) or’’. 
(24)(A) Section 856(h)(1) is amended to read 
as follows: 
‘‘(1) IN GENERAL.—For purposes of subsection 
(a)(6), a corporation, trust, or association is closely 
held if the stock ownership requirement of section 
465(a)(3) is met.’’
(B) Section 856(h)(3)(A)(i) is amended by 
striking ‘‘section 542(a)(2)’’ and inserting ‘‘section 
465(a)(3)’’.
(C) Paragraph (3) of section 856(h) is amended 
by striking subparagraph (B) and by redesignating 
subparagraphs (C) and (D) as subparagraphs (B) 
and (C), respectively. 
(D) Subparagraph (C) of section 856(h)(3), as 
redesignating by the preceding subparagraph, is 
amended by striking ‘‘subparagraph (C)’’ and insert-
ing ‘‘subparagraph (B)’’. 
(25) The last sentence of section 882(c)(2) is 
amended to read as follows: 
‘‘The preceding sentence shall not be construed to 
deny the credit provided by section 33 for tax with-
erences to sections 542 and 543 in the preceding 
sentence shall be treated as references to such sec-
tions as in effect on the day before their repeal.’’
(33) Sections 6422 is amended by striking 
paragraph (3) and by redesignating paragraphs (4) 
through (12) and paragraphs (3) through (11), re-
spectively. 
(34) Section 6501 is amended by striking sub-
section (f). 
(35) Section 6503(k) is amended by striking 
paragraph (1) and by redesignating paragraphs (2) 
through (5) as paragraphs (1) through (4), respec-
tively. 
(36) Section 6515 is amended by striking para-
graph (1) and by redesignating paragraphs (2) 
through (6) as paragraphs (1) through (5), respec-
tively. 
(37) Subsections (d)(1)(B) and (e)(2) of section 
6662 are each amended by striking ‘‘or a personal 
holding company (as defined in section 542)’’. 
(38) Section 6683 is hereby repealed. 
(c) CLERICAL AMENDMENTS.—
(1) The table of parts for subchapter G of 
chapter 1 is amended by striking the item relating 
to part II.
(2) The table of sections for part IV of such 
subchapter G is amended by striking the item relat-
ing to section 564. 
(3) The table of sections for part I of sub-
chapter B of chapter 68 is amended by striking the 
item relating to section 6683. 
(d) EFFECTIVE DATE.—The amendments made by 
this Act shall apply to taxable years beginning after De-
cember 31, 2003. 
Subtitle B—Uniform Definition of 
Child 
SEC. 121. UNIFORM DEFINITION OF CHILD. 
(a) PERSONAL EXEMPTION.—
(1) IN GENERAL.—Section 151, as amended by 
the preceding sections of this Act, is amended by re-
designating subsections (c), (d), (e), and (f) as sub-
sections (d), (e), (f), and (g), respectively, and by in-
serting after subsection (b) the following new sub-
section: 
‘‘(c) ADDITIONAL
EXEMPTION
FOR
QUALIFYING 
CHILDREN.—
‘‘(1) IN GENERAL.—An exemption of the ex-
emption amount for each qualifying child. 
‘‘(2) QUALIFYING CHILD.—For purposes of this 
section, the term ‘qualifying child’ means, with re-
spect to any taxpayer for any taxable year, an indi-
vidual—
‘‘(A) who bears a relationship to the tax-
payer described in paragraph (3), 
‘‘(B) who has the same principal place of 
abode as the taxpayer for more than 1⁄2 of such 
taxable year, and 
‘‘(C) who meets the age requirements of 
paragraph (4).
An individual shall not be treated as failing to meet 
the requirements of subparagraph (B) by reason of 
time of birth or death or by reason of temporary ab-
sences or other circumstances specified in the regu-
lations prescribed by the Secretary. 
‘‘(3) RELATIONSHIP TEST.—
‘‘(A) IN GENERAL.—For purposes of para-
graph (2)(A), an individual bears a relationship 
to the taxpayer described in this paragraph if 
such individual is—
‘‘(i) a son, daughter, stepson, or step-
daughter of the taxpayer or a descendant 
of any such relative, 
‘‘(ii) a brother, sister, stepbrother, or 
stepsister of the taxpayer or a descendant
of any such relative, whom the taxpayer 
cares for as the taxpayer’s own child, or 
‘‘(iii) an eligible foster child of the 
taxpayer. 
‘‘(B) ADOPTED CHILD.—For purposes of 
subparagraph (A), a child who is legally adopt-
ed, or who is placed with the taxpayer by an 
authorized placement agency for adoption by 
the taxpayer, shall be treated as a child by 
blood. 
‘‘(C) ELIGIBLE FOSTER CHILD.—For pur-
poses of subparagraph (A), the term ‘eligible 
foster child’ means an individual—
‘‘(i) who is placed with the taxpayer 
by an authorized placement agency or by 
judgment, decree, or other order of any 
court of competent jurisdiction, and 
‘‘(ii) whom the taxpayer cares for as 
the taxpayer’s own child. 
‘‘(4) AGE
REQUIREMENTS.—For purposes of 
paragraph (2)(C), an individual meets the require-
ments of this paragraph if such individual—
‘‘(A) has not attained the age of 19 as of 
the close of the calendar year in which the tax-
able year of the taxpayer begins,
‘‘(B) is a student who has not attained the 
age of 24 as of the close of such calendar year, 
or 
‘‘(C) is permanently and totally disabled 
(as defined in section 22(e)(3)) at any time 
during the taxable year. 
‘‘(5) SPECIAL RULES.—
‘‘(A) MARRIED
DEPENDENTS.—An indi-
vidual shall not be a qualifying child of a tax-
payer if such individual makes a joint return 
with the individual’s spouse under section 6013 
for the taxable year beginning in the calendar 
year in which the taxable year of the taxpayer 
begins. 
‘‘(B) INDIVIDUALS WHO SUPPORT THEM-
SELVES.—An individual shall not be a quali-
fying child of a taxpayer if such individual pro-
vides over half of such individual’s own support 
for the calendar year in which the taxable year 
of the taxpayer begins. 
‘‘(C) ONLY
EXEMPTION
AMOUNT.—An 
individual who is a qualifying child of any tax-
payer shall not be treated as the dependent of 
any taxpayer for purposes of this part.
‘‘(6) SPECIAL RULE RELATING TO 2 OR MORE 
CLAIMING QUALIFYING CHILD.—
‘‘(A) IN GENERAL.—Except as provided in 
paragraph (7), if an individual would (but for 
this paragraph) be a qualifying child of 2 or 
more taxpayers for taxable years beginning in 
the same calendar year, such individual shall be 
treated as the qualifying child of the taxpayer 
who is—
‘‘(i) a parent of the individual, or 
‘‘(ii) if none of such taxpayers is a 
parent of the individual, the taxpayer with 
the highest adjusted gross income for such 
taxable year. 
‘‘(B) PARENTS
NOT
FILING
JOINT
RE-
TURNS.—If an individual would (but for this 
paragraph) be a qualifying child of both parents 
of such individual and such parents do not file 
a joint return together, such child shall be 
treated as the qualifying child of—
‘‘(i) the parent with whom the child 
resided for the longest period during the 
taxable year, or 
‘‘(ii) if the child resides with both par-
ents for the same length of time during
such taxable year, the parent with the 
highest adjusted gross income. 
‘‘(C) FOSTER CHILDREN.—For purposes of 
this paragraph, the taxpayer shall be treated as 
a parent of any eligible foster child who has the 
same principal place of abode as the taxpayer 
for more than one-half of such taxable year. 
‘‘(7) SPECIAL RULE FOR CERTAIN PRE-2005 IN-
STRUMENTS.—
‘‘(A) IN GENERAL.—Notwithstanding para-
graph (6), a child who has parents who—
‘‘(i) are divorced or legally separated 
under a decree of divorce or separate 
maintenance, 
‘‘(ii) are separated under a written 
separation agreement, or 
‘‘(iii) live apart at all times during the 
last 6 months of the calendar year, 
shall be treated as being the qualifying child of 
the noncustodial parent for a calendar year if 
the requirements of subparagraph (B) are met. 
‘‘(B) REQUIREMENTS.—For purposes of 
subparagraph (A), the requirements of this sub-
paragraph are met if—
‘‘(i) such child would, but for this 
paragraph, be the qualifying child of the 
custodial parent, and 
‘‘(ii) a qualified pre-2005 instrument 
between the parents is applicable to such 
child for the taxable year beginning in such 
calendar year. 
In the case of an agreement executed before 
January 1, 1985, the requirements of this sub-
paragraph are met only if, in addition to meet-
ing the requirements of clauses (i) and (ii), the 
noncustodial parent provides at least $600 for 
the support of such child during such calendar 
year. 
‘‘(C) QUALIFIED PRE-2005 INSTRUMENT.—
For purposes of this paragraph, the term 
‘qualified pre-2005 instrument’ means any writ-
ten declaration referred to in subsection (e)(2) 
(as in effect on the day before the date of the 
enactment of the Individual and Small Business 
Tax Simplification Act of 2003)— 
‘‘(i) which is executed before January 
1, 2005, and 
‘‘(ii) which is not modified on or after 
such date in a modification which expressly
provides that this subsection shall not 
apply to such declaration. 
‘‘(D) CUSTODIAL PARENT AND NONCUSTO-
DIAL
PARENT.—For purposes of this sub-
section—
‘‘(i) CUSTODIAL PARENT.—The term 
‘custodial parent’ means the parent with 
whom a child shared the same principal 
place of abode for the greater portion of 
the calendar year. 
‘‘(ii) NONCUSTODIAL
PARENT.—The 
term ‘noncustodial parent’ means the par-
ent who is not the custodial parent. 
‘‘(E) SPECIAL RULES FOR SUPPORT.—For 
purposes of this subsection—
‘‘(i) amounts expended for the support 
of a child or children shall be treated as 
received from the noncustodial parent to 
the extent that such parent provided 
amounts for such support, and 
‘‘(ii) in the case of the remarriage of 
a parent, support of a child received from 
the parent’s spouse shall be treated as re-
ceived from the parent.’’. 
(2) CONFORMING AMENDMENTS.—
(A) Section 152 is amended by striking 
subsection (g) (relating to support test in case 
of child of divorced parents, etc.), as redesig-
nated by the preceding sections this Act. 
(B) Paragraph (6) of section 1(f), as 
amended by the preceding sections of this Act, 
is amended by striking ‘‘151(e)(3)(A)’’ and in-
serting ‘‘151(f)(3)(A)’’. 
(C) Paragraph (5) of section 21(e) is 
amended—
(i) by striking ‘‘paragraph (2) or (4) 
of section 152(e)’’ and inserting ‘‘section 
151(c)(7)’’, and 
(ii) by striking ‘‘section 152(e)(1)’’ 
and inserting ‘‘section 151(c)(7)’’. 
(D) Sections 21(e)(6) and 129(c) are each 
amended—
(i) by striking ‘‘151(c)’’ and inserting 
‘‘151(d)’’, and 
(ii) by striking ‘‘151(c)(3)’’ and in-
serting ‘‘151(d)(3)’’. 
(E) Sections 25(c)(2)(B), 32(c)(3)(C)(ii), 
152(d)(2), 
and 
2032A(c)(7)(D) 
are 
each 
amended by striking ‘‘151(c)(4)’’ and inserting 
‘‘151(d)(4)’’.
(F) 
Sections 
72(t)(7)(A)(iii) 
and 
132(h)(2)(B) are each amended by striking 
‘‘151(c)(3)’’ and inserting ‘‘151(d)(3)’’. 
(G) 
Subparagraph 
(C) 
of 
section 
642(b)(2), as amended by the preceding sec-
tions of this Act, is amended by striking 
‘‘151(e)’’ and inserting ‘‘151(f)’’. 
(H) Paragraph (1) of section 3402(f) is 
amended by striking ‘‘151(e)(2)’’ and inserting 
‘‘151(f)(2)’’. 
(I) 
Subparagraph 
(B) 
of 
section 
3402(r)(2), as so amended, is amended by 
striking ‘‘151(e)’’ and inserting ‘‘151(f)’’. 
(J) Clause (ii) of section 6012(a)(1)(D), as 
so amended, is amended—
(i) by striking ‘‘151(e)’’ and inserting 
‘‘151(f)’’, and 
(ii) by striking ‘‘151(e)(2)’’ and in-
serting ‘‘151(f)(2)’’. 
(K) 
The 
last 
sentence 
of 
section 
6013(b)(3)(A), as so amended is amended by 
striking ‘‘151(e)’’ and inserting ‘‘151(f)’’. 
(b) APPLICATION OF UNIFORM DEFINITION TO DE-
PENDENT CARE CREDIT.—Section 21(b)(1)(A) is amend-
ed to read as follows:
‘‘(A) a qualifying child of the taxpayer (as 
defined in section 151(c)) who has not attained 
age 13,’’. 
(c) APPLICATION
OF
UNIFORM
DEFINITION
TO 
CHILD TAX CREDIT.—Section 24(c)(1) is amended to 
read as follows: 
‘‘(1) IN GENERAL.—The term ‘qualifying child’ 
means a qualifying child of the taxpayer (as defined 
in section 151(c)) who has not attained age 17 as
of the close of the calendar year in which the taxable 
year of the taxpayer begins.’’. 
(d) APPLICATION
OF
UNIFORM
DEFINITION
TO 
EARNED INCOME CREDIT.—
(1) IN
GENERAL.—Paragraph (3) of section 
32(c) is amended to read as follows: 
‘‘(3) QUALIFYING CHILD.—
‘‘(A) IN GENERAL.—The term ‘qualifying 
child’ means a qualifying child of the taxpayer 
(as defined in section 151(c)). 
‘‘(B) PLACE OF ABODE.—For purposes of 
subparagraph (A), the requirements of section 
151(c)(2)(B) shall be met only if the principal 
place of abode is in the United States. 
‘‘(C) IDENTIFICATION REQUIREMENTS.—
‘‘(i) IN GENERAL—A qualifying child 
shall not be taken into account under sub-
section (b) unless the taxpayer includes the 
name, age, and TIN of the qualifying child 
on the return of tax for the taxable year. 
‘‘(ii) OTHER
METHODS.—The Sec-
retary may prescribe other methods for 
providing the information described in 
clause (i).’’. 
(2) CONFORMING AMENDMENTS.—
(A) Section 32(c)(1) is amended by strik-
ing subparagraph (C) and by redesignating sub-
paragraphs (D), (E), (F), and (G) as subpara-
graphs (C), (D), (E), and (F), respectively. 
(B) Section 32(c)(4) is amended by strik-
ing ‘‘(3)(E)’’ and inserting ‘‘(3)(B)’’. 
(C) Section 32(m) is amended by striking 
‘‘subsections (c)(1)(F)’’ and inserting ‘‘sub-
sections (c)(1)(E)’’. 
SEC. 122. TREATMENT OF GOVERNMENT BENEFITS IN DE-
TERMINING SUPPORT AND COST OF MAIN-
TAINING HOUSEHOLD. 
(a) DEPENDENCY
EXEMPTION.—Section 152 is 
amended by adding at the end the following new sub-
section:
‘‘(f) SPECIAL RULE RELATING TO TREATMENT OF 
GOVERNMENT BENEFITS IN DETERMINING SUPPORT.—
For purposes of this part, any means-tested benefits ob-
tained under programs described in section 6103(l)(7) or 
substantially similar government programs shall not be 
taken into account for purposes of determining—
‘‘(1) whether over half of the support of an in-
dividual for a calendar year is received from a tax-
payer, and 
‘‘(2) whether over half of the cost of maintain-
ing a household is furnished by a taxpayer.’’. 
(b) DEPENDENT CARE CREDIT.—Section 21(e)(1) is 
amended by adding at the end the following: ‘‘Any means-
tested benefits obtained under programs described in sec-
tion 6103(l)(7) or substantially similar government pro-
grams shall not be taken into account for purposes of de-
termining whether over half of the cost of maintaining a 
household is furnished by the individual.’’. 
(c) MARITAL STATUS.—Section 7703 (relating to de-
termination of marital status) is amended by adding at 
the end the following new subsection: 
‘‘(c) SPECIAL RULE RELATING TO TREATMENT OF 
GOVERNMENT BENEFITS
IN DETERMINING COST
OF 
MAINTAINING HOUSEHOLD.—For purposes of subsection 
(b)(2), any means-tested benefits obtained under pro-
grams described in section 6103(l)(7) or substantially 
similar government programs shall not be taken into ac-
count for purposes of determining whether over half of the 
cost of maintaining a household is furnished by the indi-
vidual.’’. 
SEC. 123. EFFECTIVE DATE. 
The amendments made by this subtitle shall apply to 
taxable years beginning after December 31, 2003. 
Subtitle C—Education Tax 
Incentives 
SEC. 131. HOPE AND LIFETIME LEARNING CREDITS COM-
BINED. 
(a) IN GENERAL.—So much of section 25A (relating 
to Hope and Lifetime Learning Credits) as precedes sub-
section (d) is amended to read as follows: 
‘‘SEC. 25A. EDUCATION CREDIT. 
‘‘(a) ALLOWANCE OF CREDIT.—In the case of an in-
dividual, there shall be allowed as a credit against the tax 
imposed by this chapter for the taxable year the amount 
equal to 50 percent of so much of the qualified expenses 
paid by the taxpayer during the taxable year (for edu-
cation furnished to an individual during any academic pe-
riod beginning in such taxable year) as does not exceed 
$3,000 for such taxable year with respect to such indi-
vidual.
‘‘(b) QUALIFIED EXPENSES.—For purposes of sub-
section (a), the term ‘qualified expenses’ means the sum 
of—
‘‘(1) qualified higher education expenses, and 
‘‘(2) the expenses described in subsection (d)(1) 
with respect to any course of instruction at an eligi-
ble educational institution to acquire or improve job 
skills of the individual.’’. 
(b) CONFORMING AMENDMENTS TO CREDIT.—
(1) Section 25A is amended—
(A) by striking subsection (h), and 
(B) by redesignating subsections (e), (f), 
(g), and (i) as subsections (c), (d), (e), and (f), 
respectively. 
(2) Subsection (e)(2) of section 25A, as so re-
designated, is amended by striking ‘‘(before the ap-
plication of subsections (b), (c), and (d))’’. 
(c) OTHER CONFORMING AND CLERICAL AMEND-
MENTS.—
(1) The following provisions are each amended 
by striking ‘‘section 25A(g)(2)’’ and inserting ‘‘sec-
tion 25A(e)(2)’’: 
(A) Section 72(t)(7)(B). 
(B) Section 221(d)(2)(B).
(C) Section 222(d)(1) (as amended by sec-
tion 132 of this Act). 
(D) Section 529(c)(3)(B)(v)(I). 
(E) Section 530(b)(2)(A). 
(F) Section 530(d)(2)(C)(i)(I). 
(G) Section 530(d)(4)(B)(iii). 
(2) Section 221(d) is amended—
(A) in paragraph (2) by striking ‘‘section 
25A(f)(2)’’ and inserting ‘‘section 25A(d)(2)’’, 
and 
(B) by amending paragraph (3) to read as 
follows: 
‘‘(3) ELIGIBLE STUDENT.—The term ‘eligible 
student’ means, with respect to any academic period, 
a student who—
‘‘(A) meets the requirements of section 
484(a)(1) of the Higher Education Act of 1965 
(20 U.S.C. 1091(a)(1)), as in effect on the date 
of the enactment of this section, and 
‘‘(B) is carrying at least 1⁄2 the normal 
full-time work load for the course of study the 
student is pursuing.’’. 
(3) Section 529(e)(3)(B)(i) is amended by strik-
ing ‘‘section 25A(b)(3)’’ and inserting ‘‘section 
221(d)(3)’’.
(4) The heading of section 529(c)(3)(B)(v) is 
amended to read as follows: ‘‘COORDINATION WITH 
EDUCATION CREDIT.—’’. 
(5) The heading of section 530(d)(2)(C) is 
amended to read as follows: ‘‘COORDINATION WITH 
EDUCATION CREDIT AND QUALIFIED TUITION PRO-
GRAMS.—’’. 
(6) Section 6050S(e) is amended by striking 
‘‘subsection 
(g)(2)’’ 
and 
inserting 
‘‘subsection 
(e)(2)’’. 
(7) Section 6213(g)(2)(J) is amended by strik-
ing ‘‘section 25A(g)(1)’’ and inserting ‘‘section 
25A(e)(1)’’. 
(8) The item relating to section 25A in the 
table of sections for subpart A of part IV of sub-
chapter A of chapter 1 is amended to read as fol-
lows:
‘‘Sec. 25A. Education Credit.’’.
(d) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003. 
SEC. 132. UNIFORM DEFINITION OF QUALIFYING HIGHER 
EDUCATION EXPENSES. 
(a) IN GENERAL.—Paragraph (3) of section 529(e) 
(relating to other definitions and special rules) is amended 
to read as follows:
‘‘(3) QUALIFIED
HIGHER
EDUCATION
EX-
PENSES.—
‘‘(A) IN
GENERAL.—The term ‘qualified 
higher education expenses’ means—
‘‘(i) tuition, fees, books, supplies, and 
equipment required for the enrollment or 
attendance of a designated beneficiary at 
an eligible educational institution; and 
‘‘(ii) expenses for special needs serv-
ices in the case of a special needs bene-
ficiary which are incurred in connection 
with such enrollment or attendance. 
‘‘(B) ROOM
AND
BOARD
INCLUDED
FOR 
STUDENTS WHO ARE AT LEAST HALF-TIME.—
‘‘(i) IN GENERAL.—In the case of an 
individual who is an eligible student for 
any academic period, such term shall also 
include reasonable costs for such period (as 
determined under the qualified tuition pro-
gram) incurred by the designated bene-
ficiary for room and board while attending 
such institution. For purposes of sub-
section (b)(7), a designated beneficiary 
shall be treated as meeting the require-
ments of this clause.
‘‘(ii) LIMITATION.—The amount treat-
ed as qualified higher education expenses 
by reason of clause (i) shall not exceed—
‘‘(I) the allowance (applicable to 
the student) for room and board in-
cluded in the cost of attendance (as 
defined in section 472 of the Higher 
Education Act of 1965 (20 U.S.C. 
1087ll), as in effect on the date of the 
enactment of the Economic Growth 
and Tax Relief Reconciliation Act of 
2001) as determined by the eligible 
educational institution for such pe-
riod, or 
‘‘(II) if greater, the actual invoice 
amount the student residing in hous-
ing owned or operated by the eligible 
educational institution is charged by 
such institution for room and board 
costs for such period. 
‘‘(iii) ELIGIBLE STUDENT.—For pur-
poses of this subparagraph, the term ‘eligi-
ble student’ means, with respect to any 
academic period, a student who—
‘‘(I) meets the requirements of 
section 484(a)(1) of the Higher Edu-
cation Act of 1965 (20 U.S.C. 
1091(a)(1)), as in effect on the date 
of the enactment of this section, and 
‘‘(II) is carrying at least 1⁄2 the 
normal full-time work load for the
course of study the student is pur-
suing. 
‘‘(C) EXCEPTIONS.—
‘‘(i) EXCEPTION FOR EDUCATION IN-
VOLVING
SPORTS, ETC.—Such term does 
not include 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) EXCEPTION FOR NONACADEMIC 
FEES.—Such term does not include stu-
dent activity fees, athletic fees, insurance 
expenses, or other expenses unrelated to an 
individual’s academic course of instruc-
tion.’’. 
(b) CONFORMING AMENDMENTS.—
(1) Section 25A and 6050S are each amended 
by striking ‘‘qualified tuition and related expenses’’ 
each place it appears and inserting ‘‘qualified higher 
education expenses’’. 
(2) Section 25A(f)(1) is amended to read as fol-
lows: 
‘‘(1) QUALIFIED
HIGHER
EDUCATION
EX-
PENSES.—The term ‘qualified higher education ex-
penses’ means the qualified higher education ex-
penses (as defined by section 529(e)(3) without re-
gard to subparagraph (B) thereof) required for the 
enrollment or attendance of—
‘‘(A) the taxpayer, 
‘‘(B) the taxpayer’s spouse, or 
‘‘(C) any dependent of the taxpayer with 
respect to whom the taxpayer is allowed a de-
duction under section 151, 
at an eligible educational institution for courses of 
instruction of such individual at such institution.’’. 
(3) Section 135(c)(2) is amended—
(A) by striking ‘‘tuition and fees’’ and in-
serting ‘‘the qualified higher education expenses 
(as defined by section 529(e)(3) without regard 
to subparagraph (B) thereof)’’, and
(B) by striking subparagraph (B) and re-
designating subparagraph (C) as subparagraph 
(B). 
(4) Section 221(d)(2) is amended by striking 
‘‘the cost of attendance (as defined in section 472 of 
the Higher Education Act of 1965, 20 U.S.C. 
1087ll, as in effect on the day before the date of the 
enactment of this Act)’’ and inserting ‘‘the qualified 
higher education expenses (as defined by section 
529(e)(3) without regard to subparagraph (B) there-
of) incurred for attendance’’. 
(5)(A) Section 222 is amended by striking 
‘‘qualified tuition and related expenses’’ each place 
it appears and inserting ‘‘qualified higher education 
expenses’’. 
(B) Section 222(d)(1) is amended to read as 
follows: 
‘‘(1) QUALIFIED
HIGHER
EDUCATION
EX-
PENSES.—The term ‘qualified higher education ex-
penses’ has the meaning given such term by section 
529(e)(3) (without regard to subparagraph (B) 
thereof). Such expenses shall be reduced in the same 
manner as under section 25A(g)(2).’’.
(C) Section 222(d) is amended by redesignating 
paragraph (6) as paragraph (7) and by inserting 
after paragraph (5) the following new paragraph: 
‘‘(6) ROOM AND BOARD INCLUDED FOR STU-
DENTS WHO ARE FULL-TIME.—No amount shall be 
taken into account under this section for an expense 
described in section 529(e)(3)(B) (relating to room 
and board included for students who are at least 
half-time) unless such individual is an eligible stu-
dent (as defined in section 25A(b)(3), determined by 
substituting ‘the normal full-time work load’ in lieu 
of ‘1⁄2 the normal full-time work load’ in subpara-
graph (B) thereof.’’. 
(D) The heading for section 222 is amended by 
striking ‘‘TUITION AND RELATED’’ and in-
serting ‘‘HIGHER EDUCATION’’. 
(E) The table of sections for part VII of sub-
chapter B of chapter 1 is amended by amending the 
item relating to section 222 to read as follows:
‘‘Sec. 222. Qualified higher education expenses.’’.
(6)(A) Section 6724(d) is amended—
(i) in paragraph (1)(B)(x) by striking 
‘‘qualified tuition and related expenses’’ and in-
serting ‘‘qualified higher education expenses’’, 
and
(ii) in paragraph (2)(Z) by striking ‘‘quali-
fied tuition and related expenses’’ and inserting 
‘‘qualified higher education expenses’’. 
(c) EFFECTIVE DATE.—The amendments made by 
this section shall apply to amounts paid in taxable years 
beginning after December 31, 2003, for education fur-
nished in periods beginning after such date. 
TITLE II—SMALL BUSINESS TAX 
SIMPLIFICATION 
SEC. 201. UNIFIED PASS-THRU ENTITY REGIME. 
(a) TERMINATION OF S CORPORATION STATUS.—
(1) NO
NEW
S
CORPORATION
ELECTIONS.—
Subsection (a) of section 1362 is amended by adding 
at the end the following new paragraph: 
‘‘(3) TERMINATION
OF
AUTHORITY
TO
MAKE 
ELECTION.—No election may be made under para-
graph (1) for any taxable year beginning after De-
cember 31, 2003.’’. 
(2) TERMINATION OF STATUS.—Subsection (d) 
of section 1362 (relating to termination) is amended 
by adding at the end the following new paragraph: 
‘‘(4) TREATMENT
AS
PARTNERSHIP
AFTER 
2012.—An election under subsection (a)—
‘‘(A) shall not be effective for any taxable 
year beginning after December 31, 2012, and
‘‘(B) shall be treated as an election under 
section 7701(a)(2)(B)(iii) for taxable years be-
ginning after such date.’’. 
(3) EFFECTIVE DATE.—The amendments made 
by this subsection shall apply to taxable years begin-
ning after December 31, 2003. 
(b) ELECTION BY CERTAIN CORPORATIONS TO BE 
TAXED AS PARTNERSHIP.—
(1) IN
GENERAL.—Paragraph (2) of section 
7701 (defining partnership and partner) is amended 
to read as follows:
‘‘(2) PARTNERSHIP AND PARTNER.—
‘‘(A) IN
GENERAL.—The term ‘partner-
ship’ includes a syndicate, group, pool, joint 
venture, or other unincorporated organization, 
through or by means of which any business, fi-
nancial operation, or venture is carried on, and 
which is not, within the meaning of this title, 
a trust or estate or a corporation; and the term 
‘partner’ includes a member in such a syn-
dicate, group, pool, joint venture, or organiza-
tion. 
‘‘(B) ELECTION BY CORPORATION TO BE 
TAXED AS PARTNERSHIP.—
‘‘(i) IN
GENERAL.—An eligible cor-
poration may elect to be treated as a part-
nership for purposes of this title. 
‘‘(ii) ELIGIBLE
CORPORATION.—For 
purposes of clause (i), the term ‘eligible 
corporation’ means an entity—
‘‘(I) which, without regard to this 
subparagraph, is a domestic corpora-
tion no stock of which is readily 
tradable on an established securities 
market or otherwise, and 
‘‘(II) which is not an ineligible 
corporation (as defined by section 
1361(b)(2)). 
‘‘(iii) 
ELECTION
AND
TERMI-
NATION.—For purposes of this subpara-
graph, rules similar to the rules of section 
1362 (other than subsections (a)(3), (d)(3) 
and (4), and (e) thereof) shall apply. 
‘‘(iv) EFFECT
OF
ELECTION.—No 
gain or loss shall be recognized by the 
shareholders or the corporation by reason 
of an election under this subparagraph, 
and rules similar to the rules of sections 
1366(f)(2) and 1374 shall apply.
‘‘(v) 
DISTRIBUTIONS, 
ETC.—Each 
partner shall include in gross income as a 
dividend, any amount that would have been 
so includible had the entity been an S cor-
poration during the period the entity was 
treated as a partnership. Notwithstanding 
the preceding sentence, the provisions of 
subchapter K of chapter 1 shall apply to 
determine the basis of any property dis-
tributed and the basis of any interest in 
the partnership.’’. 
(2) MODIFICATION TO TREATMENT OF SECTION 
1374 TAX FOR EARNINGS AND PROFITS PURPOSES.—
Paragraph (2) of section 1366(f) is amended to read 
as follows: 
‘‘(2) TREATMENT OF TAX IMPOSED ON BUILD-
IN GAINS.—
‘‘(A) IN
GENERAL.—The amount of the 
items of the net recognized built-in-gain taken 
into account under section 1374(b)(1) (reduced 
by 
any 
deduction 
allowed 
under 
section 
1374(b)(2)) shall not be taken into account 
under this section. 
‘‘(B) EARNINGS AND PROFITS.—The accu-
mulated earnings and profits of the corporation
shall be increased at the beginning of the tax-
able year by the amount not taken into account 
under this section by reason of subparagraph 
(A) (determined without regard to section 
1374(b)(2)) reduced by the tax imposed by sec-
tion 1374 (net of credits allowed).’’. 
(3) EFFECTIVE DATE.—The amendments made 
by this subsection shall apply to taxable years begin-
ning after December 31, 2003. 
(c) STEP TRANSACTION DOCTRINE NOT TO APPLY 
TO PARTNERSHIP INCORPORATION FOLLOWED BY COR-
PORATE REORGANIZATION.—
(1) IN GENERAL.—Section 351 is amended by 
redesignating subsection (h) as subsection (i) and by 
inserting after subsection (g) the following new sub-
section: 
‘‘(h) SPECIAL RULE FOR PARTNERSHIPS WHICH IN-
CORPORATE
AND
SUBSEQUENTLY
REORGANIZE.—The 
step transaction doctrine and any similar doctrine shall 
not apply for purposes of determining whether the control 
requirement of subsection (a) is met in any case in 
which—
‘‘(1) a partnership engaged in an active trade 
or business transfers substantially all of the property
used in carrying on such trade or business to a cor-
poration which is not publicly traded, and 
‘‘(2) such corporation subsequently enters into 
a reorganization under this chapter.’’. 
(2) EFFECTIVE DATE.—The amendment made 
by this subsection shall apply to transactions after 
December 31, 2003. 
SEC. 202. INCREASE IN EXPENSING UNDER SECTION 179. 
(a) INCREASE IN DOLLAR LIMITATIONS.—
(1) IN
GENERAL.—Paragraph (1) of section 
179(b) (relating to dollar limitation) is amended to 
read as follows: 
‘‘(1) DOLLAR LIMITATION.—The aggregate cost 
which may be taken into account under subsection 
(a) for any taxable year shall not exceed $25,000 
($40,000 in the case of taxable years beginning after 
December 31, 2013).’’. 
(2) INCREASE
IN
PHASEOUT
THRESHOLD.—
Paragraph (2) of section 179(b) is amended by in-
serting before the period ‘‘($325,000 in the case of 
taxable years beginning after December 31, 2013).’’. 
(b) INFLATION ADJUSTMENTS.—
(1) IN
GENERAL.—Subsection (b) of section 
179 is amended by redesignating paragraphs (3) and 
(4) as paragraphs (4) and (5), respectively, and by
inserting after paragraph (2) the following new 
paragraph: 
‘‘(3) INFLATION ADJUSTMENT.—In the case of 
any taxable year beginning in a calendar year after 
2005, the dollar amounts contained in paragraphs 
(1) and (2) which would (but for this paragraph) 
apply to such taxable year shall be increased by an 
amount equal to the product of—
‘‘(A) such dollar amount, and
‘‘(B) the cost-of-living adjustment deter-
mined under section 1(f)(3) for the calendar 
year in which the taxable year begins, deter-
mined by substituting in subparagraph (B) 
thereof—
‘‘(i) ‘calendar year 2004’ for ‘calendar 
year 1992’ with respect to the $25,000 
and $200,000 amounts, and 
‘‘(ii) ‘calendar year 2012’ for ‘cal-
endar year 1992’ with respect to the 
$40,000 and $325,000 amounts. 
If any amount after adjustment under the preceding 
sentence is not a multiple of $1,000, such amount 
shall be rounded to the next lowest multiple of 
$1,000.’’.
(2) CONFORMING AMENDMENT.—Subparagraph 
(B) of section 179(b)(5), as redesignated by para-
graph (1), is amended by striking ‘‘paragraph (3)’’ 
and inserting ‘‘paragraph (4)’’. 
(c) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003.
SEC. 203. ROLLOVER OF PROPERTY HELD FOR PRODUC-
TIVE USE OR INVESTMENT. 
(a) IN GENERAL.—Section 1031 (relating to ex-
change of property held for productive use or investment) 
is amended to read as follows: 
‘‘SEC. 1031. ROLLOVER OF PROPERTY HELD FOR PRODUC-
TIVE USE OR INVESTMENT. 
‘‘(a) NONRECOGNITION OF GAIN.—In the case of the 
sale of section 1031 property with respect to which the 
taxpayer elects the application of this section, gain from 
such sale shall be recognized only to the extent that the 
amount realized on such sale exceeds—
‘‘(1) the cost of replacement section 1031 prop-
erty purchased during the rollover period, reduced 
by 
‘‘(2) any portion of such cost previously taken 
into account under this section. 
‘‘(b) DEFINITIONS.—For purposes of this section—
‘‘(1) SECTION 1031 PROPERTY.—
‘‘(A) IN
GENERAL.—The term ‘section 
1031 property’ means any property held for 
productive use in a trade or business or for in-
vestment. 
‘‘(B) EXCEPTIONS.—The term ‘section 
1031 property’ shall not include the following: 
‘‘(i) Stock in trade or other property 
held primarily for sale. 
‘‘(ii) Stocks, bonds, or notes. 
‘‘(iii) Other securities or evidences of 
indebtedness or interest. 
‘‘(iv) Interests in a partnership. 
‘‘(v) Certificates of trust or beneficial 
interests. 
‘‘(vi) Choses in action. 
‘‘(2) 
REPLACEMENT
SECTION
1031
PROP-
ERTY.—The term ‘replacement section 1031 prop-
erty’ means, with respect to the sale of any section 
1031 property, other section 1031 property which is 
of a like kind to the section 1031 property sold. 
‘‘(3) ROLLOVER
PERIOD.—The term ‘rollover 
period’ means, with respect to the sale of any prop-
erty, the period which begins 180 days before the 
date of such sale and ends on the earlier of—
there shall be no nonrecognition of gain under this 
section to the taxpayer with respect to such sale, 
and any gain recognized by the taxpayer by reason 
of this subsection shall be taken into account as of 
the date on which the disposition referred to in sub-
paragraph (C) occurs. 
‘‘(2) PURCHASE
BY
TAXPAYER.—If the tax-
payer—
‘‘(A) purchases property from a related 
person which is taken into account under sub-
section (a)(1) (determined without regard to 
this subsection), and 
‘‘(B) disposes of such property before the 
date 2 years after the date of such purchase, 
such property shall not be taken into account under 
subsection (a)(1), and any gain recognized by reason 
of this subsection shall be taken into account on the 
date on which the disposition referred to in subpara-
graph (B) occurs. 
‘‘(3) CERTAIN DISPOSITIONS NOT TAKEN INTO 
ACCOUNT.— For purposes of paragraphs (1)(C) and 
(2)(B), there shall not be taken into account any 
disposition—
‘‘(A) after the earlier of the death of the 
taxpayer or the death of the related person,
‘‘(B) in a compulsory or involuntary con-
version (within the meaning of section 1033) if 
the transaction occurred before the threat or 
imminence of such conversion, or 
‘‘(C) with respect to which it is established 
to the satisfaction of the Secretary that neither
the transaction nor such disposition had as one 
of its principal purposes the avoidance of Fed-
eral income tax. 
‘‘(4) RELATED PERSON.— For purposes of this 
subsection, the term ‘related person’ means any per-
son bearing a relationship to the taxpayer described 
in section 267(b) or 707(b)(1). 
‘‘(5) SPECIAL RULE WHERE SUBSTANTIAL DIMI-
NUTION OF RISK.—
‘‘(A) IN GENERAL.—If subparagraph (B) 
applies to any property for any period, the run-
ning of the period set forth in paragraph (1)(C) 
with respect to such property shall be sus-
pended during such period. 
‘‘(B) PROPERTY
TO
WHICH
PARAGRAPH 
APPLIES.—This subparagraph shall apply to 
any property for any period during which the 
holder’s risk of loss with respect to the property 
is substantially diminished by—
‘‘(i) the holding of a put with respect 
to such property, 
‘‘(ii) the holding by another person of 
a right to acquire such property, or 
‘‘(iii) a short sale or any other trans-
action. 
‘‘(6) 
TREATMENT
OF
CERTAIN
TRANS-
ACTIONS.—This section shall not apply to any trans-
action which is part of a series of transactions struc-
tured to avoid the purposes of this subsection. 
‘‘(e) SPECIAL RULES.—For purposes of this sec-
tion—
‘‘(1) EXCHANGES.—A contemporaneous ex-
change by the taxpayer of section 1031 property for 
replacement section 1031 property shall be treated 
as a sale of such section 1031 property and a pur-
chase of such replacement section 1031 property 
without regard to whether the taxpayer makes the 
election described in subsection (a). In the case of 
such an exchange, no loss shall be recognized. 
‘‘(2) CERTAIN PARTNERSHIPS.—An interest in 
a partnership which has in effect a valid election 
under section 761(a) to be excluded from the appli-
cation of all of subchapter K shall be treated as an
interest in each of the assets of such partnership 
and not as an interest in a partnership. 
‘‘(3) LIVESTOCK OF DIFFERENT SEXES.—Live-
stock of different sexes are not property of a like 
kind. 
‘‘(4) FOREIGN REAL PROPERTY.—Real property 
located in the United States and real property lo-
cated outside the United States are not property of 
a like kind. 
‘‘(5) FOREIGN PERSONAL PROPERTY.—
‘‘(A) IN
GENERAL.—Personal property 
used predominantly within the United States 
and personal property used predominantly out-
side the United States are not property of a like 
kind. 
‘‘(B) PREDOMINANT USE.—Except as pro-
vided in subparagraphs (C) and (D), the pre-
dominant use of any property shall be deter-
mined based on— 
‘‘(i) in the case of the sale of any 
property by the taxpayer, the 2-year period 
ending on the date of such sale, and 
‘‘(ii) in the case of the purchase of 
any property by the taxpayer, the 2-year
period beginning on the date of such pur-
chase. 
‘‘(C) PROPERTY HELD FOR LESS THAN 2 
YEARS.—Except in the case of a sale or pur-
chase which is part of a transaction (or series 
of transactions) structured to avoid the pur-
poses of this subsection, only the periods the 
property was held by the taxpayer (or any re-
lated person) shall be taken into account under 
subparagraph (B). 
‘‘(D) SPECIAL RULE FOR CERTAIN PROP-
ERTY.—Property described in any subpara-
graph of section 168(g)(4) shall be treated as 
used predominantly in the United States.’’. 
(b) PRESERVATION OF CERTAIN GAIN, LOSS, AND 
BASIS RULES FOR EXCHANGES.—
(1) Section 1035 (relating to certain exchanges 
of insurance policies) is amended—
(A) by striking subsection (d), 
(B) by redesignating subsections (b) and 
(c) as subsections (e) and (f), respectively, and 
(C) by inserting after subsection (a) the 
following new subsections: 
‘‘(b) GAIN FROM EXCHANGES NOT SOLELY
IN 
KIND.—If an exchange would be within the provisions of
subsection (a), of section 1036(a), or of section 1037(a), 
if it were not for the fact that the property received in 
exchange consists not only of property permitted by such 
provisions to be received without the recognition of gain, 
but also of other property or money, then the gain, if any, 
to the recipient shall be recognized, but in an amount not 
in excess of the sum of such money and the fair market 
value of such other property. 
‘‘(c) LOSS FROM EXCHANGES NOT SOLELY
IN 
KIND.—If an exchange would be within the provisions of 
subsection (a), of section 1036(a), or of section 1037(a), 
if it were not for the fact that the property received in 
exchange consists not only of property permitted by such 
provisions to be received without the recognition of gain 
or loss, but also of other property or money, then no loss 
from the exchange shall be recognized. 
‘‘(d) BASIS.—If property was acquired on an ex-
change described in subsection (a), section 1036(a), or 
section 1037(a), then the basis shall be the same as that 
of the property exchanged, decreased in the amount of any 
money received by the taxpayer and increased in the 
amount of gain or decreased in the amount of loss to the 
taxpayer that was recognized on such exchange. If the 
property so acquired consisted in part of the type of prop-
erty permitted by subsection (a), section 1036(a), or sec-
tion 1037(a), to be received without the recognition of 
gain or loss, and in part of other property, the basis pro-
vided in this subsection shall be allocated between the 
properties (other than money) received, and for the pur-
pose of the allocation there shall be assigned to such other 
property an amount equivalent to its fair market value at 
the date of the exchange. For purposes of subsection (a) 
and section 1036(a), where as part of the consideration
to the taxpayer another party to the exchange assumed 
(as determined under section 357(d)) a liability of the tax-
payer, such assumption shall be considered as money re-
ceived by the taxpayer on the exchange.’’. 
(2) Section 83(g), section 424(b), section 
424(c)(1)(B), section 454(c)(2), paragraphs (1) and 
(2) of section 1036(c), and paragraphs (1) and (2) 
of section 1037(c) are each amended by striking 
‘‘section 1031’’ and inserting ‘‘section 1035’’. 
(3) Paragraphs (1) and (2) of section 1037(b) 
are each amended by striking ‘‘section 1031(b)’’ and 
inserting ‘‘section 1035(b)’’. 
(c) CONFORMING AMENDMENTS.—
(1) Clause (i) of section 197(f)(2)(B) is amend-
ed by inserting ‘‘(including any purchase taken into 
account under subsection (a)(1) thereof)’’ after 
‘‘1031’’.
(2) Paragraph (6) of section 453(f) is amended 
to read as follows: 
‘‘(6) LIKE-KIND EXCHANGES.—In the case of 
any sale or exchange to which section 1031 applies, 
the total contract price, the gross profit from such 
sale, and the amount of any payment (other than for 
purposes of subsection (b)(1)) shall be reduced to 
take into account any amount not recognized by rea-
son of section 1031. Similar rules shall apply in the 
case of an exchange which is described in section 
356(a) and is not treated as a dividend.’’. 
(3) BASIS LIMITATION FOR PLAYER CONTRACTS 
TRANSFERRED IN CONNECTION WITH THE SALE OF 
A FRANCHISE.—Paragraph (1) of section 1056(b) is 
amended to read as follows: 
‘‘(1) to any sale or exchange to which section 
1031 applies, and’’. 
(4) VALUATION OF CERTAIN FARM, ETC., REAL 
PROPERTY.—
(A) Clause (i) of section 2032A(e)(14)(C) 
is amended to read as follows: 
‘‘(i) QUALIFIED REPLACEMENT PROP-
ERTY.—The term ‘qualified replacement 
property’ means any real property the ac-
quisition of which results in the non-
recognition of gain under section 1031 or 
1033.’’. 
(B) 
Subclause 
(I) 
of 
section 
2032A(e)(14)(C)(ii) is amended by inserting 
‘‘sale or’’ before ‘‘exchange’’. 
(C) Subsection (i) of section 2032A is 
amended to read as follows: 
‘‘(i) REPLACEMENT
OF QUALIFIED REAL PROP-
ERTY.—
‘‘(1) TREATMENT OF PROPERTY SOLD OR EX-
CHANGED.—
‘‘(A) SALES
AND
EXCHANGES
WITH
NO 
RECOGNITION OF GAIN.—If an interest in quali-
fied real property is sold or exchanged and no 
gain is recognized under section 1031 by reason 
of the acquisition of qualified replacement prop-
erty, no tax shall be imposed by subsection (c) 
by reason of such sale or exchange. 
‘‘(B) SALES AND EXCHANGES WITH PAR-
TIAL RECOGNITION OF GAIN.—Except as pro-
vided in paragraph (1), if an interest in quali-
fied real property is sold or exchanged and a 
portion of the gain is not recognized under sec-
tion 1031 by reason of the acquisition of quali-
fied replacement property, the amount of the
tax imposed by subsection (c) by reason such 
sale or exchange shall be the amount of tax 
which (but for this paragraph) would have been 
imposed on such sale or exchange under sub-
section (c)(1), reduced by an amount which— 
‘‘(i) bears the same ratio to such tax, 
as 
‘‘(ii) the fair market value of the 
qualified replacement property (determined 
as of the time or acquisition) bears to the 
fair market value of the qualified real 
property sold or exchanged (determined as 
of the time of disposition). 
‘‘(2) TREATMENT OF QUALIFIED REPLACEMENT 
PROPERTY.—For purposes of subsection (c)—
‘‘(A) any interest in qualified replacement 
property shall be treated in the same manner as 
if it were a portion of the interest in the quali-
fied real property which was sold or exchanged, 
‘‘(B) any tax imposed by subsection (c) by 
reason of the sale or exchange shall be treated 
as a tax imposed on a partial disposition, and 
‘‘(C) paragraph (6) of subsection (c) shall 
be applied by treating material participation 
with respect to the sold or exchanged property
(c) EFFECTIVE DATE.—The amendments made by 
this section shall apply to sales, exchanges, and distribu-
tions made after the date of the enactment of this Act. 
SEC. 205. REFERENCES TO GENERAL PARTNERS. 
(a) EXCLUSION OF CERTAIN ACTIVE BUSINESSES 
FROM
AT
RISK
RULES.—Subclause (I) of section 
465(c)(7)(D)(ii) (defining qualified corporate partner) is 
amended to read as follows:
‘‘(I) such corporation is not pro-
hibited or limited under State law 
from participation in the management 
or business of the partnership.’’. 
(b) PAYMENTS TO RETIRING PARTNERS.—Subpara-
graph (B) of section 736(b)(3) (relating to limitation on 
application of paragraph (2)) is amended to read as fol-
lows: 
‘‘(B) any portion of the retiring or de-
ceased partner’s distributive share of partner-
ship income was subject to tax under section 
1401.’’. 
(c) FOREIGN CURRENCY TRANSACTIONS.—Subclause 
(I) of section 988(c)(1)(E)(v) is amended to read as fol-
lows: 
‘‘(I) CERTAIN
GENERAL
PART-
NERS.—The interest of a partner in
the partnership shall not be treated as 
failing to meet the 20-percent owner-
ship requirements of clause (iii)(I) for 
any taxable year of the partnership if 
for the taxable year of the partner in 
which such partnership taxable year 
ends—
‘‘(aa) the partner is not lim-
ited as to participation in the 
management or activity of the 
qualified fund, and 
‘‘(bb) such partner (and 
each corporation filing a consoli-
dated return with such partner) 
had no ordinary income or loss 
from a section 988 transaction 
which is foreign currency gain or 
loss (as the case may be).’’. 
(d) SPECIAL VALUATION RULES FOR GENERATION-
SKIPPING TAX.—Clause (ii) of section 2701(b)(2)(B) (re-
lating to partnerships) is amended to read as follows: 
‘‘(ii) in the case of a limited partner-
ship, the holding of any interest as a part-
ner who is not limited as to participation
in management or activity of the partner-
ship.’’. 
(e) TAX MATTERS PARTNER.—Paragraph (7) of sec-
tion 6231(a) (defining tax matters partner) is amended 
to read as follows: 
‘‘(7) TAX MATTERS PARTNER.—
‘‘(A) IN GENERAL.—The tax matters part-
ner of any partnership is—
‘‘(i) the partner designated as the tax 
matters partner as provided in regulations, 
or 
‘‘(ii) if there is no partner who has 
been so designated, the partner having the 
largest profits interest in the partnership 
at the close of the taxable year involved 
(or, where there is more than 1 such part-
ner, the 1 of such partners whose name 
would appear first in an alphabetical list-
ing). 
‘‘(B) SELECTION BY SECRETARY.—If there 
is no partner designated under subparagraph 
(A)(i) and the Secretary determines that it is 
impracticable to apply subparagraph (A)(ii), the 
partner selected by the Secretary shall be treat-
ed as the tax matters partner. The Secretary
shall, within 30 days of selecting a tax matters 
partner under the preceding sentence, notify all 
partners required to receive notice under sec-
tion 6223(a) of the name and address of the 
person selected. 
‘‘(C) RESTRICTION
ON
DESIGNATION
OF 
PARTNER.—A partner may not be designated as 
a tax matters partner under subparagraph 
(A)(i) unless such partner is not limited as to 
participation in management or activity of the 
partnership.’’. 
(f) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003. 
SEC. 206. REFERENCES TO LIMITED PARTNERS. 
(a) LIMITED ENTREPRENEUR.—
(1) IN GENERAL.—Subparagraph (A) of section 
464(e)(2) (defining limited entrepreneur) is amend-
ed by striking ‘‘than as a limited partner’’. 
(2) CONFORMING AMENDMENTS.—
(A) Section 464(c) is amended—
(i) by striking ‘‘limited partners or’’ 
in paragraph (1)(B), 
(ii) by striking ‘‘a limited partner or’’ 
in paragraph (2).
(B) Section 1256 is amended—
(i) by striking ‘‘limited partners or’’ 
each place it appears in subsections 
(e)(3)(B) and (f)(4), 
(ii) by striking ‘‘a limited partner or’’ 
in subsection (e)(3)(C), and
(iii) by striking ‘‘limited partner or’’ 
both places it appears in subsection 
(e)(4)(A)(i). 
(C) Section 1258(d)(5)(C) is amended—
(i) by striking ‘‘limited partner or’’ in 
the matter preceding subclause (i), 
(ii) by striking ‘‘limited partner’s (or 
limited entrepreneur’s) in subclause (i) and 
inserting ‘‘limited entrepreneur’s’’, and 
(iii) by striking ‘‘PARTNERS AND LIM-
ITED’’ in the heading. 
(b) PASSIVE LOSS RULES.—
(1) Subsection (h) of section 469 is amended by 
striking paragraph (2) and by redesignating para-
graphs (3), (4), and (5) as paragraphs (2), (3), and 
(4), respectively. 
(2) Subparagraph (A) of section 469(c)(7) is 
amended by striking the last sentence.
(3) Paragraph (6) of section 469(i) is amended 
by striking subparagraph (C) and by redesignating 
subparagraph (D) as subparagraph (C). 
(4) Subsection (f) of section 772 (relating to 
special rules for applying passive loss limitations) is 
amended to read as follows: 
‘‘(f) SPECIAL RULES FOR APPLYING PASSIVE LOSS 
LIMITATIONS.—
‘‘(1) IN GENERAL.—If any person holds an in-
terest in an electing large partnership other than as 
a partner described in paragraph (3)—
‘‘(A) paragraph (2) of subsection (c) shall 
not apply to such partner, and 
‘‘(B) such partner’s distributive share of 
the partnership items allocable to passive loss 
limitation activities shall be taken into account 
separately to the extent necessary to comply 
with the provisions of section 469. 
‘‘(2) EXCEPTION.—Paragraph (1) shall not 
apply to any items allocable to an interest held as 
a partner described in paragraph (3). 
‘‘(3) PARTNER DESCRIBED.—For purposes of 
this subsection, a partner is described in this para-
graph if the partner is a person whose participation
in the management or business activity of the part-
nership is limited under applicable State law.’’. 
(c) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003.
SEC. 207. PARTNERSHIP INCOME ATTRIBUTABLE TO CAP-
ITAL EXCLUDED FROM NET EARNINGS FROM 
SELF-EMPLOYMENT. 
(a) IN
GENERAL.—Paragraph (13) of section 
1402(a) is amended to read as follows: 
‘‘(13) there shall be excluded the distributive 
share of net income of a partner attributable to cap-
ital;’’. 
(b) PARTNERSHIP INCOME ATTRIBUTABLE TO CAP-
ITAL.—Section 1402 is amended by adding at the end the 
following new subsection: 
‘‘(l) PARTNERSHIP INCOME ATTRIBUTABLE TO CAP-
ITAL.—
‘‘(1) IN GENERAL.—For purposes of subsection 
(a)(13), the following amounts shall be treated as in-
come attributable to capital—
‘‘(A) the amount, if any, in excess of what 
would constitute reasonable compensation for 
services rendered by such partner to the part-
nership, and
‘‘(B) an amount equal to a reasonable rate 
of return on unreturned capital of the partner 
determined as of the beginning of the taxable 
year. 
‘‘(2) DEFINITIONS.—For purposes of paragraph 
(1)—
‘‘(A) UNRETURNED
CAPITAL.—The term 
‘unreturned capital’ means the excess of the ag-
gregate amount of money and the fair market 
value as of the date of contribution of other 
consideration (net of liabilities) contributed by 
the partner over the aggregate amount of 
money and the fair market value as of the date 
of distribution of other consideration (net of li-
abilities) distributed by the partnership to the 
partner, increased or decreased for the part-
ner’s distributive share of all reportable items 
as determined in section 702. If the partner ac-
quires a partnership interest and the partner-
ship makes an election under section 754, the 
partner’s unreturned capital shall take into ac-
count appropriate adjustments under section 
743. 
‘‘(B) REASONABLE RATE OF RETURN.—A 
reasonable rate of return on unreturned capital
100
shall equal 150 percent (or such higher rate as 
is established in regulations) of the highest ap-
plicable Federal rate, as determined under sec-
tion 1274(d)(1), at the beginning of the part-
nership’s taxable year. 
‘‘(3) REGULATIONS.—The Secretary shall pre-
scribe such regulations as may be necessary to carry 
out the purposes of this subsection.’’. 
(c) EFFECTIVE DATE.—The amendments made by 
this section shall apply with respect to services performed 
in taxable years beginning after December 31, 2003. 
SEC. 208. REPEAL OF ABILITY TO ELECT LARGE PARTNER-
SHIP REPORTING RULES. 
(a) IN GENERAL.—Paragraph (2) of section 775(a) 
(relating to election) is amended by adding at the end the 
following: ‘‘No election under this subsection shall be 
made after December 31, 2003.’’. 
(b) EFFECTIVE DATE.—The amendment made by 
this section shall apply to partnership taxable years begin-
ning after December 31, 2003.
Æ