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‘‘(B) the average adjusted bases (within
the meaning of section 1016) for all assets of
the taxpayer.
‘‘(3) UNBORROWED
POLICY
CASH
VALUES.—
The term ‘unborrowed policy cash value’ means,
with respect to any life insurance policy or annuity
or endowment contract, the excess of—
‘‘(A) the cash surrender value of such pol-
icy or contract determined without regard to
any surrender charge, over
‘‘(B) the amount of any loan in respect of
such policy or contract.
‘‘(4) EXCEPTION FOR CERTAIN POLICIES AND
CONTRACTS COVERING OFFICERS, DIRECTORS, AND
EMPLOYEES.—Paragraph (1) shall not apply to any
policy or contract owned by an entity engaged in a
trade or business which covers any individual who is
an officer, director, or employee of such trade or
business at the time first covered by the policy or
contract, and such policies and contracts shall not be
taken into account under paragraph (2).
‘‘(5) EXCEPTION
FOR
POLICIES
AND
CON-
TRACTS HELD BY NATURAL PERSONS; TREATMENT
OF PARTNERSHIPS AND S CORPORATIONS.—
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‘‘(A) POLICIES AND CONTRACTS HELD BY
NATURAL PERSONS.—
‘‘(i) IN
GENERAL.—This subsection
shall not apply to any policy or contract
held by a natural person.
‘‘(ii) EXCEPTION WHERE BUSINESS IS
BENEFICIARY.—If a trade or business is
directly or indirectly the beneficiary under
any policy or contract, to the extent of the
unborrowed cash value of such policy or
contract, such policy or contract shall be
treated as held by such trade or business
and not by a natural person.
‘‘(iii) SPECIAL RULES.—
‘‘(I) CERTAIN TRADES OR BUSI-
NESSES NOT TAKEN INTO ACCOUNT.—
Clause (ii) shall not apply to any
trade or business carried on as a sole
proprietorship and to any trade or
business performing services as an
employee.
‘‘(II) 
LIMITATION
ON
UNBORROWED
CASH
VALUE.—The
amount of the unborrowed cash value
of any policy or contract which is
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taken into account by reason of clause
(ii) shall not exceed the benefit to
which the trade or business is entitled
under the policy or contract.
‘‘(iv) 
REPORTING.—The 
Secretary
shall require such reporting from policy-
holders and issuers as is necessary to carry
out clause (ii). Any report required under
the preceding sentence shall be treated as
a 
statement 
referred 
to 
in 
section
6724(d)(1).
‘‘(B) TREATMENT OF PARTNERSHIPS AND
S CORPORATIONS.—In the case of a partnership
or S corporation, this subsection shall be ap-
plied at the partnership and corporate levels.
‘‘(6) SPECIAL RULES.—
‘‘(A) COORDINATION WITH SUBSECTION (a)
AND SECTION 265.—If interest on any indebted-
ness is disallowed under subsection (a) or sec-
tion 265—
‘‘(i) such disallowed interest shall not
be taken into account for purposes of ap-
plying this subsection, and
‘‘(ii) for purposes of applying para-
graph (2)(B), the adjusted bases otherwise
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taken into account shall be reduced (but
not below zero) by the amount of such in-
debtedness.
‘‘(B) 
COORDINATION
WITH
SECTION
263A.—This subsection shall be applied before
the application of section 263A (relating to cap-
italization of certain expenses where taxpayer
produces property).’’.
‘‘(7) INTEREST EXPENSE.—The term ‘interest
expense’ means the aggregate amount allowable to
the taxpayer as a deduction for interest (within the
meaning of section 265(b)(4)) for the taxable year
(determined without regard to this subsection, sec-
tion 265(b), and section 291).
‘‘(8) AGGREGATION RULES.—
‘‘(A) IN GENERAL.—All members of a con-
trolled group (within the meaning of subsection
(d)(5)(B)) shall be treated as 1 taxpayer for
purposes of this subsection.
‘‘(B) TREATMENT OF INSURANCE COMPA-
NIES.—This subsection shall not apply to an in-
surance company, and subparagraph (A) shall
be applied without regard to any insurance
company.’’.
(b) TREATMENT OF INSURANCE COMPANIES.—
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(1) Clause (ii) of section 805(a)(4)(C) is
amended by inserting ‘‘, or out of the increase for
the taxable year in policy cash values (within the
meaning of section 264(e)(3)(A)) of life insurance
policies and annuity and endowment contracts to
which section 264(e) applies’’ after ‘‘tax-exempt in-
terest’’.
(2) Clause (iii) of section 805(a)(4)(D) is
amended by striking ‘‘and’’ and inserting ‘‘, the in-
crease for the taxable year in policy cash values
(within the meaning of section 264(e)(3)(A)) of life
insurance policies and annuity and endowment con-
tracts to which section 264(e) applies, and’’.
(3) Subparagraph (B) of section 807(a)(2) is
amended by striking ‘‘interest,’’ and inserting ‘‘in-
terest and the amount of the policyholder’s share of
the increase for the taxable year in policy cash val-
ues (within the meaning of section 264(e)(3)(A)) of
life insurance policies and annuity and endowment
contracts to which section 264(e) applies,’’.
(4) Subparagraph (B) of section 807(b)(1) is
amended by striking ‘‘interest,’’ and inserting ‘‘in-
terest and the amount of the policyholder’s share of
the increase for the taxable year in policy cash val-
ues (within the meaning of section 264(e)(3)(A)) of
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‘‘(d) ADDITION TO TAX FOR FAILURE TO COMPLY
WITH SECTION.—
‘‘For addition to tax in case of partner’s disregard
of requirements of this section, see part II of sub-
chapter A of chapter 68.
‘‘SEC. 6242. PROCEDURES FOR TAKING PARTNERSHIP AD-
JUSTMENTS INTO ACCOUNT.
‘‘(a) ADJUSTMENTS FLOW THROUGH TO PARTNERS
FOR YEAR IN WHICH ADJUSTMENT TAKES EFFECT.—
‘‘(1) IN GENERAL.—If any partnership adjust-
ment with respect to any partnership item takes ef-
fect (within the meaning of subsection (d)(2)) during
any partnership taxable year and if an election
under paragraph (2) does not apply to such adjust-
ment, such adjustment shall be taken into account
in determining the amount of such item for the part-
nership taxable year in which such adjustment takes
effect. In applying this title to any person who is
(directly or indirectly) a partner in such partnership
during such partnership taxable year, such adjust-
ment shall be treated as an item actually arising
during such taxable year.
‘‘(2) 
PARTNERSHIP
LIABLE
IN
CERTAIN
CASES.—If—
‘‘(A) a partnership elects under this para-
graph to not take an adjustment into account
under paragraph (1),