196
1 because they are from outside the United 
States, equal to the percentage of gross receipts 
not so taken into account, 
‘‘(B) gambling winnings (except to the ex-
tent that the Secretary determines by regula-
tion that the collection of the tax is administra-
tively feasible), 
‘‘(C) compensation paid by a foreign em-
ployer to a nonresident alien individual for the 
period he is temporarily present in the United 
States as a nonimmigrant under subparagraph 
(F) or (J) of section 101(a)(15) of the Immi-
gration and Nationality Act, as amended, 
‘‘(D) interest from a series E or series H 
savings bond if the individual acquired the bond 
while a resident of the Ryuku Islands or the 
Trust Territory of the Pacific Islands, or 
‘‘(E) amounts earned or payable to any 
person who is a bona fide resident of Puerto 
Rico, Guam, American Samoa, or the Northern 
Mariana Islands (and, therefore, is subject to 
the tax imposed by subchapter A). 
‘‘(c) EXPATRIATION TO AVOID TAX.—
‘‘(1) IN GENERAL.—A nonresident alien indi-
vidual who at any time within the 10-year period im-
197
mediately preceding the close of the taxable year lost 
United States citizenship shall be taxable in the 
manner described in paragraph (2) unless none of 
the principal purposes of losing citizenship was 
avoidance of tax under subchapter A or subtitle B. 
‘‘(2) ALTERNATIVE TAX.—A nonresident alien 
individual described in paragraph (1) shall be sub-
ject to tax on the items taxable under subsection (a) 
as determined without regard to exceptions listed or 
based on definitions contained in subsection (b) 
using the rate schedule for single individuals under 
section 215. If the taxes determined under sub-
section (a) are greater than the tax determined 
under this subsection, the greater tax shall apply. 
‘‘SEC. 132. TAX TREATMENT OF CERTAIN COMMUNITY IN-
COME OF NONRESIDENT ALIENS. 
‘‘(a) GENERAL RULE.—In the case of a married cou-
ple one or both of whom are nonresident alien individuals 
and who have community income for the taxable year, 
such community income shall be treated as follows: 
‘‘(1) Compensation income shall be treated as 
income of the spouse who rendered the services,
‘‘(2) Partnership distributions shall be treated 
as the related distributive shares of partnership in-
come would be treated under section 1402(a)(5),
198
‘‘(3) Community income which is derived from 
the separate property of a spouse shall be treated as 
income of that spouse, and 
‘‘(4) All other such community income shall be 
treated as provided in the applicable community 
property law. 
‘‘(b) EXCEPTION WHERE ELECTION UNDER SEC-
TION 6013(g) IS IN EFFECT.—Subsection (a) shall not 
apply if an election under subsection (g) or (h) of section 
6013 (relating to election to treat nonresident alien indi-
viduals as residents of the United States) is in effect. 
‘‘SEC. 133. RELATIONSHIP WITH TREATIES. 
‘‘(a) STATEMENT OF POLICY.—It is the intention of 
the USA Tax Code to promote a worldwide tax system 
in which each nation taxes—
‘‘(1) under an individual tax, only the income of 
individuals who are residents or citizens of that na-
tion, and 
‘‘(2) under a business tax only the business ac-
tivity in such nation. 
‘‘(b) EFFECT OF TREATIES.—No tax shall be im-
posed under section 131(a) on income that is exempt from 
tax by reason of a treaty between the nation of which the 
nonresident alien is a citizen or resident and the United 
States. If any such treaty requires that a lower rate of
199
tax be imposed on some or all of the items of income sub-
ject to tax under section 331(a), such lower rate shall 
apply to such items in the case of persons to whom such 
treaty applies. 
‘‘(c) EFFECT OF UNILATERAL ACTION BY FOREIGN 
NATION.—No tax shall be imposed under section 331(a) 
on nonresident aliens who are citizens or residents of an-
other nation if—
‘‘(1) such nation exempts from its income and 
withholding taxes nonresident alien individuals who 
are residents or citizens of the United States, 
‘‘(2) such nation has entered into a tax infor-
mation sharing agreement with the United States, 
and 
‘‘(3) the Secretary certifies that the preceding 
two requirements have been satisfied. 
‘‘Subchapter I—Trusts and Estates
‘‘Sec. 140. Prepayment of tax by trusts and estates. 
‘‘Sec. 141. Application of tax. 
‘‘Sec. 142. Special rules for credits and deductions. 
‘‘Sec. 143. Definitions and rules applicable to subchapter I. 
‘‘Sec. 144. Deduction for trusts distributing current income only. 
‘‘Sec. 145. Inclusion of amounts in gross income of beneficiaries of trusts dis-
tributing current income only. 
‘‘Sec. 146. Deduction for estates and trusts accumulating income or distrib-
uting corpus. 
‘‘Sec. 147. Inclusion of amounts in gross income of beneficiaries of estates and 
trusts accumulating income or distributing corpus. 
‘‘Sec. 148. Special rules applicable to sections 146 and 147. 
‘‘Sec. 149. Charitable remainder trusts. 
‘‘Sec. 150. Definitions applicable to excess distribution rules. 
‘‘Sec. 151. Accumulation distribution allocated to preceding years. 
‘‘Sec. 152. Treatment of amounts deemed distributed by trust in preceding 
years.
200
‘‘Sec. 153. Trust income, deductions, and credits attributable to grantors and 
others as substantial owners. 
‘‘Sec. 154. Definitions and rules. 
‘‘Sec. 155. Reversionary interests. 
‘‘Sec. 156. Power to control beneficial enjoyment. 
‘‘Sec. 157. Administrative powers. 
‘‘Sec. 158. Power to revoke. 
‘‘Sec. 159. Income for benefit of grantor. 
‘‘Sec. 160. Person other than grantor treated as substantial owner. 
‘‘Sec. 161. Foreign trusts having one or more United States beneficiaries. 
‘‘Sec. 162. Limitation on charitable deduction. 
‘‘Sec. 163. Income of an estate or trust in case of divorce, etc. 
‘‘Sec. 164. Recognition of gain on certain transfers to certain foreign persons 
and estates. 
‘‘Sec. 165. Treatment of funeral trusts. 
‘‘Sec. 166. Income in respect of a decedent.
‘‘SEC. 140. PREPAYMENT OF TAX BY TRUSTS AND ESTATES. 
‘‘(a) PREPAYMENT OF TAX.—A trust or estate shall 
prepay the Simplified USA Tax for individuals in accord-
ance with the provisions of this subchapter. 
‘‘(b) IMPOSITION OF TAX.—There is hereby imposed 
a tax on the taxable income of trusts and estates (as deter-
mined in accordance with this subchapter) a tax deter-
mined as follows:
‘‘If taxable income is: 
‘‘The tax is: 
Not over $1,600 ............................
15% of taxable income. 
Over $1,600, but not over $3,800
$240, plus 25% of the excess over 
$1,600. 
Over $3,800 ...................................
$790, plus 30% of the excess over 
$3,800.
‘‘(c) INFLATION ADJUSTMENT.—The schedule in 
subsection (b) shall be adjusted for inflation in accordance 
with section 23. 
‘‘(d) BUSINESS ACTIVITIES.—
‘‘(1) TAX ON BUSINESS ACTIVITY DETERMINED 
AT BUSINESS LEVEL.—If a trust engages in business 
activity (as defined in section 206(b)), it shall be
201
considered a business entity with respect to such ac-
tivities for purposes of the business tax under chap-
ter 2. The business entity shall be considered an 
asset of the trust. 
‘‘(2) 
BUSINESS
ENTITY
AS
SOLE
BENE-
FICIARY.—If the only beneficiaries of a trust are 
business entities, no tax shall be imposed on such 
trust under this subchapter. 
‘‘SEC. 141. APPLICATION OF TAX. 
‘‘(a) IN GENERAL.—The tax imposed by section 140 
shall apply to the taxable income of estates or of any kind 
of property held in trust, including—
‘‘(1) income accumulated in trust for the ben-
efit of unborn or unascertained persons or persons 
with contingent interests, and income accumulated 
or held for future distribution under the terms of 
the will or trust; 
‘‘(2) income which is to be distributed currently 
by the fiduciary to the beneficiaries, and income col-
lected by a guardian of an infant which is to be held 
or distributed as the court may direct; 
‘‘(3) income received by estates of deceased per-
sons during the period of administration or settle-
ment of the estate; and
202
‘‘(4) income which, in the discretion of the fidu-
ciary, may be either distributed to the beneficiaries 
or accumulated. 
‘‘(b) COMPUTATION AND PAYMENT.—The taxable in-
come of an estate or trust shall be computed in the same 
manner as in the case of an individual, except as otherwise 
provided in this subchapter. The tax shall be computed 
on such taxable income and shall be paid by the fiduciary. 
For purposes of this subsection, a foreign trust or foreign 
estate shall be treated as a nonresident alien individual 
who is not present in the United States at any time. 
‘‘(c) EXCLUSION OF INCLUDIBLE GAIN FROM TAX-
ABLE INCOME.—The taxable income of a trust does not 
include the amount of any includible gain as defined in 
section 144(b) reduced by any deductions properly allo-
cable thereto. 
‘‘SEC. 142. SPECIAL RULES FOR CREDITS AND DEDUCTIONS.
‘‘(a) USA DEDUCTION AND FAMILY LIVING ALLOW-
ANCE.—
‘‘(1) NO DEDUCTION OR ALLOWANCE.—A trust 
or estate shall not be allowed any USA Deductions 
or a Family Living Allowance. 
‘‘(2) SPECIAL
DEDUCTION.—For purposes of 
determining taxable income, trusts and estates shall
203
be entitled to the following deductions from gross in-
come—
‘‘(A) ESTATE.—An estate shall be allowed 
a deduction of $600. 
‘‘(B) 
DISTRIBUTING
TRUST.—A 
trust 
which, under its governing instrument, is re-
quired to distribute all of its income currently 
shall be allowed a deduction of $300. 
‘‘(C) OTHER
TRUSTS.—Trusts not de-
scribed in subparagraph (B) shall be allowed a 
deduction of $100. 
‘‘(b) DEDUCTION FOR AMOUNTS PAID OR PERMA-
NENTLY SET ASIDE FOR A CHARITABLE PURPOSE.—
‘‘(1) GENERAL RULE.—In the case of an estate 
or trust, there shall be allowed as a deduction in 
computing its taxable income (in lieu of the philan-
thropic transfer deduction) any amount of the gross 
income, without limitation, which pursuant to the 
terms of the governing instrument is, during the 
taxable year, paid for a purpose specified in section 
101(c) (determined without regard to section 
101(c)(2)(A)). If a charitable contribution is paid 
after the close of such taxable year and on or before 
the last day of the year following the close of such 
taxable year, then the trustee or administrator may
204
elect to treat such contribution as paid during such 
taxable year. The election shall be made at such 
time and in such manner as the Secretary prescribes 
by regulations. 
‘‘(2) POOLED INCOME FUNDS.—In the case of 
a pooled income fund (as defined in paragraph (3)), 
there shall also be allowed as a deduction in com-
puting its taxable income any amount of the gross 
income attributable to gain from the sale of a capital 
asset held for more than 1 year, without limitation, 
which pursuant to the terms of the governing instru-
ment is, during the taxable year, permanently set 
aside for a purpose specified in section 101(c). 
‘‘(3) DEFINITION OF POOLED INCOME FUND.—
For purposes of paragraph (2), a pooled income 
fund is a trust—
‘‘(A) to which each donor transfers prop-
erty, contributing an irrevocable remainder in-
terest in such property to or for the use of an 
organization described in section 101(b)(1)(A) 
(other than in clauses (vii) or (viii)), and retain-
ing an income interest for the life of one or 
more beneficiaries (living at the time of such 
transfer),
205
‘‘(B) in which the property transferred by 
each donor is commingled with property trans-
ferred by other donors who have made or make 
similar transfers, 
‘‘(C) which cannot have investments in se-
curities which are exempt from taxes imposed 
by this subtitle, 
‘‘(D) which includes only amounts received 
from transfers which meet the requirements of 
this paragraph, 
‘‘(E) which is maintained by the organiza-
tion to which the remainder interest is contrib-
uted and of which no donor or beneficiary of an 
income interest is a trustee, and 
‘‘(F) from which each beneficiary of an in-
come interest receives income, for each year for 
which he is entitled to receive the income inter-
est referred to in subparagraph (A), determined 
by the rate of return earned by the trust for 
such year. 
For purposes of determining the amount of any 
charitable contribution allowable by reason of a 
transfer of property to a pooled fund, the value of 
the income interest shall be determined on the basis 
of the highest rate of return earned by the fund for
206
any of the 3 taxable years immediately preceding the 
taxable year of the fund in which the transfer is 
made. In the case of funds in existence less than 3 
taxable years preceding the taxable year of the fund 
in which a transfer is made the rate of return shall 
be deemed to be 6 percent per annum, except that 
the Secretary may prescribe a different rate of re-
turn. 
‘‘(c) UNUSED LOSS CARRYOVERS.—If on the termi-
nation of an estate or trust, the estate or trust has a loss 
carryover then such carryover shall be allowed as a deduc-
tion, in accordance with regulations prescribed by the Sec-
retary, to the beneficiaries succeeding to the property of 
the estate or trust. 
‘‘(d) CERTAIN DISTRIBUTIONS BY CEMETERY PER-
PETUAL CARE FUNDS.—In the case of a cemetery per-
petual care fund which—
‘‘(1) was created pursuant to local law by a tax-
able cemetery corporation for the care and mainte-
nance of cemetery property, and 
‘‘(2) is treated for the taxable year as a trust 
for purposes of this subchapter, 
any amount distributed by such fund for the care and 
maintenance of gravesites which have been purchased 
from the cemetery corporation before the beginning of the
207
taxable year of the trust and with respect to which there 
is an obligation to furnish care and maintenance shall be 
considered to be a distribution solely for purposes of sec-
tions 144 and 146, but only to the extent that the aggre-
gate amount so distributed during the taxable year does 
not exceed $5 multiplied by the aggregate number of such 
gravesites. 
‘‘SEC. 143. DEFINITIONS AND RULES APPLICABLE TO SUB-
CHAPTER I. 
‘‘For purposes of this subchapter—
‘‘(a) DISTRIBUTABLE NET INCOME.—‘Distributable 
net income’ means, with respect to any taxable year, the 
taxable income of the estate or trust computed with the 
following modifications—
‘‘(1) No deduction shall be taken under sections 
144 and 146 (relating to additional deductions). 
‘‘(2) No deduction shall be taken under section 
142(a)(2) (relating to deduction for personal exemp-
tions). 
‘‘(3) Gains from the sale or exchange of capital 
assets shall be excluded to the extent that such gains 
are allocated to corpus and are not (A) paid, cred-
ited, or required to be distributed to any beneficiary 
during the taxable year, or (B) paid, permanently
set aside, or to be used for the purposes specified
208
in section 142(b). Losses from the sale or exchange 
of capital assets shall be excluded, except to the ex-
tent such losses are taken into account in deter-
mining the amount of gains from the sale or ex-
change of capital assets which are paid, credited, or 
required to be distributed to any beneficiary during 
the taxable year. 
‘‘(4) For purposes only of rules under section 
ll, there shall be excluded those items of gross in-
come constituting extraordinary dividends or taxable 
stock dividends which the fiduciary, acting in good 
faith, does not pay or credit to any beneficiary by 
reason of his determination that such dividends are 
allocable to corpus under the terms of the governing 
instrument and applicable local law. 
‘‘(5) There shall be included any tax-exempt in-
terest. 
‘‘(6) In the case of a foreign trust—
‘‘(A) There shall be included the amounts 
of gross income from sources without the 
United States, reduced by any amounts which 
would be deductible in respect of disbursements 
allocable to such income but for the provisions 
of section 265(a)(1) (relating to disallowance of 
certain deductions).
209
‘‘(B) Gross income from sources within the 
United States shall be determined without re-
gard to section 894 (relating to income exempt 
under treaty). 
‘‘(C) Paragraph (3) shall not apply to a 
foreign trust. In the case of such a trust, there 
shall be included gains from the sale or ex-
change of capital assets, reduced by losses from 
such sales or exchanges to the extent such 
losses do not exceed gains from such sales or 
exchanges. 
If the estate or trust is allowed a deduction under section 
142(b), the amount of the modifications specified in para-
graphs (5) and (6) shall be reduced to the extent that the 
amount of income which is paid, permanently set aside, 
or to be used for the purposes specified in section 142(b) 
is deemed to consist of items specified in those para-
graphs. For this purpose, such amount shall (in the ab-
sence of specific provisions in the governing instrument) 
be deemed to consist of the same proportion of each class 
of items of income of the estate or trust as the total of 
each class bears to the total of all classes. 
‘‘(b) INCOME.—‘Income’, when not preceded by the 
words ‘taxable’, ‘distributable net’, ‘undistributed net’, or 
‘gross’, means the amount of income of the estate or trust
210
for the taxable year determined under the terms of the 
governing instrument and applicable local law. Items of 
gross income constituting extraordinary dividends or tax-
able stock dividends which the fiduciary, acting in good 
faith, determines to be allocable to corpus under the terms 
of the governing instrument and applicable local law shall 
not be considered income. 
‘‘(c) BENEFICIARY.—‘Beneficiary’ includes heir, leg-
atee, devisee. 
‘‘(d) TREATMENT OF PROPERTY DISTRIBUTED IN 
KIND.—
‘‘(1) BASIS OF BENEFICIARY.—The basis of any 
property received by a beneficiary in a distribution 
from an estate or trust shall be—
‘‘(A) the adjusted basis of such property in 
the hands of the estate or trust immediately be-
fore the distribution, adjusted for 
‘‘(B) any gain or loss recognized to the es-
tate or trust on the distribution. 
‘‘(2) AMOUNT OF DISTRIBUTION.—In the case 
of any distribution of property (other than cash), the 
amount taken into account under sections 146(a)(2) 
and 147(a)(2) shall be the lesser of—
211
‘‘(A) the basis of such property in the 
hands of the beneficiary (as determined under 
paragraph (1)), or 
‘‘(B) the fair market value of such prop-
erty. 
‘‘(3) ELECTION TO RECOGNIZE GAIN.—
‘‘(A) IN GENERAL.—In the case of any dis-
tribution of property (other than cash) to which 
an election under this paragraph applies—
‘‘(i) paragraph (2) shall not apply, 
‘‘(ii) gain or loss shall be recognized 
by the estate or trust in the same manner 
as if such property had been sold to the 
distributee at its fair market value, and 
‘‘(iii) the amount taken into account 
under sections 146(a)(2) and 147(a)(2) 
shall be the fair market value of such 
property. 
‘‘(B) ELECTION.—Any election under this 
paragraph shall apply to all distributions made 
by the estate or trust during a taxable year and 
shall be made on the return of such estate or 
trust for such taxable year. 
Any such election, once made, may be revoked 
only with the consent of the Secretary.
212
‘‘(4) EXCEPTION
FOR
DISTRIBUTIONS
DE-
SCRIBED IN SECTION 148(a).—This subsection shall 
not apply to any distribution described in section 
148(a). 
‘‘(e) TREATMENT OF MULTIPLE TRUSTS.—For pur-
poses of this subchapter, under regulations prescribed by 
the Secretary, 2 or more trusts shall be treated as 1 trust 
if—
‘‘(1) such trusts have substantially the same 
grantor or grantors and substantially the same pri-
mary beneficiary or beneficiaries, and 
‘‘(2) a principal purpose of such trusts is the 
avoidance of the tax imposed by this chapter. 
For purposes of the preceding sentence, a husband and 
wife shall be treated as 1 person. 
‘‘(f) CERTAIN
PAYMENTS
OF
ESTIMATED
TAX 
TREATED AS PAID BY BENEFICIARY.—Under rules pre-
scribed by the Secretary, a trustee may elect to treat any 
portion of a payment of estimated tax made by such trust 
for any taxable year of the trust as a payment made by 
a beneficiary of such trust. This rule shall also apply in 
the case of a taxable year reasonably expected to be the 
last taxable year of an estate. 
‘‘(g) FOREIGN TRUSTS AND FOREIGN INCOME.—The 
Secretary shall prescribe special rules for foreign trusts
213
and foreign income of trusts. Those rules should generally 
be consistent with the rules under subchapter J of chapter 
1 of the Internal Revenue Code of 1986, except that they 
shall take into account the principles of the Simplified 
USA Tax. 
‘‘(h) CERTAIN REVOCABLE TRUSTS TREATED
AS 
PART OF ESTATE.—
‘‘(1) IN
GENERAL.—If both the executor (if 
any) of an estate and the trustee of a qualified rev-
ocable trust elect the treatment provided in this sec-
tion, such trust shall be treated and taxed as part 
of such estate (and not as a separate trust) for all 
taxable years of the estate ending after the date of 
the decedent’s death and before the applicable date. 
‘‘(2) QUALIFIED REVOCABLE TRUST.—For pur-
poses of this subsection, ‘qualified revocable trust’ 
means any trust (or portion thereof) which was 
treated under section 158 as owned by the decedent 
of the estate referred to in paragraph (1) by reason 
of a power in the grantor (determined without re-
gard to section 154(e). 
‘‘(3) APPLICABLE DATE.—For purposes of this 
subsection, ‘applicable date’ means—
‘‘(A) if no return of tax imposed by chap-
ter 11 is required to be filed, the date which is
214
2 years after the date of the decedent’s death, 
and 
‘‘(B) if such a return is required to be 
filed, the date which is 6 months after the date 
of the final determination of the liability for tax 
imposed by chapter 11. 
‘‘(4) ELECTION.—The election under this sub-
section shall be made not later than the time pre-
scribed for filing the return of tax imposed by this 
chapter for the first taxable year of the estate (de-
termined with regard to extensions) and, once made, 
shall be irrevocable. 
‘‘SEC. 144. DEDUCTION FOR TRUSTS DISTRIBUTING CUR-
RENT INCOME ONLY. 
‘‘(a) DEDUCTION.—In the case of any trust the terms 
of which—
‘‘(1) provide that all of its income is required 
to be distributed currently, and 
‘‘(2) do not provide that any amounts are to be 
paid, permanently set aside, or used for the purposes 
specified in section 142(b) (relating to deduction for 
charitable, etc., purposes), 
there shall be allowed as a deduction in computing the 
taxable income of the trust the amount of the income for 
the taxable year which is required to be distributed cur-
215
rently. This section shall not apply in any taxable year 
in which the trust distributes amounts other than amounts 
of income described in paragraph (1). 
‘‘(b) LIMITATION ON DEDUCTION.—If the amount of 
income required to be distributed currently exceeds the 
distributable net income of the trust for the taxable year, 
the deduction shall be limited to the amount of the distrib-
utable net income. For this purpose, the computation of 
distributable net income shall not include items of income 
which are not included in the gross income of the trust 
and the deductions allocable thereto. 
‘‘SEC. 145. INCLUSION OF AMOUNTS IN GROSS INCOME OF 
BENEFICIARIES OF TRUSTS DISTRIBUTING 
CURRENT INCOME ONLY. 
‘‘(a) INCLUSION.—Subject to subsection (b), the 
amount of income for the taxable year required to be dis-
tributed currently by a trust described in section 144 shall 
be included in the gross income of the beneficiaries to 
whom the income is required to be distributed, whether 
distributed or not. If such amount exceeds the distribut-
able net income, there shall be included in the gross in-
come of each beneficiary an amount which bears the same 
ratio to distributable net income as the amount of income 
required to be distributed to such beneficiary bears to the
216
amount of income required to be distributed to all bene-
ficiaries. 
‘‘(b) CHARACTER OF AMOUNTS.—The amounts speci-
fied in subsection (a) shall have the same character in the 
hands of the beneficiary as in the hands of the trust. For 
this purpose, the amounts shall be treated as consisting 
of the same proportion of each class of items entering into 
the computation of distributable net income of the trust 
as the total of each class bears to the total distributable 
net income of the trust, unless the terms of the trust spe-
cifically allocate different classes of income to different 
beneficiaries. In the application of the preceding sentence, 
the items of deduction entering into the computation of 
distributable net income shall be allocated among the 
items of distributable net income in accordance with regu-
lations prescribed by the Secretary. 
‘‘SEC. 146. DEDUCTION FOR ESTATES AND TRUSTS ACCU-
MULATING INCOME OR DISTRIBUTING COR-
PUS.
‘‘(a) DEDUCTION.—In any taxable year there shall be 
allowed as a deduction in computing the taxable income 
of an estate or trust (other than a trust described in sec-
tion 144), the sum of—
‘‘(1) any amount of income for such taxable 
year required to be distributed currently (including
217
any amount required to be distributed which may be 
paid out of income or corpus to the extent such 
amount is paid out of income for such taxable year); 
and 
‘‘(2) any other amounts properly paid or cred-
ited or required to be distributed for such taxable 
year; 
but such deduction shall not exceed the distributable 
net income of the estate or trust. 
‘‘(b) CHARACTER OF AMOUNTS DISTRIBUTED.—The 
amount determined under subsection (a) shall be treated 
as consisting of the same proportion of each class of items 
entering into the computation of distributable net income 
of the estate or trust as the total of each class bears to 
the total distributable net income of the estate or trust 
in the absence of the allocation of different classes of in-
come under the specific terms of the governing instru-
ment. In the application of the preceding sentence, the 
items of deduction entering into the computation of dis-
tributable net income (including the deduction allowed 
under section 142(b)) shall be allocated among the items 
of distributable net income in accordance with regulations 
prescribed by the Secretary. 
‘‘(c) LIMITATION
ON DEDUCTION.—No deduction 
shall be allowed under subsection (a) in respect of any por-
218
tion of the amount allowed as a deduction under that sub-
section (without regard to this subsection) which is treated 
under subsection (b) as consisting of any item of distribut-
able net income which is not included in the gross income 
of the estate or trust. 
‘‘SEC. 147. INCLUSION OF AMOUNTS IN GROSS INCOME OF 
BENEFICIARIES OF ESTATES AND TRUSTS AC-
CUMULATING 
INCOME 
OR 
DISTRIBUTING 
CORPUS. 
‘‘(a) INCLUSION.—Subject to subsection (b), there 
shall be included in the gross income of a beneficiary to 
whom an amount specified in section 146(a) is paid, cred-
ited, or required to be distributed (by an estate or trust 
described in section 146), the sum of the following 
amounts: 
‘‘(1) AMOUNTS REQUIRED TO BE DISTRIBUTED 
CURRENTLY.—The amount of income for the taxable 
year required to be distributed currently to such 
beneficiary, whether distributed or not. If the 
amount of income required to be distributed cur-
rently to all beneficiaries exceeds the distributable 
net income (computed without the deduction allowed 
by section 142(b), relating to deduction for chari-
table, etc., purposes) of the estate or trust, then, in 
lieu of the amount provided in the preceding sen-
219
tence, there shall be included in the gross income of 
the beneficiary an amount which bears the same 
ratio to distributable net income (as so computed) as 
the amount of income required to be distributed cur-
rently to such beneficiary bears to the amount re-
quired to be distributed currently to all beneficiaries. 
For purposes of this section, the phrase ‘the amount 
of income for the taxable year required to be distrib-
uted currently’ includes any amount required to be 
paid out of income or corpus to the extent such 
amount is paid out of income for such taxable year. 
‘‘(2) 
OTHER
AMOUNTS
DISTRIBUTED.—All 
other amounts properly paid, credited, or required to 
be distributed to such beneficiary for the taxable 
year. If the sum of—
‘‘(A) the amount of income for the taxable 
year required to be distributed currently to all 
beneficiaries, and 
‘‘(B) all other amounts properly paid, cred-
ited, or required to be distributed to all bene-
ficiaries 
exceeds the distributable net income of the estate or 
trust, then, in lieu of the amount provided in the 
preceding sentence, there shall be included in the 
gross income of the beneficiary an amount which
220
bears the same ratio to distributable net income (re-
duced by the amounts specified in (A)) as the other 
amounts properly paid, credited or required to be 
distributed to the beneficiary bear to the other 
amounts properly paid, credited, or required to be 
distributed to all beneficiaries. 
‘‘(b) CHARACTER OF AMOUNTS.—The amounts de-
termined under subsection (a) shall have the same char-
acter in the hands of the beneficiary as in the hands of 
the estate or trust. For this purpose, the amounts shall 
be treated as consisting of the same proportion of each 
class of items entering into the computation of distribut-
able net income as the total of each class bears to the 
total distributable net income of the estate or trust unless 
the terms of the governing instrument specifically allocate 
different classes of income to different beneficiaries. In the 
application of the preceding sentence, the items of deduc-
tion entering into the computation of distributable net in-
come (including the deduction allowed under section 
142(b)) shall be allocated among the items of distributable 
net income in accordance with regulations prescribed by 
the Secretary. In the application of this subsection to the 
amount determined under paragraph (1) of subsection (a), 
distributable net income shall be computed without regard
221
to any portion of the deduction under section 142(b) which 
is not attributable to income of the taxable year. 
‘‘SEC. 148. SPECIAL RULES APPLICABLE TO SECTIONS 146 
AND 147. 
‘‘(a) EXCLUSIONS.—There shall not be included as 
amounts falling within section 146(a) or 147(a)—
‘‘(1) GIFTS, BEQUESTS, ETC.—Any amount 
which, under the terms of the governing instrument, 
is properly paid or credited as a gift or bequest of 
a specific sum of money or of specific property and 
which is paid or credited all at once or in not more 
than 3 installments. For this purpose an amount 
which can be paid or credited only from the income 
of the estate or trust shall not be considered as a 
gift or bequest of a specific sum of money. 
‘‘(2) CHARITABLE, ETC., DISTRIBUTIONS.—Any 
amount paid or permanently set aside or otherwise 
qualifying for the deduction provided in section 
142(b) (computed without regard to sections 508(d), 
162, and 4948(c)(4)). 
‘‘(3) DENIAL
OF
DOUBLE
DEDUCTION.—Any 
amount paid, credited, or distributed in the taxable 
year, if section 144 or section 146 applied to such 
amount for a preceding taxable year of an estate or
222
trust because credited or required to be distributed 
in such preceding taxable year. 
‘‘(b) DISTRIBUTIONS IN FIRST SIXTY-FIVE DAYS OF 
TAXABLE YEAR.—
‘‘(1) GENERAL RULE.—If within the first 65 
days of any taxable year of an estate or a trust, an 
amount is properly paid or credited, such amount 
shall be considered paid or credited on the last day 
of the preceding taxable year. 
‘‘(2) LIMITATION.—Paragraph (1) shall apply 
with respect to any taxable year of an estate or a 
trust only if the executor of such estate or the fidu-
ciary of such trust (as the case may be) elects, in 
such manner and at such time as the Secretary pre-
scribes by regulations, to have paragraph (1) apply 
for such taxable year. 
‘‘(c) SEPARATE SHARES TREATED AS SEPARATE ES-
TATES OR TRUSTS.—For the sole purpose of determining 
the amount of distributable net income in the application 
of sections 146 and 147, in the case of a single trust hav-
ing more than one beneficiary, substantially separate and 
independent shares of different beneficiaries in the trust 
shall be treated as separate trusts. Rules similar to the 
rules of the preceding provisions of this subsection shall 
apply to treat substantially separate and independent
223
shares of different beneficiaries in an estate having more 
than 1 beneficiary as separate estates. The existence of 
such substantially separate and independent shares and 
the manner of treatment as separate trusts or estates, in-
cluding the application of sections 150 through 152, shall 
be determined in accordance with regulations prescribed 
by the Secretary. 
‘‘SEC. 149. CHARITABLE REMAINDER TRUSTS. 
‘‘(a) GENERAL RULE.—Notwithstanding any other 
provision of this subchapter, the provisions of this section 
shall, in accordance with regulations prescribed by the 
Secretary, apply in the case of a charitable remainder an-
nuity trust and a charitable remainder unitrust. 
‘‘(b) CHARACTER OF DISTRIBUTIONS.—Amounts dis-
tributed by a charitable remainder annuity trust or by a 
charitable remainder unitrust shall be considered as hav-
ing the following characteristics in the hands of a bene-
ficiary to whom is paid the annuity described in subsection 
(d)(1)(A) or the payment described in subsection 
(d)(2)(A): 
‘‘(1) First, as amounts of income (other than 
gains, and amounts treated as gains, from the sale 
or other disposition of capital assets) includible in 
gross income to the extent of such income of the
224
trust for the year and such undistributed income of 
the trust for prior years; 
‘‘(2) Second, as a capital gain to the extent of 
the capital gain of the trust for the year and the un-
distributed capital gain of the trust for prior years; 
‘‘(3) Third, as other income to the extent of 
such income of the trust for the year and such un-
distributed income of the trust for prior years; and 
‘‘(4) Fourth, as a distribution of trust corpus. 
For purposes of this section, the trust shall determine the 
amount of its undistributed capital gain on a cumulative 
net basis.
‘‘(c) EXEMPTION FROM INCOME TAXES.—A chari-
table remainder annuity trust and a charitable remainder 
unitrust shall, for any taxable year, not be subject to any 
tax imposed by this chapter. Any such trust shall be liable 
for tax on its unrelated business taxable income (within 
the meaning of section 255). 
‘‘(d) DEFINITIONS.—
‘‘(1) 
CHARITABLE
REMAINDER
ANNUITY 
TRUST.—For purposes of this section, a charitable 
remainder annuity trust is a trust—
‘‘(A) from which a sum certain (which is 
not less than 5 percent nor more than 50 per-
cent of the initial net fair market value of all
226
section 4975(e)(7) in a qualified gratuitous 
transfer (as defined by subsection (g)). 
‘‘(D) the value (determined under section 
7520 of such remainder interest is at least 10 
percent of the initial net fair market value of all 
property placed in the trust. 
‘‘(2) CHARITABLE REMAINDER UNITRUST.—For 
purposes of this section, a charitable remainder 
unitrust is a trust—
‘‘(A) from which a fixed percentage (which 
is not less than 5 percent nor more than 50 
percent) of the net fair market value of its as-
sets, valued annually, is to be paid, not less 
often than annually, to one or more persons (at 
least one of which is not an organization de-
scribed in section 101(c) and, in the case of in-
dividuals, only to an individual who is living at 
the time of the creation of the trust) for a term 
of years (not in excess of 20 years) or for the 
life or lives of such individual or individuals, 
‘‘(B) from which no amount other than the 
payments described in subparagraph (A) and 
other than qualified gratuitous transfers de-
scribed in subparagraph (C) may be paid to or
227
for the use of any person other than an organi-
zation described in section 101(c), 
‘‘(C) following the termination of the pay-
ments described in subparagraph (A), the re-
mainder interest in the trust is to be trans-
ferred to, or for the use of, an organization de-
scribed in section 101(c) or is to be retained by 
the trust for such a use or, to the extent the 
remainder interest is in qualified employer secu-
rities (as defined in subsection (g)(4)), all or 
part of such securities are to be transferred to 
an employee stock ownership plan (as defined in 
section 4975(e)(7) in a qualified gratuitous 
transfer (as defined by subsection (g)). 
‘‘(D) with respect to each contribution of 
property to the trust, the value (determined 
under section 7520 of such remainder interest 
in such property is at least 10 percent of the 
net fair market value of such property as of the 
date such property is contributed to the trust. 
‘‘(3) EXCEPTION.—Notwithstanding the provi-
sions of paragraphs (2)(A) and (B), the trust instru-
ment may provide that the trustee shall pay the in-
come beneficiary for any year—
228
‘‘(A) the amount of the trust income, if 
such amount is less than the amount required 
to be distributed under paragraph (2)(A), and 
‘‘(B) any amount of the trust income 
which is in excess of the amount required to be 
distributed under paragraph (2)(A), to the ex-
tent that (by reason of subparagraph (A)) the 
aggregate of the amounts paid in prior years 
was less than the aggregate of such required 
amounts. 
‘‘(4) SEVERANCE
OF
CERTAIN
ADDITIONAL 
CONTRIBUTIONS.—If—
‘‘(A) any contribution is made to a trust 
which before the contribution is a charitable re-
mainder unitrust, and
‘‘(B) such contribution would (but for this 
paragraph) result in such trust ceasing to be a 
charitable unitrust by reason of paragraph 
(2)(D), such contribution shall be treated as a 
transfer to a separate trust under regulations 
prescribed by the Secretary. 
‘‘(e) VALUATION FOR PURPOSES OF CHARITABLE 
CONTRIBUTION.—For 
purposes 
of 
determining 
the 
amount of any charitable contribution, the remainder in-
terest of a charitable remainder annuity trust or charitable
229
remainder unitrust shall be computed on the basis that 
an amount equal to 5 percent of the net fair market value 
of its assets (or a greater amount, if required under the 
terms of the trust instrument) is to be distributed each 
year. 
‘‘(f) CERTAIN CONTINGENCIES PERMITTED.—
‘‘(1) GENERAL RULE.—If a trust would, but for 
a qualified contingency, meet the requirements of 
paragraph (1)(A) or (2)(A) of subsection (d), such 
trust shall be treated as meeting such requirements. 
‘‘(2) VALUE
DETERMINED
WITHOUT
REGARD 
TO QUALIFIED CONTINGENCY.—For purposes of de-
termining the amount of any charitable contribution 
(or the actuarial value of any interest), a qualified 
contingency shall not be taken into account. 
‘‘(3) QUALIFIED CONTINGENCY.—For purposes 
of this subsection, the term ‘qualified contingency’ 
means any provision of a trust which provides that, 
upon the happening of a contingency, the payments 
described in paragraph (1)(A) or (2)(A) of sub-
section (d) (as the case may be) will terminate not 
later than such payments would otherwise terminate 
under the trust. 
‘‘(g) QUALIFIED GRATUITOUS TRANSFER OF QUALI-
FIED EMPLOYER SECURITIES.—
230
‘‘(1) IN GENERAL.—For purposes of this sec-
tion, the term ‘qualified gratuitous transfer’ means 
a transfer of qualified employer securities to an em-
ployee stock ownership plan (as defined in section 
4975(e)(7) but only to the extent that—
‘‘(A) the securities transferred previously 
passed from a decedent dying before January 1, 
2004, to a trust described in paragraph (1) or 
(2) of subsection (d), 
‘‘(B) no deduction under section 404 is al-
lowable with respect to such transfer, 
‘‘(C) such plan contains the provisions re-
quired by paragraph (3), 
‘‘(D) such plan treats such securities as 
being attributable to employer contributions but 
without regard to the limitations otherwise ap-
plicable to such contributions under section 
404, and 
‘‘(E) the employer whose employees are 
covered by the plan described in this paragraph 
files with the Secretary a verified written state-
ment consenting to the application of sections 
4978 and 4979A with respect to such employer. 
‘‘(2) EXCEPTION.—The term ‘qualified gratu-
itous transfer’ shall not include a transfer of quali-
231
fied employer securities to an employee stock owner-
ship plan unless—
‘‘(A) such plan was in existence on August 
1, 1996, 
‘‘(B) at the time of the transfer, the dece-
dent and members of the decedent’s family 
(within the meaning of section 171(a)(6)(D)) 
own (directly or through constructive ownership 
rules) no more than 10 percent of the value of 
the stock of the corporation referred to in para-
graph (4), and 
‘‘(C) immediately after the transfer, such 
plan owns (after the application of section 
318(a)(4) at least 60 percent of the value of the 
outstanding stock of the corporation. 
‘‘(3) PLAN REQUIREMENTS.—A plan contains 
the provisions required by this paragraph if such 
plan provides that—
‘‘(A) the qualified employer securities so 
transferred are allocated to plan participants in 
a manner consistent with section 401(a)(4), 
‘‘(B) plan participants are entitled to di-
rect the plan as to the manner in which such 
securities which are entitled to vote and are al-
232
located to the account of such participant are to 
be voted, 
‘‘(C) an independent trustee votes the se-
curities so transferred which are not allocated 
to plan participants, 
‘‘(D) each participant who is entitled to a 
distribution from the plan has the rights de-
scribed in subparagraphs (A) and (B) of section 
409(h)(1), 
‘‘(E) such securities are held in a suspense 
account under the plan to be allocated each 
year, up to the limitations under section 415(c), 
after first allocating all other annual additions 
for the limitation year, up to the limitations 
under sections 415 (c) and (e), and
‘‘(F) on termination of the plan, all securi-
ties so transferred which are not allocated to 
plan participants as of such termination are to 
be transferred to, or for the use of, an organi-
zation described in section 101(c). For purposes 
of the preceding sentence, the term ‘inde-
pendent trustee’ means any trustee who is not 
a member of the family (within the meaning of 
section 171(a)(6)(D)) of the decedent or a 5-
percent shareholder. A plan shall not fail to be
233
treated as meeting the requirements of section 
401(a) by reason of meeting the requirements 
of this subsection. 
‘‘(4) QUALIFIED EMPLOYER SECURITIES.—For 
purposes of this section, the term ‘qualified employer 
securities’ means employer securities (as defined in 
section 409(l)) which are issued by a domestic cor-
poration—
‘‘(A) which has no outstanding stock which 
is readily tradable on an established securities 
market, and 
‘‘(B) which has only 1 class of stock. 
‘‘(5) TREATMENT OF SECURITIES ALLOCATED 
BY
EMPLOYEE
STOCK
OWNERSHIP
PLAN
TO
PER-
SONS
RELATED
TO
DECEDENT
OR
5-PERCENT 
SHAREHOLDERS.—
‘‘(A) IN GENERAL.—If any portion of the 
assets of the plan attributable to securities ac-
quired by the plan in a qualified gratuitous 
transfer are allocated to the account of—
‘‘(i) any person who is related to the 
decedent (within the meaning of section 
171(a)(5) or a member of the decedent’s 
family (within the meaning of section 
171(a)(6)(D), or
234
‘‘(ii) any person who, at the time of 
such allocation or at any time during the 
1-year period ending on the date of the ac-
quisition of qualified employer securities by 
the plan, is a 5-percent shareholder of the 
employer maintaining the plan, the plan 
shall be treated as having distributed (at 
the time of such allocation) to such person 
or shareholder the amount so allocated. 
‘‘(B) 
5-PERCENT
SHAREHOLDER.—For 
purposes of subparagraph (A), the term ‘5-per-
cent shareholder’ means any person who owns 
(directly or through the application of construc-
tive ownership rules) more than 5 percent of 
the outstanding stock of the corporation which 
issued such qualified employer securities or of 
any corporation which is a member of the same 
controlled group of corporations (within the 
meaning of section 409(l)(4)) as such corpora-
tion. 
‘‘(C) CROSS REFERENCE.—For excise tax 
on allocations described in subparagraph (A), 
see section 4979A. 
‘‘(6) 
TAX
ON
FAILURE
TO
TRANSFER 
UNALLOCATED SECURITIES TO CHARITY ON TERMI-
235
NATION OF PLAN.—If the requirements of paragraph 
(3)(F) are not met with respect to any securities, 
there is hereby imposed a tax on the employer main-
taining the plan in an amount equal to the sum of—
‘‘(A) the amount of the increase in the tax 
which would be imposed by chapter 11 if such 
securities were not transferred as described in 
paragraph (1), and 
‘‘(B) interest on such amount at the un-
derpayment rate under section 6621 (and com-
pounded daily) from the due date for filing the 
return of the tax imposed by chapter 11. 
‘‘SEC. 150. DEFINITIONS APPLICABLE TO EXCESS DISTRIBU-
TION RULES. 
‘‘(a) UNDISTRIBUTED NET INCOME.—For purposes 
of sections 150 through 152, the term ‘undistributed net 
income’ for any taxable year means the amount by which 
the distributable net income of the trust for such taxable 
year exceeds the sum of—
‘‘(1) the amounts for such taxable year speci-
fied in paragraphs (1) and (2) of section 146(a), 
and 
‘‘(2) the amount of taxes imposed on the trust 
attributable to such distributable net income.
236
‘‘(b) ACCUMULATION DISTRIBUTION.—For purposes 
of sections 150 through 152, except as provided in sub-
section (c), the term ‘accumulation distribution’ means, 
for any taxable year of the trust, the amount by which—
‘‘(1) the amounts specified in paragraph (2) of 
section 146(a) for such taxable year, exceed 
‘‘(2) distributable net income for such year re-
duced (but not below zero) by the amounts specified 
in paragraph (1) of section 146(a). 
For purposes of section 152 (other than subsection (c) 
thereof, relating to multiple trusts), the amounts specified 
in paragraph (2) of section 146(a) shall not include 
amounts properly paid, credited, or required to be distrib-
uted to a beneficiary from a trust (other than a foreign 
trust) as income accumulated before the birth of such ben-
eficiary or before such beneficiary attains the age of 21. 
If the amounts properly paid, credited, or required to be 
distributed by the trust for the taxable year do not exceed 
the income of the trust for such year, there shall be no 
accumulation distribution for such year. 
‘‘(c) EXCEPTION
FOR ACCUMULATION DISTRIBU-
TIONS FROM CERTAIN DOMESTIC TRUSTS.—For purposes 
of sections 150 through 152—
‘‘(1) IN GENERAL.—In the case of a qualified 
trust, any distribution in any taxable year beginning
237
after the date of the enactment of this subsection 
shall be computed without regard to any undistrib-
uted net income. 
‘‘(2) QUALIFIED TRUST.—For purposes of this 
subsection, the term ‘qualified trust’ means any 
trust other than—
‘‘(A) a foreign trust (or, except as provided 
in regulations, a domestic trust which at any 
time was a foreign trust), or 
‘‘(B) a trust created before March 1, 1984, 
unless it is established that the trust would not 
be aggregated with other trusts under section 
143(f) if such section applied to such trust. 
‘‘(d) TAXES IMPOSED ON THE TRUST.—For purposes 
of sections 150 through 152—
‘‘(1) IN GENERAL.—The term ‘taxes imposed 
on the trust’ means the amount of the taxes which 
are imposed for any taxable year of the trust under 
this chapter (without regard to sections 150 through 
152) and which, under regulations prescribed by the 
Secretary, are properly allocable to the undistributed 
portions of distributable net income and gains in ex-
cess of losses from sales or exchanges of capital as-
sets. The amount determined in the preceding sen-
tence shall be reduced by any amount of such taxes
238
deemed distributed under section 151(b) and (c) to 
any beneficiary. 
‘‘(2) FOREIGN TRUSTS.—In the case of any for-
eign trust, the term ‘taxes imposed on the trust’ in-
cludes the amount, reduced as provided in the last 
sentence of paragraph (1), of any income, war prof-
its, and excess profits taxes imposed by any foreign 
country or possession of the United States on such 
foreign trust which, as determined under paragraph 
(1), are so properly allocable. Under rules or regula-
tions prescribed by the Secretary, in the case of any 
foreign trust of which the settlor or another person 
would be treated as owner of any portion of the 
trust but for section 154(f), the term ‘taxes imposed 
on the trust’ includes the allocable amount of any 
income, war profits, and excess profits taxes imposed 
by any foreign country or possession of the United 
States on the settlor or such other person in respect 
of trust income. 
‘‘SEC. 151. ACCUMULATION DISTRIBUTION ALLOCATED TO 
PRECEDING YEARS. 
‘‘(a) AMOUNT ALLOCATED.—In the case of a trust 
which is subject to sections 146 through 149, the amount 
of the accumulation distribution of such trust for a taxable 
year shall be deemed to be an amount within the meaning
239
of paragraph (2) of section 146(a) distributed on the last 
day of each of the preceding taxable years, commencing 
with the earliest of such years, to the extent that such 
amount exceeds the total of any undistributed net income 
for all earlier preceding taxable years. The amount deemed 
to be distributed in any such preceding taxable year under 
the preceding sentence shall not exceed the undistributed 
net income for such preceding taxable year. For purposes 
of this subsection, undistributed net income for each of 
such preceding taxable years shall be computed without 
regard to such accumulation distribution and without re-
gard to any accumulation distribution determined for any 
succeeding taxable year. 
‘‘(b) TOTAL TAXES DEEMED DISTRIBUTED.—If any 
portion of an accumulation distribution for any taxable 
year is deemed under subsection (a) to be an amount with-
in the meaning of paragraph (2) of section 146(a) distrib-
uted on the last day of any preceding taxable year, and 
such portion of such distribution is not less than the un-
distributed net income for such preceding taxable year, the 
trust shall be deemed to have distributed on the last day 
of such preceding taxable year an additional amount with-
in the meaning of paragraph (2) of section 146(a). Such 
additional amount shall be equal to the taxes imposed on 
the trust for such preceding taxable year attributable to
240
the undistributed net income. For purposes of this sub-
section, the undistributed net income and the taxes im-
posed on the trust for such preceding taxable year attrib-
utable to such undistributed net income shall be computed 
without regard to such accumulation distribution and 
without regard to any accumulation distribution deter-
mined for any succeeding taxable year.
‘‘(c) PRO RATA PORTION OF TAXES DEEMED DIS-
TRIBUTED.—If any portion of an accumulation distribu-
tion for any taxable year is deemed under subsection (a) 
to be an amount within the meaning of paragraph (2) of 
section 146(a) distributed on the last day of any preceding 
taxable year and such portion of the accumulation dis-
tribution is less than the undistributed net income for such 
preceding taxable year, the trust shall be deemed to have 
distributed on the last day of such preceding taxable year 
an additional amount within the meaning of paragraph (2) 
of section 146(a). Such additional amount shall be equal 
to the taxes imposed on the trust for such taxable year 
attributable to the undistributed net income multiplied by 
the ratio of the portion of the accumulation distribution 
to the undistributed net income of the trust for such year. 
For purposes of this subsection, the undistributed net in-
come and the taxes imposed on the trust for such pre-
ceding taxable year attributable to such undistributed net
241
income shall be computed without regard to the accumula-
tion distribution and without regard to any accumulation 
distribution determined for any succeeding taxable year. 
‘‘(d) RULE WHEN INFORMATION IS NOT AVAIL-
ABLE.—If adequate records are not available to determine 
the proper application of this subchapter to an amount 
distributed by a trust, such amount shall be deemed to 
be an accumulation distribution consisting of undistrib-
uted net income earned during the earliest preceding tax-
able year of the trust in which it can be established that 
the trust was in existence. 
‘‘(e) DENIAL OF REFUND TO TRUSTS AND BENE-
FICIARIES.—No refund or credit shall be allowed to a trust 
or a beneficiary of such trust for any preceding taxable 
year by reason of a distribution deemed to have been made 
by such trust in such year under this section. 
‘‘SEC. 152. TREATMENT OF AMOUNTS DEEMED DISTRIB-
UTED BY TRUST IN PRECEDING YEARS. 
‘‘(a) GENERAL RULE.—The total of the amounts 
which are treated under section 151 as having been dis-
tributed by a trust in a preceding taxable year shall be 
included in the income of a beneficiary of the trust when 
paid, credited, or required to be distributed to the extent 
that such total would have been included in the income 
of such beneficiary under section 147(a)(2) (and, with re-
242
spect to any tax-exempt interest to which section 103 ap-
plies, under section 147(b)) if such total had been paid 
to such beneficiary on the last day of such preceding tax-
able year. The tax imposed by this subtitle on a beneficiary 
for a taxable year in which any such amount is included 
in his income shall be determined only as provided in this 
section and shall consist of the sum of—
‘‘(1) a partial tax computed on the taxable in-
come reduced by an amount equal to the total of 
such amounts, at the rate and in the manner as if 
this section had not been enacted, 
‘‘(2) a partial tax determined as provided in 
subsection (b) of this section, and 
‘‘(3) in the case of a foreign trust, the interest 
charge determined as provided in section 152. 
‘‘(b) TAX ON DISTRIBUTION.—
‘‘(1) IN GENERAL.—The partial tax imposed by 
subsection (a)(2) shall be determined. 
‘‘(A) by determining the number of pre-
ceding taxable years of the trust on the last day 
of which an amount is deemed under section 
151(a) to have been distributed, 
‘‘(B) by taking from the 5 taxable years 
immediately preceding the year of the accumu-
lation distribution the 1 taxable year for which
243
the beneficiary’s taxable income was the highest 
and the 1 taxable year for which his taxable in-
come was the lowest, 
‘‘(C) by adding to the beneficiary’s taxable 
income for each of the 3 taxable years remain-
ing after the application of subparagraph (B) 
an amount determined by dividing the amount 
deemed distributed under section 151 and re-
quired to be included in income under sub-
section (a) by the number of preceding taxable 
years determined under subparagraph (A), and 
‘‘(D) by determining the average increase 
in tax for the 3 taxable years referred to in sub-
paragraph (C) resulting from the application of 
such subparagraph. 
The partial tax imposed by subsection (a)(2) shall be 
the excess (if any) of the average increase in tax de-
termined under subparagraph (D), multiplied by the 
number of preceding taxable years determined under 
subparagraph (A), over the amount of taxes (other 
than the amount of taxes described in section 
150(d)(2)) deemed distributed to the beneficiary 
under sections 151 (b) and (c).
‘‘(2) TREATMENT OF LOSS YEARS.—For pur-
poses of paragraph (1), the taxable income of the
244
beneficiary for any taxable year shall be deemed to 
be not less than zero. 
‘‘(3) CERTAIN PRECEDING TAXABLE YEARS NOT 
TAKEN INTO ACCOUNT.—For purposes of paragraph 
(1), if the amount of the undistributed net income 
deemed distributed in any preceding taxable year of 
the trust is less than 25 percent of the amount of 
the accumulation distribution divided by the number 
of preceding taxable years to which the accumulation 
distribution is allocated under section 151(a), the 
number of preceding taxable years of the trust with 
respect to which an amount is deemed distributed to 
a beneficiary under section 151(a) shall be deter-
mined without regard to such year. 
‘‘(4) EFFECT OF OTHER ACCUMULATION DIS-
TRIBUTIONS.—In computing the partial tax under 
paragraph (1) for any beneficiary, the income of 
such beneficiary for each of his prior taxable years 
shall include amounts previously deemed distributed 
to such beneficiary in such year under section 151 
as a result of prior accumulation distributions 
(whether from the same or another trust). 
‘‘(5) MULTIPLE DISTRIBUTIONS IN THE SAME 
TAXABLE YEAR.—In the case of accumulation dis-
tributions made from more than one trust which are
245
includible in the income of a beneficiary in the same 
taxable year, the distributions shall be deemed to 
have been made consecutively in whichever order the 
beneficiary shall determine. Generation-skipping 
transfer bears to the total accumulation distribution. 
‘‘(c) SPECIAL RULE FOR MULTIPLE TRUSTS.—
‘‘(1) IN GENERAL.—If, in the same prior tax-
able year of the beneficiary in which any part of the 
accumulation distribution from a trust (hereinafter 
in this paragraph referred to as ‘‘third trust’’) is 
deemed under section 151(a) to have been distrib-
uted to such beneficiary, some part of prior distribu-
tions by each of 2 or more other trusts is deemed 
under section 151(a) to have been distributed to 
such beneficiary, then subsections (b) and (c) of sec-
tion 151 shall not apply with respect to such part 
of the accumulation distribution from such third 
trust. 
‘‘(2) ACCUMULATION
DISTRIBUTIONS
FROM 
TRUST NOT TAKEN INTO ACCOUNT UNLESS THEY 
EQUAL OR EXCEED $1,000.—For purposes of para-
graph (1), an accumulation distribution from a trust 
to a beneficiary shall be taken into account only if 
such distribution, when added to any prior accumu-
lation distributions from such trust which are
246
deemed under section 151(a) to have been distrib-
uted to such beneficiary for the same prior taxable 
year of the beneficiary, equals or exceeds $1,000. 
‘‘SEC. 153. TRUST INCOME, DEDUCTIONS, AND CREDITS AT-
TRIBUTABLE TO GRANTORS AND OTHERS AS 
SUBSTANTIAL OWNERS. 
‘‘Where it is specified in sections 153 through 161 
that the grantor or another person shall be treated as the 
owner of any portion of a trust, there shall then be in-
cluded in computing the taxable income and credits of the 
grantor or the other person those items of income, deduc-
tions, and credits against tax of the trust which are attrib-
utable to that portion of the trust to the extent that such 
items would be taken into account under this chapter in 
computing taxable income or credits against the tax of an 
individual. Any remaining portion of the trust shall be 
subject to sections 140 through 152. No items of a trust 
shall be included in computing the taxable income and 
credits of the grantor or of any other person solely on the 
grounds of his dominion and control over the trust under 
section 61 (relating to definition of gross income) or any 
other provision of this title, except as specified in this sub-
part.
247
‘‘SEC. 154. DEFINITIONS AND RULES. 
‘‘(a) ADVERSE PARTY.—For purposes of sections 153 
through 160, ‘adverse party’ means any person having a 
substantial beneficial interest in the trust which would be 
adversely affected by the exercise or nonexercise of the 
power which he possesses respecting the trust. A person 
having a general power of appointment over the trust 
property shall be deemed to have a beneficial interest in 
the trust. 
‘‘(b) NONADVERSE PARTY.—For purposes of sections 
153 through 160, ‘nonadverse party’ means any person 
who is not an adverse party. 
‘‘(c) RELATED OR SUBORDINATE PARTY.—For pur-
poses of sections 153 through 161, ‘related or subordinate 
party’ means any nonadverse party who is—
‘‘(1) the grantor’s spouse if living with the 
grantor; 
‘‘(2) any one of the following: The grantor’s fa-
ther, mother, issue, brother or sister; an employee of 
the grantor; a corporation or any employee of a cor-
poration in which the stock holdings of the grantor 
and the trust are significant from the viewpoint of 
voting control; a subordinate employee of a corpora-
tion in which the grantor is an executive. 
For purposes of subsection (f) and sections 156 and 157, 
a related or subordinate party shall be presumed to be
248
subservient to the grantor in respect of the exercise or 
nonexercise of the powers conferred on him unless such 
party is shown not to be subservient by a preponderance 
of the evidence. 
‘‘(d) RULE WHERE POWER IS SUBJECT TO CONDI-
TION PRECEDENT.—A person shall be considered to have 
a power described in sections 153 through 161 even 
though the exercise of the power is subject to a precedent 
giving of notice or takes effect only on the expiration of 
a certain period after the exercise of the power. 
‘‘(e) GRANTOR TREATED AS HOLDING ANY POWER 
OR INTEREST OF GRANTOR’S SPOUSE.—
‘‘(1) IN GENERAL.—For purposes of sections 
153 through 160, a grantor shall be treated as hold-
ing any power or interest held by—
‘‘(A) any individual who was the spouse of 
the grantor at the time of the creation of such 
power or interest, or 
‘‘(B) any individual who became the spouse 
of the grantor after the creation of such power 
or interest, but only with respect to periods 
after such individual became the spouse of the 
grantor. 
‘‘(2) MARITAL STATUS.—For purposes of para-
graph (1)(A), an individual legally separated from
249
his spouse under a decree of divorce or of separate 
maintenance shall not be considered as married. 
‘‘(f) RULES NOT TO RESULT IN FOREIGN OWNER-
SHIP.—
‘‘(1) IN GENERAL.—Notwithstanding any other 
provision in sections 153 through 160, sections 153 
through 160 shall apply only to the extent such ap-
plication results in an amount (if any) being cur-
rently taken into account (directly or through 1 or 
more entities) under this chapter in computing the 
income of a citizen or resident of the United States 
or a domestic corporation. 
‘‘(2) EXCEPTIONS.—
‘‘(A) CERTAIN
REVOCABLE
AND
IRREV-
OCABLE
TRUSTS.—Paragraph (1) shall not 
apply to any portion of a trust if—
‘‘(i) the power to revest absolutely in 
the grantor title to the trust property to 
which such portion is attributable is exer-
cisable solely by the grantor without the 
approval or consent of any other person or 
with the consent of a related or subordi-
nate party who is subservient to the grant-
or, or
250
‘‘(ii) the only amounts distributable 
from such portion (whether income or cor-
pus) during the lifetime of the grantor are 
amounts distributable to the grantor or the 
spouse of the grantor. 
‘‘(B) COMPENSATORY TRUSTS.—Except as 
provided in regulations, paragraph (1) shall not 
apply to any portion of a trust distributions 
from which are taxable as compensation for 
services rendered. 
‘‘(3) SPECIAL
RULES.—Except as otherwise 
provided in regulations prescribed by the Secretary, 
a controlled foreign corporation shall be treated as 
a domestic corporation for purposes of paragraph 
(1). 
‘‘(4) RECHARACTERIZATION
OF
PURPORTED 
GIFTS.—In the case of any transfer directly or indi-
rectly from a partnership or foreign corporation 
which the transferee treats as a gift or bequest, the 
Secretary may recharacterize such transfer in such 
circumstances as the Secretary determines to be ap-
propriate to prevent the avoidance of the purposes of 
this subsection. 
‘‘(5) SPECIAL RULE WHERE GRANTOR IS FOR-
EIGN PERSON.—If—
251
‘‘(A) but for this subsection, a foreign per-
son would be treated as the owner of any por-
tion of a trust, and 
‘‘(B) such trust has a beneficiary who is a 
United States person, 
such beneficiary shall be treated as the grantor of 
such portion to the extent such beneficiary has made 
(directly or indirectly) transfers of property (other 
than in a sale for full and adequate consideration) 
to such foreign person. 
‘‘(6) REGULATIONS.—The Secretary shall pre-
scribe such regulations as may be necessary or ap-
propriate to carry out the purposes of this sub-
section, including regulations providing that para-
graph (1) shall not apply in appropriate cases.
‘‘SEC. 155. REVERSIONARY INTERESTS. 
‘‘(a) GENERAL RULE.—The grantor shall be treated 
as the owner of any portion of a trust in which he has 
a reversionary interest in either the corpus or the income 
therefrom, if, as of the inception of that portion of the 
trust, the value of such interest exceeds 5 percent of the 
value of such portion. 
‘‘(b) REVERSIONARY INTEREST TAKING EFFECT AT 
DEATH
OF
MINOR
LINEAL
DESCENDANT
BENE-
FICIARY.—In the case of any beneficiary who—
252
‘‘(1) is a lineal descendant of the grantor, and 
‘‘(2) holds all of the present interests in any 
portion of a trust, 
the grantor shall not be treated under subsection (a) as 
the owner of such portion solely by reason of a rever-
sionary interest in such portion which takes effect upon 
the death of such beneficiary before such beneficiary at-
tains age 21. 
‘‘(c) SPECIAL RULE FOR DETERMINING VALUE OF 
REVERSIONARY INTEREST.—For purposes of subsection 
(a), the value of the grantor’s reversionary interest shall 
be determined by assuming the maximum exercise of dis-
cretion in favor of the grantor. 
‘‘(d) POSTPONEMENT OF DATE SPECIFIED FOR RE-
ACQUISITION.—Any postponement of the date specified for 
the reacquisition of possession or enjoyment of the rever-
sionary interest shall be treated as a new transfer in trust 
commencing with the date on which the postponement is 
effective and terminating with the date prescribed by the 
postponement. However, income for any period shall not 
be included in the income of the grantor by reason of the 
preceding sentence if such income would not be so includ-
ible in the absence of such postponement.
253
‘‘SEC. 156. POWER TO CONTROL BENEFICIAL ENJOYMENT. 
‘‘(a) GENERAL RULE.—The grantor shall be treated 
as the owner of any portion of a trust in respect of which 
the beneficial enjoyment of the corpus or the income there-
from is subject to a power of disposition, exercisable by 
the grantor or a nonadverse party, or both, without the 
approval or consent of any adverse party. 
‘‘(b) EXCEPTIONS
FOR CERTAIN POWERS.—Sub-
section (a) shall not apply to the following powers regard-
less of by whom held: 
‘‘(1) POWER TO APPLY INCOME TO SUPPORT OF 
A
DEPENDENT.—A power described in section 
159(b) to the extent that the grantor would not be 
subject to tax under that section. 
‘‘(2) POWER
AFFECTING
BENEFICIAL
ENJOY-
MENT
ONLY
AFTER
OCCURRENCE
OF
EVENT.—A 
power, the exercise of which can only affect the ben-
eficial enjoyment of the income for a period com-
mencing after the occurrence of an event such that 
a grantor would not be treated as the owner under 
section 155 if the power were a reversionary inter-
est; but the grantor may be treated as the owner 
after the occurrence of the event unless the power is 
relinquished. 
‘‘(3) POWER EXERCISABLE ONLY BY WILL.—A 
power exercisable only by will, other than a power in
254
the grantor to appoint by will the income of the 
trust where the income is accumulated for such dis-
position by the grantor or may be so accumulated in 
the discretion of the grantor or a nonadverse party, 
or both, without the approval or consent of any ad-
verse party. 
‘‘(4) POWER TO ALLOCATE AMONG CHARITABLE 
BENEFICIARIES.—A power to determine the bene-
ficial enjoyment of the corpus or the income there-
from if the corpus or income is irrevocably payable 
for a purpose specified in section 101(c) (relating to 
definition of charitable contributions) or to an em-
ployee stock ownership plan (as defined in section 
4975(e)(7)) in a qualified gratuitous transfer (as de-
fined in section 149(g)(1)). 
‘‘(5) POWER
TO
DISTRIBUTE
CORPUS.—A 
power to distribute corpus either—
‘‘(A) to or for a beneficiary or beneficiaries 
or to or for a class of beneficiaries (whether or 
not income beneficiaries) provided that the 
power is limited by a reasonably definite stand-
ard which is set forth in the trust instrument; 
or 
‘‘(B) to or for any current income bene-
ficiary, provided that the distribution of corpus
255
must be chargeable against the proportionate 
share of corpus held in trust for the payment 
of income to the beneficiary as if the corpus 
constituted a separate trust. 
A power does not fall within the powers described in 
this paragraph if any person has a power to add to 
the beneficiary or beneficiaries or to a class of bene-
ficiaries designated to receive the income or corpus, 
except where such action is to provide for after-born 
or after-adopted children. 
‘‘(6) POWER
TO
WITHHOLD
INCOME
TEMPO-
RARILY.—A power to distribute or apply income to 
or for any current income beneficiary or to accumu-
late the income for him, provided that any accumu-
lated income must ultimately be payable—
‘‘(A) to the beneficiary from whom dis-
tribution or application is withheld, to his es-
tate, or to his appointees (or persons named as 
alternate takers in default of appointment) pro-
vided that such beneficiary possesses a power of 
appointment which does not exclude from the 
class of possible appointees any person other 
than the beneficiary, his estate, his creditors, or 
the creditors of his estate, or
256
‘‘(B) on termination of the trust, or in con-
junction with a distribution of corpus which is 
augmented by such accumulated income, to the 
current income beneficiaries in shares which 
have been irrevocably specified in the trust in-
strument. 
Accumulated income shall be considered so payable 
although it is provided that if any beneficiary does 
not survive a date of distribution which could rea-
sonably have been expected to occur within the bene-
ficiary’s lifetime, the share of the deceased bene-
ficiary is to be paid to his appointees or to one or 
more designated alternate takers (other than the 
grantor or the grantor’s estate) whose shares have 
been irrevocably specified. A power does not fall 
within the powers described in this paragraph if any 
person has a power to add to the beneficiary or 
beneficiaries or to a class of beneficiaries designated 
to receive the income or corpus except where such 
action is to provide for after-born or after-adopted 
children. 
‘‘(7) POWER
TO
WITHHOLD
INCOME
DURING 
DISABILITY
OF
A
BENEFICIARY.—A power exer-
cisable only during—
257
‘‘(A) the existence of a legal disability of 
any current income beneficiary, or 
‘‘(B) the period during which any income 
beneficiary shall be under the age of 21 years, 
to distribute or apply income to or for such bene-
ficiary or to accumulate and add the income to cor-
pus. A power does not fall within the powers de-
scribed in this paragraph if any person has a power 
to add to the beneficiary or beneficiaries or to a 
class of beneficiaries designated to receive the in-
come or corpus, except where such action is to pro-
vide for after-born or after-adopted children. 
‘‘(8) POWER TO ALLOCATE BETWEEN CORPUS 
AND INCOME.—A power to allocate receipts and dis-
bursements as between corpus and income, even 
though expressed in broad language. 
‘‘(c) EXCEPTION FOR CERTAIN POWERS OF INDE-
PENDENT TRUSTEES.—Subsection (a) shall not apply to 
a power solely exercisable (without the approval or consent 
of any other person) by a trustee or trustees, none of 
whom is the grantor, and no more than half of whom are 
related or subordinate parties who are subservient to the 
wishes of the grantor—
258
‘‘(1) to distribute, apportion, or accumulate in-
come to or for a beneficiary or beneficiaries, or to, 
for, or within a class of beneficiaries; or 
‘‘(2) to pay out corpus to or for a beneficiary 
or beneficiaries or to or for a class of beneficiaries 
(whether or not income beneficiaries). 
A power does not fall within the powers described in this 
subsection if any person has a power to add to the bene-
ficiary or beneficiaries or to a class of beneficiaries des-
ignated to receive the income or corpus, except where such 
action is to provide for after-born or after-adopted chil-
dren. For periods during which an individual is the spouse 
of the grantor (within the meaning of section 154(e)(2)), 
any reference in this subsection to the grantor shall be 
treated as including a reference to such individual. 
‘‘(d) POWER TO ALLOCATE INCOME IF LIMITED BY 
A STANDARD.—Subsection (a) shall not apply to a power 
solely exercisable (without the approval or consent of any 
other person) by a trustee or trustees, none of whom is 
the grantor or spouse living with the grantor, to distribute, 
apportion, or accumulate income to or for a beneficiary 
or beneficiaries, or to, for, or within a class of bene-
ficiaries, whether or not the conditions of paragraph (6) 
or (7) of subsection (b) are satisfied, if such power is lim-
ited by a reasonably definite external standard which is
259
set forth in the trust instrument. A power does not fall 
within the powers described in this subsection if any per-
son has a power to add to the beneficiary or beneficiaries 
or to a class of beneficiaries designated to receive the in-
come or corpus except where such action is to provide for 
after-born or after-adopted children. 
‘‘SEC. 157. ADMINISTRATIVE POWERS.
‘‘The grantor shall be treated as the owner of any 
portion of a trust in respect of which—
‘‘(1) POWER TO DEAL FOR LESS THAN ADE-
QUATE AND FULL CONSIDERATION.—A power exer-
cisable by the grantor or a nonadverse party, or 
both, without the approval or consent of any adverse 
party enables the grantor or any person to purchase, 
exchange, or otherwise deal with or dispose of the 
corpus or the income therefrom for less than an ade-
quate consideration in money or money’s worth. 
‘‘(2) POWER TO BORROW WITHOUT ADEQUATE 
INTEREST OR SECURITY.—A power exercisable by 
the grantor or a nonadverse party, or both, enables 
the grantor to borrow the corpus or income, directly 
or indirectly, without adequate interest or without 
adequate security except where a trustee (other than 
the grantor) is authorized under a general lending
260
power to make loans to any person without regard 
to interest or security. 
‘‘(3) BORROWING OF THE TRUST FUNDS.—The 
grantor has directly or indirectly borrowed the cor-
pus or income and has not completely repaid the 
loan, including any interest, before the beginning of 
the taxable year. The preceding sentence shall not 
apply to a loan which provides for adequate interest 
and adequate security, if such loan is made by a 
trustee other than the grantor and other than a re-
lated or subordinate trustee subservient to the 
grantor. For periods during which an individual is 
the spouse of the grantor (within the meaning of 
section 154(e)(2)), any reference in this paragraph 
to the grantor shall be treated as including a ref-
erence to such individual. 
‘‘(4) GENERAL POWERS OF ADMINISTRATION.—
A power of administration is exercisable in a non-
fiduciary capacity by any person without the ap-
proval or consent of any person in a fiduciary capac-
ity. For purposes of this paragraph, the term ‘power 
of administration’ means any one or more of the fol-
lowing powers: (A) a power to vote or direct the vot-
ing of stock or other securities of a corporation in 
which the holdings of the grantor and the trust are
261
significant from the viewpoint of voting control; (B) 
a power to control the investment of the trust funds 
either by directing investments or reinvestments, or 
by vetoing proposed investments or reinvestments, to 
the extent that the trust funds consist of stocks or 
securities of corporations in which the holdings of 
the grantor and the trust are significant from the 
viewpoint of voting control; or (C) a power to reac-
quire the trust corpus by substituting other property 
of an equivalent value. 
‘‘SEC. 158. POWER TO REVOKE. 
‘‘(a) GENERAL RULE.—The grantor shall be treated 
as the owner of any portion of a trust, whether or not 
he is treated as such owner under any other provision of 
this part, where at any time the power to revest in the 
grantor title to such portion is exercisable by the grantor 
or a non-adverse party, or both. 
‘‘(b) POWER AFFECTING BENEFICIAL ENJOYMENT 
ONLY AFTER OCCURRENCE OF EVENT.—Subsection (a) 
shall not apply to a power the exercise of which can only 
affect the beneficial enjoyment of the income for a period 
commencing after the occurrence of an event such that 
a grantor would not be treated as the owner under section 
155 if the power were a reversionary interest. But the
262
grantor may be treated as the owner after the occurrence 
of such event unless the power is relinquished. 
‘‘SEC. 159. INCOME FOR BENEFIT OF GRANTOR. 
‘‘(a) GENERAL RULE.—The grantor shall be treated 
as the owner of any portion of a trust, whether or not 
he is treated as such owner under section 156, whose in-
come without the approval or consent of any adverse party 
is, or, in the discretion of the grantor or a nonadverse 
party, or both, may be—
‘‘(1) distributed to the grantor or the grantor’s 
spouse; 
‘‘(2) held or accumulated for future distribution 
to the grantor or the grantor’s spouse; or 
‘‘(3) applied to the payment of premiums on 
policies of insurance on the life of the grantor or the 
grantor’s spouse (except policies of insurance irrev-
ocably payable for a purpose specified in section 
101(c) (relating to definition of charitable contribu-
tions)). 
This subsection shall not apply to a power the exercise 
of which can only affect the beneficial enjoyment of the 
income for a period commencing after the occurrence of 
an event such that the grantor would not be treated as 
the owner under section 153 if the power were a rever-
sionary interest; but the grantor may be treated as the
263
owner after the occurrence of the event unless the power 
is relinquished. 
‘‘(b) OBLIGATIONS OF SUPPORT.—Income of a trust 
shall not be considered taxable to the grantor under sub-
section (a) or any other provision of this chapter merely 
because such income in the discretion of another person, 
the trustee, or the grantor acting as trustee or co-trustee, 
may be applied or distributed for the support or mainte-
nance of a beneficiary (other than the grantor’s spouse) 
whom the grantor is legally obligated to support or main-
tain, except to the extent that such income is so applied 
or distributed. In cases where the amounts so applied or 
distributed are paid out of corpus or out of other than 
income for the taxable year, such amounts shall be consid-
ered to be an amount paid or credited within the meaning 
of paragraph (2) of section 146(a) and shall be taxed to 
the grantor under section 147. 
‘‘SEC. 160. PERSON OTHER THAN GRANTOR TREATED AS 
SUBSTANTIAL OWNER. 
‘‘(a) GENERAL RULE.—A person other than the 
grantor shall be treated as the owner of any portion of 
a trust with respect to which: 
‘‘(1) such person has a power exercisable solely 
by himself to vest the corpus or the income there-
from in himself, or
264
‘‘(2) such person has previously partially re-
leased or otherwise modified such a power and after 
the release or modification retains such control as 
would, within the principles of sections 153 to 159, 
inclusive, subject a grantor of a trust to treatment 
as the owner thereof. 
‘‘(b) EXCEPTION WHERE GRANTOR IS TAXABLE.—
Subsection (a) shall not apply with respect to a power over 
income, as originally granted or thereafter modified, if the 
grantor of the trust or a transferor (to whom section 161 
applies) is otherwise treated as the owner under sections 
153 through 159 or section 161. 
‘‘(c) OBLIGATIONS
OF SUPPORT.—Subsection (a) 
shall not apply to a power which enables such person, in 
the capacity of trustee or cotrustee, merely to apply the 
income of the trust to the support or maintenance of a 
person whom the holder of the power is obligated to sup-
port or maintain except to the extent that such income 
is so applied. In cases where the amounts so applied or 
distributed are paid out of corpus or out of other than 
income of the taxable year, such amounts shall be consid-
ered to be an amount paid or credited within the meaning 
of paragraph (2) of section 146(a) and shall be taxed to 
the holder of the power under section 147.
265
‘‘(d) EFFECT OF RENUNCIATION OR DISCLAIMER.—
Subsection (a) shall not apply with respect to a power 
which has been renounced or disclaimed within a reason-
able time after the holder of the power first became aware 
of its existence. 
‘‘SEC. 161. FOREIGN TRUSTS HAVING ONE OR MORE 
UNITED STATES BENEFICIARIES. 
‘‘(a) TRANSFEROR TREATED AS OWNER.—
‘‘(1) IN
GENERAL.—A United States person 
who directly or indirectly transfers property to a for-
eign trust (other than a trust described in section 
6048(a)(3)(B)(ii)) shall be treated as the owner for 
his taxable year of the portion of such trust attrib-
utable to such property if for such year there is a 
United States beneficiary of any portion of such 
trust. 
‘‘(2) EXCEPTIONS.—Paragraph (1) shall not 
apply—
‘‘(A) TRANSFERS BY REASON OF DEATH.—
To any transfer by reason of the death of the 
transferor. 
‘‘(B) 
TRANSFERS
AT
FAIR
MARKET 
VALUE.—To any transfer of property to a trust 
in exchange for consideration of at least the fair 
market value of the transferred property. For
266
purposes of the preceding sentence, consider-
ation other than cash shall be taken into ac-
count at its fair market value. 
‘‘(3) CERTAIN OBLIGATIONS NOT TAKEN INTO 
ACCOUNT
UNDER
FAIR
MARKET
VALUE
EXCEP-
TION.—
‘‘(A) IN GENERAL.—In determining wheth-
er paragraph (2)(B) applies to any transfer by 
a person described in clause (ii) or (iii) of sub-
paragraph (C), there shall not be taken into ac-
count—
‘‘(i) except as provided in regulations, 
any obligation of a person described in 
subparagraph (C), and 
‘‘(ii) to the extent provided in regula-
tions, any obligation which is guaranteed 
by a person described in subparagraph (C). 
‘‘(B) TREATMENT
OF
PRINCIPAL
PAY-
MENTS
ON
OBLIGATION.—Principal payments 
by the trust on any obligation referred to in 
subparagraph (A) shall be taken into account 
on and after the date of the payment in deter-
mining the portion of the trust attributable to 
the property transferred.
267
‘‘(C) PERSONS DESCRIBED.—The persons 
described in this subparagraph are—
‘‘(i) the trust,
‘‘(ii) any grantor, owner, or bene-
ficiary of the trust, and 
‘‘(iii) any person who is related (with-
in the meaning of section 143(i)(2)(B) to 
any grantor, owner, or beneficiary of the 
trust. 
‘‘(4) SPECIAL RULES APPLICABLE TO FOREIGN 
GRANTOR WHO LATER BECOMES A UNITED STATES 
PERSON.—
‘‘(A) IN GENERAL.—If a nonresident alien 
individual has a residency starting date within 
5 years after directly or indirectly transferring 
property to a foreign trust, this section and sec-
tion 6048 shall be applied as if such individual 
transferred to such trust on the residency start-
ing date an amount equal to the portion of such 
trust attributable to the property transferred by 
such individual to such trust in such transfer. 
‘‘(B) TREATMENT OF UNDISTRIBUTED IN-
COME.—For purposes of this section, undistrib-
uted net income for periods before such individ-
ual’s residency starting date shall be taken into
268
account in determining the portion of the trust 
which is attributable to property transferred by 
such individual to such trust but shall not oth-
erwise be taken into account. 
‘‘(C) RESIDENCY
STARTING
DATE.—For 
purposes of this paragraph, an individual’s resi-
dency starting date is the residency starting 
date determined under section 7701(b)(2)(A). 
‘‘(5) OUTBOUND TRUST MIGRATIONS.—If—
‘‘(A) an individual who is a citizen or resi-
dent of the United States transferred property 
to a trust which was not a foreign trust, and 
‘‘(B) such trust becomes a foreign trust 
while such individual is alive, then this section 
and section 6048 shall be applied as if such in-
dividual transferred to such trust on the date 
such trust becomes a foreign trust an amount 
equal to the portion of such trust attributable 
to the property previously transferred by such 
individual to such trust. A rule similar to the 
rule of paragraph (4)(B) shall apply for pur-
poses of this paragraph. 
‘‘(b) TRUSTS ACQUIRING UNITED STATES BENE-
FICIARIES.—If—
269
‘‘(1) subsection (a) applies to a trust for the 
transferor’s taxable year, and 
‘‘(2) subsection (a) would have applied to the 
trust for his immediately preceding taxable year but 
for the fact that for such preceding taxable year 
there was no United States beneficiary for any por-
tion of the trust, 
then, for purposes of this chapter, the transferor shall be 
treated as having income for the taxable year (in addition 
to his other income for such year) equal to the undistrib-
uted net income (at the close of such immediately pre-
ceding taxable year) attributable to the portion of the 
trust referred to in subsection (a). 
‘‘(c) TRUSTS
TREATED
AS
HAVING
A
UNITED 
STATES BENEFICIARY.—
‘‘(1) IN GENERAL.—For purposes of this sec-
tion, a trust shall be treated as having a United 
States beneficiary for the taxable year unless—
‘‘(A) under the terms of the trust, no part 
of the income or corpus of the trust may be 
paid or accumulated during the taxable year to 
or for the benefit of a United States person, 
and 
‘‘(B) if the trust were terminated at any 
time during the taxable year, no part of the in-
270
come or corpus of such trust could be paid to 
or for the benefit of a United States person. 
‘‘(2) ATTRIBUTION OF OWNERSHIP.—For pur-
poses of paragraph (1), an amount shall be treated 
as paid or accumulated to or for the benefit of a 
United States person if such amount is paid to or 
accumulated for a foreign corporation, foreign part-
nership, or foreign trust or estate, and—
‘‘(A) in the case of a foreign corporation, 
such corporation is a controlled foreign corpora-
tion, 
‘‘(B) in the case of a foreign partnership, 
a United States person is a partner of such 
partnership, or 
‘‘(C) in the case of a foreign trust or es-
tate, such trust or estate has a United States 
beneficiary (within the meaning of paragraph 
(1)). 
‘‘(3) CERTAIN UNITED STATES BENEFICIARIES 
DISREGARDED.—A beneficiary shall not be treated 
as a United States person in applying this section 
with respect to any transfer of property to foreign 
trust if such beneficiary first became a United 
States person more than 5 years after the date of 
such transfer.
271
‘‘(d) REGULATIONS.—The Secretary shall prescribe 
such regulations as may be necessary or appropriate to 
carry out the purposes of this section. 
‘‘SEC. 162. LIMITATION ON CHARITABLE DEDUCTION. 
‘‘In computing the deduction allowable under section 
142(c) to a trust, no amount otherwise allowable under 
section 142(c) as a deduction shall be allowed as a deduc-
tion with respect to income of the taxable year which is 
allocable to unrelated business income for such year. 
‘‘SEC. 163. INCOME OF AN ESTATE OR TRUST IN CASE OF DI-
VORCE, ETC. 
‘‘(a) INCLUSION IN GROSS INCOME OF WIFE.—There 
shall be included in the gross income of a wife who is di-
vorced or legally separated under a decree of divorce or 
of separate maintenance (or who is separated from her 
husband under a written separation agreement) the 
amount of the income of any trust which such wife is enti-
tled to receive and which, except for this section, would 
be includible in the gross income of her husband, and such 
amount shall not, despite any other provision of this sub-
title, be includible in the gross income of such husband. 
This subsection shall not apply to that part of any such 
income of the trust which the terms of the decree, written 
separation agreement, or trust instrument fix, in terms 
of an amount of money or a portion of such income, as
272
a sum which is payable for the support of minor children 
of such husband. In case such income is less than the 
amount specified in the decree, agreement, or instrument, 
for the purpose of applying the preceding sentence, such 
income, to the extent of such sum payable for such sup-
port, shall be considered a payment for such support. 
‘‘(b) WIFE CONSIDERED A BENEFICIARY.—For pur-
poses of computing the taxable income of the estate or 
trust and the taxable income of a wife to whom subsection 
(a) applies, such wife shall be considered as the bene-
ficiary. 
‘‘(c) CROSS REFERENCE.—For definitions of ‘hus-
band’ and ‘wife’, as used in this section, see section 
7701(a)(17). 
‘‘SEC. 164. RECOGNITION OF GAIN ON CERTAIN TRANSFERS 
TO CERTAIN FOREIGN TRUSTS AND ESTATES. 
‘‘(a) IN GENERAL.—Except as provided in regula-
tions, in the case of any transfer of property by a United 
States person to a foreign estate or trust, for purposes 
of this subtitle, such transfer shall be treated as a sale 
or exchange for an amount equal to the fair market value 
of the property transferred, and the transferor shall recog-
nize as gain the excess of—
‘‘(1) the fair market value of the property so 
transferred, over
273
‘‘(2) the adjusted basis (for purposes of deter-
mining gain) of such property in the hands of the 
transferor. 
‘‘(b) EXCEPTION.—Subsection (a) shall not apply to 
a transfer to a trust by a United States person to the 
extent that any person is treated as the owner of such 
trust under section 153. 
‘‘(c) TREATMENT OF TRUSTS WHICH BECOME FOR-
EIGN TRUSTS.—If a trust which is not a foreign trust be-
comes a foreign trust, such trust shall be treated for pur-
poses of this section as having transferred, immediately 
before becoming a foreign trust, all of its assets to a for-
eign trust. 
‘‘SEC. 165. TREATMENT OF FUNERAL TRUSTS. 
‘‘(a) IN GENERAL.—In the case of a qualified funeral 
trust, sections 144 through 161 shall not apply, and no 
deduction shall be allowed by section 142(b). 
‘‘(b) QUALIFIED FUNERAL TRUST.—‘Qualified fu-
neral trust’ means any trust (other than a foreign trust) 
if—
‘‘(1) the trust arises as a result of a contract 
with a person engaged in the trade or business of 
providing funeral or burial services or property nec-
essary to provide such services,
274
‘‘(2) the sole purpose of the trust is to hold, in-
vest, and reinvest funds in the trust and to use such 
funds solely to make payments for such services or 
property for the benefit of the beneficiaries of the 
trust, 
‘‘(3) the only beneficiaries of such trust are in-
dividuals with respect to whom such services or 
property are to be provided at their death under 
contracts described in paragraph (1), 
‘‘(4) the only contributions to the trust are con-
tributions by or for the benefit of such beneficiaries, 
‘‘(5) the trustee elects the application of this 
subsection, and 
‘‘(6) the trust would (but for the election de-
scribed in paragraph (5)) be treated as owned under 
sections 153 through 161 by the purchasers of the 
contracts described in paragraph (1). 
‘‘(c) DOLLAR LIMITATION ON CONTRIBUTIONS.—
‘‘(1) IN
GENERAL.—Any trust which accepts 
aggregate contributions by or for the benefit of an 
individual in excess of $7,000 shall not be a quali-
fied funeral trust. 
‘‘(2) RELATED TRUSTS.—For purposes of para-
graph (1), all trusts having trustees which are re-
lated persons shall be treated as 1 trust. For pur-
275
poses of the preceding sentence, persons are related 
if—
‘‘(A) the relationship between such persons 
is described in section 171(a)(5), or 
‘‘(B) the Secretary determines that treat-
ing such persons as related is necessary to pre-
vent avoidance of the purposes of this section. 
‘‘(3) INFLATION
ADJUSTMENT.—In the case of 
any contract referred to in subsection (b)(1) which 
is entered into during any calendar year after 2003, 
the dollar amount referred to in paragraph (1) shall 
be adjusted for inflation in accordance with section 
23. 
‘‘(d) APPLICATION
OF RATE SCHEDULE.—Section 
140(b) shall be applied to each qualified funeral trust by 
treating each beneficiary’s interest in each such trust as 
a separate trust. 
‘‘(e) TREATMENT OF AMOUNTS REFUNDED TO PUR-
CHASER ON CANCELLATION.—No gain or loss shall be rec-
ognized to a purchaser of a contract described in sub-
section (b)(1) by reason of any payment from such trust 
to such purchaser by reason of cancellation of such con-
tract. If any payment referred to in the preceding sentence 
consists of property other than money, the basis of such 
property in the hands of such purchaser shall be the same
276
as the trust’s basis in such property immediately before 
the payment. 
‘‘(f) SIMPLIFIED REPORTING.—The Secretary may 
prescribe rules for simplified reporting of all trusts having 
a single trustee. 
‘‘SEC. 166. INCOME IN RESPECT OF A DECEDENT. 
‘‘(a) INCLUSION IN GROSS INCOME.—
‘‘(1) GENERAL USE.—The amount of all items 
of gross income in respect of a decedent which are 
not properly includible in respect of a taxable period 
in which falls the date of his death, or a prior pe-
riod, shall be included in gross income, for the tax-
able year when received, of—
‘‘(A) the estate of the decedent, if the right 
to receive the amount is acquired by the dece-
dent’s estate, 
‘‘(B) the person who, by reason of the 
death of the decedent, acquires the right to re-
ceive the amount, if the right to receive the 
amount is not acquired by the decedent’s estate 
from the decedent, 
‘‘(C) the person who acquires from the de-
cedent the right to receive the amount by be-
quest, devise or inheritance, if the amount is re-
277
ceived after a distribution by the decedent’s es-
tate of such right. 
‘‘(2) DEFINITION.—The Secretary shall pre-
scribe regulations on the treatment of income from 
sales of rights to receive income and installment 
sales. 
‘‘(b) The amount of any homeowner deduction or for-
eign tax credit in respect of a decedent which is not prop-
erly allowable to the decedent with respect to the taxable 
period in which falls the date of his death, or a prior pe-
riod, shall be allowed in accordance with regulations that 
reflect the principles of section 691(b) of the Internal Rev-
enue Code of 1986. 
‘‘Subchapter J—Definitions and Rules of 
Application
‘‘Sec. 171. Definitions. 
‘‘Sec. 172. Rules of application.
‘‘SEC. 171. DEFINITIONS. 
‘‘(a) IN GENERAL.—When used in this chapter, 
where not otherwise distinctly expressed or manifestly in-
compatible with the intent thereof—
‘‘(1) BUSINESS
ENTITY.—The definition of 
‘business entity’ in section 206 (relating to the busi-
ness tax) shall apply. 
‘‘(2) BUSINESS TAX.—‘Business tax’ and ‘Sim-
plified USA Tax for businesses’ mean the tax im-
278
posed by section 201 and, to the extent required by 
the context, the provisions of chapter 2. 
‘‘(3) INTERNAL REVENUE CODE OF 1986.—‘In-
ternal Revenue Code of 1986’ means the Internal 
Revenue Code of 1986 as in effect immediately be-
fore the enactment of the Simplified USA Tax Act 
of 2003. 
‘‘(4) UNITED STATES.—‘United States’ means 
the States and the District of Columbia. 
‘‘(5) 
RELATED
PARTY.—‘Related 
party’ 
means—
‘‘(A) Members of a family, as defined in 
paragraph (6)(D); 
‘‘(B) An individual and a business entity 
more than 50 percent in value of which is 
owned, directly or indirectly, by or for such in-
dividual (applying rules of constructive owner-
ship);
‘‘(C) Two business entities that are eligible 
to file a consolidated return under chapter 2; 
‘‘(D) A grantor and a fiduciary of any 
trust; 
‘‘(E) A fiduciary of a trust and a fiduciary 
of another trust, if the same person is a grantor 
of both trusts;
279
‘‘(F) A fiduciary of a trust and a bene-
ficiary of such trust; 
‘‘(G) A fiduciary of a trust and a bene-
ficiary of another trust, if the same person is 
a grantor of both trusts; 
‘‘(H) A fiduciary of a trust and a corpora-
tion more than 50 percent in value of the out-
standing stock of which is owned, directly or in-
directly, by or for the trust or by or for a per-
son who is a grantor of the trust; 
‘‘(I) A person and an organization to 
which section 251 (relating to certain edu-
cational and charitable organizations which are 
exempt from tax) applies and which is con-
trolled directly or indirectly by such person or 
(if such person is an individual) by members of 
the family of such individual; 
‘‘(J) Two business entities if the same per-
sons own more than 50 percent of the value of 
each (applying rules of constructive ownership), 
with value measured by—
‘‘(i) the value of the outstanding stock 
in the case of a corporation, 
‘‘(ii) the capital interest or the profits 
interest, whichever is greater, in the case
280
of a partnership or limited liability com-
pany; 
‘‘(K) Except in the case of a sale or ex-
change in satisfaction of a pecuniary bequest, 
an executor of an estate and a beneficiary of 
such estate. 
‘‘(6) CONSTRUCTIVE
OWNERSHIP.—For pur-
poses of determining, in applying paragraph (5), the 
ownership of a business entity—
‘‘(A) Stock or other equity interest owned, 
directly or indirectly, by or for a corporation, 
partnership, estate, or trust shall be considered 
as being owned proportionately by or for its 
shareholders, partners, or beneficiaries; 
‘‘(B) An individual shall be considered as 
owning the stock or other equity interest owned, 
directly or indirectly, by or for his family; 
‘‘(C) An individual owning (otherwise than 
by the application of subparagraph (B)) any 
stock in a corporation or other equity interest 
in another form of business entity shall be con-
sidered as owning the stock owned, directly or 
indirectly, by or for his partner; 
‘‘(D) The family of an individual shall in-
clude only his brothers and sisters (whether by
283
‘‘(2) the definition clearly would not be applica-
ble in a particular context. 
‘‘(b) INTERPRETATIONS CONSISTENT WITH INTER-
NAL REVENUE CODE OF 1986.—Terms not defined in this 
chapter or elsewhere in this title, but defined in the Inter-
nal Revenue Code of 1986, shall be interpreted in a man-
ner consistent with the Internal Revenue Code of 1986, 
except to the extent such interpretation would be incon-
sistent with the principles and purposes of this chapter.’’
(c) EXEMPTION FROM PROHIBITED TRANSACTION 
TAX.—Section 4975(g) of the Code is amended by—
(1) striking ‘‘or’’ at the end of paragraph (2), 
(2) deleting the period at the end of paragraph 
(3) and inserting ‘‘; or’’, 
(3) and inserting the following new paragraph 
(4): 
‘‘(4) to a Roth IRA in the case of a loan to or 
equity investment in a controlled business entity as 
permitted by section 30(f)).’’
284
TITLE III—SIMPLIFIED USA TAX 
FOR BUSINESSES 
SEC. 301. REPEAL OF CORPORATE INCOME TAX; NEW TAX 
PAID BY CORPORATIONS AND OTHER BUSI-
NESSES. 
(a) IN GENERAL.—Chapter 2 of the Internal Rev-
enue Code is renumbered chapter 3 and following new 
chapter is inserted after chapter 1: 
‘‘CHAPTER 2—SIMPLIFIED USA TAX FOR 
BUSINESSES
‘‘Subchapter A. Imposition of tax. 
‘‘Subchapter B. Basic rules for business tax. 
‘‘Subchapter C. Capital contributions, mergers, acquisitions, and distributions. 
‘‘Subchapter D. Accounting methods. 
‘‘Subchapter E. Land and rental property. 
‘‘Subchapter F. Insurance and financial products. 
‘‘Subchapter G. Financial intermediation and financial institutions. 
‘‘Subchapter H. Tax-exempt organizations. 
‘‘Subchapter I. Cooperatives. 
‘‘Subchapter J. Sourcing rules. 
‘‘Subchapter K. Business conducted in a possession. 
‘‘Subchapter L. Payroll tax credit. 
‘‘Subchapter M. Import tax. 
‘‘Subchapter N. Transition rules. 
‘‘Subchapter O. Rules for administration, consolidated returns. 
‘‘Subchapter P. Definitions and rules of applications.
‘‘Subchapter A—Imposition of Tax
‘‘Sec. 201. Tax imposed.
‘‘SEC. 201. TAX IMPOSED. 
‘‘(a) TAXABLE BUSINESS ACTIVITY.—A tax is im-
posed on the sale of goods and services in the United 
States by a business entity. The amount of the tax equals 
the amount by which—
285
‘‘(1) the business tax exceeds, 
‘‘(2) the payroll tax credit. 
‘‘(b) BUSINESS TAX IMPOSED.—
‘‘(1) IN GENERAL.—The ‘business tax’ imposed 
on a business entity that sells or leases property or 
sells services in the United States equals the sum 
of—
‘‘(A) 8 percent of the portion of the gross 
profits of the business entity for the taxable 
year that does not exceed $150,000, and 
‘‘(B) 12 percent of such portion of the 
gross profits of the business entity for the tax-
able year that exceeds $150,000. 
‘‘(2) LIMITATION ON APPLICATION OF BENE-
FITS OF GRADUATED RATE SCHEDULE.—The Sec-
retary shall prescribe rules under which the gross 
profits of business entities under common control 
are aggregated for purposes of applying the benefit 
of the lower rate described in subparagraph (A) of 
paragraph (1). Such rules shall be similar to rules 
applicable under sections 1551 and 1561 of the In-
ternal Revenue Code of 1986. 
‘‘(c) PAYROLL TAX CREDIT.—The ‘payroll tax credit’ 
is a credit for the social security, railroad retirement and 
hospital insurance taxes paid by an employer, as deter-
286
mined in accordance with subchapter L (sections 281 
through 283). 
‘‘(d) IMPORT TAX.—For rules relating to the import 
tax imposed by this chapter, see subchapter M (sections 
286 through 288). 
‘‘Subchapter B—Basic Rules for Business Tax
‘‘Sec. 202. Gross profits. 
‘‘Sec. 203. Taxable receipts. 
‘‘Sec. 204. Deductible amounts. 
‘‘Sec. 205. Cost of business purchases. 
‘‘Sec. 206. Business entity and business activity. 
‘‘Sec. 207. Loss carryover deduction.
‘‘SEC. 202. GROSS PROFITS. 
‘‘ ‘Gross profits’ means for a taxable year of a busi-
ness entity the amount by which—
‘‘(1) the taxable receipts of the business entity 
for the taxable year exceed, 
‘‘(2) the deductible amounts for the business 
entity for the taxable year. 
‘‘SEC. 203. TAXABLE RECEIPTS. 
‘‘(a) IN GENERAL.—‘Taxable receipts’ means all re-
ceipts from the sale of property, use of property, and per-
formance of services in the United States. 
‘‘(b) GAMES
OF CHANCE.—Amounts received for 
playing games of chance by business entities engaging in 
the activity of providing such games shall be treated as 
receipts from the sale of property or services.
287
‘‘(c) IN-KIND RECEIPTS.—The taxable receipts at-
tributable to the receipt of property, use of property or 
services in whole or partial exchange for property, use of 
property or services equal the fair market value of the 
services or property received. 
‘‘(d) TAXES.—Taxable receipts do not include any ex-
cise tax, sales tax, custom duty, or other separately stated 
levy imposed by a Federal, State, or local government re-
ceived by a business entity in connection with the sale of 
property or services or the use of property. 
‘‘(e) FINANCIAL RECEIPTS.—
‘‘(1) IN GENERAL.—Except as provided in sub-
chapter G (relating to financial intermediation and 
financial institutions), taxable receipts do not in-
clude financial receipts. 
‘‘(2) FINANCIAL
RECEIPTS.—‘Financial re-
ceipts’ include—
‘‘(A) interest, 
‘‘(B) dividends and other distributions by a 
business entity, 
‘‘(C) proceeds from the sale of stock, other 
ownership interests in business entities, or 
other financial instruments (as defined in sec-
tion 242(b)(3)), 
‘‘(D) proceeds from life insurance policies,
288
‘‘(E) proceeds from annuities, 
‘‘(F) proceeds from currency hedging or 
exchanges, and 
‘‘(G) proceeds from other financial trans-
actions. 
‘‘(f) CROSS REFERENCES.—
‘‘(1) FINANCIAL
INTERMEDIATION.—See sub-
chapters F and G for rules relating to financial 
intermediation. 
‘‘(2) 
EXPORTS, 
SALES
IN
THE
UNITED 
STATES.—See subchapter J for the exclusion from 
gross receipts for export sales and for rules on sales 
of property and services in the United States. 
‘‘(3) LAND.—See subchapter E for rules relat-
ing to certain sales of land. 
‘‘(4) INSURANCE PROCEEDS.—See section 237 
for rules on the inclusion of certain insurance pro-
ceeds in taxable receipts. 
‘‘SEC. 204. DEDUCTIBLE AMOUNTS. 
‘‘(a) IN GENERAL.—‘Deductible amounts’ for a busi-
ness entity in a taxable year include—
‘‘(1) the cost of business purchases in the tax-
able year (as determined under section 205), 
‘‘(2) such entity’s loss carryover deduction (as 
determined under section 207) , and
289
‘‘(3) the transition basis deduction (as deter-
mined under section 290). 
‘‘(b) FINANCIAL INTERMEDIATION.—See subchapters 
F and G for special rules for business entities engaging 
in financial intermediation. 
‘‘SEC. 205. COST OF BUSINESS PURCHASES. 
‘‘(a) BUSINESS PURCHASES.—
‘‘(1) IN GENERAL.—‘Business purchases’ means 
the acquisition of—
‘‘(A) property, 
‘‘(B) the use of property, or 
‘‘(C) services 
in the United States for use in a business activity. 
‘‘(2) EXAMPLES.—Business purchases include 
(without limitation) the—
‘‘(A) purchase or rental of real property, 
‘‘(B) purchase or rental of capital equip-
ment, 
‘‘(C) purchase of supplies and inventory, 
‘‘(D) purchase of services from inde-
pendent contractors, 
‘‘(E) purchase of financial intermediation 
services (as determined in accordance with sec-
tion 236),
290
‘‘(F) purchase of a business loss policy (as 
determined in accordance with section 237), 
and 
‘‘(G) imports for use in a business activity. 
‘‘(3) EXCLUSIONS.—Business purchases do not 
include—
‘‘(A) payments for use of money or capital, 
such as interest or dividends (except to the ex-
tent that a portion so paid is a fee for financial 
intermediation services), 
‘‘(B) premiums for life insurance, 
‘‘(C) the acquisition of savings assets or 
other financial instruments (as defined in sec-
tion 242(b)(3)). 
‘‘(D) property acquired outside the United 
States (but such property shall be taken into 
account as an import if imported), 
‘‘(E) services performed outside the United 
States (unless treated as imported into the 
United States), 
‘‘(F) compensation expenses for an indi-
vidual (other than amounts paid to an indi-
vidual in his capacity as a business entity), or 
‘‘(G) taxes (except as provided in sub-
section (b)(2) relating to product taxes).
291
‘‘(4) COMPENSATION
EXPENSES.—‘Compensa-
tion expenses’ means—
‘‘(A) wages, salaries or other cash payable 
for services, 
‘‘(B) any taxes imposed on the recipient 
that are withheld by the business entity, 
‘‘(C) the cost of property purchased to pro-
vide employees with compensation (other than 
property incidental to the provision of fringe 
benefits that are excluded from income under 
the individual tax), 
‘‘(D) the cost of fringe benefits which are 
includible in an employee’s, partner’s, or propri-
etor’s income under the Simplified USA Income 
Tax (or are excluded solely because they con-
stitute employee savings), including (without 
limitation)—
‘‘(i) contributions to retirement and 
severance benefit plans, 
‘‘(ii) premiums for the cost of life, 
health, accident, disability and other insur-
ance policies for which the service provider, 
members of his family, or persons des-
ignated by him or members of his family 
are the beneficiaries,
292
‘‘(iii) rental of parking spaces or park-
ing fees (unless the parking space is used 
for a vehicle that is regularly used in a 
business activity); 
‘‘(iv) employer paid educational bene-
fits; 
‘‘(v) employer paid housing (other 
than housing provided for the convenience 
of the employer); and 
‘‘(vi) employer paid meals (other than 
meals provided for the convenience of the 
employer). 
‘‘(b) COST OF BUSINESS PURCHASES.—
‘‘(1) IN
GENERAL.—The ‘cost of a business 
purchase’ is the amount paid or to be paid for the 
business purchase. 
‘‘(2) TAXES.—
‘‘(A) IN GENERAL.—The ‘cost of business 
purchases’ includes any product taxes paid with 
respect to the property or services purchased. 
‘‘(B) PRODUCT TAX.—‘Product tax’ means 
any excise tax, sales or use tax, custom duty, or 
other separately stated levy imposed by a Fed-
eral, State, or local government on the produc-
tion, severance or consumption of property or
293
on the provision of services, whether or not sep-
arately stated, and including any such taxes 
that are technically imposed on the seller of 
property or services. 
‘‘(C) TAXES NOT PRODUCT TAXES.—Prod-
uct taxes do not include—
‘‘(i) the import tax, 
‘‘(ii) state and local property taxes, 
‘‘(iii) franchise or income taxes, 
‘‘(iv) payroll taxes and self-employ-
ment taxes, or 
‘‘(v) the business tax. 
‘‘(3) IMPORTS.—In the case of an import by a 
business entity, the cost of the import is the import 
price for purposes of the import tax. The import tax 
is not part of the cost of the import. 
‘‘(c) PROPERTY
AND
SERVICES
ACQUIRED
FOR 
PROPERTY.—If a business entity receives property or serv-
ices from a business entity in whole or partial exchange 
for property or services, the property or services acquired 
shall be treated as if they were purchased for an amount 
equal to the fair market value of the services or property 
received. For purposes of this section, property includes 
stock and other equity interests in business other than 
stock or an equity interest in the business entity acquiring
294
the property or services. See section 210(b) for rules on 
property or services received in exchange for an equity in-
terest in the recipient. 
‘‘(d) GAMBLING PAYMENTS.—In the case of a busi-
ness involving gambling, lotteries, or other games of 
chance, business purchases include amounts paid to win-
ners. 
‘‘(e) SAVINGS
ASSETS.—‘Savings assets’ means 
stocks, bonds, securities, certificates of deposits, invest-
ments in partnerships and limited liability companies, 
shares of mutual funds, life insurance policies, annuities, 
and other similar savings or investment assets. 
‘‘(f) CROSS REFERENCES.—
‘‘(1) FINANCIAL INTERMEDIATION AND INSUR-
ANCE.—For rules relating to fees for financial inter-
mediation services and insurance, see subchapter F. 
‘‘(2) LAND.—For special rules relating to the 
acquisition of land, see subchapter E. 
‘‘(3) RENTAL REAL ESTATE.—For special rules 
relating to the rental of real estate previously occu-
pied by an owner of the real estate, see section 232. 
‘‘(4) OUTSIDE THE UNITED STATES.—For spe-
cial rules relating to services performed outside the 
United States but used inside the United States and 
international services, see subchapter J.
295
‘‘SEC. 206. BUSINESS ENTITY AND BUSINESS ACTIVITY. 
‘‘(a) BUSINESS ENTITY.—For purposes of the busi-
ness tax, ‘business entity’ means any corporation, unincor-
porated association, partnership, limited liability company, 
proprietorship, independent contractor, individual, or any 
other person engaging in business activity in the United 
States. An individual shall be considered a business entity 
only with respect to the individual’s business activities. 
‘‘(b) BUSINESS ACTIVITY.—‘Business activity’ means 
the sale of property or services, the leasing of property, 
the development of property or services for subsequent 
sale or use in producing property or services for subse-
quent sale. ‘Business activity’ does not include casual or 
occasional sales of property used by an individual (other 
than in a business activity), such as the sale by an indi-
vidual of a vehicle used by the individual. 
‘‘(c) EXCEPTION FOR CERTAIN EMPLOYEES.—
‘‘(1) IN GENERAL.—‘Business activity’ does not 
include—
‘‘(A) the performance of services by an em-
ployee for an employer that is a business entity 
with respect to the activity in which the em-
ployee is engaged, or 
‘‘(B) the performance of regular domestic 
household 
services 
(including 
babysitting, 
housecleaning, and lawn cutting) by an em-
296
ployee of an employer that is an individual or 
family. 
‘‘(2) EMPLOYEE
DEFINED.—For purposes of 
this subsection, ‘employee’ includes an individual 
partner who provides services to a partnership or an 
individual member who provides services to a limited 
liability company, or a proprietor with respect to 
compensation for services from his proprietorship. 
‘‘SEC. 207. LOSS CARRYOVER DEDUCTION. 
‘‘(a) DEDUCTION.—The ‘loss carryover deduction’ for 
a taxable year is the lesser of—
‘‘(1) the business entity’s gross profits for the 
taxable year (determined without the loss carryover 
deduction), or 
‘‘(2) the amount of the loss carryover to the 
taxable year. 
‘‘(b) LOSS CARRYOVER.—
‘‘(1) GENERAL RULE.—A loss for any taxable 
year shall be a loss carryover to each of the 215 tax-
able years following the taxable year of the loss. 
‘‘(2) LOSS CARRYOVERS TO A TAXABLE YEAR.—
The loss carryover to a taxable year is the sum of 
the loss carryovers from all prior taxable years be-
ginning on or after January 1, 2004, that can be 
carried over to the taxable year.
297
‘‘(3) REDUCTION OF LOSS CARRYOVERS AS A 
RESULT OF THE DEDUCTION.—A business entity’s 
loss carryovers shall be reduced each year by the 
amount of the loss carryover deduction for the year. 
Loss carryovers shall be reduced in the order that 
they arose. 
‘‘(c) LOSS FOR TAXABLE YEAR.—A business entity’s 
loss (if any) for the taxable year equals the excess (if any) 
of—
‘‘(1) the sum of—
‘‘(A) the cost of business purchases for the 
taxable year, and 
‘‘(B) the transition basis adjustment for 
the taxable year, over 
‘‘(2) taxable receipts for the taxable year. 
‘‘(d) SPECIAL RULES.—
‘‘(1) CONSOLIDATED RETURNS.—In the case of 
a consolidated return, the loss for a taxable year 
shall be determined on a consolidated group basis. 
In the case of a deconsolidation, the loss carryovers 
from the consolidated group shall be allocated in ac-
cordance with rules to be prescribed by the Sec-
retary. 
‘‘(2) LOSS
CARRYOVERS
OF
ACQUIRED
BUSI-
NESS ENTITY.—
298
‘‘(A) IN GENERAL.—If a business entity 
acquires another business entity in a trans-
action that is considered the acquisition of a 
business entity and the two entities file a con-
solidated return or if two business entities 
merge, the loss carryovers will survive and can 
be applied against the taxable receipts attrib-
utable to the business activities carried on (or 
in the case of a merger formerly carried on) by 
either entity. 
‘‘(B) ASSET ACQUISITION.—If a business 
entity acquires all or substantially all of the as-
sets of another entity in a transaction that is 
considered an asset acquisition rather than the 
acquisition of a business entity, the acquirer 
will be treated as if it acquired the loss 
carryovers of the selling entity. For purposes of 
this rule, the assets of a business entity include 
ownership interests in other business entities.
‘‘(C) SUBSTANTIALLY ALL.—For purposes 
of this paragraph ‘substantially all’ means more 
than 80 percent of the fair market value of a 
business entity’s net assets. Under rules pre-
scribed by the Secretary, the parties to a trans-
action may elect to treat acquisitions in excess
299
of 70 percent of the fair market value of a busi-
ness entity’s net assets as acquisitions of ‘sub-
stantially all’ of a business entity’s net assets. 
‘‘Subchapter C—Capital Contributions, 
Mergers, Acquisitions, and Distributions
‘‘Sec. 210. Contributions to a business entity. 
‘‘Sec. 211. Distributions of property. 
‘‘Sec. 212. Asset acquisitions. 
‘‘Sec. 213. Mergers and stock acquisitions. 
‘‘Sec. 214. Spin-offs, split-off, etc. 
‘‘Sec. 215. Allocation of certain tax attributes.
‘‘SEC. 210. CONTRIBUTIONS TO A BUSINESS ENTITY. 
‘‘(a) BY BUSINESS ENTITY.—
‘‘(1) CASH.—If a business entity contributes 
cash to a business entity of which it is or becomes 
a partial or full owner, the amount contributed is 
not a deductible amount to the contributor or a tax-
able receipt to the recipient. 
‘‘(2) PROPERTY OR SERVICES.—If a business 
entity contributes property or services to a business 
entity of which it is or becomes a partial or full 
owner, the transaction will not result in taxable re-
ceipts to the contributor or a deduction for a busi-
ness purchase for the recipient and will not con-
stitute a sale resulting in taxable receipts to the con-
tributor. 
‘‘(b) BY INDIVIDUAL.—
300
‘‘(1) CASH.—If an individual contributes cash 
to a business entity, the cash received is not a tax-
able receipt. 
‘‘(2) NEW PROPERTY.—If an individual contrib-
utes to a business entity property that the individual 
purchased for the business entity but which was not 
used by any person after its purchase, the property 
shall be considered purchased by such business enti-
ty from the person from which the individual pur-
chased the property. 
‘‘(3) PERSONAL USE PROPERTY.—
‘‘(A) IN GENERAL.—If an individual con-
tributes personal use property to a business en-
tity in which the individual has an ownership 
interest or for which the individual receives an 
ownership interest, the business entity shall not 
be permitted to deduct the value of the property 
received as a business expense. The business 
entity will have a tax basis in the contributed 
property equal to the contributor’s basis. 
‘‘(B) PERSONAL
USE
PROPERTY.—‘Per-
sonal use property’ means any property used by 
an individual at any time other than in a busi-
ness activity.
301
‘‘(4) SERVICES.—If an individual contributes 
services to a business entity in which the individual 
has an ownership interest or receives an ownership 
interest, the business entity shall not be permitted to 
deduct the value of the services received (or the 
value of the equity interest provided to the services 
provider). 
‘‘SEC. 211. DISTRIBUTIONS OF PROPERTY. 
‘‘(a) DISTRIBUTIONS OTHER THAN TO CONTROL-
LING BUSINESS.—If a business entity distributes all or a 
portion of its assets to its owners (other than a controlling 
business entity), the business entity will be treated as if 
it sold the assets to its owners at fair market value. The 
fair market value will be determined by the distributing 
corporation and those determinations, unless unreason-
able, will be binding on the recipients. 
‘‘(b) DISTRIBUTIONS
TO
A CONTROLLING BUSI-
NESS.—If a business entity distributes all or a portion of 
its assets to a controlling business, the controlling busi-
ness will assume the distributing entity’s tax attributes 
with respect to the assets and neither entity will have tax-
able receipts or a deduction as a result of the transaction. 
‘‘(c) DISTRIBUTION
OF
PERSONAL
USE
PROP-
ERTY.—If personal use property is distributed to the indi-
vidual who contributed the personal use property to a busi-
302
ness entity, the fair market value of the property for pur-
poses of paragraph (a) shall equal the basis of the prop-
erty plus any enhancement in value of the property attrib-
utable to business purchases with respect to the property. 
‘‘(d) CONTROLLING BUSINESS ENTITY.—A business 
entity is a ‘controlling business entity’ with respect to an-
other business entity if it owns directly or indirectly more 
than 50 percent of the profits or capital interest in the 
other business entity. 
‘‘(e) APPLICATION OF THIS SECTION.—This section 
applies to both liquidating and nonliquidating distribu-
tions. Property shall be treated as distributed if the prop-
erty is used for a nonbusiness purpose (as defined in sec-
tion 232) for more than an insubstantial period of time 
during a taxable year. See section 232 for rules relating 
to certain rental property. 
‘‘SEC. 212. ASSET ACQUISITIONS. 
‘‘(a) IN GENERAL.—If a business entity transfers 
some or all of its assets, the consideration received for 
such assets shall be allocated among the assets transferred 
in the same manner as was required by section 1060 of 
the Internal Revenue Code of 1986. If the transferee and 
transferor agree in writing on the allocation of any consid-
eration, or as to the fair market value of any of the assets, 
such agreement shall be binding on both the transferor
303
and transferee unless the Secretary determines that such 
allocation (or fair market value) is not appropriate. 
‘‘(b) TAX CONSEQUENCES.—The tax consequences of 
an asset acquisition shall be determined in accordance 
with the rules of this chapter and shall be dependent upon 
allocations made under subsection (a). In general, consid-
eration allocable to savings assets, such as stock in an-
other business entity, would not be included in taxable re-
ceipts of the transferor and would not be a business pur-
chase of the purchaser, but consideration allocable to the 
sale of tangible property and intangible property (other 
than savings assets) will constitute taxable receipts of the 
seller and a business purchase of the purchaser. 
‘‘(c) ELECTION TO TREAT ASSET ACQUISITION AS A 
STOCK ACQUISITION.—In the case of the sale of substan-
tially all of the assets of a business entity or substantially 
all of the assets of a line of business or a separately stand-
ing business of a business entity, the transferee and trans-
feror can jointly elect to treat the acquisition as if it were 
an acquisition of the stock of a business entity holding 
the assets so transferred. In such case, the rules of section 
213 shall apply. 
‘‘(d) AUTHORITY TO REQUIRE ALLOCATION AGREE-
MENT AND NOTICE TO THE SECRETARY.—If the Sec-
retary determines that certain types of asset acquisitions
304
have significant possibilities of tax avoidance, the Sec-
retary may require—
‘‘(1) parties to such types of acquisitions to 
enter into agreements allocating consideration, 
‘‘(2) parties to acquisitions involving certain 
kinds of assets to enter into agreements allocating 
part of the consideration to those assets, or 
‘‘(3) parties to certain acquisitions to report in-
formation to the Secretary. 
‘‘(e) ASSET ACQUISITION RULES DO NOT APPLY IF 
CONSIDERATION INCLUDES EQUITY IN PURCHASER.—
‘‘(1) IN GENERAL.—If a business entity issues 
its own equity or equity in a subsidiary or other con-
trolled entity as part of the consideration for the 
transfer of assets to it, the transaction shall not be 
treated as an asset acquisition and the rules of sec-
tion 13 shall apply. 
‘‘(2) EQUITY.—For purposes of this subsection, 
equity means—
‘‘(A) stock, in the case of a corporation, 
‘‘(B) partnership or similar interest, in the 
case of a partnership or limited liability com-
pany, and 
‘‘(C) an ownership interest or interest in 
profits in the case of any other business entity.
305
‘‘SEC. 213. MERGERS AND STOCK ACQUISITIONS. 
‘‘(a) MERGERS.—A merger of one business entity 
into another or two businesses entities into a third busi-
ness entity or any other similar transaction shall have no 
direct consequences under the business tax. The surviving 
entity shall assume the tax attributes of the merged cor-
porations, including any loss carryovers and credit 
carryovers. 
‘‘(b) STOCK ACQUISITION.—The acquisition of all or 
substantially all of the ownership interest in one business 
entity either for cash or in exchange for ownership in the 
acquiring entity or an entity controlled by the acquired 
entity shall have no direct consequences under the busi-
ness tax. 
‘‘SEC. 214. SPIN-OFFS, SPLIT-OFFS, ETC. 
‘‘A spin-off, split-off or split-up of a business entity 
shall have no direct tax consequences under the business 
tax. 
‘‘SEC. 215. ALLOCATION OF CERTAIN TAX ATTRIBUTES. 
‘‘The Secretary shall prescribe rules for allocation of 
loss carryovers and payroll tax credit carryovers in cases 
of substantial shifts of assets from one business entity to 
another business entity. Under such rules, a portion of a 
business entity’s carryovers may be deemed transferred 
when assets are transferred.
306
‘‘Subchapter D—Accounting Method Rules
‘‘Sec. 220. General accounting rules. 
‘‘Sec. 221. Use of the cash method of accounting. 
‘‘Sec. 222. Taxable year. 
‘‘Sec. 223. Long-term contracts. 
‘‘Sec. 224. Post-sale price adjustments and refunds. 
‘‘Sec. 225. Bad debts. 
‘‘Sec. 226. Transition rules.
‘‘SEC. 220. GENERAL ACCOUNTING RULES. 
‘‘(a) IN GENERAL.—Except as provided in section 
221, a business entity shall use an accrual method of ac-
counting for purposes of determining the timing of rec-
ognition of taxable receipts and deduction of business pur-
chases. All business purchases shall be deducted when in-
curred (in the case of a business entity using the accrual 
method of accounting) or when paid (in case of a business 
entity using the cash method of accounting) without re-
gard to whether the business purchases are for or relate 
to—
‘‘(1) inventory, 
‘‘(2) assets with a useful life of more than one 
year, or 
‘‘(3) property that will be used to produce other 
property. 
‘‘(b) ECONOMIC PERFORMANCE.—For purposes of 
determining whether an amount has been incurred, the all 
events test shall not be treated as met any earlier than 
when economic performance with respect to such item oc-
curs.
307
‘‘(c) CONSISTENT ACCOUNTING METHODS.—Except 
as otherwise expressly provided in this chapter, a business 
entity shall secure the consent of the Secretary before 
changing the method of accounting by which it determines 
gross profits. This provision shall not apply to changes 
required by the adoption of the business tax. 
‘‘SEC. 221. USE OF THE CASH METHOD OF ACCOUNTING. 
‘‘(a) IN GENERAL.—A business entity that was per-
mitted to use and used the cash method of accounting 
under the Internal Revenue Code of 1986 shall be per-
mitted to continue to use the cash method of accounting. 
‘‘(b) NEW BUSINESS ENTITIES.—A new business en-
tity shall be permitted to use the cash method of account-
ing if permitted to under regulations prescribed by the 
Secretary. 
‘‘(c) CHANGE OR EXPANSION OF BUSINESS.—Sub-
section (a) shall cease to apply to a business entity that 
changes or expands its business such that under regula-
tions prescribed by the Secretary it is no longer eligible 
to use the cash method of accounting. 
‘‘(d) REGULATIONS.—
‘‘(1) USE OF CASH METHOD.—The Secretary 
shall prescribe regulations defining which business 
entities may use the cash method of accounting. In 
general, those regulations shall be consistent with
308
the rules under sections 447 and 448 of the Internal 
Revenue Code of 1986, except that all corporations 
shall be treated as C corporations were treated 
under those sections. The regulations shall not re-
quire a business entity described in subsection (a) to 
convert to the accrual method prior to January 1, 
2005. 
‘‘(2) CHANGE IN ACCOUNTING METHOD.—The 
Secretary shall prescribe regulations to prevent dou-
ble counting of taxable receipts and deductible ex-
penses in the case of a change in accounting method. 
‘‘SEC. 222. TAXABLE YEAR. 
‘‘(a) COMPUTATION
OF
GROSS
PROFITS.—Gross 
profits shall be computed on the basis of a business enti-
ty’s taxable year. 
‘‘(b) TAXABLE YEAR.—‘Taxable year’ means—
‘‘(1) the taxpayer’s annual accounting period, if 
it is a calendar year or a fiscal year; 
‘‘(2) the calendar year, if subsection (g) applies; 
or 
‘‘(3) the period for which the return is made if 
the return is made for a period of less than 12 
months.
309
‘‘(c) ANNUAL ACCOUNTING PERIOD.—‘Annual ac-
counting period’ means the annual period on the basis of 
which the business entity regularly keeps its books. 
‘‘(d) CALENDAR YEAR.—‘Calendar year’ means a pe-
riod of 12 months ending on December 31. 
‘‘(e) FISCAL YEAR.—‘Fiscal year’ means a period of 
12 months ending on the last day of any month other than 
December. In the case of any business entity that has 
made the election provided by subsection (f), the term 
means the annual period (varying from 52 to 53 weeks) 
so elected. 
‘‘(f) ELECTION OF 52–53 WEEK YEAR.—
‘‘(1) GENERAL RULE.—A business entity which, 
in keeping its books, regularly computes its income 
or profits on a basis of an annual period which var-
ies from 52 to 53 weeks and ends always on the 
same day of the week and ends always—
‘‘(A) on whatever date such same day of 
the week last occurs in a calendar month, or 
‘‘(B) on whatever date such same day of 
the week falls which is nearest to the last day 
of a calendar month, 
may elect to compute its gross profits on the basis 
of such annual period.
310
‘‘(2) REGULATIONS.—The Secretary shall pre-
scribe such regulations as he deems necessary for 
the application of this subsection, including regula-
tions relating to the application of effective dates to 
taxpayers using a 52–53 week year. 
‘‘(g) CALENDAR YEAR REQUIRED.—
‘‘(1) NO ACCOUNTING PERIOD.—A business en-
tity’s taxable year shall be the calendar year if the 
business entity does not have an annual accounting 
period or has an annual accounting period that does 
not qualify as a fiscal year. 
‘‘(2) NEW
BUSINESS
ENTITY.—The taxable 
year of a business entity that begins business activ-
ity after December 31, 2003, shall be the calendar 
year (or a 52–53 week fiscal year ending in Decem-
ber) unless the business entity can demonstrate a 
business reason for selecting an accounting period 
other than the calendar year. 
‘‘(h) TRANSITION RULE FOR BUSINESS ENTITIES 
WITH A FISCAL YEAR.—
‘‘(1) IN GENERAL.—A business entity with a 
taxable year that is not the calendar year shall have 
a short taxable year ending on December 31, 2003, 
and a subsequent taxable year beginning on January 
1, 2004, and ending on the day immediately pre-
311
ceding the beginning of the business entity’s next 
fiscal year. 
‘‘(2) BUSINESS
ENTITIES
WITH
52–53
WEEK 
YEAR ENDING IN DECEMBER.—
‘‘(A) IN GENERAL.—If a business entity 
has a 52–53 week taxable year (under the In-
ternal Revenue Code of 1986) that ends in De-
cember 2003, it may elect to begin its first tax-
able year for the business tax on the first day 
immediately following the last day of such tax-
able year. 
‘‘(B) NO ELECTION.—If a business entity 
that has a 52–53 week taxable year that ends 
in December 2003, does not make the election 
under subparagraph (A) or is prohibited from 
making such election by subparagraph (C), the 
business entity’s taxable year under the Inter-
nal Revenue Code of 1986 that would end in 
December 2003 shall end on December 31, 
2003. 
‘‘(C) ANTI-ABUSE
RULE.—Subparagraph 
(A) shall not apply to any taxpayer that enters 
into business transactions in 2003 following the 
scheduled end of its fiscal year with business 
entities that are not subject to the business tax
312
at the time of such transactions if such trans-
actions deviate from the normal course of busi-
ness in order to achieve some tax benefit. 
‘‘SEC. 223. LONG-TERM CONTRACTS. 
‘‘(a) IN GENERAL.—In the case of a long-term con-
tract—
‘‘(1) CONTRACTOR EXPENSES.—The contractor 
shall be entitled to deduct its business purchases 
when paid or incurred. 
‘‘(2) CONTRACTOR RECEIPTS.—The contractor 
shall recognize taxable receipts—
‘‘(A) in the case of a project in which the 
acquirer has no ownership interest in the 
project until delivery—
‘‘(i) upon delivery of the project, in 
the case of an accrual basis contractor, or 
‘‘(ii) upon the later of delivery of the 
project or the receipt of payment, in the 
case of cash-basis contractor. 
‘‘(B) in the case of a project in which the 
acquirer obtains an ownership interest as the 
project is constructed—
‘‘(i) when the contractor has the right 
to payments, in the case of an accrual 
basis contractor, or
313
‘‘(ii) upon the later of when the con-
tractor receives the cash or has the right 
to payments, in the case of a cash basis 
contractor. 
‘‘(3) ACQUIRER EXPENSES.—The acquirer that 
is a business entity shall be entitled to deduct its 
costs of the business purchase—
‘‘(A) in the case of a cash-basis acquirer, 
at such time as a cash basis contractor would 
be required to treat the amounts paid as tax-
able receipts, or 
‘‘(B) in the case of an accrual-basis 
acquirer, at such time as an accrual basis con-
tractor would be required to treat the amounts 
paid or due as taxable receipts. 
‘‘(b) RIGHT TO PAYMENTS.—
‘‘(1) IN GENERAL.—A contractor shall be treat-
ed as having a right to payments with respect to a 
project at any time to the extent that the contractor 
would not be required to return payments received 
(or would be entitled to collect payments not yet re-
ceived) if the project were terminated at such time 
by the contractor. 
‘‘(2) CONTRACTUAL
PROVISIONS.—If a long-
term contract includes a procedure for paying the
314
contractor as work is completed (for example, by 
reason of a draw down from a trust account), the 
contractual provisions shall generally govern when a 
contractor has a right to payment. 
‘‘(3) PERCENTAGE
COMPLETION
METHOD
OF 
ACCOUNTING.—If a long-term contract does not in-
clude a mechanism for paying the contractor as 
work is completed, the percentage-of-completion 
method of accounting shall be used to determine the 
timing of taxable receipts of the contractor and busi-
ness purchases of the acquirer. 
‘‘(c) LONG-TERM CONTRACT.—
‘‘(1) 
IN
GENERAL.—‘Long-term 
contract’ 
means—
‘‘(A) any contract that covers service or 
production through parts of two different cal-
endar years if the contract includes a formal 
deposit and draw-down mechanism, and 
‘‘(B) any contract for the manufacture, 
building, installation, or construction of prop-
erty if such contract is not completed within the 
taxable year of the contractor in which such 
contract is entered into. 
‘‘(2) EXCEPTION.—A contract for the manufac-
ture of property shall not be treated as a long-term
315
contract unless such contract involves the manufac-
ture of—
‘‘(A) any unique item of a type which is 
not normally included in the finished goods in-
ventory of the taxpayer, or 
‘‘(B) any item which normally requires 
more than 12 calendar months to complete. 
‘‘(d) CONSISTENCY.—The Secretary may require 
business entities to file statements containing such infor-
mation with respect to long-term contracts as the Sec-
retary may prescribe to ensure consistency in reporting. 
‘‘(e) FOREIGN CONTRACTS.—This section shall not 
be construed to permit a deduction for a business purchase 
for the cost of property produced outside the United 
States pursuant to a long-term contract at any time prior 
to the import of such property into the United States. 
‘‘SEC. 224. POST-SALE PRICE ADJUSTMENTS AND REFUNDS. 
‘‘(a) RECEIPT OF PRICE ADJUSTMENT.—In the case 
of a post-sale price adjustment attributable to a business 
purchase which was taken into account in computing gross 
profits for a prior taxable year, the amount of such adjust-
ment shall be treated as a reduction or increase, as the 
case may be, in the cost of business purchases for the tax-
able year in which the adjustment is made or incurred.
316
‘‘(b) ISSUANCE OF PRICE ADJUSTMENT.—In the case 
of a post-sale price adjustment attributable to a sale the 
receipts from which were taken into account in deter-
mining taxable receipts for a prior taxable year, the 
amount of such adjustment shall be treated as a reduction 
or increase, as the case may be, in taxable receipts for 
the taxable year in which the adjustment is made or in-
curred. 
‘‘(c) POST-SALE PRICE ADJUSTMENT.—‘Post-sale 
price adjustment’ means a refund, rebate, or other price 
allowance attributable to a sale of property or services or 
an upward adjustment in price that was not previously 
taken into account under the business entity’s method of 
accounting. 
‘‘SEC. 225. BAD DEBTS. 
‘‘(a) SELLER.—If an amount owed to an accrual 
basis business entity for property or services sold—
‘‘(1) was taken into account as a taxable receipt 
in a prior taxable year, and 
‘‘(2) becomes wholly or partially uncollectible 
during the taxable year, then the seller shall treat 
the amount as a reduction in taxable receipts for the 
taxable year in which it becomes wholly or partially 
uncollectible.
317
‘‘(b) NOTICE REQUIREMENT.—No reduction shall be 
allowed under subsection (a) unless the seller notifies the 
purchaser of the amount which the seller has treated as 
wholly or partially uncollectible. 
‘‘(c) SUBSEQUENT
COLLECTION.—If an amount 
which was treated as uncollectible under subsection (a) is 
subsequently collected, it shall be treated as a taxable re-
ceipt when collected. 
‘‘(d) PURCHASER.—If a purchaser receives notice 
under subsection (b) from a seller and the purchaser has 
treated the amount labeled uncollectible as a business pur-
chase in a prior taxable year, then the purchaser shall 
treat such amount as a reduction in the cost of business 
purchases in the taxable year to which the notice relates. 
If the purchaser subsequently repays such amount, the re-
payment shall constitute the cost of a business purchase. 
‘‘SEC. 226. TRANSITION RULES. 
‘‘(a) NO DOUBLE DEDUCTIONS.—A business entity 
shall not be entitled to treat as a ‘cost of business pur-
chase’ any amount that the business entity deducted in 
computing taxable income under the income tax in effect 
prior the effective date of the business tax. 
‘‘(b) NO DOUBLE INCLUSION.—A business entity 
shall not be required to include in taxable receipts any 
receipt that the business entity took into account in com-
318
puting taxable income under the income tax in effect prior 
to the effect date of the business tax.
‘‘(c) NO LOSS OF DEDUCTION.—An expense which—
‘‘(1) a business entity would have been able to 
deduct as a cost of a business purchase in an ac-
counting period before the effective date of the busi-
ness tax if the business tax had been in effect in 
such period, and 
‘‘(2) the business entity would have been able to 
deduct as an expense in computing taxable income 
in a period after the business tax is effective if the 
income tax had continued in effect, 
shall be treated as a cost of a business purchase incurred 
or paid at the time that it would have been paid or in-
curred under the income tax if the income tax had contin-
ued in effect. This subsection shall not apply to any 
amount which is to be taken into account under sub-
chapter N (relating to amortization of transition basis, in-
ventory costs, and safe harbor leases), any amounts which 
would have been deducted under the income tax through 
loss carryover deductions, or any deductions deferred by 
the uniform capitalization rules under section 263A of the 
Internal Revenue Code of 1986. 
‘‘(d) ALL TAXABLE RECEIPTS TAXED.—A receipt 
which—
319
‘‘(1) a business entity would have been required 
to treat as a taxable receipt in an accounting period 
before the effective date of the business tax if the 
business tax had been in effect in such period, and 
‘‘(2) the business entity would have been re-
quired to include in gross income in a period after 
the business tax is effective if the income tax had 
continued in effect 
shall be treated as a taxable receipt at the time that it 
would have been included in income if the income tax had 
continued in effect. 
‘‘Subchapter E—Land and Rental Property
‘‘Sec. 230. No deduction for land purchased for nonbusiness use. 
‘‘Sec. 231. Taxable receipts for land held for nonbusiness use. 
‘‘Sec. 232. Certain rental property.
‘‘SEC. 230. NO DEDUCTION FOR LAND PURCHASED FOR 
NONBUSINESS USE.
‘‘(a) IN GENERAL.—The acquisition of unimproved 
land shall not constitute a business purchase if the unim-
proved land is not acquired to be used in a business activ-
ity or if the land is acquired for—
‘‘(1) speculation, 
‘‘(2) development (including subdivision), or 
‘‘(3) temporary leasing or other use not com-
mensurate with the value of the land, 
‘‘(4) indefinite future use in a business activity, 
or
320
‘‘(5) use in compensating employees. 
‘‘(b) FUTURE USE IN BUSINESS ACTIVITY.—Unim-
proved land will not be considered held for ‘indefinite fu-
ture use in a business activity’ if promptly upon acquisi-
tion, the purchaser or the lessee begins construction of im-
provements on the land (other than improvements, such 
as paving or sewage lines, intended for indefinite future 
development) that will be used in a business activity. Such 
improvement must be commensurate with the value of the 
land. 
‘‘(c) 
UNIMPROVED
LAND.—‘Unimproved 
land’ 
means—
‘‘(1) land with no buildings on it, 
‘‘(2) land with improvements if the value of the 
improvements is relatively small in comparison to 
the value of the land and it is anticipated that the 
improvements will be demolished and not used, 
‘‘(3) land in excess of the amount reasonably 
needed for the buildings located on it. 
‘‘(d) CONVERSION TO BUSINESS USE.—If the acqui-
sition of land is not treated as a business purchase by rea-
son of subsection (a) and the land is subsequently used 
in a manner for which it could have been treated as a 
business purchase, the cost of the land will be treated as 
a business purchase when the improvements on the land
321
are placed in service (or in the case of construction for 
sale, substantially completed and advertised for sale). 
‘‘SEC. 231. TAXABLE RECEIPTS FROM SALE OF LAND HELD 
FOR NONBUSINESS USE. 
‘‘(a) TAX BASIS.—A business entity shall have a tax 
basis in land equal to the cost of the land if such cost 
is not deductible by reason of section 230(a) and the land 
has not been converted to business use for purposes of 
section 230(d). 
‘‘(b) TAXABLE RECEIPTS OF A LAND SALE.—The 
taxable receipts from the sale of land (or portion thereof) 
in which a business entity has a tax basis by reason of 
subsection (a) shall be the amount by which the proceeds 
exceed the basis of such land (or portion thereof). 
‘‘SEC. 232. CERTAIN RENTAL PROPERTY. 
‘‘(a) IN GENERAL.—Except as provided in subsection 
(b), the activity of rental of real estate is a business activ-
ity to which the business tax applies. 
‘‘(b) NOT RENTAL PROPERTY.—Subsection (a) shall 
not apply to property described in section 111(b)(1) (relat-
ing to property owned by individuals and used for at least 
14 days for a nonbusiness purpose and rented for no more 
than 14 days during the taxable year). 
‘‘(c) RENTAL
PROPERTY
BECOMES
NONRENTAL 
PROPERTY.—If property which is considered rental prop-
322
erty for purposes of subsection (a) in one taxable year 
ceases to be rental property (by reason of subsection (b)) 
in the following taxable year, the property (and any associ-
ated debt) shall be treated as distributed by the business 
entity to its owners. Section 211(a) shall apply to such 
distribution. 
‘‘Subchapter F—Insurance and 
Financial Products
‘‘Sec. 235. General rules. 
‘‘Sec. 236. Fees for financial intermediation services. 
‘‘Sec. 237. Deductible insurance premiums. 
‘‘Sec. 238. Nondeductible insurance premiums. 
‘‘Sec. 239. Certain implicit fees for financial intermediate services.
‘‘SEC. 235. GENERAL RULES. 
‘‘(a) TAXABLE RECEIPTS.—Except in the case of a 
financial intermediation business, taxable receipts do not 
include financial receipts (as defined in section 203(e)(2)). 
‘‘(b) BUSINESS PURCHASES.—Except in the case of 
a financial intermediation business, business purchases do 
not include the cost of financial instruments (as defined 
in section 242(b)(3)) or payments for use of money or cap-
ital, other than fees for financial intermediation services. 
‘‘SEC. 236. FEES FOR FINANCIAL INTERMEDIATION SERV-
ICES. 
‘‘(a) BUSINESS PURCHASE.—Business purchases in-
clude explicit fees and implicit fees for financial intermedi-
ation services (except to the extent that such fees are for 
services treated as performed outside the United States
323
and not imported into the United States or for services 
treated as exported.). 
‘‘(b) FINANCIAL INTERMEDIATION SERVICES.—The 
definition of ‘financial intermediation service’ in section 
241 applies for purposes of this section. 
‘‘(c) EXPLICIT FEES.—
‘‘(1) IN GENERAL.—‘Explicit fees for financial 
intermediation services’ means separately stated fees 
for services provided by a business entity in the fi-
nancial intermediation business. Explicit fees do not 
include fees for use of money or capital. 
‘‘(2) EXAMPLES.—Explicit fees for financial 
intermediation services include (without limita-
tion)—
‘‘(A) separately listed maintenance and 
service charges of providers of financial inter-
mediation services, 
‘‘(B) loan documentation fees, 
‘‘(C) brokerage fees, 
‘‘(D) loan origination fees, 
‘‘(E) underwriting fees, 
‘‘(F) trustees’ fees, and 
‘‘(G) fees for credit checks.
‘‘(3) EXCLUSIONS.—Explicit fees for financial 
intermediation services do not include prepaid inter-
324
est and other fees for use of money or capital even 
if such fees are separately stated or are labeled as 
service fees. 
‘‘(d) IMPLICIT FEES.—
‘‘(1) IMPLICIT FEES ATTRIBUTABLE TO BOR-
ROWING.—
‘‘(A) IN
GENERAL.—Implicit fees attrib-
utable to borrowing from banks and other fi-
nancial institutions shall include the portion of 
interest payments that the Secretary designates 
as constituting service fees. 
‘‘(B) TIMING.—Implicit fees determined 
under this paragraph shall not be deductible in 
any taxable year prior to the taxable year in 
which the interest is paid. If the amount of the 
interest to which implicit fees relate was de-
ducted as original issue discount under the In-
ternal Revenue Code of 1986, the implicit fees 
with respect to such interest shall not constitute 
a deductible business purchase. 
‘‘(C) DESIGNATION BY SECRETARY.—
‘‘(i) ESTIMATE OF DIFFERENTIAL.—
The Secretary shall estimate for each cal-
endar year the difference between the cost 
of funds for banks and the rates of interest
325
(including discount points) charged to the 
most credit-worthy depositors of banks. 
The determinations shall be made sepa-
rately for—
‘‘(I) loans with terms of not more 
than 3 years, 
‘‘(II) loans with terms of over 3 
but not over 9 years, and 
‘‘(III) loans with terms of over 9 
years. 
‘‘(ii) 
DESIGNATION
OF
IMPLICIT 
FEES.—The Secretary shall designate the 
differences determined under clause (i) as 
the portion of interest expense on loans 
from banks and other financial institutions 
that constitutes an implicit fee for term 
loans originated during the following cal-
endar year for the respective periods listed 
in subclauses (I) through (III) of clause 
(i). The difference determined for loans de-
scribed in subclause (I) of clause (i) shall 
apply to determine the implicit fee portion 
of interest on demand loans outstanding 
during the following calendar year.
326
‘‘(iii) HISTORICAL DETERMINATION.—
The Secretary shall make an historical de-
termination in accordance with the prin-
ciples of this subparagraph to designate 
the portion of interest on term loans made 
before January 1, 2003, that will con-
stitute implicit fees. 
‘‘(2) IMPLICIT
FEES
FOR
OTHER
FINANCIAL 
INTERMEDIATION ACTIVITY.—Implicit fees for finan-
cial intermediation services include the portion of the 
fees or other charges paid to a provider of financial 
intermediation services (other than lending) as such 
provider designates in accordance with section 39. 
‘‘SEC. 237. DEDUCTIBLE INSURANCE PREMIUMS. 
‘‘(a) IN GENERAL.—The cost of insurance premiums 
on business loss policies that insure risks in the United 
States constitute costs of business purchases. Proceeds 
from such policies constitute taxable receipts. 
‘‘(b) BUSINESS LOSS POLICY.—A ‘business loss pol-
icy’ is an insurance policy—
‘‘(1) owned by a business entity, 
‘‘(2) the beneficiary of which is the business en-
tity or another business entity doing business with 
the owner of the policy,
327
‘‘(3) that has no inside buildup or other savings 
component, 
‘‘(4) that covers losses on a loss incurred or 
claims made basis during the term of the policy, 
‘‘(5) that has a term of not more than 2 years, 
‘‘(6) that is not a direct or indirect form of 
compensation, and 
‘‘(7) that covers direct losses of the business, 
such as—
‘‘(A) damage to or theft of property used 
in business activity, 
‘‘(B) tort claims against the business, 
‘‘(C) loss of use of business premises or 
services, 
‘‘(D) malpractice, or 
‘‘(E) alleged or actual breach of fiduciary 
obligations. 
‘‘SEC. 238. NONDEDUCTIBLE INSURANCE PREMIUMS. 
‘‘(a) NONDEDUCTIBILITY.—The cost of insurance 
policies that are not business loss policies are not deduct-
ible costs of business purchases. 
‘‘(b) PROCEEDS OF NONDEDUCTIBLE POLICIES.—In-
surance proceeds from policies described in subsection (a) 
do not constitute taxable receipts.
328
‘‘(c) APPLICATION OF THIS SECTION TO CERTAIN 
INSURANCE.—This section shall apply to life insurance 
policies. 
‘‘SEC. 239. CERTAIN IMPLICIT FEES FOR FINANCIAL INTER-
MEDIATION SERVICES. 
‘‘(a) DEDUCTIBILITY OF FEES.—If a financial inter-
mediation business (as defined in section 241(b)) elects 
to determine implicit fees for financial intermediation 
services pursuant to this section and notify its business 
customers of their share of the implicit fees in accordance 
with this section, a business entity which receives such no-
tice may treat the amount reported in the notice as an 
implicit fee for financial intermediation services in the cal-
endar year to which such notice relates. 
‘‘(b) ALLOCATION AND REPORTING.—
‘‘(1) IN GENERAL.—A financial intermediation 
business may—
‘‘(A) allocate fees received for services for 
which no separately stated fees (or implicit fees 
for 
borrowing 
determined 
under 
section 
236(d)(1)) are charged among recipients of 
such services on a reasonable and consistent 
basis, and
‘‘(B) report to each recipient not later 
than February 15th of each year the amount so
329
allocated to it with respect to the immediately 
preceding calendar year. 
‘‘(2) MAXIMUM FEES ALLOCATED.—The max-
imum amount that may be allocated by a financial 
intermediation business for a calendar is the excess 
of—
‘‘(A) the gross profits of the financial 
intermediation business for the calendar year 
(as reasonably estimated by the financial inter-
mediation business), over 
‘‘(B) the explicit fees for financial inter-
mediation services received by the financial 
intermediation business. 
‘‘(3) REASONABLE ALLOCATION.—An allocation 
will not be considered reasonable unless it takes into 
account and allocates fees to—
‘‘(A) both services provided to business en-
tities and services provided to individuals (other 
than in a business capacity), and 
‘‘(B) both persons who receive money from 
the financial intermediation business and per-
sons who pay money to the financial intermedi-
ation business (even though amounts allocated 
to the former do not constitute implicit fees).
330
‘‘(4) REGULATIONS.—The Secretary shall pre-
scribe regulations relating to the allocations under 
this subsection, including regulations addressing—
‘‘(A) rules for timing of deductions of im-
plicit fees paid by fiscal year recipients, 
‘‘(B) subsequent year adjustments if a fi-
nancial intermediation business allocates too 
much in a calendar year, 
‘‘(C) rules for advance approval from the 
Secretary for allocation procedures, and 
‘‘(D) safe-harbor alternatives to the alloca-
tion procedures described in this subsection. 
‘‘(c) NOT APPLICABLE TO LENDING SERVICES.—
This section shall not apply to lending services. 
‘‘Subchapter G—Financial Intermediation 
and Financial Institutions
‘‘Sec. 241. Activities constituting a financial intermediation business. 
‘‘Sec. 242. General rule for taxation. 
‘‘Sec. 243. Special rule for banks. 
‘‘Sec. 244. Insurance companies. 
‘‘Sec. 245. Financial pass-through entities. 
‘‘Sec. 246. Financial intermediation by other businesses.
‘‘SEC. 241. ACTIVITIES CONSTITUTING A FINANCIAL INTER-
MEDIATION BUSINESS. 
‘‘(a) FINANCIAL INTERMEDIATION BUSINESS.—The 
providing of financial intermediation services shall be con-
sidered a business activity. The gross profit of a business 
entity providing financial intermediation services shall be
331
determined by taking into account the rules of this sub-
chapter. 
‘‘(b) SEPARATE BUSINESS ACTIVITY.—The provision 
of financial intermediation services for unrelated persons 
shall be considered a separate business activity and a busi-
ness shall be considered a separate entity with respect to 
such activity. An entity engaging in such business is re-
ferred to in this chapter as a ‘financial intermediation 
business’. 
‘‘(c) FINANCIAL INTERMEDIATION BY A BUSINESS.—
Section 246 shall apply to a business that provides finan-
cial intermediation services for itself and related parties 
but generally does not provide such services for unrelated 
parties. 
‘‘(d) DEFINITIONS.—
‘‘(1) FINANCIAL INTERMEDIATION SERVICES.—
‘Financial intermediation services’ include—
‘‘(A) lending services, 
‘‘(B) insurance services, 
‘‘(C) market-making and dealer services, 
and 
‘‘(D) any other service provided as busi-
ness activity in which a person acts as an inter-
mediary in—
332
‘‘(i) the transfer of property, services, 
or financial assets, liabilities, risks or in-
struments (or income or expense derived 
therefrom) between two or more persons, 
or 
‘‘(ii) the pooling of economic risk 
among other persons 
and derives all or a portion of such person’s 
gross receipts from streams of income or ex-
pense, discounts, or other financial flows associ-
ated with the matter with respect to which such 
person is acting as an intermediary. 
‘‘(2) LENDING
SERVICES.—‘Lending services’ 
means the regular making of loans and providing 
credit to, or taking deposits from customers, but 
does not include an installment or delayed payment 
arrangement provided by a seller of property or serv-
ices under which additional charges or fees are im-
posed by the seller for the late payment. 
‘‘(3) MARKET-MAKING OR DEALER SERVICES.—
‘Market-making or dealer services’ means services 
provided by a person who—
‘‘(A) regularly purchases financial instru-
ments from or sells financial instruments to
333
customers in the ordinary course of a trade or 
business, 
‘‘(B) regularly offers to enter into, assume, 
offset, assign, or otherwise terminate positions 
in financial instruments with customers in the 
ordinary course of a trade or business. 
‘‘SEC. 242. GENERAL RULE FOR TAXATION. 
‘‘(a) IN GENERAL.—In the case of a financial inter-
mediation business, gross profits shall be computed by—
‘‘(1) substituting financial receipts for taxable 
receipts, and 
‘‘(2) including financial expenses as business 
purchases. 
‘‘(b) DEFINITIONS.—
‘‘(1) FINANCIAL
RECEIPTS.—‘Financial re-
ceipts’ means all receipts other than amounts re-
ceived as contributions to capital. 
‘‘(2) FINANCIAL
EXPENSES.—‘Financial ex-
penses’ include—
‘‘(A) payments for principal and interest 
that is properly allocable to the provision of fi-
nancial intermediation services, 
‘‘(B) the cost of and payments under fi-
nancial instruments (other than financial in-
struments in the person subject to the tax im-
334
posed under this chapter and any person re-
lated to such person), 
‘‘(C) claims and cash surrender values paid 
in connection with insurance or reinsurance 
services, and 
‘‘(D) amounts paid for reinsurance. 
‘‘(3) FINANCIAL INSTRUMENT.—‘Financial in-
strument’ means any—
‘‘(A) share of stock in a corporation, 
‘‘(B) equity ownership in any widely held 
or publicly traded partnership, trust, or other 
business entity, 
‘‘(C) note, bond, debenture, or other evi-
dence of indebtedness, 
‘‘(D) interest rate, currency, or equity no-
tional principal contract, 
‘‘(E) evidence or interest in, or a derivative 
financial instrument in, any financial instru-
ment described in subparagraph (A), (B), (C), 
or (D), or any currency, including any option, 
forward contract, short position, and any simi-
lar financial instrument in such a financial in-
strument or currency, and 
‘‘(F) a position which—
335
‘‘(i) is not a financial instrument de-
scribed in subparagraph (A), (B), (C), (D) 
or (E), 
‘‘(ii) is a hedge with respect to such 
a financial instrument, and 
‘‘(iii) is clearly identified in the deal-
er’s records as being described in this sub-
paragraph before the close of the day on 
which it was acquired or entered into. 
‘‘(c) INTERNATIONAL MATTERS.—For purposes of 
this section in the case of a financial intermediation busi-
ness with activity in and outside the United States—
‘‘(1) INCLUSION REGARDLESS OF SOURCE.—
‘‘(A) Financial receipts shall be determined 
without regard to whether they are received for 
property or service provided in or outside the 
United States, except that financial receipts do 
not include amounts that—
‘‘(i) are not taxable receipts (as deter-
mined without regard to this section), but 
‘‘(ii) would have been taxable receipts 
(as determined without regard to this sec-
tion) if they had been received for services 
or property in the United States.
336
‘‘(B) Financial expenses shall be deter-
mined without regard to whether they are re-
ceived for property or services acquired in or 
outside the United States. 
‘‘(2) ALLOCATION.—Under regulations pre-
scribed by the Secretary, gross profits (as deter-
mined without regard to this paragraph) shall be re-
duced by the amount of financial intermediation 
gross profit attributable to financial intermediation 
activity provided outside the United States. 
‘‘(3) GROSS PROFIT ATTRIBUTABLE TO FINAN-
CIAL INTERMEDIATION ACTIVITY.—‘Gross profits at-
tributable to financial intermediation activity’ means 
the excess of—
‘‘(A) gross profits as determined under 
this section (but without regard to paragraph 
(2)), over 
‘‘(B) gross profits as determined without 
regard to this subchapter. 
‘‘SEC. 243. SPECIAL RULES FOR BANKS. 
‘‘(a) IN GENERAL.—In the case of a bank, gross prof-
its shall be determined in accordance with section 242, ex-
cept that—
‘‘(1) FINANCIAL RECEIPTS.—Financial receipts 
shall include only—
337
‘‘(A) taxable receipts (as determined with-
out regard to this subchapter), 
‘‘(B) interest on loans made or acquired by 
the bank, 
‘‘(C) gain on the sale of loans, 
‘‘(D) discount points received, and 
‘‘(E) any explicit fees for financial or fidu-
ciary services not included in subparagraphs 
(A) through (E). 
‘‘(2) FINANCIAL
EXPENSES.—Financial ex-
penses shall include only—
‘‘(A) interest paid to depositors and on 
other funds borrowed by the bank, and 
‘‘(B) reasonable additions to reserves for 
bad debts. 
‘‘(3) FORECLOSURE PROPERTY.—Gross profits 
shall properly take into account proceeds from the 
operation or sale of foreclosure property. 
‘‘(b) BANK.—
‘‘(1) IN GENERAL.—‘Bank’ means a bank or 
trust company incorporated and doing business 
under the laws of the United States, the District of 
Columbia, or any State, a substantial part of the 
business of which consists of receiving deposits and 
making loans and discounts, or of exercising fidu-
338
ciary powers similar to those exercised by national 
banks under the authority of the Comptroller of the 
Currency, and which is subject by law to supervision 
and examination by State or Federal authority hav-
ing supervision over banking institutions or credit 
unions. Such term includes domestic building and 
loan associations and credit unions. 
‘‘(2) OTHER ACTIVITIES.—If a bank is engaged 
in significant amounts of activities other than those 
described in paragraph (1), the bank shall be consid-
ered as a separate business entity with respect to 
such other activity. 
‘‘SEC. 244. INSURANCE COMPANIES. 
‘‘(a) IN GENERAL.—In the case of companies pro-
viding insurance services, gross profits shall be determined 
in accordance with section 242, except—
‘‘(1) subsection (c) of section 242 (relating to 
international operations) shall not apply, and 
‘‘(2) the rules of subchapter J (sourcing rules) 
shall apply to determine financial receipts and finan-
cial expenses. 
‘‘(b) RESULT INCONSISTENT WITH STATUTORY IN-
TENT.—If an insurance company determines that the ap-
plication of subsection (a) produces results inconsistent 
with the territorial approach of the business tax, it may
339
apply to the Secretary for permission to apply section 
242(c) in lieu of subsection (a). 
‘‘SEC. 245. FINANCIAL PASS-THROUGH ENTITIES. 
‘‘(a) IN GENERAL.—In the case of a financial pass-
thru entity, gross profits shall be determined in accord-
ance with section 242, except—
‘‘(1) financial receipts shall include contribu-
tions to capital, 
‘‘(2) financial expenses shall include—
‘‘(A) distributions to persons holding inter-
ests in the pass-thru entity, 
‘‘(B) investments in related entities (in-
cluding wholly owned entities) engaging in real 
estate investment. 
‘‘(b) PASS-THRU ENTITY.—
‘‘(1) IN GENERAL.—‘Pass-thru entity’ means a 
business entity that is intended to serve as a con-
duit. The Secretary shall prescribe regulations defin-
ing pass-thru entity. Such term shall include—
‘‘(A) entities that would qualify as regu-
lated investment companies under the Internal 
Revenue Code of 1986, 
‘‘(B) entities that would qualify as real es-
tate investment trusts under the Internal Rev-
enue Code of 1986,
340
‘‘(C) 
entities 
that 
would 
qualify 
as 
REMICs under the Internal Revenue Code of 
1986, and 
‘‘(D) partnerships whose purposes are to 
invest the funds of the partners in financial in-
struments, distribute or reinvest the income 
from such investments, and distribute or rein-
vest the proceeds from the sale of such instru-
ments. 
‘‘(2) ENGAGEMENT IN BUSINESS ACTIVITY.—
An entity will not qualify as a pass-thru entity if it 
engages in more than an insubstantial amount of 
rental or other business activity (other than invest-
ing in and selling financial instruments). The pre-
ceding sentence will not apply if the business entity 
treats the business activity as engaged in by a sepa-
rate business entity (separately subject to tax under 
this chapter). 
‘‘SEC. 246. FINANCIAL INTERMEDIATION BY OTHER BUSI-
NESSES. 
‘‘(a) IN GENERAL.—If a business entity that is not 
regularly in the business of providing financial intermedi-
ation services to unrelated parties engages in significant 
financial intermediation activity, its gross profits shall be 
increased by its gross profits from financial intermediation
341
activity (determined as if such activity were activity of a 
pass-thru entity that paid all costs of such financial inter-
mediation activity including—
‘‘(1) compensation for persons engaging in such 
activity, 
‘‘(2) equipment involved in such activity, and 
‘‘(3) office space for persons involved in such 
activity). 
‘‘(b) PROXY.—A business entity to which subsection 
(a) applies will be treated as satisfying the requirements 
of that subsection if it increases its gross receipts by the 
portion of employee compensation properly allocable to the 
provision of financial intermediation services. 
‘‘(c) SIGNIFICANT FINANCIAL INTERMEDIATION.—A 
business will be considered as engaging in substantial fi-
nancial intermediation if—
‘‘(1) more than 5 percent of the compensation 
paid by the business to its employees is for employ-
ees whose primary activity is the management of the 
business’s investments in financial instruments, or 
‘‘(2) at all times during the taxable year and 
the immediately preceding full taxable year, more 
than 10 percent of its assets are financial instru-
ments other than—
342
‘‘(A) equity interests in business entities in 
which it holds more than 50 percent in value of 
the outstanding equity, 
‘‘(B) equity interests in joint ventures in 
which the company is actively participating, 
‘‘(C) purchase money loans to its cus-
tomers, and 
‘‘(D) business loans and equity invest-
ments that serve a direct business purpose. 
‘‘Subchapter H—Tax-Exempt Organizations
‘‘Sec. 251. Exemption for governmental entities. 
‘‘Sec. 252. Taxable activity of governmental entities. 
‘‘Sec. 253. Tax-exempt organizations. 
‘‘Sec. 254. Special rules for (c)(3) organizations. 
‘‘Sec. 255. Tax on unrelated business activity. 
‘‘Sec. 256. Unrelated business activity.
‘‘SEC. 251. EXEMPTION FOR GOVERNMENTAL ENTITIES.
‘‘(a) STATES.—Except as provided in section 252, a 
state, political subdivision thereof and the District of Co-
lumbia shall be exempt from taxation under this chapter 
on any gross profits derived from the exercise of any es-
sential governmental function. 
‘‘(b) POSSESSIONS.—The government of any posses-
sion of the United States shall be exempt from taxation 
under this chapter on any gross profits earned by the pos-
session.
343
‘‘SEC. 252. TAXABLE ACTIVITY OF GOVERNMENTAL ENTI-
TIES. 
‘‘(a) CERTAIN ACTIVITIES TAXABLE.—A govern-
mental entity shall be considered a business and subject 
to tax on any business activity of a type frequently pro-
vided by business entities subject to tax under this chap-
ter. 
‘‘(b) CERTAIN ACTIVITIES TREATED AS ESSENTIAL 
GOVERNMENT
FUNCTIONS.—Subsection (a) shall not 
apply to the following activities, which shall be treated as 
essential government functions: 
‘‘(1) Provision of mass transportation services. 
‘‘(2) Provision of public utility services. 
‘‘SEC. 253. TAX-EXEMPT ORGANIZATIONS. 
‘‘(a) EXEMPTION FROM TAXATION.—An organiza-
tion described in subsection (c) or (d) shall be exempt 
from taxation under this chapter. 
‘‘(b) TAX ON UNRELATED BUSINESS ACTIVITY.—An 
organization exempt from taxation under subsection (a) 
shall be subject to tax to the extent provided in sections 
255 and 256, but shall be considered a tax-exempt organi-
zation for purposes of any law that refers to tax-exempt 
organizations. 
‘‘(c) LIST OF EXEMPT ORGANIZATIONS.—The fol-
lowing organizations are referred to in subsection (a):
344
‘‘(1) 
INSTRUMENTALITY
OF
THE
UNITED 
STATES.—Any corporation organized under Act of 
Congress which is an instrumentality of the United 
States but only if such corporation—
‘‘(A) is exempt from Federal income 
taxes—
‘‘(i) under such Act as amended and 
supplemented before July 18, 1984, or 
‘‘(ii) under this title without regard to 
any provision of law which is not contained 
in this title and which is not contained in 
a revenue Act, or 
‘‘(B) is described in subsection (h).
‘‘(2) TITLE
HOLDING
COMPANIES.—Corpora-
tions organized for the exclusive purpose of holding 
title to property, collecting income therefrom, and 
turning over the entire amount thereof, less ex-
penses, to an organization which itself is exempt 
under this section. Rules similar to the rules of sub-
paragraph (G) of paragraph (25) shall apply for 
purposes of this paragraph. 
‘‘(3) CHARITABLE, EDUCATIONAL
AND
RELI-
GIOUS
ORGANIZATIONS.—Corporations, and any 
community chest, fund, or foundation, organized and 
operated exclusively for religious, charitable, sci-
345
entific, testing for public safety, literary, or edu-
cational purposes, or to foster national or inter-
national amateur sports competition (but only if no 
part of its activities involve the provision of athletic 
facilities or equipment), or for the prevention of cru-
elty to children or animals, no part of the net earn-
ings of which inures to the benefit of any private 
shareholder or individual, no substantial part of the 
activities of which is carrying on propaganda, or oth-
erwise attempting, to influence legislation (except as 
otherwise provided in subsection (g)), and which 
does not participate in, or intervene in (including the 
publishing or distributing of statements), any polit-
ical campaign on behalf of (or in opposition to) any 
candidate for public office. 
‘‘(4) SOCIAL WELFARE ORGANIZATIONS, ETC.—
‘‘(A) Civic leagues or organizations not or-
ganized for profit but operated exclusively for 
the promotion of social welfare, or local associa-
tions of employees, the membership of which is 
limited to the employees of a designated person 
or persons in a particular municipality, and the 
net earnings of which are devoted exclusively to 
charitable, educational, or recreational pur-
poses.
346
‘‘(B) Subparagraph (A) shall not apply to 
an entity unless no part of the net earnings of 
such entity inures to the benefit of any private 
shareholder or individual. 
‘‘(5) LABOR
AND
AGRICULTURAL
ORGANIZA-
TIONS.—Labor, agricultural, or horticultural organi-
zations. 
‘‘(6) TRADE ASSOCIATIONS.—Business leagues, 
chambers of commerce, real-estate boards, boards of 
trade, or professional football leagues (whether or 
not administering a pension fund for football play-
ers) not organized for profit and no part of the net 
earnings of which inures to the benefit of any pri-
vate shareholder or individual. 
‘‘(7) SOCIAL
CLUBS.—Clubs organized for 
pleasure, recreation, and other nonprofitable pur-
poses, substantially all of the activities of which are 
for such purposes and no part of the net earnings 
of which inures to the benefit of any private share-
holder. 
‘‘(8) CERTAIN
FRATERNAL
SOCIETIES.—Fra-
ternal beneficiary societies, orders, or associations—
‘‘(A) operating under the lodge system or 
for the exclusive benefit of the members of a
347
fraternity itself operating under the lodge sys-
tem, and 
‘‘(B) providing for the payment of life, 
sick, accident, or other benefits to the members 
of such society, order, or association or their 
dependents. 
‘‘(9) VEBA’S.—Voluntary employees’ bene-
ficiary associations providing for the payment of life, 
sick, accident, or other benefits to the members of 
such association or their dependents or designated 
beneficiaries, if no part of the net earnings of such 
association inures (other than through such pay-
ments) to the benefit of any private shareholder or 
individual. 
‘‘(10) OTHER
FRATERNAL
ORGANIZATIONS.—
Domestic fraternal societies, orders, or associations, 
operating under the lodge system—
‘‘(A) the net earnings of which are devoted 
exclusively to religious, charitable, scientific, lit-
erary, educational, and fraternal purposes, and 
‘‘(B) which do not provide for the payment 
of life, sick, accident, or other benefits. 
‘‘(11) 
LOCAL
TEACHERS’ 
RETIREMENT 
FUNDS.—Teachers’ retirement fund associations of a 
purely local character, if—
348
‘‘(A) no part of their net earnings inures 
(other than through payment of retirement ben-
efits) to the benefit of any private shareholder 
or individual, and 
‘‘(B) the income consists solely of amounts 
received from public taxation, amounts received 
from assessments on the teaching salaries of 
members, and income in respect of investments. 
‘‘(12) CERTAIN COOPERATIVES.—
‘‘(A) Benevolent life insurance associations 
of a purely local character, mutual ditch or irri-
gation companies, mutual or cooperative tele-
phone companies, or like organizations; but only 
if 85 percent or more of the income consists 
of amounts collected from members for the sole 
purpose of meeting losses and expenses. 
‘‘(B) In the case of a mutual or coopera-
tive telephone company, subparagraph (A) shall 
be applied without taking into account any in-
come received or accrued—
‘‘(i) from a nonmember telephone 
company for the performance of commu-
nication services which involve members of 
the mutual or cooperative telephone com-
pany,
349
‘‘(ii) from qualified pole rentals, 
‘‘(iii) from the sale of display listings 
in a directory furnished to the members of 
the mutual or cooperative telephone com-
pany, or 
‘‘(iv) from the prepayment of a loan 
under section 306A, 306B, or 311 of the 
Rural Electrification Act of 1936 (as in ef-
fect on January 1, 1987). 
‘‘(C) In the case of a mutual or cooperative 
electric company, subparagraph (A) shall be ap-
plied without taking into account any income 
received or accrued—
‘‘(i) from qualified pole rentals, or 
‘‘(ii) from the prepayment of a loan 
under section 306A, 306B, or 311 of the 
Rural Electrification Act of 1936 (as in ef-
fect on January 1, 1987). 
‘‘(D) For purposes of this paragraph, the 
term ‘qualified pole rental’ means any rental of 
a pole (or other structure used to support 
wires) if such pole (or other structure)—
‘‘(i) is used by the telephone or elec-
tric company to support one or more wires 
which are used by such company in pro-
350
viding telephone or electric services to its 
members, and 
‘‘(ii) is used pursuant to the rental to 
support one or more wires (in addition to 
the wires described in clause (i)) for use in 
connection with the transmission by wire 
of electricity or of telephone or other com-
munications. 
For purposes of the preceding sentence, the 
term ‘rental’ includes any sale of the right to 
use the pole (or other structure). 
‘‘(13) 
NONPROFIT
CEMETERIES.—Cemetery 
companies owned and operated exclusively for the 
benefit of their members or which are not operated 
for profit; and any corporation chartered solely for 
the purpose of the disposal of bodies by burial or 
cremation which is not permitted by its charter to 
engage in any business not necessarily incident to 
that purpose and no part of the net earnings of 
which inures to the benefit of any private share-
holder or individual. 
‘‘(14) GRANDFATHERED
MUTUAL
FINANCIAL 
INSTITUTIONS.—
‘‘(A) Credit unions without capital stock 
organized and operated for mutual purposes
351
and without profit, but only if organized before 
July 1, 2003. 
‘‘(B) Certain corporations or associations 
organized before September 1, 1957, and de-
scribed in subparagraphs (B) or (C) of section 
501(c)(14) of the Internal Revenue Code of 
1986. 
‘‘(15) GRANDFATHERED
SMALL
INSURANCE 
COMPANIES.—Insurance companies organized before 
July 1, 2003, and described in section 501(c)(15) of 
the Internal Revenue Code of 1986. 
‘‘(16) CROP
FINANCING
ASSOCIATIONS.—Cor-
porations organized by an association subject to part 
IV of this subchapter or members thereof, for the 
purpose of financing the ordinary crop operations of 
such members or other producers, and operated in 
conjunction with such association. Exemption shall 
not be denied any such corporation because it has 
capital stock, if the dividend rate of such stock is 
fixed at not to exceed the legal rate of interest in the 
State of incorporation or 8 percent per annum, 
whichever is greater, on the value of the consider-
ation for which the stock was issued, and if substan-
tially all such stock (other than nonvoting preferred 
stock, the owners of which are not entitled or per-
352
mitted to participate, directly or indirectly, in the 
profits of the corporation, on dissolution or other-
wise, beyond the fixed dividends) is owned by such 
association, or members thereof; nor shall exemption 
be denied any such corporation because there is ac-
cumulated and maintained by it a reserve required 
by State law or a reasonable reserve for any nec-
essary purpose.
‘‘(17) SUPPLEMENTAL EMPLOYMENT BENEFIT 
TRUST.—
‘‘(A) A trust or trusts forming part of a 
plan providing for the payment of supplemental 
unemployment compensation benefits, if—
‘‘(i) under the plan, it is impossible, 
at any time prior to the satisfaction of all 
liabilities, with respect to employees under 
the plan, for any part of the corpus or in-
come to be (within the taxable year or 
thereafter) used for, or diverted to, any 
purpose other than the providing of supple-
mental unemployment compensation bene-
fits, 
‘‘(ii) such benefits are payable to em-
ployees under a classification which is set 
forth in the plan and which is found by the
353
Secretary not to be discriminatory in favor 
of employees who are highly compensated 
employees (within the meaning of section 
414(q)), and 
‘‘(iii) such benefits do not discrimi-
nate in favor of employees who are highly 
compensated employees (within the mean-
ing of section 414(q). A plan shall not be 
considered discriminatory within the mean-
ing of this clause merely because the bene-
fits received under the plan bear a uniform 
relationship to the total compensation, or 
the basic or regular rate of compensation, 
of the employees covered by the plan. 
‘‘(B) Rules similar to those contained in 
subparagraphs (B) through (E) of section 
501(c)(7) of the Internal Revenue Code of 1986 
shall apply to subparagraph (A). 
‘‘(18) GRANDFATHERED TRUSTS.—A trust or 
trusts created before June 25, 1959, and described 
in section 501(c)(18) of the Internal Revenue Code 
of 1986. 
‘‘(19) CERTAIN VETERANS’ ORGANIZATIONS.—
A post or organization of past or present members 
of the Armed Forces of the United States, or an
354
auxiliary unit or society of, or a trust or foundation 
for, any such post or organization—
‘‘(A) organized in the United States or any 
of its possessions, 
‘‘(B) at least 75 percent of the members of 
which are past or present members of the 
Armed Forces of the United States and sub-
stantially all of the other members of which are 
individuals who are cadets or are spouses, wid-
ows, or widowers of past or present members of 
the Armed Forces of the United States or of 
cadets, and 
‘‘(C) no part of the net earnings of which 
inures to the benefit of any private shareholder 
or individual. 
‘‘(20) LEGAL SERVICE PLAN TRUSTS.—An or-
ganization or trust created or organized in the 
United States, the exclusive function of which is to 
form part of a qualified group legal services plan or 
plans. 
‘‘(21) BLACK LUNG ACT TRUSTS.—A trust or 
trusts established in writing, created or organized in 
the United States, and contributed to by any person 
(except an insurance company) if—
355
‘‘(A) the purpose of such trust or trusts is 
exclusively—
‘‘(i) to satisfy, in whole or in part, the 
liability of such person for, or with respect 
to, claims for compensation for disability 
or death due to pneumoconiosis under 
Black Lung Acts, 
‘‘(ii) to pay premiums for insurance 
exclusively covering such liability, 
‘‘(iii) to pay administrative and other 
incidental expenses of such trust in connec-
tion with the operation of the trust and the 
processing of claims against such person 
under Black Lung Acts, and 
‘‘(iv) to pay accident or health bene-
fits for retired miners and their spouses 
and dependents (including administrative 
and other incidental expenses of such trust 
in connection therewith) or premiums for 
insurance exclusively covering such bene-
fits; and 
‘‘(B) such trusts meets requirements simi-
lar to those contained in section 501(c)(21) of 
the Internal Revenue Code of 1986.
356
‘‘(22) MULTIEMPLOYER ERISA TRUST.—A trust 
created or organized in the United States and estab-
lished in writing by the plan sponsors of multiem-
ployer plans if—
‘‘(A) the purpose of such trust is exclu-
sively—
‘‘(i) to pay any amount described in 
section 4223(c) or (h) of the Employee Re-
tirement Income Security Act of 1974, and 
‘‘(ii) to pay reasonable and necessary 
administrative expenses in connection with 
the establishment and operation of the 
trust and the processing of claims against 
the trust, 
‘‘(B) no part of the assets of the trust may 
be used for, or diverted to, any purpose other 
than—
‘‘(i) the purposes described in sub-
paragraph (A), or 
‘‘(ii) prudent investment in securities, 
obligations, or time or demand deposits, 
‘‘(C) such trust meets the requirements of 
paragraphs (2), (3), and (4) of section 4223(b), 
4223(h), or, if applicable, section 4223(c) of the
357
Employee Retirement Income Security Act of 
1974, and 
‘‘(D) the trust instrument provides that, 
on dissolution of the trust, assets of the trust 
may not be paid other than to plans which have 
participated in the plan or, in the case of a 
trust established under section 4223(h) of such 
Act, to plans with respect to which employers 
have participated in the fund. 
‘‘(23) GRANDFATHERED VETERANS’ INSURANCE 
ORGANIZATION.—Any association organized before 
1880 more than 75 percent of the members of which 
are present or past members of the Armed Forces 
and a principal purpose of which is to provide insur-
ance and other benefits to veterans or their depend-
ents. 
‘‘(24) ERISA TRUST.—A trust described in sec-
tion 4049 of the Employee Retirement Income Secu-
rity Act of 1974 (as in effect on the date of the en-
actment of the Single-Employer Pension Plan 
Amendments Act of 1986). 
‘‘(25) REAL TITLE HOLDING CORPORATION OR 
TRUST.—
‘‘(A) Any corporation or trust which—
358
‘‘(i) has no more than 35 shareholders 
or beneficiaries, 
‘‘(ii) has only 1 class of stock or bene-
ficial interest, and 
‘‘(iii) is organized for the exclusive 
purposes of—
‘‘(I) acquiring real property and 
holding title to, and collecting income 
from, such property, and 
‘‘(II) remitting the entire amount 
of income from such property (less ex-
penses) to 1 or more organizations de-
scribed in subparagraph (C) which are 
shareholders of such corporation or 
beneficiaries of such trust. 
‘‘For purposes of clause (iii), the term ‘real 
property’ shall not include any interest as a 
tenant in common (or similar interest) and 
shall not include any indirect interest. 
‘‘(B) A corporation or trust shall be de-
scribed in subparagraph (A) without regard to 
whether the corporation or trust is organized by 
1 or more organizations described in subpara-
graph (C).
359
‘‘(C) An organization is described in this 
subparagraph if such organization is—
‘‘(i) a qualified pension, profit shar-
ing, or stock bonus plan that meets the re-
quirements of section 401(a), 
‘‘(ii) a governmental plan (within the 
meaning of section 414(d)), 
‘‘(iii) the United States, any State or 
political subdivision thereof, or any agency 
or instrumentality of any of the foregoing, 
or 
‘‘(iv) any organization described in 
paragraph (3). 
‘‘(D) A corporation or trust shall in no 
event be treated as described in subparagraph 
(A) unless such corporation or trust permits its 
shareholders or beneficiaries—
‘‘(i) to dismiss the corporation’s or 
trust’s investment adviser, following rea-
sonable notice, upon a vote of the share-
holders or beneficiaries holding a majority 
of interest in the corporation or trust, and 
‘‘(ii) to terminate their interest in the 
corporation or trust by either, or both, of
360
the following alternatives, as determined by 
the corporation or trust: 
‘‘(I) by selling or exchanging 
their stock in the corporation or inter-
est in the trust (subject to any Fed-
eral or State securities law) to any or-
ganization described in subparagraph 
(C) so long as the sale or exchange 
does not increase the number of 
shareholders or beneficiaries in such 
corporation or trust above 35, or 
‘‘(II) by having their stock or in-
terest redeemed by the corporation or 
trust after the shareholder or bene-
ficiary has provided 90 days notice to 
such corporation or trust.
‘‘(E)(i) For purposes of this paragraph—
‘‘(I) a corporation which is a qualified 
subsidiary shall not be treated as a sepa-
rate corporation, and 
‘‘(II) all assets, liabilities, and items 
of income, deduction, and credit of a quali-
fied subsidiary shall be treated as assets, 
liabilities, and such items (as the case may
361
be) of the corporation or trust described in 
subparagraph (A). 
‘‘(ii) For purposes of this subparagraph, 
the term ‘qualified subsidiary’ means any cor-
poration if, at all times during the period such 
corporation was in existence, 100 percent of the 
stock of such corporation is held by the cor-
poration or trust described in subparagraph 
(A). 
‘‘(iii) For purposes of this subtitle, if any 
corporation which was a qualified subsidiary 
ceases to meet the requirements of clause (ii), 
such corporation shall be treated as a new cor-
poration acquiring all of its assets (and assum-
ing all of its liabilities) immediately before such 
cessation from the corporation or trust de-
scribed in subparagraph (A) in exchange for its 
stock. 
‘‘(F) For purposes of subparagraph (A), 
the term ‘real property’ includes any personal 
property which is leased under, or in connection 
with, a lease of real property, but only if the 
rent attributable to such personal property for 
the taxable year does not exceed 15 percent of 
the total rent for the taxable year attributable
362
to both the real and personal property leased 
under, or in connection with, such lease. 
‘‘(G)(i) An organization shall not be treat-
ed as failing to be described in this paragraph 
merely by reason of the receipt of any otherwise 
disqualifying income which is incidentally de-
rived from the holding of real property. 
‘‘(ii) Clause (i) shall not apply if the 
amount of gross income described in such 
clause exceeds 10 percent of the organization’s 
gross income for the taxable year unless the or-
ganization establishes to the satisfaction of the 
Secretary that the receipt of gross income de-
scribed in clause (i) in excess of such limitation 
was inadvertent and reasonable steps are being 
taken to correct the circumstances giving rise to 
such income. 
‘‘(26) STATE ESTABLISHED MEDICAL CARE IN-
SURER.—Any membership organization if—
‘‘(A) such organization is established by a 
State exclusively to provide coverage for medical 
care on a not-for-profit basis to individuals de-
scribed in subparagraph (B) through—
‘‘(i) insurance issued by the organiza-
tion, or
363
‘‘(ii) a health maintenance organiza-
tion under an arrangement with the orga-
nization, 
‘‘(B) the only individuals receiving such 
coverage through the organization are individ-
uals—
‘‘(i) who are residents of such State, 
and 
‘‘(ii) who, by reason of the existence 
or history of a medical condition—
‘‘(I) are unable to acquire med-
ical care coverage for such condition 
through insurance or from a health 
maintenance organization, or 
‘‘(II) are able to acquire such 
coverage only at a rate which is sub-
stantially in excess of the rate for 
such coverage through the member-
ship organization, 
‘‘(C) the composition of the membership in 
such organization is specified by such State, 
and 
‘‘(D) no part of the net earnings of the or-
ganization inures to the benefit of any private 
shareholder or individual. A spouse and any
364
qualifying child) of an individual described in 
subparagraph (B) (without regard to this sen-
tence) shall be treated as described in subpara-
graph (B). 
‘‘(27) GRANDFATHERED WORKERS COMPENSA-
TION
ORGANIZATION.—Any membership organiza-
tion established before June 1, 1996, by a State ex-
clusively to reimburse its members for losses arising 
under workmen’s compensation acts, and described 
in section 501(c)(27) of the Internal Revenue Code 
of 1986. 
‘‘(d) RELIGIOUS AND APOSTOLIC ORGANIZATIONS.—
The following organizations are referred to in subsection 
(a): Religious or apostolic associations or corporations, if 
such associations or corporations have a common treasury 
or community treasury, even if such associations or cor-
porations engage in business for the common benefit of 
the members, but only if such activity is treated as unre-
lated business activity. 
‘‘(e) COOPERATIVE HOSPITAL SERVICE ORGANIZA-
TIONS.—For purposes of this chapter, an organization 
shall be treated as an organization organized and operated 
exclusively for charitable purposes, if—
‘‘(1) such organization is organized and oper-
ated solely—
365
‘‘(A) to perform, on a centralized basis, 
one or more of the following services which, if 
performed on its own behalf by a hospital which 
is an organization described in subsection (c)(3) 
and exempt from taxation under subsection (a), 
would constitute activities in exercising or per-
forming the purpose or function constituting 
the basis for its exemption: data processing, 
purchasing (including the purchasing of insur-
ance on a group basis), warehousing, billing 
and collection, food, clinical, industrial engi-
neering, laboratory, printing, communications, 
record center, and personnel (including selec-
tion, testing, training, and education of per-
sonnel) services; and 
‘‘(B) to perform such services solely for 
two or more hospitals each of which is—
‘‘(i) an organization described in sub-
section (c)(3) which is exempt from tax-
ation under subsection (a), 
‘‘(ii) a constituent part of an organi-
zation described in subsection (c)(3) which 
is exempt from taxation under subsection 
(a) and which, if organized and operated 
as a separate entity, would constitute an
366
organization described in subsection (c)(3), 
or 
‘‘(iii) owned and operated by the 
United States, a State, the District of Co-
lumbia, or a possession of the United 
States, or a political subdivision or an 
agency or instrumentality of any of the 
foregoing; 
‘‘(2) such organization is organized and oper-
ated on a cooperative basis and allocates or pays, 
within 81⁄2 months after the close of its taxable year, 
all net earnings to patrons on the basis of services 
performed for them; and 
‘‘(3) if such organization has capital stock, all 
of such stock outstanding is owned by its patrons. 
‘‘For purposes of this title, any organization which, by rea-
son of the preceding sentence, is an organization described 
in subsection (c)(3) and exempt from taxation under sub-
section (a), shall be treated as a hospital and as an organi-
zation referred to in section 101(b)(1)(A)(iii). 
‘‘(f) COOPERATIVE SERVICE ORGANIZATIONS OF OP-
ERATING EDUCATIONAL ORGANIZATIONS.—For purposes 
of this chapter, if an organization is—
‘‘(1) organized and operated solely to hold, 
commingle, and collectively invest and reinvest (in-
367
cluding arranging for and supervising the perform-
ance by independent contractors of investment serv-
ices related thereto) in stocks and securities, the 
moneys contributed thereto by each of the members 
of such organization, and to collect income there-
from and turn over the entire amount thereof, less 
expenses, to such members, 
‘‘(2) organized and controlled by one or more 
such members, and 
‘‘(3) comprised solely of members that are orga-
nizations described in clause (ii) or (iv) of section 
101(b)(1)(A)—
‘‘(A) which are exempt from taxation 
under subsection (a), or 
‘‘(B) the gross profits of which are ex-
cluded from taxation under section 251(a), 
then such organization shall be treated as an organization 
organized and operated exclusively for charitable purposes. 
‘‘(g) EXPENDITURES BY PUBLIC CHARITIES TO IN-
FLUENCE LEGISLATION.—
‘‘(1) GENERAL RULE.—In the case of an orga-
nization to which this subsection applies, exemption 
from taxation under subsection (a) shall be denied 
because a substantial part of the activities of such 
organization consists of carrying on propaganda, or
368
otherwise attempting, to influence legislation, but 
only if such organization normally—
‘‘(A) makes lobbying expenditures in ex-
cess of the lobbying ceiling amount for such or-
ganization for each taxable year, or 
‘‘(B) makes grass roots expenditures in ex-
cess of the grass roots ceiling amount for such 
organization for each taxable year. 
‘‘(2) DEFINITIONS.—For purposes of this sub-
section—
‘‘(A) LOBBYING
EXPENDITURES.—‘Lob-
bying expenditures’ means expenditures for the 
purpose of influencing legislation (as defined in 
section 4911(d)). 
‘‘(B) LOBBYING
CEILING
AMOUNT.—The 
lobbying ceiling amount for any organization 
for any taxable year is 150 percent of the lob-
bying nontaxable amount for such organization 
for such taxable year, determined under section 
4911. 
‘‘(C) GRASS
ROOTS
EXPENDITURES.—
‘Grass roots expenditures’ means expenditures 
for the purpose of influencing legislation (as de-
fined in section 4911(d) without regard to para-
graph (1)(B) thereof).
369
‘‘(D) GRASS
ROOTS
CEILING
AMOUNT.—
The grass roots ceiling amount for any organi-
zation for any taxable year is 150 percent of 
the grass roots nontaxable amount for such or-
ganization for such taxable year, determined 
under section 4911. 
‘‘(3) ORGANIZATIONS
TO
WHICH
THIS
SUB-
SECTION APPLIES.—This subsection shall apply to 
any organization which has elected (in such manner 
and at such time as the Secretary may prescribe) to 
have the provisions of this subsection apply to such 
organization and which, for the taxable year which 
includes the date the election is made, is described 
in subsection (c)(3) and is not described in para-
graph (4) and is not a private foundation. 
‘‘(4) 
DISQUALIFIED
ORGANIZATIONS.—This 
subsection does not apply to—
‘‘(A) a church, 
‘‘(B) an integrated auxiliary of a church or 
of a convention or association of churches, or 
‘‘(C) a member of an affiliated group of or-
ganizations (within the meaning of section 
4911(f)(2)) if one or more members of such 
group is described in subparagraph (A) or (B).
370
‘‘(5) YEARS FOR WHICH ELECTION IS EFFEC-
TIVE.—An election by an organization under this 
subsection shall be effective for all taxable years of 
such organization which—
‘‘(A) end after the date the election is 
made, and 
‘‘(B) begin before the date the election is 
revoked by such organization (under regulations 
prescribed by the Secretary). 
‘‘(6) NO
EFFECT
ON
CERTAIN
ORGANIZA-
TIONS.—With respect to any organization for a tax-
able year for which—
‘‘(A) such organization is described in 
paragraph (5), or 
‘‘(B) an election under this subsection is 
not in effect for such organization, nothing in 
this subsection or in section 4911 shall be con-
strued to affect the interpretation of the phrase, 
‘no substantial part of the activities of which is 
carrying on propaganda, or otherwise attempt-
ing, to influence legislation,’ under subsection 
(c)(3). 
‘‘(h) GOVERNMENT CORPORATIONS EXEMPT UNDER 
SUBSECTION (c)(1).—For purposes of subsection (c)(1),
371
the following organizations are described in this sub-
section: 
‘‘(1) The Central Liquidity Facility established 
under title III of the Federal Credit Union Act (12 
U.S.C. 1795 et seq.). 
‘‘(2) The Resolution Trust Corporation estab-
lished under section 21A of the Federal Home Loan 
Bank Act. 
‘‘(3) The Resolution Funding Corporation es-
tablished under section 21B of the Federal Home 
Loan Bank Act. 
‘‘(i) CERTAIN EDUCATIONAL ORGANIZATIONS.—An 
organization shall not be eligible for exemption as an edu-
cational organization under subsection (c)(3) if a substan-
tial amount of its activities and funds are devoted to—
‘‘(1) conducting seminars and other similar pro-
grams, 
‘‘(2) conducting research to educate Congress 
or the general public about public policy issues, 
‘‘(3) producing books and pamphlets, or 
‘‘(4) a combination of the foregoing. 
‘‘SEC. 254. SPECIAL RULES FOR (c)(3) ORGANIZATIONS. 
‘‘(a) NEW ORGANIZATIONS MUST NOTIFY SEC-
RETARY.—Except as provided in subsection (c), an organi-
372
zation shall not be treated as an organization described 
in section 253(c)(3)—
‘‘(1) unless that it has given notice to the Sec-
retary, in such manner as the Secretary may pre-
scribe, that it is applying for recognition of such sta-
tus, or
‘‘(2) for any period before giving of such notice, 
if such notice is given after the time prescribed by 
the Secretary by regulations for giving notice under 
this subsection. 
‘‘(b) PRESUMPTION THAT ORGANIZATIONS ARE PRI-
VATE FOUNDATIONS.—Except as provided in subsection 
(c), any organization described in section 253(c)(3) and 
which does not notify the Secretary, at such time and in 
such manner as the Secretary may by regulations pre-
scribe, that it is not a private foundation (as defined in 
section 102) shall be presumed to be a private foundation. 
‘‘(c) EXCEPTIONS.—Subsections (a) and (b) shall not 
apply to—
‘‘(1) organizations organized before October 10, 
1969; 
‘‘(2) organizations which obtained recognition 
of tax-exempt status under section 501(c)(3) of the 
Internal Revenue Code of 1986 (in the case of sub-
section (a) only);
373
‘‘(3) organizations which were determined not 
to be private foundations under the Internal Rev-
enue Code of 1986; 
‘‘(4) churches, their integrated auxiliaries, and 
conventions and associations of churches; 
‘‘(5) any organization that is not a private 
foundation and the gross receipts of which in each 
taxable year are not more than $25,000, or 
‘‘(6) such other classes of organizations which 
the Secretary may exempt. 
‘‘SEC. 255. TAX ON UNRELATED BUSINESS ACTIVITY. 
‘‘(a) IN GENERAL.—Each organization described in 
subsection (b) shall be subject to the Simplified USA Tax 
for businesses under section 201 on its gross profits from 
its unrelated business activity. 
‘‘(b) ORGANIZATIONS SUBJECT TO TAX.—This sec-
tion shall apply to—
‘‘(1) organizations exempt from the business 
tax under section 253(a), other than instrumental-
ities of the United States described in section 
253(c)(1). 
‘‘(2) colleges and universities which are instru-
mentalities of any government and corporations 
owned by one or more such colleges or universities.
374
‘‘SEC. 256. UNRELATED BUSINESS ACTIVITY. 
‘‘(a) IN GENERAL.—‘Unrelated business activity’ 
means any trade or business the conduct of which is not 
substantially related (aside from the need of such organi-
zation for income or funds or the use it makes of the prof-
its derived) to the exercise or performance by such organi-
zation of its charitable, educational, or other purpose or 
function constituting the basis for its exemption under 
section 253, except that such term does not include any 
trade or business—
‘‘(1) in which substantially all the work in car-
rying on such trade or business is performed for the 
organization without compensation; or 
‘‘(2) which is carried on, in the case of an orga-
nization described in section 253(c)(3) or in the case 
of a college or university described in section 255(b), 
by the organization primarily for the convenience of 
its members, students, patients, officers, or employ-
ees, which is the selling by the organization of items 
of work-related clothes and equipment and items 
normally sold through vending machines, through 
food dispensing facilities, or by snack bars, for the 
convenience of its members at their usual places of 
employment; or
375
‘‘(3) which is the selling of merchandise, sub-
stantially all of which has been received by the orga-
nization as gifts or contributions. 
‘‘(b) ADVERTISING, ETC., ACTIVITIES.—For purposes 
of this section, ‘trade or business’ includes any activity 
which is carried on for the production of income from the 
sale of goods or the performance of services. For purposes 
of the preceding sentence, an activity does not lose identity 
as a trade or business merely because it is carried on with-
in a larger aggregate of similar activities or within a larger 
complex of other endeavors which may, or may not, be 
related to the exempt purposes of the organization. Where 
an activity carried on for profit constitutes an unrelated 
trade or business, no part of such trade or business shall 
be excluded from such classification merely because it does 
not result in profit. 
‘‘(c) TRADE OR BUSINESS.—
‘‘(1) CERTAIN BUSINESS ACTIVITIES.—An ac-
tivity shall not be considered a ‘trade or business’ 
solely because the activity is a business activity 
(such as certain passive rental activity) that would 
be subject to the business tax if conducted by a busi-
ness entity other than a tax-exempt organization. 
‘‘(2) REGULATIONS.—The Secretary shall pre-
scribe regulations defining a ‘trade or business.’