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[Senate Report 104-281]
[From the U.S. Government Publishing Office]



                                                       Calendar No. 438
104th Congress                                                   Report
                                 SENATE

 2d Session                                                     104-281
_______________________________________________________________________


 
               SMALL BUSINESS JOB PROTECTION ACT OF 1996

                                _______
                                

                 June 18, 1996.--Ordered to be printed

_______________________________________________________________________


    Mr. Roth, from the Committee on Finance, submitted the following

                              R E P O R T

                        [To accompany H.R. 3448]

      [Including cost estimate of the Congressional Budget Office]

    The Committee on Finance, to which was referred the bill 
(H.R. 3448) to provide tax relief for small businesses, to 
protect jobs, to create opportunities, to increase the take 
home pay of workers, to amend the Portal-to-Portal Act of 1947 
relating to the payment of wages to employees who use employer 
owned vehicles, and to amend the Fair Labor Standards Act of 
1938 to increase the minimum wage rate and to prevent job loss 
by providing flexibility to employers in complying with minimum 
wage and overtime requirements under that Act, having 
considered the same, reports favorably thereon with an 
amendment and recommends that the bill as amended do pass.

                                CONTENTS

                                                                   Page
  I. Legislative Background...........................................6
 II. Explanation of the Bill (Title I)................................6
        Small Business and Other Tax Provisions..................     6
        A. Small Business Provisions.............................     6
             1. Increase in expensing for small businesses (sec. 
                1111)............................................     6
             2. Tax credit for Social Security taxes paid with 
                respect to employee cash tips (sec. 1112)........     7
             3. Treatment of dues paid to agricultural or 
                horticultural organizations (sec. 1113)..........     9
             4. Clarify employment tax status of certain 
                fishermen (sec. 1114)............................    10
             5. Modify rules governing issuance of tax-exempt 
                bonds for first-time farmers (sec. 1115).........    11
             6. Clarify treatment of newspaper distributors and 
                carriers as direct sellers (sec. 1116)...........    12
             7. Application of involuntary conversion rules to 
                property damaged as a result of Presidentially 
                declared disasters (sec. 1117)...................    14
             8. Establish 15-year recovery period for retail 
                motor fuel outlet stores (sec. 1118).............    14
             9. Treatment of leasehold improvements (sec. 1119)..    16
            10. Increase deductibility of business meal expenses 
                for certain seafood processing facilities (sec. 
                1120)............................................    18
            11. Provide a lower rate of excise tax on certain 
                hard ciders (sec. 1121)..........................    19
            12. Modifications to section 530 of the Revenue Act 
                of 1978 (sec. 1122)..............................    20
        B. Extension of Certain Expiring Provisions..............    28
             1. Work opportunity tax credit (sec. 1201)..........    28
             2. Employer-provided educational assistance (sec. 
                1202)............................................    36
             3. Research and experimentation tax credit (sec. 
                1203)............................................    38
             4. Orphan drug tax credit (sec. 1204)...............    41
             5. Contributions of stock to private foundations 
                (sec. 1205)......................................    42
             6. Tax credit for producing fuel from a 
                nonconventional source (sec. 1206)...............    43
             7.  Suspend imposition of diesel fuel tax on 
                recreational motorboats (sec. 1207)..............    44
        C. Provisions Relating to S Corporations.................    45
             1. S corporations permitted to have 75 shareholders 
                (sec. 1301)......................................    45
             2. Electing small business trusts (sec. 1302).......    46
             3. Expansion of post-death qualification for certain 
                trusts (sec. 1303)...............................    48
             4. Financial institutions permitted to hold safe 
                harbor debt (sec. 1304)..........................    48
             5. Rules relating to inadvertent terminations and 
                invalid elections (sec. 1305)....................    49
             6. Agreement to terminate year (sec. 1306)..........    50
             7. Expansion of post-termination transition period 
                (sec. 1307)......................................    50
             8. S corporations permitted to hold subsidiaries 
                (sec. 1308)......................................    51
             9. Treatment of distributions during loss years 
                (sec. 1309)......................................    53
            10. Treatment of S corporations under subchapter C 
                (sec. 1310)......................................    55
            11. Elimination of certain earnings and profits (sec. 
                1311)............................................    56
            12. Carryover of disallowed losses and deductions 
                under at-risk rules allowed (sec. 1312)..........    57
            13. Adjustments to basis of inherited S stock to 
                reflect certain items of income (sec. 1313)......    58
            14. S corporations eligible for rules applicable to 
                real property subdivided for sale by noncorporate 
                taxpayers (sec. 1314)............................    59
            15. Certain financial institutions as eligible 
                corporations (sec. 1315).........................    59
            16. Certain tax-exempt entities allowed to be 
                shareholders (sec. 1316).........................    60
            17. Reelection of subchapter S status (sec. 1317(b)).    61
        Pension Simplification Provisions........................    62
        A. Simplified Distribution Rules (secs. 1401-1404).......    62
        B. Increased Access to Retirement Savings Plans..........    66
             1. Establish SIMPLE retirement plans for small 
                employers (secs. 1421-1422)......................    66
             2. Tax-exempt organizations eligible under section 
                401(k) (sec. 1426)...............................    71
             3. Spousal IRAs (sec. 1427).........................    72
        C. Nondiscrimination Provisions..........................    73
             1. Definition of highly compensated employees and 
                repeal of family aggregation rules (sec. 1431)...    73
             2. Modification of additional participation 
                requirements (sec. 1432).........................    75
             3. Nondiscrimination rules for qualified cash or 
                deferred arrangements and matching contributions 
                (sec. 1433)......................................    76
             4. Definition of compensation for purposes of the 
                limits on contributions and benefits (sec. 1434).    80
        D. Miscellaneous Pension Simplification..................    80
             1. Plans covering self-employed individuals (sec. 
                1441)............................................    80
             2. Elimination of special vesting rule for 
                multiemployer plans (sec. 1442)..................    81
             3. Distributions under rural cooperative plans (sec. 
                1443)............................................    82
             4. Treatment of governmental plans under section 415 
                (sec. 1444)......................................    82
             5. Uniform retirement age (sec. 1445)...............    83
             6. Contributions on behalf of disabled employees 
                (sec. 1446)......................................    84
             7. Treatment of deferred compensation plans of State 
                and local governments and tax-exempt 
                organizations (sec. 1447)........................    84
             8. Trust requirement for deferred compensation plans 
                of State and local governments (sec. 1448).......    85
             9. Correction of GATT interest and morality rate 
                provisions in the Retirement Protection Act (sec. 
                1449)............................................    86
            10. Multiple salary reduction agreements permitted 
                under section 403(b) (sec. 1450(a))..............    87
            11. Treatment of Indian tribal governments under 
                section 403(b) (sec. 1450(b))....................    88
            12. Application of elective deferral limit to section 
                403(b) contracts (sec. 1450(c))..................    89
            13. Waiver of minimum waiting period for qualified 
                plan distributions (sec. 1451)...................    90
            14. Repeal of combined plan limit (sec. 1452)........    91
            15. Tax on prohibited transactions (sec. 1453).......    92
            16. Treatment of leased employees (sec. 1454)........    92
            17. Uniform penalty provisions to apply to certain 
                pension reporting requirements (sec. 1455).......    95
            18. Retirement benefits of ministers not subject to 
                tax on net earnings from self-employment (sec. 
                1456)............................................    95
            19. Treasury to provide model forms for spousal 
                consent and qualified domestic relations orders 
                (sec. 1457)......................................    96
            20. Treatment of length of service awards for certain 
                volunteers under section 457 (sec. 1458).........    97
            21. Date for adoption of plan amendments (sec. 1459).    98
        Other Provisions.........................................    99
        A. Miscellaneous Revenue Provisions......................    99
             1. Exempt Alaska from diesel dyeing requirement 
                while Alaska is exempt from similar Clean Air Act 
                dyeing requirement (sec. 1801)...................    99
             2. Application of common paymaster rules to certain 
                agency accounts at State universities (sec. 1802)   100
             3. Modifications to excise tax on ozone-depleting 
                chemicals........................................   101
                a. Exempt imported recycled halons from the 
                    excise tax on ozone-depleting chemicals (sec. 
                    1803)........................................   101
                b. Exempt chemicals used in metered-dose inhalers 
                    from the excise tax on ozone-depleting 
                    chemicals (sec. 1803)........................   102
             4. Tax-exempt bonds for the sale of Alaska Power 
                Administration facility (sec. 1804)..............   103
             5. Allow bank common trust funds to transfer assets 
                to regulated investment companies without 
                taxation (sec. 1805).............................   104
             6. Treatment of qualified State tuition programs 
                (sec. 1806)......................................   105
        Revenue Offsets..........................................   108
             1. Modifications of the Puerto Rico and possession 
                tax credit (sec. 1601)...........................   108
             2. Repeal 50-percent interest income exclusion for 
                financial institution loans to ESOPs (sec. 1602).   114
             3. Taxation of punitive damages received on account 
                of personal injury sickness (sec. 1603)..........   115
             4. Extension and phaseout of excise tax on luxury 
                automobiles (sec. 1604)..........................   116
             5. Allow certain persons engaged in the local 
                furnishing of electricity or gas to elect not to 
                be eligible for future tax-exempt bond financing 
                (sec. 1605)......................................   117
             6. Repeal of financial institution transition rule 
                to interest allocation rules (sec. 1606).........   118
             7. Reinstate Airport and Airway Trust Fund excise 
                taxes (sec. 1607)................................   119
             8. Modify basis adjustment rules under section 1033 
                (sec. 1608)......................................   120
             9. Extension of withholding to certain gambling 
                winnings (sec. 1609).............................   122
            10. Treatment of certain insurance contracts on 
                retired lives (sec. 1610)........................   122
            11. Treatment of contributions in aid of construction 
                for water utilities (sec. 1611(a))...............   123
            12. Require water utility property to be depreciated 
                over 25 years (sec. 1611(b)).....................   124
            13. Treatment of financial asset securitization 
                investment trusts (``FASITs'') (sec. 1621).......   125
            14. Revision of expatriation tax rules (secs. 1631-
                1633)............................................   133
        Tax Technical Corrections Provisions.....................   148
        A. Technical Corrections to the Revenue Reconciliation 
            Act of 1990..........................................   149
             1. Excise tax provisions............................   149
                a. Application of the 2.5-cents-per-gallon tax on 
                    fuel used in rail transportation to States 
                    and local governments (sec. 1702(b)(2))......   149
                b. Small winery production credit and bonding 
                    requirements (secs. 1702(b) (5), (6), and 
                    (7)).........................................   149
             2. Other revenue-increase provisions of the 1990 Act   150
                a. Deposits of Railroad Retirement Tax Act taxes 
                    (sec. 1702(c)(3))............................   150
                b. Treatment of salvage and subrogation of 
                    property and casualty insurance companies 
                    (sec. 1702(c)(4))............................   150
                c. Information with respect to certain foreign-
                    owned or foreign corporations: Suspension of 
                    statute of limitations during certain 
                    judicial proceedings (sec. 1702(c)(5)).......   151
                d. Rate of interest for large corporate 
                    underpayments (secs. 1702(c)(6) and (7)).....   152
             3. Research credit provision: Effective date for 
                repeal of special proration rule (sec. 
                1702(d)(1))......................................   153
             4. Energy tax provision: Alternative minimum tax 
                adjustment based on energy preferences (secs. 
                1702(e)(1) and (4))..............................   153
             5. Estate tax freezes (sec. 1702(f))................   155
             6. Miscellaneous provisions.........................   158
                a. Conforming amendments to the repeal of the 
                    General Utilities doctrine (secs. 1702(g) (1) 
                    and (2)).....................................   158
                b. Prohibited transaction rules (sec. 1702(g)(3))   159
                c. Effective date of LIFO adjustment for purposes 
                    of computing adjusted current earnings (sec. 
                    1702(g)(4))..................................   160
                d. Low-income housing tax credit (sec. 
                    1702(g)(5))..................................   160
             7. Expired or obsolete provisions (``deadwood 
                provisions'') (sec. 1702(h) (1)-(18))............   161
        B. Technical Corrections to the Revenue Reconciliation 
            Act of 1993..........................................   161
             1. Treatment of full-time students under the low-
                income housing credit (sec. 1703(b)(1))..........   161
             2. Indexation of threshold applicable to excise tax 
                on luxury automobiles (sec. 1703(c)).............   162
             3. Indexation of the limitation based on modified 
                adjusted gross income for income from United 
                States savings bonds used to pay higher education 
                tuition and fees (sec. 1703(d))..................   162
             4. Reporting and notification requirements for 
                lobbying and political expenditures of tax-exempt 
                organizations (sec. 1703(g)).....................   162
             5. Estimated tax rules for certain tax-exempt 
                organizations (sec. 1703(h)).....................   163
             6. Current taxation of certain earnings of 
                controlled foreign corporations--application of 
                foreign tax credit limitations (sec. 1703(i)(1)).   164
             7. Current taxation of certain earnings of 
                controlled foreign corporations--measurement of 
                accumulated earnings (sec. 1703(i)(2))...........   165
             8. Current taxation of certain earnings of 
                controlled foreign corporations--aggregation and 
                look-through rules (sec. 1703(i)(3)).............   165
             9. Treatment of certain leased assets for PFIC 
                purposes (sec. 1703(i)(5)).......................   166
            10. Expiration date of special ethanol blender refund 
                (sec. 1703(k))...................................   167
            11. Amortization of goodwill and certain other 
                intangibles (sec. 1703(l)).......................   167
            12. Empowerment zones and eligibility of small farms 
                for tax incentives (sec. 1703(m))................   168
        C. Other Tax Technical Corrections.......................   168
             1. Hedge bonds (sec. 1704(b)).......................   168
             2. Withholding on distributions from U.S. real 
                property holding companies (sec. 1704(c))........   169
             3. Treatment of credits attributable to working 
                interests in oil and gas properties (sec. 
                1704(d)).........................................   171
             4. Clarification of passive loss disposition rule 
                (sec. 1704(e))...................................   171
             5. Estate tax unified credit allowed nonresident 
                aliens under twenty (sec. 1704(f)(1))............   172
             6. Limitation on deduction for certain interest paid 
                by corporation to related persons (sec. 
                1704(f)(2)(A))...................................   173
             7. Interaction between passive activity loss rules 
                and earnings stripping rules (sec. 1704(f)(2)(B) 
                and (C)).........................................   175
             8. Branch-level interest tax (sec. 1704(f)(3))......   176
             9. Determination of source in case of sales of 
                inventory property (sec. 1704(f)(4)).............   177
            10. Repeal of obsolete provisions (sec. 1704(f)(5))..   179
            11. Clarification of a certain stadium bond 
                transition rule in Tax Reform Act of 1986 (sec. 
                1704(g)).........................................   179
            12. Health care continuation rules (sec. 1704(h))....   180
            13. Taxation of excess inclusions of a residual 
                interest in a REMIC for taxpayers subject to 
                alternative minimum tax with net operating losses 
                (sec. 1704(i))...................................   180
            14. Application of harbor maintenance tax to Alaska 
                and Hawaii ship passengers (sec. 1704(j))........   181
            15. Modify effective date provision relating to the 
                Energy Policy Act of 1992 (sec. 1704(k)).........   182
            16. Treat qualified football coaches plan as 
                multiemployer pension plan for purposes of the 
                Internal Revenue Code (sec. 1704(l)).............   182
            17. Determination of unrecovered investment in 
                annuity contract (sec. 1704(m))..................   183
            18. Election by parent to claim unearned income of 
                certain children on parent's return (sec. 
                1704(n)).........................................   184
            19. Treatment of certain veterans' reemployment 
                rights (sec. 1704(o))............................   184
            20. Reporting of real estate transactions (sec. 
                1704(p)).........................................   186
            21. Clarification of denial of deduction for stock 
                redemption expenses (sec. 1704(q))...............   187
            22. Definition of passive income in determining 
                passive foreign investment company status (sec. 
                1704(s)).........................................   188
            23. Exclusion from income for combat zone 
                compensation (sec. 1704(t)(4))...................   188
III. Budget Effects of the Bill.....................................189
        A. Committee Estimates...................................   189
        B. Budget Authority and Tax Expenditures.................   196
        C. Consultation with Congressional Budget Office.........   196
 IV. Votes of the Committee.........................................199
  V. Regulatory Impact and Other Matters............................199
        A. Regulatory Impact.....................................   199
        B. Information Relating to Unfunded Mandates.............   200
 VI. Changes in Existing Law Made by the Bill, as Reported..........202

                       I. LEGISLATIVE BACKGROUND

    H.R. 3448 (``Small Business Job Protection Act of 1996'') 
was passed by the House of Representatives on May 22, 1996. On 
May 23, the House combined H.R. 3448 (revenue provisions as 
Title I) with the minimum wage and other provisions (as Title 
II) from H.R. 1227 as passed by the House on May 23.
    H.R. 3448 was referred to the Senate Committee on Finance 
on June 6, 1996. On June 12, 1996, the Senate Committee on 
Finance marked up a committee amendment as a substitute for the 
revenue provisions of H.R. 3448 (Title I) as passed by the 
House. The Committee on Finance approved the committee 
amendment by unanimous voice vote. The Committee on Finance did 
not consider Title II of the bill. References to ``the bill'' 
in the ``Explanation of the Bill'' (Part II of this report) are 
to the Title I revenue provisions.
    Most of the provisions in the committee amendment to Title 
I of H.R. 3448 were previously approved in the Balanced Budget 
Act of 1995 (H.R. 2491) as passed by the Senate or in the 
conference agreement to H.R. 2491, which was vetoed by the 
President.

                 II. EXPLANATION OF THE BILL (TITLE I)

                Small Business and Other Tax Provisions

                      A. Small Business Provisions

1. Increase in expensing for small businesses (sec. 1111 of the bill 
        and sec. 179 of the Code)

                              Present law

    In lieu of depreciation, a taxpayer with a sufficiently 
small amount of annual investment may elect to deduct up to 
$17,500 of the cost of qualifying property placed in service 
for the taxable year (sec. 179).1 In general, qualifying 
property is defined as depreciable tangible personal property 
that is purchased for use in the active conduct of a trade or 
business. The $17,500 amount is reduced (but not below zero) by 
the amount by which the cost of qualifying property placed in 
service during the taxable year exceeds $200,000. In addition, 
the amount eligible to be expensed for a taxable year may not 
exceed the taxable income of the taxpayer for the year that is 
derived from the active conduct of a trade or business 
(determined without regard to this provision). Any amount that 
is not allowed as a deduction because of the taxable income 
limitation may be carried forward to succeeding taxable years 
(subject to similar limitations).
---------------------------------------------------------------------------
    \1\ The amount permitted to be expensed under Code section 179 is 
increased by up to an additional $20,000 for certain property placed in 
service by a business located in an empowerment zone (sec. 1397A).
---------------------------------------------------------------------------

                           Reasons for change

    The Committee believes that section 179 expensing provides 
two important benefits for small businesses. First, it lowers 
the cost of capital for tangible property used in a trade or 
business. Second, it eliminates depreciation recordkeeping 
requirements with respect to expensed property. In order to 
increase the value of these benefits, the Committee would, 
after a phase-in period, increase the amount allowed to be 
expensed under section 179 to $25,000.
    The Committee also believes that horses should qualify as 
section 179 property. The Committee believes that horses are 
similar to other tangible personal property for which expensing 
is allowed and that any potential tax shelter abuses inherent 
in allowing the cost of a horse to be expensed are better 
addressed by the phase-out and taxable income limitations of 
section 179, the hobby loss rules of section 183, and the 
passive loss rules of section 469. Thus, the Committee bill 
does not adopt a technical correction that would deny section 
179 expensing for horses.

                        Explanation of provision

    The provision increases the $17,500 amount of qualified 
property allowed to be expensed under Code section 179 to 
$25,000. The increase is phased in as follows:

        Taxable year beginning in--                    Maximum expensing
1997..........................................................   $18,000
1998..........................................................    18,500
1999..........................................................    19,000
2000..........................................................    20,000
2001..........................................................    24,000
2002..........................................................    24,000
2003 and thereafter...........................................    25,000

    The bill clarifies the present-law provision that horses 
are qualified property for purposes of section 179.

                             Effective date

    The provision increasing the amount allowed to be expensed 
under section 179 is effective for property placed in service 
in taxable years beginning after December 31, 1996, subject to 
the phase-in schedule set forth above.

2. Tax credit for Social Security taxes paid with respect to employee 
        cash tips (sec. 1112 of the bill and sec. 45B of the Code)

                              Present law

    Employee tip income is treated as employer-provided wages 
for purposes of the Federal Insurance Contributions Act 
(``FICA''). Employees are required to report to the employer 
the amount of tips received. The Omnibus Budget Reconciliation 
Act of 1993 (``OBRA 1993'') provided a business tax credit with 
respect to certain employer FICA taxes paid with respect to 
tips treated as paid by the employer. The credit applies to 
tips received from customers in connection with the provision 
of food or beverages for consumption on the premises of an 
establishment with respect to which the tipping of employees is 
customary. OBRA 1993 provided that the FICA tip credit is 
effective for taxes paid after December 31, 1993. Temporary 
Treasury regulations provide that the tax credit is available 
only with respect to tips reported by the employee. The 
temporary regulations also provide that the credit is effective 
for FICA taxes paid by an employer after December 31, 1993, 
with respect to tips received for services performed after 
December 31, 1993.

                           Reasons for change

    The Committee believes it appropriate to clarify the 
effective date and scope of the credit for FICA taxes paid on 
employer cash tips. Despite the statutory language, there has 
been some confusion regarding the effective date. The FICA tip 
credit was included in the Senate version of H.R. 4210, the Tax 
Fairness and Economic Growth Act of 1992, and was included in 
the conference agreement of H.R. 4210 as passed by the 102d 
Congress and vetoed by President Bush. The effective date of 
that provision would have applied to ``tips received and wages 
paid after the date of enactment.'' The FICA tip credit was 
also included in the House and Senate versions of H.R. 11, the 
Revenue Act of 1992, as considered by the 102d Congress. The 
effective date of both those provisions was the same as in H.R. 
4210, specifically tips received and wages paid after the date 
of enactment. The provision was included in the conference 
agreement of H.R. 11, as adopted by the Congress and vetoed by 
President Bush; however, the effective date of that provision 
was modified to apply to ``taxes paid after'' December 31, 
1992, i.e., no limitation with respect to tips earned after 
December 31, 1992, was included.
    In 1993, the House and Senate versions of the Omnibus 
Budget Reconciliation Act of 1993 (``OBRA 1993'') did not 
contain the FICA tip provision, but it was included in the 
conference agreement. The FICA tip provision as included in 
OBRA 1993 has the same effective date as the provision in the 
conference agreement for H.R. 11, except that the date was 
moved one year, to taxes paid after December 31, 1993. The 
Committee believes that the legislative history of this 
provision indicates intent to change the effective date, and 
that the Treasury's interpretation of that date is not 
consistent with the provision as finally adopted.
    The Committee also believes it appropriate to apply the 
credit to all persons who provide food and beverages, whether 
for consumption on or off the premises.

                        Explanation of provision

    The provision clarifies the credit with respect to employer 
FICA taxes paid on tips by providing that the credit is (1) 
available whether or not the employee reported the tips on 
which the employer FICA taxes were paid pursuant to section 
6053(a), and (2) effective with respect to taxes paid after 
December 31, 1993, regardless of when the services with respect 
to which the tips are received were performed.
    The provision also modifies the credit so that it applies 
with respect to tips received from customers in connection with 
the delivery or serving of food or beverages, regardless of 
whether the food or beverages are for consumption on the 
premises of the establishment.

                             Effective date

    The clarifications relating to the effective date and 
nonreported tips are effective as if included in OBRA 1993. The 
provision expanding the tip credit to the provision of food or 
beverages not for consumption on the premises of the 
establishment is effective with respect to FICA taxes paid on 
tips received with respect to services performed after December 
31, 1996.

3. Treatment of dues paid to agricultural or horticultural 
        organizations (sec. 1113 of the bill and sec. 512 of the Code)

                              Present law

    Tax-exempt organizations generally are subject to the 
unrelated business income tax (``UBIT'') on income derived from 
a trade or business regularly carried on that is not 
substantially related to the performance of the organization's 
tax-exempt functions (secs. 511-514). Dues payments made to a 
membership organization generally are not subject to the UBIT. 
However, several courts have held that, with respect to postal 
labor organizations, dues payments were subject to the UBIT 
when received from individuals who were not postal workers, but 
who became ``associate'' members for the purpose of obtaining 
health insurance available to members of the organization. See 
National League of Postmasters of the United States v. 
Commissioner, No. 8032-93, T.C. Memo (May 11, 1995); American 
Postal Workers Union, AFL-CIO v. United States, 925 F.2d 480 
(D.C. Cir. 1991); National Association of Postal Supervisors v. 
United States, 944 F.2d 859 (Fed. Cir. 1991).
    In Rev. Proc. 95-21 (issued March 23, 1995), the IRS set 
forth its position regarding when associate member dues 
payments received by an organization described in section 
501(c)(5) will be treated as subject to the UBIT. The IRS 
stated that dues payments from associate members will not be 
treated as subject to UBIT unless, for the relevant period, 
``the associate member category has been formed or availed of 
for the principal purpose of producing unrelated business 
income.'' Thus, under Rev. Proc. 95-21, the focus of the 
inquiry is upon the organization's purposes in forming the 
associate member category (and whether the purposes of that 
category of membership are substantially related to the 
organization's exempt purposes other than through the 
production of income) rather than upon the motive of the 
individuals who join as associate members.

                           Reasons for change

    In order to reduce uncertainty and legal disputes involving 
the UBIT treatment of certain associate member dues, the 
Committee believes that it is appropriate to provide a special 
rule exempting from the UBIT annual dues not exceeding $100 
paid to a tax-exempt agricultural or horticultural 
organization.

                        Explanation of provision

    Under the provision, if an agricultural or horticultural 
organization described in section 501(c)(5) requires annual 
dues not exceeding $100 to be paid in order to be a member of 
such organization, then in no event will any portion of such 
dues be subject to the UBIT by reason of any benefits or 
privileges to which members of such organization are entitled. 
For taxable years beginning after 1995, the $100 amount will be 
indexed for inflation. The term ``dues'' is defined as ``any 
payment (whether or not designated as dues) which is required 
to be made in order to be recognized by the organization as a 
member of the organization.'' Thus, if a person is recognized 
as a member of an organization by virtue of having paid annual 
dues for his or her membership, then any subsequent payments 
made by that person during the year to purchase another 
membership in the same organization will not be within the 
scope of the provision.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1994. 2
---------------------------------------------------------------------------
     2 The Committee intends that, with respect to dues payments 
received prior to the effective date of the provision, general UBIT 
rules under prior law will be applied in a manner consistent with the 
provision.
---------------------------------------------------------------------------

4. Clarify employment tax status of certain fishermen (sec. 1114 of the 
        bill and sec. 3121(b)(20) of the Code)

                              Present law

    Under present law, service as a crew member on a fishing 
vessel is generally excluded from the definition of employment 
for purposes of income tax withholding on wages and for 
purposes of the Federal Insurance Contributions Act (``FICA'') 
and the Federal Unemployment Tax Act (``FUTA'') taxes if the 
operating crew of the boat normally consists of fewer than 10 
individuals, the individual receives a share of the catch based 
on the total catch, and the individual does not receive cash 
remuneration other than proceeds from the sale of the 
individual's share of the catch. If a crew member receives any 
other cash, e.g., payment for services as an engineer, the 
exemption from FICA and FUTA taxes does not apply. Crew members 
to which the exemption applies are subject to self-employment 
taxes. Special reporting requirements apply to the operators of 
boats on which exempt crew members serve.

                           Reasons for change

    The Committee believes that providing a statutory 
definition for determining whether the crew of a fishing boat 
normally consists of fewer than 10 individuals would make the 
provision easier to apply and administer. Providing that the 
exemption continues to apply even if an individual receives, in 
addition to a share of the catch, a small amount of cash for 
certain duties performed would recognize long-standing industry 
practice.

                        Explanation of provision

    The operating crew of a boat is treated as normally made up 
of fewer than 10 individuals if the average size of the 
operating crew on trips made during the preceding 4 calendar 
quarters consisted of fewer than 10 individuals. In addition, 
the exemption still applies even if the crew member receives 
certain cash payments. The cash payments cannot exceed $100 per 
trip, must be contingent on a minimum catch, and must be paid 
solely for additional duties (e.g., as mate, engineer, or cook) 
for which additional cash remuneration is customary.

                             Effective date

    The provision applies to remuneration paid after December 
31, 1994. It is intended that, with respect to years before the 
effective date, the Secretary apply the exemption in a manner 
consistent with the proposal.

5. Modify rules governing issuance of tax-exempt bonds for first-time 
        farmers (sec. 1115 of the bill and sec. 147 of the Code)

                               Present law

    Interest on bonds issued by States and local governments to 
finance governmental activities carried out and paid for by 
those entities is exempt from the regular corporate and 
individual income taxes. Interest on bonds issued by the 
governments to provide financing to private persons is taxable 
unless an exception is provided in the Internal Revenue Code. 
One such exception allows States and local governments to issue 
bonds to finance loans to first-time farmers for the 
acquisition of farm land (and limited amounts of related 
depreciable farm property) if the purchasers will be the 
principal user of the property and will materially participate 
in the farming operation in which the property is to be used.
    The amount of financing provided under this exception may 
not exceed $1 million per farmer (and related parties). The $1 
million limit is increased to $10 million if all capital 
expenditures by the purchaser in the same county (or 
incorporated municipality) within a prescribed six-year period 
are aggregated. Aggregate depreciable farm property financing 
for any purchaser may not exceed $250,000, of which no more 
than $62,500 may be for used property.
    A first-time farmer is defined as an individual who has at 
no time owned farm land in excess of 15 percent of the median 
size of a farm in the county in which such land is located, and 
the fair market value of the land has not at any time when held 
by the individual exceeded $125,000.
    Under the general rules governing issuance of tax-exempt 
bonds, bonds for private persons generally may only be issued 
for acquisition or construction of property (i.e., may not be 
issued for working capital costs). Use of bond proceeds to 
finance purchases from related parties is precluded as a 
working capital financing.

                           Reasons for change

    The Committee determined that minor modifications to the 
rules governing tax-exempt financing for first-time farmers are 
appropriate to enable easier utilization of this exception 
allowing private activity tax-exempt financing by persons 
desiring to enter that occupation, including entry by younger 
generations purchasing family farming operations.

                        Explanation of provision

    The bill makes two modifications to the rules governing 
issuance of tax-exempt bonds for first-time farmers. First, the 
amount of farm land that an individual may own and still be 
considered a first-time farmer is doubled, from 15 percent of 
the median farm size in the county where the land is located to 
30 percent of the median farm size.
    Second, proceeds of these tax-exempt bonds are permitted to 
be used to finance farm purchases by individuals from related 
parties (e.g., a parent or grandparent), provided that the 
price paid reflects the fair market value of the property and 
that the seller has no financial interest in the farming 
operation conducted on the land after the bond-financed sale 
occurs.

                             Effective date

    The provision is effective for financing provided with 
bonds issued after the date of enactment.

6. Clarify treatment of newspaper distributors and carriers as direct 
        sellers (sec. 1116 of the bill and sec. 3508 of the Code)

                              Present law

    For Federal tax purposes, there are two classifications of 
workers: a worker is either an employee of the service 
recipient or an independent contractor. Significant tax 
consequences result from the classification of a worker as an 
employee or independent contractor. These differences relate to 
withholding and employment tax requirements, as well as the 
ability to exclude certain types of compensation from income or 
take tax deductions for certain expenses. Some of these 
consequences favor employee status, while others favor 
independent contractor status. For example, an employee may 
exclude from gross income employer-provided benefits such as 
pension, health, and group-term life insurance benefits. On the 
other hand, an independent contractor can establish his or her 
own pension plan and deduct contributions to the plan. An 
independent contractor also has greater ability to deduct work-
related expenses.
    Under present law, the determination of whether a worker is 
an employee or an independent contractor is generally made 
under a common-law facts and circumstances test that seeks to 
determine whether the service provider is subject to the 
control of the service recipient, not only as to the nature of 
the work performed, but the circumstances under which it is 
performed. Under a special safe harbor rule (sec. 530 of the 
Revenue Act of 1978), a service recipient may treat a worker as 
an independent contractor for employment tax purposes even 
though the worker is an employee under the common-law test if 
the service recipient has a reasonable basis for treating the 
worker as an independent contractor and certain other 
requirements are met.
    In addition to the common-law test, there are also some 
persons who are treated by statute as either employees or 
independent contractors. For example, ``direct sellers'' are 
deemed to be independent contractors. A direct seller is a 
person engaged in the trade or business of selling consumer 
products in the home or otherwise than in a permanent retail 
establishment, if substantially all the remuneration for the 
performance of the services is directly related to sales or 
other output rather than to the number of hours worked, and the 
services performed by the person are performed pursuant to a 
written contract between such person and the service recipient 
and such contract provides that the person will not be treated 
as an employee for Federal tax purposes.
    The newspaper industry has generally taken the position 
that newspaper distributors and carriers should be treated as 
direct sellers for income and employment tax purposes. The 
Internal Revenue Service has generally taken the position that 
the direct seller rules do not apply to newspaper distributors 
and carriers operating under an agency distribution system 
(i.e., where the publisher retains title to the newspapers).

                           Reasons for change

    The Committee recognizes that there are presently numerous 
disputes between newspaper distributors and carriers and the 
Internal Revenue Service regarding the treatment of newspaper 
distributors and carriers as direct sellers. The Committee 
believes that in the vast majority of these cases the newspaper 
distributors and carriers should properly be treated as direct 
sellers. Consequently, in order to avoid further disputes, the 
Committee wishes to clarify the treatment of qualifying 
newspaper distributors and carriers as direct sellers.

                        Explanation of provision

    The bill clarifies the treatment of qualifying newspaper 
distributors and carriers as direct sellers. Under the bill, a 
person engaged in the trade or business of the delivery or 
distribution of newspapers or shopping news (including any 
services that are directly related to such trade or business 
such as solicitation of customers or collection of receipts) 
qualifies as a direct seller, provided substantially all the 
remuneration for the performance of the services is directly 
related to sales or other output rather than to the number of 
hours worked, and the services performed by the person are 
performed pursuant to a written contract between such person 
and the service recipient and such contract provides that the 
person will not be treated as an employee for Federal tax 
purposes. The bill is intended to apply to newspaper 
distributors and carriers whether or not they hire others to 
assist in the delivery of newspapers. The bill also applies to 
newspaper distributors and carriers operating under either a 
buy-sell distribution system (i.e., where the newspaper 
distributors or carriers purchase the newspapers from the 
publisher) or an agency distribution system. For example, 
newspaper distributors and carriers operating under an agency 
distribution system who are paid based on the number of papers 
delivered and have an appropriate written agreement qualify as 
direct sellers. The status of newspaper distributors and 
carriers who do not qualify as direct sellers under the bill 
continue to be determined under present-law rules. No inference 
is intended with respect to the employment status of newspaper 
distributors and carriers prior to the effective date of the 
bill. Further, the provision is intended to clarify the worker 
classification issue for income and employment taxes only. The 
Committee does not intend the provision to have any impact 
whatsoever on the interpretation or applicability of Federal, 
State, or local labor laws.

                             Effective date

    The provision is effective with respect to services 
performed after December 31, 1995.

7. Application of involuntary conversion rules to property damaged as a 
        result of Presidentially declared disasters (sec. 1117 of the 
        bill and sec. 1033(h) of the Code)

                              Present law

    A taxpayer may elect not to recognize gain with respect to 
property that is involuntarily converted if the taxpayer 
acquires within an applicable period property similar or 
related in service or use. If the taxpayer does not replace the 
converted property with property similar or related in service 
or use, then gain generally is recognized.

                           Reasons for change

    The property damage in a Presidentially declared disaster 
may be so great that businesses are forced to suspend 
operations for a substantial time. During that hiatus, valuable 
markets and customers may be lost. If this suspension causes 
the business to fail, and the owners of the business wish to 
reinvest their capital in a new business venture, the 
involuntary conversion rules will force them to recognize gain 
when they buy replacement property that is needed for the new 
business but not similar to that used in the failed business. 
This provision will offer relief to such businesses by allowing 
them to reinvest their funds in any tangible business property 
without being forced to recognize gain. No such deferral of 
gain is available, however, if the taxpayer decides not to 
reinvest in tangible business property.

                        Explanation of provision

    Any tangible property acquired and held for productive use 
in a business is treated as similar or related in service or 
use to property that (1) was held for investment or for 
productive use in a business and (2) was involuntarily 
converted as a result of a Presidentially declared disaster.

                             Effective date

    The provision is effective for disasters for which a 
Presidential declaration is made after December 31, 1994, in 
taxable years ending after that date.

8. Establish 15-year recovery period for retail motor fuels outlet 
        stores (sec. 1118 of the bill and sec. 168 of the Code)

                              Present law

    Under present law, property used in the retail gasoline 
trade is depreciated under section 168 using a 15-year recovery 
period and the 150-percent declining balance method. 
Nonresidential real property (such as a grocery store) is 
depreciated using a 39-year recovery period and the straight-
line method. It is understood that taxpayers generally have 
taken the position that convenience stores and other buildings 
installed at retail motor fuels outlets have a 15-year recovery 
period. The Internal Revenue Service (``IRS''), in a position 
described in a recent Coordinated Issues Paper, generally 
limits the application of the 15-year recovery period to 
instances where the structure: (1) is 1,400 square feet or less 
or (2) meets a 50-percent test. The 50-percent test is met if: 
(1) 50 percent or more of the gross revenues that are generated 
from the building are derived from petroleum sales, and (2) 50 
percent or more of the floor space in the building is devoted 
to petroleum marketing sales.

                          Reasons for changes

    The Committee believes that the position taken by the IRS 
with respect to certain structures installed at motor fuel 
retail outlets is contrary to the historical treatment of such 
property. The Committee seeks to clarify (and restore) the 
treatment of such property.

                        Explanation of provision

    The provision provides that 15-year property includes any 
section 1250 property (generally, depreciable real property) 
that is a retail motor fuels outlet (whether or not food or 
other convenience items are sold at the outlet). A retail motor 
fuels outlet does not include any facility related to petroleum 
or natural gas trunk pipelines or to any section 1250 property 
used only to an insubstantial extent in the retail marketing of 
petroleum or petroleum products. In addition, the provision 
provides a 20-year class life for retail motor fuels outlets 
for purposes of the alternative depreciation system of section 
168(g).
    The Committee wishes to clarify what types of property 
qualify as a retail motor fuels outlet. Section 1250 property 
will so qualify if it meets a 50-percent test. The 50-percent 
test is met if: (1) 50 percent or more of the gross revenues 
that are generated from the property are derived from petroleum 
sales, or (2) 50 percent or more of the floor space in the 
property is devoted to petroleum marketing sales. The Committee 
intends that the determination of whether either prong of this 
test is met will be made pursuant to the recent Coordinated 
Issue Paper. Property not meeting the test will not qualify as 
a retail motor fuels outlet. For property placed in service in 
taxable years that end after the date of enactment, the 
determination of whether the property meets the 50-percent test 
generally will be made in the year the property is placed in 
service. However, the test may be applied in the subsequent 
taxable year if the property is placed in service near the end 
of the taxable year and the use of the property during such 
short period is not representative of the subsequent use of the 
property. The Committee intends that, with respect to property 
placed in service in taxable years that ended before the date 
of enactment of the provision, the determination of whether the 
property meets the 50-percent test generally will be made in a 
manner consistent with the manner in which the 50-percent test 
of the Coordinated Issues Paper is applied (but by using the 
disjunctive test intended by the Committee rather than the 
conjunctive test of the Paper). The Committee also intends that 
if property initially meets (or fails to meet) the disjunctive 
50-percent test but subsequently fails to meet (or meets) such 
test for more than a temporary period, such failure (or 
qualification) may be treated as a change in the use of 
property to which section 168(i)(5) applies.
    In addition, property the size of which is 1,400 square 
feet or less also will qualify if such property would have 
qualified under the current Coordinated Issues Paper.

                             Effective date

    The provision is effective for property placed in service 
on or after the date of enactment. The taxpayer may elect to 
apply the provision for any property to which the amendments 
made by section 201 of the Tax Reform Act of 1986 apply (i.e., 
property subject to the modified Accelerated Cost Recovery 
System of sec. 168) and which was placed in service prior to 
the date of enactment. This election shall be made in a manner 
prescribed by the Secretary of the Treasury. The Secretary of 
the Treasury may treat such election as a change in the 
taxpayer's method of accounting for such property and may 
provide rules similar to those provided in Rev. Proc. 96-31, 
1996-20 I.R.B. 11, May 13, 1996.

9. Treatment of leasehold improvements (sec. 1119 of the bill and sec. 
        168 of the Code)

                              Present law

                 Depreciation of leasehold improvements

    Depreciation allowances for property used in a trade or 
business generally is determined under the modified Accelerated 
Cost Recovery System (``MACRS'') of section 168. Depreciation 
allowances for improvements made on leased property are 
determined under MACRS, even if the MACRS recovery period 
assigned to the property is longer than the term of the lease 
(sec. 168(i)(8)).3 This rule applies regardless whether 
the lessor or lessee places the leasehold improvements in 
service.4 If a leasehold improvement constitutes an 
addition or improvement to nonresidential real property already 
placed in service, the improvement is depreciated using the 
straight-line method over a 39-year recovery period, beginning 
in the month the addition or improvement was placed in service 
(secs. 168 (b)(3), (c)(1), (d)(2), and (i)(6)).5
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    \3\ Prior to the adoption of the Accelerated Cost Recovery System 
(``ACRS'') by the Economic Recovery Act of 1981, taxpayers were allowed 
to depreciate the various components of a building as separate assets 
with separate useful lives. The use of component depreciation was 
repealed upon the adoption of ACRS. The denial of component 
depreciation also applies under MACRS, as provided by the Tax Reform 
Act of 1986.
    \4\ Former Code sections 168(f)(6) and 178 provided that in certain 
circumstances, a lessee could recover the cost of leasehold 
improvements made over the remaining term of the lease. These 
provisions were repealed by the Tax Reform Act of 1986.
    \5\ If the improvement is characterized as tangible personal 
property, ACRS depreciation is calculated using the shorter recovery 
periods and accelerated methods applicable to such property. The 
determination of whether certain improvements are characterized as 
tangible personal property or as nonresidential real property often 
depends on whether or not the improvements constitute a ``structural 
component'' of a building (as defined by Treas. Reg. sec. 1.48-
1(e)(1)). See, for example, Metro National Corp., 52 TCM 1440 (1987); 
King Radio Corp., 486 F.2d 1091 (10th Cir., 1973); Mallinckrodt, Inc., 
778 F.2d 402 (8th Cir., 1985) (with respect various leasehold 
improvements).
---------------------------------------------------------------------------

          Treatment of dispositions of leasehold improvements

    A taxpayer generally recovers the adjusted basis of 
property for purposes of determining gain or loss upon the 
disposition of the property. Upon the termination of a lease, 
the adjusted basis of leasehold improvements that were made, 
but are not retained, by a lessee are taken into account to 
compute gain or loss by the lessee.6 The proper treatment 
of the adjusted basis of improvements made by a lessor upon 
termination of a lease is less clear. Proposed Treasury 
regulation section 1.168-2(e)(1) provides that the unadjusted 
basis of a building's structural components must be recovered 
as a whole. In addition, proposed Treasury regulation sections 
1.168-2(l)(1) and 1.168-6(b) provide that ``disposition'' does 
not include the retirement of a structural component of real 
property if there is no disposition of the underlying 
building.7 Thus, it appears that it is the position of the 
Internal Revenue Service that leasehold improvements made by a 
lessor that constitute structural components of a building must 
be continued to be depreciated in the same manner as the 
underlying real property, even if such improvements are retired 
at the end of the lease term.8 Some lessors, on the other 
hand, may be taking the position that a leasehold improvement 
is a property separate and distinct from the underlying 
building and that an abandonment loss under section 165 is 
allowable at the end of the lease term for the adjusted basis 
of the property. In addition, lessors may argue that even if a 
leasehold improvement constitutes a structural component of a 
building, proposed Treasury regulation section 1.168-2(l)(1) 
(that seemingly denies the deduction at the end of the lease 
term) applies only to retirements, but not abandonments or 
demolitions, of such property.9 Thus, it appears that some 
lessors take the position that, at least in certain 
circumstances, the adjusted basis of leasehold improvements may 
be recovered at the end of the term of the lease to which the 
improvements relate even if there is no disposition of the 
underlying building.
---------------------------------------------------------------------------
    \6\ See, Report of the Committee on Ways and Means on H.R. 3838 (H. 
Rept. 99-426), p. 158, and Senate Finance Committee Report on H.R. 3838 
(S. Rept. 99-313), p. 105 (Tax Reform Act of 1986, 99th Cong.).
    \7\ For example, if a taxpayer places a new roof on building 
subject to ACRS, the taxpayer must continue to depreciate the allocable 
cost of the old roof as part of the cost of the underlying building. 
(Prop. Treas. reg. sec. 1.168-6(b)(1)) See, also, Joint Committee on 
Taxation, General Explanation of the Economic Recovery Tax Act of 1981 
(97th Cong.), p. 86.
    \8\ See, IRS General Information Letter, dated Sept. 17, 1992.
    \9\ Compare the second and fourth sentences of proposed Treasury 
regulation section 1.168-2(l)(1).
---------------------------------------------------------------------------

                           Reasons for change

    The Committee believes that costs that relate to the 
leasing of property should not be recovered beyond the term of 
the lease to the extent the costs do not provide a future 
benefit beyond such term. The Committee also believes that the 
proper present-law treatment of leasehold improvements disposed 
of at the end of the term of a lease is unclear. Thus, the 
Committee provides that the unrecovered costs of leasehold 
improvements that were placed in service by a lessor with 
respect to a lease and are irrevocably disposed of at the end 
of the lease term should be taken into account at that time.

                        Explanation of provision

    Under the provision, a lessor of leased property that 
disposes of a leasehold improvement which was made by the 
lessor for the lessee of the property may take the adjusted 
basis of the improvement into account for purposes of 
determining gain or loss if the improvement is irrevocably 
disposed of or abandoned by the lessor at the termination of 
the lease. The provision thus conforms the treatment of lessors 
and lessees with respect to leasehold improvements disposed of 
at the end of a term of lease.
    For purposes of applying the provision, it is expected that 
a lessor must be able to separately account for the adjusted 
basis of the leasehold improvement that is irrevocably disposed 
of or abandoned. In addition, the Secretary of the Treasury may 
provide guidance, as necessary, regarding the determination of 
when a leasehold improvement is made for a lessee and when such 
property is irrevocably abandoned or disposed of.

                             Effective date

    The provision is effective for leasehold improvements 
disposed of after June 12, 1996. No inference is intended as to 
the proper treatment of such dispositions before June 13, 1996.

10. Increase deductibility of business meal expenses for certain 
        seafood processing facilities (sec. 1120 of the bill and sec. 
        274 of the Code)

                              Present law

    In general, 50 percent of meal and entertainment expenses 
incurred in connection with a trade or business that are 
ordinary and necessary (and not lavish or extravagant) are 
deductible (sec. 274). Food or beverage expenses are fully 
deductible provided that they are (1) required by Federal law 
to be provided to crew members of a commercial vessel, (2) 
provided to crew members of similar commercial vessels not 
operated on the oceans, or (3) provided on certain oil or gas 
platforms or drilling rigs.

                           Reasons for change

    The Committee believes that it is appropriate to treat 
remote seafood processing facilities in the same way that 
remote oil or gas platforms and drilling rigs are treated for 
purposes of the deductibility of business meal expenses.

                        Explanation of provision

    The provision adds remote seafood processing facilities 
located in the United States north of 53 degrees north latitude 
to the present-law list of entities not subject to the 50 
percent limitation on the deductibility of business meals. 
Consequently, these expenses are fully deductible. A seafood 
processing facility is remote when there are insufficient 
eating facilities in the vicinity of the employer's 
premises.10
---------------------------------------------------------------------------
    \10\ See Treas. Reg. sec. 1.119-1(a)(2)(ii)(c) and 1.119-1(f) 
(Example 7).
---------------------------------------------------------------------------

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

11. Provide a lower rate of tax on certain hard ciders (sec. 1121 of 
        the bill and sec. 5041 of the Code)

                              Present law

    Under present law, distilled spirits are taxed at a rate of 
$13.50 per proof gallon; beer is taxed at a rate of $18 per 
barrel (approximately 58 cents per gallon); and still wines of 
14 percent alcohol or less are taxed at a rate of $1.07 per 
wine gallon. Higher rates of tax are provided for wines with 
greater alcohol content and for sparkling wines.
    Certain small wineries may claim a credit against the 
excise tax on wine of 90 cents per wine gallon on the first 
100,000 gallons of wine produced annually. Certain small 
breweries pay a reduced excise tax of $7.00 per barrel 
(approximately 22.6 cents per gallon) on the first 60,000 
barrels (1,860,000 gallons) of beer produced annually.
    Apple cider containing alcohol is classified and taxed as 
wine.

                           Reasons for change

    The Committee understands that as an alcoholic beverage, 
hard cider competes more as a substitute for beer than as a 
substitute for table wine. If most consumers of alcoholic 
beverages choose between hard cider and beer, rather than 
between hard cider and wine, taxing hard cider at tax rates 
imposed on other wine products may distort consumer choice and 
unfairly disadvantage producers of hard cider in the market 
place. The Committee also understands that producers of hard 
cider generally are small businesses and has concluded that it 
would improve market efficiency and fairness to tax this 
beverage at a rate equivalent to the tax imposed on the 
production of beer by small brewers.

                        Explanation of provision

    The bill adjusts the tax rate on apple cider having an 
alcohol content of no more than seven percent to 22.6 cents per 
gallon. Apple cider production will continue to be counted in 
determining whether other production of a producer qualifies 
for the tax credit for small producers. The bill does not 
change the classification of qualifying apple cider as wine.

                             Effective date

    The provision is effective for apple cider removed after 
December 31, 1996.

12. Modifications to section 530 of the Revenue Act of 1978 (sec. 1122 
        of the bill and sec. 530 of the Revenue Act of 1978)

                              Present law

                               In general

    For Federal tax purposes, there are two classifications of 
workers: a worker is either an employee of the service 
recipient or an independent contractor. Significant tax 
consequences result from the classification of a worker as an 
employee or independent contractor. These differences relate to 
withholding and employment tax requirements, as well as the 
ability to exclude certain types of compensation from income or 
to take tax deductions for certain expenses. Some of these 
consequences favor employee status, while others favor 
independent contractor status. For example, an employee may 
exclude from gross income employer-provided benefits such as 
pension, health, and group-term life insurance benefits. On the 
other hand, an independent contractor can establish his or her 
own pension plan and deduct contributions to the plan. An 
independent contractor also has greater ability to deduct work-
related expenses.
    In general, the determination of whether an employer-
employee relationship exists for Federal tax purposes is made 
under a common-law test. Treasury regulations provide that an 
employer-employee relationship generally exists if the person 
contracting for services has the right to control not only the 
result of the services, but also the means by which that result 
is accomplished. In other words, an employer-employee 
relationship generally exists if the person providing the 
services ``is subject to the will and control of the employer 
not only as to what shall be done but how it shall be done.'' 
11 Under the Treasury regulations, it is not necessary 
that the employer actually control the manner in which the 
services are performed, rather it is sufficient that the 
employer have a right to control. Whether the requisite control 
exists is determined based on all the relevant facts and 
circumstances.12 The Internal Revenue Service (``IRS'') 
recently issued a draft training guide for field agents that 
provides current IRS views regarding worker classification 
issues.13
---------------------------------------------------------------------------
    \11\ Treas. Reg. sec. 31.3401(c)-(1)(b).
    \12\ The Internal Revenue Service (``IRS'') has developed a list of 
20 factors that may be examined in determining whether an employer-
employee relationship exists Rev. Rul. 87-41, 1987-1 C.B. 296.
    \13\ Employee or Independent Contractor?, (Draft, February 28, 
1996)(hereinafter the ``IRS Draft Training Guide'')
---------------------------------------------------------------------------

Section 530

            In general
    With increased enforcement of the employment tax laws 
beginning in the late 1960s, controversies developed between 
the IRS and taxpayers as to whether businesses had correctly 
classified certain workers as self employed rather than as 
employees. In some instances when the IRS prevailed in 
reclassifying workers as employees under the common-law test, 
the employing business became liable for substantial portions 
of its employees' employment and income tax liabilities (that 
the employer had failed to withhold and pay over) and the 
employer's portion of such tax liabilities, although the 
employees might have fully paid their liabilities for self-
employment and income taxes.
    In response to this problem, the Congress enacted section 
530 of the Revenue Act of 1978 (``section 530'').14 That 
provision generally allows a taxpayer to treat a worker as not 
being an employee for employment tax purposes (but not income 
tax purposes), regardless of the individual's actual status 
under the common-law test, unless the taxpayer has no 
reasonable basis for such treatment. Section 530 was initially 
scheduled to terminate at the end of 1979 to give the Congress 
time to resolve the many complex issues regarding worker 
classification. It was extended through the end of 1980 by P.L. 
96-167 and through June 30, 1982, by P.L. 96-541. The provision 
was extended permanently by the Tax Equity and Fiscal 
Responsibility Act of 1982.15
---------------------------------------------------------------------------
    \14\ P.L. 95-600.
    \15\ P.L. 97-248.
---------------------------------------------------------------------------
    Under section 530, a reasonable basis for treating a worker 
as an independent contractor is considered to exist if the 
taxpayer reasonably relied on (1) published rulings or judicial 
precedent, (2) past IRS audit practice with respect to the 
taxpayer, (3) long-standing recognized practice of a 
significant segment of the industry of which the taxpayer is a 
member, or (4) if the taxpayer has any ``other reasonable 
basis'' for treating a worker as an independent contractor. The 
legislative history states that section 530 is to be 
``construed liberally in favor of taxpayers.'' 16
---------------------------------------------------------------------------
    \16\ H. Rept. No. 1748 (95th Cong., 2d Sess., 5 (1978)). The 
conference agreement to the Revenue Act of 1978 adopted the provisions 
of the House bill and therefore incorporates this legislative history.
---------------------------------------------------------------------------
    The relief under section 530 is available with respect to 
an individual only if certain additional requirements are 
satisfied. The taxpayer must not have treated the individual as 
an employee for any period, and for periods since 1978 all 
Federal tax returns, including information returns, must have 
been filed on a basis consistent with treating such individual 
as an independent contractor. Further, the taxpayer (or a 
predecessor) must not have treated any individual holding a 
substantially similar position as an employee for purposes of 
employment taxes for any period beginning after 1977.
    Under section 1706 of the Tax Reform Act of 1986, section 
530 does not apply in the case of an individual who, pursuant 
to an arrangement between the taxpayer and another person, 
provides services for such other person as an engineer, 
designer, drafter, computer programmer, systems analyst, or 
other similarly skilled worker engaged in a similar line of 
work. Thus, the determination of whether such individuals are 
employees or self employed is made in accordance with the 
common-law test.
    Section 530 also prohibits the issuance of Treasury 
regulations and revenue rulings on common-law employment 
status. Taxpayers may, however, obtain private letter rulings 
from the IRS regarding the status of workers as employees or 
independent contractors.
            Status of worker
    There is no explicit statement in the language of section 
530 requiring that there first be a determination that a worker 
is an employee under the common-law test before the relief 
under section 530 becomes available. It is the position of the 
IRS, based on legislative history, that section 530 can only 
apply after such a determination is made. 17 The IRS does 
not require the taxpayer to concede or agree to a determination 
that the worker is an employee. 18
---------------------------------------------------------------------------
    \17\ IRS Draft Training Guide, at 3-4.
    \18\ IRS Draft Training Guide, at 3-5 and 3-6; TAM 9443002 
(December 3, 1993).
---------------------------------------------------------------------------
    Several courts that have explicitly considered the question 
have held that section 530 relief is available irrespective of 
whether there has been an initial determination of worker 
classification under the common law. 19 Courts in the 
cases cited in the IRS Draft Training Guide in support of the 
IRS' position did determine worker status before applying 
section 530. However, it is unclear whether such determination 
was made because the court believed a threshold determination 
was required or merely as a natural consequence of the court's 
disposition of the case (i.e., the taxpayers first argued that 
the workers were not employees under the common law test, or in 
the alternative, section 530 provided relief). 20
---------------------------------------------------------------------------
    \19\ See e.g., Lambert's Nursery and Landscaping, Inc. v. U.S., 894 
F.2d 154 (5th Cir. 1990)(``It is not necessary to determine whether 
[taxpayer's] workers were independent contractors or employees for 
employment tax purposes.''); J & J Cab Service, Inc. v. U.S., 75 AFTR2d 
No. 95-618 (W.D. N.C. 1995)(``Section 530 relief may be granted 
irrespective of whether individuals were incorrectly treated as other 
than employees''); Queensgate Dental Family Practice, Inc. v. U.S., 91-
2 USTC No. 50,536 (M.D. Pa. 1991)(disagreeing with the IRS' contention 
that the court must first determine worker classification before 
applying section 530).
    \20\ See e.g., Overeen v. U.S., 91-2 USTC No. 50, 459 (W.D. Okla. 
1991); Galbraith and Green, Inc. v. U.S., 80-2 USTC No. 9,629 (Az. 
1980).
---------------------------------------------------------------------------
            Judicial or administrative precedent safe harbor
    Under section 530, reliance on judicial precedent, 
published rulings, technical advice with respect to the 
taxpayer, or a letter ruling to the taxpayer is deemed a 
reasonable basis for treating a worker as an independent 
contractor. If a taxpayer relies on this safe harbor, the IRS 
will look to see whether the facts of the judicial precedent or 
published ruling are sufficiently similar to the taxpayer's 
facts.21
---------------------------------------------------------------------------
    \21\ See e.g., TAM 9443002 (December 3, 1993); TAM 9330007 (April 
28, 1993).
---------------------------------------------------------------------------
            Prior audit safe harbor
    Under the prior-audit safe harbor, reasonable reliance is 
generally found to exist if the IRS failed to raise an 
employment tax issue on audit, even though the audit was not 
related to employment tax matters. A taxpayer can also rely on 
a prior audit in which an employment tax issue was raised, but 
was resolved in favor of the taxpayer. According to the IRS, an 
``audit'' must involve an examination of the taxpayer's books 
and records; mere inquiries from an IRS service center or a 
``compliance check'' to determine whether a taxpayer has filed 
all returns will not suffice.22 In order to rely on a 
prior audit, the IRS requires that the taxpayer must have 
treated the workers at issue as independent contractors during 
the period covered by the prior audit.23
---------------------------------------------------------------------------
    \22\ IRS Draft Training Guide, at 3-17.
    \23\ IRS Draft Training Guide, at 3-19.
---------------------------------------------------------------------------
            Industry practice safe harbor
    A taxpayer is also treated as having a reasonable basis for 
treating a worker as an independent contractor under section 
530 if the taxpayer reasonably relied on long-standing 
recognized practice of a significant segment of the industry in 
which the taxpayer is engaged. In applying this safe harbor, a 
number of issues arise including the definition of: (1) a long-
standing practice, (2) the taxpayer's industry, and (3) a 
significant segment of the industry.
     Section 530 does not specify a period of time in order for 
a practice to be long standing. The IRS Draft Training Guide 
provides that a practice is most clearly long standing if the 
industry has treated workers as independent contractors since 
1978.24 According to the IRS Draft Training Guide, the 
safe harbor is not met if the industry only recently began to 
treat workers as independent contractors. One court has held 
that seven years qualifies as long standing.25
---------------------------------------------------------------------------
    \24\ IRS Draft Training Guide, at 3-23.
    \25\ REAG, Inc. v. U.S., 801 F.Supp. 494 (W.D. Okla. 1992).
---------------------------------------------------------------------------
    The IRS Draft Training Guide recognizes that a taxpayer may 
use the industry practice safe harbor even if it began business 
after 1978.26 However, the IRS Draft Training Guide 
provides that if the industry practice changed by the time the 
taxpayer joined the industry, the taxpayer cannot rely on the 
former practice. The IRS position with respect to whether a new 
industry (i.e., one beginning after 1978) can take advantage of 
the industry practice safe harbor is unclear; the IRS Draft 
Training Guide is silent on this issue. However, given the IRS 
position with respect to new taxpayers, the IRS may take a 
similar position with respect to new industries.
---------------------------------------------------------------------------
    \26\ IRS Draft Training Guide, at 3-23.
---------------------------------------------------------------------------
    A taxpayer's industry generally consists of businesses 
competing for the same customers and providing the same or a 
similar product or service.27 Further, what constitutes 
the taxpayer's industry generally will be determined by 
reference to the geographic or metropolitan area in which the 
taxpayer conducts its business.28
---------------------------------------------------------------------------
    \27\ See Sanderson III v. U.S., 862 F.Supp. 196 (N.D. Ohio 1994) 
(court held that relevant industry was owner-operated truckers rather 
than trucking industry as a whole); IRS Draft Training Guide, at 3-22.
    \28\ See General Investment Corp. v. U.S., 823 F.2d 337 (9th Cir. 
1987) (court held the taxpayer's industry consisted of small mining 
business located in the taxpayer's county, rather than all mining 
businesses throughout the county); TAM 9443002 (December 3, 1993).
---------------------------------------------------------------------------
    Neither section 530, nor the legislative history, provides 
a clear standard as to what constitutes a significant segment 
of a taxpayer's industry. The IRS Draft Training Guide provides 
that the determination will be based on the facts and 
circumstances, including the percentage of employers and 
workers subject to the practice.29 A few courts have 
addressed this issue. In one case, the IRS argued that a 
significant segment of the industry means more than 50 percent 
of the industry.30 However, that court held that a 
significant segment is less than a majority of the firms in an 
industry. Another court held that 15 out of 84 industry 
respondents (18 percent) treating workers as independent 
contractors would constitute a significant segment of an 
industry.31
---------------------------------------------------------------------------
    \29\ IRS Draft Training Guide, at 3-24.
    \30\ In re Bentley, 73 AFTR2d No. 94-667 (Bkrtcy. E.D. Tenn. 1994).
    \31\ REAG, Inc. v. U.S., 801 F.Supp. 494 (W.D. Okla. 1992).
---------------------------------------------------------------------------
    Even if a taxpayer can establish a long-standing recognized 
practice of a significant segment of the industry, the IRS 
requires the taxpayer to show that it had knowledge of the 
practice at the time it began treating workers as independent 
contractors.32 For instance, the IRS Draft Training Guide 
states that ``[i]f the taxpayer relied on a survey, the survey 
must focus on the treatment of the workers at the time the 
taxpayer started treating its workers as independent 
contractors, not the treatment of workers at the time of the 
examination.'' 33
---------------------------------------------------------------------------
    \32\ TAM 9619001 (January 29, 1996).
    \33\ IRS Draft Training Guide, at 3-26.
---------------------------------------------------------------------------
            Other reasonable basis
    Even if a taxpayer is unable to rely on one of the three 
safe harbors described above, a taxpayer may still be entitled 
to relief under section 530 if the taxpayer has any other 
reasonable basis for treating a worker as an independent 
contractor.
    Under case law, reliance on the advice of an attorney or an 
accountant may constitute a reasonable basis for treating a 
worker as an independent contractor.34 The IRS appears to 
agree with this position, provided there is a showing that the 
attorney or accountant was knowledgeable about the law and the 
facts in rendering the advice.35
---------------------------------------------------------------------------
    \34\ See e.g., Smoky Mountain Secrets, Inc. v. U.S., 910 F.Supp. 
1316 (E.D. 1995); In re Arndt, 72 AFTR2d No. 93-5325 (Bkrtcy. M.D. Fl. 
1993).
    \35\ IRS Draft Training Guide, at 3-28; see also In re McAtee, 66 
AFTR2d No. 94-667 (Bkrtcy. N.D. Iowa 1990)(taxpayer could not rely on 
advice of accountant where it is not established accountant had 
expertise in employment tax matters).
---------------------------------------------------------------------------
    Taxpayers generally have argued successfully that reliance 
on the common-law test can constitute a reasonable basis for 
purposes of applying section 530.36 However, the IRS does 
not concur with this view.37
---------------------------------------------------------------------------
    \36\ See e.g., Critical Care Register Nursing, Inc. v. U.S., 776 
F.Supp. 1025 (E.D. Pa. 1991); American Institute of Family Relations v. 
U.S., 79-1 USTC No. 9,364 (C.D. Cal. 1979).
    \37\ IRS Draft Training Guide, at 3-29.
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            Reporting consistency
    To be entitled to relief under section 530, the taxpayer 
must not have treated the worker as an employee for any period, 
and, for periods since 1978, all Federal tax returns, including 
information returns, must have been filed on a basis consistent 
with treating such worker as an independent contractor. For 
example, withholding income and employment taxes from a 
worker's remuneration would not be consistent with treatment as 
an independent contractor, and the taxpayer must file a Form 
1099 (if required) with respect to the worker as opposed to a 
Form W-2.38 If a taxpayer does not file the required 
information return for a period it will not be entitled to 
section 530 relief for such period.39 Further, the courts 
have generally held that since 1978 (or such shorter period as 
the taxpayer has been in business), Federal tax reporting with 
respect to the worker (and all similarly situated workers) must 
have been consistent with independent contractor 
treatment.40 The filing of consistent Federal tax returns 
for the period of examination will not be sufficient.
---------------------------------------------------------------------------
    \38\ Rev. Proc. 85-18, 1985-1 C.B. 518.
    \39\ General Investment Corp. v. U.S., 823 F.2d 337 (9th Cir. 
1987); Rev. Rul. 81-224, 1981-2 C.B. 197.
    \40\ Henry v. U.S., 793 F.2d 289 (Fed.Cir. 1986); In re McAtee, 66 
AFTR2d No. 94-667 (Bkrtcy. N.D. Iowa 1990).
---------------------------------------------------------------------------
            Consistency among workers with substantially similar 
                    positions
    In order for section 530 to apply, the taxpayer (or a 
predecessor) must not have treated any worker holding a 
substantially similar position as an employee for purposes of 
employment taxes for any period beginning after 1977. Whether 
workers are similarly situated is dependent on the facts and 
circumstances. The IRS Draft Training Guide states that a 
``substantially similar position exists if the job functions, 
duties, and responsibilities are substantially similar and the 
control and supervision of those duties and responsibilities is 
substantially similar.'' 41
---------------------------------------------------------------------------
    \41\ IRS Draft Training Guide, at 3-10.
---------------------------------------------------------------------------
    There have been a few court decisions addressing this 
issue. For example, in REAG, Inc. v. U.S.,42 the court 
held that the position of appraisers who were owner-officers of 
the business was not substantially similar to appraisers who 
were not owners since the owner-officers had managerial 
responsibilities. By contrast, in Lowen Corp. v. U.S.,43 
the court found that all workers engaged in the business of 
selling real estate signs had substantially similar positions 
even though some were salaried and had to file daily reports 
while others were paid by commission and did not have to file 
such reports.
---------------------------------------------------------------------------
    \42\ 801 F.Supp. 494 (W.D. Okla. 1992). The IRS has nonacquiesced. 
IRS Draft Training Guide, at 3-13.
    \43\ 785 F.Supp. 913 (D. Kan. 1992).
---------------------------------------------------------------------------
            Burden of proof
    The IRS Draft Training Guide states that the burden of 
proof is on the taxpayer to demonstrate that it had a 
reasonable basis for treating a worker as an independent 
contractor.44 However, in light of the Congressional 
instruction in the legislative history to construe section 530 
liberally,45 courts appear to be split as to how stringent 
a burden to apply.
---------------------------------------------------------------------------
    \44\ IRS Draft Training Guide, at 3-25.
    \45\ H. Rept. No. 1748 (95th Cong., 2d Sess., 5 (1978)). The 
conference agreement to the Revenue Act of 1978 adopted the provisions 
of the House bill and therefore incorporates this legislative history.
---------------------------------------------------------------------------
    In McClellan v. U.S.,46 the court held that section 
530 requires the ``taxpayer to come forward with an explanation 
and enough evidence to establish prima facie grounds for a 
finding of reasonableness. . . . [T]his threshold burden is 
relatively low, and can be met with any reasonable showing. 
Once the taxpayer has made this prima facie showing, the burden 
then shifts to the IRS to verify or refute the taxpayer's 
explanation.'' By contrast, in Boles Trucking, Inc., v. 
U.S.,47 the court held that the burden is on the taxpayer 
to show, based on a preponderance of the evidence, that it had 
a reasonable basis for treating workers as independent 
contractors.
---------------------------------------------------------------------------
    \46\ 900 F.Supp. 101 (E.D. Mich. 1995). See also REAG, Inc. V. 
U.S., 801 F.Supp. 494 (W.D. Okla. 1992)(a taxpayer need only show a 
substantial rational basis for its decision to treat the workers as 
independent contractors).
    \47\ 77 F.3d 236 (8th Cir. 1996). See also Springfield v. U.S., 873 
F.Supp.1403 (S.D. Cal. 1994)(taxpayer has the burden to show it 
satisfies the requirements of section 530).
---------------------------------------------------------------------------

                           Reasons for change

    The Committee recognizes that the IRS and taxpayers 
continue to have disputes over the proper classification of 
workers, particularly with respect to the application of 
section 530. Many of these disputes involve small businesses 
without adequate resources to challenge the IRS position. 
Accordingly, the Committee believes it is appropriate to make 
certain clarifications of and modifications to section 530 
which are designed to provide both the IRS and taxpayers with 
clearer uniform standards. The Committee believes these clearer 
standards will reduce the number of disputes between the IRS 
and taxpayers over the application of section 530 and will 
reduce unnecessary and costly litigation. Further, in light of 
the unique nature of the legislative history to section 530 
which provides that it should be construed liberally in favor 
of taxpayers, the Committee believes that the burden of proof 
should generally be on the IRS once the taxpayer establishes a 
prima facie case that it was reasonable not to treat the worker 
as an employee and provided the taxpayer fully cooperates with 
reasonable requests for information by the IRS.

                        Explanation of provision

    The bill makes several clarifications of and modifications 
to section 530. First, under the bill, a worker does not have 
to otherwise be an employee of the taxpayer in order for 
section 530 to apply. The provision is intended to reverse the 
IRS position, as stated in the IRS Draft Training Guide, that 
there first must be a determination that the worker is an 
employee under the common law standards before application of 
section 530.
    The bill modifies the prior audit safe harbor so that 
taxpayers may not rely on an audit commencing after December 
31, 1996, unless such audit included an examination for 
employment tax purposes of whether the worker involved (or any 
worker holding a position substantially similar to the position 
held by the worker involved) should be treated as an employee 
of the taxpayer. The provision does not affect the ability of 
taxpayers to rely on prior audits that commenced before January 
1, 1997, even though the audit was not related to employment 
tax matters, as under present law.
    Under the bill, section 530 will not apply with respect to 
a worker unless the taxpayer and the worker sign a statement 
(at such time and in such manner as the Secretary may 
prescribe) which provides that the worker will not be treated 
as an employee for employment tax purposes. Also, the bill 
provides that an officer or employee of the IRS must, at (or 
before) the commencement of an audit involving worker 
classification issues, provide the taxpayer with written notice 
of the provisions of section 530.
    The bill makes a number of changes to the industry practice 
safe harbor. First, the bill provides that a significant 
segment of the taxpayer's industry under the industry practice 
safe harbor does not require a reasonable showing of the 
practice of more than 25 percent of an industry (determined 
without taking into account the taxpayer). The provision is 
intended to be a safe harbor; a lower percentage may constitute 
a significant segment of the taxpayer's industry based on the 
particular facts and circumstances.
    The bill also provides that an industry practice need not 
have continued for more than 10 years in order for the industry 
practice to be considered long standing. As with the 
significant segment safe harbor, this provision is intended to 
be a safe harbor; an industry practice in existence for a 
shorter period of time may be considered long standing based on 
the particular facts and circumstances. In addition, the bill 
clarifies that an industry practice will not fail to be treated 
as long standing merely because such practice began after 1978. 
Consequently, the provision clarifies that new industries can 
take advantage of section 530.
    The bill modifies the burden of proof in section 530 cases 
by providing that if a taxpayer establishes a prima facie case 
that it was reasonable not to treat a worker as an employee for 
purposes of section 530,48 the burden of proof shifts to 
the IRS with respect to such treatment.49 In order for the 
shift in burden of proof to occur, the taxpayer must fully 
cooperate with reasonable requests by the IRS for information 
relevant to the taxpayer's treatment of the worker as an 
independent contractor under section 530. The Committee intends 
that a request by the IRS will not be treated as reasonable if 
complying with the request would be impracticable given the 
particular circumstances and the relative costs involved. The 
shift in the burden of proof does not apply for purposes of 
determining whether the taxpayer had any other reasonable basis 
for treating the worker as an independent contractor, but does 
apply to all other aspects of section 530. So, for example, 
provided the taxpayer establishes its prima facie case and 
fully cooperates with the IRS' reasonable requests, the burden 
of proof shifts to the IRS with respect to all other aspects of 
section 530, including whether the taxpayer had a reasonable 
basis for treating the worker as an independent contractor 
under the judicial or administrative precedent, prior audit, or 
long-standing industry practice safe harbors, whether the 
taxpayer filed all Federal tax returns on a basis consistent 
with treating the worker as an independent contractor, and 
whether the taxpayer treated any worker holding a substantially 
similar position as an employee. No inference is intended with 
respect to the application of the burden of proof in section 
530 cases prior to the effective date of this provision.
---------------------------------------------------------------------------
    \48\ For example, the taxpayer must establish a prima facie case 
that it reasonably satisfies the requirements of section 530 for not 
treating the worker as an employee, including the reporting consistency 
and consistency among workers with substantially similar positions 
requirements, and the requirement that the taxpayer have a reasonable 
basis for not treating the worker as an employee.
    \49\  The provision is generally intended to codify the holding in 
McClellan v. U.S., discussed above, with respect to the burden of proof 
in section 530 cases.
---------------------------------------------------------------------------

                             Effective date

    The provisions generally apply to periods after December 
31, 1996. The provision regarding the burden of proof applies 
to disputes with respect to periods after December 31, 1996. In 
the case of workers engaged to perform services for a taxpayer 
before January 1, 1997, the provision requiring a written 
statement that such workers are not employees for employment 
tax purposes is effective for periods after December 31, 1997 
(unless the taxpayer elects to apply the provision earlier). 
The provision requiring the IRS to notify taxpayers of the 
provisions of section 530 applies to audits commencing after 
December 31, 1996.

              B. Extension of Certain Expiring Provisions

1. Work opportunity tax credit (sec. 1201 of the bill and sec. 51 of 
        the Code)

                               Prior law

                             General rules

    Prior to January 1, 1995, the targeted jobs tax credit was 
available on an elective basis for employers hiring individuals 
from one or more of nine targeted groups. The credit generally 
was equal to 40 percent of qualified first-year wages. 
Qualified first-year wages consisted of wages attributable to 
service rendered by a member of a targeted group during the 
one-year period beginning with the day the individual began 
work for the employer. For a vocational rehabilitation 
referral, however, the period began the day the individual 
began work for the employer on or after the beginning of the 
individual's vocational rehabilitation plan.
    No more than $6,000 of wages during the first year of 
employment were permitted to be taken into account with respect 
to any individual. Thus, the maximum credit per individual was 
$2,400.
    With respect to economically disadvantaged summer youth 
employees, the credit was equal to 40 percent of up to $3,000 
of qualified first-year wages, for a maximum credit of $1,200.
    The deduction for wages was reduced by the amount of the 
credit.

              Certification of members of targeted groups

    In general, an individual was not treated as a member of a 
targeted group unless certification that the individual was a 
member of such a group was received or requested in writing by 
the employer from the designated local agency on or before the 
day on which the individual began work for the employer. In the 
case of a certification of an economically disadvantaged youth 
participating in a cooperative education program, this 
requirement was satisfied if the certification was requested or 
received from the participating school on or before the day on 
which the individual began work for the employer. The 
``designated local agency'' was the State employment security 
agency.
    If a certification was incorrect because it was based on 
false information provided as to the employee's membership in a 
targeted group, the certification was revoked. Wages paid after 
the revocation notice was received by the employer were not 
treated as qualified wages.
    The U.S. Employment Service, in consultation with the 
Internal Revenue Service, was directed to take whatever steps 
necessary to keep employers informed of the availability of the 
credit.

                Targeted groups eligible for the credit

    The nine groups eligible for the credit were either 
recipients of payments under means-tested transfer programs, 
economically disadvantaged (as measured by family income), or 
disabled individuals.
            (1) Vocational rehabilitation referrals
    Vocational rehabilitation referrals were those individuals 
who had a physical or mental disability that constituted a 
substantial handicap to employment and who had been referred to 
the employer while receiving, or after completing, vocational 
rehabilitation services under an individualized, written 
rehabilitation plan under a State plan approved under the 
Rehabilitation Act of 1973, or under a rehabilitation plan for 
veterans carried out under Chapter 31 of Title 38, U.S. Code. 
Certification was provided by the designated local employment 
agency upon assurances from the vocational rehabilitation 
agency that the employee had met the above conditions.
            (2) Economically disadvantaged youths
    Economically disadvantaged youths were individuals 
certified by the designated local employment agency as (1) 
members of economically disadvantaged families and (2) at least 
age 18 but not age 23 on the date they were hired by the 
employer. An individual was determined to be a member of an 
economically disadvantaged family if, during the six months 
immediately preceding the earlier of the month in which the 
determination occurred or the month in which the hiring date 
occurred, the individual's family income was, on an annual 
basis, not more than 70 percent of the Bureau of Labor 
Statistics' lower living standard. A determination that an 
individual was a member of an economically disadvantaged family 
was valid for 45 days from the date on which the determination 
was made.
    Except as otherwise noted below, a determination of whether 
an individual was a member of an economically disadvantaged 
family was made on the same basis and was subject to the same 
45-day limitation, where required in connection with the four 
other targeted groups that excluded individuals who were not 
economically disadvantaged.
            (3) Economically disadvantaged Vietnam-era veterans
    The third targeted group was Vietnam-era veterans certified 
by the designated local employment agency as members of 
economically disadvantaged families. For these purposes, a 
Vietnam-era veteran was an individual who had served on active 
duty (other than for training) in the Armed Forces for more 
than 180 days, or who had been discharged or released from 
active duty in the Armed Forces for a service-connected 
disability, but in either case, the active duty must have taken 
place after August 4, 1964, and before May 8, 1975. However, 
any individual who had served for a period of more than 90 days 
during which the individual was on active duty (other than for 
training) was not an eligible employee if any of this active 
duty occurred during the 60-day period ending on the date the 
individual was hired by the employer. This latter rule was 
intended to prevent employers who hired current members of the 
armed services (or those departed from service within the last 
60-days) from receiving the credit.
            (4) SSI recipients
    The fourth targeted group was individuals receiving either 
Supplemental Security Income (``SSI'') under Title XVI of the 
Social Security Act or State supplements described in section 
1616 of that Act or section 212 of P.L. 93-66. To be an 
eligible employee, the individual must have received SSI 
payments during at least a one-month period ending during the 
60-day period that ended on the date the individual was hired 
by the employer. The designated local agency was to issue the 
certification after a determination by the agency making the 
payments that these conditions had been fulfilled.
            (5) General assistance recipients
    General assistance recipients were individuals who received 
general assistance for a period of not less than 30 days if 
that period ended within the 60-day period ending on the date 
the individual was hired by the employer. General assistance 
programs were State and local programs that provided 
individuals with money payments, vouchers, or scrip based on 
need. These programs were referred to by a wide variety of 
names, including home relief, poor relief, temporary relief, 
and direct relief. Because of the wide variety of such 
programs, Congress provided that a recipient was an eligible 
employee only after the program had been designated by the 
Secretary of the Treasury as a program that provided money 
payments, vouchers, or scrip to needy individuals. 
Certification was performed by the designated local agency.
            (6) Economically disadvantaged former convicts
    The sixth targeted group included any individual who was 
certified by the designated local employment agency as (1) 
having at some time been convicted of a felony under State or 
Federal law, (2) being a member of an economically 
disadvantaged family, and (3) having been hired within five 
years of the later of release from prison or date of 
conviction.
            (7) Economically disadvantaged cooperative education 
                    students
    The seventh targeted group was youths who (1) actively 
participated in qualified cooperative education programs, (2) 
had attained age 16 but had not attained age 20, (3) had not 
graduated from high school or vocational school, and (4) were 
members of economically disadvantaged families. The definitions 
of a qualified cooperative education program and a qualified 
school were similar to those used in the Vocational Education 
Act of 1963. Thus, a qualified cooperative education program 
meant a program of vocational education for individuals who, 
through written cooperative arrangements between a qualified 
school and one or more employers, received instruction, 
including required academic instruction, by alternation of 
study in school with a job in any occupational field, but only 
if these two experiences were planned and supervised by the 
school and the employer so that each experience contributed to 
the student's education and employability.
    For this purpose, a qualified school was (1) a specialized 
high school used exclusively or principally for the provision 
of vocational education to individuals who were available for 
study in preparation for entering the labor market, (2) the 
department of a high school used exclusively or principally for 
providing vocational education to individuals who were 
available for study in preparation for entering the labor 
market, or (3) a technical or vocational school used 
exclusively or principally for the provision of vocational 
education to individuals who had completed or left high school 
and who were available for study in preparation for entering 
the labor market. In order for a nonpublic school to be a 
qualified school, it must have been exempt from income tax 
under section 501(a) of the Code.
    The certification was performed by the school participating 
in the cooperative education program. After initial 
certification, an individual remained a member of the targeted 
group only while meeting the program participation, age, and 
degree status requirements of (a), (b), and (c), above.
            (8) AFDC recipients
    The eighth targeted group included any individual who was 
certified by the designated local employment agency as being 
eligible for Aid to Families with Dependent Children (``AFDC'') 
and as having continually received such aid during the 90 days 
before being hired by the employer.
            (9) Economically disadvantaged summer youth employees
    The ninth targeted group included youths who performed 
services during any 90-day period between May 1 and September 
15 of a given year and who were certified by the designated 
local agency as (1) being 16 or 17 years of age on the hiring 
date and (2) a member of an economically disadvantaged family. 
A youth must not have been an employee of the employer prior to 
that 90-day period. With respect to any particular employer, an 
employee could qualify only one time for this summer youth 
credit. If, after the end of the 90-day period, the employer 
continued to employ a youth who was certified during the 90-day 
period as a member of another targeted group, the limit on 
qualified first-year wages took into account wages paid to the 
youth while a qualified summer youth employee.

                          Definition of wages

    In general, wages eligible for the credit were defined by 
reference to the definition of wages under the Federal 
Unemployment Tax Act (FUTA) in section 3306(b) of the Code, 
except that the dollar limits did not apply. Because wages paid 
to economically disadvantaged cooperative education students 
and to certain agricultural and railroad employees were not 
FUTA wages, special rules were provided for these wages.
    Wages were taken into account for purposes of the credit 
only if more than one-half of the wages paid during the taxable 
year to an employee were for services in the employer's trade 
or business. The test as to whether more than one-half of an 
employee's wages were for services in a trade or business was 
applied to each separate employer without treating related 
employers as a single employer.

                              Other rules

    In order to prevent taxpayers from eliminating all tax 
liability by reason of the credit, the amount of the credit 
could not exceed 90 percent of the taxpayer's income tax 
liability. Furthermore, the credit was allowed only after 
certain other nonrefundable credits had been taken. If, after 
applying these other credits, 90 percent of an employer's 
remaining tax liability for the year was less than the targeted 
jobs tax credit, the excess credit could be carried back three 
years and carried forward 15 years.
    All employees of all corporations that were members of a 
controlled group of corporations were to be treated as if they 
were employees of the same corporation for purposes of 
determining the years of employment of any employee and wages 
for any employee up to $6,000. Generally, under the controlled 
group rules, the credit allowed the group was the same as if 
the group were a single company. A comparable rule was provided 
in the case of partnerships, sole proprietorships, and other 
trades or businesses (whether or not incorporated) that were 
under common control, so that all employees of such 
organizations generally were to be treated as if they were 
employed by a single person. The amount of targeted jobs tax 
credit allowable to each member of the controlled group was its 
proportionate share of the wages giving rise to the credit.
    No credit was available for the hiring of certain related 
individuals (primarily dependents or owners of the taxpayer). 
The credit was also not available for wages paid to an 
individual who was employed by the employer at any time during 
which the individual was not a certified member of a targeted 
group.
    No credit was available for wages paid by an employer to an 
individual for services that were the same as, or substantially 
similar to, those services performed by employees participating 
in, or affected by, a strike or lockout during the period of 
such strike or lockout. This rule applied to wages paid to 
individuals whose principal place of employment was a plant or 
facility where there was a strike or lockout.
    No credit was allowed for wages paid unless the eligible 
individual was either (1) employed by the employer for at least 
90 days (14 days in the case of economically disadvantaged 
summer youth employees) or (2) had completed at least 120 hours 
(20 hours for summer youth) of services performed for the 
employer.

                           Reasons for change

    While the prior-law targeted jobs tax credit was the 
subject of some criticism, the Committee believes that a tax 
credit mechanism can provide an important incentive for 
employers to undertake the expense of providing jobs and 
training to economically disadvantaged individuals, many of 
whom are underskilled and/or undereducated. The bill creates a 
new program whose design will focus on individuals with poor 
workplace attachments, streamline administrative burdens, 
promote longer-term employment, and thereby reduce costs 
relative to the prior-law program. The Committee intends that 
this short-term program will provide the Congress and the 
Treasury and Labor Departments an opportunity to assess fully 
the operation and effectiveness of the new credit as a hiring 
incentive.

                        Explanation of provision

                             General rules

    The bill replaces the targeted jobs tax credit with the 
``work opportunity tax credit.'' The work opportunity tax 
credit is available on an elective basis for employers hiring 
individuals from one or more of seven targeted groups. The 
credit generally is equal to 35 percent of qualified wages. 
Qualified wages consist of wages attributable to service 
rendered by a member of a targeted group during the one-year 
period beginning with the day the individual begins work for 
the employer. For a vocational rehabilitation referral, 
however, the period will begin on the day the individual begins 
work for the employer on or after the beginning of the 
individual's vocational rehabilitation plan as under prior law.
    Generally, no more than $6,000 of wages during the first 
year of employment is permitted to be taken into account with 
respect to any individual. Thus, the maximum credit per 
individual is $2,100. With respect to qualified summer youth 
employees, the maximum credit is 35 percent of up to $3,000 of 
qualified first-year wages, for a maximum credit of $1,050.
    The deduction for wages is reduced by the amount of the 
credit.

              Certification of members of targeted groups

    In general, an individual is not to be treated as a member 
of a targeted group unless: (1) on or before the day the 
individual begins work for the employer, the employer received 
in writing a certification from the designated local agency 
that the individual is a member of a specific targeted group, 
or (2) on or before the day the individual is offered work with 
the employer, a pre-screening notice is completed with respect 
to that individual by the employer and within 21 days after the 
individual begins work for the employer, the employer submits 
such notice, signed by the employer and the individual under 
penalties of perjury, to the designated local agency as part of 
a written request for certification. The pre-screening notice 
will contain the information provided to the employer by the 
individual that forms the basis of the employer's belief that 
the individual is a member of a targeted group.
    If a certification is incorrect because it is based on 
false information provided as to the individual's membership in 
a targeted group, the certification will be revoked. No credit 
will be allowed on wages paid after receipt by the employer of 
the revocation notice.
    If a designated local agency rejects a certification 
request it will have to provide a written explanation of the 
basis of the rejection.

                Targeted groups eligible for the credit

            (1) Families receiving AFDC
    An eligible recipient is an individual certified by the 
designated local employment agency as being a member of a 
family receiving benefits under AFDC or its successor program 
for a period of at least nine months part of which is during 
the nine-month period ending on the hiring date. For these 
purposes, each member of the family receiving such assistance 
is treated as receiving such assistance and therefore is 
treated as an eligible recipient.
            (2) Qualified ex-felon
    A qualified ex-felon is an individual certified as: (1) 
having been convicted of a felony under any State or Federal 
law, (2) being a member of a family that had an income during 
the six months before the earlier of the date of determination 
or the hiring date which on an annual basis is 70 percent or 
less of the Bureau of Labor Statistics lower living standard, 
and (3) having a hiring date within one year of release from 
prison or date of conviction.
            (3) High-risk-youth
    A high-risk youth is an individual certified as being at 
least 18 but not 25 on the hiring date and as having a 
principal place of abode within an empowerment zone or 
enterprise community (as defined under Subchapter U of the 
Internal Revenue Code). Qualified wages will not include wages 
paid or incurred for services performed after the individual 
moves outside an empowerment zone or enterprise community.
            (4) Vocational rehabilitation referral
    Vocational rehabilitation referrals are those individuals 
who have a physical or mental disability that constitutes a 
substantial handicap to employment and who have been referred 
to the employer while receiving, or after completing, 
vocational rehabilitation services under an individualized, 
written rehabilitation plan under a State plan approved under 
the Rehabilitation Act of 1973 or under a rehabilitation plan 
for veterans carried out under Chapter 31 of Title 38, U.S. 
Code. Certification will be provided by the designated local 
employment agency upon assurances from the vocational 
rehabilitation agency that the employee has met the above 
conditions.
            (5) Qualified summer youth employee
    Qualified summer youth employees are individuals: (1) who 
perform services during any 90-day period between May 1 and 
September 15, (2) who are certified by the designated local 
agency as being 16 or 17 years of age on the hiring date, (3) 
who have not been an employee of that employer before, and (4) 
who are certified by the designated local agency as having a 
principal place of abode within an empowerment zone or 
enterprise community (as defined under Subchapter U of the 
Internal Revenue Code). As with high-risk youths, no credit is 
available on wages paid or incurred for service performed after 
the qualified summer youth moves outside of an empowerment zone 
or enterprise community. If, after the end of the 90-day 
period, the employer continues to employ a youth who was 
certified during the 90-day period as a member of another 
targeted group, the limit on qualified first-year wages will 
take into account wages paid to the youth while a qualified 
summer youth employee.
            (6) Qualified veteran
    A qualified veteran is a veteran who is a member of a 
family certified as receiving assistance under: (1) AFDC for a 
period of at least nine months part of which is during the 12-
month period ending on the hiring date, or (2) a food stamp 
program under the Food Stamp Act of 1977 for a period of at 
least three months part of which is during the 12-month period 
ending on the hiring date.
    Further, a qualified veteran is an individual who has 
served on active duty (other than for training) in the Armed 
Forces for more than 180 days or who has been discharged or 
released from active duty in the Armed Forces for a service-
connected disability. However, any individual who has served 
for a period of more than 90 days during which the individual 
was on active duty (other than for training) is not an eligible 
employee if any of this active duty occurred during the 60-day 
period ending on the date the individual was hired by the 
employer. This latter rule is intended to prevent employers who 
hire current members of the armed services (or those departed 
from service within the last 60 days) from receiving the 
credit.
            (7) Families receiving Food Stamps
    An eligible recipient is an individual aged 18 but not 25 
certified by a designated local employment agency as being a 
member of a family receiving assistance under a food stamp 
program under the Food Stamp Act of 1977 for a period of at 
least three months ending on the hiring date. For these 
purposes, each member of the family receiving such assistance 
is treated as receiving such assistance and therefore is 
treated as an eligible recipient.

                  Definition of wages and other rules

    In general, wages eligible for the credit are defined by 
reference to the definition of wages under the Federal 
Unemployment Tax Act (``FUTA'') in section 3306(b) of the Code, 
except that the dollar limits do not apply.
    Wages are taken into account for purposes of the credit 
only if more than one-half of the wages paid during the taxable 
year to an employee are for services in the employer's trade or 
business. The test as to whether more than one-half of an 
employee's wages are for services in a trade or business are 
applied to each separate employer without treating related 
employers as a single employer.
    In order to prevent taxpayers from eliminating all tax 
liability by reason of the credit, the amount of the credit may 
not exceed 90 percent of the taxpayer's income tax liability. 
Furthermore, the credit is allowed only after certain other 
nonrefundable credits had been taken. If, after applying these 
other credits, 90 percent of an employer's remaining tax 
liability for the year is less than the targeted jobs tax 
credit, the excess credit can be carried back three years and 
carried forward 15 years.
    All employees of all corporations that are members of a 
controlled group of corporations are treated as if they were 
employees of the same corporation for purposes of determining 
the years of employment of any employee and wages for any 
employee up to $6,000. Generally, under the controlled group 
rules, the credit allowed the group is the same as if the group 
were a single company. A comparable rule is provided in the 
case of partnerships, sole proprietorships, and other trades or 
businesses (whether or not incorporated) that are under common 
control, so that all employees of such organizations generally 
are treated as if they was employed by a single person. The 
amount of the credit allowable to each member of the controlled 
group is its proportionate share of the wages giving rise to 
the credit.
    No credit is available for the hiring of certain related 
individuals (primarily dependents or owners of the taxpayer). 
The credit is also not available for wages paid to an 
individual who is employed by the employer at any time during 
which the individual is not a certified member of a targeted 
group.
    No credit is available for wages paid by an employer to an 
individual for services that are the same as, or substantially 
similar to, those services performed by employees participating 
in, or affected by, a strike or lockout during the period of 
such strike or lockout. This rule applies to wages paid to 
individuals whose principal place of employment is a plant or 
facility where there is a strike or lockout.

                       Minimum employment period

    No credit is allowed for wages paid unless the eligible 
individual is employed by the employer for at least 180 days 
(20 days in the case of a qualified summer youth employee) or 
375 hours (120 hours in the case of a qualified summer youth 
employee).

                             Effective date

    The credit is effective for wages paid or incurred to a 
qualified individual who begins work for an employer after 
September 30, 1996, and before October 1, 1997.

2. Employer-provided educational assistance (sec. 1202 of the bill and 
        sec. 127 of the Code)

                         Present and prior law

    For taxable years beginning before January 1, 1995, an 
employee's gross income and wages did not include amounts paid 
or incurred by the employer for educational assistance provided 
to the employee if such amounts were paid or incurred pursuant 
to an educational assistance program that met certain 
requirements. This exclusion, which expired for taxable years 
beginning after December 31, 1994, was limited to $5,250 of 
educational assistance with respect to an individual during a 
calendar year. The exclusion applied whether or not the 
education was job related. In the absence of this exclusion, 
educational assistance is excludable from income only if it is 
related to the employee's current job.

                           Reasons for change

    The section 127 exclusion for employer-provided educational 
assistance was first established on a temporary basis by the 
Revenue Act of 1978 (through 1983). It subsequently was 
extended, again on a temporary basis, by Public Law 98-611 
(through 1985), by the Tax Reform Act of 1986 (through 1987), 
by the Technical and Miscellaneous Revenue Act of 1988 (through 
1988), by the Omnibus Budget Reconciliation Act of 1989 
(through September 30, 1990), by the Omnibus Budget 
Reconciliation Act of 1990 (through 1991), by the Tax Extension 
Act of 1991 (through June 30, 1992), and by the Omnibus Budget 
Reconciliation Act of 1993 (through December 31, 1994). Public 
Law 98-611 adopted a $5,000 annual limit on the exclusion; this 
limit was subsequently raised to $5,250 in the Tax Reform Act 
of 1986. The Technical and Miscellaneous Revenue Act of 1988 
made the exclusion inapplicable to graduate-level courses. The 
restriction on graduate-level courses was repealed by the 
Omnibus Budget Reconciliation Act of 1990, effective for 
taxable years beginning after December 31, 1990.
    The Committee believes that the exclusion for employer-
provided educational assistance should be extended because it 
provides needed assistance to workers and aids U.S. 
competitiveness by encouraging a better-educated work force. 
The need to balance the Federal budget necessitates limiting 
the exclusion (as other expiring tax provisions) to a temporary 
extension.

                        Explanation of provision

    The provision extends the exclusion for employer-provided 
educational assistance (including the application of the 
exclusion to graduate education) for taxable years beginning 
after December 31, 1994, and before January 1, 1997.
    To the extent employers have previously filed Forms W-2 
reporting the amount of educational assistance provided as 
taxable wages, present Treasury regulations require the 
employer to file Forms W-2c (i.e., corrected Forms W-2) with 
the Internal Revenue Service.50 It is intended that 
employers also be required to provide copies of Form W-2c to 
affected employees.
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    \50\ Treasury regulation section 31.6051-1(c).
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    The Secretary is directed to establish expedited procedures 
for the refund of any overpayment of taxes paid on excludable 
educational assistance provided in 1995 and 1996, including 
procedures for waiving the requirement that an employer obtain 
an employee's signature if the employer demonstrates to the 
satisfaction of the Secretary that any refund collected by the 
employer on behalf of the employee will be paid to the 
employee.
    Because the exclusion is extended, no interest and 
penalties should be imposed if an employer failed to withhold 
income and employment taxes on excludable educational 
assistance or failed to report such educational assistance. 
Further, it is intended that the Secretary establish expedited 
procedures for refunding any interest and penalties relating to 
educational assistance previously paid.

                             Effective date

    The provision is effective with respect to taxable years 
beginning after December 31, 1994, and before January 1, 1997.

3. Research and experimentation tax credit (sec. 1203 of the bill and 
        sec. 41 of the Code)

                         Present and prior law

                              General rule

    Prior to July 1, 1995, section 41 of the Internal Revenue 
Code provided for a research tax credit equal to 20 percent of 
the amount by which a taxpayer's qualified research 
expenditures for a taxable year exceeded its base amount for 
that year. The research tax credit expired and does not apply 
to amounts paid or incurred after June 30, 1995.
    A 20-percent research tax credit also applied to the excess 
of (1) 100 percent of corporate cash expenditures (including 
grants or contributions) paid for basic research conducted by 
universities (and certain nonprofit scientific research 
organizations) over (2) the sum of (a) the greater of two 
minimum basic research floors plus (b) an amount reflecting any 
decrease in nonresearch giving to universities by the 
corporation as compared to such giving during a fixed-base 
period, as adjusted for inflation. This separate credit 
computation is commonly referred to as the ``university basic 
research credit'' (see sec. 41(e)).

                    Computation of allowable credit

     Except for certain university basic research payments made 
by corporations, the research tax credit applies only to the 
extent that the taxpayer's qualified research expenditures for 
the current taxable year exceed its base amount. The base 
amount for the current year generally is computed by 
multiplying the taxpayer's ``fixed-base percentage'' by the 
average amount of the taxpayer's gross receipts for the four 
preceding years. If a taxpayer both incurred qualified research 
expenditures and had gross receipts during each of at least 
three years from 1984 through 1988, then its ``fixed-base 
percentage'' is the ratio that its total qualified research 
expenditures for the 1984-1988 period bears to its total gross 
receipts for that period (subject to a maximum ratio of .16). 
All other taxpayers (so-called ``start-up firms'') are assigned 
a fixed-base percentage of 3 percent.51
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    \51\ The Omnibus Budget Reconciliation Act of 1993 included a 
special rule designed to gradually recompute a start-up firm's fixed-
base percentage based on its actual research experience. Under this 
special rule, a start-up firm (i.e., any taxpayer that did not have 
gross receipts in at least three years during the 1984-1988 period) 
will be assigned a fixed-base percentage of 3 percent for each of its 
first five taxable years after 1993 in which it incurs qualified 
research expenditures. In the event that the research credit is 
extended beyond the scheduled June 30, 1995 expiration date, a start-up 
firm's fixed-base percentage for its sixth through tenth taxable years 
after 1993 in which it incurs qualified research expenditures will be a 
phased-in ratio based on its actual research experience. For all 
subsequent taxable years, the taxpayer's fixed-base percentage will be 
its actual ratio of qualified research expenditures to gross receipts 
for any five years selected by the taxpayer from its fifth through 
tenth taxable years after 1993 (sec. 41(c)(3)(B)).
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    In computing the credit, a taxpayer's base amount may not 
be less than 50 percent of its current-year qualified research 
expenditures.
    To prevent artificial increases in research expenditures by 
shifting expenditures among commonly controlled or otherwise 
related entities, research expenditures and gross receipts of 
the taxpayer are aggregated with research expenditures and 
gross receipts of certain related persons for purposes of 
computing any allowable credit (sec. 41(f)(1)). Special rules 
apply for computing the credit when a major portion of a 
business changes hands, under which qualified research 
expenditures and gross receipts for periods prior to the change 
or ownership of a trade or business are treated as transferred 
with the trade or business that gave rise to those expenditures 
and receipts for purposes of recomputing a taxpayer's fixed-
base percentage (sec. 41(f)(3)).

                         Eligible expenditures

    Qualified research expenditures eligible for the research 
tax credit consist of: (1) ``in-house'' expenses of the 
taxpayer for wages and supplies attributable to qualified 
research; (2) certain time-sharing costs for computer use in 
qualified research; and (3) 65 percent of amounts paid by the 
taxpayer for qualified research conducted on the taxpayer's 
behalf (so-called ``contract research expenses'').
     To be eligible for the credit, the research must not only 
satisfy the requirements of present-law section 174 (described 
below) but must be undertaken for the purpose of discovering 
information that is technological in nature, the application of 
which is intended to be useful in the development of a new or 
improved business component of the taxpayer, and must pertain 
to functional aspects, performance, reliability, or quality of 
a business component. Research does not qualify for the credit 
if substantially all of the activities relate to style, taste, 
cosmetic, or seasonal design factors (sec. 41(d)(3)). In 
addition, research does not qualify for the credit if conducted 
after the beginning of commercial production of the business 
component, if related to the adaptation of an existing business 
component to a particular customer's requirements, if related 
to the duplication of an existing business component from a 
physical examination of the component itself or certain other 
information, or if related to certain efficiency surveys, 
market research or development, or routine quality control 
(sec. 41(d)(4)).
    Expenditures attributable to research that is conducted 
outside the United States do not enter into the credit 
computation. In addition, the credit is not available for 
research in the social sciences, arts, or humanities, nor is it 
available for research to the extent funded by any grant, 
contract, or otherwise by another person (or governmental 
entity).

                         Relation to deduction

    Under section 174, taxpayers may elect to deduct currently 
the amount of certain research or experimental expenditures 
incurred in connection with a trade or business, 
notwithstanding the general rule that business expenses to 
develop or create an asset that has a useful life extending 
beyond the current year must be capitalized. However, 
deductions allowed to a taxpayer under section 174 (or any 
other section) are reduced by an amount equal to 100 percent of 
the taxpayer's research tax credit determined for the taxable 
year. Taxpayers may alternatively elect to claim a reduced 
research tax credit amount under section 41 in lieu of reducing 
deductions otherwise allowed (sec. 280C(c)(3)).

                           Reasons for change

    Businesses may not find it profitable to invest in some 
research activities because of the difficulty in capturing the 
full benefits from the research. Costly technological advances 
made by one firm are often cheaply copied by its competitors. A 
research tax credit can help promote investment in research, so 
that research activities undertaken approach the optimal level 
for the overall economy. Therefore, the Committee believes 
that, in order to encourage research activities, it is 
appropriate to reinstate the research tax credit and to modify 
certain rules for computing the credit.

                        Explanation of provision

    The bill extends the research tax credit (including the 
university basic research credit) for the period July 1, 1996, 
through June 30, 1997.
    The bill also expands the definition of ``start-up firms'' 
under section 41(c)(3)(B)(I) to include any firm if the first 
taxable year in which such firm had both gross receipts and 
qualified research expenses began after 1983.52
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    \52\ In applying the start-up firm rules, the test is whether a 
taxpayer, in fact, both incurred research expenses (which under the 
present-law rules would be qualified research expenses) and had gross 
receipts in a particular year, not whether the taxpayer claimed a 
research tax credit for that year.
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    In addition, the bill allows taxpayers to elect an 
alternative incremental research credit regime. If a taxpayer 
elects to be subject to this alternative regime, the taxpayer 
is assigned a three-tiered fixed-base percentage (that is lower 
than the fixed-base percentage otherwise applicable under 
present law) and the credit rate likewise is reduced. Under the 
alternative credit regime, a credit rate of 1.65 percent 
applies to the extent that a taxpayer's current-year research 
expenses exceed a base amount computed by using a fixed-base 
percentage of 1 percent (i.e., the base amount equals 1 percent 
of the taxpayer's average gross receipts for the four preceding 
years) but do not exceed a base amount computed by using a 
fixed-base percentage of 1.5 percent. A credit rate of 2.2 
percent applies to the extent that a taxpayer's current-year 
research expenses exceed a base amount computed by using a 
fixed-base percentage of 1.5 percent but do not exceed a base 
amount computed by using a fixed-base percentage of 2 percent. 
A credit rate of 2.75 percent applies to the extent that a 
taxpayer's current-year research expenses exceed a base amount 
computed by using a fixed-base percentage of 2 percent. An 
election to be subject to this alternative incremental credit 
regime may be made only for a taxpayer's first taxable year 
beginning after June 30, 1996, and such an election applies to 
that taxable year and all subsequent years unless revoked with 
the consent of the Secretary of the Treasury.
    The bill also provides for a special rule for payments made 
to certain nonprofit research consortia. Under this special 
rule, 75 percent of amounts paid to a research consortium for 
qualified research is treated as qualified research expenses 
eligible for the research credit (rather than 65 percent under 
the present-law section 41(b)(3) rule governing contract 
research expenses) if (1) such research consortium is a tax-
exempt organization that is described in section 501(c)(3) 
(other than a private foundation) or section 501(c)(6) and is 
organized and operated primarily to conduct scientific 
research, and (2) such qualified research is conducted by the 
consortium on behalf of the taxpayer and one or more persons 
not related to the taxpayer.

                             Effective date

    Extension of the research tax credit is effective for 
expenditures paid or incurred during the period July 1, 1996, 
through June 30, 1997. The modification to the definition of 
``start-up firms'' is effective for taxable years ending after 
June 30, 1996. Taxpayers may elect the alternative research 
credit regime (with lower fixed-base percentages and lower 
credit rates) for taxable years beginning after June 30, 1996. 
The rule that treats 75 percent of qualified research 
consortium payments as qualified research expenses is effective 
for taxable years beginning after June 30, 1996.

4. Orphan drug tax credit (sec. 1204 of the bill and secs. 28 and 39 
        and new sec. 45C of the Code)

                         Present and prior law

    Prior to January 1, 1995, a 50-percent nonrefundable tax 
credit was allowed for qualified clinical testing expenses 
incurred in testing of certain drugs for rare diseases or 
conditions, generally referred to as ``orphan drugs.'' 
Qualified testing expenses are costs incurred to test an orphan 
drug after the drug has been approved for human testing by the 
Food and Drug Administration (FDA) but before the drug has been 
approved for sale by the FDA. A rare disease or condition is 
defined as one that (1) affects less than 200,000 persons in 
the United States, or (2) affects more than 200,000 persons, 
but for which there is no reasonable expectation that 
businesses could recoup the costs of developing a drug for such 
disease or condition from U.S. sales of the drug. These rare 
diseases and conditions include Huntington's disease, 
myoclonus, ALS (Lou Gehrig's disease), Tourette's syndrome, and 
Duchenne's dystrophy (a form of muscular dystrophy).
    Under prior law, the orphan drug tax credit could be 
claimed by a taxpayer only to the extent that its regular tax 
liability for the year the credit was earned exceeded its 
tentative minimum tax for that year, after regular tax was 
reduced by nonrefundable personal credits and the foreign tax 
credit.53 Unused credits could not be carried back or 
carried forward to reduce taxes in other years.
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    \53\ To the extent that the orphan drug tax credit could not be 
used by reason of the minimum tax limitation, the taxpayer's minimum 
tax credit was increased (sec. 53(d)(1)(B)(iii)).
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    The orphan drug tax credit expired after December 31, 1994.

                           Reasons for change

    The Committee believes that it is appropriate to reinstate 
the orphan drug tax credit.

                        Explanation of provision

    The bill extends the orphan drug tax credit for the period 
July 1, 1996, through June 30, 1997.
    In addition, the bill allows taxpayers to carry back unused 
credits to three years preceding the year the credit is earned 
and to carry forward unused credits to 15 years following the 
year the credit is earned.

                             Effective date

    The provision applies to qualified clinical testing 
expenses paid or incurred during the period July 1, 1996, 
through June 30, 1997. The provision allowing for the carry 
back and carry forward of unused credits is effective for 
taxable years ending after June 30, 1996. No portion of the 
unused business credit that is attributable to the orphan drug 
credit may be carried back under section 39 to a taxable year 
ending before July 1, 1996.

5. Contributions of stock to private foundations (sec. 1205 of the bill 
        and sec. 173(e)(5) of the Code)

                         Present and prior law

    In computing taxable income, a taxpayer who itemizes 
deductions generally is allowed to deduct the fair market value 
of property contributed to a charitable organization.54 
However, in the case of a charitable contribution of short-term 
gain, inventory, or other ordinary income property, the amount 
of the deduction generally is limited to the taxpayer's basis 
in the property. In the case of a charitable contribution of 
tangible personal property, the deduction is limited to the 
taxpayer's basis in such property if the use by the recipient 
charitable organization is unrelated to the organization's tax-
exempt purpose.55
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    \54\ The amount of the deduction allowable for a taxable year with 
respect to a charitable contribution may be reduced depending on the 
type of property contributed, the type of charitable organization to 
which the property is contributed, and the income of the taxpayer 
(secs. 170(b) and 170(e)).
    \55\ As part of the Omnibus Budget Reconciliation Act of 1993, 
Congress eliminated the treatment of contributions of appreciated 
property (real, personal, and intangible) as a tax preference for 
alternative minimum tax (AMT) purposes. Thus, if a taxpayer makes a 
gift to charity of property (other than short-term gain, inventory, or 
other ordinary income property, or gifts to private foundations) that 
is real property, intangible property, or tangible personal property 
the use of which is related to the donee's tax-exempt purpose, the 
taxpayer is allowed to claim the same fair-market-value deduction for 
both regular tax and AMT purposes (subject to present-law percentage 
limitations).
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    In cases involving contributions to a private foundation 
(other than certain private operating foundations), the amount 
of the deduction is limited to the taxpayer's basis in the 
property. However, under a special rule contained in section 
170(e)(5), taxpayers were allowed a deduction equal to the fair 
market value of ``qualified appreciated stock'' contributed to 
a private foundation prior to January 1, 1995. Qualified 
appreciated stock was defined as publicly traded stock which is 
capital gain property. The fair-market-value deduction for 
qualified appreciated stock donations applied only to the 
extent that total donations made by the donor to private 
foundations of stock in a particular corporation did not exceed 
10 percent of the outstanding stock of that corporation. For 
this purpose, an individual was treated as making all 
contributions that were made by any member of the individual's 
family. This special rule contained in section 170(e)(5) 
expired after December 31, 1994.

                           Reasons for change

    The Committee believes that, to encourage donations to 
charitable private foundations, it is appropriate to reinstate 
the special rule that allowed a fair-market-value deduction for 
certain gifts of appreciated stock to private foundations.

                        Explanation of provision

    The bill extends the special rule contained in section 
170(e)(5) for contributions of qualified appreciated stock made 
to private foundations for contributions made during the period 
July 1, 1996, through June 30, 1997.56
---------------------------------------------------------------------------
    \56\ If, during this period, a taxpayer contributes qualified 
appreciated stock as defined in section 170(e)(5) and the amount of 
such contribution exceeds the percentage limitation under section 
170(b)(1)(D), the excess may be carried over to succeeding taxable 
years. See, e.g., LTR 9444029, LTR 9424020.
---------------------------------------------------------------------------

                             Effective date

    The provision is effective for contributions of qualified 
appreciated stock to private foundations made during the period 
July 1, 1996, through June 30, 1997.

6. Tax credit for producing fuel from a nonconventional source (sec. 
        1206 of the bill and sec. 29 of the Code)

                              Present law

    Certain fuels produced from ``nonconventional sources'' and 
sold to unrelated parties are eligible for an income tax credit 
equal to $3 (generally adjusted for inflation) per barrel or 
BTU oil barrel equivalent (sec. 29) (referred to as the 
``section 29 credit''). Qualified fuels must be produced within 
the United States. Qualified fuels include:
    (1) oil produced from shale and tar sands;
    (2) gas produced from geopressured brine, Devonian shale, 
coal seams, tight formations (``tight sands''), or biomass; and
    (3) liquid, gaseous, or solid synthetic fuels produced from 
coal (including lignite).
    In general, the credit is available only with respect to 
fuels produced from wells drilled or facilities placed in 
service after December 31, 1979, and before January 1, 1993. An 
exception extends the January 1, 1993 expiration date for 
facilities producing gas from biomass and synthetic fuel from 
coal if the facility producing the fuel is placed in service 
before January 1, 1997, pursuant to a binding contract entered 
into before January 1, 1996.
    The credit may be claimed for qualified fuels produced and 
sold before January 1, 2003 (in the case of nonconventional 
sources subject to the January 1, 1993 expiration date) or 
January 1, 2008 (in the case of biomass gas and synthetic fuel 
facilities eligible for the extension period).

                           Reasons for change

    The Committee believes that a short-term extension of the 
section 29 credit is appropriate to allow projects currently in 
negotiation or under development to be placed in service in a 
more orderly manner than is possible under the present-law 
scheduled expiration.

                        Explanation of provision

    The binding contract date for facilities producing 
synthetic fuels from coal and gas from biomass is extended 
until the date which is six months after the date of the 
provision's enactment, and the placed in service date is 
extended for one year. The present sunset on production 
qualifying for the credit is not changed. Under the provision, 
synthetic fuels from coal and gas from biomass produced from a 
facility placed in service before January 1, 1998, pursuant to 
a binding contract entered into before the date which is six 
months after the date of the provision's enactment, will be 
eligible for the tax credit if produced before January 1, 2008.

                             Effective date

     The provision is effective upon enactment.

7. Suspend imposition of diesel fuel tax on recreational motorboats 
        (sec. 1207 of the bill and sec. 6427 of the Code)

                               Present law

    Diesel fuel used in recreational motorboats is subject to a 
24.4 cents-per-gallon excise tax through December 31, 1999. 
This tax was enacted by the Omnibus Budget Reconciliation Act 
of 1993 as a revenue offset for repeal of the excise tax on 
certain luxury boats.
    The diesel fuel tax is imposed on removal of the fuel from 
a registered terminal facility (i.e., at the ``terminal 
rack''). Present law provides that tax is imposed on all diesel 
fuel removed from terminal facilities unless the fuel is 
destined for a nontaxable use and is indelibly dyed pursuant to 
Treasury Department regulations. If fuel on which tax is paid 
at the terminal rack (i.e., undyed diesel fuel) ultimately is 
used in a nontaxable use, a refund is allowed. Depending on the 
aggregate amount of tax to be refunded, this refund may be 
claimed either by a direct filing with the Internal Revenue 
Service or as a credit against income tax.
    Dyed diesel fuel (fuel on which no tax is paid) may not be 
used in a taxable use. Present law imposes a penalty equal to 
the greater of $10 per gallon or $1,000 on persons found to be 
violating this prohibition.

                           Reasons for change

    The Committee understands that market conditions in the 
marine industry have produced shortages of diesel fuel for 
recreational boat use in some areas. This is reported to have 
occurred because some marinas primarily serve commercial 
vessels that burn nontaxable, dyed diesel fuel, and have 
resisted installing supplemental fuel tanks for the taxable, 
undyed diesel fuel required for recreational boats. The 
Committee believes, therefore, that a temporary suspension of 
this tax is appropriate to allow review of possible alternative 
collection regimes, and to allow marinas additional time in 
which to adapt to the requirements of the present-law rules, if 
satisfactory alternatives are not found.

                        Explanation of provision

    No tax will be imposed on diesel fuel used in recreational 
motorboats during the period July 1, 1996, through June 30, 
1997.
    This exemption will temporarily address current supply 
problems. The Committee requests the Treasury Department to 
study possible alternatives to the current collection regime 
for motorboat diesel fuel that will provide comparable 
compliance with the law, and to report to the Senate Committee 
on Ways and Means and the Senate Committee on Finance no later 
than April 1, 1997.

                             Effective date

    The provision is effective on July 1, 1996.

                C. Provisions Relating to S Corporations

1. S corporations permitted to have 75 shareholders (sec. 1301 of the 
        bill and sec. 1361 of the Code)

                              Present law

    The taxable income or loss of an S corporation is taken 
into account by the corporation's shareholders, rather than by 
the entity, whether or not such income is distributed. A small 
business corporation may elect to be treated as an S 
corporation. A ``small business corporation'' is defined as a 
domestic corporation which is not an ineligible corporation and 
which does not have (1) more than 35 shareholders, (2) as a 
shareholder, a person (other than certain trusts or estates) 
who is not an individual, (3) a nonresident alien as a 
shareholder, and (4) more than one class of stock. For purposes 
of the 35-shareholder limitation, a husband and wife are 
treated as one shareholder.

                           Reasons for change

    The Committee believes that increasing the maximum number 
of shareholders of an S corporation will facilitate corporate 
ownership by additional family members, employees and capital 
investors.

                        Explanation of provision

    The provision increases the maximum number of shareholders 
from 35 to 75.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

2. Electing small business trusts (sec. 1302 of the bill and sec. 1361 
        of the Code)

                              Present law

    Under present law, trusts other than grantor trusts, voting 
trusts, certain testamentary trusts and ``qualified subchapter 
S trusts'' may not be shareholders in an S corporation. A 
``qualified subchapter S trust'' is a trust which, under its 
terms, (1) is required to have only one current income 
beneficiary (for life), (2) any corpus distributed during the 
life of the beneficiary must be distributed to the beneficiary, 
(3) the beneficiary's income interest must terminate at the 
earlier of the beneficiary's death or the termination of the 
trust, and (4) if the trust terminates during the beneficiary's 
life, the trust assets must be distributed to the beneficiary. 
All the income (as defined for local law purposes) must be 
currently distributed to that beneficiary. The beneficiary is 
treated as the owner of the portion of the trust consisting of 
the stock in the S corporation.

                           Reasons for change

    The Committee believes that a trust that provides for 
income to be distributed to (or accumulated for) a class of 
individuals should be allowed to hold S corporation stock. This 
would allow an individual to establish a trust to hold S 
corporation stock and ``spray'' income among family members (or 
others) who are beneficiaries of the trust. The Committee 
believes allowing such an arrangement will facilitate family 
financial planning.

                        Explanation of provision

                               In general

    The provision allows stock in an S corporation to be held 
by certain trusts (``electing small business trusts''). In 
order to qualify for this treatment, all beneficiaries of the 
trust must be individuals or estates eligible to be S 
corporation shareholders, except that charitable organizations 
may hold contingent remainder interests.57 No interest in 
the trust may be acquired by purchase. For this purpose, 
``purchase'' means any acquisition of property with a cost 
basis (determined under sec. 1012). Thus, interests in the 
trust must be acquired by reason of gift, bequest, etc.
---------------------------------------------------------------------------
    \57\ For taxable years beginning after 1997, charitable 
organizations may hold current interests in a trust.
---------------------------------------------------------------------------
    A trust must elect to be treated as an electing small 
business trust. An election applies to the taxable year for 
which made and could be revoked only with the consent of the 
Secretary of the Treasury or his delegate.
    Each potential current beneficiary of the trust is counted 
as a shareholder for purposes of the proposed 75 shareholder 
limitation (or if there were no potential current 
beneficiaries, the trust would be treated as the shareholder). 
A potential current income beneficiary means any person, with 
respect to the applicable period, who is entitled to, or at the 
discretion of any person may receive, a distribution from the 
principal or income of the trust. Where the trust disposes of 
all the stock in an S corporation, any person who first became 
so eligible during the 60 days before the disposition is not 
treated as a potential current beneficiary.
    A qualified subchapter S trust with respect to which an 
election is in effect or an exempt trust is not eligible to 
qualify as an electing small business trust.

           Treatment of items relating to S corporation stock

    The portion of the trust which consists of stock in one or 
more S corporations is treated as a separate trust for purposes 
of computing the income tax attributable to the S corporation 
stock held by the trust. The trust is taxed at the highest 
individual rate (currently, 39.6 percent on ordinary income and 
28 percent on net capital gain) on this portion of the trust's 
income. The taxable income attributable to this portion 
includes (1) the items of income, loss, or deduction allocated 
to it as an S corporation shareholder under the rules of 
subchapter S, (2) gain or loss from the sale of the S 
corporation stock, and (3) to the extent provided in 
regulations, any state or local income taxes and administrative 
expenses of the trust properly allocable to the S corporation 
stock. Otherwise allowable capital losses are allowed only to 
the extent of capital gains.
    In computing the trust's income tax on this portion of the 
trust, no deduction is allowed for amounts distributed to 
beneficiaries, and no deduction or credit is allowed for any 
item other than the items described above. This income is not 
included in the distributable net income of the trust, and thus 
is not included in the beneficiaries' income. No item relating 
to the S corporation stock could be apportioned to any 
beneficiary.
    On the termination of all or any portion of an electing 
small business trust the loss carryovers or excess deductions 
referred to in section 642(h) is taken into account by the 
entire trust, subject to the usual rules on termination of the 
entire trust.

             Treatment of remainder of items held by trust

    In determining the tax liability with regard to the 
remaining portion of the trust, the items taken into account by 
the subchapter S portion of the trust are disregarded. Although 
distributions from the trust are deductible in computing the 
taxable income on this portion of the trust, under the usual 
rules of subchapter J, the trust's distributable net income 
does not include any income attributable to the S corporation 
stock.

 Termination of trust and conforming amendment applicable to all trusts

    Where the trust terminates before the end of the S 
corporation's taxable year, the trust takes into account its 
pro rata share of S corporation items for its final year. The 
provision makes a conforming amendment applicable to all trusts 
and estates clarifying that this is the present-law treatment 
of trusts and estates that terminate before the end of the S 
corporation's taxable year.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

3. Expansion of post-death qualification for certain trusts (sec. 1303 
        of the bill and sec. 1361 of the Code)

                              Present law

    Under present law, trusts other than grantor trusts, voting 
trusts, certain testamentary trusts and ``qualified subchapter 
S trusts'' may not be shareholders in an S corporation. A 
grantor trust may remain an S corporation shareholder for 60 
days after the death of the grantor. The 60-day period is 
extended to 2 years if the entire corpus of the trust is 
includible in the gross estate of the deemed owner. In 
addition, a trust may be an S corporation shareholder for 60 
days after the transfer of the S corporation stock pursuant to 
a will.

                           Reasons for change

    The Committee believes that the 60-day holding period 
applicable to certain testamentary trusts should be expanded to 
facilitate estate administration.

                        Explanation of provision

    The provision expands the post-death holding period to 2 
years for all testamentary trusts.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

4. Financial institutions permitted to hold safe harbor debt (sec. 1304 
        of the bill and sec. 1361 of the Code)

                              Present law

    A small business corporation eligible to be an S 
corporation may not have more than one class of stock. Certain 
debt (``straight debt'') is not treated as a second class of 
stock so long as such debt is an unconditional promise to pay 
on demand or on a specified date a sum certain in money if: (1) 
the interest rate (and interest payment dates) are not 
contingent on profits, the borrower's discretion, or similar 
factors; (2) there is no convertibility (directly or 
indirectly) into stock, and (3) the creditor is an individual 
(other than a nonresident alien), an estate, or certain 
qualified trusts.

                           Reasons for change

    The Committee believes that bona fide debt that is held by 
a financial institution should be able to satisfy the 
``straight debt'' safe harbor.

                        Explanation of provision

    The definition of ``straight debt'' is expanded to include 
debt held by creditors, other than individuals, that are 
actively and regularly engaged in the business of lending 
money.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

5. Rules relating to inadvertent terminations and invalid elections 
        (sec. 1305 of the bill and sec. 1362 of the Code)

                              Present law

    Under present law, if the Internal Revenue Service 
(``IRS'') determines that a corporation's Subchapter S election 
is inadvertently terminated, the IRS can waive the effect of 
the terminating event for any period if the corporation timely 
corrects the event and if the corporation and shareholders 
agree to be treated as if the election had been in effect for 
that period. Such waivers generally are obtained through the 
issuance of a private letter ruling. Present law does not grant 
the IRS the ability to waive the effect of an inadvertent 
invalid Subchapter S election.
    In addition, under present law, a small business 
corporation must elect to be an S corporation no later than the 
15th day of the third month of the taxable year for which the 
election is effective. The IRS may not validate a late 
election.

                           Reasons for change

    The Committee believes that the Secretary of the Treasury 
should have the same authority to validate inadvertently 
defective subchapter S elections as it has for inadvertent 
subchapter S terminations.

                        Explanation of provision

    Under the provision, the authority of the IRS to waive the 
effect of an inadvertent termination is extended to allow the 
IRS to waive the effect of an invalid election caused by an 
inadvertent failure to qualify as a small business corporation 
or to obtain the required shareholder consents (including 
elections regarding qualified subchapter S trusts), or both. 
The provision also allows the IRS to treat a late Subchapter S 
election as timely where the IRS determines that there was 
reasonable cause for the failure to make the election timely. 
The IRS may exercise this authority in cases where the taxpayer 
never filed an election. It is intended that the IRS be 
reasonable in exercising this authority and apply standards 
that are similar to those applied under present law to 
inadvertent subchapter S terminations and other late or invalid 
elections.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1982.58
---------------------------------------------------------------------------
    \58\ This is the effective date of the present-law provision 
regarding inadvertent terminations.
---------------------------------------------------------------------------

6. Agreement to terminate year (sec. 1306 of the bill and sec. 1377 of 
        the Code)

                              Present law

    In general, each item of S corporation income, deduction 
and loss is allocated to shareholders on a per-share, per-day 
basis. However, if any shareholder terminates his or her 
interest in an S corporation during a taxable year, the S 
corporation, with the consent of all its shareholders, may 
elect to allocate S corporation items by closing its books as 
of the date of such termination rather than applying the per-
share, per-day rule.

                           Reasons for change

    The Committee believes that the election to close the books 
of an S corporation does not need the consent of shareholders 
whose tax liability is unaffected by the election.

                        Explanation of provision

    The provision provides that, under regulations to be 
prescribed by the Secretary of the Treasury, the election to 
close the books of the S corporation upon the termination of a 
shareholder's interest is made by all affected shareholders and 
the corporation, rather than by all shareholders. The closing 
of the books applies only to the affected shareholders. For 
this purpose, ``affected shareholders'' means any shareholder 
whose interest is terminated and all shareholders to whom such 
shareholder has transferred shares during the year. If a 
shareholder transferred shares to the corporation, ``affected 
shareholders'' includes all persons who were shareholders 
during the year.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

7. Expansion of post-termination transition period (sec. 1307 of the 
        bill and secs. 1377 and 6037 of the Code)

                              Present law

    Distributions made by a former S corporation during its 
post-termination transition period are treated in the same 
manner as if the distributions were made by an S corporation 
(e.g., treated by shareholders as nontaxable distributions to 
the extent of the accumulated adjustment account). 
Distributions made after the post-termination transition period 
are generally treated as made by a C corporation (i.e., treated 
by shareholders as taxable dividends to the extent of earnings 
and profits).
    The ``post-termination transition period'' is the period 
beginning on the day after the last day of the last taxable 
year of the S corporation and ending on the later of: (1) a 
date that is one year later, or (2) the due date for filing the 
return for the last taxable year and the 120-day period 
beginning on the date of a determination that the corporation's 
S corporation election had terminated for a previous taxable 
year.
    In addition, the audit procedures adopted by the Tax Equity 
and Fiscal Responsibility Act of 1982 (``TEFRA'') with respect 
to partnerships also apply to S corporations. Thus, the tax 
treatment of items is determined at the corporate, rather than 
individual level.

                           Reasons for change

    The Committee believes that the current scope of the 
``post-termination transition period'' is insufficient under 
present law. In addition, the Committee believes that the TEFRA 
audit procedures should be inapplicable to entities with a 
limited number of owners.

                        Explanation of provision

    The present-law definition of ``post-termination transition 
period'' is expanded to include the 120-day period beginning on 
the date of any determination pursuant to an audit of the 
taxpayer that follows the termination of the S corporation's 
election and that adjusts a subchapter S item of income, loss 
or deduction of the S corporation during the S period. In 
addition, the definition of ``determination'' is expanded to 
include a final disposition of the Secretary of the Treasury of 
a claim for refund and, under regulations, certain agreements 
between the Secretary and any person, relating to the tax 
liability of the person.
    In addition, the provision repeals the TEFRA audit 
provisions applicable to S corporations and would provide other 
rules to require consistency between the returns of the S 
corporation and its shareholders.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

8. S corporations permitted to hold subsidiaries (sec. 1308 of the bill 
        and secs. 1361 and 1362 of the Code)

                              Present law

    A small business corporation may not be a member of an 
affiliated group of corporations (other than by reason of 
ownership in certain inactive corporations). Thus, an S 
corporation may not own 80 percent or more of the stock of 
another corporation (whether an S corporation or a C 
corporation).
    In addition, a small business corporation may not have as a 
shareholder another corporation (whether an S corporation or a 
C corporation).

                           Reasons for change

    The Committee understands that there are situations where 
taxpayers may wish to separate different trades or businesses 
in different corporate entities. The Committee believes that, 
in such situations, shareholders should be allowed to arrange 
these separate corporate entities under parent-subsidiary 
arrangements as well as brother-sister arrangements.

                        Explanation of provision

                       C corporation subsidiaries

    An S corporation is allowed to own 80 percent or more of 
the stock of a C corporation. The C corporation subsidiary 
could elect to join in the filing of a consolidated return with 
its affiliated C corporations. An S corporation is not allowed 
to join in such election. Dividends received by an S 
corporation from a C corporation in which the S corporation has 
an 80 percent or greater ownership stake are not treated as 
passive investment income for purposes of sections 1362 and 
1375 to the extent the dividends are attributable to the 
earnings and profits of the C corporation derived from the 
active conduct of a trade or business.

                       S corporation subsidiaries

    In addition, an S corporation is allowed to own a qualified 
subchapter S subsidiary. The term ''qualified subchapter S 
subsidiary'' means a domestic corporation that is not an 
ineligible corporation (i.e., a corporation that would be 
eligible to be an S corporation if the stock of the corporation 
were held directly by the shareholders of its parent S 
corporation) if (1) 100 percent of the stock of the subsidiary 
were held by its S corporation parent and (2) the parent elects 
to treat the subsidiary as a qualified subchapter S subsidiary. 
If a subsidiary ceases to be a qualified subchapter S 
subsidiary (either because the subsidiary fails to qualify or 
the parent revokes the election) another such election may not 
be made for the subsidiary by the parent for five years without 
the consent of the Secretary of the Treasury.
    Under the election, the qualified subchapter S subsidiary 
is not treated as a separate corporation and all the assets, 
liabilities, and items of income, deduction, loss, and credit 
of the subsidiary are treated as the assets, liabilities, and 
items of income, deduction, loss, and credit of the parent S 
corporation. Thus, transactions between the S corporation 
parent and qualified subchapter S subsidiary are not taken into 
account and items of the subsidiary (including accumulated 
earnings and profits, passive investment income, built-in 
gains, etc.) are considered to be items of the parent. In 
addition, if a subsidiary ceases to be a qualified subchapter S 
subsidiary (e.g., fails to meet the wholly-owned requirement), 
the subsidiary will be treated as a new corporation acquiring 
all of its assets (and assuming all of its liabilities) 
immediately before such cessation from the parent S corporation 
in exchange for its stock.59
---------------------------------------------------------------------------
    \59\ Similar rules apply with respect to wholly owned subsidiaries 
of real estate investment trusts (``REITs'') under section 856(i) of 
present law.
---------------------------------------------------------------------------
    Under the provision, if an election is made to treat an 
existing corporation (whether or not its stock was acquired 
from another person or previously held by the S corporation) as 
a qualified subchapter S subsidiary, the subsidiary will be 
deemed to have liquidated under sections 332 and 337 
immediately before the election is effective. The built-in 
gains tax under section 1374 and the LIFO recapture tax under 
section 1363(d) may apply where the subsidiary was previously a 
C corporation. Where the stock of the subsidiary was acquired 
by the S corporation in a qualified stock purchase, an election 
under section 338 with respect to the subsidiary may be made.
    Because the parent and each subsidiary corporation that is 
a qualified subchapter S subsidiary are treated for Federal 
income tax purposes as a single corporation, debt issued by a 
subsidiary to a shareholder of the parent corporation will be 
treated as debt of the parent for purposes of determining the 
amount of losses that may flow through to shareholders of the 
parent corporation under section 1366(d)(1)(B). The Secretary 
of the Treasury may prescribe rules as to the order that losses 
pass through where debt of both the parent and subsidiary 
corporations are held by shareholders of the parent. To the 
extent a shareholder of the parent S corporation is not at-risk 
with respect to losses of a subsidiary, the at-risk rules of 
section 465 may cause losses of the subsidiary to be suspended.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

9. Treatment of distributions during loss years (sec. 1309 of the bill 
        and secs. 1366 and 1368 of the Code)

                              Present law

    Under present law, the amount of loss an S corporation 
shareholder may take into account for a taxable year cannot 
exceed the sum of the shareholder's adjusted basis in his or 
her stock of the corporation and the adjusted basis in any 
indebtedness of the corporation to the shareholder. Any excess 
loss is carried forward.
    Any distribution to a shareholder by an S corporation 
generally is tax-free to the shareholder to the extent of the 
shareholder's adjusted basis of his or her stock. The 
shareholder's adjusted basis is reduced by the tax-free amount 
of the distribution. Any distribution in excess of the 
shareholder's adjusted basis is treated as gain from the sale 
or exchange of property.
    Under present law, income (whether or not taxable) and 
expenses (whether or not deductible) serve, respectively, to 
increase and decrease an S corporation shareholder's basis in 
the stock of the corporation. These rules require that the 
adjustments to basis for items of both income and loss for any 
taxable year apply before the adjustment for distributions 
applies.60
---------------------------------------------------------------------------
    \60\ See section 1368(d)(1); H. Rept. 97-826, p. 17; S. Rept. 97-
640, p. 18; Treas. reg. sec. 1.1367-1(e).
---------------------------------------------------------------------------
    These rules limiting losses and allowing tax-free 
distributions up to the amount of the shareholder's adjusted 
basis are similar in certain respects to the rules governing 
the treatment of losses and cash distributions by partnerships. 
Under the partnership rules (unlike the S corporation rules), 
for any taxable year, a partner's basis is first increased by 
items of income, then decreased by distributions, and finally 
is decreased by losses for that year.61
---------------------------------------------------------------------------
    \61\ Treas. reg. sec. 1.704-1(d)(2); Rev. Rul. 66-94, 1966-1 C.B. 
166.
---------------------------------------------------------------------------
    In addition, if the S corporation has accumulated earnings 
and profits,62 any distribution in excess of the amount in 
an ``accumulated adjustments account'' will be treated as a 
dividend (to the extent of the accumulated earnings and 
profits). A dividend distribution does not reduce the adjusted 
basis of the shareholder's stock. The ``accumulated adjustments 
account'' generally is the amount of the accumulated 
undistributed post-1982 gross income less deductions.
---------------------------------------------------------------------------
    \62\ An S corporation may have earnings and profits from years 
prior to its subchapter S election or from pre-1983 subchapter S years.
---------------------------------------------------------------------------

                           Reasons for change

    The Committee believes that the rules regarding the 
treatment of distributions by S corporations during loss years 
should be the same as the rules applicable to partnerships.

                        Explanation of provision

    The provision provides that the adjustments for 
distributions made by an S corporation during a taxable year 
are taken into account before applying the loss limitation for 
the year. Thus, distributions during a year reduce the adjusted 
basis for purposes of determining the allowable loss for the 
year, but the loss for a year does not reduce the adjusted 
basis for purposes of determining the tax status of the 
distributions made during that year.
    The provision also provides that in determining the amount 
in the accumulated adjustment account for purposes of 
determining the tax treatment of distributions made during a 
taxable year by an S corporation having accumulated earnings 
and profits, net negative adjustments (i.e., the excess of 
losses and deductions over income) for that taxable year are 
disregarded.
    The following examples illustrate the application of these 
provisions:
    Example 1.--X is the sole shareholder of corporation A, a 
calendar year S corporation with no accumulated earnings and 
profits. X's adjusted basis in the stock of A on January 1, 
1998, is $1,000 and X holds no debt of A. During 1998, A makes 
a distribution to X of $600, recognizes a capital gain of $200 
and sustains an operating loss of $900. Under the provision, 
X's adjusted basis in the A stock is increased to $1,200 
($1,000 plus $200 capital gain recognized) pursuant to section 
1368(d) to determine the effect of the distribution. X's 
adjusted basis is then reduced by the amount of the 
distribution to $600 ($1,200 less $600) to determine the 
application of the loss limitation of section 1366(d)(1). X is 
allowed to take into account $600 of A's operating loss, which 
reduces X's adjusted basis to zero. The remaining $300 loss is 
carried forward pursuant to section 1366(d)(2).
    Example 2.--The facts are the same as in Example 1, except 
that on January 1, 1998, A has accumulated earnings and profits 
of $500 and an accumulated adjustments account of $200. Under 
the provision, because there is a net negative adjustment for 
the year, no adjustment is made to the accumulated adjustments 
account before determining the effect of the distribution under 
section 1368(c).
    As to A, $200 of the $600 distribution is a distribution of 
A's accumulated adjustments account, reducing the accumulated 
adjustments account to zero. The remaining $400 of the 
distribution is a distribution of accumulated earnings and 
profits (``E&P;'') and reduces A's E&P; to $100. A's accumulated 
adjustments account is then increased by $200 to reflect the 
recognized capital gain and reduced by $900 to reflect the 
operating loss, leaving a negative balance in the accumulated 
adjustment account on January 1, 1999, of $700 (zero plus $200 
less $900).
    As to X, $200 of the distribution is applied against X's 
adjusted basis of $1,200 ($1,000 plus $200 capital gain 
recognized), reducing X's adjusted basis to $1,000. The 
remaining $400 of the distribution is taxable as a dividend and 
does not reduce X's adjusted basis. Because X's adjusted basis 
is $1,000, the loss limitation does not apply to X, who may 
deduct the entire $900 operating loss. X's adjusted basis is 
then decreased to reflect the $900 operating loss. Accordingly, 
X's adjusted basis on January 1, 1999, is $100 ($1,000 plus 
$200 less $200 less $900).

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

10. Treatment of S corporations under subchapter C (sec. 1310 of the 
        bill and sec. 1371 of the Code)

                              Present law

    Present law contains several provisions relating to the 
treatment of S corporations as corporations generally for 
purposes of the Internal Revenue Code.
    First, under present law, the taxable income of an S 
corporation is computed in the same manner as in the case of an 
individual (sec. 1363(b)). Under this rule, the provisions of 
the Code governing the computation of taxable income which are 
applicable only to corporations, such as the dividends received 
deduction, do not apply to S corporations.
    Second, except as otherwise provided by the Internal 
Revenue Code and except to the extent inconsistent with 
subchapter S, subchapter C (i.e., the rules relating to 
corporate distributions and adjustments) applies to an S 
corporation and its shareholders (sec. 1371(a)(1)). Under this 
second rule, provisions such as the corporate reorganization 
provisions apply to S corporations. Thus, a C corporation may 
merge into an S corporation tax-free.
    Finally, an S corporation in its capacity as a shareholder 
of another corporation is treated as an individual for purposes 
of subchapter C (sec. 1371(a)(2)). In 1988, the IRS took the 
position that this rule prevents the tax-free liquidation of a 
C corporation into an S corporation because a C corporation 
cannot liquidate tax-free when owned by an individual 
shareholder.63 In 1992, the IRS reversed its position, 
stating that the prior ruling was incorrect.64
---------------------------------------------------------------------------
    \63\ PLR 8818049 (Feb. 10, 1988).
    \64\ PLR 9245004, (July 28, 1992).
---------------------------------------------------------------------------

                           Reasons for change

    The Committee wishes to clarify that the position taken by 
the IRS in 1992 that allows the tax-free liquidation of a C 
corporation into an S corporation represents the proper policy.

                        Explanation of provision

    The provision repeals the rule that treats an S corporation 
in its capacity as a shareholder of another corporation as an 
individual. Thus, the provision clarifies that the liquidation 
of a C corporation into an S corporation will be governed by 
the generally applicable subchapter C rules, including the 
provisions of sections 332 and 337 allowing the tax-free 
liquidation of a corporation into its parent corporation. 
Following a tax-free liquidation, the built-in gains of the 
liquidating corporation may later be subject to tax under 
section 1374 upon a subsequent disposition. An S corporation 
also will be eligible to make a section 338 election (assuming 
all the requirements are otherwise met), resulting in immediate 
recognition of all the acquired C corporation's gains and 
losses (and the resulting imposition of a tax).
    The repeal of this rule does not change the general rule 
governing the computation of income of an S corporation. For 
example, it does not allow an S corporation, or its 
shareholders, to claim a dividends received deduction with 
respect to dividends received by the S corporation, or to treat 
any item of income or deduction in a manner inconsistent with 
the treatment accorded to individual taxpayers.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

11. Elimination of certain earnings and profits (sec. 1311 of the bill 
        and secs. 1362 and 1375 of the Code)

                              Present law

    Under present law, the accumulated earnings and profits of 
a corporation are not increased for any year in which an 
election to be treated as an S corporation is in effect. 
However, under the subchapter S rules in effect before revision 
in 1982, a corporation electing subchapter S for a taxable year 
increased its accumulated earnings and profits if its earnings 
and profits for the year exceeded both its taxable income for 
the year and its distributions out of that year's earnings and 
profits. As a result of this rule, a shareholder may later be 
required to include in his or her income the accumulated 
earnings and profits when it is distributed by the corporation. 
The 1982 revision to subchapter S repealed this rule for 
earnings attributable to taxable years beginning after 1982 but 
did not do so for previously accumulated S corporation earnings 
and profits.

                           Reasons for change

    The Committee believes that the existence of pre-1983 
earnings and profits of an S corporation unnecessarily 
complicates corporate recordkeeping and constitutes a potential 
trap for the unwary.

                        Explanation of provision

    The provision provides that if a corporation is an S 
corporation for its first taxable year beginning after December 
31, 1996, the accumulated earnings and profits of the 
corporation as of the beginning of that year is reduced by the 
accumulated earnings and profits (if any) accumulated in any 
taxable year beginning before January 1, 1983, for which the 
corporation was an electing small business corporation under 
subchapter S. Thus, such a corporation's accumulated earnings 
and profits are solely attributable to taxable years for which 
an S election was not in effect. This rule is generally 
consistent with the change adopted in 1982 limiting the S 
shareholder's taxable income attributable to S corporation 
earnings to his or her share of the taxable income of the S 
corporation.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

12. Carryover of disallowed losses and deductions under at-risk rules 
        allowed (sec. 1312 of the bill and sec. 1366 of the Code)

                              Present law

    Under section 1366, the amount of loss an S corporation 
shareholder may take into account cannot exceed the sum of the 
shareholder's adjusted basis in his or her stock of the 
corporation and the unadjusted basis in any indebtedness of the 
corporation to the shareholder. Any disallowed loss is carried 
forward to the next taxable year. Any loss that is disallowed 
for the last taxable year of the S corporation may be carried 
forward to the post-termination transition period. The ``post-
termination transition period'' is the period beginning on the 
day after the last day of the last taxable year of the S 
corporation and ending on the later of: (1) a date that is one 
year later, or (2) the due date for filing the return for the 
last taxable year and the 120-day period beginning on the date 
of a determination that the corporation's S corporation 
election had terminated for a previous taxable year.
    In addition, under section 465, a shareholder of an S 
corporation may not deduct losses that are flowed through from 
the corporation to the extent the shareholder is not ``at-
risk'' with respect to the loss. Any loss not deductible in one 
taxable year because of the at-risk rules is carried forward to 
the next taxable year.

                           Reasons for change

    The Committee believes that losses suspended by the at-risk 
rules should be conformed to the treatment of losses suspended 
by the subchapter S basis rules.

                        Explanation of provision

    Losses of an S corporation that are suspended under the at-
risk rules of section 465 are carried forward to the S 
corporation's post-termination transition period.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

13. Adjustments to basis of inherited S stock to reflect certain items 
        of income (sec. 1313 of the bill and sec. 1367 of the Code)

                              Present law

    Income in respect to a decedent (``IRD'') generally 
consists of items of gross income that accrued during the 
decedent's lifetime but were not includible in the decedent's 
income before his or her death under his or her method of 
accounting. IRD is includible in the income of the person 
acquiring the right to receive such item. A deduction for the 
estate tax attributable to an item of IRD is allowed to such 
person (sec. 691(c)). The cost or basis of property acquired 
from a decedent is its fair market value at the date of death 
(or alternate valuation date if that date is elected for estate 
tax purposes). This basis is often referred to as a ``stepped-
up basis.'' Property that constitutes a right to receive IRD 
does not receive a stepped-up basis.
    The basis of a partnership interest or corporate stock 
acquired from a decedent generally is stepped-up at death. 
Under Treasury regulations, the basis of a partnership interest 
acquired from a decedent is reduced to the extent that its 
value is attributable to items constituting IRD (Treas. reg. 
sec. 1.742-1). This rule insures that the items of IRD held by 
a partnership are not later offset by a loss arising from a 
stepped-up basis. Although an S corporation and its 
shareholders generally are taxed in a manner similar to the 
taxation of a partnership and its partners, no comparable 
regulation requires a reduction in the basis of stock in an S 
corporation acquired from a decedent where the S corporation 
holds items of IRD.

                           Reasons for change

    The Committee believes that the present-law treatment of 
IRD items of an S corporation is unclear and that the treatment 
of such items should be similar to the treatment of identical 
items held by a partnership.

                        Explanation of provision

    The provision provides that a person acquiring stock in an 
S corporation from a decedent would treat as IRD his or her pro 
rata share of any item of income of the corporation that would 
have been IRD if that item had been acquired directly from the 
decedent. Where an item is treated as IRD, a deduction for the 
estate tax attributable to the item generally will be allowed 
under the provisions of section 691(c). The stepped-up basis in 
the stock in an S corporation acquired from a decedent is 
reduced by the extent to which the value of the stock is 
attributable to items consisting of IRD. This basis rule is 
comparable to the present-law partnership rule.

                             Effective date

    The provision applies with respect to decedents dying after 
the date of enactment.

14. S corporations eligible for rules applicable to real property 
        subdivided for sale by noncorporate taxpayers (sec. 1314 of the 
        bill and sec. 1237 of the Code)

                              Present law

    Under present-law section 1237, a lot or parcel of land 
held by a taxpayer other than a corporation generally is not 
treated as ordinary income property solely by reason of the 
land being subdivided if (1) such parcel had not previously 
been held as ordinary income property and if in the year of 
sale, the taxpayer did not hold other real property; (2) no 
substantial improvement has been made on the land by the 
taxpayer, a related party, a lessee, or a government; and (3) 
the land has been held by the taxpayer for five years.

                           Reasons for change

    The Committee believes that rules generally applicable to 
individuals should be applicable to S corporations.

                        Explanation of provision

    The provision allows the present-law capital gains 
presumption in the case of land held by an S corporation. It is 
expected that rules similar to the attribution rules for 
partnerships will apply to S corporation (Treas. reg. sec. 
1.1237-1(b)(3)).

                             Effective date

    The provision is effective for sales in taxable years 
beginning after December 31, 1996.

15. Certain financial institutions as eligible corporations (sec. 1315 
        of the bill and sec. 1361 of the Code)

                              Present law

    A small business corporation may elect to be treated as an 
S corporation. A ``small business corporation'' is defined as a 
domestic corporation which is not an ineligible corporation and 
which meets certain other requirements. An ``ineligible 
corporation'' means any corporation which is a member of an 
affiliated group, certain depository financial institutions 
(i.e., banks, domestic savings and loan associations, mutual 
savings banks, and certain cooperative banks), certain 
insurance companies, a section 936 corporation, or a DISC or 
former DISC.

                           Reasons for change

    The Committee believes that any otherwise eligible 
corporation should be allowed to elect to be treated as an S 
corporation regardless of the type of trade or business 
conducted by the corporation, so long as special corporate tax 
benefits provided to such trades or businesses do not flow 
through to individual taxpayers.

                        Explanation of provision

    A bank (as defined in sec. 581) is allowed to be an 
eligible small business corporation unless such institution 
uses a reserve method of accounting for bad debts. Thus, a 
large bank (as defined by sec. 585(c)(2)) that meets all the 
subchapter S eligibility requirements may elect to be treated 
as an S corporation. An otherwise qualified small bank may 
elect to be treated as an S corporation if it uses the specific 
charge-off method of section 166 to account for its bad debts.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1996.

16. Certain tax-exempt entities allowed to be shareholders (sec. 1316 
        of the bill and secs. 404, 512, 1042, and 1361 of the Code)

                              Present law

    A small business corporation may elect to be treated as an 
S corporation. A ``small business corporation'' is defined as a 
domestic corporation which is not an ineligible corporation and 
which does not have (1) more than 35 shareholders; (2) as a 
shareholder, a person (other than certain trusts or estates) 
who is not an individual; (3) a nonresident alien as a 
shareholder; and (4) more than one class of stock. Thus, a tax-
exempt organization described in section 401(a) (relating to 
qualified retirement plan trusts) or section 501(c)(3) 
(relating to certain charitable organizations) cannot be a 
shareholder in an S corporation.
    A tax-exempt organization may be a partner in a 
partnership. If the partnership carries on a trade or business 
that is an unrelated trade or business with respect to the tax- 
exempt organization, the tax-exempt partner is required to 
include its distributed share of income from such trade or 
business as unrelated business taxable income (``UBTI'') (sec. 
512(c)).

                           Reasons for change

    The Committee believes that the present-law prohibition of 
certain tax-exempt organizations being S corporation 
shareholders may inhibit employee ownership of closely-held 
businesses, frustrate estate planning, discourage charitable 
giving, and restrict sources of capital for closely-held 
businesses. The Committee seeks to lift these barriers by 
allowing certain tax-exempt organizations to be shareholders in 
S corporations. However, the provisions of subchapter S were 
enacted in 1958 and substantially modified in 1982 on the 
premise that all income of the S corporation (including all 
gains on the sale of the stock) would be subject to a 
shareholder-level income tax. This underlying premise allows 
the rules governing S corporations to be relatively simple (in 
contrast, for example, to the partnership rules of subchapter 
K) because of the lack of concern about ``transferring'' income 
to non-taxpaying persons. Consistent with this underlying 
premise of subchapter S, the provision treats all the income 
flowing through to a tax-exempt shareholder, and gains and 
losses from the disposition of the stock, as unrelated business 
taxable income.

                        Explanation of provision

    Tax-exempt organizations described in Code sections 401(a) 
and 501(c)(3) (``qualified tax-exempt shareholders'') are 
allowed to be shareholders in S corporations. For purposes of 
determining the number of shareholders of an S corporation, a 
qualified tax-exempt shareholder will count as one shareholder.
    Items of income or loss of an S corporation will flow-
through to qualified tax-exempt shareholders as UBTI, 
regardless of the source or nature of such income (e.g., 
passive income of an S corporation will flow through to the 
qualified tax-exempt shareholders as UBTI.) In addition, gain 
or loss on the sale or other disposition of stock of an S 
corporation by a qualified tax-exempt shareholder will be 
treated as UBTI. If a qualified tax-exempt shareholder has gain 
on the sale of the stock in a C corporation that once was an S 
corporation while held by the shareholder, the tax-exempt 
shareholder will treat as UBTI the amount of gain that the 
shareholder would have recognized had it sold the stock for its 
fair market value as of the last day of the corporation's last 
taxable year as an S corporation.
    In addition, certain special tax rules relating to employee 
stock ownership plans (``ESOPs'') will not apply with respect 
to S corporation stock held by the ESOP. These rules include 
rules relating to certain contributions to ESOPs (sec. 
404(a)(9)), the deduction for dividends paid on employer 
securities (sec. 404(k)), and the rollover of gain on the sale 
of stock to an ESOP (sec. 1042).

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1997.

17. Reelection of subchapter S status (sec. 1317(b) of the bill and 
        sec. 1362 of the Code)

                              Present law

    A small business corporation that terminates its subchapter 
S election (whether by revocation or otherwise) may not make 
another election to be an S corporation for five taxable years 
unless the Secretary of the Treasury consents to such election.

                           Reasons for change

    The Committee believes that, given the changes made by the 
Committee to subchapter S, it is appropriate to allow 
corporations that terminated their elections under subchapter S 
within the last five years to re-elect subchapter S status 
without requiring the consent of the Secretary.

                        Explanation of provision

    For purposes of the five-year rule, any termination of 
subchapter S status in effect immediately before the date of 
enactment of the provision is not be taken into account. Thus, 
any small business corporation that had terminated its S 
corporation election within the five-year period before the 
date of enactment may re-elect subchapter S status upon 
enactment of the provision without the consent of the Secretary 
of the Treasury.

                             Effective date

    The provision is effective for terminations occurring in a 
taxable year beginning before January 1, 1997.

                   Pension Simplification Provisions

A. Simplified Distribution Rules (secs. 1401-1404 of the bill and secs. 
           72(d), 101(b), 401(a)(9), and 402(d) of the Code)

                              Present law

    In general, a distribution of benefits from a tax-favored 
retirement arrangement (i.e., a qualified plan, a qualified 
annuity plan, and a tax-sheltered annuity contract (sec. 403(b) 
annuity)) generally is includible in gross income in the year 
it is paid or distributed under the rules relating to the 
taxation of annuities.

                         Lump-sum distributions

    Lump-sum distributions from qualified plans and qualified 
annuity plans are eligible for special 5-year forward 
averaging. In general, a lump-sum distribution is a 
distribution within one taxable year of the balance to the 
credit of an employee that becomes payable to the recipient 
first, on account of the death of the employee, second, after 
the employee attains age 59\1/2\, third, on account of the 
employee's separation from service, or fourth, in the case of 
self-employed individuals, on account of disability. Lump-sum 
treatment is not available for distributions from a tax-
sheltered annuity.
    A taxpayer is permitted to make an election with respect to 
a lump-sum distribution received on or after the employee 
attains age 59\1/2\ to use 5-year forward income averaging 
under the tax rates in effect for the taxable year in which the 
distribution is made. In general, this election allows the 
taxpayer to pay a separate tax on the lump-sum distribution 
that approximates the tax that would be due if the lump-sum 
distribution were received in 5 equal installments. If the 
election is made, the taxpayer is entitled to deduct the amount 
of the lump-sum distribution from gross income. Only one such 
election on or after age 59\1/2\ may be made with respect to 
any employee.
    Under the Tax Reform Act of 1986 (the ``1986 Act''), 
individuals who attained age 50 by January 1, 1986, can elect 
to use 10-year averaging (under the rates in effect prior to 
the 1986 Act) in lieu of 5-year averaging. In addition, such 
individuals may elect to retain capital gains treatment with 
respect to the pre-1974 portion of a lump sum distribution.

         $5,000 exclusion for employer-provided death benefits

    Under present law, the beneficiary or estate of a deceased 
employee generally can exclude up to $5,000 in benefits paid by 
or on behalf of an employer by reason of the employee's death 
(sec. 101(b)).

                           Recovery of basis

    Amounts received as an annuity under a qualified plan 
generally are includible in income in the year received, except 
to the extent they represent the return of the recipient's 
investment in the contract (i.e., basis). Under present law, a 
pro-rata basis recovery rule generally applies, so that the 
portion of any annuity payment that represents nontaxable 
return of basis is determined by applying an exclusion ratio 
equal to the employee's total investment in the contract 
divided by the total expected payments over the term of the 
annuity.
    Under a simplified alternative method provided by the IRS, 
the taxable portion of qualifying annuity payments is 
determined under a simplified exclusion ratio method.
    In no event can the total amount excluded from income as 
nontaxable return of basis be greater than the recipient's 
total investment in the contract.

                         Required distributions

    Present law provides uniform minimum distribution rules 
generally applicable to all types of tax-favored retirement 
vehicles, including qualified plans and annuities, IRAs, and 
tax-sheltered annuities.
    Under present law, a qualified plan is required to provide 
that the entire interest of each participant will be 
distributed beginning no later than the participant's required 
beginning date (sec. 401(a)(9)). The required beginning date is 
generally April 1 of the calendar year following the calendar 
year in which the plan participant or IRA owner attains age 
70\1/2\. In the case of a governmental plan or a church plan, 
the required beginning date is the later of first, such April 
1, or second, the April 1 of the year following the year in 
which the participant retires.

                           Reasons for change

    In almost all cases, the responsibility for determining the 
tax liability associated with a distribution from a qualified 
plan, tax-sheltered annuity, or IRA rests with the individual 
receiving the distribution. Under present law, this task can be 
burdensome. Among other things, the taxpayer must consider (1) 
whether special tax rules apply that reduce the tax that 
otherwise would be paid, (2) the amount of the taxpayer's basis 
in the plan, annuity, or IRA and the rate at which such basis 
is to be recovered, and (3) whether or not a portion of the 
distribution is excludable from income as a death benefit.
    The number of special rules for taxing pension 
distributions makes it difficult for taxpayers to determine 
which method is best for them and also increases the likelihood 
of error. In addition, the specifics of each of the rules 
create complexity. For example, the present-law rules for 
determining the rate at which a participant's basis in a 
qualified plan is recovered often entail calculations that the 
average participant has difficulty performing. These rules 
require a fairly precise estimate of the period over which 
benefits are expected to be paid. The IRS publication on 
taxation of pension distributions (Publication 939) contains 
over 60 pages of actuarial tables used to determine total 
expected payments.
    The original intent of the income averaging rules for 
pension distributions was to prevent a bunching of taxable 
income because a taxpayer received all of the benefits in a 
qualified plan in a single taxable year. Liberalization of the 
rollover rules in the Unemployment Compensation Amendments of 
1992 increased taxpayers' ability to determine the time of the 
income inclusion of pension distributions, and eliminates the 
need for special rules such as 5-year forward income averaging 
to prevent bunching of income.
    It is inappropriate to require all participants to commence 
distributions by age 70\1/2\ without regard to whether the 
participant is still employed by the employer. However, the 
accrued benefit of employees who retire after age 70\1/2\ 
generally should be actuarially increased to take into account 
the period after age 70\1/2\ in which the employee was not 
receiving benefits.

                       Explanation of provisions

                         Lump-sum distributions

    The bill repeals 5-year averaging for lump-sum 
distributions from qualified plans. Thus, the bill repeals the 
separate tax paid on a lump-sum distribution and also repeals 
the deduction from gross income for taxpayers who elect to pay 
the separate tax on a lump-sum distribution. The bill preserves 
the transition rules adopted in the Tax Reform Act of 1986 
(i.e., 10-year averaging and capital gains treatment for the 
pre-1974 portion of the lump-sum distribution), but not 5-year 
averaging, with respect to lump-sum distributions to 
individuals eligible for such transition rules.

         $5,000 exclusion for employer-provided death benefits

    The bill repeals the $5,000 exclusion for employer-provided 
death benefits.

                           Recovery of basis

    The bill provides that basis recovery on payments from 
qualified plans generally is determined under a method similar 
to the present-law simplified alternative method provided by 
the IRS. The portion of each annuity payment that represents a 
return of basis equals to the employee's total basis as of the 
annuity starting date, divided by the number of anticipated 
payments under the following table:

        Age                                          Number of Payments:
Not more than 55..................................................   360
56-60.............................................................   310
61-65.............................................................   260
66-70.............................................................   210
More than 70......................................................   160

                         Required distributions

    The bill modifies the rule that requires all participants 
in qualified plans to commence distributions by age 70\1/2\ 
without regard to whether the participant is still employed by 
the employer and generally replaces it with the rule in effect 
prior to the Tax Reform Act of 1986. Under the bill, 
distributions generally are required to begin by April 1 of the 
calendar year following the later of first, the calendar year 
in which the employee attains age 70\1/2\ or second, the 
calendar year in which the employee retires. However, in the 
case of a 5-percent owner of the employer, distributions are 
required to begin no later than the April 1 of the calendar 
year following the year in which the 5-percent owner attains 
age 70\1/2\.
    In addition, in the case of an employee (other than a 5-
percent owner) who retires in a calendar year after attaining 
age 70\1/2\, the bill generally requires the employee's accrued 
benefit to be actuarially increased to take into account the 
period after age 70\1/2\ in which the employee was not 
receiving benefits under the plan. Thus, under the bill, the 
employee's accrued benefit is required to reflect the value of 
benefits that the employee would have received if the employee 
had retired at age 70\1/2\ and had begun receiving benefits at 
that time.
    The actuarial adjustment rule and the rule requiring 5-
percent owners to begin distributions after attainment of age 
70\1/2\ does not apply, under the bill, in the case of a 
governmental plan or church plan.

                             Effective date

                         Lump-sum distributions

    The provision is effective for taxable years beginning 
after December 31, 1999.

         $5,000 exclusion for employer-provided death benefits

    The provision applies with respect to decedents dying after 
date of enactment.

                           Recovery of basis

    The provision is effective with respect to annuity starting 
dates beginning 90 days after the date of enactment.

                         Required distributions

    The provision is effective for years beginning after 
December 31, 1996. If a participant is currently receiving 
distributions, but does not have to under the provision, the 
Committee intends that a plan (or annuity contract) could (but 
would not be required to) permit the participant to stop 
receiving distributions until such distributions are required 
under the provision.

            B. Increased Access to Retirement Savings Plans

1. Establish SIMPLE retirement plans for small employers (secs. 1421-
        1422 of the bill and secs. 401(k) and 408(p) of the Code)

                              Present law

    Present law does not contain rules relating to SIMPLE 
retirement plans. However, present law does provide a number of 
ways in which individuals can save for retirement on a tax-
favored basis. These include employer-sponsored retirement 
plans that meet the requirements of the Internal Revenue Code 
(a ``qualified plan'') and individual retirement arrangements 
(``IRAs''). Employees can earn significant retirement benefits 
under employer-sponsored retirement plans. However, in order to 
receive tax-favored treatment, such plans must comply with a 
variety of rules, including complex nondiscrimination and 
administrative rules (including top-heavy rules). Such plans 
are also subject to certain requirements under the labor law 
provisions of the Employee Retirement Income Security Act of 
1974 (``ERISA'').
    IRAs are not subject to the same rules as qualified plans, 
but the amount that can be contributed in any year is 
significantly less. The maximum deductible IRA contribution for 
a year is limited to $2,000. Distributions from IRAs and 
employer-sponsored retirement plans are generally taxable when 
made. In addition, distributions prior to age 59\1/2\ generally 
are subject to an additional 10-percent early withdrawal tax.
    Contributions to an IRA can also be made by an employer at 
the election of an employee under a salary reduction simplified 
employee pension (``SARSEP''). Under SARSEPs, which are not 
qualified plans, employees can elect to have contributions made 
to the SARSEP or to receive the contributions in cash. The 
amount the employee elects to have contributed to the SARSEP is 
not currently includible in income. The annual amount an 
employee can elect to contribute to a SARSEP is limited to 
$9,500 for 1996. This dollar limit is indexed for inflation in 
$500 increments. The election to have amounts contributed to a 
SARSEP or received in cash is available only if at least 50 
percent of the eligible employees of the employer elect to have 
amounts contributed to the SARSEP. In addition, such election 
is available for a taxable year only if the employer 
maintaining the SARSEP had 25 or fewer eligible employees at 
all times during the prior taxable year. Elective deferrals 
under SARSEPs are subject to a special nondiscrimination test.
    Under one type of qualified plan that can be maintained by 
an employer, employees can elect to reduce their taxable 
compensation and have nontaxable contributions made to the 
plan. Such contributions are called elective deferrals, and the 
plans which allow such contributions are called qualified cash 
or deferred arrangements (or ``401(k) plans''). Like SARSEPs, 
the maximum annual amount of elective deferrals that can be 
made by an individual is $9,500 for 1996. A special 
nondiscrimination test applies to elective deferrals. An 
employer may make contributions based on an employee's elective 
contributions. Such contributions are called matching 
contributions, and are subject to a special nondiscrimination 
test similar to the special nondiscrimination test applicable 
to elective deferrals.

                           Reasons for Change

    Retirement plan coverage is lower among small employers 
than among medium and large employers. The Committee believes 
that one of the reasons small employers do not establish tax-
qualified retirement plans is the complexity of rules relating 
to such plans and the cost of complying with such rules. The 
Committee believes it is appropriate to encourage small 
employers to adopt retirement plans by providing a simplified 
retirement plan that is not subject to the complex rules 
applicable to tax-qualified plans.
    Among the rules applicable to tax-qualified plans are 
nondiscrimination rules that help to ensure that plans cover a 
broad range of employees, not just an employer's highly 
compensated employees. The Committee believes that the goal of 
the nondiscrimination rules, broad pension coverage, is an 
important one. Unfortunately, the complicated nature of these 
rules may prevent small employers from establishing any plan. 
The Committee believes that the purposes of the 
nondiscrimination rules will be served in the case of small 
employers if all full-time employees are given the opportunity 
to participate in the plan, the employer is required to match 
employee contributions, and there are limits on the total 
contributions that can be made.
    The Committee believes that employees should be encouraged 
to save for retirement, and thus believes a penalty should be 
imposed on amounts withdrawn within a short period after the 
retirement plan is adopted.

                        Explanation of provision

                               In general

    The bill creates a simplified retirement plan for small 
business called the savings incentive match plan for employees 
(``SIMPLE'') retirement plan. SIMPLE plans can be adopted by 
employers who employed 100 or fewer employees earning at least 
$5,000 in compensation for the preceding year and who do not 
maintain another employer-sponsored retirement plan. A SIMPLE 
plan can be either an IRA for each employee or part of a 
qualified cash or deferred arrangement (``401(k) plan''). If 
established in IRA form, a SIMPLE plan is not subject to the 
nondiscrimination rules generally applicable to qualified plans 
(including the top-heavy rules) and simplified reporting 
requirements apply. Within limits, contributions to a SIMPLE 
plan are not taxable until withdrawn.
    A SIMPLE plan can also be adopted as part of a 401(k) plan. 
In that case, the plan does not have to satisfy the special 
nondiscrimination tests applicable to 401(k) plans and is not 
subject to the top-heavy rules. The other qualified plan rules 
continue to apply.

                  SIMPLE retirement plans in IRA form

            In general
    A SIMPLE retirement plan allows employees to make elective 
contributions to an IRA. Employee contributions have to be 
expressed as a percentage of the employee's compensation, and 
cannot exceed $6,000 per year. The $6,000 dollar limit is 
indexed for inflation in $500 increments.
    Under the bill, the employer is required to satisfy one of 
two contribution formulas. Under the matching contribution 
formula, the employer generally is required to match employee 
elective contributions on a dollar-for-dollar basis up to 3 
percent of the employee's compensation. Under a special rule, 
the employer could elect a lower percentage matching 
contribution for all employees (but not less than 1 percent of 
each employee's compensation). In order for the employer to 
lower the matching percentage for any year, the employer has to 
notify employees of the applicable match within a reasonable 
time before the 60-day election period for the year (described 
below). In addition, a lower percentage cannot be elected for 
more than 2 out of any 5 years.
    Alternatively, for any year, an employer is permitted to 
elect, in lieu of making matching contributions, to make a 2 
percent of compensation nonelective contribution on behalf of 
each eligible employee with at least $5,000 in compensation for 
such year. If such an election were made, the employer has to 
notify eligible employees of the change within a reasonable 
period before the 60-day election period for the year 
(described below). No contributions other than employee 
elective contributions and required employer matching 
contributions (or, alternatively, required employer nonelective 
contributions) can be made to a SIMPLE account.
    Only employers who employed 100 or fewer employees earning 
at least $5,000 in compensation for the preceding year and who 
do not currently maintain a qualified plan can establish SIMPLE 
retirement accounts for their employees. Under a special rule, 
employers are given a 2-year grace period to maintain a SIMPLE 
plan once they are no longer eligible.
    Each employee of the employer who received at least $5,000 
in compensation from the employer during any 2 prior years and 
who is reasonably expected to receive at least $5,000 in 
compensation during the year must be eligible to participate in 
the SIMPLE plan. Nonresident aliens and employees covered under 
a collective bargaining agreement do not have to be eligible to 
participate in the SIMPLE plan. Self-employed individuals can 
participate in a SIMPLE plan.
    All contributions to an employee's SIMPLE account have to 
be fully vested.
    Distributions from a SIMPLE plan generally are taxed as 
under the rules relating to IRAs, except that an increased 
early withdrawal tax (25 percent) applies to distributions 
within the first 2 years the employee first participates in the 
SIMPLE plan.
            Tax treatment of SIMPLE accounts, contributions, and 
                    distributions
    Contributions to a SIMPLE account generally are deductible 
by the employer. In the case of matching contributions, the 
employer will be allowed a deduction for a year only if the 
contributions are made by the due date (including extensions) 
for the employer's tax return. Contributions to a SIMPLE 
account are excludable from the employee's income. SIMPLE 
accounts, like IRAs, are not subject to tax. Distributions from 
a SIMPLE retirement account generally are taxed under the rules 
applicable to IRAs. Thus, they are includible in income when 
withdrawn. Tax-free rollovers can be made from one SIMPLE 
account to another. A SIMPLE account can be rolled over to an 
IRA on a tax-free basis after a two-year period has expired 
since the individual first participated in the SIMPLE plan. To 
the extent an employee is no longer participating in a SIMPLE 
plan (e.g., the employee has terminated employment), the 
employee's SIMPLE account will be treated as an IRA.
    Early withdrawals from a SIMPLE account generally are be 
subject to the 10-percent early withdrawal tax applicable to 
IRAs. However, withdrawals of contributions during the 2-year 
period beginning on the date the employee first participated in 
the SIMPLE plan are subject to a 25-percent early withdrawal 
tax (rather than 10 percent).
    Employer matching or nonelective contributions to a SIMPLE 
account are not treated as wages for employment tax purposes.
            Administrative requirements
    Each eligible employee can elect, within the 60-day period 
before the beginning of any year (or the 60-day period before 
first becoming eligible to participate), to participate in the 
SIMPLE plan (i.e., to make elective deferrals), and to modify 
any previous elections regarding the amount of contributions. 
An employer is required to contribute employees' elective 
deferrals to the employee's SIMPLE account within 30 days after 
the end of the month to which the contributions relate. 
Employees must be allowed to terminate participation in the 
SIMPLE plan at any time during the year (i.e., to stop making 
contributions). The plan can provide that an employee who 
terminates participation cannot resume participation until the 
following year. A plan can permit (but is not required to 
permit) an individual to make other changes to his or her 
salary reduction contribution election during the year (e.g., 
reduce contributions). An employer is permitted to designate a 
SIMPLE account trustee to which contributions on behalf of 
eligible employees are made.
    The bill also amend parts 1 and 4, Subtitle B, Title I of 
ERISA so that only simplified reporting requirements apply to 
SIMPLE plans and so that the employer (and any other plan 
fiduciary) will not be subject to fiduciary liability resulting 
from the employee (or beneficiary) exercising control over the 
assets in the SIMPLE account. For this purpose, an employee (or 
beneficiary) will be treated as exercising control over the 
assets in his or her account upon the earlier of (1) an 
affirmative election with respect to the initial investment of 
any contributions, (2) a rollover contribution (including a 
trustee-to-trustee transfer) to another SIMPLE account or IRA, 
or (3) one year after the SIMPLE account is established. The 
Committee intends that once an employee (or beneficiary) is 
treated as exercising control over his or her SIMPLE account, 
the relief from fiduciary liability would extend to the period 
prior to when the employee (or beneficiary) was deemed to 
exercise control.
            Reporting requirements
    Trustee requirements.--The trustee of a SIMPLE account is 
required each year to prepare, and provide to the employer 
maintaining the SIMPLE plan, a summary description containing 
the following basic information about the plan: the name and 
address of the employer and the trustee; the requirements for 
eligibility; the benefits provided under the plan; the time and 
method of making salary reduction elections; and the procedures 
for and effects of, withdrawals (including rollovers) from the 
SIMPLE account. At least once a year, the trustee is also 
required to furnish an account statement to each individual 
maintaining a SIMPLE account. In addition, the trustee is 
required to file an annual report with the Secretary. A trustee 
who fails to provide any of such reports or descriptions will 
be subject to a penalty of $50 per day until such failure is 
corrected, unless the failure is due to reasonable cause.
    Employer reports.--The employer maintaining a SIMPLE plan 
is required to notify each employee of the employee's 
opportunity to make salary reduction contributions under the 
plan as well as the contribution alternative chosen by the 
employer immediately before the employee becomes eligible to 
make such election. This notice must include a copy of the 
summary description prepared by the trustee. An employer who 
fails to provide such notice will be subject to a penalty of 
$50 per day on which such failure continues, unless the failure 
is due to reasonable cause.
            Definitions
    For purposes of the rules relating to SIMPLE plans, 
compensation means compensation required to be reported by the 
employer on Form W-2, plus any elective deferrals of the 
employee. In the case of a self-employed individual, 
compensation means net earnings from self-employment. The 
$150,000 compensation limit (sec. 401(a)(17)) applies only for 
purposes of the 2 percent of compensation nonelective 
contribution formula.65 The term employer includes the 
employer and related employers. Related employers includes 
trades or businesses under common control (whether incorporated 
or not), controlled groups of corporations, and affiliated 
service groups. In addition, the leased employee rules apply.
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    \65\ So, for example, the maximum employer contribution that can be 
made on behalf of any single eligible employee under the 2 percent of 
compensation nonelective contribution formula is $3,000. By contrast, 
the maximum employer contribution that can be made on behalf of any 
single eligible employee under the matching contribution formula is 
$6,000.
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    For purposes of the rule prohibiting an employer from 
establishing a SIMPLE plan, if the employer has another 
qualified plan, an employer is treated as maintaining a 
qualified plan if the employer (or a predecessor employer) 
maintained a qualified plan with respect to which contributions 
were made, or benefits were accrued, with respect to service 
for any year in the period beginning with the year the SIMPLE 
plan became effective and ending with the year for which the 
determination is being made. A qualified plan includes a 
qualified retirement plan, a qualified annuity plan, a 
governmental plan, a tax-sheltered annuity, and a simplified 
employee pension.

                          SIMPLE 401(k) plans

    In general, under the bill, a cash or deferred arrangement 
(i.e., 401(k) plan), will be deemed to satisfy the special 
nondiscrimination tests applicable to employee elective 
deferrals and employer matching contributions if the plan 
satisfies the contribution requirements applicable to SIMPLE 
plans. In addition, the plan is not subject to the top-heavy 
rules for any year for which this safe harbor is satisfied. The 
plan is subject to the other qualified plan rules.
    The safe harbor is satisfied if, for the year, the employer 
does not maintain another qualified plan and (1) employee's 
elective deferrals are limited to no more than $6,000, (2) the 
employer matches employees' elective deferrals up to 3 percent 
of compensation (or, alternatively, makes a 2 percent of 
compensation nonelective contribution on behalf of all eligible 
employees with at least $5,000 in compensation), and (3) no 
other contributions are made to the arrangement. Contributions 
under the safe harbor have to be 100 percent vested. The 
employer cannot reduce the matching percentage below 3 percent 
of compensation.

                           Repeal of SARSEPs

    Under the bill, the present-law rules permitting SARSEPs no 
longer apply after December 31, 1996, unless the SARSEP was 
established before January 1, 1997. Consequently, an employer 
is not permitted to establish a SARSEP after December 31, 1996. 
SARSEPs established before January 1, 1997, can continue to 
receive contributions under present-law rules, and new 
employees of the employer hired after December 31, 1996, can 
participate in the SARSEP in accordance with such rules.

                             Effective date

    The provisions relating to SIMPLE plans are effective for 
years beginning after December 31, 1996.

2. Tax-exempt organizations eligible under section 401(k) (sec. 1426 of 
        the bill and sec. 401(k) of the Code)

                              Present law

    Under present law, tax-exempt and State and local 
government organizations are generally prohibited from 
establishing qualified cash or deferred arrangements (sec. 
401(k) plans). Qualified cash or deferred arrangements (1) of 
rural cooperatives, (2) adopted by State and local governments 
before May 6, 1986, or (3) adopted by tax-exempt organizations 
before July 2, 1986, are not subject to this prohibition.
    There is no specific statutory provision governing the 
Federal income tax liability of Indian tribes.66 However, 
the Internal Revenue Service (``IRS'') has long taken the 
position that Indian tribal governments, as well as wholly-
owned tribal corporations chartered under Federal law, are not 
taxable entities and, thus, are immune from Federal income 
taxes.67 More recently, the IRS has ruled that any income 
earned by an unincorporated Indian tribal government or 
Federally chartered tribal corporation is not subject to 
Federal income tax, regardless of whether the activities that 
produced the income are conducted on or off the tribe's 
reservation.68
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    \66\ Section 7871 provides that Indian tribal governments are 
treated as States for certain limited tax purposes, such as the 
issuance of certain tax-exempt bonds, certain excise tax exemptions, 
and for eligibility to receive deductible charitable contributions. 
Section 7871 also treats Indian tribal governments as States for 
purposes of the provision that permits State and local government 
educational organizations to maintain tax-sheltered annuity plans (sec. 
403(b)). However, section 7871 does not treat Indian tribal governments 
as States or State governments for purposes of section 401(k).
    \67\ See Rev. Rul. 67-284, 1967-2 C.B. 55; Rev. Rul. 81-295, 1981-2 
C.B. 15.
    \68\ See Rev. Rul. 94-16, 1994-1 C.B. 19; Rev. Rul. 94-65, 1994-2 
C.B. 14.
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                           Reasons for change

    Nongovernmental tax-exempt entities should be permitted to 
maintain qualified cash or deferred arrangements for their 
employees on the same basis as other employers.

                        Explanation of provision

    The bill allows tax-exempt organizations (including, for 
this purpose, Indian tribal governments, a subdivision of an 
Indian tribal government, an agency or instrumentality of an 
Indian tribal government or subdivision thereof, or a 
corporation chartered under Federal, State, or tribal law which 
is owned in whole or in part by any of such entities) to 
maintain qualified cash or deferred arrangements. The bill 
retains the present-law prohibition against the maintenance of 
cash or deferred arrangements by State and local governments, 
except to the extent it may apply to Indian tribal governments.

                             Effective date

    The provision is effective for plan years beginning after 
December 31, 1996. The Committee intends no inference with 
respect to whether Indian tribal governments are permitted to 
maintain qualified cash or deferred arrangements under present 
law.

3. Spousal IRAs (sec. 1427 of the bill and sec. 219 of the Code)

                              Present law

    Within limits, an individual is allowed a deduction for 
contributions to an individual retirement account or an 
individual retirement annuity (an ``IRA''). An individual 
generally is not subject to income tax on amounts held in an 
IRA, including earnings on contributions, until the amounts are 
withdrawn from the IRA.
    Under present law, the maximum deductible contribution that 
can be made to an IRA generally is the lesser of $2,000 or 100 
percent of an individual's compensation (earned income in the 
case of a self-employed individual). In the case of a married 
individual whose spouse has no compensation (or elects to be 
treated as having no compensation), the $2,000 limit on IRA 
contributions is increased to $2,250.

                           Reasons for change

    The Committee is concerned about the national savings rate, 
and believes that individuals should be encouraged to save. The 
Committee believes that the ability to make deductible 
contributions to an IRA is a significant savings incentive. 
However, this incentive is not available to all taxpayers under 
present law. The Committee believes that the present-law rules 
relating to deductible IRAs penalize American homemakers. The 
Committee believes that IRA contributions should be permitted 
for both spouses even though only one spouse works.

                        Explanation of provision

    The bill modifies the present-law rules relating to 
deductible IRAs by permitting deductible IRA contributions of 
up to $2,000 to be made for each spouse (including, for 
example, a homemaker who does not work outside the home) if the 
combined compensation of both spouses is at least equal to the 
contributed amount.

                             Effective date

    The provision is effective for taxable years beginning 
after December 31, 1996.

                    C. nondiscrimination provisions

1. Definition of highly compensated employees and repeal of family 
        aggregation rules (sec. 1431 of the bill and secs. 401(a)(17), 
        404(l), and 414(g) of the Code)

                              Present law

               Definition of highly compensated employee

    An employee, including a self-employed individual, is 
treated as highly compensated if, at any time during the year 
or the preceding year, the employee (1) was a 5-percent owner 
of the employer, (2) received more than $100,000 (for 1996) in 
annual compensation from the employer, (3) received more than 
$66,000 (for 1996) in annual compensation from the employer and 
was one of the top-paid 20 percent of employees during the same 
year, or (4) was an officer of the employer who received 
compensation in excess of $60,000 (for 1996). If, for any year, 
no officer has compensation in excess of the threshold, then 
the highest paid officer of the employer is treated as a highly 
compensated employee.

                        Family aggregation rules

    A special rule applies with respect to the treatment of 
family members of certain highly compensated employees for 
purposes of the nondiscrimination rules applicable to qualified 
plans. Under the special rule, if an employee is a family 
member of either a 5-percent owner or 1 of the top-10 highly 
compensated employees by compensation, then any compensation 
paid to such family member and any contribution or benefit 
under the plan on behalf of such family member is aggregated 
with the compensation paid and contributions or benefits on 
behalf of the 5-percent owner or the highly compensated 
employee in the top-10 employees by compensation. Therefore, 
such family member and employee are treated as a single highly 
compensated employee. An individual is considered a family 
member if, with respect to an employee, the individual is a 
spouse, lineal ascendant or descendant, or spouses of a lineal 
ascendant or descendant of the employee.
    Similar family aggregation rules apply with respect to the 
$150,000 (for 1996) limit on compensation that may be taken 
into account under a qualified plan (sec. 401(a)(17)) and for 
deduction purposes (sec. 404(1)). However, under such 
provisions, only the spouse of the employee and lineal 
descendants of the employee who have not attained age 19 are 
taken into account.

                           Reasons for change

    Under present law, the administrative burden on plan 
sponsors to determine which employees are highly compensated 
can be significant. The various categories of highly 
compensated employees require employers to perform a number of 
calculations that for many employers have largely duplicative 
results.
    The family aggregation rules impose undue restrictions on 
the ability of a family-owned small business to provide 
adequate retirement benefits for all members of the family 
working for the business. In addition, the complexity of the 
calculations required under the family aggregation rules 
appears to be unnecessary in light of the numerous other 
provisions that ensure that qualified pension plans do not 
disproportionately favor highly compensated employees.

                       Explanation of provisions

               Definition of highly compensated employee

    Under the bill, an employee is treated as highly 
compensated if the employee (1) was a 5-percent owner of the 
employer at any time during the year or the preceding year or 
(2) had compensation for the preceding year in excess of 
$80,000 (indexed for inflation). The bill also repeals the rule 
requiring the highest paid officer to be treated as a highly 
compensated employee.

                        Family aggregation rules

    The bill repeals the family aggregation rules.

                             Effective date

    The provisions are effective for years beginning after 
December 31, 1996.

2. Modification of additional participation requirements (sec. 1432 of 
        the bill and sec. 401(a)(26) of the Code)

                               Present law

    Under present law, a plan is not a qualified plan unless it 
benefits no fewer than the lesser of (a) 50 employees of the 
employer or (b) 40 percent of all employees of the employer 
(sec. 401(a)(26)). This requirement may not be satisfied by 
aggregating comparable plans, but may be applied separately to 
different lines of business of the employer. A line of business 
of the employer does not qualify as a separate line of business 
unless it has at least 50 employees.

                           Reasons for change

    The minimum participation rule was adopted in the Tax 
Reform Act of 1986 because the Congress believed that it was 
inappropriate to permit an employer to maintain multiple plans, 
each of which covered a very small number of employees. 
Although plans that are aggregated for nondiscrimination 
purposes are required to satisfy comparability requirements 
with respect to the amount of contributions or benefits, such 
an arrangement may still discriminate in favor of highly 
compensated employees.
    However, it is appropriate to better target the minimum 
participation rule by limiting the scope of the rule to defined 
benefit pension plans and increasing the minimum number of 
employees required to be covered under very small plans.
    Also, the arbitrary requirement that a line of business 
must have at least 50 employees requires application of the 
minimum participation rule on an employer-wide basis in some 
cases in which the employer truly has separate lines of 
business.

                        Explanation of provision

    The bill provides that the minimum participation rule 
applies only to defined benefit pension plans. In addition, the 
bill provides that a defined benefit pension plan does not 
satisfy the rule unless it benefits no fewer than the lesser of 
(1) 50 employees or (2) the greater of (a) 40 percent of all 
employees of the employer or (b) 2 employees (1 employee if 
there is only 1 employee).
    The bill provides that the requirement that a line of 
business has at least 50 employees does not apply in 
determining whether a plan satisfies the minimum participation 
rule on a separate line of business basis.

                             Effective date

    The provision is effective for years beginning after 
December 31, 1996.

3. Nondiscrimination rules for qualified cash or deferred arrangements 
        and matching contributions (sec. 1433 of the bill and secs. 
        401(k) and 401(m) of the Code)

                              Present law

    Under present law, a special nondiscrimination test applies 
to qualified cash or deferred arrangements (sec. 401(k) plans). 
The special nondiscrimination test is satisfied if the actual 
deferral percentage (``ADP'') for eligible highly compensated 
employees for a plan year is equal to or less than either (1) 
125 percent of the ADP of all nonhighly compensated employees 
eligible to defer under the arrangement or (2) the lesser of 
200 percent of the ADP of all eligible nonhighly compensated 
employees or such ADP plus 2 percentage points.
    Employer matching contributions and after-tax employee 
contributions under qualified defined contribution plans are 
subject to a special nondiscrimination test (the actual 
contribution percentage (``ACP'') test) similar to the special 
nondiscrimination test applicable to qualified cash or deferred 
arrangements. Employer matching contributions that satisfy 
certain requirements can be used to satisfy the ADP test, but, 
to the extent so used, such contributions cannot be considered 
when calculating the ACP test.
    A plan that would otherwise fail to meet the special 
nondiscrimination test for qualified cash or deferred 
arrangements is not treated as failing such test if excess 
contributions (with allocable income) are distributed to the 
employee or, in accordance with Treasury regulations, 
recharacterized as after-tax employee contributions. For 
purposes of this rule, in determining the amount of excess 
contributions and the employees to whom they are allocated, the 
elective deferrals of highly compensated employees are reduced 
in the order of their actual deferral percentage beginning with 
those highly compensated employees with the highest actual 
deferral percentages. A similar rule applies to employer 
matching contributions.

                           Reasons for change

    The sources of complexity generally associated with the 
nondiscrimination requirements for qualified cash or deferred 
arrangements and matching contributions are the recordkeeping 
necessary to monitor employee elections, the calculations 
involved in applying the tests, and the correction mechanism, 
i.e., what to do if the plan fails the tests.
    The Committee believes that the complexity of 
nondiscrimination requirements, particularly after the Tax 
Reform Act of 1986 changes that imposed a dollar cap on 
elective deferrals ($9,500 in 1996), is not justified by the 
marginal additional participation of rank-and-file employees 
that might be achieved by the operation of these requirements. 
The result that the nondiscrimination rules are intended to 
produce can also be achieved by creating an incentive for 
employers to provide certain matching contributions or 
nonelective contributions on behalf of rank-and-file employees. 
Such contributions should create a sufficient inducement to 
rank-and-file employee participation. Thus, the Committee 
believes it is appropriate to provide a design-based safe 
harbor for qualified cash or deferred arrangements. Plans that 
satisfy the safe harbors would not have to satisfy the 
nondiscrimination tests for cash or deferred arrangements.
    In addition, the significant simplification that a design-
based safe harbor test achieves may reduce the complexity of 
the qualified cash or deferred arrangement requirements enough 
to encourage additional employers to establish such plans, 
thereby expanding employee access to voluntary retirement 
savings arrangements. The adoption of a nondiscrimination safe 
harbor that eliminates the testing of actual plan contributions 
removes a significant administrative burden that may act as a 
deterrent to employers who would not otherwise set up such a 
plan. Thus, the adoption of a simpler nondiscrimination test 
may encourage more employers, particularly small employers, who 
do not now provide any tax-favored retirement plan for their 
employees, to set up such plans.
    A design-based nondiscrimination test provides certainty to 
an employer and plan participants that does not exist under 
present law. Under such a test, an employer will know at the 
beginning of each plan year whether the plan satisfies the 
nondiscrimination requirements for the year.
     Simplifying the nondiscrimination tests will also reduce 
administrative burdens for those plans that do not utilize the 
safe harbor.

                        Explanation of provisions

                            Prior-year data

     The bill modifies the special nondiscrimination tests 
applicable to elective deferrals and employer matching and 
after-tax employee contributions to provide that the maximum 
permitted actual deferral percentage (and actual contribution 
percentage) for highly compensated employees for the year is 
determined by reference to the actual deferral percentage (and 
actual contribution percentage) for nonhighly compensated 
employees for the preceding, rather than the current, year. A 
special rule applies for the first plan year.
     Alternatively, under the bill, an employer is allowed to 
elect to use the current year actual deferral percentage (and 
actual contribution percentage). Such an election can be 
revoked only as provided by the Secretary.

             Safe harbor for cash or deferred arrangements

     The bill provides that a cash or deferred arrangement 
satisfies the special nondiscrimination tests if the plan 
satisfies one of two contribution requirements and satisfies a 
notice requirement.
     A plan satisfies the contribution requirements under the 
safe harbor rule for qualified cash or deferred arrangements if 
the plan either first, satisfies a matching contribution 
requirement or second, the employer makes a nonelective 
contribution to a defined contribution plan of at least 3 
percent of an employee's compensation on behalf of each 
nonhighly compensated employee who is eligible to participate 
in the arrangement without regard to whether the employee makes 
elective contributions under the arrangement.
     A plan satisfies the matching contribution requirement if, 
under the arrangement: first, the employer makes a matching 
contribution on behalf of each nonhighly compensated employee 
that is equal to (a) 100 percent of the employee's elective 
contributions up to 3 percent of compensation and (b) 50 
percent of the employee's elective contributions from 3 to 5 
percent of compensation; and second, the rate of match with 
respect to any elective contribution for highly compensated 
employees is not greater than the rate of match for nonhighly 
compensated employees.
     Alternatively, if the rate of matching contribution with 
respect to any rate of elective contribution requirement is not 
equal to the percentages described in the preceding paragraph, 
the matching contribution requirement will be deemed to be 
satisfied if first, the rate of an employer's matching 
contribution does not increase as an employee's rate of 
elective contribution increases and second, the aggregate 
amount of matching contributions at such rate of elective 
contribution at least equals the aggregate amount of matching 
contributions that would be made if matching contributions 
satisfied the above percentage requirements. For example, the 
alternative test will be satisfied if an employer matches 125 
percent of an employee's elective contributions up to the first 
3 percent of compensation, 25 percent of elective deferrals 
from 3 to 4 percent of compensation, and provides no match 
thereafter. However, the alternative test will not be satisfied 
if an employer matches 80 percent of an employee's elective 
contributions up to the first 5 percent of compensation. The 
former example satisfies the alternative test because the 
employer match does not increase and the aggregate amount of 
matching contributions at any rate of elective contribution is 
at least equal to the aggregate amount of matching 
contributions required under the general safe harbor rule.
     Employer matching and nonelective contributions used to 
satisfy the contribution requirements of the safe harbor rules 
are required to be nonforfeitable and are subject to the 
restrictions on withdrawals that apply to an employee's 
elective deferrals under a qualified cash or deferred 
arrangement (sec. 401(k)(2)(B) and (C)). It is intended that 
employer matching and nonelective contributions used to satisfy 
the contribution requirements of the safe harbor rules can be 
used to satisfy other qualified retirement plan 
nondiscrimination rules (except the special nondiscrimination 
test applicable to employer matching contributions (the ACP 
test)). So, for example, a cross-tested defined contribution 
plan that includes a qualified cash or deferred arrangement can 
consider such employer matching and nonelective contributions 
in testing.69
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     69 The Committee intends that if two plans which include qualified 
cash or deferred arrangements are treated as one plan for purposes of 
the nondiscrimination and coverage rules, such qualified cash or 
deferred arrangements will be treated as one qualified cash or deferred 
arrangement for purposes of the safe harbor rules. In such a case, 
unless both qualified cash or deferred arrangements satisfied the safe 
harbor, both qualified cash or deferred arrangements tested together 
will have to satisfy the ADP and ACP tests.
---------------------------------------------------------------------------
     The notice requirement is satisfied if each employee 
eligible to participate in the arrangement is given written 
notice, within a reasonable period before any year, of the 
employee's rights and obligations under the arrangement.

  Alternative method of satisfying special nondiscrimination test for 
                         matching contributions

    The bill provides a safe harbor method of satisfying the 
special nondiscrimination test applicable to employer matching 
contributions (the ACP test). Under this safe harbor, a plan is 
treated as meeting the special nondiscrimination test if first, 
the plan meets the contribution and notice requirements 
applicable under the safe harbor method of satisfying the 
special nondiscrimination requirement for qualified cash or 
deferred arrangements, and second, the plan satisfies a special 
limitation on matching contributions.
    The limitation on matching contributions is satisfied if: 
first, the employer matching contributions on behalf of any 
employee may not be made with respect to employee contributions 
or elective deferrals in excess of 6 percent of compensation; 
second, the rate of an employer's matching contribution does 
not increase as the rate of an employee's contributions or 
elective deferrals increases; and third, the matching 
contribution with respect to any highly compensated employee at 
any rate of employee contribution or elective deferral is not 
greater than that with respect to an employee who is not highly 
compensated.
    Any after-tax employee contributions made under the 
qualified cash or deferred arrangement will continue to be 
tested under the ACP test. Employer matching and nonelective 
contributions used to satisfy the safe harbor rules for 
qualified cash or deferred arrangements cannot be considered in 
calculating such test. However, employer matching and 
nonelective contributions in excess of the amount required to 
satisfy the safe harbor rules for qualified cash or deferred 
arrangements can be taken into account in calculating such 
test.

Distribution of excess contributions and excess aggregate contributions

    The bill provides that the total amount of excess 
contributions (and excess aggregate contributions) is 
determined as under present law, but the distribution of excess 
contributions (and excess aggregate contributions) are required 
to be made on the basis of the amount of contribution by, or on 
behalf of, each highly compensated employee. Thus, excess 
contributions (and excess aggregate contributions) are deemed 
attributable first to those highly compensated employees who 
have the greatest dollar amount of elective deferrals.

                             Effective date

    The provisions relating to use of prior-year data and the 
distribution of excess contributions and excess aggregate 
contributions are effective for years beginning after December 
31, 1996. The provisions providing for a safe harbor for 
qualified cash or deferred arrangements and the alternative 
method of satisfying the special nondiscrimination test for 
matching contributions are effective for years beginning after 
December 31, 1998.

4. Definition of compensation for purposes of the limits on 
        contributions and benefits (sec. 1434 of the bill and sec. 415 
        of the Code)

                              Present law

    Present law imposes limits on contributions and benefits 
under qualified plans based on the type of plan. For purposes 
of these limits, present law provides that the definition of 
compensation generally does not include elective employee 
contributions to certain employee benefit plans.

                           Reasons for change

    The Committee believes that not treating employee elective 
contributions as compensation for purposes of the limits on 
benefits and contributions under qualified plans unduly 
restricts the amount that employees, particularly employees who 
are not highly compensated, can earn under qualified plans.

                        Explanation of provision

    The bill provides that elective deferrals to section 401(k) 
plans and similar arrangements, elective contributions to 
nonqualified deferred compensation plans of tax-exempt 
employers and State and local governments (sec. 457 plans), and 
salary reduction contributions to a cafeteria plan are 
considered compensation for purposes of the limits on 
contributions and benefits.

                             Effective date

    The provision is effective for years beginning after 
December 31, 1997.

                D. Miscellaneous Pension Simplification

1. Plans covering self-employed individuals (sec. 1441 of the bill and 
        sec. 401(d) of the Code)

                              Present law

    Prior to the Tax Equity and Fiscal Responsibility Act of 
1982 (``TEFRA''), different rules applied to retirement plans 
maintained by incorporated employers and unincorporated 
employers (such as partnerships and sole proprietors). In 
general, plans maintained by unincorporated employers were 
subject to special rules in addition to the other qualification 
requirements of the Code. Most, but not all, of this disparity 
was eliminated by TEFRA. Under present law, certain special 
aggregation rules apply to plans maintained by owner employees 
of unincorporated businesses that do not apply to other 
qualified plans (sec. 401(d)(1) and (2)).

                           Reasons for change

    The remaining special aggregation rules for plans 
maintained by unincorporated employers are unnecessary and 
should be eliminated. Applying the same set of rules to all 
types of plans would make the qualification standards easier to 
apply and administer.

                        Explanation of provision

    The bill eliminates the special aggregation rules that 
apply to plans maintained by self-employed individuals that do 
not apply to other qualified plans.

                             Effective date

    The provision is effective for years beginning after 
December 31, 1996.

2. Elimination of special vesting rule for multiemployer plans (sec. 
        1442 of the bill and sec. 411(a) of the Code)

                               Present law

    Under present law, except in the case of multiemployer 
plans, a plan is not a qualified plan unless a participant's 
employer-provided benefit vests at least as rapidly as under 
one of two alternative minimum vesting schedules. A plan 
satisfies the first schedule if a participant acquires a 
nonforfeitable right to 100 percent of the participant's 
accrued benefit derived from employer contributions upon the 
participant's completion of 5 years of service. A plan 
satisfies the second schedule if a participant has a 
nonforfeitable right to at least 20 percent of the 
participant's accrued benefit derived from employer 
contributions after 3 years of service, 40 percent at the end 
of 4 years of service, 60 percent at the end of 5 years of 
service, 80 percent at the end of 6 years of service, and 100 
percent at the end of 7 years of service.
    In the case of a multiemployer plan, a participant's 
accrued benefit derived from employer contributions is required 
to be 100-percent vested no later than upon the participant's 
completion of 10 years of service. This special rule applies 
only to employees covered by the plan pursuant to a collective 
bargaining agreement.

                           Reasons for change

    The present-law vesting rules for multiemployer plans add 
to complexity because there are different vesting schedules for 
different types of plans, and different vesting schedules for 
persons within the same multiemployer plan. In addition, the 
present-law rule prevents some workers from earning a pension 
under a multiemployer plan. Conforming the multiemployer plan 
rules to the rules for other plans would mean that workers 
could earn additional benefits.

                        Explanation of provision

    The bill conforms the vesting rules for multiemployer plans 
to the rules applicable to other qualified plans.

                             Effective date

    The provision is effective for plan years beginning on or 
after the earlier of (1) the later of January 1, 1997, or the 
date on which the last of the collective bargaining agreements 
pursuant to which the plan is maintained terminates, or (2) 
January 1, 1999, with respect to participants with an hour of 
service after the effective date.

3. Distributions under rural cooperative plans (sec. 1443 of the bill 
        and sec. 401(k)(7) of the Code)

                              Present law

    A qualified cash or deferred arrangement can permit 
withdrawals of employee elective deferrals only after the 
earlier of (1) the participant's separation from service, 
death, or disability, (2) termination of the arrangement, or 
(3) in the case of a profit-sharing or stock bonus plan, the 
attainment of age 59\1/2\ or the occurrence of a hardship of 
the participant. In the case of a money purchase pension plan, 
including a rural cooperative plan, withdrawals by participants 
cannot occur upon attainment of age 59\1/2\ or upon hardship.

                           Reasons for change

    It is appropriate to permit qualified cash or deferred 
arrangements of rural cooperatives to permit distributions to 
plan participants under the same circumstances as other 
qualified cash or deferred arrangements. It is also appropriate 
to clarify that certain public utility districts and a national 
association of rural cooperatives should be treated as rural 
cooperatives for this purpose.

                        Explanation of provision

    The bill provides that a rural cooperative plan that 
includes a cash or deferred arrangement may permit 
distributions to plan participants after the attainment of age 
59\1/2\ or on account of hardship. In addition, the definition 
of a rural cooperative is expanded to include certain public 
utility districts.

                             Effective date

    The provision generally is effective for distributions 
after the date of enactment. The modifications to the 
definition of a rural cooperative apply to plan years beginning 
after December 31, 1996.

4. Treatment of governmental plans under section 415 (sec. 1444 of the 
        bill and secs. 415 and 457 of the Code)

                              Present law

    Present law imposes limits on contributions and benefits 
under qualified plans based on the type of plan (sec. 415). 
Certain special rules apply to State and local governmental 
plans under which such plans may provide benefits greater than 
those permitted by the limits on benefits applicable to plans 
maintained by private employers.
    In the case of defined benefit pension plans, the limit on 
the annual retirement benefit is the lesser of (1) 100 percent 
of compensation or (2) $120,000 (indexed for inflation). The 
dollar limit is reduced in the case of early retirement or if 
the employee has less than 10 years of plan participation.

                           Reasons for change

    The limits on contributions and benefits create unique 
problems for plans maintained by public employers.

                        Explanation of provision

    The bill makes the following modifications to the limits on 
contributions and benefits as applied to governmental plans:
    (1) the 100 percent of compensation limitation on defined 
benefit pension plan benefits would not apply; and
    (2) the early retirement reduction and the 10-year phase-in 
of the defined benefit pension plan dollar limit would not 
apply to certain disability and survivor benefits.
    The bill also permits State and local government employers 
to maintain excess benefit plans without regard to the limits 
on unfunded deferred compensation arrangements of State and 
local government employers (sec. 457).

                             Effective date

    The provision is effective for years beginning after 
December 31, 1994. No inference is intended with respect to 
whether a governmental plan complies with the requirements of 
section 415 with respect to years beginning before January 1, 
1995. With respect to such years, the Secretary is directed to 
enforce the requirements of section 415 consistent with the 
provision.

5. Uniform retirement age (sec. 1445 of the bill and sec. 401(a)(5) of 
        the Code)

                              Present law

    A qualified plan generally must provide that payment of 
benefits under the plan must begin no later than 60 days after 
the end of the plan year in which the participant reaches age 
65. Also, for purpose of the vesting and benefit accrual rules, 
normal retirement age generally can be no later than age 65. 
For purposes of applying the limits on contributions and 
benefits (sec. 415), Social Security retirement age is 
generally used as retirement age. The Social Security 
retirement age as used for such purposes is presently age 65, 
but is scheduled to gradually increase.

                           Reasons for change

    Many plans base benefits on social security retirement age 
so that the benefits under the plan complement social security. 
Under present law, plans that do so may fail applicable 
nondiscrimination tests. It is believed that the social 
security retirement age is an appropriate age for use under 
plans maintained by private employers.

                        Explanation of provision

    The bill provides that for purposes of the general 
nondiscrimination rules (sec. 401(a)(4)) the Social Security 
retirement age (as defined in sec. 415) is a uniform retirement 
age and that subsidized early retirement benefits and joint and 
survivor annuities are not treated as not being available to 
employees on the same terms merely because they are based on an 
employee's Social Security retirement age (as defined in sec. 
415).

                             Effective date

    The provision is effective for years beginning after 
December 31, 1996.

6. Contributions on behalf of disabled employees (sec. 1446 of the bill 
        and sec. 415(c)(3) of the Code)

                              Present law

    Under present law, an employer may elect to continue 
deductible contributions to a defined contribution plan on 
behalf of an employee who is permanently and totally disabled. 
For purposes of the limit on annual additions (sec. 415(c)), 
the compensation of a disabled employee is deemed to be equal 
to the annualized compensation of the employee prior to the 
employee's becoming disabled. Contributions are not permitted 
on behalf of disabled employees who were officers, owners, or 
highly compensated before they became disabled.

                           Reasons for change

    It is appropriate to facilitate the provision of benefits 
for disabled employees, if it is done on a nondiscriminatory 
basis.

                        Explanation of provision

    The bill provides that the special rule for contributions 
on behalf of disabled employees is applicable without an 
employer election and to highly compensated employees if the 
defined contribution plan provides for the continuation of 
contributions on behalf of all participants who are permanently 
and totally disabled.

                             Effective date

    The provision is effective for years beginning after 
December 31, 1996.

7. Treatment of deferred compensation plans of State and local 
        governments and tax-exempt organizations (sec. 1447 of the bill 
        and sec. 457(e) of the Code)

                              Present law

    Under a section 457 plan, an employee who elects to defer 
the receipt of current compensation is taxed on the amounts 
deferred when such amounts are paid or made available. The 
maximum annual deferral under such a plan is the lesser of (1) 
$7,500 or (2) 33\1/3\ percent of compensation (net of the 
deferral).
    Amounts deferred under a section 457 plan may not be made 
available to an employee before the earliest of (1) the 
calendar year in which the participant attains age 70\1/2\, (2) 
when the participant is separated from the service with the 
employer, or (3) when the participant is faced with an 
unforeseeable emergency.
    Benefits under a section 457 plan are not treated as made 
available if the participant may elect to receive a lump sum 
payable after separation from service and within 60 days of the 
election. This exception is available only if the total amount 
payable to the participant under the plan does not exceed 
$3,500 and no additional amounts may be deferred under the plan 
with respect to the participant.

                           Reasons for change

    It is appropriate to index the dollar limits on deferrals 
under section 457 plans to maintain the value of the deferral 
and to provide two additional exceptions to the principle of 
constructive receipt with respect to distributions from such 
plans.

                        Explanation of provision

    The bill makes three changes to the rules governing section 
457 plans.
    The bill: (1) permits in-service distributions of accounts 
that do not exceed $3,500 under certain circumstances; (2) 
increases the number of elections that can be made with respect 
to the time distributions must begin under the plan, and (3) 
provides for indexing (in $500 increments) of the dollar limit 
on deferrals.

                             Effective date

    The provision is effective for taxable years beginning 
after December 31, 1996.

8. Trust requirement for deferred compensation plans of State and local 
        governments (sec. 1448 of the bill and sec. 457 of the Code)

                              Present law

    Until deferrals under a section 457 plan are made available 
to a plan participant, such amounts deferred, all property and 
rights purchased with such amounts, and all income attributable 
to such amounts, property, or rights must remain solely the 
property and rights of the employer, subject only to the claims 
of the employer's general creditors.

                           Reasons for change

    The Committee is concerned about the potential for 
employees of certain State and local governments to lose 
significant portions of their retirement savings because their 
employer has chosen to provide benefits through an unfunded 
deferred compensation plan rather than a qualified pension 
plan. Therefore, the Committee finds it appropriate to require 
that benefits under a section 457 plan of a State and local 
government should be held in a trust (or custodial account or 
annuity contract) to insulate the retirement benefits of 
employees from the claims of the employer's creditors.

                        Explanation of provision

    Under the bill, all amounts deferred under a section 457 
plan maintained by a State and local governmental employer have 
to be held in trust (or custodial account or annuity contract) 
for the exclusive benefit of employees. The trust (or custodial 
account or annuity contract) is provided tax-exempt status. 
Amounts will not be considered made available merely because 
they are held in a trust, custodial account, or annuity 
contract.70
---------------------------------------------------------------------------
    \70\ So, for example, the constructive receipt rules contained in 
the Code (secs. 83 and 402(b)) do not apply to amounts deferred under 
the section 457 plan and contributed to the trust.
---------------------------------------------------------------------------

                             Effective date

    The provision generally is effective with respect to 
amounts held on or after the date of enactment. In the case of 
plans in existence on the date of enactment, a trust will not 
need to be established by reason of the provision until January 
1, 1999.

9. Correction of GATT interest and mortality rate provisions in the 
        Retirement Protection Act (sec. 1449 of the bill and sec. 767 
        of the General Agreement on Tariffs and Trade)

                              Present law

    The Retirement Protection Act of 1994, enacted as part of 
the implementing legislation for the General Agreement on 
Tariffs and Trade (``GATT''), modified the actuarial 
assumptions that must be used in adjusting benefits and 
limitations. In general, in adjusting a benefit that is payable 
in a form other than a straight life annuity and in adjusting 
the dollar limitation if benefits begin before age 62, the 
interest rate to be used cannot be less than the greater of 5 
percent or the rate specified in the plan. Under GATT, if the 
benefit is payable in a form subject to the requirements of 
section 417(e)(3), then the interest rate on 30-year Treasury 
securities is substituted for 5 percent. Also under GATT, for 
purposes of adjusting any limit or benefit, the mortality table 
prescribed by the Secretary must be used.
    This provision of GATT is generally effective as of the 
first day of the first limitation year beginning in 1995.
    GATT made similar changes to the interest rate and 
mortality assumptions used to calculate the value of lump-sum 
distributions for purposes of the rule permitting involuntary 
dispositions of certain accrued benefits. In the case of a plan 
adopted and in effect before December 8, 1995, those provisions 
do not apply before the earlier of (1) the date a plan 
amendment applying the new assumption is adopted or made 
effective (whichever is later), or (2) the first day of the 
first plan year beginning after December 31, 1999.

                           Reasons for change

    The Committee is aware that the GATT provisions enacted in 
the 103rd Congress had the result of reducing the benefit 
payments to certain pension plan beneficiaries. The Committee 
believes that it is appropriate to ameliorate this result by 
providing the same transition period for the modifications to 
limits on contributions and benefits to that provided under 
similar GATT provisions, and by providing that the interest 
rate to be used to reduce the dollar limit on benefits under 
section 415 in cases where the participant retires before age 
62 should be the same regardless of the form of benefit.

                        Explanation of provision

    The bill conforms the effective date of the new interest 
rate and mortality assumptions that must be used under section 
415 to calculate the limits on benefits and contributions to 
the effective date of the provision relating to the calculation 
of lump-sum distributions. This rule applies only in the case 
of plans that were adopted and in effect before the date of 
enactment of GATT (December 8, 1994). To the extent plans have 
already been amended to reflect the new assumptions, plan 
sponsors are permitted within 1 year of the date of enactment 
to amend the plan to reverse retroactively such 
amendment.71
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    \71\ The Committee intends that plan sponsors will have flexibility 
in adopting the actuarial assumptions required under GATT. For example, 
plan sponsors are permitted to apply the actuarial assumptions that 
must be used for 415 purposes retroactively as provided under GATT. 
Alternatively, plan sponsors can apply such actuarial assumptions 
prospectively by either (1) providing a benefit equal to (i) the 
accrued benefit as of the effective date of the adoption of the new 
actuarial assumptions determined after applying section 415 using the 
old actuarial assumptions, plus (ii) the benefit accrued after such 
effective date determined after applying section 415 using the new 
actuarial assumptions; or (2) providing a benefit equal to the greater 
of (i) the accrued benefit as the effective date of the adoption of the 
new actuarial assumptions determined after applying section 415 using 
the old actuarial assumptions, or (ii) the entire accrued benefit 
determined after applying section 415 using the new actuarial 
assumptions.
---------------------------------------------------------------------------
    The bill also repeals the GATT provision which requires 
that if the benefit is payable before age 62 in a form subject 
to the requirements of section 417(e)(3) (e.g., lump sum), then 
the interest rate to be used to reduce the dollar limit on 
benefits under section 415 cannot be less than the greater of 
the rate on 30-year Treasury securities or the rate specified 
in the plan. Consequently, regardless of the form of benefit, 
the interest rate to be used cannot be less than the greater of 
5 percent or the rate specified in the plan.

                             Effective date

    The provision is effective as if included in GATT.

10. Multiple salary reduction agreements permitted under section 403(b) 
        (sec. 1450(a) of the bill and sec. 403(b) of the Code)

                              Present law

    Under Treasury regulations, a participant in a tax-
sheltered annuity plan (sec. 403(b)) is not permitted to enter 
into more than one salary reduction agreement in any taxable 
year. These regulations further provide that a salary reduction 
agreement is effective only with respect to amounts ``earned'' 
after the agreement becomes effective, and that a salary 
reduction agreement must be irrevocable with respect to amounts 
earned while the agreement is in effect.
    These restrictions do not apply to other elective deferral 
arrangements such as a qualified cash or deferred arrangement 
(sec. 401(k)). Under present law, employee elective 
contributions to a qualified cash or deferred arrangement are 
not treated as distributed or made available merely because 
such arrangement permits the employee to elect between making 
the contribution or receiving the amount in cash (sec. 
402(e)(3)). Under Treasury regulations, participants in a 
qualified cash or deferred arrangement may enter into more than 
one salary reduction agreement in a taxable year, such an 
agreement is effective with respect to compensation currently 
available to the participant after the agreement becomes 
effective even though previously ``earned,'' and the agreement 
may be revoked by the participant.

                           Reasons for change

    It is appropriate to conform the treatment of salary 
reduction agreements under section 403(b) to the treatment of 
qualified cash or deferred arrangements.

                        Explanation of provision

    The bill clarifies that amounts are not treated as 
distributed or made available merely because a participant 
enters into a salary reduction agreement with respect to a tax-
sheltered annuity plan. In addition, for participants in a tax-
sheltered annuity plan, the frequency that a salary reduction 
agreement may be entered into, the compensation to which such 
agreement applies, and the ability to revoke such agreement 
shall be determined under the rules applicable to qualified 
cash or deferred arrangements.

                             Effective date

    The provision is effective for taxable years beginning 
after December 31, 1995.

11. Treatment of Indian tribal governments under section 403(b) (sec. 
        1450(b) of the bill and sec. 403(b) of the Code)

                              Present law

    Under present law, certain tax-exempt employers and certain 
State and local government educational organizations are 
permitted to maintain tax-sheltered annuity plans (sec. 
403(b)). Indian tribal governments are treated as States for 
this purpose, so certain educational organizations associated 
with a tribal government are eligible to maintain tax-sheltered 
annuity plans.

                           Reasons for change

    The Committee believes that there is some uncertainty under 
present law about the ability of Indian tribal governments to 
establish 403(b) plans for all tribal government employees. 
Following enactment of the Indian Tribal Government Tax Status 
Act of 1982, several insurance companies and financial advisors 
marketed 403(b) plans to tribes representing that the plans 
could be adopted on a tribal-wide basis to cover all employees. 
As a result, many tribes adopted 403(b) plans for their 
employees that are not in compliance with the law. Given this 
uncertainty, the Committee believes it is appropriate to 
requalify such plans. In addition, the Committee believes it is 
appropriate to permit Indian tribal governments to maintain 
tax-sheltered annuity plans in the future.

                        Explanation of provision

    The bill provides that any section 403(b) annuity contract 
purchased in a plan year beginning before January 1, 1997, by 
an Indian tribal government will be treated as purchased by an 
entity permitted to maintain a tax-sheltered annuity plan. The 
bill also provides that such contracts may be rolled over into 
a section 401(k) plan maintained by the Indian tribal 
government.
    In addition, beginning January 1, 1997, Indian tribal 
governments will be permitted to maintain tax-sheltered annuity 
plans.

                             Effective date

    The provision generally is effective on the date of 
enactment, except that the provision permitting Indian tribal 
governments to maintain tax-sheltered annuity plans is 
effective for taxable years beginning after December 31, 1996.

12. Application of elective deferral limit to section 403(b) contracts 
        (sec. 1450(c) of the bill and sec. 403(b) of the Code)

                              Present law

    A tax-sheltered annuity plan must provide that elective 
deferrals made under the plan on behalf of an employee may not 
exceed the annual limit on elective deferrals ($9,500 for 
1996). Plans that do not comply with this requirement may lose 
their tax-favored status.

                           Reasons for change

    The Committee does not believe that employees participating 
in a tax-sheltered annuity plan should be negatively affected 
if other employees violate the annual limit on elective 
deferrals with respect to their individual tax-sheltered 
annuity contracts (or custodial accounts).

                        Explanation of provision

    Under the bill, each tax-sheltered annuity contract, not 
the tax-sheltered annuity plan, must provide that elective 
deferrals made under the contract may not exceed the annual 
limit on elective deferrals. The Committee intends that the 
contract terms be given effect in order for this requirement to 
be satisfied. Thus, for example, if the annuity contract issuer 
takes no steps to ensure that deferrals under the contract do 
not exceed the applicable limit, then the contract will not be 
treated as satisfying section 403(b). The provision is intended 
to make clear that the exclusion of elective deferrals from 
gross income by employees who have not exceeded the annual 
limit on elective deferrals will not be affected to the extent 
other employees exceed the annual limit. However, if the 
occurrence of an uncorrected elective deferral made by an 
employee is attributable to reasonable error, the contract will 
not fail to satisfy section 403(b), and only the portion of the 
elective deferral in excess of the annual limit would be 
includible in gross income.

                             Effective date

    The provision is effective for years beginning after 
December 31, 1995, except that an annuity contract is not 
required to meet any change in any requirement by reason of the 
provision before the 90th day after the date of enactment. The 
Committee intends no inference as to whether the exclusion of 
elective deferrals from gross income by employees who have not 
exceeded the annual limit on elective deferrals is affected to 
the extent other employees exceed the annual limit prior to the 
effective date of this provision.

13. Waiver of minimum waiting period for qualified plan distributions 
        (sec. 1451 of the bill and sec. 417(c) of the Code)

                              Present law

    Under present law, in the case of a qualified joint and 
survivor annuity (``QJSA''), a written explanation of the form 
of benefit must generally be provided to participants no less 
than 30 days and no more than 90 days before the annuity 
starting date. Even if a participant has elected to waive the 
qualified joint and survivor annuity and the spouse has 
consented to the distribution, the distribution from the plan 
cannot be made until 30 days after the written explanation was 
provided to the participant.72
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    \72\ On September 15,1995, Treasury issued temporary regulations 
(T.D. 8620) which provide that a plan may permit a participant to elect 
(with any applicable spousal consent) a distribution with an annuity 
starting date before 30 days have elapsed since the explanation was 
provided, as long as the distribution commences more than seven days 
after the explanation was provided. Consequently, even if the 
participant (and spouse, if applicable) has elected to waive the 
minimum waiting period for receiving a qualified plan distribution, the 
distribution from the plan cannot be made until seven days have elapsed 
since the explanation was provided to the participant.
---------------------------------------------------------------------------

                           Reasons for change

    The Committee believes that the notice period applicable to 
a QJSA should not prevent the payment of benefits if such 
period is waived by the plan participant and, if applicable, 
the participant's spouse.

                        Explanation of provision

    The bill provides that the minimum period between the date 
the explanation of the qualified joint and survivor annuity is 
provided and the annuity starting date does not apply if it is 
waived by the participant and, if applicable, the participant's 
spouse. For example, if the participant has not elected to 
waive the qualified joint and survivor annuity, only the 
participant needs to waive the minimum waiting period.

                             Effective date

    The provision is effective with respect to plan years 
beginning after December 31, 1996.

14. Repeal of combined plan limit (sec. 1452 of the bill and sec. 
        415(e) of the Code)

                              Present law

                          Combined plan limit

    Present law provides limits on contributions and benefits 
under qualified retirement plans based on the type of plan 
(i.e., based on whether the plan is a defined contribution plan 
or a defined benefit pension plan). An overall limit applies if 
an individual is a participant in both a defined benefit 
pension plan and a defined contribution plan (called the 
combined plan limit).

                        Excess distribution tax

    Present law imposes a 15-percent excise tax on excess 
distributions from qualified retirement plans, tax-sheltered 
annuities, and IRAs. Excess distributions are generally the 
aggregate amount of retirement distributions from such plans 
during any calendar year in excess of $150,000 (or $750,000 in 
the case of a lump-sum distribution). An additional 15-percent 
estate tax is also imposed on an individual's excess retirement 
accumulation.

                           Reasons for change

    One of the most significant sources of complexity relating 
to qualified pension plans is the calculation of the combined 
plan limit under section 415(e). Many new employers do not 
establish defined benefit pension plans, which provide 
employees with the greatest retirement income security. One of 
the reasons that defined benefit pension plans are not being 
established is because of the complex rules governing these 
plan and the significant administrative costs entailed in 
maintaining them. Section 415(e) is just one of the deterrents 
to the establishment and maintenance of qualified defined 
benefit pension plans. Thus, the Committee does not believe 
that the administrative costs associated with section 415(e) 
and the complexity of the calculations required are justified. 
Further, the Committee believes that section 415(e) may have 
the effect of discouraging employers from providing adequate 
retirement benefits to their employees.
    The excise tax on excess distributions has a similar 
purpose to the combined plan limit, although it applies to all 
of an individual's retirement distributions, not just those 
from a single employer. The Committee believes that both the 
combined plan limit and the excise tax on excess distributions 
should not apply at the same time.

                        Explanation of provision

                          Combined plan limit

     The bill repeals the combined plan limit.

                        Excess distribution tax

     Until the repeal of the combined plan limit is effective, 
the bill suspends the excise tax on excess distributions. The 
additional estate tax on excess accumulations continues to 
apply.

                             Effective date

    The provision repealing the combined plan limit is 
effective with respect to limitation years beginning after 
December 31, 1999. The provision relating to the excise tax on 
excess distributions is effective with respect to distributions 
received in 1997, 1998, and 1999.

15. Tax on prohibited transactions (sec. 1453 of the bill and sec. 4975 
        of the Code)

                              Present law

    Present law prohibits certain transactions (prohibited 
transactions) between a qualified plan and a disqualified 
person in order to prevent persons with a close relationship to 
the qualified plan from using that relationship to the 
detriment of plan participants and beneficiaries. A two-tier 
excise tax is imposed on prohibited transactions. The initial 
level tax is equal to 5 percent of the amount involved with 
respect to the transaction. If the transaction is not corrected 
within a certain period, a tax equal to 100 percent of the 
amount involved may be imposed.

                           Reasons for change

    The Committee believes it is appropriate to increase the 
initial level prohibited transaction tax to discourage 
disqualified persons from engaging in such transactions.

                        Explanation of provision

    The bill increases the initial-level prohibited transaction 
tax from 5 percent to 10 percent.

                             Effective date

    The provision is effective with respect to prohibited 
transactions occurring after the date of enactment.

16. Treatment of leased employees (sec. 1454 of the bill and sec. 
        414(n) of the Code)

                              Present Law

    An individual (a leased employee) who performs services for 
another person (the recipient) may be required to be treated as 
the recipient's employee for various employee benefit 
provisions, if the services are performed pursuant to an 
agreement between the recipient and any other person (the 
leasing organization) who is otherwise treated as the 
individual's employer (sec. 414(n)). The individual is to be 
treated as the recipient's employee only if the individual has 
performed services for the recipient on a substantially full-
time basis for a year, and the services are of a type 
historically performed by employees in the recipient's business 
field.
    An individual who otherwise would be treated as a 
recipient's leased employee will not be treated as such an 
employee if the individual participates in a safe harbor plan 
maintained by the leasing organization meeting certain 
requirements. Each leased employee is to be treated as an 
employee of the recipient, regardless of the existence of a 
safe harbor plan, if more than 20 percent of an employer's 
nonhighly compensated workforce are leased.

                           Reasons for change

    The leased employee rules are complex and have unexpected 
and sometimes indefensible results, especially as interpreted 
under regulations proposed by the Secretary. For example, under 
the ``historically performed'' standard, the employees and 
partners of a law firm may be the leased employees of a client 
of the firm if they work a sufficient number of hours for the 
client and if it is not unusual for employers in that business 
field to have in-house counsel. While arguably meeting the 
present-law leased employee definition, it is believed that 
situations such as this are outside the intended scope of the 
rules.

                        Explanation of provision

    Under the bill, the present-law ``historically performed'' 
test is replaced with a new test under which an individual is 
not considered a leased employee unless the individual's 
services are performed under primary direction or control by 
the service recipient. As under present law, the determination 
of whether someone is a leased employee is made after 
determining whether the individual is a common-law employee of 
the recipient. Thus, an individual who is not a common-law 
employee of the service recipient could nevertheless be a 
leased employee of the service recipient. Similarly, the fact 
that a person is or is not found to perform services under 
primary direction or control of the recipient for purposes of 
the employee leasing rules is not determinative of whether the 
person is or is not a common-law employee of the recipient.
    Whether services are performed by an individual under 
primary direction or control by the service recipient depends 
on the facts and circumstances. In general, primary direction 
and control means that the service recipient exercises the 
majority of direction and control over the individual. Factors 
that are relevant in determining whether primary direction or 
control exists include whether the individual is required to 
comply with instructions of the service recipient about when, 
where, and how he or she is to perform the services, whether 
the services must be performed by a particular person, whether 
the individual is subject to the supervision of the service 
recipient, and whether the individual must perform services in 
the order or sequence set by the service recipient. Factors 
that generally are not relevant in determining whether such 
direction or control exists include whether the service 
recipient has the right to hire or fire the individual and 
whether the individual works for others.
    For example, an individual who works under the direct 
supervision of the service recipient would be considered to be 
subject to primary direction or control of the service 
recipient even if another company hired and trained the 
individual, had the ultimate (but unexercised) legal right to 
control the individual, paid his wages, withheld his employment 
and income taxes, and had the exclusive right to fire him. 
Thus, for example, temporary secretaries, receptionists, word 
processing personnel and similar office personnel who are 
subject to the day-to-day control of the employer in 
essentially the same manner as a common law employee are 
treated as leased employees if the period of service threshold 
is reached.
    On the other hand, an individual who is a common-law 
employee of Company A who performs services for Company B on 
the business premises of Company B under the supervision of 
Company A would generally not be considered to be under primary 
direction or control of Company B. The supervision by Company A 
must be more than nominal, however, and not merely a mechanism 
to avoid the literal language of the direction or control test.
    An example of the situation in the preceding paragraph 
might be a work crew that comes into a factory to install, 
repair, maintain, or modify equipment or machinery at the 
factory. The work crew includes a supervisor who is an employee 
of the equipment (or equipment repair) company and who has the 
authority to direct and control the crew, and who actually does 
exercise such direction and control. In this situation, the 
supervisor and his or her crew are required to comply with the 
safety and environmental precautions of the manufacturer, and 
the supervisor is in frequent communication with the employees 
of the manufacturer. As another example, certain professionals 
(e.g., attorneys, accountants, actuaries, doctors, computer 
programmers, systems analysts, and engineers) who regularly 
make use of their own judgement and discretion on matters of 
importance in the performance of their services and are guided 
by professional, legal, or industry standards, are not leased 
employees even though the common law employer does not closely 
supervise the professional on a continuing basis, and the 
service recipient requires the services to be performed on site 
and according to certain stages, techniques, and timetables. In 
addition to the example above, outside professionals who 
maintain their own businesses (e.g., attorneys, accountants, 
actuaries, doctors, computer programmers, systems analysts, and 
engineers) generally would not be considered to be subject to 
such primary direction or control.
    Under the direction or control test, clerical and similar 
support staff (e.g., secretaries and nurses in a doctor's 
office) generally would be considered to be subject to primary 
direction or control of the service recipient and would be 
leased employees provided the other requirements of section 
414(n) are met.
    In many cases, the ``historically performed'' test is 
overly broad, and results in the unintended treatment of 
individuals as leased employees. One of the principal purposes 
for changing the leased employee rules is to relieve the 
unnecessary hardship and uncertainty created for employers in 
these circumstances. However, it is not intended that the 
direction or control test enable employers to engage in abusive 
practices. Thus, it is intended that the Secretary interpret 
and apply the leased employee rules in a manner so as to 
prevent abuses. This ability to prevent abuses under the 
leasing rules is in addition to the present-law authority of 
the Secretary under section 414(o). For example, one 
potentially abusive situation exists where the benefit 
arrangements of the service recipient overwhelmingly favor its 
highly compensated employees, the employer has no or very few 
nonhighly compensated common-law employees, yet the employer 
makes substantial use of the services of nonhighly compensated 
individuals who are not its common-law employees.

                             Effective date

    The provision is effective for years beginning after 
December 31, 1996, except that the bill would not apply to 
relationships that have been previously determined by an IRS 
ruling not to involve leased employees. In applying the leased 
employee rules to years beginning before the effective date, it 
is intended that the Secretary use a reasonable interpretation 
of the statute to apply the leasing rules to prevent abuse.

17. Uniform penalty provisions to apply to certain pension reporting 
        requirements (sec. 1455 of the bill and secs. 6652(i) and 
        6724(d) of the Code)

                              Present law

    Any person who fails to file an information report with the 
IRS on or before the prescribed filing date is subject to 
penalties for each failure. A different, flat-amount penalty 
applies for each failure to provide information reports to the 
IRS or statements to payees relating to pension payments.

                           Reasons for change

    Conforming the information-reporting penalties that apply 
with respect to pension payments to the general information-
reporting penalty structure would simplify the overall penalty 
structure through uniformity and provide more appropriate 
information-reporting penalties with respect to pension 
payments.

                        Explanation of provision

    The bill incorporates into the general penalty structure 
the penalties for failure to provide information reports 
relating to pension payments to the IRS and to recipients.

                             Effective date

    The provision is effective with respect to returns and 
statements the due date for which is after December 31, 1996.

18. Retirement benefits of ministers not subject to tax on net earnings 
        from self-employment (sec. 1456 of the bill and sec. 1402(a) of 
        the Code)

                              Present law

    Under present law, certain benefits provided to ministers 
after they retire are subject to self-employment tax.

                           Reasons for change

    The Committee believes that, like retirement benefits paid 
from qualified plans sponsored by private employers, retirement 
benefits paid from church plans to ministers should not be 
subject to self-employment tax. The Committee believes this 
treatment should also apply to the rental value or allowance of 
any parsonage (including utilities) provided after retirement.

                        Explanation of provision

    The bill provides that retirement benefits received from a 
church plan after a minister retires, and the rental value or 
allowance of a parsonage (including utilities) furnished to a 
minister after retirement, are not subject to self-employment 
taxes.

                             Effective date

    The provision is effective for years beginning before, on, 
or after December 31, 1994.

19. Treasury to provide model forms for spousal consent and qualified 
        domestic relations orders (sec. 1457 of the bill and secs. 
        414(p) and 417(a)(2))

                              Present law

    Present law contains a number of rules designed to provide 
income to the surviving spouse of a deceased employee. Under 
these spousal protection rules, defined benefit pension plans 
and money purchase pension plans are required to provide that 
vested retirement benefits with a present value in excess of 
$3,500 are payable in the form of a qualified joint and 
survivor annuity (``QJSA'') or, in the case of a participant 
who dies before the annuity starting date, a qualified 
preretirement survivor annuity (``QPSA'').
    Benefits from a plan subject to the survivor benefit rules 
may be paid in a form other than a QJSA or QPSA if the 
participant waives the QJSA or QPSA (or both) and the 
applicable notice, election, and spousal consent requirements 
are satisfied.
    Present law contains detailed rules regarding the waiver of 
the QJSA or QPSA forms of benefit and the spousal consent 
requirements. Generally an election to waive the QJSA or QPSA 
forms of benefit must be in writing, and, if the participant is 
married on the annuity starting date, must be accompanied by a 
written spousal consent acknowledging the effect of such 
consent and witnessed by a plan representative or notary 
public. Both the participant's waiver and the spousal consent 
must state the specific nonspouse beneficiary who will receive 
the benefit, and, in the case of a QJSA waiver, must specify 
the particular optional form of benefit that will be paid. The 
waiver will not be valid unless the participant has previously 
received a written explanation of (1) the terms and conditions 
of the QJSA or QPSA forms of benefit, (2) the participant's 
right to make, and the effect of, an election to waive these 
forms of benefits, (3) the rights of the participant's spouse, 
and (4) the right to make, and the effect of, a revocation of 
an election to waive these forms of benefits.
    Also, under present law, benefits under a qualified 
retirement plan are subject to prohibitions against assignment 
or alienation of benefits. An exception to this rule generally 
applies in the case of plan benefits paid to a former spouse 
pursuant to a qualified domestic relations order (``QDRO'').

                           Reasons for change

    The Committee recognizes that the rules relating to spousal 
consents and QDROs serve important purposes in protecting 
spousal rights to retirement plan benefits. However, the 
Committee also recognizes that these rules are extremely 
complicated. Consequently, the Committee believes it is 
appropriate to direct the Secretary to develop model forms for 
spousal consent and QDROs so that spouses can more easily 
comply with these important rules.

                        Explanation of provision

Model spousal consent form

    The Secretary is required to develop a model spousal 
consent form, no later than January 1, 1997, waiving the QJSA 
and QPSA forms of benefit. Such form must be written in a 
manner calculated to be understood by the average person, and 
must disclose in plain form whether the waiver is irrevocable 
and that it may be revoked by a QDRO.

                               Model QDRO

    The Secretary is required to develop a model QDRO, no later 
than January 1, 1997, which satisfies the requirements of a 
QDRO under present law, and the provisions of which focus 
attention on the need to consider the treatment of any lump sum 
payment, QJSA, or QPSA.

                             Effective date

    The provision is effective on the date of enactment.

20. Treatment of length of service awards for certain volunteers under 
        section 457 (sec. 1458 of the bill and sec. 457 of the Code)

                              Present law

    Under section 457 of the Code, compensation deferred under 
an eligible deferred compensation plan of a tax-exempt or 
governmental employer that meets certain requirements is not 
includible in gross income until paid or made available. One of 
the requirements for a section 457 plan is that the maximum 
annual amount that can be deferred is the lesser of $7,500 or 
33\1/3\ percent of the individual's taxable compensation. This 
maximum limit is coordinated with the annual limit on elective 
deferrals under qualified cash or deferred arrangements (sec. 
401(k) plans) and under tax-sheltered annuities (sec. 403(b) 
plans), which is $9,500 for 1996. Under this rule, elective 
deferrals to section 401(k) and 403(b) plans are treated as 
amounts deferred under a section 457 plan (and vice versa). 
Thus, for example, if an individual who is a participant in 
both a section 403(b) plan and a section 457 plan elects to 
contribute $2,000 to the 403(b) plan, then the maximum amount 
that can be deferred in that year under the section 457 plan is 
$5,500.
    Another requirement under section 457 is that (until the 
compensation is made available to the participant), all amounts 
of compensation deferred under the plan, all property and 
rights purchased with such amounts, and all income attributable 
to such amounts, property, or rights must remain solely the 
property and rights of the employer, subject only to the claims 
of the employer's general creditors.
    Amounts deferred under plans of tax-exempt and governmental 
employers that do not meet the requirements of section 457 
(other than amounts deferred under tax-qualified retirement 
plans, section 403(b) annuities and certain other plans) are 
includible in gross income in the first year in which there is 
no substantial risk of forfeiture of such amounts.

                           Reasons for change

    The Committee believes it is both appropriate and important 
to allow for the provision of length of service awards to 
volunteer firefighters, and other emergency medical (including 
ambulance services) personnel.

                        Explanation of provision

    Under the bill, the requirements of section 457 do not 
apply to any plan paying solely length of service awards to 
bona fide volunteers (or their beneficiaries) on account of 
fire fighting and prevention, emergency medical, and ambulance 
services performed by such volunteers. An individual is 
considered a ``bona fide volunteer'' if the only compensation 
received by such individual for performing such services is 
reimbursement (or a reasonable allowance) for expenses incurred 
in the performance of such services, or reasonable benefits 
(including length of service awards) and nominal fees for such 
services customarily paid by tax-exempt or governmental 
employers in connection with the performance of such services 
by volunteers. Under the bill, a length of service award plan 
will not qualify for this special treatment under section 457 
if the aggregate amount of length of service awards accruing 
with respect to any year of service for any bona fide volunteer 
exceeds $3,000.
    In addition, any amounts exempt from the requirements of 
section 457 under the bill are not considered wages for 
purposes of the Federal Insurance Contribution Act (``FICA'') 
taxes.

                             Effective date

    The provision applies to accruals of length of service 
awards after December 31, 1996.

21. Date for adoption of plan amendments (sec. 1459 of the bill)

                              Present law

    Plan amendments to reflect amendments to the law generally 
must be made by the time prescribed by law for filing the 
income tax return of the employer for the employer's taxable 
year in which the change in law occurs.

                           Reasons for change

    Plan sponsors should have adequate time to amend plan 
documents.

                        Explanation of provision

    The bill generally provides that any amendments to a plan 
or annuity contract required by the pension simplification 
amendments would not be required to be made before the first 
plan year beginning on or after January 1, 1997. The date for 
amendments is extended to the first plan year beginning on or 
after January 1, 1999, in the case of a governmental plan.

                             Effective date

    The provision is effective on the date of enactment.

                            Other Provisions

                  A. Miscellaneous Revenue Provisions

1. Exempt Alaska from diesel dyeing requirement while Alaska is exempt 
        from similar Clean Air Act dyeing requirement (sec. 1801 of the 
        bill and sec. 4081 of the Code)

                              Present law

    An excise tax totaling 24.3 cents per gallon is imposed on 
diesel fuel. In the case of fuel used in highway 
transportation, 20 cents per gallon is dedicated to the Highway 
Trust Fund. The remaining portion of this tax is imposed on 
transportation generally and is retained in the General Fund.
    The diesel fuel tax is imposed on removal of the fuel from 
a pipeline or barge terminal facility (i.e., at the ``terminal 
rack''). Present law provides that tax is imposed on all diesel 
fuel removed from terminal facilities unless the fuel is 
destined for a nontaxable use and is indelibly dyed pursuant to 
Treasury Department regulations.
    In general, the diesel fuel tax does not apply to non-
transportation uses of the fuel. Off-highway business uses are 
included within this non-transportation use exemption. This 
exemption includes use on a farm for farming purposes and as 
fuel powering off-highway equipment (e.g., oil drilling 
equipment). Use as heating oil also is exempt. (Most fuel 
commonly referred to as heating oil is diesel fuel.) The tax 
also does not apply to fuel used by State and local 
governments, to exported fuels, and to fuel used in commercial 
shipping. Fuel used by intercity buses and trains is partially 
exempt from the diesel fuel tax.
    A similar dyeing regime exists for diesel fuel under the 
Clean Air Act. That Act prohibits the use on highways of diesel 
fuel with a sulphur content exceeding prescribed levels. This 
``high sulphur'' diesel fuel is required to be dyed by the EPA. 
The State of Alaska generally was exempted from the Clean Air 
Act, but not the excise tax, dyeing regime for three years 
(until October 1, 1996) (urban areas) or permanently (remote 
areas).

                           Reasons for change

    Most diesel fuel sold in Alaska is sold for nontaxable, 
off-highway uses. Due to this fact and the Clean Air Act 
provision exempting the State from that Act's dyeing 
requirement, the Committee believes that adequate tax 
compliance in Alaska can be achieved without dyeing diesel fuel 
destined for nontaxable uses.

                        Explanation of provision

    Diesel fuel sold in the State of Alaska will be exempt from 
the diesel dyeing requirement during the period when that State 
is exempt from the Clean Air Act dyeing requirements. Thus, 
subject to a certification procedure to be developed by the 
Treasury Department, undyed diesel fuel which is destined for a 
nontaxable use may be removed from terminals without payment of 
tax through September 30, 1996 (urban areas, unless extended by 
the Environmental Protection Agency) or permanently (remote 
areas).

                             Effective date

    The provision is effective beginning with the first 
calendar quarter after the date of enactment.

2. Application of common paymaster rules to certain agency accounts at 
        State universities (sec. 1802 of the bill and sec. 3121 of the 
        Code)

                              Present law

    In general, the OASDI portion of the Federal Insurance 
Contributions Act (``FICA'') taxes are payable with respect to 
employee remuneration which does not exceed the contribution 
base specified in the law. If an employee works for more than 
one employer during the year, these taxes are payable for each 
employer up to the contribution base.
    Section 3121(s) of the Internal Revenue Code provides an 
exception known as the ``common paymaster'' rule. If two or 
more related corporations concurrently employ the same 
individual and compensate that individual through a common 
paymaster which is one of the corporations, then the common 
paymaster is considered to be the only employer regardless of 
the fact that the individual performed services for other 
related corporations. Thus, the remuneration is subject to 
taxation only up to the contribution base for the total 
remuneration.
    Section 125 of the Social Security Amendments of 1983 
provides that a State university that employs health care 
professionals as faculty members at a medical school and a tax-
exempt faculty practice plan that employs faculty members of 
the medical school are deemed to be related corporations for 
purposes of the common paymaster rule, provided that 30 percent 
or more of the employees of the plan are concurrently employed 
by the medical school. Remuneration that is disbursed by the 
faculty practice plan to an individual employed by both the 
plan and the university which, when added to remuneration 
actually disbursed by the university, exceeds the contribution 
base, will be deemed to have been actually disbursed by the 
university as a common paymaster and not to have been disbursed 
by the faculty practice plan. Current Internal Revenue Service 
interpretation of the statute does not extend the ``common 
paymaster'' exception to apply to circumstances where such 
compensation is made through a university agency account, and 
not directly by a medical school faculty practice plan.

                           Reasons for change

    The Committee believes that the application of the common 
paymaster rule is appropriate under the foregoing circumstances 
where such compensation is made through a university agency 
account.

                        Explanation of provision

    The bill establishes a common paymaster rule in cases where 
a: (1) State or state university provides remuneration pursuant 
to a single contract of employment to certain health care 
professionals as members of its medical school faculty and, (2) 
an agency account at such institution also provides 
remuneration to such health care professionals. The agency 
account must receive funds for the remuneration from a faculty 
practice plan described in section 501(c)(3) of the Code. The 
payments may only be distributed by the agency account to 
faculty members who render patient care at the medical school. 
The faculty members receiving payments must comprise at least 
30 percent of the membership of the faculty practice plan.

                             Effective date

    The provision is effective for remuneration paid after 
December 31, 1996. It is intended that, with respect to years 
before the effective date, the Secretary apply present law in a 
manner consistent with the proposal.

3. Modifications to excise tax on ozone-depleting chemical

            a. Exempt imported recycled halons from the excise tax on 
                    ozone-depleting chemicals (sec. 1803 of the bill 
                    and sec. 4682 of the Code)

                              Present law

    An excise tax is imposed on the sale or use by the 
manufacturer or importer of certain ozone-depleting chemicals 
(Code sec. 4681). The amount of tax generally is determined by 
multiplying the base tax amount applicable for the calendar 
year by an ozone-depleting factor assigned to each taxable 
chemical. The base tax amount is $5.80 per pound in 1996 and 
will increase by 45 cents per pound per year thereafter. The 
ozone-depleting factors for taxable halons are 3 for halon-
1211, 10 for halon-1301, and 6 for halon-2402.
    Taxable chemicals that are recovered and recycled within 
the United States are exempt from tax.

                           Reasons for change

    The Committee recognizes that, under the Clean Air Act as 
amended and under the terms of the Montreal Protocol, domestic 
production of halons generally ceased after 1993. However, 
these chemicals are valuable as fire suppressants, particularly 
in those environments where human life may be endangered. The 
international restriction on production of halons has caused 
some individuals who had used halons in certain fire 
suppression systems to withdraw the halons from those systems 
and make them available for more highly valued uses. The 
Committee believes that the substantial tax on imported halons 
impedes the flow of these recovered and recycled halons to 
their most highly valued uses. The Committee further observes 
that, because production of new halons is banned domestically, 
permitting imported recycled halons to enter the domestic 
market with a rate of tax less than that of new production does 
not place at a disadvantage domestic producers or dealers in 
halons. Therefore, the Committee believes it is appropriate to 
provide comparable tax treatment to imported recycled halons to 
that accorded domestic recycled halons.

                        Explanation of provision

    The bill extends the exemption from tax for domestically 
recovered and recycled ozone-depleting chemicals to imported 
recycled halons. The exemption for imported recycled halons 
applies only to such chemicals imported from countries that are 
signatories to the Montreal Protocol on Substances that Deplete 
the Ozone Layer.
    The Committee recognizes that it is generally impossible to 
distinguish recycled halons from newly manufactured halons. The 
Committee intends that the Secretary of the Treasury, after 
consultation with the Administrator of the Environmental 
Protection Agency, establish a certification procedure drawing 
upon the international regulatory framework for trade in such 
chemicals provided under the Montreal Protocol and its 
subsequent amendments, as ratified by the United States Senate.

                             Effective date

     The provision is effective for chemicals imported after 
December 31, 1996.
            b. Exempt chemicals used in metered-dose inhalers from the 
                    excise tax on ozone-depleting chemicals (sec. 1803 
                    of the bill and sec. 4682 of the Code)

                              Present law

    An excise tax is imposed on the sale or use by the 
manufacturer or importer of certain ozone-depleting chemicals 
(Code sec. 4681). The amount of tax generally is determined by 
multiplying the base tax amount applicable for the calendar 
year by an ozone-depleting factor assigned to each taxable 
chemical. The base tax amount is $5.80 per pound in 1996 and 
will increase by 45 cents per pound per year thereafter.
    A reduced rate of tax of $1.67 per pound applies to 
chemicals used as propellants in metered-dose inhalers (sec. 
4682(g)(4)).

                           Reasons for change

    The Committee recognizes that under the Clean Air Act as 
amended and under the terms of the Montreal Protocol, the use 
of ozone-depleting chemicals as a propellant in metered-dose 
inhalers has been designated as an essential use, permitting 
use of ozone- depleting chemicals as propellants in metered-
dose inhalers despite the general prohibition on such 
chemicals. In light of this, the Committee believes it is 
appropriate to provide a corresponding exemption from tax for 
these important medical uses.

                        Explanation of provision

    The bill exempts chemicals used as propellants in metered-
dose inhalers from the excise tax on ozone-depleting chemicals.

                             Effective date

    The provision is effective for chemicals sold or used seven 
days after the date of enactment.

4. Tax-exempt bonds for the sale of Alaska Power Administration 
        facility (sec. 1804 of the bill and secs. 142 and 147 of the 
        Code)

                              Present law

    Interest on State and local government bonds generally is 
excluded from income unless the bonds are issued to provide 
financing for private parties. Present law includes several 
exceptions, however, that allow tax-exempt bonds to be used to 
provide financing for certain specifically identified private 
purposes (``private activity bonds''), including financing for 
certain facilities for the furnishing of electricity and gas. 
State and local government bonds issued to acquire existing 
output property (other than water facilities) are treated as 
private activity bonds even if a State or local government owns 
or operates the property. Similarly, bonds issued to acquire 
existing property, the output from which will be sold to a 
private party under a take or pay contract are private activity 
bonds.
    Most private activity bonds are subject to annual State 
volume limits of the greater of $50 per resident of the State 
or $150 million. Additionally, persons acquiring property 
financed with most private activity bonds must satisfy a 
rehabilitation requirement as a condition of the financing.

                           Reasons for change

    Limited tax-exempt financing is an integral component of 
proposed legislation for the sale of certain facilities by the 
Alaska Power Administration. That sale legislation has recently 
been enacted by the Congress. The Committee determined that a 
limited exception to the tax-exempt bond rules is appropriate 
to facilitate completion of this unique transaction.

                        Explanation of provision

    The provision provides an exception from the general 
rehabilitation requirement for private activity bonds used to 
acquire existing property for certain bonds to finance the 
acquisition of the Snettisham hydroelectric project from the 
Alaska Power Administration pursuant to legislation that has 
been enacted authorizing that transaction. Bonds for this 
acquisition will be subject to the State of Alaska's private 
activity bond volume limit.

                             Effective date

    The provision is effective for bonds issued after the date 
of enactment.

5. Allow bank common trust funds to transfer assets to regulated 
        investment companies without taxation (sec. 1805 of the bill 
        and sec. 584 of the Code)

                              Present law

                           Common trust funds

    A common trust fund is a fund maintained by a bank 
exclusively for the collective investment and reinvestment of 
monies contributed by the bank in its capacity as a trustee, 
executor, administrator, guardian, or custodian of certain 
accounts and in conformity with rules and regulations of the 
Board of Governors of the Federal Reserve System or the 
Comptroller of the Currency pertaining to the collective 
investment of trust funds by national banks (sec. 584(a)).
    The common trust fund is not subject to tax and is not 
treated as a corporation (sec. 584(b)). Each participant in a 
common trust fund includes his proportional share of common 
trust fund income, whether or not the income is distributed or 
distributable (sec. 584(c)).
    No gain or loss is realized by the fund upon admission or 
withdrawal of a participant. Participants generally treat their 
admission to the fund as the purchase of an interest. 
Withdrawals from the fund generally are treated as the sale of 
an interest by the participant (sec. 584(e)).

                 Regulated investment companies (RICs)

    A RIC also is treated as a conduit for Federal income tax 
purposes. Conduit treatment is accorded by allowing the RIC a 
deduction for dividend distributions to its shareholders. 
Present law is unclear as to the tax consequences when a common 
trust fund transfers its assets to one or more RICs.

                           Reasons for change

    The Committee understands that administrative costs of 
managing pools of assets can be reduced for many banks if the 
bank utilizes the expertise of professional investment managers 
employed at mutual funds rather than attempting to duplicate 
the same investment management services within the bank. The 
Committee further recognizes that generally both common trust 
funds and mutual funds seek broad diversification of the assets 
contributed by the investors in the common trust fund or the 
mutual fund. Because both the common trust fund and the mutual 
fund are conduit entities for Federal income tax purposes, the 
Committee believes that it would be inappropriate to impose a 
tax when the common trust fund transfers substantially all of 
its assets to one or more RICs, because only the form of the 
investment pool has been changed.

                        Explanation of provision

    In general, the bill permits a common trust fund to 
transfer substantially all of its assets to one or more RICs 
without gain or loss being recognized by the fund or its 
participants. The fund must transfer its assets to the RICs 
solely in exchange for shares of the RICs, and the fund must 
then distribute the RIC shares to the fund's participants in 
exchange for the participant's interests in the fund.
    The basis of any asset received by a RIC will be the basis 
of the asset in the hands of the fund prior to transfer 
(increased by the amount of gain recognized by reason of the 
rule regarding the assumption of liabilities). In addition, the 
basis of any RIC shares (``converted shares'') that are 
received by a fund participant will be an allocable portion of 
the participant's basis in the interests exchanged. If stock in 
more than one RIC is received in exchange for assets of a 
common trust fund, the basis of the shares in each RIC shall be 
determined by allocating the basis of common fund assets used 
in the exchange among the shares of each RIC received in the 
exchange on the basis of the respective fair market values of 
the RICs. For example, assume a common trust fund with basis of 
$100 and market value of $1,000 transfers its assets to two 
RICs, receiving $600 worth of shares in the first RIC and $400 
worth of shares in the second RIC. The basis of first RIC 
shares will be $600 multiplied by $100 divided by $1,000, or 
$60. The basis of the second RIC shares will be $40.
    The tax-free transfer is not available to a common trust 
fund with assets that are not diversified under the 
requirements of section 368(a)(2)(F)(ii), except that the 
diversification test is modified so that Government securities 
are not to be included as securities of an issuer and are to be 
included in determining total assets for purposes of the 25- 
and 50-percent tests.
    No inference is intended as to the tax consequences under 
law in effect prior to the effective date of the provision when 
a common trust fund transfers its assets to one or more RICs.

                             Effective date

    The provision is effective for transfers after December 31, 
1995.

6. Treatment of qualified State tuition programs (sec. 1806 of the bill 
        and new sec. 529 of the Code)

                              Present law

    In Michigan v. United States, 40 F.3d 817 (6th Cir. 1994), 
the Sixth Circuit held that the Michigan Education Trust, an 
entity created by the State of Michigan to operate a prepaid 
tuition payment program, is an integral part of the State, and, 
thus, the investment income realized by the Trust is not 
currently subject to Federal income tax. The Trust was 
established to receive advance payments of college tuition, 
invest the money, and ultimately make disbursements under a 
program that allows beneficiaries to attend any of the State's 
public colleges or universities without further tuition costs 
for a year or more (depending on the terms of the contract).
    Section 115 of the Code provides that gross income does not 
include income derived from any public utility or the exercise 
of any essential governmental function and accruing to a State 
or any political subdivision thereof, or the District of 
Columbia.
    Section 2501 imposes a Federal gift tax on certain 
transfers of property by gift. Section 2503(e) specifically 
excludes from gifts subject to tax under section 2501 any 
``qualified transfer,'' which includes any amount paid on 
behalf of an individual as tuition to an educational 
institution (as described in sec. 170(b)(1)(A)(ii)) for the 
education or training of such individual.
    On June 11, 1996, the Treasury Department issued final 
regulations under the original issue discount (``OID'') 
provisions of the Code (secs. 163(e) and 1271 through 1275), 
including regulations relating to debt instruments that provide 
for contingent payments (see TD 8674). These regulations 
specifically provide that they do not apply to contracts issued 
pursuant to State-sponsored prepaid tuition programs, whether 
or not the contracts are debt instruments. In addition, the IRS 
announced in Rev. Proc. 96-34 that it will not issue advance 
rulings or determination letters regarding State-sponsored 
prepaid tuition plans because issues that arise under such 
plans are being studied.

                           Reasons for change

    The Committee believes that it is appropriate to clarify 
the tax treatment of State-sponsored prepaid tuition and 
educational savings programs in order to encourage persons to 
save to meet post-secondary educational expenses.

                        Explanation of provision

    The bill provides tax-exempt status to ``qualified State 
tuition programs,'' meaning programs established and maintained 
by a State (or agency or instrumentality thereof) under which 
persons may (1) purchase tuition credits or certificates on 
behalf of a designated beneficiary that entitle the beneficiary 
to a waiver or payment of qualified higher education expenses 
of the beneficiary, or (2) make contributions to an account 
that is established for the sole purpose of meeting qualified 
higher education expenses of the designated beneficiary of the 
account. ``Qualified higher education expenses'' are defined as 
tuition, fees, books, and equipment required for the enrollment 
or attendance at a college or university (or certain vocational 
schools). Although generally exempt from Federal income tax, a 
qualified State tuition program is subject to the unrelated 
business income tax (UBIT). 73
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     73  The bill specifically provides that an interest in a qualified 
State tuition program will not be treated as debt for purposes of the 
UBIT debt-financed property rules (sec. 514). Consequently, a qualified 
State tuition program's investment income will not constitute debt-
financed property income subject to the UBIT merely because the program 
accepts contributions and is obligated to pay out (or refund) such 
contributions and certain earnings thereon to designated beneficiaries 
or to contributors. However, investment income of a qualified State 
tuition program could be subject to the UBIT as debt-financed property 
income to the extent the program acquires indebtedness when investing 
the contributions made on behalf of designated beneficiaries.
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    A qualified State tuition program is required to provide 
that purchases or contributions only be made in cash. 
Contributors and beneficiaries are not allowed to direct any 
investments made on their behalf by the program. The program is 
required to maintain a separate accounting for each designated 
beneficiary. A specified individual must be designated as the 
beneficiary at the commencement of participation in a qualified 
State tuition program (i.e., when contributions are first made 
to purchase an interest in such a program 74), unless 
interests in such a program are purchased by a State or local 
government or a tax-exempt charity described in section 
501(c)(3) as part of a scholarship program operated by such 
government or charity under which beneficiaries to be named in 
the future will receive such interests as scholarships. A 
transfer of credits (or other amounts) from one account 
benefiting one designated beneficiary to another account 
benefiting a different beneficiary will be considered a 
distribution (as will a change in the designated beneficiary of 
an interest in a qualified State tuition program) unless the 
beneficiaries are members of the same family. 75 Earnings 
on an account may be refunded to a contributor or beneficiary, 
but the State or instrumentality must impose a more than de 
minimis monetary penalty unless the refund is (1) used for 
qualified higher education expenses of the beneficiary, (2) 
made on account of the death or disability of the beneficiary 
76, or (3) made on account of a scholarship received by 
the designated beneficiary to the extent the amount refunded 
does not exceed the amount of the scholarship used for higher 
education expenses. A qualified State tuition program may not 
allow any interest in the program or any portion thereof to be 
used as security for a loan.
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     74  The bill allows for a change in designated beneficiaries, 
so long as the new beneficiary is a member of the same family as the 
old beneficiary.
     75  For this purpose, the term ``member of the same family'' 
is defined under present-law section 2032A(e)(2).
     76  Thus, a State need not impose a monetary penalty when a 
refund is made from a qualified State tuition program in order to cover 
medical expenses incurred by (or on behalf of) a designated beneficiary 
who suffers a disabling illness (and who could be any member of the 
same family of the originally designated beneficiary).
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    In addition, the bill provides that no amount shall be 
included in the gross income of a contributor to, or 
beneficiary of, a qualified State tuition program with respect 
to any contribution to, or earnings under, such program, except 
that (1) amounts distributed or educational benefits provided 
to a beneficiary (e.g., when the beneficiary attends college) 
will be included in the beneficiary's gross income (unless 
excludable under another Code section) to the extent such 
amount or the value of the educational benefits exceeds 
contributions made on behalf of the beneficiary, and (2) 
amounts distributed to a contributor (e.g., when a parent or 
other relative receives a refund) will be included in the 
contributor's gross income to the extent such amounts exceed 
contributions made by that person. 77
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     77  Specifically, the bill provides that any distribution under a 
qualified State tuition program shall be includible in the gross income 
of the distributee in the same manner as provided under present-law 
section 72 to the extent not excluded from gross income under any other 
provision of the Code.
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    The bill further provides that, for purposes of present-law 
section 2503(e), contributions made by an individual to a 
qualified State tuition program are treated as a qualified 
transfer and, thus, not subject to Federal gift tax.

                             Effective date

    The provision is effective for taxable years ending after 
the date of enactment. The bill also includes a transition rule 
providing that if (1) a State maintains (on the date of 
enactment) a program under which persons may purchase tuition 
credits on behalf of, or make contributions for educational 
expenses of, a designated beneficiary, and (2) such program 
meets the requirements of a qualified State tuition program 
before the later of (a) one year after the date of enactment, 
or (b) the first day of the first calendar quarter after the 
close of the first regular session of the State legislature 
that begins after the date of enactment, then the provisions of 
the bill will apply to contributions (and earnings allocable 
thereto) made before the later of such dates without regard to 
whether the requirements of a qualified State tuition program 
are met with respect to such contributions and earnings (e.g., 
even if the interest in the tuition or educational savings 
program covers not only qualified higher education expenses but 
also room and board expenses).

                            Revenue Offsets

1. Modifications of the Puerto Rico and possession tax credit (sec. 
        1601 of the bill and sec. 936 and new sec. 30A of the Code)

                              Present law

    Certain domestic corporations with business operations in 
the U.S. possessions (including, for this purpose, Puerto Rico 
and the U.S. Virgin Islands) may elect the Puerto Rico and 
possession tax credit which generally eliminates the U.S. tax 
on certain income related to their operations in the 
possessions. In contrast to the foreign tax credit, the Puerto 
Rico and possession tax credit is a ``tax sparing'' credit. 
That is, the credit is granted whether or not the electing 
corporation pays income tax to the possession. Income eligible 
for the credit under this provision falls into two broad 
categories: (1) possession business income, which is derived 
from the active conduct of a trade or business within a U.S. 
possession or from the sale or exchange of substantially all of 
the assets that were used in such a trade or business; and (2) 
qualified possession source investment income (``QPSII''), 
which is attributable to the investment in the possession or in 
certain Caribbean Basin countries of funds derived from the 
active conduct of a possession business.
    In order to qualify for the Puerto Rico and possession tax 
credit for a taxable year, a domestic corporation must satisfy 
two conditions. First, the corporation must derive at least 80 
percent of its gross income for the three-year period 
immediately preceding the close of the taxable year from 
sources within a possession. Second, the corporation must 
derive at least 75 percent of its gross income for that same 
period from the active conduct of a possession business.
    A domestic corporation that has elected the Puerto Rico and 
possession tax credit and that satisfies these two conditions 
for a taxable year generally is entitled to a credit based on 
the U.S. tax attributable to the sum of the taxpayer's 
possession business income and its QPSII. However, the amount 
of the credit attributable to possession business income is 
subject to the limitations enacted by the Omnibus Budget 
Reconciliation Act of 1993. Under the economic activity limit, 
the amount of the credit with respect to such income cannot 
exceed an amount equal to the sum of (i) 60 percent of the 
taxpayer's qualifying wage and fringe benefit expenses, (ii) 
specified percentages of the taxpayer's depreciation allowances 
with respect to qualifying tangible property, and (iii) in 
certain cases, the taxpayer's qualifying possession income 
taxes. The credit calculated under the economic activity limit 
is referred to herein as the ``wage credit.'' In the 
alternative, the taxpayer may elect to apply a limit equal to 
the applicable percentage of the credit that would otherwise be 
allowable with respect to possession business income; the 
applicable percentage is phased down to 50 percent for 1996, 45 
percent for 1997, and 40 percent for 1998 and thereafter. The 
credit calculated under the applicable percentage limit is 
referred to herein as the ``income credit.'' The amount of the 
Puerto Rico and possession tax credit attributable to QPSII is 
not subject to these limitations.

                           Reasons for change

    The tax benefits provided by the Puerto Rico and possession 
tax credit are enjoyed by only the relatively small number of 
U.S. corporations that operate in the possessions. The 
Committee is concerned that the high cost of these tax benefits 
is borne by all U.S. taxpayers. In light of current budget 
constraints, the Committee believes that the tax exemption 
provided to corporations pursuant to the Puerto Rico and 
possession tax credit should be modified.
    The Committee believes that appropriate transition rules 
should be provided for corporations with existing operations in 
the possessions. In this regard, the Committee believes that 
ten years is an appropriate transition period with respect to 
the credit computed without regard to the economic activity 
limit ( i.e, the income credit). On the other hand, the credit 
computed under the economic activity limit ( i.e., the wage 
credit) operates as a credit in the traditional sense, measured 
by the level of employment and other economic activity 
generated by the taxpayer in the possession. Accordingly, the 
Committee believes that it is appropriate to continue the wage 
credit for corporations with existing possession operations 
beyond such ten-year period, subject to a tighter limit on the 
amount of such credit relative to the compensation paid by the 
corporation in the possession. Moreover, the Committee believes 
that it is appropriate to move the wage credit with respect to 
operations in Puerto Rico to a new section of the Code 
contained in the subpart that includes other business-type 
credits.

                        Explanation of provision

                               In general

    The provision generally repeals the Puerto Rico and 
possession tax credit with respect to possession business 
income for taxable years beginning after December 31, 1995. 
However, the provision provides special rules under which a 
corporation that is an existing credit claimant continues to be 
eligible to claim credits under the wage credit method. In 
addition, the provision provides grandfather rules under which 
a corporation that is an existing credit claimant is eligible 
to claim credits under the income credit method for a 10-year 
transition period. Further, a special rule applies to credits 
attributable to operations in Guam, American Samoa, and the 
Commonwealth of the Northern Mariana Islands.
    The Puerto Rico and possession tax credit attributable to 
QPSII generally is eliminated for taxable years beginning after 
December 31, 1995. However, the credit attributable to QPSII 
continues to be allowed for QPSII earned before July 1, 1996.
    For taxable years beginning after December 31, 1995, 
credits with respect to possession business income under both 
the income credit and wage credit methods apply only to 
corporations that qualify as existing credit claimants (as 
defined below). The determination of whether a corporation is 
an existing credit claimant is made separately for each 
possession. A corporation that is an existing credit claimant 
with respect to such possession is subject to the limitations 
described below in determining the credit with respect to 
operations in such possession for taxable years beginning after 
December 31, 1995. The credit, subject to such limitations, is 
computed separately for each possession with respect to which 
the corporation is an existing credit claimant.

                              Wage credit

    For corporations that are existing credit claimants with 
respect to a possession and that use the wage credit, the wage 
credit is determined in the same manner as under present law 
for taxable years beginning after December 31, 1995 and before 
January 1, 2002. For taxable years beginning after December 31, 
2001 and before January 1, 2006, the corporation's possession 
business income that is eligible for the wage credit is subject 
to a cap computed as described below. For taxable years 
beginning in 2006 and thereafter, in computing the economic 
activity limit on the wage credit, the percentage of the 
taxpayer's qualifying wage and fringe benefit expenses that is 
taken into account is reduced from 60 percent to 40 percent; 
the percentages with respect to the other components of the 
economic activity limit are not changed. Moreover, for taxable 
years beginning in 2006 and thereafter, the corporation's 
business income that is eligible for the wage credit continues 
to be subject to the cap described below.
    The provision adds to the Code a new section which provides 
a credit determined under the wage credit method for business 
income from Puerto Rico. Such credit is computed under the 
rules described above with respect to the possession tax credit 
determined under the wage credit method. Such section applies 
for taxable years beginning after December 31, 1995.

                             Income credit

    For corporations that are existing credit claimants with 
respect to a possession and that elected to use the income 
credit, the income credit continues to be determined as under 
present law for taxable years beginning after December 31, 1995 
and before January 1, 1998. For taxable years beginning after 
December 31, 1997 and before January 1, 2006, the corporation's 
possession business income that is eligible for the income 
credit is subject to a cap computed as described below. For 
taxable years beginning in 2006 and thereafter, the income 
credit is eliminated.
    A corporation that had elected to use the income credit 
rather than the wage credit is permitted to revoke that 
election under present law. Under the provision, such a 
revocation is required to be made not later than with respect 
to the first taxable year beginning after December 31, 1996; 
such revocation, if made, applies to such taxable year and to 
all subsequent taxable years. Accordingly, a corporation that 
had an election in effect to use the income credit could revoke 
such election effective for its taxable year beginning in 1997 
and thereafter; such corporation would continue to use the 
income credit for its taxable year beginning in 1996 and would 
use the wage credit for its taxable year beginning in 1997 and 
thereafter.

                       Computation of income cap

    The cap on a corporation's possession business income that 
is eligible for either the income credit or the wage credit is 
computed based on the corporation's possession business income 
for the base period years (``average adjusted base period 
possession business income''). Average adjusted base period 
possession business income is the average of the adjusted 
possession business income for each of the corporation's base 
period years. For the purpose of this computation, the 
corporation's possession business income for a base period year 
is adjusted by an inflation factor that reflects inflation from 
such year to 1995. In addition, as a proxy for real growth in 
income throughout the base period, the inflation factor is 
increased by 5 percentage points compounded for each year from 
such year to the corporation's first taxable year beginning on 
or after October 14, 1995.
    The corporation's base period years generally are three of 
the corporation's five most recent years ending before October 
14, 1995, determined by disregarding the taxable years in which 
the adjusted possession business incomes were highest and 
lowest. For purposes of this computation, only years in which 
the corporation had significant possession business income are 
taken into account. A corporation is considered to have 
significant possession business income for a taxable year if 
such income exceeds 2 percent of the corporation's possession 
business income for the each of the six taxable years ending 
with the first taxable year ending on or after October 14, 
1995. If the corporation has significant possession business 
income for only four of the five most recent taxable years 
ending before October 14, 1995, the base period years are 
determined by disregarding the year in which the corporation's 
possession business income was lowest. If the corporation has 
significant possession business income for three years or fewer 
of such five years, then the base period years are all such 
years. If there is no year of such five taxable years in which 
the corporation has significant possession business income, 
then the corporation is permitted to use as its base period its 
first taxable year ending on or after October 14, 1995; for 
this purpose, the amount of possession business income taken 
into account is the annualized amount of such income for the 
portion of the year ended September 30, 1995.
    As one alternative, the corporation is permitted to elect 
to use its taxable year ending in 1992 as its base period (with 
the adjusted possession business income for such year 
constituting its cap). As another alternative, the corporation 
is permitted to elect to use as its cap the annualized amount 
of its possession business income for the first ten months of 
calendar year 1995, calculated by excluding any extraordinary 
items (as determined under generally accepted accounting 
principles) for such period. For this purpose, the Committee 
intends that transactions with a related party that are not in 
the ordinary course of business will be considered to be 
extraordinary items.
    If a corporation's possession business income in a year for 
which the cap is applicable exceeds the cap, then the 
corporation's possession business income for purposes of 
computing its income credit or its wage credit for the year is 
an amount equal to the cap. The corporation's income credit 
continues to be subject to the applicable percentage limit, 
with such limit applied based on the corporation's possession 
business income as reduced to reflect the application of the 
cap. The corporation's wage credit is subject to the economic 
activity limit, with such limit applied based on the 
corporation's possession business income as reduced to reflect 
the application of the cap.

               Qualification as existing credit claimant

    A corporation is an existing credit claimant with respect 
to a possession if (1) the corporation was engaged in the 
active conduct of a trade or business within the possession on 
October 13, 1995, and (2) the corporation has elected the 
benefits of the Puerto Rico and possession tax credit pursuant 
to an election which is in effect for its taxable year that 
includes October 13, 1995. A corporation that adds a 
substantial new line of business after October 13, 1995, ceases 
to be an existing credit claimant as of the beginning of the 
taxable year during which such new line of business is added.
    For purposes of these rules, a corporation is treated as 
engaged in the active conduct of a trade or business within a 
possession on October 13, 1995, if such corporation was engaged 
in the active conduct of such trade or business before January 
1, 1996, and such corporation had in effect on October 13, 
1995, a binding contract for the acquisition of assets to be 
used in, or the sale of property to be produced in, such trade 
or business. For example, if a corporation had in effect on 
October 13, 1995, binding contracts for the lease of a facility 
and the purchase of machinery to be used in a manufacturing 
business in a possession and if the corporation began actively 
conducting that manufacturing business in the possession before 
January 1, 1996, that corporation will be an existing credit 
claimant. A change in the ownership of a corporation does not 
affect its status as an existing credit claimant.
    In determining whether a corporation has added a 
substantial new line of business, the Committee intends that 
principles similar to those reflected in Treas. Reg. section 
1.7704-2(d) (relating to the transition rules for existing 
publicly traded partnerships) apply. For example, a corporation 
that modifies its current production methods, expands existing 
facilities, or adds new facilities to support the production of 
its current product lines and products within the same four-
digit Industry Number Standard Industrial Classification Code 
(Industry SIC Code) will not be considered to have added a 
substantial new line of business. In this regard, the Committee 
intends that the fact that a business which is added is 
assigned a different four-digit Industry SIC Code than is 
assigned to an existing business of the corporation will not 
automatically cause the corporation to be considered to have 
added a new line of business. For example, a pharmaceutical 
corporation that begins manufacturing a new drug will not be 
considered to have added a new line of business. Moreover, a 
pharmaceutical corporation that begins to manufacture a 
complete product from the bulk active chemical through the 
finished dosage form, a process that may be assigned two 
separate four-digit Industry SIC Codes, will not be considered 
to have added a new line of business even though it was 
previously engaged in activities that involved only a portion 
of the entire manufacturing process from bulk chemicals to 
finished dosages. The Committee further intends that, in the 
case of a merger of affiliated possession corporations that are 
existing credit claimants, the corporation that survives the 
merger will not be considered to have added a substantial new 
line of business by reason of its operation of the existing 
business of the affiliate that was merged into it.

                 Special rules for certain possessions

    A special rule applies to the Puerto Rico and possession 
tax credit with respect to operations in Guam, American Samoa, 
and the Commonwealth of the Northern Mariana Islands. For any 
taxable year beginning after December 31, 1995, and before 
January 1, 2006, a corporation that is an existing credit 
claimant with respect to one of these possessions for such year 
continues to determine its Puerto Rico and possession tax 
credit with respect to operations in such possession as under 
present law.
    For taxable years beginning in 2006 and thereafter, both 
the Puerto Rico and possession tax credit under the income 
credit method and the credit attributable to QPSII with respect 
to operations in Guam, American Samoa, and the Commonwealth of 
the Northern Mariana Islands are eliminated. For taxable years 
beginning in 2006 and thereafter, a corporation that is an 
existing credit claimant with respect to one of these 
possessions continues to be entitled to the wage credit with 
respect to the operations in such possession. However, for such 
years, in computing the economic activity limit on the wage 
credit, the percentage of the taxpayer's qualifying wage and 
fringe benefit expenses that is taken into account is reduced 
from 60 percent to 40 percent. Moreover, for such years, the 
corporation's possession business income attributable to 
operations in such possession that is eligible for the wage 
credit is subject to the cap computed as described above.

                      Study of wage credit method

    The Committee directs the Treasury Department to study the 
effect on the economy of Puerto Rico of the wage credit (under 
present law and as amended by the bill), including an analysis 
of the impact of such credit on unemployment rates and economic 
growth. The Treasury Department is directed to submit to the 
House Committee on Ways and Means and the Senate Committee on 
Finance reports on its findings with respect to the impact of 
the wage credit within two years of the date of enactment and 
every four years thereafter.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1995.

2. Repeal 50-percent interest income exclusion for financial 
        institution loans to ESOPs (sec. 1602 of the bill and sec. 133 
        of the Code)

                              Present law

    A bank, insurance company, regulated investment company, or 
a corporation actively engaged in the business of lending money 
may generally exclude from gross income 50 percent of interest 
received on an ESOP loan (sec. 133). The 50-percent interest 
exclusion only applies if: (1) immediately after the 
acquisition of securities with the loan proceeds, the ESOP owns 
more than 50 percent of the outstanding stock or more than 50 
percent of the total value of all outstanding stock of the 
corporation; (2) the ESOP loan term will not exceed 15 years; 
and (3) the ESOP provides for full pass-through voting to 
participants on all allocated shares acquired or transferred in 
connection with the loan.

                           Reasons for change

    The Committee believes that the 50-percent exclusion for 
interest with respect to ESOP loans provides an unnecessary tax 
benefit to financial institutions for loans they would make 
without regard to the interest exclusion. The Committee finds 
no evidence that employers that maintain ESOPs have less access 
to borrowing than other borrowers or that there is a need to 
provide an incentive to lenders to make money available to 
ESOPs.

                        Explanation of provision

    The provision repeals the 50-percent interest exclusion 
with respect to ESOP loans.

                             Effective date

    The provision is effective with respect to loans made after 
the date of enactment, other than loans made pursuant to a 
written binding contract in effect before June 10, 1996, and at 
all times thereafter before such loan is made. The repeal of 
the 50-percent interest exclusion does not apply to the 
refinancing of an ESOP loan originally made on or before the 
date of enactment or pursuant to a binding contract in effect 
before June 10, 1996, provided: (1) such refinancing loan 
otherwise meets the requirements of section 133 in effect on 
the day before the date of enactment; (2) the outstanding 
principal amount of the loan is not increased; and (3) the term 
of the refinancing loan does not extend beyond the term of the 
original ESOP loan.

3. Taxation of punitive damages received on account of personal injury 
        or sickness (sec. 1603 of the bill and sec. 104(a)(2) of the 
        Code)

                              Present law

    Under present law, gross income does not include any 
damages received (whether by suit or agreement and whether as 
lump sums or as periodic payments) on account of personal 
injury or sickness (sec. 104(a)(2)).
    The exclusion from gross income of damages received on 
account of personal injury or sickness specifically does not 
apply to punitive damages received in connection with a case 
not involving physical injury or sickness. Courts presently 
differ as to whether the exclusion applies to punitive damages 
received in connection with a case involving a physical injury 
or physical sickness.78 Certain States provide that, in 
the case of claims under a wrongful death statute, only 
punitive damages may be awarded.
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    \78\ The Supreme Court recently agreed to decide whether punitive 
damages awarded in a physical injury lawsuit are excludable from gross 
income. O'gilvie v. U.S., 66 F.3d 1550 (10th Cir. 1995), cert. granted, 
64 U.S.L.W. 3639 (U.S. March 25, 1996)(No. 95-966). Also, the Tax Court 
recently held that if punitive damages are not of a compensatory 
nature, they are not excludable from income, regardless of whether the 
underlying claim involved a physical injury or physical sickness. 
Bagley v. Commissioner, 105 T.C. No. 27 (1995).
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                           Reasons for change

    Punitive damages are intended to punish the wrongdoer and 
are not intended to compensate the claimant (e.g., for lost 
wages or pain and suffering). Thus, they are a windfall to the 
taxpayer and appropriately should be included in taxable 
income.

                        Explanation of provision

    The bill provides that the exclusion from gross income does 
not apply to any punitive damages received on account of 
personal injury or sickness whether or not related to a 
physical injury or physical sickness. Under the bill, present 
law continues to apply to punitive damages received in a 
wrongful death action if the applicable State law (as in effect 
on September 13, 1995 without regard to subsequent 
modification) provides, or has been construed to provide by a 
court decision issued on or before such date, that only 
punitive damages may be awarded in a wrongful death action. The 
Committee intends no inference as to the application of the 
exclusion to punitive damages prior to the effective date of 
the bill in connection with a case involving a physical injury 
or physical sickness.

                             Effective date

    The provision generally is effective with respect to 
amounts received after June 30, 1996. The provision does not 
apply to amounts received under a written binding agreement, 
court decree, or mediation award in effect on (or issued on or 
before) September 13, 1995.

4. Extension and phaseout of excise tax on luxury automobiles (sec. 
        1604 of the bill and sec. 4001 of the Code)

                              Present law

    Present law imposes an excise tax on the sale of 
automobiles whose price exceeds a designated threshold, 
currently $34,000. The excise tax is imposed at a rate of 10-
percent on the excess of the sales price above the designated 
threshold. The $34,000 threshold is indexed for inflation.
    The tax generally applies only to the first retail sale 
after manufacture, production, or importation of an automobile. 
It does not apply to subsequent sales of taxable automobiles.
    The tax applies to sales before January 1, 2000.

                           Reasons for change

    The Committee believes that the expiration date of January 
1, 2000, at which time the rate of tax on certain automobiles 
would fall from ten percent to zero, will create an 
unacceptable disruption of the automobile market. The Committee 
believes a more gradual phaseout of the tax will be less 
disruptive to the market and believes it is appropriate to 
commence the phaseout this year.

                        Explanation of provision

    The provision extends and phases out the luxury tax on 
automobiles. The tax rate is reduced by one percentage point 
per year beginning in 1996. The tax rate for sales (on or after 
July 1) in 1996 is 9 percent. The tax rate for sales in 1997 is 
8 percent. The tax rate for sales in 1998 is 7 percent. The tax 
rate for sales in 1999 is 6 percent. The tax rate for sales in 
2000 is 5 percent. The tax rate for sales in 2001 is 4 percent. 
The tax rate for sales in 2002 is 3 percent. The tax will 
expire after December 31, 2002.

                             Effective date

    The provision is effective for sales on or after July 1, 
1996.

5. Allow certain persons engaged in the local furnishing of electricity 
        or gas to elect not to be eligible for future tax-exempt bond 
        financing (sec. 1605 of the amendment and sec. 142 of the Code)

                              Present law

    Interest on State and local government bonds generally is 
excluded from income except where the bonds are issued to 
provide financing for private parties. Present law includes 
several exceptions, however, that allow tax-exempt bonds to be 
used to provide financing for certain specifically identified 
private parties. One such exception allows tax-exempt bonds to 
be issued to finance facilities for the furnishing of 
electricity or gas by private parties if the area served by the 
facilities does not exceed (1) two contiguous counties or (2) a 
city and a contiguous county (commonly referred to as the 
``local furnishing'' of electricity or gas).
    Most private activity tax-exempt bonds are subject to 
general State private activity bond volume limits of $50 per 
resident of the State ($150 million, if greater) per year. Tax-
exempt bonds for facilities used in the local furnishing of 
electricity or gas are subject to this limit. Like most other 
private beneficiaries of tax-exempt bonds, borrowers using tax-
exempt bonds to finance these facilities are denied interest 
deductions on the debt underlying the bonds if the facilities 
cease to be used in qualified local furnishing activities. 
Additionally, as with all tax-exempt bonds, if the use of 
facilities financed with the bonds (or the beneficiary of the 
bonds) changes to a use (or beneficiary) not qualified for tax-
exempt financing after the debt is incurred, interest on the 
bonds becomes taxable unless certain safe harbor standards are 
satisfied.

                           Reasons for change

    Tax-exempt financing is a Federal tax subsidy which should 
be subject to careful scrutiny. The Committee is aware that 
past use of this subsidy during periods when the utility 
industry was more sheltered from competition may preclude 
prudent business expansion in certain cases under the current 
environment, particularly for persons engaged in the local 
furnishing of electricity or gas. The Committee determined 
that, in light of these industry changes, a narrow provision 
allowing for acceleration of the removal of this subsidy and 
limiting the subsidy to current recipients (and certain 
successors in interest) is appropriate in view of the current 
deregulation in these industries.

                        Explanation of provision

    The provision allows persons that have received tax-exempt 
financing of facilities that currently qualify as used in the 
local furnishing of electricity or gas to elect to terminate 
their qualification for this tax-exempt financing and to expand 
their service areas without incurring the present-law loss of 
interest deductions and loss of tax-exemption penalties if--
    (1) no additional bonds are issued for facilities of the 
person making the election (or were issued for any predecessor) 
after the date of the provision's enactment;
    (2) the expansion of the person's service area is not 
financed with any tax-exempt bond proceeds; and
    (3) all outstanding tax-exempt bonds of the person making 
the election (and any predecessor) are redeemed no later than 
six months after the earliest date on which redemption is not 
prohibited under the terms of the bonds, as issued, (or six 
months after the election, if later).
    Except as described below, the provision further limits the 
exception allowing tax-exempt bonds to be issued for facilities 
used in the local furnishing of electricity or gas to bonds for 
facilities (1) of persons that qualified as engaged in that 
activity on the date of the provision's enactment and (2) that 
serve areas served by those persons on that date. The area 
which is considered to be served on the date of the provision's 
enactment consists of the geographic area in which service 
actually is being provided on that date. Service initially 
provided after the date of enactment to a new customer within 
that area (e.g., as a result of new construction or of a change 
in heating fuel type) is not treated as a service area 
expansion.
    For purposes of this requirement, a change in the identity 
of a person serving an area is disregarded if the change is the 
result of a corporate reorganization where the area served 
remains unchanged and there is common ownership of both the 
predecessor and successor entities. To facilitate compliance 
with electric and gas industry restructuring now in progress, 
the provision further permits continued qualification of 
successor entities under a ``step-in-the-shoes'' rule without 
regard to common ownership if the service provided remains 
unchanged and the area served after the facilities are 
transferred does not exceed the area served before the 
transfer. For example, if facilities of a person engaged in 
local furnishing are sold to another person, the purchaser 
(when it engages in otherwise qualified local furnishing 
activities) is eligible for continued tax-exempt financing to 
the same extent that the seller would have been had the sale 
not occurred if the service provided and the area served do not 
change.
    Similarly, a purchaser ``steps into the shoes'' of its 
seller with regard to eligibility for making the election to 
terminate its status as engaged in local furnishing without 
imposition of certain penalties on outstanding tax-exempt 
bonds. For example, if a person engaged in local furnishing 
activities on the date of the provision's enactment receives 
financing from tax-exempt bonds issued after the date of the 
provision's enactment (and is thereby ineligible to make the 
election), any purchaser from that person likewise is 
ineligible.

                             Effective date

    The provision is effective on the date of enactment.

6. Repeal of financial institution transition rule to interest 
        allocation rules (sec. 1606 of the bill and sec. 1215(c) of the 
        Tax Reform Act of 1986)

                              Present law

    For foreign tax credit purposes, taxpayers generally are 
required to allocate and apportion interest expense between 
U.S. and foreign source income based on the proportion of the 
taxpayer's total assets in each location. Such allocation and 
apportionment is required to be made for affiliated groups (as 
defined in sec. 864(e)(5)) as a whole rather than on a 
subsidiary-by-subsidiary basis. However, certain types of 
financial institutions that are members of an affiliated group 
are treated as members of a separate affiliated group for 
purposes of the allocation and apportionment of their interest 
expense. Section 1215(c)(5) of the Tax Reform Act of 1986 (P.L. 
99-514, 100 Stat. 2548) includes a targeted rule which treats a 
certain corporation as a financial institution for this 
purpose.

                           Reasons for change

    The Committee believes that it is inappropriate to provide 
narrowly targeted rules for purposes of allocating and 
apportioning interest expense under the foreign tax credit 
rules.

                        Explanation of provision

    The bill repeals the targeted rule of section 1215(c)(5) of 
the Tax Reform Act of 1986.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1995.

7. Reinstate Airport and Airway Trust Fund excise taxes (sec. 1607 of 
        the bill and secs. 4041, 4081, 4091, 4261, and 4271 of the 
        Code)

                              Present law

    Before January 1, 1996, five separate excise taxes were 
imposed to fund the Federal Airport and Airway Trust Fund (the 
``Trust Fund'') program. These aviation excise taxes were--
    (1) a 10-percent tax on domestic passenger tickets;
    (2) a 6.25-percent tax on domestic freight waybills;
    (3) a $6-per-person tax on international departures;
    (4) a 17.5-cents-per-gallon tax on jet fuel used in 
noncommercial aviation; and
    (5) a 15-cents-per-gallon tax on gasoline used in 
noncommercial aviation.79
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    \79\ 14 cents per gallon of this tax continues to be imposed, with 
the revenues being deposited in the Highway Trust Fund.
---------------------------------------------------------------------------
    Current trust fund authorizations extend through September 
30, 1996.
    During the period that these excise taxes were imposed, an 
exemption was provided for emergency medical helicopters and 
helicopters engaged in the exploration and development of hard 
minerals, oil and gas when the helicopters did not take off 
from or land at Federally assisted airports or otherwise use 
Federal aviation facilities or services.

                           Reasons for change

    The aviation excise taxes, which expired after December 31, 
1995, fund important Federal air transportation services. Their 
expiration is depleting monies available to finance these 
services, which Congress is in the process of reauthorizing for 
the period beginning October 1, 1996. The Committee determined 
that a short-term extension of those taxes will provide needed 
revenue while allowing a more complete review of the bases on 
which the excise taxes are calculated, once the findings of a 
cost allocation study currently being completed by the Federal 
Aviation Administration are available.

                        Explanation of provision

    The expired Airport and Airway Trust Fund excise taxes, and 
transfer of these revenues to the Trust Fund, are reinstated 
during the period beginning seven days after enactment and 
ending after December 31, 1996.
    The exemption for certain emergency medical helicopters is 
expanded to include fixed-wing aircraft equipped for and 
exclusively dedicated to acute care emergency medical 
transportation. Further, this exemption will no longer be 
limited to flights that do not take off from or land at 
Federally assisted airports or otherwise use the Federal air 
navigation system, but rather will apply to all qualifying 
flights by emergency medical aircraft.
    Clarification is provided that the exemption for 
helicopters when engaged in exploration for and development of 
hard minerals, oil, and gas extends to discrete segments of 
flights that otherwise originate and/or terminate at Federally 
assisted airports where no Federal air navigation facilities or 
services are utilized during the segments. That is, a flight 
segment between intermediate take-offs and landings, neither of 
which occurs at Federally assisted facilities, is exempt from 
the aviation excise taxes if no Federal facilities or services 
are used during that flight segment.

                             Effective date

    The reinstatement of the aviation excise taxes is effective 
beginning seven days after the date of the provision's 
enactment; however, the passenger ticket and freight waybill 
taxes do not apply to any amount paid before that date for 
transportation occurring during the period when the taxes 
otherwise are reinstated.

8. Modify basis adjustment rules under section 1033 (sec. 1608 of the 
        bill and sec. 1033 of the Code)

                              Present law

    Under section 1033, gain realized by a taxpayer from 
certain involuntary conversions of property is deferred to the 
extent the taxpayer purchases property similar or related in 
service or use to the converted property within a specified 
replacement period of time. The replacement property may be 
acquired directly or by acquiring control of a corporation 
(generally, 80 percent of the stock of the corporation) that 
owns replacement property. The taxpayer's basis in the 
replacement property generally is the same as the taxpayer's 
basis in the converted property, decreased by the amount of any 
money or loss recognized on the conversion, and increased by 
the amount of any gain recognized on the conversion. In cases 
in which a taxpayer purchases stock as replacement property, 
the taxpayer generally reduces the basis of the stock, but does 
not reduce the basis of the underlying assets. Thus, the 
reduction in the basis of the stock generally does not result 
in reduced depreciation deductions where the corporation holds 
depreciable property, and may result in the taxpayer having 
more aggregate depreciable basis after the acquisition of 
replacement property than before the involuntary conversion.

                           Reasons for change

    The Committee believes that if a taxpayer elects to defer 
the recognition of gain with respect to property that is 
involuntarily converted, the taxpayer should have the same 
adjusted basis in the acquired property that is similar or 
related in service or use to the converted property, regardless 
of whether such property is acquired directly or indirectly 
through the acquisition of stock of a corporation.

                        Explanation of provision

    The provision provides that where the taxpayer satisfies 
the replacement property requirement of section 1033 by 
acquiring stock in a corporation, the corporation generally 
will reduce its adjusted bases in its assets by the amount by 
which the taxpayer reduces its basis in the stock. The 
corporation's adjusted bases in its assets will not be reduced, 
in the aggregate, below the taxpayer's basis in its stock 
(determined after the appropriate basis adjustment for the 
stock). In addition, the basis of any individual asset will not 
be reduced below zero. The basis reduction first is applied to: 
(1) property that is similar or related in service or use to 
the converted property, then (2) to other depreciable property, 
then (3) to other property.
    The application of these rules can be demonstrated by the 
following examples:
    Example 1.--Assume that a taxpayer owned a commercial 
building with an adjusted basis of $100,000 that was 
involuntarily converted, causing the taxpayer to receive $1 
million in insurance proceeds. Further assume that the taxpayer 
acquires, as replacement property, all of the stock of a 
corporation, the sole asset of the corporation is a building 
with a value and an adjusted basis of $1 million. Under the 
provision, for section 1033 to apply, the taxpayer would reduce 
its basis in the stock to $100,000 (as under present law) and 
the corporation would reduce its adjusted basis in the building 
to $100,000.
    Example 2.--Assume the same facts as in Example 1, except 
that on the date of acquisition, the corporation has an 
adjusted basis of $100,000 (rather than $1 million) in the 
building. Under the bill, the taxpayer reduces its basis in the 
stock to $100,000 (as under present law) and the corporation is 
not required to reduce its adjusted basis in the building.

                             Effective date

    The provision applies to involuntary conversions occurring 
after the date of enactment of this Act.

9. Extension of withholding to certain gambling winnings (sec. 1609 of 
        the bill and sec. 3402(q) of the Code)

                              Present law

    In general, proceeds from a wagering transaction are 
subject to withholding at a rate of 28 percent if the proceeds 
exceed $5,000 and are at least 300 times as large as the amount 
wagered. No withholding tax is imposed on winnings from bingo 
or keno.

                           Reasons for change

    The Committee believes that imposing withholding on 
winnings from bingo and keno will improve tax compliance.

                        Explanation of provision

    The bill imposes withholding on proceeds from bingo or keno 
wagering transactions at a rate of 28 percent if such proceeds 
exceed $5,000, regardless of the odds of the wager.

                             Effective date

    The provision is effective 30 days after the date of 
enactment.

10. Treatment of certain insurance contracts on retired lives (sec. 
        1610 of the bill and sec. 817(d) of the Code)

                              Present law

    Life insurance companies are allowed a deduction for any 
net increase in reserves and are required to include in income 
any net decrease in reserves. The reserve of a life insurance 
company for any contract is the greater of the net surrender 
value of the contract or the reserve determined under Federally 
prescribed rules. In no event, however, may the amount of the 
reserve for tax purposes for any contract at any time exceed 
the amount of the reserve for annual statement purposes.
    Special rules are provided in the case of a variable 
contract. Under these rules, the reserve for a variable 
contract is adjusted by (1) subtracting any amount that has 
been added to the reserve by reason of appreciation in the 
value of assets underlying such contract, and (2) adding any 
amount that has been subtracted from the reserve by reason of 
depreciation in the value of assets underlying such contract. 
In addition, the basis of each asset underlying a variable 
contract is adjusted for appreciation or depreciation to the 
extent the reserve is adjusted.
    A variable contract generally is defined as any annuity or 
life insurance contract (1) that provides for the allocation of 
all or part of the amounts received under the contract to an 
account that is segregated from the general asset accounts of 
the company, and (2) under which, in the case of an annuity 
contract, the amounts paid in, or the amounts paid out, reflect 
the investment return and the market value of the segregated 
asset account, or, in the case of a life insurance contract, 
the amount of the death benefit (or the period of coverage) is 
adjusted on the basis of the investment return and the market 
value of the segregated asset account. A pension plan contract 
that is not a life, accident, or health, property, casualty, or 
liability insurance contract is treated as an annuity contract 
for purposes of this definition.

                           Reasons for change

    The Committee believes that certain contracts which provide 
insurance on retired lives should be treated as variable 
contracts in order to simplify the treatment of such contracts 
and to provide a more accurate measure of the income of life 
insurance companies with respect to such contracts.

                        Explanation of provision

    The bill provides that a variable contract is to include a 
contract that provides for the funding of group term life or 
group accident and health insurance on retired lives if: (1) 
the contract provides for the allocation of all or part of the 
amounts received under the contract to an account that is 
segregated from the general asset account of the company; and 
(2) the amounts paid in, or the amounts paid out, under the 
contract reflect the investment return and the market value of 
the segregated asset account underlying the contract.
    Thus, the reserve for such a contract is to be adjusted by 
(1) subtracting any amount that has been added to the reserve 
by reason of appreciation in the value of assets underlying 
such contract, and (2) adding any amount that has been 
subtracted from the reserve by reason of depreciation in the 
value of assets underlying such contract. In addition, the 
basis of each asset underlying the contract is to be adjusted 
for appreciation or depreciation to the extent that the reserve 
is adjusted.

                             Effective date

    The provision applies to taxable years beginning after 
December 31, 1995.

11. Treatment of contributions in aid of construction for water 
        utilities (sec. 1611(a) of the bill and sec. 118 of the Code)

                         Present and prior law

    The gross income of a corporation does not include 
contributions to its capital. A contribution to the capital of 
a corporation does not include any contribution in aid of 
construction or any other contribution as a customer or 
potential customer.
    Prior to the enactment of the Tax Reform Act of 1986 
(``1986 Act''), a regulated public utility that provided 
electric energy, gas, water, or sewage disposal services was 
allowed to treat any amount of money or property received from 
any person as a tax-free contribution to its capital so long as 
such amount: (1) was a contribution in aid of construction and 
(2) was not included in the taxpayer's rate base for rate-
making purposes. A contribution in aid of construction did not 
include a connection fee. The basis of any property acquired 
with a contribution in aid of construction was zero.
    If the contribution was in property other than electric 
energy, gas, steam, water, or sewerage disposal facilities, 
such contribution was not includible in the utility's gross 
income so long as: (1) an amount at least equal to the amount 
of the contribution was expended for the acquisition or 
construction of tangible property that was used predominantly 
in the trade or business of furnishing utility services; (2) 
the expenditure occurred before the end of the second taxable 
year after the year that the contribution was received; and (3) 
certain records were kept with respect to the contribution and 
the expenditure. In addition, the statute of limitations for 
the assessment of deficiencies was extended in the case of 
these contributions.
    These rules were repealed by the 1986 Act. Thus, after the 
1986 Act, the receipt by a utility of a contribution in aid of 
construction is includible in the gross income of the utility, 
and the basis of property received or constructed pursuant to 
the contribution is not reduced.

                           Reasons for change

    The Committee believes that the changes made by the 1986 
Act with respect to the treatment of contributions in the aid 
of construction to water utilities may inhibit the development 
of certain communities and the modernization of water and 
sewerage facilities.

                        Explanation of provision

    The provision restores the contributions in aid of 
construction provisions that were repealed by the 1986 Act for 
regulated public utilities that provide water or sewerage 
disposal services.

                             Effective date

    The provision is effective for amounts received after June 
12, 1996.

12. Require water utility property to be depreciated over 25 years 
        (sec. 1611(b) of the bill and sec. 168 of the Code)

                              Present law

    Property used by a water utility in the gathering, 
treatment, and commercial distribution of water and municipal 
sewers are depreciated over a 20-year period for regular tax 
purposes. The depreciation method generally applicable to 
property with a recovery period of 20 years is the 150-percent 
declining balance method (switching to the straight-line method 
in the year that maximizes the depreciation deduction). The 
straight-line method applies to property with a recovery period 
over 20 years.

                           Reasons for change

    The Committee believes that it is appropriate to extend the 
depreciable life of water utility property given the exception 
provided by the Committee for contributions in aid of 
construction of water utility companies and the long useful 
lives generally exhibited by such property.

                        Explanation of provision

     The provision provides that water utility property will be 
depreciated using a 25-year recovery period and the straight-
line method for regular tax purposes. For this purpose, ``water 
utility property'' means (1) property that is an integral part 
of the gathering, treatment, or commercial distribution of 
water, and that, without regard to the provision, would have a 
recovery period of 20 years and (2) any municipal sewer. Such 
property generally is described in Asset Classes 49.3 and 51 of 
Revenue Procedure 87-56, 1987-2 C.B. 674. The provision does 
not change the class lives of water utility property for 
purposes of the alternative depreciation system of section 
168(g).

                             Effective date

    The provision is effective for property placed in service 
after June 12, 1996, other than property placed in service 
pursuant to a binding contract in effect before June 10, 1996, 
and at all times thereafter before the property is placed in 
service.

13. Treatment of financial asset securitization investment trusts 
        (``FASITs'') (sec. 1621 of the bill and new secs. 860H, 860J, 
        860K, and 860L of the Code)

                              Present law

    An individual can own income-producing assets directly, or 
indirectly through an entity (i.e., a corporation, partnership, 
or trust). Where an individual owns assets through an entity 
(e.g., a corporation), the nature of the interest in the entity 
(e.g., stock of a corporation) is different than the nature of 
the assets held by the entity (e.g., assets of the 
corporation).
    Securitization is the process of converting one type of 
asset into another and generally involves the use of an entity 
separate from the underlying assets. In the case of 
securitization of debt instruments, the instruments created in 
the securitization typically have different maturities and 
characteristics than the debt instruments that are securitized.
    Entities used in securitization include entities that are 
subject to tax (e.g., a corporation), conduit entities that 
generally are not subject to tax (e.g., a partnership, grantor 
trust, or real estate mortgage investment conduit (``REMIC'')), 
or partial-conduit entities that generally are subject to tax 
only to the extent income is not distributed to owners (e.g., a 
trust, real estate investment trust (``REIT''), or regulated 
investment company (``RIC'')).
    There is no statutory entity that facilitates the 
securitization of revolving, non-mortgage debt obligations.

                           Reasons for change

    The Committee believes that there are substantial benefits 
to the economy from increased securitization of assets in the 
form of debt because securitization of such assets will spread 
the risk of credit on the debt to others. The Committee 
believes that the spreading of credit risk will lessen the 
concentration of such risk in banks and other financial 
intermediaries which, in turn, will lessen the pressure on 
Federal deposit insurance. Further, the Committee believes that 
the spreading of credit risk through securitization will result 
in lower interest rates for consumers.
    The Committee understands that it is difficult to 
securitize revolving debt (such as credit card receivables) 
under present law without the imposition of a corporate tax if 
the sponsor of the securitization does not want to report the 
securitized assets and the interests therein on his financial 
reports. Accordingly, the Committee bill would create a new 
type of entity, known as a ``financial asset securitization 
investment trust'' or ``FASIT,'' through which securitizations 
of all types of debt, including revolving credit debt, can be 
accomplished without the imposition of a corporate tax even 
though the securitized debt and the interests in the 
securitized debt are not reported on the financial statements 
of the securitization's sponsor.
    Basically, the Committee bill achieves its purpose by 
allowing the FASIT to issue instruments, called ``regular 
interests,'' which will be treated as debt (and, therefore, 
payments of the return on such interests would be deductible as 
interest) even though such instruments might not otherwise be 
treated as debt for Federal income tax purposes. Nonetheless, 
in order that there be a corporate tax on returns that approach 
returns on equity, the bill requires that instruments whose 
yield is more than five percentage points higher than the yield 
on U.S. Treasury obligations (called ``high-yield interests'') 
be held, directly or indirectly, by domestic, non-exempt 
corporations and such yield cannot be offset by any net 
operating loss of its owner. In addition, in order to insure 
that FASITs are not used for purposes other than 
securitization, the bill imposes a 100-percent excise tax on 
any income not related to securitizations (called a 
``prohibited transaction'').

                        Explanation of provision

                               In general

    The bill creates a new type of statutory entity called a 
``financial asset securitization investment trust'' (``FASIT'') 
that facilitates the securitization of debt obligations such as 
credit card receivables, home equity loans, and auto loans. A 
FASIT generally will not be taxable; the FASIT's taxable income 
or net loss will flow through to the owner of the FASIT.
    The ownership interest of a FASIT generally will be 
required to be entirely held by a single domestic C 
corporation. The Committee expects that the Treasury Department 
will issue guidance on how this rule would apply to cases in 
which the entity that owns the FASIT joins in the filing of a 
consolidated return with other members of the group that wish 
to hold an ownership interest in the FASIT. In addition, a 
FASIT generally may hold only qualified debt obligations, and 
certain other specified assets, and will be subject to certain 
restrictions on its activities. An entity that qualifies as a 
FASIT can issue instruments that meet certain specified 
requirements and treat those instruments as debt for Federal 
income tax purposes. Instruments issued by a FASIT bearing 
yields to maturity over five percentage points above the yield 
to maturity on specified United States government obligations 
(i.e., ``high-yield interests'') must be held, directly or 
indirectly, only by domestic C corporations that are not exempt 
from income tax.

Qualification as a FASIT

            In general
    To qualify as a FASIT, an entity must: (1) make an election 
to be treated as a FASIT for the year of the election and all 
subsequent years; (2) have assets substantially all of which 
(including assets that the FASIT is treated as owning because 
they support regular interests) are specified types called 
``permitted assets;'' (3) have non-ownership interests be 
certain specified types of debt instruments called ``regular 
interests''; (4) have a single ownership interest which is held 
by an ``eligible holder''; and (5) not qualify as a RIC. Any 
entity, including a corporation, partnership, or trust may be 
treated as a FASIT. In addition, a segregated pool of assets 
may qualify as a FASIT.
            Election to be a FASIT
    Once an election to be a FASIT is made, the election 
applies from the date specified in the election and all 
subsequent years until the entity ceases to be a FASIT. The 
manner of making the election to be a FASIT is to determined by 
the Secretary of the Treasury. If an election to be a FASIT is 
made after the initial year of an entity, all of the assets in 
the entity at the time of the FASIT election are deemed 
contributed to the FASIT at that time and, accordingly, any 
gain (but not loss) on such assets will be recognized at that 
time.80
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    \80\ The bill provides transitional relief under which gain in pre-
effective date entities that make a FASIT election may be deferred.
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            Ceasing to be a FASIT
     Once an entity ceases to be a FASIT, it is not a FASIT for 
that year or any subsequent year. Nonetheless, an entity can 
continue to be a FASIT where the Treasury Department determines 
that the entity inadvertently ceases to be a FASIT, steps are 
taken reasonably soon after it is discovered that the entity 
ceased being a FASIT so that it again qualifies as a FASIT, and 
the FASIT and its owner take those steps that the Treasury 
Department deems necessary. An entity will cease qualifying as 
a FASIT if the entity's owner ceases being an eligible 
corporation. Loss of FASIT status is to be treated as if all of 
the regular interests of the FASIT were retired and then 
reissued without the application of the rule which deems 
regular interests of a FASIT to be debt. The Committee 
understands that this treatment could result in the creation of 
cancellation of indebtedness income where the new instruments 
deemed to be issued are treated as stock under general tax 
principles.
            Permitted assets
    In general.--For an entity or arrangement to qualify as a 
FASIT, substantially all of its assets must consist of the 
following ``permitted assets'': (1) cash and cash equivalents; 
(2) certain permitted debt instruments; (3) certain foreclosure 
property; (4) certain instruments or contracts that represent a 
hedge or guarantee of debt held or issued by the FASIT; (5) 
contract rights to acquire permitted debt instruments or 
hedges; and (6) a regular interest in another FASIT. A FASIT 
must meet the asset test at the 90th day after its formation 
and at all times thereafter. Permitted assets may be acquired 
at any time by a FASIT, including any time after its formation.
    Permitted debt instruments.--A debt instrument will be a 
permitted asset only if the instrument is indebtedness for 
Federal income tax purposes including trade receivables, 
regular interests in a real estate mortgage investment conduit 
(REMIC), or regular interests issued by another FASIT and it 
bears (1) fixed interest or (2) variable interest of a type 
that relates to qualified variable rate debt (as defined in 
Treasury regulations prescribed under sec. 860G(a)(1)(B)). 
Except for cash equivalents, permitted debt obligations cannot 
be obligations issued, directly or indirectly, by the owner of 
the FASIT or a related person.
    Foreclosure property.--Permitted assets include property 
acquired on default (or imminent default) of debt instruments, 
swap contracts, forward contracts, or similar contracts held by 
the FASIT that would be foreclosure property to a REIT (under 
sec. 856(e)) if the property that was acquired by foreclosure 
by the FASIT was real property or would be foreclosure property 
to a REIT but for certain leases entered into or construction 
performed (as described in sec. 856(e)(4)) while held by the 
FASIT.
    Hedges.--Permitted assets include interest rate or foreign 
currency notional principal contracts, letters of credit, 
insurance, guarantees against payment defaults, notional 
principal contracts that are ``in the money,'' or other similar 
instruments as permitted under Treasury regulations, which are 
reasonably required to guarantee or hedge against the FASIT's 
risks associated with being the obligor of regular interests. 
An instrument is a hedge if it results in risk reduction as 
described in Treasury Income Tax Regulations 1.1221-2.
            ``Regular interests'' of a FASIT
    Under the bill, ``regular interests'' of a FASIT, including 
``high-yield interests,'' are treated as debt for Federal 
income tax purposes regardless of whether instruments with 
similar terms issued by non-FASITs might be characterized as 
equity under general tax principles. To be treated as a 
``regular interest,'' an instrument must have fixed terms and 
must: (1) unconditionally entitle the holder to receive a 
specified principal amount; (2) pay interest that is based on 
(a) one or more rates that are fixed, (b) rates that measure 
contemporaneous variations in the cost of newly borrowed 
funds,81 or (c) to the extent permitted by Treasury 
regulations, variable rates allowed to regular interests of a 
REMIC if the FASIT would otherwise qualify as a REMIC; (3) have 
a term to maturity of no more than 30 years, except as 
permitted by Treasury regulations; (4) be issued to the public 
with a premium of not more than 25 percent of its stated 
principal amount; and (5) have a yield to maturity determined 
on the date of issue of no more than five percentage points 
above the applicable Federal rate (AFR) for the calendar month 
in which the instrument is issued.
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    \81\ Variable interest rates that would meet this standard include 
variable interest rates described in Treasury Income Tax Regulations 
1.860G-1(a)(3).
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    A FASIT also may issue high-yield debt instruments, which 
includes any debt instrument issued by a FASIT that meets the 
second and third conditions described above, so long as such 
interests are not held by a disqualified holder. A 
``disqualified holder'' generally is any holder other than (1) 
a domestic C corporation that does not qualify as a RIC, REIT, 
REMIC, or cooperative 82 or (2) a dealer who acquires 
FASIT debt for resale to customers in the ordinary course of 
business. An excise tax is imposed at the highest corporate 
rate on a dealer if there is a change in dealer status or if 
the holding of the instrument is for investment purposes. A 31-
day grace period is granted before ownership of an interest 
held by a dealer generally could be treated as held by the 
FASIT owner for investment purposes.
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    \82\ The bill treats cooperatives as disqualified holders since 
cooperatives, like RICs and REITs, are treated as pass-through entities 
and, also like the owners of RICs and REITs, the coopertive's members 
and patrons need not be C corporations.
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            Permitted ownership holder
    A permitted holder of the ownership interest in a FASIT 
generally is a non-exempt domestic C corporation, other than a 
corporation that qualifies as a RIC, REIT, REMIC, or 
cooperative.

       Transfers to non-permitted holders of high-yield interests

    A transfer of a high-yield interest to a disqualified 
holder is to be ignored for Federal income tax purposes. Thus, 
such a transferor will continue to be liable for any taxes due 
with respect to the transferred interest.

                          Taxation of a FASIT

            In general
    A FASIT generally is not subject to tax. Instead, all of 
the FASIT's assets and liabilities are treated as assets and 
liabilities of the FASIT's owner and any income, gain, 
deduction or loss of the FASIT is allocable directly to its 
owner. Accordingly, income tax rules applicable to a FASIT 
(e.g., related party rules, sec. 871(h), sec. 165(g)(2)) are to 
be applied in the same manner as they apply to the FASIT's 
owner. Any securities held by the FASIT that are treated as 
held by its owner are treated as held for investment. The 
taxable income of a FASIT is calculated using an accrual method 
of accounting. The constant yield method and principles that 
apply for purposes of determining OID accrual on debt 
obligations whose principal is subject to acceleration apply to 
all debt obligations held by a FASIT to calculate the FASIT's 
interest and discount income and premium deductions or 
adjustments. For this purpose, a FASIT's income does not 
include any income subject to the 100-percent penalty excise 
tax on prohibited transactions.
            Income from prohibited transactions
    The owner of a FASIT is required to pay a penalty excise 
tax equal to 100 percent of net income derived from (1) an 
asset that is not a permitted asset, (2) any disposition of an 
asset other than a permitted disposition, (3) any income 
attributable to loans originated by the FASIT, and (4) 
compensation for services (other than fees for a waiver, 
amendment, or consent under permitted assets not acquired 
through foreclosure). A permitted disposition is any 
disposition of any permitted asset (1) arising from complete 
liquidation of a class of regular interests (i.e., a qualified 
liquidation 83), (2) incident to the foreclosure, default, 
or imminent default of the asset, (3) incident to the 
bankruptcy or insolvency of the FASIT, (4) necessary to avoid a 
default on any indebtedness of the FASIT attributable to a 
default (or imminent default) on an asset of the FASIT, (5) to 
facilitate a clean-up call, (6) to substitute a permitted debt 
instrument for another such instrument, or (7) in order to 
reduce over-collateralization where a principal purpose of the 
disposition was not to avoid recognition of gain arising from 
an increase in its market value after its acquisition by the 
FASIT. Notwithstanding this rule, the owner of a FASIT may 
currently deduct its losses incurred in prohibited transactions 
in computing its taxable income for the year of the loss.
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    \83\ For this purpose, a ``qualified liquidation'' has the same 
meaning as it does purposes of the exemption from the tax on prohibited 
transactions of a REMIC in section 860F(a)(4).
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                   Taxation of interests in the FASIT

            Taxation of holders of regular interests
    In general.--A holder of a regular interest, including a 
high-yield interest, is taxed in the same manner as a holder of 
any other debt instrument, except that the regular interest 
holder is required to account for income relating to the 
interest on an accrual method of accounting, regardless of the 
method of accounting otherwise used by the holder.84
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    \84\ Regular interest in a FASIT 95 percent or more of whose assets 
are real estate mortgages are treated as real estate assets where 
relevant (e.g., secs. 856, 593, 7701(a)(19)).
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    High-yield interests.--Holders of high-yield interests are 
not allowed to use net operating losses to offset any income 
derived from the high-yield debt. Any net operating loss 
carryover shall be computed by disregarding any income arising 
by reason of the disallowed loss.
    In addition, a transfer of a high-yield interest to a 
disqualified holder is not recognized for Federal income tax 
purposes such that the transferor will continue to be taxed on 
the income from the high-yield interest unless the transferee 
provides the transferor with an affidavit that the transferee 
is not a disqualified person or the Treasury Secretary 
determines that the high-yield interest is no longer held by a 
disqualified person and a corporate tax has been paid on the 
income from the high-yield interest while it was held by a 
disqualified person.85 High-yield interests may be held 
without a corporate tax being imposed on the income from the 
high-yield interest where the interest is held by a dealer in 
securities who acquired such high-yield interest for sale in 
the ordinary course of his business as a securities dealer. In 
such a case, a corporate tax is imposed on such a dealer if his 
reason for holding the high-yield interest changes to 
investment. There is a presumption that the dealer has not 
changed his intent for holding high-yield instruments to 
investment for the first 31 days he holds such interests unless 
such holding is part of a plan to avoid the restriction on 
holding of high-yield interests by disqualified persons.
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    \85\ Under this rule, no high-yield interests will be treated as 
issued where the FASIT directly issues such interests to a disqualified 
holder.
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    Where a pass-through entity (other than a FASIT) issues 
either debt or equity instruments that are secured by regular 
interests in a FASIT and such instruments bear a yield to 
maturity greater than the yield on the regular interests or the 
applicable Federal rate plus five percentage points (determined 
on date that the pass-through entity acquires the regular 
interests in the FASIT) and the pass-through entity issued such 
debt or equity with a principal purpose of avoiding the rule 
that high-yield interests be held by corporations, then an 
excise tax is imposed on the pass-through entity at a rate 
equal to the highest corporate rate on the income of any holder 
of such instrument attributable to the regular interests.
            Taxation of holder of ownership interest
    All of the FASIT's assets and liabilities are treated as 
assets and liabilities of the holder of a FASIT ownership 
interest and that owner takes into account all of the FASIT's 
income, gain, deduction, or loss in computing its taxable 
income or net loss for the taxable year. The character of the 
income to the holder of an ownership interest is the same as 
its character to the FASIT, except tax-exempt interest is taken 
into income of the holder as ordinary income.86
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    \86\ Ownership interests in a FASIT 95 percent or more of whose 
assets are real estate mortgages are treated as real estate assets 
where relevant (e.g., secs. 856, 593, 7701(a)(19)).
---------------------------------------------------------------------------
    Losses on assets contributed to the FASIT are not allowed 
upon their contribution, but may be allowed to the FASIT owner 
upon their disposition by the FASIT. A special rule provides 
that the holder of a FASIT ownership interest cannot offset 
income or gain from the FASIT ownership interest with any other 
losses. Any net operating loss carryover of the FASIT owner 
shall be computed by disregarding any income arising by reason 
of a disallowed loss.
    For purposes of the alternative minimum tax, the owner's 
taxable income is determined without regard to the minimum 
FASIT income. The alternative minimum taxable income of the 
FASIT owner cannot be less than the FASIT income for that year, 
and the alternative minimum tax net operating loss deduction is 
computed without regard to the minimum FASIT income.

                          Transfers to FASITs

    Gain generally is recognized immediately by the owner of 
the FASIT upon the transfer of assets to a FASIT. Assets that 
are acquired by the FASIT from someone other than its owner are 
treated as if they were acquired by the owner and then 
contributed to the FASIT. In addition, any assets of the FASIT 
owner or a related person that are used to support 87 
FASIT regular interests are treated as contributed to the FASIT 
and, thus, any gain on any such assets also will be recognized 
at the earliest date that such assets support any FASIT's 
regular interests.88 To the extent provided by Treasury 
regulations, gain recognition on the contributed assets may be 
deferred until such assets support regular interests issued by 
the FASIT or any indebtedness of the owner or related person. 
These regulations may adjust other statutory FASIT provisions 
to the extent such provisions are inconsistent with such 
regulations. For example, such regulations may disqualify 
certain assets as permitted assets. The basis of any FASIT 
asset is increased by the amount of the taxable gain recognized 
on the contribution of the assets to the FASIT.
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    \87\ For this purpose, supporting assets includes any assets that 
are reasonably expected to directly or indirectly pay regular interests 
or to otherwise secure or collateralize regular interests. In the case 
where there is a commitment to make additional contributions to a 
FASIT, any such assets will not be treated as supporting the FASIT 
until they are transferred to the FASIT or set aside for such use.
    \88\ In the case of a securities dealer which may be an eligible 
holder, the Committee understands that the mark-to-market rule of 
section 475 will not apply to an ownership interest in a FASIT or 
assets held in the FASIT.
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                            Valuation rules

    In general, except in the case of debt instruments, the 
value of FASIT assets is their fair market value. In the case 
of debt instruments that are traded on an established 
securities market, then the market price will be used for 
purposes of determining the amount of gain realized upon 
contribution of such assets to a FASIT. Nonetheless, the bill 
contains special rules for valuing other debt instruments for 
purposes of computing gain on the transfer to a FASIT. Under 
these rules, the value of such debt instruments is the sum of 
the present values of the reasonably expected cash flows from 
such obligations discounted over the weighted average life of 
such assets. The discount rate is 120 percent of the applicable 
Federal rate, compounded semiannually, or such other rate that 
the Treasury Secretary shall prescribe by regulations. For 
purposes of determining the value of a pool of revolving loan 
accounts having substantially the same terms, each extension of 
credit (other than the accrual of interest) is treated as a 
separate debt instrument and the maturity of the instruments is 
determined using the reasonably anticipated periodic payment 
rate at which principal payments will be made as a proportion 
of their aggregate outstanding principal balances assuming that 
payments are applied to the earliest credit extensions. The 
Committee understands that reasonably expected cash flows from 
loans will reflect nonpayment (i.e., losses), early payments 
(i.e., prepayments), and reasonable costs of servicing the 
loans. This value shall be used in determining the amount of 
gain realized upon the contribution of assets to a FASIT even 
though that value may be different than the value of such 
assets would be applying a willing buyer/willing seller 
standard.

                             Related person

    For purposes of the FASIT rules, a person is related to 
another person if that person bears a relationship to the other 
person specified in sections 267(b) or 707(b)(1), using a 20-
percent ownership test instead of the 50-percent test, or such 
persons are engaged in trades or businesses under common 
control as determined under sections 52(a) or (b).

                           Related amendments

    For purposes of the wash sale rule (sec. 1091), an 
ownership interest of a FASIT is treated as a ``security.'' In 
addition, an ownership interest in a FASIT and a residual 
interest in a pool of debt obligations that are substantially 
similar to the debt obligations in the FASIT shall be treated 
as ``substantially identical stock or securities''. Finally, 
the wash sale period begins six months before, and ends six 
months after, the sale of the ownership interest of the FASIT.

                             Effective Date

    The provision takes effect on the date of enactment. The 
bill provides a special transition rule for existing entities 
(e.g., a trust whose interests are taxed like a partnership) 
that elect to be a FASIT.

14. Revision of expatriation tax rules (secs. 1631-1633 of the bill and 
        secs. 102, 877, 2107, 2501, and 7701 and new secs. 877A and 
        6039F of the Code)

                              Present Law

Taxation of United States citizens, residents, and nonresidents

                       Individual income taxation

            Income taxation of U.S. citizens and residents
    In general.--A United States citizen generally is subject 
to the U.S. individual income tax on his or her worldwide 
taxable income. All income earned by a U.S. citizen, from 
sources inside and outside the United States, is taxable, 
whether or not the individual lives within the United States. A 
non-U.S. citizen who resides in the United States generally is 
taxed in the same manner as a U.S. citizen if the individual 
meets the definition of a ``resident alien,'' described below.
    The taxable income of a U.S. citizen or resident is equal 
to the taxpayer's total income less certain exclusions, 
exemptions, and deductions. The appropriate tax rates are then 
applied to a taxpayer's taxable income to determine his or her 
individual income tax liability. A taxpayer may reduce his or 
her income tax liability by any applicable tax credits. When an 
individual disposes of property, any gain or loss on the 
disposition is determined by reference to the taxpayer's cost 
basis in the property, regardless of whether the property was 
acquired during the period in which the taxpayer was a citizen 
or resident of the United States.
    If a U.S. citizen or resident earns income from sources 
outside the United States, and that income is subject to 
foreign income taxes, the individual generally is permitted a 
foreign tax credit against his or her U.S. income tax liability 
to the extent of foreign income taxes paid on that income. 
89 In addition, a United States citizen who lives and 
works in a foreign country generally is permitted to exclude up 
to $70,000 of annual compensation from being subject to U.S. 
income taxes, and is permitted an exclusion or deduction for 
certain housing expenses. 90
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    \89\ See sections 901-907.
    \90\ Section 911.
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    Resident aliens.--In general, a non-U.S. citizen is 
considered a resident of the United States if the individual 
(1) has entered the United States as a lawful permanent U.S. 
resident (the ``green card test''); or (2) is present in the 
United States for 31 or more days during the current calendar 
year and has been present in the United States for a 
substantial period of time--183 or more days during a 3-year 
period weighted toward the present year (the ``substantial 
presence test''). 91
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    \91\ The definitions of resident and nonresident aliens are set 
forth in section 7701(b). The substantial presence test will compare 
183 days to the sum of (1) the days present during the current calendar 
year, (2) one-third of the days present during the preceding calendar 
year, and (3) one-sixth of the days present during the second preceding 
calendar year. Presence for 122 days (or more) per year over the 3-year 
period would constitute substantial presence under the test.
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    If an individual is present in the United States for fewer 
than 183 days during the calendar year, and if the individual 
establishes that he or she has a closer connection with a 
foreign country than with the United States and has a tax home 
in that country for the year, the individual generally is not 
subject to U.S. tax as a resident on account of the substantial 
presence test. If an individual is present for as many as 183 
days during a calendar year, this closer connections/tax home 
exception is not available. An alien who has an application 
pending to change his or her status to permanent resident or 
who has taken other steps to apply for status as a lawful 
permanent U.S. resident is not eligible for the closer 
connections/tax home exception.
    For purposes of applying the substantial presence test, any 
days that an individual is present as an ``exempt individual'' 
are not counted. Exempt individuals include certain foreign 
government-related individuals, teachers, trainees, students, 
and professional athletes temporarily in the United States to 
compete in charitable sports events. In addition, the 
substantial presence test does not count days of presence of an 
individual who is physically unable to leave the United States 
because of a medical condition that arose while he or she was 
present in the United States, if the individual can establish 
to the satisfaction of the Secretary of the Treasury that he or 
she qualifies for this special medical exception.
    In some circumstances, an individual who meets the 
definition of a U.S. resident (as described above) could also 
be defined as a resident of another country under the internal 
laws of that country. In order to avoid the double taxation of 
such individuals, most income tax treaties include a set of 
``tie-breaker'' rules to determine the individual's country of 
residence for income tax purposes. In general, a dual resident 
is deemed to be a resident of the country in which such person 
has a permanent home. If the individual has a permanent home 
available in both countries, the individual's residence is 
deemed to be the country with which his or her personal and 
economic relations are closer (i.e., the ``center of vital 
interests.'') If the country in which such individual has his 
or her center of vital interests cannot be determined, or if 
such individual does not have a permanent home available in 
either country, he or she is deemed to be a resident of the 
country in which he or she has an habitual abode. If the 
individual has an habitual abode in both countries or in 
neither country, he or she is deemed to be a resident of the 
country of which he or she is a citizen. If each country 
considers the person to be its citizen or if he or she is a 
citizen of neither country, the competent authorities of the 
countries are to settle the question of residence by mutual 
agreement.
            Income taxation of nonresident aliens
    Non-U.S. citizens who do not meet the definition of 
``resident aliens'' are considered to be nonresident aliens for 
tax purposes. Nonresident aliens are subject to U.S. tax only 
to the extent their income is from U.S. sources or is 
effectively connected with the conduct of a trade or business 
within the United States. Bilateral income tax treaties may 
modify the U.S. taxation of a nonresident alien.
    A nonresident alien is taxed at regular graduated rates on 
net profits derived from a U.S. business.92 Nonresident 
aliens also are taxed at a flat rate of 30 percent on certain 
types of passive income derived from U.S. sources, although a 
lower rate may be provided by treaty (e.g., dividends are 
frequently taxed at a reduced rate of 15 percent). Such passive 
income includes interest, dividends, rents, salaries, wages, 
premiums, annuities, compensations, remunerations, emoluments, 
and other fixed or determinable annual or periodical gains, 
profits and income. There is no U.S. tax imposed, however, on 
interest earned by nonresident aliens with respect to deposits 
with U.S. banks and certain types of portfolio debt 
investments.93 Gains on the sale of stocks or securities 
issued by U.S. persons generally are not taxable to a 
nonresident alien because they are considered to be foreign 
source income.94
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    \92\ Section 871.
    \93\ See Sections 871(h) and 871(i)(3).
    \94\ Section 865(a).
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    Nonresident aliens are subject to U.S. income taxation on 
any gain recognized on the disposition of an interest in U.S. 
real property.95 Such gains generally are subject to tax 
at the same rates that apply to similar income received by U.S. 
persons. If a U.S. real property interest is acquired from a 
foreign person, the purchaser generally is required to withhold 
10 percent of the amount realized (gross sales price). 
Alternatively, either party may request that the Internal 
Revenue Service (``IRS'') determine the transferor's maximum 
tax liability and issue a certificate prescribing a reduced 
amount of withholding (not to exceed the transferor's maximum 
tax liability).96
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    \95\ Sections 897, 1445, 6039C, and 6652(f), known as the Foreign 
Investment in Real Property Tax Act (``FIRPTA''). Under the FIRPTA 
provisions, tax is imposed on gains from the disposition of an interest 
(other than an interest solely as a creditor) in real property 
(including an interest in a mine, well, or other natural deposit) 
located in the United States or the U.S. Virgin Islands. Also included 
int he definition of a U.S. real property interest is any interest 
(other than an interest solely as a creditor) in any domestic 
corporation unless the taxpayer establishes that the corporation was 
not a U.S. real property holding corporation (``USRPHC'') at any time 
during the five-year period ending on the date of the disposition of 
the interest (sec. 897(c)(1)(A)(ii). A USRPHC is any corporation, the 
fair market value of whose U.S. real property interests equals or 
exceeds 50 percent of the sum of the fair market values of (1) its U.S. 
real property interests, (2) its interests in foreign real property, 
plus (3) any other of its assets which are used or held for use in a 
trade or business (sec. 897(c)(2)).
    \96\ Section 1445.
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                        Estate and gift taxation

    The United States imposes a gift tax on any transfer of 
property by gift made by a U.S. citizen or resident, 97 
whether made directly or indirectly and whether made in trust 
or otherwise. Nonresident aliens are subject to the gift tax 
with respect to transfers of tangible real or personal property 
where the property is located in the United States at the time 
of the gift. No gift tax is imposed, however, on gifts made by 
nonresident aliens of intangible property having a situs within 
the United States (e.g., stocks and bonds). 98
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    \97\ Section 2501.
    \98\ Section 2501(a)(2).
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    The United States also imposes an estate tax on the 
worldwide ``gross estate'' of any person who was a citizen or 
resident of the United States at the time of death, and on 
certain property belonging to a nonresident of the United 
States that is located in the United States at the time of 
death. 99
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    \99\ Sections 2001, 2031, 2101, and 2103.
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     Since 1976, the gift tax and the estate tax have been 
unified so that a single graduated rate schedule applies to 
cumulative taxable transfers made by a U.S. citizen or resident 
during his or her lifetime and at death. Under this rate 
schedule, the unified estate and gift tax rates begin at 18 
percent on the first $10,000 in cumulative taxable transfers 
and reach 55 percent on cumulative taxable transfers over $3 
million. 100 A unified credit of $192,800 is available 
with respect to taxable transfers by gift and at death. The 
unified credit effectively exempts a total of $600,000 in 
cumulative taxable transfers from the estate and gift tax.
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    \100\ Section 2001(c).
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    Residency for purposes of estate and gift taxation is 
determined under different rules than those applicable for 
income tax purposes. In general, an individual is considered to 
be a resident of the United States for estate and gift tax 
purposes if the individual is ``domiciled'' in the United 
States. An individual is domiciled in the United States if the 
individual (a) is living in the United States and has the 
intention to remain in the United States indefinitely; or (b) 
has lived in the United States with such an intention and has 
not formed the intention to remain indefinitely in another 
country. In the case of a U.S. citizen who resided in a U.S. 
possession at the time of death, if the individual acquired 
U.S. citizenship solely on account of his or her birth or 
residence in a U.S. possession, that individual is not treated 
as a U.S. citizen or resident for estate tax purposes.101
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    \101\ Section 2209.
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    In addition to the estate and gift taxes, a separate 
transfer tax is imposed on certain ``generation-skipping'' 
transfers.

 Special tax rules with respect to the movement of persons into or out 
                          of the United States

            Individuals who relinquish U.S. citizenship with a 
                    principal purpose of avoiding U.S. tax
    An individual who relinquishes his or her U.S. citizenship 
with a principal purpose of avoiding U.S. taxes is subject to 
an alternative method of income taxation for 10 years after 
expatriation under section 877.102 Under this provision, 
if the Treasury Department establishes that it is reasonable to 
believe that the expatriate's loss of U.S. citizenship would, 
but for the application of this provision, result in a 
substantial reduction in U.S. tax based on the expatriate's 
probable income for the taxable year, then the expatriate has 
the burden of proving that the loss of citizenship did not have 
as one of its principal purposes the avoidance of U.S. income, 
estate or gift taxes. Section 877 does not apply to resident 
aliens who terminate their U.S. residency.
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    \102\ Treasury regulations provide that an individual's citizenship 
status is governed by the provisions of the Immigration and Nationality 
Act, specifically referrig to the ``rules governing loss of citizenship 
[set forth in] sections 349 to 357, inclusive, of such Act (8 U.S.C. 
1481-1489).'' Treas. Reg. section 1.1-1(c). Under the Immigration and 
Nationality Act, an individual is generally considered to lose U.S. 
citizenship on the date that an expatriating act is committed. The 
present-law rules governing the loss of citizenship, and a description 
of the types of expatriating acts that lead to a loss of citizenship, 
are discussed more fully below.
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    The alternative method modifies the rules generally 
applicable to the taxation of nonresident aliens in two ways. 
First, the expatriate is subject to tax on his or her U.S. 
source income at the rates applicable to U.S. citizens rather 
than the rates applicable to other nonresident aliens. (Unlike 
U.S. citizens, however, individuals subject to section 877 are 
not taxed on any foreign source income.) Second, the scope of 
items treated as U.S. source income for section 877 purposes is 
broader than those items generally considered to be U.S. source 
income under the Code. For example, gains on the sale of 
personal property located in the United States, and gains on 
the sale or exchange of stocks and securities issued by U.S. 
persons, generally are not considered to be U.S. source income 
under the Code. However, if an individual is subject to the 
alternative taxing method of section 877, such gains are 
treated as U.S. source income with respect to that individual. 
The alternative method applies only if it results in a higher 
U.S. tax liability than would otherwise be determined if the 
individual were taxed as a nonresident alien.
    Because section 877 alters the sourcing rules generally 
used to determine the country having primary taxing 
jurisdiction over certain items of income, there is an 
increased potential for such items to be subject to double 
taxation. For example, a former U.S. citizen subject to the 
section 877 rules may have capital gains derived from stock in 
a U.S. corporation. Under section 877, such gains are treated 
as U.S. source income, and are, therefore, subject to U.S. tax. 
Under the internal laws of the individual's new country of 
residence, however, that country may provide that all capital 
gains realized by a resident of that country are subject to 
taxation in that country, and thus the individual's gain from 
the sale of U.S. stock also would be taxable in his or her 
country of residence. If the individual's new country of 
residence has an income tax treaty with the United States, the 
treaty may provide for the amelioration of this potential 
double tax.
    Similar rules apply in the context of estate and gift 
taxation if the transferor relinquished U.S. citizenship with a 
principal purpose of avoiding U.S. taxes within the 10-year 
period ending on the date of the transfer. A special rule is 
applied to the estate tax treatment of any decedent who 
relinquished his or her U.S. citizenship within 10 years of 
death, if the decedent's loss of U.S. citizenship had as one of 
its principal purposes a tax avoidance motive.103 Once the 
Secretary of the Treasury establishes a reasonable belief that 
the expatriate's loss of U.S. citizenship would result in a 
substantial reduction in estate, inheritance, legacy and 
succession taxes, the burden of proving that one of the 
principal purposes of the loss of U.S. citizenship was not 
avoidance of U.S. income or estate tax is on the executor of 
the decedent's estate.
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    \103}\Section 2107.
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    In general, the estates of individuals who have 
relinquished U.S. citizenship are taxed in accordance with the 
rules generally applicable to the estates of nonresident aliens 
(i.e., the gross estate includes all U.S.-situs property held 
by the decedent at death, is subject to U.S. estate tax at the 
rates generally applicable to the estates of U.S. citizens, and 
is allowed a unified credit of $13,000, as well as credits for 
State death taxes, gift taxes, and prior transfers). However, a 
special rule provides that the individual's gross estate also 
includes his or her pro-rata share of any U.S.-situs property 
held through a foreign corporation in which the decedent had a 
10-percent or greater voting interest, provided that the 
decedent and related parties together owned more than 50 
percent of the voting power of the corporation. Similarly, 
gifts of intangible property having a situs within the United 
States (e.g., stocks and bonds) made by a nonresident alien who 
relinquished his or her U.S. citizenship within the 10-year 
period ending on the date of transfer are subject to U.S. gift 
tax, if the loss of U.S. citizenship had as one of its 
principal purposes a tax avoidance motive.104
---------------------------------------------------------------------------
    \104\ Section 2501(a)(3).
---------------------------------------------------------------------------
            Aliens having a break in residency status
    A special rule applies in the case of an individual who has 
been treated as a resident of the United States for at least 
three consecutive years, if the individual becomes a 
nonresident but regains residency status within a three-year 
period.105 In such cases, the individual is subject to 
U.S. tax for all intermediate years under the section 877 rules 
described above (i.e., the individual is taxed in the same 
manner as a U.S. citizen who renounced U.S. citizenship with a 
principal purpose of avoiding U.S. taxes). The special rule for 
a break in residency status applies regardless of the 
subjective intent of the individual.
---------------------------------------------------------------------------
    \105\ Section 7701(b)(10).
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Requirements for United States citizenship, immigration, and visas

                       United States citizenship

    An individual may acquire U.S. citizenship in one of three 
ways: (1) being born within the geographical boundaries of the 
United States; (2) being born outside the United States to at 
least one U.S. citizen parent (as long as that parent had 
previously been resident in the United States for a requisite 
period of time); or (3) through the naturalization process. All 
U.S. citizens are required to pay U.S. income taxes on their 
worldwide income. The State Department estimates that there are 
approximately 3 million U.S. citizens living abroad, although 
thousands of these individuals may not even know that they are 
U.S. citizens.
    A U.S. citizen may voluntarily give up his or her U.S. 
citizenship at any time by performing one of the following acts 
(``expatriating acts'') with the intention of relinquishing 
U.S. nationality: (1) becoming naturalized in another country; 
(2) formally declaring allegiance to another country; (3) 
serving in a foreign army; (4) serving in certain types of 
foreign government employment; (5) making a formal renunciation 
of nationality before a U.S. diplomatic or consular officer in 
a foreign country; (6) making a formal renunciation of 
nationality in the United States during a time of war; or (7) 
committing an act of treason.106 An individual who wishes 
formally to renounce citizenship (item (5), above) must execute 
an Oath of Renunciation before a consular officer, and the 
individual's loss of citizenship is effective on the date the 
oath is executed. In all other cases, the loss of citizenship 
is effective on the date that the expatriating act is 
committed, even though the loss may not be documented until a 
later date. The State Department generally documents loss in 
such cases when the individual acknowledges to a consular 
officer that the act was taken with the requisite intent. In 
all cases, the consular officer abroad submits a certificate of 
loss of nationality (``CLN'') to the State Department in 
Washington, D.C. for approval.107 Upon approval, a copy of 
the CLN is issued to the affected individual.
---------------------------------------------------------------------------
    \106\ 8 U.S.C. section 1481.
    \107\ 8 U.S.C. section 1501.
---------------------------------------------------------------------------
    Before a CLN is issued, the State Department reviews the 
individual's files to confirm that: (1) the individual was a 
U.S. citizen; (2) an expatriating act was committed; (3) the 
act was undertaken voluntarily; and (4) the individual had the 
intent of relinquishing citizenship when the expatriating act 
was committed. If the expatriating act involved an action of a 
foreign government (for example, if the individual was 
naturalized in a foreign country or joined a foreign army), the 
State Department will not issue a CLN until it has obtained an 
official statement from the foreign government confirming the 
expatriating act. If a CLN is not issued because the State 
Department does not believe that an expatriating act has 
occurred (for example, if the requisite intent appears to be 
lacking), the issue is likely to be resolved through 
litigation. Whenever the loss of U.S. nationality is put in 
issue, the burden of proof is on the person or party claiming 
that a loss of citizenship has occurred to establish, by a 
preponderance of the evidence, that the loss occurred.108 
Similarly, if a CLN has been issued, but the State Department 
later discovers that such issuance was improper (for example, 
because fraudulent documentation was submitted, or the 
requisite intent appears to be lacking), the State Department 
could initiate proceedings to revoke the CLN. If the recipient 
is unable to establish beyond a preponderance of the evidence 
that citizenship was lost on the date claimed, the CLN would be 
revoked. To the extent that the IRS believes a CLN was 
improperly issued, the IRS could present such evidence to the 
State Department and request that revocation proceedings be 
commenced. If it is determined that the individual has indeed 
committed an expatriating act, the date for loss of citizenship 
will be the date of the expatriating act.
---------------------------------------------------------------------------
    \108\ 8 U.S.C. section 1481(b).
---------------------------------------------------------------------------
    A child under the age of 18 cannot lose U.S. citizenship by 
naturalizing in a foreign state or by taking an oath of 
allegiance to a foreign state. A child under 18 can, however, 
lose U.S. citizenship by serving in a foreign military or by 
formally renouncing citizenship, but such individuals may 
regain their citizenship by asserting a claim of citizenship 
before reaching the age of eighteen years and six months.
    A naturalized U.S. citizen can have his or her citizenship 
involuntarily revoked if a U.S. court determines that the 
certificate of naturalization was illegally procured, or was 
procured by concealment of a material fact or by willful 
misrepresentation. In such cases, the individual's certificate 
of naturalization is canceled, effective as of the original 
date of the certificate; in other words, it is as if the 
individual were never a U.S. citizen at all.

                  United States immigration and visas

    In general, a non-U.S. citizen who enters the United States 
is required to obtain a visa.109 An immigrant visa (also 
known as a ``green card'') is issued to an individual who 
intends to relocate to the United States permanently. Various 
types of nonimmigrant visas are issued to individuals who come 
to the United States on a temporary basis and intend to return 
home after a certain period of time. The type of nonimmigrant 
visa issued to such individuals is dependent upon the purpose 
of the visit and its duration. An individual holding a 
nonimmigrant visa is prohibited from engaging in activities 
that are inconsistent with the purpose of the visa (for 
example, an individual holding a tourist visa is not permitted 
to obtain employment in the United States).
---------------------------------------------------------------------------
    \109\ Under the Visa Waiver Pilot Program, nationals of most 
European countries are not required to obtain a visa to enter the 
United States if they are coming as tourists and staying a maximum of 
90 days. Also, citizens of Canada, Mexico, and certain islands in close 
proximity to the United States do not need visas to enter the United 
States, although other types of travel documents may be required.
---------------------------------------------------------------------------
    Foreign business people and investors often obtain ``E'' 
visas to come into the United States. Generally, an ``E'' visa 
is initially granted for a one-year period, but it can be 
routinely extended for additional two-year periods. There is no 
overall limit on the amount of time an individual may retain an 
``E'' visa. There are two types of ``E'' visas: an ``E-1'' 
visa, for ``treaty traders'' and an ``E-2'' visa, for ``treaty 
investors.''

                     Relinquishment of green cards

    There are several ways in which a green card can be 
relinquished. First, an individual who wishes to terminate his 
or her permanent residency may simply return his or her green 
card to the INS. Second, an individual may be involuntarily 
deported from the United States (through a judicial or 
administrative proceeding), and the green card must be 
relinquished at that time. Third, a green card holder who 
leaves the United States and attempts to re-enter more than a 
year later may have his or her green card taken away by the INS 
border examiner, although the individual may appeal to an 
immigration judge to have the green card reinstated. A green-
card holder may permanently leave the United States without 
relinquishing his or her green card, although such individuals 
would continue to be taxed as U.S. residents.110
---------------------------------------------------------------------------
    \110\ Section 7701(b)(6)(B) provides that an individual who has 
obtained the status of residing permanently in the United States as an 
immigrant (i.e., an individual who has obtained a green card) will 
continue to be taxed as a lawful permanent resident of the United 
States until such status is revoked, or is administratively or 
judicially determined to have been abandoned.
---------------------------------------------------------------------------

                           Reasons for change

    The Committee has been informed that a small number of very 
wealthy individuals each year relinquish their U.S. citizenship 
for the purpose of avoiding U.S. income, estate, and gift 
taxes. By so doing, such individuals reduce their annual U.S. 
income tax liability and eliminate their eventual U.S. estate 
tax liability.
    The Committee recognizes that citizens of the United States 
have a basic right not only physically to leave the United 
States to live elsewhere, but also to relinquish their U.S. 
citizenship. The Committee does not believe that the Internal 
Revenue Code should be used to stop U.S. citizens from 
expatriating; however, the Committee also does not believe that 
the Code should provide a tax incentive for expatriating.
    The Committee is concerned that present law, which bases 
the application of the alternative method of taxation under 
section 877 on proof of a tax-avoidance purpose, is difficult 
to administer. In addition, the Committee is concerned that the 
alternative method can be avoided by postponing the realization 
of U.S. source income for 10 years. The Committee believes that 
section 877 is largely ineffective in taxing U.S. citizens who 
expatriate with a principal purpose to avoid tax.
    The Committee believes that the alternative tax system of 
section 877 should be replaced by a tax regime applicable to 
wealthy expatriates that does not rely on establishing a tax-
avoidance motive. Because U.S. citizens who retain their 
citizenship are subject to income tax on accrued appreciation 
when they dispose of their assets, as well as estate tax on the 
full value of assets that are held until death, the Committee 
believes it fair and equitable to tax expatriates on the 
appreciation in their assets when they relinquish their U.S. 
citizenship. The Committee believes that an exception from the 
expatriation tax should be provided for individuals whose 
income and net worth are relatively modest.

                        Explanation of provision

                               In general

    The provision replaces the present-law expatriation income 
tax rules with rules that generally subject certain U.S. 
citizens who relinquish their U.S. citizenship and certain 
long-term U.S. residents who relinquish their U.S. residency to 
tax on the net unrealized gain in their property as if such 
property were sold for fair market value on the expatriation 
date. The provision also imposes information reporting 
obligations on U.S. citizens who relinquish their citizenship 
and long-term residents whose U.S. residency is terminated.

                          Individuals covered

    The provision applies the expatriation tax to certain U.S. 
citizens and long-term residents who terminate their U.S. 
citizenship or residency. For this purpose, a long-term 
resident is any individual who was a lawful permanent resident 
of the United States for at least 8 out of the 15 taxable years 
ending with the year in which the termination of residency 
occurs. In applying this 8-year test, an individual is not 
considered to be a lawful permanent resident of the United 
States for any year in which the individual is taxed as a 
resident of another country under a treaty tie-breaker rule. An 
individual's U.S. residency is considered to be terminated when 
either the individual ceases to be a lawful permanent resident 
pursuant to section 7701(b)(6) (i.e., the individual loses his 
or her green-card status) or the individual is treated as a 
resident of another country under a tie-breaker provision of a 
tax treaty (and the individual does not elect to waive the 
benefits of such treaty).
    The expatriation tax applies only to individuals whose 
average income tax liability or net worth exceeds specified 
levels. U.S. citizens who lose their citizenship and long-term 
residents who terminate U.S. residency are subject to the 
expatriation tax if they meet either of the following tests: 
(1) the individual's average annual U.S. Federal income tax 
liability for the 5 taxable years ending before the date of 
such loss or termination is greater than $100,000, or (2) the 
individual's net worth as of the date of such loss or 
termination is $500,000 or more. The dollar amount thresholds 
contained in these tests are indexed for inflation in the case 
of a loss of citizenship or termination of residency occurring 
in any calendar year after 1996.
    Exceptions from the expatriation tax are provided for 
individuals in two situations. The first exception applies to 
an individual who was born with citizenship both in the United 
States and in another country, provided that (1) as of the date 
of relinquishment of U.S. citizenship the individual continues 
to be a citizen of, and is taxed as a resident of, such other 
country, and (2) the individual was a resident of the United 
States for no more than 8 out of the 15 taxable years ending 
with the year in which the relinquishment of U.S. citizenship 
occurred. The second exception applies to a U.S. citizen who 
relinquishes citizenship before reaching age 18\1/2\, provided 
that the individual was a resident of the United States for no 
more than 5 taxable years before such relinquishment.

               Deemed sale of property upon expatriation

    Under the provision, individuals who are subject to the 
expatriation tax generally are treated as having sold all of 
their property at fair market value immediately prior to the 
relinquishment of citizenship or termination of residency. Gain 
or loss from the deemed sale of property is recognized at that 
time, generally without regard to provisions of the Code that 
would otherwise provide nonrecognition treatment. The net gain, 
if any, on the deemed sale of all such property is subject to 
U.S. tax at such time to the extent it exceeds $600,000 ($1.2 
million in the case of married individuals filing a joint 
return, both of whom expatriate).
    The deemed sale rule of the provision generally applies to 
all property interests held by the individual on the date of 
relinquishment of citizenship or termination of residency, 
provided that the gain on such property interest would be 
includible in the individual's gross income if such property 
interest were sold for its fair market value on such date. 
Special rules apply in the case of trust interests (see 
``Interests in trusts'', below). U.S. real property interests, 
which remain subject to U.S. taxing jurisdiction in the hands 
of nonresident aliens, generally are excepted from the 
provision. An exception also applies to interests in qualified 
retirement plans and, subject to a limit of $500,000, interests 
in certain foreign pension plans as prescribed by regulations. 
The Secretary of the Treasury is authorized to issue 
regulations exempting other property interests as appropriate. 
For example, an exclusion could be provided for an interest in 
a nonqualified compensation plan of a U.S. employer, where 
payments from such plan to the individual following 
expatriation would continue to be subject to U.S. withholding 
tax.
    Under the provision, an individual who is subject to the 
expatriation tax is required to pay a tentative tax equal to 
the amount of tax that would be due for a hypothetical short 
tax year ending on the date the individual relinquished 
citizenship or terminated residency. Thus, the tentative tax is 
based on all the income, gain, deductions, loss and credits of 
the individual for the year through such date, including 
amounts realized from the deemed sale of property. The 
tentative tax is due on the 90th day after the date of 
relinquishment of citizenship or termination of residency.

                       Deferral of payment of tax

    Under the provision, an individual is permitted to elect to 
defer payment of the expatriation tax with respect to the 
deemed sale of any property. Under this election, the 
expatriation tax with respect to a particular property, plus 
interest thereon, is due when the property is subsequently 
disposed of. For this purpose, except as provided in 
regulations, the disposition of property in a nonrecognition 
transaction constitutes a disposition. In addition, if an 
individual holds property until his or her death, the 
individual is treated as having disposed of the property 
immediately before death. In order to elect deferral of the 
expatriation tax, the individual is required to provide 
adequate security to ensure that the deferred expatriation tax 
and interest ultimately will be paid. A bond in the amount of 
the deferred tax and interest constitutes adequate security. 
Other security mechanisms also are permitted provided that the 
individual establishes to the satisfaction of the Secretary of 
the Treasury that the security is adequate. In the event that 
the security provided with respect to a particular property 
subsequently becomes inadequate and the individual fails to 
correct such situation, the deferred expatriation tax and 
interest with respect to such property becomes due. As a 
further condition to making this election, the individual is 
required to consent to the waiver of any treaty rights that 
would preclude the collection of the expatriation tax.

                          Interests in trusts

            In general
    Under the provision, special rules apply to trust interests 
held by the individual at the time of relinquishment of 
citizenship or termination of residency. The treatment of trust 
interests depends upon whether the trust is a qualified trust. 
For this purpose, a ``qualified trust'' is a trust that is 
organized under and governed by U.S. law and that is required 
by its instruments to have at least one U.S. trustee.
    Constructive ownership rules apply to a trust beneficiary 
that is a corporation, partnership, trust or estate. In such 
cases, the shareholders, partners or beneficiaries of the 
entity are deemed to be the direct beneficiaries of the trust 
for purposes of applying these provisions. In addition, an 
individual who holds (or who is treated as holding) a trust 
interest at the time of relinquishment of citizenship or 
termination of residency is required to disclose on his or her 
tax return the methodology used to determine his or her 
interest in the trust, and whether such individual knows (or 
has reason to know) that any other beneficiary of the trust 
uses a different method.
            Nonqualified trusts
    If an individual holds an interest in a trust that is not a 
qualified trust, a special rule applies for purposes of 
determining the amount of the expatriation tax due with respect 
to such trust interest. The individual's interest in the trust 
is treated as a separate trust consisting of the trust assets 
allocable to such interest. Such separate trust is treated as 
having sold its assets as of the date of relinquishment of 
citizenship or termination of residency and having distributed 
all proceeds to the individual, and the individual is treated 
as having recontributed such proceeds to the trust. The 
individual is subject to the expatriation tax with respect to 
any net income or gain arising from the deemed distribution 
from the trust. The election to defer payment is available for 
the expatriation tax attributable to a nonqualified trust 
interest.
    A beneficiary's interest in a nonqualified trust is 
determined on the basis of all facts and circumstances. These 
include the terms of the trust instrument itself, any letter of 
wishes or similar document, historical patterns of trust 
distributions, and the role of any trust protector or similar 
advisor.
            Qualified trusts
    If the individual has an interest in a qualified trust, a 
different set of rules applies. Under these rules, the amount 
of unrealized gain allocable to the individual's trust interest 
is calculated at the time of expatriation. In determining this 
amount, all contingencies and discretionary interests are 
resolved in the individual's favor (i.e., the individual is 
allocated the maximum amount that he or she potentially could 
receive under the terms of the trust instrument). The 
expatriation tax imposed on such gains generally is collected 
when the individual receives distributions from the trust, or, 
if earlier, upon the individual's death. Interest is charged 
for the period between the date of expatriation and the date on 
which the tax is paid.
    If an individual has an interest in a qualified trust, the 
individual is subject to expatriation tax upon the receipt of 
any distribution from the trust. Such distributions may also be 
subject to U.S. income tax. For any distribution from a 
qualified trust made to an individual after he or she has 
expatriated, expatriation tax is imposed in an amount equal to 
the amount of the distribution multiplied by the highest tax 
rate generally applicable to trusts and estates, but in no 
event will the tax imposed exceed the deferred tax amount with 
respect to such trust interest. The ``deferred tax amount'' is 
equal to (1) the tax calculated with respect to the unrealized 
gain allocable to the trust interest at the time of 
expatriation, (2) increased by interest thereon, and (3) 
reduced by the tax imposed under this provision with respect to 
prior trust distributions to the individual.
    If an individual's interest in a trust is vested as of the 
expatriation date (e.g., if the individual's interest in the 
trust is non-contingent and non-discretionary), the gain 
allocable to the individual's trust interest is determined 
based on the trust assets allocable to his or her trust 
interest. If the individual's interest in the trust is not 
vested as of the expatriation date (e.g., if the individual's 
trust interest is a contingent or discretionary interest), the 
gain allocable to his or her trust interest is determined based 
on all of the trust assets that could be allocable to his or 
her trust interest, determined by resolving all contingencies 
and discretionary powers in the individual's favor. In the case 
where more than one trust beneficiary is subject to the 
expatriation tax with respect to trust interests that are not 
vested, the rules are intended to apply so that the same 
unrealized gain with respect to assets in the trust is not 
taxed to both individuals.
    If the individual disposes of his or her trust interest, 
the trust ceases to be a qualified trust, or the individual 
dies, expatriation tax is imposed as of such date. The amount 
of such tax is equal to the lesser of (1) the tax calculated 
under the rules for nonqualified trust interests applied as of 
such date or (2) the deferred tax amount with respect to the 
trust interest as of such date.
    If the individual agrees to waive any treaty rights that 
would preclude collection of the tax, the tax is imposed under 
this provision with respect to distributions from a qualified 
trust to the individual deducted and withheld from 
distributions. If the individual does not agree to such a 
waiver of treaty rights, the tax with respect to distributions 
to the individual is imposed on the trust, the trustee is 
personally liable therefor, and any other beneficiary of the 
trust will have a right of contribution against such individual 
with respect to such tax. Similarly, in the case of the tax 
imposed in connection with an individual's disposition of a 
trust interest, the individual's death while holding a trust 
interest or the individual's holding of an interest in a trust 
that ceases to be qualified, the tax is imposed on the trust, 
the trustee is personally liable therefor, and any other 
beneficiary of the trust will have a right of contribution 
against such individual with respect to such tax.

                Election to be treated as a U.S. citizen

    Under the provision, an individual is permitted to make an 
irrevocable election to continue to be taxed as a U.S. citizen 
with respect to all property that otherwise is covered by the 
expatriation tax. This election is an ``all-or-nothing'' 
election; an individual is not permitted to elect this 
treatment for some property but not other property. The 
election, if made, applies to all property that would be 
subject to the expatriation tax and to any property the basis 
of which is determined by reference to such property. Under 
this election, the individual continues to pay U.S. income 
taxes at the rates applicable to U.S. citizens following 
expatriation on any income generated by the property and on any 
gain realized on the disposition of the property, as well as 
any excise tax imposed with respect to the property (see, e.g., 
sec. 1491). In addition, the property continues to be subject 
to U.S. gift, estate, and generation-skipping transfer taxes. 
However, the amount of any transfer tax so imposed is limited 
to the amount of income tax that would have been due if the 
property had been sold for its fair market value immediately 
before the transfer or death. The $600,000 exclusion provided 
with respect to the expatriation tax under the provision is 
available to reduce the tax imposed by reason of this election. 
In order to make this election, the taxpayer is required to 
waive any treaty rights that would preclude the collection of 
the tax. The individual also is required to provide security to 
ensure payment of the tax under this election in such form, 
manner, and amount as the Secretary of the Treasury requires.

                 Date of relinquishment of citizenship

    Under the provision, an individual is treated as having 
relinquished U.S. citizenship on the date that the individual 
first makes known to a U.S. government or consular officer his 
or her intention to relinquish U.S. citizenship. Thus, a U.S. 
citizen who relinquishes citizenship by formally renouncing his 
or her U.S. nationality before a diplomatic or consular officer 
of the United States is treated as having relinquished 
citizenship on that date, provided that the renunciation is 
later confirmed by the issuance of a CLN. A U.S. citizen who 
furnishes to the State Department a signed statement of 
voluntary relinquishment of U.S. nationality confirming the 
performance of an expatriating act with the requisite interest 
to relinquish his or her citizenship is treated as having 
relinquished his or her citizenship on the date the statement 
is so furnished (regardless of when the expatriating act was 
performed), provided that the voluntary relinquishment is later 
confirmed by the issuance of a CLN. If neither of these 
circumstances exist, the individual is treated as having 
relinquished citizenship on the date a CLN is issued or a 
certificate of naturalization is canceled. The date of 
relinquishment of citizenship determined under the provision 
applies for all tax purposes.

             Effect on present-law expatriation provisions

    Under the provision, the present-law income tax provisions 
with respect to U.S. citizens who expatriate with a principal 
purpose of avoiding tax (sec. 877) and certain aliens who have 
a break in residency status (sec. 7701(b)(10)) do not apply to 
U.S. citizens who are treated as relinquishing their 
citizenship on or after February 6, 1995 or to long-term U.S. 
residents who terminate their residency on or after such date. 
The special estate and gift tax provisions with respect to 
individuals who expatriate with a principal purpose of avoiding 
tax (secs. 2107 and 2501(a)(3)), however, continue to apply; a 
credit against the tax imposed solely by reason of such special 
provisions is allowed for the expatriation tax imposed with 
respect to the same property.

         Treatment of gifts and inheritances from an expatriate

    Under the provision, the exclusion from income provided in 
section 102 does not apply to the value of any property 
received by gift or inheritance from an individual who was 
subject to the expatriation tax (i.e., an individual who 
relinquished citizenship or terminated residency and to whom 
the expatriation tax was applicable). Accordingly, a U.S. 
taxpayer who receives a gift or inheritance from such an 
individual is required to include the value of such gift or 
inheritance in gross income and is subject to U.S. income tax 
on such amount.

               Required information reporting and sharing

    Under the provision, an individual who relinquishes 
citizenship or terminates residency is required to provide a 
statement which includes the individual's social security 
number, forwarding foreign address, new country of residence 
and citizenship and, in the case of individuals with a net 
worth of at least $500,000, a balance sheet. In the case of a 
former citizen, such statement is due not later than the date 
the individual's citizenship is treated as relinquished and is 
provided to the State Department (or other government entity 
involved in the administration of such relinquishment). The 
entity to which the statement is provided by former citizens is 
required to provide to the Secretary of the Treasury copies of 
all statements received and the names of individuals who refuse 
to provide such statements. In the case of a former long-term 
resident, the statement is provided to the Secretary of the 
Treasury with the individual's tax return for the year in which 
the individual's U.S. residency is terminated. An individual's 
failure to provide the statement required under this provision 
results in the imposition of a penalty for each year the 
failure continues equal to the greater of (1) 5 percent of the 
individual's expatriation tax liability for such year or (2) 
$1,000.
    The provision requires the State Department to provide the 
Secretary of the Treasury with a copy of each CLN approved by 
the State Department. Similarly, the provision requires the 
agency administering the immigration laws to provide the 
Secretary of the Treasury with the name of each individual 
whose status as a lawful permanent resident has been revoked or 
has been determined to have been abandoned.
    Further, the provision requires the Secretary of the 
Treasury to publish in the Federal Register the names of all 
former U.S. citizens with respect to whom it receives the 
required statements or whose names it receives under the 
foregoing information-sharing provisions.

                            Treasury report

    The provision directs the Treasury Department to undertake 
a study on the tax compliance of U.S. citizens and green-card 
holders residing outside the United States and to make 
recommendations regarding the improvement of such compliance. 
The findings of such study and such recommendations are 
required to be reported to the House Committee on Ways and 
Means and the Senate Committee on Finance within 90 days of the 
date of enactment.

                             Effective date

    The provision is effective for U.S. citizens whose date of 
relinquishment of citizenship (as determined under the 
provision, see ``Date of relinquishment of citizenship'' above) 
occurs on or after February 6, 1995. Similarly, the provision 
is effective for long-term residents who terminate their U.S. 
residency on or after February 6, 1995.
    U.S. citizens who committed an expatriating act with the 
requisite intent to relinquish their U.S. citizenship prior to 
February 6, 1995, but whose date of relinquishment of 
citizenship (as determined under the provision) does not occur 
until after such date, are subject to the expatriation tax 
under the provision as of date of relinquishment of 
citizenship. However, the individual is not subject 
retroactively to worldwide tax as a U.S. citizen for the period 
after he or she committed the expatriating act (and therefore 
ceased being a U.S. citizen for tax purposes under present 
law). Such an individual continues to be subject to the 
expatriation tax imposed by present-law section 877 until the 
individual's date of relinquishment of citizenship (at which 
time the individual is subject to the expatriation tax of the 
provision). The rules described in this paragraph do not apply 
to an individual who committed an expatriating act prior to 
February 6, 1995, but did not do so with the requisite intent 
to relinquish his or her U.S. citizenship.
    The tentative tax is not required to be paid, and the 
reporting requirements are not required to be met, until 90 
days after the date of enactment. The reporting provisions 
apply to all individuals whose date of relinquishment of U.S. 
citizenship or termination of U.S. residency occurs on or after 
February 6, 1995.

                  Tax Technical Corrections Provisions

    The technical corrections subtitle contains clerical, 
conforming and clarifying amendments to the provisions enacted 
by the Revenue Reconciliation Act of 1990, the Revenue 
Reconciliation Act of 1993, and other recently enacted 
legislation. All amendments made by this title are meant to 
carry out the intent of Congress in enacting the original 
legislation. Therefore, no separate ``Reasons for Change'' is 
set forth for each individual amendment. Except as otherwise 
described, the amendments made by the technical corrections 
title take effect as if included in the original legislation to 
which each amendment relates.

   a. technical corrections to the revenue reconciliation act of 1990

1. Excise tax provisions

            a. Application of the 2.5-cents-per-gallon tax on fuel used 
                    in rail transportation to States and local 
                    governments (sec. 1702(b)(2) of the bill, sec. 
                    11211(b)(4) of the 1990 Act, and sec. 4093 of the 
                    Code)

                              Present law

    The 1990 Act increased the highway and motorboat fuels 
taxes by 5 cents per gallon, effective on December 1, 1990. The 
1990 Act continued the exemption from these taxes for fuels 
used by States and local governments.
    The 1990 Act further imposed a 2.5-cents-per-gallon tax on 
fuel used in rail transportation, also effective on December 1, 
1990. Because of a drafting error, the 2.5-cents-per-gallon tax 
on fuel used in rail transportation incorrectly applies to fuel 
used by States and local governments.

                        Explanation of provision

    The bill clarifies that the 2.5-cents-per-gallon tax on 
fuel used in rail transportation does not apply to such uses by 
States and local governments.
            b. Small winery production credit and bonding requirements 
                    (secs. 1702(b)(5), (6), and (7) of the bill, sec. 
                    11201 of the 1990 Act, and sec. 5041 of the Code)

                              Present law

    A 90-cents-per-gallon credit is allowed to wine producers 
who produce no more than 250,000 gallons of wine in a year. The 
credit may be claimed against the producers' excise or income 
taxes.
    Wine producers must post a bond in amounts determined by 
reference to expected excise tax liability as a condition of 
legally operating.

                        Explanation of provision

    The bill clarifies that wine produced by eligible small 
wineries may be transferred without payment of tax to bonded 
warehouses that become liable for payment of the wine excise 
tax without losing credit eligibility. In such cases, the 
bonded warehouse will be eligible for the credit to the same 
extent as the producer otherwise would have been.
    The bill further clarifies that the Treasury Department has 
broad regulatory authority to prevent the benefit of the credit 
from accruing (directly or indirectly) to wineries producing in 
excess of 250,000 gallons in a calendar year.
    It is intended that the Treasury regulatory authority will 
extend to all circumstances in which wine production is 
increased with a purpose of securing indirect credit 
eligibility for wine produced by such large producers.
    The bill also clarifies that the Treasury Department may 
take the amount of credit expected to be claimed against a 
producer's wine excise tax liability into account in 
determining the amount of required bond.

2. Other revenue-increase provisions of the 1990 Act

            a. Deposits of Railroad Retirement Tax Act taxes (sec. 
                    1702(c)(3) of the bill, sec. 11334 of the 1990 Act, 
                    and sec. 6302(g) of the Code)

                              Present law

    Employers must deposit income taxes withheld from 
employees' wages and FICA taxes that are equal to or greater 
than $100,000 by the close of the next banking day. Under the 
Railroad Retirement Solvency Act of 1983, the deposit rules for 
withheld income taxes and FICA taxes automatically apply to 
Railroad Retirement Tax Act taxes (sec. 226 of P.L. 98-76).

                        Explanation of provision

    The bill conforms the Internal Revenue Code to the Railroad 
Retirement Solvency Act of 1983 by stating in the Code that 
these deposit rules for withheld income taxes and FICA taxes 
apply to Railroad Retirement Tax Act taxes.
            b. Treatment of salvage and subrogation of property and 
                    casualty insurance companies (sec. 1702(c)(4) of 
                    the bill and sec. 11305 of the 1990 Act)

                              Present law

    For taxable years beginning after December 31, 1989, 
property and casualty insurance companies are required to 
reduce the deduction allowed for losses incurred (both paid and 
unpaid) by estimated recoveries of salvage and subrogation 
attributable to such losses. In the case of any property and 
casualty insurance company that took into account estimated 
salvage and subrogation recoverable in determining losses 
incurred for its last taxable year beginning before January 1, 
1990, 87 percent of the discounted amount of the estimated 
salvage and subrogation recoverable as of the close of the last 
taxable year beginning before January 1, 1990, is allowed as a 
deduction ratably over the first 4 taxable years beginning 
after December 31, 1989. This special deduction was enacted in 
order to provide such property and casualty insurance companies 
with substantially the same Federal income tax treatment as 
that provided to those property and casualty insurance 
companies that prior to the Revenue Reconciliation Act of 1990 
did not take into account estimated salvage and subrogation 
recoverable in determining losses incurred.

                        Explanation of provision

    The bill provides that the earnings and profits of any 
property and casualty insurance company that took into account 
estimated salvage and subrogation recoverable in determining 
losses incurred for its last taxable year beginning before 
January 1, 1990, is to be determined without regard to the 
special deduction that is allowed over the first 4 taxable 
years beginning after December 31, 1989. The special deduction 
is to be taken into account, however, in determining earnings 
and profits for purposes of applying sections 56, 902, and 
subpart F of part III of subchapter N of chapter 1 of the 
Internal Revenue Code of 1986. This provision is considered 
necessary in order to provide those property and casualty 
insurance companies that took into account estimated salvage 
and subrogation recoverable in determining losses incurred with 
substantially the same Federal income tax treatment as that 
provided to those property and casualty insurance companies 
that prior to the 1990 Act did not take into account estimated 
salvage and subrogation recoverable in determining losses 
incurred.
            c. Information with respect to certain foreign-owned or 
                    foreign corporations: Suspension of the statute of 
                    limitations during certain judicial proceedings 
                    (sec. 1702(c)(5) of the bill, secs. 11314 and 11315 
                    of the 1990 Act, and secs. 6038A and 6038C of the 
                    Code)

                              Present law

    Any domestic corporation that is 25-percent owned by one 
foreign person is subject to certain information reporting and 
recordkeeping requirements with respect to transactions carried 
out directly or indirectly with certain foreign persons treated 
as related to the domestic corporation (``reportable 
transactions'') (sec. 6038A(a)). In addition, the Code provides 
procedures whereby an IRS examination request or summons with 
respect to reportable transactions can be served on foreign 
related persons through the domestic corporation (sec. 
6038A(e)). Similar provisions apply to any foreign corporation 
engaged in a trade or business within the United States, with 
respect to information, records, examination requests, and 
summonses pertaining to the computation of its liability for 
tax in the United States (sec. 6038C). Certain noncompliance 
rules may be applied by the Internal Revenue Service in the 
case of the failure by a domestic corporation to comply with a 
summons pertaining to a reportable transaction (a ``6038A 
summons'') (sec. 6038A(e)), or the failure by a foreign 
corporation engaged in a U.S. trade or business to comply with 
a summons issued for purposes of determining the foreign 
corporation's liability for tax in the United States (a ``6038C 
summons'') (sec. 6038C(d)).
    Any corporation that is subject to the provisions of 
section 6038A or 6038C has the right to petition a Federal 
district court to quash a 6038A or 6038C summons, or to review 
a determination by the IRS that the corporation did not 
substantially comply in a timely manner with the 6038A or 6038C 
summons (sec. 6038A(e)(4)(A) and (B); sec. 6038C(d)(4)). During 
the period that either such judicial proceeding is pending 
(including appeals), and for up to 90 days thereafter, the 
statute of limitations is suspended with respect to any 
transaction (or item, in the case of a foreign corporation) to 
which the summons relates (secs. 6038A(e)(4)(D), 6038C(d)(4)).
    The legislative history of the 1989 Act amendments to 
section 6038A states that the suspension of the statute of 
limitations applies to ``the taxable year(s) at issue.'' 
111 The legislative history of the 1990 Act, which added 
section 6038C to the Code, uses the same language.112
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    \111\ H. Rept. No. 247, 101st Cong., 1st Sess. 1301 (1989); 
``Explanation of Provisions Approved by the Committee on October 3, 
1989,'' Senate Finance Committee Print, 101st Cong., 1st Sess. 118 
(October 12, 1989).
    \112\ ``Legislative History of Ways and Means Democratic 
Alternative,'' House Ways and Means Committee Print (WMCP: 101-37), 
101st Cong., 2nd Sess. 58 (October 15, 1990); Report language submitted 
by the Senate Finance Committee to the Senate Budget Committee on S. 
3299, 136 Cong. Rec. S 15629, S 15700 (1990).
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                        Explanation of provision

    The bill modifies the provisions in sections 6038A and 
6038C that suspend the statute of limitations to clarify that 
the suspension applies to any taxable year the determination of 
the amount of tax imposed for which is affected by the 
transaction or item to which the summons relates.
    It is intended that, under the provision, a transaction or 
item would affect the determination of the amount of tax 
imposed for the taxable year directly at issue, as well as for 
any taxable year indirectly affected through, for example, net 
operating loss carrybacks or carryforwards. It is not intended 
that, under the provision, a transaction or item would affect 
the determination of the amount of tax imposed for any taxable 
year other than the taxable year directly at issue solely by 
reason of any similarity of issues involved. Similarly, it is 
not intended that, under the provision, a transaction or item 
would affect the determination of the amount of tax imposed on 
any taxpayer unrelated to the taxpayer to whom the summons is 
directed.
            d. Rate of interest for large corporate underpayments 
                    (secs. 1702(c)(6) and (7) of the bill, sec. 11341 
                    of the 1990 Act, and sec. 6621(c) of the Code)

                              Present law

    The rate of interest otherwise applicable to underpayments 
of tax is increased by two percent in the case of large 
corporate underpayments (generally defined to exceed $100,000), 
applicable to periods after the 30th day following the earlier 
of a notice of proposed deficiency, the furnishing of a 
statutory notice of deficiency, or an assessment notice issued 
in connection with a nondeficiency procedure.

                        Explanation of provision

    The bill provides that an IRS notice that is later 
withdrawn because it was issued in error does not trigger the 
higher rate of interest. The bill also corrects an incorrect 
reference to ``this subtitle''.

3. Research credit provision: Effective date for repeal of special 
        proration rule (sec. 1702(d)(1) of the bill and sec. 11402 of 
        the 1990 Act)

                              Present law

    The Omnibus Budget Reconciliation Act of 1989 (``1989 
Act'') effectively extended the research credit for nine months 
by prorating certain qualified research expenses incurred 
before January 1, 1991. The special rule to prorate qualified 
research expenses applied in the case of any taxable year which 
began before October 1, 1990, and ended after September 30, 
1990. Under this special proration rule, the amount of 
qualified research expenses incurred by a taxpayer prior to 
January 1, 1991, was multiplied by the ratio that the number of 
days in that taxable year before October 1, 1990, bears to the 
total number of days in such taxable year before January 1, 
1991. The amendments made by the 1989 Act to the research 
credit (including the new method for calculating a taxpayer's 
base amount) generally were effective for taxable years 
beginning after December 31, 1989. However, this effective date 
did not apply to the special proration rule (which applied to 
any taxable year which began prior to October 1, 1990--
including some years which began before December 31, 1989--if 
such taxable year ended after September 30, 1990).
    Section 11402 of the Revenue Reconciliation Act of 1990 
(``1990 Act'') extended the research credit through December 
31, 1991, and repealed the special proration rule provided for 
by the 1989 Act. Section 11402 of the 1990 Act was effective 
for taxable years beginning after December 31, 1989. Thus, in 
the case of taxable years beginning before December 31, 1989, 
and ending after September 30, 1990 (e.g., a taxable year of 
November 1, 1989 through October 31, 1990), the special 
proration rule provided by the 1989 Act would continue to 
apply.

                        Explanation of provision

    The bill repeals for all taxable years ending after 
December 31, 1989, the special proration rule provided for by 
the 1989 Act.

4. Energy tax provision: Alternative minimum tax adjustment based on 
        energy preferences (secs. 1702(e)(1) and (4) of the bill, sec. 
        11531(a) of the 1990 Act, and former sec. 56(h) of the Code)

                              Present law

    In computing alternative minimum taxable income (and the 
adjusted current earnings (ACE) adjustment of the alternative 
minimum tax), certain adjustments are made to the taxpayer's 
regular tax treatment for intangible drilling costs (IDCs) and 
depletion. For certain taxable years, a special energy 
deduction is also allowed. The special energy deduction is 
initially determined by determining the taxpayer's (1) 
intangible drilling cost preference and (2) the marginal 
production depletion preference. The intangible drilling cost 
preference is the amount by which the taxpayer's alternative 
minimum taxable income would be reduced if it were computed 
without regard to the adjustments for IDCs. The marginal 
production depletion preference is the amount by which the 
taxpayer's alternative minimum taxable income would be reduced 
if it were computed without regard to depletion adjustments 
attributable to marginal production. The intangible drilling 
cost preference is then apportioned between (1) the portion of 
the preference related to qualified exploratory costs and (2) 
the remaining portion of the preference. The portion of the 
preference related to qualified exploratory costs is multiplied 
by 75 percent and the remaining portion is multiplied by 15 
percent. The marginal production depletion preference is 
multiplied by 50 percent. The three products described above 
are added together to arrive at the taxpayer's special energy 
deduction (subject to certain limitations).
    The special energy deduction is not allowed to the extent 
that it exceeds 40 percent of alternative minimum taxable 
income determined without regard to either this special energy 
deduction or the alternative tax net operating loss deduction. 
Any special energy deduction amount limited by the 40-percent 
threshold may not be carried to another taxable year. In 
addition, the combination of the special energy deduction, the 
alternative minimum tax net operating loss and the alternative 
minimum tax foreign tax credit cannot generally offset, in the 
aggregate, more than 90 percent of a taxpayer's alternative 
minimum tax determined without such attributes.
    The special energy deduction was repealed for taxable years 
beginning after December 31, 1992.

                        Explanation of provision

  Interaction of special energy deduction with net operating loss and 
                         investment tax credit

    The bill clarifies that the amount of alternative tax net 
operating loss that is utilized in any taxable year is to be 
appropriately adjusted to take into account the amount of 
special energy deduction claimed for that year. This operates 
to preserve a portion of the alternative tax net operating loss 
carryover by reducing the amount of net operating loss utilized 
to the extent of the special energy deduction claimed, which if 
unused, could not be carried forward.
    In addition, the bill contains a similar provision which 
clarifies that the limitation on the utilization of the 
investment tax credit for purposes of the alternative minimum 
tax is to be determined without regard to the special energy 
deduction.

   Interaction of special energy deduction with adjustment based on 
                       adjusted current earnings

    The bill provides that the ACE adjustment for taxable years 
beginning in 1991 and 1992 is to be computed without regard to 
the special energy deduction. Thus, the bill specifies that the 
ACE adjustment is equal to 75 percent of the excess of a 
corporation's adjusted current earnings over its alternative 
minimum taxable income computed without regard to either the 
ACE adjustment, the alternative tax net operating loss 
deduction, or the special energy deduction.

5. Estate tax freezes (sec. 1702(f) of the bill, sec. 11602 of the 1990 
        Act, and secs. 2701-2704 of the Code)

                              Present law

                               Generally

    The value of property transferred by gift or includible in 
the decedent's gross estate is its fair market value. Fair 
market value generally is the price at which the property would 
change hands between a willing buyer and willing seller, 
neither being under any compulsion to buy or sell and both 
having reasonable knowledge of relevant facts (Treas. Reg. sec. 
20.2031). Chapter 14 contains rules that supersede the willing 
buyer, willing seller standard (Code secs. 2701-2704).

          Preferred interests in corporations and partnerships

            Valuation of retained interests
    Scope.--Section 2701 provides special rules for valuing 
certain rights retained in conjunction with the transfer to a 
family member of an interest in a corporation or partnership. 
These rules apply to any applicable retained interest held by 
the transferor or an applicable family member immediately after 
the transfer of an interest in such entity. An ``applicable 
family member'' is, with respect to any transferor, the 
transferor's spouse, ancestors of the transferor and the 
spouse, and spouses of such ancestors.
    An applicable retained interest is an interest with respect 
to which there is one of two types of rights (``affected 
rights''). The first type of affected right is a liquidation, 
put, call, or conversion right, generally defined as any 
liquidation, put, call, or conversion right, or similar right, 
the exercise or nonexercise of which affects the value of the 
transferred interest. The second type of affected right is a 
distribution right 113 in an entity in which the 
transferor and applicable family members hold control 
immediately before the transfer. In determining control, an 
individual is treated as holding any interest held by the 
individual's brothers, sisters and lineal descendants. A 
distribution right does not include any right with respect to a 
junior equity interest.
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    \113\ Distribution right generally is a right to a distribution 
from a corporation with respect to its stock, or from a partnership 
with respect to a partner's interest in the partnership.
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    Valuation.--Section 2701 contains two rules for valuing 
applicable retained interests. Under the first rule, an 
affected right other than a right to qualified payments is 
valued at zero. Under the second rule, any retained interest 
that confers (1) a liquidation, put, call or conversion right 
and (2) a distribution right that consists of the right to 
receive a qualified payment is valued on the assumption that 
each right is exercised in a manner resulting in the lowest 
value for all such rights (the ``lowest value rule''). There is 
no statutory rule governing the treatment of an applicable 
retained interest that confers a right to receive a qualified 
payment, but with respect to which there is no liquidation, 
put, call or conversion right.
    A qualified payment is a dividend payable on a periodic 
basis and at a fixed rate under cumulative preferred stock (or 
a comparable payment under a partnership agreement). A 
transferor or applicable family member may elect not to treat 
such a dividend (or comparable payment) as a qualified payment. 
A transferor or applicable family member also may elect to 
treat any other distribution right as a qualified payment to be 
paid in the amounts and at the times specified in the election.
    Inclusion in transfer tax base.--Failure to make a 
qualified payment valued under the lowest value rule within 
four years of its due date generally results in an inclusion in 
the transfer tax base equal to the difference between the 
compounded value of the scheduled payments over the compounded 
value of the payments actually made. The Treasury Department 
has regulatory authority to make subsequent transfer tax 
adjustments in the transfer of an applicable retained interest 
to reflect the increase in a prior taxable gift by reason of 
section 2701.
    Generally, this inclusion occurs if the holder transfers by 
sale or gift the applicable retained interest during life or at 
death. In addition, the taxpayer may, by election, treat the 
payment of the qualified payment as giving rise to an inclusion 
with respect to prior periods.
    The inclusion continues to apply if the applicable retained 
interest is transferred to an applicable family member. There 
is no inclusion on a transfer of an applicable retained 
interest to a spouse for consideration or in a transaction 
qualifying for the marital deduction, but subsequent transfers 
by the spouse are subject to the inclusion. Other transfers to 
applicable family members result in an immediate inclusion as 
well as subjecting the transferee to subsequent inclusions.
            Minimum value of residual interest
    Section 2701 also establishes a minimum value for a junior 
equity interest in a corporation or partnership. For 
partnerships, a junior equity interest is an interest under 
which the rights to income and capital are junior to the rights 
of all other classes of equity interests.

                 Trusts and term interests in property

    The value of a transfer in trust is the value of the entire 
property less the value of rights in the property retained by 
the grantor. Section 2702 provides that in determining the 
extent to which a transfer of an interest in trust to a member 
of the transferor's family is a gift, the value of an interest 
retained by the transferor or an applicable family member is 
zero unless such interest takes certain prescribed forms.
    For a transfer with respect to a specified portion of 
property, section 2702 applies only to such portion. The 
section does not apply to the extent that the transfer is 
incomplete.

                    Options and buy-sell agreements

    A restriction upon the sale or transfer of property may 
reduce its fair market value. Treasury regulations provide that 
a restriction is to be disregarded unless the agreement 
represents a bona fide business arrangement and not a device to 
pass the decedent's shares to the natural objects of his bounty 
for less than full and adequate consideration (Treas. Reg. sec. 
20.2031-2(h)).
    Section 2703 provides, that for transfer tax purposes, the 
value of property is determined without regard to any option, 
agreement or other right to acquire or use the property at less 
than fair market value or any restriction on the right to sell 
or use such property. Certain options are excepted from this 
rule. To fall within the exception, the option, agreement, 
right or restriction must (1) be a bona fide business 
arrangement, (2) not be a device to transfer such property to 
members of the decedent's family for less than full and 
adequate consideration in money or money's worth, and (3) have 
terms comparable to similar arrangements entered into by 
persons in an arm's length transaction.

                        Explanation of provision

          Preferred interests in corporations and partnerships

            Valuation
    The bill provides that an applicable retained interest 
conferring a distribution right to qualified payments with 
respect to which there is no liquidation, put, call, or 
conversion right is valued without regard to section 2701. The 
bill also provides that the retention of such right gives rise 
to potential inclusion in the transfer tax base. In making 
these changes, it is understood that Treasury regulations could 
provide, in appropriate circumstances, that a right to receive 
amounts on liquidation of the corporation or partnership 
constitutes a liquidation right within the meaning of section 
2701 if the transferor, alone or with others, holds the right 
to cause liquidation.
    The bill modifies the definition of junior equity interest 
by granting regulatory authority to treat a partnership 
interest with rights that are junior with respect to either 
income or capital as a junior equity interest. The bill also 
modifies the definition of distribution right by replacing the 
junior equity interest exception with an exception for a right 
under an interest that is junior to the rights of the 
transferred interest. As a result, section 2701 does not affect 
the valuation of a transferred interest that is senior to the 
retained interest, even if the retained interest is not a 
junior equity interest.
    The bill modifies the rules for electing into or out of 
qualified payment treatment. A dividend payable on a periodic 
basis and at a fixed rate under a cumulative preferred stock 
held by the transferor is treated as a qualified payment unless 
the transferor elects otherwise. If held by an applicable 
family member, such stock is not treated as a qualified payment 
unless the holder so elects.114 In addition, a transferor 
or applicable family member holding any other distribution 
right may treat such right as a qualified payment to be paid in 
the amounts and at the times specified in the election.
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    \114\ With respect to gifts made prior to the date of enactment, 
the provision provides that this election may be made by the due date 
(including extensions) of the transferor's gift tax return due for the 
first calendar year after the date of enactment.
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    Prior technical corrections bills also included a provision 
to provide a special definition of ``applicable family member'' 
for purposes of determining control under section 2701. The 
bill does not include this provision.
            Inclusion in transfer tax base
    The bill grants the Treasury Department regulatory 
authority to make subsequent transfer tax adjustments to 
reflect the inclusion of unpaid amounts with respect to a 
qualified payment. This authority, for example, would permit 
the Treasury Department to eliminate the double taxation that 
might occur if, with respect to a transfer, both the inclusion 
and the value of qualified payment arrearages were included in 
the transfer tax base. It also would permit elimination of the 
double taxation that might result from a transfer to a spouse, 
who, under the statute, is both an applicable family member and 
a member of the transferor's family.
    The bill treats a transfer to a spouse falling under the 
annual exclusion the same as a transfer qualifying for the 
marital deduction. Thus, no inclusion would occur upon the 
transfer of an applicable retained interest to a spouse, but 
subsequent transfers by the spouse would be subject to 
inclusion. The bill also clarifies that the inclusion continues 
to apply if an applicable family member transfers a right to 
qualified payments to the transferor.
    The provision clarifies the consequences of electing to 
treat a distribution as giving rise to an inclusion. Under the 
bill, the election gives rise to an inclusion only with respect 
to the payment for which the election is made. The inclusion 
with respect to other payments is unaffected.

                  Trust and term interests in property

    The bill conforms section 2702 to existing regulatory 
terminology by substituting the term ``incomplete gift'' for 
``incomplete transfer.'' In addition, the bill limits the 
exception for incomplete gifts to instances in which the entire 
gift is incomplete. The Treasury Department is granted 
regulatory authority, however, to create additional exceptions 
not inconsistent with the purposes of the section. This 
authority, for example, could be used to except a charitable 
remainder trust that meets the requirements of section 664 and 
that does not otherwise create an opportunity for transferring 
property to a family member free of transfer tax.

6. Miscellaneous provisions

            a. Conforming amendments to the repeal of the General 
                    Utilities doctrine (secs. 1702(g)(1) and (2) of the 
                    bill, sec. 11702(e)(2) of the 1990 Act, and secs. 
                    897(f) and 1248 of the Code)

                              Present law

    As a result of changes made by recent tax legislation, gain 
is generally recognized on the distribution of appreciated 
property by a corporation to its shareholders. The Technical 
Corrections subtitle of the 1990 Act and technical correction 
provisions in prior acts made various conforming amendments 
arising out of these changes. For example, the 1990 Act made a 
conforming change to section 355(c) to state the treatment of 
distributions in section 355 transactions in the affirmative 
rather than by reference to the provisions of section 311. In 
addition, the Technical and Miscellaneous Revenue Act of 1988 
(``1988 Act'') made a conforming change to section 1248(f) to 
update the references to the nonrecognition provisions 
contained in that subsection. One of the changes was to change 
the reference to ``section 311(a)'' from ``section 311''.

                        Explanation of provision

    The bill makes three conforming changes to the Code with 
respect to the repeal of the General Utilities doctrine.
    First, section 1248(f) is amended to add a reference to 
section 355(c)(1), which provides generally for the 
nonrecognition of gain or loss on the distribution of stock or 
securities in certain subsidiary corporations. This retains the 
substance of the law as it existed before the conforming change 
to section 355(c) made by the 1990 Act. This provision is not 
intended to affect the authority of the Secretary of the 
Treasury to issue regulations under section 1248(f) providing 
exceptions to the rule recognizing gain in certain 
distributions (cf. Notice 87-64, 1987-2 C.B. 375).
    Second, section 1248 is amended to clarify that, 
notwithstanding the conforming changes made by the 1988 Act, 
with respect to any transaction in which a U.S. person is 
treated as realizing gain from the sale or exchange of stock of 
a controlled foreign corporation, the U.S. person shall be 
treated as having sold or exchanged the stock for purposes of 
applying section 1248. Thus, if a U.S. person distributes 
appreciated stock of a controlled foreign corporation to its 
shareholders in a transaction in which gain is recognized under 
section 311(b), section 1248 shall be applied as if the stock 
had been sold or exchanged at its fair market value. Under 
section 1248(a), part or all of the gain may be treated as a 
dividend. Under the bill, the rule treating the distribution 
for purposes of section 1248 as a sale or exchange also applies 
where the U.S. person is deemed to distribute the stock under 
the provisions of section 1248(i). Under section 1248(i), gain 
will be recognized only to the extent of the amount treated as 
a dividend under section 1248.
     Third, section 897(f), relating to the basis in a United 
States real property interest distributed to a foreign person, 
is repealed as deadwood. The basis of the distributed property 
is its fair market value in accordance with section 301(d).
            b. Prohibited transaction rules (sec. 1702(g)(3) of the 
                    bill, sec. 11701(m) of the 1990 Act, and sec. 4975 
                    of the Code)

                              Present law

    The Code and title I of the Employee Retirement Income 
Security Act of 1974 (ERISA) prohibit certain transactions 
between an employee benefit plan and certain persons related to 
such plan. An exemption to the prohibited transaction rules of 
title I of ERISA is provided in the case of sales of employer 
securities the plan is required to dispose of under the Pension 
Protection Act of 1987 (ERISA sec. 408(b)(12)). The 1990 Act 
amended the Code to provide that certain transactions that are 
exempt from the prohibited transaction rules of ERISA are 
automatically exempt from the prohibited transaction rules of 
the Code. The 1990 Act change was intended to be limited to 
transactions exempt under section 408(b)(12) of ERISA.

                        Explanation of provision

    The bill conforms the statutory language to legislative 
intent by providing that transactions that are exempt from the 
prohibited transaction rules of ERISA by reason of ERISA 
section 408(b)(12) are also exempt from the prohibited 
transaction rules of the Code.
            c. Effective date of LIFO adjustment for purposes of 
                    computing adjusted current earnings (sec. 
                    1702(g)(4) of the bill, sec. 11701 of the 1990 Act, 
                    sec. 7611(b) of the 1989 Act, and sec. 56(g) of the 
                    Code)
    For purposes of computing the adjusted current earnings 
(ACE) component of the corporate alternative minimum tax, 
taxpayers are required to make the LIFO inventory adjustments 
provided in section 312(n)(4) of the Code. Section 312(n)(4) 
generally is applicable for purposes of computing earnings and 
profits in taxable years beginning after September 30, 1984. 
The ACE adjustment generally is applicable to taxable years 
beginning after December 31, 1989.

                        Explanation of provision

    The bill clarifies that the LIFO inventory adjustment 
required for ACE purposes shall be computed by applying the 
rules of section 312(n)(4) only with respect to taxable years 
beginning after December 31, 1989. The effective date 
applicable to the determination of earnings and profits 
(September 30, 1984) is inapplicable for purposes of the ACE 
LIFO inventory adjustment. Thus, the ACE LIFO adjustment shall 
be computed with reference to increases (and decreases, to the 
extent provided in Treasury regulations) in the ACE LIFO 
reserve in taxable years beginning after December 31, 1989.
            d. Low-income housing credit (sec. 1702(g)(5) of the bill, 
                    sec. 11701(a)(11) of the 1990 Act, and sec. 42 of 
                    the Code)

                              Present law

    The amendments to the low-income housing tax credit 
contained in the Omnibus Budget Reconciliation Act of 1989 
(``1989 Act'') generally were effective for buildings placed in 
service after December 31, 1989, to the extent the buildings 
were financed by tax-exempt bonds (``bond-financed 
buildings''). This rule applied regardless of when the bonds 
were issued.
    A technical correction enacted in the Revenue 
Reconciliation Act of 1990 (``1990 Act'') limited this 
effective date to buildings financed with bonds issued after 
December 31, 1989. Thus, the technical correction applied pre-
1989 Act law to bond-financed buildings placed in service after 
December 31, 1989, if the bonds were issued before January 1, 
1990.

                        Explanation of provision

    The bill repeals the 1990 technical correction. The bill 
provides, however, that pre-1989 Act law will apply to a bond-
financed building if the owner of the building establishes to 
the satisfaction of the Secretary of the Treasury reasonable 
reliance upon the 1990 technical correction. In the case of 
buildings placed in service before the date of the bill's 
enactment, reasonable reliance may be established by a showing 
of compliance with the law as in effect for those buildings 
before enactment of the amendments made by the bill.

7. Expired or obsolete provisions (``deadwood provisions'') (secs. 
        1702(h)(1)-(18) of the bill and secs. 11801-1816 of the 1990 
        Act)

                              Present law

    The 1990 Act repealed and amended numerous sections of the 
Code by deleting obsolete provisions (``deadwood''). These 
amendments were not intended to make substantive changes to the 
tax law.

                        Explanation of provision

    The bill makes several amendments to restore the substance 
of prior law which was inadvertently changed by the deadwood 
provisions of the 1990 Act. These amendments include (1) a 
provision that clarifies that solar or wind property owned by a 
public utility may qualify as 5-year MACRS property (sec. 
168(e)(3)(B)(vi)); (2) a provision restoring the prior-law rule 
providing that if any member of an affiliated group of 
corporations elects the credit under section 901 for foreign 
taxes paid or accrued, then all members of the group paying or 
accruing such taxes must elect the credit in order for any 
dividend paid by a member of the group to qualify for the 100-
percent dividends received deduction (sec. 243(b)); and (3) a 
provision that denies section 179 expensing for property 
described in section 50(b) and air conditioning and heating 
units.
    The bill also makes several nonsubstantive clerical 
amendments to conform the Code to the amendments made by the 
deadwood provisions. None of these amendments is intended to 
change the substance of pre-1990 law.

   B. technical corrections to the revenue reconciliation act of 1993

1. Treatment of full-time students under the low-income housing credit 
        (sec. 1703(b)(1) of the bill, sec. 13142 of the 1993 Act and 
        sec. 42 of the Code).

                              Present law

    The Revenue Reconciliation Act of 1993 (``1993 Act'') 
codified prior law rules relating to the treatment of married 
students filing joint returns. Further, it provided that a 
housing unit occupied entirely by full-time students may 
qualify for the credit if the full-time students are a single 
parent and his or her minor children and none of the tenants is 
a dependent of a third party.

                        Explanation of provision

    The bill provides that the full-time student provision is 
effective on the date of enactment of the 1993 Act.

2. Indexation of threshold applicable to excise tax on luxury 
        automobiles (sec. 1703(c) of the bill, sec. 13161 of the 1993 
        Act, and sec. 4001(e)(1) of the Code)

                               Present law

    The 1993 Act indexed the threshold above which the excise 
tax on luxury automobiles is to apply.

                        Explanation of provision

    The bill corrects the application of the indexing 
adjustment so that the adjustment calculated for a given 
calendar year applies for that calendar year rather than in the 
subsequent calendar year. This conforms the indexation to that 
described in the conference report to the 1993 Act.115 The 
intent of Congress, as reflected in the conference report, was 
that current year indexation be effective on the date of 
enactment of the 1993 Act. Under the bill, the provision would, 
however, be effective on the date of enactment, to alleviate 
the difficulties that both taxpayers and the Treasury would 
experience in administering a retroactive refund effective to 
August 10, 1993.
---------------------------------------------------------------------------
    \115\ See, H. Rept. 103-213, August 4, 1993, p. 558.
---------------------------------------------------------------------------

3. Indexation of the limitation based on modified adjusted gross income 
        for income from United States Savings bonds used to pay higher 
        education tuition and fees (sec. 1703(d) of the bill, sec. 
        13201 of the 1993 Act, and sec. 135(b)(2)(B) of the Code)

                              Present law

    A taxpayer may exclude from gross income the proceeds from 
the redemption of qualified United States savings bonds if the 
proceeds are used to pay qualified higher education expenses 
and the taxpayer's modified adjusted gross income is equal to 
or less than $60,000 ($40,000 in the case of a single return). 
The exclusion is phased out for incomes above these thresholds. 
The $60,000 ($40,000) threshold is indexed for inflation 
occurring after 1992.

                        Explanation of provision

    The bill corrects the indexing of the $60,000 ($40,000) 
threshold to provide that the thresholds be indexed for 
inflation after 1989, as was provided prior to the 1993 Act.

4. Reporting and notification requirements for lobbying and political 
        expenditures of tax-exempt organizations (sec. 1703(g) of the 
        bill, sec. 13222 of the 1993 Act and sec. 6033(e) of the Code)

                              Present law

    Tax-exempt organizations which incur political expenditures 
are subject to tax under Code section 527(f). The tax is 
calculated by applying the highest corporate rate to the lesser 
of (a) the net investment income of the organization, or (b) 
the amount of political expenditures incurred by the 
organization during the taxable year. Expenditures covered by 
Code section 527(f) are those expended for ``influencing or 
attempting to influence the selection, nomination, election, or 
appointment of any individual to any Federal, State, or local 
public office or office in a political organization, or the 
election of Presidential or Vice-Presidential electors, whether 
of not such individual or electors are selected, nominated, 
elected, or appointed.''
    Code section 162(e), as amended by the 1993 Act, provides a 
separate set of rules regarding the tax treatment of lobbying 
and political expenditures. Political expenditures include 
amounts paid or incurred in connection with ``participation in, 
or intervention in, any political campaign on behalf of (or in 
opposition to) any candidate for public office.'' Taxpayers may 
not deduct the portion of dues or similar amounts paid to a 
tax-exempt organization which the organization notifies the 
taxpayer are allocable to lobbying or political expenditures.
    Code section 6033(e) sets forth reporting and notification 
requirements applicable to tax-exempt organizations (other than 
charities) that incur lobbying or political expenditures within 
the meaning of Code section 162(e). First, the organization 
must report on its annual tax return both the total amount of 
its lobbying and political expenditures, and the total amount 
of dues (or similar payments) allocable to such expenditures. 
Second, the organization must either provide notice to its 
members of the portion of dues allocable to lobbying and 
political expenditures (so that such amounts are not deductible 
by members), or may elect to pay a proxy tax (at the highest 
corporate rate) on its lobbying and political expenditures, up 
to the amount of dues receipts.

                        Explanation of provision

    The bill amends Code section 6033(e) to clarify that any 
political expenditures on which tax is paid pursuant to Code 
section 527(f) are not subject to the reporting and 
notification requirements of Code section 6033(e). In addition, 
the bill clarifies that the reporting and notification 
requirements of Code section 6033(e) apply to organizations 
exempt from tax under Code section 501(a), other than charities 
described in section 501(c)(3).

5. Estimated tax rules for certain tax-exempt organizations (sec. 
        1703(h) of the bill, sec. 13225 of the 1993 Act and sec. 
        6655(g)(3) of the Code)

                              Present law

    A tax-exempt organization is generally subject to an 
addition to tax for any underpayment of estimated tax on its 
unrelated business taxable income or its net investment income 
(as the case may be). Under the 1993 Act, for years beginning 
after December 31, 1993, a corporation or tax-exempt 
organization does not have an underpayment of estimated tax if 
it makes four timely estimated tax payments that total at least 
100 percent of the tax liability shown on its return for the 
current taxable year. A corporation or tax-exempt organization 
may estimate its current year tax liability prior to year-end 
by annualizing its income. The 1993 Act also changed the method 
by which a corporation annualizes its current year tax 
liability.

                        Explanation of provision

    The bill clarifies that the 1993 Act did not change the 
method by which a tax-exempt organization annualizes its 
current year tax liability.

6. Current taxation of certain earnings of controlled foreign 
        corporations--application of foreign tax credit limitation 
        (sec. 1703(i)(1) of the bill, sec. 13231(b) of the 1993 Act, 
        and sec. 904(d) of the Code)

                              Present law

    Present law requires U.S. shareholders of a controlled 
foreign corporation to include in income the corporation's 
subpart F income, certain earnings invested in U.S. property, 
and, as modified by the 1993 Act, certain earnings invested in 
excess passive assets. A U.S. shareholder's tax liability 
attributable to the inclusion may be offset by foreign tax 
credits for certain foreign taxes paid or deemed paid by the 
shareholder.
    The foreign tax credit limitation applies separately to 
several categories of income. The separate limitations apply to 
a dividend from a controlled foreign corporation to a U.S. 
shareholder of that controlled foreign corporation by reference 
to the character of the earnings and profits of the 
distributing corporation.
    An inclusion of a controlled foreign corporation's earnings 
invested in U.S. property is treated like a dividend for 
purposes of the foreign tax credit limitation. Although the 
1993 Act provided that inclusions of earnings invested in 
excess passive assets generally are determined in the same 
manner as inclusions of earnings invested in U.S. property, the 
1993 Act did not specify how the separate limitations of the 
foreign tax credit should apply to inclusions of earnings 
invested in excess passive assets.
    Some have argued that the separate limitations of the 
foreign tax credit do not apply to an inclusion of a controlled 
foreign corporation's earnings invested in excess passive 
assets; rather, that such an inclusion is allocated entirely to 
the general foreign tax credit limitation, without regard to 
the character of the underlying earnings and profits of the 
controlled foreign corporation.

                        Explanation of provision

    The bill clarifies that a U.S. shareholder's inclusion of a 
controlled foreign corporation's earnings invested in excess 
passive assets is treated like a dividend for purposes of the 
foreign tax credit limitation. Thus, the inclusion is 
characterized by reference to the underlying earnings and 
profits of the controlled foreign corporation. This treatment 
is consistent with present law's application of the separate 
limitations of the foreign tax credit to other amounts included 
in income with respect to a controlled foreign corporation.

7. Current taxation of certain earnings of controlled foreign 
        corporations--measurement of accumulated earnings (sec. 
        1703(i)(2) of the bill, sec. 13231(b) of the 1993 Act, and sec. 
        956A(b) of the Code)

                              Present law

    Present law, as modified by the 1993 Act, limits the 
availability of deferral of U.S. tax on certain earnings of 
controlled foreign corporations by requiring U.S. shareholders 
of a controlled foreign corporation to include in income the 
corporation's accumulated 116 or current earnings invested 
in excess passive assets. Some have argued that the Code's 
definition of earnings subject to this treatment permits an 
accumulated deficit in earnings to eliminate positive current 
earnings, resulting in no income inclusion in a case where an 
actual distribution would be treated as a dividend out of 
current earnings. In addition, some have argued that the Code's 
definition of earnings subject to this treatment takes current-
year earnings into account more than once.
---------------------------------------------------------------------------
    \116\ Accumulated earnings and profits are taken into account only 
to the extent that they were accumulated in taxable years beginning 
after September 30, 1993.
---------------------------------------------------------------------------

                        Explanation of provision

    The bill clarifies that the accumulated earnings and 
profits of a controlled foreign corporation taken into account 
for purposes of determining the foreign corporation's earnings 
invested in excess passive assets do not include any deficit in 
accumulated earnings and profits,117 and do not include 
current earnings (which are taken into account separately).
---------------------------------------------------------------------------
    \117\ Incurred in taxable years beginning after September 30, 1993.
---------------------------------------------------------------------------

8. Current taxation of certain earnings of controlled foreign 
        corporations--aggregation and look-through rules (sec. 
        1703(i)(3) of the bill, sec. 13231(b) of the 1993 Act, and sec. 
        956A(f) of the Code)

                              Present law

    Present law, as modified by the 1993 Act, provides certain 
aggregation and look-through rules in connection with requiring 
U.S. shareholders of a controlled foreign corporation to 
include in income certain of the corporation's earnings 
invested in excess passive assets. Under the aggregation rule, 
certain groups of controlled foreign corporations that are 
linked by stock ownership of more than 50 percent (CFC groups) 
are treated as a single corporation for purposes of determining 
their earnings invested in excess passive assets. Look-through 
treatment applies to certain corporations whose stock is owned 
at least 25 percent by a controlled foreign corporation. Some 
have argued that these rules permit the assets of one foreign 
corporation to be taken into account more than once through a 
combination of CFC group treatment and look-through treatment. 
In addition, some have argued that these rules permit the 
assets of one foreign corporation to be taken into account more 
than once through membership of the foreign corporation in more 
than one CFC group.

                        Explanation of provision

    The bill clarifies that, within the regulatory authority 
provided to the Secretary of the Treasury under the 1993 Act, 
regulations are specifically authorized to coordinate the CFC 
group treatment and look-through treatment applicable for 
purposes of determining a foreign corporation's earnings 
invested in excess passive assets. Pending the promulgation of 
guidance by the Secretary, it is intended that taxpayers be 
permitted to coordinate such treatment using any reasonable 
method for taking assets into account only once, so long as the 
method is consistently applied to all controlled foreign 
corporations (whether or not members of any CFC group) in all 
taxable years.

9. Treatment of certain leased assets for PFIC purposes (sec. 
        1703(i)(5) of the bill, sec. 13231(d)(4) of the 1993 Act, and 
        sec. 1297(d) of the Code)

                              Present law

    Under present law, as modified by the 1993 Act, certain 
property leased by a foreign corporation may be treated as an 
asset actually owned by the foreign corporation in measuring 
the assets of the foreign corporation for purposes of the 
passive foreign investment company (``PFIC'') asset test of 
section 1296(a)(2). The 1993 Act provided a special measurement 
rule, under which the adjusted basis of the leased asset for 
this purpose is determined by reference to the unamortized 
portion of the present value of the payments under the lease 
for the use of the property. Some have argued, however, that 
the special measurement rule does not apply to PFICs that are 
permitted to measure their assets by fair market value, rather 
than by adjusted basis. Under this argument, the entire fair 
market value of the leased asset might be treated as owned by 
the foreign corporation.

                        Explanation of provision

    The bill clarifies that, in the case of any item of 
property leased by a foreign corporation and treated as an 
asset actually owned by the foreign corporation in measuring 
the assets of the foreign corporation for purposes of the PFIC 
asset test, the amount taken into account with respect to the 
leased property is the amount determined under the 1993 Act's 
special measurement rule, which is based on the unamortized 
portion of the present value of the payments under the lease 
for the use of the property. That is, the provision clarifies 
that the special measurement rule of the 1993 Act applies to 
all PFICs, regardless of whether they are generally permitted 
to measure their assets by fair market value rather than 
adjusted basis.

10. Expiration date of special ethanol blender refund (sec. 1703(k) of 
        the bill and sec. 6427 of the Code)

                              Present law

    A 54-cents-per-gallon blender income tax credit is provided 
for ethanol used as a motor fuel. This credit applies to 
ethanol which is blended with gasoline (``gasohol'').
    Gasoline is subject to an 18.3-cents-per-gallon excise tax. 
As an alternative to claiming the income tax credit, gasohol 
blenders may claim the benefit of the ethanol income tax credit 
against their gasoline excise tax liability. The benefit may be 
claimed against excise tax liability in either of two ways: (1) 
by purchasing gasoline destined for blending with ethanol at a 
reduced excise tax rate, or (2) before October 1, 1995, by 
claiming expedited refunds of the excise tax paid on gasoline 
purchased at the full excise tax rate, after that gasoline is 
blended with ethanol. In general, the gasoline (including 
gasohol) excise tax provisions associated with the Highway 
Trust Fund expire after September 30, 1999.

                        Explanation of provision

    The bill corrects a 1990 drafting error by conforming the 
expiration date for the excise tax expedited refund provision 
for gasohol blenders to that for gasoline tax provisions 
generally. Thus, these refunds will be permitted through 
September 30, 1999.

11. Amortization of goodwill and certain other intangibles (sec. 
        1703(l) of the bill, sec. 13261(g) of the 1993 Act and sec. 197 
        of the Code)

                              Present law

    The 1993 Act allows amortization deductions to certain 
intangible assets acquired after the 1993 Act's effective date 
that were not amortizable under prior law. The 1993 Act 
contains ``antichurning'' rules that deny amortization to 
intangible assets that were not amortizable under prior law if 
such assets are acquired by the taxpayer after the effective 
date from certain related parties.
    The 1993 Act also contains an election under which a 
taxpayer and certain related parties may elect to treat all 
acquisitions after July 25, 1991 as subject to the provisions 
of the 1993 Act.

                        Explanation of provision

    The bill clarifies that when a taxpayer and its related 
parties have made an election to apply the 1993 Act to all 
acquisitions after July 25, 1991, the antichurning rules will 
not apply when property acquired from an unrelated party after 
July 25, 1991 (and not subject to the antichurning rules in the 
hands of the acquirer) is transferred to a taxpayer related to 
the acquirer after the date of enactment of the 1993 Act.

12. Empowerment zones and eligibility of small farms for tax incentives 
        (sec. 1703(m) of the bill, sec. 13301 of the 1993 Act and sec. 
        1397B(d)(5)(B) of the Code)

                              Present law

    Pursuant to the 1993 Act, on December 21, 1994, six 
empowerment zones and 65 enterprise communities were designated 
in eligible urban areas, and three empowerment zones and 30 
enterprise communities were designated in rural areas. Special 
tax incentives (i.e., a wage credit, additional section 179 
expensing, and expanded tax-exempt financing) are available for 
certain business activities conducted in urban and rural 
empowerment zones. Expanded tax-exempt financing benefits are 
available for certain facilities located in urban and rural 
enterprise communities.
    The empowerment zone wage credit is not available with 
respect to any individual employed by a trade or business the 
principal activity of which is farming (within the meaning of 
subparagraphs (A) and (B) of section 2032A(e)(5)) if, as of the 
close of the current taxable year, the sum of the aggregate 
unadjusted bases (or, if greater, the fair market value) of 
assets of the farm exceed $500,000 (sec. 1396(d)(2)(E)). In 
contrast, the additional section 179 expensing (available in 
empowerment zones) and expanded tax-exempt financing benefits 
(available in both empowerment zones and enterprise 
communities) are not allowed for any trade or business the 
principal activity of which is farming if, as of the close of 
the preceding taxable year, the sum of the aggregate bases (or, 
if greater, the fair market value) of the assets of the farm 
exceed $500,000 (sec. 1397B(d)(5)).

                        Explanation of provision

    The bill provides that the $500,000 asset test for 
determining whether a farm is eligible for additional section 
179 expensing (in an empowerment zone) and expanded tax-exempt 
financing benefits (in an empowerment zone or enterprise 
community) is applied based on the assets of the farm at the 
end of the current taxable year. Thus, the $500,000 asset test 
for determining farm eligibility is based on the same taxable 
period (i.e., the current taxable year) for purposes of all tax 
incentives available in empowerment zones and enterprise 
communities.

                   C. Other Tax Technical Corrections

1. Hedge bonds (sec. 1704(b) of the bill, sec. 11701 of the 1989 Act, 
        and sec. 149(g) of the Code)

                              Present law

    The 1989 Act provided generally that interest on hedge 
bonds is not tax-exempt unless prescribed minimum percentages 
of the proceeds are reasonably expected to be spent at set 
intervals during the five-year period after issuance of the 
bonds (sec. 149(g)). A hedge bond is defined generally as a 
bond (1) at least 85 percent of the proceeds of which is not 
reasonably expected to be spent within three years following 
issuance and (2) more than 50 percent of the proceeds of which 
is invested at substantially guaranteed yields for four years 
or more.
    This restriction does not apply, however, if at least 95 
percent of the bond proceeds is invested in other tax-exempt 
bonds (not subject to the alternative minimum tax). The 95-
percent investment requirement is not violated if investment 
earnings exceeding five percent of the proceeds are temporarily 
invested for up to 30 days pending reinvestment in taxable 
(including alternative minimum taxable) investments.
    This provision is effective as if included in the Omnibus 
Budget Reconciliation Act of 1989.

                        Explanation of provision

    The bill clarifies that the 30-day exception for temporary 
investments of investment earnings applies to amounts (i.e., 
principal and earnings thereon) temporarily invested during the 
30-day period immediately preceding redemption of the bonds as 
well as such periods preceding reinvestment of the proceeds.

2. Withholding on distributions from U.S. real property holding 
        companies (sec. 1704(c) of the bill, sec. 129 of the Deficit 
        Reduction Act of 1984, and sec. 1445 of the Code)

                              Present law

                               In general

    Under the Foreign Investment in Real Property Tax Act of 
1980 (``FIRPTA''), a foreign investor that disposes of a U.S. 
real property interest generally is required to pay tax on any 
gain on the disposition. For this purpose a U.S. real property 
interest generally includes stock in a domestic corporation 
that is a U.S. real property holding corporation (``USRPHC''), 
or was a USRPHC at any time during the previous five years.
    A sale or exchange of stock in a USRPHC is an example of a 
disposition of a U.S. real property interest. In addition, 
provisions of subchapter C of the Code treat amounts received 
in certain corporate distributions as amounts received in sales 
or exchanges, giving rise to tax liability under the FIRPTA 
rules when a foreign person receives such a distribution from a 
present or former USRPHC. Thus, amounts received by a foreign 
shareholder in a USRPHC in a distribution in complete 
liquidation of the USRPHC are treated as in full payment in 
exchange for the USRPHC stock, and are therefore subject to tax 
under FIRPTA (sec. 331; Treas. Reg. sec. 1.897-5T(b)(2)(iii)). 
Similarly, amounts received by a foreign shareholder in a 
USRPHC upon redemption of the USRPHC stock are treated as a 
distribution in part or full payment in exchange for the stock, 
and are therefore subject to tax under FIRPTA (sec. 302(a); 
Treas. Reg. sec. 1.897-5T(b)(2)(ii)). Third, amounts received 
by a foreign shareholder in a USRPHC, in a section 301 
distribution from the USRPHC that exceeds the available 
earnings and profits of the USRPHC, are treated as gain from 
the sale or exchange of the shareholder's USRPHC stock to the 
extent that they exceed the shareholder's adjusted basis in the 
stock; such amounts are therefore also subject to tax under 
FIRPTA (sec. 301(c)(3); Treas. Reg. sec. 1.897-5T(b)(2)(i)).

                           FIRPTA withholding

    The Deficit Reduction Act of 1984 established a withholding 
system to enforce the FIRPTA tax. Unless an exception applies, 
a transferee of a U.S. real property interest from a foreign 
person generally is required to withhold the lesser of 10 
percent of the amount realized (purchase price), or the maximum 
tax liability on disposition (as determined by the IRS) (sec. 
1445). Such withholding may be reduced or eliminated pursuant 
to a withholding certificate issued by the Internal Revenue 
Service (Treas. Reg. sec. 1.1445-3).
    Although the FIRPTA withholding requirement by its terms 
generally applies to all dispositions of U.S. real property 
interests, and subchapter C treats amounts received in certain 
distributions as amounts received in sales or exchanges, the 
FIRPTA withholding provisions also provide express rules for 
withholding on certain distributions treated as sales or 
exchanges. Generally, distributions in a transaction to which 
section 302 (redemptions) or part II of subchapter C 
(liquidations) applies are subject to 10-percent 
withholding.118 Although a section 301 distribution in 
excess of earnings and profits is also treated as a disposition 
for purposes of computing the FIRPTA liability of a foreign 
recipient of the distribution, there is no corresponding 
withholding provision expressly addressed to the payor of such 
a distribution.
---------------------------------------------------------------------------
    \118\ Under other rules, dividend distributions (i.e., distribtions 
to which sec. 301(c)(1) applies) to foreign persons by U.S. 
corporations, including USRPHCs, are subject to 30-percent withholding 
under the Code. Under treaties, the withholding on a dividend may be 
reduced to as little as 5 or 15 percent.
---------------------------------------------------------------------------

                        Explanation of provision

    The bill clarifies that FIRPTA withholding requirements 
apply to any section 301 distribution to a foreign person by a 
domestic corporation that is or was a USRPHC, which 
distribution is not made out of the corporation's earnings and 
profits and is therefore treated as an amount received in a 
sale or exchange of a U.S. real property interest. (The bill 
does not alter the withholding treatment of section 301 
distributions by such a corporation that are out of earnings 
and profits.) Under the bill, the FIRPTA withholding 
requirements that apply to a section 301 distribution not out 
of earnings and profits are similar to the requirements 
applicable to redemption or liquidation distributions to a 
foreign person by such a corporation. It is anticipated that 
withholding certificates will be available to taxpayers that 
expect to receive section 301 distributions not out of earnings 
and profits.
    The provision is effective for distributions made after the 
date of enactment of the bill. No inference is intended to be 
drawn from the provision as to the FIRPTA withholding 
requirements applicable to such a distribution under present 
law.

3. Treatment of credits attributable to working interests in oil and 
        gas properties (sec. 1704(d) of the bill, sec. 501 of the Tax 
        Reform Act of 1986, and sec. 469 of the Code)

                              Present law

    Under present law, a working interest in an oil and gas 
property which does not limit the liability of the taxpayer is 
not a ``passive activity'' for purposes of the passive loss 
rules (sec. 469). However, if any loss from an activity is 
treated as not being a passive loss by reason of being from a 
working interest, any net income from the activity in 
subsequent years is not treated as income from a passive 
activity, notwithstanding that the activity may otherwise have 
become passive with respect to the taxpayer.

                        Explanation of provision

    The bill clarifies that any credit attributable to a 
working interest in an oil and gas property, in a taxable year 
in which the activity is no longer treated as not being a 
passive activity, will not be treated as attributable to a 
passive activity to the extent of any tax allocable to the net 
income from the activity for the taxable year. Any credits from 
the activity in excess of this amount of tax will continue to 
be treated as arising from a passive activity and will be 
treated under the rules generally applicable to the passive 
activity credit. The provision applies to taxable years 
beginning after December 31, 1986.

4. Clarification of passive loss disposition rule (sec. 1704(e) of the 
        bill, sec. 501 of the Tax Reform Act of 1986, sec. 
        1005(a)(2)(A) of the Technical and Miscellaneous Revenue Act of 
        1988, and sec. 469(g)(1)(A) of the Code)

                              Present law

    The Tax Reform Act of 1986 (``1986 Act'') provided that if 
a passive activity is disposed of in a transaction in which all 
gain or loss is recognized, any overall loss from the activity 
in the year of disposition is recognized and allowed against 
income (whether active or passive income).119 The language 
of the 1986 Act provided that any loss was allowable, first, 
against income or gain from the passive activity, second, 
against income or gain from all passive activities, and 
finally, against any other income or gain. This rule was 
rewritten by the technical corrections portion of the Technical 
and Miscellaneous Revenue Act of 1988 (``1988 Act''). The 
statutory language (as amended by the 1988 Act) providing for 
the computation of the overall loss for the taxable year of 
disposition is not entirely clear where the activity is 
disposed of at a gain.
---------------------------------------------------------------------------
    \119\ See S. Rept. 99-313, p. 725.
---------------------------------------------------------------------------

                        Explanation of provision

    The bill clarifies the rule relating to the computation of 
the overall loss allowed upon the disposition of a passive 
activity. The bill provides that, in a transaction in which all 
gain or loss is recognized on the disposition of a passive 
activity, any loss from the activity for the taxable year 
(taking into account all income, gain, and loss, including gain 
or loss recognized on the disposition) in excess of any net 
income or gain from other passive activities for the taxable 
year is treated as a loss which is not from a passive activity. 
The provision applies to taxable years beginning after December 
31, 1986.

5. Estate tax unified credit allowed nonresident aliens under treaty 
        (sec. 1704(f)(1) of the bill, sec. 5032(b)(2) of the Technical 
        and Miscellaneous Revenue Act of 1988, and sec. 2102(c)(3)(A) 
        of the Code)

                              Present law

                         Amount subject to tax

    For U.S. citizens and residents, the amount subject to 
Federal estate and gift tax is determined by reference to all 
property, wherever situated. For nonresident aliens, the Code 
provides that the amount subject to Federal estate and gift tax 
is determined only by reference to property situated in the 
United States.
    The United States has entered into bilateral treaties 
designed to avoid double transfer taxation. Early treaties 
typically did this by providing rules for determining situs and 
requiring that the State of domicile allow a credit for taxes 
paid to the situs country.120 In contrast, treaties signed 
in the 1980s, and the U.S. and OECD model treaties, exempt most 
property, wherever situated, from taxation outside the State of 
domicile.121
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    \120\ See Staff of the Joint Committee on Taxation, 98th Cong., 2d 
Sess., Explanation of Proposed Estate and Gift Tax Treaty Between the 
United States and Sweden 8 (1984).
    \121\ See, e.g., U.S. Treasury Model Estate and Gift Tax Treaty 
(1980), Article 7, paragraph 1: ``Transfers and deemed transfers by an 
individual domiciled in a Contracting State of property other an 
property referred to in Article 5 (Real Property) and 6 (Business 
Property of a Permanent Establishment and Asset Pertaining to a Fixed 
Base Used for the Performance of Independent Personal Services) shall 
be taxable only in that State.''
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                 Specific exemption and unified credit

    Prior to the Tax Reform Act of 1976 (``1976 Act''), the 
Code allowed a ``specific exemption'' against the estate tax. 
The estate of a U.S. citizen or resident was allowed an 
exemption of $60,000, while the estate of a nonresident alien 
was allowed a lesser amount. A number of U.S. estate tax 
treaties ratified in the 1950s allowed a nonresident alien a 
``specific exemption'' equal to the exemption allowed a U.S. 
citizen or resident multiplied by the percentage of the gross 
estate subject to U.S. estate tax (the ``pro rata 
exemption'').122
---------------------------------------------------------------------------
    \122\ See Rev. Rul. 81-303, 1981-2 C.B. 255.
---------------------------------------------------------------------------
    The 1976 Act replaced the specific exemption with a unified 
credit of $47,000 for the estate of U.S. citizen or resident 
and $3,600 for the estate of a nonresident alien. After 1976, 
two courts interpreted the pro rata exemption allowed in the 
1950s treaties as applying to the unified credit, i.e., as 
allowing a unified credit no less than the unified credit 
allowed a U.S. citizen or resident multiplied by the percentage 
of the gross estate situated in the United States (and 
therefore subject to U.S. estate tax under those 
treaties).123
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    \123\ See Mudry v. United States, 11 Cl. Ct. 207 (1986) (Swiss 
treaty); Burghardt v. Commissioner, 80 T.C. 705 (1983), affd., 734F.2d 
3 (3d Cir. 1984) (Italian treaty).
---------------------------------------------------------------------------
    The Technical and Miscellaneous Revenue Act of 1988 (``1988 
Act'') increased the unified credit allowed an estate of a 
nonresident alien to $13,000. In so doing, the 1988 Act 
provided that, ``to the extent required by any treaty,'' the 
estate of a nonresident alien is allowed a unified credit equal 
to the unified credit allowed a U.S. citizen or resident 
multiplied by the percentage of the gross estate situated in 
the United States (Code sec. 2102(c)(3)(A)). Thus, the 1988 Act 
did not override the ``specific exemption'' language of the 
1950s treaties, as interpreted by the two courts, and could be 
interpreted as encouraging the negotiation of pro rata unified 
credits in future treaties.

                        Explanation of provision

    The bill clarifies that in determining the pro rata unified 
credit required by treaty, property exempted by the treaty from 
U.S. estate tax is not treated as situated in the United 
States. Under this rule, a treaty granting a pro rata unified 
credit would allow a nonresident alien the unified credit 
allowed a U.S. citizen or resident multiplied by the percentage 
of the gross estate subject to U.S. estate tax, as modified by 
treaty.
    The provision is not intended to affect existing treaties 
that contain pro rata exemptions pursuant to which the assets 
reserved for situs taxation by the non-domiciliary country are 
specifically described. In the case of a treaty that contains a 
pro rata exemption but does not provide rules for determining 
the situs for property (e.g., the treaty with Canada), the bill 
clarifies that property exempted by the treaty from U.S. estate 
tax is not treated as situated in the United States. The Senate 
Foreign Relations Committee Report with respect to the revised 
protocol amending the tax convention with Canada anticipated 
the enactment of this provision (Sen. Exec. Rep. No. 104-9, 
104th Cong., 1st Sess. at 15). For future treaties, it is 
intended that any pro rata unified credit negotiated not exceed 
the proportion of the gross worldwide estate subject to U.S. 
estate and gift tax, as modified by treaty.
    The provision is effective upon the date of its enactment.

6. Limitation on deduction for certain interest paid by corporation to 
        related persons (sec. 1704(f)(2)(A) of the bill, sec. 7210(a) 
        of the 1989 Act, and sec. 163(j) of the Code)

                              Present law

    Subject to certain limitations, a taxpayer may deduct 
interest paid or accrued on indebtedness within a taxable year 
(sec. 163(a)). The 1989 Act added a so-called ``earnings 
stripping'' limitation on interest deductibility with respect 
to certain interest paid by corporations to related persons 
(sec. 163(j)). If the provision applies to a corporation for a 
taxable year, it disallows deductions for certain amounts of 
``disqualified interest'' paid or accrued by the corporation 
during that year. If in a taxable year a deduction is 
disallowed, under the provision, for an amount of interest paid 
or accrued in that year, the disallowed amount is treated under 
the earnings stripping provision as disqualified interest paid 
or accrued in the succeeding taxable year.124
---------------------------------------------------------------------------
    \124\ Disqualified interest is interest paid by a corporation to 
related persons that are not subject to U.S. tax on the interest 
received. (If, in accordance with a U.S. income tax treaty, interest 
income of a related person is subject to a reduced rate of U.S. tax, a 
portion of the interest paid to the related person is deemed to be 
interest on which no tax is imposed.)
---------------------------------------------------------------------------
    In order for the earnings stripping provision to apply to a 
corporation for a taxable year, two thresholds must be 
exceeded. To exceed the first threshold, the corporation must 
have ``excess interest expense'' as that term is defined in the 
Code for this purpose. To exceed the second threshold, the 
corporation must have a ratio of debt to equity as of the close 
of the taxable year in question (or on any other day prescribed 
by the Secretary in regulations) that exceeds 1.5 to 1. Excess 
interest expense is the excess (if any) of the corporation's 
net interest expense over the sum of 50 percent of the adjusted 
taxable income of the corporation plus any excess limitation 
carryforward from a prior year. Excess limitation is the excess 
(if any) of 50 percent of adjusted taxable income over net 
interest expense.

                        Explanation of provision

    The bill provides that the debt-equity threshold does not 
apply for purposes of applying the earnings stripping provision 
to a carryover of excess interest expense from a prior taxable 
year. Thus, the bill clarifies that excess interest carried 
forward from a year in which the debt-equity ratio threshold is 
exceeded may be deducted in a subsequent year in which that 
threshold is not exceeded, but only to the extent that such 
interest would not otherwise be treated as excess interest 
expense in the carryforward year.
    For example, assume that in year 1 $20 of a corporation's 
interest expense is nondeductible due to the operation of the 
earnings stripping provision. The corporation carries forward 
the $20 of interest deduction that it could not use in year 1. 
Assume that in year 2 the corporation has a debt-equity ratio 
of 1 to 1 and $50 of current net and gross interest expense, 
all of which is disqualified interest, and that it earns $400 
of adjusted taxable income. The provision is intended to 
clarify that the $20 of interest carried forward from year 1 is 
deductible in year 2. This is because $70, the sum of the 
current net interest expense for year 2 ($50) plus the interest 
expense carried over from year 1 ($20), does not exceed one-
half of adjusted taxable income in year 2.
    As another example, assume that in year 2 the corporation 
has a debt-equity ratio of 1 to 1 and $50 of current net and 
gross interest expense, all of which is disqualified interest, 
and that it earns $80 of adjusted taxable income. The provision 
is intended to clarify that the $20 of interest carried forward 
from year 1 is not deductible in year 2. This is because the 
current net interest expense for year 2 ($50) exceeds by $10 
one-half of adjusted taxable income in year 2 ($80 divided by 
2, or $40). Therefore, treating the year 1 carryover as an 
interest expense in year 2 causes the corporation to have 
excess interest expense equal to $30. But for the debt-equity 
safe harbor, the corporation would have a $30 interest expense 
disallowance in year 2 if the carried over amount were treated 
as having been paid in year 2. Under the bill, no actual year 2 
interest can be disallowed. However, under these facts, none of 
the interest carried over from year 1 can be deducted in year 
2. Instead, the interest carried over from year 1 is carried 
forward for potential deduction (subject to the same rules that 
applied to the carryforward in year 2) in a year subsequent to 
year 2.
    As a third example, assume that in year 2 the corporation 
has a debt-equity ratio of 1 to 1 and $50 of current net and 
gross interest expense, all of which is disqualified interest, 
and that it earns $110 of adjusted taxable income. The 
provision is intended to clarify that $5 of interest carried 
forward from year 1 is deductible in year 2, and the other $15 
of interest carried forward from year 1 is not deductible in 
year 2. This is because the current net interest expense for 
year 2 ($50) is $5 less than one-half of adjusted taxable 
income in year 2 (one-half of $110, or $55). Therefore, even if 
the debt-equity safe harbor had not been met in year 2, the 
corporation would have had $5 of excess limitation in year 2 
had there been no carryover amount from year 1. On the other 
hand, treating the year 1 carryover as an interest expense in 
year 2 causes the corporation to have excess interest expense 
equal to $15. This $15 may be carried forward to a subsequent 
year.
    The provision is effective as if included in the amendments 
made by section 7210(a) of the Revenue Reconciliation Act of 
1989.

7. Interaction between passive activity loss rules and earnings 
        stripping rules (sec. 1704(f)(2)(B) and (C) of the bill, sec. 
        7210(a) of the 1989 Act, and sec. 163(j) of the Code)

                              Present law

    The passive loss rules limit deductions and credits from 
passive trade or business activities (sec. 469). Deductions 
attributable to passive activities, to the extent they exceed 
income from passive activities, generally may not be deducted 
against other income, such as wages, portfolio income, or 
business income that is not derived from a passive activity. 
Deductions and credits that are suspended are carried forward 
and treated as deductions and credits from passive activities 
in the next year. Suspended losses from a passive activity are 
allowed in full when a taxpayer disposes of his entire interest 
in the passive activity to an unrelated person. The passive 
loss rules apply to any taxpayer that is an individual, estate, 
trust, closely held C corporation, or personal service 
corporation. In determining passive activity deductions, 
Treasury regulations provide that ``an item of deduction arises 
in the taxable year in which the item would be allowable as a 
deduction under the taxpayer's method of accounting if taxable 
income for all taxable years were determined without regard to 
sections 469, 613A(d) and 1211'' (Treas. Reg. sec. 1.469-
2(d)(8)). Thus, these regulations effectively require other 
limitations to be applied before applying the passive loss 
rules.
    The at-risk rules limit deductible losses from an activity 
to the amount that the taxpayer has at risk, in the case of an 
individual or a closely-held corporation (sec. 465). The amount 
at risk is generally the sum of (1) cash contributions, (2) the 
adjusted basis of contributed property, and (3) amounts 
borrowed for use in the activity with respect to which the 
taxpayer has personal liability or has pledged as security 
property not used in the activity. The amount at risk is 
increased by income from the activity and decreased by losses 
and withdrawals.
    A taxpayer generally may deduct interest paid or accrued on 
indebtedness within a taxable year (sec. 163(a)). The Revenue 
Reconciliation Act of 1989 (the ``1989 Act'') added an 
``earnings stripping'' limitation on interest deductibility 
with respect to certain interest paid by corporations to 
related persons (sec. 163(j)). If the provision applies to a 
corporation for a taxable year, it disallows deductions for 
certain amounts of ``disqualified interest'' paid or accrued by 
the corporation during that year. Disqualified interest is 
interest paid by a corporation to related persons that are not 
subject to U.S. tax on the interest received. The disallowed 
amount is treated under the earnings stripping provision as 
disqualified interest paid or accrued in the succeeding taxable 
year. Proposed Treasury regulations would provide that 
``sections 465 and 469 shall be applied before applying section 
163(j)'' (Prop. Treas. Reg. sec. 1.163(j)-7(b)(3)).

                        Explanation of provision

    The provision modifies section 163(j) of the Code to 
clarify that the earnings stripping rules apply before the 
passive loss rules and the at-risk rules.
    The provision is effective as if included in the 1989 Act.

8. Branch-level interest tax (sec. 1704(f)(3) of the bill, sec. 1241 of 
        the 1986 Act, and sec. 884 of the Code)

                              Present law

    Interest paid (or treated as if paid) by a U.S. trade or 
business (i.e., a U.S. branch) of a foreign corporation is 
treated as if paid by a U.S. corporation and, hence, is U.S. 
source and subject to U.S. withholding tax of 30 percent, 
unless the tax is reduced or eliminated by a specific Code or 
treaty provision. The Treasury has regulatory authority to 
limit U.S. sourcing, and hence U.S. withholding, to the amount 
of interest reasonably expected to be deducted in arriving at 
the U.S. branch's effectively connected taxable income.
    To the extent a U.S. branch of a foreign corporation has 
allocated to it under Treasury Regulation section 1.882-5 an 
interest deduction in excess of the interest actually paid by 
the branch (this generally occurs where the indebtedness of the 
U.S. branch is disproportionately small compared to the total 
indebtedness of the foreign corporation), the excess is treated 
as if it were interest paid on a notional loan to a U.S. 
subsidiary (the U.S. branch, in actuality) from its foreign 
corporate parent (the home office). This excess is subject to 
the 30-percent tax, absent a specific Code exemption or treaty 
reduction (sec. 884(f)(1)(B)).
    These branch-level interest taxes, along with the branch 
profits tax, were intended to reflect the view that a foreign 
corporation doing business in the United States generally 
should be subject to the same substantive tax rules that apply 
to a foreign corporation operating in the United States through 
a U.S. subsidiary.125 Where a U.S. corporation pays 
interest to its foreign corporate parent, that interest, like 
the interest deducted by a U.S. branch of a foreign 
corporation, is also generally subject to a 30-percent U.S. 
withholding tax unless the tax is reduced by treaty. In the 
case of a U.S. subsidiary of a foreign parent corporation, the 
withholding tax applies without regard to whether the interest 
payment is currently deductible by the U.S. subsidiary. For 
example, deductions for interest may be delayed or denied under 
section 163, 263, 263A, 266, 267, or 469, but it is still 
subject (or not subject) to withholding when paid without 
regard to the operation of those provisions.
---------------------------------------------------------------------------
    \125\ Staff of the Joint Committee on Taxation, 100th Cong., 1st 
Sess., General Explanation of the Tax Reform Act of 1986 at 1036 
(1987).
---------------------------------------------------------------------------

                        Explanation of provision

    The bill provides that the branch level interest tax on 
interest not actually paid by the branch applies to any 
interest which is allocable to income which is effectively 
connected with the conduct of a trade or business in the United 
States. Similarly, in the case of interest paid by the U.S. 
branch, the bill provides regulatory authority to limit U.S. 
sourcing, and hence U.S. withholding, to the amount of interest 
reasonably expected to be allocable to income which is 
effectively connected with the conduct of a trade or business 
in the United States. Thus, where an interest expense of a 
foreign corporation is allocable to U.S. effectively connected 
income, but that interest expense would not have been fully 
deductible for tax purposes under another Code provision had it 
been paid by a U.S. corporation, the bill clarifies that such 
interest is nonetheless treated for branch level interest tax 
purposes like a payment by a U.S. corporation to a foreign 
corporate parent. Similarly, with regard to the Treasury's 
regulatory authority to treat an interest payment by a foreign 
corporation's U.S. branch as though not paid by a U.S. person 
for source and withholding purposes, the bill clarifies that 
the authority extends to interest payments in excess of those 
reasonably expected to be allocable to U.S. effectively 
connected income of the foreign corporation.
    These provisions are effective as if they were made by the 
Tax Reform Act of 1986.

9. Determination of source in case of sales of inventory property (sec. 
        1704(f)(4) of the bill, sec. 211 of the 1986 Act, and sec. 
        865(b) of the Code)

                              Present law

    Prior to the 1986 Act, the source of income derived from 
the sale of personal property generally was determined by the 
place of sale (commonly referred to as the ``title passage'' 
rule) (see, e.g., Treas. Reg. sec. 1.861-7, T.D. 6258, 1957-2 
C.B. 368). While the 1986 Act generally replaced the place-of-
sale rule for sales of personal property with a residence-of-
the-seller rule (sec. 865(a)), the Act did not change the 
place-of-sale rule for most sales of inventory property (sec. 
865(b)).
    Before and after the 1986 Act, statutory rules for sourcing 
income from inventory sales have included those covering income 
from (1) purchasing inventory property outside the United 
States (other than within a U.S. possession) and selling it in 
the United States (sec. 861(a)(6)); (2) purchasing inventory 
property in the United States and selling it outside the United 
States (sec. 862(a)(6)); (3) selling outside the United States 
inventory property which has been produced by the taxpayer in 
the United States (or selling in the United States inventory 
property which has been produced by the taxpayer outside the 
United States) (sec. 863(b)(2)); and (4) purchasing inventory 
property in a U.S. possession and selling it in the United 
States (sec. 863(b)(3)). Prior to the 1986 Act, these 
provisions were not limited in application to income from sales 
of inventory property, but rather covered sales of personal 
property generally.
    In addition to statutory rules for sourcing items of income 
from transactions involving inventory property specified in the 
Code, such as those listed above, the Code both before and 
after the 1986 Act has contained other sourcing rules that do 
not make specific reference to property sales, and includes 
general regulatory authority to allocate and apportion between 
U.S. and foreign sources items of gross income, expenses, 
losses, and deductions other than those specified in sections 
861(a) and 862(a) (sec. 863(a)). In carving income from the 
sale of inventory property out of the general residence-of-the-
seller rule of section 865, section 865(b) makes reference to 
the above statutory rules making specific reference to 
inventory property, but not to the general grant of regulatory 
authority in section 863(a).

                        Explanation of provision

    The bill modifies the general provision relating to the 
sourcing of income from the sale of personal property (sec. 
865) so that the cross-reference to sourcing rules applicable 
to inventory property includes a reference to all of section 
863, rather than simply to section 863(b). The bill thus 
clarifies that, to the extent that the Secretary of the 
Treasury had general regulatory authority to provide rules for 
the sourcing of income from the sales of personal property 
prior to the 1986 Act, the Secretary of the Treasury retains 
that authority under present law with respect to inventory 
property.
    The bill is not intended to increase the Treasury 
Secretary's regulatory authority under section 863(a) beyond 
the authority that he had under the law in effect prior to the 
enactment of the 1986 Act. It is intended that no inference be 
drawn from this provision either as to the correctness of, or 
as to the post-1986 Act implications of, any judicial decision 
interpreting the scope of that pre-1986 Act authority.
    The provision is effective as if it were included in the 
Tax Reform Act of 1986.

10. Repeal of obsolete provisions (sec. 1704(f)(5) of the bill, sec. 
        10202 of the Revenue Act of 1987, and secs. 6038(a)(1)(F) and 
        6038A(b)(4) of the Code)

                              Present law

    A U.S. person who controls a foreign corporation must 
report certain information related to that foreign corporation 
as may be required by the Treasury Secretary (sec. 6038). 
Information reporting is also required with respect to certain 
foreign-owned domestic corporations (sec. 6038A). Included 
under each of these information reporting provisions is a 
requirement to report such information as the Treasury 
Secretary may require for purposes of carrying out the 
provisions of section 453C. Section 453C, relating to certain 
indebtedness treated as payment on installment obligations (the 
so-called ``proportional disallowance rule''), was repealed in 
the Revenue Act of 1987.

                        Explanation of provision

    The bill repeals as obsolete the information reporting 
requirements of sections 6038 and 6038A relating to section 
453C. The provision is effective upon the date of its 
enactment.

11. Clarification of a certain stadium bond transition rule in Tax 
        Reform Act of 1986 (sec. 1704(g) of the bill and sec. 
        1317(3)(A) of the Tax Reform Act of 1986)

                              Present law

    The Tax Reform Act of 1986 included a transition rule 
authorizing tax-exempt bonds not exceeding $200 million to be 
issued by or on behalf of the City of Cleveland, Ohio, to 
finance a stadium. The bonds were required to be issued before 
January 1, 1991 (and were so issued). As enacted, the rule 
required Cleveland to retain a residual interest in the stadium 
following planned private business use.

                        Explanation of provision

    The bill permits the residual interest in the stadium 
currently held by the City of Cleveland to be assigned to 
Cuyahoga County, Ohio (the county in which both Cleveland and 
the stadium are located) because of a change in Ohio State law 
prior to issuance of the bonds. The bill does not extend the 
time for issuing the bonds or otherwise affect the amount of 
bonds or the location or design of the stadium.
    This provision is effective as if included in the Tax 
Reform Act of 1986.

12. Health care continuation rules (sec. 1704(h) of the bill, sec. 
        7862(c)(5) of the 1989 Act, sec. 4980B(f)(2)(B)(i) of the Code, 
        sec. 602(2)(A) of ERISA, and sec. 2202(2)(A) of the Public 
        Health Service Act)

                              Present law

    The Revenue Reconciliation Act of 1989 (``1989 Act'') 
amended the health care continuation rules to provide that if a 
covered employee is entitled to Medicare and within 18 months 
of such entitlement separates from service or has a reduction 
in hours, the duration of continuation coverage for the spouse 
and dependents is 36 months from the date the covered employee 
became entitled to Medicare. One possible interpretation of the 
statutory language, however, would permit continuation coverage 
for up to 54 months. This extension of the coverage period was 
not intended.

                        Explanation of provision

    The bill amends the Code (sec. 4980B), title I of the 
Employee Retirement Income Security Act (sec. 602), and the 
Public Health Service Act (sec. 2202(2)(A)) to limit the 
continuation coverage in such cases to no more than 36 months. 
The provision is effective for plan years beginning after 
December 31, 1989.

13. Taxation of excess inclusions of a residual interest in a REMIC for 
        taxpayers subject to alternative minimum tax with net operating 
        losses (sec. 1704(i) of the bill and sec. 860E(a)(6) of the 
        Code)

                              Present law

                     Residual interests in a REMIC

    A real estate mortgage investment conduit (``REMIC'') is an 
entity that holds real estate mortgages. All interests in a 
REMIC must be ``regular interests'' or ``residual interests.'' 
A regular interest is an interest the terms of which are fixed 
on the start-up day, which unconditionally entitles the holder 
to receive a specified principal amount, and which provides 
that interest amounts are payable based on a fixed rate (or a 
variable rate to the extent provided in the Treasury 
regulations). A residual interest is any interest that is so 
designated and that is not a regular interest in a REMIC.
    Generally, the holder of a residual interest in a REMIC 
takes into account his daily portion of the taxable income or 
net loss of such REMIC for each day during which he held such 
interest. The taxable income of any holder of a residual 
interest in a REMIC for any taxable year cannot be less than 
the excess inclusion for the year (sec. 860E). Thus, in 
general, income from excess inclusions cannot be offset by a 
net operating loss (or net operating loss carryover) in 
computing the taxpayer's regular tax.

                        Alternative minimum tax

    Taxpayers are subject to an alternative minimum tax which 
is payable, in addition to all other tax liabilities, to the 
extent it exceeds the taxpayer's regular tax. The tax is 
imposed at rates of 26 and 28 percent (20 percent in the case 
of a corporation) on alternative minimum taxable income in 
excess of an exemption amount. Alternative minimum taxable 
income generally is the taxpayer's taxable income, as increased 
or decreased by certain adjustments and preferences. A taxpayer 
may offset no more than ninety percent of its alternative 
minimum taxable income with its alternative tax net operating 
loss carryover.
    Because the determination of a taxpayer's alternative 
minimum taxable income begins with taxable income, a holder of 
a residual interest in a REMIC may have positive alternative 
minimum taxable income even where the taxpayer has a net 
operating loss for the year.

                        Explanation of provision

    The bill provides that three rules for determining the 
alternative minimum taxable income of a taxpayer that is not a 
thrift institution that holds residual interests in a REMIC.
    First, the alternative minimum taxable income of such a 
taxpayer is computed without regard to the REMIC rule that 
taxable income cannot be less than the amount of excess 
inclusions. This provision prevents a taxpayer from having to 
include in alternative minimum taxable income preference items 
for which it received no tax benefit.
    Second, the alternative minimum taxable income of such a 
taxpayer for a taxable year cannot be less than the excess 
inclusions of the residual interests for that year. In effect, 
this provision prevents nonrefundable credits from reducing the 
taxpayer's income tax below an amount equal to what the 
tentative minimum tax would be if computed only on excess 
inclusions.
    Third, the amount of any alternative minimum tax net 
operating loss deduction of such a taxpayer is computed without 
regard to any excess inclusions. This provision insures that 
the net operating losses will not reduce any income 
attributable to any excess inclusions. Thus, all such taxpayers 
subject to the alternative minimum tax will pay a tax on excess 
inclusions at the alternative minimum tax rate, regardless of 
whether the taxpayer has a net operating loss.
    The provision is effective for all taxable years beginning 
after December 31, 1986, unless the taxpayer elects to apply 
the rules of the bill only to taxable years beginning after the 
date of enactment.

14. Application of harbor maintenance tax to Alaska and Hawaii ship 
        passengers (sec. 1704(j) of the bill and sec. 4462(b) of the 
        Code)

                              Present law

    A harbor maintenance excise tax (``harbor tax'') of 0.125 
percent of value applies generally to commercial cargo 
(including passenger fares) loaded or unloaded at U.S. ports 
(sec. 4461). The harbor tax does not apply to commercial cargo 
(other than crude oil with respect to Alaska) loaded or 
unloaded in Alaska, Hawaii, and U.S. possessions where such 
cargo is transported to or from the U.S. mainland (for domestic 
use) or where such cargo is loaded and unloaded in the same 
State (Alaska or Hawaii) or possession (sec. 4462(b)).

                        Explanation of provision

    The bill clarifies that the harbor tax does not apply to 
passenger fares where the passengers are transported on U.S. 
flag vessels operating solely within the State waters of Alaska 
or Hawaii and adjacent international waters (i.e., leaving and 
returning to a port in the same State without stopping 
elsewhere).
    The provision applies as if included in the Harbor 
Maintenance Revenue Act of 1986 (April 1, 1987).

15. Modify effective date provision relating to the Energy Policy Act 
        of 1992 (sec. 1704(k) of the bill and secs. 53 and 30 of the 
        Code)

                              Present law

    The nonconventional fuels production credit (sec. 29) 
cannot reduce the taxpayer's tax liability to less than the 
amount of the tentative minimum tax. The credit for prior year 
minimum tax liability (sec. 53) is increased by the amount of 
the nonconventional fuels credit not allowed for the taxable 
year solely by reason of the limitation based on the taxpayer's 
tentative minimum tax.

                        Explanation of provision

    The bill corrects a cross reference to section 29(b)(6)(B) 
contained in section 53(d)(1)(B)(iv), and clarifies that the 
correction applies to taxable years beginning after December 
31, 1990. In addition, section 1702(e)(5) of the bill clarifies 
that a correction made in the Energy Policy Act of 1992 to a 
similar cross reference in section 53(d)(1)(B)(iii) applies to 
taxable years beginning after December 31, 1990.
    The bill also clarifies the relationship between the basis 
adjustment rules for the electric vehicle credit (sec. 
30(d)(1)) and the alternative minimum tax.

16. Treat qualified football coaches plan as multiemployer pension plan 
        for purposes of the Internal Revenue Code (sec. 1704(l) of the 
        bill and sec. 1022 of ERISA)

                              Present law

    Section 3(37) of the Employee Retirement Income Security 
Act of 1974 (``ERISA''), as amended by Public Law 100-202 
(Continuing Appropriations for Fiscal Year 1988), provides 
that, for purposes of Title I of ERISA, a qualified football 
coaches plan generally is treated as a multiemployer plan and 
may include a qualified cash or deferred arrangement. Under 
section 3(37) of ERISA, a qualified football coaches plan is 
defined as any defined contribution plan established and 
maintained by an organization described in section 501(c) of 
the Internal Revenue Code (the ``Code''), the membership of 
which consists entirely of individuals who primarily coach 
football as full-time employees of 4-year colleges or 
universities, if the organization was in existence on September 
18, 1986. This definition is generally intended to apply to the 
American Football Coaches Association.
    However, section 9343(a) of the Omnibus Budget 
Reconciliation Act of 1987 (P.L. 100-203) provides that Titles 
I and IV of ERISA are not applicable in interpreting Title II 
of ERISA (the Code provisions relating to qualified plans), 
except to the extent specifically provided in the Code or as 
determined by the Secretary of the Treasury.

                        Explanation of provision

    The bill amends Title II of ERISA to provide that, for 
purposes of determining the qualified plan status of a 
qualified football coaches plan, section 3(37) of ERISA is 
treated as part of Title II of ERISA and a qualified football 
coaches plan is treated as a multiemployer collectively 
bargained plan.
    The provision is effective for years beginning after 
December 22, 1987 (the date of enactment of P.L. 100-202).

17. Determination of unrecovered investment in annuity contract (sec. 
        1704(m) of the bill and sec. 72 (b) and (c) of the Code)

                              Present law

    An exclusion is provided for amounts received as an annuity 
under an annuity, endowment, or life insurance contract, as 
determined under a statutory exclusion ratio (sec. 72(b)). The 
exclusion ratio is determined as the ratio of (1) the 
taxpayer's investment in the contract (as of the annuity 
starting date) to (2) the expected return under the contract 
(as of such date). In the case of a contract with a refund 
feature, the amount of a taxpayer's investment in the contract 
is reduced by the value of the refund feature (sec.72(c)).
    This exclusion was modified by the Tax Reform Act of 1986 
to limit the excludable amount to the taxpayer's unrecovered 
investment in the contract, and to provide a deduction for the 
unrecovered investment in the contract if payments as an 
annuity under the contract cease by reason of the death of an 
annuitant. In the case of a contract with a refund feature, the 
1986 Act modifications reduce the exclusion ratio so that it is 
possible that less than the entire investment in the contract 
can be recovered tax-free.

                        Explanation of provision

    The bill modifies the definition of the unrecovered 
investment in the contract, in the case of a contract with a 
refund feature, so that the entire investment in the contract 
can be recovered tax-free.
    The provision is effective as if enacted in the Tax Reform 
Act of 1986.

18. Election by parent to claim unearned income of certain children on 
        parent's return (sec. 1704(n) of the bill and secs. 1 and 59(j) 
        of the Code)

                              Present law

    The net unearned income of a child under 14 years of age is 
taxed to the child at the parent's statutory rate. Net unearned 
income means unearned income less the sum of $650 (for 1995) 
and the greater of: (1) $650 (for 1995) or, (2) if the child 
itemizes deductions, the amount of allowable deductions 
directly connected with the production of the unearned income. 
The dollar amounts are adjusted for inflation.
    In certain circumstances, a parent may elect to include a 
child's unearned income on the parent's income tax return if 
the child's income is less than $5,000. A parent making this 
election must include the gross income of the child in excess 
of $1,000 in income for the taxable year. In addition, the 
parent must report an additional tax liability equal to the 
lesser of (1) $75 or (2) 15 percent of the excess of the 
child's income over $500. The dollar amounts for the election 
are not adjusted for inflation.
    A person claimed as a dependent cannot claim a standard 
deduction exceeding the greater of $650 (for 1995) or such 
person's earned income. For alternative minimum tax purposes, 
the exemption of a child under 14 years of age generally cannot 
exceed the sum of such child's earned income plus $1,000. The 
$650 amount is adjusted for inflation but the $1,000 amount is 
not.

                        Explanation of provision

    The bill adjusts for inflation the dollar amounts involved 
in the election to claim unearned income on the parent's 
return. It likewise indexes the $1,000 amount used in computing 
the child's alternative minimum tax.
    The provision is effective for taxable years beginning 
after December 31, 1995.

19. Treatment of certain veterans' reemployment rights (sec. 1704(o) of 
        the bill and new sec. 414(u) of the Code)

                              Present law

    Under the Uniformed Services Employment and Reemployment 
Rights Act of 1994 (``USERRA''), Pub. L. No. 103-353, 38 U.S.C. 
Sec. Sec. 4301, ff., which revised and restated the Federal law 
protecting veterans' reemployment rights, an employee who 
leaves a civilian job for qualified military service generally 
is entitled to be reemployed by the civilian employer if the 
individual returns to employment within a specified time 
period. In addition to reemployment rights, a returning veteran 
also is entitled to the restoration of certain pension, profit 
sharing and similar benefits that would have accrued, but for 
the employee's absence due to the qualified military service.
    USERRA generally provides that for a reemployed veteran 
service in the uniformed services is considered service with 
the employer for retirement plan benefit accrual purposes, and 
the employer that reemploys the returning veteran is liable for 
funding any resulting obligation. USERRA also provides that the 
reemployed veteran is entitled to any accrued benefits that are 
contingent on the making of, or derived from, employee 
contributions or elective deferrals only to the extent the 
reemployed veteran makes payment to the plan with respect to 
such contributions or deferrals. No such payment may exceed the 
amount the reemployed veteran would have been permitted or 
required to contribute had the person remained continuously 
employed by the employer throughout the period of uniformed 
service. Under USERRA, any such payment to the plan must be 
made during the period beginning with the date of reemployment 
and whose duration is three times the reemployed veteran's 
period of uniform service, not to exceed five years.
    Under the Internal Revenue Code, overall limits are 
provided on contributions and benefits under certain retirement 
plans. For example, the maximum amount of elective deferrals 
that can be made by an individual into a qualified cash or 
deferred arrangement in any taxable year is limited to $9,500 
for 1996 (sec. 402(g)). Annual additions with respect to each 
participant under a qualified defined contribution plan 
generally are limited to the lesser of $30,000 (for 1996) or 25 
percent of compensation (sec 415(c)). Annual deferrals with 
respect to each participant under an eligible deferred 
compensation plan (sec. 457) generally are limited to the 
lesser of $7,500 or 33\1/3\ percent of includible compensation. 
There is no provision under present law that permits 
contributions or deferrals to exceed these and other annual 
limits in the case of contributions with respect to a 
reemployed veteran.
    Other requirements for which there is no special provision 
for contributions with respect to a reemployed veteran include 
the limit on deductible contributions and the qualified plan 
nondiscrimination, coverage, minimum participation, and top 
heavy rules.

                        Explanation of provision

    The bill provides special rules in the case of certain 
contributions (``make-up contributions'') with respect to a 
reemployed veteran that are required or authorized under 
USERRA. The bill applies to contributions made by an employer 
or employee to an individual account plan or to contributions 
made by an employee to a defined benefit plan that provides for 
employee contributions.
    Under the bill, if any make-up contribution is made by an 
employer or employee with respect to a reemployed veteran, then 
such contributions are not subject to the generally applicable 
plan contribution limits (i.e., secs. 402(g), 402(h), 403(b), 
408, 415, or 457) or the limit on deductible contributions 
(i.e., secs. 404(a) or 404(h)) as applied with respect to the 
year in which the contribution is made. In addition, the make-
up contribution are not taken into account in applying the plan 
contribution or deductible contribution limits to any other 
contribution made during the year. However, the amount of any 
make-up contribution could not exceed the aggregate amount of 
contributions that would have been permitted under the plan 
contribution and deductible contribution limits for the year to 
which the contribution relates had the individual continued to 
be employed by the employer during the period of uniformed 
service.
    Under the bill, a plan to which a make-up contribution is 
made on account of a reemployed veteran is not treated as 
failing to meet the qualified plan nondiscrimination, coverage, 
minimum participation, and top heavy rules (i.e., secs. 
401(a)(4), 401(a)(26), 401(k)(3), 401(k)(11), 401(k)(12), 
401(m), 403(b)(12), 408(k)(3), 408(k)(6), 408(p), 410(b), or 
416) by reason of the making of such contribution. 
Consequently, for purposes of applying the requirements and 
tests associated with these rules, make-up contributions are 
not taken into account either for the year in which they are 
made or for the year to which they relate.
    Under the bill, a special rule applies in the case of make-
up contributions of salary reduction, employer matching, and 
after-tax employee amounts. A plan that provides for elective 
deferrals or employee contributions is treated as meeting the 
requirements of USERRA if the employer permits reemployed 
veterans to make additional elective deferrals or employee 
contributions under the plan during the period which begins on 
the date of reemployment and has the same length as the lesser 
of (1) the period of the individual's absence due to uniformed 
service multiplied by three or (2) five years.
    The employer is required to match any additional elective 
deferrals or employee contributions at the same rate that would 
have been required had the deferrals or contributions actually 
been made during the period of uniformed service. Additional 
elective deferrals, employer matching contributions, and 
employee contributions is treated as make-up contributions for 
purposes of the rule exempting such contributions from 
qualified plan nondiscrimination, coverage, minimum 
participation, and top heavy rules as described above.
    The bill clarifies that USERRA does not require (1) any 
earnings to be credited to an employee with respect to any 
contribution before such contribution is actually made or (2) 
any make-up allocation of any forfeiture that occurred during 
the period of uniformed service.
    The bill also provides that the plan loan, plan 
qualification, and prohibited transaction rules will not be 
violated merely because a plan suspends the repayment of a plan 
loan during a period of uniformed service.
    The bill also defines compensation to be used for purposes 
of determining make-up contributions and would conform the 
rules contained in the Code with certain rights of reemployed 
veterans contained in USERRA pertaining to employee benefit 
plans.
    The provision is effective as of December 12, 1994, the 
effective date of the benefits-related provisions of USERRA.

20. Reporting of real estate transactions (sec. 1704(p) of the bill and 
        sec. 6045(e)(3) of the Code)

                              Present law

    It is unlawful for any real estate reporting person to 
charge separately any customer for complying with the 
information reporting requirements with respect to real estate 
transactions.

                        Explanation of provision

    The bill clarifies that real estate reporting persons may 
take into account the cost of complying with the reporting 
requirements of Code section 6045 in establishing charges for 
their services, so long as a separately listed charge for such 
costs is not made.
    The provision is effective on November 11, 1988 (as if 
originally enacted as part of the amendment to the Code 
relating to separate charges).

21. Clarification of denial of deductions for stock redemption expenses 
        (sec. 1704(q) of the bill and sec. 162(k)(2) of the Code)

                               Present law

    Section 162(k), added by the Tax Reform Act of 1986, denies 
a deduction for any amount paid or incurred by a corporation in 
connection with the redemption of its stock. An exception is 
provided for any deduction allowable under section 163 
(relating to interest). The Internal Revenue Service has taken 
the position that costs properly allocable to a borrowing the 
interest on which is deductible under the exception may not be 
amortized over the period of the loan, due to section 162(k). 
Different courts have reached differing conclusions when 
taxpayers have litigated the question.126
---------------------------------------------------------------------------
    \126\ See, e.g., Fort Howard Corp. v. Commissioner 103 T.C. 345 
(1994) upholding the IRS position; compare U.S. v. Kroy (Europe) 
Limited, 27 F.3d 367 (9th Cir. 1994) (to the contrary).
---------------------------------------------------------------------------

                        Explanation of provision

    The bill clarifies that amounts properly allocable to 
indebtedness on which interest is deductible and properly 
amortized over the term of that indebtedness are not subject to 
the provision of section 162(k) denying a deduction for any 
amount paid or incurred by a corporation in connection with the 
redemption of its stock.
    In addition, the bill clarifies that the rules of section 
162(k) apply to any acquisition of its stock by a corporation 
or by a party that has a relationship to the corporation 
described in section 465(b)(3)(C) (which applies a more than 10 
percent relationship test in certain cases).
    Thus, for example, it is clarified that the denial of a 
deduction applies to any reacquisition (i.e., any transaction 
that is in effect an acquisition of previously outstanding 
stock) regardless of whether the transaction is treated as a 
redemption for purposes of subchapter C of the Code, regardless 
of whether it is treated for tax purposes as a sale of the 
stock or as a dividend, and regardless of whether the 
transaction is a reorganization or other transaction.
    Apart from the clarification relating to amounts properly 
allocable to indebtedness, it is not intended that application 
of the 1986 Act deduction denial to any amount or transaction 
be limited under the bill.
    The provision clarifying that amounts properly allocable to 
indebtedness and amortized over the term of that indebtedness 
are not subject to the denial under section 162(k), is 
effective as if included in the Tax Reform Act of 1986.
    The other clarifications apply to amounts paid or incurred 
after September 13, 1995. No inference is intended that any 
amounts described in these other clarifications are deductible 
under present law.

22. Definition of passive income in determining passive foreign 
        investment company status (sec. 1704(s) of the bill, sec. 1235 
        of the 1986 Act and sec. 1296(b)(2) of the Code)

                              Present law

    Under the export trade corporation (ETC) provisions, a 
controlled foreign corporation (CFC) that qualifies as an ETC 
is not subject to current U.S. tax on certain export trade 
income. In 1971, the ETC provisions were replaced by rules 
applicable to domestic international sales corporations 
(DISCs). Only those ETCs in existence at that time are allowed 
to continue operating as ETCs. In 1984, the DISC provisions 
were largely replaced by the rules applicable to foreign sales 
corporations (FSCs). Certain foreign trade income of a FSC is 
exempt from U.S. income tax. In addition, a domestic 
corporation is allowed a 100-percent dividends-received 
deduction for dividends distributed from the FSC out of 
earnings attributable to certain foreign trade income.
    The Tax Reform Act of 1986 established an anti-deferral 
regime for passive foreign investment companies (PFICs). A 
foreign corporation is a PFIC if (1) 75 percent or more of its 
gross income for the taxable year consists of passive income, 
or (2) 50 percent or more of the average amount of its assets 
consists of assets that produce, or are held for the production 
of passive income. Passive income for this purpose generally 
means income that satisfies the definition of foreign personal 
holding company income under subpart F. Foreign personal 
holding company income generally includes interest, dividends, 
and annuities; certain rents and royalties; related party 
factoring income; net commodities gains; net foreign currency 
gains; and net gains from sales or exchanges of certain other 
property. In determining whether a foreign corporation is a 
PFIC, passive income does not include certain active-business 
banking, insurance, or (in the case of the U.S. shareholders of 
a CFC) securities income, or certain amounts received from a 
related party (to the extent that the amounts are allocable to 
income of the related party which is not passive income).

                        Explanation of provision

    The bill clarifies that foreign trade income of a FSC and 
export trade income of an ETC do not constitute passive income 
for purposes of the PFIC definition.
    The provision is effective as if it were included in the 
Tax Reform Act of 1986.

23. Exclusion from income for combat zone compensation (sec. 1704(t)(4) 
        of the bill and sec. 112 of the Code)

                              Present law

    The Code provides that gross income does not include 
compensation received by a taxpayer for active service in the 
Armed Forces of the United States for any month during any part 
of which the taxpayer served in a combat zone (or was 
hospitalized as a result of injuries, wounds or disease 
incurred while serving in a combat zone) (limited to $500 per 
month for commissioned officers). The heading refers to 
``combat pay,'' although that term is no longer used to refer 
to special pay provisions for members of the Armed Forces, nor 
is the exclusion limited to those special pay provisions 
(hazardous duty pay (37 U.S.C. sec. 301) and hostile fire or 
imminent danger pay (37 U.S.C. sec. 310)).

                        Explanation of provision

    The bill modifies the heading of Code section 112 to refer 
to ``combat zone compensation'' instead of ``combat pay.'' The 
bill also makes conforming changes to cross-references 
elsewhere in the Code. This provision is effective on the date 
of enactment.

                    III. BUDGET EFFECTS OF THE BILL

                         A. Committee Estimates

    In accordance with paragraph 11(a) of rule XXVI of the 
Standing Rules of the Senate, the following statement is made 
concerning the estimated budget effects of the committee 
amendment to Title I of the bill.
    The revenue provisions of Title I are estimated to have the 
following effects on the budget for fiscal years 1996-2005:


                B. Budget Authority and Tax Expenditures

                            Budget authority

    In accordance with section 308(a)(1) of the Budget Act, the 
Committee states that the committee amendment to Title I 
involves no new or increased budget authority.

                            Tax expenditures

    In accordance with section 308(a)(2) of the Budget Act, the 
Committee states that the revenue-reducing income tax 
provisions of the committee amendment to Title I generally 
involve increased tax expenditures and that the revenue-
increasing income tax provisions generally involve decreased 
tax expenditures (other than the revision of expatriation tax 
rules). Excise tax and estate and gift tax provisions are not 
classified as tax expenditures under the Budget Act. (See the 
revenue table in Part III.A., above, for specific income tax 
provisions.)

            C. Consultation With Congressional Budget Office

    In accordance with section 403 of the Budget Act, the 
Committee advises that the Congressional Budget Office has 
submitted the following statement on the budget effects of the 
committee amendment to Title I of the bill:

                                     U.S. Congress,
                               Congressional Budget Office,
                                     Washington, DC, June 18, 1996.
Hon. William V. Roth, Jr.,
Chairman, Committee on Finance,
U.S. Senate, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office and the 
Joint Committee on Taxation (JCT) have reviewed H.R. 3448, the 
``Small Business Job Protection Act of 1996,'' as ordered 
reported by the Senate Committee on Finance on June 12, 1996. 
The JCT estimates that this bill would increase governmental 
receipts by $258 million in fiscal year 1996 and by $72 million 
over fiscal years 1996 through 2005. CBO concurs with this 
estimate.
    H.R. 3448 would increase the expensing limitation for small 
businesses, extend certain expiring provisions, simplify 
pension and foreign asset provisions, modify the tax treatment 
of Subchapter S corporations and make technical corrections. In 
addition, the bill would reinstate the Airport and Airway Trust 
Fund excise taxes through December 31, 1996, modify the 
possessions tax credit, repeal the 50 percent interest income 
exclusion for financial institution loans to ESOPs, and make 
other changes that would increase taxes on corporations and 
other businesses. The revenue effects of H.R. 3448 are 
summarized in the table below. Please refer to the enclosed 
table for a more detailed estimate of the bill.

                                          Revenue Effects of H.R. 3448                                          
                                    [By fiscal years, in billions of dollars]                                   
----------------------------------------------------------------------------------------------------------------
                                        1996         1997         1998         1999         2000      2001-2005 
----------------------------------------------------------------------------------------------------------------
Projected revenues: Under current                                                                               
 law \1\..........................    1,417.583    1,475.572    1,547.285    1,619,979    1,699,866    9,999.271
Proposed changes..................        0.258        0.405       -0.375       -0.179       -0.072        0.029
Projected revenues: Under H.R.                                                                                  
 3074.............................    1,417.841    1,475.977    1,546.910    1,619.800    1,699.794    9,999.300
----------------------------------------------------------------------------------------------------------------
\1\ Includes the revenue effects of P.L. 104-7 (H.R. 831), P.L. 104-104 (S. 652), P.L. 104-117 (H.R. 2778), P.L.
  104-121 (H.R. 3136), P.L. 104-132 (S. 735), and P.L. 104-134 (H.R. 3019).                                     

    In accordance with the requirements of Public Law 104-4, 
the Unfunded Mandates Reform Act of 1995, JCT has determined 
that the bill contains one intergovernmental mandate. The 
provision to reinstate the Airport and Airway Trust Fund excise 
taxes through December 31, 1996, imposes a Federal 
intergovernmental mandate because State, local, and tribal 
governments will be required to pay the requisite taxes for 
commercial air travel by their employees. JCT estimates that 
the direct costs of complying with this Federal 
intergovernmental mandate will not exceed $50 million in any of 
the first five fiscal years.
    In addition, JCT has determined that the bill contains 
several Federal private sector mandates. The JCT estimates the 
direct mandate costs of tax increases in H.R. 3448 would total 
$655 million in 1996, and about $6.914 billion over the 1996-
2000 period, as shown below:

                                         FEDERAL PRIVATE SECTOR MANDATES                                        
                                    [By fiscal years, in millions of dollars]                                   
----------------------------------------------------------------------------------------------------------------
                                                                       1996     1997     1998     1999     2000 
----------------------------------------------------------------------------------------------------------------
Direct cost of tax increases.......................................      655    2,568    1,129    1,273    1,289
----------------------------------------------------------------------------------------------------------------

    Please refer to the enclosed letter for a more detailed 
account of these provisions.
    In addition to theses Federal private sector mandates, the 
bill also provides for reductions in taxes. At this point, it 
is unclear to CBO whether these tax reductions should be viewed 
as offsets to the direct costs of the mandates in the bill. JCT 
estimates that the savings to the private sector associated 
with the tax reductions in H.R. 3448 would total $397 million 
in 1996, and about $6.051 billion over the 1996-2000 period, as 
shown below:

                                         FEDERAL PRIVATE SECTOR SAVINGS                                         
                                    [By fiscal years, in millions of dollars]                                   
----------------------------------------------------------------------------------------------------------------
                                                                  1996      1997      1998      1999      2000  
----------------------------------------------------------------------------------------------------------------
Reductions in taxes...........................................      -397    -1,865    -1,281    -1,170    -1,228
----------------------------------------------------------------------------------------------------------------

    Section 252 of the Balanced Budget and Emergency Deficit 
Control Act of 1985 sets up pay-as-you-go procedures for 
legislation affecting receipts or direct spending through 1998. 
Because the bill would affect receipts, pay-as-you-go 
procedures would apply to the bill. These effects are 
summarized in the table below.

                      PAY-AS-YOU-GO CONSIDERATIONS                      
                [By fiscal years in millions of dollars]                
------------------------------------------------------------------------
                                                 1996     1997     1998 
------------------------------------------------------------------------
Changes in receipts..........................      258      405     -375
Changes in outlays...........................     N.A.     N.A.     N.A.
------------------------------------------------------------------------
Not Applicable.                                                         

    If you wish further details, please free to contact me or 
your staff may wish to contact Stephanie Weiner.
            Sincerely,
                                           June E. O'Neill,
                                                          Director.
                                     U.S. Congress,
                               Joint Committee on Taxation,
                                     Washington, DC, June 18, 1996.
Mrs. June O'Neill,
Director, Congressional Budget Office
U.S. Congress, Washington, DC.
    Dear Mrs. O'Neill: We have reviewed H.R. 3448, the ``Small 
Business Job Protection Act,'' as amended and ordered to be 
reported by the Senate Committee on Finance on June 12, 1996. 
In accordance with the requirements of Public Law 104-4, the 
Unfunded Mandates Reform Act of 1995 (the ``Unfunded Mandates 
Act''). We have determined that the following revenue 
provisions of the bill contain Federal private sector mandates: 
(1) the provision relating to adjustments to basis of inherited 
S corporation stock; (2) the provision to repeal 5-year 
averaging for lump-sum distributions from qualified pension 
plans; (3) the provision to repeal the $5,000 exclusion for 
employee death benefits; (4) the provision that would provide a 
simplified method for taxing annuity distributions under 
qualified pension plans; (5) the provision to modify the 
section 936 credit; (6) the provision to repeal the 50-percent 
interest income exclusion for financial institution loans to 
ESOPs; (7) the provision to provide that punitive damages are 
not excludable from income; (8) the provision to phase out and 
extend the luxury automobile excise tax; (9) the provision to 
modify the two county tax-exempt bond rule for local furnishers 
of electricity or gas and to prohibit new local furnishers; 
(10) the provision to eliminate the interest allocation 
exception for certain nonfinancial corporations; (11) the 
provision to reinstate the Airport and Airway Trust Fund excise 
taxes through December 31, 1996; (12) the provision to change 
the depreciation rules for water utilities; (13) the provision 
to revise the expatriation tax rules; (14) the provision to 
modify the basis adjustment rules under section 1033; (15) the 
provision to repeal the exemption from withholding for gambling 
winnings from bingo and keno; and (16) and the provision 
relating to the treatment of retired lives reserves. The 
attached revenue table (items I.B.13., II.A.I., 2., and 3., and 
IV.1-3., 5-8., and 10., and VI.B. I-3.) generally reflects 
amounts that are no greater than the aggregate estimated 
amounts that the private sector will be required to spend in 
order to comply with these Federal private sector mandates. In 
the case of the provision modifying the depreciation rules for 
water utilities, the staff of the Joint Committee on Taxation 
estimates that the amounts that the private sector will be 
required to spend to comply with the Federal private sector 
mandate will not exceed $6 million in fiscal year 1997, $20 
million in fiscal year 1998, $34 million in fiscal year 1999, 
$47 million in fiscal year 2000, and $59 million in fiscal year 
2001.
    The provision to reinstate the Airport and Airway Trust 
Fund excise taxes through December 31, 1996, imposes a Federal 
intergovernmental mandate because State, local, and tribal 
governments will be required to pay the requisite taxes for 
commercial air travel by State, local, and tribal government 
employees. The staff of the Joint Committee on Taxation 
estimates that the direct costs of complying with this Federal 
intergovernmental mandate will not exceed $50,000,000 in either 
the first fiscal year or in any of the 4 fiscal years following 
the first fiscal year.
    If you would like to discuss this matter in further detail, 
please feel free to contact me. Thank you for your cooperation 
in this matter.
            Sincerely,
                                           Kenneth J. Kies,
                                                    Chief of Staff.

                       IV. VOTES OF THE COMMITTEE

    In accordance with paragraph 7(b) of rule XXVI of the 
Standing Rules of the Senate, the following statement is made 
concerning the votes taken on the committee amendment to Title 
I of the bill.

                 Motion to approve committee amendment

    The Committee approved the Chairman's amendment, as 
amended, by unanimous voice vote, a quorum being present. The 
committee amendment is a substitute for Title I of H.R. 3448 
(revenue provisions).

             Amendment to the Chairman's proposed amendment

    The Committee approved an en bloc amendment by Senator 
Moynihan to the Chairman's proposed committee amendment by 
unanimous voice vote, a quorum being present.

                 V. REGULATORY IMPACT AND OTHER MATTERS

                          a. regulatory impact

    In accordance with paragraph 11(b) of rule XXVI of the 
Standing Rules of the Senate, the Committee makes the following 
statement concerning the regulatory impact that might be 
incurred in carrying out the committee amendment to Title I of 
the bill.

                  Impact on individuals and businesses

    Subtitle A of Title I provides tax relief benefiting small 
businesses. Subtitle B contains temporary extensions of certain 
expired or expiring tax provisions. Subtitle C provides 
modifications benefiting S corporations. Subtitle D provides 
pension simplification provisions. Subtitle E contains certain 
revenue offsets to pay for the revenue-reducing provisions of 
the committee amendment. Subtitle F contains technical 
corrections to recent tax legislation. Subtitle G includes 
miscellaneous revenue measures.
    The revenue-increasing provisions will result in increased 
tax payments by the affected taxpayers, and will require such 
taxpayers to make the necessary calculations to comply with the 
provisions.

                Impact on personal privacy and paperwork

    The committee amendment to Title I of the bill will have 
little impact on personal privacy. Certain of the tax 
provisions will involve revised calculations by taxpayers in 
order to correctly compute their tax liability.

              b. information relating to unfunded mandates

    This information is provided in accordance with section 423 
of the Unfunded Mandates Act of 1995 (P.L. 104-4).
    The Committee has determined that the following provisions 
of the bill contain Federal mandates on the private sector: (1) 
the provision relating to adjustments to basis of inherited S 
corporation stock; (2) the provision to repeal 5-year averaging 
for lump-sum distributions from qualified pension plans; (3) 
the provision to repeal the $5,000 exclusion for employee death 
benefits; (4) the provision that would provide a simplified 
method for taxing annuity distributions under qualified pension 
plans; (5) the provision to modify the section 936 credit; (6) 
the provision to repeal the 50-percent interest income 
exclusion for financial institution loans to ESOPs; (7) the 
provision to provide that punitive damages are not excludable 
from income; (8) the provision to phase out and extend the 
luxury automobile excise tax; (9) the provision to modify the 
two county tax-exempt bond rule for local furnishers or 
electricity or gas to prohibit new local furnishers; (10) the 
provision to eliminate the interest allocation exception for 
certain nonfinancial corporations; (11) the provision to 
reinstate the Airport and Airway Trust Fund excise taxes 
through December 31, 1996; (12) the provision to change the 
depreciation rules for water utilities; (13) the provision to 
revise the expatriation tax rules, (14) the provision to modify 
the basis adjustment rules under section 1033; (15) the 
provision to repeal the exemption from withholding for gambling 
winnings from bingo and keno; and (16) and the provision 
relating to the treatment of retired lives reserves.
    The costs required to comply with each Federal private 
sector mandate generally is no greater than the revenue 
estimate for the provision. Benefits from the provisions 
include improved administration of the Federal income tax laws, 
simplification for individual taxpayers, and a more accurate 
measurement of gross income for Federal income tax purposes. 
The Committee believes the benefits of the bill are greater 
than the costs required to comply with the Federal private 
sector mandates contained in the bill.
    The provision to repeal five-year averaging for lump-sum 
distributions from qualified pension plans results in a better 
measurement of gross income for Federal income tax purposes and 
encourages taxpayers to take qualified pension plan 
distributions in a form other than a lump-sum distribution. The 
provision to repeal the $5,000 exclusion for employee death 
benefits results in a better measurement of gross income for 
Federal income tax purposes. The provision to provide a 
simplified method for taxing annuity distributions under 
qualified pension plans generally adopts an alternative method 
for taxing such distributions contained in Treasury regulations 
as the sole method for taxing such distributions and, thereby, 
simplifies the determination for individual taxpayers.
    The provision relating to the adjustment to basis of 
inherited S corporation stock provides that a person acquiring 
stock in an S corporation from a decedent will treat as income 
in respect of a decedent (``IRD'') his or her pro rata share of 
any item of income of the corporation that would have been IRD 
if that item had been acquired directly from the decedent, 
thereby improving the measurement of income for tax purposes.
    The provision to modify the section 936 credit with 
transition rules for companies that have existing operations in 
the possessions will result in the better measurement of gross 
income for Federal income tax purposes by generally eliminating 
a tax benefit enjoyed by only a small number of U.S. 
corporations operating in possessions.
    The provision to repeal the 50-percent interest income 
exclusion for financial institution loans to ESOPs will result 
in a better measurement of the income of such financial 
institutions.
    The provision to repeal the exclusion for punitive damages 
will result in a better measurement of income for Federal tax 
purposes.
    The provision to phase out and extend the luxury automobile 
excise tax will result in a more gradual phase out of the 
excise tax, which will result in less disruption of the 
automobile market.
    The provision to modify the two county tax-exempt bond rule 
for local furnishers of electricity or gas and to prohibit new 
local furnishers eliminates a Federal tax subsidy for certain 
persons engaged in the local furnishing of electricity or gas 
and should result in a more accurate measure of income for 
Federal tax purposes.
    The provision to eliminate the interest allocation 
exception for certain nonfinancial corporations eliminates a 
narrowly targeted rule for allocating and apportioning interest 
expense under the foreign tax credit rules and should result in 
a more accurate measure of income for Federal tax purposes.
    The provision to reinstate the Airport and Airway Trust 
Fund excise taxes through December 31, 1996, funds important 
air transportation services.
    The provision to change the depreciation rules for water 
utilities should result in a more accurate measure of income 
for Federal tax purposes given the long useful lives generally 
exhibited by water utility property.
    The provision to revise the expatriation rules helps to 
ensure that the Federal tax laws do not provide individuals 
with an incentive to expatriate.
    The provision to modify the basis adjustment rules under 
section 1033 should result in a more accurate measure of income 
for Federal tax purposes.
    The provision to repeal the exemption from withholding for 
gambling winnings from bingo and keno will improve tax 
compliance and administration.
    The provision relating to the treatment of retired reserves 
will simplify the treatment of such contracts and result in a 
better measurement of income for Federal tax purposes.
    The revenue-raising provisions of the bill are used to 
offset the cost of certain small business initiatives 
(including increased expensing, extension of the FICA tip 
credit to certain delivery persons, and pension and S 
corporation simplification provisions) and the extension of 
certain expiring provisions. These provisions are generally 
designed to relieve the burdens of Federal income taxation on 
individuals and small business and the revenue-raising 
provisions of the bill are critical to achieving these goals.
    The provision to reinstate the Airport and Airway Trust 
Fund taxes through December 31, 1996, imposes a Federal 
intergovernmental mandate because State, local, and tribal 
governments will be required to pay the requisite taxes for 
commercial air travel by State, local, and tribal government 
employees. The staff of the Joint Committee on Taxation 
estimates that the direct costs of complying with this Federal 
intergovernmental mandate will be less than $50,000,000 in 
either the first fiscal year or in any one of the 4 fiscal 
years following the first fiscal year. The Committee intends 
that the Federal intergovernmental mandate be unfunded because 
the Airport and Airway Trust Fund excise taxes are intended to 
fund the maintenance of U.S. airports and airways and the 
Committee believes that it is appropriate for State, local, and 
tribal governments to bear their allocable share of the 
responsibility for such funding.
    The revenue provisions of the bill generally affect 
activities that are only engaged in by the private sector. The 
provision reinstating the Airport and Airway Trust Fund excise 
taxes are imposed both on the private sector and on State, 
local, and tribal governments and, thus, do not affect the 
competitive balance between such governments and the private 
sector.

       VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED

    In the opinion of the Committee, it is necessary in order 
to expedite the business of the Senate, to dispense with the 
requirements of paragraph 12 of the Rule XXVI of the Standing 
rules of the Senate (relating to the showing of changes in 
existing law made by the bill as reported by the Committee).