S. Rept. 107-211 - 107th Congress (2001-2002)

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Senate Report 107-211 - CARE ACT OF 2002

[Senate Report 107-211]
[From the U.S. Government Publishing Office]



                                                       Calendar No. 496
107th Congress                                                   Report
                                 SENATE
 2d Session                                                     107-211

======================================================================



 
                            CARE ACT OF 2002

                                _______
                                

                 July 16, 2002.--Ordered to be printed

                                _______
                                

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

                              R E P O R T

                         [To accompany H.R. 7]

    The Committee on Finance, to which was referred the bill 
(H.R. 7) to provide incentives for charitable contributions by 
individuals and businesses, to improve the effectiveness and 
efficiency of government program delivery to individuals and 
families in need, and to enhance the ability of low-income 
Americans to gain financial security by building assets, having 
considered the same, report favorably thereon with an amendment 
in the nature of a substitute and recommend that the bill as 
amended do pass.

                                CONTENTS

                                                                   Page
 I. LEGISLATIVE BACKGROUND............................................3
II. EXPLANATION OF THE BILL...........................................4
TITLE I. CHARITABLE GIVING INCENTIVES............................     4
    A. Charitable Deduction for Nonitemizers (sec. 101 of the 
      bill and secs. 63 and 170 of the Code).....................     4
    B. Tax-Free Distributions From Individual Retirement 
      Arrangements for Charitable Purposes (sec. 102 of the bill 
      and secs. 408 and 6034 of the Code)........................     6
    C. Charitable Deduction for Contributions of Food Inventory 
      (sec. 103 of the bill and sec. 170 of the Code)............    13
    D. Charitable Deduction for Contributions of Book Inventory 
      (sec. 104 of the bill and sec. 170 of the Code)............    15
    E. Expand Charitable Contribution Allowed for Scientific 
      Property Used for Research and for Computer Technology and 
      Equipment (sec. 105 of the bill and sec. 170 of the Code)..    17
    F. Encourage Contributions of Capital Gain Real Property Made 
      for Conservation Purposes (sec. 106 of the bill and sec. 
      170 of the Code)...........................................    18
    G. Exclusion of 25 Percent of Capital Gain for Certain Sales 
      Made for Qualifying Conservation Purposes (sec. 107 of the 
      bill and new sec. 121A of the Code)........................    21
    H. Cost Sharing Payments under the Partners for Fish and 
      Wildlife Program (sec. 108 of the bill and sec. 126 of the 
      Code)......................................................    27
    I. Basis Adjustment to Stock of S Corporation Contributing 
      Property (sec. 109 of the bill and sec. 1367 of the Code)..    28
    J. Enhanced Deduction for Charitable Contribution of 
      Literary, Musical, Artistic, and Scholarly Compositions 
      (sec. 110 of the bill and sec. 170 of the Code)............    29
TITLE II. DISCLOSURE OF INFORMATION RELATING TO TAX-EXEMPT 
  ORGANIZATIONS..................................................    31
    A. Disclosure of Written Determinations (sec. 201 of the bill 
      and sec. 6110 of the Code).................................    31
    B. Disclosure of Internet Web Site and Name Under Which 
      Organization Does Business (sec. 202 of the bill and sec. 
      6033 of the Code)..........................................    35
    C. Modification to Reporting of Capital Transactions (sec. 
      203 of the bill and secs. 6033 and 6104 of the Code).......    36
    D. Disclosure that Form 990 is Publicly Available (sec. 204 
      of the bill)...............................................    37
    E. Disclosure to State Officials of Proposed Actions Related 
      to Section 501(c) Organizations (sec. 205 of the bill and 
      sec. 6104 of the Code).....................................    37
TITLE III. OTHER CHARITABLE AND EXEMPT ORGANIZATION PROVISIONS...    40
    A. Modify Tax on Unrelated Business Taxable Income of 
      Charitable Remainder Trusts (sec. 301 of the bill and sec. 
      664 of the Code)...........................................    40
    B. Modify Tax Treatment of Certain Payments to Controlling 
      Exempt Organizations (sec. 302 of the bill and sec. 512 of 
      the Code)..................................................    42
    C. Simplification of Lobbying Expenditure Limitation (sec. 
      303 of the bill and secs. 501 and 4911 of the Code)........    43
    D. Expedited Review Process for Certain Tax-Exemption 
      Applications (sec. 304 of the bill)........................    47
    E. Clarification of Definition of Church Tax Inquiry (sec. 
      305 of the bill and sec. 7611 of the Code).................    49
    F. Extension of Declaratory Judgment Procedures to Non-
      501(c)(3) Tax-Exempt Organizations (sec. 306 of the bill 
      and sec. 7428 of the Code).................................    50
    G. Definition of Convention or Association of Churches (sec. 
      307 of the bill and sec. 7701 of the Code).................    51
    H. Charitable Contribution Deduction for Certain Expenses in 
      Support of Native Alaskan Subsistence Whaling (sec. 308 of 
      the bill and sec. 170 of the Code).........................    52
    I. Payments by Charitable Organizations to Victims of War on 
      Terrorism (sec. 309 of the bill)...........................    54
    J. Modify Rules Governing Tax-Exempt Bonds for Section 
      501(c)(3) Organizations as Applied to Organizations Engaged 
      in Timber Conservation Activities (sec. 310 of the bill and 
      sec. 145 of the Code)......................................    55
    K. Provide Tax Exemption for Organizations Created by a State 
      to Provide Property and Casualty Insurance Coverage for 
      Property for Which Such Coverage is Otherwise Unavailable 
      (sec. 311 of the bill and sec. 501(c)(28) of the Code).....    57
    L. Conform Provisions Relating to Arbitrage Treatment of 
      Certain University Fund to State Constitutional Amendments 
      (sec. 312 of the bill).....................................    60
    M. Matching Grants to Low-Income Taxpayer Clinics for Return 
      Preparation (sec. 313 of the bill).........................    61
    N. Increase Percentage Limits for Certain Employer-Related 
      Scholarship Programs (sec. 314 of the bill)................    62
TITLE IV. SOCIAL SERVICES BLOCK GRANT (secs. 401-403 of the bill)    64
TITLE V. INDIVIDUAL DEVELOPMENT ACCOUNTS (secs. 501-511 of the 
  bill)..........................................................    65
TITLE VI. REVENUE PROVISIONS.....................................    69
    A. Tax Shelter Transparency Requirements.....................    69
        1. Penalty for failure to disclose reportable 
          transactions (sec. 601 of the bill and new sec. 6707A 
          of the Code)...........................................    69
        2. Modifications to the accuracy-related penalties for 
          listed transactions and reportable transactions having 
          a significant tax avoidance purpose (sec. 602 of the 
          bill and new sec. 6662A and secs. 6662 and 6664 of the 
          Code)..................................................    74
        3. Modifications to the substantial understatement 
          penalty (sec. 603 of the bill and sec. 6662 of the 
          Code)..................................................    78
        4. Tax shelter exception to confidentiality privileges 
          relating to taxpayer communications (sec. 604 of the 
          bill and sec. 7525 of the Code)........................    79
        5. Disclosure of reportable transactions by material 
          advisors (secs. 611 and 612 of the bill and secs. 6111 
          and 6707 of the Code)..................................    80
        6. Investor lists and applicable penalties (secs. 611 and 
          613 of the bill and secs. 6112 and 6708 of the Code)...    83
        7. Actions to enjoin conduct with respect to tax shelters 
          (sec. 614 of the bill and sec. 7408 of the Code).......    85
        8. Understatement of taxpayer's liability by income tax 
          return preparer (sec. 621 of the bill and sec. 6694 of 
          the Code)..............................................    85
        9. Penalty on failure to report interests in foreign 
          financial accounts (sec. 622 of the bill and sec. 5321 
          of Title 31, United States Code).......................    86
        10. Frivolous tax returns and submissions (sec. 623 of 
          the bill and sec. 6702 of the Code)....................    87
        11. Regulation of individuals practicing before the 
          Department of the Treasury (sec. 624 of the bill and 
          sec. 330 of Title 31, United States Code)..............    88
        12. Penalties on promoters of tax shelters (sec. 625 of 
          the bill and sec. 6700 of the Code)....................    89
        13. Affirmation of consolidated return regulation 
          authority (sec. 631 of the bill and sec. 1502 of the 
          Code)..................................................    90
    B. Tax Treatment of Inversion Transactions (sec. 641 of the 
      bill and new sec. 7874 of the Code)........................    94
        C. Reinsurance Agreements (sec. 651 of the bill and sec. 
          845 of the Code).......................................   100
        D. Extension of IRS User Fees (sec. 661 of the bill and 
          new sec. 7527 of the Code).............................   102
        E. Extension of Customs Service User Fees (sec. 671 of 
          the bill)..............................................   102
III.BUDGET EFFECTS OF THE BILL......................................103

    A. Committee Estimates.......................................   103
    B. Budget Authority and Tax Expenditures.....................   108
    C. Consultation with Congressional Budget Office.............   108
IV. VOTES OF THE COMMITTEE..........................................108
 V. REGULATORY IMPACT AND OTHER MATTERS.............................108
    A. Regulatory Impact.........................................   108
    B. Unfunded Mandates Statement...............................   109
    C. Tax Complexity Analysis...................................   110
VI. CHANGES IN EXISTING LAW MADE BY THE BILL AS REPORTED............114

                       I. LEGISLATIVE BACKGROUND


Overview

    H.R. 7 (the ``Community Solutions Act of 2001'') was passed 
by the House of Representatives on July 19, 2001. H.R. 7 was 
referred to the Senate Committee on Finance on July 19, 2001. 
The Senate Committee on Finance marked up the bill on June 13, 
2002, and June 18, 2002. The bill, as amended by an amendment 
in the nature of a substitute, was ordered reported on June 18, 
2002 by voice vote.

Committee hearings

    The Committee held a hearing regarding encouraging 
charitable giving on March 14, 2001.
    The Committee held a hearing on March 21, 2002, regarding 
the proliferation of tax shelters. At such hearing, notice was 
given that the Committee intended to take action to curtail the 
benefits of inversion transactions

                      II. EXPLANATION OF THE BILL


                 Title I. Charitable Giving Incentives


                A. Charitable Deduction for Nonitemizers


(Sec. 101 of the bill and secs. 63 and 170 of the Code)

                              PRESENT LAW

    In computing taxable income, an individual taxpayer who 
itemizes deductions generally is allowed to deduct the amount 
of cash and up to the fair market value of property contributed 
to a charity described in section 501(c)(3) \1\ or a Federal, 
State, or local governmental entity. The deduction also is 
allowed for purposes of calculating alternative minimum taxable 
income.
---------------------------------------------------------------------------
    \1\ All section references are to the Internal Revenue Code of 
1986, unless otherwise indicated.
---------------------------------------------------------------------------
    The amount of the deduction allowable for a taxable year 
with respect to a charitable contribution of property 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.\2\
---------------------------------------------------------------------------
    \2\ Secs. 170(b) and (e).
---------------------------------------------------------------------------
    A taxpayer who takes the standard deduction (i.e., who does 
not itemize deductions) may not take a separate deduction for 
charitable contributions.\3\
---------------------------------------------------------------------------
    \3\ Sec. 170(a). The Economic Recovery Tax Act of 1981 adopted a 
temporary provision that permitted individual taxpayers who did not 
itemize income tax deductions to claim a deduction from gross income 
for a specified percentage of their charitable contributions. The 
maximum deduction was $25 for 1982 and 1983, $75 for 1984, 50 percent 
of the amount of the contribution for 1985, and 100 percent of the 
amount of the contribution for 1986. The nonitemizer deduction 
terminated after 1986.
---------------------------------------------------------------------------
    A payment to a charity (regardless of whether it is termed 
a ``contribution'') in exchange for which the donor receives an 
economic benefit is not deductible, except to the extent that 
the donor can demonstrate that the payment exceeds the fair 
market value of the benefit received from the charity. To 
facilitate distinguishing charitable contributions from 
purchases of goods or services from charities, present law 
provides that no charitable contribution deduction is allowed 
for a separate contribution of $250 or more unless the donor 
obtains a contemporaneous written acknowledgement of the 
contribution from the charity indicating whether the charity 
provided any good or service (and an estimate of the value of 
any such good or service) to the taxpayer in consideration for 
the contribution.\4\ In addition, present law requires that any 
charity that receives a contribution exceeding $75 made partly 
as a gift and partly as consideration for goods or services 
furnished by the charity (a ``quid pro quo'' contribution) is 
required to inform the contributor in writing of an estimate of 
the value of the goods or services furnished by the charity and 
that only the portion exceeding the value of the goods or 
services is deductible as a charitable contribution.\5\
---------------------------------------------------------------------------
    \4\ See. 170(f)(8).
    \5\ Sec. 6115.
---------------------------------------------------------------------------
    Under present law, total deductible contributions of an 
individual taxpayer to public charities, private operating 
foundations, and certain types of private nonoperating 
foundations may not exceed 50-percent of the taxpayer's 
contribution base, which is the taxpayer's adjusted gross 
income for a taxable year (disregarding any net operating loss 
carryback). To the extent a taxpayer has not exceeded the 50-
percent limitation, (1) contributions of capital gain property 
to public charities generally may be deducted up to 30 percent 
of the taxpayer's contribution base, (2) contributions of cash 
to private foundations and certain other charitable 
organizations generally may be deducted up to 30 percent of the 
taxpayer's contribution base, and (3) contributions of capital 
gain property to private foundations and certain other 
charitable organizations generally may be deducted up to 20 
percent of the taxpayer's contribution base.
    Contributions by individuals in excess of the 50-percent, 
30-percent, and 20-percent limit may be carried over and 
deducted over the next five taxable years, subject to the 
relevant percentage limitations on the deduction in each of 
those years.
    In addition to the percentage limitations imposed 
specifically on charitable contributions, present law imposes a 
reduction on most itemized deductions, including charitable 
contribution deductions, for taxpayers with adjusted gross 
income in excess of a threshold amount, which is indexed 
annually for inflation. The threshold amount for 2002 is 
$137,300 ($68,650 for married individuals filing separate 
returns). For those deductions that are subject to the limit, 
the total amount of itemized deductions is reduced by three 
percent of adjusted gross income over the threshold amount, but 
not by more than 80 percent of itemized deductions subject to 
the limit. Beginning in 2006, the overall limitation on 
itemized deductions phases-out for all taxpayers. The overall 
limitation on itemized deductions is reduced by one-third in 
taxable years beginning in 2006 and 2007, and by two-thirds in 
taxable years beginning in 2008 and 2009. The overall 
limitation on itemized deductions is eliminated for taxable 
years beginning after December 31, 2009; however, this 
elimination of the limitation sunsets on December 31, 2010.

                           REASONS FOR CHANGE

    The Committee recognizes that the Administration believes 
that providing a charitable deduction for taxpayers who do not 
itemize deductions will result in an increase in charitable 
giving. In addition, the Committee appreciates that the 
charitable deduction is an important part of the President's 
faith-based initiative. The proposal is for a two-year period. 
To provide Congress adequate information in considering 
extending the proposal, the Committee requires the Secretary of 
the Treasury to submit a report on the effectiveness of the 
provision. The report should consider the extent to which 
charitable giving has increased, the burdens of complexity to 
taxpayers and the impact on tax compliance.

                        EXPLANATION OF PROVISION

    In the case of an individual taxpayer who does not itemize 
deductions, the provision allows a ``direct charitable 
deduction'' from adjusted gross income for charitable 
contributions paid in cash during the taxable year. This 
deduction is allowed in addition to the standard deduction. The 
deduction is available only for that portion of contributions 
actually made during the year that in the aggregate exceed $250 
($500 in the case of a joint return). The maximum deduction is 
$250 ($500 in the case of a joint return). Contributions that 
are below the minimum amount or that exceed the maximum 
deduction may not be carried over for purposes of a subsequent 
taxable year's calculation of the direct charitable deduction. 
Under the provision, an individual is not entitled to a 
charitable deduction for the first $250 of cash contributions 
made during the tax year, is entitled to a deduction on a 
dollar-for-dollar basis for contributions of $251 to $500 
(e.g., a $1 contribution deduction in the case of $251 of 
contributions, and a $250 deduction in the case of $500 of 
contributions), and is not entitled to a deduction for 
contributions exceeding $500.
    The provision does not alter present-law rules regarding 
the carryover of contributions to or from a taxable year, 
including a taxable year in which the taxpayer elects the 
standard deduction. The direct charitable deduction generally 
is subject to the tax rules normally governing charitable 
contribution deductions, such as the substantiation 
requirements. The deduction is allowed in computing alternative 
minimum taxable income.
    The provision requires the Secretary of the Treasury to 
complete a study by December 31, 2003, of the effect of the 
provision on increased charitable giving, and of taxpayer 
compliance, for example, by comparing compliance by taxpayers 
who itemize their charitable contributions with compliance by 
those who claim the direct charitable deduction. The Secretary 
shall report on the study to the Committee on Finance of the 
Senate and the Committee on Ways and Means of the House of 
Representatives.

                             EFFECTIVE DATE

    The direct charitable deduction is effective for taxable 
years beginning after December 31, 2001, and before January 1, 
2004. The Treasury study is required by December 31, 2003.

 B. Tax-Free Distributions From Individual Retirement Arrangements for 
                          Charitable Purposes


(Sec. 102 of the bill and secs. 408 and 6034 of the Code)

                              PRESENT LAW

In general

    If an amount withdrawn from a traditional individual 
retirement arrangement (``IRA'') or a Roth IRA is donated to a 
charitable organization, the rules relating to the tax 
treatment of withdrawals from IRAs apply to the amount 
withdrawn and the charitable contribution is subject to the 
normally applicable limitations on deductibility of such 
contributions.

Charitable contributions

    In computing taxable income, an individual taxpayer who 
itemizes deductions generally is allowed to deduct the amount 
of cash and up to the fair market value of property contributed 
to a charity described in section 501(c)(3) or a Federal, 
State, or local governmental entity. The deduction also is 
allowed for purposes of calculating alternative minimum taxable 
income.
    The amount of the deduction allowable for a taxable year 
with respect to a charitable contribution of property 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.\6\
---------------------------------------------------------------------------
    \6\ Secs. 170(b) and (e).
---------------------------------------------------------------------------
    A taxpayer who takes the standard deduction (i.e., who does 
not itemize deductions) may not take a separate deduction for 
charitable contributions.\7\
---------------------------------------------------------------------------
    \7\ Sec, 170(a). The Economic Recovery Tax Act of 1981 adopted a 
temporary provision that permitted individual taxpayers who did not 
itemize income tax deductions to claims a deduction from gross income 
for a specified percentage of their charitable contributions. The 
maximum deduction was $25 for 1982 and 1983, $75 for 1984, 50 percent 
of the amount of the contribution for 1985, and 100 percent of the 
amount of the contribution for 1986. The nonitemizer deduction 
terminated after 1986.
---------------------------------------------------------------------------
    A payment to a charity (regardless of whether it is termed 
a ``contribution'') in exchange for which the donor receives an 
economic benefit is not deductible, except to the extent that 
the donor can demonstrate that the payment exceeds the fair 
market value of the benefit received from the charity. To 
facilitate distinguishing charitable contributions from 
purchases of goods or services from charities, present law 
provides that no charitable contribution deduction is allowed 
for a separate contribution of $250 or more unless the donor 
obtains a contemporaneous written acknowledgement of the 
contribution from the charity indicating whether the charity 
provided any good or service (and an estimate of the value of 
any such good or service) to the taxpayer in consideration for 
the contribution.\8\ In addition, present law requires that any 
charity that receives a contribution exceeding $75 made partly 
as a gift and partly as consideration for goods or services 
furnished by the charity (a ``quid pro quo'' contribution) is 
required to inform the contributor in writing of an estimate of 
the value of the goods or services furnished by the charity and 
that only the portion exceeding the value of the goods or 
services is deductible as a charitable contribution.\9\
---------------------------------------------------------------------------
    \8\ Sec. 170(f)(8).
    \9\ Sec. 6115.
---------------------------------------------------------------------------
    Under present law, total deductible contributions of an 
individual taxpayer to public charities, private operating 
foundations, and certain types of private nonoperating 
foundations may not exceed 50 percent of the taxpayer's 
contribution base, which is the taxpayer's adjusted gross 
income for a taxable year (disregarding any net operating loss 
carryback). To the extent a taxpayer has not exceeded the 50-
percent limitation, (1) contributions of capital gain property 
to public charities generally may be deducted up to 30 percent 
of the taxpayer's contribution base, (2) contributions of cash 
to private foundations and certain other charitable 
organizations generally may be deducted up to 30 percent of the 
taxpayer's contribution base, and (3) contributions of capital 
gain property to private foundations and certain other 
charitable organizations generally may be deducted up to 20 
percent of the taxpayer's contribution base.
    Contributions by individuals in excess of the 50-percent, 
30-percent, and 20-percent limit may be carried over and 
deducted over the next five taxable years, subject to the 
relevant percentage limitations on the deduction in each of 
those years.
    In addition to the percentage limitations imposed 
specifically on charitable contributions, present law imposes a 
reduction on most itemized deductions, including charitable 
contribution deductions, for taxpayers with adjusted gross 
income in excess of a threshold amount, which is indexed 
annually for inflation. The threshold amount for 2002 is 
$137,300 ($68,650 for married individuals filing separate 
returns). For those deductions that are subject to the limit, 
the total amount of itemized deductions is reduced by three 
percent of adjusted gross income over the threshold amount, but 
not by more than 80 percent of itemized deductions subject to 
the limit. Beginning in 2006, the overall limitation on 
itemized deductions phases-out for all taxpayers. The overall 
limitation on itemized deductions is reduced by one-third in 
taxable years beginning in 2006 and 2007, and by two-thirds in 
taxable years beginning in 2008 and 2009. The overall 
limitation on itemized deductions is eliminated for taxable 
years beginning after December 31, 2009; however, this 
elimination of the limitation sunsets on December 31, 2010.
    In general, a charitable deduction is not allowed for 
income, estate, or gift tax purposes if the donor transfers an 
interest in property to a charity (e.g., a remainder) while 
also either retaining an interest in that property (e.g., an 
income interest) or transferring an interest in that property 
to a noncharity for less than full and adequate 
consideration.\10\ Exceptions to this general rule are provided 
for, among other interests, remainder interests in charitable 
remainder annuity trusts, charitable remainder unitrusts, and 
pooled income funds, and present interests in the form of a 
guaranteed annuity or a fixed percentage of the annual value of 
the property.\11\ For such interests, a charitable deduction is 
allowed to the extent of the present value of the interest 
designated for a charitable organization.
---------------------------------------------------------------------------
    \10\ Secs. 170(f), 2055(e)(2), and 2522(c)(2).
    \11\ Sec. 170(f)(2).
---------------------------------------------------------------------------

IRA rules

    Within limits, individuals may make deductible and 
nondeductible contributions to a traditional IRA. Amounts in a 
traditional IRA are includible in income when withdrawn (except 
to the extent the withdrawal represents a return of 
nondeductible contributions). Individuals also may make 
nondeductible contributions to a Roth IRA. Qualified 
withdrawals from a Roth IRA are excludable from gross income. 
Withdrawals from a Roth IRA that are not qualified withdrawals 
are includible in gross income to the extent attributable to 
earnings. Includible amounts withdrawn from a traditional IRA 
or a Roth IRA before attainment of age 59\1/2\ are subject to 
an additional 10-percent early withdrawal tax, unless an 
exception applies.
    If an individual has made nondeductible contributions to a 
traditional IRA, a portion of each distribution from an IRA is 
nontaxable, until the total amount of nondeductible 
contributions has been received. In general, the amount of a 
distribution that is nontaxable is determined by multiplying 
the amount of the distribution by the ratio of the remaining 
nondeductible contributions to the account balance. In making 
the calculation, all traditional IRAs of an individual are 
treated as a single IRA, all distributions during any taxable 
year are treated as a single distribution, and the value of the 
contract, income on the contract, and investment in the 
contract are computed as of the close of the calendar year.
    In the case of a distribution from a Roth IRA that is not a 
qualified distribution, in determining the portion of the 
distribution attributable to earnings, contributions and 
distributions are deemed to be distributed in the following 
order: (1) regular Roth IRA contributions; (2) taxable 
conversion contributions;\12\ (3) nontaxable conversion 
contributions; and (4) earnings. In determining the amount of 
taxable distributions from a Roth IRA, all Roth IRA 
distributions in the same taxable year are treated as a single 
distribution, all regular Roth IRA contributions for a year are 
treated as a single contribution, and all conversion 
contributions during the year are treated as a single 
contribution.
---------------------------------------------------------------------------
    \12\ Conversion contributions refer to conversions of amounts in a 
traditional IRA to a Roth IRA.
---------------------------------------------------------------------------

Split-interest trust filing requirements

    Split-interest trusts, including charitable remainder 
annuity trusts, charitable remainder unitrusts, and pooled 
income funds, are required to file an annual information return 
\13\ (Form 1041A). Trusts that are not split-interest trusts 
but that claim a charitable deduction for amounts permanently 
set aside for a charitable purpose \14\ also are required to 
file Form 1041A. The returns are required to be made publicly 
available.\15\ A trust that is required to distribute all trust 
net income currently to trust beneficiaries in a taxable year 
is exempt from this return requirement for such taxable year. A 
failure to file the required return may result in a penalty on 
the trust of $10 a day for as long as the failure continues, up 
to a maximum of $5,000 per return.
---------------------------------------------------------------------------
    \13\ Sec. 6034. This requirement applies to all split-interest 
trusts described in section 4947(a)(2).
    \14\ Sec. 642(c).
    15 Sec. 6104(b).
---------------------------------------------------------------------------
    In addition, split-interest trusts are required to file 
annually Form 5227.\16\ Form 5227 requires disclosure of 
information regarding a trust's noncharitable beneficiaries. 
The penalty for failure to file this return is calculated based 
on the amount of tax owed. A split-interest trust generally is 
not subject to tax and therefore, in general, a penalty may not 
be imposed for the failure to file Form 5227. Form 5227 is not 
required to be made publicly available.
---------------------------------------------------------------------------
    16 Sec. 6011; Treas. Reg. sec. 53.6011-1(d).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Under present law, an individual who wants to use IRA 
proceeds to make charitable contributions must treat the IRA 
distribution as a withdrawal subject to IRA income recognition 
rules and is subject to deduction limitation provisions on the 
contributions made to the charity.
    In some cases, this can result in taxable income even 
though the individual used the entire IRA distribution to make 
the charitable contribution. The Committee believes that 
taxpayers who want to make charitable contributions from IRAs 
generally should be permitted to do so without recognizing 
income because of the distribution from the IRA, whether such 
contribution is made directly to the charitable organization or 
indirectly through the use of a split-interest entity. The 
Committee believes that facilitating charitable contributions 
from IRAs will help increase giving to charitable 
organizations.

                        EXPLANATION OF PROVISION

Qualified charitable distributions from IRAs

    The provision provides an exclusion from gross income for 
otherwise taxable IRA distributions from a traditional or a 
Roth IRA in the case of qualified charitable distributions. 
Special rules apply in determining the amount of an IRA 
distribution that is otherwise taxable. The present-law rules 
regarding taxation of IRA distributions and the deduction of 
charitable contributions continue to apply to distributions 
from an IRA that are not qualified charitable distributions.
    A qualified charitable distribution is defined as any 
distribution from an IRA that is made directly by the IRA 
trustee either to (1) an organization to which deductible 
contributions can be made (a ``direct distribution'') or (2) a 
``split-interest entity.'' A split-interest entity means a 
charitable remainder annuity trust or charitable remainder 
unitrust (together referred to as a ``charitable remainder 
trust''), a pooled income fund, or a charitable gift annuity. 
Direct distributions are eligible for the exclusion only if 
made on or after the date the IRA owner attains age 70\1/2\. 
Distributions to a split interest entity are eligible for the 
exclusion only if made on or after the date the IRA owner 
attains age 59\1/2\. In the case of split-interest 
distributions, no person may hold an income interest in the 
amounts in the split-interest entity attributable to the 
charitable distribution other than the IRA owner, his or her 
spouse, or a charitable organization.
    The exclusion applies to direct distributions only if a 
charitable contribution deduction for the entire distribution 
would otherwise be allowable, determined without regard to the 
generally applicable percentage limitations. Thus, for example, 
if the deductible amount is reduced because of a benefit 
received in exchange, or if a deduction is not allowable 
because the donor did not obtain sufficient substantiation, the 
exclusion is not available with respect to any part of the IRA 
distribution. Similarly, the exclusion applies in the case of a 
distribution directly to a split-interest entity only if a 
charitable contribution deduction for the entire present value 
of the charitable interest (for example, a remainder interest) 
is allowable, determined without regard to the generally 
applicable percentage limitations.
    If the IRA owner has any IRA that includes nondeductible 
contributions, a special rule applies in determining the 
portion of a distribution that is includible in gross income 
(but for the provision) and thus is eligible for qualified 
charitable distribution treatment. In such case, the IRA owner 
aggregates all IRAs to determine eligibility for the exclusion. 
Under the special rule, the distribution is treated as 
consisting of income first, up to the aggregate amount that is 
includible in gross income (but for the provision) if all 
amounts were distributed from all IRAs otherwise taken into 
account in determining the amount of IRA distributions during 
the year that is includible in income. In determining the 
amount of subsequent IRA distributions includible in income, 
proper adjustments are made to reflect the amount treated as a 
qualified charitable distribution under the special rule.
    Special rules apply for distributions to split-interest 
entities. For distributions to charitable remainder trusts, the 
provision provides that subsequent distributions from the 
charitable remainder trust are treated as ordinary income in 
the hands of the beneficiary, notwithstanding how such amounts 
normally are treated under section 664(b). In addition, for a 
charitable remainder trust to be eligible to receive qualified 
charitable distributions, the charitable remainder trust has to 
be funded exclusively by such distributions. For example, an 
IRA owner may not make qualified charitable distributions to an 
existing charitable remainder trust any part of which was 
funded with assets that were not qualified charitable 
distributions.
    Under the provision, a pooled income fund is eligible to 
receive qualified charitable distributions only if the fund 
accounts separately for amounts attributable to such 
distributions. In addition, all distributions from the pooled 
income fund that are attributable to qualified charitable 
distributions are treated as ordinary income to the 
beneficiary. Qualified charitable distributions to a pooled 
income fund are not includible in the fund's gross income.
    In determining the amount includible in gross income by 
reason of a payment from a charitable gift annuity purchased 
with a qualified charitable distribution from an IRA, the 
portion of the distribution from the IRA used to purchase the 
annuity is not an investment in the annuity contract.
    Any amount excluded from gross income by reason of the 
provision is not taken into account in determining the 
deduction for charitable contributions under section 170.

Qualified charitable distribution examples

    The following examples illustrate the determination of the 
portion of an IRA distribution that is a qualified charitable 
distribution and the application of the special rules for a 
qualified charitable distribution to a split-interest entity. 
In each example, it is assumed that the requirements for 
qualified charitable distribution treatment are otherwise met 
(e.g., the applicable age requirement and the requirement that 
contributions are otherwise deductible) and that no other IRA 
distributions occur during the year.
    Example 1. Individual A has a traditional IRA with a 
balance of $100,000, consisting solely of deductible 
contributions and earnings. Individual A has no other IRA. The 
entire IRA balance is distributed in a direct distribution to a 
charitable organization. Under present law, the entire 
distribution of $100,000 would be includible in Individual A's 
income. Accordingly, under the provision, the entire 
distribution of $100,000 is a qualified charitable 
distribution. As a result, no amount is included in Individual 
A's income as a result of the distribution and the distribution 
is not taken into account in determining the amount of 
Individual A's charitable deduction for the year.
    Example 2. The facts are the same as in Example 1, except 
that the entire IRA balance of $100,000 is distributed to a 
charitable remainder unitrust, which contains no other assets. 
Under the terms of the trust, Individual A is entitled to 
receive five percent of the value of the trust each year. As 
explained in Example l, the entire $100,000 distribution is a 
qualified charitable distribution, no amount is included in 
Individual A's income as a result of the distribution, and the 
distribution is not taken into account in determining the 
amount of Individual A's charitable deduction for the year. In 
addition, under a special rule in the provision for charitable 
remainder trusts, any distribution from the charitable 
remainder unitrust to Individual A is includible in gross 
income as ordinary income, regardless of the character of the 
distribution under the usual rules for the taxation of 
distributions from such a trust.
    Example 3. Individual B has a traditional IRA with a 
balance of $100,000, consisting of $20,000 of nondeductible 
contributions and $80,000 of deductible contributions and 
earnings. Individual B has no other IRA. In a direct 
distribution to a charitable organization, $80,000 is 
distributed from the IRA. Under present law, a portion of the 
distribution from the IRA would be treated as a nontaxable 
return of nondeductible contributions. The nontaxable portion 
of the distribution would be $16,000, determined by multiplying 
the amount of the distribution ($80,000) by the ratio of the 
nondeductible contributions to the account balance ($20,000/
$100,000). Accordingly, under present law, $64,000 of the 
distribution ($80,000 minus $16,000) would be includible in 
Individual B's income.
    Under the provision, notwithstanding the present-law tax 
treatment of IRA distributions, the distribution is treated as 
consisting of income first, up to the total amount that would 
be includible in gross income (but for the provision) if all 
amounts were distributed from all IRAs otherwise taken into 
account in determining the amount of IRA distributions. The 
total amount that would be includible in income if all amounts 
were distributed from the IRA is $80,000. Accordingly, under 
the provision, the entire $80,000 distributed to the charitable 
organization is treated as includible in income (before 
application of the provision) and is a qualified charitable 
distribution. As a result, no amount is included in Individual 
B's income as a result of the distribution and the distribution 
is not taken into account in determining the amount of 
Individual B's charitable deduction for the year. In addition, 
for purposes of determining the tax treatment of other 
distributions from the IRA, $20,000 of the amount remaining in 
the IRA is treated as Individual B's nondeductible 
contributions.

Split-interest trust filing requirements

    The provision increases the penalty on split-interest 
trusts for failure to file a return and for failure to include 
any of the information required to be shown on such return and 
to show the correct information. The penalty is $20 for each 
day the failure continues up to $10,000 for any one return. In 
the case of a split-interest trust with gross income in excess 
of $250,000, the penalty is $100 for each day the failure 
continues up to a maximum of $50,000. In addition, if a person 
(meaning any officer, director, trustee, employee, or other 
individual who is under a duty to file the return or include 
required information) 17 knowingly failed to file 
the return or include required information, then that person is 
personally liable for such a penalty, which would be imposed in 
addition to the penalty that is paid by the organization. 
Information regarding beneficiaries that are not charitable 
organizations as described in section 170(c) is exempt from the 
requirement to make information publicly available. In 
addition, the provision repeals the present-law exception to 
the filing requirement for split-interest trusts that are 
required in a taxable year to distribute all net income 
currently to beneficiaries. Such exception remains available to 
trusts other than split-interest trusts that are otherwise 
subject to the filing requirement.
---------------------------------------------------------------------------
    \17\ Sec. 6652(c)(4)(C).
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                             EFFECTIVE DATE

    The provision generally is effective for taxable years 
beginning after December 31, 2002. The provision relating to 
information returns of split-interest trusts is effective for 
returns for taxable years beginning after December 31, 2002.

      C. Charitable Deduction for Contributions of Food Inventory


(Sec. 103 of the bill and sec. 170 of the Code)

                              PRESENT LAW

    Under present law, a taxpayer's deduction for charitable 
contributions of inventory generally is limited to the 
taxpayer's basis (typically, cost) in the inventory.
    However, for certain contributions of inventory, C 
corporations may claim an enhanced deduction equal to the 
lesser of (1) basis plus one-half of the item's appreciated 
value (i.e., basis plus one half of fair market value in excess 
of basis) or (2) two times basis.18 To be eligible 
for the enhanced deduction, the contributed property generally 
must be inventory of the taxpayer, contributed to a charitable 
organization described in section 501(c)(3) (except for private 
nonoperating foundations), and the donee must (1) use the 
property consistent with the donee's exempt purpose solely for 
the care of the ill, the needy, or infants, (2) not transfer 
the property in exchange for money, other property, or 
services, and (3) provide the taxpayer a written statement that 
the donee's use of the property will be consistent with such 
requirements. In the case of contributed property subject to 
the Federal Food, Drug, and Cosmetic Act, the property must 
satisfy the applicable requirements of such Act on the date of 
transfer and for 180 days prior to the transfer.
---------------------------------------------------------------------------
    \18\ Sec. 170(e)(3). In general, a C corporation's charitable 
contribution deductions for a year may not exceed 10 percent of the 
corporation's taxable income. Sec. 170(b)(2).
---------------------------------------------------------------------------
    To use the enhanced deduction, the taxpayer must establish 
that the fair market value of the donated item exceeds basis. 
The valuation of food inventory has been the subject of ongoing 
disputes between taxpayers and the IRS. In one case, the Tax 
Court held that the value of surplus bread inventory donated to 
charity was the full retail price of the bread rather than half 
the retail price, as the IRS asserted.19
---------------------------------------------------------------------------
    \19\ Lucky Stores Inc. v. Commissioner, 105 T.C. 420 (1995).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that expanding the present-law 
enhanced deduction for contributions of food inventory to non-C 
corporations will increase charitable contributions of food to 
those in need. By clarifying the definition of fair market 
value, the Committee believes that taxpayers will be better 
able to avoid disputes with the IRS about the valuation of food 
and receive an appropriate deduction for their contribution. In 
addition, the Committee believes that providing certain low-
basis taxpayers with a deemed basis equal to one quarter of the 
fair market value of the food will increase food donations, 
thus further providing needed nourishment to the nation's 
hungry.

                        EXPLANATION OF PROVISION

    Under the provision, any taxpayer, whether or not a C 
corporation, engaged in a trade or business is eligible to 
claim the enhanced deduction for donations of food inventory. 
For taxpayers other than C corporations, the total deduction 
for donations of food inventory in a taxable year generally may 
not exceed 10 percent of the taxpayer's net income for such 
year from its trade or business (or interest therein) from 
which contributions are made. For example, if a taxpayer is a 
sole proprietor, a shareholder in an S corporation, and a 
partner in a partnership, and each business makes charitable 
contributions of food inventory, the taxpayer's deduction for 
donations of food inventory is limited to 10 percent of the 
taxpayer's net income from the sole proprietorship, and the 
taxpayer's interests in the S corporation and partnership. 
However, if only the sole proprietorship and the S corporation 
made charitable contributions of food inventory, the taxpayer's 
deduction would be limited to 10 percent of the net income from 
the trade or business of the sole proprietorship and the S 
corporation, but not the partnership.
    The 10 percent limitation does not affect the application 
of the generally applicable percentage limitations. For 
example, if 10 percent of a sole proprietor's net income from 
the proprietor's trade or business was greater than 50 percent 
of the proprietor's contribution base, the available deduction 
for the taxable year (with respect to contributions to public 
charities) would be 50 percent of the proprietor's contribution 
base. Consistent with present law, such contributions may be 
carried forward because they exceed the 50 percent limitation. 
Contributions of food inventory by a taxpayer that is not a C 
corporation that exceed the 10 percent limitation but not the 
50 percent limitation could not be carried forward.
    For purposes of calculating the enhanced deduction, 
taxpayers who do not account for inventories under section 471 
and who are not required to capitalize indirect costs under 
section 263A are able to elect to treat the basis of the 
contributed food as being equal to 25 percent of the food's 
fair market value.20
---------------------------------------------------------------------------
    \20\ This includes, for example, taxpayers who are eligible for 
administrative relief under Revenue Procedures 2002-28 and 2001-10.
---------------------------------------------------------------------------
    Under the provision, the enhanced deduction is available 
only for food that qualifies as ``apparently wholesome food.'' 
``Apparently wholesome food'' is defined as food intended for 
human consumption that meets all quality and labeling standards 
imposed by Federal, State, and local laws and regulations even 
though the food may not be readily marketable due to 
appearance, age, freshness, grade, size, surplus, or other 
conditions.
    In addition, the provision provides that the fair market 
value of donated apparently wholesome food that cannot or will 
not be sold solely due to internal standards of the taxpayer or 
lack of market is determined without regard to such internal 
standards or lack of market and by taking into account the 
price at which the same or substantially the same food items 
are sold by the taxpayer at the time of the contribution or, if 
not so sold at such time, in the recent past.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2002.

      D. Charitable Deduction for Contributions of Book Inventory


(Sec. 104 of the bill and sec. 170 of the Code)

                              PRESENT LAW

    Under present law, a taxpayer's deduction for charitable 
contributions of inventory generally is limited to the 
taxpayer's basis (typically, cost) in the inventory.
    However, for certain contributions of inventory, C 
corporations may claim an enhanced deduction equal to the 
lesser of (1) basis plus one-half of the item's appreciated 
value (i.e., basis plus one half of fair market value in excess 
of basis) or (2) two times basis.\21\ To be eligible for the 
enhanced deduction, the contributed property generally must be 
inventory of the taxpayer, contributed to a charitable 
organization described in section 501(c)(3) (except for private 
nonoperating foundations), and the donee must: (1) use the 
property consistent with the donee's exempt purpose solely for 
the care of the ill, the needy, or infants, (2) not transfer 
the property in exchange for money, other property, or 
services, and (3) provide the taxpayer a written statement that 
the donee's use of the property will be consistent with such 
requirements.
---------------------------------------------------------------------------
    \21\ Sec. 170(e)(3).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Under present law, taxpayers sometimes are prohibited from 
receiving an enhanced deduction for charitable contributions of 
their book inventory, in part because of the requirement that 
the inventory be used for care of the ill, the needy, or 
infants. For example, such requirement generally prohibits 
donations to public libraries and adult literacy programs. The 
Committee believes that suitable book inventory should be 
eligible for an enhanced deduction in cases where a 
contribution is made to an appropriate educational 
organization. To minimize disputes between taxpayers and the 
IRS about the value of books and to encourage contributions of 
books that are suitable in terms of currency, content, and 
quantity, the Committee provides a special rule for determining 
the amount of the contribution of such books. A clear rule is 
needed so that taxpayers know that if they donate books to 
schools, libraries, and literacy programs, they will receive an 
enhanced deduction that more adequately reflects the costs of 
the donation.

                        EXPLANATION OF PROVISION

    The provision modifies the present-law enhanced deduction 
for C corporations so that it is equal to the lesser of fair 
market value or twice the taxpayer's basis in the case of 
qualified book contributions. The provision provides that the 
fair market value for this purpose is determined by reference 
to a bona fide published market price for the book (using the 
same printing and same edition), published within seven years 
preceding the contribution. The Committee intends that a bona 
fide published market price of a book would be a price that was 
reached as a result of an arm's length transaction within the 
seven years preceding the contribution, and for which the book 
was customarily sold. A publisher's listed retail price for a 
book would not meet the standard unless the publisher could 
demonstrate to the satisfaction of the Secretary that the price 
was one at which the book was customarily sold. For example, if 
a publisher entered into a contract with a local school 
district to sell textbooks six years prior to making a 
qualified book contribution of such textbooks, the publisher 
could use as a ``bona fide published market price,'' the price 
at which such books were regularly sold to the school district 
under the contract. By contrast, if a publisher listed in a 
catalogue or elsewhere a ``suggested retail price,'' but books 
were not in fact frequently sold at such price, the publisher 
could not use the ``suggested retail price'' to determine the 
fair market value of the book for purposes of the enhanced 
deduction. Thus, in general, the Committee intends that a bona 
fide published market price must be independently verifiable by 
reference to actual sales within the seven year period 
preceding the contribution, and not to a publisher's own price 
list.
    As an illustration of the mechanics of calculating the 
enhanced deduction under the provision, a C corporation that 
made a qualified book contribution with a bona fide published 
market price of $10 and a basis of $4 could take a deduction of 
$8 (twice basis). If the taxpayer's basis is $6 instead of $4, 
then the deduction is $10. Also, in such latter case, if the 
book's bona fide market published market price was $5 at the 
time of the contribution but was $10 five years before the 
contribution, then the deduction is $10.
    A qualified book contribution means a charitable 
contribution of books to: (1) an educational organization that 
normally maintains a regular faculty and curriculum and 
normally has a regularly enrolled body of pupils or students in 
attendance at the place where its educational activities are 
regularly carried on; (2) a public library; or (3) an 
organization described in section 501(c)(3) (except for private 
nonoperating foundations), that is organized primarily to make 
books available to the general public at no cost or to operate 
a literacy program. The donee must: (1) use the property 
consistent with the donee's exempt purpose; (2) not transfer 
the property in exchange for money, other property, or 
services; (3) provide the taxpayer a written statement that the 
donee's use of the property will be consistent with such 
requirements and also that the books are suitable, in terms of 
currency, content, and quantity, for use in the donee's 
educational programs and that the donee will use the books in 
such educational programs.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2002.
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    \21\ Sec. 17(e)(3).
---------------------------------------------------------------------------

E. Expand Charitable Contribution Allowed for Scientific Property Used 
         for Research and for Computer Technology and Equipment


(Sec. 105 of the bill and sec. 170 of the Code)

                              PRESENT LAW

    In the case of a charitable contribution of inventory or 
other ordinary-income or short- term capital gain property, the 
amount of the charitable 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. 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.\22\
---------------------------------------------------------------------------
    \22\ Sec. 170(e)(1).
---------------------------------------------------------------------------
    Under present law, a taxpayer's deduction for charitable 
contributions of scientific property used for research and for 
contributions of computer technology and equipment generally is 
limited to the taxpayer's basis (typically, cost) in the 
property. However, certain corporations may claim a deduction 
in excess of basis for a ``qualified research contribution'' or 
a ``qualified computer contribution.'' \23\ This enhanced 
deduction is equal to the lesser of (1) basis plus one-half of 
the item's appreciated value (i.e., basis plus one half of fair 
market value minus basis) or (2) two times basis.
---------------------------------------------------------------------------
    \23\ Secs. 170(e)(4) and 170(e)(6).
---------------------------------------------------------------------------
    A qualified research contribution means a charitable 
contribution of inventory that is tangible personal property. 
The contribution must be to a qualified educational or 
scientific organization and be made not later than two years 
after construction of the property is substantially completed. 
The original use of the property must be by the donee, and be 
used substantially for research or experimentation, or for 
research training, in the U.S. in the physical or biological 
sciences. The property must be scientific equipment or 
apparatus, constructed by the taxpayer, and may not be 
transferred by the donee in exchange for money, other property, 
or services. The donee must provide the taxpayer with a written 
statement representing that it will use the property in 
accordance with the conditions for the deduction. For purposes 
of the enhanced deduction, property is considered constructed 
by the taxpayer only if the cost of the parts used in the 
construction of the property (other than parts manufactured by 
the taxpayer or a related person) do not exceed 50 percent of 
the taxpayer's basis in the property.
    A qualified computer contribution means a charitable 
contribution of any computer technology or equipment, which 
meets standards of functionality and suitability as established 
by the Secretary of the Treasury. The contribution must be to 
certain educational organizations or public libraries and made 
not later than three years after the taxpayer acquired the 
property or, if the taxpayer constructed the property, not 
later than the date construction of the property is 
substantially completed.\24\ The original use of the property 
must be by the donor or the donee,\25\ and in the case of the 
donee, must be used substantially for educational purposes 
related to the function or purpose of the donee. The property 
must fit productively into the donee's education plan. The 
donee may not transfer the property in exchange for money, 
other property, or services, except for shipping, installation, 
and transfer costs. To determine whether property is 
constructed by the taxpayer, the rules applicable to qualified 
research contributions apply. Contributions may be made to 
private foundations under certain conditions.\26\
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    \24\ If the taxpayer constructed the property and reacquired such 
property, the contribution must be within three years of the date the 
original construction was substantially completed. Sec. 
170(e)(6)(D)(i).
    \25\ This requirement does not apply if the property was reacquired 
by the manufacturer and contributed. Sec. 170(e)(6)(D)(ii).
    \26\ Sec. 170(e)(6)(C).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that extension of the enhanced 
deduction to include property assembled by the taxpayer will 
lead to increased charitable contributions of scientific 
property used for research and computer technology and 
equipment and will help to eliminate confusion in determining 
whether property is ``constructed'' or ``assembled'' for 
purposes of claiming the enhanced deduction.

                        EXPLANATION OF PROVISION

    Under the provision, property assembled by the taxpayer, in 
addition to property constructed by the taxpayer, is eligible 
for either enhanced deduction. The Committee does not intend 
that old or used components assembled by the taxpayer into 
scientific property or computer technology or equipment are 
eligible for the enhanced deduction.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2001.

   F. Encourage Contributions of Capital Gain Real Property Made for 
                         Conservation Purposes


(Sec. 106 of the bill and sec. 170 of the Code)

                              PRESENT LAW

Charitable contributions generally

    In general, a deduction is permitted for charitable 
contributions, subject to certain limitations that depend on 
the type of taxpayer, the property contributed, and the donee 
organization. The amount of deduction generally equals the fair 
market value of the contributed property on the date of the 
contribution. Charitable deductions are provided for income, 
estate, and gift tax purposes.\27\
---------------------------------------------------------------------------
    \27\ Secs. 170, 2055, and 2522, respectively.
---------------------------------------------------------------------------
    In general, in any taxable year, charitable contributions 
by a corporation are not deductible to the extent the aggregate 
contributions exceed 10 percent of the corporation's taxable 
income computed without regard to net operating or capital loss 
carrybacks. For individuals, the amount deductible is a 
percentage of the taxpayer's contribution base, which is the 
taxpayer's adjusted gross income computed without regard to any 
net operating loss carryback. The applicable percentage of the 
contribution base varies depending on the type of donee 
organization and property contributed. Cash contributions of an 
individual taxpayer to public charities, private operating 
foundations, and certain types of private nonoperating 
foundations may not exceed 50 percent of the taxpayer's 
contribution base. Cash contributions to private foundations 
and certain other charitable organizations generally may be 
deducted up to 30 percent of the taxpayer's contribution base.
    In general, a charitable deduction is not allowed for 
income, estate, or gift tax purposes if the donor transfers an 
interest in property to a charity while also either retaining 
an interest in that property or transferring an interest in 
that property to a noncharity for less than full and adequate 
consideration. Exceptions to this general rule are provided 
for, among other interests, remainder interests in charitable 
remainder annuity trusts, charitable remainder unitrusts, and 
pooled income funds, present interests in the form of a 
guaranteed annuity or a fixed percentage of the annual value of 
the property, and qualified conservation contributions.

Capital gain property

    Capital gain property means any capital asset or property 
used in the taxpayer's trade or business the sale of which at 
its fair market value, at the time of contribution, would have 
resulted in gain that would have been long-term capital gain. 
Contributions of capital gain property to a qualified charity 
are deductible at fair market value within certain limitations. 
Contributions of capital gain property to charitable 
organizations described in section 170(b)(1)(A) (e.g., public 
charities, private foundations other than private non-operating 
foundations, and certain governmental units) generally are 
deductible up to 30 percent of the taxpayer's contribution 
base. An individual may elect, however, to bring all these 
contributions of capital gain property for a taxable year 
within the 50-percent limitation category by reducing the 
amount of the contribution deduction by the amount of the 
appreciation in the capital gain property. Contributions of 
capital gain property to charitable organizations described in 
section 170(b)(1)(B) (e.g., private non-operating foundations) 
are deductible up to 20 percent of the taxpayer's contribution 
base.
    For purposes of determining whether a taxpayer's aggregate 
charitable contributions in a taxable year exceed the 
applicable percentage limitation, contributions of capital gain 
property are taken into account after other charitable 
contributions. Contributions of capital gain property that 
exceed the percentage limitation may be carried forward for 
five years.

Qualified conservation contributions

    Qualified conservation contributions are not subject to the 
``partial interest'' rule, which generally bars deductions for 
charitable contributions of partial interests in property. A 
qualified conservation contribution is a contribution of a 
qualified real property interest to a qualified organization 
exclusively for conservation purposes. A qualified real 
property interest is defined as: (1) the entire interest of the 
donor other than a qualified mineral interest; (2) a remainder 
interest; or (3) a restriction (granted in perpetuity) on the 
use that may be made of the real property. Qualified 
organizations include certain governmental units, public 
charities that meet certain public support tests, and certain 
supporting organizations. Conservation purposes include: (1) 
the preservation of land areas for outdoor recreation by, or 
for the education of, the general public; (2) the protection of 
a relatively natural habitat of fish, wildlife, or plants, or 
similar ecosystem; (3) the preservation of open space 
(including farmland and forest land) where such preservation 
will yield a significant public benefit and is either for the 
scenic enjoyment of the general public or pursuant to a clearly 
delineated Federal, State, or local governmental conservation 
policy; and (4) the preservation of an historically important 
land area or a certified historic structure.
    Qualified conservation contributions of capital gain 
property are subject to the same limitations and carryover 
rules of other charitable contributions of capital gain 
property.

                           REASONS FOR CHANGE

    The Committee desires to provide additional incentives for 
charitable donations of real property made for qualified 
conservation purposes. The Committee believes that increasing 
the percentage limitations applicable to qualified conservation 
contributions of real property, and increasing the carryover 
period applicable to such contributions from five to fifteen 
years, will increase donations made for qualified conservation 
purposes. The Committee also believes that special incentives 
are required to encourage qualified conservation contributions 
of farm and ranch properties.

                        EXPLANATION OF PROVISION

In general

    Under the provision, the 30-percent contribution base 
limitation on contributions of capital gain property by 
individuals does not apply to qualified conservation 
contributions (as defined under present law). Thus, individuals 
may include the fair market value of any qualified conservation 
contribution of capital gain property in determining the amount 
of the charitable contributions subject to the 50-percent 
contribution base limitation.
    Individuals are allowed to carryover any qualified 
conservation contributions that exceed the 50-percent 
limitation for up to 15 years. The 50-percent contribution base 
limitation applies first to contributions other than qualified 
conservation contributions and then to qualified conservation 
contributions. For example, assume an individual with a 
contribution base of $100 makes a qualified conservation 
contribution of property with a fair market value of $80 and 
makes other charitable contributions of $60. The individual is 
allowed a deduction of $50 in the current taxable year for the 
other contributions (50 percent of the $100 contribution base) 
and is allowed to carryover the excess $10 for up to 5 years. 
No current deduction is allowed for the qualified conservation 
contribution but the entire $80 qualified conservation 
contribution may be carried forward for up to 15 years.

Farmers and ranchers

    In the case of an eligible farmer or rancher, a qualified 
conservation contribution is allowable up to 100 percent of the 
taxpayer's contribution base (after taking into account other 
charitable contributions). This rule applies both to 
individuals and corporations. In addition, corporate (as well 
as non-corporate) eligible farmers and ranchers are allowed to 
carryover any excess qualified conservation contributions for 
up to 15 years. The 100-percent contribution base limitation 
applies first to contributions other than qualified 
conservation contributions (to the extent allowable under other 
percentage limitations) and then to qualified conservation 
contributions. For example, assume an individual farmer or 
rancher with a contribution base of $100 makes a qualified 
conservation contribution of property with a fair market value 
of $80 and makes other charitable contributions of $60. The 
individual is allowed a deduction of $50 in the current taxable 
year for the other contributions (50 percent of the $100 
contribution base) and is allowed to carryover the excess $10 
for up to 5 years. The individual is also allowed a deduction 
of $50 in the current taxable year for the qualified charitable 
contribution (the amount of the remaining contribution base). 
The remaining $30 qualified conservation contribution may be 
carried forward for up to 15 years.
    For this purpose, an eligible farmer or rancher means a 
taxpayer (other than a publicly traded C corporation) whose 
gross income from the trade of business of farming is at least 
51 percent of the taxpayer's gross income for the taxable year.

                             EFFECTIVE DATE

    The provision is effective for contributions made in 
taxable years beginning after December 31, 2002.

 G. Exclusion of 25 Percent of Capital Gain for Certain Sales Made for 
                    Qualifying Conservation Purposes


(Sec. 107 of the bill and new sec. 121A of the Code)

                              PRESENT LAW

Sales of capital gain property

    Gain from the sale or exchange of land held more than one 
year generally is treated as long-term capital gain. Generally, 
the net capital gain of an individual (i.e., long-term capital 
gain less short-term capital loss) is subject to a maximum tax 
rate of 20 percent.

Charitable contributions of capital gain property for conservation 
        purposes

    Special rules apply to charitable contributions of 
qualified conservation contributions. Qualified conservation 
contributions are not subject to the ``partial interest'' rule, 
which generally bars deductions for charitable contributions of 
partial interests in property. A qualified conservation 
contribution is a contribution of a qualified real property 
interest to a qualified organization exclusively for 
conservation purposes. A qualified real property interest is 
defined as: (1) the entire interest of the donor other than a 
qualified mineral interest; (2) a remainder interest; or (3) a 
restriction (granted in perpetuity) on the use that may be made 
of the real property. Charitable contributions of interests 
that constitute the taxpayer's entire interest in the property 
are not regarded as qualified real property interests within 
the meaning of section 170(h),\28\ but instead are subject to 
the general rules applicable to charitable contributions of 
entire interests of the taxpayer. Qualified organizations 
include certain governmental units, public charities that meet 
certain public support tests, and certain supporting 
organizations. Conservation purposes include: (1) the 
preservation of land areas for outdoor recreation by, or for 
the education of, the general public; (2) the protection of a 
relatively natural habitat of fish, wildlife, or plants, or 
similar ecosystem; (3) the preservation of open space 
(including farmland and forest land) where such preservation 
will yield a significant public benefit and is either for the 
scenic enjoyment of the general public or pursuant to a clearly 
delineated Federal, State, or local governmental conservation 
policy; and (4) the preservation of an historically important 
land area or a certified historic structure.
---------------------------------------------------------------------------
    \28\ Ltr. Rul. 8626029.
---------------------------------------------------------------------------
    Treasury regulations provide that a deduction for a 
qualified conservation contribution is allowed only if the 
donor prohibits in the instrument of conveyance the donee from 
subsequently transferring the qualified real property interest, 
whether or not for consideration, unless the donee 
organization, as a condition of the subsequent transfer, 
requires that the conservation purpose which the contribution 
was originally intended to advance continues to be carried 
out.\29\ Moreover, subsequent transfers of such interests are 
restricted to organizations that are qualified conservation 
organizations.\30\
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    \29\ Treas. Reg. sec. 1.170A-14(c)(2).
    \30\ Id.
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                           REASONS FOR CHANGE

    Some landowners may want their land to be protected for 
conservation purposes but cannot afford simply to donate either 
the land or an easement on the land, especially if the land is 
the landowner's primary asset. The Committee desires to 
encourage the sale of appreciated, environmentally sensitive 
land and real property interests in land or water, as well as 
controlling stock interests in certain land corporations, to 
qualified conservation organizations and governments, thus 
achieving conservation goals through voluntary sales of 
property. The Committee believes that providing taxpayers a 
partial exclusion of capital gain derived from the voluntary 
sale of properties for conservation purposes will increase the 
number of properties dedicated to conservation purposes. The 
Committee desires to facilitate the transfers of properties to 
conservation organizations in a manner that will, to the extent 
practicable, preserve the value of the properties once they are 
acquired by the conservation organizations, while providing 
safeguards designed to ensure the protection of the 
conservation purposes for which the properties are intended to 
be used.

                        EXPLANATION OF PROVISION

In general

    The bill provides a 25-percent exclusion from gross income 
of long-term capital gain from the qualifying sale or exchange 
of land, or an interest in land or water rights, provided that 
the land or interest in land or water rights constitutes an 
interest in real property that has been held by the taxpayer or 
the taxpayer's family at all times during the five years 
preceding the date of sale. The qualifying sale must be made to 
a qualified organization that intends that the acquired 
property be used for qualified conservation purposes in 
perpetuity.\31\
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    \31\ The exclusion is mandatory if all of the requirements of the 
provision are satisfied, and a taxpayer need not file an election to 
take advantage of the exclusion. A taxpayer who transfers qualifying 
property to a qualified organization may opt out of the 25-percent 
exclusion by choosing not to satisfy one or more of the provision's 
requirements without having to file a formal election with the 
Secretary, such as by failing to obtain the requisite letter of intent 
from the qualified organization.
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Qualifying interests

    The exclusion applies only to sales or exchanges of real 
property interests in land or water rights that constitute the 
entire interest of the taxpayer in such land or water rights, 
or that constitute qualified real property interests as defined 
in section 170(h), specifically: (1) the entire interest of the 
taxpayer other than a qualified mineral interest; (2) a 
remainder interest; or (3) a restriction (granted in 
perpetuity) on the use which may be made of the real property. 
Partial interests in property that are not the entire interest 
of the taxpayer or a qualified real property interest do not 
qualify for the exclusion. For example, a taxpayer who owns 
land and related mineral rights but who sells only the mineral 
rights is not eligible for the exclusion. However, a taxpayer 
who owns only mineral rights is eligible for the 25-percent 
exclusion if the taxpayer sells his or her entire interest in 
the mineral rights and satisfies the other requirements of the 
provision.
    Generally, an undivided interest that constitutes the 
taxpayer's entire interest in the property is eligible for the 
exclusion. A partial interest (for example, an undivided 
interest) that constitutes the taxpayer's entire interest in 
the property, however, does not qualify for the exclusion if 
the property in which such partial interest exists was divided 
in an attempt to avoid the partial interest rules. The 
Committee intends that the partial interest rules contained in 
Treasury Regulations section 1.170A-7(a)(2)(i) and generally 
applicable to contributions of partial interests be applied 
similarly for purposes of this provision. For example, if a 
taxpayer transfers an undivided interest in property to a 
spouse and immediately thereafter sells the remaining undivided 
interest to a qualified organization, the exclusion will not 
apply to the taxpayer's sale to the qualified organization.
    Under the provision, the exclusion is available for long-
term capital gain from certain sales or exchanges of stock in a 
C corporation if the qualified organization ultimately obtains 
a controlling stock interest (generally a stock interest that 
provides the qualified organization at least 90 percent of the 
total voting power and total value of the corporation's stock) 
and if at least 90 percent of the fair market value of the C 
corporation's assets at the time of the sale or exchange 
consists of land or water rights, or interests in land or water 
rights, that were held by the corporation at all times during 
the five years preceding the sale. Stock in a corporation will 
not qualify if at the time of the sale or exchange the fair 
market value of water rights and infrastructure relating to the 
delivery of water constitutes more than 50 percent of the fair 
market value of all of the corporation's assets. Only a stock 
interest held by the taxpayer or the taxpayer's family at all 
times during the five years preceding the sale qualifies for 
the 25-percent exclusion. The Committee intends that in 
appropriate circumstances a controlling stock interest may be 
acquired by the qualified organization from multiple persons in 
multiple transactions, and authorizes the Secretary to issue 
guidance regarding the availability of the exclusion in such 
cases.

Qualifying gain

    The exclusion applies only to long-term capital gain. Gain 
treated as ordinary income, such as under depreciation 
recapture provisions, is not eligible for the exclusion. Gain 
attributable to certain improvements, such as buildings or 
structures that do not further a qualified conservation purpose 
(``disqualified improvements''), also does not qualify for the 
exclusion.\32\ The bill provides that the maximum amount of 
gain that may be excluded by a shareholder in the case of a 
sale or exchange of a controlling stock interest is 25 percent 
of the shareholder's proportionate share of the C corporation's 
underlying gain attributable to qualifying land, water rights, 
or interests therein held by the C corporation.
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    \32\ The Committee intends that soil and water conservation 
expenditures in the nature of those described in section 175, 
determined without regard to whether the taxpayer is engaged in a 
farming business and that the land be used for farming, generally be 
treated as furthering a qualified conservation purpose.
---------------------------------------------------------------------------
    Consistent with present law, the determination of gain or 
loss is to be calculated on an asset-by-asset basis whenever 
that is required for other purposes of the Code (such as for 
purposes of section 1245 or section 1250). To minimize 
administrative complexity and assist taxpayers in the 
preparation of their returns, the Committee intends that in 
those cases where the Code does not otherwise require a 
separate determination of gain or loss for the disqualified 
improvement, the gain allocable to the disqualified improvement 
shall be determined by reference to the fair market value of 
the disqualified improvement relative to the fair market value 
of all assets for which a gain or loss determination is not 
otherwise required by the Code.\33\
---------------------------------------------------------------------------
    \33\ The Committee intends that the taxpayer be required to use 
this gain allocation rule unless the taxpayer has adequate records to 
substantiate the adjusted basis and fair market value to support a 
separate calculation.
---------------------------------------------------------------------------
    For example, if a taxpayer sells a qualifying land interest 
with a fair market value of $100 and a basis of $30, that 
includes a building or structure that does not further a 
conservation purpose (a disqualified improvement) and that has 
a fair market value of $40, the taxpayer must determine the 
portion of the gain that is attributable to the eligible land 
and to the disqualified improvement. If determination of gain 
or loss on the sale of the improvement is required for other 
purposes of the Code, then the gain or loss determined for 
those purposes governs, and the taxpayer must determine his or 
her basis of the disqualified improvement (in this case, 
assumed to be zero), with the result that the $40 gain on the 
disqualified improvement is not eligible for the 25-percent 
exclusion and the gain of $30 on the land is eligible for the 
25-percent exclusion. On the other hand, if the determination 
of gain or loss on the sale of the improvement is not required 
for other purposes of the Code, then the Committee intends that 
the taxpayer allocate the aggregate gain of $70 attributable to 
the land and the disqualified improvement between the land and 
the improvement on the basis of their respective fair market 
values (i.e., 40 percent to the improvement and 60 percent to 
the land). Under this gain allocation rule, the $28 of gain 
allocable to the improvement is not eligible for the 25-percent 
exclusion, and the $42 of gain allocable to the land qualifies 
for the 25-percent exclusion.

Eligible sales

    An eligible sale is a sale or exchange (excluding a 
transfer made by order of condemnation or eminent domain) \34\ 
that may be made only to a qualified organization, defined as a 
Federal, State, or local government, or an agency or department 
thereof or a section 501(c)(3) organization that is organized 
and operated primarily to meet a qualified conservation 
purpose. In addition, to be an eligible sale, the organization 
acquiring the property interest must provide the taxpayer with 
a letter stating that the intent of such organization in 
acquiring the property is to further a qualified conservation 
purpose and that any subsequent transfer of the acquired 
interest will be to a qualified organization and made to 
protect the conservation purpose in perpetuity. A qualified 
conservation purpose is: (1) the preservation of land areas for 
outdoor recreation by, or the education of, the general public; 
(2) the protection of a relatively natural habitat of fish, 
wildlife, or plants, or similar ecosystem; or (3) the 
preservation of open space (including farmland and forest land) 
where the preservation is for the scenic enjoyment of the 
general public or pursuant to a clearly delineated Federal, 
State, or local governmental conservation policy and will yield 
a significant public benefit.
---------------------------------------------------------------------------
    \34\ A sale or exchange made prior to the issuance of an order, but 
that is the result of the threat of condemnation or eminent domain, may 
qualify for the exclusion.
---------------------------------------------------------------------------

Protection of conservation purposes

    The bill provides for the imposition of penalty excise 
taxes in appropriate cases where a qualified organization fails 
to take steps consistent with the protection of conservation 
purposes. Because the penalty taxes are imposed on an 
organization that fails to protect the conservation purpose, 
and do not serve to encumber the property in the same manner as 
a restriction contained in an instrument of conveyance, the 
Committee believes that the penalty taxes will adequately 
protect conservation purposes without decreasing the value of 
the property in the hands of the conservation organizations.
    If ownership or possession of the property is transferred 
by a qualified organization other than to another qualified 
organization, or a legal restriction contained in an instrument 
of conveyance that protects the qualified conservation purpose 
is removed, then: (1) a 20-percent excise tax applies to the 
proceeds or fair market value of the property, (2) any realized 
gain or income is subject to an additional excise tax imposed 
at the highest income tax rate applicable to C corporations, 
and (3) any otherwise applicable non-recognition provisions of 
the Code shall not apply to the transferor. The Committee 
intends that the excise taxes apply to all cases involving the 
transfer of ownership or possession of the property to a 
transferee that is not a qualified organization unless the 
transferring qualified organization demonstrates to the 
satisfaction of the Secretary that qualified conservation 
purposes will be protected in perpetuity. In the case of a 
removal of a legal restriction contained in an instrument of 
conveyance, the qualified organization must demonstrate to the 
satisfaction of the Secretary that a later unexpected change in 
the conditions surrounding the property makes retaining the 
conservation restriction impossible or impractical and that any 
proceeds derived from the removal of the restriction will be 
used to further qualified conservation purposes. The Committee 
authorizes the Secretary to provide guidance to identify 
appropriate cases where transfers to persons other than 
qualified organizations are regarded as protecting a 
conservation purpose in perpetuity. The Committee intends, for 
example, that a qualified organization may acquire a fee simple 
interest in real property operated as a farm and then transfer, 
without imposition of the penalty taxes, the real property 
subject to a conservation easement that constitutes a qualified 
real property interest if, in a recorded instrument of 
conveyance, the transferor prohibits the transferee from 
subsequently transferring the real property unless the 
transferee, as a condition of the subsequent transfer, requires 
that the qualified conservation purpose of preserving the 
property as open space farmland will continue to be carried 
out.
    In the case of a transfer by a qualified organization to 
another qualified organization, the transferee must provide the 
transferor at the time of the transfer a letter stating that 
the intent of the transferee is to further a qualified 
conservation purpose and that any subsequent transfer of the 
acquired interest will be made to protect the conservation 
purpose in perpetuity, and the transferee becomes subject to 
the excise tax provisions for subsequent transfers. The 
Committee intends that in the case of a sale or exchange of 
stock of a C corporation in which a qualified organization 
acquires a controlling stock interest, all of the stock of such 
corporation acquired by the qualified organization (including 
any stock which did not qualify for the exclusion), as well as 
the property held by such C corporation, becomes subject to the 
penalty tax provisions.
    The bill provides that the Secretary may require such 
reporting as may be necessary or appropriate to further the 
purpose that any conservation use be in perpetuity.

Relationship with other provisions

    In the case of an individual, the exclusion applies both 
for purposes of the regular tax and the alternative minimum 
tax. In the case of a corporation, the present-law alternative 
minimum tax provisions apply without modification.
    If a taxpayer sells a real property interest to a qualified 
organization for less than the property's fair market value, 
the amount of any charitable contribution deduction is 
determined in accordance with the bargain sale rules,\35\ and 
the taxpayer shall not fail to qualify for a contribution 
deduction under those rules solely because the taxpayer derives 
a tax benefit from the partial exclusion of long-term capital 
gain from the sale. For example, if a taxpayer sells qualifying 
land with a fair market value of $100 and an adjusted basis of 
$10 to a qualified organization for a sales price of $95 (or 
alternatively, for a sale price of $50), the taxpayer's basis 
of $10 shall be allocated between the sale and the contribution 
components of the transfer under the bargain sale rules, and 
the tax savings resulting from the 25-percent exclusion of 
long-term capital gain on the sale will not reduce the portion 
of the transfer treated as a charitable contribution under the 
bargain sale rules. The present-law requirements applicable to 
the charitable contribution component of the transfer, 
including, for example, the recordkeeping, substantiation, and 
appraisal provisions of Treasury Regulations section 1.170A-13, 
must be satisfied.
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    \35\ Sec. 1011(b) and Treas. Reg. sec. 1.1011-2.
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                             EFFECTIVE DATE

    The provision is effective for sales or exchanges occurring 
after December 31, 2003, in taxable years ending after such 
date.

   H. Cost Sharing Payments Under the Partners for Fish and Wildlife 
                                Program


(Sec. 108 of the bill and sec. 126 of the Code)

                              PRESENT LAW

    Under present law, gross income does not include the 
excludable portion of payments made to taxpayers by federal and 
state governments for a share of the cost of improvements to 
property under certain conservation programs. These programs 
include payments received under (1) the rural clean water 
program authorized by section 208(j) of the Federal Water 
Pollution Control Act, (2) the rural abandoned mine program 
authorized by section 406 of the Surface Mining Control and 
Reclamation Act of 1977, (3) the water bank program authorized 
by the Water Bank Act, (4) the emergency conservation measures 
program authorized by title IV of the Agricultural Credit Act 
of 1978, (5) the agriculture conservation program authorized by 
the Soil Conservation and Domestic Allotment Act, (6) the great 
plains conservation program authorized by section 16 of the 
Soil Conservation and Domestic Policy Act, (7) the resource 
conservation and development program authorized by the 
Bankhead-Jones Farm Tenant Act and by the Soil Conservation and 
Domestic Allotment Act, (8) the forestry incentives program 
authorized by section 4 of the Cooperative Forestry Assistance 
Act of 1978, (9) any small watershed program administered by 
the Secretary of Agriculture which is determined by the 
Secretary of the Treasury or his delegate to be substantially 
similar to the type of programs described in items (1) through 
(8), and (10) any program of a State, possession of the United 
States, a political subdivision of any of the foregoing, or the 
District of Columbia under which payments are made to 
individuals primarily for the purpose of conserving soil, 
protecting or restoring the environment, improving forests, or 
providing a habitat for wildlife.

                           REASONS FOR CHANGE

    The Committee believes that payments received by taxpayers 
under the Partners for Fish and Wildlife Program are similar to 
payments made under other government programs that are 
excludable from gross income under present law. Accordingly, 
the Committee believes it is appropriate to extend the present-
law exclusion to payments under this program.

                        EXPLANATION OF PROVISION

    The provision expands the types of qualified cost-sharing 
payments to include payments under the Partners for Fish and 
Wildlife Program.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31, 2002.

  I. Basis Adjustment to Stock of S Corporation Contributing Property


(Sec. 109 of the bill and sec. 1367 of the Code)

                              PRESENT LAW

    Under present law, if an S corporation contributes money or 
other property to a charity, each shareholder takes into 
account the shareholder's pro rata share of the contribution in 
determining its own income tax liability.\36\ A shareholder of 
an S corporation reduces the basis in the stock of the S 
corporation by the amount of the charitable contribution that 
flows through to the shareholder.\37\
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    \36\ Sec. 1366(a)(1)(A).
    \37\ Sec. 1367(a)(2)(B).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Under present law, if an S corporation makes a charitable 
contribution of appreciated property, the shareholder may be 
taxed on an amount equal to the appreciation in the contributed 
property when the S corporation stock is sold. Thus, under 
present law, a charitable contribution of appreciated property 
made by an S corporation receives less favorable tax treatment 
than other contributions of appreciated property.
    The Committee wishes to preserve the benefit of providing a 
charitable contribution deduction for contributions of property 
by an S corporation with a fair market value in excess of its 
adjusted basis. Thus, the bill provides that the basis 
adjustment to the stock of an S corporation for charitable 
contributions made by the corporation will be in an amount 
equal to the shareholder's pro rata share of the adjusted basis 
of the property contributed. This adjustment will prevent the 
later recognition of gain attributable to the appreciation in 
the contributed property on the disposition of the S 
corporation stock.

                        EXPLANATION OF PROVISION

    The provision provides that the amount of a shareholder's 
basis reduction in the stock of an S corporation by reason of a 
charitable contribution made by the corporation will be equal 
to the shareholder's pro rata share of the adjusted basis of 
the contributed property.\38\
---------------------------------------------------------------------------
    \38\ See Rev. Rul. 96-11 (1996-1 C.B. 140) for a rule reaching a 
similar result in the case of charitable contributions madee by a 
partnership.
---------------------------------------------------------------------------
    Thus, for example, assume an S corporation with one 
individual shareholder makes a charitable contribution of stock 
with a basis of $200 and a fair market value of $500. The 
shareholder will be treated as having made a $500 charitable 
contribution (or a lesser amount if the special rules of 
section 170(e) apply), and will reduce the basis of the S 
corporation stock by $200.

                             EFFECTIVE DATE

    The provision applies to contributions made in taxable 
years beginning after December 31, 2002.

J. Enhanced Deduction for Charitable Contribution of Literary, Musical, 
                  Artistic, and Scholarly Compositions


(Sec. 110 of the bill and sec. 170 of the Code)

                              PRESENT LAW

    In the case of a charitable contribution of inventory or 
other ordinary-income or short- term capital gain property, the 
amount of the deduction generally is limited to the taxpayer's 
basis in the property.\39\ 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. In cases involving 
contributions of tangible personal property to a private 
foundation (other than certain private foundations),\40\ the 
amount of the deduction is limited to the taxpayer's basis in 
the property.
---------------------------------------------------------------------------
    \39\ Sec. 170(e)(1).
    \40\ Sec. 170(e)(1)(B)(ii).
---------------------------------------------------------------------------
    Under present law, charitable contributions of literary, 
musical, and artistic compositions are considered ordinary 
income property and a taxpayer's deduction of such property is 
limited to the taxpayer's basis (typically, cost) in the 
property. To be eligible for the deduction, the contribution 
must be of an undivided portion of the donor's entire interest 
in the property.\41\ For purposes of the charitable income tax 
deduction, the copyright and the work in which the copyright is 
embodied are not treated as separate property interests. 
Accordingly, if a donor owns a work of art and the copyright to 
the work of art, a gift of the artwork without the copyright or 
the copyright without the artwork will constitute a gift of a 
``partial interest'' and will not qualify for the income tax 
charitable deduction.
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    \41\ Sec. 170(f)(3).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is appropriate to provide an 
enhanced deduction for charitable contributions of certain 
literary, musical, artistic, and scholarly compositions created 
by the personal efforts of the donor. In many cases, such works 
have a low basis, and because present law generally limits the 
deduction for such contributions to basis, the creators of 
literary, musical, artistic, and scholarly compositions do not 
have an appropriate incentive to contribute their works to 
charity. In addition, the Committee believes that the present-
law rule that a charitable contribution deduction generally is 
not available for contributions of less than the taxpayer's 
entire property interest is an inappropriate disincentive for 
contributions of such works.

                        EXPLANATION OF PROVISION

    The bill provides that a deduction for ``qualified artistic 
charitable contributions'' generally is increased from the 
value under present law (generally, basis) to the fair market 
value of the property contributed, measured at the time of the 
contribution. However, the amount of the increase of the 
deduction provided by the provision may not exceed the amount 
of the donor's adjusted gross income for the taxable year 
attributable to: (1) income from the sale or use of property 
created by the personal efforts of the donor that is of the 
same type as the donated property; and (2) income from 
teaching, lecturing, performing, or similar activities with 
respect to such property. In addition, the increase to the 
present-law deduction provided by the provision may not be 
carried over and deducted in other taxable years.
    The provision defines a qualified artistic charitable 
contribution to mean a charitable contribution of any literary, 
musical, artistic, or scholarly composition, or similar 
property, or the copyright thereon (or both) that meets certain 
requirements. First, the contributed property must have been 
created by the personal efforts of the donor at least 18 months 
prior to the date of contribution. The Committee intends that 
``personal efforts'' shall be defined by reference to Treasury 
regulations section 1.1221-1(c). Second, the donor must obtain 
a qualified appraisal of the contributed property, a copy of 
which is required to be attached to the donor's income tax 
return for the taxable year in which such contribution is made. 
The appraisal must include evidence of the extent (if any) to 
which property created by the personal efforts of the taxpayer 
and of the same type as the donated property is or has been 
owned, maintained, and displayed by certain charitable 
organizations and sold to or exchanged by persons other than 
the taxpayer, donee, or any related person. Third, the 
contribution must be made to a public charity or to certain 
limited types of private foundations. Finally, the use of 
donated property by the recipient organization must be related 
to the organization's charitable purpose or function, and the 
donor must receive a written statement from the organization 
verifying such use.
    Under the provision, the tangible property and the 
copyright on such property are treated as separate properties 
for purposes of the ``partial interest'' rule; thus, a gift of 
artwork without the copyright or a copyright without the 
artwork does not constitute a gift of a partial interest and is 
deductible. Contributions of letters, memoranda, or similar 
property that are written, prepared, or produced by or for an 
individual while the individual is an officer or employee of 
any person (including a government agency or instrumentality) 
do not qualify for a fair market value deduction unless the 
contributed property is entirely personal.

                             EFFECTIVE DATE

    The deduction for qualified artistic charitable 
contributions applies to contributions made after December 31, 
2002, in taxable years ending after such date.

      Title II. Disclosure of Information Relating to Tax-Exempt 
                             Organizations


                A. Disclosure of Written Determinations


(Sec. 201 of the bill and sec. 6110 of the Code)

                              PRESENT LAW

In general

    Three provisions of present law govern the disclosure of 
information relating to tax-exempt organizations. First, 
section 6103 provides a general rule that tax returns and 
return information generally are not subject to public 
disclosure.\42\ Second, in order to allow the public to 
scrutinize the activities of tax-exempt organizations, section 
6104 grants an exception to the confidentiality rule of section 
6103 for certain categories of tax-exempt organization 
documents and information. Section 6104 permits the release in 
unredacted form of approved applications for tax-exempt status, 
certain related documents, and annual information returns filed 
by tax-exempt organizations. As a general rule, to the extent 
section 6104 specifically provides for the disclosure of tax-
exempt organization information, other disclosure provisions do 
not apply. If tax-exempt organization information does not come 
within the scope of section 6104, other disclosure provisions 
will govern whether the information may be disclosed. Third, 
section 6110 provides that written determinations by the IRS 
and related background file documents generally are open to 
public inspection in redacted form. Section 6110 does not apply 
to any matter to which section 6104 applies.\43\
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    \42\ Sec. 6103(a). A ``return'' includes any tax or information 
return, declaration of estimated tax, or claim for refund required by, 
or provided for, or permitted under the provisions of the Code, which 
is filed with the IRS. Sec. 6103(b)(1). ``Return'' also includes any 
amendment or supplement to the filed return. Sec. 6103(b)(1). ``Return 
information'' is defined broadly to include any data received by, 
recorded by, prepared by, furnished to, or collected by the Secretary 
with respect to a return or with respect to the determination of the 
existence, or possible existence, of liability (or the amount thereof) 
of any person for any tax, penalty, interest, fine, forfeiture, or 
other imposition, or offense under the Code. The term ``return 
information'' does not include data in a form that cannot be associated 
with, or otherwise identify, directly or indirectly, a particular 
taxpayer. Sec. 6103(b)(2).
    \43\ Sec. 6110(l)(1).
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Disclosure of applications for recognition of tax exemption and annual 
        information returns

    Under present law, tax-exempt organizations are required to 
make a copy of their application for recognition of tax-exempt 
status (and certain related documents) \44\ and their annual 
information return (Form 990 or Form 990-PF) available for 
public inspection. Organizations are not required to disclose 
an application for tax exemption filed by the organization 
unless the IRS responded favorably to the application.\45\ 
Charitable organizations that are not classified as private 
foundations are not required to disclose the names of donors to 
the organization.
---------------------------------------------------------------------------
    \44\ Section 6104(a)(1)(A) provides that ``any papers submitted in 
support of'' an application for tax-exempt status must be available for 
inspection. Treasury regulations limit the definition of supporting 
documents to papers submitted by the organization. Treas. Reg. sec. 
301.6104(a)-1(e).
    \45\ Treas. Reg. sec. 301.6104(d)-1(b)(3)(iii)(A).
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    The Secretary may withhold disclosure of certain 
information described in an organization's application for tax-
exempt status if disclosure would: (1) divulge a trade secret, 
patent, process, style of work, or apparatus of the 
organization, and the Secretary determines that such disclosure 
would harm the organization; or (2) that the Secretary 
determines would harm the national defense.\46\ The 
organization must apply to the Commissioner for a determination 
that the disclosure would violate one of these criteria. The 
organization will be given 15 days to contest an adverse 
determination before the information is made available for 
public inspection.\47\
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    \46\ Sec. 6104(a)(1)(D). In the case of a pension plan, information 
may be withheld if it would identify any particular individual covered 
under the plan. Id.
    \47\ Treas. Reg. sec. 301.6104(a)-5(a)(1).
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Disclosure of written determinations

    Section 6110 provides that the text of any written 
determination by the IRS and related background file document 
is open to public inspection.\48\ The term ``written 
determination'' means a ruling,\49\ determination letter,\50\ 
technical advice memorandum,\51\ or Chief Counsel advice.\52\ 
Closing agreements, which are final and conclusive written 
agreements entered into by the IRS and a taxpayer in order to 
settle the taxpayer's tax liability with respect to a taxable 
year, do not constitute written determinations.\53\ A 
background file document includes the request for a written 
determination, any written material submitted by the taxpayer 
in support of the request, and any communications between the 
IRS and other persons in connection with the written 
determination received before issuance of the written 
determination.\54\
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    \48\ Sec. 6110(a).
    \49\ A ruling is a written statement issued by the National Office 
to a taxpayer or his or her authorized representative. Treas. Reg. sec. 
301.6110-2(d). It generally recites the relevant facts, sets forth the 
applicable provisions of law, and shows the application of the law to 
the facts. Treas. Reg. sec. 301.6110-2(d).
    \50\ A district director issues a ``determination letter'' in 
response to a written inquiry from an individual or organization that 
applies principles and precedents previously announced by the IRS 
National Office to the particular facts involved. Treas. Reg. sec. 
301.6110-2(e).
    \51\ A ``technical advice memorandum'' is a written statement 
issued by the IRS National Office to a district director in connection 
with the examination of a taxpayer's return or consideration of a 
taxpayer's claim for refund or credit. Treas. Reg. sec. 301.6110-2(f). 
Generally, a technical advice memorandum states the relevant facts, 
sets forth the applicable law, and states a legal conclusion. Treas. 
Reg. sec. 301.6110-2(f).
    \52\ Sec. 6110(b)(1). Any IRS National Office component of the 
Office of Chief Counsel can issue Chief Counsel advice. The IRS 
National Office component issues the advice to IRS field or service 
center employees, or to regional or district employees of Chief 
Counsel. Sec. 6110(i)(A)(i). The definition of Chief Counsel advice 
does not encompass advice issued from one IRS National Office component 
of the Office of Chief Counsel to another. The advice by definition 
conveys: (1) a legal interpretation of a revenue provision; (2) the IRS 
or Chief Counsel position or policy concerning a revenue provision; or 
(3) a legal interpretation of any law (Federal, State, or foreign) 
relating to the assessment or collection of liability under a revenue 
provision. Sec. 6110(i)(A)(ii).
    \53\ Sec. 6103(b)(2)(D); sec. 6110(b)(1)(B).
    \54\ Sec. 6110(b)(2). Communications between the IRS and the 
Department of Justice relating to a pending civil or criminal case are 
not considered background file documents.
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    A background file document is available upon written 
request to any person requesting a copy of the related written 
determination.\55\ Before releasing any written determination 
or background file document, the IRS must delete identifying 
details of the person about whom the written determination 
pertains and certain other information.\56\ With respect to 
tax-exempt organizations, disclosure under section 6110 is 
limited to letters and rulings unrelated to an organization's 
tax-exempt status.\57\
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    \55\ Sec. 6110(e).
    \56\ Sec. 6110(c) provides the following exemptions from 
disclosure: (1) the names, addresses, and other identifying details of 
the person to whom the written determination pertains and of any other 
person, other than a person with respect to whom a notation is made 
under subsection (d)(1) (relating to third party contacts), identified 
in the written determination or any background file document; (2) 
information specifically authorized under criteria established by an 
Executive order to be kept secret in the interest of national defense 
or foreign policy, and which is in fact properly classified pursuant to 
such Executive order; (3) information specifically exempted from 
disclosure by any statute (other than this title) which is applicable 
to the Internal Revenue Service; (4) trade secrets and commercial or 
financial information obtained from a person and privileged or 
confidential; (5) information the disclosure of which would constitute 
a clearly unwarranted invasion of personal privacy; (6) information 
contained in or related to examination, operating, or condition reports 
prepared by, or on behalf of, or for use of an agency responsible for 
the regulation or supervision of financial institutions; and (7) 
geological and geophysical information and data, including maps, 
concerning wells.
    \57\ Sec. 6110(l)(1); Treas. Reg. sec. 301.6110-1(a).
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    The application of section 6110 to guidance relating to 
tax-exempt organizations is limited. Section 6110(l)(1) 
provides, ``this section shall not apply to any matter to which 
section 6104 applies.'' The regulations under section 6110 
clarify which matters are within the ambit of section 6104 and, 
therefore, are not subject to disclosure under section 6110:

          [a]ny application filed with the Internal Revenue 
        Service with respect to the qualification or exempt 
        status of an organization * * *; any document issued by 
        the Internal Revenue Service in which the qualification 
        or exempt status of an organization is * * * granted, 
        denied or revoked or the portion of any document in 
        which technical advice with respect thereto is given to 
        a district director; * * * the portion of any document 
        issued by the Internal Revenue Service in which is 
        discussed the effect on the qualification or exempt 
        status of an organization * * * of proposed 
        transactions by such organization * * *; and any 
        document issued by the Internal Revenue Service in 
        which is discussed the qualification or status of a 
        [private foundation or private operating 
        foundation].\58\
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    \58\ Treas. Reg. sec. 301.6110-1(a).

    In addition, the regulations under section 6104 provide 
that some determination letters and other documents relating to 
tax exemption that are not open to public inspection under 
section 6104(a)(1)(A) are nevertheless ``within the ambit'' of 
section 6104 for purposes of the disclosure provisions of 
section 6110.\59\ The regulation explains that the following 
documents are, therefore, not available for public inspection 
under either section 6104 or 6110:
---------------------------------------------------------------------------
    \58\ Treas. Reg. sec. 301.6104(a)-1(i).
---------------------------------------------------------------------------
          (1) Unfavorable rulings or determination letters 
        issued in response to applications for tax exemption;
          (2) Rulings or determination letters revoking or 
        modifying a favorable determination letter;
          (3) Technical advice memoranda relating to a 
        disapproved application for tax exemption or the 
        revocation or modification of a favorable determination 
        letter;
          (4) Any letter or document filed with or issued by 
        the IRS relating to whether a proposed or accomplished 
        transaction is a prohibited transaction under section 
        503;
          (5) Any letter or document filed with or issued by 
        the IRS relating to an organization's status as a 
        private foundation or private operating foundation, 
        unless the letter or document relates to the 
        organization's application for tax exemption; and
          (6) Any other letter or document filed with or issued 
        by the IRS which, although it relates to an 
        organization's tax exempt status as an organization 
        described in section 501(c), does not relate to that 
        organization's application for tax exemption.\60\
---------------------------------------------------------------------------
    \60\ Id.
---------------------------------------------------------------------------
    The effect of these limitations is that written 
determinations relating to exempt status issues are not 
released, even in redacted form. The IRS does, however, release 
written determinations issued to tax-exempt organizations that 
include issues that clearly are not within the ambit of section 
6104, such as the application of the unrelated business income 
tax to a particular proposed transaction.

                           REASONS FOR CHANGE

    The Committee believes that present law inappropriately 
protects from disclosure certain written determinations and 
background file documents that relate to the tax-exempt status 
of organizations described in section 501(c) and (d). The 
Committee believes that written determinations and background 
file documents that ordinarily would be disclosed under section 
6110 but for the nondisclosure provided by section 6104 should 
be disclosed in redacted form, and that such disclosure will 
provide additional guidance to taxpayers as to the views of the 
IRS on certain issues.

                        EXPLANATION OF PROVISION

    The provision requires disclosure in redacted form of 
written determinations and related background file documents, 
as defined in section 6110, relating to the tax-exempt status 
of an organization described in section 501(c) or (d) that are 
not required to be disclosed by section 6104(a)(1)(A) but that 
are within the scope of section 6104 and thus are not presently 
disclosed. The provision provides that such written 
determinations and related background file documents shall be 
disclosed under the provisions of section 6110. Documents that 
are within the scope of section 6104 and that are not presently 
disclosed include: (1) unfavorable rulings or determination 
letters issued in response to applications for tax exemption; 
(2) rulings or determination letters revoking or modifying a 
favorable determination letter; (3) technical advice memoranda 
relating to a disapproved application for tax exemption or the 
revocation or modification of a favorable determination letter; 
(4) any letter or document filed with or issued by the IRS 
relating to whether a proposed or accomplished transaction is a 
prohibited transaction under section 503; (5) any letter or 
document filed with or issued by the IRS relating to an 
organization's status as a private foundation or private 
operating foundation, unless the letter or document relates to 
the organization's application for tax exemption; and (6) any 
other letter or document filed with or issued by the IRS which, 
although it relates to an organization's tax exempt status as 
an organization described in section 501(c) or (d), does not 
relate to that organization's application for tax exemption. To 
the extent section 6110 applies to such documents, they would 
be disclosed under the provision.

                             EFFECTIVE DATE

    The provision is effective for written determinations 
issued after December 31, 2002.

 B. Disclosure of Internet Web Site and Name Under Which Organization 
                             Does Business


(Sec. 202 of the bill and sec. 6033 of the Code)

                              PRESENT LAW

    Most types of tax-exempt organizations are required to file 
annually an information return.61 The Internal 
Revenue Code does not require an exempt organization to furnish 
on the applicable information return any name under which the 
organization operates or does business, if such name differs 
from the legal name of the organization, or the organization's 
Internet web site address, if any.62
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    \61\ Sec. 6033(a). See, e.g., Form 990--Return of Organization 
Exempt From Income Tax. An organization that is required to file Form 
990, but that has gross receipts of less than $100,000 during its 
taxable year, and total assets of less than $250,000 at the end of its 
taxable year, may file Form 990-EZ instead of Form 990. Private 
foundations are required to file Form 990-PF rather than Form 990.
    \62\ The IRS requires disclosure of an organization's Internet web 
site address on Forms 990 and 990-EZ.
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                           REASONS FOR CHANGE

    Some tax-exempt organizations do business and solicit 
contributions under a name that is different from the 
organization's legal name. This can cause confusion to 
individuals and others seeking information about the 
organization. Further, although much information regarding the 
operations and activities of tax-exempt organizations is 
available on the Internet web sites of such organizations, some 
members of the public might experience difficulties obtaining 
access to an organization's web site if they do not know the 
organization's web site address. The Committee believes that 
reducing confusion and increasing public access to relevant 
information regarding a tax-exempt organization would be 
achieved by requiring a tax-exempt organization to report on 
its annual return any name under which such organization 
operates or does business, and the Internet web site address 
(if any) of such organization.63
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    \63\ The staff of the Joint Committee on Taxation recommended the 
adoption of this provision. Joint Committee on Taxation, Study of 
Present-Law Taxpayer Confidentiality and Disclosure Provisions as 
Required by Section 3802 of the Internal Revenue Service Restructuring 
and Reform Act of 1998, Volume II: Study of Disclosure Provisions 
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at 
96-97.
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                        EXPLANATION OF PROVISION

    The provision requires a tax-exempt organization subject to 
reporting requirements under section 6033(a) to include on its 
annual return any name under which such organization operates 
or does business, and the Internet web site address (if any) of 
such organization.

                             EFFECTIVE DATE

    The provision applies to returns filed after December 31, 
2002.

          C. Modification to Reporting of Capital Transactions


(Sec. 203 of the bill and secs. 6033 and 6104 of the Code)

                              PRESENT LAW

    Private foundations are required to file an annual 
information return (Form 990-PF).64 Part IV of the 
Form 990-PF requires that private foundations report detailed 
information regarding the gain or loss from the sale or other 
disposition of property, including a description of the 
property sold, how it was acquired (purchase or donation), the 
date acquired, the date sold, the gross sales price, the amount 
of depreciation allowed or allowable, and the cost or other 
basis plus expenses of the sale. Such information generally is 
required for the IRS to calculate the tax on the private 
foundation's net investment income. The Form 990-PF is required 
to be made available to the public.
---------------------------------------------------------------------------
    \64\ Sec. 6033(a).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Under present law, private foundations that engage in 
capital transactions must report detailed information about 
each transaction on Form 990-PF, which is filed with the IRS 
and available to the public. For some foundations, listing 
these transactions involves hundreds of pages. The Committee 
believes that automatic disclosure of such voluminous 
information does not necessarily benefit the public, and may in 
fact reduce the level of meaningful disclosure by obscuring 
other important information. The Committee believes that 
meaningful disclosure to the public will be increased if the 
version of the Form 990-PF that is automatically available to 
the public summarizes rather than lists the capital 
transactions that affect the calculation of the organization's 
net investment income. In order to preserve the public's access 
to more specific information regarding such capital 
transactions, the Committee believes that the more detailed 
information provided to the IRS on the Form 990-PF should be 
made available to those members of the public that explicitly 
request such information.65
---------------------------------------------------------------------------
    \65\ The staff of the Joint Committee on Taxation recommended the 
adoption of this provision. Joint Committee on Taxation, Study of 
Present-Law Taxpayer Confidentiality and Disclosure Provisions as 
Required by Section 3802 of the Internal Revenue Service Restructuring 
and Reform Act of 1998, Volume II: Study of Disclosure Provisions 
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at 
99.
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                        EXPLANATION OF PROVISION

    The provision requires that any information regarding 
capital gains and losses that is required to be furnished by 
private foundations in order to calculate the tax on net 
investment income be furnished also in summary form.
    In addition, information regarding capital gains and losses 
required to be filed with the IRS but that is not in summary 
form is not required to be made available to the public by the 
IRS or by the private foundation except by the explicit request 
of a member of the public to the IRS or to the foundation. A 
member of the public may request disclosure of such information 
from the Secretary, who shall prescribe the manner of making 
such request and the manner of disclosure. A member of the 
public also may request disclosure of the private foundation, 
which must be made in person or in writing. If the request is 
made in person, the foundation shall provide a copy of the 
information immediately and, if the request is made in writing, 
the foundation shall provide the information within 30 days.
    The bill also provides that private foundations are 
required to state on the furnished summary that the more 
detailed description is available upon request.

                             EFFECTIVE DATE

    The provision applies to returns filed after December 31, 
2002.

           D. Disclosure That Form 990 Is Publicly Available


(Sec. 204 of the bill)

                              PRESENT LAW

    Under present law, there is no requirement that the IRS 
notify the public that the Form 990 is publicly available.

                           REASONS FOR CHANGE

    The information provided on Forms 990 is useful to the 
public only to the extent that the public is aware that the 
form are publicly available. The Committee believes that the 
availability of Forms 990 that have been filed by exempt 
organizations will be increased by requiring the IRS to inform 
the public regarding the availability of such forms.

                        EXPLANATION OF PROVISION

    The provision requires the IRS to notify the public in 
appropriate publications and other materials of the extent to 
which an exempt organization's Form 990, Form 990-EZ, and Form 
990-PF are publicly available.\66\
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    \66\ The staff of the Joint Committee on Taxation recommended the 
adoption of this provision. Joint Committee on Taxation, Study of 
Present-Law Taxpayer Confidentiality and Disclosure Provisions as 
Required by Section 3802 of the Internal Revenue Service Restructuring 
and Reform Act of 1998, Volume II: Study of Disclosure Provisions 
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at 
96-97.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision applies to publications or materials issued 
or revised after the date of enactment.

E. Disclosure to State Officials of Proposed Actions Related to Section 
                          501(c) Organizations


(Sec. 205 of the bill and sec. 6104 of the Code)

                              PRESENT LAW

    In the case of organizations that are described in section 
501(c)(3) and exempt from tax under section 501(a) or that have 
applied for exemption as an organization so described, present 
law (sec. 6104(c)) requires that Secretary to notify the 
appropriate State officer of (1) a refusal to recognize such 
organization as an organization described in section 501(c)(3, 
(2) a revocation of a section 501(c)(3) organization's tax-
exempt status, and (3) the mailing of a notice of deficiency 
for an tax imposed under section 507, chapter 41, or chapter 
42.\67\ In addition, at the request of such appropriate State 
officer, the Secretary is required to make available for 
inspection and copying, such returns, filed statements, 
records, reports, and other information relating to the above-
described disclosures, as are relevant to any State law 
determination. An appropriate State officer is the State 
attorney general, State tax officer, or any State official 
charged with overseeing organizations of the type described in 
section 501(c)(3).
---------------------------------------------------------------------------
    \67\ The applicable taxes include the termination tax on private 
foundations; taxes on public charities for certain excess lobbying 
expenses; taxes on a private foundation's net investment income, self-
dealing activities, undistributed income, excess business holdings, 
investments that jeopardize charitable purposes, and taxable 
expenditures (some of these taxes also apply to certain non-exempt 
trusts); taxes on the political expenditures and excess benefit 
transactions of section 501(c)(3) organizations; and certain taxes on 
black lung benefit trusts and foreign organizations.
---------------------------------------------------------------------------
    In general, return and return information (as such terms 
are defined in sec. 6103(b)) is confidential and may not be 
disclosed or inspected unless expressly provided by law.\68\ 
Present law requires the Secretary to keep records of 
disclosures and requests for inspection \69\ and requires that 
persons authorized to receive return and return information 
maintain various safeguards to protect such information against 
unauthorized disclosure.\70\ Willful unauthorized disclosure or 
inspection of return or return information is subject to a fine 
and/or imprisonment.\71\ The knowing or negligent unauthorized 
inspection or disclosure of returns or return information gives 
the taxpayer a right to bring a civil suit.\72\ Such present-
law protections against unauthorized disclosure or inspection 
of return and return information do not apply to the 
disclosures or inspections, described above, that are 
authorized by section 6104(c).
---------------------------------------------------------------------------
    \68\ Sec. 6103(a).
    \69\ Sec. 6103(p)(3).
    \70\ Sec. 6103(p)(4).
    \71\ Secs. 7213 and 7213A.
    \72\ Sec. 7431.
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                           REASONS FOR CHANGE

    The Committee believes that State officials that are 
charged with oversight of certain organizations described in 
section 501(c) have an important and legitimate interest in 
receiving certain information about such organizations' tax-
exempt status and tax filings, in some cases before the IRS has 
made a final determination with respect to an organization's 
tax-exempt status or liability for tax. By providing 
appropriate State officials with earlier access to information 
about the activities of certain section 501(c) organizations, 
State officials will be able to monitor such organizations more 
effectively and better protect the public's interest in 
assuring that organizations that have been given the benefit of 
tax-exemption operate consistently with their exempt purposes. 
In addition, the Committee believes that permitting the IRS to 
share return and return information about certain section 
501(c) organizations with appropriate State officials, when 
doing so will facilitate the resolution of Federal or State 
issues relating to the organization's tax-exempt status, will 
significantly improve oversight of such organizations.
    The Committee stresses the importance of maintaining the 
confidentiality of taxpayer return and return information and 
believes it is important to extend existing protections against 
unauthorized disclosure or inspection of return and return 
information to disclosures made or inspections allowed by the 
Secretary of return and return information regarding such 
section 501(c) organizations.

                        EXPLANATION OF PROVISION

    The bill provides that upon written request by an 
appropriate State officer, the Secretary may disclose: (1) a 
notice of proposed refusal to recognize an organization as a 
section 501(c)(3) organization; (2) a notice of proposed 
revocation of tax-exemption of a section 501(c)(3) 
organization; (3) the issuance of a proposed deficiency of tax 
imposed under section 507, chapter 41, or chapter 42; (4) the 
names and taxpayer identification numbers of organizations that 
have applied for recognition as section 501(c)(3) 
organizations; and (5) return and return information of 
organizations \73\ with respect to which information has been 
disclosed under (1) through (4) above. Disclosure or inspection 
is permitted for the purpose of, and only to the extent 
necessary in, the administration of State laws regulating 
section 501(c)(3) organizations, such as laws regulating tax-
exempt status, charitable trusts, charitable solicitation, and 
fraud. Disclosure or inspection may be made only to or by 
designated representatives of the appropriate State officer, 
which does not include independent contractors. The Secretary 
also is permitted to disclose or open to inspection the return 
and return information of an organization that is recognized as 
tax- exempt under section 501(c)(3), or that has applied for 
such recognition, to an appropriate State officer if the 
Secretary determines that disclosure or inspection may 
facilitate the resolution of Federal or State issues relating 
to the tax-exempt status of the organization. For this purpose, 
appropriate State officer means the State attorney general or 
any other State official charged with overseeing organizations 
of the type described in section 501(c)(3).
---------------------------------------------------------------------------
    \73\ Such information also may be open to inspection by an 
appropriate State officer.
---------------------------------------------------------------------------
    In addition, the bill provides that upon the written 
request by an appropriate State officer, the Secretary may make 
available for inspection or disclosure returns and return 
information of an organization described in section 501(c)(2) 
(certain title holding companies), 501(c)(4) (certain social 
welfare organizations), 501(c)(6) (certain business leagues and 
similar organizations), 501(c)(7) (certain recreational clubs), 
501(c)(8) (certain fraternal organizations), 501(c)(10) 
(certain domestic fraternal organizations operating under the 
lodge system), and 501(c)(13) (certain cemetery companies). 
Such return and return information is available for inspection 
or disclosure only for the purpose of, and to the extent 
necessary in, the administration of State laws regulating the 
tax-exempt status of such organizations. Disclosure or 
inspection may be made only to or by designated representatives 
of the appropriate State officer, which does not include 
independent contractors. For this purpose, appropriate State 
officer means the State attorney general and the head of an 
agency designated by the State attorney general as having 
primary responsibility for overseeing the tax-exempt status of 
such organizations.
    In addition, the bill provides that any return and return 
information disclosed under section 6104(c) may be disclosed in 
civil administrative and judicial proceedings pertaining to the 
enforcement of State laws regulating the applicable tax-exempt 
organization in a manner prescribed by the Secretary. Returns 
and return information are not to be disclosed under section 
6104(c), or in such an administrative or judicial proceeding, 
to the extent that the Secretary determines that such 
disclosure would seriously impair Federal tax administration. 
The provision makes disclosures of returns and return 
information under section 6104(c) subject to many of the 
provisions of section 6103, including the requirements that 
such information remain confidential (sec. 6103(a)(2)), that 
the Secretary maintain a permanent system of records of 
requests for disclosure (sec. 6103(p)(3)), and that the 
appropriate State officer maintain various safeguards that 
protect against unauthorized disclosure (sec. 6103(p)(4)). The 
bill provides that the willful unauthorized disclosure of 
return or return information described in section 6104(c) is a 
felony subject to a fine of up to $5,000 and/or imprisonment of 
up to five years (sec. 7213(a)(2)), the willful unauthorized 
inspection of return or return information described in section 
6104(c) is subject to a fine of up to $1,000 and/or 
imprisonment of up to one year (sec. 7213A), and provides the 
taxpayer the right to bring a civil action for damages in the 
case of knowing or negligent unauthorized disclosure or 
inspection of such information (sec. 7431(a)(2)).

                             EFFECTIVE DATE

    The provision is effective on the date of enactment but 
does not apply to requests made before such date.

     Title III. Other Charitable and Exempt Organization Provisions


   A. Modify Tax on Unrelated Business Taxable Income of Charitable 
                            Remainder Trusts


(Sec. 301 of the bill and sec. 664 of the Code)

                              PRESENT LAW

    Charitable remainder annuity trusts and charitable 
remainder unitrusts are exempt from Federal income tax for a 
tax year unless the trust has any unrelated business taxable 
income for the year. Unrelated business taxable income includes 
certain debt financed income. A charitable remainder trust that 
loses exemption from income tax for a taxable year is taxed as 
a regular complex trust. As such, the trust is allowed a 
deduction in computing taxable income for amounts required to 
be distributed in a taxable year, not to exceed the amount of 
the trust's distributable net income for the year. Taxes 
imposed on the trust are required to be allocated to 
corpus.74
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    \74\ Treas. Reg. sec. 1.664-1(d)(2).
---------------------------------------------------------------------------
    Distributions from a charitable remainder annuity trust or 
charitable remainder unitrust are treated in the following 
order as: (1) ordinary income to the extent of the trust's 
current and previously undistributed ordinary income for the 
trust's year in which the distribution occurred, (2) capital 
gains to the extent of the trust's current capital gain and 
previously undistributed capital gain for the trust's year in 
which the distribution occurred, (3) other income (e.g., tax-
exempt income) to the extent of the trust's current and 
previously undistributed other income for the trust's year in 
which the distribution occurred, and (4) corpus.75
---------------------------------------------------------------------------
    \75\ Sec. 664(b).
---------------------------------------------------------------------------
    In general, distributions to the extent they are 
characterized as income are includible in the income of the 
beneficiary for the year that the annuity or unitrust amount is 
required to be distributed even though the annuity or unitrust 
amount is not distributed until after the close of the trust's 
taxable year.76
---------------------------------------------------------------------------
    \76\ Treas. Reg. sec. 1.664-1(d)(4).
---------------------------------------------------------------------------
    A charitable remainder annuity trust is a trust that is 
required to pay, at least annually, a fixed dollar amount of at 
least five percent of the initial value of the trust to a 
noncharity for the life of an individual or for a period of 20 
years or less, with the remainder passing to charity. A 
charitable remainder unitrust is a trust that generally is 
required to pay, at least annually, a fixed percentage of at 
least five percent of the fair market value of the trust's 
assets determined at least annually to a noncharity for the 
life of an individual or for a period 20 years or less, with 
the remainder passing to charity.77
---------------------------------------------------------------------------
    \77\ Sec. 664(d).
---------------------------------------------------------------------------
    A trust does not qualify as a charitable remainder annuity 
trust if the annuity for a year is greater than 50 percent of 
the initial fair market value of the trust's assets. A trust 
does not qualify as a charitable remainder unitrust if the 
percentage of assets that are required to be distributed at 
least annually is greater than 50 percent. A trust does not 
qualify as a charitable remainder annuity trust or a charitable 
remainder unitrust unless the value of the remainder interest 
in the trust is at least 10 percent of the value of the assets 
contributed to the trust.

                           REASONS FOR CHANGE

    The Committee believes that in years that a charitable 
remainder trust has unrelated business income, an excise tax of 
100 percent on such income is a more appropriate remedy than 
loss of tax exemption for the year.

                        EXPLANATION OF PROVISION

    The provision imposes a 100-percent excise tax on the 
unrelated business taxable income of a charitable remainder 
trust. This replaces the present-law rule that takes away the 
income tax exemption of a charitable remainder trust for any 
year in which the trust has any unrelated business taxable 
income. Consistent with present law, the tax is treated as paid 
from corpus. The unrelated business taxable income is 
considered income of the trust for purposes of determining the 
character of the distribution made to the beneficiary.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2001.

   B. Modify Tax Treatment of Certain Payments to Controlling Exempt 
                             Organizations


(Sec. 302 of the bill and sec. 512 of the Code)

                              PRESENT LAW

    In general, interest, rents, royalties, and annuities are 
excluded from the unrelated business income of tax-exempt 
organizations. However, section 512(b)(13) generally treats 
otherwise excluded rent, royalty, annuity, and interest income 
as unrelated business income if such income is received from a 
taxable or tax-exempt subsidiary that is 50 percent controlled 
by the parent tax-exempt organization. In the case of a stock 
subsidiary, ``control'' means ownership by vote or value of 
more than 50 percent of the stock. In the case of a partnership 
or other entity, control means ownership of more than 50 
percent of the profits, capital or beneficial interests. In 
addition, present law applies the constructive ownership rules 
of section 318 for purposes of section 512(b)(13). Thus, a 
parent exempt organization is deemed to control any subsidiary 
in which it holds more than 50 percent of the voting power or 
value, directly (as in the case of a first-tier subsidiary) or 
indirectly (as in the case of a second-tier subsidiary).
    Under present law, interest, rent, annuity, or royalty 
payments made by a controlled entity to a tax-exempt 
organization are includable in the latter organization's 
unrelated business income and are subject to the unrelated 
business income tax to the extent the payment reduces the net 
unrelated income (or increases any net unrelated loss) of the 
controlled entity.
    The Taxpayer Relief Act of 1997 (the ``1997 Act'') made 
several modifications to the control requirement of section 
512(b)(13). In order to provide transitional relief, the 
changes made by the 1997 Act do not apply to any payment 
received or accrued during the first two taxable years 
beginning on or after the date of enactment of the 1997 Act 
(August 5, 1997) if such payment is received or accrued 
pursuant to a binding written contract in effect on June 8, 
1997, and at all times thereafter before such payment (but not 
pursuant to any contract provision that permits optional 
accelerated payments).

                           REASONS FOR CHANGE

    The present-law rule that requires a controlling entity to 
include as unrelated business income certain payments made by a 
controlled entity applies without regard to whether the amount 
of the payment is fair and reasonable under the circumstances 
or would otherwise constitute unrelated business income if paid 
by an organization not controlled by the exempt organization. 
The Committee believes that the controlling organization should 
not be subject to the unrelated business income tax if the 
amount of the payment from the controlled entity is determined 
in accordance with established arm's-length principles. The 
Committee intends that the controlling organization be subject 
to the present-law rule only to the extent that a payment made 
by a controlled entity exceeds the amount that would have been 
paid if the payment had been determined under established 
arm's-length principles. In order to discourage controlled 
entities from claiming deductions in excess of the arm's-length 
amount, the Committee believes that it is appropriate to 
subject the controlling organization to a penalty tax for 
making excess payments.

                        EXPLANATION OF PROVISION

    The bill provides that the general rule of section 
512(b)(13), which includes interest, rent, annuity, or royalty 
payments made by a controlled entity to a tax-exempt 
organization in the latter organization's unrelated business 
income to the extent the payment reduces the net unrelated 
income (or increases any net unrelated loss) of the controlled 
entity, applies only to the portion of payments received or 
accrued in a taxable year that exceed the amount of the 
specified payment that would have been paid or accrued if such 
payment had been determined under the principles of section 
482. Thus, if a payment of rent by a controlled subsidiary to 
its tax-exempt parent organization exceeds fair market value, 
the excess amount of such payment over fair market value (as 
determined in accordance with section 482) is included in the 
parent organization's unrelated business income, to the extent 
that such excess reduced the net unrelated income (or increased 
any net unrelated loss) of the controlled entity. In addition, 
the provision imposes a 20-percent penalty on the larger of 
such excess determined without regard to any amendment or 
supplement to a return of tax, or such excess determined with 
regard to all such amendments and supplements.
    The bill provides that if modifications to section 
512(b)(13) made by the 1997 Act did not apply to a contract 
because of the transitional relief provided by the 1997 Act, 
then such modifications also do not apply to amounts received 
or accrued under such contract before January 1, 2001.

                             EFFECTIVE DATE

    The provision applies to payments received or accrued after 
December 31, 2000.

          C. Simplification of Lobbying Expenditure Limitation


(Sec. 303 of the bill and secs. 501 and 4911 of the Code)

                              PRESENT LAW

In general

    An organization does not qualify for tax-exempt status 
under section 501(c)(3) unless ``no substantial part'' of the 
activities of the organization is ``carrying on propaganda, or 
otherwise attempting, to influence legislation,'' except as 
provided by section 501(h).\78\ Carrying on propaganda and 
attempting to influence legislation commonly are referred to as 
``lobbying'' activities. Thus, section 501(c)(3) permits a 
limited amount of lobbying activity without loss of tax-exempt 
status.
---------------------------------------------------------------------------
    \78\ Sec. 501(c)(3).
---------------------------------------------------------------------------
    For purposes of determining whether lobbying activities are 
a substantial part of an organization's overall functions, an 
organization may choose between two standards, the ``no 
substantial part'' test of section 501(c)(3) or the 
``expenditure'' test of section 501(h).
    Whether an organization meets the ``no substantial part'' 
test is based on all the facts and circumstances. There is no 
statutory or regulatory guidance, and it is not clear whether 
the determination is based on the organization's activities, 
its expenditures, or both. Alternatively, under section 501(h), 
certain organizations described in section 501(c)(3) can elect 
to be subject to the expenditure test,\79\ which consists of 
bright-line rules that specify the dollar amount of permitted 
expenses on lobbying activities.
---------------------------------------------------------------------------
    \79\ Organizations that do not make a section 501(h) election are 
subject to the ``no substantial part'' test.
---------------------------------------------------------------------------

Consequences of excess lobbying under section 501(h)

    Organizations that make a section 501(h) election 
(``electing charities'') are subject to tax if the electing 
charity makes either ``lobbying expenditures'' or ``grass roots 
expenditures'' in excess of a certain amount established for 
each type of expenditure for each taxable year. Lobbying 
expenditures are the sum of grass-roots expenditures and 
``direct lobbying'' expenditures.\80\
---------------------------------------------------------------------------
    \80\ Secs. 501(h)(2)(A), 4911(c)(1), 4911(d).
---------------------------------------------------------------------------
    The expenditure limits are based on a ``lobbying nontaxable 
amount'' for the taxable year and a ``grass roots nontaxable 
amount'' for the taxable year. The lobbying nontaxable amount 
is the lesser of $1 million or an amount determined as a 
percentage of an organization's exempt purpose 
expenditures.\81\ The grass-roots nontaxable amount is 25 
percent of the organization's lobbying nontaxable amount. An 
electing charity that exceeds either of the spending 
limitations is subject to a 25 percent tax on the excess. An 
electing charity that exceeds both of the spending limitations 
is subject to a 25 percent tax on the greater of the excess of 
the lobbying expenditures or the grass-roots expenditures.
---------------------------------------------------------------------------
    \81\ Exempt purpose expenditures generaally are expenses incurred 
for exempt purposes, such as amounts paid to accomplish exempt 
purposes, administrative expenses such as overhead, lobbying expenses, 
and certain fundraising expenses. Exempt purpose expenditures do not 
include, for example, expenses not for exempt purposes, payments of 
unrelated business income tax, or capital expenses in connection with 
an unrelated business. See Treas. Reg. sec. 56.4911-4.
---------------------------------------------------------------------------
    An electing charity that normally exceeds either of two 
``ceiling amounts,'' which are based on the expenditure limits, 
will lose its tax exemption.\82\ The ``lobbying ceiling 
amount'' is 150 percent of the electing charity's lobbying 
nontaxable amount for the taxable year and the ``grass roots 
ceiling amount'' is 150 percent of the grass-roots nontaxable 
amount for the taxable year. For this purpose, ``normal'' 
expenditures are calculated based on a four-year averaging 
mechanism.\83\
---------------------------------------------------------------------------
    \82\ Sec. 501(h)(1).
    \83\ Treas. Reg. sec. 1.501(h)-3.
---------------------------------------------------------------------------

Definitions

    Grass-roots expenditures are defined as ``any attempt to 
influence any legislation through an attempt to affect the 
opinions of the general public or any segment thereof.'' \84\ 
For a communication to constitute grass-roots lobbying, it must 
refer to ``specific legislation,'' reflect a view on such 
legislation, and encourage the recipient of the communication 
to take action with respect to such legislation (a ``call to 
action'').\85\ A communication includes a call to action if it 
incorporates one of four elements: (1) it urges the recipient 
to contact a legislator, employee of a government body, or any 
other government official or employee who may participate in 
the formulation of legislation with the principal purpose of 
influencing legislation; (2) it states the address, telephone 
number, or similar information of a legislator or an employee 
of a legislative body; (3) it provides a petition, tear-off 
postcard, or similar device for the recipient to communicate 
with government officials or employees who participate in the 
formulation of legislation with the principal purpose of 
influencing legislation; or (4) it states the position of one 
or more legislators on the legislation, except that a 
communication may name the main sponsors of legislation for 
purposes of identifying the legislation without constituting a 
call to action.\86\ In addition, a communication is presumed to 
be grass-roots lobbying if the communication is a paid 
advertisement that: (1) appears in the mass media within two 
weeks before a vote by a legislative body or committee (but not 
a subcommittee) on a highly publicized piece of legislation; 
(2) reflects a view on the general subject of the legislation; 
and (3) either refers to the legislation or encourages the 
public to communicate with legislators on the general subject 
of such legislation.\87\ The presumption is rebuttable if the 
electing charity demonstrates that the timing of the 
communication was not related to the legislation or that the 
advertisement was of a type regularly made by the electing 
charity without regard to the timing of the legislation (a 
customary course of business exception).\88\
---------------------------------------------------------------------------
    \84\ Secs. 501(h)(2)(C) & 4911(d)(1)(A).
    \85\ Treas. Reg. sec. 56.4911-2(b)(2)(i).
    \86\ Treas. Reg. sec. 56.4911-2(b)(2)(iii). The regulations provide 
that the first three elements constitute ``direct'' encouragement, 
whereas the fourth element is ``indirect'' encouragement. This 
distinction becomes relevant in determining whether a communication 
meets one of the prescribed exceptions to lobbying, i.e., an indirect 
call to action in a grass-roots communication may qualify as 
``nonpartisan analysis, study or research'' (Treas. Reg. sec. 56.4911-
2(b)(2)(iv)), and in determining the proper allocation of expenses 
between grass-roots and direct lobbying. Treas. Reg. sec. 56.4911-5(e).
    \87\ Treas. Reg. sec. 56.4911-2(b)(5)(ii).
    \88\ Id.
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    Direct lobbying expenditures are ``any attempt to influence 
any legislation through communication with any member or 
employee of a legislative body, or with any government official 
or employee who may participate in the formulation of the 
legislation'' if the principal purpose of the communication is 
to influence legislation.\89\ A communication would constitute 
direct lobbying only if the communication ``refers to specific 
legislation'' and reflects a view on such legislation.
---------------------------------------------------------------------------
    \89\ Secs. 501(h)(2)(A) and 4911(d)(1)(B) and Treas. Reg. sec. 
56.4911-2(b)(1).
---------------------------------------------------------------------------
    Certain specified activities do not constitute attempts to 
influence legislation and therefore expenditures for such 
activities are not subject to the expenditure limits for 
lobbying expenditures or grass-roots expenditures. In general, 
such activities include: (1) making available the results of 
nonpartisan analysis, study, or research; (2) providing 
technical advice or assistance to a governmental body or to a 
committee in response to a written request; (3) appearances 
before, or communications to, any legislative body with respect 
to a possible decision of such body that might affect the 
existence of the organization, its powers and duties, tax-
exempt status, or the deduction of contributions to the 
organization (so-called ``self-defense'' expenditures); (4) 
certain communications to members of the electing charity; and 
(5) communications with governmental officials or employees 
that are not intended to influence legislation.\90\
---------------------------------------------------------------------------
    \90\ Sec. 4911(d)(2).
---------------------------------------------------------------------------

Special rules for mixed lobbying expenditures

    Expenses that serve both direct and grass-roots lobbying 
purposes, e.g., communications that are sent to members and 
nonmembers, or ``mixed lobbying'' expenditures, are subject to 
special rules. The regulations specify how an electing charity 
is to allocate mixed lobbying expenditures between direct and 
grass-roots lobbying purposes.\91\ For example, for a mixed 
lobbying communication that is designed primarily for members 
(i.e., more than half the recipients are members) and that 
directly encourages grass-roots lobbying (even if it also 
encourages direct lobbying), the grass-roots expenditure amount 
includes all the costs of preparing the material used for 
purposes of grass-roots lobbying plus the mechanical and 
distributional costs associated with the communication. If a 
mixed lobbying communication encourages direct lobbying, but 
only indirectly encourages grass-roots lobbying, then the 
entire costs of the communication are allocated based on the 
proportion of members and nonmembers receiving the 
communication.
---------------------------------------------------------------------------
    \91\ Treas. Reg. sec. 56.4911-59(e).
---------------------------------------------------------------------------

Disclosure of lobbying expenditures

    An electing charity must disclose lobbying expenditures 
annually on Schedule A of Form 990. In order to meet disclosure 
requirements, electing charities are required to keep detailed 
records of direct and grass-roots lobbying expenditures. 
Required records of grass-roots expenditures include: (1) all 
amounts directly paid or incurred for grass-roots lobbying; (2) 
payments to other organizations earmarked for grass-roots 
lobbying; (3) fees and expenses paid for grass-roots lobbying; 
(4) the printing, mailing, and other costs of reproducing and 
distributing materials used in grass-roots lobbying; (5) the 
portion of amounts paid or incurred as current or deferred 
compensation for an employee's grass-roots lobbying services; 
(6) any amount paid for out-of-pocket expenditures incurred on 
behalf of the electing charity for grass-roots lobbying; (7) 
the allocable portion of administrative, overhead and other 
general expenditures attributable to grass-roots lobbying; and 
(8) expenditures for grass-roots lobbying of a controlled 
organization.\92\
---------------------------------------------------------------------------
    \92\ See Treas. Reg. sec. 56.4911-6.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the separate limitation on 
grass-roots lobbying expenditures is an unnecessary 
complication for electing charities. The Committee believes 
that the overall limit on lobbying expenditures is a sufficient 
ceiling on the lobbying activities of electing charities, 
irrespective of the proportion of lobbying activities that are 
grass-roots lobbying or direct lobbying.

                        EXPLANATION OF PROVISION

    The provision eliminates the separate limitation for grass-
roots lobbying expenditures applicable to electing charities. 
Electing charities remain subject to the overall limitation on 
lobbying expenditures, which does not change in amount, but 
electing charities are not required to limit grass roots 
expenditures as a percentage of overall lobbying. Thus, an 
electing charity is able to make tax-free any combination of 
grass-roots and direct lobbying expenditures up to the lobbying 
non-taxable amount and does not risk loss of tax-exemption as a 
result of such expenditures until total lobbying expenditures 
normally exceed the lobbying ceiling amount. For purposes of 
the section 501(h) election, electing charities are not 
required to distinguish between grass-roots lobbying and direct 
lobbying, whether for mixed lobbying expenditures or otherwise.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2001.

   D. Expedited Review Process for Certain Tax-Exemption Applications


(Sec. 304 of the bill)

                              PRESENT LAW

    Most organizations that seek tax-exempt status as a 
charitable organization are required to file an Application for 
Recognition of Exemption (Form 1023) with the IRS.\93\ 
Organizations that are not required to file Form 1023 include 
churches, their integrated auxiliaries, and conventions or 
associations of churches, and any organization (other than a 
private foundation) that normally has gross receipts of $5,000 
or less in a taxable year. Organizations that file Form 1023 
within 15 months of the end of the month of the organization's 
formation will, if the application is approved, be recognized 
as tax-exempt from the date of formation. The IRS will 
automatically grant an organization's request for an additional 
12-month extension of the 15-month period. Otherwise, exemption 
normally will be recognized as of the date the application was 
received by the IRS. In appropriate circumstances, upon written 
request, the IRS will expedite consideration of applications 
for tax-exemption. For example, organizations formed to provide 
relief to victims of disasters or other emergencies often 
receive expedited consideration.
---------------------------------------------------------------------------
    \93\ Sec. 508(a).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Many social service organizations that want to apply for 
government funding through grants or contracts are required as 
a condition of application to have been recognized as an exempt 
charitable organization. The Committee wishes to facilitate the 
formation of charitable organizations that intend to work with 
Federal, State and local governments to provide vital social 
services to many of the neediest members of society by 
implementing an expedited review procedure for exempt status 
applications, and by waiving IRS user fees pertaining to such 
applications filed by smaller social service organizations.

                        EXPLANATION OF PROVISION

    The bill provides that the Secretary or its delegate shall 
adopt procedures to expedite consideration of applications for 
exempt status by organizations that are organized and operated 
for the primary purpose of providing social services. To be 
eligible, the organization must: (1) be seeking a contract or 
grant under a Federal, State, or local program that provides 
funding for social service programs; (2) establish that tax-
exempt status is a condition of applying for such contract or 
grant; (3) include a completed copy of the contract or grant 
application with the application for exemption; and (4) meet 
such other criteria as the Secretary may provide. Organizations 
that meet the eligibility requirements described above (except 
for the requirement that tax-exempt status is a condition of 
the contract or grant application), and that certify that the 
organization's average annual gross receipts over the four year 
period preceding the application was not more than $50,000 (or, 
in the case of an organization in existence less than four 
years, is not expected to be more than $50,000 during the 
organization's first four years) are entitled to a waiver of 
any fee for application of tax-exempt status.
    For this purpose, social services is defined as services 
directed at helping people in need, reducing poverty, improving 
outcomes of low-income children, revitalizing low-income 
communities, and empowering low-income families and low-income 
individuals to become self-sufficient, including: (1) child 
care services, protective services for children and adults, 
services for children and adults in foster care, adoption 
services, services related to the management and maintenance of 
the home, day care services for adults, and services to meet 
the special needs of children, older individuals, and 
individuals with disabilities (including physical, mental, or 
emotional disabilities); (2) transportation services; (3) job 
training and related services, and employment services; (4) 
information, referral, and counseling services; (5) the 
preparation and delivery of meals, and services related to soup 
kitchens or food banks; (6) health support services; (7) 
literacy and mentoring programs; (8) services for the 
prevention and treatment of juvenile delinquency and substance 
abuse, services for the prevention of crime and the provision 
of assistance to the victims and the families of criminal 
offenders, and services related to the intervention in, and 
prevention of, domestic violence; and (9) services related to 
the provision of assistance for housing under Federal law. 
Social services does not include a program having the purpose 
of delivering educational assistance under the Elementary and 
Secondary Education Act of 1965 or under the Higher Education 
Act of 1965.

                             EFFECTIVE DATE

    The provision applies to applications for tax-exempt status 
filed after December 31, 2002.

          E. Clarification of Definition of Church Tax Inquiry


(Sec. 305 of the bill and sec. 7611 of the Code)

                              PRESENT LAW

    Under present law, the IRS may begin a church tax inquiry 
only if an appropriate high-level Treasury official reasonably 
believes, on the basis of the facts and circumstances recorded 
in writing, that an organization (1) may not qualify for tax 
exemption as a church, (2) may be carrying on an unrelated 
trade or business, or (3) otherwise may be engaged in taxable 
activities.\94\ A church tax inquiry is defined as any inquiry 
to a church (other than an examination) that serves as a basis 
for determining whether the organization qualified for tax 
exemption as a church or whether it is carrying on an unrelated 
trade or business or otherwise is engaged in taxable 
activities. An inquiry is considered to commence when the IRS 
requests information or materials from a church of a type 
contained in church records, other than routine requests for 
information or inquiries regarding matters that do not 
primarily concern the tax status or liability of the church 
itself.
---------------------------------------------------------------------------
    \94\ Sec. 7611. Prior to the year 2000 IRS restructuring, the 
lowest level official who could initiate a church tax inquiry was an 
IRS Regional Commissioner.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the present-law church tax 
inquiry procedures provide important safeguards against the IRS 
engaging in unnecessary and intrusive examinations of churches. 
However, the church tax inquiry procedures also have the effect 
of hampering IRS efforts to educate churches with respect to 
actions that are not permissible under section 501(c)(3). The 
Committee believes that a clarification of the scope of the 
church tax inquiry procedures to make it clear that the IRS may 
undertake educational outreach efforts with respect to specific 
churches (e.g., initiating meetings with representatives of a 
particular church to discuss the rules that apply to such 
church) will improve compliance with the law by churches.

                        EXPLANATION OF PROVISION

    The provision clarifies that the church tax inquiry 
procedures do not apply to contacts made by the IRS for the 
purpose of educating churches with respect to the federal 
income tax law governing tax-exempt organizations. For example, 
the IRS does not violate the church tax inquiry procedures when 
written materials are provided to a church or churches for the 
purpose of educating such church or churches with respect to 
the types of activities that are not permissible under section 
501(c)(3).

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

 F. Extension of Declaratory Judgment Procedures to Non-501(c)(3) Tax-
                          Exempt Organizations


(Sec. 306 of the bill and sec. 7428 of the Code)

                              PRESENT LAW

    In order for an organization to be granted tax exemption as 
a charitable entity described in section 501(c)(3), it 
generally must file an application for recognition of exemption 
with the IRS and receive a favorable determination of its 
status. Similarly, for most organizations, a charitable 
organization's eligibility to receive tax-deductible 
contributions is dependent upon its receipt of a favorable 
determination from the IRS. In general, a section 501(c)(3) 
organization can rely on a determination letter or ruling from 
the IRS regarding its tax-exempt status, unless there is a 
material change in its character, purposes, or methods of 
operation. In cases in which an organization violates one or 
more of the requirements for tax exemption under section 
501(c)(3), the IRS is authorized to revoke an organization's 
tax exemption, notwithstanding an earlier favorable 
determination.
    In situations in which the IRS denies an organization's 
application for recognition of exemption under section 
501(c)(3) or fails to act on such application, or in which the 
IRS informs a section 501(c)(3) organization that it is 
considering revoking or adversely modifying its tax-exempt 
status, present law authorizes the organization to seek a 
declaratory judgment regarding its tax status (sec. 7428). 
Section 7428 provides a remedy in the case of a dispute 
involving a determination by the IRS with respect to: (1) the 
initial qualification or continuing qualification of an 
organization as a charitable organization for tax exemption 
purposes or for charitable contribution deduction purposes; (2) 
the initial classification or continuing classification of an 
organization as a private foundation; (3) the initial 
classification or continuing classification of an organization 
as a private operating foundation; or (4) the failure of the 
IRS to make a determination with respect to (1), (2), or (3). A 
``determination'' in this context generally means a final 
decision by the IRS affecting the tax qualification of a 
charitable organization, although it also can include a 
proposed revocation of an organization's tax-exempt status or 
public charity classification. Section 7428 vests jurisdiction 
over controversies involving such a determination in the U.S. 
District Court for the District of Columbia, the U.S. Court of 
Federal Claims, and the U.S. Tax Court.
    Prior to utilizing the declaratory judgment procedure, an 
organization must have exhausted all administrative remedies 
available to it within the IRS. An organization is deemed to 
have exhausted its administrative remedies at the expiration of 
270 days after the date on which the request for a 
determination was made if the organization has taken, in a 
timely manner, all reasonable steps to secure such 
determination.
    If an organization (other than a section 501(c)(3) 
organization) files an application for recognition of exemption 
and receives a favorable determination from the IRS, the 
determination of tax-exempt status is usually effective as of 
the date of formation of the organization if its purposes and 
activities during the period prior to the date of the 
determination letter were consistent with the requirements for 
exemption. However, if the organization files an application 
for recognition of exemption and later receives an adverse 
determination from the IRS, the IRS may assert that the 
organization is subject to tax on some or all of its income for 
open taxable years. In addition, as with charitable 
organizations, the IRS may revoke or modify an earlier 
favorable determination regarding an organization's tax-exempt 
status.
    Under present law, a non-charity (i.e., an organization not 
described in section 501(c)(3)) may not seek a declaratory 
judgment with respect to an IRS determination regarding its 
tax-exempt status. The only remedies available to such an 
organization are to petition the U.S. Tax Court for relief 
following the issuance of a notice of deficiency or to pay any 
tax owed and sue for refund in federal district court or the 
U.S. Court of Federal Claims.

                           REASONS FOR CHANGE

    The Committee believes that it is important to provide 
certainty for organizations that have sought a determination of 
their tax-exempt status. Thus, the Committee finds it 
appropriate to extend the present-law declaratory judgment 
procedures to all organizations that apply for tax-exempt 
status as organizations described in section 501(c).

                        EXPLANATION OF PROVISION

    The provision extends declaratory judgment procedures 
similar to those currently available only to charities under 
section 7428 to other section 501(c) determinations. The 
provision limits jurisdiction over controversies involving such 
determinations to the United States Tax Court.\95\
---------------------------------------------------------------------------
    \95\ This limitation currently applies to declaratory judgments 
relating to tax qualification for certain employee retirement plans 
(sec. 7476).
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The extension of the declaratory judgment procedures to 
organizations other than section 501(c)(3) organizations is 
effective for pleadings filed with respect to determinations 
made after December 31, 2001.

         G. Definition of Convention or Association of Churches


(Sec. 307 of the bill and sec. 7701 of the Code)

                              PRESENT LAW

    Under present law, an organization that qualifies as a 
``convention or association of churches'' (within the meaning 
of sec. 170(b)(1)(A)(i)) is not required to file an annual 
return,\96\ is subject to the church tax inquiry and church tax 
examination provisions applicable to organizations claiming to 
be a church,\97\ and is subject to certain other provisions 
generally applicable to churches.\98\ The Internal Revenue Code 
does not define the term ``convention or association of 
churches.''
---------------------------------------------------------------------------
    \96\ Sec. 6033(a)(2)(A)(i).
    \97\ Sec. 7611(h)(1)(B).
    \98\ See, e.g., Sec. 402(g)(8)(B) (limitation on elective 
deferrals); sec. 403(b)(9)(B) (definition of retirement income 
account); sec. 410(d) (election to have participation, vesting, 
funding, and certain other provisions apply to church plans); sec. 
414(e) (definition of church plan); sec. 415(c)(7) (certain 
contributions by church plans); sec. 501(h)(5) (disqualification of 
certain organizations from making the sec. 501(h) election regarding 
lobbying expenditure limits); sec. 501(m)(3) (definition of commercial-
type insurance); sec. 508(c)(1)(A) (exception from requirement to file 
application seeking recognition of exempt status); sec. 512(b)(12) 
(allowance of up to $1,000 deduction for purposes of determining 
unrelated business taxable income); sec. 514(b)(3)(E) (definition of 
debt-financed property); sec. 3121(w)(3)(A) (election regarding 
exemption from social security taxes); sec. 3309(b)(1) (application of 
federal unemployment tax provisions to services performed in the employ 
of certain organizations); sec. 6043(b)(1) (requirement to file a 
return upon liquidation or dissolution of the organization); and sec. 
7702(j)(3)(A) (treatment of certain death benefit plans as life 
insurance).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The term ``convention or association of churches'' was 
added to the Code to ensure that hierarchical churches and 
congregational churches would not be treated dissimilarly for 
Federal income tax purposes merely because of their 
organizational and governance structures. The Committee 
understands that some congregational church organizations have 
only churches as members, and that others have both churches 
and individuals as members. The Committee is concerned that an 
organization with the characteristics of a convention or 
association of churches, including having a substantial number 
of churches as members, might fail to be regarded as a 
convention or association of churches merely because it 
includes individuals in its membership. The Committee intends 
that a congregational church organization that otherwise 
constitutes a convention or association of churches not be 
denied recognition as such merely because its membership 
includes individuals as well as churches.

                        EXPLANATION OF PROVISION

    The bill provides that an organization that otherwise is a 
convention or association of churches does not fail to so 
qualify merely because the membership of the organization 
includes individuals as well as churches, or because 
individuals have voting rights in the organization.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

H. Charitable Contribution Deduction for Certain Expenses in Support of 
                   Native Alaskan Subsistence Whaling


(Sec. 308 of the bill and sec. 170 of the Code)

                              PRESENT LAW

    In computing taxable income, individuals who do not elect 
the standard deduction may claim itemized deductions, including 
a deduction (subject to certain limitations) for charitable 
contributions or gifts made during the taxable year to a 
qualified charitable organization or governmental entity (sec. 
170). Individuals who elect the standard deduction may not 
claim a deduction for charitable contributions made during the 
taxable year.
    No charitable contribution deduction is allowed for a 
contribution of services. However, unreimbursed expenditures 
made incident to the rendition of services to an organization, 
contributions to which are deductible, may constitute a 
deductible contribution (Treas. Reg. sec. 1.170A-1(g)). 
Specifically, section 170(j) provides that no charitable 
contribution deduction is allowed for traveling expenses 
(including amounts expended for meals and lodging) while away 
from home, whether paid directly or by reimbursement, unless 
there is no significant element of personal pleasure, 
recreation, or vacation in such travel.

                           REASONS FOR CHANGE

    The Committee believes that subsistence bowhead whale 
hunting activities are important to certain native peoples of 
Alaska and further charitable purposes. The Committee believes 
that certain expenses paid by individuals recognized as whaling 
captains by the Alaska Eskimo Whaling Commission in the conduct 
of sanctioned whaling activities conducted pursuant to the 
management plan of that Commission should be deductible as 
charitable contributions even though they are paid other than 
directly to a charitable organization.

                        EXPLANATION OF PROVISION

    The provision allows certain individuals to claim a 
deduction under section 170 not exceeding $7,500 per taxable 
year for certain expenses incurred in carrying out sanctioned 
whaling activities. The deduction is available only to an 
individual who is recognized by the Alaska Eskimo Whaling 
Commission as a whaling captain charged with the responsibility 
of maintaining and carrying out sanctioned whaling activities. 
The deduction is available for reasonable and necessary 
expenses paid by the taxpayer during the taxable year for: (1) 
the acquisition and maintenance of whaling boats, weapons, and 
gear used in sanctioned whaling activities, (2) the supplying 
of food for the crew and other provisions for carrying out such 
activities, and (3) storage and distribution of the catch from 
such activities. The Committee intends that the Secretary shall 
require that the taxpayer substantiate deductible expenses by 
maintaining appropriate written records that show, for example, 
the time, place, date, amount, and nature of the expense, as 
well as the taxpayer's eligibility for the deduction. In 
addition, the Committee believes that it is appropriate for the 
taxpayer to provide such substantiation as part of the 
taxpayer's income tax return, to the extent provided by the 
Secretary.
    For purposes of the provision, the term ``sanctioned 
whaling activities'' means subsistence bowhead whale hunting 
activities conducted pursuant to the management plan of the 
Alaska Eskimo Whaling Commission.

                             EFFECTIVE DATE

    The provision applies to expenses paid after December 31, 
2002, in taxable years ending after such date.

 I. Payments by Charitable Organizations to Victims of War on Terrorism


(Sec. 309 of the bill)

                              PRESENT LAW

    In general, organizations described in section 501(c)(3) of 
the Code are exempt from taxation. Contributions to such 
organizations generally are tax deductible.\99\ Section 
501(c)(3) organizations must be organized and operated 
exclusively for exempt purposes and no part of the net earnings 
of such organizations may inure to the benefit of any private 
shareholder or individual. An organization is not organized or 
operated exclusively for one or more exempt purposes unless the 
organization serves a public rather than a private interest. 
Thus, an organization described in section 501(c)(3) generally 
must serve a charitable class of persons that is indefinite or 
of sufficient size.
---------------------------------------------------------------------------
    \99\ Sec. 170.
---------------------------------------------------------------------------
    Tax-exempt private foundations are a type of organization 
described in section 501(c)(3) and are subject to special 
rules. Private foundations are subject to excise taxes on acts 
of self-dealing between the private foundation and a 
disqualified person with respect to the foundation.\100\ For 
example, it is self-dealing if assets of a private foundation 
are used for the benefit of a disqualified person, such as a 
substantial contributor to the foundation or a person in 
control of the foundation, and the benefit is not incidental or 
tenuous.
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    \100\ Sec. 4941.
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                           REASONS FOR CHANGE

    The Committee believes that payments by charities to 
members of the Armed Forces of the United States (and their 
immediate families) made by reason of death, injury, wounding 
or illness and incurred as a result of our nation's military 
response to the terrorist attacks of September 11, 2001, should 
be treated as consistent with the charity's exempt purpose, to 
the extent the payments are made in good faith and pursuant to 
a reasonable and objective formula that is consistently 
applied.

                        EXPLANATION OF PROVISION

    The bill provides that organizations described in section 
501(c)(3) that make certain payments are not required to make a 
specific assessment of need for the payments to be related to 
the purpose or function constituting the basis for the 
organization's exemption, provided that the organization makes 
the payments in good faith and uses an objective formula that 
is consistently applied in making the payments.
    The provision applies to payments to a member of the Armed 
Forces of the United States (as defined in section 
7701(a)(15)), or to a member of such person's immediate family 
(including spouses, parents, children, and foster children), by 
reason of the death, injury, wounding, or illness of a member 
of the Armed Forces of the United States that was incurred as a 
result of the military response of the United States to the 
terrorist attacks against the United States on September 11, 
2001. As under present law, such payments must be for public 
and not private benefit and therefore must serve a charitable 
class. For example, a charitable organization that assists the 
families of members of the Armed Forces killed in the line of 
duty may make pro-rata distributions to the families of those 
killed, even though the specific financial needs of each family 
are not directly considered. Similarly, if the amount of a 
distribution is based on the number of dependents of a 
charitable class of persons killed in the military response to 
the attacks and this standard is applied consistently among 
distributions, the specific needs of each recipient do not have 
to be taken into account. However, it is not appropriate for a 
charity to make pro-rata payments based on the recipients' 
living expenses before the harm occurred if the result 
generally provides significantly greater assistance to persons 
in a better position to provide for themselves than to persons 
with fewer financial resources. Although such a distribution 
might be based on objective criteria, it is not a reasonable 
formula for distributing assistance in an equitable manner. 
Similarly, although specific assessments of need are not 
required, payments that do not further public purposes are not 
permitted. The provision does not change the substantive 
standards for exemption under section 501(c)(3), including the 
prohibition on private inurement. The provision also provides 
that if a private foundation makes payments under the 
conditions described above, the payment is not treated as made 
to a disqualified person for purposes of section 4941.

                             EFFECTIVE DATE

    The provision applies to payments made after the date of 
enactment and before September 11, 2003.

   J. Modify Rules Governing Tax-Exempt Bonds for Section 501(c)(3) 
      Organizations as Applied to Organizations Engaged in Timber 
                        Conservation Activities


(Sec. 310 of the bill and sec. 145 of the Code)

                              PRESENT LAW

    Interest on State or local government bonds is tax-exempt 
when the proceeds of the bonds are used to finance activities 
carried out by or paid for by those governmental units. 
Interest on bonds issued by State or local governments acting 
as conduit borrowers for private businesses is taxable unless a 
specific exception is included in the Code. One such exception 
allows tax-exempt bonds to be issued to finance activities of 
non-profit organizations described in Code section 501(c)(3) 
(``qualified 501(c)(3) bonds'').
    Qualified 501(c)(3) bonds may be issued only to finance the 
activities that qualify the organization for tax-exemption, as 
opposed to unrelated business activities of these 
organizations. If the bonds are issued to finance property that 
is intended to be sold to a private business while the bonds 
are outstanding, bond interest may not qualify for tax-
exemption. Similarly, if the property is in fact sold, bond 
interest may become retroactively taxable unless remedial 
actions specified in Treasury Department regulations are taken. 
An example of such a situation would be qualified 501(c)(3) 
bonds issued to finance the purchase of land and standing 
timber when the timber was to be sold.
    As is true of governmental activities receiving tax-exempt 
financing, section 501(c)(3) organizations are restricted in 
the arrangements they may have with private businesses relating 
to control and use of bond-financed property.

                           REASONS FOR CHANGE

    The Committee notes that thousands of acres of productive 
forest are being lost to urban uses. The Committee believes it 
is appropriate to offer greater protection of areas of 
particular environmental sensitivity and open space, while at 
the same time maintaining viable forest operations and jobs 
near growing urban areas. This provision will give qualified 
501(c)(3) organizations the flexibility to acquire and preserve 
larger tracts of forest land by lowering the financing costs. 
Thus, the provision should reduce the need to acquire these 
lands on a smaller, more piecemeal basis. Further, by allowing 
trees to be harvested to cover the bond payments, the provision 
will provide jobs, while subjecting the land to a conservation 
easement will preserve areas of particular environmental 
sensitivity and open space.

                        EXPLANATION OF PROVISION

    The provision modifies the rules governing issuance of 
qualified 501(c)(3) bonds to permit the issuance of long-term 
bonds for the acquisition of land and timber associated with 
such land subject to a conservation restriction. Under the 
provision, the bonds will not fail to be qualified 501(c)(3) 
bonds if the timber is sold or leased to, or otherwise used by, 
an unrelated person to the extent that such sale, leasing, or 
other use does not constitute an unrelated trade or business, 
and so long as the other requirements of the provision are met. 
In addition, these bonds will not be qualified 501(c)(3) bonds 
unless the seller of the land and timber property that is to be 
acquired with the bond proceeds irrevocably elects not to 
exclude from income any portion of the gain on the sale of such 
property made for qualifying conservation purposes under 
section 121A of the Code as added by section 107 of the bill.
    Under the provision, section 501(c)(3) organizations may 
enter into certain otherwise prohibited timber management 
arrangements with private businesses without losing tax-
exemption on bonds used to finance the property and timber 
provided that those arrangements do not constitute an unrelated 
trade or business with respect to the organization. Similarly, 
the bonds may be issued on a tax-exempt basis notwithstanding 
plans by the section 501(c)(3) organization to harvest and sell 
standing timber on land being acquired.
    The provision imposes a national limitation of $2 billion 
on the aggregate amount of bonds that may be issued pursuant to 
this provision. This volume limitation, for the period October 
1, 2002, to December 31, 2005, will be allocated by the 
Department of Treasury to qualified section 501(c)(3) 
organizations based on criteria established by the Department 
of Treasury (after consultation with appropriate Federal, 
State, and local officials). The Committee anticipates that the 
criteria will be based on, among other factors, the 
environmental merit and economic viability of a particular 
project, rather than an attempt to achieve geographical balance 
in making the allocations. The Committee further expects that 
no later than 90 days after the date of enactment, the 
Department of Treasury will issue guidance that specifies (1) 
how section 501(c)(3) organizations are to apply for an 
allocation and (2) the procedure through which such allocations 
are to be made to the appropriate organizations.

                             EFFECTIVE DATE

    The provision is effective for bonds issued after September 
30, 2002 and before January 1, 2006.

   K. Provide Tax Exemption for Organizations Created by a State To 
Provide Property and Casualty Insurance Coverage for Property for Which 
                 Such Coverage Is Otherwise Unavailable


(Sec. 311 of the bill and sec. 501(c)(28) of the Code)

                              PRESENT LAW

In general

    A life insurance company is subject to tax on its life 
insurance company taxable income, which is its life insurance 
income reduced by life insurance deductions (sec. 801). 
Similarly, a property and casualty insurance company is subject 
to tax on its taxable income, which is determined as the sum of 
its underwriting income and investment income (as well as gains 
and other income items) (sec. 831). Present law provides that 
the term ``corporation'' includes an insurance company (sec. 
7701(a)(3)).
    In general, the Internal Revenue Service (``IRS'') takes 
the position that organizations that provide insurance for 
their members or other individuals are not considered to be 
engaged in a tax-exempt activity. The IRS maintains that such 
insurance activity is either (1) a regular business of a kind 
ordinarily carried on for profit, or (2) an economy or 
convenience in the conduct of members' businesses because it 
relieves the members from obtaining insurance on an individual 
basis.
    Certain insurance risk pools have qualified for tax 
exemption under Code section 501(c)(6). In general, these 
organizations (1) assign any insurance policies and 
administrative functions to their member organizations 
(although they may reimburse their members for amounts paid and 
expenses); (2) serve an important common business interest of 
their members; and (3) must be membership organizations 
financed, at least in part, by membership dues.
    State insurance risk pools may also qualify for tax-exempt 
status under section 501(c)(4) as a social welfare organization 
or under section 115 as serving an essential governmental 
function of a State. In seeking qualification under section 
501(c)(4), insurance organizations generally are constrained by 
the restrictions on the provision of ``commercial-type 
insurance'' contained in section 501(m). Section 115 generally 
provides that gross income does not include income derived from 
the exercise of any essential governmental function and 
accruing to a State or any political subdivision thereof.
    Certain specific provisions provide tax-exempt status to 
organizations meeting statutory requirements.

Health coverage for high-risk individuals

    Section 501(c)(26) provides tax-exempt status to any 
membership organization that is established by a State 
exclusively to provide coverage for medical care on a nonprofit 
basis to certain high-risk individuals, provided certain 
criteria are satisfied. The organization may provide coverage 
for medical care either by issuing insurance itself or by 
entering into an arrangement with a health maintenance 
organization (``HMO'').
    High-risk individuals eligible to receive medical care 
coverage from the organization must be residents of the State 
who, due to a pre-existing medical condition, are unable to 
obtain health coverage for such condition through insurance or 
an HMO, or are able to acquire such coverage only at a rate 
that is substantially higher than the rate charged for such 
coverage by the organization. The State must determine the 
composition of membership in the organization. For example, a 
State could mandate that all organizations that are subject to 
insurance regulation by the State must be members of the 
organization.
    The provision further requires the State or members of the 
organization to fund the liabilities of the organization to the 
extent that premiums charged to eligible individuals are 
insufficient to cover such liabilities. Finally, no part of the 
net earnings of the organization can inure to the benefit of 
any private shareholder or individual.

Workers' compensation reinsurance organizations

    Section 501(c)(27)(A) provides tax-exempt status to any 
membership organization that is established by a State before 
June 1, 1996, exclusively to reimburse its members for workers' 
compensation insurance losses, and that satisfies certain other 
conditions. A State must require that the membership of the 
organization consist of all persons who issue insurance 
covering workers' compensation losses in such State, and all 
persons and governmental entities who self-insure against such 
losses. In addition, the organization must operate as a 
nonprofit organization by returning surplus income to members 
or to workers' compensation policyholders on a periodic basis 
and by reducing initial premiums in anticipation of investment 
income.

State workmen's compensation act companies

    Section 501(c)(27)(B) provides tax-exempt status for any 
organization that is created by State law, and organized and 
operated exclusively to provide workmen's compensation 
insurance and related coverage that is incidental to workmen's 
compensation insurance, and that meets certain additional 
requirements. The workmen's compensation insurance must be 
required by State law, or be insurance with respect to which 
State law provides significant disincentives if it is not 
purchased by an employer (such as loss of exclusive remedy or 
forfeiture of affirmative defenses such as contributory 
negligence). The organization must provide workmen's 
compensation to any employer in the State (for employees in the 
State or temporarily assigned out-of-State) seeking such 
insurance and meeting other reasonable requirements. The State 
must either extend its full faith and credit to the initial 
debt of the organization or provide the initial operating 
capital of such organization. For this purpose, the initial 
operating capital can be provided by providing the proceeds of 
bonds issued by a State authority; the bonds may be repaid 
through exercise of the State's taxing authority, for example. 
For periods after the date of enactment, either the assets of 
the organization must revert to the State upon dissolution, or 
State law must not permit the dissolution of the organization 
absent an act of the State legislature. Should dissolution of 
the organization become permissible under applicable State law, 
then the requirement that the assets of the organization revert 
to the State upon dissolution applies. Finally, the majority of 
the board of directors (or comparable oversight body) of the 
organization must be appointed by an official of the executive 
branch of the State or by the State legislature, or by both.

                           REASONS FOR CHANGE

    The Committee understands that certain types of insurance 
to support governmental programs to prepare for or mitigate the 
effects of natural catastrophic events (such as hurricanes) may 
be limited or unavailable at reasonable rates in the authorized 
insurance market in some States. The Committee believes it is 
appropriate to provide tax-exempt status to certain types of 
associations that provide property and casualty insurance for 
windstorm, hail and fire damage to property located within a 
State if the State has determined that coverage in the 
authorized insurance market is in fact not reasonably available 
to a substantial number of insurable real properties.

                        EXPLANATION OF PROVISION

    The provision provides tax-exempt status for any 
association created before January 1, 1999, by State law and 
organized and operated exclusively to provide property and 
casualty insurance coverage for windstorm, hail and fire damage 
to property located within the State for which the State has 
determined that coverage in the authorized insurance market is 
not reasonably available to a substantial number of insurable 
real properties, provided certain requirements are met.
    Under the provision, no part of the net earnings of the 
association may inure to the benefit of any private shareholder 
or individual. Except as provided in the case of dissolution, 
no part of the assets of the association may be used for, or 
diverted to, any purpose other than: (1) to satisfy, in whole 
or in part, the liability of the association for, or with 
respect to, claims made on policies written by the association; 
(2) to invest in investments authorized by applicable law; (3) 
to pay reasonable and necessary administration expenses in 
connection with the establishment and operation of the 
association and the processing of claims against the 
association; or (4) to make remittances pursuant to State law 
to be used by the State to provide for the payment of claims on 
policies written by the association, purchase reinsurance 
covering losses under such policies, or to support governmental 
programs to prepare for or mitigate the effects of natural 
catastrophic events. The provision requires that the State law 
governing the association permit the association to levy 
assessments on insurance companies authorized to sell property 
and casualty insurance in the State, or on property and 
casualty insurance policyholders with insurable interests in 
property located in the State to fund deficits of the 
association, including the creation of reserves. The provision 
requires that the plan of operation of the association be 
subject to approval by the chief executive officer or other 
official of the State, by the State legislature, or both. In 
addition, the provision requires that the assets of the 
association revert upon dissolution to the State, the State's 
designee, or an entity designated by the State law governing 
the association, or that State law not permit the dissolution 
of the association.
    The provision provides a special rule in the case of any 
entity or fund created before January 1, 1999, pursuant to 
State law and organized and operated exclusively to receive, 
hold, and invest remittances from an association exempt from 
tax under the provision, to make disbursements to pay claims on 
insurance contracts issued by the association, and to make 
disbursements to support governmental programs to prepare for 
or mitigate the effects of natural catastrophic events. The 
special rule provides that the entity or fund may elect to be 
disregarded as a separate entity and be treated as part of the 
association exempt from tax under the provision, from which it 
receives such remittances. The election is required to be made 
no later than 30 days following the date on which the 
association is determined to be exempt from tax under the 
provision, and would be effective as of the effective date of 
that determination.
    An organization described in the provision is treated as 
having unrelated business taxable income (``UBIT'') in the 
amount of its taxable income (computed as if the organization 
were not exempt from tax under the provision), if at the end of 
the immediately preceding taxable year, the organization's net 
equity exceeds 15 percent of the total coverage in force under 
insurance contracts issued by the organization and outstanding 
at the end of that preceding year.
    Under the provision, no income or gain is recognized solely 
as a result of the change in status to that of an association 
exempt from tax under the provision.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2002. No inference is intended as to the tax 
status under present law of associations described in the 
provision.

   L. Conform Provisions Relating to Arbitrage Treatment of Certain 
           University Fund to State Constitutional Amendments


(Sec. 312 of the bill)

                              PRESENT LAW

    In general, present law tax-exempt arbitrage restrictions 
provide that interest on a State or local government bond is 
not eligible for tax-exemption if the proceeds are invested, 
directly or indirectly, in materially higher yielding 
investments or if the debt service on the bond is secured by or 
paid from (directly or indirectly) such investments. An 
exception, enacted in 1984, provides that the pledge of income 
from investments in a permanent university fund (``the Fund'') 
established under a provision of a State constitution adopted 
in 1876 as security for a limited amount of tax-exempt bonds 
will not cause interest on those bonds to be taxable. The terms 
of this exception are limited to State constitutional or 
statutory restrictions in effect as of October 9, 1969.
    The Fund consists of certain State lands that were set 
aside for the benefit of higher education, the income from 
mineral rights to these lands, and certain other earnings on 
Fund assets. The State constitution directs that monies held in 
the Fund are to be invested in interest-bearing obligations and 
other securities. The constitution does not permit the 
expenditure or mortgage of the Fund for any purpose. Income 
from the Fund is apportioned between two university systems 
operated by the State. Tax-exempt bonds issued by the two 
university systems are secured by and payable from the income 
of the Fund. These bonds are used to finance buildings and 
other permanent improvements for the universities.
    The State constitutional rules governing the Fund have been 
modified with regard to the manner in which amounts in the Fund 
are paid for the benefit of the two university systems.

                           REASONS FOR CHANGE

    The Committee understands that the State constitutional 
amendments have the effect of permitting the Fund to make 
annual distributions in a manner similar to standard university 
endowment funds, rather than the previous practice which tied 
distributions to annual income performance, which can create a 
variable pattern of distributions. The Committee does not 
believe that the Fund should lose the benefits of the 1984 
exception from the tax-exempt bond arbitrage restrictions by 
adopting a sounder, more modern approach to the management of 
Fund distributions.

                        EXPLANATION OF PROVISION

    The 1984 exception is conformed to the present State 
constitutional provisions governing the Fund's ability to make 
annual distributions in a manner similar to standard university 
endowment funds. Limitations on the aggregate amount of bonds 
that may benefit from the exception are not modified.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

     M. Matching Grants to Low-Income Taxpayer Clinics for Return 
                              Preparation


(Sec. 313 of the bill)

                              PRESENT LAW

    The Secretary is authorized to provide up to $6 million per 
year in matching grants to certain low-income taxpayer clinics 
that represent low-income taxpayers in controversies with the 
IRS or that operate programs to inform individuals for whom 
English is a second language about their tax-related rights and 
responsibilities.\101\
---------------------------------------------------------------------------
    \101\ Sec. 7526.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the low-income taxpayer clinic 
program should be expanded to provide grants to assist low-
income taxpayers in the preparation of their Federal tax 
returns.

                        EXPLANATION OF PROVISION

    The provision authorizes the Secretary to create a separate 
grant program to provide up to $10 million per year in matching 
grants to not for profit organizations that assist low-income 
taxpayers in the preparation of their Federal tax returns.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

N. Increase Percentage Limits for Certain Employer-Related Scholarship 
                                Programs


(Sec. 314 of the bill)

                              PRESENT LAW

    Gross income does not include any amount received as a 
qualified scholarship by an individual who is a candidate for a 
degree at an educational organization (sec. 117(a)). For this 
purpose, a scholarship generally means an amount paid or 
allowed to, or for the benefit of, a student to aid that 
student in pursuing studies.\102\ However, an amount paid or 
allowed to, or on behalf of, an individual to enable the 
individual to pursue studies is not treated as a scholarship if 
the amount represents compensation for past, present, or future 
services.\103\ The determination of whether an amount is 
properly treated as a scholarship or compensation for services 
is made in light of all the relevant facts and circumstances.
---------------------------------------------------------------------------
    \102\ Treas. Reg. sec. 1.117-3(a).
    \103\ Treas. Reg. sec. 1.117-4(c).
---------------------------------------------------------------------------
    Present law imposes excise taxes on the taxable 
expenditures of a private foundation.\104\ A taxable 
expenditure includes, among other things, any amount paid or 
incurred by a private foundation as a grant to an individual 
for travel, study, or other similar purposes by such 
individual, unless such grant is awarded on an objective and 
nondiscriminatory basis pursuant to a procedure approved in 
advance by the Secretary.\105\ In the case of individual grants 
to be made as scholarships or fellowships, the private 
foundation must demonstrate to the satisfaction of the 
Secretary that the grant: (1) constitutes a scholarship or 
fellowship which would be subject to the provisions of section 
117(a),\106\ and (2) is to be used for study at an educational 
organization which normally maintains a regular faculty and 
curriculum and normally has a regularly enrolled body of pupils 
or students in attendance at the place where its educational 
activities are regularly carried on.\107\
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    \104\ Secs. 4945(a) and (b).
    \105\ Secs. 4945(d)(3) and (g).
    \106\ For the purpose of section 4945(g), the term ``scholarship or 
fellowship'' refers to the provisions of section 117(a) as in effect 
before the Tax Reform Act of 1986. Sec. 4945(g)(1).
    \107\ Secs. 4945(g)(1) and 170(b)(1)(A)(ii).
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    Private foundations may in the course of their activities 
make scholarship or fellowship grants to individuals to be used 
for educational purposes. However, a private foundation's grant 
program may not be designed or administered to the end of 
providing compensation, an employment incentive, or an employee 
fringe benefit to persons employed by the foundation or by 
another employer (including, for example, employees of a 
``related'' employer organization). Revenue Procedure 76-47 
provides advance approval guidelines to determine whether 
grants made by private foundations under employer-related grant 
programs to an employee or to a child of an employee of the 
employer to which the program relates is considered a 
scholarship or fellowship grant subject to the provisions of 
section 117(a).\108\ To the extent that such grants are 
considered scholarships or fellowships under these guidelines, 
the Secretary will assume the grants are not taxable 
expenditures subject to section 4945 taxes. Educational grants 
that are not scholarships or fellowships under these guidelines 
might, depending upon the circumstances, lead to a loss of the 
private foundation's exempt status.
---------------------------------------------------------------------------
    \108\ Rev. Proc. 76-47, 1976-2 C.B. 670. The revenue procedure 
defines an employer-related program as a program that treats some or 
all of the employees, or children of some or all of the employees, of 
an employer as a group from which grantees of some or all of the grants 
will be selected, limits the potential grantees for some or all of the 
grants to individuals who are employees or children of employees of an 
employer, or otherwise gives such individuals a preference or priority 
over others in being selected as grantees.
---------------------------------------------------------------------------
    Under Revenue Procedure 76-47, a grant made under an 
employer-related grant program that satisfies seven conditions 
and a percentage test is considered a scholarship or 
fellowship.\109\ Grants awarded to children of employees and to 
employees are considered as having been awarded under separate 
programs for purposes of the revenue procedure, regardless of 
whether they are awarded under separately administered 
programs. All such grants must satisfy each of the seven 
conditions to obtain advance approval of the grant program. The 
percentage test applicable to grants to children of employees 
requires that the number of grants awarded not exceed either 25 
percent of the eligible applicants considered by the selection 
committee in selecting grant recipients or 10 percent of those 
eligible for grants (regardless of whether they submitted grant 
applications). The percentage test applicable to grants to 
employees requires that the number of grants awarded not exceed 
10 percent of eligible applicants considered by the selection 
committee in selecting grant recipients. If the seven 
conditions are met, but the relevant percentage test is not 
satisfied, then the question of whether the grants constitute 
scholarships or fellowships is based upon all of the facts and 
circumstances.
---------------------------------------------------------------------------
    \109\ The seven conditions include: (1) the program must not be 
used to recruit employees, to induce employees to continue their 
employment, or to compel a course of action sought by the employer; (2) 
the selection of grant recipients must be made by a committee 
consisting of independent individuals; (3) the program must impose 
identifiable minimum requirements for grant eligibility; (4) the 
selection of grant recipients must be based solely upon substantial 
objective standards that are completely unrelated to employment and to 
the employer's line of business; (5) a grant may not be terminated 
because the recipient or the recipient's parent terminates employment 
with the employer; (6) the courses of study for which grants are 
available must not be limited to those would be of particular benefit 
to the employer or the foundation; and (7) the terms of the grant and 
the courses of study for which grants are available must meet all other 
requirements of section 117 and must be consistent with the 
disinterested purpose of education for personal benefit rather than for 
the benefit of the employer or the foundation.
---------------------------------------------------------------------------
    Similar requirements and percentage limits apply to 
determine whether educational loans made by a private 
foundation under an employer-related loan program are taxable 
expenditures.\110\ If an employer-related program encompasses 
educational loans and scholarship or fellowship grants to the 
same group of eligible employees or employees' children, the 
percentage tests applicable to the loan program apply to the 
total number of individuals receiving combined grants of 
scholarships, fellowships, and educational loans.\111\
---------------------------------------------------------------------------
    \110\ Rev. Proc. 80-39, 1980-2 C.B. 772.
    \111\ Id.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the quantitative limits set 
forth in Revenue Procedure 76-47 are too low for employer-
related grant programs that provide scholarships or fellowships 
to children of employees. The Committee believes that higher 
percentage limits will encourage increases in grants made for 
educational purposes. The Committee also believes that the 
higher percentage limits should be available only in cases 
where the foundation maintains a comparable grant program for 
children who are not affiliated with the employer to which the 
employer-related grant program relates.

                        EXPLANATION OF PROVISION

    The percentage limits set forth in Revenue Procedure 76-47 
for grants to children of employees are increased to 35 percent 
of eligible applicants considered by the selection committee or 
20 percent of those eligible for the grants. However, the 
higher percentage limits are available only if the private 
foundation meets the other requirements of the Revenue 
Procedure and demonstrates that the foundation provides a 
comparable number and aggregate amount of grants during the 
same grant-program year to children who are not children of 
former or current employees of any employer to which an 
employer-related grant program relates. The provision does not 
amend the percentage limits for grants to employees, or the 
percentage limits of Revenue Procedure 80-39 relating to loan 
programs or programs which encompass both loans and grants.

                             EFFECTIVE DATE

    Revenue Procedure 76-47 is to be amended effective for 
grants awarded after December 31, 2002.

                 Title IV. Social Services Block Grant


(Secs. 401-403 of the bill)

                              PRESENT LAW

    Social Services Block Grant Funding (``SSBG''), also known 
as ``Title XX'' (because it is Title XX of the Social Security 
Act), is a flexible funding stream, providing states with 
resources to support a variety of social services. SSBG funds 
can be used to assist the elderly and disabled so that they do 
not need to enter institutions, to prevent child and elder 
abuse, to provide child care, to promote and support adoption, 
and for several other services. There are certain specified 
limitations so that SSBG cannot fund most medical care, for 
example, or cash welfare payments. It is a mandatory capped 
entitlement, distributed by a population-based formula among 
the states.
    States use SSBG in differing ways. Much of the funding 
supports local social service providers, including faith-
related organizations, through contracts with state and local 
governments. Overall, in fiscal year 1999, SSBG spending was as 
follows: 13.4 percent for ``prevention'' and case management; 
13 percent for day care; 12.4 percent for child and adult 
protective services; 10.9 percent for foster care; 7.4 percent 
for home-based services. There are several other categories in 
the expenditure data as well.
    Prior to the 1996 welfare reform law, SSBG was funded at 
$2.8 billion. That legislation reduced SSBG to $2.38 billion, 
as part of achieving budgetary savings, and permitted states to 
transfer up to 10 percent of their new Temporary Assistance for 
Needy Families (TANF) welfare block grant allocations to SSBG. 
(Any transferred funds are required to be spent on behalf of 
families below 200 percent of poverty.) In 1998, as part of the 
TEA-21 highway legislation, SSBG funding as further reduced, 
declining to $1.7 billion for fiscal year 2001 and fiscal year 
2002. The TANF transfer was further limited to 4.25 percent.

                           REASONS FOR CHANGE

    The Committee believes that an increase in funding for SSBG 
will allow social service organizations to provide more 
assistance to families in need and disadvantaged individuals. 
The flexible nature of SSBG permits states and localities to 
choose their own priorities for the uses of the increased 
funding.

                        EXPLANATION OF PROVISION

    The provision increases SSBG funding to $1.975 billion for 
fiscal year 2003 and $2.8 billion for fiscal year 2004. In 
addition, the TANF transfer limit is restored to 10 percent. 
These two measures provide additional resources to faith-
related social service organizations. Finally, the Secretary of 
HHS is required to submit annual reports on SSBG expenditures 
to the Congress.

                             EFFECTIVE DATE

    The provision is effective for amounts made available for 
fiscal year 2003 and for amounts made available each fiscal 
year thereafter. The provision requiring annual reports applies 
to such reports with respect to fiscal year 2002 and each 
fiscal year thereafter.

                Title V. Individual Development Accounts


(Secs. 501-511 of the bill)

                              PRESENT LAW

    Individual development accounts were first authorized by 
the Personal Work and Responsibility Act of 1996. In 1998, the 
Assets for Independence Act established a five-year $125 
million demonstration program to permit certain eligible 
individuals to open and make contributions to an individual 
development account. Contributions by an individual to an 
individual development account do not receive a tax preference 
but are matched by contributions from a State program, a 
participating nonprofit organization, or other ``qualified 
entity.'' The IRS has ruled that matching contributions by a 
qualified entity are a gift and not taxable to the account 
owner.\112\ The qualified entity chooses a matching rate, which 
must be between 50 and 400 percent. Withdrawals from individual 
development accounts can be made for certain higher education 
expenses, a first home purchase, or small-business 
capitalization expenses. Matching contributions (and earnings 
thereon) typically are held separately from the individuals' 
contributions (and earnings thereon) and must be paid directly 
to a mortgage provider, university, or business capitalization 
account at a financial institution. The Department of Health 
and Human Services administers the individual development 
account program.
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    \112\ Rev. Rul. 99-44, 1999-2 C.B. 549.
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                           REASONS FOR CHANGE

    The Committee recognizes that the rate of private savings 
in the United States is too low. In particular, many low-income 
individuals either have inadequate savings or no savings at 
all. The Committee believes that a tax-subsidized match by 
financial institutions may help encourage more savings by low-
income working individuals. The program is intended to 
encourage a pattern of individual savings and wealth 
accumulation. Finally, the Committee believes that the program 
will allow individuals to use their savings for three important 
purposes: (1) to afford better educations; (2) to achieve home 
ownership; and (3) to start their own businesses.

                        EXPLANATION OF PROVISION

    The bill provides for a nonrefundable tax credit for an 
eligible entity (i.e., a qualified financial institution) that 
has an individual development account program in a taxable 
year. The tax credit equals the amount of matching 
contributions made by the eligible entity under the program (up 
to $500 per taxable year) plus $50 for each individual 
development account maintained during the taxable year under 
the program. Except in the first year that each account is 
open, the $50 credit is available only for accounts with a 
balance of more than $100 at year-end (including matching 
funds). No deduction or other credit is available with respect 
to the amount of matching funds taken into account in 
determining the credit.
    The credit applies with respect to the first 300,000 
individual development accounts opened before January 1, 2011, 
and with respect to matching funds for participant 
contributions that are made after December 31, 2003, and before 
January 1, 2011. An account is considered open if at any time 
the balance in the account exceeds $100 (including matching 
amounts). The individual development accounts will be available 
on the following basis: (1) a maximum of 100,000 accounts may 
be opened after December 31, 2003 and before January 1, 2007; 
(2) a second 100,000 accounts may be opened after December 31, 
2006 and before January 1, 2009, if the entire 100,000 of 
authorized accounts are opened after December 31, 2003 and 
before January 1, 2007 and the Secretary of the Treasury 
determines that these accounts are being reasonably and 
responsibly administered;\113\ and (3) a third 100,000 accounts 
may be opened after December 31, 2008 and before January 1, 
2011 if the previous cohorts of 100,000 accounts have been 
opened under the schedule described above and the Secretary of 
the Treasury makes a four-part determination. Specifically, the 
Secretary will have to determine: (1) that all previously 
opened accounts have been reasonably and responsibly 
administered to date; (2) that the individual development 
account program has increased net savings of participants in 
the program; (3) whether participants in the individual 
development account program have increased Federal income tax 
liability and decreased utilization of Federal assistance 
programs (e.g., Temporary Assistance to Needy Families and Food 
Stamps) relative to similarly situated individuals that did not 
participate in the individual development account program; and 
(4) that the sum of the increased Federal tax liability and 
reduction of Federal assistance program benefits to 
participants in the individual development account program is 
greater than the cost of the individual development account 
program to the Federal government. If the Secretary finds that 
any of the four determinations has not been satisfied, the 
Congress will have the discretion to authorize the third 
100,000 accounts after the Secretary makes his or her report to 
the Congress regarding the four determinations. The third 
100,000 accounts must be equally divided among the States. For 
all accounts, the Secretary will take steps to encourage use of 
individual development accounts in rural areas.
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    \113\ If less than 100,000 accounts are opened before January 1, 
2007, then the number of accounts that can be opened after December 31, 
2006 and before January 1, 2009 will be reduced to the lesser of 75,000 
accounts of three times the number of accounts opened before January 1, 
2007.
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    Nonstudent U.S. citizens or lawful permanent residents 
between the ages of 18 and 60 (inclusive) who meet certain 
income requirements are eligible to open and contribute to an 
individual development account. The income limit for 
participation is modified adjusted gross income of $18,000 for 
single filers, $38,000 for joint filers, and $30,000 for head-
of-household filers.\114\ Eligibility in a taxable year 
generally is based on the previous year's modified adjusted 
gross income and circumstances (e.g., status as a student). 
Modified adjusted gross income is adjusted gross income plus 
certain items that are not includible in gross income. The 
items added are tax-exempt interest and the amounts otherwise 
excluded from gross income under Code sections 86, 893, 911, 
931, and 933 (relating to the exclusion of certain social 
security and Tier 1 railroad retirement benefits; the exclusion 
of compensation of employees of foreign governments and 
international organizations; the exclusion of income of U.S. 
citizens or residents living abroad; the exclusion of income 
for residents of Guam, American Samoa, and the Northern Mariana 
Islands; and the exclusion of income for residents of Puerto 
Rico). The income limits are adjusted for inflation after 2003. 
These amounts are rounded to the nearest multiple of 50 
dollars.
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    \114\ Married taxpayers filing separate returns are not eligible to 
open an IDA or to receive matching funds for an IDA that is already 
open.
---------------------------------------------------------------------------
    Under the bill, an individual development account must: (1) 
be owned by the eligible individual for whom the account was 
established; (2) consist only of cash contributions; (3) be 
held by a person authorized to be a trustee of any individual 
retirement account under section 408(a)(2); and (4) not 
commingle account assets with other property (except in a 
common trust fund or common investment fund). These 
requirements must be reflected in the written governing 
instrument creating the account. The entity establishing the 
program is required to maintain separate accounts for the 
individual's contributions (and earnings thereon) and for 
matching funds and earnings thereon (a ``parallel account'').
    Contributions to individual development accounts by 
individuals are not deductible and earnings thereon are taxable 
to the account holder. Matching contributions and earnings 
thereon are not taxable to the account holder.
    The bill permits individuals to withdraw amounts from an 
individual development account for qualified expenses of the 
account owner, owner's spouse, or dependents as well as for 
nonqualified expenses, subject to certain restrictions. 
Qualified expenses include qualified: (1) higher education 
expenses (as generally defined in section 529(e)(3)); (2) 
first-time homebuyer costs (as generally provided in section 72 
(t)(8)); (3) business capitalization or expansion costs 
(expenditures made pursuant to a business plan that has been 
approved by the financial institution); (4) rollovers of the 
balance of the account (including the parallel account) to 
another individual development account for the benefit of the 
same owner; and (5) final distributions in the case of a 
deceased account owner. Withdrawals for qualified expenses must 
be made from funds that have been in the account for at least 
one year and must be paid directly to the unrelated third party 
to whom the amount is due, except in the case of expenses under 
a qualified business plan, rollover, or final distribution. 
Such withdrawals generally are not permitted until the account 
owner completes a financial education course offered by a 
qualified financial institution. The Secretary of the Treasury 
(the ``Secretary'') is required to establish minimum standards 
for such courses. Withdrawals for nonqualified expenses may 
result in the account owner's forfeiture of matching funds. The 
amount of the forfeiture is the lesser of: (1) an amount equal 
to the nonqualified withdrawal; or (2) the excess of the amount 
in the parallel account (excluding earnings on matching funds) 
over the amount remaining in the individual development account 
after the nonqualified withdrawal. If the individual 
development account (or a portion thereof) is pledged as 
security for a loan, then the portion so used will be treated 
as a nonqualified withdrawal and will result in the loss of an 
equal amount of matching funds from the parallel account.
    The qualified entity administering the individual 
development account program generally is required to make 
quarterly payments of matching funds to a parallel account on a 
dollar-for-dollar basis for the first $500 contributed by the 
account owner in a taxable year. Matching funds also may be 
provided by State, local, or private sources. Balances of the 
individual development account and parallel account must be 
reported annually to the account owner. If an account owner 
ceases to meet eligibility requirements, matching funds 
generally may not be contributed during the period of 
ineligibility. Any amount withdrawn from a parallel account is 
not includible in an eligible individual's gross income or the 
account sponsor's gross income.
    Qualified entities administering a qualified program are 
required to report to the Secretary that the program is 
administered in accordance with legal requirements. If the 
Secretary determines that the program was not so operated, the 
Secretary would have the power to terminate the program. 
Qualified entities also are required to report annually to the 
Secretary information about: (1) the number of individuals 
making contributions to individual development accounts; (2) 
the amounts contributed by such individuals; (3) the amount of 
matching funds contributed; (4) the amount of funds withdrawn 
and for what purpose; (5) balance information; and (6) any 
other information that the Secretary deems necessary. The 
fiduciary requirements of Title 12 of the United States Code 
with respect to insured depository institutions and insured 
credit unions (as defined therein) continue to apply to those 
financial institutions participating in the individual 
development account program.
    The Secretary is authorized to prescribe necessary 
regulations, including rules to permit individual development 
account program sponsors to verify eligibility of individuals 
seeking to open accounts and rules to allow a financial 
institution (e.g., a tax-exempt credit union) to transfer those 
credits to another taxpayer. The Secretary also is authorized 
to provide rules to recapture credits claimed with respect to 
individuals who forfeit matching funds.
    The Secretary must submit annual reports to Congress on the 
status of the qualified individual account program.

                             EFFECTIVE DATE

    The provision is effective for taxable years ending after 
December 31, 2003, and beginning before January 1, 2011.

                      Title VI. Revenue Provisions


                A. Tax Shelter Transparency Requirements


1. Penalty for failure to disclose reportable transactions (sec. 601 of 
                the bill and new sec. 6707A of the Code)


                              PRESENT LAW

    Regulations under section 6011 require a taxpayer to 
disclose with its tax return certain information with respect 
to each ``reportable transaction'' in which the taxpayer 
participates.115
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    \115\ Temp. Treas. Reg. sec. 1.6011-4T; Prop. Treas. Reg. sec. 
1.6011-4. Effective June 14, 2002, the regulations were modified to 
require non-corporate taxpayers (i.e., individuals, trusts, 
partnerships, and S corporations) to disclose their participation in 
reportable transactions that have been specified by the Treasury 
Department as ``listed'' transactions. See T.D. 9000, 67 Fed. Reg. 
41,324 (June 18, 2002). Disclosure of other reportable transactions 
under the regulations continues to be limited to corporate taxpayers.
---------------------------------------------------------------------------
    There are two categories of reportable transactions. The 
first category includes any transaction that is the same as (or 
substantially similar to) 116 a transaction that is 
specified by the Treasury Department as a tax avoidance 
transaction whose tax benefits are subject to disallowance 
under present law (referred to as a ``listed transaction''). A 
taxpayer must disclose any listed transaction that is expected 
to reduce the taxpayer's Federal income tax liability by more 
than $1 million in any single taxable year or more than $2 
million in any combination of years.117
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    \116\ The recently-modified regulations clarify that the term 
``substantially similar'' includes any transaction that is expected to 
obtain the same or similar types of tax benefits and that is either 
factually similar or based on the same or similar tax strategy. Also, 
the term must be broadly construed in favor of disclosure. See T.D. 
9000, 67 Fed. Reg. 41,324 (June 18, 2002).
    \117\ Temp. Treas. Reg. sec. 1.6011-4T(b)(2) and (b)(4)(i).
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    The second category of reportable transactions includes 
transactions that are expected to reduce a taxpayer's Federal 
income tax liability by more than $5 million in any single year 
or $10 million in any combination of years and that have at 
least two of the following characteristics: (1) the taxpayer 
has participated in the transaction under conditions of 
confidentiality; (2) the taxpayer has obtained or been provided 
with contractual protection against the possibility that part 
or all of the intended tax benefits from the transaction will 
not be sustained; (3) the promoters of the transaction have 
received or are expected to receive fees or other consideration 
with an aggregate value in excess of $100,000, and such fees 
are contingent on the taxpayer's participation; (4) the 
transaction results in a reported book/tax difference in excess 
of $5 million in any taxable year; or (5) the transaction 
involves a person that the taxpayer knows or has reason to know 
is in a Federal income tax position that differs from that of 
the taxpayer (such as a tax-exempt entity or foreign person), 
and the taxpayer knows or has reason to know that such 
difference has permitted the transaction to be structured to 
provide the taxpayer with a more favorable Federal income tax 
treatment.118
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    \118\ Temp. Treas. Reg. sec. 1.6011-4T(b)(3)(i)(A)-(E). In certain 
circumstances, a taxpayer can avoid disclosure with respect to the 
second category of reportable transactions. See Temp. Treas. Reg. sec. 
1.6011-4T(b)(3)(ii)(A)-(E).
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    Under present law, there is no specific penalty for failing 
to disclose a reportable transaction; however, such a failure 
may jeopardize the taxpayer's ability to claim that any income 
tax understatement attributable to such undisclosed transaction 
is due to reasonable cause, and that the taxpayer acted in good 
faith.119
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    \119\ Section 6664(c) provides that a taxpayer can avoid the 
imposition of a section 6662 accuracy-related penalty in cases where 
the taxpayer can demonstrate that there was reasonable cause for the 
underpayment and that the taxpayer acted in good faith.
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                           REASONS FOR CHANGE

    The Committee is aware that individuals and corporations 
are increasingly using sophisticated transactions to avoid or 
evade Federal income tax.120 Such a phenomenon could 
pose a serious threat to the efficacy of the tax system because 
of both the potential loss of revenue and the potential threat 
to the integrity of the self-assessment system.
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    \120\ In this regard, the Committee has concerns with the outcomes 
and rationales used by courts in some recent decisions involving tax-
motivated transactions. For a more detailed discussion of recent court 
decisions and other developments regarding tax shelters, see Joint 
Committee on Taxation, Background and Present Law Relating to Tax 
Shelters (JCX 19-02) March 19, 2002.
---------------------------------------------------------------------------
    The Committee over two years ago began working on 
legislation to address this significant compliance problem. In 
addition, the Treasury Department, using the tools available, 
issued regulations requiring disclosure of certain transactions 
and requiring organizers and promoters of tax-engineered 
transactions to maintain customer lists and make these lists 
available to the IRS. Nevertheless, the Committee believed that 
additional legislation was needed to provide the Treasury 
Department with additional tools to assist its efforts to 
curtail abusive transactions. In that regard, the Committee 
issued for public comment three separate staff discussion 
drafts designed to address the tax shelter problem. The most 
recent draft (released in August 2001) focused on a regime that 
emphasized disclosure of tax shelter transactions.
    On March 21, 2002, the Committee heard testimony from 
Treasury Department and IRS officials that only 272 
transactions by 99 different taxpayers were disclosed under the 
present law for the 2001 tax-filing season. In connection with 
the hearing, the Treasury Department announced a new initiative 
(the ``Treasury shelter initiative'') that is designed to 
provide the Treasury Department and the Internal Revenue 
Service (``IRS'') with the tools necessary to respond to 
abusive tax avoidance transactions.\121\ The Treasury shelter 
initiative emphasizes combating abusive transactions by 
requiring increased disclosure of such transactions by all 
parties involved. To facilitate such disclosure, the Treasury 
shelter initiative proposes clearer definitions to identify 
transactions that must be disclosed, and stiffer penalties for 
failure to disclose such transactions. The Treasury shelter 
initiative provides for

    \121\ See generally, ``The Treasury Department's Enforcement 
Proposals for Abusive Tax Avoidance Transactions,'' released on March 
20, 2002, reprinted electronically at 2002 TNT 55-28 (March 21, 2002).
---------------------------------------------------------------------------
          [A] series of clear, mutually reinforcing rules for 
        disclosure, registration, and list maintenance. These 
        rules will be easier for taxpayers and their advisors 
        to apply, and harder for those who seek to avoid 
        disclosure to manipulate. * * * The Treasury 
        Department's proposals, for example, will broaden and 
        align the rules and regulations for disclosure, 
        registration, and list keeping under Sections 6011, 
        6111, and 6112 of the Code. * * * The Treasury 
        Department's enforcement initiative will create a 
        single, clear definition of a transaction that must be 
        disclosed and registered, and for which lists must be 
        maintained.

    The Committee believes that the course of action outlined 
in the Treasury shelter initiative will bolster ongoing efforts 
to combat abusive tax avoidance transactions, and that 
encouraging greater disclosure of transactions with a potential 
for tax avoidance is beneficial to the tax system. Moreover, 
the Committee believes that a penalty for failing to make the 
required disclosures, when the imposition of such penalty is 
not dependent on the tax treatment of the underlying 
transaction ultimately being sustained, will provide an 
additional incentive for taxpayers to satisfy their reporting 
obligations under the new disclosure provisions.

                        EXPLANATION OF PROVISION

In general

    The provision creates a new penalty for any person who 
fails to include with any return or statement any required 
information with respect to a reportable transaction. The new 
penalty applies without regard to whether the transaction 
ultimately results in an understatement of tax, and applies in 
addition to any accuracy-related penalty that may be imposed.

Transactions to be disclosed

    The provision does not define the terms ``listed 
transaction'' \122\ or ``reportable transaction,'' nor does the 
provision explain the type of information that must be 
disclosed in order to avoid the imposition of a penalty. 
Rather, the provision authorizes the Treasury Department to 
define a ``listed transaction'' and a ``reportable 
transaction'' under section 6011. As part of the Treasury 
shelter initiative, the Committee expects the Treasury 
Department to issue new regulations under section 6011 that 
will provide taxpayers with a set of objective standards to be 
applied in determining whether a taxpayer must disclose 
information regarding a particular transaction. The Committee 
anticipates that the new regulations will define a reportable 
transaction to include (but not be limited to) transactions 
with any of the following characteristics: (1) a significant 
loss, (2) a brief holding period, (3) a transaction that is 
marketed under conditions of confidentiality, (4) a transaction 
that is subject to indemnification agreements, or (5) a certain 
amount of book-tax difference.\123\
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    \122\ The provision states that, except as provided in regulations, 
a listed transaction means a reportable transaction, which is the same 
as, or similar to, a transaction specifically identified by the 
Secretary as a tax avoidance transaction for purposes of section 6011. 
The Committee anticipates that regulations under section 6011 will 
provide that a transaction is similar to a listed transaction if such 
transaction is expected to obtain the same or similar types of tax 
benefits and that is either factually similar or based on the same or 
similar tax strategy. The Secretary will have discretion to modify this 
definition as appropriate (as well as the definitions of reportable and 
listed transactions).
    \123\ The Treasury shelter initiative stated that a reportable 
transaction would be defined as any transaction with any of the 
following characteristics: (1) any transaction specifically identified 
by the IRS in published guidance as a tax avoidance transaction without 
regard to the size of the tax savings (i.e., a ``listed transaction''), 
(2) certain loss transactions under section 165 in excess of $10 
million for corporations, partnerships, and S corporations ($2 million 
for trusts and individuals), (3) any transaction resulting in a tax 
credit in excess of $250,000 if the taxpayer held the underlying asset 
for less than 45 days, (4) any book-tax difference of at least $10 
million, subject to certain exceptions, and (5) any transaction 
marketed under conditions of confidentiality, if the transaction is 
expected to result in a reduction in taxable income of at least 
$250,000 ($500,000 in the case of a corporation).
---------------------------------------------------------------------------

Disclosure requirements

    The Committee further expects that the new regulations will 
specify the manner in which a taxpayer must disclose reportable 
transactions. The Committee anticipates that the information 
required to be disclosed with respect to reportable 
transactions will be sufficiently detailed so as to provide the 
Treasury Department and IRS the ability to analyze all aspects 
of the transaction and determine an appropriate course of 
action (if any). To accomplish this objective, a taxpayer may 
be required to disclose the following information with respect 
to a reportable transaction: (1) a detailed description of all 
facts relevant to the expected tax treatment of the reportable 
transaction (such as the structure of the transaction and the 
principal elements of the transaction), (2) a description and 
schedule of the expected tax benefits for all tax years 
resulting from the reportable transaction (including any 
anticipated transactions as part of the overall strategy), (3) 
if applicable, the names and addresses of any party who 
promoted, solicited, or recommended the taxpayer's 
participation in the transaction and who had a financial 
interest (including the receipt of fees) in the taxpayer's 
decision to participate, and (4) other information that the 
Secretary may prescribe (e.g., the involvement of any 
accommodation party or any tax-indifferent party, the receipt 
of a tax opinion with respect to the transaction, the amount of 
any fees paid to any promoter or advisor in connection with the 
transaction, any anticipated subsequent transactions or exit 
strategies).
    The Committee intends that, in accordance with section 6065 
(relating to verification of returns), the form the Secretary 
prescribes for taxpayer disclosure of reportable transactions 
will include a written declaration that the information is 
being provided under penalties of perjury. Moreover, the 
Committee intends that the verification under penalties of 
perjury also will apply to any large entity that discloses that 
it did not enter into any reportable transactions during the 
tax year covered by such declaration.

Penalty rate

    The penalty for failing to disclose a reportable 
transaction is $50,000. The amount is increased to $100,000 if 
the failure is with respect to a listed transaction. For large 
entities and high net worth individuals, the penalty amount is 
doubled (i.e., $100,000 for a reportable transaction and 
$200,000 for a listed transaction). The penalty cannot be 
waived with respect to a listed transaction. As to reportable 
transactions, the penalty can be rescinded or abated only in 
exceptional circumstances.\124\ All or part of the penalty may 
be rescinded only if: (1) the taxpayer on whom the penalty is 
imposed has a history of complying with the Federal tax laws, 
(2) it is shown that the violation is due to an unintentional 
mistake of fact, (3) imposing the penalty would be against 
equity and good conscience, and (4) rescinding the penalty 
would promote compliance with the tax laws and effective tax 
administration. The authority to rescind the penalty can only 
be exercised by the Commissioner personally or the head of the 
Office of Tax Shelter Analysis; this authority to rescind 
cannot otherwise be delegated by the Commissioner. Thus, the 
penalty cannot be rescinded by a revenue agent, an appeals 
officer, or other IRS personnel. The decision to rescind a 
penalty must be accompanied by a record describing the facts 
and reasons for the action and the amount rescinded. There will 
be no taxpayer right to appeal a refusal to rescind a penalty. 
The IRS also is required to submit an annual report to Congress 
summarizing the application of the disclosure penalties and 
providing a description of each penalty rescinded under this 
provision and the reasons for the rescission.
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    \124\ The Committee recognizes that the Secretary's present-law 
authority to postpone certain tax-related deadlines because of 
Presidentially-declared disasters (sec. 7508A) will also encompass the 
authority to postpone the reporting deadlines established by the 
provision.
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    A ``large entity'' is defined as any entity with gross 
receipts in excess of $10 million in the year of the 
transaction or in the preceding year. A ``high net worth 
individual'' is defined as any individual whose net worth 
exceeds $2 million, based on the fair market value of the 
individual's assets and liabilities immediately before entering 
into the transaction.
    A public entity that is required to pay a penalty for 
failing to disclose a listed transaction (or is subject to an 
accuracy-related penalty for a nondisclosed listed transaction 
or a nondisclosed reportable transaction with a significant tax 
avoidance purpose \125\) must disclose the imposition of the 
penalty in reports to the Securities and Exchange Commission 
(``SEC'') for such period as the Secretary shall specify. The 
provision applies without regard to whether the taxpayer 
determines the amount of the penalty to be material to the 
reports in which the penalty must appear, and treats any 
failure to disclose a transaction in such reports as a failure 
to disclose a listed transaction. A taxpayer must disclose a 
penalty in reports to the SEC once the taxpayer has exhausted 
its administrative and judicial remedies with respect to the 
penalty (or if earlier, when paid).
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    \125\ This category of transactions is described in greater detail 
below in connection with the provision modifying the accuracy-related 
penalty to tax shelters.
---------------------------------------------------------------------------
    As described above in connection with present law, current 
regulations under section 6011 require the disclosure of 
certain reportable transactions. Until such regulations are 
modified to reflect the new categories of reportable 
transactions, the penalty will apply to taxpayers who fail to 
timely disclose any reportable transaction under the 
definitions contained in the current regulations.

                             EFFECTIVE DATE

    The provision is effective for returns and statements the 
due date for which is after the date of enactment.

     2. Modifications to the accuracy-related penalties for listed 
   transactions and reportable transactions having a significant tax 
 avoidance purpose (sec. 602 of the bill and new sec. 6662A and secs. 
                       6662 and 6664 of the Code)


                              PRESENT LAW

    The accuracy-related penalty applies to the portion of any 
underpayment that is attributable to (1) negligence, (2) any 
substantial understatement of income tax, (3) any substantial 
valuation misstatement, (4) any substantial overstatement of 
pension liabilities, or (5) any substantial estate or gift tax 
valuation understatement. If the correct income tax liability 
exceeds that reported by the taxpayer by the greater of 10 
percent of the correct tax or $5,000 ($10,000 in the case of 
corporations), then a substantial understatement exists and a 
penalty may be imposed equal to 20 percent of the underpayment 
of tax attributable to the understatement.\126\ The amount of 
any understatement generally is reduced by any portion 
attributable to an item if (1) the treatment of the item is 
supported by substantial authority, or (2) facts relevant to 
the tax treatment of the item were adequately disclosed and 
there was a reasonable basis for its tax treatment.\127\
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    \126\ Sec. 6662.
    \127\ Sec. 6662(d)(2)(B).
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    Special rules apply with respect to tax shelters.\128\ For 
understatements by non-corporate taxpayers attributable to tax 
shelters, the penalty may be avoided only if the taxpayer 
establishes that, in addition to having substantial authority 
for the position, the taxpayer reasonably believed that the 
treatment claimed was more likely than not the proper treatment 
of the item. This reduction in the penalty is unavailable to 
corporate tax shelters.
---------------------------------------------------------------------------
    \128\ Sec. 6662(d)(2)(C).
---------------------------------------------------------------------------
    The understatement penalty generally is abated (even with 
respect to tax shelters) in cases in which the taxpayer can 
demonstrate that there was ``reasonable cause'' for the 
underpayment and that the taxpayer acted in good faith.\129\ 
The relevant regulations provide that reasonable cause exists 
where the taxpayer ``reasonably relies in good faith on an 
opinion based on a professional tax advisor's analysis of the 
pertinent facts and authorities [that] * * * unambiguously 
concludes that there is a greater than 50-percent likelihood 
that the tax treatment of the item will be upheld if 
challenged'' by the IRS.\130\
---------------------------------------------------------------------------
    \129\ Sec. 6664(c).
    \130\ Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec. 
1.6664-4(c).
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                           REASONS FOR CHANGE

    The Committee understands that taxpayers are being advised 
not to disclose tax avoidance transactions on the grounds that 
any accuracy-related penalty that could result from an 
underpayment of tax on such a transaction can be avoided.\131\ 
Because the Treasury shelter initiative emphasizes combating 
abusive tax avoidance transactions by requiring increased 
disclosure of such transactions by all parties involved, the 
Committee believes that taxpayers should be subject to a strict 
liability penalty on an understatement of tax that is 
attributable to non-disclosed listed transactions or non-
disclosed reportable transactions that have a significant 
purpose of tax avoidance. Furthermore, in order to deter 
taxpayers from entering into tax avoidance transactions, the 
Committee believes that a more meaningful (but less stringent) 
accuracy-related penalty should apply to such transactions even 
when disclosed.
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    \131\ See ``The Treasury Department's Enforcement Proposals for 
Abusive Tax Avoidance Transactions,'' at 12 (released on March 20, 
2002), reprinted electronically at 2002 TNT 55-28 (March 21, 2002).
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

In general

    The provision modifies the present-law accuracy related 
penalty by replacing the rules applicable to tax shelters with 
a new accuracy-related penalty that applies to listed 
transactions and reportable transactions with a significant tax 
avoidance purpose (hereinafter referred to as a ``reportable 
avoidance transaction'').\132\ The penalty rate and the 
taxpayer defenses available to avoid the penalty vary depending 
on the category of the transaction (i.e., listed or reportable 
avoidance transaction) and whether the transaction was 
adequately disclosed.
---------------------------------------------------------------------------
    \132\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meanings as previously described in 
connection with the penalty for failing to disclose a reportable 
transaction.
---------------------------------------------------------------------------
    In general, a 20-percent accuracy-related penalty is 
imposed on any understatement attributable to a listed 
transaction or a reportable avoidance transaction. The only 
exception to the penalty is if the taxpayer satisfies a more 
stringent reasonable cause and good faith exception 
(hereinafter referred to as the ``strengthened reasonable cause 
exception''), which is described below. The strengthened 
reasonable cause exception is available only if the relevant 
facts affecting the tax treatment are adequately disclosed, 
there is or was substantial authority for the claimed tax 
treatment, and the taxpayer reasonably believed that the 
claimed tax treatment was more likely than not the proper 
treatment.
    If the taxpayer does not adequately disclose the 
transaction, the strengthened reasonable cause exception is not 
available (i.e., a no-fault penalty applies), and the taxpayer 
is subject to an increased penalty rate. If the understatement 
is attributable to an undisclosed listed transaction, the 
penalty rate is increased to 30 percent of the understatement. 
For understatements attributable to an undisclosed reportable 
avoidance transaction, the penalty rate is 25 percent of the 
understatement.

Determination of the understatement amount

    The penalty is applied to the amount of any understatement 
attributable to the listed or reportable avoidance transaction 
without regard to other items on the tax return. For purposes 
of this provision, the amount of the understatement is 
determined as the sum of (1) the product of the highest 
corporate or individual tax rate (as appropriate) and the 
increase in taxable income resulting from the difference 
between the taxpayer's treatment of the item and the proper 
treatment of the item (without regard to other items on the tax 
return),\133\ and (2) the amount of any decrease in the 
aggregate amount of credits which results from a difference 
between the taxpayer's treatment of an item and the proper tax 
treatment of such item.
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    \133\ For this purpose, any reduction in the excess of deductions 
allowed for the taxable year over gross income for such year, and any 
reduction in the amount of capital losses which would (without regard 
to section 1211) be allowed for such year, shall be treated as an 
increase in taxable income.
---------------------------------------------------------------------------
    Except as provided in regulations, the taxpayer's treatment 
of an item shall not take into account any amendment or 
supplement to a return if the amendment or supplement is filed 
after the earlier of when the taxpayer is first contacted 
regarding an examination of the return or such other date as 
specified by the Secretary.

Strengthened reasonable cause exception

    A penalty is not imposed under the provision with respect 
to any portion of an understatement if it is shown that there 
was reasonable cause for such portion and the taxpayer acted in 
good faith. Such a showing requires (1) adequate disclosure of 
the facts affecting the transaction in accordance with the 
regulations under section 6011,\134\ (2) there is or was 
substantial authority for such treatment, and (3) the taxpayer 
reasonably believed that such treatment was more likely than 
not the proper treatment. For this purpose, a taxpayer will be 
treated as having a reasonable belief with respect to the tax 
treatment of an item only if such belief (1) is based on the 
facts and law that exist at the time the tax return (that 
includes the item) is filed, and (2) relates solely to the 
taxpayer's chances of success on the merits and does not take 
into account the possibility that (a) a return will not be 
audited, (b) the treatment will not be raised on audit, or (c) 
the treatment will be resolved through settlement if raised.
---------------------------------------------------------------------------
    \134\ See the previous discussion regarding the penalty for failing 
to disclose a reportable transaction.
---------------------------------------------------------------------------
    A taxpayer may (but is not required to) rely on an opinion 
of a tax advisor in establishing its reasonable belief with 
respect to the tax treatment of the item. However, a taxpayer 
may not rely on an opinion of a tax advisor for this purpose if 
the opinion (1) is provided by a ``disqualified tax advisor,'' 
or (2) is a ``disqualified opinion.''
            Disqualified tax advisor
    A disqualified tax advisor is any material advisor \135\ 
who (1) participates in the organization, management, promotion 
or sale of the transaction or is related (within the meaning of 
section 267 or 707) to any person who so participates, (2) is 
compensated by another material advisor with respect to the 
transaction, (3) has a fee arrangement with respect to the 
transaction that is contingent on all or part of the intended 
tax benefits from the transaction being sustained, or (4) as 
determined under regulations prescribed by the Secretary, has a 
continuing financial interest with respect to the 
transaction.\136\
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    \135\ The term ``material advisor'' (defined below in connection 
with the new information filing requirements for material advisors) 
means any person who provides any material aid, assistance, or advice 
with respect to organizing, promoting, selling, implementing, or 
carrying out any reportable transaction, and who derives gross income 
in excess of $50,000 in the case of a reportable transaction 
substantially all of the tax benefits from which are provided to 
natural persons ($250,000 in any other case).
    \136\ This situation could arise, for example, when an advisor has 
an arrangement or understanding (oral or written) with an organizer, 
manager, or promoter of a reportable transaction that such party will 
recommend or refer potential participants to the advisor for an opinion 
regarding the tax treatment of the transaction.
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            Organization, management, promotion or sale of a 
                    transaction
    The Committee intends that a material advisor be considered 
as participating in the ``organization'' of a transaction if 
the advisor performs acts relating to the development of the 
transaction. This may include, for example, preparing documents 
(1) establishing a structure used in connection with the 
transaction (such as a partnership agreement), (2) describing 
the transaction (such as an offering memorandum or other 
statement describing the transaction), or (3) relating to the 
registration of the transaction with any federal, state or 
local government body.\137\ Participation in the ``management'' 
of a transaction means involvement in the decision-making 
process regarding any business activity with respect to the 
transaction. Participation in the ``promotion or sale'' of a 
transaction means involvement in the marketing or solicitation 
of the transaction to others. Thus, an advisor who provides 
information about the transaction to a potential participant is 
involved in the promotion or sale of a transaction, as is any 
advisor who recommends the transaction to a potential 
participant.
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    \137\ An advisor should not be treated as participating in the 
organization of a transaction if the advisor's only involvement with 
respect to the organization of the transaction is the rendering of an 
opinion regarding the tax consequences of such transaction. However, 
such an advisor may be a ``disqualified tax advisor'' with respect to 
the transaction if the advisor participates in the management, 
promotion or sale of the transaction (or if the material advisor is 
compensated by another material advisor, has a fee arrangement that is 
contingent on the tax benefits of the transaction, or as determined by 
the Secretary, has a continuing financial interest with respect to the 
transaction).
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            Disqualified opinion
    An opinion may not be relied upon if the opinion (1) is 
based on unreasonable factual or legal assumptions (including 
assumptions as to future events), (2) unreasonably relies upon 
representations, statements, finding or agreements of the 
taxpayer or any other person, (3) does not identify and 
consider all relevant facts, or (4) fails to meet any other 
requirement prescribed by the Secretary.

Coordination with other penalties

    Any understatement to which a penalty is imposed under this 
provision is not subject to the accuracy-related penalty under 
section 6662. However, such understatement is included for 
purposes of determining whether any understatement (as defined 
in sec. 6662(d)(2)) is a substantial understatement as defined 
under section 6662(d)(1).
    The penalty imposed under this provision shall not apply to 
any portion of an understatement to which a fraud penalty is 
applied under section 6663.

                             EFFECTIVE DATE

    The provision is effective for taxable years ending after 
the date of enactment.

3. Modifications to the substantial understatement penalty (sec. 603 of 
                  the bill and sec. 6662 of the Code)


                              PRESENT LAW

Definition of substantial understatement

    An accuracy-related penalty equal to 20 percent applies to 
any substantial understatement of tax. A ``substantial 
understatement'' exists if the correct income tax liability for 
a taxable year exceeds that reported by the taxpayer by the 
greater of 10 percent of the correct tax or $5,000 ($10,000 in 
the case of most corporations).\138\
---------------------------------------------------------------------------
    \138\ Sec. 6662(a) and (d)(1)(A).
---------------------------------------------------------------------------

Reduction of understatement for certain positions

    For purposes of determining whether a substantial 
understatement penalty applies, the amount of any 
understatement generally is reduced by any portion attributable 
to an item if (1) the treatment of the item is supported by 
substantial authority, or (2) facts relevant to the tax 
treatment of the item were adequately disclosed and there was a 
reasonable basis for its tax treatment.\139\
---------------------------------------------------------------------------
    \139\ Sec. 6662(d)(2)(B).
---------------------------------------------------------------------------
    The Secretary is required to publish annually in the 
Federal Register a list of positions for which the Secretary 
believes there is not substantial authority and which affect a 
significant number of taxpayers.\140\
---------------------------------------------------------------------------
    \140\ Sec. 6662(d)(2)(D).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the present-law definition of 
substantial understatement allows large corporate taxpayers to 
avoid the accuracy-related penalty on questionable transactions 
of a significant size. The Committee believes that an 
understatement of more than $10 million is substantial in and 
of itself, regardless of the proportion it represents of the 
taxpayer's total tax liability.
    The Committee believes that a higher compliance standard 
should be imposed on any taxpayer in order to reduce the amount 
of an understatement resulting from a transaction that the 
taxpayer did not adequately disclose. The Committee further 
believes that a taxpayer should not take a position on a tax 
return that could give rise to a substantial understatement 
penalty that the taxpayer does not believe is more likely than 
not the correct tax treatment unless this information is 
disclosed to the IRS.

                        EXPLANATION OF PROVISION

Definition of substantial understatement

    The provision modifies the definition of ``substantial'' 
for corporate taxpayers. Under the provision, a corporate 
taxpayer has a subs
    tantial understatement if the amount of the understatement 
for the taxable year exceeds the lesser of (1) 10 percent of 
the tax required to be shown on the return for the taxable year 
(or, if greater, $10,000), or (2) $10 million.

Reduction of understatement for certain positions

    The provision elevates the standard that a taxpayer must 
satisfy in order to reduce the amount of an understatement for 
undisclosed items. With respect to the treatment of an item 
whose facts are not adequately disclosed, a resulting 
understatement is reduced only if the taxpayer had a reasonable 
belief that the tax treatment was more likely than not the 
proper treatment. The provision also authorizes (but does not 
require) the Secretary to publish a list of positions for which 
it believes there is not substantial authority or there is no 
reasonable belief that the tax treatment is more likely than 
not the proper treatment (without regard to whether such 
positions affect a significant number of taxpayers). The list 
shall be published in the Federal Register or the Internal 
Revenue Bulletin.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after date of enactment.

  4. Tax shelter exception to confidentiality privileges relating to 
  taxpayer communications (sec. 604 of the bill and sec. 7525 of the 
                                 Code)


                              PRESENT LAW

    In general, a common law privilege of confidentiality 
exists for communications between an attorney and client with 
respect to the legal advice the attorney gives the client. The 
Code provides that, with respect to tax advice, the same common 
law protections of confidentiality that apply to a 
communication between a taxpayer and an attorney also apply to 
a communication between a taxpayer and a federally authorized 
tax practitioner to the extent the communication would be 
considered a privileged communication if it were between a 
taxpayer and an attorney. This rule is inapplicable to 
communications regarding corporate tax shelters.

                           REASONS FOR CHANGE

    The Committee believes that the rule currently applicable 
to corporate tax shelters should be applied to all tax 
shelters, regardless of whether or not the participant is a 
corporation.

                        EXPLANATION OF PROVISION

    The bill modifies the rule relating to corporate tax 
shelters by making it applicable to all tax shelters, whether 
entered into by corporations, individuals, partnerships, tax-
exempt entities, or any other entity. Accordingly, 
communications with respect to tax shelters are not subject to 
the confidentiality provision of the Code that otherwise 
applies to a communication between a taxpayer and a federally 
authorized tax practitioner.

                             EFFECTIVE DATE

    The provision is effective with respect to communications 
made on or after the date of enactment.

 5. Disclosure of reportable transactions by material advisors (secs. 
      611 and 612 of the bill and secs. 6111 and 6707 of the Code)


                              PRESENT LAW

Registration of tax shelter arrangements

    An organizer of a tax shelter is required to register the 
shelter with the Secretary not later than the day on which the 
shelter is first offered for sale.\141\ A ``tax shelter'' means 
any investment with respect to which the tax shelter ratio 
\142\ for any investor as of the close of any of the first five 
years ending after the investment is offered for sale may be 
greater than two to one and which is: (1) required to be 
registered under Federal or State securities laws, (2) sold 
pursuant to an exemption from registration requiring the filing 
of a notice with a Federal or State securities agency, or (3) a 
substantial investment (greater than $250,000 and at least five 
investors).\143\
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    \141\ Sec. 6111(a)
    \142\ The tax shelter ratio is, with respect to any year, the ratio 
that the aggregate amount of the deductions and 350 percent of the 
credits, which are represented to be potentially allowable to any 
investor, bears to the investment base (money plus basis of assets 
contributed) as of the close of the tax year.
    \143\ Sec. 6111(c).
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    Other promoted arrangements are treated as tax shelters for 
purposes of the registration requirement if: (1) a significant 
purpose of the arrangement is the avoidance or evasion of 
Federal income tax by a corporate participant; (2) the 
arrangement is offered under conditions of confidentiality; and 
(3) the promoter may receive fees in excess of $100,000 in the 
aggregate.\144\
---------------------------------------------------------------------------
    \144\Sec. 6111(d).
---------------------------------------------------------------------------
    A transaction has a ``significant purpose of avoiding or 
evading Federal income tax'' if the transaction: (1) is the 
same as or substantially similar to a ``listed transaction,'' 
\145\ or (2) is structured to produce tax benefits that 
constitute an important part of the intended results of the 
arrangement and the promoter reasonably expects to present the 
arrangement to more than one taxpayer.\146\ Certain exceptions 
are provided with respect to the second category of 
transactions.\147\
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    \145\ Temp. Treas. Reg. sec. 301.6111-2T(b)(2).
    \146\ Temp. Treas. Reg. sec. 301.6111-2T(b)(3).
    \147\ Temp. Treas. Reg. sec. 301.6111-2T(b)(4).
---------------------------------------------------------------------------
    An arrangement is offered under conditions of 
confidentiality if: (1) an offeree has an understanding or 
agreement to limit the disclosure of the transaction or any 
significant tax features of the transaction; or (2) the 
promoter claims, knows, or has reason to know that a party 
other than the potential participant claims that the 
transaction (or any aspect of it) is proprietary to the 
promoter or any party other than the offeree, or is otherwise 
protected from disclosure or use.\148\
---------------------------------------------------------------------------
    \148\ The regulations provide that the determination of whether an 
arrangement is offered under conditions of confidentiality is based on 
all the facts and circumstances surrounding the offer. If an offeree's 
disclosure of the structure or tax aspects of the transaction are 
limited in any way by an express or implied understanding or agreement 
with or for the benefit of a tax shelter promoter, an offer is 
considered made under conditions of confidentiality, whether or not 
such understanding or agreement is legally binding. Treas. Reg. sec. 
301.6111-2T(c)(1).
---------------------------------------------------------------------------

Failure to register tax shelter

    The penalty for failing to timely register a tax shelter 
(or for filing false or incomplete information with respect to 
the tax shelter registration) generally is the greater of one 
percent of the aggregate amount invested in the shelter or 
$500.\149\ However, if the tax shelter involves an arrangement 
offered to a corporation under conditions of confidentiality, 
the penalty is the greater of $10,000 or 50 percent of the fees 
payable to any promoter with respect to offerings prior to the 
date of late registration. Intentional disregard of the 
requirement to register increases the penalty to 75 percent of 
the applicable fees.
---------------------------------------------------------------------------
    \149\ Sec. 6707.
---------------------------------------------------------------------------
    Section 6707 also imposes (1) a $100 penalty on the 
promoter for each failure to furnish the investor with the 
required tax shelter identification number, and (2) a $250 
penalty on the investor for each failure to include the tax 
shelter identification number on a return.

                           REASONS FOR CHANGE

    The Committee has been advised that the current promoter 
registration rules have not proven particularly helpful, 
because the rules are not appropriate for the kinds of abusive 
transactions now prevalent, and because the limitations 
regarding confidential corporate arrangements have proven easy 
to circumvent.
    The Committee believes that providing a single, clear 
definition regarding the types of transactions that must be 
disclosed by taxpayers and material advisors (as outlined in 
the Treasury shelter initiative), coupled with more meaningful 
penalties for failing to disclose such transactions, are 
necessary tools if the effort to curb the use of abusive tax 
avoidance transactions is to be effective.\150\
---------------------------------------------------------------------------
    \150\ The Treasury Department's enforcement proposals for abusive 
tax avoidance transactions are described in greater detail above in 
connection with the penalty for failing to disclose reportable 
transactions (new sec. 6707A).
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

Disclosure of reportable transactions by material advisors

    The provision repeals the present law rules with respect to 
registration of tax shelters. Instead, the provision requires 
each material advisor with respect to any reportable 
transaction 151 to timely file an information return 
with the Secretary (in such form and manner as the Secretary 
may prescribe). The return must be filed on such date as 
specified by the Secretary.
---------------------------------------------------------------------------
    \151\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meaning as previously described in 
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------
    The information return will include (1) information 
identifying and describing the transaction, (2) information 
describing any potential tax benefits expected to result from 
the transaction, and (3) such other information as the 
Secretary may prescribe. It is expected that the Secretary may 
seek from the material advisor the same type of information 
that the Secretary may request from a taxpayer in connection 
with a reportable transaction.152
---------------------------------------------------------------------------
    \152\ See the previous discussion regarding the disclosure 
requirements under new section 6707A.
---------------------------------------------------------------------------
    A ``material advisor'' means any person (1) who provides 
material aid, assistance, or advice with respect to organizing, 
promoting, selling, implementing, or carrying out any 
reportable transaction, and (2) who directly or indirectly 
derives gross income in excess of $250,000 ($50,000 in the case 
of a reportable transaction substantially all of the tax 
benefits from which are provided to natural persons) for such 
advice or assistance.
    The Secretary may prescribe regulations which provide (1) 
that only one material advisor has to file an information 
return in cases in which two or more material advisors would 
otherwise be required to file information returns with respect 
to a particular reportable transaction, (2) exemptions from the 
requirements of this section, and (3) other rules as may be 
necessary or appropriate to carry out the purposes of this 
section.

Penalty for failing to furnish information regarding reportable 
        transactions

    The provision repeals the present law penalty for failure 
to register tax shelters. Instead, the provision imposes a 
penalty on any material advisor who fails to file an 
information return with respect to any reportable transaction, 
or who files a false or incomplete information return with the 
Secretary with respect to a reportable 
transaction.153 The amount of the penalty is 
$50,000. If the penalty is with respect to a listed 
transaction, the amount of the penalty is increased to the 
greater of (1) $200,000, or (2) 50 percent of the gross income 
of such person with respect to aid, assistance, or advice which 
is provided with respect to the reportable transaction before 
the date the information return that includes the transaction 
is filed. Intentional disregard by a material advisor of the 
requirement to disclose a reportable transaction increases the 
penalty to 75 percent of such gross income.
---------------------------------------------------------------------------
    \153\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meaning as previously described in 
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------
    The penalty cannot be waived with respect to a listed 
transaction. As to reportable transactions, the penalty can be 
rescinded or abated only in exceptional 
circumstances.154 All or part of the penalty may be 
rescinded only if: (1) the material advisor on whom the penalty 
is imposed has a history of complying with the Federal tax 
laws, (2) it is shown that the violation is due to an 
unintentional mistake of fact, (3) imposing the penalty would 
be against equity and good conscience, and (4) rescinding the 
penalty would promote compliance with the tax laws and 
effective tax administration. The authority to rescind the 
penalty can only be exercised by the Commissioner personally or 
the head of the Office of Tax Shelter Analysis; this authority 
to rescind cannot otherwise be delegated by the Commissioner. 
Thus, the penalty cannot be rescinded by a revenue agent, an 
appeals officer, or other IRS personnel. The decision to 
rescind a penalty must be accompanied by a record describing 
the facts and reasons for the action and the amount rescinded. 
There will be no right to appeal a refusal to rescind a 
penalty. The IRS also is required to submit an annual report to 
Congress summarizing the application of the disclosure 
penalties and providing a description of each penalty rescinded 
under this provision and the reasons for the rescission.
---------------------------------------------------------------------------
    \154\ The Committee recognizes that the Secretary's present-law 
authority to postpone certain tax-related deadlines because of 
Presidentially-declared disasters (sec. 7508A) will also encompass the 
authority to postpone the reporting deadlines established by the 
provision.
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                             EFFECTIVE DATE

    The provision requiring disclosure of reportable 
transactions by material advisors applies to transactions with 
respect to which material aid, assistance or advice is provided 
after the date of enactment.
    The provision imposing a penalty for failing to disclose 
reportable transactions applies to returns the due date for 
which is after the date of enactment.

 6. Investor lists and applicable penalties (secs. 611 and 613 of the 
               bill and secs. 6112 and 6708 of the Code)


                              PRESENT LAW

Investor lists

    A promoter must maintain (for a period of seven years) a 
list identifying each person who was sold an interest in any 
tax shelter with respect to which registration was required 
under section 6111 (even though the particular party may not 
have been subject to confidentiality 
restrictions).155 Regulations under section 6112 
provide that, in addition to the name, tax shelter 
identification number and other identifying information the 
promoter must include detailed information about the tax 
shelter (including details of the shelter and the expected tax 
benefits, as well as copies of any additional written material 
given to any participant or advisor).156 A limited 
exception is provided for certain shelters if the total fees 
are less than $25,000 or if the expected reduction in tax 
liabilities for any single year is less than $1 million for 
corporations or $250,000 for non-corporate 
taxpayers.157 The Secretary is required to prescribe 
regulations which provide that, in cases in which 2 or more 
persons are required to maintain the same list, only one person 
would be required to maintain the list.158
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    \155\ Sec. 6112.
    \156\ See Temp. Treas. Reg. sec. 301.6112-1T Q&A 17.
    \157\ See Temp. Treas. Reg. sec. 301-6112-1T Q&A 8.
    \158\ Sec. 6112(c)(2).
---------------------------------------------------------------------------

Penalties for failing to maintain investor lists

    Under section 6708, the penalty for failing to maintain the 
list required under section 6112 is $50 for each name omitted 
from the list (with a maximum penalty of $100,000 per year).

                           REASONS FOR CHANGE

    The Committee has been advised that the present-law 
penalties for failure to maintain customer lists are not 
meaningful and that promoters often have refused to provide 
requested information to the IRS. The Committee believes that 
requiring material advisors to maintain a list of advisees with 
respect to each reportable transaction, coupled with more 
meaningful penalties for failing to maintain an investor list, 
are important tools in the ongoing efforts to curb the use of 
abusive tax avoidance transactions. Furthermore, these 
provisions are consistent with the course of action outlined in 
the Treasury shelter initiative.159
---------------------------------------------------------------------------
    \159\ The Treasury Department's enforcement proposals for abusive 
tax avoidance transactions are described in greater detail above in 
connection with the penalty for failing to disclose reportable 
transactions (new sec. 6707A).
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

Investor lists

    Each material advisor 160 that is required to 
file an information return with respect to a reportable 
transaction 161 is required to maintain a list that 
(1) identifies each person with respect to whom the advisor 
acted as a material advisor with respect to the reportable 
transaction, and (2) contains other information as may be 
required by the Secretary. In addition, the provision 
authorizes (but does not require) the Secretary to prescribe 
regulations which provide that, in cases in which 2 or more 
persons are required to maintain the same list, only one person 
would be required to maintain the list.
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    \160\ The term ``material advisor'' has the same meaning as when 
used in connection with the requirement to file an information return 
under section 6111.
    \161\ The term ``reportable transaction'' has the same meaning as 
previously described in connection with the taxpayer-related 
provisions.
---------------------------------------------------------------------------

Penalty for failing to maintain investor lists

    The provision modifies the penalty for failing to maintain 
the required list by making it a time-sensitive penalty. Thus, 
a material advisor who is required to maintain an investor list 
and who fails to make the list available upon request by the 
Secretary within 20 business days after the request will be 
subject to a $10,000 per day penalty. The penalty applies to a 
person who fails to maintain a list, maintains an incomplete 
list, or has in fact maintained a list but does not make the 
list available to the Secretary. The penalty can be waived if 
the failure to make the list available is due to reasonable 
cause.162
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    \162\ In no event will failure to maintain a list be considered 
reasonable cause for failing to make a list available to the Secretary.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision requiring a material advisor to maintain an 
investor list applies to transactions with respect to which 
material aid, assistance or advice is provided after the date 
of enactment.
    The provision imposing a penalty for failing to maintain 
investor lists applies to requests made after the date of 
enactment.

7. Actions to enjoin conduct with respect to tax shelters (sec. 614 of 
                  the bill and sec. 7408 of the Code)


                              PRESENT LAW

    The Code authorizes civil action to enjoin any person from 
promoting abusive tax shelters or aiding or abetting the 
understatement of tax liability.163
---------------------------------------------------------------------------
    \163\ Sec. 7408.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee understands that some promoters are blatantly 
ignoring the rules regarding registration and list maintenance 
regardless of the penalties. An injunction would place these 
promoters in a public proceeding under court order. Thus, the 
Committee believes that the types of tax shelter activities 
with respect to which an injunction may be sought should be 
expanded.

                        EXPLANATION OF PROVISION

    The bill expands this rule so that injunctions may also be 
sought with respect to the requirements relating to the 
reporting of tax shelters 164 and the keeping of 
lists of investors by material advisors.\165\ Thus, under the 
provision, an injunction may be sought against a material 
advisor to enjoin the advisor from (1) failing to file an 
information return with respect to a reportable transaction, or 
(2) failing to maintain, or to timely furnish upon written 
request by the Secretary, a list of investors with respect to 
each reportable transaction.
---------------------------------------------------------------------------
    \164\ Sec. 6707, as amended by other provisions of this bill.
    \165\ Sec. 6708, as amended by other provisions of this bill.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision is effective on the day after the date of 
enactment.

8. Understatement of taxpayer's liability by income tax return preparer 
        (sec. 621 of the bill and sec. 6694 of the Code)

                              PRESENT LAW

    An income tax return preparer who prepares a return with 
respect to which there is an understatement of tax that is due 
to a position for which there was not a realistic possibility 
of being sustained on its merits and the position was not 
disclosed (or was frivolous) is liable for a penalty of $250, 
provided that the preparer knew or reasonably should have known 
of the position. An income tax return preparer who prepares a 
return and engages in specified willful or reckless conduct 
with respect to preparing such a return is liable for a penalty 
of $1,000.

                           REASONS FOR CHANGE

    The Committee believes that the standards of conduct 
applicable to income tax return preparers should be the same as 
the standards applicable to taxpayers. Accordingly, the minimum 
standard for each undisclosed position on a tax return would be 
that the preparer must reasonably believe that the tax 
treatment is more likely than not the proper tax treatment. The 
Committee believes that this standard is appropriate because 
the tax return is signed under penalties of perjury, which 
implies a high standard of diligence in determining the facts 
and substantial accuracy in determining and applying the rules 
that govern those facts. The Committee believes that it is both 
appropriate and vital to the tax system that both taxpayers and 
their return preparers file tax returns that they reasonably 
believe are more likely than not correct. In addition, 
conforming the standards of conduct applicable to income tax 
return preparers to the standards applicable to taxpayers will 
simplify the law by reducing confusion inherent in different 
standards applying to the same behavior.

                        EXPLANATION OF PROVISION

    The bill alters the standards of conduct that must be met 
to avoid imposition of the first penalty. The bill replaces the 
realistic possibility standard with a requirement that there be 
a reasonable belief that the tax treatment of the position was 
more likely than not the proper treatment. The bill also 
replaces the not frivolous standard with the requirement that 
there be a reasonable basis for the tax treatment of the 
position.
    In addition, the bill increases the amount of these 
penalties. The penalty relating to not having a reasonable 
belief that the tax treatment was more likely than not the 
proper tax treatment is increased from $250 to $1,000. The 
penalty relating to willful or reckless conduct is increased 
from $1,000 to $5,000.

                             EFFECTIVE DATE

    The provision is effective for documents prepared after the 
date of enactment.

9. Penalty on failure to report interests in foreign financial accounts 
  (sec. 622 of the bill and sec. 5321 of Title 31, United States Code)


                              PRESENT LAW

    The Secretary of the Treasury must require citizens, 
residents, or persons doing business in the United States to 
keep records and file reports when that person makes a 
transaction or maintains an account with a foreign financial 
entity.\166\ In general, individuals must fulfill this 
requirement by answering questions regarding foreign accounts 
or foreign trusts that are contained in Part III of Schedule B 
of the IRS Form 1040. Taxpayers who answer ``yes'' in response 
to the question regarding foreign accounts must then file 
Treasury Department Form TD F 90-22.1. This form must be filed 
with the Department of the Treasury, and not as part of the tax 
return that is filed with the IRS.
---------------------------------------------------------------------------
    \166\ 31 U.S.C. 5314.
---------------------------------------------------------------------------
    The Secretary of the Treasury may impose a civil penalty on 
any person who willfully violates this reporting requirement. 
The civil penalty is the amount of the transaction or the value 
of the account, up to a maximum of $100,000; the minimum amount 
of the penalty is $25,000.\167\ In addition, any person who 
willfully violates this reporting requirement is subject to a 
criminal penalty. The criminal penalty is a fine of not more 
than $250,000 or imprisonment for not more than five years (or 
both); if the violation is part of a pattern of illegal 
activity, the maximum amount of the fine is increased to 
$500,000 and the maximum length of imprisonment is increased to 
10 years.\168\
---------------------------------------------------------------------------
    \167\ 31 U.S.C. 5321(a)(5).
    \168\ 31 U.S.C. 5322.
---------------------------------------------------------------------------
    On April 26, 2002, the Secretary of the Treasury submitted 
to the Congress a report on these reporting requirements.\169\ 
This report, which was statutorily required,\170\ studies 
methods for improving compliance with these reporting 
requirements. It makes several administrative recommendations, 
but no legislative recommendations. A further report is 
required to be submitted by the Secretary of the Treasury to 
the Congress by October 26, 2002.
---------------------------------------------------------------------------
    \169\ A Report to Congress in Accordance with Sec. 361(b) of the 
Uniting and Strengthening America by Providing Appropriate Tools 
Required to Intercept and Obstruct Terrorism Act of 2001, April 26, 
2002.
    \170\ Sec. 361(b) of the USA PATRIOT Act of 2001 (Pub. L. 107-56).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee understands that the number of individuals 
involved in using offshore bank accounts to engage in abusive 
tax scams has grown significantly in recent years. For one 
scheme alone, the IRS estimates that there may be one to two 
million taxpayers with offshore bank accounts attempting to 
conceal income from the IRS. The Committee is concerned about 
this activity and believes that improving compliance with this 
reporting requirement is vitally important to sound tax 
administration, to combating terrorism, and to preventing the 
use of abusive tax schemes and scams. Adding a new civil 
penalty that applies without regard to willfulness will improve 
compliance with this reporting requirement.

                        EXPLANATION OF PROVISION

    The bill adds an additional civil penalty that may be 
imposed on any person who violates this reporting requirement 
(without regard to willfulness). This new civil penalty is up 
to $5,000. The penalty may be waived if any income from the 
account was properly reported on the income tax return and 
there was reasonable cause for the failure to report.

                             EFFECTIVE DATE

    The provision is effective with respect to failures to 
report occurring on or after the date of enactment.

  10. Frivolous tax returns and submissions (sec. 623 of the bill and 
                         sec. 6702 of the Code)


                              PRESENT LAW

    The Code provides that an individual who files a frivolous 
income tax return is subject to a penalty of $500 imposed by 
the IRS (sec. 6702). The Code also permits the Tax Court \171\ 
to impose a penalty of up to $25,000 if a taxpayer has 
instituted or maintained proceedings primarily for delay or if 
the taxpayer's position in the proceeding is frivolous or 
groundless (sec. 6673(a)).
---------------------------------------------------------------------------
    \171\ Because in general the Tax Court is the only pre-payment 
forum available to taxpayers, it deals with most of the frivolous, 
groundless, or dilatory arguments raised in tax cases.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The IRS has been faced with a significant number of tax 
filers who are filing returns based on frivolous arguments or 
who are seeking to hinder tax administration by filing returns 
that are patently incorrect. In addition, taxpayers are using 
existing procedures for collection due process hearings, 
offers-in-compromise, installment agreements, and taxpayer 
assistance orders to impede or delay tax administration by 
raising frivolous arguments. These procedures were intended to 
provide assistance to taxpayers genuinely seeking to resolve 
legitimate disputes with the IRS, and the use of these 
procedures for impeding or delaying tax administration diverts 
scarce IRS resources away from resolving genuine disputes. 
Allowing the IRS to assert more substantial penalties for 
frivolous submissions and to dismiss frivolous requests without 
the need to follow otherwise mandated procedures will deter 
frivolous taxpayer behavior and enable the IRS to use its 
resources to better assist taxpayers in resolving genuine 
disputes.

                        EXPLANATION OF PROVISION

    The bill modifies the IRS-imposed penalty by increasing the 
amount of the penalty to up to $5,000 and by applying it to all 
taxpayers and to all types of Federal taxes.
    The provision also modifies present law with respect to 
certain submissions that raise frivolous arguments or that are 
intended to delay or impede tax administration. The submissions 
to which this provision applies are requests for a collection 
due process hearing, installment agreements, offers-in-
compromise, and taxpayer assistance orders. First, the 
provision permits the IRS to dismiss such requests. Second, the 
provision permits the IRS to impose a penalty of up to $5,000 
for such requests, unless the taxpayer withdraws the request 
after being given an opportunity to do so.
    The provision requires the IRS to publish a list of 
positions, arguments, requests, and proposals determined to be 
frivolous for purposes of these provisions.

                             EFFECTIVE DATE

    The provision is effective for submissions made and issues 
raised after the date on which the Secretary first prescribes 
the required list.

 11. Regulation of individuals practicing before the Department of the 
Treasury (sec. 624 of the bill and sec. 330 of Title 31, United States 
                                 Code)


                              PRESENT LAW

    The Secretary of the Treasury is authorized to regulate the 
practice of representatives of persons before the Department of 
the Treasury.\172\ The Secretary is also authorized to suspend 
or disbar from practice before the Department a representative 
who is incompetent, who is disreputable, who violates the rules 
regulating practice before the Department, or who (with intent 
to defraud) willfully and knowingly misleads or threatens the 
person being represented (or a person who may be represented). 
The rules promulgated by the Secretary pursuant to this 
provision are contained in Circular 230.
---------------------------------------------------------------------------
    \172\ 31 U.S.C. 330.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is critical that the 
Secretary have the authority to censure tax advisors as well as 
to impose monetary sanctions against tax advisors because of 
the important role of tax advisors in our tax system. Use of 
these sanctions is expected to curb the participation of tax 
advisors in both tax shelter activity and any other activity 
that is contrary to Circular 230 standards.

                        EXPLANATION OF PROVISION

    The bill makes two modifications to expand the sanctions 
that the Secretary may impose pursuant to these statutory 
provisions. First, the bill expressly permits censure as a 
sanction.
    Second, the bill permits the imposition of a monetary 
penalty as a sanction. If the representative is acting on 
behalf of an employer or other entity, the Secretary may impose 
a monetary penalty on the employer or other entity if it knew, 
or reasonably should have known, of the conduct. This monetary 
penalty on the employer or other entity may be imposed in 
addition to any monetary penalty imposed directly on the 
representative. These monetary penalties are not to exceed the 
gross income derived (or to be derived) from the conduct giving 
rise to the penalty. These monetary penalties may be in 
addition to, or in lieu of, any suspension, disbarment, or 
censure.
    The bill also confirms the present-law authority of the 
Secretary to impose standards applicable to written advice with 
respect to an entity, plan, or arrangement that is of a type 
that the Secretary determines as having a potential for tax 
avoidance or evasion.

                             EFFECTIVE DATE

    The modifications to expand the sanctions that the 
Secretary may impose are effective for actions taken after the 
date of enactment.

 12. Penalties on promoters of tax shelters (sec. 625 of the bill and 
                         sec. 6700 of the Code)


                              PRESENT LAW

    A penalty is imposed on any person who organizes, assists 
in the organization of, or participates in the sale of any 
interest in, a partnership or other entity, any investment plan 
or arrangement, or any other plan or arrangement, if in 
connection with such activity the person makes or furnishes a 
qualifying false or fraudulent statement or a gross valuation 
overstatement.\173\ A qualified false or fraudulent statement 
is any statement with respect to the allowability of any 
deduction or credit, the excludability of any income, or the 
securing of any other tax benefit by reason of holding an 
interest in the entity or participating in the plan or 
arrangement which the person knows or has reason to know is 
false or fraudulent as to any material matter. A ``gross 
valuation overstatement'' means any statement as to the value 
of any property or services if the stated value exceeds 200 
percent of the correct valuation, and the value is directly 
related to the amount of any allowable income tax deduction or 
credit.
---------------------------------------------------------------------------
    \173\ Sec. 6700.
---------------------------------------------------------------------------
    The amount of the penalty is $1,000 (or, if the person 
establishes that it is less, 100 percent of the gross income 
derived or to be derived by the person from such activity). A 
penalty attributable to a gross valuation misstatement can be 
waived on a showing that there was a reasonable basis for the 
valuation and it was made in good faith.

                           REASONS FOR CHANGE

    The Committee believes that the present-law penalty rate is 
insufficient to deter the type of conduct that gives rise to 
the penalty.

                        EXPLANATION OF PROVISION

    The provision modifies the penalty amount to equal 50 
percent of the gross income derived by the person from the 
activity for which the penalty is imposed. The new penalty rate 
applies to any activity that involves a statement regarding the 
tax benefits of participating in a plan or arrangement if the 
person knows or has reason to know that such statement is false 
or fraudulent as to any material matter. The enhanced penalty 
does not apply to a gross valuation overstatement.

                             EFFECTIVE DATE

    The provision is effective for activities after the date of 
enactment.

 13. Affirmation of consolidated return regulation authority (sec. 631 
                 of the bill and sec. 1502 of the Code)


                              PRESENT LAW

    An affiliated group of corporations may elect to file a 
consolidated return in lieu of separate returns. A condition of 
electing to file a consolidated return is that all corporations 
that are members of the consolidated group must consent to all 
the consolidated return regulations prescribed under section 
1502 prior to the last day prescribed by law for filing such 
return.\174\
---------------------------------------------------------------------------
    \174\ Sec. 1501.
---------------------------------------------------------------------------
    Section 1502 states:

          The Secretary shall prescribe such regulations as he 
        may deem necessary in order that the tax liability of 
        any affiliated group of corporations making a 
        consolidated return and of each corporation in the 
        group, both during and after the period of affiliation, 
        may be returned, determined, computed, assessed, 
        collected, and adjusted, in such manner as clearly to 
        reflect the income-tax liability and the various 
        factors necessary for the determination of such 
        liability, and in order to prevent the avoidance of 
        such tax liability.\175\
---------------------------------------------------------------------------
    \175\ Sec. 1502.

    Under this authority, the Treasury Department has issued 
extensive consolidated return regulations.\176\
---------------------------------------------------------------------------
    \176\ Regulations issued under the authority of section 1502 are 
considered to be ``legislative'' regulations rather than 
``interpretative'' regulations, and as such are usually given greater 
deference by courts in case of a taxpayer challenge to such a 
regulation. See, S. Rep. No. 960, 70th Cong., 1st Sess. at 15, 
describing the consolidated return regulations as ``legislative in 
character''. The Supreme Court has stated that ``. . . legislative 
regulations are given controlling weight unless they are arbitrary, 
capricious, or manifestly contrary to the statute.'' Chevron, U.S.A., 
Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844 
(1984) (involving an environmental protection regulation). For examples 
involving consolidated return regulations, see, e.g., Wolter 
Construction Company v. Commissioner, 634 F.2d 1029 (6th Cir. 1980); 
Garvey, Inc. v. United States, 1 Ct. Cl. 108 (1983), aff'd 726 F.2d 
1569 (Fed. Cir. 1984), cert. denied 469 U.S. 823 (1984). Compare, e.g., 
Audrey J. Walton v. Commissioner, 115 T.C. 589 (2000), describing 
different standards of review. The case did not involve a consolidated 
return regulation.
---------------------------------------------------------------------------
    In the recent case of Rite Aid Corp. v. United States,\177\ 
the Federal Circuit Court of Appeals addressed the application 
of a particular provision of certain consolidated return loss 
disallowance regulations, and concluded that the provision was 
invalid.\178\ The particular provision, known as the 
``duplicated loss'' provision,\179\ would have denied a loss on 
the sale of stock of a subsidiary by a parent corporation that 
had filed a consolidated return with the subsidiary, to the 
extent the subsidiary corporation had assets that had a built-
in loss, or had a net operating loss, that could be recognized 
or used later.\180\
---------------------------------------------------------------------------
    \177\ 255 F.3d 1357 (Fed. Cir. 2001), reh'g denied, 2001 U.S. App. 
LEXIS 23207 (Fed. Cir. Oct. 3, 2001).
    \178\ Prior to this decision, there had been a few instances 
involving prior laws in which certain consolidated return regulations 
were held to be invalid. See, e.g., American Standard, Inc. v. United 
States, 602 F.2d 256 (Ct. Cl. 1979), discussed in the text infra. see 
also Union Carbide Corp. v. United States, 612 F.2d 558 (Ct. Cl. 1979), 
and Allied Corporation v. United States, 685 F. 2d 396 (Ct. Cl. 1982), 
all three cases involving the allocation of income and loss within a 
consolidated group for purposes of computation of a deduction allowed 
under prior law by the Code for Western Hemisphere Trading 
Corporations. . See also Joseph Weidenhoff v. Commissioner, 32 T.C. 
1222, 1242-1244 (1959), involving the application of certain 
regulations to the excess profits tax credit allowed under prior law, 
and concluding that the Commissioner had applied a particular 
regulation in an arbitrary manner inconsistent with the wording of the 
regulation and inconsistent with even a consolidated group computation. 
Cf. Kanawha Gas & Utilities Co. v. Commissioner, 214 F.2d 685 (1954), 
concluding that the substance of a transaction was an acquisition of 
assets rather than stock. Thus, a regulation governing basis of the 
assets of consolidated subsidiaries did not apply to the case. See also 
General Machinery Corporation v. Commissioner, 33 B.T.A. 1215 (1936); 
Lefcourt Realty Corporation, 31 B.T.A. 978 (1935); Helvering v. 
Morgans, Inc., 293 U.S. 121 (1934), interpreting the term ``taxable 
year.''
    \179\ Treas. Reg. Sec. 1.1502-20(c)(1)(iii).
    \180\ Treasury Regulation section 1.1502-20, generally imposing 
certain ``loss disallowance'' rules on the disposition of subsidiary 
stock, contained other limitations besides the ``duplicated loss'' rule 
that could limit the loss available to the group on a disposition of a 
subsidiary's stock. Treasury Regulation section 1.1502-20 as a whole 
was promulgated in connection with regulations issued under section 
337(d), principally in connection with the so-called General Utilities 
repeal of 1986 (referring to the case of General Utilities & Operating 
Company v. Helvering, 296 U.S. 200 (1935)). Such repeal generally 
required a liquidating corporation, or a corporation acquired in a 
stock acquisition treated as a sale of assets, to pay corporate level 
tax on the excess of the value of its assets over the basis. Treasury 
regulation section 1.1502-20 principally reflected an attempt to 
prevent corporations filing consolidated returns from offsetting income 
with a loss on the sale of subsidiary stock. Such a loss could result 
from the unique upward adjustment of a subsidiary's stock basis 
required under the consolidated return regulations for subsidiary 
income earned in consolidation, an adjustment intended to prevent 
taxation of both the subsidiary and the parent on the same income or 
gain. As one example, absent a denial of certain losses on a sale of 
subsidiary stock, a consolidated group could obtain a loss deduction 
with respect to subsidiary stock, the basis of which originally 
reflected the subsidiary's value at the time of the purchase of the 
stock, and that had then been adjusted upward on recognition of any 
built-in income or gain of the subsidiary reflected in that value. The 
regulations also contained the duplicated loss factor addressed by the 
court in Rite Aid. The preamble to the regulations stated: ``it is not 
administratively feasible to differentiate between loss attributable to 
built-in gain and duplicated loss.'' T.D. 8364, 1991-2 C.B. 43, 46 
(Sept. 13, 1991). The government also argued in the Rite Aid case that 
duplicated loss was a separate concern of the regulations. 255 F.3d at 
1360.
---------------------------------------------------------------------------
    The Federal Circuit Court opinion contained language 
discussing the fact that the regulation produced a result 
different than the result that would have obtained if the 
corporations had filed separate returns rather than 
consolidated returns.\181\
---------------------------------------------------------------------------
    \181\ For example, the court stated: ``The duplicated loss factor . 
. . addresses a situation that arises from the sale of stock regardless 
of whether corporations file separate or consolidated returns. With 
I.R.C. secs. 382 and 383, Congress has addressed this situation by 
limiting the subsidiary's potential future deduction, not the parent's 
loss on the sale of stock under I.R.C. sec. 165.'' 255 F.3d 1357, 1360 
(Fed. Cir. 2001).
---------------------------------------------------------------------------
    The Federal Circuit Court opinion cited a 1928 Senate 
Finance Committee Report to legislation that authorized 
consolidated return regulations, which stated that ``many 
difficult and complicated problems, * * * have arisen in the 
administration of the provisions permitting the filing of 
consolidated returns'' and that the committee ``found it 
necessary to delegate power to the commissioner to prescribe 
regulations legislative in character covering them.'' \182\ The 
Court's opinion also cited a previous decision of the Court of 
Claims for the proposition, interpreting this legislative 
history, that section 1502 grants the Secretary ``the power to 
conform the applicable income tax law of the Code to the 
special, myriad problems resulting from the filing of 
consolidated income tax returns;'' but that section 1502 ``does 
not authorize the Secretary to choose a method that imposes a 
tax on income that would not otherwise be taxed.'' \183\
---------------------------------------------------------------------------
    \182\ S. Rep. No. 960, 70th Cong., 1st Sess. 15 (1928). Though not 
quoted by the court in Rite Aid, the same Senate report also indicated 
that one purpose of the consolidated return authority was to permit 
treatment of the separate corporations as if they were a single unit, 
stating ``The mere fact that by legal fiction several corporations 
owned by the same shareholders are separate entities should not obscure 
the fact that they are in reality one and the same business owned by 
the same individuals and operated as a unit.'' S. Rep. No. 960, 70th 
Cong., 1st Sess. 29 (1928).
    \183\ American Standard, Inc. v. United States, 602 F.2d 256, 261 
(Ct. Cl. 1979). That case did not involve the question of separate 
returns as compared to a single return approach. It involved the 
computation of a Western Hemisphere Trade Corporation (``WHTC'') 
deduction under prior law (which deduction would have been computed as 
a percentage of each WHTC's taxable income if the corporations had 
filed separate returns), in a case where a consolidated group included 
several WHTCs as well as other corporations. The question was how to 
apportion income and losses of the admittedly consolidated WHTCs and 
how to combine that computation with the rest of the group's 
consolidated income or losses. The court noted that the new, changed 
regulations approach varied from the approach taken to a similar 
problem involving public utilities within a group and previously 
allowed for WHTCs. The court objected that the allocation method 
adopted by the regulation allowed non-WHTC losses to reduce WHTC 
income. However, the court did not disallow a method that would net 
WHTC income of one WHTC with losses of another WHTC, a result that 
would not have occurred under separate returns. Nor did the court 
expressly disallow a different fractional method that would net both 
income and losses of the WHTCs with those of other corporations in the 
consolidated group. The court also found that the regulation had been 
adopted without proper notice.
---------------------------------------------------------------------------
    The Federal Circuit Court construed these authorities and 
applied them to invalidate Treas. Reg. Sec. 1.1502-
20(c)(1)(iii), stating that:

          The loss realized on the sale of a former 
        subsidiary's assets after the consolidated group sells 
        the subsidiary's stock is not a problem resulting from 
        the filing of consolidated income tax returns. The 
        scenario also arises where a corporate shareholder 
        sells the stock of a non-consolidated subsidiary. The 
        corporate shareholder could realize a loss under I.R.C. 
        sec. 1001, and deduct the loss under I.R.C. sec. 165. 
        The subsidiary could then deduct any losses from a 
        later sale of assets. The duplicated loss factor, 
        therefore, addresses a situation that arises from the 
        sale of stock regardless of whether corporations file 
        separate or consolidated returns. With I.R.C. secs. 382 
        and 383, Congress has addressed this situation by 
        limiting the subsidiary's potential future deduction, 
        not the parent's loss on the sale of stock under I.R.C. 
        sec. 165.\184\
---------------------------------------------------------------------------
    \184\ Rite Aid, 255 F.3d at 1360.

    The Treasury Department has announced that it will not 
continue to litigate the validity of the duplicated loss 
provision of the regulations, and has issued interim 
regulations that permit taxpayers for all years to elect a 
different treatment, though they may apply the provision for 
the past if they wish.\185\
---------------------------------------------------------------------------
    \185\ See Temp. Reg. 1.1502-20T(i)(2). The Treasury Department has 
also indicated its intention to continue to study all the issues that 
the original loss disallowance regulations addressed (including issues 
of furthering single entity principles) and possibly issue different 
regulations (not including the particular approach of Treas. Reg. Sec. 
1.1502-20(c)(1)(iii)) on the issues in the future. See Notice 2002-11, 
2002-7 I.R.B. 526 (Feb. 19, 2002); T.D. 8984, 67 F.R. 11034 (March 12, 
2002); REG-102740-02, 67 F.R. 11070 (March 12, 2002); see also Notice 
2002-18, 2002-12 I.R.B. 644 (March 25, 2002).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee is concerned that the language and analysis 
in the Rite Aid decision might lead taxpayers to attempt to 
challenge other Treasury consolidated return regulations that 
prescribe a tax result different from the result that would 
occur if separate returns were filed.
    The Committee is concerned that any such challenges may 
lead to protracted litigation and commitment of Internal 
Revenue Service resources to defending the consolidated return 
provisions.
    The Committee wishes to clarify that the fact that a result 
under the consolidated return regulations differs from the 
result under separate returns does not provide a basis to 
challenge a Treasury consolidated return regulation.
    The Committee believes that the result of the case with 
respect to the type of factual situation in Rite Aid, involving 
the ``duplicated loss factor'' portion of Treasury Regulation 
section 1.1502-20, which Treasury has announced that taxpayers 
need not follow, should not be overturned. Therefore, the 
committee legislatively allows the specific result of the case 
to stand for the taxpayer in Rite Aid or any similarly situated 
taxpayers.
    Apart from that specific result, the Committee disagrees 
with the reasoning of the case and believes it should not be 
applied to support any challenge to other consolidated return 
regulations. The Committee also wishes to reaffirm the broad 
authority of the Treasury Department to issue consolidated 
return regulations.

                        EXPLANATION OF PROVISION

    The provision confirms that, in exercising its authority 
under section 1502 to issue consolidated return regulations, 
the Treasury Department may provide rules treating corporations 
filing consolidated returns differently from corporations 
filing separate returns.
    Thus, under the statutory authority of section 1502, the 
Treasury Department is authorized to issue consolidated return 
regulations utilizing either a single taxpayer or separate 
taxpayer approach or a combination of the two approaches, as 
Treasury deems necessary in order that the tax liability of any 
affiliated group of corporations making a consolidated return, 
and of each corporation in the group, both during and after the 
period of affiliation, may be determined and adjusted in such 
manner as clearly to reflect the income-tax liability and the 
various factors necessary for the determination of such 
liability, and in order to prevent avoidance of such liability.
    Rite Aid is thus overruled to the extent it suggests that 
there is not a problem that can be addressed in consolidated 
return regulations if application of a particular Code 
provision on a separate taxpayer basis would produce a result 
different from single taxpayer principles that may be used for 
consolidation.
    The provision nevertheless allows the result of the Rite 
Aid case to stand with respect to the type of factual situation 
presented in the case. That is, the legislation provides for 
the override of the regulatory provision that took the approach 
of denying a loss on a deconsolidating disposition of stock of 
a consolidated subsidiary \186\ to the extent the subsidiary 
had net operating losses or built in losses that could be used 
later outside the group.\187\
---------------------------------------------------------------------------
    \186\ Treas. Reg. Sec. 1.1502-20(c)(1)(iii).
    \187\ The Committee does not intend to overrule the current 
Treasury Department regulations, which allow taxpayers for the past to 
follow Treasury Regulations Section 1.1502-20(c)(1)(iii), if they 
choose to do so. Temp. Reg. Sec. 1.1502-20T(i)(2).
---------------------------------------------------------------------------
    Retaining the result in the Rite Aid case with respect to 
the particular regulation section 1.1502-20(c)(1)(iii) as 
applied to the factual situation of the case does not in any 
way prevent or invalidate the various approaches Treasury has 
announced it will apply or that it intends to consider in lieu 
of the approach of that regulation, including, for example, the 
denial of a loss on a stock sale if inside losses of a 
subsidiary may also be used by the consolidated group, and the 
possible requirement that inside attributes be adjusted when a 
subsidiary leaves a group.\188\
---------------------------------------------------------------------------
    \188\ See, e.g., Notice 2002-11, 2002-7 I.R.B. 526 (Feb. 19, 2002); 
T.D. 8984, 67 F.R. 11034 (Mar.12, 2002); REG-102740-02, 67 F.R. 11070 
(Mar.12, 2002); see also Notice 2002-18, 2002-12 I.R.B. 644 (Mar. 25, 
2002). In exercising its authority under section 1502, the Secretary is 
also authorized to prescribe rules that protect the purpose of General 
Utilities repeal using presumptions and other simplifying conventions.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision is effective for all years, whether beginning 
before, on, or after the date of enactment of the provision.
    No inference is intended that the results following from 
this provision are not the same as the results under present 
law.

               B. Tax Treatment of Inversion Transactions


(Sec. 641 of the bill and new sec. 7874 of the Code)

                              PRESENT LAW

Determination of corporate residence

    The U.S. tax treatment of a multinational corporate group 
depends significantly on whether the top-tier ``parent'' 
corporation of the group is domestic or foreign. For purposes 
of U.S. tax law, a corporation is treated as domestic if it is 
incorporated under the law of the United States or of any 
State. All other corporations (i.e., those incorporated under 
the laws of foreign countries) are treated as foreign. Thus, 
place of incorporation determines whether a corporation is 
treated as domestic or foreign for purposes of U.S. tax law, 
irrespective of other factors that might be thought to bear on 
a corporation's ``nationality,'' such as the location of the 
corporation's management activities, employees, business 
assets, operations, or revenue sources, the exchanges on which 
the corporation's stock is traded, or the residence of the 
corporation's managers and shareholders.

U.S. taxation of domestic corporations

    The United States employs a ``worldwide'' tax system, under 
which domestic corporations generally are taxed on all income, 
whether derived in the United States or abroad. In order to 
mitigate the double taxation that may arise from taxing the 
foreign-source income of a domestic corporation, a foreign tax 
credit for income taxes paid to foreign countries is provided 
to reduce or eliminate the U.S. tax owed on such income, 
subject to certain limitations.
    Income earned by a domestic parent corporation from foreign 
operations conducted by foreign corporate subsidiaries 
generally is subject to U.S. tax when the income is distributed 
as a dividend to the domestic corporation. Until such 
repatriation, the U.S. tax on such income is generally 
deferred. However, certain anti-deferral regimes may cause the 
domestic parent corporation to be taxed on a current basis in 
the United States with respect to certain categories of passive 
or highly mobile income earned by its foreign subsidiaries, 
regardless of whether the income has been distributed as a 
dividend to the domestic parent corporation. The main anti- 
deferral regimes in this context are the controlled foreign 
corporation rules of subpart F (sections 951-964) and the 
passive foreign investment company rules (sections 1291-1298). 
A foreign tax credit is generally available to offset, in whole 
or in part, the U.S. tax owed on this foreign-source income, 
whether repatriated as an actual dividend or included under one 
of the anti-deferral regimes.

U.S. taxation of foreign corporations

    The United States taxes foreign corporations only on income 
that has a sufficient nexus to the United States. Thus, a 
foreign corporation is generally subject to U.S. tax only on 
income that is ``effectively connected'' with the conduct of a 
trade or business in the United States. Such ``effectively 
connected income'' generally is taxed in the same manner and at 
the same rates as the income of a U.S. corporation. An 
applicable tax treaty may limit the imposition of U.S. tax on 
business operations of a foreign corporation to cases in which 
the business is conducted through a ``permanent establishment'' 
in the United States.
    In addition, foreign corporations generally are subject to 
a gross-basis U.S. tax at a flat 30-percent rate on the receipt 
of interest, dividends, rents, royalties, and certain similar 
types of income derived from U.S. sources, subject to certain 
exceptions. The tax generally is collected by means of 
withholding by the person making the payment. This tax may be 
reduced or eliminated under an applicable tax treaty.

U.S. tax treatment of inversion transactions

    Under present law, U.S. corporations may reincorporate in 
foreign jurisdictions and thereby replace the U.S. parent 
corporation of a multinational corporate group with a foreign 
parent corporation. These transactions are commonly referred to 
as ``inversion'' transactions. Inversion transactions may take 
many different forms, including stock inversions, asset 
inversions, and various combinations of and variations on the 
two. Most of the known transactions to date have been stock 
inversions. In one example of a stock inversion, a U.S. 
corporation forms a foreign corporation, which in turn forms a 
domestic merger subsidiary. The domestic merger subsidiary then 
merges into the U.S. corporation, with the U.S. corporation 
surviving, now as a subsidiary of the new foreign corporation. 
The U.S. corporation's shareholders receive shares of the 
foreign corporation and are treated as having exchanged their 
U.S. corporation shares for the foreign corporation shares. An 
asset inversion reaches a similar result, but through a direct 
merger of the top-tier U.S. corporation into a new foreign 
corporation, among other possible forms. An inversion 
transaction may be accompanied or followed by further 
restructuring of the corporate group. For example, in the case 
of a stock inversion, in order to remove income from foreign 
operations from the U.S. taxing jurisdiction, the U.S. 
corporation may transfer some or all of its foreign 
subsidiaries directly to the new foreign parent corporation or 
other related foreign corporations.
    In addition to removing foreign operations from the U.S. 
taxing jurisdiction, the corporate group may derive further 
advantage from the inverted structure by reducing U.S. tax on 
U.S.-source income through various ``earnings stripping'' or 
other transactions. This may include earnings stripping through 
payment by a U.S. corporation of deductible amounts such as 
interest, royalties, rents, or management service fees to the 
new foreign parent or other foreign affiliates. In this 
respect, the post-inversion structure enables the group to 
employ the same tax-reduction strategies that are available to 
other multinational corporate groups with foreign parents and 
U.S. subsidiaries, subject to the same limitations. These 
limitations under present law include section 163(j), which 
limits the deductibility of certain interest paid to related 
parties, if the payor's debt-equity ratio exceeds 1.5 to 1 and 
the payor's net interest expense exceeds 50 percent of its 
``adjusted taxable income.'' More generally, section 482 and 
the regulations thereunder require that all transactions 
between related parties be conducted on terms consistent with 
an ``arm's length'' standard, and permit the Secretary of the 
Treasury to reallocate income and deductions among such parties 
if that standard is not met.
    Inversion transactions may give rise to immediate U.S. tax 
consequences at the shareholder and/or the corporate level, 
depending on the type of inversion. In stock inversions, the 
U.S. shareholders generally recognize gain (but not loss) under 
section 367(a), based on the difference between the fair market 
value of the foreign corporation shares received and the 
adjusted basis of the domestic corporation stock exchanged. To 
the extent that a corporation's share value has declined, and/
or it has many foreign or tax-exempt shareholders, the impact 
of this section 367(a) ``toll charge'' is reduced. The transfer 
of foreign subsidiaries or other assets to the foreign parent 
corporation also may give rise to U.S. tax consequences at the 
corporate level (e.g., gain recognition and earnings and 
profits inclusions under sections 1001, 311(b), 304, 367, 1248 
or other provisions). The tax on any income recognized as a 
result of these restructurings may be reduced or eliminated 
through the use of net operating losses, foreign tax credits, 
and other tax attributes.
    In asset inversions, the U.S. corporation generally 
recognizes gain (but not loss) under section 367(a) as though 
it had sold all of its assets, but the shareholders generally 
do not recognize gain or loss, assuming the transaction meets 
the requirements of a reorganization under section 368.

                           REASONS FOR CHANGE

    The Committee believes that inversion transactions 
resulting in a minimal presence in a foreign country of 
incorporation are a means of avoiding U.S. tax and should be 
curtailed. In particular, these transactions permit 
corporations and other entities to continue to conduct business 
in the same manner as they did prior to the inversion, but with 
the result that the inverted entity avoids U.S. tax on foreign 
operations and may engage in earnings-stripping techniques to 
avoid U.S. tax on domestic operations. The Committee believes 
that certain inversion transactions (involving 80 percent or 
more identity of stock ownership) have little or no non-tax 
effect or purpose and should be disregarded for U.S. tax 
purposes. The Committee believes that other inversion 
transactions (involving more than 50 but less than 80 percent 
identity of stock ownership) may have sufficient non-tax effect 
and purpose to be respected, but warrant heightened scrutiny 
and other restrictions to ensure that the U.S. tax base is not 
eroded through related-party transactions.

                        EXPLANATION OF PROVISION

In general

    The provision defines two different types of corporate 
inversion transactions and establishes a different set of 
consequences for each type. Certain partnership transactions 
also are covered.

Transactions involving at least 80 percent identity of stock ownership

    The first type of inversion is a transaction in which, 
pursuant to a plan or a series of related transactions: (1) a 
U.S. corporation becomes a subsidiary of a foreign-incorporated 
entity or otherwise transfers substantially all of its 
properties to such an entity; (2) the former shareholders of 
the U.S. corporation hold (by reason of holding stock in the 
U.S. corporation) 80 percent or more (by vote or value) of the 
stock of the foreign-incorporated entity after the transaction; 
and (3) the foreign-incorporated entity, considered together 
with all companies connected to it by a chain of greater than 
50 percent ownership (i.e., the ``expanded affiliated group''), 
does not have substantial business activities in the entity's 
country of incorporation, compared to the total worldwide 
business activities of the expanded affiliated group. The 
provision denies the intended tax benefits of this type of 
inversion by deeming the top-tier foreign corporation to be a 
domestic corporation for all purposes of the Code.\189\
---------------------------------------------------------------------------
    \189\ Since the top-tier foreign corporation would be treated for 
all purposes of the Code as domestic, the shareholder-level ``toll 
charge'' of sec. 367(a) would not apply to these inversion 
transactions.
---------------------------------------------------------------------------
    In determining whether a transaction would meet the 
definition of an inversion under the provision, stock held by 
members of the expanded affiliated group that includes the 
foreign incorporated entity is disregarded. For example, if the 
former top-tier U.S. corporation receives stock of the foreign 
incorporated entity (e.g., so-called ``hook'' stock), the stock 
would not be considered in determining whether the transaction 
meets the definition. Similarly, if a U.S. parent corporation 
converts an existing wholly owned U.S. subsidiary into a new 
wholly owned controlled foreign corporation, the stock of the 
new foreign corporation would be disregarded. Stock sold in a 
public offering related to the transaction also is disregarded 
for these purposes.
    Transfers of properties or liabilities as part of a plan a 
principal purpose of which is to avoid the purposes of the 
provision are disregarded. In addition, the Treasury Secretary 
is granted authority to prevent the avoidance of the purposes 
of the provision, including avoidance through the use of 
related persons, pass-through or other noncorporate entities, 
or other intermediaries, and through transactions designed to 
qualify or disqualify a person as a related person or a member 
of an expanded affiliated group. Similarly, the Treasury 
Secretary is granted authority to treat certain non-stock 
instruments as stock, and certain stock as not stock, where 
necessary to carry out the purposes of the provision.

Transactions involving greater than 50 percent but less than 80 percent 
        identity of stock ownership

    The second type of inversion is a transaction that would 
meet the definition of an inversion transaction described 
above, except that the 80-percent ownership threshold is not 
met. In such a case, if a greater-than-50-percent ownership 
threshold is met, then a second set of rules applies to the 
inversion. Under these rules, the inversion transaction is 
respected (i.e., the foreign corporation is treated as 
foreign), but: (1) any applicable corporate-level ``toll 
charges'' for establishing the inverted structure may not be 
offset by tax attributes such as net operating losses or 
foreign tax credits; (2) the IRS is given expanded authority to 
monitor related-party transactions that may be used to reduce 
U.S. tax on U.S.-source income going forward; and (3) section 
163(j), relating to ``earnings stripping'' through related-
party debt, is strengthened. These measures generally apply for 
a 10-year period following the inversion transaction. In 
addition, inverting entities are required to provide 
information to shareholders or partners and the IRS with 
respect to the inversion transaction.
    With respect to ``toll charges,'' any applicable corporate-
level income or gain required to be recognized under sections 
304, 311(b), 367, 1001, 1248, or any other provision with 
respect to the transfer of controlled foreign corporation stock 
or other assets by a U.S. corporation as part of the inversion 
transaction or after such transaction to a related foreign 
person is taxable, without offset by any tax attributes (e.g., 
net operating losses or foreign tax credits). To the extent 
provided in regulations, this rule will not apply to certain 
transfers of inventory and similar transactions conducted in 
the ordinary course of the taxpayer's business.
    In order to enhance IRS monitoring of related-party 
transactions, the provision establishes a new pre-filing 
procedure. Under this procedure, the taxpayer will be required 
annually to submit an application to the IRS for an agreement 
that all return positions to be taken by the taxpayer with 
respect to related-party transactions comply with all relevant 
provisions of the Code, including sections 163(j), 267(a)(3), 
482, and 845. The Treasury Secretary is given the authority to 
specify the form, content, and supporting information required 
for this application, as well as the timing for its submission.
    The IRS will be required to take one of the following three 
actions within 90 days of receiving a complete application from 
a taxpayer: (1) conclude an agreement with the taxpayer that 
the return positions to be taken with respect to related-party 
transactions comply with all relevant provisions of the Code; 
(2) advise the taxpayer that the IRS is satisfied that the 
application was made in good faith and substantially complies 
with the requirements set forth by the Treasury Secretary for 
such an application, but that the IRS reserves substantive 
judgment as to the tax treatment of the relevant transactions 
pending the normal audit process; or (3) advise the taxpayer 
that the IRS has concluded that the application was not made in 
good faith or does not substantially comply with the 
requirements set forth by the Treasury Secretary.
    In the case of a compliance failure described in (3) above 
(and in cases in which the taxpayer fails to submit an 
application), the following sanctions will apply for the 
taxable year for which the application was required: (1) no 
deductions or additions to basis or cost of goods sold for 
payments to foreign related parties will be permitted; (2) any 
transfers or licenses of intangible property to related foreign 
parties will be disregarded; and (3) any cost-sharing 
arrangements will not be respected.
    If the IRS fails to act on the taxpayer's application 
within 90 days of receipt, then the taxpayer will be treated as 
having submitted in good faith an application that 
substantially complies with the above-referenced requirements. 
Thus, the deduction disallowance and other sanctions described 
above will not apply, but the IRS will be able to examine the 
transactions at issue under the normal audit process. The IRS 
is authorized to request that the taxpayer extend this 90-day 
deadline in cases in which the IRS believes that such an 
extension might help the parties to reach an agreement.
    The ``earnings stripping'' rules of section 163(j), which 
deny or defer deductions for certain interest paid to foreign 
related parties, are strengthened for inverted corporations. 
With respect to such corporations, the provision eliminates the 
debt-equity threshold generally applicable under section 163(j) 
and reduces the 50-percent thresholds for ``excess interest 
expense'' and ``excess limitation'' to 25 percent. In cases in 
which a U.S. corporate group acquires subsidiaries or other 
assets from an unrelated inverted corporate group, the 
provisions described above generally do not apply to the 
acquiring U.S. corporate group or its related parties 
(including the newly acquired subsidiaries or assets) by reason 
of acquiring the subsidiaries or assets that were connected 
with the inversion transaction. The Treasury Secretary is given 
authority to issue regulations appropriate to carry out the 
purposes of this provision and to prevent its abuse.

Partnership transactions

    Under the provision, both types of inversion transactions 
include certain partnership transactions. Specifically, both 
parts of the provision apply to transactions in which a 
foreign-incorporated entity acquires substantially all of the 
properties constituting a trade or business of a domestic 
partnership, if after the acquisition at least 80 percent (or 
more than 50 percent but less than 80 percent, as the case may 
be) of the stock of the entity is held by former partners of 
the partnership (by reason of holding their partnership 
interests), and the ``substantial business activities'' test is 
not met. For purposes of determining whether these tests are 
met, all partnerships that are under common control within the 
meaning of section 482 are treated as one partnership, except 
as provided otherwise in regulations. In addition, the modified 
``toll charge'' provisions apply at the partner level.

                             EFFECTIVE DATE

    The regime applicable to transactions involving at least 80 
percent identity of ownership applies to inversion transactions 
completed after March 20, 2002. The rules for inversion 
transactions involving greater-than-50-percent identity of 
ownership apply to inversion transactions completed after 1996 
that meet the 50-percent test and to inversion transactions 
completed after 1996 that would have met the 80-percent test 
but for the March 20, 2002 date.

                       C. Reinsurance Agreements


(Sec. 651 of the bill and sec. 845 of the Code)

                              PRESENT LAW

    In the case of a reinsurance agreement between two or more 
related persons, present law provides the Treasury Secretary 
with authority to allocate among the parties or recharacterize 
income (whether investment income, premium or otherwise), 
deductions, assets, reserves, credits and any other items 
related to the reinsurance agreement, or make any other 
adjustment, in order to reflect the proper source and character 
of the items for each party.\190\ For this purpose, related 
persons are defined as in section 482. Thus, persons are 
related if they are organizations, trades or businesses 
(whether or not incorporated, whether or not organized in the 
United States, and whether or not affiliated) that are owned or 
controlled directly or indirectly by the same interests. The 
provision may apply to a contract even if one of the related 
parties is not a domestic company.\191\ In addition, the 
provision also permits such allocation, recharacterization, or 
other adjustments in a case in which one of the parties to a 
reinsurance agreement is, with respect to any contract covered 
by the agreement, in effect an agent of another party to the 
agreement, or a conduit between related persons.
---------------------------------------------------------------------------
    \190\ Sec. 845(a).
    \191\ See S. Rep. No. 97-494, ``Tax Equity and Fiscal 
Responsibility Act of 1982,'' July 12, 1982, 337 (describing provisions 
relating to the repeal of modified coinsurance provisions).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee is concerned that reinsurance transactions 
are being used to allocate income, deductions, or other items 
inappropriately among U.S. and foreign related persons. The 
Committee is concerned that foreign related party reinsurance 
arrangements may be a technique for erosion of the U.S. tax 
base. The Committee believes that the provision of present law 
permitting the Treasury Secretary to allocate or recharacterize 
items related to a reinsurance agreement should be applied to 
prevent misallocation, improper characterization, or to make 
any other adjustment in the case of such reinsurance 
transactions between U.S. and foreign related persons (or 
agents or conduits). The Committee also wishes to clarify that, 
in applying the authority with respect to reinsurance 
agreements, the amount, source or character of the items may be 
allocated, recharacterized or adjusted.

                        EXPLANATION OF PROVISION

    The provision clarifies the rules of section 845, relating 
to authority for the Treasury Secretary to allocate items among 
the parties to a reinsurance agreement, recharacterize items, 
or make any other adjustment, in order to reflect the proper 
source and character of the items for each party. The provision 
authorizes such allocation, recharacterization, or other 
adjustment, in order to reflect the proper source, character or 
amount of the item. It is intended that this authority \192\ be 
exercised in a manner similar to the authority under section 
482 for the Treasury Secretary to make adjustments between 
related parties. It is intended that this authority be applied 
in situations in which the related persons (or agents or 
conduits) are engaged in cross- border transactions that 
require allocation, recharacterization, or other adjustments in 
order to reflect the proper source, character or amount of the 
item or items. No inference is intended that present law does 
not provide this authority with respect to reinsurance 
agreements.
---------------------------------------------------------------------------
    \192\ The authority to allocate, recharacterize or make other 
adjustments was granted in connection with the repeal of provisions 
relating to modified coinsurance transactions.
---------------------------------------------------------------------------
    The Committee notes that no regulations have been issued 
under section 845(a). The Committee expects that the Treasury 
Department shall issue regulations under section 845(a) to 
address effectively the allocation of income (whether 
investment income, premium or otherwise) and other items, the 
recharacterization of such items, or any other adjustment 
necessary to reflect the proper amount, source or character of 
the item.

                             EFFECTIVE DATE

    The provision is effective for any risk reinsured after 
April 11, 2002.

                     D. Extension of IRS User Fees


(Sec. 661 of the bill and new sec. 7527 of the Code)

                              PRESENT LAW

    The IRS provides written responses to questions of 
individuals, corporations, and organizations relating to their 
tax status or the effects of particular transactions for tax 
purposes. The IRS generally charges a fee for requests for a 
letter ruling, determination letter, opinion letter, or other 
similar ruling or determination. Public Law 104-117 \193\ 
extended the statutory authorization for these user fees \194\ 
through September 30, 2003.
---------------------------------------------------------------------------
    \193\ An Act to provide that members of the Armed Forces performing 
services for the peacekeeping efforts in Bosnia and Herzegovina, 
Croatia, and Macedonia shall be entitled to tax benefits in the same 
manner as if such services were performed in a combat zone, and for 
other purposes (March 20, 1996).
    \194\ These user fees were originally enacted in section 10511 of 
the Revenue Act of 1987 (Public Law 100-203, December 22, 1987).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is appropriate to extend the 
statutory authorization for these user fees.

                        EXPLANATION OF PROVISION

    The bill extends the statutory authorization for these user 
fees through June 30, 2008. The bill also moves the statutory 
authorization for these fees into the Internal Revenue Code.

                             EFFECTIVE DATE

    The provision, including moving the statutory authorization 
for these fees into the Code and repealing the off-Code 
statutory authorization for these fees, is effective for 
requests made after the date of enactment.

               E. Extension of Customs Service User Fees


(Sec. 671 of the bill)

                              PRESENT LAW

    Section 13031(j)(3) of the Consolidated Omnibus Budget 
Reconciliation Act of 1985 (19 U.S.C. 58c(j)(3)) authorizes the 
temporary imposition and collection of custom user fees in 
connection with services provided by the United States Customs 
Service. The authorization is scheduled to expire on September 
30, 2003.

                           REASONS FOR CHANGE

    The Committee believes that it is appropriate to extend the 
statutory authorization for these user fees.

                        EXPLANATION OF PROVISION

    The provision extends the authority to impose and collect 
custom user fees through June 30, 2008, provided, however, that 
any revenue generated from such custom user fees may be used 
only to fund the operations of the United States Customs 
Service.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

                    III. BUDGET EFFECTS OF THE BILL


                         A. Committee Estimates

    In compliance 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 the bill as reported.


                B. Budget Authority and Tax Expenditures


Budget authority

    In compliance with section 308(a)(1) of the Budget Act, the 
Committee states that the revenue provisions of the committee 
amendment to the bill as reported involve new or increased 
budget authority.

Tax expenditures

    In compliance with section 308(a)(2) of the Budget Act, the 
Committee states that the revenue-reducing provisions of the 
committee amendment to the bill involve increased expenditures 
(see revenue table in Part III.A., above). The revenue 
increasing provisions of the Committee amendment to the bill 
involve reduced expenditures (see revenue table in Part III.A., 
above).

            C. Consultation with Congressional Budget Office

    In accordance with section 403 of the Budget Act, the 
Committee advises that the Congressional Budget Office has not 
submitted a statement on the committee amendment to the bill. 
The letter from the Congressional Budget Office was not 
received in a timely manner, and therefore will be provided 
separately.

                       IV. VOTES OF THE COMMITTEE

    In compliance with paragraph 7(b) of rule XXVI of the 
Standing Rules of the Senate, the following statements are made 
concerning the votes taken on the Committee's consideration of 
the amendment to the bill.

Motion to report the committee amendment

    The amendment to the bill was ordered favorably reported by 
a voice vote, a quorum being present, on June 18, 2002.

Votes on other amendments

    An amendment by Senator Breaux to increase the percentage 
limitations on certain scholarship grant programs of private 
foundations was agreed to by a voice vote.
    An amendment by Senator Grassley to provide a tax credit 
for qualified financial institutions that have an individual 
development account program was agreed to by a voice vote.
    An amendment by Senator Gramm to strike the provision 
excluding 25 percent of the capital gain on sales of land or 
interests in land made for conservation purposes was not agreed 
to by a voice vote.
    An amendment by Senator Baucus in a Chairman's modification 
to the bill adding the provision regarding the affirmation of 
the consolidated return regulation authority was agreed to by 
voice vote.

                 V. REGULATORY IMPACT AND OTHER MATTERS


                          A. Regulatory Impact

    Pursuant to 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 provisions of the bill as amended.

Impact on individuals and businesses

    With respect to the provisions that do not increase 
revenue, the committee amendment to the bill modifies the rules 
relating to (1) certain charitable giving incentives; (2) 
disclosure of information relating to tax-exempt organizations; 
(3) tax treatment and procedures relating to exempt 
organizations; (4) restoration of funds for the Social Services 
Block Grant; and (5) individual development accounts. The 
Social Services Block Grant provisions provide increased 
funding to States to support a variety of social services. 
Under the other provisions listed above, taxpayers may elect 
whether to avail themselves of the provisions. Thus, the 
provisions do not impose increased regulatory burdens on 
individuals or businesses.
    With respect to the revenue-increasing provisions, the 
committee amendment to the bill modifies the rules relating to 
(1) the disclosure of reportable transactions and tax shelters; 
(2) the substantial understatement penalty; (3) actions to 
enjoin conduct with respect to tax shelters; (4) an 
understatement of a taxpayer's liability by an income tax 
return preparer; (5) the imposition of a civil penalty (of up 
to $5,000) on a failure to report interest in foreign financial 
accounts; (6) frivolous tax submissions; and (7) inversion and 
certain partnership transactions. These provisions relate to 
taxpayers that engage in certain tax avoidance transactions; 
taxpayers that have not undertaken or planned to undertake such 
transactions generally are not affected by the provisions of 
the bill. Thus, the revenue provisions generally do not impose 
increased regulatory burdens on individuals or businesses.

Impact on personal privacy and paperwork

    The provisions of the committee amendment to the bill do 
not impact personal privacy. Individuals either elect whether 
to avail themselves of the provisions of the committee 
amendment to the bill or are subject to the committee amendment 
to the bill for engaging in certain tax avoidance transactions. 
The bill does not impose increased paperwork burdens on 
individuals. Individuals who elect to take advantage of 
provisions in the committee amendment to the bill may in some 
cases need to keep records in order to demonstrate that they 
qualify for the treatment provided. Individuals who elect to 
engage in tax avoidance transactions, and certain advisors who 
provide material aid, assistance, or advice with respect to 
such transactions, may in some cases need to file certain 
disclosure statements with the IRS.

                     B. Unfunded Mandates Statement

    The information is provided in accordance with section 423 
of the Unfunded Mandates Reform 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) 
provisions relating to reportable transactions and tax 
shelters; (2) modifications to the substantial understatement 
penalty; (3) actions to enjoin conduct with respect to tax 
shelters; (4) understatement of taxpayer's liability by an 
income tax return preparer; (5) the imposition of a civil 
penalty (of up to $5,000) on a failure to report interest in 
foreign financial accounts; (6) frivolous tax submissions; and 
(7) provisions relating to the tax treatment of inversion 
transactions and reinsurance agreements.
    The costs required to comply with each Federal private 
sector mandate generally are no greater than the estimated 
budget effect of the provision. Benefits from the provisions 
include improved administration of the Federal income tax laws 
and a more accurate measurement of income for Federal income 
tax purposes.

                       C. Tax Complexity Analysis

    Section 4022(b) of the Internal Revenue Service Reform and 
Restructuring Act of 1998 (the ``IRS Reform Act'') requires the 
Joint Committee on Taxation (in consultation with the Internal 
Revenue Service and the Department of the Treasury) to provide 
a tax complexity analysis. The complexity analysis is required 
for all legislation reported by the Senate Committee on 
Finance, the House Committee on Ways and Means, or any 
committee of conference if the legislation includes a provision 
that directly or indirectly amends the Internal Revenue Code 
(the ``Code'') and has widespread applicability to individuals 
or small businesses. For each such provision identified by the 
staff of the Joint Committee on Taxation, a summary description 
of the provision is provided, along with an estimate of the 
number and type of affected taxpayers, and a discussion 
regarding the relevant complexity and administrative issues. 
Following the analysis of the staff of the Joint Committee on 
Taxation are the comments of the IRS regarding each provision 
included in the complexity analysis, including a discussion of 
the likely effect on IRS forms and any expected impact on the 
IRS.

Direct charitable deduction for nonitemizers (sec. 101 of the bill)

            Summary description of provision
    In the case of an individual taxpayer who does not itemize 
deductions, the bill would allow a direct charitable deduction 
from adjusted gross income for charitable contributions paid in 
cash. This deduction would be allowed in addition to the 
standard deduction. The deduction would be available only for 
that portion of contributions that in the aggregate exceed $250 
($500 in the case of a joint return). The maximum deduction 
would be $250 ($500 in the case of a joint return). The direct 
charitable deduction generally would be subject to the tax 
rules normally governing charitable contribution deductions, 
such as the substantiation requirements. The deduction would be 
allowed in computing alternative minimum taxable income. The 
direct charitable deduction would be effective for taxable 
years beginning after December 31, 2001, and before January 1, 
2004.
            Number of affected taxpayers
    It is estimated that the provision could affect up to 85 
million individual income tax returns each year the deduction 
is in effect.
            Discussion
    Individuals who do not itemize their deductions will need 
to keep additional records (e.g., canceled checks, a receipt 
from the donee organization, or other reliable written records) 
in order to substantiate that a contribution was made to a 
qualified charitable organization. The information necessary to 
implement the provision should be readily available to 
taxpayers (in the form of new tax return forms and 
instructions). The direct charitable deduction is expected to 
require an additional line on the individual income tax return 
forms. The provision might result in an increase in disputes 
with the IRS for taxpayers who are unable to substantiate a 
claimed deduction. Additional regulatory guidance will not be 
necessary to implement this provision. Any increase in tax 
preparation costs is expected be negligible.
                        Department of the Treasury,
                                  Internal Revenue Service,
                                     Washington, DC, June 24, 2002.
Ms. Lindy L. Paull,
Chief of Staff, Joint Committee on Taxation,
Washington, DC.
    Dear Ms. Paull: Enclosed are the combined comments of the 
Internal Revenue Service and the Treasury Department on the 
provision for a charitable deduction for non-itemizers from the 
Senate Finance Committee's markup of H.R. 7 the ``Care Act of 
2002,'' that you identified for complexity analysis in your 
letter of June 19, 2002. Our comments are based on the 
description of that provision in your letter and in JCX-57-02, 
Joint Committee on Taxation, Description of the Care Act of 
2002, June 11, 2002.
    Due to the short turnaround time, our comments are 
provisional and subject to change upon a more complete and in-
depth analysis of the provision.
            Sincerely,
                                       Charles O. Rossotti,
                                                      Commissioner.
    Enclosure.
                                ------                                


   Complexity Analysis of Provision From H.R. 7, the Care Act of 2002

                 CHARITABLE DEDUCTION FOR NON-ITEMIZERS

    Provision: Taxpayers who do not itemize would be allowed to 
deduct their cash contributions to qualified charitable 
organizations in addition to claiming the standard deduction. 
This deduction would be calculated as the lesser of (a) the 
excess, if any, of the charitable contributions over $250 ($500 
in the case of a joint return) or (b) $250 ($500 in the case of 
a joint return). The tax rules that apply to the charitable 
contribution deduction allowed to itemizers would generally 
apply to this deduction. The non-itemizer deduction would not 
be a preference item for purposes of the alternative minimum 
tax and would not affect the calculation of adjusted gross 
income (AGI). The proposal would be effective for tax years 
beginning after December 31, 2001, and before January 1, 2004.
IRS and Treasury comments
    Two lines would have to be added to Forms 1040, 1040A, 
1040EZ, 1040NR, and 1040NR-EZ for 2002 and 2003; one for the 
allowable deduction and one to reflect the total of the 
standard deduction and the charitable contribution deduction. 
One line would be added to the TeleFile Tax Record for 2002 and 
2003 (taxpayers would enter their total contributions on the 
new line and TeleFile would calculate the allowable deduction). 
No new forms would be required.
    The new deduction would also have to be reflected on Form 
1040-ES for 2003 and in the instructions for Forms 1040X and 
1045 for 2002 and 2003. Subsequent to enactment, the IRS may 
have to advise taxpayers who make estimated tax payments for 
2002 how they can adjust their estimated tax payments for 2002 
to reflect the new deduction.
    Information necessary for taxpayers to determine their 
eligibility for the deduction, including the AGI limitation 
applicable to cash contributions, and the substantiation 
requirements would have to be reflected in the 2002 and 2003 
instructions for Forms 1040, 1040A, 1040EZ, 1040NR, and 1040NR-
EZ and for TeleFile.
    A worksheet (consisting of four lines) for taxpayers to 
calculate their allowable deduction would have to be reflected 
in the 2002 and 2003 instructions for Forms 1040, 1040A, 
1040EZ, 1040NR, and 1040NR-EZ.
    Changes to the Telefile script for 2002 and 2003 would be 
required to allow the deduction to taxpayers who use TeleFile.
    All of the above changes would have to be reversed for tax 
years beginning after December 31, 2003, to reflect the 
termination of the charitable deduction for non-itemizers 
(e.g., the lines would be removed from the Form 1040 series of 
returns, the worksheet would be removed from the instructions 
for these returns, and programming and script changes would be 
necessary to eliminate the deduction).
    Ensuring compliance with the new charitable deduction would 
be difficult. The only means of verifying amounts deducted 
would be through examination, which is not practical because of 
the relatively small amounts involved.
    The direct charitable deduction line on the 2002 and 2003 
Form 1040 series of returns would need to be transcribed and 
incorporated into our computation of taxable income. The 
programming changes needed to effectuate this for 2003 
processing (of 2002 returns) will put a strain on IRS' ability 
to complete and test other programming needed for the 2003 
filing season. Since IRS is well into its program development 
for January 2003, we recommend that the effective date be 
delayed so that the provision would be effective for tax years 
beginning in 2003 and 2004. A delayed effective date would be 
especially important if the provision were not enacted before 
September 2002.

        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 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).