H. Rept. 108-393 - 108th Congress (2003-2004)
November 21, 2003, As Reported by the Ways and Means Committee

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House Report 108-393 - AMERICAN JOBS CREATION ACT OF 2003




[House Report 108-393]
[From the U.S. Government Printing Office]



108th Congress                                                   Report
                        HOUSE OF REPRESENTATIVES
 1st Session                                                    108-393

======================================================================
 
                   AMERICAN JOBS CREATION ACT OF 2003

                                _______
                                

 November 21, 2003.--Committed to the Committee of the Whole House on 
            the State of the Union and ordered to be printed

                                _______
                                

    Mr. Thomas, from the Committee on Ways and Means, submitted the 
                               following

                              R E P O R T

                             together with

                            DISSENTING VIEWS

                        [To accompany H.R. 2896]

      [Including cost estimate of the Congressional Budget Office]

  The Committee on Ways and Means, to whom was referred the 
bill (H.R. 2896) to amend the Internal Revenue Code of 1986 to 
remove impediments in such Code and make our manufacturing, 
service, and high-technology businesses and workers more 
competitive and productive both at home and abroad, having 
considered the same, report favorably thereon with an amendment 
and recommend that the bill as amended do pass.

                                CONTENTS

                                                                   Page
  I. Summary and Background..........................................70
 II. Explanation of the Bill.........................................70
     Title I--Corporate Reform and Growth Incentives.................70
          A. Reduction in Income Tax Corporate Rates.............    70
              1. Reduced corporate income tax rate for domestic 
                  production activities income (sec. 1001 of the 
                  bill and sec. 11 of the Code)..................    70
              2. Reduced corporate income tax rate for small 
                  corporations (sec. 1002 of the bill and sec. 11 
                  of the Code)...................................    72
          B. Extension of Increased Section 179 Expensing (sec. 
              1011 of the bill and sec. 179 of the Code).........    74
          C. Recovery Period for Depreciation of Certain 
              Leasehold Improvements and Restaurant Property 
              (sec. 1021 of the bill and sec. 168 of the Code)...    76
          D. Alternative Minimum Tax Relief......................    79
              1. Net operating losses and foreign tax credit; 
                  expansion of small corporation exemption (secs. 
                  1031-1032 of the bill and secs. 55-59 of the 
                  Code)..........................................    79
              2. Income averaging for farmers not to increase 
                  alternative minimum tax (sec. 1033 of the bill 
                  and sec. 55 of the Code).......................    80
          E. Provisions Relating to S Corporation Reform and 
              Simplification (secs. 1041-1051 of the bill and 
              secs. 1361-1379 and sec. 4975 of the Code).........    81
              1. Shareholders of an S corporation................    82
              2. Treatment of S corporation shareholders.........    84
              3. Provisions relating to banks....................    85
              4. Qualified subchapter S subsidiaries.............    87
              5. S corporation distributions to an employee stock 
                  ownership plan.................................    87
          F. Employee Benefits...................................    89
              1. Treatment of nonqualified deferred compensation 
                  plans (sec. 1061 of the bill and new sec. 409A 
                  and sec. 6051 of the Code).....................    89
              2. Exclusion of incentive stock options and 
                  employee stock purchase plan stock options from 
                  wages (sec. 1062 of the bill and secs. 421(b), 
                  423(c), 3121(a), 3231, and 3306(b) of the Code)    96
              3. Extension of provision permitting qualified 
                  transfers of excess pension assets to retiree 
                  health accounts (sec. 1063 of the bill and sec. 
                  420 of the Code)...............................    98
          G. Treatment of Active Income..........................   100
              1. Treatment of European Union as one country for 
                  purposes of the foreign base company sales and 
                  services rules (sec. 1071 of the bill and sec. 
                  954 of the Code)...............................   100
              2. Look-through treatment of payments between 
                  related controlled foreign corporations under 
                  foreign personal holding company income rules 
                  (sec. 1072 of the bill and sec. 954 of the 
                  Code)..........................................   101
              3. Look-through treatment for sales of partnership 
                  interests (sec. 1073 of the bill and sec. 954 
                  of the Code)...................................   102
              4. Repeal of foreign personal holding company rules 
                  and foreign investment company rules (sec. 1074 
                  of the bill and secs. 542, 551-558, 954, 1246, 
                  and 1247 of the Code)..........................   103
              5. Subpart F treatment of pipeline transportation 
                  income (sec. 1075 of the bill and sec. 954 of 
                  the Code)......................................   104
              6. Determination of foreign personal holding 
                  company income with respect to transactions in 
                  commodities (sec. 1076 of the bill and sec. 954 
                  of the Code)...................................   105
              7. Repeal controlled foreign corporation rules for 
                  foreign base company shipping income (sec. 1077 
                  of the bill and sec. 954 of the Code)..........   108
              8. Modification of subpart F exemption for active 
                  financing (sec. 1078 of the bill and sec. 954 
                  of the Code)...................................   110
              9. Partial exclusion for qualified film income 
                  (sec. 1079 of the bill and new sec. 139A of the 
                  Code)..........................................   112
          H. Reduction of Double Taxation of Earnings............   115
               1. Interest expense allocation rules (sec. 1081 of 
                  the bill and sec. 864 of the Code).............   115
               2. Recharacterization of overall domestic loss 
                  (sec. 1082 of the bill and sec. 904 of the 
                  Code)..........................................   119
               3. Reduction to two foreign tax credit baskets 
                  (sec. 1083 of the bill and sec. 904 of the 
                  Code)..........................................   121
               4. Look-through rules to apply to dividends from 
                  noncontrolled section 902 corporations (sec. 
                  1084 of the bill and sec. 904 of the Code).....   122
               5. Attribution of stock ownership through 
                  partnerships to apply in determining sections 
                  902 and 960 credits (sec. 1085 of the bill and 
                  secs. 901, 902, and 960 of the Code)...........   124
               6. Clarification of treatment of certain transfers 
                  of intangible property (sec. 1086 of the bill 
                  and sec. 367(d) of the Code)...................   125
               7. United States property not to include certain 
                  assets acquired by dealers in ordinary course 
                  of trade or business (sec. 1087 of the bill and 
                  sec. 956 of the Code)..........................   127
               8. Election not to use average exchange rate for 
                  foreign tax paid other than in functional 
                  currency (sec. 1088 of the bill and sec. 986 of 
                  the Code)......................................   128
               9. Repeal of withholding tax on dividends from 
                  certain foreign corporations (sec. 1089 of the 
                  bill and sec. 871 of the Code).................   129
              10. Provide equal treatment for interest paid by 
                  foreign partnerships and foreign corporations 
                  (sec. 1090 of the bill and sec. 861 of the 
                  Code)..........................................   131
              11. Treatment of certain dividends of regulated 
                  investment companies (sec. 1091 of the bill and 
                  secs. 871 and 881 of the Code).................   132
          I. Other Provisions....................................   138
               1. Special rules for livestock sold on account of 
                  weather-related conditions (sec. 1101 of the 
                  bill and secs. 1033 and 451 of the Code).......   138
               2. Payment of dividends on stock of cooperatives 
                  without reducing patronage dividends (sec. 1102 
                  of the bill and sec. 1388 of the Code).........   139
               3. Add vaccines against hepatitis A to the list of 
                  taxable vaccines (sec. 1103 of the bill and 
                  sec. 4132 of the Code).........................   140
               4. Expand human clinical trials expenses 
                  qualifying for the orphan drug tax credit (sec. 
                  1104 of the bill and sec. 45C of the Code).....   141
               5. Distributions from publicly traded partnerships 
                  treated as qualifying income of regulated 
                  investment company (sec. 1105 of the bill and 
                  secs. 851 and 469(k) of the Code)..............   142
               6. REIT modification provisions (sec. 1106 of the 
                  bill and secs. 856 and 857 of the Code)........   145
               7. Simplification of excise tax imposed on bows 
                  and arrows (sec. 1107 of the bill and sec. 4161 
                  of the Code)...................................   151
               8. Repeal excise tax on fishing tackle boxes (sec. 
                  1108 of the bill and sec. 4162 of the Code)....   152
               9. Income tax credit for cost of carrying tax-paid 
                  distilled spirits in wholesale inventories 
                  (sec. 1109 of the bill and new sec. 5011 of the 
                  Code)..........................................   152
              10. Capital gains treatment to apply to outright 
                  sales of timber by landowner (sec. 1110 of the 
                  bill and sec. 631(b) of the Code)..............   154
              11. Repeal of excise tax on sonar devices suitable 
                  for finding fish (sec. 1111 of the bill and 
                  secs. 4161 and 4162 of the Code)...............   154
              12. Taxation of certain settlement funds (sec. 1112 
                  of the bill and sec. 468B of the Code).........   155
              13. Suspension of occupational taxes relating to 
                  distilled spirits, wine, and beer (sec. 1113 of 
                  the bill and sec. 5148 of the Code)............   156
     Title II--Provisions To Reduce Tax Avoidance Through Corporate 
     Earnings Stripping and Expatriation............................158
              1. Reduction in potential for earnings stripping by 
                  further limiting deduction for interest on 
                  certain indebtedness (sec. 2001 of the bill and 
                  sec. 163(j) of the Code).......................   158
              2. Tax treatment of expatriated entities (sec. 2002 
                  of the bill and new sec. 7874 of the Code).....   161
              3. Excise tax on stock compensation of insiders in 
                  expatriated corporations (sec. 2003 of the bill 
                  and secs. 162(m), 275(a), and new sec. 4985 of 
                  the Code)......................................   165
              4. Reinsurance of U.S. risks in foreign 
                  jurisdictions (sec. 2004 of the bill and sec. 
                  845(a) of the Code)............................   169
              5. Modification of the tax treatment of individual 
                  expatriates (sec. 2005 of the bill and secs. 
                  877, 2107, 2501 and 6039G of the Code).........   170
              6. Reporting of taxable mergers and acquisitions 
                  (sec. 2006 of the bill and new sec. 6043A of 
                  the Code)......................................   177
              7. Studies (sec. 2007 of the bill).................   178
     Title III--Provisions Relating to Tax Shelters.................179
          A. Taxpayer Related Provisions.........................   179
               1. Penalty for failure to disclose reportable 
                  transactions (sec. 3001 of the bill and new 
                  sec. 6707A of the Code)........................   179
               2. Modifications to the accuracy-related penalties 
                  for listed transactions and reportable 
                  transactions having a significant tax avoidance 
                  purpose (sec. 3002 of the bill and new sec. 
                  6662A of the Code).............................   182
               3. Tax shelter exception to confidentiality 
                  privileges relating to taxpayer communications 
                  (sec. 3003 of the bill and sec. 7525 of the 
                  Code)..........................................   186
               4. Statute of limitations for unreported listed 
                  transactions (sec. 3004 of the bill and sec. 
                  6501 of the Code)..............................   186
               5. Disclosure of reportable transactions by 
                  material advisors (sec. 3005 of the bill and 
                  secs. 6111 and 6707 of the Code)...............   187
               6. Investor lists and modification of penalty for 
                  failure to maintain investor lists (secs. 3006 
                  and 3007 of the bill and secs. 6112 and 6708 of 
                  the Code)......................................   190
               7. Penalty on promoters of tax shelters (sec. 3008 
                  of the bill and sec. 6700 of the Code).........   192
               8. Modifications of substantial understatement 
                  penalty for nonreportable transactions (sec. 
                  3009 of the bill and sec. 6662 of the Code)....   193
               9. Modification of actions to enjoin certain 
                  conduct related to tax shelters and reportable 
                  transactions (sec. 3010 of the bill and sec. 
                  7408 of the Code)..............................   194
              10. Penalty on failure to report interests in 
                  foreign financial accounts (sec. 3011 of the 
                  bill and sec. 5321 of Title 31, United States 
                  Code)..........................................   194
              11. Regulation of individuals practicing before the 
                  Department of the Treasury (sec. 3012 of the 
                  bill and sec. 330 of Title 31, United States 
                  Code)..........................................   195
          B. Other Provisions....................................   196
               1. Treatment of stripped interests in bond and 
                  preferred stock funds, etc. (sec. 3021 of the 
                  bill and secs. 305 and 1286 of the Code).......   196
               2. Minimum holding period for foreign tax credit 
                  on withholding taxes on income other than 
                  dividends (sec. 3022 of the bill and sec. 901 
                  of the Code)...................................   199
               3. Disallowance of certain partnership loss 
                  transfers (sec. 3023 of the bill and secs. 704, 
                  734, and 743 of the Code)......................   201
               4. No reduction of basis under section 734 in 
                  stock held by partnership in corporate partner 
                  (sec. 3024 of the bill and sec. 755 of the 
                  Code)..........................................   204
               5. Repeal of special rules for FASITs, etc. (sec. 
                  3025 of the bill and secs. 860H through 860L of 
                  the Code)......................................   205
               6. Limitation on transfer of built-in losses on 
                  REMIC residuals (sec. 3026 of the bill and sec. 
                  362 of the Code)...............................   211
               7. Clarification of banking business for purposes 
                  of determining investment of earnings in U.S. 
                  property (sec. 3027 of the bill and sec. 956 of 
                  the Code)......................................   212
               8. Modify rules related to certain small property 
                  and casualty insurance companies (sec. 3028 of 
                  the bill and secs. 501(c)(15) and 831(b) of the 
                  Code)..........................................   214
               9. Definition of insurance company for property 
                  and casualty insurance company tax rules (sec. 
                  3029 of the bill and sec. 831(c) of the Code)..   216
              10. Denial of deduction for interest on 
                  underpayments attributable to nondisclosed 
                  reportable transactions (sec. 3030 of the bill 
                  and sec. 163 of the Code)......................   218
              11. Clarification of rules for payment of estimated 
                  tax for certain deemed asset sales (sec. 3031 
                  of the bill and sec. 338 of the Code)..........   219
              12. Exclusion of like-kind exchange property from 
                  nonrecognition treatment on the sale or 
                  exchange of a principal residence (sec. 3032 of 
                  the bill and sec. 121 of the Code).............   220
              13. Prevention of mismatching of interest and 
                  original issue discount deductions and income 
                  inclusions in transactions with related foreign 
                  persons (sec. 3033 of the bill and secs. 163 
                  and 267 of the Code)...........................   221
              14. Exclusion from gross income for interest on 
                  overpayments of income tax by individuals (sec. 
                  3034 of the bill and new sec. 139A of the Code)   223
              15. Deposits made to suspend the running of 
                  interest on potential underpayments (sec. 3035 
                  of the bill and new sec. 6603 of the Code).....   225
              16. Authorize IRS to enter into installment 
                  agreements that provide for partial payment 
                  (sec. 3036 of the bill and sec. 6159 of the 
                  Code)..........................................   228
              17. Extension of IRS user fees (sec. 3037 of the 
                  bill and sec. 7528 of the Code)................   229
     Title IV--Trade Enhancement and Compliance Provisions..........229
              1. Repeal of exclusion for extraterritorial income 
                  (sec. 4001 of the bill and secs. 114 and 941-
                  943 of the Code)...............................   229
              2. Extension of customs user fees (sec. 4002 of the 
                  bill)..........................................   231
III. Votes of the Committee.........................................232
 IV. Budget Effects of the Bill.....................................234
  V. Other Matters To Be Discussed Under the Rules of the House.....247
 VI. Changes in Existing Law Made by the Bill, as Reported..........248
VII. Dissenting Views...............................................432

    The amendment is as follows:
    Strike all after the enacting clause and insert the 
following:

SECTION 1. SHORT TITLE; ETC.

    (a) Short Title.--This Act may be cited as the ``American Jobs 
Creation Act of 2003''.
    (b) Amendment of 1986 Code.--Except as otherwise expressly 
provided, whenever in this Act an amendment or repeal is expressed in 
terms of an amendment to, or repeal of, a section or other provision, 
the reference shall be considered to be made to a section or other 
provision of the Internal Revenue Code of 1986.
    (c) Table of Contents.--

Sec. 1. Short title; etc.

            TITLE I--CORPORATE REFORM AND GROWTH INCENTIVES

          Subtitle A--Reduction in Corporate Income Tax Rates

Sec. 1001. Reduced corporate income tax rate for domestic production 
activities income.
Sec. 1002. Reduced corporate income tax rate for small corporations.

                  Subtitle B--Small Business Expensing

Sec. 1011. 2-year extension of increased expensing for small business.

                        Subtitle C--Depreciation

Sec. 1021. Recovery period for depreciation of certain leasehold 
improvements and restaurant property.

               Subtitle D--Alternative Minimum Tax Relief

Sec. 1031. Net operating losses and foreign tax credit under 
alternative minimum tax.
Sec. 1032. Expansion of exemption from alternative minimum tax for 
small corporations.
Sec. 1033. Income averaging for farmers not to increase alternative 
minimum tax.

          Subtitle E--S Corporation Reform and Simplification

Sec. 1041. Members of family treated as 1 shareholder.
Sec. 1042. Increase in number of eligible shareholders to 100.
Sec. 1043. Expansion of bank S corporation eligible shareholders to 
include IRAs.
Sec. 1044. Disregard of unexercised powers of appointment in 
determining potential current beneficiaries of ESBT.
Sec. 1045. Transfer of suspended losses incident to divorce, etc.
Sec. 1046. Use of passive activity loss and at-risk amounts by 
qualified subchapter S trust income beneficiaries.
Sec. 1047. Exclusion of investment securities income from passive 
income test for bank S corporations.
Sec. 1048. Treatment of bank director shares.
Sec. 1049. Relief from inadvertently invalid qualified subchapter S 
subsidiary elections and terminations.
Sec. 1050. Information returns for qualified subchapter S subsidiaries.
Sec. 1051. Repayment of loans for qualifying employer securities.

                Subtitle F--Protecting Employee Benefits

Sec. 1061. Treatment of nonqualified deferred compensation plans.
Sec. 1062. Exclusion of incentive stock options and employee stock 
purchase plan stock options from wages.
Sec. 1063. Extension of transfers of excess pension assets to retiree 
health accounts.

                 Subtitle G--Treatment of Active Income

Sec. 1071. Member states of the European Union treated as a single 
country for certain purposes
Sec. 1072. Look-thru treatment of payments between related controlled 
foreign corporations under foreign personal holding company income 
rules.
Sec. 1073. Look-thru treatment for sales of partnership interests.
Sec. 1074. Repeal of foreign personal holding company rules and foreign 
investment company rules.
Sec. 1075. Clarification of treatment of pipeline transportation 
income.
Sec. 1076. Determination of foreign personal holding company income 
with respect to transactions in commodities.
Sec. 1077. Repeal of CFC rules on foreign base company shipping income.
Sec. 1078. Modification of subpart F exemption for active financing.
Sec. 1079. Partial exclusion for income attributable to films used 
outside the United States.

          Subtitle H--Reduction of Double Taxation of Earnings

Sec. 1081. Interest expense allocation rules.
Sec. 1082. Recharacterization of overall domestic loss.
Sec. 1083. Reduction to 2 foreign tax credit baskets.
Sec. 1084. Look-thru rules to apply to dividends from noncontrolled 
section 902 corporations.
Sec. 1085. Attribution of stock ownership through partnerships to apply 
in determining section 902 and 960 credits.
Sec. 1086. Clarification of treatment of certain transfers of 
intangible property.
Sec. 1087. United States property not to include certain assets 
acquired by dealers in ordinary course of trade or business.
Sec. 1088. Election not to use average exchange rate for foreign tax 
paid other than in functional currency.
Sec. 1089. Repeal of withholding tax on dividends from certain foreign 
corporations.
Sec. 1090. Provide equal treatment for interest paid by foreign 
partnerships and foreign corporations.
Sec. 1091. Treatment of certain dividends of regulated investment 
companies.

                      Subtitle I--Other Provisions

Sec. 1101. Special rules for livestock sold on account of weather-
related conditions.
Sec. 1102. Payment of dividends on stock of cooperatives without 
reducing patronage dividends.
Sec. 1103. Vaccine tax to apply to Hepatitis A vaccine.
Sec. 1104. Expansion of human clinical trials qualifying for orphan 
drug credit.
Sec. 1105. Distributions from publicly traded partnerships treated as 
qualifying income of regulated investment companies.
Sec. 1106. Improvements related to real estate investment trusts.
Sec. 1107. Simplification of excise tax imposed on bows and arrows.
Sec. 1108. Repeal of excise tax on fishing tackle boxes.
Sec. 1109. Income tax credit to distilled spirits wholesalers for cost 
of carrying Federal excise taxes on bottled distilled spirits.
Sec. 1110. Capital gain treatment under section 631(b) to apply to 
outright sales by landowners.
Sec. 1111. Sonar devices suitable for finding fish.
Sec. 1112. Taxation of certain settlement funds.
Sec. 1113. Suspension of occupational taxes relating to distilled 
spirits, wine, and beer.

TITLE II--PROVISIONS TO REDUCE TAX AVOIDANCE THROUGH CORPORATE EARNINGS 
                       STRIPPING AND EXPATRIATION

Sec. 2001. Reduction in potential for earnings stripping by further 
limiting deduction for interest on certain indebtedness.
Sec. 2002. Tax treatment of expatriated entities and their foreign 
parents.
Sec. 2003. Excise tax on stock compensation of insiders in expatriated 
corporations.
Sec. 2004. Reinsurance of United States risks in foreign jurisdictions.
Sec. 2005. Revision of tax rules on expatriation of individuals.
Sec. 2006. Reporting of taxable mergers and acquisitions.
Sec. 2007. Studies.

             TITLE III--PROVISIONS RELATING TO TAX SHELTERS

                Subtitle A--Taxpayer-Related Provisions

Sec. 3001. Penalty for failing to disclose reportable transactions.
Sec. 3002. Accuracy-related penalty for listed transactions, other 
reportable transactions having a significant tax avoidance purpose, 
etc.
Sec. 3003. Tax shelter exception to confidentiality privileges relating 
to taxpayer communications.
Sec. 3004. Statute of limitations for taxable years for which required 
listed transactions not reported.
Sec. 3005. Disclosure of reportable transactions.
Sec. 3006. Failure to furnish information regarding reportable 
transactions.
Sec. 3007. Modification of penalty for failure to maintain lists of 
investors.
Sec. 3008. Penalty on promoters of tax shelters.
Sec. 3009. Modifications of substantial understatement penalty for 
nonreportable transactions.
Sec. 3010. Modification of actions to enjoin certain conduct related to 
tax shelters and reportable transactions.
Sec. 3011. Penalty on failure to report interests in foreign financial 
accounts.
Sec. 3012. Regulation of individuals practicing before the Department 
of the Treasury.

                      Subtitle B--Other Provisions

Sec. 3021. Treatment of stripped interests in bond and preferred stock 
funds, etc.
Sec. 3022. Minimum holding period for foreign tax credit on withholding 
taxes on income other than dividends.
Sec. 3023. Disallowance of certain partnership loss transfers.
Sec. 3024. No reduction of basis under section 734 in stock held by 
partnership in corporate partner.
Sec. 3025. Repeal of special rules for FASITS.
Sec. 3026. Limitation on transfer of built-in losses on REMIC 
residuals.
Sec. 3027. Clarification of banking business for purposes of 
determining investment of earnings in United States property.
Sec. 3028. Modifications related to certain small insurance companies.
Sec. 3029. Definition of insurance company for section 831.
Sec. 3030. Denial of deduction for interest on underpayments 
attributable to nondisclosed reportable transactions.
Sec. 3031. Clarification of rules for payment of estimated tax for 
certain deemed asset sales.
Sec. 3032. Recognition of gain from the sale of a principal residence 
acquired in a like-kind exchange within 5 years of sale.
Sec. 3033. Prevention of mismatching of interest and original issue 
discount deductions and income inclusions in transactions with related 
foreign persons.
Sec. 3034. Exclusion from gross income for interest on overpayments of 
income tax by individuals.
Sec. 3035. Deposits made to suspend running of interest on potential 
underpayments.
Sec. 3036. Partial payment of tax liability in installment agreements.
Sec. 3037. Extension of IRS user fees.

         TITLE IV--TRADE ENHANCEMENT AND COMPLIANCE PROVISIONS

Sec. 4001. Repeal of exclusion for extraterritorial income.
Sec. 4002. COBRA fees.

            TITLE I--CORPORATE REFORM AND GROWTH INCENTIVES

          Subtitle A--Reduction in Corporate Income Tax Rates

SEC. 1001. REDUCED CORPORATE INCOME TAX RATE FOR DOMESTIC PRODUCTION 
                    ACTIVITIES INCOME.

    (a) Limitation on Tax on Qualified Production Activities Income.--
Section 11 is amended by redesignating subsections (c) and (d) as 
subsections (d) and (e), respectively, and by inserting after 
subsection (b) the following new subsection:
    ``(c) Limitation on Tax on Qualified Production Activities 
Income.--
          ``(1) In general.--If a corporation has qualified production 
        activities income for any taxable year, the tax imposed by this 
        section shall not exceed the sum of--
                  ``(A) a tax computed at the rates and in the manner 
                as if this subsection had not been enacted on the 
                taxable income reduced by the amount of qualified 
                production activities income, plus
                  ``(B) a tax equal to 32 percent (34 percent in the 
                case of taxable years beginning before January 1, 2007) 
                of the qualified production activities income (or, if 
                less, taxable income).
          ``(2) Qualified production activities income.--
                  ``(A) In general.--The term `qualified production 
                activities income' for any taxable year means an amount 
                equal to the excess (if any) of--
                          ``(i) the taxpayer's domestic production 
                        gross receipts for such taxable year, over
                          ``(ii) the sum of--
                                  ``(I) the cost of goods sold that are 
                                allocable to such receipts,
                                  ``(II) other deductions, expenses, or 
                                losses directly allocable to such 
                                receipts, and
                                  ``(III) a ratable portion of other 
                                deductions, expenses, and losses that 
                                are not directly allocable to such 
                                receipts or another class of income.
                  ``(B) Allocation method.--The Secretary shall 
                prescribe rules for the proper allocation of items of 
                income, deduction, expense, and loss for purposes of 
                determining income attributable to domestic production 
                activities.
          ``(3) Domestic production gross receipts.--For purposes of 
        this subsection, the term `domestic production gross receipts' 
        means the gross receipts of the taxpayer which are derived 
        from--
                  ``(A) any lease, rental, license, sale, exchange, or 
                other disposition of--
                          ``(i) qualifying production property which 
                        was manufactured, produced, grown, or extracted 
                        in whole or in significant part by the taxpayer 
                        within the United States, or
                          ``(ii) any qualified film produced by the 
                        taxpayer, or
                  ``(B) construction, engineering, or architectural 
                services performed in the United States for 
                construction projects in the United States.
          ``(4) Qualifying production property.--For purposes of this 
        subsection, the term `qualifying production property' means--
                  ``(A) tangible personal property,
                  ``(B) any computer software, and
                  ``(C) any property described in section 168(f)(4).
          ``(5) Qualified film.--For purposes of this subsection--
                  ``(A) In general.--The term `qualified film' means 
                any property described in section 168(f)(3) if not less 
                than 50 percent of the total compensation relating to 
                the production of such property is compensation for 
                services performed in the United States by actors, 
                production personnel, directors, and producers.
                  ``(B) Exception.--Such term does not include property 
                with respect to which records are required to be 
                maintained under section 2257 of title 18, United 
                States Code.
          ``(6) Related persons.--For purposes of this subsection--
                  ``(A) In general.-- The term `domestic production 
                gross receipts' shall not include any gross receipts of 
                the taxpayer derived from property leased, licensed, or 
                rented by the taxpayer for use by any related person.
                  ``(B) Related person.--For purposes of subparagraph 
                (A), a person shall be treated as related to another 
                person if such persons are treated as a single employer 
                under subsection (a) or (b) of section 52 or subsection 
                (m) or (o) of section 414, except that determinations 
                under subsections (a) and (b) of section 52 shall be 
                made without regard to section 1563(b).''.
    (b) Special Rule Relating to Election to Treat Cutting of Timber as 
a Sale or Exchange.--In the case of a corporation, any election under 
section 631(a) of the Internal Revenue Code of 1986 made for a taxable 
year ending on or before the date of the enactment of this Act may be 
revoked by the taxpayer for any taxable year ending after such date. 
For purposes of determining whether such taxpayer may make a further 
election under such section, such election (and any revocation under 
this section) shall not be taken into account.
    (c) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

SEC. 1002. REDUCED CORPORATE INCOME TAX RATE FOR SMALL CORPORATIONS.

    (a) In General.--Subsection (b) of section 11 (relating to tax 
imposed on corporations) is amended by redesignating paragraph (2) as 
paragraph (6) and by striking paragraph (1) and inserting the following 
new paragraphs:
          ``(1) For taxable years beginning after 2011.--In the case of 
        taxable years beginning after 2011, the amount of the tax 
        imposed by subsection (a) shall be determined in accordance 
        with the following table:
          

``If taxable income is:             The tax is:
    Not over $50,000
                                        15% of taxable income.
    Over $50,000 but not over 
        $75,000
                                        $7,500, plus 25% of the excess 
                                                over $50,000.
    Over $75,000 but not over 
        $20,000,000
                                        $13,750, plus 32% of the excess 
                                                over $75,000.
    Over $20,000,000
                                        $6,389,750, plus 35% of the 
                                                excess over 
                                                $20,000,000.

          ``(2) For taxable years beginning in 2009, 2010, or 2011.--In 
        the case of taxable years beginning in 2009, 2010, or 2011, the 
        amount of the tax imposed by subsection (a) shall be determined 
        in accordance with the following table:
          

``If taxable income is:             The tax is:
    Not over $50,000
                                        15% of taxable income.
    Over $50,000 but not over 
        $75,000
                                        $7,500, plus 25% of the excess 
                                                over $50,000.
    Over $75,000 but not over 
        $5,000,000
                                        $13,750, plus 32% of the excess 
                                                over $75,000.
    Over $5,000,000 but not over 
        $10,000,000
                                        $1,589,750, plus 34% of the 
                                                excess over $5,000,000.
    Over $10,000,000
                                        $3,289,750, plus 35% of the 
                                                excess over 
                                                $10,000,000.

          ``(3) For taxable years beginning in 2007 or 2008.--In the 
        case of taxable years beginning in 2007 or 2008, the amount of 
        the tax imposed by subsection (a) shall be determined in 
        accordance with the following table:
          

``If taxable income is:             The tax is:
    Not over $50,000
                                        15% of taxable income.
    Over $50,000 but not over 
        $75,000
                                        $7,500, plus 25% of the excess 
                                                over $50,000.
    Over $75,000 but not over 
        $1,000,000
                                        $13,750, plus 32% of the excess 
                                                over $75,000.
    Over $1,000,000 but not over 
        $10,000,000
                                        $309,750, plus 34% of the 
                                                excess over $1,000,000.
    Over $10,000,000
                                        $3,369,750, plus 35% of the 
                                                excess over 
                                                $10,000,000.

          ``(4) For taxable years beginning in 2004, 2005, or 2006.--In 
        the case of taxable years beginning in 2004, 2005, or 2006, the 
        amount of the tax imposed by subsection (a) shall be determined 
        in accordance with the following table:
          

``If taxable income is:             The tax is:
    Not over $50,000
                                        15% of taxable income.
    Over $50,000 but not over 
        $75,000
                                        $7,500, plus 25% of the excess 
                                                over $50,000.
    Over $75,000 but not over 
        $1,000,000
                                        $13,750, plus 33% of the excess 
                                                over $75,000.
    Over $1,000,000 but not over 
        $10,000,000
                                        $319,000, plus 34% of the 
                                                excess over $1,000,000.
    Over $10,000,000
                                        $3,379,000, plus 35% of the 
                                                excess over 
                                                $10,000,000.

          ``(5) Phaseout of lower rates for certain taxpayers.--
                  ``(A) General rule for years before 2012.--
                          ``(i) In general.--In the case of taxable 
                        years beginning before 2012 with respect to a 
                        corporation which has taxable income in excess 
                        of the applicable amount for any taxable year, 
                        the amount of tax determined under paragraph 
                        (1), (2), (3) or (4) for such taxable year 
                        shall be increased by the lesser of (I) 5 
                        percent of such excess, or (II) the maximum 
                        increase amount.
                          ``(ii) Maximum increase amount.--For purposes 
                        of clause (i)--
      

------------------------------------------------------------------------
    ``In the case of any taxable                          The maximum
     year   beginning during:         The applicable    increase amount
                                        amount is:            is:
------------------------------------------------------------------------
2004, 2005, or 2006...............      $1,000,000          $21,000
2007 or 2008......................      $1,000,000          $30,250
2009, 2010, or 2011...............      $5,000,000         $110,250.
------------------------------------------------------------------------

                  ``(B) Higher income corporations.--In the case of a 
                corporation which has taxable income in excess of 
                $20,000,000 ($15,000,000 in the case of taxable years 
                beginning before 2012), the amount of the tax 
                determined under the foregoing provisions of this 
                subsection shall be increased by an additional amount 
                equal to the lesser of (i) 3 percent of such excess, or 
                (ii) $610,250 ($100,000 in the case of taxable years 
                beginning before 2012).''.
    (b) Conforming Amendments.--
          (1) Section 904(b)(3)(D)(ii) is amended to read as follows:
                          ``(ii) in the case of a corporation, section 
                        1201(a) applies to such taxable year.''.
          (2) Section 1201(a) is amended by striking ``the last 2 
        sentences of section 11(b)(1)'' and inserting ``section 
        11(b)(5)''.
          (3) Section 1561(a) is amended--
                  (A) by striking ``the last 2 sentences of section 
                11(b)(1)'' and inserting ``section 11(b)(5)'', and
                  (B) by striking ``such last 2 sentences'' and 
                inserting ``section 11(b)(5)''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2003.

                  Subtitle B--Small Business Expensing

SEC. 1011. 2-YEAR EXTENSION OF INCREASED EXPENSING FOR SMALL BUSINESS.

    Subsections (b), (c), and (d) of section 179 (as amended by the 
Jobs and Growth Tax Relief Reconciliation Act of 2003) are each amended 
by striking ``2006'' each place it appears and inserting ``2008''.

                        Subtitle C--Depreciation

SEC. 1021. RECOVERY PERIOD FOR DEPRECIATION OF CERTAIN LEASEHOLD 
                    IMPROVEMENTS AND RESTAURANT PROPERTY.

    (a) 15-Year Recovery Period.--Subparagraph (E) of section 168(e)(3) 
(relating to classification of certain property) is amended by striking 
``and'' at the end of clause (ii), by striking the period at the end of 
clause (iii) and inserting a comma, and by adding at the end the 
following new clauses:
                          ``(iv) any qualified leasehold improvement 
                        property placed in service before January 1, 
                        2006, and
                          ``(v) any qualified restaurant property 
                        placed in service before January 1, 2006.''
    (b) Qualified Leasehold Improvement Property.--Subsection (e) of 
section 168 is amended by adding at the end the following new 
paragraph:
          ``(6) Qualified leasehold improvement property.--The term 
        `qualified leasehold improvement property' has the meaning 
        given such term in section 168(k)(3) except that the following 
        special rules shall apply:
                  ``(A) Improvements made by lessor.--In the case of an 
                improvement made by the person who was the lessor of 
                such improvement when such improvement was placed in 
                service, such improvement shall be qualified leasehold 
                improvement property (if at all) only so long as such 
                improvement is held by such person.
                  ``(B) Exception for changes in form of business.--
                Property shall not cease to be qualified leasehold 
                improvement property under subparagraph (A) by reason 
                of--
                          ``(i) death,
                          ``(ii) a transaction to which section 381(a) 
                        applies,
                          ``(iii) a mere change in the form of 
                        conducting the trade or business so long as the 
                        property is retained in such trade or business 
                        as qualified leasehold improvement property and 
                        the taxpayer retains a substantial interest in 
                        such trade or business,
                          ``(iv) the acquisition of such property in an 
                        exchange described in section 1031, 1033, or 
                        1038 to the extent that the basis of such 
                        property includes an amount representing the 
                        adjusted basis of other property owned by the 
                        taxpayer or a related person, or
                          ``(v) the acquisition of such property by the 
                        taxpayer in a transaction described in section 
                        332, 351, 361, 721, or 731 (or the acquisition 
                        of such property by the taxpayer from the 
                        transferee or acquiring corporation in a 
                        transaction described in such section), to the 
                        extent that the basis of the property in the 
                        hands of the taxpayer is determined by 
                        reference to its basis in the hands of the 
                        transferor or distributor.''.
    (c) Qualified Restaurant Property.--Subsection (e) of section 168 
(as amended by subsection (b)) is further amended by adding at the end 
the following new paragraph:
          ``(7) Qualified restaurant property.--The term `qualified 
        restaurant property' means any section 1250 property which is 
        an improvement to a building if--
                  ``(A) such improvement is placed in service more than 
                3 years after the date such building was first placed 
                in service, and
                  ``(B) more than 50 percent of the building's square 
                footage is devoted to preparation of, and seating for 
                on-premises consumption of, prepared meals.''.
    (d) Requirement To Use Straight Line Method.--
          (1) Paragraph (3) of section 168(b) is amended by adding at 
        the end the following new subparagraphs:
                  ``(G) Qualified leasehold improvement property 
                described in subsection (e)(6).
                  ``(H) Qualified restaurant property described in 
                subsection (e)(7).''.
          (2) Subparagraph (A) of section 168(b)(2) is amended by 
        inserting before the comma ``not referred to in paragraph 
        (3)''.
    (e) Alternative System.--The table contained in section 
168(g)(3)(B) is amended by adding at the end the following new items:

      ``(E)(iv)......................................           39     
      ``(E)(v).......................................         39''.    

    (f) Effective Date.--The amendments made by this section shall 
apply to property placed in service after the date of the enactment of 
this Act.

               Subtitle D--Alternative Minimum Tax Relief

SEC. 1031. NET OPERATING LOSSES AND FOREIGN TAX CREDIT UNDER 
                    ALTERNATIVE MINIMUM TAX.

    (a) Net Operating Losses.--
          (1) In general.--Subparagraph (A) of section 56(d)(1) is 
        amended to read as follows:
                  ``(A) the amount of such deduction shall not exceed 
                the applicable percentage (determined under paragraph 
                (3)) of the alternative minimum taxable income 
                determined without regard to such deduction, and''.
          (2) Applicable percentage.--Subsection (d) of section 56 is 
        amended by adding at the end the following new paragraph:
          ``(3) Applicable percentage.--For purposes of paragraph 
        (1)(A)--

        ``For taxable years beginning
                                                         The applicable
          in calendar year--
                                                        percentage is--
          2005, 2006, or 2007..............................        92  
          2008 or 2009.....................................        94  
          2010.............................................        96  
          2011.............................................        98  
          2012 or thereafter...............................    100.''  

    (b) Foreign Tax Credit.--
          (1) Subsection (a) of section 59 is amended by striking 
        paragraph (2) and by redesignating paragraphs (3) and (4) as 
        paragraphs (2) and (3), respectively.
          (2) Section 53(d)(1)(B)(i)(II) is amended by striking ``and 
        if section 59(a)(2) did not apply''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2004.

SEC. 1032. EXPANSION OF EXEMPTION FROM ALTERNATIVE MINIMUM TAX FOR 
                    SMALL CORPORATIONS.

    (a) In General.--Subparagraphs (A) and (B) of section 55(e)(1) are 
each amended by striking ``$7,500,000'' each place it appears and 
inserting ``$20,000,000''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2004.

SEC. 1033. INCOME AVERAGING FOR FARMERS NOT TO INCREASE ALTERNATIVE 
                    MINIMUM TAX.

    (a) In General.--Subsection (c) of section 55 (defining regular 
tax) is amended by redesignating paragraph (2) as paragraph (3) and by 
inserting after paragraph (1) the following new paragraph:
          ``(2) Coordination with income averaging for farmers.--Solely 
        for purposes of this section, section 1301 (relating to 
        averaging of farm income) shall not apply in computing the 
        regular tax liability.''.
    (b) Effective Date.--The amendment made by subsection (a) shall 
apply to taxable years beginning after December 31, 2002.

          Subtitle E--S Corporation Reform and Simplification

SEC. 1041. MEMBERS OF FAMILY TREATED AS 1 SHAREHOLDER.

    (a) In General.--Paragraph (1) of section 1361(c) (relating to 
special rules for applying subsection (b)) is amended to read as 
follows:
          ``(1) Members of family treated as 1 shareholder.--
                  ``(A) In general.--For purpose of subsection 
                (b)(1)(A)--
                          ``(i) except as provided in clause (ii), a 
                        husband and wife (and their estates) shall be 
                        treated as 1 shareholder, and
                          ``(ii) in the case of a family with respect 
                        to which an election is in effect under 
                        subparagraph (D), all members of the family 
                        shall be treated as 1 shareholder.
                  ``(B) Members of the family.--For purpose of 
                subparagraph (A)(ii)--
                          ``(i) In general.--The term `members of the 
                        family' means the common ancestor, lineal 
                        descendants of the common ancestor, and the 
                        spouses (or former spouses) of such lineal 
                        descendants or common ancestor.
                          ``(ii) Common Ancestor.--For purposes of this 
                        paragraph, an individual shall not be 
                        considered a common ancestor if, as of the 
                        later of the effective date of this paragraph 
                        or the time the election under section 1362(a) 
                        is made, the individual is more than 3 
                        generations removed from the youngest 
                        generation of shareholders who would (but for 
                        this clause) be members of the family. For 
                        purposes of the preceding sentence, a spouse 
                        (or former spouse) shall be treated as being of 
                        the same generation as the individual to which 
                        such spouse is (or was) married.
                  ``(C) Effect of adoption, etc.--In determining 
                whether any relationship specified in subparagraph (B) 
                exists, the rules of section 152(b)(2) shall apply.
                  ``(D) Election.--An election under subparagraph 
                (A)(ii)--
                          ``(i) may, except as otherwise provided in 
                        regulations prescribed by the Secretary, be 
                        made by any member of the family, and
                          ``(ii) shall remain in effect until 
                        terminated as provided in regulations 
                        prescribed by the Secretary.''.
    (b) Relief From Inadvertent Invalid Election or Termination.--
Section 1362(f) (relating to inadvertent invalid elections or 
terminations), as amended by section 1049, is amended--
          (1) by inserting ``or section 1361(c)(1)(A)(ii)'' after 
        ``section 1361(b)(3)(B)(ii),'' in paragraph (1), and
          (2) by inserting ``or section 1361(c)(1)(D)(iii)'' after 
        ``section 1361(b)(3)(C),'' in paragraph (1)(B).
    (c) Effective Dates.--
          (1) Subsection (a).--The amendment made by subsection (a) 
        shall apply to taxable years beginning after December 31, 2003.
          (2) Subsection (b).--The amendments made by subsection (b) 
        shall apply to elections and terminations made after December 
        31, 2003.

SEC. 1042. INCREASE IN NUMBER OF ELIGIBLE SHAREHOLDERS TO 100.

    (a) In General.--Section 1361(b)(1)(A) (defining small business 
corporation) is amended by striking ``75'' and inserting ``100''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

SEC. 1043. EXPANSION OF BANK S CORPORATION ELIGIBLE SHAREHOLDERS TO 
                    INCLUDE IRAS.

    (a) In General.--Section 1361(c)(2)(A) (relating to certain trusts 
permitted as shareholders) is amended by inserting after clause (v) the 
following new clause:
                          ``(vi) In the case of a corporation which is 
                        a bank (as defined in section 581), a trust 
                        which constitutes an individual retirement 
                        account under section 408(a), including one 
                        designated as a Roth IRA under section 408A, 
                        but only to the extent of the stock held by 
                        such trust in such bank as of the date of the 
                        enactment of this clause.''.
    (b) Treatment as Shareholder.--Section 1361(c)(2)(B) (relating to 
treatment as shareholders) is amended by adding at the end the 
following new clause:
                          ``(vi) In the case of a trust described in 
                        clause (vi) of subparagraph (A), the individual 
                        for whose benefit the trust was created shall 
                        be treated as a shareholder.''.
    (c) Sale of Bank Stock in IRA Relating to S Corporation Election 
Exempt From Prohibited Transaction Rules.--Section 4975(d) (relating to 
exemptions) is amended by striking ``or'' at the end of paragraph (14), 
by striking the period at the end of paragraph (15) and inserting ``; 
or'', and by adding at the end the following new paragraph:
          ``(16) a sale of stock held by a trust which constitutes an 
        individual retirement account under section 408(a) to the 
        individual for whose benefit such account is established if--
                  ``(A) such stock is in a bank (as defined in section 
                581),
                  ``(B) such stock is held by such trust as of the date 
                of the enactment of this paragraph,
                  ``(C) such sale is pursuant to an election under 
                section 1362(a) by such bank,
                  ``(D) such sale is for fair market value at the time 
                of sale (as established by an independent appraiser) 
                and the terms of the sale are otherwise at least as 
                favorable to such trust as the terms that would apply 
                on a sale to an unrelated party,
                  ``(E) such trust does not pay any commissions, costs, 
                or other expenses in connection with the sale, and
                  ``(F) the stock is sold in a single transaction for 
                cash not later than 120 days after the S corporation 
                election is made.''.
    (d) Conforming Amendment.--Section 512(e)(1) is amended by 
inserting ``1361(c)(2)(A)(vi) or'' before ``1361(c)(6)''.
    (e) Effective Date.--The amendments made by this section shall take 
effect on the date of the enactment of this Act.

SEC. 1044. DISREGARD OF UNEXERCISED POWERS OF APPOINTMENT IN 
                    DETERMINING POTENTIAL CURRENT BENEFICIARIES OF 
                    ESBT.

    (a) In General.--Section 1361(e)(2) (defining potential current 
beneficiary) is amended--
          (1) by inserting ``(determined without regard to any power of 
        appointment to the extent such power remains unexercised at the 
        end of such period)'' after ``of the trust'' in the first 
        sentence, and
          (2) by striking ``60-day'' in the second sentence and 
        inserting ``1-year''.
    (b) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2003.

SEC. 1045. TRANSFER OF SUSPENDED LOSSES INCIDENT TO DIVORCE, ETC.

    (a) In General.--Section 1366(d)(2) (relating to indefinite 
carryover of disallowed losses and deductions) is amended to read as 
follows:
          ``(2) Indefinite carryover of disallowed losses and 
        deductions.--
                  ``(A) In general.--Except as provided in subparagraph 
                (B), any loss or deduction which is disallowed for any 
                taxable year by reason of paragraph (1) shall be 
                treated as incurred by the corporation in the 
                succeeding taxable year with respect to that 
                shareholder.
                  ``(B) Transfers of stock between spouses or incident 
                to divorce.--In the case of any transfer described in 
                section 1041(a) of stock of an S corporation, any loss 
                or deduction described in subparagraph (A) with respect 
                such stock shall be treated as incurred by the 
                corporation in the succeeding taxable year with respect 
                to the transferee.''
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

SEC. 1046. USE OF PASSIVE ACTIVITY LOSS AND AT-RISK AMOUNTS BY 
                    QUALIFIED SUBCHAPTER S TRUST INCOME BENEFICIARIES.

    (a) In General.--Section 1361(d)(1) (relating to special rule for 
qualified subchapter S trust) is amended--
          (1) by striking ``and'' at the end of subparagraph (A),
          (2) by striking the period at the end of subparagraph (B) and 
        inserting ``, and'', and
          (3) by adding at the end the following new subparagraph:
                  ``(C) for purposes of applying sections 465 and 469 
                to the beneficiary of the trust, the disposition of the 
                S corporation stock by the trust shall be treated as a 
                disposition by such beneficiary.''.
    (b) Effective Date.--The amendments made by this section shall 
apply to transfers made after December 31, 2003.

SEC. 1047. EXCLUSION OF INVESTMENT SECURITIES INCOME FROM PASSIVE 
                    INCOME TEST FOR BANK S CORPORATIONS.

    (a) In General.--Section 1362(d)(3) (relating to where passive 
investment income exceeds 25 percent of gross receipts for 3 
consecutive taxable years and corporation has accumulated earnings and 
profits) is amended by adding at the end the following new 
subparagraph:
                  ``(F) Exception for banks; etc.--In the case of a 
                bank (as defined in section 581), a bank holding 
                company (within the meaning of section 2(a) of the Bank 
                Holding Company Act of 1956 (12 U.S.C. 1841(a))), or a 
                financial holding company (within the meaning of 
                section 2(p) of such Act), the term `passive investment 
                income' shall not include--
                          ``(i) interest income earned by such bank or 
                        company, or
                          ``(ii) dividends on assets required to be 
                        held by such bank or company, including stock 
                        in the Federal Reserve Bank, the Federal Home 
                        Loan Bank, or the Federal Agricultural Mortgage 
                        Bank or participation certificates issued by a 
                        Federal Intermediate Credit Bank.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

SEC. 1048. TREATMENT OF BANK DIRECTOR SHARES.

    (a) In General.--Section 1361 (defining S corporation) is amended 
by adding at the end the following new subsection:
    ``(f) Restricted Bank Director Stock.--
          ``(1) In general.--Restricted bank director stock shall not 
        be taken into account as outstanding stock of the S corporation 
        in applying this subchapter (other than section 1368(f)).
          ``(2) Restricted bank director stock.--For purposes of this 
        subsection, the term `restricted bank director stock' means 
        stock in a bank (as defined in section 581), a bank holding 
        company (within the meaning of section 2(a) of the Bank Holding 
        Company Act of 1956 (12 U.S.C. 1841(a))), or a financial 
        holding company (within the meaning of section 2(p) of such 
        Act), registered with the Federal Reserve System if such 
        stock--
                  ``(A) is required to be held by an individual under 
                applicable Federal or State law in order to permit such 
                individual to serve as a director, and
                  ``(B) is subject to an agreement with such bank or 
                company (or a corporation which controls (within the 
                meaning of section 368(c)) such bank or company) 
                pursuant to which the holder is required to sell back 
                such stock (at the same price as the individual 
                acquired such stock) upon ceasing to hold the office of 
                director.
          ``(3) Cross reference.--

                ``For treatment of certain distributions with respect 
to restricted bank director stock, see section 1368(f).''.

    (b) Distributions.--Section 1368 (relating to distributions) is 
amended by adding at the end the following new subsection:
    ``(f) Restricted Bank Director Stock.--If a director receives a 
distribution (not in part or full payment in exchange for stock) from 
an S corporation with respect to any restricted bank director stock (as 
defined in section 1361(f)), the amount of such distribution--
          ``(1) shall be includible in gross income of the director, 
        and
          ``(2) shall be deductible by the corporation for the taxable 
        year of such corporation in which or with which ends the 
        taxable year in which such amount in included in the gross 
        income of the director.''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2003.

SEC. 1049. RELIEF FROM INADVERTENTLY INVALID QUALIFIED SUBCHAPTER S 
                    SUBSIDIARY ELECTIONS AND TERMINATIONS.

    (a) In General.--Section 1362(f) (relating to inadvertent invalid 
elections or terminations) is amended--
          (1) by inserting ``, section 1361(b)(3)(B)(ii),'' after 
        ``subsection (a)'' in paragraph (1),
          (2) by inserting ``, section 1361(b)(3)(C),'' after 
        ``subsection (d)'' in paragraph (1)(B),
          (3) by amending paragraph (3)(A) to read as follows:
                  ``(A) so that the corporation for which the election 
                was made is a small business corporation or a qualified 
                subchapter S subsidiary, as the case may be, or'',
          (4) by amending paragraph (4) to read as follows:
          ``(4) the corporation for which the election was made, and 
        each person who was a shareholder in such corporation at any 
        time during the period specified pursuant to this subsection, 
        agrees to make such adjustments (consistent with the treatment 
        of such corporation as an S corporation or a qualified 
        subchapter S subsidiary, as the case may be) as may be required 
        by the Secretary with respect to such period,'', and
          (5) by inserting ``or a qualified subchapter S subsidiary, as 
        the case may be'' after ``S corporation'' in the matter 
        following paragraph (4).
    (b) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2003.

SEC. 1050. INFORMATION RETURNS FOR QUALIFIED SUBCHAPTER S SUBSIDIARIES.

    (a) In General.--Section 1361(b)(3)(A) (relating to treatment of 
certain wholly owned subsidiaries) is amended by inserting ``and in the 
case of information returns required under part III of subchapter A of 
chapter 61'' after ``Secretary''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

SEC. 1051. REPAYMENT OF LOANS FOR QUALIFYING EMPLOYER SECURITIES.

    (a) In General.--Subsection (f) of section 4975 (relating to other 
definitions and special rules) is amended by adding at the end the 
following new paragraph:
          ``(7) S corporation repayment of loans for qualifying 
        employer securities.--A plan shall not be treated as violating 
        the requirements of section 401 or 409 or subsection (e)(7), or 
        as engaging in a prohibited transaction for purposes of 
        subsection (d)(3), merely by reason of any distribution (as 
        described in section 1368(a)) with respect to S corporation 
        stock that constitutes qualifying employer securities, which in 
        accordance with the plan provisions is used to make payments on 
        a loan described in subsection (d)(3) the proceeds of which 
        were used to acquire such qualifying employer securities 
        (whether or not allocated to participants). The preceding 
        sentence shall not apply in the case of a distribution which is 
        paid with respect to any employer security which is allocated 
        to a participant unless the plan provides that employer 
        securities with a fair market value of not less than the amount 
        of such distribution are allocated to such participant for the 
        year which (but for the preceding sentence) such distribution 
        would have been allocated to such participant.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to distributions with respect to S corporation stock made after 
December 31, 2003.

                Subtitle F--Protecting Employee Benefits

SEC. 1061. TREATMENT OF NONQUALIFIED DEFERRED COMPENSATION PLANS.

    (a) In General.--Subpart A of part I of subchapter D of chapter 1 
is amended by adding at the end the following new section:

``SEC. 409A. INCLUSION IN GROSS INCOME OF DEFERRED COMPENSATION UNDER 
                    NONQUALIFIED DEFERRED COMPENSATION PLANS.

    ``(a) Rules Relating to Constructive Receipt.--
          ``(1) In general.--
                  ``(A) Gross income inclusion.--In the case of a 
                nonqualified deferred compensation plan, all 
                compensation deferred under the plan for all taxable 
                years (to the extent not subject to a substantial risk 
                of forfeiture and not previously included in gross 
                income) shall be includible in gross income for the 
                taxable year unless at all times during the taxable 
                year the plan meets the requirements of paragraphs (2), 
                (3), and (4) and is operated in accordance with such 
                requirements.
                  ``(B) Interest on tax liability payable with respect 
                to previously deferred compensation.--
                          ``(i) In general.--If compensation is 
                        required to be included in gross income under 
                        subparagraph (A) for a taxable year, the tax 
                        imposed by this chapter for such taxable year 
                        shall be increased by the amount of interest 
                        determined under clause (ii).
                          ``(ii) Interest.--For purposes of clause (i), 
                        the interest determined under this clause for 
                        any taxable year is the amount of interest at 
                        the underpayment rate plus 1 percentage point 
                        on the underpayments that would have occurred 
                        had the deferred compensation been includible 
                        in gross income for the taxable year in which 
                        first deferred or, if later, the first taxable 
                        year in which such deferred compensation is not 
                        subject to a substantial risk of forfeiture.
          ``(2) Distributions.--
                  ``(A) In general.--The requirements of this paragraph 
                are met if the plan provides that compensation deferred 
                under the plan may not be distributed earlier than--
                          ``(i) separation from service as determined 
                        by the Secretary (except as provided in 
                        subparagraph (B)(i)),
                          ``(ii) disability (as defined by section 
                        223(d) of the Social Security Act),
                          ``(iii) death,
                          ``(iv) a specified time (or pursuant to a 
                        fixed schedule) specified under the plan at the 
                        date of the deferral of such compensation,
                          ``(v) to the extent provided by the 
                        Secretary, a change in the ownership or 
                        effective control of the corporation, or in the 
                        ownership of a substantial portion of the 
                        assets of the corporation, or
                          ``(vi) the occurrence of an unforeseeable 
                        emergency.
                  ``(B) Special rules.--
                          ``(i) Specified employees.--In the case of 
                        specified employees, the requirement of 
                        subparagraph (A)(i) is met only if 
                        distributions may not be made earlier than 6 
                        months after the date of separation from 
                        service. For purposes of the preceding 
                        sentence, a specified employee is a key 
                        employee (as defined in section 416(i)) of a 
                        corporation the stock in which is publicly 
                        traded on an established securities market or 
                        otherwise.
                          ``(ii) Unforeseeable emergency.--For purposes 
                        of subparagraph (A)(vi)--
                                  ``(I) In general.--The term 
                                `unforeseeable emergency' means a 
                                severe financial hardship to the 
                                participant resulting from a sudden and 
                                unexpected illness or accident of the 
                                participant, the participant's spouse, 
                                or a dependent (as defined in section 
                                152(a)) of the participant, loss of the 
                                participant's property due to casualty, 
                                or other similar extraordinary and 
                                unforeseeable circumstances arising as 
                                a result of events beyond the control 
                                of the participant.
                                  ``(II) Limitation on distributions.--
                                The requirement of subparagraph (A)(vi) 
                                is met only if, as determined under 
                                regulations of the Secretary, the 
                                amounts distributed with respect to an 
                                emergency do not exceed the amounts 
                                necessary to satisfy such emergency 
                                plus amounts necessary to pay taxes 
                                reasonably anticipated as a result of 
                                the distribution, after taking into 
                                account the extent to which such 
                                hardship is or may be relieved through 
                                reimbursement or compensation by 
                                insurance or otherwise or by 
                                liquidation of the participant's assets 
                                (to the extent the liquidation of such 
                                assets would not itself cause severe 
                                financial hardship).
          ``(3) Acceleration of benefits.--The requirements of this 
        paragraph are met if the plan does not permit the acceleration 
        of the time or schedule of any payment under the plan, except 
        as provided in regulations by the Secretary.
          ``(4) Elections.--
                  ``(A) In general.--The requirements of this paragraph 
                are met if the requirements of subparagraphs (B) and 
                (C) are met.
                  ``(B) Initial deferral decision.--The requirements of 
                this subparagraph are met if the plan provides that 
                compensation for services performed during a taxable 
                year may be deferred at the participant's election only 
                if the election to defer such compensation is made 
                during the preceding taxable year or at such other time 
                as provided in regulations. In the case of the first 
                year in which a participant becomes eligible to 
                participate in the plan, such election may be made with 
                respect to services to be performed subsequent to the 
                election within 30 days after the date the participant 
                becomes eligible to participate in such plan.
                  ``(C) Changes in time and form of distribution.--The 
                requirements of this subparagraph are met if, in the 
                case of a plan which permits under a subsequent 
                election a delay in a payment or a change in the form 
                of payment--
                          ``(i) the plan requires that such election 
                        may not take effect until at least 12 months 
                        after the date on which the election is made,
                          ``(ii) in the case an election related to a 
                        payment not described in clause (ii), (iii), or 
                        (vi) of paragraph (2)(A), the plan requires 
                        that the first payment with respect to which 
                        such election is made be deferred for a period 
                        of not less than 5 years from the date such 
                        payment would otherwise have been made, and
                          ``(iii) the plan requires that any election 
                        related to a payment described in paragraph 
                        (2)(A)(iv) may not be made less than 12 months 
                        prior to the date of the first scheduled 
                        payment under such paragraph.
    ``(b) Rules Relating to Funding.--
          ``(1) Offshore property in a trust.--In the case of assets 
        held in a trust or set aside (directly or indirectly) in 
        another arrangement, as determined by the Secretary, for 
        purposes of paying deferred compensation under a nonqualified 
        deferred compensation plan, for purposes of section 83 such 
        assets shall be treated as property transferred in connection 
        with the performance of services whether or not such assets are 
        available to satisfy claims of general creditors--
                  ``(A) at the time set aside if such assets are 
                located outside of the United States, or
                  ``(B) at the time transferred if such assets are 
                subsequently transferred outside of the United States.
          ``(2) Employer's financial health.--In the case of a 
        nonqualified deferred compensation plan, there is a transfer of 
        property within the meaning of section 83 as of the earlier 
        of--
                  ``(A) the date on which the plan first provides that 
                assets will become restricted to the provision of 
                benefits under the plan in connection with a change in 
                the employer's financial health, or
                  ``(B) the date on which assets are so restricted.
          ``(3) Income inclusion for offshore trusts and employer's 
        financial health.--For each taxable year that assets treated as 
        transferred under this subsection remain set aside in a trust 
        or other arrangement subject to paragraph (1) or (2), any 
        increase in value in, or earnings with respect to, such assets 
        shall be treated as an additional transfer of property under 
        this subsection (to the extent not previously included in 
        income).
          ``(4) Interest on tax liability payable with respect to 
        transferred property.--
                  ``(A) In general.--If amounts are required to be 
                included in gross income by reason of paragraph (1) or 
                (2) for a taxable year, the tax imposed by this chapter 
                for such taxable year shall be increased by the amount 
                of interest determined under subparagraph (B).
                  ``(B) Interest.--The interest determined under this 
                subparagraph for any taxable year is the amount of 
                interest at the underpayment rate plus 1 percentage 
                point on the underpayments that would have occurred had 
                the amounts so required to be included in gross income 
                by paragraph (1) or (2) been includible in gross income 
                for the taxable year in which such assets were first 
                set aside (directly or indirectly) in a trust (or other 
                arrangement determined by the Secretary) for purposes 
                of the nonqualified deferred compensation plan.
    ``(c) No Inference on Earlier Income Inclusion or Requirement of 
Later Inclusion.--Nothing in this section shall be construed to prevent 
the inclusion of amounts in gross income under any other provision of 
this chapter or any other rule of law earlier than the time provided in 
this section. Any amount included in gross income under this section 
shall not be required to be included in gross income under any other 
provision of this chapter or any other rule of law later than the time 
provided in this section.
    ``(d) Other Definitions and Special Rules.--For purposes of this 
section--
          ``(1) Nonqualified deferred compensation plan.--The term 
        `nonqualified deferred compensation plan' means any plan that 
        provides for the deferral of compensation, other than--
                  ``(A) a qualified employer plan, and
                  ``(B) any bona fide vacation leave, sick leave, 
                compensatory time, disability pay, or death benefit 
                plan.
          ``(2) Qualified employer plan.--The term `qualified employer 
        plan' means--
                  ``(A) any plan, contract, pension, account, or trust 
                described in subparagraph (A) or (B) of section 
                219(g)(5), and
                  ``(B) any eligible deferred compensation plan (within 
                the meaning of section 457(b)) of an employer described 
                in section 457(e)(1)(A).
          ``(3) Plan includes arrangements, etc.--The term `plan' 
        includes any agreement or arrangement, including an agreement 
        or arrangement that includes one person.
          ``(4) Substantial risk of forfeiture.--The rights of a person 
        to compensation are subject to a substantial risk of forfeiture 
        if such person's rights to such compensation are conditioned 
        upon the future performance of substantial services by any 
        individual.
          ``(5) Treatment of earnings.--References to deferred 
        compensation shall be treated as including references to income 
        (whether actual or notional) attributable to such compensation 
        or such income.
    ``(e) Regulations.--The Secretary shall prescribe such regulations 
as may be necessary or appropriate to carry out the purposes of this 
section, including regulations--
          ``(1) providing for the determination of amounts of deferral 
        in the case of a nonqualified deferred compensation plan which 
        is a defined benefit plan,
          ``(2) relating to changes in the ownership and control of a 
        corporation or assets of a corporation for purposes of 
        subsection (a)(2)(A)(v),
          ``(3) exempting arrangements from the application of 
        subsection (b) if such arrangements will not result in an 
        improper deferral of United States tax and will not result in 
        assets being effectively beyond the reach of creditors,
          ``(4) defining financial health for purposes of subsection 
        (b)(2), and
          ``(5) disregarding a substantial risk of forfeiture in cases 
        where necessary to carry out the purposes of this section.''.
    (b) W-2 Forms.--
          (1) In general.--Subsection (a) of section 6051 (relating to 
        receipts for employees) is amended by striking ``and'' at the 
        end of paragraph (10), by striking the period at the end of 
        paragraph (11) and inserting ``, and'', and by inserting after 
        paragraph (11) the following new paragraph:
          ``(12) the total amount of deferrals under a nonqualified 
        deferred compensation plan (within the meaning of section 
        409A(d)).''.
          (2) Threshold.--Subsection (a) of section 6051 is amended by 
        adding at the end the following: ``In the case of the amounts 
        required to be shown by paragraph (12), the Secretary (by 
        regulation) may establish a minimum amount of deferrals below 
        which paragraph (12) does not apply and may provide that 
        paragraph (12) does not apply with respect to amounts of 
        deferrals which are not reasonably ascertainable.''.
    (c) Conforming and Clerical Amendments.--
          (1) Section 414(b) is amended by inserting ``409A,'' after 
        ``408(p),''.
          (2) Section 414(c) is amended by inserting ``409A,'' after 
        ``408(p),''.
          (3) The table of sections for such subpart A of part I of 
        subchapter D of chapter 1 is amended by adding at the end the 
        following new item:

                              ``Sec. 409A. Inclusion in gross income of 
                                        deferred compensation under 
                                        nonqualified deferred 
                                        compensation plans.''.
    (d) Effective Date.--
          (1) In general.--Except as otherwise provided in this 
        subsection, the amendments made by this section shall apply to 
        amounts deferred in taxable years beginning after December 31, 
        2003.
          (2) Amounts deferred in 2004 under certain irrevocable 
        elections and binding arrangements.--The amendments made by 
        this section shall not apply to amounts deferred in taxable 
        years beginning after December 31, 2003, and before January 1, 
        2005, pursuant to an irrevocable election or binding 
        arrangement made before October 24, 2003.
          (3) Earnings attributable to amount previously deferred.--The 
        amendments made by this section shall apply to earnings on 
        deferred compensation only to the extent that such amendments 
        apply to such compensation.
    (e) Guidance Relating to Change of Ownership or Control.--Not later 
than 90 days after the date of the enactment of this Act, the Secretary 
of the Treasury shall issue guidance on what constitutes a change in 
ownership or effective control for purposes of section 409A of the 
Internal Revenue Code of 1986, as added by this section.
    (f) Guidance Relating to Termination of Certain Existing 
Arrangements.--Not later than 90 days after the date of the enactment 
of this Act, the Secretary of the Treasury shall issue guidance 
providing a limited period during which an individual participating in 
a nonqualified deferred compensation plan adopted on or before December 
31, 2003, may, without violating the requirements of paragraphs (2), 
(3), and (4) of section 409A(a)(2) of the Internal Revenue Code of 1986 
(as added by this section), terminate participation or cancel an 
outstanding deferral election with regard to amounts earned after 
December 31, 2003, if such amounts are includible in income as earned.

SEC. 1062. EXCLUSION OF INCENTIVE STOCK OPTIONS AND EMPLOYEE STOCK 
                    PURCHASE PLAN STOCK OPTIONS FROM WAGES.

    (a) Exclusion From Employment Taxes.--
          (1) Social security taxes.--
                  (A) Section 3121(a) (relating to definition of wages) 
                is amended by striking ``or'' at the end of paragraph 
                (20), by striking the period at the end of paragraph 
                (21) and inserting ``; or'', and by inserting after 
                paragraph (21) the following new paragraph:
          ``(22) remuneration on account of--
                  ``(A) a transfer of a share of stock to any 
                individual pursuant to an exercise of an incentive 
                stock option (as defined in section 422(b)) or under an 
                employee stock purchase plan (as defined in section 
                423(b)), or
                  ``(B) any disposition by the individual of such 
                stock.''.
                  (B) Section 209(a) of the Social Security Act is 
                amended by striking ``or'' at the end of paragraph 
                (17), by striking the period at the end of paragraph 
                (18) and inserting ``; or'', and by inserting after 
                paragraph (18) the following new paragraph:
          ``(19) Remuneration on account of--
                  ``(A) a transfer of a share of stock to any 
                individual pursuant to an exercise of an incentive 
                stock option (as defined in section 422(b) of the 
                Internal Revenue Code of 1986) or under an employee 
                stock purchase plan (as defined in section 423(b) of 
                such Code), or
                  ``(B) any disposition by the individual of such 
                stock.''.
          (2) Railroad retirement taxes.--Subsection (e) of section 
        3231 is amended by adding at the end the following new 
        paragraph:
          ``(11) Qualified stock options.--The term `compensation' 
        shall not include any remuneration on account of--
                  ``(A) a transfer of a share of stock to any 
                individual pursuant to an exercise of an incentive 
                stock option (as defined in section 422(b)) or under an 
                employee stock purchase plan (as defined in section 
                423(b)), or
                  ``(B) any disposition by the individual of such 
                stock.''.
          (3) Unemployment taxes.--Section 3306(b) (relating to 
        definition of wages) is amended by striking ``or'' at the end 
        of paragraph (16), by striking the period at the end of 
        paragraph (17) and inserting ``; or'', and by inserting after 
        paragraph (17) the following new paragraph:
          ``(18) remuneration on account of--
                  ``(A) a transfer of a share of stock to any 
                individual pursuant to an exercise of an incentive 
                stock option (as defined in section 422(b)) or under an 
                employee stock purchase plan (as defined in section 
                423(b)), or
                  ``(B) any disposition by the individual of such 
                stock.''.
    (b) Wage Withholding Not Required on Disqualifying Dispositions.--
Section 421(b) (relating to effect of disqualifying dispositions) is 
amended by adding at the end the following new sentence: ``No amount 
shall be required to be deducted and withheld under chapter 24 with 
respect to any increase in income attributable to a disposition 
described in the preceding sentence.''.
    (c) Wage Withholding Not Required on Compensation Where Option 
Price Is Between 85 Percent and 100 Percent of Value of Stock.--Section 
423(c) (relating to special rule where option price is between 85 
percent and 100 percent of value of stock) is amended by adding at the 
end the following new sentence: ``No amount shall be required to be 
deducted and withheld under chapter 24 with respect to any amount 
treated as compensation under this subsection.''.
    (d) Effective Date.--The amendments made by this section shall 
apply to stock acquired pursuant to options exercised after the date of 
the enactment of this Act.

SEC. 1063. EXTENSION OF TRANSFERS OF EXCESS PENSION ASSETS TO RETIREE 
                    HEALTH ACCOUNTS.

    Paragraph (5) of section 420(b) (relating to expiration) is amended 
by striking ``December 31, 2005'' and inserting ``December 31, 2013''.

                 Subtitle G--Treatment of Active Income

SEC. 1071. MEMBER STATES OF THE EUROPEAN UNION TREATED AS A SINGLE 
                    COUNTRY FOR CERTAIN PURPOSES.

    (a) In General.--Subsection (d) of section 954 is amended by adding 
at the end the following new paragraph:
          ``(5) Treatment of member states of the european union.--For 
        purposes of this subsection and subsection (e), in the case of 
        a controlled foreign corporation which is created or organized 
        under the laws of a member state of the European Union, all 
        member states of the European Union shall be treated as 1 
        country.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years of foreign corporations beginning after December 31, 
2008, and to taxable years of United States shareholders with or within 
which such taxable years of foreign corporations end.

SEC. 1072. LOOK-THRU TREATMENT OF PAYMENTS BETWEEN RELATED CONTROLLED 
                    FOREIGN CORPORATIONS UNDER FOREIGN PERSONAL HOLDING 
                    COMPANY INCOME RULES.

    (a) In General.--Subsection (c) of section 954 is amended by adding 
after paragraph (3) the following new paragraph:
          ``(4) Look-thru in the case of related controlled foreign 
        corporations.--For purposes of this subsection, dividends, 
        interest, rents, and royalties received or accrued from a 
        controlled foreign corporation which is a related person (as 
        defined in subsection (d)(3)) shall not be treated as foreign 
        personal holding company income to the extent attributable or 
        properly allocable (determined under rules similar to the rules 
        of subparagraphs (C) and (D) of section 904(d)(3)) to income of 
        the related person which is not subpart F income (as defined in 
        section 952). The Secretary shall prescribe such regulations as 
        may be appropriate to prevent the abuse of the purposes of this 
        paragraph.''
    (b) Effective Date.--The amendments made by this section shall 
apply to taxable years of foreign corporations beginning after December 
31, 2006, and to taxable years of United States shareholders with or 
within which such taxable years of foreign corporations end.

SEC. 1073. LOOK-THRU TREATMENT FOR SALES OF PARTNERSHIP INTERESTS.

    (a) In General.--Section 954(c) (defining foreign personal holding 
company income) is amended by adding after paragraph (4) the following 
new paragraph:
          ``(5) Look-thru rule for certain partnership sales.--
                  ``(A) In general.--In the case of any sale by a 
                controlled foreign corporation of an interest in a 
                partnership with respect to which such corporation is a 
                25-percent owner, such corporation shall be treated for 
                purposes of this subsection as selling the 
                proportionate share of the assets of the partnership 
                attributable to such interest.
                  ``(B) 25-percent owner.--For purposes of this 
                paragraph, the term `25-percent owner' means a 
                controlled foreign corporation which owns (within the 
                meaning of section 958(a)) 25 percent or more of the 
                capital or profits interest in the partnership.''
    (b) Effective Date.--The amendments made by this section shall 
apply to taxable years of foreign corporations beginning after December 
31, 2006, and to taxable years of United States shareholders with or 
within which such taxable years of foreign corporations end.

SEC. 1074. REPEAL OF FOREIGN PERSONAL HOLDING COMPANY RULES AND FOREIGN 
                    INVESTMENT COMPANY RULES.

    (a) General Rule.--The following provisions are hereby repealed:
          (1) Part III of subchapter G of chapter 1 (relating to 
        foreign personal holding companies).
          (2) Section 1246 (relating to gain on foreign investment 
        company stock).
          (3) Section 1247 (relating to election by foreign investment 
        companies to distribute income currently).
    (b) Exemption of Foreign Corporations From Personal Holding Company 
Rules.--
          (1) In general.--Subsection (c) of section 542 (relating to 
        exceptions) is amended--
                  (A) by striking paragraph (5) and inserting the 
                following:
          ``(5) a foreign corporation,'',
                  (B) by striking paragraphs (7) and (10) and by 
                redesignating paragraphs (8) and (9) as paragraphs (7) 
                and (8), respectively,
                  (C) by inserting ``and'' at the end of paragraph (7) 
                (as so redesignated), and
                  (D) by striking ``; and'' at the end of paragraph (8) 
                (as so redesignated) and inserting a period.
          (2) Treatment of income from personal service contracts.--
        Paragraph (1) of section 954(c) is amended by adding at the end 
        the following new subparagraph:
                  ``(H) Personal service contracts.--
                          ``(i) Amounts received under a contract under 
                        which the corporation is to furnish personal 
                        services if--
                                  ``(I) some person other than the 
                                corporation has the right to designate 
                                (by name or by description) the 
                                individual who is to perform the 
                                services, or
                                  ``(II) the individual who is to 
                                perform the services is designated (by 
                                name or by description) in the 
                                contract, and
                          ``(ii) amounts received from the sale or 
                        other disposition of such a contract.
                This subparagraph shall apply with respect to amounts 
                received for services under a particular contract only 
                if at some time during the taxable year 25 percent or 
                more in value of the outstanding stock of the 
                corporation is owned, directly or indirectly, by or for 
                the individual who has performed, is to perform, or may 
                be designated (by name or by description) as the one to 
                perform, such services.''
    (c) Conforming Amendments.--
          (1) Clause (iii) of section 1(h)(11)(C) is amended by 
        striking ``a foreign personal holding company (as defined in 
        section 552), a foreign investment company (as defined in 
        section 1246(b)), or''.
          (2) Paragraph (2) of section 171(c) is amended--
                  (A) by striking ``, or by a foreign personal holding 
                company, as defined in section 552'', and
                  (B) by striking ``or foreign personal holding 
                company''.
          (3) Paragraph (2) of section 245(a) is amended by striking 
        ``foreign personal holding company or''.
          (4) Section 312 is amended by striking subsection (j).
          (5) Subsection (m) of section 312 is amended by striking ``, 
        a foreign investment company (within the meaning of section 
        1246(b)), or a foreign personal holding company (within the 
        meaning of section 552)''.
          (6) Subsection (e) of section 443 is amended by striking 
        paragraph (3) and by redesignating paragraphs (4) and (5) as 
        paragraphs (3) and (4), respectively.
          (7) Subparagraph (B) of section 465(c)(7) is amended by 
        adding ``or'' at the end of clause (i), by striking clause 
        (ii), and by redesignating clause (iii) as clause (ii).
          (8) Paragraph (1) of section 543(b) is amended by inserting 
        ``and'' at the end of subparagraph (A), by striking ``, and'' 
        at the end of subparagraph (B) and inserting a period, and by 
        striking subparagraph (C).
          (9) Paragraph (1) of section 562(b) is amended by striking 
        ``or a foreign personal holding company described in section 
        552''.
          (10) Section 563 is amended--
                  (A) by striking subsection (c),
                  (B) by redesignating subsection (d) as subsection 
                (c), and
                  (C) by striking ``subsection (a), (b), or (c)'' in 
                subsection (c) (as so redesignated) and inserting 
                ``subsection (a) or (b)''.
          (11) Subsection (d) of section 751 is amended by adding 
        ``and'' at the end of paragraph (2), by striking paragraph (3), 
        by redesignating paragraph (4) as paragraph (3), and by 
        striking ``paragraph (1), (2), or (3)'' in paragraph (3) (as so 
        redesignated) and inserting ``paragraph (1) or (2)''.
          (12) Paragraph (2) of section 864(d) is amended by striking 
        subparagraph (A) and by redesignating subparagraphs (B) and (C) 
        as subparagraphs (A) and (B), respectively.
          (13)(A) Subparagraph (A) of section 898(b)(1) is amended to 
        read as follows:
                  ``(A) which is treated as a controlled foreign 
                corporation for any purpose under subpart F of part III 
                of this subchapter, and''.
          (B) Subparagraph (B) of section 898(b)(2) is amended by 
        striking ``and sections 551(f) and 554, whichever are 
        applicable,''.
          (C) Paragraph (3) of section 898(b) is amended to read as 
        follows:
          ``(3) United states shareholder.--The term `United States 
        shareholder' has the meaning given to such term by section 
        951(b), except that, in the case of a foreign corporation 
        having related person insurance income (as defined in section 
        953(c)(2)), the Secretary may treat any person as a United 
        States shareholder for purposes of this section if such person 
        is treated as a United States shareholder under section 
        953(c)(1).''
          (D) Subsection (c) of section 898 is amended to read as 
        follows:
    ``(c) Determination of Required Year.--
          ``(1) In general.--The required year is--
                  ``(A) the majority U.S. shareholder year, or
                  ``(B) if there is no majority U.S. shareholder year, 
                the taxable year prescribed under regulations.
          ``(2) 1-month deferral allowed.--A specified foreign 
        corporation may elect, in lieu of the taxable year under 
        paragraph (1)(A), a taxable year beginning 1 month earlier than 
        the majority U.S. shareholder year.
          ``(3) Majority u.s. shareholder year.--
                  ``(A) In general.--For purposes of this subsection, 
                the term `majority U.S. shareholder year' means the 
                taxable year (if any) which, on each testing day, 
                constituted the taxable year of--
                          ``(i) each United States shareholder 
                        described in subsection (b)(2)(A), and
                          ``(ii) each United States shareholder not 
                        described in clause (i) whose stock was treated 
                        as owned under subsection (b)(2)(B) by any 
                        shareholder described in such clause.
                  ``(B) Testing day.--The testing days shall be--
                          ``(i) the first day of the corporation's 
                        taxable year (determined without regard to this 
                        section), or
                          ``(ii) the days during such representative 
                        period as the Secretary may prescribe.''
          (14) Clause (ii) of section 904(d)(2)(A) is amended to read 
        as follows:
                          ``(ii) Certain amounts included.--Except as 
                        provided in clause (iii), the term `passive 
                        income' includes, except as provided in 
                        subparagraph (E)(iii) or paragraph (3)(I), any 
                        amount includible in gross income under section 
                        1293 (relating to certain passive foreign 
                        investment companies).''
          (15)(A) Subparagraph (A) of section 904(g)(1) is amended by 
        adding ``or'' at the end of clause (i), by striking clause 
        (ii), and by redesignating clause (iii) as clause (ii).
          (B) The paragraph heading of paragraph (2) of section 904(g) 
        is amended by striking ``foreign personal holding or''.
          (16) Section 951 is amended by striking subsections (c) and 
        (d) and by redesignating subsections (e) and (f) as subsections 
        (c) and (d), respectively.
          (17) Paragraph (3) of section 989(b) is amended by striking 
        ``, 551(a),''.
          (18) Paragraph (5) of section 1014(b) is amended by inserting 
        ``and before January 1, 2008,'' after ``August 26, 1937,''.
          (19) Subsection (a) of section 1016 is amended by striking 
        paragraph (13).
          (20)(A) Paragraph (3) of section 1212(a) is amended to read 
        as follows:
          ``(3) Special rules on carrybacks.--A net capital loss of a 
        corporation shall not be carried back under paragraph (1)(A) to 
        a taxable year--
                  ``(A) for which it is a regulated investment company 
                (as defined in section 851), or
                  ``(B) for which it is a real estate investment trust 
                (as defined in section 856).''
          (B) The amendment made by subparagraph (A) shall apply to 
        taxable years beginning after December 31, 2006.
          (21) Section 1223 is amended by striking paragraph (10) and 
        by redesignating the following paragraphs accordingly.
          (22) Subsection (d) of section 1248 is amended by striking 
        paragraph (5) and by redesignating paragraphs (6) and (7) as 
        paragraphs (5) and (6), respectively.
          (23) Paragraph (2) of section 1260(c) is amended by striking 
        subparagraphs (H) and (I) and by redesignating subparagraph (J) 
        as subparagraph (H).
          (24)(A) Subparagraph (F) of section 1291(b)(3) is amended by 
        striking ``551(d), 959(a),'' and inserting ``959(a)''.
          (B) Subsection (e) of section 1291 is amended by inserting 
        ``(as in effect on the day before the date of the enactment of 
        the American Jobs Creation Act of 2003)'' after ``section 
        1246''.
          (25) Paragraph (2) of section 1294(a) is amended to read as 
        follows:
          ``(2) Election not permitted where amounts otherwise 
        includible under section 951.--The taxpayer may not make an 
        election under paragraph (1) with respect to the undistributed 
        PFIC earnings tax liability attributable to a qualified 
        electing fund for the taxable year if any amount is includible 
        in the gross income of the taxpayer under section 951 with 
        respect to such fund for such taxable year.''
          (26) Section 6035 is hereby repealed.
          (27) Subparagraph (D) of section 6103(e)(1) is amended by 
        striking clause (iv) and redesignating clauses (v) and (vi) as 
        clauses (iv) and (v), respectively.
          (28) Subparagraph (B) of section 6501(e)(1) is amended to 
        read as follows:
                  ``(B) Constructive dividends.--If the taxpayer omits 
                from gross income an amount properly includible therein 
                under section 951(a), the tax may be assessed, or a 
                proceeding in court for the collection of such tax may 
                be done without assessing, at any time within 6 years 
                after the return was filed.''
          (29) Subsection (a) of section 6679 is amended--
                  (A) by striking ``6035, 6046, or 6046A'' in paragraph 
                (1) and inserting ``6046 or 6046A'', and
                  (B) by striking paragraph (3).
          (30) Sections 170(f)(10)(A), 508(d), 4947, and 4948(c)(4) are 
        each amended by striking ``556(b)(2),'' each place it appears.
          (31) The table of parts for subchapter G of chapter 1 is 
        amended by striking the item relating to part III.
          (32) The table of sections for part IV of subchapter P of 
        chapter 1 is amended by striking the items relating to sections 
        1246 and 1247.
          (33) The table of sections for subpart A of part III of 
        subchapter A of chapter 61 is amended by striking the item 
        relating to section 6035.
          (34) Sections 163(e)(3)(B)(i) and 267(a)(3)(B)(i) are each 
        amended by--
                  (A) striking ``a foreign personal holding company (as 
                defined in section 552),'', and
                  (B) striking the comma after ``(as defined in section 
                957)''.
    (d) Effective Date.--Except as otherwise provided in this section, 
the amendments made by this section shall apply to taxable years of 
foreign corporations beginning after December 31, 2006, and to taxable 
years of United States shareholders with or within which such taxable 
years of foreign corporations end.

SEC. 1075. CLARIFICATION OF TREATMENT OF PIPELINE TRANSPORTATION 
                    INCOME.

    (a) In General.--Section 954(g)(1) (defining foreign base company 
oil related income) is amended by striking ``or'' at the end of 
subparagraph (A), by striking the period at the end of subparagraph (B) 
and inserting ``, or'', and by inserting after subparagraph (B) the 
following new subparagraph:
                  ``(C) the pipeline transportation of oil or gas 
                within such foreign country.''
    (b) Effective Date.--The amendments made by this section shall 
apply to taxable years of foreign corporations beginning after December 
31, 2004, and to taxable years of United States shareholders with or 
within which such taxable years of foreign corporations end.

SEC. 1076. DETERMINATION OF FOREIGN PERSONAL HOLDING COMPANY INCOME 
                    WITH RESPECT TO TRANSACTIONS IN COMMODITIES.

    (a) In General.--Clauses (i) and (ii) of section 954(c)(1)(C) 
(relating to commodity transactions) are amended to read as follows:
                          ``(i) arise out of commodity hedging 
                        transactions (as defined in paragraph (6)(A)),
                          ``(ii) are active business gains or losses 
                        from the sale of commodities, but only if 
                        substantially all of the controlled foreign 
                        corporation's commodities are property 
                        described in paragraph (1), (2), or (8) of 
                        section 1221(a), or''.
    (b) Definition and Special Rules.--Subsection (c) of section 954 is 
amended by adding after paragraph (5) the following new paragraph:
          ``(6) Definition and special rules relating to commodity 
        transactions.--
                  ``(A) Commodity hedging transactions.--For purposes 
                of paragraph (1)(C)(i), the term `commodity hedging 
                transaction' means any transaction with respect to a 
                commodity if such transaction--
                          ``(i) is a hedging transaction as defined in 
                        section 1221(b)(2), determined--
                                  ``(I) without regard to subparagraph 
                                (A)(ii) thereof,
                                  ``(II) by applying subparagraph 
                                (A)(i) thereof by substituting 
                                `ordinary property or property 
                                described in section 1231(b)' for 
                                `ordinary property', and
                                  ``(III) by substituting `controlled 
                                foreign corporation' for `taxpayer' 
                                each place it appears, and
                          ``(ii) is clearly identified as such in 
                        accordance with section 1221(a)(7).
                  ``(B) Regulations.--The Secretary shall prescribe 
                such regulations as are appropriate to carry out the 
                purposes of paragraph (1)(C) in the case of 
                transactions involving related persons.''
    (c) Effective Date.--The amendments made by this section shall 
apply to transactions entered into after December 31, 2004.

SEC. 1077. REPEAL OF CFC RULES ON FOREIGN BASE COMPANY SHIPPING INCOME.

    (a) Elimination of Foreign Base Company Shipping Income.--Section 
954 (relating to foreign base company income) is amended--
          (1) by striking paragraph (4) of subsection (a) (relating to 
        foreign base company shipping income), and
          (2) by striking subsection (f) (relating to foreign base 
        company shipping income).
    (b) Safe Harbor for Certain Leasing Activities.--Subparagraph (A) 
of section 954(c)(2) is amended by adding at the end the following new 
sentence: ``For purposes of the preceding sentence, rents derived from 
leasing an aircraft or vessel in foreign commerce shall not fail to be 
treated as derived in the active conduct of a trade or business if, as 
determined under regulations prescribed by the Secretary, the active 
leasing expenses are not less than 10 percent of the profit on the 
lease.''
    (c) Conforming Amendments.--
          (1) Section 952(c)(1)(B)(iii) is amended by striking 
        subclause (I) and redesignating subclauses (II) through (VI) as 
        subclauses (I) through (V), respectively.
          (2) Subsection (b) of section 954 is amended--
                  (A) by striking ``the foreign base company shipping 
                income,'' in paragraph (5),
                  (B) by striking paragraphs (6) and (7), and
                  (C) by redesignating paragraph (8) as paragraph (6).
    (d) Effective Date.--The amendments made by this section shall 
apply to taxable years of foreign corporations beginning after December 
31, 2004, and to taxable years of United States shareholders with or 
within which such taxable years of foreign corporations end.

SEC. 1078. MODIFICATION OF SUBPART F EXEMPTION FOR ACTIVE FINANCING.

    (a) In General.--Section 954(h)(3) is amended by adding at the end 
the following:
                  ``(E) Direct conduct of activities.--For purposes of 
                subparagraph (A)(ii)(II), an activity shall be treated 
                as conducted directly by an eligible controlled foreign 
                corporation or qualified business unit in its home 
                country if the activity is performed by employees of a 
                related person and--
                          ``(i) the related person is an eligible 
                        controlled foreign corporation the home country 
                        of which is the same as the home country of the 
                        corporation or unit to which subparagraph 
                        (A)(ii)(II) is being applied,
                          ``(ii) the activity is performed in the home 
                        country of the related person, and
                          ``(iii) the related person is compensated on 
                        an arm's-length basis for the performance of 
                        the activity by its employees and such 
                        compensation is treated as earned by such 
                        person in its home country for purposes of the 
                        home country's tax laws.''.
    (b) Effective Date.--The amendments made by this section shall 
apply to taxable years of foreign corporations beginning after December 
31, 2004, and to taxable years of United States shareholders with or 
within which such taxable years of foreign corporations end.

SEC. 1079. PARTIAL EXCLUSION FOR INCOME ATTRIBUTABLE TO FILMS USED 
                    OUTSIDE THE UNITED STATES.

    (a) In General.--Part III of subchapter B of chapter 1 (relating to 
items specifically excluded from gross income) is amended by inserting 
after section 139 the following new section:

``SEC. 139A. INCOME ATTRIBUTABLE TO FILMS USED OUTSIDE THE UNITED 
                    STATES.

    ``(a) Exclusion.--
          ``(1) In general.--There shall be excluded from gross income 
        an amount equal to the applicable percentage of qualified film 
        income.
          ``(2) Applicable percentage.--For purposes of paragraph (1), 
        the applicable percentage shall be determined in accordance 
        with the following table:

                ``For taxable years ending
                                                         The applicable
                  in calendar year--
                                                        percentage is--
                  2007.....................................          1 
                  2008.....................................          2 
                  2009.....................................          3 
                  2010.....................................          5 
                  2011.....................................          8 
                  2012.....................................          9 
                  2013 or thereafter.......................         10.

    ``(b) Qualified Film Income.--For purposes of this section--
          ``(1) In general.--The term `qualified film income' means 
        gross income from a license of a qualified film in the ordinary 
        course of a trade or business for the exploitation or direct 
        use outside the United States less any associated film costs.
          ``(2) Exceptions.--
                  ``(A) Certain uses.--Such term does not include 
                exploitation of characters, soundtracks, designs, 
                scripts, scores, or any other ancillary intangibles 
                associated with the qualified film.
                  ``(B) Related person license.--
                          ``(i) In general.--Such term does not include 
                        any amount from the license of a qualified film 
                        to a related person.
                          ``(ii) Exception.--Clause (i) shall not apply 
                        if such film is held for license by such 
                        related person to an unrelated person for the 
                        direct use or exploitation by such unrelated 
                        person outside the United States.
                          ``(iii) Related person.--For purposes of this 
                        subparagraph, a person shall be related to 
                        another person if such persons are treated as a 
                        single employer under subsection (a) or (b) of 
                        section 52 or subsection (m) or (o) of section 
                        414, except that determinations under 
                        subsections (a) and (b) of section 52 shall be 
                        made without regard to section 1563(b).
    ``(c) Other Definitions.--For purposes of this section--
          ``(1) Qualified Film.--The term `qualified film' means 
        property described in section 168(f)(3) the original use of 
        which commences after December 31, 2006, if not less than 50 
        percent of the total compensation relating to the production of 
        such property is compensation for services performed in the 
        United States by actors, production personnel, directors, and 
        producers. Such term does not include property with respect to 
        which records are required to be maintained under section 2257 
        of title 18, United States Code.
          ``(2) Associated film costs.--The term `associated film 
        costs' means any expense properly apportioned and allocated to 
        income taken into account under subsection (b)(1), determined 
        as provided under regulations prescribed by the Secretary.
    ``(d) Election.--The taxpayer may elect not to apply this section 
to a qualified film. Such election shall be made by the due date 
(including extensions of time) for filing the return for the taxable 
year in which such film is placed in service, and, once made for such 
film, such election shall be irrevocable.
    ``(e) Denial of Foreign Tax Credit.--
          ``(1) In general.--No credit shall be allowed under section 
        901 for any taxes paid or accrued (or treated as paid or 
        accrued) with respect to the excludable portion of any 
        qualified film income. No deduction shall be allowed under this 
        chapter for any tax for which credit is not allowable by reason 
        of the preceding sentence.
          ``(2) Excludable portion.--For purposes of paragraph (1), the 
        taxes paid or accrued (or treated as paid or accrued) with 
        respect to the excludable portion is the amount which bears the 
        same ratio to the amount of taxes paid or accrued (or treated 
        as paid or accrued) with respect to qualified film income as 
        the amount excluded under subsection (a) for the taxable year 
        bears to the qualified film income for such year.''.
    (b) Clerical Amendment.--The table of sections for part III of 
subchapter B of chapter 1 is amended by inserting after the item 
relating to section 139 the following new item:

                              ``Sec. 139A. Income attributable to films 
                                        used outside the United 
                                        States.''.

    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years ending after December 31, 2006.

          Subtitle H--Reduction of Double Taxation of Earnings

SEC. 1081. INTEREST EXPENSE ALLOCATION RULES.

    (a) Election To Allocate on Worldwide Basis.-- Section 864 is 
amended by redesignating subsection (f) as subsection (g) and by 
inserting after subsection (e) the following new subsection:
    ``(f) Election To Allocate Interest, Etc. on Worldwide Basis.--For 
purposes of this subchapter, at the election of the worldwide 
affiliated group--
          ``(1) Allocation and apportionment of interest expense.--
                  ``(A) In general.--The taxable income of each 
                domestic corporation which is a member of a worldwide 
                affiliated group shall be determined by allocating and 
                apportioning interest expense of each member as if all 
                members of such group were a single corporation.
                  ``(B) Treatment of worldwide affiliated group.--The 
                taxable income of the domestic members of a worldwide 
                affiliated group from sources outside the United States 
                shall be determined by allocating and apportioning the 
                interest expense of such domestic members to such 
                income in an amount equal to the excess (if any) of--
                          ``(i) the total interest expense of the 
                        worldwide affiliated group multiplied by the 
                        ratio which the foreign assets of the worldwide 
                        affiliated group bears to all the assets of the 
                        worldwide affiliated group, over
                          ``(ii) the interest expense of all foreign 
                        corporations which are members of the worldwide 
                        affiliated group to the extent such interest 
                        expense of such foreign corporations would have 
                        been allocated and apportioned to foreign 
                        source income if this subsection were applied 
                        to a group consisting of all the foreign 
                        corporations in such worldwide affiliated 
                        group.
                  ``(C) Worldwide affiliated group.--For purposes of 
                this paragraph, the term `worldwide affiliated group' 
                means a group consisting of--
                          ``(i) the includible members of an affiliated 
                        group (as defined in section 1504(a), 
                        determined without regard to paragraphs (2) and 
                        (4) of section 1504(b)), and
                          ``(ii) all controlled foreign corporations in 
                        which such members in the aggregate meet the 
                        ownership requirements of section 1504(a)(2) 
                        either directly or indirectly through applying 
                        paragraph (2) of section 958(a) or through 
                        applying rules similar to the rules of such 
                        paragraph to stock owned directly or indirectly 
                        by domestic partnerships, trusts, or estates.
          ``(2) Allocation and apportionment of other expenses.--
        Expenses other than interest which are not directly allocable 
        or apportioned to any specific income producing activity shall 
        be allocated and apportioned as if all members of the 
        affiliated group were a single corporation. For purposes of the 
        preceding sentence, the term `affiliated group' has the meaning 
        given such term by section 1504 (determined without regard to 
        paragraph (4) of section 1504(b)).
          ``(3) Treatment of tax-exempt assets; basis of stock in 
        nonaffiliated 10-percent owned corporations.--The rules of 
        paragraphs (3) and (4) of subsection (e) shall apply for 
        purposes of this subsection; except that paragraph (4) shall be 
        applied on worldwide affiliated group basis.
          ``(4) Treatment of certain financial institutions.--
                  ``(A) In general.--For purposes of paragraph (1), any 
                corporation described in subparagraph (B) shall be 
                treated as an includible corporation for purposes of 
                section 1504 only for purposes of applying this 
                subsection separately to corporations so described.
                  ``(B) Description.--A corporation is described in 
                this subparagraph if--
                          ``(i) such corporation is a financial 
                        institution described in section 581 or 591,
                          ``(ii) the business of such financial 
                        institution is predominantly with persons other 
                        than related persons (within the meaning of 
                        subsection (d)(4)) or their customers, and
                          ``(iii) such financial institution is 
                        required by State or Federal law to be operated 
                        separately from any other entity which is not 
                        such an institution.
                  ``(C) Treatment of bank holding companies.--To the 
                extent provided in regulations--
                          ``(i) a bank holding company (within the 
                        meaning of section 2(a) of the Bank Holding 
                        Company Act of 1956 (12 U.S.C. 1841(a))),
                          ``(ii) a financial holding company (within 
                        the meaning of section 2(p) of such Act), and
                          ``(iii) any subsidiary of a financial 
                        institution described in section 581 or 591, or 
                        any such bank or financial holding company, if 
                        such subsidiary is predominantly engaged 
                        (directly or indirectly) in the active conduct 
                        of a banking, financing, or similar business,
                shall be treated as a corporation described in 
                subparagraph (B).
          ``(5) Election to expand financial institution group of 
        worldwide group.--
                  ``(A) In general.--If a worldwide affiliated group 
                elects the application of this subsection, all 
                financial corporations which--
                          ``(i) are members of such worldwide 
                        affiliated group, but
                          ``(ii) are not corporations described in 
                        paragraph (4)(B),
                shall be treated as described in paragraph (4)(B) for 
                purposes of applying paragraph (4)(A). This subsection 
                (other than this paragraph) shall apply to any such 
                group in the same manner as this subsection (other than 
                this paragraph) applies to the pre-election worldwide 
                affiliated group of which such group is a part.
                  ``(B) Financial corporation.--For purposes of this 
                paragraph, the term `financial corporation' means any 
                corporation if at least 80 percent of its gross income 
                is income described in section 904(d)(2)(D)(ii) and the 
                regulations thereunder which is derived from 
                transactions with persons who are not related (within 
                the meaning of section 267(b) or 707(b)(1)) to the 
                corporation. For purposes of the preceding sentence, 
                there shall be disregarded any item of income or gain 
                from a transaction or series of transactions a 
                principal purpose of which is the qualification of any 
                corporation as a financial corporation.
                  ``(C) Antiabuse rules.--In the case of a corporation 
                which is a member of an electing financial institution 
                group, to the extent that such corporation--
                          ``(i) distributes dividends or makes other 
                        distributions with respect to its stock after 
                        the date of the enactment of this paragraph to 
                        any member of the pre-election worldwide 
                        affiliated group (other than to a member of the 
                        electing financial institution group) in excess 
                        of the greater of--
                                  ``(I) its average annual dividend 
                                (expressed as a percentage of current 
                                earnings and profits) during the 5-
                                taxable-year period ending with the 
                                taxable year preceding the taxable 
                                year, or
                                  ``(II) 25 percent of its average 
                                annual earnings and profits for such 5-
                                taxable-year period, or
                          ``(ii) deals with any person in any manner 
                        not clearly reflecting the income of the 
                        corporation (as determined under principles 
                        similar to the principles of section 482),
                an amount of indebtedness of the electing financial 
                institution group equal to the excess distribution or 
                the understatement or overstatement of income, as the 
                case may be, shall be recharacterized (for the taxable 
                year and subsequent taxable years) for purposes of this 
                paragraph as indebtedness of the worldwide affiliated 
                group (excluding the electing financial institution 
                group). If a corporation has not been in existence for 
                5 taxable years, this subparagraph shall be applied 
                with respect to the period it was in existence.
                  ``(D) Election.--An election under this paragraph 
                with respect to any financial institution group may be 
                made only by the common parent of the pre-election 
                worldwide affiliated group and may be made only for the 
                first taxable year beginning after December 31, 2008, 
                in which such affiliated group includes 1 or more 
                financial corporations. Such an election, once made, 
                shall apply to all financial corporations which are 
                members of the electing financial institution group for 
                such taxable year and all subsequent years unless 
                revoked with the consent of the Secretary.
                  ``(E) Definitions relating to groups.--For purposes 
                of this paragraph--
                          ``(i) Pre-election worldwide affiliated 
                        group.--The term `pre-election worldwide 
                        affiliated group' means, with respect to a 
                        corporation, the worldwide affiliated group of 
                        which such corporation would (but for an 
                        election under this paragraph) be a member for 
                        purposes of applying paragraph (1).
                          ``(ii) Electing financial institution 
                        group.--The term `electing financial 
                        institution group' means the group of 
                        corporations to which this subsection applies 
                        separately by reason of the application of 
                        paragraph (4)(A) and which includes financial 
                        corporations by reason of an election under 
                        subparagraph (A).
                  ``(F) Regulations.--The Secretary shall prescribe 
                such regulations as may be appropriate to carry out 
                this subsection, including regulations--
                          ``(i) providing for the direct allocation of 
                        interest expense in other circumstances where 
                        such allocation would be appropriate to carry 
                        out the purposes of this subsection,
                          ``(ii) preventing assets or interest expense 
                        from being taken into account more than once, 
                        and
                          ``(iii) dealing with changes in members of 
                        any group (through acquisitions or otherwise) 
                        treated under this paragraph as an affiliated 
                        group for purposes of this subsection.
          ``(6) Election.--An election to have this subsection apply 
        with respect to any worldwide affiliated group may be made only 
        by the common parent of the domestic affiliated group referred 
        to in paragraph (1)(C) and may be made only for the first 
        taxable year beginning after December 31, 2008, in which a 
        worldwide affiliated group exists which includes such 
        affiliated group and at least one foreign corporation. Such an 
        election, once made, shall apply to such common parent and all 
        other corporations which are members of such worldwide 
        affiliated group for such taxable year and all subsequent years 
        unless revoked with the consent of the Secretary.''.
    (b) Expansion of Regulatory Authority.--Paragraph (7) of section 
864(e) is amended--
          (1) by inserting before the comma at the end of subparagraph 
        (B) ``and in other circumstances where such allocation would be 
        appropriate to carry out the purposes of this subsection'', and
          (2) by striking ``and'' at the end of subparagraph (E), by 
        redesignating subparagraph (F) as subparagraph (G), and by 
        inserting after subparagraph (E) the following new 
        subparagraph:
                  ``(F) preventing assets or interest expense from 
                being taken into account more than once, and''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2008.

SEC. 1082. RECHARACTERIZATION OF OVERALL DOMESTIC LOSS.

    (a) General Rule.--Section 904 is amended by redesignating 
subsections (g), (h), (i), (j), and (k) as subsections (h), (i), (j), 
(k), and (l) respectively, and by inserting after subsection (f) the 
following new subsection:
    ``(g) Recharacterization of Overall Domestic Loss.--
          ``(1) General rule.--For purposes of this subpart and section 
        936, in the case of any taxpayer who sustains an overall 
        domestic loss for any taxable year beginning after December 31, 
        2005, that portion of the taxpayer's taxable income from 
        sources within the United States for each succeeding taxable 
        year which is equal to the lesser of--
                  ``(A) the amount of such loss (to the extent not used 
                under this paragraph in prior taxable years), or
                  ``(B) 50 percent of the taxpayer's taxable income 
                from sources within the United States for such 
                succeeding taxable year,
        shall be treated as income from sources without the United 
        States (and not as income from sources within the United 
        States).
          ``(2) Overall domestic loss defined.--For purposes of this 
        subsection--
                  ``(A) In general.--The term `overall domestic loss' 
                means any domestic loss to the extent such loss offsets 
                taxable income from sources without the United States 
                for the taxable year or for any preceding taxable year 
                by reason of a carryback. For purposes of the preceding 
                sentence, the term `domestic loss' means the amount by 
                which the gross income for the taxable year from 
                sources within the United States is exceeded by the sum 
                of the deductions properly apportioned or allocated 
                thereto (determined without regard to any carryback 
                from a subsequent taxable year).
                  ``(B) Taxpayer must have elected foreign tax credit 
                for year of loss.--The term `overall domestic loss' 
                shall not include any loss for any taxable year unless 
                the taxpayer chose the benefits of this subpart for 
                such taxable year.
          ``(3) Characterization of subsequent income.--
                  ``(A) In general.--Any income from sources within the 
                United States that is treated as income from sources 
                without the United States under paragraph (1) shall be 
                allocated among and increase the income categories in 
                proportion to the loss from sources within the United 
                States previously allocated to those income categories.
                  ``(B) Income category.--For purposes of this 
                paragraph, the term `income category' has the meaning 
                given such term by subsection (f)(5)(E)(i).
          ``(4) Coordination with subsection (f).--The Secretary shall 
        prescribe such regulations as may be necessary to coordinate 
        the provisions of this subsection with the provisions of 
        subsection (f).''
    (b) Conforming Amendments.--
          (1) Section 535(d)(2) is amended by striking ``section 
        904(g)(6)'' and inserting ``section 904(h)(6)''.
          (2) Subparagraph (A) of section 936(a)(2) is amended by 
        striking ``section 904(f)'' and inserting ``subsections (f) and 
        (g) of section 904''.
    (c) Effective Date.--The amendments made by this section shall 
apply to losses sustained for taxable years beginning after December 
31, 2005.

SEC. 1083. REDUCTION TO 2 FOREIGN TAX CREDIT BASKETS.

    (a) In General.--Paragraph (1) of section 904(d) (relating to 
separate application of section with respect to certain categories of 
income) is amended to read as follows:
          ``(1) In general.--The provisions of subsections (a), (b), 
        and (c) and sections 902, 907, and 960 shall be applied 
        separately with respect to--
                  ``(A) passive category income, and
                  ``(B) general category income.''
    (b) Categories.--Paragraph (2) of section 904(d) is amended by 
striking subparagraph (B), by redesignating subparagraph (A) as 
subparagraph (B), and by inserting before subparagraph (B) (as so 
redesignated) the following new subparagraph:
                  ``(A) Categories.--
                          ``(i) Passive category income.--The term 
                        `passive category income' means passive income 
                        and specified passive category income.
                          ``(ii) General category income.--The term 
                        `general category income' means income other 
                        than passive category income.''
    (c) Specified Passive Category Income.--Subparagraph (B) of section 
904(d)(2), as so redesignated, is amended by adding at the end the 
following new clause:
                          ``(v) Specified passive category income.--The 
                        term `specified passive category income' 
                        means--
                                  ``(I) dividends from a DISC or former 
                                DISC (as defined in section 992(a)) to 
                                the extent such dividends are treated 
                                as income from sources without the 
                                United States,
                                  ``(II) taxable income attributable to 
                                foreign trade income (within the 
                                meaning of section 923(b)), and
                                  ``(III) distributions from a FSC (or 
                                a former FSC) out of earnings and 
                                profits attributable to foreign trade 
                                income (within the meaning of section 
                                923(b)) or interest or carrying charges 
                                (as defined in section 927(d)(1)) 
                                derived from a transaction which 
                                results in foreign trade income (as 
                                defined in section 923(b)).''
    (d) Treatment of Financial Services.--Paragraph (2) of section 
904(d) is amended by striking subparagraph (D), by redesignating 
subparagraph (C) as subparagraph (D), and by inserting before 
subparagraph (D) (as so redesignated) the following new subparagraph:
                  ``(C) Treatment of financial services income and 
                companies.--
                          ``(i) In general.--Financial services income 
                        shall be treated as general category income in 
                        the case of--
                                  ``(I) a member of a financial 
                                services group, and
                                  ``(II) any other person if such 
                                person is predominantly engaged in the 
                                active conduct of a banking, insurance, 
                                financing, or similar business.
                          ``(ii) Financial services group.--The term 
                        `financial services group' means any affiliated 
                        group (as defined in section 1504(a) without 
                        regard to paragraphs (2) and (3) of section 
                        1504(b)) which is predominantly engaged in the 
                        active conduct of a banking, insurance, 
                        financing, or similar business. In determining 
                        whether such a group is so engaged, there shall 
                        be taken into account only the income of 
                        members of the group that are--
                                  ``(I) United States corporations, or
                                  ``(II) controlled foreign 
                                corporations in which such United 
                                States corporations own, directly or 
                                indirectly, at least 80 percent of the 
                                total voting power and value of the 
                                stock.
                          ``(iii) Pass-thru entities.--The Secretary 
                        shall by regulation specify for purposes of 
                        this subparagraph the treatment of financial 
                        services income received or accrued by 
                        partnerships and by other pass-thru entities 
                        which are not members of a financial services 
                        group.''
    (e) Conforming Amendments.--
          (1) Clause (iii) of section 904(d)(2)(B) (relating to 
        exceptions from passive income), as so redesignated, is amended 
        by striking subclause (I) and by redesignating subclauses (II) 
        and (III) as subclauses (I) and (II), respectively.
          (2) Clause (i) of section 904(d)(2)(D) (defining financial 
        services income), as so redesignated, is amended by adding 
        ``or'' at the end of subclause (I) and by striking subclauses 
        (II) and (III) and inserting the following new subclause:
                                  ``(II) passive income (determined 
                                without regard to subparagraph 
                                (B)(iii)(II)).''
          (3) Section 904(d)(2)(D) (defining financial services 
        income), as so redesignated, is amended by striking clause 
        (iii).
          (4) Paragraph (3) of section 904(d) is amended to read as 
        follows:
          ``(3) Look-thru in case of controlled foreign corporations.--
                  ``(A) In general.--Except as otherwise provided in 
                this paragraph, dividends, interest, rents, and 
                royalties received or accrued by the taxpayer from a 
                controlled foreign corporation in which the taxpayer is 
                a United States shareholder shall not be treated as 
                passive category income.
                  ``(B) Subpart f inclusions.--Any amount included in 
                gross income under section 951(a)(1)(A) shall be 
                treated as passive category income to the extent the 
                amount so included is attributable to passive category 
                income.
                  ``(C) Interest, rents, and royalties.--Any interest, 
                rent, or royalty which is received or accrued from a 
                controlled foreign corporation in which the taxpayer is 
                a United States shareholder shall be treated as passive 
                category income to the extent it is properly allocable 
                (under regulations prescribed by the Secretary) to 
                passive category income of the controlled foreign 
                corporation.
                  ``(D) Dividends.--Any dividend paid out of the 
                earnings and profits of any controlled foreign 
                corporation in which the taxpayer is a United States 
                shareholder shall be treated as passive category income 
                in proportion to the ratio of--
                          ``(i) the portion of the earnings and profits 
                        attributable to passive category income, to
                          ``(ii) the total amount of earnings and 
                        profits.
                  ``(E) Look-thru applies only where subpart f 
                applies.--If a controlled foreign corporation meets the 
                requirements of section 954(b)(3)(A) (relating to de 
                minimis rule) for any taxable year, for purposes of 
                this paragraph, none of its foreign base company income 
                (as defined in section 954(a) without regard to section 
                954(b)(5)) and none of its gross insurance income (as 
                defined in section 954(b)(3)(C)) for such taxable year 
                shall be treated as passive category income, except 
                that this sentence shall not apply to any income which 
                (without regard to this sentence) would be treated as 
                financial services income. Solely for purposes of 
                applying subparagraph (D), passive income of a 
                controlled foreign corporation shall not be treated as 
                passive category income if the requirements of section 
                954(b)(4) are met with respect to such income.
                  ``(F) Coordination with high-taxed income 
                provisions.--
                          ``(i) In determining whether any income of a 
                        controlled foreign corporation is passive 
                        category income, subclause (II) of paragraph 
                        (2)(B)(iii) shall not apply.
                          ``(ii) Any income of the taxpayer which is 
                        treated as passive category income under this 
                        paragraph shall be so treated notwithstanding 
                        any provision of paragraph (2); except that the 
                        determination of whether any amount is high-
                        taxed income shall be made after the 
                        application of this paragraph.
                  ``(G) Dividend.--For purposes of this paragraph, the 
                term `dividend' includes any amount included in gross 
                income in section 951(a)(1)(B). Any amount included in 
                gross income under section 78 to the extent 
                attributable to amounts included in gross income in 
                section 951(a)(1)(A) shall not be treated as a dividend 
                but shall be treated as included in gross income under 
                section 951(a)(1)(A).
                  ``(H) Look-thru applies to passive foreign investment 
                company inclusion.--If--
                          ``(i) a passive foreign investment company is 
                        a controlled foreign corporation, and
                          ``(ii) the taxpayer is a United States 
                        shareholder in such controlled foreign 
                        corporation,
                any amount included in gross income under section 1293 
                shall be treated as income in a separate category to 
                the extent such amount is attributable to income in 
                such category.''
          (5) Treatment of income tax base differences.--Paragraph (2) 
        of section 904(d) is amended by redesignating subparagraphs (H) 
        and (I) as subparagraphs (I) and (J), respectively, and by 
        inserting after subparagraph (G) the following new 
        subparagraph:
                  ``(H) Treatment of income tax base differences.--Tax 
                imposed under the law of a foreign country or 
                possession of the United States on an amount which does 
                not constitute income under United States tax 
                principles shall be treated as imposed on income 
                described in paragraph (1)(B).''
          (6) Paragraph (2) of section 904(d) is amended by adding at 
        the end the following new subparagraph:
                  ``(K) Transitional rules for 2005 changes.--For 
                purposes of paragraph (1)--
                          ``(i) taxes carried from any taxable year 
                        beginning before January 1, 2005, to any 
                        taxable year beginning on or after such date, 
                        with respect to any item of income, shall be 
                        treated as described in the subparagraph of 
                        paragraph (1) in which such income would be 
                        described were such taxes paid or accrued in a 
                        taxable year beginning on or after such date, 
                        and
                          ``(ii) the Secretary may by regulations 
                        provide for the allocation of any carryback of 
                        taxes with respect to income to such a taxable 
                        year for purposes of allocating such income 
                        among the separate categories in effect for 
                        such taxable year.''.
          (7) Section 904(j)(3)(A)(i) is amended by striking 
        ``subsection (d)(2)(A)'' and inserting ``subsection 
        (d)(2)(B)''.
    (f) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2004.

SEC. 1084. LOOK-THRU RULES TO APPLY TO DIVIDENDS FROM NONCONTROLLED 
                    SECTION 902 CORPORATIONS.

    (a) In General.--Section 904(d)(4) (relating to look-thru rules 
apply to dividends from noncontrolled section 902 corporations) is 
amended to read as follows:
          ``(4) Look-thru applies to dividends from noncontrolled 
        section 902 corporations.--
                  ``(A) In general.--For purposes of this subsection, 
                any dividend from a noncontrolled section 902 
                corporation with respect to the taxpayer shall be 
                treated as income described in a subparagraph of 
                paragraph (1) in proportion to the ratio of--
                          ``(i) the portion of earnings and profits 
                        attributable to income described in such 
                        subparagraph, to
                          ``(ii) the total amount of earnings and 
                        profits.
                  ``(B) Special rules.--For purposes of this 
                paragraph--
                          ``(i) Earnings and profits.--
                                  ``(I) In general.--The rules of 
                                section 316 shall apply.
                                  ``(II) Regulations.--The Secretary 
                                may prescribe regulations regarding the 
                                treatment of distributions out of 
                                earnings and profits for periods before 
                                the taxpayer's acquisition of the stock 
                                to which the distributions relate.
                          ``(ii) Inadequate substantiation.--If the 
                        Secretary determines that the proper 
                        subparagraph of paragraph (1) in which a 
                        dividend is described has not been 
                        substantiated, such dividend shall be treated 
                        as income described in paragraph (1)(A).
                          ``(iii) Look-thru with respect to 
                        carryforwards of credit.--Rules similar to 
                        subparagraph (A) also shall apply to any 
                        carryforward under subsection (c) from a 
                        taxable year beginning before January 1, 2003, 
                        of tax allocable to a dividend from a 
                        noncontrolled section 902 corporation with 
                        respect to the taxpayer. The Secretary may by 
                        regulations provide for the allocation of any 
                        carryback of tax allocable to a dividend from a 
                        noncontrolled section 902 corporation to such a 
                        taxable year for purposes of allocating such 
                        dividend among the separate categories in 
                        effect for such taxable year.
                          ``(iv) Coordination with high-taxed income 
                        provisions.--Rules similar to the rules of 
                        paragraph (3)(F) shall apply for purposes of 
                        this paragraph.''.
    (b) Conforming Amendments.--
          (1) Section 904(d)(2)(E) is amended--
                  (A) by inserting ``or (4)'' after ``paragraph (3)'' 
                in clause (i), and
                  (B) by striking clauses (ii) and (iv) and by 
                redesignating clause (iii) as clause (ii).
          (2) Clause (i) of section 864(d)(5)(A) is amended to read as 
        follows:
                          ``(i) Subclause (I) of section 
                        904(d)(2)(B)(iii).''
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2002.

SEC. 1085. ATTRIBUTION OF STOCK OWNERSHIP THROUGH PARTNERSHIPS TO APPLY 
                    IN DETERMINING SECTION 902 AND 960 CREDITS.

    (a) In General.--Subsection (c) of section 902 is amended by 
redesignating paragraph (7) as paragraph (8) and by inserting after 
paragraph (6) the following new paragraph:
          ``(7) Constructive ownership through partnerships.--Stock 
        owned, directly or indirectly, by or for a partnership shall be 
        considered as being owned proportionately by its partners. 
        Stock considered to be owned by a person by reason of the 
        preceding sentence shall, for purposes of applying such 
        sentence, be treated as actually owned by such person. The 
        Secretary may prescribe such regulations as may be necessary to 
        carry out the purposes of this paragraph, including rules to 
        account for special partnership allocations of dividends, 
        credits, and other incidents of ownership of stock in 
        determining proportionate ownership.''
    (b) Clarification of Comparable Attribution Under Section 
901(b)(5).--Paragraph (5) of section 901(b) is amended by striking 
``any individual'' and inserting ``any person''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxes of foreign corporations for taxable years of such 
corporations beginning after the date of the enactment of this Act.

SEC. 1086. CLARIFICATION OF TREATMENT OF CERTAIN TRANSFERS OF 
                    INTANGIBLE PROPERTY.

    (a) In General.--Subparagraph (C) of section 367(d)(2) is amended 
by adding at the end the following new sentence: ``For purposes of 
applying section 904(d), any such amount shall be treated in the same 
manner as if such amount were a royalty.''
    (b) Effective Date.--The amendment made by this section shall apply 
to amounts treated as received pursuant to section 367(d)(2) of the 
Internal Revenue Code of 1986 on or after August 5, 1997.

SEC. 1087. UNITED STATES PROPERTY NOT TO INCLUDE CERTAIN ASSETS 
                    ACQUIRED BY DEALERS IN ORDINARY COURSE OF TRADE OR 
                    BUSINESS.

    (a) In General.--Section 956(c)(2) (relating to exceptions from 
property treated as United States property) is amended by striking 
``and'' at the end of subparagraph (J), by striking the period at the 
end of subparagraph (K) and inserting ``; and'', and by adding at the 
end the following new subparagraph:
                  ``(L) securities acquired and held by a controlled 
                foreign corporation in the ordinary course of its 
                business as a dealer in securities if--
                          ``(i) the dealer accounts for the securities 
                        as securities held primarily for sale to 
                        customers in the ordinary course of business, 
                        and
                          ``(ii) the dealer disposes of the securities 
                        (or such securities mature while held by the 
                        dealer) within a period consistent with the 
                        holding of securities for sale to customers in 
                        the ordinary course of business.''
    (b) Conforming Amendment.--Section 956(c)(2) is amended by striking 
``and (K)'' in the last sentence and inserting ``, (K), and (L)''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years of foreign corporations beginning after December 
31, 2004, and to taxable years of United States shareholders with or 
within which such taxable years of foreign corporations end.

SEC. 1088. ELECTION NOT TO USE AVERAGE EXCHANGE RATE FOR FOREIGN TAX 
                    PAID OTHER THAN IN FUNCTIONAL CURRENCY.

    (a) In General.--Paragraph (1) of section 986(a) (relating to 
determination of foreign taxes and foreign corporation's earnings and 
profits) is amended by redesignating subparagraph (D) as subparagraph 
(E) and by inserting after subparagraph (C) the following new 
subparagraph:
                  ``(D) Elective exception for taxes paid other than in 
                functional currency.--
                          ``(i) In general.--At the election of the 
                        taxpayer, subparagraph (A) shall not apply to 
                        any foreign income taxes the liability for 
                        which is denominated in any currency other than 
                        in the taxpayer's functional currency.
                          ``(ii) Application to qualified business 
                        units.--An election under this subparagraph may 
                        apply to foreign income taxes attributable to a 
                        qualified business unit in accordance with 
                        regulations prescribed by the Secretary.
                          ``(iii) Election.--Any such election shall 
                        apply to the taxable year for which made and 
                        all subsequent taxable years unless revoked 
                        with the consent of the Secretary.''
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2004.

SEC. 1089. REPEAL OF WITHHOLDING TAX ON DIVIDENDS FROM CERTAIN FOREIGN 
                    CORPORATIONS.

    (a) In General.--Paragraph (2) of section 871(i) (relating to tax 
not to apply to certain interest and dividends) is amended by adding at 
the end the following new subparagraph:
                  ``(D) Dividends paid by a foreign corporation which 
                are treated under section 861(a)(2)(B) as income from 
                sources within the United States.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to payments made after December 31, 2004.

SEC. 1090. PROVIDE EQUAL TREATMENT FOR INTEREST PAID BY FOREIGN 
                    PARTNERSHIPS AND FOREIGN CORPORATIONS.

    (a) In General.--Paragraph (1) of section 861(a) is amended by 
striking ``and'' at the end of subparagraph (A), by striking the period 
at the end of subparagraph (B) and inserting ``, and'', and by adding 
at the end the following new subparagraph:
                  ``(C) in the case of a foreign partnership in which 
                United States persons do not hold directly or 
                indirectly 20 percent or more of either the capital or 
                profits interests, any interest not paid by a trade or 
                business engaged in by the partnership in the United 
                States and not allocable to income which is effectively 
                connected (or treated as effectively connected) with 
                the conduct of a trade or business in the United 
                States.''
    (b) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2003.

SEC. 1091. TREATMENT OF CERTAIN DIVIDENDS OF REGULATED INVESTMENT 
                    COMPANIES.

    (a) Treatment of Certain Dividends.--
          (1) Nonresident alien individuals.--Section 871 (relating to 
        tax on nonresident alien individuals) is amended by 
        redesignating subsection (k) as subsection (l) and by inserting 
        after subsection (j) the following new subsection:
    ``(k) Exemption for Certain Dividends of Regulated Investment 
Companies.--
          ``(1) Interest-related dividends.--
                  ``(A) In general.--Except as provided in subparagraph 
                (B), no tax shall be imposed under paragraph (1)(A) of 
                subsection (a) on any interest-related dividend 
                received from a regulated investment company.
                  ``(B) Exceptions.--Subparagraph (A) shall not apply--
                          ``(i) to any interest-related dividend 
                        received from a regulated investment company by 
                        a person to the extent such dividend is 
                        attributable to interest (other than interest 
                        described in subparagraph (E) (i) or (iii)) 
                        received by such company on indebtedness issued 
                        by such person or by any corporation or 
                        partnership with respect to which such person 
                        is a 10-percent shareholder,
                          ``(ii) to any interest-related dividend with 
                        respect to stock of a regulated investment 
                        company unless the person who would otherwise 
                        be required to deduct and withhold tax from 
                        such dividend under chapter 3 receives a 
                        statement (which meets requirements similar to 
                        the requirements of subsection (h)(5)) that the 
                        beneficial owner of such stock is not a United 
                        States person, and
                          ``(iii) to any interest-related dividend paid 
                        to any person within a foreign country (or any 
                        interest-related dividend payment addressed to, 
                        or for the account of, persons within such 
                        foreign country) during any period described in 
                        subsection (h)(6) with respect to such country.
                Clause (iii) shall not apply to any dividend with 
                respect to any stock which was acquired on or before 
                the date of the publication of the Secretary's 
                determination under subsection (h)(6).
                  ``(C) Interest-related dividend.--For purposes of 
                this paragraph, an interest-related dividend is any 
                dividend (or part thereof) which is designated by the 
                regulated investment company as an interest-related 
                dividend in a written notice mailed to its shareholders 
                not later than 60 days after the close of its taxable 
                year. If the aggregate amount so designated with 
                respect to a taxable year of the company (including 
                amounts so designated with respect to dividends paid 
                after the close of the taxable year described in 
                section 855) is greater than the qualified net interest 
                income of the company for such taxable year, the 
                portion of each distribution which shall be an 
                interest-related dividend shall be only that portion of 
                the amounts so designated which such qualified net 
                interest income bears to the aggregate amount so 
                designated.
                  ``(D) Qualified net interest income.--For purposes of 
                subparagraph (C), the term `qualified net interest 
                income' means the qualified interest income of the 
                regulated investment company reduced by the deductions 
                properly allocable to such income.
                  ``(E) Qualified interest income.--For purposes of 
                subparagraph (D), the term `qualified interest income' 
                means the sum of the following amounts derived by the 
                regulated investment company from sources within the 
                United States:
                          ``(i) Any amount includible in gross income 
                        as original issue discount (within the meaning 
                        of section 1273) on an obligation payable 183 
                        days or less from the date of original issue 
                        (without regard to the period held by the 
                        company).
                          ``(ii) Any interest includible in gross 
                        income (including amounts recognized as 
                        ordinary income in respect of original issue 
                        discount or market discount or acquisition 
                        discount under part V of subchapter P and such 
                        other amounts as regulations may provide) on an 
                        obligation which is in registered form; except 
                        that this clause shall not apply to--
                                  ``(I) any interest on an obligation 
                                issued by a corporation or partnership 
                                if the regulated investment company is 
                                a 10-percent shareholder in such 
                                corporation or partnership, and
                                  ``(II) any interest which is treated 
                                as not being portfolio interest under 
                                the rules of subsection (h)(4).
                          ``(iii) Any interest referred to in 
                        subsection (i)(2)(A) (without regard to the 
                        trade or business of the regulated investment 
                        company).
                          ``(iv) Any interest-related dividend 
                        includable in gross income with respect to 
                        stock of another regulated investment company.
                  ``(F) 10-percent shareholder.--For purposes of this 
                paragraph, the term `10-percent shareholder' has the 
                meaning given such term by subsection (h)(3)(B).
          ``(2) Short-term capital gain dividends.--
                  ``(A) In general.--Except as provided in subparagraph 
                (B), no tax shall be imposed under paragraph (1)(A) of 
                subsection (a) on any short-term capital gain dividend 
                received from a regulated investment company.
                  ``(B) Exception for aliens taxable under subsection 
                (a)(2).--Subparagraph (A) shall not apply in the case 
                of any nonresident alien individual subject to tax 
                under subsection (a)(2).
                  ``(C) Short-term capital gain dividend.--For purposes 
                of this paragraph, a short-term capital gain dividend 
                is any dividend (or part thereof) which is designated 
                by the regulated investment company as a short-term 
                capital gain dividend in a written notice mailed to its 
                shareholders not later than 60 days after the close of 
                its taxable year. If the aggregate amount so designated 
                with respect to a taxable year of the company 
                (including amounts so designated with respect to 
                dividends paid after the close of the taxable year 
                described in section 855) is greater than the qualified 
                short-term gain of the company for such taxable year, 
                the portion of each distribution which shall be a 
                short-term capital gain dividend shall be only that 
                portion of the amounts so designated which such 
                qualified short-term gain bears to the aggregate amount 
                so designated.
                  ``(D) Qualified short-term gain.--For purposes of 
                subparagraph (C), the term `qualified short-term gain' 
                means the excess of the net short-term capital gain of 
                the regulated investment company for the taxable year 
                over the net long-term capital loss (if any) of such 
                company for such taxable year. For purposes of this 
                subparagraph--
                          ``(i) the net short-term capital gain of the 
                        regulated investment company shall be computed 
                        by treating any short-term capital gain 
                        dividend includible in gross income with 
                        respect to stock of another regulated 
                        investment company as a short-term capital 
                        gain, and
                          ``(ii) the excess of the net short-term 
                        capital gain for a taxable year over the net 
                        long-term capital loss for a taxable year (to 
                        which an election under section 4982(e)(4) does 
                        not apply) shall be determined without regard 
                        to any net capital loss or net short-term 
                        capital loss attributable to transactions after 
                        October 31 of such year, and any such net 
                        capital loss or net short-term capital loss 
                        shall be treated as arising on the 1st day of 
                        the next taxable year.
                To the extent provided in regulations, clause (ii) 
                shall apply also for purposes of computing the taxable 
                income of the regulated investment company.''
          (2) Foreign corporations.--Section 881 (relating to tax on 
        income of foreign corporations not connected with United States 
        business) is amended by redesignating subsection (e) as 
        subsection (f) and by inserting after subsection (d) the 
        following new subsection:
    ``(e) Tax Not To Apply to Certain Dividends of Regulated Investment 
Companies.--
          ``(1) Interest-related dividends.--
                  ``(A) In general.--Except as provided in subparagraph 
                (B), no tax shall be imposed under paragraph (1) of 
                subsection (a) on any interest-related dividend (as 
                defined in section 871(k)(1)) received from a regulated 
                investment company.
                  ``(B) Exception.--Subparagraph (A) shall not apply--
                          ``(i) to any dividend referred to in section 
                        871(k)(1)(B), and
                          ``(ii) to any interest-related dividend 
                        received by a controlled foreign corporation 
                        (within the meaning of section 957(a)) to the 
                        extent such dividend is attributable to 
                        interest received by the regulated investment 
                        company from a person who is a related person 
                        (within the meaning of section 864(d)(4)) with 
                        respect to such controlled foreign corporation.
                  ``(C) Treatment of dividends received by controlled 
                foreign corporations.--The rules of subsection 
                (c)(5)(A) shall apply to any interest-related dividend 
                received by a controlled foreign corporation (within 
                the meaning of section 957(a)) to the extent such 
                dividend is attributable to interest received by the 
                regulated investment company which is described in 
                clause (ii) of section 871(k)(1)(E) (and not described 
                in clause (i) or (iii) of such section).
          ``(2) Short-term capital gain dividends.--No tax shall be 
        imposed under paragraph (1) of subsection (a) on any short-term 
        capital gain dividend (as defined in section 871(k)(2)) 
        received from a regulated investment company.''
          (3) Withholding taxes.--
                  (A) Section 1441(c) (relating to exceptions) is 
                amended by adding at the end the following new 
                paragraph:
          ``(12) Certain dividends received from regulated investment 
        companies.--
                  ``(A) In general.--No tax shall be required to be 
                deducted and withheld under subsection (a) from any 
                amount exempt from the tax imposed by section 
                871(a)(1)(A) by reason of section 871(k).
                  ``(B) Special rule.--For purposes of subparagraph 
                (A), clause (i) of section 871(k)(1)(B) shall not apply 
                to any dividend unless the regulated investment company 
                knows that such dividend is a dividend referred to in 
                such clause. A similar rule shall apply with respect to 
                the exception contained in section 871(k)(2)(B).''
                  (B) Section 1442(a) (relating to withholding of tax 
                on foreign corporations) is amended--
                          (i) by striking ``and the reference in 
                        section 1441(c)(10)'' and inserting ``the 
                        reference in section 1441(c)(10)'', and
                          (ii) by inserting before the period at the 
                        end the following: ``, and the references in 
                        section 1441(c)(12) to sections 871(a) and 
                        871(k) shall be treated as referring to 
                        sections 881(a) and 881(e) (except that for 
                        purposes of applying subparagraph (A) of 
                        section 1441(c)(12), as so modified, clause 
                        (ii) of section 881(e)(1)(B) shall not apply to 
                        any dividend unless the regulated investment 
                        company knows that such dividend is a dividend 
                        referred to in such clause)''.
    (b) Estate Tax Treatment of Interest in Certain Regulated 
Investment Companies.--Section 2105 (relating to property without the 
United States for estate tax purposes) is amended by adding at the end 
the following new subsection:
    ``(d) Stock in a RIC.--
          ``(1) In general.--For purposes of this subchapter, stock in 
        a regulated investment company (as defined in section 851) 
        owned by a nonresident not a citizen of the United States shall 
        not be deemed property within the United States in the 
        proportion that, at the end of the quarter of such investment 
        company's taxable year immediately preceding a decedent's date 
        of death (or at such other time as the Secretary may designate 
        in regulations), the assets of the investment company that were 
        qualifying assets with respect to the decedent bore to the 
        total assets of the investment company.
          ``(2) Qualifying assets.--For purposes of this subsection, 
        qualifying assets with respect to a decedent are assets that, 
        if owned directly by the decedent, would have been--
                  ``(A) amounts, deposits, or debt obligations 
                described in subsection (b) of this section,
                  ``(B) debt obligations described in the last sentence 
                of section 2104(c), or
                  ``(C) other property not within the United States.''
    (c) Treatment of Regulated Investment Companies Under Section 
897.--
          (1) Paragraph (1) of section 897(h) is amended by striking 
        ``REIT'' each place it appears and inserting ``qualified 
        investment entity''.
          (2) Paragraphs (2) and (3) of section 897(h) are amended to 
        read as follows:
          ``(2) Sale of stock in domestically controlled entity not 
        taxed.--The term `United States real property interest' does 
        not include any interest in a domestically controlled qualified 
        investment entity.
          ``(3) Distributions by domestically controlled qualified 
        investment entities.--In the case of a domestically controlled 
        qualified investment entity, rules similar to the rules of 
        subsection (d) shall apply to the foreign ownership percentage 
        of any gain.''
          (3) Subparagraphs (A) and (B) of section 897(h)(4) are 
        amended to read as follows:
                  ``(A) Qualified investment entity.--The term 
                `qualified investment entity' means any real estate 
                investment trust and any regulated investment company.
                  ``(B) Domestically controlled.--The term 
                `domestically controlled qualified investment entity' 
                means any qualified investment entity in which at all 
                times during the testing period less than 50 percent in 
                value of the stock was held directly or indirectly by 
                foreign persons.''
          (4) Subparagraphs (C) and (D) of section 897(h)(4) are each 
        amended by striking ``REIT'' and inserting ``qualified 
        investment entity''.
          (5) The subsection heading for subsection (h) of section 897 
        is amended by striking ``REITS'' and inserting ``Certain 
        Investment Entities''.
    (d) Effective Date.--
          (1) In general.--Except as otherwise provided in this 
        subsection, the amendments made by this section shall apply to 
        dividends with respect to taxable years of regulated investment 
        companies beginning after the date of the enactment of this 
        Act.
          (2) Estate tax treatment.--The amendment made by subsection 
        (b) shall apply to estates of decedents dying after the date of 
        the enactment of this Act.
          (3) Certain other provisions.--The amendments made by 
        subsection (c) (other than paragraph (1) thereof) shall take 
        effect on the date of the enactment of this Act.

                      Subtitle I--Other Provisions

SEC. 1101. SPECIAL RULES FOR LIVESTOCK SOLD ON ACCOUNT OF WEATHER-
                    RELATED CONDITIONS.

    (a) Rules for Replacement of Involuntarily Converted Livestock.--
Subsection (e) of section 1033 (relating to involuntary conversions) is 
amended--
          (1) by striking ``Conditions.--For purposes'' and inserting 
        ``Conditions.--
          ``(1) In general.--For purposes'', and
          (2) by adding at the end the following new paragraph:
          ``(2) Extension of replacement period.--
                  ``(A) In general.--In the case of drought, flood, or 
                other weather-related conditions described in paragraph 
                (1) which result in the area being designated as 
                eligible for assistance by the Federal Government, 
                subsection (a)(2)(B) shall be applied with respect to 
                any converted property by substituting `4 years' for `2 
                years'.
                  ``(B) Further extension by secretary.--The Secretary 
                may extend on a regional basis the period for 
                replacement under this section (after the application 
                of subparagraph (A)) for such additional time as the 
                Secretary determines appropriate if the weather-related 
                conditions which resulted in such application continue 
                for more than 3 years.''.
    (b) Income Inclusion Rules.--Subsection (e) of section 451 
(relating to special rule for proceeds from livestock sold on account 
of drought, flood, or other weather-related conditions) is amended by 
adding at the end the following new paragraph:
          ``(3) Special election rules.--If section 1033(e)(2) applies 
        to a sale or exchange of livestock described in paragraph (1), 
        the election under paragraph (1) shall be deemed valid if made 
        during the replacement period described in such section.''.
    (c) Effective Date.--The amendments made by this section shall 
apply to any taxable year with respect to which the due date (without 
regard to extensions) for the return is after December 31, 2002.

SEC. 1102. PAYMENT OF DIVIDENDS ON STOCK OF COOPERATIVES WITHOUT 
                    REDUCING PATRONAGE DIVIDENDS.

    (a) In General.--Subsection (a) of section 1388 (relating to 
patronage dividend defined) is amended by adding at the end the 
following: ``For purposes of paragraph (3), net earnings shall not be 
reduced by amounts paid during the year as dividends on capital stock 
or other proprietary capital interests of the organization to the 
extent that the articles of incorporation or bylaws of such 
organization or other contract with patrons provide that such dividends 
are in addition to amounts otherwise payable to patrons which are 
derived from business done with or for patrons during the taxable 
year.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to distributions in taxable years beginning after the date of the 
enactment of this Act.

SEC. 1103. VACCINE TAX TO APPLY TO HEPATITIS A VACCINE.

    (a) In General.--Paragraph (1) of section 4132(a) (defining taxable 
vaccine) is amended by redesignating subparagraphs (I), (J), (K), and 
(L) as subparagraphs (J), (K), (L), and (M), respectively, and by 
inserting after subparagraph (H) the following new subparagraph:
                  ``(I) Any vaccine against hepatitis A.''
    (b) Effective Date.--
          (1) Sales, etc.--The amendments made by subsection (a) shall 
        apply to sales and uses on or after the first day of the first 
        month which begins more than 4 weeks after the date of the 
        enactment of this Act.
          (2) Deliveries.--For purposes of paragraph (1) and section 
        4131 of the Internal Revenue Code of 1986, in the case of sales 
        on or before the effective date described in such paragraph for 
        which delivery is made after such date, the delivery date shall 
        be considered the sale date.

SEC. 1104. EXPANSION OF HUMAN CLINICAL TRIALS QUALIFYING FOR ORPHAN 
                    DRUG CREDIT.

    (a) In General.--Paragraph (2) of section 45C(b) (relating to 
qualified clinical testing expenses) is amended by adding at the end 
the following new subparagraph:
                  ``(C) Treatment of certain expenses incurred before 
                designation.--For purposes of subparagraph (A)(ii)(I), 
                if a drug is designated under section 526 of the 
                Federal Food, Drug, and Cosmetic Act not later than the 
                due date (including extensions) for filing the return 
                of tax under this subtitle for the taxable year in 
                which the application for such designation of such drug 
                was filed, such drug shall be treated as having been 
                designated on the date that such application was 
                filed.''.
    (b) Effective Date.--The amendment made by subsection (a) shall 
apply to expenses incurred after the date of the enactment of this Act.

SEC. 1105. DISTRIBUTIONS FROM PUBLICLY TRADED PARTNERSHIPS TREATED AS 
                    QUALIFYING INCOME OF REGULATED INVESTMENT 
                    COMPANIES.

    (a) In General.--Paragraph (2) of section 851(b) (defining 
regulated investment company) is amended to read as follows:
          ``(2) at least 90 percent of its gross income is derived 
        from--
                  ``(A) dividends, interest, payments with respect to 
                securities loans (as defined in section 512(a)(5)), and 
                gains from the sale or other disposition of stock or 
                securities (as defined in section 2(a)(36) of the 
                Investment Company Act of 1940, as amended) or foreign 
                currencies, or other income (including but not limited 
                to gains from options, futures or forward contracts) 
                derived with respect to its business of investing in 
                such stock, securities, or currencies, and
                  ``(B) distributions or other income derived from an 
                interest in a qualified publicly traded partnership (as 
                defined in subsection (h)); and''.
    (b) Source Flow-Through Rule Not To Apply.--The last sentence of 
section 851(b) is amended by inserting ``(other than a qualified 
publicly traded partnership as defined in subsection (h))'' after 
``derived from a partnership''.
    (c) Limitation on Ownership.--Subsection (c) of section 851 is 
amended by redesignating paragraph (5) as paragraph (6) and inserting 
after paragraph (4) the following new paragraph:
          ``(5) The term `outstanding voting securities of such issuer' 
        shall include the equity securities of a qualified publicly 
        traded partnership (as defined in subsection (h)).''.
    (d) Definition of Qualified Publicly Traded Partnership.--Section 
851 is amended by adding at the end the following new subsection:
    ``(h) Qualified Publicly Traded Partnership.--For purposes of this 
section, the term `qualified publicly traded partnership' means a 
publicly traded partnership described in section 7704(b) other than a 
partnership which would satisfy the gross income requirements of 
section 7704(c)(2) if qualifying income included only income described 
in subsection (b)(2)(A).''.
    (e) Definition of Qualifying Income.--Section 7704(d)(4) is amended 
by striking ``section 851(b)(2)'' and inserting ``section 
851(b)(2)(A)''.
    (f) Limitation on Composition of Assets.--Subparagraph (B) of 
section 851(b)(3) is amended to read as follows:
                  ``(B) not more than 25 percent of the value of its 
                total assets is invested in--
                          ``(i) the securities (other than Government 
                        securities or the securities of other regulated 
                        investment companies) of any one issuer,
                          ``(ii) the securities (other than the 
                        securities of other regulated investment 
                        companies) of two or more issuers which the 
                        taxpayer controls and which are determined, 
                        under regulations prescribed by the Secretary, 
                        to be engaged in the same or similar trades or 
                        businesses or related trades or businesses, or
                          ``(iii) the securities of one or more 
                        qualified publicly traded partnerships (as 
                        defined in subsection (h)).''.
    (g) Application of Special Passive Activity Rule to Regulated 
Investment Companies.--Subsection (k) of section 469 (relating to 
separate application of section in case of publicly traded 
partnerships) is amended by adding at the end the following new 
paragraph:
          ``(4) Application to regulated investment companies.--For 
        purposes of this section, a regulated investment company (as 
        defined in section 851) holding an interest in a qualified 
        publicly traded partnership (as defined in section 851(h)) 
        shall be treated as a taxpayer described in subsection (a)(2) 
        with respect to items attributable to such interest.''.
    (h) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after the date of the enactment of 
this Act.

SEC. 1106. IMPROVEMENTS RELATED TO REAL ESTATE INVESTMENT TRUSTS.

    (a) Expansion of Straight Debt Safe Harbor.--Section 856 (defining 
real estate investment trust) is amended--
          (1) in subsection (c) by striking paragraph (7), and
          (2) by adding at the end the following new subsection:
    ``(m) Safe Harbor in Applying Subsection (c)(4).--
          ``(1) In general.--In applying subclause (III) of subsection 
        (c)(4)(B)(iii), except as otherwise determined by the Secretary 
        in regulations, the following shall not be considered 
        securities held by the trust:
                  ``(A) Straight debt securities of an issuer which 
                meet the requirements of paragraph (2).
                  ``(B) Any loan to an individual or an estate.
                  ``(C) Any section 467 rental agreement (as defined in 
                section 467(d)), other than with a person described in 
                subsection (d)(2)(B).
                  ``(D) Any obligation to pay rents from real property 
                (as defined in subsection (d)(1)).
                  ``(E) Any security issued by a State or any political 
                subdivision thereof, the District of Columbia, a 
                foreign government or any political subdivision 
                thereof, or the Commonwealth of Puerto Rico, but only 
                if the determination of any payment received or accrued 
                under such security does not depend in whole or in part 
                on the profits of any entity not described in this 
                subparagraph or payments on any obligation issued by 
                such an entity,
                  ``(F) Any security issued by a real estate investment 
                trust.
                  ``(G) Any other arrangement as determined by the 
                Secretary.
          ``(2) Special rules relating to straight debt securities.--
                  ``(A) In general.--For purposes of paragraph (1)(A), 
                securities meet the requirements of this paragraph if 
                such securities are straight debt, as defined in 
                section 1361(c)(5) (without regard to subparagraph 
                (B)(iii) thereof).
                  ``(B) Special rules relating to certain 
                contingencies.--For purposes of subparagraph (A), any 
                interest or principal shall not be treated as failing 
                to satisfy section 1361(c)(5)(B)(i) solely by reason of 
                the fact that the time of payment of such interest or 
                principal is subject to a contingency, but only if--
                          ``(i) any such contingency does not have the 
                        effect of changing the effective yield to 
                        maturity, as determined under section 1272, 
                        other than a change in the annual yield to 
                        maturity which either--
                                  ``(I) does not exceed the greater of 
                                \1/4\ of 1 percent or 5 percent of the 
                                annual yield to maturity, or
                                  ``(II) results solely from a default 
                                or the exercise of a prepayment right 
                                by the issuer of the debt, or
                          ``(ii) neither the aggregate issue price nor 
                        the aggregate face amount of the issuer's debt 
                        instruments held by the trust exceeds 
                        $1,000,000 and not more than 12 months of 
                        unaccrued interest can be required to be 
                        prepaid thereunder.
                  ``(C) Special rules relating to corporate or 
                partnership issuers.--In the case of an issuer which is 
                a corporation or a partnership, securities that 
                otherwise would be described in paragraph (1)(A) shall 
                be considered not to be so described if the trust 
                holding such securities and any of its controlled 
                taxable REIT subsidiaries (as defined in subsection 
                (d)(8)(A)(iv)) hold any securities of the issuer 
                which--
                          ``(i) are not described in paragraph (1) 
                        (prior to the application of this 
                        subparagraph), and
                          ``(ii) have an aggregate value greater than 1 
                        percent of the issuer's outstanding securities 
                        determined without regard to paragraph 
                        (3)(A)(i).
          ``(3) Look-through rule for partnership securities.--
                  ``(A) In general.--For purposes of applying subclause 
                (III) of subsection (c)(4)(B)(iii)--
                          ``(i) a trust's interest as a partner in a 
                        partnership (as defined in section 7701(a)(2)) 
                        shall not be considered a security, and
                          ``(ii) the trust shall be deemed to own its 
                        proportionate share of each of the assets of 
                        the partnership.
                  ``(B) Determination of trust's interest in 
                partnership assets.--For purposes of subparagraph (A), 
                with respect to any taxable year beginning after the 
                date of the enactment of this subparagraph--
                          ``(i) the trust's interest in the partnership 
                        assets shall be the trust's proportionate 
                        interest in any securities issued by the 
                        partnership (determined without regard to 
                        subparagraph (A)(i) and paragraph (4), but not 
                        including securities described in paragraph 
                        (1)), and
                          ``(ii) the value of any debt instrument shall 
                        be the adjusted issue price thereof, as defined 
                        in section 1272(a)(4).
          ``(4) Certain partnership debt instruments not treated as a 
        security.--For purposes of applying subclause (III) of 
        subsection (c)(4)(B)(iii)--
                  ``(A) any debt instrument issued by a partnership and 
                not described in paragraph (1) shall not be considered 
                a security to the extent of the trust's interest as a 
                partner in the partnership, and
                  ``(B) any debt instrument issued by a partnership and 
                not described in paragraph (1) shall not be considered 
                a security if at least 75 percent of the partnership's 
                gross income (excluding gross income from prohibited 
                transactions) is derived from sources referred to in 
                subsection (c)(3).
          ``(5) Secretarial guidance.--The Secretary is authorized to 
        provide guidance (including through the issuance of a written 
        determination, as defined in section 6110(b)) that an 
        arrangement shall not be considered a security held by the 
        trust for purposes of applying subclause (III) of subsection 
        (c)(4)(B)(iii) notwithstanding that such arrangement otherwise 
        could be considered a security under subparagraph (F) of 
        subsection (c)(5).''.
    (b) Clarification of Application of Limited Rental Exception.--
Subparagraph (A) of section 856(d)(8) (relating to special rules for 
taxable REIT subsidiaries) is amended to read as follows:
                  ``(A) Limited rental exception.--
                          ``(i) In general.--The requirements of this 
                        subparagraph are met with respect to any 
                        property if at least 90 percent of the leased 
                        space of the property is rented to persons 
                        other than taxable REIT subsidiaries of such 
                        trust and other than persons described in 
                        paragraph (2)(B).
                          ``(ii) Rents must be substantially 
                        comparable.--Clause (i) shall apply only to the 
                        extent that the amounts paid to the trust as 
                        rents from real property (as defined in 
                        paragraph (1) without regard to paragraph 
                        (2)(B)) from such property are substantially 
                        comparable to such rents paid by the other 
                        tenants of the trust's property for comparable 
                        space.
                          ``(iii) Times for testing rent 
                        comparability.--The substantial comparability 
                        requirement of clause (ii) shall be treated as 
                        met with respect to a lease to a taxable REIT 
                        subsidiary of the trust if such requirement is 
                        met under the terms of the lease--
                                  ``(I) at the time such lease is 
                                entered into,
                                  ``(II) at the time of each extension 
                                of the lease, including a failure to 
                                exercise a right to terminate, and
                                  ``(III) at the time of any 
                                modification of the lease between the 
                                trust and the taxable REIT subsidiary 
                                if the rent under such lease is 
                                effectively increased pursuant to such 
                                modification.
                        With respect to subclause (III), if the taxable 
                        REIT subsidiary of the trust is a controlled 
                        taxable REIT subsidiary of the trust, the term 
                        `rents from real property' shall not in any 
                        event include rent under such lease to the 
                        extent of the increase in such rent on account 
                        of such modification.
                          ``(iv) Controlled taxable reit subsidiary.--
                        For purposes of clause (iii), the term 
                        `controlled taxable REIT subsidiary' means, 
                        with respect to any real estate investment 
                        trust, any taxable REIT subsidiary of such 
                        trust if such trust owns directly or 
                        indirectly--
                                  ``(I) stock possessing more than 50 
                                percent of the total voting power of 
                                the outstanding stock of such 
                                subsidiary, or
                                  ``(II) stock having a value of more 
                                than 50 percent of the total value of 
                                the outstanding stock of such 
                                subsidiary.
                          ``(v) Continuing qualification based on third 
                        party actions.--If the requirements of clause 
                        (i) are met at a time referred to in clause 
                        (iii), such requirements shall continue to be 
                        treated as met so long as there is no increase 
                        in the space leased to any taxable REIT 
                        subsidiary of such trust or to any person 
                        described in paragraph (2)(B).
                          ``(vi) Correction period.--If there is an 
                        increase referred to in clause (v) during any 
                        calendar quarter with respect to any property, 
                        the requirements of clause (iii) shall be 
                        treated as met during the quarter and the 
                        succeeding quarter if such requirements are met 
                        at the close of such succeeding quarter.''.
    (c) Deletion of Customary Services Exception.--Subparagraph (B) of 
section 857(b)(7) (relating to redetermined rents) is amended by 
striking clause (ii) and by redesignating clauses (iii), (iv), (v), 
(vi), and (vii) as clauses (ii), (iii), (iv), (v), and (vi), 
respectively.
    (d) Conformity with General Hedging Definition.--Subparagraph (G) 
of section 856(c)(5) (relating to treatment of certain hedging 
instruments) is amended to read as follows:
                  ``(G) Treatment of certain hedging instruments.--
                Except to the extent provided by regulations, any 
                income of a real estate investment trust from a hedging 
                transaction (as defined in clause (ii) or (iii) of 
                section 1221(b)(2)(A)) which is clearly identified 
                pursuant to section 1221(a)(7), including gain from the 
                sale or disposition of such a transaction, shall not 
                constitute gross income under paragraph (2) to the 
                extent that the transaction hedges any indebtedness 
                incurred or to be incurred by the trust to acquire or 
                carry real estate assets.''.
    (e) Conformity with Regulated Investment Company Rules.--Clause (i) 
of section 857(b)(5)(A) (relating to imposition of tax in case of 
failure to meet certain requirements) is amended by striking ``90 
percent'' and inserting ``95 percent''.
    (f) Effective Dates.--
          (1) In general.--Except as provided in paragraph (2), the 
        amendments made by this section shall apply to taxable years 
        beginning after December 31, 2000.
          (2) Subparagraphs (c) through  (e).--The amendments made by 
        subsections (c), (d), and (e) shall apply to taxable years 
        beginning after the date of the enactment of this Act.

SEC. 1107. SIMPLIFICATION OF EXCISE TAX IMPOSED ON BOWS AND ARROWS.

    (a) Bows.--Paragraph (1) of section 4161(b) (relating to bows) is 
amended to read as follows:
          ``(1) Bows.--
                  ``(A) In general.--There is hereby imposed on the 
                sale by the manufacturer, producer, or importer of any 
                bow which has a peak draw weight of 30 pounds or more, 
                a tax equal to 11 percent of the price for which so 
                sold.
                  ``(B) Archery equipment.--There is hereby imposed on 
                the sale by the manufacturer, producer, or importer--
                          ``(i) of any part or accessory suitable for 
                        inclusion in or attachment to a bow described 
                        in subparagraph (A), and
                          ``(ii) of any quiver or broadhead suitable 
                        for use with an arrow described in paragraph 
                        (3),
                a tax equal to 11 percent of the price for which so 
                sold.''.
    (b) Arrows.--Subsection (b) of section 4161 (relating to bows and 
arrows, etc.) is amended by redesignating paragraph (3) as paragraph 
(4) and inserting after paragraph (2) the following:
          ``(3) Arrows.--
                  ``(A) In general.--There is hereby imposed on the 
                sale by the manufacturer, producer, or importer of any 
                arrow, a tax equal to 12 percent of the price for which 
                so sold.
                  ``(B) Exception.--The tax imposed by subparagraph (A) 
                on an arrow shall not apply if the arrow contains an 
                arrow shaft with respect to which tax was paid under 
                paragraph (2).
                  ``(C) Arrow.--For purposes of this paragraph, the 
                term `arrow' means any shaft described in paragraph (2) 
                to which additional components are attached.''.
    (c) Conforming Amendments.--(1) Section 4161(b)(2) is amended by 
inserting ``(other than a broadhead)'' after ``point''.
    (2) The heading of section 4161(b)(2) is amended by striking 
``Arrows.--'' and inserting ``Arrow components.--''.
    (d) Effective Date.--The amendments made by this section shall 
apply to articles sold by the manufacturer, producer, or importer after 
December 31, 2003.

SEC. 1108. REPEAL OF EXCISE TAX ON FISHING TACKLE BOXES.

    (a) Repeal.--Paragraph (6) of section 4162(a) (defining sport 
fishing equipment) is amended by striking subparagraph (C) and by 
redesignating subparagraphs (D) through (J) as subparagraphs (C) 
through (I), respectively.
    (b) Effective Date.--The amendments made this section shall apply 
to articles sold by the manufacturer, producer, or importer after 
December 31, 2003.

SEC. 1109. INCOME TAX CREDIT TO DISTILLED SPIRITS WHOLESALERS FOR COST 
                    OF CARRYING FEDERAL EXCISE TAXES ON BOTTLED 
                    DISTILLED SPIRITS.

    (a) In General.--Subpart A of part I of subchapter A of chapter 51 
(relating to gallonage and occupational taxes) is amended by adding at 
the end the following new section:

``SEC. 5011. INCOME TAX CREDIT FOR WHOLESALER'S AVERAGE COST OF 
                    CARRYING EXCISE TAX.

    ``(a) In General.--For purposes of section 38, in the case of an 
eligible wholesaler, the amount of the distilled spirits wholesalers 
credit for any taxable year is the amount equal to the product of--
          ``(1) the number of cases of bottled distilled spirits--
                  ``(A) which were bottled in the United States, and
                  ``(B) which are purchased by such wholesaler during 
                the taxable year directly from the bottler of such 
                spirits, and
          ``(2) the average tax-financing cost per case for the most 
        recent calendar year ending before the beginning of such 
        taxable year.
    ``(b) Eligible Wholesaler.--For purposes of this section, the term 
`eligible wholesaler' means any person who holds a permit under the 
Federal Alcohol Administration Act as a wholesaler of distilled 
spirits.
    ``(c) Average Tax-Financing Cost.--
          ``(1) In general.--For purposes of this section, the average 
        tax-financing cost per case for any calendar year is the amount 
        of interest which would accrue at the deemed financing rate 
        during a 60-day period on an amount equal to the deemed Federal 
        excise per case.
          ``(2) Deemed financing rate.--For purposes of paragraph (1), 
        the deemed financing rate for any calendar year is the average 
        of the corporate overpayment rates under paragraph (1) of 
        section 6621(a) (determined without regard to the last sentence 
        of such paragraph) for calendar quarters of such year.
          ``(3) Deemed federal excise tax based on case of 12 80-proof 
        750ml bottles.--For purposes of paragraph (1), the deemed 
        Federal excise tax per case is $22.83.
          ``(4) Number of cases in lot.--For purposes of this section, 
        the number of cases in any lot of distilled spirits shall be 
        determined by dividing the number of liters in such lot by 9.''
    (b) Conforming Amendments.--
          (1) Subsection (b) of section 38 is amended by striking 
        ``plus'' at the end of paragraph (14), by striking the period 
        at the end of paragraph (15) and inserting ``, plus'', and by 
        adding at the end the following new paragraph:
          ``(16) in the case of an eligible wholesaler (as defined in 
        section 5011(b)), the distilled spirits wholesaler credit 
        determined under section 5011(a).''
          (2) Subsection (d) of section 39 (relating to carryback and 
        carryforward of unused credits) is amended by adding at the end 
        the following new paragraph:
          ``(11) No carryback of section 5011 credit before january 1, 
        2004.--No portion of the unused business credit for any taxable 
        year which is attributable to the credit determined under 
        section 5011(a) may be carried back to a taxable year beginning 
        before January 1, 2004.''.
          (3) The table of sections for subpart A of part I of 
        subchapter A of chapter 51 is amended by adding at the end the 
        following new item:

                              ``Sec. 5011. Income tax credit for 
                                        wholesaler's average cost of 
                                        carrying excise tax.''.

    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2003.

SEC. 1110. CAPITAL GAIN TREATMENT UNDER SECTION 631(B) TO APPLY TO 
                    OUTRIGHT SALES BY LANDOWNERS.

    (a) In General.--The first sentence of section 631(b) (relating to 
disposal of timber with a retained economic interest) is amended by 
striking ``retains an economic interest in such timber'' and inserting 
``either retains an economic interest in such timber or makes an 
outright sale of such timber''.
    (b) Conforming Amendments.--
          (1) The third sentence of section 631(b) is amended by 
        striking ``The date of disposal'' and inserting ``In the case 
        of disposal of timber with a retained economic interest, the 
        date of disposal''.
          (2) The heading for section 631(b) is amended by striking 
        ``With a Retained Economic Interest''.
    (c) Effective Date.--The amendments made by this section shall 
apply to sales after December 31, 2003.

SEC. 1111. SONAR DEVICES SUITABLE FOR FINDING FISH.

    (a) Not Treated as Sport Fishing Equipment.--Subsection (a) of 
section 4162 (relating to sport fishing equipment defined) is amended 
by inserting ``and'' at the end of paragraph (8), by striking ``, and'' 
at the end of paragraph (9) and inserting a period, and by striking 
paragraph (10).
    (b) Conforming Amendment.--Section 4162 is amended by striking 
subsection (b) and by redesignating subsection (c) as subsection (b).
    (c) Effective Date.--The amendments made this section shall apply 
to articles sold by the manufacturer, producer, or importer after 
December 31, 2003.

SEC. 1112. TAXATION OF CERTAIN SETTLEMENT FUNDS.

    (a) In General.--Subsection (g) of section 468B (relating to 
clarification of taxation of certain funds) is amended to read as 
follows:
    ``(g) Clarification of Taxation of Certain Funds.--
          ``(1) In general.--Except as provided in paragraph (2), 
        nothing in any provision of law shall be construed as providing 
        that an escrow account, settlement fund, or similar fund is not 
        subject to current income tax. The Secretary shall prescribe 
        regulations providing for the taxation of any such account or 
        fund whether as a grantor trust or otherwise.
          ``(2) Exemption from tax for certain settlement funds.--An 
        escrow account, settlement fund, or similar fund shall be 
        treated as beneficially owned by the United States and shall be 
        exempt from taxation under this subtitle if--
                  ``(A) it is established pursuant to a consent decree 
                entered by a judge of a United States District Court,
                  ``(B) it is created for the receipt of settlement 
                payments as directed by a government entity for the 
                sole purpose of resolving or satisfying one or more 
                claims asserting liability under the Comprehensive 
                Environmental Response, Compensation, and Liability Act 
                of 1980,
                  ``(C) the authority and control over the expenditure 
                of funds therein (including the expenditure of 
                contributions thereto and any net earnings thereon) is 
                with such government entity, and
                  ``(D) upon termination, any remaining funds will be 
                disbursed upon instructions by such government entity 
                in accordance with applicable law.
        For purposes of this paragraph, the term `government entity' 
        means the United States, any State or political subdivision 
        thereof, the District of Columbia, any possession of the United 
        States, and any agency or instrumentality of any of the 
        foregoing.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

SEC. 1113. SUSPENSION OF OCCUPATIONAL TAXES RELATING TO DISTILLED 
                    SPIRITS, WINE, AND BEER.

    (a) In General.--Subpart G of part II of subchapter A of chapter 51 
is amended by redesignating section 5148 as section 5149 and by 
inserting after section 5147 the following new section:

``SEC. 5148. SUSPENSION OF OCCUPATIONAL TAX.

    ``(a) In General.--Notwithstanding sections 5081, 5091, 5111, 5121, 
and 5131, the rate of tax imposed under such sections for the 
suspension period shall be zero. During such period, persons engaged in 
or carrying on a trade or business covered by such sections shall 
register under section 5141 and shall comply with the recordkeeping 
requirements under this part.
    ``(b) Suspension Period.--For purposes of subsection (a), the 
suspension period is the period beginning on July 1, 2004, and ending 
on June 30, 2007.''.
    (b) Conforming Amendment.--Section 5117 is amended by adding at the 
end the following new subsection:
    ``(d) Special Rule During Suspension Period.--Except as provided by 
the Secretary, during the suspension period (as defined in section 
5148) it shall be unlawful for any dealer to purchase distilled spirits 
for resale from any person other than a wholesale dealer in liquors who 
is required to keep records under section 5114.''.
    (c) Clerical Amendment.--The table of sections for subpart G of 
part II of subchapter A of chapter 51 is amended by striking the last 
item and inserting the following new items:

                              ``Sec. 5148. Suspension of occupational 
                                        tax.
                              ``Sec. 5149. Cross references.''.

    (d) Effective Date.--The amendments made by this section shall take 
effect on the date of the enactment of this Act.

TITLE II--PROVISIONS TO REDUCE TAX AVOIDANCE THROUGH CORPORATE EARNINGS 
                       STRIPPING AND EXPATRIATION

SEC. 2001. REDUCTION IN POTENTIAL FOR EARNINGS STRIPPING BY FURTHER 
                    LIMITING DEDUCTION FOR INTEREST ON CERTAIN 
                    INDEBTEDNESS.

    (a) Reduction in Potential for Earnings Stripping.--
          (1) In general.--Section 163(j) is amended by striking 
        paragraphs (1) and (2), by redesignating paragraphs (3) through 
        (8) as paragraphs (4) through (9), respectively, and by 
        inserting before paragraph (4), as so redesignated, the 
        following new paragraphs:
          ``(1) Limitation.--
                  ``(A) In general.--In the case of a corporation, no 
                deduction shall be allowed under this chapter for 
                disqualified interest paid or accrued during the 
                taxable year.
                  ``(B) Maximum disallowance.--The amount disallowed 
                under subparagraph (A) shall not exceed the sum of--
                          ``(i) the corporation's excess interest 
                        expense for the taxable year, and
                          ``(ii) the corporation's excess related party 
                        interest expense for such year.
                In no event shall the disallowance under subparagraph 
                (A) reduce the deduction for interest below the sum of 
                the amount of interest includible in the gross income 
                of the taxpayer for such taxable year and an amount 
                equal to 25 percent of adjusted taxable income (35 
                percent in the case of the first taxable year beginning 
                after December 31, 2003).
                  ``(C) Disallowed amount carried to succeeding taxable 
                year.--
                          ``(i) In general.--Any amount disallowed 
                        under subparagraph (A) for any taxable year 
                        shall be treated as paid or accrued in the 
                        succeeding taxable year and in the 2nd through 
                        10th succeeding taxable years to the extent not 
                        previously taken into account under this 
                        subparagraph.
                          ``(ii) Limitation on amount carried to 
                        year.--A carryforward amount may not be taken 
                        into account for any such succeeding taxable 
                        year to the extent that such amount, when added 
                        to amounts carried to such succeeding taxable 
                        year from taxable years preceding the taxable 
                        year from which the amount is being carried 
                        forward, would result in (or increase) a 
                        disallowance under subparagraph (A).
                          ``(iii) Carryover applied separately to 
                        categories of disqualified interest.--Clauses 
                        (i) and (ii) shall be applied separately to 
                        disqualified interest described in paragraph 
                        (3)(A) and to disqualified interest described 
                        in paragraph (3)(B). For purposes of this 
                        subparagraph, any amount disallowed under 
                        subparagraph (A) for any taxable year shall be 
                        treated as disqualified interest described in 
                        paragraph (3)(A) to the extent thereof and then 
                        as disqualified interest described in paragraph 
                        (3)(B).
          ``(2) Excess interest expense; excess related party interest 
        expense.--For purposes of this subsection--
                  ``(A) Excess interest expense.--The term `excess 
                interest expense' means the excess (if any) of--
                          ``(i) the corporation's net interest expense, 
                        over
                          ``(ii) 50 percent of the adjusted taxable 
                        income of the corporation.
                  ``(B) Excess related party interest expense.--The 
                term `excess related party interest expense' means the 
                excess (if any) of--
                          ``(i) the lesser of--
                                  ``(I) the amount of disqualified 
                                interest described in paragraph (3)(A), 
                                or
                                  ``(II) the corporation's net interest 
                                expense, over
                          ``(ii) 25 percent (35 percent in the case of 
                        the first taxable year beginning after December 
                        31, 2003) of the adjusted taxable income of the 
                        corporation.
          ``(3) Alternative maximum disallowance.--
                  ``(A) In general.--In the case of a corporation with 
                respect to which an election is in effect under 
                subparagraph (B), the amount disallowed under paragraph 
                (1)(A) shall not exceed the excess (if any) of--
                          ``(i) the corporation's net interest expense, 
                        over
                          ``(ii) 30 percent of the adjusted taxable 
                        income of the corporation.
                  ``(B) Election.--A corporation may make a one-time 
                irrevocable election to have the alternative maximum 
                disallowance described in subparagraph (A) apply for 
                purposes of this subsection in lieu of paragraph 
                (1)(B). An election under this subparagraph shall not 
                apply with respect to any taxable year beginning before 
                January 1, 2005.
                  ``(C) Limitation.--Subparagraph (B) shall not apply 
                with respect to any corporation which is--
                          ``(i) a surrogate foreign corporation (as 
                        defined in section 7874(a)(2)(B)),
                          ``(ii) a corporation which would be a 
                        surrogate foreign corporation (as so defined) 
                        if ``December 31, 1996'' were substituted for 
                        ``March 4, 2003'' in section 7874(a), or
                          ``(iii) a corporation which is an expatriated 
                        entity (as defined in section 7874(a)) with 
                        respect to a corporation described in clause 
                        (i) or (ii).''.
          (2) Conforming amendment.--Paragraph (5)(B)(ii) of section 
        163(j), as redesignated by paragraph (1), is amended by 
        striking ``paragraph (5)(B)'' and inserting ``paragraph 
        (6)(B)''.
    (b) Maintenance of Current Law for Interest Paid by Taxable REIT 
Subsidiaries to REIT.--
          (1) Exception from 163(j).--Paragraph (4) of section 163(j), 
        as redesignated by subsection (a), is amended by inserting 
        ``and'' at the end of subparagraph (A), by striking ``, and'' 
        at the end of subparagraph (B) and inserting a period, and by 
        striking subparagraph (C).
          (2) Disallowance.--Section 856 is amended by adding at the 
        end the following new subsection:
    ``(n) Limitation on Deduction for Interest on Certain Indebtedness 
of Taxable REIT Subsidiary.--
          ``(1) Limitation.--
                  ``(A) In general.--If this subsection applies to any 
                taxable REIT subsidiary for any taxable year, no 
                deduction shall be allowed under this chapter for 
                disqualified interest paid or accrued by such 
                subsidiary during such taxable year. The amount 
                disallowed under the preceding sentence shall not 
                exceed the subsidiary's excess interest expense for the 
                taxable year.
                  ``(B) Disallowed amount carried to succeeding taxable 
                year.--Any amount disallowed under subparagraph (A) for 
                any taxable year shall be treated as disqualified 
                interest paid or accrued in the succeeding taxable year 
                (and clause (ii) of paragraph (2)(A) shall not apply 
                for purposes of applying this subsection to the amount 
                so treated).
          ``(2) Subsidiaries to which subsection applies.--
                  ``(A) In general.--This subsection shall apply to any 
                taxable REIT subsidiary for any taxable year if--
                          ``(i) such subsidiary has excess interest 
                        expense for such taxable year, and
                          ``(ii) the ratio of debt to equity of such 
                        subsidiary as of the close of such taxable year 
                        (or on any other day during the taxable year as 
                        the Secretary may by regulations prescribe) 
                        exceeds 1.5 to 1.
                  ``(B) Excess interest expense.--
                          ``(i) In general.--For purposes of this 
                        subsection, the term `excess interest expense' 
                        means the excess (if any) of--
                                  ``(I) the taxable REIT subsidiary's 
                                net interest expense, over
                                  ``(II) the sum of 50 percent of the 
                                adjusted taxable income of the 
                                subsidiary plus any excess limitation 
                                carryforward under clause (ii).
                          ``(ii) Excess limitation carryforward.--If a 
                        taxable REIT subsidiary has an excess 
                        limitation for any taxable year, the amount of 
                        such excess limitation shall be an excess 
                        limitation carryforward to the 1st succeeding 
                        taxable year and to the 2nd and 3rd succeeding 
                        taxable years to the extent not previously 
                        taken into account under this clause. The 
                        amount of such a carryforward taken into 
                        account for any such succeeding taxable year 
                        shall not exceed the excess interest expense 
                        for such succeeding taxable year (determined 
                        without regard to the carryforward from the 
                        taxable year of such excess limitation).
                          ``(iii) Excess limitation.--For purposes of 
                        clause (ii), the term `excess limitation' means 
                        the excess (if any) of--
                                  ``(I) 50 percent of the adjusted 
                                taxable income of the subsidiary, over
                                  ``(II) the subsidiary's net interest 
                                expense.
                  ``(C) Ratio of debt to equity.--For purposes of this 
                paragraph, the term `ratio of debt to equity' means the 
                ratio which the total indebtedness of the subsidiary 
                bears to the sum of its money and all other assets 
                reduced (but not below zero) by such total 
                indebtedness. The rules of section 163(j)(6)(E) shall 
                apply for purposes of the preceding sentence.
          ``(3) Disqualified interest.--For purposes of this 
        subsection, the term `disqualified interest' means any interest 
        paid or accrued (directly or indirectly) by a taxable REIT 
        subsidiary of a real estate investment trust to such trust.
          ``(4) Other rules to apply.--Rules similar to the rules of 
        paragraphs (7), (8), and (9) of section 163(j) shall apply for 
        purposes of this subsection.''
    (c) Effective Date.--
          (1) In general.--Except as otherwise provided in this 
        subsection, the amendments made by this section shall apply to 
        taxable years beginning after December 31, 2003.
          (2) Earlier effective date with respect to expatriated 
        corporations, etc.--The amendments made by this section shall 
        apply to taxable years ending after March 4, 2003, in the case 
        of a taxpayer which is--
                  (A) a surrogate foreign corporation, as defined in 
                section 7874(a)(2)(B) of the Internal Revenue Code of 
                1986, as added by section 2002,
                  (B) a corporation which would be a surrogate foreign 
                corporation (as so defined) if ``December 31, 1996'' 
                were substituted for ``March 4, 2003'' in such section 
                7874(a), or
                  (C) a corporation which is an expatriated entity (as 
                defined in such section 7874(a)) with respect to a 
                corporation described in subparagraph (A) or (B).
        In applying such amendments to a taxpayer described in the 
        preceding sentence, subparagraph (B) of section 163(j)(2) of 
        such Code, as amended by this section, shall be applied by 
        substituting ``25 percent'' for ``35 percent''.
          (3) Limitation on carryover of disallowed interest.--
                  (A) In general.--Except in the case of a taxpayer 
                described in paragraph (2), for purposes of applying 
                section 163(j)(1)(C) of the Internal Revenue Code of 
                1986 (as added by this section), amounts carried from a 
                taxable year beginning before January 1, 2004, to any 
                taxable year beginning after December 31, 2003, shall 
                be treated as disqualified interest described in 
                section 163(j)(3)(B) of such Code which is disallowed 
                for the most recent taxable year beginning before 
                January 1, 2004.
                  (B) Expatriated corporations.--In the case of a 
                taxpayer described in paragraph (2), a rule similar to 
                the rule of subparagraph (A) shall apply to amounts 
                carried from a taxable year ending on or before March 
                5, 2003.

SEC. 2002. TAX TREATMENT OF EXPATRIATED ENTITIES AND THEIR FOREIGN 
                    PARENTS.

    (a) In General.--Subchapter C of chapter 80 (relating to provisions 
affecting more than one subtitle) is amended by adding at the end the 
following new section:

``SEC. 7874. RULES RELATING TO EXPATRIATED ENTITIES AND THEIR FOREIGN 
                    PARENTS.

    ``(a) Tax on Inversion Gain of Expatriated Entities.--
          ``(1) In general.--The taxable income of an expatriated 
        entity for any taxable year which includes any portion of the 
        applicable period shall in no event be less than the inversion 
        gain of the entity for the taxable year.
          ``(2) Expatriated entity.--For purposes of this subsection--
                  ``(A) In general.--The term `expatriated entity' 
                means--
                          ``(i) the domestic corporation or partnership 
                        referred to in subparagraph (B)(i) with respect 
                        to which a foreign corporation is a surrogate 
                        foreign corporation, and
                          ``(ii) any United States person who is 
                        related (within the meaning of section 267(b) 
                        or 707(b)(1)) to a domestic corporation or 
                        partnership described in clause (i).
                  ``(B) Surrogate foreign corporation.--A foreign 
                corporation shall be treated as a surrogate foreign 
                corporation if, pursuant to a plan (or a series of 
                related transactions)--
                          ``(i) the entity completes after March 4, 
                        2003, the direct or indirect acquisition of 
                        substantially all of the properties held 
                        directly or indirectly by a domestic 
                        corporation or substantially all of the 
                        properties constituting a trade or business of 
                        a domestic partnership,
                          ``(ii) after the acquisition at least 60 
                        percent of the stock (by vote or value) of the 
                        entity is held--
                                  ``(I) in the case of an acquisition 
                                with respect to a domestic corporation, 
                                by former shareholders of the domestic 
                                corporation by reason of holding stock 
                                in the domestic corporation, or
                                  ``(II) in the case of an acquisition 
                                with respect to a domestic partnership, 
                                by former partners of the domestic 
                                partnership by reason of holding a 
                                capital or profits interest in the 
                                domestic partnership, and
                          ``(iii) after the acquisition the expanded 
                        affiliated group which includes the entity does 
                        not have substantial business activities in the 
                        foreign country in which, or under the law of 
                        which, the entity is created or organized, when 
                        compared to the total business activities of 
                        such expanded affiliated group.
                An entity otherwise described in clause (i) with 
                respect to any domestic corporation or partnership 
                trade or business shall be treated as not so described 
                if, on or before March 4, 2003, such entity acquired 
                directly or indirectly more than half of the properties 
                held directly or indirectly by such corporation or more 
                than half of the properties constituting such 
                partnership trade or business, as the case may be.
    ``(b) Definitions and Special Rules.--
          ``(1) Expanded affiliated group.--The term `expanded 
        affiliated group' means an affiliated group as defined in 
        section 1504(a) but without regard to section 1504(b)(3), 
        except that section 1504(a) shall be applied by substituting 
        `more than 50 percent' for `at least 80 percent' each place it 
        appears.
          ``(2) Certain stock disregarded.--There shall not be taken 
        into account in determining ownership under subsection 
        (a)(2)(B)(ii)--
                  ``(A) stock held by members of the expanded 
                affiliated group which includes the foreign 
                corporation, or
                  ``(B) stock of such foreign corporation which is sold 
                in a public offering related to the acquisition 
                described in subsection (a)(2)(B)(i).
          ``(3) Plan deemed in certain cases.--If a foreign corporation 
        acquires directly or indirectly substantially all of the 
        properties of a domestic corporation or partnership during the 
        4-year period beginning on the date which is 2 years before the 
        ownership requirements of subsection (a)(2)(B)(ii) are met, 
        such actions shall be treated as pursuant to a plan.
          ``(4) Certain transfers disregarded.--The transfer of 
        properties or liabilities (including by contribution or 
        distribution) shall be disregarded if such transfers are part 
        of a plan a principal purpose of which is to avoid the purposes 
        of this section.
          ``(5) Special rule for related partnerships.--For purposes of 
        applying subsection (a)(2)(B)(ii) to the acquisition of a trade 
        or business of a domestic partnership, except as provided in 
        regulations, all partnerships which are under common control 
        (within the meaning of section 482) shall be treated as 1 
        partnership.
          ``(6) Regulations.--The Secretary shall prescribe such 
        regulations as may be appropriate to determine whether a 
        corporation is a surrogate foreign corporation, including 
        regulations--
                  ``(A) to treat warrants, options, contracts to 
                acquire stock, convertible debt interests, and other 
                similar interests as stock, and
                  ``(B) to treat stock as not stock.
    ``(c) Other Definitions.--For purposes of this section--
          ``(1) Applicable period.--The term `applicable period' means 
        the period--
                  ``(A) beginning on the first date properties are 
                acquired as part of the acquisition described in 
                subsection (a)(2)(B)(i), and
                  ``(B) ending on the date which is 10 years after the 
                last date properties are acquired as part of such 
                acquisition.
          ``(2) Inversion gain.--The term `inversion gain' means the 
        income or gain recognized by reason of the transfer during the 
        applicable period of stock or other properties by an 
        expatriated entity, and any income received or accrued during 
        the applicable period by reason of a license of any property by 
        an expatriated entity --
                  ``(A) as part of the acquisition described in 
                subsection (a)(2)(B)(i), or
                  ``(B) after such acquisition if the transfer or 
                license is to a foreign related person.
        Subparagraph (B) shall not apply to property described in 
        section 1221(a)(1) in the hands of the expatriated entity.
          ``(3) Foreign related person.--The term `foreign related 
        person' means, with respect to any expatriated entity, a 
        foreign person which--
                  ``(A) is related (within the meaning of section 
                267(b) or 707(b)(1)) to such entity, or
                  ``(B) is under the same common control (within the 
                meaning of section 482) as such entity.
    ``(d) Special Rules.--
          ``(1) Credits not allowed against tax on inversion gain.--
        Credits (other than the credit allowed by section 901) shall be 
        allowed against the tax imposed by this chapter on an 
        expatriated entity for any taxable year described in subsection 
        (a) only to the extent such tax exceeds the product of--
                  ``(A) the amount of the inversion gain for the 
                taxable year, and
                  ``(B) the highest rate of tax specified in section 
                11(b)(1).
        For purposes of determining the credit allowed by section 901, 
        inversion gain shall be treated as from sources within the 
        United States.
          ``(2) Special rules for partnerships.--In the case of an 
        expatriated entity which is a partnership--
                  ``(A) subsection (a)(1) shall apply at the partner 
                rather than the partnership level,
                  ``(B) the inversion gain of any partner for any 
                taxable year shall be equal to the sum of--
                          ``(i) the partner's distributive share of 
                        inversion gain of the partnership for such 
                        taxable year, plus
                          ``(ii) gain recognized for the taxable year 
                        by the partner by reason of the transfer during 
                        the applicable period of any partnership 
                        interest of the partner in such partnership to 
                        the surrogate foreign corporation, and
                  ``(C) the highest rate of tax specified in the rate 
                schedule applicable to the partner under this chapter 
                shall be substituted for the rate of tax referred to in 
                paragraph (1).
          ``(3) Coordination with section 172 and minimum tax.--Rules 
        similar to the rules of paragraphs (3) and (4) of section 
        860E(a) shall apply for purposes of subsection (a).
          ``(4) Statute of limitations.--
                  ``(A) In general.--The statutory period for the 
                assessment of any deficiency attributable to the 
                inversion gain of any taxpayer for any pre-inversion 
                year shall not expire before the expiration of 3 years 
                from the date the Secretary is notified by the taxpayer 
                (in such manner as the Secretary may prescribe) of the 
                acquisition described in subsection (a)(2)(B)(i) to 
                which such gain relates and such deficiency may be 
                assessed before the expiration of such 3-year period 
                notwithstanding the provisions of any other law or rule 
                of law which would otherwise prevent such assessment.
                  ``(B) Pre-inversion year.--For purposes of 
                subparagraph (A), the term `pre-inversion year' means 
                any taxable year if--
                          ``(i) any portion of the applicable period is 
                        included in such taxable year, and
                          ``(ii) such year ends before the taxable year 
                        in which the acquisition described in 
                        subsection (a)(2)(B)(i) is completed.
    ``(e) Special Rule for Treaties.--Nothing in section 894 or 7852(d) 
or in any other provision of law shall be construed as permitting an 
exemption, by reason of any treaty obligation of the United States 
heretofore or hereafter entered into, from the provisions of this 
section.
    ``(f) Regulations.--The Secretary shall provide such regulations as 
are necessary to carry out this section, including regulations 
providing for such adjustments to the application of this section as 
are necessary to prevent the avoidance of the purposes of this section, 
including the avoidance of such purposes through--
          ``(1) the use of related persons, pass-through or other 
        noncorporate entities, or other intermediaries, or
          ``(2) transactions designed to have persons cease to be (or 
        not become) members of expanded affiliated groups or related 
        persons.''.
    (b) Conforming Amendment.--The table of sections for subchapter C 
of chapter 80 is amended by adding at the end the following new item:

                              ``Sec. 7874. Rules relating to 
                                        expatriated entities and their 
                                        foreign parents.''

    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years ending after March 4, 2003.

SEC. 2003. EXCISE TAX ON STOCK COMPENSATION OF INSIDERS IN EXPATRIATED 
                    CORPORATIONS.

    (a) In General.--Subtitle D is amended by inserting after chapter 
44 end the following new chapter:

       ``CHAPTER 45--PROVISIONS RELATING TO EXPATRIATED ENTITIES

                              ``Sec. 4985. Stock compensation of 
                                        insiders in expatriated 
                                        corporations.

``SEC. 4985. STOCK COMPENSATION OF INSIDERS IN EXPATRIATED 
                    CORPORATIONS.

    ``(a) Imposition of Tax.--In the case of an individual who is a 
disqualified individual with respect to any expatriated corporation, 
there is hereby imposed on such person a tax equal to 15 percent of the 
value (determined under subsection (b)) of the specified stock 
compensation held (directly or indirectly) by or for the benefit of 
such individual or a member of such individual's family (as defined in 
section 267) at any time during the 12-month period beginning on the 
date which is 6 months before the expatriation date.
    ``(b) Value.--For purposes of subsection (a)--
          ``(1) In general.--The value of specified stock compensation 
        shall be--
                  ``(A) in the case of a stock option (or other similar 
                right) or a stock appreciation right, the fair value of 
                such option or right, and
                  ``(B) in any other case, the fair market value of 
                such compensation.
          ``(2) Date for determining value.--The determination of value 
        shall be made--
                  ``(A) in the case of specified stock compensation 
                held on the expatriation date, on such date,
                  ``(B) in the case of such compensation which is 
                canceled during the 6 months before the expatriation 
                date, on the day before such cancellation, and
                  ``(C) in the case of such compensation which is 
                granted after the expatriation date, on the date such 
                compensation is granted.
    ``(c) Tax To Apply Only if Shareholder Gain Recognized.--Subsection 
(a) shall apply to any disqualified individual with respect to an 
expatriated corporation only if gain (if any) on any stock in such 
corporation is recognized in whole or part by any shareholder by reason 
of the acquisition referred to in section 7874(a)(2)(B)(i) with respect 
to such corporation.
    ``(d) Exception Where Gain Recognized on Compensation.--Subsection 
(a) shall not apply to--
          ``(1) any stock option which is exercised on the expatriation 
        date or during the 6-month period before such date and to the 
        stock acquired in such exercise, if income is recognized under 
        section 83 on or before the expatriation date with respect to 
        the stock acquired pursuant to such exercise, and
          ``(2) any other specified stock compensation which is 
        exercised, sold, exchanged, distributed, cashed-out, or 
        otherwise paid during such period in a transaction in which 
        income, gain, or loss is recognized in full.
    ``(e) Definitions.--For purposes of this section--
          ``(1) Disqualified individual.--The term `disqualified 
        individual' means, with respect to a corporation, any 
        individual who, at any time during the 12-month period 
        beginning on the date which is 6 months before the expatriation 
        date--
                  ``(A) is subject to the requirements of section 16(a) 
                of the Securities Exchange Act of 1934 with respect to 
                such corporation or any member of the expanded 
                affiliated group which includes such corporation, or
                  ``(B) would be subject to such requirements if such 
                corporation or member were an issuer of equity 
                securities referred to in such section.
          ``(2) Expatriated corporation; expatriation date.--
                  ``(A) Expatriated corporation.--The term `expatriated 
                corporation' means any corporation which is an 
                expatriated entity (as defined in section 7874(a)(2)). 
                Such term includes any predecessor or successor of such 
                a corporation.
                  ``(B) Expatriation date.--The term `expatriation 
                date' means, with respect to a corporation, the date on 
                which the corporation first becomes an expatriated 
                corporation.
          ``(3) Specified stock compensation.--
                  ``(A) In general.--The term `specified stock 
                compensation' means payment (or right to payment) 
                granted by the expatriated corporation (or by any 
                member of the expanded affiliated group which includes 
                such corporation) to any person in connection with the 
                performance of services by a disqualified individual 
                for such corporation or member if the value of such 
                payment or right is based on (or determined by 
                reference to) the value (or change in value) of stock 
                in such corporation (or any such member).
                  ``(B) Exceptions.--Such term shall not include--
                          ``(i) any option to which part II of 
                        subchapter D of chapter 1 applies, or
                          ``(ii) any payment or right to payment from a 
                        plan referred to in section 280G(b)(6).
          ``(4) Expanded affiliated group.--The term `expanded 
        affiliated group' means an affiliated group (as defined in 
        section 1504(a) without regard to section 1504(b)(3)); except 
        that section 1504(a) shall be applied by substituting `more 
        than 50 percent' for `at least 80 percent' each place it 
        appears.
    ``(f) Special Rules.--For purposes of this section--
          ``(1) Cancellation of restriction.--The cancellation of a 
        restriction which by its terms will never lapse shall be 
        treated as a grant.
          ``(2) Payment or reimbursement of tax by corporation treated 
        as specified stock compensation.--Any payment of the tax 
        imposed by this section directly or indirectly by the 
        expatriated corporation or by any member of the expanded 
        affiliated group which includes such corporation--
                  ``(A) shall be treated as specified stock 
                compensation, and
                  ``(B) shall not be allowed as a deduction under any 
                provision of chapter 1.
          ``(3) Certain restrictions ignored.--Whether there is 
        specified stock compensation, and the value thereof, shall be 
        determined without regard to any restriction other than a 
        restriction which by its terms will never lapse.
          ``(4) Property transfers.--Any transfer of property shall be 
        treated as a payment and any right to a transfer of property 
        shall be treated as a right to a payment.
          ``(5) Other administrative provisions.--For purposes of 
        subtitle F, any tax imposed by this section shall be treated as 
        a tax imposed by subtitle A.
    ``(g) Regulations.--The Secretary shall prescribe such regulations 
as may be necessary or appropriate to carry out the purposes of this 
section.''
    (b) Denial of Deduction.--
          (1) In general.--Paragraph (6) of section 275(a) is amended 
        by inserting ``45,'' before ``46,''.
          (2) $1,000,000 limit on deductible compensation reduced by 
        payment of excise tax on specified stock compensation.--
        Paragraph (4) of section 162(m) is amended by adding at the end 
        the following new subparagraph:
                  ``(G) Coordination with excise tax on specified stock 
                compensation.--The dollar limitation contained in 
                paragraph (1) with respect to any covered employee 
                shall be reduced (but not below zero) by the amount of 
                any payment (with respect to such employee) of the tax 
                imposed by section 4985 directly or indirectly by the 
                expatriated corporation (as defined in such section) or 
                by any member of the expanded affiliated group (as 
                defined in such section) which includes such 
                corporation.''
    (c) Conforming Amendments.--
          (1) The last sentence of section 3121(v)(2)(A) is amended by 
        inserting before the period ``or to any specified stock 
        compensation (as defined in section 4985) on which tax is 
        imposed by section 4985''.
          (2) The table of chapters for subtitle D is amended by 
        inserting after the item relating to chapter 44 the following 
        new item:

                              ``Chapter 45. Provisions relating to 
                                        expatriated entities.''

    (d) Effective Date.--The amendments made by this section shall take 
effect on March 4, 2003; except that periods before such date shall not 
be taken into account in applying the periods in subsections (a) and 
(e)(1) of section 4985 of the Internal Revenue Code of 1986, as added 
by this section.

SEC. 2004. REINSURANCE OF UNITED STATES RISKS IN FOREIGN JURISDICTIONS.

    (a) In General.--Section 845(a) (relating to allocation in case of 
reinsurance agreement involving tax avoidance or evasion) is amended by 
striking ``source and character'' and inserting ``amount, source, or 
character''.
    (b) Effective Date.--The amendments made by this section shall 
apply to any risk reinsured after the date of the enactment of this 
Act.

SEC. 2005. REVISION OF TAX RULES ON EXPATRIATION OF INDIVIDUALS.

    (a) Expatriation To Avoid Tax.--
          (1) In general.--Subsection (a) of section 877 (relating to 
        treatment of expatriates) is amended to read as follows:
    ``(a) Treatment of Expatriates.--
          ``(1) In general.--Every nonresident alien individual to whom 
        this section applies and who, within the 10-year period 
        immediately preceding the close of the taxable year, lost 
        United States citizenship shall be taxable for such taxable 
        year in the manner provided in subsection (b) if the tax 
        imposed pursuant to such subsection (after any reduction in 
        such tax under the last sentence of such subsection) exceeds 
        the tax which, without regard to this section, is imposed 
        pursuant to section 871.
          ``(2) Individuals subject to this section.--This section 
        shall apply to any individual if--
                  ``(A) the average annual net income tax (as defined 
                in section 38(c)(1)) of such individual for the period 
                of 5 taxable years ending before the date of the loss 
                of United States citizenship is greater than $122,000,
                  ``(B) the net worth of the individual as of such date 
                is $2,000,000 or more, or
                  ``(C) such individual fails to certify under penalty 
                of perjury that he has met the requirements of this 
                title for the 5 preceding taxable years or fails to 
                submit such evidence of such compliance as the 
                Secretary may require.
        In the case of the loss of United States citizenship in any 
        calendar year after 2003, such $122,000 amount shall be 
        increased by an amount equal to such dollar amount multiplied 
        by the cost-of-living adjustment determined under section 
        1(f)(3) for such calendar year by substituting `2002' for 
        `1992' in subparagraph (B) thereof. Any increase under the 
        preceding sentence shall be rounded to the nearest multiple of 
        $1,000.''.
          (2) Revision of exceptions from alternative tax.--Subsection 
        (c) of section 877 (relating to tax avoidance not presumed in 
        certain cases) is amended to read as follows:
    ``(c) Exceptions.--
          ``(1) In general.--Subparagraphs (A) and (B) of subsection 
        (a)(2) shall not apply to an individual described in paragraph 
        (2) or (3).
          ``(2) Dual citizens.--
                  ``(A) In general.--An individual is described in this 
                paragraph if--
                          ``(i) the individual became at birth a 
                        citizen of the United States and a citizen of 
                        another country and continues to be a citizen 
                        of such other country, and
                          ``(ii) the individual has had no substantial 
                        contacts with the United States.
                  ``(B) Substantial contacts.--An individual shall be 
                treated as having no substantial contacts with the 
                United States only if the individual--
                          ``(i) was never a resident of the United 
                        States (as defined in section 7701(b)),
                          ``(ii) has never held a United States 
                        passport, and
                          ``(iii) was not present in the United States 
                        for more than 30 days during any calendar year 
                        which is 1 of the 10 calendar years preceding 
                        the individual's loss of United States 
                        citizenship.
          ``(3) Certain minors.--An individual is described in this 
        paragraph if--
                  ``(A) the individual became at birth a citizen of the 
                United States,
                  ``(B) neither parent of such individual was a citizen 
                of the United States at the time of such birth,
                  ``(C) the individual's loss of United States 
                citizenship occurs before such individual attains age 
                18\1/2\, and
                  ``(D) the individual was not present in the United 
                States for more than 30 days during any calendar year 
                which is 1 of the 10 calendar years preceding the 
                individual's loss of United States citizenship.''.
          (3) Conforming amendment.--Section 2107(a) is amended to read 
        as follows:
    ``(a) Treatment of Expatriates.--A tax computed in accordance with 
the table contained in section 2001 is hereby imposed on the transfer 
of the taxable estate, determined as provided in section 2106, of every 
decedent nonresident not a citizen of the United States if the date of 
death occurs during a taxable year with respect to which the decedent 
is subject to tax under section 877(b).''.
    (b) Special Rules for Determining When an Individual Is No Longer a 
United States Citizen or Long-Term Resident.--Section 7701 (relating to 
definitions) is amended by redesignating subsection (n) as subsection 
(o) and by inserting after subsection (m) the following new subsection:
    ``(n) Special Rules for Determining When an Individual Is No Longer 
a United States Citizen or Long-Term Resident.--An individual who would 
(but for this subsection) cease to be treated as a citizen or resident 
of the United States shall continue to be treated as a citizen or 
resident of the United States, as the case may be, until such 
individual--
          ``(1) gives notice of an expatriating act or termination of 
        residency (with the requisite intent to relinquish citizenship 
        or terminate residency) to the Secretary of State or the 
        Secretary of Homeland Security, and
          ``(2) provides a statement in accordance with section 
        6039G.''.
    (c) Physical Presence in the United States for More Than 30 Days.--
Section 877 (relating to expatriation to avoid tax) is amended by 
adding at the end the following new subsection:
    ``(g) Physical Presence.--
          ``(1) In general.--This section shall not apply to any 
        individual to whom this section would otherwise apply for any 
        taxable year during the 10-year period referred to in 
        subsection (a) in which such individual is physically present 
        in the United States at any time on more than 30 days in the 
        calendar year ending in such taxable year, and such individual 
        shall be treated for purposes of this title as a citizen or 
        resident of the United States, as the case may be, for such 
        taxable year.
          ``(2) Exception.--
                  ``(A) In general.--In the case of an individual 
                described in any of the following subparagraphs of this 
                paragraph, a day of physical presence in the United 
                States shall be disregarded if the individual is 
                performing services in the United States on such day 
                for an employer. The preceding sentence shall not apply 
                if--
                          ``(i) such employer is related (within the 
                        meaning of section 267 and 707) to such 
                        individual, or
                          ``(ii) such employer fails to meet such 
                        requirements as the Secretary may prescribe by 
                        regulations to prevent the avoidance of the 
                        purposes of this paragraph.
                Not more than 30 days during any calendar year may be 
                disregarded under this subparagraph.
                  ``(B) Individuals with ties to other countries.--An 
                individual is described in this subparagraph if--
                          ``(i) the individual becomes (not later than 
                        the close of a reasonable period after loss of 
                        United States citizenship or termination of 
                        residency) a citizen or resident of the country 
                        in which--
                                  ``(I) such individual was born,
                                  ``(II) if such individual is married, 
                                such individual's spouse was born, or
                                  ``(III) either of such individual's 
                                parents were born, and
                          ``(ii) the individual becomes fully liable 
                        for income tax in such country.
                  ``(C) Minimal prior physical presence in the united 
                states.--An individual is described in this 
                subparagraph if, for each year in the 10-year period 
                ending on the date of loss of United States citizenship 
                or termination of residency, the individual was 
                physically present in the United States for 30 days or 
                less. The rule of section 7701(b)(3)(D)(ii) shall apply 
                for purposes of this subparagraph.''.
    (d) Transfers Subject to Gift Tax.--
          (1) In general.--Subsection (a) of section 2501 (relating to 
        taxable transfers) is amended by striking paragraph (4), by 
        redesignating paragraph (5) as paragraph (4), and by striking 
        paragraph (3) and inserting the following new paragraph:
          ``(3) Exception.--
                  ``(A) Certain individuals.--Paragraph (2) shall not 
                apply in the case of a donor to whom section 877(b) 
                applies for the taxable year which includes the date of 
                the transfer.
                  ``(B) Credit for foreign gift taxes.--The tax imposed 
                by this section solely by reason of this paragraph 
                shall be credited with the amount of any gift tax 
                actually paid to any foreign country in respect of any 
                gift which is taxable under this section solely by 
                reason of this paragraph.''
          (2) Transfers of certain stock.--Subsection (a) of section 
        2501 is amended by adding at the end the following new 
        paragraph:
          ``(5) Transfers of certain stock.--
                  ``(A) In general.--In the case of a transfer of stock 
                in a foreign corporation described in subparagraph (B) 
                by a donor to whom section 877(b) applies for the 
                taxable year which includes the date of the transfer--
                          ``(i) section 2511(a) shall be applied 
                        without regard to whether such stock is 
                        situated within the United States, and
                          ``(ii) the value of such stock for purposes 
                        of this chapter shall be its U.S.-asset value 
                        determined under subparagraph (C).
                  ``(B) Foreign corporation described.--A foreign 
                corporation is described in this subparagraph with 
                respect to a donor if--
                          ``(i) the donor owned (within the meaning of 
                        section 958(a)) at the time of such transfer 10 
                        percent or more of the total combined voting 
                        power of all classes of stock entitled to vote 
                        of the foreign corporation, and
                          ``(ii) such donor owned (within the meaning 
                        of section 958(a)), or is considered to have 
                        owned (by applying the ownership rules of 
                        section 958(b)), at the time of such transfer, 
                        more than 50 percent of--
                                  ``(I) the total combined voting power 
                                of all classes of stock entitled to 
                                vote of such corporation, or
                                  ``(II) the total value of the stock 
                                of such corporation.
                  ``(C) U.S.-asset value.--For purposes of subparagraph 
                (A), the U.S.-asset value of stock shall be the amount 
                which bears the same ratio to the fair market value of 
                such stock at the time of transfer as--
                          ``(i) the fair market value (at such time) of 
                        the assets owned by such foreign corporation 
                        and situated in the United States, bears to
                          ``(ii) the total fair market value (at such 
                        time) of all assets owned by such foreign 
                        corporation.''
    (e) Enhanced Information Reporting From Individuals Losing United 
States Citizenship.--
          (1) In general.--Subsection (a) of section 6039G is amended 
        to read as follows:
    ``(a) In General.--Notwithstanding any other provision of law, any 
individual to whom section 877(b) applies for any taxable year shall 
provide a statement for such taxable year which includes the 
information described in subsection (b).''.
          (2) Information to be provided.--Subsection (b) of section 
        6039G is amended to read as follows:
    ``(b) Information To Be Provided.--Information required under 
subsection (a) shall include--
          ``(1) the taxpayer's TIN,
          ``(2) the mailing address of such individual's principal 
        foreign residence,
          ``(3) the foreign country in which such individual is 
        residing,
          ``(4) the foreign country of which such individual is a 
        citizen,
          ``(5) information detailing the income, assets, and 
        liabilities of such individual,
          ``(6) the number of days during any portion of which that the 
        individual was physically present in the United States during 
        the taxable year, and
          ``(7) such other information as the Secretary may 
        prescribe.''.
          (3) Increase in penalty.--Subsection (d) of section 6039G is 
        amended to read as follows:
    ``(d) Penalty.--If--
          ``(1) an individual is required to file a statement under 
        subsection (a) for any taxable year, and
          ``(2) fails to file such a statement with the Secretary on or 
        before the date such statement is required to be filed or fails 
        to include all the information required to be shown on the 
        statement or includes incorrect information,
such individual shall pay a penalty of $10,000 unless it is shown that 
such failure is due to reasonable cause and not to willful neglect.''.
          (4) Conforming amendment.--Section 6039G is amended by 
        striking subsections (c), (f), and (g) and by redesignating 
        subsections (d) and (e) as subsection (c) and (d), 
        respectively.
    (f) Effective Date.--The amendments made by this section shall 
apply to individuals who expatriate after February 27, 2003.

SEC. 2006. REPORTING OF TAXABLE MERGERS AND ACQUISITIONS.

    (a) In General.--Subpart B of part III of subchapter A of chapter 
61 is amended by inserting after section 6043 the following new 
section:

``SEC. 6043A. RETURNS RELATING TO TAXABLE MERGERS AND ACQUISITIONS.

    ``(a) In General.--According to the forms or regulations prescribed 
by the Secretary, the acquiring corporation in any taxable acquisition 
shall make a return setting forth--
          ``(1) a description of the acquisition,
          ``(2) the name and address of each shareholder of the 
        acquired corporation who is required to recognize gain (if any) 
        as a result of the acquisition,
          ``(3) the amount of money and the fair market value of other 
        property transferred to each such shareholder as part of such 
        acquisition, and
          ``(4) such other information as the Secretary may prescribe.
To the extent provided by the Secretary, the requirements of this 
section applicable to the acquiring corporation shall be applicable to 
the acquired corporation and not to the acquiring corporation.
    ``(b) Nominees.--According to the forms or regulations prescribed 
by the Secretary--
          ``(1) Reporting.--Any person who holds stock as a nominee for 
        another person shall furnish in the manner prescribed by the 
        Secretary to such other person the information provided by the 
        corporation under subsection (d).
          ``(2) Reporting to nominees.--In the case of stock held by 
        any person as a nominee, references in this section (other than 
        in subsection (c)) to a shareholder shall be treated as a 
        reference to the nominee.
    ``(c) Taxable Acquisition.--For purposes of this section, the term 
`taxable acquisition' means any acquisition by a corporation of stock 
in or property of another corporation if any shareholder of the 
acquired corporation is required to recognize gain (if any) as a result 
of such acquisition.
    ``(d) Statements To Be Furnished to Shareholders.--According to the 
forms or regulations prescribed by the Secretary, every person required 
to make a return under subsection (a) shall furnish to each shareholder 
whose name is required to be set forth in such return a written 
statement showing--
          ``(1) the name, address, and phone number of the information 
        contact of the person required to make such return,
          ``(2) the information required to be shown on such return 
        with respect to such shareholder, and
          ``(3) such other information as the Secretary may prescribe.
The written statement required under the preceding sentence shall be 
furnished to the shareholder on or before January 31 of the year 
following the calendar year during which the taxable acquisition 
occurred.''
    (b) Assessable Penalties.--
          (1) Subparagraph (B) of section 6724(d)(1) (relating to 
        definitions) is amended by redesignating clauses (ii) through 
        (xviii) as clauses (iii) through (xix), respectively, and by 
        inserting after clause (i) the following new clause:
                          ``(ii) section 6043A(a) (relating to returns 
                        relating to taxable mergers and 
                        acquisitions),''.
          (2) Paragraph (2) of section 6724(d) is amended by 
        redesignating subparagraphs (F) through (BB) as subparagraphs 
        (G) through (CC), respectively, and by inserting after 
        subparagraph (E) the following new subparagraph:
                  ``(F) subsections (b) and (d) of section 6043A 
                (relating to returns relating to taxable mergers and 
                acquisitions).''.
    (c) Clerical Amendment.--The table of sections for subpart B of 
part III of subchapter A of chapter 61 is amended by inserting after 
the item relating to section 6043 the following new item:

                              ``Sec. 6043A. Returns relating to taxable 
                                        mergers and acquisitions.''.

    (d) Effective Date.--The amendments made by this section shall 
apply to acquisitions after the date of the enactment of this Act.

SEC. 2007. STUDIES.

    (a) Transfer Pricing Rules.--The Secretary of the Treasury or the 
Secretary's delegate shall conduct a study regarding the effectiveness 
of current transfer pricing rules and compliance efforts in ensuring 
that cross-border transfers and other related-party transactions, 
particularly transactions involving intangible assets, service 
contracts, or leases cannot be used improperly to shift income out of 
the United States. The study shall include a review of the 
contemporaneous documentation and penalty rules under section 6662 of 
the Internal Revenue Code of 1986, a review of the regulatory and 
administrative guidance implementing the principles of section 482 of 
such Code to transactions involving intangible property and services 
and to cost-sharing arrangements, and an examination of whether 
increased disclosure of cross-border transactions should be required. 
The study shall set forth specific recommendations to address all 
abuses identified in the study. Not later than June 30, 2004, such 
Secretary or delegate shall submit to the Congress a report of such 
study.
    (b) Income Tax Treaties.--The Secretary of the Treasury or the 
Secretary's delegate shall conduct a study of United States income tax 
treaties to identify any inappropriate reductions in United States 
withholding tax that provide opportunities for shifting income out of 
the United States, and to evaluate whether existing anti-abuse 
mechanisms are operating properly. The study shall include specific 
recommendations to address all inappropriate uses of tax treaties. Not 
later than June 30, 2004, such Secretary or delegate shall submit to 
the Congress a report of such study.
    (c) Impact of Corporate Expatriation Provisions.--The Secretary of 
the Treasury or the Secretary's delegate shall conduct a study of the 
impact of the provisions of this title on earnings stripping and 
corporate expatriation. The study shall include such recommendations as 
such Secretary or delegate may have to improve the impact of such 
provisions in carrying out the purposes of this title. Not later than 
December 31, 2005, such Secretary or delegate shall submit to the 
Congress a report of such study.

             TITLE III--PROVISIONS RELATING TO TAX SHELTERS

                Subtitle A--Taxpayer-Related Provisions

SEC. 3001. PENALTY FOR FAILING TO DISCLOSE REPORTABLE TRANSACTIONS.

    (a) In General.--Part I of subchapter B of chapter 68 (relating to 
assessable penalties) is amended by inserting after section 6707 the 
following new section:

``SEC. 6707A. PENALTY FOR FAILURE TO INCLUDE REPORTABLE TRANSACTION 
                    INFORMATION WITH RETURN.

    ``(a) Imposition of Penalty.--Any person who fails to include on 
any return or statement any information with respect to a reportable 
transaction which is required under section 6011 to be included with 
such return or statement shall pay a penalty in the amount determined 
under subsection (b).
    ``(b) Amount of Penalty.--
          ``(1) In general.--Except as provided in paragraph (2), the 
        amount of the penalty under subsection (a) shall be--
                  ``(A) $10,000 in the case of a natural person, and
                  ``(B) $50,000 in any other case.
          ``(2) Listed transaction.--The amount of the penalty under 
        subsection (a) with respect to a listed transaction shall be--
                  ``(A) $100,000 in the case of a natural person, and
                  ``(B) $200,000 in any other case.
    ``(c) Definitions.--For purposes of this section--
          ``(1) Reportable transaction.--The term `reportable 
        transaction' means any transaction with respect to which 
        information is required to be included with a return or 
        statement because, as determined under regulations prescribed 
        under section 6011, such transaction is of a type which the 
        Secretary determines as having a potential for tax avoidance or 
        evasion.
          ``(2) Listed transaction.--The term `listed transaction' 
        means a reportable transaction which is the same as, or 
        substantially similar to, a transaction specifically identified 
        by the Secretary as a tax avoidance transaction for purposes of 
        section 6011.
    ``(d) Authority To Rescind Penalty.--
          ``(1) In general.--The Commissioner of Internal Revenue may 
        rescind all or any portion of any penalty imposed by this 
        section with respect to any violation if--
                  ``(A) the violation is with respect to a reportable 
                transaction other than a listed transaction, and
                  ``(B) rescinding the penalty would promote compliance 
                with the requirements of this title and effective tax 
                administration.
          ``(2) No judicial appeal.--Notwithstanding any other 
        provision of law, any determination under this subsection may 
        not be reviewed in any judicial proceeding.
          ``(3) Records.--If a penalty is rescinded under paragraph 
        (1), the Commissioner shall place in the file in the Office of 
        the Commissioner the opinion of the Commissioner or the head of 
        the Office of Tax Shelter Analysis with respect to the 
        determination, including--
                  ``(A) a statement of the facts and circumstances 
                relating to the violation,
                  ``(B) the reasons for the rescission, and
                  ``(C) the amount of the penalty rescinded.
    ``(e) Coordination With Other Penalties.--The penalty imposed by 
this section shall be in addition to any other penalty imposed by this 
title.''
    (b) Conforming Amendment.--The table of sections for part I of 
subchapter B of chapter 68 is amended by inserting after the item 
relating to section 6707 the following:

                              ``Sec. 6707A. Penalty for failure to 
                                        include reportable transaction 
                                        information with return.''
    (c) Effective Date.--The amendments made by this section shall 
apply to returns and statements the due date for which is after the 
date of the enactment of this Act.
    (d) Report.--The Commissioner of Internal Revenue shall annually 
report to the Committee on Ways and Means of the House of 
Representatives and the Committee on Finance of the Senate--
          (1) a summary of the total number and aggregate amount of 
        penalties imposed, and rescinded, under section 6707A of the 
        Internal Revenue Code of 1986, and
          (2) a description of each penalty rescinded under section 
        6707(c) of such Code and the reasons therefor.

SEC. 3002. ACCURACY-RELATED PENALTY FOR LISTED TRANSACTIONS, OTHER 
                    REPORTABLE TRANSACTIONS HAVING A SIGNIFICANT TAX 
                    AVOIDANCE PURPOSE, ETC.

    (a) In General.--Subchapter A of chapter 68 is amended by inserting 
after section 6662 the following new section:

``SEC. 6662A. IMPOSITION OF ACCURACY-RELATED PENALTY ON UNDERSTATEMENTS 
                    WITH RESPECT TO REPORTABLE TRANSACTIONS.

    ``(a) Imposition of Penalty.--If a taxpayer has a reportable 
transaction understatement for any taxable year, there shall be added 
to the tax an amount equal to 20 percent of the amount of such 
understatement.
    ``(b) Reportable Transaction Understatement.--For purposes of this 
section--
          ``(1) In general.--The term `reportable transaction 
        understatement' means the sum of--
                  ``(A) the product of--
                          ``(i) the amount of the increase (if any) in 
                        taxable income which results from a difference 
                        between the proper tax treatment of an item to 
                        which this section applies and the taxpayer's 
                        treatment of such item (as shown on the 
                        taxpayer's return of tax), and
                          ``(ii) the highest rate of tax imposed by 
                        section 1 (section 11 in the case of a taxpayer 
                        which is a corporation), and
                  ``(B) the amount of the decrease (if any) in the 
                aggregate amount of credits determined under subtitle A 
                which results from a difference between the taxpayer's 
                treatment of an item to which this section applies (as 
                shown on the taxpayer's return of tax) and the proper 
                tax treatment of such item.
        For purposes of subparagraph (A), any reduction of 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.
          ``(2) Items to which section applies.--This section shall 
        apply to any item which is attributable to--
                  ``(A) any listed transaction, and
                  ``(B) any reportable transaction (other than a listed 
                transaction) if a significant purpose of such 
                transaction is the avoidance or evasion of Federal 
                income tax.
    ``(c) Higher Penalty for Nondisclosed Transactions.--Subsection (a) 
shall be applied by substituting `30 percent' for `20 percent' with 
respect to the portion of any reportable transaction understatement 
with respect to which the requirement of section 6664(d)(2)(A) is not 
met.
    ``(d) Definitions of Reportable and Listed Transactions.--For 
purposes of this section, the terms `reportable transaction' and 
`listed transaction' have the respective meanings given to such terms 
by section 6707A(c).
    ``(e) Special Rules.--
          ``(1) Coordination with penalties, etc., on other 
        understatements.--In the case of an understatement (as defined 
        in section 6662(d)(2))--
                  ``(A) the amount of such understatement (determined 
                without regard to this paragraph) shall be increased by 
                the aggregate amount of reportable transaction 
                understatements for purposes of determining whether 
                such understatement is a substantial understatement 
                under section 6662(d)(1), and
                  ``(B) the addition to tax under section 6662(a) shall 
                apply only to the excess of the amount of the 
                substantial understatement (if any) after the 
                application of subparagraph (A) over the aggregate 
                amount of reportable transaction understatements.
          ``(2) Coordination with other penalties.--
                  ``(A) Application of fraud penalty.--References to an 
                underpayment in section 6663 shall be treated as 
                including references to a reportable transaction 
                understatement.
                  ``(B) No double penalty.--This section shall not 
                apply to any portion of an understatement on which a 
                penalty is imposed under section 6663.
          ``(3) Special rule for amended returns.--Except as provided 
        in regulations, in no event shall any tax treatment included 
        with an amendment or supplement to a return of tax be taken 
        into account in determining the amount of any reportable 
        transaction understatement if the amendment or supplement is 
        filed after the earlier of the date the taxpayer is first 
        contacted by the Secretary regarding the examination of the 
        return or such other date as is specified by the Secretary.''
    (b) Determination of Other Understatements.--Subparagraph (A) of 
section 6662(d)(2) is amended by adding at the end the following flush 
sentence:
                ``The excess under the preceding sentence shall be 
                determined without regard to items to which section 
                6662A applies.''
    (c) Reasonable Cause Exception.--
          (1) In general.--Section 6664 is amended by adding at the end 
        the following new subsection:
    ``(d) Reasonable Cause Exception for Reportable Transaction 
Understatements.--
          ``(1) In general.--No penalty shall be imposed under section 
        6662A with respect to any portion of a reportable transaction 
        understatement if it is shown that there was a reasonable cause 
        for such portion and that the taxpayer acted in good faith with 
        respect to such portion.
          ``(2) Special rules.--Paragraph (1) shall not apply to any 
        reportable transaction understatement unless--
                  ``(A) the relevant facts affecting the tax treatment 
                of the item are adequately disclosed in accordance with 
                the regulations prescribed under section 6011,
                  ``(B) there is or was substantial authority for such 
                treatment, and
                  ``(C) the taxpayer reasonably believed that such 
                treatment was more likely than not the proper 
                treatment.
        A taxpayer failing to adequately disclose in accordance with 
        section 6011 shall be treated as meeting the requirements of 
        subparagraph (A) if the penalty for such failure was rescinded 
        under section 6707A(d).
          ``(3) Rules relating to reasonable belief.--For purposes of 
        paragraph (2)(C)--
                  ``(A) In general.--A taxpayer shall be treated as 
                having a reasonable belief with respect to the tax 
                treatment of an item only if such belief--
                          ``(i) is based on the facts and law that 
                        exist at the time the return of tax which 
                        includes such tax treatment is filed, and
                          ``(ii) relates solely to the taxpayer's 
                        chances of success on the merits of such 
                        treatment and does not take into account the 
                        possibility that a return will not be audited, 
                        such treatment will not be raised on audit, or 
                        such treatment will be resolved through 
                        settlement if it is raised.
                  ``(B) Certain opinions may not be relied upon.--
                          ``(i) In general.--An opinion of a tax 
                        advisor may not be relied upon to establish the 
                        reasonable belief of a taxpayer if--
                                  ``(I) the tax advisor is described in 
                                clause (ii), or
                                  ``(II) the opinion is described in 
                                clause (iii).
                          ``(ii) Disqualified tax advisors.--A tax 
                        advisor is described in this clause if the tax 
                        advisor--
                                  ``(I) is a material advisor (within 
                                the meaning of section 6111(b)(1)) and 
                                participates in the organization, 
                                management, promotion, or sale of the 
                                transaction or is related (within the 
                                meaning of section 267(b) or 707(b)(1)) 
                                to any person who so participates,
                                  ``(II) is compensated directly or 
                                indirectly by a material advisor with 
                                respect to the transaction,
                                  ``(III) has a fee arrangement with 
                                respect to the transaction which is 
                                contingent on all or part of the 
                                intended tax benefits from the 
                                transaction being sustained, or
                                  ``(IV) as determined under 
                                regulations prescribed by the 
                                Secretary, has a disqualifying 
                                financial interest with respect to the 
                                transaction.
                          ``(iii) Disqualified opinions.--For purposes 
                        of clause (i), an opinion is disqualified if 
                        the opinion--
                                  ``(I) is based on unreasonable 
                                factual or legal assumptions (including 
                                assumptions as to future events),
                                  ``(II) unreasonably relies on 
                                representations, statements, findings, 
                                or agreements of the taxpayer or any 
                                other person,
                                  ``(III) does not identify and 
                                consider all relevant facts, or
                                  ``(IV) fails to meet any other 
                                requirement as the Secretary may 
                                prescribe.''
          (2) Conforming amendments.--
                  (A) Paragraph (1) of section 6664(c) is amended by 
                striking ``this part'' and inserting ``section 6662 or 
                6663''.
                  (B) The heading for subsection (c) of section 6664 is 
                amended by inserting ``for Underpayments'' after 
                ``Exception''.
    (d) Reduction in Penalty for Substantial Understatement of Income 
Tax Not To Apply to Tax Shelters.--Subparagraph (C) of section 
6662(d)(2) (relating to substantial understatement of income tax) is 
amended to read as follows:
                  ``(C) Reduction not to apply to tax shelters.--
                          ``(i) In general.--Subparagraph (B) shall not 
                        apply to any item attributable to a tax 
                        shelter.
                          ``(ii) Tax shelter.--For purposes of clause 
                        (i), the term `tax shelter' means--
                                  ``(I) a partnership or other entity,
                                  ``(II) any investment plan or 
                                arrangement, or
                                  ``(III) any other plan or 
                                arrangement,
                        if a significant purpose of such partnership, 
                        entity, plan, or arrangement is the avoidance 
                        or evasion of Federal income tax.''
    (e) Conforming Amendments.--
          (1) Sections 461(i)(3)(C), 1274(b)(3), and 7525(b) are each 
        amended by striking ``section 6662(d)(2)(C)(iii)'' and 
        inserting ``section 6662(d)(2)(C)(ii)''.
          (2) The heading for section 6662 is amended to read as 
        follows:

``SEC. 6662. IMPOSITION OF ACCURACY-RELATED PENALTY ON UNDERPAYMENTS.''

          (3) The table of sections for part II of subchapter A of 
        chapter 68 is amended by striking the item relating to section 
        6662 and inserting the following new items:

                              ``Sec. 6662. Imposition of accuracy-
                                        related penalty on 
                                        underpayments.
                              ``Sec. 6662A. Imposition of accuracy-
                                        related penalty on 
                                        understatements with respect to 
                                        reportable transactions.''

    (f) Effective Date.--The amendments made by this section shall 
apply to taxable years ending after the date of the enactment of this 
Act.

SEC. 3003. TAX SHELTER EXCEPTION TO CONFIDENTIALITY PRIVILEGES RELATING 
                    TO TAXPAYER COMMUNICATIONS.

    (a) In General.--Section 7525(b) (relating to section not to apply 
to communications regarding corporate tax shelters) is amended to read 
as follows:
    ``(b) Section Not To Apply to Communications Regarding Tax 
Shelters.--The privilege under subsection (a) shall not apply to any 
written communication which is--
          ``(1) between a federally authorized tax practitioner and--
                  ``(A) any person,
                  ``(B) any director, officer, employee, agent, or 
                representative of the person, or
                  ``(C) any other person holding a capital or profits 
                interest in the person, and
          ``(2) in connection with the promotion of the direct or 
        indirect participation of the person in any tax shelter (as 
        defined in section 6662(d)(2)(C)(ii)).''
    (b) Effective Date.--The amendment made by this section shall apply 
to communications made on or after the date of the enactment of this 
Act.

SEC. 3004. STATUTE OF LIMITATIONS FOR TAXABLE YEARS FOR WHICH REQUIRED 
                    LISTED TRANSACTIONS NOT REPORTED.

    (a) In General.--Section 6501(c) (relating to exceptions) is 
amended by adding at the end the following new paragraph:
          ``(10) Listed transactions.--If a taxpayer fails to include 
        on any return or statement for any taxable year any information 
        with respect to a listed transaction (as defined in section 
        6707A(c)(2)) which is required under section 6011 to be 
        included with such return or statement, the time for assessment 
        of any tax imposed by this title with respect to such 
        transaction shall not expire before the date which is 1 year 
        after the earlier of--
                  ``(A) the date on which the Secretary is furnished 
                the information so required, or
                  ``(B) the date that a material advisor (as defined in 
                section 6111) meets the requirements of section 6112 
                with respect to a request by the Secretary under 
                section 6112(b) relating to such transaction with 
                respect to such taxpayer.''
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years with respect to which the period for assessing a 
deficiency did not expire before the date of the enactment of this Act.

SEC. 3005. DISCLOSURE OF REPORTABLE TRANSACTIONS.

    (a) In General.--Section 6111 (relating to registration of tax 
shelters) is amended to read as follows:

``SEC. 6111. DISCLOSURE OF REPORTABLE TRANSACTIONS.

    ``(a) In General.--Each material advisor with respect to any 
reportable transaction shall make a return (in such form as the 
Secretary may prescribe) setting forth--
          ``(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.
Such return shall be filed not later than the date specified by the 
Secretary.
    ``(b) Definitions.--For purposes of this section--
          ``(1) Material advisor.--
                  ``(A) In general.--The term `material advisor' means 
                any person--
                          ``(i) who provides any material aid, 
                        assistance, or advice with respect to 
                        organizing, managing, promoting, selling, 
                        implementing, or carrying out any reportable 
                        transaction, and
                          ``(ii) who directly or indirectly derives 
                        gross income in excess of the threshold amount 
                        (or such other amount as may be prescribed by 
                        the Secretary) for such advice or assistance.
                  ``(B) Threshold amount.--For purposes of subparagraph 
                (A), the threshold amount is--
                          ``(i) $50,000 in the case of a reportable 
                        transaction substantially all of the tax 
                        benefits from which are provided to natural 
                        persons, and
                          ``(ii) $250,000 in any other case.
          ``(2) Reportable transaction.--The term `reportable 
        transaction' has the meaning given to such term by section 
        6707A(c).
    ``(c) Regulations.--The Secretary may prescribe regulations which 
provide--
          ``(1) that only 1 person shall be required to meet the 
        requirements of subsection (a) in cases in which 2 or more 
        persons would otherwise be required to meet such requirements,
          ``(2) exemptions from the requirements of this section, and
          ``(3) such rules as may be necessary or appropriate to carry 
        out the purposes of this section.''
    (b) Conforming Amendments.--
          (1) The item relating to section 6111 in the table of 
        sections for subchapter B of chapter 61 is amended to read as 
        follows:

                              ``Sec. 6111. Disclosure of reportable 
                                        transactions.''

          (2) So much of section 6112 as precedes subsection (c) 
        thereof is amended to read as follows:

``SEC. 6112. MATERIAL ADVISORS OF REPORTABLE TRANSACTIONS MUST KEEP 
                    LISTS OF ADVISEES, ETC.

    ``(a) In General.--Each material advisor (as defined in section 
6111) with respect to any reportable transaction (as defined in section 
6707A(c)) shall (whether or not required to file a return under section 
6111 with respect to such transaction) maintain (in such manner as the 
Secretary may by regulations prescribe) a list--
          ``(1) identifying each person with respect to whom such 
        advisor acted as a material advisor with respect to such 
        transaction, and
          ``(2) containing such other information as the Secretary may 
        by regulations require.''
          (3) Section 6112 is amended--
                  (A) by redesignating subsection (c) as subsection 
                (b),
                  (B) by inserting ``written'' before ``request'' in 
                subsection (b)(1) (as so redesignated), and
                  (C) by striking ``shall prescribe'' in subsection 
                (b)(2) (as so redesignated) and inserting ``may 
                prescribe''.
          (4) The item relating to section 6112 in the table of 
        sections for subchapter B of chapter 61 is amended to read as 
        follows:

                              ``Sec. 6112. Material advisors of 
                                        reportable transactions must 
                                        keep lists of advisees, etc.''

          (5)(A) The heading for section 6708 is amended to read as 
        follows:

``SEC. 6708. FAILURE TO MAINTAIN LISTS OF ADVISEES WITH RESPECT TO 
                    REPORTABLE TRANSACTIONS.''

          (B) The item relating to section 6708 in the table of 
        sections for part I of subchapter B of chapter 68 is amended to 
        read as follows:

                              ``Sec. 6708. Failure to maintain lists of 
                                        advisees with respect to 
                                        reportable transactions.''

    (c) Required Disclosure Not Subject to Claim of Confidentiality.--
Paragraph (1) of section 6112(b), as redesignated by subsection (b), is 
amended by adding at the end the following new flush sentence:
        ``For purposes of this section, the identity of any person on 
        such list shall not be privileged.''.
    (d) Effective Date.--
          (1) In general.--Except as provided in paragraph (2), the 
        amendments made by this section shall apply to transactions 
        with respect to which material aid, assistance, or advice 
        referred to in section 6111(b)(1)(A)(i) of the Internal Revenue 
        Code of 1986 (as added by this section) is provided after the 
        date of the enactment of this Act.
          (2) No claim of confidentiality against disclosure.--The 
        amendment made by subsection (c) shall take effect as if 
        included in the amendments made by section 142 of the Deficit 
        Reduction Act of 1984.

SEC. 3006. FAILURE TO FURNISH INFORMATION REGARDING REPORTABLE 
                    TRANSACTIONS.

    (a) In General.--Section 6707 (relating to failure to furnish 
information regarding tax shelters) is amended to read as follows:

``SEC. 6707. FAILURE TO FURNISH INFORMATION REGARDING REPORTABLE 
                    TRANSACTIONS.

    ``(a) In General.--If a person who is required to file a return 
under section 6111(a) with respect to any reportable transaction--
          ``(1) fails to file such return on or before the date 
        prescribed therefor, or
          ``(2) files false or incomplete information with the 
        Secretary with respect to such transaction,
such person shall pay a penalty with respect to such return in the 
amount determined under subsection (b).
    ``(b) Amount of Penalty.--
          ``(1) In general.--Except as provided in paragraph (2), the 
        penalty imposed under subsection (a) with respect to any 
        failure shall be $50,000.
          ``(2) Listed transactions.--The penalty imposed under 
        subsection (a) with respect to any listed transaction shall be 
        an amount equal to the greater of--
                  ``(A) $200,000, or
                  ``(B) 50 percent of the gross income derived by such 
                person with respect to aid, assistance, or advice which 
                is provided with respect to the listed transaction 
                before the date the return is filed under section 6111.
        Subparagraph (B) shall be applied by substituting `75 percent' 
        for `50 percent' in the case of an intentional failure or act 
        described in subsection (a).
    ``(c) Rescission Authority.--The provisions of section 6707A(d) 
(relating to authority of Commissioner to rescind penalty) shall apply 
to any penalty imposed under this section.
    ``(d) Reportable and Listed Transactions.--For purposes of this 
section, the terms `reportable transaction' and `listed transaction' 
have the respective meanings given to such terms by section 6707A(c).''
    (b) Clerical Amendment.--The item relating to section 6707 in the 
table of sections for part I of subchapter B of chapter 68 is amended 
by striking ``tax shelters'' and inserting ``reportable transactions''.
    (c) Effective Date.--The amendments made by this section shall 
apply to returns the due date for which is after the date of the 
enactment of this Act.

SEC. 3007. MODIFICATION OF PENALTY FOR FAILURE TO MAINTAIN LISTS OF 
                    INVESTORS.

    (a) In General.--Subsection (a) of section 6708 is amended to read 
as follows:
    ``(a) Imposition of Penalty.--
          ``(1) In general.--If any person who is required to maintain 
        a list under section 6112(a) fails to make such list available 
        upon written request to the Secretary in accordance with 
        section 6112(b) within 20 business days after the date of such 
        request, such person shall pay a penalty of $10,000 for each 
        day of such failure after such 20th day.
          ``(2) Reasonable cause exception.--No penalty shall be 
        imposed by paragraph (1) with respect to the failure on any day 
        if such failure is due to reasonable cause.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to requests made after the date of the enactment of this Act.

SEC. 3008. PENALTY ON PROMOTERS OF TAX SHELTERS.

    (a) Penalty on Promoting Abusive Tax Shelters.--Section 6700(a) is 
amended by adding at the end the following new sentence: 
``Notwithstanding the first sentence, if an activity with respect to 
which a penalty imposed under this subsection involves a statement 
described in paragraph (2)(A), the amount of the penalty shall be equal 
to 50 percent of the gross income derived (or to be derived) from such 
activity by the person on which the penalty is imposed.''
    (b) Effective Date.--The amendment made by this section shall apply 
to activities after the date of the enactment of this Act.

SEC. 3009. MODIFICATIONS OF SUBSTANTIAL UNDERSTATEMENT PENALTY FOR 
                    NONREPORTABLE TRANSACTIONS.

    (a) Substantial Understatement of Corporations.--Section 
6662(d)(1)(B) (relating to special rule for corporations) is amended to 
read as follows:
                  ``(B) Special rule for corporations.--In the case of 
                a corporation other than an S corporation or a personal 
                holding company (as defined in section 542), there is a 
                substantial understatement of income tax for any 
                taxable year if the amount of the understatement for 
                the taxable year exceeds the lesser of--
                          ``(i) 10 percent of the tax required to be 
                        shown on the return for the taxable year (or, 
                        if greater, $10,000), or
                          ``(ii) $10,000,000.''
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after the date of the enactment of this Act.

SEC. 3010. MODIFICATION OF ACTIONS TO ENJOIN CERTAIN CONDUCT RELATED TO 
                    TAX SHELTERS AND REPORTABLE TRANSACTIONS.

    (a) In General.--Section 7408 (relating to action to enjoin 
promoters of abusive tax shelters, etc.) is amended by redesignating 
subsection (c) as subsection (d) and by striking subsections (a) and 
(b) and inserting the following new subsections:
    ``(a) Authority To Seek Injunction.--A civil action in the name of 
the United States to enjoin any person from further engaging in 
specified conduct may be commenced at the request of the Secretary. Any 
action under this section shall be brought in the district court of the 
United States for the district in which such person resides, has his 
principal place of business, or has engaged in specified conduct. The 
court may exercise its jurisdiction over such action (as provided in 
section 7402(a)) separate and apart from any other action brought by 
the United States against such person.
    ``(b) Adjudication and Decree.--In any action under subsection (a), 
if the court finds--
          ``(1) that the person has engaged in any specified conduct, 
        and
          ``(2) that injunctive relief is appropriate to prevent 
        recurrence of such conduct,
the court may enjoin such person from engaging in such conduct or in 
any other activity subject to penalty under this title.
    ``(c) Specified Conduct.--For purposes of this section, the term 
`specified conduct' means any action, or failure to take action, 
subject to penalty under section 6700, 6701, 6707, or 6708.''
    (b) Conforming Amendments.--
          (1) The heading for section 7408 is amended to read as 
        follows:

``SEC. 7408. ACTIONS TO ENJOIN SPECIFIED CONDUCT RELATED TO TAX 
                    SHELTERS AND REPORTABLE TRANSACTIONS.''

          (2) The table of sections for subchapter A of chapter 76 is 
        amended by striking the item relating to section 7408 and 
        inserting the following new item:

        ``Sec. 7408. Actions to enjoin specified conduct related to tax 
                        shelters and reportable transactions.''

    (c) Effective Date.--The amendment made by this section shall take 
effect on the day after the date of the enactment of this Act.

SEC. 3011. PENALTY ON FAILURE TO REPORT INTERESTS IN FOREIGN FINANCIAL 
                    ACCOUNTS.

    (a) In General.--Section 5321(a)(5) of title 31, United States 
Code, is amended to read as follows:
          ``(5) Foreign financial agency transaction violation.--
                  ``(A) Penalty authorized.--The Secretary of the 
                Treasury may impose a civil money penalty on any person 
                who violates, or causes any violation of, any provision 
                of section 5314.
                  ``(B) Amount of penalty.--
                          ``(i) In general.--Except as provided in 
                        subparagraph (C), the amount of any civil 
                        penalty imposed under subparagraph (A) shall 
                        not exceed $5,000.
                          ``(ii) Reasonable cause exception.--No 
                        penalty shall be imposed under subparagraph (A) 
                        with respect to any violation if--
                                  ``(I) such violation was due to 
                                reasonable cause, and
                                  ``(II) the amount of the transaction 
                                or the balance in the account at the 
                                time of the transaction was properly 
                                reported.
                  ``(C) Willful violations.--In the case of any person 
                willfully violating, or willfully causing any violation 
                of, any provision of section 5314--
                          ``(i) the maximum penalty under subparagraph 
                        (B)(i) shall be increased to the greater of--
                                  ``(I) $25,000, or
                                  ``(II) the amount (not exceeding 
                                $100,000) determined under subparagraph 
                                (D), and
                          ``(ii) subparagraph (B)(ii) shall not apply.
                  ``(D) Amount.--The amount determined under this 
                subparagraph is--
                          ``(i) in the case of a violation involving a 
                        transaction, the amount of the transaction, or
                          ``(ii) in the case of a violation involving a 
                        failure to report the existence of an account 
                        or any identifying information required to be 
                        provided with respect to an account, the 
                        balance in the account at the time of the 
                        violation.''
    (b) Effective Date.--The amendment made by this section shall apply 
to violations occurring after the date of the enactment of this Act.

SEC. 3012. REGULATION OF INDIVIDUALS PRACTICING BEFORE THE DEPARTMENT 
                    OF THE TREASURY.

    (a) Censure; Imposition of Penalty.--
          (1) In general.--Section 330(b) of title 31, United States 
        Code, is amended--
                  (A) by inserting ``, or censure,'' after 
                ``Department'', and
                  (B) by adding at the end the following new flush 
                sentence:
``The Secretary may impose a monetary penalty on any representative 
described in the preceding sentence. If the representative was acting 
on behalf of an employer or any firm or other entity in connection with 
the conduct giving rise to such penalty, the Secretary may impose a 
monetary penalty on such employer, firm, or entity if it knew, or 
reasonably should have known, of such conduct. Such penalty shall not 
exceed the gross income derived (or to be derived) from the conduct 
giving rise to the penalty. Any such penalty imposed on an individual 
may be in addition to, or in lieu of, any suspension, disbarment, or 
censure of such individual.''
          (2) Effective date.--The amendments made by this subsection 
        shall apply to actions taken after the date of the enactment of 
        this Act.
    (b) Tax Shelter Opinions, Etc.--Section 330 of such title 31 is 
amended by adding at the end the following new subsection:
    ``(d) Nothing in this section or in any other provision of law 
shall be construed to limit the authority of the Secretary of the 
Treasury to impose standards applicable to the rendering of written 
advice with respect to any entity, transaction plan or arrangement, or 
other plan or arrangement, which is of a type which the Secretary 
determines as having a potential for tax avoidance or evasion.''

                      Subtitle B--Other Provisions

SEC. 3021. TREATMENT OF STRIPPED INTERESTS IN BOND AND PREFERRED STOCK 
                    FUNDS, ETC.

    (a) In General.--Section 1286 (relating to tax treatment of 
stripped bonds) is amended by redesignating subsection (f) as 
subsection (g) and by inserting after subsection (e) the following new 
subsection:
    ``(f) Treatment of Stripped Interests in Bond and Preferred Stock 
Funds, Etc.--In the case of an account or entity substantially all of 
the assets of which consist of bonds, preferred stock, or a combination 
thereof, the Secretary may by regulations provide that rules similar to 
the rules of this section and 305(e), as appropriate, shall apply to 
interests in such account or entity to which (but for this subsection) 
this section or section 305(e), as the case may be, would not apply.''
    (b) Cross Reference.--Subsection (e) of section 305 is amended by 
adding at the end the following new paragraph:
          ``(7) Cross reference.--

                  ``For treatment of stripped interests in certain 
accounts or entities holding preferred stock, see section 1286(f).''

    (c) Effective Date.--The amendments made by this section shall 
apply to purchases and dispositions after the date of the enactment of 
this Act.

SEC. 3022. MINIMUM HOLDING PERIOD FOR FOREIGN TAX CREDIT ON WITHHOLDING 
                    TAXES ON INCOME OTHER THAN DIVIDENDS.

    (a) In General.--Section 901 is amended by redesignating subsection 
(l) as subsection (m) and by inserting after subsection (k) the 
following new subsection:
    ``(l) Minimum Holding Period for Withholding Taxes on Gain and 
Income Other Than Dividends Etc.--
          ``(1) In general.--In no event shall a credit be allowed 
        under subsection (a) for any withholding tax (as defined in 
        subsection (k)) on any item of income or gain with respect to 
        any property if--
                  ``(A) such property is held by the recipient of the 
                item for 15 days or less during the 30-day period 
                beginning on the date which is 15 days before the date 
                on which the right to receive payment of such item 
                arises, or
                  ``(B) to the extent that the recipient of the item is 
                under an obligation (whether pursuant to a short sale 
                or otherwise) to make related payments with respect to 
                positions in substantially similar or related property.
        This paragraph shall not apply to any dividend to which 
        subsection (k) applies.
          ``(2) Exception for taxes paid by dealers.--
                  ``(A) In general.--Paragraph (1) shall not apply to 
                any qualified tax with respect to any property held in 
                the active conduct in a foreign country of a business 
                as a dealer in such property.
                  ``(B) Qualified tax.--For purposes of subparagraph 
                (A), the term `qualified tax' means a tax paid to a 
                foreign country (other than the foreign country 
                referred to in subparagraph (A)) if--
                          ``(i) the item to which such tax is 
                        attributable is subject to taxation on a net 
                        basis by the country referred to in 
                        subparagraph (A), and
                          ``(ii) such country allows a credit against 
                        its net basis tax for the full amount of the 
                        tax paid to such other foreign country.
                  ``(C) Dealer.--For purposes of subparagraph (A), the 
                term `dealer' means--
                          ``(i) with respect to a security, any person 
                        to whom paragraphs (1) and (2) of subsection 
                        (k) would not apply by reason of paragraph (4) 
                        thereof if such security were stock, and
                          ``(ii) with respect to any other property, 
                        any person with respect to whom such property 
                        is described in section 1221(a)(1).
                  ``(D) Regulations.--The Secretary may prescribe such 
                regulations as may be appropriate to carry out this 
                paragraph, including regulations to prevent the abuse 
                of the exception provided by this paragraph and to 
                treat other taxes as qualified taxes.
          ``(3) Exceptions.--The Secretary may by regulation provide 
        that paragraph (1) shall not apply to property where the 
        Secretary determines that the application of paragraph (1) to 
        such property is not necessary to carry out the purposes of 
        this subsection.
          ``(4) Certain rules to apply.--Rules similar to the rules of 
        paragraphs (5), (6), and (7) of subsection (k) shall apply for 
        purposes of this subsection.
          ``(5) Determination of holding period.--Holding periods shall 
        be determined for purposes of this subsection without regard to 
        section 1235 or any similar rule.''
    (b) Conforming Amendment.--The heading of subsection (k) of section 
901 is amended by inserting ``on Dividends'' after ``Taxes''.
    (c) Effective Date.--The amendments made by this section shall 
apply to amounts paid or accrued more than 30 days after the date of 
the enactment of this Act.

SEC. 3023. DISALLOWANCE OF CERTAIN PARTNERSHIP LOSS TRANSFERS.

    (a) Treatment of Contributed Property With Built-In Loss.--
Paragraph (1) of section 704(c) is amended by striking ``and'' at the 
end of subparagraph (A), by striking the period at the end of 
subparagraph (B) and inserting ``, and'', and by adding at the end the 
following:
                  ``(C) if any property so contributed has a built-in 
                loss--
                          ``(i) such built-in loss shall be taken into 
                        account only in determining the amount of items 
                        allocated to the contributing partner, and
                          ``(ii) except as provided in regulations, in 
                        determining the amount of items allocated to 
                        other partners, the basis of the contributed 
                        property in the hands of the partnership shall 
                        be treated as being equal to its fair market 
                        value at the time of contribution.
        For purposes of subparagraph (C), the term `built-in loss' 
        means the excess of the adjusted basis of the property 
        (determined without regard to subparagraph (C)(ii)) over its 
        fair market value at the time of contribution.''
    (b) Adjustment to Basis of Partnership Property on Transfer of 
Partnership Interest If There Is Substantial Built-In Loss.--
          (1) Adjustment required.--Subsection (a) of section 743 
        (relating to optional adjustment to basis of partnership 
        property) is amended by inserting before the period ``or unless 
        the partnership has a substantial built-in loss immediately 
        after such transfer''.
          (2) Adjustment.--Subsection (b) of section 743 is amended by 
        inserting ``or with respect to which there is a substantial 
        built-in loss immediately after such transfer'' after ``section 
        754 is in effect''.
          (3) Substantial built-in loss.--Section 743 is amended by 
        adding at the end the following new subsection:
    ``(d) Substantial Built-In Loss.--
          ``(1) In general.--For purposes of this section, a 
        partnership has a substantial built-in loss with respect to a 
        transfer of an interest in a partnership if the partnership's 
        adjusted basis in the partnership property exceeds by more than 
        $250,000 the fair market value of such property.
          ``(2) Regulations.--The Secretary shall prescribe such 
        regulations as may be appropriate to carry out the purposes of 
        paragraph (1) and section 734(d), including regulations 
        aggregating related partnerships and disregarding property 
        acquired by the partnership in an attempt to avoid such 
        purposes.''
          (4) Clerical amendments.--
                  (A) The section heading for section 743 is amended to 
                read as follows:

``SEC. 743. ADJUSTMENT TO BASIS OF PARTNERSHIP PROPERTY WHERE SECTION 
                    754 ELECTION OR SUBSTANTIAL BUILT-IN LOSS.''

                  (B) The table of sections for subpart C of part II of 
                subchapter K of chapter 1 is amended by striking the 
                item relating to section 743 and inserting the 
                following new item:

                              ``Sec. 743. Adjustment to basis of 
                                        partnership property where 
                                        section 754 election or 
                                        substantial built-in loss.''

    (c) Adjustment to Basis of Undistributed Partnership Property if 
There Is Substantial Basis Reduction.--
          (1) Adjustment required.--Subsection (a) of section 734 
        (relating to optional adjustment to basis of undistributed 
        partnership property) is amended by inserting before the period 
        ``or unless there is a substantial basis reduction''.
          (2) Adjustment.--Subsection (b) of section 734 is amended by 
        inserting ``or unless there is a substantial basis reduction'' 
        after ``section 754 is in effect''.
          (3) Substantial basis reduction.--Section 734 is amended by 
        adding at the end the following new subsection:
    ``(d) Substantial Basis Reduction.--
          ``(1) In general.--For purposes of this section, there is a 
        substantial basis reduction with respect to a distribution if 
        the sum of the amounts described in subparagraphs (A) and (B) 
        of subsection (b)(2) exceeds $250,000.
          ``(2) Regulations.--

                  ``For regulations to carry out this subsection, see 
section 743(d)(2).''

          (4) Clerical amendments.--
                  (A) The section heading for section 734 is amended to 
                read as follows:

``SEC. 734. ADJUSTMENT TO BASIS OF UNDISTRIBUTED PARTNERSHIP PROPERTY 
                    WHERE SECTION 754 ELECTION OR SUBSTANTIAL BASIS 
                    REDUCTION.''

                  (B) The table of sections for subpart B of part II of 
                subchapter K of chapter 1 is amended by striking the 
                item relating to section 734 and inserting the 
                following new item:

                              ``Sec. 734. Adjustment to basis of 
                                        undistributed partnership 
                                        property where section 754 
                                        election or substantial basis 
                                        reduction.''
    (d) Effective Dates.--
          (1) Subsection (a).--The amendment made by subsection (a) 
        shall apply to contributions made after the date of the 
        enactment of this Act.
          (2) Subsection (b).--The amendments made by subsection (b) 
        shall apply to transfers after the date of the enactment of 
        this Act.
          (3) Subsection (c).--The amendments made by subsection (c) 
        shall apply to distributions after the date of the enactment of 
        this Act.

SEC. 3024. NO REDUCTION OF BASIS UNDER SECTION 734 IN STOCK HELD BY 
                    PARTNERSHIP IN CORPORATE PARTNER.

    (a) In General.--Section 755 is amended by adding at the end the 
following new subsection:
    ``(c) No Allocation of Basis Decrease to Stock of Corporate 
Partner.--In making an allocation under subsection (a) of any decrease 
in the adjusted basis of partnership property under section 734(b)--
          ``(1) no allocation may be made to stock in a corporation (or 
        any person related (within the meaning of sections 267(b) and 
        707(b)(1)) to such corporation) which is a partner in the 
        partnership, and
          ``(2) any amount not allocable to stock by reason of 
        paragraph (1) shall be allocated under subsection (a) to other 
        partnership property.
Gain shall be recognized to the partnership to the extent that the 
amount required to be allocated under paragraph (2) to other 
partnership property exceeds the aggregate adjusted basis of such other 
property immediately before the allocation required by paragraph (2).''
    (b) Effective Date.--The amendment made by this section shall apply 
to distributions after the date of the enactment of this Act.

SEC. 3025. REPEAL OF SPECIAL RULES FOR FASITS.

    (a) In General.--Part V of subchapter M of chapter 1 (relating to 
financial asset securitization investment trusts) is hereby repealed.
    (b) Conforming Amendments.--
          (1) Paragraph (6) of section 56(g) is amended by striking 
        ``REMIC, or FASIT'' and inserting ``or REMIC''.
          (2) Clause (ii) of section 382(l)(4)(B) is amended by 
        striking ``a REMIC to which part IV of subchapter M applies, or 
        a FASIT to which part V of subchapter M applies,'' and 
        inserting ``or a REMIC to which part IV of subchapter M 
        applies,''.
          (3) Paragraph (1) of section 582(c) is amended by striking 
        ``, and any regular interest in a FASIT,''.
          (4) Subparagraph (E) of section 856(c)(5) is amended by 
        striking the last sentence.
          (5)(A) Section 860G(a)(1) is amended by adding at the end the 
        following new sentence: ``An interest shall not fail to qualify 
        as a regular interest solely because the specified principal 
        amount of the regular interest (or the amount of interest 
        accrued on the regular interest) can be reduced as a result of 
        the nonoccurrence of 1 or more contingent payments with respect 
        to any reverse mortgage loan held by the REMIC if, on the 
        startup day for the REMIC, the sponsor reasonably believes that 
        all principal and interest due under the regular interest will 
        be paid at or prior to the liquidation of the REMIC.''.
          (B) The last sentence of section 860G(a)(3) is amended by 
        inserting ``, and any reverse mortgage loan (and each balance 
        increase on such loan meeting the requirements of subparagraph 
        (A)(iii)) shall be treated as an obligation secured by an 
        interest in real property'' before the period at the end.
          (6) Paragraph (3) of section 860G(a) is amended by adding 
        ``and'' at the end of subparagraph (B), by striking ``, and'' 
        at the end of subparagraph (C) and inserting a period, and by 
        striking subparagraph (D).
          (7) Section 860G(a)(3) is amended by adding at the end the 
        following new sentence: ``For purposes of subparagraph (A), if 
        more than 50 percent of the obligations transferred to, or 
        purchased by, the REMIC are originated by the United States or 
        any State (or any political subdivision, agency, or 
        instrumentality of the United States or any State) and are 
        principally secured by an interest in real property, then each 
        obligation transferred to, or purchased by, the REMIC shall be 
        treated as secured by an interest in real property.''.
          (8)(A) Section 860G(a)(3)(A) is amended by striking ``or'' at 
        the end of clause (i), by inserting ``or'' at the end of clause 
        (ii), and by inserting after clause (ii) the following new 
        clause:
                          ``(iii) represents an increase in the 
                        principal amount under the original terms of an 
                        obligation described in clause (i) or (ii) if--
                                  ``(I) such increase in the balance is 
                                attributable to an advance made to the 
                                obligor pursuant to the original terms 
                                of the obligation,
                                  ``(II) such increase in the balance 
                                occurs after the startup day, and
                                  ``(III) such increase in the balance 
                                is purchased by the REMIC pursuant to a 
                                fixed price contract in effect on the 
                                startup day.''.
          (B) Section 860G(a)(7)(B) is amended to read as follows:
                  ``(B) Qualified reserve fund.--For purposes of 
                subparagraph (A), the term `qualified reserve fund' 
                means any reasonably required reserve to--
                          ``(i) provide for full payment of expenses of 
                        the REMIC or amounts due on regular interests 
                        in the event of defaults on qualified mortgages 
                        or lower than expected returns on cash flow 
                        investments, or
                          ``(ii) provide a source of funds for the 
                        purchase of obligations described in clause 
                        (ii) or (iii) of paragraph (3)(A).
                The aggregate fair market value of the assets held in 
                any such reserve shall not exceed 50 percent of the 
                aggregate fair market value of all of the assets of the 
                REMIC on the startup day, and the amount of any such 
                reserve shall be promptly and appropriately reduced to 
                the extent the amount held in such reserve is no longer 
                reasonably required for purposes specified in clause 
                (i) or (ii) of paragraph (3)(A).''.
          (9) Subparagraph (C) of section 1202(e)(4) is amended by 
        striking ``REMIC, or FASIT'' and inserting ``or REMIC''.
          (10) Section 1272(a)(6)(B) is amended by adding at the end 
        the following new flush sentence:
                ``For purposes of clause (iii), the Secretary shall 
                prescribe regulations permitting the use of a current 
                prepayment assumption, determined as of the close of 
                the accrual period (or such other time as the Secretary 
                may prescribe during the taxable year in which the 
                accrual period ends).''.
          (11) Subparagraph (C) of section 7701(a)(19) is amended by 
        adding ``and'' at the end of clause (ix), by striking ``, and'' 
        at the end of clause (x) and inserting a period, and by 
        striking clause (xi).
          (12) The table of parts for subchapter M of chapter 1 is 
        amended by striking the item relating to part V.
    (c) Effective Date.--
          (1) In general.--Except as provided in paragraph (2), the 
        amendments made by this section shall apply to taxable years 
        beginning after December 31, 2003.
          (2) Exception for existing fasits.--
                  (A) In general.--Paragraph (1) shall not apply to any 
                FASIT in existence on the date of the enactment of this 
                Act to the extent that regular interests issued by the 
                FASIT before such date continue to remain outstanding 
                in accordance with the original terms of issuance.
                  (B) Transfer of additional assets not permitted.--
                Except as provided in regulations prescribed by the 
                Secretary of the Treasury or the Secretary's delegate, 
                subparagraph (A) shall cease to apply as of the 
                earliest date after the date of the enactment of this 
                Act that any property is transferred to the FASIT.

SEC. 3026. LIMITATION ON TRANSFER OF BUILT-IN LOSSES ON REMIC 
                    RESIDUALS.

    (a) In General.--Section 362 (relating to basis to corporations) is 
amended by adding at the end the following new subsection:
    ``(e) Limitation on Transfer of Built-in Losses on REMIC Residuals 
in Section 351 Transactions.--If--
          ``(1) a residual interest (as defined in section 860G(a)(2)) 
        in a REMIC is transferred in any transaction which is described 
        in subsection (a), and
          ``(2) the transferee's adjusted basis in such residual 
        interest would (but for this paragraph) exceed its fair market 
        value immediately after such transaction,
then, notwithstanding subsection (a), the transferee's adjusted basis 
in such residual interest shall not exceed its fair market value 
(whether or not greater than zero) immediately after such 
transaction.''
    (b) Effective Date.--The amendment made by this section shall apply 
to transactions after the date of the enactment of this Act.

SEC. 3027. CLARIFICATION OF BANKING BUSINESS FOR PURPOSES OF 
                    DETERMINING INVESTMENT OF EARNINGS IN UNITED STATES 
                    PROPERTY.

    (a) In General.--Subparagraph (A) of section 956(c)(2) is amended 
to read as follows:
                  ``(A) obligations of the United States, money, or 
                deposits with any corporation with respect to which a 
                bank holding company (within the meaning of section 
                2(a) of the Bank Holding Company Act of 1956 (12 U.S.C. 
                1841(a))) or financial holding company (within the 
                meaning of section 2(p) of such Act) owns directly or 
                indirectly more than 80 percent by vote or value of the 
                stock of such corporation;''.
    (b) Effective Date.--The amendment made by this section shall take 
effect on the date of the enactment of this Act.

SEC. 3028. MODIFICATIONS RELATED TO CERTAIN SMALL INSURANCE COMPANIES.

    (a) Exemption for Small Property and Casualty Insurance 
Companies.--
          (1) In general.--Section 501(c)(15)(A) is amended to read as 
        follows:
                  ``(A) Insurance companies (as defined in section 
                816(a)) other than life (including interinsurers and 
                reciprocal underwriters) if--
                          ``(i) the gross receipts for the taxable year 
                        do not exceed $600,000, and
                          ``(ii) more than 50 percent of such gross 
                        receipts consist of premiums.''.
          (2) Controlled group rule.--Section 501(c)(15)(C) is amended 
        by inserting ``, except that in applying section 1563 for 
        purposes of section 831(b)(2)(B)(ii), subparagraphs (B) and (C) 
        of section 1563(b)(2) shall be disregarded'' before the period 
        at the end.
          (3) Conforming amendment.--Clause (i) of section 831(b)(2)(A) 
        is amended by striking ``exceed $350,000 but''.
    (b) Alternative Tax for Certain Small Insurance Companies.--
          (1) Increased limitation.--Clause (i) of section 831(b)(2)(A) 
        is amended by striking ``$1,200,000'' and inserting 
        ``$1,890,000''.
          (2) Inflation adjustment.--Paragraph (2) of section 831(b) is 
        amended by adding at the end the following new subparagraph:
                  ``(C) Inflation adjustment.--In the case of any 
                taxable year beginning in a calendar year after 2004, 
                the $1,890,000 amount in subparagraph (A) shall be 
                increased by an amount equal to--
                          ``(i) $1,890,000, multiplied by
                          ``(ii) the cost-of-living adjustment 
                        determined under section 1(f)(3) for such 
                        calendar year by substituting `calendar year 
                        2003' for `calendar year 1992' in subparagraph 
                        (B) thereof.
                If the amount as adjusted under the preceding sentence 
                is not a multiple of $1,000, such amount shall be 
                rounded to the next lowest multiple of $1,000.''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2003.

SEC. 3029. DEFINITION OF INSURANCE COMPANY FOR SECTION 831.

    (a) In General.--Section 831 is amended by redesignating subsection 
(c) as subsection (d) and by inserting after subsection (b) the 
following new subsection:
    ``(c) Insurance Company Defined.--For purposes of this section, the 
term `insurance company' has the meaning given to such term by section 
816(a).''
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

SEC. 3030. DENIAL OF DEDUCTION FOR INTEREST ON UNDERPAYMENTS 
                    ATTRIBUTABLE TO NONDISCLOSED REPORTABLE 
                    TRANSACTIONS.

    (a) In General.--Section 163 (relating to deduction for interest) 
is amended by redesignating subsection (m) as subsection (n) and by 
inserting after subsection (l) the following new subsection:
    ``(m) Interest on Unpaid Taxes Attributable To Nondisclosed 
Reportable Transactions.--No deduction shall be allowed under this 
chapter for any interest paid or accrued under section 6601 on any 
underpayment of tax which is attributable to the portion of any 
reportable transaction understatement (as defined in section 6662A(b)) 
with respect to which the requirement of section 6664(d)(2)(A) is not 
met.''.
    (b) Effective Date.--The amendments made by this section shall 
apply to transactions in taxable years beginning after the date of the 
enactment of this Act.

SEC. 3031. CLARIFICATION OF RULES FOR PAYMENT OF ESTIMATED TAX FOR 
                    CERTAIN DEEMED ASSET SALES.

    (a) In General.--Paragraph (13) of section 338(h) (relating to tax 
on deemed sale not taken into account for estimated tax purposes) is 
amended by adding at the end the following: ``The preceding sentence 
shall not apply with respect to a qualified stock purchase for which an 
election is made under paragraph (10).''.
    (b) Effective Date.--The amendment made by subsection (a) shall 
apply to transactions occurring after the date of the enactment of this 
Act.

SEC. 3032. RECOGNITION OF GAIN FROM THE SALE OF A PRINCIPAL RESIDENCE 
                    ACQUIRED IN A LIKE-KIND EXCHANGE WITHIN 5 YEARS OF 
                    SALE.

    (a) In General.--Section 121(d) (relating to special rules for 
exclusion of gain from sale of principal residence) is amended by 
adding at the end the following new paragraph:
          ``(10) Property acquired in like-kind exchange.--If a 
        taxpayer acquired property in an exchange to which section 1031 
        applied, subsection (a) shall not apply to the sale or exchange 
        of such property if it occurs during the 5-year period 
        beginning with the date of the acquisition of such property.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to sales or exchanges after the date of the enactment of this Act.

SEC. 3033. PREVENTION OF MISMATCHING OF INTEREST AND ORIGINAL ISSUE 
                    DISCOUNT DEDUCTIONS AND INCOME INCLUSIONS IN 
                    TRANSACTIONS WITH RELATED FOREIGN PERSONS.

    (a) Original Issue Discount.--Section 163(e)(3) (relating to 
special rule for original issue discount on obligation held by related 
foreign person) is amended by redesignating subparagraph (B) as 
subparagraph (C) and by inserting after subparagraph (A) the following 
new subparagraph:
                  ``(B) Special rule for certain foreign entities.--
                          ``(i) In general.--In the case of any debt 
                        instrument having original issue discount which 
                        is held by a related foreign person which is a 
                        foreign personal holding company (as defined in 
                        section 552), a controlled foreign corporation 
                        (as defined in section 957), or a passive 
                        foreign investment company (as defined in 
                        section 1297), a deduction shall be allowable 
                        to the issuer with respect to such original 
                        issue discount for any taxable year before the 
                        taxable year in which paid only to the extent 
                        such original issue discount is included during 
                        such prior taxable year in the gross income of 
                        a United States person who owns (within the 
                        meaning of section 958(a)) stock in such 
                        corporation.
                          ``(ii) Secretarial authority.--The Secretary 
                        may by regulation exempt transactions from the 
                        application of clause (i), including any 
                        transaction which is entered into by a payor in 
                        the ordinary course of a trade or business in 
                        which the payor is predominantly engaged.''.
    (b) Interest and Other Deductible Amounts.--Section 267(a)(3) is 
amended--
          (1) by striking ``The Secretary'' and inserting:
                  ``(A) In general.--The Secretary'', and
          (2) by adding at the end the following new subparagraph:
                  ``(B) Special rule for certain foreign entities.--
                          ``(i) In general.--Notwithstanding 
                        subparagraph (A), in the case of any amount 
                        payable to a foreign personal holding company 
                        (as defined in section 552), a controlled 
                        foreign corporation (as defined in section 
                        957), or a passive foreign investment company 
                        (as defined in section 1297), a deduction shall 
                        be allowable to the payor with respect to such 
                        amount for any taxable year before the taxable 
                        year in which paid only to the extent such 
                        amount is included during such prior taxable 
                        year in the gross income of a United States 
                        person who owns (within the meaning of section 
                        958(a)) stock in such corporation.
                          ``(ii) Secretarial authority.--The Secretary 
                        may by regulation exempt transactions from the 
                        application of clause (i), including any 
                        transaction which is entered into by a payor in 
                        the ordinary course of a trade or business in 
                        which the payor is predominantly engaged and in 
                        which the payment of the accrued amounts occurs 
                        within 8\1/2\ months after accrual or within 
                        such other period as the Secretary may 
                        prescribe.''.
    (c) Effective Date.--The amendments made by this section shall 
apply to payments accrued on or after the date of the enactment of this 
Act.

SEC. 3034. EXCLUSION FROM GROSS INCOME FOR INTEREST ON OVERPAYMENTS OF 
                    INCOME TAX BY INDIVIDUALS.

    (a) In General.--Part III of subchapter B of chapter 1 (relating to 
items specifically excluded from gross income) is amended by inserting 
after section 139A the following new section:

``SEC. 139B. EXCLUSION FROM GROSS INCOME FOR INTEREST ON OVERPAYMENTS 
                    OF INCOME TAX BY INDIVIDUALS.

    ``(a) In General.--In the case of an individual, gross income shall 
not include interest paid under section 6611 on any overpayment of tax 
imposed by this subtitle.
    ``(b) Exception.--Subsection (a) shall not apply in the case of a 
failure to claim items resulting in the overpayment on the original 
return if the Secretary determines that the principal purpose of such 
failure is to take advantage of subsection (a).
    ``(c) Special Rule for Determining Modified Adjusted Gross 
Income.--For purposes of this title, interest not included in gross 
income under subsection (a) shall not be treated as interest which is 
exempt from tax for purposes of sections 32(i)(2)(B) and 6012(d) or any 
computation in which interest exempt from tax under this title is added 
to adjusted gross income.''.
    (b) Clerical Amendment.--The table of sections for part III of 
subchapter B of chapter 1 is amended by inserting after the item 
relating to section 139A the following new item:

                              ``Sec. 139B. Exclusion from gross income 
                                        for interest on overpayments of 
                                        income tax by individuals.''.

    (c) Effective Date.--The amendments made by this section shall 
apply to interest received in calendar years beginning after the date 
of the enactment of this Act.

SEC. 3035. DEPOSITS MADE TO SUSPEND RUNNING OF INTEREST ON POTENTIAL 
                    UNDERPAYMENTS.

    (a) In General.--Subchapter A of chapter 67 (relating to interest 
on underpayments) is amended by adding at the end the following new 
section:

``SEC. 6603. DEPOSITS MADE TO SUSPEND RUNNING OF INTEREST ON POTENTIAL 
                    UNDERPAYMENTS, ETC.

    ``(a) Authority To Make Deposits Other Than As Payment of Tax.--A 
taxpayer may make a cash deposit with the Secretary which may be used 
by the Secretary to pay any tax imposed under subtitle A or B or 
chapter 41, 42, 43, or 44 which has not been assessed at the time of 
the deposit. Such a deposit shall be made in such manner as the 
Secretary shall prescribe.
    ``(b) No Interest Imposed.--To the extent that such deposit is used 
by the Secretary to pay tax, for purposes of section 6601 (relating to 
interest on underpayments), the tax shall be treated as paid when the 
deposit is made.
    ``(c) Return of Deposit.--Except in a case where the Secretary 
determines that collection of tax is in jeopardy, the Secretary shall 
return to the taxpayer any amount of the deposit (to the extent not 
used for a payment of tax) which the taxpayer requests in writing.
    ``(d) Payment of Interest.--
          ``(1) In general.--For purposes of section 6611 (relating to 
        interest on overpayments), a deposit which is returned to a 
        taxpayer shall be treated as a payment of tax for any period to 
        the extent (and only to the extent) attributable to a 
        disputable tax for such period. Under regulations prescribed by 
        the Secretary, rules similar to the rules of section 6611(b)(2) 
        shall apply.
          ``(2) Disputable tax.--
                  ``(A) In general.--For purposes of this section, the 
                term `disputable tax' means the amount of tax specified 
                at the time of the deposit as the taxpayer's reasonable 
                estimate of the maximum amount of any tax attributable 
                to disputable items.
                  ``(B) Safe harbor based on 30-day letter.--In the 
                case of a taxpayer who has been issued a 30-day letter, 
                the maximum amount of tax under subparagraph (A) shall 
                not be less than the amount of the proposed deficiency 
                specified in such letter.
          ``(3) Other definitions.--For purposes of paragraph (2)--
                  ``(A) Disputable item.--The term `disputable item' 
                means any item of income, gain, loss, deduction, or 
                credit if the taxpayer--
                          ``(i) has a reasonable basis for its 
                        treatment of such item, and
                          ``(ii) reasonably believes that the Secretary 
                        also has a reasonable basis for disallowing the 
                        taxpayer's treatment of such item.
                  ``(B) 30-day letter.--The term `30-day letter' means 
                the first letter of proposed deficiency which allows 
                the taxpayer an opportunity for administrative review 
                in the Internal Revenue Service Office of Appeals.
          ``(4) Rate of interest.--The rate of interest allowable under 
        this subsection shall be the Federal short-term rate determined 
        under section 6621(b), compounded daily.
    ``(e) Use of Deposits.--
          ``(1) Payment of tax.--Except as otherwise provided by the 
        taxpayer, deposits shall be treated as used for the payment of 
        tax in the order deposited.
          ``(2) Returns of deposits.--Deposits shall be treated as 
        returned to the taxpayer on a last-in, first-out basis.''.
    (b) Clerical Amendment.--The table of sections for subchapter A of 
chapter 67 is amended by adding at the end the following new item:

                              ``Sec. 6603. Deposits made to suspend 
                                        running of interest on 
                                        potential underpayments, 
                                        etc.''.
    (c) Effective Date.--
          (1) In general.--The amendments made by this section shall 
        apply to deposits made after the date of the enactment of this 
        Act.
          (2) Coordination with deposits made under revenue procedure 
        84-58.--In the case of an amount held by the Secretary of the 
        Treasury or his delegate on the date of the enactment of this 
        Act as a deposit in the nature of a cash bond deposit pursuant 
        to Revenue Procedure 84-58, the date that the taxpayer 
        identifies such amount as a deposit made pursuant to section 
        6603 of the Internal Revenue Code (as added by this Act) shall 
        be treated as the date such amount is deposited for purposes of 
        such section 6603.

SEC. 3036. PARTIAL PAYMENT OF TAX LIABILITY IN INSTALLMENT AGREEMENTS.

    (a) In General.--
          (1) Section 6159(a) (relating to authorization of agreements) 
        is amended--
                  (A) by striking ``satisfy liability for payment of'' 
                and inserting ``make payment on'', and
                  (B) by inserting ``full or partial'' after 
                ``facilitate''.
          (2) Section 6159(c) (relating to Secretary required to enter 
        into installment agreements in certain cases) is amended in the 
        matter preceding paragraph (1) by inserting ``full'' before 
        ``payment''.
    (b) Requirement To Review Partial Payment Agreements Every Two 
Years.--Section 6159 is amended by redesignating subsections (d) and 
(e) as subsections (e) and (f), respectively, and inserting after 
subsection (c) the following new subsection:
    ``(d) Secretary Required To Review Installment Agreements for 
Partial Collection Every Two Years.--In the case of an agreement 
entered into by the Secretary under subsection (a) for partial 
collection of a tax liability, the Secretary shall review the agreement 
at least once every 2 years.''.
    (c) Effective Date.--The amendments made by this section shall 
apply to agreements entered into on or after the date of the enactment 
of this Act.

SEC. 3037. EXTENSION OF IRS USER FEES.

    (a) In General.--Section 7528(c) (relating to termination) is 
amended by striking ``December 31, 2004'' and inserting ``September 30, 
2013''.
    (b) Effective Date.--The amendment made by this section shall apply 
to requests after the date of the enactment of this Act.

         TITLE IV--TRADE ENHANCEMENT AND COMPLIANCE PROVISIONS

SEC. 4001. REPEAL OF EXCLUSION FOR EXTRATERRITORIAL INCOME.

    (a) In General.--Section 114 is hereby repealed.
    (b) Conforming Amendments.--
          (1) Subpart E of part III of subchapter N of chapter 1 
        (relating to qualifying foreign trade income) is hereby 
        repealed.
          (2) The table of subparts for such part III is amended by 
        striking the item relating to subpart E.
          (3) The table of sections for part III of subchapter B of 
        chapter 1 is amended by striking the item relating to section 
        114.
    (c) Effective Date.--Except as provided in subsection (d), the 
amendments made by this section shall apply to transactions after 
December 31, 2003.
    (d) Transitional Rule for 2004, 2005, and 2006.--
          (1) In general.--In the case of transactions during 2004, 
        2005, or 2006, the amount includible in gross income by reason 
        of the amendments made by this section shall not exceed the 
        applicable percentage of the amount which would have been so 
        included but for this subsection.
          (2) Applicable percentage.--For purposes of paragraph (1), 
        the applicable percentage shall be as follows:
                  (A) For 2004, the applicable percentage shall be 20 
                percent.
                  (B) For 2005, the applicable percentage shall be 20 
                percent.
                  (C) For 2006, the applicable percentage shall be 40 
                percent.
    (e) Revocation of Election To Be Treated as Domestic Corporation.--
If, during the 1-year period beginning on the date of the enactment of 
this Act, a corporation for which an election is in effect under 
section 943(e) of the Internal Revenue Code of 1986 revokes such 
election, no gain or loss shall be recognized with respect to property 
treated as transferred under clause (ii) of section 943(e)(4)(B) of 
such Code to the extent such property--
          (1) was treated as transferred under clause (i) thereof, or
          (2) was acquired during a taxable year to which such election 
        applies and before May 1, 2003, in the ordinary course of its 
        trade or business.
The Secretary of the Treasury (or such Secretary's delegate) may 
prescribe such regulations as may be necessary to prevent the abuse of 
the purposes of this subsection.
    (f) Binding Contracts.--The amendments made by this section shall 
not apply to any transaction in the ordinary course of a trade or 
business which occurs pursuant to a binding contract--
          (1) which is between the taxpayer and a person who is not a 
        related person (as defined in section 943(b)(3) of such Code, 
        as in effect on the day before the date of the enactment of 
        this Act), and
          (2) which is in effect on January 14, 2002, and at all times 
        thereafter.
For purposes of this subsection, a binding contract shall include a 
purchase option, renewal option, or replacement option which is 
included in such contract and which is enforceable against the seller 
or lessor.

SEC. 4002. COBRA FEES.

    (a) Use of Merchandise Processing Fee.--Section 13031(f) of the 
Consolidated Omnibus Budget Reconciliation Act of 1985 (19 U.S.C. 
58c(f)) is amended--
          (1) in paragraph (1), by aligning subparagraph (B) with 
        subparagraph (A); and
          (2) in paragraph (2), by striking ``commercial operations'' 
        and all that follows through ``processing.'' and inserting 
        ``customs revenue functions as defined in section 415 of the 
        Homeland Security Act of 2002 (other than functions performed 
        by the Office of International Affairs referred to in section 
        415(8) of that Act), and for automation (including the 
        Automation Commercial Environment computer system), and for no 
        other purpose. To the extent that funds in the Customs User Fee 
        Account are insufficient to pay the costs of such customs 
        revenue functions, customs duties in an amount equal to the 
        amount of such insufficiency shall be available, to the extent 
        provided for in appropriations Acts, to pay the costs of such 
        customs revenue functions in the amount of such insufficiency, 
        and shall be available for no other purpose. The provisions of 
        the first and second sentences of this paragraph specifying the 
        purposes for which amounts in the Customs User Fee Account may 
        be made available shall not be superseded except by a provision 
        of law which specifically modifies or supersedes such 
        provisions.''.
    (b) Reimbursement of Appropriations From COBRA Fees.--Section 
13031(f)(3) of the Consolidated Omnibus Budget Reconciliation Act of 
1985 (19 U.S.C. 58c(f)(3)) is amended by adding at the end the 
following:
    ``(E) Nothing in this paragraph shall be construed to preclude the 
use of appropriated funds, from sources other than the fees collected 
under subsection (a), to pay the costs set forth in clauses (i), (ii), 
and (iii) of subparagraph (A).''.
    (c) Sense of Congress; Effective Period for Collecting Fees; 
Standard for Setting Fees.--
          (1) Sense of congress.--The Congress finds that--
                  (A) the fees set forth in paragraphs (1) through (8) 
                of subsection (a) of section 13031 of the Consolidated 
                Omnibus Budget Reconciliation Act of 1985 have been 
                reasonably related to the costs of providing customs 
                services in connection with the activities or items for 
                which the fees have been charged under such paragraphs; 
                and
                  (B) the fees collected under such paragraphs have not 
                exceeded, in the aggregate, the amounts paid for the 
                costs described in subsection (f)(3)(A) incurred in 
                providing customs services in connection with the 
                activities or items for which the fees were charged 
                under such paragraphs.
          (2) Effective period; standard for setting fees.--Section 
        13031(j)(3) of the Consolidated Omnibus Budget Reconciliation 
        Act of 1985 is amended to read as follows:
    ``(3)(A) Fees may not be charged under paragraphs (9) and (10) of 
subsection (a) after September 30, 2013.
    ``(B)(i) Subject to clause (ii), Fees may not be charged under 
paragraphs (1) through (8) of subsection (a) after September 30, 2013.
    ``(ii) In fiscal year 2006 and in each succeeding fiscal year for 
which fees under paragraphs (1) through (8) of subsection (a) are 
authorized--
          ``(I) the Secretary of the Treasury shall charge fees under 
        each such paragraph in amounts that are reasonably related to 
        the costs of providing customs services in connection with the 
        activity or item for which the fee is charged under such 
        paragraph, except that in no case may the fee charged under any 
        such paragraph exceed by more than 10 percent the amount 
        otherwise prescribed by such paragraph;
          ``(II) the amount of fees collected under such paragraphs may 
        not exceed, in the aggregate, the amounts paid in that fiscal 
        year for the costs described in subsection (f)(3)(A) incurred 
        in providing customs services in connection with the activity 
        or item for which the fees are charged under such paragraphs;
          ``(III) a fee may not be collected under any such paragraph 
        except to the extent such fee will be expended to pay the costs 
        described in subsection (f)(3)(A) incurred in providing customs 
        services in connection with the activity or item for which the 
        fee is charged under such paragraph; and
          ``(IV) any fee collected under any such paragraph shall be 
        available for expenditure only to pay the costs described in 
        subsection (f)(3)(A) incurred in providing customs services in 
        connection with the activity or item for which the fee is 
        charged under such paragraph.''.
    (d) Clerical Amendments.--Section 13031 of the Consolidated Omnibus 
Budget Reconciliation Act of 1985 is amended--
          (1) in subsection (a)(5)(B), by striking ``$1.75'' and 
        inserting ``$1.75.'';
          (2) in subsection (b)--
                  (A) in paragraph (1)(A), by aligning clause (iii) 
                with clause (ii);
                  (B) in paragraph (7), by striking ``paragraphs'' and 
                inserting ``paragraph''; and
                  (C) in paragraph (9), by aligning subparagraph (B) 
                with subparagraph (A); and
          (3) in subsection (e)(2), by aligning subparagraph (B) with 
        subparagraph (A).
    (e) Study of All Fees Collected by Department of Homeland 
Security.--The Secretary of the Treasury shall conduct a study of all 
the fees collected by the Department of Homeland Security, and shall 
submit to the Congress, not later than September 30, 2005, a report 
containing the recommendations of the Secretary on--
          (1) what fees should be eliminated;
          (2) what the rate of fees retained should be; and
          (3) any other recommendations with respect to the fees that 
        the Secretary considers appropriate.

                       I . SUMMARY AND BACKGROUND


                         A. Purpose and Summary

    The bill, H.R. 2896, as amended, (the ``American Jobs 
Creation Act of 2003'') repeals the exclusion for 
extraterritorial income, provides a reduced corporate income 
tax rate for domestic production activities, makes U.S. 
companies competitive in the United States and globally, and 
provides other corporate reform and growth incentives.
    The bill provides net tax reductions of over $21.136 
billion over fiscal years 2004-2008.

                 B. Background and Need for Legislation

    The provisions approved by the Committee bring U.S. tax law 
into compliance with the WTO Appellate Body holding that the 
ETI regime constitutes a prohibited export subsidy under the 
relevant trade agreements. The provisions approved by the 
Committee provide corporate reform and growth incentives that 
will make U.S. businesses and workers more competitive and will 
create jobs in the United States. The estimated revenue effects 
of the provisions comply with the most recent Congressional 
Budget Office revisions of budget surplus projections.

                         C. Legislative History

    The Committee on Ways and Means marked up the American Jobs 
Creation Act of 2003 on October 28, 2003, and ordered the bill, 
as amended, favorably reported by a roll call vote of 24 yeas 
and 15 nays (with a quorum being present).

                      II. EXPLANATION OF THE BILL


            TITLE I--CORPORATE REFORM AND GROWTH INCENTIVES


               A. Reduction in Income Tax Corporate Rates


1. Reduced corporate income tax rate for domestic production activities 
        income (sec. 1001 of the bill and sec. 11 of the Code)

                              PRESENT LAW

    A corporation's regular income tax liability is determined 
by applying the following tax rate schedule to its taxable 
income.

     TABLE 1.--MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2003
------------------------------------------------------------------------
          Taxable income                       Income tax rate
------------------------------------------------------------------------
$0-$50,000........................  15 percent of taxable income.
$50,001-$75,000...................  25 percent of taxable income.
$75,001-$10,000,000...............  34 percent of taxable income.
Over $10,000,000..................  35 percent of taxable income.
------------------------------------------------------------------------

    The benefit of the first two graduated rates described 
above are phased out by a five-percent surcharge for 
corporations with taxable income between $100,000 and $335,000. 
Also, the benefit of the 34-percent rate is phased out by a 
three-percent surcharge for corporations with taxable income 
between $15 million and $18,333,333; a corporation with taxable 
income of $18,333,333 or more effectively is subject to a flat 
rate of 35 percent.
    Under present law, there is no provision that reduces the 
corporate income tax for taxable income attributable to 
domestic production activities.

                           REASONS FOR CHANGE

    The Committee believes that creating new jobs is an 
essential element of economic recovery and expansion, and that 
tax policies designed to foster job creation also must reverse 
the recent declines in manufacturing sector employment levels. 
To accomplish this objective, the Committee believes that 
Congress should enact tax laws that enhance the ability of 
domestic businesses, and domestic manufacturing firms in 
particular, to compete in the global marketplace.
    The Committee believes that a reduced tax burden on 
domestic manufacturers will improve the cash flow of domestic 
manufacturers and make investments in domestic manufacturing 
facilities more attractive. Such investment will create and 
preserve U.S. manufacturing jobs.

                        EXPLANATION OF PROVISION

In general

    The bill provides that the corporate tax rate applicable to 
qualified production activities income may not exceed 32 
percent (34 percent for taxable years beginning before 2007) of 
the qualified production activities income.

Qualified production activities income

    ``Qualified production activities income'' is the income 
attributable to domestic production gross receipts, reduced by 
the sum of: (1) the costs of goods sold that are allocable to 
such receipts; (2) other deductions, expenses, or losses that 
are directly allocable to such receipts; and (3) a proper share 
of other deductions, expenses, and losses that are not directly 
allocable to such receipts or another class of income.\1\
---------------------------------------------------------------------------
    \1\ The Secretary shall prescribe rules for the proper allocation 
of items of income, deduction, expense, and loss for purposes of 
determining income attributable to domestic production activities. 
Where appropriate, such rules shall be similar to and consistent with 
relevant present-law rules (e.g., secs. 263A and 861).
---------------------------------------------------------------------------

Domestic production gross receipts

    ``Domestic production gross receipts'' generally are gross 
receipts of a corporation that are derived from: (1) any sale, 
exchange or other disposition, or any lease, rental or license, 
of qualifying production property that was manufactured, 
produced, grown or extracted (in whole or in significant part) 
by the corporation within the United States; \2\ (2) any sale, 
exchange or other disposition, or any lease, rental or license, 
of qualified film produced by the taxpayer; or (3) 
construction, engineering or architectural services performed 
in the United States for construction projects located in the 
United States. However, domestic production gross receipts do 
not include any gross receipts of the taxpayer derived from 
property that is leased, licensed or rented by the taxpayer for 
use by any related person.\3\
---------------------------------------------------------------------------
    \2\ Domestic production gross receipts include gross receipts for a 
taxpayer derived from any sale, exchange or other disposition of 
agricultural products with respect to which the taxpayer performs 
storage, handling or other processing activities (other than 
transportation activities) within the United States, provided such 
products are consumed in connection with, or incorporated into, the 
manufacturing, production, growth or extraction of qualifying 
production property (whether or not by the taxpayer). Domestic 
production gross receipts also include gross receipts of a taxpayer 
derived from any sale, exchange or other disposition of food products 
with respect to which the taxpayer performs processing activities (in 
whole or in significant part) within the United States.
    \3\ It is intended that principles similar to those under the 
present-law extraterritorial income regime apply for this purpose. See 
Temp. Treas. Reg. sec. 1.927(a)-1T(f)(2)(i). For example, this 
exclusion generally does not apply to property leased by the taxpayer 
to a related person if the property is held for sublease, or is 
subleased, by the related person to an unrelated person for the 
ultimate use of such unrelated person. Similarly, the license of 
computer software to a related person for reproduction and sale, 
exchange, lease, rental or sublicense to an unrelated person for the 
ultimate use of such unrelated person is not treated as excluded 
property by reason of the license to the related person.
---------------------------------------------------------------------------
    ``Qualifying production property'' generally is any 
tangible personal property, computer software, or property 
described in section 168(f)(4) of the Code. ``Qualified film'' 
is any property described in section 168(f)(3) of the Code 
(other than certain sexually explicit productions) if 50 
percent or more of the total compensation relating to the 
production of such film (other than compensation in the form of 
residuals and participations) constitutes compensation for 
services performed in the United States by actors, production 
personnel, directors, and producers.
    Under the bill, an election under section 631(a) made by a 
corporate taxpayer for a taxable year ending on or before the 
date of enactment to treat the cutting of timber as a sale or 
exchange, may be revoked by the taxpayer without the consent of 
the IRS for any taxable year ending after that date. The prior 
election (and revocation) is disregarded for purposes of making 
a subsequent election.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2003.

2. Reduced corporate income tax rate for small corporations (sec. 1002 
        of the bill and sec. 11 of the Code)

                              PRESENT LAW

    A corporation's regular income tax liability is determined 
by applying the following tax rate schedule to its taxable 
income.

     TABLE 1.--MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2003
------------------------------------------------------------------------
          Taxable income                       Income tax rate
------------------------------------------------------------------------
$0-$50,000........................  15 percent of taxable income.
$50,001-$75,000...................  25 percent of taxable income.
$75,001-$10,000,000...............  34 percent of taxable income.
Over $10,000,000..................  35 percent of taxable income.
------------------------------------------------------------------------

    The benefit of the first two graduated rates described 
above are phased out by a five-percent surcharge for 
corporations with taxable income between $100,000 and $335,000. 
Also, benefit of the 34-percent rate is phased out by a three-
percent surcharge for corporations with taxable income between 
$15 million and $18,333,333; a corporation with taxable income 
of $18,333,333 or more effectively is subject to a flat rate of 
35 percent.

                           REASONS FOR CHANGE

    The Committee believes that reducing the tax burden on 
small and medium sized businesses will enable them to continue 
to maintain and create new jobs in the United States. A reduced 
tax burden on smaller businesses simultaneously makes 
investments by small businesses more attractive and improves 
the cash flow of such businesses, thus facilitating the 
financing of investments. New investment by small business is 
responsible for substantial job creation in the economy and 
provides the foundation for new industries, new technology, and 
the future of the U. S. economy.

                        EXPLANATION OF PROVISION

    Under the provision, a corporation's regular income tax 
liability is determined by applying the following tax rate 
schedules to its taxable income.

   TABLE 2.--MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2012 AND
                               THEREAFTER
------------------------------------------------------------------------
          Taxable income                       Income tax rate
------------------------------------------------------------------------
$0-$50,000........................  15 percent of taxable income.
$50,001-$75,000...................  25 percent of taxable income.
$75,001-$20,000,000...............  32 percent of taxable income.
Over $20,000,000..................  35 percent of taxable income.
------------------------------------------------------------------------

    The benefit of the graduated rates described above are 
phased out by a three-percent surcharge for corporations with 
taxable income between $20 million and $40,341,667; a 
corporation with taxable income of $40,341,667 or more 
effectively is subject to a flat rate of 35 percent.

   TABLE 3.--MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2007-2008
------------------------------------------------------------------------
          Taxable income                       Income tax rate
------------------------------------------------------------------------
$0-$50,000........................  15 percent of taxable income.
$50,001-$75,000...................  25 percent of taxable income.
$75,001-$5,000,000................  32 percent of taxable income.
$5,000,000-$10,000,000............  34 percent of taxable income.
Over $10,000,000..................  35 percent of taxable income.
------------------------------------------------------------------------

    The benefit of the first three graduated rates described 
above are phased out by a five-percent surcharge for 
corporations with taxable income between $5,000,000 and 
$7,480,000. Also, the benefit of the 34-percent rate is phased 
out by a three-percent surcharge for corporations with taxable 
income between $15 million and $18,333,333; a corporation with 
taxable income of $18,333,333 or more effectively is subject to 
a flat rate of 35 percent.

   TABLE 4.--MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2007-2008
------------------------------------------------------------------------
          Taxable income                       Income tax rate
------------------------------------------------------------------------
$0-$50,000........................  15 percent of taxable income.
$50,001-$75,000...................  25 percent of taxable income.
$75,001-$1,000,000................  32 percent of taxable income.
$1,000,000-$10,000,000............  34 percent of taxable income.
Over $10,000,000..................  35 percent of taxable income.
------------------------------------------------------------------------

    The benefit of the first three graduated rates described 
above are phased out by a five-percent surcharge for 
corporations with taxable income between $1,000,000 and 
$1,605,000. Also, the benefit of the 34-percent rate is phased 
out by a three-percent surcharge for corporations with taxable 
income between $15 million and $18,333,333; a corporation with 
taxable income of $18,333,333 or more effectively is subject to 
a flat rate of 35 percent.

   TABLE 5.--MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2004-2006
------------------------------------------------------------------------
          Taxable income                       Income tax rate
------------------------------------------------------------------------
$0-$50,000........................  15 percent of taxable income.
$50,001-$75,000...................  25 percent of taxable income.
$75,001-$1,000,000................  33 percent of taxable income.
$1,000,000-$10,000,000............  34 percent of taxable income.
Over $10,000,000..................  35 percent of taxable income.
------------------------------------------------------------------------

    The benefit of the first three graduated rates described 
above are phased out by a five-percent surcharge for 
corporations with taxable income between $1,000,000 and 
$1,420,000. Also, the benefit of the 34-percent rate is phased 
out by a three-percent surcharge for corporations with taxable 
income between $15 million and $18,333,333; a corporation with 
taxable income of $18,333,333 or more effectively is subject to 
a flat rate of 35 percent.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2003.

            B. Extension of Increased Section 179 Expensing


(Sec. 1011 of the bill and sec. 179 of the Code)

                              PRESENT LAW

    Present law provides that, in lieu of depreciation, a 
taxpayer with a sufficiently small amount of annual investment 
may elect to deduct such costs. The Jobs and Growth Tax Relief 
Reconciliation Act (JGTRRA) of 2003 4 increased the 
amount a taxpayer may deduct, for taxable years beginning in 
2003 through 2005, to $100,000 of the cost of qualifying 
property placed in service for the taxable year.5 In 
general, qualifying property is defined as depreciable tangible 
personal property that is purchased for use in the active 
conduct of a trade or business. For taxable years beginning 
after 2002 and before 2006, the $100,000 amount is reduced (but 
not below zero) by the amount by which the cost of qualifying 
property placed in service during the taxable year exceeds 
$400,000. The dollar limitations are indexed annually for 
inflation for taxable years beginning in a calendar year after 
2003 and before 2006. The provision also includes off-the-shelf 
computer software placed in service in a taxable year beginning 
in 2003 through 2005 as qualifying property.
---------------------------------------------------------------------------
    \4\ Pub. Law No. 108-27, sec. 202(2003).
    \5\ Additional section 179 incentives are provided with respect to 
qualified property used by a business in the New York Liberty Zone 
(sec. 1400L(f)), an empowerment zone (sec. 1397A), or a renewal 
community (sec. 1400J).
---------------------------------------------------------------------------
    Prior to the enactment of JGTRRA (and for taxable years 
beginning in 2006 and thereafter) a taxpayer with a 
sufficiently small amount of annual investment may elect to 
deduct up to $25,000 of the cost of qualifying property placed 
in service for the taxable year. The $25,000 amount is reduced 
(but not below zero) by the amount by which the cost of 
qualifying property placed in service during the taxable year 
exceeds $200,000. In general, qualifying property is defined as 
depreciable tangible personal property that is purchased for 
use in the active conduct of a trade or business.
    The amount eligible to be expensed for a taxable year may 
not exceed the taxable income for a taxable year that is 
derived from the active conduct of a trade or business 
(determined without regard to this provision). Any amount that 
is not allowed as a deduction because of the taxable income 
limitation may be carried forward to succeeding taxable years 
(subject to similar limitations). No general business credit 
under section 38 is allowed with respect to any amount for 
which a deduction is allowed under section 179.
    Under present law, an expensing election is made under 
rules prescribed by the Secretary.6 Applicable 
Treasury Regulations provide that an expensing election 
generally is made on the taxpayer's original return for the 
taxable year to which the election relates.7
---------------------------------------------------------------------------
    \6\ Sec. 179(c)(1).
    \7\ Treas. Reg. sec. 1.179-5. Under these regulations, a taxpayer 
may make the election on the original return (whether or not the return 
is timely), or on an amended return filed by the due date (including 
extensions) for filing the return for the tax year the property was 
placed in service. If the taxpayer timely filed an original return 
without making the election, the taxpayer may still make the election 
by filing an amended return within six months of the due date of the 
return (excluding extensions).
---------------------------------------------------------------------------
    Prior to the enactment of JGTRRA (and for taxable years 
beginning in 2006 and thereafter), an expensing election may be 
revoked only with consent of the Commissioner.8 
JGTRRA permits taxpayers to revoke expensing elections on 
amended returns without the consent of the Commissioner with 
respect to a taxable year beginning after 2002 and before 
2006.9
---------------------------------------------------------------------------
    \8\ Sec. 179(c)(2).
    \9\ Id.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that section 179 expensing provides 
two important benefits for small businesses. First, it lowers 
the cost of capital for property used in a trade or business. 
With a lower cost of capital, the Committee believes small 
business will invest in more equipment and employ more workers. 
Second, it eliminates depreciation recordkeeping requirements 
with respect to expensed property. In the Jobs and Growth Tax 
Relief Reconciliation Act of 2003, Congress acted to increase 
the value of these benefits and to increase the number of 
taxpayers eligible for taxable years through 2005. The 
Committee believes that these changes to section 179 expensing 
will continue to provide important benefits if extended, and 
the bill therefore extends these changes for an additional two 
years.

                        EXPLANATION OF PROVISION

    The provision extends the increased amount that a taxpayer 
may deduct, and other changes that were made by JGTRRA of 2003, 
for an additional two years. Thus, the provision provides that 
the maximum dollar amount that may be deducted under section 
179 is $100,000 for property placed in service in taxable years 
beginning before 2008 ($25,000 for taxable years beginning in 
2008 and thereafter). In addition, the $400,000 amount applies 
for property placed in service in taxable years beginning 
before 2008 ($200,000 for taxable years beginning in 2008 and 
thereafter). The provision extends, through 2007 (from 2005), 
the indexing for inflation of both the maximum dollar that may 
be deducted and the $400,000 amount. The provision also 
includes off-the-shelf computer software placed in service in 
taxable years beginning before 2008 as qualifying property. The 
provision permits taxpayers to revoke expensing elections on 
amended returns without the consent of the Commissioner with 
respect to a taxable year beginning before 2008. The Committee 
expects that the Secretary will prescribe regulations to permit 
a taxpayer to make an expensing election on an amended return 
without the consent of the Commissioner.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

 C. Recovery Period for Depreciation of Certain Leasehold Improvements 
                        and Restaurant Property


(Sec. 1021 of the bill and sec. 168 of the Code)

                              PRESENT LAW

    A taxpayer generally must capitalize the cost of property 
used in a trade or business and recover such cost over time 
through annual deductions for depreciation or amortization. 
Tangible property generally is depreciated under the modified 
accelerated cost recovery system (``MACRS''), which determines 
depreciation by applying specific recovery periods, placed-in-
service conventions, and depreciation methods to the cost of 
various types of depreciable property (sec. 168). The cost of 
nonresidential real property is recovered using the straight-
line method of depreciation and a recovery period of 39 years. 
Nonresidential real property is subject to the mid-month 
placed-in-service convention. Under the mid-month convention, 
the depreciation allowance for the first year property is 
placed in service is based on the number of months the property 
was in service, and property placed in service at any time 
during a month is treated as having been placed in service in 
the middle of the month.

Depreciation of leasehold improvements

    Depreciation allowances for improvements made on leased 
property are determined under MACRS, even if the MACRS recovery 
period assigned to the property is longer than the term of the 
lease (sec. 168(i)(8)).\10\ This rule applies regardless of 
whether the lessor or the lessee places the leasehold 
improvements in service.\11\ If a leasehold improvement 
constitutes an addition or improvement to nonresidential real 
property already placed in service, the improvement is 
depreciated using the straight-line method over a 39-year 
recovery period, beginning in the month the addition or 
improvement was placed in service (secs. 168(b)(3), (c), 
(d)(2), and (i)(6)).\12\
---------------------------------------------------------------------------
    \10\ The Tax Reform Act of 1986 modified the Accelerated Cost 
Recovery System (``ACRS'') to institute MACRS. Prior to the adoption of 
ACRS by the Economic Recovery Tax Act of 1981, taxpayers were allowed 
to depreciate the various components of a building as separate assets 
with separate useful lives. The use of component depreciation was 
repealed upon the adoption of ACRS. The Tax Reform Act of 1986 also 
denied the use of component depreciation under MACRS.
    \11\ Former sections 168(f)(6) and 178 provided that, in certain 
circumstances, a lessee could recover the cost of leasehold 
improvements made over the remaining term of the lease. The Tax Reform 
Act of 1986 repealed these provisions.
    \12\ If the improvement is characterized as tangible personal 
property, ACRS or MACRS depreciation is calculated using the shorter 
recovery periods and accelerated methods applicable to such property. 
The determination of whether improvements are characterized as tangible 
personal property or as nonresidential real property often depends on 
whether or not the improvements constitute a ``structural component'' 
of a building (as defined by Treas. Reg. sec. 1.48-1(c)(1)). See, e.g., 
Metro National Corp v. Commissioner., 52 TCM (CCH) 1440 (1987); King 
Radio Corp Inc v. U.S., 486 F.2d 1091 (105h Cir. 1973); Mallinekrodt, 
Inc. v. Commissioner, 778 F.2d 402 (8th Cir. 1985)(with respect to 
various leasehold improvements).
---------------------------------------------------------------------------

Qualified leasehold improvement property

    The Job Creation and Worker Assistance Act of 2002\13\ as 
amended by the Jobs and Growth Tax Relief Reconciliation Act of 
2003\14\ generally provides an additional first-year 
depreciation deduction equal to either 30 percent or 50 percent 
of the adjusted basis of qualified property placed in service 
before January 1, 2005. Qualified property includes qualified 
leasehold improvement property. For this purpose, qualified 
leasehold improvement property is any improvement to an 
interior portion of a building that is nonresidential real 
property, provided certain requirements are met. The 
improvement must be made under or pursuant to a lease either by 
the lessee (or sublessee), or by the lessor, of that portion of 
the building to be occupied exclusively by the lessee (or 
sublessee). The improvement must be placed in service more than 
three years after the date the building was first placed in 
service. Qualified leasehold improvement property does not 
include any improvement for which the expenditure is 
attributable to the enlargement of the building, any elevator 
or escalator, any structural component benefiting a common 
area, or the internal structural framework of the building.
---------------------------------------------------------------------------
    \13\ Pub. Law No. 107-147, sec 101 (2002).
    \14\ Pub. Law No. 198-27, sec. 201 (2003).
---------------------------------------------------------------------------

Treatment of dispositions of leasehold improvements

    A lessor of leased property that disposes of a leasehold 
improvement which was made by the lessor for the lessee of the 
property may take the adjusted basis of the improvement into 
account for purposes of determining gain or loss if the 
improvement is irrevocably disposed of or abandoned by the 
lessor at the termination of the lease. This rule conforms the 
treatment of lessors and lessees with respect to leasehold 
improvements disposed of at the end of a term of lease.

                           REASONS FOR CHANGE

    The Committee believes that taxpayers should not be 
required to recover the costs of investments beyond the useful 
life of the investment. The present law 39-year recovery period 
for leasehold improvements extends well beyond the useful life 
of such investments. Although lease terms differ, the Committee 
believes that lease terms for commercial real estate typically 
are shorter than the present-law 39-year recovery period. In 
the interests of simplicity and administrability, a uniform 
period for recovery of leasehold improvements is desirable. The 
Committee bill therefore shortens the recovery period for 
leasehold improvements to a more realistic 15 years.
    The Committee also believes that unlike other commercial 
buildings, restaurant buildings generally are more specialized 
structures. Restaurants also experience considerably more 
traffic, and remain open longer than most retail properties. 
This daily assault causes rapid deterioration of restaurant 
properties, and forces restaurateurs to constantly repair and 
upgrade their facilities. As such, restaurant facilities have a 
much shorter life span than other commercial establishments. 
The Committee bill reduces the 39-year recovery period for 
improvements made to restaurant buildings and more accurately 
reflects the true economic life of the properties by reducing 
the recovery period to 15 years.

                        EXPLANATION OF PROVISION

    The provision provides a statutory 15-year recovery period 
for qualified leasehold improvement property placed in service 
before January 1, 2006.\15\ The provision requires that 
qualified leasehold improvement property be recovered using the 
straight-line method.
---------------------------------------------------------------------------
    \15\ Qualified leasehold improvement property continues to be 
eligible for the additional first-year depreciation deduction under 
sec. 168(k).
---------------------------------------------------------------------------
    Qualified leasehold improvement property is defined as 
under present law for purposes of the additional first-year 
depreciation deduction (sec. 168(k)), with the following 
modification. If a lessor makes an improvement that qualifies 
as qualified leasehold improvement property such improvement 
shall not qualify as qualified leasehold improvement property 
to any subsequent owner of such improvement. An exception to 
the rule applies in the case of death and certain transfers of 
property that qualify for non-recognition treatment.
    The provision also provides a statutory 15-year recovery 
period for qualified restaurant property placed in service 
before January 1, 2006.\16\ For purposes of the provision, 
qualified restaurant property means any improvement to a 
building if such building has been in service more than three 
years and more than 50 percent of the building's square footage 
is devoted to the preparation of, and seating for, on-premises 
consumption of prepared meals. The provision requires that 
qualified restaurant property be recovered using the straight-
line method.
---------------------------------------------------------------------------
    \16\ Qualified restaurant property would become eligible for the 
additional first-year depreciation deduction under sec. 168(k) by 
virtue of the assigned 20-year recovery period.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision is effective for property placed in service 
after the date of enactment.

                   D. Alternative Minimum Tax Relief


1. Net operating losses and foreign tax credit; expansion of small 
        corporation exemption (secs. 1031-1032 of the bill and secs. 
        55-59 of the Code)

                              PRESENT LAW

In general

    Under present law, taxpayers are subject to an alternative 
minimum tax (``AMT''), which is payable in addition to all 
other tax liabilities. The tax is imposed on the amount by 
which the tentative minimum tax exceeds the regular tax 
liability. In the case of corporations, the tentative minimum 
tax is computed at a flat rate of 20 percent on alternative 
minimum taxable income (``AMTI'') in excess of an exemption 
amount that phases out.\17\ AMTI is the taxpayer's taxable 
income increased for certain tax preferences and adjusted by 
determining the tax treatment of certain items in a manner that 
limits the tax benefits resulting from the regular tax 
treatment of such items.
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    \17\ In the case of individuals, the rates are 26 and 28 percent.
---------------------------------------------------------------------------

Net operating loss

    Taxpayers generally may use the net operating loss 
deduction to offset 90 percent of AMTI (determined without 
regard to the net operating loss deduction). A special rule 
allows a net operating loss carryback from, or carryover to, a 
taxable year ending during 2001 or 2002 to offset 100 percent 
of AMTI.

Foreign tax credit

    Taxpayers are permitted to reduce their AMT liability by an 
AMT foreign tax credit. The AMT foreign tax credit for a 
taxable year is determined under principles similar to those 
used in computing the regular tax foreign tax credit, except 
that (1) the numerator of the AMT foreign tax credit limitation 
fraction is foreign source AMTI and (2) the denominator of that 
fraction is total AMTI. Taxpayers may elect to use as their AMT 
foreign tax credit limitation fraction the ratio of foreign 
source regular taxable income to total AMTI.
    The AMT foreign tax credit for any taxable year generally 
may not offset a taxpayer's entire pre-credit AMT. Rather, the 
AMT foreign tax credit is limited to 90 percent of AMT computed 
without any AMT net operating loss deduction and the AMT 
foreign tax credit. For example, assume that a corporation has 
$10 million of AMTI, has no AMT net operating loss deduction, 
and has no regular tax liability. In the absence of the AMT 
foreign tax credit, the corporation's tax liability would be $2 
million. Accordingly, the AMT foreign tax credit cannot be 
applied to reduce the taxpayer's tax liability below $200,000. 
Any unused AMT foreign tax credit may be carried back two years 
and carried forward five years for use against AMT in those 
years under the principles of the foreign tax credit carryback 
and carryover rules set forth in section 904(c).

Small corporation exemption

    Corporations with average gross receipts of less than $7.5 
million for the prior three taxable years are exempt from the 
corporate alternative minimum tax. The $7.5 million threshold 
is reduced to $5 million for the corporation's first three-
taxable year period.

                           REASONS FOR CHANGE

    The Committee believes that the alternative minimum tax is 
merely a prepayment of tax. The corporate alternative minimum 
tax requires businesses to prepay their taxes when they can 
least afford it, during a business downturn. The Committee 
believes that increasing the gross receipts cap for companies 
exempt from corporate AMT from $7.5 million of gross receipts 
to $20 million of gross receipts will relieve many taxpayers of 
both the administrative burden of calculating their income tax 
liability under two separate tax systems and the financial 
burden of having to prepay their tax when they can least afford 
it. The Committee also believes that taxpayers should be 
permitted to more fully utilize net operating losses and 
foreign tax credits in computing the alternative minimum tax 
than is permitted under current law.

                        EXPLANATION OF PROVISION

    The provision phases-out the 90-percent limitation on the 
use of the net operating loss deduction in computing AMTI. The 
limitation is increased to 92 percent for taxable years 
beginning in 2005, 2006 and 2007; 94 percent for taxable years 
beginning in 2008 and 2009; 96 percent for taxable years 
beginning in 2010; 98 percent for taxable years beginning in 
2011; and 100 percent for taxable years beginning in and after 
2012.
    The provision repeals the 90-percent limitation on the 
utilization of the AMT foreign tax credit.
    The provision increases the amount of average gross 
receipts that an exempt corporation may receive from $7.5 
million to $20 million.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2004.

2. Income averaging for farmers not to increase alternative minimum tax 
        (sec. 1033 of the bill and sec. 55 of the Code)

                              PRESENT LAW

    An individual engaged in a farming business (as defined in 
section 263A(e)(4)) may elect to compute his or her current 
year income tax liability by averaging, over the prior three-
year period, all or portion of his or her taxable income from 
the trade or business of farming.\18\ The averaging election is 
not available in computing the tentative minimum tax. As a 
result, some farmers may become liable for the alternative 
minimum tax as a result of the averaging election.
---------------------------------------------------------------------------
    \18\ Sec. 1301.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that farmer income averaging should 
be coordinated with the alternative minimum tax so that a 
farmer's alternative minimum tax liability is not increased 
because he or she elects income averaging.

                        EXPLANATION OF PROVISION

    The bill modifies the alternative minimum tax to allow 
farmers the full benefit of income averaging. Under the bill, a 
farmer owes alternative minimum tax only to the extent he or 
she would owe alternative minimum tax had averaging not been 
elected. This result is achieved by excluding the impact of the 
election to average farm income from the calculation of regular 
tax liability in computing the alternative minimum tax.

                             EFFECTIVE DATE

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

   E. Provisions Relating to S Corporation Reform and Simplification


(Secs. 1041-1051 of the bill and secs. 1361-1379 sec. and 4975 of the 
        Code)

                                OVERVIEW

    In general, an S corporation is not subject to corporate-
level income tax on its items of income and loss. Instead, an S 
corporation passes through its items of income and loss to its 
shareholders. The shareholders take into account separately 
their shares of these items on their individual income tax 
returns. To prevent double taxation of these items when the 
stock is later disposed of, each shareholder's basis in the 
stock of the S corporation is increased by the amount included 
in income (including tax-exempt income) and is decreased by the 
amount of any losses (including nondeductible losses) taken 
into account. A shareholder's loss may be deducted only to the 
extent of his or her basis in the stock or debt of the 
corporation. To the extent a loss is not allowed due to this 
limitation, the loss generally is carried forward with respect 
to the shareholder.

                           REASONS FOR CHANGE

    The bill contains a number of general provisions relating 
to S corporations. The Committee adopted these provisions that 
modernize the S corporation rules and eliminate undue 
restrictions on S corporations in order to expand the 
application of the S corporation provisions so that more 
corporations and their shareholders will be able to enjoy the 
benefits of subchapter S status.
    The Committee is aware of obstacles that have prevented 
banks from electing subchapter S status.\19\ The bill contains 
provisions that apply specifically to banks in order to remove 
these obstacles and make S corporation status more readily 
available to banks.
---------------------------------------------------------------------------
    \19\ See GAO/GGD-00-159, Banking Taxation, Implications of Proposed 
Revisions Governing S-Corporations on Community Banks (June 23, 2000), 
for discussion of issues relating to community banks electing 
subchapter S.
---------------------------------------------------------------------------
    The bill also revises the prohibited transaction rules 
applicable to employee stock ownership plans (``ESOPs'') 
maintained by S corporations in order to expand the ability to 
use distributions made with respect to S corporation stock held 
by an ESOP to repay a loan used to purchase the stock, subject 
to the same conditions that apply to C corporation dividends 
used to repay such a loan.

1. Shareholders of an S corporation

                              PRESENT LAW

In general

    A small business corporation may elect to be an S 
corporation with the consent of all its shareholders, and may 
terminate its election with the consent of shareholders holding 
more than 50 percent of the stock. A ``small business 
corporation'' is defined as a domestic corporation which is not 
an ineligible corporation and which has (1) no more than 75 
shareholders, all of whom are individuals (and certain trusts, 
estates, charities, and qualified retirement plans)\20\ who are 
citizens or residents of the United States, and (2) only one 
class of stock. For purposes of the 75-shareholder limitation, 
a husband and wife are treated as one shareholder. An 
``ineligible corporation'' means a corporation that is a 
financial institution using the reserve method of accounting 
for bad debts, an insurance company, a corporation electing the 
benefits of the Puerto Rico and possessions tax credit, or a 
Domestic International Sales Corporation (``DISC'') or former 
DISC.
---------------------------------------------------------------------------
    \20\ If a qualified retirement plan (other than an employee stock 
ownership plan) or a charity holds stock in an S corporation, the 
interest held is treated an an interest in an unrelated trade or 
business, and the plan or charity's share of the S corporation's items 
of income, loss, or deduction, and gain or loss on the disposition of 
the S corporation stock, are taken into account in computing unrelated 
business taxable income.
---------------------------------------------------------------------------

Individual retirement accounts

    An individual retirement account (``IRA'') is a trust or 
account established for the exclusive benefit of an individual 
and his or her beneficiaries. There are two general types of 
IRAs: traditional IRAs, to which both deductible and 
nondeductible contributions may be made, and Roth IRAs, 
contributions to which are not deductible. Amounts held in a 
traditional IRA are includible in income when withdrawn (except 
to the extent the withdrawal is a return of nondeductible 
contributions). Amounts held in a Roth IRA that are withdrawn 
as a qualified distribution are not includible in income; 
distributions from a Roth IRA that are not qualified 
distributions are includible in income to the extent 
attributable to earnings. A qualified distribution is a 
distribution that (1) is made after the five-taxable year 
period beginning with the first taxable year for which the 
individual made a contribution to a Roth IRA, and (2) is made 
after attainment of age 59\1/2\ on account of death or 
disability, or is made for first-time homebuyer expenses of up 
to $10,000.
    Under present law, an IRA cannot be a shareholder of an S 
corporation.
    Certain transactions are prohibited between an IRA and the 
individual for whose benefit the IRA is established, including 
a sale of property by the IRA to the individual. If a 
prohibited transaction occurs between an IRA and the IRA 
beneficiary, the account ceases to be an IRA, and an amount 
equal to the fair market value of the assets held in the IRA is 
deemed distributed to the beneficiary.

                        EXPLANATION OF PROVISION

In general

    The bill provides that all family members can elect to be 
treated as one shareholder for purposes of determining the 
number of shareholders in the corporation. A family is defined 
as the lineal descendants of a common ancestor (and their 
spouses). The common ancestor cannot be more than three 
generations removed from the youngest generation of shareholder 
at the time the S election is made (or the effective date of 
this provision, if later). Except as provided by Treasury 
regulations, the election may be made by any family member and 
the election remains in effect until terminated.
    The bill increases the maximum number of eligible 
shareholders from 75 to 100.

Individual retirement accounts

    The bill allows an IRA (including a Roth IRA) to be a 
shareholder of a bank that is an S corporation, but only to the 
extent of bank stock held by the IRA on the date of enactment 
of the provision.\21\
---------------------------------------------------------------------------
    \21\ Under the bill, the present-law rules treating S corporation 
stock held by a qualified retirement plan (other than an employee stock 
ownership plan) or a charity as an interest in an unrelated trade or 
business apply to an IRA holding S corporation stock of a bank.
---------------------------------------------------------------------------
    The bill also provides an exemption from prohibited 
transaction treatment for the sale by an IRA to the IRA 
beneficiary of bank stock held by the IRA on the date of 
enactment of the provision. Under the bill, a sale is not a 
prohibited transaction if: (1) the sale is pursuant to an S 
corporation election by the bank; (2) the sale is for fair 
market value (as established by an independent appraiser) and 
is on terms at least as favorable to the IRA as the terms would 
be on a sale to an unrelated party; (3) the IRA incurs no 
commissions, costs, or other expenses in connection with the 
sale; and (4) the stock is sold in a single transaction for 
cash not later than 120 days after the S corporation election 
is made.

                             EFFECTIVE DATE

    The provisions generally apply to taxable years beginning 
after December 31, 2003. The provision relating to IRAs takes 
effect on the date of enactment of the bill.

2. Treatment of S corporation shareholders

            (a) Electing small business trusts

                              PRESENT LAW

    An electing small business trust (``ESBT'') holding stock 
in an S corporation is taxed at the maximum individual tax rate 
on its ratable share of items of income, deduction, gain, or 
loss passing through from the S corporation. An ESBT generally 
is an electing trust all of whose beneficiaries are eligible S 
corporation shareholders. For purposes of determining the 
maximum number of shareholders, each person who is entitled to 
receive a distribution from the trust (``potential current 
beneficiary'') is treated as a shareholder during the period 
the person may receive a distribution from the trust.
    An ESBT has 60 days to dispose of the S corporation stock 
after an ineligible shareholder becomes a potential current 
beneficiary to avoid disqualification.

                        EXPLANATION OF PROVISION

    Under the bill, powers of appointment to the extent not 
exercised are disregarded in determining the potential current 
beneficiaries of an electing small business trust.
    The bill increases the period during which an ESBT can 
dispose of S corporation stock after an ineligible shareholder 
becomes a potential current beneficiary from 60 days to one 
year.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31, 2003.
            (b) Qualified subchapter S trusts

                              PRESENT LAW

    Under present law, the share of income of an S corporation 
whose stock is held by a qualified subchapter S trust 
(``QSST''), with respect to which the beneficiary makes an 
election, is taxed to the beneficiary. However, the trust, and 
not the beneficiary, is treated as the owner of the S 
corporation stock for purposes of determining the tax 
consequences of the disposition of the S corporation stock by 
the trust. A QSST generally is a trust with one individual 
income beneficiary for the life of the beneficiary.

                        EXPLANATION OF PROVISION

    Under the bill, the beneficiary of a qualified subchapter S 
trust is generally allowed to deduct suspended losses under the 
at-risk rules and the passive loss rules when the trust 
disposes of the S corporation stock.

                             EFFECTIVE DATE

    The provision applies to transfers made after December 31, 
2003.
            (c) Transfers of losses incident to divorce, etc.

                              PRESENT LAW

    Under present law, any loss or deduction that is not 
allowed to a shareholder of an S corporation, because the loss 
exceeds the shareholder's basis in stock and debt of the 
corporation, is treated as incurred by the corporation with 
respect to that shareholder in the subsequent taxable year.

                        EXPLANATION OF PROVISION

    Under the bill, if a shareholder's stock in an S 
corporation is transferred to a spouse, or to a former spouse 
incident to a divorce, any suspended loss or deduction with 
respect to that stock is treated as incurred by the corporation 
with respect to the transferee in the subsequent taxable year.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31, 2003.

3. Provisions relating to banks

            (a) Exclusion of investment securities income from passive 
                    investment income test for bank S corporations

                              PRESENT LAW

    An S corporation is subject to corporate-level tax, at the 
highest corporate tax rate, on its excess net passive income if 
the corporation has (1) accumulated earnings and profits at the 
close of the taxable year and (2) gross receipts more than 25 
percent of which are passive investment income. In addition, an 
S corporation election is terminated whenever the corporation 
has accumulated earnings and profits at the close of each of 
three consecutive taxable years and has gross receipts for each 
of those years more than 25 percent of which are passive 
investment income.
    Excess net passive income is the net passive income for a 
taxable year multiplied by a fraction, the numerator of which 
is the amount of passive investment income in excess of 25 
percent of gross receipts and the denominator of which is the 
passive investment income for the year. Net passive income is 
defined as passive investment income reduced by the allowable 
deductions that are directly connected with the production of 
that income. Passive investment income generally means gross 
receipts derived from royalties, rents, dividends, interest, 
annuities, and sales or exchanges of stock or securities (to 
the extent of gains). Passive investment income generally does 
not include interest on accounts receivable, gross receipts 
that are derived directly from the active and regular conduct 
of a lending or finance business, gross receipts from certain 
liquidations, or gain or loss from any section 1256 contract 
(or related property) of an options or commodities dealer.\22\
---------------------------------------------------------------------------
    \22\ IRS Notice 97-5, 1997-1 C.B. 352, sets forth guidance relating 
to passive investment income on banking assets.
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The bill provides that, in the case of a bank (as defined 
in section 581), a bank holding company (as defined in section 
2(a) of the Bank Holding Company Act of 1956), or a financial 
holding company (as defined in section 2(p) of that Act), 
interest income and dividends on assets required to be held by 
the bank or holding company are not treated as passive 
investment income for purposes of applying the excess net 
passive income rules.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31, 2003.
            (b) Treatment of bank director shares

                              PRESENT LAW

    An S corporation may have no more than 75 shareholders and 
may have only one outstanding class of stock.\23\
---------------------------------------------------------------------------
    \23\ Another provision of the bill increases the maximum number of 
shareholders to 100.
---------------------------------------------------------------------------
    An S corporation has one class of stock if all outstanding 
shares of stock confer identical rights to distribution and 
liquidation proceeds. Differences in voting rights are 
disregarded.\24\
---------------------------------------------------------------------------
    \24\ Treas. Reg. sec. 1.1361-1(1). The regulations provide that 
buy-sell and redemption agreements are disregarded in determining 
whether a corporation's outstanding shares confer identical 
distribution and liquidation rights unless (1) a principal purpose of 
the agreement is to circumvent the one class of stock requirement and 
(2) the agreement establishes a purchase price that, at the time the 
agreement is entered into, is significantly in excess of or below the 
fair market value of the stock.
---------------------------------------------------------------------------
    National banking law requires that a director of a national 
bank own stock in the bank and that the bank have at least five 
directors.\25\ A number of states have similar requirements for 
state-chartered banks. Apparently, it is common for bank 
directors to enter into agreements with the bank under which 
the director will sell the stock back to the bank upon ceasing 
to be a director at the price paid for the stock.\26\
---------------------------------------------------------------------------
    \25\ 12 U.S.C. secs. 71-72.
    \26\ For example, see Private Letter Ruling 200217048 (January 24, 
2002) describing such an agreement and holding that it creates a second 
class of stock.
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    Under the bill, restricted bank director stock shall not be 
taken into account as outstanding stock in applying the 
provisions of subchapter S. Thus, for example, the stock will 
not be treated as a second class of stock; the holder of the 
stock will not be treated as a shareholder by reason of the 
ownership of the stock; and the stock will be disregarded in 
allocating items of income, loss, etc. among the shareholders.
    Restricted bank director stock means shares in a bank (as 
defined in section 581), a bank holding company (within the 
meaning of section 2(a) of the Bank Holding Company Act of 
1956), or a financial holding company (as defined in section 
2(p) of that Act) held by an individual solely by reason of 
status as a director of the bank or company and which are 
subject to an agreement with the bank or holding company (or 
corporation in control of the bank or company) pursuant to 
which the holder agrees to sell the stock back upon ceasing to 
be a director at the same price the individual acquired the 
stock.
    Distributions (not in exchange for the stock) with respect 
to the restricted shares are includible in the gross income of 
the director and deductible by the corporation.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31, 2003.

4. Qualified subchapter S subsidiaries

            (a) Relief from inadvertently invalid qualified subchapter 
                    S subsidiary elections and terminations

                              PRESENT LAW

    Under present law, inadvertent invalid subchapter S 
elections and terminations may be waived.

                        EXPLANATION OF PROVISION

    The bill allows inadvertent invalid qualified subchapter S 
subsidiary elections and terminations to be waived by the IRS.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31, 2003.
            (b) Information returns for qualified subchapter S 
                    subsidiaries

                              PRESENT LAW

    Under present law, a corporation all of whose stock is held 
by an S corporation is treated as a qualified subchapter S 
subsidiary if the S corporation so elects. The assets, 
liabilities, and items of income, deduction, and credit of the 
subsidiary are treated as assets, liabilities, and items of the 
parent S corporation.

                        EXPLANATION OF PROVISION

    The bill provides authority to the Secretary to provide 
guidance regarding information returns of qualified subchapter 
S subsidiaries.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31, 2003.

5. S corporation distributions to an employee stock ownership plan

                              PRESENT LAW

    An employee stock ownership plan (an ``ESOP'') is a defined 
contribution plan that is designated as an ESOP and is designed 
to invest primarily in qualifying employer securities. For 
purposes of ESOP investments, a ``qualifying employer 
security'' is defined as: (1) publicly traded common stock of 
the employer or a member of the same controlled group; (2) if 
there is no such publicly traded common stock, common stock of 
the employer (or member of the same controlled group) that has 
both voting power and dividend rights at least as great as any 
other class of common stock; or (3) noncallable preferred stock 
that is convertible into common stock described in (1) or (2) 
and that meets certain requirements. In some cases, an employer 
may design a class of preferred stock that meets these 
requirements and that is held only by the ESOP. Special rules 
apply to ESOPs that do not apply to other types of qualified 
retirement plans, including a special exemption from the 
prohibited transaction rules.
    Certain transactions between an employee benefit plan and a 
disqualified person, including the employer maintaining the 
plan, are prohibited transactions that result in the imposition 
of an excise tax.\27\ Prohibited transactions include, among 
other transactions, (1) the sale, exchange or leasing of 
property, (2) the lending of money or other extension of 
credit, and (3) the transfer to, or use by or for the benefit 
of, the income or assets of the plan. However, certain 
transactions are exempt from prohibited transaction treatment, 
including certain loans to enable an ESOP to purchase 
qualifying employer securities.\28\ In such a case, the 
employer securities purchased with the loan proceeds are 
generally pledged as security for the loan. Contributions to 
the ESOP and dividends paid on employer stock held by the ESOP 
are used to repay the loan. The employer stock is held in a 
suspense account and released for allocation to participants' 
accounts as the loan is repaid.
---------------------------------------------------------------------------
    \27\ Sec. 4975.
    \28\ Sec. 4975(d)(3). An ESOP that borrows money to purchase 
employer stock is referred to as a ``leveraged'' ESOP.
---------------------------------------------------------------------------
    A loan to an ESOP is exempt from prohibited transaction 
treatment if the loan is primarily for the benefit of the 
participants and their beneficiaries, the loan is at a 
reasonable rate of interest, and the collateral given to a 
disqualified person consists of only qualifying employer 
securities. No person entitled to payments under the loan can 
have the right to any assets of the ESOP other than (1) 
collateral given for the loan, (2) contributions made to the 
ESOP to meet its obligations on the loan, and (3) earnings 
attributable to the collateral and the investment of 
contributions described in (2).\29\ In addition, the payments 
made on the loan by the ESOP during a plan year cannot exceed 
the sum of those contributions and earnings during the current 
and prior years, less loan payments made in prior years.
---------------------------------------------------------------------------
    \29\ Treas. reg. sec. 54.4975-7(b)(5).
---------------------------------------------------------------------------
    An ESOP of a C corporation is not treated as violating the 
qualification requirements of the Code or as engaging in a 
prohibited transaction merely because, in accordance with plan 
provisions, a dividend paid with respect to qualifying employer 
securities held by the ESOP is used to make payments on a loan 
(including payments of interest as well as principal) that was 
used to acquire the employer securities (whether or not 
allocated to participants).\30\ In the case of a dividend paid 
with respect to any employer security that is allocated to a 
participant, this relief does not apply unless the plan 
provides that employer securities with a fair market value of 
not less than the amount of the dividend is allocated to the 
participant for the year which the dividend would have been 
allocated to the participant.\31\
---------------------------------------------------------------------------
    \30\ Sec. 404(k)(5)(B).
    \31\ Sec. 404(k)(2)(B).
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    Under the provision, an ESOP maintained by an S corporation 
is not treated as violating the qualification requirements of 
the Code or as engaging in a prohibited transaction merely 
because, in accordance with plan provisions, a distribution 
made with respect to S corporation stock that constitutes 
qualifying employer securities held by the ESOP is used to 
repay a loan that was used to acquire the securities (whether 
or not allocated to participants). This relief does not apply 
in the case of a distribution with respect to S corporation 
stock that is allocated to a participant unless the plan 
provides that stock with a fair market value of not less than 
the amount of such distribution is allocated to the participant 
for the year which the distribution would have been allocated 
to the participant.

                             EFFECTIVE DATE

    The provision is effective for distributions made with 
respect to S corporation stock after December 31, 2003.

                          F. Employee Benefits


1. Treatment of nonqualified deferred compensation plans (sec. 1061 of 
        the bill and new sec. 409A and sec. 6051 of the Code)

                              PRESENT LAW

In general

    The determination of when amounts deferred under a 
nonqualified deferred compensation arrangement are includible 
in the gross income of the individual earning the compensation 
depends on the facts and circumstances of the arrangement. A 
variety of tax principles and Code provisions may be relevant 
in making this determination, including the doctrine of 
constructive receipt, the economic benefit doctrine,\32\ the 
provisions of section 83 relating generally to transfers of 
property in connection with the performance of services, and 
provisions relating specifically to nonexempt employee trusts 
(sec. 402(b)) and nonqualified annuities (sec. 403(c)).
---------------------------------------------------------------------------
    \32\ See, e.g., Sproull v. Commissioner, 16 T.C. 244 (1951), aff'd 
per curiam, 194 F.2d 541 (6th Cir. 1952); Rev. Rul. 60-31, 1960-1 C.B. 
174.
---------------------------------------------------------------------------
    In general, the time for income inclusion of nonqualified 
deferred compensation depends on whether the arrangement is 
unfunded or funded. If the arrangement is unfunded, then the 
compensation is generally includible in income when it is 
actually or constructively received. If the arrangement is 
funded, then income is includible for the year in which the 
individual's rights are transferable or not subject to a 
substantial risk of forfeiture.
    Nonqualified deferred compensation is generally subject to 
social security and Medicare taxes when the compensation is 
earned (i.e., when services are performed), unless the 
nonqualified deferred compensation is subject to a substantial 
risk of forfeiture. If nonqualified deferred compensation is 
subject to a substantial risk of forfeiture, it is subject to 
social security and Medicare tax when the risk of forfeiture is 
removed (i.e., when the right to the nonqualified deferred 
compensation vests). This treatment is not affected by whether 
the arrangement is funded or unfunded, which is relevant in 
determining when amounts are includible in income (and subject 
to income tax withholding).
    In general, an arrangement is considered funded if there 
has been a transfer of property under section 83. Under that 
section, a transfer of property occurs when a person acquires a 
beneficial ownership interest in such property. The term 
``property'' is defined very broadly for purposes of section 
83.\33\ Property includes real and personal property other than 
money or an unfunded and unsecured promise to pay money in the 
future. Property also includes a beneficial interest in assets 
(including money) that are transferred or set aside from claims 
of the creditors of the transferor, for example, in a trust or 
escrow account. Accordingly, if, in connection with the 
performance of services, vested contributions are made to a 
trust on an individual's behalf and the trust assets may be 
used solely to provide future payments to the individual, the 
payment of the contributions to the trust constitutes a 
transfer of property to the individual that is taxable under 
section 83. On the other hand, deferred amounts are generally 
not includible in income if nonqualified deferred compensation 
is payable from general corporate funds that are subject to the 
claims of general creditors, as such amounts are treated as 
unfunded and unsecured promises to pay money or property in the 
future.
---------------------------------------------------------------------------
    \33\ Treas. Reg. sec. 1.83-3(e). This definition in part reflects 
previous IRS rulings on nonqualified deferred compensation.
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    As discussed above, if the arrangement is unfunded, then 
the compensation is generally includible in income when it is 
actually or constructively received under section 451.\34\ 
Income is constructively received when it is credited to an 
individual's account, set apart, or otherwise made available so 
that it may be drawn on at any time. Income is not 
constructively received if the taxpayer's control of its 
receipt is subject to substantial limitations or restrictions. 
A requirement to relinquish a valuable right in order to make 
withdrawals is generally treated as a substantial limitation or 
restriction.
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    \34\ Treas. Reg. secs. 1.451-1 and 1.451-2.
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Rabbi trusts

    Arrangements have developed in an effort to provide 
employees with security for nonqualified deferred compensation, 
while still allowing deferral of income inclusion. A ``rabbi 
trust'' is a trust or other fund established by the employer to 
hold assets from which nonqualified deferred compensation 
payments will be made. The trust or fund is generally 
irrevocable and does not permit the employer to use the assets 
for purposes other than to provide nonqualified deferred 
compensation, except that the terms of the trust or fund 
provide that the assets are subject to the claims of the 
employer's creditors in the case of insolvency or bankruptcy.
    As discussed above, for purposes of section 83, property 
includes a beneficial interest in assets set aside from the 
claims of creditors, such as in a trust or fund, but does not 
include an unfunded and unsecured promise to pay money in the 
future. In the case of a rabbi trust, terms providing that the 
assets are subject to the claims of creditors of the employer 
in the case of insolvency or bankruptcy have been the basis for 
the conclusion that the creation of a rabbi trust does not 
cause the related nonqualified deferred compensation 
arrangement to be funded for income tax purposes.\35\ As a 
result, no amount is included in income by reason of the rabbi 
trust; generally income inclusion occurs as payments are made 
from the trust.
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    \35\ This conclusion was first provided in a 1980 private ruling 
issued by the IRS with respect to an arrangement covering a rabbi; 
hence the popular name ``rabbi trust.'' Priv. Ltr. Rul. 8113107 (Dec. 
31, 1980).
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    The IRS has issued guidance setting forth model rabbi trust 
provisions.\36\ Revenue Procedure 92-64 provides a safe harbor 
for taxpayers who adopt and maintain grantor trusts in 
connection with unfunded deferred compensation arrangements. 
The model trust language requires that the trust provide that 
all assets of the trust are subject to the claims of the 
general creditors of the company in the event of the company's 
insolvency or bankruptcy.
---------------------------------------------------------------------------
    \36\ Rev. Proc. 92-64, 1992-2 C.B. 422, modified in part by Notice 
2000-56, 2000-2 C.B. 393.
---------------------------------------------------------------------------
    Since the concept of rabbi trusts was developed, 
arrangements have developed which attempt to protect the assets 
from creditors despite the terms of the trust. Arrangements 
also have developed which effectively allow deferred amounts to 
be available to individuals, while still meeting the safe 
harbor requirements set forth by the IRS.

                           REASONS FOR CHANGE

    The Committee is aware of the popular use of deferred 
compensation arrangements by executives to defer current 
taxation of substantial amounts of income. The Committee 
believes that many nonqualified deferred compensation 
arrangements have developed which allow improper deferral of 
income. Executives often use arrangements that allow deferral 
of income, but also provide security of future payment and 
control over amounts deferred. For example, nonqualified 
deferred compensation arrangements often contain provisions 
that allow participants to receive distributions upon request, 
subject to forfeiture of a minimal amount (i.e., a ``haircut'' 
provision).
    Since the concept of a rabbi trust was developed, 
techniques have developed that attempt to protect the assets 
from creditors despite the terms of the trust. For example, the 
trust or fund may be located in a foreign jurisdiction, making 
it difficult or impossible for creditors to reach the assets.
    While the general tax principles governing deferred 
compensation are well established, the determination whether a 
particular arrangement effectively allows deferral of income is 
generally made on a facts and circumstances basis. There is 
limited specific guidance with respect to common deferral 
arrangements. The Committee believes that it is appropriate to 
provide specific rules regarding whether deferral of income 
inclusion should be permitted.
    The Committee believes that, consistent with the intent of 
current law, certain arrangements that allow participants 
inappropriate levels of control or access to amounts deferred 
should not result in deferral of income inclusion. The 
Committee also believes that certain arrangements, such as 
offshore trusts, which effectively protect assets from 
creditors, should be treated as funded and not result in 
deferral of income inclusion.\37\
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    \37\ The staff of the Joint Committee on Taxation made 
recommendations similar to the new provision in the report on their 
investigation of Enron Corporation, which detailed how executives 
deferred millions of dollars in Federal income taxes through 
nonqualified deferred compensation arrangements. See Joint Committee on 
Taxation, ``Report of Investigation of Enron Corporation and Related 
Entities Regarding Federal Tax and Compensation Issues, and Policy 
Recommendations'' (JCS-3-03), February 2003.
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                        EXPLANATION OF PROVISION

    Under the provision, all amounts deferred under a 
nonqualified deferred compensation plan \38\ for all taxable 
years are currently includible in gross income to the extent 
not subject to a substantial risk of forfeiture \39\ and not 
previously included in gross income, unless certain 
requirements are satisfied. If the requirements of the 
provision are not satisfied, in addition to current income 
inclusion, interest at the underpayment rate plus one 
percentage point is imposed on the underpayments that would 
have occurred had the compensation been includible in income 
when first deferred, or if later, when not subject to a 
substantial risk of forfeiture. Actual or notional earnings on 
amounts deferred are also subject to the provision.
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    \38\ A plan includes an agreement or arrangement, including an 
agreement or arrangement that includes one person.
    \39\ As under section 83, the rights of a person to compensation 
are subject to a substantial risk of forfeiture if the person's rights 
to such compensation are conditioned upon the performance of 
substantial services by any individual.
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    Under the provision, distributions from a nonqualified 
deferred compensation plan may be allowed only upon separation 
from service (as determined by the Secretary), disability, 
death, a specified time (or pursuant to a fixed schedule), 
change in control in a corporation (to the extent provided by 
the Secretary), or occurrence of an unforeseeable emergency. A 
nonqualified deferred compensation plan may not allow 
distributions other than upon the permissible distribution 
events and may not permit acceleration of a distribution, 
except as provided in regulations by the Secretary.
    In the case of a specified employee, distributions upon 
separation from service may not be made earlier than six months 
after the date of the separation from service. Specified 
employees are key employees\40\ of publicly-traded 
corporations.
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    \40\ Key employees are defined in section 416(i) and generally 
include officers having annual compensation greater than $130,000 
(adjusted for inflation and limited to 50 employees), five percent 
owners, and one percent owners having annual compensation from the 
employer greater than $150,000.
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    Disability is defined as under the Social Security Act. 
Under such definition, an individual is considered to be 
disabled if he or she is unable to engage in any substantial 
gainful activity by reason of any medically determinable 
physical or mental impairment which can be expected to result 
in death or which has lasted or can be expected to last for a 
continuous period of not less than twelve months. In 
determining if a participant is disabled, a determination 
letter from the Social Security Administration is not required. 
It is intended that a nonqualified deferred compensation plan 
provide that the determination of whether a participant is 
disabled must be based on the Social Security Administration 
statutory standard.
    Amounts payable at a specified time or pursuant to a fixed 
schedule must be specified under the plan at the time of 
deferral. Amounts payable upon the occurrence of an event are 
not treated as amounts payable at a specified time. For 
example, amounts payable when an individual attains age 65 are 
payable at a specified time, while amounts payable when an 
individual's child begins college are payable upon the 
occurrence of an event.
    Distributions upon a change in the ownership or effective 
control of a corporation, or in the ownership of a substantial 
portion of the assets of a corporation, may only be made to the 
extent provided by the Secretary. It is intended that the 
Secretary use a similar, but more restrictive, definition of 
change in control as is used for purposes of the golden 
parachute provisions of section 280G consistent with the 
purposes of the provision. The provision requires the Secretary 
to issue guidance defining change of control within 90 days 
after the date of enactment.
    An unforeseeable emergency is defined as a severe financial 
hardship to the participant resulting from a sudden and 
unexpected illness or accident of the participant, the 
participant's spouse, or a dependent (as defined in 152(a)) of 
the participant; loss of the participant's property due to 
casualty; or other similar extraordinary and unforeseeable 
circumstances arising as a result of events beyond the control 
of the participant. The amount of the distribution must be 
limited to the amount needed to satisfy the emergency plus 
taxes reasonably anticipated as a result of the distribution. 
Distributions may not be allowed to the extent that the 
hardship may be relieved through reimbursement or compensation 
by insurance or otherwise, or by liquidation of the 
participant's assets (to the extent such liquidation would not 
itself cause a severe financial hardship).
    As previously discussed, except as provided in regulations 
by the Secretary, no accelerations of distributions may be 
allowed. For example, changes in the form of a distribution 
from an annuity to a lump sum are not permitted. The provision 
provides the Secretary authority to provide, through 
regulations, limited exceptions to the general rule that no 
accelerations can be permitted. It is intended that exceptions 
be provided only in limited cases where the accelerated 
distribution is required for reasons beyond the control of the 
participant. For example, it is anticipated that an exception 
could be provided in order to comply with Federal conflict of 
interest requirements or court-approved settlements.
    The provision requires that the plan must provide that 
compensation for services performed during a taxable year may 
be deferred at the participant's election only if the election 
to defer is made during the preceding taxable year, or at such 
other time as provided in Treasury regulations. In the first 
year that an employee becomes eligible for participation in a 
nonqualified deferred compensation plan, the election may be 
made within 30 days after the date that the employee is 
initially eligible.
    Under the provision, a plan may allow changes in the time 
and form of distributions subject to certain requirements. A 
nonqualified deferred compensation plan may allow a subsequent 
election to delay the timing or form of distributions only if: 
(1) the plan requires that such election cannot be effective 
for at least 12 months after the date on which the election is 
made; (2) except in the case of elections relating to 
distributions on account of death, disability or unforeseeable 
emergency, the plan requires that the additional deferral with 
respect to which such election is made is for a period of not 
less than five years from the date such payment would otherwise 
have been made; and (3) the plan requires that an election 
related to a distribution to be made upon a specified time may 
not be made less than 12 months prior to the date of the first 
scheduled payment. It is expected that the Secretary shall 
issue guidance regarding to what extent elections to change a 
steam of payments are permissible.
    If impermissible distributions or elections are made, or if 
the nonqualified deferred compensation plan allows 
impermissible distributions or elections, all amounts deferred 
under the plan (including amounts deferred in prior years) are 
currently includible in income to the extent not subject to a 
substantial risk of forfeiture and not previously included in 
income. In addition, interest at the underpayment rate plus one 
percentage point is imposed on the underpayments that would 
have occurred had the compensation been includible in income 
when first deferred, or if later, when not subject to a 
substantial risk of forfeiture.
    Under the provision, in the case of assets held in a trust 
or set aside (directly or indirectly) in another arrangement, 
as determined by the Secretary, for purposes of paying 
nonqualified deferred compensation, such assets are treated as 
property transferred in connection with the performance of 
services under section 83 at the time set aside or transferred 
outside of the United States (whether or not such assets are 
available to satisfy the claims of general creditors). Any 
increases in the value of, or any earnings with respect to, 
such assets are treated as additional transfers of property. 
Interest at the underpayment rate plus one percentage point is 
imposed on the underpayments that would have occurred had the 
amounts been includible in income for the taxable year such 
assets were first set aside for purposes of nonqualified 
deferred compensation. The Secretary has authority to exempt 
arrangements from the provision if the arrangements do not 
result in an improper deferral of U.S. tax and will not result 
in assets being effectively beyond the reach of creditors.
    Under the provision, a transfer of property in connection 
with the performance of services under section 83 also occurs 
if a nonqualified deferred compensation plan provides that, 
upon a change in the employer's financial health, assets will 
be restricted to the payment of nonqualified deferred 
compensation. The transfer of property occurs as of the earlier 
of when the assets are so restricted or when the plan provides 
that assets will be restricted. Any increases in the value of, 
or any earnings with respect to, such assets are treated as 
additional transfers of property. Interest at the underpayment 
rate plus one percentage point is imposed on the underpayments 
that would have occurred had the amounts been includible in 
income for the taxable year such assets were first set aside 
for purposes of nonqualified deferred compensation.
    A nonqualified deferred compensation plan is any plan that 
provides for the deferral of compensation other than a 
qualified employer plan or any bona fide vacation leave, sick 
leave, compensatory time, disability pay, or death benefit 
plan. A qualified employer plan means a qualified retirement 
plan, tax-deferred annuity, simplified employee pension, and 
SIMPLE.\41\ A governmental eligible deferred compensation plan 
(sec. 457) is also a qualified employer plan under the 
provision.
---------------------------------------------------------------------------
    \41\ A qualified employer plan also includes a section 501(c)(18) 
trust.
---------------------------------------------------------------------------
    Interest imposed under the provision is treated as interest 
on an underpayment of tax. Income (whether actual or notional) 
attributable to nonqualified deferred compensation is treated 
as additional deferred compensation and is subject to the 
provision. The provision is not intended to prevent the 
inclusion of amounts in gross income under any provision or 
rule of law earlier than the time provided in the provision. 
Any amount included in gross income under the provision shall 
not be required to be included in gross income under any 
provision of law later than the time provided in the provision. 
The provision does not affect the rules regarding the timing of 
an employer's deduction for nonqualified deferred compensation.
    The provision requires annual reporting to the Internal 
Revenue Service of amounts deferred. Such amounts are required 
to be reported on an individual's Form W-2 for the year 
deferred even if the amount is not currently includible in 
income for that taxable year. Under the provision, the 
Secretary is authorized, through regulations, to establish a 
minimum amount of deferrals below which the reporting 
requirement does not apply. The Secretary may also provide that 
the reporting requirement does not apply with respect to 
amounts of deferrals that are not reasonably ascertainable. It 
is intended that the exception for amounts not reasonably 
ascertainable only apply to nonaccount balance plans and that 
amounts be required to be reported when they first become 
reasonably ascertainable.\42\
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    \42\ It is intended that the exception be similar to that under 
Treas. Regs. sec. 31.3121(v)(2)-1(e)(4).
---------------------------------------------------------------------------
    The provision provides the Secretary authority to prescribe 
regulations as are necessary to carry out the purposes of 
provision, including regulations: (1) providing for the 
determination of amounts of deferral in the case of defined 
benefit plans; (2) relating to changes in the ownership and 
control of a corporation or assets of a corporation; (3) 
exempting from the provisions providing for transfers of 
property arrangements that will not result in an improper 
deferral of U.S. tax and will not result in assets being 
effectively beyond the reach of creditors; (4) defining 
financial health; and (5) disregarding a substantial risk of 
forfeiture.
    It is intended that substantial risk of forfeitures may not 
be used to manipulate the timing of income inclusion. It is 
intended that substantial risks of forfeiture should be 
disregarded in cases in which they are illusory or are 
principally used to postpone the timing of income inclusion. 
For example, if an executive is effectively able to control the 
acceleration of the lapse of a substantial risk of forfeiture, 
such risk of forfeiture should be disregarded and income 
inclusion should not be postponed on account of such 
restriction.

                             EFFECTIVE DATE

    The provision is effective for amounts deferred in taxable 
years beginning after December 31, 2003.
    The provision does not apply to amounts deferred in a 
taxable year beginning after December 31, 2003, and before 
January 1, 2005, pursuant to an irrevocable election or binding 
arrangement made before October 24, 2003. Amounts deferred in 
taxable years beginning after December 31, 2004, even if 
pursuant to an election made before October 24, 2003, are 
subject to the provision. Earnings on amounts deferred before 
the effective date are subject to the provision to the extent 
that such amounts deferred are subject to the provision.
    No later than 90 days after the date of enactment, the 
Secretary shall issue guidance providing a limited period of 
time during which an individual participating in a nonqualified 
deferred compensation plan adopted on or before December 31, 
2003, may, without violating the requirements of the provision, 
terminate participation or cancel an outstanding deferral 
election with regard to amounts earned after December 31, 2003, 
if such amounts are includible in income as earned.
    Existing nonqualified deferred compensation plans will have 
to be amended to comply with the modifications made by this 
provision. It is the intent of the Committee that, immediately 
following the date of enactment, the Secretary shall issue 
guidance providing that employers shall have a limited period 
of time to amend the terms of existing plans relating to 
amounts deferred pursuant to deferral elections made after 
October 23, 2003, and before January 1, 2004.

2. Exclusion of incentive stock options and employee stock purchase 
        plan stock options from wages (sec. 1062 of the bill and secs. 
        421(b), 423(c), 3121(a), 3231, and 3306(b) of the Code)

                              PRESENT LAW

    Generally, when an employee exercises a compensatory option 
on employer stock, the difference between the option price and 
the fair market value of the stock (i.e., the ``spread'') is 
includible in income as compensation. In the case of an 
incentive stock option or an option to purchase stock under an 
employee stock purchase plan (collectively referred to as 
``statutory stock options''), the spread is not included in 
income at the time of exercise.\43\
---------------------------------------------------------------------------
    \43\ Sec. 421. For purposes of the individual alternative minimum 
tax, the transfer of stock pursuant to an incentive stock option is 
generally treated as the transfer of stock pursuant to a nonstatutory 
option. Sec. 56(b)(3).
---------------------------------------------------------------------------
    If the statutory holding period requirements are satisfied 
with respect to stock acquired through the exercise of a 
statutory stock option, the spread, and any additional 
appreciation, will be taxed as capital gain upon disposition of 
such stock. Compensation income is recognized, however, if 
there is a disqualifying disposition (i.e., if the statutory 
holding period is not satisfied) of stock acquired pursuant to 
the exercise of a statutory stock option.
    Federal Insurance Contribution Act (``FICA'') and Federal 
Unemployment Tax Act (``FUTA'') taxes (collectively referred to 
as ``employment taxes'') are generally imposed in an amount 
equal to a percentage of wages paid by the employer with 
respect to employment.\44\ The applicable Code provisions \45\ 
do not provide a specific exception from FICA and FUTA taxes 
for wages paid to an employee arising from the exercise of a 
statutory stock option, i.e., for the excess of the fair market 
value of the stock at the time of exercise over the amount paid 
for the stock by the individual.
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    \44\ Secs. 3101, 3111 and 3301.
    \45\ Secs. 3121 and 3306
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    In January 2001, the Internal Revenue Service issued notice 
of its intent to clarify, through future guidance, the 
application of FICA, FUTA, and Federal income tax withholding 
to statutory stock options.\46\ Proposed Treasury regulations 
issued in November 2001 provided that the payment of FICA and 
FUTA taxes upon the exercise of statutory stock options would 
apply to the exercise of statutory stock options on or after 
January 1, 2003.\47\ Federal income tax withholding was not 
required under the proposed regulations.
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    \46\ Notice 2001-14, 2001-6 I.R.B. 516.
    \47\ 66 Fed. Reg. 57023 (Nov. 14, 2001).
---------------------------------------------------------------------------
    On June 25, 2002, the IRS announced that until further 
guidance is issued, it would not assess FICA or FUTA taxes, or 
impose Federal income tax withholding obligations, upon either 
the exercise of a statutory stock option or the disposition of 
stock acquired pursuant to the exercise of a statutory stock 
option.\48\
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    \48\ Notice 2002-47, 2002-28 I.R.B. 97.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    To provide taxpayers certainty, the Committee believes that 
it is appropriate to clarify the treatment of statutory stock 
options for employment tax and income tax withholding purposes. 
The Committee believes that in the past, the IRS has been 
inconsistent in its treatment of taxpayers with respect to this 
issue and did not uniformly challenge taxpayers who did not 
collect employment taxes and withhold income taxes on statutory 
stock options.
    Until January 2001, the IRS had not published guidance with 
respect to the imposition of employment taxes and income tax 
withholding on statutory stock options. Many taxpayers relied 
on guidance published with respect to qualified stock options 
(the predecessor to incentive stock options) to take the 
position that no employment taxes or income tax withholding 
were required with respect to statutory stock options. It is 
the Committee's belief that a majority of taxpayers did not 
withhold employment and income taxes with respect to statutory 
stock options. Thus, the proposed IRS regulations would have 
altered the treatment of statutory stock options for most 
employers.
    Because there is a specific income tax exclusion with 
respect to statutory stock options, the Committee believes it 
is appropriate to clarify that there is a conforming exclusion 
for employment taxes and income tax withholding. Statutory 
stock options are required to meet certain Code requirements 
that do not apply to nonqualified stock options. The Committee 
believes that such requirements are intended to make statutory 
stock options a tool of employee ownership rather than a form 
of compensation subject to employment taxes. Furthermore, this 
clarification will ensure that, if further IRS guidance is 
issued, employees will not be faced with a tax increase that 
will reduce their net paychecks even though their total 
compensation has not changed.
    The clarification will also eliminate the administrative 
burden and cost to employers who, in the absence of the 
Committee bill, could be required to modify their payroll 
systems to provide for the withholding of income and employment 
taxes on statutory stock options that they are not currently 
required to withhold.

                        EXPLANATION OF PROVISION

    The provision provides specific exclusions from FICA and 
FUTA wages for remuneration on account of the transfer of stock 
pursuant to the exercise of an incentive stock option or under 
an employee stock purchase plan, or any disposition of such 
stock. Thus, under the provision, FICA and FUTA taxes do not 
apply upon the exercise of a statutory stock option.\49\ The 
provision also provides that such remuneration is not taken 
into account for purposes of determining Social Security 
benefits.
---------------------------------------------------------------------------
    \49\ The provision also provides a similar exclusion under the 
Railroad Retirement Tax Act.
---------------------------------------------------------------------------
    Additionally, the provision provides that Federal income 
tax withholding is not required on a disqualifying disposition, 
nor when compensation is recognized in connection with an 
employee stock purchase plan discount. Present-law reporting 
requirements continue to apply.

                             EFFECTIVE DATE

    The provision is effective for stock acquired pursuant to 
options exercised after the date of enactment.

3. Extension of provision permitting qualified transfers of excess 
        pension assets to retiree health accounts (sec. 1063 of the 
        bill and sec. 420 of the Code)

                              PRESENT LAW

    Defined benefit plan assets generally may not revert to an 
employer prior to termination of the plan and satisfaction of 
all plan liabilities. In addition, a reversion of plan assets 
to the employer may occur only if the plan so provides. A 
reversion prior to plan termination may constitute a prohibited 
transaction and may result in plan disqualification. Any assets 
that revert to the employer upon plan termination are 
includible in the gross income of the employer and subject to 
an excise tax. The excise tax rate is 20 percent if the 
employer maintains a replacement plan or makes certain benefit 
increases in connection with the termination; if not, the 
excise tax rate is 50 percent. Upon plan termination, the 
accrued benefits of all plan participants are required to be 
100-percent vested.
    A pension plan may provide medical benefits to retired 
employees through a separate account that is part of such plan. 
A qualified transfer of excess assets of a defined benefit plan 
to such a separate account within the plan may be made in order 
to fund retiree health benefits.\50\ A qualified transfer does 
not result in plan disqualification, is not a prohibited 
transaction, and is not treated as a reversion. Thus, 
transferred assets are not includible in the gross income of 
the employer and are not subject to the excise tax on 
reversions. No more than one qualified transfer may be made in 
any taxable year.
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    \50\ Sec. 420.
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    Excess assets generally means the excess, if any, of the 
value of the plan's assets \51\ over the greater of (1) the 
lesser of (a) the accrued liability under the plan (including 
normal cost) or (b) 170 percent of the plan's current liability 
(for 2003),\52\ or (2) 125 percent of the plan's current 
liability. In addition, excess assets transferred in a 
qualified transfer may not exceed the amount reasonably 
estimated to be the amount that the employer will pay out of 
such account during the taxable year of the transfer for 
qualified current retiree health liabilities. No deduction is 
allowed to the employer for (1) a qualified transfer or (2) the 
payment of qualified current retiree health liabilities out of 
transferred funds (and any income thereon).
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    \51\ The value of plan assets for this purpose is the lesser of 
fair market value or acturial value.
    \52\ These amounts relate to the full funding limit for defined 
benefit plans. The current liability full funding limit is repealed for 
years beginning after 2003. Under the general sunset provision of the 
Economic Growth and Tax Relief Reconciliation Act of 2001 (``EGTRRA'') 
the limit is reinstated for years after 2010.
---------------------------------------------------------------------------
    Transferred assets (and any income thereon) must be used to 
pay qualified current retiree health liabilities for the 
taxable year of the transfer. Transferred amounts generally 
must benefit pension plan participants, other than key 
employees, who are entitled upon retirement to receive retiree 
medical benefits through the separate account. Retiree health 
benefits of key employees may not be paid out of transferred 
assets.
    Amounts not used to pay qualified current retiree health 
liabilities for the taxable year of the transfer are to be 
returned to the general assets of the plan. These amounts are 
not includible in the gross income of the employer, but are 
treated as an employer reversion and are subject to a 20-
percent excise tax.
    In order for the transfer to be qualified, accrued 
retirement benefits under the pension plan generally must be 
100-percent vested as if the plan terminated immediately before 
the transfer (or in the case of a participant who separated in 
the one-year period ending on the date of the transfer, 
immediately before the separation).
    In order for a transfer to be qualified, the employer 
generally must maintain retiree health benefit costs at the 
same level for the taxable year of the transfer and the 
following four years.
    In addition, the Employee Retirement Income Security Act of 
1974 (``ERISA'') provides that, at least 60 days before the 
date of a qualified transfer, the employer must notify the 
Secretary of Labor, the Secretary, employee representatives, 
and the plan administrator of the transfer, and the plan 
administrator must notify each plan participant and beneficiary 
of the transfer.\53\
---------------------------------------------------------------------------
    \53\ ERISA sec. 101(e). ERISA also provides that a qualified 
transfer is not a prohibited transaction under ERISA or a prohibited 
reversion.
---------------------------------------------------------------------------
    No qualified transfers may be made after December 31, 2005.

                           REASONS FOR CHANGE

    The Committee believes it is appropriate to extend the 
ability of employers to fund retiree health benefits through 
the transfer of excess pension assets.

                        EXPLANATION OF PROVISION

    The provision allows qualified transfers of excess defined 
benefit plan assets through December 31, 2013.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

                     G. Treatment of Active Income


1. Treatment of European Union as one country for purposes of the 
        foreign base company sales and services rules (sec. 1071 of the 
        bill and sec. 954 of the Code)

                              PRESENT LAW

    In general, the subpart F rules (secs. 951-964) require 
U.S. shareholders with a 10-percent or greater interest in a 
controlled foreign corporation to include currently in income 
for U.S. tax purposes certain passive and other income of the 
controlled foreign corporation (referred to as ``subpart F 
income''), without regard to whether the income is distributed 
to the shareholders (sec. 951(a)(1)(A)). In effect, the Code 
treats the U.S. 10-percent shareholders of a controlled foreign 
corporation as having received a current distribution of their 
pro rata shares of the controlled foreign corporation's subpart 
F income. The amounts included in income by the controlled 
foreign corporation's U.S. 10-percent shareholders under these 
rules are subject to U.S. tax currently. The U.S. tax on such 
amounts may be reduced through foreign tax credits.
    Subpart F income encompasses certain categories of non-
passive income, including foreign base company sales and 
services income (sec. 954(a)). Foreign base company sales 
income generally consists of sales income of a controlled 
foreign corporation located in a country that is neither the 
origin nor the destination of the goods with respect to sales 
of property purchased from or sold to a related person (sec. 
954(d)). Foreign base company services income consists of 
income from services performed outside the controlled foreign 
corporation's country of incorporation for or on behalf of a 
related party (sec. 954(e)).
    A special branch rule applies only for purposes of 
determining a controlled foreign corporation's foreign base 
company sales income. Under this rule, a branch of a controlled 
foreign corporation is treated as a separate corporation where 
the activities of the controlled foreign corporation through 
the branch outside the controlled foreign corporation's country 
of incorporation have substantially the same effect as if such 
branch were a subsidiary (sec. 954(d)(2)).
    For purposes of the subpart F rules, a related person is 
defined as any individual, corporation, trust, or estate that 
controls or is controlled by the controlled foreign 
corporation, or any individual, corporation, trust, or estate 
that is controlled by the same person or persons that control 
the controlled foreign corporation (sec. 954(d)(3)). Control 
with respect to a corporation means ownership of more than 50 
percent of the corporation's stock (by vote or value). Control 
with respect to a partnership, trust, or estate means ownership 
of more than 50 percent of the value of the beneficial 
interests of the partnership, trust, or estate. Indirect and 
constructive ownership rules apply.
    The European Union (``EU'') is a union of independent 
states founded with a goal to enhance political, economic and 
social co-operation between its members. For example, the EU 
member states have entered into a series of agreements, 
including the Parent-Subsidiary Directive, that remove certain 
intra-EU cross-border tax barriers between EU companies, 
thereby providing a tax advantage to EU-based companies with EU 
subsidiaries over U.S.-based companies with EU subsidiaries. 
The current member states of the EU are Belgium, Denmark, 
Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, The 
Netherlands, Austria, Portugal, Sweden, Finland and the United 
Kingdom. As of January 1, 2004, the European Union will admit 
Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, 
Malta, Poland, Slovakia and Slovenia. Bulgaria, Romania and 
Turkey have applied for admittance.

                           REASONS FOR CHANGE

    Because the EU has taken steps to remove barriers to trade 
between member states and to create a single market in which 
goods, services and capital can move freely between members, 
the Committee believes that the foreign base company sales and 
foreign base company services rules should be revised to allow 
U.S.-based companies to structure their operations in a way 
that reflects these developments. The Committee further 
believes that these changes are necessary to ensure that U.S. 
companies can compete on a more even basis against their 
foreign competitors. The Committee believes that this change 
will increase U.S. company competitiveness in the EU and 
increase exports from the United States, thus increasing U.S. 
production and U.S. jobs.
    The Committee notes the importance of continuing to examine 
the operation of these rules, which were enacted over 40 years 
ago. The Committee believes that it is important for Congress 
and the Department of the Treasury to look closely at further 
updating these outdated rules that, for example, include rules 
that were developed before the dramatic evolution of the 
service sector in the global economy.

                        DESCRIPTION OF PROVISION

    The proposal treats all of the member states of the EU as 
one country for purposes of the foreign base company sales and 
foreign base company services rules.

                             EFFECTIVE DATE

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2008, and taxable 
years of U.S. shareholders with or within which such taxable 
years of foreign corporations end.

2. Look-through treatment of payments between related controlled 
        foreign corporations under foreign personal holding company 
        income rules (sec. 1072 of the bill and sec. 954 of the Code)

                              PRESENT LAW

    In general, the rules of subpart F (secs. 951-964) require 
U.S. shareholders with a 10-percent or greater interest in a 
controlled foreign corporation to include certain income of the 
controlled foreign corporation (referred to as ``subpart F 
income'') on a current basis for U.S. tax purposes, regardless 
of whether the income is distributed to the shareholders.
    Subpart F income includes foreign base company income. One 
category of foreign base company income is foreign personal 
holding company income. For subpart F purposes, foreign 
personal holding company income generally includes dividends, 
interest, rents and royalties, among other types of income. 
However, foreign personal holding company income does not 
include dividends and interest received by a controlled foreign 
corporation from a related corporation organized and operating 
in the same foreign country in which the controlled foreign 
corporation is organized, or rents and royalties received by a 
controlled foreign corporation from a related corporation for 
the use of property within the country in which the controlled 
foreign corporation is organized. Interest, rent, and royalty 
payments do not qualify for this exclusion to the extent that 
such payments reduce the subpart F income of the payor.

                           REASONS FOR CHANGE

    Most countries allow their companies to redeploy foreign 
active earnings with no additional tax burden. In fact, many 
countries, including several EU countries, do not impose a home 
country tax on active income earned outside the home country's 
borders. The Committee believes that this provision will make 
U.S. companies and U.S. workers more competitive with respect 
to such countries. By allowing U.S. companies to reinvest their 
active foreign earnings where they are most needed without 
incurring the immediate additional tax that companies based in 
many other countries never incur, the Committee believes that 
the provision will enable U.S. companies to make more sales 
overseas, and thus, produce more goods in the United States.

                        EXPLANATION OF PROVISION

    Under the provision, dividends, interest, rents, and 
royalties received by one controlled foreign corporation from a 
related controlled foreign corporation are not treated as 
foreign personal holding company income to the extent 
attributable to non-subpart-F earnings of the payor. For these 
purposes, a related controlled foreign corporation is a 
controlled foreign corporation that controls or is controlled 
by the other controlled foreign corporation, or a controlled 
foreign corporation that is controlled by the same person or 
persons that control the other controlled foreign corporation. 
Ownership of more than 50 percent of the controlled foreign 
corporation's stock (by vote or value) constitutes control for 
these purposes.

                             EFFECTIVE DATE

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2006, and taxable 
years of U.S. shareholders with or within which such taxable 
years of foreign corporations end.

3. Look-through treatment for sales of partnership interests (sec. 1073 
        of the bill and sec. 954 of the Code)

                              PRESENT LAW

    In general, the subpart F rules (secs. 951-964) require 
U.S. shareholders with a 10-percent or greater interest in a 
controlled foreign corporation to include in income currently 
for U.S. tax purposes certain types of income of the controlled 
foreign corporation, whether or not such income is actually 
distributed currently to the shareholders (referred to as 
``subpart F income''). Subpart F income includes foreign 
personal holding company income. Foreign personal holding 
company income generally consists of the following: (1) 
dividends, interest, royalties, rents, and annuities; (2) net 
gains from the sale or exchange of (a) property that gives rise 
to the preceding types of income, (b) property that does not 
give rise to income, and (c) interests in trusts, partnerships, 
and REMICs; (3) net gains from commodities transactions; (4) 
net gains from foreign currency transactions; (5) income that 
is equivalent to interest; (6) income from notional principal 
contracts; and (7) payments in lieu of dividends. Thus, if a 
controlled foreign corporation sells a partnership interest at 
a gain, the gain generally constitutes foreign personal holding 
company income and is included in the income of 10-percent U.S. 
shareholders of the controlled foreign corporation as subpart F 
income.

                           REASONS FOR CHANGE

    The Committee believes that the sale of a partnership 
interest by a controlled foreign corporation that owns a 
significant interest in the partnership should constitute 
subpart F income only to the extent that a proportionate sale 
of the underlying partnership assets attributable to the 
partnership interest would constitute subpart F income.

                        EXPLANATION OF PROVISION

    The provision treats the sale by a controlled foreign 
corporation of a partnership interest as a sale of the 
proportionate share of partnership assets attributable to such 
interest for purposes of determining subpart F foreign personal 
holding company income. This rule applies only to partners 
owning directly or indirectly at least 25 percent of a capital 
or profits interest in the partnership. Thus, the sale of a 
partnership interest by a controlled foreign corporation that 
meets this ownership threshold constitutes subpart F income 
under the provision only to the extent that a proportionate 
sale of the underlying partnership assets attributable to the 
partnership interest would constitute subpart F income.

                             EFFECTIVE DATE

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2006, and taxable 
years of U.S. shareholders with or within which such taxable 
years of foreign corporations end.

4. Repeal of foreign personal holding company rules and foreign 
        investment company rules (sec. 1074 of the bill and secs. 542, 
        551-558, 954, 1246, and 1247 of the Code)

                              PRESENT LAW

    Income earned by a foreign corporation from its foreign 
operations generally is subject to U.S. tax only when such 
income is distributed to any U.S. persons that hold stock in 
such corporation. Accordingly, a U.S. person that conducts 
foreign operations through a foreign corporation generally is 
subject to U.S. tax on the income from those operations when 
the income is repatriated to the United States through a 
dividend distribution to the U.S. person. The income is 
reported on the U.S. person's tax return for the year the 
distribution is received, and the United States imposes tax on 
such income at that time. The foreign tax credit may reduce the 
U.S. tax imposed on such income.
    Several sets of anti-deferral rules impose current U.S. tax 
on certain income earned by a U.S. person through a foreign 
corporation. Detailed rules for coordination among the anti-
deferral rules are provided to prevent the U.S. person from 
being subject to U.S. tax on the same item of income under 
multiple rules.
    The Code sets forth the following anti-deferral rules: the 
controlled foreign corporation rules of subpart F (secs. 951-
964); the passive foreign investment company rules (secs. 1291-
1298); the foreign personal holding company rules (secs. 551-
558); the personal holding company rules (secs. 541-547); the 
accumulated earnings tax rules (secs. 531-537); and the foreign 
investment company rules (secs. 1246-1247).

                           REASONS FOR CHANGE

    The Committee believes that the overlap among the various 
anti-deferral regimes results in significant complexity usually 
with little or no ultimate tax consequences. These overlaps 
require the application of specific rules of priority for 
income inclusions among the regimes, as well as additional 
coordination provisions pertaining to other operational 
differences among the various regimes.

                        EXPLANATION OF PROVISION

    The provision: (1) eliminates the rules applicable to 
foreign personal holding companies and foreign investment 
companies; (2) excludes foreign corporations from the 
application of the personal holding company rules; and (3) 
includes as subpart F foreign personal holding company income 
personal services contract income that is subject to the 
present-law foreign personal holding company rules.

                             EFFECTIVE DATE

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2006, and taxable 
years of U.S. shareholders with or within which such taxable 
years of foreign corporations end.

5. Subpart F treatment of pipeline transportation income (sec. 1075 of 
        the bill and sec. 954 of the Code)

                              PRESENT LAW

    Under the subpart F rules, U.S. 10-percent shareholders of 
a controlled foreign corporation are subject to U.S. tax 
currently on their shares of certain income earned by the 
foreign corporation, whether or not such income is distributed 
to the shareholders (referred to as ``subpart F income''). 
Subpart F income includes foreign base company income, which in 
turn includes foreign base company oil related income (sec. 
954(a)).
    Foreign base company oil related income is income derived 
outside the United States from the processing of minerals 
extracted from oil or gas wells into their primary products; 
the transportation, distribution, or sale of such minerals or 
primary products; the disposition of assets used by the 
taxpayer in a trade or business involving the foregoing; or the 
performance of any related services. However, foreign base 
company oil related income does not include income derived from 
a source within a foreign country in connection with: (1) oil 
or gas which was extracted from a well located in such foreign 
country or, (2), oil, gas, or a primary product of oil or gas 
which is sold by the controlled foreign corporation or a 
related person for use or consumption within such foreign 
country or is loaded in such country as fuel on a vessel or 
aircraft. An exclusion also is provided for income of a 
controlled foreign corporation that is a small producer (i.e., 
a corporation whose average daily oil and natural gas 
production, including production by related corporations, is 
less than 1,000 barrels).

                           REASONS FOR CHANGE

    The subpart F rules were designed to impose immediate U.S. 
taxation on passive and certain other income earned outside the 
borders of the United States. The construction of an oil or gas 
pipeline and the movement of oil or gas through that pipeline 
are not passive activities, and the Committee believes that the 
income from these activities is not the kind of income that the 
subpart F rules were designed to cover.

                        EXPLANATION OF PROVISION

    The provision provides an additional exception to the 
definition of foreign base company oil related income. Under 
the provision, foreign base company oil related income does not 
include income derived from a source within a foreign country 
in connection with the pipeline transportation of oil or gas 
within such foreign country. Thus, the exception applies 
whether or not the controlled foreign corporation that owns the 
pipeline also owns any interest in the oil or gas transported. 
In addition, the exception applies to income earned from the 
transportation of oil or gas by pipeline in a country in which 
the oil or gas was neither extracted nor consumed within such 
foreign country.

                             EFFECTIVE DATE

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2004, and taxable 
years of U.S. shareholders with or within which such taxable 
years of foreign corporations end.

6. Determination of foreign personal holding company income with 
        respect to transactions in commodities (sec. 1076 of the bill 
        and sec. 954 of the Code)

                              PRESENT LAW

Subpart F foreign personal holding company income

    Under the subpart F rules, U.S. shareholders with a 10-
percent or greater interest in a controlled foreign corporation 
(``U.S. 10-percent shareholders'') are subject to U.S. tax 
currently on certain income earned by the controlled foreign 
corporation, whether or not such income is distributed to the 
shareholders. The income subject to current inclusion under the 
subpart F rules includes, among other things, ``foreign 
personal holding company income.''
    Foreign personal holding company income generally consists 
of the following: dividends, interest, royalties, rents and 
annuities; net gains from sales or exchanges of (1) property 
that gives rise to the foregoing types of income, (2) property 
that does not give rise to income, and (3) interests in trusts, 
partnerships, and real estate mortgage investment conduits 
(``REMICs''); net gains from commodities transactions; net 
gains from foreign currency transactions; income that is 
equivalent to interest; income from notional principal 
contracts; and payments in lieu of dividends.
    With respect to transactions in commodities, foreign 
personal holding company income does not consist of gains or 
losses which arise out of bona fide hedging transactions that 
are reasonably necessary to the conduct of any business by a 
producer, processor, merchant, or handler of a commodity in the 
manner in which such business is customarily and usually 
conducted by others. In addition, foreign personal holding 
company income does not consist of gains or losses which are 
comprised of active business gains or losses from the sale of 
commodities, but only if substantially all of the controlled 
foreign corporation's business is as an active producer, 
processor, merchant, or handler of commodities.\54\
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    \54\ Treasury regulations provide that substantially all of a 
controlled foreign corporation's business is as an active producer, 
processor, merchant or handler of commodities if the sum of its gross 
receipts from active sales of commodities in such capacity and 
commodities hedging transactions that qualify for exclusion from the 
definition of foreign personal holding company income, equals or 
exceeds 85 percent of its total receipts for the taxable year (computed 
as though the controlled foreign corporation was a domestic 
corporation) (Treas. Reg. sec. 1.954-2(f)(2)(iii)(C)).
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Hedging transactions

    Under present law, the term ``capital asset'' does not 
include any hedging transaction which is clearly identified as 
such before the close of the day on which it was acquired, 
originated, or entered into (or such other time as the 
Secretary may by regulations prescribe).\55\ The term ``hedging 
transaction'' means any transaction entered into by the 
taxpayer in the normal course of the taxpayer's trade or 
business primarily: (1) to manage risk of price changes or 
currency fluctuations with respect to ordinary property which 
is held or to be held by the taxpayer; (2) to manage risk of 
interest rate or price changes or currency fluctuations with 
respect to borrowings made or to be made, or ordinary 
obligations incurred or to be incurred, by the taxpayer; or (3) 
to manage such other risks as the Secretary may prescribe in 
regulations.\56\
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    \55\ Sec. 1221(a)(7).
    \56\ Sec. 121(b)(2)(A).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the exceptions from subpart F 
foreign personal holding company income for commodities hedging 
transactions and active business sales of commodities should be 
modified to better reflect current active business practices 
and, in the case of hedging transactions, to simplify the 
present-law rules by providing more consistency with the 
generally applicable definition of a hedging transaction.

                        EXPLANATION OF PROVISION

    The provision modifies the requirements that must be 
satisfied for gains or losses from a commodities hedging 
transaction to qualify for exclusion from the definition of 
subpart F foreign personal holding company income. Under the 
provision, gains or losses from a transaction with respect to a 
commodity are not treated as foreign personal holding company 
income if the transaction satisfies the general definition of a 
hedging transaction under section 1221(b)(2). For purposes of 
this provision, the general definition of a hedging transaction 
under section 1221(b)(2) is modified to include any transaction 
with respect to a commodity entered into by a controlled 
foreign corporation in the normal course of the controlled 
foreign corporation's trade or business primarily: (1) to 
manage risk of price changes or currency fluctuations with 
respect to ordinary property or property described in section 
1231(b) which is held or to be held by the controlled foreign 
corporation; or (2) to manage such other risks as the Secretary 
may prescribe in regulations. Gains or losses from a 
transaction that satisfies the modified definition of a hedging 
transaction are excluded from the definition of foreign 
personal holding company income only if the transaction is 
clearly identified as a hedging transaction in accordance with 
the hedge identification requirements that apply generally to 
hedging transactions under section 1221(b)(2).\57\
---------------------------------------------------------------------------
    \57\ Sec. 1221(a)(7) and (b)(2)(B).
---------------------------------------------------------------------------
    The provision also changes the requirements that must be 
satisfied for active business gains or losses from the sale of 
commodities to qualify for exclusion from the definition of 
foreign personal holding company income. Under the provision, 
such gains or losses are not treated as foreign personal 
holding company income if substantially all of the controlled 
foreign corporation's commodities are comprised of: (1) stock 
in trade of the controlled foreign corporation or other 
property of a kind which would properly be included in the 
inventory of the controlled foreign corporation if on hand at 
the close of the taxable year, or property held by the 
controlled foreign corporation primarily for sale to customers 
in the ordinary course of the controlled foreign corporation's 
trade or business; (2) property that is used in the trade or 
business of the controlled foreign corporation and is of a 
character which is subject to the allowance for depreciation 
under section 167; or (3) supplies of a type regularly used or 
consumed by the controlled foreign corporation in the ordinary 
course of a trade or business of the controlled foreign 
corporation.\58\
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    \58\ For purposes of determining whether substantially all of the 
controlled foreign corporation's commodities are comprised of such 
property, it is intended that the 85-percent requirement provided in 
the current Treasury regulations (as modified to reflect the change 
made by the proposal) continue to apply.
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                             EFFECTIVE DATE

    The provision is effective with respect to transactions 
entered into after December 31, 2004.

7. Repeal controlled foreign corporation rules for foreign base company 
        shipping income (sec. 1077 of the bill and sec. 954 of the 
        Code)

                              PRESENT LAW

    In general, the subpart F rules (secs. 951-964) require 
U.S. shareholders with a 10-percent or greater interest in a 
controlled foreign corporation to include currently in income 
for U.S. tax purposes certain income of the controlled foreign 
corporation (referred to as ``subpart F income''), without 
regard to whether the income is distributed to the shareholders 
(sec. 951(a)(1)(A)). In effect, the Code treats the U.S. 10-
percent shareholders of a controlled foreign corporation as 
having received a current distribution of their pro rata shares 
of the controlled foreign corporation's subpart F income. The 
amounts included in income by the controlled foreign 
corporation's U.S. 10-percent shareholders under these rules 
are subject to U.S. tax currently. The U.S. tax on such amounts 
may be reduced through foreign tax credits.
    Subpart F income includes foreign base company shipping 
income (sec. 954(f)). Foreign base company shipping income 
generally includes income derived from the use of an aircraft 
or vessel in foreign commerce, the performance of services 
directly related to the use of any such aircraft or vessel, the 
sale or other disposition of any such aircraft or vessel, and 
certain space or ocean activities (e.g., leasing of satellites 
for use in space). Foreign commerce generally involves the 
transportation of property or passengers between a port (or 
airport) in the U.S. and a port (or airport) in a foreign 
country, two ports (or airports) within the same foreign 
country, or two ports (or airports) in different foreign 
countries. In addition, foreign base company shipping income 
includes dividends and interest that a controlled foreign 
corporation receives from certain foreign corporations and any 
gains from the disposition of stock in certain foreign 
corporations, to the extent the dividends, interest, or gains 
are attributable to foreign base company shipping income. 
Foreign base company shipping income also includes incidental 
income derived in the course of active foreign base company 
shipping operations (e.g., income from temporary investments in 
or sales of related shipping assets), foreign exchange gain or 
loss attributable to foreign base company shipping operations, 
and a controlled foreign corporation's distributive share of 
gross income of any partnership and gross income received from 
certain trusts to the extent that the income would have been 
foreign base company shipping income had it been realized 
directly by the corporation.
    Subpart F income also includes foreign personal holding 
company income (sec. 954(c)). For subpart F purposes, foreign 
personal holding company income generally consists of the 
following: (1) dividends, interest, royalties, rents and 
annuities; (2) net gains from the sale or exchange of (a) 
property that gives rise to the preceding types of income, (b) 
property that does not give rise to income, and (c) interests 
in trusts, partnerships, and REMICS; (3) net gains from 
commodities transactions; (4) net gains from foreign currency 
transactions; (5) income that is equivalent to interest; (6) 
income from notional principal contracts; and (7) payments in 
lieu of dividends.
    Subpart F foreign personal holding company income does not 
include rents and royalties received by the controlled foreign 
corporation in the active conduct of a trade or business from 
unrelated persons (sec. 954(c)(2)(A)). Also generally excluded 
are dividends and interest received by the controlled foreign 
corporation from a related corporation organized and operating 
in the same foreign country in which the controlled foreign 
corporation was organized, and rents and royalties received by 
the controlled foreign corporation from a related corporation 
for the use of property within the country in which the 
controlled foreign corporation was organized (sec. 954(c)(3)). 
However, interest, rent, and royalty payments do not qualify 
for this exclusion to the extent that such payments reduce 
subpart F income of the payor.

                           REASONS FOR CHANGE

    In general, other countries do not tax foreign shipping 
income, whereas the United States imposes immediate U.S. tax on 
such income. The noncompetitive U.S. taxation of shipping 
income has directly caused a steady and substantial decline of 
the U.S. shipping industry. The Committee believes that this 
provision will provide U.S. shippers the opportunity to be 
competitive with their tax-advantaged foreign competitors.

                        EXPLANATION OF PROVISION

    The provision repeals the subpart F rules relating to 
foreign base company shipping income (sec. 954(f)). The bill 
also amends the exception from foreign personal holding company 
income applicable to rents or royalties derived from unrelated 
persons in an active trade or business (sec. 954(c)(2)(A)), by 
providing a safe harbor for rents derived from leasing an 
aircraft or vessel in foreign commerce. Such rents are excluded 
from foreign personal holding company income if the active 
leasing expenses comprise at least 10-percent of the profit on 
the lease. This provision is to be applied in accordance with 
existing regulations under sec. 954(c)(2)(A) by comparing the 
lessor's ``active leasing expenses'' for its pool of leased 
assets to its ``adjusted leasing profit.''
    The safe harbor will not prevent a lessor from otherwise 
showing that it actively carries on a trade or business. In 
this regard, the requirements of section 954(c)(2)(A) will be 
met if a lessor regularly and directly performs active and 
substantial marketing, remarketing, management and operational 
functions with respect to the leasing of an aircraft or vessel 
(or component engines). This will be the case regardless of 
whether the lessor engages in marketing of the lease as a form 
of financing (versus marketing the property as such) or whether 
the lease is classified as a finance lease or operating lease 
for financial accounting purposes. If a lessor acquires, from 
an unrelated or related party, a ship or aircraft subject to an 
existing FSC or ETI lease, the requirements of section 
954(c)(2)(A) will be satisfied if, following the acquisition, 
the lessor performs active and substantial management, 
operational, and remarketing functions with respect to the 
leased property. If such a lease is transferred to a CFC 
lessor, it will no longer be eligible for FSC or ETI benefits.
    An aircraft or vessel will be considered to be leased in 
foreign commerce if it is used for the transportation of 
property or passengers between a port (or airport) in the 
United States and one in a foreign country or between foreign 
ports (or airports), provided the aircraft or vessel is used 
predominantly outside the United States. An aircraft or vessel 
will be considered used predominantly outside the United States 
if more than 50 percent of the miles during the taxable year 
are traversed outside the United States or the aircraft or 
vessel is located outside the United States more than 50 
percent of the time during such taxable year.
    The Committee expects the Secretary of the Treasury to 
issue timely guidance to make conforming changes to existing 
regulations, including guidance that aircraft or vessel leasing 
activity that satisfies the requirements of section 
954(c)(2)(A) shall also satisfy the requirements for avoiding 
income inclusion under section 956 and section 367(a).

                             EFFECTIVE DATE

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2004, and taxable 
years of U.S. shareholders with or within which such taxable 
years of foreign corporations end.

8. Modification of subpart F exemption for active financing (sec. 1078 
        of the bill and sec. 954 of the Code)

                              PRESENT LAW

    Under the subpart F rules, U.S. shareholders with a 10-
percent or greater interest in a controlled foreign corporation 
(``CFC'') are subject to U.S. tax currently on certain income 
earned by the CFC, whether or not such income is distributed to 
the shareholders. The income subject to current inclusion under 
the subpart F rules includes, among other things, foreign 
personal holding company income and insurance income. In 
addition, 10-percent U.S. shareholders of a CFC are subject to 
current inclusion with respect to their shares of the CFC's 
foreign base company services income (i.e., income derived from 
services performed for a related person outside the country in 
which the CFC is organized).
    Foreign personal holding company income generally consists 
of the following: (1) dividends, interest, royalties, rents, 
and annuities; (2) net gains from the sale or exchange of (a) 
property that gives rise to the preceding types of income, (b) 
property that does not give rise to income, and (c) interests 
in trusts, partnerships, and REMICs; (3) net gains from 
commodities transactions; (4) net gains from foreign currency 
transactions; (5) income that is equivalent to interest; (6) 
income from notional principal contracts; and (7) payments in 
lieu of dividends.
    Insurance income subject to current inclusion under the 
subpart F rules includes any income of a CFC attributable to 
the issuing or reinsuring of any insurance or annuity contract 
in connection with risks located in a country other than the 
CFC's country of organization. Subpart F insurance income also 
includes income attributable to an insurance contract in 
connection with risks located within the CFC's country of 
organization, as the result of an arrangement under which 
another corporation receives a substantially equal amount of 
consideration for insurance of other country risks. Investment 
income of a CFC that is allocable to any insurance or annuity 
contract related to risks located outside the CFC's country of 
organization is taxable as subpart F insurance income (Treas. 
Reg. sec. 1.953-1(a)).
    Temporary exceptions from foreign personal holding company 
income, foreign base company services income, and insurance 
income apply for subpart F purposes for certain income that is 
derived in the active conduct of a banking, financing, or 
similar business, or in the conduct of an insurance business 
(so-called ``active financing income'').\59\
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    \59\ Temporary exceptions from the subpart F provisions for certain 
active financing income applied only for taxable years beginning in 
1998. Those exceptions were modified and extended for one year, 
applicable only for taxable years beginning in 1999. The Tax Relief 
Extension Act of 1999 (P.L. No. 106-170) clarified and extended the 
temporary exceptions for two years, applicable only for taxable years 
beginning after 1999 and before 2002. The Job Creation and Worker 
Assistance Act of 2002 (P.L. No. 107-147) extended the temporary 
exceptions for five years, applicable only for taxable years beginning 
after 2001 and before 2007, with a modification relating to insurance 
reserves.
---------------------------------------------------------------------------
    With respect to income derived in the active conduct of a 
banking, financing, or similar business, a CFC is required to 
be predominantly engaged in such business and to conduct 
substantial activity with respect to such business in order to 
qualify for the exceptions. In addition, certain nexus 
requirements apply, which provide that income derived by a CFC 
or a qualified business unit (``QBU'') of a CFC from 
transactions with customers is eligible for the exceptions if, 
among other things, substantially all of the activities in 
connection with such transactions are conducted directly by the 
CFC or QBU in its home country, and such income is treated as 
earned by the CFC or QBU in its home country for purposes of 
such country's tax laws. Moreover, the exceptions apply to 
income derived from certain cross border transactions, provided 
that certain requirements are met. Additional exceptions from 
foreign personal holding company income apply for certain 
income derived by a securities dealer within the meaning of 
section 475 and for gain from the sale of active financing 
assets.
    In the case of insurance, in addition to temporary 
exceptions from insurance income and from foreign personal 
holding company income for certain income of a qualifying 
insurance company with respect to risks located within the 
CFC's country of creation or organization, temporary exceptions 
from insurance income and from foreign personal holding company 
income apply for certain income of a qualifying branch of a 
qualifying insurance company with respect to risks located 
within the home country of the branch, provided certain 
requirements are met under each of the exceptions. Further, 
additional temporary exceptions from insurance income and from 
foreign personal holding company income apply for certain 
income of certain CFCs or branches with respect to risks 
located in a country other than the United States, provided 
that the requirements for these exceptions are met.

                           REASONS FOR CHANGE

    The Committee believes that the rules for determining 
whether income earned by an eligible CFC or QBU is active 
financing income should be more consistent with the rules for 
determining whether a CFC or QBU is eligible to earn active 
financing income.

                        EXPLANATION OF PROVISION

    The provision modifies the present-law temporary exceptions 
from subpart F foreign personal holding company income and 
foreign base company services income for income derived in the 
active conduct of a banking, financing, or similar business. 
For purposes of determining whether a CFC or QBU has conducted 
directly in its home country substantially all of the 
activities in connection with transactions with customers, the 
provision provides that an activity is treated as conducted 
directly by the CFC or QBU in its home country if the activity 
is performed by employees of a related person and: (1) the 
related person is itself an eligible CFC the home country of 
which is the same as that of the CFC or QBU; (2) the activity 
is performed in the home country of the related person; and (3) 
the related person is compensated on an arm's length basis for 
the performance of the activity by its employees and such 
compensation is treated as earned by such person in its home 
country for purposes of the tax laws of such country. For 
purposes of determining whether a CFC or QBU is eligible to 
earn active financing income, such activity may not be taken 
into account by any CFC or QBU (including the employer of the 
employees performing the activity) other than the CFC or QBU 
for which the activities are performed.

                             EFFECTIVE DATE

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2004, and taxable 
years of U.S. shareholders with or within which such taxable 
years of foreign corporations end.

9. Partial exclusion for qualified film income (sec. 1079 of the bill 
        and new sec. 139A of the Code)

                              PRESENT LAW

In general

    Present law provides that gross income for U.S. tax 
purposes does not include extraterritorial income. Because the 
exclusion of such extraterritorial income is a means of 
avoiding double taxation, no foreign tax credit is allowed for 
income taxes paid with respect to such excluded income. 
Extraterritorial income is eligible for the exclusion to the 
extent that it is ``qualifying foreign trade income.''

Qualifying foreign trade income

    ``Qualifying foreign trade income'' is the amount of gross 
income that, if excluded, would result in a reduction of 
taxable income by the greatest of (1) 1.2 percent of the 
``foreign trading gross receipts'' derived by the taxpayer from 
the transaction, (2) 15 percent of the ``foreign trade income'' 
derived by the taxpayer from the transaction, or (3) 30 percent 
of the ``foreign sale and leasing income'' derived by the 
taxpayer from the transaction. The amount of qualifying foreign 
trade income determined using 1.2 percent of the foreign 
trading gross receipts is limited to 200 percent of the 
qualifying foreign trade income that would result using 15 
percent of the foreign trade income. Although these 
calculations are determined by reference to a reduction of 
taxable income (a net income concept), qualifying foreign trade 
income is an exclusion from gross income.

Foreign trading gross receipts

    ``Foreign trading gross receipts'' are gross receipts 
derived from certain activities in connection with ``qualifying 
foreign trade property'' with respect to which certain 
``economic processes'' take place outside of the United States. 
The threshold for determining if gross receipts will be treated 
as foreign trading gross receipts is whether the gross receipts 
are derived from a transaction involving ``qualifying foreign 
trade property.''
    Qualifying foreign trade property is property manufactured, 
produced, grown, or extracted within or outside of the United 
States that is held primarily for sale, lease, or rental, in 
the ordinary course of a trade or business, for direct use, 
consumption, or disposition outside of the United States. In 
addition, not more than 50 percent of the fair market value of 
such property can be attributable to the sum of (1) the fair 
market value of articles manufactured outside of the United 
States, plus (2) the direct costs of labor performed outside of 
the United States. Certain property is excluded from the 
definition of qualifying foreign trade property, including 
patents, inventions, models, designs, formulas, or processes 
whether or not patented, copyrights (other than films, tapes, 
records, or similar reproductions, and other than computer 
software (whether or not patented), for commercial or home 
use), goodwill, trademarks, trade brands, franchises, or other 
like property. Consequently, gross receipts from the license of 
films for reproduction abroad generally constitutes foreign 
trading gross receipts.

Foreign trade income

    ``Foreign trade income'' is the taxable income of the 
taxpayer (determined without regard to the exclusion of 
qualifying foreign trade income) attributable to foreign 
trading gross receipts. Certain dividends-paid deductions of 
cooperatives are disregarded in determining foreign trade 
income for this purpose.

Foreign sale and leasing income

    ``Foreign sale and leasing income'' is the amount of the 
taxpayer's foreign trade income (with respect to a transaction) 
that is properly allocable to activities that constitute 
foreign economic processes.

                           REASONS FOR CHANGE

    The Committee recognizes that the extraterritorial income 
(``ETI'') regime must be repealed and that its repeal 
constitutes a significant tax increase on the United States 
motion picture and film industry. In addition, the Committee 
understands that over the past decade, production of some 
American film projects has moved to foreign locations, as a 
number of foreign governments have offered tax and other 
incentives designed to entice production of motion pictures and 
television programs to their countries. Consequently, the 
Committee believes that it is appropriate to provide tax relief 
for motion pictures and films made in the United States.

                        EXPLANATION OF PROVISION

    The provision provides an exclusion from gross income for 
an amount equal to the applicable percentage of qualified film 
income. ``Qualified film income'' is defined as a taxpayer's 
gross income from the license of a qualified film for the 
exploitation or direct use outside the United States less all 
associated film costs.\60\ Qualified film income does not 
include any gross income from the exploitation of characters, 
soundtracks, designs, scripts, scores, or other ancillary 
intangibles. For example, gross income from the foreign 
theatrical, home video, digital video disc, and television 
markets would be eligible for the provision, whereas gross 
income from the foreign license of characters, scripts, video 
and board games, and other ancillary intangibles of such film 
would not be eligible for the provision. In addition, qualified 
film income does not include any amount from the license of a 
qualified film to a related person \61\ unless such film is 
held for license by such related person to an unrelated person 
for the exploitation or direct use by such unrelated person 
outside the United States.
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    \60\ Associated film costs is defined as any expense properly 
apportioned and allocated to qualified film income, determined as 
provided under regulations prescribed by the Secretary.
    \61\ A person is related to another person if such persons are 
treated as a single employer under subsection (a) or (b) of section 52 
or subsection (m) or (o) of section 414, except that determinations 
under subsections (a) and (b) of section 52 are made without regard to 
section 1563(b).
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    For purposes of the provision, the applicable percentage 
for taxable years ending in 2007 is one percent, in 2008 is two 
percent, in 2009 is three percent, in 2010 is five percent, in 
2011 is eight percent, in 2012 is nine percent, and after 2012 
is ten percent.
    A ``qualified film'' is defined as property described in 
section 168(f)(3) the original use of which commences after 
December 31, 2006 if (excluding compensation in the form of 
residuals and participations) 50 percent or more of the total 
compensation relating to the production of such film 
constitutes compensation for services performed in the United 
States by actors, production personnel, directors, and 
producers. However, a qualified film does not include sexually 
explicit productions as defined by section 2257 of title 18 of 
the U.S. Code.
    The provision provides that no foreign tax credit or 
deduction is allowed for foreign taxes paid or accrued with 
respect to the excludible portion of any qualified film income. 
In addition, the provision provides that a taxpayer may elect 
not to apply the provision to a qualified film. Such election 
shall be made by the due date (including extensions of time) 
for filing the taxpayer's return for the taxable year in which 
the qualified film is placed in service.

                             EFFECTIVE DATE

    The provision is effective for taxable years ending after 
December 31, 2006.

              H. Reduction of Double Taxation of Earnings


1. Interest expense allocation rules (sec. 1081 of the bill and sec. 
        864 of the Code)

                              PRESENT LAW

In general

    In order to compute the foreign tax credit limitation, a 
taxpayer must determine the amount of its taxable income from 
foreign sources. Thus, the taxpayer must allocate and apportion 
deductions between items of U.S.-source gross income, on the 
one hand, and items of foreign-source gross income, on the 
other.
    In the case of interest expense, the rules generally are 
based on the approach that money is fungible and that interest 
expense is properly attributable to all business activities and 
property of a taxpayer, regardless of any specific purpose for 
incurring an obligation on which interest is paid. (Exceptions 
to the fungibility concept are recognized or required, however, 
in particular cases, some of which are described below). The 
Code provides that for interest allocation purposes all members 
of an affiliated group of corporations generally are to be 
treated as a single corporation (the so-called ``one-taxpayer 
rule''), and that allocation must be made on the basis of 
assets rather than gross income.

Affiliated group

            In general
    The term ``affiliated group'' in this context generally is 
defined by reference to the rules for determining whether 
corporations are eligible to file consolidated returns. 
However, some groups of corporations are eligible to file 
consolidated returns yet are not treated as affiliated for 
interest allocation purposes, and other groups of corporations 
are treated as affiliated for interest allocation purposes even 
though they are not eligible to file consolidated returns. 
Thus, under the one-taxpayer rule, the factors affecting the 
allocation of interest expense of one corporation may affect 
the sourcing of taxable income of another, related corporation 
even if the two corporations do not elect to file, or are 
ineligible to file, consolidated returns.
            Definition of affiliated group--consolidated return rules
    For consolidation purposes, the term ``affiliated group'' 
means one or more chains of includible corporations connected 
through stock ownership with a common parent corporation which 
is an includible corporation, but only if: (1) the common 
parent owns directly stock possessing at least 80 percent of 
the total voting power and at least 80 percent of the total 
value of at least one other includible corporation; and (2) 
stock meeting the same voting power and value standards with 
respect to each includible corporation (excluding the common 
parent) is directly owned by one or more other includible 
corporations.
    Generally, the term ``includible corporation'' means any 
domestic corporation except certain corporations exempt from 
tax under section 501 (for example, corporations organized and 
operated exclusively for charitable or educational purposes), 
certain life insurance companies, corporations electing 
application of the possession tax credit, regulated investment 
companies, real estate investment trusts, and domestic 
international sales corporations. A foreign corporation 
generally is not an includible corporation.
            Definition of affiliated group--special interest allocation 
                    rules
    Subject to exceptions, the consolidated return and interest 
allocation definitions of affiliation generally are consistent 
with each other.\62\ For example, both definitions generally 
exclude all foreign corporations from the affiliated group. 
Thus, while debt generally is considered fungible among the 
assets of a group of domestic affiliated corporations, the same 
rules do not apply as between the domestic and foreign members 
of a group with the same degree of common control as the 
domestic affiliated group.
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    \62\ One such exception is that the affiliated group for interest 
allocation purposes includes section 936 corporations that are excluded 
from the consolidated group.
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            Banks, savings institutions, and other financial affiliates
    The affiliated group for interest allocation purposes 
generally excludes what are referred to in the Treasury 
regulations as ``financial corporations'' (Treas. Reg. sec. 
1.861-11T(d)(4)). These include any corporation, otherwise a 
member of the affiliated group for consolidation purposes, that 
is a financial institution (described in section 581 or section 
591), the business of which is predominantly with persons other 
than related persons or their customers, and which is required 
by State or Federal law to be operated separately from any 
other entity which is not a financial institution (sec. 
864(e)(5)(C)). The category of financial corporations also 
includes, to the extent provided in regulations, bank holding 
companies, subsidiaries of banks and bank holding companies, 
and savings institutions predominantly engaged in the active 
conduct of a banking, financing, or similar business (sec. 
864(e)(5)(D)).
    A financial corporation is not treated as a member of the 
regular affiliated group for purposes of applying the one-
taxpayer rule to other non-financial members of that group. 
Instead, all such financial corporations that would be so 
affiliated are treated as a separate single corporation for 
interest allocation purposes.

                           REASONS FOR CHANGE

    The Committee observes that the United States is the only 
country that currently imposes harsh and anti-competitive 
interest expense allocation rules on its businesses and 
workers. The present-law interest expense allocation rules 
result in U.S. companies allocating a portion of their U.S. 
interest expense against foreign-source income, even when the 
foreign operation has its own debt. The tax effect of this rule 
is that U.S. companies end up paying double tax. The practical 
effect is that the cost for U.S. companies to borrow in the 
United States is increased and it becomes more expensive to 
invest in the United States. The Committee believes that these 
rules should be modified so that U.S. companies are not 
discouraged from investing in the United States. To this end, 
U.S. companies should not be required to allocate U.S. interest 
expense against foreign-source income (and thereby incur double 
taxation) unless their debt-to-asset ratio is higher in the 
United States than in foreign countries.

                        EXPLANATION OF PROVISION

In general

    The provision modifies the present-law interest expense 
allocation rules (which generally apply for purposes of 
computing the foreign tax credit limitation) by providing a 
one-time election under which the taxable income of the 
domestic members of an affiliated group from sources outside 
the United States generally is determined by allocating and 
apportioning interest expense of the domestic members of a 
worldwide affiliated group on a worldwide-group basis (i.e., as 
if all members of the worldwide group were a single 
corporation). If a group makes this election, the taxable 
income of the domestic members of a worldwide affiliated group 
from sources outside the United States is determined by 
allocating and apportioning the interest expense of those 
domestic members to foreign-source income in an amount equal to 
the excess (if any) of (1) the worldwide affiliated group's 
worldwide interest expense multiplied by the ratio which the 
foreign assets of the worldwide affiliated group bears to the 
total assets of the worldwide affiliated group, over (2) the 
interest expense incurred by a foreign member of the group to 
the extent such interest would be allocated to foreign sources 
if the provision's principles were applied separately to the 
foreign members of the group.\63\
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    \63\ Although the interest expense of a foreign subsidiary is taken 
into account for purposes of allocating the interest of the domestic 
members of the electing worldwide affiliated group for foreign tax 
credit limitation purposes, the interest expense incurred by a foreign 
subsidiary is not deductible on a U.S. return.
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    For purposes of the new elective rules based on worldwide 
fungibility, the worldwide affiliated group means all 
corporations in an affiliated group (as that term is defined 
under present law for interest allocation purposes) \64\ as 
well as all controlled foreign corporations that in the 
aggregate either directly or indirectly \65\ would be members 
of such an affiliated group if section 1504(b)(3) did not apply 
(i.e., in which at least 80 percent of the vote and value of 
the stock of such corporations is owned by one or more other 
corporations included in the affiliated group). Thus, if an 
affiliated group makes this election, the taxable income from 
sources outside the United States of domestic group members 
generally is determined by allocating and apportioning interest 
expense of the domestic members of the worldwide affiliated 
group as if all of the interest expense and assets of 80-
percent or greater owned domestic corporations (i.e., 
corporations that are part of the affiliated group under 
present-law section 864(e)(5)(A) as modified to include 
insurance companies) and certain controlled foreign 
corporations were attributable to a single corporation.
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    \64\ The provision expands the definition of an affiliated group 
for interest expense allocation purposes to include certain insurance 
companies that are generally excluded from an affiliated group under 
section 1504(b)(2) (without regard to whether such companies are 
covered by an election under section 1504(c)(2)).
    \65\ Indirect ownership is determined under the rules of section 
958(a)(2) or through applying rules similar to those of section 
958(a)(2) to stock owned directly or indirectly by domestic 
partnerships, trusts, or estates.
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    In addition, if an affiliated group elects to apply the new 
elective rules based on worldwide fungibility, the present-law 
rules regarding the treatment of tax-exempt assets and the 
basis of stock in nonaffiliated ten-percent owned corporations 
apply on a worldwide affiliated group basis.
    The worldwide affiliated group election is to be made by 
the common parent of the domestic affiliated group. The 
election is to be made for the first taxable year, beginning 
after December 31, 2008, in which a worldwide affiliated group 
exists that includes at least one foreign corporation that 
meets the requirements for inclusion in a worldwide affiliated 
group. Once made, the election applies to the common parent and 
all other members of the worldwide affiliated group for the 
taxable year for which the election was made and all subsequent 
taxable years, unless revoked with the consent of the 
Secretary.

Financial institution group election

    The provision allows taxpayers to apply the present-law 
bank group rules to exclude certain financial institutions from 
the affiliated group for interest allocation purposes under the 
worldwide fungibility approach. The provision also provides a 
one-time ``financial institution group'' election that expands 
the present-law bank group. Under the provision, at the 
election of the common parent of the pre-election worldwide 
affiliated group, the interest expense allocation rules are 
applied separately to a subgroup of the worldwide affiliated 
group that consists of (1) all corporations that are part of 
the present-law bank group,\66\ and (2) all ``financial 
corporations.'' For this purpose, a corporation is a financial 
corporation if at least 80 percent of its gross income is 
financial services income (as described in section 
904(d)(2)(C)(i) and the regulations thereunder) that is derived 
from transactions with unrelated persons.\67\ For these 
purposes, items of income or gain from a transaction or series 
of transactions are disregarded if a principal purpose for the 
transaction or transactions is to qualify any corporation as a 
financial corporation.
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    \66\ No inference is intended as to the treatment under present law 
with respect to financial holding companies (within the meaning of 
section 2(p) of the Bank Holding Company Act of 1956), as well as 
subsidiaries of financial holding companies that are predominantly 
engaged (directly or indirectly) in the active conduct of a banking, 
financing, or similar business. With respect to financial holding 
companies that make a financial institution group election under the 
bill, no inference is intended as to the application of present law to 
such taxpayers for taxable years prior to the taxable year for which 
such an election is made.
    \67\ See Treas. Reg. sec. 1.904-4(e)(2).
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    The common parent of the pre-election worldwide affiliated 
group is to make the election for the first taxable year, 
beginning after December 31, 2008, in which a worldwide 
affiliated group includes a financial corporation. Once made, 
the election applies to the financial institution group for the 
taxable year and all subsequent taxable years unless revoked 
with the consent of the Treasury Secretary. In addition, the 
provision provides anti-abuse rules under which certain 
transfers from a member of a financial institution group to a 
member of the worldwide affiliated group outside of the 
financial institution group are treated as reducing the amount 
of indebtedness of the separate financial institution group 
(and increasing the indebtedness of the worldwide affiliated 
group outside the financial institution group). The provision 
provides regulatory authority with respect to the election to 
provide for the direct allocation of interest expense in 
circumstances in which such allocation is appropriate to carry 
out the purposes of the provision, prevent assets or interest 
expense from being taken into account more than once, and 
addressing changes in members of any group (through 
acquisitions or otherwise) treated as affiliated under this 
provision.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2008.

2. Recharacterization of overall domestic loss (sec. 1082 of the bill 
        and sec. 904 of the Code)

                              PRESENT LAW

    The United States provides a credit for foreign income 
taxes paid or accrued. The foreign tax credit generally is 
limited to the U.S. tax liability on a taxpayer's foreign-
source income, in order to ensure that the credit serves the 
purpose of mitigating double taxation of foreign-source income 
without offsetting the U.S. tax on U.S.-source income. This 
overall limitation is calculated by prorating a taxpayer's pre-
credit U.S. tax on its worldwide income between its U.S.-source 
and foreign-source taxable income. The ratio (not exceeding 100 
percent) of the taxpayer's foreign-source taxable income to 
worldwide taxable income is multiplied by its pre-credit U.S. 
tax to establish the amount of U.S. tax allocable to the 
taxpayer's foreign-source income and, thus, the upper limit on 
the foreign tax credit for the year.
    If a taxpayer's losses from foreign sources exceed its 
foreign-source income, the excess (``overall foreign loss,'' or 
``OFL'') may offset U.S.-source income. Such an offset reduces 
the effective rate of U.S. tax on U.S.-source income.
    In order to eliminate a double benefit (that is, the 
reduction of U.S. tax previously noted and, later, full 
allowance of a foreign tax credit with respect to foreign-
source income), present law includes an OFL recapture rule. 
Under this rule, a portion of foreign-source taxable income 
earned after an OFL year is recharacterized as U.S.-source 
taxable income for foreign tax credit purposes (and for 
purposes of the possessions tax credit). Unless a taxpayer 
elects a higher percentage, however, generally no more than 50 
percent of the foreign-source taxable income earned in any 
particular taxable year is recharacterized as U.S.-source 
taxable income. The effect of the recapture is to reduce the 
foreign tax credit limitation in one or more years following an 
OFL year and, therefore, the amount of U.S. tax that can be 
offset by foreign tax credits in the later year or years.
    A U.S.-source loss reduces pre-credit U.S. tax on worldwide 
income to an amount less than the hypothetical tax that would 
apply to the taxpayer's foreign-source income if viewed in 
isolation. The existence of foreign-source taxable income in 
the year of the U.S.-source loss reduces or eliminates any net 
operating loss carryover that the U.S.-source loss would 
otherwise have generated absent the foreign income. In 
addition, as the pre-credit U.S. tax on worldwide income is 
reduced, so is the foreign tax credit limitation. As a result, 
some foreign tax credits in the year of the U.S.-source loss 
must be credited, if at all, in a carryover year. Tax on U.S.-
source taxable income in a subsequent year may be offset by a 
net operating loss carryforward, but not by a foreign tax 
credit carryforward. There is currently no mechanism for 
recharacterizing such subsequent U.S.-source income as foreign-
source income.
    For example, suppose a taxpayer generates a $100 U.S.-
source loss and earns $100 of foreign-source income in Year 1, 
and pays $30 of foreign tax on the $100 of foreign-source 
income. Because the taxpayer has no net taxable income in Year 
1, no foreign tax credit can be claimed in Year 1 with respect 
to the $30 of foreign taxes. If the taxpayer then earns $100 of 
U.S.-source income and $100 of foreign-source income in Year 2, 
present law does not recharacterize any portion of the $100 of 
U.S.-source income as foreign-source income to reflect the fact 
that the previous year's $100 U.S.-source loss reduced the 
taxpayer's ability to claim foreign tax credits.

                           REASONS FOR CHANGE

    The Committee believes that it is important to create 
parity in the treatment of overall foreign losses and overall 
domestic losses in order to prevent the double taxation of 
income. The Committee believes that preventing double taxation 
will make U.S. businesses more competitive and will lead to 
increased export sales. The Committee believes that this 
increase in export sales will increase production in the United 
States and increase jobs in the United States to support the 
increased exports.

                        EXPLANATION OF PROVISION

    The provision applies a re-sourcing rule to U.S.-source 
income in cases in which a taxpayer's foreign tax credit 
limitation has been reduced as a result of a prior overall 
domestic loss. Under the provision, a portion of the taxpayer's 
U.S.-source income for each succeeding taxable year is 
recharacterized as foreign-source income in an amount equal to 
the lesser of: (1) the amount of the unrecharacterized overall 
domestic loss, and (2) 50 percent of the taxpayer's U.S.-source 
income for such succeeding taxable year.
    The provision defines an overall domestic loss for this 
purpose as any domestic loss to the extent it offsets foreign-
source taxable income for the current taxable year or for any 
preceding taxable year by reason of a loss carryback. For this 
purpose, a domestic loss means the amount by which the U.S.-
source gross income for the taxable year is exceeded by the sum 
of the deductions properly apportioned or allocated thereto, 
determined without regard to any loss carried back from a 
subsequent taxable year. Under the provision, an overall 
domestic loss does not include any loss for any taxable year 
unless the taxpayer elected the use of the foreign tax credit 
for such taxable year.
    Any U.S.-source income recharacterized under the provision 
is allocated among and increases the various foreign tax credit 
separate limitation categories in the same proportion that 
those categories were reduced by the prior overall domestic 
loss.
    It is anticipated that situations may arise in which a 
taxpayer generates an overall domestic loss in a year following 
a year in which it had an overall foreign loss, or vice versa. 
In such a case, it would be necessary for ordering and other 
coordination rules to be developed for purposes of computing 
the foreign tax credit limitation in subsequent taxable years. 
The provision grants the Secretary authority to prescribe such 
regulations as may be necessary to coordinate the operation of 
the OFL recapture rules with the operation of the overall 
domestic loss recapture rules added by the provision.

                             EFFECTIVE DATE

    The provision applies to losses incurred in taxable years 
beginning after December 31, 2005.

3. Reduction to two foreign tax credit baskets (sec. 1083 of the bill 
        and sec. 904 of the Code)

                              PRESENT LAW

    The United States taxes its citizens and residents on their 
worldwide income. Because the countries in which income is 
earned also may assert their jurisdiction to tax the same 
income on the basis of source, foreign-source income earned by 
U.S. persons may be subject to double taxation. In order to 
mitigate this possibility, the United States provides a credit 
against U.S. tax liability for foreign income taxes paid, 
subject to a number of limitations. The foreign tax credit 
generally is limited to the U.S. tax liability on a taxpayer's 
foreign-source income, in order to ensure that the credit 
serves its purpose of mitigating double taxation of cross-
border income without offsetting the U.S. tax on U.S.-source 
income.
    The foreign tax credit limitation is applied separately to 
the following categories of income: (1) passive income, (2) 
high withholding tax interest, (3) financial services income, 
(4) shipping income, (5) certain dividends received from 
noncontrolled section 902 foreign corporations (``10/50 
companies''),\68\ (6) certain dividends from a domestic 
international sales corporation or former domestic 
international sales corporation, (7) taxable income 
attributable to certain foreign trade income, (8) certain 
distributions from a foreign sales corporation or former 
foreign sales corporation, and (9) any other income not 
described in items (1) through (8) (so-called ``general 
basket'' income).
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    \68\ Subject to certain exceptions, dividends paid by a 10/50 
company in taxable years beginning after December 31, 2002 are subject 
to either a look-through approach in which the dividend is attributed 
to a particular limitation category based on the underlying earnings 
which gave rise to the dividend (for post-2002 earnings and profits), 
or a single-basket limitation approach for dividends from all 10/50 
companies (for pre-2003 earnings and profits). Under section 1115 of 
the bill, these dividends are subject to a look-through approach, 
irrespective of when the underlying earnings and profits arose.
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                           REASONS FOR CHANGE

    Requiring taxpayers to separate income and tax credits into 
nine separate tax baskets creates some of the most complex tax 
reporting and compliance issues in the Code. The Committee 
believes that reducing the number of foreign tax credit baskets 
to two greatly simplifies the Code and undoes much of the 
complexity created by the Tax Reform Act of 1986. The Committee 
believes that simplifying these rules will reduce double 
taxation, make U.S. businesses more competitive, and create 
jobs in the United States.

                        EXPLANATION OF PROVISION

    The provision provides for two foreign tax credit 
limitation categories: passive category income and general 
category income. Financial services income is treated as 
general category income in the case of (1) a member of a 
financial services group (i.e., any affiliated group \69\ that 
is predominately engaged in the active conduct of a banking, 
insurance, financing, or similar business) or (2) any other 
person predominantly engaged in the active conduct of a 
banking, insurance, financing, or similar business.\70\ Other 
income is included in one of the two categories, as 
appropriate. For example, shipping income generally falls into 
the general limitation category, whereas high withholding tax 
interest generally could fall into the passive income or the 
general limitation category, depending on the circumstances. 
Dividends from a domestic international sales corporation or 
former domestic international sales corporation, income 
attributable to certain foreign trade income, and certain 
distributions from a foreign sales corporation or former 
foreign sales corporation all are assigned to the passive 
income limitation category. Creditable foreign taxes that are 
imposed on amounts that do not constitute income under U.S. tax 
principles are treated as imposed on general limitation income.
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    \69\ The provision expands the definition of an affiliated group as 
defined under section 1504(a) for these purposes to include certain 
insurance companies (without regard to whether such companies are 
covered by an election under 1504(c)(2)) and foreign corporations that 
are generally excluded from an affiliated group under section 
1504(b)(2) and section 1504(b)(3) respectively. In determining whether 
an affiliated group is predominately engaged in the active conduct of a 
banking, insurance, financing, or similar business, only the income of 
members of the group that are U.S. corporations or controlled foreign 
corporations in which such U.S. corporations own (directly or 
indirectly) at least 80 percent of total voting power and value of the 
stock is taken into account.
    \70\ The provision requires the Secretary to specify the treatment 
of financial services income received or accrued by pass-through 
entities that are not members of a financial services group.
---------------------------------------------------------------------------
    Taxes paid or accrued in a taxable year beginning before 
January 1, 2005, and carried to any subsequent taxable year are 
treated as if this provision were in effect on the date such 
taxes were paid or accrued. Thus, such taxes are assigned to 
one of the two foreign tax credit limitation categories, as 
appropriate. The Secretary has the authority to provide 
regulations relating to the allocation of income with respect 
to taxes carried back to years in which more than two foreign 
tax credit limitation categories were in existence.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2004.

4. Look-through rules to apply to dividends from noncontrolled section 
        902 corporations (sec. 1084 of the bill and sec. 904 of the 
        Code)

                              PRESENT LAW

    U.S. persons may credit foreign taxes against U.S. tax on 
foreign-source income. The amount of foreign tax credits that 
may be claimed in a year is subject to a limitation that 
prevents taxpayers from using foreign tax credits to offset 
U.S. tax on U.S.-source income. Separate limitations are 
applied to specific categories of income.
    Special foreign tax credit limitations apply in the case of 
dividends received from a foreign corporation in which the 
taxpayer owns at least 10 percent of the stock by vote and 
which is not a controlled foreign corporation (a so-called 
``10/50 company''). Dividends paid by a 10/50 company that is 
not a passive foreign investment company out of earnings and 
profits accumulated in taxable years beginning before January 
1, 2003 are subject to a single foreign tax credit limitation 
for all 10/50 companies (other than passive foreign investment 
companies).\71\ Dividends paid by a 10/50 company that is a 
passive foreign investment company out of earnings and profits 
accumulated in taxable years beginning before January 1, 2003, 
continue to be subject to a separate foreign tax credit 
limitation for each such 10/50 company. Dividends paid by a 10/
50 company out of earnings and profits accumulated in taxable 
years after December 31, 2002 are treated as income in a 
foreign tax credit limitation category in proportion to the 
ratio of the earnings and profits attributable to income in 
such foreign tax credit limitation category to the total 
earnings and profits (a ``look-through'' approach).
---------------------------------------------------------------------------
    \71\ Dividends paid by a 10/50 company in taxable years beginning 
before January 1, 2003 are subject to a separate foreign tax credit 
limitation for each 10/50 company.
---------------------------------------------------------------------------
    For these purposes, distributions are treated as made from 
the most recently accumulated earnings and profits. Regulatory 
authority is granted to provide rules regarding the treatment 
of distributions out of earnings and profits for periods prior 
to the taxpayer's acquisition of such stock.

                           REASONS FOR CHANGE

    The Committee believes that significant simplification can 
be achieved by eliminating the requirement that taxpayers 
segregate the earnings and profits of 10/50 companies on the 
basis of when such earnings and profits arose.

                        EXPLANATION OF PROVISION

    The provision applies the look-through approach to all 
dividends paid by a 10/50 company, regardless of the year in 
which the earnings and profits out of which the dividend is 
paid were accumulated.\72\ If the Secretary determines that the 
taxpayer has not substantiated which limitation category 
applies under the look-through approach with respect to all or 
a portion of the dividend, such portion is treated as passive 
category income for foreign tax credit purposes.
---------------------------------------------------------------------------
    \72\ Section 1113 of the bill eliminates the separate basket for 
dividends from 10/50 companies.
---------------------------------------------------------------------------
    The provision also provides transition rules regarding the 
use of pre-effective date foreign tax credits associated with a 
10/50 company separate limitation category in post-effective 
date years. Look-through principles similar to those applicable 
to post-effective date dividends from a 10/50 company apply to 
determine the appropriate foreign tax credit limitation 
category or categories with respect to carrying forward foreign 
tax credits into future years. The provision provides 
regulatory authority for the Secretary to address the carryback 
of foreign tax credits associated with a dividend from a 10/50 
company to pre-effective date years.

                             EFFECTIVE DATE

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

5. Attribution of stock ownership through partnerships to apply in 
        determining section 902 and 960 credits (sec. 1085 of the bill 
        and secs. 901, 902, and 960 of the Code)

                              PRESENT LAW

    Under section 902, a domestic corporation that receives a 
dividend from a foreign corporation in which it owns ten 
percent or more of the voting stock is deemed to have paid a 
portion of the foreign taxes paid by such foreign corporation. 
Thus, such a domestic corporation is eligible to claim a 
foreign tax credit with respect to such deemed-paid taxes. The 
domestic corporation that receives a dividend is deemed to have 
paid a portion of the foreign corporation's post-1986 foreign 
income taxes based on the ratio of the amount of the dividend 
to the foreign corporation's post-1986 undistributed earnings 
and profits.
    Foreign income taxes paid or accrued by lower-tier foreign 
corporations also are eligible for the deemed-paid credit if 
the foreign corporation falls within a qualified group (sec. 
902(b)). A ``qualified group'' includes certain foreign 
corporations within the first six tiers of a chain of foreign 
corporations if, among other things, the product of the 
percentage ownership of voting stock at each level of the chain 
(beginning from the domestic corporation) equals at least five 
percent. In addition, in order to claim indirect credits for 
foreign taxes paid by certain fourth-, fifth-, and sixth-tier 
corporations, such corporations must be controlled foreign 
corporations (within the meaning of sec. 957) and the 
shareholder claiming the indirect credit must be a U.S. 
shareholder (as defined in sec. 951(b)) with respect to the 
controlled foreign corporations. The application of the 
indirect foreign tax credit below the third tier is limited to 
taxes paid in taxable years during which the payor is a 
controlled foreign corporation. Foreign taxes paid below the 
sixth tier of foreign corporations are ineligible for the 
indirect foreign tax credit.
    Section 960 similarly permits a domestic corporation with 
subpart F inclusions from a controlled foreign corporation to 
claim deemed-paid foreign tax credits with respect to foreign 
taxes paid or accrued by the controlled foreign corporation on 
its subpart F income.
    The foreign tax credit provisions in the Code do not 
specifically address whether a domestic corporation owning ten 
percent or more of the voting stock of a foreign corporation 
through a partnership is entitled to a deemed-paid foreign tax 
credit.\73\ In Rev. Rul. 71-141,\74\ the IRS held that a 
foreign corporation's stock held indirectly by two domestic 
corporations through their interests in a domestic general 
partnership is attributed to such domestic corporations for 
purposes of determining the domestic corporations' eligibility 
to claim a deemed-paid foreign tax credit with respect to the 
foreign taxes paid by such foreign corporation. Accordingly, a 
general partner of a domestic general partnership is permitted 
to claim deemed-paid foreign tax credits with respect to a 
dividend distribution from the foreign corporation to the 
partnership.
---------------------------------------------------------------------------
    \73\ Under section 901(b)(5), an individual member of a partnership 
or a beneficiary of an estate or trust generally may claim a direct 
foreign tax credit with respect to the amount of his or her 
proportionate share of the foreign taxes paid or accrued by the 
partnership, estate, or trust. This rule does not specifically apply to 
corporations that are either members of a partnership or beneficiaries 
of an estate or trust. However, section 702(a)(6) provides that each 
partner (including individuals or corporations) of a partnership must 
take into account separately its distributive share of the 
partnership's foreign taxes paid or accrued. In addition, under section 
703(b)(3), the election under section 901 (whether to credit the 
foreign taxes) is made by each partner separately.
    \74\ 1971-1 C.B. 211.
---------------------------------------------------------------------------
    However, in 1997, the Treasury Department issued final 
regulations under section 902, and the preamble to the 
regulations states that ``[t]he final regulations do not 
resolve under what circumstances a domestic corporate partner 
may compute an amount of foreign taxes deemed paid with respect 
to dividends received from a foreign corporation by a 
partnership or other pass-through entity.'' \75\ In recognition 
of the holding in Rev. Rul. 71-141, the preamble to the final 
regulations under section 902 states that a ``domestic 
shareholder'' for purposes of section 902 is a domestic 
corporation that ``owns'' the requisite voting stock in a 
foreign corporation rather than one that ``owns directly'' the 
voting stock. At the same time, the preamble states that the 
IRS is still considering under what other circumstances Rev. 
Rul. 71-141 should apply. Consequently, uncertainty remains 
regarding whether a domestic corporation owning ten percent or 
more of the voting stock of a foreign corporation through a 
partnership is entitled to a deemed-paid foreign tax credit 
(other than through a domestic general partnership).
---------------------------------------------------------------------------
    \75\ T.D. 8708, 1997-1 C.B. 137.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that a clarification is appropriate 
regarding the ability of a domestic corporation owning ten 
percent or more of the voting stock of a foreign corporation 
through a partnership to claim a deemed-paid foreign tax 
credit.

                        EXPLANATION OF PROVISION

    The provision clarifies that a domestic corporation is 
entitled to claim deemed-paid foreign tax credits with respect 
to a foreign corporation that is held indirectly through a 
foreign or domestic partnership, provided that the domestic 
corporation owns (indirectly through the partnership) ten 
percent or more of the foreign corporation's voting stock. No 
inference is intended as to the treatment of such deemed-paid 
foreign tax credits under present law. The provision also 
clarifies that both individual and corporate partners (or 
estate or trust beneficiaries) may claim direct foreign tax 
credits with respect to their proportionate shares of taxes 
paid or accrued by a partnership (or estate or trust).

                             EFFECTIVE DATE

    The provision applies to taxes of foreign corporations for 
taxable years of such corporations beginning after the date of 
enactment.

6. Clarification of treatment of certain transfers of intangible 
        property (sec. 1086 of the bill and sec. 367(d) of the Code)

                              PRESENT LAW

    In the case of transfers of intangible property to foreign 
corporations by means of contributions and certain other 
nonrecognition transactions, special rules apply that are 
designed to mitigate the tax avoidance that may arise from 
shifting the income attributable to intangible property 
offshore. Under section 367(d), the outbound transfer of 
intangible property is treated as a sale of the intangible for 
a stream of contingent payments. The amounts of these deemed 
payments must be commensurate with the income attributable to 
the intangible. The deemed payments are included in gross 
income of the U.S. transferor as ordinary income, and the 
earnings and profits of the foreign corporation to which the 
intangible was transferred are reduced by such amounts.
    The Taxpayer Relief Act of 1997 repealed a rule of prior 
law that treated all such deemed payments as giving rise to 
U.S.-source income. Because the foreign tax credit is generally 
limited to the U.S. tax imposed on foreign-source income, the 
prior-law rule reduced the taxpayer's ability to claim foreign 
tax credits. As a result of the repeal of the rule, the source 
of payments deemed received under section 367(d) is determined 
under general sourcing rules. These rules treat income from 
sales of intangible property for contingent payments the same 
as royalties, with the result that the deemed payments may give 
rise to foreign-source income.\76\
---------------------------------------------------------------------------
    \76\ Secs. 865(d), 862(a).
---------------------------------------------------------------------------
    The Taxpayer Relief Act of 1997 did not address the 
characterization of the deemed payments for purposes of 
applying the foreign tax credit separate limitation 
categories.\77\ If the deemed payments are treated like 
proceeds of a sale, then they could fall into the passive 
category; if the deemed payments are treated like royalties, 
then in many cases they could fall into the general category 
(under look-through rules applicable to payments of dividends, 
interest, rents, and royalties received from controlled foreign 
corporations).\78\
---------------------------------------------------------------------------
    \77\ Sec. 904(d).
    \78\ Sec. 904(d)(3).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is appropriate to treat 
payments under section 367(d) the same as royalties for 
purposes of applying the separate limitation categories of the 
foreign tax credit, and that this treatment should be effective 
for all transactions subject to the underlying provision of the 
1997 Act.

                        EXPLANATION OF PROVISION

    The provision specifies that deemed payments under section 
367(d) are treated as royalties for purposes of applying the 
separate limitation categories of the foreign tax credit.

                             EFFECTIVE DATE

    The provision is effective for amounts treated as received 
on or after August 5, 1997 (the effective date of the relevant 
provision of the Taxpayer Relief Act of 1997).

7. United States property not to include certain assets acquired by 
        dealers in ordinary course of trade or business (sec. 1087 of 
        the bill and sec. 956 of the Code)

                              PRESENT LAW

    In general, the subpart F rules (secs. 951-964) require 
U.S. shareholders with a 10-percent or greater interest in a 
controlled foreign corporation (``U.S. 10-percent 
shareholders'') to include in taxable income their pro rata 
shares of certain income of the controlled foreign corporation 
(referred to as ``subpart F income'') when such income is 
earned, whether or not the earnings are distributed currently 
to the shareholders. In addition, the U.S. 10-percent 
shareholders of a controlled foreign corporation are subject to 
U.S. tax on their pro rata shares of the controlled foreign 
corporation's earnings to the extent invested by the controlled 
foreign corporation in certain U.S. property in a taxable year 
(sec. 951(a)(1)(B)).
    A shareholder's income inclusion with respect to a 
controlled foreign corporation's investment in U.S. property 
for a taxable year is based on the controlled foreign 
corporation's average investment in U.S. property for such 
year. For this purpose, the U.S. property held (directly or 
indirectly) by the controlled foreign corporation must be 
measured as of the close of each quarter in the taxable year 
(sec. 956(a)). The amount taken into account with respect to 
any property is the property's adjusted basis as determined for 
purposes of reporting the controlled foreign corporation's 
earnings and profits, reduced by any liability to which the 
property is subject. The amount determined for inclusion in 
each taxable year is the shareholder's pro rata share of an 
amount equal to the lesser of: (1) the controlled foreign 
corporation's average investment in U.S. property as of the end 
of each quarter of such taxable year, to the extent that such 
investment exceeds the foreign corporation's earnings and 
profits that were previously taxed on that basis; or (2) the 
controlled foreign corporation's current or accumulated 
earnings and profits (but not including a deficit), reduced by 
distributions during the year and by earnings that have been 
taxed previously as earnings invested in U.S. property (secs. 
956 and 959). An income inclusion is required only to the 
extent that the amount so calculated exceeds the amount of the 
controlled foreign corporation's earnings that have been 
previously taxed as subpart F income (secs. 951(a)(1)(B) and 
959).
    For purposes of section 956, U.S. property generally is 
defined to include tangible property located in the United 
States, stock of a U.S. corporation, an obligation of a U.S. 
person, and certain intangible assets including a patent or 
copyright, an invention, model or design, a secret formula or 
process or similar property right which is acquired or 
developed by the controlled foreign corporation for use in the 
United States (sec. 956(c)(1)).
    Specified exceptions from the definition of U.S. property 
are provided for: (1) obligations of the United States, money, 
or deposits with persons carrying on the banking business; (2) 
certain export property; (3) certain trade or business 
obligations; (4) aircraft, railroad rolling stock, vessels, 
motor vehicles or containers used in transportation in foreign 
commerce and used predominantly outside of the United States; 
(5) certain insurance company reserves and unearned premiums 
related to insurance of foreign risks; (6) stock or debt of 
certain unrelated U.S. corporations; (7) moveable property 
(other than a vessel or aircraft) used for the purpose of 
exploring, developing, or certain other activities in 
connection with the ocean waters of the U.S. Continental Shelf; 
(8) an amount of assets equal to the controlled foreign 
corporation's accumulated earnings and profits attributable to 
income effectively connected with a U.S. trade or business; (9) 
property (to the extent provided in regulations) held by a 
foreign sales corporation and related to its export activities; 
(10) certain deposits or receipts of collateral or margin by a 
securities or commodities dealer, if such deposit is made or 
received on commercial terms in the ordinary course of the 
dealer's business as a securities or commodities dealer; and 
(11) certain repurchase and reverse repurchase agreement 
transactions entered into by or with a dealer in securities or 
commodities in the ordinary course of its business as a 
securities or commodities dealer (sec. 956(c)(2)).

                           REASONS FOR CHANGE

    The Committee believes that the acquisition of securities 
by a controlled foreign corporation in the ordinary course of 
its business as a securities dealer generally should not give 
rise to an income inclusion as an investment in U.S. property 
under the provisions of subpart F.

                        EXPLANATION OF PROVISION

    The provision adds a new exception from the definition of 
U.S. property for determining current income inclusion by a 
U.S. 10-percent shareholder with respect to an investment in 
U.S. property by a controlled foreign corporation. The 
exception generally applies to securities acquired and held by 
a controlled foreign corporation in the ordinary course of its 
trade or business as a dealer in securities. The exception 
applies only if the controlled foreign corporation dealer: (1) 
accounts for the securities as securities held primarily for 
sale to customers in the ordinary course of business; and (2) 
disposes of such securities (or such securities mature while 
being held by the dealer) within a period consistent with the 
holding of securities for sale to customers in the ordinary 
course of business.

                             EFFECTIVE DATE

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2004, and for taxable 
years of United States shareholders with or within which such 
taxable years of foreign corporations end.

8. Election not to use average exchange rate for foreign tax paid other 
        than in functional currency (sec. 1088 of the bill and sec. 986 
        of the Code)

                              PRESENT LAW

    For taxpayers that take foreign income taxes into account 
when accrued, present law provides that the amount of the 
foreign tax credit generally is determined by translating the 
amount of foreign taxes paid in foreign currencies into a U.S. 
dollar amount at the average exchange rate for the taxable year 
to which such taxes relate.\79\ This rule applies to foreign 
taxes paid directly by U.S. taxpayers, which taxes are 
creditable in the year paid or accrued, and to foreign taxes 
paid by foreign corporations that are deemed paid by a U.S. 
corporation that is a shareholder of the foreign corporation, 
and hence creditable in the year that the U.S. corporation 
receives a dividend or has an income inclusion from the foreign 
corporation. This rule does not apply to any foreign income 
tax: (1) that is paid after the date that is two years after 
the close of the taxable year to which such taxes relate; (2) 
of an accrual-basis taxpayer that is actually paid in a taxable 
year prior to the year to which the tax relates; or (3) that is 
denominated in an inflationary currency (as defined by 
regulations).
---------------------------------------------------------------------------
    \79\ Sec. 986(a)(1).
---------------------------------------------------------------------------
    Foreign taxes that are not eligible for translation at the 
average exchange rate generally are translated into U.S. dollar 
amounts using the exchange rates as of the time such taxes are 
paid. However, the Secretary is authorized to issue regulations 
that would allow foreign tax payments to be translated into 
U.S. dollar amounts using an average exchange rate for a 
specified period.\80\
---------------------------------------------------------------------------
    \80\ Sec. 986(a)(2).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that taxpayers generally should be 
permitted to elect whether to translate foreign income tax 
payments using an average exchange rate the taxable year or the 
exchange rate when the taxes are paid, provided the elected 
method continues to be applied consistently unless revoked with 
the consent of the Treasury Secretary.

                        EXPLANATION OF PROVISION

    For taxpayers that are required under present law to 
translate foreign income tax payments at the average exchange 
rate, the provision provides an election to translate such 
taxes into U.S. dollar amounts using the exchange rates as of 
the time such taxes are paid, provided the foreign income taxes 
are denominated in a currency other than the taxpayer's 
functional currency.\81\ Any election under the provision 
applies to the taxable year for which the election is made and 
to all subsequent taxable years unless revoked with the consent 
of the Secretary. The provision authorizes the Secretary to 
issue regulations that apply the election to foreign income 
taxes attributable to a qualified business unit.
---------------------------------------------------------------------------
    \81\ Electing taxpayers translate foreign income tax payments 
pursuant to the same present-law that apply to taxpayers that are 
required to translate foreign income taxes using the exchange rates as 
of the time such taxes are paid.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision is effective with respect to taxable years 
beginning after December 31, 2004.

9. Repeal of withholding tax on dividends from certain foreign 
        corporations (sec. 1089 of the bill and sec. 871 of the Code)

                              PRESENT LAW

    Nonresident individuals who are not U.S. citizens and 
foreign corporations (collectively, foreign persons) are 
subject to U.S. tax on income that is effectively connected 
with the conduct of a U.S. trade or business; the U.S. tax on 
such income is calculated in the same manner and at the same 
graduated rates as the tax on U.S. persons (secs. 871(b) and 
882). Foreign persons also are subject to a 30-percent gross 
basis tax, collected by withholding, on certain U.S.-source 
passive income (e.g., interest and dividends) that is not 
effectively connected with a U.S. trade or business. This 30-
percent withholding tax may be reduced or eliminated pursuant 
to an applicable tax treaty. Foreign persons generally are not 
subject to U.S. tax on foreign-source income that is not 
effectively connected with a U.S. trade or business.
    In general, dividends paid by a domestic corporation are 
treated as being from U.S. sources and dividends paid by a 
foreign corporation are treated as being from foreign sources. 
Thus, dividends paid by foreign corporations to foreign persons 
generally are not subject to withholding tax because such 
income generally is treated as foreign-source income.
    An exception from this general rule applies in the case of 
dividends paid by certain foreign corporations. If a foreign 
corporation derives 25 percent or more of its gross income as 
income effectively connected with a U.S. trade or business for 
the three-year period ending with the close of the taxable year 
preceding the declaration of a dividend, then a portion of any 
dividend paid by the foreign corporation to its shareholders 
will be treated as U.S.-source income and, in the case of 
dividends paid to foreign shareholders, will be subject to the 
30-percent withholding tax (sec. 861(a)(2)(B)). This rule is 
sometimes referred to as the ``secondary withholding tax.'' The 
portion of the dividend treated as U.S.-source income is equal 
to the ratio of the gross income of the foreign corporation 
that was effectively connected with its U.S. trade or business 
over the total gross income of the foreign corporation during 
the three-year period ending with the close of the preceding 
taxable year. The U.S.-source portion of the dividend paid by 
the foreign corporation to its foreign shareholders is subject 
to the 30-percent withholding tax.
    Under the branch profits tax provisions, the United States 
taxes foreign corporations engaged in a U.S. trade or business 
on amounts of U.S. earnings and profits that are shifted out of 
the U.S. branch of the foreign corporation. The branch profits 
tax is comparable to the second-level taxes imposed on 
dividends paid by a domestic corporation to its foreign 
shareholders. The branch profits tax is 30 percent of the 
foreign corporation's ``dividend equivalent amount,'' which 
generally is the earnings and profits of a U.S. branch of a 
foreign corporation attributable to its income effectively 
connected with a U.S. trade or business (secs. 884(a) and (b)).
    If a foreign corporation is subject to the branch profits 
tax, then no secondary withholding tax is imposed on dividends 
paid by the foreign corporation to its shareholders (sec. 
884(e)(3)(A)). If a foreign corporation is a qualified resident 
of a tax treaty country and claims an exemption from the branch 
profits tax pursuant to the treaty, the secondary withholding 
tax could apply with respect to dividends it pays to its 
shareholders. Several tax treaties (including treaties that 
prevent imposition of the branch profits tax), however, exempt 
dividends paid by the foreign corporation from the secondary 
withholding tax.

                           REASONS FOR CHANGE

    The Committee observes that the secondary withholding tax 
with respect to dividends paid by certain foreign corporations 
has been largely superseded by the branch profits tax and 
applicable income tax treaties. Accordingly, the Committee 
believes that the tax should be repealed in the interest of 
simplification.

                        EXPLANATION OF PROVISION

    The provision eliminates the secondary withholding tax with 
respect to dividends paid by certain foreign corporations.

                             EFFECTIVE DATE

    The provision is effective for payments made after December 
31, 2004.

10. Provide equal treatment for interest paid by foreign partnerships 
        and foreign corporations (sec. 1090 of the bill and sec. 861 of 
        the Code)

                              PRESENT LAW

    In general, interest income from bonds, notes or other 
interest-bearing obligations of noncorporate U.S. residents or 
domestic corporations is treated as U.S.-source income.\82\ 
Other interest (e.g., interest on obligations of foreign 
corporations and foreign partnerships) generally is treated as 
foreign-source income. However, Treasury regulations provide 
that a foreign partnership is a U.S. resident for purposes of 
this rule if at any time during its taxable year it is engaged 
in a trade or business in the United States.\83\ Therefore, any 
interest received from such a foreign partnership is U.S.-
source income.
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    \82\ Sec. 861(a)(1).
    \83\ Treas. Reg. sec. 1.861-2(a)(2).
---------------------------------------------------------------------------
    Notwithstanding the general rule described above, in the 
case of a foreign corporation engaged in a U.S. trade or 
business (or having gross income that is treated as effectively 
connected with the conduct of a U.S. trade or business), 
interest paid by such U.S. trade or business is treated as if 
it were paid by a domestic corporation (i.e., such interest is 
treated as U.S.-source income).\84\
---------------------------------------------------------------------------
    \84\ Sec. 884(f)(1).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the determination of the source 
of interest income received from a foreign partnership or 
foreign corporation should be consistent. The Committee 
believes that interest payments from a foreign partnership 
engaged in a trade or business in the United States should be 
sourced in the same manner as interest payments from a foreign 
corporation engaged in a trade or business in the United 
States.

                        EXPLANATION OF PROVISION

    The provision treats interest paid by foreign partnerships 
in a manner similar to the treatment of interest paid by 
foreign corporations. Thus, interest paid by a foreign 
partnership is treated as U.S.-source income only if the 
interest is paid by a U.S. trade or business conducted by the 
partnership or is allocable to income that is treated as 
effectively connected with the conduct of a U.S. trade or 
business. The provision applies only to foreign partnerships 
that are principally owned by foreign persons. For this 
purpose, a foreign partnership is principally owned by foreign 
persons if, in the aggregate, U.S. citizens, resident aliens 
and domestic corporations do not own, directly or indirectly, 
20 percent (or more) of the capital or profits interests in the 
partnership.

                             EFFECTIVE DATE

    This provision is effective for taxable years beginning 
after December 31, 2003.

11. Treatment of certain dividends of regulated investment companies 
        (sec. 1091 of the bill and secs. 871 and 881 of the Code)

                              PRESENT LAW

Regulated investment companies

    A regulated investment company (``RIC'') is a domestic 
corporation that, at all times during the taxable year, is 
registered under the Investment Company Act of 1940 as a 
management company or as a unit investment trust, or has 
elected to be treated as a business development company under 
that Act (sec. 851(a)).
    In addition, to qualify as a RIC, a corporation must elect 
such status and must satisfy certain tests (sec. 851(b)). These 
tests include a requirement that the corporation derive at 
least 90 percent of its gross income from dividends, interest, 
payments with respect to certain securities loans, and gains on 
the sale or other disposition of stock or securities or foreign 
currencies, or other income derived with respect to its 
business of investment in such stock, securities, or 
currencies.
    Generally, a RIC pays no income tax because it is permitted 
to deduct dividends paid to its shareholders in computing its 
taxable income. The amount of any distribution generally is not 
considered as a dividend for purposes of computing the 
dividends paid deduction unless the distribution is pro rata, 
with no preference to any share of stock as compared with other 
shares of the same class (sec. 562(c)). For distributions by 
RICs to shareholders who made initial investments of at least 
$10,000,000, however, the distribution is not treated as non-
pro rata or preferential solely by reason of an increase in the 
distribution due to reductions in administrative expenses of 
the company.
    A RIC generally may pass through to its shareholders the 
character of its long-term capital gains. It does this by 
designating a dividend it pays as a capital gain dividend to 
the extent that the RIC has net capital gain (i.e., net long-
term capital gain over net short-term capital loss). These 
capital gain dividends are treated as long-term capital gain by 
the shareholders. A RIC generally also can pass through to its 
shareholders the character of tax-exempt interest from State 
and local bonds, but only if, at the close of each quarter of 
its taxable year, at least 50 percent of the value of the total 
assets of the RIC consists of these obligations. In this case, 
the RIC generally may designate a dividend it pays as an 
exempt-interest dividend to the extent that the RIC has tax-
exempt interest income. These exempt-interest dividends are 
treated as interest excludable from gross income by the 
shareholders.

U.S. source investment income of foreign persons

            In general
    The United States generally imposes a flat 30-percent tax, 
collected by withholding, on the gross amount of U.S.-source 
investment income payments, such as interest, dividends, rents, 
royalties or similar types of income, to nonresident alien 
individuals and foreign corporations (``foreign persons'') 
(secs. 871(a), 881, 1441, and 1442). Under treaties, the United 
States may reduce or eliminate such taxes. Even taking into 
account U.S. treaties, however, the tax on a dividend generally 
is not entirely eliminated. Instead, U.S.-source portfolio 
investment dividends received by foreign persons generally are 
subject to U.S. withholding tax at a rate of at least 15 
percent.
            Interest
    Although payments of U.S.-source interest that is not 
effectively connected with a U.S. trade or business generally 
are subject to the 30-percent withholding tax, there are 
exceptions to that rule. For example, interest from certain 
deposits with banks and other financial institutions is exempt 
from tax (secs. 871(i)(2)(A) and 881(d)). Original issue 
discount on obligations maturing in 183 days or less from the 
date of original issue (without regard to the period held by 
the taxpayer) is also exempt from tax (sec. 871(g)). An 
additional exception is provided for certain interest paid on 
portfolio obligations (secs. 871(h) and 881(c)). ``Portfolio 
interest'' generally is defined as any U.S.-source interest 
(including original issue discount), not effectively connected 
with the conduct of a U.S. trade or business, (i) on an 
obligation that satisfies certain registration requirements or 
specified exceptions thereto (i.e., the obligation is ``foreign 
targeted''), and (ii) that is not received by a 10-percent 
shareholder (secs. 871(h)(3) and 881(c)(3)). With respect to a 
registered obligation, a statement that the beneficial owner is 
not a U.S. person is required (secs. 871(h)(2), (5) and 
881(c)(2)). This exception is not available for any interest 
received either by a bank on a loan extended in the ordinary 
course of its business (except in the case of interest paid on 
an obligation of the United States), or by a controlled foreign 
corporation from a related person (sec. 881(c)(3)). Moreover, 
this exception is not available for certain contingent interest 
payments (secs. 871(h)(4) and 881(c)(4)).
            Capital gains
    Foreign persons generally are not subject to U.S. tax on 
gain realized on the disposition of stock or securities issued 
by a U.S. person (other than a ``U.S. real property holding 
corporation,'' as described below), unless the gain is 
effectively connected with the conduct of a trade or business 
in the United States. This exemption does not apply, however, 
if the foreign person is a nonresident alien individual present 
in the United States for a period or periods aggregating 183 
days or more during the taxable year (sec. 871(a)(2)). A RIC 
may elect not to withhold on a distribution to a foreign person 
representing a capital gain dividend. (Treas. Reg. sec. 1.1441-
3(c)(2)(D)).
    Gain or loss of a foreign person from the disposition of a 
U.S. real property interest is subject to net basis tax as if 
the taxpayer were engaged in a trade or business within the 
United States and the gain or loss were effectively connected 
with such trade or business (sec. 897). In addition to an 
interest in real property located in the United States or the 
Virgin Islands, U.S. real property interests include (among 
other things) any interest in a domestic corporation unless the 
taxpayer establishes that the corporation was not, during a 5-
year period ending on the date of the disposition of the 
interest, a U.S. real property holding corporation (which is 
defined generally to mean a corporation the fair market value 
of whose U.S. real property interests equals or exceeds 50 
percent of the sum of the fair market values of its real 
property interests and any other of its assets used or held for 
use in a trade or business).
            Estate taxation
    Decedents who were citizens or residents of the United 
States are generally subject to Federal estate tax on all 
property, wherever situated.\85\ Nonresidents who are not U.S. 
citizens, however, are subject to estate tax only on their 
property which is within the United States. Property within the 
United States generally includes debt obligations of U.S. 
persons, including the Federal government and State and local 
governments (sec. 2104(c)), but does not include either bank 
deposits or portfolio obligations, the interest on which would 
be exempt from U.S. income tax under section 871 (sec. 
2105(b)). Stock owned and held by a nonresident who is not a 
U.S. citizen is treated as property within the United States 
only if the stock was issued by a domestic corporation (sec. 
2104(a); Treas. Reg. sec. 20.2104-1(a)(5)).
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    \85\ The Economic Growth and Tax Relief Reconciliation Act of 2001 
(``EGTRRA'') repealed the estate tax for estates of decedents dying 
after December 31, 2009. However, EGTRRA included a ``sunset'' 
provision, pursuant to which EGTRRA's provisions (including estate tax 
repeal) do not apply to estates of decedents dying after December 31, 
2010.
---------------------------------------------------------------------------
    Treaties may reduce U.S. taxation on transfers by estates 
of nonresident decedents who are not U.S. citizens. Under 
recent treaties, for example, U.S. tax may generally be 
eliminated except insofar as the property transferred includes 
U.S. real property or business property of a U.S. permanent 
establishment.

                           REASONS FOR CHANGE

    Under present law, a disparity exists between foreign 
persons who invest directly in certain interest-bearing and 
other securities and a foreign person who invests in such 
securities indirectly through U.S. mutual funds. In general, 
certain amounts received by the direct foreign investor (or a 
foreign investor through a foreign fund) may be exempt from the 
U.S. gross-basis withholding tax. In contrast, distributions 
from a RIC generally are treated as dividends subject to the 
withholding tax, notwithstanding that the distributions may be 
attributable to amounts that otherwise could qualify for an 
exemption from withholding tax. U.S. financial institutions 
often respond to this disparate treatment by forming ``mirror 
funds'' outside the United States. The Committee believes that 
such disparate treatment should be eliminated so that U.S. 
financial institutions will be encouraged to form and operate 
their mutual funds within the United States rather than outside 
the United States.
    Therefore, the Committee believes that, to the extent a RIC 
distributes to a foreign person a dividend attributable to 
amounts that would have been exempt from U.S. withholding tax 
had the foreign person received it directly (such as portfolio 
interest and capital gains, including short-term capital 
gains), such dividend similarly should be exempt from the U.S. 
gross-basis withholding tax. The Committee also believes that 
comparable treatment should be afforded for estate tax purposes 
to foreign persons who invest in certain assets through a RIC 
to the extent that such assets would not be subject to the 
estate tax if held directly.

                        EXPLANATION OF PROVISION

In general

    Under the bill, a RIC that earns certain interest income 
that would not be subject to U.S. tax if earned by a foreign 
person directly may, to the extent of such income, designate a 
dividend it pays as derived from such interest income. A 
foreign person who is a shareholder in the RIC generally would 
treat such a dividend as exempt from gross-basis U.S. tax, as 
if the foreign person had earned the interest directly. 
Similarly, a RIC that earns an excess of net short-term capital 
gains over net long-term capital losses, which excess would not 
be subject to U.S. tax if earned by a foreign person, generally 
may, to the extent of such excess, designate a dividend it pays 
as derived from such excess. A foreign person who is a 
shareholder in the RIC generally would treat such a dividend as 
exempt from gross-basis U.S. tax, as if the foreign person had 
realized the excess directly. The bill also provides that the 
estate of a foreign decedent is exempt from U.S. estate tax on 
a transfer of stock in the RIC in the proportion that the 
assets held by the RIC are debt obligations, deposits, or other 
property that would generally be treated as situated outside 
the United States if held directly by the estate.

Interest-related dividends

    Under the bill, a RIC may, under certain circumstances, 
designate all or a portion of a dividend as an ``interest-
related dividend,'' by written notice mailed to its 
shareholders not later than 60 days after the close of its 
taxable year. In addition, an interest-related dividend 
received by a foreign person generally is exempt from U.S. 
gross-basis tax under sections 871(a), 881, 1441 and 1442.
    However, this exemption does not apply to a dividend on 
shares of RIC stock if the withholding agent does not receive a 
statement, similar to that required under the portfolio 
interest rules, that the beneficial owner of the shares is not 
a U.S. person. The exemption does not apply to a dividend paid 
to any person within a foreign country (or dividends addressed 
to, or for the account of, persons within such foreign country) 
with respect to which the Treasury Secretary has determined, 
under the portfolio interest rules, that exchange of 
information is inadequate to prevent evasion of U.S. income tax 
by U.S. persons.
    In addition, the exemption generally does not apply to 
dividends paid to a controlled foreign corporation to the 
extent such dividends are attributable to income received by 
the RIC on a debt obligation of a person with respect to which 
the recipient of the dividend (i.e., the controlled foreign 
corporation) is a related person. Nor does the exemption 
generally apply to dividends to the extent such dividends are 
attributable to income (other than short-term original issue 
discount or bank deposit interest) received by the RIC on 
indebtedness issued by the RIC-dividend recipient or by any 
corporation or partnership with respect to which the recipient 
of the RIC dividend is a 10-percent shareholder. However, in 
these two circumstances the RIC remains exempt from its 
withholding obligation unless the RIC knows that the dividend 
recipient is such a controlled foreign corporation or 10-
percent shareholder. To the extent that an interest-related 
dividend received by a controlled foreign corporation is 
attributable to interest income of the RIC that would be 
portfolio interest if received by a foreign corporation, the 
dividend is treated as portfolio interest for purposes of the 
de minimis rules, the high-tax exception, and the same country 
exceptions of subpart F (see sec. 881(c)(5)(A)).
    The aggregate amount designated as interest-related 
dividends for the RIC's taxable year (including dividends so 
designated that are paid after the close of the taxable year 
but treated as paid during that year as described in section 
855) generally is limited to the qualified net interest income 
of the RIC for the taxable year. The qualified net interest 
income of the RIC equals the excess of: (1) the amount of 
qualified interest income of the RIC; over (2) the amount of 
expenses of the RIC properly allocable to such interest income.
    Qualified interest income of the RIC is equal to the sum of 
its U.S.-source income with respect to: (1) bank deposit 
interest; (2) short term original issue discount that is 
currently exempt from the gross-basis tax under section 871; 
(3) any interest (including amounts recognized as ordinary 
income in respect of original issue discount, market discount, 
or acquisition discount under the provisions of sections 1271-
1288, and such other amounts as regulations may provide) on an 
obligation which is in registered form, unless it is earned on 
an obligation issued by a corporation or partnership in which 
the RIC is a 10-percent shareholder or is contingent interest 
not treated as portfolio interest under section 871(h)(4); and 
(4) any interest-related dividend from another RIC.
    If the amount designated as an interest-related dividend is 
greater than the qualified net interest income described above, 
the portion of the distribution so designated which constitutes 
an interest-related dividend will be only that proportion of 
the amount so designated as the amount of the qualified net 
interest income bears to the amount so designated.

Short-term capital gain dividends

    Under the bill, a RIC also may, under certain 
circumstances, designate all or a portion of a dividend as a 
``short-term capital gain dividend,'' by written notice mailed 
to its shareholders not later than 60 days after the close of 
its taxable year. For purposes of the U.S. gross-basis tax, a 
short-term capital gain dividend received by a foreign person 
generally is exempt from U.S. gross-basis tax under sections 
871(a), 881, 1441 and 1442. This exemption does not apply to 
the extent that the foreign person is a nonresident alien 
individual present in the United States for a period or periods 
aggregating 183 days or more during the taxable year. However, 
in this circumstance the RIC remains exempt from its 
withholding obligation unless the RIC knows that the dividend 
recipient has been present in the United States for such 
period.
    The aggregate amount qualified to be designated as short-
term capital gain dividends for the RIC's taxable year 
(including dividends so designated that are paid after the 
close of the taxable year but treated as paid during that year 
as described in sec. 855) is equal to the excess of the RIC's 
net short-term capital gains over net long-term capital losses. 
The short-term capital gain includes short-term capital gain 
dividends from another RIC. As provided under present law for 
purposes of computing the amount of a capital gain dividend, 
the amount is determined (except in the case where an election 
under sec. 4982(e)(4) applies) without regard to any net 
capital loss or net short-term capital loss attributable to 
transactions after October 31 of the year. Instead, that loss 
is treated as arising on the first day of the next taxable 
year. To the extent provided in regulations, this rule also 
applies for purposes of computing the taxable income of the 
RIC.
    In computing the amount of short-term capital gain 
dividends for the year, no reduction is made for the amount of 
expenses of the RIC allocable to such net gains. In addition, 
if the amount designated as short-term capital gain dividends 
is greater than the amount of qualified short-term capital 
gain, the portion of the distribution so designated which 
constitutes a short-term capital gain dividend is only that 
proportion of the amount so designated as the amount of the 
excess bears to the amount so designated.
    As under present law for distributions from REITs, the bill 
provides that any distribution by a RIC to a foreign person 
shall, to the extent attributable to gains from sales or 
exchanges by the RIC of an asset that is considered a U.S. real 
property interest, be treated as gain recognized by the foreign 
person from the sale or exchange of a U.S. real property 
interest. The bill also extends the special rules for 
domestically-controlled REITs to domestically-controlled RICs.

Estate tax treatment

    Under the bill, a portion of the stock in a RIC held by the 
estate of a nonresident decedent who is not a U.S. citizen is 
treated as property without the United States. The portion so 
treated is based upon the proportion of the assets held by the 
RIC at the end of the quarter immediately preceding the 
decedent's death (or such other time as the Secretary may 
designate in regulations) that are ``qualifying assets''. 
Qualifying assets for this purpose are bank deposits of the 
type that are exempt from gross-basis income tax, portfolio 
debt obligations, certain original issue discount obligations, 
debt obligations of a domestic corporation that are treated as 
giving rise to foreign source income, and other property not 
within the United States.

                             EFFECTIVE DATE

    The provision generally applies to dividends with respect 
to taxable years of RICs beginning after the date of enactment. 
With respect to the treatment of a RIC for estate tax purposes, 
this provision applies to estates of decedents dying after the 
date of enactment. With respect to the treatment of RICs under 
section 897 (relating to U.S. real property interests), this 
provision is effective on the date of enactment.

                          I. Other Provisions


1. Special rules for livestock sold on account of weather-related 
        conditions (sec. 1101 of the bill and secs. 1033 and 451 of the 
        Code)

                              PRESENT LAW

    Generally, a taxpayer recognizes gain to the extent the 
sales price (and any other consideration received) exceeds the 
seller's basis in the property. The recognized gain is subject 
to current income tax unless the gain is deferred or not 
recognized under a special tax provision.
    Under section 1033, gain realized by a taxpayer from an 
involuntary conversion of property is deferred to the extent 
the taxpayer purchases property similar or related in service 
or use to the converted property within the applicable period. 
The taxpayer's basis in the replacement property generally is 
the same as the taxpayer's basis in the converted property, 
decreased by the amount of any money or loss recognized on the 
conversion, and increased by the amount of any gain recognized 
on the conversion.
    The applicable period for the taxpayer to replace the 
converted property begins with the date of the disposition of 
the converted property (or if earlier, the earliest date of the 
threat or imminence of requisition or condemnation of the 
converted property) and ends two years after the close of the 
first taxable year in which any part of the gain upon 
conversion is realized (the ``replacement period''). Special 
rules extend the replacement period for certain real property 
and principle residences damaged by a Presidentially declared 
disaster to three years and four years, respectively, after the 
close of the first taxable year in which gain is realized.
    Section 1033(e) provides that the sale of livestock (other 
than poultry) that is held for draft, breeding, or dairy 
purposes in excess of the number of livestock that would have 
been sold but for drought, flood, or other weather-related 
conditions is treated as an involuntary conversion. 
Consequently, gain from the sale of such livestock could be 
deferred by reinvesting the proceeds of the sale in similar 
property within a two-year period.
    In general, cash-method taxpayers report income in the year 
it is actually or constructively received. However, section 
451(e) provides that a cash-method taxpayer whose principal 
trade or business is farming who is forced to sell livestock 
due to drought, flood, or other weather-related conditions may 
elect to include income from the sale of the livestock in the 
taxable year following the taxable year of the sale. This 
elective deferral of income is available only if the taxpayer 
establishes that, under the taxpayer's usual business 
practices, the sale would not have occurred but for drought, 
flood, or weather-related conditions that resulted in the area 
being designated as eligible for Federal assistance. This 
exception is generally intended to put taxpayers who receive an 
unusually high amount of income in one year in the position 
they would have been in absent the weather-related condition.

                           REASONS FOR CHANGE

    The Committee is aware of situations in which cattlemen 
sold livestock in excess of their usual business practice as a 
result of weather-related conditions, but have been unable to 
purchase replacement property because the weather-related 
conditions have continued. The Committee believes it is 
appropriate to extend the time period for cattlemen to purchase 
replacement property in such situations.

                        EXPLANATION OF PROVISION

    The provision extends the applicable period for a taxpayer 
to replace livestock sold on account of drought, flood, or 
other weather-related conditions from two years to four years 
after the close of the first taxable year in which any part of 
the gain on conversion is realized. The extension is only 
available if the taxpayer establishes that, under the 
taxpayer's usual business practices, the sale would not have 
occurred but for drought, flood, or weather-related conditions 
that resulted in the area being designated as eligible for 
Federal assistance. In addition, the Secretary is granted 
authority to further extend the replacement period on a 
regional basis should the weather-related conditions continue 
longer than three years. Also, for property eligible for the 
provision's extended replacement period, the provision provides 
that the taxpayer can make an election under section 451(e) 
until the period for reinvestment of such property under 
section 1033 expires.

                             EFFECTIVE DATE

    The provision is effective for any taxable year with 
respect to which the due date (without regard to extensions) 
for the return is after December 31, 2002.

2. Payment of dividends on stock of cooperatives without reducing 
        patronage dividends (sec. 1102 of the bill and sec. 1388 of the 
        Code)

                              PRESENT LAW

    Under present law, cooperatives generally are entitled to 
deduct or exclude amounts distributed as patronage dividends in 
accordance with Subchapter T of the Code. In general, patronage 
dividends are comprised of amounts that are paid to patrons (1) 
on the basis of the quantity or value of business done with or 
for patrons, (2) under a valid and enforceable obligation to 
pay such amounts that was in existence before the cooperative 
received the amounts paid, and (3) which are determined by 
reference to the net earnings of the cooperative from business 
done with or for patrons.
    Treasury Regulations provide that net earnings are reduced 
by dividends paid on capital stock or other proprietary capital 
interests (referred to as the ``dividend allocation 
rule'').86 The dividend allocation rule has been 
interpreted to require that such dividends be allocated between 
a cooperative's patronage and nonpatronage operations, with the 
amount allocated to the patronage operations reducing the net 
earnings available for the payment of patronage dividends.
---------------------------------------------------------------------------
    \86\ Treas. Reg. sec. 1.1388-1(a)(1).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the dividend allocation rule 
should not apply to the extent that the organizational 
documents of a cooperative provide that capital stock dividends 
do not reduce the amounts owed to patrons as patronage 
dividends. To the extent that capital stock dividends are in 
addition to amounts paid under the cooperative's organizational 
documents to patrons as patronage dividends, the Committee 
believes that those capital stock dividends are not being paid 
from earnings from patronage business.
    In addition, the Committee believes cooperatives should be 
able to raise needed equity capital by issuing capital stock 
without dividends paid on such stock causing the cooperative to 
be taxed on a portion of its patronage income, and without 
preventing the cooperative from being treated as operating on a 
cooperative basis.

                        EXPLANATION OF PROVISION

    The provision provides a special rule for dividends on 
capital stock of a cooperative. To the extent provided in 
organizational documents of the cooperative, dividends on 
capital stock do not reduce patronage income and do not prevent 
the cooperative from being treated as operating on a 
cooperative basis.

                             EFFECTIVE DATE

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

3. Add vaccines against hepatitis A to the list of taxable vaccines 
        (sec. 1103 of the bill and sec. 4132 of the Code)

                              PRESENT LAW

    A manufacturer's excise tax is imposed at the rate of 75 
cents per dose 87 on the following vaccines 
routinely recommended for administration to children: 
diphtheria, pertussis, tetanus, measles, mumps, rubella, polio, 
HIB (haemophilus influenza type B), hepatitis B, varicella 
(chicken pox), rotavirus gastroenteritis, and streptococcus 
pneumoniae. The tax applied to any vaccine that is a 
combination of vaccine components equals 75 cents times the 
number of components in the combined vaccine.
---------------------------------------------------------------------------
    \87\ sec. 4131
---------------------------------------------------------------------------
    Amounts equal to net revenues from this excise tax are 
deposited in the Vaccine Injury Compensation Trust Fund to 
finance compensation awards under the Federal Vaccine Injury 
Compensation Program for individuals who suffer certain 
injuries following administration of the taxable vaccines. This 
program provides a substitute Federal, ``no fault'' insurance 
system for the State-law tort and private liability insurance 
systems otherwise applicable to vaccine manufacturers. All 
persons immunized after September 30, 1988, with covered 
vaccines must pursue compensation under this Federal program 
before bringing civil tort actions under State law.

                           REASONS FOR CHANGE

    The Committee is aware that the Centers for Disease Control 
and Prevention have recommended that children in 17 highly 
endemic States be inoculated with a hepatitis A vaccine. The 
population of children in the affected States exceeds 20 
million. Several of the affected States mandate childhood 
vaccination against hepatitis A. The Committee is aware that 
the Advisory Commission on Childhood Vaccines has recommended 
that the vaccine excise tax be extended to cover vaccines 
against hepatitis A. For these reasons, the Committee believes 
it is appropriate to include vaccines against hepatitis A as 
part of the Vaccine Injury Compensation Program. Making the 
hepatitis A vaccine taxable is a first step.88 In 
the unfortunate event of an injury related to this vaccine, 
families of injured children are eligible for the no-fault 
arbitration system established under the Vaccine Injury 
Compensation Program rather than going to Federal Court to seek 
compensatory redress.
---------------------------------------------------------------------------
    \88\ The Committee recognizes that, to become covered under the 
Vaccine Injury Compensation Program, the Secretary of Health and Human 
Services also must list the hepatitis A vaccine on the Vaccine Injury 
Table.
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The bill adds any vaccine against hepatitis A to the list 
of taxable vaccines. The bill also makes a conforming amendment 
to the trust fund expenditure purposes.

                             EFFECTIVE DATE

    The provision is effective for sales and uses of vaccines 
beginning on the first day of the first month beginning more 
than four weeks after the date of enactment.

4. Expand human clinical trials expenses qualifying for the orphan drug 
        tax credit (sec. 1104 of the bill and sec. 45C of the Code)

                              PRESENT LAW

    Taxpayers may claim a 50-percent credit for expenses 
related to human clinical testing of drugs for the treatment of 
certain rare diseases and conditions, generally those that 
afflict less than 200,000 persons in the United States. 
Qualifying expenses are those paid or incurred by the taxpayer 
after the date on which the drug is designated as a potential 
treatment for a rare disease or disorder by the Food and Drug 
Administration (``FDA'') in accordance with section 526 of the 
Federal Food, Drug, and Cosmetic Act.

                           REASONS FOR CHANGE

    The Committee understands that approval for human clinical 
testing and designation as a potential treatment for a rare 
disease or disorder require separate reviews within the FDA. As 
a result, in some cases, a taxpayer may be permitted to begin 
human clinical testing prior to a drug being designated as a 
potential treatment for a rare disease or disorder. If the 
taxpayer delays human clinical testing in order to obtain the 
benefits of the orphan drug tax credit, which currently may be 
claimed only for expenses incurred after the drug is designated 
as a potential treatment for a rare disease or disorder, 
valuable time will have been lost and Congress's original 
intent in enacting the orphan drug tax credit will have been 
partially thwarted. Because taxpayers generally seek 
designation of a potential drug as a treatment for a rare 
disease or disorder at the time they seek approval to 
clinically test such drugs, the Committee believes it is 
appropriate to make such expenses related to human clinical 
testing that the taxpayer incurs prior to FDA designation 
eligible for the orphan drug tax credit to help speed cures to 
such insidious diseases.
    The Committee also observes that the staff of the Joint 
Committee on Taxation identifies present law with respect to 
the FDA review dates as a source of complexity and recommends 
that the definition of qualifying expenses be expanded to 
include those expenses related to human clinical testing 
incurred after the date on which the taxpayer files an 
application with the FDA for designation of the drug under 
section 526 of the Federal Food, Drug, and Cosmetic Act as a 
potential treatment for a rare disease or disorder.\89\
---------------------------------------------------------------------------
    \89\ Joint Committee on Taxation, Study of the Overall State of the 
Federal Tax System and Recommendations for Simplification, Pursuant to 
Section 8022(3)(B) of the Internal Revenue Code of 1986 (JCS-3-01), 
volume II, April 2001, page 310
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The bill expands qualifying expenses to include those 
expenses related to human clinical testing incurred after the 
date on which the taxpayer files an application with the FDA 
for designation of the drug under section 526 of the Federal 
Food, Drug, and Cosmetic Act as a potential treatment for a 
rare disease or disorder. As under present law, the credit may 
only be claimed for such expenses related to drugs designated 
as a potential treatment for a rare disease or disorder by the 
FDA in accordance with section 526 of such Act.

                             EFFECTIVE DATE

    The provision is effective for expenditures paid or 
incurred after the date of enactment.

5. Distributions from publicly traded partnerships treated as 
        qualifying income of regulated investment company (sec. 1105 of 
        the bill and secs. 851 and 469(k) of the Code)

                              PRESENT LAW

Treatment of regulated investment companies

    A regulated investment company (``RIC'') generally is 
treated as a conduit for Federal income tax purposes. In 
computing its taxable income, a RIC deducts dividends paid to 
its shareholders to achieve conduit treatment (sec. 852(b)). In 
order to qualify for conduit treatment, a RIC must be a 
domestic corporation that, at all times during the taxable 
year, is registered under the Investment Company Act of 1940 as 
a management company or as a unit investment trust, or has 
elected to be treated as a business development company under 
that Act (sec. 851(a)). In addition, the corporation must elect 
RIC status, and must satisfy certain other requirements (sec. 
851(b)).
    One of the RIC qualification requirements is that at least 
90 percent of the RIC's gross income is derived from dividends, 
interest, payments with respect to securities loans, and gains 
from the sale or other disposition of stock or securities or 
foreign currencies, or other income (including but not limited 
to gains from options, futures, or forward contracts) derived 
with respect to its business of investing in such stock, 
securities, or currencies (sec. 851(b)(2)). Income derived from 
a partnership is treated as meeting this requirement only to 
the extent such income is attributable to items of income of 
the partnership that would meet the requirement if realized by 
the RIC in the same manner as realized by the partnership (the 
``look-through'' rule for partnership income) (sec. 851(b)). 
Under present law, no distinction is made under this rule 
between a publicly traded partnership (that is treated as a 
partnership for Federal tax purposes) and any other 
partnership.
    The RIC qualification rules include limitations on the 
ownership of assets and on the composition of the RIC's assets 
(sec. 851(b)(3)). Under the ownership limitation, at least 50 
percent of the value of the RIC's total assets must be 
represented by cash, government securities and securities of 
other RICs, and other securities; however, in the case of such 
other securities, the RIC may invest no more than 5 percent of 
the value of the total assets of the RIC in the securities of 
any one issuer, and may hold no more than 10 percent of the 
outstanding voting securities of any one issuer. Under the 
limitation on the composition of the RIC's assets, no more than 
25 percent of the value of the RIC's total assets may be 
invested in the securities of any one issuer (other than 
Government securities), or in securities of two or more 
controlled issuers in the same or similar trades or businesses. 
These limitations generally are applied at the end of each 
quarter (sec. 851(d)).

Treatment of publicly traded partnerships

    Under present law, a publicly traded partnership is defined 
as a partnership, interests in which are traded on an 
established securities market, or are readily tradable on a 
secondary market (or the substantial equivalent thereof). In 
general, a publicly traded partnership is treated as a 
corporation (sec. 7704(a)), but an exception to corporate 
treatment is provided if 90 percent or more of its gross income 
is interest, dividends, real property rents, or certain other 
types of qualifying income (sec. 7704(c) and (d)).
    A special rule for publicly traded partnerships applies 
under the passive loss rules. The passive loss rules limit 
deductions and credits from passive trade or business 
activities (sec. 469). Deductions attributable to passive 
activities, to the extent they exceed income from passive 
activities, generally may not be deducted against other income. 
Deductions and credits that are suspended under these rules are 
carried forward and treated as deductions and credits from 
passive activities in the next year. The suspended losses from 
a passive activity are allowed in full when a taxpayer disposes 
of his entire interest in the passive activity to an unrelated 
person. The special rule for publicly traded partnerships 
provides that the passive loss rules are applied separately 
with respect to items attributable to each publicly traded 
partnership (sec. 469(k)). Thus, income or loss from the 
publicly traded partnership is treated as separate from income 
or loss from other passive activities.

                           REASONS FOR CHANGE

    The Committee understands that publicly traded partnerships 
generally are treated as corporations under rules enacted to 
address Congress' view that publicly traded partnerships 
resemble corporations in important respects.\90\ Publicly 
traded partnerships with specified types of income are not 
treated as corporations, however, for the reason that if the 
income is from sources that are commonly considered to be 
passive investments, then there is less reason to treat the 
publicly traded partnership as a corporation.\91\ The Committee 
understands that these types of publicly traded partnerships 
may have improved access to capital markets if their interests 
were permitted investments of mutual funds. Therefore, the bill 
treats publicly traded partnership interests as permitted 
investments for mutual funds (RICs).
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    \90\ H.R. Rep. No. 100-391, pt. 2 of 2, at 1066 (1987).
    \91\ Id.
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    Nevertheless, the Committee believes that permitting mutual 
funds to hold interests in a publicly traded partnership should 
not give rise to avoidance of unrelated business income tax or 
withholding of income tax that would apply if tax-exempt 
organizations or foreign persons held publicly traded 
partnership interests directly rather than through a mutual 
fund. Therefore, the Committee bill requires that present-law 
limitations on ownership and composition of assets of mutual 
funds apply to any investment in a publicly traded partnership 
by a mutual fund. The Committee believes that these limitations 
will serve to limit the use of mutual funds as conduits for 
avoidance of unrelated business income tax or withholding rules 
that would otherwise apply with respect to publicly traded 
partnership income.

                        EXPLANATION OF PROVISION

    The provision modifies the 90 percent test with respect to 
income of a RIC to include income derived from an interest in 
certain publicly traded partnerships. The provision also 
modifies the lookthrough rule for partnership income of a RIC 
so that it applies only to income from a partnership other than 
such publicly traded partnerships.
    The provision provides that the limitation on ownership and 
the limitation on composition of assets that apply to other 
investments of a RIC also apply to RIC investments in such 
publicly traded partnership interests.
    A publicly traded partnership to which the provision 
applies is a publicly traded partnership described in section 
7704(b) other than one that would satisfy the 90-percent gross 
income requirements for publicly traded partnerships if 
qualifying income included only income that is qualifying 
income described in section 851(b)(2)(A) for a RIC (i.e., 
income that is derived from dividends, interest, payments with 
respect to securities loans, and gains from the sale or other 
disposition of stock or securities or foreign currencies, or 
other income (including but not limited to gains from options, 
futures, or forward contracts) derived with respect to its 
business of investing in such stock, securities, or 
currencies).
    The provision provides that the special rule for publicly 
traded partnerships under the passive loss rules (requiring 
separate treatment) applies to a RIC holding an interest in 
such a publicly traded partnership, with respect to items 
attributable to the interest in the publicly traded 
partnership.
    The Committee intends that the provision not be used to 
avoid tax on the partnership's income in the hands of the 
mutual fund shareholders that would be subject to tax or to 
withholding if they held the partnership interest directly. The 
Committee expects that guidance issued by the Treasury 
Department with respect to the provision will provide rules 
that carry out this intent.

                             EFFECTIVE DATE

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

6. REIT modification provisions (sec. 1106 of the bill and secs. 856 
        and 857 of the Code)

                              PRESENT LAW

In general

    Real estate investment trusts (``REITs'') are treated, in 
substance, as pass-through entities under present law. Pass-
through status is achieved by allowing the REIT a deduction for 
dividends paid to its shareholders. REITs are generally 
restricted to investing in passive investments primarily in 
real estate and securities.
    A REIT must satisfy four tests on a year-by-year basis: 
organizational structure, source of income, nature of assets, 
and distribution of income. Whether the REIT meets the asset 
tests is generally measured each quarter.

Organizational structure requirements

    To qualify as a REIT, an entity must be for its entire 
taxable year a corporation or an unincorporated trust or 
association that would be taxable as a domestic corporation but 
for the REIT provisions, and must be managed by one or more 
trustees. The beneficial ownership of the entity must be 
evidenced by transferable shares or certificates of ownership. 
Except for the first taxable year for which an entity elects to 
be a REIT, the beneficial ownership of the entity must be held 
by 100 or more persons, and the entity may not be so closely 
held by individuals that it would be treated as a personal 
holding company if all its adjusted gross income constituted 
personal holding company income. A REIT is disqualified for any 
year in which it does not comply with regulations to ascertain 
the actual ownership of the REIT's outstanding shares.

Income requirements

    In order for an entity to qualify as a REIT, at least 95 
percent of its gross income generally must be derived from 
certain passive sources (the ``95 percent income test''). In 
addition, at least 75 percent of its income generally must be 
from certain real estate sources (the ``75-percent income 
test''), including rents from real property (as defined) and 
gain from the sale or other disposition of real property.
            Qualified rental income
    Amounts received as impermissible ``tenant services 
income'' are not treated as rents from real property.\92\ In 
general, such amounts are for services rendered to tenants that 
are not ``customarily furnished'' in connection with the rental 
of real property.\93\ Special rules also permit amounts to be 
received from certain ``foreclosure property'' treated as such 
for 3 years after the property is acquired by the REIT in 
foreclosure after a default (or imminent default) on a lease of 
such property or an indebtedness which such property secured.
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    \92\ A REIT is not treated as providing services that produce 
impermissible tenant services income if such services are provided by 
an independent contractor from whom the REIT does not derive or receive 
any income. An independent contractor is defined as a person who does 
not own, directly or indirectly, more than 35 percent of the shares of 
the REIT. Also, no more than 35 percent of the total shares of stock of 
an independent contractor (or of the interests in net assets or net 
profits, if not a corporation) can be owned directly or indirectly by 
persons owning 35 percent or more of the interests in the REIT.
    \93\ Rents for certain personal property leased in connection are 
treated as rents from real property if the fair market value of the 
personal property does not exceed 15 percent of the aggregate fair 
market values of the real and personal property.
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    Rents from real property, for purposes of the 95-percent 
and 75-percent income tests, generally do not include any 
amount received or accrued from any person in which the REIT 
owns, directly or indirectly, 10 percent or more of the vote or 
value.\94\ An exception applies to rents received from a 
taxable REIT subsidiary (``TRS'') (described further below) if 
at least 90 percent of the leased space of the property is 
rented to persons other than a TRS or certain related persons, 
and if the rents from the TRS are substantially comparable to 
unrelated party rents.\95\
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    \94\ Section 856(d)(2)(B).
    \95\ Section 856(d)(8).
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            Certain hedging instruments
    Except as provided in regulations, a payment to a REIT 
under an interest rate swap or cap agreement, option, futures 
contract, forward rate agreement, or any similar financial 
instrument, entered into by the trust in a transaction to 
reduce the interest rate risks with respect to any indebtedness 
incurred or to be incurred by the REIT to acquire or carry real 
estate assets, and any gain from the sale or disposition of any 
such investment, is treated as income qualifying for the 95-
percent income test.
            Tax if qualified income tests not met
    If a REIT fails to meet the 95-percent or 75-percent income 
tests but has set out the income it did receive in a schedule 
and any error in the schedule is due to reasonable cause and 
not willful neglect, then the REIT does not lose its REIT 
status but instead pays a tax measured by the greater of the 
amount by which 90 percent \96\ of the REIT's gross income 
exceeds the amount of items subject to the 95-percent test, or 
the amount by which 75 percent of the REIT's gross income 
exceeds the amount of items subject to the 75-percent test.\97\
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    \96\ Prior to 1999, the rule had applied to the amount by which 95 
percent of the income exceeded the items subject to the 95 percent 
test.
    \97\ The ratio of the REIT's net to gross income is applied to the 
excess amount, to determine the amount of tax (disregarding certain 
items otherwise subject to a 100-percent tax). In effect, the formula 
seeks to require that all of the REIT net income attributable to the 
failure of the income tests will be paid as tax. Sec. 857(b)(5).
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Asset requirements

    To satisfy the asset requirements to qualify for treatment 
as a REIT, at the close of each quarter of its taxable year, an 
entity must have at least 75 percent of the value of its assets 
invested in real estate assets, cash and cash items, and 
government securities (the ``75-percent asset test''). The term 
real estate asset is defined to mean real property (including 
interests in real property and mortgages on real property) and 
interests in REITs.
            Limitation on investment in other entities
    A REIT is limited in the amount that it can own in other 
corporations. Specifically, a REIT cannot own securities (other 
than Government securities and certain real estate assets) in 
an amount greater than 25 percent of the value of REIT assets. 
In addition, it cannot own such securities of any one issuer 
representing more than 5 percent of the total value of REIT 
assets or more than 10 percent of the voting securities or 10 
percent of the value of the outstanding securities of any one 
issuer. Securities for purposes of these rules are defined by 
reference to the Investment Company Act of 1940.
            ``Straight debt'' exception
    Securities of an issuer that are within a safe-harbor 
definition of ``straight debt'' (as defined for purposes of 
subchapter S) \98\ are not taken into account in applying the 
limitation that a REIT may not hold more than 10 percent of the 
value of outstanding securities of a single issuer, if: (1) the 
issuer is an individual, or (2) the only securities of such 
issuer held by the REIT or a taxable REIT subsidiary of the 
REIT are straight debt, or (3) the issuer is a partnership and 
the trust holds at least a 20 percent profits interest in the 
partnership.
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    \98\ Section 1361(c)(5), without regard to paragraph (B)(iii) 
thereof.
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    Straight debt is defined as a written or unconditional 
promise to pay on demand or on a specified date a sum certain 
in money if (i) the interest rate (and interest payment dates) 
are not contingent on profits, the borrower's discretion, or 
similar factors; and (ii) there is no convertibility (directly 
or indirectly) into stock.
            Certain subsidiary ownership permitted with income treated 
                    as income of the REIT
    Under one exception to the rule limiting a REIT's 
securities holdings to no more than 10 percent of the vote or 
value of a single issuer, a REIT can own 100 percent of the 
stock of a corporation, but in that case the income and assets 
of such corporation are treated as income and assets of the 
REIT.
            Special rules for Taxable REIT subsidiaries
    Under another exception to the general rule limiting REIT 
securities ownership of other entities, a REIT can own stock of 
a taxable REIT subsidiary (``TRS''), generally, a corporation 
other than a real estate investment trust \99\ with which the 
REIT makes a joint election to be subject to special rules. A 
TRS can engage in active business operations that would produce 
income that would not be qualified income for purposes of the 
95-percent or 75-percent income tests for a REIT, and that 
income is not attributed to the REIT. For example a TRS could 
provide noncustomary services to REIT tenants, or it could 
engage directly in the active operation and management of real 
estate (without use of an independent contractor); and the 
income the TRS derived from these nonqualified activities would 
not be treated as disqualified REIT income. Transactions 
between a TRS and a REIT are subject to a number of specified 
rules that are intended to prevent the TRS (taxable as a 
separate corporate entity) from shifting taxable income from 
its activities to the pass through entity REIT or from 
absorbing more than its share of expenses. Under one rule, a 
100 percent excise tax is imposed on rents, deductions, or 
interest paid by the TRS to the REIT to the extent such items 
would exceed an arm's length amount as determined under section 
482.\100\
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    \99\ Certain corporations are not eligible to be a TRS, such as a 
corporation which directly or indirectly operates or manages a lodging 
facility or a health care facility or directly or indirectly provides 
to any other person rights to a brand name under which any lodging 
facility or health care facility is operated. Sec. 856((l)(3).
    \100\ If the excise tax applies, the item is not also reallocated 
back to the TRS under section 482.
---------------------------------------------------------------------------
    Rents subject to the 100 percent excise tax do not include 
rents for services of a TRS that are for services customarily 
furnished or rendered in connection with the rental of real 
property.
    They also do not include rents from a TRS that are for real 
property or from incidental personal property provided with 
such real property.

Income distribution requirements

    A REIT is generally required to distribute 90 percent of 
its income before the end of its taxable year, as deductible 
dividends paid to shareholders. This rule is similar to a rule 
for regulated investment companies (``RICs'') that requires 
distribution of 90 percent of income. Both RICS and REITs can 
make certain ``deficiency dividends'' after the close of the 
taxable year, and have these treated as made before the end of 
the year. Deficiency dividends may be declared on or after the 
date of ``determination''. A determination is defined to 
include only (i) a final decision by the Tax Court or other 
court of competent jurisdiction, (ii) a closing agreement under 
section 7121, or (iii) under Treasury regulations, an agreement 
signed by the Secretary and the REIT.

                           REASONS FOR CHANGE

    The Committee believes that the ``straight debt'' 
definition of present law may not fully accommodate certain 
common REIT financing situations that should be permitted. The 
Committee wishes to clarify certain situations that should not 
cause loss of REIT status if the securities held by the REIT 
should happen to exceed 10 percent of the value of the 
borrower. Also, the Committee wishes to clarify the testing 
dates for purposes of the provision permitting certain rental 
income from a related party to be qualified rental income.
    The Committee also believes that is it desirable to provide 
express rules for testing a REIT's interest in partnership 
assets for certain ``straight debt'' purposes, and to modify 
certain other provisions, on a prospective basis.

                        EXPLANATION OF PROVISION

    The provision makes several modifications to the REIT 
rules.

Straight debt modification

    The provision modifies the definition of ``straight debt'' 
for purposes of the limitation that a REIT may not hold more 
than 10 percent of the value of the outstanding securities of a 
single issuer, to provide more flexibility than the present law 
rule. In addition, except as provided in regulations, neither 
such straight debt nor certain other types of securities are 
considered ``securities'' for purposes of this rule.
            Straight debt securities
    ``Straight-debt'' is still defined by reference to section 
1361(c)(5), without regard to subparagraph (B)(iii) thereof 
(limiting the nature of the creditor).
    Special rules are provided permitting certain contingencies 
for purposes of the REIT provision. Any interest or principal 
shall not be treated as failing to satisfy section 
1361(c)(5)(B)(i) solely by reason of the fact that the time of 
payment of such interest or principal is subject to a 
contingency, but only if one of several factors applies. The 
first type of contingency that is permitted is one that does 
not have the effect of changing the effective yield to 
maturity, as determined under section 1272, other than a change 
in the annual yield to maturity which either (i) does not 
exceed the greater of \1/4\ of 1 percent or 5 percent of the 
annual yield to maturity, or (ii) results solely from a default 
or the exercise of a prepayment right by the issuer of the 
debt.
    The second type of contingency that is permitted is one 
under which neither the aggregate issue price nor the aggregate 
face amount of the debt instruments held by the REIT exceeds 
$1,000,000 and not more than 12 months of unaccrued interest 
can be required to be prepaid thereunder.
    The provision eliminates the present law rule that allows a 
REIT to use the safe harbor when it loans money to a 
partnership in which it owns a 20 percent equity interest. The 
provision instead provides new ``look-through'' rules 
determining a REIT partner's share of partnership securities, 
generally treating debt to the REIT as part of the REIT's 
partnership interest for this purpose, except in the case of 
otherwise qualifying debt of the partnership.
    Certain corporate or partnership issues that otherwise 
would be permitted to be held without limitation under the 
special straight debt rules described above will not be so 
permitted if the REIT holding such securities, and any of its 
taxable REIT subsidiaries, holds any securities of the issuer 
which are not permitted securities (prior to the application of 
this rule) and have an aggregate value greater than 1 percent 
of the issuer's outstanding securities (determined without 
regard to the new ``look-through'' rules).
            Other securities
    Except as provided in regulations, the following also are 
not considered ``securities'' for purposes of the rule that a 
REIT cannot own more than 10 percent of the value of the 
outstanding securities of a single issuer: (i) any loan to an 
individual or an estate, (ii) any section 467 rental agreement, 
(as defined in section 467(d)), other than with a person 
described in section 856(d)(2)(B), (iii) any obligation to pay 
rents from real property, (iv) any security issued by a State 
or any political subdivision thereof, the District of Columbia, 
a foreign government, or any political subdivision thereof, or 
the Commonwealth of Puerto Rico, but only if the determination 
of any payment received or accrued under such security does not 
depend in whole or in part on the profits of any entity not 
described in this category, or payments on any obligation 
issued by such an entity, (v) any security issued by a real 
estate investment trust; (vi) any other arrangement that, as 
determined by the Secretary, is excepted from the definition of 
a security.

Safe harbor testing date for certain rents

    The provision provides specific safe-harbor rules regarding 
the dates for testing whether 90 percent of a REIT property is 
rented to unrelated persons and whether the rents paid by 
related persons are substantially comparable to unrelated party 
rents. These testing rules are provided solely for purposes of 
the special provision permitting rents received from a related 
party to be treated as qualified rental income for purposes of 
the income tests.\101\
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    \101\ The proposal does not modify any of the standards of section 
482 as they apply to REITS and to taxable REIT subsidiaries.
---------------------------------------------------------------------------

Customary services exception

    The provision prospectively eliminates the safe harbor 
allowing rents received by a REIT to be exempt from the 100 
percent excise tax if the rents are for customary services 
performed by the TRS 102 or are from a TRS and are 
for the provision of certain incidental personal property. 
Instead, such payments would be free of the excise tax if they 
satisfy the present law safe-harbor that applies if the REIT 
pays the TRS at least 150 percent of the cost to the TRS of 
providing any services.
---------------------------------------------------------------------------
    \102\ Although a REIT could itself provide such services and 
receive the income for them without receiving any disqualified income, 
in that case the REIT itself would be bearing the cost of providing the 
service. Under the present law exception for a TRS providing such 
service, there is no explicit requirement that the TRS be reimbursed 
for the full cost of the service.
---------------------------------------------------------------------------

Hedging rules

    The rules governing the tax treatment of arrangements 
engaged in by a REIT to reduce interest rate risks are 
prospectively conformed to the rules included in section 1221.

95-percent gross income requirement

    The provision prospectively amends the tax liability owed 
by the REIT when it fails to meet the 95-percent of gross 
income test by applying a taxable fraction based on 95 percent, 
rather than 90 percent of the REIT's gross income.

                             EFFECTIVE DATE

    The provision is generally effective for taxable years 
beginning after December 31, 2000.
    However, some of the provisions are effective for taxable 
years beginning after the date of enactment. These are: the new 
``look through'' rules determining a REIT partner's share of 
partnership securities for purposes of the ``straight debt'' 
rules; the provision changing the 90-percent of gross income 
reference to 95 percent, for purposes of the tax liability if a 
REIT fails to meet the 95-percent of gross income test; the new 
hedging definition; and the rule modifying the treatment of 
rents with respect to customary services.

7. Simplification of excise tax imposed on bows and arrows (sec. 1107 
        of the bill and sec. 4161 of the Code)

                              PRESENT LAW

    The Code imposes an excise tax of 11 percent on the sale by 
a manufacturer, producer or importer of any bow with a draw 
weight of 10 pounds or more.103 An excise tax of 
12.4 percent is imposed on the sale by a manufacturer or 
importer of any shaft, point, nock, or vane designed for use as 
part of an arrow which after its assembly (1) is over 18 inches 
long, or (2) is designed for use with a taxable bow (if shorter 
than 18 inches).104 No tax is imposed on finished 
arrows. An 11-percent excise tax also is imposed on any part of 
an accessory for taxable bows and on quivers for use with 
arrows (1) over 18 inches long or (2) designed for use with a 
taxable bow (if shorter than 18 inches).105
---------------------------------------------------------------------------
    \103\ Sec. 4161(b)(1)(A).
    \104\ Sec. 4161(b)(2).
    \105\ Sec. 4161(b)(1)(B).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Under present law, foreign manufacturers and importers of 
arrows avoid the 12.4 percent excise tax paid by domestic 
manufacturers because the tax is placed on arrow components 
rather than finished arrows. As a result, arrows assembled 
outside of the United States have a price advantage over 
domestically manufactured arrows. The Committee believes it is 
appropriate to close this loophole. The Committee also believes 
that adjusting the minimum draw weight for taxable bows from 10 
pounds to 30 pounds will better target the excise tax to actual 
hunting use by eliminating the excise tax on instructional 
(``youth'') bows.

                        EXPLANATION OF PROVISION

    The provision increases the draw weight for a taxable bow 
from 10 pounds or more to a peak draw weight of 30 pounds or 
more.106 The provision also imposes an excise tax of 
12 percent on arrows generally. An arrow for this purpose is 
defined as a taxable arrow shaft to which additional components 
are attached. The present law 12.4-percent excise tax on 
certain arrow components is unchanged by the provision. The 
provision provides that the 12-percent excise tax on arrows 
will not apply if the arrow contains an arrow shaft upon which 
the tax imposed on arrow components has been paid. Finally, the 
provision subjects certain broadheads (a type of arrow point) 
to an excise tax equal to 11 percent of the sales price instead 
of 12.4 percent.
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    \106\ Draw weight is the maximum force required to bring the 
bowstring to a full-draw position not less than 26\1/4\-inches, 
measured from the pressure point of the hand grip to the nocking 
position on the bowstring.
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                             EFFECTIVE DATE

    The provision is effective for articles sold by the 
manufacturer, producer, or importer after December 31, 2003.

8. Repeal excise tax on fishing tackle boxes (sec. 1108 of the bill and 
        sec. 4162 of the Code)

                              PRESENT LAW

    Under present law, a 10-percent manufacturer's excise tax 
is imposed on specified sport fishing equipment. Examples of 
taxable equipment include fishing rods and poles, fishing 
reels, artificial bait, fishing lures, line and hooks, and 
fishing tackle boxes. Revenues from the excise tax on sport 
fishing equipment are deposited in the Sport Fishing Account of 
the Aquatic Resources Trust Fund. Monies in the fund are spent, 
subject to an existing permanent appropriation, to support 
Federal-State sport fish enhancement and safety programs.

                           REASONS FOR CHANGE

    The Committee observes that fishing ``tackle boxes'' are 
little different in design and appearance from ``tool boxes,'' 
yet the former are subject to a Federal excise tax at a rate of 
10 percent, while the latter are not subject to Federal excise 
tax. This excise tax can create a sufficiently large price 
difference that some fishermen will choose to use a ``tool 
box'' to hold their hooks and lures rather than a traditional 
``tackle box.'' The Committee finds that such a distortion of 
consumer choice places an inappropriate burden on the 
manufacturers and purchasers of traditional tackle boxes, 
particularly in comparison to the modest amount of revenue 
raised by the present-law provision, and that this burden 
warrants repeal of the tax. The Committee also believes that 
elimination of the excise tax on tackle boxes will provide some 
modest simplification of the tax system for both taxpayers and 
the Internal Revenue Service.

                        EXPLANATION OF PROVISION

    The provision repeals the excise tax on fishing tackle 
boxes.

                             EFFECTIVE DATE

    The provision is effective for articles sold by the 
manufacturer, producer, or importer after December 31, 2003.

9. Income tax credit for cost of carrying tax-paid distilled spirits in 
        wholesale inventories (sec. 1109 of the bill and new sec. 5011 
        of the Code)

                              PRESENT LAW

    As is true of most major Federal excise taxes, the excise 
tax on distilled spirits is imposed at a point in the chain of 
distribution before the product reaches the retail (consumer) 
level. Tax on domestically produced and/or bottled distilled 
spirits arises upon production (receipt) in a bonded distillery 
and is collected based on removals from the distillery during 
each semi-monthly period. Distilled spirits that are bottled 
before importation into the United States are taxed on removal 
from the first U.S. warehouse where they are landed (including 
a warehouse located in a foreign trade zone).
    No tax credits are allowed under present law for business 
costs associated with having tax-paid products in inventory. 
Rather, excise tax that is included in the purchase price of a 
product is treated the same as the other components of the 
product cost, i.e., deductible as a cost of goods sold.

                           REASONS FOR CHANGE

    Under current law, wholesale importers of distilled spirits 
are not required to pay the Federal excise tax on imported 
spirits until after the product is removed from a bonded 
warehouse for sale to a retailer. In contrast, the tax on 
domestically produced spirits is included as part of the 
purchase price and passed on from the supplier to wholesaler. 
It is the Committee's understanding that in some instances, 
wholesalers can carry this tax-paid inventory for an average of 
60 days before selling it to a retailer. The Committee believes 
it is appropriate to provide an income tax credit to 
approximate the interest charge--more commonly referred to as 
float--that results from carrying tax-paid distilled spirits in 
inventory.

                        EXPLANATION OF PROVISION

    The provision creates a new income tax credit for eligible 
wholesale distributors of distilled spirits. An eligible 
wholesaler is any person who holds a permit under the Federal 
Alcohol Administration Act as a wholesaler of distilled 
spirits.
    The credit is calculated by multiplying the number of cases 
of bottled distilled spirits by the average tax-financing cost 
per case for the most recent calendar year ending before the 
beginning of such taxable year. A case is 12 80-proof 750-
milliliter bottles. The average tax-financing cost per case is 
the amount of interest that would accrue at corporate 
overpayment rates during an assumed 60-day holding period on an 
assumed tax rate of $22.83 per case of 12 750-milliliter 
bottles.
    The credit only applies to domestically bottled distilled 
spirits 107 purchased directly from the bottler of 
such spirits. The credit is in addition to present-law rules 
allowing tax included in inventory costs to be deducted as a 
cost of goods sold.
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    \107\ Distilled spirits that are imported in bulk and then bottled 
domestically qualify as domestically bottled distilled spirits.
---------------------------------------------------------------------------
    The credit cannot be carried back to a taxable year 
beginning before January 1, 2004.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2003.

10. Capital gains treatment to apply to outright sales of timber by 
        landowner (sec. 1110 of the bill and sec. 631(b) of the Code)

                              PRESENT LAW

    Under present law, a taxpayer disposing of timber held for 
more than one year is eligible for capital gains treatment in 
three situations. First, if the taxpayer sells or exchanges 
timber that is a capital asset (sec. 1221) or property used in 
the trade or business (sec. 1231), the gain generally is long-
term capital gain; however, if the timber is held for sale to 
customers in the taxpayer's business, the gain will be ordinary 
income. Second, if the taxpayer disposes of the timber with a 
retained economic interest, the gain is eligible for capital 
gain treatment (sec. 631(b)). Third, if the taxpayer cuts 
standing timber, the taxpayer may elect to treat the cutting as 
a sale or exchange eligible for capital gains treatment (sec. 
631(a)).

                           REASONS FOR CHANGE

    The Committee believes that the requirement that the owner 
of timber retain an economic interest in the timber in order to 
obtain capital gain treatment under section 631(b) results in 
poor timber management. Under present law, the buyer, when 
cutting and removing timber, has no incentive to protect young 
or other uncut trees because the buyer only pays for the timber 
that is cut and removed. Therefore, the Committee bill 
eliminates this requirement and provides for capital gain 
treatment under section 631(b) in the case of outright sales of 
timber.

                        EXPLANATION OF PROVISION

    Under the provision, in the case of a sale of timber by the 
owner of the land from which the timber is cut, the requirement 
that a taxpayer retain an economic interest in the timber in 
order to treat gains as capital gain under section 631(b) does 
not apply. Outright sales of timber by the landowner will 
qualify for capital gains treatment in the same manner as sales 
with a retained economic interest qualify under present law, 
except that the usual tax rules relating to the timing of the 
income from the sale of the timber will apply (rather than the 
special rule of section 631(b) treating the disposal as 
occurring on the date the timber is cut).

                             EFFECTIVE DATE

    The provision is effective for sales of timber after 
December 31, 2003.

11. Repeal of excise tax on sonar devices suitable for finding fish 
        (sec. 1111 of the bill and secs. 4161 and 4162 of the Code)

                              PRESENT LAW

    In general, the Code imposes a 10-percent tax on the sale 
by the manufacturer, producer, or importer of specified sport 
fishing equipment.\108\ A three-percent rate, however, applies 
to the sale of electric outboard motors and sonar devices 
suitable for finding fish.\109\ Further, the tax imposed on the 
sale of electric outboard motors and sonar devices suitable for 
finding fish is limited to $30. A sonar device suitable for 
finding fish does not include any device that is a graph 
recorder, a digital type, a meter readout, a combination graph 
recorder or combination meter readout.\110\
---------------------------------------------------------------------------
    \108\ Sec. 4161(a)(1).
    \109\ Sec. 4161(a)(2).
    \110\ Sec. 4162(b).
---------------------------------------------------------------------------
    Revenues from the excise tax on sport fishing equipment are 
deposited in the Sport Fishing Account of the Aquatic Resources 
Trust Fund. Monies in the fund are spent, subject to an 
existing permanent appropriation, to support Federal-State 
sport fish enhancement and safety programs.

                           REASONS FOR CHANGE

    The Committee observes that the current exemption for 
certain forms of sonar devices has the effect of exempting 
almost all of the devices currently on the market. The 
Committee understands that only one form of sonar device is not 
exempt from the tax, those units utilizing light-emitting diode 
(``LED'') display technology. The Committee understands that 
LED devices are not currently exempt from the tax because the 
technology was developed after the exemption for the other 
technologies was enacted. In the Committee's view, the 
application of the tax to LED display devices and not to 
devices performing the same function with a different 
technology, creates an unfair advantage for the exempt devices. 
Because most of the devices on the market already are exempt, 
the Committee believes it is appropriate to level the playing 
field by repealing the tax imposed on all sonar devices 
suitable for finding fish. The Committee believes this is a 
more suitable solution than exempting a device from the tax 
based on the type of technology used.

                        EXPLANATION OF PROVISION

    The provision repeals the excise tax on all sonar devices 
suitable for finding fish.

                             EFFECTIVE DATE

    The provision is effective articles sold by the 
manufacturer, producer, or importer after December 31, 2003.

12. Taxation of certain settlement funds (sec. 1112 of the bill and 
        sec. 468B of the Code)

                              PRESENT LAW

    The cleanup of hazardous waste sites is sometimes funded by 
environmental ``settlement funds'' or escrow accounts. These 
escrow accounts are established in consent decrees between the 
Environmental Protection Agency (``EPA'') and the settling 
parties under the jurisdiction of a Federal district court. The 
EPA uses these accounts to resolve claims against private 
parties under Comprehensive Environmental Response, 
Compensation and Liability Act of 1980 (``CERCLA'').
    In general, section 468(B) provides that a payment to a 
designated settlement fund that extinguishes a tort liability 
of the taxpayer will result in a deduction to the taxpayer. A 
designated settlement fund means a fund which is established 
pursuant to a court order, extinguishes the taxpayer's tort 
liability, is managed and controlled by persons unrelated to 
the taxpayer, and in which the taxpayer does not have a 
beneficial interest in the trust.
    Generally, a designated or qualified settlement fund is 
taxed as a separate entity at the maximum trust rate on its 
modified income. Modified income is generally gross income less 
deductions for administrative costs and other incidental 
expenses incurred in connection with the operation of the 
settlement fund.

                           REASONS FOR CHANGE

    The Committee believes that these environmental escrow 
accounts, established under court consent decrees, are 
essential for the EPA to resolve or satisfy claims under the 
Comprehensive Environmental Response, Compensation and 
Liability Act of 1980. Uncertainty as to the tax treatment of 
these settlement funds may prevent taxpayers from entering into 
prompt settlements with the EPA for the cleanup of Superfund 
hazardous waste sites and reduce the ultimate amount of funds 
available for the sites' cleanup. As these settlement funds are 
controlled by the government, the Committee believes it is 
appropriate to establish that these funds are to be treated as 
beneficially owned by the United States.

                        EXPLANATION OF PROVISION

    The provision provides that certain settlement funds 
established in consent decrees for the sole purpose of 
resolving claims under CERCLA are to be treated as beneficially 
owned by the United States government and therefore, not 
subject to Federal income tax.
    To qualify the settlement fund must be: (1) established 
pursuant to a consent decree entered by a judge of a United 
States District Court; (2) created for the receipt of 
settlement payments for the sole purpose of resolving or 
satisfying claims under CERCLA; (3) controlled (in terms of 
expenditures of contributions and earnings thereon) by the 
government or an agency or instrumentality thereof; and (4) 
upon termination, disbursed to the government or an agency or 
instrumentality thereof (e.g., the EPA).

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2003.

13. Suspension of occupational taxes relating to distilled spirits, 
        wine, and beer (sec. 1113 of the bill and sec. 5148 of the 
        Code)

                              PRESENT LAW

    Under present law, special occupational taxes are imposed 
on producers and others engaged in the marketing of distilled 
spirits, wine, and beer. These excise taxes are imposed as part 
of a broader Federal tax and regulatory regime governing the 
production and marketing of alcoholic beverages. The special 
occupational taxes are payable annually, on July 1 of each 
year. The present tax rates are as follows:

Producers: \111\
---------------------------------------------------------------------------
    \111\ A reduced rate of tax in the amount of $500.00 is imposed on 
small proprietors (secs. 5081(b) and 5091(b)).
---------------------------------------------------------------------------
Distilled spirits and wines (sec. 5081)--$1,000 per year, per 
        premise
Brewers (sec. 5091)--$1,000 per year, per premise
Wholesale dealers (sec. 5111): Liquors, wines, or beer--$500 
        per year
Retail dealers (sec. 5121): Liquors, wines, or beer--$250 per 
        year
Nonbeverage use of distilled spirits (sec. 5131): $500 per year
Industrial use of distilled spirits (sec. 5276): $250 per year

    The Code requires every wholesale or retail dealer in 
liquors, wine or beer to keep records of their 
transactions.\112\ A delegate of the Secretary is authorized to 
inspect the records of any dealer during business hours.\113\ 
There are penalties for failing to comply with the 
recordkeeping requirements.\114\
---------------------------------------------------------------------------
    \112\ Secs. 5114 and 5124.
    \113\ Sec. 5146.
    \114\ Sec. 5603.
---------------------------------------------------------------------------
    The Code limits the persons from whom dealers may purchase 
their liquor stock intended for resale. Under the Code, a 
dealer may only purchase from:
          (1) A wholesale dealer in liquors who has paid the 
        special occupational tax as such dealer to cover the 
        place where such purchase is made; or
          (2) A wholesale dealer in liquors who is exempt, at 
        the place where such purchase is made, from payment of 
        such tax under any provision of chapter 51 of the Code; 
        or
          (3) A person who is not required to pay special 
        occupational tax as a wholesale dealer in liquors.\115\
---------------------------------------------------------------------------
    \115\ Sec. 5117. For example, purchases from a proprietor of a 
distilled spirits plant at his principal business office would be 
covered under item (2) since such a proprietor is not subject to the 
special occupational tax on account of sales at his principal business 
office (sec. 5113(a)). Purchases from a State-operated liquor store 
would be covered under item (3) (sec. 5113(b)).
---------------------------------------------------------------------------
    Violation of this restriction is punishable by $1,000 fine, 
imprisonment of one year, or both.\116\ A violation also makes 
the alcohol subject to seizure and forfeiture.\117\
---------------------------------------------------------------------------
    \116\ Sec. 5687.
    \117\ Sec. 7302.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The special occupational tax is not a tax on alcoholic 
products but rather operates as a license fee on businesses. 
The Committee believes that this tax places an unfair burden on 
business owners. However, the Committee recognizes that the 
recordkeeping and registration authorities applicable to 
wholesalers and retailers engaged in such businesses are 
necessary enforcement tools to ensure the protection of the 
revenue arising from the excise taxes on these products. Thus, 
the Committee believes it appropriate to suspend the tax for a 
three-year period, while retaining present-law recordkeeping 
and registration requirements.

                        EXPLANATION OF PROVISION

    The special occupational taxes on producers and marketers 
of alcoholic beverages are suspended for a three-year period, 
July 1, 2004 through June 30, 2007. Present law recordkeeping 
and registration requirements will continue to apply, 
notwithstanding the suspension of the special occupation taxes. 
In addition, during the suspension period, it shall be unlawful 
for any dealer to purchase distilled spirits for resale from 
any person other than a wholesale dealer in liquors who is 
subject to the recordkeeping requirements.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

TITLE II--PROVISIONS TO REDUCE TAX AVOIDANCE THROUGH CORPORATE EARNINGS 
                       STRIPPING AND EXPATRIATION


1. Reduction in potential for earnings stripping by further limiting 
        deduction for interest on certain indebtedness (sec. 2001 of 
        the bill and sec. 163(j) of the Code)

                              PRESENT LAW

    Present law provides rules to limit the ability of U.S. 
corporations to reduce the U.S. tax on their U.S.-source income 
through earnings stripping transactions. Section 163(j) 
specifically addresses earnings stripping involving interest 
payments, by limiting the deductibility of interest paid to 
certain related parties (``disqualified interest''),\118\ 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'' (generally taxable income computed without 
regard to deductions for net interest expense, net operating 
losses, and depreciation, amortization, and depletion). 
Disallowed interest amounts can be carried forward 
indefinitely. In addition, excess limitation (i.e., any excess 
of the 50-percent limit over a company's net interest expense 
for a given year) can be carried forward three years.
---------------------------------------------------------------------------
    \118\ This interest also may include interest paid to unrelated 
parties in certain cases in which a related party guarantees the debt.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is necessary to tighten the 
earnings stripping rules in order to: (1) prevent the erosion 
of the U.S. tax base; (2) curtail corporate inversion 
transactions; and (3) decrease the competitive advantage that 
U.S. tax law conveys to foreign-based companies operating in 
the United States.
    As a matter of practice, foreign-based corporate groups may 
lower their U.S. tax liability by having their U.S. 
subsidiaries make tax-deductible interest payments to their 
foreign parents or foreign affiliates. These interest payments 
reduce the foreign-based group's U.S. income that is taxed at 
35 percent, but the interest income received by the foreign 
parent or foreign affiliate is often taxed at a very low rate 
or is not taxed at all. This practice reduces the amount of tax 
collected by the U.S. Treasury.
    As a result of hearings on this issue, the Committee agrees 
with the Treasury Department that the ability of foreign-based 
companies to strip earnings out of the United States through 
the use of related-party interest payments provides the 
``juice,'' or immediate financial incentive, for a company to 
invert (reincorporate in a foreign country). The current U.S. 
earnings stripping rules and the significant tax advantages 
that they give foreign companies often leave U.S. companies 
with the undesirable choice of: (1) going out of business; (2) 
being bought by their foreign competitor that enjoys 
significant tax advantages that come with foreign ownership; or 
(3) inverting and operating under the same rules as the foreign 
competition.
    The Committee also agrees with the findings of the Treasury 
Department that abusive earnings stripping opportunities are 
not limited to inverted companies, but rather are available to 
foreign-based companies generally. The current earnings 
stripping rules provide an advantage to foreign ownership over 
U.S. ownership, even in the United States. This advantage comes 
from the ability of foreign-based companies to ``strip'' or 
``export'' their earnings from the United States, thus lowering 
their net cost of doing business in the United States relative 
to their U.S.-owned competitors. This advantage helps to 
explain why more than 78 percent of recent acquisitions between 
U.S. and foreign companies resulted in the foreign company 
acquiring the U.S. company.
    While foreign investment in the United States is generally 
positive for the U.S. economy, the acquisition of U.S.-based 
companies by their foreign competition eventually results in 
the shift of jobs and research outside the United States. The 
Committee believes that U.S. companies deserve the opportunity 
to compete fairly against their foreign counterparts, 
especially in the United States. The Committee believes that 
tightening the current rules will provide a more level playing 
field on which U.S. companies can compete.

                        EXPLANATION OF PROVISION

    The bill strengthens the earnings stripping provisions of 
section 163(j) in several respects. The debt-equity threshold 
is eliminated, carryovers of excess limitation are eliminated, 
and carryovers of disallowed interest are limited to 10 years.
    In addition, the ``adjusted taxable income'' percentage 
threshold is lowered from 50 percent to 25 percent with respect 
to disqualified interest other than interest paid to unrelated 
parties on debt that is subject to a related-party guarantee 
(hereinafter referred to as ``guaranteed debt'').\119\ Interest 
on guaranteed debt generally is not subject to the lowered 
threshold under the bill.\120\ Disallowed interest is treated 
as interest on related-party debt to the extent thereof, and 
then as interest on guaranteed debt to the extent of any 
excess, for purposes of determining whether a deduction is 
allowable for such interest when carried forward to another 
taxable year.
---------------------------------------------------------------------------
    \119\ This lowered threshold is phased in over two years. The 
threshold is 35 percent for a taxpayer's first taxable year beginning 
after 2003. The remainder of this discussion describes the provisions 
of the bill as fully phased-in.
    \120\ However, a taxpayer can make a one-time election to apply to 
a 30-percent threshold for purposes of determining the disallowance 
amount with respect to all of its disqualified interest, in which case 
no distinction is made between guaranteed debt and other debt. This 
election is not available to taxpayers involved in certain inversion 
transactions completed after 1996.
---------------------------------------------------------------------------
    The bill applies the different percentage thresholds to 
interest on related-party debt and interest on guaranteed debt 
by disallowing all disqualified interest, subject to a cap 
equal to the sum of ``excess interest expense'' and ``excess 
related party interest expense.'' Excess interest expense is 
defined as the excess of net interest expense over 50 percent 
of adjusted taxable income. Excess related party interest 
expense is determined by subtracting 25 percent of adjusted 
taxable income from the lesser of: (1) interest on related-
party debt, or (2) net interest expense. In no event can the 
disallowance under the provision reduce the taxpayer's 
deduction for interest expense below the sum of: (1) the amount 
of interest income included in the gross income of the 
taxpayer, and (2) 25 percent of adjusted taxable income.
    The following examples illustrate the basic operation of 
the bill:
    Example 1.--Foreign Parent owns all the stock of U.S. 
Subsidiary (``U.S. Sub''). U.S. Sub has adjusted taxable income 
of $100, incurs interest expense of $70 on debt owed to Foreign 
Parent, incurs interest expense of $5 on non-guaranteed debt 
owed to unrelated third parties, and has no interest income or 
other interest expense. Under the bill, U.S. Sub has $70 of 
disqualified interest, the disallowance of which is subject to 
a cap equal to the sum of excess interest expense ($75 - $50 = 
$25) and excess related party interest expense ($70 - $25 = 
$45), or $70. Under the special disallowance limit, however, 
the provision cannot cause U.S. Sub's interest expense 
deduction to fall below $25. Thus, only $50 of interest is 
disallowed, and U.S. Sub can deduct its $5 of unrelated-party 
interest and $20 of its related-party interest.
    Example 2.--Same as Example 1, except U.S. Sub incurs $25 
of interest expense on non-guaranteed debt owed to unrelated 
third parties and $30 of interest expense on debt owed to 
Foreign Parent. Under the bill, U.S. Sub has $30 of 
disqualified interest, the disallowance of which is subject to 
a cap equal to the sum of excess interest expense ($55 - $50 = 
$5) and excess related party interest expense ($30 - $25 = $5), 
for $10 of disallowance.
    Example 3.--Same as Example 2, except U.S. Sub also incurs 
$20 of interest expense on debt owed to unrelated third 
parties, subject to a guarantee by Foreign Parent. Under the 
bill, U.S. Sub has $30 + $20 = $50 of disqualified interest, 
the disallowance of which is subject to a cap equal to the sum 
of excess interest expense ($75 - $50 = $25) and excess related 
party interest expense ($30 - $25 = $5), for $30 of 
disallowance. This example illustrates how the bill effectively 
applies the present-law 50-percent threshold to interest on 
guaranteed debt, subjecting only interest on debt owed to 
related parties to the lowered threshold under the bill.
    Example 4.--Same as Example 3, except U.S. Sub also earns 
$10 of interest income. Under the bill, U.S. Sub has $30 + $20 
= $50 of disqualified interest, the disallowance of which is 
subject to a cap equal to the sum of excess interest expense 
($65 - $50 = $15) and excess related party interest expense 
($30 - $25 = $5), for $20 of disallowance.
    Example 5.--Same as Example 4, except U.S. Sub earns $50 of 
interest income. Under the bill, U.S. Sub has $30 + $20 = $50 
of disqualified interest, the disallowance of which is subject 
to a cap equal to the sum of excess interest expense ($25 - $50 
= $0) and excess related party interest expense ($25 - $25 = 
$0), thus yielding no disallowance. Examples 4 and 5 illustrate 
the operation of the interest-income netting rules.
    The bill continues the present-law rules in the case of 
taxable REIT subsidiaries.

                             EFFECTIVE DATE

    The provision generally is effective for taxable years 
beginning after December 31, 2003. For purposes of applying the 
ten-year limit on carryovers of interest, amounts carried to 
any taxable year beginning after December 31, 2003 are treated 
as having been first disallowed for the most recent taxable 
year beginning before January 1, 2004. For taxpayers involved 
in certain inversion transactions completed after 1996, the 
provision is effective for taxable years ending after March 4, 
2003, with a similar rule for carryovers. In addition, such 
taxpayers are subject to the fully reduced 25-percent threshold 
immediately, with no phase-in.

2. Tax treatment of expatriated entities (sec. 2002 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 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.

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, a U.S. corporation may reincorporate in 
a foreign jurisdiction 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 (e.g., 
sections 163(j) and 482).
    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 corporate inversion 
transactions are a symptom of larger problems with our current 
uncompetitive system for taxing U.S.-based global businesses 
and are also indicative of the unfair advantages that our tax 
laws convey to foreign ownership. The bill addresses the 
underlying problems with the U.S. system for taxing its global 
businesses and contains several provisions to remove the 
incentives for entering into inversion transactions. Imposing 
full U.S. tax on gains of companies undertaking an inversion 
transaction is one such provision that helps to remove the 
incentive to enter into an inversion transaction.

                        EXPLANATION OF PROVISION

    The bill applies special tax rules to corporations that 
undertake certain defined inversion transactions. For this 
purpose, an 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 after March 4, 2003; (2) the 
former shareholders of the U.S. corporation hold (by reason of 
holding stock in the U.S. corporation) 60 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 conduct substantial 
business activities in the entity's country of incorporation 
compared to the total worldwide business activities of the 
expanded affiliated group.
    In such a case, any applicable corporate-level ``toll 
charges'' for establishing the inverted structure are not 
offset by tax attributes such as net operating losses or 
foreign tax credits. Specifically, 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 the transfer or license of 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). This rule does not apply to certain 
transfers of inventory and similar property. These measures 
generally apply for a 10-year period following the inversion 
transaction.
    In determining whether a transaction meets 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 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 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.
    Under the provision, inversion transactions include certain 
partnership transactions. Specifically, the provision applies 
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 60 percent of the stock of the entity is held by former 
partners of the partnership (by reason of holding their 
partnership interests), provided that the other terms of the 
basic definition are met. For purposes of applying this test, 
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.
    A transaction otherwise meeting the definition of an 
inversion transaction is not treated as an inversion 
transaction if, on or before March 4, 2003, the foreign-
incorporated entity had acquired directly or indirectly more 
than half of the properties held directly or indirectly by the 
domestic corporation, or more than half of the properties 
constituting the partnership trade or business, as the case may 
be.

                             EFFECTIVE DATE

    The provision applies to taxable years ending after March 
4, 2003.

3. Excise tax on stock compensation of insiders in expatriated 
        corporations (sec. 2003 of the bill and secs. 162(m), 275(a), 
        and new sec. 4985 of the Code)

                              PRESENT LAW

    The income taxation of a nonstatutory \121\ compensatory 
stock option is determined under the rules that apply to 
property transferred in connection with the performance of 
services (sec. 83). If a nonstatutory stock option does not 
have a readily ascertainable fair market value at the time of 
grant, which is generally the case unless the option is 
actively traded on an established market, no amount is included 
in the gross income of the recipient with respect to the option 
until the recipient exercises the option.\122\ Upon exercise of 
such an option, the excess of the fair market value of the 
stock purchased over the option price is generally included in 
the recipient's gross income as ordinary income in such taxable 
year.\123\
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    \121\ Nonstatutory stock options refer to stock options other than 
incentive stock options and employee stock purchase plans, the taxation 
of which is determined under sections 421-424.
    \122\ If an individual receives a grant of a nonstatutory option 
that has a readily ascertainable fair market value at the time the 
option is granted, the excess of the fair market value of the option 
over the amount paid for the option is included in the recipient's 
gross incomes as ordinary income in the first taxable year in which the 
option is either transferable or not subject to a substantial risk of 
forfeiture.
    \123\ Under section 83, such amount is includable in gross income 
in the first taxable year in which the rights to the stock are 
transferable or are not subject to substantial risk of forfeiture.
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    The tax treatment of other forms of stock-based 
compensation (e.g., restricted stock and stock appreciation 
rights) is also determined under section 83. The excess of the 
fair market value over the amount paid (if any) for such 
property is generally includable in gross income in the first 
taxable year in which the rights to the property are 
transferable or are not subject to substantial risk of 
forfeiture.
    Shareholders are generally required to recognize gain upon 
stock inversion transactions. An inversion transaction is 
generally not a taxable event for holders of stock options and 
other stock-based compensation.

                           REASONS FOR CHANGE

    The Committee is concerned that, while shareholders are 
generally required to recognize gain upon stock inversion 
transactions, executives holding stock options and certain 
stock-based compensation are not taxed upon such transactions. 
Since such executives are often instrumental in deciding 
whether to engage in inversion transactions, the Committee 
believes that, upon certain inversion transactions, it is 
appropriate to impose an excise tax on certain executives 
holding stock options and stock-based compensation. Because 
shareholders are taxed at the capital gains rate upon inversion 
transactions, the Committee believes that it is appropriate to 
impose the excise tax at an equivalent rate.

                        EXPLANATION OF PROVISION

    Under the provision, specified holders of stock options and 
other stock-based compensation are subject to an excise tax 
upon certain inversion transactions. The provision imposes a 
15-percent excise tax on the value of specified stock 
compensation held (directly or indirectly) by or for the 
benefit of a disqualified individual, or a member of such 
individual's family, at any time during the 12-month period 
beginning six months before the corporation's expatriation 
date. Specified stock compensation is treated as held for the 
benefit of a disqualified individual if such compensation is 
held by an entity, e.g., a partnership or trust, in which the 
individual, or a member of the individual's family, has an 
ownership interest.
    A disqualified individual is any individual who, with 
respect to a corporation, is, at any time during the 12-month 
period beginning on the date which is six months before the 
expatriation date, subject to the requirements of section 16(a) 
of the Securities and Exchange Act of 1934 with respect to the 
corporation, or any member of the corporation's expanded 
affiliated group,\124\ or would be subject to such requirements 
if the corporation (or member) were an issuer of equity 
securities referred to in section 16(a). Disqualified 
individuals generally include officers (as defined by section 
16(a)),\125\ directors, and 10-percent-or-greater owners of 
private and publicly-held corporations.
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    \124\ An expanded affiliated group is an affiliated group (under 
section 1504) except that such group is determined without regard to 
the exceptions for certain corporations and is determined applying a 
greater than 50 percent threshold, in lieu of the 80 percent test.
    \125\ An officer is defined as the president, principal financial 
officer, principal accounting officer (or, if there is no such 
accounting officer, the controller), any vice-president in charge of a 
principal business unit, division or function (such as sales, 
administration or finance), any other officer who performs a policy-
making function, or any other person who performs similar policy-making 
functions.
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    The excise tax is imposed on a disqualified individual of 
an expatriated corporation (as previously defined in the bill) 
only if gain (if any) is recognized in whole or part by any 
shareholder by reason of a corporate inversion transaction 
previously defined in the bill.
    Specified stock compensation subject to the excise tax 
includes any payment \126\ (or right to payment) granted by the 
expatriated corporation (or any member of the corporation's 
expanded affiliated group) to any person in connection with the 
performance of services by a disqualified individual for such 
corporation (or member of the corporation's expanded affiliated 
group) if the value of the payment or right is based on, or 
determined by reference to, the value or change in value of 
stock of such corporation (or any member of the corporation's 
expanded affiliated group). In determining whether such 
compensation exists and valuing such compensation, all 
restrictions, other than a non-lapse restriction, are ignored. 
Thus, the excise tax applies, and the value subject to the tax 
is determined, without regard to whether such specified stock 
compensation is subject to a substantial risk of forfeiture or 
is exercisable at the time of the inversion transaction. 
Specified stock compensation includes compensatory stock and 
restricted stock grants, compensatory stock options, and other 
forms of stock-based compensation, including stock appreciation 
rights, phantom stock, and phantom stock options. Specified 
stock compensation also includes nonqualified deferred 
compensation that is treated as though it were invested in 
stock or stock options of the expatriating corporation (or 
member). For example, the provision applies to a disqualified 
individual's deferred compensation if company stock is one of 
the actual or deemed investment options under the nonqualified 
deferred compensation plan.
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    \126\ Under the provision, any transfer of property is treated as a 
payment and any right to a transfer of property is treated as a right 
to a payment.
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    Specified stock compensation includes a compensation 
arrangement that gives the disqualified individual an economic 
stake substantially similar to that of a corporate shareholder. 
Thus, the excise tax does not apply if a payment is simply 
triggered by a target value of the corporation's stock or where 
a payment depends on a performance measure other than the value 
of the corporation's stock. Similarly, the tax does not apply 
if the amount of the payment is not directly measured by the 
value of the stock or an increase in the value of the stock. 
For example, an arrangement under which a disqualified 
individual would be paid a cash bonus of $500,000 if the 
corporation's stock increased in value by 25 percent over two 
years or $1,000,000 if the stock increased by 33 percent over 
two years is not specified stock compensation, even though the 
amount of the bonus generally is keyed to an increase in the 
value of the stock. By contrast, an arrangement under which a 
disqualified individual would be paid a cash bonus equal to 
$10,000 for every $1 increase in the share price of the 
corporation's stock is subject to the provision because the 
direct connection between the compensation amount and the value 
of the corporation's stock gives the disqualified individual an 
economic stake substantially similar to that of a shareholder.
    The excise tax applies to any such specified stock 
compensation previously granted to a disqualified individual 
but cancelled or cashed-out within the six-month period ending 
with the expatriation date, and to any specified stock 
compensation awarded in the six-month period beginning with the 
expatriation date. As a result, for example, if a corporation 
cancels outstanding options three months before the transaction 
and then reissues comparable options three months after the 
transaction, the tax applies both to the cancelled options and 
the newly granted options. It is intended that the Secretary 
issue guidance to avoid double counting with respect to 
specified stock compensation that is cancelled and then 
regranted during the applicable twelve-month period.
    Specified stock compensation subject to the tax does not 
include a statutory stock option or any payment or right from a 
qualified retirement plan or annuity, tax-sheltered annuity, 
simplified employee pension, or SIMPLE. In addition, under the 
provision, the excise tax does not apply to any stock option 
that is exercised during the six-month period before the 
expatriation date or to any stock acquired pursuant to such 
exercise, if income is recognized under section 83 on or before 
the expatriation date with respect to the stock acquired 
pursuant to such exercise. The excise tax also does not apply 
to any specified stock compensation that is exercised, sold, 
exchanged, distributed, cashed-out, or otherwise paid during 
such period in a transaction in which income, gain, or loss is 
recognized in full.
    For specified stock compensation held on the expatriation 
date, the amount of the tax is determined based on the value of 
the compensation on such date. The tax imposed on specified 
stock compensation cancelled during the six-month period before 
the expatriation date is determined based on the value of the 
compensation on the day before such cancellation, while 
specified stock compensation granted after the expatriation 
date is valued on the date granted. Under the provision, the 
cancellation of a non-lapse restriction is treated as a grant.
    The value of the specified stock compensation on which the 
excise tax is imposed is the fair value in the case of stock 
options (including warrants or other similar rights to acquire 
stock) and stock appreciation rights and the fair market value 
for all other forms of compensation. For purposes of the tax, 
the fair value of an option (or a warrant or other similar 
right to acquire stock) or a stock appreciation right is 
determined using an appropriate option-pricing model, as 
specified or permitted by the Secretary, that takes into 
account the stock price at the valuation date; the exercise 
price under the option; the remaining term of the option; the 
volatility of the underlying stock and the expected dividends 
on it; and the risk-free interest rate over the remaining term 
of the option. Options that have no intrinsic value (or 
``spread'') because the exercise price under the option equals 
or exceeds the fair market value of the stock at valuation 
nevertheless have a fair value and are subject to tax under the 
provision. The value of other forms of compensation, such as 
phantom stock or restricted stock, is the fair market value of 
the stock as of the date of the expatriation transaction. The 
value of any deferred compensation that can be valued by 
reference to stock is the amount that the disqualified 
individual would receive if the plan were to distribute all 
such deferred compensation in a single sum on the date of the 
expatriation transaction (or the date of cancellation or grant, 
if applicable). It is expected that the Secretary issue 
guidance on valuation of specified stock compensation, 
including guidance similar to the revenue procedures issued 
under section 280G, except that the guidance would not permit 
the use of a term other than the full remaining term and would 
be modified as necessary or appropriate to carry out the 
purposes of the provision. Pending the issuance of guidance, it 
is intended that taxpayers can rely on the revenue procedure 
issued under section 280G (except that the full remaining term 
must be used and recalculation is not permitted).
    The excise tax also applies to any payment by the 
expatriated corporation or any member of the expanded 
affiliated group made to an individual, directly or indirectly, 
in respect of the tax. Whether a payment is made in respect of 
the tax is determined under all of the facts and circumstances. 
Any payment made to keep the individual in the same after-tax 
position that the individual would have been in had the tax not 
applied is a payment made in respect of the tax. This includes 
direct payments of the tax and payments to reimburse the 
individual for payment of the tax. It is expected that the 
Secretary issue guidance on determining when a payment is made 
in respect of the tax and that such guidance include certain 
factors that give rise to a rebuttable presumption that a 
payment is made in respect of the tax, including a rebuttable 
presumption that if the payment is contingent on the inversion 
transaction, it is made in respect to the tax. Any payment made 
in respect of the tax is includible in the income of the 
individual, but is not deductible by the corporation.
    To the extent that a disqualified individual is also a 
covered employee under section 162(m), the $1,000,000 limit on 
the deduction allowed for employee remuneration for such 
employee is reduced by the amount of any payment (including 
reimbursements) made in respect of the tax under the provision. 
As discussed above, this includes direct payments of the tax 
and payments to reimburse the individual for payment of the 
tax.
    The payment of the excise tax has no effect on the 
subsequent tax treatment of any specified stock compensation. 
Thus, the payment of the tax has no effect on the individual's 
basis in any specified stock compensation and no effect on the 
tax treatment for the individual at the time of exercise of an 
option or payment of any specified stock compensation, or at 
the time of any lapse or forfeiture of such specified stock 
compensation. The payment of the tax is not deductible and has 
no effect on any deduction that might be allowed at the time of 
any future exercise or payment.
    Under the provision, the Secretary is authorized to issue 
regulations as may be necessary or appropriate to carry out the 
purposes of the provision.

                             EFFECTIVE DATE

    The provision is effective as of March 4, 2003, except that 
periods before March 4, 2003, are not taken into account in 
applying the excise tax to specified stock compensation held or 
cancelled during the six-month period before the expatriation 
date.

4. Reinsurance of U.S. risks in foreign jurisdictions (sec. 2004 of the 
        bill and sec. 845(a) of the Code)

                              PRESENT LAW

    In the case of a reinsurance agreement between two or more 
related persons, present law provides the 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.\127\ 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.\128\ 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.
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    \127\ Sec. 845(a).
    \128\ See S. Rep. No. 97-494, 99th Cong., 2d Sess., 337 (1982) 
(describing provisions relating to the repeal of modified coinsurance 
provisions).
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                           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 eroding 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 bill clarifies the rules of section 845, relating to 
authority for the 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 bill 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 \129\ be exercised in a 
manner similar to the authority under section 482 for the 
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.
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    \129\ The authority to allocate, recharacterize or make other 
adjustments was granted in connection with the repeal of provisions 
relating to modified coinsurance transactions.
---------------------------------------------------------------------------
    No regulations have been issued under section 845(a). It is 
expected that the Secretary will 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 the 
date of enactment of the provision.

5. Modification of the tax treatment of individual expatriates (sec. 
        2005 of the bill and secs. 877, 2107, 2501 and 6039G of the 
        Code)

                              PRESENT LAW

    U.S. citizens and residents generally are subject to U.S. 
income taxation on their worldwide income. The U.S. tax may be 
reduced or offset by a credit allowed for foreign income taxes 
paid with respect to foreign source income. Nonresidents who 
are not U.S. citizens are taxed at a flat rate of 30 percent 
(or a lower treaty rate) on certain types of passive income 
derived from U.S. sources, and at regular graduated rates on 
net profits derived from a U.S. trade or business.
    An individual who relinquishes his or her U.S. citizenship 
or terminates his or her U.S. residency \130\ with a principal 
purpose of avoiding U.S. taxes is subject to an alternative 
method of income taxation for the 10 taxable years ending after 
the citizenship relinquishment or residency termination (the 
``alternative tax regime''). The alternative tax regime 
modifies the rules generally applicable to the taxation of 
nonresident noncitizens. For the 10-year period, the individual 
is subject to tax only on U.S.-source income at the rates 
applicable to U.S. citizens, rather than the rates applicable 
to nonresident noncitizens. However, for this purpose, U.S.-
source income has a broader scope than it does for normal U.S. 
Federal tax purposes and includes, for example, gain from the 
sale of U.S. corporate stock or debt obligations. The 
alternative tax regime applies only if it results in a higher 
U.S. tax liability than the liability that would result if the 
individual were taxed as a nonresident noncitizen.
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    \130\ The alternative tax regime applies to long-term residents of 
the United States that have terminated their residency with a principal 
purpose of avoiding U.S. tax. A ``long-term resident'' is any 
individual who was a lawful permanent resident of the United States for 
at least 8 out of the 15 taxable years ending with the year in which 
such termination occurs. In applying the 8-year test, an individual is 
not considered to be a lawful permanent resident for any year in which 
the individual is treated as a resident of another country under a 
treaty tiebreaker rule (and the individual does not elect to waive the 
benefits of such treaty).
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    In addition, the alternative tax regime includes special 
estate and gift tax rules. Under present law, estates of 
nonresident noncitizens are subject to U.S. estate tax on U.S.-
situated property. For these purposes, stock in a foreign 
corporation generally is not treated as U.S.-situated property, 
even if the foreign corporation itself owns U.S.-situated 
property. However, a special estate tax rule (sec. 2107) 
applies to former citizens and former long-term residents who 
are subject to the alternative tax regime. Under this rule, 
certain closely-held foreign stock owned by the former citizen 
or former long-term resident is includible in his or her gross 
estate to the extent that the foreign corporation owns U.S.-
situated assets, if the former citizen or former long-term 
resident dies within 10 years of citizenship relinquishment or 
residency termination. This rule prevents former citizens and 
former long-term residents who are subject to the alternative 
tax regime from avoiding U.S. estate tax through the expedient 
of transferring U.S.-situated assets to a foreign corporation 
(subject to income tax on any appreciation under section 367). 
In addition, under the alternative tax regime, the individual 
is subject to gift tax on gifts of U.S.-situated intangibles, 
such as U.S. stock, made during the 10 years following 
citizenship relinquishment or residency termination.
    Anti-abuse rules are provided to prevent the circumvention 
of the alternative tax regime. Accordingly, the alternative tax 
regime generally applies to an exchange of property that gives 
rise to U.S.-source income for property that gives rise to 
foreign source income. In addition, amounts earned by former 
citizens and former long-term residents through controlled 
foreign corporations are subject to the alternative tax regime, 
and the 10-year liability period is suspended during any time a 
former citizen's or former long-term resident's risk of loss 
with respect to property subject to the alternative tax regime 
is substantially diminished, among other measures.
    A U.S. citizen who relinquishes citizenship or a long-term 
resident who terminates residency is treated as having done so 
with a principal purpose of tax avoidance (and, thus, generally 
is subject to the alternative tax regime described above) if: 
(1) the individual's average annual U.S. Federal income tax 
liability for the five taxable years preceding citizenship 
relinquishment or residency termination exceeds $100,000; or 
(2) the individual's net worth on the date of citizenship 
relinquishment or residency termination equals or exceeds 
$500,000. These amounts are adjusted annually for 
inflation.\131\ Certain categories of individuals may avoid 
being deemed to have a tax avoidance purpose for relinquishing 
citizenship or terminating residency by submitting a ruling 
request to the IRS regarding whether the individual 
relinquished citizenship or terminated residency principally 
for tax reasons.
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    \131\ The income tax liability and net worth thresholds under 
section 877(a)(2) for 2003 are $122,000 and $608,000, respectively. See 
Rev. Proc. 2002-70, 2002-46 I.R.B. 845.
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    Under present law, the Immigration and Nationality Act 
governs the determination of when a U.S. citizen is treated for 
U.S. Federal tax purposes as having relinquished citizenship. 
Similarly, an individual's U.S. residency is considered 
terminated for U.S. Federal tax purposes when the individual 
ceases to be a lawful permanent resident under the immigration 
laws (or is treated as a resident of another country under a 
tax treaty and does not waive the benefits of such treaty). In 
view of this reliance on immigration-law status, it is possible 
in many instances for a U.S. citizen or resident to convert his 
or her Federal tax status to that of a nonresident noncitizen 
without notifying the IRS.
    Individuals subject to the alternative tax regime are 
required to provide certain tax information, including tax 
identification numbers, upon relinquishment of citizenship or 
termination of residency (on IRS Form 8854, Expatriation 
Initial Information Statement). In the case of an individual 
with a net worth of at least $500,000, the individual also must 
provide detailed information about the individual's assets and 
liabilities. The penalty for failure to provide the required 
tax information is the greater of $1,000 or five percent of the 
tax imposed under the alternative tax regime for the year.\132\ 
In addition, the U.S. Department of State and other 
governmental agencies are required to provide this information 
to the IRS.
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    \132\ The penalty applies for each year of the 10-year period 
beginning on the date the individual ceases to be a U.S. citizen or 
resident.
---------------------------------------------------------------------------
    Former citizens and former long-term residents who are 
subject to the alternative tax regime also are required to file 
annual income tax returns, but only in the event that they owe 
U.S. Federal income tax. If a tax return is required, the 
former citizen or former long-term resident is required to 
provide the IRS with a statement setting forth (generally by 
category) all items of U.S.-source and foreign-source gross 
income, but no detailed information with respect to all assets 
held by the individual.

                           REASONS FOR CHANGE

    The Committee believes there are several difficulties in 
administering the present-law alternative tax regime. One such 
difficulty is that the IRS is required to determine the 
subjective intent of taxpayers who relinquish citizenship or 
terminate residency. The present-law presumption of a tax-
avoidance purpose in cases in which objective income tax 
liability or net worth thresholds are exceeded mitigates this 
problem to some extent. However, the present-law rules still 
require the IRS to make subjective determinations of intent in 
cases involving taxpayers who fall below these thresholds, as 
well for certain taxpayers who exceed these thresholds but are 
nevertheless allowed to seek a ruling from the IRS to the 
effect that they did not have a principal purpose of tax 
avoidance. The Committee believes that the replacement of the 
subjective determination of tax avoidance as a principal 
purpose for citizenship relinquishment or residency termination 
with objective rules will result in easier administration of 
the tax regime for individuals who relinquish their citizenship 
or terminate residency.
    Similarly, present-law information-reporting and return-
filing provisions do not provide the IRS with the information 
necessary to administer the alternative tax regime. Although 
individuals are required to file tax information statements 
upon the relinquishment of their citizenship or termination of 
their residency, difficulties have been encountered in 
enforcing this requirement. The Committee believes that the tax 
benefits of citizenship relinquishment or residency termination 
should be denied an individual until he or she provides the 
information necessary for the IRS to enforce the alternative 
tax regime. The Committee also believes an annual report 
requirement and a penalty for the failure to comply with such 
requirement are needed to provide the IRS with sufficient 
information to monitor the compliance of former U.S. citizens 
and long-term residents.
    Individuals who relinquish citizenship or terminate 
residency for tax reasons often do not want to fully sever 
their ties with the United States; they hope to retain some of 
the benefits of citizenship or residency without being subject 
to the U.S. tax system as a U.S. citizen or resident. These 
individuals generally may continue to spend significant amounts 
of time in the United States following citizenship 
relinquishment or residency termination--approximately four 
months every year--without being treated as a U.S. resident. 
The Committee believes that provisions in the bill that impose 
full U.S. taxation if the individual is present in the United 
States for more than 30 days in a calendar year will 
substantially reduce the incentives to relinquish citizenship 
or terminate residency for individuals who desire to maintain 
significant ties to the United States.
    With respect to the estate and gift tax rules, the 
Committee is concerned that present-law does not adequately 
address opportunities for the avoidance of tax on the value of 
assets held by a foreign corporation whose stock the individual 
transfers. Thus, the provision imposes gift tax under the 
alternative tax regime in the case of gifts of certain stock of 
a closely held foreign corporation.

                        EXPLANATION OF PROVISION

In general

    The bill provides: (1) objective standards for determining 
whether former citizens or former long-term residents are 
subject to the alternative tax regime; (2) tax-based (instead 
of immigration-based) rules for determining when an individual 
is no longer a U.S. citizen or long-term resident for U.S. 
Federal tax purposes; (3) the imposition of full U.S. taxation 
for individuals who are subject to the alternative tax regime 
and who return to the United States for extended periods; (4) 
imposition of U.S. gift tax on gifts of stock of certain 
closely-held foreign corporations that hold U.S.-situated 
property; and (5) an annual return-filing requirement for 
individuals who are subject to the alternative tax regime, for 
each of the 10 years following citizenship relinquishment or 
residency termination.\133\
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    \133\ These proposals reflect recommendations contained in Joint 
Committee on Taxation, Review of the Present Law Tax and Immigration 
Treatment of Relinquishment of Citizenship and Termination of Long-Term 
Residency, (JCS-2-03), February 2003.
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Objective rules for the alternative tax regime

    The bill replaces the subjective determination of tax 
avoidance as a principal purpose for citizenship relinquishment 
or residency termination under present law with objective 
rules. Under the bill, a former citizen or former long-term 
resident would be subject to the alternative tax regime for a 
10-year period following citizenship relinquishment or 
residency termination, unless the former citizen or former 
long-term resident: (1) establishes that his or her average 
annual net income tax liability for the five preceding years 
does not exceed $122,000 (adjusted for inflation after 2003) 
and his or her net worth does not exceed $2 million, or 
alternatively satisfies limited, objective exceptions for dual 
citizens and minors who have had no substantial contact with 
the United States; and (2) certifies under penalties of perjury 
that he or she has complied with all U.S. Federal tax 
obligations for the preceding five years and provides such 
evidence of compliance as the Secretary may require.
    The monetary thresholds under the bill replace the present-
law inquiry into the taxpayer's intent. In addition, the bill 
eliminates the present-law process of IRS ruling requests.
    If a former citizen exceeds the monetary thresholds, that 
person is excluded from the alternative tax regime if he or she 
falls within the exceptions for certain dual citizens and 
minors (provided that the requirement of certification and 
proof of compliance with Federal tax obligations is met). These 
exceptions provide relief to individuals who have never had 
substantial connections with the United States, as measured by 
certain objective criteria, and eliminate IRS inquiries as to 
the subjective intent of such taxpayers.
    In order to be excepted from the application of the 
alternative tax regime under the bill, whether by reason of 
falling below the net worth and income tax liability thresholds 
or qualifying for the dual-citizen or minor exceptions, the 
former citizen or former long-term resident also is required to 
certify, under penalties of perjury, that he or she has 
complied with all U.S. Federal tax obligations for the five 
years preceding the relinquishment of citizenship or 
termination of residency and to provide such documentation as 
the Secretary may require evidencing such compliance (e.g., tax 
returns, proof of tax payments). Until such time, the 
individual remains subject to the alternative tax regime. It is 
intended that the IRS will continue to verify that the 
information submitted was accurate, and it is intended that the 
IRS will randomly audit such persons to assess compliance.

Termination of U.S. citizenship or long-term resident status for U.S. 
        Federal income tax purposes

    Under the bill, an individual continues to be treated as a 
U.S. citizen or long-term resident for U.S. Federal tax 
purposes, including for purposes of section 7701(b)(10), until 
the individual: (1) gives notice of an expatriating act or 
termination of residency (with the requisite intent to 
relinquish citizenship or terminate residency) to the Secretary 
of State or the Secretary of Homeland Security, respectively; 
and (2) provides a statement in accordance with section 6039G.

Sanction for individuals subject to the individual tax regime who 
        return to the United States for extended periods

    The alternative tax regime does not apply to any individual 
for any taxable year during the 10-year period following 
citizenship relinquishment or residency termination if such 
individual is present in the United States for more than 30 
days in the calendar year ending in such taxable year. Such 
individual is treated as a U.S. citizen or resident for such 
taxable year and therefore is taxed on his or her worldwide 
income.
    Similarly, if an individual subject to the alternative tax 
regime is present in the United States for more than 30 days in 
any calendar year ending during the 10-year period following 
citizenship relinquishment or residency termination, and the 
individual dies during that year, he or she is treated as a 
U.S. resident, and the individual's worldwide estate is subject 
to U.S. estate tax. Likewise, if an individual subject to the 
alternative tax regime is present in the United States for more 
than 30 days in any year during the 10-year period following 
citizenship relinquishment or residency termination, the 
individual is subject to U.S. gift tax on any transfer of his 
or her worldwide assets by gift during that taxable year.
    For purposes of these rules, an individual is treated as 
present in the United States on any day if such individual is 
physically present in the United States at any time during that 
day. The present-law exceptions from being treated as present 
in the United States for residency purposes \134\ generally do 
not apply for this purpose. However, for individuals with 
certain ties to countries other than the United States \135\ 
and individuals with minimal prior physical presence in the 
United States,\136\ a day of physical presence in the United 
States is disregarded if the individual is performing services 
in the United States on such day for an unrelated employer 
(within the meaning of sections 267 and 707), who meets the 
requirements the Secretary may prescribe in regulations. No 
more than 30 days may be disregarded during any calendar year 
under this rule.
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    \134\ Sections 7701(b)(3)(D), 7701(b)(5) and 7701(b)(7)(B)-(D).
    \135\ An individual has such a relationship to a foreign country if 
the individual becomes a citizen or resident of the country in which 
(1) the individual becomes fully liable for income tax or (2) the 
individual was born, such individual's spouse was born, or either of 
the individual's parents was born.
    \136\ An individual has a minimal prior physical presence in the 
United States if the individual was physically present for no more than 
30 days during each year in the ten-year period ending on the date of 
loss of United States citizenship or termination of residency. However, 
an individual is not treated as being present in the United States on a 
day if (1) the individual is a teacher or trainee, a student, a 
professional athlete in certain circumstances, or a foreign government-
related individual or (2) the individual remained in the United States 
because of a medical condition that arose while the individual was in 
the United States. Section 7701(b)(3)(D)(ii).
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Imposition of gift tax with respect to stock of certain closely held 
        foreign corporations

    Gifts of stock of certain closely-held foreign corporations 
by a former citizen or former long-term resident who is subject 
to the alternative tax regime are subject to gift tax under 
this bill, if the gift is made within the 10-year period after 
citizenship relinquishment or residency termination. The gift 
tax rule applies if: (1) the former citizen or former long-term 
resident, before making the gift, directly or indirectly owns 
10 percent or more of the total combined voting power of all 
classes of stock entitled to vote of the foreign corporation; 
and (2) directly or indirectly, is considered to own more than 
50 percent of (a) the total combined voting power of all 
classes of stock entitled to vote in the foreign corporation, 
or (b) the total value of the stock of such corporation. If 
this stock ownership test is met, then taxable gifts of the 
former citizen or former long-term resident include that 
proportion of the fair market value of the foreign stock 
transferred by the individual, at the time of the gift, which 
the fair market value of any assets owned by such foreign 
corporation and situated in the United States (at the time of 
the gift) bears to the total fair market value of all assets 
owned by such foreign corporation (at the time of the gift).
    This gift tax rule applies to a former citizen or former 
long-term resident who is subject to the alternative tax regime 
and who owns stock in a foreign corporation at the time of the 
gift, regardless of how such stock was acquired (e.g., whether 
issued originally to the donor, purchased, or received as a 
gift or bequest).

Annual return

    The bill requires former citizens and former long-term 
residents to file an annual return for each year following 
citizenship relinquishment or residency termination in which 
they are subject to the alternative tax regime. The annual 
return is required even if no U.S. Federal income tax is due. 
The annual return requires certain information, including 
information on the permanent home of the individual, the 
individual's country of residence, the number of days the 
individual was present in the United States for the year, and 
detailed information about the individual's income and assets 
that are subject to the alternative tax regime. This 
requirement includes information relating to foreign stock 
potentially subject to the special estate tax rule of section 
2107(b) and the gift tax rules of this bill.
    If the individual fails to file the statement in a timely 
manner or fails correctly to include all the required 
information, the individual is required to pay a penalty of 
$5,000. The $5,000 penalty does not apply if it is shown that 
the failure is due to reasonable cause and not to willful 
neglect.

                             EFFECTIVE DATE

    The provision applies to individuals who relinquish 
citizenship or terminate long-term residency after February 27, 
2003.

6. Reporting of taxable mergers and acquisitions (sec. 2006 of the bill 
        and new sec. 6043A of the Code)

                              PRESENT LAW

    Under section 6045 and the regulations thereunder, brokers 
(defined to include stock transfer agents) are required to make 
information returns and to provide corresponding payee 
statements as to sales made on behalf of their customers, 
subject to the penalty provisions of sections 6721-6724. Under 
the regulations issued under section 6045, this requirement 
generally does not apply with respect to taxable transactions 
other than exchanges for cash (e.g., stock inversion 
transactions taxable to shareholders by reason of section 
367(a)).

                           REASONS FOR CHANGE

    The Committee believes that administration of the tax laws 
would be improved by greater information reporting with respect 
to taxable non-cash transactions, and that the Secretary's 
authority to require such enhanced reporting should be made 
explicit in the Code.

                        EXPLANATION OF PROVISION

    Under the bill, if gain or loss is recognized in whole or 
in part by shareholders of a corporation by reason of a second 
corporation's acquisition of the stock or assets of the first 
corporation, then the acquiring corporation (or the acquired 
corporation, if so prescribed by the Secretary) is required to 
make a return containing:
          (1) A description of the transaction;
          (2) The name and address of each shareholder of the 
        acquired corporation that recognizes gain as a result 
        of the transaction (or would recognize gain, if there 
        was a built-in gain on the shareholder's shares);
          (3) The amount of money and the value of stock or 
        other consideration paid to each shareholder described 
        above; and
          (4) Such other information as the Secretary may 
        prescribe.
    Alternatively, a stock transfer agent who records transfers 
of stock in such transaction may make the return described 
above in lieu of the second corporation.
    In addition, every person required to make a return 
described above is required to furnish to each shareholder (or 
the shareholder's nominee \137\) whose name is required to be 
set forth in such return a written statement showing:
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    \137\ In the case of a nominee, the nominee must furnish the 
information to the shareholder in the manner prescribed by the 
Secretary.
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          (1) The name, address, and phone number of the 
        information contact of the person required to make such 
        return;
          (2) The information required to be shown on that 
        return; and
          (3) Such other information as the Secretary may 
        prescribe.
    This written statement is required to be furnished to the 
shareholder on or before January 31 of the year following the 
calendar year during which the transaction occurred.
    The present-law penalties for failure to comply with 
information reporting requirements is extended to failures to 
comply with the requirements set forth under this bill

                             EFFECTIVE DATE

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

7. Studies (sec. 2007 of the bill)

                              PRESENT LAW

    Due to the variation in tax rates and tax systems among 
countries, a multinational enterprise, whether U.S.-based or 
foreign-based, may have an incentive to shift income, 
deductions, or tax credits in order to arrive at a reduced 
overall tax burden. Such a shifting of items could be 
accomplished by establishing artificial, non-arm's-length 
(i.e., non-market) prices for transactions between group 
members.
    Under section 482, the Secretary is authorized to 
reallocate income, deductions, or credits between or among two 
or more organizations, trades, or businesses under common 
control if he determines that such a reallocation is necessary 
to prevent tax evasion or to clearly reflect income. Treasury 
regulations adopt the arm's length standard as the standard for 
determining whether such reallocations are appropriate. Thus, 
the regulations provide rules to identify the respective 
amounts of taxable income of the related parties that would 
have resulted if the parties had been uncontrolled parties 
dealing at arm's length. Transactions involving intangible 
property and certain services may present particular challenges 
to the administration of the arm's length standard, because the 
nature of these transactions may make it difficult or 
impossible to compare them with third-party market 
transactions.
    Present law also provides rules to limit the ability of 
U.S. corporations to reduce the U.S. tax on their U.S.-source 
income through earnings stripping transactions. Section 163(j) 
specifically addresses earnings stripping involving interest 
payments, by limiting the deductibility of interest paid to 
certain related parties (``disqualified interest''),\138\ 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'' (generally taxable income computed without 
regard to deductions for net interest expense, net operating 
losses, and depreciation, amortization, and depletion). 
Disallowed interest amounts can be carried forward 
indefinitely. In addition, excess limitation (i.e., any excess 
of the 50-percent limit over a company's net interest expense 
for a given year) can be carried forward three years.
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    \138\ This interest also may include interest paid to unrelated 
parties in certain cases in which a related party guarantees the debt.
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    In addition to the statutory rules governing the taxation 
of foreign income of U.S. persons and U.S. income of foreign 
persons, bilateral income tax treaties limit the amount of 
income tax that may be imposed by one treaty partner on 
residents of the other treaty partner. For example, treaties 
often reduce or eliminate withholding taxes imposed by a treaty 
country on certain types of income (e.g., dividends, interest 
and royalties) paid to residents of the other treaty country. 
Treaties also contain provisions governing the creditability of 
taxes imposed by the treaty country in which income was earned 
in computing the amount of tax owed to the other country by its 
residents with respect to such income. Treaties further provide 
procedures under which inconsistent positions taken by the 
treaty countries with respect to a single item of income or 
deduction may be mutually resolved by the two countries.

                           REASONS FOR CHANGE

    The Committee believes that it is important to evaluate the 
effectiveness of the current transfer pricing rules and 
compliance efforts with respect to related-party transactions 
to ensure that income is not being shifted outside of the 
United States. The Committee also believes that it is necessary 
to review current U.S. income tax treaties to identify any 
inappropriate reductions in withholding tax rates that may 
create opportunities for shifting income outside the United 
States. In addition, the Committee believes that the impact of 
the provisions of this bill on earnings stripping and inversion 
transactions should be studied.

                        EXPLANATION OF PROVISION

    The bill requires the Secretary to conduct and submit to 
the Congress three studies. The first study will examine the 
effectiveness of the transfer pricing rules of section 482, 
with an emphasis on transactions involving intangible property. 
The second study will examine income tax treaties to which the 
United States is a party, with a view toward identifying any 
inappropriate reductions in withholding tax or opportunities 
for abuse that may exist. The third study will examine the 
impact of the provisions of this bill on earnings stripping and 
inversion transactions.

                             EFFECTIVE DATE

    The tax treaty study required under the provision is due no 
later than June 30, 2004. The transfer pricing study required 
under the provision is due no later than June 30, 2004. The 
earnings stripping and inversions study required under the 
provision is due no later than December 31, 2005.

             TITLE III--PROVISIONS RELATING TO TAX SHELTERS


                     A. Taxpayer Related Provisions


1. Penalty for failure to disclose reportable transactions (sec. 3001 
        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.\139\
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    \139\ On February 27, 2003, the Treasury Department and the IRS 
released final regulations regarding the disclosure of reportable 
transactions. In general, the regulations are effective for 
transactions entered into on or after February 28, 2003.
    The discussion of present law refers to the new regulations. The 
rules that apply with respect to transactions entered into on or before 
February 28, 2003, are contained in Treas. Reg. sec. 1.6011-4T in 
effect on the date the transaction was entered into.
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    There are six categories of reportable transactions. The 
first category is any transaction that is the same as (or 
substantially similar to) \140\ 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'').\141\
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    \140\ The regulations clarify that the term ``substantially 
similar'' includes any transaction that is expected to obtain the same 
or similar types of tax consequences and that is either factually 
similar or based on the same or similar tax strategy. Further, the term 
must be broadly construed in favor of disclosure. Treas. Reg. sec. 
1.6011-4(c)(4).
    \141\ Treas. Reg. sec. 1.6011-4(b)(2).
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    The second category is any transaction that is offered 
under conditions of confidentiality. In general, if a 
taxpayer's disclosure of the structure or tax aspects of the 
transaction is limited in any way by an express or implied 
understanding or agreement with or for the benefit of any 
person who makes or provides a statement, oral or written, as 
to the potential tax consequences that may result from the 
transaction, it is considered offered under conditions of 
confidentiality (whether or not the understanding is legally 
binding).\142\
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    \142\ Treas. Reg. sec. 1.6011-4(b)(3).
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    The third category of reportable transactions is any 
transaction for which (1) the taxpayer has the right to a full 
or partial refund of fees if the intended tax consequences from 
the transaction are not sustained or, (2) the fees are 
contingent on the intended tax consequences from the 
transaction being sustained.\143\
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    \143\ Treas. Reg. sec. 1.6011-4(b)(4).
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    The fourth category of reportable transactions relates to 
any transaction resulting in a taxpayer claiming a loss (under 
section 165) of at least (1) $10 million in any single year or 
$20 million in any combination of years by a corporate taxpayer 
or a partnership with only corporate partners; (2) $2 million 
in any single year or $4 million in any combination of years by 
all other partnerships, S corporations, trusts, and 
individuals; or (3) $50,000 in any single year for individuals 
or trusts if the loss arises with respect to foreign currency 
translation losses.\144\
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    \144\ Treas. Reg. sec. 1.6011-4(b)(5). IRS Rev. Proc. 2003-24, 
2003-11 I.R.B. 599, exempts certain types of losses from this 
reportable transaction category.
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    The fifth category of reportable transactions refers to any 
transaction done by certain taxpayers \145\ in which the tax 
treatment of the transaction differs (or is expected to differ) 
by more than $10 million from its treatment for book purposes 
(using generally accepted accounting principles) in any 
year.\146\
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    \145\ The significant book-tax category applies only to taxpayers 
that are reporting companies under the Securities Exchange Act of 1934 
or business entities that have $250 million or more in gross assets.
    \146\ Treas. Reg. sec. 1.6011-4(b)(6). IRS Rev. Proc. 2003-25, 
2003-11 I.R.B. 601, exempts certain types of transactions from this 
reportable transaction category.
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    The final category of reportable transactions is any 
transaction that results in a tax credit exceeding $250,000 
(including a foreign tax credit) if the taxpayer holds the 
underlying asset for less than 45 days.\147\
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    \147\ Treas. Reg. sec. 1.6011-4(b)(7).
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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 a 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.\148\
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    \148\ 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. On December 31, 
2002, the Treasury Department and IRS issued proposed regulations under 
sections 6662 and 6664 (REG-126016-01) that limit the defenses 
available to the imposition of an accuracy-related penalty in 
connection with a reportable transaction when the transaction is not 
disclosed.
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                           REASONS FOR CHANGE

    The Committee believes that the best way to combat tax 
shelters is to be aware of them. 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 
believes that additional legislation is needed to provide the 
Treasury Department with additional tools to assist its efforts 
to curtail abusive transactions. 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'' \149\ 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.
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    \149\ The provision states that, except as provided in regulations, 
a listed transaction means a reportable transaction, which is the same 
as, or substantially similar to, a transaction specifically identified 
by the Secretary as a tax avoidance transaction for purposes of section 
6011. For this purpose, it is expected that the definition of 
``substantially similar'' will be the definition used in Treas. Reg. 
sec. 1.6011-4(c)(4). However, the Secretary may modify this definition 
(as well as the definitions of ``listed transaction'' and ``reportable 
transactions'') as appropriate.
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Penalty rate

    The penalty for failing to disclose a reportable 
transaction is $10,000 in the case of a natural person and 
$50,000 in any other case. The amount is increased to $100,000 
and $200,000, respectively, if the failure is with respect to 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 if 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 IRS Commissioner 
personally. Thus, a revenue agent, an Appeals officer, or any 
other IRS personnel cannot rescind the penalty. 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.\150\ 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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    \150\ This does not limit the ability of a taxpayer to challenge 
whether a penalty is appropriate (e.g., a taxpayer may litigate the 
issue of whether a transaction is a reportable transaction (and thus 
subject to the penalty if not disclosed) or not a reportable 
transaction (and thus not subject to the penalty)).
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                             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. 3002 of the bill and new sec. 6662A 
        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.\151\ The amount of 
any understatement generally is reduced by any portion 
attributable to an item if (1) the treatment of the item is or 
was 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.\152\
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    \151\ Sec. 6662.
    \152\ Sec. 6662(d)(2)(B).
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    Special rules apply with respect to tax shelters.\153\ 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.
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    \153\ Sec. 6662(d)(2)(C).
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    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.154 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.155
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    \154\ Sec. 6664(c).
    \155\ Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec. 
1.6664-4(c).
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                           REASONS FOR CHANGE

    Because disclosure is so vital to combating abusive tax 
avoidance transactions, 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 not a strict liability) accuracy-related penalty should 
apply to such transactions even when disclosed.

                        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'').156 The penalty rate and 
defenses available to avoid the penalty vary depending on 
whether the transaction was adequately disclosed.
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    \156\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meanings as used for purposes of the 
penalty for failing to disclose reportable transactions.
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            Disclosed transactions
    In general, a 20-percent accuracy-related penalty is 
imposed on any understatement attributable to an adequately 
disclosed listed transaction or 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.
            Undisclosed transactions
    If the taxpayer does not adequately disclose the 
transaction, the strengthened reasonable cause exception is not 
available (i.e., a strict-liability penalty applies), and the 
taxpayer is subject to an increased penalty rate equal to 30 
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),157 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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    \157\ 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.
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    Except as provided in regulations, a 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 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 6011,158 (2) that there is 
or was substantial authority for such treatment, and (3) that 
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.
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    \158\ See the previous discussion regarding the penalty for failing 
to disclose a reportable transaction.
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    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 advisor who (1) is a 
material advisor 159 and who participates in the 
organization, management, promotion or sale of the transaction 
or is related (within the meaning of section 267(b) or 
707(b)(1)) to any person who so participates, (2) is 
compensated directly or indirectly 160 by a 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 disqualifying 
financial interest with respect to the transaction.
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    \159\ 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, managing, 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).
    \160\ 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.--A material advisor is 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.161 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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    \161\ 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 advisor is compensated 
by a 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 upon 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. Tax shelter exception to confidentiality privileges relating to 
        taxpayer communications (sec. 3003 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 provision 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.

4. Statute of limitations for unreported listed transactions (sec. 3004 
        of the bill and sec. 6501 of the Code)

                              PRESENT LAW

    In general, the Code requires that taxes be assessed within 
three years 162 after the date a return is 
filed.163 If there has been a substantial omission 
of items of gross income that totals more than 25 percent of 
the amount of gross income shown on the return, the period 
during which an assessment must be made is extended to six 
years.164 If an assessment is not made within the 
required time periods, the tax generally cannot be assessed or 
collected at any future time. Tax may be assessed at any time 
if the taxpayer files a false or fraudulent return with the 
intent to evade tax or if the taxpayer does not file a tax 
return at all.165
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    \162\ Sec. 6501(a).
    \163\ For this purpose, a return that is filed before the date on 
which it is due is considered to be filed on the required due date 
(sec. 6501(b)(1)).
    \164\ Sec. 6501(e).
    \165\ Sec. 6501(c).
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                           REASONS FOR CHANGE

    The Committee has noted that some taxpayers and their 
advisors have been employing dilatory tactics and failing to 
cooperate with the IRS in an attempt to avoid liability because 
of the expiration of the statute of limitations. The Committee 
accordingly believes that it is appropriate to extend the 
statute of limitations for unreported listed transactions.

                        EXPLANATION OF PROVISION

    The provision extends the statute of limitations with 
respect to a listed transaction if a taxpayer fails to include 
on any return or statement for any taxable year any information 
with respect to a listed transaction 166 which is 
required to be included (under section 6011) with such return 
or statement. The statute of limitations with respect to such a 
transaction will not expire before the date which is one year 
after the earlier of (1) the date on which the Secretary is 
furnished the information so required, or (2) the date that a 
material advisor (as defined in 6111) satisfies the list 
maintenance requirements (as defined by section 6112) with 
respect to a request by the Secretary. For example, if a 
taxpayer engaged in a transaction in 2005 that becomes a listed 
transaction in 2007 and the taxpayer fails to disclose such 
transaction in the manner required by Treasury regulations, 
then the transaction is subject to the extended statute of 
limitations.167
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    \166\ The term ``listed transaction'' has the same meaning as 
described in a previous provision regarding the penalty for failure to 
disclose reportable transactions.
    \167\ If the Treasury Department lists a transaction in a year 
subsequent to the year in which a taxpayer entered into such 
transaction and the taxpayer's tax return for the year the transaction 
was entered into is closed by the statute of limitations prior to the 
date the transaction became a listed transaction, this provision does 
not re-open the statute of limitations with respect to such transaction 
for such year. However, if the purported tax benefits of the 
transaction are recognized over multiple tax years, the provision's 
extension of the statute of limitations shall apply to such tax 
benefits in any subsequent tax year in which the statute of limitations 
had not closed prior to the date the transaction became a listed 
transaction.
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                             EFFECTIVE DATE

    The provision is effective for taxable years with respect 
to which the period for assessing a deficiency did not expire 
before the date of enactment.

5. Disclosure of reportable transactions by material advisors (sec. 
        3005 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.168 A ``tax 
shelter'' means any investment with respect to which the tax 
shelter ratio 169 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 involving at least five 
investors).170
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    \168\ Sec. 6111(a).
    \169\ 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.
    \170\ 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.171
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    \171\ Sec. 6111(d).
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    In general, 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,'' 172 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.173 Certain exceptions are provided with 
respect to the second category of transactions.174
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    \172\ Treas. Reg. sec. 301.6111-2(b)(2).
    \173\ Treas. Reg. sec. 301.6111-2(b)(3).
    \174\ Treas. Reg. sec. 301.6111-2(b)(4).
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    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 knows, or has reason to know that the offeree's use or 
disclosure of information relating to the transaction is 
limited in any other manner.175
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    \175\ 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. 
301.6111-2(c)(1).
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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 
$500.176 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.
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    \176\ Sec. 6707.
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    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 believes that providing a single, clear 
definition regarding the types of transactions that must be 
disclosed by taxpayers and material advisors, 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.

                        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 (including any listed transaction) 177 
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.
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    \177\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meaning as previously described in 
connection with the taxpayer-related provisions.
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    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.178
---------------------------------------------------------------------------
    \178}\See the previous discussion regarding the disclosure 
requirements under new section 6707A.
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    A ``material advisor'' means any person (1) who provides 
material aid, assistance, or advice with respect to organizing, 
managing, 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) or such 
other amount as may be prescribed by the Secretary 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 (including, for example, rules regarding the 
aggregation of fees in appropriate circumstances).

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, or who files a false or incomplete 
information return, with respect to a reportable transaction 
(including a listed transaction).179 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 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 listed transaction increases the 
penalty to 75 percent of the gross income.
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    \179\ 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.180 All or part of the penalty may be 
rescinded only if 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. Thus, a revenue agent, an Appeals 
officer, or other IRS personnel cannot rescind the penalty. 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.
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    \180\ 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 modification of penalty for failure to maintain 
        investor lists (secs. 3006 and 3007 of the bill and secs. 6112 
        and 6708 of the Code)

                              PRESENT LAW

Investor lists

    Any organizer or seller of a potentially abusive tax 
shelter must maintain a list identifying each person who was 
sold an interest in any such 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).181 Recently issued regulations under 
section 6112 contain rules regarding the list maintenance 
requirements.182 In general, the regulations apply 
to transactions that are potentially abusive tax shelters 
entered into, or acquired after, February 28, 
2003.183
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    \181\ Sec. 6112.
    \182\ Treas. Reg. sec. 301-6112-1.
    \183\ A special rule applies the list maintenance requirements to 
transactions entered into after February 28, 2000 if the transaction 
becomes a listed transaction (as defined in Treas. Reg. 1.6011-4) after 
February 28, 2003.
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    The regulations provide that a person is an organizer or 
seller of a potentially abusive tax shelter if the person is a 
material advisor with respect to that 
transaction.184 A material advisor is defined as any 
person who is required to register the transaction under 
section 6111, or expects to receive a minimum fee of (1) 
$250,000 for a transaction that is a potentially abusive tax 
shelter if all participants are corporations, or (2) $50,000 
for any other transaction that is a potentially abusive tax 
shelter.185 For listed transactions (as defined in 
the regulations under section 6011), the minimum fees are 
reduced to $25,000 and $10,000, respectively.
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    \184\ Treas. Reg. sec. 301.6112-1(c)(1).
    \185\ Treas. Reg. sec. 301.6112-1(c)(2) and (3).
---------------------------------------------------------------------------
    A potentially abusive tax shelter is any transaction that 
(1) is required to be registered under section 6111, (2) is a 
listed transaction (as defined under the regulations under 
section 6011), or (3) any transaction that a potential material 
advisor, at the time the transaction is entered into, knows is 
or reasonably expects will become a reportable transaction (as 
defined under the new regulations under section 
6011).186
---------------------------------------------------------------------------
    \186\ Treas. Reg. sec. 301.6112-1(b).
---------------------------------------------------------------------------
    The Secretary is required to prescribe regulations which 
provide that, in cases in which two or more persons are 
required to maintain the same list, only one person would be 
required to maintain the list.187
---------------------------------------------------------------------------
    \187\ Sec. 6112(c)(2).
---------------------------------------------------------------------------

Penalty 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.

                        EXPLANATION OF PROVISION

Investor lists

    Each material advisor \188\ with respect to a reportable 
transaction (including a listed transaction) \189\ 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 two or more 
persons are required to maintain the same list, only one person 
would be required to maintain the list.
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    \188\ The term ``material advisor'' has the same meaning as when 
used in connection with the requirement to file an information return 
under section 6111.
    \189\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meaning as previously described in 
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------
    The provision also clarifies that, for purposes of section 
6112, the identity of any person is not privileged under the 
common law attorney-client privilege (or, consequently, the 
section 7525 federally authorized tax practitioner 
confidentiality provision).

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 written 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.\190\
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    \190\ In no event will failure to maintain a list be considered 
reasonable cause for failing to make a list available to the Secretary.
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                             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.
    The provision clarifying that the identity of any person is 
not privileged for purposes of section 6112 is effective as if 
included in the amendments made by section 142 of the Deficit 
Reduction Act of 1984.

7. Penalty on promoters of tax shelters (sec. 3008 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.\191\ 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.
---------------------------------------------------------------------------
    \191\ 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 current law $1,000 penalty 
for tax shelter promoters is insufficient to deter tax shelter 
activities. The Committee believes that the increased penalties 
for tax shelter promoters are meaningful and will help deter 
the promotion of tax shelters.

                        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.

8. Modifications of substantial understatement penalty for 
        nonreportable transactions (sec. 3009 of the bill and sec. 6662 
        of the Code)

                              PRESENT LAW

    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).\192\
---------------------------------------------------------------------------
    \192\ Sec. 6662(a) and (d)(1)(A).
---------------------------------------------------------------------------

                           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.

                        EXPLANATION OF PROVISION

    The provision modifies the definition of ``substantial'' 
for corporate taxpayers. Under the provision, a corporate 
taxpayer has a substantial 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.

                             EFFECTIVE DATE

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

9. Modification of actions to enjoin certain conduct related to tax 
        shelters and reportable transactions (sec. 3010 of the bill and 
        sec. 7408 of the Code)

                              PRESENT LAW

    The Code authorizes civil actions to enjoin any person from 
promoting abusive tax shelters or aiding or abetting the 
understatement of tax liability.\193\
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    \193\ Sec. 7408.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that expanding the authority to 
obtain injunctions against promoters and material advisors that 
(1) fail to file an information return with respect to a 
reportable transaction or (2) fail to maintain, or to timely 
furnish upon written request by the Secretary, a list of 
investors with respect to reportable transactions will 
discourage tax shelter activity and encourage compliance with 
the tax shelter disclosure requirements.

                        EXPLANATION OF PROVISION

    The provision expands this rule so that injunctions may 
also be sought with respect to the requirements relating to the 
reporting of reportable transactions \194\ and the keeping of 
lists of investors by material advisors.\195\ 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.
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    \194\ Sec. 6707, as amended by other provisions of this bill.
    \195\ Sec. 6708, as amended by other provisions of this bill.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

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

10. Penalty on failure to report interests in foreign financial 
        accounts (sec. 3011 of the bill and sec. 5321 of Title 31, 
        United States Code)

                              PRESENT LAW

    The Secretary 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.\196\ 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.
---------------------------------------------------------------------------
    \196\ 31 U.S.C. 5314.
---------------------------------------------------------------------------
    The Secretary 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.\197\ 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.\198\
---------------------------------------------------------------------------
    \197\ 31 U.S.C. 5321(a)(5).
    \198\ 31 U.S.C. 5322.
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    On April 26, 2002, the Secretary submitted to the Congress 
a report on these reporting requirements.\199\ This report, 
which was statutorily required,\200\ studies methods for 
improving compliance with these reporting requirements. It 
makes several administrative recommendations, but no 
legislative recommendations. A further report was required to 
be submitted by the Secretary to the Congress by October 26, 
2002.
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    \199\ 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.
    \200\ Sec. 361(b) of the USA PATRIOT Act of 2001 (Pub. L. 107-56).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that imposing a new civil penalty 
for failure to report an interest in foreign financial accounts 
that applies (without regard to willfulness) will increase the 
reporting of foreign financial accounts.

                        EXPLANATION OF PROVISION

    The provision 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.

11. Regulation of individuals practicing before the Department of the 
        Treasury (sec. 3012 of the bill and sec. 330 of Title 31, 
        United States Code)

                              PRESENT LAW

    The Secretary is authorized to regulate the practice of 
representatives of persons before the Department of the 
Treasury.\201\ 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.
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    \201\ 31 U.S.C. 330.
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                           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 provision makes two modifications to expand the 
sanctions that the Secretary may impose pursuant to these 
statutory provisions. First, the provision expressly permits 
censure as a sanction. Second, the provision 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 of such individual.
    The provision 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.

                          B. Other Provisions


1. Treatment of stripped interests in bond and preferred stock funds, 
        etc. (sec. 3021 of the bill and secs. 305 and 1286 of the Code)

                              PRESENT LAW

Assignment of income in general

    In general, an ``income stripping'' transaction involves a 
transaction in which the right to receive future income from 
income-producing property is separated from the property 
itself. In such transactions, it may be possible to generate 
artificial losses from the disposition of certain property or 
to defer the recognition of taxable income associated with such 
property.
    Common law has developed a rule (referred to as the 
``assignment of income'' doctrine) that income may not be 
transferred without also transferring the underlying property. 
A leading judicial decision relating to the assignment of 
income doctrine involved a case in which a taxpayer made a gift 
of detachable interest coupons before their due date while 
retaining the bearer bond. The U.S. Supreme Court ruled that 
the donor was taxable on the entire amount of interest when 
paid to the donee on the grounds that the transferor had 
``assigned'' to the donee the right to receive the income.\202\
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    \202\ Helvering v. Horst, 311 U.S. 112 (1940).
---------------------------------------------------------------------------
    In addition to general common law assignment of income 
principles, specific statutory rules have been enacted to 
address certain specific types of stripping transactions, such 
as transactions involving stripped bonds and stripped preferred 
stock (which are discussed below).\203\ However, there are no 
specific statutory rules that address stripping transactions 
with respect to common stock or other equity interests (other 
than preferred stock).\204\
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    \203\ Depending on the facts, the IRS also could determine that a 
variety of other Code-based and common law-based authorities could 
apply to income stripping transactions, including: (1) sections 269, 
382, 446(b), 482, 701, or 704 and the regulations thereunder; (2) 
authorities that recharacterize certain assignments or accelerations of 
future payments as financings; (3) business purpose, economic 
substance, and sham transaction doctrines; (4) the step transaction 
doctrine; and (5) the substance-over-form doctrine. See Notice 95-53, 
1995-2 C.B. 334 (accounting for lease strips and other stripping 
transactions).
    \204\ However, in Estate of Stranahan v. Commissioner, 472 F.2d 867 
(6th Cir. 1973), the court held that where a taxpayer sold a carved-out 
interest of stock dividends, with no personal obligation to produce the 
income, the transaction was treated as a sale of an income interest.
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Stripped bonds

    Special rules are provided with respect to the purchaser 
and ``stripper'' of stripped bonds.\205\ A ``stripped bond'' is 
defined as a debt instrument in which there has been a 
separation in ownership between the underlying debt instrument 
and any interest coupon that has not yet become payable.\206\ 
In general, upon the disposition of either the stripped bond or 
the detached interest coupons each of the retained portion and 
the portion that is disposed is treated as a new bond that is 
purchased at a discount and is payable at a fixed amount on a 
future date. Accordingly, section 1286 treats both the stripped 
bond and the detached interest coupons as individual bonds that 
are newly issued with original issue discount (``OID'') on the 
date of disposition. Consequently, section 1286 effectively 
subjects the stripped bond and the detached interest coupons to 
the general OID periodic income inclusion rules.
---------------------------------------------------------------------------
    \205\ Sec. 1286.
    \206\ Sec. 1286(e).
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    A taxpayer who purchases a stripped bond or one or more 
stripped coupons is treated as holding a new bond that is 
issued on the purchase date with OID in an amount that is equal 
to the excess of the stated redemption price at maturity (or in 
the case of a coupon, the amount payable on the due date) over 
the ratable share of the purchase price of the stripped bond or 
coupon, determined on the basis of the respective fair market 
values of the stripped bond and coupons on the purchase 
date.\207\ The OID on the stripped bond or coupon is includible 
in gross income under the general OID periodic income inclusion 
rules.
---------------------------------------------------------------------------
    \207\ Sec. 1286(a).
---------------------------------------------------------------------------
    A taxpayer who strips a bond and disposes of either the 
stripped bond or one or more stripped coupons must allocate his 
basis, immediately before the disposition, in the bond (with 
the coupons attached) between the retained and disposed 
items.\208\ Special rules apply to require that interest or 
market discount accrued on the bond prior to such disposition 
must be included in the taxpayer's gross income (to the extent 
that it had not been previously included in income) at the time 
the stripping occurs, and the taxpayer increases his basis in 
the bond by the amount of such accrued interest or market 
discount. The adjusted basis (as increased by any accrued 
interest or market discount) is then allocated between the 
stripped bond and the stripped interest coupons in relation to 
their respective fair market values. Amounts realized from the 
sale of stripped coupons or bonds constitute income to the 
taxpayer only to the extent such amounts exceed the basis 
allocated to the stripped coupons or bond. With respect to 
retained items (either the detached coupons or stripped bond), 
to the extent that the price payable on maturity, or on the due 
date of the coupons, exceeds the portion of the taxpayer's 
basis allocable to such retained items, the difference is 
treated as OID that is required to be included under the 
general OID periodic income inclusion rules.\209\
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    \208\ Sec. 1286(b). Similar rules apply in the case of any person 
whose basis in any bond or coupon is determined by reference to the 
basis in the hands of a person who strips the bond.
    \209\ Special rules are provided with respect to stripping 
transactions involving tax-exempt obligations that treat OID (computed 
under the stripping rules) in excess of OID computed on the basis of 
the bond's coupon rate (or higher rate if originally issued at a 
discount) as income from a non-tax-exempt debt instrument (sec. 
1286(d)).
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Stripped preferred stock

    ``Stripped preferred stock'' is defined as preferred stock 
in which there has been a separation in ownership between such 
stock and any dividend on such stock that has not become 
payable.\210\ A taxpayer who purchases stripped preferred stock 
is required to include in gross income, as ordinary income, the 
amounts that would have been includible if the stripped 
preferred stock was a bond issued on the purchase date with OID 
equal to the excess of the redemption price of the stock over 
the purchase price.\211\ This treatment is extended to any 
taxpayer whose basis in the stock is determined by reference to 
the basis in the hands of the purchaser. A taxpayer who strips 
and disposes the future dividends is treated as having 
purchased the stripped preferred stock on the date of such 
disposition for a purchase price equal to the taxpayer's 
adjusted basis in the stripped preferred stock.\212\
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    \210\ Sec. 305(e)(5).
    \211\ Sec. 305(e)(1).
    \212\ Sec. 305(e)(3).
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                           REASONS FOR CHANGE

    The Committee is concerned that taxpayers are entering into 
tax avoidance transactions to generate artificial losses, or 
defer the recognition of ordinary income and convert such 
income into capital gains, by selling or purchasing stripped 
interests that are not subject to the present-law rules 
relating to stripped bonds and preferred stock but that 
represent interests in bonds or preferred stock. Therefore, the 
Committee believes that it is appropriate to provide Treasury 
with regulatory authority to apply such rules to interests that 
do not constitute bonds or preferred stock but nevertheless 
derive their economic value and characteristics exclusively 
from underlying bonds or preferred stock.

                        EXPLANATION OF PROVISION

    The provision authorizes the Treasury Department to 
promulgate regulations that, in appropriate cases, apply rules 
that are similar to the present-law rules for stripped bonds 
and stripped preferred stock to direct or indirect interests in 
an entity or account substantially all of the assets of which 
consist of bonds (as defined in section 1286(e)(1)), preferred 
stock (as defined in section 305(e)(5)(B)), or any combination 
thereof. The provision applies only to cases in which the 
present-law rules for stripped bonds and stripped preferred 
stock do not already apply to such interests.
    For example, such Treasury regulations could apply to a 
transaction in which a person effectively strips future 
dividends from shares in a money market mutual fund (and 
disposes either the stripped shares or stripped future 
dividends) by contributing the shares (with the future 
dividends) to a custodial account through which another person 
purchases rights to either the stripped shares or the stripped 
future dividends. However, it is intended that Treasury 
regulations issued under this provision would not apply to 
certain transactions involving direct or indirect interests in 
an entity or account substantially all the assets of which 
consist of tax-exempt obligations (as defined in section 
1275(a)(3)), such as a tax-exempt bond partnership described in 
Rev. Proc. 2002-68,\213\ modifying and superceding Rev. Proc. 
2002-16.\214\
---------------------------------------------------------------------------
    \213\ 2002-43 I.R.B. 753.
    \214\ 2002-9 I.R.B. 572.
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    No inference is intended as to the treatment under the 
present-law rules for stripped bonds and stripped preferred 
stock, or under any other provisions or doctrines of present 
law, of interests in an entity or account substantially all of 
the assets of which consist of bonds, preferred stock, or any 
combination thereof. The Treasury regulations, when issued, 
would be applied prospectively, except in cases to prevent 
abuse.

                             EFFECTIVE DATE

    The provision is effective for purchases and dispositions 
occurring after the date of enactment.

2. Minimum holding period for foreign tax credit on withholding taxes 
        on income other than dividends (sec. 3022 of the bill and sec. 
        901 of the Code)

                              PRESENT LAW

    In general, U.S. persons may credit foreign taxes against 
U.S. tax on foreign-source income. The amount of foreign tax 
credits that may be claimed in a year is subject to a 
limitation that prevents taxpayers from using foreign tax 
credits to offset U.S. tax on U.S.-source income. Separate 
limitations are applied to specific categories of income.
    As a consequence of the foreign tax credit limitations of 
the Code, certain taxpayers are unable to utilize their 
creditable foreign taxes to reduce their U.S. tax liability. 
U.S. taxpayers that are tax-exempt receive no U.S. tax benefit 
for foreign taxes paid on income that they receive.
    Present law denies a U.S. shareholder the foreign tax 
credits normally available with respect to a dividend from a 
corporation or a regulated investment company (``RIC'') if the 
shareholder has not held the stock for more than 15 days 
(within a 30-day testing period) in the case of common stock or 
more than 45 days (within a 90-day testing period) in the case 
of preferred stock (sec. 901(k)). The disallowance applies both 
to foreign tax credits for foreign withholding taxes that are 
paid on the dividend where the dividend-paying stock is held 
for less than these holding periods, and to indirect foreign 
tax credits for taxes paid by a lower-tier foreign corporation 
or a RIC where any of the required stock in the chain of 
ownership is held for less than these holding periods. Periods 
during which a taxpayer is protected from risk of loss (e.g., 
by purchasing a put option or entering into a short sale with 
respect to the stock) generally are not counted toward the 
holding period requirement. In the case of a bona fide contract 
to sell stock, a special rule applies for purposes of indirect 
foreign tax credits. The disallowance does not apply to foreign 
tax credits with respect to certain dividends received by 
active dealers in securities. If a taxpayer is denied foreign 
tax credits because the applicable holding period is not 
satisfied, the taxpayer is entitled to a deduction for the 
foreign taxes for which the credit is disallowed.

                           REASONS FOR CHANGE

    The Committee believes that the present-law holding period 
requirement for claiming foreign tax credits with respect to 
dividends is too narrow in scope and, in general, should be 
extended to apply to items of income or gain other than 
dividends, such as interest.

                        EXPLANATION OF PROVISION

    The provision expands the present-law disallowance of 
foreign tax credits to include credits for gross-basis foreign 
withholding taxes with respect to any item of income or gain 
from property if the taxpayer who receives the income or gain 
has not held the property for more than 15 days (within a 30-
day testing period), exclusive of periods during which the 
taxpayer is protected from risk of loss. The provision does not 
apply to foreign tax credits that are subject to the present-
law disallowance with respect to dividends. The provision also 
does not apply to certain income or gain that is received with 
respect to property held by active dealers. Rules similar to 
the present-law disallowance for foreign tax credits with 
respect to dividends apply to foreign tax credits that are 
subject to the provision. In addition, the provision authorizes 
the Treasury Department to issue regulations providing that the 
provision does not apply in appropriate cases.

                             EFFECTIVE DATE

    The provision is effective for amounts that are paid or 
accrued more than 30 days after the date of enactment.

3. Disallowance of certain partnership loss transfers (sec. 3023 of the 
        bill and secs. 704, 734, and 743 of the Code)

                              PRESENT LAW

Contributions of property

    Under present law, if a partner contributes property to a 
partnership, generally no gain or loss is recognized to the 
contributing partner at the time of contribution.215 
The partnership takes the property at an adjusted basis equal 
to the contributing partner's adjusted basis in the 
property.216 The contributing partner increases its 
basis in its partnership interest by the adjusted basis of the 
contributed property.217 Any items of partnership 
income, gain, loss and deduction with respect to the 
contributed property are allocated among the partners to take 
into account any built-in gain or loss at the time of the 
contribution.218 This rule is intended to prevent 
the transfer of built-in gain or loss from the contributing 
partner to the other partners by generally allocating items to 
the noncontributing partners based on the value of their 
contributions and by allocating to the contributing partner the 
remainder of each item.219
---------------------------------------------------------------------------
    \215\ Sec. 721.
    \216\ Sec. 723.
    \217\ Sec. 722.
    \218\ 704(c)(1)(A).
    \219\ If there is an insufficient amount of an item to allocate to 
the noncontributing partners, Treasury regulations allow for reasonable 
allocations to remedy this insufficiency. Treas. Reg. sec. 1.704-3(c) 
and (d).
---------------------------------------------------------------------------
    If the contributing partner transfers its partnership 
interest, the built-in gain or loss will be allocated to the 
transferee partner as it would have been allocated to the 
contributing partner.220 If the contributing 
partner's interest is liquidated, there is no specific guidance 
preventing the allocation of the built-in loss to the remaining 
partners. Thus, it appears that losses can be ``transferred'' 
to other partners where the contributing partner no longer 
remains a partner.
---------------------------------------------------------------------------
    \220\ Treas. Reg. 1.704-3(a)(7).
---------------------------------------------------------------------------

Transfers of partnership interests

    Under present law, a partnership does not adjust the basis 
of partnership property following the transfer of a partnership 
interest unless the partnership has made a one-time election 
under section 754 to make basis adjustments.221 If 
an election is in effect, adjustments are made with respect to 
the transferee partner in order to account for the difference 
between the transferee partner's proportionate share of the 
adjusted basis of the partnership property and the transferee's 
basis in its partnership interest.222 These 
adjustments are intended to adjust the basis of partnership 
property to approximate the result of a direct purchase of the 
property by the transferee partner. Under these rules, if a 
partner purchases an interest in a partnership with an existing 
built-in loss and no election under section 754 in effect, the 
transferee partner may be allocated a share of the loss when 
the partnership disposes of the property (or depreciates the 
property).
---------------------------------------------------------------------------
    \221\ Sec. 743(a).
    \222\ Sec. 743(b).
---------------------------------------------------------------------------

Distributions of partnership property

    With certain exceptions, partners may receive distributions 
of partnership property without recognition of gain or loss by 
either the partner or the partnership.223 In the 
case of a distribution in liquidation of a partner's interest, 
the basis of the property distributed in the liquidation is 
equal to the partner's adjusted basis in its partnership 
interest (reduced by any money distributed in the 
transaction).224 In a distribution other than in 
liquidation of a partner's interest, the distributee partner's 
basis in the distributed property is equal to the partnership's 
adjusted basis in the property immediately before the 
distribution, but not to exceed the partner's adjusted basis in 
the partnership interest (reduced by any money distributed in 
the same transaction).225
---------------------------------------------------------------------------
    \223\ Sec. 731(a) and (b).
    \224\ Sec. 732(b).
    \225\ Sec. 732(a).
---------------------------------------------------------------------------
    Adjustments to the basis of the partnership's undistributed 
properties are not required unless the partnership has made the 
election under section 754 to make basis 
adjustments.226 If an election is in effect under 
section 754, adjustments are made by a partnership to increase 
or decrease the remaining partnership assets to reflect any 
increase or decrease in the adjusted basis of the distributed 
properties in the hands of the distributee partner (or gain or 
loss recognized by the distributee partner).227 To 
the extent the adjusted basis of the distributed properties 
increases (or loss is recognized) the partnership's adjusted 
basis in its properties is decreased by a like amount; 
likewise, to the extent the adjusted basis of the distributed 
properties decrease (or gain is recognized), the partnership's 
adjusted basis in its properties is increased by a like amount. 
Under these rules, a partnership with no election in effect 
under section 754 may distribute property with an adjusted 
basis lower than the distributee partner's proportionate share 
of the adjusted basis of all partnership property and leave the 
remaining partners with a smaller net built-in gain or a larger 
net built-in loss than before the distribution.
---------------------------------------------------------------------------
    \226\ Sec. 734(a).
    \227\ Sec. 734(b).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the partnership rules currently 
allow for the inappropriate transfer of losses among partners. 
This has allowed partnerships to be created and used to aid 
tax-shelter transactions.
    The bill limits the ability to transfer losses among 
partners, while preserving the simplification aspects of the 
current partnership rules for transactions involving smaller 
amounts.

                        EXPLANATION OF PROVISION

Contributions of property

    Under the provision, a built-in loss may be taken into 
account only by the contributing partner and not by other 
partners. Except as provided in regulations, in determining the 
amount of items allocated to partners other than the 
contributing partner, the basis of the contributed property is 
treated as the fair market value at the time of contribution. 
Thus, if the contributing partner's partnership interest is 
transferred or liquidated, the partnership's adjusted basis in 
the property is based on its fair market value at the time of 
contribution, and the built-in loss is 
eliminated.228
---------------------------------------------------------------------------
    \228\ It is intended that a corporation succeeding to attributes of 
the contributing corporate partner under section 381 shall be treated 
in the same manner as the contributing partner.
---------------------------------------------------------------------------

Transfers of partnership interests

    The provision provides that the basis adjustment rules 
under section 743 are mandatory in the case of the transfer of 
a partnership interest with respect to which there is a 
substantial built-in loss (rather than being elective as under 
present law). For this purpose, a substantial built-in loss 
exists if the partnership's adjusted basis in its property 
exceeds by more than $250,000 the fair market value of the 
partnership property.
    Thus, for example, assume that partner A sells his 25-
percent partnership interest to B for its fair market value of 
$1 million. Also assume that, immediately after the transfer, 
the fair market value of partnership assets is $4 million and 
the partnership's adjusted basis in the partnership assets is 
$4.3 million. Under the bill, section 743(b) applies, so that a 
$300,000 decrease is required to the adjusted basis of the 
partnership assets with respect to B. As a result, B would 
recognize no gain or loss if the partnership immediately sold 
all its assets for their fair market value.

Distributions of partnership property

    The provision provides that a basis adjustment under 
section 734(b) is required in the case of a distribution with 
respect to which there is a substantial basis reduction. A 
substantial basis reduction means a downward adjustment of more 
than $250,000 that would be made to the basis of partnership 
assets if a section 754 election were in effect.
    Thus, for example, assume that A and B each contributed 
$2.5 million to a newly formed partnership and C contributed $5 
million, and that the partnership purchased LMN stock for $3 
million and XYZ stock for $7 million. Assume that the value of 
each stock declined to $1 million. Assume LMN stock is 
distributed to C in liquidation of its partnership interest. 
Under present law, the basis of LMN stock in C's hands is $5 
million. Under present law, C would recognize a loss of $4 
million if the LMN stock were sold for $1 million.
    Under the provision, however, there is a substantial basis 
adjustment because the $2 million increase in the adjusted 
basis of LMN stock (described in section 734(b)(2)(B)) is 
greater than $250,000. Thus, the partnership is required to 
decrease the basis of XYZ stock (under section 734(b)(2)) by $2 
million (the amount by which the basis of LMN stock was 
increased), leaving a basis of $5 million. If the XYZ stock 
were then sold by the partnership for $1 million, A and B would 
each recognize a loss of $2 million.

                             EFFECTIVE DATE

    The provision applies to contributions, transfers, and 
distributions (as the case may be) after the date of enactment.

4. No reduction of basis under section 734 in stock held by partnership 
        in corporate partner (sec. 3024 of the bill and sec. 755 of the 
        Code)

                              PRESENT LAW

In general

    Generally, a partner and the partnership do not recognize 
gain or loss on a contribution of property to a 
partnership.229 Similarly, a partner and the 
partnership generally do not recognize gain or loss on the 
distribution of partnership property.230 This 
includes current distributions and distributions in liquidation 
of a partner's interest.
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    \229\ Sec. 721(a).
    \230\ Sec. 731(a) and (b).
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Basis of property distributed in liquidation

    The basis of property distributed in liquidation of a 
partner's interest is equal to the partner's tax basis in its 
partnership interest (reduced by any money distributed in the 
same transaction).231 Thus, the partnership's tax 
basis in the distributed property is adjusted (increased or 
decreased) to reflect the partner's tax basis in the 
partnership interest.
---------------------------------------------------------------------------
    \231\ Sec. 732(b).
---------------------------------------------------------------------------

Election to adjust basis of partnership property

    When a partnership distributes partnership property, 
generally, the basis of partnership property is not adjusted to 
reflect the effects of the distribution or transfer. The 
partnership is permitted, however, to make an election 
(referred to as a 754 election) to adjust the basis of 
partnership property in the case of a distribution of 
partnership property.232 The effect of the 754 
election is that the partnership adjusts the basis of its 
remaining property to reflect any change in basis of the 
distributed property in the hands of the distributee partner 
resulting from the distribution transaction. Such a change 
could be a basis increase due to gain recognition, or a basis 
decrease due to the partner's adjusted basis in its partnership 
interest exceeding the adjusted basis of the property received. 
If the 754 election is made, it applies to the taxable year 
with respect to which such election was filed and all 
subsequent taxable years.
---------------------------------------------------------------------------
    \232\ Sec. 754.
---------------------------------------------------------------------------
    In the case of a distribution of partnership property to a 
partner with respect to which the 754 election is in effect, 
the partnership increases the basis of partnership property by 
(1) any gain recognized by the distributee partner (2) the 
excess of the adjusted basis of the distributed property to the 
partnership immediately before its distribution over the basis 
of the property to the distributee partner, and decreases the 
basis of partnership property by (1) any loss recognized by the 
distributee partner and (2) the excess of the basis of the 
property to the distributee partner over the adjusted basis of 
the distributed property to the partnership immediately before 
the distribution.
    The allocation of the increase or decrease in basis of 
partnership property is made in a manner that has the effect of 
reducing the difference between the fair market value and the 
adjusted basis of partnership properties.233 In 
addition, the allocation rules require that any increase or 
decrease in basis be allocated to partnership property of a 
like character to the property distributed. For this purpose, 
the two categories of assets are (1) capital assets and 
depreciable and real property used in the trade or business 
held for more than one year, and (2) any other 
property.234
---------------------------------------------------------------------------
    \233\ Sec. 755(a).
    \234\ Sec. 755(b).
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                           REASONS FOR CHANGE

    The Joint Committee on Taxation staff's investigative 
report of Enron Corporation 235 revealed that 
certain transactions were being undertaken that purported to 
use the interaction of the partnership basis adjustment rules 
and the rules protecting a corporation from recognizing gain on 
its stock to obtain unintended tax results. These transactions 
generally purported to increase the tax basis of depreciable 
assets and to decrease, by a corresponding amount, the tax 
basis of the stock of a partner. Because the tax rules protect 
a corporation from gain on the sale of its stock (including 
through a partnership), the transactions enable taxpayers to 
duplicate tax deductions at no economic cost. The provision 
precludes the ability to reduce the basis of corporate stock of 
a partner (or related party) in certain transactions.
---------------------------------------------------------------------------
    \235\ See Joint Committee on Taxation, Report of Investigation of 
Enron Corporation and Related Entities Regarding Federal Tax and 
Compensation Issues, and Policy Recommendations (JCS-3-03), February 
2003.
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The provision provides that in applying the basis 
allocation rules to a distribution in liquidation of a 
partner's interest, a partnership is precluded from decreasing 
the basis of corporate stock of a partner or a related person. 
Any decrease in basis that, absent the provision, would have 
been allocated to the stock is allocated to other partnership 
assets. If the decrease in basis exceeds the basis of the other 
partnership assets, then gain is recognized by the partnership 
in the amount of the excess.

                             EFFECTIVE DATE

    The provision applies to distributions after date of 
enactment.

5. Repeal of special rules for FASITs, etc. (sec. 3025 of the bill and 
        secs. 860H through 860L of the Code)

                              PRESENT LAW

Financial asset securitization investment trusts

    In 1996, Congress created a new type of statutory entity 
called a ``financial asset securitization trust'' (``FASIT'') 
that facilitates the securitization of debt obligations such as 
credit card receivables, home equity loans, and auto 
loans.236 A FASIT generally is not taxable. Instead, 
the FASIT's taxable income or net loss flows through to the 
owner of the FASIT. The ownership interest of a FASIT generally 
is required to be held entirely by a single domestic C 
corporation. In addition, a FASIT generally may hold only 
qualified debt obligations, and certain other specified assets, 
and is subject to certain restrictions on its activities. An 
entity that qualifies as a FASIT can issue one or more classes 
of instruments that meet certain specified requirements and 
treat those instruments as debt for Federal income tax 
purposes.
---------------------------------------------------------------------------
    \236\ Sections 860H through 860L.
---------------------------------------------------------------------------
            Qualification as a FASIT
    To qualify as a FASIT, an entity must: (1) make an election 
to be treated as a FASIT for the year of the election and all 
subsequent years; 237 (2) have assets substantially 
all of which (including assets that the FASIT is treated as 
owning because they support regular interests) are specified 
types called ``permitted assets;'' (3) have non-ownership 
interests be certain specified types of debt instruments called 
``regular interests''; (4) have a single ownership interest 
which is held by an ``eligible holder''; and (5) not qualify as 
a regulated investment company (``RIC''). Any entity, including 
a corporation, partnership, or trust may be treated as a FASIT. 
In addition, a segregated pool of assets may qualify as a 
FASIT.
---------------------------------------------------------------------------
    \237\ Once an election to be a FASIT is made, the election applies 
from the date specified in the election and all subsequent years until 
the entity ceases to be a FASIT. If an election to be a FASIT is made 
after the initial year of an entity, all of the assets in the entity at 
the time of the FASIT election are deemed contributed to the FASIT at 
that time and, accordingly, any gain (but not loss) on such assets will 
be recognized at that time.
---------------------------------------------------------------------------
    An entity ceases qualifying as a FASIT if the entity's 
owner ceases being an eligible corporation. Loss of FASIT 
status is treated as if all of the regular interests of the 
FASIT were retired and then reissued without the application of 
the rule that deems regular interests of a FASIT to be debt.
            Permitted assets
    For an entity or arrangement to qualify as a FASIT, 
substantially all of its assets must consist of the following 
``permitted assets'': (1) cash and cash equivalents; (2) 
certain permitted debt instruments; (3) certain foreclosure 
property; (4) certain instruments or contracts that represent a 
hedge or guarantee of debt held or issued by the FASIT; (5) 
contract rights to acquire permitted debt instruments or 
hedges; and (6) a regular interest in another FASIT. Permitted 
assets may be acquired at any time by a FASIT, including any 
time after its formation.
            ``Regular interests'' of a FASIT
    ``Regular interests'' of a FASIT are treated as debt for 
Federal income tax purposes, regardless of whether instruments 
with similar terms issued by non-FASITs might be characterized 
as equity under general tax principles. To be treated as a 
``regular interest'', an instrument generally must have fixed 
terms and must: (1) unconditionally entitle the holder to 
receive a specified principal amount; (2) pay interest that is 
based on (a) fixed rates, or (b) except as provided by 
regulations issued by the Secretary, variable rates permitted 
with respect to real estate mortgage investment conduit 
interests under section 860G(a)(1)(B)(i); (3) have a term to 
maturity of no more than 30 years, except as permitted by 
Treasury regulations; (4) be issued to the public with a 
premium of not more than 25 percent of its stated principal 
amount; and (5) have a yield to maturity determined on the date 
of issue of less than five percentage points above the 
applicable Federal rate (``AFR'') for the calendar month in 
which the instrument is issued. Instruments that do not satisfy 
certain of these general requirements nevertheless may be 
treated as regular interests if they are held by a domestic 
taxable C corporation that is not a RIC, real estate investment 
trust (``REIT''), FASIT, or cooperative.
            Transfers to FASITs
    In general, gain (but not loss) is recognized immediately 
by the owner of the FASIT upon the transfer of assets to a 
FASIT. Where property is acquired by a FASIT from someone other 
than the FASIT's owner (or a person related to the FASIT's 
owner), the property is treated as being first acquired by the 
FASIT's owner for the FASIT's cost in acquiring the asset from 
the non-owner and then transferred by the owner to the FASIT.
    Valuation rules.--In general, except in the case of debt 
instruments, the value of FASIT assets is their fair market 
value. Similarly, in the case of debt instruments that are 
traded on an established securities market, the market price is 
used for purposes of determining the amount of gain realized 
upon contribution of such assets to a FASIT. However, in the 
case of debt instruments that are not traded on an established 
securities market, special valuation rules apply for purposes 
of computing gain on the transfer of such debt instruments to a 
FASIT. Under these rules, the value of such debt instruments is 
the sum of the present values of the reasonably expected cash 
flows from such obligations discounted over the weighted 
average life of such assets. The discount rate is 120 percent 
of the AFR, compounded semiannually, or such other rate that 
the Secretary shall prescribe by regulations.
            Taxation of a FASIT
    A FASIT generally is not subject to tax. Instead, all of 
the FASIT's assets and liabilities are treated as assets and 
liabilities of the FASIT's owner and any income, gain, 
deduction or loss of the FASIT is allocable directly to its 
owner. Accordingly, income tax rules applicable to a FASIT 
(e.g., related party rules, sec. 871(h), sec. 165(g)(2)) are to 
be applied in the same manner as they apply to the FASIT's 
owner. The taxable income of a FASIT is calculated using an 
accrual method of accounting. The constant yield method and 
principles that apply for purposes of determining original 
issue discount (``OID'') accrual on debt obligations whose 
principal is subject to acceleration apply to all debt 
obligations held by a FASIT to calculate the FASIT's interest 
and discount income and premium deductions or adjustments.
            Taxation of holders of FASIT regular interests
    In general, a holder of a regular interest is taxed in the 
same manner as a holder of any other debt instrument, except 
that the regular interest holder is required to account for 
income relating to the interest on an accrual method of 
accounting, regardless of the method of accounting otherwise 
used by the holder.
            Taxation of holders of FASIT ownership interests
    Because all of the assets and liabilities of a FASIT are 
treated as assets and liabilities of the holder of a FASIT 
ownership interest, the ownership interest holder takes into 
account all of the FASIT's income, gain, deduction, or loss in 
computing its taxable income or net loss for the taxable year. 
The character of the income to the holder of an ownership 
interest is the same as its character to the FASIT, except tax-
exempt interest is included in the income of the holder as 
ordinary income.
    Although the recognition of losses on assets contributed to 
the FASIT is not allowed upon contribution of the assets, such 
losses may be allowed to the FASIT owner upon their disposition 
by the FASIT. Furthermore, the holder of a FASIT ownership 
interest is not permitted to offset taxable income from the 
FASIT ownership interest (including gain or loss from the sale 
of the ownership interest in the FASIT) with other losses of 
the holder. In addition, any net operating loss carryover of 
the FASIT owner shall be computed by disregarding any income 
arising by reason of a disallowed loss. Where the holder of a 
FASIT ownership interest is a member of a consolidated group, 
this rule applies to the consolidated group of corporations of 
which the holder is a member as if the group were a single 
taxpayer.

Real estate mortgage investment conduits

    In general, a real estate mortgage investment conduit 
(``REMIC'') is a self-liquidating entity that holds a fixed 
pool of mortgages and issues multiple classes of investor 
interests. A REMIC is not treated as a separate taxable entity. 
Rather, the income of the REMIC is allocated to, and taken into 
account by, the holders of the interests in the REMIC under 
detailed rules.238 In order to qualify as a REMIC, 
substantially all of the assets of the entity must consist of 
qualified mortgages and permitted investments as of the close 
of the third month beginning after the startup day of the 
entity. A ``qualified mortgage'' generally includes any 
obligation which is principally secured by an interest in real 
property, and which is either transferred to the REMIC on the 
startup day of the REMIC in exchange for regular or residual 
interests in the REMIC or purchased by the REMIC within three 
months after the startup day pursuant to a fixed-price contract 
in effect on the startup day. A ``permitted investment'' 
generally includes any intangible property that is held for 
investment and is part of a reasonably required reserve to 
provide for full payment of certain expenses of the REMIC or 
amounts due on regular interests.
---------------------------------------------------------------------------
    \238\ See sections 860A through 860G.
---------------------------------------------------------------------------
    All of the interests in the REMIC must consist of one or 
more classes of regular interests and a single class of 
residual interests. A ``regular interest'' is an interest in a 
REMIC that is issued with a fixed term, designated as a regular 
interest, and unconditionally entitles the holder to receive a 
specified principal amount (or other similar amount) with 
interest payments that are either based on a fixed rate (or, to 
the extent provided in regulations, a variable rate) or consist 
of a specified portion of the interest payments on qualified 
mortgages that does not vary during the period such interest is 
outstanding. In general, a ``residual interest'' is any 
interest in the REMIC other than a regular interest, and which 
is so designated by the REMIC, provided that there is only one 
class of such interest and that all distributions (if any) with 
respect to such interests are pro rata. Holders of residual 
REMIC interests are subject to tax on the portion of the income 
of the REMIC that is not allocated to the regular interest 
holders.
            Original issue discount accruals with respect to debt 
                    instruments and pools of debt instruments subject 
                    to acceleration of principal payment
    The holder of a debt instrument with original issue 
discount (``OID'') generally accrues and includes in gross 
income, as interest, the OID over the life of the obligation, 
even though the amount of the interest may not be received 
until the maturity of the instrument.\239\ In general, issuers 
of debt instruments with OID accrue and deduct the amount of 
OID as interest expense in the same manner as the holder.
---------------------------------------------------------------------------
    \239\ The amount of OID with respect to a debt instrument is the 
excess of the stated redemption price at maturity over the issue price 
of the debt instrument. The stated redemption price at maturity 
includes all amounts payable at maturity. The amount of OID in a debt 
instrument is allocated over the life of the instrument through a 
series of adjustments to the issue price for each accrual period. The 
adjustment to the issue price is determined by multiplying the adjusted 
issue price (i.e., the issue price increased by adjustments prior to 
the accrual period) by the instrument's yield to maturity, and then 
subtracting the interest payable during the accrual period.
---------------------------------------------------------------------------
    Special rules for determining the amount of OID allocated 
to a period apply to certain instruments and pools of 
instruments that may be subject to prepayment. First, if a 
borrower can reduce the yield on a debt by exercising a 
prepayment option, the OID rules assume that the borrower will 
prepay the debt. In addition, in the case of (1) any regular 
interest in a REMIC or qualified mortgage held by a REMIC, (2) 
any other debt instrument if payments under the instrument may 
be accelerated by reason of prepayments of other obligations 
securing the instrument, or (3) any pool of debt instruments 
the yield on which may be affected by reason of prepayments, 
the daily portions of the OID on such debt instruments and 
pools of debt instruments generally are determined by taking 
into account an assumption regarding the prepayment of 
principal for such instruments. The prepayment assumption to be 
used for this purpose is that which the parties use in pricing 
the particular transaction.

                           REASONS FOR CHANGE

    The Joint Committee on Taxation staff's investigative 
report of Enron Corporation \240\ described two structured tax-
motivated transactions--Projects Apache and Renegade--that 
Enron undertook in which the use of a FASIT was a key component 
in the structure of the transactions. The Committee is aware 
that FASITs are not being used widely in the manner envisioned 
by the Congress and, consequently, the FASIT rules have not 
served the purpose for which they originally were intended. 
Moreover, the Joint Committee's report indicates that FASITs 
are particularly prone to abuse and likely are being used 
primarily to facilitate tax avoidance transactions. Therefore, 
the Committee believes that the potential for abuse that is 
inherent in FASITs far outweighs any beneficial purpose that 
the FASIT rules may serve. Accordingly, the Committee believes 
that these rules should be repealed, with appropriate 
transition relief for existing FASITs and appropriate 
modifications to the present-law REMIC rules to permit the use 
of REMICs by taxpayers that have relied upon FASITs to 
securitize certain obligations secured by an interest in real 
property.
---------------------------------------------------------------------------
    \240\ See Joint Committee on Taxation, Report of Investigation of 
Enron Corporation and Related Entities Regarding Federal Tax and 
Compensation Issues, and Policy Recommendations (JCS-3-03), February 
2003.
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The provision repeals the special rules for FASITs. The 
provision provides a transition period for existing FASITs, 
pursuant to which the repeal of the FASIT rules would not apply 
to any FASIT in existence on the date of enactment to the 
extent that regular interests issued by the FASIT prior to such 
date continue to remain outstanding in accordance with their 
original terms.
    For purposes of the REMIC rules, the provision also 
modifies the definitions of REMIC regular interests, qualified 
mortgages, and permitted investments so that certain types of 
real estate loans and loan pools can be transferred to, or 
purchased by, a REMIC. Specifically, the provision modifies the 
present-law definition of a REMIC ``regular interest'' to 
provide that an interest in a REMIC does not fail to qualify as 
a regular interest solely because the specified principal 
amount of such interest or the amount of interest accrued on 
such interest could be reduced as a result of the nonoccurrence 
of one or more contingent payments with respect to one or more 
reverse mortgages loans, as defined below, that are held by the 
REMIC, provided that on the startup day for the REMIC, the 
REMIC sponsor reasonably believes that all principal and 
interest due under the interest will be paid at or prior to the 
liquidation of the REMIC. For this purpose, a reasonable belief 
concerning ultimate payment of all amounts due under an 
interest is presumed to exist if, as of the startup day, the 
interest receives an investment grade rating from at least one 
nationally recognized statistical rating agency.
    In addition, the provision makes three modifications to the 
present-law definition of a ``qualified mortgage.'' First, the 
provision modifies the definition to include an obligation 
principally secured by real property which represents an 
increase in the principal amount under the original terms of an 
obligation, provided such increase: (1) is attributable to an 
advance made to the obligor pursuant to the original terms of 
the obligation; (2) occurs after the REMIC startup day; and (3) 
is purchased by the REMIC pursuant to a fixed price contract in 
effect on the startup day. Second, the provision modifies the 
definition to generally include reverse mortgage loans and the 
periodic advances made to obligors on such loans. For this 
purpose, a ``reverse mortgage loan'' is defined as a loan that: 
(1) is secured by an interest in real property; (2) provides 
for one or more advances of principal to the obligor (each such 
advance giving rise to a ``balance increase''), provided such 
advances are principally secured by an interest in the same 
real property as that which secures the loan; (3) may provide 
for a contingent payment at maturity based upon the value or 
appreciation in value of the real property securing the loan; 
(4) provides for an amount due at maturity that cannot exceed 
the value, or a specified fraction of the value, of the real 
property securing the loan; (5) provides that all payments 
under the loan are due only upon the maturity of the loan; and 
(6) matures after a fixed term or at the time the obligor 
ceases to use as a personal residence the real property 
securing the loan. Third, the provision modifies the definition 
to provide that, if more than 50 percent of the obligations 
transferred to, or purchased by, the REMIC are (1) originated 
by the United States or any State (or any political 
subdivision, agency, or instrumentality of the United States or 
any State) and (2) principally secured by an interest in real 
property, then each obligation transferred to, or purchased by, 
the REMIC shall be treated as secured by an interest in real 
property.
    In addition, the provision modifies the present-law 
definition of a ``permitted investment'' to include intangible 
investment property held as part of a reasonably required 
reserve to provide a source of funds for the purchase of 
obligations described above as part of the modified definition 
of a ``qualified mortgage.''
    The provision also modifies the OID rules with respect to 
certain instruments and pools of instruments that may be 
subject to principal prepayment by directing the Secretary to 
prescribe regulations permitting the use of a current 
prepayment assumption determined as of the close of the accrual 
period (or such other time as the Secretary may prescribe 
during the taxable year in which the accrual period ends).

                             EFFECTIVE DATE

    Except as provided by the transition period for existing 
FASITs, the provision is effective for taxable years beginning 
after December 31, 2003.

6. Limitation on transfer of built-in losses on REMIC residuals (sec. 
        3026 of the bill and sec. 362 of the Code)

                              PRESENT LAW

    Generally, no gain or loss is recognized when one or more 
persons transfer property to a corporation in exchange for 
stock and immediately after the exchange such person or persons 
control the corporation.\241\ The transferor's basis in the 
stock of the controlled corporation is the same as the basis of 
the property contributed to the controlled corporation, 
increased by the amount of any gain (or dividend) recognized by 
the transferor on the exchange, and reduced by the amount of 
any money or property received, and by the amount of any loss 
recognized by the transferor.\242\
---------------------------------------------------------------------------
    \241\ Sec. 351.
    \242\ Sec. 358.
---------------------------------------------------------------------------
    The basis of property received by a corporation, whether 
from domestic or foreign transferors, in a tax-free 
incorporation, reorganization, or liquidation of a subsidiary 
corporation is the same as the adjusted basis in the hands of 
the transferor, adjusted for gain or loss recognized by the 
transferor.\243\
---------------------------------------------------------------------------
    \243\ Secs. 334(b) and 362(a) and (b).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Joint Committee on Taxation staff's investigative 
report of Enron Corporation \244\ revealed that Enron was using 
REMIC residual interests in tax motivated transactions to 
purportedly duplicate a single economic loss and deduct the 
loss more than once. The Committee understands that, under the 
statutory rules regarding the taxation of REMICS, phantom 
income is allocated to REMIC residual interest holders. Because 
of the associated basis increases in the REMIC residual 
interests, the phantom income allocation inevitably creates 
built-in losses to the holders of the REMIC residual interests, 
thus making such interests a natural component of transactions 
designed to duplicate a single economic loss. Congress did not 
intend REMIC residual interests to be used in this manner. 
Therefore, the Committee believes that a corporation's basis in 
REMIC residual interests acquired in a tax-free transfer should 
be limited to the fair market value of such interests.
---------------------------------------------------------------------------
    \244\ See Joint Committee on Taxation, Report of Investigation of 
Enron Corporation and Related Entities Regarding Federal Tax and 
Compensation Issues, and Policy Recommendations (JCS-3-03), February 
2003.
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The provision provides that if a residual interest (as 
defined in section 860G(a)(2)) in a real estate mortgage 
investment conduit (``REMIC'') is contributed to a corporation 
and the transferee corporation's adjusted basis in the REMIC 
residual interest would (but for the provision) exceed the fair 
market value of the REMIC residual interest immediately after 
the contribution, the transferee corporation's adjusted basis 
in the REMIC residual interest is limited to the fair market 
value of the REMIC residual interest immediately after the 
contribution, regardless of whether the fair market value of 
the REMIC residual interest is less than, equal to, or greater 
than zero (i.e., the provision may result in the transferee 
corporation having a negative adjusted basis in the REMIC 
residual interest).

                             EFFECTIVE DATE

    The provision applies to transactions after the date of 
enactment.

7. Clarification of banking business for purposes of determining 
        investment of earnings in U.S. property (sec. 3027 of the bill 
        and sec. 956 of the Code)

                              PRESENT LAW

    In general, the subpart F rules \245\ require the U.S. 10-
percent shareholders of a controlled foreign corporation to 
include in income currently their pro rata shares of certain 
income of the controlled foreign corporation (referred to as 
``subpart F income''), whether or not such earnings are 
distributed currently to the shareholders. In addition, the 
U.S. 10-percent shareholders of a controlled foreign 
corporation are subject to U.S. tax currently on their pro rata 
shares of the controlled foreign corporation's earnings to the 
extent invested by the controlled foreign corporation in 
certain U.S. property.\246\
---------------------------------------------------------------------------
    \245\ Secs. 951-964.
    \246\ Sec. 951(a)(1)(B).
---------------------------------------------------------------------------
    A shareholder's current income inclusion with respect to a 
controlled foreign corporation's investment in U.S. property 
for a taxable year is based on the controlled foreign 
corporation's average investment in U.S. property for such 
year. For this purpose, the U.S. property held (directly or 
indirectly) by the controlled foreign corporation must be 
measured as of the close of each quarter in the taxable 
year.\247\ The amount taken into account with respect to any 
property is the property's adjusted basis as determined for 
purposes of reporting the controlled foreign corporation's 
earnings and profits, reduced by any liability to which the 
property is subject. The amount determined for current 
inclusion is the shareholder's pro rata share of an amount 
equal to the lesser of: (1) the controlled foreign 
corporation's average investment in U.S. property as of the end 
of each quarter of such taxable year, to the extent that such 
investment exceeds the foreign corporation's earnings and 
profits that were previously taxed on that basis; or (2) the 
controlled foreign corporation's current or accumulated 
earnings and profits (but not including a deficit), reduced by 
distributions during the year and by earnings that have been 
taxed previously as earnings invested in U.S. property.\248\ An 
income inclusion is required only to the extent that the amount 
so calculated exceeds the amount of the controlled foreign 
corporation's earnings that have been previously taxed as 
subpart F income.\249\
---------------------------------------------------------------------------
    \247\ Sec. 956(a).
    \248\ Secs. 956 and 959.
    \249\ Secs. 951(a)(1)(B) and 959.
---------------------------------------------------------------------------
    For purposes of section 956, U.S. property generally is 
defined to include tangible property located in the United 
States, stock of a U.S. corporation, an obligation of a U.S. 
person, and certain intangible assets including a patent or 
copyright, an invention, model or design, a secret formula or 
process or similar property right which is acquired or 
developed by the controlled foreign corporation for use in the 
United States.\250\
---------------------------------------------------------------------------
    \250\ Sec. 956(c)(1).
---------------------------------------------------------------------------
    Specified exceptions from the definition of U.S. property 
are provided for: (1) obligations of the United States, money, 
or deposits with persons carrying on the banking business; (2) 
certain export property; (3) certain trade or business 
obligations; (4) aircraft, railroad rolling stock, vessels, 
motor vehicles or containers used in transportation in foreign 
commerce and used predominantly outside of the United States; 
(5) certain insurance company reserves and unearned premiums 
related to insurance of foreign risks; (6) stock or debt of 
certain unrelated U.S. corporations; (7) moveable property 
(other than a vessel or aircraft) used for the purpose of 
exploring, developing, or certain other activities in 
connection with the ocean waters of the U.S. Continental Shelf; 
(8) an amount of assets equal to the controlled foreign 
corporation's accumulated earnings and profits attributable to 
income effectively connected with a U.S. trade or business; (9) 
property (to the extent provided in regulations) held by a 
foreign sales corporation and related to its export activities; 
(10) certain deposits or receipts of collateral or margin by a 
securities or commodities dealer, if such deposit is made or 
received on commercial terms in the ordinary course of the 
dealer's business as a securities or commodities dealer; and 
(11) certain repurchase and reverse repurchase agreement 
transactions entered into by or with a dealer in securities or 
commodities in the ordinary course of its business as a 
securities or commodities dealer.\251\
---------------------------------------------------------------------------
    \251\ Sec. 956(c)(2).
---------------------------------------------------------------------------
    With regard to the exception for deposits with persons 
carrying on the banking business, the U.S. Court of Appeals for 
the Sixth Circuit in The Limited, Inc. v. Commissioner \252\ 
concluded that a U.S. subsidiary of a U.S. shareholder was 
``carrying on the banking business'' even though its operations 
were limited to the administration of the private label credit 
card program of the U.S. shareholder. Therefore, the court held 
that a controlled foreign corporation of the U.S. shareholder 
could make deposits with the subsidiary (e.g., through the 
purchase of certificates of deposit) under this exception, and 
avoid taxation of the deposits under section 956 as an 
investment in U.S. property.
---------------------------------------------------------------------------
    \252\ 286 F.3d 324 (6th Cir. 2002), rev'g 113 T.C. 169 (1999).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that further guidance is necessary 
under the U.S. property investment provisions of subpart F with 
regard to the treatment of deposits with persons carrying on 
the banking business. In particular, the Committee believes 
that the transaction at issue in The Limited case was not 
contemplated or intended by Congress when it excepted from the 
definition of U.S. property deposits with persons carrying on 
the banking business. Therefore, the Committee believes that it 
is appropriate and necessary to clarify the scope of this 
exception so that it applies only to deposits with regulated 
banking businesses and their affiliates.

                        EXPLANATION OF PROVISION

    The provision provides that the exception from the 
definition of U.S. property under section 956 for deposits with 
persons carrying on the banking business is limited to deposits 
with corporations with respect to which a bank holding company 
(as defined by section 2(a) of the Bank Holding Company Act of 
1956 (12 U.S.C. 1841(c)) or financial holding company (as 
defined by section 2(p) of such Act) owns directly or 
indirectly more than 80 percent by vote or value of the stock 
of such corporation.
    No inference is intended as to the meaning of the phrase 
``carrying on the banking business'' under present law or 
whether this phrase was correctly interpreted by the Sixth 
Circuit in The Limited.

                             EFFECTIVE DATE

    This provision is effective on the date of enactment.

8. Modify rules related to certain small property and casualty 
        insurance companies (sec. 3028 of the bill and secs. 501(c)(15) 
        and 831(b) of the Code)

                              PRESENT LAW

    A property and casualty insurance company generally is 
subject to tax on its taxable income (sec. 831(a)). The taxable 
income of a property and casualty insurance company is 
determined as the sum of its underwriting income and investment 
income (as well as gains and other income items), reduced by 
allowable deductions (sec. 832).
    A property and casualty insurance company is eligible to be 
exempt from Federal income tax if its net written premiums or 
direct written premiums (whichever is greater) for the taxable 
year do not exceed $350,000 (sec. 501(c)(15)).
    A property and casualty insurance company may elect to be 
taxed only on taxable investment income if its net written 
premiums or direct written premiums (whichever is greater) for 
the taxable year exceed $350,000, but do not exceed $1.2 
million (sec. 831(b)).
    For purposes of determining the amount of a company's net 
written premiums or direct written premiums under these rules, 
premiums received by all members of a controlled group of 
corporations of which the company is a part are taken into 
account. For this purpose, a more-than-50-percent threshhold 
applies under the vote and value requirements with respect to 
stock ownership for determining a controlled group, and rules 
treating a life insurance company as part of a separate 
controlled group or as an excluded member of a group do not 
apply (secs. 501(c)(15), 831(b)(2)(B) and 1563).

                           REASONS FOR CHANGE

    The Committee has become aware of abuses in the area of 
tax-exempt insurance companies.\253\ The Committee believes 
that the use of these organizations as vehicles for sheltering 
income was never contemplated by Congress. The Committee 
believes it is necessary to limit the availability of tax-
exempt status under the provision so that it cannot be abused. 
To that end, the bill applies a gross receipts test and 
requires that premiums received for the taxable year be greater 
than 50 percent of gross receipts.
---------------------------------------------------------------------------
    \253\ See Janet Novack, Are You a Chump?, Forbes, Mar. 5, 2001; 
David Cay Johnston, Insurance Loophole Helps Rich, N.Y. Times, April 1, 
2003; David Cay Johnston, Tiny Insurers Face Scrutiny as Tax Shields, 
N.Y. Times, April 4, 2003, at C1.
---------------------------------------------------------------------------
    The bill correspondingly expands the availability of the 
present-law election of a property and casualty insurer to be 
taxed only on taxable investment income to companies with 
premiums below $350,000, and also increases the upper limit on 
premiums to $1.89 million (indexed for inflation) for purposes 
of the election. This provision of present law provides a 
relatively simple tax calculation for small property and 
casualty insurers, and because the election results in the 
taxation of taxable investment income, the Committee does not 
believe that it is abused to avoid tax on investment income. 
Thus, the bill provides that a company whose net written 
premiums (or if greater, direct written premiums) do not exceed 
the indexed $1.89 million amount (without regard to the 
$350,000 threshhold of present law), is eligible for the 
simplification benefit of this election.

                        EXPLANATION OF PROVISION

    The provision modifies the requirements for a property and 
casualty insurance company to be eligible for tax-exempt 
status, and to elect to be taxed only on taxable investment 
income.
    Under the provision, a property and casualty insurance 
company is eligible to be exempt from Federal income tax if (a) 
its gross receipts for the taxable year do not exceed $600,000, 
and (b) the premiums received for the taxable year are greater 
than 50 percent of its gross receipts. For purposes of 
determining gross receipts, the gross receipts of all members 
of a controlled group of corporations of which the company is a 
part are taken into account. The provision expands the present-
law controlled group rule so that it also takes into account 
gross receipts of foreign and tax-exempt corporations.
    A company that does not meet the definition of an insurance 
company is not eligible to be exempt from Federal income tax 
under the bill. For this purpose, the term ``insurance 
company'' means any company, more than half of the business of 
which during the taxable year is the issuing of insurance or 
annuity contracts or the reinsuring of risks underwritten by 
insurance companies (sec. 816(a) and new sec. 831(c)). A 
company whose investment activities outweigh its insurance 
activities is not considered to be an insurance company for 
this purpose.\254\ It is intended that IRS enforcement 
activities address the misuse of present-law section 
501(c)(15).
---------------------------------------------------------------------------
    \254\ See, e.g., Inter-American Life Insurance Co. v. Comm'r, 56 
T.C. 497, aff'd per curiam, 469 F.2d 697 (9th Cir. 1972).
---------------------------------------------------------------------------
    The provision also provides that a property and casualty 
insurance company may elect to be taxed only on taxable 
investment income if its net written premiums or direct written 
premiums (whichever is greater) do not exceed a specified 
amount (without regard to whether such premiums exceed 
$350,000) (sec. 831(b)). The provision increases from $1.2 
million to $1.89 million the upper limit on net (or direct) 
written premiums for purposes of such election. The $1.89 
million amount is indexed for inflation for taxable years 
beginning in calendar years after 2004. As under present law, 
for purposes of determining the amount of a company's net 
written premiums or direct written premiums under this rule, 
premiums received by all members of a controlled group of 
corporations (as defined in section 831(b)) of which the 
company is a part are taken into account.
    It is intended that regulations or other Treasury guidance 
provide for anti-abuse rules so as to prevent improper use of 
the provision, including, for example, by attempts to 
characterize as premiums any income that is other than premium 
income.

                             EFFECTIVE DATE

    The provisions are effective for taxable years beginning 
after December 31, 2003.

9. Definition of insurance company for property and casualty insurance 
        company tax rules (sec. 3029 of the bill and sec. 831(c) of the 
        Code)

                              PRESENT LAW

    Present law provides specific rules for taxation of the 
life insurance company taxable income of a life insurance 
company (sec. 801), and for taxation of the taxable income of a 
company other than a life insurance company (sec. 831) 
(generally referred to as a property and casualty insurance 
company). For Federal income tax purposes, a life insurance 
company means an insurance company that is engaged in the 
business of issuing life insurance and annuity contracts, or 
noncancellable health and accident insurance contracts, and 
that meets a 50-percent test with respect to its reserves (sec. 
816(a)). This statutory provision applicable to life insurance 
companies explicitly defines the term ``insurance company'' to 
mean any company, more than half of the business of which 
during the taxable year is the issuing of insurance or annuity 
contracts or the reinsuring of risks underwritten by insurance 
companies (sec. 816(a)).
    The life insurance company statutory definition of an 
insurance company does not explicitly apply to property and 
casualty insurance companies, although a long-standing Treasury 
regulation\255\ that is applied to property and casualty 
companies provides a somewhat similar definition of an 
``insurance company'' based on the company's ``primary and 
predominant business activity.'' \256\
---------------------------------------------------------------------------
    \255\ The Treasury regulation provides that ``the term `insurance 
company' means a company whose primary and predominant business 
activity during the taxable year is the issuing of insurance or annuity 
contracts or the reinsuring of risks underwritten by insurance 
companies. Thus, though its name, charter powers, and subjection to 
State insurance laws are significant in determining the business which 
a company is authorized and intends to carry on, it is the character of 
the business actually done in the taxable year which determines whether 
a company is taxable as an insurance company under the Internal Revenue 
Code.'' Treas. Reg. section 1.801-3(a)(1).
    \256\ Court cases involving a determination of whether a company is 
an insurance company for Federal tax purposes have examined all of the 
business and other activities of the company. In considering whether a 
company is an insurance company for such purposes, courts have 
considered, among other factors, the amount and source of income 
received by the company from its different activities. See Bowers v. 
Lawyers Mortgage Co., 285 U.S. 182 (1932); United States v. Home Title 
Insurance Co., 285 U.S. 191 (1932). See also Inter-American Life 
Insurance Co. v. Comm'r, 56 T.C. 497, aff'd per curiam, 469 F.2d 697 
(9th Cir. 1972), in which the court concluded that the company was not 
an insurance company: ``The * * * financial data clearly indicates that 
petitioner's primary and predominant source of income was from its 
investments and not from issuing insurance contracts or reinsuring 
risks underwritten by insurance companies. During each of the years in 
issue, petitioner's investment income far exceeded its premiums and the 
amounts of earned premiums were de minimis during those years. It is 
equally as clear that petitioner's primary and predominant efforts were 
not expended in issuing insurance contracts or in reinsurance. Of the 
relatively few policies directly written by petitioner, nearly all were 
issued to [family members]. Also, Investment Life, in which [family 
members] each owned a substantial stock interest, was the source of 
nearly all of the policies reinsured by petitioner. These facts, 
coupled with the fact that petitioner did not maintain an active sales 
staff soliciting or selling insurance policies * * *, indicate a lack 
of concentrated effort on petitioner's behalf toward its chartered 
purpose of engaging in the insurance business. * * * For the above 
reasons, we hold that during the years in issue, petitioner was not `an 
insurance company * * * engaged in the business of issuing life 
insurance' and hence, that petitioner was not a life insurance company 
within the meaning of section 801.'' 56 T.C. 497, 507-508.
---------------------------------------------------------------------------
    When enacting the statutory definition of an insurance 
company in 1984, Congress stated, ``[b]y requiring [that] more 
than half rather than the `primary and predominant business 
activity' be insurance activity, the bill adopts a stricter and 
more precise standard for a company to be taxed as a life 
insurance company than does the general regulatory definition 
of an insurance company applicable for both life and nonlife 
insurance companies * * * Whether more than half of the 
business activity is related to the issuing of insurance or 
annuity contracts will depend on the facts and circumstances 
and factors to be considered will include the relative 
distribution of the number of employees assigned to, the amount 
of space allocated to, and the net income derived from, the 
various business activities.'' \257\
---------------------------------------------------------------------------
    \257\ H.R. Rep. 98-432, part 2, at 1402-1403 (1984); S. Prt. No. 
98-169, vol. I, at 525-526 (1984); see also H.R. Rep. No. 98-861 at 
1043-1044 (1985) (Conference Report).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that this change will clarify the 
tax rules and improve the administration of those rules by 
conforming the definition of an insurance company for purposes 
of the property and casualty insurance rules and the life 
insurance rules. Further, the Committee expects that IRS 
enforcement activities to prevent abuse of the provision 
relating to tax-exempt insurance companies will be simplified 
and improved by this provision of the bill.

                        EXPLANATION OF PROVISION

    The bill provides that, for purposes of determining whether 
a company is a property and casualty insurance company, the 
term ``insurance company'' is defined to mean any company, more 
than half of the business of which during the taxable year is 
the issuing of insurance or annuity contracts or the reinsuring 
of risks underwritten by insurance companies. Thus, the bill 
conforms the definition of an insurance company for purposes of 
the rules taxing property and casualty insurance companies to 
the rules taxing life insurance companies, so that the 
definition is uniform. The provision adopts a stricter and more 
precise standard than the ``primary and predominant business 
activity'' test contained in Treasury Regulations. A company 
whose investment activities outweigh its insurance activities 
is not considered to be an insurance company under the 
provision.\258\ It is not intended that a company whose sole 
activity is the run-off of risks under the company's insurance 
contracts be treated as a company other than an insurance 
company, even if the company has little or no premium income.
---------------------------------------------------------------------------
    \258\ See Inter-American Life Insurance Co. v. Comm'r, supra.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31, 2003.

10. Denial of deduction for interest on underpayments attributable to 
        nondisclosed reportable transactions (sec. 3030 of the bill and 
        sec. 163 of the Code)

                              PRESENT LAW

    In general, corporations may deduct interest paid or 
accrued within a taxable year on indebtedness.\259\ Interest on 
indebtedness to the Federal government attributable to an 
underpayment of tax generally may be deducted pursuant to this 
provision.
---------------------------------------------------------------------------
    \259\ Sec. 163(a).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is inappropriate for 
corporations to deduct interest paid to the Government with 
respect to certain tax shelter transactions.

                        EXPLANATION OF PROVISION

    The provision disallows any deduction for interest paid or 
accrued within a taxable year on any portion of an underpayment 
of tax that is attributable to an understatement arising from 
an undisclosed listed transaction or from an undisclosed 
reportable transaction (other than a listed transaction) if a 
significant purpose of such transaction is the avoidance or 
evasion of Federal income tax.\260\
---------------------------------------------------------------------------
    \260\ The definitions of these transactions are the same as those 
previously described in connection with the provision elsewhere in this 
bill to modify the accuracy-related penalty for listed and certain 
reportable transactions.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision is effective for underpayments attributable 
to transactions entered into in taxable years beginning after 
the date of enactment.

11. Clarification of rules for payment of estimated tax for certain 
        deemed asset sales (sec. 3031 of the bill and sec. 338 of the 
        Code)

                              PRESENT LAW

    In certain circumstances, taxpayers can make an election 
under section 338(h)(10) to treat a qualifying purchase of 80 
percent of the stock of a target corporation by a corporation 
from a corporation that is a member of an affiliated group (or 
a qualifying purchase of 80 percent of the stock of an S 
corporation by a corporation from S corporation shareholders) 
as a sale of the assets of the target corporation, rather than 
as a stock sale. The election must be made jointly by the buyer 
and seller of the stock and is due by the 15th day of the ninth 
month beginning after the month in which the acquisition date 
occurs. An agreement for the purchase and sale of stock often 
may contain an agreement of the parties to make a section 
338(h)(10) election.
    Section 338(a) also permits a unilateral election by a 
buyer corporation to treat a qualified stock purchase of a 
corporation as a deemed asset acquisition, whether or not the 
seller of the stock is a corporation (or an S corporation is 
the target). In such a case, the seller or sellers recognize 
gain or loss on the stock sale (including any estimated taxes 
with respect to the stock sale), and the target corporation 
recognizes gain or loss on the deemed asset sale.
    Section 338(h)(13) provides that, for purposes of section 
6655 (relating to additions to tax for failure by a corporation 
to pay estimated income tax), tax attributable to a deemed 
asset sale under section 338(a)(1) shall not be taken into 
account.

                           REASONS FOR CHANGE

    The Committee is concerned that some taxpayers may 
inappropriately be taking the position that estimated tax and 
the penalty (computed in the amount of an interest charge) 
under section 6655 applies neither to the stock sale nor to the 
asset sale in the case of a section 338(h)(10) election. The 
Committee believes that estimated tax should not be avoided 
merely because an election may be made under section 
338(h)(10). Furthermore, the Committee understands that parties 
typically negotiate a sale with an understanding as to whether 
or not an election under section 338(h)(10) will be made. In 
the event there is a contingency in this regard, the parties 
would typically provide for adjustments to the price to reflect 
the effect of the election.

                        EXPLANATION OF PROVISION

    The bill clarifies section 338(h)(13) to provide that the 
exception for estimated tax purposes with respect to tax 
attributable to a deemed asset sale does not apply with respect 
to a qualified stock purchase for which an election is made 
under section 338(h)(10).
    Under the bill if a transaction eligible for the election 
under section 338(h)(10) occurs, estimated tax would be 
determined based on the stock sale unless and until there is an 
agreement of the parties to make a section 338(h)(10) election.
    If at the time of the sale there is an agreement of the 
parties to make a section 338(h)(10) election, then estimated 
tax is computed based on an asset sale, computed from the date 
of the sale.
    If the agreement to make a section 338(h)(10) election is 
concluded after the stock sale, such that the original 
computation was based on a stock sale, estimated tax is 
recomputed based on the asset sale election.
    No inference is intended as to present law.

                             EFFECTIVE DATE

    The bill is effective for qualified stock purchase 
transactions that occur after the date of enactment.

12. Exclusion of like-kind exchange property from nonrecognition 
        treatment on the sale or exchange of a principal residence 
        (sec. 3032 of the bill and sec. 121 of the Code)

                              PRESENT LAW

    Under present law, a taxpayer may exclude up to $250,000 
($500,000 if married filing a joint return) of gain realized on 
the sale or exchange of a principal residence.\261\ To be 
eligible for the exclusion, the taxpayer must have owned and 
used the residence as a principal residence for at least two of 
the five years prior to the sale or exchange. A taxpayer who 
fails to meet these requirements by reason of a change of place 
of employment, health, or, to the extent provided under 
regulations, unforeseen circumstances is able to exclude an 
amount equal to the fraction of the $250,000 ($500,000 if 
married filing a joint return) that is equal to the fraction of 
the two years that the ownership and use requirements are met. 
There are no special rules relating to the sale or exchange of 
a principal residence that was acquired in a like-kind exchange 
within the prior five years.
---------------------------------------------------------------------------
    \261\ Sec. 121.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the present-law exclusion of 
gain allowable upon the sale or exchange of principal 
residences serves an important role in encouraging home 
ownership. The Committee does not believe that this exclusion 
is appropriate for properties that were recently acquired in 
like-kind exchanges. Under the like-kind exchange rules, a 
taxpayer that exchanges property that was held for productive 
use or investment for like-kind property may acquire the 
replacement property on a tax-free basis. Because the 
replacement property generally has a low carry-over tax basis, 
the taxpayer will have taxable gain upon the sale or exchange 
of the replacement property. However, when the taxpayer 
converts the replacement property into the taxpayer's principal 
residence, the taxpayer may shelter some or all of this gain 
from income taxation. The Committee believes that this proposal 
balances the concerns associated with these provisions to 
reduce this tax shelter concern without unduly limiting the 
exclusion on sales or exchanges of principal residences.

                        EXPLANATION OF PROVISION

    The bill provides that the exclusion for gain on the sale 
or exchange of a principal residence does not apply if the 
principal residence was acquired in a like-kind exchange in 
which any gain was not recognized within the prior five years.

                             EFFECTIVE DATE

    The provision is effective for sales or exchanges of 
principal residences after the date of enactment.

13. Prevention of mismatching of interest and original issue discount 
        deductions and income inclusions in transactions with related 
        foreign persons (sec. 3033 of the bill and secs. 163 and 267 of 
        the Code)

                              PRESENT LAW

    Income earned by a foreign corporation from its foreign 
operations generally is subject to U.S. tax only when such 
income is distributed to any U.S. person that holds stock in 
such corporation. Accordingly, a U.S. person that conducts 
foreign operations through a foreign corporation generally is 
subject to U.S. tax on the income from such operations when the 
income is repatriated to the United States through a dividend 
distribution to the U.S. person. The income is reported on the 
U.S. person's tax return for the year the distribution is 
received, and the United States imposes tax on such income at 
that time. However, certain anti-deferral regimes may cause the 
U.S. person to be taxed on a current basis in the United States 
with respect to certain categories of passive or highly mobile 
income earned by the foreign corporations in which the U.S. 
person holds stock. The main anti-deferral regimes are the 
controlled foreign corporation rules of subpart F (sections 
951-964), the passive foreign investment company rules 
(sections 1291-1298), and the foreign personal holding company 
rules (sections 551-558).
    As a general rule, there is allowed as a deduction all 
interest paid or accrued within the taxable year with respect 
to indebtedness, including the aggregate daily portions of 
original issue discount (``OID'') of the issuer for the days 
during such taxable year.\262\ However, if a debt instrument is 
held by a related foreign person, any portion of such OID is 
not allowable as a deduction to the payor of such instrument 
until paid (``related-foreign-person rule''). This related-
foreign-person rule does not apply to the extent that the OID 
is effectively connected with the conduct by such foreign 
related person of a trade or business within the United States 
(unless such OID is exempt from taxation or is subject to a 
reduced rate of taxation under a treaty obligation).\263\ 
Treasury regulations further modify the related-foreign-person 
rule by providing that in the case of a debt owed to a foreign 
personal holding company (``FPHC''), controlled foreign 
corporation (``CFC'') or passive foreign investment company 
(``PFIC''), a deduction is allowed for OID as of the day on 
which the amount is includible in the income of the FPHC, CFC 
or PFIC, respectively.\264\
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    \262\ Section 163(e)(1).
    \263\ Section 163(e)(3).
    \264\ Treas. Reg. sec. 1.163-12(b)(3). In the case of a PFIC, the 
regulations further require that the person owing the amount at issue 
has in effect a qualified electing fund election pursuant to section 
1295 with respect to the PFIC.
---------------------------------------------------------------------------
    In the case of unpaid stated interest and expenses of 
related persons, where, by reason of a payee's method of 
accounting, an amount is not includible in the payee's gross 
income until it is paid but the unpaid amounts are deductible 
currently by the payor, the amount generally is allowable as a 
deduction when such amount is includible in the gross income of 
the payee.\265\ With respect to stated interest and other 
expenses owed to related foreign corporations, Treasury 
regulations provide a general rule that requires a taxpayer to 
use the cash method of accounting with respect to the deduction 
of amounts owed to such related foreign persons (with an 
exception for income of a related foreign person that is 
effectively connected with the conduct of a U.S. trade or 
business and that is not exempt from taxation or subject to a 
reduced rate of taxation under a treaty obligation).\266\ As in 
the case of OID, the Treasury regulations additionally provide 
that in the case of stated interest owed to a FPHC, CFC, or 
PFIC, a deduction is allowed as of the day on which the amount 
is includible in the income of the FPHC, CFC or PFIC.\267\
---------------------------------------------------------------------------
    \265\ Section 267(a)(2).
    \266\ Treas. Reg. sec. 1.267(a)-3(b)(1), (c).
    \267\ Treas. Reg. sec. 1.267(a)-3(c)(4).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The special rules in the Treasury regulations for FPHCs, 
CFCs and PFICs are an exception to the general rule that OID 
and unpaid interest owed to a related foreign person are 
deductible when paid (i.e., under a cash method). These special 
rules were deemed appropriate in the case of FPHCs, CFCs and 
PFICs because it was thought that there would be little 
material distortion in matching of income and deductions with 
respect to amounts owed to a related foreign corporation that 
is required to determine its taxable income and earnings and 
profits for U.S. tax purposes pursuant to the FPHC, subpart F 
or PFIC provisions. The Committee believes that this premise 
fails to take into account the situation where amounts owed to 
the related foreign corporation are included in the income of 
the related foreign corporation but are not currently included 
in the income of the related foreign corporation's U.S. 
shareholder. Consequently, under the Treasury regulations, both 
the U.S. payors and U.S.-owned foreign payors may be able to 
accrue deductions for amounts owed to related FPHCs, CFCs or 
PFICs without the U.S. owners of such related entities taking 
into account for U.S. tax purposes a corresponding amount of 
income. These deductions can be used to reduce U.S. income or, 
in the case of a U.S.-owned foreign payor, to reduce earnings 
and profits which could reduce a CFC's income that would be 
currently taxable to its U.S. shareholders under subpart F.

                        EXPLANATION OF PROVISION

    The provision provides that deductions for amounts accrued 
but unpaid (whether by U.S. or foreign persons) to related 
FPHCs, CFCs, or PFICs are allowable only to the extent that the 
amounts accrued by the payor are, for U.S. tax purposes, 
currently included in the income of all of the direct or 
indirect U.S. owners of the related foreign person under the 
relevant inclusion rules. Deductions that have accrued but are 
not allowable under this proposal are allowed when the amounts 
are paid. The provision grants the Secretary regulatory 
authority to provide exceptions to these rules, including an 
exception for amounts accrued where payment of the amount 
accrued occurs within a short period after accrual, and the 
transaction giving rise to the payment is entered into by the 
payor in the ordinary course of a business in which the payor 
is predominantly engaged.

                             EFFECTIVE DATE

    The provision is effective for payments accrued on or after 
date of enactment.

14. Exclusion from gross income for interest on overpayments of income 
        tax by individuals (sec. 3034 of the bill and new sec. 139A of 
        the Code)

                              PRESENT LAW

Overpayment interest

    Interest is included in the list of items that are required 
to be included in gross income (sec. 61(a)(4)). Interest on 
overpayments of Federal income tax is required to be included 
in taxable income in the same manner as any other interest that 
is received by the taxpayer.
    Cash basis taxpayers are required to report overpayment 
interest as income in the period the interest is received. 
Accrual basis taxpayers are required to report overpayment 
interest as income when all events fixing the right to the 
receipt of the overpayment interest have occurred and the 
amount can be estimated with reasonable accuracy. Generally, 
this occurs on the date the appropriate IRS official signs the 
pertinent schedule of overassessments.

Underpayment interest

    A corporate taxpayer is allowed to currently take into 
account interest paid on underpayments of Federal income tax as 
an ordinary and necessary business expense. Typically, this 
results in a current deduction. However, the deduction may be 
deferred if the interest is required to be capitalized or may 
be disallowed if and to the extent it is determined to be a 
cost of earning tax exempt income under section 265.
    Section 163(h) of the Code prohibits the deduction of 
personal interest by taxpayers other than corporations. 
Noncorporate taxpayers, including individuals, generally are 
not allowed to deduct interest on the underpayment of Federal 
income taxes.
    Temporary regulations provide that personal interest 
includes interest paid on underpayments of individual Federal, 
State or local income taxes, regardless of the source of the 
income generating the tax liability. This is consistent with 
the statement in the General Explanation of the Tax Reform Act 
of 1986 that ``(p)ersonal interest also includes interest on 
underpayments of individual Federal, State, or local income 
taxes notwithstanding that all or a portion of the income may 
have arisen in a trade or business, because such taxes are not 
considered derived from conduct of a trade or business.'' The 
validity of the temporary regulation has been upheld in those 
Circuits that have considered the issue, including the Fourth, 
Sixth, Eighth, and Ninth Circuits.
    Personal interest also includes interest that is paid by a 
trust, S corporation, or other pass-through entity on 
underpayments of State or local income taxes. Personal interest 
does not include interest that is paid with respect to sales, 
excise or similar taxes that are incurred in connection with a 
trade or business or an investment activity.

                           REASONS FOR CHANGE

    The Committee believes that there should be consistency in 
the treatment of interest paid by the Federal government to an 
individual taxpayer and interest paid by an individual taxpayer 
to the Federal government. Allowing individual taxpayers to 
exclude interest on overpayments will treat all individual 
taxpayers consistently, whether or not they itemize deductions.

                        EXPLANATION OF PROVISION

    The provision excludes overpayment interest that is paid to 
individual taxpayers on overpayments of Federal income tax from 
gross income. Interest excluded under the provision is not 
considered disqualified income that could limit the earned 
income credit. Interest excluded under the provision also is 
not considered in determining what portion of a taxpayer's 
Social Security or tier 1 railroad retirement benefits are 
subject to tax (sec. 86), whether a taxpayer has sufficient 
taxable income to be required to file a return (sec. 6012(d)), 
or for any other computation in which interest exempt from tax 
is otherwise required to be added to adjusted gross income.
    The exclusion from income of overpayment interest does not 
apply if the Secretary determines that the taxpayer's principal 
purpose for overpaying his or her tax is to take advantage of 
the exclusion.
    For example, a taxpayer prepares his return without taking 
into account significant itemized deductions of which he is, or 
should be, aware. Before the expiration of the statute of 
limitations, the taxpayer files an amended return claiming 
these itemized deductions and requesting a refund with 
interest. Unless the taxpayer can establish a principal purpose 
for originally overpaying the tax other than collecting 
excludible interest, the Secretary may determine that the 
principal purpose of waiting to claim the deductions on an 
amended return was to earn interest that would be excluded from 
income. In that case, the interest on the overpayment could not 
be excluded from income.
    It is expected that the Secretary will indicate whether the 
interest is eligible to be excluded from income on the Form 
1099 it provides that taxpayer for taxable year in which the 
underpayment interest is paid.

                             EFFECTIVE DATE

    The provision is effective for interest received in 
calendar years beginning after the date of enactment.

15. Deposits made to suspend the running of interest on potential 
        underpayments (sec. 3035 of the bill and new sec. 6603 of the 
        Code)

                              PRESENT LAW

    Generally, interest on underpayments and overpayments 
continues to accrue during the period that a taxpayer and the 
IRS dispute a liability. The accrual of interest on an 
underpayment is suspended if the IRS fails to notify an 
individual taxpayer in a timely manner, but interest will begin 
to accrue once the taxpayer is properly notified. No similar 
suspension is available for other taxpayers.
    A taxpayer that wants to limit its exposure to underpayment 
interest has a limited number of options. The taxpayer can 
continue to dispute the amount owed and risk paying a 
significant amount of interest. If the taxpayer continues to 
dispute the amount and ultimately loses, the taxpayer will be 
required to pay interest on the underpayment from the original 
due date of the return until the date of payment.
    In order to avoid the accrual of underpayment interest, the 
taxpayer may choose to pay the disputed amount and immediately 
file a claim for refund. Payment of the disputed amount will 
prevent further interest from accruing if the taxpayer loses 
(since there is no longer any underpayment) and the taxpayer 
will earn interest on the resultant overpayment if the taxpayer 
wins. However, the taxpayer will generally lose access to the 
Tax Court if it follows this alternative. Amounts paid 
generally cannot be recovered by the taxpayer on demand, but 
must await final determination of the taxpayer's liability. 
Even if an overpayment is ultimately determined, overpaid 
amounts may not be refunded if they are eligible to be offset 
against other liabilities of the taxpayer.
    The taxpayer may also make a deposit in the nature of a 
cash bond. The procedures for making a deposit in the nature of 
a cash bond are provided in Rev. Proc. 84-58.
    A deposit in the nature of a cash bond will stop the 
running of interest on an amount of underpayment equal to the 
deposit, but the deposit does not itself earn interest. A 
deposit in the nature of a cash bond is not a payment of tax 
and is not subject to a claim for credit or refund. A deposit 
in the nature of a cash bond may be made for all or part of the 
disputed liability and generally may be recovered by the 
taxpayer prior to a final determination. However, a deposit in 
the nature of a cash bond need not be refunded to the extent 
the Secretary determines that the assessment or collection of 
the tax determined would be in jeopardy, or that the deposit 
should be applied against another liability of the taxpayer in 
the same manner as an overpayment of tax. If the taxpayer 
recovers the deposit prior to final determination and a 
deficiency is later determined, the taxpayer will not receive 
credit for the period in which the funds were held as a 
deposit. The taxable year to which the deposit in the nature of 
a cash bond relates must be designated, but the taxpayer may 
request that the deposit be applied to a different year under 
certain circumstances.

                           REASONS FOR CHANGE

    The Committee believes that an improved deposit system that 
allows for the payment of interest on amounts that are not 
ultimately needed to offset tax liability when the taxpayer's 
position is upheld, as well as allowing for the offset of tax 
liability when the taxpayer's position fails, will provide an 
effective way for taxpayers to manage their exposure to 
underpayment interest. However, the Committee believes that 
such an improved deposit system should be reserved for the 
issues that are known to both parties, either through IRS 
examination or voluntary taxpayer disclosure.

                        EXPLANATION OF PROVISION

In general

    The provision allows a taxpayer to deposit cash with the 
IRS that may subsequently be used to pay an underpayment of 
income, gift, estate, generation-skipping, or certain excise 
taxes. Interest will not be charged on the portion of the 
underpayment that is deposited for the period that the amount 
is on deposit. Generally, deposited amounts that have not been 
used to pay a tax may be withdrawn at any time if the taxpayer 
so requests in writing. The withdrawn amounts will earn 
interest at the applicable Federal rate to the extent they are 
attributable to a disputable tax.
    The Secretary may issue rules relating to the making, use, 
and return of the deposits.

Use of a deposit to offset underpayments of tax

    Any amount on deposit may be used to pay an underpayment of 
tax that is ultimately assessed. If an underpayment is paid in 
this manner, the taxpayer will not be charged underpayment 
interest on the portion of the underpayment that is so paid for 
the period the funds were on deposit.
    For example, assume a calendar year individual taxpayer 
deposits $20,000 on May 15, 2005, with respect to a disputable 
item on its 2004 income tax return. On April 15, 2007, an 
examination of the taxpayer's year 2004 income tax return is 
completed, and the taxpayer and the IRS agree that the taxable 
year 2004 taxes were underpaid by $25,000. The $20,000 on 
deposit is used to pay $20,000 of the underpayment, and the 
taxpayer also pays the remaining $5,000. In this case, the 
taxpayer will owe underpayment interest from April 15, 2005 
(the original due date of the return) to the date of payment 
(April 15, 2007) only with respect to the $5,000 of the 
underpayment that is not paid by the deposit. The taxpayer will 
owe underpayment interest on the remaining $20,000 of the 
underpayment only from April 15, 2005, to May 15, 2005, the 
date the $20,000 was deposited.

Withdrawal of amounts

    A taxpayer may request the withdrawal of any amount of 
deposit at any time. The Secretary must comply with the 
withdrawal request unless the amount has already been used to 
pay tax or the Secretary properly determines that collection of 
tax is in jeopardy. Interest will be paid on deposited amounts 
that are withdrawn at a rate equal to the short-term applicable 
Federal rate for the period from the date of deposit to a date 
not more than 30 days preceding the date of the check paying 
the withdrawal. Interest is not payable to the extent the 
deposit was not attributable to a disputable tax.
    For example, assume a calendar year individual taxpayer 
receives a 30-day letter showing a deficiency of $20,000 for 
taxable year 2004 and deposits $20,000 on May 15, 2006. On 
April 15, 2007, an administrative appeal is completed, and the 
taxpayer and the IRS agree that the 2004 taxes were underpaid 
by $15,000. $15,000 of the deposit is used to pay the 
underpayment. In this case, the taxpayer will owe underpayment 
interest from April 15, 2005 (the original due date of the 
return) to May 15, 2006, the date the $20,000 was deposited. 
Simultaneously with the use of the $15,000 to offset the 
underpayment, the taxpayer requests the return of the remaining 
amount of the deposit (after reduction for the underpayment 
interest owed by the taxpayer from April 15, 2005, to May 15, 
2006). This amount must be returned to the taxpayer with 
interest determined at the short-term applicable Federal rate 
from the May 15, 2006, to a date not more than 30 days 
preceding the date of the check repaying the deposit to the 
taxpayer.

Limitation on amounts for which interest may be allowed

    Interest on a deposit that is returned to a taxpayer shall 
be allowed for any period only to the extent attributable to a 
disputable item for that period. A disputable item is any item 
for which the taxpayer (1) has a reasonable basis for the 
treatment used on its return and (2) reasonably believes that 
the Secretary also has a reasonable basis for disallowing the 
taxpayer's treatment of such item.
    All items included in a 30-day letter to a taxpayer are 
deemed disputable for this purpose. Thus, once a 30-day letter 
has been issued, the disputable amount cannot be less than the 
amount of the deficiency shown in the 30-day letter. A 30-day 
letter is the first letter of proposed deficiency that allows 
the taxpayer an opportunity for administrative review in the 
Internal Revenue Service Office of Appeals.

Deposits are not payments of tax

    A deposit is not a payment of tax prior to the time the 
deposited amount is used to pay a tax. Thus, the interest 
received on withdrawn deposits will not be eligible for the 
proposed exclusion from income of an individual. Similarly, 
withdrawal of a deposit will not establish a period for which 
interest was allowable at the short-term applicable Federal 
rate for the purpose of establishing a net zero interest rate 
on a similar amount of underpayment for the same period.

                             EFFECTIVE DATE

    The provision applies to deposits made after the date of 
enactment. Amounts already on deposit as of the date of 
enactment are treated as deposited (for purposes of applying 
this provision) on the date the taxpayer identifies the amount 
as a deposit made pursuant to this provision.

16. Authorize IRS to enter into installment agreements that provide for 
        partial payment (sec. 3036 of the bill and sec. 6159 of the 
        Code)

                              PRESENT LAW

    The Code authorizes the IRS to enter into written 
agreements with any taxpayer under which the taxpayer is 
allowed to pay taxes owed, as well as interest and penalties, 
in installment payments if the IRS determines that doing so 
will facilitate collection of the amounts owed (sec. 6159). An 
installment agreement does not reduce the amount of taxes, 
interest, or penalties owed. Generally, during the period 
installment payments are being made, other IRS enforcement 
actions (such as levies or seizures) with respect to the taxes 
included in that agreement are held in abeyance.
    Prior to 1998, the IRS administratively entered into 
installment agreements that provided for partial payment 
(rather than full payment) of the total amount owed over the 
period of the agreement. In that year, the IRS Chief Counsel 
issued a memorandum concluding that partial payment installment 
agreements were not permitted.

                           REASONS FOR CHANGE

    The Committee believes that clarifying that the IRS is 
authorized to enter into installment agreements with taxpayers 
which do not provide for full payment of the taxpayer's 
liability over the life of the agreement will improve effective 
tax administration.
    The Committee recognizes that some taxpayers are unable to 
enter into a realistic offer in compromise. The Committee 
believes that these taxpayers should be encouraged to make 
partial payments toward resolving their tax liability, and that 
providing for partial payment installment agreements will help 
facilitate this. The Committee also believes, however, that the 
offer in compromise program should remain the sole avenue via 
which taxpayers fully resolve their tax liabilities and attain 
a fresh start.

                        EXPLANATION OF PROVISION

    The provision clarifies that the IRS is authorized to enter 
into installment agreements with taxpayers which do not provide 
for full payment of the taxpayer's liability over the life of 
the agreement. The provision also requires the IRS to review 
partial payment installment agreements at least every two 
years. The primary purpose of this review is to determine 
whether the financial condition of the taxpayer has 
significantly changed so as to warrant an increase in the value 
of the payments being made.

                             EFFECTIVE DATE

    The provision is effective for installment agreements 
entered into on or after the date of enactment.

17. Extension of IRS user fees (sec. 3037 of the bill and sec. 7528 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.\268\ Public Law 108-89 \269\ 
extended the statutory authorization for these user fees 
through December 31, 2004, and moved the statutory 
authorization for these fees into the Code.\270\
---------------------------------------------------------------------------
    \268\ These user fees were originally enacted in section 10511 of 
the Revenue Act of 1987 (Pub. Law No. 100-203, December 22, 1987). 
Public Law 104-117 (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)) extended the statutory 
authorization for these user fees through September 30, 2003.
    \269\ 117 Stat. 1131; H.R. 3146, signed by the President on October 
1, 2003.
    \270\ That Public Law also moved into the Code the user fee 
provision relating to pension plans that was enacted in section 620 of 
the Economic Growth and Tax Relief Reconciliation Act of 2001 (Pub. L. 
107-16, June 7, 2001).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is appropriate to provide a 
further extension of these user fees.

                        EXPLANATION OF PROVISION

    The provision extends the statutory authorization for these 
user fees through September 30, 2013.

                             EFFECTIVE DATE

    The provision is effective for requests made after the date 
of enactment.

         TITLE IV--TRADE ENHANCEMENT AND COMPLIANCE PROVISIONS


1. Repeal of exclusion for extraterritorial income (sec. 4001 of the 
        bill and secs. 114 and 941-943 of the Code)

                              PRESENT LAW

    The United States has long provided export-related benefits 
under a series of tax regimes, including the domestic 
international sales corporation (``DISC'') regime, the foreign 
sales corporation (``FSC'') regime, and the extraterritorial 
income (``ETI'') regime. Each of these regimes has been found 
to violate U.S. obligations under international trade 
agreements. In 2000, the European Union (``EU'') succeeded in 
having the FSC regime declared a prohibited export subsidy by 
the WTO. In response to this WTO ruling, the United States 
repealed the FSC rules and enacted a new regime under the FSC 
Repeal and Extraterritorial Income Exclusion Act of 2000. The 
EU immediately challenged the ETI regime in the WTO, and in 
January of 2002 a WTO Appellate Body held that the ETI regime 
also constituted a prohibited export subsidy under the relevant 
trade agreements.
    Under the ETI regime, an exclusion from gross income 
applies with respect to ``extraterritorial income,'' which is a 
taxpayer's gross income attributable to ``foreign trading gross 
receipts.'' This income is eligible for the exclusion to the 
extent that it is ``qualifying foreign trade income.'' 
Qualifying foreign trade income is the amount of gross income 
that, if excluded, would result in a reduction of taxable 
income by the greatest of: (1) 1.2 percent of the foreign 
trading gross receipts derived by the taxpayer from the 
transaction; (2) 15 percent of the ``foreign trade income'' 
derived by the taxpayer from the transaction; \271\ or (3) 30 
percent of the ``foreign sale and leasing income'' derived by 
the taxpayer from the transaction.\272\
---------------------------------------------------------------------------
    \271\ ``Foreign trade income'' is the taxable income of the 
taxpayer (determined without regard to the exclusion of qualifying 
foreign trade income) attributable to foreign trading gross receipts.
    \272\ ``Foreign sale and leasing income'' is the amount of the 
taxpayer's foreign trade income (with respect to a transaction) that is 
properly allocable to activities that constitute foreign economic 
processes. Foreign sale and leasing income also includes foreign trade 
income derived by the taxpayer in connection with the lease or rental 
of qualifying foreign trade property for use by the lessee outside the 
United States.
---------------------------------------------------------------------------
    Foreign trading gross receipts are gross receipts derived 
from certain activities in connection with ``qualifying foreign 
trade property'' with respect to which certain economic 
processes take place outside of the United States. 
Specifically, the gross receipts must be: (1) from the sale, 
exchange, or other disposition of qualifying foreign trade 
property; (2) from the lease or rental of qualifying foreign 
trade property for use by the lessee outside the United States; 
(3) for services which are related and subsidiary to the sale, 
exchange, disposition, lease, or rental of qualifying foreign 
trade property (as described above); (4) for engineering or 
architectural services for construction projects located 
outside the United States; or (5) for the performance of 
certain managerial services for unrelated persons. A taxpayer 
may elect to treat gross receipts from a transaction as not 
foreign trading gross receipts. As a result of such an 
election, a taxpayer may use any related foreign tax credits in 
lieu of the exclusion.
    Qualifying foreign trade property generally is property 
manufactured, produced, grown, or extracted within or outside 
the United States that is held primarily for sale, lease, or 
rental in the ordinary course of a trade or business for direct 
use, consumption, or disposition outside the United States. No 
more than 50 percent of the fair market value of such property 
can be attributable to the sum of: (1) the fair market value of 
articles manufactured outside the United States; and (2) the 
direct costs of labor performed outside the United States. With 
respect to property that is manufactured outside the United 
States, certain rules are provided to ensure consistent U.S. 
tax treatment with respect to manufacturers.

                           REASONS FOR CHANGE

    The Committee believes it is important that the United 
States, and all members of the WTO, comply with WTO decisions 
and honor their obligations under WTO agreements. Therefore, 
the Committee believes that the ETI regime should be repealed. 
The Committee believes that it is necessary and appropriate to 
provide transition relief comparable to that which has been 
included in the past in measures taken by WTO members to bring 
their laws into compliance with WTO decisions and obligations.
    The Committee also believes that it is important to use the 
opportunity afforded by the repeal of the ETI regime to reform 
the U.S. tax system in a manner that makes U.S. businesses and 
workers more productive and competitive than they are today. To 
this end, the Committee believes that it is important to 
provide tax cuts to U.S. domestic manufacturers and to update 
the U.S. international tax rules, which are over 40 years old 
and make U.S. companies uncompetitive in the United States and 
abroad.

                        EXPLANATION OF PROVISION

    The bill repeals the ETI exclusion. Pursuant to transition 
rules, taxpayers retain a portion of their otherwise-applicable 
ETI benefits for transactions during a three-year transition 
period (80 percent for 2004 and 2005, and 60 percent for 2006). 
The bill also provides that the ETI exclusion provisions remain 
in effect for transactions in the ordinary course of a trade or 
business if such transactions are pursuant to a binding 
contract \273\ between the taxpayer and an unrelated person and 
such contract is in effect on January 14, 2002, and at all 
times thereafter.
---------------------------------------------------------------------------
    \273\ This rule also applies to a purchase option, renewal option, 
or replacement option that is included in such contract.
---------------------------------------------------------------------------
    In addition, foreign corporations that elected to be 
treated for all Federal tax purposes as domestic corporations 
pursuant to an election available under the ETI rules are 
allowed to revoke such elections within one year of the date of 
enactment of the bill without recognition of gain or loss, 
subject to anti-abuse rules.

                             EFFECTIVE DATE

    The provision is effective for transactions after December 
31, 2003.

2. Extension of customs user fees (sec. 4002 of the bill)

                              PRESENT LAW

    Section 13031 of the Consolidated Omnibus Budget 
Reconciliation Act of 1985 (COBRA) (P.L. 99-272), authorized 
the Secretary to collect certain service fees. Section 412 (P.L 
107-296) of the Homeland Security Act of 2002 authorized the 
Secretary to delegate such authority to the Secretary of 
Homeland Security. Provided for under 19 U.S.C. 58c, these fees 
include: processing fees for air and sea passengers, commercial 
trucks, rail cars, private aircraft and vessels, commercial 
vessels, dutiable mail packages, barges and bulk carriers, 
merchandise, and Customs broker permits. COBRA was amended on 
several occasions but most recently by P.L. 108-89, which 
extended authorization for the collection of these fees through 
March 31, 2004.

                           REASONS FOR CHANGE

    The Committee believes it is important to extend these fees 
to cover the expenses of the services provided. However, the 
Committee also believes it is important that any fee imposed be 
a true user fee. That is, the Committee believes that when the 
Congress authorizes the executive branch to assess user fees, 
those fees must be determined to reflect only the cost of 
providing the service for which the fee is assessed.

                        EXPLANATION OF PROVISION

    The bill extends the certain merchandise processing fees 
authorized under the Consolidated Omnibus Budget Reconciliation 
Act of 1985 through September 30, 2013. Certain other fees, the 
so-called ``COBRA fees'' related to overtime and premium 
services, also are extended through September 30, 2013. For 
fiscal years after September 30, 2005, the Secretary is to 
charge fees in amount that are reasonably related to the costs 
of providing customs services in connection with the activity 
or item for which the fee is charged.
    The bill also includes a Sense of the Congress that the 
fees set forth in paragraphs (1) through (8) of subsection (a) 
of section 13031 of the Consolidated Omnibus Budget 
Reconciliation Act of 1985 have been reasonably related to the 
costs of providing customs services in connection with the 
activities or items for which the fees have been charged under 
such paragraphs. The Sense of Congress also states that the 
fees collected under such paragraphs have not exceeded, in the 
aggregate, the amounts paid for the costs described in 
subsection (f)(3)(A) incurred in providing customs services in 
connection with the activities or items for which the fees were 
charged under such paragraphs.
    The bill further provides that the Secretary conduct a 
study of all the fees collected by the Department of Homeland 
Security, and shall submit to the Congress, not later than 
September 30, 2005, a report containing the recommendations of 
the Secretary on what fees should be eliminated, what the rate 
of fees retains should be, and any other recommendations with 
respect to the fees that the Secretary considers appropriate.

                             EFFECTIVE DATE

    The provisions are effective upon the date of enactment.

                      III. VOTES OF THE COMMITTEE

    In compliance with clause 3(b) of rule XIII of the Rules of 
the House of Representatives, the following statements are made 
concerning the votes of the Committee on Ways and Means in its 
consideration of the bill, H.R. 2896.

                       MOTION TO REPORT THE BILL

    The bill, H.R. 2896, as amended, was ordered favorably 
reported by a rollcall vote of 24 yeas to 15 nays (with a 
quorum being present). The vote was as follows:

----------------------------------------------------------------------------------------------------------------
        Representatives             Yea       Nay     Present    Representatives      Yea       Nay     Present
----------------------------------------------------------------------------------------------------------------
Mr. Thomas.....................        X   ........  .........  Mr. Rangel.......  ........        X   .........
Mr. Crane......................        X   ........  .........  Mr. Stark........  ........        X   .........
Mr. Shaw.......................        X   ........  .........  Mr. Matsui.......  ........  ........  .........
Mrs. Johnson...................        X   ........  .........  Mr. Levin........  ........        X   .........
Mr. Houghton...................        X   ........  .........  Mr. Cardin.......  ........        X   .........
Mr. Herger.....................        X   ........  .........  Mr. McDermott....  ........        X   .........
Mr. McCrery....................        X   ........  .........  Mr. Kleczka......  ........        X   .........
Mr. Camp.......................        X   ........  .........  Mr. Lewis (GA)...  ........        X   .........
Mr. Ramstad....................        X   ........  .........  Mr. Neal.........  ........        X   .........
Mr. Nussle.....................        X   ........  .........  Mr. McNulty......  ........        X   .........
Mr. Johnson....................        X   ........  .........  Mr. Jefferson....  ........        X   .........
Ms. Dunn.......................        X   ........  .........  Mr. Tanner.......  ........  ........  .........
Mr. Collins....................        X   ........  .........  Mr. Becerra......  ........        X   .........
Mr. Portman....................        X   ........  .........  Mr. Doggett......  ........        X   .........
Mr. English....................        X   ........  .........  Mr. Pomeroy......  ........        X   .........
Mr. Hayworth...................        X   ........  .........  Mr. Sandlin......  ........        X   .........
Mr. Weller.....................        X   ........  .........  Ms. Tubbs Jones..  ........        X   .........
Mr. Hulshof....................        X   ........  .........
Mr. McInnis....................        X   ........  .........
Mr. Lewis (KY).................        X   ........  .........
Mr. Foley......................        X   ........  .........
Mr. Brady......................        X   ........  .........
Mr. Ryan.......................        X   ........  .........
Mr. Cantor.....................        X   ........  .........
----------------------------------------------------------------------------------------------------------------

                          VOTES ON AMENDMENTS

    A rollcall vote was conducted on the following amendments 
to the Chairman's amendment in the nature of a substitute.
    An amendment by Mr. Doggett, which would codify the 
economic substance doctrine and impose penalties for 
understatements attributable to transactions lacking economic 
substance, was defeated by a rollcall vote of 14 yeas to 24 
nays. The vote was as follows:

----------------------------------------------------------------------------------------------------------------
        Representatives             Yea       Nay     Present    Representatives      Yea       Nay     Present
----------------------------------------------------------------------------------------------------------------
Mr. Thomas.....................  ........        X   .........  Mr. Rangel.......        X   ........  .........
Mr. Crane......................  ........        X   .........  Mr. Stark........        X   ........  .........
Mr. Shaw.......................  ........        X   .........  Mr. Matsui.......        X   ........  .........
Mrs. Johnson...................  ........        X   .........  Mr. Levin........        X   ........  .........
Mr. Houghton...................  ........        X   .........  Mr. Cardin.......        X   ........  .........
Mr. Herger.....................  ........        X   .........  Mr. McDermott....        X   ........  .........
Mr. McCrery....................  ........        X   .........  Mr. Kleczka......        X   ........  .........
Mr. Camp.......................  ........        X   .........  Mr. Lewis (GA)...        X   ........  .........
Mr. Ramstad....................  ........        X   .........  Mr. Neal.........        X   ........  .........
Mr. Nussle.....................  ........        X   .........  Mr. McNulty......        X   ........  .........
Mr. Johnson....................  ........        X   .........  Mr. Jefferson....        X   ........  .........
Ms. Dunn.......................  ........        X   .........  Mr. Tanner.......        X   ........  .........
Mr. Collins....................  ........        X   .........  Mr. Becerra......        X   ........  .........
Mr. Portman....................  ........        X   .........  Mr. Doggett......        X   ........  .........
Mr. English....................  ........        X   .........  Mr. Pomeroy......        X   ........  .........
Mr. Hayworth...................  ........        X   .........  Mr. Sandlin......        X   ........  .........
Mr. Weller.....................  ........        X   .........  Ms. Tubbs Jones..        X   ........  .........
Mr. Hulshof....................  ........        X   .........
Mr. McInnis....................  ........        X   .........
Mr. Lewis (KY).................  ........        X   .........
Mr. Foley......................  ........        X   .........
Mr. Brady......................  ........        X   .........
Mr. Ryan.......................  ........        X   .........
Mr. Cantor.....................  ........        X   .........
----------------------------------------------------------------------------------------------------------------

    An amendment by Mr. Doggett, which would override certain 
U.S. income tax treaties in certain circumstances, was defeated 
by a rollcall vote of 13 yeas to 24 nays. The vote was as 
follows:

----------------------------------------------------------------------------------------------------------------
        Representatives             Yea       Nay     Present    Representatives      Yea       Nay     Present
----------------------------------------------------------------------------------------------------------------
Mr. Thomas.....................        X   ........  .........  Mr. Rangel.......        X   ........  .........
Mr. Crane......................  ........        X   .........  Mr. Stark........        X   ........  .........
Mr. Shaw.......................  ........        X   .........  Mr. Matsui.......  ........  ........  .........
Mrs. Johnson...................  ........        X   .........  Mr. Levin........        X   ........  .........
Mr. Houghton...................  ........        X   .........  Mr. Cardin.......        X   ........  .........
Mr. Herger.....................        X   ........  .........  Mr. McDermott....        X   ........  .........
Mr. McCrery....................        X   ........  .........  Mr. Kleczka......        X   ........  .........
Mr. Camp.......................        X   ........  .........  Mr. Lewis (GA)...  ........  ........  .........
Mr. Ramstad....................        X   ........  .........  Mr. Neal.........        X   ........  .........
Mr. Nussle.....................        X   ........  .........  Mr. McNulty......        X   ........  .........
Mr. Johnson....................        X   ........  .........  Mr. Jefferson....        X   ........  .........
Ms. Dunn.......................        X   ........  .........  Mr. Tanner.......  ........  ........  .........
Mr. Collins....................        X   ........  .........  Mr. Becerra......        X   ........  .........
Mr. Portman....................        X   ........  .........  Mr. Doggett......        X   ........  .........
Mr. English....................        X   ........  .........  Mr. Pomeroy......  ........  ........  .........
Mr. Hayworth...................        X   ........  .........  Mr. Sandlin......        X   ........  .........
Mr. Weller.....................        X   ........  .........  Ms. Tubbs Jones..        X   ........  .........
Mr. Hulshof....................        X   ........  .........
Mr. McInnis....................        X   ........  .........
Mr. Lewis (KY).................        X   ........  .........
Mr. Foley......................        X   ........  .........
Mr. Brady......................        X   ........  .........
Mr. Ryan.......................        X   ........  .........
Mr. Cantor.....................        X   ........  .........
----------------------------------------------------------------------------------------------------------------

    A substitute amendment by Mr. Rangel was defeated by a 
rollcall vote of 13 yeas to 24 nays. The vote was as follows:

----------------------------------------------------------------------------------------------------------------
        Representatives             Yea       Nay     Present    Representatives      Yea       Nay     Present
----------------------------------------------------------------------------------------------------------------
Mr. Thomas.....................        X   ........  .........  Mr. Rangel.......        X   ........  .........
Mr. Crane......................        X   ........  .........  Mr. Stark........  ........  ........  .........
Mr. Shaw.......................        X   ........  .........  Mr. Matsui.......  ........  ........  .........
Mrs. Johnson...................        X   ........  .........  Mr. Levin........        X   ........  .........
Mr. Houghton...................        X   ........  .........  Mr. Cardin.......        X   ........  .........
Mr. Herger.....................        X   ........  .........  Mr. McDermott....        X   ........  .........
Mr. McCrery....................        X   ........  .........  Mr. Kleczka......        X   ........  .........
Mr. Camp.......................        X   ........  .........  Mr. Lewis (GA)...        X   ........  .........
Mr. Ramstad....................        X   ........  .........  Mr. Neal.........        X   ........  .........
Mr. Nussle.....................        X   ........  .........  Mr. McNulty......        X   ........  .........
Mr. Johnson....................        X   ........  .........  Mr. Jefferson....        X   ........  .........
Ms. Dunn.......................        X   ........  .........  Mr. Tanner.......  ........  ........  .........
Mr. Collins....................        X   ........  .........  Mr. Becerra......        X   ........  .........
Mr. Portman....................        X   ........  .........  Mr. Doggett......  ........  ........  .........
Mr. English....................        X   ........  .........  Mr. Pomeroy......        X   ........  .........
Mr. Hayworth...................        X   ........  .........  Mr. Sandlin......        X   ........  .........
Mr. Weller.....................        X   ........  .........  Ms. Tubbs Jones..        X   ........  .........
Mr. Hulshof....................        X   ........  .........
Mr. McInnis....................        X   ........  .........
Mr. Lewis (KY).................        X   ........  .........
Mr. Foley......................        X   ........  .........
Mr. Brady......................        X   ........  .........
Mr. Ryan.......................        X   ........  .........
Mr. Cantor.....................        X   ........  .........
----------------------------------------------------------------------------------------------------------------

                     IV. BUDGET EFECTS OF THE BILL


               A. Committee Estimate of Budgetary Effects

    In compliance with clause 3(d)(2) of the rule XIII of the 
Rules of the House of Representatives, the following statement 
is made concerning the effects on the budget of the revenue 
provisions of the bill, H.R. 2896 as reported.
    The bill is estimated to have the following effects on 
budget receipts for fiscal years 2003-2008:

            ESTIMATED BUDGET EFFECTS OF H.R. 2896, THE ``AMERICAN JOBS CREATION ACT OF 2003,'' AS REPORTED BY THE COMMITTEE ON WAYS AND MEANS
                                                    [Fiscal years 2004-2008, in millions of dollars]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                  Provision                                Effective                 2004        2005        2006        2007        2008       2004-08
--------------------------------------------------------------------------------------------------------------------------------------------------------
    Corporate Reform and Growth Incentive
                 Provisions

A. Reduction in Corporate Income Tax Rates:
    1. Corporate tax rate reductions for      tyba 12/31/03.....................      -1,378      -2,112      -3,600      -5,658      -6,253     -19,001
     manufacturing and other specified
     income, including maximum 34% rate for
     2004 through 2006, and 32% for 2007 and
     thereafter \1\..
    2. 33% corporate income tax rate applies  tyba 12/31/03.....................        -353        -627        -757      -1,030      -1,150      -3,917
     to taxable income over $75,000 and
     under $1 million in 2004 through 2006;
     32% corporate income tax rate applies
     to taxable income over $75,000 and
     under: $1 million in 2007 and 2008, $5
     million in 2009 through 2011, and $20
     million thereafter for non-
     manufacturing income \1\.
B. Two-Year Extension of Increased Expensing  tyba 12/31/05.....................  ..........  ..........      -3,833      -6,832        -899     -11,564
 for Small Business--increase section 179
 expensing from $25,000 to $100,000 and
 increase the phaseout threshold amount from
 $200,000 to $400,000; include software in
 section 179 property; and extend indexing
 of both the deduction limit and the
 phaseout threshold (sunset after 2007).
C. Recovery Period for Depreciation of
 Certain Leasehold Improvements and
 Restaurant Property:
    1. 15-year straight-line cost recovery    ppisa DOE.........................         -59        -148        -245        -276        -267        -995
     for qualified leasehold improvements
     (sunset after 2005).
    2. 15-year straight-line cost recovery    ppisa DOE.........................        -300        -174         -28         -33         -33        -568
     for qualified restaurant improvements
     (sunset after 2005).
D. Alternative Minimum Tax Relief:
    1. Repeal the 90% limitation on the use   tyba 12/31/04.....................  ..........        -236        -355        -338        -334      -1,263
     of foreign tax credits against the AMT.
    2. Phaseout 90% limitation on use of net  tyba 12/31/04.....................  ..........        -116        -175        -171        -310        -773
     operating losses (92% in 2005 through
     2007, 94% in 2008 and 2009, 96% in
     2010, 98% in 2011, and 100% in 2012 and
     thereafter).
    3. Expansion of exemption from            tyba 12/31/04.....................  ..........        -105        -136        -118        -113        -472
     alternative minimum tax for small
     corporations to $20 million.
    4. Coordinate farmer income averaging     tyba 12/31/02.....................          -2          -2          -2          -3          -4         -13
     and the alternative minimum tax.
E. S Corporation Reform and Simplification:
    1. Treat members of family as one         generally.........................          -1          -3          -4          -6          -7         -21
     shareholder (3 generations, without      tyba 12/31/03.....................
     limit) (includes interaction with line
     2 below).
    2. Increase in number of eligible         tyba 12/31/03.....................         -17         -42         -54         -64         -72        -250
     shareholders to 100.
    3. Expansion of bank S corporation        DOE...............................         -16         -33         -34         -36         -37        -156
     eligible shareholders to include IRAs.
    4. Disregard unexercised powers of        tyba 12/31/03.....................                         Negligible Revenue Effect
     appointment in determining potential
     current beneficiaries of ESBT.
    5. Use of passive activity loss by        tma 12/31/03......................          -1          -1          -1          -1          -1          -4
     subchapter S trust income beneficiaries.
    6. Transfer of suspended losses incident  tyba 12/31/03.....................          -1          -2          -2          -2          -2         -10
     to divorce.
    7. Exclusion of investment securities       ................................                         Negligible Revenue Effect
     income from passive income test for
     bank S corporations.
    8. Treatment of bank director shares....  tyba 12/31/03.....................          -4         -10         -13          14         -15         -56
    9. Relief from inadvertently invalid      tyba 12/31/03.....................          -1          -1          -1          -1          -1          -7
     qualified subchapter S subsidiary
     elections and terminations.
    10. Information retiurns for qualified    tyba 12/31/03.....................                             No Revenue Effect
     subchapter S subsidiaries.
    11. Repayment of loan for qualifying      dma 12/31/03......................       (\2\)       (\2\)       (\2\)       (\2\)       (\2\)          -2
     employer securities.
F. Employee Benefits:
    1. treatment of nonqualified deferred     (\3\).............................         137         160          91          31          15         433
     compensation plans.
    2. Exclusion of incentive stock options   saptoea DOE.......................                             No Revenue Effect
     and employee stock purchase plan stock
     options from wages.
    3. Extend provision under section 420     DOE...............................  ..........  ..........          18          38          40          97
     permitting qualified transfers of
     excess defined benefit permitting
     qualified transfers of excess defined
     pension plan assets to section 401(h)
     accounts (through 12/31/13.
G. Treatment of Active Income:
    1. Treat European Union as one country    (\4\).............................  ..........  ..........  ..........  ..........  ..........  ..........
     for certain purposes of subpart F.
    2. Look-through treatment of payments     (\5\).............................  ..........  ..........  ..........         -83        -235        -318
     between related CFCs under foreign
     personal holding company income rules.
    3. Look-through treatment for sales of    (\5\).............................  ..........  ..........  ..........         -43        -101        -144
     partnership interests.
    4. Repeal of foreign personal holding     (\5\).............................  ..........  ..........  ..........         -31         -81        -112
     company rules and foreign investment
     company rules.
    5. Treatment of pipeline transportation   (\6\).............................  ..........          -1          -7          -9         -11         -28
     income.
    6. Determination of foreign personal      teia 12/31/04.....................  ..........          -4         -10         -10         -10         -34
     holding company income with respect to
     transactions in commodities.
    7. Repeal of CFC rules on foreign base    (\6\).............................  ..........          -6         -42         -52         -64        -164
     company shipping income \7\.
    8. Modification of exceptions under       (\6\).............................                         Negligible Revenue Effect
     subpart F for active financing income.
    9. Partial exclusion for foreign-source   tyea 12/31/06.....................  ..........  ..........       (\2\)          -2         -14         -16
     royalties from certain film-related
     intangibles.
H. Reduction in Double Taxation of Corporate
 Earnings:
    1. Interest expense allocation rules....  tyba 12/31/08.....................  ..........  ..........  ..........  ..........  ..........  ..........
    2. Recharacterization of overall          isf tyba 12/31/05.................  ..........  ..........         -54        -647        -680      -1,381
     domestic loss.
    3. Reduction to 2 foreign tax credit      tyba 12/31/04.....................  ..........        -557        -749        -824        -900      -3,030
     baskets \8\.
    4. Look-through rules to apply to         tyba 12/31/02.....................        -585         -77         -51         -23          -6        -742
     dividends from noncontrolled section
     902 corporations.
    5. Attribution of stock ownership         tyba DOE..........................  ..........          -1          -3          -3          -3         -10
     through partnerships to apply in
     determining section 902 and 960 credits.
    6. Clarification of treatment of certain  aro/a 8/5/97......................         -22          -4          -5          -5          -5         -41
     transfers of intangible property.
    7. United States property not to include  (\6\).............................  ..........          -1         -12         -12         -12         -37
     certain assets acquired by dealers in
     ordinary course of trade or business.
    8. Election not to use average exchange   tyb 12/31/04......................                         Negligible Revenue Effect
     rate for foreign tax paid other than in
     functional currency.
    9. Repeal of withholding tax on           pma 12/31/04......................  ..........       (\2\)          -3          -3          -3         -11
     dividends from certain foreign
     corporations.
    10. Provide equal treatment for interest  tyba 12/31/03.....................          -1          -2          -2          -2          -2          -9
     paid by foreign partnerships and
     foreign corporations doing business in
     the U.S..
    11. Treatment of certain dividends of     (\9\).............................         -14         -38         -59         -61         -63        -235
     regulated investment companies.
    12. Interaction.........................  ..................................  ..........         217         238         263         313       1,031
I. Other Provisions:
    1. Special rules for livestock sold on    trda 12/31/02.....................  ..........         -18          -7          -4          -3         -32
     account of weather-related conditions--
     increase reinvestment period from 2 to
     4 years for involuntary conversion of
     livestock due to drought, flood, or
     other weather-related conditions.
    2. Payment of dividends on stock of       dmi tyba DOE......................       (\2\)       (\2\)          -1          -1          -1          -3
     cooperatives without reducing patronage
     dividends.
    3. Add hepatitis A to the list of         (\10\)............................           6           9           9           9           9          42
     taxable vaccines.
    4. Expand human clinical trials expenses  eia DOE...........................         -10         -16         -16         -17         -18         -77
     qualifying for the orphan drug tax
     credit.
    5. Distributions from publicly traded     tyba DOE..........................          -1          -3          -4          -5          -6         -19
     partnerships treated as qualifying
     income for regulated investment company.
    6. Real estate investment trust           tyba 12/31/00 &...................                         Negligible Revenue Effect
     modification provisions.                 tyba DOE..........................
    7. Simplification of excise tax imposed   asbmpoia 12/31/03.................          -1          -1          -1          -1          -1          -3
     on bows and arrows [11].
    8. Repeal excise tax on fishing tackle    asbmpoia 12/31/03.................          -3          -3          -3          -3          -3         -12
     boxes [11].
    9. Income tax credit for cost of          tyba 12/31/03.....................         -12         -18         -19         -19         -20         -88
     carrying tax-paid distilled spirits in
     wholesale inventories.
    10. Capital gains treatment to apply to   sota 12/31/03.....................                         Negligible Revenue Effect
     outright sales of timber by landowner.
    11. Repeal excise tax on sonar devices    asbmpoia 12/31/03.................       (\2\)       (\2\)       (\2\)       (\2\)       (\2\)          -2
     suitable for finding fish [11].
    12. Taxation of certain settlement funds  tyba 12/31/03.....................          -4          -6          -6          -6          -7         -29
    13. Suspension of the occupational taxes  DOE...............................         -66         -78         -78         -12                    -234
     relating to distilled spirits, wine,
     and beer (sunset 6/30/07).
                                                                                 -----------------------------------------------------------------------
      Total of Corporate Reform and Growth    ..................................      -2,709      -4,062     -10,016     -16,120     -11,370     -44,280
       Incentive Provisions.
                                                                                 =======================================================================
 Provisions to Reduce Tax Avoidance Through
      Corporate Earnings Stripping and
                Expatriation

1. Reduction in potential for earnings        (\12\)............................          61          65         142         288         318         874
 stripping by further limiting deduction for
 interest on certain indebtedness (eliminate
 debt/equity safe harbor, use 35% generally
 for pre-2005 and 25% for post-2004 debt and
 50% for guaranteed debt, or elect 30% for
 all post-2004 debt, eliminate excess limit
 carryforward, and change excess interest
 carryforward period for net interest
 expense/ATI test to 10 years).
2. Tax treatment of expatriated entities....  tyea 3/4/03.......................          27          19          24          28          30         128
3. 15% excise tax on stock compensation of    (\13\)............................          11           7           7           7           7          38
 insiders in expatriated corporations.
4. Reinsurance of United States risks in      rra DOE...........................      (\14\)      (\14\)      (\14\)      (\14\)      (\14\)           2
 foreign jurisdictions.
5. Revision of tax rules for individuals who  iwea 2/27/03......................          19          18          21          24          28         110
 expatriate.
6. Reporting of taxable mergers and           aaDOE.............................           1           2           3           3           3          12
 acquisitions.
7. Studies..................................  DOE...............................                             No Revenue Effect
                                                                                 -----------------------------------------------------------------------
      Total of Provisions to Reduce Tax       ..................................         119         111         197         350         386       1,164
       Avoidance Through Corporate Earnings
       Stripping and Expatriation.
                                                                                 =======================================================================
   Provisions Relating to Tax Shelters and
       Miscellaneous Other Provisions:

A. Tax Shelter Provisions:
    1. Provisions relating to reportable      various dates.....................          92         115         119         120         124         570
     transactions and tax shelters.           after DOE \15\....................
    2. Modifications to the substantial       tyba DOE..........................  ..........           4          11          19          23          57
     understatement penalty for
     nonreportable transactions.
    3. Modification of actions to enjoin      da DOE............................                         Negligible Revenue Effect
     certain conduct related to tax shelters
     and reportable transactions.
    4. Impose a civil penalty (of up to       voa DOE...........................  ..........      (\14\)      (\14\)      (\14\)      (\14\)           1
     $5,000) on failure to report interest
     in foreign financial accounts.
    5. Regulation of individuals practicing   ata DOE...........................                             No Revenue Effect
     before the Department of Treasury.
B. Other Provisions:
    1. Treatment of stripped interest in      pada DOE..........................           2          13          11           8           5          39
     bond and preferred stock funds.
    2. Minimum holding period for foreign     apoamt 30da DOE...................      (\14\)           3           3           3           3          12
     tax credit on withholding tax on income
     other than dividends.
    3. Disallowance of certain partnership    ctada DOE.........................          18          39          57          70          79         264
     loss transfers.
    4. No reduction of basis under section    Da DOE............................           5          13          20          28          36         101
     734 in stock held by partnership in
     corporate partner.
    5. Repeal of special rules for FASITs...  tyba 12/31/03.....................                         Negligible Revenue Effect
    6. Limitation on transfer of built-in     ta DOE............................      (\14\)           2           4           6           8          20
     losses on REMIC residuals.
    7. Clarification of banking business for  DOE...............................  ..........           7          13          14          16          50
     purposes of determining investment of
     earnings in United States property.
    8. Modify rules related to certain small  tyba 12/31/03.....................          45          98         111         117         122         492
     property and casualty insurance
     companies--reform of section 501(c)(15)
     to apply to organizations with gross
     receipts not exceeding $600,000 and
     premiums greater than 50% of gross
     receipts; increase the net-written-
     premium threshold permitting certain
     small insurance companies to be taxed
     on investment income to $1.89 million
     and index for inflation.
    9. Modification of definition of          tyba 12/31/03.....................           1           2           2           2           2          11
     insurance companies other than life
     insurance companies.
    10. Deny deduction for interest paid to   tyba DOE..........................  ..........  ..........           1           1           3           5
     the IRS on underpayments involving
     certain tax motivated transactions.
    11. Clarification of rules for payment    toa DOE...........................          51          37          10           3           3         104
     of estimated tax for certain deemed
     asset sales.
    12. Exclusion of like-kind exchange       sopra DOE.........................      (\14\)          11          13          15          17          56
     property from nonrecognition treatment
     on the sale or exchange of a principal
     residence.
    13. Prevent mismatching of deductions     pao/a DOE.........................          12          41          84          79          33         249
     and income inclusions in transactions
     with related foreign persons.
    14. Exclusion from gross income for       iri cyba DOE......................  ..........       1,034        -103        -106        -109         716
     interests on overpayments of income tax
     by individuals.
    15. Deposits made to suspend the running  Dma DOE...........................         157          -5          -6          -6          -6         134
     of interest on potential underpayments.
    16. Authorize IRS to enter into           iaeio/a DOE.......................          48          14           5      (\16\)      (\16\)          67
     installment agreements that provide for
     partial payment.
    17. Extension of IRS user fees (through   DOE...............................  ..........          25          35          36          38         135
     9/30/13).
                                                                                 -----------------------------------------------------------------------
      Provisions Relating to Tax Shelters     ..................................         431       1,453         390         409         397       3,083
       and Miscellaneous Other Provisions.
                                                                                 =======================================================================
 Trade Enhancement and Compliance Provisions

1. Repeal of exclusion for extraterritorial   (\17\)............................         453         880       1,436       3,636       5,490      11,895
 income.
2. Extend Customs User Fees:................  ..................................  ..........  ..........  ..........  ..........  ..........  ..........
    a. Passenger and conveyance processing    DOE...............................  ..........         108         329         346         363       1,146
     fee (through 12/31/13) \18\ \19\.
    b. Merchandise processing fee (through    DOE...............................  ..........         671       1,216       1,286       1,359       4,532
     12.31.13) \18\ \19\.
                                                                                 -----------------------------------------------------------------------
      Total of Trade Enhancement and          ..................................         453       1,659       2,981       5,268       7,212      17,573
       Compliance Provisions.
                                                                                 =======================================================================
      Net Total.............................  ..................................      -1,706        -839      -6,448     -10,093      -3,375     -22,460
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Overlap between the two rate reduction proposals (items A.1. and A.2.) is reflected in A.1.
\2\ Loss of less than $500,000.
\3\ Effective for amounts in taxable years beginning after December 31, 2003, except for amounts deferred in 2004 pursuant to an irrevocable election
  made prior to October 24, 2003.
\4\ Effective for taxable years of foreign corporations beginning after December 31, 2008, and for taxable years of U.S. shareholders with or within
  which such taxable years of foreign corporations end.
\5\ Effective for taxable years of foreign corporations beginning after December 31, 2006, and for taxable years of U.S. shareholders with or within
  which such taxable years of foreign corporations end.
\6\ Effective for taxable years of foreign corporations beginning after December 31, 2004, and for taxable years of U.S. shareholders with or within
  which such taxable years of foreign corporations end.
\7\ Estimate accounts for interaction with reduction to 2 foreign tax credit baskets in item H.3.
\8\ Pre-effective date excess credits carried forward to new basket that would apply under new system.
\9\ Effective for dividends with respect to taxable years of regulated investment companies beginning after the date of enactment.
\10\ Effective for vaccines sold beginning on the first day of the first month beginning more than four weeks after the date of enactment.
\11\ Provision will have partially offsetting effects on outlays which will be provided by the Congressional Budget Office.
\12\ Effective for taxable years beginning after 2003, and taxable years ending after March 4, 2003, for ``surrogate'' corporations with lookback to
  December 31, 1996.
\13\ Generally effective March 4, 2003.
\14\ Gain of less than $1 million.
\15\ Effective dates for provisions relating to reportable transactions and tax shelters: the penalty for failure to disclose reportable transactions is
  effective for returns and statements the due date of which is after the date of enactment; the modification to the accuracy-related penalty for listed
  or reportable transactions is effective for taxable years ending after the date of enactment; the tax shelter exception to confidentiality privileges
  is effective for communications made on or after the date of enactment; the statute of limitations for unreported listed transactions applies to all
  taxable years for which the statute of limitations under section 6501 has not run as of the date of enactment; the disclosure of reportable
  transactions by material advisors is effective for transactions with respect to which material aid, assistance or advice is provided after the date of
  enactment; the investor list penalty is effective for returns the due date for which is after the date of enactment; the modification of penalty for
  failure to maintain investor lists is effective for requests made after the date of enactment; and the penalty on promoters of tax shelters is
  effective for activities after the date of enactment.
\16\ Gain of less than $500,000.
\17\ Generally effective for transactions after 2003, with transition for transactions during 2004 through 2006.
\18\ Estimate is subject to review by the Congressional Budget Office.
\19\ Estimate reflects enactment of H.R. 3365, the ``Military Family Tax Relief Act of 2003.''

Legend for ``Effective'' column: aa=acquisitions after; apoamt=amounts paid or accrued more than; aro/a=amounts received on or after; asbmpoia=articles
  sold by the manufacturer, producer, or importer after; ata=actions taken after; ctada=contributions, transfers, and distributions after; cyba=calendar
  years beginning after; da=day after; Da=distributions after; dma=distributions made after; Dma=deposits made after; DOE=date of enactment;
  dmi=distributions made in; iwea=individuals who expatriate after; eia=expenses incurred after; iaeio/a=installment agreements entered into on or
  after; iri=interest received in; Isf=losses sustained for; pa=periods after; pada=purchases and dispositions after; pao/a=payments accrued on or
  after; pma=payments made after; ppisa=property placed in service after; rra=risk reinsured after; saptoea=stock acquired pursuant to options exercised
  after; sopra=sales of principal residences after; sota=sales of timber after; ta=transactions after; teia=transactions entered into after;
  tma=transfers made after; toa=transactions occurring after; trda=tax returns due after; tyba=taxable years beginning after; tyea=taxable years ending
  after; voa=violations occurring after; and 30da=30 days after.

Note.--Details may not add to totals due to rounding.

Source: Joint Committee on Taxation.

B. Statement Regarding New Budget Authority and Tax Expenditures Budget 
                               Authority

    In compliance with clause 3(c)(2) of rule XIII of the Rules 
of the House of Representatives, the Committee states that the 
bill involves no new or increased budget authority. The 
Committee further states that the revenue reducing income tax 
provisions involve increased tax expenditures, and the revenue 
increasing provisions involve reduced tax expenditures (See 
amounts in table in Part IV.A., above.)

      C. Cost Estimate Prepared by the Congressional Budget Office

    In compliance with clause 3(c)(3) of rule XIII of the Rules 
of the House of Representatives, requiring a cost estimate 
prepared by the CBO, the following statement by CBO is 
provided.

                                     U.S. Congress,
                               Congressional Budget Office,
                                  Washington, DC, November 5, 2003.
Hon. William ``Bill'' M. Thomas,
Chairman, Committee on Ways and Means,
House of Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for H.R. 2896, the American 
Jobs Creation Act of 2003.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contact is Annabelle 
Bartsch.
            Sincerely,
                                      Elizabeth M. Robinson
                               (For Douglas Holtz-Eakin, Director).
    Enclosure.

H.R. 2896--American Jobs Creation Act of 2003

    Summary: H.R. 2896 would repeal the exclusion for 
extraterritorial income, institute a reduced tax rate on 
certain corporate income, and make numerous other changes to 
existing tax law relating to corporations. In addition, H.R. 
2896 would extend IRS and customs user fees. The tax provisions 
of the bill would generally take effect after December 31, 
2003.
    The Congressional Budget Office (CBO) and the Joint 
Committee on Taxation (JCT) estimate that enacting the bill 
would reduce federal revenues by about $1.7 billion in 2004, 
$28.2 billion over the 2004-2008 period, and $76.6 billion over 
the 2004-2013 period. CBO estimates that the bill would 
decrease direct spending by $614 million in 2004, about $7 
billion over the 2004-2008 period, and about $17.1 billion over 
the 2004-2013 period.
    JCT has determined that the following tax provisions of 
H.R. 2896 contain private-sector mandates as defined in the 
Unfunded Mandates Reform Act (UMRA): (1) the provisions to 
reduce the potential for earnings stripping by further limiting 
the deduction for interest on certain indebtedness; (2) the 
provisions relating to reportable transactions and tax 
shelters; (3) the provision relating to the modification of the 
rules for certain property and casualty insurance companies; 
and (4) the provision to repeal the exclusion for 
extraterritorial income. CBO has reviewed the non-tax 
provisions and determined that the extension of the customs 
user fees is a private-sector mandate as defined in UMRA. In 
aggregate, the costs of those mandates would greatly exceed the 
annual threshold established by UMRA for private-sector 
mandates ($120 million in 2004, adjusted annually for 
inflation) in each of the first five years the mandates are in 
effect. JCT and CBO have determined that H.R. 2896 contains no 
intergovernmental mandates as defined in UMRA.
    Estimated cost to the Federal Government: The estimated 
budgetary impact of H.R. 2896 is shown in the following table. 
The costs of the legislation fall within budget functions 300 
(natural resources and environment), 550 (health), 750 
(administration of justice), and 800 (general government).

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              By fiscal year, in millions of dollars--
                                           -------------------------------------------------------------------------------------------------------------
                                               2004       2005       2006       2007       2008       2009       2010       2011       2012       2013
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                   CHANGES IN REVENUES

Title I: Tax Provisions Relating to            -2,709     -4,062    -10,016    -16,120    -11,370     -9,931    -15,467    -17,175    -20,031    -21,841
 Corporate Tax Rates, Depreciation Rules,
 and to Other Changes.....................
Title II: Provisions to Relating to               119        111        197        350        386        429        445        466        487        508
 Corporate Earnings Stripping and
 Expatriation.............................
Title III: Provisions Relating to Tax             441      1,448        382        401        392        428        459        492        525        556
 Shelters and Other Miscellaneous
 Provisions...............................
Title IV: Trade and Compliance Provisions.        453        880      1,436      3,636      5,490      5,714      5,983      6,253      6,515      6,787
                                           -------------------------------------------------------------------------------------------------------------
      Estimated Revenues..................     -1,696     -1,623     -8,001    -11,733     -5,102     -3,360     -8,580     -9,964    -12,504    -13,990

                                                               CHANGES IN DIRECT SPENDING

Taxation of Hepatitis A Vaccine:
    Estimated Budget Authority............          5          7          7          7          7          7          7          7          7          7
    Estimated Outlays.....................          5          7          7          7          7          7          7          7          7          7
Reduction of Certain Excise Taxes:
    Estimated Budget Authority............          0         -4         -4         -4         -4         -4         -4         -5         -5         -5
    Estimated Outlays.....................          0         -1         -2         -4         -4         -4         -4         -4         -5         -5
Installment Agreements for Tax Payments:
    Estimated Budget Authority............          *          *          *          *          *          *          *          *          *          *
    Estimated Outlays.....................          *          *          *          *          *          *          *          *          *          *
Extension of Customs User Fees:
    Estimated Budget Authority............       -619     -1,464     -1,546     -1,632     -1,722     -1,818     -1,919     -2,025     -2,138     -2,257
    Estimated Outlays.....................       -619     -1,464     -1,546     -1,632     -1,722     -1,818     -1,919     -2,025     -2,138     -2,257
Total Changes in Direct Spending:
    Estimated Budget Authority............       -614     -1,461     -1,543     -1,629     -1,719     -1,815     -1,916     -2,023     -2,136     -2,255
    Estimated Outlays.....................       -614     -1,458     -1,541     -1,629     -1,719     -1,815     -1,916     -2,022     -2,136     -2,255

                                                      CHANGES IN SPENDING SUBJECT TO APPROPRIATION

Extension of IRS User Fees:
    Estimated Authorization Level.........          0          3          4          4          4          4          4          4          4
    Estimated Outlays.....................          0          3          4          4          4          4          4          4         4
--------------------------------------------------------------------------------------------------------------------------------------------------------
Notes:--Positive (negative) changes in revenues correspond to decreases (increases) in budget deficits. Positive (negative) changes in direct spending
  correspond to increases (decreases) in budget deficits.
* = increase of less than $500,000.
Sources: CBO and the Joint Committee on Taxation.

Basis of estimate

            Revenues
    With the exception of the extension of IRS user fees, JCT 
provided all the revenue estimates. All together, CBO and JCT 
estimate that the provisions contained in H.R. 2896 would 
reduce federal revenues by about $1.7 billion in 2004, $28.2 
billion over the 2004-2008 period, and $76.6 billion over the 
2004-2013 period. The largest budgetary effects would result 
from repealing the exclusion for extraterritorial income and 
instituting a reduced tax rate on certain corporate income.
    Title I of H.R. 2896 would alter numerous provisions of tax 
law for corporations. In total, JCT estimates enacting the 
provisions of title I would reduce federal revenues by about 
$2.7 billion in 2004, $44.3 billion over the 2004-2008 period, 
and $128.7 billion over the 2004-2013 period. A large portion 
of this reduction would come from lowering the tax rate on 
corporations for income from certain manufacturing and 
nonmanufacturing activities, which JCT estimates would decrease 
governmental receipts by about $1.7 billion in 2004, $22.9 
billion over the 2004-2008 period, and $77.5 billion over the 
2004-2013 period. Some of the other provisions in title I would 
extend increased expensing for small businesses for two years, 
alter depreciation rules, and modify the alternative minimum 
tax. Title I also would add Hepatitis A to the list of taxable 
vaccines, which would also affect direct spending (see ``Direct 
Spending'' section).
    The provisions of title II would increase federal revenues 
by reducing tax avoidance through corporate earnings stripping 
and expatriation. In total, JCT estimates that these provisions 
would raise governmental receipts by $119 million in 2004, 
about $1.2 billion over the 2004-2008 period, and about $3.5 
billion over the 2004-2013 period. Over half of the total 
increase would result from further limiting interest deductions 
on certain indebtedness in order to curb corporate earnings 
stripping.
    The provisions of title III also would raise federal 
revenues over the next ten years. JCT estimates that modifying 
existing tax law relating to tax shelters and reportable and 
nonreportable transactions would increase revenues by $92 
million in 2004, $628 million over the 2004-2008 period, and 
about $1.6 billion over the 2004-2013 period. Another provision 
of title III would extend IRS user fees through September 30, 
2013. Currently, the fees are set to expire on December 31, 
2004. CBO estimates this would increase revenues by $135 
million over the 2005-2008 period and $345 million over the 
2005-2013 period. In addition, the provisions include 
authorizing the IRS to enter into installment agreements for 
tax payments, which also would affect direct spending (see 
``Direct Spending'' section). In total, CBO and JCT estimate 
that title III would increase governmental receipts by $441 
million in 2004, about $3.1 billion over the 2004-2008 period, 
and about $5.5 billion over the 2004-2013 period.
    Title IV of the bill would repeal the exclusion for 
extraterritorial income, including a transition period through 
2006. JCT estimates doing so would increase federal revenues by 
about $453 million in 2004, by about $11.9 billion over the 
2004-2008 period, and by about $43.1 billion over the 2004-2013 
period.
            Direct spending
    In total, CBO estimates that the bill would decrease direct 
spending by $614 million in 2004, by about $7 billion over the 
2004-2008 period, and by about $17.1 billion over the 2004-2013 
period. In addition, CBO estimates H.R. 2896 would increase 
spending by $15 million over the 2004-2008 period and $36 
million over the 2004-2013 period, subject to the appropriation 
of the estimated amounts.
    Taxation of Hepatitis A Vaccine. The Hepatitis A vaccine 
tax provision (section 1103) would require vaccine buyers to 
pay an excise tax on each dose purchased. Medicaid is a major 
purchaser of vaccines through the Vaccines for Children 
program, administered through the Centers for Disease Control 
and Prevention (CDC). CBO assumes that Medicaid purchases 
approximately half of the Hepatitis A vaccines sold annually. 
Based on estimates provided by JCT, CBO expects that 
implementing section 1103 would cost the Medicaid program about 
$47 million over the 2004-2013 period.
    Receipts from the tax would go to the Vaccine Injury 
Compensation Fund (VICF), which is administered by the Health 
Resources and Services Administration (HRSA). The fund uses tax 
revenues to pay compensation to claimants injured by vaccines. 
Once a vaccine becomes taxable, injuries attributed to its use 
become compensable through this fund. Based on information 
provided by HRSA and CDC, we assume there will be few 
compensable claims related to the Hepatitis A vaccine. CBO 
estimates the provision would increase outlays from the VICF by 
$21 million over the 2004-2013 period.
    Reducing Certain Excise Taxes. Reducing excise taxes on 
certain hunting and fishing equipment would reduce deposits to 
the federal aid-wildlife fund and the aquatic resources trust 
fund. The loss of this income (and related interest earnings to 
the two funds) would result in lower spending for fish and 
wildlife conservation projects beginning in fiscal year 2005. 
CBO estimates that the resulting savings would be about $33 
million over the 2005-2013 period.
    Installment Agreements for Tax Payments. Section 3036 would 
allow the IRS to enter into agreements for the partial payment 
of tax liabilities. Under current law taxpayers can elect to 
pay their full tax liability through installments. The IRS 
charges a fee of $43 for each installment agreement, which it 
can retain and spend without further appropriation action. CBO 
estimates that allowing for the partial payment of tax 
liabilities would increase direct spending by about $1 million 
over the 2004-2013 period.
    Extension of Customs User Fees. Under current law, customs 
user fees expire after March 31, 2004. H.R. 2896 would extend 
these fees through September 30, 2013. CBO estimates that this 
would increase offsetting receipts by about $17.1 billion over 
the 2004-2013 period.
            Spending subject to appropriation
    Extension of IRS User Fees. Section 3037 would extend the 
authority of the IRS to charge taxpayers fees for certain 
rulings, opinion letters, and determinations through September 
30, 2013. The bill would authorize the IRS to retain and spend 
a portion of the fees collected, subject to appropriation. 
Based on the historical level of fees spent, CBO estimates that 
implementing this provision would cost $15 million over the 
2005-2008 period and $36 million over the 2005-2013 period, 
subject to the appropriation of the estimated amounts.
    Estimated impact on state, local, and tribal governments: 
JCT and CBO have reviewed the provisions of H.R. 2896 and have 
determined that the bill contains no intergovernmental mandates 
as defined in UMRA and would not affect the budgets of state, 
local, and tribal governments.
    Estimated impact on the private sector: JCT has determined 
that the following tax provisions of H.R. 2896 contain private-
sector mandates as defined in UMRA: (1) the provisions to 
reduce the potential for earnings stripping by further limiting 
the deduction for interest on certain indebtedness; (2) the 
provisions relating to reportable transactions and tax 
shelters; (3) the provision relating to the modification of the 
rules for certain property and casualty insurance companies; 
and (4) the provision to repeal the exclusion for 
extraterritorial income. In aggregate, the costs of those 
mandates would greatly exceed the annual threshold established 
by UMRA for private-sector mandates ($120 million in 2004, 
adjusted annually for inflation).
    CBO has reviewed the non-tax provisions of H.R. 2896 and 
determined that the extension of the customs user fees is a 
private-sector mandate as defined in UMRA. H.R. 2896 would 
extend through 2013 customs user fees that are scheduled to 
expire at the end of March 2004 under current law. CBO cannot 
determine the direct cost of this provision, however, because 
UMRA does not clearly specify how to calculate the cost 
associated with extending an existing mandate that has not yet 
expired. Under one interpretation, UMRA requires the direct 
cost to be measured relative to a case that assumes that the 
current mandate will not exist beyond its current expiration 
date. Under that interpretation, CBO estimates that the direct 
cost of the mandate would be more than $600 million in 2004 and 
larger in later years. Under the other interpretation, UMRA 
requires the direct cost to be measured relative to the mandate 
currently in effect. Under that interpretation, the direct cost 
of this provision would be zero.
    Estimate prepared by: Federal Revenues: Annabelle Bartsch. 
Federal Spending: Excise Taxes on Fishing and Hunting 
Equipment: Deborah Reis; Installment Agreements and IRS User 
Fees: Matthew Pickford; Hepatitis A Vaccine: Tom Bradley; and 
Customs User Fees: Mark Grabowicz. Impact on State, Local, and 
Tribal Governments: Melissa Merrell. Impact on the Private 
Sector: Patrice Gordon and Paige Piper/Bach.
    Estimate approved by: G. Thomas Woodward, Assistant 
Director for Tax Analysis and Peter H. Fontaine, Deputy 
Assistant Director for Budget Analysis.

                    D. Macroeconomic Impact Analysis

    In compliance with clause 3(h)(2) of rule XIII of the Rules 
of the House of Representatives, the following statement is 
made by the Joint Committee on Taxation with respect to the 
provisions of the bill amending the Internal Revenue Code of 
1986: the effects of the bill on total economic activity within 
the ten-year budget horizon are so small as to be incalculable 
within the context of a model of the aggregate economy.

     V. OTHER MATTERS TO BE DISCUSSED UNDER THE RULES OF THE HOUSE


          A. Committee Oversight Findings and Recommendations

    With respect to clause 3(c)(1) of rule XIII of the Rules of 
the House of Representatives (relating to oversight findings), 
the Committee advises that it was a result of the Committee's 
oversight review concerning the tax burden on American 
taxpayers that the Committee concluded that it is appropriate 
and timely to enact the revenue provisions included in the bill 
as reported.

        B. Statement of General Performance Goals and Objectives

    With respect to clause 3(c)(4) of rule XIII of the Rules of 
the House of Representatives, the Committee advises that the 
bill contains no measure that authorizes funding, so no 
statement of general performance goals and objectives for which 
any measure authorizes funding is required.

                 C. Constitutional Authority Statement

    With respect to clause 3(d)(1) of the rule XIII of the 
Rules of the House of Representatives (relating to 
Constitutional Authority), the Committee states that the 
Committee's action in reporting this bill is derived from 
Article I of the Constitution, Section 8 (``The Congress shall 
have Power To lay and collect Taxes, Duties, Imposts and 
Excises * * *''), and from the 16th Amendment to the 
Constitution.

              D. Information Relating to Unfunded Mandates

    This information is provided in accordance with section 423 
of the Unfunded Mandates Act of 1995 (P.L. 104-4).
    The Committee has determined that the bill contains four 
Federal mandates on the private sector: (1) the provision to 
reduce the potential for earnings stripping by further limiting 
the deduction for interest on certain indebtedness; (2) the 
provision relating to reportable transactions and tax shelters; 
(3) the provision relating to modification of the rules for 
certain property and casualty insurance companies; and (4) the 
provision to repeal the exclusion for extraterritorial income. 
The costs required to comply with each Federal private sector 
mandate generally are no greater than the aggregate estimated 
budget effects of the provision. Benefits from the provision 
include improved administration of the tax laws and a more 
accurate measurement of income for Federal tax purposes.
    The Committee has determined that the bill does not impose 
a Federal intergovernmental mandate on State, local, or tribal 
governments.

                E. Applicability of House Rule XXI 5(b)

    Rule XXI 5(b) of the Rules of the House of Representatives 
provides, in part, that ``A bill or joint resolution, 
amendment, or conference report carrying a Federal income tax 
rate increase may not be considered as passed or agreed to 
unless so determined by a vote of not less than three-fifths of 
the Members voting, a quorum being present.'' The Committee has 
carefully reviewed the provisions of the bill, and states that 
the provisions of the bill do not involve any Federal income 
tax rate increases within the meaning of the rule.

                       F. 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 House Committee on Ways and 
Means, the Senate Committee on Finance, or any committee of 
conference if the legislation includes a provision that 
directly or indirectly amends the Internal Revenue Code and has 
widespread applicability to individuals or small businesses.
    The staff of the Joint Committee on Taxation has determined 
that a complexity analysis is not required under section 
4022(b) of the IRS Reform Act because the bill contains no 
provisions that amend the Internal Revenue Code and that have 
``widespread applicability'' to individuals or small 
businesses.

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

  In compliance with clause 3(e) of rule XIII of the Rules of 
the House of Representatives, changes in existing law made by 
the bill, as reported, are shown as follows (existing law 
proposed to be omitted is enclosed in black brackets, new 
matter is printed in italic, existing law in which no change is 
proposed is shown in roman):

INTERNAL REVENUE CODE OF 1986

           *       *       *       *       *       *       *



Subtitle A--Income Taxes

           *       *       *       *       *       *       *


CHAPTER 1--NORMAL TAXES AND SURTAXES

           *       *       *       *       *       *       *


Subchapter A--Determination of Tax Liability

           *       *       *       *       *       *       *


PART I--TAX ON INDIVIDUALS

           *       *       *       *       *       *       *



SEC. 1. TAX IMPOSED.

  (a) * * *

           *       *       *       *       *       *       *

  (h) Maximum Capital Gains Rate.--
          (1) * * *

           *       *       *       *       *       *       *

          (11) Dividends taxed as net capital gain.--
                  (A) * * *

           *       *       *       *       *       *       *

                  (C) Qualified foreign corporations.--
                          (i) * * *

           *       *       *       *       *       *       *

                          (iii) Exclusion of dividends of 
                        certain foreign corporations.--Such 
                        term shall not include any foreign 
                        corporation which for the taxable year 
                        of the corporation in which the 
                        dividend was paid, or the preceding 
                        taxable year, is [a foreign personal 
                        holding company (as defined in section 
                        552), a foreign investment company (as 
                        defined in section 1246(b)), or] a 
                        passive foreign investment company (as 
                        defined in section 1297).

           *       *       *       *       *       *       *


PART II--TAX ON CORPORATIONS

           *       *       *       *       *       *       *



SEC. 11. TAX IMPOSED.

  (a) * * *
  (b) Amount of Tax.--
          [(1) In general.--The amount of the tax imposed by 
        subsection (a) shall be the sum of--
                  [(A) 15 percent of so much of the taxable 
                income as does not exceed $50,000,
                  [(B) 25 percent of so much of the taxable 
                income as exceeds $50,000 but does not exceed 
                $75,000,
                  [(C) 34 percent of so much of the taxable 
                income as exceeds $75,000 but does not exceed 
                $10,000,000, and
                  [(D) 35 percent of so much of the taxable 
                income as exceeds $10,000,000.
        In the case of a corporation which has taxable income 
        in excess of $100,000 for any taxable year, the amount 
        of tax determined under the preceding sentence for such 
        taxable year shall be increased by the lesser of (i) 5 
        percent of such excess, or (ii) $11,750. In the case of 
        a corporation which has taxable income in excess of 
        $15,000,000, the amount of the tax determined under the 
        foregoing provisions of this paragraph shall be 
        increased by an additional amount equal to the lesser 
        of (i) 3 percent of such excess, or (ii) $100,000.]
          (1) For taxable years beginning after 2011.--In the 
        case of taxable years beginning after 2011, the amount 
        of the tax imposed by subsection (a) shall be 
        determined in accordance with the following table:

If taxable income isThe tax is:
  Not over $50,000..15% of taxable income...............................
  Over $50,000 but n$7,500, plus 25% of the excess over $50,000.........
  Over $75,000 but n$13,750, plus 32% of the excess over $75,000........
  Over $20,000,000..$6,389,750, plus 35% of the excess over $20,000,000.
          (2) For taxable years beginning in 2009, 2010, or 
        2011.--In the case of taxable years beginning in 2009, 
        2010, or 2011, the amount of the tax imposed by 
        subsection (a) shall be determined in accordance with 
        the following table:

If taxable income isThe tax is:
  Not over $50,000..15% of taxable income...............................
  Over $50,000 but n$7,500, plus 25% of the excess over $50,000.........
  Over $75,000 but n$13,750, plus 32% of the excess over $75,000........
  Over $5,000,000 bu$1,589,750, plus 34% of the excess over $5,000,000..
  Over $10,000,000..$3,289,750, plus 35% of the excess over $10,000,000.
          (3) For taxable years beginning in 2007 or 2008.--In 
        the case of taxable years beginning in 2007 or 2008, 
        the amount of the tax imposed by subsection (a) shall 
        be determined in accordance with the following table:

If taxable income isThe tax is:
  Not over $50,000..15% of taxable income...............................
  Over $50,000 but n$7,500, plus 25% of the excess over $50,000.........
  Over $75,000 but n$13,750, plus 32% of the excess over $75,000........
  Over $1,000,000 bu$309,750, plus 34% of the excess over $1,000,000....
  Over $10,000,000..$3,369,750, plus 35% of the excess over $10,000,000.
          (4) For taxable years beginning in 2004, 2005, or 
        2006.--In the case of taxable years beginning in 2004, 
        2005, or 2006, the amount of the tax imposed by 
        subsection (a) shall be determined in accordance with 
        the following table:

If taxable income isThe tax is:
  Not over $50,000..15% of taxable income...............................
  Over $50,000 but n$7,500, plus 25% of the excess over $50,000.........
  Over $75,000 but n$13,750, plus 33% of the excess over $75,000........
  Over $1,000,000 bu$319,000, plus 34% of the excess over $1,000,000....
  Over $10,000,000..$3,379,000, plus 35% of the excess over $10,000,000.
          (5) Phaseout of lower rates for certain taxpayers.--
                  (A) General rule for years before 2012.--
                          (i) In general.--In the case of 
                        taxable years beginning before 2012 
                        with respect to a corporation which has 
                        taxable income in excess of the 
                        applicable amount for any taxable year, 
                        the amount of tax determined under 
                        paragraph (1), (2), (3) or (4) for such 
                        taxable year shall be increased by the 
                        lesser of (I) 5 percent of such excess, 
                        or (II) the maximum increase amount.
                          (ii) Maximum increase amount.--For 
                        purposes of clause (i)--


------------------------------------------------------------------------
   In the case of any taxable year                        The maximum
         beginning during:            The applicable    increase amount
                                        amount is:            is:
------------------------------------------------------------------------
2004, 2005, or 2006...............      $1,000,000          $21,000
2007 or 2008......................      $1,000,000          $30,250
2009, 2010, or 2011...............      $5,000,000         $110,250.
------------------------------------------------------------------------

                  (B) Higher income corporations.--In the case 
                of a corporation which has taxable income in 
                excess of $20,000,000 ($15,000,000 in the case 
                of taxable years beginning before 2012), the 
                amount of the tax determined under the 
                foregoing provisions of this subsection shall 
                be increased by an additional amount equal to 
                the lesser of (i) 3 percent of such excess, or 
                (ii) $610,250 ($100,000 in the case of taxable 
                years beginning before 2012).
          [(2)] (6) Certain personal service corporations not 
        eligible for graduated rates.--Notwithstanding 
        paragraph (1), the amount of the tax imposed by 
        subsection (a) on the taxable income of a qualified 
        personal service corporation (as defined in section 
        448(d)(2) shall be equal to 35 percent of the taxable 
        income.
  (c) Limitation on Tax on Qualified Production Activities 
Income.--
          (1) In general.--If a corporation has qualified 
        production activities income for any taxable year, the 
        tax imposed by this section shall not exceed the sum 
        of--
                  (A) a tax computed at the rates and in the 
                manner as if this subsection had not been 
                enacted on the taxable income reduced by the 
                amount of qualified production activities 
                income, plus
                  (B) a tax equal to 32 percent (34 percent in 
                the case of taxable years beginning before 
                January 1, 2007) of the qualified production 
                activities income (or, if less, taxable 
                income).
          (2) Qualified production activities income.--
                  (A) In general.--The term ``qualified 
                production activities income'' for any taxable 
                year means an amount equal to the excess (if 
                any) of--
                          (i) the taxpayer's domestic 
                        production gross receipts for such 
                        taxable year, over
                          (ii) the sum of--
                                  (I) the cost of goods sold 
                                that are allocable to such 
                                receipts,
                                  (II) other deductions, 
                                expenses, or losses directly 
                                allocable to such receipts, and
                                  (III) a ratable portion of 
                                other deductions, expenses, and 
                                losses that are not directly 
                                allocable to such receipts or 
                                another class of income.
                  (B) Allocation method.--The Secretary shall 
                prescribe rules for the proper allocation of 
                items of income, deduction, expense, and loss 
                for purposes of determining income attributable 
                to domestic production activities.
          (3) Domestic production gross receipts.--For purposes 
        of this subsection, the term ``domestic production 
        gross receipts'' means the gross receipts of the 
        taxpayer which are derived from--
                  (A) any lease, rental, license, sale, 
                exchange, or other disposition of--
                          (i) qualifying production property 
                        which was manufactured, produced, 
                        grown, or extracted in whole or in 
                        significant part by the taxpayer within 
                        the United States, or
                          (ii) any qualified film produced by 
                        the taxpayer, or
                  (B) construction, engineering, or 
                architectural services performed in the United 
                States for construction projects in the United 
                States.
          (4) Qualifying production property.--For purposes of 
        this subsection, the term ``qualifying production 
        property'' means--
                  (A) tangible personal property,
                  (B) any computer software, and
                  (C) any property described in section 
                168(f)(4).
          (5) Qualified film.--For purposes of this 
        subsection--
                  (A) In general.--The term ``qualified film'' 
                means any property described in section 
                168(f)(3) if not less than 50 percent of the 
                total compensation relating to the production 
                of such property is compensation for services 
                performed in the United States by actors, 
                production personnel, directors, and producers.
                  (B) Exception.--Such term does not include 
                property with respect to which records are 
                required to be maintained under section 2257 of 
                title 18, United States Code.
          (6) Related persons.--For purposes of this 
        subsection--
                  (A) In general.-- The term ``domestic 
                production gross receipts'' shall not include 
                any gross receipts of the taxpayer derived from 
                property leased, licensed, or rented by the 
                taxpayer for use by any related person.
                  (B) Related person.--For purposes of 
                subparagraph (A), a person shall be treated as 
                related to another person if such persons are 
                treated as a single employer under subsection 
                (a) or (b) of section 52 or subsection (m) or 
                (o) of section 414, except that determinations 
                under subsections (a) and (b) of section 52 
                shall be made without regard to section 
                1563(b).
  [(c)] (d) Exceptions.--Subsection (a) shall not apply to a 
corporation subject to a tax imposed by--
          (1) * * *

           *       *       *       *       *       *       *

  [(d)] (e) Foreign Corporations.--In the case of a foreign 
corporation, the taxes imposed by subsection (a) and section 55 
shall apply only as provided by section 882.

           *       *       *       *       *       *       *


PART IV--CREDITS AGAINST TAX

           *       *       *       *       *       *       *


Subpart D--Business Related Credits

           *       *       *       *       *       *       *


SEC. 38. GENERAL BUSINESS CREDIT.

  (a) * * *
  (b) Current Year Business Credit.--For purposes of this 
subpart, the amount of the current year business credit is the 
sum of the following credits determined for the taxable year:
          (1) * * *

           *       *       *       *       *       *       *

          (14) in the case of an eligible employer (as defined 
        in section 45E(c)), the small employer pension plan 
        startup cost credit determined under section 45E(a), 
        [plus]
          (15) the employer-provided child care credit 
        determined under section 45F(a)[.], plus
          (16) in the case of an eligible wholesaler (as 
        defined in section 5011(b)), the distilled spirits 
        wholesaler credit determined under section 5011(a).

           *       *       *       *       *       *       *


SEC. 39. CARRYBACK AND CARRYFORWARD OF UNUSED CREDITS.

  (a) * * *

           *       *       *       *       *       *       *

  (d) Transitional Rules.--
          (1) * * *

           *       *       *       *       *       *       *

          (11) No carryback of section 5011 credit before 
        january 1, 2004.--No portion of the unused business 
        credit for any taxable year which is attributable to 
        the credit determined under section 5011(a) may be 
        carried back to a taxable year beginning before January 
        1, 2004.

           *       *       *       *       *       *       *


SEC. 45C. CLINICAL TESTING EXPENSES FOR CERTAIN DRUGS FOR RARE DISEASES 
                    OR CONDITIONS.

  (a) * * *
  (b) Qualified Clinical Testing Expenses.--For purposes of 
this section--
          (1) * * *
          (2) Clinical testing.--
                  (A) * * *

           *       *       *       *       *       *       *

                  (C) Treatment of certain expenses incurred 
                before designation.--For purposes of 
                subparagraph (A)(ii)(I), if a drug is 
                designated under section 526 of the Federal 
                Food, Drug, and Cosmetic Act not later than the 
                due date (including extensions) for filing the 
                return of tax under this subtitle for the 
                taxable year in which the application for such 
                designation of such drug was filed, such drug 
                shall be treated as having been designated on 
                the date that such application was filed.

           *       *       *       *       *       *       *


   Subpart G--Credit Against Regular Tax for Prior Year Minimum Tax 
Liability

           *       *       *       *       *       *       *


SEC. 53. CREDIT FOR PRIOR YEAR MINIMUM TAX LIABILITY.

  (a) * * *

           *       *       *       *       *       *       *

  (d) Definitions.--For purposes of this section--
          (1) Net minimum tax.--
                  (A) * * *
                  (B) Credit not allowed for exclusion 
                preferences.--
                          (i) Adjusted net minimum tax.--The 
                        adjusted net minimum tax for any 
                        taxable year is--
                                  (I) * * *
                                  (II) the amount which would 
                                be the net minimum tax for such 
                                taxable year if the only 
                                adjustments and items of tax 
                                preference taken into account 
                                were those specified in clause 
                                (ii) [and if section 59(a)(2) 
                                did not apply].

           *       *       *       *       *       *       *


PART VI--MINIMUM TAX FOR TAX PREFERENCES

           *       *       *       *       *       *       *


SEC. 55. ALTERNATIVE MINIMUM TAX IMPOSED.

  (a)  * * *

           *       *       *       *       *       *       *

  (c) Regular tax.--
          (1)  * * *
          (2) Coordination with income averaging for farmers.--
        Solely for purposes of this section, section 1301 
        (relating to averaging of farm income) shall not apply 
        in computing the regular tax liability.
          [(2)] (3) Cross references.--
          For provisions providing that certain credits are not 
        allowable against the tax imposed by this section, see sections 
        26(a), 29(b)(6), 30(b)(3) and 38(c).

           *       *       *       *       *       *       *

  (e) Exemption for Small Corporations.--
          (1) In general.--
                  (A) [$7,500,000] $20,000,000 Gross receipts 
                test.--The tentative minimum tax of a 
                corporation shall be zero for any taxable year 
                if the corporation's average annual gross 
                receipts for all 3-taxable-year periods ending 
                before such taxable year does not exceed 
                [$7,500,000] $20,000,000. For purposes of the 
                preceding sentence, only taxable years 
                beginning after December 31, 1993, shall be 
                taken into account.
                  (B) $5,000,000 Gross receipts test for first 
                3-year period.--Subparagraph (A) shall be 
                applied by substituting ``$5,000,000'' for 
                ``[$7,500,000] $20,000,000'' for the first 3-
                taxable-year period (or portion thereof) of the 
                corporation which is taken into account under 
                subparagraph (A).

           *       *       *       *       *       *       *


SEC. 56. ADJUSTMENTS IN COMPUTING ALTERNATIVE MINIMUM TAXABLE INCOME.

  (a) * * *

           *       *       *       *       *       *       *

  (d) Alternative Tax Net Operating Loss Deduction Defined.--
          (1) In general.--For purposes of subsection (a)(4), 
        the term ``alternative tax net operating loss 
        deduction'' means the net operating loss deduction 
        allowable for the taxable year under section 172, 
        except that--
                  [(A) the amount of such deduction shall not 
                exceed the sum of--
                          [(i) the lesser of--
                                  [(I) the amount of such 
                                deduction attributable to net 
                                operating losses (other than 
                                the deduction attributable to 
                                carryovers described in clause 
                                (ii)(I)), or
                                  [(II) 90 percent of 
                                alternative minimum taxable 
                                income determined without 
                                regard to such deduction, plus
                          [(ii) the lesser of--
                                  [(I) the amount of such 
                                deduction attributable to the 
                                sum of carrybacks of net 
                                operating losses for taxable 
                                years ending during 2001 or 
                                2002 and carryforwards of net 
                                operating losses to taxable 
                                years ending during 2001 and 
                                2002, or
                                  [(II) alternative minimum 
                                taxable income determined 
                                without regard to such 
                                deduction reduced by the amount 
                                determined under clause (i), 
                                and]
                  (A) the amount of such deduction shall not 
                exceed the applicable percentage (determined 
                under paragraph (3)) of the alternative minimum 
                taxable income determined without regard to 
                such deduction, and

           *       *       *       *       *       *       *

          (3) Applicable percentage.--For purposes of paragraph 
        (1)(A)--
    For taxable years beginning                           The applicable
      in calendar year--                                 percentage is--
      2005, 2006, or 2007.....................................       92 
      2008 or 2009............................................       94 
      2010....................................................       96 
      2011....................................................       98 
100.2012 or thereafter......................................

           *       *       *       *       *       *       *

  (g) Adjustments Based on Adjusted Current Earnings.--
          (1) * * *

           *       *       *       *       *       *       *

          (6) Exception for certain corporations.--This 
        subsection shall not apply to any S corporation, 
        regulated investment company, real estate investment 
        trust, [REMIC, or FASIT] or REMIC.

           *       *       *       *       *       *       *


SEC. 59. OTHER DEFINITIONS AND SPECIAL RULES.

  (a) Alternative Minimum Tax Foreign Tax Credit.--For purposes 
of this part--
          (1) * * *
          [(2) Limitation to 90 percent of tax.--
                  [(A) In general.--The alternative minimum tax 
                foreign tax credit for any taxable year shall 
                not exceed the excess (if any) of--
                          [(i) the pre-credit tentative minimum 
                        tax for the taxable year, over
                          [(ii) 10 percent of the amount which 
                        would be the pre-credit tentative 
                        minimum tax without regard to the 
                        alternative tax net operating loss 
                        deduction and section 57(a)(2)(E).
                  [(B) Carryback and carryforward.--If the 
                alternative minimum tax foreign tax credit 
                exceeds the amount determined under 
                subparagraph (A), such excess shall, for 
                purposes of this part, be treated as an amount 
                to which section 904(c) applies.]
          [(3)] (2) Pre-credit tentative minimum tax.--For 
        purposes of this subsection, the term ``pre-credit 
        tentative minimum tax'' means--
                  (A) * * *

           *       *       *       *       *       *       *

          [(4)] (3) Election to use simplified section 904 
        limitation.--
                  (A) * * *

           *       *       *       *       *       *       *


Subchapter B--Computation of Taxable Income

           *       *       *       *       *       *       *


        PART III--ITEMS SPECIFICALLY EXCLUDED FROM GROSS INCOME

        Sec. 101. Certain death benefits.
     * * * * * * *
        [Sec. 114. Extraterritorial income.]
     * * * * * * *
        Sec. 139A. Income attributable to films used outside the United 
                  States.
        Sec. 139B. Exclusion from gross income for interest on 
                  overpayments of income tax by individuals.

           *       *       *       *       *       *       *


PART III--ITEMS SPECIALLY EXCLUDED FROM GROSS INCOME

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[SEC. 114. EXTRATERRITORIAL INCOME.

  [(a) Exclusion.--Gross income does not include 
extraterritorial income.
  [(b) Exception.--Subsection (a) shall not apply to 
extraterritorial income which is not qualifying foreign trade 
income as determined under subpart E of part III of subchapter 
N.
  [(c) Disallowance of deductions.--
          [(1) In general.--Any deduction of a taxpayer 
        allocated under paragraph (2) to extraterritorial 
        income of the taxpayer excluded from gross income under 
        subsection (a) shall not be allowed.
          [(2) Allocation.--Any deduction of the taxpayer 
        properly apportioned and allocated to the 
        extraterritorial income derived by the taxpayer from 
        any transaction shall be allocated on a proportionate 
        basis between--
                  [(A) the extraterritorial income derived from 
                such transaction which is excluded from gross 
                income under subsection (a), and
                  [(B) the extraterritorial income derived from 
                such transaction which is not so excluded.
  [(d) Denial of Credits for Certain Foreign Taxes.--
Notwithstanding any other provision of this chapter, no credit 
shall be allowed under this chapter for any income, war 
profits, and excess profits taxes paid or accrued to any 
foreign country or possession of the United States with respect 
to extraterritorial income which is excluded from gross income 
under subsection (a).
  [(e) Extraterritorial Income.--For purposes of this section, 
the term ``extraterritorial income'' means the gross income of 
the taxpayer attributable to foreign trading gross receipts (as 
defined in section 942) of the taxpayer.]

SEC. 121. EXCLUSION OF GAIN FROM SALE OF PRINCIPAL RESIDENCE.

  (a) * * *

           *       *       *       *       *       *       *

  (d) Special Rules.--
          (1) * * *

           *       *       *       *       *       *       *

          (10) Property acquired in like-kind exchange.--If a 
        taxpayer acquired property in an exchange to which 
        section 1031 applied, subsection (a) shall not apply to 
        the sale or exchange of such property if it occurs 
        during the 5-year period beginning with the date of the 
        acquisition of such property.

           *       *       *       *       *       *       *


SEC. 139A. INCOME ATTRIBUTABLE TO FILMS USED OUTSIDE THE UNITED STATES.

  (a) Exclusion.--
          (1) In general.--There shall be excluded from gross 
        income an amount equal to the applicable percentage of 
        qualified film income.
          (2) Applicable percentage.--For purposes of paragraph 
        (1), the applicable percentage shall be determined in 
        accordance with the following table:

        For taxable years ending                          The applicable
          in calendar year--                             percentage is--
          2007................................................        1 
          2008................................................        2 
          2009................................................        3 
          2010................................................        5 
          2011................................................        8 
          2012................................................        9 
          2013 or thereafter..................................       10.

  (b) Qualified Film Income.--For purposes of this section--
          (1) In general.--The term ``qualified film income'' 
        means gross income from a license of a qualified film 
        in the ordinary course of a trade or business for the 
        exploitation or direct use outside the United States 
        less any associated film costs.
          (2) Exceptions.--
                  (A) Certain uses.--Such term does not include 
                exploitation of characters, soundtracks, 
                designs, scripts, scores, or any other 
                ancillary intangibles associated with the 
                qualified film.
                  (B) Related person license.--
                          (i) In general.--Such term does not 
                        include any amount from the license of 
                        a qualified film to a related person.
                          (ii) Exception.--Clause (i) shall not 
                        apply if such film is held for license 
                        by such related person to an unrelated 
                        person for the direct use or 
                        exploitation by such unrelated person 
                        outside the United States.
                          (iii) Related person.--For purposes 
                        of this subparagraph, a person shall be 
                        related to another person if such 
                        persons are treated as a single 
                        employer under subsection (a) or (b) of 
                        section 52 or subsection (m) or (o) of 
                        section 414, except that determinations 
                        under subsections (a) and (b) of 
                        section 52 shall be made without regard 
                        to section 1563(b).
  (c) Other Definitions.--For purposes of this section--
          (1) Qualified Film.--The term ``qualified film'' 
        means property described in section 168(f)(3) the 
        original use of which commences after December 31, 
        2006, if not less than 50 percent of the total 
        compensation relating to the production of such 
        property is compensation for services performed in the 
        United States by actors, production personnel, 
        directors, and producers. Such term does not include 
        property with respect to which records are required to 
        be maintained under section 2257 of title 18, United 
        States Code.
          (2) Associated film costs.--The term ``associated 
        film costs'' means any expense properly apportioned and 
        allocated to income taken into account under subsection 
        (b)(1), determined as provided under regulations 
        prescribed by the Secretary.
  (d) Election.--The taxpayer may elect not to apply this 
section to a qualified film. Such election shall be made by the 
due date (including extensions of time) for filing the return 
for the taxable year in which such film is placed in service, 
and, once made for such film, such election shall be 
irrevocable.
  (e) Denial of Foreign Tax Credit.--
          (1) In general.--No credit shall be allowed under 
        section 901 for any taxes paid or accrued (or treated 
        as paid or accrued) with respect to the excludable 
        portion of any qualified film income. No deduction 
        shall be allowed under this chapter for any tax for 
        which credit is not allowable by reason of the 
        preceding sentence.
          (2) Excludable portion.--For purposes of paragraph 
        (1), the taxes paid or accrued (or treated as paid or 
        accrued) with respect to the excludable portion is the 
        amount which bears the same ratio to the amount of 
        taxes paid or accrued (or treated as paid or accrued) 
        with respect to qualified film income as the amount 
        excluded under subsection (a) for the taxable year 
        bears to the qualified film income for such year.

SEC. 139B. EXCLUSION FROM GROSS INCOME FOR INTEREST ON OVERPAYMENTS OF 
                    INCOME TAX BY INDIVIDUALS.

  (a) In General.--In the case of an individual, gross income 
shall not include interest paid under section 6611 on any 
overpayment of tax imposed by this subtitle.
  (b) Exception.--Subsection (a) shall not apply in the case of 
a failure to claim items resulting in the overpayment on the 
original return if the Secretary determines that the principal 
purpose of such failure is to take advantage of subsection (a).
  (c) Special Rule for Determining Modified Adjusted Gross 
Income.--For purposes of this title, interest not included in 
gross income under subsection (a) shall not be treated as 
interest which is exempt from tax for purposes of sections 
32(i)(2)(B) and 6012(d) or any computation in which interest 
exempt from tax under this title is added to adjusted gross 
income.

           *       *       *       *       *       *       *


PART VI--ITEMIZED DEDUCTIONS FOR INDIVIDUALS AND CORPORATIONS

           *       *       *       *       *       *       *


SEC. 162. TRADE OR BUSINESS EXPENSES.

  (a) * * *

           *       *       *       *       *       *       *

  (m) Certain Excessive Employee Remuneration.--
          (1) * * *

           *       *       *       *       *       *       *

          (4) Applicable employee remuneration.--For purposes 
        of this subsection--
                  (A) * * *

           *       *       *       *       *       *       *

                  (G) Coordination with excise tax on specified 
                stock compensation.--The dollar limitation 
                contained in paragraph (1) with respect to any 
                covered employee shall be reduced (but not 
                below zero) by the amount of any payment (with 
                respect to such employee) of the tax imposed by 
                section 4985 directly or indirectly by the 
                expatriated corporation (as defined in such 
                section) or by any member of the expanded 
                affiliated group (as defined in such section) 
                which includes such corporation.

           *       *       *       *       *       *       *


SEC. 163. INTEREST.

  (a) * * *

           *       *       *       *       *       *       *

  (e) Original Issue Discount.--
          (1) * * *

           *       *       *       *       *       *       *

          (3) Special rule for original issue discount on 
        obligation held by related foreign person.--
                  (A)  * * *
                  (B) Special rule for certain foreign 
                entities.--
                          (i) In general.--In the case of any 
                        debt instrument having original issue 
                        discount which is held by a related 
                        foreign person which is a foreign 
                        personal holding company (as defined in 
                        section 552), a controlled foreign 
                        corporation (as defined in section 
                        957), or a passive foreign investment 
                        company (as defined in section 1297), a 
                        deduction shall be allowable to the 
                        issuer with respect to such original 
                        issue discount for any taxable year 
                        before the taxable year in which paid 
                        only to the extent such original issue 
                        discount is included during such prior 
                        taxable year in the gross income of a 
                        United States person who owns (within 
                        the meaning of section 958(a)) stock in 
                        such corporation.
                          (ii) Secretarial authority.--The 
                        Secretary may by regulation exempt 
                        transactions from the application of 
                        clause (i), including any transaction 
                        which is entered into by a payor in the 
                        ordinary course of a trade or business 
                        in which the payor is predominantly 
                        engaged.
                  [(B)] (C) Related foreign person.--For 
                purposes of subparagraph (A), the term 
                ``related foreign person'' means any person--
                          (i) who is not a United States 
                        person, and
                          (ii) who is related (within the 
                        meaning of section 267(b)) to the 
                        issuer.

   [Note: The amendment made by section 1074(c)(34) of H.R. 2896 to 
section 163(e)(3)(B) (shown below) applies to taxable years of foreign 
corporations beginning after December 31, 2006, and to taxable years of 
 United States shareholders with or within which such taxable years of 
                       foreign corporations end.]

  (e) Original Issue Discount.--
          (1) * * *

           *       *       *       *       *       *       *

          (3) Special rule for original issue discount on 
        obligation held by related foreign person.--
                  (A)  * * *
                  (B) Special rule for certain foreign 
                entities.--
                          (i) In general.--In the case of any 
                        debt instrument having original issue 
                        discount which is held by a related 
                        foreign person which is a controlled 
                        foreign corporation (as defined in 
                        section 957) or a passive foreign 
                        investment company (as defined in 
                        section 1297), a deduction shall be 
                        allowable to the issuer with respect to 
                        such original issue discount for any 
                        taxable year before the taxable year in 
                        which paid only to the extent such 
                        original issue discount is included 
                        during such prior taxable year in the 
                        gross income of a United States person 
                        who owns (within the meaning of section 
                        958(a)) stock in such corporation.
                          (ii) Secretarial authority.--The 
                        Secretary may by regulation exempt 
                        transactions from the application of 
                        clause (i), including any transaction 
                        which is entered into by a payor in the 
                        ordinary course of a trade or business 
                        in which the payor is predominantly 
                        engaged.

           *       *       *       *       *       *       *

  (j) Limitation on Deduction for Interest on Certain 
Indebtedness.--
          [(1) Limitation.--
                  [(A) In general.--If this subsection applies 
                to any corporation for any taxable year, no 
                deduction shall be allowed under this chapter 
                for disqualified interest paid or accrued by 
                such corporation during such taxable year. The 
                amount disallowed under the preceding sentence 
                shall not exceed the corporation's excess 
                interest expense for the taxable year.
                  [(B) Disallowed amount carried to succeeding 
                taxable year.--Any amount disallowed under 
                subparagraph (A) for any taxable year shall be 
                treated as disqualified interest paid or 
                accrued in the succeeding taxable year (and 
                clause (ii) of paragraph (2)(A) shall not apply 
                for purposes of applying this subsection to the 
                amount so treated).
          [(2) Corporations to which subsection applies.--
                  [(A) In general.--This subsection shall apply 
                to any corporation for any taxable year if--
                          [(i) such corporation has excess 
                        interest expense for such taxable year, 
                        and
                          [(ii) the ratio of debt to equity of 
                        such corporation as of the close of 
                        such taxable year (or on any other day 
                        during the taxable year as the 
                        Secretary may by regulations prescribe) 
                        exceeds 1.5 to 1.
                  [(B) Excess interest expense.--
                          [(i) In general.--For purposes of 
                        this subsection, the term ``excess 
                        interest expense'' means the excess (if 
                        any) of--
                                  [(I) the corporation's net 
                                interest expense, over
                                  [(II) the sum of 50 percent 
                                of the adjusted taxable income 
                                of the corporation plus any 
                                excess limitation carryforward 
                                under clause (ii).
                          [(ii) Excess limitation 
                        carryforward.--If a corporation has an 
                        excess limitation for any taxable year, 
                        the amount of such excess limitation 
                        shall be an excess limitation 
                        carryforward to the 1st succeeding 
                        taxable year and to the 2nd and 3rd 
                        succeeding taxable years to the extent 
                        not previously taken into account under 
                        this clause. The amount of such a 
                        carryforward taken into account for any 
                        such succeeding taxable year shall not 
                        exceed the excess interest expense for 
                        such succeeding taxable year 
                        (determined without regard to the 
                        carryforward from the taxable year of 
                        such excess limitation).
                          [(iii) Excess limitation.--For 
                        purposes of clause (ii), the term 
                        ``excess limitation'' means the excess 
                        (if any) of--
                                  [(I) 50 percent of the 
                                adjusted taxable income of the 
                                corporation, over
                                  [(II) the corporation's net 
                                interest expense.
                  [(C) Ratio of debt to equity.--For purposes 
                of this paragraph, the term ``ratio of debt to 
                equity'' means the ratio which the total 
                indebtedness of the corporation bears to the 
                sum of its money and all other assets reduced 
                (but not below zero) by such total 
                indebtedness. For purposes of the preceding 
                sentence--
                          [(i) the amount taken into account 
                        with respect to any asset shall be the 
                        adjusted basis thereof for purposes of 
                        determining gain,
                          [(ii) the amount taken into account 
                        with respect to any indebtedness with 
                        original issue discount shall be its 
                        issue price plus the portion of the 
                        original issue discount previously 
                        accrued as determined under the rules 
                        of section 1272 (determined without 
                        regard to subsection (a)(7) or (b)(4) 
                        thereof), and
                          [(iii) there shall be such other 
                        adjustments as the Secretary may by 
                        regulations prescribe.]
          (1) Limitation.--
                  (A) In general.--In the case of a 
                corporation, no deduction shall be allowed 
                under this chapter for disqualified interest 
                paid or accrued during the taxable year.
                  (B) Maximum disallowance.--The amount 
                disallowed under subparagraph (A) shall not 
                exceed the sum of--
                          (i) the corporation's excess interest 
                        expense for the taxable year, and
                          (ii) the corporation's excess related 
                        party interest expense for such year.
                In no event shall the disallowance under 
                subparagraph (A) reduce the deduction for 
                interest below the sum of the amount of 
                interest includible in the gross income of the 
                taxpayer for such taxable year and an amount 
                equal to 25 percent of adjusted taxable income 
                (35 percent in the case of the first taxable 
                year beginning af