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Full text of "Summary of H.R. 3838 (Tax Reform Act of 1986) as passed by the Senate"

[JOINT COMMITTEE PRINT] 



SUMMARY OF H.R. 3838 
(TAX REFORM ACT OF 1986) 
AS PASSED BY THE SENATE 



Prepared by the Staff 

OF THE 

JOINT COMMITTEE ON TAXATION 




JULY 14, 1986 



U.S. GOVERNMENT PRINTING OFFICE 
61-685 O WASHINGTON : 1986 JCS-14-86 



For sale by the Superintendent of Documents, U.S. Government Printing Office, 
Washington, DC 20402 



CONTENTS 



Page 

Introduction 1 

Summary of the Bill 3 

Title I— Individual Income Tax Provisions 3 

A. Basic Rate Structure 3 

B. Tax Credits for Individuals 5 

C. Personal Deductions 6 

D. Exclusions From Income 6 

E. Business Meals and Entertainment; Miscellane- 

ous Expenses 7 

Title II — Accelerated Cost Recovery System and Invest- 
ment Tax Credit 9 

A. Depreciation 9 

B. Regular Investment Tax Credit 9 

C. Finance Leasing 9 

Title III — Accounting Provisions 10 

A. Limitations on the Use of the Cash Method of 

Accounting 10 

B. Utilities Using Accrual Accounting 10 

C. Installment Sales 10 

D. Capitalization of Inventory, Construction, and De- 

velopment Costs 11 

E. Special Treatment of Certain Items 11 

F. Cancellation of Indebtedness for Solvent Taxpay- 

ers 12 

G. Taxable Year of Partnerships, Corporations, and 

Personal Service Corporations 12 

Title IV — Capital Gains 13 

A. Capital Gains for Individuals 13 

B. Incentive Stock Options 13 

C. Tax Straddles 13 

(III) 



IV 

Page 

Title V — Compliance and Tax Administration 14 

A. Penalties 14 

B. Interest Provisions 14 

C. Information Reporting Provisions 15 

D. Tax Shelters 15 

E. Estimated Tax Payments by Individuals 15 

F. Tax Litigation and Tax Court 16 

G. Tax Administration Trust Fund 16 

H. Tax Administration Provisions 16 

I. Modification of Withholding Schedules 17 

J. Report on Return-Free Tax System 17 

Title VI — Corporate and General Business Taxation 18 

A. General Corporate Provisions 18 

B. Rapid Amortization Provisions 20 

C. Other Provisions 20 

Title VII — Agriculture, Energy, and Natural Resources . 21 

A. Provisions Relating to Agriculture 21 

B. Energy-Related Tax Credits and Other Incentives. 22 

C. Foreign Intangible Drilling Costs (IDCs) and 

Mining-Related Costs 23 

D. Estate and Gift Tax Deductions for Certain Con- 

servation Easement Donations 23 

Title VIII— Financial Institutions 24 

A. Reserves for Bad Debts of Thrift Institutions 24 

B. Special Rules for Net Operating Losses of Thrift 

Institutions 24 

C. Treatment of Losses on Deposits in Insolvent Fi- 

nancial Institutions 24 

Title IX — Foreign Tax Provisions 25 

A. Foreign Tax Credit 25 

B. Source Rules 25 

C. Taxation of U.S. Shareholders of Foreign Corpo- 

rations 27 

D. Special Tax Provisions of U.S. Persons 28 

E. Treatment of Foreign Taxpayers 28 

F. Foreign Currency Exchange Gain or Loss 29 

G. Tax Treatment of Possessions 29 

H. Other Provisions 29 

Title X — Insurance Products and Companies 31 

A. Insurance Policyholders 31 

B. Life Insurance Companies 31 

C. Property and Casualty Insurance Companies 32 

Title XI — Minimum Tax Provisions 34 

A. Individual Minimum Tax 34 

B. Corporate Minimum Tax 34 



V 

Page 

Title XII — Pensions and Deferred Compensation; Employ- 
ee Benefits; ESOPs 35 

A. Treatment of Tax-Favored Savings 35 

B. Nondiscrimination Requirements 38 

C. Treatment of Distributions 40 

D. Limits on Tax Deferral Under Qualified Plans 42 

E. Miscellaneous Pension and Deferred Compensa- 

tion Provisions 43 

F. Employee Benefit Provisions 44 

G. Employee Stock Ownership Plans (ESOPs) 46 

Title XIII — Research and Development 48 

A. Incremental Research Tax Credit; University 
Basic Research Credit 48 

B. Allocation of Research and Experimental Expend- 

itures 48 

C. Treatment of Computer Software Royalties for 

Certain Tax Purposes 48 

Title XIV— Tax Shelters; Real Estate; Interest Expense... 49 

A. Limitations on Losses and Credits From Passive 

Activities 49 

B. Extension of At-Risk Rules to Real Estate Activi- 

ties 49 

C. Tax Credit for Rehabilitation Expenditures 50 

D. Low-Income Housing Tax Credit 50 

E. Real Estate Investment Trusts 51 

F. Mortgage-Backed Securities 51 

G. Interest Deduction Limitation 52 

Title XV— Tax-Exempt Bonds 53 

A. Tax-Exempt Bond Provisions 53 

B. General Stock Ownership Corporations (GSOCs).... 56 

Title XVI — Unearned Income of Minor Children; Income 

Taxation of Trusts and Estates; Gift and Estate Taxes. 57 

A. Unearned Income of Minor Children 57 

B. Income Taxation of Trusts and Estates 57 

C. Gift and Estate Tax Provisions 58 

Title XVII — Miscellaneous Provisions..... 59 

A. Extension of Expiring Provisions 59 

B. Exempt Organization Provisions 59 

C. Cooperative Housing Corporations 60 

D. Budget-Related Provisions 61 

E. Other Provisions 61 

Title XVIII — Technical Corrections 63 



INTRODUCTION 

This pamphlet ^ provides a summary of the principal provisions 
of H.R. 3838 (Tax Reform Act of 1986) as amended and passed by 
the Senate on June 24, 1986. 

The pamphlet provides a title-by-title summary of the principal 
provisions of the bill,^ including effective dates. The summary does 
not make reference to special transitional rules. 



■ This pamphlet may be cited as follows: Joint Committee on Taxation, Summary of H.R 
(Tax Reform Act of 1986) as Passed by the Senate (JCS-14-86), (July 14, 1986). 

" References to "the bill" are to the Senate amendment in the nature of a substitute to H.R 
3838 as passed by the House of Representatives. 

(1) 



SUMMARY OF THE BILL 
Title L Individual Income Tax Provisions 
A. Basic Rate Structure 

1. Tax rate schedules 

New schedules. — The bill provides new two-bracket tax rate 
schedules for individuals, with rates of 15 and 27 percent. This re- 
places the present-law structure of up to 15 brackets, with a top 
rate of 50 percent. 

The 27-percent rate begins at taxable income levels of $29,300 for 
married individuals filing jointly and surviving spouses, $23,500 for 
heads of household, $17,600 for single individuals, and $14,650 for 
married individuals filing separately. (Taxable income equals ad- 
justed gross income less personal exemptions and less the standard 
deduction or itemized deductions.) Beginning in 1988, the taxable 
income amounts at which the 27-percent rate starts (the "break- 
points") will be adjusted for inflation. 

Blended rates for 1987. — For 1987 returns, the bill directs the 
Treasury Department to prepare blended tax rate schedules; these 
schedules will incorporate half of the present-law rate structure (as 
adjusted for inflation) and half of the new rate structure. The 
income tax withholding tables published by the IRS will be 
changed effective January 1, 1987, to reflect the 1987 blended rate 
schedules. 

Rate adjustment. — The benefit of the 15-percent bracket is 
phased out for taxpayers above certain income levels through a 
rate adjustment requiring additional tax liability. The rate adjust- 
ment occurs between $75,000 and $145,320 of adjusted gross income 
(AGI) for married individuals filing jointly; between $55,000 and 
$111,400 of AGI for heads of household; between $45,000 and 
$87,240 of AGI for single individuals; and between $37,500 and 
$72,660 for married individuals filing separately. (These amounts 
are adjusted for inflation, beginning in 1988.) If lesser in amount, 
the rate adjustment instead applies to the taxpayer's taxable 
income in excess of the breakpoint between the 15-percent and 27- 
percent brackets. There is no rate adjustment if the taxpayer's tax- 
able income does not exceed the maximum dollar amount in the 
15-percent bracket (e.g., taxable income of $29,300 for married indi- 
viduals filing jointly). 

The maximum rate adjustment cannot exceed 12 percent of the 
maximum amount of taxable income within the 15-percent bracket 
applicable to the taxpayer. Thus, if the maximum rate adjustment 
applies, in effect the 27-percent rate applies to all of the taxpayer's 
taxable income, rather than the amount of taxable income above 
the breakpoint. 

(3) 



Resolution. — It is the sense of the Senate that the Senate confer- 
ees give the highest priority to increasing the tax cut for all 
middle-income Americans. 

2. Standard deduction 

Increased amounts. — Under the bill, the standard deduction re- 
places the zero bracket amount (ZBA). Effective in 1988, the stand- 
ard deduction amounts are $5,000 for married individuals filing 
jointly and for surviving spouses; $4,400 for heads of households; 
$3,000 for single individuals; and $2,500 for married individuals 
filing separately. Beginning in 1989, these amounts will be adjusted 
for inflation. 

Additional amount for the elderly. — An additional standard de- 
duction amount of $600 is allowed for an elderly or blind individual 
($1,200 for an individual who is both elderly and blind). For these 
taxpayers only, the new standard deduction amounts (listed in the 
preceding paragraph) and the additional $600 standard deduction 
amount are effective on January 1, 1987. Beginning in 1989, the 
$600 additional standard deduction amount will be adjusted for in- 
flation. 

1987 amounts. — For all individual taxpayers other than elderly 
or blind individuals, the standard deduction amounts for 1987 are 
$3,800 for married individuals filing jointly and surviving spouses; 
$2,570 for heads of households and single individuals; and $1,900 
for married individuals filing separately. 

3. Personal exemption 

Exemption amount. — The bill increases the personal exemption 
for each individual, individual's spouse, and each dependent to 
$1,900 for 1987 and to $2,000 for 1988. Beginning in 1989, the $2,000 
personal exemption amount will be adjusted for inflation. 

The personal exemption amounts are reduced starting at the 
AGI level at which the benefit of 15-percent rate is totally phased 
out (see "rate adjustment," above), and ending at $40,000 above 
that amount. For example, in the case of married individuals filing 
jointly, in 1988 the $2,000 personal exemptions for each individual 
and each dependent are reduced beginning at AGI of $145,320, and 
are completely phased out at AGI of $185,320 or higher. 

Relief for elderly. — The additional exemption in present law for 
the elderly and for blind individuals is repealed starting in 1987. 
As stated above, the bill provides an additional standard deduction 
amount of $600 for an elderly individual and for a blind individual, 
starting in 1987. In addition, the increased standard deduction 
amounts generally applicable in 198r '^e.g., $5,000 for married indi- 
viduals filing jointly) apply for elderly or blind individuals starting 
in 1987. The present-law tax credit for the elderly and certain dis- 
abled individuals is retained. 

Rules for dependents.— The bill provides that the personal ex- 
emption is not allowed to an individual who is eligible to be 
claimed as a dependent on another taxpayer's return (for example, 
where a child is eligible to be claimed as a dependent on his or her 
parents' return). This rule is intended to preclude the doubling of 
tax benefits allowed under present law, where the personal exemp- 
tion for a child can be claimed by the parents on their return and 



also by the child on his or her return. Also, the dependent may use 
the standard deduction only to offset earned income; this rule is 
similar to the present-law rule applicable to the ZBA. 

The bill also provides that if a child or other dependent who is 
not allowed a personal exemption under this provision has gross 
income of less than $100 in a year, the individual is not subject to 
tax on that amount and is not required to file a Federal income tax 
return for that year. 

Jf. Inflation adjustments 

Inflation adjustments ("indexing") to the rate brackets, standard 
deduction (and the $600 additional standard deduction), and person- 
al exemption will be made as described above. These adjustments 
will be rounded down to the nearest multiple of $50. 

5. Repeal of two-earner deduction 

The deduction for two-earner married individuals is repealed, be- 
ginning in 1987. Adjustments made in the standard deduction for 
married individuals filing jointly and in the relationship of the rate 
schedules for unmarried individuals and married individuals filing 
joint returns are intended to compensate for the repeal of this pro- 
vision. 

6. Income averaging 

In light of the significantly flatter rate structure under the bill, 
income averaging generally is repealed after 1986. It is retained, 
however, for qualified farmers, i.e., individuals who are actively en- 
gaged in the trade or business of farming and who derived more 
than 50 percent of their average annual gross receipts from farm- 
ing during the prior three taxable years. 

B. Tax Credits for Individuals 

1. Increase in earned income credit 

The bill increases the rate of the refundable earned income 
credit from 11 to 14 percent of the first $5,000 of earned income. 
(The earned income credit provides tax relief to low-income work- 
ing individuals with children.) In addition, the bill delays the credit 
phase-out to higher income levels than under present law. These 
changes apply after 1986. 

As a further liberalization of present law, the $5,000 maximum 
amount of earned income against which the credit applies and the 
income levels at which the phase-out of the credit begins ($6,500 in 
1987 and $10,000 in 1988 and later years) will be adjusted for infla- 
tion occurring after 1984. These adjustments will not be subject to 
the $50 rounding-down rule otherwise applicable under the bill to 
inflation adjustments. 

2. Repeal of political contributions credit 

The bill repeals the tax credit allowed to individuals for one-half 
the amount of contributions to political candidates and certain po- 
litical campaign organizations, up to a maximum of $50 ($100 on a 
joint return), effective after 1986. 



C. Personal Deductions 

The bill retains the itemized deductions for State and local taxes, 
other than sales taxes, which are made deductible only in part. 
Other itemized deductions that are retained include medical ex- 
penses (subject to an increased floor); interest on the taxpayer's 
principal residence and a second residence, plus investment inter- 
est expense up to the amount of the taxpayer's investment income; 
charitable contributions; casualty and theft losses; and several 
specified miscellaneous deductions, including the deduction for 
costs of adopting children with special needs. The changes to the 
present-law itemized deductions are summarized below and under 
Title XIV., item G (phase-out of itemized deduction for interest 
other than interest described in the preceding sentence). 

As under present law, no deduction (other than the standard de- 
duction) is provided after 1986 for charitable contributions by non- 
itemizers. 

1. Limitation on itemized sales tax deduction 

The itemized deduction for State and local sales taxes is limited, 
effective after 1986, to 60 percent of the excess of such taxes over 
income taxes paid or incurred by the taxpayer during the year. 
However, it is the sense of the Senate that the conferees retain 
present law regarding this deduction. If incurred in a business or 
investment activity. State, local, and foreign taxes for which an 
itemized deduction is not allowed are to be added to the basis of 
property to which they are allocable. The itemized deductions for 
State and local income taxes, real estate taxes, and personal prop- 
erty taxes are retained. 

2. Modification to medical expense deduction 

Effective after 1986, the floor under the medical expense deduc- 
tion is increased from five percent to a higher percentage (less than 
10 percent, to be determined based on certain revenue estimates) of 
the taxpayer's adjusted gross income. It is clarified that certain ex- 
penses incurred to accommodate a personal residence to the needs 
of a handicapped individual are eligible for the medical expense de- 
duction. 

S. Housing allowances for ministers and military personnel 

The bill provides that the receipt of tax-free housing allowances 
by ministers or military personnel does not result in loss of deduc- 
tions for interest or real property taxes on the individual's resi- 
dence, effective for past and future years. 

D. Exclusions From Income 

1. Inclusion of unemployment compensation benefits 

The bill repeals the present-law partial exclusion for unemploy- 
ment compensation benefits, effective for amounts received after 
1986. 

2. Exclusion for prizes and awards 

The exclusion under present law for certain prizes and awards 
for charitable, scientific, artistic, and similar achievements will 



apply only if the winner assigns the award to charity. (No change 
is made to the present-law exclusion for scholarships and fellow- 
ships.) The bill provides a limited exclusion for certain employee 
awards for length of service or safety achievement; all other 
awards by employers to employees are includible in income. These 
provisions apply after 1986. 

E. Business Meals and Entertainment; Miscellaneous Expenses 

1. Limitations on travel and entertainment deductions 

Under the bill, 80 percent of business meal expenses and busi- 
ness entertainment expenses are deductible, subject to certain ex- 
ceptions, including one for meals provided in 1987 or 1988 as an in- 
tegral part of a qualified banquet meeting. Requirements for de- 
ducting business meal expenses are tightened. 

No deductions are allowed for costs of attending investment con- 
ventions or seminars or for educational travel expenses. Deductions 
for entertainment ticket costs and luxury water travel are limited. 
For purposes of the present-law foreign convention rule, Bermuda 
can be treated as in the North American area under certain condi- 
tions. 

These provisions are effective for taxable years beginning after 
1986. 

2. Repeal of miscellaneous itemized deductions 

The bill repeals the miscellaneous deductions allowed under 
present law only as itemized deductions on Form 1040 Schedule A, 
Lines 20-23, other than deductions for (a) costs of adopting children 
with special needs, (b) wagering losses not in excess of wagering 
income, (c) the estate tax in the case of income in respect of a dece- 
dent, (d) the adjustment deduction where a taxpayer restores cer- 
tain amounts held under claim of right, and (e) impairment-related 
expenses of handicapped employees. Itemized deductions will not 
be allowed, for example, for investment advisor fees and similar ex- 
penses allocable to interest and dividend income, certain unreim- 
bursed employee expenses such as bar association and union dues, 
and fees for preparing individuals' tax returns. This provision is ef- 
fective for taxable years beginning after 1986. 

3. Treatment of certain employee business expenses 

Deductions for certain unreimbursed employee business expenses 
(reported on Form 2106) that under present law may be taken 
above-the-line are limited in the bill to itemizers and are made sub- 
ject to a floor of one percent of the taxpayer's adjusted gross 
income, effective after 1986. This rule applies to employee travel 
and transportation expenses and business expenses of employees 
who are "outside" salespersons. 

The bill retains the present-law above-the-line deductions for cer- 
tain reimbursed employee expenses, moving expenses, and alimony 
payments. (See summary of Title XII below, concerning the IRA de- 
duction and other retirement plan provisions of the bill.) 



(ii_ARR n - Rft - 2 



8 

4- Changes in treatment of hobby losses 

Under present law, an activity other than horse breeding, train- 
ing, showing, or racing is presumed not to be a hobby if it is profit- 
able in two out of five consecutive years. Under the bill, an activity 
(other than one involving horses) is presumed not to be a hobby if 
it is profitable in three out of five consecutive years. The provision 
is effective for taxable years beginning after 1986. 

5. Deductions for business use of home 

Under the bill, no deduction is allowed for costs associated with 
business use of one's home (except for items allowable without ref- 
erence to such use, such as home mortgage interest) in the case of 
an employee who rents a portion of the home to the employer. 
Also, home office costs are deductible only to the extent of net 
income from the business activity (rather than certain gross 
income, as under present law); excess deductions can be carried for- 
ward. These provisions are effective for taxable years beginning 
after 1986. 



Title II. Accelerated Cost Recovery System and Investment Tax 

Credit 

A. Depreciation 

Accelerated Cost Recovery System. — The bill modifies the Acceler- 
ated Cost Recovery System (ACRS) for property placed in service 
after December 31, 1986, except for property covered by transition 
rules. 

The bill provides more accelerated depreciation for the revised 
five-year and ten-year classes and reclassifies certain assets accord- 
ing to their present class life (or "ADR midpoint life"). The bill pre- 
scribes depreciation methods for each ACRS class (in lieu of provid- 
ing statutory tables). Eligible personal property is assigned among 
a three-year class, a five-year class, a ten-year class, or a fifteen- 
year class. The bill applies the 150-percent declining balance 
method, switching to the straight-line method at a time to maxi- 
mize the depreciation allowance, to certain property in the three- 
year class and to the fifteen year class. The depreciation method 
for other property in the three-year class is the straight-line 
method. The depreciation method applicable to property included 
in the five- and ten-year classes is the double declining balance 
method, switching to the straight-line method at a time to maxi- 
mize the depreciation allowance. The cost of real property is recov- 
ered using the straight-line method over 21 Vz years for residential 
rental property and 3iy2 years for nonresidential property. 

Alternative Depreciation System. — A taxpayer may elect to recov- 
er the cost of property over the ACRS class life or, generally, the 
ADR midpoint life, using the straight-line method. Additionally, 
assets used abroad or by tax-exempt entities, and for the alterna- 
tive minimum tax computation and certain other purposes, must 
be recovered using the straight-line method generally over the 
ADR midpoint life. 

Expensing. — The amount of personal property that may be ex- 
pensed is increased to $10,000 (from the present-law $5000). For 
every dollar of qualifying investment in excess of $200,000, the 
$10,000 limit is reduced by one dollar. 

B. Regular Investment Tax Credit 

The bill repeals the investment tax credit for property placed in 
service after December 31, 1985, except for property covered by 
transition rules. 

C. Finance Leasing 

Finance leasing is repealed for agreements entered into after De- 
cember 31, 1986, except for property covered by transition rules. 

(9) 



Title III. Accounting Provisions 

A. Limitations on the Use of the Cash Method of Accounting 

The bill prohibits the use of the cash method of accounting by 
any taxpayer that is eligible (under the bill) to use the reserve 
method of computing deductions for bad debts. These taxpayers are 
banks, thrift institutions, banks for cooperatives, production credit 
associations, and certain finance companies. The provision is effec- 
tive for taxable years beginning after December 31, 1986. 

B. Utilities Using Accrual Accounting 

The bill provides that taxpayers using the accrual method of ac- 
counting must recognize income attributable to the sale or furnish- 
ing of utility services to customers not later than the year in which 
such services are provided to customers. The provision is effective 
for taxable years beginning after December 31, 1986. 

C. Installment Sales 

Urder the bill, use of the installment method is denied for sales 
pursuant to a revolving credit plan and for sales of certain publicly 
traded property. The bill also limits the use of the installment 
method based on the ratio of the taxpayer's debt to assets for all 
sales of property held for sale to customers, and for sales of busi- 
ness or rental property (other than certain farm property) if the 
selling price of such property exceeds $150,000. Personal use and 
certain farm property, and debt related to such property, are not 
taken into account in applying the limitation. Taxpayers selling 
certain "residential lots" and "timeshares" are permitted to elect 
to pay interest on deferral of tax liability attributable to the use of 
the installment method, rather than be subject to the limitations 
under the bill. An exception from the provisions of the bill is pro- 
vided for certain sales by a manufacturer to a dealer where the 
term of the installment obligation is based on the time that the 
property is resold by the dealer. 

The denial of use of the installment method for sales pursuant to 
revolving credit plans and for sales of certain publicly traded prop- 
erty is effective for sales after December 31, 1986. Taxpayers sell- 
ing property on revolving credit plans are permitted to spread any 
adjustment arising from the change in accounting method over a 
period not exceeding five years. The limitation on the use of the 
installment method based on the ratio of the taxpayer's debt to 
assets is effective as of January 1, 1987, for sales on or after March 
1, 1986. 



(10) 



11 

D. Capitalization of Inventory, Construction, and Development Costs 

1. Uniform capitalization rules 

The bill provides that, in general, uniform rules for determining 
costs that must be capitalized apply to all persons who produce 
property or acquire property for resale. Thus, the rules apply to in- 
ventory, noninventory property held for sale to customers, and 
assets constructed for self-use. These comprehensive capitalization 
rules, which are based on the rules of present law applicable to ex- 
tended period long-term contracts, generally apply to costs paid or 
incurred after December 31, 1986. In the case of inventories, the 
rules apply to the taxpayer's first taxable year beginning after De- 
cember 31, 1986. 

2. Interest 

Interest is subject to a special rule requiring capitalization only 
if the property is real property, long-lived property produced for 
self-use, or property that requires more than two years (one year if 
the cost of the item is greater than $1 million) to produce. This 
rule applies to interest incurred after December 31, 1986. 

3. Long-term contracts 

In general, all long-term contracts are subject to the extended 
period long-term contract regulations of present law. In addition, 
general and administrative expenses identified under the contract 
or pursuant to Federal certification procedures as contract-related 
must be treated as contract costs. The general rules requiring capi- 
talization of interest also apply to long-term contracts. This provi- 
sion applies to contracts entered into after February 28, 1986. 

E. Special Treatment of Certain Items 

1. Reserves for bad debts 

The bill generally repeals the reserve method of computing de- 
ductions for bad debts, other than for financial institutions, banks 
for cooperatives, production credit associations, and certain finance 
companies. The reserve method of computing deductions for losses 
on debt obligations guaranteed by a dealer also is repealed. Tax- 
payers that are not allowed to continue to use the reserve method 
are allowed a deduction for business bad debts when the debt be- 
comes wholly or partially worthless. Wholly worthless business 
debts must be treated as worthless on a taxpayer's books in order 
to be allowed as a deduction for Federal income tax purposes, as is 
the case under present law for partially worthless debts. The bal- 
ance of any reserve for bad debts or guarantees is taken into 
income ratably over a period of five years. The provision is effec- 
tive for taxable years beginning after December 31, 1986. 

2. Qualified discount coupons 

The bill repeals the election to deduct the cost of redeeming 
qualified discount coupons that are received for redemption after 
the close of the taxable year. A deduction will be allowed only for 
the cost of redeeming coupons which have been received by the 



12 

close of the taxable year. The provision is effective for taxable 
years beginning after December 31, 1986. 

S. Depreciation recapture income on installment sales of farm 
irrigation equipment 

The bill provides that depreciation recapture income resulting 
from an installment sale of farm irrigation equipment may be re- 
ported as gain is recognized under the installment method, rather 
than entirely in the year of sale. This provision is effective as if 
included in the Deficit Reduction Act of 1984. 

F. Cancellation of Indebtedness for Solvent Taxpayers 

The bill repeals the provision of present law that allows income 
from the discharge of qualified business indebtedness to be ex- 
cluded from gross income. Income from the discharge of indebted- 
ness will be required to be recognized currently unless the dis- 
charge occurs in a title 11 (bankruptcy) case or when the debtor is 
considered to be insolvent. The provision is effective for discharges 
of indebtedness occurring after December 31, 1986. 

G. Taxable Year of Partnerships, S Corporations, and Personal 

Service Corporations 

The bill requires that partnerships, S corporations, and personal 
service corporations use a taxable year that generally conforms to 
the taxable year of their owners. A partnership must use (in order 
of priority) the taxable year of the partners owning the majority of 
partnership profits and capital, the taxable year of all of its princi- 
pal partners, or the calendar year. An S corporation or a personal 
service corporation must use the calendar year. An exception is 
made for any partnership, S corporation, or personal service corpo- 
ration that establishes to the satisfaction of the Treasury Depart- 
ment a business purpose for having a different taxable year. The 
deferral of income to partners or shareholders of three months or 
less is not to be treated as a business purpose. The provision is ef- 
fective for taxable years beginning after December 31, 1986. 



Title IV. Capital Gains 

A. Capital Gains for Individuals 

The bill repeals the present law exclusion for long-term capital 
gains of individuals for taxable years beginning after December 31, 
1986. The bill also provides that the tax rate on long-term capital 
gains will not increase even if the tax rates on ordinary income are 
increased. Also, the tax rate on long-term capital gains during cal- 
endar year 1987 will not exceed the capital gain rate for years after 
1987. 

B. Incentive Stock Options 

The bill liberalizes the incentive stock option provisions by re- 
pealing the requirement that options be exercised in the order 
granted. Also, the application of the $100,000 limit on the amount 
of options which may be granted in any year is modified. These 
provisions apply to options granted after 1986. 

C. Tax Straddles 

Under the loss deferral rule in the straddle provisions, the bill 
denies the qualified covered call exception to a taxpayer who fails 
to hold an option for 30 days after the related stock is disposed of 
at a loss, where gain on termination or other disposition of the 
option is included in the subsequent year. Also, gain on contracts 
marked to market is treated as short-term capital gain. In addition, 
the hedging exception to the mark to market and loss deferral 
rules is repealed for dealers, except dealers in certain agricultural 
or horticultural commodities. These provisions apply to positions 
established after December 31, 1986. 

(13) 



Title V. Compliance and Tax Administration 

A. Penalties 

1. Penalty for failure to file information returns or statements. — 
The bill consolidates the present-law penalty for failure to file an 
information return with the IRS and the present-law penalty for 
failure to supply a copy of the information return to the taxpayer. 
The bill also provides a new penalty for failure to include correct 
information on an information return. This applies to information 
returns the due date for which is after December 31, 1986. 

2. Increase in penalty for failure to pay tax. — The bill increases 
the penalty for failure to pay taxes from one-half of one percent 
under present law to one percent after the IRS notifies the taxpay- 
er that the IRS will levy upon the assets of the taxpayer. This ap- 
plies to amounts assessed after December 31, 1986. The bill also re- 
quires the Treasury Department to report (by March 1, 1987) on 
the cost of collection charge system. 

3. Negligence and fraud penalties. — The bill expands the scope of 
the negligence penalty by making it applicable to all taxes under 
the Code. The bill modifies the negligence penalty by increasing 
the rate to 10 percent but applying the penalty only to the amount 
of the underpayment attributable to negligence. The bill also pro- 
vides that failure to report on a tax return any amount reported on 
an information return is considered negligence in the absence of 
clear and convincing evidence to the contrary. The bill modifies the 
fraud penalty by increasing the rate to 75 percent but applying the 
penalty only to the amount of the underpayment attributable to 
fraud. This is effective for returns the due date of which is after 
December 31, 1986. 

4- Penalty for substantial understatement of tax liability. — The 
bill increases the penalty for substantial understatement of tax li- 
ability from 10 to 20 percent of the amount of the underpayment of 
tax attributable to the understatement. This is effective for returns 
the due date of which is after December 31, 1986. 

B. Interest Provisions 

1. Differential interest rate. — The bill provides that the Govern- 
ment pays interest to taxpayers at the Federal short-term rate plus 
2 percentage points, and that taxpayers pay interest to the Govern- 
ment at the Federal short-term rate plus 3 percentage points. 
These rates are adjusted quarterly, and apply to interest for peri- 
ods after December 31, 1986. 

2. Interest on accumulated earnings tax. — The bill provides that 
interest is imposed on underpayments of the accumulated earnings 
tax from the due date of the tax return with respect to which that 
tax is imposed. This applies to returns the due date for which (de- 
termined without regard to extensions) is after December 31, 1986. 

(14) 



15 

C. Information Reporting Provisions 

1. Real estate transactions. — The bill provides that specified per- 
sons must provide an information report on real estate transac- 
tions. This is effective beginning January 1, 1987. 

2. Information reporting on persons receiving Federal contracts. — 
The bill requires Federal executive agencies to provide information 
reports on contracts that they enter. Reporting is required begin- 
ning January 1, 1987. 

3. Royalties. — The bill modifies current information reporting re- 
quirements for royalties, effective January 1, 1987. 

4. Taxpayer identification numbers of dependents. — The bill re- 
quires that any taxpayer claiming a deduction for a dependent who 
is at least 5 years old must report the taxpayer identification 
number of that dependent on that tax return, effective for returns 
required to be filed after December 31, 1986. 

5. Modification of separate mailing requirement. — The bill modi- 
fies the separate mailing requirement for information reports on 
interest, dividends, patronage dividends, and royalties, effective for 
those returns required to be filed after December 31, 1986. 

D. Tax Shelters 

1. Tax shelter user fee. — The bill requires that taxpayers who 
claim cumulative net losses (plus three times the value of cumula- 
tive net credits) that exceed cumulative actual cash invested in a 
tax shelter pay a user fee of one percent of the losses claimed and 
three percent of the credits claimed with respect to that tax shel- 
ter. This is effective for returns filed after December 31, 1986. 

2. Tax shelter registration. — The bill conforms the tax shelter 
ratio computation (used to determine whether a tax shelter must 
register with the IRS) more closely to the new tax rate schedule in 
the bill, effective July 1, 1987. 

3. Tax shelter penalties. — The bill increases the penalties for fail- 
ure to register a tax shelter, for failure to report a tax shelter iden- 
tification number, and for failure to maintain lists of tax shelter 
investors, effective on the date of enactment. 

4. Tax shelter interest. — The bill increases the rate of interest on 
underpayments of tax attributable to tax-motivated transactions 
from 12() percent to 200 percent of the generally applicable interest 
rate, effective for interest accruing after December 31, 1986. 

E. Estimated Tax Payments 

The bill increases from 80 to 90 percent the proportion of the 
current year's tax liability that individual taxpayers must make as 
estimated tax payments in order to avoid the estimated tax penal- 
ty, effective for taxable years beginning after December 31, 1986. 
The bill also requires that tax-exempt organizations subject to the 
unrelated business income tax and private foundations subject to 
the excise tax on their net investment income must make quarterly 
estimated payments of those taxes, effective for taxable years be- 
ginning after December 31, 1986. 



16 

F. Tax Litigation and Tax Court 

1. Awards of attorney's fees in tax cases. — The bill extends perma- 
nently with several modifications the provisions of present law au- 
thorizing awards of attorney's fees in tax cases. These modifica- 
tions relate to the burden of proof and the basis for such awards. 

£. Tax Court provisions. — The bill permits the Tax Court to 
impose a practice fee, clarifies that the Tax Court has jurisdiction 
over the penalty for failure to pay tax, clarifies that the Tax Court 
may obtain the assistance of U.S. Marshals, clarifies the pay and 
travel rules pertaining to Special Trial Judges, and permits a judge 
to elect to practice law after retirement and receive retirement 
pay. 

G. Tax Administration Trust Fund 

The bill establishes a Tax Administration Trust Fund. A speci- 
fied level of spending is available to the IRS for each of the next 
five fiscal years, which will provide for funding at the current level 
plus a sizeable increase each year. The increase in spending is spe- 
cifically targeted to examination, collection and other increased 
compliance measures. The Trust Fund is effective for fiscal years 
1987 through 1991; it then expires. 

H. Tax Administration Provisions 

1. Suspend statute of limitations during prolonged dispute over 
third-party records.— The bill provides that, if a dispute between 
the IRS and a third-party recordkeeper is not resolved within six 
months, the statute of limitations is suspended until the issue is re- 
solved. 

2. Authority to rescind notice of deficiency. — The bill gives the 
IRS authority, if the taxpayer consents, to rescind a statutory 
notice of deficiency. 

S. Authority to abate interest.— The bill gives the IRS the author- 
ity to abate interest attributable to error or delay by an IRS em- 
ployee in performing a ministerial act. 

4- Suspension of compounding when underlying interest is sus- 
pended. — The bill suspends the compounding of interest in circum- 
stances in which the underlying interest on the deficiency is also 
suspended. 

5. Additional exemption from levy. — The bill exempts from IRS 
levy military service disability benefits. 

6. Certain recordkeeping requirements. — The bill provides that 
IRS special agents are subject to tb*^ same income inclusion and 
recordkeeping rules that other law enforcement officers are with 
respect to use of an automobile. 

7. Disclosure of return information to certain large cities. — The 
bill authorizes the Treasury to exchange tax return information 
with any city with a population exceeding two million that imposes 
an income or wage tax. 

8. Regulatory Flexibility Act.— The bill applies the Regulatory 
Flexibility Act to rules and regulations issued by the Treasury (in- 
cluding the IRS). 



17 

/. Modification of Withholding Schedules 

The bill requires employees to file revised withholding certifi- 
cates by January 1, 1988. The bill also instructs the Treasury De- 
partment to modify withholding schedules to better approximate 
actual tax liability under the amendments made by the bill. 

/. Report on Return-Free System 

The bill requires the Treasury Department to report to the Con- 
gress on the potential for implementing a return-free system for in- 
dividuals. The report is due not later than six months after the en- 
actment of the bill. 



Title VI. Corporate and General Business Taxation 
A. General Corporate Provisions 

1. Corporate tax rates 

The bill provides a three-bracket graduated corporate rate struc- 
ture as follows: 

Tax rate 
Taxable income: (percent) 

Not over $50,000 15 

Over $50,000 but not over $75,000 25 

Over $75,000 33 

This structure reduces from five to three the number of corpo- 
rate income tax brackets, and lowers from 46 to 33 the tax rate ap- 
plicable to large corporations. The benefit of graduated rates is 
phased out for corporations with more than $320,000 of taxable 
income (compared to $1,405,000 under present law). 

The 28-percent alternative tax rate for net capital gains of corpo- 
rations is retained. 

The graduated income tax rates are effective for taxable years 
beginning on or after July 1, 1987. The rate schedule for taxable 
years including July 1, 1987 will reflect blended rates. 

2. Dividends received deduction 

The 85 percent dividends received deduction under present law is 
reduced to 80 percent for dividends received after December 31, 
1986. 

S. Dividend exclusion for individuals 

The $100 dividend exclusion for individuals ($200 for a joint 
return) is repealed, effective for taxable years beginning after De- 
cember 31, 1986. 

4- Nondeductibility of stock redemption payments 

The bill provides that no amount paid or incurred by a corpora- 
tion in connection with a redemption of its stock is deductible or 
amortizable. This would preclude, for example, deduction of so- 
called "greenmail" payments made to stockholders to avert a hos- 
tile takeover. The provision is effective for amounts paid or in- 
curred after February 28, 1986. 

5. Special limitations on net operating loss (NOD and other 
carryforwards 

The bill alters the special limitations on the use of net operating 
loss (NOD and other carryforwards. After a change in ownership of 
more than 50 percent of value of stock in a loss corporation, howev- 

(18) 



19 

er effected, the taxable income available for offset by pre-acquisi- 
tion NOLs is limited to the Federal mid-term rate in effect on the 
ownership change date, times the value of the loss corporation's 
equity. The bill also expands the scope of the special limitations to 
include built-in losses (other than depreciation) and takes into ac- 
count built-in gains. The bill includes a number of rules designed to 
ensure the limitations accomplish their intended objectives and 
makes other changes to present law, of a more technical nature, 
including rules relating to the measurement of beneficial owner- 
ship. The bill applies similar rules to carryforwards other than 
NOLs, such as net capital losses and excess foreign tax credits, as 
well as passive activity losses and credits and minimum tax credits 
under the bill. 

In general, the bill applies to changes in ownership that occur 
after December 31, 1986 (unless pursuant to plans of tax-free reor- 
ganization adopted before January 1, 1987). 

6. Extraordinary dividends 

The bill requires the basis of stock held by a corporation to be 
reduced by the untaxed portion of extraordinary dividends, regard- 
less of the holding period of the stock. For purposes of determining 
whether a dividend is extraordinary, a taxpayer may measure the 
dividend by reference to the market value of the stock rather than 
its basis, provided market value is established to the satisfaction of 
the IRS. The provision applies to dividends declared after March 
18, 1986. 

7. Allocation of purchase price in certain asset sales 

The bill conforms the basis allocation rules in asset acquisitions 
to the rules for stock acquisitions where basis is stepped up (section 
338 rules) so that both buyer and seller would use the so-called "re- 
sidual" method of allocating the purchase price to nondepreciable 
goodwill and going concern value. The Treasury Department is au- 
thorized to require information reporting with respect to purchase 
price allocations. The provision applies to transactions after May 6, 
1986, unless pursuant to a binding contract in effect on that date. 

8. Corporate shareholder redemptions 

The bill generally treats a corporate shareholder that receives a 
distribution in redemption of stock as having sold the stock rather 
than as being eligible for the dividends- received deduction; howev- 
er, no additional loss is created. The provision applies to distribu- 
tions after June 23, 1986 unless pursuant to a written contract 
binding on that date. 

9. Related party sales 

The bill modifies the rules that limit installment sales treatment 
and ordinary income treatment on certain sales between related 
parties, by expanding the definition of related parties. Persons and 
entities with certain more than 50-percent relationships are cov- 
ered (rather than the 80-percent relationships under present law). 
The attribution rules are also expanded. The provision is effective 
for sales after June 20, 1986 unless pursuant to a binding contract 
in effect on that date. 



61-685 0-86-3 



20 

10. Amortizable bond premium 

The bill requires amortizable bond premium deductions to be 
treated as interest, except as provided in regulations. The provision 
applies to obligations acquired after date of enactment. 

11. Net operating loss carrybacks — tax rate limitation 

Under regulations designed to raise no more than $200 million 
over fiscal years 1987-1991, net operating loss carrybacks are limit- 
ed in use to the tax rate in effect in the year the loss arose. The 
provision applies to net operating losses for taxable years begin- 
ning after December 31, 1986. 

B. Rapid Amortization Provisions 

1. Trademark and trade name expenditures 

The bill repeals five-year amortization for trademarks and tra- 
denames, for expenditures paid or incurred after December 31, 
1986. Transitional rules are provided for certain binding contracts. 

2. Bus operating authorities 

Owners of certain bus operating authorities are allowed an ordi- 
nary deduction ratably over five years for loss in value of such au- 
thorities, effective for taxable years ending after November 18, 

1982. 

C. Other Provisions 

1. Limitation on business tax credits 

The bill reduces the 85-percent limitation on the amount of 
income tax liability that can be offset by business tax credits to 75 
percent, for taxable years beginning after December 31, 1986. 

2. Regulated investment companies 

Regulated investment companies ("RICs") are taxed under the 
bill on a calendar-year basis for taxable years beginning after De- 
cember 31, 1986. Also, RICs are required to pay a five-percent non- 
deductible excise tax on dividends for which the RIC elects to re- 
ceive a deduction in the taxable year prior to distribution. 

Permitted income for RICs generally is defined to include income 
from foreign currencies, and options and futures contracts, derived 
with respect to the RICs business of investing. In the case of RICs 
that have series funds, each fund is treated as a separate corpora- 
tion. The time for filing notices for capital gains dividends and cer- 
tain other purposes is extended from 45 to 60 days. RICs are treat- 
ed as third party recordkeepers. 

3. Payroll tax deposits 

The bill increases from $3,000 to $5,000 the amount of undeposit- 
ed payroll taxes an employer may aggregate before the current 
one-eighth-monthly deposit rule becomes effective. This provision 
applies to months beginning after December 31, 1986. 



Title VII. Agriculture, Energy, and Natural Resources 
A. Provisions Relating to Agriculture 

1. Special expensing and amortization provisions affecting ag- 

riculture 

The bill provides that soil and water conservation expenditures 
are deductible only if they relate to improvements that are consist- 
ent with a conservation plan approved by the the U.S. Department 
of Agriculture or (in the absence of a federally approved plan) a 
comparable State agency. In no event, however, may expenditures 
relating to the draining or filling of wetlands or the installation or 
operation of a center pivot irrigation system be deducted under this 
provision. 

The bill repeals the special provision allowing a deduction for 
land clearing expenditures. 

These provisions apply to expenditures incurred after December 
31, 1986. 

2. Dispositions of converted wetlands and highly erodible 

croplands 

The bill provides that gain from the disposition of wetlands and 
highly erodible cropland that is converted to agricultural use (other 
than livestock grazing) is not eligible for capital gains treatment, 
and that any loss on such disposition is not treated as ordinary 
loss, effective for dispositions of land converted after March 1, 1986. 

S. Prepayments of farming expenses 

The bill provides that to the extent a farmer's prepaid farming 
expenses of a farmer using the cash method of accounting exceed 
50 percent of total farm expenses, amounts paid for feed, seed, fer- 
tilizer, and other similar farm supplies may be deducted only as 
such supplies are actually consumed. This provision applies to 
amounts with respect to which a deduction would be allowable 
under present law after March 1, 1986. 

4. Special rule for expenses incurred in replanting groves, or- 
chards, or vineyards destroyed in natural disasters 

The bill provides that a deduction for planting and maintenance 
costs incurred following loss or damage to a grove, orchard, or vine- 
yard as a result of freezing temperatures, disease, drought, pests, 
or casualty, may be deducted by persons other than the farmer 
who owned the grove, etc., at the time of the damage, provided: (1) 
the taxpayer who owned the property at such time retains an 
equity interest of more than 50 percent in the property, and (2) the 
person claiming the deduction owns part of the remaining equity 
interest and materially participates in the planting or maintenance 

(21) 



22 

of the property. This provision is effective for costs paid or incurred 
after the date of enactment. 

5. Treatment of discharge of indebtedness income for certain 

farmers 

The bill provides that discharge of indebtedness income arising 
from an agreement between a solvent individual debtor engaged in 
the trade or business of farming and an unrelated person to dis- 
charge certain farming indebtedness will be treated as income real- 
ized by an insolvent individual (and hence eligible for exclusion 
from income). Qualified indebtedness includes debt incurred to fi- 
nance production of agricultural products and debt secured by farm 
land or equipment. The provision applies to discharge of indebted- 
ness income realized after the date of enactment of the bill. 

6. Agricultural wages under FUTA 

The bill increases the quarterly payroll threshold at which agri- 
cultural wages are covered under the Federal Unemployment Tax 
Act from $20,000 to $40,000, effective for wages paid after Septem- 
ber 30, 1986. 

B. Energy-Related Tax Credits and Other Incentives 

1. Business energy tax credits 

The energy tax credit for solar property is extended through 
1988 at a 15-percent rate in 1986 and at 12 percent in 1987 and 
1988. For geothermal energy systems, the credit is extended for 
three years at 15 percent in 1986 and 10 percent in 1987 and 1988. 
(It is clarified that dual purpose property which serves both quali- 
fied geothermal energy property and nonqualified energy property 
is eligible for the geothermal energy credit, if at least 50 percent of 
the energy used comes from qualified geothermal energy property.) 
The 15-percent credit for ocean thermal energy is extended, un- 
changed, through 1988. 

For both wind and biomass properties, the energy tax credit is 
extended for two years, at 15 percent in 1986 and 10 percent in 
1987. 

The expiration date of the 10-percent energy tax credit that was 
allowable for modifications to chlor-alkali electrolytic cells is 
changed from December 31, 1982, to December 31, 1983. 

2. Alcohol fuels credit and related excise tax exemptions; 

import duty 

Alcohol fuels. — The 9-cents-per-gallon exemption from the gaso- 
line and motor fuels excise taxes for neat alcohol and methanol 
fuels is reduced to 6 cents per gallon, effective on and after Janu- 
ary 1, 1987. The 6-cents-per-gallon excise tax exemption for gasohol 
and the 60-cents-per-gallon nonrefundable income tax credit for 
blending alcohol with gasoline are unchanged from present law. 

Import duty. — Ethyl alcohol for use as a fuel may be imported 
duty-free into the United States from a Caribbean Basin Initiative 
(CBI) country, if it is produced in a CBI country from source mate- 
rial which is the product of a CBI country or the United States. 



23 

C. Foreign Intangible Drilling Costs (IDCs) and Mining-Related 

Costs 

The bill retains present-law tax provisions applicable to the do- 
mestic production of oil, gas and hard minerals. 

Foreign intangible drilling and development costs (IDCs) and 
mining exploration and development costs are recovered under the 
bill (1) using 10-year, straight-line amortization, or (2) at the tax- 
payer's election, as part of the basis for cost depletion. (These costs 
generally qualify for expensing under present law, under the same 
provisions that apply to equivalent domestic costs.) 

This provision generally is effective for costs paid or incurred 
after December 31, 1986. 

D. Estate and Gift Tax Deductions for Certain Conservation Ease- 

ment Donations 

Contributions of certain interests in real property to charitable 
organizations, to the United States, or to a State or local govern- 
ment are allowed for Federal estate and gift tax purposes even if 
the contributions do not meet the requirement for deductibility for 
Federal income tax purposes that the contributions be for conserva- 
tion purposes. The provision is effective for transfers and contribu- 
tions made after December 31, 1986. 



Title VIII. Financial Institutions 

A. Reserves for Bad Debts of Thrift Institutions 

The bill reduces the maximum percentage of income that a thrift 
institution (a mutual savings bank, domestic building and loan as- 
sociation, or a cooperative bank) may exclude from income as an 
addition to a reserve for bad debts from 40 to 25 percent. The provi- 
sion is effective for taxable years beginning after December 31, 
1986. 

B. Special Rules for Net Operating Losses of Thrift Institutions 

The bill povides that net operating losses incurred by a thrift in- 
stitution in taxable years beginning after 1981 and before 1986 may 
be carried back to the prior ten years and forward to the succeed- 
ing eight years. The provision is effective on the date of the enact- 
ment of the bill. 

C. Treatment of Losses on Deposits in Insolvent Financial Institu- 

tions 

Under the bill, individuals are given an election to deduct losses 
on deposits in qualified financial institutions as a casualty loss at 
the time the loss can be reasonably estimated. The election applies 
only where the loss arises as a result of the bankruptcy or insol- 
vency of the financial institution. The election is not available to 
any one-percent shareholder, any officer, or any relative or related 
party of a one-percent shareholder or officer of the institution. The 
provision is effective for losses incurred in taxable years beginning 
after December 31, 1982. 

(24) 



Title IX. Foreign Tax Provisions 

A. Foreign Tax Credit 

1. Foreign tax credit limitation. — The overall foreign tax credit 
limitation of present law is retained. The separate limitation for in- 
terest income is replaced with a separate limitation for passive 
income. Passive income includes certain categories of income that 
are subject to current taxation if earned by a controlled foreign 
corporation. These rules are effective for taxable years beginning 
after 1986. 

Foreign gross withholding taxes on interest paid to financial in- 
stitutions that are at least five percent of the gross amount are 
subject to a separate foreign tax credit limitation. This provision is 
generally effective for taxes paid in taxable years beginning after 
1986, but transitional relief is provided. 

2. Subsidies. — The bill clarifies that foreign taxes that are rebat- 
ed directly or indirectly are not creditable. This provision applies 
to taxable years beginning after 1986. 

3. Effect of losses on foreign tax credit. — Foreign source losses 
reduce all types of foreign source income before reducing U.S. 
source income. U.S. losses reduce categories of foreign income pro 
rata. This provision applies to losses incurred in taxable years be- 
ginning after 1986. 

4. Deemed-paid credit. — (a) The deemed paid credit for a U.S. cor- 
poration's share of foreign taxes paid by a foreign corporation is de- 
termined with respect to the foreign corporation's 10-year pool of 
accumulated earnings and profits; and (b) earnings and profits gen- 
erally are computed in the same manner for actual distributions as 
they are now for subpart F inclusions. These rules are generally ef- 
fective for earnings and profits accumulated in taxable years begin- 
ning after 1986. 

5. Carrybacks. — Foreign tax credits that are currently unusable 
only because of the bill's rate reductions cannot be carried back for 
use in higher-rate taxable years. 

B. Source Rules 

1. Income from purchase and sale of inventory-type property. — 
Present law generally is retained for U.S. persons (i.e., the title 
passage rule), except income earned by a foreign person attributa- 
ble to a fixed place of business within the United States is U.S. 
source (except for foreign tax credit limitation purposes). 

2. Income from intangible property. — With respect to royalty 
income, the bill retains the place-of-use source rule of present law. 
With respect to sales income, unless the amount received is contin- 
gent on the use of the intangibles, the source is generally in the 
country of residence of the seller. However, for U.S. persons, sales 
involving a foreign office will jdeld foreign source income (if the 

(25) 



26 

income is subject to at least a 10-percent foreign tax). In addition, 
income earned by a foreign person attributable to a fixed place of 
business within the United States is U.S. source (except for foreign 
tax credit limitation purposes). 

3. Income from sale of other personal property. — Under the bill, 
recapture income derived from sales of personal property used by 
the seller in a business is sourced where deductions with respect to 
such property previously offset income. Income in excess of those 
deductions is sourced according to where title passes. Income de- 
rived from sales of other personal property, including passive in- 
vestment property, is generally sourced in the country of residence 
of the seller. However, for U.S. persons, sales involving a foreign 
office will yield foreign source income (if the income is subject to at 
least a 10-percent foreign tax). Certain sales of corporate stock are 
sourced in the country where the corporation whose stock is sold 
did most of its business. In addition, income earned by a foreign 
person attributable to a fixed place of business within the United 
States is U.S. source (except for foreign tax credit limitation pur- 
poses). 

4. Transportation income. — The bill sources transportation 
income from United States-foreign routes as 50-percent U.S. source 
income and 50-percent foreign source. (Present law generally treats 
most transportation income earned on such routes as foreign 
source income.) The special U.S. sourcing rule for income and ex- 
penses associated with vessels or aircraft constructed in the United 
States and leased to U.S. persons is repealed. The bill also repeals 
a similar rule for transportation income earned in leasing certain 
aircraft used on United States-U.S. possessions routes. The repeal 
of both special rules is subject to a grandfather rule. 

The reciprocal tax exemption for foreign persons' shipping and 
aircraft income is available only if a foreign person's country of 
residence gives U.S.persons an equivalent foreign tax exemption. 
Eligibility for the reciprocal exemption is extended to bareboat 
charter income. In addition, a four-percent gross basis tax is gener- 
ally imposed on U.S. source transportation income of foreign per- 
sons resident in countries that impose a gross basis tax on U.S. car- 
riers. 

5. Other offshore income and income earned in space. — The bill 
generally sources other offshore income and income earned in 
space in the recipient's country of residence. Certain communica- 
tions income is sourced half in the place of transmission, half in 
the place of reception. 

6. Dividend and interest income. — In general, interest and divi- 
dend income paid by a U.S. corporation that earns more than 80 
percent of its income from foreign sources (an "80/20" company) is 
foreign source to the extent that the company's income is derived 
from foreign sources. A similar rule applies to interest paid by an 
''80/20 individual. The bill also restructures certain interest 
income exceptions. 

7. Allocation of interest and other expenses. — Generally, corporate 
members of affiliated groups must allocate all expenses between 
U.S. and foreign income on an affiliated group basis. With respect 
to interest expense "'^ allocation is based on the borrowing and 
assets of an expandea aifiliated group, which includes foreign mem- 



27 

bers. Unguaranteed debt of a lower-tier U.S. member may be treat- 
ed as supporting only that member's assets. If the unguaranteed 
debt rule comes into play, other members' debt is allocated to for- 
eign income to the extent necessary to reach the result that would 
have obtained absent the unguaranteed debt rule, if possible. The 
asset method of allocating interest expense is modified and the op- 
tional gross income method is eliminated. Tax-exempt income and 
assets are not taken into account for purposes of allocating ex- 
penses. The new interest allocation rules will be phased in over 
four years in certain cases. Other transitional relief is provided. 

Effective date. — The rules governing the source of income are 
generally effective for taxable years beginning after 1986, although 
the bill provides certain transitional relief. Certain rules applicable 
to foreign taxpayers apply to transactions occurring after March 
18, 1986. 

C. Taxation of U.S. Shareholders of Foreign Corporations 

1. Subpart F income generally. — Net gains from sales of passive 
assets, net gains from transactions in commodities, foreign curren- 
cy, and certain other property, and amounts equivalent to interest 
generally are taxed currently if earned by controlled foreign corpo- 
rations. 

2. Determination of U.S. control of foreign corporations. — The 
U.S. ownership requirement for imposition of the subpart F rules is 
amended. For the subpart F rules to apply to a foreign corporation, 
more than 50 percent of the vote or value (not merely vote) of that 
corporation must belong to 10-percent U.S. shareholders. Similarly, 
for the foreign personal holding company rules to apply, more than 
50 percent of the vote or value of a foreign corporation must be 
owned by five or fewer U.S. individuals. 

3. De minimis tax haven income rule. — Present law is amended to 
reduce the 10 percent threshold for foreign base company income 
to 5 percent of gross income. 

4. Possessions-chartered corporations. — The exception in the sub- 
part F rules for possessions-chartered corporations is repealed sub- 
ject to a transition rule. 

5. Foreign investment companies (FICs). — Present law is amended 
to require either payment of an interest charge on eventual recog- 
nition of income earned by U.S. investors through passive FICs 
(subject to a gain limitation) or current recognition, and to apply 
these rules to U.S. investors irrespective of the degree of aggregate 
U.S. ownership. 

6. Application of accumulated earnings tax (AET) and personal 
holding company (PHC) tax to foreign corporations. — Present law is 
amended to allow foreign corporations a net capital gain deduction 
for purposes of calculating the AET or PHC tax only if the gains 
are taxed by the United States at the corporate level. This provi- 
sion applies to transactions occurring after March 1, 1986. 

7. Delayed effective date for 198^^ amendment to earnings and 
profits rules. — 'The bill extends through 1987 the delay in the appli- 
cation to foreign corporations of the 1984 Act's amendments to the 
earnings and profits rules relating to installment sales. 



28 

Effective date. — Except as indicated above, the bill's rules appli- 
cable to income earned through foreign corporations are generally 
effective for taxable years beginning after 1986. 

D. Special Tax Provisions for U.S. Persons 

1. Possession tax credit. — For section 936 companies, the passive 
income limitation is reduced from 35 to 25 percent, and the re- 
quired cost sharing payment is increased to 110 percent of the 
present-law cost sharing payment. The bill also requires an in- 
crease in the cost sharing payment (20 percent above present law) 
for purposes of the 50/50 profit split method. Under the bill, 
income from loans for active business assets and development 
projects in qualified Caribbean Basin Initiative countries is eligible 
for U.S. tax exemption. Compliance rules are provided. In addition, 
the requirement that funds be received in a possession to qualify 
for the section 936 credit does not apply to active business income 
from an unrelated party. Finally, section 936 treatment is extended 
to the U.S. Virgin Islands. 

3. Taxation of U.S. employees of Panama Canal Commission. — 
The bill clarifies that the Panama Canal Treaty and its implement- 
ing agreements do not exempt U.S. taxpayers from U.S. tax. The 
bill provides that Commission and Defense Department employees 
are entitled to certain tax-free allowances like those available for 
State Department employees. These provisions apply for taxable 
years beginning after 1986. 

. S. Private sector earnings of Americans aboard. — The bill reduces 
the maximum annual exclusion for foreign earned income of Amer- 
icans working abroad, from the present $80,000 to $70,000. It denies 
this exclusion to Americans in foreign countries to which travel is 
prohibited by law. These provisions are effective for taxable years 
beginning after 1986. 

E. Treatment of Foreign Taxpayers 

1. Branch profits tax. — The branch profits tax proposed by the 
President as a substitute for the present dividend withholding tax 
is generally adopted. The bill generally retains present law (but 
with a reduction of present law's 50 percent income threshold to 10 
percent) when a treaty allows present law to apply but would not 
allow a branch profits tax to apply. Interest payments of foreign 
corporations are subject to tax if 10 percent of their gross income 
(rather than 50 percent as under present law) has a U.S. connec- 
tion. The bill does not override treaties, including those regarding 
dividend and interest payments, except in treaty shopping cases. 
These rules are effective for taxable years beginning after 1986. 

2. Retain character of effectively connected income. — The bill 
treats income or gain as effectively connected with a U.S. trade or 
business if it is attributable to a different taxable year and would 
have been so treated if it had been taken into account in the other 
year. Removal of an asset from U.S. tax jurisdiction by a foreign 
person is a taxable event. These rules apply to taxable years begin- 
ning after 1986. 

3. Tax-free exchanges by expatriates. — The tax-avoidance expatri- 
ate rules under present law are applied to gains on the sale of 
property the basis of which was determined by reference to U.S. 



29 

property. This rule applies to sales or exchanges of property re- 
ceived in exchanges after March 1, 1986. 

4. Study of excise tax on insurance premiums paid to foreign in- 
surers. — The bill mandates a Treasury study on the effect of treaty 
waivers of the excise tax on casualty reinsurance premiums on the 
U.S. reinsurance industry. 

5. Definition of resident alien. — The bill provides that, in deter- 
mining whether an alien individual is a U.S. resident for U.S. 
income tax purposes under the 1984 Act's substantial presence test, 
days in which a professional athlete is present in the United States 
competing in certain charitable sports events will not be counted. 
This provision applies to periods after the bill's date of enactment. 

F. Foreign Currency Exchange Gain or Loss 

The tax treatment of exchange gain or loss, including character, 
source, and timing, is clarified. Generally, exchange gain or loss 
arises if the exchange rate fluctuates between the date an item is 
taken into account for tax purposes and the date it is paid. In gen- 
eral, the bill provides that exchange gain or loss is ordinary in 
nature. To the extent provided by regulations, a special rule will 
require a taxpayer to recognize gain or loss currently with respect 
to an item that is "hedged" by an offsetting position (e.g., a foreign 
currency futures contract). All business entities that account for 
foreign operations in a foreign currency are generally required to 
use a profit and loss translation method. For purposes of the direct 
foreign tax credit and the indirect foreign tax credit, a foreign tax 
is generally calculated on the basis of the exchange rate in effect 
on the date the related income is included by a U.S. person (the 
Bon Ami rule). 

These rules are effective for taxable years beginning after 1986. 

G. Tax Treatment of Possessions 

1. U.S. Virgin Islands. — The Virgin Islands will continue to use 
the mirror code. The Virgin Islands inhabitant rule is repealed for 
all open years. To be exempt from U.S. withholding tax, 65 percent 
of a Virgin Islands corporation's income must be effectively con- 
nected with a trade or business in a possession or in the United 
States. Anti-abuse rules are provided. 

2. Guam, the Commonweath of the Northern Mariana Islands 
(CNMI), and American Samoa. — After 1986, full authority will be 
granted to Guam and the CNMI to determine their own income tax 
laws (as American Samoa currently does). To avoid U.S. withhold- 
ing tax, 65 percent of a possession corporation's income must be ef- 
fectively connected with a trade or business in a possession or in 
the United States. Anti-abuse rules are provided. 

Effective da^e.— The bill's rules coordinating United States and 
possessions taxation generally apply to taxable years beginning 
after 1986, or as soon as the applicable possession enters into an 
implementation agreement with the United States in tax matters. 

H. Other Provisions 

1. Transfer prices for imports. — Importers cannot claim a transfer 
price for income tax purposes that is higher than would be consist- 



30 

ent with the value they claim for customs purposes. This provision 
applies to transactions entered into after March 18, 1986. 

2. Income of foreign governments. — The bill provides that the tax 
exemption for foreign governments applies only to investment 
income. It provides that pa3mients from a controlled entity that en- 
gages in U.S. trade or business are not investment income, so they 
are taxable. The foreign government exception will not apply to 
controlled entities that engage in any commercial activities any- 
where in the world. This provision is effective on July 1, 1986. 

3. Dual resident companies. — Losses of a U.S. corporation that 
offset a foreign corporation's foreign tax on income that the United 
States does not subject to tax cannot offset any income of any other 
corporation for U.S. tax purposes. This provision applies to taxable 
years beginning after 1986. 

4. Earnings stripping: interest paid to related tax-exempt par- 
ties. — The bill denies the deduction for net interest paid or accrued 
to related tax-exempt parties (other than ESOPs) to the extent 
such interest exceeds 50 percent of taxable income before the net 
interest deduction. This provision is effective for taxable years be- 
ginning after September 30, 1986. 

5. Withholding on foreign investors in U.S. partnerships. — The 
bill requires that domestic partnerships withhold on certain distri- 
butions to foreign partners. This provision is effective for taxable 
years beginning after 1986. 

6. Compliance provisions applicable to U.S. persons resident 
abroad. — The bill requires that passport and green card applicants 
complete an IRS information return. It also requires withholding 
on pension payments to persons with foreign addresses. These pro- 
visions apply to taxable years beginning after 1986. 

7. Dividends received deduction. — The deduction for dividends re- 
ceived from foreign corporations is modified to extend to dividends 
from corporations earning either any amount of U.S.-connected 
income or dividends from U.S. subsidiaries. The deduction is limit- 
ed to 10-percent U.S. corporate shareholders, and is to be calculat- 
ed on a net basis. Any amount eligible for the deduction is to be 
treated as U.S. source. 



Title X. Insurance Products and Companies 

A. Insurance Policyholders 

1. Interest on installment payments of life insurance proceeds 

The bill repeals the provision of present law under which the 
income on the proceeds of life insurance that are paid to a surviv- 
ing spouse as periodic payments are includible in gross income only 
to the extent that the amount of income paid during any taxable 
year exceeds $1,000. The provision is effective for amounts received 
by a beneficiary with respect to deaths occurring after December 
31, 1986. 

2. Treatment of structured settlement agreements 

The bill repeals the special treatment of structured settlement 
agreements and replaces those rules with a new deduction election 
for a taxpayer assuming a liability to make damage payments to 
an injured party. The provision is effective for assignments entered 
into in taxable years beginning after December 31, 1986. 

3. Treatment of policies to cover prearranged funeral expenses 

Life insurance policies purchased to cover payment of burial ex- 
penses or prearranged funeral expenses may be treated as life in- 
surance contracts if the initial death benefit is $5,000 or less in the 
aggregate per policyholder, and if the policies provide for fixed 
annual death benefit increases not exceeding certain amounts. 

4- Treatment of interest on loans from, life insurance policies 

A deduction for interest on policyholder loans is not allowed in 
the case of loans aggregating more than $50,000 per officer, em- 
ployee, or owner of an interest in any trade or business carried on 
by the taxpayer. The provision is effective for interest on loans 
under policies purchased after June 20, 1986. 

B. Life Insurance Companies 

1. Special life insurance company deduction 

Under the bill, the special life insurance company deduction 
equal to 20 percent of tentative life insurance company taxable 
income (LICTI) is repealed, generally effective for taxable years be- 
ginning after December 31, 1986. A special rule provides that, in 
the case of a life insurance company owning stock of another com- 
pany through a partnership, which stock was acquired January 14, 
1981, income or deductions attributable to such ownership are 
taken into account at a rate which provides the same tax benefit to 
the life insurance company as is provided under present law, with- 
out regard to the reduction of the top corporate rate under the bill. 

(31) 



32 

2. Operations loss deduction of insolvent companies 

Under the bill, a life insurance company may apply current 
losses from operations and loss carryovers against the increase in 
its taxable income attributable to amounts deemed distributed 
from the policyholder surplus account, if the company is required 
to be liquidated pursuant to a court order and certain other crite- 
ria are met. 

S. Treatment of electing mutual life insurance company 

The requirement under the Deficit Reduction Act of 1984 that 
stock life insurance company affiliates of a certain mutual life in- 
surance company parent, which elects to be taxed as a property 
and casualty insurance company, are treated as mutual life insur- 
ance companies is suspended for the taxable years beginning after 
December 31, 1986, and before January 1, 1992. 

4- Physicians ' and surgeons ' mutual protection associations 

The bill provides that contributions to a pooled malpractice in- 
surance association are currently deductible to the extent they do 
not exceed the cost of a commercial insurance premium and are in- 
cluded in the association's income, and that refunds of such contri- 
butions are deductible to the fund only to the extent included in 
income of the recipient. The provision applies to associations oper- 
ating under State law prior to January 1, 1984, and is effective for 
contributions and refunds after the date of enactment of the bill. 

C. Property and Casualty Insurance Companies 

1. Inclusion in income of 20 percent of unearned premium re- 

serves 

Under the bill, 20 percent of the annual increase in unearned 
premiums is included in property and casualty insurance company 
income. Also, 20 percent of the unearned premium reserve out- 
standing at the end of the most recent taxable year beginning 
before January 1, 1987, is included ratably over a seven and one- 
half year period commencing with the first taxable year beginning 
after December 31, 1986. 

In the case of insurance against default in the payment of princi- 
pal or interest on securities with a maturity of five years or more 
(i.e., bond insurance), the percentage of unearned premiums includ- 
ed in income is 10 percent, rather than 20 percent. 

If a property and casualty insurance company ceases to be sub- 
ject to tax as a property and casualty insurance company, the re- 
maining portion (if any) of the amount to be ratably included over 
seven and one-half years is includible for the taxable year preced- 
ing the taxable year in which the company ceases to be taxed as a 
property and casualty insurance company. 

2. Loss reserve deductions 

The deduction for unpaid losses (i.e., reported losses that have 
not been paid, estimates of losses incurred but not reported, resist- 
ed claims, and unpaid loss adjustment expenses) is limited to the 
amount of discounted unpaid losses. This provision applies to prop- 
erty and casualty lines of business reported on Schedules O and P 



33 

of the annual statement approved by the National Association of 
Insurance Commissioners, to accident and health reserves (other 
than life insurance reserves subject to discounting under life insur- 
ance company tax rules), international and reinsurance lines of 
business, and to loss reserves of title insurance companies (regard- 
less of whether denominated as unearned premium reserves under 
applicable State law). This treatment applies to loss reserves of 
both property and casualty insurance companies and life insurance 
companies to the extent such loss reserves are not subject to life 
insurance company reserve rules. 

The amount of the discounted unpaid losses as of the end of any 
taxable year attributable to any accident year is determined by 
using (1) the gross amount to be subjected to discounting (i.e., the 
undiscounted loss reserves), (2) the pattern of payment of claims, 
including the duration in years over which the claims will be paid, 
and (3) the rate of interest to be assumed in calculating the dis- 
counted reserve. 

The interest rate to be applied is five percent for all accident 
years beginning before or in 1987, and 75 percent of a five-year 
rolling average of the applicable Federal midterm rate for later pe- 
riods. The five-year rolling average is computed by taking into ac- 
count the Federal midterm rate for calendar months beginning 
after December 31, 1986. The loss payment patterns are to be pro- 
mulgated by the Secretary of the Treasury for 1987 and every fifth 
year thereafter, taking account of aggregate industry experience 
for each line of business. 

A company may elect to use its own loss payment pattern experi- 
ence. Special rules are provided for long-tail lines and for interna- 
tional and reinsurance lines of business. The provision is effective 
for taxable years beginning after 1986, with a fresh start provision 
and special treatment for reserve strengthening after March 1, 
1986. 

3. Repeal of protection against loss account 

Effective for taxable years beginning after December 31, 1986, 
the deduction for contributions to the protection against loss (PAL) 
account for mutual property and casualty companies is repealed. 
Balances in the account are includible in income than over the 
first five years beginning after December 31, 1986. 

4. Revision of special treatment for small companies 

Under the bill, property and casualty companies (whether stock 
or mutual) with net written premiums or direct written premiums 
(whichever is greater) that do not exceed $350,000 for the taxable 
year are exempt from tax. Property and casualty companies 
(whether stock or mutual) with net written premiums or direct 
written premiums (whichever is greater) that exceed $350,000, but 
do not exceed $1,200,000, may elect to be taxed only on taxable in- 
vestment income. In the case of a controlled group, these amounts 
are determined on a group basis. The provisions are effective for 
taxable years beginning after December 31, 1986. 



Title XL Minimum Tax Provisions 

A. Individual Minimum Tax 

The present-law individual alternative minimum tax is retained 
with the following modifications. The exemption amount is phased 
out at a rate of 25 cents on the dollar for alternative minimum tax- 
able income in excess of $150,000 ($112,500 for single taxpayers and 
$75,000 for married taxpayers filing separately). Accelerated depre- 
ciation on all property placed in service after 1986 (other than 
property granted a transitional exception for regular tax deprecia- 
tion and investment tax credit purposes) is a preference to the 
extent different from alternative depreciation. Use of the complet- 
ed contract method of accounting and of the installment method by 
dealers are preferences. Certain passive farm losses are denied, and 
the rule limiting passive losses for regular tax purposes applies 
under the minimum tax without a phase-in. 

Certain timing preferences (such as depreciation) are measured 
for post- 1986 property on an aggregated basis, instead of item-by- 
item without netting. A credit is allowed against the regular tax 
for prior years' minimum tax liability attributable to timing prefer- 
ences. The foreign tax credit is not permitted to offset more than 
90 percent of tentative minimum tax liability. The provision ap- 
plies to taxable years beginning after December 31, 1986. 

B. Corporate Minimum Tax 

An alternative minimum tax, similar to the individual minimum 
tax, replaces the present-law add-on tax. The rate is 20 percent, 
and there is a $40,000 exemption amount (phased out at the rate of 
25 cents on the dollar for alternative minimum taxable income in 
excess of $150,000). The items of tax preference include the corpo- 
rate preferences under present law, accelerated depreciation (to the 
extent different from alternative depreciation) for all property 
(other than transitional property) placed in service after 1986, in- 
tangible drilling costs (with the same offset for net oil and gas 
income applying under present law for individuals), use of the com- 
pleted contract method of accounting and of the installment 
method for dealers, capital construction funds for shipping compa- 
nies, and one-half of the excess of pre-tax book income of the tax- 
payer (including members of a group filing a consolidated tax 
return for the year), over other alternative minimum taxable 
income. 

Rules similar to those under the individual alternative minimum 
tax apply to incentive credits, the foreign tax credit, net operating 
losses, and the credit for minimum tax liability attributable to 
timing preferences. The provision applies to taxable years begin- 
ning after December 31, 1986. 

(34) 



Title XII. Pensions and Deferred Compensation; Employee 
Benefits; ESOPs 

A. Treatment of Tax-Favored Savings 

1. Individual retirement arrangements (IRAs) 

Under the bill, no deductible IRA contribution can be made for 
an individual's taxable year if the individual is an active partici- 
pant in an employer-maintained retirement plan for any part of 
the plan year ending with or within the individual's taxable year. 
For purposes of this rule, an employer-maintained retirement plan 
means (1) a qualified pension, profit-sharing, or stock bonus plan 
(sec. 401(a)), (2) a qualified annuity plan (sec. 403(a)), (3) a simplified 
employee pension (sec. 408(k)), (4) a plan established for its employ- 
ees by the United States, by a State or political subdivision, or by 
any agency or instrumentality of the United States or a State or 
political subdivision, or (5) a plan described in section 501(c)(18). In 
addition, an individual is not permitted to make deductible IRA 
contributions if amounts are contributed, on an elective or nonelec- 
tive basis, on the individual's behalf by an employer for a tax-shel- 
tered annuity (sec. 403(b)). 

The bill provides that individuals who are active participants 
(and who, therefore, are not eligible to make deductible IRA contri- 
butions for a taxable year) may make nondeductible IRA contribu- 
tions. The limit on nondeductible contributions for a taxable year 
is the same as the limit on deductible IRA contributions (i.e., the 
lesser of 100 percent of compensation (earned income in the case of 
a self-employed individual) or $2,000 ($2,250 in the case of an addi- 
tional contribution to a spousal IRA)). Earnings on nondeductible 
IRA contributions are not subject to tax until they are withdrawn. 

In addition to the foregoing provisions limiting the deductibility 
of IRA contributions, the bill expresses the sense of the Senate that 
the conferees on the tax reform bill should give the highest priority 
to retaining the maximum possible tax benefits for individual re- 
tirement arrangements, to encourage their use as a principal vehi- 
cle for ensuring retirement security. 

Under the bill, the rules relating to spousal IRA contributions 
are amended to eliminate the requirement that the spouse have no 
earned income for the year in order to be eligible for the spousal 
IRA contribution. 

The bill provides that no deduction is allowed for interest on in- 
debtedness incurred or continued to make an IRA contribution. 
Under the bill, the interest deduction is denied whether or not a 
deduction is allowed for the IRA contribution. 

The bill also amends present law to permit the acquisition by 
IRAs of certain gold and silver coins issued by the United States. 

The provisions are effective for taxable years beginning (or loans 
made) after December 31, 1986. 

(35) 



36 

2. Qualified cash or deferred arrangements (sec. 401(k) plans) 

Under the bill, effective for taxable years beginning after Decem- 
ber 31, 1986, the maximum amount that an employee can elect to 
defer for any taxable year under all cash or deferred arrangements 
in which the employee participates is limited to $7,000. The $7,000 
cap is adjusted for inflation by reference to percentage increases in 
the social security wage base at the same time and in the same 
manner as the dollar limits on annual benefits under defined bene- 
fit pension plans (sec. 415(d)). 

The $7,000 cap on elective deferrals (as indexed) is increased by 
up to $2,500 in the case of certain investments in employer securi- 
ties. The amount of the increase in the annual cap for an individ- 
ual equals the lesser of (1) $2,500 or (2) the amount of elective de- 
ferrals for the year invested in employer securities and held by an 
ESOP. 

Effective generally for taxable years beginning after December 
31, 1988, the bill modifies the special nondiscrimination test appli- 
cable to qualified cash or deferred arrangements by (1) clarifying 
the rules for aggregating elective contributions with certain none- 
lective contributions for purposes of the special nondiscrimination 
test; (2) redefining the group of highly compensated employees to 
conform to the new uniform definition of highly compensated em- 
ployees applicable generally to qualified plans and employee bene- 
fit programs; (3) establishing a mechanism for the return of contri- 
butions that violate the special nondiscrimination test; and (4) im- 
posing an excise tax on contributions that are not returned (or for- 
feited) within a specified period of time. 

The bill modifies certain present-law restrictions and imposes 
several additional restrictions on qualified cash or deferred ar- 
rangements. First, the bill provides that distributions may be made 
to a participant in a qualified cash or deferred arrangement on ac- 
count of the sale of a subsidiary or the termination of the plan of 
which the arrangement is a part. 

The bill limits hardship withdrawals under a qualified cash or 
deferred arrangement to the amount of an employee's elective de- 
ferrals. In addition, the bill provides that a qualified cash or de- 
ferred arrangement cannot require, as a condition of participation 
in the arrangement, that an employee complete a period of service 
with the employer (or employers) maintaining the plan in excess of 
one year of service. 

Under the bill, an employer generally may not condition, either 
directly or indirectly, contributions and benefits (other than match- 
ing contributions) upon an employee's elective deferrals. 

The bill provides that qualified cash or deferred arrangements 
are not available to employees of State or local governments. 

3. Employer matching contributions and employee contribu- 

tions 

Under the bill, a special nondiscrimination test is applied to em- 
ployer matching contributions and employee contributions under 
all qualified defined contribution plans and employee contributions 
under a defined benefit plan (to the extent allocated to a separate 
account on behalf of the employee). This nondiscrimination test ap- 



37 

plies in lieu of the usual nondiscrimination rules applicable to the 
amount of contributions under qualified plans and is similar to the 
special nondiscrimination test applicable to qualified cash or de- 
ferred arrangements. 

The provisions are effective for plan years beginning after De- 
cember 31, 1988. 

J^. Unfunded deferred compensation plans of State and local 
governments 

The bill (1) requires that amounts deferred on a before-tax basis 
by an employee under a simplified employee plan (SEP) or a quali- 
fied cash or deferred arrangement (sec. 401(k)) that is grandfa- 
thered under the bill be taken into account in determining whether 
the employee's deferrals under an eligible deferred compensation 
plan exceed the limits on deferrals under the eligible plan; (2) 
modifies the distribution requirements applicable to eligible de- 
ferred compensation plans; (3) permits rollovers between eligible 
deferred compensation plans; and (4) modifies the rule that defer- 
rals under an eligible plan are includible in an employee's income 
when made available to the employee. An exception is provided for 
qualified State judicial plans. 

The provisions are effective for taxable years beginning after De- 
cember 31, 1988. 

5. Deferred annuity contracts 

Under the bill, if an annuity contract is held by a person who is 
not a natural person (e.g., a corporation or a trust is not a natural 
person), then the contract is not treated as an annuity contract for 
Federal income tax purposes and the investment income on the 
contract for any taxable year is treated as ordinary income re- 
ceived or accrued by the owner of the contract during the taxable 
year. 

In addition, the bill modifies the circumstances under which the 
additional income tax on early withdrawals from deferred annuity 
contracts will be imposed to conform generally to the circum- 
stances under which the early withdrawal tax is imposed under 
qualified plans. 

The provisions are effective for years beginning after December 
31, 1986. 

6. Simplified employee pensions (SEPs) 

The bill revises the qualification requirements relating to SEPs 
to permit an employee to elect to have SEP contributions made on 
the employee's behalf or to receive the contributions in cash with- 
out being treated as having constructively received the amounts 
contributed to the SEP pursuant to the employee's election. 

Elective deferrals under a SEP are to be treated like elective de- 
ferrals under a qualified cash or deferred arrangement and, thus, 
are subject to the $7,000 (indexed) cap on elective deferrals. 

Consistent with the rules applicable to elective deferrals under a 
qualified cash or deferred arrangement or tax-sheltered annuity 
under present law, elective deferrals under a SEP are treated as 
wages for emplo5niient tax purposes. 



38 

The bill provides that the election to have amounts contributed 
to a SEP or received in cash is available only if at least 50 percent 
of the employees of the employer elect to have amounts contribut- 
ed to the SEP and is available only in a taxable year in which the 
employer maintaining the SEP has 25 or fewer employees as of the 
beginning of the year. 

In addition, elective deferrals under SEPs are subject to special 
nondiscrimination rules similar to the special nondiscrimination 
rules applicable to qualified cash or deferred arrangements. 

In addition, the bill makes miscellaneous changes to the SEP re- 
quirements to decrease the administrative burden of maintaining a 
SEP. 

The provisions are effective for years beginning after December 
31, 1986. 

7. Salary reduction permitted under section 501(c)(18) plans 

Under the bill, employees who participate in a section 501(c)(18) 
pension plan are permitted to elect to make deductible contribu- 
tions up to the lesser of $7,000 or 25 percent of the compensation of 
the employee includible in income for the taxable year subject to 
nondiscrimination rules similar to the rules applicable to qualified 
cash or deferred arrangements. 

The provision is effective for years beginning after December 31, 
1986. 

B. Nondiscrimination Requirements 

1. Minimum coverage requirements 

Under present law, a qualified plan is required to cover employ- 
ees in general rather than merely the employees of an employer 
who are officers, shareholders, or highly compensated. A plan gen- 
erally satisfies the present-law coverage rule if (1) it benefits a sig- 
nificant percentage (generally, 70 percent) of the employer's work- 
force (percentage test), or (2) it benefits a classification of employ- 
ees determined by the Secretary of the Treasury not to discrimi- 
nate in favor of employees who are officers, shareholders, or highly 
compensated (classification test). 

The bill (1) increases, to 80 percent of all employees, the level of 
coverage necessary to satisfy the "percentage test;" (2) replaces the 
"classification test" of present law with a "reasonable classification 
test" and provides the Treasury with guidance as to the manner in 
which the test is to be interpreted; (3) establishes an alternative 
method for satisfying the reasonable classification test ("alterna- 
tive reasonable classification test"); (4) clarifies the circumstances 
under which an employee will be treated as benefiting under a 
plan for purposes of the coverage rules; (5) permits, for purposes of 
satisfying the reasonable classification test, the exclusion from con- 
sideration of employees who have not satisfied certain minimum 
age and service requirements; (6) establishes a uniform objective 
definition of those employees in whose favor discriminatory cover- 
age is prohibited; (7) permits satisfaction of certain of the coverage 
rules on a controlled group or line of business basis; (8) establishes 
a definition of a line of business or separate operating unit with a 



39 

special safe-harbor rule; and (9) contains a special transition rule 
for certain dispositions or acquisitions of a business. 

The provision generally is effective for plan years beginning 
after December 31, 1988. A special effective date applies to plans 
maintained pursuant to a collective bargaining agreement. 

2. Minimum participation rule 

Under the bill, a plan is not a qualified plan unless it benefits at 
least (a) 50 employees or (b) 40 percent or more of all employees of 
the employer (if less). The requirement may not be satisfied by ag- 
gregating comparable plans. 

The provisions are generally effective for plan years beginning 
after December 31, 1988. A special effective date applies to plans 
maintained pursuant to a collective bargaining agreement. 

3. Vesting standards 

The bill amends the Code to provide that a plan (other than a 
top-heavy plan subject to separate vesting requirements) is not a 
qualified plan of an employer unless a participant's employer-pro- 
vided benefit vests at least as rapidly as under one of two alterna- 
tive minimum vesting schedules. The bill makes conforming 
amendments to ERISA. 

A plan satisfies the first schedule if a participant has a nonfor- 
feitable right to 100 percent of the participant's accrued benefit de- 
rived from employer contributions upon the participant's comple- 
tion of five years of service. A plan satisfies the second alternative 
schedule if a participant has a nonforfeitable right to at least 20 
percent of the participant's accrued benefit derived from employer 
contributions after three years of service, 40 percent at the end of 
four years of service, 60 percent at the end of five years of service, 
80 percent at the end of six years of service, and 100 percent at the 
end of seven years of service. 

A special rule is provided in the case of a multiemployer plan to 
require 100-percent vesting after 10 years of service. 

The provisions are generally applicable for plan years beginning 
after December 31, 1988, with respect to participants who perform 
at least one hour of service in a plan year to which the new provi- 
sions apply. A special effective date applies to plans maintained 
pursuant to a collective bargaining agreement. 

Jf. Integration of pension plans 

The bill provides that a plan is not to be considered discriminato- 
ry merely because the contributions and benefits of employees 
under the plan favor highly compensated employees if the plan 
meets the new requirements (i.e., the disparity limits) of the bill re- 
lating to the integration of contributions or benefits under quali- 
fied plans. 

Under the bill, a defined contribution plan meets the disparity 
limits for integrated plans only if the contribution percentage 
under the plan for compensation over the integration level does not 
exceed the lesser of (1) 200 percent of the contribution percentage 
for compensation up to the integration level or (2) the sum of the 
contribution percentage for compensation up to the integration 
level and the rate of the tax imposed on employers under the Fed- 



40 

eral Insurance Contributions Act (5.7 percent for 1986) as of the be- 
ginning of the plan year. 

A defined benefit pension plan meets the disparity limits for in- 
tegrated excess plans if (1) the benefit percentage for compensation 
above the integration level does not exceed 200 percent of the bene- 
fit percentage for compensation up to the integration level, and (2) 
any optional form of benefit, preretirement benefit, actuarial 
factor, or other benefit or feature provided by the plan with respect 
to remuneration in excess of the integration level specified by the 
plan for the year is provided with respect to remuneration that is 
not in excess of that level. 

A defined benefit pension plan meets the requirements for inte- 
grated offset plans if it provides that a participant's accrued bene- 
fit derived from employer contributions (sec. 411(c)(1)) may not be 
reduced by reason of the offset by more than 50 percent of the ben- 
efit that would have accrued without regard to the reduction. 

The provisions are effective for plan years beginning after De- 
cember 31, 1988. A special effective date applies to plans main- 
tained pursuant to a collective bargaining agreement. 

5. Benefits treated as accruing ratably for purposes of deter- 

mining top-heavy status 

Under the bill, a uniform accrual rule is used in testing whether 
a qualified plan is top-heavy (or super top-heavy). The provision ap- 
plies for plan years beginning after December 31, 1986. 

6. Modification of rules for benefit forfeitures 

The bill creates uniform rules for forfeitures under any defined 
contribution plan, effective for plan years beginning after Decem- 
ber 31, 1985. 

7. Uniform definition of highly compensated employees 

The bill provides a new uniform definition of the group of em- 
ployees in whose favor discrimination is prohibited ("highly com- 
pensated employees") that generally applies for purposes of the 
nondiscrimination rules for qualified plans and statutory employee 
benefit plans. 

An employee is treated as highly compensated with respect to a 
year if, at any time during the year or the preceding year, the em- 
ployee (1) was a 5-percent owner of the employer (as defined in sec. 
416(i)); (2) earned more than $100,000 in annual compensation from 
the employer; (3) earned more than $50,000 in annual compensa- 
tion from the employer and was a member of the top-paid group of 
employees, i.e., the top 20 percent of employees by pay during the 
same year; or (4) was an officer of the employer (as defined in sec. 
416(i)). The $50,000 and $100,000 thresholds are indexed by refer- 
ence to percentage increases in the social security taxable wage 
base 

C. Treatment of Distributions 

1. Uniform minimum distribution rules 

The bill extends the required benefit commencement date for 5- 
percent owners to all participants in a plan who are highly com- 



41 

pensated employees. In addition, the bill establishes a new sanction, 
as an alternative to plan disqualification, in the form of an excise 
tax for failure to satisfy the minimum distribution rules. 

The provisions generally apply to years beginning after Decem- 
ber 31, 1986. An exception is provided for certain individuals who 
made grandfathered designations under section 242 of TEFRA. 

2. Taxation of distributions 

The bill generally (1) phases out capital gains treatment over six 
years (except for certain grandfathered individuals); (2) eliminates 
10-year forward averaging (except for certain grandfathered indi- 
viduals who may elect 10-year averaging at present-law tax rates) 
and permits five-year forward averaging for lump-sum distributions 
received after attainment of age 59 Va; (3) modifies the present-law 
basis recovery rules for amounts distributed prior to a participant's 
annuity starting date; (4) eliminates on a phased-in basis (begin- 
ning in 1988) the special 3-year basis recovery rule of present law; 
(5) modifies the general basis recovery rules for amounts paid as an 
annuity; and (6) provides basis recovery rules for distributions from 
an IRA to which nondeductible contributions have been made. 

The provisions are generally effective for distributions made 
after December 31, 1986. The repeal of the special three-year basis 
recovery rule generally is effective with respect to any individual 
whose annuity starting date is after January 1, 1988. If the employ- 
ee's annuity starting date is after January 1, 1988, but on or before 
January 1, 1989, and the amount to be distributed during the first 
three years under the annuity is greater than the employee's total 
basis, then 50 percent of such basis may be recovered before any 
amounts are taxable. After the first 50 percent of the participant's 
basis has been recovered, the remaining 50 percent is to be recov- 
ered under the general pro-rata basis recovery rule for post-annu- 
ity starting date distributions. 

3. Uniform taxation of early distributions from qualified re- 

tirement plans 

The bill (1) generally extends the additional income tax on pre- 
mature distributions from an IRA (or for 5-percent owners under a 
qualified plan) to early distributions by any participant from any 
qualified retirement plan; (2) increases the additional income tax 
on premature distributions from 10 to 15 percent for all early dis- 
tributions other than distributions of income and employer match- 
ing contributions attributable to after-tax employee contributions 
and income attributable to nondeductible IRA contributions; (3) ex- 
empts certain hardship, early retirement, and ESOP distributions 
from the tax; and (4) requires that an employer offer an employee 
who separates from service and who elects to receive a lump-sum 
distribution the option of a direct transfer of the benefit to an IRA. 

The provisions generally are effective for distributions in taxable 
years beginning after December 31, 1986. 

.4. Treatment of loans 

The bill modifies the rules relating to the tax treatment of loans 
under qualified plans by (1) eliminating the ability of plan partici- 
pants to maintain permanent loan balances and (2) limiting the 



42 

availability of the extended repayment period for loans for princi- 
pal residences. 
The provision applies to loans made after December 31, 1986. 

D. Limits on Tax Deferral under Qualified Plans 

1. Adjustments to limitations on contributions and benefits 

under qualified plans 

The bill makes several changes to the overall limits on contribu- 
tions and benefits under qualified plans, tax-sheltered annuity pro- 
grams, and SEPs of private and public employers. 

The normal retirement age for purposes of the limit on benefits 
under a defined benefit pension plan is conformed to the social se- 
curity retirement age. If the retirement benefit under a defined 
benefit plan begins before the social security retirement age (pres- 
ently, age 65), then the $90,000 limitation on annual benefits gener- 
ally is reduced so that it is the actuarial equivalent of an annual 
benefit of $90,000 beginning at the social security retirement age. 
Under transition rules provided by the bill, benefits already ac- 
crued by a plan participant under an existing plan are not affected 
by the reductions for actuarial equivalence. 

Although cost-of-living adjustments will be made to the defined 
benefit plan limit beginning in 1988, no cost-of-living adjustments 
to the defined contribution plan limit will be made until the 
$30,000 defined contribution plan limit is equal to 25 percent of the 
defined benefit dollar limit. The method for calculating cost-of- 
living adjustments is determined by reference to the percentage in- 
creases in the social security taxable wage base. 

Under the bill, the class of employers whose employees are enti- 
tled to the special catch-up elections for tax-sheltered annuities is 
expanded to include employers that are health and welfare service 
agencies. 

The bill provides special rules for commercial airline pilots, par- 
ticipants in a qualified police or firefighters' pension plan, and for 
certain correctional officers. 

The bill provides a limit on the amount of compensation that 
may be taken into account under any plan. The $200,000 limit pres- 
ently applicable to top-heavy plans and SEPs is applied to all quali- 
fied plans, whether or not top-heavy (sec. 401(a)(17)). The limit on 
includible compensation will be increased at the same time and in 
the same manner as the dollar limits on benefits under a defined 
benefit plan. 

The provisions generally are effective for years beginning after 
December 31, 1986. Special rules are provided in the case of plans 
maintained pursuant to collective bargaining agreements. 

2. Adjustments to deduction (sec. 404) limitations 

The bill makes several changes to the limits on employer deduc- 
tions for contributions to qualified plans. The bill (1) repeals the 
limit carryforward applicable to profit-sharing and stock bonus 
plans and (2) extends the 25-percent of compensation combined 
plan deduction limit to any combination of a defined benefit pen- 
sion plan and a money purchase pension plan, profit-sharing, or 
stock bonus plan. 



43 

The provisions are effective for years beginning after December 
31, 1986. 

3. Excise tax on reversion of qualified plan assets to employer 

The bill imposes a 10-percent nondeductible excise tax on a re- 
version from a qualified plan. The tax is imposed on the person 
who received the reversion. The bill provides an exception to the 
excise tax on reversions in the case of transfers of assets from a 
defined benefit pension plan upon plan termination to an employee 
stock ownership plan (ESOP). 

The provision applies to reversions received after December 31, 
1985, with an exception for a certain employer. 

E. Miscellaneous Pension and Deferred Compensation Provisions 

1. Discretionary contribution plans 

Under the bill, effective for plan years beginning after December 
31, 1986, an employer's contribution to a profit-sharing plan is not 
limited to the employer's current or accumulated profits. This pro- 
vision applies without regard to whether the employer is tax- 
exempt. 

2. Requirement that collective bargaining agreements be bona 

fide 

Under the bill, it is clarified that no agreement will be treated as 
a collective bargaining agreement unless it is a bona fide agree- 
ment between bona fide employee representatives and one or more 
employers. 

3. Treatment of certain fishing boat crews as self-employed in- 

dividuals 

Under the bill, members of fishing boat crews (described in sec. 
3121(b)(20)) are treated as self-employed individuals for purposes of 
the rules relating to qualified pension, profit-sharing, or stock 
bonus plans. 

The provision is effective for taxable years beginning after De- 
cember 31, 1986. 

4. Cash out of certain accrued benefits 

The bill amends the rules of the Code and ERISA relating to 
cash outs of accrued benefits to require that, for purposes of deter- 
mining the present value of a participant's accrued benefit, a plan 
is to compute the first $3,500 of the present value of a benefit by 
using an interest rate no greater than the interest rate (deferred or 
immediate, whichever is appropriate) that would be used by the 
PBGC (as of the date of distribution) upon the plan's termination. 
The remaining portion of the present value of the benefit is to be 
determined by using an interest rate no greater than 120 percent 
of the PBGC interest rate. 

The provision is applicable for distributions after December 31, 
1984. However, it does not apply to distributions that were made 
after December 31, 1984, and before the date of enactment, if such 
distributions were made in accordance with the requirements of 
regulations issued under the Retirement Equity Act of 1984. 



44 

5. Time required for plan amendments, issuance of regula- 

tions, and development of section 401(k) master and pro- 
totype and model plans 

Under the bill, a delayed effective date is provided for plan 
amendments to comply with the provisions of the bill relating to 
qualified plans. 

Further, the bill provides that the Treasury Department is to 
issue final regulations by February 1, 1988, for (1) the rules relat- 
ing to the integration of benefits under qualified plans, (2) the cov- 
erage requirements applicable to qualified plans, (3) the amend- 
ments applicable to qualified cash or deferred arrangements (sec. 
401(k) plans), and (4) the new nondiscrimination rules for employer 
matching and employee contributions (sec. 401(m)). 

The bill provides that the Treasury Department is to publish, no 
later than May 1, 1987, a model plan document for qualified plans 
that include qualified cash or deferred arrangements, and to begin, 
by that date, issuing determination letters with respect to master 
and prototype plans that include qualified cash or deferred ar- 
rangements. 

6. Exemption from the survivor benefit requirements of the 

Retirement Equity Act of 1984 ("REA ") 

The bill exempts a plan from the survivor benefits requirements 
of REA if (1) the plan was established prior to January 1, 1954, as a 
result of an agreement between employee representatives and the 
Federal Government during a period of Government operation, 
under seizure powers, of a major part of the productive facilities of 
the industry, and (2) under the plan, participation is substantially 
limited to participants who, before January 1, 1976, ceased employ- 
ment covered by the plan. 

F. Employee Benefit Provisions 

1. Nondiscrimination rules for certain statutory employee ben- 
efit plans 

The bill establishes comprehensive nondiscrimination rules for 
certain statutory employee benefit plans. Under the bill, a highly 
compensated employee who is a participant in any discriminatory 
statutory employee benefit plan is taxed on the value of such em- 
ployee's employer-provided benefit under the plan. 

The bill (1) revises the nondiscrimination rules applicable to 
group-term life insurance plans and self-insured accident or health 
plans; (2) extends those rules to insured accident or health plans; 
(3) establishes a new nondiscrimination test applicable (at the elec- 
tion of the employer) to any type of statutory employee benefit 
plan, in lieu of the present-law nondiscrimination rules; (4) estab- 
lishes a concentration test applicable to both group-term life plans 
and accident or health plans, and an additional concentration test 
applicable only to group-term life plans; (5) establishes a uniform 
definition of highly compensated employee; (6) modifies the list of 
employees who may be excluded from consideration in applying the 
coverage rules; (7) permits satisfaction of the coverage rules on a 
controlled group or line of business basis; and (8) contains a special 
transition rule for certain dispositions or acquisitions of a business. 



45 

The provisions generally are effective for years beginning after 
December 31, 1986. A delayed effective date is provided for church 
plans. 

2. Deductibility of health insurance costs of self-employed in- 
dividuals 

The bill provides a deduction for 50 percent of the amounts paid 
for health insurance for a taxable year on behalf of a self-employed 
individual and the individual's spouse and dependents. No deduc- 
tion is allowable to the extent the deduction exceeds the self-em- 
ployed individual's net earnings from self emplojnnent (sec. 1402(a)) 
for the taxable year. In addition, no deduction is allowable for any 
taxable year for which the self-employed individual is eligible to 
participate (on a subsidized basis) in a health plan of an employer 
of the self-employed individual or such individual's spouse. 

The provision is effective for taxable years beginning after De- 
cember 31, 1986. 

S. Exclusions for educational assistance programs and quali- 
fied group legal services made permanent 

The bill retroactively makes permanent the exclusions from 
gross income for educational assistance and group legal services 
and the tax exemption for qualified group legal services organiza- 
tions. 

In addition, the bill increases the cap on annual excludable edu- 
cational assistance benefits to $5,250 from $5,000. This cap is in- 
dexed, under the bill, by reference to percentage increases in the 
social security taxable wage base. 

The provisions generally are effective (1) in the case of education- 
al assistance benefits, for taxable years beginning after December 
31, 1985, and (2) in the case of group legal services benefits and the 
tax exemption for qualified group legal services organizations, for 
taxable years ending after December 31, 1985. A special rule is pro- 
vided for group legal services benefits provided under a cafeteria 
plan. 

4. Tax treatment of qualified campus lodging 

The bill provides that, for Federal tax purposes, the fair market 
value of the use (on an annualized basis) of qualified campus lodg- 
ing furnished by, or on behalf of, a school, college, or university is 
to be treated as not greater than five percent of the appraised 
value for the lodging, but only if, under Treasury regulations, an 
independent appraisal of the fair market value is obtained by a 
qualified appraiser. 

The provision is effective for taxable years or periods beginning 
after December 31, 1985. 

5. Health benefits for retirees 

The bill provides that, for purposes of calculating an employer's 
deduction for contributions to a welfare benefit fund, projected in- 
creases in medical costs may be taken into account in the funding 
for post-retirement medical benefits. The amount of such projected 
increases to be used is determined under an index specified by the 
Secretary of the Treasury. 



46 

The provision is effective for taxable years beginning after De- 
cember 31, 1986. 

6. Accrued vacation pay 

Under the bill, the special rule allowing a deduction for additions 
to a reserve account for vacation pay (sec. 463) is limited to the va- 
cation pay that is paid during the current taxable year or within 
8V2 months after the close of the taxable year of the employer with 
respect to which the vacation pay was earned by the employees. 

The provision is effective for taxable years beginning after De- 
cember 31, 1986. 

G. Employee Stock Ownership Plans (ESOPs) 

1. Repeal of employee stock ownership credit 

The bill repeals the special payroll-based ESOP tax credit for 
compensation paid or accrued after December 31, 1986. 

2. Certain additional tax benefits relating to ESOPs 

The bill permits an exclusion from the gross estate of 50 percent 
of the qualified proceeds from a qualified sale of employer securi- 
ties. Under the bill, a qualified sale means any sale of employer se- 
curities (within the meaning of sec. 409(1)) by the executor of an 
estate to (1) an ESOP, or (2) an eligible worker-owned cooperative 
(as defined in sec. 1042(c)(2)). 

Under the bill, the deduction for dividends paid on ESOP stock is 
expanded to apply to dividends that are used to repay ESOP loans 
used to acquire the stock on which the dividends are paid. 

The bill modifies the 50-percent exclusion for interest paid on se- 
curities acquisition loans (sec. 133) in two respects. First, the bill 
provides that the exclusion is also available with respect to a loan 
to a corporation to the extent that, within 30 days, employer secu- 
rities are transferred to the plan in an amount equal to the pro- 
ceeds of the loan and such contributions are allocable to partici- 
pants' accounts within one year after the date of the loan. Second, 
under the bill, a lender eligible for the interest exclusion is amend- 
ed to include a regulated investment company (as defined in sec. 
851). 

The provision is effective for years beginning after December 31, 
1986. 

J. Changes in qualification requirements relating to ESOPs 

Under the bill, additional requirements are provided for any 
ESOP. These additional qualification requirements (1) permit dis- 
tributions upon termination of an ESOP, (2) modify the distribution 
and put option requirements, (3) modify the special limits on alloca- 
tions of contributions to an ESOP to conform the definition of 
highly compensated employee to the new definition provided for 
qualified plans generally, (4) require stock bonus plans to satisfy 
the put option requirements applicable to ESOPs, and (5) eliminate, 
with respect to ESOPs maintained by closely held newspaper pub- 
lishers, the passthrough voting requirements. 

The provision permitting distributions upon plan termination 
generally is effective for termination distributions made after De- 



47 

cember 31, 1984. The distribution requirements and the extension 
of the put option requirement to stock bonus plans are effective for 
distributions attributable to stock acquired after December 31, 
1986. The modifications of the put option requirement are effective 
with respect to stock acquired after the date of enactment. The 
modified definition of highly compensated employees is effect, e for 
years beginning after December 31, 1986. 



Title XIII. Research and Development 

A. Incremental Research Tax Credit; University Basic Research 

Credit 

Incremental credit. — The bill extends the 25-percent incremental 
research tax credit for four additional years, i.e., for qualified re- 
search expenditures paid or incurred through December 31, 1989. 
The bill also provides a modified definition of qualified research for 
purposes of the extended credit, effective for taxable years begin- 
ning after 1985. 

University credit. — The university basic research credit is modi- 
fied. Under the bill, a 20-percent tax credit applies to the excess of 
(1) 100 percent of corporate cash expenditures for university basic 
research over (2) the sum of (a) the greater of two fixed research 
floors plus (b) an amount reflecting any decrease in nonresearch 
giving to universities by the corporation as compared to such 
giving during a fixed base period, as adjusted for inflation. This 
provision is effective for taxable years beginning after 1985. 

Credit use limitation. — The general limitation on use of business 
credits applies to the research credit, effective for taxable years be- 
ginning after 1985. 

B. Allocation of Research and Experimental Expenditures 

Under the bill, for taxable years beginning generally after 
August 1, 1986, and on or before August 1, 1987, the application of 
the research expense allocation rule in Treasury Regulation section 
1.861-8 is modified to provide generally that 75 percent of U.S.-in- 
curred research expense may be allocated to domestic income, with 
the remainder apportioned on the basis of sales or gross income. 

C. Treatment of Computer Software Royalties for Certain Tax Pur- 

poses 

An exception from the definition of personal holding company 
income and foreign personal holding company income is provided 
for computer software royalties received by certain corporations 
that are actively engaged in the business of developing computer 
software, effective for past and future years. 

(48) 



Title XIV. Tax Shelters; Real Estate; Interest Expense 

A. Limitations on Losses and Credits from Passive Activities 

Deductions from passive activities, to the extent that they exceed 
income from all such activities (exclusive of portfolio income) gen- 
erally may not be deducted against other income of the taxpayer. 
Similarly, credits from passive activities generally are limited to 
the tax allocable to the passive activities. Suspended losses and 
credits are carried forward and treated as deductions and credits 
from passive activities in the next taxable year. When the taxpayer 
disposes of his entire interest in an activity, any remaining sus- 
pended loss incurred in connection with that activity is allowed in 
full. 

Passive activities are defined to include trade or business activi- 
ties in which the taxpayer does not materially participate (e.g., a 
limited partnership interest in an activity), and rental activities. 
Passive activities do not include working interests in oil and gas 
property in which the taxpayer's form of ownership does not limit 
liability. In the case of rental real estate activities in which an in- 
dividual actively participates, up to $25,000 of losses (and credits, in 
a deduction-equivalent sense) from all such activities may be taken 
in each year against non-passive income of the taxpayer. This 
amount is phased out ratably between $100,000 and $150,000 of ad- 
justed gross income (determined without regard to passive losses). 
Low-income housing credits may be taken (in a deduction-equiva- 
lent sense) under the $25,000 allowance against non-passive income 
without regard to whether the individual actively participates. 

The provision generally applies to individuals, estates, trusts, 
and personal service corporations (as defined for purposes of the 
provision). Certain closely held corporations are subject to a more 
limited rule under which passive losses and credits may not be ap- 
plied to offset portfolio income. The provision is effective for tax- 
able years beginning after December 31, 1986, but is phased in over 
5 years for activities in which the taxpayer invested prior to the 
bill's date of enactment. During the transitional period, the 
amount of excess losses and credits from such activities that are 
disallowed is limited to 35 percent in 1987, 60 percent in 1988, 80 
percent in 1989, 90 percent in 1990, and 100 percent in 1991 and 
thereafter. 

B. Extension of At-Risk Rules to Real Estate Activities 

The at-risk rules are extended to the activity of holding real 
property, with an exception for qualified nonrecourse financing 
which is secured by real property used in the activity. Under this 
rule, real estate joint ventures may obtain financing from an other- 
wise qualified lender who has an equity interest in the venture, but 
seller financing is not treated as qualified nonrecourse financing. 

(49) 



50 

The provision is effective with respect to property acquired after 
December 31, 1986. 

C. Tax Credit for Rehabilitation Expenditures 

The bill replaces the existing three-tier rehabilitation tax credit 
with a two-tier credit for qualified rehabilitation expenditures. The 
credit percentage is 20 percent for expenditures incurred in reha- 
bilitation of certified historic structures and 10 percent for rehabili- 
tation of buildings (other than certified historic structures) built 
before 1936. In general, the bill retains the structure of the existing 
rehabilitation credit, except the external walls requirement is 
tightened in the case of non-historic buildings and relaxed in the 
case of certified historic structures. In addition, the bill requires a 
basis adjustment for the full amount of the rehabilitation credit in 
the case of both historic and non-historic buildings. 

The modifications to the rehabilitation credit are generally appli- 
cable to property placed in service after December 31, 1986. 

D. Low-Income Housing Tax Credit 

The bill provides a new tax credit that may be claimed by 
owners of residential rental projects providing low-income housing. 
The credit is claimed annually for a period of 10 years. The annua- 
lized credit amounts have a present value of 60 percent or 30 per- 
cent of the basis attributable to qualifying low-income units, de- 
pending on the income of the tenant qualifying the unit for the 
credit. Initially, the annual credit rate is eight percent for units oc- 
cupied by individuals with incomes of 50 percent or less of area 
median income (as adjusted for family size) and four percent for a 
limited number of units occupied by individuals with incomes of be- 
tween 50 percent and 70 percent of area median income. 

Newly constructed properties, as well as existing properties 
which are transferred and substantially rehabilitated, are eligible 
for the credit. 

Residential rental projects are eligible for the credit only if a^ 
minimum of 20 percent of the housing units in the project are occu- 
pied by individuals with incomes of 50 percent or less of area 
median income, adjusted for family size, and the rent charged to 
tenants in units with respect to which the credit is allowable does 
not exceed a specified amount. Generally, projects are not eligi- 
ble for the credit if they receive tax-exempt bond financing. 

Newly constructed or newly acquired and substantially rehabili- 
tated housing receiving assistance under the HUD section 8 or the 
FmHA section 515 program are only eligible for the credit on units 
occupied by tenants with incomes of 50 percent or less of area 
median income. Federal grants and similar assistance must be ex- 
cluded from the basis on which the low-income credit is allowable. 
Certain existing federally assisted projects are eligible for the 
credit only if a minimum of 50 percent of the housing units are oc- 
cupied by individuals with incomes of 50 percent or less of area 
median income. These existing properties are eligible for a reduced 
credit on all residential rental units and are excepted from the sub- 
stantial rehabilitation requirement. Section 8 payments on all 
units eligible for the credit may not exceed prescribed amounts. 



51 

The qualifying basis of the credit is hmited to the amount at 
risk, with an exception for certain nonrecourse financing provided 
by lenders related to the taxpayer, and an exception for nonre- 
course financing (including seller financing) provided by charitable 
and social welfare organizations. 

Eligible projects must continuously comply with these require- 
ments for a 15-year period. The penalty for noncompliance is recap- 
ture of prior credits. 

The credit is effective for property placed in service after Decem- 
ber 31, 1986. 

E. Real Estate Investment Trusts 

The bill modifies several aspects of the requirements for qualifi- 
cation as, and the taxation of, real estate investment trusts 
("REITs"). Under the bill, relief is granted from certain sharehold- 
er and income and asset requirements for the first year that an 
entity otherwise qualifies as a REIT. In addition, relief is granted 
from certain income and asset requirements for the first year after 
a REIT receives new equity capital. REITs also are permitted to 
hold assets in wholly-owned subsidiaries under the bill. 

The bill modifies the definition of rents from real property to 
permit REITs to perform those services that would not result in 
the receipt of "unrelated business income" if performed by certain 
tax-exempt entities, without using an independent contractor. The 
bill also includes in the definition of rents from real property and 
the definition of interest, rent or interest that is based on the net 
income of the tenant or debtor, but only if such net income is based 
on amounts that would be treated as rents from real property if 
received directly by the REIT. 

The bill provides certain relief from the distribution requirement 
where a REIT has certain types of income that are not accompa- 
nied by the receipt of cash. The REIT is required to pay tax on 
amounts not distributed, however. In addition, the safe harbor 
under which sales by a REIT may not be treated as prohibited 
transactions is expanded, the computation of the amount of capital 
gains dividends that a REIT may pay is modified, and one of the 
penalties relating to the distribution of deficiency dividends is 
eliminated. 

The provisions of the bill are effective for taxable years begin- 
ning after December 31, 1986. 

F. Mortgage-Backed Securities 

The bill provides a new vehicle, referred to as a "real estate 
mortgage investment company" or "REMIC" for the issuance of 
multiple class mortgage-backed securities. The REMIC may be in 
the form of a corporation, partnership or trust. The assets that the 
REMIC is permitted to hold generally are limited to mortgages se- 
cured by real property. 

If an entity qualifies as a REMIC, it is permitted to deduct 
amounts representing interest with respect to "regular interests" 
whether or not such interests otherwise would be treated as indebt- 
edness of the REMIC for Federal income tax purposes. The REMIC 
also is allowed a deduction for certain amounts paid to the "residu- 
al interests." The amount of this deduction generally is limited to 



52 

an amount that approximates the economic income of the residual 
interests. Thus, to the extent of these deductions allowed, the 
REMIC is in effect a conduit entity. 

Gain is recognized on the transfer of mortgages to a REMIC 
under the bill. The bill also clarifies the application of the original 
issue discount and market discount rules for certain mortgage- , 
backed securities. In addition, in order to assure only one set of 
Federal income tax consequences arise from the issuance of multi- 
ple class mortgage-backed securities, the bill treats certain other 
entities that otherwise may be used to issue mortgage-backed secu- 
rities as corporations. 

The provisions of the bill are effective for taxable years begin- 
ning after December 31, 1986. 

G. Interest Deduction Limitation 

No deduction is allowed for consumer interest (such as interest 
on car loans or credit card balances for personal expenditures), or 
for investment interest expense in excess of net investment income. 
The definitions of investment interest and investment income are 
modified to treat limited business interests as held for investment. 
Interest on the principal residence and a second residence of the 
taxpayer remain fully deductible. 

The effect of this provision is phased in, so that 35 percent of 
such interest would be disallowed in 1987, 60 percent in 1988, 80 
percent in 1989, and 90 percent in 1990; 100 percent disallowance 
commences in 1991. 



Title XV. Tax-Exempt Bonds 
A. Tax-Exempt Bond Provisions 

1. Bonds to finance general government operations 

The bill retains the tax-exemption for interest on State and local 
government bonds used to finance traditional governmental oper- 
ations. These bonds may continue to be issued without regard to 
the volume limits and certain other limitations applicable to bonds 
for nongovernmental persons. 

2. Tax-exemption for interest on certain other bonds 

As under present law, interest on bonds to provide conduit fi- 
nancing for nongovernmental persons is taxable unless a specific 
exception is provided in the Code. The bill provides the following 
exceptions permitting the issuance of tax-exempt bonds for such fi- 
nancing: 

Industrial development bonds. — Under present law, industrial de- 
velopment bonds (IDBs) are defined as bonds (a) all or a major por- 
tion of the proceeds of which are used in a trade or business car- 
ried on by a nongovernmental person (other than a tax-exempt sec- 
tion 501(c)(3) organization), and (b) which are repaid from, or se- 
cured by, money or prop(erty used in a trade or business. Interest 
oil IDBs is tax-exempt only if they are issued for certain specified 
activities or are small-issue IDBs. 

The bill clarifies that the * 'security interest" test for defining 
IDBs is satisfied by indirect, as well as direct, payments by private 
users of bond-financed facilities. The bill further directs the Treas- 
ury Department to liberalize its advance ruling guidelines, under 
which certain private management contracts are not treated as a 
private trade or business) use. 

Interest on IDBs is tax-exempt under the bill if the bonds are 
used in the following exempt activities: projects for multifamily 
residential rental property (subject to revised targeting rules); air- 
ports (not including hotels); docks and wharves; sewage and solid 
waste disposal facilities; facilities for the furnishing of water; facili- 
ties for the local furnishing of electric energy or gas; local district 
heating and cooling facilities; and hazardous waste treatment fa- 
cilities. An additional tax-exemption is provided for interest on cer- 
tain tax-increment financing bonds issued in connection with rede- 
velopment activities (qualified redevelopment bonds). 

The bill retains the tax-exemption for interest on small-issue 
IDBs, subject to present-law sunset dates (i.e., December 31, 1986, 
for other than manufacturing facilities, and December 31, 1988, for 
manufacturing facilities). Bonds for first-time farmers are treated 
as bonds for manufacturing facilities for this purpose. The first- 
time farmer rules are liberalized with respect to previously insol- 
vent farmers and the acquisition of used equipment. The bill also 

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54 

imposes a $250,000 lifetime limit on IDB financing of depreciable 
farm property for any principal user. 

Mortgage revenue bonds. — The tax exemption for interest on 
qualified mortgage bonds and qualified veterans' mortgage bonds is 
retained under the bill (subject to the present December 31, 1987 
sunset date for qualified mortgage bonds). The option to exchange 
qualified mortgage bond authority for authority to issue mortgage 
credit certificates (MCCs) is also retained, with a 25-percent trade- 
in rate. 

Limited equity cooperatives are permitted to elect to satisfy the 
targeting rules applicable to IDBs for multifamily rental housing, 
rather than the qualified mortgage bond rules. If they so elect, the 
tenant-stockholders are denied a deduction for interest and real 
estate taxes under section 216 and the bonds are counted toward 
the qualified mortgage bond volume limit. 

Qualified 501(c)(3) bonds. — The bill retains the tax-exemption for 
interest on bonds to finance activities of tax-exempt section 
501(c)(3) organizations, provided 95 percent or more of the bond 
proceeds are used to finance activities directly related to the 
exempt purpose of the organization. 

Student loan bonds. — Tax-exempt student loan bonds may be 
issued under the bill in connection with (a) the GSL and PLUS pro- 
grams of the Federal Government (as under present law) and Qa) 
qualifying State supplemental loan programs. 

Related use requirement. — The bill requires that private trade or 
business use of governmental bond proceeds, equal to or exceeding 
five percent of bond proceeds, be related to governmental facilities 
also financed with the bonds. 

Private loan bond restriction. — The private (consumer) loan bond 
restriction of present law is retained by the bill. 

3. State volume limitations 

The bill retains the three separate volume limitations that apply 
under present law to (1) most IDBs and all student loan bonds, (2) 
qualified mortgage bonds, and (3) qualified veterans' mortgage 
bonds (in States permitted to issue such bonds). The scheduled re- 
duction in the IDB and student loan volume limit after 1986, from 
$150 to $100 per capita, is retained. 

As under present law, no volume limitation applies to qualified 
501(c)(3) bonds or IDBs for multifamily rental housing. IDBs for 
governmentally owned airports, docks and wharves, and sewage, 
solid waste disposal, and water facilities are also exempt from 
volume limits. 

4. Arbitrage restrictions 

Interest on arbitrage bonds is taxable under present law. Arbi- 
trage bonds are bonds more than a minor portion of the proceeds of 
which are invested in materially higher yielding, taxable obliga- 
tions. IDBs and qualified mortgage bonds are subject to additional 
arbitrage restrictions that require rebate to the Federal Govern- 
ment of arbitrage profits on obligations unrelated to the purpose of 
the borrowing and restrict the amount of bond proceeds that may 
be invested in such obligations. 



55 

The bill makes several modifications to the arbitrage rules appli- 
(able to tax-exempt bonds, including the following: 

(1) Rebate requirements, similar to the present law IDB 
rules, are applied to all tax-exempt bonds. (Mortgage revenue 
bonds are subject to the present law qualified mortgage bond 
rules.) Exceptions are provided for bonds to finance operations 
of certain small governmental units with general taxing 
powers, and for arbitrage earned during an initial temporary 
period on student loan bonds which are issued in connection 
with the Federal GSL and PLUS programs. 

(2) A special penalty, rather than loss of tax exemption, is 
applied for failure to rebate arbitrage on governmental and 
qualified 501(c)(3) bonds. This rule does not apply if the failure 
results from willful disregard of the rebate requirement. 

(3) The limit on investment in nonpurpose obligations, pres- 
ently applied to most IDBs and qualified mortgage bonds, is ex- 
tended to all tax-exempt bonds. 

(4) Yield on all tax-exempt bonds is determined using the 
original issue discount rules of the Code (i.e., the State of 
Washington case is overruled). 

(5) Tax-exemption is denied for pension arbitrage bonds. 

(6) The Treasury Department is directed to modify its SLGS 
program to allow more flexible investment of bond proceeds. 

5. Restriction on advance refundings 

Advance refundings are limited to governmental and qualified 
)01(c)(3) bonds and are subject to various new restrictions, includ- 
ng a prohibition of devices used to obtain material financial ad- 
vantages (other than lower interest rates). 

6. Changes in use of bond-financed facilities 

The bill provides that, in addition to loss of tax-exemption on 
Dond interest (where provided under present law), certain amounts 
3aid in connection with bond-financed property that ceases to be 
ised in a use qualifying for tax-exempt financing may not be de- 
ducted for Federal income tax purposes. In general, the nondeduct- 
ible amount is the interest (or the interest component of rent or 
3ther user fees) paid on bond-financed loans or with respect to 
bond-financed property. 

7. Cost recovery for bond-financed property 

Under the bill, tax-exempt bond-financed property is depreciated 
using the straight-line method. In general, such property is depreci- 
ated over the ADR midpoint life of the property (40 years for real 
property). Multifamily residential rental property is depreciated 
over a 27y2-year period, while solid waste disposal and hazardous 
waste treatment facilities are depreciated over eight years. 

8. Information reporting for all bonds 

Information reporting requirements are extended to issuers of all 
tax-exempt bonds. 



56 

9. Effective dates 

The tax-exempt bond provisions of the bill generally apply t( 
bonds issued after the date of enactment. Special effective dates 
are provided for certain provisions. Transitional exceptions are als( 
provided for various provisions of the bill. 

B. General Stock Ownership Corporations (GSOCs) 

The bill eliminates the Code provisions relating to General Stocl- 
Ownership Corporations (GSOCs) as deadwood, effective January 1 
1984. 



Title XVI. Unearned Income of Minor Children; Income Taxation 
of Trusts and Estates; Estate and Gift Taxes 

4. Unearned Income of Minor Children 

Under the bill, the unearned income of a child under 14 is taxed 
:o the child at the top marginal rate of the parents to the extent 
attributable to property received from the parents. Unearned 
income that is derived from assets received from other sources (or 
3y reason of a parent's death) and that is placed in a qualified seg- 
regated account is taxed at the child's marginal rate, as is earned 
ncome of the child. The provision is generally effective for taxable 
i^ears beginning after December 31, 1986. 

B. Income Taxation of Trusts and Estates 

1. Tax rate schedule 

The rate schedule applicable to the retained income of trusts and 
estates is compressed as compared with the rates applicable to indi- 
dduals. The first $5,000 of taxable income of trusts and estates is 
taxed at 15 percent, with any excess taxed at 27 percent. The bene- 
fit of the 15-percent rate is phased out between $13,000 and $25,000 
of taxable income. The compressed rate schedule applies to estates 
only in years beginning after their second taxable year. 

The new rate schedules apply to both new and existing trusts 
and estates, and are effective on July 1, 1987. For 1987 returns, tax 
rate schedules will blend the schedules of rates that would have ap- 
plied under present law (i.e., 1986 rates as adjusted for inflation) 
with the new schedules. 

2. Grantor trust rules 

The income of a trust generally is taxed to its grantor if the trust 
corpus will revert to the grantor or the grantor's spouse at any 
time. An exception is provided where the trust may revert only 
after the death of the income beneficiary of the trust who is a 
lineal descendant of the grantor. The provision applies to transfers 
in trust made after March 1, 1986, with an exception for certain 
trusts created pursuant to a binding property settlement entered 
into before March 1, 1986. 

3. Taxable years of trusts 

The bill requires that existing and newly created trusts adopt a 
taxable year ending on October 31, November 30, or December 31. 
This applies for taxable years beginning after December 31, 1986. 

4. TYusts and estates to make estimated payments of income 

tax 

The bill requires that new and existing trusts and estates pay es- 
timated tax in the same manner as individuals. Also, the bill re- 

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58 

peals the rules that permit estates to pay tax over four equal in- 
stallments. This is effective for taxable years beginning after De- 
cember 31, 1986. 

C. Gift and Estate Tax Provisions 

1. Current use valuation recapture period 

The period during which heirs of individuals d5dng before 1982 
leaving property for which estate tax current use valuation was 
elected must continue to own and use such property without incur- 
ring a special recapture tax is reduced from 15 years to 10 years. 
The provision is effective on enactment of the bill. 

2. Filing information for estate tax current use valuation elec- 

tions 

Where an executor of an estate of an individual dying before 
1986 elected current use valuation on a timely filed estate tas 
return by providing substantially all the information elicited bj 
the return form, the executor will have an additional 90 days, after 
being notified by the IRS, to supply any missing information. The 
provision is effective on enactment of the bill. 

3. Certain gift tax disclaimers 

Certain disclaimers executed before December 9, 1980, with re 
spect to property interests created before November 15, 1958, are 
treated as qualified disclaimers for gift tax purposes. The provisior 
is effective on enactment of the bill. 

4. Certain gift and estate tax marital deduction elections 

The bill permits gift and estate tax elections to qualify certair 
marital deduction property as "qualified terminable interest prop 
erty" to be made within 90 days after the property is found to con 
stitute terminable interest. This provision generally applies tc 
transfers made after 1981. 



Title XVII. Miscellaneous Tax Provisions 

A. Extension of Expiring Provisions 

1. Extension and modification of the targeted Jobs tax credit 

The bill extends the targeted jobs credit for three additional 
years, i.e., for first-year wages paid to individuals who begin work 
for the employer before 1989. Under the bill, wages paid in the 
second year of a targeted individual's employment are not eligible 
for the credit, and the credit is not available if the employee works 
less than a specified minimum period. These modifications to the 
credit apply with respect to individuals who begin work for the em- 
ployer after 1985; the period for satisfying the certification require- 
ment for the credit is extended for individuals hired after 1985 and 
before 25 days after enactment of the bill. 

2. Tax credit for orphan drug clinical testing 

The bill makes permanent the 50-percent tax credit for a taxpay- 
er's expenses of clinical testing of certain drugs for rare diseases or 
conditions. The credit currently is scheduled to expire after 1987. 

S. Expensing of costs for removal of architectural barriers to 
the handicapped and elderly 

The bill reinstates on a permanent basis, effective for expenses 
incurred in taxable years beginning after 1985, the provision that 
allows the expensing of up to $35,000 of costs incurred in the re- 
moval of architectural and transportation barriers to the handi- 
capped and elderly. 

4- Reinstatement of rules for spouses of Vietnam MIA 's 

Under the bill, four tax relief provisions applicable with respect 
to Vietnam MIA's (and their spouses) that expired after 1982 are 
retroactively reinstated and made permanent. 

B. Exempt and Nonprofit Organization Provisions 

1. Exemption from unrelated business income tax for rental 
of mailing lists 

The bill provides an exemption from the unrelated business 
income tax (UBIT), in the case of tax-exempt organizations eligible 
to receive tax-deductible charitable contributions, for income from 
exchanges or rentals of donor or member lists with or to other such 
t£ix-exempt organizations, effective for transactions occurring after 
the date of enactment. 

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60 

2. Exemption from unrelated business income tax for quali- 

fied trade shows 

The bill expands the UBIT exemption to cover qualified trade 
shows or conventions and qualified trade show and convention ac- 
tivities of charitable organizations, effective in taxable years begin- 
ning after the date of enactment. 

3. Tax-exempt status for certain title-holding companies 

The bill adds a new category of section 501(c) tax-exempt organi- 
zations consisting of title-holding companies that have up to 35 re- 
lated or unrelated tax-exempt organizations as shareholders or 
beneficiaries, if certain conditions are met. This provision is effec- 
tive for taxable years beginning after 1986. 

4. Divestiture exemption for certain grandfathered excess 

business holdings of private foundations 

The bill allows private foundations to retain "grandfathered" 
business holdings acquired prior to May 27, 1969, if certain condi- 
tions are met. 

5. Reduction of private foundation distributable amount by 

certain costs of hazardous waste removal 

The bill reduces the otherwise applicable distributable amount 
for the James Graham Brown Foundation by certain costs paid or 
incurred by the Foundation for certain costs of hazardous sub- 
stance removal at a facility owned or operated by the Foundation. 

6. Tax-exempt status for technology transfer organization 

Under the bill, an organization that transfers technology from 
universities and scientific research organizations to the private 
sector is treated as a tax-exempt charitable organization if it meets 
certain requirements. 

7. Deductions incurred by certain membership organizations 

in transactions with members 

The bill provides that membership organizations engaged primar- 
ily in the gathering and distribution of news to their members for 
publication are permitted to deduct expenses relating to the fur- 
nishing of goods and services to members from income whether or 
not derived from members. 

C. Cooperative Housing Corporations 

Under the bill, the tax treatment of individuals owning stock in 
cooperative housing corporations is extended to corporations, 
trusts, and other entities that are stockholders. Also, the bill disal- 
lows maintenance and lease deductions by tenant-stockholders in 
situations where the amount paid by such stockholders is properly 
chargeable to the capital account of the cooperative. These provi- 
sions are effective for taxable years beginning after 1986. 



61 

•. Budget-lielated Provisions 

1. Revenues for budget purposes 

The bill provides that net revenue increases or shortfalls as a 
esult of the bill are not to be taken into account for determining 
ludget resolution totals for fiscal years 1!)H()-1989. 

2. Budget revenue fluctuations 

It is the sense of the Senate that the conference committee on 
le bill should approve tax reform legislation that produces a reve- 
ue path with minimal net revenue fluctuations. 

'. Other Provisions ' 

1. Collection of diesel fuel excise tax 

Under the bill, the diesel fuel excise tax for highway use may be 
nposed on the sale from a wholesaler to a retailer of the fuel (or 
y the manufacturer where the sale is direct to the retailer), at the 
lection of a qualified retailer, effective for sales of diesel fuel for 
se in highway vehicles after the first calendar quarter beginning 
lore than (50 days after the date of enactment of the bill. 

2. Common paymaster rule for FICA and FUTA taxes 

The bill provides that corporations and partnerships related to 
le corporations may be treated as a single employer, i.e., as a 
ommon paymaster, for purposes of collection of FICA and FUTA 
axes. 

r?. Minister reelecting into social security 

The bill provides for a one-time irrevocable election back into 
ocial security coverage for ministers who elected out of social secu- 
ity coverage after 1977 on religious grounds. 

4- Treatment of certain technical personnel as independent 
contractors 

The bill amends the Revenue Act of 1978 to allow certain individ- 
lals providing technical services (as an engineer, designer, draftee, 
lomputer programmer, systems analyst, or other similar skilled 
vorker) to be classified as independent contractors for (employment 
ax purposes. 

5. Exempt certain reindeer income 

Certain income derived from the sale of reindeer or reindeer 
products as provided in the Reindeer Industry Act of 19.'i7 is 
jxempt from Federal income taxation, effective September 1, 19.'i7. 

6. Moratorium on tax reform legislation 

It is the sense of the Congress that provisions of the Internal 
Revenue Code that are added or amended in the current legislation 
^•emain unchanged for a period of at least five years from the date 
)f enactment. 



62 

7. Transition rules 

It is the sense of the Senate that the conference report on thi 
bill contain the names of all persons receiving transitional relief as 
well as the costs and reasons for such relief. 



Title XVIII. Technical Corrections 

This title contains technical, clerical, conforming, and clarifying 
nendments to provisions enacted by the Tax Reform Act of 1984, 
le Retirement Equity Act of 1984, and other recently enacted tax 
gislation, as well as similar amendments to nontax provisions of 
le Deficit Reduction Act of 1984. 

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O 



61-685 (72)