The IRS has issued further guidance on issues related to Code Sec. 7216. The IRS had previously issued final, temporary and proposed regulations that provide updated guidance concerning the disclosure and use of tax return information by tax return preparers under Code Sec. 7216 T.D. 9478.

Notice 2010-4

In Notice 2010-4, the IRS addressed three issues with respect to the use of taxpayer information to solicit new business from previous or existing clients.
Changes in law that could result in amended returns. A tax return preparer may use tax return information to contact taxpayers to inform them of changes in tax law that could affect the income tax liability on the taxpayers’ returns that were previously prepared or processed by this tax preparer. Code Sec. 7216 does not prohibit the use of tax return information to prepare a "tax return," and, under Reg. §301.7216-1(b)(1), a tax return includes an amended return. Accordingly, the preparer could use client tax return information to identify affected taxpayers, inform them regarding the change in tax law, advise whether it would be appropriate for them to file amended income tax returns, and assist in the preparation and filing of any amended returns.

Accountant or lawyer seeking to give compliance advice. A tax return preparer who is also an accountant may use tax return information to determine who might be affected by a prospective tax rule change in order to contact potentially affected taxpayers for whom the accountant/preparer reasonably expected to provide accounting services in the next year. The contact would notify these taxpayers of the change, explain how the change may affect them, and advise them with regard to actions they may take in response to the change. Reg. §301.7216-2(h)(1)(i) allows a preparer who is lawfully engaged in the practice of law or accountancy to use tax return information to provide other legal or accounting services to the taxpayer, and such services could include advice related to current and future income tax compliance.
Disclosure of taxpayer list to auxiliary service provider. Finally, tax return preparers may disclose their taxpayer lists kept under Reg. §301.7216-2(n) to a third party service provider holding itself out as providing services that include creation, publication, and distribution of newsletters, bulletins, or similar communications to taxpayers whose tax returns the tax return preparers have prepared or processed containing tax information and general business and economic information or analysis for educational purposes or for purposes of soliciting additional tax return preparation services for the tax return preparer. Although restrictions apply to transfers of taxpayer lists under Reg. §301.7216-2(n), a preparer is allowed under Reg. §301.7216-2(d)(1) to disclose, without taxpayer consent, tax return information to another tax return preparer located in the United States for the purpose of obtaining auxiliary services in connection with the preparation of any tax return, so long as the services provided are not substantive determinations or advice affecting the tax liability reported by taxpayers. The service provider, is prohibited from the further use or disclosure of the tax return information for purposes other than those related to the provision of the auxiliary services or as otherwise expressly permitted under Code Secs. 6713 and Code Sec. 7216.
Rev. Rul. 2010-5

In Notice 2010-5, the IRS discussed disclosure of information to tax return preparer insurance carriers. The IRS held that tax return preparers will not be liable for criminal penalties under Code Sec. 7216 and civil penalties under Code Sec. 6713 with respect to certain disclosures of tax return information made to the preparer's professional liability insurance carrier. Under Reg. §301.7216-2(a)(1), a tax return preparer may dislcose, without taxpayer consent, tax return information to another tax return preparer located in the United States in order to obtain auxillary services, not involving substantive determinations or tax advice. Disclosures, without taxpayer consent, may also be made to an attorney for the purpose of obtaining legal advice under Reg. §301.7216-2(g).
A professional liability insurance policy purchased by a return preparer is an auxiliary service provided in connection with the preparation of tax returns; thus, the insurance carrier is a tax return preparer. Accordingly, disclosures necessary for price quotes or to otherwise obtain or maintain professional liability insurance coverage will not result in penalties. This could include a list of client names and description of the services provided, Similarly, disclosures made to the insurance carrier as required for purposes of reporting and investigating claims or for the carrier's selection of an attorney to represent the return preparer will not result in penalties. This could include client names, a description of the services provided, a description of the claim or potential claim, and if necessary, copies of returns relevant to the claims. In both cases, disclosures beyond those that are necessary for the provision of the auxiliary services are prohibited. Finally, a return preparer may make disclosures to the selected attorney related to the claim or potential claim or in seeking legal advice from an attorney who is not a representative of the carrier, without taxpayer consent.

A married couple had unreported gambling income in an amount equal to their winnings from one day of playing a slot machine, less the money they began with and money they lost before cashing out. The couple, who were not professional gamblers, could not, however, net all wagering gains or losses they sustained throughout the year. Gambling losses incurred other than in the trade or business of gambling are allowable only as itemized deductions when calculating taxable income. Because the taxpayers elected to use the standard the deduction, they were not entitled to itemize their deductions.


George D. and Lillian M. Shollenberger v. Commissioner.
U.S. Tax Court, Dkt. No. 5504-08, TC Memo. 2009-306, December 28, 2009.

OPINION
Gross income includes all income from whatever source derived, including gambling. Sec. 61(a); McClanahan v. United States, 292 F.2d 630, 631-632 (5th Cir. 1961). In the case of a taxpayer not engaged in the trade or business of gambling, gambling losses from “wagering transactions” are allowable as an itemized deduction but “only to the extent of the gains from such transactions.” Sec. 165(d); see McClanahan v. United States, supra; Winkler v. United States, 230 F.2d 766 (1st Cir. 1956).
Respondent asserts that for purposes of applying section 165(d) to casual gamblers like petitioners, the correct analysis and methodology is set forth in Chief Counsel Advice 2008-011 (Dec. 5, 2008) (the Chief Counsel Advice), which states in part:
A key question in interpreting §165(d) is the significance of the term “transactions.” The statute refers to gains and losses in terms of wagering transactions. Some would contend that transaction means every single play in a game of chance or every wager made. Under that reading, a taxpayer would have to calculate the gain or loss on every transaction separately and treat every play or wager as a taxable event. The gambler would also have to trace and recompute the basis through all transactions to calculate the result of each play or wager. Courts considering that reading have found it unduly burdensome and unreasonable. See Green v. Commissioner, 66 T.C. 538 (1976); Szkirscak [sic] v. Commissioner, T.C. Memo. 1980-129. Moreover, the statute uses the plural term “transactions” implying that gain or loss may be calculated over a series of separate plays or wagers.
The better view is that a casual gambler, such as the taxpayer who plays the slot machines, recognizes a wagering gain or loss at the time she redeems her tokens. We think that the fluctuating wins and losses left in play are not accessions to wealth until the taxpayer redeems her tokens and can definitively calculate the amount above or below basis (the wager) realized. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955). For example, a casual gambler who enters a casino with $100 and redeems his or her tokens for $300 after playing the slot machines has a wagering gain of $200 ($300-$100). This is true even though the taxpayer may have had $1,000 in winning spins and $700 in losing spins during the course of play. Likewise, a casual gambler who enters a casino with $100 and loses the entire amount after playing the slot machines has a wagering loss of $100, even though the casual gambler may have had winning spins of $1,000 and losing spins of $1,100 during the course of play. [Fn. ref. omitted.]
Applying this methodology, respondent concedes that if we find, as we have found, that on March 29, 2005, petitioners entered the casino with $500 and took home $1,600 of winnings, the amount of gambling income which petitioners should have reported on their 2005 return was $1,100 ($2,000 jackpot winnings less $500 brought to the casino for gambling and less $400 taken from the jackpot for additional gambling) rather than $2,000 as determined in the notice of deficiency.
Although petitioners have stated that they “agree with” the Chief Counsel Advice, they nevertheless maintain, contrary to the Chief Counsel Advice, that they should be allowed to offset their March 29, 2005, net winnings with $2,264 of gambling losses they claim to have incurred throughout 2005. They contend that this result is necessary to treat “regular and casual gamblers equally”. 2
The Code mandates, however, that casual gamblers be treated differently from taxpayers who are in the trade or business of gambling. In particular, gambling losses incurred in a trade or business of gambling are allowable in computing adjusted gross income pursuant to section 62(a)(1). Gambling losses incurred other than in the trade or business of gambling are allowable, if at all, as itemized deductions in calculating taxable income. See sec. 63(a), (d); Johnston v. Commissioner, 25 T.C. 106, 108 (1955); Cromley v. Commissioner, T.C. Memo. 2008-176; Heidelberg v. Commissioner, T.C. Memo. 1977-133.
Because petitioners were not engaged in the trade or business of gambling, their gambling losses are allowable only as itemized deductions. But because petitioners have elected the standard deduction, they are not entitled to itemize their deductions. 3 Sec. 63(b), (e); see Johnston v. Commissioner, supra; Heidelberg v. Commissioner, supra. We reject as without merit petitioners' contention that this statutory arrangement is unconstitutional. See Tschetschot v. Commissioner, T.C. Memo. 2007-38 (upholding constitutionality of section 165(d)); Valenti v. Commissioner, T.C. Memo. 1994-483 (same); cf. Gajewski v. Commissioner, 84 T.C. 980 (1985) (holding that for purposes of computing the minimum tax the 16th Amendment does not require that a casual gambler's gambling losses be netted against gambling gains).
Drawing an analogy to the recovery of a capital investment, this Court has held that a casual gambler's gross income from a wagering transaction should be calculated by subtracting the bets placed to produce the winnings, not as a deduction in calculating adjusted gross income or taxable income but as a preliminary computation in determining gross income. See Lutz v. Commissioner, T.C. Memo. 2002-89 (slot machine winnings); Hochman v. Commissioner, T.C. Memo. 1986-24 (horse race winnings). This Court has also recognized the practical difficulties of tracking the basis of each wager individually in a session of like play. See Green v. Commissioner, 66 T.C. 538, 548 (1976) (stating that a “tabulation of the amounts paid for chips less the amount paid to redeem chips would have served to verify the net win or loss figures”); Szkircsak v. Commissioner, T.C. Memo. 1980-129 (stating that “it is impractical to record each separate roll of the dice or spin of the wheel”). The methodology put forward by respondent is consistent with these principles.
Insofar as petitioners mean to suggest that section 165(d) permits their gross income from slot machine play to be calculated by netting all their 2005 slot machine gains and losses, we disagree. Section 165(d) does not define gross income but instead limits the deductibility of losses on wagering “transactions” to the amount of gains from wagering “transactions”. Consistent with general principles treating each wager as a separate taxable event under Federal tax law, see Abeid v. Commissioner, 122 T.C. 404, 411 (2004), section 165(d) clearly contemplates that gross income from wagering is determined in the first instance by reference to individual wagering “transactions.” To permit a casual gambler to net all wagering gains or losses throughout the year would intrude upon, if not defeat or render superfluous, the careful statutory arrangement that allows deduction of casual gambling losses, if at all, only as itemized deductions, subject to the limitations of section 165(d).
Respondent has effectively conceded that petitioners' gross income from their March 29, 2005, slot machine play was $1,100. Cf. LaPlante v. Commissioner, T.C. Memo. 2009-226 (holding that taxpayers failed to substantiate claims of net gambling gains and losses). Giving effect to this concession, we hold that petitioners had $1,100 of unreported gross income from gambling in 2005 and are entitled to no deduction for gambling losses.
To reflect the foregoing,
Decision will be entered under Rule 155.

Footnotes


1
Certain computational adjustments that follow from the resolution of this issue are not in controversy, and we do not address them.
2
By “regular” gamblers, we understand petitioners to mean gamblers who are in the trade or business of gambling.
3
A taxpayer may change an election to claim the standard deduction at any time before the period of limitations has expired. Sec. 63(e). Insofar as the record shows, petitioners have not sought to change their election to claim the standard deduction. In any event, on the record before us it would not appear advantageous for petitioners to do so.

Payments made by an individual to his former wife were not deductible as alimony under Code Sec. 215. The payments were not required by the couple's divorce agreement, which specifically stated that neither party was obligated to pay maintenance to the other party. An untitled single-page document that ordered the taxpayer to pay his ex-wife amounts related to his pension plan was incomplete and not explained at trial; therefore, the document was not probative. The Tax Court did, however, comment that its holding only referred to the year at issue, and that the taxpayer could ask a local court for a qualified domestic relations order (QDRO) with respect to the monthly payments of a portion of his pension.

Tax Extenders Act of 2009 JCX-60-09

http://www.jct.gov/publications.html?func=startdown&id=3640

The IRS denied innocent spouse relief to a wife for a tax deficiency arising from the married couple's failure to report on their joint income tax return income derived from the couple's business. The wife was not entitled to relief under Code Sec. 6015(b)(1)(B) or Code Sec. 6015(b)(1)(C) because she did not prove that the income was her husband's alone, and she did not offer any evidence of how the revenue could be allocated between the two spouses. Furthermore, testimony showed that the wife had reason to know that the return she signed understated the couple's income. The wife was also not entitled to relief under Code Sec. 6015(c) because the couple was married in the year in issue and continue to be married. Additionally, the wife did not prove that it was inequitable to hold her jointly liable under Code Sec. 6015(b)(1)(D) and Code Sec. 6015(f) because she did not satisfy several factors considered for equitable relief as set forth in Rev. Proc. 2003-61, 2003-2 C.B. 296.


Callie Sue Olson v. Commissioner., U.S. Tax Court, CCH Dec. 58,031(M), T.C. Memo. 2009-294, (Dec. 21, 2009)
Callie Sue Olson v. Commissioner.
U.S. Tax Court, Dkt. No. 20384-07, TC Memo. 2009-294, December 21, 2009.

MEMORANDUM FINDINGS OF FACT AND OPINION
GUSTAFSON, Judge: This case arises from petitioner Callie Sue Olson's request for “innocent spouse” relief from joint liability under section 6015 1 for 2003 taxes—i.e., an income tax deficiency of $13,600, an addition to tax of $3,400 under section 6651(a)(1) for failure to file the return on time, and an accuracy-related penalty of $2,720 under section 6662. In a statutory notice of deficiency issued to Ms. Olson and her husband on June 12, 2007, 2 the Internal Revenue Service (IRS) denied Ms. Olson's request for relief from joint liability; and in response, Ms. Olson timely filed a petition with the Court on September 10, 2007. The issue for decision is whether Ms. Olson is entitled under section 6015 to relief from joint liability. We find that Ms. Olson is not entitled to such relief.
ed.
OPINION
I. Standard and Scope of Review
When determining whether a taxpayer is entitled to relief under section 6015 (whether under subsection (b), (c), or (f)), we conduct a trial de novo, in which we may consider evidence introduced at trial which was not included in the administrative record. Porter v. Commissioner, 130 T.C. 115, 117 (2008). For all claims under section 6015 (including claims for equitable relief under section 6015(f)), we do not review for abuse of discretion but instead employ a de novo standard of review. Porter v. Commissioner, 132 T.C. ___ (2009). Respondent contends, however, that when the Court reviews a denial of relief under section 6015 (f), it must apply an abuse-of-discretion standard of review and must limit the scope of its review to the administrative record. We have held otherwise in the two Porter opinions cited above, and we do not repeat in this opinion the reasons for those holdings.
An appeal in this case would lie to the U.S. Court of Appeals for the Eighth Circuit. That court held in Robinette v. Commissioner, 439 F.3d 455, 460 (8th Cir. 2006), revg. 123 T.C. 85 (2004), that the Tax Court's scope of review in a collection due process (CDP) proceeding under sections 6320 and 6330 should be limited to the administrative record. 4 However, the CDP provisions of sections 6320 and 6330 are different from the “innocent spouse” provisions of section 6015, and those differences include the following:
The CDP petitioner's agency-level remedies are described at some length in section 6330(a), (b), and (c), and section 6330(d)(2) requires the CDP petitioner to “exhaust[] all administrative remedies”; but section 6015 makes no explicit provision of agency-level remedies for “innocent spouse” relief and says nothing about exhausting them. The agency's CDP action is repeatedly characterized in section 6330 as a “hearing”, but no agency hearing is explicitly provided for the “innocent spouse” in section 6015. 5 The taxpayer's CDP submission to the Tax Court under section 6330(d) is called an “appeal” and is not referred to as a “petition” anywhere in the statute, while section 6015(e) provides that the innocent spouse files a “petition” that is nowhere called an “appeal”. The Tax Court “determine[s]” innocent spouse relief, sec. 6015(e)(1)(A), but has “jurisdiction with respect to such matter” in the case of an appeal from the agency's CDP determination, sec. 6330(d)(1). 6
All these differences in statutory vocabulary suggest that even if a CDP case under sections 6320 and 6330 is held to be governed by a “record rule”, as the Court of Appeals for the Eighth Circuit holds, the same rule is not warranted for an “innocent spouse” case under section 6015. We therefore follow our Porter decisions and apply a de novo standard of review and scope of review in deciding this case under section 6015.
II. Joint and Several Liability and Section 6015 Relief
Section 6013(d)(3) provides that if a joint return is filed, the tax is computed on the taxpayers' aggregate income, and liability for the resulting tax is joint and several. See also sec. 1.6013-4(b), Income Tax Regs. (26 C.F.R.). That is, each spouse is responsible for the entire joint tax liability. However, section 6015 provides for relief from joint liability for spouses who meet the conditions of subsection (b) and for divorced and separated persons under subsection (c), and provides equitable relief in subsection (f) when the relief provided in subsections (b) and (c) is not available. Except as otherwise provided in section 6015, the taxpayer bears the burden of proof. See sec. 6015(c)(2); Rule 142(a); Alt v. Commissioner, 119 T.C. 306, 311 (2002), affd. 101 Fed. Appx. 34 (6th Cir. 2004). Because Ms. Olson generally requests relief under section 6015, we analyze her eligibility under all three subsections.
A. Subsection (b) Relief
Section 6015 provides as follows in subsections (a) and (b)(1):
SEC. 6015. RELIEF FROM JOINT AND SEVERAL LIABILITY ON JOINT RETURN.
(a) In General.—Notwithstanding section 6013(d)(3)—
(1) an individual who has made a joint return may elect to seek relief under the procedures prescribed under subsection (b); and
(2) if such individual is eligible to elect the application of subsection (c), such individual may, in addition to any election under paragraph (1), elect to limit such individual's liability for any deficiency with respect to such joint return in the manner prescribed under subsection (c).
Any determination under this section shall be made without regard to community property laws.
(b) Procedures for Relief from Liability Applicable to All Joint Filers.—
(1) In general.—Under procedures prescribed by the Secretary, if—
(A) a joint return has been made for a taxable year;
(B) on such return there is an understatement of tax attributable to erroneous items of one individual filing the joint return;
(C) the other individual filing the joint return establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement;
(D) taking into account all the facts and circumstances, it is inequitable to hold the other individual liable for the deficiency in tax for such taxable year attributable to such understatement; and
(E) the other individual elects (in such form as the Secretary may prescribe) the benefits of this subsection not later than the date which is 2 years after the date the Secretary has begun collection activities with respect to the individual making the election,
then the other individual shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent such liability is attributable to such understatement.
Section 6015(b)(1) thus authorizes “innocent spouse” relief if a taxpayer satisfies all five of the requirements set out in subparagraphs (A) through (E). Respondent does not dispute that Ms. Olson meets the requirements of subparagraphs (A) (joint return) and (E) (timely election), but he denies that she meets the other three requirements in subparagraphs (B), (C), and (D). We therefore discuss those three.
1. Erroneous Item of Non-requesting Spouse ( Section 6015(b)(1)(B)
Ms. Olson has the burden to prove that the understatement of tax on the joint return was attributable to erroneous items of Mr. Olson and not of Ms. Olson. See Jonson v. Commissioner, 118 T.C. 106, 113 (2002), affd. 353 F.3d 1181 (10th Cir. 2003). However, the erroneous item on the return was the business income of Fun Stuff Rental, 7 which was the family business. The business is identified on the company checks as “Greg & Callie's” (emphasis added), and Ms. Olson was active in the business—answering the phone, sending out mail, paying the help, handling the equipment, and working some of the jobs. Mr. and Ms. Olson's work was collaborative and mutual. Ms. Olson did not prove that the Fun Stuff Rental income was an item of Mr. Olson alone, and she did not offer any evidence of how the revenue could be allocated between the two spouses. See Ishizaki v. Commissioner, T.C. Memo. 2001-318, 82 T.C.M. (CCH) 995, 1000-1001 (2001) (income is not an item of one spouse when the other “actively and substantially participated”). We hold that Ms. Olson did not prove that she meets the requirement of section 6015(b)(1)(B).
2. Requesting Spouse's Knowledge ( Section 6015(b)(1)(C))
As for the requirement of section 6015(b)(1)(C), Ms. Olson did make a credible showing that “in signing the return * * * she did not know * * * that there was such understatement”, but she did not prove that she “had no reason to know”. 8 On the contrary, her testimony showed that she did have reason to know that the return she signed understated the liability. She had quit her hospital job the prior year, so that in 2003 the family's only income source was Fun Stuff Rental; she saw that family expenses were being paid from the revenues of the business; she had access to all the records of the business; yet she signed a joint return on which Fun Stuff Rental reported a loss of $10,376. From the facts immediately available to her, she had reason to know that Fun Stuff Rental had not really experienced a loss of $10,376.
The loss reported on the return that Ms. Olson signed simply cannot be reconciled with her knowledge of the business and the family activities. If she did not know that the return she signed understated the income of Fun Stuff Rental, it is because she chose to pay no attention to the matter. But as the Court of Appeals for the Eighth Circuit has observed:
a taxpayer cannot satisfy the lack of knowledge requirement by claiming that he or she failed to review the joint return before signing it. “ Section 6013(e) is designed to protect the innocent, not the intentionally ignorant.” Cohen v. Commissioner, T.C. Memo. 1987-537 (Oct. 20, 1987). * * *
Erdahl v. Commissioner, 930 F.2d 585, 589 (8th Cir. 1991), revg. T.C. Memo. 1990-101. We hold that Ms. Olson did not prove that she had no reason to know that the loss reported on the joint return that she signed was erroneous. Rather, she could and should have known that the reported loss was erroneous.
3. Inequitable To Hold Liable ( Section 6015(b)(1)(D))
As for the requirement of section 6015(b)(1)(D), Ms. Olson did not show that “it is inequitable to hold * * * [her] liable for the deficiency in tax”. The statute provides that this judgment on the equities is to be made “taking into account all the facts and circumstances”. 9 Since this “inequitable” requirement under section 6015(b)(1)(D) is equivalent to the “inequitable” requirement under section 6015(f)(1), which is discussed below in part II.C, we relegate our analysis to that part of this opinion. In sum, Ms. Olson did not prove that it is inequitable to hold her jointly liable.
Thus, Ms. Olson fails to satisfy the requirements of subparagraphs (B), (C), and (D) of section 6015(b)(1) and does not qualify for relief under section 6015(b).
B. Subsection (c) Relief.
Section 6015(c) is entitled “Procedures to Limit Liability for Taxpayers No Longer Married or Taxpayers Legally Separated or Not Living Together.” Because Mr. and Ms. Olson were married in the year in issue and continue to be married, Ms. Olson is not entitled to relief under subsection (c).
C. Equitable Relief Under Subsection (f)
1. Standards Applicable Under Section 6015(f)
Subsection (f) of section 6015 provides as follows:
SEC. 6015(f). Equitable Relief.—Under procedures prescribed by the Secretary, if—
(1) taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency (or any portion of either); and
(2) relief is not available to such individual under subsection (b) or (c),
the Secretary may relieve such individual of such liability.
Thus, a taxpayer may be relieved from joint and several liability under section 6015(f) if, taking into account all the facts and circumstances, it is inequitable to hold the taxpayer liable.
In accord with the statutory provision that section 6015(f) relief is to be granted “[u]nder procedures prescribed by the Secretary,” the Commissioner has issued revenue procedures to guide IRS employees in determining whether a requesting spouse is entitled to relief from joint and several liability. See Rev. Proc. 2003-61, supra, 2003-2 C.B. 296, modifying and superseding Rev. Proc. 2000-15, 2000-1 C.B. 447. Revenue Procedure 2003-61 provides a three-step analysis for IRS employees to use in deciding whether to grant relief: Section 4.01 (discussed below) lists seven threshold conditions that must be met for any relief to be granted; section 4.02, not applicable here, lists circumstances in which relief will ordinarily be granted as to liabilities (unlike those at issue here) that were reported on a return; and section 4.03 (discussed below) sets out eight non exclusive factors to be considered in determining whether equitable relief should be granted.
The Tax Court has been given express authority to review the IRS's denial of equitable relief under section 6015(f). Section 6015(e)(1) provides:
[I]n the case of an individual who requests equitable relief under subsection (f) * * * [i]n addition to any other remedy provided by law, the individual may petition the Tax Court (and the Tax Court shall have jurisdiction) to determine the appropriate relief available to the individual under this section * * *.
In “determin[ing] the appropriate relief”, the Court reviews the IRS's three-step analysis prescribed in its revenue procedure, see Washington v. Commissioner, 120 T.C. 137, 147-152 (2003), but our review is not circumscribed by that matrix. Rather, we consider “all the facts and circumstances” in determining whether the taxpayer is entitled to “innocent spouse” relief. Sec.6015(f)(1); see Porter v. Commissioner, 132 T.C. at ___ (slip op. at 12-13); Lantz v. Commissioner, 132 T.C. ___ (2009).
2. Evaluation of Ms. Olson's Entitlement to Relief Under Section 6015(f)
As we now show, the IRS correctly employed the analysis prescribed in Revenue Procedure 2003-61, supra, to determine that Ms. Olson is not entitled to equitable relief under section 6015(f). We find that that the IRS's analysis did not exclude any relevant fact or circumstance that ought to be taken into account, and that relief from joint liability is not appropriate in this case.
a. Threshold Eligibility Under Rev. Proc. 2003-61, Sec. 4.01
Revenue Procedure 2003-61 sets out, in section 4.01, seven threshold conditions that all requesting spouses must meet in order for the IRS to grant relief pursuant to section 6015(f). 10 In his pretrial memorandum respondent asserts generally that Ms. Olson “fails to meet the threshold eligibility requirements” but does not specify which one or ones she fails to meet. It appears that she satisfies the first six but that she fails to satisfy the seventh—i.e., “The income tax liability from which the requesting spouse seeks relief is attributable to an item of the individual with whom the requesting spouse filed the joint return”. As we explained above in part II.A.1, Ms. Olson failed to show that the underreported income of Fun Stuff Rental was an item attributable to Mr. Olson alone. Rather, Ms. Olson was also active in the business, so that its income is properly attributable not only to Mr. Olson but also to her. Ms. Olson therefore fails to meet the threshold conditions for the IRS to grant equitable relief.
We nonetheless proceed to consider “[i]n the alternative”, see O'Meara v. Commissioner, T.C. Memo. 2009-71, whether there are any additional facts and circumstances that would justify relief for Ms. Olson. We find that there are not.
b. Facts-and-Circumstances Test of Rev. Proc. 2003-61, Sec. 4.03
Where the requesting spouse satisfies the threshold conditions of section 4.01 of Revenue Procedure 2003-61 (not the case here), the IRS may grant relief under the facts-and-circumstances test of section 4.03. Under that test the IRS considers a “nonexclusive list of factors” in section 4.03(2)(a) to determine whether “taking into account all the facts and circumstances, it is inequitable to hold the requesting spouse liable”: (i) whether the requesting spouse is separated or divorced from the nonrequesting spouse; (ii) whether the requesting spouse would suffer economic hardship if not granted relief; (iii) whether the requesting spouse knew or had reason to know that the other spouse would not pay the liability; (iv) whether the nonrequesting spouse has a legal obligation to pay the outstanding tax liability pursuant to a divorce decree or agreement; (v) whether the requesting spouse received a significant benefit from the item giving rise to the deficiency; and (vi) whether the requesting spouse has made a good faith effort to comply with the tax laws for the taxable years following the taxable year to which the request for such relief relates. Other factors that the IRS considers under section 4.03(2)(b) are (i) whether the nonrequesting spouse abused the requesting spouse and (ii) whether the requesting spouse was in poor mental or physical health at the time he or she signed the tax return or at the time he or she requested relief.
We consider these factors and any other relevant facts and circumstances in determining whether the taxpayer is entitled to “innocent spouse” relief. No single factor is determinative, and all factors are to be considered and weighted appropriately. Haigh v. Commissioner, T.C. Memo. 2009-140. In this case the IRS's factors provide a sufficient basis for evaluating Ms. Olson's claim for equitable relief, and the record suggests no additional facts and circumstances that should be considered. We therefore address the factors listed in section 4.03 of Revenue Procedure 2003-61.
i. Marital Status
Ms. Olson was not divorced, separated, or living apart from Mr. Olson when she filed her request for “innocent spouse” relief. This factor weighs against granting relief. See McKnight v. Commissioner, T.C. Memo. 2006-155.
ii. Economic Hardship
Generally, economic hardship exists if collection of the tax liability will cause the taxpayer to be unable to pay reasonable basic living expenses. Butner v. Commissioner, T.C. Memo. 2007-136. Ms. Olson made no showing of economic hardship, so this factor weighs against granting relief.
iii. Knowledge or Reason To Know
As is discussed above in part II.A.2, Ms. Olson has failed to establish that she did not have reason to know of the item giving rise to the deficiency (i.e., the income of Fun Stuff Rental). This factor weighs against granting relief. See Beatty v. Commissioner, T.C. Memo. 2007-167.
iv. Nonrequesting Spouse's Legal Obligation
Where a divorce decree or other court order gives the nonrequesting spouse a legal obligation to pay the liability, this fact can weigh in favor of granting relief to the requesting spouse. No divorce decree or separation order imposes such a liability on Mr. Olson, and this factor therefore weighs against granting relief to Ms. Olson.
v. Significant Benefit
While Ms. Olson did share in the benefit of the Fun Stuff Rental income in 2003 and did share with Mr. Olson the benefit of the money that they did not use to pay their tax liability, there is nothing in the record that indicates that Ms. Olson “received significant benefit (beyond normal support) from the unpaid income tax liability or item giving rise to the liability”, and respondent does not contend that she did. Therefore, this factor weighs moderately in favor of relief. See Magee v. Commissioner, T.C. Memo. 2005-263.
vi. Compliance With Federal Tax Laws
As of the time the IRS issued the notice of deficiency that denied Ms. Olson's request for relief for 2003, the Olsons had not filed returns for 2004 and 2005, so respondent contends that Ms. Olson had not (for purposes of Rev. Proc. 2003-61, sec. 4.03(2)(a)(vi)) “made a good faith effort to comply with income tax laws in the taxable years following the taxable year or years to which the request for relief relates.” We have found that in 2003 the income of Fun Stuff Rental was an item of both Mr. and Ms. Olson. However, the record is not clear on this point as to 2004 and 2005; and when the IRS determined deficiencies for 2004 and 2005, it issued the notice of deficiency to Mr. Olson only. Since this factor, even if found in Ms. Olson's favor, would not sufficiently tip the scales to justify relief, we do not decide this issue and instead assume arguendo that this factor weighs in favor of relief. See Fox v. Commissioner, T.C. Memo. 2006-22.
vii. Abuse
There is no evidence or allegation of abuse by Mr. Olson. Therefore, this factor is neutral. See Magee v. Commissioner, supra.
viii. Mental or Physical Health
Ms. Olson has not alleged, nor does the record show, that her mental or physical health was poor at the relevant times. Therefore, this factor is neutral. See id.
When we weigh the facts and circumstances implicated in these eight factors, we find that Ms. Olson is not entitled to relief. Two factors are neutral, no more than two factors weigh in favor of relief, and at least four factors weigh against relief. We find that the two favorable factors (subsequent compliance and lack of significant benefit) are easily outweighed by the four unfavorable factors: Ms. Olson lived with and continues to live with Mr. Olson; she showed no economic hardship that would result if relief were not granted; she should have known of the understatement reflected on the return; and Mr. Olson is not under any order or decree to pay the liability. As a result, when the facts and circumstances are weighed, Ms. Olson is not entitled to “innocent spouse” relief under section 6015(f) with respect to the Olsons' joint Federal income tax liability for 2003.
In sum, we find that Ms. Olson is not entitled to relief from joint liability under section 6015(b), (c), or (f).
To reflect the foregoing,
Decision will be entered for respondent.

Footnotes


1
Unless otherwise indicated, all citations of sections refer to the Internal Revenue Code of 1986 (26 U.S.C.), as amended, and all citations of Rules refer to the Tax Court Rules of Practice and Procedure.
2
The 2003 deficiency itself was disputed in Gregory John Olson v. Commissioner, docket No. 20383-07, in which case Ms. Olson was not a petitioner. Mr. Olson conceded the case, and decision was entered on November 17, 2009, sustaining against him the IRS's deficiency determination.
3
In the “Filing Status” block on the first page of the return, neither the block for “Married filing jointly” nor any other block is checked. However, the names of both Mr. and Ms. Olson appear on the appropriate lines (with Ms. Olson's name on the line marked “If a joint return, spouse's first name and initial”); and Ms. Olson signed in the signature block on the second page, under “Spouse's signature. If a joint return, both must sign.” The IRS treated the return as a joint return, and Ms. Olson's request for innocent spouse relief characterized the return as a joint return.
4
This Court held to the contrary in Robinette v. Commissioner, 123 T.C. 85 (2004), revd. 439 F.3d 455, 460 (8th Cir. 2006), and in CDP cases we generally do not follow the record rule. However, in cases appealable to Courts of Appeals that follow the record rule, we do follow those precedents pursuant to our “ Golsen rule”. See Golsen v. Commissioner, 54 T.C. 742, 757 (1970), affd. 445 F.2d 985 (10th Cir. 1971). However, as we noted in Porter v. Commissioner, 130 T.C. 115, 120 (2008), the Court of Appeals' decision in Robinette interpreting section 6330 does not govern the interpretation of section 6015.

5
See Porter v. Commissioner, supra, 130 T.C. at 135 (Thornton, J., concurring); Friday v. Commissioner, 124 T.C. 220, 222 (2005) (“There is in section 6015 no analog to section 6330 granting the Court jurisdiction after a hearing at the Commissioner's Appeals Office”).
6
See Porter v. Commissioner, supra at 120; id. at 134-135 (Thornton, J., concurring).
7
Ms. Olson did not argue that the understatement was attributable to the erroneous exclusion of one or more specific revenue items of which she could not have been aware or that it was attributable to the erroneous deduction of one or more specific items of expense whose legitimacy she could not have known. Since she did not show what particular items contributing to the income of Fun Stuff Rental gave rise to the understatement, and since in any event the bank statements and other records were all accessible to her, this argument could not have prevailed.
8
See also sec. 6015-2(c), Income Tax Regs. (26 C.F.R.) (“A requesting spouse has * * * reason to know of an understatement * * * if a reasonable person in similar circumstances would have known of the understatement. * * * All of the facts and circumstances are considered in determining whether a requesting spouse had reason to know of an understatement. The facts and circumstances that are considered include, but are not limited to, the nature of the erroneous item and the amount of the erroneous item relative to other items; the couple's financial situation; the requesting spouse's educational background and business experience; the extent of the requesting spouse's participation in the activity that resulted in the erroneous item; whether the requesting spouse failed to inquire, at or before the time the return was signed, about items on the return or omitted from the return that a reasonable person would question; and whether the erroneous item represented a departure from a recurring pattern reflected in prior years' returns (e.g., omitted income from an investment regularly reported on prior years' returns)”).
9
See also sec. 1.6015-2(d), Income Tax Regs. (26 C.F.R.) (“All of the facts and circumstances are considered in determining whether it is inequitable to hold a requesting spouse jointly and severally liable for an understatement. One relevant factor for this purpose is whether the requesting spouse significantly benefitted, directly or indirectly, from the understatement. A significant benefit is any benefit in excess of normal support. Evidence of direct or indirect benefit may consist of transfers of property or rights to property, including transfers that may be received several years after the year of the understatement. Thus, for example, if a requesting spouse receives property (including life insurance proceeds) from the nonrequesting spouse that is beyond normal support and traceable to items omitted from gross income that are attributable to the nonrequesting spouse, the requesting spouse will be considered to have received significant benefit from those items. Other factors that may also be taken into account, if the situation warrants, include the fact that the requesting spouse has been deserted by the nonrequesting spouse, the fact that the spouses have been divorced or separated, or that the requesting spouse received benefit on the return from the understatement. For guidance concerning the criteria to be used in determining whether it is inequitable to hold a requesting spouse jointly and severally liable under this section, see Rev. Proc. 2000-15 (2000-1 C.B. 447), or other guidance published by the Treasury and IRS (see § 601.601(d)(2) of this chapter)”). The revenue procedure cited in the regulation has been superseded by Revenue Procedure 2003-61, 2003-2 C.B. 296.

10
See Rev. Proc. 2003-61, sec. 4.01, 2003-2 C.B. at 297 (all requesting spouses must meet seven threshold conditions: (i) The requesting spouse filed a joint return for the taxable year for which he or she seeks relief; (ii) relief is not available to the requesting spouse under section 6015(b) or (c); (iii) the requesting spouse applies for relief no later than 2 years after the date of the Service's first collection activity after July 22, 1998, with respect to the requesting spouse; (iv) no assets were transferred between the spouses as part of a fraudulent scheme by the spouses; (v) the nonrequesting spouse did not transfer disqualified assets to the requesting spouse; (vi) the requesting spouse did not file or fail to file the return with fraudulent intent; and (vii) absent enumerated exceptions, the income tax liability from which the requesting spouse seeks relief is attributable to an item of the individual with whom the requesting spouse filed the joint return). As to requirement (iii) above, we have held that the two-year rule is invalid. See Lantz v. Commissioner, 132 T.C. ___ (2009).

Save this case. The Tax Court has finally been able to hold the IRS to a strict reading of the levy prohibition in section 6343. I take my hat off to Judge Dawson who knows how to read a statute.
The IRS's determination to proceed with a levy was an abuse of discretion. Although the settlement officer determined that a levy on the taxpayer's car and wages would create an economic hardship, the officer determined to proceed with the levy because the taxpayer was not in compliance with filing and payment requirements. However, neither case law nor the Internal Revenue Code or regulations under Code Sec. 6343 condition the release of a levy upon compliance with filing and payment requirements when there is an economic hardship. Rather, the regulations require the release of a levy that creates an economic hardship; therefore, the settlement officer's determination to proceed with the levy was contrary to law and an abuse of discretion.—

Kathleen A. Vinatieri v. Commissioner.
U.S. Tax Court, Dkt. No. 15895-08L, 133 TC —, No. 16, December 22, 2009.
.
R issued P a notice of intent to levy to collect P's unpaid Federal income taxes for 2002..P timely requested a hearing under sec. 6330, I.R.C.
P submitted to the settlement officer Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, indicating she had monthly income of *800 and expenses of *800, had *14 cash on hand, and owned a 1996 Toyota Corolla four-door sedan with 243,000 miles and a value of *300..If P's wages are levied on she will be unable to pay her reasonable basic living expenses..If her car is levied on, she will be unable to work.
The settlement officer stated in her log that P meets the criteria to have her account reported as currently not collectible because of hardship in accordance with the Internal Revenue Manual (IRM). However, R's Appeals Office issued a notice of determination to proceed with levy, stating that P was not entitled to collection alternatives because she had not filed her 2005 and 2007 Federal income tax returns. P timely petitioned for review of that determination under sec. 6330(d), I.R.C..R filed a motion for summary judgment..P, proceeding pro se, did not file a cross-motion for summary judgment.
Under regulations prescribed by the Secretary, the Secretary must release a levy upon all, or part of, a taxpayer's property or rights to property if, inter alia, the Secretary has determined that the levy is creating an economic hardship due to the financial condition of the taxpayer.. Sec. 6343(a)(1)(D), I.R.C. The regulations provide that a levy is creating an economic hardship due to the financial condition of an individual taxpayer and must be released “if satisfaction of the levy in whole or in part will cause an individual taxpayer to be unable to pay his or her reasonable basic living expenses.”.Sec. 301.6343-1(b)(4), Proced. & Admin. Regs.
1. Held:. Sec. 6343(a)(1)(D), I.R.C., and sec. 301.6343-1(b)(4), Proced. & Admin. Regs., require release of a levy that creates an economic hardship regardless of the taxpayer's noncompliance with filing required returns.
2. Held, further, a levy on P's wages or car would cause P to be unable to pay her reasonable basic living expenses, creating an economic hardship that would require release of the levy pursuant to sec. 6343(a)(1)(D), I.R.C., and sec. 301.6343-1(b)(4), Proced. & Admin. Regs.
3. Held, further, R's motion for summary judgment is denied because R's determination to proceed with the levy was wrong as a matter of law and, therefore, was an abuse of discretion.
OPINION
DAWSON, Judge:.This matter is before the Court on respondent's motion for summary judgment filed pursuant to Rule 121. 1 Petitioner timely filed a petition pursuant to section 6330(d) appealing respondent's determination to proceed with collection by levy of petitioner's 2002 income tax liability. The issue to be decided is whether respondent's determination was an abuse of discretion.
Background
Petitioner resided in Tennessee when she filed the petition. Her residence is an apartment that she rents for *600 per month.
On September 13, 2007, respondent sent petitioner a Final Notice of Intent to Levy and Notice of Your Right to a Hearing (levy notice)..The underlying tax liability was attributable to unpaid self-assessed tax reported on her 2002 return..Petitioner timely requested a hearing on September 24, 2007, and the hearing was conducted through correspondence and by telephone with the settlement officer.
Petitioner first learned of the collection activity when her employer notified her about the proposed levy on her wages. When the settlement officer asked petitioner whether she wanted to enter into an installment agreement, petitioner said “she has nothing.” 2 Petitioner told the settlement officer that she has pulmonary fibrosis and is dying..Because of her health she can only find part-time employment.
The settlement officer could not find a record that petitioner had filed a return for 2005..Petitioner explained to the settlement officer that the payroll company responsible for completing her 2005 Form W-2, Wage and Tax Statement, was no longer in business..She had attempted to get the tax information from the Internal Revenue Service (IRS), but the IRS had no information regarding her income for 2005.
The settlement officer told petitioner that she might be able to have her account placed in currently not collectible status..The settlement officer asked petitioner to submit a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, and a diagnosis regarding her current health condition.
Petitioner sent a completed Form 433-A, indicating she had monthly income of *800 and expenses of *800, had *14 cash on hand, and owned a 1996 Toyota Corolla four-door sedan with 243,000 miles and a value of *300..The Form 433-A reported that petitioner did not own any other assets..Verification received by the settlement officer was consistent with the information petitioner provided in the Form 433-A..Petitioner was unable to obtain a written diagnosis of her medical condition from her physician because her physician would provide a diagnosis only ina claim for worker's compensation.
The settlement officer's log entry dated May 15, 2008, states:
TP [petitioner] meets the criteria to have account placed in CNC [currently not collectible] status per IRM 5.16.[1.]2.9 Hardship..The balance due is less than 10K and the TP has stated she has a terminal illness..CIS verification is not required..The TP has stated she has nothing and is not able to full pay or make payments..However, the TP is not in compliance. The TP has not filed a 2005 return and there is no record of the 2007 tax return being filed..The TP stated she does not have income information for 2005 and company that did payroll is no longer in business. TP stated she contacted IRS and they advised her they have no income information..There is no information per IRTRL..S/O [the settlement officer] contacted TP regarding filing of the 2007 return..The TP stated the return was filed late..The S/O requested the TP fax a copy of the return with the W-2..TP to fax information by 5-19-08..S/O asked TP if she obtained health diagnosis and the TP stated the doctor would only give her something if she is applying for diability..S/O requested income information for 2005 per IRPTRE.
The settlement officer's log entry dated May 20, 2008, states:
TP did not provide a copy of 2007 return and there is no record that the return has been filed per IDRS research..The TP was employed in 2007 and is currently employed..The 2005 return has not been filed..Since the TP is not in compliance, collection alternative cannot be considered..S/O will issue determination letter..If the 2005 income information is received, the S/O will forward it to the TP.
Respondent issued petitioner a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330 (notice of determination) dated June 2, 2008, sustaining the proposed levy action and stating that, because petitioner was not in compliance with filing the required tax returns, a collection alternative could not be considered..The notice of determination was reviewed and signed by the Appeals team manager..The attachment to the notice of determination stated:
The settlement officer inquired about a collection alternative and you stated you could not make payments. You stated you had pulmonary fibrosis and can only work part-time hours due to your heath condition..The Settlement officer [who] advised you of the collection alternative however explained a collection alternative could not be considered because you were not in compliance with filing required tax returns. * * *
The attachment explained the balancing of efficient tax collection with concern regarding intrusiveness as follows:
Appeals has verified, or received verification, that applicable laws and administrative procedures have been met; has considered the issues raised; and has balanced the proposed collection with the legitimate concern that such action be no more intrusive than necessary by IRC Section 6330(c)(3).
Collection alternatives include full payment, installment agreement, offer in compromise and currently-not-collectible..However, since unfiled tax returns exist, the only alternative at present is to take enforced action by levying your assets..It is Appeals decision that the proposed levy action is appropriate..The proposed levy action balances the need for the efficient collection of the taxes with the legitimate concern that any collection action be no more intrusive than necessary.
Neither the notice of determination nor the attachment reflect any consideration of the fact that the levy would create an economic hardship as stated by the settlement officer in her.daily log and supported by the Form 433-A petitioner submitted.
Petitioner timely filed a petition in this Court challenging respondent's determination..Respondent filed the motion for summary judgment, and the Court ordered petitioner to file a response. 3 Petitioner filed a response to respondent's motion for summary judgment but did not file a cross-motion for summaryjudgment. 4 In her response petitioner describes her situation as follows:
To Whom It May Concern,
I don't know what you want to know cause I don't understand all the legal stuff you sent me..I can't afford a lawyer..And the closest legal aid is in Knoxville 30 miles away..My poor car will not go that far..So I will start at the beginning of my story and see if you can help me.
I was in an unhealthy relationship for many years. During a great deal of that time my husband was doing alcohol and drugs..I had 2 children plus his 3 to take care of..I had been doing janitorial work at a strip mall * * *..It was the only place that I could work that I could take my [then] 3 year old daughter with me..I could not support my family and pay day care. * * * My husband took care of bills and such cause he demanded that I turn over my money..We even got a divorce during that time cause I was not obeying him. * * *
Now I am not looking for sympathy just understanding..Do you know how hard it is to be a single parent?.* * * I have a high school education and nothing else.
It was nearly five years before I was notified of a problem by the I.R.S..Danny [petitioner's former spouse] was suppose to be doing taxes..He even made me sign a form that because he made more money he could claim my kids on his taxes cause we were no longer legally married.
I got all the W-2's from the I.R.S. except 2005 that they still have not sent me..That is why they are not done..I did all those taxes and forfeited the refunds..I do not remember what that total came to. But it was enough to pay I would say most of back taxes..The 2007 taxes were late and I don't know why they didn't arrive..I sent a second copy in as soon as my son gave me my copy..He had my copy for college financial aid and he lost them for a bit of time.
I am not a rich person..I work in a job so I can be home with my daughter..I left my husband in July after he threatened to beat my daughter with a baseball bat..Beating me is one thing but I could not have him beating my girl..So I am a single parent again..Right now we have not had much work in nearly a year..I have rent of 600 a mo..Utilities of 150 and get food stamps or I wouldn't eat..I make about 700-800 [per] month. There are no better jobs in our town..My daughter is only 11 so its not like I can leave her alone at night or on weekends..D.H.S. says it's not even legal..She is too young..There is no child care and I have no family here..I have pulmonary fibrosis that makes me sick all the time and the diagnosis says I have about 10 yrs to live..Right now I can work thank God.
I did my taxes this year [for 2008] and you are getting a little over *4,700..I'm not asking for much just a break..You can have my tax returns [refunds ?] I don't care..Well I do that is a tremendous loss but oh well..I don't have any money to send you on a monthly basis..Can we stop all the penalties..They are killing me..I will never be able to pay it off. * * * I let a relationship screw me up..I am truly sorry for that and am begging for a lifeline here..You can come to my home and see for yourself..I don't have fancy t.v.'s or even cable except for internet..I can't afford a phone..My clothes have holes in them. I even cut my own hair..If I could pay this off faster I would just to stop the nightmares it gives me.
Discussion
A. Summary Judgment
Summary judgment is used to expedite litigation and avoid unnecessary and expensive trials..The Court will render a decision on a motion for summary judgment if the pleadings, answers to interrogatories, depositions, admissions, and other acceptable materials, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law..Rule 121(b). Because the effect of granting a motion for summary judgment is to decide the case against a party without allowing that party an opportunity for a trial, the Court should grant the motion only after a careful consideration of the case.. Associated Press v. United States, 326 U.S. 1, 6 (1945); Kroh v. Commissioner, 98 T.C. 383, 390 (1992).
For purposes of respondent's motion for summary judgment, respondent has the burden of showing the absence of a genuine issue as to any material fact..Petitioner is afforded the benefit of all reasonable doubt, and the material submitted by both sides is viewed in the light most favorable to petitioner. See, e.g., Adickes v. S.H. Kress & Co., 398 U.S. 144, 157 (1970); Kroh v. Commissioner, supra at 390.
Respondent moves the Court for summary judgment on the ground that the settlement officer did not abuse her discretion in rejecting collection alternatives and determining to proceed with levy because petitioner was not in compliance with the filing requirements..Petitioner asks that the levy not be sustained because, if her wages are taken, she will be unable to pay her basic living expenses; and, if her car is taken, she will not be able to work.
B. Collection of Federal Taxes by Levy
If a taxpayer liable for Federal taxes fails to pay the taxes within 10 days after notice and demand, section 6331 authorizes the Secretary to collect the tax by levy upon all property and rights to property (except any property that is exempt under section 6334) belonging to the taxpayer or on which there is a lien for the payment of the tax.
Section 6343(a)(1) provides that, under regulations prescribed by the Secretary, if the Secretary has determined that the levy is creating an economic hardship due to the financial condition of the taxpayer, the Secretary must release a levy upon all, or part of, a taxpayer's property or rights to property. 5 Sec. 6343(a)(1)(D)..The regulations provide that a levy is creating an economic hardship due to the financial condition of an individual taxpayer and must be released “if satisfaction of the levy in whole or in part will cause an individual taxpayer to be unable to pay his or her reasonable basic living expenses.” Sec. 301.6343-1(b)(4), Proced. & Admin. Regs.
A taxpayer alleging that collection of the liability would create undue hardship must submit complete and current financial data to enable the Commissioner to evaluate the taxpayer's qualification for collection alternatives or other relief. Picchiottino v. Commissioner, T.C. Memo. 2004-231..The regulations provide that, for purposes of determining the taxpayer's reasonable amount of living expenses, any information that is provided by the taxpayer is to be considered, including the following:
(A) The taxpayer's age, employment status and history, ability to earn, number of dependents, and status as a dependent of someone else;
(B) The amount reasonably necessary for food, clothing, housing * * *, medical expenses * * *, transportation, current tax payments * * *, alimony, child support, or other court-ordered payments, and expenses necessary to the taxpayer's production of income * * *;
(C) The cost of living in the geographic area in which the taxpayer resides;
(D) The amount of property exempt from levy which is available to pay the taxpayer's expenses;
(E) Any extraordinary circumstances such as special education expenses, a medical catastrophe, or natural disaster; and
(F) Any other factor that the taxpayer claims bears on economic hardship and brings to the attention of the director.
Sec. 301.6343-1(b)(4)(ii), Proced. & Admin. Regs.
C. Section 6330 Procedures
Section 6330(a) provides the general rule that no levy may be made on any property or right to property of any taxpayer unless the Secretary has provided 30 days' notice to the taxpayer of the right to an administrative hearing before the levy is carried out..If the taxpayer makes a timely request for an administrative hearing, the hearing is conducted by the IRS Office of Appeals (Appeals Office) before an impartial officer. Sec. 6330(b)(1), (3).
The taxpayer may raise any relevant issue during the hearing, including appropriate spousal defenses and challenges to “the appropriateness of collection actions”, and may make “offers of collection alternatives, which may include the posting of a bond, the substitution of other assets, an installment agreement, or an offer-in-compromise.”. Sec. 6330(c)(2)(A)..The taxpayer also may raise challenges to the existence or amount of the underlying tax liability if he/she did not receive a notice of deficiency for that liability or did not otherwise have an opportunity to dispute it.. Sec. 6330(c)(2)(B).
During the hearing the Appeals officer must verify that the requirements of applicable law and administrative procedure have been met, consider issues properly raised by the taxpayer, and consider whether any proposed collection action balances the need for the efficient collection of taxes with the taxpayer's legitimate concern that any collection action be no more intrusive than necessary.. Sec. 6330(c)(3)..The Appeals Office then issues a notice of determination indicating whether the proposed levy may proceed.
Under section 6330(d)(1) the taxpayer may petition this Court to review the determination made by the Appeals Office. See sec. 301.6330-1(f)(1), Proced. & Admin. Regs..Where, as in this case, the underlying tax liability is not at issue, we review the Appeals Office's determinations regarding the collection action for abuse of discretion.. Goza v. Commissioner, 114 T.C. 176 (2000)..An abuse of discretion occurs if the Appeals Office exercises its discretion “arbitrarily, capriciously, or without sound basis in fact or law.”. Woodral v. Commissioner, 112 T.C. 19, 23 (1999).
When a taxpayer establishes in a pre-levy collection hearing under section 6330 that the proposed levy would create an economic hardship, it is unreasonable for the settlement officer to determine to proceed with the levy which section 6343(a)(1)(D) would require the IRS to immediately release..Rather than proceed with the levy, the settlement officer should consider alternatives to the levy.
Respondent argues under the holdings of Rodriguez v. Commissioner, T.C. Memo. 2003-153, and McCorkle v. Commissioner, T.C. Memo. 2003-34, that there is no abuse of discretion if a settlement officer rejects collection alternatives because the taxpayer was not in compliance with the filing requirements for all required tax returns. 6
Generally, we have found the Commissioner's policy requiring individuals seeking collection alternatives to be current with filing their returns to be reasonable. 7 However, taxpayers in those cases have had sufficient income to meet basic living expenses..See, e.g., Speltz v. Commissioner, 124 T.C. 165, 178 (2005) (taxpayers claimed hardship because the tax liability was disproportionate to the value that they received from initial stock offerings and because they had already been forced to change their lifestyle), affd. 454 F.3d 782 (8th Cir. 2006); Peterson v. Commissioner, T.C. Memo. 2009-46 (the Court upheld rejection of taxpayers' offer of *20,000 to compromise *70,000 liability where, although they had minimal income from Social Security retirement and disability payments, they had reasonable collection potential of *68,000 from two parcels of real property valued at *80,000); Fangonilo v. Commissioner, T.C. Memo. 2008-75 (Commissioner's refusal to treat taxpayer's tax liability as currently not collectible was not an abuse of discretion where although taxpayer's income was not sufficient to meet his stated monthly living expenses, he had a liquid asset worth more than his tax liability); Willis v. Commissioner, T.C. Memo. 2003-302 (taxpayers' ability to make some payments toward their cumulative liability made them ineligible to have the cumulative liability classified as currently not collectible); Rodriguez v. Commissioner, T.C. Memo. 2003-153 (taxpayer had not filed returns for 12 years and did not submit all of the financial information supporting her offer-in-compromise that the settlement officer requested); Ashley v. Commissioner, T.C. Memo. 2002-286 (taxpayer had income in excess of expenses and sufficient equity in his real property to pay his tax liability in full).
We have found no cases addressing the requirement that the taxpayer be current with filing returns in a levy case involving economic hardship under section 6343(a)(1)(D) and section 301.6343-1(b)(4), Proced. & Admin. Regs..Neither section 6343 nor the regulations condition a release of a levy that is creating an economic hardship on the taxpayer's compliance with filing and payment requirements..The purpose of section 6330 is to “afford taxpayers adequate notice of collection activity and a meaningful hearing before the IRS deprives them of their property.”.S. Rept. 105-174, at 67 (1998), 1998-3 C.B. 537, 603 (emphasis added)..A determination in a hardship case to proceed with a levy that must immediately be released is unreasonable and undermines public confidence that tax laws are being administered fairly..In a section 6330 pre-levy hearing, if the taxpayer has provided information that establishes the proposed levy will create an economic hardship, the settlement officer cannot go forward with the levy and must consider an alternative.
D. Appeals Office's Determination To Proceed With Levy of Petitioner's Assets
The financial information petitioner submitted on the Form 433-A, which was consistent with other information the settlement officer obtained, showed that if petitioner's wages are levied on, she will be unable to pay her basic living expenses; and, if her car is levied on, she will not be able to work..After analyzing petitioner's financial information, the settlement officer concluded that the levy would create an economic hardship and so stated in her log..However, the settlement officer determined collection alternatives to the levy, including an installment agreement, an offer-in-compromise, and reporting the account as currently not collectible, were not available because petitioner had not filed her 2005 and 2007 returns..The settlement officer's determination to proceed with the levy was reviewed and approved by the Appeals team manager who signed the notice of determination..Although the attachment to the notice of determination shows that the Appeals team manager was aware of petitioner's financial situation and health problems, the Appeals team manager signed the notice of determination to proceed with the levy because petitioner had not filed her 2005 and 2007 returns..Proceeding with the levy would be unreasonable because section 6343 would require its immediate release, and the determination to do so was arbitrary..The determination to proceed with the levy was wrong as a matter of law and, therefore, was an abuse of discretion..Respondent is not entitled to summary judgment, and respondent's motion will be denied.
An order denying respondent's motion will be issued.

Footnotes


1
All Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code.
2
Petitioner explained to the settlement officer that she had previously agreed to pay in installments and that she was told she would be sent envelopes for each payment, but she never received the envelopes or monthly bills.
3
In the order we observed that our preliminary review of the record indicated that the proposed levy action involved a hardship situation and that petitioner needed the assistance of an attorney..We urged petitioner to contact the legal aid society or the local bar association pro bono services and provided their addresses and phone numbers.
4
After petitioner filed her response to respondent's motion for summary judgment, respondent filed a motion to continue the case wherein respondent stated that petitioner was in the process of submitting a collection alternative to the IRS and that, if the alternative is accepted by the IRS, a trial in this case would not be necessary..The Court granted respondent's motion and directed the parties to file a status report on or before July 27, 2009..In a status report filed on July 17, 2009, respondent reported that respondent has not received any communication from petitioner and requested the Court to grant respondent's motion for summary judgment.
5
The regulations provide a method whereby a taxpayer may inform the Secretary that a levy is creating an economic hardship and request that the levy be released..See sec. 301.6343-1(c), Proced. & Admin. Regs..“A taxpayer who wishes to obtain a release of a levy must submit a request for release in writing or by telephone to the district director for the Internal Revenue district in which the levy was made.”. Id..However, service center directors and compliance center directors (to whom requests by taxpayers are not made) who have determined that a levy is creating an economic hardship must also release the levy and promptly notify the taxpayer of the release pursuant to sec. 301.6343-1(a), Proced. & Admin. Regs.
6
Generally, the IRS will not grant an installment agreement, accept an offer-in-compromise, or report an account as currently not collectible if any tax return for which the taxpayer has a filing requirement has not been filed..See Internal Revenue Manual pts. 5.14.1.4.1(4)-(6) (Sept. 26, 2008) (installment agreements); 5.8.3.13(1), (2), (4) (Sept. 23, 2008) (offers-in-compromise); 5.16.1.1(5) and (6), 5.16.1.2.9(8) (May 5, 2009) (currently not collectible), 5.1.11.2.3 (June 2, 2004) (general collection procedures).
7
In Estate of Atkinson v. Commissioner, T.C. Memo. 2007-89, we found reasonable requirements that an entity seeking collection alternatives to full payment, including reporting an account as currently not collectible, filing any outstanding tax returns and submitting a full financial statement and verification information for analysis..Mandatory release of levy creating an economic hardship applies only to individuals..Sec. 301.6343-1(b)(4), Proced. & Admin. Regs.

USTC Cases, United States of America v. Kenneth A. Evans, Appellant., U.S. Court of Appeals, Third Circuit, 2010-1 U.S.T.C. ¶50,118, (Dec. 15, 2009)

United States of America v. Kenneth A. Evans, Appellant.
U.S. Court of Appeals, 3rd Circuit; 08-2528, December 15, 2009.

Before: Ambro, Garth and Roth, Circuit Judges.
OPINION
Ambro, Circuit Judge: Kenneth A. Evans (“Evans”) was convicted in the Eastern District of Pennsylvania of three counts of filing false tax returns (in violation of 26 U.S.C. § 7206(1)) and two counts of tax evasion (in violation of 26 U.S.C. § 7201). The District Court sentenced him to 36 months' imprisonment. He now challenges his conviction and sentence. 1 We affirm both.
I. Background
Because we write solely for the parties, we will recite only those facts necessary to our disposition. Evans, a sales representative, stopped filing tax returns in 1999. In January 2001, he filed a civil suit in federal court against the Government requesting a full refund of his 1999 federal income tax. Evans claimed that no legal authority required him to pay income tax on his wages, the filing of a tax return would violate his Fifth Amendment right against self-incrimination, and the Sixteenth Amendment does not grant the Government authority to tax directly his wages without apportionment. In June 2001, the District Court found in the Government's favor on summary judgment. The Court, noting that these types of tax protest claims were appearing with some frequency, rejected in detail Evans' claims. Evans appealed, and we affirmed the District Court, noting the clear precedent that explicitly rejects Evans' arguments. See Evans v. United States, No. 01-3161, 32 F. App'x 31 (3d Cir. Mar. 26, 2002) (unpublished). We ordered Evans to pay $4,000 as a sanction for filing a frivolous appeal. The United States Supreme Court denied Evans' request for a writ of certiorari.

In August 2001, the IRS sent Evans a report regarding Evans' failure to file his 1999 return. At a meeting requested by Evans, IRS agents Vastardis and Burton informed Evans that his earnings were taxable income and Evans was required to file a return to obtain a refund for 1999. The meeting was recorded at Evans' request.
After this meeting, Evans filed a late tax return for the year 2000. He listed his income as zero, yet the Form W-2 wage and tax statement submitted by his employer showed he was paid over $55,000 in wages in 2000. Evans again reported zero income in his 2001 tax return. The corresponding W-2 showed he earned over $77,000 in 2001. In his 2000 and 2001 tax returns, Evans sought a refund of all taxes that had been withheld from his paychecks. The IRS denied these refund claims.
In January 2002, Evans submitted an IRS Form W-4 to his employer claiming he was exempt from withholding because he had no tax liability. His employer complied with this request and did not withhold federal taxes from 2002 through 2004. Evans did not file a tax return for the years 2002 and 2003.
In March 2003, Evans filed a second civil suit against the Government for a refund of federal income tax he paid in the 2000 and 2001 tax years. The District Court held a hearing and allowed Evans to argue his position. In granting judgment for the Government and rejecting Evans' arguments, the District Court noted that, instead of paying the sanctions imposed by our Court, Evans chose to burden the federal courts with yet another frivolous suit. The District Court imposed an additional $1,000 sanction.
In November 2004, the IRS wrote to Evans regarding his failure to file returns, and Evans met with IRS Agents Michael Taibi and Susan Hough. This meeting also was recorded at Evans' request. Evans argued that he was not required to file returns because he had no taxable income. Agent Taibi communicated with Evans' employer to request they begin withholding federal income tax. Taibi then referred the matter for criminal investigation.
In January 2005, Evans submitted to his employer a form “W-4E,” captioned “Exemption from Withholding,” in which he claimed he was exempt from withholding. The company did not honor the exemption request, as the “form” was not Governmentissued. Evans filed a tax return for 2004 stating that he had no income, as he had done in his 2000 and 2001 returns.
A grand jury indicted Evans for filing false tax returns in the years 2000, 2001, and 2004, and tax evasion for the years 2002 and 2003. At trial, the Government presented testimony of several IRS agents regarding Evans' filing history. The agents testified about the meetings with Evans in 2001 and 2004, and a recording was played of a December 2005 interview between Evans and an IRS agent with the criminal investigation division. Evans' Forms W-4 and Forms W-2 were introduced, and representatives of his employer described his withholding and wage history. Evidence was presented of the rejection of Evans' position by two District Court judges and the imposition of sanctions by this Court for filing a frivolous appeal. The Government also introduced evidence of Evans' tax-protestor status and activities, including postings from Evans' website regarding his tax beliefs and e-mails between Evans and other tax protestors.
Evans testified at length on his own behalf. He presented his interpretation of the case law, Tax Code, and IRS regulations. Evans claimed that Agent Vastardis told him at the 2001 meeting that a filer must declare that he had no income in order to claim a refund, and that filing a return was voluntary and not mandatory. Evans played selected portions of the tape of this meeting, and introduced numerous exhibits, including attachments to his W-4s.
The jury convicted Evans on all counts, and this appeal followed his sentencing.
II. Discussion
Evans makes four arguments on appeal: (1) the District Court erred by not admitting attachments to Evans' Form W-4s contemporaneously under Federal Rule of Evidence 106; (2) the evidence presented at trial was insufficient to establish Evans willfully failed to file tax returns and filed false tax returns; (3) the District Court erred in its jury charge; and 4) it relied on an impermissible factor in varying upward from the advisory Guidelines range.
A. Evidentiary Challenge
The prosecution introduced into evidence the “Employee's Withholding Allowance Certificate,” IRS Form W-4, completed by Evans in the years 2002, 2003, and 2004. The District Court denied Evans' motion in limine to admit letters and a videotape Evans attached to his W-4s, including letters to his employer explaining his view that he had no income tax liability and instructing his employer not to withhold any taxes. The District Court's decision to admit or exclude evidence is reviewed for abuse of discretion. United States v. Mathis, 264 F.3d 321, 326-27 (3d Cir. 2001).
Evans claims that the District Court's denial of his motion was an abuse of discretion under Federal Rule of Evidence 106, which provides that
[w]hen a writing or recorded statement or part thereof is introduced by a party, an adverse party may require the introduction at that time of any other part or any other writing or recorded statement which ought in fairness to be considered contemporaneously with it.
This codification of the doctrine of completeness guards against the potential for evidence to be misleading when presented out of context. Admission of additional evidence is compelled “if it is necessary to (1) explain the admitted portion, (2) place the admitted portion in context, (3) avoid misleading the trier of fact, or (4) insure a fair and impartial understanding.” United States v. Soures, 736 F.2d 87, 91 (3d Cir. 1984). Evans asserts that failure to include his writings and the video with the Form W-4s gave the jury a distorted and misleading view, as Evans incorporated them specifically to provide his reasoning for completing the forms in the manner he did.
The District Court found that a Form W-4 is a distinct and complete Government issued document, and the mere fact that Evans appended writings or videos did not render these additional submissions part of the Form W-4. The District Court also concluded that the Form W-4 alone was not so misleading or unfairly prejudicial as to warrant application of Rule 106.
Even were we to assume this was an abuse of discretion, any conceivable error was harmless. Under our traditional harmless error standard, a non-constitutional error is harmless when it is “ highly probable that the error did not contribute to the judgment.” United States v. Gambone, 314 F.3d 163, 177 (3d Cir. 2003) (internal quotation marks and citation omitted) (emphasis in original). “High probability requires that the court possess a sure conviction that the error did not prejudice the defendant.” Id. (internal quotation marks and citation omitted).
Here, one of the letters attached to a Form W-4 was discussed in detail during cross-examination of Evans' employer's corporate counsel. ( See Gov't App. 170-74.) Moreover, Evans testified about various letters he wrote to the IRS containing largely the same arguments he made in letters attached to the Form W-4s. Evans opined at length at trial about his reasons for completing the Form W-4s as he did. Therefore, any error was harmless.
B. Sufficiency of the Evidence
Evans argues that the trial evidence was insufficient to show that he willfully failed to file tax returns and willfully filed false tax returns. 2 In support of this contention, Evans contends that the Government did not prove willfulness, an element of the five counts in the indictment. We are unpersuaded.
“Willfulness requires the voluntary, intentional violation of a known legal duty as a condition precedent to criminal liability.” United States v. McKee, 506 F.3d 225, 236 (3d Cir. 2007) ( citing Cheek v. United States, 498 U.S. 192 (1991)). This element “protects the average citizen from criminal prosecution for innocent mistakes in filing tax forms that may result from nothing more than negligence or the complexity of the tax laws.” Id. Willfulness is negated by a defendant's good faith belief that he is not violating any laws. Cheek, 498 U.S. at 202. Once raised as a defense, the burden is on the Government to prove the defendant did not have a good faith belief. Id.
Viewing the evidence in the light most favorable to the Government, the element of willfulness is satisfied here by the judgments of two District Courts and our Court in the civil cases brought by Evans, communications to Evans by IRS agents, Evans' failure to file, evidence of his tax protest activities, and his knowledge of the conviction and sentencing of another tax protestor. Numerous authorities, including our Court, informed Evans of his duty to file a return and treat his wages as income. This is not a case of a good faith misunderstanding of a tax law provision. This is a case where the defendant knew and understood the law. Someone who knows the law and disagrees with it is not someone who in good faith believes the law does not apply to him.
C. Jury Instructions
Evans next challenges several of the District Court's jury instructions. When a party timely objects to jury instructions, “[w]e exercise plenary review to determine whether jury instructions misstated the applicable law, but in the absence of a misstatement we review for abuse of discretion.” Cooper Distrib. Co. v. Amana Refrigeration, Inc., 180 F.3d 542, 549 (3d Cir. 1999). However, where a party claiming error in a jury instruction “did not make a timely objection, we review for plain error.” Id. We will reverse if that error was “fundamental and highly prejudicial, such that the instructions failed to provide the jury with adequate guidance and our refusal to consider the issue would result in a miscarriage of justice.” Id. (internal quotation marks and citations omitted). 3
Where a district court denies a requested jury instruction, we will reverse “only when the requested instruction was correct, not substantially covered by the instructions given, and was so consequential that the refusal to give the instruction was prejudicial to the defendant.” United States v. Phillips, 959 F.2d 1187, 1191 (3d Cir. 1992). Jury instructions are to be read as a whole. United States v. Flores, 454 F.3d 149, 157 (3d Cir. 2006). “It is well-settled that the trial judge retains discretion to determine the language of the jury charge … [s]o long as the court conveys the required meaning,” and the court is under no obligation to use language proffered by the defendant. Id. at 161.
First, Evans challenges the District Court's use of the word “genuine” when it instructed the jury that a defendant's disagreement with a legal duty, even if genuine, does not provide a good faith defense. Read in context, the District Court accurately instructed the jury on the issue of good faith in accordance with Supreme Court and Third Circuit precedent.
Relatedly, Evans argues that the District Court erred in refusing to give his proposed good faith and willfulness instructions and a theory-of-the-defense instruction. However, the Court's explanation of willfulness in the jury charge substantially covered the relevant points and allowed Evans to argue his theory of the case. Therefore, the Court's refusal to include specific language or instruct on particular legal arguments requested by Evans was not an abuse of discretion.
Evans also claims that the District Court erroneously informed the jury that willfulness does not require that Evans knew his conduct was in violation of the law. Although Evans is correct in noting that the Court misspoke on one occasion while giving the jury instructions, the mistake was corrected when the Court accurately stated repeatedly that willfulness required proof that Evans knew his conduct violated the law, and on numerous occasions informed the jury that willfulness required violation of a “known legal duty.” Given the instructions in their entirety, this one misstatement could not have confused the jury. Therefore, the jury was properly charged on the willfulness element.
Evans' remaining challenges to the jury charge, which include a challenge to the state-of-mind instruction and a reference to income under the Tax Code, are without merit. Viewing the jury instructions in their entirety and in context, the District Court did not abuse its discretion.
D. Sentencing
Finally, Evans argues that the District Court improperly relied on the two civil tax suits filed by Evans against the United States in its consideration of the 18 U.S.C. § 3553(a) factors. This is Evans' only complaint regarding his sentencing; he does not challenge the calculation of the Guidelines range or the Court's consideration of the § 3553(a) factors in general.
We review the District Court's sentence for reasonableness under an abuse of discretion standard. United States v. Tomko, 562 F.3d 558, 564, 567 (3d Cir. 2009) (en banc). “Where, as here, a district court decides to vary from the Guidelines' recommendations, we ‘must give due deference to the district court's decision that the § 3553(a) factors, on a whole, justify the extent of the variance.’” Id. at 561 ( quoting Gall v. United States, 128 S.Ct. 586, 597 (2007)).
The Guidelines range was 15 to 21 months. The District Court imposed an above-Guidelines sentence of 36 months. It discussed at length the factors set forth at 18 U.S.C. § 3553(a). We do not think it was improper for the Court, in evaluating those factors (including the nature and circumstances of the offense), to consider that, despite several courts' unequivocal rejection of Evans' claims that his income was not subject to taxation, Evans continued to violate the law. 4 The Court noted Evans' disrespect for the court process, his disdainful interactions with IRS agents, the need for him genuinely to appreciate the authority of the law, and the need to deter the public. We have no hesitancy in concluding that it rationally and meaningfully considered the § 3553(a) factors, and the sentence of 36 months was reasonable in this case.
* * * * *
For these reasons, we affirm both Evans' conviction and sentence.



Footnotes


1
The District Court had jurisdiction under 18 U.S.C. § 3231. We have jurisdiction under 28 U.S.C. § 1291 and 18 U.S.C. § 3742.
2
"‘We apply a particularly deferential standard of review when deciding whether a jury verdict rests on legally sufficient evidence.’" United States v. Soto, 539 F.3d 191, 193-94 (3d Cir. 2008) ( quoting United States v. Dent, 149 F.3d 180, 187 (3d Cir. 1998)). We will sustain the verdict if, viewing the evidence in the light most favorable to the Government, "‘any rational trier of fact could have found the essential elements of the crime beyond a reasonable doubt.’" Id. at 194 ( quoting Dent, 149 F.3d at 187).
3
Evans objected to the Court's instructions on willfulness and the Court's refusal to give certain of Evans' proposed instructions. Therefore, these instructions are subject to harmless error review. Evans did not preserve his objection to his proposed theory of the defense instruction, and he concedes this issue is reviewed for plain error.
4
Evans' allegation that this violated his First Amendment rights is meritless.

The IRS has issued guidance regarding the reporting requirements of widely held fixed investment trusts (WHFITs). The new guidance provides interim rules on transition payments for trustees and "middlemen" with respect to WHFITs and trust interest holders (TIHs) and also limited penalty relief for trustees and middlemen. A middleman for this purpose is a person who hold interests in a WHFIT, but is not the ultimate beneficial owner of such interest. The guidance also provides rules for: inclusion of summary totals of WHFIT interest, dividend and miscellaneous income on Form 1099; the format of the written tax information statement required to be provided to TIHs; and the obligations of trustees and middlemen for information reporting with respect to certain nonmortgage WHFITs (NMWHFITs).



Notice 2010-4, I.R.B. 2010-2, December 18, 2009.

[ Code Sec. 671]\
Information reporting: Widely held fixed investment trusts.–



SECTION I: PURPOSE
This notice provides guidance to trustees, middlemen and trust interest holders (TIHs) of widely held fixed investment trusts (WHFITs) regarding the WHFIT reporting rules in § 1.671-5 of the Income Tax Regulations. Specifically, this notice provides (1) guidance on transition payments (as defined in Section III below) and limited penalty relief for trustees and middlemen required to file Forms 1099 and furnish written tax information statements under the widely held mortgage trust (WHMT) safe harbor in § 1.671-5(g); (2) guidance regarding the TIHs' treatment of the transition payments; (3) guidance regarding the inclusion of WHFIT interest, dividend, and miscellaneous income in the summary totals on Forms 1099; (4) guidance regarding the format of the written tax information statement provided to TIHs under § 1.671-5(e); and (5) guidance regarding the obligations of trustees and middlemen with respect to reporting under the WHFIT rules for certain non-mortgage WHFITs (NMWHFITs).

SECTION II: BACKGROUND
Section 1.671-5 provides the WHFIT reporting rules. A WHFIT is an arrangement classified as a trust under § 301.7701-4(c), provided that: (i) the trust is a United States person under § 7701(a)(30)(E); (ii) the beneficial owners of the trust are treated as owners under subpart E, part I, subchapter J, chapter 1 of the Code; and (iii) at least one interest in the trust is held by a middleman. See § 1.671-5(b)(22). A WHMT is a WHFIT, the assets of which consist only of mortgages, regular interests in a REMIC, interests in another WHMT, reasonably required reserve funds, amounts received with respect to these assets, and during a brief initial funding period, cash and short-term contracts to purchase these assets. See § 1.671-5(b)(23).

Trustees of fixed investment trusts frequently do not know the identities of the beneficial owners of the trust interests because the trust interests are often held in the name of a middleman. Thus, trustees are unable to communicate tax information directly to the beneficial owners of the trust interests. The WHFIT reporting rules in § 1.671-5 provide rules that specifically require the sharing of tax information among trustees, middlemen, and beneficial owners of the trust interests. To accomplish this, § 1.671-5 generally requires trustees to make trust tax information available to middlemen. Sections 1.671-5(d) and (e) require middlemen, and in some cases, trustees, to file a Form 1099 with the IRS and to furnish a written tax information statement to a TIH for the trust interests that the trustee or middleman holds on behalf of, or for the account of, the TIH.

Section 1.671-5(n) provides that the WHFIT reporting rules are applicable January 1, 2007. The preamble to the final regulations under § 1.671-5 ( T.D. 9308, 2007-8 I.R.B. 523 [71 FR 78351] (December 29, 2006)) informed trustees and middlemen that the IRS would not impose any penalties that would otherwise apply as a result of a failure to comply with the WHFIT reporting rules with respect to the 2007 calendar year in cases where the trustee or middleman was unable to change its information reporting systems to comply with the WHFIT reporting rules. In September of 2008, the IRS and the Treasury Department issued Notice 2008-77, 2008-40 I.R.B. 814, which informed trustees and middlemen of WHFITs that the IRS would not assert penalties as a result of a failure to comply with the WHFIT reporting rules with respect to calendar year 2008.

Except as provided in Section III below, trustees and middlemen must comply with the WHFIT reporting rules for calendar year 2009.

SECTION III: TRANSITION PAYMENTS AND LIMITED PENALTY RELIEF FOR TRUSTEES AND MIDDLEMEN REPORTING UNDER THE WHMT SAFE HARBOR
The WHMT safe harbor in § 1.671-5(g) provides safe harbor reporting rules for trustees of certain WHMTs. If a trustee reports WHMT items in accordance with the safe harbor, the information provided by a middleman or trustee with respect to WHMT items on the Forms 1099 required to be filed with the IRS and on the written tax information statement furnished to the TIH must be determined as provided in § 1.671-5(g)(2). For the purpose of determining the timing of when an item of trust income that is attributable to a TIH is included on the Form 1099 filed for that TIH, the WHMT safe harbor looks to the record date for the payment rather than the actual payment date. See § 1.671-5(g)(2)(ii). Further, the regulations require that a TIH be provided with information regarding the amount of the gross income and separately provided with information regarding the amount of the expenses of a WHMT that are attributable to the TIH. See § 1.671-5(g)(1)(iii)(C).

Prior to the effective date of the WHFIT reporting rules, many trustees and middlemen reported income from a WHMT to a beneficial owner based on payment dates and amounts rather than based on record dates and amounts as required under the WHMT safe harbor. As a result, when a trustee or middleman transitions to the new reporting rules, some income might not be reported to the IRS on Forms 1099 and some income and expense information may not be furnished to TIHs. These omissions could occur where the record date for a payment falls in a year prior to the first year of reporting under the WHMT safe harbor and the payment date falls in the first year of reporting under the safe harbor. For example, income received by many WHMTs for December 2008 and payable to record holders as of December 31, 2008, was paid on January 15, 2009. The income and expenses which relate to the December 31 st record date and January 15 th payment date were not included on the Form 1099 or written tax information statement for 2008 under the reporting method used by the trustees and middlemen for 2008 if the trustees and middlemen were reporting based on the payment date, which occurred in 2009. If the trustees or middlemen transition to the WHMT safe harbor for 2009, absent the rules contained in this Section III, the income and expenses also would not be included by trustees and middlemen in calculating trust income for 2009 under the safe harbor because they would be reporting based on the record date, which occurred in 2008.

To address this problem, trustees and middlemen must report as provided in this Section III in the first year that the trustee or middleman transitions from reporting based on payment dates to reporting based on record dates under the WHMT safe harbor. For purposes of this Notice, a Transition Payment is any payment (gross income less applicable expenses) that has (1) a payment date in the first year that the trustee or middleman transitions to reporting under § 1.671-5(g)(2) of the WHMT safe harbor (“transition year”); and (2) a record date in a year prior to the transition year. Trustees and middlemen that are transitioning to reporting under the WHMT safe harbor must include information with respect to Transition Payments on Forms 1099 filed with the IRS for the transition year, if information for these payments has not previously been included on a Form 1099 for a prior year. Additionally, the trustee or middleman must include information with respect to Transition Payments in the written tax information statement furnished to the TIH for the transition year. Although § 1.671-5(g)(1)(iii)(C) requires middlemen and trustees reporting under the WHMT safe harbor to provide TIHs with information regarding gross income and separately provide information regarding the expenses of the WHMT attributable to the TIH, trustees and middlemen may report net amounts with respect to Transition Payments. The trustee or middleman need not separately identify the information with respect to the Transition Payments on the Form 1099 or on the written tax information statement.

Trustees and middlemen also must provide the TIH with a statement that explains that (i) the WHFIT is transitioning from reporting based on payment dates to reporting based on record dates to comply with the newly applicable WHFIT reporting rules; (ii) to effect this transition, the information reported on the statement and to the IRS includes information with respect to Transition Payments and that a Transition Payment is a payment that had a record date in a prior year and payment date in the current year, which was not previously included on a prior Form 1099; and (iii) the TIH must include the Transition Payment in computing its taxable income for the transition year as a § 481(a) adjustment to prevent omission of income caused by the reporting transition (see Section IV below).

The IRS and the Treasury Department recognize that trustees and middlemen may not have adequate time to modify their reporting systems to report Transition Payments that span the 2008 and 2009 calendar years as required under this Section III. Accordingly, the IRS will not impose any penalties on trustees and middlemen for 2009 for a failure to comply with §§ 1.671-5(d), (e), and (g)(2) with respect to TIHs in a WHMT. However, trustees and middlemen must continue to comply with §§ 6041 through 6050W to the extent applicable, and this Notice does not provide penalty relief with respect to a failure to comply with those reporting sections. In addition, a trustee or middleman must report Transition Payments as required under this Section III in the first year that the trustee or middleman transitions to reporting under the WHMT safe harbor, regardless of whether the trustee transitions for 2009 or 2010.

SECTION IV: TREATMENT OF TRANSITION PAYMENTS BY THE TIHs
A change from recognizing trust income in the year of the payment date to the year of the record date in accordance with the transition to record date reporting under the WHMT safe harbor is a change in method of accounting under § 446(e) and § 1.446-1(e)(2)(ii)(a). A taxpayer generally must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. Section 446(e) and § 1.446-1(e)(2)(i). Section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions deemed necessary to permit a taxpayer to obtain consent to change a method of accounting. Section 481(a) requires those adjustments necessary to prevent amounts from being duplicated or omitted when the taxpayer's taxable income is computed under a method of accounting different from the method used to compute taxable income for the preceding taxable year.

In accordance with § 1.446-1(e)(3)(ii), the Commissioner hereby grants consent to a cash method TIH who included income on its individual income tax return consistent with the amount reported on a Form 1099 for the year prior to the transition year, to change its method of accounting for trust income from recognizing the income based on the payment date to recognizing the income based on the record date in accordance with the transition to record date reporting under the WHMT safe harbor. The Transition Payment reported on a TIH's Form 1099 and written tax information statement for the transition year is an adjustment required under § 481(a). The entire amount of the § 481(a) adjustment (i.e., the Transition Payment) must be taken into account in computing a TIH's taxable income for the transition year. A TIH who changes its method of accounting for the trust income in accordance with this section does not need to file a Form 3115, Application for Change in Accounting Method.

SECTION V: WHFIT INTEREST AND DIVIDEND INCOME MAY BE INCLUDED IN THE SUMMARY TOTALS PROVIDED TO THE IRS ON FORMS 1099
Middlemen and trustees have also indicated that they provide the IRS with a summary total for interest, dividends and miscellaneous payments made to a TIH during the calendar year on the relevant Form 1099. These middlemen and trustees have questioned whether including WHFIT items of income in these summary totals is permissible under § 1.671-5(d) or whether a separate Form 1099 must be filed to report WHFIT income to the IRS. This notice informs middlemen and trustees that WHFIT income that is appropriately reported on a Form 1099-INT, a Form 1099-DIV, or a Form 1099-MISC under § 1.671-5(d) may be included in the summary total on the Form 1099 filed with the IRS.

SECTION VI: PROCEDURES FOR FURNISHING THE WRITTEN TAX INFORMATION STATEMENT TO BENEFICIAL OWNERS UNDER REGULATION
§ 1.671-5
(a) Electronic statements.

Section 1.671-5(k) provides that the information reporting sections in subpart B, part III, subchapter A, chapter 61, of the Code ( §§ 6041 through 6050W) and the regulations thereunder are incorporated into the WHFIT rules to the extent those provisions are not inconsistent with the WHFIT reporting rules.

Effective March 9, 2002, § 401 of the Job Creation and Worker Assistance Act of 2002, an off-Code provision, removed the paper delivery impediment by authorizing all payee statements required by §§ 6041 through 6050W to be furnished electronically. Additionally, § 4.5.1 of Rev. Proc. 2008-36, 2008-33 I.R.B. 340, provides that if a person is required to furnish a written statement (Copy B or acceptable substitute) to a recipient, then the statement may be furnished electronically instead of on paper. Provided that the trustee or middleman has followed the rules and procedures outlined in § 4.5.1 of Rev. Proc. 2008-36, a trustee or middleman may provide electronically the written tax information statement required to be furnished to a beneficial owner under § 1.671-5(e).

(b) Composite statements.

Section 4.2.1 of Rev. Proc. 2008-36 indicates that a composite recipient statement may be used for certain Forms 1099 and provides the rules for providing such a composite statement. Composite statements that meet the requirements of § 4.2.1 of Rev. Proc. 2008-36 may be used to provide the WHFIT information required to be furnished to beneficial owners under the WHFIT reporting rules, provided that the information required to be provided to the beneficial owner that is not required to be reported to the IRS on Forms 1099 also is included in an accompanying statement.

(c) Summary totals.

As noted above, it is permissible for middlemen and trustees to include income from a WHFIT in the summary totals on Forms 1099-INT, Forms 1099-DIV, and Forms 1099-MISC, when these forms are provided to the IRS. Middlemen and trustees may also include income from a WHFIT in a summary total provided to a beneficial owner, but only if the summary total is accompanied by sufficient information to enable the beneficial owner to properly report its items of income, deduction and credits from the WHFIT on its federal income tax return and such information satisfies the requirements of § 1.671-5(e) as modified by the reporting safe harbors in §§ 1.671-5(f) and (g) and for the transition year, satisfies Section III of this Notice.

However, the deadline for furnishing WHFIT information to a TIH may differ from that for furnishing information with respect to other securities that the middleman may hold for the TIH. Where WHFIT information is included in a summary total with information regarding securities that are required to be reported at an earlier date, the inclusion of WHFIT information on the statement does not alter the earlier deadline. Additionally, if the amount of WHFIT income is determined to be different than what was reported on the earlier date, a corrected Form 1099 must be sent to the TIH.

SECTION VII: FURNISHING TAX INFORMATION PACKAGES FOR CERTAIN NMWHFITS
There are a number of royalty trusts and commodity trusts that meet the definition of a WHFIT. The IRS and the Treasury Department have been asked to clarify the application of the WHFIT rules with respect to furnishing TIHs in a royalty trust or a commodity trust with information necessary to properly report the tax consequences of their ownership interest in the trust. Under the structure of the WHFIT reporting rules, trustees are to make trust information available to middlemen. See § 1.671-5(c). The middlemen are then required to provide Forms 1099 to the IRS and to furnish written tax information statements to TIHs on whose behalf or account the middleman holds an interest in the WHFIT or acts as an intermediary. See §§ 1.671-5(d) and (e).

TIHs in royalty and commodity trusts need certain information (e.g., cost depletion schedules) in order for them to properly report the tax consequences of ownership of a trust interest. Historically, some royalty trusts have distributed annual tax packages or booklets to TIHs that included this information. In some cases, the trustee of a royalty trust makes this information available on an Internet website.

Middlemen are concerned that the WHFIT rules now require them to publish and mail this information, which was formerly provided by the trustees of these trusts. Middlemen have inquired whether they can provide this additional information by providing a TIH with the address of an Internet website where the information can be found. Until further guidance is issued, the IRS and the Treasury Department have determined that providing the TIH of a royalty or commodity trust with the address of an Internet website where the information can be found is sufficient to meet the requirements of § 1.671-5(e) if the trustee or middleman also informs the TIH that a written tax information package will be provided if requested and the middleman or trustee does in fact furnish a written package if requested. This does not, however, relieve trustees and middlemen of any requirement to provide the IRS and TIHs with individualized calculation of the items of income that are required to be reported to the IRS on a Form 1099.

It has been suggested that the IRS and the Treasury Department clarify the application of the WHFIT reporting rules to royalty and commodity trusts. One suggested clarification is to limit the burden on middlemen to providing the IRS with appropriate Forms 1099 and providing TIHs with statements regarding the information provided on the Form 1099, and to require trustees to maintain an Internet website capable of providing investor-specific information for other items that are required to be provided to the TIH under § 1.671-5(e) but are not required to be included on the Form 1099. The IRS and the Treasury Department request comments regarding this suggestion and also welcome any alternative suggestions on how trustees and middlemen should share the reporting burden. The IRS and the Treasury Department also request comments on whether there are other types of NMWHFITs from which TIHs need significant information to report the tax consequences of ownership of an interest in the NMWHFIT on their individual tax returns and suggestions on how this information could best be provided.

Comments should include a reference to Notice 2010-4. Send submissions to CC:PA:LPD:RU ( Notice 2010-4), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:RU ( Notice 2010-4), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC 20224, or sent electronically via the following email address: Comments@ irscounsel.treas.gov. Please include the notice number 2010-4 in the subject line of any electronic communication. All materials submitted will be available for public inspection and copying.

SECTION VIII: EFFECTIVE DATE
This notice is effective on December 17, 2009.

SECTION IX: DRAFTING INFORMATION
The principal author of this notice is Michala P. Irons of the Office of Associate Chief Counsel (Passthroughs & Special Industries). For further information regarding this notice contact Michala P. Irons at (202) 622-3050 (not a toll-free call).

IRS News Release IR-2009-114, December 8, 2009.

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The IRS has reminded taxpayers that several important tax law provisions affecting charitable donations have taken effect in recent years. Specifically, the IRS addressed special charitable contributions for certain individual retirement account (IRA) owners, rules for clothing and household items, and the requirements to be able to deduct cash contributions. Back references: ¶11,620.6803 and ¶11,700.50.



IRS Offers Tips for Year-End Donations
Individuals and businesses making contributions to charity should keep in mind several important tax law provisions that have taken effect in recent years.

Some of these changes include the following:

Special Charitable Contributions for Certain IRA Owners
This provision, currently scheduled to expire at the end of 2009, offers older owners of individual retirement accounts (IRAs) a different way to give to charity. An IRA owner, age 701/2 or over, can directly transfer tax-free up to $100,000 per year to an eligible charity. This option, created in 2006, is available for distributions from IRAs, regardless of whether the owners itemize their deductions. Distributions from employer-sponsored retirement plans, including SIMPLE IRAs and simplified employee pension (SEP) plans, are not eligible.

To qualify, the funds must be contributed directly by the IRA trustee to the eligible charity. Amounts so transferred are not taxable and no deduction is available for the transfer.

Not all charities are eligible. For example, donor-advised funds and supporting organizations are not eligible recipients.

Amounts transferred to a charity from an IRA are counted in determining whether the owner has met the IRA's required minimum distribution. Where individuals have made nondeductible contributions to their traditional IRAs, a special rule treats transferred amounts as coming first from taxable funds, instead of proportionately from taxable and nontaxable funds, as would be the case with regular distributions. See Publication 590, Individual Retirement Arrangements (IRAs), for more information on qualified charitable distributions.

Rules for Clothing and Household Items
To be deductible, clothing and household items donated to charity generally must be in good used condition or better. A clothing or household item for which a taxpayer claims a deduction of over $500 does not have to meet this standard if the taxpayer includes a qualified appraisal of the item with the return. Household items include furniture, furnishings, electronics, appliances and linens.

Guidelines for Monetary Donations
To deduct any charitable donation of money, regardless of amount, a taxpayer must have a bank record or a written communication from the charity showing the name of the charity and the date and amount of the contribution. Bank records include canceled checks, bank or credit union statements, and credit card statements. Bank or credit union statements should show the name of the charity, the date, and the amount paid. Credit card statements should show the name of the charity, the date, and the transaction posting date.

Donations of money include those made in cash or by check, electronic funds transfer, credit card and payroll deduction. For payroll deductions, the taxpayer should retain a pay stub, a Form W-2 wage statement or other document furnished by the employer showing the total amount withheld for charity, along with the pledge card showing the name of the charity.

These requirements for the deduction of monetary donations do not change the long-standing requirement that a taxpayer obtain an acknowledgment from a charity for each deductible donation (either money or property) of $250 or more. However, one statement containing all of the required information may meet both requirements.

Reminders
To help taxpayers plan their holiday-season and year-end giving, the IRS offers the following additional reminders:

Contributions are deductible in the year made. Thus, donations charged to a credit card before the end of 2009 count for 2009. This is true even if the credit card bill isn't paid until 2010. Also, checks count for 2009 as long as they are mailed in 2009 and clear, shortly thereafter.

Check that the organization is qualified. Only donations to qualified organizations are tax-deductible. IRS Publication 78, available online and at many public libraries, lists most organizations that are qualified to receive deductible contributions. The searchable online version can be found at IRS.gov under Search for Charities. In addition, churches, synagogues, temples, mosques and government agencies are eligible to receive deductible donations, even if they are not listed in Publication 78.

For individuals, only taxpayers who itemize their deductions on Form 1040 Schedule A can claim deductions for charitable contributions. This deduction is not available to individuals who choose the standard deduction, including anyone who files a short form (Form 1040A or 1040EZ). A taxpayer will have a tax savings only if the total itemized deductions (mortgage interest, charitable contributions, state and local taxes, etc.) exceed the standard deduction. Use the 2009 Form 1040 Schedule A, available now on IRS.gov, to determine whether itemizing is better than claiming the standard deduction.

For all donations of property, including clothing and household items, get from the charity, if possible, a receipt that includes the name of the charity, date of the contribution, and a reasonably-detailed description of the donated property. If a donation is left at a charity's unattended drop site, keep a written record of the donation that includes this information, as well as the fair market value of the property at the time of the donation and the method used to determine that value. Additional rules apply for a contribution of $250 or more.

The deduction for a motor vehicle, boat or airplane donated to charity is usually limited to the gross proceeds from its sale. This rule applies if the claimed value is more than $500. Form 1098-C, or a similar statement, must be provided to the donor by the organization and attached to the donor's tax return.

If the amount of a taxpayer's deduction for all noncash contributions is over $500, a properly-completed Form 8283 must be submitted with the tax return.

Ian and Mary A. Menzies v. Commissioner.
Docket No. 4569-08S. Filed December 15, 2009.
.
Discussion
II. Deductions
A. Deductions in General
Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to any deduction claimed on a return. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Taxpayers must maintain records sufficient to substantiate the amounts of the deductions claimed. Sec. 6001; Ronnen v. Commissioner, 90 T.C. 74, 102 (1988).
Where the taxpayer establishes that the failure to produce adequate records is due to a loss of the records through circumstances beyond the taxpayer's control, the taxpayer may substantiate the deduction by reasonable reconstruction of the records. Gizzi v. Commissioner, 65 T.C. 342, 345 (1976); sec. 1.274-5T(c)(5), Temporary Income Tax Regs., 50 Fed. Reg. 46022 (Nov. 6, 1985). A loss beyond the taxpayer's control includes events such as fire, flood, or earthquake. Gizzi v. Commissioner, supra at 345.
Section 162(a) allows a deduction for ordinary and necessary expenses incurred during the taxable year in carrying on a trade or business. Generally, the performance of services as an employee constitutes a trade or business. Primuth v. Commissioner, 54 T.C. 374, 377 (1970). For such expenses to be deductible, the taxpayer must not have received reimbursement and must not have the right to obtain reimbursement from his employer. See Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), affg. T.C. Memo. 1984-533; Leamy v. Commissioner, 85 T.C. 798, 810 (1985).
If a taxpayer establishes that an expense is deductible but is unable to substantiate the precise amount, the Court may estimate the amount, bearing heavily against the taxpayer whose inexactitude is of his own making. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930) (the Cohan rule or simply Cohan). The taxpayer must present sufficient evidence for the Court to form an estimate because without such a basis, any allowance would amount to unguided largesse. Williams v. United States, 245 F.2d 559, 560-561 (5th Cir. 1957); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).
Section 274(d), however, supersedes the Cohan rule with regard to certain expenses. Sanford v. Commissioner, 50 T.C. 823, 827 (1968), affd. 412 F.2d 201 (2d Cir. 1969); Sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). Section 274(d) requires stricter substantiation for certain expenses including travel, meals, and listed property such as personal automobiles. Section 274(d) requires taxpayers to provide adequate records or sufficient other evidence to corroborate the taxpayer's statements as to the amount, time, place, business purpose, and business relationship of certain expenses. See sec. 1.274-5T(a), Temporary Income Tax Regs., supra. Taxpayers must maintain and produce substantiation that will constitute proof of each expenditure or use. Sec. 1.274-5T(c)(1), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).
Considering the above well-established principles, the Court turns to the deductibility of petitioner's claimed $18,649 in unreimbursed employee business expenses for 2005.
B. Vehicle Expenses
Petitioner claimed vehicle expenses of $12,249 for use of his personal vehicle during 2005, a 1998 Ford Crown Victoria. Petitioner used this vehicle for commuting and for travel that Porter and Titan required. The Ford was one of three cars owned by petitioners' household. The other vehicles included a car used by Mrs. Menzies for her insurance underwriting work and a Grand Prix used for their “personal pleasure”. Petitioner reported on Form 2106-EZ, Unreimbursed Employee Business Expenses, that he drove the Ford 52,000 miles in 2005, of which 27,400 miles were business-related travel, 14,480 miles were for commuting, and 11,200 miles were for personal travel.
Petitioner calculated the amount of the deduction by multiplying the business mileage by the standard mileage rates in effect during 2005. Each workday, petitioner recorded the mileage from his first worksite to the last worksite of the day in a “day planner”. Petitioner noted all the sites he visited during the day; however, he did not record the mileage between sites.
Petitioner testified that he discarded his day planner in 2007, sometime after filing his 2006 return and receiving his refund, because he felt the documentation was no longer necessary. Petitioner was therefore unable to produce any records to substantiate the business mileage and, further, he did not attempt to reconstruct a record of his business mileage.
The Court believes petitioner incurred unreimbursed vehicle expenses related to his work for Porter and Titan during 2005. However, the Court may not estimate vehicle expenses under Cohan. See Sanford v. Commissioner, supra; Rodriguez v. Commissioner, T.C. Memo. 2009-22 (the strict substantiation requirement of section 274(d) precludes the Court and taxpayers from approximating expenses); sec. 1.274-5T(a), Temporary Income Tax Regs., supra. Therefore, we must sustain respondent's determination.
C. Travel Expenses
Petitioner also claimed $400 for travel expenses for an overnight trip to Morristown, Tennessee, in 2005 for training in fire and flood restoration in connection with his job at Porter. He did not maintain any receipts or other documentation verifying the expense but testified that the $400 included one night of lodging, two meals each day, and gasoline costs for his car. He could not recall exactly how much he separately spent for lodging, meals, or gasoline.
For travel expenses, section 274(d) requires the taxpayer to substantiate: (1) The amount of the expense; (2) the time and place the expense was incurred; and (3) the business purpose for which the expense was incurred. Sec. 1.274-5T(b)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). Petitioner did not satisfy the first or the second element. He was unable to show receipts or other evidence of the expenses associated with this trip, and he did not provide a reconstruction of the expenses.
In the case of travel expenses, including meals and lodging while away from home, section 274(d) again overrides the Cohan rule. Sanford v. Commissioner, supra. Unfortunately, without substantiation, petitioner may not deduct these travel expenses. We therefore sustain respondent's determination.
D. Other Miscellaneous Unreimbursed Employee Business Expenses
Petitioner deducted $6,000 for other miscellaneous unreimbursed employee business expenses that he incurred in 2005. He testified that these expenditures included new uniform items, a specialized winter coat, duty gear, two pairs of steel-toed work boots, battle dress uniform (BDU-style) duty pants, a duty belt, a weapon holster, handcuffs, a flashlight, a bullet-resistant vest, a Sig Sauer Model P229 semiautomatic handgun which he purchased for about $1,000, and bullets. Petitioner also testified that he made all of the purchases during 2005, that he used the items exclusively for his security job with Titan, and that he did not receive reimbursement and was not eligible to receive reimbursement for these purchases.
Expenses for clothing are deductible only if the clothing is of a type specifically required as a condition of employment and is not adaptable to general or personal use. Yeomans v. Commissioner, 30 T.C. 757, 767-769 (1958); Beckey v. Commissioner, T.C. Memo. 1994-514. Under section 262(a), no deductions are allowed for personal, living, or family expenses.
The Court finds petitioner's testimony to be highly credible with respect to the items he purchased and the employers' lack of a reimbursement policy. We also find that most of the clothing that petitioner purchased during 2005 was required by Porter or Titan and was not adaptable to personal use.
In summary, using our best judgment and on the entire record before us, the Court is satisfied that petitioner purchased, and was not reimbursed for, many miscellaneous work-related items for his employment with Titan and Porter in 2005. However, under Cohan, we must bear heavily against petitioner. Petitioner could not recollect many of the items that made up the $6,000 in expenses he claimed. Accordingly, petitioner is limited to a deduction of $3,000, subject to the 2-percent floor for other miscellaneous unreimbursed employee business expenses for 2005.
To reflect the foregoing,
Decision will be entered under Rule 155.

Ian and Mary A. Menzies v. Commissioner.
Docket No. 4569-08S. Filed December 15, 2009.
.
Discussion
II. Deductions
A. Deductions in General
Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to any deduction claimed on a return. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Taxpayers must maintain records sufficient to substantiate the amounts of the deductions claimed. Sec. 6001; Ronnen v. Commissioner, 90 T.C. 74, 102 (1988).
Where the taxpayer establishes that the failure to produce adequate records is due to a loss of the records through circumstances beyond the taxpayer's control, the taxpayer may substantiate the deduction by reasonable reconstruction of the records. Gizzi v. Commissioner, 65 T.C. 342, 345 (1976); sec. 1.274-5T(c)(5), Temporary Income Tax Regs., 50 Fed. Reg. 46022 (Nov. 6, 1985). A loss beyond the taxpayer's control includes events such as fire, flood, or earthquake. Gizzi v. Commissioner, supra at 345.
Section 162(a) allows a deduction for ordinary and necessary expenses incurred during the taxable year in carrying on a trade or business. Generally, the performance of services as an employee constitutes a trade or business. Primuth v. Commissioner, 54 T.C. 374, 377 (1970). For such expenses to be deductible, the taxpayer must not have received reimbursement and must not have the right to obtain reimbursement from his employer. See Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), affg. T.C. Memo. 1984-533; Leamy v. Commissioner, 85 T.C. 798, 810 (1985).
If a taxpayer establishes that an expense is deductible but is unable to substantiate the precise amount, the Court may estimate the amount, bearing heavily against the taxpayer whose inexactitude is of his own making. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930) (the Cohan rule or simply Cohan). The taxpayer must present sufficient evidence for the Court to form an estimate because without such a basis, any allowance would amount to unguided largesse. Williams v. United States, 245 F.2d 559, 560-561 (5th Cir. 1957); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).
Section 274(d), however, supersedes the Cohan rule with regard to certain expenses. Sanford v. Commissioner, 50 T.C. 823, 827 (1968), affd. 412 F.2d 201 (2d Cir. 1969); Sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). Section 274(d) requires stricter substantiation for certain expenses including travel, meals, and listed property such as personal automobiles. Section 274(d) requires taxpayers to provide adequate records or sufficient other evidence to corroborate the taxpayer's statements as to the amount, time, place, business purpose, and business relationship of certain expenses. See sec. 1.274-5T(a), Temporary Income Tax Regs., supra. Taxpayers must maintain and produce substantiation that will constitute proof of each expenditure or use. Sec. 1.274-5T(c)(1), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).
Considering the above well-established principles, the Court turns to the deductibility of petitioner's claimed $18,649 in unreimbursed employee business expenses for 2005.
B. Vehicle Expenses
Petitioner claimed vehicle expenses of $12,249 for use of his personal vehicle during 2005, a 1998 Ford Crown Victoria. Petitioner used this vehicle for commuting and for travel that Porter and Titan required. The Ford was one of three cars owned by petitioners' household. The other vehicles included a car used by Mrs. Menzies for her insurance underwriting work and a Grand Prix used for their “personal pleasure”. Petitioner reported on Form 2106-EZ, Unreimbursed Employee Business Expenses, that he drove the Ford 52,000 miles in 2005, of which 27,400 miles were business-related travel, 14,480 miles were for commuting, and 11,200 miles were for personal travel.
Petitioner calculated the amount of the deduction by multiplying the business mileage by the standard mileage rates in effect during 2005. Each workday, petitioner recorded the mileage from his first worksite to the last worksite of the day in a “day planner”. Petitioner noted all the sites he visited during the day; however, he did not record the mileage between sites.
Petitioner testified that he discarded his day planner in 2007, sometime after filing his 2006 return and receiving his refund, because he felt the documentation was no longer necessary. Petitioner was therefore unable to produce any records to substantiate the business mileage and, further, he did not attempt to reconstruct a record of his business mileage.
The Court believes petitioner incurred unreimbursed vehicle expenses related to his work for Porter and Titan during 2005. However, the Court may not estimate vehicle expenses under Cohan. See Sanford v. Commissioner, supra; Rodriguez v. Commissioner, T.C. Memo. 2009-22 (the strict substantiation requirement of section 274(d) precludes the Court and taxpayers from approximating expenses); sec. 1.274-5T(a), Temporary Income Tax Regs., supra. Therefore, we must sustain respondent's determination.
C. Travel Expenses
Petitioner also claimed $400 for travel expenses for an overnight trip to Morristown, Tennessee, in 2005 for training in fire and flood restoration in connection with his job at Porter. He did not maintain any receipts or other documentation verifying the expense but testified that the $400 included one night of lodging, two meals each day, and gasoline costs for his car. He could not recall exactly how much he separately spent for lodging, meals, or gasoline.
For travel expenses, section 274(d) requires the taxpayer to substantiate: (1) The amount of the expense; (2) the time and place the expense was incurred; and (3) the business purpose for which the expense was incurred. Sec. 1.274-5T(b)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). Petitioner did not satisfy the first or the second element. He was unable to show receipts or other evidence of the expenses associated with this trip, and he did not provide a reconstruction of the expenses.
In the case of travel expenses, including meals and lodging while away from home, section 274(d) again overrides the Cohan rule. Sanford v. Commissioner, supra. Unfortunately, without substantiation, petitioner may not deduct these travel expenses. We therefore sustain respondent's determination.
D. Other Miscellaneous Unreimbursed Employee Business Expenses
Petitioner deducted $6,000 for other miscellaneous unreimbursed employee business expenses that he incurred in 2005. He testified that these expenditures included new uniform items, a specialized winter coat, duty gear, two pairs of steel-toed work boots, battle dress uniform (BDU-style) duty pants, a duty belt, a weapon holster, handcuffs, a flashlight, a bullet-resistant vest, a Sig Sauer Model P229 semiautomatic handgun which he purchased for about $1,000, and bullets. Petitioner also testified that he made all of the purchases during 2005, that he used the items exclusively for his security job with Titan, and that he did not receive reimbursement and was not eligible to receive reimbursement for these purchases.
Expenses for clothing are deductible only if the clothing is of a type specifically required as a condition of employment and is not adaptable to general or personal use. Yeomans v. Commissioner, 30 T.C. 757, 767-769 (1958); Beckey v. Commissioner, T.C. Memo. 1994-514. Under section 262(a), no deductions are allowed for personal, living, or family expenses.
The Court finds petitioner's testimony to be highly credible with respect to the items he purchased and the employers' lack of a reimbursement policy. We also find that most of the clothing that petitioner purchased during 2005 was required by Porter or Titan and was not adaptable to personal use.
In summary, using our best judgment and on the entire record before us, the Court is satisfied that petitioner purchased, and was not reimbursed for, many miscellaneous work-related items for his employment with Titan and Porter in 2005. However, under Cohan, we must bear heavily against petitioner. Petitioner could not recollect many of the items that made up the $6,000 in expenses he claimed. Accordingly, petitioner is limited to a deduction of $3,000, subject to the 2-percent floor for other miscellaneous unreimbursed employee business expenses for 2005.
To reflect the foregoing,
Decision will be entered under Rule 155.

Gregory Houston v. Commissioner.
U.S. Tax Court, Dkt. No. 24342-07, TC Memo. 2009-286, December 14, 2009.
An individual was not entitled to some of the business expense deductions claimed on late-filed tax returns because he did not provide adequate evidence that those particular deductions were business related. Although he submitted receipts, he did not keep records of the business purpose of the expenditures and he did not show a ratio of business use to personal use on some of the items. He also failed to show that bank overdraft charges were ordinary and necessary expenses of his moving business. The individual was entitled to deduct some office supply expenditures, which were calculated based on "best judgment." He was also entitled to deduct parking and taxicab expenses since the amount claimed was small enough that it did not require documentary evidence and to deduct expenses for renting equipment for use in his moving business.—CCH.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: Respondent determined deficiencies in petitioner's Federal income taxes and additions to tax as follows:
Additions to Tax
Year Deficiency Sec. 6651(a)(1)
Sec. 6651(a)(2)
Sec. 6654(a)

2003 $7,378 $1,525.05 $1,253.93 $173.17
2004 4,511 983.70 546.50 124.81
The issues for decision are: (1) Whether petitioner is entitled to certain business expense deductions for taxable years 2003 and 2004; and (2) whether petitioner is liable for additions to tax for failure to file under section 6651(a)(1), 1 failure to pay under section 6651(a)(2), and failure to pay estimated taxes under section 6654 for the years at issue.
FINDINGS OF FACT
ay.
OPINION
I. Schedule C Business Expenses
Deductions are a matter of legislative grace. Taxpayers generally bear the burden of proving that they are entitled to claimed deductions. See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). The taxpayer is required to maintain records that are sufficient to enable the Commissioner to determine his or her correct tax liability. See sec. 6001; sec. 1.6001-1(a), Income Tax Regs.
The Commissioner's determinations set forth in a notice of deficiency are generally presumed correct, and the taxpayer bears the burden of proving that the determinations are in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Pursuant to section 7491(a), the burden of proof as to factual issues may shift to the Commissioner where the taxpayer complies with substantiation requirements, maintains records, and cooperates fully with reasonable requests for information. Petitioner does not claim and has not shown that the burden shifts to respondent under section 7491(a).
A. Automobile Expenses
Petitioner claimed deductions for automobile expenses of $857 and $2,215, respectively, for tax years 2003 and 2004 on his Schedules' C, Profit or Loss from Business, as business expenses. Pursuant to section 274(d), automobile expenses otherwise deductible as business expenses will be disallowed in full unless the taxpayer satisfies strict substantiation requirements. The taxpayer must substantiate the automobile expenses by adequate records or other corroborating evidence of items such as the amount of the expense, the time and place of the automobile's use, and the business purpose of its use. See Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968), affd. per curiam 412 F.2d 201 (2d Cir. 1969); Maher v. Commissioner, T.C. Memo. 2003-85. Petitioner provided gas receipts that he claimed are evidence that he had traveled to Baltimore, Pennsylvania, and New York. Petitioner did not (1) keep records of each trip, (2) keep a log as to the business purpose of each trip, and (3) keep a record of what vehicle was used. Gas expenses were paid from petitioner's personal checking account, and there is no indication that expenses listed on the receipts represent expenses paid for petitioner's business activities. Therefore, petitioner is not entitled to deductions for automobile expenses.
B. Bank Charges
Petitioner claimed deductions for bank charges of $60 and $154, respectively, for 2003 and 2004. Petitioner argues that the claimed bank charges were deductible ordinary and necessary business expenses. To substantiate his claim, petitioner provided bank statements and claimed the charges were for overdraft fees during the year. Petitioner admitted that the account giving rise to the overdraft fees was in part a personal account. Petitioner has not provided any evidence showing the fees for the returned checks to be ordinary and necessary expenses of his businesses. Cf. Bailey v. Commissioner, T.C. Memo. 1991-385, affd. without published opinion 968 F.2d 25 (11th Cir. 1992). Petitioner has not sustained his burden of proving that the claimed bank charges for overdrafts were ordinary and necessary expenses of his businesses.
C. Computer Equipment and Repairs
Petitioner claimed deductions for computer equipment and repairs for 2003 and 2004 of $2,538 and $591, respectively. Petitioner claimed to have purchased a computer to maintain business records at his house. Petitioner also claimed deductions for repairing the computers as part of his moving business. As evidence, petitioner offered receipts from various computer stores with charges for computer equipment.
A computer is “listed property” and subject to the strict substantiation requirements of section 274(d). Sec. 280F(d)(4)(A)(iv). Petitioner failed to present any evidence that the computer was used for his moving business. Further, petitioner has not shown that he did not use the computer for personal reasons. Petitioner has failed to substantiate a Schedule C deduction relating to the computer.
Petitioner's purchase of computer equipment and/or upgrades to the computer equipment is not shown to be an ordinary and necessary business expense. See Riley v. Commissioner, T.C. Memo. 2007-153; Wasik v. Commissioner, T.C. Memo. 2007-148.
D. Client Entertainment
Petitioner claimed deductions for client entertainment expenses of $271 and $211, respectively, for 2003 and 2004 on his Schedules C. Petitioner must satisfy the requirements of section 274(d) to the extent provided under the applicable regulations. Under those regulations, petitioner must maintain adequate records showing the amount, time, place, business purpose, and business relationship of the recipient. Sec. 1.274-5T(b)(3), Temporary Income Tax Regs. 50 Fed. Reg. 46015 (Nov. 6, 1985). Petitioner testified that he would take clients and coworkers out after work for drinks and food and provided receipts from several social establishments. Petitioner has not met the section 274 substantiation requirements because he has not provided evidence as to the business nature of the expense. See Henry Schwartz Corp. v. Commissioner, 60 T.C. 728 (1973).
E. Office Expenses/Supplies
Petitioner claimed deductions for office expenses of $138 and $85, respectively, for 2003 and 2004 on his Schedule C. Petitioner testified that these deductions are for office paper and carbon paper. As evidence, petitioner provided receipts for purchases made at a Staples office supply store. Under these circumstances we may estimate the amount of deductible expenses, using our best judgment. Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930). Considering the record as a whole, we find that petitioner is entitled to deductions for office expenses and supplies of $86 and $11, respectively, for 2003 and 2004.
F. Telephone/Internet/Faxes
Petitioner claimed deductions for telephone, Internet, and fax expenses for his residence of $1,058 and $517, respectively, for 2003 and 2004.
Section 262 provides that personal, living, and family expenses are not deductible unless expressly allowed, and the regulations specify that personal, living, and family expenses include utilities provided to a taxpayer's home unless the taxpayer uses a part of his home for his business. Sec. 1.262-1(b)(3), Income Tax Regs. Section 262(b) specifically disallows any deduction for the first line of basic local telephone service provided to a taxpayer's residence. Petitioner claimed a deduction for his telephone and fax expenses in 2003 and 2004. Petitioner has provided no evidence to establish that he uses his home as a place of business. Petitioner's telephone and fax expenses are nondeductible personal expenses under section 262.
Petitioner claimed a deduction for Internet expenses. Petitioner provided monthly bills for Internet services; however, he failed to show the ratio of business to personal use. In addition, petitioner did not produce evidence that his business required him to have Internet access. The Internet expense deductions petitioner claimed are therefore disallowed.
G. Parking and Taxicabs
Petitioner claimed deductions for taxicabs and parking of $43 and $36, respectively, for 2003. Petitioner often traveled to meet with clients in their offices. Petitioner would either take a taxicab to these local meetings or drive himself. Petitioner presented several taxicab receipts totaling $43.
Section 274(d)(4) applies to parking expenses, but expenditures of $75 or less for transportation charges do not require documentary evidence. See sec. 1.274-5(c)(2)(iii)(A)(2), Income Tax Regs. Petitioner presented receipts from parking garages totaling $36. We find that petitioner is entitled to a deduction of $79 for these business expenses.
H. Rental Expenses
Petitioner claimed deductions on his Schedule C for rental expenses in 2003 and 2004 totaling $3,542, respectively. Petitioner testified that those costs represented rental costs for shipping carts, trucks, and jacks for his moving business. At trial petitioner produced invoices of equipment rentals totaling $1,158.09 for 2003 as well as receipts for truck rentals totaling $262.26 for 2004. We find that petitioner is entitled to the claimed deductions.
II. Additions to Tax
Respondent determined that petitioner is liable for (1) additions to tax for failure to timely file a return under section 6651(a)(1); (2) failure to timely pay tax under section 6651(a)(2); and (3) failure to pay estimated income tax under section 6654(a), for the 2 years at issue. The Commissioner bears the burden of production with respect to a taxpayer's liability for additions to tax under sections 6651(a)(1) and (2) and 6654(a). Sec. 7491(c); Rule 142(a); Higbee v. Commissioner, 116 T.C. 438 (2001). At trial petitioner conceded that there was no reasonable cause for his failure to timely file his income tax returns nor any basis for not finding that he is liable for the additions to tax.
The evidence establishes that petitioner failed to timely file income tax returns for 2003 and 2004. Therefore, respondent has sustained his burden of proving that the additions to tax are appropriate. See sec. 7491(c); Rule 142(a)(2). Accordingly, we hold that petitioner is liable for the additions to tax under sections 6651(a)(1) and (2) and 6654 for the years in issue.
To reflect the foregoing,
Decision will be entered under Rule 155.

Footnotes


1
All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated

Aaron Lee Hill v. Commissioner., U.S. Tax Court, T.C. Summary Opinion 2009-188, (Dec. 10, 2009)

Docket No. 28057-08S. Filed December 10, 2009.

A taxpayer who provided a home and support for his niece and nephew was entitled to claim them as dependents. Because the children were his qualifying children, he was also entitled the to the child credit for each of them, as well as the earned income credit. However, he could not file his return as a head of household, absent evidence that he paid more than half of the total cost of maintaining the household.—CCH.

Discussion
In general, the Commissioner's determinations set forth in a notice of deficiency are presumed correct, and the taxpayer bears the burden of showing that the determinations are in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions are a matter of legislative grace. Deputy v. du Pont, 308 U.S. 488, 493 (1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). A taxpayer bears the burden of proving that the taxpayer is entitled to any deduction claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Welch v. Helvering, supra; Wilson v. Commissioner, T.C. Memo. 2001-139. A taxpayer is required to maintain records sufficient to substantiate deductions claimed on his or her income tax return. Sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs. The fact that a taxpayer reports a deduction on a return is not sufficient to substantiate the claimed deduction. Wilkinson v. Commissioner, 71 T.C. 633, 639 (1979); Roberts v. Commissioner, 62 T.C. 834, 837 (1974). Rather, an income tax return is merely a statement of the taxpayer's claim; it is not presumed to be correct. Wilkinson v. Commissioner, supra at 639; Roberts v. Commissioner, supra at 837; see also Seaboard Commercial Corp. v. Commissioner, 28 T.C. 1034, 1051 (1957) (a taxpayer's income tax return is a self-serving declaration that may not be accepted as proof for the claimed deduction or exclusion); Halle v. Commissioner, 7 T.C. 245 (1946) (a taxpayer's income tax return is not self-proving as to the truth of its contents), affd. 175 F.2d 500 (2d Cir. 1949).
Pursuant to section 7491(a), the burden of proof as to factual matters shifts to the Commissioner under certain circumstances. Petitioner has neither alleged that section 7491(a) applies nor established his compliance with the substantiation and recordkeeping requirements. Sec. 7491(a)(2)(A) and (B). Petitioner therefore bears the burden of proof. See Rule 142(a).
I. Dependency Exemption Deductions
Section 151 allows a deduction for each individual who qualifies as a dependent of the taxpayer as defined in section 152. Section 152(a) provides that a dependent means a qualifying child or a qualifying relative. Section 152(c)(1) defines a “qualifying child” as an individual:
(A) who bears a relationship to the taxpayer, such as a descendant of the taxpayer's brother or sister;
(B) who has the same principal place of abode as the taxpayer for more than one-half of such taxable year (aside from special rules applicable to divorced or separated parents);
(C) who is under the age of 19 or is a student who has not attained the age of 24 as of the close of the calendar year and
(D) who has not provided over one-half of such individual's own support for the calendar year in which the taxable year of the taxpayer begins.
Petitioner has produced sufficient evidence to show A.M. and S.M. meet the requirements of section 152(c)(1)(A) since they are children of his sister. Petitioner has produced credible evidence to show both that the children resided with him for more than one-half of 2007 and the ages of A.M. and S.M. (1 and 9 in 2007) to meet the requirements of section 152(c)(1)(B) and (C). The Court is further satisfied that the children, ages 1 and 9, did not provide more than one-half of their own support in 2007, and there is no evidence that A.M. and S.M. received any other support as defined in section 1.152-1(a)(2), Income Tax Regs. Thus, the children meet the requirement of section 152(c)(1)(D). Consequently, A.M. and S.M. are “qualifying children” under section 152(c) and are thus petitioner's dependents under section 152(a)(1). Consequently, petitioner is entitled to dependency exemption deductions for the two children. 3
II. Head of Household Filing Status
Section 1(b) imposes a special tax rate on an individual taxpayer who files a Federal income tax return as a head of household. Section 2(b) defines a head of household as an individual taxpayer who: (1) Is unmarried as of the close of the taxable year and is not a surviving spouse; and (2) maintains as his home a household that constitutes for more than one-half of the taxable year the principal place of abode, as a member of such household, of a dependent for whom the taxpayer is entitled to a deduction under section 151. See also, e.g., Rowe v. Commissioner, 128 T.C. 13, 16-17 (2007). The taxpayer is considered as maintaining a household only if the taxpayer furnishes over one-half of the cost of maintaining the household. Sec. 2(b)(1).
In order for the Court to determine whether the taxpayer provided over one-half of the cost of maintaining the household, the taxpayer must prove the total cost of maintaining the household. Costs of maintaining a household include “property taxes, mortgage interest, rent, utility charges, upkeep and repairs, property insurance, and food consumed on the premises.” Sec. 1.2-2(d), Income Tax Regs.
As indicated, petitioner testified that he gave his domestic partner approximately $400 per month for household expenses and expended approximately $200 per month on food for the household. There is no evidence of the total cost of maintaining the household. Without evidence showing the total cost, the Court cannot conclude that petitioner has provided more than one-half of the cost of maintaining the household. Since petitioner has not provided evidence to show he maintained the household as defined in the regulations, he is not entitled to head of household filing status.
III. Earned Income Credit
An eligible individual is entitled to a credit against his Federal income tax liability, calculated as a percentage of his earned income, subject to certain limitations. Sec. 32(a)(1); Rowe v. Commissioner, supra at 15. Different percentages and amounts are used to calculate the EIC, depending on whether the eligible individual has no qualifying children, one qualifying child, or two or more qualifying children. Sec. 32(b); Rowe v. Commissioner, supra at 15. A “qualifying child” means a qualifying child of the taxpayer as defined in section 152(c). Sec. 32(c)(3)(A).
As previously discussed, A.M. and S.M. are petitioner's qualifying children; thus, petitioner is entitled to the EIC for 2007 with two qualifying children.
IV. Child Tax Credits
Section 24(a) provides a credit with respect to each qualifying child of the taxpayer. Section 24(c)(1) defines the term “qualifying child” as “a qualifying child of the taxpayer (as defined in section 152(c)) who has not attained age 17.” 4 The child tax credit may not exceed the taxpayer's regular tax liability. Sec. 24(b)(3). Where a taxpayer is eligible for the child tax credit but the taxpayer's regular tax liability is less than the amount of the child tax credit potentially available under section 24(a), section 24(d) makes a portion of the credit, known as the additional child tax credit, refundable.
Since A.M. and S.M. are qualifying children and as noted above were below the age 17 in 2007, petitioner is entitled to the child tax credit and the additional child tax credit.
To reflect the foregoing,
Decision will be entered under Rule 155.

Footnotes


1
The Court refers to minor children by their initials. Rule 27(a)(3).
2
Petitioner's income, without claiming the dependency exemption deductions, would make him ineligible for the EIC. Changing his filing status and disallowing the deductions and credits would show petitioner owing a tax of about $162. This amount, in addition to the $5,678 refund, results in the deficiency of $5,840.
3
We recognize that our conclusion suggests a finding that virtually all of petitioner's expendable income went to support the children. We found petitioner's testimony to be credible, and we are satisfied that he was committed to caring for his sister's children at a time when his sister was unable to care for them.
4
The credit is reduced by $50 for each $1,000 (or fraction thereof) by which an individual's modified adjusted gross income exceeds $110,000 in the case of a joint return, $75,000 in the case of an unmarried individual, and $55,000 in the case of a married individual filing a separate return. Sec. 24(b).

Joint Committee on Taxation Technical Explanation of HR 4213, the Tax Extenders Act of 2009, As Introduced in the House of Representatives on December 7, 2009,Congress (United States)
JCX- 60-09
111th Congress


TECHNICAL EXPLANATION OF H.R. 4213, THE “TAX EXTENDERS ACT OF 2009,” AS INTRODUCED IN THE HOUSE OF REPRESENTATIVES ON DECEMBER 7, 2009
Prepared by the Staff of the JOINT COMMITTEE ON TAXATION

December 8, 2009

JCX-60-09

CONTENTS
Page

INTRODUCTION

TITLE I - GENERAL PROVISIONS

A. Individual Tax Relief

1. Deduction of State and local general sales taxes (sec. 101 of the bill and sec. 164 of the Code)

2. Additional standard deduction for State and local real property taxes (sec. 102 of the bill and sec. 63 of the Code)

3. Above-the-line deduction for qualified tuition and related expenses (sec. 103 of the bill and sec. 222 of the Code)

4. Deduction for certain expenses of elementary and secondary school teachers (sec. 104 of the bill and sec. 62(a)(2)(D) of the Code)

B. Business Tax Relief

1. Research credit (sec. 111 of the bill and sec. 41 of the Code)

2. Subpart F exception for active financing income (sec. 112 of the bill and secs. 953 and 954 of the Code)

3. Look-through treatment of payments between related controlled foreign corporations under foreign personal holding company rules (sec. 113 of the bill and sec. 954(c)(6) of the Code)

4. Extension of 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant improvements, and qualified retail improvement property (sec. 114 of the bill and sec. 168 of the Code)

5. Seven-year cost recovery period for motorsports racing track facilities (sec. 115 of the bill and sec. 168 of the Code)

6. Railroad track maintenance credit (sec. 116 of the bill and sec. 45G of the Code)

7. Special expensing rules for certain film and television productions (sec. 117 of the bill and sec. 181 of the Code)

8. Expensing of environmental remediation costs (sec. 118 of the bill and sec. 198 of the Code)

9. Mine rescue team training credit (sec. 119 of the bill and sec. 45N of the Code)

10. Election to expense advanced mine safety equipment (sec. 120 of the bill and sec. 179E of the Code)

11. Employer wage credit for employees who are active duty members of the uniformed services (sec. 121 of the bill and sec. 45P of the Code)

12. Certain farming business machinery and equipment treated as 5-year property (sec. 122 of the bill and sec. 168 of the Code)

13. Treatment of certain dividends of regulated investment companies (sec. 123 of the bill and sec. 871(k) of the Code)

14. Special rule for regulated investment company stock held in the estate of a nonresident non-citizen (sec. 124 of the bill and sec. 2105 of the Code)

15. Treatment of RICs as “qualified investment entities” under section 897 (FIRPTA) (sec. 125 of the bill and sec. 897 of the Code)

16. Suspension of limitation on percentage depletion for oil and gas from marginal wells (sec. 126 of the bill and sec. 613A of the Code)

C. Charitable Provisions

1. Contributions of capital gain real property made for conservation purposes (sec. 131 of the bill and sec. 170 of the Code)

2. Enhanced charitable deduction for contributions of food inventory (sec. 132 of the bill and sec. 170 of the Code)

3. Enhanced charitable deduction for contributions of book inventories to public schools (sec. 133 of the bill and sec. 170 of the Code)

4. Enhanced charitable deduction for corporate contributions of computer technology and equipment for educational purposes (sec. 134 of the bill and sec. 170 of the Code)

5. Tax-free distributions from individual retirement plans for charitable purposes (sec. 135 of the bill and sec. 408 of the Code)

6. Modification of tax treatment of certain payments to controlling exempt organizations (sec. 136 of the bill and sec. 512 of the Code)

7. Exclusion of gain or loss on sale or exchange of certain brownfield sites from unrelated business taxable income (sec. 137 of the bill and secs. 512 and 514 of the Code)

8. Basis adjustment to stock of S corporations making charitable contributions of property (sec. 138 of the bill and sec. 1367 of the Code)

D. Miscellaneous Provisions

1. Indian employment tax credit (sec. 141 of the bill and sec. 45A of the Code)

2. Accelerated depreciation for business property on Indian reservations (sec. 142 of the bill and sec. 168(j) of the Code)

3. Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico (sec. 143 of the bill and sec. 199 of the Code)

4. Temporary increase in limit on cover over of rum excise taxes to Puerto Rico and the Virgin Islands (sec. 144 of the bill and sec. 7652(f) of the Code)

5. American Samoa economic development credit (sec. 145 of the bill and sec. 119 of Pub. L. No. 109-432)

TITLE II - COMMUNITY ASSISTANCE PROVISIONS

1. Empowerment zone tax incentives (sec. 201 of the bill and secs. 1391 and 1202 of the Code)

2. Renewal community tax incentives (sec. 202 of the bill and secs. 1400E, 1400F, 1400I, and 1400J of the Code)

3. New markets tax credit (sec. 203 of the bill and sec. 45D of the Code)

4. Tax incentives for investment in the District of Columbia (sec. 204 of the bill and secs. 1400, 1400A, 1400B, and 1400C of the Code)

5. Special depreciation allowance for certain New York Liberty Zone property (sec. 205(a) of the bill and sec. 1400L(b) of the Code)

6. New York Liberty Zone bond provision (sec. 205(b) of the bill and sec. 1400L of the Code)

7. Work opportunity tax credit for Hurricane Katrina employees (sec. 206(a) of the bill)

8. Increased rehabilitation credit for structures in the Gulf Opportunity Zone (sec. 206(b) of the bill and sec. 1400N(h) of the Code)

9. Election for refundable low-income housing credit for 2010 (sec. 207 of the bill and sec. 42 of the Code)

TITLE III - DISASTER RELIEF PROVISIONS

1. Deductibility of personal casualty losses attributable to federally declared disasters (sec. 301 of the Act and sec. 165 of the Code)

2. Expensing of qualified disaster expenses (sec. 302 of the bill and sec. 198A of the Code)

3. Net operating losses attributable to federally declared disasters (sec. 303 of the bill and sec. 172 of the Code)

4. Special rules for mortgage revenue bonds in Federally declared disaster areas (sec. 304 of the bill and sec. 143 of the Code)

5. Special depreciation allowance and expensing for qualified disaster assistance property (sec. 305 of the bill and secs. 168(n) and 179(e) of the Code)

TITLE IV - ENERGY PROVISIONS

1. Incentives for biodiesel and renewable diesel (sec. 401 of the bill and sec. 40A of the Code)

2. Alternative motor vehicle credit for heavy hybrids (sec. 402 of the bill and sec. 30B of the Code)

3. Alternative fuel credits for natural gas and liquefied petroleum gas (sec. 403 of the bill and secs. 6426 and 6427(e) of the Code)

4. Special rule to implement FERC and State electric restructuring policy (sec. 404 of the bill and sec. 451(i) of the Code)

TITLE V - FOREIGN ACCOUNT TAX COMPLIANCE

A. Increase Disclosure of Beneficial Owners

1. Reporting on certain foreign accounts (sec. 501 of the bill and new secs. 1471, 1472, 1473, and 1474 of the Code, and sec. 6611 of the Code)

2. Repeal of certain foreign exceptions to registered bond requirements (sec. 502 of the bill and secs. 163, 165, 871, 881, 1287, and 4701 of the Code and 31 U.S.C. sec. 3121)

B. Under Reporting With Respect to Foreign Assets

1. Disclosure of information with respect to foreign financial assets (sec. 511 of the bill and new sec. 6038D of the Code)

2. Penalties for underpayments attributable to undisclosed foreign financial assets (sec. 512 of the bill and sec. 6662 of the Code)

3. Modification of statute of limitations for significant omission of income in connection with foreign assets (sec. 513 of the bill and secs. 6229 and 6501 of the Code)

C. Other Disclosure Provisions

1. Reporting of activities with respect to passive foreign investment companies (sec. 521 of the bill and sec. 1298 of the Code)

2. Secretary permitted to require financial institutions to file certain returns related to withholding on foreign transfers electronically (sec. 522 of the bill and sec. 6011 of the Code).

D. Provisions Related to Foreign Trusts

1. Clarifications with respect to foreign trusts which are treated as having a United States beneficiary (sec. 531 of the bill and sec. 679 of the Code)

2. Presumption that foreign trust has United States beneficiary (sec. 532 of the bill and sec. 679 of the Code)

3. Uncompensated use of trust property (sec. 533 of the bill and secs. 643 and 679 of the Code)

4. Reporting requirement of United States owners of foreign trusts (sec. 534 of the bill and sec. 6048 of the Code)

5. Minimum penalty with respect to failure to report on certain foreign trusts (sec. 535 of the bill and sec. 6677 of the Code)

E. Substitute Dividends and Dividend Equivalent Payments Received by Foreign Persons Treated as Dividends (sec. 541 of the bill and sec. 871 of the Code)

TITLE VI - OTHER REVENUE PROVISIONS

A. Income of Partners for Performing Investment Management Services Treated as Ordinary Income Received for Performance of Services (secs. 601 and 602 of the bill and secs. 83, 710, 856, 1402, 6662, 6662A, 6664, and 7704 of the Code)

B. Time for Payment of Corporate Estimated Taxes (sec. 611 of the bill and sec. 6655 of the Code)

C. Study of Extended Tax Expenditures (sec. 621 and 622 of the bill)

INTRODUCTION
This document, 1 prepared by the staff of the Joint Committee on Taxation, provides a technical explanation of H.R. 4213, the “Tax Extenders Act of 2009,” as introduced in the House of Representatives on December 7, 2009.

TITLE I - GENERAL PROVISIONS
A. Individual Tax Relief
1. Deduction of State and local general sales taxes (sec. 101 of the bill and sec. 164 of the Code)
Present Law
For purposes of determining regular tax liability, an itemized deduction is permitted for certain State and local taxes paid, including individual income taxes, real property taxes, and personal property taxes. The itemized deduction is not permitted for purposes of determining a taxpayer's alternative minimum taxable income. For taxable years beginning in 2004-2009, at the election of the taxpayer, an itemized deduction may be taken for State and local general sales taxes in lieu of the itemized deduction provided under present law for State and local income taxes. As is the case for State and local income taxes, the itemized deduction for State and local general sales taxes is not permitted for purposes of determining a taxpayer's alternative minimum taxable income. Taxpayers have two options with respect to the determination of the sales tax deduction amount. Taxpayers may deduct the total amount of general State and local sales taxes paid by accumulating receipts showing general sales taxes paid. Alternatively, taxpayers may use tables created by the Secretary that show the allowable deduction. The tables are based on average consumption by taxpayers on a State-by-State basis taking into account number of dependents, modified adjusted gross income and rates of State and local general sales taxation. Taxpayers who live in more than one jurisdiction during the tax year are required to pro-rate the table amounts based on the time they live in each jurisdiction. Taxpayers who use the tables created by the Secretary may, in addition to the table amounts, deduct eligible general sales taxes paid with respect to the purchase of motor vehicles, boats and other items specified by the Secretary. Sales taxes for items that may be added to the tables are not reflected in the tables themselves.

The term “general sales tax” means a tax imposed at one rate with respect to the sale at retail of a broad range of classes of items. However, in the case of items of food, clothing, medical supplies, and motor vehicles, the fact that the tax does not apply with respect to some or all of such items is not taken into account in determining whether the tax applies with respect to a broad range of classes of items, and the fact that the rate of tax applicable with respect to some or all of such items is lower than the general rate of tax is not taken into account in determining whether the tax is imposed at one rate. Except in the case of a lower rate of tax applicable with respect to food, clothing, medical supplies, or motor vehicles, no deduction is allowed for any general sales tax imposed with respect to an item at a rate other than the general rate of tax. However, in the case of motor vehicles, if the rate of tax exceeds the general rate, such excess shall be disregarded and the general rate is treated as the rate of tax.

A compensating use tax with respect to an item is treated as a general sales tax, provided such tax is complementary to a general sales tax and a deduction for sales taxes is allowable with respect to items sold at retail in the taxing jurisdiction that are similar to such item.

Explanation of Provision
The present-law provision allowing taxpayers to elect to deduct State and local sales taxes in lieu of State and local income taxes is extended for one year (through December 31, 2010).

Effective Date
The provision applies to taxable years beginning after December 31, 2009.

2. Additional standard deduction for State and local real property taxes (sec. 102 of the bill and sec. 63 of the Code)
Present Law
In general
An individual taxpayer's taxable income is computed by reducing adjusted gross income either by a standard deduction or, if the taxpayer elects, by the taxpayer's itemized deductions. Unless an individual taxpayer elects, no itemized deduction is allowed for the taxable year. The deduction for certain taxes, including income taxes, real property taxes, and personal property taxes, generally is an itemized deduction. 2

Special rule for State and local property taxes
An individual taxpayer's standard deduction for a taxable year beginning in 2009 is increased by the lesser of (1) the amount allowable 3 to the taxpayer as a deduction for State and local taxes described in section 164(a)(1) (relating to real property taxes), or (2) $500 ($1,000 in the case of a married individual filing jointly). The increased standard deduction is determined by taking into account real estate taxes for which a deduction is allowable to the taxpayer under section 164 and, in the case of a tenant-stockholder in a cooperative housing corporation, real estate taxes for which a deduction is allowable to the taxpayer under section 216. No taxes deductible in computing adjusted gross income are taken into account in computing the increased standard deduction.

Explanation of Provision
The provision extends the additional standard deduction for State and local property taxes for one year so that it is available for taxable years beginning before January 1, 2011.

Effective Date
The provision applies to taxable years beginning after December 31, 2009.

3. Above-the-line deduction for qualified tuition and related expenses (sec. 103 of the bill and sec. 222 of the Code)
Present Law
An individual is allowed an above-the-line deduction for qualified tuition and related expenses for higher education paid by the individual during the taxable year. 4 The term qualified tuition and related expenses is defined in the same manner as for the Hope and Lifetime Learning credits, and includes tuition and fees required for the enrollment or attendance of the taxpayer, the taxpayer's spouse, or any dependent of the taxpayer with respect to whom the taxpayer may claim a personal exemption, at an eligible institution of higher education for courses of instruction of such individual at such institution. 5 The expenses must be in connection with enrollment at an institution of higher education during the taxable year, or with an academic period beginning during the taxable year or during the first three months of the next taxable year. The deduction is not available for tuition and related expenses paid for elementary or secondary education.

The maximum deduction is $4,000 for an individual whose adjusted gross income for the taxable year does not exceed $65,000 ($130,000 in the case of a joint return), or $2,000 for other individuals whose adjusted gross income does not exceed $80,000 ($160,000 in the case of a joint return). No deduction is allowed for an individual whose adjusted gross income exceeds the relevant adjusted gross income limitations, for a married individual who does not file a joint return, or for an individual with respect to whom a personal exemption deduction may be claimed by another taxpayer for the taxable year. The deduction is not available for taxable years beginning after December 31, 2009.

The amount of qualified tuition and related expenses must be reduced by certain scholarships, educational assistance allowances, and other amounts paid for the benefit of such individual, 6 and by the amount of such expenses taken into account for purposes of determining any exclusion from gross income of: (1) income from certain U.S. savings bonds used to pay higher education tuition and fees; and (2) income from a Coverdell education savings account. 7 Additionally, such expenses must be reduced by the earnings portion (but not the return of principal) of distributions from a qualified tuition program if an exclusion under section 529 is claimed with respect to expenses eligible for the qualified tuition deduction. No deduction is allowed for any expense for which a deduction is otherwise allowed or with respect to an individual for whom a Hope or Lifetime Learning credit is elected for such taxable year.

Explanation of Provision
The provision extends the qualified tuition deduction for one year so that it is generally available for taxable years beginning before January 1, 2011.

Effective Date
The provision is effective for expenses incurred in taxable years beginning after December 31, 2009.

4. Deduction for certain expenses of elementary and secondary school teachers (sec. 104 of the bill and sec. 62(a)(2)(D) of the Code)
Present Law
In general, ordinary and necessary business expenses are deductible. However, unreimbursed employee business expenses generally are deductible only as an itemized deduction and only to the extent that the individual's total miscellaneous deductions (including employee business expenses) exceed two percent of adjusted gross income. An individual's otherwise allowable itemized deductions may be further limited by the overall limitation on itemized deductions, which reduces itemized deductions for taxpayers with adjusted gross income in excess of $166,800 ($83,400 for married individuals filing separate returns) for 2009. In addition, miscellaneous itemized deductions are not allowable under the alternative minimum tax.

Certain expenses of eligible educators are allowed as an above-the-line deduction. Specifically, for taxable years beginning prior to January 1, 2010, an above-the-line deduction is allowed for up to $250 annually of expenses paid or incurred by an eligible educator for books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment, and supplementary materials used by the eligible educator in the classroom. 8 To be eligible for this deduction, the expenses must be otherwise deductible under section 162 as a trade or business expense. A deduction is allowed only to the extent the amount of expenses exceeds the amount excludable from income under section 135 (relating to education savings bonds), 529(c)(1) (relating to qualified tuition programs), and section 530(d)(2) (relating to Coverdell education savings accounts).

An eligible educator is a kindergarten through grade twelve teacher, instructor, counselor, principal, or aide in a school for at least 900 hours during a school year. A school means any school that provides elementary education or secondary education, as determined under State law.

The above-the-line deduction for eligible educators is not allowed for taxable years beginning after December 31, 2009.

Explanation of Provision
The provision extends the deduction for eligible educator expenses for one year so that it is available for taxable years beginning before January 1, 2011.

Effective Date
The provision is effective for expenses incurred in taxable years beginning after December 31, 2009.

B. Business Tax Relief
1. Research credit (sec. 111 of the bill and sec. 41 of the Code)
Present Law
General rule
A taxpayer may claim a research credit equal to 20 percent of the amount by which the taxpayer's qualified research expenses for a taxable year exceed its base amount for that year. 9 Thus, the research credit is generally available with respect to incremental increases in qualified research.

A 20-percent research tax credit is also available with respect to the excess of (1) 100 percent of corporate cash expenses (including grants or contributions) paid for basic research conducted by universities (and certain nonprofit scientific research organizations) over (2) the sum of (a) the greater of two minimum basic research floors plus (b) an amount reflecting any decrease in nonresearch giving to universities by the corporation as compared to such giving during a fixed-base period, as adjusted for inflation. This separate credit computation is commonly referred to as the university basic research credit. 10

Finally, a research credit is available for a taxpayer's expenditures on research undertaken by an energy research consortium. This separate credit computation is commonly referred to as the energy research credit. Unlike the other research credits, the energy research credit applies to all qualified expenditures, not just those in excess of a base amount.

The research credit, including the university basic research credit and the energy research credit, expires for amounts paid or incurred after December 31, 2009. 11

Computation of allowable credit
Except for energy research payments and certain university basic research payments made by corporations, the research tax credit applies only to the extent that the taxpayer's qualified research expenses for the current taxable year exceed its base amount. The base amount for the current year generally is computed by multiplying the taxpayer's fixed-base percentage by the average amount of the taxpayer's gross receipts for the four preceding years. If a taxpayer both incurred qualified research expenses and had gross receipts during each of at least three years from 1984 through 1988, then its fixed-base percentage is the ratio that its total qualified research expenses for the 1984-1988 period bears to its total gross receipts for that period (subject to a maximum fixed-base percentage of 16 percent). All other taxpayers (so-called start-up firms) are assigned a fixed-base percentage of three percent. 12

In computing the credit, a taxpayer's base amount cannot be less than 50 percent of its current-year qualified research expenses.

To prevent artificial increases in research expenditures by shifting expenditures among commonly controlled or otherwise related entities, a special aggregation rule provides that all members of the same controlled group of corporations are treated as a single taxpayer. 13 Under regulations prescribed by the Secretary, special rules apply for computing the credit when a major portion of a trade or business (or unit thereof) changes hands, under which qualified research expenses and gross receipts for periods prior to the change of ownership of a trade or business are treated as transferred with the trade or business that gave rise to those expenses and receipts for purposes of recomputing a taxpayer's fixed-base percentage. 14

Alternative simplified credit
Taxpayers may elect to claim an alternative simplified credit for qualified research expenses. The alternative simplified research credit is equal to 14 percent of qualified research expenses that exceed 50 percent of the average qualified research expenses for the three preceding taxable years. The rate is reduced to six percent if a taxpayer has no qualified research expenses in any one of the three preceding taxable years. An election to use the alternative simplified credit applies to all succeeding taxable years unless revoked with the consent of the Secretary.

Eligible expenses
Qualified research expenses eligible for the research tax credit consist of: (1) in-house expenses of the taxpayer for wages and supplies attributable to qualified research; (2) certain time-sharing costs for computer use in qualified research; and (3) 65 percent of amounts paid or incurred by the taxpayer to certain other persons for qualified research conducted on the taxpayer's behalf (so-called contract research expenses). 15 Notwithstanding the limitation for contract research expenses, qualified research expenses include 100 percent of amounts paid or incurred by the taxpayer to an eligible small business, university, or Federal laboratory for qualified energy research.

To be eligible for the credit, the research not only has to satisfy the requirements of present-law section 174 (described below) but also must be undertaken for the purpose of discovering information that is technological in nature, the application of which is intended to be useful in the development of a new or improved business component of the taxpayer, and substantially all of the activities of which constitute elements of a process of experimentation for functional aspects, performance, reliability, or quality of a business component. Research does not qualify for the credit if substantially all of the activities relate to style, taste, cosmetic, or seasonal design factors. 16 In addition, research does not qualify for the credit: (1) if conducted after the beginning of commercial production of the business component; (2) if related to the adaptation of an existing business component to a particular customer's requirements; (3) if related to the duplication of an existing business component from a physical examination of the component itself or certain other information; or (4) if related to certain efficiency surveys, management function or technique, market research, market testing, or market development, routine data collection or routine quality control. 17 Research does not qualify for the credit if it is conducted outside the United States, Puerto Rico, or any U.S. possession.

Relation to deduction
Under section 174, taxpayers may elect to deduct currently the amount of certain research or experimental expenditures paid or incurred in connection with a trade or business, notwithstanding the general rule that business expenses to develop or create an asset that has a useful life extending beyond the current year must be capitalized. 18 However, deductions allowed to a taxpayer under section 174 (or any other section) are reduced by an amount equal to 100 percent of the taxpayer's research tax credit determined for the taxable year. 19 Taxpayers may alternatively elect to claim a reduced research tax credit amount under section 41 in lieu of reducing deductions otherwise allowed. 20

Explanation of Provision
The provision extends the research credit for one year, through December 31, 2010.

Effective Date
The provision is effective for amounts paid or incurred after December 31, 2009.

2. Subpart F exception for active financing income (sec. 112 of the bill and secs. 953 and 954 of the Code)
Present Law
Under the subpart F rules, 21 10-percent-or-greater U.S. shareholders of a controlled foreign corporation (“CFC”) are subject to U.S. tax currently on certain income earned by the CFC, whether or not such income is distributed to the shareholders. The income subject to current inclusion under the subpart F rules includes, among other things, insurance income and foreign base company income. Foreign base company income includes, among other things, foreign personal holding company income and foreign base company services income (i.e., income derived from services performed for or on behalf of a related person outside the country in which the CFC is organized).

Foreign personal holding company income generally consists of the following: (1) dividends, interest, royalties, rents, and annuities; (2) net gains from the sale or exchange of (a) property that gives rise to the preceding types of income, (b) property that does not give rise to income, and (c) interests in trusts, partnerships, and real estate mortgage investment conduits (“REMICs”); (3) net gains from commodities transactions; (4) net gains from certain foreign currency transactions; (5) income that is equivalent to interest; (6) income from notional principal contracts; (7) payments in lieu of dividends; and (8) amounts received under personal service contracts.

Insurance income subject to current inclusion under the subpart F rules includes any income of a CFC attributable to the issuing or reinsuring of any insurance or annuity contract in connection with risks located in a country other than the CFC's country of organization. Subpart F insurance income also includes income attributable to an insurance contract in connection with risks located within the CFC's country of organization, as the result of an arrangement under which another corporation receives a substantially equal amount of consideration for insurance of other country risks. Investment income of a CFC that is allocable to any insurance or annuity contract related to risks located outside the CFC's country of organization is taxable as subpart F insurance income. 22

Temporary exceptions from foreign personal holding company income, foreign base company services income, and insurance income apply for subpart F purposes for certain income that is derived in the active conduct of a banking, financing, or similar business, as a securities dealer, or in the conduct of an insurance business (so-called “active financing income”). These provisions were enacted in the Taxpayer Relief Act of 1997 as one-year temporary exceptions, and in 1998, 1999, 2002, 2006, and 2008, the provisions were extended, and in some cases, modified. 23

With respect to income derived in the active conduct of a banking, financing, or similar business, a CFC is required to be predominantly engaged in such business and to conduct substantial activity with respect to such business in order to qualify for the active financing exceptions. In addition, certain nexus requirements apply, which provide that income derived by a CFC or a qualified business unit (“QBU”) of a CFC from transactions with customers is eligible for the exceptions if, among other things, substantially all of the activities in connection with such transactions are conducted directly by the CFC or QBU in its home country, and such income is treated as earned by the CFC or QBU in its home country for purposes of such country's tax laws. Moreover, the exceptions apply to income derived from certain cross border transactions, provided that certain requirements are met. Additional exceptions from foreign personal holding company income apply for certain income derived by a securities dealer within the meaning of section 475 and for gain from the sale of active financing assets.

In the case of a securities dealer, the temporary exception from foreign personal holding company income applies to certain income. The income covered by the exception is any interest or dividend (or certain equivalent amounts) from any transaction, including a hedging transaction or a transaction consisting of a deposit of collateral or margin, entered into in the ordinary course of the dealer's trade or business as a dealer in securities within the meaning of section 475. In the case of a QBU of the dealer, the income is required to be attributable to activities of the QBU in the country of incorporation, or to a QBU in the country in which the QBU both maintains its principal office and conducts substantial business activity. A coordination rule provides that this exception generally takes precedence over the exception for income of a banking, financing or similar business, in the case of a securities dealer.

In the case of insurance, a temporary exception from foreign personal holding company income applies for certain income of a qualifying insurance company with respect to risks located within the CFC's country of creation or organization. In the case of insurance, temporary exceptions from insurance income and from foreign personal holding company income also apply for certain income of a qualifying branch of a qualifying insurance company with respect to risks located within the home country of the branch, provided certain requirements are met under each of the exceptions. Further, additional temporary exceptions from insurance income and from foreign personal holding company income apply for certain income of certain CFCs or branches with respect to risks located in a country other than the United States, provided that the requirements for these exceptions are met. In the case of a life insurance or annuity contract, reserves for such contracts are determined under rules specific to the temporary exceptions. Present law also permits a taxpayer in certain circumstances, subject to approval by the IRS through the ruling process or in published guidance, to establish that the reserve of a life insurance company for life insurance and annuity contracts is the amount taken into account in determining the foreign statement reserve for the contract (reduced by catastrophe, equalization, or deficiency reserve or any similar reserve). IRS approval is to be based on whether the method, the interest rate, the mortality and morbidity assumptions, and any other factors taken into account in determining foreign statement reserves (taken together or separately) provide an appropriate means of measuring income for Federal income tax purposes.

Explanation of Provision
The provision extends for one year (for taxable years beginning before 2011) the present-law temporary exceptions from subpart F foreign personal holding company income, foreign base company services income, and insurance income for certain income that is derived in the active conduct of a banking, financing, or similar business, or in the conduct of an insurance business.

Effective Date
The provision is effective for taxable years of foreign corporations beginning after December 31, 2009, and for taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end.

3. Look-through treatment of payments between related controlled foreign corporations under foreign personal holding company rules (sec. 113 of the bill and sec. 954(c)(6) of the Code)
Present Law
In general
In general, the rules of subpart F 24 require U.S. shareholders with a 10-percent or greater interest in a controlled foreign corporation (“CFC”) to include certain income of the CFC (referred to as “subpart F income”) on a current basis for U.S. tax purposes, regardless of whether the income is distributed to the shareholders.

Subpart F income includes foreign base company income. One category of foreign base company income is foreign personal holding company income. For subpart F purposes, foreign personal holding company income generally includes dividends, interest, rents, and royalties, among other types of income. There are several exceptions to these rules. For example, foreign personal holding company income does not include dividends and interest received by a CFC from a related corporation organized and operating in the same foreign country in which the CFC is organized, or rents and royalties received by a CFC from a related corporation for the use of property within the country in which the CFC is organized. Interest, rent, and royalty payments do not qualify for this exclusion to the extent that such payments reduce the subpart F income of the payor. In addition, subpart F income of a CFC does not include any item of income from sources within the United States that is effectively connected with the conduct by such CFC of a trade or business within the United States (“ECI”) unless such item is exempt from taxation (or is subject to a reduced rate of tax) pursuant to a tax treaty.

The “look-through rule ”
Under the “look-through rule” (sec. 954(c)(6)), dividends, interest (including factoring income that is treated as equivalent to interest under section 954(c)(1)(E)), rents, and royalties received by one CFC from a related CFC are not treated as foreign personal holding company income to the extent attributable or properly allocable to income of the payor that is neither subpart F income nor treated as ECI. For this purpose, a related CFC is a CFC that controls or is controlled by the other CFC, or a CFC that is controlled by the same person or persons that control the other CFC. Ownership of more than 50 percent of the CFC's stock (by vote or value) constitutes control for these purposes.

The Secretary is authorized to prescribe regulations that are necessary or appropriate to carry out the look-through rule, including such regulations as are appropriate to prevent the abuse of the purposes of such rule.

The look-through rule is effective for taxable years of foreign corporations beginning before January 1, 2010, and for taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end.

Explanation of Provision
The provision extends for one year the application of the look-through rule, to taxable years of foreign corporations beginning before January 1, 2011, and for taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end.

Effective Date
The provision is effective for taxable years of foreign corporations beginning after December 31, 2009, and for taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end.

4. Extension of 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant improvements, and qualified retail improvement property (sec. 114 of the bill and sec. 168 of the Code)
Present Law
In general
A taxpayer generally must capitalize the cost of property used in a trade or business and recover such cost over time through annual deductions for depreciation or amortization. Tangible property generally is depreciated under the modified accelerated cost recovery system (“MACRS”), which determines depreciation by applying specific recovery periods, placed-in-service conventions, and depreciation methods to the cost of various types of depreciable property. 25 The cost of nonresidential real property is recovered using the straight-line method of depreciation and a recovery period of 39 years. Nonresidential real property is subject to the mid-month placed-in-service convention. Under the mid-month convention, the depreciation allowance for the first year property is placed in service is based on the number of months the property was in service, and property placed in service at any time during a month is treated as having been placed in service in the middle of the month.

Depreciation of leasehold improvements
Generally, depreciation allowances for improvements made on leased property are determined under MACRS, even if the MACRS recovery period assigned to the property is longer than the term of the lease. This rule applies regardless of whether the lessor or the lessee places the leasehold improvements in service. If a leasehold improvement constitutes an addition or improvement to nonresidential real property already placed in service, the improvement generally is depreciated using the straight-line method over a 39-year recovery period, beginning in the month the addition or improvement was placed in service. However, exceptions exist for certain qualified leasehold improvements and qualified restaurant property.

Qualified leasehold improvement property
Section 168(e)(3)(E)(iv) provides a statutory 15-year recovery period for qualified leasehold improvement property placed in service before January 1, 2010. Qualified leasehold improvement property is recovered using the straight-line method and a half-year convention. Leasehold improvements placed in service in 2010 and later will be subject to the general rules described above.

Qualified leasehold improvement property is any improvement to an interior portion of a building that is nonresidential real property, provided certain requirements are met. The improvement must be made under or pursuant to a lease either by the lessee (or sublessee), or by the lessor, of that portion of the building to be occupied exclusively by the lessee (or sublessee). The improvement must be placed in service more than three years after the date the building was first placed in service. Qualified leasehold improvement property does not include any improvement for which the expenditure is attributable to the enlargement of the building, any elevator or escalator, any structural component benefiting a common area, or the internal structural framework of the building.

If a lessor makes an improvement that qualifies as qualified leasehold improvement property, such improvement does not qualify as qualified leasehold improvement property to any subsequent owner of such improvement. An exception to the rule applies in the case of death and certain transfers of property that qualify for non-recognition treatment.

Qualified restaurant property
Section 168(e)(3)(E)(v) provides a statutory 15-year recovery period for qualified restaurant property placed in service before January 1, 2010. Qualified restaurant property is any section 1250 property that is a building (if the building is placed in service before January 1, 2010) or an improvement to a building, if more than 50 percent of the building's square footage is devoted to the preparation of, and seating for on-premises consumption of, prepared meals. 26 Qualified restaurant property is recovered using the straight-line method and a half-year convention. Additionally, qualified restaurant property is not eligible for bonus depreciation. 27 Restaurant property placed in service in 2010 and later will be subject to the general rules described above.

Qualified retail property
Section 168(e)(3)(E)(ix) provides a statutory 15-year recovery period and for qualified retail improvement property placed in service after December 31, 2008 and before January 1, 2010. Qualified retail improvement property is any improvement to an interior portion of a building which is nonresidential real property if such portion is open to the general public 28 and is used in the retail trade or business of selling tangible personal property to the general public, and such improvement is placed in service more than three years after the date the building was first placed in service. Qualified retail improvement property does not include any improvement for which the expenditure is attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building. In the case of an improvement made by the owner of such improvement, the improvement is a qualified retail improvement only so long as the improvement is held by such owner.

Retail establishments that qualify for the 15-year recovery period include those primarily engaged in the sale of goods. Examples of these retail establishments include, but are not limited to, grocery stores, clothing stores, hardware stores and convenience stores. Establishments primarily engaged in providing services, such as professional services, financial services, personal services, health services, and entertainment, do not qualify. It is generally intended that businesses defined as a store retailer under the current North American Industry Classification System (industry sub-sectors 441 through 453) qualify while those in other industry classes do not qualify.

Qualified retail property is recovered using the straight-line method and a half-year convention. Additionally, qualified retail property is not eligible for bonus depreciation. 29 Retail property placed in service in 2010 and later will be subject to the general rules described above.

Explanation of Provision
The present law provisions for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property are extended for one year (through December 31, 2010).

Effective Date
The provision is effective for property placed in service after December 31, 2009.

5. Seven-year cost recovery period for motorsports racing track facilities (sec. 115 of the bill and sec. 168 of the Code)
Present Law
A taxpayer generally must capitalize the cost of property used in a trade or business and recover such cost over time through annual deductions for depreciation or amortization. Tangible property generally is depreciated under the modified accelerated cost recovery system (“MACRS”), which determines depreciation by applying specific recovery periods, placed-in-service conventions, and depreciation methods to the cost of various types of depreciable property. 30 The cost of nonresidential real property is recovered using the straight-line method of depreciation and a recovery period of 39 years. Nonresidential real property is subject to the mid-month placed-in-service convention. Under the mid-month convention, the depreciation allowance for the first year property is placed in service is based on the number of months the property was in service, and property placed in service at any time during a month is treated as having been placed in service in the middle of the month. Land improvements (such as roads and fences) are recovered over 15 years. An exception exists for the theme and amusement park industry, whose assets are assigned a recovery period of seven years. Additionally, a motorsports entertainment complex placed in service before December 31, 2009 is assigned a recovery period of seven years. 31 For these purposes, a motorsports entertainment complex means a racing track facility which is permanently situated on land that during the 36 month period following its placed in service date it hosts a racing event. 32 The term motorsports entertainment complex also includes ancillary facilities, land improvements (e.g., parking lots, sidewalks, fences), support facilities (e.g., food and beverage retailing, souvenir vending), and appurtenances associated with such facilities (e.g., ticket booths, grandstands).

Explanation of Provision
The provision extends the present law seven-year recovery period for one year (to apply to property placed in service before January 1, 2011).

Effective Date
The provision is effective for property placed in service after December 31, 2009.

6. Railroad track maintenance credit (sec. 116 of the bill and sec. 45G of the Code)
Present Law
Present law provides a 50-percent business tax credit for qualified railroad track maintenance expenditures paid or incurred by an eligible taxpayer during the taxable year. 33 The credit is limited to the product of $3,500 times the number of miles of railroad track (1) owned or leased by an eligible taxpayer as of the close of its taxable year, and (2) assigned to the eligible taxpayer by a Class II or Class III railroad that owns or leases such track at the close of the taxable year. 34 Each mile of railroad track may be taken into account only once, either by the owner of such mile or by the owner's assignee, in computing the per-mile limitation. The credit may also reduce a taxpayer's tax liability below its tentative minimum tax. 35

Qualified railroad track maintenance expenditures are defined as gross expenditures (whether or not otherwise chargeable to capital account) for maintaining railroad track (including roadbed, bridges, and related track structures) owned or leased as of January 1, 2005, by a Class II or Class III railroad (determined without regard to any consideration for such expenditure given by the Class II or Class III railroad which made the assignment of such track). 36

An eligible taxpayer means any Class II or Class III railroad, and any person who transports property using the rail facilities of a Class II or Class III railroad or who furnishes railroad-related property or services to a Class II or Class III railroad, but only with respect to miles of railroad track assigned to such person by such railroad under the provision. 37

The terms Class II or Class III railroad have the meanings given by the Surface Transportation Board. 38

The provision applies to qualified railroad track maintenance expenditures paid or incurred during taxable years beginning before January 1, 2010.

Explanation of Provision
The provision extends the present law credit for one year, for qualified railroad track maintenance expenditures paid or incurred before January 1, 2011.

Effective Date
The provision is effective for expenses paid or incurred in taxable years beginning after December 31, 2009.

7. Special expensing rules for certain film and television productions (sec. 117 of the bill and sec. 181 of the Code)
Present Law
The modified accelerated cost recovery system (“MACRS”) does not apply to certain property, including any motion picture film, video tape, or sound recording, or to any other property if the taxpayer elects to exclude such property from MACRS and the taxpayer properly applies a unit-of-production method or other method of depreciation not expressed in a term of years. Section 197 does not apply to certain intangible property, including property produced by the taxpayer or any interest in a film, sound recording, video tape, book or similar property not acquired in a transaction (or a series of related transactions) involving the acquisition of assets constituting a trade or business or substantial portion thereof. Thus, the recovery of the cost of a film, video tape, or similar property that is produced by the taxpayer or is acquired on a “stand-alone” basis by the taxpayer may not be determined under either the MACRS depreciation provisions or under the section 197 amortization provisions. The cost recovery of such property may be determined under section 167, which allows a depreciation deduction for the reasonable allowance for the exhaustion, wear and tear, or obsolescence of the property. A taxpayer is allowed to recover, through annual depreciation deductions, the cost of certain property used in a trade or business or for the production of income. Section 167(g) provides that the cost of motion picture films, sound recordings, copyrights, books, and patents are eligible to be recovered using the income forecast method of depreciation.

Under section 181, taxpayers may elect 39 to deduct the cost of any qualifying film and television production, commencing prior to January 1, 2010, in the year the expenditure is incurred in lieu of capitalizing the cost and recovering it through depreciation allowances. 40 Taxpayers may elect to deduct up to $15 million of the aggregate cost of the film or television production under this section. 41 The threshold is increased to $20 million if a significant amount of the production expenditures are incurred in areas eligible for designation as a low-income community or eligible for designation by the Delta Regional Authority as a distressed county or isolated area of distress. 42

A qualified film or television production means any production of a motion picture (whether released theatrically or directly to video cassette or any other format) or television program if at least 75 percent of the total compensation expended on the production is for services performed in the United States by actors, directors, producers, and other relevant production personnel. 43 The term “compensation” does not include participations and residuals (as defined in section 167(g)(7)(B)). 44 With respect to property which is one or more episodes in a television series, each episode is treated as a separate production and only the first 44 episodes qualify under the provision. 45 Qualified property does not include sexually explicit productions as defined by section 2257 of title 18 of the U.S. Code. 46

For purposes of recapture under section 1245, any deduction allowed under section 181 is treated as if it were a deduction allowable for amortization. 47

Explanation of the Provision
The provision extends the present law expensing provision for one year, to qualified film and television productions commencing prior to January 1, 2011.

Effective Date
The provision applies to qualified film and television productions commencing after December 31, 2009.

8. Expensing of environmental remediation costs (sec. 118 of the bill and sec. 198 of the Code)
Present Law
Present law allows a deduction for ordinary and necessary expenses paid or incurred in carrying on any trade or business. 48 Treasury regulations provide that the cost of incidental repairs that neither materially add to the value of property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted currently as a business expense. Section 263(a)(1) limits the scope of section 162 by prohibiting a current deduction for certain capital expenditures. Treasury regulations define “capital expenditures” as amounts paid or incurred to materially add to the value, or substantially prolong the useful life, of property owned by the taxpayer, or to adapt property to a new or different use. Amounts paid for repairs and maintenance do not constitute capital expenditures. The determination of whether an expense is deductible or capitalizable is based on the facts and circumstances of each case.

Taxpayers may elect to treat certain environmental remediation expenditures paid or incurred before January 1, 2010, that would otherwise be chargeable to capital account as deductible in the year paid or incurred. 49 The deduction applies for both regular and alternative minimum tax purposes. The expenditure must be incurred in connection with the abatement or control of hazardous substances at a qualified contaminated site. In general, any expenditure for the acquisition of depreciable property used in connection with the abatement or control of hazardous substances at a qualified contaminated site does not constitute a qualified environmental remediation expenditure. However, depreciation deductions allowable for such property, which would otherwise be allocated to the site under the principles set forth in Commissioner v. Idaho Power Co. 50 and section 263A, are treated as qualified environmental remediation expenditures.

A “qualified contaminated site” (a so-called “brownfield”) generally is any property that is held for use in a trade or business, for the production of income, or as inventory and is certified by the appropriate State environmental agency to be an area at or on which there has been a release (or threat of release) or disposal of a hazardous substance. Both urban and rural property may qualify. However, sites that are identified on the national priorities list under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (“CERCLA”) 51 cannot qualify as targeted areas. Hazardous substances generally are defined by reference to sections 101(14) and 102 of CERCLA, subject to additional limitations applicable to asbestos and similar substances within buildings, certain naturally occurring substances such as radon, and certain other substances released into drinking water supplies due to deterioration through ordinary use, as well as petroleum products defined in section 4612(a)(3) of the Code.

In the case of property to which a qualified environmental remediation expenditure otherwise would have been capitalized, any deduction allowed under section 198 is treated as a depreciation deduction and the property is treated as section 1245 property. Thus, deductions for qualified environmental remediation expenditures are subject to recapture as ordinary income upon a sale or other disposition of the property. In addition, sections 280B (demolition of structures) and 468 (special rules for mining and solid waste reclamation and closing costs) do not apply to amounts that are treated as expenses under this provision.

Section 1400N(g) permits the expensing of environmental remediation expenditures paid or incurred before January 1, 2010, to abate contamination at qualified contaminated sites located in the Gulf Opportunity Zone.

Explanation of Provision
The provision extends the present law expensing provision for one year to include expenditures paid or incurred before January 1, 2011.

Effective Date
The provision is effective for expenditures paid or incurred after December 31, 2009.

9. Mine rescue team training credit (sec. 119 of the bill and sec. 45N of the Code)
Present Law
As part of the general business credit, an eligible employer may claim a credit with respect to each qualified mine rescue team employee equal to the lesser of: (1) 20 percent of the amount paid or incurred by the taxpayer during the taxable year with respect to the training program costs of such qualified mine rescue team employee, including wages of the employee while attending the program; or (2) $10,000. 52 A qualified mine rescue team employee is any full-time employee of the taxpayer who is a miner eligible for more than six months of a taxable year to serve as a mine rescue team member by virtue of either having completed the initial 20 hour course of instruction prescribed by the Mine Safety and Health Administration's Office of Educational Policy and Development, or receiving at least 40 hours of refresher training in such instruction. 53

An eligible employer is any taxpayer which employs individuals as miners in underground mines in the United States. 54 The term “wages” has the meaning given to such term by section 3306(b) (determined without regard to any dollar limitation contained in that section). 55

No deduction is allowed for the portion of the expenses otherwise deductible which is equal to the amount of the credit. 56 The credit does not apply to taxable years beginning after December 31, 2009.

Explanation of Provision
The provision extends the credit for one year. Under the provision, the credit does not apply to taxable years beginning after December 31, 2010.

Effective Date
The provision is effective for taxable years beginning after December 31, 2009.

10. Election to expense advanced mine safety equipment (sec. 120 of the bill and sec. 179E of the Code)
Present Law
A taxpayer is allowed to recover, through annual depreciation deductions, the cost of certain property used in a trade or business or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year is determined under the modified accelerated cost recovery system (“MACRS”). 57 Under MACRS, different types of property generally are assigned applicable recovery periods and depreciation methods. The recovery periods applicable to most tangible personal property (generally tangible property other than residential rental property and nonresidential real property) range from 3 to 20 years. The depreciation methods generally applicable to tangible personal property are the 200-percent and 150-percent declining balance methods, switching to the straight-line method for the taxable year in which the depreciation deduction would be maximized.

In lieu of depreciation, a taxpayer with a sufficiently small amount of annual investment may elect to deduct (or “expense”) such costs under section 179. Present law provides that the maximum amount a taxpayer may expense for taxable years beginning in 2009 is $250,000 of the cost of the qualifying property for the taxable year. 58 For taxable years beginning in 2010, the limitation is $125,000. In general, qualifying property is defined as depreciable tangible personal property that is purchased for use in the active conduct of a trade or business. For taxable years beginning in 2009, the $250,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $800,000. The reduction amount is $500,000 for taxable years beginning in 2010. The $125,000 and $500,000 amounts are indexed for inflation in taxable years beginning in 2010.

A taxpayer may elect to treat 50 percent of the cost of any qualified advanced mine safety equipment property as an expense in the taxable year in which the equipment is placed in service. 59 “Qualified advanced mine safety equipment property” means any advanced mine safety equipment property for use in any underground mine located in the United States the original use of which commences with the taxpayer and which is placed in service before January 1, 2010. 60

Advanced mine safety equipment property means any of the following: (1) emergency communication technology or devices used to allow a miner to maintain constant communication with an individual who is not in the mine; (2) electronic identification and location devices that allow individuals not in the mine to track at all times the movements and location of miners working in or at the mine; (3) emergency oxygen-generating, self-rescue devices that provide oxygen for at least 90 minutes; (4) pre-positioned supplies of oxygen providing each miner on a shift the ability to survive for at least 48 hours; and (5) comprehensive atmospheric monitoring systems that monitor the levels of carbon monoxide, methane and oxygen that are present in all areas of the mine and that can detect smoke in the case of a fire in a mine. 61

The portion of the cost of any property with respect to which an expensing election under section 179 is made may not be taken into account for purposes of the 50-percent deduction under section 179E. 62 In addition, a taxpayer making an election under section 179E must file with the Secretary a report containing information with respect to the operation of the mines of the taxpayer as required by the Secretary. 63

Explanation of Provision
The provision extends for one year, to December 31, 2010, the placed in service termination date for the present-law rule relating to expensing of mine safety equipment.

Effective Date
The provision applies to property placed in service after December 31, 2009.

11. Employer wage credit for employees who are active duty members of the uniformed services (sec. 121 of the bill and sec. 45P of the Code)
Present Law
In general, compensation paid by an employer to an employee is deductible by the employer under section 162(a)(1), unless the expense must be capitalized. In the case of an employee who is called to active duty to the uniformed services of the United States, some employers voluntarily pay the employee the difference between the compensation that the employer would have paid to the employee during the period of military service and the amount of pay received by the employee from the military (such payments are commonly referred to as “differential wage payments”).

If a taxpayer qualifies as an eligible small business employer, the taxpayer may take a credit against the taxpayer's income tax liability for a taxable year in an amount equal to 20 percent of the sum of the eligible differential wage payments for each of the taxpayer's qualified employees for the taxable year.

An eligible small business employer means, with respect to a taxable year, any taxpayer which: (1) employed on average less than 50 employees on business days during the taxable year; and (2) under a written plan of the taxpayer, provides eligible differential wage payments to every qualified employee of the taxpayer. Taxpayers under common control are aggregated for purposes of determining whether a taxpayer is an eligible small business employer.

Differential wage payments means any payment which: (1) is made by an employer to an individual with respect to any period during which the individual is performing service in the uniformed services of the United States while on active duty for a period of more than 30 days; and (2) represents all or a portion of the wages that the individual would have received from the employer if the individual were performing services for the employer. The term eligible differential wage payments means so much of the differential wage payments paid to a qualified employee as does not exceed $20,000.

A qualified employee of a taxpayer is a person who has been an employee for the 91-day period immediately preceding the period for which any differential wage payment is made.

No deduction may be taken for that portion of compensation which is equal to the credit. In addition, the amount of any other credit otherwise allowable under Chapter 1 (Normal Taxes and Surtaxes) of Subtitle A (Income Taxes) of the Code with respect to compensation paid to an employee must be reduced by the differential wage payment credit allowed with respect to such employee. The differential wage payment credit is part of the general business credit, and thus this credit is subject to the rules applicable to business credits. For example, an unused credit generally may be carried back to the taxable year that precedes an unused credit year or carried forward to each of the 20 taxable years following the unused credit year. 64 The credit is not allowable against a taxpayer's alternative minimum tax liability.

The credit is not available with respect to a taxpayer who has failed to comply with the employment and reemployment rights of members of the uniformed services (as provided under Chapter 43 of Title 38 of the U.S. Code).

The differential wage payment credit is not available for payments made after December 31, 2009.

Explanation of Provision
The provision extends for one year the differential wage payment credit for employees who are active duty members of the uniformed services. Thus, the differential wage payment credit is available for payments made before January 1, 2011.

Effective Date
The provision is effective with respect to payments made after December 31, 2009.

12. Certain farming business machinery and equipment treated as 5-year property (sec. 122 of the bill and sec. 168 of the Code)
Present Law
A taxpayer is allowed to recover, through annual depreciation deductions, the cost of certain property used in a trade or business or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year is determined under the modified accelerated cost recovery system (“MACRS”). 65 The class lives of assets placed in service after 1986 are generally set forth in Revenue Procedure 87-56. 66 Asset class 01.1 includes machinery and equipment, grain bins, and fences (but no other land improvements), that are used in the production of crops or plants, vines, and trees; livestock; the operation of farm dairies, nurseries, greenhouses, sod farms, mushrooms cellars, cranberry bogs, apiaries, and fur farms; and the performance of agricultural, animal husbandry, and horticultural services. These assets are assigned a class life of 10 years and a recovery period of seven years.

However, Section 168(e)(3)(C)(vii) provides a statutory 5-year recovery period for any machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) which is used in a farming business and placed in service before January 1, 2010, and the original use of which commences with the taxpayer after December 31, 2008. For these purposes, the term “farming business” means a trade or business involving the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity. 67 A farming business includes processing activities that are normally incident to the growing, raising, or harvesting of agricultural or horticultural products. 68

Explanation of Provision
The provision extends the 5-year recovery period for one year (to apply to property placed in service before January 1, 2011).

Effective Date
The provision is effective for property placed in service after December 31, 2009.

13. Treatment of certain dividends of regulated investment companies (sec. 123 of the bill and sec. 871(k) of the Code)
Present Law 69
In general
A regulated investment company (“RIC”) is an entity that meets certain requirements, including a requirement that its income generally be derived from passive investments such as dividends and interest, that it distribute 90 percent of its income, and that elects to be taxed under a special tax regime. Unlike an entity taxed as a corporation, an entity that is taxed as a RIC can deduct amounts paid to its shareholders as dividends. In this manner, tax on RIC income is generally not paid by the RIC but rather by its shareholders. However, income of a RIC is treated as a dividend by those shareholders, unless other special rules apply. Dividends received by foreign persons from a RIC are generally subject to gross-basis tax under sections 871(a) or 881, and the RIC payor of such dividends is obligated to withhold such tax under sections 1441 and 1442.

Under present law, a RIC that earns certain interest income that would not be subject to U.S. tax if earned by a foreign person directly may, to the extent of such income, designate a dividend it pays as derived from such interest income. A foreign person who is a shareholder in the RIC generally can treat such a dividend as exempt from gross-basis U.S. tax, as if the foreign person had earned the interest directly. Also, subject to certain requirements, the RIC is exempt from withholding the gross basis tax on such dividends. Similar rules apply with respect to the designation of certain short term capital gain dividends. However, these provisions relating to certain dividends with respect to interest income and short term capital gain of the RIC do not apply to dividends with respect to any taxable year of a RIC beginning after December 31, 2009.

Explanation of Provision
The provision extends the rules exempting from gross basis tax and from withholding tax the interest-related dividends and to short term capital gain dividends received from a RIC, to dividends with respect to taxable years of a RIC beginning before January 1, 2011.

Effective Date
The provision applies to dividends paid with respect to any taxable year of the RIC beginning after December 31, 2009 (but before January 1, 2011).

14. Special rule for regulated investment company stock held in the estate of a nonresident non-citizen (sec. 124 of the bill and sec. 2105 of the Code)
Present Law
The gross estate of a decedent who was a U.S. citizen or resident generally includes all property - real, personal, tangible, and intangible - wherever situated. 70 The gross estate of a nonresident non-citizen decedent, by contrast, generally includes only property that at the time of the decedent's death is situated within the United States. 71 Property within the United States generally includes debt obligations of U.S. persons, including the Federal government and State and local governments, but does not include either bank deposits or portfolio obligations the interest on which would be exempt from U.S. income tax under section 871. 72 Stock owned and held by a nonresident non-citizen generally is treated as property within the United States if the stock was issued by a domestic corporation. 73

Treaties may reduce U.S. taxation of transfers of the estates of nonresident non-citizens. Under recent treaties, for example, U.S. tax generally may be eliminated except insofar as the property transferred includes U.S. real property or business property of a U.S. permanent establishment.

Although stock issued by a domestic corporation generally is treated as property within the United States, stock of a regulated investment company (“RIC”) that was owned by a nonresident non-citizen is not deemed property within the United States in the proportion that, at the end of the quarter of the RIC's taxable year immediately before a decedent's date of death, the assets held by the RIC are debt obligations, deposits, or other property that would be treated as situated outside the United States if held directly by the estate (the “estate tax look-through rule for RIC stock”). 74 This estate tax look-through rule for RIC stock does not apply to estates of decedents dying after December 31, 2009.

Explanation of Provision
The provision permits the estate tax look-through rule for RIC stock to apply to estates of decedents dying before January 1, 2011.

Effective Date
The provision is effective for taxable years beginning after December 31, 2009.

15. Treatment of RICs as “qualified investment entities” under section 897 (FIRPTA) (sec. 125 of the bill and sec. 897 of the Code)
Present law
Special U.S. tax rules apply to capital gains of foreign persons that are attributable to dispositions of interests in U.S. real property. In general, although a foreign person (a foreign corporation or a nonresident alien individual) is not generally taxed on U.S. source capital gains unless certain personal presence or active business requirements are met, a foreign person who sells a U.S. real property interest (USRPI) is subject to tax at the same rates as a U.S. person, under the Foreign Investment in Real Property Tax Act (“FIRPTA”) provisions codified in section 897 of the Code. Withholding tax is also imposed under section 1445.

A USRPI includes stock or a beneficial interest in any U.S. real property holding corporation (as defined), with the exception of a domestically controlled “qualified investment entity.” A distribution from a “qualified investment entity” that is attributable to the sale of a USRPI is also subject to tax under FIRPTA unless the distribution is with respect to an interest that is regularly traded on an established securities market located in the United Sates and the recipient foreign corporation or nonresident alien individual did not hold more than 5 percent of that class of stock or beneficial interest within the 1-year period ending on the date of distribution. Special rules apply to situations involving tiers of qualified investment entities.

The term “qualified investment entity” includes a regulated investment company (“RIC”) that meets certain requirements, although the inclusion of a RIC in that definition is scheduled to expire, for certain purposes, on December 31, 2009. 75

Explanation of Provision
The provision extends the inclusion of a RIC within the definition of a “qualified investment entity” under section 897 of the Code through December 31, 2010, for those situations in which that that inclusion would otherwise expire at the end of 2009.

Effective Date
The provision applies to distributions made after December 31, 2009.

16. Suspension of limitation on percentage depletion for oil and gas from marginal wells (sec. 126 of the bill and sec. 613A of the Code)
Present Law
The Code permits taxpayers to recover their investments in oil and gas wells through depletion deductions. Two methods of depletion are currently allowable under the Code: (1) the cost depletion method, and (2) the percentage depletion method. 76 Under the cost depletion method, the taxpayer deducts that portion of the adjusted basis of the depletable property which is equal to the ratio of units sold from that property during the taxable year to the number of units remaining as of the end of taxable year plus the number of units sold during the taxable year. Thus, the amount recovered under cost depletion may never exceed the taxpayer's basis in the property.

The Code generally limits the percentage depletion method for oil and gas properties to independent producers and royalty owners. 77 Generally, under the percentage depletion method, 15 percent of the taxpayer's gross income from an oil- or gas-producing property is allowed as a deduction in each taxable year. 78 The amount deducted generally may not exceed 100 percent of the net income from that property in any year (the “net-income limitation”). 79 The 100-percent net-income limitation for marginal production has been suspended for taxable years beginning before January 1, 2010.

Marginal production is defined as domestic crude oil and natural gas production from stripper well property or from property substantially all of the production from which during the calendar year is heavy oil. Stripper well property is property from which the average daily production is 15 barrel equivalents or less, determined by dividing the average daily production of domestic crude oil and domestic natural gas from producing wells on the property for the calendar year by the number of wells. Heavy oil is domestic crude oil with a weighted average gravity of 20 degrees API or less (corrected to 60 degrees Fahrenheit). 80

Explanation of Provision
The provision extends the suspension of the 100-percent net-income limitation for marginal production for one year (to apply to tax years beginning before January 1, 2011).

Effective Date
The provision is effective for taxable years beginning after December 31, 2009.

C. Charitable Provisions
1. Contributions of capital gain real property made for conservation purposes (sec. 131 of the bill and sec. 170 of the Code)
Present Law
Charitable contributions generally
In general, a deduction is permitted for charitable contributions, subject to certain limitations that depend on the type of taxpayer, the property contributed, and the donee organization. The amount of deduction generally equals the fair market value of the contributed property on the date of the contribution. Charitable deductions are provided for income, estate, and gift tax purposes. 81

In general, in any taxable year, charitable contributions by a corporation are not deductible to the extent the aggregate contributions exceed 10 percent of the corporation's taxable income computed without regard to net operating or capital loss carrybacks. For individuals, the amount deductible is a percentage of the taxpayer's contribution base, (i.e., taxpayer's adjusted gross income computed without regard to any net operating loss carryback). The applicable percentage of the contribution base varies depending on the type of donee organization and property contributed. Cash contributions of an individual taxpayer to public charities, private operating foundations, and certain types of private nonoperating foundations may not exceed 50 percent of the taxpayer's contribution base. Cash contributions to private foundations and certain other organizations generally may be deducted up to 30 percent of the taxpayer's contribution base.

In general, a charitable deduction is not allowed for income, estate, or gift tax purposes if the donor transfers an interest in property to a charity while also either retaining an interest in that property or transferring an interest in that property to a noncharity for less than full and adequate consideration. Exceptions to this general rule are provided for, among other interests, remainder interests in charitable remainder annuity trusts, charitable remainder unitrusts, and pooled income funds, present interests in the form of a guaranteed annuity or a fixed percentage of the annual value of the property, and qualified conservation contributions.

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

For purposes of determining whether a taxpayer's aggregate charitable contributions in a taxable year exceed the applicable percentage limitation, contributions of capital gain property are taken into account after other charitable contributions. Contributions of capital gain property that exceed the percentage limitation may be carried forward for five years.

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

Qualified conservation contributions of capital gain property are subject to the same limitations and carryover rules of other charitable contributions of capital gain property.

Special rule regarding contributions of capital gain real property for conservation purposes
In general
Under a temporary provision that is effective for contributions made in taxable years beginning after December 31, 2005, 82 the 30-percent contribution base limitation on contributions of capital gain property by individuals does not apply to qualified conservation contributions (as defined under present law). Instead, individuals may deduct the fair market value of any qualified conservation contribution to an organization described in section 170(b)(1)(A) to the extent of the excess of 50 percent of the contribution base over the amount of all other allowable charitable contributions. These contributions are not taken into account in determining the amount of other allowable charitable contributions.

Individuals are allowed to carry over any qualified conservation contributions that exceed the 50-percent limitation for up to 15 years.

For example, assume an individual with a contribution base of $100 makes a qualified conservation contribution of property with a fair market value of $80 and makes other charitable contributions subject to the 50-percent limitation of $60. The individual is allowed a deduction of $50 in the current taxable year for the non-conservation contributions (50 percent of the $100 contribution base) and is allowed to carry over the excess $10 for up to 5 years. No current deduction is allowed for the qualified conservation contribution, but the entire $80 qualified conservation contribution may be carried forward for up to 15 years.

Farmers and ranchers
In the case of an individual who is a qualified farmer or rancher for the taxable year in which the contribution is made, a qualified conservation contribution is allowable up to 100 percent of the excess of the taxpayer's contribution base over the amount of all other allowable charitable contributions.

In the above example, if the individual is a qualified farmer or rancher, in addition to the $50 deduction for non-conservation contributions, an additional $50 for the qualified conservation contribution is allowed and $30 may be carried forward for up to 15 years as a contribution subject to the 100-percent limitation.

In the case of a corporation (other than a publicly traded corporation) that is a qualified farmer or rancher for the taxable year in which the contribution is made, any qualified conservation contribution is allowable up to 100 percent of the excess of the corporation's taxable income (as computed under section 170(b)(2)) over the amount of all other allowable charitable contributions. Any excess may be carried forward for up to 15 years as a contribution subject to the 100-percent limitation. 83

As an additional condition of eligibility for the 100 percent limitation, with respect to any contribution of property in agriculture or livestock production, or that is available for such production, by a qualified farmer or rancher, the qualified real property interest must include a restriction that the property remain generally available for such production. (There is no requirement as to any specific use in agriculture or farming, or necessarily that the property be used for such purposes, merely that the property remain available for such purposes.) Such additional condition does not apply to contributions made on or before August 17, 2006.

A qualified farmer or rancher means a taxpayer whose gross income from the trade or business of farming (within the meaning of section 2032A(e)(5)) is greater than 50 percent of the taxpayer's gross income for the taxable year.

Termination
The special rule regarding contributions of capital gain real property for conservation purposes does not apply to contributions made in taxable years beginning after December 31, 2009. 84

Explanation of Provision
The Act extends the special rule regarding contributions of capital gain real property for conservation purposes for one year for contributions made in taxable years beginning before January 1, 2011.

Effective Date
The provision is effective for contributions made in taxable years beginning after December 31, 2009.

2. Enhanced charitable deduction for contributions of food inventory (sec. 132 of the bill and sec. 170 of the Code)
Present Law
Charitable contributions in general
In general, an income tax deduction is permitted for charitable contributions, subject to certain limitations that depend on the type of taxpayer, the property contributed, and the donee organization (sec. 170).

Charitable contributions of cash are deductible in the amount contributed. In general, contributions of capital gain property to a qualified charity are deductible at fair market value with certain exceptions. Capital gain property means any capital asset or property used in the taxpayer's trade or business the sale of which at its fair market value, at the time of contribution, would have resulted in gain that would have been long-term capital gain. Contributions of other appreciated property generally are deductible at the donor's basis in the property. Contributions of depreciated property generally are deductible at the fair market value of the property.

General rules regarding contributions of food inventory
Under present law, a taxpayer's deduction for charitable contributions of inventory generally is limited to the taxpayer's basis (typically, cost) in the inventory, or if less the fair market value of the inventory.

For certain contributions of inventory, C corporations may claim an enhanced deduction equal to the lesser of (1) basis plus one-half of the item's appreciation (i.e., basis plus one-half of fair market value in excess of basis) or (2) two times basis. 85 In general, a C corporation's charitable contribution deductions for a year may not exceed 10 percent of the corporation's taxable income. 86 To be eligible for the enhanced deduction, the contributed property generally must be inventory of the taxpayer, contributed to a charitable organization described in section 501(c)(3) (except for private nonoperating foundations), and the donee must (1) use the property consistent with the donee's exempt purpose solely for the care of the ill, the needy, or infants, (2) not transfer the property in exchange for money, other property, or services, and (3) provide the taxpayer a written statement that the donee's use of the property will be consistent with such requirements. In the case of contributed property subject to the Federal Food, Drug, and Cosmetic Act, the property must satisfy the applicable requirements of such Act on the date of transfer and for 180 days prior to the transfer.

A donor making a charitable contribution of inventory must make a corresponding adjustment to the cost of goods sold by decreasing the cost of goods sold by the lesser of the fair market value of the property or the donor's basis with respect to the inventory. 87 Accordingly, if the allowable charitable deduction for inventory is the fair market value of the inventory, the donor reduces its cost of goods sold by such value, with the result that the difference between the fair market value and the donor's basis may still be recovered by the donor other than as a charitable contribution.

To use the enhanced deduction, the taxpayer must establish that the fair market value of the donated item exceeds basis. The valuation of food inventory has been the subject of disputes between taxpayers and the IRS. 88

Temporary rule expanding and modifying the enhanced deduction for contributions of food inventory
Under a special temporary provision, any taxpayer, whether or not a C corporation, engaged in a trade or business is eligible to claim the enhanced deduction for donations of food inventory. 89 For taxpayers other than C corporations, the total deduction for donations of food inventory in a taxable year generally may not exceed 10 percent of the taxpayer's net income for such taxable year from all sole proprietorships, S corporations, or partnerships (or other non C corporation) from which contributions of apparently wholesome food are made. For example, if a taxpayer is a sole proprietor, a shareholder in an S corporation, and a partner in a partnership, and each business makes charitable contributions of food inventory, the taxpayer's deduction for donations of food inventory is limited to 10 percent of the taxpayer's net income from the sole proprietorship and the taxpayer's interests in the S corporation and partnership. However, if only the sole proprietorship and the S corporation made charitable contributions of food inventory, the taxpayer's deduction would be limited to 10 percent of the net income from the trade or business of the sole proprietorship and the taxpayer's interest in the S corporation, but not the taxpayer's interest in the partnership. 90

Under the temporary provision, the enhanced deduction for food is available only for food that qualifies as “apparently wholesome food.” “Apparently wholesome food” is defined as food intended for human consumption that meets all quality and labeling standards imposed by Federal, State, and local laws and regulations even though the food may not be readily marketable due to appearance, age, freshness, grade, size, surplus, or other conditions.

The temporary provision does not apply to contributions made after December 31, 2009.

Explanation of Provision
The provision extends the expansion of, and modifications to, the enhanced deduction for charitable contributions of food inventory to contributions made before January 1, 2011.

Effective Date
The provision is effective for contributions made after December 31, 2009.

3. Enhanced charitable deduction for contributions of book inventories to public schools (sec. 133 of the bill and sec. 170 of the Code)
Present Law
Charitable contributions in general
In general, an income tax deduction is permitted for charitable contributions, subject to certain limitations that depend on the type of taxpayer, the property contributed, and the donee organization (sec. 170).

Charitable contributions of cash are deductible in the amount contributed. In general, contributions of capital gain property to a qualified charity are deductible at fair market value with certain exceptions. Capital gain property means any capital asset or property used in the taxpayer's trade or business the sale of which at its fair market value, at the time of contribution, would have resulted in gain that would have been long-term capital gain. Contributions of other appreciated property generally are deductible at the donor's basis in the property. Contributions of depreciated property generally are deductible at the fair market value of the property.

General rules regarding contributions of food inventory
Under present law, a taxpayer's deduction for charitable contributions of inventory generally is limited to the taxpayer's basis (typically, cost) in the inventory, or, if less, the fair market value of the inventory.

In general, for certain contributions of inventory, C corporations may claim an enhanced deduction equal to the lesser of (1) basis plus one-half of the item's appreciation (i.e., basis plus one-half of fair market value in excess of basis) or (2) two times basis. 91 In general, a C corporation's charitable contribution deductions for a year may not exceed 10 percent of the corporation's taxable income. 92 To be eligible for the enhanced deduction, the contributed property generally must be inventory of the taxpayer contributed to a charitable organization described in section 501(c)(3) (except for private nonoperating foundations), and the donee must (1) use the property consistent with the donee's exempt purpose solely for the care of the ill, the needy, or infants, (2) not transfer the property in exchange for money, other property, or services, and (3) provide the taxpayer a written statement that the donee's use of the property will be consistent with such requirements. In the case of contributed property subject to the Federal Food, Drug, and Cosmetic Act, the property must satisfy the applicable requirements of such Act on the date of transfer and for 180 days prior to the transfer.

A donor making a charitable contribution of inventory must make a corresponding adjustment to the cost of goods sold by decreasing the cost of goods sold by the lesser of the fair market value of the property or the donor's basis with respect to the inventory. 93 Accordingly, if the allowable charitable deduction for inventory is the fair market value of the inventory, the donor reduces its cost of goods sold by such value, with the result that the difference between the fair market value and the donor's basis may still be recovered by the donor other than as a charitable contribution.

To use the enhanced deduction, the taxpayer must establish that the fair market value of the donated item exceeds basis.

Special rule expanding and modifying the enhanced deduction for contributions of book inventory
The generally applicable enhanced deduction for C corporations is expanded and modified to include certain qualified book contributions made after August 28, 2005, and before January 1, 2010. 94 A qualified book contribution means a charitable contribution of books to a public school that provides elementary education or secondary education (kindergarten through grade 12) and that is an educational organization that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on. The enhanced deduction for qualified book contributions is not allowed unless the donee organization certifies in writing that the contributed books are suitable, in terms of currency, content, and quantity, for use in the donee's educational programs and that the donee will use the books in such educational programs. The donee also must make the certifications required for the generally applicable enhanced deduction, i.e., the donee will (1) use the property consistent with the donee's exempt purpose solely for the care of the ill, the needy, or infants, (2) not transfer the property in exchange for money, other property, or services, and (3) provide the taxpayer a written statement that the donee's use of the property will be consistent with such requirements.

Explanation of Provision
The provision extends the expansion of, and modifications to, the enhanced deduction for contributions of book inventory to contributions made before January 1, 2011.

Effective Date
The provision is effective for contributions made after December 31, 2009.

4. Enhanced charitable deduction for corporate contributions of computer technology and equipment for educational purposes (sec. 134 of the bill and sec. 170 of the Code)
Present Law
In the case of a charitable contribution of inventory or other ordinary-income or short-term capital gain property, the amount of the charitable deduction generally is limited to the taxpayer's basis in the property. In the case of a charitable contribution of tangible personal property, the deduction is limited to the taxpayer's basis in such property if the use by the recipient charitable organization is unrelated to the organization's tax-exempt purpose. In cases involving contributions to a private foundation (other than certain private operating foundations), the amount of the deduction is limited to the taxpayer's basis in the property. 95

Under present law, a taxpayer's deduction for charitable contributions of computer technology and equipment generally is limited to the taxpayer's basis (typically, cost) in the property. However, certain corporations may claim a deduction in excess of basis for a “qualified computer contribution.” 96 This enhanced deduction is equal to the lesser of (1) basis plus one-half of the item's appreciation (i.e., basis plus one half of fair market value in excess of basis) or (2) two times basis. The enhanced deduction for qualified computer contributions expires for any contribution made during any taxable year beginning after December 31, 2009. 97

A qualified computer contribution means a charitable contribution of any computer technology or equipment, which meets standards of functionality and suitability as established by the Secretary. The contribution must be to certain educational organizations or public libraries and made not later than three years after the taxpayer acquired the property or, if the taxpayer constructed or assembled the property, not later than the date construction or assembly of the property is substantially completed. 98 The original use of the property must be by the donor or the donee, 99 and in the case of the donee, must be used substantially for educational purposes related to the function or purpose of the donee. The property must fit productively into the donee's education plan. The donee may not transfer the property in exchange for money, other property, or services, except for shipping, installation, and transfer costs. To determine whether property is constructed or assembled by the taxpayer, the rules applicable to qualified research contributions apply. Contributions may be made to private foundations under certain conditions. 100

Explanation of Provision
The provision extends the enhanced deduction for computer technology and equipment to contributions made during taxable years beginning after December 31, 2009, and before January 1, 2011.

Effective Date
The provision is effective for contributions made in taxable years beginning after December 31, 2009.

5. Tax-free distributions from individual retirement plans for charitable purposes (sec. 135 of the bill and sec. 408 of the Code)
Present Law
In general
If an amount withdrawn from a traditional individual retirement arrangement (“IRA”) or a Roth IRA is donated to a charitable organization, the rules relating to the tax treatment of withdrawals from IRAs apply to the amount withdrawn and the charitable contribution is subject to the normally applicable limitations on deductibility of such contributions. An exception applies in the case of a qualified charitable distribution.

Charitable contributions
In computing taxable income, an individual taxpayer who itemizes deductions generally is allowed to deduct the amount of cash and up to the fair market value of property contributed to a charity described in section 501(c)(3), to certain veterans' organizations, fraternal societies, and cemetery companies, 101 or to a Federal, State, or local governmental entity for exclusively public purposes. 102 The deduction also is allowed for purposes of calculating alternative minimum taxable income.

The amount of the deduction allowable for a taxable year with respect to a charitable contribution of property may be reduced depending on the type of property contributed, the type of charitable organization to which the property is contributed, and the income of the taxpayer. 103

A taxpayer who takes the standard deduction (i.e., who does not itemize deductions) may not take a separate deduction for charitable contributions. 104

A payment to a charity (regardless of whether it is termed a “contribution”) in exchange for which the donor receives an economic benefit is not deductible, except to the extent that the donor can demonstrate, among other things, that the payment exceeds the fair market value of the benefit received from the charity. To facilitate distinguishing charitable contributions from purchases of goods or services from charities, present law provides that no charitable contribution deduction is allowed for a separate contribution of $250 or more unless the donor obtains a contemporaneous written acknowledgement of the contribution from the charity indicating whether the charity provided any good or service (and an estimate of the value of any such good or service) to the taxpayer in consideration for the contribution. 105 In addition, present law requires that any charity that receives a contribution exceeding $75 made partly as a gift and partly as consideration for goods or services furnished by the charity (a “quid pro quo” contribution) is required to inform the contributor in writing of an estimate of the value of the goods or services furnished by the charity and that only the portion exceeding the value of the goods or services may be deductible as a charitable contribution. 106

Under present law, total deductible contributions of an individual taxpayer to public charities, private operating foundations, and certain types of private nonoperating foundations may not exceed 50 percent of the taxpayer's contribution base, which is the taxpayer's adjusted gross income for a taxable year (disregarding any net operating loss carryback). To the extent a taxpayer has not exceeded the 50-percent limitation, (1) contributions of capital gain property to public charities generally may be deducted up to 30 percent of the taxpayer's contribution base, (2) contributions of cash to private foundations and certain other charitable organizations generally may be deducted up to 30 percent of the taxpayer's contribution base, and (3) contributions of capital gain property to private foundations and certain other charitable organizations generally may be deducted up to 20 percent of the taxpayer's contribution base.

Contributions by individuals in excess of the 50-percent, 30-percent, and 20-percent limits may be carried over and deducted over the next five taxable years, subject to the relevant percentage limitations on the deduction in each of those years.

In addition to the percentage limitations imposed specifically on charitable contributions, present law imposes a reduction on most itemized deductions, including charitable contribution deductions, for taxpayers with adjusted gross income in excess of a threshold amount, which is indexed annually for inflation. The threshold amount for 2009 is $166,800 ($83,400 for married individuals filing separate returns). For those deductions that are subject to the limit, the total amount of itemized deductions is reduced by three percent of adjusted gross income over the threshold amount, but not by more than 80 percent of itemized deductions subject to the limit. From 2006 through 2009, the overall limitation on itemized deductions phases out for all taxpayers. The overall limitation on itemized deductions was reduced by one-third in taxable years beginning in 2006 and 2007, and is reduced by two-thirds in taxable years beginning in 2008 and 2009. The overall limitation on itemized deductions is eliminated for taxable years beginning after December 31, 2009; however, this elimination of the limitation sunsets on December 31, 2010.

In general, a charitable deduction is not allowed for income, estate, or gift tax purposes if the donor transfers an interest in property to a charity (e.g., a remainder) while also either retaining an interest in that property (e.g., an income interest) or transferring an interest in that property to a noncharity for less than full and adequate consideration. 107 Exceptions to this general rule are provided for, among other interests, remainder interests in charitable remainder annuity trusts, charitable remainder unitrusts, and pooled income funds, and present interests in the form of a guaranteed annuity or a fixed percentage of the annual value of the property. 108 For such interests, a charitable deduction is allowed to the extent of the present value of the interest designated for a charitable organization.

IRA rules
Within limits, individuals may make deductible and nondeductible contributions to a traditional IRA. Amounts in a traditional IRA are includible in income when withdrawn (except to the extent the withdrawal represents a return of nondeductible contributions). Individuals also may make nondeductible contributions to a Roth IRA. Qualified withdrawals from a Roth IRA are excludable from gross income. Withdrawals from a Roth IRA that are not qualified withdrawals are includible in gross income to the extent attributable to earnings. Includible amounts withdrawn from a traditional IRA or a Roth IRA before attainment of age 59-1/2 are subject to an additional 10-percent early withdrawal tax, unless an exception applies. Under present law, minimum distributions are required to be made from tax-favored retirement arrangements, including IRAs. Minimum required distributions from a traditional IRA must generally begin by the April 1 of the calendar year following the year in which the IRA owner attains age 70- ½. 109

If an individual has made nondeductible contributions to a traditional IRA, a portion of each distribution from an IRA is nontaxable until the total amount of nondeductible contributions has been received. In general, the amount of a distribution that is nontaxable is determined by multiplying the amount of the distribution by the ratio of the remaining nondeductible contributions to the account balance. In making the calculation, all traditional IRAs of an individual are treated as a single IRA, all distributions during any taxable year are treated as a single distribution, and the value of the contract, income on the contract, and investment in the contract are computed as of the close of the calendar year.

In the case of a distribution from a Roth IRA that is not a qualified distribution, in determining the portion of the distribution attributable to earnings, contributions and distributions are deemed to be distributed in the following order: (1) regular Roth IRA contributions; (2) taxable conversion contributions; 110 (3) nontaxable conversion contributions; and (4) earnings. In determining the amount of taxable distributions from a Roth IRA, all Roth IRA distributions in the same taxable year are treated as a single distribution, all regular Roth IRA contributions for a year are treated as a single contribution, and all conversion contributions during the year are treated as a single contribution.

Distributions from an IRA (other than a Roth IRA) are generally subject to withholding unless the individual elects not to have withholding apply. 111 Elections not to have withholding apply are to be made in the time and manner prescribed by the Secretary.

Qualified charitable distributions
Present law provides an exclusion from gross income for otherwise taxable IRA distributions from a traditional or a Roth IRA in the case of qualified charitable distributions. 112 The exclusion may not exceed $100,000 per taxpayer per taxable year. Special rules apply in determining the amount of an IRA distribution that is otherwise taxable. The otherwise applicable rules regarding taxation of IRA distributions and the deduction of charitable contributions continue to apply to distributions from an IRA that are not qualified charitable distributions. Qualified charitable distributions are taken into account for purposes of the minimum distribution rules applicable to traditional IRAs to the same extent the distribution would have been taken into account under such rules had the distribution not been directly distributed under the qualified charitable distribution provision. An IRA does not fail to qualify as an IRA as a result of qualified charitable distributions being made from the IRA.

A qualified charitable distribution is any distribution from an IRA directly by the IRA trustee to an organization described in section 170(b)(1)(A) (other than an organization described in section 509(a)(3) or a donor advised fund (as defined in section 4966(d)(2)). Distributions are eligible for the exclusion only if made on or after the date the IRA owner attains age 70-1/2.

The exclusion applies only if a charitable contribution deduction for the entire distribution otherwise would be allowable (under present law), determined without regard to the generally applicable percentage limitations. Thus, for example, if the deductible amount is reduced because of a benefit received in exchange, or if a deduction is not allowable because the donor did not obtain sufficient substantiation, the exclusion is not available with respect to any part of the IRA distribution.

If the IRA owner has any IRA that includes nondeductible contributions, a special rule applies in determining the portion of a distribution that is includible in gross income (but for the qualified charitable distribution provision) and thus is eligible for qualified charitable distribution treatment. Under the special rule, the distribution is treated as consisting of income first, up to the aggregate amount that would be includible in gross income (but for the qualified charitable distribution provision) if the aggregate balance of all IRAs having the same owner were distributed during the same year. In determining the amount of subsequent IRA distributions includible in income, proper adjustments are to be made to reflect the amount treated as a qualified charitable distribution under the special rule.

Distributions that are excluded from gross income by reason of the qualified charitable distribution provision are not taken into account in determining the deduction for charitable contributions under section 170.

The exclusion for qualified charitable distributions applies to distributions made in taxable years beginning after December 31, 2005. Under present law, the exclusion does not apply to distributions made in taxable years beginning after December 31, 2009.

Explanation of Provision
The provision extends the exclusion for qualified charitable distributions to distributions made in taxable years beginning after December 31, 2009, and before January 1, 2011.

Effective Date
The provision is effective for distributions made in taxable years beginning after December 31, 2009.

6. Modification of tax treatment of certain payments to controlling exempt organizations (sec. 136 of the bill and sec. 512 of the Code)
Present Law
In general, organizations exempt from Federal income tax are subject to the unrelated business income tax on income derived from a trade or business regularly carried on by the organization that is not substantially related to the performance of the organization's tax-exempt functions. 113 In general, interest, rents, royalties, and annuities are excluded from the unrelated business income of tax-exempt organizations. 114

Section 512(b)(13) provides special rules regarding income derived by an exempt organization from a controlled subsidiary. In general, section 512(b)(13) treats otherwise excluded rent, royalty, annuity, and interest income as unrelated business income if such income is received from a taxable or tax-exempt subsidiary that is 50-percent controlled by the parent tax-exempt organization to the extent the payment reduces the net unrelated income (or increases any net unrelated loss) of the controlled entity (determined as if the entity were tax exempt). However, a special rule provides that, for payments made pursuant to a binding written contract in effect on August 17, 2006 (or renewal of such a contract on substantially similar terms), the general rule of section 512(b)(13) applies only to the portion of payments received or accrued in a taxable year that exceeds the amount of the payment that would have been paid or accrued if the amount of such payment had been determined under the principles of section 482 (i.e., at arm's length). 115 In addition, the special rule imposes a 20-percent penalty on the larger of such excess determined without regard to any amendment or supplement to a return of tax, or such excess determined with regard to all such amendments and supplements.

In the case of a stock subsidiary, “control” means ownership by vote or value of more than 50 percent of the stock. In the case of a partnership or other entity, “control” means ownership of more than 50 percent of the profits, capital, or beneficial interests. In addition, present law applies the constructive ownership rules of section 318 for purposes of section 512(b)(13). Thus, a parent exempt organization is deemed to control any subsidiary in which it holds more than 50 percent of the voting power or value, directly (as in the case of a first-tier subsidiary) or indirectly (as in the case of a second-tier subsidiary).

The special rule does not apply to payments received or accrued after December 31, 2009.

Explanation of Provision
The provision extends the special rule to payments received or accrued before January 1, 2011. Accordingly, under the provision, payments of rent, royalties, annuities, or interest income by a controlled organization to a controlling organization pursuant to a binding written contract in effect on August 17, 2006 (or renewal of such a contract on substantially similar terms), may be includible in the unrelated business taxable income of the controlling organization only to the extent the payment exceeds the amount of the payment determined under the principles of section 482 (i.e., at arm's length). Any such excess is subject to a 20-percent penalty on the larger of such excess determined without regard to any amendment or supplement to a return of tax, or such excess determined with regard to all such amendments and supplements.

Effective Date
The provision is effective for payments received or accrued after December 31, 2009.

7. Exclusion of gain or loss on sale or exchange of certain brownfield sites from unrelated business taxable income (sec. 137 of the bill and secs. 512 and 514 of the Code)
Present Law
Taxation of unrelated business income, in general
In general, an organization that is otherwise exempt from Federal income tax is taxed on income from a trade or business regularly carried on that is not substantially related to the organization's exempt purposes. Gains or losses from the sale, exchange, or other disposition of property, other than stock in trade, inventory, or property held primarily for sale to customers in the ordinary course of a trade or business, generally are excluded from unrelated business taxable income. Gains or losses are treated as unrelated business taxable income, however, if derived from “debt-financed property.” Debt-financed property generally means any property that is held to produce income and with respect to which there is acquisition indebtedness at any time during the taxable year.

In general, income of a tax-exempt organization that is produced by debt-financed property is treated as unrelated business income in proportion to the acquisition indebtedness on the income-producing property. Acquisition indebtedness generally means the amount of unpaid indebtedness incurred by an organization to acquire or improve the property and indebtedness that would not have been incurred but for the acquisition or improvement of the property. Acquisition indebtedness does not include: (1) certain indebtedness incurred in the performance or exercise of a purpose or function constituting the basis of the organization's exemption; (2) obligations to pay certain types of annuities; (3) an obligation, to the extent it is insured by the Federal Housing Administration, to finance the purchase, rehabilitation, or construction of housing for low and moderate income persons; or (4) indebtedness incurred by certain qualified organizations to acquire or improve real property.

Special rules apply in the case of an exempt organization that owns an interest in a partnership that holds debt-financed property. An exempt organization's share of partnership income that is derived from debt-financed property generally is taxed as debt-financed income unless an exception provides otherwise.

Special rules for certain qualifying brownfield properties
In general
Section 512(b)(19) provides a special exclusion from unrelated business taxable income for the gain or loss from the qualified sale, exchange, or other disposition of a qualifying brownfield property by an eligible taxpayer. The exclusion from unrelated business taxable income generally is available to an exempt organization that acquires, remediates, and disposes of the qualifying brownfield property. In addition, present law provides an exception from the debt-financed property rules for such properties.

In order to qualify for the exclusions from unrelated business income and the debt-financed property rules, the eligible taxpayer is required to: (a) acquire from an unrelated person real property that constitutes a qualifying brownfield property; (b) pay or incur a minimum level of eligible remediation expenditures with respect to the property; and (c) transfer the remediated site to an unrelated person in a transaction that constitutes a sale, exchange, or other disposition for purposes of Federal income tax law. 116

The special exclusion applies only to gain or loss on the sale, exchange, or other disposition of property that is acquired by the eligible taxpayer or qualifying partnership during the period beginning January 1, 2005, and ending December 31, 2009. 117

Qualifying brownfield properties
The exclusion from unrelated business taxable income applies only to real property that constitutes a qualifying brownfield property. A qualifying brownfield property means real property that is certified, before the taxpayer incurs any eligible remediation expenditures (other than to obtain a Phase I environmental site assessment), by an appropriate State agency (within the meaning of section 198(c)(4)) in the State in which the property is located as a brownfield site within the meaning of section 101(39) of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) (as in effect on the date of enactment of the provision). The taxpayer's request for certification must include a sworn statement of the taxpayer and supporting documentation of the presence of a hazardous substance, pollutant, or contaminant on the property that is complicating the expansion, redevelopment, or reuse of the property given the property's reasonably anticipated future land uses or capacity for uses of the property (including a Phase I environmental site assessment and, if applicable, evidence of the property's presence on a local, State, or Federal list of brownfields or contaminated property) and other environmental assessments prepared or obtained by the taxpayer.

Eligible taxpayer
An eligible taxpayer with respect to a qualifying brownfield property is an organization exempt from tax under section 501(a) that acquired such property from an unrelated person and paid or incurred a minimum amount of eligible remediation expenditures with respect to such property. The exempt organization (or the qualifying partnership of which it is a partner) is required to pay or incur eligible remediation expenditures with respect to a qualifying brownfield property in an amount that exceeds the greater of: (a) $550,000; or (b) 12 percent of the fair market value of the property at the time such property is acquired by the taxpayer, determined as if the property were not contaminated.

An eligible taxpayer does not include an organization that is: (1) potentially liable under section 107 of CERCLA with respect to the property; (2) affiliated with any other person that is potentially liable thereunder through any direct or indirect familial relationship or any contractual, corporate, or financial relationship (other than a contractual, corporate, or financial relationship that is created by the instruments by which title to a qualifying brownfield property is conveyed or financed by a contract of sale of goods or services); or (3) the result of a reorganization of a business entity which was so potentially liable. 118

Qualified sale, exchange, or other disposition
A sale, exchange, or other disposition of a qualifying brownfield property is considered qualified if such property is transferred by the eligible taxpayer to an unrelated person, and within one year of such transfer the taxpayer has received a certification (a “remediation certification”) from the Environmental Protection Agency or an appropriate State agency (within the meaning of section 198(c)(4)) in the State in which the property is located that, as a result of the taxpayer's remediation actions, such property would not be treated as a qualifying brownfield property in the hands of the transferee. A taxpayer's request for a remediation certification must be made no later than the date of the transfer and must include a sworn statement by the taxpayer certifying that: (1) remedial actions that comply with all applicable or relevant and appropriate requirements (consistent with section 121(d) of CERCLA) have been substantially completed, such that there are no hazardous substances, pollutants or contaminants that complicate the expansion, redevelopment, or reuse of the property given the property's reasonably anticipated future land uses or capacity for uses of the property; (2) the reasonably anticipated future land uses or capacity for uses of the property are more economically productive or environmentally beneficial than the uses of the property in existence on the date the property was certified as a qualifying brownfield property; 119 (3) a remediation plan has been implemented to bring the property in compliance with all applicable local, State, and Federal environmental laws, regulations, and standards and to ensure that remediation protects human health and the environment; (4) the remediation plan, including any physical improvements required to remediate the property, is either complete or substantially complete, and if substantially complete, 120 sufficient monitoring, funding, institutional controls, and financial assurances have been put in place to ensure the complete remediation of the site in accordance with the remediation plan as soon as is reasonably practicable after the disposition of the property by the taxpayer; and (5) public notice and the opportunity for comment on the request for certification (in the same form and manner as required for public participation required under section 117(a) of CERCLA (as in effect on the date of enactment of the provision)) was completed before the date of such request. Public notice must include, at a minimum, publication in a major local newspaper of general circulation.

Eligible remediation expenditures
Eligible remediation expenditures means, with respect to any qualifying brownfield property: (1) expenditures that are paid or incurred by the taxpayer to an unrelated person to obtain a Phase I environmental site assessment of the property; (2) amounts paid or incurred by the taxpayer after receipt of the certification that the property is a qualifying brownfield property for goods and services necessary to obtain the remediation certification; and (3) expenditures to obtain remediation cost-cap or stop-loss coverage, re-opener or regulatory action coverage, or similar coverage under environmental insurance policies, 121 or to obtain financial guarantees required to manage the remediation and monitoring of the property. Eligible remediation expenditures include expenditures to: (1) manage, remove, control, contain, abate, or otherwise remediate a hazardous substance, pollutant, or contaminant on the property; (2) obtain a Phase II environmental site assessment of the property, including any expenditure to monitor, sample, study, assess, or otherwise evaluate the release, threat of release, or presence of a hazardous substance, pollutant, or contaminant on the property; or (3) obtain environmental regulatory certifications and approvals required to manage the remediation and monitoring of the hazardous substance, pollutant, or contaminant on the property. Eligible remediation expenditures do not include: (1) any portion of the purchase price paid or incurred by the eligible taxpayer to acquire the qualifying brownfield property; (2) environmental insurance costs paid or incurred to obtain legal defense coverage, owner/operator liability coverage, lender liability coverage, professional liability coverage, or similar types of coverage; 122 (3) any amount paid or incurred to the extent such amount is reimbursed, funded or otherwise subsidized by: (a) grants provided by the United States, a State, or a political subdivision of a State for use in connection with the property; (b) proceeds of an issue of State or local government obligations used to provide financing for the property, the interest of which is exempt from tax under section 103; or (c) subsidized financing provided (directly or indirectly) under a Federal, State, or local program in connection with the property; or (4) any expenditure paid or incurred before the date of enactment of the provision.

Qualified gain or loss
Section 512(b)(19) generally excludes from unrelated business taxable income the exempt organization's gain or loss from the sale, exchange, or other disposition of a qualifying brownfield property. Income, gain, or loss from other transfers does not qualify under the provision. 123 The amount of gain or loss excluded from unrelated business taxable income is not limited to or based upon the increase or decrease in value of the property that is attributable to the taxpayer's expenditure of eligible remediation expenditures. Further, the exclusion does not apply to an amount treated as gain that is ordinary income with respect to section 1245 or section 1250 property, including any amount deducted as a section 198 expense that is subject to the recapture rules of section 198(e), if the taxpayer had deducted such amount in the computation of its unrelated business taxable income. 124

Special rules for qualifying partnerships
In the case of a tax-exempt organization that is a partner of a qualifying partnership that acquires, remediates, and disposes of a qualifying brownfield property, the provision applies to the tax-exempt partner's distributive share of the qualifying partnership's gain or loss from the disposition of the property. 125 A qualifying partnership is a partnership that: (1) has a partnership agreement that satisfies the requirements of section 514(c)(9)(B)(vi) at all times beginning on the date of the first certification received by the partnership that one of its properties is a qualifying brownfield property; (2) satisfies the requirements of the provision if such requirements are applied to the partnership (rather than to the eligible taxpayer that is a partner of the partnership); and (3) is not an organization that would be prevented from constituting an eligible taxpayer by reason of it or an affiliate being potentially liable under CERCLA with respect to the property.

The exclusion is available to a tax-exempt organization with respect to a particular property acquired, remediated, and disposed of by a qualifying partnership only if the exempt organization is a partner of the partnership at all times during the period beginning on the date of the first certification received by the partnership that one of its properties is a qualifying brownfield property, and ending on the date of the disposition of the property by the partnership.

If the property is acquired and remediated by a qualifying partnership of which the exempt organization is a partner, it is intended that the certification as to status as a qualified brownfield property and the remediation certification will be obtained by the qualifying partnership, rather than by the tax-exempt partner, and that both the eligible taxpayer and the qualifying partnership will be required to make available such copies of the certifications to the IRS. Any elections or revocations regarding the application of the eligible remediation expenditure rules to multiple properties (as described below) acquired, remediated, and disposed of by a qualifying partnership must be made by the partnership. A tax-exempt partner is bound by an election made by the qualifying partnership of which it is a partner.

Special rules for multiple properties
The eligible remediation expenditure determinations generally are made on a property-by-property basis. An exempt organization (or a qualifying partnership of which the exempt organization is a partner) that acquires, remediates, and disposes of multiple qualifying brownfield properties, however, may elect to make the eligible remediation expenditure determinations on a multiple-property basis. In the case of such an election, the taxpayer satisfies the eligible remediation expenditures test with respect to all qualifying brownfield properties acquired during the election period if the average of the eligible remediation expenditures for all such properties exceeds the greater of: (a) $550,000; or (b) 12 percent of the average of the fair market value of the properties, determined as of the dates they were acquired by the taxpayer and as if they were not contaminated. If the eligible taxpayer elects to make the eligible remediation expenditure determination on a multiple property basis, then the election shall apply to all qualifying sales, exchanges, or other dispositions of qualifying brownfield properties the acquisition and transfer of which occur during the period for which the election remains in effect. 126

Debt-financed property
The present law provision provides that debt-financed property, as defined by section 514(b), does not include any property the gain or loss from the sale, exchange, or other disposition of which is excluded by reason of the provisions of the provision that exclude such gain or loss from computing the gross income of any unrelated trade or business of the taxpayer. Thus, gain or loss from the sale, exchange, or other disposition of a qualifying brownfield property that otherwise satisfies the requirements of the provision is not taxed as unrelated business taxable income merely because the taxpayer incurred debt to acquire or improve the site.

Termination date
As noted above, only gain or loss on the sale, exchange, or other disposition of property that is acquired by the eligible taxpayer or qualifying partnership during the period beginning January 1, 2005, and ending December 31, 2009, is eligible for the special exclusion. Property acquired during the five-year acquisition period need not be disposed of by the termination date in order to qualify for the exclusion. For purposes of the multiple property election, gain or loss on property acquired after December 31, 2009, is not eligible for the exclusion from unrelated business taxable income, although properties acquired after the termination date (but during the election period) are included for purposes of determining average eligible remediation expenditures.

Explanation of Provision
The provision extends the special exclusion from unrelated business taxable income to properties acquired by an eligible taxpayer or qualifying partnership before January 1, 2011.

Effective Date
The provision is effective for property acquired after December 31, 2009.

8. Basis adjustment to stock of S corporations making charitable contributions of property (sec. 138 of the bill and sec. 1367 of the Code)
Present Law
Under present law, if an S corporation contributes money or other property to a charity, each shareholder takes into account the shareholder's pro rata share of the contribution in determining its own income tax liability. 127 A shareholder of an S corporation reduces the basis in the stock of the S corporation by the amount of the charitable contribution that flows through to the shareholder. 128

In the case of contributions made in taxable years beginning before January 1, 2010, the amount of a shareholder's basis reduction in the stock of an S corporation by reason of a charitable contribution made by the corporation is equal to the shareholder's pro rata share of the adjusted basis of the contributed property. For contributions made in taxable years beginning after December 31, 2009, the amount of the reduction is the shareholder's pro rata share of the fair market value of the contributed property.

Explanation of Provision
The provision extends the rule relating to the basis reduction on account of charitable contributions of property for one year to contributions made in taxable years beginning before January 1, 2011.

Effective Date
The provision applies to contributions made in taxable years beginning after December 31, 2009.

D. Miscellaneous Provisions
1. Indian employment tax credit (sec. 141 of the bill and sec. 45A of the Code)
Present Law
In general, a credit against income tax liability is allowed to employers for the first $20,000 of qualified wages and qualified employee health insurance costs paid or incurred by the employer with respect to certain employees. 129 The credit is equal to 20 percent of the excess of eligible employee qualified wages and health insurance costs during the current year over the amount of such wages and costs incurred by the employer during 1993. The credit is an incremental credit, such that an employer's current-year qualified wages and qualified employee health insurance costs (up to $20,000 per employee) are eligible for the credit only to the extent that the sum of such costs exceeds the sum of comparable costs paid during 1993. No deduction is allowed for the portion of the wages equal to the amount of the credit.

Qualified wages means wages paid or incurred by an employer for services performed by a qualified employee. A qualified employee means any employee who is an enrolled member of an Indian tribe or the spouse of an enrolled member of an Indian tribe, who performs substantially all of the services within an Indian reservation, and whose principal place of abode while performing such services is on or near the reservation in which the services are performed. An “Indian reservation” is a reservation as defined in section 3(d) of the Indian Financing Act of 1974 or section 4(1) of the Indian Child Welfare Act of 1978. For purposes of the preceding sentence, section 3(d) is applied by treating “former Indian reservations in Oklahoma” as including only lands that are (1) within the jurisdictional area of an Oklahoma Indian tribe as determined by the Secretary of the Interior, and (2) recognized by such Secretary as an area eligible for trust land status under 25 C.F.R. Part 151 (as in effect on August 5, 1997).

An employee is not treated as a qualified employee for any taxable year of the employer if the total amount of wages paid or incurred by the employer with respect to such employee during the taxable year exceeds an amount determined at an annual rate of $30,000 (which after adjusted for inflation is currently $45,000 for 2009). In addition, an employee will not be treated as a qualified employee under certain specific circumstances, such as where the employee is related to the employer (in the case of an individual employer) or to one of the employer's shareholders, partners, or grantors. Similarly, an employee will not be treated as a qualified employee where the employee has more than a five percent ownership interest in the employer. Finally, an employee will not be considered a qualified employee to the extent the employee's services relate to gaming activities or are performed in a building housing such activities.

The wage credit is available for wages paid or incurred in taxable years that begin before January 1, 2010.

Explanation of Provision
The provision extends for one year the present-law employment credit provision (through taxable years beginning on or before December 31, 2010).

Effective Date
The provision is effective for taxable years beginning after December 31, 2009.

2. Accelerated depreciation for business property on Indian reservations (sec. 142 of the bill and sec. 168(j) of the Code)
Present Law
With respect to certain property used in connection with the conduct of a trade or business within an Indian reservation, depreciation deductions under section 168(j) are determined using the following recovery periods:

3-year property
2 years

5-year property
3 years

7-year property
4 years

10-year property
6 years

15-year property
9 years

20-year property
12 years

Nonresidential real property
22 years


“Qualified Indian reservation property” eligible for accelerated depreciation includes property described in the table above which is: (1) used by the taxpayer predominantly in the active conduct of a trade or business within an Indian reservation; (2) not used or located outside the reservation on a regular basis; (3) not acquired (directly or indirectly) by the taxpayer from a person who is related to the taxpayer; 130 and (4) is not property placed in service for purposes of conducting gaming activities. 131 Certain “qualified infrastructure property” may be eligible for the accelerated depreciation even if located outside an Indian reservation, provided that the purpose of such property is to connect with qualified infrastructure property located within the reservation (e.g., roads, power lines, water systems, railroad spurs, and communications facilities). 132

An “Indian reservation” means a reservation as defined in section 3(d) of the Indian Financing Act of 1974 or section 4(10) of the Indian Child Welfare Act of 1978. For purposes of the preceding sentence, section 3(d) is applied by treating “former Indian reservations in Oklahoma” as including only lands that are (1) within the jurisdictional area of an Oklahoma Indian tribe as determined by the Secretary of the Interior, and (2) recognized by such Secretary as an area eligible for trust land status under 25 C.F.R. Part 151 (as in effect on August 5, 1997).

The depreciation deduction allowed for regular tax purposes is also allowed for purposes of the alternative minimum tax. The accelerated depreciation for qualified Indian reservation property is available with respect to property placed in service on or after January 1, 1994, and before January 1, 2010.

Explanation of Provision
The provision extends for one year the present-law incentive relating to depreciation of qualified Indian reservation property (to apply to property placed in service through December 31, 2010).

Effective Date
The provision is effective for property placed in service after December 31, 2009.

3. Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico (sec. 143 of the bill and sec. 199 of the Code)
Present Law
In general
Present law provides a deduction from taxable income (or, in the case of an individual, adjusted gross income) that is equal to a portion of the taxpayer's qualified production activities income. For taxable years beginning in 2009 the deduction is six percent, and after 2009, the deduction is nine percent of qualified production activities income. For taxpayers subject to the 35-percent corporate income tax rate, the nine-percent deduction effectively reduces the corporate income tax rate to just under 32 percent on qualified production activities income.

Qualified production activities income
In general, qualified production activities income is equal to domestic production gross receipts (defined by section 199(c)(4)), reduced by the sum of: (1) the costs of goods sold that are allocable to those receipts and (2) other expenses, losses, or deductions which are properly allocable to those receipts.

Domestic production gross receipts
Domestic production gross receipts generally are gross receipts of a taxpayer that are derived from (1) any sale, exchange, or other disposition, or any lease, rental, or license, of qualifying production property 133 that was manufactured, produced, grown or extracted by the taxpayer in whole or in significant part within the United States; (2) any sale, exchange, or other disposition, or any lease, rental, or license, of qualified film 134 produced by the taxpayer; (3) any lease, rental, license, sale, exchange, or other disposition of electricity, natural gas, or potable water produced by the taxpayer in the United States; (4) construction of real property performed in the United States by a taxpayer in the ordinary course of a construction trade or business; or (5) engineering or architectural services performed in the United States for the construction of real property located in the United States.

Wage limitation
The amount of the deduction for a taxable year is limited to 50 percent of the wages paid by the taxpayer, and properly allocable to domestic production gross receipts, during the calendar year that ends in such taxable year. 135 Wages paid to bona fide residents of Puerto Rico generally are not included in the wage limitation amount. 136

Rules for Puerto Rico
When used in the Code in a geographical sense, the term “United States” generally includes only the States and the District of Columbia. 137 A special rule for determining domestic production gross receipts, however, provides that in the case of any taxpayer with gross receipts from sources within the Commonwealth of Puerto Rico, the term “United States” includes the Commonwealth of Puerto Rico, but only if all of the taxpayer's gross receipts are taxable under the Federal income tax for individuals or corporations. 138 In computing the 50-percent wage limitation, that taxpayer is permitted to take into account wages paid to bona fide residents of Puerto Rico for services performed in Puerto Rico. 139

The special rules for Puerto Rico apply only with respect to the first four taxable years of a taxpayer beginning after December 31, 2005 and before January 1, 2010.

Explanation of Provision
The provision allows the special domestic production activities rules for Puerto Rico to apply for the first five taxable years of a taxpayer beginning after December 31, 2005 and before January 1, 2011.

Effective Date
The provision is effective for taxable years beginning after December 31, 2009.

4. Temporary increase in limit on cover over of rum excise taxes to Puerto Rico and the Virgin Islands (sec. 144 of the bill and sec. 7652(f) of the Code)
Present Law
A $13.50 per proof gallon 140 excise tax is imposed on distilled spirits produced in or imported (or brought) into the United States. 141 The excise tax does not apply to distilled spirits that are exported from the United States, including exports to U.S. possessions (e.g., Puerto Rico and the Virgin Islands). 142

The Code provides for cover over (payment) to Puerto Rico and the Virgin Islands of the excise tax imposed on rum imported (or brought) into the United States, without regard to the country of origin. 143 The amount of the cover over is limited under Code section 7652(f) to $10.50 per proof gallon ($13.25 per proof gallon before January 1, 2010).

Tax amounts attributable to shipments to the United States of rum produced in Puerto Rico are covered over to Puerto Rico. Tax amounts attributable to shipments to the United States of rum produced in the Virgin Islands are covered over to the Virgin Islands. Tax amounts attributable to shipments to the United States of rum produced in neither Puerto Rico nor the Virgin Islands are divided and covered over to the two possessions under a formula. 144 Amounts covered over to Puerto Rico and the Virgin Islands are deposited into the treasuries of the two possessions for use as those possessions determine. 145 All of the amounts covered over are subject to the limitation.

Explanation of Provision
The provision suspends for one year the $10.50 per proof gallon limitation on the amount of excise taxes on rum covered over to Puerto Rico and the Virgin Islands. Under the provision, the cover over limitation of $13.25 per proof gallon is extended for rum brought into the United States after December 31, 2009 and before January 1, 2011. After December 31, 2010, the cover over amount reverts to $10.50 per proof gallon.

Effective Date
The provision is effective for articles brought into the United States after December 31, 2009.

5. American Samoa economic development credit (sec. 145 of the bill and sec. 119 of Pub. L. No. 109-432)
Present and Prior Law
In general
For taxable years beginning before January 1, 2006, certain domestic corporations with business operations in the U.S. possessions were eligible for the possession tax credit. 146 This credit offset the U.S. tax imposed on certain income related to operations in the U.S. possessions. For purposes of the credit, possessions included, among other places, American Samoa. Subject to certain limitations described below, the amount of the possession tax credit allowed to any domestic corporation equaled the portion of that corporation's U.S. tax that was attributable to the corporation's non-U.S. source taxable income from (1) the active conduct of a trade or business within a U.S. possession, (2) the sale or exchange of substantially all of the assets that were used in such a trade or business, or (3) certain possessions investment. 147 No deduction or foreign tax credit was allowed for any possessions or foreign tax paid or accrued with respect to taxable income that was taken into account in computing the credit under section 936. 148 The section 936 credit generally expired for taxable years beginning after December 31, 2005, but a special credit, described below, was allowed with respect to American Samoa.

To qualify for the possession tax credit for a taxable year, a domestic corporation was required to satisfy two conditions. First, the corporation was required to derive at least 80 percent of its gross income for the three-year period immediately preceding the close of the taxable year from sources within a possession. Second, the corporation was required to derive at least 75 percent of its gross income for that same period from the active conduct of a possession business.

The possession tax credit was available only to a corporation that qualified as an existing credit claimant. The determination of whether a corporation was an existing credit claimant was made separately for each possession. The possession tax credit was computed separately for each possession with respect to which the corporation was an existing credit claimant, and the credit was subject to either an economic activity-based limitation or an income-based limitation.

Qualification as existing credit claimant
A corporation was an existing credit claimant with respect to a possession if (1) the corporation was engaged in the active conduct of a trade or business within the possession on October 13, 1995, and (2) the corporation elected the benefits of the possession tax credit in an election in effect for its taxable year that included October 13, 1995. 149 A corporation that added a substantial new line of business (other than in a qualifying acquisition of all the assets of a trade or business of an existing credit claimant) ceased to be an existing credit claimant as of the close of the taxable year ending before the date on which that new line of business was added.

Economic activity-based limit
Under the economic activity-based limit, the amount of the credit determined under the rules described above was not permitted to exceed an amount equal to the sum of (1) 60 percent of the taxpayer's qualified possession wages and allocable employee fringe benefit expenses, (2) 15 percent of depreciation allowances with respect to short-life qualified tangible property, plus 40 percent of depreciation allowances with respect to medium-life qualified tangible property, plus 65 percent of depreciation allowances with respect to long-life qualified tangible property, and (3) in certain cases, a portion of the taxpayer's possession income taxes.

Income-based limit
As an alternative to the economic activity-based limit, a taxpayer was permitted to elect to apply a limit equal to the applicable percentage of the credit that otherwise would have been allowable with respect to possession business income; in taxable years beginning in 1998 and subsequent years, the applicable percentage was 40 percent.

Repeal and phase out
In 1996, the section 936 credit was repealed for new claimants for taxable years beginning after 1995 and was phased out for existing credit claimants over a period including taxable years beginning before 2006. The amount of the available credit during the phase-out period generally was reduced by special limitation rules. These phase-out period limitation rules did not apply to the credit available to existing credit claimants for income from activities in Guam, American Samoa, and the Northern Mariana Islands. As described previously, the section 936 credit generally was repealed for all possessions, including Guam, American Samoa, and the Northern Mariana Islands, for all taxable years beginning after 2005, but a modified credit was allowed for activities in American Samoa.

American Samoa economic development credit
A domestic corporation that was an existing credit claimant with respect to American Samoa and that elected the application of section 936 for its last taxable year beginning before January 1, 2006 is allowed a credit based on the economic activity-based limitation rules described above. The credit is not part of the Code but is computed based on the rules of sections 30A and 936. The credit is allowed for the first four taxable years of a corporation that begin after December 31, 2005, and before January 1, 2010.

The amount of the credit allowed to a qualifying domestic corporation under the provision is equal to the sum of the amounts used in computing the corporation's economic activity-based limitation (described previously) with respect to American Samoa, except that no credit is allowed for the amount of any American Samoa income taxes. Thus, for any qualifying corporation the amount of the credit equals the sum of (1) 60 percent of the corporation's qualified American Samoa wages and allocable employee fringe benefit expenses and (2) 15 percent of the corporation's depreciation allowances with respect to short-life qualified American Samoa tangible property, plus 40 percent of the corporation's depreciation allowances with respect to medium-life qualified American Samoa tangible property, plus 65 percent of the corporation's depreciation allowances with respect to long-life qualified American Samoa tangible property.

The section 936(c) rule denying a credit or deduction for any possessions or foreign tax paid with respect to taxable income taken into account in computing the credit under section 936 does not apply with respect to the credit allowed by the provision.

The credit is not available for taxable years beginning after December 31, 2009.

Explanation of Provision
The provision allows the American Samoa economic development credit to apply for the first five taxable years of a corporation that begin after December 31, 2005, and before January 1, 2011.

Effective Date
The provision is effective for taxable years beginning after December 31, 2009.

TITLE II - COMMUNITY ASSISTANCE PROVISIONS
1. Empowerment zone tax incentives (sec. 201 of the bill and secs. 1391 and 1202 of the Code)
Present Law
The Omnibus Budget Reconciliation Act of 1993 (“OBRA 93”) authorized the designation of nine empowerment zones (“Round I empowerment zones”) to provide tax incentives for businesses to locate within certain targeted areas 150 designated by the Secretaries of the Department of Housing and Urban Development (“HUD”) and the U.S Department of Agriculture (“USDA”). The Taxpayer Relief Act of 1997 authorized the designation of two additional Round I urban empowerment zones, and 20 additional empowerment zones (“Round II empowerment zones”). The Community Renewal Tax Relief Act of 2000 (“2000 Community Renewal Act”) authorized a total of ten new empowerment zones (“Round III empowerment zones”), bringing the total number of authorized empowerment zones to 40. 151 In addition, the 2000 Community Renewal Act conformed the tax incentives that are available to businesses in the Round I, Round II, and Round III empowerment zones, and extended the empowerment zone incentives through December 31, 2009. 152

The tax incentives available within the designated empowerment zones include a Federal income tax credit for employers who hire qualifying employees, accelerated depreciation deductions on qualifying equipment, tax-exempt bond financing, deferral of capital gains tax on sale of qualified assets sold and replaced, and partial exclusion of capital gains tax on certain sales of qualified small business stock.

The following is a description of the tax incentives that are currently all scheduled to expire as of December 31, 2009.

Employment credit
A 20-percent wage credit is available to employers for the first $15,000 of qualified wages paid to each employee (i.e., a maximum credit of $3,000 with respect to each qualified employee) who (1) is a resident of the empowerment zone, and (2) performs substantially all employment services within the empowerment zone in a trade or business of the employer. 153

The wage credit rate applies to qualifying wages paid before January 1, 2010. Wages paid to a qualified employee who earns more than $15,000 are eligible for the wage credit (although only the first $15,000 of wages is eligible for the credit). The wage credit is available with respect to a qualified full-time or part-time employee (employed for at least 90 days), regardless of the number of other employees who work for the employer. In general, any taxable business carrying out activities in the empowerment zone may claim the wage credit, regardless of whether the employer meets the definition of an “enterprise zone business.” 154

An employer's deduction otherwise allowed for wages paid is reduced by the amount of wage credit claimed for that taxable year. 155 Wages are not to be taken into account for purposes of the wage credit if taken into account in determining the employer's work opportunity tax credit under section 51 or the welfare-to-work credit under section 51A. 156 In addition, the $15,000 cap is reduced by any wages taken into account in computing the work opportunity tax credit or the welfare-to-work credit. 157 The wage credit may be used to offset up to 25 percent of alternative minimum tax liability. 158

Increased section 179 expensing limitation
An enterprise zone business is allowed an additional $35,000 of section 179 expensing (for a total of up to $285,000 in 2009) for qualified zone property placed in service before January 1, 2010. 159 The section 179 expensing allowed to a taxpayer is phased out by the amount by which 50 percent of the cost of qualified zone property placed in service during the year by the taxpayer exceeds $500,000. 160 The term “qualified zone property” is defined as depreciable tangible property (including buildings) provided that (i) the property is acquired by the taxpayer (from an unrelated party) after the designation took effect, (ii) the original use of the property in an empowerment zone commences with the taxpayer, and (iii) substantially all of the use of the property is in an empowerment zone in the active conduct of a trade or business by the taxpayer. Special rules are provided in the case of property that is substantially renovated by the taxpayer.

An enterprise zone business means any qualified business entity and any qualified proprietorship. A qualified business entity means, any corporation or partnership if for such year: (1) every trade or business of such entity is the active conduct of a qualified business within an empowerment zone; (2) at least 50 percent of the total gross income of such entity is derived from the active conduct of such business; (3) a substantial portion of the use of the tangible property of such entity (whether owned or leased) is within an empowerment zone; (4) a substantial portion of the intangible property of such entity is used in the active conduct of any such business; (5) a substantial portion of the services performed for such entity by its employees are performed in an empowerment zone; (6) at least 35 percent of its employees are residents of an empowerment zone; (7) less than five percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to collectibles other than collectibles that are held primarily for sale to customers in the ordinary course of such business; and (8) less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to nonqualified financial property. 161

A qualified proprietorship is any qualified business carried on by an individual as a proprietorship if for such year: (1) at least 50 percent of the total gross income of such individual from such business is derived from the active conduct of such business in an empowerment zone; (2) a substantial portion of the use of the tangible property of such individual in such business (whether owned or leased) is within an empowerment zone; (3) a substantial portion of the intangible property of such business is used in the active conduct of such business; (4) a substantial portion of the services performed for such individual in such business by employees of such business are performed in an empowerment zone; (5) at least 35 percent of such employees are residents of an empowerment zone; (6) less than 5 percent of the average of the aggregate unadjusted bases of the property of such individual which is used in such business is attributable to collectibles other than collectibles that are held primarily for sale to customers in the ordinary course of such business; and (7) less than 5 percent of the average of the aggregate unadjusted bases of the property of such individual which is used in such business is attributable to nonqualified financial property. 162

A qualified business is defined as any trade or business other than a trade or business that consists predominantly of the development or holding of intangibles for sale or license or any business prohibited in connection with the employment credit. 163 In addition, the leasing of real property that is located within the empowerment zone is treated as a qualified business only if (1) the leased property is not residential property, and (2) at least 50 percent of the gross rental income from the real property is from enterprise zone businesses. The rental of tangible personal property is not a qualified business unless at least 50 percent of the rental of such property is by enterprise zone businesses or by residents of an empowerment zone.

Expanded tax-exempt financing for certain zone facilities
States or local governments can issue enterprise zone facility bonds to raise funds to provide an enterprise zone business with qualified zone property. 164 These bonds can be used in areas designated enterprise communities as well as areas designated empowerment zones. To qualify, 95 percent (or more) of the net proceeds from the bond issue must be used to finance: (1) qualified zone property whose principal user is an enterprise zone business, and (2) certain land functionally related and subordinate to such property.

The term enterprise zone business is the same as that used for purposes of the increased section 179 deduction limitation (discussed above) with certain modifications for start-up businesses. First, a business will be treated as an enterprise zone business during a start-up period if (1) at the beginning of the period, it is reasonable to expect the business to be an enterprise zone business by the end of the start-up period, and (2) the business makes bona fide efforts to be an enterprise zone business. The start-up period is the period that ends with the start of the first tax year beginning more than two years after the later of (1) the issue date of the bond issue financing the qualified zone property, and (2) the date this property is first placed in service (or, if earlier, the date that is three years after the issue date). 165

Second, a business that qualifies as at the end of the start-up period must continue to qualify during a testing period that ends three tax years after the start-up period ends. After the three-year testing period, a business will continue to be treated as an enterprise zone business as long as 35 percent of its employees are residents of an empowerment zone or enterprise community.

The face amount of the bonds may not exceed $60 million for an empowerment zone in a rural area, $130 million for an empowerment zone in an urban area with zone population of less than 100,000, and $230 million for an empowerment zone in an urban area with zone population of at least 100,000.

Elective roll over of capital gain from the sale or exchange of any qualified empowerment zone asset purchased after December 21, 2000
Taxpayers can elect to defer recognition of gain on the sale of a qualified empowerment zone asset 166 held for more than one year and replaced within 60 days by another qualified empowerment zone asset in the same zone. 167 The deferral is accomplished by reducing the basis of the replacement asset by the amount of the gain recognized on the sale of the asset.

Partial exclusion of capital gains on certain small business stock
For taxpayers other than corporations, 50 percent of the gain from the sale of qualified small business stock held for more than five years is excluded from gross income. 168 In the case of qualified small business stock acquired after December 21, 2000, in a corporation which is a qualified business entity (as defined in section 1397C(b)) during substantially all of the taxpayer's holding period, the exclusion is increased to 60 percent. 169 The portion of the gain includible in taxable income is taxed at a maximum rate of 28 percent under the regular tax. 170 A percentage of the excluded gain is an alternative minimum tax preference; 171 the portion of the gain includible in alternative minimum taxable income (“AMTI”) is taxed at a maximum rate of 28 percent under the AMT.

The amount of gain eligible for the exclusion by an individual with respect to any corporation is the greater of (1) ten times the taxpayer's basis in the stock or (2) $10 million. To qualify as a small business, when the stock is issued, the gross assets of the corporation may not exceed $50 million. The corporation also must meet certain active trade or business requirements.

For all qualified small business stock acquired after February 17, 2009, and before January 1, 2011, the exclusion is increased to 75 percent. As a result of the increased exclusion, gain from the sale of qualified small business stock to which the provision applies is taxed at maximum effective rates of seven percent under the regular tax 172 and 12.88 percent under the AMT. 173

Other tax incentives
Other incentives not specific to empowerment zones but beneficial to these areas include the work opportunity tax credit for employers based on the first year of employment of certain targeted groups, including empowerment zone residents (up to $2,400 per employee), and qualified zone academy bonds for certain public schools located in an empowerment zone, or expected (as of the date of bond issuance) to have at least 35 percent of its students receiving free or reduced lunches.

Explanation of Provision
The provision extends for one year, through December 31, 2010, the period for which the designation of an empowerment zone is in effect, thus extending for one year the empowerment zone tax incentives, including the wage credit, accelerated depreciation deductions on qualifying equipment, tax-exempt bond financing, and deferral of capital gains tax on sale of qualified assets sold and replaced.

The provision extends for one year, through December 31, 2015, the period for which gain from the sale or exchange of qualified business stock held for more than five years is excluded from gross income.

Effective Date
The provision relating to the designation of an empowerment zone and the provision relating to the exclusion of gain from the sale or exchange of qualified small business stock held for more than five years applies to periods after December 31, 2009.

2. Renewal community tax incentives (sec. 202 of the bill and secs. 1400E, 1400F, 1400I, and 1400J of the Code)
Present Law
The Community Renewal Tax Relief Act of 2000, Pub. L. No. 106-554, authorized the designation of 40 “renewal communities” within which special Federal tax incentives are available to attract business and investment to distressed urban and rural areas. The targeted areas are those that have pervasive poverty, high unemployment, and general economic distress, and that satisfy certain eligibility criteria, including specified poverty rates and population and geographic size limitations.

The Secretary of Housing and Urban Development has awarded renewal community designations to 40 selected communities (12 rural and 28 urban), including areas that remained distressed after previously having received empowerment zone or enterprise community designations. 174 To qualify as a renewal community, the community must have (1) a minimum unemployment rate of 9.45 percent (versus 6.3 percent for enterprise communities and empowerment zones) and (2) a minimum population of 4,000 within a metro area or 1,000 otherwise and a maximum population of 200,000. The designation of an area as a renewal community is effective on January 1, 2002, and terminates after December 31, 2009. 175

The tax incentives provided under the renewal communities program include a Federal income tax credit for employers who hire qualifying employees, enhanced tax deductions on qualifying equipment and expenditures to construct or rehabilitate certain nonresidential buildings, and capital gains tax exclusion on sales of qualified assets. The tax incentives for renewal communities generally are available through December 31, 2009. 176

The following is a description of these tax incentives.

Renewal community employment credit
A 15-percent wage credit is available to employers for the first $10,000 of qualified wages paid to each employee (i.e., a maximum credit of $1,500 with respect to each qualified employee) who (1) is a resident of the renewal community, and (2) performs substantially all employment services within the renewal community in a trade or business of the employer. 177

The wage credit applies to qualifying wages paid before January 1, 2010. Wages paid to a qualified employee who earns more than $10,000 are eligible for the wage credit (although only the first $10,000 of wages is eligible for the credit). The wage credit is available with respect to a qualified full-time or part-time employee, employed for at least 90 days, regardless of the number of other employees who work for the employer. In general, any taxable business carrying out activities in the renewal community may claim the wage credit, regardless of whether the employer meets the definition of a “renewal community business.” 178

An employer's deduction otherwise allowed for wages paid is reduced by the amount of wage credit claimed for that taxable year. 179 Wages are not to be taken into account for purposes of the wage credit if taken into account in determining the employer's work opportunity tax credit under section 51 or the welfare-to-work credit under section 51A. 180 In addition, the $10,000 cap is reduced by any wages taken into account in computing the work opportunity tax credit or the welfare-to-work credit. 181 The wage credit may be used to offset up to 25 percent of alternative minimum tax liability. 182

Additional section 179 expensing
A renewal community business (as defined below in connection with the zero-percent capital gains rate) is allowed an additional $35,000 of section 179 expensing for qualified renewal property placed in service before January 1, 2010. 183 The section 179 expensing allowed to a taxpayer is phased out by the amount by which 50 percent of the cost of qualified renewal property placed in service during the year by the taxpayer exceeds $500,000. 184

The term “qualified renewal property” is defined as depreciable tangible property (including buildings), provided that (1) the property is acquired by the taxpayer (from an unrelated party) after the designation took effect, (2) the original use of the property in the renewal community commences with the taxpayer, and (3) substantially all of the use of the property is in the renewal community in the active conduct of a trade or business by the taxpayer. 185 Special rules are provided in the case of property that is substantially renovated by the taxpayer.

Commercial revitalization deduction
Each State is permitted to allocate up to $12 million of commercial revitalization expenditures to each renewal community located within the State for each calendar year after 2001 and before 2010. The appropriate State agency will make the allocations pursuant to a qualified allocation plan. 186

A commercial revitalization expenditure means the cost of a new building or the cost of substantially rehabilitating an existing building. The building must be used for commercial purposes and be located in a renewal community. In the case of the rehabilitation of an existing building, the cost of acquiring the building will be treated as a qualifying expenditure only to the extent that such costs do not exceed 30 percent of the other rehabilitation expenditures. The qualifying expenditures for any building cannot exceed $10 million.

A taxpayer can elect either to (a) deduct one-half of the commercial revitalization expenditures for the taxable year the building is placed in service or (b) amortize all the expenditures ratably over the 120-month period beginning with the month the building is placed in service. 187 No depreciation is allowed for amounts deducted under this provision. The adjusted basis of the building is reduced by the amount of the commercial revitalization deduction, and the deduction is treated as a depreciation deduction in applying the depreciation recapture rules.

The commercial revitalization deduction is treated in the same manner as the low-income housing credit in applying the passive loss rules. Thus, up to $25,000 of deductions (together with the other deductions and credits not subject to the passive loss limitation by reason of section 469(i)) are allowed to an individual taxpayer regardless of the taxpayer's adjusted gross income. The commercial revitalization deduction is allowed in computing a taxpayer's alternative minimum taxable income.

Zero-percent capital gains rate
A zero-percent capital gains rate applies with respect to gain from the sale of a qualified community asset acquired after December 31, 2001, and before January 1, 2010, and held for more than five years. 188 A qualified community asset includes: (1) qualified community stock (meaning original-issue stock purchased for cash in a renewal community business); (2) a qualified community partnership interest (meaning a partnership interest acquired for cash in a renewal community business); and (3) qualified community business property (meaning tangible property originally used in a renewal community business by the taxpayer) that is purchased or substantially improved after December 31, 2001.

A renewal community business is defined as a corporation or partnership (or proprietorship) if for the taxable year (1) the sole trade or business of the corporation or partnership is the active conduct of a qualified business 189 within a renewal community; (2) at least 50 percent of the total gross income is derived from the active conduct of a “qualified business” within a renewal community; (3) a substantial portion of the business's tangible property is used within a renewal community; (4) a substantial portion of the business's intangible property is used in the active conduct of such business; (5) a substantial portion of the services performed by employees are performed within a renewal community; (6) at least 35 percent of the employees are residents of the renewal community; and (7) less than 5 percent of the average of the aggregate unadjusted bases of the property owned by the business is attributable to (a) certain financial property, or (b) collectibles not held primarily for sale to customers in the ordinary course of an active trade or business. Property will continue to be a qualified community asset if sold (or otherwise transferred) to a subsequent purchaser, provided that the property continues to represent an interest in (or tangible property used in) a renewal community business.

The termination of an area's status as a renewal community will not affect whether property is a qualified community asset, but any gain attributable to the period before January 1, 2002, or after December 31, 2014, is not eligible for the zero-percent rate.

Other tax incentives
Other incentives not specific to renewal communities but beneficial to these areas include the work opportunity tax credit for employers based on the first year of employment of certain targeted groups, including renewal community residents (up to $2,400 per employee), and qualified zone academy bonds for certain public schools expected (as of the date of bond issuance) to have at least 35 percent of its students receiving free or reduced-cost lunches.

Explanation of Provision
The provision extends for one year, through December 31, 2010, the period for which the designation of a renewal community is in effect.

The provision extends for one year, through January 1, 2011, the period for which the taxpayer can acquire a qualified community asset defined to include qualified community stock, a qualified community partnership interest, and qualified community business property. The provision extends for one year, through December 31, 2015, the period for which qualified capital gain from the sale or exchange of a qualified community asset held for more than five years is excluded from gross income.

The provision extends for one year, through December 31, 2010, the period for which a taxpayer can place a qualified revitalization building in service for purposes of the commercial revitalization deduction.

The provision extends for one year, through December 31, 2010, the period through which the taxpayer can acquire qualified renewal property.

Effective Date
The provision relating to the designation of a renewal community and the provision relating to the exclusion of gain from the sale or exchange of a qualified community asset held for more than five years applies to periods after December 31, 2009. The provision relating to the period for which the taxpayer can acquire a qualified community asset or qualified renewal property applies to acquisitions after December 31, 2009. The provision relating to the placed in service date for qualified revitalization buildings eligible for the commercial revitalization deduction applies to buildings placed in service after December 31, 2009.

3. New markets tax credit (sec. 203 of the bill and sec. 45D of the Code)
Present Law
Section 45D provides a new markets tax credit for qualified equity investments made to acquire stock in a corporation, or a capital interest in a partnership, that is a qualified community development entity (“CDE”). 190 The amount of the credit allowable to the investor (either the original purchaser or a subsequent holder) is (1) a five-percent credit for the year in which the equity interest is purchased from the CDE and for each of the following two years, and (2) a six-percent credit for each of the following four years. The credit is determined by applying the applicable percentage (five or six percent) to the amount paid to the CDE for the investment at its original issue, and is available for a taxable year to the taxpayer who holds the qualified equity investment on the date of the initial investment or on the respective anniversary date that occurs during the taxable year. The credit is recaptured if at any time during the seven-year period that begins on the date of the original issue of the investment the entity ceases to be a qualified CDE, the proceeds of the investment cease to be used as required, or the equity investment is redeemed.

A qualified CDE is any domestic corporation or partnership: (1) whose primary mission is serving or providing investment capital for low-income communities or low-income persons; (2) that maintains accountability to residents of low-income communities by their representation on any governing board of or any advisory board to the CDE; and (3) that is certified by the Secretary as being a qualified CDE. A qualified equity investment means stock (other than nonqualified preferred stock) in a corporation or a capital interest in a partnership that is acquired directly from a CDE for cash, and includes an investment of a subsequent purchaser if such investment was a qualified equity investment in the hands of the prior holder. Substantially all of the investment proceeds must be used by the CDE to make qualified low-income community investments. For this purpose, qualified low-income community investments include: (1) capital or equity investments in, or loans to, qualified active low-income community businesses; (2) certain financial counseling and other services to businesses and residents in low-income communities; (3) the purchase from another CDE of any loan made by such entity that is a qualified low-income community investment; or (4) an equity investment in, or loan to, another CDE.

A “low-income community” is a population census tract with either (1) a poverty rate of at least 20 percent or (2) median family income which does not exceed 80 percent of the greater of metropolitan area median family income or statewide median family income (for a non-metropolitan census tract, does not exceed 80 percent of statewide median family income). In the case of a population census tract located within a high migration rural county, low-income is defined by reference to 85 percent (rather than 80 percent) of statewide median family income. For this purpose, a high migration rural county is any county that, during the 20-year period ending with the year in which the most recent census was conducted, has a net out-migration of inhabitants from the county of at least 10 percent of the population of the county at the beginning of such period.

The Secretary has the authority to designate “targeted populations” as low-income communities for purposes of the new markets tax credit. For this purpose, a “targeted population” is defined by reference to section 103(20) of the Riegle Community Development and Regulatory Improvement Act of 1994 (12 U.S.C. 4702(20)) to mean individuals, or an identifiable group of individuals, including an Indian tribe, who (A) are low-income persons; or (B) otherwise lack adequate access to loans or equity investments. Under such Act, “low-income” means (1) for a targeted population within a metropolitan area, less than 80 percent of the area median family income; and (2) for a targeted population within a non-metropolitan area, less than the greater of 80 percent of the area median family income or 80 percent of the statewide non-metropolitan area median family income. 191 Under such Act, a targeted population is not required to be within any census tract. In addition, a population census tract with a population of less than 2,000 is treated as a low-income community for purposes of the credit if such tract is within an empowerment zone, the designation of which is in effect under section 1391, and is contiguous to one or more low-income communities.

A qualified active low-income community business is defined as a business that satisfies, with respect to a taxable year, the following requirements: (1) at least 50 percent of the total gross income of the business is derived from the active conduct of trade or business activities in any low-income community; (2) a substantial portion of the tangible property of such business is used in a low-income community; (3) a substantial portion of the services performed for such business by its employees is performed in a low-income community; and (4) less than five percent of the average of the aggregate unadjusted bases of the property of such business is attributable to certain financial property or to certain collectibles.

The maximum annual amount of qualified equity investments is capped at $5 billion per year for calendar years 2008 and 2009.

Explanation of Provision
The provision extends the new markets tax credit for one year, through 2010, permitting up to $5 billion in qualified equity investments for that calendar year. The provision also extends for one year, through 2015, the carryover period for unused new markets tax credits.

Effective Date
The provision applies to calendar years beginning after 2009.

4. Tax incentives for investment in the District of Columbia (sec. 204 of the bill and secs. 1400, 1400A, 1400B, and 1400C of the Code)
Present Law
In general
The Taxpayer Relief Act of 1997 192 designated certain economically depressed census tracts within the District of Columbia as the “District of Columbia Enterprise Zone,” or “DC Zone,” within which businesses and individual residents are eligible for special tax incentives. The census tracts that comprise the District of Columbia Enterprise Zone are (1) all census tracts that presently are part of the D.C. enterprise community designated under section 1391 (i.e., portions of Anacostia, Mt. Pleasant, Chinatown, and the easternmost part of the District of Columbia), and (2) all additional census tracts within the District of Columbia where the poverty rate is not less than 20 percent. The District of Columbia Enterprise Zone designation remains in effect for the period from January 1, 1998, through December 31, 2009.

The following tax incentives are available for businesses located in an empowerment zone and the District of Columbia Enterprise Zone is treated as an empowerment zone for this purpose: 193 (1) 20-percent wage credit, (2) an additional $35,000 of section 179 expensing for qualified zone property, and (3) expanded tax-exempt financing for certain zone facilities. In addition, a zero-percent capital gains rate applies to capital gains from the sale of certain qualified DC Zone assets held for more than five years.

Present law also provides for a nonrefundable tax credit for first-time homebuyers of a principal residence in the District of Columbia.

Employment credit
A 20-percent wage credit is available to employers for the first $15,000 of qualified wages paid to each employee (i.e., a maximum credit of $3,000 with respect to each qualified employee) who (1) is a resident of the District of Columbia, and (2) performs substantially all employment services within an empowerment zone in a trade or business of the employer. 194

The wage credit rate applies to qualifying wages paid after December 31, 2001, and before January 1, 2010. Wages paid to a qualified employee who earns more than $15,000 are eligible for the wage credit (although only the first $15,000 of wages is eligible for the credit). The wage credit is available with respect to a qualified full-time or part-time employee (employed for at least 90 days), regardless of the number of other employees who work for the employer. In general, any taxable business carrying out activities in the empowerment zone may claim the wage credit, regardless of whether the employer meets the definition of an “enterprise zone business,” as defined below. 195

An employer's deduction otherwise allowed for wages paid is reduced by the amount of wage credit claimed for that taxable year. 196 Wages are not to be taken into account for purposes of the wage credit if taken into account in determining the employer's work opportunity tax credit under section 51 or the welfare-to-work credit under section 51A. 197 In addition, the $15,000 cap is reduced by any wages taken into account in computing the work opportunity tax credit or the welfare-to-work credit. 198 The wage credit may be used to offset up to 25 percent of alternative minimum tax liability. 199

Increased section 179 expensing limitation
An enterprise zone business is allowed an additional $35,000 of section 179 expensing (for a total of up to $285,000 in 2009) for qualified zone property placed in service after December 31, 2001, and before January 1, 2010. 200 The section 179 expensing allowed to a taxpayer is phased out by the amount by which 50 percent of the cost of qualified zone property placed in service during the year by the taxpayer exceeds $500,000. 201 The term “qualified zone property” is defined as depreciable tangible property (including buildings) provided that (i) the property is acquired by the taxpayer (from an unrelated party) after the designation took effect, (ii) the original use of the property in an empowerment zone commences with the taxpayer, and (iii) substantially all of the use of the property is in an empowerment zone in the active conduct of a trade or business by the taxpayer. For this purpose, special rules are provided in the case of property that is substantially renovated by the taxpayer.

An enterprise zone business means any qualified business entity and any qualified proprietorship. A qualified business entity means, any corporation or partnership if for such year: (1) every trade or business of such entity is the active conduct of a qualified business within an empowerment zone; (2) at least 50 percent of the total gross income of such entity is derived from the active conduct of such business; (3) a substantial portion of the use of the tangible property of such entity (whether owned or leased) is within an empowerment zone; (4) a substantial portion of the intangible property of such entity is used in the active conduct of any such business; (5) a substantial portion of the services performed for such entity by its employees are performed in an empowerment zone; (6) at least 35 percent of its employees are residents of an empowerment zone; (7) less than five percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to collectibles other than collectibles that are held primarily for sale to customers in the ordinary course of such business; and (8) less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to nonqualified financial property. 202

A qualified proprietorship is any qualified business carried on by an individual as a proprietorship if for such year: (1) at least 50 percent of the total gross income of such individual from such business is derived from the active conduct of such business in an empowerment zone; (2) a substantial portion of the use of the tangible property of such individual in such business (whether owned or leased) is within an empowerment zone; (3) a substantial portion of the intangible property of such business is used in the active conduct of such business; (4) a substantial portion of the services performed for such individual in such business by employees of such business are performed in an empowerment zone; (5) at least 35 percent of such employees are residents of an empowerment zone; (6) less than 5 percent of the average of the aggregate unadjusted bases of the property of such individual which is used in such business is attributable to collectibles other than collectibles that are held primarily for sale to customers in the ordinary course of such business; and (7) less than 5 percent of the average of the aggregate unadjusted bases of the property of such individual which is used in such business is attributable to nonqualified financial property. 203

A qualified business is defined as any trade or business other than a trade or business that consists predominantly of the development or holding of intangibles for sale or license or any business prohibited in connection with the employment credit. 204 In addition, the leasing of real property that is located within the empowerment zone is treated as a qualified business only if (1) the leased property is not residential property, and (2) at least 50 percent of the gross rental income from the real property is from enterprise zone businesses. The rental of tangible personal property is not a qualified business unless at least 50 percent of the rental of such property is by enterprise zone businesses or by residents of an empowerment zone.

Expanded tax-exempt financing for certain zone facilities
An enterprise zone business is permitted to borrow proceeds from the issuance of tax-exempt enterprise zone facility bonds (as defined in section 1394, without regard to the employee residency requirement) issued by the District of Columbia. 205 To qualify, 95 percent (or more) of the net proceeds must be used to finance: (1) qualified zone property whose principal user is an enterprise zone business, and (2) certain land functionally related and subordinate to such property. Accordingly, most of the proceeds have to be used to finance certain facilities within the DC Zone. The aggregate face amount of all outstanding qualified enterprise zone facility bonds per enterprise zone business may not exceed $15 million and may be issued only while the DC Zone designation is in effect, from January 1, 1998 through December 31, 2009.

The term enterprise zone business is the same as that used for purposes of the increased section 179 deduction limitation with certain modifications for start-up businesses. First, a business will be treated as an enterprise zone business during a start-up period if (1) at the beginning of the period, it is reasonable to expect the business to be an enterprise zone business by the end of the start-up period, and (2) the business makes bona fide efforts to be an enterprise zone business. The start-up period is the period that ends with the start of the first tax year beginning more than two years after the later of (1) the issue date of the bond issue financing the qualified zone property, and (2) the date this property is first placed in service (or, if earlier, the date that is three years after the issue date). 206

Second, a business that qualifies as at the end of the start-up period must continue to qualify during a testing period that ends three tax years after the start-up period ends. After the three-year testing period, a business will continue to be treated as an enterprise zone business as long as 35 percent of its employees are residents of an empowerment zone or enterprise community.

Zero-percent capital gains
A zero-percent capital gains rate applies to capital gains from the sale of certain qualified DC Zone assets held for more than five years. 207 In general, a “qualified DC Zone asset” means stock or partnership interests held in, or tangible property held by, a DC Zone business. For purposes of the zero-percent capital gains rate, the DC Zone is defined to include all census tracts within the District of Columbia where the poverty rate is not less than ten percent.

In general, gain eligible for the zero-percent tax rate is that from the sale or exchange of a qualified DC Zone asset that is (1) a capital asset or (2) property used in a trade or business, as defined in section 1231(b). Gain that is attributable to real property, or to intangible assets, qualifies for the zero-percent rate, provided that such real property or intangible asset is an integral part of a qualified DC Zone business. 208 However, no gain attributable to periods before January 1, 1998, and after December 31, 2014, is qualified capital gain.

District of Columbia homebuyer tax credit
First-time homebuyers of a principal residence in the District of Columbia 209 qualify for a tax credit of up to $5,000. 210 The $5,000 maximum credit amount applies both to individuals and married couples. The credit phases out for individual taxpayers with adjusted gross income between $70,000 and $90,000 ($110,000-$130,000 for joint filers). The credit is available with respect to purchases of existing property as well as new construction.

A “first-time homebuyer” means any individual if such individual (and, if married, such individual's spouse) did not have a present ownership interest in a principal residence in the District of Columbia during the one-year period ending on the date of the purchase of the principal residence to which the credit applies. A taxpayer will be treated as a first-time homebuyer with respect to only one residence—i.e., a taxpayer may claim the credit only once. A taxpayer's basis in a property is reduced by the amount of any homebuyer tax credit claimed with respect to such property.

The first-time homebuyer credit is a nonrefundable personal credit and may offset the regular tax and the alternative minimum tax. Any credit in excess of tax liability may be carried forward indefinitely. The homebuyer credit is generally available for property purchased after August 4, 1997, and before January 1, 2010. However, the credit does not apply to the purchase of a residence after December 31, 2008 to which the national first-time homebuyer credit under Section 36 of the Code applies.

Explanation of Provision
The provision extends for one year, through December 31, 2010, the designation of the District of Columbia Enterprise Zone.

The provision extends for one year the zero-percent capital gains rate applicable to capital gains from the sale or exchange of any DC Zone asset held for more than five years (and, as amended, acquired or substantially improved before January 1, 2011). The provision also extends for one year the period for which the term “qualified capital gain” refers. As amended, the term “qualified capital gain” shall not include any gain attributable to periods before January 1, 1998, or after December 31, 2015.

The provision extends the first-time homebuyer credit for one year (as amended, to apply to property purchased before January 1, 2011).

Effective Date
The provision extending the period of designation of the District of Columbia Enterprise Zone and the provision extending the period for which the term “qualified capital gain” refers applies to periods after December 31, 2009. The provision extending tax-exempt financing for certain zone facilities applies to bonds issued after December 31, 2009. The provision amending the definitions of DC Zone business stock, DC Zone partnership interest, and DC Zone business property applies to property acquired or substantially approved after December 31, 2009. The provision extending the first-time homebuyer credit applies to property purchased after December 31, 2009.

5. Special depreciation allowance for certain New York Liberty Zone property (sec. 205(a) of the bill and sec. 1400L(b) of the Code)
Present Law
A taxpayer is allowed to recover, through annual depreciation deductions, the cost of certain property used in a trade or business or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year generally is determined under the modified accelerated cost recovery system (“MACRS”). 211 Under MACRS, different types of property generally are assigned applicable recovery periods and depreciation methods. The recovery periods applicable to most tangible personal property (generally tangible property other than residential rental property and nonresidential real property) range from 3 to 20 years. The depreciation methods generally applicable to tangible personal property are the 200-percent and 150-percent declining balance methods, switching to the straight-line method for the taxable year in which the depreciation deduction would be maximized.

Present law includes an additional first-year depreciation deduction equal to 30 percent of the adjusted basis of qualified New York Liberty Zone (“Liberty Zone”) property. The additional first-year depreciation deduction is allowed for both regular tax and alternative minimum tax purposes. The basis of the property and the depreciation allowances in the year of purchase and later years are appropriately adjusted to reflect the additional first-year depreciation deduction. In addition, there are no adjustments to the allowable amount of depreciation for purposes of computing a taxpayer's alternative minimum taxable income with respect to property to which the provision applies. A taxpayer may elect out of the additional first-year depreciation for any class of property for any taxable year.

For property to qualify for the additional first-year depreciation deduction it must meet all of the following requirements. First, the property must be eligible real property. 212 Second, substantially all of the use of such property must be in the Liberty Zone. Third, the original use 213 of the property in the Liberty Zone must commence with the taxpayer on or after September 11, 2001. 214 Finally, the property must be acquired by purchase 215 by the taxpayer on or after September 11, 2001.

Nonresidential real property and residential rental property are eligible for the additional first-year depreciation only to the extent such property rehabilitates real property damaged, or replaces real property destroyed or condemned as a result of the terrorist attacks of September 11, 2001. Property is treated as replacing destroyed property, if as part of an integrated plan, such property replaces real property that is included in a continuous area that includes real property destroyed or condemned. It is intended that, for this purpose, real property destroyed (or condemned) only include circumstances in which an entire building or structure was destroyed (or condemned) as a result of the terrorist attacks. Otherwise, such property is considered damaged real property. For example, if certain structural components (e.g., wall, floors, or plumbing fixtures) of a building are damaged or destroyed as a result of the terrorist attacks, but the building is not destroyed (or condemned), then only costs related to replacing the damaged or destroyed components qualify for the provision.

Eligible real property that is constructed by the taxpayer for use by the taxpayer qualifies if the taxpayer begins the construction of the property after September 11, 2001, and the property is placed in service on or before December 31, 2009 (assuming all other requirements are met). Property that is constructed for the taxpayer by another person under a contract that is entered into prior to the construction of the property is considered to be constructed by the taxpayer. 216

The Liberty Zone means the area located on or south of Canal Street, East Broadway (east of its intersection with Canal Street), or Grand Street (east of its intersection with East Broadway) in the Borough of Manhattan in the City of New York, New York.

Explanation of Provision
The provision extends for one year the additional 30-percent depreciation deduction for eligible real property (to apply to property placed in service on or before December 31, 2010).

Effective Date
The provision is effective for eligible real property placed in service after December 31, 2009.

6. New York Liberty Zone bond provision (sec. 205(b) of the bill and sec. 1400L of the Code)
Present Law
An aggregate of $8 billion in tax-exempt private activity bonds is authorized for the purpose of financing the construction and repair of infrastructure in New York City (“Liberty Zone bonds”). The bonds must be issued before January 1, 2010.

Explanation of Provision
The provision extends authority to issue Liberty Zone bonds for one year (through December 31, 2010).

Effective Date
The provision is effective for bonds issued after December 31, 2009.

7. Work opportunity tax credit for Hurricane Katrina employees (sec. 206(a) of the bill)
Present Law
General work opportunity tax credit rules
Targeted groups eligible for the credit
The work opportunity tax credit is available on an elective basis for employers hiring individuals from one or more of nine targeted groups.

Qualified wages
Generally, qualified wages are defined as cash wages paid by the employer to a member of a targeted group. The employer's deduction for wages is reduced by the amount of the credit.

Calculation of the credit
Generally, the credit available to an employer for qualified wages paid to members of all targeted groups except for long-term family assistance recipients equals 40 percent (25 percent for employment of 400 hours or less) of qualified first-year wages. Generally, qualified first-year wages are qualified wages (not in excess of $6,000) attributable to service rendered by a member of a targeted group during the one-year period beginning with the day the individual began work for the employer. Therefore, the maximum credit per employee is $2,400 (40 percent of the first $6,000 of qualified first-year wages). With respect to qualified summer youth employees, the maximum credit is $1,200 (40 percent of the first $3,000 of qualified first-year wages). In the case of certain qualified veterans, the definition of first-year wages is increased from $6,000 to $12,000, which increases the maximum credit per such employee to $4,800. Except for long-term family assistance recipients, no credit is allowed for second-year wages.

In the case of long-term family assistance recipients, the credit equals 40 percent (25 percent for employment of 400 hours or less) of $10,000 for qualified first-year wages and 50 percent of the first $10,000 of qualified second-year wages. Generally, qualified second-year wages are qualified wages (not in excess of $10,000) attributable to service rendered by a member of the long-term family assistance category during the one-year period beginning on the day after the one-year period beginning with the day the individual began work for the employer. Therefore, the maximum credit per employee is $9,000 (40 percent of the first $10,000 of qualified first-year wages plus 50 percent of the first $10,000 of qualified second-year wages).

Minimum employment period
No credit is allowed for qualified wages paid to employees who work less than 120 hours in the first year of employment.

Certification requirement
In general, an individual is not treated as a member of a targeted group unless (1) on or before the day on which such individual begins work for the employer, the employer has received a certification from a designated local agency that such individual is a member of a targeted group or (2) on or before the day the individual is offered employment with the employer, a pre-screening notice is completed by the employer with respect to such individual and not later than the twenty-first day after the individual begins work for the employer, the employer submits such notice, signed by the employer and the individual under the penalties of perjury, to the designated local agency as part of a written request for such a certification from such agency.

Qualifying rehires
No credit is available for any individual if, prior to the hiring date of such individual, such individual had been employed by the employer at any time.

Other rules
The work opportunity tax credit is not allowed for wages paid to a relative or dependent of the taxpayer. Similarly, wages paid to replacement workers during a strike or lockout are not eligible for the work opportunity tax credit. Wages paid to any employee during any period for which the employer received on-the-job training program payments with respect to that employee are not eligible for the work opportunity tax credit. The work opportunity tax credit generally is not allowed for wages paid to individuals who had previously been employed by the employer. In addition, many other technical rules apply.

Expiration date
The work opportunity tax credit is effective for wages paid or incurred to a qualified individual who begins work for an employer before September 1, 2011.

Hurricane Katrina work opportunity tax credit rules
In general
A Hurricane Katrina employee is treated as a member of a targeted group for purposes of the work opportunity tax credit. A Hurricane Katrina employee is: (1) an individual who on August 28, 2005, had a principal place of abode in the core disaster area and is hired during the four-year period beginning on such date for a position, the principal place of employment of which is located in the core disaster area.

Certification requirement
The WOTC certification requirement is waived for such individuals. In lieu of the certification requirement, an individual may provide to the employer reasonable evidence that the individual is a Hurricane Katrina employee.

Qualifying rehires
The general rule that denies the credit with respect to wages of employees who had been previously employed by the employer is waived for the first hire of such employee as a Hurricane Katrina employee unless such employee was an employee of the employer on August 28, 2005.

Explanation of Provision
The provision extends the work opportunity tax credit for Hurricane Katrina employees for one year (through August 27, 2010).

Effective Date
The provision is effective for individuals hired after August 27, 2009 and before August 28, 2010.

8. Increased rehabilitation credit for structures in the Gulf Opportunity Zone (sec. 206(b) of the bill and sec. 1400N(h) of the Code)
Present Law
Present law provides a two-tier tax credit for rehabilitation expenditures.

A 20-percent credit is provided for qualified rehabilitation expenditures with respect to a certified historic structure. For this purpose, a certified historic structure means any building that is listed in the National Register, or that is located in a registered historic district and is certified by the Secretary of the Interior to the Secretary of the Treasury as being of historic significance to the district.

A 10-percent credit is provided for qualified rehabilitation expenditures with respect to a qualified rehabilitated building, which generally means a building that was first placed in service before 1936. The pre-1936 building must meet requirements with respect to retention of existing external walls and internal structural framework of the building in order for expenditures with respect to it to qualify for the 10-percent credit. A building is treated as having met the substantial rehabilitation requirement under the 10-percent credit only if the rehabilitation expenditures during the 24-month period selected by the taxpayer and ending within the taxable year exceed the greater of (1) the adjusted basis of the building (and its structural components), or (2) $5,000.

The provision requires the use of straight-line depreciation or the alternative depreciation system in order for rehabilitation expenditures to be treated as qualified under the provision.

Present law increases from 20 to 26 percent, and from 10 to 13 percent, respectively, the credit under section 47 with respect to any certified historic structure or qualified rehabilitated building located in the Gulf Opportunity Zone, provided the qualified rehabilitation expenditures with respect to such buildings or structures are incurred on or after August 28, 2005, and before January 1, 2010. The provision is effective for expenditures incurred on or after August 28, 2005, for taxable years ending on or after August 28, 2005.

Explanation of Provision
The provision extends for one additional year the increase in the rehabilitation credit from 20 to 26 percent, and from 10 to 13 percent, respectively, with respect to any certified historic structure or qualified rehabilitated building located in the Gulf Opportunity Zone. Thus, the increase applies for qualified rehabilitation expenditures with respect to such buildings or structures incurred before January 1, 2011.

Effective Date
The provision is effective upon enactment.

9. Election for refundable low-income housing credit for 2010 (sec. 207 of the bill and sec. 42 of the Code)
Present Law
Tax credits
In general
The low-income housing credit may be claimed over a 10-year period by owners of certain residential rental property for the cost of rental housing occupied by tenants having incomes below specified levels. 217 The amount of the credit for any taxable year in the credit period is the applicable percentage of the qualified basis of each qualified low-income building. The qualified basis of any qualified low-income building for any taxable year equals the applicable fraction of the eligible basis of the building.

Volume limits
A low-income housing credit is allowable only if the owner of a qualified building receives a housing credit allocation from the State or local housing credit agency. The aggregate credit authority provided annually to each State is indexed for inflation. For calendar year 2010 is $2.10 per resident, with a minimum annual cap of $2,430,000 for certain small population States. 218 These amounts are indexed for inflation. Projects that also receive financing with proceeds of tax-exempt bonds issued subject to the private activity bond volume limit do not require an allocation of the low-income housing credit.

Basic rule for Federal grants
The basis of a qualified building must be reduced by the amount of any federal grants with respect to such building.

Grants in lieu of tax credits for 2009
Low-income housing grant election amount
The Secretary makes a grant to the State housing credit agency of each State in an amount equal to the low-income housing grant election amount for 2009.

The low-income housing grant election amount for a State is an amount elected by the State subject to certain limits. The maximum low-income housing grant election amount for a State may not exceed 85 percent of the product of ten and the sum of the State's: (1) unused housing credit ceiling for 2008; (2) any returns to the State during 2009 of credit allocations previously made by the State; (3) 40 percent of the State's 2009 credit allocation; and (4) 40 percent of the State's share of the national pool allocated in 2009, if any).

These grants are not taxable income to recipients.

Subawards to low-income housing credit buildings
A State receiving a grant under this election is to use these monies to make subawards to finance the construction, or acquisition and rehabilitation of qualified low-income buildings as defined under the low-income housing credit. A subaward may be made to finance a qualified low-income building regardless of whether the building has an allocation of low-income housing credit. However, in the case of qualified low-income buildings without allocations of the low-income housing credit, the State housing credit agency must make a determination that the subaward with respect to such building will increase the total funds available to the State to build and rehabilitate affordable housing. In conjunction with this determination the State housing credit agency must establish a process in which applicants for the subawards must demonstrate good faith efforts to obtain investment commitments before the agency makes such subawards.

Any building receiving grant money from a subaward is required to satisfy the low-income housing credit rules. The State housing credit agency shall perform asset management functions to ensure compliance with the low-income housing credit rules and the long-term viability of buildings financed with these subawards. 219 Failure to satisfy the low-income housing credit rules will result in recapture enforced by means of liens or other methods that the Secretary (or delegate) deems appropriate. Any such recapture will be payable to the Secretary for deposit in the general fund of the Treasury.

Any grant funds not used to make subawards before January 1, 2011 and any grant monies from subawards returned on or after January 1, 2011 must be returned to the Secretary.

Basic rule for Federal grants
The grants received under the grant election do not reduce tax basis of a qualified low-income building.

Reduction in low-income housing credit volume limit for 2009
The otherwise applicable low-income housing credit volume limit for any State for 2009 is reduced by the amount taken into account in determining the low-income housing grant election amount.

Appropriations
Present law appropriates to the Secretary such sums as may be necessary to carry out this provision.

Explanation of Provision
The provision creates a refundable tax credit for 2010 (rather than to extend the 2009 election to substitute grants for nonrefundable tax credits). Specifically, the provision allows each State a refundable low income housing tax credit to finance low-income buildings through grants to taxpayers. The amount of such refundable credit for each State shall equal the low-income housing refundable tax credit election amount.

For 2010 the maximum low-income housing refundable credit election amount for a State may not exceed 85 percent of the product of ten and the sum of the State's: (1) unused housing credit ceiling for 2009; (2) any returns to the State during 2010 of credit allocations previously made by the State; (3) 40 percent of the State's 2010 credit allocation; and (4) 40 percent of the State's share of the national pool allocated in 2010, if any).

Any refundable tax credits allowed under this provision not used to make grants before January 1, 2012 and any grant monies to taxpayers under this provision returned on or after January 1, 2012 must be returned to the Secretary.

The payments made under the provision do not reduce the tax basis of a qualified low-income building.

No change is made to the operation of the 2009 election.

Effective Date
The provision is effective on the date of enactment.

TITLE III - DISASTER RELIEF PROVISIONS
1. Deductibility of personal casualty losses attributable to federally declared disasters (sec. 301 of the Act and sec. 165 of the Code)
Present Law
Personal casualty losses
In general
Under present law, a taxpayer may generally claim a deduction for any loss sustained during the taxable year and not compensated by insurance or otherwise. 220 For individual taxpayers, deductible losses must be incurred in a trade or business or other profit-seeking activity or consist of losses of property arising from fire, storm, shipwreck, or other casualty, or from theft. 221 In the case of any loss occurring in a disaster area and attributable to a federally declared disaster area, the taxpayer may elect to take into account the casualty loss for the taxable year immediately preceding the taxable year in which the disaster occurs. 222

Dollar limitation
In the case of an individual, a casualty or theft loss not connected with a trade or business or transaction entered into for profit (“personal casualty loss”) is allowed only to the extent the loss exceeds $500 ($100 for taxable years beginning after December 31, 2009). 223

Adjusted gross income limitation
In general, the net aggregate personal casualty losses for a taxable year are deductible only to the extent they exceed 10 percent of an individual taxpayer's adjusted gross income. 224

Present law waives the 10-percent of adjusted gross income limitation for a “net disaster loss.” The term “net disaster loss” means the excess of personal casualty losses attributable to a federally declared disaster occurring before January 1, 2010, and occurring in a disaster area, over personal casualty gains. The term “federally declared disaster” means any disaster subsequently determined by the President of the United States to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. The term “disaster area” means the area so determined to warrant assistance.

Standard deduction
An individual taxpayer's taxable income is computed by reducing adjusted gross income either by a standard deduction or, if the taxpayer elects, by the taxpayer's itemized deductions. 225 Unless an individual elects, no itemized deductions are allowed for the taxable year. The deduction for personal casualty losses is an itemized deduction.

Present law increases an individual taxpayer's standard deduction by the “disaster loss deduction.” The “disaster loss deduction” means the net disaster loss (as defined above).

Explanation of Provision
One year extension of net disaster loss
The provision extends for one year the definition of a net disaster loss to include personal casualty losses attributable to federally declared disasters occurring in 2010. Thus the waiver of the 10-percent of adjusted gross income limitation for net disaster losses and the inclusion of net disaster losses in the standard deduction are extended for one year.

One year extension of the increase to $500 limitation per casualty
The provision extends the $500 per casualty dollar limitation for one year to taxable years beginning after December 31, 2009, and before January 1, 2011.

Effective Dates
The provision generally applies to disasters occurring after December 31, 2009.

The provision increasing the limitation per casualty to $500 applies to taxable years beginning after December 31, 2009.

2. Expensing of qualified disaster expenses (sec. 302 of the bill and sec. 198A of the Code)
Present Law
Under present law, a taxpayer may elect to treat any qualified disaster expense that is paid or incurred by the taxpayer as a deduction for the taxable year in which paid or incurred. For purposes of the provision, a qualified disaster expense is any otherwise capitalizable expenditure paid or incurred in connection with a trade or business or with business-related property that is: (1) for the abatement or control of hazardous substances that were released on account of a Federally declared disaster 226 occurring before January 1, 2010; (2) for the removal of debris from, or the demolition of structures on, real property damaged or destroyed as a result of a Federally declared disaster occurring before January 1, 2010; or (3) for the repair of business-related property damaged as a result of a Federally declared disaster occurring before January 1, 2010. No inference is intended as to the proper present law treatment of expenditures to repair business-related property damaged in a casualty event. The purpose of the provision is to provide that, in any case in which such costs are otherwise required to be capitalized, the costs may be deducted in the taxable year paid or incurred to the extent incurred as a result of a Federally declared disaster.

For purposes of section 198A, “business-related property” is property held by the taxpayer for use in a trade or business, for the production of income, or as inventory. In addition, any deduction allowed under this provision is treated as a deduction for depreciation and section 1245 property for purposes of applying the depreciation recapture rules.

This provision does not apply to any disaster that has been declared by the President on or after May 20, 2008, and before August 1, 2008, under section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act by reason of severe storms, tornados, or flooding occurring in any of the States of Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, and Wisconsin.

Explanation of Provision
The provision extends the deduction for qualified disaster expenditures for one year (to apply to amounts paid or incurred in connection with Federally declared disasters occurring before January 1, 2011).

Effective Date
The provision is effective for expenditures on account of disasters occurring after December 31, 2009.

3. Net operating losses attributable to federally declared disasters (sec. 303 of the bill and sec. 172 of the Code)
Present Law
Under present law, a net operating loss (“NOL”) is, generally, the amount by which a taxpayer's business deductions exceed its gross income. In general, an NOL may be carried back two years and carried over 20 years to offset taxable income in such years. 227 NOLs offset taxable income in the order of the taxable years to which the NOL may be carried. 228

Section 172(b)(1)(J) provides a special five-year carryback period for NOLs to the extent of a qualified disaster loss. A qualified disaster loss is the lesser of: (1) the sum of (a) section 165 losses for the taxable year attributable to a Federally declared disaster 229 occurring after December 31, 2007, and before January 1, 2010, and occurring in a disaster area, 230 and (b) the deduction for the taxable year for qualified disaster expenses allowable under section 198A(a) or which would be allowable as a deduction under that section if not treated as an expense in another section of the Code; or (2) the NOL for the taxable year.

A qualified disaster loss does not include any loss with respect to any property used in connection with any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises, or any gambling or animal racing property (as defined in section 1400N(p)(3)(B)).

The amount of the NOL to which the five-year carryback period applies is limited to the amount of the corporation's overall NOL for the taxable year. Any remaining portion of the taxpayer's NOL is subject to the general two-year carryback period. Ordering rules similar to those for specified liability losses apply to losses carried back under section 172(b)(1)(J).

Any taxpayer entitled to the five-year carryback under section 172(b)(1)(J) may elect to have the carryback period determined without regard to this provision. In addition, the general rule which limits a taxpayer's NOL deduction to 90 percent of alternative minimum taxable income (“AMTI”) does not apply to any NOL to which the five-year carryback period applies under the provision. Instead, a taxpayer may apply such NOL carrybacks to offset up to 100 percent of AMTI.

Section 172(b)(1)(J) does not apply to any disaster that has been declared by the President on or after May 20, 2008, and before August 1, 2008, under section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act by reason of severe storms, tornados, or flooding occurring in any of the States of Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, and Wisconsin.

Explanation of Provision
The provision extends the five-year NOL carryback period for one year (to apply to losses incurred in connection with Federally declared disasters occurring before January 1, 2011).

Effective Date
The provision is effective for losses attributable to disasters occurring after December 31, 2009.

4. Special rules for mortgage revenue bonds in Federally declared disaster areas (sec. 304 of the bill and sec. 143 of the Code)
Present Law
Qualified mortgage bonds
Generally
Under present law, gross income does not include interest on State or local bonds. 231 State and local bonds are classified generally as either governmental bonds or private activity bonds. Governmental bonds are bonds that are primarily used to finance governmental functions or are repaid with governmental funds. Private activity bonds are bonds with respect to which the State or local government serves as a conduit providing financing to nongovernmental persons (e.g., private businesses or individuals). The exclusion from income for State and local bonds does not apply to private activity bonds, unless the bonds are issued for certain permitted purposes (“qualified private activity bonds”) (secs. 103(b)(1) and 141).

The definition of a qualified private activity bond includes a qualified mortgage bond (sec. 143). Qualified mortgage bonds are issued to make mortgage loans to qualified mortgagors for the purchase, qualified home improvement, or rehabilitation of owner-occupied residences.

The Code imposes several limitations on qualified mortgage bonds in the case of a purchase of a residence, including purchase price limitations for the residence financed with bond proceeds and income limitations for homebuyers. In general, the purchase price limitation is met if the acquisition cost of each residence financed does not exceed 90 percent of the average area purchase price (i.e., the average single-family residence purchase price purchased for the most recent one-year period in the statistical area in which the residence is located) (sec. 143(e)). The income limitation generally is met if all the owner-financing provided under the issue is provided to individuals who have family income of 115 percent or less of the applicable median family income (sec. 143(f)).

Qualified home improvement loans are defined as financing, not in excess of $15,000, of alterations, repairs, and improvements on or in connection with an existing residence by an owner thereof. These are further limited only to such items as substantially protect or improve the basic livability or energy efficiency of the property.

Rehabilitation loans are eligible for such financing if: (1) the mortgagor receiving the financing is the first resident after the completion of the rehabilitation; (2) at least 20 years have elapsed between the first use of the residence and the start of the physical work of the rehabilitation; (3) certain percentages of internal and external walls are retained after the rehabilitation; and (4) rehabilitation expenditures equal at least 25 percent of the taxpayer's adjusted basis in the residence after such rehabilitation (sec. 143 (k)(5)).

First-time homebuyers
In addition to the purchase price and income limitations, qualified mortgage bonds generally cannot be used to finance a mortgage for a homebuyer who had an ownership interest in a principal residence in the three years preceding the execution of the mortgage (the “first-time homebuyer” requirement) (sec. 143(d)). The first-time homebuyer requirement does not apply to targeted area residences (described below).

Special rules for targeted area residences
A targeted area residence is one located in either (1) a census tract in which at least 70 percent of the families have an income which is 80 percent or less of the state-wide median income or (2) an area of chronic economic distress (sec. 143(j)).

In addition to the waiver of the first-time homebuyer rule, targeted area residences have special purchase price limitations and income limitations. For targeted area residences, the purchase price limitation is applied by substituting 110 percent for 90 percent (i.e., the purchase price limitation is met if the acquisition cost of each residence financed does not exceed 110 percent of the average area purchase applicable to the residence) (sec. 143(e)(5)). For targeted area residences, the income limitation generally is met if at least two-thirds of all the owner-financing provided under the issue is provided to individuals who have family income of 140 percent or less of the applicable median family income. The other third is not subject to an income limitation (sec. 143(f)(3)).

Special rules for Federally declared disaster areas
A temporary provision waives the first-time homebuyer requirement for residences located in Federally declared disaster areas (sec. 143(k)(11)). Also, under the provision, residences located in Federally declared disaster areas are treated as targeted area residences for purposes of the income and purchase price limitations. The special rules for residences located in Federally declared disaster areas applies to bonds issued after May 1, 2008, and before January 1, 2010.

Election to waive certain mortgage revenue bond rules
In general
Present law allows certain taxpayers affected by natural disasters to elect to waive the first-time homebuyer requirement and modify the purchase price limitation from 90% to 110%, if taxpayer's principal residence is destroyed as a result of a Federally declared disaster. Any owner-financing provided with respect to repair or reconstruction is deemed a qualified rehabilitation loan, if the taxpayer's principal residence is damaged as a result of a Federally declared disaster. If a taxpayer makes such an election, then the otherwise applicable special rules for Federally declared disaster areas do not apply. If there is no such election, then the otherwise applicable special rules for Federally declared disaster areas apply.

Principal residence destroyed
This election for destroyed residences is available for principal residences located in Federally declared disaster areas when the principal residence of a taxpayer is: (1) rendered unsafe for use by reason of a Federally declared disaster occurring before January 1, 2010; or (2) demolished or relocated by reason of an order of the government of a State or political subdivision thereof on account of a Federally declared disaster occurring before January 1, 2010. This election applies for the two-year period beginning on the date of the disaster.

The election provides for: (1) a waiver of the first-time homebuyer requirement; and (2) the purchase price limitation otherwise applicable to targeted area residences (i.e., the purchase price limitation is met if the acquisition cost of each residence financed does not exceed 110 percent of the average area purchase applicable to the residence).

Principal residence damaged
The election for damaged residences allows certain taxpayers to elect to waive the otherwise applicable qualified rehabilitation loan rules and treat the cost of repair or reconstruction of a taxpayer's principal residence as a qualified rehabilitation loan. This election is limited to taxpayers whose principal residence is damaged as a result of a Federally declared disaster occurring before January 1, 2010. Such rehabilitation loans are limited to the lesser of $150,000 or the cost of repair or reconstruction.

Other rules
Once made, an election under these provisions may not be revoked by the taxpayer except with the consent of the Secretary.

For purposes of the provision, the term “Federally declared disaster” has the same definition as in section 165(h)(3)(C)(i) of the Code. 232 The provision is effective for disaster occurring after December 31, 2007. However, the provision does not apply to any disaster that has been declared by the President on or after May 20, 2008, and before August 1, 2008, under section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act by reason of severe storms, tornados, or flooding occurring in any of the States of Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, and Wisconsin. 233

Explanation of Provision
The provision extends: (1) the special rules for Federally declared disaster areas; and (2) the election to waive certain mortgage revenue bond rules relating to Federally declared disasters for one additional year (through 2010).

Effective Date
The provision relating to the special rules for Federally declared disaster areas is effective for bonds issued after December 31, 2009. The provision relating to the election to waive certain mortgage revenue bond rules relating to Federally declared disasters is effective for disasters occurring after December 31, 2009.

5. Special depreciation allowance and expensing for qualified disaster assistance property (sec. 305 of the bill and secs. 168(n) and 179(e) of the Code)
Present Law
Special depreciation allowance
A taxpayer is allowed to recover, through annual depreciation deductions, the cost of certain property used in a trade or business or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year generally is determined under the modified accelerated cost recovery system (“MACRS”). 234 Under MACRS, different types of property generally are assigned applicable recovery periods and depreciation methods. The recovery periods applicable to most tangible personal property (generally tangible property other than residential rental property and nonresidential real property) range from 3 to 20 years. The depreciation methods generally applicable to tangible personal property are the 200-percent and 150-percent declining balance methods, switching to the straight-line method for the taxable year in which the depreciation deduction would be maximized.

Present law includes an additional first-year depreciation deduction equal to 50 percent of the adjusted basis of any “qualified disaster assistance property.” 235 The additional first-year depreciation deduction is allowed for both regular tax and alternative minimum tax purposes. The basis of the property and the depreciation allowances in the year of purchase and later years are appropriately adjusted to reflect the additional first-year depreciation deduction. In addition, there are no adjustments to the allowable amount of depreciation for purposes of computing a taxpayer's alternative minimum taxable income with respect to property to which the provision applies.

Qualified disaster assistance property means any property: (1) to which the general rules of the MACRS apply with (a) an applicable recovery period of 20 years or less, (b) computer software other than computer software covered by section 197, (c) water utility property (as defined in section 168(e)(5)), (d) certain leasehold improvement property, or (e) certain nonresidential real property and residential rental property; (2) substantially all of which is used in a disaster area with respect to a Federally declared disaster occurring before January 1, 2010, in the active conduct of a trade or business by the taxpayer in such disaster area; (3) which rehabilitates property damaged, or replaces property destroyed or condemned, as a result of the Federally declared disaster, except that property is treated as replacing property destroyed or condemned if, as part of an integrated plan, the property replaces property which is included in a continuous area which includes real property destroyed or condemned, and is similar in nature to, and located in the same county as, the property being rehabilitated or replaced; (4) the original use of the property in the disaster area commences with an eligible taxpayer (a taxpayer who has suffered an economic loss attributable to a Federally declared disaster) on or after the applicable disaster date (the date on which a Federally declared disaster occurs); (5) which is acquired by an eligible taxpayer by purchase (as defined under section 179(d)) by the taxpayer on or after the applicable disaster date (and no written binding contract for the acquisition was in effect before such date); and (6) which is placed in service by an eligible taxpayer on or before the date which is the last day of the third calendar year following the applicable disaster date (the fourth calendar year in the case of nonresidential real property and residential rental property). 236

Qualified disaster assistance property does not include any property: (1) to which the special allowance for depreciation under section 168(k) (regardless of any election under section 168(k)(4)), section 168(l) for cellulosic biofuel property, or section 168(m) for reuse and recycling property applies; (2) to which the special allowance for qualified Gulf Opportunity Zone property under section 1400N(d) applies; (3) used in connection with any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises, or any gambling or animal racing property (as defined in section 1400N(p)(3)(B)); (4) to which the alternative depreciation system under section 168(g) applies (determined without regard to the election to use such system under section 168(g)(7)); (5) any portion of which is financed with proceeds of any obligation the interest on which is exempt from tax under section 103; and (6) which is a qualified revitalization building with respect to which the taxpayer has made an election under section 1400I(a) to either expense one-half of qualified revitalization expenditures or recover such expenditures over 120 months. 237 A taxpayer may elect to not apply the rules of this provision with respect to any class of property for any taxable year.

The special rules of section 168(k)(2)(E) apply with modifications. For example, property that is manufactured, constructed, or produced by the taxpayer for use by the taxpayer qualifies if the taxpayer begins the manufacture, construction, or production of the property after the applicable disaster date, and which is placed in service by an eligible taxpayer on or before the date which is the last day of the third calendar year following the applicable disaster date (the fourth calendar year in the case of nonresidential real property and residential rental property). Property that is manufactured, constructed, or produced for the taxpayer by another person under a contract that is entered into prior to the manufacture, construction, or production of the property is considered to be manufactured, constructed, or produced by the taxpayer.

Recapture rules similar to section 179(d)(10) apply to any qualified disaster assistance property that ceases to be qualified disaster assistance property.

Section 179 expensing
A taxpayer that satisfies limitations on annual investment may elect under section 179 to deduct (or “expense”) the cost of qualifying property, rather than to recover such costs through depreciation deductions. 238 For taxable years beginning in 2009, the maximum amount that a taxpayer may expense is $250,000 of the cost of qualifying property placed in service for the taxable year. The $250,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $800,000. 239 For taxable years beginning in 2010, the maximum amount that a taxpayer may expense is $125,000 of the cost of qualifying property placed in service for the taxable year. The $125,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $500,000. The $125,000 and $500,000 amounts are indexed for inflation.

Qualified disaster assistance property is eligible for increased dollar limits on expensing under section 179. Specifically, the maximum amount that a taxpayer may expense is increased by the lesser of $100,000 or the cost of qualified section 179 disaster assistance property placed in service in the taxable year. The $800,000 limitation (for taxable years beginning in 2009) is increased by the lesser of $600,000 or the cost of qualified section 179 disaster assistance property placed in service during the taxable year. 240

Qualified section 179 disaster assistance property is depreciable tangible personal property that is purchased for use in the active conduct of a trade or business (not including off-the-shelf computer software) that meets the definition of qualified disaster assistance property. 241 Thus, the provision applies with respect to property placed in service in a disaster area with respect to a Federally declared disaster occurring before January 1, 2010.

Explanation of Provision
The provision extends for one year the special depreciation allowance and expensing provisions for qualified disaster assistance property (to apply to property placed in service in a disaster area with respect to a Federally declared disaster occurring before January 1, 2011).

Effective Date
The provision is effective for disasters occurring after December 31, 2009.

TITLE IV - ENERGY PROVISIONS
1. Incentives for biodiesel and renewable diesel (sec. 401 of the bill and sec. 40A of the Code)
Present Law
Biodiesel
The Code provides an income tax credit for biodiesel fuels (the “biodiesel fuels credit”). 242 The biodiesel fuels credit is the sum of three credits: (1) the biodiesel mixture credit, (2) the biodiesel credit, and (3) the small agri-biodiesel producer credit. The biodiesel fuels credit is treated as a general business credit. The amount of the biodiesel fuels credit is includable in gross income. The biodiesel fuels credit is coordinated to take into account benefits from the biodiesel excise tax credit and payment provisions discussed below. The credit does not apply to fuel sold or used after December 31, 2009.

Biodiesel is monoalkyl esters of long chain fatty acids derived from plant or animal matter that meet (1) the registration requirements established by the EPA under section 211 of the Clean Air Act (42 U.S.C. sec. 7545) and (2) the requirements of the American Society of Testing and Materials (“ASTM”) D6751. Agri-biodiesel is biodiesel derived solely from virgin oils including oils from corn, soybeans, sunflower seeds, cottonseeds, canola, crambe, rapeseeds, safflowers, flaxseeds, rice bran, mustard seeds, camelina, or animal fats.

Biodiesel may be taken into account for purposes of the credit only if the taxpayer obtains a certification (in such form and manner as prescribed by the Secretary) from the producer or importer of the biodiesel that identifies the product produced and the percentage of biodiesel and agri-biodiesel in the product.

Biodiesel mixture credit
The biodiesel mixture credit is $1.00 for each gallon of biodiesel (including agri-biodiesel) used by the taxpayer in the production of a qualified biodiesel mixture. A qualified biodiesel mixture is a mixture of biodiesel and diesel fuel that is (1) sold by the taxpayer producing such mixture to any person for use as a fuel, or (2) used as a fuel by the taxpayer producing such mixture. The sale or use must be in the trade or business of the taxpayer and is to be taken into account for the taxable year in which such sale or use occurs. No credit is allowed with respect to any casual off-farm production of a qualified biodiesel mixture.

Per IRS guidance a mixture need only contain 1/10th of one percent of diesel fuel to be a qualified mixture. 243 Thus, a qualified biodiesel mixture can contain 99.9 percent biodiesel and 0.1 percent diesel fuel.

Biodiesel credit (straight biodiesel)
The biodiesel credit is $1.00 for each gallon of biodiesel that is not in a mixture with diesel fuel (100 percent biodiesel or B-100) and which during the taxable year is (1) used by the taxpayer as a fuel in a trade or business or (2) sold by the taxpayer at retail to a person and placed in the fuel tank of such person's vehicle.

Small agri-biodiesel producer credit
The Code provides a small agri-biodiesel producer income tax credit, in addition to the biodiesel and biodiesel fuel mixture credits. The credit is a 10-cents-per-gallon credit for up to 15 million gallons of agri-biodiesel produced by small producers, defined generally as persons whose agri-biodiesel production capacity does not exceed 60 million gallons per year. The agri-biodiesel must (1) be sold by such producer to another person (a) for use by such other person in the production of a qualified biodiesel mixture in such person's trade or business (other than casual off-farm production), (b) for use by such other person as a fuel in a trade or business, or, (c) who sells such agri-biodiesel at retail to another person and places such agri-biodiesel in the fuel tank of such other person; or (2) used by the producer for any purpose described in (a), (b), or (c).

Biodiesel mixture excise tax credit
The Code also provides an excise tax credit for biodiesel mixtures. 244 The credit is $1.00 for each gallon of biodiesel used by the taxpayer in producing a biodiesel mixture for sale or use in a trade or business of the taxpayer. A biodiesel mixture is a mixture of biodiesel and diesel fuel that (1) is sold by the taxpayer producing such mixture to any person for use as a fuel or (2) is used as a fuel by the taxpayer producing such mixture. No credit is allowed unless the taxpayer obtains a certification (in such form and manner as prescribed by the Secretary) from the producer of the biodiesel that identifies the product produced and the percentage of biodiesel and agri-biodiesel in the product. 245

The credit is not available for any sale or use for any period after December 31, 2009. This excise tax credit is coordinated with the income tax credit for biodiesel such that credit for the same biodiesel cannot be claimed for both income and excise tax purposes.

Payments with respect to biodiesel fuel mixtures
If any person produces a biodiesel fuel mixture in such person's trade or business, the Secretary is to pay such person an amount equal to the biodiesel mixture credit. 246 The biodiesel fuel mixture credit must first be taken against tax liability for taxable fuels. To the extent the biodiesel fuel mixture credit exceeds such tax liability, the excess may be received as a payment. Thus, if the person has no section 4081 liability, the credit is refundable. The Secretary is not required to make payments with respect to biodiesel fuel mixtures sold or used after December 31, 2009.

Renewable diesel
“Renewable diesel” is liquid fuel that (1) is derived from biomass (as defined in section 45K(c)(3)), (2) meets the registration requirements for fuels and fuel additives established by the EPA under section 211 of the Clean Air Act, and (3) meets the requirements of the ASTM D975 or D396, or equivalent standard established by the Secretary. ASTM D975 provides standards for diesel fuel suitable for use in diesel engines. ASTM D396 provides standards for fuel oil intended for use in fuel-oil burning equipment, such as furnaces. Renewable diesel also includes fuel derived from biomass that meets the requirements of a Department of Defense specification for military jet fuel or an ASTM for aviation turbine fuel.

For purposes of the Code, renewable diesel is generally treated the same as biodiesel. In the case of renewable diesel that is aviation fuel, kerosene is treated as though it were diesel fuel for purposes of a qualified renewable diesel mixture. Like biodiesel, the incentive may be taken as an income tax credit, an excise tax credit, or as a payment from the Secretary. 247 The incentive for renewable diesel is $1.00 per gallon. There is no small producer credit for renewable diesel. The incentives for renewable diesel expire after December 31, 2009.

Explanation of Provision
The provision extends the income tax, excise tax and payment provisions for biodiesel and renewable diesel for one additional year (through December 31, 2010).

Effective Date
The provision is effective for sales and uses after December 31, 2009.

2. Alternative motor vehicle credit for heavy hybrids (sec. 402 of the bill and sec. 30B of the Code)
Present Law
In general
A credit is available for each new qualified fuel cell vehicle, hybrid vehicle, advanced lean burn technology vehicle, and alternative fuel vehicle placed in service by the taxpayer during the taxable year. 248 In general, the credit amount varies depending upon the type of technology used, the weight class of the vehicle, the amount by which the vehicle exceeds certain fuel economy standards, and, for some vehicles, the estimated lifetime fuel savings. The credit generally is available for vehicles purchased after 2005. The credit terminates after 2009, 2010, or 2014, depending on the type of vehicle.

In general, the credit is allowed to the vehicle owner, including the lessor of a vehicle subject to a lease. If the use of the vehicle is described in paragraphs (3) or (4) of section 50(b) (relating to use by tax-exempt organizations, governments, and foreign persons) and is not subject to a lease, the seller of the vehicle may claim the credit so long as the seller clearly discloses to the user in a document the amount that is allowable as a credit. A vehicle must be used predominantly in the United States to qualify for the credit. The portion of the credit attributable to vehicles of a character subject to an allowance for depreciation is treated as a portion of the general business credit.

Hybrid vehicles
Qualified hybrid vehicles
A qualified hybrid vehicle is a motor vehicle that draws propulsion energy from on-board sources of stored energy that include both an internal combustion engine or heat engine using combustible fuel and a rechargeable energy storage system (e.g., batteries). A qualified hybrid vehicle must be placed in service before January 1, 2011 (January 1, 2010 in the case of a hybrid vehicle weighing more than 8,500 pounds).

Hybrid vehicles that are automobiles and light trucks
In the case of an automobile or light truck (vehicles weighing 8,500 pounds or less), the amount of credit for the purchase of a hybrid vehicle is the sum of two components: (1) a fuel economy credit amount that varies with the rated fuel economy of the vehicle compared to a 2002 model year standard (the “base fuel economy”) and (2) a conservation credit based on the estimated lifetime fuel savings of the qualified vehicle compared to a comparable 2002 model year vehicle that is powered solely by a gasoline or diesel internal combustion engine. A qualified hybrid automobile or light truck must have a maximum available power 249 from the rechargeable energy storage system of at least four percent. In addition, the vehicle must meet or exceed certain Environmental Protection Agency (“EPA”) emissions standards. For a vehicle with a gross vehicle weight rating of 6,000 pounds or less, the applicable emissions standards are the Bin 5 Tier II emissions standards. For a vehicle with a gross vehicle weight rating greater than 6,000 pounds and less than or equal to 8,500 pounds, the applicable emissions standards are the Bin 8 Tier II emissions standards.

Table 2, below, shows the fuel economy credit available to a hybrid passenger automobile or light truck whose fuel economy (on a gasoline gallon equivalent basis) exceeds that of the base fuel economy.

Table 2.—Fuel Economy Credit

If Fuel Economy of the Hybrid Vehicle Is:



Credit
at least
but less than


$400
125% of base fuel economy
150% of base fuel economy


$800
150% of base fuel economy
175% of base fuel economy


$1,200
175% of base fuel economy
200% of base fuel economy


$1,600
200% of base fuel economy
225% of base fuel economy


$2,000
225% of base fuel economy
250% of base fuel economy


$2,400
250% of base fuel economy



Table 3, below, shows the conservation credit.

Table 3.—Conservation Credit
Estimated Lifetime Fuel Savings (gallons of gasoline)
Conservation Amount


At least 1,200 but less than 1,800
$250


At least 1,800 but less than 2,400
$500


At least 2,400 but less than 3,000
$750


At least 3,000
$1,000



Limitation on number of qualified hybrid and advanced lean burn technology vehicles eligible for the credit
There is a limitation on the number of passenger and light truck qualified hybrid vehicles and advanced lean burn technology vehicles 250 sold by each manufacturer of such vehicles that are eligible for the credit. Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter after the quarter in which the manufacturer records the 60,000th hybrid and advanced lean burn technology vehicle sale occurring after December 31, 2005. Taxpayers may claim one half of the otherwise allowable credit during the two calendar quarters subsequent to the first quarter after the manufacturer has recorded its 60,000th such sale. In the third and fourth calendar quarters subsequent to the first quarter after the manufacturer has recorded its 60,000th such sale, the taxpayer may claim one quarter of the otherwise allowable credit.

Thus, for example, summing the sales of qualified hybrid vehicles that are passenger vehicles or light trucks and all sales of qualified advanced lean burn technology vehicles, if a manufacturer records the sale of its 60,000th qualified vehicle in February of 2007, taxpayers purchasing such vehicles from the manufacturer may claim the full amount of the credit on their purchases of qualified vehicles through June 30, 2007. For the period July 1, 2007, through December 31, 2007, taxpayers may claim one half of the otherwise allowable credit on purchases of qualified vehicles of the manufacturer. For the period January 1, 2008, through June 30, 2008, taxpayers may claim one quarter of the otherwise allowable credit on the purchases of qualified vehicles of the manufacturer. After June 30, 2008, no credit may be claimed for purchases of such hybrid vehicles or advanced lean burn technology vehicles sold by the manufacturer.

Hybrid vehicles that are medium and heavy trucks
In the case of a qualified hybrid vehicle weighing more than 8,500 pounds, the amount of credit is determined by the estimated increase in fuel economy and the incremental cost of the hybrid vehicle compared to a comparable vehicle powered solely by a gasoline or diesel internal combustion engine and that is comparable in weight, size, and use of the vehicle. For a vehicle that achieves a fuel economy increase of at least 30 percent but less than 40 percent, the credit is equal to 20 percent of the incremental cost of the hybrid vehicle. For a vehicle that achieves a fuel economy increase of at least 40 percent but less than 50 percent, the credit is equal to 30 percent of the incremental cost of the hybrid vehicle. For a vehicle that achieves a fuel economy increase of 50 percent or more, the credit is equal to 40 percent of the incremental cost of the hybrid vehicle.

The credit is subject to certain maximum applicable incremental cost amounts. For a qualified hybrid vehicle weighing more than 8,500 pounds but not more than 14,000 pounds, the maximum allowable incremental cost amount is $7,500. For a qualified hybrid vehicle weighing more than 14,000 pounds but not more than 26,000 pounds, the maximum allowable incremental cost amount is $15,000. For a qualified hybrid vehicle weighing more than 26,000 pounds, the maximum allowable incremental cost amount is $30,000.

A qualified hybrid vehicle weighing more than 8,500 pounds but not more than 14,000 pounds must have a maximum available power from the rechargeable energy storage system of at least 10 percent. A qualified hybrid vehicle weighing more than 14,000 pounds must have a maximum available power from the rechargeable energy storage system of at least 15 percent. 251

Base fuel economy
The base fuel economy is the 2002 model year city fuel economy by vehicle type and vehicle inertia weight class. For this purpose, “vehicle inertia weight class” has the same meaning as when defined in regulations prescribed by the EPA for purposes of Title II of the Clean Air Act. Table 4, below, shows the 2002 model year city fuel economy for vehicles by type and by inertia weight class.

Table 4.—2002 Model Year City Fuel Economy
Vehicle Inertia Weight Class (pounds)
Passenger Automobile (miles per gallon)
Light Truck (miles per gallon)


1,500
45.2
39.4


1,750
45.2
39.4


2,000
39.6
35.2


2,250
35.2
31.8


2,500
31.7
29.0


2,750
28.8
26.8


3,000
26.4
24.9


3,500
22.6
21.8


4,000
19.8
19.4


4,500
17.6
17.6


5,000
15.9
16.1


5,500
14.4
14.8


6,000
13.2
13.7


6,500
12.2
12.8


7,000
11.3
12.1


8,500
11.3
12.1



Explanation of Provision
The provision extends for one year the credit available to hybrid vehicles that are medium and heavy trucks.

Effective Date
The provision is effective for property purchased after December 31, 2009.

3. Alternative fuel credits for natural gas and liquefied petroleum gas (sec. 403 of the bill and secs. 6426 and 6427(e) of the Code)
Present Law
The Code provides two per-gallon excise tax credits with respect to alternative fuel, the alternative fuel credit, and the alternative fuel mixture credit. For this purpose, the term “alternative fuel” means liquefied petroleum gas, P Series fuels (as defined by the Secretary of Energy under 42 U.S.C. sec. 13211(2)), compressed or liquefied natural gas, liquefied hydrogen, liquid fuel derived from coal through the Fischer-Tropsch process (“coal-to-liquids”), compressed or liquified gas derived from biomass, or liquid fuel derived from biomass. Such term does not include ethanol, methanol, or biodiesel.

For coal-to-liquids produced after September 30, 2009 through December 30, 2009, the fuel must be certified as having been derived from coal produced at a gasification facility that separates and sequesters 50 percent of such facility's total carbon dioxide emissions. The sequestration percentage increases to 75 percent for fuel produced after December 30, 2009.

The alternative fuel credit is allowed against section 4041 liability, and the alternative fuel mixture credit is allowed against section 4081 liability. Neither credit is allowed unless the taxpayer is registered with the Secretary. The alternative fuel credit is 50 cents per gallon of alternative fuel or gasoline gallon equivalents 252 of nonliquid alternative fuel sold by the taxpayer for use as a motor fuel in a motor vehicle or motorboat, sold for use in aviation or so used by the taxpayer.

The alternative fuel mixture credit is 50 cents per gallon of alternative fuel used in producing an alternative fuel mixture for sale or use in a trade or business of the taxpayer. An “alternative fuel mixture” is a mixture of alternative fuel and taxable fuel that contains at least 1/10 of one percent taxable fuel. The mixture must be sold by the taxpayer producing such mixture to any person for use as a fuel, or used by the taxpayer producing the mixture as a fuel. The credits generally expire after December 31, 2009 (September 30, 2014 for liquefied hydrogen).

A person may file a claim for payment equal to the amount of the alternative fuel credit and alternative fuel mixture credits. These payment provisions generally also expire after December 31, 2009. With respect to liquefied hydrogen, the payment provisions expire after September 30, 2014. The alternative fuel credit and alternative fuel mixture credit must first be applied to excise tax liability for special and alternative fuels, and any excess credit may be taken as a payment.

Explanation of Provision
The provision extends the alternative fuel credit and payment provisions for compressed and liquefied natural gas, and liquefied petroleum gas (other than liquefied petroleum gas for use in forklifts) for one additional year (through December 31, 2010).

Effective Date
The provision is effective for fuel sold or used after December 31, 2009.

4. Special rule to implement FERC and State electric restructuring policy (sec. 404 of the bill and sec. 451(i) of the Code)
Present Law
A taxpayer selling property generally recognizes gain to the extent the sales price (and any other consideration received) exceeds the seller's basis in the property. The recognized gain is subject to current income tax unless the gain is deferred or not recognized under a special tax provision.

One such special tax provision permits taxpayers to elect to recognize gain from qualifying electric transmission transactions ratably over an eight-year period beginning in the year of sale if the amount realized from such sale is used to purchase exempt utility property within the applicable period 253 (the “reinvestment property”). 254 If the amount realized exceeds the amount used to purchase reinvestment property, any realized gain is recognized to the extent of such excess in the year of the qualifying electric transmission transaction.

A qualifying electric transmission transaction is the sale or other disposition of property used by a qualified electric utility to an independent transmission company prior to January 1, 2010. A qualified electric utility is defined as an electric utility, which as of the date of the qualifying electric transmission transaction, is vertically integrated in that it is both (1) a transmitting utility (as defined in the Federal Power Act) 255 with respect to the transmission facilities to which the election applies, and (2) an electric utility (as defined in the Federal Power Act). 256

In general, an independent transmission company is defined as: (1) an independent transmission provider 257 approved by the Federal Energy Regulatory Commission (“FERC”); (2) a person (i) who the FERC determines under section 203 of the Federal Power Act (or by declaratory order) is not a “market participant” and (ii) whose transmission facilities are placed under the operational control of a FERC-approved independent transmission provider no later than four years after the close of the taxable year in which the transaction occurs; or (3) in the case of facilities subject to the jurisdiction of the Public Utility Commission of Texas, (i) a person which is approved by that Commission as consistent with Texas State law regarding an independent transmission organization, or (ii) a political subdivision, or affiliate thereof, whose transmission facilities are under the operational control of an organization described in (i).

Exempt utility property is defined as: (1) property used in the trade or business of generating, transmitting, distributing, or selling electricity or producing, transmitting, distributing, or selling natural gas, or (2) stock in a controlled corporation whose principal trade or business consists of the activities described in (1). Exempt utility property does not include any property that is located outside of the United States.

If a taxpayer is a member of an affiliated group of corporations filing a consolidated return, the reinvestment property may be purchased by any member of the affiliated group (in lieu of the taxpayer).

Explanation of Provision
The provision extends the treatment under the present-law deferral provision to sales or dispositions by a qualified electric utility prior to January 1, 2011.

Effective Date
The extension provision applies to dispositions after December 31, 2009.

TITLE V - FOREIGN ACCOUNT TAX COMPLIANCE
A. Increase Disclosure of Beneficial Owners
1. Reporting on certain foreign accounts (sec. 501 of the bill and new secs. 1471, 1472, 1473, and 1474 of the Code, and sec. 6611 of the Code)
Present Law
Withholding on payments to foreign persons
Payments of U.S.-source fixed or determinable annual or periodical (“FDAP”) income, including interest, dividends, and similar types of investment income, that are made to foreign persons are subject to U.S. withholding tax at a 30-percent rate, unless the withholding agent can establish that the beneficial owner of the amount is eligible for an exemption from withholding or a reduced rate of withholding under an income tax treaty. 258 The term “FDAP income” includes all items of gross income, except gains on sales of property (including market discount on bonds and option premiums) and insurance premiums paid to a foreign insurer or reinsurer. 259

Interest is derived from U.S. sources if it is paid by the United States or any agency or instrumentality thereof, a State or any political subdivision thereof, or the District of Columbia. Interest is also from U.S. sources if it is paid by a resident or a domestic corporation on a bond, note, or other interest-bearing obligation. 260 Dividend income is sourced by reference to the payor's place of incorporation. 261 Thus, dividends paid by a domestic corporation are generally treated as entirely U.S.-source income. Similarly, dividends paid by a foreign corporation are generally treated as entirely foreign-source income. Rental income is sourced by reference to the location or place of use of the leased property. 262 The nationality or the country of residence of the lessor or lessee does not affect the source of rental income. Rental income from property located or used in the United States (or from any interest in such property) is U.S.-source income, regardless of whether the property is real or personal, intangible or tangible. Royalties are sourced in the place of use (or the privilege of use) of the property for which the royalties are paid. 263 This source rule applies to royalties for the use of either tangible or intangible property, including patents, copyrights, secret processes, formulas, goodwill, trademarks, trade names, and franchises.

The principal statutory exemptions from the 30-percent withholding tax apply to interest on bank deposits, portfolio interest, and capital gains. Since 1984, the United States has not imposed withholding tax on portfolio interest received by a nonresident individual or foreign corporation from sources within the United States. 264 Portfolio interest includes, generally, any interest (including original issue discount) other than interest received by a 10-percent shareholder, 265 certain contingent interest, 266 interest received by a controlled foreign corporation from a related person, 267 and interest received by a bank on an extension of credit made pursuant to a loan agreement entered into in the ordinary course of its trade or business. 268

In the case of interest paid on a debt obligation that is in registered form, 269 the portfolio interest exemption is available only to the extent that the U.S. person otherwise required to withhold tax (the “withholding agent”) has received a statement made by the beneficial owner of the obligation (or a securities clearing organization, bank, or other financial institution that holds customers' securities in the ordinary course of its trade or business) that the beneficial owner is not a U.S. person. 270

Interest on deposits with foreign branches of domestic banks and domestic savings and loan associations is not treated as U.S.-source income and is thus exempt from U.S. withholding tax (regardless of whether the recipient is a U.S. or foreign person). 271 In addition, interest on bank deposits, deposits with domestic savings and loan associations, and certain amounts held by insurance companies are not subject to the U.S. withholding tax when paid to a foreign person, unless the interest is effectively connected with a U.S. trade or business of the recipient. 272 Similarly, interest and original issue discount on certain short-term obligations is also exempt from U.S. withholding tax when paid to a foreign person. 273 Consequently, there is no information reporting with respect to payments of such amounts. 274

Gains derived from the sale of property by a nonresident alien individual or foreign corporation generally are exempt from U.S. tax, unless they are or are treated as effectively connected with the conduct of a U.S. trade or business. Gains derived by a nonresident alien individual generally are subject to U.S. taxation only if the individual is present in the United States for 183 days or more during the taxable year. 275 Foreign corporations are subject to tax with respect to certain gains on disposal of timber, coal, or domestic iron ore and certain gains from contingent payments made in connection with sales or exchanges of patents, copyrights, goodwill, trademarks, and similar intangible property. 276 Gain from the disposition of certain U.S. real property interests (which include interests in U.S. real property holding corporations) are treated as effectively connected with a U.S. trade or business. 277 Special rules apply in the case of interests in real estate investment trusts or regulated investment companies that may hold, or interests in which may be treated, as U.S. real property interests. 278 Most capital gains realized by foreign investors on the sale of portfolio investment securities thus are exempt from U.S. taxation.

The 30-percent withholding tax may be reduced or eliminated by a tax treaty between the United States and the country in which the recipient of income otherwise subject to withholding is resident. Thus, most U.S. income tax treaties provide a zero rate of withholding tax on interest payments (other than certain interest the amount of which is determined by reference to certain income items or other amounts of the debtor or a related person). Most U.S. income tax treaties also reduce the rate of withholding on dividends to 15 percent (in the case of portfolio dividends) and to five percent (in the case of “direct investment” dividends paid to a 10 percent-or-greater shareholder). 279 For royalties, the U.S. withholding rate is typically reduced to five percent or to zero. In each case, the reduced withholding rate is available only to a beneficial owner who qualifies as a resident of the treaty country within the meaning of the treaty and otherwise satisfies any applicable limitation on benefits provisions of the treaty.

Refund or credits of taxes withheld from foreign persons
A withholding agent that makes payments of U.S.-source amounts to a foreign person is required to report those payments, including any amounts of U.S. tax withheld, to the IRS on IRS Forms 1042 and 1042-S by March 15 of the calendar year following the year in which the payment is made. 280 To the extent that the withholding agent deducts and withholds an amount, the withheld tax is credited to the recipient of the income. 281 If the agent withholds more than is required, and results in an overpayment of tax, the excess may be refunded to the recipient of the income upon filing of a timely claim for refund.

Payment of tax
The date an amount is paid is relevant for determining the limitations period in which to claim a refund, the amount of refund available, 282 and the period for which interest may accrue on any overpayment. 283 An amount that is withheld, paid or credited as an estimate or deposit of tax generally does not count as the payment of tax until applied to a specific tax liability. To the extent that amounts previously withheld, paid or credited as an estimate or deposit of tax are applied to the tax liability for a year, they are deemed to have been paid as of the last day prescribed for payment of the tax, for both the recipient of the income 284 and the withholding agent. 285 Amounts that are refunded, credited to other periods, or offset against other liabilities are not considered as paid for this purpose. 286 Any amount that was previously paid but has been credited to a later year is considered credited on the last day prescribed for the payment of tax. 287

Interest on overpayments
The IRS is generally required to pay interest to a taxpayer whenever there is an overpayment of tax. 288 An overpayment of tax exists whenever more than the correct amount of tax is paid as of the last date prescribed for the payment of the tax. The last date prescribed for the payment of the income tax is the original due date of the return. 289 However, no interest is required to be paid by the IRS if it refunds or credits the amount due with 45 days of the filing of the return. 290 Notwithstanding these general rules, if a required return on which the payment should have been reported is either not filed, or is filed late, no interest on the overpayment accrues for any period prior to the filing of the return. 291

Different interest rates are provided for the payment of interest depending upon the type of taxpayer, whether the interest relates to an underpayment or overpayment, and the size of the underpayment or overpayment. Interest on both underpayments and overpayments is compounded daily. 292 A special net interest rate of zero applies in situations where interest is both payable and allowable on offsetting amounts of overpayment and underpayment. 293 For individuals, interest on both underpayments and overpayments accrues at a rate equal to the short term applicable Federal rate (AFR) plus three percentage points. 294 Interest on corporate overpayments generally accrues at a rate equal to the short term AFR plus two percentage points, unless the overpayment exceeds $10,000 in which case interest accrues at a rate equal to the short term AFR plus one-half percentage point.

Period of overpayment
If the overpayment is to be refunded to the taxpayer, interest accrues on the overpayment from the later of the due date of the return or the date the payment is made until a date that is not less than 45 days 295 before the date of the refund check. If the overpayment is to be credited or offset against some other liability, interest will accrue until the date it is so credited or offset.

A payment is not considered made by the taxpayer earlier than the time the taxpayer files a return showing the liability. In MNOPF Trustees, Ltd. V. United States, 296 the Federal Circuit held that overpayment interest accrued on the taxes unnecessarily withheld from the date that the withholdings were paid to the Service, because MNOPF was a tax-exempt organization, and, therefore, was not required to file tax returns. As a result, the court rejected arguments by the government that interest commenced no earlier than the filing of the refund claims. The court reasoned that sections 6611(d) and 6513(b)(3) did not apply because those sections only relate to taxable income and the taxpayer was exempt from federal taxation. Instead, the court held that the organization's overpayment was deemed paid, pursuant to section 6611(b)(2), on the date the withholding agent filed the returns reporting the withheld taxes.

No interest accrues on an overpayment if the IRS makes the refund within 45 days of the later of the filing or the due date of the return showing the refund. If the IRS fails to make the refund within such 45-day period, interest is required to be paid for the entire period of the overpayment. For example, an individual taxpayer files his return on April 15th, properly showing a refund due of $10,000. If the IRS pays the refund within 45 days, no interest on the overpayment will be required. However, if the IRS does not pay the refund until the 46th day, interest will be required from April 15th.

Certification of foreign status and reporting by U.S. withholding agents
The U.S. withholding tax rules are administered through a system of self-certification. Thus, a nonresident investor seeking to obtain withholding tax relief for U.S.-source investment income typically must provide a certification, on Internal Revenue Service (“IRS”) Form W-8 to the withholding agent in order to establish foreign status and eligibility for an exemption or reduced rate. Provision of the IRS Form W-8 also establishes an exemption from the rules that apply to many U.S. persons governing information reporting on IRS Form 1099 and backup withholding (discussed below). 297

There are four relevant types of IRS Forms W-8. 298 Three of these forms are designed to be provided to the withholding agent by the beneficial owner of a payment of U.S.-source income: 299 (1) the IRS Form W-8BEN, which is provided by a beneficial owner of U.S.-source non-effectively-connected income; (2) the IRS Form W-8ECI, which is provided by a beneficial owner of U.S.-source effectively-connected income; 300 and (3) the IRS Form W-8EXP, which is provided by a beneficial owner of U.S.-source income that is an exempt organization or foreign government. 301 Each of these forms requires that the beneficial owner provide its name and address and certify that the beneficial owner is not a U.S. person. The IRS Form W-8BEN also includes a certification of eligibility for treaty benefits (for completion where applicable). All certifications on IRS Forms W-8 are made under penalties of perjury.

The fourth type of IRS Form W-8 is the IRS Form W-8IMY, which is provided by a payee that receives a payment of U.S.-source income as an intermediary for the beneficial owner of that income. The intermediary's IRS Form W-8IMY must be accompanied by an IRS Form W-8BEN, W-8EXP, or W-8ECI, as applicable, 302 furnished by the beneficial owner, unless the intermediary is a qualified intermediary (“QI”), a withholding foreign partnership, or a withholding foreign trust. The rules applicable to qualified intermediaries are discussed below. A withholding foreign partnership or trust is a foreign partnership or trust that has entered into an agreement with the IRS to collect appropriate IRS Forms W-8 from its partners or beneficiaries and act as a U.S. withholding agent with respect to those persons. 303

Information reporting and backup withholding with respect to U.S. persons
Every person engaged in a trade or business must file with the IRS an information return on IRS Form 1099 (or, for wages or other compensation, on IRS Form W-2) for payments of certain amounts totaling at least $600 that it makes to another person in the course of its trade or business. 304 Detailed rules are provided for the reporting of various types of investment income, including interest, dividends, and gross proceeds from brokered transactions (such as a sale of stock). 305 In general, the requirement to file IRS Form 1099 applies with respect to amounts paid to U.S. persons and is linked to the backup withholding rules of section 3406. Thus, to avoid backup withholding, a U.S. payee (other than exempt recipients, including corporations and financial institutions) of interest, dividends, or gross proceeds generally must furnish to the payor an IRS Form W-9 providing that person's name and taxpayer identification number. 306 That information is then used to complete the IRS Form 1099.

If an IRS Form W-9 is not provided by a U.S. payee (other than payees exempt from reporting), the payor is required to impose a backup withholding tax of 28 percent of the gross amount of the payment. 307 The backup withholding tax may be credited by the payee against regular income tax liability. 308 This combination of reporting and backup withholding is designed to ensure that U.S. persons not exempt from reporting pay tax with respect to investment income, either by providing the IRS with the information that it needs to audit payment of the tax or, in the absence of such information, requiring collection of the tax on payment.

As described above, amounts paid to foreign persons are generally exempt from information reporting on IRS Form 1099. Foreign persons are subject to a separate information reporting requirement linked to the nonresident withholding provisions of chapter 3 of the Code.

In the case of U.S. source investment income, the information reporting, backup withholding and nonresident withholding rules apply broadly to any financial institution or other payor, including foreign financial institutions. 309 As a practical matter, however, these reporting and withholding requirements are difficult to enforce with respect to foreign financial institutions, unless these institutions have some connection to the United States, e.g., the institution is a foreign subsidiary of a U.S. financial institution, or the foreign financial institution is doing business in the United States. Moreover, to the extent that these rules apply to foreign financial institutions, the rules may also be modified by QI agreements between the institutions and the IRS, as described below.

The qualified intermediary program
A QI is defined as a foreign financial institution or a foreign clearing organization, other than a U.S. branch or U.S. office of such institution or organization or a foreign branch of a U.S. financial institution that has entered into a withholding and reporting agreement (a “QI agreement”) with the IRS. 310

A foreign financial institution that becomes a QI is not required to forward beneficial ownership information with respect to its customers to a U.S. financial institution or other withholding agent of U.S.-source investment-type income to establish the customer's eligibility for an exemption from, or reduced rate of, U.S. withholding tax. 311 Instead, the QI is permitted to establish for itself the eligibility of its customers for an exemption or reduced rate, based on an IRS Form W-8 or W-9, or other specified documentary evidence, and information as to residence obtained under the know-your-customer rules to which the QI is subject in its home jurisdiction as approved by the IRS or as specified in the QI agreement. 312 The QI certifies as to eligibility on behalf of its customers, and provides withholding rate pool information to the U.S. withholding agent as to the portion of each payment that qualifies for an exemption or reduced rate of withholding.

The IRS has published a model QI agreement for foreign financial institutions. 313 A prospective QI must submit an application to the IRS providing specified information, and any additional information and documentation requested by the IRS. The application must establish to the IRS's satisfaction that the applicant has adequate resources and procedures to comply with the terms of the QI agreement.

Before entering into a QI agreement that provides for the use of documentary evidence obtained under a country's know-your-customer rules, the IRS must receive (1) that country's know-your-customer practices and procedures for opening accounts and (2) responses to 18 related items. 314 If the IRS has already received this information, a particular prospective QI need not submit it again. The IRS has received such information and has approved know-your-customer rules in 59 countries.

A foreign financial institution or other eligible person becomes a QI by entering into an agreement with the IRS. Under the agreement, the financial institution acts as a QI only for accounts that the financial institution has designated as QI accounts. A QI is not required to act as a QI for all of its accounts; however, if a QI designates an account as one for which it will act as a QI, it must act as a QI for all payments made to that account.

The model QI agreement describes in detail the QI's withholding and reporting obligations. Certain key aspects of the model agreement are described below. 315

Withholding and reporting responsibilities
As a technical matter, all QIs are withholding agents for purposes of the nonresident withholding and reporting rules, and payors (who are required to withhold and report) for purposes of the backup withholding and IRS Form 1099 information reporting rules. However, under the QI agreement, a QI may choose not to assume primary responsibility for nonresident withholding. In that case, the QI is not required to withhold on payments made to non-U.S. customers, or to report those payments on IRS Form 1042-S. Instead, the QI must provide a U.S. withholding agent with an IRS Form W-8IMY that certifies as to the status of its (unnamed) non-U.S. account holders and withholding rate pool information.

Similarly, a QI may choose not to assume primary responsibility for IRS Form 1099 reporting and backup withholding. In that case, the QI is not required to backup withhold on payments made to U.S. customers or to file IRS Forms 1099. Instead, the QI must provide a U.S. payor with an IRS Form W-9 for each of its U.S. non-exempt recipient account holders (i.e., account holders that are U.S. persons not generally exempt from IRS Form 1099 reporting and backup withholding). 316

A QI may elect to assume primary nonresident withholding and reporting responsibility, primary backup withholding and IRS Form 1099 reporting responsibility, or both. 317 A QI that assumes such responsibility is subject to all of the related obligations imposed by the Code on U.S. withholding agents or payors. The QI must also provide the U.S. withholding agent (or U.S. payor) additional information about the withholding rates to enable the withholding agent to appropriately withhold and report on payments made through the QI. These rates can be supplied with respect to withholding rate pools that aggregate payments of a single type of income (e.g., interest or dividends) that is subject to a single rate of withholding.

If a U.S. non-exempt recipient has not provided a IRS Form W-9, the QI must disclose the name, address, and taxpayer identification number (“TIN”) (if available) to the withholding agent (and the withholding agent must apply backup withholding). However, no such disclosure is necessary if the QI is, under local law, prohibited from making the disclosure and the QI has followed certain procedural requirements (including providing for backup withholding, as described further below).

Documentation of account holders
A QI agrees to use its best efforts to obtain documentation regarding the status of their account holders in accordance with the terms of its QI agreement. 318 A QI must apply presumption rules 319 unless a payment can be reliably associated with valid documentation from the account holder. The QI agrees to adhere to the know-your-customer rules set forth in the QI agreement with respect to the account holder from whom the evidence is obtained.

A QI may treat an account holder as a foreign beneficial owner of an amount if the account holder provides a valid IRS Form W-8 (other than an IRS Form W-8IMY) or valid documentary evidence that supports the account holder's status as a foreign person. 320 With such documentation, a QI generally may treat an account holder as entitled to a reduced rate of withholding if all the requirements for the reduced rate are met and the documentation supports entitlement to a reduced rate. A QI may not reduce the rate of withholding if the QI knows that the account holder is not the beneficial owner of a payment to the account.

If a foreign account holder is the beneficial owner of a payment, then a QI may shield the account holder's identity from U.S. custodians and the IRS. If a foreign account holder is not the beneficial owner of a payment (for example, because the account holder is a nominee), the account holder must provide the QI with an IRS Form W-8IMY for itself along with specific information about each beneficial owner to which the payment relates. A QI that receives this information may shield the account holder's identity from a U.S. custodian, but not from the IRS. 321

In general, if an account holder is a U.S. person, the account holder must provide the QI with an IRS Form W-9 or appropriate documentary evidence that supports the account holder's status as a U.S. person. However, if a QI does not have sufficient documentation to determine whether an account holder is a U.S. or foreign person, the QI must apply certain presumption rules detailed in the QI agreement. These presumption rules may not be used to grant a reduced rate of nonresident withholding; instead they merely determine whether a payment should be subject to full nonresident withholding (at a 30-percent rate), subject to backup withholding (at a 28-percent rate), or treated as exempt from backup withholding.

In general, under the QI agreement presumptions, U.S.-source investment income that is paid outside the United States to an offshore account is presumed to be paid to an undocumented foreign account holder. A QI must treat such a payment as subject to withholding at a 30-percent rate and report the payment to an unknown account holder on IRS Form 1042-S. However, most U.S.-source deposit interest and interest or original issue discount on short-term obligations that is paid outside the United States to an offshore account is presumed made to an undocumented U.S. non-exempt recipient account holder and thus is subject to backup withholding at a 28-percent rate. 322 Importantly, both foreign-source income and broker proceeds are presumed to be paid to a U.S. exempt recipient (and thus are exempt from both nonresident and backup withholding) when such amounts are paid outside the United States to an offshore account.

QI information return requirements
A QI must file IRS Form 1042 by March 15 of the year following any calendar year in which the QI acts as a QI. A QI is not required to file IRS Forms 1042-S for amounts paid to each separate account holder, but instead files a separate IRS Form 1042-S for each type of reporting pool. 323 A QI must file separate IRS Forms 1042-S for amounts paid to certain types of account holders, including: (1) other QIs which receive amounts subject to foreign withholding; (2) each foreign account holder of a nonqualified intermediary or other flow-through entity to the extent that the QI can reliably associate such amounts with valid documentation; and (3) unknown recipients of amounts subject to withholding paid through a nonqualified intermediary or other flow-through entity to the extent the QI cannot reliably associate such amounts with valid documentation. The IRS Form 1042 must also include an attachment setting forth the aggregate amounts of reportable payments paid to U.S. non-exempt recipient account holders, and the number of such account holders, whose identity is prohibited by foreign law (including by contract) from disclosure. 324

A QI has specified IRS Form 1099 325 filing requirements including: (1) filing an aggregate IRS Form 1099 for each type of reportable amount paid to U.S. non-exempt recipient account holders whose identities are prohibited by law from being disclosed; (2) filing an aggregate IRS Form 1099 for reportable payments other than reportable amounts 326 paid to U.S. non-exempt recipient account holders whose identities are prohibited by law from being disclosed; (3) filing separate IRS Forms 1099 for reportable amounts paid to U.S. non-exempt recipient account holders for whom the QI has not provided an IRS Form W-9 or identifying information to a withholding agent; (4) filing separate IRS Forms 1099 for reportable payments other than reportable amounts paid to U.S. non-exempt recipient account holders; (5) filing separate IRS Forms 1099 for reportable amounts paid to U.S. non-exempt recipient accounts holders for which the QI has assumed primary IRS Form 1099 reporting and backup withholding responsibility; and (6) filing separate IRS Forms 1099 for reportable payments to an account holder that is a U.S. person if the QI has applied backup withholding and the amount was not otherwise reported on an IRS Form 1099.

Foreign law prohibition of disclosure
The QI agreement includes procedures to address situations in which foreign law (including by contract) prohibits the QI from disclosing the identities of U.S. non-exempt recipients (such as individuals). Separate procedures are provided for accounts established with a QI prior to January 1, 2001, and for accounts established on or after January 1, 2001.

Accounts established prior to January 1, 2001 .-For accounts established prior to January 1, 2001, if the QI knows that the account holder is a U.S. non-exempt recipient, the QI must (1) request from the account holder the authority to disclose its name, address, TIN (if available), and reportable payments; (2) request from the account holder the authority to sell any assets that generate, or could generate, reportable payments; or (3) request that the account holder disclose itself by mandating the QI to provide an IRS Form W-9 completed by the account holder. The QI must make these requests at least two times during each calendar year and in a manner consistent with the QI's normal communications with the account holder (or at the time and in the manner that the QI is authorized to communicate with the account holder). Until the QI receives a waiver on all prohibitions against disclosure, authorization to sell all assets that generate, or could generate, reportable payments, or a mandate from the account holder to provide an IRS Form W-9, the QI must backup withhold on all reportable payments paid to the account holder and report those payments on IRS Form 1099 or, in certain cases, provide another withholding agent with all of the information required for that withholding agent to backup withhold and report the payments on IRS Form 1099.

Accounts established on or after January 1, 2001 .-For any account established by a U.S. non-exempt recipient on or after January 1, 2001, the QI must (1) request from the account holder the authority to disclose its name, address, TIN (if available), and reportable payments; (2) request from the account holder, prior to opening the account, the authority to exclude from the account holder's account any assets that generate, or could generate, reportable payments; or (3) request that the account holder disclose itself by mandating the QI to transfer an IRS Form W-9 completed by the account holder.

If a QI is authorized to disclose the account holder's name, address, TIN, and reportable amounts, it must obtain a valid IRS Form W-9 from the account holder, and, to the extent the QI does not have primary IRS Form 1099 and backup withholding responsibility, provide the IRS Form W-9 to the appropriate withholding agent promptly after obtaining the form. If an IRS Form W-9 is not obtained, the QI must provide the account holder's name, address, and TIN (if available) to the withholding agents from whom the QI receives reportable amounts on behalf of the account holder, together with the withholding rate applicable to the account holder. If a QI is not authorized to disclose an account holder's name, address, TIN (if available), and reportable amounts, but is authorized to exclude from the account holder's account any assets that generate, or could generate, reportable payments, the QI must follow procedures designed to ensure that it will not hold any assets that generate, or could generate, reportable payments in the account holder's account. 327

External audit procedures
The IRS generally does not audit a QI with respect to withholding and reporting obligations covered by a QI agreement if an approved external auditor conducts an audit of the QI. An external audit must be performed in the second and fifth full calendar years in which the QI agreement is in effect. In general, the IRS must receive the external auditor's report by June 30 of the year following the year being audited.

Requirements for the external audit are provided in the QI agreement. In general, the QI must permit the external auditor to have access to all relevant records of the QI, including information regarding specific account holders. In addition, the QI must permit the IRS to communicate directly with the external auditor, review the audit procedures followed by the external auditor, and examine the external auditor's work papers and reports.

In addition to the external audit requirements set forth in the QI agreement, the IRS has issued further guidance (the “QI audit guidance”) for an external auditor engaged by a QI to verify the QI's compliance with the QI agreement. 328 An external auditor must conduct its audit in accordance with the procedures described in the QI agreement. However, the QI audit guidance is intended to assist the external auditor in understanding and applying those procedures. The QI audit guidance does not amend, modify, or interpret the QI agreement.

Term of a QI agreement
A QI agreement expires on December 31 of the fifth full calendar year after the year in which the QI agreement first takes effect, although it may be renewed. Either the IRS or the QI may terminate the QI agreement prior to its expiration by delivering a notice of termination to the other party. However, the IRS generally does not terminate a QI agreement unless there is a significant change in circumstances or an event of default occurs, and the IRS determines that the change in circumstance or event of default warrants termination. In the event that an event of default occurs, a QI is given an opportunity to cure it within a specified time.

Know-your-customer due diligence requirements
United States
The U.S. know-your-customer rules 329 require financial institutions 330 to develop and maintain a written customer identification program and anti-money laundering policies and procedures. Additionally, financial institutions must perform customer due diligence. The due diligence requirements are enhanced where the account or the financial institution has a higher risk profile. 331

A customer identification program at a minimum requires the financial institution to collect the name, date of birth (for individuals), address, 332 and identification number 333 for new customers. In fulfilling their customer due diligence requirements, financial institutions are required to verify enough customer information to enable the financial institution to form a “reasonable belief that it knows the true identity of each customer.” 334

In many cases the know-your-customer rules do not require financial institutions to look through an entity to determine its ultimate ownership. 335 However, based on the financial institution's risk assessment, the financial institution may need to obtain information about individuals with authority or control over such an account in order to verify the identity of the customer. 336 A financial institution's customer due diligence must include gathering sufficient information on a business entity and its owners for the financial institution to understand and assess the risks of the account relationship. 337

Enhanced due diligence is required if customers are deemed to be of higher risk, and is mandated for certain types of accounts including foreign correspondent accounts, private banking accounts, and accounts for politically exposed persons. Private banking accounts are considered to be of significant risk and enhanced due diligence requires identification of nominal and beneficial owners for these accounts. 338

Financial institutions must maintain records for a minimum of five years after the account is closed or becomes dormant. They are required to monitor accounts including the frequency, size and ultimate destinations of transfers and must update customer due diligence and enhanced due diligence when there are significant changes to the customer's profile (for example, volume of transaction activity, risk level, or account type).

European Union Third Money Laundering Directive
The European Union (“EU”) Third Money Laundering Directive 339 is also applicable to a broad range of persons including credit institutions and financial institutions as well as to persons acting in the exercise of certain professional activities. 340 It requires systems, adequate policies and procedures for customer due diligence, reporting, record keeping, internal controls, risk assessment, risk management, compliance management, and communication. Required customer due diligence measures go further than the know-your-customer rules in the United States in requiring identification and verification of the beneficial owner and an understanding of the ownership and control structure of the customer in addition to the basic customer identification program and customer due diligence requirements.

A beneficial owner is defined as the natural person who ultimately owns or controls the customer and/or the natural person on whose behalf a transaction or activity is being conducted. For corporations, beneficial owner includes: (1) the natural person or persons who ultimately owns or controls a legal entity through direct or indirect ownership or control over a sufficient percentage (25 percent plus one share) of the shares or voting rights in that legal entity; and 2) the natural person or persons who otherwise exercises control over the management of the legal entity. 341 For foundations, trusts, and like entities that administer and distribute funds, beneficial owner includes: (1) in cases in which future beneficiaries are determined, a natural person who is the beneficiary of 25 percent or more of the property; (2) in cases in which future beneficiaries have yet to be determined, the class of person in whose main interest the legal arrangement is set up or operates; and (3) natural person who exercises control over 25 percent or more of the property. 342 Under the EU Third Money Laundering Directive, EU member states generally must require identification of the customer and any beneficial owners before the establishment of a business relationship. 343

The EU Third Money Laundering Directive requires ongoing account monitoring including scrutiny of transactions throughout the course of relationship to ensure that the transactions conducted are consistent with the customer and the business risk profile. It requires documents and other information to be updated and requires performance of customer due diligence procedures at appropriate times (such as a change in account signatories or change in the use of an account) for existing customers on a risk sensitive basis. Records must be maintained for up to five years after the customer relationship has ended.

Explanation of Provision
The provision adds a new chapter 4 to the Code that provides for withholding taxes to enforce new reporting requirements on specified foreign accounts owned by specified United States persons or by United States owned foreign entities. The provision establishes rules for withholdable payments to foreign financial institutions and for withholdable payments to other foreign entities.

Withholdable payments to foreign financial institutions
The provision requires a withholding agent to deduct and withhold a tax equal to 30 percent on any withholdable payment made to a foreign financial institution if the foreign financial institution does not meet certain requirements. Specifically, withholding is generally not required if an agreement is in effect between the foreign financial institution and the Secretary under which the institution agrees to:

1. Obtain information regarding each holder of each account maintained by the institution as is necessary to determine which accounts are United States accounts;

2. Comply with verification and due diligence procedures as the Secretary requires with respect to the identification of United States accounts;

3. Report annually certain information with respect to any United States account maintained by such institution;

4. Deduct and withhold 30 percent from any passthru payment that is made to a (1) recalcitrant account holder or another financial institution that does not enter into an agreement with the Secretary, or (2) foreign financial institution that has elected to be withheld upon rather than to withhold with respect to the portion of the payment that is allocable to a recalcitrant account holder or to foreign financial institutions that do not have an agreement with the Secretary.

5. Comply with requests by the Secretary for additional information with respect to any United States account maintained by such institution; and

6. Attempt to obtain a waiver in any case in which any foreign law would (but for a waiver) prevent the reporting of information required by the provision with respect to any United States account maintained by such institution, and if a waiver is not obtained from each account holder within a reasonable period of time, to close the account.


If the Secretary determines that the foreign financial institution is out of compliance with the agreement, the agreement may be terminated by the Secretary. The provision applies with respect to United States accounts maintained by the foreign financial institution and, except as provided by the Secretary, to United States accounts maintained by each other financial institution that is a member of the same expanded affiliated group (other than any foreign financial institution that also enters into an agreement with the Secretary).

It is expected that in complying with the requirements of this provision, the foreign financial institution and the other members of the same expanded affiliated group comply with know-your-customer, anti-money laundering, anti-corruption, or other similar rules to which they are subject, as well as with such procedures and rules as the Secretary may prescribe, both with respect to due diligence by the foreign financial institution and verification by or on behalf of the IRS to ensure the accuracy of the information, documentation, or certification obtained to determine if the account is a United States account. The Secretary may use existing know-your-customer, anti-money laundering, anti-corruption, and other regulatory requirements as a basis in crafting due diligence and verification procedures in jurisdictions where those requirements provide reasonable assurance that the foreign financial institution is in compliance with the requirements of this provision.

The provision allowing for withholding on payments made to an account holder that fails to provide the information required under this provision is not intended to create an alternative to information reporting. It is anticipated that the Secretary may require, under the terms of the agreement, that the foreign financial institution achieve certain levels of reporting and make reasonable attempts to acquire the information necessary to comply with the requirements of this section or to close accounts where necessary to meet the purposes of this provision. It is anticipated that the Secretary may also require, under the terms of the agreement, that, in the case of new accounts, the foreign financial institution may not withhold as an alternative to collecting the required information.

A foreign financial institution may be deemed, by the Secretary, to meet the requirements of this provision if: (1) the institution complies with procedures prescribed by the Secretary to ensure that the institution does not maintain United States accounts, and meets other requirements as the Secretary may prescribe with respect to accounts of other foreign financial institutions; or (2) the institution is a member of a class of institutions for which the Secretary has determined that the requirements are not necessary to carry out the purposes of this provision. For instance, it is anticipated that the Secretary may provide rules that would permit certain classes of widely held collective investment vehicles to be deemed to meet the requirements of this provision. It is anticipated that a foreign financial institution that has an agreement with the Secretary may meet the requirements under this provision with respect to certain members of its expanded affiliated group if the affiliated foreign financial institution complies with procedures prescribed by the Secretary and does not maintain United States accounts. Additionally, the Secretary may identify classes of institutions that are deemed to meet the requirements of this provision if such institutions are subject to similar due diligence and reporting requirements under other provisions in the Code. Such institutions may include certain controlled foreign corporations owned by U.S. financial institutions and certain U.S. branches of foreign financial institutions that are treated as U.S. payors under present law.

Under the provision, a foreign financial institution may elect to have a U.S. withholding agent or a foreign financial institution that has entered into an agreement with the Secretary withhold on payments made to the electing foreign financial institution rather than acting as a withholding agent for the payments it makes to other foreign financial institutions that either do not enter into agreements with the Secretary or that themselves have elected not to act as a withholding agent, or for payments it makes to account holders that fail to provide required information. If the election under this provision is made, the withholding tax will apply with respect to any payment made to the electing foreign financial institution to the extent the payment is allocable to accounts held by foreign financial institutions that do not enter into an agreement with the Secretary or to payments made to recalcitrant account holders.

A payment may be allocable to accounts held by a recalcitrant account holder or a foreign financial institution that does not meet the requirements of this section either as a result of such person holding an account directly with the electing foreign financial institution, or in relation to an indirect account held through other foreign financial institutions that either do not enter into an agreement with the Secretary or are themselves electing foreign financial institutions.

The electing foreign financial institution must notify the withholding agent of its election and must provide information necessary for the withholding agent to determine the appropriate amount of withholding. The information may include information regarding the amount of any payment that is attributable to a withholdable payment and information regarding the amount of any payment that is allocable to recalcitrant account holders or to foreign financial institutions that have not entered into agreements with the Secretary. Additionally, the electing foreign financial institution must waive any right under a treaty with respect to an amount deducted and withheld pursuant to the election. To the extent provided by the Secretary, the election may be made with respect to certain classes or types of accounts.

A foreign financial institution meets the annual information reporting requirements under the provision by reporting the following information:

1. The name, address, and TIN of each account holder that is a specified United States person;

2. The name, address, and TIN of each substantial United States owner of any account holder that is a United States owned foreign entity;

3. The account number;

4. The account balance or value (determined at such time and in such manner as the Secretary provides); and

5. The gross receipts and gross withdrawals or payments from the account (determined for such period and in such manner as the Secretary may provide).


This information is required with respect to each United States account maintained by the foreign financial institution and, except as provided by the Secretary, each United States account maintained by each other foreign financial institution that is a member of the same expanded affiliated group (other than any foreign financial institution that also enters into an agreement with the Secretary).

Alternatively, a foreign financial institution may make an election and report under sections 6041 (information at source), 6042 (returns regarding payments of dividends and corporate earnings and profits), 6045 (returns of brokers), and 6049 (returns regarding payments of interest), as if such foreign financial institution were a U.S. person (i.e., elect to provide full IRS Form 1099 reporting under these sections). Under this election, the foreign financial institution reports on each account holder that is a specified United States person or United States owned foreign entity as if the holder of the account were a natural person and citizen of the United States. As a result, both U.S.- and foreign-source amounts (including gross proceeds) are subject to reporting under this election regardless of whether the amounts are paid inside or outside the United States. If a foreign financial institution makes this election, the institution is also required to report the following information with respect to each United States account maintained by the institution: (1) the name, address, and TIN of each account holder that is a specified United States person; (2) the name, address, and TIN of each substantial United States owner of any account holder that is a United States owned foreign entity; and (3) the account number. This election can be made by a foreign financial institution even if other members of its expanded affiliated group do not make the election. The Secretary has authority to specify the time and manner of the election and to provide other conditions for meeting the reporting requirements of the election.

Foreign financial institutions that have entered into QI or similar agreements with the Secretary, under section 1441 and the regulations thereunder, are required to meet the requirements of this provision in addition to any other requirements imposed under the QI or similar agreement.

Under the provision, a United States account is any financial account held by one or more specified United States persons or United States owned foreign entities. Depository accounts are not treated as United States accounts for these purposes if (1) each holder of the account is a natural person and (2) the aggregate value of all depository accounts held (in whole or in part) by each holder of the account maintained by the financial institution does not exceed $50,000. A foreign financial institution may, however, elect to include all depository accounts held by U.S. individuals as United States accounts. To the extent provided by the Secretary, financial institutions that are members of the same expanded affiliated group may be treated as a single financial institution for purposes of determining the aggregate value of depository accounts maintained at the financial institution.

In addition, a financial account is not a United States account if the account is held by a foreign financial institution that has entered into an agreement with the Secretary or is otherwise subject to information reporting requirements that the Secretary determines would make the reporting duplicative. It is anticipated that the Secretary may exclude certain financial accounts held by bona fide residents of any possession of the United States maintained by a financial organization organized under the laws of the possession if the Secretary determines that such reporting is not necessary to carry out the purposes of this provision.

A financial account is any depository or custodial account maintained by a foreign financial institution and, except as otherwise provided by the Secretary, any equity or debt interest in a foreign financial institution (other than interests that are regularly traded on an established securities market). Any equity or debt interest that is treated as a financial account with respect to any financial institution is treated for purposes of this provision as maintained by the financial institution. It is anticipated that the Secretary may determine that certain short-term obligations pose a low risk of U.S. tax evasion and may exclude such debt for these purposes.

A United States owned foreign entity is any foreign entity that has one or more substantial United States owners. A foreign entity is any entity that is not a U.S. person.

A foreign financial institution is any financial institution that is a foreign entity, and except as provided by the Secretary, does not include a financial institution organized under the laws of any possession of the United States. The Secretary may exercise its authority to issue guidance that it deems necessary to prevent financial institutions organized under the laws of U.S. possessions from being used as intermediaries in arrangements under which U.S. tax avoidance or evasion is facilitated.

Except as otherwise provided by the Secretary, a financial institution for these purposes is (1) any entity that accepts deposits in the ordinary course of a banking or similar business, (2) any entity that is engaged in the business of holding financial assets for the account of others, and (3) any entity engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, 344 interests in partnerships, commodities, 345 or any interest (including a futures or forward contract or option) in such securities, partnership interests, or commodities. Accordingly, the term financial institution may include among other entities, investment vehicles such as hedge funds and private equity funds. Additionally, the Secretary may provide exceptions for certain classes of institutions. Such exceptions may include entities such as certain holding companies, research and development subsidiaries, or financing subsidiaries within an affiliated group of non-financial operating companies. It is anticipated that the Secretary may prescribe special rules addressing the circumstances in which certain categories of companies, such as insurance companies, are financial institutions, or the circumstances in which certain accounts or policies, such as policies written by insurance companies, are financial accounts or United States accounts for these purposes.

For purposes of this provision, a recalcitrant account holder is any account holder that: (1) fails to comply with reasonable requests for information necessary to determine if the account is a United States account; (2) fails to provide the name, address, and TIN of each specified United States person and each substantial United States owner of a United States owned foreign entity; or (3) fails to provide a waiver of any foreign law that would prevent the foreign financial institution from reporting any information required under this provision.

A passthru payment is any withholdable payment or other payment that is attributable to a withholdable payment.

The reporting requirements apply with respect to United States accounts maintained by a foreign financial institution and, except as otherwise provided by the Secretary, with respect to United States accounts maintained by each other foreign financial institution that is a member of the same expanded affiliated group as such foreign financial institution. An expanded affiliated group for these purposes is an affiliated group as defined in section 1504(a) except that “more than 50 percent” is substituted for “at least 80 percent” each place it appears in that section, and is determined without regard to paragraphs (2) and (3) of section 1504(b). A partnership or any other entity that is not a corporation is treated as a member of an expanded affiliated group if such entity is controlled by members of such group. 346

This provision does not apply with respect to a payment if the beneficial owner of such payment is (1) a foreign government, a political subdivision of a foreign government, or a wholly owned agency of any foreign government or political subdivision; (2) an international organization or any wholly owned agency or instrumentality thereof; (3) a foreign central bank of issue; or (4) any other class of persons identified by the Secretary as posing a low risk of U.S. tax evasion.

Under the provision, a withholding agent includes any person, in whatever capacity, having the control, receipt, custody, disposal, or payment of any withholdable payment.

Except as provided by the Secretary, a withholdable payment is any payment of interest (including any original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income from sources within the United States. The term also includes any gross proceeds from the sale or other disposition of any property that could produce interest or dividends from sources within the United States, including dividend equivalent payments treated as dividends from sources in the United States pursuant to section 541 of the Act. Any item of income effectively connected with the conduct of a trade or business within the United States that is taken into account under sections 871(b)(1) or 882(a)(2) is not treated as a withholdable payment for purposes of the provision. In determining the source of a payment, section 861(a)(1)(B) (the rule for sourcing interest paid by foreign branches of domestic financial institutions) does not apply.

A substantial United States owner is: (1) with respect to any corporation, any specified U.S. person that directly or indirectly owns more than 10 percent of the stock (by vote or value) of such corporation; (2) with respect to any partnership, a specified United States person that directly or indirectly owns more than 10 percent of the profits or capital interests of such partnership; and (3) with respect to any trust, any specified United States person treated as an owner of any portion of such trust under the grantor trust rules, 347 or to the extent provided by the Secretary, any specified United States person that holds, directly or indirectly, more than 10 percent of the beneficial interests of the trust. To the extent the foreign entity is a corporation or partnership engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, interests in partnerships, commodities, or any interest (including a futures or forward contract or option) in such securities, interests or commodities, the 10-percent threshold is reduced to zero percent. In determining whether an entity is a United States owned foreign entity (and whether any person is a substantial United States owner of such entity), only specified United States persons are considered.

Except as otherwise provided by the Secretary, a specified United States person is any U.S. person other than (1) a publicly traded corporation or a member of the same expanded affiliated group as a publicly traded corporation, (2) any tax-exempt organization or individual retirement plan, (3) the United States or a wholly owned agency or instrumentality of the United States, (4) a State, the District of Columbia, any possession of the United States, or a political subdivision or wholly owned agency of a State, the District of Columbia, or a possession of the United States, (5) a bank, 348 (6) a real estate investment trust, 349 (7) a regulated investment company, 350 (8) a common trust fund, 351 and (9) a trust that is exempt from tax under section 664(c) 352 or is described in section 4947(a)(1). 353

Withholdable payments to other foreign entities
The provision requires a withholding agent to deduct and withhold a tax equal to 30 percent of any withholdable payment made to a non-financial foreign entity if the beneficial owner of such payment is a non-financial foreign entity that does not meet specified requirements.

A non-financial foreign entity is any foreign entity that is not a financial institution under the provision. A non-financial foreign entity meets the requirements of the provision (i.e., payments made to such entity will not be subject to the imposition of 30-percent withholding tax) if the payee or the beneficial owner of the payment provides the withholding agent with either a certification that the foreign entity does not have a substantial United States owner, or provides the withholding agent with the name, address, and TIN of each substantial United States owner. Additionally, the withholding agent must not know or have reason to know that the certification or information provided regarding substantial United States owners is incorrect, and the withholding agent must report the name, address, and TIN of each substantial United States owner to the Secretary.

The provision does not apply to any payment beneficially owned by a publicly traded corporation or a member of an expanded affiliated group of a publicly traded corporation (defined as above but without the inclusion of partnerships or other non-corporate entities). Publicly traded corporations (and their affiliates) receiving payments directly from U.S. withholding agents may present a lower risk of U.S. tax evasion than other non-financial foreign entities. The provision also does not apply to any payment beneficially owned by any: (1) entity that is organized under the laws of a possession of the United States and that is wholly owned by one or more bona fide residents of the possession; (2) foreign government, political subdivision of a foreign government, or wholly owned agency or instrumentality of any foreign government or political subdivision of a foreign government; (3) international organization or any wholly owned agency or instrumentality of an international organization; (4) foreign central bank of issue; (5) any other class of persons identified by the Secretary for purposes of the provision; or (6) class of payments identified by the Secretary as posing a low risk of U.S. tax evasion. It is anticipated that the Secretary may exclude certain payments made for goods, services, or the use of property if the payment is made pursuant to an arm's length transaction in the ordinary course of the payor's trade or business.

It is expected that the Secretary will provide coordinating rules for application of the withholding provisions applicable to foreign financial institutions and to foreign entities that are non-financial foreign entities under this provision.

Credits and refunds
In general, the determination of whether an overpayment of tax deducted and withheld under the provision results in an overpayment by the beneficial owner of the payment is made in the same manner as if the tax had been deducted and withheld under subchapter A of chapter 3 (withholding tax on nonresident aliens and foreign corporations). An amount of tax required to be withheld by a foreign financial institution under its agreement with the Secretary is treated the same as if it were required to be withheld on a withholdable payment made to a foreign financial institution that does not enter into an agreement with the Secretary. Under the provision, if a beneficial owner of a payment is entitled under an income tax treaty to a reduced rate of withholding tax on the payment, that beneficial owner may be eligible for a credit or refund of the excess of the amount withheld under the provision over the amount permitted to be withheld under the treaty. Similarly, if a payment is of an amount not otherwise subject to U.S. tax (because, for instance, the payment represents gross proceeds from the sale of stock or is interest eligible for the portfolio interest exemption), the beneficial owner of the payment generally is eligible for a credit or refund of the full amount of the tax withheld.

The Secretary has the authority to provide guidance ensuring that taxpayers claiming credits or refunds of amounts withheld from payments to which the provision applies supply appropriate documentation establishing that they are the beneficial owners of the payments from which tax was withheld, and that, in circumstances in which treaty benefits are being claimed, they are eligible for treaty benefits.

If tax is withheld under this provision, this credit and refund mechanism ensures that the provisions are consistent with U.S. obligations under existing income tax treaties. U.S. income tax treaties do not require the United States and its treaty partners to follow a specific procedure for providing treaty benefits. 354 For example, in cases in which proof of entitlement to treaty benefits is demonstrated in advance of payment, the United States may permit reduced withholding or exemption at the time of payment. Alternatively, the United States may require withholding at the relevant statutory rate at the time of payment and allow treaty country residents to obtain treaty benefits through a refund process. The credit and refund mechanism ensures that residents of treaty partners continue to obtain treaty benefits in the event tax is withheld under the provision.

A special rule applies with respect to any tax properly deducted and withheld from a specified financial institution payment, which is defined as any payment with respect to which a foreign financial institution is the beneficial owner. Credits and refunds with respect to specified financial institution payments generally are not allowed. However, refunds and credits are allowed if, with respect to the payment, the foreign financial institution is entitled to an exemption or a reduced rate of tax by reason of any treaty obligation of the United States. In such a case, the foreign financial institution is entitled to an exemption or a reduced rate of tax only to the extent provided under the treaty. In no event will interest be allowed or paid with respect to any credit or refund of tax properly withheld on a specified financial institution payment.

Additionally, no credit or refund is allowed with respect to tax properly deducted and withheld unless the beneficial owner of the payment provides the Secretary with such information as the Secretary may require to determine whether the beneficial owner of the payment is a United States owned foreign entity and the identity of any substantial United States owners of such entity.

Under the provision, the grace period for which the government is not required to pay interest on an overpayment is increased from 45 days to 180 days for overpayments resulting from excess amounts deducted and withheld under chapters 3 or 4 of the Code. The increased grace period applies to refunds of withheld taxes with respect to (1) returns due after the date of enactment, (2) claims for refund filed after date of enactment and (3) IRS-initiated adjustments if the refunds are paid after the date of enactment. It is anticipated that the Secretary may specify the proper form and information required for a claim for refund under section 6611(e)(2) and may provide that a purported claim that does not include such information is not considered filed.

General provisions
Every person required to deduct and withhold any tax under the provision is liable for such tax and is indemnified against claims and demands of any person for the amount of payments made in accordance with the provision.

No person may use information under the provision except for the purpose of meeting any requirements under the provision or for purposes permitted under section 6103. However, the identity of foreign financial institutions that have entered into an agreement with the Secretary is not treated as return information for purposes of section 6103.

The Secretary is expected to provide for the coordination of withholding under this provision with other withholding provisions of the Code, including providing for the proper crediting of amounts deducted and withheld under this provision against amounts required to be deducted and withheld under other provisions of the Code. The Secretary may provide further coordinating rules to prevent double withholding, including in situations involving tiered U.S. withholding agents.

The provision makes several conforming amendments to other provisions in the Code. The provision grants authority to the Secretary to prescribe regulations necessary and appropriate to carry out the purposes of the provision.

Effective Date
The provision generally applies to payments made after December 31, 2012. The provision, however, does not require any amount to be deducted or withheld from any payment under any obligation outstanding on the date that is two years after the date of enactment. It is anticipated that the Secretary may provide guidance as to the application of the material modification rules under section 1001 in determining whether an obligation is considered to be outstanding on the date that is two years after the date of enactment.

The interest provisions increasing the grace period for which the government is not required to pay interest on an overpayment from 45 to 180 days apply to: (1) returns with due dates after the date of enactment; (2) claims for credit or refund of overpayment filed after the date of enactment; and (3) refunds paid on adjustments initiated by the Secretary paid after the date of enactment.

2. Repeal of certain foreign exceptions to registered bond requirements (sec. 502 of the bill and secs. 163, 165, 871, 881, 1287, and 4701 of the Code and 31 U.S.C. sec. 3121)
Present Law
Registration-required obligations and treatment of bonds not issued in registered form
In general, a taxpayer may deduct all interest paid or accrued within the taxable year on indebtedness. 355 For registration-required obligations, a deduction for interest is allowed only if the obligation is in registered form. Generally, an obligation is treated as issued in registered form if the issuer or its agent maintains a registration of the identity of the owner of the obligation and the obligation can be transferred only through this registration system. 356 A registration-required obligation is any obligation other than one that: (1) is made by a natural person; (2) matures in one year or less; (3) is not of a type offered to the public; or (4) is a foreign targeted obligation. 357

In applying this requirement, the IRS has adopted a flexible approach that recognizes that a debt obligation that is formally in bearer (i.e., not in registered) form is nonetheless “in registered form” for these purposes where there are arrangements that preclude individual investors from obtaining definitive bearer securities or that permit such securities to be issued only upon the occurrence of an extraordinary event. 358

A foreign targeted obligation (to which the registration requirement does not apply) is any obligation satisfying the following requirements: (1) there are arrangements reasonably designed to ensure that such obligation will be sold (or resold in connection with the original issue) only to a person who is not a United States person; (2) interest is payable only outside the United States and its possessions; and (3) the face of the obligation contains a statement that any United States person who holds this obligation will be subject to limitations under the U.S. income tax laws. 359

In addition to the denial of an interest deduction, an excise tax is imposed on the issuer of any registration-required obligation that is not in registered form. 360 The excise tax is equal to one percent of the principal amount of the obligation multiplied by the number of calendar years (or portions thereof) during the period beginning on the date of issuance of the obligation and ending on the date of maturity.

Moreover, any gain realized by the beneficial owner of a registration-required obligation that is not in registered form on the sale or other disposition of the obligation is treated as ordinary income (rather than capital gain), unless the issuer of the obligation was subject to the excise tax described above. 361 Finally, deductions for losses realized by beneficial owners of registration-required obligations that are not in a registered form are disallowed. 362 For the purposes of ordinary income treatment and denial of deduction for losses,a registration-required obligation is any obligation other than one that: (1) is made by a natural person; (2) matures in one year or less; or (3) is not of a type offered to the public.

Treatment as portfolio interest
Payments of U.S.-source “fixed or determinable annual or periodical” income, including interest, dividends, and similar types of investment income, that are made to foreign persons are subject to U.S. withholding tax at a 30-percent rate, unless the withholding agent can establish that the beneficial owner of the amount is eligible for an exemption from withholding or a reduced rate of withholding under an income tax treaty. 363 In 1984, the Congress repealed the 30-percent tax on portfolio interest received by a nonresident individual or foreign corporation from sources within the United States. 364

The term “portfolio interest” means any interest (including original issue discount) that is (1) paid on an obligation that is in registered form and for which the beneficial owner has provided to the U.S. withholding agent a statement certifying that the beneficial owner is not a U.S. person, or (2) paid on an obligation that is not in registered form and that meets the foreign targeting requirements of section 163(f)(2)(B). 365 Portfolio interest, however, does not include interest received by a 10-percent shareholder, 366 certain contingent interest, 367 interest received by a controlled foreign corporation from a related person, 368 or interest received by a bank on an extension of credit made pursuant to a loan agreement entered into in the ordinary course of its trade or business. 369

Requirement that U.S. Treasury obligations be in registered form
Under title 31 of the United States Code, every “registration-required obligation” of the U.S. Treasury must be in registered form. 370 For this purpose, a foreign targeted obligation is excluded from the definition of a registration-required obligation. 371 Thus, a foreign targeted obligation of the Treasury can be in bearer (rather than registered) form.

Explanation of Provision
Repeal of the foreign targeted obligation exception to the registration requirement
The provision repeals the foreign targeted obligation exception to the denial of a deduction for interest on bonds not issued in registered form. Thus, under the provision, a deduction for interest is disallowed with respect to any obligation not issued in registered form, unless that obligation (1) is issued by a natural person, (2) matures in one year or less, or (3) is not of a type offered to the public.

The bill preserves the ordinary income treatment under present law of any gain realized by the beneficial owner from the sale or other disposition of a registration-required obligation that is not in registered form. Similarly, the bill does not change the present law rule disallowing deductions for losses realized by a beneficial owner of a registration-required obligation that is not in a registered form.

Preservation of exception to the registration requirement for excise tax purposes
Under the provision, the foreign targeted obligation exception is available with respect to the excise tax applicable to issuers of registration-required obligations that are not in registered form. Thus, the excise tax applies with respect to any obligation that is not in registered form unless the obligation (1) is issued by a natural person, (2) matures in one year or less, (3) is not of a type offered to the public, or (4) is a foreign targeted obligation.

Repeal of treatment as portfolio interest
The provision repeals the treatment as portfolio interest of interest paid on bonds that are not issued in registered form but meet the foreign targeting requirements of section 163(f)(2)(B). Under the provision, interest qualifies as portfolio interest only if it is paid on an obligation that is issued in registered form and either (1) the beneficial owner has provided the withholding agent with a statement certifying that the beneficial owner is not a United States person (on IRS Form W-8), or (2) the Secretary has determined that such statement is not required in order to carry out the purposes of the subsection. It is anticipated that the Secretary may exercise its authority under this rule to waive the requirement of collecting Forms W-8 in circumstances in which the Secretary has determined there is a low risk of tax evasion and there are adequate documentation standards within the country of tax residency of the beneficial owner of the obligations in question. Generally, however, as a result of the provision, interest paid to a foreign person on an obligation that is not issued in registered form is subject to U.S. withholding tax at a 30-percent rate, unless the withholding agent can establish that the beneficial owner of the amount is eligible for an exemption from withholding other than the portfolio interest exemption or for a reduced rate of withholding under an income tax treaty.

Dematerialized book-entry systems treated as registered form
The provision provides that a debt obligation held through a dematerialized book entry system is treated, for purposes of section 163(f), as held through a book entry system for the purpose of treating the obligation as in registered form. 372 A debt obligation that is formally in bearer form is treated, for the purposes of section 163(f), as held in a book-entry system as long as the debt obligation may be transferred only by book entries and the holder of the obligation does not have the ability to withdraw the obligation from the book-entry system and obtain a physical certificate in bearer form in the ordinary course of business. 373

Repeal of exception to requirement that Treasury obligations be in registered form
The provision includes a conforming change to title 31 of the United States Code that repeals the foreign targeted exception to the definition of a registration-required obligation. Thus, a foreign targeted obligation of the Treasury must be in registered form.

Effective Date
The provision applies to debt obligations issued after the date which is two years after the date of enactment.

B. Under Reporting With Respect to Foreign Assets
1. Disclosure of information with respect to foreign financial assets (sec. 511 of the bill and new sec. 6038D of the Code)
Present Law
U.S. persons who transfer assets to, and hold interests in, foreign bank accounts or foreign entities may be subject to self-reporting requirements under both Title 26 (the Internal Revenue Code) and Title 31 (the Bank Secrecy Act) of the United States Code.

Since its enactment, the Bank Secrecy Act has been expanded beyond its original focus on large currency transactions, while retaining its broad purpose of obtaining self-reporting of information with “a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings.” 374 As the reporting regime has expanded, 375 reporting obligations have been imposed on both financial institutions and account holders. With respect to account holders, a . U.S. citizen, resident, or person doing business in the United States is required to keep records and file reports, as specified by the Secretary, when that person enters into a transaction or maintains an account with a foreign financial agency. 376 Regulations promulgated pursuant to broad regulatory authority granted to the Secretary in the Bank Secrecy Act 377 provide additional guidance regarding the disclosure obligation with respect to foreign accounts. The Bank Secrecy Act specifies only that such disclosure contain the following information “in the way and to the extent the Secretary prescribes”: (1) the identity and address of participants in a transaction or relationship; (2) the legal capacity in which a participant is acting; (3) the identity of real parties in interest; and (4) a description of the transaction.

Treasury Department Form TD F 90-22.1, “Report of Foreign Bank and Financial Accounts,” (the “FBAR”) must be filed by June 30 of the year following the year in which the $10,000 filing threshold is met. 378 The FBAR is filed with the Treasury Department at the IRS Detroit Computing Center. Failure to file the FBAR is subject to both criminal 379 and civil penalties. 380 Since 2004, the civil sanctions have included penalties not to exceed (1) $10,000 for failures that are not willful and (2) the greater of $100,000 or 50 percent of the balance in the account for willful failures. Although the FBAR is received and processed by the IRS, it is neither part of the income tax return filed with the IRS nor filed in the same office as that return. As a result, for purposes of Title 26, the FBAR is not considered “return information,” and its distribution to other law enforcement agencies is not limited by the nondisclosure rules of Title 26. 381

Although the obligation to file an FBAR arises under Title 31, individual taxpayers subject to the FBAR reporting requirements are alerted to this requirement in the preparation of annual Federal income tax returns. Part III (“Foreign Accounts and Trusts”) of Schedule B of the 2008 IRS Form 1040 includes the question, “At any time during 2008, did you have an interest in or signatory or any other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account?” and directs taxpayers to “See page B-2 for exceptions and filing requirements for Form TD F 90-22.1.” The Form 1040 instructions advise individuals who answer “yes” to this question to identify the foreign country or countries in which such accounts are located. 382 Responding to this question does not discharge one's obligations under Title 31 and constitutes “return information” protected from routine disclosure to those charged with enforcing Title 31. In addition, the Form 1040 instructions identify certain types of accounts that are not subject to disclosure, including those instances in which the combined value of all accounts held by the taxpayer did not exceed $10,000 at any point during the relevant tax year.

The FBAR requires disclosure of any account in which the filer has a financial interest or as to which the filer has signature or other authority (in which case the filer must identify the owner of the account). The Treasury Department and the IRS revised the FBAR and its accompanying instructions in October, 2008, to clarify the filing requirements for U.S. persons holding interests in foreign bank accounts. 383 For example, the terminology has been updated to reflect new types of financial transactions. For example, “financial account” now specifies that debit or prepaid credit cards are financial accounts, 384 and the definition of “signature or other authority” now encompasses the ability to indirectly exercise this authority, even in the absence of written instructions. 385 The revised instructions also provide that foreign individuals doing business in the United States may be required to file an FBAR. 386 In August, 2009, the IRS requested public comments to help determine the scope and nature of future additional guidance. 387

The revised instructions explain the basis for reporting other information in more detail, and provide that (1) all foreign persons with an interest in the account must be identified (including foreign identification numbers for each), (2) the highest value held in the account at any point in the year must be disclosed, (3) corporate employees with signature authority but no financial interest are generally required to disclose the signature authority, unless the corporate Chief Financial Officer (“CFO”) (or in the case of an employee of a subsidiary, the parent company's CFO) certifies that the account will be reported on the corporate filing and (4) any amended or delinquent filing should be identified as such, and accompanied by an explanatory statement.

In addition to the FBAR requirements under Title 31, there are additional reports required by the Code to be filed with the IRS by U.S. persons engaged in foreign activities, directly or indirectly, through a foreign business entity. Upon the formation, acquisition or ongoing ownership of certain foreign corporations, U.S. persons that are officers, directors, or shareholders must file a Form 5471, “Information Return of U.S. Persons with Respect to Certain Foreign Corporations.” 388 Similarly, an IRS Form 8865, “Return of U.S. Persons with Respect to Certain Foreign Partnerships,” must be filed with respect to certain interests in a controlled foreign partnership; an IRS Form 3520, “Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts,” must be filed with respect to certain foreign trusts; and an IRS Form 8858, “Information Return of U.S. Persons With Respect To Foreign Disregarded Entities” must be filed with respect to a foreign disregarded entity. 389 To the extent that the U.S. person engages in such foreign activities indirectly through a foreign business entity, other self-reporting requirements may apply. In addition, a U.S. person that capitalizes a foreign entity generally is required to file an IRS Form 926, “Return by a U.S. Transferor of Property to a Foreign Corporation.” 390

With the exception of the questions included on Form 1040, Schedule B, there is no requirement to disclose the information includible on FBAR on an individual tax return.

FBAR enforcement responsibility
Until 2003, the Financial Crimes and Enforcement Network (“FinCEN”), an agency of the Department of the Treasury, had responsibility for civil penalty enforcement of FBAR. In 2003, the authority to investigate FBAR compliance was delegated to the IRS Criminal Investigation Division. 391 As a result, persons who were more than 180 days delinquent in paying any FBAR penalties were referred for collection action to the Financial Management Service of the Treasury Department, which is responsible for such non-tax collections. 392 Continued nonpayment resulted in a referral to the Department of Justice for institution of court proceedings against the delinquent person. In 2003, the Secretary delegated civil enforcement to the IRS. 393 This change reflected the fact that a major purpose of the FBAR was to identify potential tax evasion, and therefore was not closely aligned with FinCEN's core mission. 394 The authority delegated to the IRS in 2003 included the authority to determine and enforce civil penalties, 395 as well as to revise the form and instructions. However, the collection and enforcement powers available to enforce the Internal Revenue Code under Title 26 are not available to the IRS in the enforcement of FBAR civil penalties, which remain collectible only in accord with the procedures for non-tax collections described above.

In general, information reported on an FBAR is available to the IRS and other law enforcement agencies. In contrast, information on income tax returns-including the Schedule B information regarding foreign bank accounts-is not readily available to those within the IRS who are charged with administering FBAR compliance, despite the fact that Federal returns and return information may be the best source of information for this purpose.

The nondisclosure constraints on IRS personnel who examine income tax liability (i.e., Form 1040 reporting) generally preclude the sharing of tax return information with any other IRS personnel or Treasury officials, except for tax administration purposes. 396 Tax administration is defined as “the administration, management, conduct, direction, and supervision of the execution and application of the internal revenue laws or related statutes” and does not necessarily include administration of Title 31. 397 Because Title 31 includes enforcement of non-tax provisions of the Bank Secrecy Act, Title 31 is not, per se, a “related statute,” for purposes of finding that a disclosure of such information would be for tax administration purposes. As a result, IRS personnel charged with investigating and enforcing the civil penalties under Title 31 are not routinely permitted access to Form 1040 information that would support or shed light on the existence of an FBAR violation. Instead, there must be a determination, in writing, that the FBAR violation was in furtherance of a Title 26 violation in order to support a finding that the statutes are “related statutes” for purposes of authorizing the disclosure. The effect of this prerequisite is to subsume the bank account information reported on Form 1040 under the scope of “return information” and therefore, the protection from disclosure provided under Title 26. 398

Penalties
Failure to comply with the FBAR filing requirements is subject to penalties imposed under Title 31 of the United States Code, and may be both civil and criminal. Since the initial enactment of the Bank Secrecy Act, a willful failure to comply with the FBAR reporting requirement has been subject to a civil penalty. In 2004, the available penalties were expanded to include a reduced penalty for a non-willful failure to file. 399 Willful failure to file an FBAR may be subject to penalties in amounts not to exceed the greater of $100,000 or 50 percent of the amount in the account at the time of the violation. 400 A non-willful, but negligent, failure to file is subject to a penalty of $10,000 for each negligent violation. 401 The penalty may be waived if (1) there is reasonable cause for the failure to report and (2) the amount of the transaction or balance in the account was properly reported. In addition, serious violations are subject to criminal prosecution, potentially resulting in both monetary penalties and imprisonment. Civil and criminal sanctions are not mutually exclusive.

Failure to comply with information returns required by the Internal Revenue Code is subject to a variety of sanctions, including (1) suspension of the applicable statute of limitations, 402 (2) disallowance of otherwise permitted tax attributes, deductions or credits, 403 and (3) imposition of penalties. For most information returns, the failure to file penalty is $50 per return, up to a maximum of $250,000 per taxpayer. 404 Failures to disclose control of any foreign business entity, 405 foreign parties with 25 percent ownership interest in a domestic company, 406 domestic officers and 10 percent owners of a foreign corporation, 407 or change in ownership of a foreign partnership 408 are subject to penalties of $10,000, plus $10,000 for every 30 days the failure to file persists longer than 90 days after the taxpayer is informed of the failure. A failure to report a transfer to a foreign corporation is subject to a penalty equal to 10 percent of the value of the transfer, but is capped at $10,000 if the failure is not willful. 409 Failure to report the creation of a foreign trust is subject to a 35 percent penalty on the reportable amount (or five percent for a Form 3520-A report), plus $10,000 for every 30 days the failure to file persists after 90 days from the date on which the taxpayer is informed of the failure to file. The penalty is capped at the gross reportable amount. 410

Explanation of Provision
The provision requires individual taxpayers with an interest in a “specified foreign financial asset” during the taxable year to attach a disclosure statement to their income tax return for any year in which the aggregate value of all such assets is greater than $50,000. Although the nature of the information required is similar to the information disclosed on an FBAR, it is not identical. For example, a beneficiary of a foreign trust who is not within the scope of the FBAR reporting requirements because his interest in the trust is less than 50 percent may nonetheless be required to disclose the interest in the trust with his tax return under this provision if the value threshold is met. Nothing in this provision is intended as a substitute for compliance with the FBAR reporting requirements, which are unchanged by this provision.

“Specified foreign financial assets” are depository or custodial accounts at foreign financial institutions and, to the extent not held in an account at a financial institution, (1) stocks or securities issued by foreign persons, (2) any other financial instrument or contract held for investment that is issued by or has a counterparty that is not a U.S. person, and (3) any interest in a foreign entity. The information to be included on the statement includes identifying information for each asset and its maximum value during the taxable year. For an account, the name and address of the institution at which the account is maintained and the account number are required. For a stock or security, the name and address of the issuer, and any other information necessary to identify the stock or security and terms of its issuance must be provided. For all other instruments or contracts, or interests in foreign entities, the information necessary to identify the nature of the instrument, contract or interest must be provided, along with the names and addresses of all foreign issuers and counterparties. An individual is not required under this provision to disclose interests under that are held in a custodial account with a U.S. financial institution nor is an individual required to identify separately any stock, security instrument, contract, or interest in a foreign financial account disclosed under the provision. In addition, the provision permits the Secretary to issue regulations that would apply the reporting obligations to a domestic entity in the same manner as if such entity were an individual if that domestic entity is formed or availed of to hold such interests, directly or indirectly.

Individuals who fail to make the required disclosures are subject to a penalty of $10,000 for the taxable year. An additional penalty may apply if the Secretary notifies an individual by mail of the failure to disclose and the failure to disclose continues. If the failure continues beyond 90 days following the mailing, the penalty increases by $10,000 for each 30 day period (or a fraction thereof), up to a maximum penalty of $50,000 for one taxable period. The computation of the penalty is similar to that applicable to failures to file reports with respect to certain foreign corporations under section 6038. Thus, an individual who is notified of his failure to disclose with respect to a single taxable year under this provision and who takes remedial action on the 95th day after such notice is mailed incurs a penalty of $20,000 comprising the base amount of $10,000, plus $10,000 for the fraction (i.e., the five days) of a 30-day period following the lapse of 90 days after the notice of noncompliance was mailed. An individual who postpones remedial action until the 181st day is subject to the maximum penalty of $50,000: the base amount of $10,000, plus $30,000 for the three 30-day periods, plus $10,000 for the one fraction (i.e., the single day) of a 30-day period following the lapse of 90 days after the notice of noncompliance was mailed.

No penalty is imposed under the provision against an individual who can establish that the failure was due to reasonable cause and not willful neglect. Foreign law prohibitions against disclosure of the required information cannot be relied upon to establish reasonable cause.

To the extent the Secretary determines that the individual has an interest in one or more foreign financial assets but the individual does not provide enough information to enable the Secretary to determine the aggregate value thereof, the aggregate value of such identified foreign financial assets will be presumed to have exceeded $50,000 for purposes of assessing the penalty.

The provision also grants authority to promulgate regulations necessary to carry out the intent. Such regulations may include exceptions for nonresident aliens and classes of assets identified by the Secretary, including those assets which the Secretary determines are subject to reporting requirements under other provisions of the Code. In particular, regulatory exceptions to avoid duplicative reporting requirements are anticipated.

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

2. Penalties for underpayments attributable to undisclosed foreign financial assets (sec. 512 of the bill and sec. 6662 of the Code)
Present Law
The Code imposes penalties equal to 20 percent of the portion of any underpayments that are attributable to any of the following five grounds: (1) negligence or disregard of rules or regulations; (2) any substantial understatement 411 of income tax; (3) any substantial valuation misstatement; (4) any substantial overstatement of pension liabilities; and (5) any substantial estate or gift tax valuation understatement. With the exception of a penalty based on negligence or disregard of rules or regulations, these penalties are commonly referred to as accuracy-related penalties, because the imposition of the penalty does not require an inquiry into the culpability of the taxpayer. If the penalty is asserted, a taxpayer may defend against the penalty by demonstrating that (1) there was “reasonable cause” for the underpayment and (2) the taxpayer acted in good faith. 412 Regulations provide that reasonable cause exists in cases in which the taxpayer “reasonably relies in good faith on the opinion of a professional tax advisor, if the opinion is based on the tax advisor's analysis of the pertinent facts and authorities … and unambiguously states that the tax advisor concludes that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld if challenged” by the IRS. 413

A penalty for a substantial understatement may be reduced to the extent of the portion of the understatement attributable to an item on the return for which the challenged tax treatment (1) is supported by substantial authority or (2) is adequately disclosed on the return and there was a reasonable basis for such treatment. The tax treatment is considered to have been adequately disclosed only if all relevant facts are disclosed with the return. Regardless of whether an item would otherwise meet either of these tests, this defense is not available with respect to penalties imposed on understatements arising from tax shelters. 414 The Secretary may prescribe a list of positions which the Secretary believes do not meet the requirements for substantial authority under this provision.

Under present law, failure to comply with the various information reporting requirements generally does not, in itself, determine the amount of the penalty imposed on an underpayment of tax. However, such failure to comply may be relevant to (1) establishing negligence under section 6662 or fraudulent intent, 415 (2) determining whether penalties based on culpability are applicable or (3) determining whether certain defenses are available.

In the context of transactions that are subject to the “reportable transaction” disclosure regime, 416 a separate accuracy-related penalty may apply. 417 That penalty applies to “listed transactions” and other “reportable transactions” that have a significant tax avoidance purpose (a “reportable avoidance transaction”). The penalty rate and defenses available to avoid the section 6662A penalty vary, based on the adequacy of disclosure. In general, a 20-percent accuracy-related penalty is imposed on any understatement attributable to an adequately disclosed listed transaction or reportable avoidance transaction. 418 An exception is available if the taxpayer satisfies a higher standard under the reasonable cause and good faith exception. This higher standard requires the taxpayer to demonstrate that there was (1) adequate disclosure of the relevant facts affecting the treatment on the taxpayer's return, (2) substantial authority for the treatment on the taxpayer's return, and (3) a reasonable belief that the treatment on the taxpayer's return was more likely than not the proper treatment. 419 If the transaction is not adequately disclosed, the reasonable cause exception is not available and the taxpayer is subject to a penalty equal to 30 percent of the understatement. 420

Explanation of Provision
The provision adds a new accuracy related penalty to section 6662. The new provision, which is subject to the same defenses as are otherwise available under section 6662, imposes a 40-percent penalty on any understatement attributable to an undisclosed foreign financial asset. The term “undisclosed foreign financial asset” includes all assets subject to certain information reporting requirements 421 for which the required information was not provided by the taxpayer as required under the applicable reporting provisions. An understatement is attributable to an undisclosed foreign financial asset if it is attributable to any transaction involving such asset. Thus, a U.S. person who fails to comply with the various self-reporting requirements for a foreign financial asset and engages in a transaction with respect to that asset incurs a penalty on any resulting underpayment that is double the otherwise applicable penalty for substantial understatements or negligence. For example, if a taxpayer fails to disclose amounts held in a foreign financial account, any underpayment of tax related to the transaction that gave rise to the income would be subject to the penalty provision, as would any underpayment related to interest, dividends or other returns accrued on such undisclosed amounts.

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

3. Modification of statute of limitations for significant omission of income in connection with foreign assets (sec. 513 of the bill and secs. 6229 and 6501 of the Code)
Present Law
Taxes are generally required to be assessed within three years after a taxpayer's return was filed, whether or not it was timely filed. 422 Of the exceptions to this general rule, only section 6501(c)(8) is specifically targeted at the identification of, and collection of information about, cross-border transactions. Under this exception, the limitation period for assessment of any tax imposed under the Code with respect to any event or period to which information about certain cross-border transactions required to be reported relates does not expire any earlier than three years after the required information is actually provided to the Secretary by the person required to file the return. 423 In general, such information reporting is due with the taxpayer's return; thus, the three-year limitation period commences when a timely and complete (including all information reporting) return is filed. Without the inclusion of the information reporting with the return, the limitation period does not commence until such time as the information reports are subsequently provided to the Secretary, even though the return has been filed.

In the case of a false or fraudulent return filed with the intent to evade tax, or if the taxpayer fails to file a required return, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time. 424 The limitation period also may be extended by taxpayer consent. 425 If a taxpayer engages in a listed transaction but fails to include any of the information required under section 6011 on any return or statement for a taxable year, the limitation period with respect to such transaction will not expire before the date which is one year after the earlier of (1) the date on which the Secretary is provided the information so required, or (2) the date that a “material advisor” (as defined in section 6111) makes its section 6112(a) list available for inspection pursuant to a request by the Secretary under section 6112(b)(1)(A). 426

A special rule is provided where there is a substantial omission of income. If a taxpayer omits substantial income on a return, any tax with respect to that return may be assessed and collected within six years of the date on which the return was filed. In the case of income taxes, “substantial” means at least 25 percent of the amount that was properly includible in gross income; for estate and gift taxes, it means 25 percent of a gross estate or total gifts. For this purpose, the gross income of a trade or business means gross receipts, without reduction for the cost of sales or services. 427 An amount is not considered to have been omitted if the item properly includible in income is disclosed on the return. 428

In addition to the exceptions described, there are also circumstances under which the three-year limitation period is suspended. For example, service of an administrative summons triggers the suspension either (1) beginning six months after service (in the case of John Doe summonses) 429 or (2) when a proceeding to quash a summons is initiated by a taxpayer named in a summons to a third-party record-keeper. Judicial proceedings initiated by the government to enforce a summons generally do not suspend the limitation period.

Explanation of Provision
The provision authorizes a new six-year limitations period for assessment of tax on understatements of income attributable to foreign financial assets. The present exception that provides a six-year period for substantial omission of an amount equal to 25 percent of the gross income reported on the return is not changed.

The new exception applies if there is an omission of gross income in excess of $5,000 and the omitted gross income is attributable to an asset with respect to which information reports are required under section 6038D, as applied without regard to the dollar threshold, the statutory exception for nonresident aliens and any exceptions provided by regulation. If a domestic entity is formed or availed of to hold foreign financial assets and is subject to the reporting requirements of section 6038D in the same manner as an individual, the six-year limitations period may also apply to that entity. The Secretary is permitted to assess the resulting deficiency at any time within six years of the filing of the income tax return.

In providing that the applicability of section 6038D information reporting requirements is to be determined without regard to the statutory or regulatory exceptions, the statute ensures that the longer limitation period applies to omissions of income with respect to transactions involving foreign assets owned by individuals. Thus, a regulatory provision that alleviates duplicative reporting obligations by providing that a report that complies with another provision of the Code may satisfy one's obligations under new section 6038D does not change the nature of the asset subject to reporting. The asset remains one that is subject to the requirements of section 6038D for purposes of determining whether the exception to the three-year statute of limitations applies.

The provision also suspends the limitations period for assessment if a taxpayer fails to provide timely information returns required with respect to passive foreign investment corporations 430 and the new self-reporting of foreign financial assets. The limitations period will not begin to run until the information required by those provisions has been furnished to the Secretary. The provision also clarifies that the extension is not limited to adjustments to income related to the information required to be reported by one of the enumerated sections.

Effective Date
The provision applies to returns filed after the date of enactment as well as for any other return for which the assessment period specified in section 6501 has not yet expired as of the date of enactment.

C. Other Disclosure Provisions
1. Reporting of activities with respect to passive foreign investment companies (sec. 521 of the bill and sec. 1298 of the Code)
Present Law
In general, active foreign business income derived by a foreign corporation with U.S. owners is not subject to current U.S. taxation until the corporation makes a dividend distribution to those owners. Certain rules, however, restrict the benefit of deferral of U.S. tax on income derived through foreign corporations. One such regime applies to U.S. persons who own stock of passive foreign investment companies (“PFICs”). A PFIC generally is defined as any foreign corporation if 75 percent or more of its gross income for the taxable year consists of passive income, or 50 percent or more of its assets consist of assets that produce, or are held for the production of, passive income. 431 Various sets of income inclusion rules apply to U.S. persons that are shareholders in a PFIC, regardless of their percentage ownership in the company. One set of rules applies to PFICs under which U.S. shareholders pay tax on certain income or gain realized through the companies, plus an interest charge intended to eliminate the benefit of deferral. 432 A second set of rules applies to PFICs that are “qualified electing funds” (“QEF”), under which electing U.S. shareholders currently include in gross income their respective shares of the company's earnings, with a separate election to defer payment of tax, subject to an interest charge, on income not currently received. 433 A third set of rules applies to marketable PFIC stock, under which electing U.S. shareholders currently take into account as income (or loss) the difference between the fair market value of the stock as of the close of the taxable year and their adjusted basis in such stock (subject to certain limitations), often referred to as “marking to market.” 434

In general, a U.S. person that is a direct or indirect shareholder of a PFIC must file IRS Form 8621, “Return by a Shareholder of a Passive Foreign Investment Company or Qualifying Electing Fund” for each tax year in which that U.S. person (1) recognizes gain on a direct or indirect disposition of PFIC stock, (2) receives certain direct or indirect distributions from a PFIC, or (3) is making a reportable election. 435 The Code includes a general reporting requirement for certain PFIC shareholders which is contingent upon the issuance of regulations. 436 Although Treasury issued proposed regulations in 1992 requiring U.S. persons to file annually Form 8621 for each PFIC of which the person is a shareholder during the taxable year, such regulations have not been finalized and current IRS Form 8621 requires reporting only based on one of the triggering events described above. 437

Explanation of Provision
The provision requires that, unless otherwise provided by the Secretary, each U.S. person who is a shareholder of a PFIC must file an annual information return containing such information as the Secretary may require. A person that meets the reporting requirements of this provision may, however, also meet the reporting requirements of section 511 of the bill and new section 6038D of the Code requiring disclosure of information with respect to foreign financial assets. It is anticipated that the Secretary will exercise regulatory authority under this provision or new section 6038D to avoid duplicative reporting.

Effective Date
The provision is effective on the date of enactment.

2. Secretary permitted to require financial institutions to file certain returns related to withholding on foreign transfers electronically (sec. 522 of the bill and sec. 6011 of the Code).
Present Law
Withholding responsibility
A withholding agent is any person required to withhold U.S. income tax under sections 1441, 1442, 1443, or 1461. For purposes of these sections, a withholding agent is any person, whether a U.S. or a foreign person, that has the control, receipt, custody, disposal, or payment of an item of income of a foreign person subject to withholding. 438 A withholding agent is personally liable for the tax required to be withheld. 439

Reporting liability of a withholding agent
Every withholding agent must file an annual return with the IRS on Form 1042, “Annual Withholding Tax Return for U.S. Source Income of Foreign Persons,” reporting all taxes withheld during the preceding year and remitting any taxes still owing for such preceding year. 440 IRS Form 1042 must be filed on or before March 15 of the year following the year of the payment. The form must be filled even though no tax has been withheld from income paid during the year. 441 A withholding agent must also file an information return, IRS Form 1042-S, which is entitled “Foreign Person's U.S. Source Income Subject to Withholding,” on or before March 15 of year the succeeding the year of payment. IRS Form 1042-S requires the withholding agent to provide all items of income specified in section 1441(b) paid during the previous year to foreign persons. 442 IRS Form 1042-S must be filed for each foreign recipient to whom payments were made during the preceding year, 443 even if no tax was required to have been withheld. A copy of IRS Form 1042-S must be sent to the payee.

IRS's authority to require electronic filing
The Internal Revenue Service Restructuring and Reform Act of 1998 (“RRA 1998”) 444 states that it is a congressional policy to promote the paperless filing of Federal tax returns. Section 2001(a) of RRA 1998 set a goal for the IRS to have at least 80 percent of all Federal tax and information returns filed electronically by 2007. Section 2001(b) of RRA 1998 requires the IRS to establish a 10-year strategic plan to eliminate barriers to electronic filing.

The Secretary has limited authority to issue regulations specifying which returns must be filed electronically. First, such regulations can only apply to persons required to file at least 250 returns during the year. 445 Second, the Secretary is prohibited from requiring that income tax returns of individuals, estates, and trusts be submitted in any format other than paper (although these returns may be filed electronically by choice). Third, the Secretary, in determining which returns must be filed on magnetic media, must take into account relevant factors, including the ability of a taxpayer to comply with magnetic media filing at reasonable cost. 446 Finally, a failure to comply with the regulations mandating electronic filing cannot in itself support a penalty for failure to file an information return, with certain exceptions for corporations and partnerships. 447

Accordingly, the Secretary requires corporations and tax-exempt organizations that have assets of $10 million or more and file at least 250 returns during a calendar year, including income tax, information, excise tax, and employment tax returns to file electronically their Form IRS 1120/1120-S income tax returns and IRS Form 990 information returns for tax years ending on or after December 31, 2006. Private foundations and charitable trusts that file at least 250 returns during a calendar year are required to file electronically their IRS Form 990-PF information returns for tax years ending on or after December 31, 2006, regardless of their asset size. Taxpayers can request waivers of the electronic filing requirement if they cannot meet that requirement due to technological constraints, or if compliance with the requirement would result in undue financial burden.

Explanation of Provision
The provision provides an exception to the general annual 250 returns threshold and permits the Secretary to issue regulations to require filing on magnetic media for any return filed by a “financial institution” 448 with respect to any taxes withheld by the “financial institution” for which it is personally liable. 449 Under the provision, the Secretary is authorized to require a financial institution to electronically file returns with respect to any taxes withheld by the financial institution even though such financial institution would be required to file less than 250 returns during the year.

The provision also makes a conforming amendment to section 6724, permitting assertion of a failure to file penalty under section 6721 against a financial institution that fails to comply with the electronic filing requirements.

Effective Date
The provision applies to returns the due date for which (determined without regard to extensions) is after the date of enactment.

D. Provisions Related to Foreign Trusts
1. Clarifications with respect to foreign trusts which are treated as having a United States beneficiary (sec. 531 of the bill and sec. 679 of the Code)
Present Law
Under the grantor trust rules, a U.S. person that directly or indirectly transfers property to a foreign trust 450 is generally treated as the owner of the portion of the trust comprising the transferred property for any taxable year in which there is a U.S. beneficiary of any portion of the trust. 451 This treatment generally does not apply to transfers by reason of death, or to transfers of property to the trust in exchange for at least the fair market value of the transferred property. 452 A trust is treated as having a U.S. beneficiary for the taxable year unless (1) under the terms of the trust, no part of the income or corpus of the trust may be paid or accumulated during the taxable year to or for the benefit of a U.S. person, and (2) if the trust were terminated at any time during the taxable year, no part of the income or corpus of the trust could be paid to or for the benefit of a U.S. person. 453

Regulations under section 679 employ a broad approach in determining whether a foreign trust is treated as having a U.S. beneficiary. The determination of whether the trust has a U.S. beneficiary is made for each taxable year of the transferor. The default rule under the statute and regulations is that a trust has a U.S. beneficiary unless during the U.S. transferor's taxable year the trust meets the two requirements as stated above. Income or corpus may be paid or accumulated to or for the benefit of a U.S. person if, directly or indirectly, income may be distributed to or accumulated for the benefit of a U.S. person, or corpus of the trust may be distributed to or held for the future benefit of a U.S. person. 454 The determination is made without regard to whether income or corpus is actually distributed, and without regard to whether a U.S. person's interest in the trust income or corpus is contingent on a future event. A person who is not a named beneficiary and is not a member of a class of beneficiaries will not be taken into account if the transferor can show that the person's contingent interest in the trust is so remote as to be negligible. 455 In considering whether a foreign trust has a U.S. beneficiary under the terms of the trust, the trust instrument must be read together with other relevant factors including (1) all written and oral agreements and understandings related to the trust, (2) memoranda or letters of wishes, (3) all records that relate to the actual distribution of income and corpus, and (4) all other documents that relate to the trust, whether or not of any purported legal effect. 456 Other factors taken into account in determining whether a foreign trust is deemed to have a U.S. beneficiary include whether (1) the terms of the trust allow the trust to be amended to benefit a U.S. person, (2) the trust instrument does not allow such an amendment, but the law applicable to the foreign trust may require payments or accumulations of income or corpus to a U.S. person, or (3) the parties to the trust ignore the terms of the trust, or it reasonably expected that they will do so to benefit a U.S. person. 457

If a foreign trust that was not treated as a grantor trust acquires a U.S. beneficiary and is treated as a grantor trust under section 679 for the taxable year, the transferor is taxable on the trust's undistributed net income 458 computed at the end of the preceding taxable year. 459 Any additional amount included in the transferor's gross income as a result of this provision is subject to the interest charge rules of section 668. 460

Explanation of Provision
In determining whether, under section 679, a foreign trust has a U.S. beneficiary, the provision clarifies that an amount is treated as accumulated for the benefit of a U.S. person even if the U.S. person's interest in the trust is contingent on a future event. Under the provision, if any person has the discretion (by authority given in the trust agreement, by power of appointment, or otherwise) to make a distribution from the trust to, or for the benefit of, any person, the trust is treated as having a U.S. beneficiary unless (1) the terms of the trust specifically identify the class of persons to whom such distributions may be made, and (2) none of those persons is a U.S. person during the taxable year. The provision is meant to be consistent with existing regulations under section 679.

The provision clarifies that if any U.S. person who directly or indirectly transfers property to the trust is directly or indirectly involved in any agreement or understanding (whether written, oral, or otherwise) that may result in the income or corpus of the trust being paid or accumulated to or for the benefit of a U.S. person, such agreement or understanding is treated as a term of the trust. It is assumed for these purposes that a transferor of property to the trust is generally directly or indirectly involved with agreements regarding the accumulation or disposition of the income and corpus of the trust.

Effective Date
The provision is effective on the date of enactment.

2. Presumption that foreign trust has United States beneficiary (sec. 532 of the bill and sec. 679 of the Code)
Present Law
Under the grantor trust rules, a U.S. person that directly or indirectly transfers property to a foreign trust 461 is generally treated as the owner of the portion of the trust comprising that property for any taxable year in which there is a U.S. beneficiary of any portion of the trust. 462 This treatment generally does not apply to transfers by reason of death, or to transfers of property to the trust in exchange for at least the fair market value of the transferred property. 463 A trust is treated as having a U.S. beneficiary for the taxable year unless (1) under the terms of the trust, no part of the income or corpus of the trust may be paid or accumulated during the taxable year to or for the benefit of a U.S. person, and (2) if the trust were terminated at any time during the taxable year, no part of the income or corpus of the trust could be paid to or for the benefit of a U.S. person. 464

Section 6048 imposes various reporting obligations on foreign trusts and persons creating, making transfers to, or receiving distributions from such trusts. Within 90 days after a U.S. person transfers property to a foreign trust, the transferor must provide written notice of the transfer to the Secretary. 465

Explanation of Provision
Under the provision, if a U.S. person directly or indirectly transfers property to a foreign trust, 466 the Secretary may treat the trust as having a U.S. beneficiary for purposes of section 679 unless such U.S. person submits information as required by the Secretary and demonstrates to the satisfaction of the Secretary that (1) under the terms of the trust, no part of the income or corpus of the trust may be paid or accumulated during the taxable year to or for the benefit of a U.S. person, and (2) if the trust were terminated during the taxable year, no part of the income or corpus of the trust could be paid to or for the benefit of a U.S. person.

Effective Date
The provision applies to transfers of property after the date of enactment.

3. Uncompensated use of trust property (sec. 533 of the bill and secs. 643 and 679 of the Code)
Present Law
Under section 643(i), a loan of cash or marketable securities made by a foreign trust to any U.S. grantor, U.S. beneficiary, or any other U.S. person who is related to a U.S. grantor or U.S. beneficiary is treated as a distribution by the foreign trust to such grantor or beneficiary. This rule applies for purposes of determining if the foreign trust is a simple or complex trust, computing the distribution deduction for the trust, determining the amount of gross income of the beneficiaries, and computing any accumulation distribution. Loans to tax-exempt entities are excluded from this rule. 467 A trust treated under this rule as making a distribution is not treated as a simple trust for the year of the distribution. 468 This rule does not apply for purposes of determining if a trust has a U.S. beneficiary under section 679.

A subsequent repayment, satisfaction, or cancellation of a loan treated as a distribution under section 643(i) is disregarded for tax purposes. 469 This section applies a broad set of related party rules that treat a loan of cash or marketable securities to a spouse, sibling, ancestor, descendant of the grantor or beneficiary, other trusts in which the grantor or beneficiary has an interest, and corporations or partnerships controlled by the beneficiary or grantor or by family members of the beneficiary or grantor, as a distribution to the related grantor or beneficiary. 470

Explanation of Provision
The provision expands section 643(i) to provide that any use of trust property by the U.S. grantor, U.S. beneficiary or any U.S. person related to a U.S. grantor or U.S. beneficiary is treated as a distribution of the fair market value of the use of the property to the U.S. grantor or U.S. beneficiary. The use of property is not treated as a distribution to the extent that the trust is paid the fair market value for the use of the property within a reasonable period of time. A subsequent return of property treated as a distribution under section 643(i) is disregarded for tax purposes.

For purposes of determining whether a foreign trust has a U.S. beneficiary under section 679, a loan of cash or marketable securities or the use of any other trust property by a U.S. person is treated as a payment from the trust to the U.S. person in the amount of the loan or the fair market value of the use of the property. A loan or use of property is not treated as a payment to the extent that the U.S. person repays the loan at a market rate of interest or pays the fair market value for the use of the trust property within a reasonable period of time.

Effective Date
The provision applies to loans made and uses of property after the date of enactment.

4. Reporting requirement of United States owners of foreign trusts (sec. 534 of the bill and sec. 6048 of the Code)
Present Law
Section 6048 imposes various reporting obligations on foreign trusts and persons creating, making transfers to, or receiving distributions from such trusts. If a U.S. person is treated as the owner of any portion of a foreign trust under the rules of subpart E of part I of subchapter J of chapter 1 (grantor trust provisions), the U.S. person is responsible for ensuring that the trust files a tax return for the year and that the trust provides other information as the Secretary may require to each U.S. person who (1) is treated as the owner of any portion of the trust, or (2) receives (directly or indirectly) any distribution from the trust. 471

Explanation of Provision
The provision requires a U.S. person that is treated as an owner of any portion of a foreign trust under the rules of subpart E of part I of subchapter J of chapter 1 (grantor trust provisions) to provide information as the Secretary may require with respect to the trust, in addition to ensuring that the trust complies with its reporting obligations.

Effective Date
The provision applies to taxable years beginning after the date of enactment.

5. Minimum penalty with respect to failure to report on certain foreign trusts (sec. 535 of the bill and sec. 6677 of the Code)
Present Law
Minimum penalty with respect to failure to report on certain foreign trusts
Section 6048 imposes various reporting obligations on foreign trusts and persons creating, making transfers to, or receiving distributions from such trusts. Generally, a trust is a foreign trust unless a U.S. court is able to exercise primary supervision over the trust's administration and a U.S. trustee has authority to control all substantial decisions of the trust. 472 If a U.S. person creates or transfers property to a foreign trust, the U.S. person generally must report this event and certain other information by the due date for the U.S. person's tax return, including extensions, for the tax year in which the creation of the trust or the transfer occurs. 473 Similar rules apply in the case of the death of a U.S. citizen or resident if the decedent was treated as the owner of any portion of a foreign trust under the grantor trust rules or if any portion of a foreign trust was included in the decedent's gross estate. If a U.S. person directly or indirectly receives a distribution from a foreign trust, the U.S. person generally must report the distribution by the due date for the U.S. person's tax return, including extensions, for the tax year during which the distribution is received. 474 If a U.S. person is the owner of any portion of a foreign grantor trust at any time during the year, the person is responsible for causing an information return to be filed for the trust, which must, among other things, give the name of a U.S. agent for the trust. 475

If a notice or return required under the rules just described is not filed when due or is filed without all required information, the person required to file is generally subject to a penalty based on the “gross reportable amount.” 476 The gross reportable amount is (1) the value of the property transferred to the foreign trust if the delinquency is failure to file notice of the creation of or a transfer to a foreign trust; (2) the value (on the last day of the year) of the portion of a grantor trust owned by a U.S. person who fails to cause an annual return to be filed for the trust; and (3) the amount distributed to a distributee who fails to report distributions. 477 The initial penalty is 35 percent of the gross reportable amount in cases (1) and (3) and five percent in case (2). 478 If the return is more than 90 days late, additional penalties are imposed of $10,000 for every 30 days the delinquency continues, except that the aggregate of the penalties may not exceed the gross reportable amount. 479

Maximum penalty with respect to failure to report on certain foreign trusts
In no event may the penalties imposed with respect to any failure to report under section 6048 exceed the gross reportable amount. 480

Explanation of Provision
Increase of the minimum penalty with respect to failure to report on certain foreign trusts
Under the provision, the initial penalty for failing to report under section 6048 is the greater of $10,000 or 35 percent of the gross reportable amount in cases (1) and (3) and the greater of $10,000 or five percent of the gross reportable amount in case (2). Thus, an initial penalty of $10,000 may be imposed even where the Secretary has insufficient information to determine the gross reportable amount. The additional $10,000 penalty for every additional 30 days of delinquency continues to apply.

Amendment to the maximum penalty with respect to failure to report on certain foreign trusts
The provision provides that the penalties with respect to failure to report on certain foreign trusts may exceed the gross reportable amount. However, to the extent that a taxpayer provides sufficient information for the Secretary to determine that the aggregate amount of the penalties exceeds the gross reportable amount, the Secretary is required to refund such excess to the taxpayer.

Effective Date
The provision applies to notices and returns required to be filed after December 31, 2009.

E. Substitute Dividends and Dividend Equivalent Payments Received by Foreign Persons Treated as Dividends (sec. 541 of the bill and sec. 871 of the Code)
Present Law
Payments of U.S.-source “fixed or determinable annual or periodical” income, including interest, dividends, and similar types of investment income, made to foreign persons are generally subject to U.S. tax, collected by withholding, at a 30-percent rate, unless the withholding agent can establish that the beneficial owner of the amount is eligible for an exemption from withholding or a reduced rate of withholding under an income tax treaty. 481 Dividends paid by a domestic corporation are generally U.S.-source 482 and therefore potentially subject to withholding tax when paid to foreign persons.

The source of notional principal contract income generally is determined by reference to the residence of the recipient of the income. 483 Consequently, a foreign person's income related to a notional principal contract that references stock of a domestic corporation, including any amount attributable to, or calculated by reference to, dividends paid on the stock, generally is foreign source and is therefore not subject to U.S. withholding tax.

In contrast, a substitute dividend payment made to the transferor of stock in a securities lending transaction or a sale-repurchase transaction is sourced in the same manner as actual dividends paid on the transferred stock. 484 Accordingly, because dividends paid with respect to the stock of a U.S. company are generally U.S. source, if a foreign person lends stock of a U.S. company to another person (or sells the stock to the other person and later repurchases the stock in a transaction treated as a loan for U.S. federal income tax purposes) and receives substitute dividend payments from that other person, the substitute dividend payments are U.S. source and are generally subject to U.S. withholding tax. 485 In 1997, the Treasury and IRS issued Notice 97-66 to address concerns that the sourcing rule just described (and the accompanying character rule) could cause the total U.S. withholding tax imposed in a series of securities lending or sale-repurchase transactions to be excessive. 486 In that Notice, the Treasury and IRS also stated that they intended to propose new regulations to provide detailed guidance on how substitute dividend payments made by one foreign person to another foreign person were to be treated. To date, no regulations have been proposed. 487

Explanation of Provision
The provision treats a dividend equivalent as a dividend from U.S. sources for certain purposes, including the U.S. withholding tax rules applicable to foreign persons.

A dividend equivalent is any substitute dividend (as defined in Treas. Reg. section 1.861-3(a)(6)) or any payment made under a specified notional principal contract that directly or indirectly is contingent upon, or determined by reference to, the payment of a dividend from sources within the United States. A dividend equivalent also includes any other payment that the Secretary determines is substantially similar to a payment described in the immediately preceding sentence. Under this rule, for example, the Secretary may conclude that payments under certain forward contracts or other financial contracts that reference stock of U.S. corporations are dividend equivalents.

A specified notional principal contract is any notional principal contract that has any one of the following five characteristics: (1) In connection with entering into the contract, any long party transfers the underlying security; 488 (2) in connection with the termination of the contract, any short party transfers the underlying security to any long party; (3) the underlying security is not readily tradable on an established securities market; (4) in connection with entering into the contract, any short party to the contract posts the underlying security as collateral; or (5) the Secretary identifies the contract as a specified notional principal contract. 489 For purposes of these characteristics, for any underlying security of any notional principal contract (1) a long party is any party to the contract that is entitled to receive any payment under the contract that is contingent upon or determined by reference to the payment of a U.S.-source dividend on the underlying security, and (2) a short party is any party to the contract that is not a long party in respect of the underlying security. An underlying security in a notional principal contract is the security with respect to which the dividend equivalent is paid. For these purposes, any index or fixed basket of securities is treated as a single security.

For payments made more than two years after the provision's date of enactment, a specified notional principal contract also includes any notional principal contract unless the Secretary determines that the contract is of a type that does not have the potential for tax avoidance.

No inference is intended as to whether the definition of specified notional principal contract, or any determination under this provision that a transaction does not have the potential for the avoidance of taxes on U.S.-source dividends, is relevant in determining whether an agency relationship exists under general tax principles or whether a foreign party to a contract should be treated as having beneficial tax ownership of the stock giving rise to U.S.-source dividends.

The payments that are treated as U.S.-source dividends under the provision are the gross amounts that are used in computing any net amounts transferred to or from the taxpayer. The example of a “total return swap” referencing stock of a domestic corporation (an example of a notional principal contract to which the provision generally applies), illustrates the consequences of this rule. Under a typical total return swap, a foreign investor enters into an agreement with a counterparty under which amounts due to each party are based on the returns generated by a notional investment in a specified dollar amount of the stock underlying the swap. The investor agrees for a specified period to pay to the counterparty (1) an amount calculated by reference to a market interest rate (such as the London Interbank Offered Rate (“LIBOR”)) on the notional amount of the underlying stock and (2) any depreciation in the value of the stock. In return, the counterparty agrees for the specified period to pay the investor (1) any dividends paid on the stock and (2) any appreciation in the value of the stock. Amounts owed by each party under this swap typically are netted so that only one party makes an actual payment. The provision treats any dividend-based amount under the swap as a payment even though any actual payment under the swap is a net amount determined in part by other amounts (for example, the interest amount and the amount of any appreciation or depreciation in value of the referenced stock). Accordingly, a counterparty to a total return swap may be obligated to withhold and remit tax on the gross amount of a dividend equivalent even though, as a result of a netting of payments due under the swap, the counterparty is not required to make an actual payment to the foreign investor.

If there is a chain of dividend equivalents (under, for example, transactions similar to those described in Notice 97-66), and one or more of the dividend equivalents is subject to tax under the provision or under section 881, the Secretary may reduce that tax, but only to the extent that the taxpayer establishes that the tax has been paid on another dividend equivalent in the chain. An actual dividend is treated as a dividend equivalent for purposes of this rule.

For purposes of chapter 3 (withholding of tax on nonresident aliens and foreign corporations) and chapter 4 (taxes to enforce reporting on certain foreign accounts), each person that is a party to a contract or other arrangement that provides for the payment of a dividend equivalent is treated as having control of the payment. Accordingly, Treasury may provide guidance requiring either party to withhold tax on dividend equivalents.

The rule treating dividend equivalents as U.S.-source dividends is not intended to limit the authority of the Secretary (1) to determine the appropriate source of income from financial arrangements (including notional principal contracts) under present law section 863 or 865 or (2) to provide additional guidance addressing the source and characterization of substitute payments made in securities lending and similar transactions.

Effective Date
The provision applies to payments made on or after the date that is 90 days after the date of enactment.

TITLE VI - OTHER REVENUE PROVISIONS
A. Income of Partners for Performing Investment Management Services Treated as Ordinary Income Received for Performance of Services (secs. 601 and 602 of the bill and secs. 83, 710, 856, 1402, 6662, 6662A, 6664, and 7704 of the Code)
Present Law
Partnership profits interest for services
A profits interest in a partnership is the right to receive future profits in the partnership but does not generally include any right to receive money or other property upon the immediate liquidation of the partnership. The treatment of the receipt of a profits interest in a partnership (sometimes referred to as a carried interest) in exchange for the performance of services has been the subject of controversy. Though courts have differed, in some instances, a taxpayer receiving a profits interest for performing services has not been taxable upon the receipt of the partnership interest. 490

In 1993, the Internal Revenue Service, referring to the results of cases, issued administrative guidance that the IRS generally would treat the receipt of a partnership profit interest for services as not a taxable event for the partnership or the partner. 491 Under this guidance, this treatment does not apply, however, if: (1) the profits interest relates to a substantially certain and predictable stream of income from partnership assets, such as income from high-quality debt securities or a high-quality net lease; (2) within two years of receipt, the partner disposes of the profits interest; or (3) the profits interest is a limited partnership interest in a publicly traded partnership. More recent administrative guidance 492 clarifies that this treatment applies provided the service partner takes into income his distributive share of partnership income, and the partnership does not deduct any amount either on grant or on vesting of the profits interest. 493

By contrast, a partnership capital interest received for services is includable in the partner's income under generally applicable rules relating to the receipt of property for the performance of services. 494 A partnership capital interest for this purpose is an interest that would entitle the receiving partner to a share of the proceeds if the partnership's assets were sold at fair market value and the proceeds were distributed in liquidation. 495

Property received for services under section 83
In general
Section 83 governs the amount and timing of income and deductions attributable to transfers of property in connection with the performance of services. If property is transferred in connection with the performance of services, the person performing the services (the “service provider”) generally must recognize income for the taxable year in which the property is first substantially vested (i.e., transferable or not subject to a substantial risk of forfeiture). The amount includible in the service provider's income is the excess of the fair market value of the property over the amount (if any) paid for the property. A deduction is allowed to the person for whom such services are performed (the “service recipient”) equal to the amount included in gross income by the service provider. 496 The deduction is allowed for the taxable year of the service recipient in which or with which ends the taxable year in which the amount is included in the service provider's income.

Property that is subject to a substantial risk of forfeiture and that is not transferable is generally referred to as “substantially nonvested.” Property is subject to a substantial risk of forfeiture if the individual's right to the property is conditioned on the future performance (or refraining from performance) of substantial services. In addition, a substantial risk of forfeiture exists if the right to the property is subject to a condition other than the performance of services, provided that the condition relates to a purpose of the transfer and there is a substantial possibility that the property will be forfeited if the condition does not occur.

Section 83(b) election
Under section 83(b), even if the property is substantially nonvested at the time of transfer, the service provider may nevertheless elect within 30 days of the transfer to recognize income for the taxable year of the transfer. Such an election is referred to as a “section 83(b) election.” The service provider makes an election by filing with the IRS a written statement that includes the fair market value of the property at the time of transfer and the amount (if any) paid for the property. The service provider must also provide a copy of the statement to the service recipient.

Proposed regulations on compensatory transfer of a partnership interest
The Department of Treasury has issued proposed regulations regarding the application of section 83 to the compensatory transfer of a partnership interest. 497 The proposed regulations provide that a partnership interest is “property” for purposes of section 83. Thus, a compensatory transfer of a partnership interest is includible in the service provider's gross income at the time that it first becomes substantially vested (or, in the case of a substantially nonvested partnership interest, at the time of grant if a section 83(b) election is made).

However, because the fair market value of a compensatory partnership interest is often difficult to determine, the proposed regulations also permit a partnership and a partner to elect a safe harbor under which the fair market value of a compensatory partnership interest is treated as being equal to the liquidation value of that interest. Therefore, in the case of a true profits interest (one under which the partner would be entitled to nothing if the partnership were liquidated immediately following the grant) in a partnership, under the proposed regulations, the grant of a substantially vested profits interest (or, if a section 83(b) election is made, the grant of a substantially nonvested profits interest) results in no income inclusion under section 83 because the fair market value of the property received by the service provider is zero. The proposed safe harbor is subject to a number of conditions. For example, the election cannot be made retroactively and must apply to all compensatory partnership transfers that occur during the period that the election is in effect.

Passthrough tax treatment of partnerships
The character of partnership items passes through to the partners, as if the items were realized directly by the partners. 498 Thus, for example, long-term capital gain of the partnership is treated as long-term capital gain in the hands of the partners.

A partner holding a partnership interest includes in income its distributive share (whether or not actually distributed) of partnership items of income and gain, including capital gain eligible for the lower tax rates. A partner's basis in the partnership interest is increased by any amount of gain thus included and is decreased by losses. These basis adjustments prevent double taxation of partnership income to the partner, preserving the partnership's tax status as a passthrough entity. Amounts distributed to the partner by the partnership are taxed to the extent the amount exceeds the partner's basis in the partnership interest.

Employment tax treatment of partners
As part of the financing for Social Security and Medicare benefits, a tax is imposed on the wages of an individual received with respect to his or her employment under the Federal Insurance Contributions Act (“FICA”). 499 A similar tax is imposed on the net earnings from self-employment of an individual under the Self-Employment Contributions Act (“SECA”). 500

The FICA tax has two components. Under the old-age, survivors, and disability insurance component (“OASDI”), the rate of tax is 12.4 percent, half of which is imposed on the employer, and the other half of which is imposed on the employee. 501 The amount of wages subject to this component is capped at $106,800 for 2009. Under the hospital insurance (“HI”) component, the rate is 2.9 percent, also split equally between the employer and the employee. The amount of wages subject to the HI component of the tax is not capped. The wages of individuals employed by a business in any form (for example, a C corporation) generally are subject to the FICA tax. 502

The SECA tax rate is the combined employer and employee rate for FICA taxes. Under the OASDI component, the rate of tax is 12.4 percent and the amount of earnings subject to this component is capped at $106,800 for 2009. Under the HI component, the rate is 2.9 percent, and the amount of self-employment income subject to the HI component is not capped.

For SECA tax purposes, net earnings from self-employment means the gross income derived by an individual from any trade or business carried on by the individual, less the deductions attributable to the trade or business that are allowed under the self-employment tax rules. 503 Specified types of income or loss are excluded, such as rentals from real estate in certain circumstances, dividends and interest, and gains or loss from the sale or exchange of a capital asset or from timber, certain minerals, or other property that is neither inventory nor held primarily for sale to customers.

For an individual who is a partner in a partnership, the net earnings from self-employment generally include the partner's distributive share (whether or not distributed) of income or loss from any trade or business carried on by the partnership (excluding specified types of income, such as capital gains and dividends, as described above). This rule applies to individuals who are general partners.

A special rule applies for limited partners of a partnership. 504 In determining a limited partner's net earnings from self-employment, an exclusion is provided for his or her distributive share of partnership income or loss. The exclusion does not apply with respect to guaranteed payments to the limited partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services.

Income tax treatment of publicly traded partnerships
Under present law, a publicly traded partnership generally is treated as a corporation for Federal tax purposes (sec. 7704(a)). For this purpose, a publicly traded partnership means any partnership if interests in the partnership are traded on an established securities market, or interests in the partnership are readily tradable on a secondary market (or the substantial equivalent thereof).

An exception from corporate treatment is provided for certain publicly traded partnerships, 90 percent or more of whose gross income is qualifying income (sec. 7704(c)(2)). However, this exception does not apply to any partnership that would be described in section 851(a) if it were a domestic corporation, which includes a corporation registered under the Investment Company Act of 1940 as a management company or unit investment trust.

Qualifying income includes interest, dividends, and gains from the disposition of a capital asset (or of property described in section 1231(b)) that is held for the production of income that is qualifying income. Qualifying income also includes rents from real property, gains from the sale or other disposition of real property, and income and gains from the exploration, development, mining or production, processing, refining, transportation (including pipelines transporting gas, oil, or products thereof), or the marketing of any mineral or natural resource (including fertilizer, geothermal energy, and timber). It also includes income and gains from commodities (not described in section 1221(a)(1)) or futures, options, or forward contracts with respect to such commodities (including foreign currency transactions of a commodity pool) in the case of a partnership, a principal activity of which is the buying and selling of such commodities, futures, options or forward contracts.

The rules generally treating publicly traded partnerships as corporations were enacted in 1987 to address concern about long-term erosion of the corporate tax base. At that time, Congress stated, “[t]o the extent that activities would otherwise be conducted in corporate form, and earnings would be subject to two levels of tax (at the corporate and shareholder levels), the growth of publicly traded partnerships engaged in such activities tends to jeopardize the corporate tax base.” (H.R. Rep. No. 100-391, 100th Cong., 1st Sess. 1065.) Referring to recent tax law changes affecting corporations, the Congress stated, “[t]hese changes reflect an intent to preserve the corporate level tax. The committee is concerned that the intent of these changes is being circumvented by the growth of publicly traded partnerships that are taking advantage of an unintended opportunity for disincorporation and elective integration of the corporate and shareholder levels of tax.” (H.R. Rep. No. 100-391, 100th Cong., 1st Sess. 1066.)

The 1987 legislation provided a transition rule grandfathering existing partnerships for 10 years. Under the transition rule, in the case of partnerships existing on December 31, 1987, the general rule treating publicly traded partnerships as corporations applied for taxable years beginning after December 31, 1997. 505 A partnership was not treated as an existing partnership for this purpose if a substantial new line of business was added.

Real estate investment trusts (REITs)
A real estate investment trust (“REIT”) is an entity that derives most of its income from passive real-estate-related investments. A REIT must satisfy a number of tests on an annual basis that relate to the entity's organizational structure, the source of its income, and the nature of its assets. If an electing entity meets the requirements for REIT status, the portion of its income that is distributed to its investors each year generally is treated as a dividend deductible by the REIT and includible in income by its investors. In this manner, the distributed income of the REIT is not taxed at the entity level. The distributed income is taxed only at the investor level. A REIT generally is required to distribute 90 percent of its income (other than net capital gain) to its investors before the end of its taxable year.

In order for an entity to qualify as a REIT, at least 95 percent of its gross income generally must be derived from certain passive sources (the “95-percent income test”). In addition, at least 75 percent of its income generally must be from certain real estate sources (the “75-percent income test”), including rents from real property (as defined) and gain from the sale or other disposition of real property. Amounts received as impermissible “tenant services income” are not treated as rents from real property. 506 In general, such amounts are for services rendered to tenants that are not “customarily furnished” in connection with the rental of real property. In addition, at least 75 percent of the value of its total assets must be represented by real estate assets, cash and cash items (including receivables), and Government securities, and maximum percentages apply to ownership of other types of securities (the “asset test”).

Accuracy-related penalties
An accuracy-related penalty of 20 percent is imposed under section 6662 on the portion of any underpayment of tax attributable to (1) negligence, (2) any substantial understatement of income tax, (3) any substantial valuation misstatement, (4) any substantial overstatement of pension liabilities, or (5) any substantial estate or gift tax valuation understatement. 507 An understatement of income tax is the excess of the amount of tax properly required to be shown on a return over the amount actually shown on the return, subject to certain reductions. 508 An understatement is substantial for a noncorporate taxpayer if the amount of the understatement exceeds the greater of (1) 10 percent of the correct tax liability or (2) $5,000. 509 For corporate taxpayers an understatement is substantial if it exceeds the lesser of (1) 10 percent of the correct tax liability (or $10,000 if greater) or (2) $10,000,000. 510

Similarly, section 6662A imposes a 20-percent penalty on reportable transaction understatements, that is, understatements involving listed transactions or any reportable transaction (other than a listed transaction) if a significant purpose of the transaction is the avoidance or evasion of Federal income tax. 511 The penalty rate is increased to 30 percent for transactions subject to 6662A which are not adequately disclosed in accordance with section 6011 and the regulations promulgated thereunder. 512

The section 6662 accuracy-related penalty is not imposed on an underpayment (or portion thereof) if the taxpayer demonstrates a reasonable cause for the underpayment and the taxpayer acted in good faith. 513 The section 6662A reportable transaction understatement penalty is subject to a more stringent reasonable cause exception (commonly referred to as the “strengthened reasonable cause exception”). In addition to demonstrating reasonable cause and good faith, to avoid application of the section 6662A penalty a taxpayer must demonstrate (1) adequate disclosure of the facts affecting the transaction in accordance with the regulations under section 6011, (2) that there is or was substantial authority for such treatment, and (3) reasonable belief that such treatment was more likely than not the proper treatment. A reasonable belief must be based on the facts and law as they exist at the time that the return in question is filed and must relate solely to the taxpayer's chances of success on the merits of the treatment. 514 Moreover, reliance on professional advice may support a taxpayer's reasonable belief only in certain circumstances. 515

Explanation of Provision
Partnership interests transferred in connection with the performance of services under section 83
In the case of a transfer after the date of enactment of any interest in a partnership in connection with the provision of services to or for the benefit of the partnership, the bill provides for a determination of the fair market value of the partnership interest, and provides that the recipient of the partnership interest is deemed to have made the section 83(b) election unless the person affirmatively elects otherwise. Thus, absent such an election, a transferee of a partnership interest for services must include in income for the taxable year of the transfer the fair market value (if any) of the partnership interest.

For purposes of section 83, the fair market value of the partnership interest is generally its liquidation value; that is, specifically, the fair market value is deemed to be the amount the partner would receive if, at the time of transfer of the partnership interest, the partnership had sold all its assets at fair market value and distributed the proceeds (reduced by partnership liabilities) to the partners in liquidation of the partnership.

Recharacterization as ordinary income
The provision generally treats net income from an investment services partnership interest as ordinary income except to the extent it is attributable to the partner's qualified capital interest. Thus, the provision recharacterizes the partner's distributive share of income from the partnership, regardless of whether such income would otherwise be treated as capital gain, dividend income, or any other type of income in the hands of the partner. Such income is taxed at ordinary income rates and is subject to self-employment tax.

Net income means, with respect to an investment services partnership interest, the excess (if any) of (1) all items of income and gain taken into account by the partner with respect to the partnership interest for the partnership taxable year, over (2) all items of deduction and loss taken into account by the partner with respect to the partnership interest for the partnership taxable year. All items of income, gain, deduction, and loss that are taken into account in computing net income (or net loss) are treated as ordinary income (or ordinary loss, as the case may be). Any amount treated as ordinary income or ordinary loss from an investment services partnership interest is included in determining net earnings from self-employment.

The provision provides that an investment services partnership interest is a partnership interest held (directly or indirectly) by any person if it was reasonably expected (at the time the person acquired the partnership interest) that the person (or any related person) would provide, or already has provided, (directly or indirectly) a substantial quantity of certain services with respect to assets held (directly or indirectly) by the partnership. The services are: (1) advising as to the advisability of investing in, purchasing, or selling any specified asset; (2) managing, acquiring, or disposing of any specified asset; (3) arranging financing with respect to acquiring specified assets; (4) any activity in support of any of the foregoing services. Activities in support of these services are intended to include supervising others who perform the services as well as assisting others who perform the services.

For this purpose, specified assets means securities (as defined in section 475(c)(2) without regard to the last sentence), real estate held for rental or investment, interests in partnerships, commodities (as defined in section 475(e)(2)), or options or derivative contracts with respect to such securities, real estate, partnership interests, or commodities. A security for this purpose means any (1) share of corporate stock, (2) partnership interest or beneficial ownership interest in a widely held or publicly traded partnership or trust, (3) note, bond, debenture, or other evidence of indebtedness, (4) interest rate, currency, or equity notional principal contract, (5) interest in, or derivative financial instrument in, any such security or any currency (regardless of whether section 1256 applies to the contract), and (6) position that is not such a security and is a hedge with respect to such a security and is clearly identified. A partnership interest includes any partnership interest that is not otherwise treated as a security for purposes of the provision (for example, an interest in a partnership that is not widely held or publicly traded). For example, assume that a private equity fund acquires an interest in an operating business conducted in the form of a non-publicly traded partnership that is not widely held; the partnership interest is a specified asset for purposes of the provision. 516 For purposes of the provision, real estate held for rental or investment does not include, for example, real estate on which the holder operates an active farm. A commodity for this purpose means a (1) commodity that is actively traded, (2) notional principal contract with respect to such a commodity, (3) interest in, or derivative financial instrument in, such a commodity, or (4) position that is not such a commodity and is a hedge with respect to such a commodity and is clearly identified.

For purposes of this rule, assets held (directly or indirectly) by the partnership are considered to include assets held through any other entity, including a corporation. It is intended that the general rule not be avoided by means of arrangements though which a partner has the right to income or gains based on the performance of assets while taking the position that the partnership does not directly or indirectly hold the assets. Similarly, it is intended that the general rule not be avoided by disposing at capital gains rates (or on a tax-favored basis) of rights to receive income or gains based on the performance of assets. Treasury regulatory authority is provided to implement this intent. For example, such a disposition may be treated as giving rise to ordinary income under Treasury guidance under the provision (described below) relating to a disqualified interest in the form of a derivative instrument with respect to an entity.

The provision does not apply to services other than those giving rise to an investment services partnership interest. For example, assume that three individuals form a partnership to operate a biotechnology business; two each contribute $1 million in cash, and the third contributes his personal services as a research scientist. In the following year, the business profits of the partnership are $300,000, and the partnership agreement provides that each of the three partners' distributive share is $100,000. The profits are ordinary income to the partners under present law, so the provision does not affect the income tax rate applicable to the partners. 517 In the following year, the third partner sells his partnership interest. Because the third partner's services do not consist of the services described above, the gain on sale of the partnership interest is not subject to recharacterization under the provision. As another example, assume instead that a partnership of three individuals is formed to manage investments in specified assets. The first two individuals contribute $1 million each and the third contributes his personal services advising the partnership as to the advisability of investing in particular specified assets, and managing, acquiring, arranging financing for, and disposing of such assets. In the following year, the profits of the partnership are $300,000, and the partnership agreement provides that each of the three partners' distributive share is $100,000. Because the third partner's services consist of the services described above with respect to specified assets, the third partner's share of profits is subject to recharacterization under the provision. When the third partner sells his partnership interest in the following year, the gain is recharacterized as ordinary income under the provision. 518

Exception for qualified capital interest
In general
The provision provides an exception to recharacterization as ordinary in the case of items of income, gain, loss, and deduction that are allocated to the portion of an investment services partnership interest that is a qualified capital interest, provided other requirements are met.

Allocations to qualified capital interests
These requirements are met if (1) items are allocated to the service providing partner's qualified capital interest in the same manner as the items are allocated to other qualified capital interests of partners that do not provide any of the described services and that are not related to the service-providing partner, and (2) the allocations made to the qualified capital interests of unrelated non-service providing partners are significant compared to the allocations made to the service providing partner's qualified capital interest.

Items allocated among the partners in proportion to each partner's qualified capital may be considered as allocated in the same manner, under this rule, if the qualified capital interests to which the allocations are made are substantially identical as to the degree of risk and with respect to all other economically significant aspects, benefits and burdens. For example, items are not allocated in the same manner under this rule if they are allocated in the same proportion to riskier interests and to safer interests. Similarly, items are not considered as allocated in the same manner under this rule if allocations to qualified capital interests of nonservice providing partners are artificially high while returns that are below market, or artificially low, are made to other types of interests (for example, debt) held by the nonservice providing partners.

A special rule applies in the case of no or insignificant partnership allocations to unrelated nonservice providers. The special rule applies, to the extent provided in Treasury guidance, in any case in which allocations to unrelated nonservice providers' qualified capital interests are not significant compared to allocations made to the service provider's qualified capital interest. Under the special rule, partnership items of income, gain, loss, and deduction are not recharacterized as ordinary under the general rule of the provision, to the extent the items are properly allocable to the qualified capital interests as provided in the Treasury guidance.

For example, it would be appropriate for Treasury guidance to implement the special rule in the case in which all of the partners of the partnership are service providers, so there are no unrelated nonservice providers. It is anticipated that Treasury guidance may provide that pro rata allocation of partnership items to qualified capital interests generally satisfies the special rule in this situation. It is anticipated that the Treasury guidance will take into account whether the partnership agreement provides for proper allocation of the items among the partners and, with respect to a service provider, as between the partner's qualified capital interest and the remainder of the partner's interest in the partnership.

Definition of qualified capital interest
A qualified capital interest means the amount of a partner's interest in partnership capital attributable to (1) the fair market value of money or other property contributed by the partner to the partnership in exchange for the partnership interest (determined without regard to the deemed contribution rules of section 752(a), and without regard to any other deemed contribution), (2) the amount included in the partner's gross income under section 83 with respect to the transfer of the partnership interest by the partnership for services, and (3) the partner's distributive share of cumulative net income and gain of the partnership included in the partner's income, if any, that has not been distributed by the partnership in taxable years to which the provision applies. The qualified capital interest is reduced by partnership distributions to the partner in taxable years to which the provision applies, and by the partner's share of partnership losses, if any.

In the case of the transfer of an investment services partnership interest in a fully taxable transaction, the transferee partner accedes to the amount of the qualified capital account of the transferor partner. Unlike the basis rules of section 743 in the case of a transfer of a partnership interest, only the amount of the transferor's qualified capital interest is treated as the transferee's qualified capital interest. A qualified capital interest does not include any amount paid to a person other than the partnership; for example, such an interest does not include the price of a partnership interest acquired by purchase from another partner. It is intended that rules similar to the rules of section 197(f)(9) apply.

Loans, advances, guarantees
For purposes of the exception for qualified capital interests, an investment services partnership interest is not treated as acquired by contribution of capital by a service providing partner to the extent of any loan or other advance made or guaranteed, directly or indirectly, by any other partner or the partnership (or by a person related to that other partner or the partnership). For example, if partner A loans partner B funds that partner B contributes to the partnership, the loaned amount is not a qualified capital interest of partner B.

In addition, for this purpose, any loan or other advance to the partnership made or guaranteed, directly or indirectly by a partner not providing services to the partnership is treated as the capital interest of that partner, for purposes of determining the amount of the service-providing partner's qualified capital interest (but not, however, for purposes of comparing allocations to the service provider's qualified capital interest to qualified capital interests of non-service-providing unrelated partners). Income and loss treated as allocable to capital interests of partners are adjusted accordingly.

For example, if investors in a private equity fund that is a partnership contribute capital primarily as debt rather than as equity, while the manager of the fund contributes only equity so that his capital interest appears to be a large percentage of the total equity contributed, the provision treats the partnership debt to the investors as the investors' capital interests for this purpose. The percentage of total capital interests that is attributable to the fund manager in this example is determined taking into account this debt as well as the equity contributed to the fund, so the manager's capital interest is a smaller percentage of total capital interests than if only equity contributions were taken into account.

Losses, dispositions, and partnership distributions
The provision provides rules for the treatment of losses with respect to an investment services partnership interest, as well as rules for disposition of all or a portion of such a partnership interest, and rules for distributions of partnership property with respect to such a partnership interest.

Losses
Consistent with the general rule providing that net income with respect to such a partnership interest is ordinary income, the provision provides that net loss with respect to such a partnership interest (to the extent not disallowed) generally is treated as ordinary loss. For this purpose, net loss means, with respect to an investment services partnership interest, the excess (if any) of (1) all items of deduction and loss taken into account by the partner with respect to the partnership interest for the partnership taxable year, over (2) all items of income and gain taken into account by the partner with respect to the partnership interest for the partnership taxable year. The net loss is allowed for a partnership taxable year, however, only to the extent that the loss does not exceed the excess (if any) of (1) aggregate net income with respect to the partnership interest for prior partnership taxable years, over (2) the aggregate net loss with respect to the partnership interest not disallowed for prior partnership years. Any net loss that is not allowed for the partnership taxable year is carried forward to the next partnership taxable year.

Notwithstanding the present-law rule that the basis of a partnership interest generally is reduced by the partner's distributive share of partnership losses and deductions (sec. 705(a)(2)), the provision provides that no adjustment is made to the basis of a partnership interest on account of a net loss that is not allowed for the partnership taxable year. When any such net loss that is carried forward is allowed in a subsequent year, the adjustment is made to the basis of the partnership interest.

For purposes of determining self-employment tax, a net loss from an investment services partnership interest (to the extent it is allowed in computing taxable income) is taken into account in determining net earnings from self-employment for the taxable year. Thus, for example, if an individual has three investment services partnership interests, two of which generate net income for the taxable year and the third of which generates a net loss that is allowable under the provision as an ordinary loss for the taxable year, then the entire net income and net loss are taken into account in determining the individual's net earnings from self-employment for the taxable year. However, to the extent a loss is disallowed under this provision for a taxable year, that loss does not reduce the taxpayer's net earnings from self-employment for that taxable year, but is taken into account in the carryover year for which it is allowed in determining the amount of ordinary income under this provision. To the same extent as under present law, the provision does not permit net operating loss deductions in calculating net earnings from self-employment (sec. 1402(a)(4)).

Dispositions
On the disposition of an investment services partnership interest, gain is treated as ordinary income, notwithstanding the present-law rule that gain or loss from the disposition of a partnership interest generally is considered as capital gain or loss. 519 Gain on the disposition of an investment services partnership interest is recognized notwithstanding any other income tax provision, such as nonrecognition or deferral rules. Loss on the disposition of an investment services partnership interest is treated as ordinary loss, but only to the extent of the amount by which aggregate net income previously treated as ordinary exceeds aggregate net loss previously allowed as ordinary under the provision.

The amount of net loss that otherwise (but for the rule providing for no basis reduction described above) would have reduced the basis of the investment services partnership interest is disregarded for purposes of the provision, in the event of any disposition of the interest.

On the disposition of an investment services partnership interest, any portion of which is a qualified capital interest, a special rule provides that a proportionate amount of the gain or loss on disposition is not subject to recharacterization as ordinary. Under this special rule, the proportionate amount of the gain or loss is determined generally by the ratio of the gain or loss on liquidation of the partner's qualified capital interest to the gain or loss on liquidation of the partner's entire investment services partnership interest (as if the liquidation occurred immediately before the disposition).

Partnership distributions
On the distribution of property by a partnership to a partner with respect to an investment services partnership interest, the provision provides generally that the partner recognizes ordinary income to the extent of any appreciation in the property. Specifically, the provision provides that the excess (if any) of the fair market value of the property at the time of the distribution over the adjusted basis of the distributed property in the hands of the partnership is included in income by the partner, and is considered ordinary income by reason of the general rule of the provision (new section 710(a)(1)). This amount is not so includable to the extent otherwise taken into account in computing the taxable income of the partnership, for example, by reason of section 751(b), treating certain distributions as sales or exchanges.

To the extent the fair market value of the property (which is treated as money) exceeds the partner's adjusted basis in its partnership interest, the partner has ordinary income (secs. 731(a)(1) and 710(a)(1)). The basis of the distributed property is its fair market value at the time of the distribution. The adjusted basis of the distributee partner's interest in the partnership is reduced (but not below zero) under section 733 by the amount of money upon the distribution.

For example, assume a partnership has an adjusted basis of 20 in a property whose fair market value is 50. The partnership distributes the property to a partner whose investment services partnership interest has an adjusted basis of 35. Under the provision, 30 (50 minus 20) is included in the partner's income as ordinary income. The partner's basis in his investment services partnership interest is increased from 35 to 65 by the 30 of income taken into account and then reduced to 15 by the 50 value of the property distributed. If the partner sells the partnership interest at a gain, the gain is treated as ordinary income under the general rule of the provision (new section 710(a)).

So that the other partners' shares of the basis of partnership property are not affected by the property distribution, the present-law rules providing for an adjustment to the basis of the partnership's property in the event of a section 754 election or a substantial basis reduction are applied without regard to the income inclusion rule for property distributions with respect to an investment services partnership interest.

In applying the present-law rules relating to ordinary income treatment of amounts attributable to unrealized receivables and inventory items on sale or exchange of a partnership interest (sec. 751(a)), an investment services partnership interest is treated as an inventory item of the partnership. Thus, for example, upon the sale or exchange of an interest in a partnership that in turn holds an investment services partnership interest, amounts received by the transferor partner that are attributable to the investment services partnership interest are considered as ordinary income.

Other entities
The provision also recharacterizes as ordinary income the income or gain with respect to certain other interests, including interests in entities, that are held by a person who performs, directly or indirectly, investment management services for the entity.

This rule applies if (1) a person performs (directly or indirectly) investment management services for any entity, (2) the person holds a disqualified interest with respect to the entity, and (3) the value of the interest (or payments thereunder) is substantially related to the amount of realized or unrealized income or gain from the assets with respect to which the investment management services are performed. In this case, any income or gain with respect to the interest is treated as ordinary income. Rules similar to the exception for a partner's qualified capital interest apply for this purpose. For this purpose, a disqualified interest in an entity means (1) any interest other than debt, (2) convertible or contingent debt, (3) an option or other right to acquire either of the foregoing, or (4) a derivative instrument entered into (directly or indirectly) with the entity or an investor in the entity. A disqualified interest does not include a partnership interest. However, an option to acquire a partnership interest may be a disqualified interest. A disqualified interest also does not include, except as provided otherwise in Treasury regulations or guidance, stock in an S corporation, or except as provided otherwise in Treasury regulations or guidance, stock in a taxable corporation, which for this purpose means either a domestic C corporation or a foreign corporation, substantially all of the income of which is effective connected with the conduct of a trade or business in the United States, or that is subject to a comprehensive foreign income tax. It is not intended that the exception for stock in an S corporation or domestic C corporation permit avoidance of the general rule relating to partnership interests through establishment of economically similar arrangements. Under this rule, a comprehensive income tax means the income tax of a foreign country if the foreign corporation is eligible for the benefits of a comprehensive income tax treaty between that country and the United States, or if the corporation demonstrates to the satisfaction of the Treasury Secretary that the foreign country has a comprehensive income tax.

For example, if a hedge fund manager holds stock of a Cayman Islands corporation that in turn is a partner in a hedge fund partnership, the manager performs investment management services for the hedge fund, and the value of the stock (or dividends) is substantially related to the growth and income in hedge fund assets for which the manager provides investment management services, then gain in the value of the stock, and dividends, are treated as ordinary income for the performance of services. The fact that the services are performed for the hedge fund, rather than directly for the Cayman Islands corporation in which the manager has a disqualified interest, does not change this result under the provision. Thus, the gain is not eligible for the capital gain tax rate, the dividend is not eligible for the special rate on qualified dividends, but rather, both are subject to tax at ordinary rates as income from the performance of services. The income is treated as net earnings from self-employment for purposes of the self-employment tax of the individual who performs the services. Though the amounts received may exceed the cap (imposed by reason of section 1402(b)) on the old-age, survivors, and disability insurance portion of the self-employment tax, the hospital insurance portion of the self-employment tax is not capped, and applies to the income.

Underpayment penalty
The provision provides that the accuracy-related penalty under section 6662 on underpayments applies to underpayments attributable to the failure to comply with section 710(d) (relating to the treatment of income in connection with investment management services involving disqualified interests) or the regulations under section 710(e) to prevent the avoidance of the purposes of section 710. The penalty rate is 40 percent. A strengthened reasonable cause exception similar to that applicable to reportable transaction understatements may apply with respect to the section 710(d) or (e) underpayments if the requirements for it are met. The strengthened reasonable cause exception does not apply unless (1) the relevant facts affecting the tax treatment of the item are adequately disclosed, (2) there is or was substantial authority for the tax treatment, and (3) the taxpayer reasonably believed that the tax treatment was more likely than not the proper treatment. Rules similar to the rules of section 6664(d)(3) apply for purposes of determining reasonable belief.

Self-employment tax treatment
Under the provision, in the case of any individual who is engaged in the trade or business of performing the services described in new section 710(c)(1) with respect to any entity, any amount treated as ordinary income or loss from an investment services partnership interest is taken into account in determining self-employment tax. It is intended that an entity include a partnership as well as an entity described in new section 710(d) or guidance thereunder. Because net income or gain from disposition of an investment services partnership is treated as ordinary income, the present-law exception under the self-employment tax rules for gain or loss from the sale or exchange of a capital asset does not apply, even though the net income from the investment service partnership interest might otherwise be characterized as capital gain. The provision applies notwithstanding the present-law special rule for limited partners under the self-employment tax, so the present-law exclusion for limited partners does not apply to any amount treated as ordinary income or loss from an investment services partnership interest under new section 710. Amounts that are not treated as ordinary income under the recharacterization rule of new section 710 because they are allocated to a qualified capital interest and meet applicable requirements under that exception are not taken into account in determining net earnings from self-employment (unless another provision of law requires them to be so taken into account). 520

Rules relating to publicly traded partnerships
The provision provides that items of income and gain that are ordinary income by reason of new section 710 are not qualifying income of a publicly traded partnership. Thus, for example, if a publicly traded partnership holds a partnership interest that is an investment services partnership interest by reason of the performance of investment management services with respect to specified assets, the publicly traded partnership's income from that partnership interest is not qualifying income for purposes of section 7704. A publicly traded partnership, more than 10 percent of whose gross income consists of income from an investment services partnership interest, is treated as a corporation for Federal tax purposes under section 7704. The present-law exception to corporate treatment for a publicly traded partnership, 90 percent or more of whose gross income is qualifying income within the meaning of section 7704(c)(2), does not apply, because net income from an investment services partnership interest is not qualifying income within the meaning of section 7704(c)(2). The bill provides a transition rule, under which the rule treating income and gain that are ordinary under new section 710 as nonqualifying does not apply to a partnership that is publicly traded on the date of enactment for any taxable year of the partnership that begins before the date 10 years after the date of enactment.

The provision provides a special rule for certain partnerships that are owned by publicly traded REITs and that meet specific requirements. Under the special rule, the general rule that items of income and gain that are ordinary income by reason of new section 710 are not qualifying income of a publicly traded partnership does not apply, provided the following requirements are met. The requirements are: (1) the partnership is treated as publicly traded (under section 7704) solely because interests in the partnership are convertible into interests in a publicly traded REIT; (2) 50 percent or more of the capital and profits interests of the partnership are owned, directly or indirectly, at all times during the taxable year, by the REIT (taking into account attribution rules under section 267(c)); and (3) the partnership itself satisfies the REIT income and asset limitations (secs. 856(c)(2), (3), and (4). Thus, for example, this special rule provides that a partnership is not treated as a corporation under section 7704, in an “upreit” structure in which a publicly traded REIT owns more than 50 percent of the capital and profits interests of the partnership, partnership interests held by persons other than the REIT are convertible into publicly traded REIT stock, and the partnership itself meets the income and asset limitations of the REIT rules (secs. 856(c)(2), (3) and (4)). For this purpose, if the partnership interest may be put to the REIT or the partnership for REIT stock, it is considered convertible into interests of the publicly traded REIT. It is not intended that convertibility of partnership interests into a class of publicly traded REIT stock that tracks the performance of particular partnership assets (such as assets of a type that, if held in excess, would cause the REIT asset or income limitations not to be satisfied), or performance of the partnership assets generally, satisfies this special rule; rather, it is intended that such a partnership does not meet the requirements of this special rule.

The provision provides a special rule for certain publicly traded partnerships that own interests in exchange-traded partnerships whose income is ordinary. The general rule that items of income and gain that are ordinary income by reason of new section 710 are not qualifying income of a publicly traded partnership does not apply in the case of a partnership that meets two requirements: (1) substantially all of the partnership's assets are interests in other partnerships that are traded on an established securities market; and (2) substantially all of the partnership' income is ordinary income or section 1231 gain. For this purpose, partnership interests that are readily tradable on a secondary market (or the substantial equivalent thereof) do not qualify; only those that are traded on an established securities market (for example, the New York Stock Exchange) meet the requirement of the special rule. It is intended that a substantial portion of the equity of the partnership be so traded; for example, if less than a substantial portion of the interests of the partnership are traded on an established securities market, the requirement is not satisfied.

Regulatory authority
The Treasury Department shall prescribe such regulations as are necessary or appropriate to carry out the purpose of new section 710, including regulations to provide modifications to the application of this section (including treating related persons as not related to one another) to the extent such modification is consistent with the purposes of this section, to prevent the avoidance of the purposes of the provision, and to coordinate the provision with other provisions of Federal tax law.

It is expected that these regulations will, among other things, address the effects, if any, of the provision on whether income is U.S. or foreign source (or is sourced within a U.S. possession); how income is characterized for purposes of the foreign tax credit limitation rules; whether income is subject to tax by the United States by reason of sections 897 and 1445 (sale of U.S. real property) or is exempt from U.S. tax under section 892 (income of foreign governments); whether income is effectively connected with the conduct of a trade or business within the United States; and whether income is subject to current U.S. tax under the passive foreign investment company or subpart F rules. The intent of the provision is generally not to change the result under these rules, to the extent that is consistent with not providing an opportunity to avoid the recharacterization of income as ordinary under the provision and not creating an opportunity for exclusion or deferral of otherwise includable amounts. For example, it is not intended that the provision be utilized to effect a recharacterization as untaxed foreign-source ordinary income from personal services the amount of any otherwise taxable (or witholdable) U.S.-source dividend, effectively connected income, U.S. real property gain, or similar income or of any otherwise taxable subpart F inclusion or passive foreign investment company inclusion.

It is not intended that solely the recharacterization of income as ordinary under the provision cause income of a REIT that otherwise meets the requirements of section 856(c)(2), (3), or (4) to fail to meet the requirements of those paragraphs. Similarly, it is not intended that solely the recharacterization of income as ordinary under the provision cause income not otherwise treated as unrelated business income of an exempt organization to fail to meet provisions of section 512(b) that are otherwise satisfied.

It is not intended that income or loss characterized as ordinary under the provision be taken into account in determining net investment income for purposes of the investment interest limitation of section 163(d).

It is not intended that opportunities to avoid or defer income inclusion be created by the recharacterization of income or loss as ordinary under the provision.

Effective Date
The provision relating to transfers of partnership interests under section 83 is effective for partnership interests transferred after the date of enactment.

The provision treating net income from an investment services partnership interest as ordinary is effective generally for taxable years ending after December 31, 2009.

In the case of a partnership taxable year that includes December 31, 2009, the amount of net income of a partner that is recharacterized as ordinary income for the performance of services under the provision is limited to the lesser of (1) net income for the entire partnership taxable year, or (2) net income determined by taking into account only items attributable to the part of the taxable year after December 31, 2009.

The provision is effective for dispositions of partnership interests, and partnership distributions, after December 31, 2009.

The provision relating to income or gain with respect to interests in certain entities other than partnerships that are held by a person who performs, directly or indirectly, investment management services for the entity takes effect on January 1, 2010.

For purposes of applying the rules relating to publicly traded partnerships (section 7704), the provision applies to taxable years beginning after December 31, 2009.

B. Time for Payment of Corporate Estimated Taxes (sec. 611 of the bill and sec. 6655 of the Code)
Present Law
In general, corporations are required to make quarterly estimated tax payments of their income tax liability. 521 For a corporation whose taxable year is a calendar year, these estimated tax payments must be made by April 15, June 15, September 15, and December 15. In the case of a corporation with assets of at least $1 billion (determined as of the end of the preceding tax year), payments due in July, August, or September, 2014, are increased to 133.25 percent of the payment otherwise due and the next required payment is reduced accordingly. 522

Explanation of Provision
The provision increases the required payment of estimated tax otherwise due in July, August, or September, 2014, by 26.5 percentage points.

Effective Date
The provision is effective on the date of the enactment of this Act.

C. Study of Extended Tax Expenditures (sec. 621 and 622 of the bill)
Present Law
The Congressional Budget and Impoundment Control Act of 1974 523 (“the Budget Act”) created the House and Senate Budget Committees and charged them with the duty “to request and evaluate continuing studies of tax expenditures, to devise methods of coordinating tax expenditures, policies, and programs with direct budget outlays, and to report the results of such studies” to the respective chamber of Congress on a recurring basis. It defines tax expenditures as “revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability.” 524

The Budget Act also created the Congressional Budget Office (“CBO”), and requires it to provide an annual report to Congress on “the levels of tax expenditures under existing law, taking into account projected economic factors and any changes in such levels based on provisions in the budget submitted by the President for such fiscal year.” 525 In light of the traditional expertise of the staff of the Joint Committee on Taxation (“JCT staff”) with respect to revenue matters, and a separate statutory requirement that Congress rely on JCT staff estimates when considering the revenue effects of proposed legislation, 526 the CBO has always relied on the JCT staff for the production of its annual tax expenditure publication. 527

The Congressional Research Service (“CRS”) prepares a biennial publication 528 for the use of the Committee on the Budget of the United States Senate in support of the Budget Act mandate for the Budget Committees to examine tax expenditures as they develop the Congressional Budget Resolution. The publication includes for each provision its legal authorization, a description of the tax provision and its impact, the rationale at the time of adoption, an assessment, and bibliographic citations.

The U.S. Government Accountability Office (“GAO”) issues reports on tax expenditures from time to time in its role of supporting Congressional oversight of how taxpayer dollars are spent. 529

Explanation of Provision
The provision requires the Chief of Staff of the Joint Committee on Taxation, in consultation with the Comptroller General of the Government Accountability Office, to submit to the Committee on Ways and Means of the House of Representatives and the Committee on Finance of the Senate a report on each tax expenditure extended by this Act. Reports for each tax expenditure enacted in subtitle B of title I (relating to business tax relief) and title IV (relating to energy provisions) are to be submitted first, in order from those with the least aggregate cost for the fiscal year in which this Act is enacted, and the following nine fiscal years, to the greatest aggregate cost for such fiscal years. These cost estimates are determined by the Chief of Staff. Thereafter, reports may be submitted in such order as the Chief of Staff determines appropriate. Reports are due not later than November 30, 2010.

Such reports shall contain the following: (1) an explanation of the tax expenditure and any relevant economic, social, or other context under which it was first enacted; (2) a description of the intended purpose of the tax expenditure; (3) an analysis of the overall success of the tax expenditure in achieving such purpose, and evidence supporting such analysis; (4) an analysis of the extent to which further extending the tax expenditure, or making it permanent, would contribute to achieving such purpose; (5) a description of the direct and indirect beneficiaries of the tax expenditure, including identifying any unintended beneficiaries; (6) an analysis of whether the tax expenditure is the most cost-effective method for achieving the purpose for which it was intended, and a description of any more cost-effective methods through which such purpose could be accomplished; (7) a description of any unintended effects of the tax expenditure that are useful in understanding the tax expenditure's overall value; (8) an analysis of how the tax expenditure could be modified to better achieve its original purpose; (9) a brief description of any interactions (actual or potential) with other tax expenditures or direct spending programs in the same or related budget function worthy of further study; and (10) a description of any unavailable information the staff of the Joint Committee on Taxation may need to complete a more thorough examination and analysis of the tax expenditure, and what must be done to make such information available.

In the event the Chief of Staff concludes it will not be feasible to complete all reports by November 30, 2010, at a minimum, the reports for each tax expenditure enacted in subtitle B of title I (relating to business tax relief) and title IV (relating to energy provisions) shall be completed by such date.

Effective Date
The provision is effective on the date of enactment of this Act.


Footnotes

1 This document may be cited as follows: Joint Committee on Taxation, Technical Explanation of H.R. 4213, the "Tax Extenders Act of 2009," as Introduced in the House of Representatives on December 7, 2009 (JCX-60-09), December 8, 2009. This document can also be found on our website at www.jct.gov.

2 If the deduction for State and local taxes is attributable to business or rental income, the deduction is allowed in computing adjusted gross income and therefore is not an itemized deduction.

3 In the case of an individual taxpayer who does not elect to itemize deductions, although no itemized deductions are allowed to the taxpayer, itemized deductions are nevertheless treated as "allowable." See section 63(e).

4 Sec. 222.

5 The deduction generally is not available for expenses with respect to a course or education involving sports, games, or hobbies, and is not available for student activity fees, athletic fees, insurance expenses, or other expenses unrelated to an individual's academic course of instruction.

6 Secs. 222(d)(1) and 25A(g)(2).

7 Sec. 222(c). These reductions are the same as those that apply to the Hope and Lifetime Learning credits.

8 Sec. 62(a)(2)(D).

9 Sec. 41.

10 Sec. 41(e).

11 Sec. 41(h).

12 The Small Business Job Protection Act of 1996 expanded the definition of start-up firms under section 41(c)(3)(B)(i) to include any firm if the first taxable year in which such firm had both gross receipts and qualified research expenses began after 1983. A special rule (enacted in 1993) is designed to gradually recompute a start-up firm's fixed-base percentage based on its actual research experience. Under this special rule, a start-up firm is assigned a fixed-base percentage of three percent for each of its first five taxable years after 1993 in which it incurs qualified research expenses. A start-up firm's fixed-base percentage for its sixth through tenth taxable years after 1993 in which it incurs qualified research expenses is a phased-in ratio based on the firm's actual research experience. For all subsequent taxable years, the taxpayer's fixed-base percentage is its actual ratio of qualified research expenses to gross receipts for any five years selected by the taxpayer from its fifth through tenth taxable years after 1993. Sec. 41(c)(3)(B).

13 Sec. 41(f)(1).

14 Sec. 41(f)(3).

15 Under a special rule, 75 percent of amounts paid to a research consortium for qualified research are treated as qualified research expenses eligible for the research credit (rather than 65 percent under the general rule under section 41(b)(3) governing contract research expenses) if (1) such research consortium is a tax-exempt organization that is described in section 501(c)(3) (other than a private foundation) or section 501(c)(6) and is organized and operated primarily to conduct scientific research, and (2) such qualified research is conducted by the consortium on behalf of the taxpayer and one or more persons not related to the taxpayer. Sec. 41(b)(3)(C).

16 Sec. 41(d)(3).

17 Sec. 41(d)(4).

18 Taxpayers may elect 10-year amortization of certain research expenditures allowable as a deduction under section 174(a). Secs. 174(f)(2) and 59(e).

19 Sec. 280C(c).

20 Sec. 280C(c)(3).

21 Secs. 951-964.

22 Prop. Treas. Reg. sec. 1.953-1(a).

23 Temporary exceptions from the subpart F provisions for certain active financing income applied only for taxable years beginning in 1998 (Taxpayer Relief Act of 1997, Pub. L. No. 105-34). Those exceptions were modified and extended for one year, applicable only for taxable years beginning in 1999 (the Tax and Trade Relief Extension Act of 1998, Pub. L. No. 105-277). The Tax Relief Extension Act of 1999 (Pub. L. No. 106-170) clarified and extended the temporary exceptions for two years, applicable only for taxable years beginning after 1999 and before 2002. The Job Creation and Worker Assistance Act of 2002 (Pub. L. No. 107-147) modified and extended the temporary exceptions for five years, for taxable years beginning after 2001 and before 2007. The Tax Increase Prevention and Reconciliation Act of 2005 (Pub. L. No. 109-222) extended the temporary provisions for two years, for taxable years beginning after 2006 and before 2009. The Energy Improvement and Extension Act of 2008 (Pub. L. No. 110-343) extended the temporary provisions for one year, for taxable years beginning after 2008 and before 2010.

24 Secs. 951-964.

25 Sec. 168.

26 Sec. 168(e)(7)((A).

27 Property that satisfies the definition of both qualified leasehold improvement property and qualified restaurant property is eligible for bonus depreciation.

28 Improvements to portions of a building not open to the general public (e.g., stock room in back of retail space) do not qualify under the provision.

29 Property that satisfies the definition of both qualified leasehold improvement property and qualified retail property is eligible for bonus depreciation.

30 Sec. 168.

31 Sec. 168(e)(3)(C)(ii).

32 Sec. 168(i)(15).

33 Sec. 45G(a).

34 Sec. 45G(b)(1).

35 Sec. 38(c)(4).

36 Sec. 45G(d).

37 Sec. 45G(c).

38 Sec. 45G(e)(1).

39 See Treas. Reg. section 1.181-2T for rules on making an election under this section.

40 For this purpose, a production is treated as commencing on the first date of principal photography.

41 Sec. 181(a)(2)(A).

42 Sec. 181(a)(2)(B).

43 Sec. 181(d)(3)(A).

44 Sec. 181(d)(3)(B).

45 Sec. 181(d)(2)(B).

46 Sec. 181(d)(2)(C).

47 Sec. 1245(a)(2)(C).

48 Sec. 162.

49 Sec. 198.

50 418 U.S. 1 (1974).

51 Pub. L. No. 96-510 (1980).

52 Sec. 45N(a).

53 Sec. 45N(b).

54 Sec. 45N(c).

55 Sec. 45N(d).

56 Sec. 280C(e).

57 Sec. 168.

58 Additional section 179 incentives are provided with respect to qualified property meeting applicable requirements that is used by a business in an empowerment zone (sec. 1397A) and a renewal community (sec. 1400J).

59 Sec. 179E(a).

60 Secs. 179E(c) and (g).

61 Sec. 179E(d).

62 Sec. 179E(e).

63 Sec. 179E(f).

64 A credit that is included in the general business credit cannot be carried back to a tax year before the first tax year for which that component credit is allowable under the effective date of that component credit. Unlike many of the other credits that are included in the general business credit, the differential wage payment credit is not a “qualified business credit” under section 196(c). Thus, a taxpayer cannot deduct under section 196(c) any differential wage payment credits that remain unused at the end of the 20-year carry forward period.

65 Sec. 168.

66 1987-2 C.B. 674 (as clarified and modified by Rev. Proc. 88-22, 1988-1 C.B. 785).

67 Treas. Reg. sec. 1.263A-4(a)(4)(i).

68 Treas. Reg. sec. 1.263A-4(a)(4)(ii).

69 Secs. 871(k), 881, 1441 and 1442.

70 Sec. 2031. The Economic Growth and Tax Relief Reconciliation Act of 2001 ( "EGTRRA" ) repealed the estate tax for estates of decedents dying after December 31, 2009. EGTRRA, however, included a termination provision under which EGTRRA's rules, including estate tax repeal, do not apply to estates of decedents dying after December 31, 2010.

71 Sec. 2103.

72 Secs. 2104(c), 2105(b).

73 Sec. 2104(a); Treas. Reg. sec. 20.2104-1(a)(5)).

74 Sec. 2105(d).

75 Section 897(h).

76 Secs. 611-613.

77 Sec. 613A.

78 Sec. 613A(c).

79 Sec. 613(a).

80 The American Petroleum Institute gravity, or API gravity, is a measure of how heavy or light a petroleum liquid is compared to water.

81 Secs. 170, 2055, and 2522, respectively.

82 Sec. 170(b)(1)(E).

83 Sec. 170(b)(2)(B).

84 Secs. 170(b)(1)(E)(vi) and 170(b)(2)(B)(iii).

85 Sec. 170(e)(3).

86 Sec. 170(b)(2).

87 Treas. Reg. sec. 1.170A-4A(c)(3).

88 Lucky Stores Inc. v. Commissioner, 105 T.C. 420 (1995) (holding that the value of surplus bread inventory donated to charity was the full retail price of the bread rather than half the retail price, as the IRS asserted).

89 Sec. 170(e)(3)(C).

90 The 10 percent limitation does not affect the application of the generally applicable percentage limitations. For example, if 10 percent of a sole proprietor's net income from the proprietor's trade or business was greater than 50 percent of the proprietor's contribution base, the available deduction for the taxable year (with respect to contributions to public charities) would be 50 percent of the proprietor's contribution base. Consistent with present law, such contributions may be carried forward because they exceed the 50 percent limitation. Contributions of food inventory by a taxpayer that is not a C corporation that exceed the 10 percent limitation but not the 50 percent limitation could not be carried forward.

91 Sec. 170(e)(3).

92 Sec. 170(b)(2).

93 Treas. Reg. sec. 1.170A-4A(c)(3).

94 Sec. 170(e)(3)(D).

95 Sec. 170(e)(1).

96 Secs. 170(e)(4) and 170(e)(6).

97 Sec. 170(e)(6)(G).

98 If the taxpayer constructed the property and reacquired such property, the contribution must be within three years of the date the original construction was substantially completed. Sec. 170(e)(6)(D)(i).

99 This requirement does not apply if the property was reacquired by the manufacturer and contributed. Sec. 170(e)(6)(D)(ii).

100 Sec. 170(e)(6)(C).

101 Secs. 170(c)(3)-(5).

102 Sec. 170(c)(1).

103 Secs. 170(b) and (e).

104 Sec. 170(a).

105 Sec. 170(f)(8). For any contribution of a cash, check, or other monetary gift, no deduction is allowed unless the donor maintains as a record of such contribution a bank record or written communication from the donee charity showing the name of the donee organization, the date of the contribution, and the amount of the contribution. Sec. 170(f)(17).

106 Sec. 6115.

107 Secs. 170(f), 2055(e)(2), and 2522(c)(2).

108 Sec. 170(f)(2).

109 Minimum distribution rules also apply in the case of distributions after the death of a traditional or Roth IRA owner.

110 Conversion contributions refer to conversions of amounts in a traditional IRA to a Roth IRA.

111 Sec. 3405.

112 The exclusion does not apply to distributions from employer-sponsored retirements plans, including SIMPLE IRAs and simplified employee pensions ( "SEPs" ).

113 Sec. 511.

114 Sec. 512(b).

115 Sec. 512(b)(13)(E).

116 A person is related to another person if (1) such person bears a relationship to such other person that is described in section 267(b) (determined without regard to paragraph (9)), or section 707(b)(1), determined by substituting 25 percent for 50 percent each place it appears therein; or (2) if such other person is a nonprofit organization, if such person controls directly or indirectly more than 25 percent of the governing body of such organization.

117 Sec. 512(b)(19)(K).

118 In general, a person is potentially liable under section 107 of CERCLA if: (1) it is the owner and operator of a vessel or a facility; (2) at the time of disposal of any hazardous substance it owned or operated any facility at which such hazardous substances were disposed of; (3) by contract, agreement, or otherwise it arranged for disposal or treatment, or arranged with a transporter for transport for disposal or treatment, of hazardous substances owned or possessed by such person, by any other party or entity, at any facility or incineration vessel owned or operated by another party or entity and containing such hazardous substances; or (4) it accepts or accepted any hazardous substances for transport to disposal or treatment facilities, incineration vessels or sites selected by such person, from which there is a release, or a threatened release which causes the incurrence of response costs, of a hazardous substance. 42 U.S.C. sec. 9607(a) (2004).

119 For this purpose, use of the property as a landfill or other hazardous waste facility shall not be considered more economically productive or environmentally beneficial.

120 For these purposes, substantial completion means any necessary physical construction is complete, all immediate threats have been eliminated, and all long-term threats are under control.

121 Cleanup cost-cap or stop-loss coverage is coverage that places an upper limit on the costs of cleanup that the insured may have to pay. Re-opener or regulatory action coverage is coverage for costs associated with any future government actions that require further site cleanup, including costs associated with the loss of use of site improvements.

122 For this purpose, professional liability insurance is coverage for errors and omissions by public and private parties dealing with or managing contaminated land issues, and includes coverage under policies referred to as owner-controlled insurance. Owner/operator liability coverage is coverage for those parties that own the site or conduct business or engage in cleanup operations on the site. Legal defense coverage is coverage for lawsuits associated with liability claims against the insured made by enforcement agencies or third parties, including by private parties.

123 For example, rent income from leasing the property does not qualify.

124 Depreciation or section 198 amounts that the taxpayer had not used to determine its unrelated business taxable income are not treated as gain that is ordinary income under sections 1245 or 1250 (secs. 1.1245-2(a)(8) and 1.1250-2(d)(6)), and are not recognized as gain or ordinary income upon the sale, exchange, or disposition of the property. Thus, an exempt organization would not be entitled to a double benefit resulting from a section 198 expense deduction and the proposed exclusion from gain with respect to any amounts it deducts under section 198.

125 The exclusions do not apply to a tax-exempt partner's gain or loss from the tax-exempt partner's sale, exchange, or other disposition of its partnership interest. Such transactions continue to be governed by prior law.

126 If the taxpayer fails to satisfy the averaging test for the properties subject to the election, then the taxpayer may not apply the exclusion on a separate property basis with respect to any of such properties.

127 Sec. 1366(a)(1)(A).

128 Sec. 1367(a)(2)(B).

129 Sec. 45A.

130 For these purposes, related persons is defined in Sec. 465(b)(3)(C).

131 Sec. 168(j)(4)(A).

132 Sec. 168(j)(4)(C).

133 Qualifying production property generally includes any tangible personal property, computer software, and sound recordings.

134 Qualified film includes any motion picture film or videotape (including live or delayed television programming, but not including certain sexually explicit productions) if 50 percent or more of the total compensation relating to the production of the film (including compensation in the form of residuals and participations) constitutes compensation for services performed in the United States by actors, production personnel, directors, and producers.

135 For purposes of the provision, "wages" include the sum of the amounts of wages as defined in section 3401(a) and elective deferrals that the taxpayer properly reports to the Social Security Administration with respect to the employment of employees of the taxpayer during the calendar year ending during the taxpayer's taxable year.

136 Sec. 3401(a)(8)(C).

137 Sec. 7701(a)(9).

138 Sec. 199(d)(8)(A).

139 Sec. 199(d)(8)(B).

140 A proof gallon is a liquid gallon consisting of 50 percent alcohol. See sec. 5002(a)(10) and (11).

141 Sec. 5001(a)(1).

142 Secs. 5062(b), 7653(b) and (c).

143 Secs. 7652(a)(3), (b)(3), and (e)(1). One percent of the amount of excise tax collected from imports into the United States of articles produced in the Virgin Islands is retained by the United States under section 7652(b)(3).

144 Sec. 7652(e)(2).

145 Secs. 7652(a)(3), (b)(3), and (e)(1).

146 Secs. 27(b), 936.

147 Under phase-out rules described below, investment only in Guam, American Samoa, and the Northern Mariana Islands (and not in other possessions) now may give rise to income eligible for the section 936 credit.

148 Sec. 936(c).

149 A corporation will qualify as an existing credit claimant if it acquired all the assets of a trade or business of a corporation that (1) actively conducted that trade or business in a possession on October 13, 1995, and (2) had elected the benefits of the possession tax credit in an election in effect for the taxable year that included October 13, 1995.

150 The targeted areas are those that have pervasive poverty, high unemployment, and general economic distress, and that satisfy certain eligibility criteria, including specified poverty rates and population and geographic size limitations.

151 The urban part of the program is administered by the HUD and the rural part of the program is administered by the USDA. The eight Round I urban empowerment zones are Atlanta, GA, Baltimore, MD, Chicago, IL, Cleveland, OH, Detroit, MI, Los Angeles, CA, New York, NY, and Philadelphia, PA/Camden, NJ. Atlanta relinquished its empowerment zone designation in Round III. The three Round I rural empowerment zones are Kentucky Highlands, KY, Mid-Delta, MI, and Rio Grande Valley, TX. The 15 Round II urban empowerment zones are Boston, MA, Cincinnati, OH, Columbia, SC, Columbus, OH, Cumberland County, NJ, El Paso, TX, Gary/Hammond/East Chicago, IN, and Ironton, OH/Huntington, WV. The five Round II rural empowerment zones are Desert Communities, CA, Griggs-Steele, ND, Oglala Sioux Tribe, SD, Southernmost Illinois Delta, IL, and Southwest Georgia United, GA. The eight Round III urban empowerment zones are Fresno, CA, Jacksonville, FL, Oklahoma City, OK, Pulaski County, AR, San Antonio, TX, Syracuse, NY, Tucson, AZ, and Yonkers, NY. The two Round III rural empowerment zones are Aroostook County, ME, and Futuro, TX.

152 If an empowerment zone designation were terminated prior to December 31, 2009, the tax incentives would cease to be available as of the termination date.

153 Sec. 1396. The $15,000 limit is annual, not cumulative such that the limit is the first $15,000 of wages paid in a calendar year which ends with or within the taxable year.

154 Secs. 1397C(b) and 1397C(c). However, the wage credit is not available for wages paid in connection with certain business activities described in section 144(c)(6)(B), including a golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack, or liquor store, or certain farming activities. In addition, wages are not eligible for the wage credit if paid to (1) a person who owns more than five percent of the stock (or capital or profits interests) of the employer, (2) certain relatives of the employer, or (3) if the employer is a corporation or partnership, certain relatives of a person who owns more than 50 percent of the business.

155 Sec. 280C(a).

156 Secs. 1396(c)(3)(A) and 51A(d)(2).

157 Secs. 1396(c)(3)(B) and 51A(d)(2).

158 Sec. 38(c)(2).

159 Secs. 1397A, 1397D.

160 Sec. 1397A(a)(2), 179(b)(2), (7). For 2008 and 2009, the limit is $800,000.

161 Sec. 1397C(b).

162 Sec. 1397C(c).

163 Sec. 1397C(d). Excluded businesses include any private or commercial golf course, country club, massage parlor, hot tub facility, sun tan facility, racetrack, or other facility used for gambling or any store the principal business of which is the sale of alcoholic beverages for off-premises consumption. Sec. 144(c)(6).

164 Sec. 1394.

165 Sec. 1394(b)(3).

166 The term "qualified empowerment zone asset" means any property which would be a qualified community asset (as defined in section 1400F, relating to certain tax benefits for renewal communities) if in section 1400F—(i) references to empowerment zones were substituted for references to renewal communities, (ii) references to enterprise zone businesses (as defined in section 1397C) were substituted for references to renewal community businesses, and (iii) the date of the enactment of this paragraph were substituted for "December 31, 2001" each place it appears. Sec. 1397B(b)(1)(A).

A "qualified community asset" includes: (1) qualified community stock (meaning original-issue stock purchased for cash in an enterprise zone business), (2) a qualified community partnership interest (meaning a partnership interest acquired for cash in an enterprise zone business), and (3) qualified community business property (meaning tangible property originally used in a enterprise zone business by the taxpayer) that is purchased or substantially improved after the date of the enactment of this paragraph.

For the definition of "enterprise zone business," see text accompanying supra notes 161-29. For the definition of "qualified business," see text accompanying supra note 163.

167 Sec. 1397B.

168 Sec. 1202.

169 The increased exclusion does not apply to gain attributable to periods after December 31, 2014.

170 Sec. 1(h).

171 Sec. 57(a)(7). In the case of qualified small business stock, the percentage of gain excluded from gross income which is an alternative minimum tax preference is (i) seven percent in the case of stock disposed of in an taxable year beginning before 2011; (ii) 42 percent in the case of stock acquired before January 1, 2001, and disposed of in a taxable year beginning after 2010; and (iii) 28 percent in the case of stock acquired after December 31, 2000, and disposed of in a taxable year beginning after 2010.

172 The 25 percent of gain included in taxable income is taxed at a maximum rate of 28 percent.

173 The 46 percent of gain included in AMTI is taxed at a maximum rate of 28 percent. Forty-six percent is the sum of 25 percent (the percentage of total gain included in taxable income) plus 21 percent (the percentage of total gain which is an alternative minimum tax preference).

174 The 28 urban renewal communities are: Mobile, AL; Los Angeles, San Diego, and San Francisco, CA; Atlanta, GA; Chicago, IL; New Orleans and Ouachita Parish, LA; Lawrence and Lowell, MA; Detroit and Flint, MI; Camden and Newark, NJ; Buffalo-Lackawanna, Niagara Falls, Rochester, and Schenectady, NY; Hamilton and Youngstown, OH; Philadelphia, PA; Charleston, SC; Chattanooga and Memphis, TN; Corpus Christi, TX; Tacoma and Yakima, WA; and Milwaukee, WI.

The 12 rural renewal communities are: Greene-Sumter, AL; Southern Alabama; Orange Cove and Parlier, CA; Eastern Kentucky; Central and Northern Louisiana; West-Central Mississippi; Turtle Mountain Band of Chippewa, ND; Jamestown, NY; El Paso County, TX; and Burlington, VT.

175 The designation would terminate earlier than December 31, 2009, if (1) an earlier termination date is so designated by the State or local government, or (2) the Secretary of HUD revokes the designation as of an earlier date.

176 If a renewal community designation is terminated prior to December 31, 2009, the tax incentives cease to be available as of the termination date.

177 Sec. 1400H. This section treats a renewal community as an empowerment zone for purposes of section 1396 with respect to wages paid or incurred after December 31, 2001, subject to modifications of the applicable percentage amount (15 percent instead of 20 percent) and the qualified wage amount ($10,000 instead of $15,000).

178 Sec. 1400G. However, the wage credit is not available for wages paid in connection with certain business activities described in section 144(c)(6)(B) or certain farming activities. In addition, wages are not eligible for the wage credit if paid to (1) a person who owns more than 5 percent of the stock (or capital or profits interests) of the employer, (2) certain relatives of the employer, or (3) if the employer is a corporation or partnership, certain relatives of a person who owns more than 50 percent of the business.

179 Sec. 280C(a).

180 Secs. 1400H(a), 1396(c)(3)(A) and 51A(d)(2).

181 Secs. 1400H(a), 1396(c)(3)(B) and 51A(d)(2).

182 Sec. 38(c)(2).

183 Sec. 1400J.

184 Sec. 1400J, 179(b)(2), 179(b)(7). For 2008 and 2009, the limit is $800,000.

185 Secs. 1400J(b), 1397D.

186 Sec. 1400I.

187 Sec. 1400I.

188 Sec. 1400F.

189 A qualified business is defined as any trade or business other than a trade or business that consists predominantly of the development or holding of intangibles for sale or license. In addition, the leasing of real property that is located within the renewal community is treated as a qualified business only if (1) the leased property is not residential property, and (2) at least 50 percent of the gross rental income from the real property is from renewal community businesses. The rental of tangible personal property is not a qualified business unless at least 50 percent of the rental of such property is by enterprise zone businesses or by residents of a renewal community.

190 Section 45D was added by section 121(a) of the Community Renewal Tax Relief Act of 2000, Pub. L. No. 106-554 (December 21, 2000).

191 12 U.S.C. 4702(17) (defines "low-income" for purposes of 12 U.S.C. 4702(20)).

192 Pub. L. No. 105-34.

193 Sec. 1400(a)(2) ( "except as otherwise provided in this subchapter, the District of Columbia Enterprise Zone shall be treated as an empowerment zone designated under subchapter U." ). Herein all references to "empowerment zone" shall also include "the District of Columbia Enterprise Zone."

194 Secs. 1396, 1400(d), and 1400(e).

195 Secs. 1400(a)(2), 1397C(b) and 1397C(c). However, the wage credit is not available for wages paid in connection with certain business activities described in section 144(c)(6)(B), including a golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack, or liquor store, or certain farming activities. In addition, wages are not eligible for the wage credit if paid to (1) a person who owns more than five percent of the stock (or capital or profits interests) of the employer, (2) certain relatives of the employer, or (3) if the employer is a corporation or partnership, certain relatives of a person who owns more than 50 percent of the business. Sec. 1396(d)(2).

196 Sec. 280C(a).

197 Secs. 1400H(a), 1396(c)(3)(A) and 51A(d)(2).

198 Secs. 1400H(a), 1396(c)(3)(B) and 51A(d)(2).

199 Sec. 38(c)(2).

200 Sec. 1397D.

201 Sec. 1397A(a)(2), 179(b)(2), (7). For 2008 and 2009, the limit is $800,000.

202 Sec. 1397C(b).

203 Sec. 1397C(c).

204 Sec. 1397C(d). Excluded businesses include any private or commercial golf course, country club, massage parlor, hot tub facility, sun tan facility, racetrack, or other facility used for gambling or any store the principal business of which is the sale of alcoholic beverages for off-premises consumption. Sec. 144(c)(6).

205 Secs. 1394, 1400A.

206 Sec. 1394(b)(3).

207 Sec. 1400B.

208 However, sole proprietorships and other taxpayers selling assets directly cannot claim the zero-percent rate on capital gain from the sale of any intangible property (i.e., the integrally related test does not apply).

209 The homebuyer credit applies to the purchase of a principal residence anywhere in the District of Columbia. It is not limited to the D.C. Enterprise Zone area.

210 Sec. 1400C.

211 Sec. 168.

212 For property acquired and placed in service prior to December 31, 2006, Liberty Zone property included property to which the general rules of MACRS apply with (1) an applicable recovery period of 20 years or less, (2) water utility property (as defined in section 168(e)(5)), or (3) computer software other than computer software covered by section 197. A special rule precluded the additional first-year depreciation under section 1400L(b) for (qualified New York Liberty Zone leasehold improvement property and (2) property eligible for the additional first-year depreciation under section 168(k) (i.e., property is eligible for only one 30 percent additional first year depreciation).

213 Thus, used property may constitute qualified property so long as it has not previously been used within the Liberty Zone. In addition, it is intended that additional capital expenditures incurred to recondition or rebuild property the original use of which in the Liberty Zone began with the taxpayer would satisfy the "original use" requirement. See Treas. Reg. Sec. 1.48-2, Example 5.

214 A special rule applies in the case of certain leased property. In the case of any property that is originally placed in service by a person and that is sold to the taxpayer and leased back to such person by the taxpayer within three months after the date that the property was placed in service, the property would be treated as originally placed in service by the taxpayer not earlier than the date that the property is used under the leaseback.

215 For this purpose, purchase is defined under section 179(d).

216 Similar rules applied with respect to the manufacture or production of tangible personal property for which the manufacture or production began after September 11, 2001, and that was placed in service on or before December 31, 2006.

217 Sec. 42.

218 Rev. Proc. 2009-50.

219 The State housing credit agency may collect reasonable fees from subaward recipients to cover the expenses of the agency's asset management duties. Alternatively, the State housing credit agency may retain a third party to perform these asset management duties.

220 Sec. 165(a).

221 Sec. 165(c).

222 Sec. 165(i).

223 Sec. 165(h)(1).

224 Sec. 165(h)(2).

225 Sec. 63.

226 For these purposes, the term "Federally declared disaster" means any disaster subsequently determined by the President of the United States to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.

227 Sec. 172(b)(1)(A).

228 Sec. 172(b)(2).

229 The term "federally declared disaster" means any disaster subsequently determined by the President of the United States to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.

230 The term "disaster area" means the area so determined to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act.

231 Sec. 103

232 Sec. 165 relates to personal casualty losses.

233 Sec. 712 of Pub. L. No. 110-343 Div. C.

234 Sec. 168.

235 Sec. 168(n).

236 Sec. 168(n)(2)(A).

237 Sec. 168(n)(2)(B).

238 Additional section 179 incentives are provided with respect to qualified property meeting applicable requirements that is used by a business in an empowerment zone (sec. 1397A), a renewal community (sec. 1400J), or the Gulf Opportunity Zone (sec. 1400N(e)).

239 The temporary $250,000 and $800,000 amounts were enacted in the Economic Stimulus Act of 2008, Pub. L. No. 110-185, and extended for taxable years beginning in 2009 by the American Recovery and Reinvestment Act of 2009, Pub. L. No. 111-5.

240 Sec. 179(e)(1).

241 Sec. 179(e)(2).

242 Sec. 40A.

243 Notice 2005-62, I.R.B. 2005-35, 443 (2005). "A biodiesel mixture is a mixture of biodiesel and diesel fuel containing at least 0.1 percent (by volume) of diesel fuel. Thus, for example, a mixture of 999 gallons of biodiesel and 1 gallon of diesel fuel is a biodiesel mixture." Id.

244 Sec. 6426(c).

245 Sec. 6426(c)(4).

246 Sec. 6427(e).

247 Secs. 40A(f), 6426(c), and 6427(e).

248 Sec. 30B.

249 For hybrid passenger vehicles and light trucks, the term "maximum available power" means the maximum power available from the rechargeable energy storage system, during a standard 10 second pulse power or equivalent test, divided by such maximum power and the SAE net power of the heat engine. Sec. 30B(d)(3)(C)(i).

250 A qualified advanced lean burn technology vehicle is a passenger automobile or a light truck that incorporates direct injection, achieves at least 125 percent of the 2002 model year city fuel economy, and for 2004 and later model vehicles meets or exceeds certain Environmental Protection Agency emissions standards. Sec. 30B(c)(3). For a vehicle with a gross vehicle weight rating of 6,000 pounds or less the applicable emissions standards are the Bin 5 Tier II emissions standards. For a vehicle with a gross vehicle weight rating greater than 6,000 pounds and less than or equal to 8,500 pounds, the applicable emissions standards are the Bin 8 Tier II emissions standards. Ibid. A qualified advanced lean burn technology vehicle must be placed in service before January 1, 2011. Sec. 30B(k)(2).

251 In the case of such heavy-duty hybrid motor vehicles, the percentage of maximum available power is computed by dividing the maximum power available from the rechargeable energy storage system during a standard 10-second pulse power test, divided by the vehicle's total traction power. A vehicle's total traction power is the sum of the peak power from the rechargeable energy storage system and the heat (e.g., internal combustion or diesel) engine's peak power. If the rechargeable energy storage system is the sole means by which the vehicle can be driven, then the total traction power is the peak power of the rechargeable energy storage system.

252 "Gasoline gallon equivalent" means, with respect to any nonliquid alternative fuel (for example, compressed natural gas), the amount of such fuel having a Btu (British thermal unit) content of 124,800 (higher heating value).

253 The applicable period for a taxpayer to reinvest the proceeds is four years after the close of the taxable year in which the qualifying electric transmission transaction occurs.

254 Sec. 451(i).

255 Sec. 3(23), 16 U.S.C. 796, defines "transmitting utility" as any electric utility, qualifying cogeneration facility, qualifying small power production facility, or Federal power marketing agency which owns or operates electric power transmission facilities which are used for the sale of electric energy at wholesale.

256 Sec. 3(22), 16 U.S.C. 796, defines "electric utility" as any person or State agency (including any municipality) which sells electric energy; such term includes the Tennessee Valley Authority, but does not include any Federal power marketing agency.

257 For example, a regional transmission organization, an independent system operator, or an independent transmission company.

258 Secs. 871, 881, 1441, 1442; Treas. Reg. sec. 1.1441-1(b). Unless otherwise noted, all section references are to the Internal Revenue Code of 1986, as amended (the "Code" ). For purposes of the withholding tax rules applicable to payments to nonresident alien individuals and foreign corporations, a withholding agent is defined broadly to include any U.S. or foreign person that has the control, receipt, custody, disposal, or payment of an item of income of a foreign person subject to withholding. Treas. Reg. sec. 1.1441-7(a).

259 Treas. Reg. sec. 1.1441-2(b)(1)(i), -2(b)(2); Rev. Rul. 2004-75, 2004-2 C.B. 109 (holding that the income of a nonresident alien individual under a life insurance or annuity contract issued by a foreign branch of a U.S. life insurance company is FDAP income from U.S. sources); Rev. Rul. 2004-97, 2004-2 C.B. 516 (stating that Rev. Rul. 2004-75 does not apply to payments made before January 1, 2005, pursuant to binding life insurance or annuity contracts issued by a foreign branch on or before July 12, 2004). However, gain on a sale or exchange of section 306 stock of a domestic corporation is FDAP income to the extent section 306(a) treats the gain as ordinary income. Treas. Reg. sec. 1.306-3(h).

260 Sec. 861(a)(1); Treas. Reg. sec. 1.861-2(a)(1). Interest paid by the U.S. branch of a foreign corporation is also treated as U.S.-source interest under section 884(f)(1).

261 Secs. 861(a)(2), 862(a)(2).

262 Sec. 861(a)(4).

263 Ibid.

264 Secs. 871(h), 881(c). Congress believed that the imposition of a withholding tax on portfolio interest paid on debt obligations issued by U.S. persons might impair the ability of domestic corporations to raise capital in the Eurobond market (i.e., the global market for U.S. dollar-denominated debt obligations). Congress also anticipated that repeal of the withholding tax on portfolio interest would allow the Treasury Department direct access to the Eurobond market. See Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984 (JCS-41-84), December 31, 1984, pp. 391-92.

265 Sec. 871(h)(3). A 10-percent shareholder includes any person who owns 10 percent or more of the total combined voting power of all classes of stock of the corporation (in the case of a corporate obligor), or 10 percent or more of the capital or profits interest of the partnership (in the case of a partnership obligor). The attribution rules of section 318 apply for this purpose, with certain modifications.

266 Sec. 871(h)(4). Contingent interest generally includes any interest if the amount of such interest is determined by reference to any receipts, sales, or other cash flow of the debtor or a related person; any income or profits of the debtor or a related person; any change in value of any property of the debtor or a related person; any dividend, partnership distributions, or similar payments made by the debtor or a related person; and any other type of contingent interest identified by Treasury regulation. Certain exceptions also apply.

267 Sec. 881(c)(3)(C). A related person includes, among other things, an individual owning more than 50 percent of the stock of the corporation by value, a corporation that is a member of the same controlled group (defined using a 50-percent common ownership test), a partnership if the same persons own more than 50 percent in value of the stock of the corporation and more than 50 percent of the capital interests in the partnership, any U.S. shareholder (as defined in section 951(b) and generally including any U.S. person who owns 10 percent or more of the voting stock of the corporation), and certain persons related to such a U.S. shareholder.

268 Sec. 881(c)(3)(A).

269 An obligation is treated as in registered form if (1) it is registered as to both principal and interest with the issuer (or its agent) and transfer of the obligation may be effected only by surrender of the old instrument and either the reissuance by the issuer of the old instrument to the new holder or the issuance by the issuer of a new instrument to the new holder, (2) the right to principal and stated interest on the obligation may be transferred only through a book entry system maintained by the issuer or its agent, or (3) the obligation is registered as to both principal and interest with the issuer or its agent and may be transferred through both of the foregoing methods. Treas. Reg. sec. 5f.103-1(c).

270 Sec. 871(h)(2)(B), (5). This certification of non-U.S. ownership most commonly is made on an IRS Form W-8. This certification is not valid if the Secretary determines that statements from the person making the certification do not meet certain requirements.

271 Sec. 861(a)(1)(B); Treas. Reg. sec. 1.1441-1(b)(4)(iii).

272 Secs. 871(i)(2)(A), 881(d); Treas. Reg. sec. 1.1441-1(b)(4)(ii). If the bank deposit interest is effectively connected with a U.S. trade or business, it is subject to regular U.S. income tax rather than withholding tax.

273 Secs. 871(g)(1)(B), 881(a)(3); Treas. Reg. sec. 1.1441-1(b)(4)(iv).

274 Treas. Reg. sec. 1.1461-1(c)(2)(ii)(A), (B). However, Treasury regulations require a bank to report interest if the recipient is a resident of Canada and the deposit is maintained at an office in the United States. Treas. Reg. secs. 1.6049-4(b)(5), 1.6049-8. This reporting is required to comply with the obligations of the United States under the U.S.-Canada income tax treaty. T.D. 8664, 1996-1 C.B. 292. In 2001, the IRS and the Treasury Department issued proposed regulations that would require annual reporting to the IRS of U.S. bank deposit interest paid to any foreign individual. 66 Fed. Reg. 3925 (Jan. 17, 2001). The 2001 proposed regulations were withdrawn in 2002 and replaced with proposed regulations that would require reporting with respect to payments made only to residents of certain specified countries (Australia, Denmark, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, and the United Kingdom). 67 Fed. Reg. 50,386 (Aug. 2, 2002). The proposed regulations have not been finalized.

275 Sec. 871(a)(2). In most cases, however, an individual satisfying this presence test will be treated as a U.S. resident under section 7701(b)(3), and thus will be subject to full residence-based U.S. income taxation.

276 Secs. 881(a), 631(b), and 631(c).

277 Sec. 897. Section 1445 imposes withholding requirements with respect to such dispositions.

278 See Sec. 897(h).

279 A number of recent U.S. income tax treaties eliminate withholding tax on dividends paid to a majority (typically 80-percent or greater) shareholder, including the present treaties with Australia, Belgium, Denmark, Finland, Germany, Japan, Mexico, the Netherlands, Sweden, and the United Kingdom.

280 Treas. Reg. sec. 1.1461-1(b), (c). IRS Form 1042, "Annual Withholding Tax Return for U.S.-Source Income of Foreign Persons," is the IRS form on which a withholding agent reports a summary of the total U.S. source income paid and withholding tax withheld on foreign persons for the year. IRS Form 1042-S, "Foreign Person's U.S. Source Income Subject to Withholding," is the IRS form on which a withholding agent reports, to the foreign person and the IRS, a foreign person's U.S.-source income that is subject to reporting.

281 Sec. 1462.

282 See secs. 6511(a) (prescribing the period within which a claim must be filed) and 6511(b)(2) (limiting the amount that can be recovered if a claim is not filed within three years of filing a return). If a return is not filed, a claim for refund of any tax paid must be filed within two years of payment.

283 Secs. 6611(b)(2) and 6611(d).

284 Sec. 6513(b)(3).

285 Sec. 6513(c)(2).

286 Sec. 6513(d).

287 Sec. 6513(d).

288 Sec. 6611.

289 Sec. 6601(b).

290 Sec. 6611(e).

291 Sec. 6611(b)(3).

292 Sec. 6622.

293 Sec. 6621(d).

294 Sec. 6621.

295 The grace period afforded the government was originally included as section 3771(b)(2) in the Internal Revenue Code of 1939 and was only 30-days. The grace period provides a period of time within which the IRS can transmit the refund information to the Financial Management Service of the Treasury Department, which is the agency that actually issues the refund checks.

296 123 F.3d 1460, 1465 (Fed. Cir. 1997).

297 See Treas. Reg. sec. 1.1441-1(b)(5).

298 A fifth type of IRS Form W-8, the W-8CE, is filed to provide the payor with notice of a taxpayer's expatriation.

299 The United States imposes tax on the beneficial owner of income, not its formal recipient. For example, if a U.S. citizen owns securities that are held in "street" name at a brokerage firm, that U.S. citizen (and not the brokerage firm nominee) is treated as the beneficial owner of the securities. A corporation (and not its shareholders) ordinarily is treated as the beneficial owner of the corporation's income. Similarly, a foreign complex trust ordinarily is treated as the beneficial owner of income that it receives, and a U.S. beneficiary or grantor is not subject to tax on that income unless and until he receives a distribution.

300 The IRS Form W-8ECI requires that the beneficial owner specify the items of income to which the form is intended to apply and certify that those amounts are effectively connected with the conduct of a trade or business in the United States and includible in the beneficial owner's gross income for the taxable year.

301 The IRS Form W-8EXP requires that the beneficial owner certify as to its qualification as a foreign government, an international organization, a foreign central bank of issue or a foreign tax-exempt organization, in each case meeting certain requirements.

302 In limited cases, the intermediary may furnish documentary evidence, other than the IRS Form W-8, of the status of the beneficial owner.

303 Rev. Proc. 2003-64, 2003-32 I.R.B. 306 (July 10, 2003), provides procedures for qualification as a withholding foreign partnership or withholding foreign trust in addition to providing model withholding agreements.

304 Sec. 6041; Treas. Reg. secs. 1.6041-1, 1.6041-2.

305 See secs. 6042 (dividends), 6045 (broker reporting), 6049 (interest), and the corresponding Treasury regulations.

306 See Treas. Reg. secs. 31.3406(d)-1, 31.3406(h)-3.

307 Sec. 3406(a)(1).

308 Sec. 3406(h)(10).

309 See Treas. Reg. secs. 1.1441-7(a) (definition of withholding agent includes foreign persons), 31.3406(a)-2 (payor for backup withholding purposes means the person (the payor) required to file information returns for payments of interest, dividends, and gross proceeds (and other amounts)), 1.6049-4(a)(2) (definition of payor for interest reporting purposes does not exclude foreign persons), 1.6042-3(b)(2) (payor for dividend reporting purposes has the same meaning as for interest reporting purposes), 1.6045-1(a)(1) (brokers required to report include foreign persons). But see Treas. Reg. secs. 1.6049-5(b) (exception for interest from sources outside the U.S. paid outside the U.S. by a non-U.S. payor or a non-U.S. middleman), 1.6045-1(g)(1)(i) (exception for sales effected at an office outside the U.S. by a non-U.S. payor or a non-U.S. middleman), 1.6042-3(b)(1)(iv) (exceptions for distributions from sources outside the U.S. by a non-U.S. payor or a non-U.S. middleman).

310 The definition also includes: a foreign branch or office of a U.S. financial institution or U.S. clearing organization; a foreign corporation for purposes of presenting income tax treaty claims on behalf of its shareholders; and any other person acceptable to the IRS, in each case that such person has entered into a withholding agreement with the IRS. Treas. Reg. sec. 1.1441-1(e)(5)(ii).

311 U.S. withholding agents are allowed to rely on a QI's IRS Form W-8IMY without any underlying beneficial owner documentation. By contrast, nonqualified intermediaries are required both to provide an IRS Form W-8IMY to a U.S. withholding agent and to forward with that document IRS Forms W-8 or W-9 or other specified documentation for each beneficial owner.

312 See Rev. Proc. 2000-12, 2000-1 C.B. 387, QI agreement secs. 2.12, 2.12, 5.03, 6.01.

313 Rev. Proc. 2000-12, 2000-1 C.B. 387, supplemented by Announcement 2000-50, 2000-1 C.B. 998, and modified by Rev. Proc. 2003-64, 2003-2 C.B. 306, and Rev. Proc. 2005-77, 2005-2 C.B. 1176. The QI agreement applies only to foreign financial institutions, foreign clearing organizations, and foreign branches or offices of U.S. financial institutions or U.S. clearing organizations. However, the principles of the QI agreement may be used to conclude agreements with other persons defined as QIs.

314 See Rev. Proc. 2000-12, 2000-1 C.B. 387, sec. 3.02.

315 Additional detail can be found in Joint Committee on Taxation, Selected Issues Relating to Tax Compliance with Respect to Offshore Accounts and Entities (JCX-65-08), July 23, 2008.

316 Regardless of whether a QI assumes primary Form 1099 reporting and backup withholding responsibility, the QI is responsible for IRS Form 1099 reporting and backup withholding on certain reportable payments that are not reportable amounts. See Rev. Proc. 2000-12, 2001-1 C.B. 387, QI agreement sec. 2.43 (defining reportable amount), sec. 2.44 (defining reportable payment), sec. 3.05, sec. 8.04. The reporting responsibility differs depending on whether the QI is a U.S. payor or a non-U.S. payor. Examples of payments for which the QI assumes primary IRS Form 1099 reporting and backup withholding responsibility include certain broker proceeds from the sale of certain assets owned by a U.S. non-exempt recipient and payments of certain foreign-source income to a U.S. non-exempt recipient if such income is paid in the United States or to an account maintained in the United States.

317 To the extent that a QI assumes primary responsibility for an account, it must do so for all payments made by the withholding agent to that account. See Rev. Proc. 2000-12, QI agreement sec. 3.

318 See Rev. Proc. 2000-12, QI agreement sec. 5.

319 The QI agreement contains its own presumption rules. See Rev. Proc. 2000-12, QI agreement sec. 5.13(C). An amount subject to withholding that is paid outside the United States to an account maintained outside the United States is presumed made to an undocumented foreign account holder (i.e., subject to 30-percent withholding). Payments of U.S. source deposit interest and certain other U.S. source interest and original issue discount paid outside of the United States to an offshore account is presumed made to an undocumented U.S. non-exempt account holder (i.e., subject to backup withholding). For payments of foreign source income, broker proceeds and certain other amounts, the QI can assume such payments are made to an exempt recipient if the amounts are paid outside the United States to an account maintained outside the United States.

320 Documentary evidence is any documentation obtained under know-your-customer rules per the QI agreement, evidence sufficient to establish a reduced rate of withholding under Treas. Reg. sec. 1.1441-6, and evidence sufficient to establish status for purposes of chapter 61 under Treas. Reg. 1.6049-5(c). See Rev. Proc. 2000-12, QI agreement sec. 2.12.

321 This rule restricts one of the principal benefits of the QI regime, nondisclosure of account holders, to financial institutions that have assumed the documentation and other obligations associated with QI status.

322 These amounts are statutorily exempt from nonresident withholding when paid to non-U.S. persons.

323 A reporting pool consists of income that falls within a particular withholding rate and within a particular income code, exemption code, and recipient code as determined on IRS Form 1042-S.

324 For undisclosed accounts, QIs must separately report each type of reportable payment (determined by reference to the types of income reported on IRS Forms 1099) and the number of undisclosed account holders receiving such payments.

325 If the QI is required to file IRS Forms 1099, it must file the appropriate form for the type of income paid (e.g., IRS Form 1099-DIV for dividends, IRS Form 1099-INT for interest, and IRS Form 1099-B for broker proceeds).

326 The term reportable amount generally includes those amounts that would be reported on IRS Form 1042-S if the amount were paid to a foreign account holder. The term reportable payment generally refers to amounts subject to backup withholding, but it has a different meaning depending upon the status of the QI as a U.S. or non-U.S. payor.

327 Under both of these procedures, if the QI is a non-U.S. payor, a U.S. non-exempt recipient may effectively avoid disclosure and backup withholding by investing in assets that generate solely non-reportable payments such as foreign source income (such as bonds issued by a foreign government) paid outside of the United States.

328 Rev. Proc. 2002-55, 2002-2 C.B. 435.

329 The U.S. know-your-customer rules are primarily found in the Bank Secrecy Act of 1970 and in Title III, The International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 of the USA PATRIOT Act.

330 The term financial institution is broadly defined under 31 U.S.C. sec. 5312(a)(2) or (c)(1) and includes U.S. banks and agencies or branches of foreign banks doing business in the United States, insurance companies, credit unions, brokers and dealers in securities or commodities, money services businesses, and certain casinos.

331 Relevant risks include the types of accounts held at the financial institution, the methods available for opening accounts, the types of customer identification information available, and the size, location, and customer base of the financial institution. 31 C.F.R. sec. 103.121(b)(2).

332 For a person other than an individual the address is the principal place of business, local office, or other physical location. 31 C.F.R. sec. 103.121(b)(2)(i)(3)(iii).

333 For a U.S. person the identification number is the TIN. For a non-U.S. person the identification number could be a TIN, passport number, alien identification number, or number and country of issuance of any other government-issued document evidencing nationality or residence and bearing a photograph or similar safeguard. 31 C.F.R. sec.103.121(b)(2)(i)(4).

334 See 31 C.F.R. sec. 103.121(b)(2).

335 For example, a financial institution is not "required to look through trust, escrow, or similar accounts to verify the identities of beneficiaries and instead will only be required to verify the identity of the named accountholder." See 68 Fed. Reg. 25,090, 25,094 (May 9, 2003).

336 See 31 C.F.R. sec. 103.121(b)(2)(ii)(C).

337 In order to assess the risk of the account relationship, a financial institution may need to ascertain the type of business, the purpose of the account, the source of the account funds, and the source of the wealth of the owner or beneficial owner of the entity.

338 31 C.F.R. sec. 103.178. A private banking account is an account that (1) requires a minimum deposit of not less than 1 million dollars; (2) is established for the benefit of one or more non-U.S. persons who are direct or beneficial owners of the account; and (3) is administered or managed by an officer, employee or agent of the financial institution. Beneficial owner for these purposes is defined as an individual who has a level of control over, or entitlement to the funds or assets in the account. 31 C.F.R. secs. 103.175(b), 103.175(o).

339 Directive 2005/60/EC of the European Parliament and of the Council, October 26, 2005 ( "EU Third Money Laundering Directive" ).

340 The directive applies to auditors, accountants, tax advisors, notaries, legal professionals, real estate agents, certain persons trading in goods (cash transactions in excess of EUR 15,000), and casinos.

341 EU Third Money Laundering Directive Art. 3(6)(a). Inquiries into beneficial ownership generally may stop at the level of any owner that is a company listed on a regulated market.

342 EU Third Money Laundering Directive Art. 3(6)(b).

343 EU Third Money Laundering Directive Art. 9.

344 As defined in section 475(c)(2), without regard to the last sentence thereof.

345 As defined in section 475(e)(2).

346 Control for these purposes has the same meaning as control for purposes of section 954(d)(3).

347 Subpart E of Part I of subchapter J of chapter 1.

348 As defined in section 581.

349 As defined in section 856.

350 As defined in section 851.

351 As defined in section 584(a).

352 This includes charitable remainder annuity trusts and charitable remainder unitrusts.

353 This includes certain charitable trusts not exempt under section 501(a).

354 See, for example, the Commentaries on the OECD Model Tax Convention on Income and on Capital, which make clear that individual countries are free to establish procedures for providing any reduced tax rates agreed to by treaty partners. These procedures can include both relief at source and/or full withholding at domestic rates, followed by a refund. See, e.g., Commentary 26.2 to Article 1.

A number of Articles of the Convention limit the right of a State to tax income derived from its territory. As noted in paragraph 19 of the Commentary on Article 10 as concerns the taxation of dividends, the Convention does not settle procedural questions and each State is free to use the procedure provided in its domestic law in order to apply the limits provided by the Convention. A State can therefore automatically limit the tax that it levies in accordance with the relevant provisions of the Convention, subject to possible prior verification of treaty entitlement, or it can impose the tax provided for under its domestic law and subsequently refund the part of that tax that exceeds the amount that it can levy under the provisions of the Convention.

Ibid. While Commentary 26.2 notes that a refund mechanism is not the preferred approach, the bill establishes such a mechanism for beneficial owners in certain circumstances. This approach serves to address, in part, observed difficulties in identifying U.S. persons who inappropriately seek treaty benefits to which they are not entitled.

355 Sec. 163(a).

356 An obligation is treated as in registered form if (1) it is registered as to both principal and interest with the issuer (or its agent) and transfer of the obligation may be effected only by surrender of the old instrument and either the reissuance by the issuer of the old instrument to the new holder or the issuance by the issuer of a new instrument to the new holder, (2) the right to principal and stated interest on the obligation may be transferred only through a book entry system maintained by the issuer or its agent, or (3) the obligation is registered as to both principal and interest with the issuer or its agent and may be transferred through both of the foregoing methods. Treas. Reg. sec. 5f.103-1(c).

357 Sec. 163(f)(2)(A). The registration requirement is intended to preserve liquidity while reducing opportunities for noncompliant taxpayers to conceal income and property from the reach of the income, estate and gift taxes. See Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (JCS-38-82), December 31, 1982, p. 190.

358 Priv. Ltr. Rul. 1993-43-018 (1993); Priv. Ltr. Rul. 1993-43-019 (1993); Priv. Ltr. Rul. 1996-13-002 (1996). The IRS held that the registration requirement may be satisfied by "dematerialized book-entry systems" developed in some foreign countries, even if, under such a system, a holder is entitled to receive a physical certificate, tradable as a bearer instrument, in the event the clearing organization maintaining the system goes out of existence, because "cessation of operation of the book-entry system would be an extraordinary event." Notice 2006-99, 2006-2 C.B. 907.

359 Sec. 163(f)(2)(B).

360 Sec. 4701.

361 Sec. 1287.

362 Sec. 165(j).

363 Secs. 871, 881; Treas. Reg. sec. 1.1441-1(b). Generally, the determination by a withholding agent of the U.S. or foreign status of a payee and of its other relevant characteristics (e.g., as a beneficial owner or intermediary, or as an individual, corporation, or flow-through entity) is made on the basis of a withholding certificate that is a Form W-8 or a Form 8233 (indicating foreign status of the payee or beneficial owner) or a Form W-9 (indicating U.S. status of the payee).

364 Secs. 871(h) and 881(c). Congress believed that the imposition of a withholding tax on portfolio interest paid on debt obligations issued by U.S. persons might impair the ability of U.S. corporations to raise capital in the Eurobond market (i.e., the global market for U.S. dollar-denominated debt obligations). Congress also anticipated that repeal of the withholding tax on portfolio interest would allow the U.S. Treasury Department direct access to the Eurobond market. See Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984 (JCS-41-84), December 31, 1984, pp. 391-92.

365 In repealing the 30-percent tax on portfolio interest, under the Deficit Reduction Act of 1984, Congress expressed concern about potential compliance problems in connection with obligations issued in bearer form. Given the foreign targeted exception to the registration requirement under section 163(f)(2)(A), U.S. persons intent on evading U.S. tax on interest income might attempt to buy U.S. bearer obligations overseas, claiming to be foreign persons. These persons might then claim the statutory exemption from withholding tax for the interest paid on the obligations and fail to declare the interest income on their U.S. tax returns, without concern that their ownership of the obligations would come to the attention of the IRS. Because of these concerns, Congress expanded the Treasury's authority to require registration of obligations deigned to be sold to foreign persons. See Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984 (JCS-41-84), December 31, 1984, p. 393.

366 Sec. 871(h)(3).

367 Sec. 871(h)(4).

368 Sec. 881(c)(3)(C).

369 Sec. 881(c)(3)(A).

370 31 U.S.C. sec. 3121(g)(3). For purposes of title 31 of the United States Code, registration-required obligation is defined as any obligation except: (1) an obligation not of a type offered to the public; (2) an obligation having a maturity (at issue) of not more than one year; or (3) a foreign targeted obligation.

371 31 U.S.C. sec. 3121(g)(2).

372 By reason of cross references, this rule will also apply to sections 165(j), 312(m), 871(h), 881(c), 1287 and 4701.

373 The issuance of physical certificates in bearer form in the event that the book entry system goes out of existence would be an extraordinary event that is not in the ordinary course of business. Notice 2006-99, 2006-2 C.B. 907.

374 31 U.S.C. sec. 5311.

375 See e.g., Title III of the USA PATRIOT Act, Pub. L. No. 107-56 (October 26, 2001) (sections 351 through 366 amended the Bank Secrecy Act as part of a series of reforms directed at international financing of terrorism).

376 31 U.S.C. sec. 5314. The term "agency" in the Bank Secrecy Act includes financial institutions.

377 31 U.S.C. sec. 5314(a) provides: "Considering the need to avoid impeding or controlling the export or import of monetary instruments and the need to avoid burdening unreasonably a person making a transaction with a foreign financial agency, the Secretary of the Treasury shall require a resident or citizen of the United States or a person in, and doing business in, the United States, to keep records, file reports, or keep records and file reports, when the resident, citizen, or person makes a transaction or maintains a relation for any person with a foreign financial agency."

378 31 C.F.R. sec. 103.27(c). The $10,000 threshold is the aggregate value of all foreign financial accounts in which a U.S. person has a financial interest or over which the U.S. person has signature or other authority.

379 31 U.S.C. sec. 5322 (failure to file is punishable by a fine up to $250,000 and imprisonment for five years, which may double if the violation occurs in conjunction with certain other violations).

380 31 U.S.C. sec. 5321(a)(5).

381 Section 6103 bars disclosure of return information, unless permitted by an exception.

382 31 C.F.R. sec. 103.24.

383 Treasury Department Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, and its instructions states:

A financial interest in a bank, securities, or other financial account in a foreign country means an interest described in one of the following three paragraphs: 1. A United States person has a financial interest in each account for which such person is the owner of record or has legal title, whether the account is maintained for his or her own benefit or for the benefit of others including non-United States persons. 2. A United States person has a financial interest in each bank, securities, or other financial account in a foreign country for which the owner of record or holder of legal title is: (a) a person acting as an agent, nominee, attorney, or in some other capacity on behalf of the U.S. person; (b) a corporation in which the United States person owns directly or indirectly more than 50 percent of the total value of shares of stock or more than 50 percent of the voting power for all shares of stock; (c) a partnership in which the United States person owns an interest in more than 50 percent of the profits (distributive share of income, taking into account any special allocation agreement) or more than 50 percent of the capital of the partnership; or (d) a trust in which the United States person either has a present beneficial interest, either directly or indirectly, in more than 50 percent of the assets or from which such person receives more than 50 percent of the current income. 3. A United States person has a financial interest in each bank, securities, or other financial account in a foreign country for which the owner of record or holder of legal title is a trust, or a person acting on behalf of a trust, that was established by such United States person and for which a trust protector has been appointed. A trust protector is a person who is responsible for monitoring the activities of a trustee, with the authority to influence the decisions of the trustee or to replace, or recommend the replacement of, the trustee. Correspondent or "nostro" accounts (international interbank transfer accounts) maintained by banks that are used solely for the purpose of bank-to-bank settlement need not be reported on this form, but are subject to other Bank Secrecy Act filing requirements. This exception is intended to encompass those accounts utilized for bank-to-bank settlement purposes only.

384 See Chief Counsel Advice 200603026 (January 20, 2006) for a discussion of whether payment card accounts constitute financial accounts.

385 According to the instructions to the FBAR, a person has "signature authority" over an account "if such person can control the disposition of money or other property in it by delivery of a document containing his or her signature (or his or her signature and that of one or more other persons) to the bank or other person with whom the account is maintained." "Other authority" exists in a person "who can exercise comparable power over an account by communication to the bank or other person with whom the account is maintained, either directly or through an agent, nominee, attorney, or in some other capacity on behalf of the US person, either orally or by some other means."

386 Although the revised instructions currently track the language of the statute in stating that a person in or doing business in the United States is within its purview, and thus merely clarify what has long been required, the IRS announced that pending publication of guidance on the scope of the statute, people could rely on the earlier, unrevised instructions to determine whether they are required to file a FBAR. Announcement 2009-51, 2009-25 I.R.B. 1105. Subsequently, the IRS announced that persons with only signature authority over a foreign financial account as well as for signatories or owners of financial interest in a foreign commingled fund have until June 30, 2010 to file an FBAR for the 2008 and earlier calendar years with respect to those accounts. Notice 2009-62, 2009-35 I.R.B. 260.

387 Notice 2009-62, 2009-35 I.R.B. 260, specifically requested comments concerning: (1) when a person having only signature authority or having an interest in a commingled fund should be relieved of filing an FBAR; (2) the circumstances under which the FBAR filing exceptions for officers and employees of banks and some publicly traded domestic corporations should be expanded; (3) when an interest in a foreign entity should be subject to FBAR reporting; and (4) whether the passive asset and passive income thresholds are appropriate and should apply conjunctively.

388 Secs. 6038, 6046.

389 Form 8858 is used to satisfy reporting requirements of sections 6011, 6012, 6031, 6038, and related regulations.

390 Sec. 6038B. The filing of this form may also be required upon future contributions to the foreign corporation.

391 Treas. Directive 15-14 (December 1, 1992), in which the Secretary delegated to the IRS authority to investigate violations of the Bank Secrecy Act. If the IRS Criminal Investigation Division declines to pursue a possible criminal case, it is to refer the matter to FinCEN for civil enforcement.

392 31 U.S.C. sec. 3711(g).

393 31 C.F.R. sec. 103.56(g). Memorandum of Agreement and Delegation of Authority for Enforcement of FBAR Requirements (April 2, 2003); News Release, Internal Revenue Service, IR-2003-48 (April 10, 2003).

394 Secretary of the Treasury, "A Report to Congress in Accordance with sec. 361(b) of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act)" (April 24, 2003).

395 A penalty may be assessed before the end of the six-year period beginning on the date of the transaction with respect to which the penalty is assessed. 31 U.S.C. sec. 5321(b)(1). A civil action for collection may be commenced within two years of the later of the date of assessment and the date a judgment becomes final in any a related criminal action. 31 U.S.C. sec. 5321(b)(2).

396 Sec. 6103(h)(1). In essence, section 6103(h)(1) authorizes officers and employees of both the Treasury Department and IRS to have access to return information on the basis of a "need to know" in order to perform a tax administration function.

397 Sec. 6103(b)(4).

398 Internal Revenue Manual, paragraphs 4.26.14.2 and 4.26.14.2.1.

399 American Jobs Creation Act of 2004, Pub. L. No. 108-357, sec. 821(b), 118 Stat. 1418. This provision is codified in 31 U.S.C. sec. 5321(a)(5).

400 31 U.S.C. sec. 5321(a)(5)(C).

401 31 U.S.C. sec. 5321(a)(5)(B)(i), (ii).

402 Sec. 6501(c)(8).

403 Secs. 1295, 6038.

404 Sec. 6721.

405 Sec. 6038.

406 Sec. 6038A.

407 Sec. 6046.

408 Sec. 6046A.

409 Sec. 6038B.

410 Sec. 6048.

411 If the correct income tax liability exceeds that reported by the taxpayer by the greater of 10 percent of the correct tax or $5,000 (or, in the case of corporations, by the lesser of (1) 10 percent of the correct tax (or, if greater, $10,000) or (2) $10 million), then a substantial understatement exists.

412 Sec. 6664(c).

413 Treas. Reg. secs. 1.6662-4(g)(4)(i)(B), 1.6664-4(c).

414 A tax shelter is defined for this purpose as a partnership or other entity, an investment plan or arrangement, or any other plan or arrangement if a significant purpose of such partnership, other entity, plan, or arrangement is the avoidance or evasion of Federal income tax. Sec. 6662(d)(2)(C).

415 Section 6663 imposes a penalty of 75 percent on that portion of the understatement attributable to fraud. If the government proves that such understatement was attributable to fraud, there is a rebuttable presumption that any other understatement is attributable to fraud.

416 Secs. 6011 through 6112 require taxpayers and their advisers to disclose certain transactions determined to have the potential for tax avoidance. All such transactions are referred to as "reportable transactions," and include within that class of transactions, those that are "listed," that is, the subject of published guidance in which the Secretary announces his intent to challenge such transactions.

417 Sec. 6662A.

418 Sec. 6662A(a).

419 Sec. 6664(d).

420 Sec. 6662A(c).

421 The information reporting requirements identified include sections 6038, 6038A, new 6038D, 6046A, and 6048.

422 Sec. 6501(a). Returns that are filed before the date they are due are deemed filed on the due date. See sec. 6501(b)(1) and (2).

423 Required information reporting subject to this three-year rule is reporting under sections 6038 (certain foreign corporations and partnerships), 6038A (certain foreign-owned corporations), 6038B (certain transfers to foreign persons), 6046 (organizations, reorganizations, and acquisitions of stock of foreign corporations), 6046A (interests in foreign partnerships), and 6048 (certain foreign trusts).

424 Sec. 6501(c).

425 Sec. 6501(c)(4).

426 Sec. 6501(c)(10).

427 Sec. 6501(e)(1)(A)(i).

428 Sec. 6501(e)(1)(A)(ii) provides that, in determining whether an amount was omitted, any amounts that are disclosed in the return or in a statement attached to the return in a manner adequate to apprise the Secretary of the nature and amount of such item are not taken into account.

429 Sec. 7609(e)(2).

430 Sec. 1295(b), (f).

431 Sec. 1297.

432 Sec. 1291.

433 Secs. 1293-1295.

434 Sec. 1296.

435 See Instructions to IRS Form 8621. According to the form, reportable elections include the following: (i) an election to treat the PFIC as a QEF; (ii) an election to recognize gain on the deemed sale of a PFIC interest on the first day of the PFIC's tax year as a QEF; (iii) an election to treat an amount equal to the shareholder's post-1986 earnings and profits of a CFC as an excess distribution on the first day of a PFIC's tax year as a QEF that is also a controlled foreign corporation under section 957(a); (iv) an election to extend the time for payment of the shareholder's tax on the undistributed earnings and profits of a QEF; (v) an election to treat as an excess distribution the gain recognized on the deemed sale of the shareholder's interest in the PFIC, or to treat such shareholder's share of the PFIC's post-1986 earnings and profits as an excess distribution, on the last day of its last tax year as a PFIC under section 1297(a) if eligible; or (vi) an election to mark-to-market the PFIC stock that is marketable within the meaning of section 1296(e).

436 Sec. 1291(e) by reference to sec. 1246(f).

437 Prop. Treas. Reg. sec. 1.1291-1(i).

438 Treas. Reg. sec. 1.1441-7(a)(1).

439 Sec. 1461.

440 Treas. Reg. sec.1.1461-1(b)(1).

441 Ibid.

442 Treas. Reg. sec. 1.1461-1(c)(1). IRS Form 1042-S filings provide information important for the Secretary's purposes in properly effecting refund claims and in meeting IRS's obligations under exchange of information agreements with various treaty partners. Also, the IRS has the ability to validate electronically filed Form 1042-S upon such filing, thereby serving to better ensure the reliability of information included in such filings.

443 Ibid. If payments are made to a nominee or representative of a foreign payee, Form 1042-S must also be sent to the beneficial owner of such payments, if known to the withholding agent.

444 Pub. L. No. 105-206 (1998).

445 Partnerships with more than 100 partners are required to file electronically. Sec. 6011(e)(2).

446 Sec. 6011(e).

447 Sec. 6724(c). If a corporation fails to comply with the electronic filing requirements for more than 250 returns that it is required to file, it may be subject to the penalty for failure to file information returns under section 6721. For partnerships, the penalty may only be imposed if the failure extends to more than 100 returns.

448 See section 1471(d)(5) in section 101 of the bill.

449 The "financial institution" is personally liable for any tax withheld in accordance with section 1461 and the proposed section 1474(a) under section 101 of the bill.

450 A trust is a foreign trust if it is not a U.S. person. Sec. 7701(a)(31)(B). A trust is a U.S. person if (1) a U.S. court is able to exercise primary supervision over the administration of the trust, and (2) one or more U.S. persons have the authority to control all substantial decisions of the trust. Sec. 7701(a)(30)(E).

451 Sec. 679(a)(1). This rule does not apply to transfers to trusts established to fund qualified deferred compensation plans or to trusts exempt from tax under section 501(c)(3).

452 Sec. 679(a)(2).

453 Sec. 679(c)(1).

454 Treas. Reg. sec. 1.679-2(a)(2)(i).

455 Treas. Reg. sec. 1.679-2(a)(2)(ii).

456 Treas. Reg. sec. 1.679-2(a)(4)(i).

457 Treas. Reg. sec. 1.679-2(a)(4)(ii).

458 Undistributed net income is defined in section 665(a).

459 Sec. 679(b).

460 Treas. Reg. sec. 1.679-2(c)(1).

461 A trust is a foreign trust if it is not a U.S. person. Sec. 7701(a)(31)(B). A trust is a U.S. person if (1) a U.S. court is able to exercise primary supervision over the administration of the trust and (2) one or more U.S. persons have the authority to control all substantial decisions of the trust. Sec. 7701(a)(30)(E).

462 Sec. 679(a)(1). This rule does not apply to transfers to trusts established to fund qualified deferred compensation plans or to trusts exempt from tax under section 501(c)(3).

463 Sec. 679(a)(2).

464 Sec. 679(c)(1).

465 Sec. 6048(a).

466 A foreign trust for this purpose does not include deferred compensation and charitable trusts described in section 6048(a)(3)(B)(ii).

467 Sec. 643(i)(2)(C).

468 Sec. 643(i)(2)(D).

469 Sec. 643(i)(3).

470 Section 643(i)(2)(B) treats a person as a related person if the relationship between such person would result in a disallowance of losses under sections 267 or 707(b), broadened to include the spouses of members of the family described in such sections.

471 Sec. 6048(b)(1).

472 Sec. 7701(a)(30)(E), (31)(B). In addition, for purposes of section 6048, the IRS can classify a trust as foreign if it "has substantial activities, or holds substantial property, outside the United States." Sec. 6048(d)(2).

473 Sec. 6048(a).

474 Sec. 6048(c).

475 Sec. 6048(b).

476 Sec. 6677(a).

477 Sec. 6677(c).

478 Sec. 6677(b).

479 Sec. 6677(a).

480 Ibid.

481 Secs. 871, 881, 1441, 1442; Treas. Reg. sec. 1.1441-1(b). For purposes of the withholding tax rules applicable to payments to nonresident alien individuals and foreign corporations, a withholding agent is defined broadly to include any U.S. or foreign person that has the control, receipt, custody, disposal, or payment of an item of income of a foreign person subject to withholding. Treas. Reg. sec. 1.1441-7(a).

482 Sec. 861(a)(2).

483 Treas. Reg. sec. 1.863-7(b)(1). A notional principal contract is a financial instrument that provides for the payment of amounts by one party to another at specified intervals calculated by reference to a specified index upon a notional principal amount in exchange for specified consideration or a promise to pay similar amounts. Treas. Reg. sec. 1.446-3(c)(1).

484 Treas. Reg. sec. 1.861-3(a)(6). This regulation defines a substitute dividend payment as a payment, made to the transferor of a security in a securities lending transaction or a sale-repurchase transaction, of an amount equivalent to a dividend distribution which the owner of the transferred security is entitled to receive during the term of the transaction.

485 For purposes of the imposition of the 30-percent withholding tax, substitute dividend payments (and substitute interest payments) received by a foreign person under a securities lending or sale-repurchase transaction have the same character as dividend (and interest) income received in respect of the transferred security. Treas. Reg. secs. 1.871-7(b)(2), 1.881-2(b)(2).

486 Notice 97-66, 1997-2 C.B. 328 (December 1, 1997).

487 There is evidence that some taxpayers have taken the position that Notice 97-66 sanctions the elimination of withholding tax in certain situations. See United States Senate, Permanent Subcommittee on Investigations, Committee on Homeland Security and Governmental Affairs, Dividend Tax Abuse: How Offshore Entities Dodge Taxes on U.S. Stock Dividends , Staff Report, September 11, 2008, pp. 18-20, 22-23, 40, 47, 52. In the Obama administration's fiscal year 2010 budget, the Treasury Department has announced that, to address the avoidance of U.S. withholding tax through the use of securities lending transactions, it plans to revoke Notice 97-66 and issue guidance that eliminates the benefits of those transactions but minimizes over-withholding. Department of the Treasury, General Explanations of the Administration's Fiscal Year 2010 Revenue Proposals, May 2009, p. 37.

488 The Secretary may issue guidance addressing the application of this rule in circumstances in which the long party transfers the underlying security to an unrelated third party.

489 Any notional principal contract identified by the Secretary as a specified notional principal contract will be subject to the provision's general effective date described below.

490 Only a handful of cases have addressed this issue. Though one case required the value to be included currently, where value was easily determined by a sale of the profits interest soon after receipt ( Diamond v. Commissioner , 56 T. C. 530 (1971), aff'd 492 F.2d 286 (7 th Cir. 1974)), a more recent case concluded that partnership profits interests were not includable on receipt, because the profits interests were speculative and without fair market value ( Campbell v. Commissioner, 943 F. 2d 815 (8 th Cir. 1991)).

491 Rev. Proc. 93-27 (1993-2 C.B. 343) citing the Diamond and Campbell cases, supra .

492 Rev. Proc. 2001-43 (2001-2 C.B. 191).

493 A similar result would occur under the "safe harbor" election under proposed regulations regarding the application of section 83 to the compensatory transfer of a partnership interest. REG-105346-03, 70 Fed. Reg. 29675 (May 24, 2005).

494 Secs. 61 and 83; Treas. Reg. sec. 1.721-1(b)(1); see U.S. v. Frazell , 335 F.2d 487 (5th Cir. 1964), cert. denied , 380 U.S. 961 (1965).

495 Rev. Proc. 93-27, 1993-2 C.B. 343.

496 Sec. 83(h).

497 70 Fed. Reg. 29675 (May 24, 2005).

498 Sec. 702.

499 See Chapter 21 of the Code.

500 Sec. 1401.

501 Secs. 3101 and 3111.

502 S corporation shareholders who are employees of the S corporation are subject to FICA taxes. A considerable body of case law has addressed the issue of whether amounts paid to S corporation shareholder-employees are reasonable compensation for services and therefore are wages subject to FICA tax or are properly characterized as another type of income (typically, dividends) and therefore not subject to FICA tax.

503 For purposes of determining net earnings from self-employment, taxpayers are permitted a deduction from net earnings from self-employment equal to the product of the taxpayer's net earnings (determined without regard to this deduction) and one-half of the sum of the rates for OASDI (12.4 percent) and HI (2.9 percent), i.e., 7.65 percent of net earnings. This deduction reflects the fact that the FICA rates apply to an employee's wages, which do not include FICA taxes paid by the employer, whereas a self-employed individual's net earnings are economically the equivalent of an employee's wages plus the employer share of FICA taxes. The deduction is intended to provide parity between FICA and SECA taxes. In addition, self-employed individuals may deduct one-half of self-employment taxes for income tax purposes under section 164(f).

504 Sec. 1402(a)(13).

505 The Taxpayer Relief Act of 1997 (Pub. L. No. 105-34) added section 7704(g), permitting electing 1987 partnerships not to be subject to the general rule treating publicly traded partnerships as corporations and to be subject to an additional tax.

506 A REIT is not treated as providing services that produce impermissible tenant services income if such services are provided by an independent contractor from whom the REIT does not derive or receive any income. An independent contractor is defined as a person who does not own, directly or indirectly, more than 35 percent of the shares of the REIT. Also, no more than 35 percent of the total shares of stock of an independent contractor (or of the interests in net assets or net profits, if not a corporation) can be owned directly or indirectly by persons owning 35 percent or more of the interests in the REIT.

507 Sec. 6662. The penalty rate is increase to 40 percent for gross valuation misstatements. Sec. 6662(h).

508 Sec. 6662(d)(2). An understatement is generally reduced by amounts attributable to (1) positions for which the taxpayer has substantial authority, or (2) items adequately disclosed and for which the taxpayer has a reasonable basis. The reduction does not apply to tax shelter items.

509 Sec. 6662(d)(1)(A).

510 Sec. 6662(d)(1)(B).

511 Sec. 6662A(b)(2).

512 Sec. 6662A(c).

513 Sec. 6664(c).

514 Sec. 6664(d)(3).

515 Section 6664(d)(3)(B) does not allow a reasonable belief to be based on a "disqualified opinion" or on an opinion from a "disqualified tax advisor."

516 It is intended that income from providing the services described above with respect to the business or assets of the partnership in which the partner (directly or indirectly) holds a partnership interest is subject to the recharacterization rule of the provision.

517 The income generally is subject to self-employment tax under present law in the hands of a general partner, or a limited partner receiving guaranteed payments as remuneration for services, without regard to the provision.

518 The rule providing that gain is treated as ordinary income on the disposition of an investment services partnership interest is described below.

519 Sec. 741; except ordinary treatment applies to the extent gain is attributable to inventory and unrealized receivables under section 751(a). The bill adds investment services partnership interests to this category under section 751(a).

520 Further described above is the rule providing that a net loss from an investment services partnership interest (to the extent it is allowed in computing taxable income) is taken into account in determining net earnings from self-employment for the taxable year.

521 Sec. 6655.

522 Pub. L. No. 111-92, Sec. 18; Pub. L. No. 111-42, sec. 202(b)(1).

523 Pub. L. No. 93-344.

524 Pub. L. No. 93-344, sec. 3(3), codified at 2 USC 622(3).

525 Pub. L. No. 93-344, sec. 202(f)(1)(B).

526 Pub. L. No. 93-344, sec. 201(g), codified at 2 USC 601(f).

527 See e.g., Joint Committee on Taxation, Estimates of Federal Tax Expenditures (JCS-2-08), October 31, 2008.

528 See e.g., Congressional Research Service, Tax Expenditures: Compendium of Background Material on Individual Provisions , S. Prt. 110-667, December 2008.

529 See e.g., Government Accountability Office, Home Mortgage Interest Deduction (GAO-09-769), July 29, 2009, and Government Accountability Office, Tax Expenditures Represent a Substantial Federal Commitment and Need to Be Reexamined (GAO-05-690), September 23, 2005.


Committee on Taxation Technical Explanation of HR 4213, the Tax

IRS Small Business/Self-Employed Rapid Response Appeals Process (RRAP), SBSE-05-1109-061, (Dec. 11, 2009)

2009ARD 238-2



DEPARTMENT OF THE TREASURY INTERNAL REVENUE SERVICE Washington, DC 20224
SMALL BUSINESS / SELF-EMPLOYED DIVISION

November 20, 2009

Control Number: SBSE-05-1109-061

SBSE Expiration: November 20, 2010

IRM Impacted: IRM 5.1.9

MEMORANDUM FOR DIRECTORS, COLLECTION AREA OFFICES

FROM: Frederick W. Schindler /s/ Frederick W. Schindler Director, Collection Policy

SUBJECT: Rapid Response Appeals Process (RRAP)

This memorandum provides guidance for implementing a pilot program that provides new priority procedures for pyramiding in-business trust fund (IBTF) Collection Due Process (CDP) cases in Appeals. We will pilot this program, referred to as the Rapid Response Appeals Process (RRAP), for one year. After a year, we will review these procedures to determine if we will permanently implement this process.

A case meeting ALL the following criteria qualifies for RRAP:

An in-business taxpayer who owes employment taxes.

The taxpayer is not making required Federal Tax Deposits (FTD) in the current quarter.

The unpaid tax due, including accruals, is $25,000 or more, and

A timely request for a CDP hearing regarding a levy or a levy and a Notice of Federal Tax Lien.

The following cases do not qualify for RRAP:

An equivalent hearing;

A request solely to appeal a Notice of Federal Tax Lien under IRC § 6320 , or

The taxpayer qualifies for a disqualified employment tax levy (DETL)

Please ensure that this information is distributed to all affected employees within your organization. In addition, a RRAP articulate presentation is available to brief collection personnel on this change. The articulate presentation also includes information on processing frivolous CDP hearing requests.

If you have any questions, please feel free to contact me or Ken Marek, Program Manager, or a member of your staff may contact Tasia Agne, Senior Program Analyst. Territory personnel should direct any questions, through their management staff, to the appropriate Area contact.

Field Processing of RRAP Cases
1. When a Revenue Officer (RO) receives an IBTF CDP Levy hearing request that meets RRAP criteria, the RO will:

Annotate the ICS history,

Prepare Form 12153-A, and

Submit the Form 12153, Form 12153-A, Form 433B, Collection Information Statement (or appropriate financial documentation, if available) to the Group Manager for review and approval.

2. After managerial approval:

Request input of the case to the CDP tracking system, Stage 1 and Stage 3,

Open an OI and change the ICS Sub Code to 919 (IBTF RRAP/CDP),

Uses IDRS command code CDPTRT to verify that all periods are on CDPTS,

Prepare Form 3210 and annotate in Remarks: “CDP IBTF RRAP Case”,

Create a digitized case file by scanning documents to a file, and

Email the digitized case documents to the designated Appeals Processing Team Manager (PTM) with a “cc” to the Appeals Team Manager (ATM) designated as the Area RRAP Coordinator.

3. The case file forwarded to Appeals will include the following digitized documents:

Form 3210

F12153,

F12153-A,

CDP Notice L-1058 (or L-3172 and Notice of Federal Tax Lien, if applicable),

Envelope,

Form 433-B or other financial documentation, if available,

Additional documentation/correspondence sent with the F12153,

Any additional documentation/information in the case file pertinent to the issue(s) raised by the taxpayer, and

IDRS screen print of cc “CDPTRT” or equivalent documentation, verifying that case is on CDPTS.

4. Send RRAP cases via encrypted email to the Appeals Processing Team Manager (PTM) and the Appeals Team Manager (ATM) RRAP Coordinator as follows:

a. East - PTM, Loretta.Loney@IRS.gov

RRAP coordinator, ATM, Catherine.L.Lacienski@IRS.gov

North Atlantic Area

South Atlantic Area

Central Area

Gulf Area states of Georgia, Alabama, Mississippi, Tennessee, and Louisiana

Midwest Area states of Missouri, and Indiana.

b. West - PTM, Velton.R.Walton@IRS.gov

RRAP coordinator, ATM, Gina.Smith@IRS.gov

California Area

Western Area

Gulf Area states of Oklahoma, Texas, and Arkansas

Midwest Area states of North Dakota, South Dakota, Nebraska, Kansas, Minnesota, Iowa, Wisconsin, and Illinois.

Appeals Processing of RRAP Cases
1. Appeals Processing Section (APS) will:

Card-in the CDP hearing request,

Add feature code PY to indicate Pyramiding, and

Inform the ATM by email that the case has been carded in and is ready for assignment.

2. After the PTM has informed the ATM that the case has been carded in, the ATM will assign the case to a Settlement Officer within five business days.

3. The Settlement Officer (SO) will:

Make a substantive contact with the taxpayer within ten business days of assignment via either telephone or letter,

Hold a hearing within 14 calendar days of the date of the letter or the telephone contact,

Note: The conference may be scheduled greater than 14 calendar days, if warranted

Where the substantive contact is by telephone, clearly and accurately document the case activity record.

4. When the case is closed and the decision is final, APS will fax copies of the Appeals closing documents to the originating RO. At a minimum this should include:

The fax cover sheet prepared by the SO,

Form 5402,

Letter 3193 with enclosure,

Case Activity Record, and

Other documents obtained by Appeals during the CDP hearing process. Note: If these “other documents” exceed 10 pages, including the fax cover sheet, they can be mailed to the revenue officer.

The sole issue for decision is whether petitioners are entitled to deduct $28,307 in expenses that John Y. Ding (petitioner) claimed on Schedule C, Profit or Loss From Business, for 2004An individual was not entitled to deduct any Schedule C trade or business expenses claimed in connection with a failed consulting venture that had no clients and generated no income. The expenses were incurred during the start-up phase of the business prior to the commencement of an active trade or business and, therefore, were nondeductible start-up costs. Certain expenses claimed on Form 1040 Schedule C, however, were incurred in connection with his separate trade or business as an employee-manager of a manufacturing firm. To the extent deemed substantiated under the Cohan rule, these unreimbursed expenses were deductible as itemized employee business expenses on Form 1040 Schedule A. The portion of the taxpayer's home office expense deduction related to his employment in the manufacturing firm was also deductible as an itemized deduction. In determining whether the office was used exclusively for business purposes, its use in the consulting venture could be counted. The office was also required for the convenience of the taxpayer's employer since the employer did not provide him with an office and he needed a central location to conduct his managerial and administrative responsibilities. Telephone expenses deemed attributable to the taxpayer's employment were also allowed. Based on the volume of phone calls made in the evenings and nights and the taxpayer's responsibilities, it was highly probable that the expenses were for a second line as required by Code Sec. 262(b)


John Y. Ding and Linda H. Zhang v. Commissioner., U.S. Tax Court, T.C. Summary Opinion 2009-186, (Dec. 7, 2009)
Docket No. 18253-07S. Filed December 7, 2009.
.
.

















Discussion

Taxpayers may deduct ordinary and necessary expenses that they pay in connection with operating a trade or business. Sec. 162(a); Boyd v. Commissioner, 122 T.C. 305, 313 (2004). Generally, the performance of services as an employee constitutes a trade or business. Primuth v. Commissioner, 54 T.C. 374, 377 (1970). To be “ordinary” the expense must be of a common or frequent occurrence in the type of business involved. Deputy v. du Pont, 308 U.S. 488, 495 (1940). To be “necessary” an expense must be appropriate and helpful to the taxpayer's business. Welch v. Helvering, supra at 113. Additionally, the expenditure must be “directly connected with or pertaining to the taxpayer's trade or business”. Sec. 1.162-1(a), Income Tax Regs.
For such expenses to be deductible the taxpayer must not have the right to obtain reimbursement from his employer. See Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), affg. T.C. Memo. 1984-533. Section 262(a) disallows deductions for personal, living, or family expenses.
If a taxpayer establishes that an expense is deductible, but is unable to substantiate the precise amount, we may estimate the amount, bearing heavily against the taxpayer whose inexactitude is of his own making. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). The taxpayer must present sufficient evidence for the Court to form an estimate, because without such a basis, any allowance would amount to unguided largesse. Williams v. United States, 245 F.2d 559, 560-561 (5th Cir. 1957); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).
Section 274 overrides the Cohan rule with regard to certain expenses. Sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). Section 274 requires more stringent substantiation for travel, meals, and listed property, defined under section 280F(d)(4) to include passenger automobiles, computers or peripheral equipment, and cellular telephones. Section 274(d) requires taxpayers to provide adequate records or sufficient other evidence establishing the amount, time, place, and business purpose of the expense to corroborate the taxpayer's statements. Thus, even if such an expense would otherwise be deductible under Cohan, section 274 may still prohibit a deduction if the taxpayer does not have sufficient substantiation. Sec. 1.274-5T(a), Temporary Income Tax Regs., supra.
B. Business Expenses v. Startup Expenses
While section 162 generally allows a deduction for ordinary and necessary expenses paid in connection with carrying on a trade or business, the trade or business must be functioning as a business at the time the taxpayer incurred the expenses. Hardy v. Commissioner, 93 T.C. 684, 687 (1989), affd. in part and remanded in part per order (10th Cir., Oct. 29, 1990); Woody v. Commissioner, T.C. Memo. 2009-93; Glotov v. Commissioner, T.C. Memo. 2007-147; sec. 1.162-1(a), Income Tax Regs. For this purpose, “A taxpayer is not carrying on a trade or business under section 162(a) until the business is functioning as a going concern and performing the activities for which it was organized.” Glotov v. Commissioner, supra. Until that time, expenses related to the activity are not ordinary and necessary expenses deductible under section 162 or section 212 (expenses incurred for the production of income), but instead are “start-up” or “pre-opening” expenses. Hardy v. Commissioner, supra at 687-688.
Section 195 governs the deductibility of startup expenses, providing in pertinent part that the taxpayer must capitalize the expenditures and “Except as otherwise provided in this section, no deduction shall be allowed for start-up expenditures.” Sec. 195(a). The taxpayer may elect to amortize the capitalized startup costs evenly over a period of not less than 60 months, “beginning with the month in which the active trade or business begins”. 1 Sec. 195(b). When a taxpayer's endeavor never rises to the status of an active trade or business, the taxpayer may not amortize the startup costs. See Bernard v. Commissioner, T.C. Memo. 1998-20.
Therefore, the threshold issue here is whether petitioner completed the startup phase and became actively engaged in a trade or business during 2004. Courts have adopted a facts and circumstances test focusing on whether the taxpayer has satisfied all of the following three factors: (1) Whether the taxpayer undertook the activity intending to earn a profit; (2) whether the taxpayer was regularly and actively involved in the activity; and (3) whether the taxpayer's activity has actually commenced. See Woody v. Commissioner, supra; McManus v. Commissioner, T.C. Memo. 1987-457, affd. without published opinion 865 F.2d 255 (4th Cir. 1988).
We find that petitioner intended to earn a profit; however, petitioner did not establish that he was regularly and actively engaged in his consulting efforts or that the business actually began in 2003 or 2004. Petitioner failed to attract a single client or generate a single dollar or yuan in income in 2003 or 2004. Petitioner acknowledged that his business model “needed to be more thought out and well planned out than what I started to do”, adding “Well, it just looked so easy when everybody else was doing it”. Petitioner further acknowledged that he was going to try to launch the activity again at a later date.
Thus, petitioner's own candid testimony together with the record as a whole establishes that petitioner was not carrying on an active trade or business in 2003 or 2004. Therefore, we sustain respondent's characterization that the business expenses petitioner reported for 2004 are not Schedule C trade or business expenses.
III. Petitioner's Schedule A Unreimbursed Employee Business Expenses
The holding above, however, does not end the case. As noted in respondent's notice of deficiency, some of the 2004 expenses that petitioner claimed on Schedule C may qualify as Schedule A unreimbursed employee business expenses related to his job at Leggett & Platt. Consequently, we will now examine the business expenses petitioner reported on Schedule C for possible reclassification to Schedule A as 2004 unreimbursed employee business expenses.
A. Car and Truck Expenses
Petitioner deducted $7,496 in car and truck expenses for 2004 for a 2000 Lexus he placed in service on January 1, 2003, the date he started his consulting efforts. Petitioner reported that in 2004 he drove the Lexus 7,590 miles for business. Despite the mileage information, petitioner used actual costs to determine his car expense deduction, inputting the information regarding his automobile expenses into his computer and relying on his tax preparation software to determine the maximum deductions for depreciation and other car expenses.
Because of the nondeductibility of petitioner's startup expenses relating to his consulting efforts, the only deductible use of an automobile would be in connection with his employment with Leggett & Platt. Petitioner has not established that he used his car in connection with his employment with Leggett & Platt. Even if the car expenses were employment related, petitioner has also not shown that the expenses were not reimbursable by Leggett & Platt. Therefore, petitioner is not entitled to deduct any of the car and truck expenses as unreimbursed employee business expenses for 2004.
B. Travel and Meals and Entertainment Expenses
Petitioner reported $7,438 of business travel expenses away from home and $1,075 of business meals and entertainment expenses on his 2004 Schedule C. Petitioner testified that he paid these expenses in connection with his consulting efforts during three trips he made to Asia during 2004. We have already found that the expenses petitioner paid in conjunction with his consulting efforts are nondeductible startup expenses. Further, some of the traveling expenses may have been for personal family expenses. Petitioner's mother lives in northern China, and his wife's mother recently moved back to China. They also have other relatives in Beijing and other cities. Moreover, Leggett & Platt reimbursed petitioner for all of his 2004 foreign travel business expenses, including meals and lodging.
In summary, none of petitioner's 2004 traveling expenses are deductible as unreimbursed employee business expenses. Instead, petitioner's 2004 travel and meals and entertainment expenses were either nondeductible startup or personal expenses.
C. Office Expenses and Supplies
Petitioner deducted $977 in office expenses and $780 in supplies on his 2004 Schedule C. Petitioner testified that about 70 to 80 percent of these expenditures were for his employment with Leggett & Platt, and the remainder were for his consulting efforts. Because Leggett & Platt did not reimburse petitioner for expenses associated with working from home, and because we find that these expenditures were ordinary and necessary business expenses, we apply Cohan, concluding that petitioner may deduct 70 percent of the expenditures as unreimbursed employee business expenses for 2004, as follows: $684 for office expense and $546 for supplies. The remaining 30 percent of the expenses are nondeductible startup expenses.
D. Home Office Expenses
Generally, a taxpayer may not deduct expenses paid in connection with the business use of a home. Sec. 280A(a). However, a taxpayer may deduct expenses allocable to a portion of his home if, in pertinent part, he uses the space exclusively on a regular basis as his principal place of business, or as a place of business where he meets patients, clients, or customers in the normal course of his business. Sec. 280A(c)(1)(A) and (B). The definition of “principal place of business” for this purpose includes a portion of the home that the taxpayer uses for the administrative or management activities of his trade or business if there is no other fixed location for those activities. Sec. 280A(c)(1).
The exclusive use requirement of section 280A(c)(1) “is an all-or-nothing standard”. Hamacher v. Commissioner, 94 T.C. 348, 357 (1990). Thus, for example, if a taxpayer uses his den as the principal place for conducting his attorney business but also uses the den for personal purposes, then the taxpayer may not deduct any expenses related to the den. S. Rept. 94-938, at 148 (1976), 1976-3 C.B. (Vol. 3) 49, 186. Congress' intent in enacting section 280A was to exclude taxpayers from converting otherwise “‘nondeductible personal, living, and family expenses’” into “‘deductible business expenses’” merely because they had some connection with a business activity. Hamacher v. Commissioner, supra at 357 (quoting S. Rept. 94-938, supra at 147, 1976-3 C.B. (Vol. 3) at 185.
Where a taxpayer uses his home office for more than one business, the taxpayer satisfies the exclusive use test only if each business is one of the types described in section 280A(c)(1). Hamacher v. Commissioner, supra at 357-358. Although we found that petitioner's consulting activities were a nondeductible startup activity, we are nonetheless satisfied that petitioner's consulting activity is of the type described by section 280A(c)(1); he met potential clients there, it was the principal place of his activity, and the consulting was not a personal, family, or living usage. Similarly, as discussed below, petitioner's use of the basement for his work as an employee of Leggett & Platt is also a type of business described by section 280A(c)(1). Accordingly, petitioner satisfies the “all-or-nothing” exclusive use test.
A taxpayer, such as petitioner, who is an employee must also satisfy an additional requirement that his exclusive use is “for the convenience of his employer.” Sec. 280A(c). Neither the Code nor the regulations define that phrase. Caselaw, however, holds that an employee satisfies the requirement when the employee maintains the home office as a condition of his employment or as necessary for the functioning of the employer's business or as necessary for the employee to properly perform his duties. Hamacher v. Commissioner, supra at 358. In contrast, the home office must not “be ‘purely a matter of personal convenience, comfort, or economy’ with respect to the employee.” Id. (quoting Sharon v. Commissioner, 66 T.C. 515, 523 (1976), affd. 591 F.2d 1273 (9th Cir. 1978).
Petitioner's activities were essential to Leggett & Platt. He was responsible for overseeing the corporation's Asian operations, planning, and budgeting work. These responsibilities required that he conduct telephone calls late at night with Leggett & Platt facilities in Asia and that he maintain necessary records for his managerial and administrative duties. Though petitioner may have enjoyed the convenience and comfort of working from home, Leggett & Platt did not furnish him with an office. Cf. Tokh v. Commissioner, T.C. Memo. 2001-45. Petitioner had nowhere else to regularly and properly perform these responsibilities.
Therefore, we conclude that petitioner's home office was for the convenience of the employer and overall that petitioner has satisfied the requirements of section 280A with respect to business use of the home for 2004. We must, however, continue our inquiry to separate the expenses between the deductible expenses he paid with respect to his employment with Leggett & Platt and the nondeductible expenses he paid related to his startup consulting activities.
1. Furniture, Repairs and Maintenance, and Utilities
Petitioner reported on his 2004 Schedule C that he spent $1,215 for furniture, $4,196 for repairs and maintenance, and $1,782 for utilities in 2004 related to his business use of his basement. Petitioner testified that he paid these expenditures for finishing the remodeling and maintaining his basement in 2004.
As noted earlier, petitioner divided about one-half of the basement space into a conference area for his consulting activities. The record gives no indication that petitioner used the conference area for his employment with Leggett & Platt. Accordingly, one-half of the basement expenditures are nondeductible startup costs. With respect to the other half of the expenditures, petitioner testified further that he split his time in the basement office evenly between Leggett & Platt and his consulting activities. Because we have already found that petitioner's home office was for the convenience of his employer, petitioner is eligible to deduct the portion of his office expenditures pertaining to Leggett & Platt.
Consequently, separating the conference room and excluding one-half of the office expenditures, we apply Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930), to conclude that for 2004, petitioner may deduct $304 ($1,215 × 1/2; × 1/2;) of his furniture purchases, 2 $1,049 ($4,196 × 1/2 × 1/2;) of his basement repairs and maintenance expense, and $446 ($1,782 × 1/2 × 1/2) of his basement utility expenses as unreimbursed employee business expenses for the business use of his home. The remainder of these expenses for 2004 are nondeductible startup expenses.
2. Computer, Printer, Fax, and Telephone
On his 2004 Schedule C petitioner deducted $1,910 for a new computer he purchased in 2004, $495 in printer expenses, $296 for fax expenses, and $687 for telephone expenses. Petitioner testified that he used his computer and printer “primarily for my consulting business” and that his fax and telephone expenses were split “roughly half and half” between his consulting activities and his employment with Leggett & Platt.
Section 280F(d)(4)(A)(iv) includes computers and peripherals as listed property. However, section 280F(d)(4)(B) provides an exception for computer or peripheral equipment used at a regular place of business, including a portion of the home qualifying under section 280A(c)(1) (requiring in pertinent part that the portion of the dwelling unit must be the principal place of business for the trade or business). Verma v. Commissioner, T.C. Memo. 2001-132. Petitioner qualifies for the exception of section 280F(d)(4)(B) because, as noted above, his home served as his principal place of business for his employment with Leggett & Platt.
With respect to the telephone expense, a taxpayer may not deduct the cost of basic local telephone service for the first telephone line provided to a residence, because the expenditure is a personal expense. Sec. 262(b). The record is silent as to the number of lines to petitioner's home. Respondent made no assertion that petitioner's telephone expenses related to a first telephone line. Given petitioner's work circumstance of residing in Massachusetts with responsibility for Asian operations and his need to communicate regularly with corporate headquarters in Missouri, we conclude that a significant portion of the telephone use would have been for long distance calls. Moreover, because of the number of people residing in his home, the location of the telephone in an office in the basement beneath a 3,000-square-foot home, and the volume of calls that petitioner made during the evenings and nights, we find it highly probable that the telephone expenses petitioner claimed for 2004 were for a second telephone line that he maintained exclusively for business.
Returning to the analysis of all of the equipment expenses, we apply Cohan, finding that “primarily for my consulting business” means 75 percent of the use, and that “roughly half and half” means 50 percent of the use. Thus, petitioner may deduct as 2004 unreimbursed employee business expenses the following items: Computer expenses of $478 ($1,910 × 25 percent), 3 printer expenses of $124 ($495 × 25 percent), fax expenses of $148 ($296 × 50 percent), and telephone expenses of $344 ($687 × 50 percent). The remainder of petitioner's 2004 equipment expenses are nondeductible startup expenses.
To reflect the foregoing,
Decision will be entered under Rule 155.

Footnotes


1
For startup expenses that were incurred after Oct. 22, 2004, sec. 195(b) allows the taxpayer to elect to deduct a limited amount of the capitalized startup costs for the year of which the active trade or business begins, and to deduct the remainder over 180 months of amortization beginning with the month in which the active trade or business begins. See sec. 1.195-1T(b), (d), Temporary Income Tax Regs., 73 Fed. Reg. 38913 (July 8, 2008).
2
Deductible in the first year, 2004, under sec. 179, Election To Expense Certain Depreciable Business Assets.
3
Also deductible in the first year, 2004, under sec. 179.

Employee/contractor classification determinations


PRESENT LAW AND BACKGROUND RELATING TO
WORKER CLASSIFICATION FOR
FEDERAL TAX PURPOSES
Scheduled for a Public Hearing
before the SUBCOMMITTEE ON SELECT REVENUE MEASURES
and the
SUBCOMMITTEE ON INCOME SECURITY AND FAMILY SUPPORT
of the
HOUSE COMMITTEE ON WAYS AND MEANS
on May 8, 2007
Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION

May 7, 2007

JCX-26-07

i
CONTENTS
Page
INTRODUCTION .......................................................................................................................... 1
I. WORKER CLASSIFICATION RULES............................................................................... 2
A. Present Law...................................................................................................................... 2
B. Reasons for Misclassification of Workers ....................................................................... 8
II. EFFECT OF MISCLASSIFICATION ON FEDERAL REVENUES................................. 10
III. ALTERNATIVE METHODS OF CLASSIFYING WORKERS........................................ 12
A. General Issues ................................................................................................................ 12
B. Issues Under Specific Proposals .................................................................................... 14
1
INTRODUCTION
The Subcommittee on Income Security and Family Support and the Subcommittee on
Select Revenue Measures of the House Committee on Ways and Means have scheduled a joint
public hearing for Tuesday, May 8, 2007, on the effects of misclassifying workers as
independent contractors. This document,1 prepared by the staff of the Joint Committee on
Taxation, provides a description of present law and background relating to worker classification
for Federal tax purposes.
1 This document may be cited as follows: Joint Committee on Taxation, Present Law and
Background Relating to Worker Classification for Federal Tax Purposes (JCX-26-07), May 7, 2007.
This publication is also available on the web at www.house.gov/jct.
2
I. WORKER CLASSIFICATION RULES
A. Present Law
In general
Significant tax consequences result from the classification of a worker as an employee or
independent contractor. These consequences relate to withholding and employment tax
requirements, as well as the ability to exclude certain types of compensation from income or take
tax deductions for certain expenses. Some consequences favor employee status, while others
favor independent contractor status. For example, an employee may exclude from gross income
employer-provided benefits such as pension, health, and group-term life insurance benefits. On
the other hand, an independent contractor can establish his or her own pension plan and deduct
contributions to the plan. An independent contractor also has greater ability to deduct workrelated
expenses.
Under present law, the determination of whether a worker is an employee or an
independent contractor is generally made under a facts and circumstances test that seeks to
determine whether the worker is subject to the control of the service recipient, not only as to the
nature of the work performed, but the circumstances under which it is performed. Under a
special safe harbor rule (sec. 530 of the Revenue Act of 1978), a service recipient may treat a
worker as an independent contractor for employment tax purposes even though the worker is in
fact an employee if the service recipient has a reasonable basis for treating the worker as an
independent contractor and certain other requirements are met. In some cases, the treatment of a
worker as an employee or independent contractor is specified by statute.
Significant tax consequences also result if a worker was misclassified and is subsequently
reclassified, e.g., as a result of an audit. For the service recipient, such consequences may
include liability for withholding taxes for a number of years, interest and penalties, and potential
disqualification of employee benefit plans. For the worker, such consequences may include
liability for self-employment taxes and denial of certain business-related deductions.
Common-law test
In general, the determination of whether an employer-employee relationship exists for
Federal tax purposes is made under a common-law test that has been incorporated into specific
provisions of the Internal Revenue Code (the “Code”) or that is required to be used pursuant to
Treasury regulations or case law. For example, section 3121(d)(2)2 (which defines terms for
purposes of the Social Security taxes that apply to wages paid to an employee) generally defines
the term “employee” to include any individual who, under the usual common law rules
applicable in determining the employer-employee relationship, has the status of an employee.
By contrast, section 3401 (which defines terms for purposes of an employer’s Federal income tax
withholding obligation with respect to wages paid to an employee) does not define the term
“employee.” However, regulations issued under section 3401 incorporate the common-law test.
2 Except as otherwise indicated, all references to sections are to sections of the Code.
3
The regulations provide that an employer-employee relationship generally exists if the
person contracting for services has the right to control not only the result of the services, but also
the means by which that result is accomplished. In other words, an employer-employee
relationship generally exists if the person providing the services “is subject to the will and
control of the employer not only as to what shall be done but how it shall be done.”3 Under the
regulations, it is not necessary that the employer actually control the manner in which the
services are performed, rather it is sufficient that the employer have a right to control.4 Whether
the requisite control exists is determined based on all the relevant facts and circumstances.
Over the years courts have identified on a case-by-case basis various facts or factors that
are relevant in determining whether an employer-employee relationship exists. In 1987, based
on an examination of cases and rulings, the Internal Revenue Service (“IRS”) developed a list of
20 factors that may be examined in determining whether an employer-employee relationship
exists.5 The degree of importance of each factor varies depending on the occupation and the
factual context in which the services are performed; factors other than the listed 20 factors may
also be relevant.
The 20 factors identified by the IRS are as follows:
1. Instructions: If the person for whom the services are performed has the right to
require compliance with instructions, this indicates employee status.
2. Training: Worker training (e.g., by requiring attendance at training sessions)
indicates that the person for whom services are performed wants the services
performed in a particular manner (which indicates employee status).
3. Integration: Integration of the worker’s services into the business operations of the
person for whom services are performed is an indication of employee status.
4. Services rendered personally: If the services are required to be performed
personally, this is an indication that the person for whom services are performed is
interested in the methods used to accomplish the work (which indicates employee
status).
5. Hiring, supervision, and paying assistants: If the person for whom services are
performed hires, supervises or pays assistants, this generally indicates employee
3 Treas. Reg. sec. 31.3401(c)-(1)(b).
4 Id. See also, Gierek v. Commissioner, 66 T.C.M. 1866 (1993) (involving the classification of a
stockbroker and stating that the key inquiry is whether the brokerage firm had a right to control the
worker regardless of the extent to which such control was actually exercised). See also, IRS Publication
1779 (Rev. 1-2005).
5 Rev. Rul. 87-41, 1987-1 C.B. 296 (providing guidance with respect to section 530 of the
Revenue Act of 1978).
4
status. However, if the worker hires and supervises others under a contract pursuant to
which the worker agrees to provide material and labor and is only responsible for the
result, this indicates independent contractor status.
6. Continuing relationship: A continuing relationship between the worker and the
person for whom the services are performed indicates employee status.
7. Set hours of work: The establishment of set hours for the worker indicates employee
status.
8. Full time required: If the worker must devote substantially full time to the business
of the person for whom services are performed, this indicates employee status. An
independent contractor is free to work when and for whom he or she chooses.
9. Doing work on employer’s premises: If the work is performed on the premises of
the person for whom the services are performed, this indicates employee status,
especially if the work could be done elsewhere.
10. Order or sequence test: If a worker must perform services in the order or sequence
set by the person for whom services are performed, that shows the worker is not free
to follow his or her own pattern of work, and indicates employee status.
11. Oral or written reports: A requirement that the worker submit regular reports
indicates employee status.
12. Payment by the hour, week, or month: Payment by the hour, week, or month
generally points to employment status; payment by the job or a commission indicates
independent contractor status.
13. Payment of business and/or traveling expenses. If the person for whom the
services are performed pays expenses, this indicates employee status. An employer, to
control expenses, generally retains the right to direct the worker.
14. Furnishing tools and materials: The provision of significant tools and materials to
the worker indicates employee status.
15. Significant investment: Investment in facilities used by the worker indicates
independent contractor status.
16. Realization of profit or loss: A worker who can realize a profit or suffer a loss as a
result of the services (in addition to profit or loss ordinarily realized by employees) is
generally an independent contractor.
17. Working for more than one firm at a time: If a worker performs more than de
minimis services for multiple firms at the same time, that generally indicates
independent contractor status.
5
18. Making service available to the general public: If a worker makes his or her
services available to the public on a regular and consistent basis, that indicates
independent contractor status.
19. Right to discharge: The right to discharge a worker is a factor indicating that the
worker is an employee.
20. Right to terminate: If a worker has the right to terminate the relationship with the
person for whom services are performed at any time he or she wishes without
incurring liability, that indicates employee status.
More recently, the IRS has identified three categories of evidence that may be relevant in
determining whether the requisite control exists under the common-law test and has grouped
illustrative factors under these three categories: (1) behavioral control; (2) financial control; and
(3) relationship of the parties.6 The IRS emphasizes that factors in addition to the 20 factors
identified in 1987 may be relevant, that the weight of the factors may vary based on the
circumstances, that relevant factors may change over time, and that all facts must be examined.7
Generally, individuals who follow an independent trade, business, or profession in which
they offer services to the public are not employees. Courts have recognized that a highly
educated or skilled worker does not require close supervision; therefore, the degree of day-to-day
control over the worker’s performance of services is not particularly helpful in determining the
worker’s status. Courts have considered other factors in these cases, tending to focus on the
individual’s ability to realize a profit or suffer a loss as evidenced by business investments and
expenses.
Section 530 of the Revenue Act of 1978
Section 530 of the Revenue Act of 1978 (“section 530”) generally allows a taxpayer to
treat a worker as not being an employee for employment tax purposes (but not income tax
purposes), regardless of the worker’s actual status under the common-law test, unless the
taxpayer has no reasonable basis for such treatment or fails to meet certain requirements. The
relief provided to an employer under section 530 was initially scheduled to terminate at the end
of 1979 to give Congress time to resolve the many complex issues regarding worker
classification. It was extended through the end of 1980 by P.L. 96-167 and through June 30,
1982, by P.L. 96-541. The provision was extended permanently by the Tax Equity and Fiscal
Responsibility Act of 1982. A number of changes to section 530 were made by the Tax Reform
Act of 1986, the Small Business Job Protection Act of 1996, and the Pension Protection Act of
2006.
6 Department of the Treasury, Internal Revenue Service, Independent Contractor or Employee?
Training Materials, Training 3320-102 (10-96) TPDS 84238I, at 2-7. This document is publicly available
through the IRS website.
7 Id. at 2-3 through 2-7.
6
Under section 530, a reasonable basis for treating a worker as an independent contractor
is considered to exist if the taxpayer reasonably relied on (1) past IRS audit practice with respect
to the taxpayer, (2) published rulings or judicial precedent, (3) long-standing recognized practice
in the industry of which the taxpayer is a member, or (4) if the taxpayer has any “other
reasonable basis” for treating a worker as an independent contractor. The legislative history
states that section 530 is to be “construed liberally in favor of taxpayers.”
The relief under section 530 is available with respect to a worker only if certain
additional requirements are satisfied. The taxpayer must not have treated the worker as an
employee for any period, and for periods after 1978 all Federal tax returns, including information
returns, must have been filed on a basis consistent with treating such worker as an independent
contractor. Further, the taxpayer (or a predecessor) must not have treated any worker holding a
substantially similar position as an employee for purposes of employment taxes for any period
beginning after 1977 (the “similar worker consistency requirement”).
Under section 1706 of the Tax Reform Act of 1986, section 530 does not apply in the
case of a worker who, pursuant to an arrangement between the taxpayer and another person,
provides services for such other person as an engineer, designer, drafter, computer programmer,
systems analyst, or other similarly skilled worker engaged in a similar line of work. Thus, the
determination of whether such workers are employees or independent contractors is made in
accordance with the common-law test.
Under section 864 of the Pension Protection Act of 2006, the similar worker consistency
requirement does not apply with respect to services performed after December 31, 2006, by an
individual who provides services as a test proctor or room supervisor by assisting in the
administration of college entrance or placement examinations. This exception only applies if the
service recipient is an organization that is described in section 501(c) and the service provider is
not otherwise treated as an employee of the organization for employment tax purposes.
Section 530 also prohibits the Department of Treasury and the IRS from publishing
regulations and revenue rulings with respect to the employment status of any individual for
purposes of the employment taxes.8 However, a taxpayer may generally obtain a written
determination from the IRS regarding the status of a particular worker as an employee or
independent contractor for purposes of Federal employment taxes and income tax withholding.9
Statutory employees or independent contractors
The Code contains various provisions that prescribe treatment of a specific category or
type of worker as an employee or an independent contractor. Some of these provisions apply for
8 Rev. Rul. 87-41 (described above) provides guidance with respect to section 530 of the
Revenue Act of 1978.
9 IRS Form SS-8 (Rev. 11-2006). A written determination with regard to prior employment
status may be issued by the IRS. The IRS will not issue a written determination with respect to
prospective employment status. Rev. Proc. 2007-3, 2007-1 I.R.B. 108.
7
Federal tax purposes generally; for example, certain real estate agents and direct sellers are
treated for all tax purposes as not being employees.10 Others apply only for specific purposes;
for example, full-time life insurance salesmen are treated as employees for social security tax
and employee benefit purposes,11 and certain salesmen are treated as employees for social
security tax purposes.12
10 Sec. 3508.
11 Sec. 3121(d)(3)(B) and 7701(a)(20).
12 Sec. 3121(d)(3)(D).
8
B. Reasons for Misclassification of Workers
Need to make factual determinations
A major source of the confusion regarding classification of a worker as an employee or
an independent contractor is that present law requires an examination of a variety of factors that
often do not result in a clear answer. Although the proper classification of a worker often will be
clear, in close cases the law creates a significant gray area that leads to complexity, with the
potential for inadvertent errors and abuse.
Under the common-law test, some of the relevant factors may support employee status,
while some may indicate independent contractor status, and there are no rules for the weight that
any particular factor is given. In addition, some of the relevant factors involve an examination of
objective facts, while others involve an examination of subjective facts or an examination of a
combination of objective and subjective facts. Because the determination of proper classification
is factual, reasonable people may differ as to the correct result given a certain set of facts. Thus,
for example, even though a taxpayer in good faith determines that a worker is an independent
contractor, an IRS agent may reach a different conclusion by weighing some of the relevant
factors differently than the taxpayer. Similarly, a worker and a service recipient may reach
different conclusions as to the proper classification of the worker.
Misclassification of workers also may be deliberate. In some cases, workers and service
recipients may prefer to classify workers as independent contractors, both for tax and nontax
reasons. For example, the worker may wish to take advantage of the ability to contribute on a
deductible basis to a pension plan or to deduct significant work-related expenses. A service
recipient may wish to avoid administrative problems associated with withholding income and
employment taxes. The service recipient also may wish to avoid coverage and nondiscrimination
requirements applicable to qualified retirement plans by classifying lower-paid workers as
independent contractors. The IRS may have an interest in classifying workers as employees, in
order to obtain the compliance benefits of mandatory withholding.
Workers sometimes argue that they prefer independent contractor status because it gives
them more control over their own lives. To the extent such reasons exist in particular cases,
service recipients may feel compelled to classify workers as independent contractors rather than
employees. In many instances, it may be very difficult to distinguish whether a misclassification
was deliberate or inadvertent.
Lack of published guidance
As discussed above, since the enactment of the Revenue Act of 1978, the Department of
Treasury and the IRS have been prohibited from publishing regulations and revenue rulings with
respect to the employment status of any individual for purposes of employment taxes. The
resulting lack of current guidance contributes to the lack of clarity in the law and increases the
likelihood of inadvertent misclassification of workers. Previously issued guidance may not
reflect current case law, statutory changes, or changes in workplace situations. Without
appropriate guidance, not only are differences between taxpayers and the IRS more likely, but
9
different IRS agents may reach different conclusions on the law as well as the relevant facts,
resulting in increased inconsistent enforcement.
The IRS has made publicly available its training guide for agents on worker classification
issues. Department of the Treasury, Internal Revenue Service, Independent Contractor or
Employee? Training Materials, Training 3320-102 (10-96) TPDS 84238I. The guide may aid
consistent enforcement by different agents and provide a guide to taxpayers regarding the state of
the law; however, the guidelines leave substantial discretion to individual agents and do not
resolve all issues. Further, the guidelines do not carry the same force of law as revenue rulings
or regulations.
Section 530 of the Revenue Act of 1978
Although section 530 was intended to reduce disputes between the IRS and taxpayers
regarding classification issues, it also has been a source of disputes. Like the common-law test,
some aspects of section 530 depend on the facts and circumstances and reasonable people may
differ as to the correct result given a certain set of facts, i.e., whether section 530 properly is
available to the taxpayer.
Another source of confusion regarding worker classification stemming from section 530
is that it applies only to the service recipient and only for employment tax purposes. As a result
of these limitations, if a worker is treated by the service recipient as an independent contractor
under section 530, the worker may mistakenly believe he or she is in fact an independent
contractor for Federal income tax purposes. However, because section 530 does not apply for
Federal income tax purposes, the worker is still required to determine whether he or she is an
independent contractor or employee under the common-law test without regard to section 530.
Section 530 also causes confusion because it is not available to all taxpayers. In
particular, section 530 does not apply with respect to certain services provided by technical
services personnel and test proctors. Section 530 also causes confusion because it is not codified
in the Code. Thus, it may be difficult for taxpayers and tax practitioners to locate the provision
and subsequent changes made to it by other laws.
10
II. EFFECT OF MISCLASSIFICATION ON FEDERAL REVENUES
Under present law, there is revenue loss associated with lower compliance rates of
independent contractors and service recipients compared to the compliance rates of employees
and their employers. This revenue loss, however, is not necessarily the result of
misclassification of a worker’s status, but is largely due to differences in the rules, such as
reporting and withholding requirements, that apply as a result of worker classification, regardless
of whether that classification was legally correct.
Tax data indicate that service recipients often fail to file requisite Forms 1099 for
payments made to independent contractors, and that independent contractors often fail to report
the unreported payments as income. In addition, employers must file information reports on all
wages paid to employees; the requirement with respect to service recipients is not as
comprehensive. Even when Forms 1099 are issued, compliance is somewhat less than when
workers are classified as employees and withholding is required.
The IRS has prepared several surveys from audits of employment tax returns. Two of the
most widely utilized in the analysis of employment tax issues are the 1984 Strategic Initiative to
Establish a Research Project on Withholding Noncompliance13 (the “1984 Strategic Initiative”)
and the Employment Tax Examination Program.
The 1984 Strategic Initiative examined 3,331 employers for tax year 1984 and found that
nearly 15 percent of employers misclassified employees as independent contractors. According
to the IRS, the section 530 safe harbor protected nine percent of misclassified employees from
being reclassified as employees.14 Of those returns using the section 530 safe harbor protections,
nearly half relied on the prior audit provision. The 1984 Strategic Initiative survey also found
that when employers classified workers as employees, more than 99 percent of wage and salary
income was reported. However, when workers were classified as independent contractors, 77
percent of gross income was reported when a Form 1099 was filed, and only 29 percent of gross
income was reported when no Form 1099 was filed.
The IRS performed 11,380 audits in the Employment Tax Examination Program from
fiscal years 1988 through 1994. Employers were audited to determine employment status of
personnel who often were not classified as employees for employment tax purposes. The
Government Accountability Office has conducted a study of audits from the program and has
reported that these audits resulted in proposed tax assessments of $751 million and
reclassification of 483,000 workers as employees.15
13 This survey is often referred to as SVC-1.
14 Several changes have been made to the section 530 safe harbor since this survey that could
affect the number of workers subject to the safe harbor.
15 General Accounting Office (now the Government Accountability Office), Tax Administration:
Issues Involving Worker Classification, GGD-95-224 (Aug. 2, 1995).
11
In addition to these data sources, the Taxpayer Compliance Measurement Program
provides information on the overall level of tax compliance of sole proprietorships. This program
consists of approximately 54,000 individual income tax returns that are extensively audited. The
most recent year of the Taxpayer Compliance Measurement Program is for tax year 1988. The
1988 data indicated that gross income reporting for Schedule C filers improved when a Form
1099 was issued. This data also indicated that overall compliance for gross income reporting
averaged 94 percent, while net income reporting averaged only 75 percent for Schedule C (Profit
or Loss from Sole Proprietorship) filers. (The voluntary compliance percentage varies by
employment sector and with income.) The successor to the Taxpayer Compliance Measurement
Program is the National Research Program, which for tax year 2001, indicated that net income
reporting averaged only 73 percent for Schedule C filers.
12
III. ALTERNATIVE METHODS OF CLASSIFYING WORKERS
A. General Issues
Introduction
A variety of different proposals have been suggested to modify the rules relating to the
determination of worker status. A concern with proposals that seek to add safe harbors or other
modifications to the existing rules is that such approaches increase the complexity of an already
complex determination. A concern with approaches that seek to replace the existing rules is that
such approaches are likely to have their own uncertainties and thus may not result in a practical
reduction in the misclassification of workers. In addition, the likely effects of the proposals raise
significant policy issues.
General policy implications
Any modification to the worker classification rules is likely to produce different results in
some cases than would present law. That is, some workers that are properly classified as
employees under present law may be classified as independent contractors under modified rules
(or vice versa). Depending on the specifics of any given proposal, a change to the law could
result in the reclassification of significant numbers of workers, which could have a variety of
consequences. For example, a change to the Federal tax rules applicable to the worker and the
service recipient would require a substantial adjustment to behavior from a tax and a personal
viewpoint. The eligibility of the worker for employee benefits, such as health care and pension
benefits would change. Compliance and Federal tax revenues also could be affected by the
reclassifications of large numbers of workers. Further, even if a proposal were intended to be
limited to the Federal tax laws, any new Federal tax rules regarding worker status may spill over
into State tax rules, as well as Federal and State nontax rules relating to workers (e.g., various
worker protection laws). Finally, how a worker views himself or herself may be affected by
reclassification.
If a proposal results in more workers being classified as independent contractors, the
proposal may significantly increase such workers’ compliance responsibilities. One reason for
this is that employees are subject to wage withholding, whereas independent contractors are
required to make quarterly estimated tax payments. In addition, workers previously classified as
employees would now be required to calculate and pay self-employment taxes, rather than have
FICA taxes withheld and remitted by their employer. Further, employees are generally eligible
for employee benefit and pension plans, whereas independent contractors are not. Thus, for
example, if an employee who was participating in an employer-sponsored retirement plan is
reclassified as an independent contractor, the individual would no longer be eligible to
participate in the employer plan but would be eligible to establish his or her own qualified
retirement plan. Although such plans may in some cases provide greater benefits than an
employer’s plan, they also involve greater complexity. To the extent that workers do not realize
benefits from being reclassified as independent contractors, they may view themselves as worse
off by having to deal with more complicated tax rules.
13
Effects on compliance
As discussed above, there is revenue loss associated with lower compliance rates of
independent contractors and service recipients compared to employees and their employers.
Thus, compliance and tax revenues could be affected by proposals that reclassify large numbers
of workers.
Effects on pension and benefit coverage
As previously mentioned, employees are eligible to participate in certain employersponsored
benefit plans. While independent contractors generally cannot participate in the
benefit plans of the service recipient, they can set up their own plan. In some cases, an
independent contractor may be able to establish a plan that provides greater benefits than does a
typical employer plan.
For example, an independent contractor would be able to set up his or her own profitsharing
plan and make contributions to the plan of up to $45,000 (for 2007) per year. As an
employee, a worker is subject to the limits on contributions and benefits contained in the
employer plan, which for most workers are lower than the maximum permitted contributions.
Thus, an independent contractor may receive greater pension benefits under his or her own plan
than under an employer plan. On the other hand, some employees who are reclassified as
independent contractors may not take advantage of the opportunities available to them, thereby
possibly causing a reduction in future retirement savings. In short, the effect of reclassification
of a worker from an employee to an independent contractor (or vice versa) on retirement plan or
other benefit coverage is unclear.
14
B. Issues Under Specific Proposals
“Check-the-box” approach
One method for determining worker status that has been suggested is to let the parties
decide by contract whether the worker is to be treated for all Federal tax purposes as an
employee or independent contractor.16 This approach would generally eliminate
misclassification errors. However, the approach places a significant burden on workers because
they would need to understand the consequences of deciding which status to choose.
This approach essentially shifts the basis for determining worker status from a fact-based
determination to a determination grounded in which party has the greater bargaining power. As
a result, this approach has the potential for producing significantly different results than the
present-law rules, or other proposals that attempt to narrow the factors that are relevant to
determining worker status.
Specifying relevant factors
A number of proposals attempt to eliminate the uncertainty surrounding the
determination of worker status by limiting the number of relevant factors, either by way of an
additional safe harbor or by replacing the present-law rules. Because workplace situations vary
substantially, it may be difficult to develop a limited set of specific factors that are relevant in all
situations.17 On the other hand, the factors need to be drawn so that they have some effect;
otherwise the proposal may in practice be a “check-the-box” approach. For example, some
proposals provide that, subject to the agreement of the parties, a worker may be treated as an
independent contractor if the worker has a substantial investment in training or education. Such
a proposal could be interpreted to mean that any worker with a college degree could be treated as
an independent contractor if the contract between the worker and the service recipient so
provides.
Another potential issue with respect to proposals that specify relevant factors is that the
factors themselves may give rise to factual questions of interpretation that could lead to disputes
between taxpayers and the IRS, and ultimately, to litigation. For example, some proposals
provide that a worker may be treated as (or is) an independent contractor if the worker has a
“substantial” investment in work facilities or “substantial” unreimbursed business expenses.
16 Under this approach, rules would need to be developed as to the specific manner in which the
decision is made, e.g., pursuant to a written contract meeting certain requirements. Rules would also be
necessary to address situations in which the parties have not specified worker status by contract. For
example, in the absence of a contract, a worker could be deemed to be an employee. Alternatively, in the
absence of a contract, the common-law rules could be used to determine worker status. The latter
alternative would involve the uncertainties of present law.
17 It is precisely this difficulty that has led to the present-law multifactor facts and circumstances
approach.
15
This raises the question of what “substantial” means. For example, it could be based on a
flat dollar amount, or some percentage of the worker’s gross receipts. What is considered
“small” might be different for different occupations. Similarly, some proposals have provided
that workers with “special skills” may be treated as independent contractors. To provide clarity,
the proposal would need to define what is meant by “special skills.” In other words, some
proposals introduce new factual questions that may be as complex and as uncertain as present
law.
Providing similar treatment of workers for all Federal tax purposes
As discussed above, a major reason that worker classification is significant is that the
Federal tax treatment of employees and independent contractors varies. Some commentators
have suggested that worker classification should be made irrelevant (or at least minimized) by
providing similar treatment for all workers.
Such an approach would involve significant changes to a variety of Federal tax laws and
would raise policy issues. Major areas of the law that would require modification to achieve
conformity of treatment, and some of the policy issues involved, are summarized below.
1. Withholding and estimated tax rules.–In general, employees are subject to
withholding, whereas independent contractors are required to make quarterly
estimated tax payments. To provide consistent treatment, withholding would have to
be extended to all taxpayers or all taxpayers would have to be required to make
estimated tax payments. As mentioned above, imposing estimated taxes on all
workers would add substantial complexity compared to present law, and could also
have an adverse effect on compliance. A variety of issues would also need to be
addressed if withholding were imposed on independent contractors. For example, the
appropriate level of withholding can be difficult if the independent contractor works
for multiple service providers.
2. Eligibility for employee benefit plans.–Conformity of treatment with respect to
pension and benefit plans could be achieved by providing that independent contractors
must be treated as employees for purposes of employee plan coverage. Alternatively,
employees could be given the same opportunity for tax-favored benefits as
independent contractors (e.g., employees could be allowed to establish their own
retirement plan as if they were an independent contractor). Either approach would
involve significant changes to present law and significant policy issues.
3. Deductibility of business expenses.–Independent contractors have greater ability to
deduct business expenses than employees, who generally can deduct such expenses
only as an itemized deduction and only to the extent all miscellaneous itemized
deductions (including employee business expenses) exceed two percent of adjusted
gross income. This disparate treatment would need to be addressed.

Proposed technical corrections for 2009

HR 4169
111th Congress


(Original Signature of Member)

111 th CONGRESS
1st Session
H. R.
To amend the Internal Revenue Code of 1986 to make technical corrections, and for other purposes

IN THE HOUSE OF REPRESENTATIVES
Mr. RANGEL (for himself and Mr. CAMP) introduced the following bill; which was referred to the Committee on
A BILL
To amend the Internal Revenue Code of 1986 to make technical corrections, and for other purposes

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

section 1. short title; amendment of 1986 code; table of contents .
(a) Short Title .—This Act may be cited as the “Tax Technical Corrections Act of 2009”.

(b) Amendment of 1986 Code .—Except as otherwise expressly provided, whenever in this Act an amendment or repeal is expressed in terms of an amendment to, or repeal of, a section or other provision, the reference shall be considered to be made to a section or other provision of the Internal Revenue Code of 1986.

(c) Table of Contents .—The table of contents of this Act is as follows:

Sec. 1. Short title; amendment of 1986 Code; table of contents.

Sec. 2. Amendments relating to American Recovery and Reinvestment Tax Act of 2009.

Sec. 3. Amendments relating to Energy Improvement and Extension Act of 2008.

Sec. 4. Amendments relating to Tax Extenders and Alternative Minimum Tax Relief Act of 2008.

Sec. 5. Clerical amendments relating to Housing Assistance Tax Act of 2008.

Sec. 6. Amendments and provision relating to Heroes Earnings Assistance and Relief Tax Act of 2008.

Sec. 7. Amendments relating to Economic Stimulus Act of 2008.

Sec. 8. Amendments relating to Tax Technical Corrections Act of 2007.

Sec. 9. Amendments relating to Energy Tax Incentives Act of 2005.

Sec. 10. Other clerical corrections.

sec. 2. amendments relating to american recovery and reinvestment tax act of 2009 .
(a) Amendment Related to Section 1004 .— Paragraph (3) of section 25A(i) is amended by striking “Subsection (f)(1)(A) shall be applied” and inserting “For purposes of determining the Hope Scholarship Credit, subsection (f)(1)(A) shall be applied”.

(b) Amendments Relating to Section 1008 .—

(1) Paragraph (6) of section 164(b) is amended by striking subparagraph (E) and by redesignating subparagraphs (F) and (G) as subparagraphs (E) and (F), respectively.

(2) Subparagraphs (E) and (F) of section 164(b)(6), as so redesignated, are each amended by striking “This paragraph” and inserting “Subsection (a)(6)”.


(c) Amendments Relating to Section 1102 .—

(1)
(A) Subparagraph (A) of section 48(a)(5) is amended by striking “which is part” and inserting “which is an integral part”.

(B) Clause (i) of section 48(a)(5)(D) is amended to read as follows:

“(i) which is tangible property (not including a building or its structural components),”.


(2) Subparagraph (D) of section 48(a)(5) is amended by striking the period at the end of clause (ii) and inserting “, and”, and by adding at the end the following new clause:

“(iii) which is acquired by the taxpayer and the original use of which commences with the taxpayer.”.


(d) Amendment Relating to Section 1104 .— Subparagraph (A) of section 48(d)(3) is amended by inserting “or alternative minimum taxable income” after “includible in the gross income”.

(e) Amendment Relating to Section 1121 .— Paragraph (1) of section 25C(c) is amended by striking “2000” and inserting “2009”.

(f) Amendments Relating to Section 1141 .—

(1) Subsection (f) of section 30D is amended—

(A) by inserting “(determined without regard to subsection (c))” before the period at the end of paragraph (1), and

(B) by inserting “(determined without regard to subsection (c))” before the period at the end of paragraph (2).


(2) Paragraph (3) of section 30D(f) is amended by adding at the end the following: “For purposes of subsection (c), property to which this paragraph applies shall be treated as of a character subject to an allowance for depreciation.”


(g) Amendments Relating to Section 1142 .—

(1) Subsection (b) of section 38 is amended by striking “plus” at the end of paragraph (34) and inserting a comma, by striking the period at the end of paragraph (35) and inserting “, plus”, and by adding at the end the following new paragraph:

“(36) the portion of the qualified plug-in electric vehicle credit to which section 30(c)(1) applies.”.

(2)
(A) Subsection (e) of section 30 is amended—

(i) by inserting “(determined without regard to subsection (c))” before the period at the end of paragraph (1), and

(ii) by inserting “(determined without regard to subsection (c))” before the period at the end of paragraph (2).


(B) Paragraph (3) of section 30(e) is amended by adding at the end the following: “For purposes of subsection (c), property to which this paragraph applies shall be treated as of a character subject to an allowance for depreciation.”



(h) Amendment Relating to Section 1251 .— Subparagraph (B) of section 1374(d)(7) is amended by striking “7th taxable year” and inserting “7th year”.

(i) Amendment Relating to Section 1521 .—The second sentence of section 54F(e) is amended by striking “subsection (d)(4)” and inserting “paragraphs (2) and (4) of subsection (d)”.

(j) Amendments Related to Section 1541 .—

(1) Paragraph (2) of section 853A(a) is amended by inserting “(determined after the application of this section)” before the comma at the end.

(2) Subsection (a) of section 853A is amended—

(A) by striking “with respect to credits” and inserting “with respect to some or all of the credits”, and

(B) by inserting “(determined without regard to this section and sections 54(c), 54A(c), 54AA(c), and 1397E(c))” after “credits allowable”.


(3) Subsection (b) of section 853A is amended to read as follows:


“(b) Effect of Election .—If the election provided in subsection (a) is in effect with respect to any credits for any taxable year—

“(1) the regulated investment company—

“(A) shall not be allowed such credits,

“(B) shall include in gross income (as interest) for such taxable year the amount which would have been so included with respect to such credits had the application of this section not been elected,

“(C) shall increase earnings and profits by the amount so included, and

“(D) shall be treated as making one or more distributions of money with respect to its stock equal to the amount of such credits on the date or dates during such taxable year (on or after the applicable date for such credit) selected by the company, and

“(2) each shareholder of such investment company shall—

“(A) be treated as receiving such shareholder's proportionate share of any distribution of money which is treated as made by such investment company under paragraph (1)(D), and

“(B) be allowed credits against the tax imposed by this chapter equal to the amount of such distribution, subject to the provisions of this title applicable to the credit involved.”.

(4) Subsection (c) of section 853A is amended to read as follows:


“(c) Notice to Shareholders .—The amount treated as a distribution of money received by a shareholder under subsection (b)(2)(A) (and as credits allowed to such shareholder under subsection (b)(2)(B)) shall not exceed the amount so designated by the regulated investment company in a notice delivered to such shareholder. Except as otherwise provided by the Secretary, such notice shall be written notice mailed to its shareholders not later than 60 days after the close of its taxable year.”.

(5) Clause (ii) of section 853A(e)(1)(A) is amended by inserting “other than a qualified bond described in section 54AA(g)” after “as defined in section 54AA(d))”.


(k) Amendments Relating to Section 1603 .—

(1) Paragraphs (1) and (2) of section 1603(a) of the American Recovery and Reinvestment Tax Act of 2009 are each amended by striking “is placed in service” and inserting “is originally placed in service by such person”.

(2) Paragraph (1) of section 1603(d) of such Act is amended—

(A) by striking “(within the meaning of section 45 of such Code)”, and

(B) by inserting before the period at the end the following: “which would (but for section 48(d)(1) of such Code) be eligible for credit under section 45 of such Code (determined without regard to subsection (a)(2)(B) thereof)”.


(3) Subsection (f) of section 1603 of such Act is amended—

(A) by striking the second sentence and inserting the following: “In applying such rules, any increase in tax under chapter 1 of such Code by reason of the property being disposed of (or otherwise ceasing to be specified energy property) shall be imposed on the person to whom the grant was made.”.

(B) by striking “In making grants under” and inserting the following:


“(1) In general .—In making grants under”, and

(C) by adding at the end following new paragraph:


“(2) Special rules .—

“(A) Recapture of excessive grant amounts .—If the amount of a grant made under this section exceeds the amount allowable as a grant under this section, such excess shall be recaptured under paragraph (1) as if the property to which such grant relates were disposed of immediately after such grant was made.

“(B) Grant information not treated as return information .—For purposes of section 6103 of the Internal Revenue Code of 1986, in no event shall any of the following be treated as return information:

“(i) The amount of a grant made under subsection (a).

“(ii) The identity of the person to whom the grant was made.

“(iii) A description of the property with respect to which the grant was made.

“(iv) The fact and amount of any recapture.

“(v) The content of any report required by the Secretary of the Treasury to be filed in connection with the grant.”.

(4) Subsection (g) of section 1603 of such Act is amended—

(A) by redesignating paragraphs (1) through (4) as subparagraphs (A) through (D), respectively,

(B) by moving such subparagraphs (as so redesignated) 2 ems to the right,

(C) by striking “paragraph (1), (2), or (3)” in subparagraph (D) (as so redesignated) and inserting “subparagraphs (A), (B), or (C)”,

(D) by striking “The Secretary” and inserting the following:


“(1) In general .—Except as provided in paragraph (2), the Secretary”, and

(E) by adding at the end the following new paragraph:


“(2) Exception where property used in unrelated trade or business .—

“(A) In general .—Paragraph (1) shall not apply to any person or entity described therein to the extent the grant is with respect to unrelated trade or business property.

“(B) Unrelated trade or business property .—For purposes of this paragraph, the term ‘unrelated trade or business property’ means any property with respect to which substantially all of the income derived therefrom by an organization described in section 511(a)(2) of the Internal Revenue Code of 1986 is subject to tax under section 511 of such Code.

“(C) Information with respect to pass-thrus .—In the case of a partnership or other pass-thru entity, partners or other holders of an equity or profits interest must provide to such partnership or entity such information as the Secretary may require to carry out the purposes of this subsection.”.


(l) Amendment Relating to Section 2202 .—

(1) Subparagraph (A) of section 2202(b)(1) of the division B of the American Recovery and Reinvestment Act of 2009 is amended by inserting “political subdivision of a State,” after “any State,”.

(2) Section 2202 of division B of the American Recovery and Reinvestment Act of 2009 is amended by adding at the end the following new subsection:


“(e) Treatment of Possessions .—

“(1) Payments to possessions .—

“(A) Mirror code possession .—The Secretary of the Treasury shall pay to each possession of the United States with a mirror code tax system amounts equal to the loss to that possession by reason of credits allowed under subsection (a) with respect to taxable years beginning in 2009. Such amounts shall be determined by the Secretary of the Treasury based on information provided by the government of the respective possession.

“(B) Other possessions .—The Secretary of the Treasury shall pay to each possession of the United States which does not have a mirror code tax system amounts estimated by the Secretary of the Treasury as being equal to the aggregate benefits that would have been provided to residents of such possession by reason of credits allowed under subsection (a) for taxable years beginning in 2009 if a mirror code tax system had been in effect in such possession. The preceding sentence shall not apply with respect to any possession of the United States unless such possession has a plan, which has been approved by the Secretary of the Treasury, under which such possession will promptly distribute such payments to the residents of such possession.

“(2) Coordination with credit allowed against united states income taxes .—No credit shall be allowed against United States income taxes for any taxable year under this section to any person—

“(A) to whom a credit is allowed against taxes imposed by the possession by reason of the credit allowed under subsection (a) for such taxable year, or

“(B) who is eligible for a payment under a plan described in paragraph (1)(B) with respect to such taxable year.

“(3) Definitions and special rules .—

“(A) Possession of the united states .—For purposes of this subsection, the term ‘possession of the United States’ includes the Commonwealth of Puerto Rico and the Commonwealth of the Northern Mariana Islands.

“(B) Mirror code tax system .—For purposes of this subsection, the term ‘mirror code tax system’ means, with respect to any possession of the United States, the income tax system of such possession if the income tax liability of the residents of such possession under such system is determined by reference to the income tax laws of the United States as if such possession were the United States.

“(C) Treatment of payments .—For purposes of section 1324(b)(2) of title 31, United States Code, the payments under this subsection shall be treated in the same manner as a refund due from the credit allowed under section 36A of the Internal Revenue Code of 1986 (as added by this Act).”.

(m) Clerical Amendments .—

(1) Amendment relating to section 1131.—Paragraph (2) of section 45Q(d) is amended by striking “Administrator of the Environmental Protection Agency” and all that follows through “shall establish” and inserting “Administrator of the Environmental Protection Agency, the Secretary of Energy, and the Secretary of the Interior, shall establish”.

(2) Amendments relating to section 3001.—

(A) Subsection (g) of section 35 is amended by striking “section 3002(a) of the Health Insurance Assistance for the Unemployed Act of 2009” and inserting “section 3001(a) of title III of division B of the American Recovery and Reinvestment Act of 2009”.

(B) Section 139C is amended by striking “section 3002 of the Health Insurance Assistance for the Unemployed Act of 2009” and inserting “section 3001 of title III of division B of the American Recovery and Reinvestment Act of 2009”.

(C) Section 6432 is amended—

(i) by striking “section 3002(a) of the Health Insurance Assistance for the Unemployed Act of 2009” in subsection (a) and inserting “section 3001(a) of title III of division B of the American Recovery and Reinvestment Act of 2009”, and

(ii) by striking “section 3002(a)(1)(A) of such Act” in subsection (c)(3) and inserting “section 3001(a)(1)(A) of title III of division B of the American Recovery and Reinvestment Act of 2009”.


(D) Subsection (a) of section 6720C is amended by striking “section 3002(a)(2)(C) of the Health Insurance Assistance for the Unemployed Act of 2009” and inserting “section 3001(a)(2)(C) of title III of division B of the American Recovery and Reinvestment Act of 2009”.



(n) Effective Date .—The amendments made by this section shall take effect as if included in the provisions of the American Recovery and Reinvestment Tax Act of 2009 to which they relate.

sec. 3. amendments relating to energy improvement and extension act of 2008 .
(a) Amendment Relating to Section 108.—Subparagraph (E) of section 45K(g)(2) is amended to read as follows:

“(E) Coordination with section 45.— No credit shall be allowed with respect to any coke or coke gas which is manufactured using steel industry fuel (as defined in section 45(c)(7)) as feedstock if a credit is allowed to any taxpayer under section 45 with respect to the production of such fuel.”.

(b) Amendment Relating to Section 113.—Paragraph (1) of section 113(b) of the Energy Improvement and Extension Act of 2008 is amended by adding at the end the following new subparagraph:

“(F) Trust fund .—The term ‘Trust Fund’ means the Black Lung Disability Trust Fund established under section 9501 of the Internal Revenue Code of 1986.”.

(c) Amendments Relating to Section 306.—

(1) Clause (ii) of section 168(i)(18)(A) is amended by striking “10 years” and inserting “16 years”.

(2) Clause (ii) of section 168(i)(19)(A) is amended by striking “10 years” and inserting “16 years”.


(d) Amendment Relating to Section 308.—Clause (i) of section 168(m)(2)(B) is amended by striking “section 168(k)” and inserting “subsection (k) (determined without regard to paragraph (4) thereof)”.

(e) Amendment Relating to Section 402.—Subparagraph (A) of section 907(f)(4) is amended by striking “this subsection shall be applied” and all that follows through the period at the end and inserting the following: “this subsection, as in effect on the day before the date of the enactment of the Energy Improvement and Extension Act of 2008, shall apply to unused oil and gas extraction taxes carried from such unused credit year to a taxable year beginning after December 31, 2008.”.

(f) Amendments Relating to Section 403.—

(1) Subsection (c) of section 1012 is amended—

(A) by striking “ funds ” in the heading for paragraph (2) and inserting “ regulated investment companies ”,

(B) by striking “ fund ” in the heading for paragraph (2)(B), and

(C) by striking “fund” each place it appears in paragraph (2) and inserting “regulated investment company”.


(2) Paragraph (1) of section 1012(d) is amended—

(A) by striking “December 31, 2010” and inserting “December 31, 2011”, and

(B) by striking “an open-end fund” and inserting “a regulated investment company”.


(3) Paragraph (3) of section 1012(d) is amended to read as follows:

“(3) Separate accounts; election for treatment as single account .—

“(A) In general .—Rules similar to the rules of subsection (c)(2) shall apply for purposes of this subsection.

“(B) Average basis for pre-2012 stock .—Notwithstanding paragraph (1), in the case of an election under rules similar to the rules of subsection (c)(2)(B) with respect to stock held in connection with a dividend reinvestment plan, the average basis method is permissible with respect to all such stock without regard to the date of the acquisition of such stock.”.

(4) Subsection (g) of section 6045 is amended by adding at the end the following new paragraph:

“(6) Special rule for certain stock held in connection with dividend reinvestment plan .—For purposes of this subsection, stock acquired before January 1, 2012, in connection with a dividend reinvestment plan shall be treated as stock described in clause (ii) of paragraph (3)(C) (unless the broker with respect to such stock elects not to have this paragraph apply with respect to such stock).”.


(g) Clerical Amendments .—

(1) Amendment relating to section 108.—Paragraph (2) of section 45(b) is amended by striking “$3 amount” and inserting “$2 amount”.

(2) Amendment relating to section 706.—The heading for paragraph (1) of section 165(h) is amended by striking “$100” and inserting “ Dollar ”.


(h) Effective Date .—The amendments made by this section shall take effect as if included in the provisions of the Energy Improvement and Extension Act of 2008 to which they relate.

sec. 4. amendments relating to tax extenders and alternative minimum tax relief act of 2008.
(a) Amendment Relating to Section 208.—Subsection (b) of section 208 of the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 is amended to read as follows:

“(b) Effective Date .—

“(1) In general .—The amendment made by subsection (a) shall take effect on January 1, 2008. Notwithstanding the preceding sentence, such amendment shall not apply with respect to the with-holding requirement under section 1445 of the Internal Revenue Code of 1986 for any payment made before October 4, 2008.

“(2) Amounts withheld on or before date of enactment .—In the case of a regulated investment company—

“(A) which makes a distribution after December 31, 2007, and before October 4, 2008, and

“(B) which would (but for the second sentence of paragraph (1)) have been required to withhold with respect to such distribution under section 1445 of such Code,

such investment company shall not be liable to any person to whom such distribution was made for any amount so withheld and paid over to the Secretary of the Treasury.”.

(b) Amendments Relating to Section 305.—Paragraphs (7)(B) and (8)(D) of section 168(e) are each amended by inserting “which is not qualified leasehold improvement property” after “Property described in this paragraph”.

(c) Amendments Relating to Section 801.—

(1) Subparagraph (A) of section 457A(b)(2) is amended to read as follows:

“(A) foreign persons with respect to whom such income is not—

“(i) effectively connected with the conduct of a trade or business within the United States, or

“(ii) subject to a comprehensive foreign income tax, and”.

(2) Subparagraph (B) of section 457A(b)(2) is amended to read as follows:

“(B) organizations which are exempt from tax under this title (other than any organization with respect to which such income is unrelated business taxable income (as defined in section 512) subject to tax under section 511).”.

(3)
(A) Subparagraph (A) of section 457A(d)(3) is amended by striking “except that such term” and inserting the following: “except that—

“(i) such term”.

(B) Subparagraph (A) of section 457A(d)(3), as amended by this Act, is amended by striking the period at the end of clause (i) and inserting “, and”, and by adding at the end the following new clause:

“(ii) whether compensation is treated as subject to a substantial risk of forfeiture shall be determined under subsection (d)(1).”.


(4) Paragraph (5) of section 457A(d) is amended—

(A) by striking “paragraphs (5) and (6)” and inserting “paragraph (5)”, and

(B) by inserting “and, to the extent provided by the Secretary, subsections (b) and (c) of section 414” before “shall apply”.


(5) Subsection (d) of section 457A is amended by adding at the end the following new paragraph:

“(6) Service provider .—The term ‘service provider’ has the meaning given such term in the regulations under section 409A, determined without regard to method of accounting.”.

(6) Subsection (d) of section 801 of the Tax Extenders and Alternative Minimum Relief Act of 2008 is amended—

(A) by striking “paragraph (4)” in paragraph (3) and inserting “paragraph (3)”, and

(B) by striking “paragraph (4) or (5)” in paragraph (5) and inserting “paragraph (3) or (4)”.



(d) Clerical Amendments .—

(1) Amendment relating to section 306.—Paragraph (5) of section 168(b) is amended by striking “(2)(C)” and inserting “(2)(D)”.

(2) Amendments relating to section 706.—

(A) Paragraph (2) of section 1033(h) is amended by inserting “is” before “compulsorily”.

(B) Subclause (II) of section 172(b)(1)(F)(ii) is amended by striking “subsection (h)(3)(C)(i)” and inserting “section 165(h)(3)(C)(i)”.


(3) Amendment relating to section 709.—Subsection (k) of section 143 is amended by redesignating the second paragraph (12) (relating to special rules for residences destroyed in Federally declared disasters) as paragraph (13).

(4) Amendment relating to section 712.—Section 712 of the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 is amended by striking “section 702(c)(1)(A)” and inserting “section 702(b)(1)(A)”.


(e) Effective Date .—The amendments made by this section shall take effect as if included in the provisions of the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 to which they relate.

sec. 5. clerical amendments relating to housing assistance tax act of 2008.
(a) Amendment Relating to Section 3002.— Paragraph (1) of section 42(b) is amended by striking “For purposes of this section, the term” and inserting the following: “For purposes of this section—

“(A) In general .—The term”.

(b) Amendment Relating to Section 3081.— Clause (iv) of section 168(k)(4)(E) is amended by striking “adjusted minimum tax” and inserting “adjusted net minimum tax”.

(c) Amendment Relating to Section 3092.— Subsection (b) of section 121 is amended by redesignating the second paragraph (4) (relating to exclusion of gain allocated to nonqualified use) as paragraph (5).

(d) Effective Date .—The amendments made by this section shall take effect as if included in the provisions of the Housing Assistance Tax Act of 2008 to which they relate.

sec. 6. amendments and provision relating to heroes earnings assistance and relief tax act of 2008.
(a) Amendment Relating to Section 106.— Paragraph (2) of section 106(c) of the Heroes Earnings Assistance and Relief Tax Act of 2008 is amended by striking “substituting for” and inserting “substituting ‘June 17, 2008’ for”.

(b) Provision Relating to Section 111.—For purposes of section 45P(b)(1) of the Internal Revenue Code of 1986, section 3401(h)(2) of such Code shall be treated as in effect with respect to amounts paid after the date of the enactment of the Heroes Earnings Assistance and Relief Tax Act of 2008.

(c) Amendment Relating to Section 114.— Paragraph (1) of section 125(h) is amended by inserting “(and shall not fail to be treated as an accident or health plan under section 105)” before “merely”.

(d) Clerical Amendment Relating to Section 301.—Paragraph (2) of section 877(e) is amended by striking “subparagraph (A) or (B) of”.

(e) Effective Date .—The amendments made by this section shall take effect as if included in the provisions of the Heroes Earnings Assistance and Relief Tax Act of 2008 to which they relate.

sec. 7. amendments relating to economic stimulus act of 2008.
(a) Amendments Relating to Section 101.— Paragraph (2) of section 6213(g) is amended—

(1) by striking “32, or 6428” in subparagraph (L) and inserting “or 32”, and

(2) by striking “and” at the end of subparagraph (M), by striking the period at the end of subparagraph (N) and inserting “, and”, and by inserting after subparagraph (N) the following new subparagraph:

“(O) an omission of a correct TIN required under section 6428(h) (relating to 2008 recovery rebates for individuals) to be included on a return.”.


(b) Clerical Amendment Relating to Section 103.—Subclause (IV) of section 168(k)(2)(B)(i) is amended by striking “clauses also apply” and inserting “clause also applies”.

(c) Effective Date .—The amendments made by this section shall take effect as if included in the provisions of the Economic Stimulus Act of 2008 to which they relate.

sec. 8. amendments relating to tax technical corrections act of 2007.
(a) Amendment Relating to Section 4(c).— Paragraph (1) of section 911(f) is amended by adding at the end the following flush sentence:

“For purposes of this paragraph, the amount excluded under subsection (a) shall be reduced by the aggregate amount of any deductions or exclusions disallowed under subsection (d)(6) with respect to such excluded amount.”.

(b) Clerical Amendment Relating to Section 11(g).—Clause (iv) of section 56(g)(4)(C) is amended by striking “a cooperative described in section 927(a)(4)” and inserting “an organization to which part I of subchapter T (relating to tax treatment of cooperatives) applies which is engaged in the marketing of agricultural or horticultural products”.

(c) Effective Date .—The amendments made by this section shall take effect as if included in the provisions of the Tax Technical Corrections Act of 2007 to which they relate.

sec. 9. amendments relating to energy tax incentives act of 2005.
(a) Amendment Relating to Section 1341.— Subparagraph (B) of section 30D(h)(5) is amended by inserting “(determined without regard to subsection (g))” before the period at the end.

(b) Amendment Relating to Section 1342.— Paragraph (1) of section 30C(e) is amended to read as follows:

“(1) Reduction in basis .—For purposes of this subtitle, the basis of any property for which a credit is allowable under subsection (a) shall be reduced by the amount of such credit so allowed (determined without regard to subsection (d)).”.

(c) Effective Date .—The amendment made by this section shall take effect as if included in the provision of the Energy Tax Incentives Act of 2005 to which it relates.

sec. 10. other clerical corrections.
(a) Subparagraph (B) of section 25A(i)(5) is amended by inserting “30, 30B,” after “25D,”

(b) Paragraph (8) of section 30B(h) is amended by striking “vehicle)., except that” and inserting “vehicle), except that”.

(c) Subparagraph (A) of section 38(c)(2) is amended by striking “credit credit” and inserting “credit”.

(d) Section 46 is amended by adding “, and” at the end of paragraph (4).

(e) Clause (i) of section 54A(d)(2)(A) is amended by striking “100 percent or more” and inserting “100 percent”.

(f) Paragraph (5) of section 55(e) is amended by striking “38(c)(3)(B)” and inserting “38(c)(5)(B)”.

(g) Paragraph (2) of section 125(h) is amended by striking “means, any” and inserting “means any”.

(h) Clause (i) of section 163(h)(4)(E) is amended—

(1) by striking “Veterans Administration” and inserting “Department of Veterans Affairs”, and

(2) by striking “Rural Housing Administration” and inserting “Rural Housing Service”.


(i) Subsection (i) of section 904 is amended by inserting “25D,” after “25B,”.

(j) Subsections (e)(3)(B) and (f)(7)(B) of section 4943 are each amended by striking “January 1, 1970” and inserting “January 1, 1971”.

(k) Subsection (b) of section 6072 is amended by striking “6011(e)(2)” and inserting “6011(c)(2)”.

(l) Subparagraph (A) of section 6211(b)(4) is amended by striking “53(e),” and all that follows through “6428,” and inserting “53(e), 168(k)(4), 6428,”.

(m) Subsection (d) of section 6104 is amended by redesignating the second paragraph (6) (relating to disclosure of reports by Internal Revenue Service) and third paragraph (6) (relating to application to nonexempt charitable trusts and nonexempt private foundations) as paragraphs (7) and (8), respectively.

(n) Section 9802 is amended by redesignating the second subsection (f) (relating to genetic information of a fetus or embryo) as subsection (g).

Esther Njoroge and Paul Kibiro v. Commissioner., U.S. Tax Court, T.C. Summary Opinion 2009-177, (Nov. 30, 2009)
Docket No. 18133-08S. Filed November 30, 2009.
OR ANY OTHER CASE.
Discussion
Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to the deductions claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Pursuant to section 7491(a) the burden of proof may be shifted to the Commissioner where a taxpayer has introduced credible evidence regarding factual issues relevant to ascertaining his tax liability. Rule 142(a)(2). Petitioners have neither claimed nor shown eligibility for a shift in the burden of proof. Consequently, the burden of proof remains with petitioners.
Section 469(a) generally disallows any passive activity loss for any taxable year. A “passive activity loss” is defined as the excess of the aggregate losses from all passive activities for the taxable year over the aggregate income from all passive activities for that year. Sec. 469(d)(1). The term “passive activity” is defined as any activity involving the conduct of any trade or business in which the taxpayer does not materially participate. Sec. 469(c)(1). Rental activity is treated as a per se passive activity whether or not the taxpayer materially participates in the activity. Sec. 469(c)(2), (4).
There are two principal exceptions to the general disallowance rule of section 469(a) for rental real estate activity. The first exception is found in section 469(i). Section 469(i)(1) provides:
(1) In general.—In the case of any natural person, subsection (a) shall not apply to that portion of the passive activity loss or the deduction equivalent * * * of the passive activity credit for any taxable year which is attributable to all rental real estate activities with respect to which such individual actively participated in such taxable year * * *.
This exception in section 469(i) is limited to losses that do not exceed $25,000. Sec. 469(i)(2). The $25,000 maximum “offset”, however, begins to phase out for taxpayers whose adjusted gross income exceeds $100,000 and is completely phased out for taxpayers whose adjusted gross income is $150,000 or more. Sec. 469(i)(3)(A). For this purpose, adjusted gross income is determined without regard to “any passive activity loss or any loss allowable by reason of subsection (c)(7).” Sec. 469(i)(3)(F).
On their 2005 Form 1040, petitioners reported adjusted gross income of $113,861. On their attached Schedule E they reported $40,503 of either passive activity losses or losses determined under section 469(c)(7). Consequently, for this purpose, petitioners' adjusted gross income is modified by adding the $40,503 loss back to the reported adjusted gross income of $113,861; i.e., petitioners' modified adjusted gross income, for purposes of section 469(i), is $154,364. Because petitioners' modified adjusted gross income is more than $150,000, they are not entitled to any offset under section 469(i).
The second exception, under section 469(c)(7), applies special rules if the taxpayer is a real estate professional. Under section 469(c)(7)(B) a taxpayer qualifies as a real estate professional, and the rental real estate activity of the taxpayer is not a per se passive activity under section 469(c)(2), if:
(i) More than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and
(ii) such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.
See Bailey v. Commissioner, T.C. Memo. 2001-296. In the case of a joint return the requirements of section 469(c)(7)(B) are satisfied if and only if either spouse separately satisfies the requirements. Sec. 469(c)(7)(B) (flush language). As a result, if either spouse qualifies as a real estate professional, the rental activities of such spouse are not per se passive under section 469(c)(2). See sec. 469(c)(7)(A)(i).
Although a taxpayer may establish the extent of his or her participation in a real estate business by “any reasonable means”, sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), a postevent “ballpark guesstimate” will not suffice, see Lee v. Commissioner, T.C. Memo. 2006-193; Bailey v. Commissioner, supra; Carlstedt v. Commission, T.C. Memo. 1997-331; Speer v. Commissioner, T.C. Memo. 1996-323; Goshorn v. Commissioner, T.C. Memo. 1993-578.
The record is devoid of any evidence establishing that either petitioner met the requirements of section 469(c)(7)(B). Petitioners have not provided even a “ballpark guesstimate” of the number of hours either of them spent on the rental real estate activity. Nothing in the record establishes whether more than one-half of the personal services performed by either of petitioners was performed in their rental real estate activity or whether either of them spent more than 750 hours in that activity. Mr. Kibiro testified that he and his wife did not keep “meticulous records” regarding the rental properties, and petitioners produced no such records at trial. Although Mrs. Njoroge testified that she traveled to the Springfield property two or three times a week, there is no indication of the number of hours she spent working on the rental properties. Consequently, petitioners have not established that they meet the requirements of either section 469(c)(7)(B)(i) or (ii). Because petitioners have failed to establish that either spouse qualifies as a real estate professional under section 469(C)(7)(B), their rental real estate activity is per se passive under section 469(c)(2).
Petitioners have not met the requirements of any of the exceptions to the general disallowance rule of section 469(a). Accordingly, we sustain respondent's determination to disallow the $40,503 loss.
To reflect the foregoing,
Decision will be entered for respondent.

Footnotes


1
Unless otherwise indicated, all section references are to the Internal Revenue Code as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.
2
Although neither party has addressed it, we note that respondent also disallowed a $3,250 tuition and fees expense deduction petitioners claimed on the 2005 return. Furthermore, petitioners have not asserted that respondent's computational adjustments to itemized deductions are erroneous.
Rule 34(b)(4) provides that the petition in a deficiency action shall contain: “Clear and concise assignments of each and every error which the petitioner alleges to have been committed by the Commissioner in the determination of the deficiency or liability. * * * Any issue not raised in the assignments of error shall be deemed to be conceded.”
Petitioners have not pleaded error regarding the disallowance of the deduction for tuition and fees expense, nor have they pleaded error regarding the computational adjustments to itemized deductions. Accordingly, we deem any issue regarding the tuition and fees expense deduction and the computational issue regarding itemized deductions conceded by petitioners.