Revenue Reconciliation Act p10

Revenue Reconciliation Act Page 10

Articles by Alvin Brown
Tax Preparation
Offer In Compromise
State Offers in Compromise
Levy
IRS Tax Liens
IRS Tax Liens - continued
IRS Tax Liens - continued 2
Levy - continued
Audit Techniques Guide
Congressional Contacts
Criminal Investigation
D.O.J Criminal Tax Manual
Tax Litigation
Penalty
Installment Agreements
Statute of Limitations
Frivolous Tax Argument
Interest Abatement
IRS Misconduct
IRS Abuses
Tax Fraud
Fraud Statutes
Bankruptcy
Tax Reform Legislation
Tax Shelters
Tax Court
Trust Fund Penalty
Legislation
Innocent Spouse Relief
Important Links

Revenue Reconciliation Act page10

3. Qualified State tuition plans (sec. 1401(h)(1) of the bill and sec. 529 of the Code)

Present Law

Section 529 provides tax-exempt status to certain qualified State tuition programs and provides rules governing the tax treatment of distributions from such programs. Section 529 was effective on the date of enactment of the Small Business Job Protection Act of 1996, but a special transition rule provides that if (1) a State maintains (on the date of enactment) a program under which persons may purchase tuition credits on behalf of, or make contributions for educational expenses of, a designated beneficiary, and (2) such program meets the requirements of a qualified State tuition program before the later of (a) one year after the date of enactment, or (b) the first day of the first calendar quarter after the close of the first regular session of the State legislature that begins after the date of enactment, then the provisions of the Small Business Act will apply to contributions (and earnings allocable thereto) made before the date the program meets the requirements of a qualified State tuition program, without regard to whether the requirements of a qualified State tuition program are satisfied with respect to such contributions and earnings (e.g., even if the interest in the tuition or educational savings program covers not only qualified higher education expenses but also room and board expenses).

Explanation of Provision

The provision clarifies that, if a State program under which persons may purchase tuition credits comes into compliance with the requirements of a "qualified State tuition program" as defined in section 529 within a specified time period, then such program will be treated as a qualified State tuition program with respect to any contributions (and earnings allocable thereto) made pursuant to a contract entered into under the program before the date on which the program comes into compliance with the present-law requirements of a qualified State tuition program under section 529.

4. Adoption credit (sec. 1401(h)(2) of the bill, sec. 1807 of the Small Business Act, and sec. 23 of the Code)

Present Law

Taxpayers are allowed a maximum nonrefundable tax credit against income tax liability of $5,000 per child for qualified adoption expenses ($6,000 in the case of certain domestic adoptions) paid or incurred by the taxpayer. Qualified adoption expenses are reasonable and necessary adoption fees, court costs, attorneys' fees, and other expenses that are directly related to the legal adoption of an eligible child.

Otherwise qualified adoption expenses paid or incurred in one taxable year are not taken into account for purposes of the credit until the next taxable year unless the expenses are paid or incurred in the year the adoption becomes final.

Explanation of Provision

The technical correction conforms the treatment of otherwise qualified adoption expenses paid or incurred in years after the year the adoption becomes final to the treatment of expenses paid or incurred in the year the adoption becomes final. Another technical correction repeals as "deadwood" an ordering rule inadvertently included in the credit.

5. Phaseout of adoption assistance exclusion (sec. 1401(h)(2) of the bill, sec. 1807 of the Small Business Act, and sec. 137 of the Code)

Present Law

The adoption tax credit and the exclusion for employer provided adoption assistance are generally phased out ratably for taxpayers with modified adjusted gross income (AGI) above $75,000, and are fully phased out at $115,000 of modified AGI. For these purposes modified AGI is computed by increasing the taxpayer's AGI by the amount otherwise excluded from gross income under Code sections 911, 931, or 933 (relating to the exclusion of income of U.S. citizens or residents living abroad; residents of Guam , American Samoa , and the Northern Mariana Islands, and residents of Puerto Rico , respectively).

Explanation of Provision

The technical correction conforms the phaseout range of the adoption assistance exclusion to the phaseout range of the credit for qualified adoption expenses.

II. HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996

1. Medical savings accounts (sec. 1402(a) of the bill and sec. 220 of the Code)

a. Additional tax on distributions not used for medical purposes

Present Law

Under present law, distributions from a medical savings account ("MSA") that are not used for medical expenses are includible in gross income and subject to a 15-percent additional tax unless the distribution is after age 65 or death or on account of disability. A similar additional 10-percent tax is imposed on early withdrawals from individual retirement arrangements and qualified pension plans. The 10-percent additional tax on early withdrawals is not treated as tax liability for purposes of the minimum tax. No such rule applies to the 15-percent additional tax applicable to MSAs.

Explanation of Provision

The bill provides that the 15-percent tax on nonmedical withdrawals from an MSA is not treated as tax liability for purposes of the minimum tax.

b. Definition of permitted coverage

Present Law

Under present law, in order to be eligible to have an MSA an individual must be covered under a high deductible health plan and no other health plan, except for plans that provide certain permitted coverage. Medicare supplemental plans are one of the types of permitted coverage, even though an individual covered by Medicare is not eligible to have an MSA.

Explanation of Provision

Under the bill, Medicare supplemental plans would be deleted from the types of permitted coverage an individual may have and still qualify for an MSA.

c. Taxation of distributions

Present Law

Under present law, in order to be eligible to have a medical savings account ("MSA") an individual must be covered under a high deductible health plan and no other health plan, except for plans that provide certain permitted coverage and must be either (1) a self-employed individual, or (2) employed by a small employer. Distributions from an MSA for the medical expenses of the MSA account holder and his or her spouse or dependents are generally excludable from income. However, in any year for which a contribution is made to an MSA, withdrawals from the MSA are excludable from income only if the individual for whom the expenses were incurred was an eligible individual for the month in which the expenses were incurred. This rule is designed to ensure that MSAs are used in conjunction with a high deductible plan and that they are not primarily used by other individuals who have health plans that are not high deductible plans.

Explanation of Provision

The bill would clarify that, in any year for which a contribution is made to an MSA, withdrawals from the MSA are excludable from income only if the individual for whom the expenses were incurred was covered under a high deductible health plan (and no other health plan except for plans that provide certain permitted coverage) in the month in which the expenses were incurred. That is, the individual for whom the expenses were incurred does not have to be self employed or employed by a small employer in order for a withdrawal for medical expenses to be excludible.

d. Penalty for failure to provide required reports

Present Law

Trustees of an MSA are required to provide such reports to the Secretary and the account holder as the Secretary may require. A penalty of $50 applies with respect to each failure to provide a required report. Under present law, separate penalties apply to information returns required by the Code.

Explanation of Provision

The bill provides that the $50 penalty does not apply to information returns.

2. Definition of chronically ill individual under a qualified long-term care insurance contract (sec. 1402(b) of the bill and sec. 7702B(c)(2) of the Code)

Present Law

Under the long-term care insurance rules, a chronically ill individual is one who has been certified within the previous 12 months by a licensed health care practitioner as (1) being unable to perform (without substantial assistance) at least 2 activities of daily living for at least 90 days due to a loss of functional capacity, (2) having a level of disability similar (as determined under regulations prescribed by the Secretary in consultation with the Secretary of Health and Human Services) to the level of disability described above, or (3) requiring substantial supervision to protect the individual from threats to health and safety due to severe cognitive impairment. A contract is not treated as a qualified long-term care insurance contract unless the determination of whether an individual is a chronically ill individual takes into account at least 5 of such activities.

Explanation of Provision

The technical correction clarifies that the five-activity requirement --i.e., that the number of activities of daily living that are taken into account not be less than five --applies only for purposes of the first of three alternative definitions of a chronically ill individual (Code sec. 7702B(c)(2)(A)(i)), that is, by reason of the individual being unable to perform (without substantial assistance) at least 2 activities of daily living for at least 90 days due to a loss of functional capacity. Thus, the requirement does not apply to the determination of whether an individual is a chronically ill individual either (1) by virtue of severe cognitive impairment, or (2) if the insured satisfies a standard (if any) that is not based upon activities of daily living, as determined under regulations.

3. Deduction for long-term care insurance of self-employed individuals (sec. 1402(c) of the bill and sec. 162(l)(2) of the Code)

Present Law

Present law provides that the deduction for health insurance expenses of a self-employed individual is not available for a month for which the individual is eligible to participate in any subsidized health plan maintained by any employer of the individual or the individual's spouse. Present law also provides that in the case of a qualified long-term care insurance contract, only eligible long-term care premiums (as defined for purposes of the medical expense deduction) are taken into account in determining the deduction for health insurance expenses of a self-employed individual.

Explanation of Provision

The technical correction applies the rules for the deduction for health insurance expenses of a self-employed individual separately with respect to (1) plans that include coverage for qualified long-term care services or that are qualified long-term care insurance contracts, and (2) plans that do not include such coverage and are not such contracts. Thus, the provision clarifies that the fact that an individual is eligible for employer-subsidized health insurance does not affect the ability of such an individual to deduct long-term care insurance premiums, so long as the individual is not eligible for employer-subsidized long-term care insurance.

4. Applicability of reporting requirements of long-term care contracts and accelerated death benefits (sec. 1402(d) of the bill and sec. 6050Q of the Code)

Present Law

Present law provides that amounts (other than policyholder dividends or premium refunds) received under a long-term care insurance contract generally are excludable as amounts received for personal injuries and sickness, subject to a dollar cap on per diem contracts only. If the aggregate amount of periodic payments under all qualified long-term care contracts exceeds the dollar cap for the period, then the amount of such excess payments is excludable only to the extent of the individual's costs (that are not otherwise compensated for by insurance or otherwise) for long-term care services during the period.

Present law also provides an exclusion from gross income as an amount paid by reason of the death of an insured for (1) amounts received under a life insurance contract and (2) amounts received for the sale or assignment of any portion of the death benefit under a life insurance contract to a qualified viatical settlement provider, provided that the insured under the life insurance contract is either terminally ill or chronically ill (the accelerated death benefit rules).

A payor of long-term care benefits (defined for this purpose to include any amount paid under a product advertised, marketed or offered as long-term care insurance), and a payor of amounts treated as subject to reporting under the accelerated death benefit rules, is required to report to the IRS the aggregate amount of such benefits paid to any individual during any calendar year, and the name, address and taxpayer identification number of such individual. A payor is also required to report the name, address, and taxpayer identification number of the chronically ill individual on account of whose condition the amounts are paid, and whether the contract under which the amount is paid is a per diem-type contract. A copy of the report must be provided to the payee by January 31 following the year of payment, showing the name of the payor and the aggregate amount of benefits paid to the individual during the calendar year. Failure to file the report or provide the copy to the payee is subject to the generally applicable penalties for failure to file similar information reports.

Explanation of Provision

The technical correction clarifies that the reporting requirements include the need to report the address and phone number of the information contact. This conforms these reporting requirements to the requirements of the Taxpayer Bill of Rights 2.

5. Consumer protection provisions for long-term care insurance contracts (sec. 1402(e) of the bill and sec. 7702B(g)(4)(b) of the Code)

Present Law

The long-term care insurance rules of present law include consumer protection provisions (sec. 7702B(g)). Among these provisions is a requirement that the issuer of a contract offer to the policyholder a nonforfeiture provision that meets certain requirements. The requirements include a rule that the nonforfeiture provision shall provide for a benefit available in the event of a default in the payment of any premiums and the amount of the benefit may be adjusted subsequent to being initially granted only as necessary to reflect changes in claims, persistency, and interest as reflected in changes in rates for premium paying policies approved by the Secretary for the same contract form.

Explanation of Provision

The technical correction clarifies that the nonforfeiture provision shall provide for a benefit available in the event of a default in the payment of any premiums and the amount of the benefit may be adjusted subsequent to being initially granted only as necessary to reflect changes in claims, persistency, and interest as reflected in changes in rates for premium paying policies approved by the appropriate State regulatory authority (not by the Secretary) for the same contract form.

6. Insurable interests under the COLI provision (sec. 1402(f)(1) of the bill and sec. 264(a)(4) of the Code)

Present Law

Explanation of Provision

The technical correction is intended to prevent unintended avoidance of the COLI rule by clarifying that the rule relates to life insurance policies or annuity or endowment contracts covering any individual who (1) is or was an officer or employee of, or (2) is or was financially interested in, any trade or business carried on currently or formerly by the taxpayer. Thus, for example, the provision would clarify the treatment of interest on debt with respect to contracts covering former employees of the taxpayer. As another example, the provision would clarify the treatment of interest on debt with respect to a business formerly conducted by the taxpayer and transferred to an affiliate of the taxpayer. No inference is intended as the interpretation of this provision under prior law.

7. Applicable period for purposes of applying the interest rate for a variable rate contract under the COLI rules (sec. 1402(f)(2) of the bill and sec. 264(d)(2)(B)(ii) of the Code)

Present Law

Explanation of Provision

The technical correction provides that an election of an applicable period for purposes of applying the interest rate for a variable rate contract can be made no later than the 90th date after the date of enactment of the proposal, and applies to the taxpayer's first taxable year ending on or after October 13, 1995. If no election is made, the applicable period is the policy year. The policy year is the 12-month period beginning on the anniversary date of the policy.

8. Definition of 20-percent owner for purposes of key person exception under COLI rule (sec. 1402(f)(3) of the bill and sec. 264(d)(4) of the Code)

Present Law

Explanation of Provision

The technical correction clarifies that, in determining a key person, if the taxpayer is not a corporation, a 20-percent owner is an individual who directly owns 20 percent or more of the capital or profits interest of the taxpayer.

9. Effective date of interest rate cap on key persons and pre-1986 contracts under the COLI rule (sec. 1402(f)(4) of the bill and sec. 501(c) of HIPA)

Present Law

Explanation of Provision

The technical correction clarifies that, under the COLI rule, the interest rate cap on key persons and pre-1986 contracts applies to interest paid or accrued for any month beginning after December 31, 1995. This technical correction eliminates the discrepancy between the October and the December dates in the grandfather rule for pre-1986 contracts.

10. Clarification of contract lapses under effective date provisions of the COLI rule (sec. 1402(f)(5) of the bill and sec. 501(d)(2) of HIPA)

Present Law

No deduction is allowed for interest paid or accrued on any indebtedness with respect to one or more life insurance policies or annuity or endowment contracts owned by the taxpayer covering any individual who is (1) an officer or employee of, or (2) is financially interested in, any trade or business carried on by the taxpayer. An exception is provided for interest on indebtedness with respect to life insurance policies covering up to 20 key persons, subject to an interest rate cap.

Additional limitations are imposed on the deductibility of interest with respect to single premium contracts, and interest on debt incurred or continued to purchase or carry a life insurance, endowment, or annuity contract pursuant to a plan of purchase that contemplates the systematic direct or indirect borrowing of part or all of the increases in the cash value of the contract. An exception to the latter rule is provided, permitting deductibility of interest on bona fide debt that is part of such a plan, if no part of 4 of the annual premiums due during the first 7 years is paid by means of debt (the "4-out-of-7" rule).

Present law provides that the COLI rule is phased in. In connection with the phase-in rule, a transition rule provides that any amount included in income during 1996, 1997, or 1998, that is received under a contract described in the provision on the complete surrender, redemption or maturity of the contract or in full discharge of the obligation under the contract that is in the nature of a refund of the consideration paid for the contract, is includable ratably over the first 4 taxable years beginning with the taxable year the amount would otherwise have been includable. The lapse of a contract after October 13, 1995, due to nonpayment of premiums does not cause interest paid or accrued prior to January 1, 1999, to be nondeductible solely by reason of (1) failure to meet the 4-out-of-7 rule of present law, or (2) causing the contract to be treated as a single premium contract within the meaning of section 264(b)(1). This lapse provision states that the relief is provided in the following case: solely by reason of no additional premiums being received by reason of a lapse.

Explanation of Provision

The technical correction clarifies that, under the transition relief provided under the COLI rule, the 4-out-of-7 rule and the single premium rule of present law are not to apply solely by reason of a lapse occurring by reason of no additional premiums being received under the contract after October 13, 1995.

11. Requirement of gain recognition on certain exchanges (sec. 1402(g)(1) and (2) of the bill, sec. 511 of the Act, and sec. 877(d)(2) of the Code)

Present Law

Under the expatriation tax provisions in section 877, special tax treatment applies to certain former U.S. citizens and former long-term U.S. residents for 10 years following the date of loss of U.S. citizenship or U.S. residency status. Gain recognition is required on certain exchanges of property following loss of U.S. citizenship or U.S. residency status, unless a gain recognition agreement is entered into. In addition, regulatory authority is granted to apply this rule to the 15-year period beginning 5 years before the loss of U.S. citizenship or U.S. residency status.

Explanation of Provision

The technical correction clarifies that the period to which the general rule requiring gain recognition on certain exchanges applies is the 10-year period that begins on the date of loss of U.S. citizenship or U.S. residency status. In addition, the technical correction clarifies that in the case of an exchange occurring during the 5-year period before the loss of U.S. citizenship or U.S. residency status, any gain required to be recognized under regulations is to be recognized immediately after the date of such loss of U.S. citizenship.

12. Suspension of 10-year period in case of substantial diminution of risk of loss (sec. 1402(g)(3) of the bill, sec. 511 of the Act, and sec. 877(d)(3) of the Code)

Present Law

Under the expatriation tax provisions in section 877, special tax treatment applies to certain former U.S. citizens and former long-term U.S. residents for 10 years following the date of loss of U.S. citizenship or U.S. residency status. The running of this period with respect to gain on the sale or exchange of any property is suspended for any period during which the individual's risk of loss with respect to the property is substantially diminished.

Explanation of Provision

The technical correction clarifies that the period to which the rule suspending such period in the case of a substantial diminution of risk of loss applies is the 10-year period that begins on the date of loss of U. S. citizenship or U.S. residency status.

13. Treatment of property contributed to certain foreign corporations (sec. 1402(g)(4) of the bill, sec. 511 of the Act, and sec. 877(d)(4) of the Code)

Present Law

Under the expatriation tax provisions in section 877, special tax treatment applies to certain former U.S. citizens and former long-term U.S. residents for 10 years following the date of loss of U.S. citizenship or U.S. residency status. Special rules apply in the case of certain contributions of U.S. property by such an individual to a foreign corporation during such period.

Explanation of Provision

The technical correction clarifies that the period to which the rule regarding certain contributions to foreign corporations applies is the 10-year period that begins on the date of loss of U.S. citizenship or U.S. residency status. The technical correction also clarifies that the rule applies in the case of property the income from which, immediately before the contribution, was from U.S. sources.

14. Credit for foreign estate tax (sec. 1402(g)(6) of the bill, sec. 511 of the Act, and sec. 2107(c) of the Code)

Present Law

Under the expatriation tax provisions in section 2107, special estate tax treatment applies to certain former U.S. citizens and former long-term U.S. residents who die within 10 years following the date of loss of U.S. citizenship or U.S. residency status. Special rules provide a credit against the U.S. estate tax for foreign estate taxes paid with respect to property that is includible in the decedent's U.S. estate solely by reason of the expatriation estate tax provisions.

Explanation of Provision

The technical correction clarifies the formula for determining the amount of the foreign tax credit allowable against U.S. estate taxes on property includible in the decedent's U.S. estate solely by reason of the expatriation estate tax provisions. The credit for the estate taxes paid to any foreign country generally is limited to the lesser of (1) the foreign estate taxes attributable to the property includible in the decedent's U.S. estate solely by reason of the expatriation estate tax provisions or (2) the U.S. estate tax attributable to property that is subject to estate tax in such foreign country and is includible in the decedent's U.S. estate solely by reason of the expatriation tax provisions. The amount of taxes attributable to such property is determined on a pro rata basis.

III. TECHNICAL CORRECTIONS TO THE TAXPAYER BILL OF RIGHTS 2

1. Reasonable cause abatement for first-tier intermediate sanctions excise tax (sec. 1403(a) of the bill and section 4962 of the Code)

Present Law

Section 4958 imposes penalty excise taxes as an intermediate sanction in cases where organizations exempt from tax under sections 501(c)(3) or 501(c)(4) (other than private foundations) engage in an "excess benefit transaction." The excise tax may be imposed on certain disqualified persons (i.e., insiders) who improperly benefit from an excess benefit transaction and on organization managers who participate in such a transaction knowing that it is improper.

A disqualified person who benefits from an excess benefit transaction is subject to a first-tier penalty tax equal to 25 percent of the amount of the excess benefit. Organization managers who participate in an excess benefit transaction knowing that it is improper are subject to a first-tier penalty tax of 10 percent of the amount of the excess benefit. Additional second-tier taxes equal to 200 percent of the amount of the excess benefit may be imposed on a disqualified person if there is no correction of the transaction within a specified time period.

Under section 4962, the IRS has the authority to abate certain first-tier taxes if the taxable event was due to reasonable cause and not to willful neglect and the event was corrected within the applicable correction period. First-tier taxes which may be abated include, among others, the taxes imposed under sections 4941 (on acts of self-dealing between private foundations and disqualified persons), 4942 (for failure by private foundations to distribute a minimum amount of income), and 4943 (on private foundations with excess business holdings).

In enacting the new excise taxes on excess benefit transactions, Congress explicitly intended to provide the IRS with abatement authority under section 4962.¹⁵⁰ However, the abatement rules of section 4962 apply only to qualified first-tier taxes imposed by subchapter A or C of Chapter 42. The section 4958 excise tax is located in subchapter D of Chapter 42. The failure to cross reference subchapter D in section 4962 means that IRS does not have such abatement authority with respect to the section 4958 excise taxes.

Explanation of Provision

The bill amends section 4962(b) to include a cross-reference to first-tier taxes imposed by subchapter D (i.e., the section 4958 excise taxes on excess benefit transactions). Thus, the IRS has authority to abate the first-tier excise taxes on excess benefit transactions in cases where it is established that the violation was due to reasonable cause and not due to willful neglect and the transaction at issue was corrected within the specified period.

2. Reporting by public charities with respect to intermediate sanctions and certain other excise tax penalties (sec. 1403(b) of the bill and sec. 6033 of the Code)

Present Law

Section 4958 imposes penalty excise taxes as an intermediate sanction in cases where organizations exempt from tax under sections 501(c)(3) or 501(c)(4) (other than private foundations) engage in an "excess benefit transaction." The excise tax may be imposed on certain disqualified persons (i.e., insiders) who improperly benefit from an excess benefit transaction and on organization managers who participate in such a transaction knowing that it is improper. No tax is imposed on the organization itself with respect under section 4958.

Section 4911 imposes an excise tax penalty on excess lobbying expenditures made by public charities. The tax is imposed on the organization itself. Section 4912 imposes a penalty excise tax on certain public charities that make disqualifying lobbying expenditures and section 4955 imposes a penalty excise tax on political expenditures of section 501(c)(3) organizations. Both of these penalty taxes are imposed not only on the affected organization, but also on organization managers who agree to an expenditure knowing that it is improper.

Under section 4962, the IRS has the authority to abate certain first-tier taxes if the taxable event was due to reasonable cause and not to willful neglect and the event was corrected within the applicable correction period. First-tier taxes which may be abated include, among others, the taxes imposed under section 4955.¹⁵¹

Under section 6033(b)(10), 501(c)(3) organizations are required to report annually on Form 990 any amounts paid by the organization under section 4911, 4912, and 4955. Thus, although sections 4912 and 4955 impose excise taxes on organization managers, organizations technically are not required to report any such excise taxes paid by such managers.

In addition, under section 6033(b)(11), an organization exempt from tax under section 501(c)(3) must report on Form 990 any amount of excise tax on excess benefit transactions paid by the organization, or any disqualified person with respect to such organization, during the taxable year. The Code does not explicitly require the reporting of any excess benefit excise taxes paid by an organization manager solely in his or her capacity as such (i.e., an organization manager might also be a disqualified person with respect to an excess benefit transaction, in which case any tax paid would be reported).

Explanation of Provision

The bill makes the reporting requirements of section 6033(b)(10) and (11) consistent with the excise tax penalty provisions to which they relate. Thus, section 6033(b)(10) is amended to require 501(c)(3) organizations to report any amounts of tax imposed under sections 4911, 4912, and 4955 on the organization or any organization manager of the organization. In addition, the bill requires reporting with respect to any reimbursements paid by an organization with respect to taxes imposed under sections 4912 or 4955 on any organization manager of the organization. Section 6033(b)(11) is amended to require 501(c)(3) organizations to report any amounts of tax imposed under section 4958 on any organization manager or any disqualified person, as well as any reimbursements of section 4958 excise tax liability paid by the organization to such organization managers or disqualified persons.

In addition, the bill clarifies that no reporting is required under sections 6033(b)(10) or (11) in the event a first-tier penalty excise tax imposed under section 4955 or section 4958 is abated by the IRS pursuant to its authority under section 4962.

IV. TECHNICAL CORRECTIONS TO OTHER ACTS

1. Correction of GATT interest and mortality rate provisions in the Retirement Protection Act (sec. 1404(b)(3) of the bill and sec. 1449(a) of the Small Business Act)

Present Law

The Retirement Protection Act of 1994, enacted as part of the implementing legislation for the General Agreements on Tariffs and Trade (" GATT "), modified the actuarial assumptions that must be used in adjusting benefits and limitations under section 415. In general, in adjusting a benefit that is payable in a form other than a straight life annuity and in adjusting the dollar limitation if benefits begin before age 62, the interest rate to be used cannot be less than the greater of 5 percent or the rate specified by the plan. Under GATT , the benefit is payable in a form subject to the requirements of section 417(e)(3), then the interest rate on 30-year Treasury securities is substituted for 5 percent. Also under GATT , for purposes of adjusting any limit or benefit, the mortality table prescribed by the Secretary must be used. This provision of GATT was generally effective as of the first day of the limitation year beginning in 1995.

The Small Business Act conformed the effective date of these changes to the effective date of similar changes by providing generally that, in the case of a plan that was adopted and in effect before December, 8, 1994, the GATT change is not effective with respect to benefits accrued before the earlier of (1) the later of the date a plan amendment applying the amendments is adopted or made effective or (2) the first day of the first limitation year beginning after December 31, 1999 . The Small Business Act provides that "Determinations under section 415(b)(2)(E) before such earlier date are to be made with respect to such benefits on the basis of such section as in effect on December 7, 1994 (except that the modification made by section 1449(b) of the Small Business Job Protection Act of 1996 shall be taken into account), and the provisions of the plan as in effect on December 7, 1994 , but only if such provisions of the plan meet the requirements of such section (as so in effect)."

Explanation of Provision

The provision in the Small Business Act was intended to permit plans to apply pre- GATT law under section 415(b)(2)(E) for a transition period. The bill conforms the statute to this intent by providing that determinations under section 415(b)(2)(E) before such earlier date are to be made with respect to such benefits on the basis of such section as in effect on December 7, 1994 and the provisions of the plan as in effect on December 7, 1994 , but only if such provisions of the plan meet the requirements of such section (as so in effect).

2. Related parties determined by reference to section 267 (sec. 1404(d) of the bill and sec. 267(f) of the Code)

Present Law

Section 267 disallows loses arising in transactions between certain defined related parties. In the case of related corporations, such losses may be deferred. Several Code provisions, in defining related parties, often incorporate the relationships described in section 267 by cross-reference to such section.

Explanation of Provision

Any provision of the Internal Revenue Code of 1986 that refers to a relationship that would result in loss disallowance under section 267 also refers to relationships where loss is deferred, where such relationship is applicable to the provision.

For purposes of the 75-percent credit rate, "community colleges" are defined as any institution of higher education (as defined in sec. 1201 of the Higher Education Act of 1965 (20 U.S.C. 1141)) that awards an associate's degree. "Vocational schools" are defined as post-secondary vocational institutions (as defined in sec. 481 of the Higher Education Act of 1965 (20 U.S.C. 1088)).

At the time that a final distribution is made from a qualified tuition program or education IRA, the distribution will be deemed to include the full amount of any basis remaining with respect to the program or account.

The bill also provides that funds from an education IRA are deemed to be distributed to pay qualified higher education expenses if the funds are used to make contributions to (or purchase tuition credits from) a qualified tuition program for the benefit of the account holder.

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 will be assigned a fixed-base percentage of 3 percent for each of its first five taxable years after 1993 in which it incurs qualified research expenditures. In the event that the research credit is extended beyond the scheduled expiration date, a start-up firm's fixed-base percentage for its sixth through tenth taxable years after 1993 in which it incurs qualified research expenditures will be a phased-in ratio based on its actual research experience. For all subsequent taxable years, the taxpayer's fixed-base percentage will be its actual ratio of qualified research expenditures to gross receipts for any five years selected by the taxpayer from its fifth through tenth taxable years after 1993 (sec. 41(c)(3)(B)).

Federal Taxation of Partnerships and Partners (3rd ed. 1997), para. 19.06.

¹ If the aggregate redemption amount (i.e., principal plus interest) of all Series EE bonds redeemed by the taxpayer during the taxable year exceeds the qualified education expenses incurred, then the excludable portion of interest income is based on the ratio that the education expenses bears to the aggregate redemption amount (sec. 135(b)).

² Specifically, section 529(c)(3)(A) provides that any distribution under a qualified State tuition program shall be includible in the gross income of the distributee in the same manner as provided under present-law section 72 to the extent not excluded from gross income under any other provision of the Code.

³ Thus, students attending community colleges or vocational schools may be eligible for the $1,500 maximum HOPE credit if they incur $2,000 of qualified tuition and related expenses. In contrast, students attending other institutions (e.g., four-year colleges) may be eligible for the $1,500 maximum HOPE credit if they incur $3,000 of qualified tuition and related expenses.

⁴ The HOPE credit may not be claimed against a taxpayer's alternative minimum tax (AMT) liability.

⁵ The Treasury Department will have authority to issue regulations providing that the HOPE credit will be recaptured in cases where the student or taxpayer receives a refund of tuition and related expenses with respect to which a credit was claimed in a prior year.

⁶ For any taxable year, a taxpayer may claim the HOPE credit for qualified tuition and related expenses paid with respect to one student and also claim the proposed exclusion for distributions made from a qualified tuition program or education IRA (described below) used to cover higher education expenses paid with respect to one or more other students. If the HOPE credit is claimed with respect to one student for one or two taxable years, then the exclusion for distributions from a qualified tuition program or education IRA may be available with respect to that same student for subsequent taxable years.

⁷ In addition, the bill amends present-law section 135 to provide that the amount of qualified higher education expenses taken into account for purposes of that section is reduced by the amount of such expenses taken into account in determining the HOPE credit allowed to any taxpayer with respect to the student for the taxable year.

⁸ If the aggregate redemption amount (i.e., principal plus interest) of all Series EE bonds redeemed by the taxpayer during the taxable year exceeds the qualified education expenses incurred, then the excludable portion of interest income is based on the ratio that the education expenses bears to the aggregate redemption amount (sec. 135(b)).

⁹ Specifically, section 529(c)(3)(A) provides that any distribution under a qualified State tuition program shall be includible in the gross income of the distributee in the same manner as provided under present-law section 72 to the extent not excluded from gross income under any other provision of the Code.

¹⁰ The exclusion will not be a preference item for alternative minimum tax (AMT) purposes.

¹¹ If a HOPE credit was claimed with respect to a student for an earlier taxable year (i.e., the student's first or second year of post-secondary education), the exclusion provided for by the bill may be claimed with respect to that student for a subsequent taxable year.

¹² Specifically, the bill provides as a general rule that distributions from a qualified tuition program or education IRA are includible in gross income to the extent allocable to income on the program or account and are not includible in gross income to the extent allocable to the investment (i.e., contributions) in the program or account. However, the bill further provides that, if the HOPE credit is not claimed with respect to the student for the taxable year, then a distribution from a qualified tuition program or education IRA will not be includible in gross income to the extent that the distribution does not exceed the qualified higher expenses of the student for the year. If a distribution consists of providing in-kind education benefits to the student which, if paid for by the student, would constitute payment of qualified higher education expenses, then no portion of such distribution will be includible in gross income.

¹³ For example, if a $1,000 distribution from a qualified tuition program or education IRA consists of $600 of principal (i.e., contributions) and $400 of earnings, and if the student incurs $750 of qualified higher education expenses during the year, then $300 of the earnings will be excludable from gross income under the bill (i.e., an exclusion will be provided for the pro-rata portion of the earnings, based on the ratio that the $750 of qualified expenses bears to the $1,000 total distribution) and the remaining $100 of earnings will be includible in the distributee's gross income.

¹⁴ The bill allows taxpayers to redeem U.S. Savings Bonds and be eligible for the exclusion under section 135 (as if the proceeds were used to pay qualified higher education expenses) if the proceeds from the redemption are contributed to a qualified tuition program or education IRA on behalf of the taxpayer, the taxpayer's spouse, or a dependent. In such a case, the beneficiary's or account holder's basis in the bond proceeds contributed on his or her behalf to the qualified tuition program or education IRA will be the contributor's basis in the bonds (i.e., the original purchase price paid by the contributor for such bonds).

¹⁵ State-sponsored qualified tuition programs will continue to be governed by the rule contained in present-law section 529(b)(7) that such programs provide adequate safeguards to prevent contributions on behalf of a designated beneficiary in excess of those necessary to provide for the qualified higher education expenses of the beneficiary. State-sponsored qualified tuition programs will not be subject to a specific dollar limit on annual contributions that can be made under the program on behalf of a designated beneficiary.

¹⁶ The maximum contribution limit for the year is increased even if the child is younger than age 13 --that is, even in cases where the parent is not required (under the provision described previously) but may elect to deposit an amount equal to the child credit into a qualified tuition program or education IRA on behalf of the child.

¹⁷ The annual $2,000 to $2,500 contribution limit is applied by taking into account all contributions made to any qualified tuition program not maintained by a State and any education IRA on behalf of a designated individual (but not any contributions made to State-sponsored qualified tuition programs). To the extent contributions exceed the annual contribution limit, an excise tax penalty may be imposed on the contributor under present-law section 4973, unless the excess contributions (and any earnings thereon) are returned to the contributor before the due date for the return for the taxable year during which the excess contribution is made.

¹⁸ In such cases, the 5-year holding period applicable to IRA Plus accounts begins with the taxable year in which the education IRA is deemed to be an IRA Plus account.

¹⁹ In the event of such a rollover, the 5-year holding period applicable to IRA Plus accounts begins with the taxable year in which the rollover occurs.

²⁰ For this purpose, a "member of the family" means persons described in paragraphs (1) through (8) of section 152(a), and any spouse of such persons.

²¹ An interest in a qualified tuition program is not treated as debt for purposes of the debt-financed property UBIT rules of section 514.

²² Distributions from State-sponsored qualified tuition programs will not be subject to this 10-percent additional penalty tax, but will continue to be governed by the present-law section 529(b)(3) rule that the State-sponsored programs themselves are required to impose a "more than de minimis penalty" on any refund of earnings not used for qualified higher education expenses (other than in cases where the refund is made on account of death or disability of, or receipt of a scholarship by, the beneficiary).

²³ Contributions to only one State-sponsored qualified tuition program per beneficiary will be excluded from the gift tax by reason of the bill (although a contributor may also make contributions excluded from the gift tax on behalf of other beneficiaries to the same State-sponsored program or any other State-sponsored program).

²⁴ For purposes of sections 86, 135, 219, and 469, adjusted gross income is determined without regard to the deduction for student loan interest.

²⁵ The legislative history reflects congressional intent that the provision expire with respect to courses beginning after May 31, 1997.

²⁶ To be eligible, a teacher must have completed at least two academic years as a K-12 teacher in an elementary or secondary school before the qualified professional development expenses are incurred.

²⁷ The bill also provides for penalty-free withdrawals from IRAs for education expenses (see above).

²⁸ The bill does not modify the present-law rule permitting IRAs to be invested in certain State coins.

²⁹ As is the case with IRAs generally, contributions to an IRA Plus may be made for a year by the due date for the individual's tax return for the year (determined without regard to extensions). In the case of a contribution to an IRA Plus made after the end of the taxable year, the 5-year holding period begins with the taxable year to which the contribution relates, rather than the year in which the contribution is actually made.

³⁰ In the case of conversions from an IRA to an IRA Plus, the 5-taxable year holding period begins with the taxable year in which the conversion was made.

³¹ Prior to 1976, separate tax rate schedules applied to the gift tax and the estate tax.

³² Thus, if a taxpayer has made cumulative taxable transfers equaling $21,040,000 or more, his or her average transfer tax rate is 55 percent. The phaseout has the effect of creating a 60-percent marginal transfer tax rate on transfers in the phaseout range.

³³ A member of the transferor's family includes: (1) his or her ancestors; (2) his or her spouse; (3) a lineal descendant of the decedent, the decedent's spouse or the decedent's parents; and (4) the spouse of any of the foregoing lineal descendants.

³⁴ When originally enacted, the research tax credit applied to qualified expenses incurred after June 30, 1981. The credit was modified several times and was extended through June 30, 1995. The credit later was extended for the period July 1, 1996, through May 31, 1997 (with a special 11-month extension for taxpayers that elect to be subject to the alternative incremental research credit regime).

³⁵ 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.

³⁶ Under a special rule enacted as part of the Small Business Job Protection Act of 1996, 75 percent of amounts paid to a research consortium for qualified research is treated as qualified research expenses eligible for the research credit (rather than 65 percent under the 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.

³⁷ The amount of the deduction allowable for a taxable year with respect to a charitable contribution may be reduced depending on the type of property contributed, the type of charitable organization to which the property is contributed, and the income of the taxpayer (secs. 170(b) and 170(e)).

³⁸ As part of the Omnibus Budget Reconciliation Act of 1993, Congress eliminated the treatment of contributions of appreciated property (real, personal, and intangible) as a tax preference for alternative minimum tax (AMT) purposes. Thus, if a taxpayer makes a gift to charity of property (other than short-term gain, inventory, or other ordinary income property, or gifts to private foundations) that is real property, intangible property, or tangible personal property the use of which is related to the donee's tax-exempt purpose, the taxpayer is allowed to claim the same fair-market-value deduction for both regular tax and AMT purposes (subject to present-law percentage limitations).

³⁹ The special rule contained in section 170(e)(5), which was originally enacted in 1984, expired January 1, 1995. The Small Business Job Protection Act of 1996 reinstated the rule for 11 months --for contributions of qualified appreciated stock made to private foundations during the period July 1, 1996, through May 31, 1997.

⁴⁰ The orphan drug tax credit originally was enacted in 1983 and was extended on several occasions. The credit expired on December 31, 1994, and later was reinstated for the period July 1, 1996, through May 31, 1997.

⁴¹ The six designated urban empowerment zones are located in New York City , Chicago , Atlanta , Detroit , Baltimore , and Philadelphia-Camden ( New Jersey ). The three designated rural empowerment zones are located in Kentucky Highlands (Clinton, Jackson, and Wayne counties, Kentucky), Mid-Delta Mississippi (Bolivar, Holmes, Humphreys, Leflore counties, Mississippi), and Rio Grande Valley Texas (Cameron, Hidalgo, Starr, and Willacy counties, Texas).

⁴² Also, a qualified business does not include certain facilities described in section 144(c)(6)(B) (e.g., massage parlor, hot tub facility, or liquor store) or certain large farms.

⁴³ The Revenue Reconciliation Act of 1993 added Code section 1202, which provides a 50-percent exclusion for gain from the sale of certain small business stock acquired at original issue and held for at least five years.

⁴⁴ The provision of the bill that excludes sales of certain personal residences from the real estate transaction reporting requirement would not apply to sales of personal residences in the District of Columbia . In addition, the Committee anticipates that the Secretary of Treasury will require such information as may be necessary to verify eligibility for the D.C. first-time homebuyer credit.

⁴⁵ Special rules apply to members of the Armed Forces and certain individuals with tax homes outside the United States with respect to whom the rollover period available under section 1034 (as in effect prior to the enactment of the bill) is suspended pursuant to sections 1034(h) or (k).

⁴⁶ As a general business credit, the credit can be carried back three years (but not before January 1, 1998) and forward for fifteen years.

⁴⁷ The requirement under present-law section 1397B(b)(6) that at least 35 percent of the employees of the business be zone residents does not apply when determining whether an entity is a qualified D.C. business.

⁴⁸ Also, as under present law, a qualified business does not include certain facilities described in section 144(c)(6)(B) (e.g., massage parlor, hot tub facility, or liquor store) or certain large farms.

⁴⁹ In the case of a new corporation, it is sufficient if the corporation is being organized for purposes of being a qualified D.C. business.

⁵⁰ As under section 1202(c)(3), qualified D.C. business stock does not include any stock acquired from a corporation which made a substantial stock redemption or distribution (without a bona fide business purpose therefore) in an attempt to avoid the purposes of the provision. A similar rule applies with respect to qualified D.C. partnership interests.

⁵¹ In the case of a new partnership, it is sufficient if the partnership is being formed for purposes of being a D.C. business.

⁵³ This requirement was enacted in 1993 (sec. 523 of P.L. 103-182).

⁵⁴ Treasury had earlier developed TAXLINK as the prototype for EFTPS. TAXLINK has been operational for several years; EFTPS is currently operational. Employers currently using TAXLINK will ultimately be required to participate in EFTPS.

⁵⁵ Sec. 1809 of P.L. 104-188.

⁵⁶ IR-97-32.

⁵⁷ Notice 97-13, January 28, 1997.

⁵⁸ Related coverage that is incidental to workmen's compensation insurance includes liability under Federal workmen's compensation laws, the Jones Act, and the Longshore and Harbor Workers Compensation Act, for example.

⁵⁹ Omnibus Budget Reconciliation Act of 1987 (P.L. 100-203), sec. 10211(c).

⁶⁰ See United States v. American College of Physicians, 475 U.S. 834 (1986)(holding that activity of selling advertising in medical journal was not substantially related to the organization's exempt purposes and, as a separate business under section 513(c), was subject to tax).

⁶¹ See Prop.Treas. Reg. sec. 1.513-4 (issued January 19, 1993, EE-74-92, IRB 1993-7, 71). These proposed regulations generally exclude from the UBIT financial arrangements under which the tax-exempt organization provides so-called "institutional" or "good will" advertising to a sponsor (i.e., arrangements under which a sponsor's name, logo, or product line is acknowledged by the tax-exempt organization). However, specific product advertising (e.g., "comparative or qualitative descriptions of the sponsor's products") provided by a tax-exempt organization on behalf of a sponsor is not shielded from the UBIT under the proposed regulations.

⁶² In determining whether a payment is a qualified sponsorship payment, it is irrelevant whether the sponsored activity is related or unrelated to the organization's exempt purpose.

⁶³ See Treas. Reg. sec. 1.119-1(a)(2)(ii)(c) and 1.119-1(f)(Example 7).

⁶⁴ Rev. Rul. 94-38 generally rendered moot the holding in TAM 9315004 (December 17, 1992) requiring a taxpayer to capitalize certain costs associated with the remediation of soil contaminated with polychlorinated biphenyls (PCBs).

⁶⁵ Comm'r v. Idaho Power Co., 418 U.S. 1 (1974) (holding that equipment depreciation allocable to the taxpayer's construction of capital facilities must be capitalized under section 263(a)(1)).

⁶⁶ The six designated urban empowerment zones are located in New York City , Chicago , Atlanta , Detroit , Baltimore , and Philadelphia-Camden ( New Jersey ). The three designated rural empowerment zones are located in Kentucky Highlands (Clinton, Jackson, and Wayne counties, Kentucky), Mid-Delta Mississippi (Bolivar, Holmes, Humphreys, Leflore counties, Mississippi), and Rio Grande Valley Texas (Cameron, Hidalgo, Starr, and Willacy counties, Texas).

⁶⁷ 106 T.C. No. 19 (May 23, 1996).

⁶⁸ U.S. D.C. Nev. CV-5-94-1146-HDM(LRL) (September 26, 1996).

⁶⁹ Until such regulations are issued, it is intended that the Treasury regulations promulgated under the similar provisions of section 731(c)(2) generally will apply. Specifically, it is intended that an entity will meet the "substantially all" requirement if 90 percent or more of its assets are listed assets (Treas. reg. sec. 1.731-2(c)(3)(i)). Similarly, with respect to partnerships and other non-corporate entities, it is intended that, where 20 percent or more (but less than 90 percent) of the entity's assets consist of listed assets, a pro rata portion of the interest in the entity will be treated as a listed asset.(Treas. reg. sec. 1.731-2(c)(3)(ii))

⁷⁰ Although money is counted toward the 80-percent test under the bill, this provision in the regulations should have the effect that where money is contributed and, pursuant to a plan, assets not treated as stock or securities under the bill are either purchased or contributed by other parties, the investment company determination would be made only on the basis of the entity's assets after such events.

⁷¹ Code section 1221 defines a capital asset to mean property held by the taxpayer other than (1) property properly includible in inventory of the taxpayer or primarily held for sale to customers in the ordinary course of the taxpayer's trade or business, (2) depreciable and real property used in the taxpayer's trade or business, (3) a copyright, a literary musical; or artistic composition, letter or memorandum, or similar property that was created by the taxpayer (or whose basis is determined, in whole or in part, the basis of the creator, (4) accounts or notes receivable acquired in the ordinary course of the taxpayer's trade or business, and (5) a publication of the United States Government which was received from the Government other than by sale.

⁷² Helvering v. William Flaccus Oak Leather Co., 313

U.S.

247 (1941).

⁷³ See bill section 311, which provides an alternative tax rates on long-term capital gains of 10 percent or 20 percent for taxpayers otherwise marginal bracket is 15 percent or greater than 15 percent, respectively.

⁷⁴ See bill section 321, which provides an alternative tax rate of 30 percent on corporate capital gains on assets held lower than 5 years.

⁷⁵ The result in this case was overturned by enactment in 1934 of the predecessor of present law sec. 1271(a), see below. See section 117 of the Revenue Act of 1934, 28 Stat. 680, 714-715.

⁷⁶ Treasury Regulations generally define "actively traded" as any personal property for which there an established financial market. In addition, those regulations provided that "notional principal contract constitutes personal property of a type that is actively traded if contracts based on the same or substantially similar specified indices are purchased, sold, or entered into on an established financial market" and that "rights and obligations of a party to a notional principal contract are rights and obligations with respect to personal property and constitute an interest is personal property." Treas. Reg. sec. 1.092(d)-1(c).

⁷⁷ A "section 1256 contract" means (1) any regulated futures contract, (2) foreign currency contract, (3) nonequity option, or (4) dealer equity option.

⁷⁸ The present law provision (sec. 1234A) which treats cancellation, lapse, expiration, or other termination of a right or obligation with respect to personal property as a sale of a capital asset was added by Congress in 1981 when Congress adopted a number of provisions dealing with tax straddles. There are two components or "legs" to a straddle, where the value of one leg changes inversely with the value of the other leg. Without a special rule, taxpayers were able to "leg-out" of the loss leg of the straddle, while retaining the gain leg, resulting the creation of an ordinary loss. In 1981, Congress believed that the effective ability of taxpayer to elect the character of a gain or loss leg of a straddle was unwarranted and provided the present law rule that a cancellation, lapse, expiration or other termination of a right is a sale or exchange. However, since straddles were the focus the 1981 legislation, that legislation was limited to types of property which were the subject of straddles, i.e., personal property (other than stock) of a type which is actively traded which is, or would be on acquisition, a capital asset in the hands of the taxpayer. The provision subsequently was extended to section 1256 contracts.

⁷⁹ The issuer of a debt instrument with OID generally accrues and deducts the discount, as interest, over the life of the obligation even though the amount of such interest is not paid until the debt matures. The holder of such a debt instrument also generally includes the OID in income as it accrues as interest on an accrual basis. The mandatory inclusion of OID in income does not apply, among other exceptions, to debt obligations issued by natural persons before March 2, 1984, and loans of less than $10,000 between natural persons if such loan is not made in the ordinary course of business of the lender (secs. 1272(a)(2)(D) and (E)).

⁸⁰ 8 See Billy Rose Diamond Horseshoe, Inc. v. Commissioner, 448 F. 2d 549 (1971), where the Second Circuit held that payments were not entitled to capital gain treatment because there was no sale or exchange. See also, Sirbo Holdings, Inc. v. Commissioner, 509 F.2d 1220 (2d Cir. 1975).

⁸¹ See U.S. Freight Co. v. U.S. 422 F.2d 887 (Ct. Cl. 1970), holding that forfeiture was an ordinary loss.

⁸² See H. Rept. 99-841, II-166, 99th Cong. 2d Sess. (September 18, 1986).

⁸³ See Treas. reg. sec. 1.701-2(f), Example (2).

⁸⁴ For example, it has been reported that Seagram Corporation intends to take the position that the corporate dividends-received deduction will eliminate tax on significant distributions received from DuPont Corporation in a redemption of almost all the DuPont stock held by Seagram, coupled with the issuance of certain rights to reacquire DuPont stock. (See, e.g., Landro and Shapiro, "Hollywood Shuffle," Wall Street Journal, pp. A1 and A11 (April 7, 1995); Sloan, "For Seagram and DuPont, a Tax Deal that No One Wants to Brandy About," Washington Post, p. D3 (April 11, 1995); Sheppard, "Can Seagram Bail Out of DuPont without Capital Gain Tax," Tax Notes Today, (April 10, 1995, 95 TNT 75-4).

⁸⁵ Thus, for example, where a portion of such a distribution would not have been treated as a dividend due to insufficient earnings and profits, the rule applies to the portion treated as a dividend.

⁸⁶ Thus, for example, in the case of a distribution prior to the effective date, the provisions of present law would continue to apply, including the provisions of present-law sections 1059(a) and 1059(d)(1), requiring reduction in basis immediately before any sale or disposition of the stock, and requiring recognition of gain at the time of such sale or disposition.

⁸⁷ If a controlled corporation is acquired after a distribution, an issue may arise whether the acquisition can be viewed under step-transaction concepts as having occurred before the distribution, with the result that the distributing corporation would not be viewed as having distributed the necessary 80 percent control. The Internal Revenue Service has indicated that it will not rule on requests for section 355 treatment in cases in which there have been negotiations, agreements, or arrangements with respect to transactions or events which, if consummated before the distribution, would result in the distribution of stock or securities of a corporation which is not "controlled" by the distributing corporation. Rev. Proc. 96-39, 1996-33 I.R.B. 11; see also Rev. Rul. 96-30, 1996-1 C.B. 36; Rev. Rul. 70-225, 1970-1 C.B. 80.

⁸⁸ Excess loss accounts in consolidation generally are created when a subsidiary corporation makes a distribution (or has a loss that is used by other members of the group) that exceeds the parent's basis in the stock of the subsidiary. In general, such excess loss accounts in consolidation are permitted to be deferred rather than causing immediate taxable gain. Nevertheless, they are recaptured when a subsidiary leaves the group or in certain other situations. However, such excess loss accounts are not recaptured in certain cases where there is an internal spin-off prior to the subsidiary leaving the group. See. Treas. reg. sec. 1.1502-19(g). In addition, an excess loss account may not be created at all in certain cases that are similar economically to a distribution that would reduce the stock basis of the distributing subsidiary corporation, if the distribution from the subsidiary is structured to meet the form of a section 355 distribution.

⁸⁹ Notice and demand is the notice given to a person liable for tax stating that the tax has been assessed and demanding that payment be made. The notice and demand must be mailed to the person's last known address or left at the person's dwelling or usual place of business (Code sec. 6303).

⁹⁰ Code sec. 6331.

⁹¹ Code secs. 6335-6343.

⁹² Code sec. 6331(b).

⁹³ Code sec. 6331(c).

⁹⁴ Code sec. 6331(e).

⁹⁵ Code sec. 6334(a)(9).

⁹⁶ Code sec. 6334(d).

⁹⁷ Standard deduction of $6,700 plus four personal exemptions at $2,550 each equals $16,900, which when divided by 52 equals $325.

⁹⁸ Code sec. 6334(a)(7).

⁹⁹ Sec. 6334(a)(4).

¹⁰⁰ Sec. 6334(a)(11).

¹⁰¹ The $6 per passenger international departure excise tax, described below, does apply to this transportation.

¹⁰² This special rule also applies to domestic segments between the contiguous 48 states and Alaska or Hawaii which are associated with international arrivals or departures to or from those States. Thus, the flight segment between the 48 contiguous States and Alaska or Hawaii is subject to a tax of $6 plus 10 percent of the apportioned mileage in U.S. territorial airspace, and the flight segment between Alaska or Hawaii and a foreign country is subject to the new $8 international arrival and departure tax rate.

¹⁰³ The Treasury Department is directed to published an annual list of qualified rural airports, based on passenger enplanemnts for the requisite calendar year.

¹⁰⁴ For this purpose, a "controlled organization" is defined under section 368(c).

¹⁰⁵ Treas. reg. sec. 1.512(b)-1(l)(4)(I)(a).

¹⁰⁶ Treas. reg. sec. 1.512(b)-l(1)(4)(I)(b).

¹⁰⁷ See PLR 9338003 (June 16, 1993) (holding that because no indirect ownership rules are applicable under section 512(b)(13), rents paid by a second-tier taxable subsidiary are not UBTI to a tax-exempt parent organization). In contrast, an example of an indirect ownership rule can be found in Code section 318. Section 318(a)(2)(C) provides that if 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such person shall be considered as owning the stock owned, directly or indirectly by or for such corporation, in the proportion the value of the person's stock ownership bears to the total value of all stock in the corporation.

¹⁰⁸ See PLR 9542045 (July 28, 1995) (holding that first-tier holding company and second-tier operating subsidiary were organized with bona fide business functions and were not agents of the tax-exempt parent organization; therefore, rents, royalties, and interest received by tax-exempt parent organization from second-tier subsidiary were not UBTI).

¹⁰⁹ This favorable tax treatment is available only if the policyholder has an insurable interest in the insured when the contract is issued and if the life insurance contract meets certain requirements designed to limit the investment character of the contract (sec. 7702). Distributions from a life insurance contract (other than a modified endowment contract) that are made prior to the death of the insured generally are includible in income, to the extent that the amounts distributed exceed the taxpayer's basis in the contract; such distributions generally are treated first as a tax-free recovery of basis, and then as income (sec. 72(e)). In the case of a modified endowment contract, however, in general, distributions are treated as income first, loans are treated as distributions (i.e., income rather than basis recovery first), and an additional 10 percent tax is imposed on the income portion of distributions made before age 59-1/2 and in certain other circumstances (secs. 72(e) and (v)). A modified endowment contract is a life insurance contract that does not meet a statutory "7-pay" test, i.e., generally is funded more rapidly than 7 annual level premiums (sec. 7702A). Certain amounts received under a life insurance contract on the life of a terminally or chronically ill individual, and certain amounts paid for the sale or assignment to a viatical settlement provider of a life insurance contract on the life of a terminally ill or chronically ill individual, are treated as excludable as if paid of the death of the insured (sec. 101(g)).

¹¹⁰ Phase-in rules apply generally with respect to otherwise deductible interest paid or accrued after December 31, 1995, and before January 1, 1999, in the case of debt incurred before January 1, 1996. In addition, transition rules apply.

¹¹¹ Since 1942, a limitation has applied to the deductibility of interest with respect to single premium contracts (sec. 264(a)(2)). For this purpose, a contract is treated as a single premium contract if (1) substantially all the premiums on the contract are paid within a period of 4 years from the date on which the contract is purchased, or (2) an amount is deposited with the insurer for payment of a substantial number of future premiums on the contract. Further, under a limitation added in 1964, no deduction is allowed for any amount paid or accrued on debt incurred or continued to purchase or carry a life insurance, endowment, or annuity contract pursuant to a plan of purchase that contemplates the systematic direct or indirect borrowing of part or all of the increases in the cash value of the contract (sec. 264(a)(3)). An exception to the latter rule is provided, permitting deductibility of interest on bona fide debt that is part of such a plan, if no part of 4 of the annual premiums due during the first 7 years is paid by means of debt (the "4-out-of-7 rule") (sec. 264(c)(1)). In addition to the specific disallowance rules of section 264, generally applicable principles of tax law apply.

¹¹² Special rules apply for certain tax-exempt obligations of small issuers (sec. 265(b)(3)).

¹¹³ See "Fannie Mae Designing a Program to Link Life Insurance, Loans," Washington Post, p. E3, February 8, 1997; "Fannie Mae Considers Whether to Bestow Mortgage Insurance," Wall St. Journal, p. C1, April 22, 1997.

¹¹⁴ Exceptions to this nonrecognition rule apply: (1) when money (and the fair market value of marketable securities) received exceeds a partner's adjusted basis in the partnership (sec. 731(a)(1)); (2) when only money, inventory and unrealized receivables are received in liquidation of a partner's interest and loss is realized (sec. 731(a)(2)); (3) to certain disproportionate distributions involving inventory and unrealized receivables (sec. 751(b)); and (4) to certain distributions relating to contributed property (secs. 704(c) and 737). In addition, if a partner engages in a transaction with a partnership other than in its capacity as a member of the partnership, the transaction generally is considered as occurring between the partnership and one who is not a partner (sec. 707).

¹¹⁵ A special rule allows a partner that acquired a partnership interest by transfer within two years of a distribution to elect to allocate the basis of property received in the distribution as if the partnership had a section 754 election in effect (sec. 732(d)). The special rule also allows the Service to require such an allocation where the value at the time of transfer of the property received exceeds 110 percent of its adjusted basis to the partnership (sec. 732(d)). Treas. Reg. sec. 1.732-1(d)(4) generally requires the application of section 732(d) where the allocation of basis under section 732(c) upon a liquidation of the partner's interest would have resulted in a shift of basis from non-depreciable property to depreciable property.

¹¹⁶ "The failure of these rules to take fair market value into account puts a high premium on tax planning in connection with in-kind liquidating distributions. Allocation of the portion of the basis in excess of the partnership's basis in the distributed assets according to their relative market values would be a conceptually sound approach, and would eliminate the strange results and manipulation possibilities . . ." W. McKee, W. Nelson and R. Whitmire,

¹¹⁷ The 1984 ALI study on partnership rules referred to the substantial appreciation requirement as subject to manipulation and tax planning (American Law Institute, Federal Income Tax Project: Subchapter K: Proposals on the Taxation of Partners (R. Cohen, reporter, 1984), 26. In 1993, the definition of substantially appreciated inventory was modified, and the present-law test relating to a principal purpose of avoidance was added (Omnibus Budget Reconciliation Act of 1993, P.L. 103-66, sec. 13206(e)(1)). Nevertheless, the substantial appreciation requirement is still criticized as ineffective (W. McKee, W. Nelson and R.Whitmire, Federal Taxation of Partners and Partnerships, (3rd ed. 1997) para. 16.04[2]).

¹¹⁸ See, e.g., Rev. Rul. 60-358, 1960-2 C.B. 68; Rev. Rul. 64-273, 1964-2 C.B. 62; Rev. Rul 79-285, 1979-2 C.B. 91; and Rev. Rul. 89-62, 1989-1 C.B. 78.

¹¹⁹ See, ABC Rentals of San Antonio v. Comm., No. 95-9008 (10th Cir. 9/27/96), where the Tenth Circuit decision reversed the holding of ABC Rentals of San Antonio v. Comm., 68 TCM 1362 (1994) and held that consumer durable property subject to short-term, "rent-to-own" leases were eligible for the income forecast method. For decisions supporting the Tax Court memorandum decision denying eligibility for certain tangible personal property, see El Charro TV Rental v. Comm., No. 95-60301 (5th Cir., 1995) (rent-to-own property not eligible) and Carland, Inc. v. Comm., 90 T.C. 505 (1988), aff'd on this issue, 909 F.2d 1101 (8th Cir., 1990) (railroad rolling stock subject to a lease not eligible).

¹²⁰ I.e., the sale of the property must be intended to be for resale or leasing by the dealer.

¹²¹ The indexed amount is projected to be $700 for 1998.

¹²² Projected to be $700 for 1998.

¹²³ Projected to be $700 for 1998.

¹²⁴ Projected to be $700 for 1998.

¹²⁵ The overpayment rate equals the applicable Federal short-term rate plus two percentage points. This rate is adjusted quarterly by the IRS. Thus, in applying the look-back method for a contract year, a taxpayer may be required to use five different interest rates.

¹²⁶ Treas. reg. sec. 1.471-2(d).

¹²⁷ 101 T.C. 462 (1993).

¹²⁸ T.C. Memo (filed June 11, 1997).

¹²⁹ Wal-Mart v. Commissioner, T.C. Memo 1997-1 and Kroger v. Commissioner, T.C. Memo 1997-2.

¹³⁰ The Tax Reform Act of 1986 modified the Accelerated Cost Recovery System ("ACRS") to institute MACRS. Prior to the adoption of ACRS by the Economic Recovery Act of 1981, taxpayers were allowed to depreciate the various components of a building as separate assets with separate useful lives. The use of component depreciation was repealed upon the adoption of ACRS. The denial of component depreciation also applies under MACRS, as provided by the Tax Reform Act of 1986.

¹³¹ Former Code sections 168(f)(6) and 178 provided that in certain circumstances, a lessee could recover the cost of leasehold improvements made over the remaining term of the lease. These provisions were repealed by the Tax Reform Act of 1986.

¹³² John B. White, Inc. v. Comm., 55 T.C. 729 (1971), aff'd per curiam 458 F. 2d 989 (3d Cir.), cert. denied, 409 U.S. 876 (1972).

¹³³ An individual who actively participates in a rental real estate activity and holds at least a 10-percent interest may deduct up to $25,000 of passive losses. The $25,000 amount phases out as the individual's income increases from $100,000 to $150,000.

¹³⁴ In determining the amounts required to be separately taken into account by a partner, those provisions of the large partnership rules governing computations of taxable income are applied separately with respect to that partner by taking into account that partner's distributive share of the partnership's items of income, gain, loss, deduction or credit. This rule permits partnerships to make otherwise valid special allocations of partnership items to partners.

¹³⁵ An electing large partnership is allowed a deduction under section 212 for expenses incurred for the production of income, subject to 70-percent disallowance. No income from an electing large partnership is treated as fishing or farming income.

¹³⁶ The term "net capital gain" has the same meaning as in section 1222(11). The term "net capital loss" means the excess of the losses from sales or exchanges of capital assets over the gains from sales or exchanges of capital assets. Thus, the partnership cannot offset any portion of capital losses against ordinary income.

¹³⁷ The 70 percent figure is intended to approximate the amount of such deductions that would be denied at the partner level as a result of the two-percent floor.

¹³⁸ It is understood that the rehabilitation and low-income housing credits which are subject to the same passive loss rules (i.e., in the case of the low-income housing credit, where the partnership interest was acquired or the property was placed in service before 1990) could be reported together on the same line.

¹³⁹ Tax Equity and Fiscal Responsibility Act of 1982.

¹⁴⁰ IRS Declaration of Privacy Principles, May 9, 1994.

¹⁴¹

U.S.

v. Czubinski, DTR 2/25/97, p. K-2.

¹⁴² P.L. 104-294, sec. 201 (October 11, 1996).

¹⁴³ Pursuant to 18 U.S.C. sec. 3571 (added by the Sentencing Reform Act of 1984), the amount of the fine is not more than the greater of the amount specified in this new Code section or $100,000.

¹⁴⁴ Application of the separate share rule is not elective; it is mandatory if there are separate shares in the trust.

¹⁴⁵ Note that in some civil law States (e.g., Louisiana) an entity similar to a trust, called a usufruct, exists.

¹⁴⁶ See Announcement 96-13 and Announcement 97-52.

¹⁴⁷ Generally, the amount of the first quarter payment must be at least 25 percent of the lesser of (1) the preceding year's tax liability, as shown on the foundation's Form 990-PF, or (2) 95 percent of the foundation's current-year tax liability.

¹⁴⁸ Notice 96-65, I.R.B. 1996-52. See Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 104th Congress (JCS-12-96), December 12, 1996, pp. 277-278.

¹⁴⁹ For this purpose, a "qualified liquidation" has the same meaning as it does purposes of the exemption from the tax on prohibited transactions of a real estate mortgage investment conduit ("REMIC') in section 860F(a)(4).

¹⁵⁰ See Ways and Means Committee Report 104-506 accompanying H.R. 2377, p. 59.

¹⁵¹ A separate provision in the bill makes a technical correction to section 4962(b) to permit the abatement of first-tier penalty excise taxes imposed under section 4958.