Revenue Reconciliation Act
page5
 
4.
Establish IRS continuous levy and improve debt
collection (secs. 834, 835, and 836 of the bill and
secs. 6331 and 6334 of the Code)
a.
Continuous levy
Present
Law
If any person is liable for any internal revenue tax
and does not pay it within 10 days after notice and
demand89
by the IRS, the IRS may then collect the tax by levy
upon all property and rights to property belonging
to the person,90
unless there is an explicit statutory restriction on
doing so. A levy is the seizure of the person's
property or rights to property. Property that is not
cash is sold pursuant to statutory requirements.91
In general, a levy does not apply to property
acquired after the date of the levy,92
regardless of whether the property is held by the
taxpayer or by a third party (such as a bank) on
behalf of a taxpayer. Successive seizures may be
necessary if the initial seizure is insufficient to
satisfy the liability.93
The only exception to this rule is for salary and
wages.94
A levy on salary and wages is continuous from the
date it is first made until the date it is fully
paid or becomes unenforceable.
A minimum exemption is provided for salary and
wages.95
It is computed on a weekly basis by adding the value
of the standard deduction plus the aggregate value
of personal exemptions to which the taxpayer is
entitled, divided by 52.96
For a family of four for taxable year 1996, the
weekly minimum exemption is $325.97
Reasons
for Change
The extension of the continuous levy provisions will
substantially ease the administrative burdens of
collecting taxes by levy. The Committee anticipates
that taxpayers who already comply with the tax laws
will have a positive view of increased collections
of taxes owed by taxpayers who have not complied
with the tax laws.
Explanation
of Provision
The provision amends the Code to provide that a
continuous levy is also applicable to non-means
tested recurring Federal payments. This is defined
as a Federal payment for which eligibility is not
based on the income and/or assets of a payee. For
example, Social Security payments, which are subject
to levy under present law, would become subject to
continuous levy.
In addition, the provision provides that this levy
would attach up to 15 percent of any specified
payment due the taxpayer. This rule explicitly
replaces the other specifically enumerated
exemptions from levy in the Code. A continuous levy
of up to 15 percent would also apply to unemployment
benefits and means-tested public assistance.
The bill also permits the disclosure of otherwise
confidential tax return information to the Treasury
Department's Financial Management Service only for
the purpose of, and to the extent necessary in,
implementing these levy provisions.
Effective
Date
The provision is effective for levies issued after
the date of enactment.
b.
Modifications of levy exemptions
Present
Law
The Code exempts from levy workmen's compensation
payments,98
unemployment benefits99
and means-tested public assistance.100
Reasons
for Change
The Committee believes that if wages are subject to
levy, wage replacement payments should also be
subject to levy.
Explanation
of Provision
The provision provides that the following property
is not exempt from continuous levy if the Secretary
of the Treasury (or his delegate) approves the levy
of such property:
(1) workmen's compensation payments,
(2) unemployment benefits, and
(3) means-tested public assistance.
Effective
Date
The provision applies to levies issued after the
date of enactment.
E.
Excise Tax Provisions
1.
Extension and modification of Airport and Airway
Trust Fund excise taxes (sec. 841 of the bill and
secs. 4081, 4091, and 4261 of the Code)
Present
Law
Present law imposes a variety of excise taxes on air
transportation to finance the Airport and Airway
Trust Fund programs administered by the Federal
Aviation Administration (the "FAA"). In
general, the full cost of FAA capital programs is
financed from the Airport and Airway Trust Fund,
while only a portion of FAA operational expenses is
Trust Fund-financed. Overall, the portion of total
FAA expenditures that has been financed from the
Trust Fund has declined from 75 percent through the
early 1990s to 62 percent for the 1997 fiscal year.
The balance is financed by general taxpayers, rather
than directly by program users. Each of the Airport
and Airway Trust Fund excise taxes is scheduled to
expire after September 30, 1997.
Commercial
air passenger transportation taxes
Domestic air passenger transportation is subject to
an ad valorem excise tax equal to 10 percent
of the amount paid for the transportation. Taxable
domestic air transportation includes both travel
within the
United States
and certain travel between the
United States
and points in
Canada
or
Mexico
that are within 225 miles of the
U.S.
border (the "225-mile zone").
Special rules apply to air transportation between
the continental
United States
and
Alaska
or
Hawaii
and between
Alaska
and
Hawaii
. The portion of such transportation which is not
within the United States (e.g., the portion over the
Pacific Ocean between the continental West Coast and
Hawaii) is not subject to the 10-percent air
passenger excise tax.101
The 10-percent excise tax applies in full, however,
to air transportation within the States of Alaska
and
Hawaii
.
The 10-percent air passenger transportation excise
tax also does not apply to domestic
U.S.
segments of uninterrupted international air
transportation. Uninterrupted international air
transportation includes only travel (entirely by
air) that does not both begin and end in the
United States
(or in the 225-mile zone) and during which there is
no more than a 12-hour scheduled period between
arrival and departure at any intermediate point in
the
United States
. For example, assume that a passenger travels from
New York
to
Tokyo
, with a four-hour stop and aircraft change in
Seattle
. The domestic segment of the flight (i.e.,
New York
to
Seattle
) is not subject to the domestic air passenger
transportation excise tax because that segment is a
part of uninterrupted international air
transportation.
International air passenger transportation is
subject to a $6 departure excise tax imposed on
passengers departing the
United States
for other countries. No tax is imposed on passengers
arriving in the
United States
from other countries. As with passengers departing
the
United States
, separate domestic flights of arriving passengers
that connect from international flights are exempt
from tax, provided that stopover time at any point
within the
United States
does not exceed 12 hours.
Because both the domestic and international air
passenger excise taxes are imposed only on
transportation for which an amount is paid, no tax
is imposed on "free" travel (e.g.,
frequent flyer travel and airline industry employee
travel for which the passenger is not directly
charged).
The air passenger transportation excise taxes are
imposed on passengers; transportation providers
(generally airlines) are responsible for collecting
and remitting the taxes to the Federal Government.
In general, both the domestic and international air
passenger transportation excise taxes are imposed
without regard to whether the transportation is
purchased within the
United States
. An exception provides that travel between the
United States
and the 225-mile zone is subject to the ad
valorem domestic tax only if it is purchased
within the
United States
.
The amount of air passenger transportation excise
tax collected from a passenger must be stated
separately on the ticket.
Commercial
air cargo transportation
Domestic air cargo transportation is subject to a
6.25-percent ad valorem excise tax. This tax,
like the air passenger excise taxes, is imposed on
the consumer, with the transportation provider being
required to collect and remit the tax to the Federal
Government. However, there is no requirement that
the tax be stated separately on shipping invoices.
Noncommercial
aviation
Noncommercial aviation, or transportation on private
aircraft which is not "for hire," is
subject to excise taxes imposed on fuel in lieu of
the commercial air passenger ticket and air cargo
excise taxes. The current Airport and Airway Trust
Fund tax rates on these fuels are 15 cents per
gallon on aviation gasoline and 17.5 cents per
gallon on jet fuel.
The aviation gasoline excise tax is imposed on
removal of the fuel from a registered terminal
facility (the same point as the highway gasoline
excise tax). The jet fuel excise tax is imposed on
sale of the fuel by a wholesale distributor. Many
larger airports have dedicated pipeline facilities
that directly service aircraft; in such a case, the
tax effectively is imposed at the retail level. The
person removing the gasoline from a terminal
facility or the wholesale distributor of the jet
fuel is liable for these taxes.
Deposit
of air transportation excise taxes
Under present law, the air passenger ticket and
freight excise taxes are collected from passengers
and freight shippers by the commercial air carriers.
The air carriers then remit the funds to the
Treasury Department; however, the air carriers are
not required to remit monies immediately. Excise tax
returns are filed quarterly (similar to annual
income tax returns), with taxes being deposited on a
semi-monthly basis (similar to estimated income
taxes). For air transportation sold during a
semi-monthly period, air carriers may elect to treat
the taxes as collected on the last day of the first
week of the second following semi-monthly period.
Under these "deemed collected" rules, for
example, the taxes on air transportation sold
between August 1 and August 15, are treated as
collected by the air carriers on or before September
7, with the amounts generally being deposited with
the Treasury Department by September 10. A special
rule requires certain amounts deemed collected
during the second half of September to be deposited
by September 29.
Semi-monthly deposits and quarterly excise tax
returns also are required with respect to the fuels
excise taxes imposed on air transportation.
Overflight
user fees
Non-tax user fees are imposed on air transportation
(both commercial and noncommercial aviation) that
travels through airspace for which the
United States
provides air traffic control services, but that
neither lands in nor takes off from a point in the
United States
. These fees are imposed and collected by the FAA
with respect to mileage actually flown, and apply
both to travel within U.S. territorial airspace and
to travel within international oceanic airspace for
which the United States is responsible for providing
air traffic control services.
Reasons
for Change
The Committee determined that provisions to ensure a
long-term, stable funding source for the Airport and
Airway Trust Fund should be enacted at this time. As
illustrated by the recent events when a shortfall in
fiscal year 1997 FAA funding was narrowly averted by
an emergency extension of the present-law excise
taxes through September 30, 1997, longer-term
assurance of these funding needs is imperative.
Therefore, the bill extends (with certain
modifications) the current Airport and Airway Trust
Fund excise taxes for a 10-year period, a move that
it is believed will resolve, for this 10-year
period, concerns about the availability of adequate
user tax revenues to fund the portion of FAA
programs to be appropriated from the Airport and
Airway Trust Fund.
The Committee determined that limited modifications
to the current passenger excise tax structure are
warranted to improve the perceived fairness of these
taxes. First, the Committee was very concerned that,
under present law, passengers traveling in
international transportation pay significantly less
tax for transportation involving comparable FAA
services than do entirely domestic passengers. The
Committee believes it unfair for American families
traveling domestically on, e.g., family vacations,
to be required to subsidize persons engaged in this
international travel. In particular, the Committee
is extremely concerned that domestic passengers
flying on entirely domestic flights currently are
exempt from tax if they connect to or from another,
international flight while passengers on the same
flight who do not go on to or arrive from an
international destination are fully taxed.
Similarly, the Committee believes it is
inappropriate that passengers arriving in the
United States
should not pay any tax for the FAA services they
receive. To achieve greater equity in the air
transportation user taxes, the bill extends the tax
to internationally arriving passengers, reclassifies
domestic segments of international travel as
domestic transportation, and clarifies that the tax
applies to payments to airlines (and related
parties) from credit card and other companies in
exchange for the right to award frequent flyer miles
or other reduced air travel rights.
The Committee further believes that continued
availability of air transportation services to rural
areas is an important national objective.
Accordingly, the bill provides a special, reduced
tax rate for flight segments to and from smaller
rural airports.
Explanation
of Provisions
Extension
of Airport and Airway Trust Fund taxes
The Airport and Airway Trust Fund excise taxes, as
modified below, are extended for 10 years, for the
period October 1, 1997, through September 30, 2007.
The taxes that are extended include the domestic and
international air passenger excise taxes, the air
cargo excise tax, and the noncommercial aviation
fuels taxes. Gross receipts from these taxes will
continue to be deposited in the Airport and Airway
Trust Fund.
Modification
of commercial air passenger transportation taxes
Tax on international arrivals and departures;
treatment of domestic flight segments associated
with international travel. --The current $6
international departure tax is increased to $8 per
departure, and an identical $8 per passenger tax is
imposed on arrivals in the
United States
from international locations. The definition of
international transportation is modified to
eliminate domestic flight segments associated with
that travel (which are taxed the same as other
domestic transportation under the bill). Thus, the
$8 per passenger tax applies to all uninterrupted
flight segments between a point in the
United States
and a point in a foreign country.
Under the bill, domestic flight segments associated
with international transportation are taxed the same
as other domestic flights. Domestic flight segments
are flight segments between two
U.S.
points (or between a
U.S.
point and a point within the 225-mile zone) from
which the passenger continues to or from an
international flight. The 10-percent domestic tax
rate applies to all such flight segments. The
portion of a passenger's fare that is subject to
this tax is equal to the percentage of total travel
miles covered by the fare (determined based on the
aggregate number of miles in all of the flight
segments) that the domestic flight segment miles
comprise. For this purpose, flight miles are
"Great Circle" miles unless the Treasury
Department develops another measure (such as
predominate routed mileage). Great Circle miles are
based on the shortest distance (i.e., "as the
crow flies") between two points. In general,
this mileage calculation is identical to that which
is used by frequent flyer programs offered by all
major
U.S.
airlines today. Computer programs are readily
available for calculating "Great Circle"
miles between origin and destination points for
flights.
These provisions are illustrated by the following
example. Assume that a passenger travels from
Paris
to
Los Angeles
with a intermediate stop and aircraft change in
New York
. The passenger is subject to an $8 tax on the
flight segment from
Paris
to
New York
. Assume further that 50 percent of the aggregate
miles on the
London
to
Los Angeles
trip are attributable to travel between
New York
and
Los Angeles
. In this case, 50 percent of the fare is subject to
the 10-percent ad valorem tax for the flight
segment between
New York
and
Los Angeles
. The combined tax amount (international and
domestic rate portions) are calculated by the
airline and stated on the passenger's ticket.
Special rules applicable to certain
transportation. --Transportation between the 48
contiguous States and
Alaska
or
Hawaii
(or between those States) remains subject to the
special rules provided in present law. Thus, this
transportation is taxed on apportioned mileage in
U.S. territorial airspace plus $6 per passenger per
one-way flight.102
Clarification is provided that only one $6 per
passenger tax is imposed on a single flight segment
(despite the fact that such a flight segment
technically constitutes both an international
departure and an international arrival).
Additionally, the current special provisions
governing transportation between the United States
and points within the 225-mile zone of Canada or
Mexico are retained, with that transportation being
taxed on the same basis as other domestic
transportation in the circumstances provided under
present law (as modified by the provisions of the
bill recharacterizing certain domestic flight
segments associated with international
transportation).
A further special rule is provided for certain
flight segments to or from qualified rural airports.
A qualified rural airport is an airport that (1) in
the second preceding calendar year had fewer than
100,000 commercial passenger enplanements (i.e.,
departures), and (2) either (a) is not located
within 75 miles of another airport that had more
than 100,000 such passenger enplanements in that
year, or (b) is eligible for payments under the
Federal "essential air services" program
(as in effect on the date of enactment). Flight
segments to or from a qualified rural airport are
subject to a reduced, 7.5-percent ad valorem
rate (in lieu of the general 10-percent rate).103
The term flight segment is defined as transportation
involving a single take-off and a single landing. In
the case of transportation involving multiple flight
segments, the portion of the fare allocable to the
rural segment is determined based on the number of
Great Circle miles in the rural flight segment as
compared to the aggregate number of miles in all of
the flight segments. This is the same calculation
that is used in apportioning international
transportation between taxable international travel
and associated domestic flight segments.
Extension of tax to certain currently exempt
passengers. --As described above, passengers
arriving in the
United States
from other countries, who currently are the only
group of travelers whose transportation is subject
neither to an excise tax nor a user fee for
U.S.-provided aviation services, are subject to tax
on their arriving international flights. Similarly,
passengers traveling on domestic flight segments
that either connect to or from international flight
segments are subject to tax in the same manner as
other, entirely domestic passengers.
Clarification further is provided that any amounts
paid to air carriers (in cash or in kind) for the
right to award or otherwise distribute free or
reduced-rate air transportation are treated as
amounts paid for taxable air transportation, subject
to the 10-percent ad valorem tax rate.
Examples of such taxable amounts include (1)
payments for frequent flyer miles purchased by
credit card companies, telephone companies, rental
car companies, television networks, restaurants and
hotels, and other businesses for distribution to
their customers and others (e.g., employees) and (2)
amounts received by airlines pursuant to joint
venture credit card or other marketing arrangements.
The Treasury Department is authorized specifically
to disregard accounting allocations or other
arrangements which have the effect of reducing
artificially the base to which the 10-percent tax is
applied. (No inference is intended from this
provision as to the proper treatment of these
payments under present law.)
Liability for tax. --The present-law
provision imposing liability for the tax on
passengers (with transportation providers being
liable for collecting and remitting revenues to the
Federal Government) are modified to impose secondary
liability on air carriers. As with the current tax,
the aggregate tax will continue to be required to be
stated separately on passenger tickets.
Modification of air passenger excise tax deposit
rules. --The deposit rules with respect to the
commercial air passenger excise taxes are modified
to permit payment of these taxes that otherwise
would have been required to be deposited during the
period August 15, 1997 through September 30, 1997,
to be deposited on October 10, 1997. Similarly, tax
deposits that would be due during the period July 1,
2001, through September 30, 2001, are required to be
made no later than October 10, 2001.
Effective
Date
These provisions generally are effective on the date
of enactment, for air transportation beginning after
September 30, 1997.
Present law requires transportation providers to
continue collecting the commercial aviation excise
taxes (at the current rates) on transportation to be
provided after September 30, 1997, if the
transportation is purchased before October 1, 1997.
The bill requires transportation providers to
collect the taxes at the modified rates for
transportation purchased after the date of enactment
for travel beginning after September 30, 1997.
The extension of the general aviation fuels excise
taxes is effective for fuels removed or sold after
September 30, 1997.
The provision clarifying application of the
commercial air passenger excise tax to certain
amounts paid for the right to award air
transportation is effective for amounts paid (or
benefits transferred) after September 30, 1997. A
special rule provides that payments (or transfers)
between related parties occurring after June 16,
1997 and before October 1, 1997, are subject to tax
if the payments relate to rights to transportation
to be awarded or otherwise distributed after
September 30, 1997.
The modifications to the commercial air passenger
excise tax deposit rules are effective on the date
of enactment.
2.
Reinstate Leaking Underground Storage Tank Trust
Fund excise tax (sec. 842 of the bill and secs.
4041(d), 4081(a)(2), and 4081(d)(2) of the Code)
Present
Law
Before January 1, 1996, an excise tax of 0.1 cent
per gallon was imposed on gasoline, diesel fuel
(including train diesel fuel), special motor fuels
(other than liquefied petroleum gas), aviation
fuels, and inland waterways fuels. Revenues from the
tax were dedicated to the Leaking Underground
Storage Tank Trust Fund to finance cleanups of
leaking underground storage tanks.
Reasons
for Change
The Committee determined that the Leaking
Underground Storage Tank Trust Fund excise tax
should be reinstated to ensure the availability of
funds to pay cleanup costs of leaking underground
storage tanks.
Explanation
of Provision
The bill reinstates the prior-law Leaking
Underground Storage Tank Trust Fund excise tax
through September 30, 2007.
Effective
Date
The provision is effective on October 1, 1997.
3.
Application of communications tax to long-distance
prepaid telephone cards (sec. 843 of the bill and
sec. 4251 of the Code)
Present
Law
A 3-percent excise tax is imposed on amounts paid
for local and toll (long-distance) telephone service
and teletypewriter exchange service. The tax is
collected by the provider of the service from the
consumer (business and residential custormers).
Reasons
for Change
The Committee understands that communication service
providers sometimes sell units of long-distance
service to third parties who, in turn, resell or
distribute these units of long-distance telephone
service to the ultimate customer in the form of
prepaid telephone cards or similar arrangements. The
Committee believes that such payments clearly
represent payments for long-distance telephone
service and clarifies that such payments are subject
to the communications excise tax.
Explanation
of Provision
The bill provides that any amounts paid to telephone
carriers (in cash or in kind) for the right to award
or otherwise distribute long-distance telephone
service, including free or reduced-rate service, are
treated as amounts paid for taxable communication
services, subject to the 3-percent ad valorem
tax rate. Examples of such taxable amounts include
(1) prepaid telephone cards offered through service
stations, convenience stores and other businesses to
their customers and others (e.g., employees) and (2)
amounts received by telephone carriers pursuant to
joint venture credit card or other marketing
arrangements.
For example, company A, which is a telephone carrier
that owns telephone transmission and switching
equipment and generally offers telephone service to
the public, may sell a block of long-distance
message units to company B for X dollars. Company B
owns no transmission or switching equipment, but
rather acts a reseller of long distance telephone
services and also is a telephone carrier. Company B,
in turn, resells all or part of the long-distance
message units purchased from Company A to Company C
for Y dollars. Company C operates a chain of
convenience stores. Company C resells some of the
long-distance message units in the form of prepaid
telephone cards to its convenience store customers
and also makes some of the message units available
to its employees as a benefit by the free
distribution of such prepaid telephone cards to the
employees. The amount Y will be considered an amount
paid for telecommunications services subject to the
3-percent telephone excise tax. Alternatively, if
company C had purchased the block of message units
directly from company A for X dollars, the amount X
will be considered an amount paid for
telecommunications services subject to the 3-percent
telephone excise tax.
In the case of amounts received by
telecommunications carriers pursuant to joint
venture credit card or other marketing arrangements,
the Treasury Department is authorized specifically
to disregard accounting allocations or other
arrangements which have the effect of reducing
artificially the base to which the 3-percent tax is
applied.
No inference is intended from this provision as to
the proper treatment of these payments under present
law.
Effective
Date
The provision is effective for amounts paid on or
after the date of enactment.
4.
Uniform rate of excise tax on vaccines (sec. 844 of
the bill and secs. 4131 and 4132 of the Code)
Present
Law
Under section 4131, a manufacturer's excise tax is
imposed on the following vaccines routinely
recommended for administration to children: DPT
(diphtheria, pertussis, tetanus,), $4.56 per dose;
DT (diphtheria, tetanus), $0.06 per dose; MMR
(measles, mumps, or rubella), $4.44 per dose; and
polio, $0.29 per dose. In general, if any vaccine is
administered by combining more than one of the
listed taxable vaccines, the amount of tax imposed
is the sum of the amounts of tax imposed for each
taxable vaccine. However, in the case of MMR and its
components, any component vaccine of MMR is taxed at
the same rate as the MMR-combined vaccine.
Amounts equal to net revenues from this excise tax
are deposited in the Vaccine Injury Compensation
Trust Fund to finance compensation awards under the
Federal Vaccine Injury Compensation Program for
individuals who suffer certain injuries following
administration of the taxable vaccines. This program
provides a substitute Federal, "no fault"
insurance system for the State-law tort and private
liability insurance systems otherwise applicable to
vaccine manufacturers. All persons immunized after
September 30, 1998, with covered vaccines must
pursue compensation under this Federal program
before bringing civil tort actions under State law.
Reasons
for Change
The Committee understands that the present-law tax
rates applicable to taxable vaccines were chosen to
reflect estimated probabilities of adverse reactions
and the severity of the injury that might result
from such reactions. The Committee understands that
medical researchers believe that there is
insufficient data to support fine gradations of
estimates of potential harm from the various
different childhood vaccines. In the light of this
scientific assessment, the Committee believes some
simplicity can be achieved by taxing such vaccines
at the same rate per dose.
The Committee further believes it is appropriate to
review the list of taxable vaccines from time to
time as medical science advances. The Center for
Disease Control has recommended that the vaccines
for HIB (haemophilus influenza type B), Hepatitis B,
and varicella (chicken pox) be widely administered
among the nation's children. In light of the growing
number of immunizations using these vaccines, the
Committee adds these vaccines to the list of taxable
vaccines.
Explanation
of Provision
The bill replaces the present-law excise tax rates,
that differ by vaccine, with a single rate tax of
$0.84 per dose on any listed vaccine component.
Thus, the bill provides that the tax applied to any
vaccine that is a combination of vaccine components
is 84 cents times the number of components in the
combined vaccine. For example, the MMR vaccine is to
be taxed at a rate of $2.52 per dose and the DT
vaccine is to be taxed at rate of $1.68 per dose.
In addition, the provision adds three new taxable
vaccines to the present-law taxable vaccines: (1)
HIB (haemophilus influenza type B); (2) Hepatitis B;
and (3) varicella (chicken pox). The three newly
listed vaccines also are subject to the 84-cents per
dose excise tax.
Lastly, the Committee directs the Secretary of the
Treasury to undertake a study of the efficacy of the
new flat-rate vaccine tax system as a means to
finance the Vaccine Injury Compensation Trust Fund.
Among other issues that the Secretary might find
pertinent, the Committee directs the Secretary to
explore the following questions. For each taxable
vaccine, how does the magnitude of the tax compare
to the total price of the vaccine that is charged to
the patient (or the patient's insurance company)?
Have any changes in the prices of taxable vaccines
that might have resulted from the changes in tax
enacted by this bill altered the use of taxable
vaccines (i.e., what is the price elasticity of
demand for the various taxable vaccines)? Does
scientific evidence exist to permit a vaccine tax
structure that reflects possibly different medical
risks from the different vaccines? Does the
flat-rate structure generate savings in compliance
costs for taxpayers and administrative cost savings
for the Internal Revenue Service? The Committee
welcomes recommendations regarding possible changes
in this tax structure. However, the Committee
reminds the Secretary that determination of the tax
base and the tax rate are the constitutional
prerogative of the Congress and that recommendations
for delegation of such authority to the executive
branch are inappropriate. The results of the study
are to be reported to the Senate Committee on
Finance and the House Committee on Ways and Means by
September 30, 1999.
Effective
Date
The provision is effective for vaccine purchases
after September 30, 1997. No floor stocks tax is to
be collected or refunds permitted for amounts held
for sale on October 1, 1997. Returns to the
manufacturer occurring on or after October 1, 1997,
are assumed to be returns of vaccines to which the
new rates of tax apply.
5.
Modify treatment of tires under the heavy highway
vehicle retail excise tax (sec. 845 of the bill and
sec. 4071 of the Code)
Present
Law
A 12-percent retail excise tax is imposed on certain
heavy highway trucks and trailers, and on highway
tractors. A separate manufacturers' excise tax is
imposed on tires weighing more than 40 pounds. This
tire tax is imposed as a fixed dollar amount which
varies based on the weight of the tire. Because
tires are taxed separately, the value of tires
installed on a highway vehicle is excluded from the
12-percent excise tax on heavy highway vehicles. The
determination of value is factual and has given rise
to numerous tax audit challenges.
Reasons
for Change
Allowing a credit for the tire tax actually paid on
truck tires will simplify the application of the
retail truck tax.
Explanation
of Provision
The current exclusion of the value of tires
installed on a taxable highway vehicle is repealed.
Instead, a credit for the amount of manufacturers'
excise tax actually paid on the tires is allowed.
Effective
Date
The provision is effective after December 31, 1997.
6.
Increase tobacco excise taxes (sec. 846 of the bill
and sec. 5701 of the Code)
Present
Law
The following is a listing of the Federal excise
taxes imposed on tobacco products under present law:
Article Tax imposed
Cigars:
Small cigars $1.125 per thousand.
12.75% of manufacturer's price, up to $30
Large cigars per
thousand.
Cigarettes:
$12.00 per thousand (24 cents per pack of
Small cigarettes 20
cigarettes).
Large cigarettes $25.20 per thousand.
Cigarette papers $0.0075 per 50 papers.
Cigarette tubes $0.15 per 50 tubes.
Chewing tobacco $0.12 per
pound.
Snuff $0.36 per pound.
Pipe tobacco $0.675 per pound.
Reasons
for Change
The Committee believes it is appropriate to increase
taxes on tobacco products. Raising such taxes will
have the positive effect of discouraging smoking,
particularly smoking by children and teenagers,
thereby helping millions of Americans avoid the
health hazards that accompany long-term tobacco use.
Explanation
of Provision
In
general
The bill increases the current excise tax rates on
all tobacco products, including cigarettes, cigars,
chewing tobacco, snuff, and pipe tobacco, effective
October 1, 1997. Floor stocks taxes are imposed on
tobacco products at the time of the rate increase
(including tobacco products in foreign trade zones).
Specific
tax rate increases
The following table shows the specific tobacco
excise tax rates under the bill as of October 1,
1997:
Article Tax rate (October 1, 1997)
Cigars:
Small cigars $2.063 per thousand.
23.375% of manufacturer's price, up to
Large cigars $55 per
thousand.
Cigarettes:
$22.00 per thousand (44 cents per pack of
Small cigarettes 20
cigarettes).
Large cigarettes $46.20 per thousand.
Cigarette papers $0.0138 per 50 papers.
Cigarette tubes $0.0275 per 50 tubes.
Chewing tobacco $0.22 per pound.
Snuff $0.66 per pound.
Pipe tobacco $1.2375 per pound.
Roll-your-own tobacco $0.66 per pound.
The bill also includes expanded compliance measures
designed to prevent diversion of non-tax-paid
tobacco products nominally destined for export for
use within the
United States
.
Effective
Date
The provision is effective on October 1, 1997.
F.
Provisions Relating to Tax-Exempt Entities
1.
Extend UBIT rules to second-tier subsidiaries and
amend control test (sec. 851 of the bill and sec.
512(b)(13) of the Code)
Present
Law
In general, interest, rents, royalties and annuities
received by tax-exempt organizations are not subject
to the unrelated business income tax (UBIT).
However, section 512(b)(13) treats otherwise
excluded rent, royalty, annuity, and interest income
as potentially subject to UBIT if such income is
received from a taxable or tax-exempt subsidiary
that is 80 percent controlled by the parent
tax-exempt organization.104
Rent, royalty, annuity, and interest payments
received from a controlled subsidiary are treated as
unrelated business income (UBTI) in the hands of the
parent organization based on the percentage of the
subsidiary's income that is unrelated business
taxable income (either in the hands of the
subsidiary if the subsidiary is tax-exempt, or in
the hands of the parent organization if the
subsidiary is taxable).
In the case of a stock subsidiary, the 80 percent
control test under section 512(b)(13) is met if the
parent organization owns 80 percent or more of the
voting stock and all other classes of stock of the
subsidiary.105
In the case of a non-stock subsidiary, the
applicable Treasury regulations look to factors such
as the representation of the parent corporation on
the board of directors of the nonstock subsidiary,
or the power of the parent corporation to appoint or
remove the board of directors of the subsidiary.106
The control test under section 512(b)(13) does not,
however, incorporate any indirect ownership rules.107
Consequently, rents, royalties, annuities and
interest derived from second-tier subsidiaries
generally do not constitute UBTI to the tax-exempt
parent organization.108
Reasons
for Change
Section 512(b)(13) was enacted to prevent
subsidiaries of tax-exempt organizations from
reducing their otherwise taxable income by
borrowing, leasing, or licensing assets from a
tax-exempt parent organization at inflated levels.
Because section 512(b)(13) was narrowly drafted,
organizations were able to circumvent its
application through, for example, the issuance of 21
percent of nonvoting stock with nominal value to a
separate friendly party or through the use of tiered
or brother/sister subsidiaries. The Committee
believes that the modifications to the control
requirement and inclusion of attribution rules will
ensure that section 512(b)(13) operate consistent
with its intended purpose.
Explanation
of Provision
The bill modifies the test for determining control
for purposes of section 512(b)(13). Under the bill,
"control" means (in the case of a stock
corporation) 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, the bill 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 bill also makes technical modifications to the
method provided in section 512(b)(13) for
determining how much of an interest, rent, annuity,
or royalty payment made by a controlled entity to a
tax-exempt organization is includible in the latter
organization's UBTI. Such payments are subject to
UBIT to the extent the payment reduces the net
unrelated income (or increases any net unrelated
loss) of the controlled entity.
Effective
Date
The modification of the control test to one based on
vote or value, the application of the constructive
ownership rules of section 318, and the technical
modifications to the flow-through method apply to
taxable years beginning after the date of enactment.
The reduction of the ownership threshold for
purposes of the control test from 80 percent to more
than 50 percent applies to taxable years beginning
after December 31, 1998.
2.
Limitation on increase in basis of property
resulting from sale by tax-exempt entity to related
person (sec. 852 of the bill and sec. 1061 of the
Code)
Present
law
If a tax-exempt entity transfers assets to a
controlled taxable entity in a transaction that is
treated as a sale, the transferee taxable entity
obtains a fair market value basis in the assets.
Because the transferor is tax-exempt, no gain is
recognized on the transfer except to the extent of
certain unrelated business taxable income, if any.
Other provisions of the Code deny certain tax
benefits when a transferor and transferee are
related parties. For example, losses on sales
between related parties are not recognized (sec.
267). As another example, ordinary income treatment,
rather than capital gain treatment, is required on a
sale of depreciable property between related
parties.(sec.1239).
Reasons
for Change
The Committee recognizes that a tax-exempt entity
can sell assets to a taxable party without
recognition of gain, while that party receives a
fair market value basis in the property. However,
the Committee is concerned that tax-exempt entities
may in effect structure transactions in which assets
are transferred to taxable entities controlled by
the tax-exempt entity, in a form such that a
stepped-up basis and depreciation are available to
reduce the amount that would otherwise have been
taxable unrelated business income, if the tax-exempt
entity had converted the same assets to taxable
operation and operated the business itself.
Explanation
of Provision
In the case of a sale or exchange of property
directly or indirectly between a tax-exempt entity
and a related person, the basis of the related
person in the property will not exceed the adjusted
basis of such property immediately before the sale
in the hands of the tax-exempt entity, increased by
the amount of any gain recognized to the tax-exempt
entity under the unrelated business taxable income
rules of section 511.
A tax-exempt entity for this purpose is defined as
in section 168(h)(2)(A), without regard to section
(iii) of that section.
A related person means any person having a
relationship to the tax-exempt entity described in
section 267(b) or 707(b)(1) (generally, certain
more-than-50-percent relationships, with specified
attribution rules). For purposes of applying section
267(b)(2), such an entity is treated as if it were
an individual.
Effective
Date
The provision applies to sales or exchanges after
June 8, 1997; except that it will not apply to a
sale or exchange made pursuant to a written
agreement which was binding on such date and at all
times thereafter.
3.
Repeal grandfather rule with respect to pension
business of insurer (sec. 853 of the bill and sec.
1012(c) of the Tax Reform Act of 1986)
Present
Law
Present law provides that an organization described
in sections 501(c)(3) or (4) of the Code is exempt
from tax only if no substantial part of its
activities consists of providing commercial-type
insurance. When this rule was enacted in 1986,
certain treatment (described below) applied to Blue
Cross and Blue Shield organizations providing health
insurance that (1) were in existence on August 16,
1986; (2) were determined at any time to be
tax-exempt under a determination that had not been
revoked; and (3) were tax-exempt for the last
taxable year beginning before January 1, 1987 (when
the present-law rule became effective), provided
that no material change occurred in the structure or
operations of the organizations after August 16,
1986, and before the close of 1986 or any subsequent
taxable year.
The treatment applicable to such organizations,
which became taxable organizations under the
provision, is as follows. A special deduction
applies with respect to health business equal to 25
percent of the claims and expenses incurred during
the taxable year less the adjusted surplus at the
beginning of the year. An exception is provided for
such organizations from the application of the
20-percent reduction in the deduction for increases
in unearned premiums that applies generally to
property and casualty insurance companies. A fresh
start was provided with respect to changes in
accounting methods resulting from the change from
tax-exempt to taxable status. Thus, no adjustment
was made under section 481 on account of an
accounting method change. Such an organization was
required to compute its ending 1986 loss reserves
without artificial changes that would reduce 1987
income. Thus, any reserve weakening after August 16,
1986 was treated as occurring in the organization's
first taxable year beginning after December 31,
1986. The basis of such an organization's assets was
deemed to be equal to the amount of the assets' fair
market value on the first day of the organization's
taxable year beginning after December 31, 1986, for
purposes of determining gain or loss (but not for
determining depreciation or for other purposes).
Grandfather rules were provided in the 1986 Act
relating to the provision. It was provided that the
provision does not apply with respect to that
portion of the business of Mutual of America which
is attributable to pension business. Pension
business means the administration of any plan
described in section 401(a) of the Code which
includes a trust exempt from tax under section
501(a), and plan under which amounts are contributed
by an individual's employer for an annuity contract
described in section 403(b) of the Code, any
individual retirement plan described in section 408
of the Code, and any eligible deferred compensation
plan to which section 457(a) of the Code applies.
Reasons
for Change
The Committee is concerned that the continued
tax-exempt status of an organization that engages in
insurance activities with respect pension business
gives such an organization an unfair competitive
advantage. Thus, the Committee believes, it is no
longer appropriate to continue the grandfather rule.
Explanation
of Provision
The provision repeals the grandfather rule
applicable to that portion of the business of Mutual
of America which is attributable to pension
business. Mutual of
America
is to be treated for Federal tax purposes as a life
insurance company.
A fresh start is provided with respect to changes in
accounting methods resulting from the change from
tax-exempt to taxable status. Thus, no adjustment is
made under section 481 on account of an accounting
method change. Mutual of
America
is required to compute ending 1997 loss reserves
without artificial changes that would reduce 1998
income. Thus, any reserve weakening after June 8,
1997, is treated as occurring in the organization's
first taxable year beginning after December 31,
1997. The basis of assets of Mutual of America is
deemed to be equal to the amount of the assets' fair
market value on the first day of the organization's
taxable year beginning after December 31, 1997, for
purposes of determining gain or loss (but not for
determining depreciation, amortization or for other
purposes).
Effective
Date
The provision is effective for taxable years
beginning after December 31, 1997.
G.
Foreign Provisions
1.
Inclusion of income from notional principal
contracts and stock lending transactions under
subpart F (sec. 861 of the bill and sec. 954 of the
Code)
Present
Law
Under the subpart F rules, the
U.S.
10-percent 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, "foreign personal holding company
income."
Foreign personal holding company income generally
consists of the following: dividends, interest,
royalties, rents and annuities; net gains from sales
or exchanges of (1) property that gives rise to the
foregoing types of income, (2) property that does
not give rise to income, and (3) interests in
trusts, partnerships, and REMICs; net gains from
commodities transactions; net gains from foreign
currency transactions; and income that is equivalent
to interest. Income from notional principal
contracts referenced to commodities, foreign
currency, interest rates, or indices thereon is
treated as foreign personal holding company income;
income from equity swaps or other types of notional
principal contracts is not treated as foreign
personal holding company income. Income derived from
transfers of debt securities (but not equity
securities) pursuant to the rules governing
securities lending transactions (sec. 1058) is
treated as foreign personal holding company income.
Income earned by a CFC that is a regular dealer in
the property sold or exchanged generally is excluded
from the definition of foreign personal holding
company income. However, no exception is available
for a CFC that is a regular dealer in financial
instruments referenced to commodities.
A
U.S.
shareholder of a passive foreign investment company
("PFIC") is subject to
U.S.
tax and an interest charge with respect to certain
distributions from the PFIC and gains on
dispositions of the stock of the PFIC, unless the
shareholder elects to include in income currently
for
U.S.
tax purposes its share of the earnings of the PFIC.
A foreign corporation is a PFIC if it satisfies
either a passive income test or a passive assets
test. For this purpose, passive income is defined by
reference to foreign personal holding company
income.
Reasons
for Change
The Committee understands that income from notional
principal contracts and stock-lending transactions
is economically equivalent to types of income that
are treated as foreign personal holding company
income under present law. Accordingly, the Committee
believes that the categories of foreign personal
holding company income should be expanded to cover
such income. In addition, the Committee believes
that an exception from the foreign personal holding
company income rules should be available for dealers
in financial instruments referenced to commodities.
Explanation
of Provision
The bill treats net income from all types of
notional principal contracts as a new category of
foreign personal holding company income. However,
income, gain, deduction or loss from a notional
principal contract entered into to hedge an item of
income in another category of foreign personal
holding company income is included in that other
category.
The bill treats payments in lieu of dividends
derived from equity securities lending transactions
pursuant to section 1058 as another new category of
foreign personal holding company income.
The bill provides an exception from foreign personal
holding company income for certain income, gain,
deduction, or loss from transactions (including
hedging transactions) entered into in the ordinary
course of a CFC's business as a regular dealer in
property, forward contracts, options, notional
principal contracts, or similar financial
instruments (including instruments referenced to
commodities).
These modifications to the definition of foreign
personal holding company income apply for purposes
of determining a foreign corporation's status as a
PFIC.
Effective
Date
The provision applies to taxable years beginning
after the date of enactment.
2.
Restrict like-kind exchange rules for certain
personal property (sec. 862 of the bill and sec.
1031 of the Code)
Present
Law
Like-kind
exchanges
An exchange of property, like a sale, generally is a
taxable event. However, no gain or loss is
recognized if property held for productive use in a
trade or business or for investment is exchanged for
property of a "like-kind" which is to be
held for productive use in a trade or business or
for investment (sec. 1031). In general, any kind of
real estate is treated as of a like-kind with other
real property as long as the properties are both
located either within or both outside the
United States
. In addition, certain types of property, such as
inventory, stocks and bonds, and partnership
interests, are not eligible for nonrecognition
treatment under section 1031.
If section 1031 applies to an exchange of
properties, the basis of the property received in
the exchange is equal to the basis of the property
transferred, decreased by any money received by the
taxpayer, and further adjusted for any gain or loss
recognized on the exchange.
Application
of depreciation rules
Tangible personal property that is used
predominantly outside the
United States
generally is accorded a less favorable depreciation
regime than is property that is used predominantly
within the
United States
. Thus, under present law, if a taxpayer exchanges
depreciable U.S. property with a low adjusted basis
(relative to its fair market value) for similar
property situated outside the United States, the
adjusted basis of the acquired property will be the
same as the adjusted basis of the relinquished
property, but the depreciation rules applied to such
acquired property generally will be different than
the rules that were applied to the relinquished
property.
Reasons
for Change
The committee believes that the depreciation rules
applicable to foreignand domestic-use are
sufficiently dissimilar so as to treat such property
as not "like-kind" property for purposes
of section 1031.
Explanation
of Provision
The bill provides that personal property
predominantly used within the
United States
and personal property predominantly used outside the
United States
are not "like-kind" properties. For this
purpose, the use of the property surrendered in the
exchange will be determined based upon the use
during the 24 months immediately prior to the
exchange. Similarly, for section 1031 to apply,
property received in the exchange must continue in
the same use (i.e., foreign or domestic) for the 24
months immediately after the exchange. The 24-month
period is reduced to such lesser time as the
taxpayer held the property, unless such shorter
holding period is a result of a transaction (or
series of transactions) structured to avoid the
purposes of the provision. Property described in
section 168(g)(4) (generally, property used both
within and without the United States that is
eligible for accelerated depreciation as if used in
the United States) will be treated as property
predominantly used in the United States.
Effective
Date
The provision is effective for exchanges after June
8, 1997, unless the exchange is pursuant to a
binding contract in effect on such date and all
times thereafter. A contract will not fail to be
considered to be binding solely because (1) it
provides for a sale in lieu of an exchange or (2)
either the property to be disposed of as
relinquished property or the property to be acquired
as replacement property (whichever is applicable)
was not identified under the contract before June 9,
1997.
3.
Holding period requirement for certain foreign taxes
(sec. 863 of the bill and new sec. 901(k) of the
Code)
Present
Law
A
U.S.
person that receives a dividend from a foreign
corporation generally is entitled to a credit for
income taxes paid to a foreign government on the
dividend, regardless of the
U.S.
person's holding period for the foreign
corporation's stock. A
U.S.
corporation that receives a dividend from a foreign
corporation in which it has a 10-percent or greater
voting interest may be entitled to a credit for the
foreign taxes paid by the foreign corporation, also
without regard to the
U.S.
shareholder's holding period for the corporation's
stock (secs. 902 and 960).
As a consequence of the foreign tax credit
limitations of the Code, certain taxpayers are
unable to utilize their creditable foreign taxes to
reduce their
U.S.
tax liability.
U.S.
shareholders that are tax-exempt receive no
U.S.
tax benefit for foreign taxes paid on dividends they
receive.
Reasons
for Change
Although present law imposes a holding period
requirement for the dividends-received deduction for
a corporate shareholder (sec. 246), there is no
similar holding period requirement for foreign tax
credits with respect to dividends. As a result, some
U.S. persons have engaged in tax-motivated
transactions designed to transfer foreign tax
credits from persons that are unable to benefit from
such credits (such as a tax-exempt entity or a
taxpayer whose use of foreign tax credits is
prevented by the limitation) to persons that can use
such credits. These transactions sometimes involve a
short-term transfer of ownership of dividend-paying
shares. Other transactions involve the use of
derivatives to allow a person that cannot benefit
from the foreign tax credits with respect to a
dividend to retain the economic benefit of the
dividend while another person receives the foreign
tax credit benefits.
Explanation
of Provision
The bill denies a shareholder the foreign tax
credits normally available with respect to a
dividend from a corporation or a regulated
investment company ("RIC") if the
shareholder has not held the stock for a minimum
period during which it is not protected from risk of
loss. Under the bill, the minimum holding period for
dividends on common stock is 16 days. The minimum
holding period for preferred stock is 46 days.
Where the holding period requirement is not met for
stock of a foreign corporation, the bill disallows
the foreign tax credits for the foreign withholding
taxes that are paid with respect to a dividend. Such
credits are denied both to the shareholder and any
other taxpayer who would otherwise be entitled to
claim foreign tax credits for such withholding
taxes. In addition, the bill applies to all foreign
tax credits otherwise allowable for taxes paid by a
lower-tier foreign corporation and for foreign tax
credits of a RIC that elects to treat its foreign
taxes as paid by the shareholders. The bill denies
such credits where any of the stock in the chain of
ownership that is a requirement for claiming the
credits is held for less than the required holding
period.
The bill denies these same foreign tax credit
benefits, regardless of the shareholder's holding
period for the stock, to the extent that the
taxpayer has an obligation to make payments related
to the dividend (whether pursuant to a short sale or
otherwise) with respect to substantially similar or
related property.
The 16- or 46-day holding period under the bill
(whichever applies) must be satisfied over a period
immediately before or immediately after the
shareholder becomes entitled to receive each
dividend. For purposes of determining whether the
required holding period is met, any period during
which the shareholder has protected itself from risk
of loss (under the rules of section 246(c)(4)) would
not be included. For example, assume a taxpayer buys
foreign common stock. Assume also that, the day
after the stock is purchased, the taxpayer enters
into an equity swap under which the taxpayer is
entitled to receive payments equal to the losses on
the stock, and the taxpayer retains the swap
position for the entire period it holds the stock.
Under the bill, the taxpayer would not be able to
claim any foreign tax credits with respect to
dividends on the stock because the taxpayer's
holding period is limited to the single day during
which the loss on the stock was not protected. For
purposes of entitlement to certain indirect foreign
tax credits (secs. 902 and 960), the bill provides
an exception from the risk reduction rule for a bona
fide contract to sell stock.
The bill also provides an exception for foreign tax
credits with respect to certain dividends received
by active dealers in securities. In order to qualify
for the exception, the following requirements must
be met: (1) the dividend must be received by the
entity on stock which it holds in its capacity as a
dealer in securities, (2) the entity must be subject
to net income taxation on the dividend (on either a
residence or worldwide income basis) in a foreign
country, and (3) the foreign taxes to which the
exception applies must be taxes that are creditable
under the foreign county's tax system. A securities
dealer for purposes of the exception must be an
entity which (1) is engaged in the active conduct of
a securities business in a foreign country and (2)
is registered as a securities broker or dealer under
the Securities Exchange Act of 1934 or is licenced
or authorized to conduct securities activities in
such foreign county and subject to bona fide
regulation by the securities regulatory authority of
the foreign country. Under the bill, the Secretary
of the Treasury is granted authority to issue
regulations appropriate to prevent abuse of this
exception.
If a taxpayer is denied foreign tax credits under
the bill because the 16- or 46-day holding period
requirement is not satisfied, the taxpayer would be
entitled to a deduction for the foreign taxes for
which the credit is disallowed. This deduction would
be available even if the taxpayer claimed the
foreign tax credit for other taxes in the same
taxable year.
No inference is intended as to the treatment under
present law of tax-motivated transactions intended
to transfer foreign tax credit benefits.
Effective
Date
The provision is effective for dividends paid or
accrued more than 30 days after the date of
enactment.
4.
Treatment of income from certain sales of inventory
as
U.S.
source (sec. 864 of the bill and sec. 865 of the
Code)
Present
Law
U.S.
persons are subject to
U.S.
tax on their worldwide income. A credit against
U.S.
tax on foreign source income is allowed for foreign
taxes. The amount of foreign tax credits that can be
claimed in a year is subject to a limitation that
prevents taxpayers from using foreign tax credits to
offset
U.S.
tax on
U.S.
source income. Specific rules apply in determining
whether income is from
U.S.
or foreign sources. Income from the sale or exchange
of inventory property generally is sourced where the
sale occurs. In Liggett Group, Inc. v.
Commissioner, 58 T.C.M. 1167 (1990), the court
concluded that a sale of inventory property by a
U.S.
corporation to
U.S.
customers gave rise to foreign source income because
the sale occurred outside the
United States
.
Reasons
for Change
The Committee believes that when a
U.S.
person sells inventory to its
U.S.
customers, the resulting income is inherently
domestic, regardless of the site of the particular
transaction. The Committee believes that income from
sales of inventory property by a
U.S.
resident to another
U.S.
resident for use in the
United States
should be treated as income from
U.S.
sources, without regard to where the sale occurs.
Explanation
of Provision
Under the bill, income from a sale of inventory
property by a
U.S.
resident to another
U.S.
resident for use, consumption, or disposition in the
United States
is treated as
U.S.
source income, if the sale is not attributable to an
office or other fixed place of business maintained
by the seller outside the
United States
.
Effective
Date
The provision is effective for taxable years
beginning after date of enactment.
5.
Interest on underpayment reduced by foreign tax
credit carryback (sec. 865 of the bill and secs.
6601 and 6611 of the Code)
Present
Law
U.S.
persons may credit foreign taxes against
U.S.
tax on foreign source income. The amount of foreign
tax credits that can be claimed in a year is subject
to a limitation that prevents taxpayers from using
foreign tax credits to offset
U.S.
tax on
U.S.
source income. Separate limitations are applied to
specific categories of income. The amount of
creditable taxes paid or accrued in any taxable year
which exceeds the foreign tax credit limitation is
permitted to be carried back two years and carried
forward five years.
For purposes of the computation of interest on
overpayments of tax, if an overpayment for a taxable
year results from a foreign tax credit carryback
from a subsequent taxable year, the overpayment is
deemed not to arise prior to the filing date for the
subsequent taxable year in which the foreign taxes
were paid or accrued (sec. 6611(g)). Accordingly,
interest does not accrue on the overpayment prior to
the filing date for the year of the carryback that
effectively created such overpayment. In Fluor
Corp. v.
United States
, 35 Fed. Cl. 520 (1996), the court held that in
the case of an underpayment of tax (rather than an
overpayment) for a taxable year that is eliminated
by a foreign tax credit carryback from a subsequent
taxable year, interest does not accrue on the
underpayment that is eliminated by the foreign tax
credit carryback. The Government has filed an appeal
in the Fluor case.
Reasons
for Change
The Committee believes that the application of the
interest rules in the case of a deficiency that is
reduced or eliminated by a foreign tax credit
carryback must be consistent with the application of
the interest rules in the case of an overpayment
that is created by a foreign tax credit carryback.
The Committee believes that in such cases the
deficiency cannot be considered to have been
eliminated, and the overpayment cannot be considered
to have been created, until the filing date for the
taxable year in which the foreign tax credit
carryback arises. Accordingly, interest should
continue to accrue on the deficiency through such
date. In addition, the Committee believes that it is
appropriate to clarify the interest rules that apply
in the case of a foreign tax credit carryback that
is itself triggered by another carryback from a
subsequent year.
Explanation
of Provision
Under the bill, if an underpayment for a taxable
year is reduced or eliminated by a foreign tax
credit carryback from a subsequent taxable year,
such carryback does not affect the computation of
interest on the underpayment for the period ending
with the filing date for such subsequent taxable
year in which the foreign taxes were paid or
accrued. The bill also clarifies the application of
the interest rules of both section 6601 and section
6611 in the case of a foreign tax credit carryback
that is triggered by a net operating loss or net
capital loss carryback; in such a case, a deficiency
is not considered to have been reduced, and an
overpayment is not considered to have been created,
until the filing date for the subsequent year in
which the loss carryback arose. No inference is
intended regarding the computation of interest under
present law in the case of a foreign tax credit
carryback (including a foreign tax credit carryback
that is triggered by a net operating loss or net
capital loss carryback).
Effective
Date
The provision is effective for foreign taxes
actually paid or accrued in taxable years beginning
after date of enactment.
6.
Determination of period of limitations relating to
foreign tax credits (sec. 866 of the bill and sec.
6511(d) of the Code)
Present
Law
U.S.
persons may credit foreign taxes against
U.S.
tax on foreign source income. The amount of foreign
tax credits that can be claimed in a year is subject
to a limitation that prevents taxpayers from using
foreign tax credits to offset
U.S.
tax on
U.S.
source income. Separate limitations are applied to
specific categories of income. The amount of
creditable taxes paid or accrued in any taxable year
which exceeds the foreign tax credit limitation is
permitted to be carried back two years and carried
forward five years.
For purposes of the period of limitations on filing
claims for credit or refund, in the case of a claim
relating to an overpayment attributable to foreign
tax credits, the limitations period is ten years
from the filing date for the taxable year with
respect to which the claim is made. The Internal
Revenue Service has taken the position that, in the
case of a foreign tax credit carryforward, the
period of limitations is determined by reference to
the year in which the foreign taxes were paid or
accrued (and not the year to which the foreign tax
credits are carried) (Rev. Rul. 84-125, 1984-2 C.B.
125). However, the court in Ampex Corp. v. United
States, 620 F.2d 853 (1980), held that, in the
case of a foreign tax credit carryforward, the
period of limitations is determined by reference to
the year to which the foreign tax credits are
carried (and not the year in which the foreign taxes
were paid or accrued).
Reasons
for Change
The Committee believes that it is appropriate to
identify clearly the date on which the ten-year
period of limitations for claims with respect to
foreign tax credits begins.
Explanation
of Provision
Under the bill, in the case of a claim relating to
an overpayment attributable to foreign tax credits,
the limitations period is determined by reference to
the year in which the foreign taxes were paid or
accrued (and not the year to which the foreign tax
credits are carried). No inference is intended
regarding the determination of such limitations
period under present law.
Effective
Date
The provision is effective for foreign taxes paid or
accrued in taxable years beginning after date of
enactment.
7.
Modify foreign tax credit carryover rules (sec. 867
of the bill and sec. 904 of the Code)
Present
Law
U.S.
persons may credit foreign taxes against
U.S.
tax on foreign source income. The amount of foreign
tax credits that can be claimed in a year is subject
to a limitation that prevents taxpayers from using
foreign tax credits to offset
U.S.
tax on
U.S.
source income. Separate foreign tax credit
limitations are applied to specific categories of
income.
The amount of creditable taxes paid or accrued (or
deemed paid) in any taxable year which exceeds the
foreign tax credit limitation is permitted to be
carried back two years and forward five years. The
amount carried over may be used as a credit in a
carryover year to the extent the taxpayer otherwise
has excess foreign tax credit limitation for such
year. The separate foreign tax credit limitations
apply for purposes of the carryover rules.
Reasons
for Change
The Committee believes that reducing the carryback
period for foreign tax credits to one year and
increasing the carryforward period to seven years
will reduce some of the complexity associated with
carrybacks while continuing to address the timing
differences between
U.S.
and foreign tax rules.
Explanation
of Provision
The bill reduces the carryback period for excess
foreign tax credits from two years to one year. The
bill also extends the excess foreign tax credit
carryforward period from five years to seven years.
Effective
Date
The provision applies to foreign tax credits arising
in taxable years beginning after December 31, 1997.
8.
Repeal special exception to foreign tax credit
limitation for alternative minimum tax purposes
(sec. 868 of the bill and sec. 59 of the Code)
Present
Law
Present law imposes a minimum tax on a corporation
to the extent the taxpayer's minimum tax liability
exceeds its regular tax liability. The corporate
minimum tax is imposed at a rate of 20 percent on
alternative minimum taxable income in excess of a
phased-out $40,000 exemption amount.
The combination of the taxpayer's net operating loss
carryover and foreign tax credits cannot reduce the
taxpayer's alternative minimum tax liability by more
than 90 percent of the amount determined without
these items.
The Omnibus Budget Reconciliation Act of 1989
("1989 Act") provided a special exception
to the limitation on the use of the foreign tax
credit against the tentative minimum tax. In order
to qualify for this exception, a corporation must
meet four requirements. First, more than 50 percent
of both the voting power and value of the stock of
the corporation must be owned by
U.S.
persons who are not members of an affiliated group
which includes such corporation. Second, all of the
activities of the corporation must be conducted in
one foreign country with which the
United States
has an income tax treaty in effect and such treaty
must provide for the exchange of information between
such country and the
United States
. Third, the corporation generally must distribute
to its shareholders all current earnings and profits
(except for certain amounts utilized for normal
maintenance or capital expenditures related to its
existing business). Fourth, all of such
distributions which are received by
U.S.
persons must be utilized by such persons in a
U.S.
trade or business. This exception applies to taxable
years beginning after March 31, 1990 (with a
proration rule effective for certain taxable years
which include March 31, 1990).
Reasons
for Change
The committee believes that taxpayers should be
treated the same with respect to the foreign tax
credit limitation of the alternative minimum tax.
Explanation
of Provision
The special exception regarding the use of foreign
tax credits for purposes of the alternative minimum
tax, as provided by the 1989 Act, is repealed.
Effective
Date
The provision is effective for taxable years
beginning after the date of enactment.
H.
Other Revenue-Increase Provisions
1.
Phase out suspense accounts for certain large farm
corporations (sec. 871 of the bill and sec. 477 of
the Code)
Present
Law
A corporation (or a partnership with a corporate
partner) engaged in the trade or business of farming
must use an accrual method of accounting for such
activities unless such corporation (or partnership),
for each prior taxable year beginning after December
31, 1975, did not have gross receipts exceeding $1
million. If a farm corporation is required to change
its method of accounting, the section 481 adjustment
resulting from such change is included in gross
income ratably over a 10-year period, beginning with
the year of change. This rule does not apply to a
family farm corporation.
A provision of the Revenue Act of 1987 ("1987
Act") requires a family corporation (or a
partnership with a family corporation as a partner)
to use an accrual method of accounting for its
farming business unless, for each prior taxable year
beginning after December 31, 1985, such corporation
(and any predecessor corporation) did not have gross
receipts exceeding $25 million. A family corporation
is one where at 50 percent or more of the stock of
the corporation is held by one (or in some limited
cases, two or three) families.
A family farm corporation that must change to an
accrual method of accounting as a result of the 1987
Act provision is to establish a suspense account in
lieu of including the entire amount of the section
481 adjustment in gross income. The initial balance
of the suspense account equals the lesser of (1) the
section 481 adjustment otherwise required for the
year of change, or (2) the section 481 adjustment
computed as if the change in method of accounting
had occurred as of the beginning of the taxable year
preceding the year of change.
The amount of the suspense account is required to be
included in gross income if the corporation ceases
to be a family corporation. In addition, if the
gross receipts of the corporation attributable to
farming for any taxable year decline to an amount
below the lesser of (1) the gross receipts
attributable to farming for the last taxable year
for which an accrual method of accounting was not
required, or (2) the gross receipts attributable to
farming for the most recent taxable year for which a
portion of the suspense account was required to be
included in income, a portion of the suspense
account is required to be included in gross income.
Reasons
for Change
The committee believes that an accrual method of
accounting more accurately measures the economic
income of a corporation than does the cash receipts
and disbursements method and that changes from one
method of accounting to another should be taken into
account under section 481. However, the committee
believes that it may be appropriate for a family
farm corporation to retain the use of the cash
method of accounting until such corporation reaches
a certain size. At that time, the corporation should
be subject to tax accounting rules to which other
corporations are so subject. In addition, the
committee believes that the present-law suspense
account provision applicable to large family farm
corporations may effectively provide an exclusion
for, rather than a deferral of, amounts otherwise
properly taken into account under section 481 upon
the required change in the method of accounting for
such corporations. However, the committee recognizes
that requiring the recognition of previously
established suspense accounts may impose liquidity
concerns upon some farm corporations. Thus, the
committee provides an extended period over which
existing suspense accounts must be restored to
income and provides further deferral where the
corporation has insufficient income for the year.
Explanation
of Provision
The bill repeals the ability of a family farm
corporation to establish a suspense account when it
is required to change to an accrual method of
accounting. Thus, under the bill, any family farm
corporation required to change to an accrual method
of accounting would restore the section 481
adjustment applicable to the change in gross income
ratably over a 10-year period beginning with the
year of change.
In addition, any taxpayer with an existing suspense
account is required to restore the account into
income ratably over a 20-year period beginning in
the first taxable year beginning after June 8, 1997,
subject to the present-law requirements to restore
such accounts more rapidly. The amount required to
be restored to income for a taxable year pursuant to
the 20-year spread period shall not exceed the net
operating loss of the corporation for the year (in
the case of a corporation with a net operating loss)
or 50 percent of the net income of the taxpayer for
the year (for corporations with taxable income). For
this purpose, a net operating loss or taxable income
is determined without regard to the amount restored
to income under the bill. Any reduction in the
amount required to be restored to income is taken
into account ratably over the remaining years in the
20-year period or, if applicable, after the end of
the 20-year period. Amounts that extend beyond the
20-year period remain subject to the net operating
loss and 50-percent-of-taxable income rules.
Finally, the present-law requirement that a portion
of a suspense account be restored to income if the
gross receipts of the corporation diminishes is
repealed.
Effective
Date
The provision is effective for taxable years ending
after June 8, 1997.
2.
Modify net operating loss carryback and carryforward
rules (sec. 872 of the bill and sec. 172 of the
Code)
Present
Law
The net operating loss ("NOL") of a
taxpayer (generally, the amount by which the
business deductions of a taxpayer exceeds its gross
income) may be carried back three years and carried
forward 15 years to offset taxable income in such
years. A taxpayer may elect to forgo the carryback
of an NOL. Special rules apply to real estate
investment trusts ("REITs") (no carrybacks),
specified liability losses (10-year carryback), and
excess interest losses (no carrybacks).
Reason
for Change
The committee recognizes that while Federal income
tax reporting requires a taxpayer to report income
and file returns based on a 12-month period, the
natural business cycle of a taxpayer may exceed 12
months. However, the committee believes that
allowing a two-year carryback of NOLs is sufficient
to account for these business cycles, particularly
since (1) many deductions allowed for tax purposes
relate to future, rather than past, income streams
and (2) certain deductions that do relate to past
income streams are granted special, longer carryback
periods under present law (which are retained by the
bill).
Explanation
of Provision
The bill limits the NOL carryback period to two
years and extends the NOL carryforward period to 20
years. The bill does not apply to the carryback
rules relating to REITs, specified liability losses,
excess interest losses, and corporate capital
losses.
The bill does not apply to NOLs arising from
casualty losses of individual taxpayers. In
addition, the bill does not apply to NOLs
attributable to losses incurred in Presidentially
declared disaster areas by taxpayers engaged in a
farming business or a small business. For this
purpose, a "small business" means any
trade or business (including one conducted in or
through a corporation, partnership, or sole
proprietorship) the average annual gross receipts
(as determined under sec. 448(c)) of which are $5
million or less, and a "farming business"
is defined as in section 263A(e)(4).
Effective
Date
The provision is effective for NOLs for taxable
years beginning after the date of enactment. The
provision does not apply to NOLs carried forward
from prior taxable years.
3.
Expand the limitations on deductibility of premiums
and interest with respect to life insurance,
endowment and annuity contracts (sec. 873 of the
bill and sec. 264 of the Code)
Present
Law
Exclusion
of inside buildup and amounts received by reason of
death
No Federal income tax generally is imposed on a
policyholder with respect to the earnings under a
life insurance contract ("inside
buildup").109
Further, an exclusion from Federal income tax is
provided for amounts received under a life insurance
contract paid by reason of the death of the insured
(sec. 101(a)).
Premium
deduction limitation
No deduction is permitted for premiums paid on any
life insurance policy covering the life of any
officer or employee, or of any person financially
interested in any trade or business carried on by
the taxpayer, when the taxpayer is directly or
indirectly a beneficiary under such policy (sec.
264(a)(1)).
Interest
deduction disallowance with respect to life
insurance
Present law provides generally that no deduction is
allowed for interest paid or accrued on any
indebtedness with respect to one or more life
insurance contracts or annuity or endowment
contracts owned by the taxpayer covering any
individual who is or was (1) an officer or employee
of, or (2) financially interested in, any trade or
business currently or formerly carried on by the
taxpayer (the "COLI" rules).
This interest deduction disallowance rule generally
does not apply to interest on debt with respect to
contracts purchased on or before June 20, 1986;
rather, an interest deduction limit based on Moody's
Corporate Bond Yield Average --Monthly Average
Corporates applies in the case of such contracts.110
An exception to this interest disallowance rule is
provided for interest on indebtedness with respect
to life insurance policies covering up to 20 key
persons. A key person is an individual who is either
an officer or a 20-percent owner of the taxpayer.
The number of individuals that can be treated as key
persons may not exceed the greater of (1) 5
individuals, or (2) the lesser of 5 percent of the
total number of officers and employees of the
taxpayer, or 20 individuals. For determining who is
a 20-percent owner, all members of a controlled
group are treated as one taxpayer. Interest paid or
accrued on debt with respect to a contract covering
a key person is deductible only to the extent the
rate of interest does not exceed Moody's Corporate
Bond Yield Average - Monthly Average Corporates for
each month beginning after December 31, 1995, that
interest is paid or accrued.
The foregoing interest deduction limitation was
added in 1996 to existing interest deduction
limitations with respect to life insurance and
similar contracts.111
Interest
deduction limitation with respect to tax-exempt
interest income
Present law provides that no deduction is allowed
for interest on debt incurred or continued to
purchase or carry obligations the interest on which
is wholly exempt from Federal income tax (sec.
265(a)(2)). In addition, in the case a financial
institution, a proration rule provides that no
deduction is allowed for that portion of the
taxpayer's interest that is allocable to tax-exempt
interest (sec. 265(b)). The portion of the interest
deduction that is disallowed under this rule
generally is the portion determined by the ratio of
the taxpayer's (1) average adjusted bases of
tax-exempt obligations acquired after August 7,
1986, to (2) the average adjusted bases for all of
the taxpayer's assets (sec. 265(b)(2)).112
Reasons
for Change
The Committee understands that, under applicable
State laws, the holder of a life insurance policy
generally is required to have an insurable interest
in the life of the insured individual only when the
policyholder purchases the life insurance policy.
The Committee understands that under State laws
relating to insurable interests, a taxpayer
generally has an insurable interest in the lives of
its debtors. Further, rules governing permitted
investments of financial institutions may allow the
institutions to acquire cash value life insurance
covering the lives of debtors, as well as the lives
of individuals with other relationships to the
taxpayer such as shareholders, employees or
officers. In addition, insurable interest laws in
many States have been expanded in recent years, and
States could decide in the future to expand further
the range of persons in whom a taxpayer has an
insurable interest.
For example, a business could purchase cash value
life insurance on the lives of its debtors, and
increase the investment in these contracts as the
debt diminishes and even after the debt is repaid.
If a mortgage lender can (under applicable State law
and banking regulations) buy a cash value life
insurance policy on the lives of mortgage borrowers,
the lender may be able to deduct premiums or
interest on debt with respect to such a contract, if
no other deduction disallowance rule or principle of
tax law applies to limit the deductions. The
premiums or interest could be deductible even after
the individual's mortgage loan is sold to another
lender or to a mortgage pool. If the loan were sold
to a second lender, the second lender might also be
able to buy a cash value life insurance contract on
the life of the same borrower, and to deduct
premiums or interest with respect to that contract.
The Committee bill addresses this issue by providing
that no deduction is allowed for premiums on any
life insurance policy, or endowment or annuity
contract, if the taxpayer is directly or indirectly
a beneficiary under the policy or contract, and by
providing that no deduction is allowed for interest
paid or accrued on any indebtedness with respect to
life insurance policy, or endowment or annuity
contract, covering the life of any individual.
In addition, the Committee understands that
taxpayers may be seeking new means of deducting
interest on debt that in substance funds the
tax-free inside build-up of life insurance or the
tax-deferred inside buildup of annuity and endowment
contracts.113
The Committee believes that present law was not
intended to promote tax arbitrage by allowing
financial or other businesses that have the ongoing
ability to borrow funds from depositors,
bondholders, investors or other lenders to
concurrently invest a portion of their assets in
cash value life insurance contracts, or endowment or
annuity contracts. Therefore, the bill provides
that, for taxpayers other than natural persons, no
deduction is allowed for the portion of the
taxpayer's interest expense that is allocable to
unborrowed policy cash values of any life insurance
policy or annuity or endowment contract issued after
June 8, 1997.
Explanation
of Provision
Expansion
of premium deduction limitation to individuals in
whom taxpayer has an insurable interest
Under the provision, the present-law premium
deduction limitation is modified to provide that no
deduction is permitted for premiums paid on any life
insurance, annuity or endowment contract, if the
taxpayer is directly or indirectly a beneficiary
under the contract.
Expansion
of interest disallowance to individuals in whom
taxpayer has insurable interest
Under the provision, no deduction is allowed for
interest paid or accrued on any indebtedness with
respect to life insurance policy, or endowment or
annuity contract, covering the life of any
individual. Thus, the provision limits interest
deductibility in the case of such a contract
covering any individual in whom the taxpayer has an
insurable interest when the contract is first issued
under applicable State law, except as otherwise
provided under present law with respect to key
persons and pre-1986 contracts.
Pro
rata disallowance of interest on debt to fund life
insurance
In the case of a taxpayer other than a natural
person, no deduction is allowed for the portion of
the taxpayer's interest expense that is allocable to
unborrowed policy cash surrender values with respect
to any life insurance policy or annuity or endowment
contract issued after June 8, 1997. Interest expense
is so allocable based on the ratio of (1) the
taxpayer's average unborrowed policy cash values of
life insurance policies, and annuity and endowment
contracts, issued after June 8, 1997, to (2) the
average adjusted bases for all assets of the
taxpayer. This rule does not apply to any policy or
contract owned by an entity engaged in a trade or
business, covering any individual who is an
employee, officer or director of the trade or
business at the time first covered by the policy or
contract. Such a policy or contract is not taken
into account in determining unborrowed policy cash
values.
The unborrowed policy cash values means the cash
surrender value of the policy or contract determined
without regard to any surrender charge, reduced by
the amount of any loan with respect to the policy or
contract. The cash surrender value is to be
determined without regard to any other contractual
or noncontractual arrangement that artificially
depresses the cash value of a contract.
If a trade or business (other than a sole
proprietorship or a trade or business of performing
services as an employee) is directly or indirectly
the beneficiary under any policy or contract, then
the policy or contract is treated as held by the
trade or business. For this purpose, the amount of
the unborrowed cash value is treated as not
exceeding the amount of the benefit payable to the
trade or business. In the case of a partnership or S
corporation, the provision applies at the
partnership or corporate level. The amount of the
benefit is intended to take into account the amount
payable to the business under the contract (e.g., as
a death benefit) or pursuant to another agreement
(e.g., under a split dollar agreement). The amount
of the benefit is intended also to include any
amount by which liabilities of the business would be
reduced by payments under the policy or contract
(e.g., when payments under the policy reduce the
principal or interest on a liability owed to or by
the business).
As provided in regulations, the issuer or
policyholder of the life insurance policy or
endowment or annuity contract is required to report
the amount of the amount of the unborrowed cash
value in order to carry out this rule.
If interest expense is disallowed under other
provisions of section 264 (limiting interest
deductions with respect to life insurance policies
or endowment or annuity contracts) or under section
265 (relating to tax-exempt interest), then the
disallowed interest expense is not taken into
account under this provision, and the average
adjusted bases of assets is reduced by the amount of
debt, interest on which is so disallowed. The
provision is applied before present-law rules
relating to capitalization of certain expenses where
the taxpayer produces property (sec. 263A).
An aggregation rule is provided, treating related
persons as one for purposes of the provision.
The provision does not apply to any insurance
company subject to tax under subchapter L of the
Code. Rather, the rules reducing certain deductions
for losses incurred, in the case of property and
casualty companies, and reducing reserve deductions
or dividends received deductions of life insurance
companies, are modified to take into account the
increase in cash values of life insurance policies
or annuity or endowment contracts held by insurance
companies.
Effective
Date
The provision s apply with respect to contracts
issued after June 8, 1997. For this purpose, a
material increase in the death benefit or other
material change in the contract causes the contract
to be treated as a new contract. To the extent of
additional covered lives under a contract after June
8, 1997, the contract is treated as a new contract.
In the case of an increase in the death benefit of a
contract that is converted to extended term
insurance pursuant to nonforfeiture provisions, in a
transaction to which section 501(d)(2) of the Health
Insurance Portability and Accountability Act of 1996
applies, the contract is not treated as a new
contract.
4.
Allocation of basis of properties distributed to a
partner by a partnership (sec. 874 of the bill and
sec. 732(c) of the Code)
Present
Law
In
general
The partnership provisions of present law generally
permit partners to receive distributions of
partnership property without recognition of gain or
loss (sec. 731).114
Rules are provided for determining the basis of the
distributed property in the hands of the distributee,
and for allocating basis among multiple properties
distributed, as well as for determining adjustments
to the distributee partner's basis in its
partnership interest. Property distributions are
tax-free to a partnership. Adjustments to the basis
of the partnership's remaining undistributed assets
are not required unless the partnership has made an
election that requires basis adjustments both upon
partnership distributions and upon transfers of
partnership interests (sec. 754).
Partner's
basis in distributed properties and partnership
interest
Present law provides two different rules for
determining a partner's basis in distributed
property, depending on whether or not the
distribution is in liquidation of the partner's
interest in the partnership. Generally, a
substituted basis rule applies to property
distributed to a partner in liquidation. Thus, the
basis of property distributed in liquidation of a
partner's interest is equal to the partner's
adjusted basis in its partnership interest (reduced
by any money distributed in the same transaction)
(sec. 732(b)).
By contrast, generally, a carryover basis rule
applies to property distributed to a partner other
than in liquidation of its partnership interest,
subject to a cap (sec. 732(a)). Thus, in a
non-liquidating distribution, the distributee
partner's basis in the property is equal to the
partnership's adjusted basis in the property
immediately before the distribution, but not to
exceed the partner's adjusted basis in its
partnership interest (reduced by any money
distributed in the same transaction). In a
non-liquidating distribution, the partner's basis in
its partnership interest is reduced by the amount of
the basis to the distributee partner of the property
distributed and is reduced by the amount of any
money distributed (sec. 733).
Allocating
basis among distributed properties
In the event that multiple properties are
distributed by a partnership, present law provides
allocation rules for determining their bases in the
distributee partner's hands. An allocation rule is
needed when the substituted basis rule for
liquidating distributions applies, in order to
assign a portion of the partner's basis in its
partnership interest to each distributed asset. An
allocation rule is also needed in a non-liquidating
distribution of multiple assets when the total
carryover basis would exceed the partner's basis in
its partnership interest, so a portion of the
partner's basis in its partnership interest is
assigned to each distributed asset.
Present law provides for allocation in proportion to
the partnership's adjusted basis. The rule allocates
basis first to unrealized receivables and inventory
items in an amount equal to the partnership's
adjusted basis (or if the allocated basis is less
than partnership basis, then in proportion to the
partnership's basis), and then among other
properties in proportion to their adjusted bases to
the partnership (sec. 732(c)).115
Under this allocation rule, in the case of a
liquidating distribution, the distributee partner
can have a basis in the distributed property that
exceeds the partnership's basis in the property.
Reasons
for Change
The rule providing that distributee partners
allocate basis in proportion to the partnership's
adjusted basis in the distributed property gives
rise to problems in application.116
The Committee is concerned that the present-law rule
permits basis shifting transactions in which basis
is allocated so as to increase basis artificially,
giving rise to inflated depreciation deductions or
artificially large losses, for example. The
Committee believes that these problems would be
significantly reduced by taking into account the
fair market value of property distributed by a
partnership for purposes of allocating basis in the
hands of the distributee partner.
Explanation
of Provision
The provision modifies the basis allocation rules
for distributee partners. It allocates a distributee
partner's basis adjustment among distributed assets
first to unrealized receivables and inventory items
in an amount equal to the partnership's basis in
each such property (as under present law). If the
basis to be allocated is less than the sum of the
adjusted bases of the properties in the hands of the
partnership, then, to the extent a decrease is
required to make the total adjusted bases of the
properties equal the basis to be allocated, the
decrease is allocated as described below for
adjustments that are decreases.
Under the provision, to the extent of any basis not
allocated under the above rules, basis is allocated
first to the extent of each distributed property's
adjusted basis to the partnership. Any remaining
basis adjustment, if an increase, is allocated among
properties with unrealized appreciation in
proportion to their respective amounts of unrealized
appreciation (to the extent of each property's
appreciation), and then in proportion to their
respective fair market values. For example, assume
that a partnership with two assets, A and B,
distributes them both in liquidation to a partner
whose basis in its interest is 55. Neither asset
consists of inventory or unrealized receivables.
Asset A has a basis to the partnership of 5 and a
fair market value of 40, and asset B has a basis to
the partnership of 10 and a fair market value of 10.
Under the provision, basis is first allocated to
asset A in the amount of 5 and to asset B in the
amount of 10 (their adjusted bases to the
partnership). The remaining basis adjustment is an
increase totaling 40 (the partner's 55 basis minus
the partnership's total basis in distributed assets
of 15). Basis is then allocated to asset A in the
amount of 35, its unrealized appreciation, with no
allocation to asset B attributable to unrealized
appreciation because its fair market value equals
the partnership's adjusted basis. The remaining
basis adjustment of 5 is allocated in the ratio of
the assets' fair market values, i.e., 4 to asset A
(for a total basis of 44) and 1 to asset B (for a
total basis of 11).
If the remaining basis adjustment is a decrease, it
is allocated among properties with unrealized
depreciation in proportion to their respective
amounts of unrealized depreciation (to the extent of
each property's depreciation), and then in
proportion to their respective adjusted bases
(taking into account the adjustments already made).
A remaining basis adjustment that is a decrease
arises under the provision when the partnership's
total adjusted basis in the distributed properties
exceeds the amount of the partner's basis in its
partnership interest, and the latter amount is the
basis to be allocated among the distributed
properties. For example, assume that a partnership
with two assets, C and D, distributes them both in
liquidation to a partner whose basis in its
partnership interest is 20. Neither asset consists
of inventory or unrealized receivables. Asset C has
a basis to the partnership of 15 and a fair market
value of 15, and asset D has a basis to the
partnership of 15 and a fair market value of 5.
Under the provision, basis is first allocated to the
extent of the partnership's basis in each
distributed property, or 15 to each distributed
property, for a total of 30. Because the partner's
basis in its interest is only 20, a downward
adjustment of 10 (30 minus 20) is required. The
entire amount of the 10 downward adjustment is
allocated to the property D, reducing its basis to
5. Thus, the basis of property C is 15 in the hands
of the distributee partner, and the basis of
property D is 5 in the hands of the distributee
partner.
Effective
Date
The provision applies to partnership distributions
after the date of enactment.
5.
Treatment of inventory items of a partnership (sec.
875 of the bill and sec. 751 of the Code)
Present
Law
Under present law, upon the sale or exchange of a
partnership interest, any amount received that is
attributable to unrealized receivables, or to
inventory that has substantially appreciated, is
treated as an amount realized from the sale or
exchange of property that is not a capital asset
(sec. 751(a)).
Present law provides a similar rule to the extent
that a distribution is treated as a sale or exchange
of a partnership interest. A distribution by a
partnership in which a partner receives
substantially appreciated inventory or unrealized
receivables in exchange for its interest in certain
other partnership property (or receives certain
other property in exchange for its interest in
substantially appreciated inventory or unrealized
receivables) is treated as a taxable sale or
exchange of property, rather than as a nontaxable
distribution (sec. 751(b)).
For purposes of these rules, inventory of a
partnership generally is treated as substantially
appreciated if the fair market value of the
inventory exceeds 120 percent of adjusted basis of
the inventory to the partnership (sec.
751(d)(1)(A)). In applying this rule, inventory
property is excluded from the calculation if a
principal purpose for acquiring the inventory
property was to avoid the rules relating to
inventory (sec. 751(d)(1)(B)).
Reasons
for Change
The substantial appreciation requirement with
respect to inventory of a partnership has been
criticized as both ineffective at insulating
partnerships from the potential complexity of the
disproportionate distribution rules of section
751(b), and also ineffective at properly treating
income attributable to inventory as ordinary income
under the section 751 rules for partnerships with
profit margins below 20 percent.117
Because the Committee believes that income
attributable to inventory should be treated as
ordinary income, the bill repeals the substantial
appreciation requirement with respect to inventory,
in the case of partnership sales, exchanges and
distributions.
Explanation
of Provision
The provision eliminates the requirement that
inventory be substantially appreciated in order to
give rise to ordinary income under the rules
relating to sales and exchanges of partnership
interests and certain partnership distributions.
This conforms the treatment of inventory to the
treatment of unrealized receivables under these
rules.
Effective
Date
The provision is effective for sales, exchanges, and
distributions after the date of enactment.
6.
Eligibility for income forecast method (sec. 876 of
the bill and secs. 167 and 168 of the Code)
Present
Law
A taxpayer generally recovers the cost of property
used in a trade or business through depreciation or
amortization deductions over time. Tangible property
generally is depreciated under the modified
Accelerated Cost Recovery System ("MACRS")
of section 168, which applies specific recovery
periods and depreciation methods to the cost of
various types of depreciable property. Intangible
property generally is amortized under section 197,
which applies a 15-year recovery period and the
straight-line method to the cost of applicable
property.
MACRS does not apply to certain property, including
any motion picture film, video tape, or sound
recording or to other any property if the taxpayer
elects to exclude such property from MACRS and the
taxpayer 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 transaction (or a series of related
transactions) involving the acquisition of assets
constituting a trade or business or substantial
portion thereof. Thus, 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 recovered under
either the MACRS depreciation provisions or under
the section 197 amortization provisions. The cost of
such property may be depreciated under the
"income forecast" method.
The income forecast method is considered to be a
method of depreciation not expressed in a term of
years. Under the income forecast method, the
depreciation deduction for a taxable year for a
property is determined by multiplying the cost of
the property (less estimated salvage value) by a
fraction, the numerator of which is the income
generated by the property during the year and the
denominator of which is the total forecasted or
estimated income to be derived from the property
during its useful life. The income forecast method
is available to any property if (1) the taxpayer
elects to exclude such property from MACRS and (2)
for the first taxable year for which depreciation is
allowable, the property is properly depreciated
under such method. The income forecast method has
been held to be applicable for computing
depreciation deductions for motion picture films,
television films and taped shows, books, patents,
master sound recordings and video games.118
Most recently, the income forecast method has been
held applicable to consumer durable property subject
to short-term "rent-to-own" leases.119
Reasons
for Change
Depreciation allowances attempt to measure the
decline in the value of property due to wear, tear,
and obsolescence and to match the cost recovery for
the property with the income stream produced by the
property. The committee believes that the income
forecast method of depreciation is, in theory, an
appropriate method to match the recovery of cost of
property with the income stream produced by the
property. However, when compared to MACRS, the
income forecast method involves significant
complexities, including the determination of the
income estimated to be generated by the property,
the determination of the residual value of the
property, and the application of the look-back
method. Thus, the committee believes that the
availability of the income forecast method should be
limited to instances where the economic depreciation
of the property cannot be adequately reflected by
the passage of time alone or where the income stream
from the property is sufficiently unpredictable or
uneven such that the application of another method
of depreciation may result in the distortion of
income. In addition, because the income forecast
method is elective, the committee is concerned about
taxpayer selectivity.
Finally, the committee provides a MACRS class life
for certain depreciable consumer durables subject to
rent-to-own contracts, in order to avoid future
controversies with respect to the proper treatment
of such property.
Explanation
of Provision
The bill clarifies the types of property to which
the income forecast method may be applied. Under the
bill, the income forecast method is available to
motion picture films, television films and taped
shows, books, patents, master sound recordings,
copyrights, and other such property as designated by
the Secretary of the Treasury. It is expected that
the Secretary will exercise this authority such that
the income forecast method will be available to
property the economic depreciation of which cannot
be adequately measured by the passage of time alone
or to property the income from which is sufficiently
unpredictable or uneven so as to result in the
distortion of income. The mere fact that property is
subject to a lease should not make the property
eligible for the income forecast method. The income
forecast method is not be applicable to property to
which section 197 applies.
In addition, consumer durables subject to
rent-to-own contracts are provided a three-year
recovery period and a four-year class life for MACRS
purposes (and would not be eligible for the income
forecast method). Such property generally is
described in Rev. Proc. 95-38, 1995-34 I.R.B. 25.
Effective
Date
The provision is effective for property placed in
service after the date of enactment.
7.
Modify the exception to the related party rule of
section 1033 for individuals to only provide an
exception for de minimis amounts (sec. 877 of the
bill and sec. 1033 of the Code)
Present
Law
Under section 1033, gain realized by a taxpayer from
certain involuntary conversions of property is
deferred to the extent the taxpayer purchases
property similar or related in service or use to the
converted property within a specified replacement
period of time. Pursuant to a provision of Public
Law 104-7, subchapter C corporations (and certain
partnerships with corporate partners) are not
entitled to defer gain under section 1033 if the
replacement property or stock is purchased from a
related person. A person is treated as related to
another person if the person bears a relationship to
the other person described in section 267(b) or
707(b)(1). An exception to this related party rule
provides that a taxpayer could purchase replacement
property or stock from a related person and defer
gain under section 1033 to the extent the related
person acquired the replacement property or stock
from an unrelated person within the replacement
period.
Reasons
for Change
The committee believes that, except for de minimis
cases, individuals should be subject to the same
rules with respect to the acquisition of replacement
property from a related person as are other
taxpayers.
Explanation
of Provision
The bill expands the present-law denial of the
application of section 1033 to any other taxpayer
(including an individual) that acquires replacement
property from a related party (as defined by secs.
267(b) and 707(b)(1)) unless the taxpayer has
aggregate realized gain of $100,000 or less for the
taxable year with respect to converted property with
aggregate realized gains. In the case of a
partnership (or S corporation), the annual $100,000
limitation applies to both the partnership (or S
corporation) and each partner (or shareholder).
Effective
Date
The provision applies to involuntary conversions
occurring after June 8, 1997.
|
