Revenue Reconciliation Act
page6
 
8.
Repeal of exception for certain sales by
manufacturers to dealer (sec. 878 of the bill and
sec. 811(c)(9) of the Tax Reform Act of 1986 (P.L.
99-514))
Present
Law
In general, the installment sales method of
accounting may not be used by dealers in personal
property. Present law provides an exception which
permits the use of the installment method for
installment obligations arising from the sale of
tangible personal property by a manufacturer of the
property (or an affiliate of the manufacturer) to a
dealer,120
but only if the dealer is obligated to make payments
of principal only when the dealer resells (or rents)
the property, the manufacturer has the right to
repurchase the property at a fixed (or
ascertainable) price after no longer than a nine
month period following the sale to the dealer, and
certain other conditions are met. In order to meet
the other conditions, the aggregate face amount of
the installment obligations that otherwise qualify
for the exception must equal at least 50 percent of
the total sales to dealers that gave rise to such
receivables (the "fifty percent test") in
both the taxable year and the preceding taxable
year, except that, if the taxpayer met all of the
requirements for the exception in the preceding
taxable year, the taxpayer would not be treated as
failing to meet the fifty percent test before the
second consecutive year in which the taxpayer did
not actually meet the test. For purposes of applying
the fifty percent test, the aggregate face amount of
the taxpayer's receivables is computed using the
weighted average of the taxpayer's receivables
outstanding at the end of each month during the
taxpayer's taxable year. In addition, these
requirements must be met by the taxpayer in its
first taxable year beginning after October 22, 1986,
except that obligations issued before that date are
treated as meeting the applicable requirements if
such obligations were conformed to the requirements
of the provision within 60 days of that date.
Reasons
for Change
The committee believes that the special exception
that permitted certain dealers to use the
installment method is no longer necessary or
approriate and the installment sale method of
accounting should not be available to such dealers.
Accordingly, the committee bill repeals that
exception.
Explanation
of Provision
The bill repeals the exception that permits the use
of the installment method of accounting for certain
sales by manufacturers to dealers.
Effective
Date
The provision is effective for taxable years
beginning one year after the date of enactment. Any
resulting adjustment from a required change in
accounting will be includible ratably over the
4-year taxable years beginning after that date.
9.
Cash out of certain accrued benefits (sec. 879 of
the bill and secs. 411 and 417 of the Code)
Present
Law
Under present law, in the case of an employee whose
plan participation terminates, a qualified plan may
involuntarily "cash out" the benefit
(i.e., pay out the balance to the credit of a plan
participant without the participant's consent, and,
if applicable, the consent of the participant's
spouse) if the present value of the benefit does not
exceed $3,500. If a benefit is cashed out under this
rule and the participant subsequently returns to
employment covered by the plan, then service taken
into account in computing benefits payable under the
plan after the return need not include service with
respect to which benefits were cashed out unless the
employee "buys back" the benefit.
Generally, a cash-out distribution from a qualified
plan to a plan participant can be rolled over, tax
free, to an IRA or to another qualified plan.
Reasons
for Change
The Committee believes that the limit on involuntary
cash-outs should be raised to $5,000 in recognition
of the effects of inflation and the value of small
benefits payable under a qualified pension plan.
Explanation
of Provision
The bill increases the limit on involuntary
cash-outs to $5,000 from $3,500. The $5,000 amount
is adjusted annually for inflation beginning after
1997 in $50 increments. The bill will also make the
corresponding changes to the Employee Retirement
Income Security Act of 1974, as amended ("ERISA").
Effective
Date
The provision is effective for plan years beginning
on and after the date of enactment.
10.
Election to receive taxable cash compensation in
lieu of nontaxable parking benefits (sec. 880 of the
bill and sec. 132 of the Code)
Present
Law
Under present law, up to $165 per month of
employer-provided parking is excludable from gross
income. In order for the exclusion to apply, the
parking must be provided in addition to and not in
lieu of any compensation that is otherwise payable
to the employee. Employer-provided parking cannot be
provided as part of a cafeteria plan.
Reasons
for Change
The Committee believes that the present-law rules
relating to employer-provided parking result in an
overutilization of parking as a fringe benefit. By
permitting employers to offer cash compensation in
lieu of parking, the Committee believes that
employees will be more likely to elect to receive
cash compensation, which will increase the electing
employees' taxable income. In addition, the election
to take cash may promote sound energy policy by
increasing the use of mass transit and reduce the
amount of commuting by car.
Explanation
of Provision
Under the bill, no amount is includible in the
income of an employee merely because the employer
offers the employee a choice between cash and
employer-provided parking. The amount of cash
offered is includible in income only if the employee
chooses the cash instead of parking.
Effective
Date
The provision is effective with respect to taxable
years beginning after December 31, 1997.
11.
Extension of Federal unemployment surtax (sec. 881
of the bill and sec. 3301 of the Code)
Present
Law
The Federal Unemployment Tax Act (FUTA) imposes a
6.2-percent gross tax rate on the first $7,000 paid
annually by covered employers to each employee.
Employers in States with programs approved by the
Federal Government and with no delinquent Federal
loans may credit 5.4-percentage points against the
6.2-percent tax rate, making the minimum, net
Federal unemployment tax rate 0.8 percent. Since all
States have approved programs, 0.8 percent is the
Federal tax rate that generally applies. This
Federal revenue finances administration of the
system, half of the Federal-State extended benefits
program, and a Federal account for State loans. The
States use the revenue turned back to them by the
5.4 percent credit to finance their regular State
programs and half of the Federal-State extended
benefits program.
In 1976, Congress passed a temporary surtax of 0.2
percent of taxable wages to be added to the
permanent FUTA tax rate. Thus, the current 0.8
percent FUTA tax rate has two components: a
permanent tax rate of 0.6 percent, and a temporary
surtax rate of 0.2 percent. The temporary surtax has
been subsequently extended through 1998.
Reasons
for Change
The Committee believes that the surtax extension
will increase the Federal Unemployment Trust Fund to
provide a cushion against future expenditures. The
monies retained in the Federal Unemployment Account
of the Federal Unemployment Trust Fund can then be
used to make loans to the 53 State Unemployment
Compensation benefit accounts as needed.
Explanation
of Provision
The bill extends the temporary surtax rate through
December 31, 2007. The bill also increases the limit
from 0.25 percent to 0.50 percent of covered wages
on the Federal Unemployment Account (FUA) in the
Unemployment Trust Fund
Effective
Date
The provision is effective for labor performed on or
after January 1, 1999.
12.
Repeal of excess distribution and excess retirement
accumulation taxes (sec. 882 of the bill and sec.
4980A of the Code)
Present
Law
Under present law, a 15-percent excise tax is
imposed on excess distributions from qualified
retirement plans, tax-sheltered annuities, and IRAs.
Excess distributions are generally the aggregate
amount of retirement distributions from such plans
during any calendar year in excess of $160,000 (for
1997) or 5 times that amount in the case of a
lump-sum distribution. The 15-percent excise tax
does not apply to distributions received in 1997,
1998, and 1999.
An additional 15-percent estate tax is imposed on an
individual's excess retirement accumulations. Excess
retirement accumulations are generally the balance
in retirement plans in excess of the present value
of a benefit that would not be subject to the
15-percent tax in excess distributions.
Reasons
for Change
The excess distribution and retirement accumulation
taxes are designed to limit the overall tax-deferred
savings by individuals, as well as to help ensure
that tax-favored retirement vehicles are used
primarily for retirement purposes. The Committee
believes that the limits on contributions and
benefits applicable to each type of vehicle are
sufficient limits on tax-deferred savings.
Additional penalties are unnecessary, and may also
deter individuals from saving. The excess
accumulation and distribution taxes also
inappropriately penalize favorable investment
returns.
Explanation
of Provision
The bill repeals both the 15-percent excise tax on
excess distributions and the 15-percent estate tax
on excess retirement accumulations.
Effective
Date
The provision repealing the excess distribution tax
is effective with respect to excess distributions
received after December 31, 1996. The repeal of the
excess accumulation tax is effective with respect to
decedents dying after December 31, 1996.
13.
Treatment of charitable remainder trusts with
greater than 50 percent annual payout (sec. 883 of
the bill and sec. 664 of the Code)
Present
Law
In
general
Sections 170(f), 2055(e)(2) and 2522(c)(2) disallow
a charitable deduction for income, estate or gift
tax purposes, respectively, where the donor
transfers an interest in property to a charity (e.g.,
a remainder) while also either retaining an interest
in that property (e.g., an income interest)
or transferring an interest in that property to a
noncharity for less than full and adequate
consideration. Exceptions to this general rule are
provided for (1) remainder interests in charitable
remainder annuity trusts, charitable remainder
unitrusts, pooled income funds, farms, and personal
residences; (2) present interests in the form of a
guaranteed annuity or a fixed percentage of the
annual value of the property, (3) an undivided
portion of the donor's entire interest in the
property, and (4) a qualified conservation easement.
Charitable
remainder annuity trusts and charitable remainder
unitrusts
A charitable remainder annuity trust is a trust
which is required to pay, at least annually, a fixed
dollar amount at least 5 percent of the initial
value of the trust to a non-charity for the life of
an individual or period of less than 20 years, with
the remainder passing to charity. A charitable
remainder unitrust is a trust which generally is
required to pay, at least annually, a fixed
percentage of the fair market value of the trust's
assets determined at least annually to a non-charity
for the life of an individual or period less than 20
years, with the remainder passing to charity. Sec.
664(d).
Distributions from a charitable remainder annuity
trust or charitable remainder unitrust are treated
in the following order as: (1) ordinary income to
the extent of the trust's current and previously
undistributed ordinary income for the trust's year
in which the distribution occurred, (2) capital
gains to the extent of the trust's current capital
gain and previously undistributed capital gain for
the trust's year in which the distribution occurred;
(3) other income (e.g., tax-exempt income) to
the extent of the trust's current and previously
undistributed other income for the trust's year in
which the distribution occurred, and (4) corpus.
Sec. 664(b).
Distributions are includible in the income of the
beneficiary for the year that the annuity or
unitrust amount is required to be distributed even
though the annuity or unitrust amount is not
distributed until after the close of the trust's
taxable year. Treas. Reg. sec. 1.664-1(d)(4).
Reasons
for Change
The Committee is concerned that the interplay of the
rules governing the timing of income from
distributions from charitable remainder trusts (i.e.,
Treas. Reg. sec. 1.664-1(d)(4)) and the rules
governing the character of distributions (i.e.,
sec. 664(b)) have created opportunities for abuse
where the required annual payments are a large
portion of the trust and realization of income and
gain can be postponed until a year later than the
accrual of such large payments. For example, some
taxpayers have been creating charitable remainder
unitrusts with a required annual payout of 80
percent of the trust's assets and then funding the
trust with highly appreciated nondividend paying
stock which the trust sells in a year subsequent to
when the required distribution is includible in the
beneficiary's income, and using proceeds from that
sale to pay the required distribution attributable
to the prior year. Those taxpayers have treated the
distribution of 80 percent of the trust's assets
attributable to the trust's first required
distribution as non-taxable distributions of corpus
because the trust had not realized any income in its
first taxable year. The Committee believes that such
treatment is abusive and is inconsistent with the
purpose of the charitable remainder trust rules. In
order to limit this kind of abuse, the Committee
bill provides that a trust cannot be a charitable
remainder trust if the required payout is greater
than 50 percent of the initial fair market value of
the trusts assets (in the case of a charitable
remainder annuity trust) or 50 percent of the annual
value of the trusts assets (in the case of a
charitable remainder unitrust).
On April 18, 1997, the Treasury Department proposed
regulations providing additional rules under
sections 664 and 2702 to address the abuse described
above and other perceived abuses involving
distributions from charitable remainder trusts. One
of those proposed rules would require that payment
of any required annuity or unitrust amount by a
charitable remainder trust be made by the close of
the trust's taxable year in which such payments are
due. See Prop. Treas. Reg. secs. 1.664-2(a)(1)(i)
and 1.664-3(a)(1)(i). The Committee intends that the
provision of the Committee bill does not limit or
alter the validity of the regulations proposed by
the Treasury Department on April 18, 1997, or the
Treasury Department's authority to address this or
other abuses of the rules governing the taxation of
charitable remainder trusts or their beneficiaries.
Explanation
of Provision
Under the provision, a trust would not qualify as
charitable remainder annuity trust if the annuity
for a year is greater than 50 percent of the initial
fair market value of the trust's assets or a trust
would not qualify as a charitable remainder unitrust
if the percentage of assets that are required to be
distributed at least annually is greater than 50
percent. Any trust that fails this 50 percent rule
will not be a charitable remainder trust whose
taxation is governed under section 664, but will be
treated as a complex trust and, accordingly, all of
its income will be taxed to its beneficiaries or to
the trust.
Effective
Date
The provision applies to transfers to a trust made
after June 18, 1997.
14.
Tax on prohibited transactions (sec. 884 of
the
bill and sec. 4975 of the Code)
Present
Law
Present law prohibits certain transactions
(prohibited transactions) between a qualified plan
and a disqualified person in order to prevent
persons with a close relationship to the qualified
plan from using that relationship to the detriment
of plan participants and beneficiaries. A two-tier
excise tax is imposed on prohibited transactions.
The initial level tax was equal to 10-percent of the
amount involved with respect to the transaction. If
the transaction is not corrected within a certain
period, a tax equal to 100 percent of the amount
involved may be imposed.
Reasons
for Change
The Committee believes it is appropriate to increase
the initial level prohibited transaction tax to
discourage disqualified persons from engaging in
such transactions.
Explanation
of Provision
The bill increases the initial-level prohibited
transaction tax from 10-percent to 15-percent. No
changes were made to the prohibited transaction
provisions of title I of the Employee Retirement
Income Security Act of 1974, as amended ("ERISA").
Effective
Date
The provision is effective with respect to
prohibited transactions occurring after the date of
enactment.
15.
Basis recovery rules (sec. 885 of the bill and sec.
72 of the Code)
Present
Law
Under present law, amounts received as an annuity
under a tax-qualified pension plan generally are
includible in income in the year received, except to
the extent the amount received represents return of
the recipient's investment in the contract (i.e.,
basis). The portion of each annuity payment that
represents a return of basis generally is determined
by a simplified method. Under this method, the
portion of each annuity payment that is a return to
basis is equal to the employee's total basis as of
the annuity starting date, divided by the number of
anticipated payments under a specified table, shown
below. The number of anticipated payments listed in
the table is based on the age of the primary
annuitant on the annuity starting date.
Age of Primary Annuitant Number of
Payments:
55 or less 360
56-60 310
61-65 260
66-70 210
71 or more 160
If the number of payments is fixed under the terms
of the annuity, that number is used instead of the
number of anticipated payments listed in the table.
The simplified method is not available if the
primary annuitant has attained age 75 on the annuity
starting date unless there are fewer than 5 years of
guaranteed payments under the annuity. If, in
connection with commencement of annuity payments,
the recipient receives a lump-sum payment that is
not part of the annuity stream, such payment is
taxable under the rules relating to annuities (sec.
72) as if received before the annuity starting date,
and the investment in the contract used to calculate
the simplified exclusion ratio for the annuity
payments is reduced by the amount of the payment. In
no event is the total amount excluded from income as
nontaxable return of basis greater than the
recipient's total investment in the contract.
Reasons
for Change
The table for determining anticipated payments does
not differ depending on whether the annuity is
payable in the form of a single life annuity or a
joint and survivor annuity. Applying the table for
single life annuities to joint and survivor
annuities understates the expected payments under a
joint and survivor annuity.
Explanation
of Provision
Under the bill, the present-law table would apply to
benefits based on the life of one annuitant. A
separate table would apply to benefits based on the
life of more than one annuitant, as follows:
Combined age of annuitants: No. of payments:
110 or less 410
111-120 360
121-130 310
131-140 260
141 and over 210
Effective
Date
The provision is effective with respect to annuity
starting dates beginning after December 31, 1997.
TITLE
IX. FOREIGN-RELATED SIMPLIFICATION PROVISIONS
1.
General provisions affecting treatment of controlled
foreign corporations (secs. 911-913 of the bill and
secs. 902, 904, 951, 952, 959, 960, 961, 964, and
1248 of the Code)
Present
Law
If an upper-tier controlled foreign corporation
("CFC") sells stock of a lower-tier CFC,
the gain generally is included in the income of
U.S.
10-percent shareholders as subpart F income and such
U.S.
shareholder's basis in the stock of the first-tier
CFC is increased to account for the inclusion. The
inclusion is not characterized for foreign tax
credit limitation purposes by reference to the
nature of the income of the lower-tier CFC; instead
it generally is characterized as passive income.
For purposes of the foreign tax credit limitations
applicable to so-called 10/50 companies, a CFC is
not treated as a 10/50 company with respect to any
distribution out of its earnings and profits for
periods during which it was a CFC and, except as
provided in regulations, the recipient of the
distribution was a U.S. 10-percent shareholder in
such corporation.
If subpart F income of a lower-tier CFC is included
in the gross income of a
U.S.
10-percent shareholder, no provision of present law
allows adjustment of the basis of the upper-tier
CFC's stock in the lower-tier CFC.
The subpart F income earned by a foreign corporation
during its taxable year is taxed to the persons who
are
U.S.
10-percent shareholders of the corporation on the
last day, in that year, on which the corporation is
a CFC. In the case of a U.S. 10-percent shareholder
who acquired stock in a CFC during the year, such
inclusions are reduced by all or a portion of the
amount of dividends paid in that year by the foreign
corporation to any person other than the acquiror
with respect to that stock.
As a general rule, subpart F income does not include
income earned from sources within the
United States
if the income is effectively connected with the
conduct of a
U.S.
trade or business by the CFC. This general rule does
not apply, however, if the income is exempt from, or
subject to a reduced rate of,
U.S.
tax pursuant to a provision of a
U.S.
treaty.
A
U.S.
corporation that owns at least 10 percent of the
voting stock of a foreign corporation is treated as
if it had paid a share of the foreign income taxes
paid by the foreign corporation in the year in which
the foreign corporation's earnings and profits
become subject to
U.S.
tax as dividend income of the
U.S.
shareholder. A
U.S.
corporation also may be deemed to have paid taxes
paid by a second- or third-tier foreign corporation
if certain conditions are satisfied.
Reasons
for Change
The Committee believes that complexities are caused
by uncertainties and gaps in the present statutory
schemes for taxing gains on dispositions of stock in
CFCs as dividend income or subpart F income. The
Committee believes that it is appropriate to reduce
complexities by rationalizing these rules.
The Committee also understands that certain
arbitrary limitations placed on the operation of the
indirect foreign tax credit may have resulted in
taxpayers undergoing burdensome and sometimes costly
corporate restructuring. In other cases, there is
concern that these limitations may have contributed
to decisions by
U.S.
companies against acquiring foreign subsidiaries.
The Committee deems it appropriate to ease these
restrictions.
Explanation
of Provision
Lower-tier
CFCs
Characterization
of gain on stock disposition
Under the bill, if a CFC is treated as having gain
from the sale or exchange of stock in a foreign
corporation, the gain is treated as a dividend to
the same extent that it would have been so treated
under section 1248 if the CFC were a
U.S.
person. This provision, however, does not affect the
determination of whether the corporation whose stock
is sold or exchanged is a CFC.
Thus, for example, if a U.S. corporation owns 100
percent of the stock of a foreign corporation, which
owns 100 percent of the stock of a second foreign
corporation, then under the bill, any gain of the
first corporation upon a sale or exchange of stock
of the second corporation is treated as a dividend
for purposes of subpart F income inclusions to the
U.S. shareholder, to the extent of earnings and
profits of the second corporation attributable to
periods in which the first foreign corporation owned
the stock of the second foreign corporation while
the latter was a CFC with respect to the U.S.
shareholder.
Gain on disposition of stock in a related
corporation created or organized under the laws of,
and having a substantial part of its assets in a
trade or business in, the same foreign country as
the gain recipient, even if recharacterized as a
dividend under the proposal, is not excluded from
foreign personal holding company income under the
same-country exception that applies to actual
dividends.
Under the bill, for purposes of this rule, a CFC is
treated as having sold or exchanged stock if, under
any provision of subtitle A of the Code, the CFC is
treated as having gain from the sale or exchange of
such stock. Thus, for example, if a CFC distributes
to its shareholder stock in a foreign corporation,
and the distribution results in gain being
recognized by the CFC under section 311(b) as if the
stock were sold to the shareholder for fair market
value, the bill makes clear that, for purposes of
this rule, the CFC is treated as having sold or
exchanged the stock.
The bill also repeals a provision added to the Code
by the Technical and Miscellaneous Revenue Act of
1988 that, except as provided by regulations,
requires a recipient of a distribution from a CFC to
have been a U.S. 10-percent shareholder of that CFC
for the period during which the earnings and profits
which gave rise to the distribution were generated
in order to avoid treating the distribution as one
coming from a 10/50 company. Thus, under the bill, a
CFC is not treated as a 10/50 company with respect
to any distribution out of its earnings and profits
for periods during which it was a CFC, whether or
not the recipient of the distribution was a U.S.
10-percent shareholder of the corporation when the
earnings and profits giving rise to the distribution
were generated.
Adjustments
to basis of stock
Under the bill, when a lower-tier CFC earns subpart
F income, and stock in that corporation is later
disposed of by an upper-tier CFC, the resulting
income inclusion of the U.S. 10-percent
shareholders, under regulations, is to be adjusted
to account for previous inclusions, in a manner
similar to the adjustments provided to the basis of
stock in a first-tier CFC. Thus, just as the basis
of a U.S. 10-percent shareholder in a first-tier CFC
rises when subpart F income is earned and falls when
previously taxed income is distributed, so as to
avoid double taxation of the income on a later
disposition of the stock of that company, the
subpart F income from gain on the disposition of a
lower-tier CFC generally is reduced by income
inclusions of earnings that were not subsequently
distributed by the lower-tier CFC.
For example, assume that a
U.S.
person is the owner of all of the stock of a
first-tier CFC which, in turn, is the sole
shareholder of a second-tier CFC. In year 1, the
second-tier CFC earns $100 of subpart F income which
is included in the
U.S.
person's gross income for that year. In year 2, the
first-tier CFC disposes of the second-tier CFC's
stock and recognizes $300 of income with respect to
the disposition. All of that income constitutes
subpart F foreign personal holding company income.
Under the bill, the Secretary is granted regulatory
authority to reduce the U.S. person's year 2 subpart
F inclusion by $100 --the amount of year 1 subpart F
income of the second-tier CFC that was included, in
that year, in the U.S. person's gross income. Such
an adjustment, in effect, allows for a step-up in
the basis of the stock of the second-tier CFC to the
extent of its subpart F income previously included
in the
U.S.
person's gross income.
Subpart
F inclusions in year of acquisition
If a U.S. 10-percent shareholder acquires the stock
of a CFC from another U.S. 10-percent shareholder
during a taxable year of the CFC in which it earns
subpart F income, the proposal reduces the
acquiror's subpart F income inclusion for that year
by a portion of the amount of the dividend deemed
(under sec. 1248) to be received by the transferor.
The portion by which the inclusion is reduced (as is
the case if a dividend was paid to the previous
owner of the stock) does not exceed the lesser of
the amount of dividends with respect to such stock
deemed received (under sec. 1248) by other persons
during the year or the amount determined by
multiplying the subpart F income for the year by the
proportion of the year during which the acquiring
shareholder did not own the stock.
Treatment
of U.S. income earned by a CFC
Under the bill, an exemption or reduction by treaty
of the branch profits tax that would be imposed
under section 884 on a CFC does not affect the
general statutory exemption from subpart F income
that is granted for
U.S.
source effectively connected income. For example,
assume a CFC earns income of a type that generally
would be subpart F income, and that income is earned
from sources within the
United States
in connection with business operations therein.
Further assume that repatriation of that income is
exempted from the
U.S.
branch profits tax under a provision of an
applicable
U.S.
income tax treaty. The bill provides that,
notwithstanding the treaty's effect on the branch
tax, the income is not treated as subpart F income
as long as it is not exempt from U.S. taxation (or
subject to a reduced rate of tax) under any other
treaty provision.
Extension
of indirect foreign tax credit
The bill extends the application of the indirect
foreign tax credit (secs. 902 and 960) to taxes paid
or accrued by certain fourth-, fifth-, and
sixth-tier foreign corporations. In general, three
requirements are required to be satisfied by a
foreign company at any of these tiers to qualify for
the credit. First, the company must be a CFC.
Second, the
U.S.
corporation claiming the credit under section 902(a)
must be a
U.S.
shareholder (as defined in sec. 951(b)) with respect
to the foreign company. Third, the product of the
percentage ownership of voting stock at each level
from the
U.S.
corporation down must equal at least 5 percent. The
bill limits the application of the indirect foreign
tax credit below the third tier to taxes paid or
incurred in taxable years during which the payor is
a CFC. Foreign taxes paid below the sixth tier of
foreign corporations remain ineligible for the
indirect foreign tax credit.
Effective
Dates
Lower-tier CFCs. --The provision that treats
gains on dispositions of stock in lower-tier CFCs as
dividends under section 1248 principles applies to
gains recognized on transactions occurring after the
date of enactment.
The provision that expands look-through treatment,
for foreign tax credit limitation purposes, of
dividends from CFCs is effective for distributions
after the date of enactment.
The provision that provides for regulatory
adjustments to
U.S.
shareholder inclusions, with respect to gains of
CFCs from dispositions of stock in lower-tier CFCs
is effective for determining inclusions for taxable
years of
U.S.
shareholders beginning after December 31, 1997.
Thus, the bill permits regulatory adjustments to an
inclusion occurring after the effective date to
account for income that was previously taxed under
the subpart F provisions either prior to or
subsequent to the effective date.
Subpart F inclusions in year of acquisition.
--The provision that permits dispositions of stock
to be taken into consideration in determining a
U.S.
shareholder's subpart F inclusion for a taxable year
is effective with respect to dispositions occurring
after the date of enactment.
Treatment of
U.S.
source income earned by a CFC. --The provision
concerning the effect of treaty exemptions from, or
reductions of, the branch profits tax on the
determination of subpart F income is effective for
taxable years beginning after December 31, 1986.
Extension of indirect foreign tax credit.
--The provision that extends application of the
indirect foreign tax credit to certain CFCs below
the third tier is effective for foreign taxes paid
or incurred by CFCs for taxable years of such
corporations beginning after the date of enactment.
In the case of any chain of foreign corporations,
the taxes of which would be eligible for the
indirect foreign tax credit, under present law or
under the bill, but for the denial of indirect
credits below the third or sixth tier, as the case
may be, no liquidation, reorganization, or similar
transaction in a taxable year beginning after the
date of enactment will have the effect of permitting
taxes to be taken into account under the indirect
foreign tax credit provisions of the Code which
could not have been taken into account under those
provisions but for such transaction.
2.
Simplify formation and operation of international
joint ventures (secs. 921, 931-935, and 941 of the
bill and secs. 367, 721, 1491-1494, 6031, 6038,
6038B, 6046A, and 6501 of the Code)
Present
Law
Under section 1491, an excise tax generally is
imposed on transfers of property by a
U.S.
person to a foreign corporation as paid-in surplus
or as a contribution to capital or to a foreign
partnership, estate or trust. The tax is 35 percent
of the amount of gain inherent in the property
transferred but not recognized for income tax
purposes at the time of the transfer. However,
several exceptions to the section 1491 excise tax
are available. Under section 1494(c), a substantial
penalty applies in the case of a failure to report a
transfer described in section 1491.
Section 367 applies to require gain recognition upon
certain transfers by
U.S.
persons to foreign corporations. Under section
367(d), a U.S. person that contributes intangible
property to a foreign corporation is treated as
having sold the property to the corporation and is
treated as receiving deemed royalty payments from
the corporation. These deemed royalty payments are
treated as
U.S.
source income. A
U.S.
person may elect to apply similar rules to a
transfer of intangible property to a foreign
partnership that otherwise would be subject to the
section 1491 excise tax.
A foreign partnership may be required to file a
partnership return. If a foreign partnership fails
to file a required return, losses and credits with
respect to the partnership may be disallowed to the
partnership. A U.S. person that acquires or disposes
of an interest in a foreign partnership, or whose
proportional interest in the partnership changes
substantially, may be required to file an
information return with respect to such event.
A partnership generally is considered to be a
domestic partnership if it is created or organized
in the
United States
or under the laws of the
United States
or any State. A foreign partnership generally is any
partnership that is not a domestic partnership.
Reasons
for Change
The Committee understands that the present-law rules
imposing an excise tax on certain transfers of
appreciated property to a foreign entity unless the
requirements for an exception from such excise tax
are satisfied operate as a trap for the unwary. The
Committee further understands that the special
source rule of present law for deemed royalty
payments with respect to a transfer of an
appreciated intangible to a foreign corporation was
intended to discourage such transfers. The Committee
believes that the imposition of enhanced information
reporting obligations with respect to both foreign
partnerships and foreign corporations would
eliminate the need for both of these sets of rules.
Explanation
of Provision
The bill repeals the sections 1491-1494 excise tax
and information reporting rules that apply to
certain transfers of appreciated property by a
U.S.
person to a foreign entity. Instead of the excise
tax that applies under present law to transfers to a
foreign estate or trust, gain recognition is
required upon a transfer of appreciated property by
a
U.S.
person to a foreign estate or trust. Instead of the
excise tax that applies under present law to certain
transfers to foreign corporations, regulatory
authority is granted under section 367 to deny
nonrecognition treatment to such a transfer in a
transaction that is not otherwise described in
section 367. Instead of the excise tax that applies
under present law to transfers to foreign
partnerships, regulatory authority is granted to
provide for gain recognition on a transfer of
appreciated property to a partnership in cases where
such gain otherwise would be transferred to a
foreign partner. In addition, regulatory authority
is granted to deny the nonrecognition treatment that
is provided under section 1035 to certain exchanges
of insurance policies, where the transfer is to a
foreign person.
The bill repeals the rule that treats as
U.S.
source income any deemed royalty arising under
section 367(d). Under the bill, in the case of a
transfer of intangible property to a foreign
corporation, the deemed royalty payments under
section 367(d) are treated as foreign source income
to the same extent that an actual royalty payment
would be considered to be foreign source income.
Regulatory authority is granted to provide similar
treatment in the case of a transfer of intangible
property to a foreign partnership.
The bill provides detailed information reporting
rules in the case of foreign partnerships. A foreign
partnership generally is required to file a
partnership return for a taxable year if the
partnership has
U.S.
source income or is engaged in a
U.S.
trade or business, except to the extent provided in
regulations.
Under the bill, reporting rules similar to those
applicable under present law in the case of
controlled foreign corporations apply in the case of
foreign partnerships. A
U.S.
partner that controls a foreign partnership is
required to file an annual information return with
respect to such partnership. For this purpose, a
U.S.
partner is considered to control a foreign
partnership if the partner holds a more than 50
percent interest in the capital, profits, or, to the
extent provided in regulations, losses, of the
partnership. Similar information reporting also will
be required from a
U.S.
10-percent partner of a foreign partnership that is
controlled by
U.S.
10-percent partners. A $10,000 penalty applies to a
failure to comply with these reporting requirements;
additional penalties of up to $50,000 apply in the
case of continued noncompliance after notification
by the Secretary of the Treasury. Under the bill,
the penalties for failure to report information with
respect to a controlled foreign corporation are
conformed with these penalties.
Under the bill, reporting by a U.S. person of an
acquisition or disposition of an interest in a
foreign partnership, or a change in the person's
proportional interest in the partnership, is
required only in the case of acquisitions,
dispositions, or changes involving at least a
10-percent interest. A $10,000 penalty applies to a
failure to comply with these reporting requirements;
additional penalties of up to $50,000 apply in the
case of continued noncompliance after notification
by the Secretary. Under the bill, the penalties for
failure to report information with respect to a
foreign corporation are conformed with these
penalties.
Under the bill, reporting rules similar to those
applicable under present law in the case of
transfers by
U.S.
persons to foreign corporations apply in the case of
transfers to foreign partnerships. These reporting
rules apply in the case of a transfer to a foreign
partnership only if the
U.S.
person holds at least a 10-percent interest in the
partnership or the value of the property transferred
by such person to the partnership during a 12-month
period exceeded $100,000. A penalty equal to 10
percent of the value of the property transferred
applies to a failure to comply with these reporting
requirements. Under the bill, the penalty under
present law for failure to report transfers to a
foreign corporation is conformed with this penalty.
In the case of a transfer to a foreign partnership,
failure to comply also results in gain recognition
with respect to the property transferred.
Under the bill, in the case of a failure to report
required information with respect to a foreign
corporation, partnership, or trust, the statute of
limitations with respect to any event or period to
which such information relates not expire before the
date that is three years after the date on which
such information is provided.
Under the bill, regulatory authority is granted to
provide rules treating a partnership as a domestic
or foreign partnership, where such treatment is more
appropriate, without regard to where the partnership
is created or organized. It is expected that a
recharcterization of a partnership under such
regulations will be based only on material factors
such as the residence of the partners and the extent
to which the partnership is engaged in business in
the
United States
or earns
U.S.
source income. It also is expected that such
regulations will provide guidance regarding the
determination of whether an entity that is a
partnership for Federal income tax purposes is to be
considered to be created or organized in the
United States
or under the law of the
United States
or any State.
Effective
Date
The provision s with respect to the repeal of
sections 1491-1494 are effective upon date of
enactment. The provisions with respect to the source
of a deemed royalty under section 367(d) also are
effective for transfers made and royalties deemed
received after date of enactment.
The provision s regarding information reporting with
respect to foreign partnerships generally are
effective for partnership taxable years beginning
after date of enactment. The provisions regarding
information reporting with respect to interests in,
and transfers to, foreign partnerships are effective
for transfers to, and changes in interest in,
foreign partnerships after date of enactment.
Taxpayers may elect to apply these rules to
transfers made after August 20, 1996 (and thereby
avoid a penalty under section 1494(c)) and the
Secretary may prescribe simplified reporting
requirements for these cases. The provision with
respect to the statute of limitations in the case of
noncompliance with reporting requirements is
effective for information returns due after date of
enactment.
The provision granting regulatory authority with
respect to the treatment of partnerships as foreign
or domestic is effective for partnership taxable
years beginning after date of enactment.
3.
Modification of reporting threshold for stock
ownership of a foreign corporation (sec. 936 of the
bill and sec. 6046 of the Code)
Present
Law
Several provisions of the Code require
U.S.
persons to report information with respect to a
foreign corporation in which they are shareholders
or officers or directors. Sections 6038 and 6035
generally require every
U.S.
citizen or resident who is an officer, or director,
or who owns at least 10 percent of the stock, of a
foreign corporation that is a controlled foreign
corporation or a foreign personal holding company to
file Form 5471 annually.
Section 6046 mandates the filing of information
returns by certain
U.S.
persons with respect to a foreign corporation upon
the occurrence of certain events.
U.S.
persons required to file these information returns
are those who acquire 5 percent or more of the value
of the stock of a foreign corporation, others who
become
U.S.
persons while owning that percentage of the stock of
a foreign corporation, and
U.S.
citizens and residents who are officers or directors
of foreign corporations with such
U.S.
ownership.
A failure to file the required information return
under section 6038 may result in monetary penalties
or reduction of foreign tax credit benefits. A
failure to file the required information returns
under sections 6035 or 6046 may result in monetary
penalties.
Reasons
for Change
The Committee believes that it is appropriate to
make the stock ownership threshold at which
reporting with respect to an ownership interest in a
foreign corporation is required generally parallel
to the thresholds that apply in the case of other
annual information reporting with respect to foreign
corporations. The Committee believes that increasing
the threshold for such reporting from 5 percent to
10 percent will reduce the compliance burdens on
taxpayers.
Explanation
of Provision
The bill increases the threshold for stock ownership
of a foreign corporation that results in information
reporting obligations under section 6046 from 5
percent (based on value) to 10 percent (based on
vote or value).
Effective
Date
The provision is effective for reportable
transactions occurring after December 31, 1997.
4.
Simplify translation of foreign taxes (sec. 902 of
the bill and secs. 905(c) and 986 of the Code)
Present
Law
Translation
of foreign taxes
Foreign income taxes paid in foreign currencies are
required to be translated into U.S. dollar amounts
using the exchange rate as of the time such taxes
are paid to the foreign country or
U.S.
possession. This rule applies to foreign taxes paid
directly by U.S. taxpayers, which taxes are
creditable in the year paid or accrued, and to
foreign taxes paid by foreign corporations that are
deemed paid by a U.S. corporation that is a
shareholder of the foreign corporation, and hence
creditable, in the year that the U.S. corporation
receives a dividend or has an income inclusion from
the foreign corporation.
Redetermination
of foreign taxes
For taxpayers that utilize the accrual basis of
accounting for determining creditable foreign taxes,
accrued and unpaid foreign tax liabilities
denominated in foreign currencies are translated
into U.S. dollar amounts at the exchange rate as of
the last day of the taxable year of accrual. If a
difference exists between the dollar value of
accrued foreign taxes and the dollar value of those
taxes when paid, a redetermination of foreign taxes
arises. A foreign tax redetermination may occur in
the case of a refund of foreign taxes. A foreign tax
redetermination also may arise because the amount of
foreign currency units actually paid differs from
the amount of foreign currency units accrued. In
addition, a redetermination may arise due to
fluctuations in the value of the foreign currency
relative to the dollar between the date of accrual
and the date of payment.
As a general matter, a redetermination of foreign
tax paid or accrued directly by a
U.S.
person requires notification of the Internal Revenue
Service and a redetermination of
U.S.
tax liability for the taxable year for which the
foreign tax was claimed as a credit. The Treasury
regulations provide exceptions to this rule for de
minimis cases. In the case of a redetermination of
foreign taxes that qualify for the indirect (or
"deemed-paid") foreign tax credit under
sections 902 and 960, the Treasury regulations
generally require taxpayers to make appropriate
adjustments to the payor foreign corporation's pools
of earnings and profits and foreign taxes.
Reasons
for Change
The Committee believes that the administrative
burdens associated with the foreign tax credit can
be reduced significantly by permitting foreign taxes
to be translated using reasonably accurate average
translation rates for the period in which the tax
payments are made. This approach will reduce,
sometimes substantially, the number of translation
calculations that are required to be made. In
addition, the Committee believes that taxpayers that
are on the accrual basis of accounting for purposes
of determining creditable foreign taxes should be
permitted to translate those taxes into U.S. dollar
amounts in the year to which those taxes relate, and
should not be required to make adjustments or
redetermination to those translated amounts, if
actual tax payments are made within a reasonably
short period of time after the close of such year.
Moreover, the Committee believes that it is
appropriate to use an average exchange rate for the
taxable year with respect to which such foreign
taxes relate for purposes of translating those
taxes. On the other hand, the Committee believes
that a foreign tax not paid within a reasonably
short period after the close of the year to which
the taxes relate should not be treated as a foreign
tax for such year. By drawing a bright line between
those foreign tax payment delays that do and do not
require a redetermination, the Committee believes
that a reasonable degree of certainty and clarity
will be added to the law in this area.
Explanation
of Provision
Translation
of foreign taxes
Translation
of certain accrued foreign taxes
With respect to taxpayers that take foreign income
taxes into account when accrued, the bill generally
provides for foreign taxes to be translated at the
average exchange rate for the taxable year to which
such taxes relate. This rule does not apply (1) to
any foreign income tax paid after the date two years
after the close of the taxable year to which such
taxes relate, (2) with respect to taxes of an
accrual-basis taxpayer that are actually paid in a
taxable year prior to the year to which they relate,
or (3) to tax payments that are denominated in an
inflationary currency (as defined by regulations).
Translation
of all other foreign taxes
Under the bill, foreign taxes not eligible for
application of the preceding rule generally are
translated into U.S. dollars using the exchange
rates as of the time such taxes are paid. The bill
provides the Secretary of the Treasury with
authority to issue regulations that would allow
foreign tax payments to be translated into U.S.
dollar amounts using an average exchange rate for a
specified period.
Redetermination
of foreign taxes
Under the bill, a redetermination is required if:
(1) accrued taxes when paid differ from the amounts
claimed as credits by the taxpayer, (2) accrued
taxes are not paid before the date two years after
the close of the taxable year to which such taxes
relate, or (3) any tax paid is refunded in whole or
in part. Thus, for example, the bill provides that
if at the close of the second taxable year after the
taxable year to which an accrued tax relates, any
portion of the tax so accrued has not yet been paid,
a foreign tax redetermination under section 905(c)
is required for the amount representing the unpaid
portion of that accrued tax. In other words, the
previous accrual of any tax that is unpaid as of
that date is denied. In cases where a
redetermination is required, as under present law,
the bill specifies that the taxpayer must notify the
Secretary, who will redetermine the amount of the
tax for the year or years affected. In the case of
indirect foreign tax credits, regulatory authority
is granted to prescribe appropriate adjustments to
the foreign corporation's pool of post-1986 foreign
income taxes in lieu of such a redetermination.
The bill provides specific rules for the treatment
of accrued taxes that are paid more than two years
after the close of the taxable year to which such
taxes relate. In the case of the direct foreign tax
credit, any such taxes subsequently paid are taken
into account for the taxable year to which such
taxes relate, but would be translated into U.S.
dollar amounts using the exchange rates in effect as
of the time such taxes are paid. In the case of the
indirect foreign tax credit, any such taxes
subsequently paid are taken into account for the
taxable year in which paid, and would be translated
into U.S. dollar amounts using the exchange rates as
of the time such taxes are paid.
For example, assume that in year 1 a taxpayer
accrues 1,000 units of foreign tax that relate to
year 1 and that give rise to a foreign tax credit
under section 901 and assume that the currency
involved is not inflationary . Further assume that
as of the end of year 1 the tax is unpaid. In this
case, the bill provides that the taxpayer translates
1,000 units of accrued foreign tax into U.S. dollars
at the average exchange rate for year 1. If the
1,000 units of tax are paid by the taxpayer in
either year 2 or year 3, no redetermination of
foreign tax is required. If any portion of the tax
so accrued remains unpaid as of the end of year 3,
however, the taxpayer is required to redetermine its
foreign tax accrued in year 1 to eliminate the
accrued but unpaid tax, thereby reducing its foreign
tax credit for such year. If the taxpayer pays the
disallowed taxes in year 4, the taxpayer again
redetermines its foreign taxes (and foreign tax
credit) for year 1, but the taxes paid in year 4 are
translated into U.S. dollars at the exchange rate
for year 4.
Effective
Date
The provision generally is effective for foreign
taxes paid (in the case of taxpayers using the cash
basis for determining the foreign tax credit) or
accrued (in the case of taxpayers using the accrual
basis for determining the foreign tax credit) in
taxable years beginning after December 31, 1997. The
provision's changes to the foreign tax
redetermination rules apply to foreign taxes which
relate to taxable years beginning after December 31,
1997.
5.
Election to use simplified foreign tax credit
limitation for alternative minimum tax purposes
(sec. 903 of the bill and sec. 59 of the Code)
Present
Law
Computing foreign tax credit limitations requires
the allocation and apportionment of deductions
between items of foreign source income and items of
U.S.
source income. Foreign tax credit limitations must
be computed both for regular tax purposes and for
purposes of the alternative minimum tax (AMT).
Consequently, the allocation and apportionment of
deductions must be done separately for regular tax
foreign tax credit limitation purposes and AMT
foreign tax credit limitation purposes.
Reasons
for Change
The process of allocating and apportioning
deductions for purposes of calculating the regular
and AMT foreign tax credit limitations can be
complex. Taxpayers that have allocated and
apportioned deductions for regular tax purposes
generally must reallocate and reapportion the same
deductions for AMT foreign tax credit purposes,
based on assets and income that reflect AMT
adjustments (including depreciation). However, the
differences between regular taxable income and
alternative minimum taxable income often are
relevant primarily to
U.S.
source income. The Committee believes that
permitting taxpayers to use foreign source regular
taxable income in computing their AMT foreign tax
credit limitation would provide an appropriate
simplification of the necessary computations by
eliminating the need to reallocate and reapportion
every deduction.
Explanation
of Provision
The provision permits taxpayers to elect to use as
their AMT foreign tax credit limitation fraction the
ratio of foreign source regular taxable
income to entire alternative minimum taxable income,
rather than the ratio of foreign source alternative
minimum taxable income to entire alternative
minimum taxable income. Under this election, foreign
source regular taxable income is used, however, only
to the extent it does not exceed entire alternative
minimum taxable income. In the event that foreign
source regular taxable income does exceed entire
alternative minimum taxable income, and the taxpayer
has income in more than one foreign tax credit
limitation category, the Committee intends that the
foreign source taxable income in each such category
generally would be reduced by a pro rata portion of
that excess.
The election is available only in the first taxable
year beginning after December 31, 1997 for which the
taxpayer claims an AMT foreign tax credit. The
Committee intends that a taxpayer will be treated,
for this purpose, as claiming an AMT foreign tax
credit for any taxable year for which the taxpayer
chooses to have the benefits of the foreign tax
credit and in which the taxpayer is subject to the
alternative minimum tax or would be subject to the
alternative minimum tax but for the availability of
the AMT foreign tax credit. The election, once made,
will apply to all subsequent taxable years, and may
be revoked only with the consent of the Secretary of
the Treasury.
Effective
Date
The provision applies to taxable years beginning
after December 31, 1997.
6.
Simplify stock and securities trading safe harbor
(sec. 952 of the bill and sec. 864(b)(2)(A) of the
Code)
Present
Law
A nonresident alien individual or foreign
corporation that is engaged in a trade or business
within the
United States
is subject to
U.S.
taxation on its net income that is effectively
connected with the trade or business, at graduated
rates of tax. Under a "safe harbor" rule,
foreign persons that trade in stocks or securities
for their own accounts are not treated as engaged in
a
U.S.
trade or business for this purpose.
For a foreign corporation to qualify for the safe
harbor, it must not be a dealer in stock or
securities. In addition, if the principal business
of the foreign corporation is trading in stock or
securities for its own account, the safe harbor
generally does not apply if the principal office of
the corporation is in the
United States
.
For foreign persons who invest in securities trading
partnerships, the safe harbor applies only if the
partnership is not a dealer in stock and securities.
In addition, if the principal business of the
partnership is trading stock or securities for its
own account, the safe harbor generally does not
apply if the principal office of the partnership is
in the
United States
.
Under Treasury regulations which apply to both
corporations and partnerships, the determination of
the location of the entity's principal office turns
on the location of various functions relating to
operation of the entity, including communication
with investors and the general public, solicitation
and acceptance of sales of interests, and
maintenance and audits of its books of account
(Treas. reg. sec. 1.864-2(c)(2)(ii) and (iii)).
Under the regulations, the location of the entity's
principal office does not depend on the location of
the entity's management or where investment
decisions are made.
Reasons
for Change
The foreign principal office requirement does not
promote any important tax policy and has been easily
circumvented. The stock and securities trading safe
harbor serves to promote foreign investment in
U.S.
capital markets. The Committee believes that the
elimination of the principal office rule would
facilitate foreign investment in
U.S.
markets. Because the location of a partnership's or
foreign corporation's principal office is determined
by the location of certain administrative functions
rather than the location of management and
investment decisions, the requirement of a foreign
principal office is met even if only administrative
functions are performed abroad.
Explanation
of Provision
The bill modifies the stock and securities trading
safe harbor by eliminating the requirement for both
partnerships and foreign corporations that trade
stock or securities for their own accounts that the
entity's principal office not be within the
United States
.
Effective
Date
The provision is effective for taxable years
beginning after December 31, 1997.
7.
Simplify foreign tax credit limitation for
individuals (sec. 901 of the bill and sec. 904 of
the Code)
Present
Law
In order to compute the foreign tax credit, a
taxpayer computes foreign source taxable income and
foreign taxes paid in each of the applicable
separate foreign tax credit limitation categories.
In the case of an individual, this requires the
filing of IRS Form 1116.
In many cases, individual taxpayers who are eligible
to credit foreign taxes may have only a modest
amount of foreign source gross income, all of which
is income from investments. Taxable income of this
type ordinarily is includible in the single foreign
tax credit limitation category for passive income.
However, under certain circumstances, the Code
treats investment-type income (e.g., dividends and
interest) as income in one of several other separate
limitation categories (e.g., high withholding tax
interest income or general limitation income). For
this reason, any taxpayer with foreign source gross
income is required to provide sufficient detail on
Form 1116 to ensure that foreign source taxable
income from investments, as well as all other
foreign source taxable income, is allocated to the
correct limitation category.
Reasons
for Change
The Committee believes that a significant number of
individuals are entitled to credit relatively small
amounts of foreign tax imposed at modest effective
tax rates on foreign source investment income. For
taxpayers in this class, the applicable foreign tax
credit limitations typically exceed the amounts of
taxes paid. Therefore, exempting these taxpayers
from the foreign tax credit limitation rules
significantly reduces the complexity of the tax law
without significantly altering actual tax
liabilities. At the same time, however, the
Committee believes that this exemption should be
limited to those cases where the taxpayer receives a
payee statement showing the amount of the foreign
source income and the foreign tax.
Explanation
of Provision
The bill allows individuals with no more than $300
($600 in the case of married persons filing jointly)
of creditable foreign taxes, and no foreign source
income other than passive income, an exemption from
the foreign tax credit limitation rules. (The
Committee intends that an individual electing this
exemption will not be required to file Form 1116 in
order to obtain the benefit of the foreign tax
credit.) An individual making this election is not
entitled to any carryover of excess foreign taxes to
or from a taxable year to which the election
applies.
For purposes of this election, passive income
generally is defined to include all types of income
that is foreign personal holding company income
under the subpart F rules, plus income inclusions
from foreign personal holding companies and passive
foreign investment companies, provided that the
income is shown on a payee statement furnished to
the individual. For purposes of this election,
creditable foreign taxes include only foreign taxes
that are shown on a payee statement furnished to the
individual.
Effective
Date
The provision applies to taxable years beginning
after December 31, 1997.
8.
Simplify treatment of personal transactions in
foreign currency (sec. 904 of the bill and sec. 988
of the Code)
Present
Law
When a U.S. taxpayer makes a payment in a foreign
currency, gain or loss (referred to as
"exchange gain or loss") generally arises
from any change in the value of the foreign currency
relative to the U.S. dollar between the time the
currency was acquired (or the obligation to pay was
incurred) and the time that the payment is made.
Gain or loss results because foreign currency,
unlike the U.S. dollar, is treated as property for
Federal income tax purposes.
Exchange gain or loss can arise in the course of a
trade or business or in connection with an
investment transaction. Exchange gain or loss also
can arise where foreign currency was acquired for
personal use. For example, the IRS has ruled that a
taxpayer who converts U.S. dollars to a foreign
currency for personal use while traveling abroad
realizes exchange gain or loss on reconversion of
appreciated or depreciated foreign currency (Rev.
Rul. 74-7, 1974-1 C.B. 198).
Prior to the Tax Reform Act of 1986 ("1986
Act"), most of the rules for determining the
Federal income tax consequences of foreign currency
transactions were embodied in a series of court
cases and revenue rulings issued by the IRS.
Additional rules of limited application were
provided by Treasury regulations. Pre-1986 law was
believed to be unclear regarding the character, the
timing of recognition, and the source of gain or
loss due to fluctuations in the exchange rate of
foreign currency. The 1986 Act provided a
comprehensive set of rules for the
U.S.
tax treatment of transactions involving foreign
currencies.
However, the 1986 Act provisions designed to clarify
the treatment of currency transactions, primarily
found in section 988 of the Code, apply to
transactions entered into by an individual only to
the extent that expenses attributable to such
transactions are deductible under section 162 (as a
trade or business expense) or section 212 (as an
expense of producing income). Therefore, the
principles of pre-1986 law continue to apply to
personal currency transactions.
Reasons
for Change
An individual who lives or travels abroad generally
cannot use U.S. dollars to make all of the purchases
incident to daily life. If an individual must treat
foreign currency in this instance as property giving
rise to U.S.-dollar income or loss every time the
individual, in effect, "barters" the
foreign currency for goods or services, the U.S.
individual living in or visiting a foreign country
will have a significant administrative burden that
may bear little or no relation to whether
U.S.-dollar measured income has increased or
decreased. The Committee believes that individuals
should be given relief from the requirement to keep
track of exchange gains on a
transaction-by-transaction basis in de minimis
cases.
Explanation
of Provision
If an individual acquires foreign currency and
disposes of it in a personal transaction and the
exchange rate changes between the acquisition and
disposition of such currency, the provision applies
nonrecognition treatment to any resulting exchange
gain, provided that such gain does not exceed $200.
The provision does not change the treatment of
resulting exchange losses. The Committee understands
that under other Code provisions such losses
typically are not deductible by individuals (e.g.,
sec. 165(c)).
Effective
Date
The provision applies to taxable years beginning
after December 31, 1997.
9.
Transition rule for certain trusts (sec. 951 of the
bill and sec. 7701(a)(30) of the Code)
Present
Law
Under rules enacted with the Small Business Job
Protection Act of 1996, a trust is considered to be
a
U.S.
trust if two criteria are met. First, a court within
the
United States
must be able to exercise primary supervision over
the administration of the trust. Second,
U.S.
fiduciaries of the trust must have the authority to
control all substantial decisions of the trust. A
trust that does not satisfy both of these criteria
is considered to be a foreign trust. These rules for
defining a
U.S.
trust generally are effective for taxable years of a
trust that begin after December 31, 1996. A trust
that qualified as a
U.S.
trust under prior law could fail to qualify as a
U.S.
trust under these new criteria.
Reasons
for Change
The change in the criteria for qualification as a
U.S.
trust could cause large numbers of existing domestic
trusts to become foreign trusts, unless they are
able to make the modifications necessary to satisfy
the new criteria. The Committee believes that an
election is appropriate for those existing domestic
trusts that prefer to continue to be subject to tax
as
U.S.
trusts.
Explanation
of Provision
Under the bill, the Secretary of the Treasury is
granted authority to allow nongrantor trusts that
had been treated as
U.S.
trusts under prior law to elect to continue to be
treated as
U.S.
trusts, notwithstanding the new criteria for
qualification as a
U.S.
trust.
Effective
Date
The provision is effective for taxable years
beginning after December 31, 1996.
10.
Clarification of determination of foreign taxes
deemed paid (sec. 953(a) of the bill and sec. 902 of
the Code)
Present
Law
Under section 902, a domestic corporation that
receives a dividend from a foreign corporation in
which it owns 10 percent or more of the voting stock
is deemed to have paid a portion of the foreign
taxes paid by such foreign corporation. The domestic
corporation that receives a dividend is deemed to
have paid a portion of the foreign corporation's
post-1986 foreign income taxes based on the ratio of
the amount of such dividend to the foreign
corporation's post-1986 undistributed earnings. The
foreign corporation's post-1986 foreign income taxes
is the sum of the foreign income taxes with respect
to the taxable year in which the dividend is
distributed plus certain foreign income taxes with
respect to prior taxable years (beginning after
December 31, 1986).
Reasons
for Change
The Committee believes that it is appropriate to
clarify the determination of foreign taxes deemed
paid for purposes of the indirect foreign tax
credit.
Explanation
of Provision
The bill clarifies that, for purposes of the deemed
paid credit under section 902 for a taxable year, a
foreign corporation's post-1986 foreign income taxes
includes foreign income taxes with respect to prior
taxable years (beginning after December 31, 1986)
only to the extent such taxes are not attributable
to dividends distributed by the foreign corporation
in prior taxable years. No inference is intended
regarding the determination of foreign taxes deemed
paid under present law.
Effective
Date
The provision is effective on date of enactment.
11.
Clarification of foreign tax credit limitation for
financial services income (sec. 953(b) of the bill
and sec. 904 of the Code)
Present
Law
Under section 904, separate foreign tax credit
limitations apply to various categories of income.
Two of these separate limitation categories are
passive income and financial services income. For
purposes of the separate foreign tax credit
limitation applicable to passive income, certain
income that is treated as high-taxed income is
excluded from the definition of passive income. For
purposes of the separate foreign tax credit
limitation applicable to financial services income,
the definition of financial services income
generally incorporates passive income as defined for
purposes of the separate limitation applicable to
passive income.
Reasons
for Change
The Committee believes that it is appropriate to
clarify that high-taxed income is not
excluded from the separate foreign tax credit
limitation for financial services income.
Explanation
of Provision
The bill clarifies that the exclusion of income that
is treated as high-taxed income does not apply for
purposes of the separate foreign tax credit
limitation applicable to financial services income.
No inference is intended regarding the treatment of
high-taxed income for purposes of the separate
foreign tax credit limitation applicable to
financial services income under present law.
Effective
Date
The provision is effective on date of enactment.
TITLE
X. SIMPLIFICATION PROVISIONS RELATING TO INDIVIDUALS
AND BUSINESSES
A.
Provisions Relating to Individuals
1.
Modifications to standard deduction of dependents;
AMT treatment of certain minor children (sec. 1001
of the bill and secs. 59(j) and 63(c)(5) of the
Code)
Present
Law
Standard deduction of dependents. --The
standard deduction of a taxpayer for whom a
dependency exemption is allowed on another
taxpayer's return can not exceed the lesser of (1)
the standard deduction for an individual taxpayer
(projected to be $4,250 for 1998) or (2) the greater
of $500 (indexed)121
or the dependent's earned income (sec. 63(c)(5)).
Taxation of unearned income of children under age
14. --The tax on a portion of the unearned
income (e.g., interest and dividends) of a child
under age 14 is the additional tax that the child's
custodial parent would pay if the child's unearned
income were included in that parent's income. The
portion of the child's unearned income which is
taxed at the parent's top marginal rate is the
amount by which the child's unearned income is more
than the sum of (1) $500122
(indexed) plus (2) the greater of (a) $500123
(indexed) or (b) the child's itemized deductions
directly connected with the production of the
unearned income (sec. 1(g)).
Alternative minimum tax ("AMT")
exemption for children under age 14. --Single
taxpayers are entitled to an exemption from the
alternative minimum tax ("AMT") of
$33,750. However, in the case of a child under age
14, his exemption from the AMT, in substance, is the
unused alternative minimum tax exemption of the
child's custodial parent, limited to sum of earned
income and $1,400 (sec. 59(j)).
Reasons
for Change
The committee believes that significant
simplification of the existing income tax system can
be achieved by providing larger exemptions such that
taxpayers with incomes less than the exemption are
not required to compute and pay any tax. The
committee particularly believes that the present-law
exemptions of dependent children are too small.
Explanation
of Provision
Standard deduction of dependents. --The bill
increases the standard deduction for a taxpayer with
respect to whom a dependency exemption is allowed on
another taxpayer's return to the lesser of (1) the
standard deduction for individual taxpayers or (2)
the greater of: (a) $500124
(indexed for inflation as under present law), or (b)
the individual's earned income plus $250. The $250
amount is indexed for inflation after 1998.
Alternative minimum tax exemption for children
under age 14. --The bill increases the AMT
exemption amount for a child under age 14 to the
lesser of (1) $33,750 or (2) the sum of the child's
earned income plus $5,000. The $5,000 amount is
indexed for inflation after 1998.
Effective
Date
The provision is effective for taxable years
beginning after December 31, 1997.
2.
Increase de minimis threshold for estimated tax to
$1,000 for individuals (sec. 1002 of the bill and
sec. 6654 of the Code)
Present
Law
An individual taxpayer generally is subject to an
addition to tax for any underpayment of estimated
tax (sec. 6654). An individual generally does not
have an underpayment of estimated tax if he or she
makes timely estimated tax payments at least equal
to: (1) 100 percent of the tax shown on the return
of the individual for the preceding year (the
"100 percent of last year's liability safe
harbor") or (2) 90 percent of the tax shown on
the return for the current year. The 100 percent of
last year's liability safe harbor is modified to be
a 110 percent of last year's liability safe harbor
for any individual with an AGI of more than $150,000
as shown on the return for the preceding taxable
year. Income tax withholding from wages is
considered to be a payment of estimated taxes. In
general, payment of estimated taxes must be made
quarterly. The addition to tax is not imposed where
the total tax liability for the year, reduced by any
withheld tax and estimated tax payments, is less
than $500.
Reasons
for Change
Raising the individual estimated tax de minimis
threshold will simplify the tax laws for a number of
taxpayers.
Explanation
of Provision
The bill increases the $500 individual estimated tax
de minimis threshold to $1,000.
Effective
Date
The provision is effective for taxable years
beginning after December 31, 1997.
3.
Treatment of certain reimbursed expenses of rural
letter carriers' vehicles (sec. 1003 of the bill and
sec. 162 of the Code)
Present
Law
A taxpayer who uses his or her automobile for
business purposes may deduct the business portion of
the actual operation and maintenance expenses of the
vehicle, plus depreciation (subject to the
limitations of sec. 280F). Alternatively, the
taxpayer may elect to utilize a standard mileage
rate in computing the deduction allowable for
business use of an automobile that has not been
fully depreciated. Under this election, the
taxpayer's deduction equals the applicable rate
multiplied by the number of miles driven for
business purposes and is taken in lieu of deductions
for depreciation and actual operation and
maintenance expenses.
An employee of the U.S. Postal Service may compute
his deduction for business use of an automobile in
performing services involving the collection and
delivery of mail on a rural route by using, for all
business use mileage, 150 percent of the standard
mileage rate.
Rural letter carriers are paid an equipment
maintenance allowance (EMA) to compensate them for
the use of their personal automobiles in delivering
the mail. The tax consequences of the EMA are
determined by comparing it with the automobile
expense deductions that each carrier is allowed to
claim (using either the actual expenses method or
the 150 percent of the standard mileage rate). If
the EMA exceeds the allowable automobile expense
deductions, the excess generally is subject to tax.
If the EMA falls short of the allowable automobile
expense deductions, a deduction is allowed only to
the extent that the sum of this shortfall and all
other miscellaneous itemized deductions exceeds two
percent of the taxpayer's adjusted gross income.
Reasons
for Change
The filing of tax returns by rural letter carriers
can be complex. Under present law, those who are
reimbursed at more than the 150 percent rate must
report their reimbursement as income and deduct
their expenses as miscellaneous itemized deductions
(subject to the two-percent floor). Permitting the
income and expenses to wash, so that neither will
have to be reported on the rural letter carrier's
tax return, will simplify these tax returns.
Explanation
of Provision
The bill repeals the special rate for Postal Service
employees of 150 percent of the standard mileage
rate. In its place, the bill requires that the rate
of reimbursement provided by the Postal Service to
rural letter carriers be considered to be equivalent
to their expenses. The rate of reimbursement that is
considered to be equivalent to their expenses is the
rate of reimbursement contained in the 1991
collective bargaining agreement, which may be
increased by no more than the rate of inflation.
Effective
Date
The provision is effective for taxable years
beginning after December 31, 1997.
4.
Travel expenses of Federal employees participating
in a Federal criminal investigation (sec. 1004 of
the bill and sec. 162 of the Code)
Present
Law
Unreimbursed ordinary and necessary travel expenses
paid or incurred by an individual in connection with
temporary employment away from home (e.g.,
transportation costs and the cost of meals and
lodging) are generally deductible, subject to the
two-percent floor on miscellaneous itemized
deductions. Travel expenses paid or incurred in
connection with indefinite employment away from
home, however, are not deductible. A taxpayer's
employment away from home in a single location is
indefinite rather than temporary if it lasts for one
year or more; thus, no deduction is permitted for
travel expenses paid or incurred in connection with
such employment (sec. 162(a)). If a taxpayer's
employment away from home in a single location lasts
for less than one year, whether such employment is
temporary or indefinite is determined on the basis
of the facts and circumstances.
Reasons
for Change
The Committee believes that it would be
inappropriate if this provision in the tax laws were
to be a hindrance to the investigation of a Federal
crime.
Explanation
of Provision
The one-year limitation with respect to
deductibility of expenses while temporarily away
from home does not include any period during which a
Federal employee is certified by the Attorney
General (or the Attorney General's designee) as
traveling on behalf of the Federal Government in a
temporary duty status to investigate or provide
support services to the investigation of a Federal
crime. Thus, expenses for these individuals during
these periods are fully deductible, regardless of
the length of the period for which certification is
given (provided that the other requirements for
deductibility are satisfied).
Effective
Date
The provision is effective for amounts paid or
incurred with respect to taxable years ending after
the date of enactment.
B.
Provisions Relating to Businesses Generally
1.
Modifications to look-back method for long-term
contracts (sec. 1011 of the bill and secs. 460 and
167(g) of the Code)
Present
Law
Taxpayers engaged in the production of property
under a long-term contract generally must compute
income from the contract under the percentage of
completion method. Under the percentage of
completion method, a taxpayer must include in gross
income for any taxable year an amount that is based
on the product of (1) the gross contract price and
(2) the percentage of the contract completed as of
the end of the year. The percentage of the contract
completed as of the end of the year is determined by
comparing costs incurred with respect to the
contract as of the end of the year with estimated
total contract costs.
Because the percentage of completion method relies
upon estimated, rather than actual, contract price
and costs to determine gross income for any taxable
year, a "look-back method" is applied in
the year a contract is completed in order to
compensate the taxpayer (or the Internal Revenue
Service) for the acceleration (or deferral) of taxes
paid over the contract term. The first step of the
look-back method is to reapply the percentage of
completion method using actual contract price and
costs rather than estimated contract price and
costs. The second step generally requires the
taxpayer to recompute its tax liability for each
year of the contract using gross income as
reallocated under the look-back method. If there is
any difference between the recomputed tax liability
and the tax liability as previously determined for a
year, such difference is treated as a hypothetical
underpayment or overpayment of tax to which the
taxpayer applies a rate of interest equal to the
overpayment rate, compounded daily.125
The taxpayer receives (or pays) interest if the net
amount of interest applicable to hypothetical
overpayments exceeds (or is less than) the amount of
interest applicable to hypothetical underpayments.
The look-back method must be reapplied for any item
of income or cost that is properly taken into
account after the completion of the contract.
The look-back method does not apply to any contract
that is completed within two taxable years of the
contract commencement date and if the gross contract
price does not exceed the lesser of (1) $1 million
or (2) one percent of the average gross receipts of
the taxpayer for the preceding three taxable years.
In addition, a simplified look-back method is
available to certain pass-through entities and,
pursuant to Treasury regulations, to certain other
taxpayers. Under the simplified look-back method,
the hypothetical underpayment or overpayment of tax
for a contract year generally is determined by
applying the highest rate of tax applicable to such
taxpayer to the change in gross income as recomputed
under the look-back method.
Reasons
for Change
Present law may require multiple applications of the
look-back method with respect to a single contract
or may otherwise subject contracts to the look-back
method even though amounts necessitating the
look-back calculations are de minimis relative to
the aggregate contract income. In addition, the use
of multiple interest rates complicates the mechanics
of the look-back calculation. The committee wishes
to address these concerns.
Explanation
of Provision
Election
not to apply the look-back method for de minimis
amounts
The provision provides that a taxpayer may elect not
to apply the look-back method with respect to a
long-term contract if for each prior contract year,
the cumulative taxable income (or loss) under the
contract as determined using estimated contract
price and costs is within 10 percent of the
cumulative taxable income (or loss) as determined
using actual contract price and costs.
Thus, under the election, upon completion of a
long-term contract, a taxpayer would be required to
apply the first step of the look-back method (the
reallocation of gross income using actual, rather
than estimated, contract price and costs), but is
not required to apply the additional steps of the
look-back method if the application of the first
step resulted in de minimis changes to the amount of
income previously taken into account for each prior
contract year.
The election applies to all long-term contracts
completed during the taxable year for which the
election is made and to all long-term contracts
completed during subsequent taxable years, unless
the election is revoked with the consent of the
Secretary of the Treasury.
Example 1. --A taxpayer enters into a
three-year contract and upon completion of the
contract, determines that annual net income under
the contract using actual contract price and costs
is $100,000, $150,000, and $250,000, respectively,
for Years 1, 2, and 3 under the percentage of
completion method. An electing taxpayer need not
apply the look-back method to the contract if it had
reported cumulative net taxable income under the
contract using estimated contract price and costs of
between $90,000 and $110,000 as of the end of Year
1; and between $225,000 and $275,000 as of the end
of Year 2.
Election
not to reapply the look-back method
The provision provides that a taxpayer may elect not
to reapply the look-back method with respect to a
contract if, as of the close of any taxable year
after the year the contract is completed, the
cumulative taxable income (or loss) under the
contract is within 10 percent of the cumulative
look-back income (or loss) as of the close of the
most recent year in which the look-back method was
applied (or would have applied but for the other de
minimis exception described above). In applying this
rule, amounts that are taken into account after
completion of of the contract are not discounted.
Thus, an electing taxpayer need not apply or reapply
the look-back method if amounts that are taken into
account after the completion of the contract are de
minimis.
The election applies to all long-term contracts
completed during the taxable year for which the
election is made and to all long-term contracts
completed during subsequent taxable years, unless
the election is revoked with the consent of the
Secretary of the Treasury.
Example 2. --A taxpayer enters into a
three-year contract and reports taxable income of
$12,250, $15,000 and $12,750, respectively, for
Years 1 through 3 with respect to the contract. Upon
completion of the contract, cumulative look-back
income with respect to the contract is $40,000, and
10 percent of such amount is $4,000. After the
completion of the contract, the taxpayer incurs
additional costs of $2,500 in each of the next three
succeeding years (Years 4, 5, and 6) with respect to
the contract. Under the provision, an electing
taxpayer does not reapply the look-back method for
Year 4 because the cumulative amount of contract
taxable income ($37,500) is within 10 percent of
contract look-back income as of the completion of
the contract ($40,000). However, the look-back
method must be applied for Year 5 because the
cumulative amount of contract taxable income
($35,000) is not within 10 percent of contract
look-back income as of the completion of the
contract ($40,000). Finally, the taxpayer does not
reapply the look-back method for Year 6 because the
cumulative amount of contract taxable income
($32,500) is within 10 percent of contract look-back
income as of the last application of the look-back
method ($35,000).
Interest
rates used for purposes of the look-back method
The provision provides that for purposes of the
look-back method, only one rate of interest is to
apply for each accrual period. An accrual period
with respect to a taxable year begins on the day
after the return due date (determined without regard
to extensions) for the taxable year and ends on such
return due date for the following taxable year. The
applicable rate of interest is the overpayment rate
in effect for the calendar quarter in which the
accrual period begins.
Effective
Date
The provision applies to contracts completed in
taxable years ending after the date of enactment.
The change in the interest rate calculation also
applies for purposes of the look-back method
applicable to the income forecast method of
depreciation for property placed in service after
September 13, 1995.
2.
Minimum tax treatment of certain property and
casualty insurance companies (sec. 1012 of the bill
and sec. 56(g)(4)(B) of the Code)
Present
Law
Present law provides that certain property and
casualty insurance companies may elect to be taxed
only on taxable investment income for regular tax
purposes (sec. 831(b)). Eligible property and
casualty insurance companies are those whose net
written premiums (or if greater, direct written
premiums) for the taxable year exceed $350,000 but
do not exceed $1,200,000.
Under present law, all corporations including
insurance companies are subject to an alternative
minimum tax. Alternative minimum taxable income is
increased by 75 percent of the excess of adjusted
current earnings over alternative minimum taxable
income (determined without regard to this adjustment
and without regard to net operating losses).
Reasons
for Change
The Committee believes that property and casualty
companies small enough to be eligible to simplify
their regular tax computation by electing to be
taxed only on taxable investment income should be
accorded comparable simplicity in the calculation of
their alternative minimum tax. Under present law,
the simplicity under the regular tax is nullified
because electing companies must calculate
underwriting income for tax purposes under the
alternative minimum tax. The provision thus
simplifies the entire Federal income tax calculation
for a group of small taxpayers whom Congress has
previously determined merit a simpler tax
calculation.
Explanation
of Provision
The provision provides that a property and casualty
insurance company that elects for regular tax
purposes to be taxed only on taxable investment
income determines its adjusted current earnings
under the alternative minimum tax without regard to
any amount not taken into account in determining its
gross investment income under section 834(b). Thus,
adjusted current earnings of an electing company is
determined without regard to underwriting income (or
underwriting expense, as provided in sec. 56(g)(4)(B)(i)(II)).
Effective
Date
The provision is effective for taxable years
beginning after December 31, 1997.
3.
Shrinkage for inventory accounting (sec. 1013 of the
bill and sec. 471 of the Code)
Present
Law
Section 471(a) provides that "(w)henever in the
opinion of the Secretary the use of inventories is
necessary in order clearly to determine the income
of any taxpayer, inventories shall be taken by such
taxpayer on such basis as the Secretary may
prescribe as conforming as nearly as may be to the
best accounting practice in the trade or business
and as most clearly reflecting income." Where a
taxpayer maintains book inventories in accordance
with a sound accounting system, the net value of the
inventory will be deemed to be the cost basis of the
inventory, provided that such book inventories are
verified by physical inventories at reasonable
intervals and adjusted to conform therewith.126
The physical count is used to determine and adjust
for certain items, such as undetected theft,
breakage, and bookkeeping errors, collectively
referred to as "shrinkage."
Some taxpayers verify and adjust their book
inventories by a physical count taken on the last
day of the taxable year. Other taxpayers may verify
and adjust their inventories by physical counts
taken at other times during the year. Still other
taxpayers take physical counts at different
locations at different times during the taxable year
(cycle counting).
If a physical inventory is taken at year-end, the
amount of shrinkage for the year is known. If a
physical inventory is not taken at year-end,
shrinkage through year-end will have to be based on
an estimate, or not taken into account until the
following year. In the first decision in Dayton
Hudson v. Commissioner 127
, the U.S. Tax Court held that a taxpayer's method
of accounting may include the use of an estimate of
shrinkage occurring through year-end, provided the
method is sound and clearly reflects income. In the
second decision in Dayton Hudson v. Commissioner 128
, the U.S. Tax Court adhered to this holding.
However, the U.S. Tax Court in the second decision
determined that this taxpayer had not established
that its method of accounting clearly reflected
income. Other cases decided by the U.S. Tax Court129
have held that taxpayers' methods of accounting that
included shrinkage estimates do clearly reflect
income.
The U.S. Tax Court in the second Dayton Hudson
opinion noted that "(I)n most cases, generally
accepted accounting principles (GAAP), consistently
applied, will pass muster for tax purposes. The
Supreme Court has made clear, however, that GAAP
does not enjoy a presumption of accuracy that must
be rebutted by the Commissioner."
Reasons
for Change
The Committee believes that inventories should be
kept in a manner that clearly reflects income. The
Committee also believes that it is inappropriate to
require a physical count of a taxpayer's entire
inventory to be taken exactly at year-end, provided
that physical counts are taken on a regular and
consistent basis. Where physical inventories are not
taken at year-end, the Committee believes that
income will be more clearly reflected if the
taxpayer makes a reasonable estimate of the
shrinkage occurring through year-end, rather than
simply ignoring it.
The Committee believes that a taxpayer should have
the opportunity to change its method of accounting
to a method that keeps inventories using shrinkage
estimates, so long as such method is sound and
clearly reflects income. The Committee does not
believe that it is appropriate to deny a taxpayer
access to such a method solely because its current,
acceptable method of accounting does not utilize
shrinkage estimates.
Explanation
of Provision
The bill provides that a method of keeping
inventories will not be considered unsound, or to
fail to clearly reflect income, solely because it
includes an adjustment for the shrinkage estimated
to occur through year-end, based on inventories
taken other than at year-end. Such an estimate must
be based on actual physical counts. Where such an
estimate is used in determining ending inventory
balances, the taxpayer is required to take a
physical count of inventories at each location on a
regular and consistent basis. A taxpayer is required
to adjust its ending inventory to take into account
all physical counts performed through the end of its
taxable year.
Effective
Date
The provision is effective for taxable years ending
after the date of enactment.
A taxpayer is permitted to change its method of
accounting by this section if the taxpayer is
currently using a method that does not utilize
estimates of inventory shrinkage and wishes to
change to a method for inventories that includes
shrinkage estimates based on physical inventories
taken other than at year-end. Such a change is
treated as a voluntary change in method of
accounting, initiated by the taxpayer with the
consent of the Secretary of the Treasury, provided
the taxpayer changes to a permissible method of
accounting. The period for taking into account any
adjustment required under section 481 as a result of
such a change in method is 4 years.
No inference is intended by the Committee by the
adoption of this provision with regard to whether
any particular method of accounting for inventories
is permissible under present law.
4.
Treatment of construction allowances provided to
lessees (sec. 1014 of the bill and new sec. 110 of
the Code)
Present
Law
Depreciation allowances for property used in a trade
or business generally are determined under the
modified Accelerated Cost Recovery System ("MACRS")
of section 168. Depreciation allowances for
improvements made on leased property are determined
under MACRS, even if the MACRS recovery period
assigned to the property is longer than the term of
the lease (sec. 168(i)(8)).130
This rule applies whether the lessor or lessee
places the leasehold improvements in service.131
If a leasehold improvement constitutes an addition
or improvement to nonresidential real property
already placed in service, the improvement is
depreciated using the straight-line method over a
39-year recovery period, beginning in the month the
addition or improvement was placed in service (secs.
168(b)(3), (c)(1), (d)(2), and (l)(6)). A lessor of
leased property that disposes of a leasehold
improvement that was made by the lessor for the
lessee of the property may take the adjusted basis
of the improvement into account for purposes of
determining gain or loss if the improvement is
irrevocably disposed of or abandoned by the lessor
at the termination of the lease (sec. 168(i)(8)).
The gross income of a lessor of real property does
not include any amount attributable to the value of
buildings erected, or other improvements made by, a
lessee that revert to the lessor at the termination
of a lease (sec. 109).
Issues have arisen as to the proper treatment of
amounts provided to a lessee by a lessor for
property to be constructed and used by the lessee
pursuant to the lease ("construction
allowances"). In general, incentive payments
are includible in income as accessions to wealth.132
A coordinated issue paper issued by the Internal
Revenue Service ("IRS") on October 7,
1996, states the IRS position that construction
allowances should generally be included in income in
the year received. However, the paper does recognize
that amounts received by a lessee from a lessor and
expended by the lessee on assets owned by the lessor
were not includible in the lessee's income. The
issue paper provides that tax ownership is
determined by applying a "benefits and burdens
of ownership" test that includes an examination
of the following factors: (1) whether legal title
passes; (2) how the parties treat the transaction;
(3) whether an equity interest was acquired in the
property; (4) whether the contract creates present
obligations on the seller to execute and deliver a
deed and on the buyer to make payments; (5) whether
the right of possession is vested; (6) who pays
property taxes; (7) who bears the risk of loss or
damage to the property; (8) who receives the profits
from the operation and sale of the property; (9) who
carries insurance with respect to the property; (9)
who is responsible for replacing the property the
property; and (10) who has the benefits of any
remainder interests in the property.
Reasons
for Change
The committee understands that it is common industry
practice for a lessor to custom improve retail space
for the use by a lessee pursuant to a lease. Such
leasehold improvements may be provided by the lessor
directly constructing the improvements to the
lessee's specifications. Alternatively, the lessee
may receive a construction allowance from the lessor
pursuant to the lease in order for the lessee to
build or improve the property. The committee
believes that the tax treatment of lessors and
lessees in either case should be the same. The
committee understands that the IRS issue paper
reaches a similar conclusion in cases where the
lessor is treated as the tax owner of the
constructed or improved property. However, the
committee is concerned that the traditional factors
cited by the IRS in making the determination of who
is the tax owner of the property may be applied
differently by the lessor and the lessee and may
lead to controversies between the IRS and taxpayers.
Thus, the bill provides, in effect, a safe harbor
such that it will be assumed that a construction
allowance is used to construct or improve lessor
property (and is properly excludible by the lessee)
when long-lived property is constructed or improved
and used pursuant to a short-term lease. In
addition, the bill provides safeguards to ensure
that lessors and lessees consistently treat the
property subject to the construction allowance as
nonresidential real property.
Explanation
of Provision
The bill provides that the gross income of a lessee
does not include amounts received in cash (or
treated as a rent reduction) from a lessor under a
short-term lease of retail space for the purpose of
the lessee's construction or improvement of
qualified long-term real property for use in the
lessee's trade or business at such retail space. The
exclusion only applies to the extent the allowance
does not exceed the amount expended by the lessee on
the construction or improvement of qualified
long-term real property. For this purpose,
"qualified long-term real property" means
nonresidential real property that is part of, or
otherwise present at, retail space used by the
lessee and that reverts to the lessor at the
termination of the lease. A "short-term
lease" means a lease or other agreement for the
occupancy or use of retail space for a term of 15
years or less (as determined pursuant to sec.
168(i)(3)). "Retail space" means real
property leased, occupied, or otherwise used by the
lessee in its trade or business of selling tangible
personal property or services to the general public.
The bill provides that the lessor must treat the
amounts expended on the construction allowance as
nonresidential real property owner by the lessor.
However, the lessee's exclusion is not dependent
upon the lessor's treatment of the property as
nonresidential real property.
The bill contains reporting requirements to ensure
that both the lessor and lessee treat such amounts
consistently as nonresidential real property. Under
regulations, the lessor and the lessee shall, at
such times and in such manner as provided by the
regulations, furnish to the Secretary of the
Treasury information concerning the amounts received
(or treated as a rent reduction), the amounts
expended on qualified long-term real property, and
such other information as the Secretary deems
necessary to carry out the provisions of the bill.
It is expected that the Secretary, in promulgating
such regulations, will attempt to minimize the
administrative burdens of taxpayers while ensuring
compliance with the bill.
Effective
Date
The provision applies to leases entered into after
the date of enactment. No inference is intended as
to the treatment of amounts that are not subject to
the provision.
C.
Partnership Simplification Provisions
1.
General provisions
a.
Simplified flow-through for electing large
partnerships (sec. 1021 of the bill and new secs.
771-777 of the Code)
Present
Law
Treatment
of partnerships in general
A partnership generally is treated as a conduit for
Federal income tax purposes. Each partner takes into
account separately his distributive share of the
partnership's items of income, gain, loss, deduction
or credit. The character of an item is the same as
if it had been directly realized or incurred by the
partner. Limitations affecting the computation of
taxable income generally apply at the partner level.
The taxable income of a partnership is computed in
the same manner as that of an individual, except
that no deduction is permitted for personal
exemptions, foreign taxes, charitable contributions,
net operating losses, certain itemized deductions,
or depletion. Elections affecting the computation of
taxable income derived from a partnership are made
by the partnership, except for certain elections
such as those relating to discharge of indebtedness
income and the foreign tax credit.
Capital
gains
The net capital gain of an individual is taxed
generally at the same rates applicable to ordinary
income, subject to a maximum marginal rate of 28
percent. Net capital gain is the excess of net
long-term capital gain over net short-term capital
loss. Individuals with a net capital loss generally
may deduct up to $3,000 of the loss each year
against ordinary income. Net capital losses in
excess of the $3,000 limit may be carried forward
indefinitely.
A special rule applies to gains and losses on the
sale, exchange or involuntary conversion of certain
trade or business assets (sec. 1231). In general,
net gains from such assets are treated as long-term
capital gains but net losses are treated as ordinary
losses.
A partner's share of a partnership's net short-term
capital gain or loss and net long-term capital gain
or loss from portfolio investments is separately
reported to the partner. A partner's share of a
partnership's net gain or loss under section 1231
generally is also separately reported.
Deductions
and credits
Miscellaneous itemized deductions (e.g., certain
investment expenses) are deductible only to the
extent that, in the aggregate, they exceed two
percent of the individual's adjusted gross income.
In general, taxpayers are allowed a deduction for
charitable contributions, subject to certain
limitations. The deduction allowed an individual
generally cannot exceed 50 percent of the
individual's adjusted gross income for the taxable
year. The deduction allowed a corporation generally
cannot exceed 10 percent of the corporation's
taxable income. Excess contributions are carried
forward for five years.
A partner's distributive share of a partnership's
miscellaneous itemized deductions and charitable
contributions is separately reported to the partner.
Each partner is allowed his distributive share of
credits against his taxable income.
Foreign
taxes
The foreign tax credit generally allows
U.S.
taxpayers to reduce
U.S.
income tax on foreign income by the amount of
foreign income taxes paid or accrued with respect to
that income. In lieu of electing the foreign tax
credit, a taxpayer may deduct foreign taxes. The
total amount of the credit may not exceed the same
proportion of the taxpayer's
U.S.
tax which the taxpayer's foreign source taxable
income bears to the taxpayer's worldwide taxable
income for the taxable year.
Unrelated
business taxable income
Tax-exempt organizations are subject to tax on
income from unrelated businesses. Certain types of
income (such as dividends, interest and certain
rental income) are not treated as unrelated business
taxable income. Thus, for a partner that is an
exempt organization, whether partnership income is
unrelated business taxable income depends on the
character of the underlying income. Income from a
publicly traded partnership, however, is treated as
unrelated business taxable income regardless of the
character of the underlying income.
Special
rules related to oil and gas activities
Taxpayers involved in the search for and extraction
of crude oil and natural gas are subject to certain
special tax rules. As a result, in the case of
partnerships engaged in such activities, certain
specific information is separately reported to
partners.
A taxpayer who owns an economic interest in a
producing deposit of natural resources (including
crude oil and natural gas) is permitted to claim a
deduction for depletion of the deposit as the
minerals are extracted. In the case of oil and gas
produced in the
United States
, a taxpayer generally is permitted to claim the
greater of a deduction for cost depletion or
percentage depletion. Cost depletion is computed by
multiplying a taxpayer's adjusted basis in the
depletable property by a fraction, the numerator of
which is the amount of current year production from
the property and the denominator of which is the
property's estimated reserves as of the beginning of
that year. Percentage depletion is equal to a
specified percentage (generally, 15 percent in the
case of oil and gas) of gross income from
production. Cost depletion is limited to the
taxpayer's basis in the depletable property;
percentage depletion is not so limited. Once a
taxpayer has exhausted its basis in the depletable
property, it may continue to claim percentage
depletion deductions (generally referred to as
"excess percentage depletion").
Certain limitations apply to the deduction for oil
and gas percentage depletion. First, percentage
depletion is not available to oil and gas producers
who also engage (directly or indirectly) in
significant levels of oil and gas retailing or
refining activities (so-called "integrated
producers" of oil and gas). Second, the
deduction for percentage depletion may be claimed by
a taxpayer only with respect to up to 1,000
barrels-per-day of production. Third, the percentage
depletion deduction may not exceed 100 percent of
the taxpayer's net income for the taxable year from
the depletable oil and gas property. Fourth, a
percentage depletion deduction may not be claimed to
the extent that it exceeds 65 percent of the
taxpayer's pre-percentage depletion taxable income.
In the case of a partnership that owns depletable
oil and gas properties, the depletion allowance is
computed separately by the partners and not by the
partnership. In computing a partner's basis in his
partnership interest, basis is increased by the
partner's share of any partnership-related excess
percentage depletion deductions and is decreased
(but not below zero) by the partner's total amount
of depletion deductions attributable to partnership
property.
Intangible drilling and development costs ("IDCs")
incurred with respect to domestic oil and gas wells
generally may be deducted at the election of the
taxpayer. In the case of integrated producers, no
more than 70 percent of IDCs incurred during a
taxable year may be deducted. IDCs not deducted are
capitalized and generally are either added to the
property's basis and recovered through depletion
deductions or amortized on a straight-line basis
over a 60-month period.
The special treatment granted to IDCs incurred in
the pursuit of oil and gas may give rise to an item
of tax preference or (in the case of corporate
taxpayers) an adjusted current earnings
("ACE") adjustment for the alternative
minimum tax. The tax preference item is based on a
concept of "excess IDCs." In general,
excess IDCs are the excess of IDCs deducted for the
taxable year over the amount of those IDCs that
would have been deducted had they been capitalized
and amortized on a straight-line basis over 120
months commencing with the month production begins
from the related well. The amount of tax preference
is then computed as the difference between the
excess IDC amount and 65 percent of the taxpayer's
net income from oil and gas (computed without a
deduction for excess IDCs). For IDCs incurred in
taxable years beginning after 1992, the ACE
adjustment related to IDCs is repealed for taxpayers
other than integrated producers. Moreover, beginning
in 1993, the IDC tax preference generally is
repealed for taxpayers other than integrated
producers. In this case, however, the repeal of the
excess IDC preference may not result in more than a
40 percent reduction (30 percent for taxable years
beginning in 1993) in the amount of the taxpayer's
alternative minimum taxable income computed as if
that preference had not been repealed.
Passive
losses
The passive loss rules generally disallow deductions
and credits from passive activities to the extent
they exceed income from passive activities. Losses
not allowed in a taxable year are suspended and
treated as current deductions from passive
activities in the next taxable year. These losses
are allowed in full when a taxpayer disposes of the
entire interest in the passive activity to an
unrelated person in a taxable transaction. Passive
activities include trade or business activities in
which the taxpayer does not materially participate.
(Limited partners generally do not materially
participate in the activities of a partnership.)
Passive activities also include rental activities
(regardless of the taxpayer's material
participation)133
. Portfolio income (such as interest and dividends),
and expenses allocable to such income, are not
treated as income or loss from a passive activity.
The $25,000 allowance also applies to low-income
housing and rehabilitation credits (on a deduction
equivalent basis), regardless of whether the
taxpayer claiming the credit actively participates
in the rental real estate activity generating the
credit. In addition, the income phaseout range for
the $25,000 allowance for rehabilitation credits is
$200,000 to $250,000 (rather than $100,000 to
$150,000). For interests acquired after December 31,
1989 in partnerships holding property placed in
service after that date, the $25,000
deduction-equivalent allowance is permitted for the
low-income housing credit without regard to the
taxpayer's income.
A partnership's operations may be treated as
multiple activities for purposes of the passive loss
rules. In such case, the partnership must separately
report items of income and deductions from each of
its activities.
Income, loss and other items from a publicly traded
partnership are treated as separate from income and
loss from any other publicly traded partnership, and
also as separate from any income or loss from
passive activities.
The Omnibus Budget Reconciliation Act of 1993 added
a rule, effective for taxable years beginning after
December 31, 1993, treating a taxpayer's rental real
estate activities in which he materially
participates as not subject to limitation under the
passive loss rules if the taxpayer meets eligibility
requirements relating to real property trades or
businesses in which he performs services (sec.
469(c)(7)). Real property trade or business means
any real property development, redevelopment,
construction, reconstruction, acquisition,
conversion, rental, operation, management, leasing,
or brokerage trade or business. An individual
taxpayer generally meets the eligibility
requirements if (1) more than half of the personal
services the taxpayer performs in trades or business
during the taxable year are performed in real
property trades or businesses in which the taxpayer
materially participates, and (2) such taxpayer
performs more than 750 hours of services during the
taxable year in real property trades or businesses
in which the taxpayer materially participates.
REMICs
A tax is imposed on partnerships holding a residual
interest in a real estate mortgage investment
conduit ("REMIC"). The amount of the tax
is the amount of excess inclusions allocable to
partnership interests owned by certain tax-exempt
organizations ("disqualified
organizations") multiplied by the highest
corporate tax rate.
Contribution
of property to a partnership
In general, a partner recognizes no gain or loss
upon the contribution of property to a partnership.
However, income, gain, loss and deduction with
respect to property contributed to a partnership by
a partner must be allocated among the partners so as
to take into account the difference between the
basis of the property to the partnership and its
fair market value at the time of contribution. In
addition, the contributing partner must recognize
gain or loss equal to such difference if the
property is distributed to another partner within
five years of its contribution (sec. 704(c)), or if
other property is distributed to the contributor
within the five year period (sec. 737).
Election
of optional basis adjustments
In general, the transfer of a partnership interest
or a distribution of partnership property does not
affect the basis of partnership assets. A
partnership, however, may elect to make certain
adjustments in the basis of partnership property
(sec. 754). Under a section 754 election, the
transfer of a partnership interest generally results
in an adjustment in the partnership's basis in its
property for the benefit of the transferee partner
only, to reflect the difference between that
partner's basis for his interest and his
proportionate share of the adjusted basis of
partnership property (sec. 743(b)). Also under the
election, a distribution of property to a partner in
certain cases results in an adjustment in the basis
of other partnership property (sec. 734(b)).
Terminations
A partnership terminates if either (1) all partners
cease carrying on the business, financial operation
or venture of the partnership, or (2) within a
12-month period 50 percent or more of the total
partnership interests are sold or exchanged (sec.
708).
Reasons
for Change
The requirement that each partner take into account
separately his distributive share of a partnership's
items of income, gain, loss, deduction and credit
can result in the reporting of a large number of
items to each partner. The schedule K-1, on which
such items are reported, contains space for more
than 40 items. Reporting so many separately stated
items is burdensome for individual investors with
relatively small, passive interests in large
partnerships. In many respects such investments are
indistinguishable from those made in corporate stock
or mutual funds, which do not require reporting of
numerous separate items.
In addition, the number of items reported under the
current regime makes it difficult for the Internal
Revenue Service to match items reported on the K-1
against the partner's income tax return. Matching is
also difficult because items on the K-1 are often
modified or limited at the partner level before
appearing on the partner's tax return.
By significantly reducing the number of items that
must be separately reported to partners by an
electing large partnership, the provision eases the
reporting burden of partners and facilitates
matching by the IRS. Moreover, it is understood that
the Internal Revenue Service is considering
restricting the use of substitute reporting forms by
large partnerships. Reduction of the number of items
makes possible a short standardized form.
Explanation
of Provisions
In
general
The bill modifies the tax treatment of an electing
large partnership (generally, any partnership that
elects under the provision, if the number of
partners in the preceding taxable year is 100 or
more) and its partners. The provision provides that
each partner takes into account separately the
partner's distributive share of the following items,
which are determined at the partnership level: (1)
taxable income or loss from passive loss limitation
activities; (2) taxable income or loss from other
activities (e.g., portfolio income or loss); (3) net
capital gain or loss to the extent allocable to
passive loss limitation activities and other
activities; (4) tax-exempt interest; (5) net
alternative minimum tax adjustment separately
computed for passive loss limitation activities and
other activities; (6) general credits; (7)
low-income housing credit; (8) rehabilitation
credit; (9) credit for producing fuel from a
nonconventional source; (10) creditable foreign
taxes and foreign source items; and (11) any other
items to the extent that the Secretary determines
that separate treatment of such items is
appropriate.134
Separate treatment may be appropriate, for example,
should changes in the law necessitate such treatment
for any items.
Under the bill, the taxable income of an electing
large partnership is computed in the same manner as
that of an individual, except that the items
described above are separately stated and certain
modifications are made. These modifications include
disallowing the deduction for personal exemptions,
the net operating loss deduction and certain
itemized deductions.135
All limitations and other provisions affecting the
computation of taxable income or any credit (except
for the at risk, passive loss and itemized deduction
limitations, and any other provision specified in
regulations) are applied at the partnership (and not
the partner) level.
All elections affecting the computation of taxable
income or any credit generally are made by the
partnership.
Capital
gains
Under the bill, netting of capital gains and losses
occurs at the partnership level. A partner in a
large partnership takes into account separately his
distributive share of the partnership's net capital
gain or net capital loss.136
Such net capital gain or loss is treated as
long-term capital gain or loss.
Any excess of net short-term capital gain over net
long-term capital loss is consolidated with the
partnership's other taxable income and is not
separately reported.
A partner's distributive share of the partnership's
net capital gain is allocated between passive loss
limitation activities and other activities. The net
capital gain is allocated to passive loss limitation
activities to the extent of net capital gain from
sales and exchanges of property used in connection
with such activities, and any excess is allocated to
other activities. A similar rule applies for
purposes of allocating any net capital loss.
Any gains and losses of the partnership under
section 1231 are netted at the partnership level.
Net gain is treated as long-term capital gain and is
subject to the rules described above. Net loss is
treated as ordinary loss and consolidated with the
partnership's other taxable income.
Deductions
The bill contains two special rules for deductions.
First, miscellaneous itemized deductions are not
separately reported to partners. Instead, 70 percent
of the amount of such deductions is disallowed at
the partnership level;137
the remaining 30 percent is allowed at the
partnership level in determining taxable income, and
is not subject to the two- percent floor at the
partner level.
Second, charitable contributions are not separately
reported to partners under the bill. Instead, the
charitable contribution deduction is allowed at the
partnership level in determining taxable income,
subject to the limitations that apply to corporate
donors.
Credits
in general
Under the bill, general credits are separately
reported to partners as a single item. General
credits are any credits other than the low-income
housing credit, the rehabilitation credit and the
credit for producing fuel from a nonconventional
source. A partner's distributive share of general
credits is taken into account as a current year
general business credit. Thus, for example, the
credit for clinical testing expenses is subject to
the present law limitations on the general business
credit. The refundable credit for gasoline used for
exempt purposes and the refund or credit for
undistributed capital gains of a regulated
investment company are allowed to the partnership,
and thus are not separately reported to partners.
In recognition of their special treatment under the
passive loss rules, the low-income housing and
rehabilitation credits are separately reported.138
In addition, the credit for producing fuel from a
nonconventional source is separately reported.
The bill imposes credit recapture at the partnership
level and determines the amount of recapture by
assuming that the credit fully reduced taxes. Such
recapture is applied first to reduce the
partnership's current year credit, if any; the
partnership is liable for any excess over that
amount. Under the bill, the transfer of an interest
in an electing large partnership does not trigger
recapture.
Foreign
taxes
The bill retains present-law treatment of foreign
taxes. The partnership reports to the partner
creditable foreign taxes and the source of any
income, gain, loss or deduction taken into account
by the partnership. Elections, computations and
limitations are made by the partner.
Tax-exempt
interest
The bill retains present-law treatment of tax-exempt
interest. Interest on a State or local bond is
separately reported to each partner.
Unrelated
business taxable income
The bill retains present-law treatment of unrelated
business taxable income. Thus, a tax-exempt
partner's distributive share of partnership items is
taken into account separately to the extent
necessary to comply with the rules governing such
income.
Passive
losses
Under the bill, a partner in an electing large
partnership takes in an electing to account
separately his distributive share of the
partnership's taxable income or loss from passive
loss limitation activities. The term "passive
loss limitation activity" means any activity
involving the conduct of a trade or business
(including any activity treated as a trade or
business under sec. 469(c)(5) or (6)) and any rental
activity. A partner's share of an electing large
partnership's taxable income or loss from passive
loss limitation activities is treated as an item of
income or loss from the conduct of a trade or
business which is a single passive activity, as
defined in the passive loss rules. Thus, an electing
large partnership generally is not required to
separately report items from multiple activities.
A partner in an electing large partnership also
takes into account separately his distributive share
of the partnership's taxable income or loss from
activities other than passive loss limitation
activities. Such distributive share is treated as an
item of income or expense with respect to property
held for investment. Thus, portfolio income (e.g.,
interest and dividends) is reported separately and
is reduced by portfolio deductions and allocable
investment interest expense.
In the case of a partner holding an interest in an
electing large partnership which is not a limited
partnership interest, such partner's distributive
share of any items are taken into account separately
to the extent necessary to comply with the passive
loss rules. Thus, for example, income of an electing
large partnership is not treated as passive income
with respect to the general partnership interest of
a partner who materially participates in the
partnership's trade or business.
Under the bill, the requirement that the passive
loss rule be separately applied to each publicly
traded partnership (sec. 469(k) of the Code)
continues to apply.
Alternative
minimum tax
Under the bill, alternative minimum tax
("AMT") adjustments and preferences are
combined at the partnership level. An electing large
partnership would report to partners a net AMT
adjustment separately computed for passive loss
limitation activities and other activities. In
determining a partner's alternative minimum taxable
income, a partner's distributive share of any net
AMT adjustment is taken into account instead of
making separate AMT adjustments with respect to
partnership items. The net AMT adjustment is
determined by using the adjustments applicable to
individuals (in the case of partners other than
corporations), and by using the adjustments
applicable to corporations (in the case of corporate
partners). Except as provided in regulations, the
net AMT adjustment is treated as a deferral
preference for purposes of the section 53 minimum
tax credit.
Discharge
of indebtedness income
If an electing large partnership has income from the
discharge of any indebtedness, such income is
separately reported to each partner. In addition,
the rules governing such income (sec. 108) are
applied without regard to the large partnership
rules. Partner-level elections under section 108 are
made by each partner separately. Thus, for example,
the large partnership provisions do not affect
section 108(d)(6), which provides that certain
section 108 rules apply at the partner level, or
section 108(b)(5), which provides for an election to
reduce the basis of depreciable property. The large
partnership provisions also do not affect the
election under 108(c) (added by the Omnibus Budget
Reconciliation Act of 1993) to exclude discharge of
indebtedness income with respect to qualified real
property business indebtedness.
REMICs
For purposes of the tax on partnerships holding
residual interests in REMICs, all interests in an
electing large partnership are treated as held by
disqualified organizations. Thus, an electing large
partnership holding a residual interest in a REMIC
is subject to a tax equal to the excess inclusions
multiplied by the highest corporate rate. The amount
subject to tax is excluded from partnership income.
Election
of optional basis adjustments
Under the bill, an electing large partnership may
still elect to adjust the basis of partnership
assets with respect to transferee partners. The
computation of an electing large partnership's
taxable income is made without regard to the section
743(b) adjustment. As under present law, the section
743(b) adjustment is made only with respect to the
transferee partner. In addition, an electing large
partnership is permitted to adjust the basis of
partnership property under section 734(b) if
property is distributed to a partner, as under
present law.
Terminations
The bill provides that an electing large partnership
does not terminate for tax purposes solely because
50 percent of its interests are sold or exchanged
within a 12-month period.
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