Taxpayer
Relief Act of 1997 page6
 
House
Bill
The House 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.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
G. Other Foreign Provisions
1. Eligibility of licenses of computer software for
foreign sales corporation benefits (sec. 1101 of the
House bill and sec. 741 of the Senate amendment)
Present
law
Under special tax provisions that provide an export
benefit, a portion of the foreign trade income of an
eligible foreign sales corporation("FSC")
is exempt from Federal income tax. Foreign trade
income is defined as the gross income of a FSC that
is attributable to foreign trading gross receipts.
The term "foreign trading gross receipts"
includes the gross receiptsof a FSC from the sale,
lease, or rental of export property and from
services related and subsidiary to such sales,
leases, or rentals.
For purposes of the FSC rules, export property is
defined as property (1) which is manufactured,
produced, grown, or extracted in the United States
by a person other than a FSC; (2) which is held
primarily for sale, lease, or rental in the ordinary
conduct of a trade or business by or to a FSC for
direct use, consumption, or disposition outside the
United States; and (3) not more than 50 percent of
the fair market value of which is attributable to
articles imported into the United States. Intangible
property generally is excluded from the definition
of export property for purposes of the FSC rules;
this exclusion applies to copyrights other than
films, tapes, records,or similar reproductions for
commercial or home use. The temporary Treasury
regulations provide that a license of a master
recording tape for reproduction outside the United
States is not excluded from the definition of export
property (Treas. Reg. sec. 1.927(a)-1T(f)(3)). The
statutory exclusion for intangible property does not
contain any specific reference to computer software.
However, the temporary Treasury regulations provide
that a copyright on computer software does not
constitute export property, and that standardized,
mass marketed computer software constitutes export
property if such software is not accompanied by a
right to reproduce for external use (Treas. Reg.
sec. 1.927(a)-1T(f)(3)).
House
Bill
The House bill provides that computer software
licensed for reproduction abroad is not
excluded from the definition of export property
forpurposes of the FSC provisions. Accordingly,
computer software that is exported with a right to
reproduce is eligible for the benefits of the FSC
provisions. In light of the rapid innovations in the
computer and software industries, the Committee
intends that the term "computer software"
be construed broadly toaccommodate technological
changes in the products produced by both industries.
No inference is intended regarding the qualification
as export property of computer software licensed for
reproduction abroad under present law.
Effective date. --The provision generally
applies to gross receiptsfrom computer software
licenses attributable to periods after
December 31, 1997
. Accordingly, in the case of a multi-year license,
the provision applies to gross receipts attributable
to the period of such license that is after
December 31, 1997
. In the case of gross receipts attributable to
1998, the provision applies to only one-third of
such gross receipts. In the case of gross receipts
attributable to 1999, the provision applies to only
two-thirds of such gross receipts.
Senate
Amendment
The Senate amendment is the same as the House bill,
with a modification to the effective date.
Effective date. --The provision applies to
gross receipts fromcomputer software licenses
attributable to periods after
December 31, 1997
. Accordingly, in the case of a multi-year license,
the provision applies to gross receipts attributable
to the period of such license that is after
December 31, 1997
.
Conference
Agreement
The conference agreement follows the Senate
amendment.
2. Increase dollar limitation on section 911
exclusion (sec. 1102 of the House bill)
Present
Law
U.S.
citizens generally are subject to
U.S.
income tax on all their income, whether derived in
the
United States
or elsewhere. A
U.S.
citizen who earns income in a foreign country also
may be taxed on such income by that foreign country.
A credit against the
U.S.
income tax imposed on foreign source income is
allowed for foreign taxes paid on such income.
U.S.
citizens living abroad may be eligible to exclude
from their income for
U.S.
tax purposes certain foreign earned income and
foreign housing costs. In order to qualify for these
exclusions, a
U.S.
citizen must be either (1) a bona fide resident of a
foreign country for an uninterrupted period that
includes an entire taxable year or (2) present
overseas for 330 days out of any 12 consecutive
month period. In addition, the taxpayer must have
his or her tax home in a foreign country.
The exclusion for foreign earned income generally
applies to income earned from sources outside the
United States
as compensation for personal services actually
rendered by the taxpayer. The maximum exclusion for
foreign earned income for a taxable year is $70,000.
The exclusion for housing costs applies to
reasonable expenses, other than deductible interest
and taxes, paid or incurred by or on behalf of the
taxpayer for housing for the taxpayer and his or her
spouse and dependents in a foreign country. The
exclusion amount for housing costs for a taxable
year is equal to the excess of such housing costs
for the taxable year over an amount computed
pursuant to a specified formula.
The combined earned income exclusion and housing
cost exclusion may not exceed the taxpayer's total
foreign earned income. The taxpayer's foreign tax
credit is reduced by the amount the credit that is
attributable to excluded income.
House
Bill
Under the House bill, the $70,000 limitation on the
exclusion for foreign earned income is increased to
$80,000, in increments of $2,000 each year beginning
in 1998. The $80,000 limitation on the exclusion for
foreign earned income is indexed for inflation
beginning in 2008 (for inflation after 2006).
Effective date. --The provision is effective
for taxable yearsbeginning after
December 31, 1997
.
Senate
Amendment
No provision.
Conference
Agreement
The conference agreement follows the House bill.
3. Treatment of certain securities positions under
the subpart F investment in
U.S.
property rules (sec. 743 of the Senate amendment)
Present
Law
Under the rules of subpart F (secs. 951-964), the
U.S. 10-percent shareholders of a controlled foreign
corporation (CFC) are required to include in income
currently for U.S. tax purposes certain earnings of
the CFC, whether or not such earnings are
distributed currently to the shareholders. The
U.S.
10-percent shareholders of a CFC are subject to
current
U.S.
tax on their shares of certain income earned by the
CFC (referred to as "subpart F income").
The
U.S.
10-percent shareholders also are subject to
currentU.S. tax on their shares of the CFC's
earnings to the extent invested by theCFC in certain
U.S.
property.
A shareholder's current income inclusion with
respect to a CFC's investment in
U.S.
property for a taxable year is based on the CFC's
average investment in
U.S.
property for such year. For this purpose, the
U.S.
property held by the CFC must be measured as of the
close of each quarter in the taxable year.
U.S.
property generally is defined to include tangible
property located in the
United States
, stock of a
U.S.
corporation, obligations of a
U.S.
person, and the right to use certain intellectual
property in the
United States
. Exceptions are provided for, among other things,
obligations of the
United States
, U.S. bank deposits, certain trade or business
obligations, and stock or debts of certain unrelated
U.S.
corporations.
House
Bill
No provision.
Senate
Amendment
The Senate amendment provides two additional
exceptions from the definition of
U.S.
property for purposes of the subpart F rules. Both
exceptions relate to transactions entered into by a
securities or commodities dealer in the ordinary
course of its business as a securities or
commodities dealer.
The first exception covers the deposit of collateral
or margin by a securities or commodities dealer, or
the receipt of such a deposit by a securities or
commodities dealer, if such deposit is made or
received on commercial terms in the ordinary course
of the dealer's business as a securities or
commodities dealer. This exception applies to
deposits of margin or collateral for securities
loans, notional principal contracts, options
contracts, forward contracts, futures contracts, and
any other financial transaction with respect to
which the Secretary of the Treasury determines that
the posting of collateral or margin is customary.
The second exception covers repurchase agreement
transactions and reverse repurchase agreement
transactions entered into by or with a securities or
commodities dealer in the ordinary course of its
business as a securities or commodities dealer. The
exception applies only to the extent that the
obligation under the transaction does not exceed the
fair market value of readily marketable securities
transferred or otherwise posted as collateral.
Effective date. --The provision is effective
for taxable years offoreign corporations beginning
after
December 31, 1997
, and taxable years of
U.S.
shareholders with or within which such taxable years
of foreign corporations end.
Conference
Agreement
The conference agreement generally follows the
Senate amendment. Under the conference agreement,
for purposes of these two additional exceptions
under section 956, the term "dealer in
commodities" means futurescommission merchants
and dealers in commodities within the meaning of the
new definition that is added to section 475 by the
conference agreement. In addition, the conferees
wish to clarify that the addition of these two
exceptions under section 956 is not intended to
create any inference regarding the treatment of an
obligation of a
U.S.
person to return stock that is borrowed pursuant to
a securities loan.
4. Exception from foreign personal holding company
income under subpart F for active financing income
(sec. 744 of the Senate amendment)
Present
Law
Under the subpart F rules, certain
U.S.
shareholders of a controlled foreign corporation
("CFC") are subject to
U.S.
tax currently on certainincome earned by the CFC,
whether or not such income is distributed to the
shareholders. The income subject to current
inclusion under the subpart F rules includes, among
other things, "foreign personal holding company
income" andinsurance income. The
U.S.
10-percent shareholders of a CFC also are subject to
current inclusion with respect to their shares of
the CFC's foreign base company services income
(i.e., income derived from services performed for a
related person outside the country in which the CFC
is organized).
Foreign personal holding company income generally
consists of the following: dividends, interest,
royalties, rents and annuities; net gains from sales
or exchanges of (1) property that gives rise to the
preceding types of income, (2) property that does
not give rise to income, and (3) interests in
trusts, partnerships, and REMICs; net gains from
commodities transactions; net gains from foreign
currency transactions; and income that is equivalent
to interest.
Insurance income subject to current inclusion under
the subpart F rules includes any income of a CFC
attributable to the issuing or reinsuring of any
insurance or annuity contract in connection with
risks located in a country other than the CFC's
country of organization and related person insurance
income. Subpart F insurance income also includes
income attributable to an insurance contract in
connection with risks located within the CFC's
country of organization, as the result of an
arrangement under which another corporation receives
a substantially equal amount of consideration for
insurance of other-country risks. Investment income
of a CFC that is allocable to any insurance or
annuity contract related to risks located outside
the CFC's country of organization is taxable as
subpart F insurance income (Prop. Treas. reg. sec.
1.953-1(a)). Investment income allocable to risks
located within the CFC's country of organization
generally is taxable as foreign personal holding
company income.
House
Bill
No provision.
Senate
Amendment
The Senate amendment provides a temporary exception
from foreign personal holding company income for
subpart F purposes for certain income that is
derived in the active conduct of an insurance,
banking, financing or similar business. Such
exception is applicable only for taxable years
beginning in 1998.
Under the Senate amendment, foreign personal holding
company income does not include income that is
derived in or incident to the active conduct of a
banking, financing or similar business by a CFC that
is predominantly engaged in the active conduct of
such business. For this purpose, income derived in
the active conduct of a banking, financing, or
similar business generally is determined under the
principles applicable in determining financial
services income for foreign tax credit limitation
purposes. Moreover, the Secretary of the Treasury
shall prescribe regulations applying look-through
treatment in characterizing for this purpose
dividends, interest, income equivalent to interest,
rents, and royalties from related persons. A CFC is
considered to be predominantly engaged in the active
conduct of a banking, financing, or similar business
if (1) more than 70 percent of its gross income is
derived from transactions with unrelated persons and
more than 20 percent of its gross income from that
business is derived from transactions with unrelated
persons located within the country in which the CFC
is organized or incorporated, or (2) the CFC is
predominantly engaged in the active conduct of a
banking or securities business, or is a qualified
bank or securities affiliate, as defined for
purposes of the passive foreign investment company
provisions.
Under the Senate amendment, foreign personal holding
company income also does not include certain
investment income of a qualifying insurance company
with respect to risks located within the CFC's
country of organization. These exceptions apply to
income derived from investments of assets equal to
the total of (1) unearned premiums and reserves
ordinary and necessary for the proper conduct of the
CFC's insurance business, (2) one-third of premiums
earned during the taxable year on insurance
contracts regulated in the country in which sold as
property, casualty, or health insurance contracts,
and (3) the greater of $10 million or 10 percent of
reserves for insurance contracts regulated in the
country in which sold as life insurance or annuity
contracts. For this purpose, a qualifying insurance
company is an entity that is subject to regulation
as an insurance company under the laws of its
country of incorporation and that realizes at least
50 percent of its gross income (other than income
from investments) from premiums related to risks
located within such country. These exceptions for
insurance investment income do not apply to
investment income which is received by the CFC from
a related person. Similarly, the exceptions do not
apply to investment income that is attributable
directly or indirectly to the insurance or
reinsurance of risks of related persons. The Senate
amendment does not change the rule of present law
that investment income of a CFC that is attributable
to the issuing or reinsuring any insurance or
annuity contract related to risks outside of its
country of organization is taxable as Subpart F
insurance income.
The Senate amendment also provides an exception from
foreign base company services income for income
derived from services performed in connection with
the active conduct of a banking, financing,
insurance or similar business by a CFC that is
predominantly engaged in the active conduct of such
business.
Effective date. --The provision applies only
to taxable years offoreign corporations beginning in
1998, and to taxable years of
United States
shareholders with or within which such taxable years
of foreign corporations end.
Conference
Agreement
The conference agreement generally follows the
Senate amendment with modifications.
Under the conference agreement, the temporary
exception from foreign personal holding company
income applies to income that is derived in the
active conduct of a banking, financing or similar
business by a CFC that is predominantly engaged in
the active conduct of such business. For this
purpose, income derived in the active conduct of a
banking, financing, or similar business generally is
determined under the principles applicable in
determining financial services income for foreign
tax credit limitation purposes. However, in the case
of a corporation that is engaged in the active
conduct of a banking or securities business, the
income that is eligible for this exception is
determined under the principles applicable in
determining the income which is treated as
nonpassive income for purposes of the passive
foreign investment company provisions. The conferees
generally intend that the income of a corporation
engaged in the active conduct of a banking or
securities business that is eligible for this
exception is the income that is treated as
nonpassive under the regulations proposed under
section 1296(b). See Prop. Treas. Reg. secs.
1.1296-4 and 1.1296-6. In this regard, the conferees
intend that eligible income will include income or
gains with respect to foreclosed property which is
incident to the active conduct of a banking
business.
For purposes of the temporary exception, a
corporation is considered to be predominantly
engaged in the active conduct of a banking,
financing, or similar business if it is engaged in
the active conduct of a banking or securities
business or is a qualified bank affiliate or
qualified securities affiliate. In this regard, the
conferees intend that a corporation will be
considered to be engaged in the active conduct of a
banking or securities business if the corporation
would be treated as so engaged under the regulations
proposed under section 1296(b); the conferees
further intend that qualified bank affiliates and
qualified securities affiliates will be as
determined under such proposed regulations. See
Prop. Treas. Reg. secs. 1.1296-4 and 1.1296-6.
Alternatively, a corporation is considered to be
engaged in the active conduct of a banking,
financing or similar business if more than 70
percent of its gross income is derived from such
business from transactions with unrelated persons
located within the country under the laws of which
the corporation is created or organized. For this
purpose, income derived by a qualified business unit
of a corporation from transactions with unrelated
persons located in the country in which the
qualified business unit maintains its principal
office and conducts substantial business activity is
treated as derived by the corporation from
transactions with unrelated persons located within
the country in which the corporation is created or
organized. A person other than a natural person is
considered to be located within the country in which
it maintains an office through which it engages in a
trade or business and by which the transaction is
effected. A natural person is treated as located
within the country in which such person is
physically located when such person enters into the
transaction.
The conference agreement provides a temporary
exception from foreign personal holding company
income for certain investment income of a qualifying
insurance company with respect to risks located
within the CFC's country of creation or
organization. The rules of this provision of the
conference agreement differ from the rules of
present-law section 953 of the Code, which
determines the subpart F inclusions of a
U.S.
shareholder relating to insurance income of a CFC.
Such insurance income under section 953 generally is
computed in accordance with the rules of subchapter
L of the Code. The conferees believe that review of
the rules of this provision would be appropriate
when final guidance under section 953 is published
by the Treasury Department.
The conference agreement provides a temporary
exception for income (received from a person other
than a related person) from investments made by a
qualifying insurance company of its reserves or 80
percent of its unearned premiums (as defined for
purposes of the provision). For this purpose, in the
case of contracts regulated in the country in which
sold as property, casualty, or health insurance
contracts, unearned premiums and reserves mean
unearned premiums and reserves for losses incurred
determined using the methods and interest rates that
would be used if the qualifying insurance company
were subject to tax under subchapter L of the Code.
Thus, for this purpose, unearned premiums are
determined in accordance with section 832(b)(4), and
reserves for losses incurred are determined in
accordance with section 832(b)(5) and 846 of the
Code (as well as any other rules applicable to a
U.S. property and casualty insurance company with
respect to such amounts).
In the case of a contract regulated in the country
in which sold as a life insurance or annuity
contract, the following three alternative rules for
determining reserves are provided under the
conference agreement. It is intended that any one of
the three rules may be elected with respect to a
particular line of business.
First, reserves for such contracts may be determined
generally under the rules applicable to domestic
life insurance companies under subchapter L of the
Code, using the methods there specified, but
substituting for the interest rates in Code section
807(d)(2)(B) an interest rate determined for the
country in which the qualifying insurance company
was created or organized, calculated in the same
manner as the mid-term applicable Federal interest
rate("AFR") (within the meaning of section
1274(d)).
Second, the reserves for such contracts may be
determined generally using a preliminary term
foreign reserve method, except that the interest
rate to be used is the interest rate determined for
the country in which the qualifying insurance
company was created or organized, calculated in the
same manner as the mid-term AFR. If a qualifying
insurance company uses such a preliminary term
method with respect to contracts insuring risks
located in the country in which the company is
created or organized, then such method is the method
that applies for purposes of this election.
Third, reserves for such contracts may be determined
to be equal to the net surrender value of the
contract (as defined in section 807(e)(1)(A)).
In no event may the reserve for any contract at any
time exceed the foreign statement reserve for the
contract, reduced by any catastrophe or deficiency
reserve. This rule applies whether the contract is
regulated as a property, casualty, health, life
insurance, annuity, or any other type of contract.
The conference agreement also provides a temporary
exception for income from investment of assets equal
to (1) one-third of premiums earned during the
taxable year on insurance contracts regulated in the
country in which sold as property, casualty, or
health insurance contacts, and (2) the greater of 10
percent of reserves, or, in the case of a qualifying
insurance company that is a startup company, $10
million. For this purpose, a startup company is a
company (including any predecessor) that has not
been engaged in the active conduct of an insurance
business for more than 5 years. It is intended that
the 5-year period commences when the foreign company
first is engaged in the active conduct of an
insurance business. If the foreign company was
formed before being acquired by the
U.S.
shareholder, the 5-year period commences when the
acquired company first was engaged in the active
conduct of an insurance business. The conferees
intend that in the event of the acquisition of a
book of business from another company through an
assumption or indemnity reinsurance transaction, the
period commences when the acquiring company first
engaged in the active conduct of an insurance
business, except that if more than a substantial
part (e.g., 80 percent) of the business of the
ceding company is acquired, then the 5-year period
commences when the ceding company first engaged in
the active conduct of an insurance business. In
addition, it is not intended that reinsurance
transactions among related persons be used to
multiply the number of 5-year periods.
To prevent the shifting of relatively high-yielding
assets to generate investment income that qualifies
under this temporary exception, the conference
agreement provides that, under rules prescribed by
the Secretary, income is allocated to contracts as
follows. In the case of contracts that are
separate-account-type contracts (including variable
contracts not meeting the requirements of section
817), only the income specifically allocable to such
contracts is taken into account. In the case of
other contracts, income not specifically allocable
is allocated ratably among such contracts.
The conference agreement modifies the definition of
a qualifying insurance company. Under the conference
agreement, a qualifying insurance company means any
entity which: (1) is regulated as an insurance
company under the laws of the country in which it is
incorporated; (2) derives at least 50 percent of its
net written premiums from the insurance or
reinsurance of risks situated within its country of
incorporation; and (3) is engaged in the active
conduct of an insurance business and would be
subject to tax under subchapter L if it were a
domestic corporation.
The conference agreement clarifies that this
provision does not apply to investment income
(includable in the income of a U.S. shareholder of a
CFC pursuant to section 953) allocable to contracts
that insure related party risks or risks located in
a country other than the country in which the
qualifying insurance company is created or
organized.
Finally, the conference agreement provides an
anti-abuse rule applicable for purposes of these
temporary exceptions from foreign personal holding
company income. For purposes of applying these
exceptions, items with respect to a transaction or
series of transactions shall be disregarded if one
of the principal purposes of the transaction or
transactions is to qualify income or gain for these
exceptions, including any change in the method of
computing reserves or any other transaction or
transactions one of the principal purposes of which
is the acceleration or deferral of any item in order
to claim the benefits of these exceptions.
The conferees recognize that insurance, banking,
financing, and similar businesses are businesses the
active conduct of which involves the generation of
income, such as interest and dividends, of a type
that generally is treated as passive for purposes of
subpart F. For purposes of this temporary provision,
the conferees intend to delineate the income derived
in the active conduct of such businesses, while
retaining the present-law anti-deferral rules of
subpart F with respect to income not derived in the
active conduct of these financial services
businesses. However, the conferees recognize that
the line between income derived in the active
conduct of such businesses and income otherwise
derived by entities so engaged can be difficult to
draw. The conferees believe that the issues of the
determination of income derived in the active
conduct of such businesses and the potential
mobility of the business activity and income
recognition of insurance, banking, financing, and
similar businesses require further study. In the
event that it becomes necessary to consider a
possible extension of the provision in the future,
the conferees would invite the comments of taxpayers
and the Treasury Department regarding these issues.
5. Treat service income of nonresident alien
individuals earned on foreign ships as foreign
source income and disregard the
U.S.
presence of such individuals (sec. 745 of the Senate
amendment)
Present
Law
Nonresident alien individuals generally are subject
to
U.S.
taxation and withholding on their
U.S.
source income. Compensation for labor and personal
services performed within the
United States
is considered
U.S.
source unless such income qualifies for a de minimis
exception. To qualify for the exception, the
compensation paid to a nonresident alien individual
must not exceed $3,000, the compensation must
reflect services performed on behalf of a foreign
employer, and the individual must be present in the
United Sates for not more than 90 days during the
taxable year. Special rules apply to exclude certain
items from the gross income of a nonresident alien.
An exclusion applies to gross income derived by a
nonresident alien individual from the international
operation of a ship if the country in which such
individual is resident provides a reciprocal
exemption for
U.S.
residents. However, this exclusion does not apply to
income from personal services performed by an
individual crew member on board a ship.
Consequently, wages exceeding $3,000 in a taxable
year that are earned by nonresident alien individual
crew members of a foreign ship while the vessel is
within U.S. territory are subject to income taxation
by the United States.
U.S.
residents are subject to
U.S.
tax on their worldwide income. In general, a non-U.S.
citizen is considered to be a resident of the United
States if the individual (1) has entered the United
States as a lawful permanent U.S. resident or (2) is
present in the United States for 31 or more days
during the current calendar year and has been
present in the United States for a substantial
period of time --183 or more days --during a three-yearperiod
computed by weighting toward the present year (the
"substantial presence test"). An
individual generally is treated as present in the
UnitedStates on any day if such individual is
physically present in the
United States
at any time during the day. Certain categories of
individuals (e.g., foreign government employees and
certain students) are not treated as
U.S.
residents even if they are present in the
United States
for the requisite period of time. Crew members of a
foreign vessel who are on board the vessel while it
is stationed within
U.S.
territorial waters are treated as present in the
United States
.
House
Bill
No provision.
Senate
Amendment
The Senate amendment treats gross income of a
nonresident alien individual, who is present in the
United States
as a member of the regular crew of a foreign vessel,
from the performance of personal services in
connection with the international operation of a
ship as income from foreign sources. Thus, such
income is exempt from
U.S.
income and withholding tax. However, such persons
are not excluded for purposes of applying the
minimum participation standards of section 410 to a
plan of the employer. In addition, for purposes of
determining whether an individual is a
U.S.
resident under the substantial presence test, the
Senate amendment provides that the days that such
individual is present as a member of the regular
crew of a foreign vessel are disregarded.
Effective date. --The provision is effective
for taxable yearsbeginning after
December 31, 1997
.
Conference
Agreement
The conference agreement generally follows the
Senate amendment with modifications. The conference
agreement provides that the treatment of income of a
nonresident alien crew member of a foreign vessel as
foreign source income will not apply for purposes of
the pension rules and certain employee benefit
provisions. The conference agreement further
provides that, for purposes of determining whether
an individual is a U.S. resident under the
substantial presence test, any day that such
individual is present as a member of the regular
crew of a foreign vessel is disregarded only if the
individual does not otherwise engage in trade or
business within the United States on such day.
XII. SIMPLIFICATION PROVISIONS RELATING TO
INDIVIDUALS ANDBUSINESSES
A. Provisions Relating to Individuals
1. Modifications to standard deduction of
dependents;
AMT
treatment of certain minor children (sec. 1201 of
the House bill and sec. 1001 of the Senate
amendment)
Present
Law
Standard deduction of dependents. --The
standard deduction of ataxpayer 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)1
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) $5002
(indexed) plus (2) the greater of (a) $5003
(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 underage 14.
--Single taxpayers are entitled to an exemption from
thealternative minimum tax ("
AMT
") of $33,750. However, in the case of a
childunder 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)).
House
Bill
Standard deduction of dependents. --The House
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) $5004
(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. --TheHouse 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 yearsbeginning after
December 31, 1997
.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
2. Increase de minimis threshold for estimated tax
to $1,000 for individuals (sec. 1202 of the House
bill and sec. 1002 of the Senate amendment)
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 returnfor 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.
House
Bill
The House bill increases the $500 individual
estimated tax de minimis threshold to $1,000.
Effective date. --The provision is effective
for taxable yearsbeginning after
December 31, 1997
.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
3. Optional methods for computing SECA tax combined
(sec. 1203 of the House bill)
Present
Law
The Self-Employment Contributions Act ("SECA")
imposes taxes onnet earnings from self-employment to
provide social security coverage to self-employed
workers. The maximum amount of earnings subject to
the SECA tax is coordinated with, and is set at the
same level as, the maximum level of wages and
salaries subject to FICA taxes ($65,000 for OASDI
taxes in 1997 and indexed annually, and without
limit for the Hospital Insurance tax). Special rules
allow certain self-employed individuals to continue
to maintain social security coverage during a period
of low income. The method applicable to farmers is
slightly more favorable than the method applicable
to other self-employed persons.
A farmer may increase his or her self-employment
income, for purposes of obtaining social security
coverage, by reporting two-thirds of the first
$2,400 of gross income as net earnings from
self-employment, i.e., the optional amount of net
earnings from self-employment would not exceed
$1,600. There is no limit on the number of times a
farmer may use this method. The optional method for
non farm income is similar, also permitting
two-thirds of the first $2,400 of gross income to be
treated as self-employment income. However, the
optional non farm method may not be used more than
five times by any individual, and may only be used
if the taxpayer had net earnings from
self-employment of $400 or more in at least two of
the three years immediately preceding the year in
which the optional method is elected.
In general, to receive benefits, including
Disability Insurance Benefits, under the Social
Security Act, a worker must have a minimum number of
quarters of coverage. A minimum amount of wages or
self-employment income must be reported to obtain a
quarter of coverage. A maximum of four quarters of
coverage may be obtained each year. In 1978, the
amount of earnings required to obtain a quarter of
coverage began increasing each year. Starting in
1994, a farmer could obtain only two quarters of
coverage under the optional method applicable to
farmers.
House
Bill
The House bill combines the farm and non farm
optional methods into a single combined optional
method applicable to all self-employed workers. A
self-employed worker may elect to use the optional
method an unlimited number of times. If it is used,
it must be applied to all self-employment earnings
for the year, both farm and non farm.
The $2,400 amount is increased to an amount which
would provide four quarters of coverage in 1998 (the
"lower limit"). Such amount increaseseach
year based on the earnings requirements under the
Social Security Act.
The optional method in this provision is elected on
a year-by-year basis. An election for a taxable year
must be filed with the original Federal income tax
return for the year, and may not be made
retroactively by filing an amended return.
Effective
date
: The provision is effective for taxable years
beginning after
January 1, 1998
.
Senate
Amendment
No provision.
Conference
Agreement
The conference agreement does not include the House
bill provision.
4. Treatment of certain reimbursed expenses of rural
letter carriers' vehicles (sec. 1204 of the House
bill and sec. 1003 of the Senate amendment)
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.
House
Bill
The House bill repeals the special rate for Postal
Service employees of 150 percent of the standard
mileage rate. In its place, the House 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 yearsbeginning after
December 31, 1997
.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
5. Travel expenses of Federal employees
participating in a Federal criminal investigation
(sec. 1205 of the House bill and sec. 1004 of the
Senate amendment)
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.
House
Bill
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.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
6. Payment of taxes by commercially acceptable means
(sec. 1206 of the House bill)
Present
Law
Payment of taxes may be made by checks or money
orders, to the extent and under the conditions
provided by Treasury regulations (sec. 6311).
House
Bill
In
general
The Internal Revenue Service (
IRS
) is engaged in a long-term modernization of its
information systems, the Tax Systems Modernization (
TSM
) Program. This modernization is intended to address
deficiencies in the current
IRS
information systems and to plan effectively for
future information system needs and requirements.
The systems changes are designed to reduce the
burden on taxpayers, generate additional revenue
through improved voluntary compliance, and achieve
productivity gains throughout the
IRS
. One key element of this program is electronic
filing of tax returns.
At the present time, increasing reliance is being
placed upon electronic funds transfers for payment
of obligations. In light of this, the
IRS
seeks to integrate these payment methods in its
TSM
program, including electronic filing of returns, as
well as into its traditional collection functions.
The House bill allows the
IRS
to accept payment by any commercially acceptable
means that the Secretary deems appropriate, to the
extent and under the conditions provided in Treasury
regulations. This will include, for example,
electronic funds transfers, including those arising
from credit cards, debit cards, and charge cards.
The
IRS
contemplates that it will proceed to negotiate
contracts to implement this provision with one or
more private sector credit and debit card systems.
The House bill provides that the Federal Government
may pay fees with respect to any such contracts only
out of amounts specifically appropriated for that
purpose.
Billing
error resolution
In the course of processing these transactions, it
will be necessary to resolve billing errors and
other disputes. The Internal Revenue Code contains
mechanisms for the determination of tax liability,
defenses and other taxpayer protections, and the
resolution of disputes with respect to those
liabilities. The Truth-in-Lending Act contains
provisions for determination of credit card
liabilities, defenses and other consumer
protections, and the resolution of disputes with
respect to these liabilities.
The House bill excludes credit card, debit card, and
charge card issuers and processing mechanisms from
the resolution (such as through the "billingerror"
resolution process) of tax liability, but makes
IRS
subject to the Truth-in-Lending provisions insofar
as those provisions impose obligations and
responsibilities with regard to the "billing
error" resolutionprocess. It is not intended
that consumers obtain additional ways to dispute
their tax liabilities under the Truth-in-Lending
provisions.
The House bill also specifically includes the use of
debit cards in this provision and provides that the
corresponding defenses and "billingerror"
provisions of the Electronic Fund Transfer Act will
apply in a similar manner.
The House bill adds new section 6311(d)(3) to the
Code. This section describes the circumstances under
which section 161 of the Truth-in-Lending
Act("TILA") and section 908 of the
Electronic Fund Transfer Act ("EFTA")
applyto disputes that may arise in connection with
payments of taxes made by credit card or debit card.
Subsections (A) through (C) recognize that "billingerrors"
relating to the credit card account, such as an
error arising from a credit card transaction posted
to a cardholder's account without the cardholder's
authorization, an amount posted to the wrong
cardholder's account, or an incorrect amount posted
to a cardholder's account as a result of a
computational error or numerical transposition, are
governed by the billing error provisions of section
161 of TILA. Similarly, subsections
6311(d)(3)(A)-(C) provide that errors such as those
described above which arise in connection with
payments of internal revenue taxes made by debit
card, are governed by section 908 of EFTA.
The Internal Revenue Code provides that refunds are
only authorized to be paid to the person who made
the overpayment (generally the taxpayer). Subsection
6311(d)(3)(E), however, provides that where a
taxpayer is entitled to receive funds as a result of
the correction of a billing error made under section
161 of TILA in connection with a credit card
transaction, or under section 908 of EFTA in
connection with a debit card transaction, the
IRS
is authorized to utilize the appropriate credit card
or debit card system to initiate a credit to the
taxpayer's credit card or debit card account. The
IRS
may, therefore, provide such funds through the
taxpayer's credit card or debit card account rather
than directly to the taxpayer.
On the other hand, subsections 6311(d)(3)(A)-(C)
provide that any alleged error or dispute asserted
by a taxpayer concerning the merits of the
taxpayer's underlying tax liability or tax return is
governed solely by existing tax laws, and is not
subject to section 161 or section 170 of TILA,
section 908 of EFTA, or any similar provisions of
State law. Absent the exclusion from section 170 of
TILA, in a collection action brought against the
cardholder by the card issuer the cardholder might
otherwise assert as a defense that the
IRS
had incorrectly computed his tax liability. A
collection action initiated by a credit card issuer
against the taxpayer/cardholder will be an
inappropriate vehicle for the determination of a
taxpayer's tax liability, especially since the
United States
will not be a party to such an action.
Similarly, without the exclusion from section 161 of
TILA and section 908 of EFTA, a taxpayer could
contest the merits of his tax liability by putting
the charge which appears on the credit card bill in
dispute. Pursuant to TILA or EFTA, the taxpayer's
card issuer will have to investigate the dispute,
thereby finding itself in the middle of a dispute
between the
IRS
and the taxpayer. It is believed that it is improper
to attempt to resolve tax disputes through the
billing process. It is also noted that the taxpayer
retains the traditional, existing remedies for
resolving tax disputes, such as resolving the
dispute administratively with the
IRS
, filing a petition with the Tax Court after
receiving a statutory notice of deficiency, or
paying the disputed tax and filing a claim for
refund (and subsequently filing a refund suit if the
claim is denied or not acted upon).
Creditor
status
The TILA imposes various responsibilities and
obligations on creditors. Although the definition of
the term "creditor" set forth in 15U.S.C.
sec. 1602 is limited, and will generally not include
the
IRS
, in the case of an open-end credit plan involving a
credit card, the card issuer and any person who
honors the credit card are, pursuant to 15 U.S.C.
sec. 1602(f), creditors.
In addition, 12
CFR
sec. 226.12(e) provides that the creditor must
transmit a credit statement to the card issuer
within 7 business days from accepting the return or
forgiving the debt. There is a concern that the
response deadlines otherwise imposed by 12
CFR
sec. 226.12(e), if applicable, will be difficult for
the
IRS
to comply with (given the volume of payments the
IRS
is likely to receive in peak periods). This could
subject the
IRS
to unwarranted damage actions. Consequently, the
House bill generally provides an exception to
creditor status for the
IRS
.
Privacy
protections
The House bill also addresses privacy questions that
arise from the
IRS
' participation in credit card processing systems.
It is believed that taxpayers expect that the
maximum possible protection of privacy will be
accorded any transactions they have with the
IRS
. Accordingly, the House bill provides the greatest
possible protection of taxpayers' privacy that is
consistent with developing and operating an
efficient tax administration system. It is expected
that the principle will be fully observed in the
implementation of this provision.
A key privacy issue is the use and redisclosure of
tax information by financial institutions for
purposes unrelated to the processing of credit card
charges, i.e., marketing and related uses. To accept
credit card charges by taxpayers, the
IRS
will have to disclose tax information to financial
institutions to obtain payment and to resolve
billing disputes. To obtain payment, the
IRS
will have to disclose, at a minimum, information on
the "credit slip," i.e., the dollar amount
of the payment and thetaxpayer's credit card number.
The resolution of billing disputes may require the
disclosure of additional tax information to
financial institutions. In most cases, providing a
copy of the credit slip and verifying the
transaction amount will be sufficient. Conceivably,
financial institutions could require some
information regarding the underlying liability even
where the dispute concerns a "billingdispute"
matter. This additional information will not
necessarily be shared as widely as the initial
payment data. In lieu of disclosing further
information, the
IRS
may elect to allow disputed amounts to be charged
back to the
IRS
and to reinstate the corresponding tax liability.
Despite the language in most cardholder agreements
that permits redisclosure of credit card transaction
information, the public may be largely unaware of
how widely that information is shared. For example,
some financial institutions may share credit,
payment, and purchase information with private
credit bureaus, who, in turn, may sell this
information to direct mail marketers, and others.
Without use and redisclosure restrictions, taxpayers
may discover that some traditionally confidential
tax information might be widely disseminated to
direct mail marketers and others.
It is intended that credit or debit card transaction
information will generally be restricted to those
uses necessary to process payments and resolve
billing errors, as well as other purposes that are
specified in the statute. The House bill directs the
Secretary to issue published procedures on what
constitutes authorized uses and disclosures. It is
anticipated that the Secretary's published
procedures will prohibit the use of transaction
information for marketing tax-related services by
the issuer or any marketing that targets only those
who use their credit card to pay their taxes. It is
also anticipated that the published procedures will
prohibit the sale of transaction information to a
third party.
Effective date. --The provision is effective
nine months after thedate of enactment. The
IRS
may, in this interim period, conduct internal tests
and negotiate with card issuers, but may not accept
credit or debit cards for payment of tax liability.
Senate
Amendment
No provision.
Conference
Agreement
The conference agreement follows the House bill,
except that the requirement that a separate
appropriation be made for payment by the
IRS
of credit card fees is deleted, and a prohibition on
the payment by the
IRS
of any fee or the provision of any other
consideration is added.
B. Provisions Relating to Businesses Generally
1. Modifications to look-back method for long-term
contracts (sec. 1211 of the House bill, and sec.
1011 of the Senate amendment)
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 iscompleted 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.5
The taxpayer receives (or pays) interest if thenet
amount of interest applicable to hypothetical
overpayments exceeds (or is less than) the amount of
interest applicable to hypothetical underpayments.
House
Bill
Election
not to apply the look-back method for de minimis
amounts
The House bill 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. The House
bill also 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).
Further, the House bill 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
.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
2. Minimum tax treatment of certain property and
casualty insurance companies (sec. 1212 of the House
bill and sec. 1012 of the Senate amendment)
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).
House
Bill
The House bill 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. --Taxable years beginning
after
December 31, 1997
.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
3. Treatment of construction allowances provided to
lessees (sec. 961 of the House bill and sec. 1014 of
the Senate amendment)
Present
Law
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, incentivepayments are
includible in income as accessions to wealth.6
A coordinated issuepaper issued by the Internal
Revenue Service ("
IRS
") on
October 7, 1996
, statesthe
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 several factors.
House
Bill
The House 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.
The House bill provides that the lessor must treat
the amounts expended on the construction allowance
as nonresidential real property owned by the lessor.
The House bill contains reporting requirements to
ensure that both the lessor and lessee treat such
amounts in accordance with the provision. 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 provision.
Effective date. --The provision applies to
leases entered into afterthe date of enactment. No
inference is intended as to the treatment of amounts
that are not subject to the provision.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement generally follows the House
bill and the Senate amendment, with a clarification
of the coordination of the provision and present-law
rule that allows lessors to take losses with respect
to certain leasehold improvements abandoned at the
end of the term of the lease (sec. 168(i)(8)). In
addition, the conferees wish to emphasize that no
inference is intended as to the treatment of amounts
that are not subject to the provision, and that the
provisions of the
IRS
issue paper and present law (including case law)
will continue to apply where applicable.
C. Partnership Simplification Provisions
1. General provisions
a. Simplified flow-through for electing large
partnerships (sec. 1221 of the House bill and sec.
1021 of the Senate amendment)
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 "integratedproducers"
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 withrespect 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 thealternative
minimum tax. The tax preference item is based on a
concept of "excessIDCs." 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)7
.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
isthe amount of excess inclusions allocable to
partnership interests owned by certain tax-exempt
organizations ("disqualified
organizations") multipliedby 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).
House
Bill
In
general
The House 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.8
Separate treatment may be appropriate, for example,
should changes in the law necessitate such treatment
for any items.
Under the House 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.9
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 House 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.10
Such net capital gain or loss is treated aslong-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 House 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;11
the remaining 30 percent is allowed at the
partnershiplevel 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 House 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.12
In addition, the credit for producing fuel from a
nonconventional source is separately reported.
The House 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 House bill, the transfer of an
interest in an electing large partnership does not
trigger recapture.
Foreign
taxes
The House 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 House 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 House 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 House 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
involvingthe 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 House 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 House bill, alternative minimum tax
("
AMT
") adjustmentsand 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 House 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 House 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.
Partnerships
and partners subject to large partnership rules
Definition
of electing large partnership
An "electing large partnership" is any
partnership that electsunder the provision, if the
number of partners in the preceding taxable year is
100 or more. The number of partners is determined by
counting only persons directly holding partnership
interests in the taxable year, including persons
holding through nominees; persons holding indirectly
(e.g., through another partnership) are not counted.
Regulations may provide, however, that if the number
of partners in any taxable year falls below 100, the
partnership may not be treated as an electing large
partnership. The election applies to the year for
which made and all subsequent years and cannot be
revoked without the Secretary's consent.
Special
rules for certain service partnerships
An election under this provision is not effective
for any partnership if substantially all the
partners are: (1) individuals performing substantial
services in connection with the partnership's
activities, or personal service corporations the
owner-employees of which perform such services; (2)
retired partners who had performed such services; or
(3) spouses of partners who had performed such
services. In addition, the term "partner"
does notinclude any individual performing
substantial services in connection with the
partnership's activities and holding a partnership
interest, or an individual who formerly performed
such services and who held a partnership interest at
the time the individual performed such services.
Exclusion
for commodity partnerships
An election under this provision is not effective
for any partnership the principal activity of which
is the buying and selling of commodities (not
described in sec. 1221(1)), or options, futures or
forwards with respect to commodities.
Special
rules for partnerships holding oil and gas
properties
Simplified
reporting treatment of electing large partnerships
with oil and gas activities
The House bill provides special rules for electing
large partnerships with oil and gas activities that
operate under the simplified reporting regime. These
partnerships are collectively referred to herein as
"oil and gas large partnerships."
Generally, the House bill provides that an oil and
gaslarge partnership reports information to its
partners under the general simplified large
partnership reporting regime described above. To
prevent the extension of percentage depletion
deductions to persons excluded therefrom under
present law, however, certain partners are treated
as disqualified persons under theHouse bill.
The treatment of a disqualified person's
distributive share of any item of income, gain,
loss, deduction, or credit attributable to any
partnership oil or gas property is determined under
the bill without regard to the special rules
applicable to large partnerships. Thus, an oil and
gas large partnership reports information related to
oil and gas activities to a partner who is a
disqualified person in the same manner and to the
same extent that it reports such information to that
partner under present law. The simplified reporting
rules of the bill, however, apply with respect to
reporting such a partner's share of items not
related to oil and gas activities.
The House bill defines two categories of taxpayers
as disqualified persons. The first category
encompasses taxpayers who do not qualify for the
deduction for percentage depletion under section
613A (i.e., integrated producers of oil and gas).
The second category includes any person whose
average daily production of oil and gas (for
purposes of determining the depletable oil and
natural gas quantity under section 613A(c)(2)) is at
least 500 barrels for its taxable year in which (or
with which) the partnership's taxable year ends. In
making this computation, all production of domestic
crude oil and natural gas attributable to the
partner is taken into account, including such
partner's proportionate share of any production of
the large partnership.
A taxpayer that falls within a category of
disqualified person has the responsibility of
notifying any large partnership in which it holds a
direct or indirect interest (e.g., through a
pass-through entity) of its status as such. Thus,
for example, if an integrated producer owns an
interest in a partnership which in turn owns an
interest in an oil and gas large partnership, it is
responsible for providing the management of the
electing large partnership information regarding its
status as a disqualified person and details
regarding its indirect interest in the electing
large partnership.
Under the House bill, an oil and gas large
partnership computes its deduction for oil and gas
depletion under the general statutory rules (subject
to certain exceptions described below) under the
assumptions that the partnership is the taxpayer and
that it qualifies for the percentage depletion
deduction. The amount of the depletion deduction, as
well as other oil and gas related items, generally
are reported to each partner (other than to partners
who are disqualified persons) as components of that
partner's distributive share of taxable income or
loss from passive loss limitation activities. The
House bill provides that in computing the
partnership's oil and gas percentage depletion
deduction, the 1,000-barrel-per-day limitation does
not apply. In addition, an oil and gas large
partnership is allowed to compute percentage
depletion under the bill without applying the
65-percent-of-taxable-income limitation under
section 613A(d)(1).
As under present law, an election to deduct IDCs
under section 263(c) is made at the partnership
level. Since the House bill treats those taxpayers
required by the Code (sec. 291) to capitalize 30
percent of IDCs as disqualified persons, an oil and
gas large partnership may pass through a full
deduction of IDCs to its partners who are not
disqualified persons. In contrast to present law, an
oil and gas large partnership also has the
responsibility with respect to its partners who are
not disqualified persons for making an election
under section 59(e) to capitalize and amortize
certain specified IDCs. Partners who are
disqualified persons are permitted to make their own
separate section 59(e) elections under the House
bill.
Effective date. --Taxable years beginning
after December 31, 1997.No inference is intended as
to the status of such organizations under present
law.
Consistent with the general reporting regime for
electing large partnerships, the House bill provides
that a single
AMT
adjustment (under either corporate or non-corporate
principles, as the case may be) is made and reported
to the partners (other than disqualified persons) of
an oil and gas large partnership as a separate item.
This separately-reported item is affected by the
limitation on the repeal of the tax preference for
excess IDCs. For purposes of computing this
limitation, the bill treats an oil and gas large
partnership as the taxpayer. Thus, the limitation on
repeal of the IDC preference is applied at the
partnership level and is based on the cumulative
reduction in the partnership's alternative minimum
taxable income resulting from repeal of that
preference.
The House bill provides that in making
partnership-level computations, any item of income,
gain, loss, deduction, or credit attributable to a
partner who is a disqualified person is disregarded.
For example, in computing the partnership's net
income from oil and gas for purposes of determining
the IDC preference (if any) to be reported to
partners who are not disqualified persons as part of
the
AMT
adjustment, disqualified persons' distributive
shares of the partnership's net income from oil and
gas are not to be taken into account.
Regulatory
authority
The Secretary of the Treasury is granted authority
to prescribe such regulations as may be appropriate
to carry out the purposes of the provisions.
Effective
date
The provision s generally apply to partnership
taxable years beginning after
December 31, 1997
.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
b. Simplified audit procedures for electing large
partnerships (sec. 1222 of the House bill and sec.
1022 of the Senate amendment)
Present
Law
In
general
Prior to 1982, regardless of the size of a
partnership, adjustments to a partnership's items of
income, gain, loss, deduction, or credit had to be
made in separate proceedings with respect to each
partner individually. Because a large partnership
sometimes had many partners located in different
audit districts, adjustments to items of income,
gains, losses, deductions, or credits of the
partnership had to be made in numerous actions in
several jurisdictions, sometimes with conflicting
outcomes.
The Tax Equity and Fiscal Responsibility Act of 1982
("TEFRA")established unified audit rules
applicable to all but certain small (10 or fewer
partners) partnerships. These rules require the tax
treatment of all "partnershipitems" to be
determined at the partnership, rather than the
partner, level. Partnership items are those items
that are more appropriately determined at the
partnership level than at the partner level, as
provided by regulations.
Under the TEFRA rules, a partner must report all
partnership items consistently with the partnership
return or must notify the
IRS
of any inconsistency. If a partner fails to report
any partnership item consistently with the
partnership return, the
IRS
may make a computational adjustment and immediately
assess any additional tax that results.
Administrative
proceedings
Under the TEFRA rules, a partner must report all
partnership items consistently with the partnership
return or must notify the
IRS
of any inconsistency. If a partner fails to report
any partnership item consistently with the
partnership return, the
IRS
may make a computational adjustment and immediately
assess any additional tax that results.
The
IRS
may challenge the reporting position of a
partnership by conducting a single administrative
proceeding to resolve the issue with respect to all
partners. But the
IRS
must still assess any resulting deficiency against
each of the taxpayers who were partners in the year
in which the understatement of tax liability arose.
Any partner of a partnership can request an
administrative adjustment or a refund for his own
separate tax liability. Any partner also has the
right to participate in partnership-level
administrative proceedings. A settlement agreement
with respect to partnership items binds all parties
to the settlement.
Tax
Matters Partner
The TEFRA rules establish the "Tax Matters
Partner" as the primary representative of a
partnership in dealings with the
IRS
. The Tax Matters Partner is a general partner
designated by the partnership or, in the absence of
designation, the general partner with the largest
profits interest at the close of the taxable year.
If no Tax Matters Partner is designated, and it is
impractical to apply the largest profits interest
rule, the
IRS
may select any partner as the Tax Matters Partner.
Notice
requirements
The
IRS
generally is required to give notice of the
beginning of partnership-level administrative
proceedings and any resulting administrative
adjustment to all partners whose names and addresses
are furnished to the
IRS
. For partnerships with more than 100 partners,
however, the
IRS
generally is not required to give notice to any
partner whose profits interest is less than one
percent.
Adjudication
of disputes concerning partnership items
After the
IRS
makes an administrative adjustment, the Tax Matters
Partner (and, in limited circumstances, certain
other partners) may file a petition for readjustment
of partnership items in the Tax Court, the district
court in which the partnership's principal place of
business is located, or the Claims Court.
Statute
of limitations
The
IRS
generally cannot adjust a partnership item for a
partnership taxable year if more than 3 years have
elapsed since the later of the filing of the
partnership return or the last day for the filing of
the partnership return.
House
Bill
The House bill creates a new audit system for
electing large partnerships. The provision defines
"electing large partnership" the same way
foraudit and reporting purposes (generally, any
partnership that elects under the reporting
provisions, if the number of partners in the
preceding taxable year is 100 or more).
As under present law, electing large partnerships
and their partners are subject to unified audit
rules. Thus, the tax treatment of "partnershipitems"
are determined at the partnership, rather than the
partner, level. The term "partnership
items" is defined as under present law.
Unlike present law, however, partnership adjustments
generally will flow through to the partners for the
year in which the adjustment takes effect. Thus, the
current-year partners' share of current-year
partnership items of income, gains, losses,
deductions, or credits will be adjusted to reflect
partnership adjustments that take effect in that
year. The adjustments generally will not affect
prior-year returns of any partners (except in the
case of changes to any partner's distributive
shares).
In lieu of flowing an adjustment through to its
partners, the partnership may elect to pay an
imputed underpayment. The imputed underpayment
generally is calculated by netting the adjustments
to the income and loss items of the partnership and
multiplying that amount by the highest tax rate
(whether individual or corporate; currently, the top
individual rate of 39.6 percent). A partner may not
file a claim for credit or refund of his allocable
share of the payment. A partnership may make this
election only if it meets requirements set forth in
Treasury regulations designed to ensure payment (for
example, in the case of a foreign partnership).
Regardless of whether a partnership adjustment flows
through to the partners, an adjustment must be
offset if it requires another adjustment in a year
after the adjusted year and before the year the
offsetted adjustment takes effect. For example, if a
partnership expensed a $1,000 item in year 1, and it
was determined in year 4 that the item should have
been capitalized and amortized ratably over 10
years, the adjustment in year 4 would be $700, apart
from any interest or penalty. (The $900 adjustment
for the improper deduction would be offset by $200
of adjustments for amortization deductions.) The
year 4 partners would be required to include an
additional $700 in income for that year. The
partnership may ratably amortize the remaining $700
of expenses in years 4-10.
In addition, the partnership, rather than the
partners individually, generally is liable for any
interest and penalties that result from a
partnership adjustment. Interest is computed for the
period beginning on the return due date for the
adjusted year and ending on the earlier of the
return due date for the partnership taxable year in
which the adjustment takes effect or the date the
partnership pays the imputed underpayment. Thus, in
the above example, the partnership would be liable
for 4 years' worth of interest (on a declining
principal amount).
Penalties (such as the accuracy and fraud penalties)
are determined on a year-by-year basis (without
offsets) based on an imputed underpayment. All
accuracy penalty criteria and waiver criteria (such
as reasonable cause, substantial authority, etc.)
are determined as if the partnership were a taxable
individual. Accuracy and fraud penalties are
assessed and accrue interest in the same manner as
if asserted against a taxable individual.
Any payment (for Federal income taxes, interest, or
penalties) that an electing large partnership is
required to make is non-deductible.
If a partnership ceases to exist before a
partnership adjustment takes effect, the former
partners are required to take the adjustment into
account, as provided by regulations. Regulations are
also authorized to prevent abuse and to enforce
efficiently the audit rules in circumstances that
present special enforcement considerations (such as
partnership bankruptcy).
Administrative
proceedings
Under the electing large partnership audit rules, a
partner is not permitted to report any partnership
items inconsistently with the partnership return,
even if the partner notifies the
IRS
of the inconsistency. The
IRS
may treat a partnership item that was reported
inconsistently by a partner as a mathematical or
clerical error and immediately assess any additional
tax against that partner.
As under present law, the
IRS
may challenge the reporting position of a
partnership by conducting a single administrative
proceeding to resolve the issue with respect to all
partners. Unlike under present law, however,
partners will have no right individually to
participate in settlement conferences or to request
a refund.
Partnership
representative
The House bill requires each electing large
partnership to designate a partner or other person
to act on its behalf. If an electing large
partnership fails to designate such a person, the
IRS
is permitted to designate any one of the partners as
the person authorized to act on the partnership's
behalf. After the
IRS
's designation, an electing large partnership could
still designate a replacement for the
IRS
-designated partner.
Notice
requirements
Unlike under present law, the
IRS
is not required to give notice to individual
partners of the commencement of an administrative
proceeding or of a final adjustment. Instead, the
IRS
is authorized to send notice of a partnership
adjustment to the partnership itself by certified or
registered mail. The
IRS
could give proper notice by mailing the notice to
the last known address of the partnership, even if
the partnership had terminated its existence.
Adjudication
of disputes concerning partnership items
As under present law, an administrative adjustment
could be challenged in the Tax Court, the district
court in which the partnership's principal place of
business is located, or the
Claims Court
. However, only the partnership, and not partners
individually, can petition for a readjustment of
partnership items.
If a petition for readjustment of partnership items
is filed by the partnership, the court with which
the petition is filed will have jurisdiction to
determine the tax treatment of all partnership items
of the partnership for the partnership taxable year
to which the notice of partnership adjustment
relates, and the proper allocation of such items
among the partners. Thus, the court's jurisdiction
is not limited to the items adjusted in the notice.
Statute
of limitations
Absent an agreement to extend the statute of
limitations, the
IRS
generally could not adjust a partnership item of an
electing large partnership more than 3 years after
the later of the filing of the partnership return or
the last day for the filing of the partnership
return. Special rules apply to false or fraudulent
returns, a substantial omission of income, or the
failure to file a return. The
IRS
would assess and collect any deficiency of a partner
that arises from any adjustment to a partnership
item subject to the limitations period on
assessments and collection applicable to the year
the adjustment takes effect (secs. 6248, 6501 and
6502).
Regulatory
authority
The Secretary of the Treasury is granted authority
to prescribe regulations as may be necessary to
carry out the simplified audit procedure provisions,
including regulations to prevent abuse of the
provisions through manipulation. The regulations may
include rules that address transfers of partnership
interests, in anticipation of a partnership
adjustment, to persons who are tax-favored (e.g.,
corporations with net operating losses, tax-exempt
organizations, and foreign partners) or persons who
are expected to be unable to pay tax (e.g., shell
corporations). For example, if prior to the time a
partnership adjustment takes effect, a taxable
partner transfers a partnership interest to a
nonresident alien to avoid the tax effect of the
partnership adjustment, the rules may provide, among
other things, that income related to the partnership
adjustment is treated as effectively connected
taxable income, that the partnership adjustment is
treated as taking effect before the partnership
interest was transferred, or that the former partner
is treated as a current partner to whom the
partnership adjustment is allocated.
Effective
date
The provision applies to partnership taxable years
beginning after
December 31, 1997
.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment, with technical modifications.
c. Due date for furnishing information to partners
of electing large partnerships (sec. 1223 of the
House bill and sec. 1023 of the Senate amendment)
Present
Law
A partnership required to file an income tax return
with the Internal Revenue Service must also furnish
an information return to each of its partners on or
before the day on which the income tax return for
the year is required to be filed, including
extensions. Under regulations, a partnership must
file its income tax return on or before the
fifteenth day of the fourth month following the end
of the partnership's taxable year (on or before
April 15, for calendar year partnerships). This is
the same deadline by which most individual partners
must file their tax returns.
House
Bill
The House bill provides that an electing large
partnership must furnish information returns to
partners by the first March 15 following the close
of the partnership's taxable year. Electing large
partnerships are those partnerships subject to the
simplified reporting and audit rules (generally, any
partnership that elects under the reporting
provision, if the number of partners in the
preceding taxable year is 100 or more).
The House bill also provides that, if the
partnership is required to provide copies of the
information returns to the Internal Revenue Service
on magnetic media, each schedule (such as each
Schedule K-1) with respect to each partner is
treated as a separate information return with
respect to the corrective periods and penalties that
are generally applicable to all information returns.
Effective date. --The provision is effective
for partnership taxable years beginning after
December 31, 1997.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
d. Partnership returns required on magnetic media
(sec. 1224 of the House bill and sec. 1024 of the
Senate amendment)
Present
Law
Partnerships are permitted, but not required, to
provide the tax return of the partnership (Form
1065), as well as copies of the schedules sent to
each partner (Form K-1), to the Internal Revenue
Service on magnetic media.
House
Bill
The House bill provides generally that any
partnership is required to provide the tax return of
the partnership (Form 1065), as well as copies of
the schedule sent to each partner (Form K-1), to the
Internal Revenue Service on magnetic media. An
exception is provided for partnerships with 100 or
fewer partners.
Effective date. --The provision is effective
for partnership taxable years beginning after
December 31, 1997.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
e. Treatment of partnership items of individual
retirement arrangements (sec. 1225 of the House bill
and sec. 1025 of the Senate amendment)
Present
Law
Return
filing requirements
An individual retirement account ("IRA")
is a trust whichgenerally is exempt from taxation
except for the taxes imposed on income from an
unrelated trade or business. A fiduciary of a trust
that is exempt from taxation (but subject to the
taxes imposed on income from an unrelated trade or
business) generally is required to file a return on
behalf of the trust for a taxable year if the trust
has gross income of $1,000 or more included in
computing unrelated business taxable income for that
year (Treas. Reg. sec. 1.6012-3(a)(5)).
Unrelated business taxable income is the gross
income (including gross income from a partnership)
derived by an exempt organization from an unrelated
trade or business, less certain deductions which are
directly connected with the carrying on of such
trade or business (sec. 512(a)(1). In calculating
unrelated business taxable income, exempt
organizations (including IRAs) generally also are
permitted a specific deduction of $1,000 (sec.
512(b)(12)).
Unified
audits of partnerships
All but certain small partnerships are subject to
unified audit rules established by the Tax Equity
and Fiscal Responsibility Act of 1982. These rules
require the tax treatment of all "partnership
items" to bedetermined at the partnership,
rather than the partner, level. Partnership items
are those items that are more appropriately
determined at the partnership level than at the
partner level, including such items as gross income
and deductions of the partnership.
House
Bill
The House bill modifies the filing threshold for an
IRA with an interest in a partnership that is
subject to the partnership-level audit rules. A
fiduciary of such an IRA could treat the trust's
share of partnership taxable income as gross income,
for purposes of determining whether the trust meets
the $1,000 gross income filing threshold. A
fiduciary of an IRA that receives taxable income
from a partnership that is subject to
partnership-level audit rules of less than $1,000
(before the $1,000 specific deduction) is not
required to file an income tax return if the IRA
does not have any other income from an unrelated
trade or business.
Effective date. --The provision applies to
taxable years beginningafter
December 31, 1997
.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
2. Other partnership audit rules
a. Treatment of partnership items in deficiency
proceedings (sec. 1231 of the House bill and sec.
1031 of the Senate amendment)
Present
Law
Partnership proceedings under rules enacted in TEFRA13
must be keptseparate from deficiency proceedings
involving the partners in their individual
capacities. Prior to the Tax Court's opinion in
Munro v. Commissioner, 92 T.C. 71 (1989), the
IRS
computed deficiencies by assuming that all items
that were subject to the TEFRA partnership
procedures were correctly reported on the taxpayer's
return. However, where the losses claimed from TEFRA
partnerships were so large that they offset any
proposed adjustments to nonpartnership items, no
deficiency could arise from a non-TEFRA proceeding,
and if the partnership losses were subsequently
disallowed in a partnership proceeding, the non-TEFRA
adjustments might be uncollectible because of the
expiration of the statute of limitations with
respect to nonpartnership items.
Faced with this situation in Munro, the
IRS
issued a notice of deficiency to the taxpayer that
presumptively disallowed the taxpayer's TEFRA
partnership losses for computational purposes only.
Although the Tax Court ruled that a deficiency
existed and that the court had jurisdiction to hear
the case, the court disapproved of the methodology
used by the
IRS
to compute the deficiency. Specifically, the court
held that partnership items (whether income, loss,
deduction, or credit) included on a taxpayer's
return must be completely ignored in determining
whether a deficiency exists that is attributable to
nonpartnership items.
House
Bill
The House bill overrules Munro and allow the
IRS
to return to its prior practice of computing
deficiencies by assuming that all TEFRA items whose
treatment has not been finally determined had been
correctly reported on the taxpayer's return. This
eliminates the need to do special computations that
involve the removal of TEFRA items from a taxpayer's
return, and will restore to taxpayers a prepayment
forum with respect to the TEFRA items. In addition,
the provision provides a special rule to address the
factual situation presented in Munro.
Specifically, the House bill provides a declaratory
judgment procedure in the Tax Court for adjustments
to an oversheltered return. An oversheltered return
is a return that shows no taxable income and a net
loss from TEFRA partnerships. In such a case, the
IRS
is authorized to issue a notice of adjustment with
respect to non-TEFRA items, notwithstanding that no
deficiency would result from the adjustment.
However, the
IRS
could only issue such a notice if a deficiency would
have arisen in the absence of the net loss from
TEFRA partnerships.
The Tax Court is granted jurisdiction to determine
the correctness of such an adjustment as well as to
make a declaration with respect to any other item
for the taxable year to which the notice of
adjustment relates, except for partnership items and
affected items which require partner-level
determinations. No tax is due upon such a
determination, but a decision of the Tax Court is
treated as a final decision, permitting an appeal of
the decision by either the taxpayer or the
IRS
. An adjustment determined to be correct would thus
have the effect of increasing the taxable income
that is deemed to have been reported on the
taxpayer's return. If the taxpayer's partnership
items were then adjusted in a subsequent proceeding,
the
IRS
has preserved its ability to collect tax on any
increased deficiency attributable to the
nonpartnership items.
Alternatively, if the taxpayer chooses not to
contest the notice of adjustment within the 90-day
period, the bill provides that when the taxpayer's
partnership items are finally determined, the
taxpayer has the right to file a refund claim for
tax attributable to the items adjusted by the
earlier notice of adjustment for the taxable year.
Although a refund claim is not generally permitted
with respect to a deficiency arising from a TEFRA
proceeding, such a rule is appropriate with respect
to a defaulted notice of adjustment because
taxpayers may not challenge such a notice when
issued since it does not require the payment of
additional tax.
In addition, the House bill incorporates a number of
provisions intended to clarify the coordination
between TEFRA audit proceedings and individual
deficiency proceedings. Under these provisions, any
adjustment with respect to a non-partnership item
that caused an increase in tax liability with
respect to a partnership item would be treated as a
computational adjustment and assessed after the
conclusion of the TEFRA proceeding. Accordingly,
deficiency procedures do not apply with respect to
this increase in tax liability, and the statute of
limitations applicable to TEFRA proceedings are
controlling.
Effective date. --The provision is effective
for partnership taxable years ending after the date
of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
b. Partnership return to be determinative of audit
procedures to be followed (sec. 1232 of the House
bill and sec. 1032 of the Senate amendment)
Present
Law
TEFRA established unified audit rules applicable to
all partnerships, except for partnerships with 10 or
fewer partners, each of whom is a natural person
(other than a nonresident alien) or an estate, and
for which each partner's share of each partnership
item is the same as that partner's share of
everyother partnership item. Partners in the
exempted partnerships are subject to regular
deficiency procedures.
House
Bill
The House bill permits the
IRS
to apply the TEFRA audit procedures if, based on the
partnership's return for the year, the
IRS
reasonably determines that those procedures should
apply. Similarly, the provision permits the
IRS
to apply the normal deficiency procedures if, based
on the partnership's return for the year, the
IRS
reasonably determines that those procedures should
apply.
Effective date. --The provision is effective
for partnership taxable years ending after the date
of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
c. Provisions relating to statute of limitations
i. Suspend statute when an untimely petition is
filed (sec. 1233(a) of the House bill and sec.
1033(a) of the Senate amendment)
Present
Law
In a deficiency case, section 6503(a) provides that
if a proceeding in respect of the deficiency is
placed on the docket of the Tax Court, the period of
limitations on assessment and collection is
suspended until the decision of the Tax Court
becomes final, and for 60 days thereafter. The
counterpart to this provision with respect to TEFRA
cases is contained in section 6229(d). That section
provides that the period of limitations is suspended
for the period during which an action may be brought
under section 6226 and, if an action is brought
during such period, until the decision of the court
becomes final, and for 1 year thereafter. As a
result of this difference in language, the running
of the statute of limitations in a TEFRA case will
only be tolled by the filing of a timely petition
whereas in a deficiency case, the statute of
limitations is tolled by the filing of any petition,
regardless of whether the petition is timely.
House
Bill
The House bill conforms the suspension rule for the
filing of petitions in TEFRA cases with the rule
under section 6503(a) pertaining to deficiency
cases. Under the provision, the statute of
limitations in TEFRA cases is suspended by the
filing of any petition under section 6226,
regardless of whether the petition is timely or
valid, and the suspension will remain in effect
until the decision of the court becomes final, and
for one year thereafter. Hence, if the statute of
limitations is open at the time that an untimely
petition is filed, the limitations period would no
longer continue to run and possibly expire while the
action is pending before the court.
Effective date. --The provision is effective
with respect to allcases in which the period of
limitations has not expired under present law as of
the date of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
ii. Suspend statute of limitations during bankruptcy
proceedings (sec. 1233(b) of the House bill and sec.
1033(b) of the Senate amendment)
Present
Law
The period for assessing tax with respect to
partnership items generally is the longer of the
periods provided by section 6229 or section 6501.
For partnership items that convert to nonpartnership
items, section 6229(f) provides that the period for
assessing tax shall not expire before the date which
is 1 year after the date that the items become
nonpartnership items. Section 6503(h) provides for
the suspension of the limitations period during the
pendency of a bankruptcy proceeding. However, this
provision only applies to the limitations periods
provided in sections 6501 and 6502.
Under present law, because the suspension provision
in section 6503(h) applies only to the limitations
periods provided in section 6501 and 6502, some
uncertainty exists as to whether section 6503(h)
applies to suspend the limitations period pertaining
to converted items provided in section 6229(f) when
a petition naming a partner as a debtor in a
bankruptcy proceeding is filed. As a result, the
limitations period provided in section 6229(f) may
continue to run during the pendency of the
bankruptcy proceeding, notwithstanding that the
IRS
is prohibited from making an assessment against the
debtor because of the automatic stay provisions of
the Bankruptcy Code.
House
Bill
The House bill clarifies that the statute of
limitations is suspended for a partner who is named
in a bankruptcy petition. The suspension period is
for the entire period during which the
IRS
is prohibited by reason of the bankruptcy proceeding
from making an assessment, and for 60 days
thereafter. The provision does not purport to create
any inference as to the proper interpretation of
present law.
Effective date. --The provision is effective
with respect to allcases in which the period of
limitations has not expired under present law as of
the date of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
iii. Extend statute of limitations for bankrupt TMPs
(sec. 1233(c) of the House bill and sec. 1033(c) of
the Senate amendment)
Present
Law
Section 6229(b)(1)(B) provides that the statute of
limitations is extended with respect to all partners
in the partnership by an agreement entered into
between the tax matters partner (
TMP
) and the
IRS
. However, Temp. Treas. Reg. secs.
301.6231
(a)(7)-1T(1)(4) and
301.6231
(c)-7T(a) provide that upon the filing of a petition
naming a partner as a debtor in a bankruptcy
proceeding, that partner's partnership items convert
to nonpartnership items, and if the debtor was the
tax matters partner, such status terminates. These
rules are necessary because of the automatic stay
provision contained in 11 U.S.C. sec. 362(a)(8). As
a result, if a consent to extend the statute of
limitations is signed by a person who would be the
TMP
but for the fact that at the time that the agreement
is executed the person was a debtor in a bankruptcy
proceeding, the consent would not be binding on the
other partners because the person signing the
agreement was no longer the
TMP
at the time that the agreement was executed.
House
Bill
The House bill provides that unless the
IRS
is notified of a bankruptcy proceeding in accordance
with regulations, the
IRS
can rely on a statute extension signed by a person
who is the tax matters partner but for the fact that
said person was in bankruptcy at the time that the
person signed the agreement. Statute extensions
granted by a bankrupt
TMP
in these cases are binding on all of the partners in
the partnership. The provision is not intended to
create any inference as to the proper interpretation
of present law.
Effective date. --The provision is effective
for extensionagreements entered into after the date
of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
d. Expansion of small partnership exception (sec.
1234 of the House bill and sec. 1034 of the Senate
amendment)
Present
Law
TEFRA established unified audit rules applicable to
all partnerships, except for partnerships with 10 or
fewer partners, each of whom is a natural person
(other than a nonresident alien) or an estate, and
for which each partner's share of each partnership
item is the same as that partner's share of every
other partnership item. Partners in the exempted
partnerships are subject to regular deficiency
procedures.
House
Bill
The House bill permits a small partnership to have a
C corporation as a partner or to specially allocate
items without jeopardizing its exception from the
TEFRA rules. However, the provision retains the
prohibition of present law against having a
flow-through entity (other than an estate of a
deceased partner) as a partner for purposes of
qualifying for the small partnership exception.
Effective date. --The provision is effective
for partnership taxable years ending after the date
of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
e. Exclusion of partial settlements from 1-year
limitation on assessment (sec. 1235 of the House
bill and sec. 1035 of the Senate amendment)
Present
Law
The period for assessing tax with respect to
partnership items generally is the longer of the
periods provided by section 6229 or section 6501.
For partnership items that convert to nonpartnership
items, section 6229(f) provides that the period for
assessing tax shall not expire before the date which
is 1 year after the date that the items become
nonpartnership items. Section 6231(b)(1)(C) provides
that the partnership items of a partner for a
partnership taxable year become nonpartnership items
as of the date the partner enters into a settlement
agreement with the
IRS
with respect to such items.
House
Bill
The House bill provides that if a partner and the
IRS
enter into a settlement agreement with respect to
some but not all of the partnership items in dispute
for a partnership taxable year and other partnership
items remain in dispute, the period for assessing
any tax attributable to the settled items is
determined as if such agreement had not been entered
into. Consequently, the limitations period that is
applicable to the last item to be resolved for the
partnership taxable year is controlling with respect
to all disputed partnership items for the
partnership taxable year. The provision does not
purport to create any inference as to the proper
interpretation of present law.
Effective date. --The provision is effective
for settlements entered into after the date of
enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
f. Extension of time for filing a request for
administrative adjustment (sec. 1236 of the House
bill and sec. 1036 of the Senate amendment)
Present
Law
If an agreement extending the statute is entered
into with respect to a non-TEFRA statute of
limitations, that agreement also extends the statute
of limitations for filing refund claims (sec.
6511(c)). There is no comparable provision for
extending the time for filing refund claims with
respect to partnership items subject to the TEFRA
partnership rules.
House
Bill
The House bill provides that if a TEFRA statute
extension agreement is entered into, that agreement
also extends the statute of limitations for filing
refund claims attributable to partnership items or
affected items until 6 months after the expiration
of the limitations period for assessments.
Effective date. --The provision is effective
as if included in the amendments made by section 402
of the Tax Equity and Fiscal Responsibility Act of
1982.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
g. Availability of innocent spouse relief in context
of partnership proceedings (sec. 1237 of the House
bill and sec. 1037 of the Senate amendment)
Present
Law
In general, an innocent spouse may be relieved of
liability for tax, penalties and interest if certain
conditions are met (sec. 6013(e)). However, existing
law does not provide the spouse of a partner in a
TEFRA partnership with a judicial forum to raise the
innocent spouse defense with respect to any tax or
interest that relates to an investment in a TEFRA
partnership.
House
Bill
The House bill provides both a prepayment forum and
a refund forum for raising the innocent spouse
defense in TEFRA cases.
With respect to a prepayment forum, the provision
provides that within 60 days of the date that a
notice of computational adjustment relating to
partnership items is mailed to the spouse of a
partner, the spouse could request that the
assessment be abated. Upon receipt of such a
request, the assessment is abated and any
reassessment will be subject to the deficiency
procedures. If an abatement is requested, the
statute of limitations does not expire before the
date which is 60 days after the date of the
abatement. If the spouse files a petition with the
Tax Court, the Tax Court only has jurisdiction to
determine whether the requirements of section
6013(e) have been satisfied. In making this
determination, the treatment of the partnership
items that gave rise to the liability in question is
conclusive.
Alternatively, the House bill provides that the
spouse of a partner could file a claim for refund to
raise the innocent spouse defense. The claim has to
be filed within 6 months from the date that the
notice of computational adjustment is mailed to the
spouse. If the claim is not allowed, the spouse
could file a refund action. For purposes of any
claim or suit under this provision, the treatment of
the partnership items that gave rise to the
liability in question is conclusive.
Effective date. --The provision is effective
as if included in the amendments made by section 402
of the Tax Equity and Fiscal Responsibility Act of
1982.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
h. Determination of penalties at partnership level
(sec. 1238 of the House bill and sec. 1038 of the
Senate amendment)
Present
Law
Partnership items include only items that are
required to be taken into account under the income
tax subtitle. Penalties are not partnership items
since they are contained in the procedure and
administration subtitle. As a result, penalties may
only be asserted against a partner through the
application of the deficiency procedures following
the completion of the partnership-level proceeding.
House
Bill
The House bill provides that the partnership-level
proceeding is to include a determination of the
applicability of penalties at the partnership level.
However, the provision allows partners to raise any
partner-level defenses in a refund forum.
Effective date. --The provision is effective
for partnership taxable years ending after the date
of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment, with technical modifications.
i. Provisions relating to Tax Court jurisdiction
(sec. 1239 of the House bill and sec. 1039 of the
Senate amendment)
Present
Law
Improper assessment and collection activities by the
IRS
during the 150-day period for filing a petition or
during the pendency of any Tax Court proceeding,
"may be enjoined in the proper court."
Present law maybe unclear as to whether this
includes the Tax Court.
For a partner other than the Tax Matters Partner to
be eligible to file a petition for redetermination
of partnership items in any court or to participate
in an existing case, the period for assessing any
tax attributable to the partnership items of that
partner must not have expired. Since such a partner
would only be treated as a party to the action if
the statute of limitations with respect to them was
still open, the law is unclear whether the partner
would have standing to assert that the statute of
limitations had expired with respect to them.
House
Bill
The House bill clarifies that an action to enjoin
premature assessments of deficiencies attributable
to partnership items may be brought in the Tax
Court. The provision also permits a partner to
participate in an action or file a petition for the
sole purpose of asserting that the period of
limitations for assessing any tax attributable to
partnership items has expired for that person.
Additionally, the provision clarifies that the Tax
Court has overpayment jurisdiction with respect to
affected items.
Effective date. --The provision is effective
for partnership taxable years ending after the date
of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment, with technical modifications.
j. Treatment of premature petitions filed by notice
partners or 5-percent groups (sec. 1240 of the House
bill and sec. 1040 of the Senate amendment)
Present
Law
The Tax Matters Partner is given the exclusive right
to file a petition for a readjustment of partnership
items within the 90-day period after the issuance of
the notice of a final partnership administrative
adjustment (FPAA). If the Tax Matters Partner does
not file a petition within the 90-day period,
certain other partners are permitted to file a
petition within the 60-day period after the close of
the 90-day period. There are ordering rules for
determining which action goes forward and for
dismissing other actions.
House
Bill
The House bill treats premature petitions filed by
certain partners within the 90-day period as being
filed on the last day of the following 60-day period
under specified circumstances, thus affording the
partnership with an opportunity for judicial review
that is not available under present law.
Effective date. --The provision is effective
with respect topetitions filed after the date of
enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
k. Bonds in case of appeals from certain proceedings
(sec. 1241 of the House bill and sec. 1041 of the
Senate amendment)
Present
Law
A bond must be filed to stay the collection of
deficiencies pending the appeal of the Tax Court's
decision in a TEFRA proceeding. The amount of the
bond must be based on the court's estimate of the
aggregate deficiencies of the partners.
House
Bill
The House bill clarifies that the amount of the bond
should be based on the Tax Court's estimate of the
aggregate liability of the parties to the action
(and not all of the partners in the partnership).
For purposes of this provision, the amount of the
bond could be estimated by applying the highest
individual rate to the total adjustments determined
by the Tax Court and doubling that amount to take
into account interest and penalties.
Effective date. --The provision is effective
as if included in the amendments made by section 402
of the Tax Equity and Fiscal Responsibility Act of
1982.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
l. Suspension of interest where delay in
computational adjustment resulting from certain
settlements (sec. 1242 of the House bill and sec.
1042 of the Senate amendment)
Present
Law
Interest on a deficiency generally is suspended when
a taxpayer executes a settlement agreement with the
IRS
and waives the restrictions on assessments and
collections, and the
IRS
does not issue a notice and demand for payment of
such deficiency within 30 days. Interest on a
deficiency that results from an adjustment of
partnership items in TEFRA proceedings, however, is
not suspended.
House
Bill
The House bill suspends interest where there is a
delay in making a computational adjustment relating
to a TEFRA settlement.
Effective date. --The provision is effective
with respect toadjustments relating to taxable years
beginning after the date of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
m. Special rules for administrative adjustment
requests with respect to bad debts or worthless
securities (sec. 1243 of the House bill and sec.
1043 of the Senate amendment)
Present
Law
The non-TEFRA statute of limitations for filing a
claim for credit or refund generally is the later of
(1) three years from the date the return in question
was filed or (2) two years from the date the claimed
tax was paid, whichever is later (sec. 6511(b)).
However, an extended period of time, seven years
from the date the return was due, is provided for
filing a claim for refund of an overpayment
resulting from a deduction for a worthless security
or bad debt (sec. 6511(d)).
Under the TEFRA partnership rules, a request for
administrative adjustment ("RAA") must be
filed within three years after the later of (1)the
date the partnership return was filed or (2) the due
date of the partnership return (determined without
regard to extensions) (sec. 6227(a)(1)). In
addition, the request must be filed before a final
partnership administrative adjustment
("FPAA") is mailed for the taxable year
(sec. 6227(a)(2)). Thereis no special provision for
extending the time for filing an RAA that relates to
a deduction for a worthless security or an entirely
worthless bad debt.
House
Bill
The House bill extends the time for the filing of an
RAA relating to the deduction by a partnership for a
worthless security or bad debt. In these
circumstances, in lieu of the three-year period
provided in sec. 6227(a)(1), the period for filing
an RAA is seven years from the date the partnership
return was due with respect to which the request is
made (determined without regard to extensions). The
RAA is still required to be filed before the FPAA is
mailed for the taxable year.
Effective date. --The provision is effective
as if included in the amendments made by section 402
of the Tax Equity and Fiscal Responsibility Act of
1982.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
3. Closing of partnership taxable year with respect
to deceased partner (sec. 1246 of the House bill and
sec. 1046 of the Senate amendment)
Present
Law
The partnership taxable year closes with respect to
a partner whose entire interest is sold, exchanged,
or liquidated. Such year, however, generally does
not close upon the death of a partner. Thus, a
decedent's entire share of items of income, gain,
loss, deduction and credit for the partnership year
in which death occurs is taxed to the estate or
successor in interest rather than to the decedent on
his or her final income tax return. See Estate of
Hesse
v. Commissioner, 74 T.C. 1307, 1311
(1980).
House
Bill
The House bill provides that the taxable year of a
partnership closes with respect to a partner whose
entire interest in the partnership terminates,
whether by death, liquidation or otherwise. The
provision does not change present law with respect
to the effect upon the partnership taxable year of a
transfer of a partnership interest by a debtor to
the debtor's estate (under Chapters 7 or 11 of Title
11, relating to bankruptcy).
Effective date. --Partnership taxable years
beginning after December31, 1997.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment. D. Modifications of Rules for
Real Estate Investment Trusts (secs. 1251-1263 of
the House bill and secs. 1051-1063 of the Senate
amendment)
Present
Law
Overview
In general, a real estate investment trust
("REIT") is an entitythat receives most of
its income from passive real estate related
investments and that receives conduit treatment for
income that is distributed to shareholders. If an
entity meets the qualifications for REIT status, the
portion of its income that is distributed to the
investors each year generally is taxed to the
investors without being subjected to a tax at the
REIT level; the REIT generally is subject to a
corporate tax only on the income that it retains and
on certain income from property that qualifies as
foreclosure property.
Election
to be treated as a REIT
In order to qualify as a REIT, and thereby receive
conduit treatment, an entity must elect REIT status.
A newly-electing entity generally cannot have
earnings and profits accumulated from any year in
which the entity was in existence and not treated as
a REIT (sec. 857(a)(3)). To satisfy this
requirement, the entity must distribute, during its
first REIT taxable year, any earnings and profits
that were accumulated in non-REIT years. For this
purpose, distributions by the entity generally are
treated as being made from the most recently
accumulated earnings and profits.
Taxation
of REITs
Overview
In general, if an entity qualifies as a REIT by
satisfying the various requirements described below,
the entity is taxable as a corporation on its
"real estate investment trust taxable
income"("REITTI"), and also is
taxable on certain other amounts (sec. 857). REITTI
is the taxable income of the REIT with certain
adjustments (sec. 857(b)(2)). The most significant
adjustment is a deduction for dividends paid. The
allowance of this deduction is the mechanism by
which the REIT becomes a conduit for income tax
purposes.
Capital
gains
A REIT that has a net capital gain for a taxable
year generally is subject to tax on such capital
gain under the capital gains tax regime generally
applicable to corporations (sec. 857(b)(3)).
However, a REIT may diminish or eliminate its tax
liability attributable to such capital gain by
paying a "capital gain dividend" to its
shareholders (sec. 857(b)(3)(C)). Acapital gain
dividend is any dividend or part of a dividend that
is designated by the payor REIT as a capital gain
dividend in a written notice mailed to shareholders.
Shareholders who receive capital gain dividends
treat the amount of such dividends as long-term
capital gain regardless of the holding period of
their stock (sec. 857(b)(3)(C)).
A regulated investment company ("
RIC
"), but not a REIT, may electto retain and pay
income tax on net long-term capital gains it
received during the tax year. If a
RIC
makes this election, the
RIC
shareholders must include in their income as
long-term capital gains their proportionate share of
these undistributed long-term capital gains as
designated by the
RIC
. The shareholder is deemed to have paid the
shareholder's share of the tax, which can be
credited or refunded to the shareholder. Also, the
basis of the shareholder's shares is increased by
the amount of the undistributed long-term capital
gains (less the amount of capital gains tax paid by
the
RIC
) included in the shareholder's long-term capital
gains.
Income
from foreclosure property
In addition to tax on its REITTI, a REIT is subject
to tax at the highest rate of tax paid by
corporations on its net income from foreclosure
property (sec. 857(b)(4)). Net income from
foreclosure property is the excess of the sum of
gains from foreclosure property that is held for
sale to customers in the ordinary course of a trade
or business and gross income from foreclosure
property (other than income that otherwise would
qualify under the 75-percent income test described
below) over all allowable deductions directly
connected with the production of such income.
Foreclosure property is any real property or
personal property incident to such real property
that is acquired by a REIT as a result of default or
imminent default on a lease of such property or
indebtedness secured by such property, provided that
(unless acquired as foreclosure property), such
property was not held by the REIT for sale to
customers (sec. 856(e)). A property generally may be
treated as foreclosure property for a period of two
years after the date the property is acquired by the
REIT. The
IRS
may grant extensions of the period for treating the
property as foreclosure property if the REIT
establishes that an extension of the grace period is
necessary for the orderly liquidation of the REIT's
interest in the property. The grace period cannot be
extended beyond six years from the date the property
is acquired by the REIT.
Property will cease to be treated as foreclosure
property if, after 90 days after the date of
acquisition, the REIT operates the foreclosure
property in a trade or business other than through
an independent contractor from whom the REIT does
not derive or receive any income (sec.
856(e)(4)(C)).
Income
or loss from prohibited transactions
In general, a REIT must derive its income from
passive sources and not engagein any active trade or
business. Accordingly, in addition to the tax on its
REITTI and on its net income from foreclosure
property, a 100 percent tax is imposed on the net
income of a REIT from
"prohibitedtransactions" (sec. 857(b)(6)).
A prohibited transaction is the sale or other
disposition of property described in section 1221(1)
of the Code (property held for sale in the ordinary
course of a trade or business) other than
foreclosure property. Thus, the 100 percent tax on
prohibited transactions helps to ensure that the
REIT is a passive entity and may not engage in
ordinary retailing activities such as sales to
customers of condominium units or subdivided lots in
a development project. A safe harbor is provided for
certain sales that otherwise might be considered
prohibited transactions (sec. 857(b)(6)(C)). The
safe harbor is limited to seven or fewer sales a
year or, alternatively, any number of sales provided
that the aggregate adjusted basis of the property
sold does not exceed 10 percent of the aggregate
basis of all the REIT's assets at the beginning of
the REIT's taxable year.
Requirements
for REIT status
A REIT must satisfy four tests on a year-by-year
basis: organizational structure, source of income,
nature of assets, and distribution of income. These
tests are intended to allow conduit treatment in
circumstances in which a corporate tax otherwise
would be imposed, only if there really is a pooling
of investment arrangement that is evidenced by its
organizational structure, if its investments are
basically in real estate assets, and if its income
is passive income from real estate investment, as
contrasted with income from the operation of
business involving real estate. In addition,
substantially all of the entity's income must be
passed through to its shareholders on a current
basis.
Organizational
structure requirements
To qualify as a REIT, an entity must be for its
entire taxable year a corporation or an
unincorporated trust or association that would be
taxable as a domestic corporation but for the REIT
provisions, and must be managed by one or more
trustees (sec. 856(a)). The beneficial ownership of
the entity must be evidenced by transferable shares
or certificates of ownership. Except for the first
taxable year for which an entity elects to be a
REIT, the beneficial ownership of the entity must be
held by 100 or more persons, and the entity may not
be so closely held by individuals that it would be
treated as a personal holding company if all its
adjusted gross income constituted personal holding
company income. A REIT is disqualified for any year
in which it does not comply with regulations to
ascertain the actual ownership of the REIT's
outstanding shares. Treasury regulations require
that the entity request information from certain
shareholders regarding shares directly or indirectly
owned by them.
Income
requirements
Overview
In order for an entity to qualify as a REIT, at
least 95 percent of its gross income generally must
be derived from certain passive sources
(the"95-percent test"). In addition, at
least 75 percent of its income generally must befrom
certain real estate sources (the "75-percent
test"), includingrents from real property.
In addition, less than 30 percent of the entity's
gross income may be derived from gain from the sale
or other disposition of stock or securities held for
less than one year, real property held less than
four years (other than foreclosure property, or
property subject to an involuntary conversion within
the meaning of sec. 1033), and property that is sold
or disposed of in a prohibited transaction (sec.
856(c)(4)).
Definition
of rents from real property
For purposes of the income requirements, rents from
real property generally include: (1) rents from
interests in real property; (2) charges for services
customarily rendered or furnished in connection with
the rental of real property, whether or not such
charges are separately stated; and (3) rent
attributable to personal property that is leased
under or in connection with a lease of real
property, but only if the rent attributable to such
personal property does not exceed 15 percent of the
total rent for the year under the lease (sec.
856(d)(1)).
Services provided to tenants are regarded as
customary if, in the geographic market within which
the building is located, tenants in buildings that
are of a similar class (for example, luxury
apartment buildings) are customarily provided with
the service. The furnishing of water, heat, light,
and air conditioning, the cleaning of windows,
public entrances, exits, and lobbies, the
performance of general maintenance, and of
janitorial and cleaning services, the collection of
trash, the furnishing of elevator services,
telephone answering services, incidental storage
space, laundry equipment, watchman or guard service,
parking facilities and swimming pool facilities are
examples of services that are customarily furnished
to tenants of a particular class of buildings in
many geographical marketing areas (Treas. Reg. sec.
1.856-4(b)).
Exclusion
of rents from related tenants
Amounts are not treated as qualified rent if they
are received from corporate or noncorporate tenants
in which the REIT, directly or indirectly, has an
ownership interest of 10 percent or more (sec.
856(d)(2)(B)).
Exclusion
of rents where services to tenants are performed by
related contractors
Where a REIT furnishes or renders services to the
tenants, amounts received or accrued with respect to
such property generally are not treated as
qualifying rents unless the services are furnished
through an independent contractor (sec.
856(d)(2)(C)). A REIT may furnish or render a
service directly, however, if the service would not
generate unrelated business taxable income under
section 512(b)(3) if provided by an organization
described in section 511(a)(2). In general, an
independent contractor is a person who does not own
more than a 35 percent interest in the REIT (sec.
856(d)(3)(A)), and in which no more than a 35
percent interest is held by persons with a 35
percent or greater interest in the REIT (sec.
856(d)(3)(B)).
Constructive
ownership rules involving corporations
For purposes of determining the REIT's ownership
interest in a tenant and whether a contractor is
independent, the attribution rules of section 318
apply, except that 10 percent is substituted for 50
percent where it appears in subparagraph (C) of
section 318(a)(2) and 318(a)(3) (sec. 856(d)(5)).
Thus, under section 318(a)(2)(C) (as so modified),
if 10 or more percent of a REIT or other corporation
is owned, directly or indirectly, by or for a
person, that person is treated as owning that
person's proportionate share of any stock owned
directly or indirectly by that corporation.
Constructive
ownership rules involving partnerships
Under section 318, stock owned, directly or
indirectly, by or for a partnership is considered
owned proportionately by its partners (sec.
318(a)(2)(A)). In addition, stock owned, directly or
indirectly, by or for a partner is considered owned
by the partnership (sec. 318(a)(3)(A)). However,
stock constructively owned by a partnership is not
considered as owned for purposes of being
constructively owned by partners (sec.
318(a)(5)(C)). The following examples illustrate the
application of these provisions for purposes of the
related tenant and independent contractor rules.
|
