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B.
Provisions Relating to Tax Shelters
1. Penalty for failure to disclose reportable
transactions (sec. 611 of the House bill, sec. 402
of the Senate amendment, and new sec. 6707A of the
Code)
Present
Law
Regulations under section 6011 require a taxpayer to
disclose with its tax return certain information
with respect to each "reportable
transaction" in which the taxpayer
participates.452
There are six categories of reportable transactions.
The first category is any transaction that is the
same as (or substantially similar to)453
a transaction that is specified by the Treasury
Department as a tax avoidance transaction whose tax
benefits are subject to disallowance under present
law (referred to as a "listed
transaction").454
The second category is any transaction that is
offered under conditions of confidentiality. In
general, a transaction is considered to be offered
to a taxpayer under conditions of confidentiality if
the advisor who is paid a minimum fee places a
limitation on disclosure by the taxpayer of the tax
treatment or tax structure of the transaction and
the limitation on disclosure protects the
confidentiality of that advisor's tax strategies
(irrespective if such terms are legally binding).455
The third category of reportable transactions is any
transaction for which (1) the taxpayer has the right
to a full or partial refund of fees if the intended
tax consequences from the transaction are not
sustained or, (2) the fees are contingent on the
intended tax consequences from the transaction being
sustained.456
The fourth category of reportable transactions
relates to any transaction resulting in a taxpayer
claiming a loss (under section 165) of at least (1)
$10 million in any single year or $20 million in any
combination of years by a corporate taxpayer or a
partnership with only corporate partners; (2) $2
million in any single year or $4 million in any
combination of years by all other partnerships, S
corporations, trusts, and individuals; or (3)
$50,000 in any single year for individuals or trusts
if the loss arises with respect to foreign currency
translation losses.457
The fifth category of reportable transactions refers
to any transaction done by certain taxpayers458
in which the tax treatment of the transaction
differs (or is expected to differ) by more than $10
million from its treatment for book purposes (using
generally accepted accounting principles) in any
year.459
The final category of reportable transactions is any
transaction that results in a tax credit exceeding
$250,000 (including a foreign tax credit) if the
taxpayer holds the underlying asset for less than 45
days.460
Under present law, there is no specific penalty for
failing to disclose a reportable transaction;
however, such a failure can jeopardize a taxpayer's
ability to claim that any income tax understatement
attributable to such undisclosed transaction is due
to reasonable cause, and that the taxpayer acted in
good faith.461
House
Bill
In general
The House bill creates a new penalty for any person
who fails to include with any return or statement
any required information with respect to a
reportable transaction. The new penalty applies
without regard to whether the transaction ultimately
results in an understatement of tax, and applies in
addition to any accuracy-related penalty that may be
imposed.
Transactions to be disclosed
The House bill does not define the terms
"listed transaction"462
or "reportable transaction," nor does it
explain the type of information that must be
disclosed in order to avoid the imposition of a
penalty. Rather, the House bill authorizes the
Treasury Department to define a "listed
transaction" and a "reportable
transaction" under section 6011.
Penalty rate
The penalty for failing to disclose a reportable
transaction is $10,000 in the case of a natural
person and $50,000 in any other case. The amount is
increased to $100,000 and $200,000, respectively, if
the failure is with respect to a listed transaction.
The penalty cannot be waived with respect to a
listed transaction. As to reportable transactions,
the
IRS
Commissioner or his delegate can rescind (or abate)
the penalty only if rescinding the penalty would
promote compliance with the tax laws and effective
tax administration. The decision to rescind a
penalty must be accompanied by a record describing
the facts and reasons for the action and the amount
rescinded. There will be no taxpayer right to
judicially appeal a refusal to rescind a penalty.463
The
IRS
also is required to submit an annual report to
Congress summarizing the application of the
disclosure penalties and providing a description of
each penalty rescinded under this provision and the
reasons for the rescission.
Effective date
The House bill provision is effective for returns
and statements the due date for which is after the
date of enactment.
Senate
Amendment
In general
The Senate amendment is the same as the House bill,
with certain modifications.
Transactions to be disclosed
Like the House bill, the Senate amendment does not
define the terms "listed transaction" or
"reportable transaction" but, rather,
authorizes the Treasury Department to define a
"listed transaction" and a
"reportable transaction" under section
6011.
Penalty rate
Under the Senate amendment, the penalty for failing
to disclose a reportable transaction generally is
$50,000. The amount is increased to $100,000 if the
failure is with respect to a listed transaction. For
large entities and high net worth individuals, the
penalty amount is doubled (i.e., $100,000 for a
reportable transaction and $200,000 for a listed
transaction).
The penalty cannot be waived with respect to a
listed transaction. As to reportable transactions,
the penalty can be rescinded (or abated) only if:
(1) the taxpayer on whom the penalty is imposed has
a history of complying with the Federal tax laws,
(2) it is shown that the violation is due to an
unintentional mistake of fact, (3) imposing the
penalty would be against equity and good conscience,
and (4) rescinding the penalty would promote
compliance with the tax laws and effective tax
administration. The authority to rescind the penalty
can only be exercised by the
IRS
Commissioner personally or the head of the Office of
Tax Shelter Analysis. Thus, the penalty cannot be
rescinded by a revenue agent, an Appeals officer, or
any other
IRS
personnel. The decision to rescind a penalty must be
accompanied by a record describing the facts and
reasons for the action and the amount rescinded.
There will be no taxpayer right to appeal a refusal
to rescind a penalty. The
IRS
also is required to submit an annual report to
Congress summarizing the application of the
disclosure penalties and providing a description of
each penalty rescinded under this provision and the
reasons for the rescission.
A "large entity" is defined as any entity
with gross receipts in excess of $10 million in the
year of the transaction or in the preceding year. A
"high net worth individual" is defined as
any individual whose net worth exceeds $2 million,
based on the fair market value of the individual's
assets and liabilities immediately before entering
into the transaction.
A public entity that is required to pay a penalty
for failing to disclose a listed transaction (or is
subject to an understatement penalty attributable to
a non-disclosed listed transaction, a non-disclosed
reportable avoidance transaction,464
or a transaction that lacks economic substance) must
disclose the imposition of the penalty in reports to
the Securities and Exchange Commission for such
period as the Secretary shall specify. The provision
applies without regard to whether the taxpayer
determines the amount of the penalty to be material
to the reports in which the penalty must appear, and
treats any failure to disclose a transaction in such
reports as a failure to disclose a listed
transaction. A taxpayer must disclose a penalty in
reports to the Securities and Exchange Commission
once the taxpayer has exhausted its administrative
and judicial remedies with respect to the penalty
(or if earlier, when paid). In addition, the
Secretary is required to make public the name of any
person that is required to pay a penalty for failing
to disclose a listed transaction (or is subject to
an understatement penalty attributable to a
nondisclosed listed transaction, a non-disclosed
reportable avoidance transaction, or a transaction
that lacks economic substance), as well as the
amount of such penalty.
Effective date
The Senate amendment provision is effective for
returns and statements the due date for which is
after the date of enactment.
Conference Agreement
The conference agreement follows the House bill,
with the following modifications.
In determining whether to rescind (or abate) the
penalty for failing to disclose a reportable
transaction on the grounds that doing so would
promote compliance with the tax laws and effective
tax administration, the conferees intend that the
IRS
Commissioner take into account whether: (1) the
person on whom the penalty is imposed has a history
of complying with the tax laws; (2) the violation is
due to an unintentional mistake of fact; and (3)
imposing the penalty would be against equity and
good conscience.
In addition, the conference agreement provides that
a public entity that is required to pay a penalty
for failing to disclose a listed transaction (or is
subject to an understatement penalty attributable to
a non-disclosed listed transaction or a
non-disclosed reportable avoidance transaction) must
disclose the imposition of the penalty in reports to
the Securities and Exchange Commission for such
period as the Secretary shall specify. This
requirement applies without regard to whether the
taxpayer determines the amount of the penalty to be
material to the reports in which the penalty must
appear, and treats any failure to disclose a
transaction in such reports as a failure to disclose
a listed transaction. A taxpayer must disclose a
penalty in reports to the Securities and Exchange
Commission once the taxpayer has exhausted its
administrative and judicial remedies with respect to
the penalty (or if earlier, when paid). However, the
taxpayer is only required to report the penalty one
time. The conference agreement further provides that
this requirement also applies to a public entity
that is subject to a gross valuation misstatement
penalty under section 6662(h) attributable to a
non-disclosed listed transaction or non-disclosed
reportable avoidance transaction.
2. Modifications to the accuracy-related
penalties for listed transactions and reportable
transactions having a significant tax avoidance
purpose (sec. 612 of the House bill, sec. 403 of the
Senate amendment, and new sec. 6662A of the Code)
Present
Law
The accuracy-related penalty applies to the portion
of any underpayment that is attributable to (1)
negligence, (2) any substantial understatement of
income tax, (3) any substantial valuation
misstatement, (4) any substantial overstatement of
pension liabilities, or (5) any substantial estate
or gift tax valuation understatement. If the correct
income tax liability exceeds that reported by the
taxpayer by the greater of 10 percent of the correct
tax or $5,000 ($10,000 in the case of corporations),
then a substantial understatement exists and a
penalty may be imposed equal to 20 percent of the
underpayment of tax attributable to the
understatement.465
The amount of any understatement generally is
reduced by any portion attributable to an item if
(1) the treatment of the item is or was supported by
substantial authority, or (2) facts relevant to the
tax treatment of the item were adequately disclosed
and there was a reasonable basis for its tax
treatment.466
Special rules apply with respect to tax shelters.467
For understatements by non-corporate taxpayers
attributable to tax shelters, the penalty may be
avoided only if the taxpayer establishes that, in
addition to having substantial authority for the
position, the taxpayer reasonably believed that the
treatment claimed was more likely than not the
proper treatment of the item. This reduction in the
penalty is unavailable to corporate tax shelters.
The understatement penalty generally is abated (even
with respect to tax shelters) in cases in which the
taxpayer can demonstrate that there was
"reasonable cause" for the underpayment
and that the taxpayer acted in good faith.468
The relevant regulations provide that reasonable
cause exists where the taxpayer "reasonably
relies in good faith on an opinion based on a
professional tax advisor's analysis of the pertinent
facts and authorities [that] ... unambiguously
concludes that there is a greater than 50-percent
likelihood that the tax treatment of the item will
be upheld if challenged" by the
IRS
.469
House
Bill
In general
The House bill modifies the present-law accuracy
related penalty by replacing the rules applicable to
tax shelters with a new accuracy-related penalty
that applies to listed transactions and reportable
transactions with a significant tax avoidance
purpose (hereinafter referred to as a
"reportable avoidance transaction").470
The penalty rate and defenses available to avoid the
penalty vary depending on whether the transaction
was adequately disclosed.
Disclosed transactions
In general, a 20-percent accuracy-related penalty is
imposed on any understatement attributable to an
adequately disclosed listed transaction or
reportable avoidance transaction. The only exception
to the penalty is if the taxpayer satisfies a more
stringent reasonable cause and good faith exception
(hereinafter referred to as the "strengthened
reasonable cause exception"), which is
described below. The strengthened reasonable cause
exception is available only if the relevant facts
affecting the tax treatment are adequately
disclosed, there is or was substantial authority for
the claimed tax treatment, and the taxpayer
reasonably believed that the claimed tax treatment
was more likely than not the proper treatment.
Undisclosed transactions
If the taxpayer does not adequately disclose the
transaction, the strengthened reasonable cause
exception is not available (i.e., a strict-liability
penalty applies), and the taxpayer is subject to an
increased penalty equal to 30 percent of the
understatement.
Determination of the understatement amount
The penalty is applied to the amount of any
understatement attributable to the listed or
reportable avoidance transaction without regard to
other items on the tax return. For purposes of this
provision, the amount of the understatement is
determined as the sum of (1) the product of the
highest corporate or individual tax rate (as
appropriate) and the increase in taxable income
resulting from the difference between the taxpayer's
treatment of the item and the proper treatment of
the item (without regard to other items on the tax
return),471
and (2) the amount of any decrease in the aggregate
amount of credits which results from a difference
between the taxpayer's treatment of an item and the
proper tax treatment of such item.
Except as provided in regulations, a taxpayer's
treatment of an item shall not take into account any
amendment or supplement to a return if the amendment
or supplement is filed after the earlier of when the
taxpayer is first contacted regarding an examination
of the return or such other date as specified by the
Secretary.
Strengthened reasonable cause exception
A penalty is not imposed under the provision with
respect to any portion of an understatement if it
shown that there was reasonable cause for such
portion and the taxpayer acted in good faith. Such a
showing requires (1) adequate disclosure of the
facts affecting the transaction in accordance with
the regulations under section 6011,472
(2) that there is or was substantial authority for
such treatment, and (3) that the taxpayer reasonably
believed that such treatment was more likely than
not the proper treatment. For this purpose, a
taxpayer will be treated as having a reasonable
belief with respect to the tax treatment of an item
only if such belief (1) is based on the facts and
law that exist at the time the tax return (that
includes the item) is filed, and (2) relates solely
to the taxpayer's chances of success on the merits
and does not take into account the possibility that
(a) a return will not be audited, (b) the treatment
will not be raised on audit, or (c) the treatment
will be resolved through settlement if raised.
A taxpayer may (but is not required to) rely on an
opinion of a tax advisor in establishing its
reasonable belief with respect to the tax treatment
of the item. However, a taxpayer may not rely on an
opinion of a tax advisor for this purpose if the
opinion (1) is provided by a "disqualified tax
advisor," or (2) is a "disqualified
opinion."
Disqualified tax advisor
A disqualified tax advisor is any advisor who (1) is
a material advisor473
and who participates in the organization,
management, promotion or sale of the transaction or
is related (within the meaning of section 267(b) or
707(b)(1)) to any person who so participates, (2) is
compensated directly or indirectly474
by a material advisor with respect to the
transaction, (3) has a fee arrangement with respect
to the transaction that is contingent on all or part
of the intended tax benefits from the transaction
being sustained, or (4) as determined under
regulations prescribed by the Secretary, has a
disqualifying financial interest with respect to the
transaction.
Organization, management, promotion or sale of a
transaction. --A material advisor is considered
as participating in the "organization" of
a transaction if the advisor performs acts relating
to the development of the transaction. This may
include, for example, preparing documents (1)
establishing a structure used in connection with the
transaction (such as a partnership agreement), (2)
describing the transaction (such as an offering
memorandum or other statement describing the
transaction), or (3) relating to the registration of
the transaction with any federal, state or local
government body.475
Participation in the "management" of a
transaction means involvement in the decision-making
process regarding any business activity with respect
to the transaction. Participation in the
"promotion or sale" of a transaction means
involvement in the marketing or solicitation of the
transaction to others. Thus, an advisor who provides
information about the transaction to a potential
participant is involved in the promotion or sale of
a transaction, as is any advisor who recommends the
transaction to a potential participant.
Disqualified opinion
An opinion may not be relied upon if the opinion (1)
is based on unreasonable factual or legal
assumptions (including assumptions as to future
events), (2) unreasonably relies upon
representations, statements, finding or agreements
of the taxpayer or any other person, (3) does not
identify and consider all relevant facts, or (4)
fails to meet any other requirement prescribed by
the Secretary.
Coordination with other penalties
Any understatement upon which a penalty is imposed
under the House bill is not subject to the
accuracy-related penalty under section 6662.
However, such understatement is included for
purposes of determining whether any understatement
(as defined in sec. 6662(d)(2)) is a substantial
understatement as defined under section 6662(d)(1).
The penalty imposed under the House bill shall not
apply to any portion of an understatement to which a
fraud penalty is applied under section 6663.
Effective date
The House bill provision is effective for taxable
years ending after the date of enactment.
Senate
Amendment
In general
The Senate amendment is the same as the House bill,
with certain modifications.
Disclosed transactions
The Senate amendment is the same as the House bill
with regard to accuracy-related penalties for
understatements attributable to an adequately
disclosed listed transaction or reportable avoidance
transaction.
Undisclosed transactions
Like the House bill, the Senate amendment provides
that a taxpayer is subject to an increased
accuracy-related penalty equal to 30 percent of the
understatement, and the strengthened reasonable
cause exception is not available (i.e., a
strict-liability penalty applies), if the taxpayer
does not adequately disclose the transaction.
Under the Senate amendment, a public entity that is
required to pay the 30-percent penalty also must
disclose the imposition of the penalty in reports to
the
SEC
for such periods as the Secretary shall specify. The
disclosure to the
SEC
applies without regard to whether the taxpayer
determines the amount of the penalty to be material
to the reports in which the penalty must appear, and
any failure to disclose such penalty in the reports
is treated as a failure to disclose a listed
transaction. A taxpayer must disclose a penalty in
reports to the
SEC
once the taxpayer has exhausted its administrative
and judicial remedies with respect to the penalty
(or if earlier, when paid).
The Senate amendment also provides that, once the
30-percent penalty has been included in the Revenue
Agent Report, the penalty cannot be compromised for
purposes of a settlement without approval of the
Commissioner personally or the head of the Office of
Tax Shelter Analysis. Furthermore, the
IRS
is required to submit an annual report to Congress
summarizing the application of this penalty and
providing a description of each penalty compromised
under this provision and the reasons for the
compromise.
Disqualified tax advisor
The Senate amendment provides that a disqualified
tax advisor also includes ad advisor who has an
arrangement with respect to the transaction which
provides that contractual disputes between the
taxpayer and the advisor are to be settled by
arbitration or which limits damages by reference to
fees paid to the advisor for such transaction.
Determination of the understatement amount
The Senate amendment is the same as the House bill
with regard to determining the amount of an
understatement that is subject to this provision.
Strengthened reasonable cause exception
The Senate amendment is the same as the House bill
with regard to the reasonable cause exception to
accuracy-related penalties under this provision.476
Coordination with other penalties
The Senate amendment is the same as the House bill
with regard to coordination between the penalty
imposed under this provision and other penalties.
Effective date
The Senate amendment provision is effective for
taxable years ending after the date of enactment.
Conference
Agreement
The conference agreement follows the House bill,
except the conference agreement also provides that
any understatement upon which a penalty is imposed
under the conference agreement is not subject to the
valuation misstatement penalties under sections
6662(e) or 6662(h).
3. Tax shelter exception to confidentiality
privileges relating to taxpayer communications (sec.
613 of the House bill, sec. 406 of the Senate
amendment, and sec. 7525 of the Code)
Present
Law
In general, a common law privilege of
confidentiality exists for communications between an
attorney and client with respect to the legal advice
the attorney gives the client. The Code provides
that, with respect to tax advice, the same common
law protections of confidentiality that apply to a
communication between a taxpayer and an attorney
also apply to a communication between a taxpayer and
a federally authorized tax practitioner to the
extent the communication would be considered a
privileged communication if it were between a
taxpayer and an attorney. This rule is inapplicable
to communications regarding corporate tax shelters.
House
Bill
The House bill modifies the rule relating to
corporate tax shelters by making it applicable to
all tax shelters, whether entered into by
corporations, individuals, partnerships, tax-exempt
entities, or any other entity. Accordingly,
communications with respect to tax shelters are not
subject to the confidentiality provision of the Code
that otherwise applies to a communication between a
taxpayer and a federally authorized tax
practitioner.
Effective date. --The House bill provision is
effective with respect to communications made on or
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.
4. Statute of limitations for unreported listed
transactions (sec. 614 of the House bill, sec. 416
of the Senate amendment, and sec. 6501 of the Code)
Present
Law
In general, the Code requires that taxes be assessed
within three years477
after the date a return is filed.478
If there has been a substantial omission of items of
gross income that totals more than 25 percent of the
amount of gross income shown on the return, the
period during which an assessment must be made is
extended to six years.479
If an assessment is not made within the required
time periods, the tax generally cannot be assessed
or collected at any future time. Tax may be assessed
at any time if the taxpayer files a false or
fraudulent return with the intent to evade tax or if
the taxpayer does not file a tax return at all.480
House
Bill
The House bill extends the statute of limitations
with respect to a listed transaction if a taxpayer
fails to include on any return or statement for any
taxable year any information with respect to a
listed transaction481
which is required to be included (under section
6011) with such return or statement. The statute of
limitations with respect to such a transaction will
not expire before the date which is one year after
the earlier of (1) the date on which the Secretary
is furnished the information so required, or (2) the
date that a material advisor (as defined in 6111)
satisfies the list maintenance requirements (as
defined by section 6112) with respect to a request
by the Secretary. For example, if a taxpayer engaged
in a transaction in 2005 that becomes a listed
transaction in 2007 and the taxpayer fails to
disclose such transaction in the manner required by
Treasury regulations, then the transaction is
subject to the extended statute of limitations.482
Effective date. --The House bill provision is
effective for taxable years with respect to which
the period for assessing a deficiency did not expire
before 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.
5. Disclosure of reportable transactions by
material advisors (secs. 615 and 616 of the House
bill, secs. 407 and 408 of the Senate amendment, and
secs. 6111 and 6707 of the Code)
Present
Law
Registration of tax shelter arrangements
An organizer of a tax shelter is required to
register the shelter with the Secretary not later
than the day on which the shelter is first offered
for sale.483
A "tax shelter" means any investment with
respect to which the tax shelter ratio484
for any investor as of the close of any of the first
five years ending after the investment is offered
for sale may be greater than two to one and which
is: (1) required to be registered under Federal or
State securities laws, (2) sold pursuant to an
exemption from registration requiring the filing of
a notice with a Federal or State securities agency,
or (3) a substantial investment (greater than
$250,000 and involving at least five investors).485
Other promoted arrangements are treated as tax
shelters for purposes of the registration
requirement if: (1) a significant purpose of the
arrangement is the avoidance or evasion of Federal
income tax by a corporate participant; (2) the
arrangement is offered under conditions of
confidentiality; and (3) the promoter may receive
fees in excess of $100,000 in the aggregate.486
In general, a transaction has a "significant
purpose of avoiding or evading Federal income
tax" if the transaction: (1) is the same as or
substantially similar to a "listed
transaction,"487
or (2) is structured to produce tax benefits that
constitute an important part of the intended results
of the arrangement and the promoter reasonably
expects to present the arrangement to more than one
taxpayer.488
Certain exceptions are provided with respect to the
second category of transactions.489
An arrangement is offered under conditions of
confidentiality if: (1) an offeree has an
understanding or agreement to limit the disclosure
of the transaction or any significant tax features
of the transaction; or (2) the promoter knows, or
has reason to know, that the offeree's use or
disclosure of information relating to the
transaction is limited in any other manner.490
Failure to register tax shelter
The penalty for failing to timely register a tax
shelter (or for filing false or incomplete
information with respect to the tax shelter
registration) generally is the greater of one
percent of the aggregate amount invested in the
shelter or $500.491
However, if the tax shelter involves an arrangement
offered to a corporation under conditions of
confidentiality, the penalty is the greater of
$10,000 or 50 percent of the fees payable to any
promoter with respect to offerings prior to the date
of late registration. Intentional disregard of the
requirement to register increases the penalty to 75
percent of the applicable fees.
Section 6707 also imposes (1) a $100 penalty on the
promoter for each failure to furnish the investor
with the required tax shelter identification number,
and (2) a $250 penalty on the investor for each
failure to include the tax shelter identification
number on a return.
House
Bill
Disclosure of reportable transactions by
material advisors
The House bill repeals the present law rules with
respect to registration of tax shelters. Instead,
the House bill requires each material advisor with
respect to any reportable transaction (including any
listed transaction)492
to timely file an information return with the
Secretary (in such form and manner as the Secretary
may prescribe). The return must be filed on such
date as specified by the Secretary.
The information return will include (1) information
identifying and describing the transaction, (2)
information describing any potential tax benefits
expected to result from the transaction, and (3)
such other information as the Secretary may
prescribe. It is expected that the Secretary may
seek from the material advisor the same type of
information that the Secretary may request from a
taxpayer in connection with a reportable
transaction.493
A "material advisor" means any person (1)
who provides material aid, assistance, or advice
with respect to organizing, managing, promoting,
selling, implementing, or carrying out any
reportable transaction, and (2) who directly or
indirectly derives gross income for such assistance
or advice in excess of $250,000 ($50,000 in the case
of a reportable transaction substantially all of the
tax benefits from which are provided to natural
persons) or such other amount as may be prescribed
by the Secretary.
The Secretary may prescribe regulations which
provide (1) that only one material advisor has to
file an information return in cases in which two or
more material advisors would otherwise be required
to file information returns with respect to a
particular reportable transaction, (2) exemptions
from the requirements of this section, and (3) other
rules as may be necessary or appropriate to carry
out the purposes of this section (including, for
example, rules regarding the aggregation of fees in
appropriate circumstances).
Penalty for failing to furnish information
regarding reportable transactions
The House bill repeals the present-law penalty for
failure to register tax shelters. Instead, the House
bill imposes a penalty on any material advisor who
fails to file an information return, or who files a
false or incomplete information return, with respect
to a reportable transaction (including a listed
transaction).494
The amount of the penalty is $50,000. If the penalty
is with respect to a listed transaction, the amount
of the penalty is increased to the greater of (1)
$200,000, or (2) 50 percent of the gross income of
such person with respect to aid, assistance, or
advice which is provided with respect to the
transaction before the date the information return
that includes the transaction is filed. Intentional
disregard by a material advisor of the requirement
to disclose a listed transaction increases the
penalty to 75 percent of the gross income.
The penalty cannot be waived with respect to a
listed transaction. As to reportable transactions,
the penalty can be rescinded (or abated) only in
exceptional circumstances.495
All or part of the penalty may be rescinded only if
rescinding the penalty would promote compliance with
the tax laws and effective tax administration. The
decision to rescind a penalty must be accompanied by
a record describing the facts and reasons for the
action and the amount rescinded. There will be no
right to judicially appeal a refusal to rescind a
penalty. The
IRS
also is required to submit an annual report to
Congress summarizing the application of the
disclosure penalties and providing a description of
each penalty rescinded under this provision and the
reasons for the rescission.
Effective date
The House bill provision requiring disclosure of
reportable transactions by material advisors applies
to transactions with respect to which material aid,
assistance or advice is provided after the date of
enactment.
The House bill provision imposing a penalty for
failing to disclose reportable transactions applies
to returns the due date for which is after the date
of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill,
except the Senate amendment also includes in the
definition of a "material advisor" any
person who provides material aid, assistance, or
advice with respect to insuring any reportable
transaction (and who derives gross income for such
assistance or advice in excess of the amounts
specified in the House bill).
COM-
RPT
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HIST
, HRRepNo 108-755, Conference Committee Report
on the American Jobs Creation Act of 2004, HR
4520, (October 8, 2004), Part 06 of 08
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Conference
Agreement
The conference agreement follows the Senate
amendment.
6. Investor lists and modification of penalty for
failure to maintain investor lists (secs. 615 and
617 of the House bill, secs. 407 and 409 of the
Senate amendment, and secs. 6112 and 6708 of the
Code)
Present
Law
Investor lists
Any organizer or seller of a potentially abusive tax
shelter must maintain a list identifying each person
who was sold an interest in any such tax shelter
with respect to which registration was required
under section 6111 (even though the particular party
may not have been subject to confidentiality
restrictions).496
Recently issued regulations under section 6112
contain rules regarding the list maintenance
requirements.497
In general, the regulations apply to transactions
that are potentially abusive tax shelters entered
into, or acquired after, February 28, 2003.498
The regulations provide that a person is an
organizer or seller of a potentially abusive tax
shelter if the person is a material advisor with
respect to that transaction.499
A material advisor is defined as any person who is
required to register the transaction under section
6111, or expects to receive a minimum fee of (1)
$250,000 for a transaction that is a potentially
abusive tax shelter if all participants are
corporations, or (2) $50,000 for any other
transaction that is a potentially abusive tax
shelter.500
For listed transactions (as defined in the
regulations under section 6011), the minimum fees
are reduced to $25,000 and $10,000, respectively.
A potentially abusive tax shelter is any transaction
that (1) is required to be registered under section
6111, (2) is a listed transaction (as defined under
the regulations under section 6011), or (3) any
transaction that a potential material advisor, at
the time the transaction is entered into, knows is
or reasonably expects will become a reportable
transaction (as defined under the new regulations
under section 6011).501
The Secretary is required to prescribe regulations
which provide that, in cases in which two or more
persons are required to maintain the same list, only
one person would be required to maintain the list.502
Penalty for failing to maintain investor lists
Under section 6708, the penalty for failing to
maintain the list required under section 6112 is $50
for each name omitted from the list (with a maximum
penalty of $100,000 per year).
House
Bill
Investor lists
Each material advisor503
with respect to a reportable transaction (including
a listed transaction)504
is required to maintain a list that (1) identifies
each person with respect to whom the advisor acted
as a material advisor with respect to the reportable
transaction, and (2) contains other information as
may be required by the Secretary. In addition, the
provision authorizes (but does not require) the
Secretary to prescribe regulations which provide
that, in cases in which two or more persons are
required to maintain the same list, only one person
would be required to maintain the list.
Penalty for failing to maintain investor lists
The provision modifies the penalty for failing to
maintain the required list by making it a
time-sensitive penalty. Thus, a material advisor who
is required to maintain an investor list and who
fails to make the list available upon written
request by the Secretary within 20 business days
after the request will be subject to a $10,000 per
day penalty. The penalty applies to a person who
fails to maintain a list, maintains an incomplete
list, or has in fact maintained a list but does not
make the list available to the Secretary. The
penalty can be waived if the failure to make the
list available is due to reasonable cause.505
Effective date
The House bill provision requiring a material
advisor to maintain an investor list applies to
transactions with respect to which material aid,
assistance or advice is provided after the date of
enactment. The House bill provision imposing a
penalty for failing to maintain investor lists
applies to requests made after the date of
enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
In addition, the Senate amendment clarifies that,
for purposes of section 6112, the identity of any
person is not privileged under the common law
attorney-client privilege (or, consequently, the
section 7525 federally authorized tax practitioner
confidentiality provision).
Effective date. --The Senate amendment
provision clarifying that the identity of any person
is not privileged for purposes of section 6112 is
effective as if included in the amendments made by
section 142 of the Deficit Reduction Act of 1984.
Conference
Agreement
The conference agreement follows the House bill.
7. Penalty on promoters of tax shelters (sec. 618
of the House bill, sec. 415 of the Senate amendment,
and sec. 6700 of the Code)
Present
Law
A penalty is imposed on any person who organizes,
assists in the organization of, or participates in
the sale of any interest in, a partnership or other
entity, any investment plan or arrangement, or any
other plan or arrangement, if in connection with
such activity the person makes or furnishes a
qualifying false or fraudulent statement or a gross
valuation overstatement.506
A qualified false or fraudulent statement is any
statement with respect to the allowability of any
deduction or credit, the excludability of any
income, or the securing of any other tax benefit by
reason of holding an interest in the entity or
participating in the plan or arrangement which the
person knows or has reason to know is false or
fraudulent as to any material matter. A "gross
valuation overstatement" means any statement as
to the value of any property or services if the
stated value exceeds 200 percent of the correct
valuation, and the value is directly related to the
amount of any allowable income tax deduction or
credit.
The amount of the penalty is $1,000 (or, if the
person establishes that it is less, 100 percent of
the gross income derived or to be derived by the
person from such activity). A penalty attributable
to a gross valuation misstatement can be waived on a
showing that there was a reasonable basis for the
valuation and it was made in good faith.
House
Bill
The House bill modifies the penalty amount to equal
50 percent of the gross income derived by the person
from the activity for which the penalty is imposed.
The new penalty rate applies to any activity that
involves a statement regarding the tax benefits of
participating in a plan or arrangement if the person
knows or has reason to know that such statement is
false or fraudulent as to any material matter. The
enhanced penalty does not apply to a gross valuation
overstatement.
Effective date. --The House bill provision is
effective for activities occurring after the date of
enactment.
Senate
Amendment
The Senate amendment modifies the penalty amount to
equal 100 percent of the gross income derived by the
person from the activity for which the penalty is
imposed. The new penalty rate applies to (1) each
instance of any activity that involves a statement
(including a gross valuation overstatement)
regarding the tax benefits of participating in a
plan or arrangement if the person knows or has
reason to know that such statement is false or
fraudulent as to any material matter, (2) each
instance in which income was derived from such
activity, and (3) each person who participated in
such activity. In addition, the Senate amendment
imposes joint and several liability upon all persons
who are subject to a penalty for such activity. The
Senate amendment also provides that the payment of a
penalty under this provision, or the payment of any
amount to settle or avoid the imposition of such a
penalty, is not deductible for tax purposes.
Effective date. --The Senate amendment
provision is effective for activities occurring
after the date of enactment.
Conference
Agreement
The conference agreement follows the House bill.
8. Penalty for aiding and abetting the
understatement of tax liability (sec. 419 of the
Senate amendment and sec. 6701 of the Code)
Present
Law
A penalty is imposed on a person who: (1) aids or
assists in or advises with respect to a tax return
or other document; (2) knows (or has reason to
believe) that such document will be used in
connection with a material tax matter; and (3) knows
that this would result in an understatement of tax
of another person. In general, the amount of the
penalty is $1,000. If the document relates to the
tax return of a corporation, the amount of the
penalty is $10,000.
House
Bill
No provision.
Senate
Amendment
The Senate amendment expands the scope of this
penalty in several ways. First, it applies the
penalty to aiding or assisting with respect to tax
liability. Second, it applies the penalty to each
instance of aiding or abetting. Third, it increases
the amount of the penalty to a maximum of 100
percent of the gross income derived (or to be
derived) from the aiding or abetting. Fourth, if
more than one person is liable for the penalty, all
such persons are jointly and severally liable for
the penalty. Fifth, the penalty, as well as amounts
paid to settle or avoid the imposition of the
penalty, is not deductible for tax purposes.
Effective date. --The Senate amendment
provision is effective for activities after the date
of enactment.
Conference
Agreement
The conference agreement does not include the Senate
amendment provision.
9. Modifications of substantial understatement
penalty for nonreportable transactions (sec. 619 of
the House bill, sec. 405 of the Senate amendment,
and sec. 6662 of the Code)
Present
Law
An accuracy-related penalty equal to 20 percent
applies to any substantial understatement of tax. A
"substantial understatement" exists if the
correct income tax liability for a taxable year
exceeds that reported by the taxpayer by the greater
of 10 percent of the correct tax or $5,000 ($10,000
in the case of most corporations).507
House
Bill
The House bill modifies the definition of
"substantial" for corporate taxpayers.
Under the House bill, a corporate taxpayer has a
substantial understatement if the amount of the
understatement for the taxable year exceeds the
lesser of (1) 10 percent of the tax required to be
shown on the return for the taxable year (or, if
greater, $10,000), or (2) $10 million.
Effective date. --The House bill provision is
effective for taxable years beginning after date of
enactment.
Senate
Amendment
The Senate amendment is the same as the House bill
with regard to modifying the definition of
"substantial" for corporate taxpayers.
In addition, the Senate amendment elevates the
standard that a taxpayer must satisfy in order to
reduce the amount of an understatement for
undisclosed items. With respect to the treatment of
an item whose facts are not adequately disclosed, a
resulting understatement is reduced only if the
taxpayer had a reasonable belief that the tax
treatment was more likely than not the proper
treatment.
The Senate amendment also authorizes (but does not
require) the Secretary to publish a list of
positions for which it believes there is not
substantial authority or there is no reasonable
belief that the tax treatment is more likely than
not the proper treatment (without regard to whether
such positions affect a significant number of
taxpayers). The list shall be published in the
Federal Register or the Internal Revenue Bulletin.
Effective date. --The Senate amendment
provision is effective for taxable years beginning
after the date of enactment.
Conference
Agreement
The conference agreement follows the House bill,
except the conference agreement also modifies the
requirement of the Secretary to prescribe a list of
positions that do not have substantial authority,
and authorizes (but does not require) the Secretary
to publish such list.
10. Modification of actions to enjoin certain
conduct related to tax shelters and reportable
transactions (sec. 620 of the House bill, sec. 410
of the Senate amendment, and sec. 7408 of the Code)
Present
Law
The Code authorizes civil actions to enjoin any
person from promoting abusive tax shelters or aiding
or abetting the understatement of tax liability.508
House
Bill
The House bill expands this rule so that injunctions
may also be sought with respect to the requirements
relating to the reporting of reportable transactions509
and the keeping of lists of investors by material
advisors.510
Thus, under the House bill, an injunction may be
sought against a material advisor to enjoin the
advisor from (1) failing to file an information
return with respect to a reportable transaction, or
(2) failing to maintain, or to timely furnish upon
written request by the Secretary, a list of
investors with respect to each reportable
transaction.
Effective date. --The House bill provision is
effective on the day after the date of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill,
except the Senate amendment also permits injunctions
to be sought with respect to violations of any of
the rules under Circular 230, which regulates the
practice of representatives of persons before the
Department of the Treasury.
Conference
Agreement
The conference agreement follows the Senate
amendment.
11. Penalty on failure to report interests in
foreign financial accounts (sec. 621 of the House
bill, sec. 412 of the Senate amendment, and sec.
5321 of Title 31,
United States
Code)
Present
Law
The Secretary must require citizens, residents, or
persons doing business in the United States to keep
records and file reports when that person makes a
transaction or maintains an account with a foreign
financial entity.511
In general, individuals must fulfill this
requirement by answering questions regarding foreign
accounts or foreign trusts that are contained in
Part
III
of Schedule B of the
IRS
Form 1040. Taxpayers who answer "yes" in
response to the question regarding foreign accounts
must then file Treasury Department Form TD F
90-22.1. This form must be filed with the Department
of the Treasury, and not as part of the tax return
that is filed with the
IRS
.
The Secretary may impose a civil penalty on any
person who willfully violates this reporting
requirement. The civil penalty is the amount of the
transaction or the value of the account, up to a
maximum of $100,000; the minimum amount of the
penalty is $25,000.512
In addition, any person who willfully violates this
reporting requirement is subject to a criminal
penalty. The criminal penalty is a fine of not more
than $250,000 or imprisonment for not more than five
years (or both); if the violation is part of a
pattern of illegal activity, the maximum amount of
the fine is increased to $500,000 and the maximum
length of imprisonment is increased to 10 years.513
On April 26, 2002, the Secretary submitted to the
Congress a report on these reporting requirements.514
This report, which was statutorily required,515
studies methods for improving compliance with these
reporting requirements. It makes several
administrative recommendations, but no legislative
recommendations. A further report was required to be
submitted by the Secretary to the Congress by
October 26, 2002.
House
Bill
The House bill adds an additional civil penalty that
may be imposed on any person who violates this
reporting requirement (without regard to
willfulness). This new civil penalty is up to
$5,000. The penalty may be waived if any income from
the account was properly reported on the income tax
return and there was reasonable cause for the
failure to report.
Effective date. --The House bill provision is
effective with respect to failures to report
occurring on or after the date of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill,
except the maximum additional civil penalty for a
non-willful act is up to $10,000. In addition, the
Senate amendment increases the present-law penalty
for willful behavior to the greater of $100,000 or
50 percent of the amount of the transaction or
account.
Effective date. --The Senate amendment
provision is effective with respect to failures to
report occurring on or after the date of enactment.
Conference
Agreement
The conference agreement follows the Senate
amendment.
12. Regulation of individuals practicing before
the Department of the Treasury (sec. 622 of the
House bill, sec. 414 of the Senate amendment, and
sec. 330 of Title 31, United States Code)
Present
Law
The Secretary is authorized to regulate the practice
of representatives of persons before the Department
of the Treasury.516
The Secretary is also authorized to suspend or
disbar from practice before the Department a
representative who is incompetent, who is
disreputable, who violates the rules regulating
practice before the Department, or who (with intent
to defraud) willfully and knowingly misleads or
threatens the person being represented (or a person
who may be represented). The rules promulgated by
the Secretary pursuant to this provision are
contained in Circular 230.
House
Bill
The House bill makes two modifications to expand the
sanctions that the Secretary may impose pursuant to
these statutory provisions. First, the House bill
expressly permits censure as a sanction. Second, the
House bill permits the imposition of a monetary
penalty as a sanction. If the representative is
acting on behalf of an employer or other entity, the
Secretary may impose a monetary penalty on the
employer or other entity if it knew, or reasonably
should have known, of the conduct. This monetary
penalty on the employer or other entity may be
imposed in addition to any monetary penalty imposed
directly on the representative. These monetary
penalties are not to exceed the gross income derived
(or to be derived) from the conduct giving rise to
the penalty. These monetary penalties may be in
addition to, or in lieu of, any suspension,
disbarment, or censure of such individual.
The House bill also confirms the present-law
authority of the Secretary to impose standards
applicable to written advice with respect to an
entity, plan, or arrangement that is of a type that
the Secretary determines as having a potential for
tax avoidance or evasion.
Effective date. --The House bill
modifications to expand the sanctions that the
Secretary may impose are effective for actions taken
after the date of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill
(except for several technical drafting
modifications).
Effective date. --The Senate amendment
modifications to expand the sanctions that the
Secretary may impose are effective for actions taken
after the date of enactment.
Conference
Agreement
The conference agreement follows the Senate
amendment.
13. Treatment of stripped bonds to apply to
stripped interests in bond and preferred stock funds
(sec. 631 of the House bill, sec. 461 of the Senate
amendment, and secs. 305 and 1286 of the Code)
Present
Law
Assignment of income in general
In general, an "income stripping"
transaction involves a transaction in which the
right to receive future income from income-producing
property is separated from the property itself. In
such transactions, it may be possible to generate
artificial losses from the disposition of certain
property or to defer the recognition of taxable
income associated with such property.
Common law has developed a rule (referred to as the
"assignment of income" doctrine) whereby
if the right to receive income is transferred
without an accompanying transfer of the underlying
property, the transfer is not respected. A leading
judicial decision relating to the assignment of
income doctrine involved a case in which a taxpayer
made a gift of detachable interest coupons before
their due date while retaining the bearer bond. The
U.S. Supreme Court ruled that the donor was taxable
on the entire amount of interest when paid to the
donee on the grounds that the transferor had
"assigned" to the donee the right to
receive the income.517
In addition to general common law assignment of
income principles, specific statutory rules have
been enacted to address certain specific types of
stripping transactions, such as transactions
involving stripped bonds and stripped preferred
stock (which are discussed below).518
However, there are no specific statutory rules that
address stripping transactions with respect to
common stock or other equity interests (other than
preferred stock).519
Stripped bonds
Special rules are provided with respect to the
purchaser and "stripper" of stripped
bonds.520
A "stripped bond" is defined as a debt
instrument in which there has been a separation in
ownership between the underlying debt instrument and
any interest coupon that has not yet become payable.521
In general, upon the disposition of either the
stripped bond or the detached interest coupons, the
retained portion and the portion that is disposed of
each is treated as a new bond that is purchased at a
discount and is payable at a fixed amount on a
future date. Accordingly, section 1286 treats both
the stripped bond and the detached interest coupons
as individual bonds that are newly issued with
original issue discount ("OID") on the
date of disposition. Consequently, section 1286
effectively subjects the stripped bond and the
detached interest coupons to the general OID
periodic income inclusion rules.
A taxpayer who purchases a stripped bond or one or
more stripped coupons is treated as holding a new
bond that is issued on the purchase date with OID in
an amount that is equal to the excess of the stated
redemption price at maturity (or in the case of a
coupon, the amount payable on the due date) over the
ratable share of the purchase price of the stripped
bond or coupon, determined on the basis of the
respective fair market values of the stripped bond
and coupons on the purchase date.522
The OID on the stripped bond or coupon is includible
in gross income under the general OID periodic
income inclusion rules.
A taxpayer who strips a bond and disposes of either
the stripped bond or one or more stripped coupons
must allocate the taxpayer's basis, immediately
before the disposition, in the bond (with the
coupons attached) between the retained and disposed
items.523
Special rules apply to require that interest or
market discount accrued on the bond prior to such
disposition must be included in the taxpayer's gross
income (to the extent that it had not been
previously included in income) at the time the
stripping occurs, and the taxpayer increases the
basis in the bond by the amount of such accrued
interest or market discount. The adjusted basis (as
increased by any accrued interest or market
discount) is then allocated between the stripped
bond and the stripped interest coupons in relation
to their respective fair market values. Amounts
realized from the sale of stripped coupons or bonds
constitute income to the taxpayer only to the extent
such amounts exceed the basis allocated to the
stripped coupons or bond. With respect to retained
items (either the detached coupons or stripped
bond), to the extent that the price payable on
maturity, or on the due date of the coupons, exceeds
the portion of the taxpayer's basis allocable to
such retained items, the difference is treated as
OID that is required to be included under the
general OID periodic income inclusion rules.524
Stripped preferred stock
"Stripped preferred stock" is defined as
preferred stock in which there has been a separation
in ownership between such stock and any dividend on
such stock that has not become payable.525
A taxpayer who purchases stripped preferred stock is
required to include in gross income, as ordinary
income, the amounts that would have been includible
if the stripped preferred stock was a bond issued on
the purchase date with OID equal to the excess of
the redemption price of the stock over the purchase
price.526
This treatment is extended to any taxpayer whose
basis in the stock is determined by reference to the
basis in the hands of the purchaser. A taxpayer who
strips and disposes the future dividends is treated
as having purchased the stripped preferred stock on
the date of such disposition for a purchase price
equal to the taxpayer's adjusted basis in the
stripped preferred stock.527
House
Bill
The House bill authorizes the Treasury Department to
promulgate regulations that, in appropriate cases,
apply rules that are similar to the present-law
rules for stripped bonds and stripped preferred
stock to direct or indirect interests in an entity
or account substantially all of the assets of which
consist of bonds (as defined in section 1286(e)(1)),
preferred stock (as defined in section
305(e)(5)(B)), or any combination thereof. The House
bill applies only to cases in which the present-law
rules for stripped bonds and stripped preferred
stock do not already apply to such interests.
For example, such Treasury regulations could apply
to a transaction in which a person effectively
strips future dividends from shares in a money
market mutual fund (and disposes either the stripped
shares or stripped future dividends) by contributing
the shares (with the future dividends) to a
custodial account through which another person
purchases rights to either the stripped shares or
the stripped future dividends. However, it is
intended that Treasury regulations issued under the
House bill would not apply to certain transactions
involving direct or indirect interests in an entity
or account substantially all the assets of which
consist of taxexempt obligations (as defined in
section 1275(a)(3)), such as a tax-exempt bond
partnership described in Rev. Proc. 2002-68,528
modifying and superceding Rev. Proc. 2002-16.529
No inference is intended as to the treatment under
the present-law rules for stripped bonds and
stripped preferred stock, or under any other
provisions or doctrines of present law, of interests
in an entity or account substantially all of the
assets of which consist of bonds, preferred stock,
or any combination thereof. The Treasury
regulations, when issued, would be applied
prospectively, except in cases to prevent abuse.
Effective date. --The House bill provision is
effective for purchases and dispositions occurring
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.
14. Minimum holding period for foreign tax credit
with respect to withholding taxes on income other
than dividends (sec. 632 of the House bill, sec. 456
of the Senate amendment, and sec. 901 of the Code)
Present
Law
In general, U.S. persons may credit foreign taxes
against U.S. tax on foreign-source income. The
amount of foreign tax credits that may be claimed in
a year is subject to a limitation that prevents
taxpayers from using foreign tax credits to offset
U.S. tax on U.S.-source income. Separate limitations
are applied to specific categories of income.
As a consequence of the foreign tax credit
limitations of the Code, certain taxpayers are
unable to utilize their creditable foreign taxes to
reduce their U.S. tax liability. U.S. taxpayers that
are tax-exempt receive no U.S. tax benefit for
foreign taxes paid on income that they receive.
Present law denies a U.S. shareholder the foreign
tax credits normally available with respect to a
dividend from a corporation or a regulated
investment company ("
RIC
") if the shareholder has not held the stock
for more than 15 days (within a 30-day testing
period) in the case of common stock or more than 45
days (within a 90-day testing period) in the case of
preferred stock (sec. 901(k)). The disallowance
applies both to foreign tax credits for foreign
withholding taxes that are paid on the dividend
where the dividend-paying stock is held for less
than these holding periods, and to indirect foreign
tax credits for taxes paid by a lower-tier foreign
corporation or a
RIC
where any of the required stock in the chain of
ownership is held for less than these holding
periods. Periods during which a taxpayer is
protected from risk of loss (e.g., by purchasing a
put option or entering into a short sale with
respect to the stock) generally are not counted
toward the holding period requirement. In the case
of a bona fide contract to sell stock, a special
rule applies for purposes of indirect foreign tax
credits. The disallowance does not apply to foreign
tax credits with respect to certain dividends
received by active dealers in securities. If a
taxpayer is denied foreign tax credits because the
applicable holding period is not satisfied, the
taxpayer is entitled to a deduction for the foreign
taxes for which the credit is disallowed.
House
Bill
The House bill expands the present-law disallowance
of foreign tax credits to include credits for
gross-basis foreign withholding taxes with respect
to any item of income or gain from property if the
taxpayer who receives the income or gain has not
held the property for more than 15 days (within a
30-day testing period), exclusive of periods during
which the taxpayer is protected from risk of loss.
The House bill does not apply to foreign tax credits
that are subject to the present-law disallowance
with respect to dividends. The House bill also does
not apply to certain income or gain that is received
with respect to property held by active dealers.
Rules similar to the present-law disallowance for
foreign tax credits with respect to dividends apply
to foreign tax credits that are subject to the House
bill. In addition, the House bill authorizes the
Treasury Department to issue regulations providing
that the House bill does not apply in appropriate
cases.
Effective date. --The House bill provision is
effective for amounts that are paid or accrued more
than 30 days 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 provision, except the 30-day
testing period is changed to a 31-day testing
period.
In addition, the conferees intend that the Secretary
will prescribe regulations to adapt the holding
period and hedging rules of section 901(k) to
property other than stock. It is anticipated that
such regulations will provide that credits are not
disallowed merely because a taxpayer eliminates its
risk of loss from interest rate or currency
fluctuations. In addition, it is intended that such
regulations might permit other hedging activities,
such as hedging of credit risk, provided that the
taxpayer does not hedge most of its risk of loss
with respect to the property unless there has been a
meaningful and unanticipated change in
circumstances.
15. Treatment of partnership loss transfers and
partnership basis adjustments (sec. 633 of the House
bill, sec. 469 of the Senate amendment, and secs.
704, 734, 743, and 754 of the Code)
Present
Law
Contributions of property
Under present law, if a partner contributes property
to a partnership, generally no gain or loss is
recognized to the contributing partner at the time
of contribution.530
The partnership takes the property at an adjusted
basis equal to the contributing partner's adjusted
basis in the property.531
The contributing partner increases its basis in its
partnership interest by the adjusted basis of the
contributed property.532
Any items of partnership income, gain, loss and
deduction with respect to the contributed property
are allocated among the partners to take into
account any built-in gain or loss at the time of the
contribution.533
This rule is intended to prevent the transfer of
built-in gain or loss from the contributing partner
to the other partners by generally allocating items
to the noncontributing partners based on the value
of their contributions and by allocating to the
contributing partner the remainder of each item.534
If the contributing partner transfers its
partnership interest, the built-in gain or loss will
be allocated to the transferee partner as it would
have been allocated to the contributing partner.535
If the contributing partner's interest is
liquidated, there is no specific guidance preventing
the allocation of the built-in loss to the remaining
partners. Thus, it appears that losses can be
"transferred" to other partners where the
contributing partner no longer remains a partner.
Transfers of partnership interests
Under present law, a partnership does not adjust the
basis of partnership property following the transfer
of a partnership interest unless the partnership has
made a one-time election under section 754 to make
basis adjustments.536
If an election is in effect, adjustments are made
with respect to the transferee partner to account
for the difference between the transferee partner's
proportionate share of the adjusted basis of the
partnership property and the transferee's basis in
its partnership interest.537
These adjustments are intended to adjust the basis
of partnership property to approximate the result of
a direct purchase of the property by the transferee
partner. Under these rules, if a partner purchases
an interest in a partnership with an existing
built-in loss and no election under section 754 is
in effect, the transferee partner may be allocated a
share of the loss when the partnership disposes of
the property (or depreciates the property).
Distributions of partnership property
With certain exceptions, partners may receive
distributions of partnership property without
recognition of gain or loss by either the partner or
the partnership.538
In the case of a distribution in liquidation of a
partner's interest, the basis of the property
distributed in the liquidation is equal to the
partner's adjusted basis in its partnership interest
(reduced by any money distributed in the
transaction).539
In a distribution other than in liquidation of a
partner's interest, the distributee partner's basis
in the distributed property is equal to the
partnership's adjusted basis in the property
immediately before the distribution, but not to
exceed the partner's adjusted basis in the
partnership interest (reduced by any money
distributed in the same transaction).540
The determination of the basis of individual
properties distributed by a partnership is dependent
on the adjusted basis of the properties in the hands
of the partnership.541
If a partnership interest is transferred to a
partner and the partnership has not elected to
adjust the basis of partnership property, a special
basis rule provides for the determination of the
transferee partner's basis of properties that are
later distributed by the partnership.542
Under this rule, in determining the basis of
property distributed by a partnership within 2 years
following the transfer of the partnership interest,
the transferee may elect to determine its basis as
if the partnership had adjusted the basis of the
distributed property under section 743(b) on the
transfer. The special basis rule also applies to
distributed property if, at the time of the
transfer, the fair market value of partnership
property other than money exceeds 110 percent of the
partnership's basis in such property and a
liquidation of the partnership interest immediately
after the transfer would have resulted in a shift of
basis to property subject to an allowance of
depreciation, depletion or amortization.543
Adjustments to the basis of the partnership's
undistributed properties are not required unless the
partnership has made the election under section 754
to make basis adjustments.544
If an election is in effect under section 754,
adjustments are made by a partnership to increase or
decrease the remaining partnership assets to reflect
any increase or decrease in the adjusted basis of
the distributed properties in the hands of the
distributee partner (or gain or loss recognized by
the distributee partner).545
To the extent the adjusted basis of the distributed
properties increases (or loss is recognized) the
partnership's adjusted basis in its properties is
decreased by a like amount; likewise, to the extent
the adjusted basis of the distributed properties
decrease (or gain is recognized), the partnership's
adjusted basis in its properties is increased by a
like amount. Under these rules, a partnership with
no election in effect under section 754 may
distribute property with an adjusted basis lower
than the distributee partner's proportionate share
of the adjusted basis of all partnership property
and leave the remaining partners with a smaller net
built-in gain or a larger net built-in loss than
before the distribution.
House
Bill
Contributions of property
Under the provision, a built-in loss may be taken
into account only by the contributing partner and
not by other partners. Except as provided in
regulations, in determining the amount of items
allocated to partners other than the contributing
partner, the basis of the contributed property is
treated as the fair market value at the time of
contribution. Thus, if the contributing partner's
partnership interest is transferred or liquidated,
the partnership's adjusted basis in the property is
based on its fair market value at the time of
contribution, and the built-in loss is eliminated.546
Transfers of partnership interests
The provision provides generally that the basis
adjustment rules under section 743 are mandatory in
the case of the transfer of a partnership interest
with respect to which there is a substantial
built-in loss (rather than being elective as under
present law). For this purpose, a substantial
built-in loss exists if the partnership's adjusted
basis in its property exceeds by more than $250,000
the fair market value of the partnership property.
Thus, for example, assume that partner A sells his
25-percent partnership interest to B for its fair
market value of $1 million. Also assume that,
immediately after the transfer, the fair market
value of partnership assets is $4 million and the
partnership's adjusted basis in the partnership
assets is $4.3 million. Under the bill, section
743(b) applies, so that an adjustment is required to
the adjusted basis of the partnership assets with
respect to B. As a result, B would recognize no gain
or loss if the partnership immediately sold all its
assets for their fair market value.
The bill provides that an electing investment
partnership is not treated as having a substantial
built-in loss, and thus is not required to make
basis adjustments to partnership property, in the
case of a transfer of a partnership interest. In
lieu of the partnership basis adjustments, a
partner-level loss limitation rule applies. Under
this rule, the transferee partner's distributive
share of losses (determined without regard to gains)
from the sale or exchange of partnership property is
not allowed, except to the extent it is established
that the partner's share of such losses exceeds the
loss recognized by the transferor partner. In the
event of successive transfers, the transferee
partner's distributive share of such losses is not
allowed, except to the extent that it is established
that such losses exceed the loss recognized by the
transferor (or any prior transferor to the extent
not fully offset by a prior disallowance under this
rule). Losses disallowed under this rule do not
decrease the transferee partner's basis in its
partnership interest. Thus, on subsequent
disposition of its partnership interest, the
partner's gain is reduced (or loss increased)
because the basis of the partnership interest has
not been reduced by such losses. The provision is
applied without regard to any termination of a
partnership under section 708(b)(1)(B). In the case
of a basis reduction to property distributed to the
transferee partner in a nonliquidating distribution,
the amount of the transferor's loss taken into
account under this rule is reduced by the amount of
the basis reduction.
For this purpose, an electing investment partnership
means a partnership that satisfies the following
requirements: (1) it makes an election under the
provision that is irrevocable except with the
consent of the Secretary; (2) it would be an
investment company under section 3(a)(1)(A) of the
Investment Company Act of 1940547
but for an exemption under paragraph (1) or (7) of
section 3(c) of that Act; (3) it has never been
engaged in a trade or business; (4) substantially
all of its assets are held for investment; (5) at
least 95 percent of the assets contributed to it
consist of money; (6) no assets contributed to it
had an adjusted basis in excess of fair market value
at the time of contribution; (7) all partnership
interests are issued by the partnership pursuant to
a private offering and during the 24-month period
beginning on the date of the first capital
contribution to the partnership; (8) the partnership
agreement has substantive restrictions on each
partner's ability to cause a redemption of the
partner's interest, and (9) the partnership
agreement provides for a term that is not in excess
of 15 years.
The provision requires an electing investment
partnership to furnish to any transferee partner the
information necessary to enable the partner to
compute the amount of losses disallowed under this
rule.
Distributions of partnership property
The provision provides that a basis adjustment under
section 734(b) is required in the case of a
distribution with respect to which there is a
substantial basis reduction. A substantial basis
reduction means a downward adjustment of more than
$250,000 that would be made to the basis of
partnership assets if a section 754 election were in
effect.
Thus, for example, assume that A and B each
contributed $2.5 million to a newly formed
partnership and C contributed $5 million, and that
the partnership purchased LMN stock for $3 million
and XYZ stock for $7 million. Assume that the value
of each stock declined to $1 million. Assume LMN
stock is distributed to C in liquidation of its
partnership interest. Under present law, the basis
of LMN stock in C's hands is $5 million. Under
present law, C would recognize a loss of $4 million
if the LMN stock were sold for $1 million.
Under the provision, there is a substantial basis
adjustment because the $2 million increase in the
adjusted basis of LMN stock (described in section
734(b)(2)(B)) is greater than $250,000. Thus, the
partnership is required to decrease the basis of XYZ
stock (under section 734(b)(2)) by $2 million (the
amount by which the basis of LMN stock was
increased), leaving a basis of $5 million. If the
XYZ stock were then sold by the partnership for $1
million, A and B would each recognize a loss of $2
million.
Effective date
The provision applies to contributions,
distributions and transfers (as the case may be)
after the date of enactment.
In the case of an electing investment partnership in
existence on June 4, 2004, the requirement that the
partnership agreement have substantive restrictions
on redemptions does not apply, and the requirement
that the partnership agreement provide for a term
not exceeding 15 years is modified to permit a term
not exceeding 20 years.
Senate
Amendment
Under the provision, adjustments to the basis of
partnership property in the event of a partnership
distribution or the transfer of a partnership
interest are required, not elective as under present
law. However, the basis adjustments are elective, as
under present law, in the case of the transfer of a
partnership interest by reason of the partner's
death. Any election made by a partnership under
section 754 that is in effect when the provision
becomes effective is treated as an election to
adjust the basis of partnership property with
respect to the transferee partner in the case of a
transfer of a partnership interest upon the death of
a partner. The provision repeals the special rule of
section 732(d) for determining the transferee
partner's basis in property that is later
distributed by the partnership in cases in which the
partnership did not have a section 754 election in
effect with respect to the transfer of the
partnership interest.
Effective date. --The provision requiring
partnership basis adjustments applies to transfers
and distributions after the date of enactment.
The provision repealing section 732(d) applies
generally to transfers after the date of enactment,
except that it applies to distributions made after
the date which is 2 years following the date of
enactment in the case of any transfer to which
section 732(d) applies that is made on or before the
date of enactment.
Conference
Agreement
The conference agreement generally follows the House
bill, with modifications.
The conference agreement modifies the qualification
requirements for electing investment partnerships
that are subject to a partner-level loss limitation
rule in lieu of the requirement of partnership basis
adjustments following certain transfers of
partnership interests. Specifically, the conference
agreement requires that all partnership interests be
issued by such a partnership pursuant to a private
offering prior to the date that is 24 months after
the date of the first capital contribution to the
partnership. The conferees intend that
"dry" closings in which partnership
interests are issued without the contribution of
capital not start the running of the 24-month
period.
It is intended that in applying the requirement
(with respect electing investment partnerships) that
the partnership agreement have substantive
restrictions on each partner's ability to cause a
redemption, the following are illustrative examples
of substantive restrictions: a violation of Federal
or State law (such as ERISA or the Bank Holding
Company Act); and imposition of a Federal excise tax
on, or a change in the Federal tax-exempt status of,
a taxexempt partner.
The conferees understand that electing investment
partnerships will generally include venture capital
funds, buyout funds, and funds of funds. These funds
are formed to raise capital from investors pursuant
to a private offering and to make investments during
the limited term of the partnership with the
intention of holding the investments for capital
appreciation.
With respect to the requirement that an electing
investment partnership furnish to any transferee
partner the information necessary to enable the
partner to compute the amount of losses disallowed
under this rule, it is expected that in some cases
the transferor of the partnership interest will
furnish information relating to the amount of its
loss to the transferee partner. It is intended that
the requirement that the electing investment
partnership furnish necessary information to the
transferee partner be administered by the Treasury
Secretary in a manner that (to the greatest extent
feasible) minimizes the need for the partnership to
furnish information to the transferee partner that
the transferee partner has obtained from the
transferor.
The conference agreement adds an exception for
securitization partnerships to the rules requiring
partnership basis adjustments in the case of
transfers of partnership interests and distributions
of property to a partner. The exceptions provide
that a securitization partnership is not treated as
having a substantial built-in loss in the case of a
transfer of a partnership interest, or as having a
substantial basis reduction in the case of a
partnership distribution, and thus is not required
to make basis adjustments to partnership property.
Partnership basis adjustments remain elective for
such a partnership. Unlike in the case of an
electing investment partnership, the partner-level
loss limitation rule does not apply in the case of a
securitization partnership. For this purpose, a
securitization partnership is any partnership the
sole business activity of which is to issue
securities that provide for a fixed principal (or
similar) amount and that are primarily serviced by
the cash flows of a discrete pool (either fixed or
revolving) of receivables or other financial assets
that by their terms convert into cash in a finite
period, but only if the sponsor of the pool
reasonably believes that the receivables and other
financial assets comprising the pool are not
acquired so as to be disposed of. It is intended
that rules similar to those applicable to sponsors
of REMICs apply in determining whether the sponsor's
belief is reasonable.548
It is not intended that the rules requiring
partnership basis adjustments on transfers or
distributions be avoided through dispositions of
pool assets.
It is intended that an electing investment
partnership or securitization partnership that
subsequently fails to meet the definition of an
electing investment partnership or of a
securitization partnership will be subject to the
partnership basis adjustment rules of the provision
with respect to the first transfer of a partnership
interest (and, in the case of a securitization
partnership, the first distribution) that occurs
after the partnership ceases to meet the applicable
definition and to each subsequent transfer (and
distribution, in the case of a securitization
partnership).
It is not intended that the rules of the conference
agreement provisions be avoided through the use of
tiered partnerships.
It is not intended that the provision relating to
contributions of built-in loss property limit the
ability of master-feeder structures to apply an
aggregate method for making allocations under
section 704(c) to the extent the aggregate method is
permitted under present law.549
Effective date. --The conference agreement
follows the House bill.
16. No reduction of basis under section 734 in
stock held by partnership in corporate partner (sec.
634 of the House bill, sec. 432 of the Senate
amendment, and sec. 755 of the Code)
Present
Law
In general
Generally, a partner and the partnership do not
recognize gain or loss on a contribution of property
to the partnership.550
Similarly, a partner and the partnership generally
do not recognize gain or loss on the distribution of
partnership property.551
This includes current distributions and
distributions in liquidation of a partner's
interest.
Basis of property distributed in liquidation
The basis of property distributed in liquidation of
a partner's interest is equal to the partner's tax
basis in its partnership interest (reduced by any
money distributed in the same transaction).552
Thus, the partnership's tax basis in the distributed
property is adjusted (increased or decreased) to
reflect the partner's tax basis in the partnership
interest.
Election to adjust basis of partnership
property
When a partnership distributes partnership property,
the basis of partnership property generally is not
adjusted to reflect the effects of the distribution
or transfer. However, the partnership is permitted
to make an election (referred to as a 754 election)
to adjust the basis of partnership property in the
case of a distribution of partnership property.553
The effect of the 754 election is that the
partnership adjusts the basis of its remaining
property to reflect any change in basis of the
distributed property in the hands of the distributee
partner resulting from the distribution transaction.
Such a change could be a basis increase due to gain
recognition, or a basis decrease due to the
partner's adjusted basis in its partnership interest
exceeding the adjusted basis of the property
received. If the 754 election is made, it applies to
the taxable year with respect to which such election
was filed and all subsequent taxable years.
In the case of a distribution of partnership
property to a partner with respect to which the 754
election is in effect, the partnership increases the
basis of partnership property by (1) any gain
recognized by the distributee partner and (2) the
excess of the adjusted basis of the distributed
property to the partnership immediately before its
distribution over the basis of the property to the
distributee partner, and decreases the basis of
partnership property by (1) any loss recognized by
the distributee partner and (2) the excess of the
basis of the property to the distributee partner
over the adjusted basis of the distributed property
to the partnership immediately before the
distribution.
The allocation of the increase or decrease in basis
of partnership property is made in a manner that has
the effect of reducing the difference between the
fair market value and the adjusted basis of
partnership properties.554
In addition, the allocation rules require that any
increase or decrease in basis be allocated to
partnership property of a like character to the
property distributed. For this purpose, the two
categories of assets are (1) capital assets and
depreciable and real property used in the trade or
business held for more than one year, and (2) any
other property.555
House
Bill
The provision provides that in applying the basis
allocation rules to a distribution in liquidation of
a partner's interest, a partnership is precluded
from decreasing the basis of corporate stock of a
partner or a related person. Any decrease in basis
that, absent the provision, would have been
allocated to the stock is allocated to other
partnership assets. If the decrease in basis exceeds
the basis of the other partnership assets, then gain
is recognized by the partnership in the amount of
the excess.
Effective date. --The provision applies to
distributions after the date of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill,
except for the effective date.
Effective date. --The provision applies to
distributions after
February 13, 2003
.
Conference
Agreement
The conference agreement follows the House bill.
Effective date. --The conference agreement
follows the House bill.
17. Repeal of special rules for FASITs (sec. 635
of the House bill, sec. 433 of the Senate amendment,
and secs. 860H through 860L of the Code)
Present
Law
Financial asset securitization investment
trusts
In 1996 Congress created a new type of statutory
entity called a "financial asset securitization
trust" ("FASIT") that facilitates the
securitization of debt obligations such as credit
card receivables, home equity loans, and auto loans.556
A FASIT generally is not taxable; the FASIT's
taxable income or net loss flows through to the
owner of the FASIT.
The ownership interest of a FASIT generally is
required to be entirely held by a single domestic C
corporation. In addition, a FASIT generally may hold
only qualified debt obligations, and certain other
specified assets, and is subject to certain
restrictions on its activities. An entity that
qualifies as a FASIT can issue one or more classes
of instruments that meet certain specified
requirements and treat those instruments as debt for
Federal income tax purposes. Instruments issued by a
FASIT bearing yields to maturity over five
percentage points above the yield to maturity on
specified United States government obligations
(i.e., "high-yield interests") must be
held, directly or indirectly, only by domestic C
corporations that are not exempt from income tax.
Qualification as a FASIT
To qualify as a FASIT, an entity must: (1) make an
election to be treated as a FASIT for the year of
the election and all subsequent years;557
(2) have assets substantially all of which
(including assets that the FASIT is treated as
owning because they support regular interests) are
specified types called "permitted assets;"
(3) have non-ownership interests be certain
specified types of debt instruments called
"regular interests"; (4) have a single
ownership interest which is held by an
"eligible holder"; and (5) not qualify as
a regulated investment company ("
RIC
"). Any entity, including a corporation,
partnership, or trust may be treated as a FASIT. In
addition, a segregated pool of assets may qualify as
a FASIT.
An entity ceases qualifying as a FASIT if the
entity's owner ceases being an eligible corporation.
Loss of FASIT status is treated as if all of the
regular interests of the FASIT were retired and then
reissued without the application of the rule that
deems regular interests of a FASIT to be debt.
Permitted assets
For an entity or arrangement to qualify as a FASIT,
substantially all of its assets must consist of the
following "permitted assets": (1) cash and
cash equivalents; (2) certain permitted debt
instruments; (3) certain foreclosure property; (4)
certain instruments or contracts that represent a
hedge or guarantee of debt held or issued by the
FASIT; (5) contract rights to acquire permitted debt
instruments or hedges; and (6) a regular interest in
another FASIT. Permitted assets may be acquired at
any time by a FASIT, including any time after its
formation.
"Regular interests" of a FASIT
"Regular interests" of a FASIT are treated
as debt for Federal income tax purposes, regardless
of whether instruments with similar terms issued by
non-FASITs might be characterized as equity under
general tax principles. To be treated as a
"regular interest", an instrument must
have fixed terms and must: (1) unconditionally
entitle the holder to receive a specified principal
amount; (2) pay interest that is based on (a) fixed
rates, or (b) except as provided by regulations
issued by the Treasury Secretary, variable rates
permitted with respect to REMIC interests under
section 860G(a)(1)(B)(i); (3) have a term to
maturity of no more than 30 years, except as
permitted by Treasury regulations; (4) be issued to
the public with a premium of not more than 25
percent of its stated principal amount; and (5) have
a yield to maturity determined on the date of issue
of less than five percentage points above the
applicable Federal rate ("AFR") for the
calendar month in which the instrument is issued.
Permitted ownership holder
A permitted holder of the ownership interest in a
FASIT generally is a non-exempt (i.e., taxable)
domestic C corporation, other than a corporation
that qualifies as a
RIC
, REIT, REMIC, or cooperative.
Transfers to FASITs
In general, gain (but not loss) is recognized
immediately by the owner of the FASIT upon the
transfer of assets to a FASIT. Where property is
acquired by a FASIT from someone other than the
FASIT's owner (or a person related to the FASIT's
owner), the property is treated as being first
acquired by the FASIT's owner for the FASIT's cost
in acquiring the asset from the non-owner and then
transferred by the owner to the FASIT.
Valuation rules. --In general, except in the
case of debt instruments, the value of FASIT assets
is their fair market value. Similarly, in the case
of debt instruments that are traded on an
established securities market, the market price is
used for purposes of determining the amount of gain
realized upon contribution of such assets to a FASIT.
However, in the case of debt instruments that are
not traded on an established securities market,
special valuation rules apply for purposes of
computing gain on the transfer of such debt
instruments to a FASIT. Under these rules, the value
of such debt instruments is the sum of the present
values of the reasonably expected cash flows from
such obligations discounted over the weighted
average life of such assets. The discount rate is
120 percent of the AFR, compounded semiannually, or
such other rate that the Treasury Secretary shall
prescribe by regulations.
Taxation of a FASIT
A FASIT generally is not subject to tax. Instead,
all of the FASIT's assets and liabilities are
treated as assets and liabilities of the FASIT's
owner and any income, gain, deduction or loss of the
FASIT is allocable directly to its owner.
Accordingly, income tax rules applicable to a FASIT
(e.g., related party rules, sec. 871(h), sec.
165(g)(2)) are to be applied in the same manner as
they apply to the FASIT's owner. The taxable income
of a FASIT is calculated using an accrual method of
accounting. The constant yield method and principles
that apply for purposes of determining original
issue discount ("OID") accrual on debt
obligations whose principal is subject to
acceleration apply to all debt obligations held by a
FASIT to calculate the FASIT's interest and discount
income and premium deductions or adjustments.
Taxation of holders of FASIT regular interests
In general, a holder of a regular interest is taxed
in the same manner as a holder of any other debt
instrument, except that the regular interest holder
is required to account for income relating to the
interest on an accrual method of accounting,
regardless of the method of accounting otherwise
used by the holder.
Taxation of holders of FASIT ownership
interests
Because all of the assets and liabilities of a FASIT
are treated as assets and liabilities of the holder
of a FASIT ownership interest, the ownership
interest holder takes into account all of the
FASIT's income, gain, deduction, or loss in
computing its taxable income or net loss for the
taxable year. The character of the income to the
holder of an ownership interest is the same as its
character to the FASIT, except tax-exempt interest
is included in the income of the holder as ordinary
income.
Although the recognition of losses on assets
contributed to the FASIT is not allowed upon
contribution of the assets, such losses may be
allowed to the FASIT owner upon their disposition by
the FASIT. Furthermore, the holder of a FASIT
ownership interest is not permitted to offset
taxable income from the FASIT ownership interest
(including gain or loss from the sale of the
ownership interest in the FASIT) with other losses
of the holder. In addition, any net operating loss
carryover of the FASIT owner shall be computed by
disregarding any income arising by reason of a
disallowed loss. Where the holder of a FASIT
ownership interest is a member of a consolidated
group, this rule applies to the consolidated group
of corporations of which the holder is a member as
if the group were a single taxpayer.
House
Bill
The House bill repeals the special rules for FASITs.
The House bill provides a transition period for
existing FASITs, pursuant to which the repeal of the
FASIT rules generally does not apply to any FASIT in
existence on the date of enactment to the extent
that regular interests issued by the FASIT prior to
such date continue to remain outstanding in
accordance with their original terms.
For purposes of the REMIC rules, the House bill also
modifies the definitions of REMIC regular interests,
qualified mortgages, and permitted investments so
that certain types of real estate loans and loan
pools can be transferred to, or purchased by, a
REMIC. Specifically, the provision modifies the
present-law definition of a REMIC "regular
interest" to provide that an interest in a
REMIC does not fail to qualify as a regular interest
solely because the specified principal amount of
such interest or the amount of interest accrued on
such interest could be reduced as a result of the
nonoccurrence of one or more contingent payments
with respect to one or more reverse mortgages loans,
as defined below, that are held by the REMIC,
provided that on the startup day for the REMIC, the
REMIC sponsor reasonably believes that all principal
and interest due under the interest will be paid at
or prior to the liquidation of the REMIC. For this
purpose, a reasonable belief concerning ultimate
payment of all amounts due under an interest is
presumed to exist if, as of the startup day, the
interest receives an investment grade rating from at
least one nationally recognized statistical rating
agency.
In addition, the provision makes three modifications
to the present-law definition of a "qualified
mortgage." First, the provision modifies the
definition to include an obligation principally
secured by real property which represents an
increase in the principal amount under the original
terms of an obligation, provided such increase: (1)
is attributable to an advance made to the obligor
pursuant to the original terms of the obligation;
(2) occurs after the REMIC startup day; and (3) is
purchased by the REMIC pursuant to a fixed price
contract in effect on the startup day. Second, the
provision modifies the definition to generally
include reverse mortgage loans and the periodic
advances made to obligors on such loans. For this
purpose, a "reverse mortgage loan" is
defined as a loan that: (1) is secured by an
interest in real property; (2) provides for one or
more advances of principal to the obligor (each such
advance giving rise to a "balance
increase"), provided such advances are
principally secured by an interest in the same real
property as that which secures the loan; (3) may
provide for a contingent payment at maturity based
upon the value or appreciation in value of the real
property securing the loan; (4) provides for an
amount due at maturity that cannot exceed the value,
or a specified fraction of the value, of the real
property securing the loan; (5) provides that all
payments under the loan are due only upon the
maturity of the loan; and (6) matures after a fixed
term or at the time the obligor ceases to use as a
personal residence the real property securing the
loan. Third, the provision modifies the definition
to provide that, if more than 50 percent of the
obligations transferred to, or purchased by, the
REMIC are (1) originated by the United States or any
State (or any political subdivision, agency, or
instrumentality of the United States or any State)
and (2) principally secured by an interest in real
property, then each obligation transferred to, or
purchased by, the REMIC shall be treated as secured
by an interest in real property.
In addition, the provision modifies the present-law
definition of a "permitted investment" to
include intangible investment property held as part
of a reasonably required reserve to provide a source
of funds for the purchase of obligations described
above as part of the modified definition of a
"qualified mortgage."
Effective date. --Except as provided by the
transition period for existing FASITs, the House
bill is effective January 1, 2005.
Senate
Amendment
The Senate amendment is the same as the House bill,
except for the effective date.
Effective date. --Except as provided by the
transition period for existing FASITs, the Senate
amendment is effective on
February 14, 2003
.
Conference
Agreement
The conference agreement follows the House bill
provision.
18. Limitation on transfer and importation of
built-in losses (sec. 636 of the House bill, sec.
431 of the Senate amendment, and secs. 362 and 334
of the Code)
Present
Law
Generally, no gain or loss is recognized when one or
more persons transfer property to a corporation in
exchange for stock and immediately after the
exchange such person or persons control the
corporation.558
The transferor's basis in the stock of the
controlled corporation is the same as the basis of
the property contributed to the controlled
corporation, increased by the amount of any gain (or
dividend) recognized by the transferor on the
exchange, and reduced by the amount of any money or
property received, and by the amount of any loss
recognized by the transferor.559
The basis of property received by a corporation,
whether from domestic or foreign transferors, in a
tax-free incorporation, reorganization, or
liquidation of a subsidiary corporation is the same
as the adjusted basis in the hands of the
transferor, adjusted for gain or loss recognized by
the transferor.560
House
Bill
The House bill provides that if a residual interest
(as defined in section 860G(a)(2)) in a real estate
mortgage investment conduit ("REMIC") is
contributed to a corporation and the transferee
corporation's adjusted basis in the REMIC residual
interest would (but for the provision) exceed the
fair market value of the REMIC residual interest
immediately after the contribution, the transferee
corporation's adjusted basis in the REMIC residual
interest is limited to the fair market value of the
REMIC residual interest immediately after the
contribution, regardless of whether the fair market
value of the REMIC residual interest is less than,
equal to, or greater than zero (i.e., the provision
may result in the transferee corporation having a
negative adjusted basis in the REMIC residual
interest).
Effective date. --The House bill provision
applies to transactions after the date of enactment.
Senate
Amendment
Importation of built-in losses
The Senate Amendment provides that if a net built-in
loss is imported into the U.S in a tax-free
organization or reorganization from persons not
subject to U.S. tax, the basis of each property so
transferred is its fair market value.561
A similar rule applies in the case of the taxfree
liquidation by a domestic corporation of its foreign
subsidiary.
Under the Senate amendment, a net built-in loss is
treated as imported into the U.S. if the aggregate
adjusted bases of property received by a transferee
corporation exceed the fair market value of the
properties transferred. Thus, for example, if in a
tax-free incorporation, some properties are received
by a corporation from U.S. persons subject to tax,
and some properties are received from foreign
persons not subject to U.S. tax, this provision
applies to limit the adjusted basis of each property
received from the foreign persons to the fair market
value of the property. In the case of a transfer by
a partnership (either domestic or foreign), this
provision applies as if the properties had been
transferred by each of the partners in proportion to
their interests in the partnership.
Limitation on transfer of built-in losses in
section 351 transactions
The Senate amendment provides that if the aggregate
adjusted bases of property contributed by a
transferor (or by a control group of which the
transferor is a member) to a corporation exceed the
aggregate fair market value of the property
transferred in a tax-free incorporation, the
transferee's aggregate basis of the properties is
limited to the aggregate fair market value of the
transferred property. Under the Senate Amendment,
any required basis reduction is allocated among the
transferred properties in proportion to their
built-in-loss immediately before the transaction. In
the case of a transfer in which the transferor owns
at least 80 percent of the vote and value of the
stock of the transferee corporation, any basis
reduction required by the provision is made to the
stock received by the transferor and not to the
assets transferred.
Effective date
The Senate amendment provision applies to
transactions after December 31, 2003.
Conference
Agreement
The conference agreement follows the Senate
amendment, with modifications to the limitation on
transfer of built-in losses in section 351
transactions. The conference agreement eliminates
the provision that requires a basis reduction to be
made to stock received by the transferor (rather
than to the assets transferred) in the case of a
transfer in which the transferor owns at least 80
percent of the vote and value of the stock of the
transferee corporation. Thus, the provision that
limits the transferee's aggregate basis in the
transferred property to the aggregate fair market
value of the transferred property generally applies,
regardless of the ownership percentage of the
transferor in the stock of the transferee
corporation.
In addition, the conference agreement permits the
transferor and transferee to elect to limit the
basis in the stock received by the transferor to the
aggregate fair market value of the transferred
property, in lieu of limiting the basis in the
assets transferred. Such election shall be included
with the tax returns of the transferor and
transferee for the taxable year in which the
transaction occurs and, once made, shall be
irrevocable.
19. Clarification of banking business for
purposes of determining investment of earnings in
U.S. property (sec. 637 of the House bill, sec. 451
of the Senate amendment, and sec. 956 of the Code)
Present
Law
In general, the subpart F rules562
require the U.S. 10-percent shareholders of a
controlled foreign corporation to include in income
currently their pro rata shares of certain income of
the controlled foreign corporation (referred to as
"subpart F income"), whether or not such
earnings are distributed currently to the
shareholders. In addition, the U.S. 10-percent
shareholders of a controlled foreign corporation are
subject to U.S. tax currently on their pro rata
shares of the controlled foreign corporation's
earnings to the extent invested by the controlled
foreign corporation in certain U.S. property.563
A shareholder's current income inclusion with
respect to a controlled foreign corporation's
investment in U.S. property for a taxable year is
based on the controlled foreign corporation's
average investment in U.S. property for such year.
For this purpose, the U.S. property held (directly
or indirectly) by the controlled foreign corporation
must be measured as of the close of each quarter in
the taxable year.564
The amount taken into account with respect to any
property is the property's adjusted basis as
determined for purposes of reporting the controlled
foreign corporation's earnings and profits, reduced
by any liability to which the property is subject.
The amount determined for current inclusion is the
shareholder's pro rata share of an amount equal to
the lesser of: (1) the controlled foreign
corporation's average investment in U.S. property as
of the end of each quarter of such taxable year, to
the extent that such investment exceeds the foreign
corporation's earnings and profits that were
previously taxed on that basis; or (2) the
controlled foreign corporation's current or
accumulated earnings and profits (but not including
a deficit), reduced by distributions during the year
and by earnings that have been taxed previously as
earnings invested in U.S. property.565
An income inclusion is required only to the extent
that the amount so calculated exceeds the amount of
the controlled foreign corporation's earnings that
have been previously taxed as subpart F income.566
For purposes of section 956, U.S. property generally
is defined to include tangible property located in
the United States, stock of a U.S. corporation, an
obligation of a U.S. person, and certain intangible
assets including a patent or copyright, an
invention, model or design, a secret formula or
process or similar property right which is acquired
or developed by the controlled foreign corporation
for use in the United States.567
Specified exceptions from the definition of U.S.
property are provided for: (1) obligations of the
United States, money, or deposits with persons
carrying on the banking business; (2) certain export
property; (3) certain trade or business obligations;
(4) aircraft, railroad rolling stock, vessels, motor
vehicles or containers used in transportation in
foreign commerce and used predominantly outside of
the United States; (5) certain insurance company
reserves and unearned premiums related to insurance
of foreign risks; (6) stock or debt of certain
unrelated U.S. corporations; (7) moveable property
(other than a vessel or aircraft) used for the
purpose of exploring, developing, or certain other
activities in connection with the ocean waters of
the U.S. Continental Shelf; (8) an amount of assets
equal to the controlled foreign corporation's
accumulated earnings and profits attributable to
income effectively connected with a U.S. trade or
business; (9) property (to the extent provided in
regulations) held by a foreign sales corporation and
related to its export activities; (10) certain
deposits or receipts of collateral or margin 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; and (11) certain repurchase and
reverse repurchase agreement transactions entered
into by or with a dealer in securities or
commodities in the ordinary course of its business
as a securities or commodities dealer.568
With regard to the exception for deposits with
persons carrying on the banking business, the U.S.
Court of Appeals for the Sixth Circuit in The
Limited, Inc. v. Commissioner569
concluded that a U.S. subsidiary of a U.S.
shareholder was "carrying on the banking
business" even though its operations were
limited to the administration of the private label
credit card program of the U.S. shareholder.
Therefore, the court held that a controlled foreign
corporation of the U.S. shareholder could make
deposits with the subsidiary (e.g., through the
purchase of certificates of deposit) under this
exception, and avoid taxation of the deposits under
section 956 as an investment in U.S. property.
House
Bill
The House bill provides that the exception from the
definition of U.S. property under section 956 for
deposits with persons carrying on the banking
business is limited to deposits with persons at
least 80 percent of the gross income of which is
derived in the active conduct of a banking business
from unrelated persons. For purposes of applying the
House bill, the deposit recipient and all persons
related to the deposit recipient are treated as one
person in applying the 80-percent test.
No inference is intended as to the meaning of the
phrase "carrying on the banking business"
under present law.
Effective date. --The House bill provision is
effective on the date of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill,
except the Senate amendment applies the 80-percent
test by reference to financial services income (as
defined in section 904(d)(2)(C)(ii) rather than the
active conduct of a banking business.
Effective date. --The Senate amendment
provision is effective on the date of enactment.
Conference
Agreement
The conference agreement provides that the exception
from the definition of U.S. property under section
956 for deposits with persons carrying on the
banking business is limited to deposits with: (1)
any bank (as defined by section 2(c) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(c),
without regard to paragraphs (C) and (G) of
paragraph (2) of such section); or (2) any other
corporation with respect to which a bank holding
company (as defined by section 2(a) of such Act) or
financial holding company (as defined by section
2(p) of such Act) owns directly or indirectly more
than 80 percent by vote or value of the stock of
such corporation.
No inference is intended as to the meaning of the
phrase "carrying on the banking business"
under present law.
Effective date. --The conference agreement
provision is effective on the date of enactment.
20. Alternative tax for small insurance companies
and modification of exemption from tax for small
property and casualty insurance companies (sec. 638
of the House bill, sec. 493 of the Senate amendment,
and secs. 501(c)(15) and 831(b) of the Code)
Present
Law
A property and casualty insurance company generally
is subject to tax on its taxable income (sec.
831(a)). The taxable income of a property and
casualty insurance company is determined as the sum
of its underwriting income and investment income (as
well as gains and other income items), reduced by
allowable deductions (sec. 832).
A property and casualty insurance company may elect
to be taxed only on taxable investment income if its
net written premiums or direct written premiums
(whichever is greater) do not exceed $1.2 million
(sec. 831(b)). For purposes of determining the
amount of a company's net written premiums or direct
written premiums under this rule, premiums received
by all members of a controlled group of corporations
(as defined in section 831(b)) of which the company
is a part are taken into account (including foreign
and tax-exempt corporations).
A property and casualty insurance company is
eligible to be exempt from Federal income tax if (a)
its gross receipts for the taxable year do not
exceed $600,000, and (b) the premiums received for
the taxable year are greater than 50 percent of its
gross receipts.570
For purposes of determining gross receipts, the
gross receipts of all members of a controlled group
of corporations of which the company is a part are
taken into account (including gross receipts of
foreign and tax-exempt corporations).
House
Bill
Under the provision, the $1.2 million ceiling on net
written premiums or direct written premiums for
purposes of the election to be taxed only on taxable
investment income is increased to $1.89 million, and
is indexed for taxable years beginning in a calendar
year after 2004.
Effective date. --The provision is effective
for taxable years beginning after
December 31, 2003
.
Senate
Amendment
The Senate amendment follows the House bill, except
that the $1.89 million amount is indexed for taxable
years beginning in a calendar year after 2005. In
addition, the Senate amendment modifies one of the
present-law requirements for a property and casualty
insurance company to eligible to be exempt from
Federal income tax by requiring that the premiums
received for the taxable year be greater than 60
percent of its gross receipts (rather than 50
percent as under present law).
Effective date. --The provision is effective
for taxable years beginning after
December 31, 2004
.571
Conference
Agreement
The conference agreement does not include the House
bill provision or the Senate amendment provision.
21. Denial of deduction for interest on
underpayments attributable to nondisclosed
reportable transactions (sec. 639 of the House bill,
sec. 417 of the Senate amendment, and sec. 163 of
the Code)
Present
Law
In general, corporations may deduct interest paid or
accrued within a taxable year on indebtedness.572
Interest on indebtedness to the Federal government
attributable to an underpayment of tax generally may
be deducted pursuant to this provision.
House
Bill
The House bill disallows any deduction for interest
paid or accrued within a taxable year on any portion
of an underpayment of tax that is attributable to an
understatement arising from an undisclosed listed
transaction or from an undisclosed reportable
avoidance transaction (other than a listed
transaction).573
Effective date. --The House bill provision is
effective for underpayments attributable to
transactions entered into in taxable years beginning
after the date of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill,
except the Senate amendment also disallows any
deduction for interest paid or accrued within a
taxable year on any portion of an underpayment of
tax that is attributable to an understatement
arising from a transaction that lacks economic
substance.
Effective date. --The Senate amendment
provision is effective for underpayments
attributable to transactions entered into in taxable
years beginning after the date of enactment.
Conference
Agreement
The conference agreement follows the House bill.
22. Clarification of rules for payment of
estimated tax for certain deemed asset sales (sec.
640 of the House bill, sec. 481 of the Senate
amendment, and sec. 338 of the Code)
Present
Law
In certain circumstances, taxpayers can make an
election under section 338(h)(10) to treat a
qualifying purchase of 80 percent of the stock of a
target corporation by a corporation from a
corporation that is a member of an affiliated group
(or a qualifying purchase of 80 percent of the stock
of an S corporation by a corporation from S
corporation shareholders) as a sale of the assets of
the target corporation, rather than as a stock sale.
The election must be made jointly by the buyer and
seller of the stock and is due by the 15th
day of the ninth month beginning after the month in
which the acquisition date occurs. An agreement for
the purchase and sale of stock often may contain an
agreement of the parties to make a section
338(h)(10) election.
Section 338(a) also permits a unilateral election by
a buyer corporation to treat a qualified stock
purchase of a corporation as a deemed asset
acquisition, whether or not the seller of the stock
is a corporation (or an S corporation is the
target). In such a case, the seller or sellers
recognize gain or loss on the stock sale (including
any estimated taxes with respect to the stock sale),
and the target corporation recognizes gain or loss
on the deemed asset sale.
Section 338(h)(13) provides that, for purposes of
section 6655 (relating to additions to tax for
failure by a corporation to pay estimated income
tax), tax attributable to a deemed asset sale under
section 338(a)(1) shall not be taken into account.
House
Bill
The bill clarifies section 338(h)(13) to provide
that the exception for estimated tax purposes with
respect to tax attributable to a deemed asset sale
does not apply with respect to a qualified stock
purchase for which an election is made under section
338(h)(10).
Under the bill if a transaction eligible for the
election under section 338(h)(10) occurs, estimated
tax would be determined based on the stock sale
unless and until there is an agreement of the
parties to make a section 338(h)(10) election.
If at the time of the sale there is an agreement of
the parties to make a section 338(h)(10) election,
then estimated tax is computed based on an asset
sale, computed from the date of the sale.
If the agreement to make a section 338(h)(10)
election is concluded after the stock sale, such
that the original computation was based on a stock
sale, estimated tax is recomputed based on the asset
sale election.
No inference is intended as to present law.
Effective date. --The bill is effective for
qualified stock purchase transactions that occur
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.
23. Exclusion of like-kind exchange property from
nonrecognition treatment on the sale or exchange of
a principal residence (sec. 641 of the House bill
and sec. 492 of the Senate amendment)
Present
Law
A taxpayer may exclude up to $250,000 ($500,000 if
married filing a joint return) of gain realized on
the sale or exchange of a principal residence. There
are no special rules relating to the sale or
exchange of a principal residence that was acquired
in a like-kind exchange within the prior five years.
House
Bill
The House bill provides that the exclusion for gain
on the sale or exchange of a principal residence
does not apply if the principal residence was
acquired in a like-kind exchange in which any gain
was not recognized within the prior five years.
Effective date. --Sales or exchanges of
principal residences 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.
24. Prevention of mismatching of interest and
original issue discount deductions and income
inclusions in transactions with related foreign
persons (sec. 642 of the House bill, sec. 453 of the
Senate amendment, and secs. 163 and 267 of the Code)
Present
Law
Income earned by a foreign corporation from its
foreign operations generally is subject to U.S. tax
only when such income is distributed to any U.S.
person that holds stock in such corporation.
Accordingly, a U.S. person that conducts foreign
operations through a foreign corporation generally
is subject to U.S. tax on the income from such
operations when the income is repatriated to the
United States through a dividend distribution to the
U.S. person. The income is reported on the U.S.
person's tax return for the year the distribution is
received, and the United States imposes tax on such
income at that time. However, certain anti-deferral
regimes may cause the U.S. person to be taxed on a
current basis in the United States with respect to
certain categories of passive or highly mobile
income earned by the foreign corporations in which
the U.S. person holds stock. The main anti-deferral
regimes are the controlled foreign corporation rules
of subpart F (secs. 951-964), the passive foreign
investment company rules (secs. 1291-1298), and the
foreign personal holding company rules (secs.
551-558).
As a general rule, there is allowed as a deduction
all interest paid or accrued within the taxable year
with respect to indebtedness, including the
aggregate daily portions of original issue discount
("OID") of the issuer for the days during
such taxable year.574
However, if a debt instrument is held by a related
foreign person, any portion of such OID is not
allowable as a deduction to the payor of such
instrument until paid ("related-foreign-person
rule"). This related-foreign-person rule does
not apply to the extent that the OID is effectively
connected with the conduct by such foreign related
person of a trade or business within the United
States (unless such OID is exempt from taxation or
is subject to a reduced rate of taxation under a
treaty obligation).575
Treasury regulations further modify the
related-foreign-person rule by providing that in the
case of a debt owed to a foreign personal holding
company ("FPHC"), controlled foreign
corporation ("CFC") or passive foreign
investment company ("PFIC"), a deduction
is allowed for OID as of the day on which the amount
is includible in the income of the FPHC, CFC or PFIC,
respectively.576
In the case of unpaid stated interest and expenses
of related persons, where, by reason of a payee's
method of accounting, an amount is not includible in
the payee's gross income until it is paid but the
unpaid amounts are deductible currently by the payor,
the amount generally is allowable as a deduction
when such amount is includible in the gross income
of the payee.577
With respect to stated interest and other expenses
owed to related foreign corporations, Treasury
regulations provide a general rule that requires a
taxpayer to use the cash method of accounting with
respect to the deduction of amounts owed to such
related foreign persons (with an exception for
income of a related foreign person that is
effectively connected with the conduct of a U.S.
trade or business and that is not exempt from
taxation or subject to a reduced rate of taxation
under a treaty obligation).578
As in the case of OID, the Treasury regulations
additionally provide that in the case of stated
interest owed to a FPHC, CFC, or PFIC, a deduction
is allowed as of the day on which the amount is
includible in the income of the FPHC, CFC or PFIC.579
House
Bill
The provision provides that deductions for amounts
accrued but unpaid (whether by U.S. or foreign
persons) to related FPHCs, CFCs, or PFICs are
allowable only to the extent that the amounts
accrued by the payor are, for U.S. tax purposes,
currently includible in the income of the direct or
indirect U.S. owners of the related foreign
corporation under the relevant inclusion rules.580
Deductions that have accrued but are not allowable
under this provision are allowed when the amounts
are paid.
For purposes of determining the amount of the
deduction allowable, the extent that an amount
attributable to OID or an item is includible in the
income of a U.S. person is determined without regard
to (1) properly allocable deductions of the related
foreign corporation, and (2) qualified deficits of
the related foreign corporation under section
952(c)(1)(B). Properly allocable deductions of the
related foreign corporation are those expenses,
losses, and other deductible amounts of the related
foreign corporation that are properly allocated or
apportioned, under the principles of section
954(b)(5), to the relevant income item of the
related foreign corporation.
The provision grants the Secretary regulatory
authority to exempt transactions from these rules,
including any transactions entered into by the payor
in the ordinary course of a trade or business in
which the payor is predominantly engaged, and (in
the case of items other than OID) in which the
payment of the accrued amounts occurs shortly after
its accrual.
Effective date. --The provision is effective
for payments accrued on or after 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. The following examples
illustrate the operation of this provision. Assume
the following facts. A U.S. parent corporation owns
60 percent of the stock of a CFC. An unrelated
foreign corporation owns the remaining 40 percent
interest in the CFC. The U.S. parent accrues an
expense item of 100 to the CFC. The parent would be
entitled to a current deduction of 100 for the
accrued amount, before taking into account this
provision. The item constitutes gross foreign base
company income in the hands of the CFC. The item is
the only gross income item of the CFC that has the
potential to result in the CFC having subpart F
income, and has not been paid by the end of the
taxable year of the parent. The CFC has deductions
of 60 that are properly allocated or apportioned to
the 100 of gross foreign base company income under
the principles of section 954(b)(5), resulting in 40
(100 - 60) of net foreign base company income. The
CFC has earnings and profits for its taxable year in
excess of 40, and has 40 of subpart F income. Under
these facts, the U.S. parent is allowed a current
deduction of 60 (100 60%) under the
provision.
If, in the example above, the CFC has deductions of
100 (or more) properly allocated or apportioned to
the sole item of 100 of gross foreign base company
income under the principles of section 954(b)(5),
and has no other income or deductions, the same
deduction is allowed to the U.S. parent. Under these
circumstances, the parent is allowed a deduction of
60, whether the CFC has positive earnings and
profits for its taxable year or has a deficit in
earnings and profits for such year.
If the CFC's item of net foreign base company income
is positive, and the earnings and profits limitation
of section 952(c)(1)(A) reduces what would otherwise
be a U.S. shareholder's pro rata share of the CFC's
subpart F income, then the deduction will also be
reduced under the provision. For example, assume the
facts in the first example above, in which the CFC
has deductions of 60 that are properly allocated or
apportioned to the item of 100 of gross foreign base
company income under the principles of section
954(b)(5), resulting in 40 of net foreign base
company income. Further assume that, due solely to
other losses, the CFC's earnings and profits for its
taxable year are 10 instead of 40. In that case, the
CFC's subpart F income is limited to 10, and only
six is includible in the gross income of the U.S.
parent as its pro rata share of subpart F income.
Under the provision, the U.S. parent is allowed a
current deduction in that case of 42 ((10 + 60)
60%). The conferees intend that, if as a
result of such other losses, the CFC has no earnings
and profits for its taxable year or has a deficit in
earnings and profits for such year, the U.S. parent
is instead allowed a current deduction of 36 ((0 +
60) 60%).
25. Exclusion from gross income for interest on
overpayments of income tax by individuals (sec. 643
of the House bill)
Present
Law
Overpayment interest
Interest is included in the list of items that are
required to be included in gross income (sec.
61(a)(4)). Interest on overpayments of Federal
income tax is required to be included in taxable
income in the same manner as any other interest that
is received by the taxpayer.
Cash basis taxpayers are required to report
overpayment interest as income in the period the
interest is received. Accrual basis taxpayers are
required to report overpayment interest as income
when all events fixing the right to the receipt of
the overpayment interest have occurred and the
amount can be estimated with reasonable accuracy.
Generally, this occurs on the date the appropriate
IRS
official signs the pertinent schedule of
overassessments.
Underpayment interest
A corporate taxpayer is allowed to currently take
into account interest paid on underpayments of
Federal income tax as an ordinary and necessary
business expense. Typically, this results in a
current deduction. However, the deduction may be
deferred if the interest is required to be
capitalized or may be disallowed if and to the
extent it is determined to be a cost of earning tax
exempt income under section 265.
Section 163(h) of the Code prohibits the deduction
of personal interest by taxpayers other than
corporations. Noncorporate taxpayers, including
individuals, generally are not allowed to deduct
interest on the underpayment of Federal income
taxes.
Temporary regulations provide that personal interest
includes interest paid on underpayments of
individual Federal, State or local income taxes,
regardless of the source of the income generating
the tax liability. This is consistent with the
statement in the General Explanation of the Tax
Reform Act of 1986 that "(p)ersonal interest
also includes interest on underpayments of
individual Federal, State, or local income taxes
notwithstanding that all or a portion of the income
may have arisen in a trade or business, because such
taxes are not considered derived from conduct of a
trade or business." The validity of the
temporary regulation has been upheld in those
Circuits that have considered the issue, including
the Fourth, Sixth, Eighth, and Ninth Circuits.
Personal interest also includes interest that is
paid by a trust, S corporation, or other passthrough
entity on underpayments of State or local income
taxes. Personal interest does not include interest
that is paid with respect to sales, excise or
similar taxes that are incurred in connection with a
trade or business or an investment activity.
House
Bill
The bill excludes overpayment interest that is paid
to individual taxpayers on overpayments of Federal
income tax from gross income. Interest excluded
under the provision is not considered disqualified
income that could limit the earned income credit.
Interest excluded under the provision also is not
considered in determining what portion of a
taxpayer's social security or tier 1 railroad
retirement benefits are subject to tax (sec. 86),
whether a taxpayer has sufficient taxable income to
be required to file a return (sec. 6012(d)), or for
any other computation in which interest exempt from
tax is otherwise required to be added to adjusted
gross income.
The exclusion from income of overpayment interest
does not apply if the Secretary determines that the
taxpayer's principal purpose for overpaying his or
her tax is to take advantage of the exclusion.
For example, a taxpayer prepares his return without
taking into account significant itemized deductions
of which he is, or should be, aware. Before the
expiration of the statute of limitations, the
taxpayer files an amended return claiming these
itemized deductions and requesting a refund with
interest. Unless the taxpayer can establish a
principal purpose for originally overpaying the tax
other than collecting excludible interest, the
Secretary may determine that the principal purpose
of waiting to claim the deductions on an amended
return was to earn interest that would be excluded
from income. In that case, the interest on the
overpayment could not be excluded from income.
It is expected that the Secretary will indicate
whether the interest is eligible to be excluded from
income on the Form 1099 it provides that taxpayer
for taxable year in which the underpayment interest
is paid.
Effective date. --Interest received in
calendar years beginning after the date of
enactment.
Senate
Amendment
No provision.
Conference
Agreement
The conference agreement does not include the House
bill provision.
26. Deposits made to suspend the running of
interest on potential underpayments (sec. 644 of the
House bill, sec. 486 of the Senate amendment, and
new sec. 6603 of the Code))
Present
Law
Generally, interest on underpayments and
overpayments continues to accrue during the period
that a taxpayer and the
IRS
dispute a liability. The accrual of interest on an
underpayment is suspended if the
IRS
fails to notify an individual taxpayer in a timely
manner, but interest will begin to accrue once the
taxpayer is properly notified. No similar suspension
is available for other taxpayers.
A taxpayer that wants to limit its exposure to
underpayment interest has a limited number of
options. The taxpayer can continue to dispute the
amount owed and risk paying a significant amount of
interest. If the taxpayer continues to dispute the
amount and ultimately loses, the taxpayer will be
required to pay interest on the underpayment from
the original due date of the return until the date
of payment.
In order to avoid the accrual of underpayment
interest, the taxpayer may choose to pay the
disputed amount and immediately file a claim for
refund. Payment of the disputed amount will prevent
further interest from accruing if the taxpayer loses
(since there is no longer any underpayment) and the
taxpayer will earn interest on the resultant
overpayment if the taxpayer wins. However, the
taxpayer will generally lose access to the Tax Court
if it follows this alternative. Amounts paid
generally cannot be recovered by the taxpayer on
demand, but must await final determination of the
taxpayer's liability. Even if an overpayment is
ultimately determined, overpaid amounts may not be
refunded if they are eligible to be offset against
other liabilities of the taxpayer.
The taxpayer may also make a deposit in the nature
of a cash bond. The procedures for making a deposit
in the nature of a cash bond are provided in Rev.
Proc. 84-58.
A deposit in the nature of a cash bond will stop the
running of interest on an amount of underpayment
equal to the deposit, but the deposit does not
itself earn interest. A deposit in the nature of a
cash bond is not a payment of tax and is not subject
to a claim for credit or refund. A deposit in the
nature of a cash bond may be made for all or part of
the disputed liability and generally may be
recovered by the taxpayer prior to a final
determination. However, a deposit in the nature of a
cash bond need not be refunded to the extent the
Secretary determines that the assessment or
collection of the tax determined would be in
jeopardy, or that the deposit should be applied
against another liability of the taxpayer in the
same manner as an overpayment of tax. If the
taxpayer recovers the deposit prior to final
determination and a deficiency is later determined,
the taxpayer will not receive credit for the period
in which the funds were held as a deposit. The
taxable year to which the deposit in the nature of a
cash bond relates must be designated, but the
taxpayer may request that the deposit be applied to
a different year under certain circumstances.
House
Bill
In general
The provision allows a taxpayer to deposit cash with
the
IRS
that may subsequently be used to pay an underpayment
of income, gift, estate, generation-skipping, or
certain excise taxes. Interest will not be charged
on the portion of the underpayment that is deposited
for the period that the amount is on deposit.
Generally, deposited amounts that have not been used
to pay a tax may be withdrawn at any time if the
taxpayer so requests in writing. The withdrawn
amounts will earn interest at the applicable Federal
rate to the extent they are attributable to a
disputable tax.
The Secretary may issue rules relating to the
making, use, and return of the deposits.
Use of a deposit to offset underpayments of
tax
Any amount on deposit may be used to pay an
underpayment of tax that is ultimately assessed. If
an underpayment is paid in this manner, the taxpayer
will not be charged underpayment interest on the
portion of the underpayment that is so paid for the
period the funds were on deposit.
For example, assume a calendar year individual
taxpayer deposits $20,000 on May 15, 2005, with
respect to a disputable item on its 2004 income tax
return. On April 15, 2007, an examination of the
taxpayer's year 2004 income tax return is completed,
and the taxpayer and the
IRS
agree that the taxable year 2004 taxes were
underpaid by $25,000. The $20,000 on deposit is used
to pay $20,000 of the underpayment, and the taxpayer
also pays the remaining $5,000. In this case, the
taxpayer will owe underpayment interest from April
15, 2005 (the original due date of the return) to
the date of payment (April 15, 2007) only with
respect to the $5,000 of the underpayment that is
not paid by the deposit. The taxpayer will owe
underpayment interest on the remaining $20,000 of
the underpayment only from April 15, 2005, to May
15, 2005, the date the $20,000 was deposited.
Withdrawal of amounts
A taxpayer may request the withdrawal of any amount
of deposit at any time. The Secretary must comply
with the withdrawal request unless the amount has
already been used to pay tax or the Secretary
properly determines that collection of tax is in
jeopardy. Interest will be paid on deposited amounts
that are withdrawn at a rate equal to the short-term
applicable Federal rate for the period from the date
of deposit to a date not more than 30 days preceding
the date of the check paying the withdrawal.
Interest is not payable to the extent the deposit
was not attributable to a disputable tax.
For example, assume a calendar year individual
taxpayer receives a 30-day letter showing a
deficiency of $20,000 for taxable year 2004 and
deposits $20,000 on May 15, 2006. On April 15, 2007,
an administrative appeal is completed, and the
taxpayer and the
IRS
agree that the 2004 taxes were underpaid by $15,000.
$15,000 of the deposit is used to pay the
underpayment. In this case, the taxpayer will owe
underpayment interest from April 15, 2005 (the
original due date of the return) to May 15, 2006,
the date the $20,000 was deposited. Simultaneously
with the use of the $15,000 to offset the
underpayment, the taxpayer requests the return of
the remaining amount of the deposit (after reduction
for the underpayment interest owed by the taxpayer
from April 15, 2005, to May 15, 2006). This amount
must be returned to the taxpayer with interest
determined at the short-term applicable Federal rate
from the May 15, 2006, to a date not more than 30
days preceding the date of the check repaying the
deposit to the taxpayer.
Limitation on amounts for which interest may
be allowed
Interest on a deposit that is returned to a taxpayer
shall be allowed for any period only to the extent
attributable to a disputable item for that period. A
disputable item is any item for which the taxpayer
(1) has a reasonable basis for the treatment used on
its return and (2) reasonably believes that the
Secretary also has a reasonable basis for
disallowing the taxpayer's treatment of such item.
All items included in a 30-day letter to a taxpayer
are deemed disputable for this purpose. Thus, once a
30-day letter has been issued, the disputable amount
cannot be less than the amount of the deficiency
shown in the 30-day letter. A 30-day letter is the
first letter of proposed deficiency that allows the
taxpayer an opportunity for administrative review in
the Internal Revenue Service Office of Appeals.
Deposits are not payments of tax
A deposit is not a payment of tax prior to the time
the deposited amount is used to pay a tax.
Similarly, withdrawal of a deposit will not
establish a period for which interest was allowable
at the short-term applicable Federal rate for the
purpose of establishing a net zero interest rate on
a similar amount of underpayment for the same
period.
Effective date. --Deposits made after 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.
27. Authorize
IRS
to enter into installment agreements that provide
for partial payment (sec. 645 of the House bill,
sec. 484 of the Senate amendment, and sec. 6159 of
the Code)
Present
Law
The Code authorizes the
IRS
to enter into written agreements with any taxpayer
under which the taxpayer is allowed to pay taxes
owed, as well as interest and penalties, in
installment payments if the
IRS
determines that doing so will facilitate collection
of the amounts owed (sec. 6159). An installment
agreement does not reduce the amount of taxes,
interest, or penalties owed. Generally, during the
period installment payments are being made, other
IRS
enforcement actions (such as levies or seizures)
with respect to the taxes included in that agreement
are held in abeyance.
Prior to 1998, the
IRS
administratively entered into installment agreements
that provided for partial payment (rather than full
payment) of the total amount owed over the period of
the agreement. In that year, the
IRS
Chief Counsel issued a memorandum concluding that
partial payment installment agreements were not
permitted.
House
Bill
The provision clarifies that the
IRS
is authorized to enter into installment agreements
with taxpayers which do not provide for full payment
of the taxpayer's liability over the life of the
agreement. The provision also requires the
IRS
to review partial payment installment agreements at
least every two years. The primary purpose of this
review is to determine whether the financial
condition of the taxpayer has significantly changed
so as to warrant an increase in the value of the
payments being made.
Effective date. --Installment agreements
entered into on or 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.
28. Affirmation of consolidated return regulation
authority (sec. 646 of the House bill, sec. 421 of
the Senate amendment, and sec. 1502 of the Code)
Present
Law
An affiliated group of corporations may elect to
file a consolidated return in lieu of separate
returns. A condition of electing to file a
consolidated return is that all corporations that
are members of the consolidated group must consent
to all the consolidated return regulations
prescribed under section 1502 prior to the last day
prescribed by law for filing such return.581
Section 1502 states:
The
Secretary shall prescribe such regulations as he may
deem necessary in order that the tax liability of
any affiliated group of corporations making a
consolidated return and of each corporation in the
group, both during and after the period of
affiliation, may be returned, determined, computed,
assessed, collected, and adjusted, in such manner as
clearly to reflect the income-tax liability and the
various factors necessary for the determination of
such liability, and in order to prevent the
avoidance of such tax liability.582
Under this authority, the Treasury Department has
issued extensive consolidated return regulations.583
In the recent case of Rite Aid Corp. v. United
States,584
the Federal Circuit Court of Appeals addressed the
application of a particular provision of certain
consolidated return loss disallowance regulations,
and concluded that the provision was invalid.585
The particular provision, known as the
"duplicated loss" provision,586
would have denied a loss on the sale of stock of a
subsidiary by a parent corporation that had filed a
consolidated return with the subsidiary, to the
extent the subsidiary corporation had assets that
had a built-in loss, or had a net operating loss,
that could be recognized or used later.587
The Federal Circuit Court opinion contained language
discussing the fact that the regulation produced a
result different than the result that would have
obtained if the corporations had filed separate
returns rather than consolidated returns.588
The Federal Circuit Court opinion cited a 1928
Senate Finance Committee Report to legislation that
authorized consolidated return regulations, which
stated that "many difficult and complicated
problems, ... have arisen in the administration of
the provisions permitting the filing of consolidated
returns" and that the committee "found it
necessary to delegate power to the commissioner to
prescribe regulations legislative in character
covering them."589
The Court's opinion also cited a previous decision
of the Court of Claims for the proposition,
interpreting this legislative history, that section
1502 grants the Secretary "the power to conform
the applicable income tax law of the Code to the
special, myriad problems resulting from the filing
of consolidated income tax returns;" but that
section 1502 "does not authorize the Secretary
to choose a method that imposes a tax on income that
would not otherwise be taxed."590
The Federal Circuit Court construed these
authorities and applied them to invalidate Treas.
Reg. Sec. 1.1502-20(c)(1)(iii), stating that:
The
loss realized on the sale of a former subsidiary's
assets after the consolidated group sells the
subsidiary's stock is not a problem resulting from
the filing of consolidated income tax returns. The
scenario also arises where a corporate shareholder
sells the stock of a non-consolidated subsidiary.
The corporate shareholder could realize a loss under
I.R.C. sec. 1001, and deduct the loss under I.R.C.
sec. 165. The subsidiary could then deduct any
losses from a later sale of assets. The duplicated
loss factor, therefore, addresses a situation that
arises from the sale of stock regardless of whether
corporations file separate or consolidated returns.
With I.R.C. secs. 382 and 383, Congress has
addressed this situation by limiting the
subsidiary's potential future deduction, not the
parent's loss on the sale of stock under I.R.C. sec.
165.591
The Treasury Department has announced that it will
not continue to litigate the validity of the
duplicated loss provision of the regulations, and
has issued interim regulations that permit taxpayers
for all years to elect a different treatment, though
they may apply the provision for the past if they
wish.592
House
Bill
The provision confirms that, in exercising its
authority under section 1502 to issue consolidated
return regulations, the Treasury Department may
provide rules treating corporations filing
consolidated returns differently from corporations
filing separate returns.
Thus, under the statutory authority of section 1502,
the Treasury Department is authorized to issue
consolidated return regulations utilizing either a
single taxpayer or separate taxpayer approach or a
combination of the two approaches, as Treasury deems
necessary in order that the tax liability of any
affiliated group of corporations making a
consolidated return, and of each corporation in the
group, both during and after the period of
affiliation, may be determined and adjusted in such
manner as clearly to reflect the income-tax
liability and the various factors necessary for the
determination of such liability, and in order to
prevent avoidance of such liability.
Rite Aid is thus overruled to the extent it
suggests that the Secretary is required to identify
a problem created from the filing of consolidated
returns in order to issue regulations that change
the application of a Code provision. The Secretary
may promulgate consolidated return regulations to
change the application of a tax code provision to
members of a consolidated group, provided that such
regulations are necessary to clearly reflect the
income tax liability of the group and each
corporation in the group, both during and after the
period of affiliation.
The provision nevertheless allows the result of the Rite
Aid case to stand with respect to the type of
factual situation presented in the case. That is,
the bill provides for the override of the regulatory
provision that took the approach of denying a loss
on a deconsolidating disposition of stock of a
consolidated subsidiary593
to the extent the subsidiary had net operating
losses or built in losses that could be used later
outside the group.594
Retaining the result in the Rite Aid case
with respect to the particular regulation section
1.1502-20(c)(1)(iii) as applied to the factual
situation of the case does not in any way prevent or
invalidate the various approaches Treasury has
announced it will apply or that it intends to
consider in lieu of the approach of that regulation,
including, for example, the denial of a loss on a
stock sale if inside losses of a subsidiary may also
be used by the consolidated group, and the possible
requirement that inside attributes be adjusted when
a subsidiary leaves a group.595
Effective date. --The provision is effective
for all years, whether beginning before, on, or
after the date of enactment of the provision. No
inference is intended that the results following
from this provision are not the same as the results
under present law.
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.
29. Reform of tax treatment of certain leasing
arrangements and limitation on deductions allocable
to property used by governments or other tax-exempt
entities (secs. 647 through 649 of the bill, secs.
475 and 476 of the Senate amendment, secs. 167 and
168 of the Code, and new sec. 470 of the Code)
Present
Law
Overview of depreciation
A taxpayer is allowed to recover, through annual
depreciation deductions, the cost of certain
property used in a trade or business or for the
production of income. The amount of the depreciation
deduction allowed with respect to tangible property
for a taxable year is determined under the modified
accelerated cost recovery system ("MACRS").
Under MACRS, different types of property generally
are assigned applicable recovery periods and
depreciation methods based on such property's class
life. The recovery periods applicable to most
tangible personal property (generally tangible
property other than residential rental property and
nonresidential real property) range from 3 to 25
years and are significantly shorter than the
property's class life, which is intended to
approximate the economic useful life of the
property. In addition, the depreciation methods
generally applicable to tangible personal property
are the 200-percent and 150-percent declining
balance methods, switching to the straight-line
method for the taxable year in which the
depreciation deduction would be maximized.
Characterization of leases for tax purposes
In general, a taxpayer is treated as the tax owner
and is entitled to depreciate property leased to
another party if the taxpayer acquires and retains
significant and genuine attributes of a traditional
owner of the property, including the benefits and
burdens of ownership. No single factor is
determinative of whether a lessor will be treated as
the owner of the property. Rather, the determination
is based on all the facts and circumstances
surrounding the leasing transaction.
A sale-leaseback transaction is respected for
Federal tax purposes if "there is a genuine
multiple-party transaction with economic substance
which is compelled or encouraged by business or
regulatory realities, is imbued with tax-independent
considerations, and is not shaped solely by
tax-avoidance features that have meaningless labels
attached."596
Recovery period for tax-exempt use property
Under present law, "tax-exempt use
property" must be depreciated on a
straight-line basis over a recovery period equal to
the longer of the property's class life or 125
percent of the lease term.597
For purposes of this rule, "tax-exempt use
property" is tangible property that is leased
(other than under a short-term lease) to a
tax-exempt entity.598
For this purpose, the term "tax-exempt
entity" includes Federal, State and local
governmental units, charities, and, foreign entities
or persons.599
In determining the length of the lease term for
purposes of the 125-percent calculation, several
special rules apply. In addition to the stated term
of the lease, the lease term includes options to
renew the lease or other periods of time during
which the lessee could be obligated to make rent
payments or assume a risk of loss related to the
leased property.
Tax-exempt use property does not include property
that is used by a taxpayer to provide a service to a
tax-exempt entity. So long as the relationship
between the parties is a bona fide service contract,
the taxpayer will be allowed to depreciate the
property used in satisfying the contract under
normal MACRS rules, rather than the rules applicable
to tax-exempt use property.600
In addition, property is not treated as tax-exempt
use property merely by reason of a short-term lease.
In general, a short-term lease means any lease the
term of which is less than three years and less than
the greater of one year or 30 percent of the
property's class life.601
Also, tax-exempt use property generally does not
include qualified technological equipment that meets
the exception for leases of high technology
equipment to tax-exempt entities with lease terms of
five years or less.602
The recovery period for qualified technological
equipment that is treated as tax-exempt use
property, but is not subject to the high technology
equipment exception, is five years.603
The term "qualified technological
equipment" is defined as computers and related
peripheral equipment, high technology telephone
station equipment installed on a customer's
premises, and high technology medical equipment.604
In addition, tax-exempt use property does not
include computer software because it is intangible
property.
House
Bill
Overview
The House bill modifies the recovery period of
certain property leased to a tax-exempt entity,
alters the definition of lease term for all property
leased to a tax-exempt entity, expands the
short-term lease exception for qualified
technological equipment, and establishes rules to
limit deductions associated with leases to
tax-exempt entities if the leases do not satisfy
specified criteria.
Modify the recovery period of certain property
leased to a tax-exempt entity
The House bill modifies the recovery period for
qualified technological equipment and computer
software leased to a tax-exempt entity605
to be the longer of the property's assigned class
life (or assigned useful life in the case of
computer software) or 125 percent of the lease term.
The House bill does not apply to short-term leases,
as defined under present law with a modification
described below for short-term leases of qualified
technological equipment.
Modify definition of lease term
In determining the length of the lease term for
purposes of the 125-percent calculation, the House
bill provides that the lease term includes all
service contracts (whether or not treated as a lease
under section 7701(e)) and other similar
arrangements that follow a lease of property to a
tax-exempt entity and that are part of the same
transaction (or series of transactions) as the
lease.606
Under the House bill, service contracts and other
similar arrangements include arrangements by which
services are provided using the property in exchange
for fees that provide a source of repayment of the
capital investment in the property.607
This requirement applies to all leases of property
to a tax-exempt entity.
Expand short-term lease exception for
qualified technological equipment
For purposes of determining whether a lease of
qualified technological equipment to a tax-exempt
entity satisfies the present-law 5-year short-term
lease exception for leases of qualified
technological equipment, the House bill provides
that the term of the lease does not include an
option or options of the lessee to renew or extend
the lease, provided the rents under the renewal or
extension are based upon fair market value
determined at the time of the renewal or extension.
The aggregate period of such renewals or extensions
not included in the lease term under this provision
may not exceed 24 months. In addition, this
provision does not apply to any period following the
failure of a tax-exempt lessee to exercise a
purchase option if the result of such failure is
that the lease renews automatically at fair market
value rents.
Limit deductions for certain leases of
property to tax-exempt parties
The House bill also provides that if a taxpayer
leases property to a tax-exempt entity, the taxpayer
may not claim deductions for a taxable year from the
lease transaction in excess of the taxpayer's gross
income from the lease for that taxable year. This
provision does not apply to certain transactions
involving property with respect to which the
low-income housing credit or the rehabilitation
credit is allowable.
This provision applies to deductions or losses
related to a lease to a tax-exempt entity and the
leased property.608
Any disallowed deductions are carried forward and
treated as deductions related to the lease in the
following taxable year subject to the same
limitations. Under rules similar to those applicable
to passive activity losses (including the treatment
of dispositions of property in which less than all
of the gain or loss from the disposition is
recognized),609
a taxpayer generally is permitted to deduct
previously disallowed deductions and losses when the
taxpayer completely disposes of its interest in the
property.
A lease of property to a tax-exempt party is not
subject to the deduction limitations of this
provision if the lease satisfies all of the
following requirements:610
(1) Tax-exempt lessee does not monetize its lease
obligations
In general, the tax-exempt lessee may not monetize
its lease obligations (including any purchase
option) in an amount that exceeds 20 percent of the
taxpayer's adjusted basis611
in the leased property at the time the lease is
entered into.612
Specifically, a lease does not satisfy this
requirement if the tax-exempt lessee monetizes such
excess amount pursuant to an arrangement, set-aside,
or expected set-aside, that is to or for the benefit
of the taxpayer or any lender, or is to or for the
benefit of the tax-exempt lessee, in order to
satisfy the lessee's obligations or options under
the lease. This determination shall be made at all
times during the lease term and shall include the
amount of any interest or other income or gain
earned on any amount set aside or subject to an
arrangement described in this provision. For
purposes of determining whether amounts have been
set aside or are expected to be set aside, amounts
are treated as set aside or expected to be set aside
only if a reasonable person would conclude that the
facts and circumstances indicate that such amounts
are set aside or expected to be set aside.613
The Secretary may provide by regulations that this
requirement is satisfied, even if a taxexempt lessee
monetizes its lease obligations or options in an
amount that exceeds 20 percent of the taxpayer's
adjusted basis in the leased property, in cases in
which the creditworthiness of the tax-exempt lessee
would not otherwise satisfy the taxpayer's customary
underwriting standards. Such credit support would
not be permitted to exceed 50 percent of the
taxpayer's adjusted basis in the property. In
addition, if the lease provides the tax-exempt
lessee an option to purchase the property for a
fixed purchase price (or for other than the fair
market value of the property determined at the time
of exercise of the option), such credit support at
the time that such option may be exercised would not
be permitted to exceed 50 percent of the purchase
option price.
Certain lease arrangements that involve circular
cash flows or insulation of the taxpayer's equity
investment from the risk of loss fail this
requirement without regard to the amount in which
the tax-exempt lessee monetizes its lease
obligations or options. Thus, a lease does not
satisfy this requirement if the tax-exempt lessee
enters into an arrangement to monetize in any amount
its lease obligations or options if such arrangement
involves (1) a loan (other than an amount treated as
a loan under section 467 with respect to a section
467 rental agreement) from the tax-exempt lessee to
the taxpayer or a lender, (2) a deposit that is
received, a letter of credit that is issued, or a
payment undertaking agreement that is entered into
by a lender otherwise involved in the transaction,
or (3) in the case of a transaction that involves a
lender, any credit support made available to the
taxpayer in which any such lender does not have a
claim that is senior to the taxpayer.
(2) Taxpayer makes and maintains a substantial
equity investment in the leased property
The taxpayer must make and maintain a substantial
equity investment in the leased property. For this
purpose, a taxpayer generally does not make or
maintain a substantial equity investment unless (1)
at the time the lease is entered into, the taxpayer
initially makes an unconditional at-risk equity
investment in the property of at least 20 percent of
the taxpayer's adjusted basis614
in the leased property at that time,615
(2) the taxpayer maintains such equity investment
throughout the lease term, and (3) at all times
during the lease term, the fair market value of the
property at the end of the lease term is reasonably
expected to be equal to at least 20 percent of such
basis.616
For this purpose, the fair market value of the
property at the end of the lease term is reduced to
the extent that a person other than the taxpayer
bears a risk of loss in the value of the property.
This requirement does not apply to leases with lease
terms of 5 years or less.
(3) Tax-exempt lessee does not bear more than a
minimal risk of loss
The tax-exempt lessee generally may not assume or
retain more than a minimal risk of loss, other than
the obligation to pay rent and insurance premiums,
to maintain the property, or other similar
conventional obligations of a net lease.617
For this purpose, a tax-exempt lessee assumes or
retains more than a minimal risk of loss if, as a
result of obligations assumed or retained by, on
behalf of, or pursuant to an agreement with the
tax-exempt lessee, the taxpayer is protected from
either (1) any portion of the loss that would occur
if the fair market value of the leased property were
25 percent less than the leased property's
reasonably expected fair market value at the time
the lease is terminated, or (2) an aggregate loss
that is greater than 50 percent of the loss that
would occur if the fair market value of the leased
property were zero at lease termination.618
In addition, the Secretary may provide by
regulations that this requirement is not satisfied
where the tax-exempt lessee otherwise retains or
assumes more than a minimal risk of loss. Such
regulations shall be prospective only.
This requirement does not apply to leases with lease
terms of 5 years or less.
Coordination with like-kind exchange and
involuntary conversion rules
Under this provision, neither the like-kind exchange
rules (sec. 1031) nor the involuntary conversion
rules (sec. 1033) apply if either (1) the exchanged
or converted property is taxexempt use property
subject to a lease that was entered into prior to
the effective date of this provision and the lease
would not have satisfied the requirements of this
provision had such requirements been in effect when
the lease was entered into, or (2) the replacement
property is tax-exempt use property subject to a
lease that does not meet the requirements of this
provision.
Other rules
This provision continues to apply throughout the
lease term to property that initially was tax-exempt
use property, even if the property ceases to be
tax-exempt use property during the lease term.619
In addition, this provision is applied before the
application of the passive activity loss rules under
section 469.
This provision does not alter the treatment of any
Qualified Motor Vehicle Operating Agreement within
the meaning of section 7701(h). In the case of any
such agreement, the second and third requirements
provided by this provision (relating to taxpayer
equity investment and tax-exempt lessee risk of
loss, respectively) shall be applied without regard
to any terminal rental adjustment clause.
Effective date
The House bill provision generally is effective for
leases entered into after March 12, 2004.620
However, the House bill provision does not apply to
property located in the United States that is
subject to a lease with respect to which a formal
application (1) was submitted for approval to the
Federal Transit Administration (an agency of the
Department of Transportation) after June 30, 2003,
and before March 13, 2004, (2) is approved by the
Federal Transit Administration before January 1,
2005, and (3) includes a description and the fair
market value of such property.
The House bill provisions relating to coordination
with the like-kind exchange and involuntary
conversion rules are effective with respect to
property that is exchanged or converted after the
date of enactment.
No inference is intended regarding the appropriate
present-law tax treatment of transactions entered
into prior to the effective date of the House bill
provision. In addition, it is intended that the
House bill provision shall not be construed as
altering or supplanting the present-law tax rules
providing that a taxpayer is treated as the owner of
leased property only if the taxpayer acquires and
retains significant and genuine attributes of an
owner of the property, including the benefits and
burdens of ownership. The House bill provision also
is not intended to affect the scope of any other
present-law tax rules or doctrines applicable to
purported leasing transactions.
Senate
Amendment
Overview
The Senate amendment is similar to the House bill in
that it modifies the recovery period of certain
property leased to a tax-exempt entity, alters the
definition of lease term for all property leased to
a tax-exempt entity, and establishes rules to limit
deductions associated with leases to tax-exempt
entities if the leases do not satisfy specified
criteria.
Modify the recovery period of certain property
leased to a tax-exempt entity
The Senate amendment provision that modifies the
recovery period for qualified technological
equipment and computer software leased to a
tax-exempt entity is the same as the House bill
provision.
Modify definition of lease term
The Senate amendment provision that modifies the
definition of a lease term is the same as the House
bill provision.
Expand short-term lease exception for
qualified technological equipment
The Senate amendment does not include the House bill
provision that excludes certain renewals and
extensions of up to 24 months from the determination
of whether a lease of qualified technological
equipment to a tax-exempt entity satisfies the
present-law 5-year shortterm lease exception for
leases of qualified technological equipment.
Limit deductions for certain leases of
property to tax-exempt parties
The Senate amendment is similar to the House bill in
that it limits a taxpayer's deductions for a taxable
year from a lease transaction with a tax-exempt
entity to the taxpayer's gross income from the lease
for that taxable year. However, the Senate amendment
does not exclude transactions involving property
with respect to which the rehabilitation credit is
allowable.
Like the House bill, the Senate amendment provides
that a lease of property to a taxexempt party is not
subject to the deduction limitations of this
provision if the lease satisfies a series of
requirements similar to that provided in the House
bill, with the following modifications:
(1) Leased property is not financed with
tax-exempt bonds or Federal funds
The Senate amendment provides that the leased
property must not have been not directly or
indirectly financed with tax-exempt bonds that are
outstanding when the lease is entered into, or with
Federal funds. This requirement is not included in
the House bill.
For example, a lease of rolling stock to a
municipality would be subject to the Senate
amendment if the proceeds of the municipality's
general obligation bond were used to finance the
acquisition of the rolling stock (in whole or part)
and the bond is outstanding when the lease is
entered into.
The Senate amendment permits the Secretary to
provide a de minimis exception from this
requirement.
(2) Tax-exempt lessee does not monetize its lease
obligations
The Senate amendment is similar to the House bill in
that it provides that the tax-exempt lessee may not
monetize its lease obligations in an amount that
exceeds 20 percent of the taxpayer's adjusted basis
in the leased property at the time the lease is
entered into. However, the Senate amendment also
permits the Secretary to identify arrangements (in
addition to those specified in the provision) to
which the requirement applies.
(3) Taxpayer makes and maintains a substantial
equity investment in the leased property
The Senate amendment is similar to the House bill in
that it requires the taxpayer to make and maintain a
substantial equity investment in the leased
property. However, the Senate amendment does not
generally exclude from the application of this
requirement leases with lease terms of 5 years or
less. Instead, the Senate amendment provides that,
with respect to short-term leases as defined under
present law, the taxpayer is required to make a
substantial equity investment, but is not required
to maintain a substantial equity investment, and the
leased property is not required to be reasonably
expected to equal 20 percent of the taxpayer's
adjusted basis at the time the lease is entered
into.
(4) Tax-exempt lessee does not bear more than a
minimal risk of loss
The Senate amendment is similar to the House bill in
that it provides that the tax-exempt lessee
generally may not assume or retain more than a
minimal risk of loss with respect to the lease.
However, the Senate amendment does not exclude from
the application of this requirement leases with
lease terms of 5 years or less.
(5) Lease of certain property does not include a
fixed-price purchase option of the tax-exempt lessee
The Senate amendment provides that the tax-exempt
lessee may not have an option to purchase the leased
property for any stated purchase price other than
the fair market value of the property (as determined
at the time of exercise of the option). This
requirement does not apply to property with a class
life (as defined in section 168(i)(1)) of seven
years or less. This requirement is not included in
the House bill.
(6) Lease meets any other requirement prescribed
in regulations
The Senate amendment requires the lease to meet any
other requirements that the Secretary prescribes by
regulations. This requirement is not included in the
House bill.
Coordination with like-kind exchange and
involuntary conversion rules
The Senate amendment does not include the House bill
provisions that coordinate the like-kind exchange
and involuntary conversion rules with the deduction
limitation provision.
Effective date
The Senate amendment provision generally is
effective for leases entered into after November 18,
2003. However, with respect to tax-exempt use
property that is leased to a foreign tax-exempt
entity or person in a transaction entered into on or
before November 18, 2003, the Senate amendment
provision is effective for taxable years beginning
after January 31, 2004.
Conference
Agreement
The conference agreement follows the House bill,
with the following modifications.
Definition of tax-exempt entity
The conference agreement expands the present-law
definition of tax-exempt entity for this purpose to
include certain Indian tribal governments in
addition to Federal, State, local, and foreign
governmental units, charities, foreign entities or
persons.
Modify the recovery period of certain property
leased to a tax-exempt entity
The conference agreement also modifies the recovery
period for certain intangibles leased to a
tax-exempt entity to be the no less than 125 percent
of the lease term.621
The conference agreement modification does not apply
to short-term leases, as defined under present law
with a modification described below for short-term
leases of qualified technological equipment.
Limit deductions for leases of property to
tax-exempt parties
The conference agreement provides an additional
requirement that must be satisfied to avoid the
deduction limitations for certain leases of property
to tax-exempt parties. This requirement provides
that the tax-exempt lessee may not have an option to
purchase the leased property for any stated purchase
price other than the fair market value of the
property (as determined at the time of exercise of
the option). This requirement does not apply to (1)
property with a class life (as defined in section
168(i)(1)) of seven years or less, or (2) any
fixedwing aircraft or vessels (i.e., ships).
Effective date
The conference agreement modifies the Federal
Transit Administration approval deadline to January
1, 2006.
In addition, the conference agreement provides that
the provisions relating to intangible assets and
Indian tribal governments are effective for leases
entered into after October 3, 2004.
30. Clarification of the economic substance
doctrine (sec. 401 of the Senate amendment and sec.
7701 of the Code)
Present
Law
In general
The Code provides specific rules regarding the
computation of taxable income, including the amount,
timing, source, and character of items of income,
gain, loss and deduction. These rules are designed
to provide for the computation of taxable income in
a manner that provides for a degree of specificity
to both taxpayers and the government. Taxpayers
generally may plan their transactions in reliance on
these rules to determine the federal income tax
consequences arising from the transactions.
In addition to the statutory provisions, courts have
developed several doctrines that can be applied to
deny the tax benefits of tax motivated transactions,
notwithstanding that the transaction may satisfy the
literal requirements of a specific tax provision.
The common-law doctrines are not entirely
distinguishable, and their application to a given
set of facts is often blurred by the courts and the
IRS
. Although these doctrines serve an important role
in the administration of the tax system, invocation
of these doctrines can be seen as at odds with an
objective, "rule-based" system of
taxation. Nonetheless, courts have applied the
doctrines to deny tax benefits arising from certain
transactions.622
A common-law doctrine applied with increasing
frequency is the "economic substance"
doctrine. In general, this doctrine denies tax
benefits arising from transactions that do not
result in a meaningful change to the taxpayer's
economic position other than a purported reduction
in federal income tax.623
Economic substance doctrine
Courts generally deny claimed tax benefits if the
transaction that gives rise to those benefits lacks
economic substance independent of tax considerations
--notwithstanding that the purported activity
actually occurred. The tax court has described the
doctrine as follows:
The
tax law ... requires that the intended transactions
have economic substance separate and distinct from
economic benefit achieved solely by tax reduction.
The doctrine of economic substance becomes
applicable, and a judicial remedy is warranted,
where a taxpayer seeks to claim tax benefits,
unintended by Congress, by means of transactions
that serve no economic purpose other than tax
savings.624
Business purpose doctrine
Another common law doctrine that overlays and is
often considered together with (if not part and
parcel of) the economic substance doctrine is the
business purpose doctrine. The business purpose test
is a subjective inquiry into the motives of the
taxpayer --that is, whether the taxpayer intended
the transaction to serve some useful non-tax
purpose. In making this determination, some courts
have bifurcated a transaction in which independent
activities with non-tax objectives have been
combined with an unrelated item having only
tax-avoidance objectives in order to disallow the
tax benefits of the overall transaction.625
Application by the courts
Elements of the doctrine
There is a lack of uniformity regarding the proper
application of the economic substance doctrine.626
Some courts apply a conjunctive test that requires a
taxpayer to establish the presence of both economic
substance (i.e., the objective component) and
business purpose (i.e., the subjective component) in
order for the transaction to survive judicial
scrutiny.627
A narrower approach used by some courts is to
conclude that either a business purpose or economic
substance is sufficient to respect the transaction).628
A third approach regards economic substance and
business purpose as "simply more precise
factors to consider" in determining whether a
transaction has any practical economic effects other
than the creation of tax benefits.629
Profit potential
There also is a lack of uniformity regarding the
necessity and level of profit potential necessary to
establish economic substance. Since the time of Gregory
v. Helvering,630
several courts have denied tax benefits on the
grounds that the subject transactions lacked profit
potential.631
In addition, some courts have applied the economic
substance doctrine to disallow tax benefits in
transactions in which a taxpayer was exposed to risk
and the transaction had a profit potential, but the
court concluded that the economic risks and profit
potential were insignificant when compared to the
tax benefits.632
Under this analysis, the taxpayer's profit potential
must be more than nominal. Conversely, other courts
view the application of the economic substance
doctrine as requiring an objective determination of
whether a "reasonable possibility of
profit" from the transaction existed apart from
the tax benefits.633
In these cases, in assessing whether a reasonable
possibility of profit exists, it is sufficient if
there is a nominal amount of pre-tax profit as
measured against expected net tax benefits.
House
Bill
No provision.
Senate
Amendment
The Senate amendment clarifies and enhances the
application of the economic substance doctrine. The
Senate amendment provides that, in a case in which a
court determines that the economic substance
doctrine is relevant to a transaction (or a series
of transactions), such transaction (or series of
transactions) has economic substance (and thus
satisfies the economic substance doctrine) only if
the taxpayer establishes that (1) the transaction
changes in a meaningful way (apart from Federal
income tax consequences) the taxpayer's economic
position, and (2) the taxpayer has a substantial
non-tax purpose for entering into such transaction
and the transaction is a reasonable means of
accomplishing such purpose.634
The Senate amendment does not change current law
standards used by courts in determining when to
utilize an economic substance analysis.635
Also, the Senate amendment does not alter the
court's ability to aggregate, disaggregate or
otherwise recharacterize a transaction when applying
the doctrine.636
The Senate amendment provides a uniform definition
of economic substance, but does not alter the
flexibility of the courts in other respects.
Conjunctive analysis
The Senate amendment clarifies that the economic
substance doctrine involves a conjunctive analysis
--there must be an objective inquiry regarding the
effects of the transaction on the taxpayer's
economic position, as well as a subjective inquiry
regarding the taxpayer's motives for engaging in the
transaction. Under the Senate amendment, a
transaction must satisfy both tests --i.e.,
it must change in a meaningful way (apart from
Federal income tax consequences) the taxpayer's
economic position, and the taxpayer must have a
substantial nontax purpose for entering into such
transaction (and the transaction is a reasonable
means of accomplishing such purpose) --in order to
satisfy the economic substance doctrine. This
clarification eliminates the disparity that exists
among the circuits regarding the application of the
doctrine, and modifies its application in those
circuits in which either a change in economic
position or a non-tax business purpose (without
having both) is sufficient to satisfy the economic
substance doctrine.
Non-tax business purpose
The Senate amendment provides that a taxpayer's
non-tax purpose for entering into a transaction (the
second prong in the analysis) must be
"substantial," and that the transaction
must be "a reasonable means" of
accomplishing such purpose. Under this formulation,
the non-tax purpose for the transaction must bear a
reasonable relationship to the taxpayer's normal
business operations or investment activities.637
In determining whether a taxpayer has a substantial
non-tax business purpose, an objective of achieving
a favorable accounting treatment for financial
reporting purposes will not be treated as having a
substantial non-tax purpose.638
Furthermore, a transaction that is expected to
increase financial accounting income as a result of
generating tax deductions or losses without a
corresponding financial accounting charge (i.e., a
permanent book-tax difference)639
should not be considered to have a substantial
non-tax purpose unless a substantial non-tax purpose
exists apart from the financial accounting benefits.640
By requiring that a transaction be a
"reasonable means" of accomplishing its
non-tax purpose, the Senate amendment reiterates the
present-law ability of the courts to bifurcate a
transaction in which independent activities with
non-tax objectives are combined with an unrelated
item having only tax-avoidance objectives in order
to disallow the tax benefits of the overall
transaction.641
Profit potential
Under the Senate amendment, a taxpayer may rely on
factors other than profit potential to demonstrate
that a transaction results in a meaningful change in
the taxpayer's economic position; the Senate
amendment merely sets forth a minimum threshold of
profit potential if that test is relied on to
demonstrate a meaningful change in economic
position. If a taxpayer relies on a profit
potential, however, the present value of the
reasonably expected pre-tax profit must be
substantial in relation to the present value of the
expected net tax benefits that would be allowed if
the transaction were respected.642
Moreover, the profit potential must exceed a
risk-free rate of return. In addition, in
determining pre-tax profit, fees and other
transaction expenses and foreign taxes are treated
as expenses.
In applying the profit potential test to a lessor of
tangible property, depreciation, applicable tax
credits (such as the rehabilitation tax credit and
the low income housing tax credit), and any other
deduction as provided in guidance by the Secretary
are not taken into account in measuring tax
benefits.
Transactions with tax-indifferent parties
The Senate amendment also provides special rules for
transactions with tax-indifferent parties. For this
purpose, a tax-indifferent party means any person or
entity not subject to Federal income tax, or any
person to whom an item would have no substantial
impact on its income tax liability. Under these
rules, the form of a financing transaction will not
be respected if the present value of the tax
deductions to be claimed is substantially in excess
of the present value of the anticipated economic
returns to the lender. Also, the form of a
transaction with a tax-indifferent party will not be
respected if it results in an allocation of income
or gain to the tax-indifferent party in excess of
the tax-indifferent party's economic gain or income
or if the transaction results in the shifting of
basis on account of overstating the income or gain
of the taxindifferent party.
Other rules
The Secretary may prescribe regulations which
provide (1) exemptions from the application of the
Senate amendment, and (2) other rules as may be
necessary or appropriate to carry out the purposes
of the Senate amendment.
No inference is intended as to the proper
application of the economic substance doctrine under
present law. In addition, except with respect to the
economic substance doctrine, the Senate amendment
shall not be construed as altering or supplanting
any other common law doctrine (including the sham
transaction doctrine), and the Senate amendment
shall be construed as being additive to any such
other doctrine.
Effective date
The Senate amendment provision applies to
transactions entered into after the date of
enactment.
Conference
Agreement
The conference agreement does not include the Senate
amendment.
31. Penalty for understatements attributable to
transactions lacking economic substance, etc. (sec.
404 of the Senate amendment and sec. 6662B of the
Code)
Present
Law
An accuracy-related penalty applies to the portion
of any underpayment that is attributable to (1)
negligence, (2) any substantial understatement of
income tax, (3) any substantial valuation
misstatement, (4) any substantial overstatement of
pension liabilities, or (5) any substantial estate
or gift tax valuation understatement. If the correct
income tax liability exceeds that reported by the
taxpayer by the greater of 10 percent of the correct
tax or $5,000 ($10,000 in the case of corporations),
then a substantial understatement exists and a
penalty may be imposed equal to 20 percent of the
underpayment of tax attributable to the
understatement.643
The amount of any understatement is reduced by any
portion attributable to an item if (1) the treatment
of the item is supported by substantial authority,
or (2) facts relevant to the tax treatment of the
item were adequately disclosed and there was a
reasonable basis for its tax treatment.
Special rules apply with respect to tax shelters.644
For understatements by non-corporate taxpayers
attributable to tax shelters, the penalty may be
avoided only if the taxpayer establishes that, in
addition to having substantial authority for the
position, the taxpayer reasonably believed that the
treatment claimed was more likely than not the
proper treatment of the item. This reduction in the
penalty is unavailable to corporate tax shelters.
The penalty generally is abated (even with respect
to tax shelters) in cases in which the taxpayer can
demonstrate that there was "reasonable
cause" for the underpayment and that the
taxpayer acted in good faith.645
The relevant regulations provide that reasonable
cause exists where the taxpayer "reasonably
relies in good faith on an opinion based on a
professional tax advisor's analysis of the pertinent
facts and authorities [that] ... unambiguously
concludes that there is a greater than 50-percent
likelihood that the tax treatment of the item will
be upheld if challenged" by the
IRS
.646
House
Bill
No provision.
Senate
Amendment
The Senate amendment imposes a penalty for an
understatement attributable to any transaction that
lacks economic substance (referred to in the statute
as a "non-economic substance transaction
understatement").647
The penalty rate is 40 percent (reduced to 20
percent if the taxpayer adequately discloses the
relevant facts in accordance with regulations
prescribed under section 6011). No exceptions
(including the reasonable cause or rescission rules)
to the penalty would be available under the Senate
amendment (i.e., the penalty is a strict-liability
penalty).
A "non-economic substance transaction"
means any transaction if (1) the transaction lacks
economic substance (as defined in the earlier Senate
amendment provision regarding the economic substance
doctrine),648
(2) the transaction was not respected under the
rules relating to transactions with tax-indifferent
parties (as described in the earlier Senate
amendment provision regarding the economic substance
doctrine),649
or (3) any similar rule of law. For this purpose, a
similar rule of law would include, for example, an
understatement attributable to a transaction that is
determined to be a sham transaction.
For purposes of the Senate amendment, the
calculation of an "understatement" is made
in the same manner as in the separate Senate
amendment provision relating to accuracy-related
penalties for listed and reportable avoidance
transactions (new sec. 6662A). Thus, the amount of
the understatement under the Senate amendment
provision would be determined as the sum of (1) the
product of the highest corporate or individual tax
rate (as appropriate) and the increase in taxable
income resulting from the difference between the
taxpayer's treatment of the item and the proper
treatment of the item (without regard to other items
on the tax return),650
and (2) the amount of any decrease in the aggregate
amount of credits which results from a difference
between the taxpayer's treatment of an item and the
proper tax treatment of such item. In essence, the
penalty will apply to the amount of any
understatement attributable solely to a noneconomic
substance transaction.
Except as provided in regulations, the taxpayer's
treatment of an item will not take into account any
amendment or supplement to a return if the amendment
or supplement is filed after the earlier of the date
the taxpayer is first contacted regarding an
examination of such return or such other date as
specified by the Secretary.
A public entity that is required to pay a penalty
under the Senate amendment (regardless of whether
the transaction was disclosed) must disclose the
imposition of the penalty in reports to the
SEC
for such periods as the Secretary shall specify. The
disclosure to the
SEC
applies without regard to whether the taxpayer
determines the amount of the penalty to be material
to the reports in which the penalty must appear, and
any failure to disclose such penalty in the reports
is treated as a failure to disclose a listed
transaction. A taxpayer must disclose a penalty in
reports to the
SEC
once the taxpayer has exhausted its administrative
and judicial remedies with respect to the penalty
(or if earlier, when paid).
Prior to this penalty being asserted in the first
letter of proposed deficiency that allows the
taxpayer an opportunity for administrative review in
the
IRS
Office of Appeals (e.g., a Revenue Agent Report),
the
IRS
Chief Counsel or his delegate at the
IRS
National Office must approve the inclusion in
writing. Once a penalty (regardless of whether the
transaction was disclosed) has been included in the
Revenue Agent Report, the penalty cannot be
compromised for purposes of a settlement without
approval of the Commissioner personally or the head
of the Office of Tax Shelter Analysis. Furthermore,
the
IRS
is required to submit an annual report to Congress
summarizing the application of this penalty and
providing a description of each penalty compromised
under the Senate amendment and the reasons for the
compromise.
Any understatement to which a penalty is imposed
under the Senate amendment will not be subject to
the accuracy-related penalty under section 6662 or
under new 6662A (accuracyrelated penalties for
listed and reportable avoidance transactions).
However, an understatement under the Senate
amendment would be taken into account for purposes
of determining whether any understatement (as
defined in sec. 6662(d)(2)) is a substantial
understatement as defined under section 6662(d)(1).
The penalty imposed under the Senate amendment will
not apply to any portion of an understatement to
which a fraud penalty is applied under section 6663.
Effective date. --The Senate amendment
provision applies to transactions entered into after
the date of enactment.
Conference
Agreement
The conference agreement does not include the Senate
amendment.
32. Understatement of taxpayer's liability by
income tax return preparer (sec. 411 of the Senate
amendment)
Present
Law
An income tax return preparer who prepares a return
with respect to which there is an understatement of
tax that is due to an undisclosed position for which
there was not a realistic possibility of being
sustained on its merits, or a frivolous position, is
liable for a penalty of $250, provided the preparer
knew or reasonably should have known of the
position. An income tax return preparer who prepares
a return and engages in specified willful or
reckless conduct with respect to preparing such a
return is liable for a penalty of $1,000.
House
Bill
No provision.
Senate
Amendment
The Senate amendment alters the standards of conduct
that must be met to avoid imposition of the first
penalty by replacing the realistic possibility
standard with a requirement that there be a
reasonable belief that the tax treatment of the
position was more likely than not the proper
treatment. The Senate amendment also replaces the
not frivolous standard with the requirement that
there be a reasonable basis for the tax treatment of
the position, increases the present-law $250 penalty
to $1,000, and increases the present-law $1,000
penalty to $5,000.
Effective date. --Documents prepared after
the date of enactment.
Conference
Agreement
The conference agreement does not include the Senate
amendment provision.
33. Frivolous tax submissions (sec. 413 of the
Senate amendment and sec. 6702 of the Code)
Present
Law
The Code provides that an individual who files a
frivolous income tax return is subject to a penalty
of $500 imposed by the
IRS
(sec. 6702). The Code also permits the Tax Court651
to impose a penalty of up to $25,000 if a taxpayer
has instituted or maintained proceedings primarily
for delay or if the taxpayer's position in the
proceeding is frivolous or groundless (sec.
6673(a)).
House
Bill
No provision.
Senate
Amendment
The provision modifies the
IRS
-imposed penalty by increasing the amount of the
penalty to up to $5,000 and by applying it to all
taxpayers and to all types of Federal taxes.
The provision also modifies present law with respect
to certain submissions that raise frivolous
arguments or that are intended to delay or impede
tax administration. The submissions to which this
provision applies are requests for a collection due
process hearing, installment agreements,
offers-in-compromise, and taxpayer assistance
orders. First, the provision permits the
IRS
to dismiss such requests. Second, the provision
permits the
IRS
to impose a penalty of up to $5,000 for such
requests, unless the taxpayer withdraws the request
after being given an opportunity to do so.
The provision requires the
IRS
to publish a list of positions, arguments, requests,
and submissions determined to be frivolous for
purposes of these provisions.
Effective date. --Submissions made and issues
raised after the date on which the Secretary first
prescribes the required list of frivolous positions.
Conference
Agreement
The conference agreement does not include the Senate
amendment provision.
34. Authorization of appropriations for tax law
enforcement (sec. 418 of the Senate amendment)
Present
Law
There is no explicit authorization of appropriations
to the
IRS
to be used to combat abusive tax avoidance
transactions.
House
Bill
No provision.
Senate
Amendment
The provision includes an authorization of an
additional $300 million to the
IRS
to be used to combat abusive tax avoidance
transactions.
Effective date. --Date of enactment.
Conference
Agreement
The conference agreement does not include the Senate
amendment provision.
35. Declaration by chief executive officer
relating to Federal annual corporate income tax
return (sec. 422 of the Senate amendment)
Present
Law
The Code requires652
that the income tax return of a corporation must be
signed by either the president, the vice-president,
the treasurer, the assistant treasurer, the chief
accounting officer, or any other officer of the
corporation authorized by the corporation to sign
the return.
The Code also imposes653
a criminal penalty on any person who willfully signs
any tax return under penalties of perjury that that
person does not believe to be true and correct with
respect to every material matter at the time of
filing. If convicted, the person is guilty of a
felony; the Code imposes a fine of not more than
$100,000654
($500,000 in the case of a corporation) or
imprisonment of not more than three years, or both,
together with the costs of prosecution.
House
Bill
No provision.
Senate
Amendment
The provision requires that a corporation's Federal
income tax return include a declaration signed under
penalties of perjury by the chief executive officer
of the corporation that the corporation has in place
processes and procedures to ensure that the return
complies with the Internal Revenue Code and that the
CEO was provided reasonable assurance of the
accuracy of all material aspects of the return. This
declaration is part of the income tax return. The
provision is in addition to the requirement of
present law as to the signing of the income tax
return itself. Because a CEO's duties generally do
not require a detailed or technical understanding of
the corporation's tax return, it is anticipated that
this declaration of the CEO will be more limited in
scope than the declaration of the officer required
to sign the return itself.
The Secretary of the Treasury shall prescribe the
matters to which the declaration of the CEO applies.
It is intended that the declaration help insure that
the preparation and completion of the corporation's
tax return be given an appropriate level of care.
For example, it is anticipated that the CEO would
declare that processes and procedures have been
implemented to ensure that the return complies with
the Internal Revenue Code and all regulations and
rules promulgated thereunder. Although appropriate
processes and procedures can vary for each taxpayer
depending on the size and nature of the taxpayer's
business, in every case the CEO should be briefed on
all material aspects of the corporation's tax return
by the corporation's chief financial officer (or
another person authorized to sign the return under
present law).
If the corporation does not have a chief executive
officer, the
IRS
may designate another officer of the corporation;
otherwise, no other person is permitted to sign the
declaration. It is intended that the
IRS
issue general guidance, such as a revenue procedure,
to: (1) address situations when a corporation does
not have a chief executive officer; and (2) define
who the chief executive officer is, in situations
(for example) when the primary official bears a
different title, when a corporation has multiple
chief executive officers, or when the corporation is
a foreign corporation and the CEO is not a U.S.
resident.655
It is intended that, in every instance, the highest
ranking corporate officer (regardless of title) sign
this declaration. The provision does not apply to
the income tax returns of mutual funds;656
they are required to be signed as under present law.
Effective date. --Federal tax returns for
taxable years ending after the date of enactment.
Conference
Agreement
The conference agreement does not include the Senate
amendment.
36. Denial of deduction for certain fines,
penalties, and other amounts (sec. 423 of the Senate
amendment and sec. 162 of the Code)
Present
Law
Under present law, no deduction is allowed as a
trade or business expense under section 162(a) for
the payment of a fine or similar penalty to a
government for the violation of any law (sec.
162(f)). The enactment of section 162(f) in 1969
codified existing case law that denied the
deductibility of fines as ordinary and necessary
business expenses on the grounds that
"allowance of the deduction would frustrate
sharply defined national or State policies
proscribing the particular types of conduct
evidenced by some governmental declaration
thereof."657
Treasury regulation section 1.162-21(b)(1) provides
that a fine or similar penalty includes an amount:
(1) paid pursuant to conviction or a plea of guilty
or nolo contendere for a crime (felony or
misdemeanor) in a criminal proceeding; (2) paid as a
civil penalty imposed by Federal, State, or local
law, including additions to tax and additional
amounts and assessable penalties imposed by chapter
68 of the Code; (3) paid in settlement of the
taxpayer's actual or potential liability for a fine
or penalty (civil or criminal); or (4) forfeited as
collateral posted in connection with a proceeding
which could result in imposition of such a fine or
penalty. Treasury regulation section 1.162-21(b)(2)
provides, among other things, that compensatory
damages (including damages under section 4A of the
Clayton Act (15 U.S.C. 15a), as amended) paid to a
government do not constitute a fine or penalty.
House
Bill
No provision.
Senate
Amendment
The bill modifies the rules regarding the
determination whether payments are nondeductible
payments of fines or penalties under section 162(f).
In particular, the bill generally provides that
amounts paid or incurred (whether by suit,
agreement, or otherwise) to, or at the direction of,
a government in relation to the violation of any law
or the investigation or inquiry into the potential
violation of any law658
are nondeductible under any provision of the income
tax provisions.659
The bill applies to deny a deduction for any such
payments, including those where there is no
admission of guilt or liability and those made for
the purpose of avoiding further investigation or
litigation. An exception applies to payments that
the taxpayer establishes are restitution.660
The bill is intended to apply only where a
government (or other entity treated in a manner
similar to a government under the bill) is a
complainant or investigator with respect to the
violation or potential violation of any law.661
It is intended that a payment will be treated as
restitution only if substantially all of the payment
is required to be paid to the specific persons, or
in relation to the specific property, actually
harmed by the conduct of the taxpayer that resulted
in the payment. Thus, a payment to or with respect
to a class substantially broader than the specific
persons or property that were actually harmed (e.g.,
to a class including similarly situated persons or
property) does not qualify as restitution.662
Restitution is limited to the amount that bears a
substantial quantitative relationship to the harm
caused by the past conduct or actions of the
taxpayer that resulted in the payment in question.
If the party harmed is a government or other entity,
then restitution includes payment to such harmed
government or entity, provided the payment bears a
substantial quantitative relationship to the harm.
However, restitution does not include reimbursement
of government investigative or litigation costs, or
payments to whistleblowers.
Amounts paid or incurred (whether by suit,
agreement, or otherwise) to, or at the direction of,
any self-regulatory entity that regulates a
financial market or other market that is a qualified
board or exchange under section 1256(g)(7), and that
is authorized to impose sanctions (e.g., the
National Association of Securities Dealers) are
likewise subject to the provision if paid in
relation to a violation, or investigation or inquiry
into a potential violation, of any law (or any rule
or other requirement of such entity). To the extent
provided in regulations, amounts paid or incurred
to, or at the direction of, any other
nongovernmental entity that exercises
self-regulatory powers as part of performing an
essential governmental function are similarly
subject to the provision. The exception for payments
that the taxpayer establishes are restitution
likewise applies in these cases.
No inference is intended as to the treatment of
payments as nondeductible fines or penalties under
present law. In particular, the Senate amendment is
not intended to limit the scope of present-law
section 162(f) or the regulations thereunder.
Effective date. --The bill is effective for
amounts paid or incurred on or after April 28, 2003;
however the proposal does not apply to amounts paid
or incurred under any binding order or agreement
entered into before such date. Any order or
agreement requiring court approval is not a binding
order or agreement for this purpose unless such
approval was obtained on or before April 27, 2003.
Conference
Agreement
The conference agreement does not include the Senate
amendment provision.
37. Denial of deduction for punitive damages
(sec. 424 of the Senate amendment and sec. 162 of
the Code)
Present
Law
In general, a deduction is allowed for all ordinary
and necessary expenses that are paid or incurred by
the taxpayer during the taxable year in carrying on
any trade or business.663
However, no deduction is allowed for any payment
that is made to an official of any governmental
agency if the payment constitutes an illegal bribe
or kickback or if the payment is to an official or
employee of a foreign government and is illegal
under Federal law.664
In addition, no deduction is allowed under present
law for any fine or similar payment made to a
government for violation of any law.665
Furthermore, no deduction is permitted for
two-thirds of any damage payments made by a taxpayer
who is convicted of a violation of the Clayton
antitrust law or any related antitrust law.666
In general, gross income does not include amounts
received on account of personal physical injuries
and physical sickness.667
However, this exclusion does not apply to punitive
damages.668
House
Bill
No provision.
Senate
Amendment
The Senate amendment denies any deduction for
punitive damages that are paid or incurred by the
taxpayer as a result of a judgment or in settlement
of a claim. If the liability for punitive damages is
covered by insurance, any such punitive damages paid
by the insurer are included in gross income of the
insured person and the insurer is required to report
such amounts to both the insured person and the
IRS
.
Effective date. --The Senate amendment
provision is effective for punitive damages that are
paid or incurred on or after the date of enactment.
Conference
Agreement
The conference agreement does not include the Senate
amendment provision.
38. Increase in criminal monetary penalty
limitation for the underpayment or overpayment of
tax due to fraud (sec. 425 of the Senate amendment)
Present
Law
Attempt to evade or defeat tax
In general, section 7201 imposes a criminal penalty
on persons who willfully attempt to evade or defeat
any tax imposed by the Code. Upon conviction, the
Code provides that the penalty is up to $100,000 or
imprisonment of not more than five years (or both).
In the case of a corporation, the Code increases the
monetary penalty to a maximum of $500,000.
Willful failure to file return, supply
information, or pay tax
In general, section 7203 imposes a criminal penalty
on persons required to make estimated tax payments,
pay taxes, keep records, or supply information under
the Code who willfully fails to do so. Upon
conviction, the Code provides that the penalty is up
to $25,000 or imprisonment of not more than one year
(or both). In the case of a corporation, the Code
increases the monetary penalty to a maximum of
$100,000.
Fraud and false statements
In general, section 7206 imposes a criminal penalty
on persons who make fraudulent or false statements
under the Code. Upon conviction, the Code provides
that the penalty is up to $100,000 or imprisonment
of not more than three years (or both). In the case
of a corporation, the Code increases the monetary
penalty to a maximum of $500,000.
Uniform sentencing guidelines
Under the uniform sentencing guidelines established
by 18 U.S.C. 3571, a defendant found guilty of a
criminal offense is subject to a maximum fine that
is the greatest of: (a) the amount specified in the
underlying provision, (b) for a felony669
$250,000 for an individual or $500,000 for an
organization, or (c) twice the gross gain if a
person derives pecuniary gain from the offense. This
Title 18 provision applies to all criminal
provisions in the United States Code, including
those in the Internal Revenue Code. For example, for
an individual, the maximum fine under present law
upon conviction of violating section 7206 is
$250,000 or, if greater, twice the amount of gross
gain from the offense.
House
Bill
No provision.
Senate
Amendment
Attempt to evade or defeat tax
The bill increases the criminal penalty under
section 7201 of the Code for individuals to $250,000
and for corporations to $1,000,000. The bill
increases the maximum prison sentence to ten years.
Willful failure to file return, supply
information, or pay tax
The bill increases the criminal penalty under
section 7203 of the Code from a misdemeanor to a
felony and increases the maximum prison sentence to
ten years.
Fraud and false statements
The bill increases the criminal penalty under
section 7206 of the Code for individuals to $250,000
and for corporations to $1,000,000. Increases the
maximum prison sentence to five years. The bill
provides that in no event shall the amount of the
monetary penalty under this provision be less than
the amount of the underpayment or overpayment
attributable to fraud.
Effective date
Underpayments and overpayments attributable to
actions occurring after the date of enactment.
Conference
Agreement
The conference agreement does not include the Senate
amendment provision.
39. Expanded disallowance of deduction for
interest on convertible debt (sec. 434 of the Senate
amendment and sec. 163 of the Code)
Present
Law
Whether an instrument qualifies for tax purposes as
debt or equity is determined under all the facts and
circumstances based on principles developed in case
law. If an instrument qualifies as equity, the
issuer generally does not receive a deduction for
dividends paid and the holder generally includes
such dividends in income (although corporate holders
generally may obtain a dividends-received deduction
of at least 70 percent of the amount of the
dividend). If an instrument qualifies as debt, the
issuer may receive a deduction for accrued interest
and the holder generally includes interest in
income, subject to certain limitations.
Original issue discount ("OID") on a debt
instrument is the excess of the stated redemption
price at maturity over the issue price of the
instrument. An issuer of a debt instrument with OID
generally accrues and deducts the discount as
interest over the life of the instrument even though
interest may not be paid until the instrument
matures. The holder of such a debt instrument also
generally includes the OID in income as it accrues.
Under present law, no deduction is allowed for
interest or OID on a debt instrument issued by a
corporation (or issued by a partnership to the
extent of its corporate partners) that is payable in
equity of the issuer or a related party (within the
meaning of sections 267(b) and 707(b)), including a
debt instrument a substantial portion of which is
mandatorily convertible or convertible at the
issuer's option into equity of the issuer or a
related party.670
In addition, a debt instrument is treated as payable
in equity if a substantial portion of the principal
or interest is required to be determined, or may be
determined at the option of the issuer or related
party, by reference to the value of equity of the
issuer or related party.671
A debt instrument also is treated as payable in
equity if it is part of an arrangement that is
designed to result in the payment of the debt
instrument with or by reference to such equity, such
as in the case of certain issuances of a forward
contract in connection with the issuance of debt,
nonrecourse debt that is secured principally by such
equity, or certain debt instruments that are paid
in, converted to, or determined with reference to
the value of equity if it may be so required at the
option of the holder or a related party and there is
a substantial certainty that option will be
exercised.672
House
Bill
No provision.
Senate
Amendment
The Senate amendment expands the present-law
disallowance of interest deductions on certain
convertible or equity-linked corporate debt that is
payable in, or by reference to the value of, equity.
Under the Senate amendment, the disallowance is
expanded to include interest on corporate debt that
is payable in, or by reference to the value of, any
equity held by the issuer (or by any related party)
in any other person, without regard to whether such
equity represents more than a 50-percent ownership
interest in such person. However, the Senate
amendment does not apply to debt that is issued by
an active dealer in securities (or by a related
party) if the debt is payable in, or by reference to
the value of, equity that is held by the securities
dealer in its capacity as a dealer in securities.
Effective date. --The Senate amendment
provision applies to debt instruments that are
issued after
February 13, 2003
.
Conference
Agreement
The conference agreement follows the Senate
amendment, except the conference agreement applies
to debt instruments that are issued after
October 3, 2004
.
40. Expand authority to disallow tax benefits
under section 269 (sec. 435 of the Senate amendment
and sec. 269 of the Code)
Present
Law
Section 269 provides that if a taxpayer acquires,
directly or indirectly, control (defined as at least
50 percent of vote or value) of a corporation, and
the principal purpose of the acquisition is the
evasion or avoidance of Federal income tax by
securing the benefit of a deduction, credit, or
other allowance that would not otherwise have been
available, the Secretary may disallow the tax
benefits.673
Similarly, if a corporation acquires, directly or
indirectly, property of another corporation (not
controlled, directly or indirectly, by the acquiring
corporation or its stockholders immediately before
the acquisition), the basis of such property is
determined by reference to the basis in the hands of
the transferor corporation, and the principal
purpose of the acquisition is the evasion or
avoidance of Federal income tax by securing a tax
benefit that would not otherwise have been
available, the Secretary may disallow such tax
benefits.674
House
Bill
No provision.
Senate
Amendment
The Senate amendment expands section 269 by
repealing the requirement that the acquisition of
property be from a corporation not controlled by the
acquirer. Thus, under the Senate amendment, section
269 disallows the tax benefits of (1) any
acquisition of stock sufficient to obtain control of
a corporation (as under present law), and (2) any
acquisition by a corporation of property from a
corporation in which the basis of such property is
determined by reference to the basis in the hands of
the transferor corporation, if the principal purpose
of such acquisition is the evasion or avoidance of
Federal income tax.
Effective date. --The Senate amendment
applies to stock and property acquired after
February 13, 2003
.
Conference
Agreement
The conference agreement does not include the Senate
amendment provision.
41. Modification of coordination rules for
controlled foreign corporation and passive foreign
investment company regimes (sec. 436 of the Senate
amendment and sec. 1297 of the Code)
Present
Law
The
United States
employs a "worldwide" tax system, under
which domestic corporations generally are taxed on
all income, whether derived in the
United States
or abroad. Income earned by a domestic parent
corporation from foreign operations conducted by
foreign corporate subsidiaries generally is subject
to
U.S.
tax when the income is distributed as a dividend to
the domestic corporation. Until such repatriation,
the
U.S.
tax on such income generally is deferred. However,
certain anti-deferral regimes may cause the domestic
parent corporation to be taxed on a current basis in
the
United States
with respect to certain categories of passive or
highly mobile income earned by its foreign
subsidiaries, regardless of whether the income has
been distributed as a dividend to the domestic
parent corporation. The main anti-deferral regimes
in this context are the controlled foreign
corporation rules of subpart F675
and the passive foreign investment company rules.676
Deferral of
U.S.
tax is considered appropriate, on the other hand,
with respect to most types of active business income
earned abroad. A foreign tax credit generally is
available to offset, in whole or in part, the U.S.
tax owed on foreign-source income, whether earned
directly by the domestic corporation, repatriated as
an actual dividend, or included under one of the
anti-deferral regimes.677
Subpart F,678
applicable to controlled foreign corporations and
their shareholders, is the main anti-deferral regime
of relevance to a U.S.-based multinational corporate
group. A controlled foreign corporation generally is
defined as any foreign corporation if U.S. persons
own (directly, indirectly, or constructively) more
than 50 percent of the corporation's stock (measured
by vote or value), taking into account only those
U.S. persons that own at least 10 percent of the
stock (measured by vote only).679
Under the subpart F rules, the United States
generally taxes the U.S. 10-percent shareholders of
a controlled foreign corporation on their pro rata
shares of certain income of the controlled foreign
corporation (referred to as "subpart F
income"), without regard to whether the income
is distributed to the shareholders.680
Subpart F income generally includes passive income
and other income that is readily movable from one
taxing jurisdiction to another. Subpart F income
consists of foreign base company income,681
insurance income,682
and certain income relating to international
boycotts and other violations of public policy.683
Foreign base company income consists of foreign
personal holding company income, which includes
passive income (e.g., dividends, interest, rents,
and royalties), as well as a number of categories of
non-passive income, including foreign base company
sales income, foreign base company services income,
foreign base company shipping income and foreign
base company oil-related income.684
In effect, the
United States
treats the
U.S.
10-percent shareholders of a controlled foreign
corporation as having received a current
distribution out of the corporation's subpart F
income. In addition, the U.S. 10-percent
shareholders of a controlled foreign corporation are
required to include currently in income for U.S. tax
purposes their pro rata shares of the corporation's
earnings invested in U.S. property.685
The Tax Reform Act of 1986 established an additional
anti-deferral regime, for passive foreign investment
companies. A passive foreign investment company
generally is defined as any foreign corporation if
75 percent or more of its gross income for the
taxable year consists of passive income, or 50
percent or more of its assets consists of assets
that produce, or are held for the production of,
passive income.686
Alternative sets of income inclusion rules apply to
U.S.
persons that are shareholders in a passive foreign
investment company, regardless of their percentage
ownership in the company. One set of rules applies
to passive foreign investment companies that are
"qualified electing funds," under which
electing U.S. shareholders currently include in
gross income their respective shares of the
company's earnings, with a separate election to
defer payment of tax, subject to an interest charge,
on income not currently received.
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