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House Bill

The House bill adds two new exceptions from the definition of U.S. property for determining current income inclusion by a U.S. 10-percent shareholder with respect to an investment in U.S. property by a controlled foreign corporation.

The first exception generally applies to securities acquired and held by a controlled foreign corporation in the ordinary course of its trade or business as a dealer in securities. The exception applies only if the controlled foreign corporation dealer: (1) accounts for the securities as securities held primarily for sale to customers in the ordinary course of business; and (2) disposes of such securities (or such securities mature while being held by the dealer) within a period consistent with the holding of securities for sale to customers in the ordinary course of business.

The second exception generally applies to the acquisition by a controlled foreign corporation of obligations issued by a U.S. person that is not a domestic corporation and that is not (1) a U.S. 10-percent shareholder of the controlled foreign corporation, or (2) a partnership, estate or trust in which the controlled foreign corporation or any related person is a partner, beneficiary or trustee immediately after the acquisition by the controlled foreign corporation of such obligation.

Effective date. --The House bill provision is effective for taxable years of foreign corporations beginning after December 31, 2004 , and for taxable years of United States shareholders with or within which such taxable years of such foreign corporations end.

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.



8. Election not to use average exchange rate for foreign tax paid other than in functional currency (sec. 308 of the House bill, sec. 224 of the Senate amendment, and sec. 986 of the Code)

Present Law

For taxpayers that take foreign income taxes into account when accrued, present law provides that the amount of the foreign tax credit generally is determined by translating the amount of foreign taxes paid in foreign currencies into a U.S. dollar amount at the average exchange rate for the taxable year to which such taxes relate.²³⁶ This rule applies to foreign taxes paid directly by U.S. taxpayers, which taxes are creditable in the year paid or accrued, and to foreign taxes paid by foreign corporations that are deemed paid by a U.S. corporation that is a shareholder of the foreign corporation, and hence creditable in the year that the U.S. corporation receives a dividend or has an income inclusion from the foreign corporation. This rule does not apply to any foreign income tax: (1) that is paid after the date that is two years after the close of the taxable year to which such taxes relate; (2) of an accrual-basis taxpayer that is actually paid in a taxable year prior to the year to which the tax relates; or (3) that is denominated in an inflationary currency (as defined by regulations).

Foreign taxes that are not eligible for translation at the average exchange rate generally are translated into U.S. dollar amounts using the exchange rates as of the time such taxes are paid. However, the Secretary is authorized to issue regulations that would allow foreign tax payments to be translated into U.S. dollar amounts using an average exchange rate for a specified period.²³⁷

House Bill

For taxpayers that are required under present law to translate foreign income tax payments at the average exchange rate, the House bill provides an election to translate such taxes into U.S. dollar amounts using the exchange rates as of the time such taxes are paid, provided the foreign income taxes are denominated in a currency other than the taxpayer's functional currency.²³⁸ Any election under the provision applies to the taxable year for which the election is made and to all subsequent taxable years unless revoked with the consent of the Secretary. The House bill authorizes the Secretary to issue regulations that apply the election to foreign income taxes attributable to a qualified business unit.

Effective date. --The House bill provision is effective with respect to taxable years beginning after December 31, 2004 .

Senate Amendment

The Senate amendment is the same as the House bill.

Effective date. --The Senate amendment provision is effective with respect to taxable years beginning after December 31, 2004 .

Conference Agreement

The conference agreement follows the House bill and the Senate amendment. In addition, the conference agreement provides that the election does not apply to regulated investment companies that take into account income on an accrual basis. Instead, the conference agreement provides that foreign income taxes paid or accrued by a regulated investment company with respect to such income are translated into U.S. dollar amounts using the exchange rate as of the date the income accrues.



9. Eliminate secondary withholding tax with respect to dividends paid by certain foreign corporations (sec. 309 of the House bill, sec. 215 of the Senate amendment, and sec. 871 of the Code)

Present Law

Nonresident individuals who are not U.S. citizens and foreign corporations (collectively, foreign persons) are subject to U.S. tax on income that is effectively connected with the conduct of a U.S. trade or business; the U.S. tax on such income is calculated in the same manner and at the same graduated rates as the tax on U.S. persons (secs. 871(b) and 882). Foreign persons also are subject to a 30-percent gross basis tax, collected by withholding, on certain U.S.-source passive income (e.g., interest and dividends) that is not effectively connected with a U.S. trade or business. This 30-percent withholding tax may be reduced or eliminated pursuant to an applicable tax treaty. Foreign persons generally are not subject to U.S. tax on foreign-source income that is not effectively connected with a U.S. trade or business.

In general, dividends paid by a domestic corporation are treated as being from U.S. sources and dividends paid by a foreign corporation are treated as being from foreign sources. Thus, dividends paid by foreign corporations to foreign persons generally are not subject to withholding tax because such income generally is treated as foreign-source income.

An exception from this general rule applies in the case of dividends paid by certain foreign corporations. If a foreign corporation derives 25 percent or more of its gross income as income effectively connected with a U.S. trade or business for the three-year period ending with the close of the taxable year preceding the declaration of a dividend, then a portion of any dividend paid by the foreign corporation to its shareholders will be treated as U.S.-source income and, in the case of dividends paid to foreign shareholders, will be subject to the 30-percent withholding tax (sec. 861(a)(2)(B)). This rule is sometimes referred to as the "secondary withholding tax." The portion of the dividend treated as U.S.-source income is equal to the ratio of the gross income of the foreign corporation that was effectively connected with its U.S. trade or business over the total gross income of the foreign corporation during the three-year period ending with the close of the preceding taxable year. The U.S.-source portion of the dividend paid by the foreign corporation to its foreign shareholders is subject to the 30-percent withholding tax.

Under the branch profits tax provisions, the United States taxes foreign corporations engaged in a U.S. trade or business on amounts of U.S. earnings and profits that are shifted out of the U.S. branch of the foreign corporation. The branch profits tax is comparable to the second-level taxes imposed on dividends paid by a domestic corporation to its foreign shareholders. The branch profits tax is 30 percent of the foreign corporation's "dividend equivalent amount," which generally is the earnings and profits of a U.S. branch of a foreign corporation attributable to its income effectively connected with a U.S. trade or business (secs. 884(a) and (b)).

If a foreign corporation is subject to the branch profits tax, then no secondary withholding tax is imposed on dividends paid by the foreign corporation to its shareholders (sec. 884(e)(3)(A)). If a foreign corporation is a qualified resident of a tax treaty country and claims an exemption from the branch profits tax pursuant to the treaty, the secondary withholding tax could apply with respect to dividends it pays to its shareholders. Several tax treaties (including treaties that prevent imposition of the branch profits tax), however, exempt dividends paid by the foreign corporation from the secondary withholding tax.

House Bill

The provision eliminates the secondary withholding tax with respect to dividends paid by certain foreign corporations.

Effective date. --The provision is effective for payments made after December 31, 2004 .

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.



10. Equal treatment for interest paid by foreign partnerships and foreign corporations (sec. 310 of the House bill, sec. 228 of the Senate amendment, and sec. 861 of the Code)

Present Law

In general, interest income from bonds, notes or other interest-bearing obligations of noncorporate U.S. residents or domestic corporations is treated as U.S.-source income.²³⁹ Other interest (e.g., interest on obligations of foreign corporations and foreign partnerships) generally is treated as foreign-source income. However, Treasury regulations provide that a foreign partnership is a U.S. resident for purposes of this rule if at any time during its taxable year it is engaged in a trade or business in the United States.²⁴⁰ Therefore, any interest received from such a foreign partnership is U.S.-source income.

Notwithstanding the general rule described above, in the case of a foreign corporation engaged in a U.S. trade or business (or having gross income that is treated as effectively connected with the conduct of a U.S. trade or business), interest paid by such U.S. trade or business is treated as if it were paid by a domestic corporation (i.e., such interest is treated as U.S.-source income).²⁴¹

House Bill

The House bill treats interest paid by foreign partnerships in a manner similar to the treatment of interest paid by foreign corporations. Thus, interest paid by a foreign partnership is treated as U.S.-source income only if the interest is paid by a U.S. trade or business conducted by the partnership or is allocable to income that is treated as effectively connected with the conduct of a U.S. trade or business. The House bill applies only to foreign partnerships that are predominantly engaged in the active conduct of a trade or business outside the United States .

Effective date. --This House bill provision is effective for taxable years beginning after December 31, 2003 .

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.



11. Look-through treatment of payments between related controlled foreign corporations (sec. 311 of the House bill, sec. 222 of the Senate amendment, and sec. 954 of the Code)

Present Law

In general, the rules of subpart F (secs. 951-964) require U.S. shareholders with a 10-percent or greater interest in a controlled foreign corporation to include certain income of the controlled foreign corporation (referred to as "subpart F income") on a current basis for U.S. tax purposes, regardless of whether the income is distributed to the shareholders.

Subpart F income includes foreign base company income. One category of foreign base company income is foreign personal holding company income. For subpart F purposes, foreign personal holding company income generally includes dividends, interest, rents and royalties, among other types of income. However, foreign personal holding company income does not include dividends and interest received by a controlled foreign corporation from a related corporation organized and operating in the same foreign country in which the controlled foreign corporation is organized, or rents and royalties received by a controlled foreign corporation from a related corporation for the use of property within the country in which the controlled foreign corporation is organized. Interest, rent, and royalty payments do not qualify for this exclusion to the extent that such payments reduce the subpart F income of the payor.

House Bill

Under the provision, dividends, interest, rents, and royalties received by one controlled foreign corporation from a related controlled foreign corporation are not treated as foreign personal holding company income to the extent attributable or properly allocable to non-subpart-F income of the payor. For these purposes, a related controlled foreign corporation is a controlled foreign corporation that controls or is controlled by the other controlled foreign corporation, or a controlled foreign corporation that is controlled by the same person or persons that control the other controlled foreign corporation. Ownership of more than 50 percent of the controlled foreign corporation's stock (by vote or value) constitutes control for these purposes.

Effective date. --The provision is effective for taxable years of foreign corporations beginning after December 31, 2004 , and taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end.

Senate Amendment

The Senate amendment is the same as the House bill.

Conference Agreement

The conference agreement does not include the House bill or Senate amendment provision.



12. Look-through treatment under subpart F for sales of partnership interests (sec. 312 of the House bill, sec. 223 of the Senate amendment, and sec. 954 of the Code)

Present Law

In general, the subpart F rules (secs. 951-964) require U.S. shareholders with a 10-percent or greater interest in a controlled foreign corporation to include in income currently for U.S. tax purposes certain types of income of the controlled foreign corporation, whether or not such income is actually distributed currently to the shareholders (referred to as "subpart F income"). Subpart F income includes foreign personal holding company income. Foreign personal holding company income generally consists of the following: (1) dividends, interest, royalties, rents, and annuities; (2) net gains from the sale or exchange of (a) property that gives rise to the preceding types of income, (b) property that does not give rise to income, and (c) interests in trusts, partnerships, and real estate mortgages investment conduits ("REMICs"); (3) net gains from commodities transactions; (4) net gains from foreign currency transactions; (5) income that is equivalent to interest; (6) income from notional principal contracts; and (7) payments in lieu of dividends. Thus, if a controlled foreign corporation sells a partnership interest at a gain, the gain generally constitutes foreign personal holding company income and is included in the income of 10-percent U.S. shareholders of the controlled foreign corporation as subpart F income.

House Bill

The provision treats the sale by a controlled foreign corporation of a partnership interest as a sale of the proportionate share of partnership assets attributable to such interest for purposes of determining subpart F foreign personal holding company income. This rule applies only to partners owning directly, indirectly, or constructively at least 25 percent of a capital or profits interest in the partnership. Thus, the sale of a partnership interest by a controlled foreign corporation that meets this ownership threshold constitutes subpart F income under the provision only to the extent that a proportionate sale of the underlying partnership assets attributable to the partnership interest would constitute subpart F income. The Treasury Secretary is directed to prescribe such regulations as may be appropriate to prevent the abuse of this provision.

Effective date. --The provision is effective for taxable years of foreign corporations beginning after December 31, 2004 , and taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end.

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.



13. Repeal of foreign personal holding company rules and foreign investment company rules (sec. 313 of the House bill, sec. 211 of the Senate amendment, and secs. 542, 551-558, 954, 1246, and 1247 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. persons that hold 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 those 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. The foreign tax credit may reduce the U.S. tax imposed on such income.

Several sets of anti-deferral rules impose current U.S. tax on certain income earned by a U.S. person through a foreign corporation. Detailed rules for coordination among the antideferral rules are provided to prevent the U.S. person from being subject to U.S. tax on the same item of income under multiple rules.

The Code sets forth the following anti-deferral rules: the controlled foreign corporation rules of subpart F (secs. 951-964); the passive foreign investment company rules (secs. 1291-1298); the foreign personal holding company rules (secs. 551-558); the personal holding company rules (secs. 541-547); the accumulated earnings tax rules (secs. 531-537); and the foreign investment company rules (secs. 1246-1247).

House Bill

The provision: (1) eliminates the rules applicable to foreign personal holding companies and foreign investment companies; (2) excludes foreign corporations from the application of the personal holding company rules; and (3) includes as subpart F foreign personal holding company income personal services contract income that is subject to the present-law foreign personal holding company rules.

Effective date. --The provision is effective for taxable years of foreign corporations beginning after December 31, 2004 , and taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end.

Senate Amendment

The Senate amendment provision is the same as the House bill provision.

Conference Agreement

The conference agreement follows the House bill and the Senate amendment.



14. Determination of foreign personal holding company income with respect to transactions in commodities (sec. 314 of the House bill, sec. 206 of the Senate amendment, and sec. 954 of the Code)

Present Law

Subpart F foreign personal holding company income

Under the subpart F rules, U.S. shareholders with a 10-percent or greater interest in a controlled foreign corporation ("U.S. 10-percent shareholders") are subject to U.S. tax currently on certain income earned by the controlled foreign corporation, whether or not such income is distributed to the shareholders. The income subject to current inclusion under the subpart F rules includes, among other things, "foreign personal holding company income."

Foreign personal holding company income generally consists of the following: dividends, interest, royalties, rents and annuities; net gains from sales or exchanges of (1) property that gives rise to the foregoing types of income, (2) property that does not give rise to income, and (3) interests in trusts, partnerships, and real estate mortgage investment conduits ("REMICs"); net gains from commodities transactions; net gains from foreign currency transactions; income that is equivalent to interest; income from notional principal contracts; and payments in lieu of dividends.

With respect to transactions in commodities, foreign personal holding company income does not consist of gains or losses which arise out of bona fide hedging transactions that are reasonably necessary to the conduct of any business by a producer, processor, merchant, or handler of a commodity in the manner in which such business is customarily and usually conducted by others.²⁴² In addition, foreign personal holding company income does not consist of gains or losses which are comprised of active business gains or losses from the sale of commodities, but only if substantially all of the controlled foreign corporation's business is as an active producer, processor, merchant, or handler of commodities.²⁴³



Hedging transactions

Under present law, the term "capital asset" does not include any hedging transaction which is clearly identified as such before the close of the day on which it was acquired, originated, or entered into (or such other time as the Secretary may by regulations prescribe).²⁴⁴ The term "hedging transaction" means any transaction entered into by the taxpayer in the normal course of the taxpayer's trade or business primarily: (1) to manage risk of price changes or currency fluctuations with respect to ordinary property which is held or to be held by the taxpayer; (2) to manage risk of interest rate or price changes or currency fluctuations with respect to borrowings made or to be made, or ordinary obligations incurred or to be incurred, by the taxpayer; or (3) to manage such other risks as the Secretary may prescribe in regulations.²⁴⁵

House Bill

The House bill modifies the requirements that must be satisfied for gains or losses from a commodities hedging transaction to qualify for exclusion from the definition of subpart F foreign personal holding company income. Under the House bill, gains or losses from a transaction with respect to a commodity are not treated as foreign personal holding company income if the transaction satisfies the general definition of a hedging transaction under section 1221(b)(2). For purposes of the House bill, the general definition of a hedging transaction under section 1221(b)(2) is modified to include any transaction with respect to a commodity entered into by a controlled foreign corporation in the normal course of the controlled foreign corporation's trade or business primarily: (1) to manage risk of price changes or currency fluctuations with respect to ordinary property or property described in section 1231(b) which is held or to be held by the controlled foreign corporation; or (2) to manage such other risks as the Secretary may prescribe in regulations. Gains or losses from a transaction that satisfies the modified definition of a hedging transaction are excluded from the definition of foreign personal holding company income only if the transaction is clearly identified as a hedging transaction in accordance with the hedge identification requirements that apply generally to hedging transactions under section 1221(b)(2).²⁴⁶

The House bill also changes the requirements that must be satisfied for active business gains or losses from the sale of commodities to qualify for exclusion from the definition of foreign personal holding company income. Under the House bill, such gains or losses are not treated as foreign personal holding company income if substantially all of the controlled foreign corporation's commodities are comprised of: (1) stock in trade of the controlled foreign corporation or other property of a kind which would properly be included in the inventory of the controlled foreign corporation if on hand at the close of the taxable year, or property held by the controlled foreign corporation primarily for sale to customers in the ordinary course of the controlled foreign corporation's trade or business; (2) property that is used in the trade or business of the controlled foreign corporation and is of a character which is subject to the allowance for depreciation under section 167; or (3) supplies of a type regularly used or consumed by the controlled foreign corporation in the ordinary course of a trade or business of the controlled foreign corporation.²⁴⁷

For purposes of applying the requirements for active business gains or losses from commodities sales to qualify for exclusion from the definition of foreign personal holding company income, the House bill also provides that commodities with respect to which gains or losses are not taken into account as foreign personal holding company income by a regular dealer in commodities (or financial instruments referenced to commodities) are not taken into account in determining whether substantially all of the dealer's commodities are comprised of the property described above.

Effective date. --The House bill provision is effective with respect to transactions entered into after December 31, 2004.

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.



15. Modifications to treatment of aircraft leasing and shipping income (sec. 315 of the House bill, sec. 221 of the Senate amendment, and sec. 954 of the Code)

Present Law

In general, the subpart F rules (secs. 951-964) require U.S. shareholders with a 10-percent or greater interest in a controlled foreign corporation ("CFC") to include currently in income for U.S. tax purposes certain income of the CFC (referred to as "subpart F income"), without regard to whether the income is distributed to the shareholders (sec. 951(a)(1)(A)). In effect, the Code treats the U.S. 10-percent shareholders of a CFC as having received a current distribution of their pro rata shares of the CFC's subpart F income. The amounts included in income by the CFC's U.S. 10-percent shareholders under these rules are subject to U.S. tax currently. The U.S. tax on such amounts may be reduced through foreign tax credits.

Subpart F income includes foreign base company shipping income (sec. 954(f)). Foreign base company shipping income generally includes income derived from the use of an aircraft or vessel in foreign commerce, the performance of services directly related to the use of any such aircraft or vessel, the sale or other disposition of any such aircraft or vessel, and certain space or ocean activities (e.g., leasing of satellites for use in space). Foreign commerce generally involves the transportation of property or passengers between a port (or airport) in the U.S. and a port (or airport) in a foreign country, two ports (or airports) within the same foreign country, or two ports (or airports) in different foreign countries. In addition, foreign base company shipping income includes dividends and interest that a CFC receives from certain foreign corporations and any gains from the disposition of stock in certain foreign corporations, to the extent the dividends, interest, or gains are attributable to foreign base company shipping income. Foreign base company shipping income also includes incidental income derived in the course of active foreign base company shipping operations (e.g., income from temporary investments in or sales of related shipping assets), foreign exchange gain or loss attributable to foreign base company shipping operations, and a CFC's distributive share of gross income of any partnership and gross income received from certain trusts to the extent that the income would have been foreign base company shipping income had it been realized directly by the corporation.

Subpart F income also includes foreign personal holding company income (sec. 954(c)). For subpart F purposes, foreign personal holding company income generally consists of the following: (1) dividends, interest, royalties, rents and annuities; (2) net gains from the sale or exchange of (a) property that gives rise to the preceding types of income, (b) property that does not give rise to income, and (c) interests in trusts, partnerships, and real estate mortgage investment conduits ("REMICs"); (3) net gains from commodities transactions; (4) net gains from foreign currency transactions; (5) income that is equivalent to interest; (6) income from notional principal contracts; and (7) payments in lieu of dividends.

Subpart F foreign personal holding company income does not include rents and royalties received by a CFC in the active conduct of a trade or business from unrelated persons (sec. 954(c)(2)(A)). The determination of whether rents or royalties are derived in the active conduct of a trade or business is based on all the facts and circumstances. However, the Treasury regulations provide certain types of rents are treated as derived in the active conduct of a trade or business. These include rents derived from property that is leased as a result of the performance of marketing functions by the lessor if the lessor (through its own officers or employees located in a foreign country) maintains and operates an organization in such country that regularly engages in the business of marketing, or marketing and servicing, the leased property and that is substantial in relation to the amount of rents derived from the leasing of such property. An organization in a foreign country is substantial in relation to rents if the active leasing expenses²⁴⁸ equal at least 25 percent of the adjusted leasing profit.²⁴⁹

Also generally excluded from subpart F foreign personal holding company income are rents and royalties received by the CFC from a related corporation for the use of property within the country in which the CFC was organized (sec. 954(c)(3)). However, rent and royalty payments do not qualify for this exclusion to the extent that such payments reduce subpart F income of the payor.

House Bill

The provision repeals the subpart F rules relating to foreign base company shipping income. The bill also amends the exception from foreign personal holding company income applicable to rents or royalties derived from unrelated persons in an active trade or business by providing a safe harbor for rents derived from leasing an aircraft or vessel in foreign commerce. Such rents are excluded from foreign personal holding company income if the active leasing expenses comprise at least 10 percent of the profit on the lease. This provision is to be applied in accordance with existing regulations under section 954(c)(2)(A) by comparing the lessor's "active leasing expenses" for its pool of leased assets to its "adjusted leasing profit."

The safe harbor will not prevent a lessor from otherwise showing that it actively carries on a trade or business. In this regard, the requirements of section 954(c)(2)(A) will be met if a lessor regularly and directly performs active and substantial marketing, remarketing, management and operational functions with respect to the leasing of an aircraft or vessel (or component engines). This will be the case regardless of whether the lessor engages in marketing of the lease as a form of financing (versus marketing the property as such) or whether the lease is classified as a finance lease or operating lease for financial accounting purposes. If a lessor acquires, from an unrelated or related party, a ship or aircraft subject to an existing FSC or ETI lease, the requirements of section 954(c)(2)(A) will be satisfied if, following the acquisition, the lessor performs active and substantial management, operational, and remarketing functions with respect to the leased property. If such a lease is transferred to a CFC lessor, it will no longer be eligible for FSC or ETI benefits.

An aircraft or vessel is considered to be leased in foreign commerce if it is used for the transportation of property or passengers between a port (or airport) in the United States and one in a foreign country or between foreign ports (or airports), provided the aircraft or vessel is used predominantly outside the United States. An aircraft or vessel will be considered used predominantly outside the United States if more than 50 percent of the miles during the taxable year are traversed outside the United States or the aircraft or vessel is located outside the United States more than 50 percent of the time during such taxable year.

It is expected that the Secretary of the Treasury will issue timely guidance to make conforming changes to existing regulations, including guidance that aircraft or vessel leasing activity that satisfies the requirements of section 954(c)(2)(A) shall also satisfy the requirements for avoiding income inclusion under section 956 and section 367(a).

It is anticipated that taxpayers now eligible for the benefits of the ETI exclusion (or the FSC provisions pursuant to the FSC Repeal and Extraterritorial Income Exclusion Act of 2000), will find it appropriate, as matter of sound business judgment, to restructure their business operations to take into account the tax law changes brought about by the bill. It is noted that courts have recognized the validity of structuring operations for the purpose of obtaining the benefit of tax regimes expressly intended by Congress. It is intended that structuring or restructuring of operations for the purposes of adapting to the repeal of the ETI exclusion (or the FSC regime) will be considered to serve a valid business purpose and will not constitute tax avoidance, where the restructured operations conform to the requirements expressly mandated by Congress for obtaining tax benefits that remain available. For example, it is intended that a restructuring undertaken to transfer aircraft subject to existing FSC or ETI leases to a CFC lessor, to take advantage of the amendments made by this bill, would serve a valid business purpose and would not constitute tax avoidance, for purposes of determining whether a particular tax treatment (such as nonrecognition of gain) applies to such restructuring. It is intended, for example, that if such a restructuring meets the other requirements necessary to qualify as a "reorganization" under section 368, the transaction will also be deemed to meet the "business purpose" requirements under section 368, and thus, qualify as a reorganization under that section.

Effective date. --The provision is effective for taxable years of foreign corporations beginning after December 31, 2004, and taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end.

Senate Amendment

The provision provides that "qualified leasing income" derived from or in connection with the leasing or rental of any aircraft or vessel is not treated as foreign personal holding company income or foreign base company shipping income of a controlled foreign corporation. The provision defines "qualified leasing income" as rents or gains derived in the active conduct of a leasing trade or business with respect to which the controlled foreign corporation conducts substantial activity, provided that the leased property is used by the lessee or other end-user in foreign commerce and predominantly outside the United States, and such lessee or other enduser is not related to the controlled foreign corporation (within the meaning of sec. 954(d)(3)).

In determining whether an aircraft or vessel is used in foreign commerce, it is intended that foreign commerce encompass the use of an aircraft or vessel in the transportation of property or passengers: (1) between an airport or port in the United States (including for this purpose any possession of the United States) and an airport or port in a foreign country; (2) between an airport or port in a foreign country and another in the same country; or (3) between an airport or port in a foreign country and another in a different foreign country. It is intended that an aircraft or vessel be considered as used predominantly outside the United States if more than 70 percent of its miles traveled during the taxable year are traveled outside the United States, or if the aircraft or vessel is located outside the United States for more than 70 percent of the time during the taxable year.

Effective date. --The provision is effective for taxable years of foreign corporations beginning after December 31, 2006 , and taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end.

Conference Agreement

The conference agreement follows the House bill with the following clarifications. First, the terms "aircraft or vessels" include engines that are leased separately from an aircraft or vessel. Second, if a lessor acquires (from a related or unrelated party) or aircraft or vessel subject to an existing lease, the requirements of section 954(c)(2)(A) are satisfied if, following the acquisition, the lessor performs active and substantial management, operational, and remarketing functions with respect to the leased property. However, if an existing FSC or ETI lease is transferred to a CFC lessor, the lease will no longer be eligible for FSC or ETI benefits.



16. Modification of exceptions under subpart F for active financing (sec. 316 of the House bill, sec. 226 of the Senate amendment, and sec. 954 of the Code)

Present Law

Under the subpart F rules, U.S. shareholders with a 10-percent or greater interest in a controlled foreign corporation ("CFC") are subject to U.S. tax currently on certain income earned by the CFC, whether or not such income is distributed to the shareholders. The income subject to current inclusion under the subpart F rules includes, among other things, foreign personal holding company income and insurance income. In addition, 10-percent U.S. shareholders of a CFC are subject to current inclusion with respect to their shares of the CFC's foreign base company services income (i.e., income derived from services performed for a related person outside the country in which the CFC is organized).

Foreign personal holding company income generally consists of the following: (1) dividends, interest, royalties, rents, and annuities; (2) net gains from the sale or exchange of (a) property that gives rise to the preceding types of income, (b) property that does not give rise to income, and (c) interests in trusts, partnerships, and real estate mortgage investment conduits ("REMICs"); (3) net gains from commodities transactions; (4) net gains from foreign currency transactions; (5) income that is equivalent to interest; (6) income from notional principal contracts; and (7) payments in lieu of dividends.

Insurance income subject to current inclusion under the subpart F rules includes any income of a CFC attributable to the issuing or reinsuring of any insurance or annuity contract in connection with risks located in a country other than the CFC's country of organization. Subpart F insurance income also includes income attributable to an insurance contract in connection with risks located within the CFC's country of organization, as the result of an arrangement under which another corporation receives a substantially equal amount of consideration for insurance of other country risks. Investment income of a CFC that is allocable to any insurance or annuity contract related to risks located outside the CFC's country of organization is taxable as subpart F insurance income (Treas. Reg. sec. 1.953-1(a)).

Temporary exceptions from foreign personal holding company income, foreign base company services income, and insurance income apply for subpart F purposes for certain income that is derived in the active conduct of a banking, financing, or similar business, or in the conduct of an insurance business (so-called "active financing income").²⁵⁰

With respect to income derived in the active conduct of a banking, financing, or similar business, a CFC is required to be predominantly engaged in such business and to conduct substantial activity with respect to such business in order to qualify for the exceptions. In addition, certain nexus requirements apply, which provide that income derived by a CFC or a qualified business unit ("QBU") of a CFC from transactions with customers is eligible for the exceptions if, among other things, substantially all of the activities in connection with such transactions are conducted directly by the CFC or QBU in its home country, and such income is treated as earned by the CFC or QBU in its home country for purposes of such country's tax laws. Moreover, the exceptions apply to income derived from certain cross border transactions, provided that certain requirements are met. Additional exceptions from foreign personal holding company income apply for certain income derived by a securities dealer within the meaning of section 475 and for gain from the sale of active financing assets.

In the case of insurance, in addition to temporary exceptions from insurance income and from foreign personal holding company income for certain income of a qualifying insurance company with respect to risks located within the CFC's country of creation or organization, temporary exceptions from insurance income and from foreign personal holding company income apply for certain income of a qualifying branch of a qualifying insurance company with respect to risks located within the home country of the branch, provided certain requirements are met under each of the exceptions. Further, additional temporary exceptions from insurance income and from foreign personal holding company income apply for certain income of certain CFCs or branches with respect to risks located in a country other than the United States, provided that the requirements for these exceptions are met.

House Bill

The House bill modifies the present-law temporary exceptions from subpart F foreign personal holding company income and foreign base company services income for income derived in the active conduct of a banking, financing, or similar business. For purposes of determining whether a CFC or QBU has conducted directly in its home country substantially all of the activities in connection with transactions with customers, the House bill provides that an activity is treated as conducted directly by the CFC or QBU in its home country if the activity is performed by employees of a related person and: (1) the related person is itself an eligible CFC the home country of which is the same as that of the CFC or QBU; (2) the activity is performed in the home country of the related person; and (3) the related person is compensated on an arm's length basis for the performance of the activity by its employees and such compensation is treated as earned by such person in its home country for purposes of the tax laws of such country. For purposes of determining whether a CFC or QBU is eligible to earn active financing income, such activity may not be taken into account by any CFC or QBU (including the employer of the employees performing the activity) other than the CFC or QBU for which the activities are performed.

Effective date. --The House bill provision is effective for taxable years of foreign corporations beginning after December 31, 2004 , and taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end.

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.



17. Ten-year foreign tax credit carryover; one-year foreign tax credit carryback (sec. 201 of the Senate amendment and sec. 904 of the Code)

Present Law

U.S. persons may credit foreign taxes against U.S. tax on foreign-source income. The amount of foreign tax credits that 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. The amount of foreign tax credits generally is limited to a portion of the taxpayer's U.S. tax which portion is calculated by multiplying the taxpayer's total U.S. tax by a fraction, the numerator of which is the taxpayer's foreign-source taxable income (i.e., foreign-source gross income less allocable expenses or deductions) and the denominator of which is the taxpayer's worldwide taxable income for the year.²⁵¹

In addition, this limitation is calculated separately for various categories of income, generally referred to as "separate limitation categories." The total amount of the foreign tax credit used to offset the U.S. tax on income in each separate limitation category may not exceed the proportion of the taxpayer's U.S. tax which the taxpayer's foreign-source taxable income in that category bears to its worldwide taxable income.

The amount of creditable taxes paid or accrued (or deemed paid) in any taxable year which exceeds the foreign tax credit limitation is permitted to be carried back to the two immediately preceding taxable years (to the earliest year first) and carried forward five taxable years (in chronological order) and credited (not deducted) to the extent that the taxpayer otherwise has excess foreign tax credit limitation for those years. Excess credits that are carried back or forward are usable only to the extent that there is excess foreign tax credit limitation in such carryover or carryback year. Consequently, foreign tax credits arising in a taxable year are utilized before excess credits from another taxable year may be carried forward or backward. In addition, excess credits are carried forward or carried back on a separate limitation basis. Thus, if a taxpayer has excess foreign tax credits in one separate limitation category for a taxable year, those excess credits may be carried back and forward only as taxes allocable to that category, notwithstanding the fact that the taxpayer may have excess foreign tax credit limitation in another category for that year. If credits cannot be so utilized, they are permanently disallowed.

House Bill

No provision.

Senate Amendment

The provision extends the excess foreign tax credit carryforward period to twenty years and limits the carryback period to one year.

Effective date. --The extension of the carryforward period is effective for excess foreign tax credits that may be carried to any taxable years ending after the date of enactment of the provision; the limited carryback period is effective for excess foreign tax credits arising in taxable years beginning after the date of enactment of the provision.

Conference Agreement

The conference agreement follows the Senate amendment, with the modification that the foreign tax credit carryforward period is extended to 10 years.



18. Expand the subpart F de minimis rule to the lesser of five percent of gross income or $5 million (sec. 212 of the Senate amendment and sec. 954 of the Code)

Present Law

Under the rules of subpart F (secs. 951-964), U.S. 10-percent shareholders of a controlled foreign corporation are required to include in income currently for U.S. tax purposes certain types of income of the controlled foreign corporation, whether or not such income is actually distributed currently to the shareholders (referred to as "subpart F income"). Subpart F income includes foreign base company income and certain insurance income. Foreign base company income includes five categories of income: foreign personal holding company income, foreign base company sales income, foreign base company services income, foreign base company shipping income, and foreign base company oil-related income (sec. 954(a)). Under a de minimis rule, if the gross amount of a controlled foreign corporation's foreign base company income and insurance income for a taxable year is less than the lesser of five percent of the controlled foreign corporation's gross income or $1 million, then no part of the controlled foreign corporation's gross income is treated as foreign base company income or insurance income (sec. 954(b)(3)(A)).

House Bill

No provision.

Senate Amendment

The provision expands the subpart F de minimis rule to provide that, if the gross amount of a controlled foreign corporation's foreign base company income and insurance income for a taxable year is less than the lesser of five percent of the controlled foreign corporation's gross income or $5 million, then no part of the controlled foreign corporation's gross income is treated as foreign base company income or insurance income.

Effective date. --The provision is effective for taxable years of foreign corporations beginning after December 31, 2004 , and taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end.

Conference Agreement

The conference agreement does not contain the Senate amendment provision.



19. Limit application of uniform capitalization rules in the case of foreign persons (sec. 214 of the Senate amendment and sec. 263A of the Code)

Present Law

Taxpayers generally may not currently deduct the costs incurred in producing property or acquiring property for resale. In general, the uniform capitalization rules require that a portion of the direct and indirect costs of producing property or acquiring property for resale be capitalized or included in the cost of inventory (sec. 263A). Consequently, such costs must be recovered through an offset to the sales price if the property is produced for sale, or through depreciation or amortization if the property is produced for the taxpayer's own use in a business or investment activity. The purpose of this requirement is to match the costs of producing or acquiring goods with the revenues realized from their sale or use in the business or investment activity.

The uniform capitalization rules apply to foreign corporations, whether or not engaged in business in the United States. In the case of a foreign corporation carrying on a U.S. trade or business, for example, the uniform capitalization rules apply for purposes of computing the corporation's U.S. effectively connected taxable income, as well as computing its effectively connected earnings and profits for purposes of the branch profits tax.

When a foreign corporation is not engaged in a trade or business in the United States, its taxable income and earnings and profits may nonetheless be relevant under the Code. For example, the subpart F income of a controlled foreign corporation may be currently includible on the return of a U.S. shareholder of the controlled foreign corporation. Regardless of whether or not a foreign corporation is U.S.-controlled, its accumulated earnings and profits must be computed in order to determine the amount of taxable dividends and the indirect foreign tax credit carried by distributions from the foreign corporation to any domestic corporation that owns at least 10 percent of its voting stock.

The earnings and profits surplus or deficit of any foreign corporation for any taxable year generally is determined according to rules substantially similar to those applicable to domestic corporations. However, proposed regulations provide that, for purposes of computing a foreign corporation's earnings and profits, the amount of expenses that must be capitalized into inventory under the uniform capitalization rules may not exceed the amount capitalized in keeping the taxpayer's books and records.²⁵² For this purpose, the taxpayer's books and records must be prepared in accordance with U.S. generally accepted accounting principles for purposes of reflecting in the financial statements of a domestic corporation the operations of its foreign affiliates. This proposed regulation applies only for purposes of determining a foreign corporation's earnings and profits and does not apply for purposes of determining subpart F income or income effectively connected with a U.S. trade or business of a foreign corporation.

House Bill

No provision.

Senate Amendment

The provision provides that, in lieu of the uniform capitalization rules, costs incurred in producing property or acquiring property for resale are capitalized using U.S. generally accepted accounting principles (i.e., the method used to ascertain income, profit, or loss for purposes of reports or statements to shareholders, partners, other proprietors, or beneficiaries, or for credit purposes) for purposes of determining a U.S.-owned foreign corporation's earnings and profits and subpart F income. The uniform capitalization rules continue to apply to foreign corporations for purposes of determining income effectively connected with a U.S. trade or business and the related earnings and profits therefrom. Any change in the taxpayer's method of accounting required as a result of this provision is treated as a voluntary change initiated by the taxpayer and is deemed made with the consent of the Secretary of the Treasury (i.e., no application for change in method of accounting is required to be filed with the Secretary). Any resultant section 481(a) adjustment required to be taken into account is to be taken into account in the first year.

Effective date. --The provision applies to taxable years beginning after December 31, 2004 .

Conference Agreement

The conference agreement does not contain the Senate amendment provision.



20. Eliminate the 30-percent tax on certain U.S.-source capital gains of nonresident individuals (sec. 216 of the Senate amendment and sec. 871 of the Code)

Present Law

In general, resident aliens are taxed in the same manner as U.S. citizens. Nonresident aliens are subject to (1) U.S. tax on income from U.S. sources that are effectively connected with a U.S. trade or business, and (2) a 30-percent withholding tax on the gross amount of certain types of passive income derived from U.S. sources, such as interest, dividends, rents, and other fixed or determinable annual or periodical income (sec. 871(a)(1)). Bilateral income tax treaties may modify these tax rules.

Income derived from the sale of personal property other than inventory property generally is sourced based on the residence of the seller (sec. 865(a)). Thus, nonresident aliens generally are not taxable on capital gains because the gains generally are considered to be foreign-source income.²⁵³

Special rules apply in the case of sales of personal property by certain foreign persons. In this regard, an individual who is otherwise treated as a nonresident is treated as a U.S. resident for purposes of sourcing income from the sale of personal property if the individual has a tax home in the United States (sec. 865(g)(1)(A)(i)(II)). An individual's U.S. tax home generally is the place where the individual has his or her principal place of business. For example, if a nonresident individual with a tax home in the United States sells stocks or other securities for a gain, the individual will be treated as a U.S. resident with respect to the sale such that the gain will be treated as U.S.-source income potentially subject to U.S. tax.

Under the special capital gains tax of section 871(a)(2), a nonresident individual who is physically present in the United States for 183 days or more during a taxable year is subject to a 30-percent tax on the excess of U.S.-source capital gains over U.S.-source capital losses. This 30-percent tax is not a withholding tax. The tax under section 871(a)(2) does not apply to gains and losses subject to the gross 30-percent withholding tax under section 871(a)(1) or to gains effectively connected with a U.S. trade or business. Capital gains and losses are taken into account only to the extent that they would be recognized and taken into account if such gains and losses were effectively connected with a U.S. trade or business. Capital loss carryovers are not taken into account.

As a practical matter, the special rule under section 871(a)(2) applies only in a very limited set of cases. In order for the rule to apply, two conditions must be satisfied: (1) the individual must spend at least 183 days in the United States during a taxable year without being treated as a U.S. resident, and (2) the individual's capital gains must be from U.S. sources. If these conditions are satisfied, then the 30-percent tax applies to the excess of U.S.-source capital gains over U.S.-source capital losses. However, section 871(a)(2) generally is not applicable because if the individual spends 183 days or more in the United States in most cases he or she would be treated as a U.S. resident, or if not treated as a U.S. resident, would generally not have U.S.-source capital gains.

An individual who is not a citizen and who spends 183 days or more in the United States during a calendar year generally would be treated as a U.S. resident under the substantial presence test of section 7701(b). Thus, in most cases, the individual who spends at least 183 days in the United States would not be subject to section 871(a)(2).²⁵⁴ However, under the substantial presence test under section 7701(b), certain days of physical presence in the United States are not counted for purposes of meeting the 183-day rule. This includes days spent in the United States in which the individual regularly commutes to employment (or self-employment) in the United States from Canada or Mexico; the individual is in transit between two points outside the United States and is physically present in the United States for less than 24 hours; the individual is temporarily present in the United States as a regular member of the crew of a foreign vessel engaged in transportation between the United States and a foreign country or U.S. possession; and certain exempt individuals. These exceptions from counting physical presence in the United States do not apply, however, for purposes of the special rule under section 871(a)(2). Thus, it is possible in certain cases for an individual to be present in the United States for at least 183 days without being treated as a U.S. resident under the substantial presence test of section 7701(b).²⁵⁵

Even if an individual spends at least 183 days in the United States but is not treated as a U.S. resident under section 7701(b), the nonresident individual's capital gains generally will be treated as foreign-source income and, thus, not subject to section 871(a)(2). In this regard, capital gains generally are from foreign sources if the individual is a nonresident, and from U.S. sources if the individual is a U.S. resident. Under a special rule, an individual is treated as a U.S. resident for sales of personal property (including sales giving rise to capital gains) if the individual has a tax home in the United States. This rule applies even if the individual is treated as a nonresident for other U.S. tax purposes. An individual's capital gains would be treated as U.S.-source income and potentially subject to section 871(a)(2) if the individual is treated as a U.S. resident under this special rule.²⁵⁶

Even in the limited cases in which the special rule under section 871(a)(2) could potentially apply, a tax treaty might prevent its application.²⁵⁷

House Bill

No provision.

Senate Amendment

The provision repeals the special tax on certain capital gains of nonresident aliens under section 871(a)(2).

Effective date. --The provision is effective for taxable years beginning after December 31, 2003 .

Conference Agreement

The conference agreement does not contain the Senate amendment provision.



21. Modify FIRPTA rules for real estate investment trusts (sec. 230 of the Senate amendment and secs. 857 and 897 of the Code)

Present Law

A real estate investment trust ("REIT") is a U.S. entity that derives most of its income from passive real estate-related investments. A REIT must satisfy a number of tests on an annual basis that relate to the entity's organizational structure, the source of its income, and the nature of its assets. If an electing entity meets the requirements for REIT status, the portion of its income that is distributed to its investors each year generally is treated as a dividend deductible by the REIT, and includible in income by its investors. In this manner, the distributed income of the REIT is not taxed at the entity level. The distributed income is taxed only at the investor level. A REIT generally is required to distribute 90 percent of its income to its investors before the end of its taxable year.

Special U.S. tax rules apply to gains of foreign persons attributable to dispositions of interests in U.S. real property, including certain transactions involving REITs. The rules governing the imposition and collection of tax on such dispositions are contained in a series of provisions that were enacted in 1980 and that are collectively referred to as the Foreign Investment in Real Property Tax Act ("FIRPTA").

In general, FIRPTA provides that gain or loss of a foreign person from the disposition of a U.S. real property interest is taken into account for U.S. tax purposes as if such gain or loss were effectively connected with a U.S. trade or business during the taxable year. Accordingly, foreign persons generally are subject to U.S. tax on any gain from a disposition of a U.S. real property interest at the same rates that apply to similar income received by U.S. persons. For these purposes, the receipt of a distribution from a REIT is treated as a disposition of a U.S. real property interest by the recipient to the extent that it is attributable to a sale or exchange of a U.S. real property interest by the REIT. These capital gains distributions from REITs generally are subject to withholding tax at a rate of 35 percent (or a lower treaty rate). In addition, the recipients of these capital gains distributions are required to file Federal income tax returns in the United States, since the recipients are treated as earning income effectively connected with a U.S. trade or business.

In addition, foreign corporations that have effectively connected income generally are subject to the branch profits tax at a 30-percent rate (or a lower treaty rate).

House Bill

No provision.

Senate Amendment

The provision removes from treatment as effectively connected income for a foreign investor a capital gain distribution from a REIT, provided that (1) the distribution is received with respect to a class of stock that is regularly traded on an established securities market located in the United States and (2) the foreign investor does not own more than five percent of the class of stock at any time during the taxable year within which the distribution is received.

Thus, a foreign investor is not required to file a U.S. Federal income tax return by reason of receiving such a distribution. The distribution is to be treated as a REIT dividend to that investor, taxed as a REIT dividend that is not a capital gain. Also, the branch profits tax no longer applies to such a distribution.

Effective date. --The provision applies to taxable years beginning after the date of enactment.

Conference Agreement

The conference agreement follows the Senate amendment.



22. Exclusion of certain horse-racing and dog-racing gambling winnings from the income of nonresident alien individuals (sec. 232 of the Senate amendment and sec. 872 of the Code)

Present Law

Under section 871, certain items of gross income received by a nonresident alien from sources within the United States are subject to a flat 30-percent withholding tax. Gambling winnings received by a nonresident alien from wagers placed in the United States are U.S.-source and thus generally are subject to this withholding tax, unless exempted by treaty. Currently, several U.S. income tax treaties exempt U.S.-source gambling winnings of residents of the other treaty country from U.S. withholding tax. In addition, no withholding tax is imposed under section 871 on the non-business gambling income of a nonresident alien from wagers on the following games (except to the extent that the Secretary determines that collection of the tax would be administratively feasible): blackjack, baccarat, craps, roulette, and big-6 wheel. Various other (non-gambling-related) items of income of a nonresident alien are excluded from gross income under section 872(b) and are thereby exempt from the 30-percent withholding tax, without any authority for the Secretary to impose the tax by regulation. In cases in which a withholding tax on gambling winnings applies, section 1441(a) of the Code requires the party making the winning payout to withhold the appropriate amount and makes that party responsible for amounts not withheld.

With respect to gambling winnings of a nonresident alien resulting from a wager initiated outside the United States on a pari-mutuel²⁵⁸ event taking place within the United States, the source of the winnings, and thus the applicability of the 30-percent U.S. withholding tax, depends on the type of wagering pool from which the winnings are paid. If the payout is made from a separate foreign pool, maintained completely in a foreign jurisdiction (e.g., a pool maintained by a racetrack or off-track betting parlor that is showing in a foreign country a simulcast of a horse race taking place in the United States), then the winnings paid to a nonresident alien generally would not be subject to withholding tax, because the amounts received generally would not be from sources within the United States. However, if the payout is made from a "merged" or "commingled" pool, in which betting pools in the United States and the foreign country are combined for a particular event, then the portion of the payout attributable to wagers placed in the United States could be subject to withholding tax. The party making the payment, in this case a racetrack or off-track betting parlor in a foreign country, would be responsible for withholding the tax.

House Bill

No provision.

Senate Amendment

The provision provides an exclusion from gross income under section 872(b) for winnings paid to a nonresident alien resulting from a legal wager initiated outside the United States in a pari-mutuel pool on a live horse or dog race in the United States, regardless of whether the pool is a separate foreign pool or a merged U.S.-foreign pool.

Effective date. --The provision is effective for wagers made after the date of enactment of the provision.

Conference Agreement

The conference agreement follows the Senate amendment.



23. Limitation of withholding on U.S.-source dividends paid to Puerto Rico corporation (sec. 233 of the Senate amendment and secs. 881 and 1442 of the Code)

Present Law

In general, dividends paid by corporations organized in the United States²⁵⁹ to corporations organized outside of the United States and its possessions are subject to U.S. income tax withholding at the flat rate of 30 percent. The rate may be reduced or eliminated under a tax treaty. Dividends paid by U.S. corporations to corporations organized in certain U.S. possessions are subject to different rules.²⁶⁰ Corporations organized in the U.S. possessions of the Virgin Islands, Guam, American Samoa or the Northern Mariana Islands are not subject to withholding tax on dividends from corporations organized in the United States, provided that certain local ownership and activity requirements are met. Each of those possessions have adopted local internal revenue codes that provide a zero rate of withholding tax on dividends paid by corporations organized in the possession to corporations organized in the United States.

Under the tax laws of Puerto Rico, which is also a U.S. possession, a 10 percent withholding tax is imposed on dividends paid by Puerto Rico corporations to non-Puerto Rico corporations.²⁶¹ Dividends paid by corporations organized in the United States to Puerto Rico corporations are subject to U.S. withholding tax at a 30 percent rate. Under Puerto Rico law, Puerto Rico corporations may elect to credit their U.S. income taxes against their Puerto Rico income taxes. Creditable income taxes include the 30 percent dividend withholding tax and the underlying U.S. corporate tax attributable to the dividends. However, a Puerto Rico corporation's tax credit for U.S. income taxes may be limited because the sum of the U.S. withholding tax and the underlying U.S. corporate tax generally exceeds the amount of Puerto Rico corporate income tax imposed on the dividend. Consequently, Puerto Rico corporations with subsidiaries organized in the United States may be subject to some degree of double taxation on their U.S. subsidiaries' earnings.

House Bill

No provision.

Senate Amendment

The provision lowers the withholding income tax rate on U.S. source dividends paid to a corporation created or organized in Puerto Rico from 30 percent to 10 percent, to create parity with the generally applicable 10 percent withholding tax imposed by Puerto Rico on dividends paid to U.S. corporations. The lower rate applies only if the same local ownership and activity requirements are met that are applicable to corporations organized in other possessions receiving dividends from corporations organized in the United States.

Effective date. --The provision is effective for dividends paid after date of enactment.

Conference Agreement

The conference agreement follows the Senate amendment with modifications. Under the provision as modified, if the generally applicable withholding tax rate imposed by Puerto Rico on dividends paid to U.S. corporations increases to greater than 10 percent, the U.S. withholding rate on dividends to Puerto Rico corporations reverts to 30 percent.



24. Require Commerce Department report on adverse decisions of the World Trade Organization (sec. 234 of the Senate amendment)

Present Law

The Secretary of Commerce does not have an obligation to transmit any future report to the Senate Committee on Finance and the House of Representatives Committee on Ways and Means, in consultation with the United States Trade Representative, regarding whether dispute settlement panels or the Appellate Body of the World Trade Organization have (1) added to or diminished the rights of the United States by imposing obligations and restrictions on the use of antidumping, countervailing, or safeguard measures not agreed to under the World Trade Organization Antidumping Agreement, the Agreement on Subsidies and Countervailing Measures, or the Agreement on Safeguards; (2) appropriately applied the standard of review contained in Article 17.6 of the Antidumping Agreement; or (3) exceeded its authority or terms of reference.

House Bill

No provision.

Senate Amendment

The provision requires that by no later than March 31, 2004 , the Secretary of Commerce, in consultation with the United States Trade Representative, shall transmit a report to the Senate Committee on Finance and the House of Representatives Committee on Ways and Means regarding whether dispute settlement panels or the Appellate Body of the World Trade Organization have (1) added to or diminished the rights of the United States by imposing obligations and restrictions on the use of antidumping, countervailing, or safeguard measures not agreed to under the World Trade Organization Antidumping Agreement, the Agreement on Subsidies and Countervailing Measures, or the Agreement on Safeguards; (2) appropriately applied the standard of review contained in Article 17.6 of the Antidumping Agreement; or (3) exceeded its authority or terms of reference.

Effective date. --The provision is effective on the date of enactment.

Conference Agreement

The conference agreement does not contain the Senate amendment provision.



25. Study of impact of international tax law on taxpayers other than large corporations (sec. 235 of the Senate amendment)

Present Law

The United States employs a "worldwide" tax system, under which U.S. persons (including domestic corporations) generally are taxed on all income, whether derived in the United States or abroad. In contrast, foreign persons (including foreign corporations) are subject to U.S. tax only on U.S.-source income and income that has a sufficient nexus to the United States. The United States generally provides a credit to U.S. persons for foreign income taxes paid or accrued.²⁶² The foreign tax credit generally is limited to the U.S. tax liability on a taxpayer's foreign-source income, in order to ensure that the credit serves its purpose of mitigating double taxation of foreign-source income without offsetting the U.S. tax on U.S.-source income.²⁶³

Within this basic framework, there are a variety of rules that affect the U.S. taxation of cross-border transactions. Detailed rules govern the determination of the source of income and the allocation and apportionment of expenses between foreign-source and U.S.-source income. Such rules are relevant not only for purposes of determining the U.S. taxation of foreign persons (because foreign persons are subject to U.S. tax only on income that is from U.S. sources or otherwise has sufficient U.S. nexus), but also for purposes of determining the U.S. taxation of U.S. persons (because the U.S. tax on a U.S. person's foreign-source income may be reduced or eliminated by foreign tax credits). Authority is provided for the reallocation of items of income and deductions between related persons in order to ensure the clear reflection of the income of each person and to prevent the avoidance of tax. Although U.S. tax generally is not imposed on a foreign corporation that operates abroad, several anti-deferral regimes apply to impose current U.S. tax on certain income from foreign operations of certain U.S.-owned foreign corporations.

A cross-border transaction potentially gives rise to tax consequences in two (or more) countries. The tax treatment in each country generally is determined under the tax laws of the respective country. However, an income tax treaty between the two countries may operate to coordinate the two tax regimes and mitigate the double taxation of the transaction. In this regard, the United States' network of bilateral income tax treaties includes provisions affecting both U.S. and foreign taxation of both U.S. persons with foreign income and foreign persons with U.S. income.

House Bill

No provision.

Senate Amendment

The provision requires the Secretary of the Treasury or the Secretary's delegate to conduct a study of the impact of Federal international tax rules on taxpayers other than large corporations, including the burdens placed on such taxpayers in complying with such rules. In addition, not later than 180 days after the date of the enactment of this provision, the Secretary shall report to the Committee on Finance of the Senate and the Committee on Ways and Means of the House of Representatives the results of the study conducted as a result of this provision, including any recommendations for legislative or administrative changes to reduce the compliance burden on taxpayers other than large corporations and for such other purposes as the Secretary determines appropriate.

Effective date. --The provision is effective on the date of enactment.

Conference Agreement

The conference agreement does not contain the Senate amendment provision.



26. Delay in effective date of final regulations governing exclusion of income from international operations of ships and aircraft (sec. 236 of the Senate amendment and sec. 883 of the Code)

Present Law

Section 883 generally provides an exemption from gross income for earnings of a foreign corporation derived from the international operation of ships and aircraft if an equivalent exemption from tax is granted by the applicable foreign country to corporations organized in the United States.

Treasury has issued regulations implementing the rules of section 883 that are effective for taxable years beginning 30 days or more after August 26, 2003 . The regulations provide, in general, that a foreign corporation organized in a qualified foreign country and engaged in the international operation of ships or aircraft shall exclude qualified income from gross income for purposes of United States Federal income taxation, provided that the corporation can satisfy certain ownership and related documentation requirements. The proposed rules explain when a foreign country is a qualified foreign country and what income is considered to be qualified income.

House Bill

No provision.

Senate Amendment

The provision delays the effective date for the Treasury regulations so that they apply to taxable years of foreign corporations seeking qualified foreign corporation status beginning after December 31, 2004 .

Effective date. --The provision is effective after date of enactment.

Conference Agreement

The conference agreement follows the Senate amendment, except the regulations apply to taxable years of foreign corporations seeking qualified foreign corporation status beginning after September 24, 2004 .



27. Interest payments deductible where taxpayer could have borrowed without a guarantee (sec. 237 of the Senate amendment and sec. 163(j) of the Code)

Present Law

Present law provides rules to limit the ability of U.S. corporations to reduce the U.S. tax on their U.S.-source income through earnings stripping transactions. These rules limit the deductibility of interest paid to certain related parties ("disqualified interest"), if the payor's debt-equity ratio exceeds 1.5 to 1 and the payor's net interest expense exceeds 50 percent of its "adjusted taxable income" (generally taxable income computed without regard to deductions for net interest expense, net operating losses, and depreciation, amortization, and depletion).

Disqualified interest for these purposes also may include interest paid to unrelated parties in certain cases in which a related party guarantees the debt.

House Bill

No provision.

Senate Amendment

Under the provision, a foreign related-party guarantee does not trigger the earnings stripping rules to the extent of the amount of debt that the taxpayer establishes (to the satisfaction of the Treasury Secretary) that it could have borrowed without the guarantee.

Effective date. --The provision is effective for guarantees issued on or after the date of enactment.

Conference Agreement

The conference agreement does not contain the Senate amendment provision.

TITLE IV --EXTENSION OF CERTAIN EXPIRING PROVISIONS

1. Nonrefundable personal credits allowed against the alternative minimum tax (" AMT ") (sec. 401 of the House bill, sec. 713 of the Senate amendment, and sec. 26 of the Code)

Present Law

Present law provides for certain nonrefundable personal tax credits (i.e., the dependent care credit, the credit for the elderly and disabled, the adoption credit, the child tax credit,²⁶⁴ the credit for interest on certain home mortgages, the HOPE Scholarship and Lifetime Learning credits, the credit for savers, and the D.C. first-time homebuyer credit).

For taxable years beginning before 2006, all the nonrefundable personal credits are allowed to the extent of the full amount of the individual's regular tax and alternative minimum tax.

For taxable years beginning after 2005, the credits (other than the adoption credit, child credit and credit for savers) are allowed only to the extent that the individual's regular income tax liability exceeds the individual's tentative minimum tax, determined without regard to the minimum tax foreign tax credit. The adoption credit, child credit, and IRA credit are allowed to the full extent of the individual's regular tax and alternative minimum tax.

House Bill²⁶⁵

The House bill allows all nonrefundable personal credits against the AMT .

Effective date. --Taxable years beginning in 2004 and 2005.

Senate Amendment²⁶⁶

The Senate amendment allows all nonrefundable personal credits against the AMT .

Effective date. --Taxable years beginning in 2004.

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



2. Extension and modification of the research credit (sec. 402 of the House bill, secs. 311 and 312 of the Senate amendment, and sec. 41 of the Code)

Present Law

Section 41 provides for a research tax credit equal to 20 percent of the amount by which a taxpayer's qualified research expenses for a taxable year exceed its base amount for that year. Taxpayers may elect an alternative incremental research credit regime in which the taxpayer is assigned a three-tiered fixed-base percentage and the credit rate likewise is reduced. Under the alternative credit regime, a credit rate of 2.65 percent applies to the extent that a taxpayer's current-year research expenses exceed a base amount computed by using a fixed-base percentage of one percent but do not exceed a base amount computed by using a fixed-base percentage of 1.5 percent. A credit rate of 3.2 percent applies to the extent that a taxpayer's current-year research expenses exceed a base amount computed by using a fixed-base percentage of 1.5 percent but do not exceed a base amount computed by using a fixed-base percentage of two percent. A credit rate of 3.75 percent applies to the extent that a taxpayer's current-year research expenses exceed a base amount computed by using a fixed-base percentage of two percent.

The research tax credit generally applies to amounts paid or incurred before January 1, 2006 .

House Bill²⁶⁷

The House bill extends the present-law research credit to qualified amounts paid or incurred before January 1, 2006 .

Effective date. --The provision is effective for amounts paid or incurred after June 30, 2004 .

Senate Amendment²⁶⁸

The Senate amendment is the same as the House bill with respect to extension of the present-law research credit. In addition, the Senate amendment makes the following modifications:

(4) Increases the credit rates of the alternative incremental credit to three percent, four percent, and five percent.

(5) Creates a third alternative for taxpayers, the alternative simplified credit. The taxpayer may elect to claim a credit equal to 12 percent of qualified research expenses in excess of 50 percent of the average qualified research expenses for the preceding three taxable years.

(6) Permits taxpayers to claim a credit equal to 20 percent of amounts paid to certain research consortia.

The provision also permits taxpayers to include 100 percent of contract research expenses (rather than 65 percent) if the contractor is an eligible small business, a college or university, or a Federal laboratory.

Effective date. --With respect to extension of the present-law research credit, the provision is effective for amounts paid or incurred after the date of enactment.

With respect to the increase in the alternative incremental credit and the alternative simplified credit, the provisions are effective for taxable years beginning after December 31, 2004 .

With respect to payments to research consortia and certain contract research, the provisions are effective for amounts paid or incurred after December 31, 2004 .

Conference Agreement

The conference agreement does not include the House bill or Senate amendment provision.



3. Extension of credit for electricity produced from certain renewable resources (sec. 403 of the House bill, secs. 714 and 801 of the Senate amendment, and sec. 45 of the Code)

Present Law

An income tax credit is allowed for the production of electricity from either qualified wind energy, qualified "closed-loop" biomass, or qualified poultry waste facilities. The amount of the credit is 1.8 cents per kilowatt hour for 2004. The credit amount is indexed for inflation.

The credit applies to electricity produced by a wind energy facility placed in service after December 31, 1993 , and before January 1, 2006 , to electricity produced by a closed-loop biomass facility placed in service after December 31, 1992 , and before January 1, 2006 , and to a poultry waste facility placed in service after December 31, 1999 , and before January 1, 2006 . The credit is allowable for production during the 10-year period after a facility is originally placed in service.

House Bill²⁶⁹

Extends the placed-in-service date for wind facilities and closed-loop biomass facilities to facilities placed in service after December 31, 1993 (December 31, 1992 in the case of closed-loop biomass facilities) and before January 1, 2006 . Does not extend the placed-in-service date for poultry waste facilities.

Effective date. --The provision is effective for facilities placed in service after December 31, 2003 .

Senate Amendment²⁷⁰

With respect to extension of the present-law credit, the Senate amendment extends the placed-in-service date for wind, closed-loop biomass, and poultry waste facilities to facilities placed in service prior to January 1, 2007 .

(The Senate amendment would also expand the definition of qualified facilities and make certain other modifications to the operation of credit. These expansions and modifications are described later in this document.)

Effective date. --With respect to the extension of the placed-in-service dates, the provision is generally effective for facilities placed in service after December 31, 2003 .

Conference Agreement

The conference agreement does not include the House bill or Senate amendment provision with respect to the extension of present law, but it does make modifications to present law that are described later in this document.



4. Indian employment tax credit (sec. 404 of the House bill, sec. 716 of the Senate amendment, and sec. 45A of the Code)

Present Law

In general, a credit against income tax liability is allowed to employers for the first $20,000 of qualified wages and qualified employee health insurance costs paid or incurred by the employer with respect to certain employees. The credit is equal to 20 percent of the excess of eligible employee qualified wages and health insurance costs during the current year over the amount of such wages and costs incurred by the employer during 1993. The credit is an incremental credit, such that an employer's current-year qualified wages and qualified employee health insurance costs (up to $20,000 per employee) are eligible for the credit only to the extent that the sum of such costs exceeds the sum of comparable costs paid during 1993. No deduction is allowed for the portion of the wages equal to the amount of the credit.

Qualified wages means wages paid or incurred by an employer for services performed by a qualified employee. A qualified employee means any employee who is an enrolled member of an Indian tribe or the spouse of an enrolled member of an Indian tribe, who performs substantially all of the services within an Indian reservation, and whose principal place of abode while performing such services is on or near the reservation in which the services are performed. An employee will not be treated as a qualified employee for any taxable year of the employer if the total amount of wages paid or incurred by the employer with respect to such employee during the taxable year exceeds an amount determined at an annual rate of $30,000 (adjusted for inflation after 1993).

The wage credit is available for wages paid or incurred on or after January 1, 1994 , in taxable years that begin before January 1, 2006 .

House Bill²⁷¹

The provision extends the Indian employment credit incentive for one year (to taxable years beginning before January 1, 2006 ).

Effective date. --The provision is effective on the date of enactment.

Senate Amendment²⁷²

Same as the House bill.

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



5. Extension of the work opportunity tax credit (sec. 405 of the House bill, sec. 702 of the Senate amendment, and sec. 51 of the Code)

Present Law

Work opportunity tax credit



Targeted groups eligible for the credit

The work opportunity tax credit is available on an elective basis for employers hiring individuals from one or more of eight targeted groups. The eight targeted groups are: (1) certain families eligible to receive benefits under the Temporary Assistance for Needy Families Program; (2) high-risk youth; (3) qualified ex-felons; (4) vocational rehabilitation referrals; (5) qualified summer youth employees; (6) qualified veterans; (7) families receiving food stamps; and (8) persons receiving certain Supplemental Security Income (SSI) benefits.

A qualified ex-felon is an individual certified as: (1) having been convicted of a felony under State or Federal law; (2) being a member of an economically disadvantaged family; and (3) having a hiring date within one year of release from prison or conviction.



Qualified wages

Generally, qualified wages are defined as cash wages paid by the employer to a member of a targeted group. The employer's deduction for wages is reduced by the amount of the credit.



Calculation of the credit

The credit equals 40 percent (25 percent for employment of 400 hours or less) of qualified first-year wages. Generally, qualified first-year wages are qualified wages (not in excess of $6,000) attributable to service rendered by a member of a targeted group during the one-year period beginning with the day the individual began work for the employer. Therefore, the maximum credit per employee is $2,400 (40 percent of the first $6,000 of qualified first-year wages). With respect to qualified summer youth employees, the maximum credit is $1,200 (40 percent of the first $3,000 of qualified first-year wages).



Minimum employment period

No credit is allowed for qualified wages paid to employees who work less than 120 hours in the first year of employment.



Coordination of the work opportunity tax credit and the welfare-to-work tax credit

An employer cannot claim the work opportunity tax credit with respect to wages of any employee on which the employer claims the welfare-to-work tax credit.



Other rules

The work opportunity tax credit is not allowed for wages paid to a relative or dependent of the taxpayer. Similarly wages paid to replacement workers during a strike or lockout are not eligible for the work opportunity tax credit. Wages paid to any employee during any period for which the employer received on-the-job training program payments with respect to that employee are not eligible for the work opportunity tax credit. The work opportunity tax credit generally is not allowed for wages paid to individuals who had previously been employed by the employer. In addition, many other technical rules apply.



Expiration

The credit is effective for wages paid or incurred to a qualified individual who begins work for an employer before January 1, 2006.

House Bill²⁷³

The House bill extends the WOTC for two years (through December 31, 2005 ).

Effective date. --Wages paid or incurred for individuals beginning work after December 31, 2003 .

Senate Amendment²⁷⁴

The Senate amendment permanently extends the WOTC.

The Senate amendment also makes the following modifications to the WOTC:

(1) repeals the requirement that a qualified ex-felon be a member of an economically disadvantaged family for purposes of eligibility for the tax credit;

(2) expands the category of vocational rehabilitation referrals to include certain individuals who have a physical or mental disability that constitutes a substantial handicap to employment and who are receiving vocational services or have completed an individual work plan developed by a private employment network as defined under section 1148(f) of the Social Security Act qualify as members of the vocational rehabilitation referral targeted group.

(3) increases the age limit for qualified food stamp recipients. Therefore a food stamp recipient is an individual aged 18 but not aged 40 certified as being a member of a family either currently or recently receiving assistance under an eligible food stamp program.

(4) increases the age limit for high-risk youths. Therefore a high-risk youth is an individual aged 18 but not aged 40 having a principal place of abode within an empowerment zone, enterprise community, or renewal community.

Effective date. --The extension is effective for wages paid or incurred for individuals beginning work after December 31, 2003 . The modifications are effective for wages paid or incurred for individuals beginning work after December 31, 2004 .

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



6. Extension of the welfare-to-work tax credit (sec. 406 of the House bill, sec. 702 of the Senate amendment, and sec. 51A of the Code)

Present Law

Welfare-to-work tax credit



Targeted group eligible for the credit

The welfare-to-work tax credit is available on an elective basis to employers of qualified long-term family assistance recipients. Qualified long-term family assistance recipients are: (1) members of a family that has received family assistance for at least 18 consecutive months ending on the hiring date; (2) members of a family that has received such family assistance for a total of at least 18 months (whether or not consecutive) after August 5, 1997 (the date of enactment of the welfare-to-work tax credit) if they are hired within 2 years after the date that the 18-month total is reached; and (3) members of a family who are no longer eligible for family assistance because of either Federal or State time limits, if they are hired within 2 years after the Federal or State time limits made the family ineligible for family assistance.



Qualified wages

Qualified wages for purposes of the welfare-to-work tax credit are defined more broadly than the work opportunity tax credit. Unlike the definition of wages for the work opportunity tax credit which includes simply cash wages, the definition of wages for the welfare-to-work tax credit includes cash wages paid to an employee plus amounts paid by the employer for: (1) educational assistance excludable under a section 127 program (or that would be excludable but for the expiration of sec. 127); (2) health plan coverage for the employee, but not more than the applicable premium defined under section 4980B(f)(4); and (3) dependent care assistance excludable under section 129. The employer's deduction for wages is reduced by the amount of the credit.



Calculation of the credit

The welfare-to-work tax credit is available on an elective basis to employers of qualified long-term family assistance recipients during the first two years of employment. The maximum credit is 35 percent of the first $10,000 of qualified first-year wages and 50 percent of the first $10,000 of qualified second-year wages. Qualified first-year wages are defined as qualified wages (not in excess of $10,000) attributable to service rendered by a member of the targeted group during the one-year period beginning with the day the individual began work for the employer. Qualified second-year wages are defined as qualified wages (not in excess of $10,000) attributable to service rendered by a member of the targeted group during the one-year period beginning immediately after the first year of that individual's employment for the employer. The maximum credit is $8,500 per qualified employee.



Minimum employment period

No credit is allowed for qualified wages paid to a member of the targeted group unless they work at least 400 hours or 180 days in the first year of employment.



Coordination of the work opportunity tax credit and the welfare-to-work tax credit

An employer cannot claim the work opportunity tax credit with respect to wages of any employee on which the employer claims the welfare-to-work tax credit.



Other rules

The welfare-to-work tax credit incorporates directly or by reference many of these other rules contained on the work opportunity tax credit.



Expiration

The welfare to work credit is effective for wages paid or incurred to a qualified individual who begins work for an employer before January 1, 2006.

House Bill²⁷⁵

The House bill extends the WWTC for two years (through December 31, 2005 ).

Effective date. --The provision is effective for wages paid or incurred for individuals beginning work after December 31, 2003 .

Senate Amendment²⁷⁶

The Senate amendment permanently extends the WWTC.

Effective date. --Wages paid or incurred for individuals beginning work after December 31, 2003 .

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



7. Combination and modification of the work opportunity tax credit and the welfare-to-work tax credit (sec. 703 of the Senate amendment and sec. 51 of the Code)

Present Law

Same as items 5 and 6, above.

House Bill²⁷⁷

No provision.

Senate Amendment²⁷⁸

The Senate amendment combines and modifies the work opportunity and welfare-to-work tax credits with the following modifications:

The combined credit uses the WOTC definition of wages; in the case of first-year wages for long-term family assistance recipients the maximum credit is increased to $4,000 (40 percent of the first $10,000 of qualified first-year wages);

The combined credit uses the WOTC definition for the minimum employment period (i.e., the combined credit is not allowed for qualified wages paid to employees who work less than 120 hours in the first year of employment).

Effective date. --The provision is effective for wages paid or incurred for individuals beginning work after December 31, 2004 .

Conference Agreement

The conference agreement does not include the Senate amendment provision.



8. Certain expenses of elementary and secondary school teachers (sec. 407 of the House bill, sec. 707 of the Senate amendment, and sec. 62 of the Code)

Present Law

In general, ordinary and necessary business expenses are deductible (sec. 162). However, in general, unreimbursed employee business expenses are deductible only as an itemized deduction and only to the extent that the individual's total miscellaneous deductions (including employee business expenses) exceed two percent of adjusted gross income. An individual's otherwise allowable itemized deductions may be further limited by the overall limitation on itemized deductions, which reduces itemized deductions for taxpayers with adjusted gross income in excess of $142,700 (for 2004). In addition, miscellaneous itemized deductions are not allowable under the alternative minimum tax.

Certain expenses of eligible educators are allowed an above-the-line deduction. Specifically, for taxable years beginning prior to January 1, 2006, an above-the-line deduction is allowed for up to $250 annually of expenses paid or incurred by an eligible educator for books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment, and supplementary materials used by the eligible educator in the classroom. To be eligible for this deduction, the expenses must be otherwise deductible under section 162 as a trade or business expense. A deduction is allowed only to the extent the amount of expenses exceeds the amount excludable from income under section 135 (relating to education savings bonds), section 529(c)(1) (relating to qualified tuition programs), and section 530(d)(2) (relating to Coverdell education savings accounts).

An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide in a school for at least 900 hours during a school year. A school means any school which provides elementary education or secondary education, as determined under State law.

The above-the-line deduction for eligible educators is not allowed for taxable years beginning after December 31, 2005.

House Bill²⁷⁹

The House bill allows the above-the-line deduction for taxable years beginning prior to January 1, 2006 .

Effective date. --The provision is effective for taxable years beginning in 2004 and 2005.

Senate Amendment²⁸⁰

The Senate amendment is the same as the House bill.

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



9. Accelerated depreciation for business property on Indian reservations (sec. 408 of the House bill, sec. 717 of the Senate amendment, and sec. 168 of the Code)

Present Law

With respect to certain property used in connection with the conduct of a trade or business within an Indian reservation, depreciation deductions under section 168(j) will be determined using the following recovery periods:

                 3-year property........................... 2 years

                 5-year property........................... 3 years

                 7-year property........................... 4 years

                 10-year property.......................... 6 years

                 15-year property.......................... 9 years

                                                                 12

                 20-year property..........................   years

                                                                 22

                 Nonresidential real property .............   years

"Qualified Indian reservation property" eligible for accelerated depreciation includes property which is (1) used by the taxpayer predominantly in the active conduct of a trade or business within an Indian reservation, (2) not used or located outside the reservation on a regular basis, (3) not acquired (directly or indirectly) by the taxpayer from a person who is related to the taxpayer (within the meaning of section 465(b)(3)(C)), and (4) described in the recovery-period table above. In addition, property is not "qualified Indian reservation property" if it is placed in service for purposes of conducting gaming activities. Certain "qualified infrastructure property" may be eligible for the accelerated depreciation even if located outside an Indian reservation, provided that the purpose of such property is to connect with qualified infrastructure property located within the reservation (e.g., roads, power lines, water systems, railroad spurs, and communications facilities).

The depreciation deduction allowed for regular tax purposes is also allowed for purposes of the alternative minimum tax. The accelerated depreciation for Indian reservations is available with respect to property placed in service on or after January 1, 1994 , and before January 1, 2006 .

House Bill²⁸¹

The provision extends eligibility for the special depreciation periods to property placed in service before January 1, 2006 .

Effective date. --The provision is effective on the date of enactment.

Senate Amendment²⁸²

Same as the House bill.

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



10. Charitable contributions of computer technology and equipment used for educational purposes and of scientific property used for research (sec. 409 of the House bill, sec. 706 of the Senate amendment, and sec. 170 of the Code)

Present Law

A deduction for charitable contributions of computer technology and equipment and of scientific property used for research generally is limited to the taxpayer's basis in the property. However, certain corporations may claim a deduction in excess of basis for a qualified computer contribution or a qualified research contribution. To be eligible for the enhanced deduction, the contributed property must be constructed by the taxpayer, among other requirements. The enhanced deduction for qualified computer contributions expires for contributions made during any taxable year beginning after December 31, 2005 .

House Bill²⁸³

The House bill extends the enhanced deduction for qualified computer contributions to contributions made during any taxable year beginning before January 1, 2006 .

Effective date. --Taxable years beginning after December 31, 2003 .

Senate Amendment²⁸⁴

The Senate amendment expands the enhanced deduction for qualified computer contributions and qualified research contributions to apply to property assembled by the taxpayer as well as property constructed by the taxpayer.

The extension of the enhanced deduction for qualified computer contributions is the same as the House bill.

Effective date. --The Senate amendment is effective for taxable years beginning after December 31, 2003 .

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



11. Expensing of environmental remediation costs (sec. 410 of the House bill, sec. 708 of the Senate amendment, and sec. 198 of the Code)

Present Law

Taxpayers can elect to treat certain environmental remediation expenditures that would otherwise be chargeable to capital account as deductible in the year paid or incurred. The deduction applies for both regular and alternative minimum tax purposes. The expenditure must be incurred in connection with the abatement or control of hazardous substances at a qualified contaminated site (so called "brownfields").

Eligible expenditures are those paid or incurred before January 1, 2006 .

House Bill²⁸⁵

The House bill extends the present law expensing provision for two years (through December 31, 2005 ).

Effective date. --The provision is effective for expenses paid or incurred after December 31, 2003 .

Senate Amendment²⁸⁶

The Senate amendment is the same as the House bill.

Conference Agreement

The conference agreement does not include the House bill or Senate amendment provision.



12. Availability of Archer medical savings accounts (sec. 411 of the House bill and sec. 220 of the Code)

Present Law

In general

Within limits, contributions to an Archer medical savings account ("Archer MSA ") are deductible in determining adjusted gross income if made by an eligible individual and are excludable from gross income and wages for employment tax purposes if made by the employer of an eligible individual. Earnings on amounts in an Archer MSA are not currently taxable. Distributions from an Archer MSA for medical expenses are not includible in gross income. Distributions not used for medical expenses are includible in gross income. In addition, distributions not used for medical expenses are subject to an additional 15-percent tax unless the distribution is made after age 65, death, or disability.



Eligible individuals

Archer MSAs are available to employees covered under an employer-sponsored high deductible plan of a small employer and self-employed individuals covered under a high deductible health plan.²⁸⁷ An employer is a small employer if it employed, on average, no more than 50 employees on business days during either the preceding or the second preceding year. An individual is not eligible for an Archer MSA if he or she is covered under any other health plan in addition to the high deductible plan.



Tax treatment of and limits on contributions

Individual contributions to an Archer MSA are deductible (within limits) in determining adjusted gross income (i.e., "above-the-line"). In addition, employer contributions are excludable from gross income and wages for employment tax purposes (within the same limits), except that this exclusion does not apply to contributions made through a cafeteria plan. In the case of an employee, contributions can be made to an Archer MSA either by the individual or by the individual's employer.

The maximum annual contribution that can be made to an Archer MSA for a year is 65 percent of the deductible under the high deductible plan in the case of individual coverage and 75 percent of the deductible in the case of family coverage.



Definition of high deductible plan

A high deductible plan is a health plan with an annual deductible of at least $1,700 and no more than $2,600 in the case of individual coverage and at least $3,450 and no more than $5,150 in the case of family coverage. In addition, the maximum out-of-pocket expenses with respect to allowed costs (including the deductible) must be no more than $3,450 in the case of individual coverage and no more than $6,300 in the case of family coverage.²⁸⁸ A plan does not fail to qualify as a high deductible plan merely because it does not have a deductible for preventive care as required by State law. A plan does not qualify as a high deductible health plan if substantially all of the coverage under the plan is for permitted coverage (as described above). In the case of a self-insured plan, the plan must in fact be insurance (e.g., there must be appropriate risk shifting) and not merely a reimbursement arrangement.



Cap on taxpayers utilizing Archer MSAs and expiration of pilot program

The number of taxpayers benefiting annually from an Archer MSA contribution is limited to a threshold level (generally 750,000 taxpayers). The number of Archer MSAs established has not exceeded the threshold level.

After 2005, no new contributions may be made to Archer MSAs except by or on behalf of individuals who previously made (or had made on their behalf) Archer MSA contributions and employees who are employed by a participating employer.

Trustees of Archer MSAs are generally required to make reports to the Treasury by August 1 regarding Archer MSAs established by July 1 of that year. If any year is a cut-off year, the Secretary is required to make and publish such determination by October 1 of such year.

The reports required by MSA trustees for 2004 are treated as timely if made within 90 days after October 4, 2004. In addition, the determination of whether 2004 is a cut-off year and the publication of such determination is to be made within 120 days of October 4, 2004. If 2004 is a cut-off year, the cut-off date will be the last day of such 120-day period.

House Bill²⁸⁹

The House bill extends Archer MSAs through December 31, 2005 .

Effective date. --The provision is effective for January 1, 2004 .

Senate Amendment²⁹⁰

No provision.

Conference Agreement

The conference agreement does not include the House bill or Senate amendment provision.



13. Suspension of 100-percent-of-net-income limitation on percentage depletion for oil and gas from marginal wells (sec. 412 of the House bill, secs. 715 and 846 of the Senate amendment, and sec. 613A of the Code)

Present Law

Overview of depletion

Depletion, like depreciation, is a form of capital cost recovery. In both cases, the taxpayer is allowed a deduction in recognition of the fact that an asset --in the case of depletion for oil or gas interests, the mineral reserve itself --is being expended in order to produce income. Certain costs incurred prior to drilling an oil or gas property are recovered through the depletion deduction. These include costs of acquiring the lease or other interest in the property and geological and geophysical costs (in advance of actual drilling).

Depletion is available to any person having an economic interest in a producing property. An economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in minerals in place, and secures, by any form of legal relationship, income derived from the extraction of the mineral, to which it must look for a return of its capital.²⁹¹ Thus, for example, both working interests and royalty interests in an oil- or gasproducing property constitute economic interests, thereby qualifying the interest holders for depletion deductions with respect to the property. A taxpayer who has no capital investment in the mineral deposit does not possess an economic interest merely because it possesses an economic or pecuniary advantage derived from production through a contractual relation.



Cost depletion

Two methods of depletion are currently allowable under the Code: (1) the cost depletion method, and (2) the percentage depletion method.²⁹² Under the cost depletion method, the taxpayer deducts that portion of the adjusted basis of the depletable property which is equal to the ratio of units sold from that property during the taxable year to the number of units remaining as of the end of the taxable year plus the number of units sold during the taxable year. Thus, the amount recovered under cost depletion may never exceed the taxpayer's basis in the property.



Percentage depletion and related income limitations

The Code generally limits the percentage depletion method for oil and gas properties to independent producers and royalty owners.²⁹³ Generally, under the percentage depletion method, 15 percent of the taxpayer's gross income from an oil- or gas-producing property is allowed as a deduction in each taxable year.²⁹⁴ The amount deducted generally may not exceed 100 percent of the net income from that property in any year (the "net-income limitation").²⁹⁵ The 100-percent net-income limitation for marginal wells has been suspended for taxable years beginning after December 31, 1997, and before January 1, 2006.

House Bill²⁹⁶

The provision extends the suspension of the net-income limitation for marginal wells for taxable years beginning before January 1, 2006 .

Effective date. --The provision is effective for taxable years beginning after December 31, 2003 .

Senate Amendment²⁹⁷

The Senate amendment extends the suspension of the net-income limitation for marginal wells for taxable years beginning before January 1, 2007 .

Effective date. --Same as the House bill.

Conference Agreement

The conference agreement does not contain the House bill or Senate amendment provision.



14. Qualified zone academy bonds (sec. 413 of the House bill, secs. 612 and 704 of the Senate amendment, and sec. 1397E of the Code)

Present Law

Generally, "qualified zone academy bonds" are bonds issued by a State or local government, provided that at least 95 percent of the proceeds are used for one or more qualified purposes with respect to a "qualified zone academy" and private entities have promised to contribute to the qualified zone academy certain equipment, technical assistance or training, employee services, or other property or services with a value equal to at least 10 percent of the bond proceeds. Qualified purposes with respect to any qualified zone academy are: (1) rehabilitating or repairing the public school facility in which the academy is established; (2) providing equipment for use at such academy; (3) developing course materials for education at such academy, and (4) training teachers and other school personnel. A total of $400 million of qualified zone academy bonds may be issued annually in calendar years 1998 through 2005.

House Bill²⁹⁸

The House bill authorizes $400 million of qualified zone academy bonds to be issued in 2004 and 2005.

Effective date. --The House bill provision is effective for obligations issued after the date of enactment.

Senate Amendment²⁹⁹

The Senate amendment expands the qualified purposes for which qualified zone academy bonds may be issued to include construction of the public school facility in which the qualified zone academy is established, and the acquisition of land on which the facility is to be constructed.

The Senate amendment authorizes $400 million of qualified zone academy bonds to be issued in 2004 and 2005.

Effective date. --The Senate amendment is effective for obligations issued after December 31, 2003 .

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



15. Tax Incentives for Investment in the District of Columbia (sec. 414 of the House bill, sec. 711 of the Senate amendment, and secs. 1400, 1400A, and 1400C of the Code)

Present Law

Certain economically depressed census tracts within the District of Columbia are designated as the District of Columbia Enterprise Zone (the "D.C. Zone") within which businesses and individual residents are eligible for special tax incentives. The designation expires on December 31, 2005 .

First-time homebuyers of a principal residence in the District of Columbia are eligible for a nonrefundable tax credit of up to $5,000 of the amount of the purchase price. The credit expires for property purchased after December 31, 2005 .

House Bill³⁰⁰

The House bill extends the D.C. Zone designation and related tax incentives for two years, and extends the first-time homebuyer credit for two years.

Effective date. --The provision takes effect on the date of enactment, except that the provision relating to tax-exempt financing incentives, which applies to obligations issued after December 31, 2003 .

Senate Amendment³⁰¹

Same as the House bill.

Effective date. --The provision takes effect on January 1, 2004 , except that the provision relating to tax-exempt financing incentives applies to obligations issued after the date of enactment.

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



16. Modifications to New York Liberty Zone bond provisions (sec. 415 of the House bill, secs. 611 and 709 of the Senate amendment, and sec. 1400L of the Code)

Present Law

An aggregate of $8 billion in tax-exempt private activity bonds is authorized for the purpose of financing the construction and repair of infrastructure in New York City ("Liberty Zone bonds"). The bonds must be issued before January 1, 2010 .

Certain bonds used to fund facilities located in New York City are permitted one additional advance refunding before January 1, 2006 ("advance refunding bonds"). In addition to satisfying other requirements, the bond refunded must be (1) a State or local bond that is a general obligation of New York City, (2) a State or local bond issued by the New York Municipal Water Finance Authority or Metropolitan Transportation Authority of the City of New York, or (3) a qualified 501(c)(3) bond which is a qualified hospital bond issued by or on behalf of the State of New York or the City of New York.³⁰² The maximum amount of advance refunding bonds is $9 billion.

House Bill³⁰³

The House bill provision extends authority to issue Liberty Zone bonds through December 31, 2009 .

Effective date. --The provision is effective for bonds issued after the date of enactment and before January 1, 2010 .

Senate Amendment³⁰⁴

The Senate amendment extends authority to issue Liberty Zone bonds through December 31, 2009 , and extends the additional advance refunding authority through December 31, 2005 . The Senate amendment provides that bonds issued by the Municipal Assistance Corporation are eligible for advance refunding.

Effective date. --The provisions extending authority to issue Liberty Zone bonds and an additional advance refunding are effective on the date of enactment. The provision relating to the advance refunding of bonds of the Municipal Assistance Corporation is effective as if included in the amendments made by section 301 of the Job Creation and Worker Assistance Act of 2002.

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



17. Qualified New York Liberty Zone leasehold improvement election out (sec. 709(c) of the Senate amendment)

Present Law

Qualified New York Liberty Zone leasehold improvements placed in service after September 10, 2001 and before January 1, 2007 are depreciable over five years (rather than 39 years) using the straight line method of depreciation. There is no election out of this provision.

Liberty Zone leasehold improvements that are eligible for a five-year recovery period are not also eligible for the 30-percent first-year bonus depreciation under section 168(k) or 1400L(b). A taxpayer may elect out of bonus depreciation. The election out is made at the property class level. Section 168(k)(2)(C)(iii) provides that the election applies to all property in the class or classes for which the election out is made that is placed in service for the tax year of the election.

House Bill³⁰⁵

No provision.

Senate Amendment³⁰⁶

The Senate amendment permits a taxpayer to elect out of the five-year recovery period for qualified New York Liberty Zone leasehold improvement property under rules similar to section 168(k)(2)(C)(iii).

Effective date. --The Senate amendment is effective as if included in the amendments made by section 301 of the Job Creation and Worker Assistance Act of 2002.

Conference Agreement

The conference agreement does not include the Senate amendment provision.



18. Disclosures relating to terrorist activities (sec. 416 of the House bill and sec. 6103 of the Code)

Present Law

In connection with terrorist activities, the IRS is permitted to disclose return information, other than taxpayer return information, to officers and employees of Federal law enforcement upon a written request. The Code requires the request to be made by the head of the Federal law enforcement agency (or his delegate) involved in the response to or investigation of terrorist incidents, threats, or activities, and set forth the specific reason or reasons why such disclosure may be relevant to a terrorist incident, threat, or activity. Disclosure of the information is permitted to officers and employees of the Federal law enforcement agency who are personally and directly involved in the response to or investigation of terrorist incidents, threats, or activities. The information is to be used by such officers and employees solely for such response or investigation.³⁰⁷ A taxpayer's identity is not treated as taxpayer return information for purposes of disclosures to law enforcement agencies regarding terrorist activities.

The Code permits the head of the Federal law enforcement agency to redisclose the information to officers and employees of State and local law enforcement personally and directly engaged in the response to or investigation of the terrorist incident, threat, or activity. The State or local law enforcement agency is required to be part of an investigative or response team with the Federal law enforcement agency for these disclosures to be made.³⁰⁸

The Code also allows the IRS to disclose return information (other than taxpayer return information) upon the written request of an officer or employee of the Department of Justice or Treasury who is appointed by the President with the advice and consent of the Senate, or who is the Director of the U.S. Secret Service, if such individual is responsible for the collection and analysis of intelligence and counterintelligence concerning any terrorist incident, threat, or activity.³⁰⁹ Taxpayer identity information for this purpose is not considered taxpayer return information. Such written request is required to set forth the specific reason or reasons why such disclosure may be relevant to a terrorist incident, threat, or activity. Disclosures under this authority are permitted to be made to those officers and employees of the Department of Justice, Treasury, and Federal intelligence agencies who are personally and directly engaged in the collection or analysis of intelligence and counterintelligence information or investigation concerning any terrorist incident, threat, or activity. Such disclosures are permitted solely for the use of such officers and employees in such investigation, collection, or analysis.

The IRS , on its own initiative, is permitted to disclose in writing return information (other than taxpayer return information) that may be related to a terrorist incident, threat, or activity to the extent necessary to apprise the head of the appropriate investigating Federal law enforcement agency.³¹⁰ Taxpayer identity information for this purpose is not considered taxpayer return information. The head of the agency is permitted to redisclose such information to officers and employees of such agency to the extent necessary to investigate or respond to the terrorist incident, threat, or activity.

If taxpayer return information is sought, the disclosure is required to be made pursuant to the ex parte order of a Federal district court judge or magistrate.

No disclosures may be made under these provisions after December 31, 2005.

House Bill³¹¹

The House bill provision extends all disclosure authority relating to terrorist activities through December 31, 2005 . The House bill provision permits the disclosure of taxpayer identity upon receiving a proper written request from the head of a Federal law enforcement agency.

Effective date. --The House bill generally applies to disclosures made on or after the date of enactment. The provision permitting the disclosure of taxpayer identity upon receiving a proper written request from the head of a Federal law enforcement agency is effective as if included in section 201 of the Victims of Terrorism Tax Relief Act of 2001.

Senate Amendment

No provision.

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



19. Disclosure of return information relating to student loans (sec. 417 of the House bill, sec. 718 of the Senate amendment, and sec. 6103(l) of the Code)

Present Law

Present law prohibits the disclosure of returns and return information, except to the extent specifically authorized by the Code.³¹² An exception is provided for disclosure to the Department of Education (but not to contractors thereof) of a taxpayer's filing status, adjusted gross income and identity information (i.e., name, mailing address, taxpayer identifying number) to establish an appropriate repayment amount for an applicable student loan.³¹³ The Department of Education disclosure authority is scheduled to expire after December 31, 2005.³¹⁴

An exception to the general rule prohibiting disclosure is also provided for the disclosure of returns and return information to a designee of the taxpayer.³¹⁵ Because the Department of Education utilizes contractors for the income-contingent loan verification program, the Department of Education obtains taxpayer information by consent under section 6103(c), rather than under the specific exception.³¹⁶ The Department of Treasury has reported that the Internal Revenue Service processes approximately 100,000 consents per year for this purpose.³¹⁷

House Bill³¹⁸

The House bill extends the disclosure authority relating to the disclosure of return information to carry out income-contingent repayment of student loans. No disclosures can be made after December 31, 2005 .

Effective date. --The provision is effective on the date of enactment.

Senate Amendment³¹⁹

Same as the House bill.

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



20. Extension of cover over of excise tax on distilled spirits to Puerto Rico and Virgin Islands (sec. 418 of the House bill, sec. 705 of the Senate amendment, and sec. 7652 of the Code)

Present Law

A $13.50 per proof gallon (a proof gallon is a liquid gallon consisting of 50 percent alcohol) excise tax is imposed on distilled spirits produced in or imported into the United States.

The Code provides for cover over (payment) to Puerto Rico and the Virgin Islands of the excise tax imposed on rum imported into the United States, without regard to the country of origin. The amount of the cover over is limited under section 7652(f) to $10.50 per proof gallon ($13.25 per proof gallon during the period July 1, 1999 through December 31, 2003 ).

Thus, tax amounts attributable to rum produced in Puerto Rico are covered over to Puerto Rico. Tax amounts attributable to rum produced in the Virgin Islands are covered over to the Virgin Islands. Tax amounts attributable to rum produced in neither Puerto Rico nor the Virgin Islands are divided and covered over to the two possessions under a formula. All of the amounts covered over are subject to the limitation.

Section 305 of H.R. 1308, Pub. L. No. 108-311 (the "Working Families Tax Relief Act of 2004") temporarily suspended the $10.50 per proof gallon limitation on the amount of excise taxes on rum covered over to Puerto Rico and the Virgin Islands. That law extended the cover over amount of $13.25 per proof gallon for rum brought into the United States after December 31, 2003 , and before January 1, 2006 . After December 31, 2005 , the cover over amount reverts to $10.50 per proof gallon.

House Bill³²⁰

The provision temporarily suspends the $10.50 per proof gallon limitation on the amount of excise taxes on rum covered over to Puerto Rico and the Virgin Islands. Under the provision, the cover over amount of $13.25 per proof gallon is extended for rum brought into the United States after December 31, 2003 , and before January 1, 2006 . After December 31, 2005 , the cover over amount reverts to $10.50 per proof gallon.

Effective date. --The provision applies to articles brought into the United States after December 31, 2003 .

Senate Amendment³²¹

Same as the House bill.

Conference Agreement

The conference agreement does not include the House bill and the Senate amendment provision.



21. Joint review of strategic plans and budget for the IRS (sec. 419 of the House bill and secs. 8021 and 8022 of the Code)

Present Law

The Joint Committee on Taxation is required to conduct a joint review³²² of the strategic plans and budget of the IRS from 1999 through 2004.³²³ The joint review required in 2004 is considered as timely if conducted before June 1, 2005 . The Joint Committee was required to provide an annual report³²⁴ from 1999 through 2003 with respect to:

 Strategic and business plans for the IRS ;

 Progress of the IRS in meeting its objectives;

 The budget for the IRS and whether it supports its objectives;

 Progress of the IRS in improving taxpayer service and compliance;

 Progress of the IRS on technology modernization; and

 The annual filing season.

With respect to the annual report for the joint review required in 2004, the report must cover the matters addressed in the joint review.

House Bill³²⁵

The Joint Committee on Taxation is required to conduct a joint review before June 1, 2005 , and to provide an annual report with respect to such joint review. The content of the annual report is the matters addressed in the joint review.

Effective date. --The provision is effective on the date of enactment.

Senate Amendment

No provision.

Conference Agreement

The conference agreement does not include the House bill provision.



22. Extension of parity in the application of certain limits to mental health benefits (sec. 420 of the House bill, sec. 701 of the Senate amendment, sec. 9812 of the Code, sec. 712 of ERISA, and section 2705 of the PHSA)

Present Law

The Mental Health Parity Act of 1996 amended the Employee Retirement Income Security Act of 1974 ("ERISA") and the Public Health Service Act ("PHSA") to provide that group health plans that provide both medical and surgical benefits and mental health benefits cannot impose aggregate lifetime or annual dollar limits on mental health benefits that are not imposed on substantially all medical and surgical benefits. The provisions of the Mental Health Parity Act were initially effective with respect to plan years beginning on or after January 1, 1998, for a temporary period. Since enactment, the mental health parity requirements in ERISA and the PHSA have been extended on more than one occasion and were most recently extended to apply with respect to benefits for services furnished before January 1, 2006, by the Working Families Tax Relief Act of 2004 ("WFTRA").³²⁶

The Taxpayer Relief Act of 1997 added to the Code the requirements imposed under the Mental Health Parity Act, and imposed an excise tax on group health plans that fail to meet the requirements. The excise tax is equal to $100 per day during the period of noncompliance and is generally imposed on the employer sponsoring the plan if the plan fails to meet the requirements. The maximum tax that can be imposed during a taxable year cannot exceed the lesser of 10 percent of the employer's group health plan expenses for the prior year or $500,000. No tax is imposed if the Secretary determines that the employer did not know, and exercising reasonable diligence would not have known, that the failure existed.

The mental health parity requirements in the Code were initially effective with respect to plan years beginning on or after January 1, 1998, for a temporary period. Since enactment, the mental health parity requirements in the Code have been extended on more than one occasion and were most recently extended to apply with respect to benefits for services furnished before January 1, 2006, by the WFTRA.

House Bill³²⁷

The House bill extends the Code provisions relating to mental health parity to benefits for services furnished on or after the date of enactment and before January 1, 2006 . The excise tax on failures to meet the requirements imposed by the Code provisions does not apply after December 31, 2003 , and before the date of enactment.

Effective date. --The provision is effective for benefits for services furnished on or after December 31, 2003 .

Senate Amendment³²⁸

The Senate amendment extends the ERISA and PHSA provisions relating to mental health parity to benefits for services furnished before January 1, 2006 . The Senate amendment also extends the Code provisions relating to mental health parity to benefits for services furnished on or after the date of enactment and before January 1, 2006 . The excise tax on failures to meet the requirements imposed by the Code provisions does not apply after December 31, 2003 , and before the date of enactment.

Effective date. --The Senate amendment provision extending the Code provision applies to benefits for services furnished on or after December 31, 2003 . The ERISA and PHSA provisions apply to benefits for services furnished on or after December 31, 2004 .

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



23. Combined employment tax reporting (sec. 421 of the House bill and sec. 712 of the Senate amendment)

Present Law

Traditionally, Federal tax forms are filed with the Federal government and State tax forms are filed with individual States. This necessitates duplication of items common to both returns.

The Taxpayer Relief Act of 1997 permits implementation of a limited demonstration project to assess the feasibility and desirability of expanding combined Federal and State reporting. As enacted, it was limited to the sharing of information between the State of Montana and the IRS , but any State may participate in a combined reporting program under present law. However, the project is limited to employment tax reporting. In addition, it is limited to disclosure of the name, address, TIN , and signature of the taxpayer. The authority for the demonstration project expired on the date five years after the date of enactment (August 5, 2002).

The Working Families Tax Relief Act of 2004 expanded to all States the authority to participate in a combined Federal and State employment tax reporting program. The authority for this expanded program expires December 31, 2005 .

House Bill³²⁹

The House bill provision extends the demonstration project through December 31, 2005 .

Effective date. --The House bill provision takes effect on the date of enactment.

Senate Amendment³³⁰

The Senate amendment provides permanent authority for any State to participate in a combined Federal and State employment tax reporting program, provided that the program has been approved by the Secretary.

Effective date. --The Senate amendment takes effect on the date of enactment.

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



24. Deduction for qualified clean-fuel vehicle property (sec. 422 of the House bill, sec. 721 of the Senate amendment, and sec. 179 of the Code)

Present Law

Certain costs of qualified clean-fuel vehicles may be expensed and deducted when such property is placed in service. Qualified clean-fuel vehicle property includes motor vehicles that use certain clean-burning fuels (natural gas, liquefied natural gas, liquefied petroleum gas, hydrogen, electricity and any other fuel at least 85 percent of which is methanol, ethanol, any other alcohol or ether). The maximum amount of the deduction is $50,000 for a truck or van with a gross vehicle weight over 26,000 pounds or a bus with seating capacities of at least 20 adults; $5,000 in the case of a truck or van with a gross vehicle weight between 10,000 and 26,000 pounds; and $2,000 in the case of any other motor vehicle. The deduction is one quarter of the otherwise allowable amount in 2006, and is unavailable for purchases after December 31, 2006 .

House Bill³³¹

The House bill repeals the phase down of the allowable deduction for clean-fuel vehicles in 2004 and 2005. Thus, a taxpayer who purchases a qualifying vehicle may claim 100 percent of the otherwise allowable deduction for vehicles purchased in 2004 and 2005. For vehicles purchased in 2006 the deduction remains at 25 percent of the otherwise allowable amount as under present law.

Effective date. --The provision is effective for vehicles placed in service after December 31, 2003 .

Senate Amendment³³²

The Senate amendment repeals the phase down for each of 2004, 2005, and 2006.

(Other sections of the Senate amendment create new credits for the purchase of certain vehicles that would be qualified clean-fuel vehicles under present law. These modifications are not described in this document.)

Effective date. --The provision is effective for vehicles placed in service after December 31, 2003 .

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



25. Credit for qualified electric vehicles (sec. 422 of the House bill, sec. 720 of the Senate amendment, and sec. 30 of the Code)

Present Law

A ten-percent tax credit is provided for the cost of a qualified electric vehicle, up to a maximum credit of $4,000. A qualified electric vehicle generally is a motor vehicle that is powered primarily by an electric motor drawing current from rechargeable batteries, fuel cells, or other portable sources of electrical current. The full amount of the credit is available for purchases prior to 2006. The credit is reduced for purchases in 2006, and is unavailable for purchases after December 31, 2006 .

House Bill³³³

The House bill repeals the phase down of allowable tax credit for electric vehicles in 2004 and 2005. Thus, a taxpayer who purchases a qualifying vehicle may claim 100 percent of the otherwise allowable credit for vehicles purchased in 2004 and 2005. For vehicles purchased in 2006 the credit remains at 25 percent of the otherwise allowable amount as under present law.

Effective date. --The provision is effective for vehicles placed in service after December 31, 2003 .

Senate Amendment³³⁴

The Senate amendment repeals the phase down for each of 2004, 2005, and 2006.

(Other sections of the Senate amendment modify the credit. These modifications are not described in this document.)

Effective date. --The provision is effective for vehicles placed in service after December 31, 2003 .

Conference Agreement

The conference agreement does not include the House bill or the Senate amendment provision.



26. Repeal of reduction of deductions for mutual life insurance companies (sec. 710 of the Senate amendment and sec. 809 of the Code)

Present Law

The Pension Funding Equity Act of 2004³³⁵ repealed the rule requiring reduction in certain deductions of a mutual life insurance company (sec. 809), effective for taxable years beginning after 2004.

For taxable years beginning in 2004, under section 809, a mutual life insurance company is required to reduce its deduction for policyholder dividends by the company's differential earnings amount. If the company's differential earnings amount exceeds the amount of its deductible policyholder dividends, the company is required to reduce its deduction for changes in its reserves by the excess of its differential earnings amount over the amount of its deductible policyholder dividends. The differential earnings amount is the product of the differential earnings rate and the average equity base of a mutual life insurance company.

The differential earnings rate is based on the difference between the average earnings rate of the 50 largest stock life insurance companies and the earnings rate of all mutual life insurance companies. The mutual earnings rate applied under the provision is the rate for the second calendar year preceding the calendar year in which the taxable year begins. Under present law, the differential earnings rate cannot be a negative number.

A company's equity base equals the sum of: (1) its surplus and capital increased by 50 percent of the amount of any provision for policyholder dividends payable in the following taxable year; (2) the amount of its nonadmitted financial assets; (3) the excess of its statutory reserves over its tax reserves; and (4) the amount of any mandatory security valuation reserves, deficiency reserves, and voluntary reserves. A company's average equity base is the average of the company's equity base at the end of the taxable year and its equity base at the end of the preceding taxable year.

A recomputation or "true-up" in the succeeding year is required if the differential earnings amount for the taxable year either exceeds, or is less than, the recomputed differential earnings amount. The recomputed differential earnings amount is calculated taking into account the average mutual earnings rate for the calendar year (rather than the second preceding calendar year, as above). The amount of the true-up for any taxable year is added to, or deducted from, the mutual company's income for the succeeding taxable year.

For taxable years beginning in 2001, 2002, or 2003, the differential earnings amount is treated as zero for purposes of computing both the differential earnings amount and the recomputed differential earnings amount (true-up).

House Bill

No provision.

Senate Amendment

The provision repeals the rule requiring reduction in certain deductions of a mutual life insurance company (sec. 809) for taxable years beginning in 2004.

Effective date. --The provision is effective for taxable years beginning after December 31, 2003 .

Conference Agreement

The conference agreement does not include the Senate amendment provision.



27. Study of earnings stripping provisions (sec. 163(j) of the Code)

Present Law

Present law provides rules to limit the ability of U.S. corporations to reduce the U.S. tax on their U.S.-source income through certain earnings stripping transactions. These rules limit the deductibility of interest paid to certain related parties ("disqualified interest"), if the payor's debt-equity ratio exceeds 1.5 to 1 and the payor's net interest expense exceeds 50 percent of its "adjusted taxable income" (generally taxable income computed without regard to deductions for net interest expense, net operating losses, and depreciation, amortization, and depletion). Disqualified interest for these purposes also may include interest paid to unrelated parties in certain cases in which a related party guarantees the debt.

House Bill

No provision.

Senate Amendment

No provision.

Conference Agreement

The conference agreement requires the Treasury Department to conduct a study of the earnings stripping rules, including a study of the effectiveness of these rules in preventing the shifting of income outside the United States, whether any deficiencies in these rules have the effect of placing U.S.-based businesses at a competitive disadvantage relative to foreign-based businesses, the impact of earnings stripping activities on the U.S. tax base, whether laws of foreign countries facilitate the stripping of earnings out of the United States, and whether changes to the earnings stripping rules would affect jobs in the United States. This study is to include specific recommendations for improving these rules and is to be submitted to the Congress not later than June 30, 2005 .

Effective date. --The provision is effective on the date of enactment.

TITLE V --DEDUCTION OF STATE AND LOCAL GENERAL SALES TAXES

A. Deduction of State and Local General Sales Taxes (sec. 501 of the House bill and sec. 164 of the Code)

Present Law

An itemized deduction is permitted for certain State and local taxes paid, including individual income taxes, real property taxes, and personal property taxes. No itemized deduction is permitted for State or local general sales taxes.

House Bill

The provision provides that, at the election of the taxpayer, an itemized deduction may be taken for State and local general sales taxes in lieu of the itemized deduction provided under present law for State and local income taxes. The allowable deduction would be determined under tables prescribed by the Secretary. The tables would be based on the average consumption of taxpayers on a State-by-State basis, and would take into account filing status, number of dependents, adjusted gross income, and rates of State and local general sales taxes.

The term 'general sales tax' means a tax imposed at one rate with respect to the sale at retail of a broad range of classes of items. However, in the case of items of food, clothing, medical supplies, and motor vehicles, the fact that the tax does not apply with respect to some or all of such items is not taken into account in determining whether the tax applies with respect to a broad range of classes of items, and the fact that the rate of tax applicable with respect to some or all of such items is lower than the general rate of tax is not taken into account in determining whether the tax is imposed at one rate. Except in the case of a lower rate of tax applicable with respect to food, clothing, medical supplies, or motor vehicles, no deduction is allowed for any general sales tax imposed with respect to an item at a rate other than the general rate of tax. However, in the case of motor vehicles, if the rate of tax exceeds the general rate, such excess shall be disregarded and the general rate is treated as the rate of tax.

A compensating use tax with respect to an item is treated as a general sales tax, provided such tax is complimentary to a general sales tax and a deduction for sales taxes is allowable with respect to items sold at retail in the taxing jurisdiction that are similar to such item.

Effective date. --The provision is effective for taxable years beginning after December 31, 2003 , and prior to January 1, 2006 .

Senate Amendment

No provision.

Conference Agreement

The conference agreement follows the House bill with the following modification.

Rather than requiring that taxpayers use tables prescribed by the Secretary to determine their allowable sales tax deduction, taxpayers would instead have two options with respect to the determination of the sales tax deduction amount. Taxpayers would be able to deduct the total amount of general State and local sales taxes paid by accumulating receipts showing general sales taxes paid. Alternatively, taxpayers may use tables created by the Secretary of the Treasury. The tables are to be based on average consumption by taxpayers on a State-by-State basis taking into account filing status, number of dependents, adjusted gross income and rates of State and local general sales taxation. Taxpayers who use the tables created by the Secretary may, in addition to the table amounts, deduct eligible general sales taxes paid with respect to the purchase of motor vehicles, boats and other items specified by the Secretary. Sales taxes for items that may be added to the tables would not be reflected in the tables themselves.

The IRS is currently in the process of finalizing tax forms for 2004. The Code has not contained an itemized deduction for State and local sales taxes for a number of years. Developing the tables required by the provision will in general require a significant amount of time and effort. The conferees anticipate that IRS will do the best they can to reasonably and accurately implement this statutory provision in order to effectuate the deduction for the 2005 filing season.

TITLE VI - FAIR AND EQUITABLE TOBACCO REFORM

A. Tobacco Reform (secs. 701-725 of the House bill and title XI of the Senate amendment)

Present Law

The current tobacco program has two main components: a supply management component and a price support component. In addition, in 1982, Congress passed the "No-Net-Cost Tobacco Program Act"³³⁶ that assured the tobacco program would run at no-net cost to the Federal government.



Supply management

The supply management component limits and stabilizes the quantity of tobacco marketed by farmers. This is achieved through marketing quotas. The Secretary of Agriculture raises or lowers the national marketing quota on an annual basis. The Secretary establishes the national marketing quota for each type of tobacco based upon domestic and export demand, but at a price above the government support price. The purpose of matching supply with demand is to keep the price of tobacco high. There is a secondary market in tobacco quota. Tobacco growers who do not have sufficient quota may purchase or rent one.



Support price

Given the numerous variables that affect tobacco supply and demand, marketing quotas alone have not always been able to guarantee tobacco prices. Therefore, in addition to marketing quotas, Federal support prices are established and guaranteed through the mechanism of nonrecourse loans available on each farmer's marketed crop. The loan price for each type of tobacco is announced each year by the Department of Agriculture using the formula specified in the law to calculate loan levels. This system guarantees minimum prices for the different types of tobacco.

The national loan price on 2004 crop flue-cured tobacco is $1.69 per pound; the burley loan price is $1.873 per pound.



No-net-cost assessment

In 1982, Congress passed the "No-Net-Cost Tobacco Program Act." The purpose of this program is to ensure that the nonrecourse loan program is run at no-net-cost to the Federal government.

When tobacco is not contracted, it is sold at an auction sale barn. At the auction sale barn, each lot of tobacco goes to the highest bidder, unless that bid does not exceed the government's loan price. When the bid does not exceed this price, the farmer may choose to be paid the loan price by a cooperative, with money borrowed from the Commodity Credit Corporation (" CCC "). In such cases, the tobacco is consigned to the cooperative (known as a price stabilization cooperative), which redries, packs, and stores the tobacco as collateral for the CCC . The cooperative, acting as an agent for the CCC , later sells the tobacco, with the proceeds going to repay the loan plus interest. If the cooperative does not recover the cost of the loan plus interest, the Secretary of Agriculture assesses growers, purchasers and importers of tobacco in order to repay the difference. All growers, purchasers and importers of tobacco participate in paying these assessments, regardless of whether or not they participate in the loan program.

The no-net-cost assessment on 2004 crop flue-cured is $0.10 per pound; the burley assessment is $0.02 per pound. The no-net-cost assessment funds are deposited in an escrow account that is held to reimburse the government for any financial losses resulting from tobacco loan operations.

Currently, over 80 percent of growers market their tobacco through contracts with tobacco companies, and thus these growers do not participate in the loan program. However, they must still pay the no-net-cost assessment when the Secretary levies it. The remaining 20 percent of growers market their tobacco through the auction system, and are eligible for participation in the loan program. Of this group, over 60 percent have consistently participated in the loan program during the past several years.

House Bill

The House bill repeals the Federal tobacco support program, including marketing quotas and nonrecourse marketing loans. The House bill also provides quota holders $7.00 per pound based on their 2002 quota allotment paid in equal installments over five years. Additionally, the House bill provides producers transition payments of $3.00 per pound based on their 2002 quota levels paid in equal installments over five years. The House bill caps payments to quota holders and growers at $9.6 billion over fiscal years 2005 through 2009. The House bill applies to the 2005 and subsequent crops of tobacco.

Effective date. --The House bill is effective on the date of enactment.

Senate Amendment

The Senate amendment ends the current Federal tobacco program. The Senate amendment also provides quota holders $8.00 per pound based on their 2002 quota levels paid over a 10-year period. Additionally, the Senate amendment provides tobacco growers with of $4.00 per pound based on their 2002 quota levels, paid over a 10-year period. The payments are funded by assessments on tobacco companies. The Senate amendment also restricts tobacco production to traditional tobacco producing counties and provides poundage and acreage limitations on how much tobacco can be produced in the future as determined by production boards for each type of tobacco. The Senate amendment applies to the 2004 and subsequent crops of tobacco.

Additionally, the Senate amendment gives the Food and Drug Administration regulatory authority over the content and marketing of tobacco products.

Effective date. --The Senate amendment is effective on the date of enactment.

Conference Agreement

The conference agreement repeals all aspects of the Federal tobacco support program, including marketing quotas and nonrecourse marketing loans. The conference agreement provides eligible quota holders $7 per pound on their basic quota allotment paid in equal installments over 10 years. Additionally, the conference agreement provides eligible producers transition payments of $3 per pound based on their effective quota paid in equal installments over 10 years.

The Managers intend the payments to producers and quota holders to be made as quickly and effectively as possible. The Managers expect the Secretary to evaluate and consider the utilization of the proven financial and administrative expertise of the Phase II settlement system to achieve effective and prompt payment. The Managers further expect the Secretary to use the facilities of the Farm Service Agency to furnish information relating to accelerated payment options offered by financial institutions.

Manufacturers and importers of tobacco products will pay a quarterly assessment into a newly formed Tobacco Trust Fund. These assessments will be on the following classes of tobacco: Cigarettes, Snuff, Chewing Tobacco, Pipe Tobacco, Roll-your-own tobacco, and Cigars. Assessment allocations will then be divided into manufacturers' and importers' market share. Funds from the Tobacco Trust Fund will be used to provide payments to quota holders and eligible producers as well as pay for program losses incurred by the U.S. Department of Agriculture.

The conference agreement applies to the 2005 and subsequent crops of tobacco.

Effective date. --The conference agreement is effective on the date of enactment.

TITLE VII - PROTECTION OF UNITED STATES WORKERS FROM COMPETITION OF FOREIGN WORKFORCES

THE SENATE AMENDMENT CONTAINED A PROVISION RELATING TO PROTECTION OF UNITED STATES WORKERS FROM COMPETITION OF FOREIGN WORKFORCES. THE CONFERENCE AGREEMENT DOES NOT INCLUDE THE SENATE AMENDMENT PROVISION.

TITLE VIII - OTHER PROVISIONS

A. Provisions Relating to Housing

1. Treatment of qualified mortgage revenue bonds (sec. 601 of the Senate amendment and sec. 143 of the Code)

Present Law

Under present law, qualified mortgage bonds are tax-exempt bonds used to finance owner-occupied residences. Among other requirements, these bonds are subject to income and purchase price limitations, as well as a requirement that the homebuyer not have an ownership interest in the principal residence in the preceding three years.

Generally, in order for a bond to be a qualified mortgage bond, the mortgagor's family income cannot exceed 115 percent of the applicable median family income. Adjustments are made for targeted area residences, for areas that have high housing costs in relation to income, and for family size. Further, 95 percent or more of the net proceeds of qualified mortgage bonds must be used to finance residences for first-time homebuyers. Exceptions are made for financing of targeted area residences, qualified home improvement loans, and qualified rehabilitation loans.

A residence financed with a mortgage funded by qualified mortgage bonds may not have a purchase price in excess of 90 percent of the average area purchase price for that residence. Adjustments are made for residences located in certain low-income or economically distressed areas, and for the number of families for which a residence is designed.

Part or all of the interest subsidy provided by qualified mortgage bonds is recaptured if the borrower experiences substantial increases in income and disposes of the subsidized residence within nine years after purchase. The annual volume limitations imposed on most qualified private activity bonds limits the aggregate face amount of qualified mortgage bonds that may be issued. In addition, repayments of mortgage principal received after 10 years from the date of issue must be used to retire outstanding bonds (the "10-year rule").

House Bill

No provision.

Senate Amendment

The Senate amendment suspends the 10-year rule for one year for outstanding bonds, allowing repayments of principal received during this period to be used to finance new mortgage loans rather than retiring outstanding bonds. The Senate amendment repeals the 10-year rule for bonds originally issued after the date of enactment.

Effective date. --The provision repeals the 10-year rule for bonds issued after the date of enactment and suspends the 10-year rule for outstanding bonds for a one-year period beginning on the date of enactment.

Conference Agreement

The conference agreement does not include the Senate amendment provision.



2. Premiums for mortgage insurance (sec. 602 of the Senate amendment and secs. 163(h) and 6050H of the Code)

Present Law

Present law provides that qualified residence interest is deductible notwithstanding the general rule that personal interest is nondeductible (sec. 163(h)).

Qualified residence interest is interest on acquisition indebtedness and home equity indebtedness with respect to a principal and a second residence of the taxpayer. The maximum amount of home equity indebtedness is $100,000. The maximum amount of acquisition indebtedness is $1 million. Acquisition indebtedness means debt that is incurred in acquiring constructing, or substantially improving a qualified residence of the taxpayer, and that is secured by the residence. Home equity indebtedness is debt (other than acquisition indebtedness) that is secured by the taxpayer's principal or second residence, to the extent the aggregate amount of such debt does not exceed the difference between the total acquisition indebtedness with respect to the residence, and the fair market value of the residence.

House Bill

No provision.

Senate Amendment

The Senate amendment provision provides that premiums paid or accrued for qualified mortgage insurance by a taxpayer during the taxable year in connection with acquisition indebtedness on a qualified residence of the taxpayer are treated as qualified residence interest and thus deductible. The amount allowable as a deduction under the provision is phased out ratably by 10 percent for each $1,000 by which the taxpayer's adjusted gross income exceeds $100,000 ($500 and $50,000, respectively, in the case of a married individual filing a separate return). Thus, the deduction is not allowed if the taxpayer's adjusted gross income exceeds $110,000 ($55,000 in the case of married individual filing a separate return).

For this purpose, qualified mortgage insurance means the Home Loan Guaranty Program of the Department of Veterans Affairs, and mortgage insurance provided by the Federal Housing Administration, or the Rural Housing Administration, and private mortgage insurance (defined in section 2 of the Homeowners Protection Act of 1998).

Amounts paid for qualified mortgage insurance that are properly allocable to periods after the close of the taxable year are treated as paid in the period to which it is allocated. No deduction is allowed for the unamortized balance if the mortgage is paid before its term (except in the case of qualified mortgage insurance provided by the Department of Veterans Affairs or Rural Housing Administration).

Reporting rules apply under the provision.

Effective date. --The Senate amendment provision is effective for amounts paid or accrued after the date of enactment in taxable years beginning after December 31, 2004 , and ending before January 1, 2006 .

Conference Agreement

The conference agreement does not include the Senate amendment provision.



3. Increase in historic rehabilitation credit for residential housing for the elderly (sec. 603 of the Senate amendment and secs. 42 and 47 of the Code)

Present Law

Rehabilitation credit

Present law provides a credit for rehabilitation expenditures (sec. 47). A 20-percent credit is provided for rehabilitation expenditures with respect to a certified historic structure. For this purpose, a certified historic structure means any building that is listed in the National Register, or that is located in a registered historic district and is certified by the Secretary of the Interior to the Secretary of the Treasury as being of historic significance to the district.

A building is treated as having been substantially rehabilitated only if the rehabilitation expenditures during the 24-month period selected by the taxpayer and ending within the taxable year exceed the greater of the adjusted basis of the building (and its structural components), or $5,000. The taxpayer's depreciable basis in the property is reduced by any rehabilitation credit claimed.



Low-income housing credit

The low-income housing tax credit (sec. 42) may be claimed over a 10-year period for the cost of rental housing occupied by tenants having incomes below specified levels. The credit percentage for newly constructed or substantially rehabilitated housing that is not Federally subsidized is adjusted monthly by the Internal Revenue Service so that the 10 annual installments have a present value of 70 percent of the total qualified expenditures. The credit percentage for new substantially rehabilitated housing that is Federally subsidized and for existing housing that is substantially rehabilitated is calculated to have a present value of 30 percent of qualified expenditures. The aggregate credit authority provided annually to each State is $1.75 per resident, except in the case of projects that also receive financing with proceeds of tax-exempt bonds issued subject to the private activity bond volume limit and certain carry-over amounts. The $1.75 per resident cap is indexed for inflation.

Qualified basis with respect to which the credit may be computed is generally determined as the portion of the eligible basis of the qualified low-income building attributable to the lowincome rental units. Qualified basis generally is the taxpayer's depreciable basis in a qualified low-income building. In the case of a taxpayer who claims the rehabilitation credit for a qualified low-income building, the taxpayer's depreciable basis in the building is reduced by the amount of the rehabilitation credit claimed. In addition, eligible basis is reduced by any Federal grant received with respect to the building. A qualified low-income building is a building that meets certain compliance criteria and is depreciable under the modified accelerated cost recovery system ("MACRS").

House Bill

No provision.

Senate Amendment

The Senate amendment increases the present-law 20-percent credit for historic rehabilitation expenses to 25 percent in the case of rehabilitation expenses incurred with respect to a building which is also a low-income housing credit property in which substantially all of the tenants, both those tenants in rent-restricted units and in other residential units, are age 65 or greater. The Senate amendment permits the 25-percent rehabilitation credit to be claimed with respect to all parts of the building, not only those parts on which the taxpayer also claims the low-income housing credit.³³⁷

Effective date. --The Senate amendment provision is effective for property placed in service after the date of enactment.

Conference Agreement

The conference agreement does not include the Senate amendment provision.

B. Provisions Relating to Bonds

1. Modification of the authority of Indian tribal governments to issue tax-exempt bonds (sec. 613 of the Senate amendment and sec. 7871 of the Code)

Present Law

Under present law, the interest on bonds issued by an Indian tribal government is taxexempt if substantially all of the proceeds of are to be used in the exercise of an essential government function. The term essential government function does not include any function that is not customarily performed by State or local governments with general taxing powers. In addition, Indian tribal governments are prohibited from issuing private activity bonds, with the exception of bonds issued to finance certain manufacturing facilities.

House Bill

No provision.

Senate Amendment

The Senate amendment expands the tax-exemption for Indian tribal government bonds to include obligations 95 percent or more of the proceeds of which are used to finance any facility located on an Indian reservation. The tax-exemption does not include any obligations used to finance any portion of a building in which class II or class III gaming (as defined in section 4 of the Indian Gaming Regulatory Act) is conducted or housed.

For purposes of the Senate amendment, an Indian reservation means: (1) a reservation as defined in section 4(10) of the Indian Child Welfare Act of 1978, and (2) lands held under the provisions of the Alaska Native Claims Settlement Act by a Native corporation as defined in section 3(m) of that Act.

Effective date. --The provision is effective for bonds issued after the date of enactment and before January 1, 2006 .

Conference Agreement

The conference agreement does not include the Senate amendment provision.



2. Definition of manufacturing facility for qualified small issue bonds (sec. 614 of the Senate amendment and sec. 144 of the Code)

Present Law

Qualified small-issue bonds are bonds used to finance private business manufacturing facilities or the acquisition of land and equipment by certain farmers. Generally, no more than $1 million of small-issue bond financing may be outstanding at any time for property of a business (including related parties) in the same municipality or county. This $1 million limit may be increased to $10 million if all other capital expenditures of the business (including related parties) in the same municipality or county over a six-year period are counted toward the limit. In addition, 95 percent or more of the net proceeds of qualified small-issue bonds must be used for the acquisition, construction, reconstruction, or improvement of land or property of a character subject to the allowance for depreciation, or to redeem a prior issue that was used for those purposes.

Under present law, a manufacturing facility is defined as any facility used in the manufacturing or production of tangible personal property. Facilities that are directly related and ancillary to a manufacturing facility may be financed with small-issue bonds if such facilities are located on the same site as the manufacturing facility and no more than 25 percent of the net proceeds of the bonds are used to finance such facilities.

House Bill

No provision.

Senate Amendment

The Senate amendment expands the definition of manufacturing facilities eligible for small-issue bond financing to include facilities: (1) used in the manufacture or development of software products or processes, if it takes more than six months to manufacture or develop such products or processes, such manufacture or development could not with due diligence be reasonably expected to occur in less than six months, and the software product or process comprises programs, routines, and attendant documentation developed and maintained for use in computer and telecommunications technology; and (2) used in the manufacture or development of any biobased product or bioenergy, if it takes more than six months to manufacture or develop and the manufacture or development could not with due diligence be reasonably expected to occur in less than six months. The term biobased product means a commercial or industrial product which utilizes biological products or renewable domestic agricultural or forestry materials. The term bioenergy means biomass used in the production of energy, including liquid, solid, or gaseous fuels, electricity, and heat.

The Senate amendment expands the definition of eligible facilities to include directly and functionally related offices and research and development facilities located on the same site as the manufacturing facilities. Such office and research and development facilities may not constitute more than 40 percent of the net proceeds of the issue used to finance the facility.

Effective date. --The provision is effective for bonds issued after the date of enactment.

Conference Agreement

The conference agreement does not include the Senate amendment provision.



3. Qualified forest conservation bonds (sec. 615 of the Senate amendment and sec. 142 of the Code)

Present Law

Tax-exempt bonds



In general

Interest on debt incurred by States or local governments is excluded from income if the proceeds of the borrowing are used to carry out governmental functions of those entities or the debt is repaid with governmental funds. Interest on bonds that nominally are issued by States or local governments, but the proceeds of which are used (directly or indirectly) by a private person and payment of which is derived from funds of such a private person is taxable unless the purpose of the borrowing is approved specifically in the Code or in a non-Code provision of a revenue Act. These bonds are called "private activity bonds." The term "private person" includes the Federal Government and all other individuals and entities other than States or local governments.