General Explanation of the Tax Reform Act of 1976

GENERAL EXPLANATIONEXPLANATION OF THETHE TAX REFORMREFORM ACTACT OFOF 19761976

(H.R. 10612,10612, 94TH94TH CONGRESS, PUBLIC LAWLAW 94-455)94^55)

PREPAREDBY BY THE

STAFF OF THE JOINT COMMITTEECOMMITTEE ONON TAXATIONTAXATION

DECEMBER 29,29, 19761976

GENERAL EXPLANATIONEXPLANATION OF THETHE TAX REFORM ACTACT OFOF 19761976

(H.R.(H.K. 10612, 94TH94TH CONGRESS,CONGRESS, PUBLICPUBLIC LAWLAW 94-455)94-455)

PREPARED BY TOTETHE

STAFFSTAEF OF THE JOINT COMMITTEECOMMITTEE ONON TAXATIONTAXATION

DECEMBER 29,29, 19761976

U.S. GOVERNMENTGOVERNMENT PRINTING OFFICE

79-667 O0 WASHINGTON : 19761976 JCS-33-76

For sale by the SuperintendentSuperintendent ofof Documents,Documents, U.S.U.S. GovernmentGovernment PrintingPrinting OfficeOffice Washington, D.C.D.C. 2040220402 Stock No. 052-070-03850-1052-070-03860-1 CONGRESS OFOF THE UNITEDUNITED STATESSTATES

(94th Cong.,Cong., 2d sess.)sess.) JOINTJoint COMMITTEECommittee ONon TAXATIONTaxation SENATESenate HOUSEHouse RUSSELL B. LONG, Louisiana,Louisiana, Chairman AL ULLMAN, Oregon, Vice ChairmanChairman HERMAN E. TALMADGE, Georgia JAMES A. BURKE, Massachusetts VANCE HARTKE,HARTKE, Indiana Illinois , DAN ROSTENKOWSKI, Illinois CARL T. CURTIS, Nebraska HERMAN T.T. SCHNEEBELI,SCENEEBELI, Pennsylvania PAUL J. FANNIN, Arizona BARBER B.B. CONABLE,CONABLE, JR.,Jr., New York LAURENCELaurence N. WOODWORTH,Woodworth, Chief of Staff HERBERTHerbert L. CHABOT,Chabot, Assistant ChiefChief of Staff BERNARDBernard M. SHAPIRO,Shapiro, Assistant ChiefChief ofof StaffStaff

(ID LETTER OFOF TRANSMITTALTRANSMITTAL

CONGRESSCongress of OFthe THE UnitedUNITED STATES,States, JOINTJoint COMMITTEECommittee ONon TAXATION,Taxation, Washington, D.C.,D.C., DecemberDecember 29,29, 1976.1976. Hon. RUSSELLRussell B. LONG,Long, Chairman,Ohmrman, Hon. ALAl ULLMAN,Ullman, Vice Chairman,Chairman, JointJoint CommitteeCommittee on Taxation,Taxation, U.S. Congress,Congress, Washington, D.C.

DEARDear MESSRS.Messrs. CHAIRMENChairmen : While committee reports explain the posi-posi- tion of thethe HouseHouse CommitteeCommittee on Ways andand Means,Means, or the positionposition ofof the SenateSenate CommitteeCommittee on Finance, they do not inin allall casescases explainexplain the tax legislationlegislation asas finallyfinally passedpassed by the Congress.Congress. This becamesbecames particularly important inin thethe casecase ofof majormajor legislationlegislation wherewhere there areare many changes between the bill as passed by the House, or as passed by the Senate,Senate, and thethe billbill whichwhich finallyfinally becomesbecomes public law. The Tax Reform ActAct ofof 1976,1976, because of its comprehensivecomprehensive scopescope and becausebecause of the many changes which were made inin thisthis legislation, both by the Sen- ate andand subsequentlysubsequently by the conferees.conferees, isis anan illustration of wherewhere the differences were especially significant..significant. This document represents thethe efforteffort ofof thethe staff ofof the Joint Com-Com- mittee on Taxation to provide an explanation of the Tax ReformReform Act of 19761976 as finally enacted and is comparable toto a number of similarsimilar documents prepared by the staff on other revenuerevenue acts in recent years. For thethe mostmost part,part, wherewhere provisionsprovisions whichwhich werewere unchanged in conference werewere describeddescribedin ineither eithertlie the HouseHouseor or SenateSenate report,report, thatthat explanation is carried over in this document. No attempt is made here to carry the explanation further thanthan isis customarycustomary inin thethe casecase ofof committteecommitttee reports and thereforetherefore itit doesdoes notnot dealdeal withwith issuesissues whichwhich areare customar-customar- ily explained in regulations or rulings. The first major part ofof thethe documentdocument contains a summary of and the reasons previouslypreviously givengiven forfor the various provisions.provisions. The second part contains the revenue estimates on the legislation as finally enacted and the third partpart isis aa generalgeneral explanationexplanation ofof thethe provisionsprovisions appearing in the order in whichwhich they appear inin thethe publicpublic law.law. This material hashas beenbeen prepared by the staff of the Joint CommitteeCommittee on Taxation after thethe TaxTax ReformReform ActAct ofof 19761976 was passed. ItIt has not been reviewed byby thethe tax committeescommittees and therefore onlyonly reflectsreflects the staff's view asas to'theto the intentintent of Congress. ItIt is hoped thatthat this documentdocument ••willwill be usefuluseful inin gaininggaining aa betterbetter understandingunderstanding of the Tax Reform Act of 1976.1976. • Sincerely yours,yours, LAURENCELaurence N. WOODWORTH,Woodworth, Chief of Staff.Staff. (in)

. :

LEGISLATIVE HISTORY OFOF THE ACTACT The TaxTax ReformEeform ActAct ofof 19761976 was the resultresult ofof overover twotwo yearsyears ofof legislative deliberations largelylargely during thethe 94th94th Congress,Congress, althoughalthough some ofof thethe provisions were originallyoriginally considered by the House Ways and Means Committee duringduring the 93rd Congress.^Congress.' Consideration of the Act in thethe 94th94th CongressCongress proceeded on the following schedule:schedule June 2323 through JuneJune 25,25, 1975:1975 : PanelPanel DiscussionsDiscussions beforebefore the House Committee on Ways and Means.

July 88 throughthrough JulyJuly 31,31, 1975:1975 : HearingsHearings beforebefore thethe HouseHouse Commit-Commit- tee on Ways and Means.

November 12,12, 19751975:: BillBill (H.R.(H.R. 10612)10612) reportedreported byby thethe HouseHouse Com-Com- mittee on Ways and MeansMeans (House Report 94-658)94-658).

December 3 and 4, 1975 : : BillBill considered and passed by the House of Representatives. March 17 through April 13,13, 1976; JulyJuly 20 through 22, 1976: Hear- ings before the Senate Committee on Finance.Finance.

June 10,10, 1976:1976 : BillBill reportedreported byby thethe SenateSenate CommitteeCommittee onon Finance

(Senate ReportReport 94-938)94-938) : SupplementalSupplemental reportreport filedfiled byby SenateSenate Com-Com- mittee on Finance on July 20,20, 19761976 (Senate Report 94-938, PartPart 2). June 16-18,16-18, 21-25, 28-30, JulyJuly 1-2,1-2, 20-23,20-23, 26-30.26-30, andand August 3-6, 1976:1976: Bill considered andand passed by the Senate. September 13, 1976: Committee on Conference submitted Confer-Confer- ence ReportReport (House Report 94-1515;94-1515; Senate Report 94-1236).94-1236). September 16, 1976: ConferenceConference reportreport (and(and HouseHouse ConcurrentConcurrent Resolution 751) approved by the House and Senate. October 4,4, 1976: Tax ReformReform ActAct ofof 19761976 (Public(Public LawLaw 94-455)94-455) signed by the President.

1 The Ways and Means CommitteeCommitteedid didnot notreport report aa taxtax reform bill in thethe 93rd93rd CongressCongress but diddid holdhold extensiveextensive discussionsdiscussions (February(February 5-28,5-28, 1973) and hearingshearings (March(March 5 through May 1, 1973)1973) onon thethe subject.subject. TheThe WaysWays andand MeansMeans CommitteeCommittee alsoalso heldheld legisla-legislative markup sessions on on taxtax reformreform latelate inin thethe 2nd2nd sessionsession (1974),(1974), butbut hadhad onlyonly mademade tentative decisionsdecisions priorprior toto the endend ofof thethe 93rd93rd Congress.Congress. InIn addition,addition, H.R.H.R. 17488,17488, TheThe Energy Tax and IndividualIndividual ReliefRelief ActAct ofof 1974,1974, reportedreported byby thatthat committeecommittee onon NovemberNovember 26, 19741974 (House(House ReportReport 93-1502),93-1502), includedIncluded provisions relating relating toto real estateestate invest-investment trusts andand thethe taxationtaxation ofof foreignforeign income,Income, muchmuch ofof whichwhich waswas laterlater includedIncluded in the Tax ReformReform ActAct ofof 1976.1976.

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CONTENTS

Page Transmittal Letter illiii Legislative HistoryHistory of the ActAct v I. SummarySummary andand ReasonsReasons forfor the ActAct 1 A. Tax RevisionRevision 2 B. Tax SimplificationSimplification 7 C. Extension of Tax Reductions 8 D. Capital Formation 1010 E. Administrative ProvisionsProvisions 11 F. Estate and GiftGift TaxTax ProvisionsProvisions 12 II. RevenueRevenue EffectsEffects ofof the ActAct 15 III. GeneralGeneral ExplanationExplanation of the ActAct 25 A. Tax shelter provisionsprovisions 25 1. RealReal EstateEstate 25 a. Capitalization andand Amortization ofof Real PropertyProperty Construction PeriodPeriod InterestIntei est andand TaxesTaxes (Sec.(Sec. 201)201) _ 25 b. Recapture of DepreciationDepreciation on Real PropertyProperty (Sec.(Sec. 202)____.202) 29 c. Five-YearFive- Year AmortizationAmortization for Low-IncomeLow-Income RentalRental Housing (Sec.(Sec. 203) 32 2. Limitation ofof Loss to Amount At-RiskAt- Risk (Sec.(Sec. 204)204) 33 3. FarmFarm OperationsOperations 40 a. Farming SyndicatesSyndicates (Sec.(Sec. 207)207) 40 b. Limitation ofof Loss WithWith RespectRespect toto Farms to the Amount for Which thethe Taxpayer Is At RiskRisk (Sec.(Sec. 204) 50 c. Method of AccountingAccounting for Corporations Engaged in Farming (Sec.(Sec. 207(c)) 51 d. Termination of AdditionsAdditions toto ExcessExcess DeductionsDeduction? Accounts Under Sec.Sec. 125]1251 (Sec.(Sec. 206)206) 57 e. Scope ofof WaiverWaiver ofof StatuteStatute of Limitations in CaseCase ofof Activities Not EngagedEngaged inin forfor ProfitProfit (Sec.(Sec. 214)214) 59 4. OilOilandGas and Gas i 62 a. Limitation ofof LossLoss toto AmountAmount AtAt RiskRisk (Sec.(Sec. 204)204) _ _ _ _ 62 b. Gain From Disposition ofof anan Interest in OilOil and GasGas PropertyPropertv (Sec.(Sec. 205)205) 64 5. Motion Picture.Picture Films 67 a. At Risk Rule and CapitalizationCapitalization ofof Production CostsCosts (Secs.(Sees. 204 and 210) 67 b. Clarification ofof Definition ofof Produced Film Rents (Sec. 211) 75 6. EquipmentEquipment Leasing—LimitationLeasing—Limitation onon Loss to AmountAmount AtAt Risk (Sec.(Sec. 204) 77 7. Sports Franchises and Player ContractsContracts (Sec.(Sec. 212)212) 82 8. PartnershipPartnership ProvisionsProvisions 87 a. Partnership AdditionalAdditional First-YearFirst- Year DepreciationDepreciation (Sec. 213(a)) 87 b. Partnership SyndicationSyndication and OrganizationOrganization FeesFees (Sec. 213(b))_213(b)) 89 c. Retroactive Allocations ofof Partnership IncomeIncome oror Loss (Sec.(Sec. 213(c)) 91 d. Partnership SpecialSpecial AllocationsAllocations (Sec.(Sec. 213(d))213(d)) 94 e. Treatment of PartnershipPartnership LiabilitiesLiabilities WhereWhere aa

Partner IsIs NotNot PersonallyPersonally LiableLiable (Sec.(Sec . 213(e))2 1 3 (e) ) 96

(VII) . .

VIII

III. GeneralGeneral ExplanationExplanation ofof thethe Act—ContinuedAct—Continued A. Tax shelter provisions—Continuedprovisions—Continued Page'^"^^ 9. InterestInterest 97 a. Treatment ofof PrepaidPrepaid InterestInterest (Sec.(Sec. 208)208) 97 b. Limitation onon thethe DeductionDeduction forfor InvestmentInvestment Inter- est (Sec.(Sec. 209)209) 102 B. Minimum and Maximum Tax 105105 1.1 Minimum Tax for IndividualsIndividuals (Sec.(Sec. 301)301) 105 2. Minimum Tax for CorporationsCorporations (Sec.(Sec. 301)301) 107107 3. MaximumMaxim.um Tax RateRate (Sec.(Sec. 302)302) 109109 C. Extension of Individual Income Tax ReductionsReductions (Secs.(Sees. 401 and 402) 111111 D. Tax Simplification inin thethe Individual Income Tax 115115 1.1. Revision of Tax Tables for IndividualsIndividuals (Sec.(Sec. 501)501) 115115 2. Alimony Payments (Sec.(Sec. 502)502) 116116 3. Retirement IncomeIncome CreditCredit (Sec.(Sec. 503)503) 117117 4. Credit for ChildChild CareCare ExpensesExpenses (Sec.(Sec. 504)504) 123 5. Sick Pay andand CertainCertain Military,Military, etc.,etc., DisabilityDisability PensionsPensions (Sec. 505) 127127 6. Moving ExpensesExpenses (Sec.(Sec. 506)506) 131131 7. Tax Simplification Study by Joint CommitteeCommittee (Sec.(Sec. 507)507) 135135 E. Business-Related Individual Income Tax RevisionsRevisions 136136 1. Deductions for Expenses Attributable to BusinessBusiness UseUse ofof Home (Sec.(Sec. 601)601) 136136 2. Deduction forfor Expenses AttributableAttributable toto Rental ofof Vaca-Vaca- tion HomesHomes (Sec.(Sec. 601)601) 141141 3. Deductions forfor AttendingAttending ForeignForeign ConventionsConventions (Sec.(Sec. 602)602) __ __ 146 4. Qualified Stock Options (Sec.(Sec. 603)603) 151151 5. Treatment ofof LossesLosses From Certain Nonbusiness Guaranties (Sec. 605)605) 156156 F. Accumulation Trusts (Sec.(Sec. 701)701) 159159 G. Capital Formation 165 1. InvestmentInvestment TaxTax Credit—ExtensionCredit—Extension ofof 10-Percent10-Percent CreditCredit and $100,000$100,000 Limitation For Used PropertyProperty (Secs.(Sees. 801801 and 802)802) 165 2. First-In-First-OutFirst-In-First-Out TreatmentTreatment ofof InvestmentInvestment TaxTax CreditsCredits (Sec. 802) 166166 3. ESOP Investment CreditCredit ProvisionsProvisions (Sec.(Sec. 803)803) 167167 4. InvestmentInvestment CreditCredit inin thethe CaseCase ofof MoviesMovies andand TelevisionTelevision Films (Sec.•804)_(Sec.-804) 176 5. InvestmentInvestment TaxTax CreditCredit inin thethe CaseCase ofof CertainCertain ShipsShips (Sec.(Sec. 805) 186186 6. Net OperatingOperating LossesLosses 188188 a. Net OperatingOperating Loss Carryover Years and Carry-Carrj'- back ElectionElection (Sec.(Sec. 806(a)—(d))806(a)-(d)) 188 b. Limitations on Net OperatingOperating LossLoss CarryoversCarryovers (Sec.(Sec. 806(e)) 190190 7. SmallSmall CommercialCommercial FishingFishing VesselVessel ConstructionConstruction ReservesReserves (Sec. 807)807) 205 H.II. Small Business Provisions 206 1. Extension ofof Certain Corporate Income TaxTax Rate Reduc-Reduc- tions (Sec.(Sec. 901)901) 206 2. Changes in Subchapter S RulesRules 207 a. Subchapter S CorporationCorporation ShareholderShareholder RulesRules (Secs.(Sees. 902(a)902 (a) and (c))(c) ) 207 b. Distributions by SubchapterSubchapter SS CorporationsCorporations (Sec.(Sec. 902902 (b)) 209 c. Changes to RulesRules ConcerningConcerning TerminationTermination of Sub-Sub- chapter SS Election (Sec.(Sec. 902(c)) 211 I. Tax Treatment ofof Foreign Income 212 1.1 Exclusion for Income Earned AbroadAbroad (Sec.(Sec. 1011)1011) 212 2. U.S. Taxpayers MarriedMarried toto NonresidentNonresident AliensAliens (Sec.(Sec. 1012)_1012). 215 3. Income of Foreign TrustsTrusts and Transfers to Foreign Trusts and Other ForeignForeign EntitiesEntities (Secs.(Sees. 1013-1015)1013-1015) 218 4. Amendments AffectingAffectingTax Tax Treatment ofof ControlledControlled Foreign CorporationsCorporations and TheirTheir ShareholdersShareholders (Secs.(Sees. 1021-1024)1021-1024) 227227 IX

III. GeneralGreneral ExplanationExplanation ofof thethe Act—ContinuedAct—Continued I. Tax Treatment ofof ForeignForeign Income—ContinuedIncome—Continued PegsPage 5. Amendments toto thethe ForeignForeign TaxTax CreditCredit (Secs.(Sees. 1031-1037)1031-1037) _. _. 233 6. Exclusion FromFrom Gross Income andand From GrossGross Estate ofof Portfolio InvestmentsInvestmentsin in thethe United States ofof Non-Non- resident AliensAliens andand ForeignForeign CorporationsCorporations (Sec.(Sec. 1041)1041) _ _ __ 255 7. Changes in Ruling RequirementsRequirements UnderUnder SectionSection 367367 and Changes in AmountsAmounts TreatedTreated asas DividendsDividends (Sec.(Sec. 1042)1042) _ _ _ __ 256 8. Contiguous Country BranchesBranches of DomesticDomestic InsuranceInsurance Companies (Sec.(Sec. 1043)1043) 267267 9. Transitional RuleRule forfor Bond,Bond, Etc.,Etc., LossesLosses ofof Foreign Banks (Sec. 1044)1044) 271 10.10. Tax TreatmentTreatment ofof CorporationsCorporations ConductingConducting Trade oror Business in PossessionsPossessions ofof the UnitedUnited StatesStates (Sec.(Sec. 1051)1051) _ __ 272 11.11. Western Hemisphere Trade CorporationsCorporations (Sec.(Sec. 1052)1052) 278 12.12. ChinaChinaTrade Trade ActAct CorporationsCorporations (Sec.(Sec. 1053)1053) 280 13. Denial of CertainCertain TaxTax BenefitsBenefits for CooperationCooperation With oror Participation in an InternationalInternational BoycottBoycott (Secs.(Sees. 1061-1061- 1064,10661064, 1066and and 1067)1067) 282 14.14. Denial of CertainCertain TaxTax BenefitsBenefits AttributableAttributable to Bribe-Bribe- Produced IncomeIncome (Sec.(Sec. 1065)1065) 288288 J. Domestic International SalesSales Corporations (Sec.(Sec. 1101)1101) 290 K. Administrative Provisions 30]301 1.1. PublicPublic InspectionInspection ofof WrittenWritten DeterminationsDeterminations by InternalInternal Revenue ServiceService (Sec.(Sec. 1201)1201) 301 2. DisclosureDisclosure ofof TaxTax ReturnsReturns andand TaxTax ReturnReturn InformationInformation (Sec.(Sec. 1202)1202) 313 3. Income Tax Return PreparersPreparers (Sec.(Sec. 1203)1203) 345 4. JeopardyJeopardy andand TerminationTermination AssessmentsAssessments (Sec.(Sec. 1204)1204) 356 5. AdministrativeAdministrative SummonsSummons (Sec.(Sec. 1205)1205) 364 6. AssessmentsAssessments inin CaseCase ofof MathematicalMathematical oror ClericalClerical ErrorsErrors (Sec. 1206)1206) 371 7. WithholdingWithholding TaxTax ProvisionsProvisions 375 a. Withholding ofof State and DistrictDistrict IncomeIncome TaxesTaxes for MilitaryMilitary PersonnelPersonnel (Sec.(Sec. 1207(a))1207(a)) 375 b. Withholding StateState and CityCity IncomeIncome TaxesTaxes FromFrom the CompensationCompensation of MembersMembers of the NationalNational '• ' Guard or the ReadyReady ReserveReserve (Sec.(Sec. 1207(b))1207(b)) 377 c. Voluntary Withholding ofof State IncomeIncome TaxesTaxes From thethe CompensationCompensation ofof FederalFederal EmployeesEmployees (Sec. 1207(c))1207(c)) 378 d. Withholding TaxTax on CertainCertain GamblingGambling WinningsWinnings (Sec. 1207(d))1207(d)) _379 e. Withholding of of FederalFederal Taxes on CertainCertain Indi-Indi- viduals Engaged inin FishingFishing (Sec.(Sec. 1207(e))1207(e)).- ._. 380 8. State-ConductedState-Conducted LotteriesLotteries (Sec.(Sec. 1208)1208) 383 9. MinimumMinimum ExemptionExemption fromfrom LevyLevy forfor Wages,Wages, Salary,Salary, andand Other IncomeIncome (See.(Sec. 1209)1209) _ __' 384 10. JointJoint CommitteeCommittee RefundRefund CasesCases (Sec.(Sec. 1210)1210) 386 11.11. Use of SocialSocial Security NumbersNumbers (Sec.(Sec. 1211)1211) 387 12.12. InterestInterest onon MathematicalMathematical ErrorsErrors onon ReturnsReturns PreparedPrepared byby IRS (Sec.(Sec. 1212)1212) '. 388 L. Tax-ExemptTax-Exempt OrganizationsOrganizations 390 1.1. Modification ofof TransitionalTransitional RuleRule for SalesSales of PropertyProperty by PrivatePrivate FoundationsFoundations (Sec.(Sec. 1301)1301) 390 2. New Private FoundationFoundation Set-AsidesSet-Asides (Sec.(Sec. 1302)_1302) 391 3. Reduction in MinimumMinimum Distribution Amount for Private Foundations (Sec.(Sec. 1303)1303) 394 4. Extension of TimeTime ToTo ConformConform CharitableCharitable RemainderRemainder Trusts forfor EstateEstate TaxTax PurposesPurposes (Sec.(Sec. 1304)1304) . _._ _ 396396 5. Income From Fairs,Fairs, Expositions,Expositions, and TradeTrade ShowsShows (Sec.(Sec. 1305)1305) 398398 6. Declaratory JudgmentsJudgmentsas as toto Tax-ExemptTax-Exempt StatusStatus" asas Charitable, etc.,etc.. OrganizationOrganization (Sec.(Sec. 1306)1306) _ _ 400 7. Lobbying Activities of Public CharitiesCharities (Sec.(Sec. 1307)1307) _ 407 X

III. GeneralGeneral ExplanationExplanation of the Act-ContinuedAct—Continued L. Tax-ExemptTax-Exempt Organizations-ContinuedOrganizations—Continued 8. Tax Liens, etc., Not to ConstituteConstitute "Acquisition"Acquisition Indebted-Indebted- PagePuse ness" (Sec.(Sec. 1308)1308) 416 9. Extension ofof private foundation transition rule forfor salesale of business holdings (Sec.(Sec. 1309)1309) 418 10. Private foundationsfoundations imputedimputed interestinterest (Sec.(Sec. 1310)1310) 420 11. Unrelated BusinessBusiness Income from Services ProvidedProvided byby a Tax-exempt HospitalHospital to OtherOther Tax-exemptTax-exempt HospitalsHospitals (Sec. 1311)1311) 421 12. Clinical Services ProvidedProvided toto Tax-Exempt HospitalsHospitals (Sec.(Sec. 1312) _ 422 13. Exemption of CertainCertain AmateurAmateur AthleticAthletic OrganizationsOrganizations From TaxTax (Sec.(Sec. 1313)1313) 423 M. CapitalCapital GainsGains andand LossesLosses 425 1. Deduction of CapitalCapital LossesLosses AgainstAgainst OrdinaryOrdinary IncomeIncome (Sec. 1401)1401) 425 2. Increase in HoldingHolding PeriodPeriod for Long-TermLong-Term Capital GainsGains (Sec. 1402)____1402) 426 3. Capital Loss CarryoverCarryover for RegulatedRegulated InvestmentInvestment Com-Com- panies (Sec.(Sec. 1403)1403) 427 4. Gain on Sale of Residence by Elderly (Sec.(Sec. 1404)1404) 428 N. Pension and Insurance Taxation 430 1. Individual Retirement AccountAccount (IRA)(IRA) forfor SpouseSpouse (Sec.(Sec. 1501)1501) 430430 2. Limitation onon Contributionsto to Certain H.R. 1010 PlansPlans (Sec. 1502)1502) 431 3. Retirement Deductions for MembersMembers ofof ArmedArmed ForcesForces Reserves, National GuardGuard andand VolunteerVolunteer FirefightersFirefighters (Sec. 1503)1503) 432 4. Tax-Exempt Annuity Contracts in Closed-EndClosed-End MutualMutual Funds (Sec.(Sec. 1504)1504) 433 5. Pension Fund InvestmentsInvestments inin SegregatedSegregated AssetAsset AccountsAccounts of Life Insurance CompaniesCompanies (Sec.(Sec. 1505)1505) 433 6. Study ofof Salary Reduction PensionPension PlansPlans (Sec.(Sec. 1506)1506) 434 7. ConsolidatedReturns Returnsfor for LifeLife and MutualMutual InsuranceInsurance /^ Companies (Sec.(Sec. 1507)1507) _ 435 8. Guaranteed Renewable Life InsuranceInsurance ContractsContracts (Sec.(Sec. 1508) 438 9. Study of Expanded Participation in Individual Retirement Accounts (Sec.(Sec. 1509)1509) 439 10. Taxable Status ofof PensionPension BenefitBenefit GuarantyGuaranty CorporationCorporation (Sec. 1510)1510) 440 11.11. Level PremiumPremium PlansPlans CoveringCovering Owner-EmployeesOwner-Employees (Sec.(Sec. 1511) 440440 12. Lump-Sum DistributionsDistributions FromFrom PensionPension PlansPlans (Sec.(Sec. 1512)1512) __ __ 441 0.O. Real Estate InvestmentInvestment Trusts 443 1.1. Deficiency Dividend Procedure (Sec.(Sec. 1601)1601) 445 2. Distributions ofof REIT TaxableTaxable IncomeIncome AfterAfter CloseClose ofof Taxable YearYear (Secs.(Sees. 16041604 and 1605)1606) 449 3. Property HeldHeld forfor SaleSale (Sec.(Sec. 1603)1603) 451 4. Failure to MeetMeet IncomeIncome SourceSource TestsTests (Sec.(Sec. 1602)1602) 452 5. Other ChangesChanges in LimitationLimitation; : andand RequirementsRequirements (Sec.(Sec. 1604) 453 P. Railroad andand AirlineAirline ProvisionsProvisions 460 1. TreatmentTreatmentof of CertainCertain RailroadRailroad TiesTies (Sec.(Sec. 1701(a))1701(a)) 460 2. Limitation on Use of Investment Tax CreditCredit forfor RailroadRailroad Property (Sec.(Sec. 1701(b))1701(b)) 461 3. Amortizationof of Railroad Grading and TunnelTunnel BoresBores (Sec. 1702)1702) _ 463 4. Limitation on Use of InvestmentInvestment TaxTax CreditCredit forfor AirlineAirline Property (Sec.(Sec. 1703)1703) 465 Q. International TradeTrade AmendmentsAmendments 468 1. United States InternationalInternational TradeTrade CommissionCommission (Sec.(Sec. 1801)1801) __ 468 2. Trade ActAct ofof 19741974 AmendmentsAmendments (Sec.(Sec. 1802)1802) 469 R. "Deadwood" ProvisionsProvisions 470470

III. GeneralGeneral ExplanationExplanation of the Act-ContinuedAct—Continued PajrePage S. Estate and GiftGift TaxesTaxes 525 1.1. Unified Rate Schedule forfor Estate and GiftGift Taxes;Taxes; UnifiedUnified Credit inin LieuLieu ofof SpecificSpecific Exemptions (Sec.(Sec. 2001)2001) 525 2. Increase in Limitations on Marital Deductions;Deductions; FractionalFractional Interest ofof SpouseSpouse (Sec.(Sec. 2002)2002) 532 3. Valuation for Purposes of thethe FederalFederal Estate Tax of Certain Real PropertyProperty DevotedDevoted to FarmingFarming oror CloselyClosely HeldHeld Business Use (Sec.(Sec. 2003)2003) 536 4. Extension of Time forfor PaymentPayment of EstateEstate Tax (Sec. 2004)2004)___ _ . 543 5. Carryover BasisBasis (Sec.(Sec. 2005)2005) 551 6. Generation-Skipping Transfers (Sec.(Sec. 2006)2006) 564 7. Orphans' ExclusionExclusion (Sec.(Sec. 2007)2007) 583 8. Administrative ChangesChanges (Sec.(Sec. 2008)2008) 584 9. Miscellaneous Provisions (Sec.(Sec. 2009)2009) 588 T. Miscellaneous Provisions 598 1. TaxTaxTreatmentof Treatment of CertainCertain HousingHousing AssociationsAssociations (Sec.(Sec. 2101)_2101). 598 2. TreatmentTreatmentof of CertainCertain CropCrop DisasterDisaster PaymentsPayments (Sec.(See. 2102)__2102)-. 604 3. Tax Treatment inin thethe CaseCase ofof CertainCertain 19721972 Disaster LoansLoans (Sec. 2103) 605 4. Tax Treatment ofof CertainCertain DebtsDebts OwedOwed by Political Parties to AccrualAccrual BasisBasis TaxpayersTaxpayers (Sec.(Sec. 2104)2104) 607 5. Tax-Exempt BondsBonds for StudentStudent LoansLoans (Sec.(Sec. 2105)2105) 608 6. Personal Holding CompanyCompany AmendmentsAmendments (Sec.(Sec. 2106)2106) 610 7. Work Incentive (WIN)(WIN) andand FederalFederal WelfareWelfare RecipientRecipient Employment Incentive TaxTax CreditsCredits (Sec.(Sec. 2107)2107) 613 8. ExciseTaxonPartsforExcise Tax on Parts for Light-Duty TrucksTrucks (Sec.(Sec. 2108)2108) 614 9. Exclusion FromFrom Manufacturers' Excise Tax for CertainCertain Articles Resold After ModificationModification (Sec.(Sec. 2109)2109) . __ 615 10.10. Franchise TransfersTransfers (Sec.(Sec. 2110)2110) 616 11. Employer's DutiesDuties toto Keep Records andand toto Report TipsTips (Sec. 2111) 617 12. Treatment of CertainCertain PollutionPollution ControlControl FacilitiesFacilities (Sec.(Sec. 2112) 619 13. Clarification ofof Status ofof CertainCertain Fishermen'sFishermen's Organiza-Organiza- tions (Sec.(Sec. 2113)2113) 621 14.14. Innocent SpouseSpouse (Sec.(Sec. 2114)2114) 622 15. Rules Relating to LimitationsLimitations onon PercentagePercentage DepletionDepletion in Case of Oil and GasGas WellsWells (Sec.(Sec. 2115)2115) 624 16.16. Federal Collection ofof State Individual IncomeIncome TaxesTaxes (Sec.(Sec. 2116) 628 17. Cancellation of Certain StudentStudent LoansLoans (Sec.(Sec. 2117)2117) 630 18. Simultaneous Liquidation of Parent and Subsidiary Corporations (Sec.(Sec. 2118)__2118) 631 19.19. Prepublication ExpensesExpenses (Sec.(Sec. 2119)2119) 633 20. Contributions toto Capital of RegulatedRegulated PublicPublic UtilitiesUtilities in Aid of Construction (Sec.(Sec. 2120)2120) 635 21. Prohibition of Discriminatory StateState Taxes on ProductionProduction and ConsumptionConsumption ofof ElectricityElectricity (Sec.(Sec. 2121)2121) 638 22. Deduction for Cost of Removing Architectural and Transportation Barriers for HandicappedHandicapped and ElderlyElderly Persons (Sec.(Sec. 2122)2122) 639 23. Reports onon High-IncomeHigh-Income TaxpayersTaxpayers (Sec.(Sec. 2123)2123) 640 24. Tax Treatment ofof CertifiedCertified HistoricHistoric StructuresStructures (Sec.(Sec. 2124)_2124). 643 25. Supplemental SecuritySecurity IncomeIncome forfor Victims of CertainCertain Natural DisastersDisasters (Sec.(Sec. 2125)2125) 645 26. Net OperatingOperating LossLoss CarryoversCarryovers for CubanCuban ExpropriationExpropriation Losses (Sec.(Sec. 2126)2126) 645 27. Outdoor AdvertisingAdvertising DisplaysDisplays (Sec.(Sec. 2127)2127). . _ ._ _ _ 646 28. Tax Treatment ofof LargeLarge CigarsCigars (Sec.(Sec. 2128)2128) 648 29. Treatment ofof Gain fromfrom SalesSales oror ExchangesExchanges BetweenBetween Related PartiesParties (Sec.(Sec. 2129)2129) 651 30. Application of Section 117 toto Certain Education ProgramsPrograms for MembersMembers ofof thethe UniformedUniformed ServicesServices (Sec.(Sec. 2130)____2130) 654 31. Exchange Funds (Sec.(Sec. 2131)2131) _. _ 655656 XIIxn

III. GeneralGreneral ExplanationExplanation ofof thethe Act—ContinuedAct—Continued T. Miscellaneous ProvisionsProvisions—Continued—Continued 32. Contributions of CertainCertain GovernmentGovernment PublicationsPublications (Sec.(Sec. Pagerage 2132) 667 33. Study of TaxTax IncentivesIncentives byby JointJoint CommitteeCommittee (Sec.(Sec. 2133)2133) __667 34. Prepaid LegalLegal ServicesServices (Sec.(Sec. 2134)2134) 668 35. Certain CharitableCharitable ContributionsContributions ofof InventoryInventory (Sec.(Sec. 2135)_2135). 672 36. Tax Treatment ofof GrantorGrantor ofof CertainCertain OptionsOptions (Sec.(Sec. 2136)..2136). 673 37. Exempt-Interest Dividends of RegulatedRegulated InvestmentInvestment Companies (Sec.(Sec. 2137)2137) 678 38. Common TrustTrust Fund TreatmentTreatment ofof CertainCertain CustodialCustodial Accounts (Sec.(Sec. 2138)2138) 679 39. Support Test forfor DependentDependent ChildrenChildren ofof SeparatedSeparated oror Divorced Parents (Sec.(Sec. 2139)2139) 680 40. Deferral ofof GainGain onon InvoluntaryInvoluntary ConversionConversion of RealReal Property (Sec.(Sec. 2140)2140) 681 41. Livestock Sold on Account of Drought (Sec.(Sec. 2141)2141) 681 I. SUMMARYSUMMARY AND REASONS FOR THE ACTACT

The Tax ReformReform ActAct ofof 19761976 will serve six major purposes. First,First, it willwill improveimprove thethe equityequity ofof thethe taxtax systemsystem atat allall incomeincome levels without impairing economic.economic efficiencyand and gi'owth.growth. Second, the Act effectseffects important simplificationssimplifications of the taxtax systemsystem by modifying certaincertain deduc-deductions and creditscredits affectingaffecting individuals, by increasing the standard de-deduction to encourage taxpayers to switch from itemizingitemizing their deduc-deductions to usingusing thethe standardstandard deduction,deduction, andand byby redraftingredrafting complexcomplex provisions ofof the tax lawlaw andand deletingdeleting obsoleteobsolete and little usedused provisions. Third, the ActAct extendsextends thethe fiscalfiscal stimulus provided by the Tax Reduction Act of 19751975 and extended by the Revenue Adjustment Act of 1975,1975, andand makes permanentpermanent partpart of these tax cuts forfoi- individuals.individuals. Fourth, thethe ActAct encouragesencourages capital formationformation by extendingextending the in-increased investment creditcredit for four years, by modifying the application of the credit,credit, byby extendingextending andand revisingrevising thethe incentiveincentive for investinginvesting in employee stockstock ownershipownership plans,plans, andand byby liberalizingliberalizing thethe net operating loss carryover.carryover. Fifth,Fifth, itit improvesimproves the administration ofof thethe taxtax lawslaws by making it more efficient and andstrengthening strengthening taxpayers'taxpayers' rights.rights. Sixth, the Act makes a major revision in the estate and gift taxes.taxes. It reducesreduces the estate and gift taxtax forfor small-small- andand medium-sizedmedium-sized estatesestates and atat thethe samesame time eliminates tax avoidance possibilities. In addition,addition, thethe ActAct makesmakes certaincertain changeschanges in the operationoperation of the U.S. InternationalInternational TradeTrade CommissionCommission as wellwell as thethe withholdingwithholding ofof preferential trade treatment forfor countriescountries who aid oror abetabet interna-international terrorists.terrorists. (1) A. TAX REVISION While no oneone contendscontends that ourour incomeincome taxtax systemsystem doesdoes notnot needneed improving, it isis stillstill widelywidely acknowledgedacknowledged to be the best in the world. The difficultydifficulty facedfaced inin improving the system is that thethe AmericanAmerican people wantwant different thingsthings from their taxtax system.system. On the oneone hand, they want every individual and corporation to to paypay aa fair shareshare ofof the overalloverall income taxtax burden. In aa systemsystem thatthat dependsdepends heavilyheavily onon voluntary compliance withwith thethe tax laws,laws, as oursours does,does, tax equityequity is especially important.important. However, at the samesame time,time, AmericansAmericans do not want thethe incomeincome taxtax systemsystem toto interfereinterfere withwith economiceconomic efficiencyefficiency and growth. This impliesimplies that taxtax changeschanges toto promotepromote equityequity shouldshould not retard eithereither thethe currentcurrent recoveryrecovery fromfrom whatwhat hashas beenbeen thethe worstworst reces-recession since thethe 1930's oror impedeimpede thethe long-runlong-run growth of the economy.economy. The tax revisions in the Act represent aa carefulcareful balancebalance betweenbetween thesethese some-some- times conflicting objectives. The Act contains manymany taxtax revisions,revisions, describeddescribed inin moremore detaildeta,il below,below, designed toto eliminate tax abusesabuses and make the taxtax systemsystem moremore equi-equitable. Tax shelter provisionsprovisions Congress believed that changeschanges werewere neededneeded to endend thethe excessiveexcessive tax deferrals provided by tax shelters,shelters, as well as the opportunityopportunity theythey provide to, inin effect,effect, convertconvert ordinaryordinary incomeincome into capitalcapital gains.gains. Too manymany investmentsinvestments havehave beenbeen motivatedmotivated byby excessiveexcessive con-concern with thethe taxtax benefitsbenefits associatedassociated withwith them,them, notnot theirtheir economiceconomic merits. In somesome cases, the manner in whichwhich the taxtax sheltersshelters werewere con-con- trived waswas questionablequestionable eveneven underunder priorprior law. In others,others, individualsindividuals were combining provisionsprovisions of thethe law, oror leveragingleveraging themthem throughthrough non- recourse borrowings,borrowings,in in aa wayway whichwhich multipliedmultiplied severalfoldseveralfold anyany possible advantagesadvantages intended by Congress.Congress. SuchSuch activitiesactivities reducereduce citizens' respect for thethe incomeincome taxtax andand representrepresent anan inefficientinefficient alloca-alloca- tion of resources.resources. The Act contains a number of provisionsprovisions designed to curb thesethese abuses without interferinginterfering withwith economicallyeconomically worthwhileworthwhile investments. The Act expands the use of the so-called "recapture""recapture" rules to prevent conversion ofof ordinaryordinary income intointo capitalcapital gains in the casecase of realreal estate, oil andand gas drilling and sports franchises. For oil and gas drilling, farm operations,operations, equipmentequipment leasing,leasing, and Minfilm purchases and production, losses fromfrom accelerated deductions areare limited to the amountamount for whichwhich the individualindividual is "at"at risk."risk." ThisThis isis designeddesigned toto preventprevent leveraging of taxtax sheltershelter benefitsbenefits through thethe useuse ofof nonrecoursenonrecourse loans.loans. There is also an "at risk"risk" rulerule forfor limitedlimited partnershipspartnerships inin areasareas notnot specifically dealtdealt with by thethe Act,Act, whichwhich shouldshould discouragediscourage develop-develop- ment of new leveraged taxtax shelters. InIn addition, in thethe casecase of farmfarm syndicates (or passive farm partnerships) andand motionmotion picturepicture produc-production companiescompanies (and(and companiescompanies producingproducing books,books, records,records, etc.),etc.), certain costs are requiredrequired to bebe capitalizedcapitalized and writtenwritten offoff overover the (2) 3 productive period of the relatedrelated assets,assets, or thethe writeoffwriteoff is delayed until the itemsitems involvedinvolved areare used. For realreal estate,estate, thethe ActAct alsoalso requiresrequires capitalization of interest and taxestaxes during thethe constructionconstruction period. The provisionsprovisions relating toto variousvarious deductionsdeductions andand exclusionsexclusions inin the case of partnerships are tightenedtightened so that thethe deductionsdeductions oror ex-ex- clusions cannotcannot bebe allocatedallocated amongamong thethe variousvarious partnei*spartners according to whomever cancan maximize thethe taxtax benefitsbenefits unlessunless suchsuch allocationallocation has substantial economiceconomic effect. Also,Also, limitslimits areare placedplaced on the amount of "bonus""bonus" first-yearfirst-year depreciation deductions of of thethe partners. TheThe Act requires prepaid interestinterest toto bebe deducteddeducted overover the periodperiod toto whichwhich it relatesrelates andand requiresrequires useuse ofof accrualaccrual accountingaccounting by many farm corpo-corporations. Also, it tightenstightens thethe existingexisting limitlimit onon deductionsdeductions ofof excessexcess investment interest. Minimum andand maximum taxes Congress believed thatthat high-income people and corporations should not bebe ableable completelycompletely to escapeescape liability for incomeincome tax. Prevent-Prevent- ing this isis aa majormajor featurefeature ofof thethe Act.Act. ItIt greatlygreatly reducesreduces thethe incidenceincidence of taxtax avoidanceavoidance byby high-incomehigh-income people through two related provi-provisions—asions—a stifferstiffer minimumminimum taxtax on tax-preferred incomeincome and aa revisionrevision in the maximummaximum tax designeddesigned toto discouragediscourage use of tax preferences.preferences. MininiufnMinimum taxfax The prior minimumminimum tax forfor individualsindividuals waswas inadequate.inadequate. In 19741974 it raised only $130$130 million, down from $182$182 million in 1973,1973, which is only a small fraction of total tax-preferred income.income. Also,Also, the minimum tax forfor individualsindividuals waswas largelylargely aa taxtax onon oneone preference—thepreference—the excludedexcluded half ofof capitalcapital gains.gains. TheThe ActAct amendsamends the minimumminimum tax both to in-increase its revenue yield and toto broadenbroaden thethe taxtax preferencespreferences coveredcovered by it. The Act raises the minimumminimum taxtax raterate fromfrom 1010 percent,percent to 1515 percent. In placeplace ofof thethe existingexisting $30,000$30,000 exemption andand the deduction for regu- lar incomeincome taxes, the Act hashas anan exemptionexemption forfor individualsindividuals equalequal to one-half ofof regularregular incomeincome taxestaxes oror $10,000,$10,000, whichever is greater.greater. These changes reflect Congress'Congress'view viewthat that thethe effective tax tax raterate on taxtax preferences shouldshould bebe higher.higher. Two new minimum tax preferences are added. To reduce the tax benefit ofof sheltersshelters inin oiloil andand gasgas drillingdrilling and to ensure thatthat oil drillers pay some minimumminimum incomeincometax, tax, thethe ActAct addsadds aa preferencepreference forfor intangible drilling costs.costs. ToTo imposeimpose somesome taxtax inin casescases wherewhere therethere isis excessiveexcessive use of itemized personal deductions, there is a new preference for itemized deductions (other thanthan medicalmedical expensesexpenses and casualtycasualty losses)losses) inin excess ofof 6060 percentpercent ofof adjustedadjusted gross income. Congress also believedbelieved thatthat the minimum tax on corporations shouldshould be strengthened in order to raiseraise the effective taxtax rate on corporate tax preferences. However, because corporatecorporate income isis subjectsubject toto both the individual andand corporatecorporate incomeincome taxes, CongressCongress feltfelt itit waswas appropriateappropriate to retain inin fullfull thethe deductiondeduction forfor regularregular taxestaxes forfor corporations.corporations. MammumMaximum tax In 1969,1969, Congress enactedenacted aa 50-percent50-percent maximummaximum marginalmarginal taxtax rate on income from personal services. To reduce the incentive to invest in tax shelters,shelters, thethe lawlaw providedprovided thatthat incomeincome eligibleeligible forfor thisthis maximummaximum 4 rate bebe reducedreduced byby taxtax preferencespreferences (as(as defineddefined underunder thethe minimumminimum tax) inin excessexcess ofof $30,000.$30,000. The ActAct extendsextends thisthis 50-percent50-percent maximummaximum rate toto deferreddeferred compensationcompensation (including(including pensionspensions and annuities). The.The "" preferencepreference. offset"offset" inin thethe maximummaximum tax hashas notnot beenl)cen asas effective in discouraging investment in tax sheltersshelters as originally planned. The expanded list ofof minimumminimum taxtax preferencespreferences willwill makemake thethe preferencepreference offset more effective. Also,Also, thethe Act repealsrepeals thethe existingexisting $30,000$30,000 floorfloor on preferencespreferences that reducereduce personalpersonal serviceservice incomeincome eligible for the maximum tax. Business expenses under the individual income taxtax law Many individuals areare nownow claimingclaiming deductionsdeductions forfor thethe businessbusiness useuse of theirtheir home,home, for expensesexpenses relatedrelated toto the rentalrental ofof theirtheir vacationvacation homes forfor aa briefbrief part ofof thethe year.year, or forfor expensesexpenses of attendingattending foreign conventions. WhileWhile inin theorytheory therethere isis nothingnothing wrongwrong withwith appropriateappropriate deductions for business or investment expenses, inin ])racticepractice itit is often extremely difficultdifficult to allocateallocate betweenbetween deductibledeductible businessbusiness expensesexpenses and nondeductible personal expenses. The The resultresult isis that manymany peoplepeople have been deducting amounts as businessbusiness expenses whichwhich inin part actually representrepresent personalpersonal expenses.expenses. ToTo deal with this problem,problem, the Act places strictstrict limitations onon these deductions. The ActAct alsoalso repealsrepeals the specialspecial tax treatmenttreatment forfor qualifiedqualified stockstock options. With personalpersonal serviceservice income subjectsubject toto a maximum rate ofof 50 percent,percent. Congress decided decidedthat that therethere isis nono reason forfor not taxing this formform ofof compensationcompensation as ordinary income.income. Tax treatment ofof foreignforeign incomeincome The Act makesmakes several importantimportant changes inin thethe tax treatment ofof forehtnforei.^rn i"come.i'^come. Congress believedbelieved thatthat it is necessary to strike a deli-deli- cate bb'hince 'lance between encouraging thethe free flow of capital acrossacross national b-rdersb-^rders andand makingmaking suresure thatthat thethe taxtax lawslaws dodo notnot provideprovide exces-exces- sive,siv^e incentivesincentivesfor for foreignforeign investment insteadinstead ofof investment in the United States. CongressCongress decided toto retainretain the basic structure of the taxation ofof foreignforeign income—namely,income—namely, aa foreign tax credit forfor incomeincome earned abroad and deferraldeferral ofof taxtax onon incomeincome ofof foreignforeign subsidiariessubsidiaries (except inin the casecase of "tax haven"haven" income)income) until returned to thisthis country. However.However, thethe Act eliminates virtuallyvirtually all otherother tax-relatedtax-related incentives for investment abroad. An important change mademade byby thethe ActAct isis the repeal of thethe per-per- country limitation on the foreignforeign tax credit.credit. TheThe per-countryper-country limitlimit enables aa firmfirm withwith aa loss inin one countrycountry andand aa profit in another to deduct.deduct thethe.loss lossagainst againstU.S. U.S.income incomeand andstill still avoidavoid U.S.U.S. taxtax on the profit through the foreign tax credit. Its repealrepeal willwill eliminateeliminate this possibility andand willwill alsoalso greatlygreatly shnplifysimplify thisthis part of the tax law.law. The Act also provides forfor recapture of foreignforeign losseslosses deducteddeducted from U.S. income whenwhen foreignforeign profits are earned inin subsequentsubsequent years.years. The ActAct repealsrepeals numerousnumerous taxtax incentivesincentives whichwhich favorfavor investment.investment in some foreign areas overover others—thoseothers—those which favor investmentinvestment in less-developed country corporations, China Trade ActAct corporationscorporations and Western Hemisphere trade corporations. ItIt alsoalso substantially revises and improves the tax proNprovisions isions relatingrelating to U.S. possessions.possessions. Ex- cept in thethe casecase ofof U.S.U.S. possessions,possessions, CongressCongressfelt felt thatthat there waswas nono longer any good reason for favoringfavoring investmentinvestment inin oneone ofof thesethese foreign areas over another.another. The Act, while retaining anan exclusionexchision for incomeincome earned abroad by individuals, eliminates special features of this provision enabling those with income above thethe basic exemptionexemption levelslevels toto obtainobtain additionaladditional tax benefits from the exclusion and reduces the maximum amounts eligible for thethe exclusion.exclusion. CongressCongressdid didnot not feelfeel thatthat the tax preferencepreference for income earnedearned abroadabroad shouldshould bebe asaslarge large asas itit waswas underunder prior law.law. Another area of concern is the DISC provisionprovision that permitspermits defer-deferral ofof taxtax forfor one-halfone-half ofof exportexport income.income. ToTo makemake thisthis incentiveincentive moremore efficient.efficient, the the ActAct limitslimits DISCDISC treatment toto thethe excessexcess of a firm's exports above a moving base period level.level. Congress diddid not believebelieve thatthat multinationalmultinational corporationscorporations shouldshould benefit fromfrom tax incentivesincentives when they engageengage inin misconduct.misconduct. Thus,Thus, the Act denies thethe foreignforeign taxtax credit,credit, taxtax deferral,deferral, andand DISC treatment,ment forfor incomeincomeearned earned inin connectionconnectionwith with participationparticipation in international boycotts, suchsuch asas thethe ArabArab boycottboycott o,fof Israel.Israel. Similarly, it pro-provides thatthat amounts paid asas bribes by foreign subsidiariessubsidiaries willwill be taxed to the U.S. parentparent corporation. To eliminate the possibility that oiloil companiescompanies which operate abroad gain undueundue advantageadvantage from thethe characterizationcharacterization of theirtheir paymentspayments to foreign governments asas creditablecreditable taxes,taxes. thethe ActAct furtherfurther limits the extent to whichwhich foreign tax creditscredits fromfrom oiloil extractionextraction cancan bebe usedused while continuing the requirement that thesethese taxestaxes maymay not reducereduce the tax on other foreignforeign oiloil income.income. The ActAct alsoalso makesmakes severalseveral technicaltechnical correctionscorrections that werewere consid-considered necessary resultingresulting fromfrom thethe changes inin the taxation of foreignforeign income made byby thethe Tax Reduction ActAct ofof 1975.1975. Capital gains and losses The Act makesmakes three important changes inin the tax treatmenttreatment ofof capital gainsgains andand losses.losses. The holding periodperiod definingdefining long-terlong-term m capital gains, which receivereceivepreferential preferential taxtax treatment,treatment, is raised (over(over a period of twotwo years)years) fromfrom sixsix monthsmonths toto oneone year.year. ThisThis shouldshould encourageencourage longer term investments as contrasted to short-term speculative invest-investments. Also, thethe Act (over a period of two years) increasesincreases the amount of ordinary incomeincome againstagainst whichwhich capitalcapital losseslosses cancan bebe deducted from $1,000 toto $3,000.$3,000.This Thischange changeis isdesigned designedto toprovide provide reliefrelief to those who have capital losseslosses in excess of of capitalcapital gains, which is notnot onlyonly fair but also should encourage individualsindividuals to make equityequity investments. Finally,Finally, the Act increasesincreases the exemption level for capital gainsgains onon thethe salesale of aa principal residenceresidence by a taxpayer ageage 6565 or over. Other tax revisionsrevisions The Act makesmakes a largelarge numbernumber ofof otherother relativelyrelatively minorminor revisionsrevisions in thethe taxtax law.law. TheseThese dealdeal withwith inequitiesinequities oror technicaltechnical problemsproblems that.that have comeconic toto thethe attentionattention of the Congress. There areare severalseveral provisionsprovisions relating toto tax-exempttax-exempt organizations.organizations. Among these isis oneone whichwhichsets setsthe thepayout payoutrequirement requirement (if(if largerlarger than actual earnings) forfor foundationsfoundations atat 55 percentpercent ofof assetasset valuevalue (instead(instead of aa minimumminimum of 6 percent) and providesprovides that thisthis limitlimit isis notnot toto bebe varied as interest ratesrates generallygenerally change.change. AA secondsecond provision sets up a courtcourt reviewreview procedure where thethe IRS holdsholds that anan organizationorganization does not qualify forfor exemptexempt status.status. AA thirdthird changechange makesmakes moremore specificspecific the rules for lobbyinglobbying by charitable and educational organizations.

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The Act includes a number of provisions relating to pensions. Prob- ably the mostmost, importantimportant ofof thesethese isis oneone whichwhich expandsexpands the existingexisting provision for individual retirement accounts (IRAs) toto permitpermit aa work- ing spouse toto set up anan IRAIRA forfor a anonworkingnonworking spouse.spouse. ThisThis changechange recognizesthe the contributions to to the familyfamily mademade byby nonworkingnonworking spouses. IfIf an IRAIRA isis setset upup forfor bothboth spouses,spouses, a a$1,750$1,750 contributioncontribution limit applies.applies. Contributions cancan bebe made,made, subjectsubjectto to thatthat limit, to a single IRA withwith separateseparate subaccount.ssubaccounts oror twotwo separateseparate IRAs. Another pension provision permits anan amountamount ofof upup toto $750$750 toto bebe setset asideaside eacheach year inin anan H.R.H.R. 10-type10-type planplan wherewhere incomeincome isis $15,000$15,000 oror underunder without the amountamount set asideaside being limited to 2525 percent of anan individual'sindividual's earnings. There also are a numbernumber ofof changeschanges relating to thethe taxationtaxation ofof insurance companies. Among thesethese isis oneone which,which, afterafter a periodperiod ofof fivefive years, will permitpermit casualtycasualty insuranceinsurance companiescompanies toto filefile consolidatedconsolidated returns with lifelife insuranceinsurance companiescompanies butbut in aa mannermanner whichwhich doesdoes not permit thethe losseslosses of the casualty companiescompanies to remove more thanthan a limited amount of the life insurance income .fromfrom taxation.taxation. There are technical changes inin the tax treatment of realreal estate investment trusts, housing cooperatives and condominiums, certaincertain franchise transfers, authorsauthors andand publishers,publishers, creditorscreditors of politicalpolitical parties,parties, sub-subchapter SS corporations, the work incentive (WIN) taxtax credit,,credit, personalpersonal holding companies, oil and gas producers, losseslosses from disasters, simultaneous liquidation of parent andand subsidiarysubsidiary corporations,corporations, gain fromfrom sales or exchanges between relatedrelated parties,parties, and deductions for remov-removing architecturalarchitectural and transportationtransportation barriersbarriers forfor handicappedhandicapped andand elderly people.people. The Act makesmakes revisions in depreciation rulesrules designeddesigned to encourage rehabilitation of historic structures. Several tax provisionsprovisions that havehave recentlyrecently expiredexpired areare extendedextended in the Act. These include rapidrapid amortization provisionsprovisions for pollution con-con- trol facilitiesfacilities andand rehabilitatedrehabilitated low-incomelow-income housing. Pollution controlcontrol facilities are also given half ofof thethe normalnormal investmentinvestment credit,credit, whichwhich differs from the prior provisionprovision under whichwhich 5-year amortization was an alternativealternative toto thethe investmentinvestment credit.credit. CongressCongress believedbelieved that sincesince Federal regulationsre^ilations requirerequire installation ofof pollutionpollution controlcontix>l equipment, it is equitable to reduce the cost ofof capitalcapital for sii.l. equipment. Also, the exclusion fromfrom income forfor certain forgiven studentstudent loansloans isis extendedextended through 1978.1978. Further,Further, the Act extendsextends for aa limitedlimited periodperiod thethe exclu-exclusion for certaincertain health-relatedhealth -related scholarshipsscholarships for membersmembers of the uni-uni- formed services forfor those participatingparticipating inin 1976.1976. Tax exemptionexemption is provided for contributionscontributions byby employers to qualified groupgroup legal services plans,plans, designeddesigned toto encourageencourage useuse ofof thisthis fringefringe benefit. To broaden the market for StateState andand locallocal governmentgovernment bonds, mutual funds are allowedallowed to pass through tax-exempttax-exempt interestinterest onon suchsuch bondsbonds to shareholders. Also, the Act redefinesredefines income oror lossloss fromfrom writingwriting options as short- term capital gain or lossloss in order to limitlimit the taxtax sheltersshelters that havehave developed in recent years in stock option hedges. In addition.addition, thethe ActAct makesmakes certaincertain smallsmall changeschanges inin thethe exciseexcise tax treatment ofof trucktruck modificationsmodifications and trucktruck partsparts andand accessories,accessories, and simplifies and revises thethe excise taxtax treatmenttreatment of cigars. 7

B. TAXTAX SIMPLIFICATIONSIMPLIFICATION

Tax simplificationsimplification isis the second major goal of thethe Act.Act. Simplifi-Simplifi- cation must be an ongoing process, andand thethe individualindividual provisions of the tax lawlaw mustmust bebe reexaminedreexamined periodicallyperiodically to seesee how they contributecontribute to the complexity of the tax law. Unless this reexamination occurs,occurs, the tax lawlaw willwill growgrow graduallygradually moremore complicatedcomplicated as newnew provisions are added to achieveachieve new goals of society. TheThe,Act Act repealsrepeals oror restructuresrestructures several provisions ofof the tax law,lav,', andand directsdirects thatthat aa CongressionalCongressional study be made regarding further simplificationsimplification of the taxtax system.system. One such provision concerns thethe useuse ofof the income tax tables. The Act eliminates the existing tax tablestables basedbased onon adjustedadjusted grossgross income,income, which have beenbeen aa majormajor sourcesource ofof taxpayertaxpayer error, and substitutessubstitutes aa simpler setset ofof tablestables basedbased onon taxabletaxable income.income. ltIt alsoalso raisesraises toto $20,000$20,000 the taxable incomeincome levellevel where these tax tables maymay bebe used. A second simplification concerns thethe retirementretirement income credit.credit. This was originally designeddesigned to give those who retireretire without social security a taxtax benefitbenefit similarsimilar toto thatthat accordedaccorded socialsocial securitysecurity benefits.benefits. As a result, eligibility forfor the.the credit and itsits computationcomputation werewere designeddesigned to follow as closely as possible eligibilityeligibility for, and computation of,of, socialsocial security benefits. ThisThis required aa complex form that filledfilled aa wholewhole page, and it isis estimatedestimated thatthat aa largelarge fractionfraction ofof thethe peoplepeople eligibleeligible for the creditcredit eithereither diddid notnot claimclaim itit oror mademade errorserrors inin computingcomputing it. In responseresponse to this problem, Congress restructuredrestructured the credit toto elimi-eliminate virtuallyvirtually allall thethe complexity,complexity, eveneven thoughthough thisthis meansmeans breakingbreaking the close linklink between thethe retirement income creditcredit and socialsocial security eligibility. This new creditcredit forfor the elderly also willwill bebe fairerfairer than the retirement incomeincome credit under prior lawlaw sincesince it willwill alsoalso be applicable to earned income for taxpayers ageage 6565 or over. Another complicated provision has been the sick pay exclusion.exclusion. In this case,case. Congress concluded that.that the exclusion should be.be allowed only for persons who areare permanentlypermanently andand totallytotally disabled,disabled, sincesince for other people there is no reasonreason whywhy sicksickpay pay shouldshould bebetreated treated moremore favorablyfavorably than wagewage income,income, particularly inin viewview of thethe deductibilitydeductibility ofof medical andand drug expenses. ForFor thosethose stillstill eligible forfor the sicksick paypay exclusion, thethe provision has beenbeen considerably simplified and coordi-coordi- nated with the newnew credit.credit forfor the elderly. The Act makes majormajor changes inin thethe treatmenttreatment of child and dependent carecare expenses.expenses. Formerly, thesethese werewere allowed as an itemizeditemized deduction, subject to somesome complicated limitations.limitations. TheThe Act converts the deduction into a 20-percent credit, so that itit willwill bebe available,available to those who useuse thethe standardstandard deduction asas wellwell asas toto itemizersitemizers andand soso thatthat it will provide the same taxtax reliefrelief to taxpayers inin lowlow brackets as to those in highhigh brackets.brackets. The childchild carecare deductiondeduction in prior lawlaw waswas worth.worth, for examp'e,exampV, 70 cents for each dollar of child carecare expenses forfor a taxpayer in thethe 70-percent70-percent bracket, butbut onlyonly 1414 cents to a low-bracket taxpayer whowho itemized deductions and nothingnothing toto someonesomeone who used the standard deduction.deduction. TheThe newnew creditcredit willwill bebe worthworth 2020 centscents for eacheach dollar ofof qualifiedqualified child care expenses forfor allall taxpayers.taxpayers. In addition.addition, the Act significantly simplifies thethe child care provision and broadensbroadens eli-eligibility for it. The Act makes several otherother changeschanges thatthat will simplify the law or make itit more equitable, includingincluding aa revisionrevision ofof thethe rules relating to 8 accumulation trusts andand thethe movingmoving expenseexpense deduction.deduction. The alimonyalimony deduction is moved fromfrom an itemized deduction to a deduction in determining adjusted gross income, soso thatthat it cancan bebe usedused byby peoplepeople whowho take the standard deduction. There areare somesome casescases where it isis possiblepossible to achieveachieve taxtax simplifica-simplification withoutwithout changingchanging thethe substancesubstance of the law.law. TheThe ActAct includesincludes the so-called "deadwood provisions" whichwhich deletesdeletes obsolete andand rarely used parts fromfrom thethe InternalInternal RevenueRevenue CodeCode andand makesmakes many other changeschanges to shorten and simplify thethe languagelanguage ofof thethe Code.Code. These provisions are only the beginning of what must be a continual process ofof tax simplification. Congress plans further taxtax simplicat.ionsimplication measures and has directed the Joint CommitteeCommittee onon Taxation toto conductconduct a comprehensivecomprehensive studystudy ofof waysways toto simplifysimplify thethe taxtax system (with a re-le- port to the House "Ways and Means and Senate Finance Committees port to the House Ways' and Means and Senate Finance Committees due by June 30,30, 1977).

C. EXTENSION OFOF TAXTAX REDUCTIONSREDUCTIONS Economic conditions A thirdthird majormajor purposepurpose ofof thethe TaxTax ReformReform ActAct ofof 19761976 is toto ex-extend the fiscalfiscal stimulus provided by thethe TaxTax ReductionReduction ActAct ofof 19751975 and subsequentlysubsequently extended forfor the first halfhalf ofof 19761976 byby thethe RevenueRevenue Adjustment Act ofof 1975.1975. The Tax ReductionReduction ActAct ofof 19751975 provided a tax cut,cut, aa taxtax rebaterebate andand increasedincreased expendituresexpenditures totalingtotaling $23$23 billionbillion in 1975.1975.11 The 19751975 taxtax cut includedincluded a temporarytemporaiy increaseincrease in the standardstandard deduction and a.a $30$30 nonrefundablenonrefundabletax tax creditcredit for each taxpayer and dependent, which reduced tax liabilityliability byby $8$8 billionbillion 'andand waswas reflectedreflected in lowerlower withheld andand estimatedestimated taxtax paymentspayments overover thethe last,last 88 months of 1975.1975. ThereThere was also an earned incomeincome credit involvinginvolving $1.4$1.4 billion and aa homehome purchase credit amountingamounting toto aboutabout $0.6$0.6 billion. Finally, there werewere business tax reductions—anreductions—an increaseincrease inin thethe investment tax credit andand aa corporatecorporate raterate cutcut forfor smallsmall businesses—amountingbusinesses—amounting to $5 billion. The 19751975 increaseincrease inin thethe standardstandard deduction andand thethe $30$30 credit, which reduced tax liabilityliability byby $8$8 'billion,billion, werewere reflectedreflected in lowerlower withheldwithheld and estimatedestimated tax paymentspayments over the last 88 monthsmonths of 19751975 at thethe rate ofof $1$1 billionbillion per month,month, oror $12$12 billion per year. InIn thethe RevenueRevenue Adjustment ActAct ofof 1975,1975, CongressCongress decided to extend these same withholding rates for thethe firstfirst halfhalf ofof 19761976 and to provide a cut in tax liability forfor 19761976 approximately equalequal to this $6$6 billion reduction in withholding. Also, that ActAct extendedextended the,the small business taxtax cutscuts and the earned income credit credit forfor thethe'first half ofof 1976.1976. (The(The increaseincrease in the investment creditcredit had beenbeen put intointo effecteffect forfor 19751975 and 19761976 in the Tax Reduction Act.) Congress analyzed economic conditions again inin 19761976 and believedbelieved it waswas inappropriateinappropriate toto withdrawwithdraw thethe economiceconomic stimulusstimulus providedprovided by the 19751975 taxtax reductions. Due in no small part toto thethe 1975-761975-76 tax reduc-

1 This includedincluded a rebaterebate onon 19741974 Individualindividual incomeIncome taxes ofof $8.1$8.1 billionbillion plusplus aa $50$50 one-one- time ,payment.payment to socialsocial securitysecurity recipientsrecipients andand increasedincreased unemploymentunemployment compensationcompensation amounting to $2 billion. 9 tions, there hashas beenbeen anan overalloverall economiceconomic recoveryrecovery fromfrom thethe 1974-751974-75 recession inin thethe pastpast 18 months.months. OutputOutput hashas growngrown atat a rate ofof moremore than 66 percent,percent, andand wewe havehave exceededexceeded the levellevel of incomeincome and production thatthat existedexisted atat thethe endend ofof 1973,1973, priorprior toto thethe recession.recession. SinceSince then, however, thethe capacity of the economyeconomy has grown and will continue to grow, andand thethe economiceconomic forecastsforecasts examinedexamined byby CongressCongress indicatedindicated that therethere isis likelylikely toto bebe excessexcess capacitycapacity in thethe economyeconomy for at leastleast the next year. While the unemployment rate had fallenfallen fromfrom 99 percent to 7.87.8 percent (at(at thethe timetime ofof passagepassage ofof thethe TaxTax R-eformReform Act), the existing unemployment rate waswas stillstill consideredconsidered toto bebe unacceptablyunacceptably high. For thesethese reasons,reasons. CongressCongress agreed to extend the existing tax cuts at least through 19771977 and to make partpart of the tax cuts permanent. Congress diddid not believe thatthat a permanent extension ofof the entire $20 million in tax reductionsreductions thenthen inin effecteffect waswas appropriate.appropriate. ThereThere was imcertaintyuncertainty aboutabout justjust howhow muchmuch excess capacitycapacity therethere was (or was likely to be)be) inin thethe economy,economy, howhow seriousserious the inflationinflation problemproblem wouldwould be in the years ahead, as wellwell asas whatwhat budgetarybudgetary requirements would be necessary for the rest of the decade. In viewview of the uncertain economic andand budgetarybudgetary situation, Congress agreed to make part ofof thethe $20$20 billionbillion taxtax reductionreduction permanentpermanant but to extend the restrest onlyonly temporarily.temporarily. ThisThis willwill affordafford CongressCongress andand the AdministrationAdministration an opportunityopportunity inin 19771977 toto reviewreview economiceconomic conditions andand the fiscal requirementsrequirementsto to seeseewhat, what, ifif any, further extensions oror enlargements ofof thesethese taxtax cuts shouldshould bebe made.made. Individual tax reductionsreductions The Act makesmakes permanent $4 billion of individual tax reductions.reductions. These result from the increasesincreases in the standardstandard deduction.deduction. The ActAct extends through 1977 thethe general tax credit adoptedadopted inin thethe RevenueRevenue Adjustment ActAct andand thethe earnedearned incomeincome credit,credit, whichwhich togethertogether involveinvolve a tax cut ofof $11$11 billion for 1977.1977. The ActAct permanentlypermanently increasesincreases the minimumminimum standardstandard deductiondeduction (or low-incomelow-income allowance) from $1,300$1,300 toto $1,700 forfor single returns and to $2,100$2,100 forfor joint returns. ItIt increasesincreases thethe percentagepercentage standard deduction from 1515 percent to 1616 percent. Also, it increasesincreases the maxi-maximum standard deductiondeduction fromfrom $2,000$2,000 to $2,400 forfor singlesingle returnsreturns and to $2,800for for jointjoint returns.returns. This will reduce taxtax liabilityliability at an annualannual rate ofof $4.2$4.2 billionbillion forfor 1977,1977, andand willwill lowerlower budgetbudget receiptsreceipts inin fiscalfiscal year 19771977 byby $4.1$4.1billion. billion.This This increaseincrease inin thethe standardstandard deduction represents a majormajor simplificationsimplification of thethe individualindividual incomeincome tax, sincesince it will make it worthwhile for filersfilers of 9 million tax returns to switchswitch to the standardstandard deduction.deduction. Also,Also, this changechange creates greater tax equity,equity, since itemized deductions havehave beenbeen freefree toto rise with inflation,inflation, whilewhile the minimum and maximummaximum standard deductionsdeductions staystay constantconstant unlessunless there isis specific legislativelegislative action. There is also an extension of the earned incomeincome credit through 1977.1977. This isis aa refundablerefundable creditcredit equalequal toto 1010 percentpercent ofof thethe firstfirst $4,000$4,000 ofof earnings, withwith aa phaseoutphaseout asas incomeincome risesrises betweenbetween $4,000$4,000 andand $8,000.$8,000. It isis availableavailable onlyonly toto peoplepeople withwith dependentdependent children.children. It involvesinvolves a cut in tax liabilityliability inin 19771977 at aa raterate ofof $1.3$1.3 billion, and a reduction in fiscal year 19771977 budget receipts of $0.7$0.7 billion.billion. TheThe earnedearned incomeincome credit provides a work incentive for those withwith jobsjobs thatthat pay relatively 1010 low wages. It provides desperately needed tax relief to a hard-pressed group, who are faced with high foodfood andand energyenergy pricesprices and areare sub-subject to the payroll tax. The Act extends through 19771977 thethe generalgeneral taxtax creditcredit for individuals adopted in thethe RevenueRevenue Adjustment Act,Act, whichwhich reduces taxtax liability in 19771977 at an annual raterate ofof $10.1$10.1 billion. The.The extensionextension ofof thisthis credit will reduce fiscal year 19771977 receiptsreceipts by $9.5 billion.billion. ThisThis credit equalsequals the greater of $35$35 for eacheach taxpayertaxpayer andand dependentdependent or 22 percentpercent of thethe first $9,000$9,000 ofof taxabletaxable income. Together, thethe, individualindividual taxtax cuts amount toto aa cut in tax liability in 1977 atat anan annual rate ofof $15.6$15.6 billion.billion. TheyThey willwill reduce budgetbudget receipts in fiscalfiscal year 19771977 by $14.4 billion.billion. Business tax reductions In orderorder toto provideprovide sufficientsufficient economiceconomic stimulus and toto encourageencourage businesses toto invest, thethe. ActAct extendsextends thethe business taxtax cuts provided by the TaxTax ReductionReduction ActAct ofof 1975.1975. These reduce tax liability inin 19771977 at an annual raterate ofof $5.4$5.4 billionbillion andand willwill reducereduce taxtax receiptsreceipts inin fiscalfiscal year 19771977 by $3.0 billion.billion. As discusseddiscussed later underunder Capital Foilriation,Fcnvnation, the ActAct extendsextends through 19801980 the currentcurrent 10-percent10-percent investmentinvestment credit (applicable(applicable previously throughthrough 1976). ThisThis represents an increaseincrease from thethe previous 7-percent raterate forfor mostmost businessesbusinesses and fromfrom thethe 4-percent4-percent rate forfor publicpublic utilities.utilities. TheseThese changeschanges willwill reducereduce tax liabilityliability byby $3.3$3.3 billion inin 1977,1977, and willwill lowerlower budgetbudget receiptsreceipts byby $1.3$1.3 billionbillion inin fiscalfiscal year 1977.1977. The investment credit has provenproven anan effectiveeffective way to stimulate in-investment in equipment. ItsIts enactment in 19621962 and its reenactmentreenactment in 19711971 were followed by investment,investment booms,booms, andand its suspensionsuspension inin 19661966 and repealrepeal inin 19691969 werewere followedfollowed by sharpsharp declinesdeclines inin investment.investment. Increased investment in thethe U.S.U.S. economyeconomy isis neededneeded to improveimprove ourour standard ofof livingliving andand toto achieveachieve energy,energy, environmentalenvironmental and otherother goals;goals ; andand underunder thesethese circumstances,circumstances. CongressCongress believedbelieved anan extensionextension of thethe 10-percent10-percent investment creditcredit waswas appropriate.appropriate. TheThe credit for utilities isis increasedincreased to the same rate as that forfor otherother businessesbusinesses becausebecause Congress believedbelieved theythey shouldshould bebe ableable toto competecompete forfor capitalcapital on the same basis asas otherother industries.industries. The Act,Act alsoalso extendsextends throughthrough 19771977 thethe small business taxtax cuts enacted in 1975.1975. TheseThese increaseincrease thethe corporatecorporate surtax exemptionexemption fromfrom $25,000$25,000 to $50,000and and reducereducethe the taxtax rate onon thethe initialinitial $25,000$25,000 ofof corporatecorporate income fromfrom 2222 percentpercent toto 2020percent. percent.The The reductionreduction inin taxtax liabilityliability isis $2.1 billion in 1977,1977, andand thethe reduction inin budget,budget receipts isis $1.7$1.7 billion in fiscalfiscal year 1977.1977. ThisThis changechange will improve the competitive positionposition of small business.business, D. CAPITAL FORMATIONFORMATION

A fourthfourth majormajor aspectaspect ofof thethe ActAct isis thethe encouragementencouragement of capital formation through thethe continuationcontinuation andand modificationmodification ofof certain in-investment-related tax incentives.incentives. Congress was concerned thatthat the U.S. economy facedfaced aa severe shortageshortage of capital. InIn 19731973 andand earlyearly 1974,1974, there were capacity shortages in many majormajoi- industriesindustries becausebecause investment in themthem hadhad beenbeen inadequateinadequate inin thethe previousprevious five.five years. Also, the 11

growth rate ofof laborlabor productivityproductivity hashas slowed,slowed, againagain partlypartly becausebecause ofof inadequate capital investment.investment. WeWe havehave had thethe mostmost successsuccess in stim- ulating capital investmentinvestment inin recentrecent yearsyears byby thethe useuse of the investment tax credit.credit. ThereThere appearsappears toto bebe aa closeclose correlationcorrelation sincesince 19621962 betweenbetween the presence ofof the investment credit and purchasespurchases of equipment.equipment. As a result,result, thethe ActAct extendsextends thethe 10-percent10-percent investmentinvestment credit forfor foie•four years (or(or through 1980).1980). The Act extendsextends and expandsexpands aa provisionprovision enactedenacted inin 19751975 allowingallowing an additionaladditional one-percentone- percent investment,investment creditcredit ifif an equivalentequivalent amountamount is placed in anan employeeemployee stock ownership plan. These changeschanges should significantly increaseincreasethe the extentextent toto which thethe provision is usedused byby business. UnderUnder thethe newnew law,law, aa creditcredit of an additional one-halfone-half per- centage point is also allowed if it isis matchedmatched withwith employeeemployee contributions. This optionoption isis consideredconsidered desirable inin order toto broadenbroaden em-employees ownershipownership inin businessbusiness andand therebythereby increaseincrease theirtheir interest in improving productivity. ItIt willwill alsoalso serveserve the twin goalsgoals of increasing capital accumulationaccumulation andand creating a moremore equalequal distributiondistribution ofof wealth. To make the investment credit availableavailable toto lessless profitable businesses, thethe ActAct makes itit available on aa first-in,first-in, first-outfirst-out basis.basis. Another provision to promotepromote capital accumulation,accumulation, which will bebe especially importantimportant forfor new business, is is oneone thatthat extends the netnet operating lossloss carryforward periodperiod toto 77 years.years. ByBy allowingallowing moremore flexi-flexi- bility in averagingaveraging profitsprofits andand losses,losses, this will encourageencourage risktaking. It will also encourage investment in new businesses. The The ActAct tightenstightens the existing rulesrules toto prevent.prevent "trafficking" inin losses inin order to reducereduce any tax incentivesincentives toward business mergers.mergers. InIn addition, the capital loss carryover periodperiod forfor mutual funds is extended from 5 years to 8 years.years. For railroadsrailroads andand airlines,airlines, industriesindustries whichwhich havehave had trouble gener-gener- ating internalinternal fundsfunds asas aa resultresult ofof thethe recession,recession, thethe Act provides (for a limitedlimited periodperiod of time)time) aa taxtax reductionreduction throughthrough changeschanges in thethe investment creditcredit andand in amortizationamortization rules. For similarsimilar reasons,reasons, at least half investmentinvestment credit.credit is made available to the domestic merchant marine for fundsfunds withdrawnwithdrawn fromfrom theirtheir tax-deferredtax-deferred shipship construc-construction fund toto purchasepurchase ships.ships. Finally, thethe Act,Act, inin orderorder toto encourageencourage domesticdomestic production,production, makesmakes the investment creditcredit availableavailable inin thethe futurefuture for motionmotion picture pro- ductions only where theythey areare predominantlypredominantly American-produced films.films. For thethe past,past, aa compromisecompromise between thethe InternalInternal RevenueRevenue Service and the industry isis workedworked out asas toto thethe appropriateappropriate investmentinvestment creditcredit intended underunder the relatively uncertain provisions ofof prior law.law.

E. ADMINISTRATIVEADMINISTRATIVE PROVISIONSPROVISIONS

A fifth major goal of the Act is toto improveimprove thethe administrationadministration of the tax laws.laws. ItIt containscontains severalseveral provisionsprovisions toto improveimprove efficiencyefficiency ofof tax administration through changeschanges in withholdingwithholding provisionsprovisions and better regulation of tax returnreturn preparers.preparers. ItIt alsoalso makesmakes significantsignificant admin-administrative changes designed toto strengthenstrengthen taxpayers'taxpayers' rights. The Act providesprovides definitive rules relating to thethe confidentialityconfidentiality of tax returns,returns, an areaarea wherewhere therethere has been abuseabusein in thethe past. It strictly limitslimits disclosure ofof informationinformation fromfrom taxtax returns. The ability 12 of the Internal RevenueRevenue ServiceService to use jeopardy and termination assess-assess- ments and to issue administrativeadministrative summons also isis limitedlimited byby providingproviding better courtcourt reviewreview inin thesethese cases.cases. At thethe samesame time, rules are provided for the publicationpublication of pri-private letter rulingsrulings soso everyone will have an equal opportunityopportunity to knowknow the view ofof thethe IRSIRS on the proper interpretation ofof thethe taxtax law.law. NewNew rules are also added to aid the ServiceService in reviewingreviewing the wayway inin whichwhich tax return preparers carrycarry outout their duties. In thethe casecase of withholding tax provisions,provisions, a numbernumber of changeschanges are made, including provisionprovision toto withholdwithhold atat the rate ofof 2020 percentpercent onon income from most,most wageringwagering wlierewhere the amountamount wonwon isis $1,000$1,000 or over.over. Further, inin thethe casecase ofof fishingfishing vesselsvessels where the catch is shared, stern- men are classifiedclassified as independent contractors for tax purposes.purposes. TheThe Act alsoalso provides mandatory withholdingwithholding of StateState andand locallocal incomeincome taxes for members of the Armed Forces.

F. ESTATEESTATE ANDAND GIFTGIFT TAXTAX PROVISIONSPROVISIONS

The estate and giftgift taxtax provisionsprovisions provideprovide aa comprehensivecomprehensive revisionrevision of thesethese taxes. In thisthis area,area, thethe ActAct providesprovides substantialsubstantial reliefrelief for moderate-sized estates, farms andand otherother closely-heldclosely-held businesses,businesses, allevi- ates the liquidityliquidity problemproblem forfor estatesestates comprisedcomprised largely of farms and other closely-heldclosely-held business, whilewhile atat the samesame timetime it,it removesremoves tax avoidance devices fromfrom the present system.system. This isis accomplishedaccomplished with a balanced set of provisions whichwhich inin thethe long run will at leastleast main-maintain thethe presentpresent levellevel of revenues. The Act substantiallysubstantially reducesreduces estateestate taxestaxes forfor medium-sizedmedium-sized estates. The existingexisting $60,000$60,000 estateestate. taxtax exemption was enacted in 19421942 and since that timetime thethe percentagepercentage ofof decedentsdecedents whosewhose estatesestates havehave beenbeen subjected toto the Federal estateestate tax hashas increasedincreased from 11 percent to 88 percent. ThisThis increase hashas resulted from inflation and the greatergreater ability ofof peoplepeople toto accumulateaccumulate wealthwealth becausebecause of thethe unprecedentedunprecedented economicprosperity prosperityin in thethe post-war era. TheThe ActAct increasesincreases fromfrom $60,000to to $175,000$175,000the thelevel levelat atwhich whichthe the taxationtaxation of estatesestates begins.begins. It,It also changes thethe exemptionexemptioninto into aa taxtax creditcredit in order to confer the maximum possible taxtax relief onon thethe smallsmall andand medium-sizedmedium-sized estates.estates. In addition,addition, thethe priorprior estateestate taxtax imposedimposed acuteacute problemsproblems whenwhen the principal asset of the estateestate waswas equity in aa farmfarm oror smallsmall business.business. Because.Because assets assetsare arevalued valued atat.their their "highest"highest andand best use" for estateestate tax purposes,purposes, rather thanthan onon thethe basisbasis ofof thethe specificspecific useuse to whichwhich the assets were beingbeing putput (and(and alsoalso becausebecause thesethese assets are illiquid).illiquid), family membersmembers have often been forced to sell farms andand smallsmall busi-businesses inin orderorder to pay thethe estateestate tax.tax. ToTo dealdeal withwith these,these problemsproblems the Act allows farms (and(and otherother familyfamily businesses)businesses) to be valued (to the extent of $500,000) atat thethe valuevalue forfor farming purposes (or other smallsmall business use)use),, if they remain in the family forfor aa periodperiod ofof tenten toto fifteenfifteen years after thethe deathdeath ofof thethe decedent.,decedent, ratherrather than beingbeing valued at the "highest andand bestbest use"use" marketmarket value.value. Also,Also, inin thesethese cases,cases, the ActAct ex-extends the time forfor paymentpayment of estateestate taxtax liabilityliability andand providesprovides for a lowlow 4-percent interestinterest,rate rate onon thethe taxtax on up to $1$1 million of farm or smallsmall businessbusiness value. These changes are intended to preservepreserve the family farm andand otherother familyfamily businesses—twobusinesses—two veryvery importantimportant Ameri-Amen- can institutions, both economically andand culturally.culturally. 13

The estate and gift tax structure isis anan important part,part of the Federal tax systemsystem and asas suchsuch needsneeds to bebe asas nearlynearly equitableequitable asas possiblepossible in its application. Tax liabilityliability shouldshould notnot dependdepend onon thethe methodmethod usedused to transfer thethe propertyproperty fromfrom oneone generationgeneration toto thethe next.next. BecauseBecause of this, a number of steps Averewere takentaken toto reformreform thethe estateestate andand giftgift tax provisions. This reform provides assurance thatthat in the long run thesethese provisions will not lose revenue. Two features of prior lawlaw whichwhich givegive rise to considerable variationsvariations in estate and gift taxtax burdensburdens forfor peoplepeople whowho transfer thethe samesame amount of wealth were the separate rate scheduleschedule and exemption provision for estates and gifts. ThereThere werewere severalseveral taxtax advantagesadvantages toto lifetime.lifetime Gifts.gifts.

The gift taxtax ratesrates werewere 7575 percent of estate tax rates;rates ; and,and, unlikeunlike the estate tax, the amount of the gift taxtax itselfitself waswas notnot includedincluded in the tax base. Also, someonesomeonewho whosplit splithis his totaltotal transfers between giftsgifts and bequests achievedachievedthe the advantageadvantageof of "rate"rate splitting," sincesince the firstfirst dollar ofof taxabletaxable bequestsbequests waswas taxed at.at thethe bottom estate tax rate eveneven where there had beenbeen substantial lifetimelifetime gifts. TheseThese opportunitiesopportunities for redactingreducting thethe overalloverall burdenburden byby lifetimelifetime givinggiving werewere inequitable,inequitable, especially since manymany people areare not wealthy enough to make lifetime gifts. TheThe ActAct unifiesunifies thethe estateestate andand (rift.gift taxes—bothtaxes—both the exemptionsexemptions (which have been converted intointo a credit.)credit) and the rates—torates—to deal with these inequities. Another cause of unequalunequal treatment,treatment ofof taxpayers with thethe samesa,me amount of wealth transfers hashas beenbeen the abilityability toto useuse "generation"generation skipping" trusts.trusts. WhenWlien IN-Pathweath is isbequeathed bequeathedfrom fromthe the parentparent to his child, then from the child to a grandchild and finally from the grandchild to aa great-grandchild,great-grandchild, the estateestate taxtax isis imposedimposed threethree times.times. However, ifif thetheparent.parent placesplaces the wealth in a trust inin whichwhich the childchild and then the grandchildgrandchild has the right toto thethe incomeincome from the trust, with the principalprincipal goinggoing to thethe great-grandchild,great-grandchild, the parentparent willwill achieve virtually the samesame resultresult and,and, inin effect,effect, skipskip twotwo generationsgenerations of estate tax. InIn thesethese cases,cases, thethe estateestate taxtax couldcould bebe avoidedavoided forfor 100100 years or moremore under prior law.law. SinceSince suchsuch trust arrangementsarrangements havehave been used largelylargely byby wealthier people, thisthis failurefailure to tax generation-generation- skipping trusts hashas underminedundermined thethe progressivityprogressivity ofof the.the estateestate andand gift taxes.taxes. TheThe ActAct significantlysignificantly limitslimits estateestate taxtax avoidanceavoidance through generation-skippingtrusts trustsby byimposing imposinga atax taxat at thethe time of thethe death of thethe childchild oror grandchild,grandchild, inin thethe exampleexample citedcited above,above, ofof substantially the.the samesame sizesize asas would bebe imposed hadhad the propertyproperty passed directlydirectly fromfrom thethe child toto the grandchild and to thethe great-great- grandchild, although the additional taxtax inin thisthis casecase isis payablepayable by the trust..trust. However, an exception to this rulerule isis providedprovided forfor upup toto $250,000$250,000 passing from a child to one oror moremore grandchildren.grandchildren. Still anotheranother inequity in the prior law resulted from the fact that when appreciated propertyproperty was transferredtransferred at death,death, thethe basisbasis of the property forfor the.the heirs (on(on whichwhich any capital gaingain oror lossloss isis computed) was the fair marketmarket value at the time of death rather thanthan thethe basisbasis of the decedent. ThisThis contrasted with the rule forfor gifts,gifts, wherewhere thethe doneedonee must carry over the basis ofof the donor. OneOne unfortunateunfortunate result of the prior lawlaw hashas been that peoplepeople were reluctant to sell appreciatedappreciated property inin 'anticipationanticipation of the step-up in basis atat death. Another result has been thatthat assets accumulated out of savings from ordinary incomeincome bore 14 a heavierheavier total tax burdenburden thanthan, thosethose resultingresulting fromfrom appreciationappreciation in value where the gaingain hadhad notnot beenbeen realized.realized. ToTo reduce.reduce thethe inefficiencyinefficiency and inequityinequity of the priorprior system,system, the ActAct generallygenerally providesprovides for a carryover basis at death butbut provides,provides, however, thatthat there will continue to be a step-upstep-up inin basisbasis forfor appreciationappreciation whichwhich hashas occurredoccurred throughthrougli the end of the calendar yearyear 1976.1976.

G. INTERNATIONAL.INTERNATIONAL TRADE AMENDMENTSAMENDMENTS

Another area of thethe ActAct involvesinvolves changes in the operation of the U.S. InternationalInternational TradeTrade .CommissionCommission and amendments toto the Trade Act of 1974 regardingregarding tarifftariff treatment of countries aiding or abetting

international terrorists. , international terrorists. , The Congress concluded that,that ,thethe votingvoting proceduresprocedures ofof thethe Interna-Interna- tional TradeTrade Commission,Commission, needed neededreyising revisingin inorder order toto facilitate thethe functioning ofof thethe CongressionqlCongressiorial overrideoverride mechanismmechanism inin casescases where a plurality oof threethree commissionerscommissioners reachedreached ,agreementagreemeiiit onon aa particular remedy but, because aa majoi'itymajority ofof thethe commissionerscommissioners voting did notnot agree on aa remedy,remedy, therethere waswas nono "recommendation""recommendation"' byby thethe Commis-Commis- sion which CongressCongress could implement under the overrideoverride provisionsprovisions (contained in the Trade Act of 1974). Thus,Thus, thethe ActAct providesprovides thatthat if a majority ofof thethe CommissionersCommissioners voting on anan escapeescape clause or market disruption case.case cannotcannot agree on a remedy finding, the remedy finding agreed upon by a plurality ofof notnot lessless thanthan threethree CommissionersCommissioners is to be treated asas thethe remedyremedy findingfinding ofof thethe CommissionCommission for the purposespurposes of thethe CongressionalCongressional overrideoverride mechanism.mechanism. The ActAct alsoalso modifiesmodifies the rule forfor thethe termterm ofof officeoffice for aa membermember ofof thethe CommissionCommission soso thatthat aa Commissionermay may continuecontinueto toserve serveafter after thethe expirationexpiration of the term of officeoffice untiluntil the successor isis appointed and qualified.qualified. In addition,addition, thethe ActAct amendsamends thethe TradeTrade ActAct ofof 19741974 to add aa newnew category of reasons forfor denying preferential tariff treatment toto "bene-"bene- ficiary developing countries.''countries." TheThe new provisionprovision wouldwould prohibitprohibit preferential tariff treatment to suchsuch countries thatthat aid or abetabet anyany indi-individual or group which has committed anan actact ofof internationalinternational terrorism. The President, however,however, could waive thisthis prohibitionprohibition (as he may for certain of the other categories forfor denialdenial ofof preferentialpreferential treatment)treatment) if a waiverwaiver is determineddetermined to bebe inin thethe nationalnational economiceconomic interest of the ITnitedUnited States.States. 608 or services inin the ordinary coursecourse of their trade oror business.business. Thus, the receipts giving rise to thethe debtdebt mustmust havehave beenbeen takentaken intointo incomeincome in order for thethe deductiondeduction toto be obtained. The Act limitslimits thisthis exceptionexception toto thosethose casescases inin whichwhich 3030 percentpercent ofof all ofof thethe receivablesreceivables accruedaccruedin in thethe ordinary course ofof allall of thethe trades oror businessesbusinesses ofof the taxpayertaxpayer areare cluedue fromfrom politicalpolitical parties.parties. Thus, the exception is limited to thosethose taxpayers whosewhose sales to political parties (including(inchiding politicalpolitical campaignscampaigns and candidates) constituteconstitute a majormajor portionportion ofof theirtheir tradestrades oror businesses.businesses. InIn determiningdetermining the amount.amount required requiredto to meetmeet thethe 3030 percentpercent rule,rule, allall of thethe taxpayer'staxpayer's trades andand businessesbusinesses are to be considered. Thus,Thus, in the case of an individual, every trade oror businessbusiness which the taxpayer controls is to bebe aggregated for purposespurposes of thisthis test.test. InIn thethe case.case of a taxpayertaxpayer whichwhich is a.a corporation, everyevery tradetrade and businessbusiness of allall corporationscorporations under common ov/nershipownership withwith thethe taxpayertaxpayer is to bebe aggregated.aggregated. The bad debt.debt deduction isis toto hebe allowed onlyonly ifif the taxpayer has made substantial continuingcontinuing effortsefforts to collectcollect on the debt. Thus,Tints, a taxpayer must make good faith effortsefforts overover a period ofof timetime to collectcollect the debt andand mustmust bebe ableable toto documentdocument thosethose efforts.efforts. However, itit is not intended thatthat a taxpayertaxpayer isis requiredrequired inin anyany casecase toto filefile aa lawsuitlawsuit against the debtordebtor inin orderorder toto bebe determineddetermined toto havehave made substantial continuing efforts.efforts. The CongressCongress affirmed that that thethe provision ofof prior law was not in-intended to applyapply toto taxpayerstaxi:)ayers whosewhose primaryprimary businessbusiness isis toto provideprovide goods or services toto political parties. The changeschanges made by the Act thus reflectreflect Congress' originaloriginal intentintent in enacting prior law.law. Effective (latedate This provision is to applyapply toto taxabletaxable yearsyears beginningbeginning afterafter Decem-Decem- ber 31,31, 1975.1975.

Revenue effect It is anticipated that thisthis provisionprovision willwill prodn-eproduce aa negligiblenegligible lossloss ofof revenues.

5. Tax-Exempt BondsBonds forfor StudentStudent LoansLoans (Sec.(Sec. 21052105 of the Act and sec. 103 ofof thethe Code) Prior lawlaw Under section 103(a) of thethe Code,Code, interest paid onon certaincertain govern-governmental obligations is exempt from FederalFederal incomeincome tax.tax. TheseThese obliga-obligations are those of the StatesStates andand theirtheir politicalpolitical subdivisions,subdivisions, and ofof certain corporations organized underunder an Act ofof CongressCongress as instru-instru- mentalities of the UnitedUnited States.States. However,However, interestinterest onon suchsuch govern-governmental obligations (with a minorminor exception)exception) isis not exempt from taxation if aa majormajor portionportion ofof thethe proceedsproceeds cancan bebe reasonablyreasonably expectedexpected to be used, directly or indirectly,indirectly, toto purchasepurchase nonexemptnonexempt securitiessecurities or obligations that cancan reasonablyreasonably be.be expected toto produce a higher yield over the term of the issueissue than thethe yieldyield onon thethe governmentalgovernmental obliga-obligations. These governmental obligations, whichwhich areare subject to Federal taxation, are calledcalled "arbitrage"arbitrage bonds."bonds." InIn addition,addition, governmentalgovernmental obligations whose proceeds areare expected toto be used to replacereplace suchsuch nonexempt go.ernmentalgo, ernmental obligations are themselves subjectsubject toto tax. 609

However, governmentalgovernmentalobligations obligationsare arenot not treatedtreated as arbitragearbitrage bonds merely because theirtheir proceeds are temporarily investedinvested in ob-obligations paying aa higherhigher yieldyield untiluntil thosethose proceedsproceeds can be putput to theirtheir intended purpose. In addition,addition, obligationsobligations areare not,not arbitragearbitrage bondsbonds simply because theirtheir proceeds are invested in obligationsobligations paying a higher yield that areare aa partpart ofof a areasonablyreasonably requiredrequired reservereserve or re-re- placement fund. Reasons for changechange Congress isis a^vareawarethat that groups inin at least one State are attempting to developdevelop a studentstudent loanloan programprogram forfor studentsstudents desiringdei?iring aa collegecollege education. Since politicalpolitical subdivisionssubdivisionsin in thethe StateState apparently do not have the governmentalgovernmental authority toto issueissue bondsbonds toto financefinance their ownown student loanloan programs,programs, not-for-profit corporations inin thatthat. State are being organized to financefinance the neededneeded student.student loan programs. TheseThese corporations, however,however, faced considerable obstacles because tliethe interestinterest on bonds tlieythey wishedwished to issueissue to financefinance student loansloans maymay havehave beenbeen taxable under priorprioi- law.law. TheThe corporationscorporations areare notnot politicalpolitical subdi-subdivisions ofof thethe StateState and could notnot bebe treatedtreated underunder the Treasury reg-reg- ulationsulatio)is as acting "on behalfbehalf of" the.the StateState oror itsits politicalpolitical subdi-subdivisions. EvenEven if theythey werewere describeddescribed in sectionsection 103(a), thesethese obliga-obligations mightmight notnot havehave beenbeen exemptexempt becausebecause theythey might,might havehave beenbeen arbitrage bondsbonds underunder sectionsection 10:3(e).103 (c) . Under thethe EmergencyEmergency TnsuredInsured StudentStudent LoanLoan ActAct ofof 1969,1969, thethe Com-Com- missioner ofof Education (of(of thethe (Department.Department of Health, Education,Education, and 'Welfare)"Welfare) is authorized to provideprovide incentiveincentive payments to institutions providing student,student loans. AlthoughAlthough the maximinnmaximum raterate of interest to be paid byby studentsstudents onon theirtheir loansloans isis nownow setset atat sevenseven percent, this yield, together with the incentiveincentive payments received byby thethe institution making the.the loanloan from the CommissionerCommissioner of Education, wouldwould consti- tute a.a yieldyield thatthat could be higherhigher than the maximum yield the corporations believe theythey vv'ouldwould bebe ableableto to paypay onon theirtheir bonds ifif they are to cover administrative expenses andand maintainmaintain a solvent loan program. Consequently,tlieir their bonds,bonds, underunder prior law,law, wouldwould bebe consideredconsidered arbitrage bondsbonds and not entitled to tax exemption. Congress believesbelievesit it.is isappropriate appropriate toto treattreat the obligationsobligations of these corporations providingproviding studentstudent.loans loansin in thethe samesame mannermanner asas ifif the State hadhad issuedissued the bonds directly. ExpluTiationExplanation ofof provision.provision This provisionproAdsion addsadds toto the.the list ofof exemptexempt obligationsobligations describeddescribed in section 103(a) those.those obligationsobligations ofof not-for-profit.not-for-profit corporationscorporations or-organized by, or requestedrequested to act by,by, aa State.State or aa politicalpolitical subdivisionsubdivision of aa State.State (or(or ofof a.a possessionpossession ofof thethe UnitedUnited States), solelysolely to acquireacquire student loanloan notesnotes incurredincurred underunder thethe HigherHigher EducationEducation Act.Act ofof 1965.1965, The entire.entire income ofof these corporations (after(after payment,payment ofof expensesexpenses and provision for debt service requirements)requirements) must accrue toto thethe State or politicalpolitical subdivision.subdivision, or be recmiredreauired toto be used to purchasepurchase addi-additional studentstudent loanloan notes.notes. The obligations are to hliee cacalledlled "Qualified"Qualified ScholarshipScholarshi]) FundiFundingnir Bonds." As a result ofof thisthis provision,provision, organizationsorganizations whichwhich wishv.-ish to maintain student loan iirogramsprograms will have statutory authorityautliority to issueissue tax-tax- exempt bonds toto financefinance theirtheir operations.operations. 610

In addition,addition, aa provisionprovision is added to make itit clear that the studentstudent loan incentiveincentive payments made byby thethe CommissionerCommissioner of EducationEducation under the EmergencyEmergency Insured StudentStudent LoanLoan ActAct ofof 19691969 are not to be taken into accountaccount in determining whether the yield on the studentstudent loan notes is higher than thethe yieldyield onon thethe bondsbonds issuedissued toto financefinance the student loanloan program.program. AsAs aa result,result, bondsbonds issuedissued toto financefinance student loan programs would bebe expected toto be able to avoidavoid arbitragearbitrage bondbond classification.

E-ffectiveEffective datedate These provisions wouldwould applyapply to obligationsobligations issuedissued onon oror after the date ofof enactment.enactment. Thus, the interestinterest onon bondsbonds issued on or after the datedate ofof enactmentenactment inin orderorder toto financefinance studentstudent loanloan programsprograms to enable studentsstudents toto attend institutionsinstitutions of higherhigher learninglearning maymay bebe exempt from Federal taxation ifif thethe requirementsrequirements ofof thethe amendmentamendment are.are met.

Revenue effectejfect It isis estimatedestimated thatthat thesethese provisionsprovisions willwill reducereduce thethe revenuesrevenues byby lessless than $5$5 million annually.annually.

6. Personal HoldingHolding CompanyCompany AmendmentsAmendments (Sec.(Sec. 21062106 ofof the Act and Sec.Sec. 543543 ofof thethe Code) Prior lawla/w A corporation whichwhich is a personalpersonal holding companycompany is taxed on its undistributed personal holdingholding companycompany income atat, aa raterate of 7070 percent (sec.(sec. 541). A corporationcorporation isis aa personalpersonal holdingholding companycompany wherewhere five oror fewer individuals own moremore thanthan 50 percentpercent inin value of its outstanding stockstock and atat leastleast 6060 percent.percent ofof thethe corporation'scorporation's adjusted ordinary grossgross incomeincome comes from certain types ofof income.income. Royalties (other than mineral,mineial, oiloil oror gasgas royaltiesroyalties andand copyrightcopyright royalties) receivedreceived by aa corporationcorporation areare personalpersonal holdingholding companycompany income, regardlessregardless of how much income ofof otherother typestypes the corporation may have (sec.(sec. 543(a) (1)). "Royalties""Royalties'' includeinclude amountsamounts receivedreceived for a licenselicense to use trade brands,brands, secretsecret processes,processes, franchises and similar intangible property. In general,general, rentalrental incomeincome receivedreceived from persons other than major shareholders is treatedtreated asas personalpersonal holdingholding companycompany incomeincome unlessunless such rent comprisescomprises 50 percent oror more of the corporation'scorporation's adjustedadjusted ordinary grossgross incomeincome and, if thethe companycompanj^ hashas aa substantialsubstantial amount.amount of other typestypes ofof personalpersonal holdingholding companycompany income,income, it distributes suchsuch income (sec. 543(a) (2)).(2) ). Under a separateseparate rule ofof priorprior lawlaw (sec.(sec. 543(a)543(a) (6)),(6) ), rentsrents receivedreceived by a corporation from leasing corporate "property" toto aa 25-percent25 -percent or greater shareholdershareholder werewere personalpei-sonal holdingholding companycompany income,income, but.but only if over10over 10 percent of the company's total incomeincome came fromfrom otlierother types of personal holding companycompany income.income. In Rev.Rev. Rul.Rul. 71-596,71-596, 1971-21971-2 Cum. Bull. 242, thethe IRS ruledruled thatthat aa company'scompany's incomeincome fromfrom licensinglicensing a major shareholder to makemake andand sellsell aa secretsecret processprocess waswas governedgoverned by the "royalty" rulerule ratherrather thanthan byby the.the "shareholder"sliareholder rent."rent" rule. In 1975 thetl►e I7.S.U.S. Court of Claims also held in illMontgomeryon.tgovnery Coca-Cola BottlmgBottling Ca.Co. v. United States, 75-1 USTC para. 9291,9291, 35 AFTR 2d2d