[JOINT COMMITTEE PRINT] REPORT TO THE HOUSE COMMITTEE ON WAYS AND MEANS ON PRESENT LAW AND SUGGESTIONS FOR REFORM SUBMITTED TO THE TAX REFORM WORKING GROUPS Prepared by the Staff of the JOINT COMMITTEE ON TAXATION May 6, 2013 U.S. Government Printing Office Washington: 2013 JCS-3-13 JOINT COMMITTEE ON TAXATION 113TH CONGRESS, 1ST SESSION ________ HOUSE SENATE Dave Camp, Michigan Max Baucus, Montana Chairman Vice Chairman Sam Johnson, Texas John D. Rockefeller IV, West Virginia Kevin Brady, Texas Ron Wyden, Oregon Sander M. Levin, Michigan Orrin G. Hatch, Utah Charles B. Rangel, New York Chuck Grassley, Iowa Thomas A. Barthold, Chief of Staff Bernard A. Schmitt, Deputy Chief of Staff CONTENTS Page INTRODUCTION .......................................................................................................................... 1 I. OVERVIEW OF PRESENT LAW FEDERAL TAX SYSTEM ........................................ 2 A. Individual Income Tax .................................................................................................. 2 B. Corporate Income Tax ................................................................................................ 10 C. Estate, Gift and Generation-Skipping Transfer Taxes ................................................ 14 D. Social Insurance Taxes ............................................................................................... 16 E. Major Excise Taxes ..................................................................................................... 18 II. DETAILS OF PRESENT LAW BY WORKING GROUP TOPIC AREA ..................... 19 A. Present Law: Charitable/Exempt Organizations ......................................................... 19 1. Tax-exempt status ................................................................................................. 19 2. Deduction for charitable contributions ................................................................. 43 B. Present Law: Debt, Equity and Capital ....................................................................... 58 1. Background comparing debt and equity ............................................................... 58 2. General rules for issuers and holders of debt and equity ...................................... 60 3. Definition of debt and equity ................................................................................ 69 4. Rules to address stripping of U.S. corporate tax base in the case of nontaxed holders ................................................................................................................... 73 5. Rules to Address Corporate Base Erosion Without Regard to Holders’ Tax Status ..................................................................................................................... 78 6. Rules to address tax arbitrage in the case of borrowing to fund untaxed income ................................................................................................................... 84 7. Rules to match timing of tax deduction and income inclusion relating to debt .... 95 8. Other rules relating to business debt and equity ................................................. 100 9. Treatment of capital gains and losses under present law .................................... 106 10. Treatment of partnership carried interests under present law ............................. 115 11. New markets tax credit (“NMTC”) ..................................................................... 120 C. Present Law: Education and Family Benefits .......................................................... 123 1. Overview of tax benefits for individuals who incur education expenses ........... 123 2. Tax benefits for current expenses ....................................................................... 124 3. Tax benefits for saving for education expenses .................................................. 132 4. Tax benefits relating to past expenses (student loans) ........................................ 137 5. Exclusion of income from student loan forgiveness ........................................... 137 6. Tax benefits related to families ........................................................................... 138 7. Other tax-provisions related to families .............................................................. 145 D. Present Law: Energy ................................................................................................ 149 1. Extraction and production ................................................................................... 149 2. Transportation, transmission, and generation ..................................................... 155 3. Vehicles, alternative fuels, and specialty manufacturing .................................... 162 4. Conservation and consumption ........................................................................... 172 5. Competitiveness .................................................................................................. 174 6. Other energy tax provisions ................................................................................ 175 iii E. Present Law: Financial Services Businesses and Financial Instruments ................. 176 1. Banks, thrifts, and credit unions ......................................................................... 176 2. Insurance companies ........................................................................................... 180 3. Broker-dealers ..................................................................................................... 186 4. Regulated investment companies or RICs (mutual funds) ................................. 187 5. U.S. income tax principles applicable to the taxation of financial instruments .. 188 6. Income tax rules related to five fundamental financial instruments ................... 196 F. Present Law: Income and Tax Distribution ............................................................. 216 G. Present Law: U.S. International Taxation ................................................................ 223 1. General overview ................................................................................................ 223 2. U.S. tax rules applicable to U.S. activities of non-U.S. persons (inbound) ........ 230 3. U.S. tax rules applicable to foreign activities of U.S. persons (outbound) ......... 243 4. U.S. tax rules applicable to the U.S. territories ................................................... 250 H. Present Law: Manufacturing .................................................................................... 261 1. Brief overview of taxation of income derived from business activities ............. 261 2. Capital expenditures ............................................................................................ 270 3. Cost recovery for capital expenditures ............................................................... 273 4. Cost recovery for tangible assets ........................................................................ 276 5. Cost recovery for intangible assets ..................................................................... 288 6. Start-up expenditures .......................................................................................... 290 7. Other cost recovery provisions ........................................................................... 291 8. Recapture rules .................................................................................................... 293 9. Statutory recovery periods .................................................................................. 295 10. Tax treatment and incentives related to items purchased or produced by the taxpayer ............................................................................................................... 308 11. Tax treatment and incentives related to research and development expenses .... 318 I. Present Law: Pensions/Retirement .......................................................................... 323 1. Tax-favored employer-sponsored retirement plans ............................................ 323 2. Defined contribution plans .................................................................................. 336 3. Defined benefit plans .......................................................................................... 352 4. Individual retirement arrangements .................................................................... 366 5. Early distributions and required minimum distributions .................................... 373 6. Tax treatment of life insurance and annuity contracts ........................................ 377 J. Present Law: Real Estate .......................................................................................... 380 1. Tax incentives for homeownership ..................................................................... 380 2. Tax incentives for residential rental housing ...................................................... 391 3. Present law tax treatment of real estate investment ............................................ 399 K. Present Law: Small Businesses/Pass Throughs ....................................................... 414 1. Overview ............................................................................................................. 414 2. Choice of business entity .................................................................................... 415 3. Federal income tax rate structure .......................................................................