Senate Report 108-11 - CARE ACT OF 2003

[Senate Report 108-11]
[From the U.S. Government Publishing Office]

Calendar No. 22
108th Congress Report
1st Session SENATE 108-11
======================================================================

CARE ACT OF 2003

_______

February 27, 2003.--Ordered to be printed

_______

Mr. Grassley, from the Committee on Finance, submitted the following

R E P O R T

[To accompany S. 476]

[Including cost estimate of the Congressional Budget Office]

The Committee on Finance reported an original bill S. 476,
to provide incentives for charitable contributions by
individuals and businesses, to improve the public disclosure of
activities of exempt organizations, and to enhance the ability
of low-income Americans to gain financial security by building
assets, and for other purposes, having considered the same,
reports favorably thereon and recommends that the bill do pass.

CONTENTS

Page
I. Legislative Background............................................5
II. Explanation of the Bill...........................................5
Title I. Charitable Giving Incentives..............................
A. Charitable Deduction for Nonitemizers (sec. 101 of the
bill and sec. 63 and 170 of the Code)................ 5
B. Tax-Free Distributions From Individual Retirement
Arrangements for Charitable Purposes (sec. 102 of the
bill and secs. 408 and 6034 of the Code)............. 8
C. Charitable Deduction for Contributions of Food
Inventory (sec. 103 of the bill and sec. 170 of the
Code)................................................ 15
D. Charitable Deduction for Contributions of Book
Inventory (sec. 104 of the bill and sec. 170 of the
Code)................................................ 17
E. Expand Charitable Contribution Allowed for Scientific
Property Used for Research and for Computer
Technology and Equipment (sec. 105 of the bill and
sec. 170 of the Code)................................ 19
F. Encourage Contributions of Capital Gain Real Property
Made for Conservation Purposes (sec. 106 of the bill
and sec. 170 of the Code)............................ 21
G. Exclusion of 25 Percent of Capital Gain for Certain
Sales Made for Qualifying Conservation Purposes (sec.
107 of the bill and new sec. 121A of the Code)....... 24
H. Cost Sharing Payments under the Partners for Fish and
Wildlife Program (sec. 108 of the bill and sec. 126
of the Code)......................................... 30
I. Basis Adjustment to Stock of S Corporation
Contributing Property (sec. 109 of the bill and sec.
1367 of the Code).................................... 31
J. Enhanced Deduction for Charitable Contributions of
Literary, Musical, Artistic, and Scholarly
Compositions (sec. 110 of the bill and sec. 170 of
the Code)............................................ 32
K. Exclusion for Certain Mileage Reimbursements to
Charitable Volunteers (sec. 111 of the bill and new
sec. 139A of the Code)............................... 34
L. Extend Enhanced Deduction for Inventory to Include
Public Schools (sec. 112 of the bill and sec. 170 of
the Code)............................................ 35
Title II. Provisions Improving the Oversight of Tax-Exempt
Organizations....................................................37
A. Disclosure of Written Determinations (sec. 201 of the
bill and sec. 6110 of the Code)...................... 37
B. Disclosure of Internet Web Site and Name Under Which
Organization Does Business sec. 202 of the bill and
sec. 6033 of the Code)............................... 39
C. Modification to Reporting of Capital Transactions
(sec. 203 of the bill and secs. 6033 and 6104 of the
Code)................................................ 40
D. Disclosure that Form 990 is Publicly Available (sec.
204 of the bill)..................................... 42
E. Disclosure to State Officials of Proposed Actions
Related to Section 501(c) Organizations (sec. 205 of
the bill and sec. 6104 of the Code).................. 42
F. Expansion of Penalties to Preparers of Form 990 (sec.
206 of the bill and sec. 6695 of the Code)........... 45
G. Notification Requirement for Exempt Entities not
Currently Required to File an Annual Information
Return (sec. 207 of the bill and sec. 6033 of the
Code)................................................ 46
H. Suspension of Tax-Exempt Status of Terrorist
Organizations (sec. 208 of the bill and sec. 501 of
the Code)............................................ 48
Title III. Other Charitable and Exempt Organization Provisions...50
A. Modify Tax on Unrelated Business Taxable Income of
Charitable Remainder Trusts (sec. 301 of the bill and
sec. 664 of the Code)................................ 50
B. Modify Tax Treatment of Certain Payments to
Controlling Exempt Organizations (sec. 302 of the
bill and sec. 512 of the Code)....................... 52
C. Simplification of Lobbying Expenditure Limitation
(sec. 303 of the bill and secs. 501 and 4911 of the
Code)................................................ 53
D. Expedited Review Process for Certain Tax-Exemption
Applications (sec. 304 of the bill).................. 57
E. Clarification of Definition of Church Tax Inquiry
(sec. 305 of the bill and sec. 7611 of the Code)..... 59
F. Extension of Declaratory Judgment Procedures to Non-
501(c)(3) Tax-Exempt Organizations (sec. 306 of the
bill and sec. 7428 of the Code)...................... 60
G. Definition of Convention or Association of Churches
(sec. 307 of the bill and sec. 7701 of the Code)..... 61
H. Payments by Charitable Organizations to Victims of War
on Terrorism and Families of Astronauts (sec. 308 of
the bill)............................................ 63
I. Increase Percentage Limits for Certain Employer-
Related Scholarship Programs (sec. 309 of the bill).. 64
J. Treatment of Certain Hospital Support Organizations in
Determining Acquisition Indebtedness (sec. 310 of the
bill and sec. 514 of the Code)....................... 67
K. Charitable Contribution Deduction for Certain Expenses
in Support of Native Alaskan Subsistence Whaling
(sec. 311 of the bill and sec. 170 of the Code)...... 68
L. Matching grants to low-income taxpayer clinics for
return preparation (sec. 312 of the bill and new sec.
7526A of the Code)................................... 69
Title IV. Social Services Block Grant (Secs 401-403 of the Bill).70
Title V. Individual Development Accounts (Sec. 501-512 of the Bil71
Title VI. Management of Exempt Organizations (Sec. 601 of the Bil75
Title VII. Revenue Provisions....................................76
A. Provisions Designed to Curtail Tax Shelters........... 76
1. Clarification of the economic substance doctrine
(sec. 701 of the bill and sec. 7701 of the Code). 76
2. Penalty for failure to disclose reportable
transactions (sec. 702 of the bill and new sec.
6707A of the Code)............................... 81
3. Modifications to the accuracy-related penalties
for listed transactions and reportable
transactions having a significant tax avoidance
purpose (sec. 703 of the bill and new sec. 6662A
of the Code)..................................... 84
4. Penalty for understatements from transactions
lacking economic substance (sec. 704 of the bill
and new sec. 6662B of the Code).................. 89
5. Modifications to the substantial understatement
penalty (sec. 705 of the bill and sec. 6662 of
the Code)........................................ 91
6. Tax shelter exception to confidentiality
privileges relating to taxpayer communications
(sec. 706 of the bill and sec. 7525 of the Code). 93
7. Disclosure of reportable transactions by material
advisors (secs. 707 and 708 of the bill and secs.
6111 and 6707 of the Code)....................... 93
8. Investor lists and modification of penalty for
failure to maintain investor lists (secs. 707 and
709 of the bill and secs. 6112 and 6708 of the
Code)............................................ 97
9. Actions to enjoin conduct with respect to tax
shelters and reportable transactions (sec. 710 of
the bill and sec. 7408 of the Code).............. 99
10. Understatement of taxpayer's liability by income
tax return preparer (sec. 711 of the bill and
sec. 6694 of the Code)........................... 99
11. Penalty for failure to report interests in
foreign financial accounts (sec. 712 of the bill
and sec. 5321 of Title 31, United States Code)... 100
12. Frivolous tax returns and submissions (sec. 713
of the bill and sec. 67021 of the Code).......... 102
13. Regulation of individuals practicing before the
Department of the Treasury (sec. 714 of the bill
and sec. 330 of Title 31, United States Code).... 103
14. Penalties on promoters of tax shelters (sec. 715
of the bill and sec. 6700 of the Code)........... 104
15. Extend statute of limitations for certain
undisclosed transactions (sec. 716 of the bill
and sec. 6501 of the Code)....................... 105
16. Deny deduction for interest paid to IRS on
underpayments involving certain tax-motivated
transactions (sec. 717 of the bill and sec. 163
of the Code)..................................... 106
17. Authorize additional $300 million per year to the
IRS to combat abusive tax avoidance transactions
(sec. 718 of the bill)........................... 106
B. Other Provisions...................................... 107
1. Affirmation of consolidated return regulation
authority (sec. 721 of the bill and sec. 1502 of
the Code)........................................ 107
2. Chief Executive Officer Required To Sign Corporate
Income Tax Returns (sec. 722 of the bill and sec.
6062 of the Code)................................ 111
III.Budget Effects of the Bill......................................112

A. Committee Estimates................................... 112
B. Budget Authority and Tax Expenditures................. 116
C. Consultation with Congressional Budget Office......... 116
IV. Votes of the Committee..........................................121
V. Regulatory Impact and Other Matters.............................122
A. Regulatory Impact..................................... 122
B. Unfunded Mandates Statement........................... 122
C. Tax Complexity Analysis............................... 123
VI. Changes in Existing Law Made by the Bill as Reported............125

I. LEGISLATIVE BACKGROUND

The ``CARE Act of 2003'' was referred to the Senate
Committee on Finance on January 30, 2003. The Senate Committee
on Finance marked up an original bill the ``CARE Act of 2003''
on February 5, 2003, and ordered the bill, as amended,
favorably reported by voice vote.

II. EXPLANATION OF THE BILL

TITLE I. CHARITABLE GIVING INCENTIVES

A. Charitable Deduction for Nonitemizers

(Sec. 101 of the bill and sec. 63 and 170 of the Code)

PRESENT LAW

In computing taxable income, an individual taxpayer who
itemizes deductions generally is allowed to deduct the amount
of cash and up to the fair market value of property contributed
to a charity described in section 501(c)(3),\1\ to certain
veterans' organizations, fraternal societies, and cemetery
companies,\2\ or to a Federal, State, or local governmental
entity for exclusively public purposes\3\ The deduction also is
allowed for purposes of calculating alternative minimum taxable
income.
---------------------------------------------------------------------------
\1\ All section references are to the Internal Revenue Code of
1986, unless otherwise indicated.
\2\ Secs. 170(c)(3)-(5).
\3\ Sec. 170(c)(1).
---------------------------------------------------------------------------
The amount of the deduction allowable for a taxable year
with respect to a charitable contribution of property may be
reduced depending on the type of property contributed, the type
of charitable organization to which the property is
contributed, and the income of the taxpayer.\4\
---------------------------------------------------------------------------
\4\ Secs. 170(b) and (e).
---------------------------------------------------------------------------
A taxpayer who takes the standard deduction (i.e., who does
not itemize deductions) may not take a separate deduction for
charitable contributions.\5\
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\5\ Sec. 170(a). The Economic Recovery Tax Act of 1981 adopted a
temporary provision that permitted individual taxpayers who did not
itemize income tax deductions to claim a deduction from gross income
for a specified percentage of their charitable contributions. The
maximum deduction was $25 for 1982 and 1983, $75 for 1984, 50 percent
of the amount of the contribution for 1985, and 100 percent of the
amount of the contribution for 1986. The nonitemizer deduction
terminated for contributions made after 1986.
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A payment to a charity (regardless of whether it is termed
a ``contribution'') in exchange for which the donor receives an
economic benefit is not deductible, except to the extent that
the donor can demonstrate that the payment exceeds the fair
market value of the benefit received from the charity. To
facilitate distinguishing charitable contributions from
purchases of goods or services from charities, present law
provides that no charitable contribution deduction is allowed
for a separate contribution of $250 or more unless the donor
obtains a contemporaneous written acknowledgement of the
contribution from the charity indicating whether the charity
provided any good or service (and an estimate of the value of
any such good or service) to the taxpayer in consideration for
the contribution.\6\ In addition, present law requires that any
charity that receives a contribution exceeding $75 made partly
as a gift and partly as consideration for goods or services
furnished by the charity (a ``quid pro quo'' contribution) is
required to inform the contributor in writing of an estimate of
the value of the goods or services furnished by the charity and
that only the portion exceeding the value of the goods or
services is deductible as a charitable contribution.\7\
---------------------------------------------------------------------------
\6\ Sec. 170(f)(8).
\7\ Sec. 6115.
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Under present law, total deductible contributions of an
individual taxpayer to public charities, private operating
foundations, and certain types of private nonoperating
foundations may not exceed 50 percent of the taxpayer's
contribution base, which is the taxpayer's adjusted gross
income for a taxable year (disregarding any net operating loss
carryback). To the extent a taxpayer has not exceeded the 50-
percent limitation, (1) contributions of capital gain property
to public charities generally may be deducted up to 30 percent
of the taxpayer's contribution base, (2) contributions of cash
to private foundations and certain other charitable
organizations generally may be deducted up to 30 percent of the
taxpayer's contribution base, and (3) contributions of capital
gain property to private foundations and certain other
charitable organizations generally may be deducted up to 20
percent of the taxpayer's contribution base.
Contributions by individuals in excess of the 50-percent,
30-percent, and 20-percent limit may be carried over and
deducted over the next five taxable years, subject to the
relevant percentage limitations on the deduction in each of
those years.
In addition to the percentage limitations imposed
specifically on charitable contributions, present law imposes a
reduction on most itemized deductions, including charitable
contribution deductions, for taxpayers with adjusted gross
income in excess of a threshold amount, which is indexed
annually for inflation. The threshold amount for 2003 is
$139,500 ($69,750 for married individuals filing separate
returns). For those deductions that are subject to the limit,
the total amount of itemized deductions is reduced by three
percent of adjusted gross income over the threshold amount, but
not by more than 80 percent of itemized deductions subject to
the limit. Beginning in 2006, the overall limitation on
itemized deductions phases-out for all taxpayers. The overall
limitation on itemized deductions is reduced by one-third in
taxable years beginning in 2006 and 2007, and by two-thirds in
taxable years beginning in 2008 and 2009. The overall
limitation on itemized deductions is eliminated for taxable
years beginning after December 31, 2009; however, this
elimination of the limitation sunsets on December 31, 2010.

REASONS FOR CHANGE

The Committee recognizes that the Administration believes
that providing a charitable deduction for taxpayers who do not
itemize deductions will result in an increase in charitable
giving. In addition, the Committee appreciates that the
charitable deduction is an important part of the President's
faith-based initiative. The provision is for a two-year period.
To provide Congress adequate information in considering
extending the provision, the Committee requires the Secretary
of the Treasury to submit a report on the effectiveness of the
provision. The report should consider the extent to which
charitable giving has increased, the burdens of complexity to
taxpayers, and the impact on tax compliance.

EXPLANATION OF PROVISION

In the case of an individual taxpayer who does not itemize
deductions, the provision allows a ``direct charitable
deduction'' from adjusted gross income for charitable
contributions paid in cash during the taxable year. This
deduction is allowed in addition to the standard deduction. The
deduction is available only for that portion of contributions
actually made during the year that in the aggregate exceed $250
($500 in the case of a joint return). The maximum deduction is
$250 ($500 in the case of a joint return). Contributions that
are below the minimum amount or that exceed the maximum
deduction may not be carried over for purposes of a subsequent
taxable year's calculation of the direct charitable deduction.
Under the provision, an individual is not entitled to a
charitable deduction for the first $250 of cash contributions
made during the tax year, is entitled to a deduction on a
dollar-for-dollar basis for contributions of $251 to $500
(e.g., a $1 contribution deduction in the case of $251 of
contributions, and a $250 deduction in the case of $500 of
contributions), and is not entitled to a deduction for
contributions exceeding $500.
The provision does not alter present-law rules regarding
the carryover of contributions to or from a taxable year,
including a taxable year in which the taxpayer elects the
standard deduction. The direct charitable deduction generally
is subject to the tax rules normally governing charitable
contribution deductions, such as the substantiation
requirements. The deduction is allowed in computing alternative
minimum taxable income.
The provision requires the Secretary of the Treasury to
complete a study by December 31, 2004, of the effect of the
provision on increased charitable giving, and of taxpayer
compliance, for example, by comparing compliance by taxpayers
who itemize their charitable contributions with compliance by
those who claim the direct charitable deduction. The Secretary
shall report on the study to the Committee on Finance of the
Senate and the Committee on Ways and Means of the House of
Representatives.

EFFECTIVE DATE

The direct charitable deduction is effective for taxable
years beginning after December 31, 2002, and before January 1,
2005. The Treasury study is required by December 31, 2004.

B. Tax-Free Distributions From Individual Retirement Arrangements for
Charitable Purposes

(Sec. 102 of the bill and secs. 408 and 6034 of the Code)

PRESENT LAW

In general

If an amount withdrawn from a traditional individual
retirement arrangement (``IRA'') or a Roth IRA is donated to a
charitable organization, the rules relating to the tax
treatment of withdrawals from IRAs apply to the amount
withdrawn and the charitable contribution is subject to the
normally applicable limitations on deductibility of such
contributions.

Charitable contributions

In computing taxable income, an individual taxpayer who
itemizes deductions generally is allowed to deduct the amount
of cash and up to the fair market value of property contributed
to a charity described in section 501(c)(3),\8\ to certain
veterans' organizations, fraternal societies, and cemetery
companies,\9\ or to a Federal, State, or local governmental
entity for exclusively public purposes.\10\ The deduction also
is allowed for purposes of calculating alternative minimum
taxable income.
---------------------------------------------------------------------------
\8\ All section references are to the Internal Revenue Code of
1986, unless otherwise indicated.
\9\ Secs. 170(c)(3)-(5).
\10\ Sec. 170(c)(1).
---------------------------------------------------------------------------
The amount of the deduction allowable for a taxable year
with respect to a charitable contribution of property may be
reduced depending on the type of property contributed, the type
of charitable organization to which the property is
contributed, and the income of the taxpayer.\11\
---------------------------------------------------------------------------
\11\ Secs. 170(b) and (e).
---------------------------------------------------------------------------
A taxpayer who takes the standard deduction (i.e., who does
not itemize deductions) may not take a separate deduction for
charitable contributions.\12\
---------------------------------------------------------------------------
\12\ Sec. 170(a). The Economic Recovery Tax Act of 1981 adopted a
temporary provision that permitted individual taxpayers who did not
itemize income tax deductions to claim a deduction from gross income
for a specified percentage of their charitable contributions. The
maximum deduction was $25 for 1982 and 1983, $75 for 1984, 50 percent
of the amount of the contribution for 1985, and 100 percent of the
amount of the contribution for 1986. The nonitemizer deduction
terminated for contributions made after 1986.
---------------------------------------------------------------------------
A payment to a charity (regardless of whether it is termed
a ``contribution'') in exchange for which the donor receives an
economic benefit is not deductible, except to the extent that
the donor can demonstrate that the payment exceeds the fair
market value of the benefit received from the charity. To
facilitate distinguishing charitable contributions from
purchases of goods or services from charities, present law
provides that no charitable contribution deduction is allowed
for a separate contribution of $250 or more unless the donor
obtains a contemporaneous written acknowledgement of the
contribution from the charity indicating whether the charity
provided any good or service (and an estimate of the value of
any such good or service) to the taxpayer in consideration for
the contribution.\13\ In addition, present law requires that
any charity that receives a contribution exceeding $75 made
partly as a gift and partly as consideration for goods or
services furnished by the charity (a ``quid pro quo''
contribution) is required to inform the contributor in writing
of an estimate of the value of the goods or services furnished
by the charity and that only the portion exceeding the value of
the goods or services is deductible as a charitable
contribution.\14\
---------------------------------------------------------------------------
\13\ Sec. 170(f)(8).
\14\ Sec. 6115.
---------------------------------------------------------------------------
Under present law, total deductible contributions of an
individual taxpayer to public charities, private operating
foundations, and certain types of private nonoperating
foundations may not exceed 50 percent of the taxpayer's
contribution base, which is the taxpayer's adjusted gross
income for a taxable year (disregarding any net operating loss
carryback). To the extent a taxpayer has not exceeded the 50-
percent limitation, (1) contributions of capital gain property
to public charities generally may be deducted up to 30 percent
of the taxpayer's contribution base, (2) contributions of cash
to private foundations and certain other charitable
organizations generally may be deducted up to 30 percent of the
taxpayer's contribution base, and (3) contributions of capital
gain property to private foundations and certain other
charitable organizations generally may be deducted up to 20
percent of the taxpayer's contribution base.
Contributions by individuals in excess of the 50-percent,
30-percent, and 20-percent limit may be carried over and
deducted over the next five taxable years, subject to the
relevant percentage limitations on the deduction in each of
those years.
In addition to the percentage limitations imposed
specifically on charitable contributions, present law imposes a
reduction on most itemized deductions, including charitable
contribution deductions, for taxpayers with adjusted gross
income in excess of a threshold amount, which is indexed
annually for inflation. The threshold amount for 2003 is
$139,500 ($69,750 for married individuals filing separate
returns). For those deductions that are subject to the limit,
the total amount of itemized deductions is reduced by three
percent of adjusted gross income over the threshold amount, but
not by more than 80 percent of itemized deductions subject to
the limit. Beginning in 2006, the overall limitation on
itemized deductions phases-out for all taxpayers. The overall
limitation on itemized deductions is reduced by one-third in
taxable years beginning in 2006 and 2007, and by two-thirds in
taxable years beginning in 2008 and 2009. The overall
limitation on itemized deductions is eliminated for taxable
years beginning after December 31, 2009; however, this
elimination of the limitation sunsets on December 31, 2010.
In general, a charitable deduction is not allowed for
income, estate, or gift tax purposes if the donor transfers an
interest in property to a charity (e.g., a remainder) while
also either retaining an interest in that property (e.g., an
income interest) or transferring an interest in that property
to a noncharity for less than full and adequate
consideration.\15\ Exceptions to this general rule are provided
for, among other interests, remainder interests in charitable
remainder annuity trusts, charitable remainder unitrusts, and
pooled income funds, and present interests in the form of a
guaranteed annuity or a fixed percentage of the annual value of
the property.\16\ For such interests, a charitable deduction is
allowed to the extent of the present value of the interest
designated for a charitable organization.
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\15\ Secs. 170(f), 2055(e)(2), and 2522(c)(2).
\16\ Sec. 170(f)(2).
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IRA rules

Within limits, individuals may make deductible and
nondeductible contributions to a traditional IRA. Amounts in a
traditional IRA are includible in income when withdrawn (except
to the extent the withdrawal represents a return of
nondeductible contributions). Individuals also may make
nondeductible contributions to a Roth IRA. Qualified
withdrawals from a Roth IRA are excludable from gross income.
Withdrawals from a Roth IRA that are not qualified withdrawals
are includible in gross income to the extent attributable to
earnings. Includible amounts withdrawn from a traditional IRA
or a Roth IRA before attainment of age 59\1/2\ are subject to
an additional 10-percent early withdrawal tax, unless an
exception applies.
If an individual has made nondeductible contributions to a
traditional IRA, a portion of each distribution from an IRA is
nontaxable, until the total amount of nondeductible
contributions has been received. In general, the amount of a
distribution that is nontaxable is determined by multiplying
the amount of the distribution by the ratio of the remaining
nondeductible contributions to the account balance. In making
the calculation, all traditional IRAs of an individual are
treated as a single IRA, all distributions during any taxable
year are treated as a single distribution, and the value of the
contract, income on the contract, and investment in the
contract are computed as of the close of the calendar year.
In the case of a distribution from a Roth IRA that is not a
qualified distribution, in determining the portion of the
distribution attributable to earnings, contributions and
distributions are deemed to be distributed in the following
order: (1) regular Roth IRA contributions; (2) taxable
conversion contributions;\17\ (3) nontaxable conversion
contributions; and (4) earnings. In determining the amount of
taxable distributions from a Roth IRA, all Roth IRA
distributions in the same taxable year are treated as a single
distribution, all regular Roth IRA contributions for a year are
treated as a single contribution, and all conversion
contributions during the year are treated as a single
contribution.
---------------------------------------------------------------------------
\17\ Conversion contributions refer to conversions of amounts in a
traditional IRA to a Roth IRA.
---------------------------------------------------------------------------

Split-interest trust filing requirements

Split-interest trusts, including charitable remainder
annuity trusts, charitable remainder unitrusts, and pooled
income funds, are required to file an annual information return
\18\ (Form 1041A). Trusts that are not split-interest trusts
but that claim a charitable deduction for amounts permanently
set aside for a charitable purpose \19\ also are required to
file Form 1041A. The returns are required to be made publicly
available.\20\ A trust that is required to distribute all trust
net income currently to trust beneficiaries in a taxable year
is exempt from this return requirement for such taxable year. A
failure to file the required return may result in a penalty on
the trust of $10 a day for as long as the failure continues, up
to a maximum of $5,000 per return.
---------------------------------------------------------------------------
\18\ Sec. 6034. This requirement applies to all split-interest
trusts described in section 4947(a)(2).
\19\ Sec. 642(c).
\20\ Sec. 6104(b).
---------------------------------------------------------------------------
In addition, split-interest trusts are required to file
annually Form 5227.\21\ Form 5227 requires disclosure of
information regarding a trust's noncharitable beneficiaries.
The penalty for failure to file this return is calculated based
on the amount of tax owed. A split-interest trust generally is
not subject to tax and therefore, in general, a penalty may not
be imposed for the failure to file Form 5227. Form 5227 is not
required to be made publicly available.
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\21\ Sec. 6011; Treas. Reg. sec. 53.6011-1(d).
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REASONS FOR CHANGE

Under present law, an individual who wants to use IRA
proceeds to make charitable contributions must treat the IRA
distribution as a withdrawal subject to IRA income recognition
rules and is subject to deduction limitation provisions on the
contributions made to the charity. In some cases, this can
result in taxable income even though the individual used the
entire IRA distribution to make the charitable contribution.
The Committee believes that taxpayers who want to make
charitable contributions from IRAs generally should be
permitted to do so without recognizing income because of the
distribution from the IRA, whether such contribution is made
directly to the charitable organization or indirectly through
the use of a split-interest entity. The Committee believes that
facilitating charitable contributions from IRAs will help
increase giving to charitable organizations.

EXPLANATION OF PROVISION

Qualified charitable distributions from IRAs

The provision provides an exclusion from gross income for
otherwise taxable IRA distributions from a traditional or a
Roth IRA in the case of qualified charitable distributions.
Special rules apply in determining the amount of an IRA
distribution that is otherwise taxable. The present-law rules
regarding taxation of IRA distributions and the deduction of
charitable contributions continue to apply to distributions
from an IRA that are not qualified charitable distributions.
A qualified charitable distribution is defined as any
distribution from an IRA that is made directly by the IRA
trustee either to (1) an organization to which deductible
contributions can be made (a ``direct distribution'') or (2) a
``split-interest entity.'' A split-interest entity means a
charitable remainder annuity trust or charitable remainder
unitrust (together referred to as a ``charitable remainder
trust''), a pooled income fund, or a charitable gift annuity.
Direct distributions are eligible for the exclusion only if
made on or after the date the IRA owner attains age 70\1/2\.
Distributions to a split interest entity are eligible for the
exclusion only if made on or after the date the IRA owner
attains age 59\1/2\ (or, if later, January 1, 2004). In the
case of split-interest distributions, no person may hold an
income interest in the amounts in the split-interest entity
attributable to the charitable distribution other than the IRA
owner, his or her spouse, or a charitable organization.
The exclusion applies to direct distributions only if a
charitable contribution deduction for the entire distribution
otherwise would be allowable, determined without regard to the
generally applicable percentage limitations. Thus, for example,
if the deductible amount is reduced because of a benefit
received in exchange, or if a deduction is not allowable
because the donor did not obtain sufficient substantiation, the
exclusion is not available with respect to any part of the IRA
distribution. Similarly, the exclusion applies in the case of a
distribution directly to a split-interest entity only if a
charitable contribution deduction for the entire present value
of the charitable interest (for example, a remainder interest)
otherwise would be allowable, determined without regard to the
generally applicable percentage limitations.
If the IRA owner has any IRA that includes nondeductible
contributions, a special rule applies in determining the
portion of a distribution that is includible in gross income
(but for the provision) and thus is eligible for qualified
charitable distribution treatment. In such case, the IRA owner
aggregates all IRAs to determine eligibility for the exclusion.
Under the special rule, the distribution is treated as
consisting of income first, up to the aggregate amount that
would be includible in gross income (but for the provision) if
the aggregate balance of all IRAs having the same owners were
distributed during the same year. In determining the amount of
subsequent IRA distributions includible in income, proper
adjustments are made to reflect the amount treated as a
qualified charitable distribution under the special rule.
Special rules apply for distributions to split-interest
entities. For distributions to charitable remainder trusts, the
provision provides that subsequent distributions from the
charitable remainder trust are treated as ordinary income in
the hands of the beneficiary, notwithstanding how such amounts
normally are treated under section 664(b). In addition, for a
charitable remainder trust to be eligible to receive qualified
charitable distributions, the charitable remainder trust has to
be funded exclusively by such distributions. For example, an
IRA owner may not make qualified charitable distributions to an
existing charitable remainder trust any part of which was
funded with assets that were not qualified charitable
distributions.
Under the provision, a pooled income fund is eligible to
receive qualified charitable distributions only if the fund
accounts separately for amounts attributable to such
distributions. In addition, all distributions from the pooled
income fund that are attributable to qualified charitable
distributions are treated as ordinary income to the
beneficiary. Qualified charitable distributions to a pooled
income fund are not includible in the fund's gross income.
In determining the amount includible in gross income by
reason of a payment from a charitable gift annuity purchased
with a qualified charitable distribution from an IRA, the
portion of the distribution from the IRA used to purchase the
annuity is not an investment in the annuity contract.
Any amount excluded from gross income by reason of the
provision is not taken into account in determining the
deduction for charitable contributions under section 170.

Qualified charitable distribution examples

The following examples illustrate the determination of the
portion of an IRA distribution that is a qualified charitable
distribution and the application of the special rules for a
qualified charitable distribution to a split-interest entity.
In each example, it is assumed that the requirements for
qualified charitable distribution treatment are otherwise met
(e.g., the applicable age requirement and the requirement that
contributions are otherwise deductible) and that no other IRA
distributions occur during the year.
Example 1. Individual A has a traditional IRA with a
balance of $100,000, consisting solely of deductible
contributions and earnings. Individual A has no other IRA. The
entire IRA balance is distributed in a direct distribution to a
charitable organization. Under present law, the entire
distribution of $100,000 would be includible in Individual A's
income. Accordingly, under the provision, the entire
distribution of $100,000 is a qualified charitable
distribution. As a result, no amount is included in Individual
A's income as a result of the distribution and the distribution
is not taken into account in determining the amount of
Individual A's charitable deduction for the year.
Example 2. The facts are the same as in Example 1, except
that the entire IRA balance of $100,000 is distributed to a
charitable remainder unitrust, which contains no other assets
and which must be funded exclusively by qualified charitable
distributions. Under the terms of the trust, Individual A is
entitled to receive five percent of the value of the trust each
year. As explained in Example l, the entire $100,000
distribution is a qualified charitable distribution, no amount
is included in Individual A's income as a result of the
distribution, and the distribution is not taken into account in
determining the amount of Individual A's charitable deduction
for the year. In addition, under a special rule in the
provision for charitable remainder trusts, any distribution
from the charitable remainder unitrust to Individual A is
includible in gross income as ordinary income, regardless of
the character of the distribution under the usual rules for the
taxation of distributions from such a trust.
Example 3. Individual B has a traditional IRA with a
balance of $100,000, consisting of $20,000 of nondeductible
contributions and $80,000 of deductible contributions and
earnings. Individual B has no other IRA. In a direct
distribution to a charitable organization, $80,000 is
distributed from the IRA. Under present law, a portion of the
distribution from the IRA would be treated as a nontaxable
return of nondeductible contributions. The nontaxable portion
of the distribution would be $16,000, determined by multiplying
the amount of the distribution ($80,000) by the ratio of the
nondeductible contributions to the account balance ($20,000/
$100,000). Accordingly, under present law, $64,000 of the
distribution ($80,000 minus $16,000) would be includible in
Individual B's income.
Under the provision, notwithstanding the present-law tax
treatment of IRA distributions, the distribution is treated as
consisting of income first, up to the total amount that would
be includible in gross income (but for the provision) if all
amounts were distributed from all IRAs otherwise taken into
account in determining the amount of IRA distributions. The
total amount that would be includible in income if all amounts
were distributed from the IRA is $80,000. Accordingly, under
the provision, the entire $80,000 distributed to the charitable
organization is treated as includible in income (before
application of the provision) and is a qualified charitable
distribution. As a result, no amount is included in Individual
B's income as a result of the distribution and the distribution
is not taken into account in determining the amount of
Individual B's charitable deduction for the year. In addition,
for purposes of determining the tax treatment of other
distributions from the IRA, $20,000 of the amount remaining in
the IRA is treated as Individual B's nondeductible
contributions.

Split-interest trust filing requirements

The provision increases the penalty on split-interest
trusts for failure to file a return and for failure to include
any of the information required to be shown on such return and
to show the correct information. The penalty is $20 for each
day the failure continues up to $10,000 for any one return. In
the case of a split-interest trust with gross income in excess
of $250,000, the penalty is $100 for each day the failure
continues up to a maximum of $50,000. In addition, if a person
(meaning any officer, director, trustee, employee, or other
individual who is under a duty to file the return or include
required information) \22\ knowingly failed to file the return
or include required information, then that person is personally
liable for such a penalty, which would be imposed in addition
to the penalty that is paid by the organization. Information
regarding beneficiaries that are not charitable organizations
as described in section 170(c) is exempt from the requirement
to make information publicly available. In addition, the
provision repeals the present-law exception to the filing
requirement for split-interest trusts that are required in a
taxable year to distribute all net income currently to
beneficiaries. Such exception remains available to trusts other
than split-interest trusts that are otherwise subject to the
filing requirement.
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\22\ Sec. 6652(c)(4)(C).
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EFFECTIVE DATE

The provision relating to qualified charitable
distributions is effective for distributions made after the
date of enactment. The provision relating to information
returns of split-interest trusts is effective for returns for
taxable years beginning after December 31, 2003.

C. Charitable Deduction for Contributions of Food Inventory

(Sec. 103 of the bill and sec. 170 of the Code)

PRESENT LAW

Under present law, a taxpayer's deduction for charitable
contributions of inventory generally is limited to the
taxpayer's basis (typically, cost) in the inventory.
However, for certain contributions of inventory, C
corporations may claim an enhanced deduction equal to the
lesser of (1) basis plus one-half of the item's appreciated
value (i.e., basis plus one half of fair market value in excess
of basis) or (2) two times basis.\23\ To be eligible for the
enhanced deduction, the contributed property generally must be
inventory of the taxpayer, contributed to a charitable
organization described in section 501(c)(3) (except for private
nonoperating foundations), and the donee must (1) use the
property consistent with the donee's exempt purpose solely for
the care of the ill, the needy, or infants, (2) not transfer
the property in exchange for money, other property, or
services, and (3) provide the taxpayer a written statement that
the donee's use of the property will be consistent with such
requirements. In the case of contributed property subject to
the Federal Food, Drug, and Cosmetic Act, the property must
satisfy the applicable requirements of such Act on the date of
transfer and for 180 days prior to the transfer.
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\23\ Sec. 170(e)(3). In general, a C corporation's charitable
contribution deductions for a year may not exceed 10 percent of the
corporation's taxable income. Sec. 170(b)(2).
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To use the enhanced deduction, the taxpayer must establish
that the fair market value of the donated item exceeds basis.
The valuation of food inventory has been the subject of ongoing
disputes between taxpayers and the IRS. In one case, the Tax
Court held that the value of surplus bread inventory donated to
charity was the full retail price of the bread rather than half
the retail price, as the IRS asserted.\24\
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\24\ Lucky Stores Inc. v. Commissioner, 105 T.C. 420 (1995).
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REASONS FOR CHANGE

The Committee believes that expanding the present-law
enhanced deduction for contributions of food inventory to non-C
corporations and raising the amount of the enhanced deduction
will increase charitable contributions of food to those in
need. By clarifying the definition of fair market value, the
Committee believes that taxpayers will be better able to avoid
disputes with the IRS about the valuation of food and receive
an appropriate deduction for their contribution. In addition,
the Committee believes that providing certain low-basis
taxpayers with a deemed basis equal to one quarter of the fair
market value of the food will increase food donations, thus
further providing needed nourishment to the nation's hungry.

EXPLANATION OF PROVISION

Under the provision, any taxpayer, whether or not a C
corporation, engaged in a trade or business is eligible to
claim the enhanced deduction for donations of food inventory.
For taxpayers other than C corporations, the total deduction
for donations of food inventory in a taxable year generally may
not exceed 10 percent of the taxpayer's net income for such
year from its trade or business (or interest therein) from
which contributions are made. For example, if a taxpayer is a
sole proprietor, a shareholder in an S corporation, and a
partner in a partnership, and each business makes charitable
contributions of food inventory, the taxpayer's deduction for
donations of food inventory is limited to 10 percent of the
taxpayer's net income from the sole proprietorship and the
taxpayer's interests in the S corporation and partnership.
However, if only the sole proprietorship and the S corporation
made charitable contributions of food inventory, the taxpayer's
deduction would be limited to 10 percent of the net income from
the trade or business of the sole proprietorship and the S
corporation, but not the partnership.
The 10 percent limitation does not affect the application
of the generally applicable percentage limitations. For
example, if 10 percent of a sole proprietor's net income from
the proprietor's trade or business was greater than 50 percent
of the proprietor's contribution base, the available deduction
for the taxable year (with respect to contributions to public
charities) would be 50 percent of the proprietor's contribution
base. Consistent with present law, such contributions may be
carried forward because they exceed the 50 percent limitation.
Contributions of food inventory by a taxpayer that is not a C
corporation that exceed the 10 percent limitation but not the
50 percent limitation could not be carried forward.
For purposes of calculating the enhanced deduction,
taxpayers who do not account for inventories under section 471
and who are not required to capitalize indirect costs under
section 263A are able to elect to treat the basis of the
contributed food as being equal to 25 percent of the food's
fair market value.\25\
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\25\ This includes, for example, taxpayers who are eligible for
administrative relief under Revenue Procedures 2002-28 and 2001-10.
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The provision changes the amount of the present-law
enhanced deduction for eligible contributions of food inventory
to the lesser of fair market value or twice the taxpayer's
basis in the inventory. For example, a taxpayer who makes an
eligible donation of food that has a fair market value of $10
and a basis of $4 could take a deduction of $8 (twice basis).
If the taxpayer's basis was $6 instead of $4, then the
deduction would be $10 (fair market value). By contrast, under
present law, a C corporation's deduction in the first example
would be $7 (fair market value less half the appreciation) and
in the second example would be $8. (Under present law,
taxpayers other than C corporations generally could take a
deduction for a contribution of food inventory only for the $4
basis in either example.) Taxpayers that do not account for
inventories under section 471 and who are not required to
capitalize indirect costs under section 263A would be able to
elect to treat the basis of the contributed food as being equal
to 25 percent of the food's fair market value.
Under the provision, the enhanced deduction is available
only for food that qualifies as ``apparently wholesome food.''
``Apparently wholesome food'' is defined as food intended for
human consumption that meets all quality and labeling standards
imposed by Federal, State, and local laws and regulations even
though the food may not be readily marketable due to
appearance, age, freshness, grade, size, surplus, or other
conditions.
In addition, the provision provides that the fair market
value of donated apparently wholesome food that cannot or will
not be sold solely due to internal standards of the taxpayer or
lack of market is determined without regard to such internal
standards or lack of market and by taking into account the
price at which the same or substantially the same food items
(as to both type and quality) are sold by the taxpayer at the
time of the contribution or, if not so sold at such time, in
the recent past.

EFFECTIVE DATE

The provision is effective for contributions made after the
date of enactment.

D. Charitable Deduction for Contributions of Book Inventory

(Sec. 104 of the bill and sec. 170 of the Code)

PRESENT LAW

REASONS FOR CHANGE

Under present law, taxpayers sometimes are prohibited from
receiving an enhanced deduction for charitable contributions of
their book inventory, in part because of the requirement that
the inventory be used for care of the ill, the needy, or
infants. For example, such requirement generally prohibits
donations to public libraries and adult literacy programs. The
Committee believes that suitable book inventory should be
eligible for an enhanced deduction in cases where a
contribution is made to an appropriate educational
organization. To minimize disputes between taxpayers and the
IRS about the value of books and to encourage contributions of
books that are suitable in terms of currency, content, and
quantity, the Committee provides a special rule for determining
the amount of the contribution of such books. A clear rule is
needed so that taxpayers know that if they donate books to
schools, libraries, and literacy programs, they will receive an
enhanced deduction that more adequately reflects the costs of
the donation.

EXPLANATION OF PROVISION

The provision modifies the present-law enhanced deduction
for C corporations so that it is equal to the lesser of fair
market value or twice the taxpayer's basis in the case of
qualified book contributions. The provision provides that the
fair market value for this purpose is determined by reference
to a bona fide published market price for the book. Under the
provision, a bona fide published market price of a book means a
price: (1) determined using the same printing and edition; (2)
determined in the usual market in which such a book has been
customarily sold by the taxpayer; and (3) for which the
taxpayer can demonstrate to the satisfaction of the Secretary
that the taxpayer customarily sold such books in arm's length
transactions within 7 years preceding the contribution. For
example, a publisher's listed retail price for a book would not
meet the standard if the publisher could not demonstrate to the
satisfaction of the Secretary that the price was one at which
the publisher customarily sold the book in its usual market in
arm's length transactions occurring within the 7-year period
prior to the contribution. If a publisher entered into a
contract with a local school district to sell newly published
textbooks six years prior to making a qualified book
contribution of such textbooks, the publisher could use as a
bona fide published market price, the price at which such books
regularly were sold to the school district under the contract.
By contrast, if a publisher listed in a catalogue or elsewhere
a ``suggested retail price,'' but the publisher did not in fact
customarily sell the books at such price, the publisher could
not use the ``suggested retail price'' to determine the fair
market value of the book for purposes of the enhanced
deduction. Thus, in general, a bona fide published market price
must be independently verifiable by reference to actual sales
within the seven-year period preceding the contribution, and
not to a publisher's own price list.
As an illustration of the mechanics of calculating the
enhanced deduction under the provision, a C corporation that
made a qualified book contribution with a bona fide published
market price of $10 and a basis of $4 could take a deduction of
$8 (twice basis). If the taxpayer's basis is $6 instead of $4,
then the deduction is $10. Also, in such latter case, if the
book's bona fide market published market price was $5 at the
time of the contribution but was $10 five years before the
contribution, then the deduction is $10.
A qualified book contribution means a charitable
contribution of books to: (1) an educational organization that
normally maintains a regular faculty and curriculum and
normally has a regularly enrolled body of pupils or students in
attendance at the place where its educational activities are
regularly carried on; (2) a public library; or (3) an
organization described in section 501(c)(3) (except for private
nonoperating foundations), that is organized primarily to make
books available to the general public at no cost or to operate
a literacy program. The donee must: (1) use the property
consistent with the donee's exempt purpose; (2) not transfer
the property in exchange for money, other property, or
services; and (3) provide the taxpayer a written statement that
the donee's use of the property will be consistent with such
requirements and also that the books are suitable, in terms of
currency, content, and quantity, for use in the donee's
educational programs and that the donee will use the books in
such educational programs.

EFFECTIVE DATE

The provision is effective for contributions made after the
date of enactment.

E. Expand Charitable Contribution Allowed for Scientific Property Used
for Research and for Computer Technology and Equipment

(Sec. 105 of the bill and sec. 170 of the Code)

PRESENT LAW

In the case of a charitable contribution of inventory or
other ordinary-income or short-term capital gain property, the
amount of the charitable deduction generally is limited to the
taxpayer's basis in the property. In the case of a charitable
contribution of tangible personal property, the deduction is
limited to the taxpayer's basis in such property if the use by
the recipient charitable organization is unrelated to the
organization's tax-exempt purpose. In cases involving
contributions to a private foundation (other than certain
private operating foundations), the amount of the deduction is
limited to the taxpayer's basis in the property.\27\
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\27\ Sec. 170(e)(1).
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Under present law, a taxpayer's deduction for charitable
contributions of scientific property used for research and for
contributions of computer technology and equipment generally is
limited to the taxpayer's basis (typically, cost) in the
property. However, certain corporations may claim a deduction
in excess of basis for a ``qualified research contribution'' or
a ``qualified computer contribution.'' \28\ This enhanced
deduction is equal to the lesser of (1) basis plus one-half of
the item's appreciated value (i.e., basis plus one half of fair
market value minus basis) or (2) two times basis. The enhanced
deduction for qualified computer contributions expires for any
contribution made during any taxable year beginning after
December 31, 2003.
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\28\ Secs. 170(e)(4) and 170(e)(6).
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A qualified research contribution means a charitable
contribution of inventory that is tangible personal property.
The contribution must be to a qualified educational or
scientific organization and be made not later than two years
after construction of the property is substantially completed.
The original use of the property must be by the donee, and be
used substantially for research or experimentation, or for
research training, in the U.S. in the physical or biological
sciences. The property must be scientific equipment or
apparatus, constructed by the taxpayer, and may not be
transferred by the donee in exchange for money, other property,
or services. The donee must provide the taxpayer with a written
statement representing that it will use the property in
accordance with the conditions for the deduction. For purposes
of the enhanced deduction, property is considered constructed
by the taxpayer only if the cost of the parts used in the
construction of the property (other than parts manufactured by
the taxpayer or a related person) do not exceed 50 percent of
the taxpayer's basis in the property.
A qualified computer contribution means a charitable
contribution of any computer technology or equipment, which
meets standards of functionality and suitability as established
by the Secretary of the Treasury. The contribution must be to
certain educational organizations or public libraries and made
not later than three years after the taxpayer acquired the
property or, if the taxpayer constructed the property, not
later than the date construction of the property is
substantially completed.\29\ The original use of the property
must be by the donor or the donee,\30\ and in the case of the
donee, must be used substantially for educational purposes
related to the function or purpose of the donee. The property
must fit productively into the donee's education plan. The
donee may not transfer the property in exchange for money,
other property, or services, except for shipping, installation,
and transfer costs. To determine whether property is
constructed by the taxpayer, the rules applicable to qualified
research contributions apply. Contributions may be made to
private foundations under certain conditions.\31\
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\29\ If the taxpayer constructed the property and reacquired such
property, the contribution must be within three years of the date the
original construction was substantially completed. Sec.
170(e)(6)(D)(i).
\30\ This requirement does not apply if the property was reacquired
by the manufacturer and contributed. Sec. 170(e)(6)(D)(ii).
\31\ Sec. 170(e)(6)(C).
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REASONS FOR CHANGE

The Committee believes that extension of the enhanced
deduction to include property assembled by the taxpayer will
lead to increased charitable contributions of scientific
property used for research and computer technology and
equipment and will help to eliminate confusion in determining
whether property is ``constructed'' or ``assembled'' for
purposes of claiming the enhanced deduction. The Committee
believes it is appropriate to extend temporarily the enhanced
deduction for qualified computer contributions.

EXPLANATION OF PROVISION

Under the provision, property assembled by the taxpayer, in
addition to property constructed by the taxpayer, is eligible
for either enhanced deduction. The Committee does not intend
that old or used components assembled by the taxpayer into
scientific property or computer technology or equipment are
eligible for the enhanced deduction.
The provision extends the enhanced deduction for qualified
computer contributions to contributions made during any taxable
year beginning before January 1, 2006.

EFFECTIVE DATE

The provision is effective for taxable years beginning
after December 31, 2002.

F. Encourage Contributions of Capital Gain Real Property Made for
Conservation Purposes

(Sec. 106 of the bill and sec. 170 of the Code)

PRESENT LAW

Charitable contributions generally

In general, a deduction is permitted for charitable
contributions, subject to certain limitations that depend on
the type of taxpayer, the property contributed, and the donee
organization. The amount of deduction generally equals the fair
market value of the contributed property on the date of the
contribution. Charitable deductions are provided for income,
estate, and gift tax purposes.\32\
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\32\ Secs. 170, 2055, and 2522, respectively.
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In general, in any taxable year, charitable contributions
by a corporation are not deductible to the extent the aggregate
contributions exceed 10 percent of the corporation's taxable
income computed without regard to net operating or capital loss
carrybacks. For individuals, the amount deductible is a
percentage of the taxpayer's contribution base, which is the
taxpayer's adjusted gross income computed without regard to any
net operating loss carryback. The applicable percentage of the
contribution base varies depending on the type of donee
organization and property contributed. Cash contributions of an
individual taxpayer to public charities, private operating
foundations, and certain types of private nonoperating
foundations may not exceed 50 percent of the taxpayer's
contribution base. Cash contributions to private foundations
and certain other organizations generally may be deducted up to
30 percent of the taxpayer's contribution base.
In general, a charitable deduction is not allowed for
income, estate, or gift tax purposes if the donor transfers an
interest in property to a charity while also either retaining
an interest in that property or transferring an interest in
that property to a noncharity for less than full and adequate
consideration. Exceptions to this general rule are provided
for, among other interests, remainder interests in charitable
remainder annuity trusts, charitable remainder unitrusts, and
pooled income funds, present interests in the form of a
guaranteed annuity or a fixed percentage of the annual value of
the property, and qualified conservation contributions.

Capital gain property

Capital gain property means any capital asset or property
used in the taxpayer's trade or business the sale of which at
its fair market value, at the time of contribution, would have
resulted in gain that would have been long-term capital gain.
Contributions of capital gain property to a qualified charity
are deductible at fair market value within certain limitations.
Contributions of capital gain property to charitable
organizations described in section 170(b)(1)(A) (e.g., public
charities, private foundations other than private non-operating
foundations, and certain governmental units) generally are
deductible up to 30 percent of the taxpayer's contribution
base. An individual may elect, however, to bring all these
contributions of capital gain property for a taxable year
within the 50-percent limitation category by reducing the
amount of the contribution deduction by the amount of the
appreciation in the capital gain property. Contributions of
capital gain property to charitable organizations described in
section 170(b)(1)(B) (e.g., private non-operating foundations)
are deductible up to 20 percent of the taxpayer's contribution
base.
For purposes of determining whether a taxpayer's aggregate
charitable contributions in a taxable year exceed the
applicable percentage limitation, contributions of capital gain
property are taken into account after other charitable
contributions. Contributions of capital gain property that
exceed the percentage limitation may be carried forward for
five years.

Qualified conservation contributions

Qualified conservation contributions are not subject to the
``partial interest'' rule, which generally bars deductions for
charitable contributions of partial interests in property. A
qualified conservation contribution is a contribution of a
qualified real property interest to a qualified organization
exclusively for conservation purposes. A qualified real
property interest is defined as: (1) the entire interest of the
donor other than a qualified mineral interest; (2) a remainder
interest; or (3) a restriction (granted in perpetuity) on the
use that may be made of the real property. Qualified
organizations include certain governmental units, public
charities that meet certain public support tests, and certain
supporting organizations. Conservation purposes include: (1)
the preservation of land areas for outdoor recreation by, or
for the education of, the general public; (2) the protection of
a relatively natural habitat of fish, wildlife, or plants, or
similar ecosystem; (3) the preservation of open space
(including farmland and forest land) where such preservation
will yield a significant public benefit and is either for the
scenic enjoyment of the general public or pursuant to a clearly
delineated Federal, State, or local governmental conservation
policy; and (4) the preservation of an historically important
land area or a certified historic structure.
Qualified conservation contributions of capital gain
property are subject to the same limitations and carryover
rules of other charitable contributions of capital gain
property.

REASONS FOR CHANGE

The Committee desires to provide additional incentives for
charitable donations of real property made for qualified
conservation purposes. The Committee believes that increasing
the percentage limitations applicable to qualified conservation
contributions of real property, and increasing the carryover
period applicable to such contributions from five to fifteen
years, will increase donations made for qualified conservation
purposes. The Committee also believes that special incentives
are required to encourage qualified conservation contributions
of farm and ranch properties.

EXPLANATION OF PROVISION

In general

Under the provision, the 30-percent contribution base
limitation on contributions of capital gain property by
individuals does not apply to qualified conservation
contributions (as defined under present law). Thus, individuals
may include the fair market value of any qualified conservation
contribution of capital gain property in determining the amount
of the charitable contributions subject to the 50-percent
contribution base limitation.
Individuals are allowed to carryover any qualified
conservation contributions that exceed the 50-percent
limitation for up to 15 years. The 50-percent contribution base
limitation applies first to contributions other than qualified
conservation contributions and then to qualified conservation
contributions. For example, assume an individual with a
contribution base of $100 makes a qualified conservation
contribution of property with a fair market value of $80 and
makes other charitable contributions of $60. The individual is
allowed a deduction of $50 in the current taxable year for the
other contributions (50 percent of the $100 contribution base)
and is allowed to carryover the excess $10 for up to 5 years.
No current deduction is allowed for the qualified conservation
contribution but the entire $80 qualified conservation
contribution may be carried forward for up to 15 years.

Farmers and ranchers

In the case of an eligible farmer or rancher, a qualified
conservation contribution is allowable up to 100 percent of the
taxpayer's contribution base (after taking into account other
charitable contributions). This rule applies both to
individuals and corporations. In addition, corporate (as well
as non-corporate) eligible farmers and ranchers are allowed to
carryover any excess qualified conservation contributions for
up to 15 years. The 100-percent contribution base limitation
applies first to contributions other than qualified
conservation contributions (to the extent allowable under other
percentage limitations) and then to qualified conservation
contributions. For example, assume an individual farmer or
rancher with a contribution base of $100 makes a qualified
conservation contribution of property with a fair market value
of $80 and makes other charitable contributions of $60. The
individual is allowed a deduction of $50 in the current taxable
year for the other contributions (50 percent of the $100
contribution base) and is allowed to carryover the excess $10
for up to 5 years. The individual also is allowed a deduction
of $50 in the current taxable year for the qualified charitable
contribution (the amount of the remaining contribution base).
The remaining $30 qualified conservation contribution may be
carried forward for up to 15 years.
For this purpose, an eligible farmer or rancher means a
taxpayer (other than a publicly traded C corporation) whose
gross income from the trade of business of farming is at least
51 percent of the taxpayer's gross income for the taxable year.

EFFECTIVE DATE

The provision is effective for contributions made after the
date of enactment.

G. Exclusion of 25 Percent of Capital Gain for Certain Sales Made for
Qualifying Conservation Purposes

(Sec. 107 of the bill and new sec. 121A of the Code)

PRESENT LAW

Sales of capital gain property

Gain from the sale or exchange of land held more than one
year generally is treated as long-term capital gain. Generally,
the net capital gain of an individual (i.e., long-term capital
gain less short-term capital loss) is subject to a maximum tax
rate of 20 percent.

Charitable contributions of capital gain property for conservation
purposes

Special rules apply to charitable contributions of
qualified conservation contributions. Qualified conservation
contributions are not subject to the ``partial interest'' rule,
which generally bars deductions for charitable contributions of
partial interests in property. A qualified conservation
contribution is a contribution of a qualified real property
interest to a qualified organization exclusively for
conservation purposes. A qualified real property interest is
defined as: (1) the entire interest of the donor other than a
qualified mineral interest; (2) a remainder interest; or (3) a
restriction (granted in perpetuity) on the use that may be made
of the real property. Charitable contributions of interests
that constitute the taxpayer's entire interest in the property
are not regarded as qualified real property interests within
the meaning of section 170(h),\33\ but instead are subject to
the general rules applicable to charitable contributions of
entire interests of the taxpayer. Qualified organizations
include certain governmental units, public charities that meet
certain public support tests, and certain supporting
organizations. Conservation purposes include: (1) the
preservation of land areas for outdoor recreation by, or for
the education of, the general public; (2) the protection of a
relatively natural habitat of fish, wildlife, or plants, or
similar ecosystem; (3) the preservation of open space
(including farmland and forest land) where such preservation
will yield a significant public benefit and is either for the
scenic enjoyment of the general public or pursuant to a clearly
delineated Federal, State, or local governmental conservation
policy; and (4) the preservation of an historically important
land area or a certified historic structure.
---------------------------------------------------------------------------
\33\ Ltr. Rul. 8626029.
---------------------------------------------------------------------------
Treasury regulations provide that a deduction for a
qualified conservation contribution is allowed only if the
donor prohibits in the instrument of conveyance the donee from
subsequently transferring the qualified real property interest,
whether or not for consideration, unless the donee
organization, as a condition of the subsequent transfer,
requires that the conservation purpose which the contribution
was originally intended to advance continues to be carried
out.\34\ Moreover, subsequent transfers of such interests are
restricted to organizations that are qualified conservation
organizations.\35\
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\34\ Treas. Reg. sec. 1.170A-14(c)(2).
\35\ Id.
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REASONS FOR CHANGE

Some landowners may want their land to be protected for
conservation purposes but cannot afford simply to donate either
the land or an easement on the land, especially if the land is
the landowner's primary asset. The Committee desires to
encourage the sale of appreciated, environmentally sensitive
land and real property interests in land or water, as well as
controlling stock interests in certain land corporations, to
qualified conservation organizations and governments, thus
achieving conservation goals through voluntary sales of
property. The Committee believes that providing taxpayers a
partial exclusion of capital gain derived from the voluntary
sale of properties for conservation purposes will increase the
number of properties dedicated to conservation purposes. The
Committee desires to facilitate the transfers of properties to
conservation organizations in a manner that will, to the extent
practicable, preserve the value of the properties once they are
acquired by the conservation organizations, while providing
safeguards designed to ensure the protection of the
conservation purposes for which the properties are intended to
be used.

EXPLANATION OF PROVISION

In general

The provision provides a 25-percent exclusion from gross
income of long-term capital gain from the qualifying sale or
exchange of land, or an interest in land or water rights,
provided that the land or interest in land or water rights
constitutes an interest in real property that has been held by
the taxpayer or the taxpayer's family at all times during the
five years preceding the date of sale. The qualifying sale must
be made to a qualified organization that intends that the
acquired property be used for qualified conservation purposes
in perpetuity.\36\
---------------------------------------------------------------------------
\36\ The exclusion is mandatory if all of the requirements of the
provision are satisfied, and a taxpayer need not file an election to
take advantage of the exclusion. A taxpayer who transfers qualifying
property to a qualified organization may opt out of the 25-percent
exclusion by choosing not to satisfy one or more of the provision's
requirements without having to file a formal election with the
Secretary, such as by failing to obtain the requisite letter of intent
from the qualified organization.
---------------------------------------------------------------------------

Qualifying interests

The exclusion applies only to sales or exchanges of real
property interests in land or water rights that constitute the
entire interest of the taxpayer in such land or water rights,
or that constitute qualified real property interests as defined
in section 170(h), specifically: (1) the entire interest of the
taxpayer other than a qualified mineral interest; (2) a
remainder interest; or (3) a restriction (granted in
perpetuity) on the use which may be made of the real property.
Partial interests in property that are not the entire interest
of the taxpayer or a qualified real property interest do not
qualify for the exclusion. For example, a taxpayer who owns
land and related mineral rights but who sells only the mineral
rights is not eligible for the exclusion. However, a taxpayer
who owns only mineral rights is eligible for the 25-percent
exclusion if the taxpayer sells his or her entire interest in
the mineral rights and satisfies the other requirements of the
provision.
Generally, an undivided interest that constitutes the
taxpayer's entire interest in the property is eligible for the
exclusion. A partial interest that constitutes the taxpayer's
entire interest in the property, however, does not qualify for
the exclusion if the property in which such partial interest
exists was divided in an attempt to avoid the partial interest
rules. The Committee intends that the partial interest rules
contained in Treasury Regulations section 1.170A-7(a)(2)(i) and
generally applicable to contributions of partial interests be
applied similarly for purposes of this provision. For example,
if a taxpayer transfers an undivided interest in property to a
spouse and immediately thereafter sells the remaining undivided
interest to a qualified organization, the exclusion will not
apply to the taxpayer's sale to the qualified organization.
Under the provision, the exclusion is available for long-
term capital gain from certain sales or exchanges of stock in a
C corporation if the qualified organization ultimately obtains
a controlling stock interest (generally a stock interest that
provides the qualified organization at least 90 percent of the
total voting power and total value of the corporation's stock)
and if at least 90 percent of the fair market value of the C
corporation's assets at the time of the sale or exchange
consists of land or water rights, or interests in land or water
rights, that were held by the corporation at all times during
the five years preceding the sale. Stock in a corporation will
not qualify if at the time of the sale or exchange the fair
market value of water rights and infrastructure relating to the
delivery of water constitutes more than 50 percent of the fair
market value of all of the corporation's assets. Only a stock
interest held by the taxpayer or the taxpayer's family at all
times during the five years preceding the sale qualifies for
the 25-percent exclusion. The Committee intends that in
appropriate circumstances a controlling stock interest may be
acquired by the qualified organization from multiple persons in
multiple transactions, and authorizes the Secretary to issue
guidance regarding the availability of the exclusion in such
cases.

Qualifying gain

The exclusion applies only to long-term capital gain. Gain
treated as ordinary income, such as under depreciation
recapture provisions, is not eligible for the exclusion. Gain
attributable to certain improvements, such as buildings or
structures that do not further a qualified conservation purpose
(``disqualified improvements''), also does not qualify for the
exclusion.\37\ The provision provides that the maximum amount
of gain that may be excluded by a shareholder in the case of a
sale or exchange of a controlling stock interest is 25 percent
of the shareholder's proportionate share of the C corporation's
underlying gain attributable to qualifying land, water rights,
or interests therein held by the C corporation.
---------------------------------------------------------------------------
\37\ The Committee intends that soil and water conservation
expenditures in the nature of those described in section 175,
determined without regard to whether the taxpayer is engaged in a
farming business and that the land be used for farming, generally shall
be treated as furthering a qualified conservation purpose.
---------------------------------------------------------------------------
Consistent with present law, the determination of gain or
loss is to be calculated on an asset-by-asset basis whenever
that is required for other purposes of the Code (such as for
purposes of section 1245 or section 1250). To minimize
administrative complexity and assist taxpayers in the
preparation of their returns, the Committee intends that in
those cases where the Code does not otherwise require a
separate determination of gain or loss for the disqualified
improvement, the gain allocable to the disqualified improvement
shall be determined by reference to the fair market value of
the disqualified improvement relative to the fair market value
of all assets for which a gain or loss determination is not
otherwise required by the Code.\38\
---------------------------------------------------------------------------
\38\ The Committee intends that the taxpayer be required to use
this gain allocation rule unless the taxpayer has adequate records to
substantiate the adjusted basis and fair market value to support a
separate calculation.
---------------------------------------------------------------------------
For example, if a taxpayer sells a qualifying land interest
with a fair market value of $100 and a basis of $30, that
includes a building or structure that does not further a
conservation purpose (a disqualified improvement) and that has
a fair market value of $40, the taxpayer must determine the
portion of the gain that is attributable to the eligible land
and to the disqualified improvement. If determination of gain
or loss on the sale of the improvement is required for other
purposes of the Code, then the gain or loss determined for
those purposes governs, and the taxpayer must determine his or
her basis of the disqualified improvement (in this case,
assumed to be zero), with the result that the $40 gain on the
disqualified improvement is not eligible for the 25-percent
exclusion and the gain of $30 on the land is eligible for the
25-percent exclusion. On the other hand, if the determination
of gain or loss on the sale of the improvement is not required
for other purposes of the Code, then the Committee intends that
the taxpayer allocate the aggregate gain of $70 attributable to
the land and the disqualified improvement between the land and
the improvement on the basis of their respective fair market
values (i.e., 40 percent to the improvement and 60 percent to
the land). Under this gain allocation rule, the $28 of gain
allocable to the improvement is not eligible for the 25-percent
exclusion, and the $42 of gain allocable to the land qualifies
for the 25-percent exclusion.

Eligible sales

An eligible sale is a sale or exchange (excluding a
transfer made by order of condemnation or eminent domain) \39\
that may be made only to a qualified organization, defined as a
Federal, State, or local government, or an agency or department
thereof or a section 501(c)(3) organization that is organized
and operated primarily to meet a qualified conservation
purpose. In addition, to be an eligible sale, the organization
acquiring the property interest must provide the taxpayer with
a letter stating that the intent of such organization in
acquiring the property is to further a qualified conservation
purpose and that any subsequent transfer of the acquired
interest will be to a qualified organization and made to
protect the conservation purpose in perpetuity. A qualified
conservation purpose is: (1) the preservation of land areas for
outdoor recreation by, or the education of, the general public;
(2) the protection of a relatively natural habitat of fish,
wildlife, or plants, or similar ecosystem; or (3) the
preservation of open space (including farmland and forest land)
where the preservation is for the scenic enjoyment of the
general public or pursuant to a clearly delineated Federal,
State, or local governmental conservation policy and will yield
a significant public benefit.
---------------------------------------------------------------------------
\39\ A sale or exchange made prior to the issuance of an order, but
that is the result of a threat of condemnation or eminent domain, may
qualify for the exclusion.
---------------------------------------------------------------------------

Protection of conservation purposes

The provision provides for the imposition of penalty excise
taxes in appropriate cases where a qualified organization fails
to take steps consistent with the protection of conservation
purposes. Because the penalty taxes are imposed on an
organization that fails to protect the conservation purpose,
and do not serve to encumber the property in the same manner as
a restriction contained in an instrument of conveyance, the
Committee believes that the penalty taxes will adequately
protect conservation purposes without decreasing the value of
the property in the hands of the conservation organizations.
If ownership or possession of the property is transferred
by a qualified organization other than to another qualified
organization that provides the requisite letter of intent, or a
legal restriction contained in an instrument of conveyance that
protects the qualified conservation purpose is removed, then:
(1) a 20-percent excise tax applies to the proceeds or fair
market value of the property; (2) any realized gain or income
is subject to an additional excise tax imposed at the highest
income tax rate applicable to C corporations; and (3) any
otherwise applicable non-recognition provisions of the Code
shall not apply to the transferor. The Committee intends that
the excise taxes apply to all cases involving the transfer of
ownership or possession of the property to a transferee that is
not a qualified organization unless the transferring qualified
organization demonstrates to the satisfaction of the Secretary
that qualified conservation purposes will be protected in
perpetuity. In the case of a removal of a legal restriction
contained in an instrument of conveyance, the qualified
organization must demonstrate to the satisfaction of the
Secretary that a later unexpected change in the conditions
surrounding the property makes retaining the conservation
restriction impossible or impractical and that any proceeds
derived from the removal of the restriction will be used to
further qualified conservation purposes. The Committee
authorizes the Secretary to provide guidance to identify
appropriate cases where transfers to persons other than
qualified organizations are regarded as protecting a
conservation purpose in perpetuity. The Committee intends, for
example, that a qualified organization may acquire a fee simple
interest in real property operated as a farm and then transfer,
without imposition of the penalty taxes, the real property
subject to a conservation easement that constitutes a qualified
real property interest if, in a recorded instrument of
conveyance, the transferor prohibits the transferee from
subsequently transferring the real property unless the
transferee, as a condition of the subsequent transfer, requires
that the qualified conservation purpose of preserving the
property as open space farmland will continue to be carried
out.
In the case of a transfer by a qualified organization to
another qualified organization, the transferee must provide the
transferor at the time of the transfer a letter stating that
the intent of the transferee is to further a qualified
conservation purpose and that any subsequent transfer of the
acquired interest will be made to protect the conservation
purpose in perpetuity, and the transferee becomes subject to
the excise tax provisions for subsequent transfers. The
Committee intends that in the case of a sale or exchange of
stock of a C corporation in which a qualified organization
acquires a controlling stock interest, all of the stock of such
corporation acquired by the qualified organization (including
any stock which did not qualify for the exclusion), as well as
the property held by such C corporation, becomes subject to the
penalty tax provisions.
The provision provides that the Secretary may require such
reporting as may be necessary or appropriate to further the
purpose that any conservation use be in perpetuity.

Relationship with other provisions

In the case of an individual, the exclusion applies both
for purposes of the regular tax and the alternative minimum
tax. In the case of a corporation, the present-law alternative
minimum tax provisions apply without modification.
If a taxpayer sells a real property interest to a qualified
organization for less than the property's fair market value,
the amount of any charitable contribution deduction is
determined in accordance with the bargain sale rules,\40\ and
the taxpayer shall not fail to qualify for a contribution
deduction under those rules solely because the taxpayer derives
a tax benefit from the partial exclusion of long-term capital
gain from the sale. For example, if a taxpayer sells qualifying
land with a fair market value of $100 and an adjusted basis of
$10 to a qualified organization for a sales price of $95 (or
alternatively, for a sale price of $50), the taxpayer's basis
of $10 shall be allocated between the sale and the contribution
components of the transfer under the bargain sale rules, and
the tax savings resulting from the 25-percent exclusion of
long-term capital gain on the sale will not reduce the portion
of the transfer treated as a charitable contribution under the
bargain sale rules. The present-law requirements applicable to
the charitable contribution component of the transfer,
including, for example, the recordkeeping, substantiation, and
appraisal provisions of Treasury Regulations section 1.170A-13,
must be satisfied.
---------------------------------------------------------------------------
\40\ Sec. 1011(b) and Treas. Reg. sec. 1.1011-2.
---------------------------------------------------------------------------

EFFECTIVE DATE

The provision is effective for sales or exchanges occurring
after the date of enactment.

H. Cost Sharing Payments Under the Partners for Fish and Wildlife
Program

(Sec. 108 of the bill and sec. 126 of the Code)

PRESENT LAW

Under present law, gross income does not include the
excludable portion of payments made to taxpayers by federal and
state governments for a share of the cost of improvements to
property under certain conservation programs. These programs
include payments received under (1) the rural clean water
program authorized by section 208(j) of the Federal Water
Pollution Control Act, (2) the rural abandoned mine program
authorized by section 406 of the Surface Mining Control and
Reclamation Act of 1977, (3) the water bank program authorized
by the Water Bank Act, (4) the emergency conservation measures
program authorized by title IV of the Agricultural Credit Act
of 1978, (5) the agriculture conservation program authorized by
the Soil Conservation and Domestic Allotment Act, (6) the great
plains conservation program authorized by section 16 of the
Soil Conservation and Domestic Policy Act, (7) the resource
conservation and development program authorized by the
Bankhead-Jones Farm Tenant Act and by the Soil Conservation and
Domestic Allotment Act, (8) the forestry incentives program
authorized by section 4 of the Cooperative Forestry Assistance
Act of 1978, (9) any small watershed program administered by
the Secretary of Agriculture which is determined by the
Secretary of the Treasury or his delegate to be substantially
similar to the type of programs described in items (1) through
(8), and (10) any program of a State, possession of the United
States, a political subdivision of any of the foregoing, or the
District of Columbia under which payments are made to
individuals primarily for the purpose of conserving soil,
protecting or restoring the environment, improving forests, or
providing a habitat for wildlife.

REASONS FOR CHANGE

The Committee believes that payments received by taxpayers
under the Partners for Fish and Wildlife Program are similar to
payments made under other government programs that are
excludable from gross income under present law. Accordingly,
the Committee believes it is appropriate to extend the present-
law exclusion to payments under this program.

EXPLANATION OF PROVISION

The provision expands the types of qualified cost-sharing
payments to include payments under the Partners for Fish and
Wildlife Program.

EFFECTIVE DATE

The provision applies to payments received after the date
of enactment.

I. Basis Adjustment to Stock of S Corporation Contributing Property

(Sec. 109 of the bill and sec. 1367 of the Code)

PRESENT LAW

Under present law, if an S corporation contributes money or
other property to a charity, each shareholder takes into
account the shareholder's pro rata share of the contribution in
determining its own income tax liability.\41\ A shareholder of
an S corporation reduces the basis in the stock of the S
corporation by the amount of the charitable contribution that
flows through to the shareholder.\42\
---------------------------------------------------------------------------
\41\ Sec. 1366(a)(1)(A).
\42\ Sec. 1367(a)(2)(B).
---------------------------------------------------------------------------

REASONS FOR CHANGE

Under present law, if an S corporation makes a charitable
contribution of appreciated property, the shareholder may be
taxed on an amount equal to the appreciation in the contributed
property when the S corporation stock is sold. Thus, under
present law, a charitable contribution of appreciated property
made by an S corporation receives less favorable tax treatment
than other contributions of appreciated property.
The Committee wishes to preserve the benefit of providing a
charitable contribution deduction for contributions of property
by an S corporation with a fair market value in excess of its
adjusted basis. Thus, the bill provides that the basis
adjustment to the stock of an S corporation for charitable
contributions made by the corporation will be in an amount
equal to the shareholder's pro rata share of the adjusted basis
of the property contributed. This adjustment will prevent the
later recognition of gain attributable to the appreciation in
the contributed property on the disposition of the S
corporation stock.

EXPLANATION OF PROVISION

The provision provides that the amount of a shareholder's
basis reduction in the stock of an S corporation by reason of a
charitable contribution made by the corporation will be equal
to the shareholder's pro rata share of the adjusted basis of
the contributed property.\43\
---------------------------------------------------------------------------
\43\ See Rev. Rul. 96-11 (1996-1 C.B. 140) for a rule reaching a
similar result in the case of charitable contributions made by a
partnership.
---------------------------------------------------------------------------
Thus, for example, assume an S corporation with one
individual shareholder makes a charitable contribution of stock
with a basis of $200 and a fair market value of $500. The
shareholder will be treated as having made a $500 charitable
contribution (or a lesser amount if the special rules of
section 170(e) apply), and will reduce the basis of the S
corporation stock by $200.

EFFECTIVE DATE

The provision applies to contributions made after the date
of enactment.

J. Enhanced Deduction for Charitable Contributions of Literary,
Musical, Artistic, and Scholarly Compositions

(Sec. 110 of the bill and sec. 170 of the Code)

PRESENT LAW

In the case of a charitable contribution of inventory or
other ordinary-income or short-term capital gain property, the
amount of the deduction generally is limited to the taxpayer's
basis in the property.\44\ In the case of a charitable
contribution of tangible personal property, the deduction is
limited to the taxpayer's basis in such property if the use by
the recipient charitable organization is unrelated to the
organization's tax-exempt purpose. In cases involving
contributions of tangible personal property to a private
foundation (other than certain private foundations),\45\ the
amount of the deduction is limited to the taxpayer's basis in
the property.
---------------------------------------------------------------------------
\44\ Sec. 170(e)(1).
\45\ Sec. 170(e)(1)(B)(ii).
---------------------------------------------------------------------------
Under present law, charitable contributions of literary,
musical, and artistic compositions created or prepared by the
donor are considered ordinary income property and a taxpayer's
deduction of such property is limited to the taxpayer's basis
(typically, cost) in the property. A charitable contribution of
a literary, musical, or artistic composition by a person other
than the person who created or prepared the work generally is
eligible for a fair market value deduction if the donee
organization's use of the property is related to such
organization's exempt purposes.
To be eligible for the deduction, the contribution must be
of an undivided portion of the donor's entire interest in the
property.\46\ For purposes of the charitable income tax
deduction, the copyright and the work in which the copyright is
embodied are not treated as separate property interests.
Accordingly, if a donor owns a work of art and the copyright to
the work of art, a gift of the artwork without the copyright or
the copyright without the artwork will constitute a gift of a
``partial interest'' and will not qualify for the income tax
charitable deduction.
---------------------------------------------------------------------------
\46\ Sec. 170(f)(3).
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that it is appropriate to provide an
enhanced deduction for charitable contributions of certain
literary, musical, artistic, and scholarly compositions created
by the personal efforts of the donor. In many cases, such works
have a low basis, and because present law generally limits the
deduction for such contributions to basis, the creators of
literary, musical, artistic, and scholarly compositions do not
have an appropriate incentive to contribute their works to
charity. In addition, the Committee believes that the present-
law rule that a charitable contribution deduction generally is
not available for contributions of less than the taxpayer's
entire property interest is an inappropriate disincentive for
contributions of such works.

EXPLANATION OF PROVISION

The provision provides that a deduction for ``qualified
artistic charitable contributions'' generally is increased from
the value under present law (generally, basis) to the fair
market value of the property contributed, measured at the time
of the contribution. However, the amount of the increase of the
deduction provided by the provision may not exceed the amount
of the donor's adjusted gross income for the taxable year
attributable to: (1) income from the sale or use of property
created by the personal efforts of the donor that is of the
same type as the donated property; and (2) income from
teaching, lecturing, performing, or similar activities with
respect to such property. In addition, the increase to the
present-law deduction provided by the provision may not be
carried over and deducted in other taxable years.
The provision defines a qualified artistic charitable
contribution to mean a charitable contribution of any literary,
musical, artistic, or scholarly composition, or similar
property, or the copyright thereon (or both) that meets certain
requirements. First, the contributed property must have been
created by the personal efforts of the donor at least 18 months
prior to the date of contribution. Second, the donor must
obtain a qualified appraisal of the contributed property, a
copy of which is required to be attached to the donor's income
tax return for the taxable year in which such contribution is
made. The appraisal must include evidence of the extent (if
any) to which property created by the personal efforts of the
taxpayer and of the same type as the donated property is or has
been owned, maintained, and displayed by certain charitable
organizations and sold to or exchanged by persons other than
the taxpayer, donee, or any related person. Third, the
contribution must be made to a public charity or to certain
limited types of private foundations. Finally, the use of
donated property by the recipient organization must be related
to the organization's charitable purpose or function, and the
donor must receive a written statement from the organization
verifying such use.
Under the provision, the tangible property and the
copyright on such property are treated as separate properties
for purposes of the ``partial interest'' rule; thus, a gift of
artwork without the copyright or a copyright without the
artwork does not constitute a gift of a partial interest and is
deductible. Contributions of letters, memoranda, or similar
property that are written, prepared, or produced by or for an
individual while the individual is an officer or employee of
any person (including a government agency or instrumentality)
do not qualify for a fair market value deduction unless the
contributed property is entirely personal.

EFFECTIVE DATE

The deduction for qualified artistic charitable
contributions applies to contributions made after the date of
enactment.

K. Exclusion for Certain Mileage Reimbursements to Charitable
Volunteers

(Sec. 111 of the bill and new sec. 139A of the Code)

PRESENT LAW

Unreimbursed out-of-pocket expenditures made incident to
providing donated services to a qualified charitable
organization--such as out-of-pocket transportation expenses
necessarily incurred in performing donated services--may
constitute an itemized deduction for charitable
contributions.\47\ No charitable contribution deduction is
allowed for traveling expenses (including expenses for meals
and lodging) while away from home, whether paid directly or by
reimbursement, unless there is no significant element of
personal pleasure, recreation, or vacation in such travel.\48\
In determining the amount treated as a charitable contribution
where a taxpayer operates a vehicle in providing services to a
charity, the taxpayer either may deduct actual out-of-pocket
expenditures or may use the charitable standard mileage rate.
The taxpayer may also deduct (under either computation method),
any parking fees and tolls incurred in rendering the services,
but may not deduct any amount (regardless of the computation
method used) for general repair or maintenance expenses,
depreciation, insurance, registration fees, etc.
---------------------------------------------------------------------------
\47\ Treas. Reg. sec. 1.170A-1(g).
\48\ Sec. 170(j).
---------------------------------------------------------------------------
The charitable standard mileage rate is set by statute at
14 cents per mile.\49\ The standard mileage rate for charitable
purposes is lower than the standard business rate because the
charitable rate covers only the out-of-pocket operating
expenses (including gasoline and oil) directly related to the
use of the car in performing the donated services that a
taxpayer may deduct as a charitable contribution. The
charitable rate does not include costs that are not deductible
as a charitable contribution such as general repair or
maintenance expenses, depreciation, insurance, and registration
fees. Such costs are, however, included in computing the
business standard mileage rate (the rate allowed for business
use of an automobile), which is 36 cents per mile.
---------------------------------------------------------------------------
\49\ Sec. 170(i).
---------------------------------------------------------------------------
Volunteer drivers who are reimbursed for mileage expenses
have taxable income to the extent the reimbursement exceeds
deductible travel expenses. Employees who are reimbursed for
mileage expenses under a qualified arrangement that pays a
mileage allowance in lieu of reimbursing actual expenses
generally have taxable income to the extent the reimbursement
exceeds the amount of the business standard mileage rate
multiplied by the actual business miles.

REASONS FOR CHANGE

The Committee believes that it is important to recognize
the valuable contributions made by volunteers to charitable
organizations by providing an exclusion from income up to the
applicable business standard mileage rate for volunteers who
receive reimbursements for the costs of using their automobiles
while performing services for charitable organizations.

EXPLANATION OF PROVISION

Under the provision, reimbursement by an organization
described in section 170(c) (including public charities and
private foundations) to a volunteer for the costs of using an
automobile in connection with providing donated services is
excludable from the gross income of the volunteer, provided
that (1) the reimbursement does not exceed the business
standard mileage rate prescribed for business use (as
periodically adjusted), and (2) recordkeeping requirements
applicable to deductible business expenses are satisfied. The
provision does not permit a volunteer to claim a deduction or
credit with respect amounts excluded under the provision.
Information reporting required by section 6041 is not required
with respect to reimbursements excluded under the provision.

EFFECTIVE DATE

The provision is effective for taxable years beginning
after the date of enactment.

L. Extend Enhanced Deduction for Inventory To Include Public Schools

(Sec. 112 of the bill and sec. 170 of the Code)

PRESENT LAW

Under present law, a taxpayer's deduction for charitable
contributions of inventory generally is limited to the
taxpayer's basis (typically, cost) in the inventory.
However, for certain contributions of inventory, C
corporations may claim an enhanced deduction equal to the
lesser of (1) basis plus one-half of the item's appreciated
value (i.e., basis plus one half of fair market value in excess
of basis) or (2) two times basis.\50\ To be eligible for the
enhanced deduction, the contributed property generally must be
inventory of the taxpayer, contributed to a charitable
organization described in section 501(c)(3) (except for private
nonoperating foundations), and the donee must: (1) use the
property consistent with the donee's exempt purpose solely for
the care of the ill, the needy, or infants, (2) not transfer
the property in exchange for money, other property, or
services, and (3) provide the taxpayer a written statement that
the donee's use of the property will be consistent with such
requirements. In the case of contributed property subject to
the Federal Food, Drug, and Cosmetic Act, the property must
satisfy the applicable requirements of such Act on the date of
transfer and for 180 days prior to the transfer.
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\50\ Sec. 170(e)(3). In general, a C corporation's charitable
contribution deductions for a year may not exceed 10 percent of the
corporation's taxable income. Sec. 170(b)(2).
---------------------------------------------------------------------------
Donations to educational organizations described in section
170(b)(1)(A)(ii) (and that are not described in section
501(c)(3) and exempt under section 501(a)) are not eligible to
receive the enhanced deduction. An organization is described in
section 170(b)(1)(A)(ii) if it normally maintains a regular
faculty and curriculum and normally has a regularly enrolled
body of pupils or students in attendance at the place where its
educational activities are regularly carried on. Donations to
such organizations are eligible to receive an enhanced
deduction if the donation qualifies as a qualified computer
contribution.\51\
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\51\ Sec. 170(e)(6).
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REASONS FOR CHANGE

The Committee believes that charitable contributions of
inventory to public schools should receive the same treatment
as charitable contributions of inventory to private schools and
therefore should be eligible for the enhanced deduction. The
Committee intends that contributions to a public school, like
contributions to any other eligible donee, must be used solely
for the care of the ill, the needy, or infants in order to
qualify for the enhanced deduction.

EXPLANATION OF PROVISION

The provision would extend the enhanced deduction for
inventory property to donations to educational organizations
described in section 170(b)(1)(A)(ii) (to the extent such
organizations are not described in section 501(c)(3) and exempt
under section 501(a)). Charitable contributions of computer
technology and equipment continue to be covered by the present
law enhanced deduction of section 170(e)(6) and are not
eligible property for an enhanced deduction under the
provision.
The provision retains present law requirements: (1) that
use of the donated property by the donee is related to the
donee's exempt purposes (or, in the case of a section
170(b)(1)(A)(ii) organization, to educational purposes) and is
used solely for the care of the ill, the needy, or infants, (2)
that the organization not transfer the property in exchange for
money, other property, or services, and (3) that the
organization provide the taxpayer a written statement that the
donee's use of the property will be consistent with such
requirements.
The Committee believes that the enhanced deduction
continues to provide a useful incentive for charitable
contributions of inventory, but also emphasizes that the
enhanced deduction is available only for inventory that is used
by the donee in the direct provision of care to the ill, the
needy or infants. Thus, for example, the Committee does not
intend that inventory property that may be useful to a school
in maintaining its physical plant (e.g., paint, electrical
supplies, equipment not used directly for educational purposes)
or administrative offices but that is not used directly for the
educational benefit of the ill, the needy, or infants is
eligible for the enhanced deduction.

EFFECTIVE DATE

The provision is effective for contributions made after
December 31, 2003.

TITLE II. PROVISIONS IMPROVING THE OVERSIGHT OF TAX-EXEMPT
ORGANIZATIONS

A. Disclosure of Written Determinations

(Sec. 201 of the bill and sec. 6110 of the Code)

PRESENT LAW

In general

Three provisions of present law govern the disclosure of
information relating to tax-exempt organizations. First,
section 6103 provides a general rule that tax returns and
return information generally are not subject to disclosure
unless authorized by the Code.\52\ Second, in order to allow
the public to scrutinize the activities of tax-exempt
organizations, section 6104 grants an exception to the
confidentiality rule of section 6103 for certain categories of
tax-exempt organization documents and information. Third,
section 6110 provides that written determinations by the IRS
and related background file documents generally are open to
public inspection in redacted form. Section 6110 does not apply
to any matter to which section 6104 applies.\53\
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\52\ Sec. 6103(a).
\53\ Sec. 6110(l)(1).
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Disclosure of applications for recognition of tax exemption and annual
information returns

Under present law, the IRS is required to make approved
applications for recognition of tax-exempt status (and certain
related documents) \54\ and annual information returns (Form
990 or Form 990-PF) available for public inspection, except
that the IRS is not authorized to disclose the names and
addresses of contributors (other than contributors to a private
foundation).
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\54\ Section 6104(a)(1)(A) provides that ``any papers submitted in
support of'' an application for tax-exempt status must be available for
inspection. Treasury regulations limit the definition of supporting
documents to papers submitted by the organization. Treas. Reg. sec.
301.6104(a)-1(e).
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The Secretary may withhold disclosure of certain
information described in an organization's application for tax-
exempt status if disclosure would: (1) divulge a trade secret,
patent, process, style of work, or apparatus of the
organization, and the Secretary determines that such disclosure
would harm the organization; or (2) that the Secretary
determines would harm the national defense.\55\ The
organization must apply to the Commissioner for a determination
that the disclosure would violate one of these criteria. The
organization will be given 15 days to contest an adverse
determination before the information is made available for
public inspection.\56\
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\55\ Sec. 6104(a)(1)(D).
\56\ Treas. Reg. sec. 301.6104(a)-5(a)(1).
---------------------------------------------------------------------------

Disclosure of written determinations

Section 6110 provides that the text of any written
determination by the IRS and related background file document
is open to public inspection.\57\ The term ``written
determination'' means a ruling, determination letter, technical
advice memorandum, or Chief Counsel advice. Closing agreements,
which are final and conclusive written agreements entered into
by the IRS and a taxpayer in order to settle the taxpayer's tax
liability with respect to a taxable year, do not constitute
written determinations.\58\
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\57\ Sec. 6110(a). A background file document includes the request
for a written determination, any written material submitted by the
taxpayer in support of the request, and any communications between the
IRS and other persons in connection with the written determination
received before issuance of the written determination. Sec. 6110(b)(2).
\58\ Sec. 6103(b)(2)(D); sec. 6110(b)(1)(B).
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Before releasing any written determination or background
file document, the IRS must delete identifying details of the
person about whom the written determination pertains and
certain other private information.\59\
---------------------------------------------------------------------------
\59\ Sec. 6110(c).
---------------------------------------------------------------------------
The application of section 6110 to guidance relating to
tax-exempt organizations is limited to written determinations
unrelated to an organization's tax-exempt status. Section
6110(l)(1) provides, ``this section shall not apply to any
matter to which section 6104 applies.'' The regulations under
section 6110 clarify which matters are within the ambit of
section 6104 and, therefore, are not subject to disclosure
under section 6110:

[a]ny application filed with the Internal Revenue
Service with respect to the qualification or exempt
status of an organization * * *; any document issued by
the Internal Revenue Service in which the qualification
or exempt status of an organization is * * * granted,
denied or revoked or the portion of any document in
which technical advice with respect thereto is given to
a district director; * * * the portion of any document
issued by the Internal Revenue Service in which is
discussed the effect on the qualification or exempt
status of an organization * * * of proposed
transactions by such organization * * *; and any
document issued by the Internal Revenue Service in
which is discussed the qualification or status of a
[private foundation or private operating
foundation].\60\
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\60\ Treas. Reg. sec. 301.6110-1(a).

In addition, the regulations under section 6104 provide
that some documents relating to tax exemption that are not open
to public inspection under section 6104(a)(1)(A) are
nevertheless ``within the ambit'' of section 6104 for purposes
of the disclosure provisions of section 6110.\61\ The
regulation explains that the following documents are,
therefore, not available for public inspection under either
section 6104 or 6110:
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\61\ Treas. Reg. sec. 301.6104(a)-1(i).
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(1) Unfavorable rulings or determination letters
issued in response to applications for tax exemption;
(2) Rulings or determination letters revoking or
modifying a favorable determination letter;
(3) Technical advice memoranda relating to a
disapproved application for tax exemption or the
revocation or modification of a favorable determination
letter;
(4) Any letter or document filed with or issued by
the IRS relating to whether a proposed or accomplished
transaction is a prohibited transaction under section
503;
(5) Any letter or document filed with or issued by
the IRS relating to an organization's status as a
private foundation or private operating foundation,
unless the letter or document relates to the
organization's application for tax exemption; and
(6) Any other letter or document filed with or issued
by the IRS which, although it relates to an
organization's tax exempt status as an organization
described in section 501(c), does not relate to that
organization's application for tax exemption.\62\
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\62\ Id.
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The effect of these limitations is that written
determinations relating to exempt status issues are not
released, even in redacted form. The IRS does, however, release
under section 6110 written determinations issued to tax-exempt
organizations that include issues that clearly are not within
the ambit of section 6104, such as the application of the
unrelated business income tax to a particular proposed
transaction.

REASONS FOR CHANGE

The Committee believes that written determinations and
background file documents that ordinarily would be disclosed
under section 6110 but for the nondisclosure provided by
section 6104 should be disclosed in redacted form, and that
such disclosure will provide additional guidance to taxpayers
as to the views of the IRS on certain issues.

EXPLANATION OF PROVISION

The provision provides that the provisions of section 6110
apply to written determinations and related background file
documents relating to an organization described in section
501(c) or (d) (including any written determination denying an
organization exempt status under such subsection), or to a
political organization described in section 527, that are not
required to be disclosed by section 6104(a)(1)(A).

EFFECTIVE DATE

The provision is effective for written determinations
issued after the date of enactment.

B. Disclosure of Internet Web Site and Name Under Which Organization
Does Business

(Sec. 202 of the bill and sec. 6033 of the Code)

PRESENT LAW

Most types of tax-exempt organizations are required to file
annually an information return.\63\ The Internal Revenue Code
does not specifically require an exempt organization to furnish
on the applicable information return any name under which the
organization operates or does business, if such name differs
from the legal name of the organization, or the organization's
Internet web site address, if any.\64\
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\63\ Sec. 6033(a). See, e.g., Form 990--Return of Organization
Exempt From Income Tax. An organization that is required to file Form
990, but that has gross receipts of less than $100,000 during its
taxable year, and total assets of less than $250,000 at the end of its
taxable year, may file Form 990-EZ instead of Form 990. Private
foundations are required to file Form 990-PF rather than Form 990.
\64\ The IRS requires disclosure of an organization's Internet web
site address on Forms 990 and 990-EZ.
---------------------------------------------------------------------------

REASONS FOR CHANGE

Some tax-exempt organizations do business and solicit
contributions under a name that is different from the
organization's legal name. This can cause confusion to
individuals and others seeking information about the
organization. Further, although much information regarding the
operations and activities of tax-exempt organizations is
available on the Internet web sites of such organizations, some
members of the public might experience difficulties obtaining
access to an organization's web site if they do not know the
organization's web site address. The Committee believes that
reducing confusion and increasing public access to relevant
information regarding a tax-exempt organization would be
achieved by requiring a tax-exempt organization to report on
its annual return any name under which such organization
operates or does business, and the Internet web site address
(if any) of such organization.\65\
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\65\ The staff of the Joint Committee on Taxation recommended the
adoption of this provision. Joint Committee on Taxation, Study of
Present-Law Taxpayer Confidentiality and Disclosure Provisions as
Required by Section 3802 of the Internal Revenue Service Restructuring
and Reform Act of 1998, Volume II: Study of Disclosure Provisions
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at
96-97.
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EXPLANATION OF PROVISION

The provision requires a tax-exempt organization subject to
reporting requirements under section 6033(a) to include on its
annual return any name under which such organization operates
or does business, and the Internet web site address (if any) of
such organization.

EFFECTIVE DATE

The provision applies to returns filed after December 31,
2003.

C. Modification to Reporting of Capital Transactions

(Sec. 203 of the bill and secs. 6033 and 6104 of the Code)

PRESENT LAW

Private foundations are required to file an annual
information return (Form 990-PF).\66\ Part IV of the Form 990-
PF requires that private foundations report detailed
information regarding the gain or loss from the sale or other
disposition of property, including a description of the
property sold, how it was acquired (purchase or donation), the
date acquired, the date sold, the gross sales price, the amount
of depreciation allowed or allowable, and the cost or other
basis plus expenses of the sale. Such information generally is
required for the IRS to calculate the tax on the private
foundation's net investment income. The Form 990-PF is required
to be made available to the public.
---------------------------------------------------------------------------
\66\ Sec. 6033(a).
---------------------------------------------------------------------------

REASONS FOR CHANGE

Under present law, private foundations that engage in
capital transactions must report detailed information about
each transaction on Form 990-PF, which is filed with the IRS
and available to the public. For some foundations, listing
these transactions involves hundreds of pages. The Committee
believes that automatic disclosure of such voluminous
information does not necessarily benefit the public, and may in
fact reduce the level of meaningful disclosure by obscuring
other important information. The Committee believes that
meaningful disclosure to the public will be increased if the
version of the Form 990-PF that automatically is available to
the public summarizes rather than lists the securities
transactions that affect the calculation of the organization's
net investment income. In order to preserve the public's access
to more specific information regarding such securities
transactions, the Committee believes that the more detailed
information provided to the IRS on the Form 990-PF should be
made available to those members of the public that explicitly
request such information.\67\
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\67\ The staff of the Joint Committee on Taxation recommended the
adoption of this provision. Joint Committee on Taxation, Study of
Present-Law Taxpayer Confidentiality and Disclosure Provisions as
Required by Section 3802 of the Internal Revenue Service Restructuring
and Reform Act of 1998, Volume II: Study of Disclosure Provisions
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at
99.
---------------------------------------------------------------------------

EXPLANATION OF PROVISION

The provision requires that any information regarding
capital gains and losses from the sale or disposition of stock
or securities that are listed on an established securities
market that is required to be furnished by private foundations
in order to calculate the tax on net investment income be
furnished also in summary form.
In addition, information regarding capital gains and losses
from the sale or disposition of stock or securities that are
listed on an established securities market that is required to
be filed with the IRS but that is not in summary form is not
required to be made available to the public by the IRS or by
the private foundation except by the explicit request of a
member of the public to the IRS or to the foundation. A member
of the public may request disclosure of such information from
the Secretary, who shall prescribe the manner of making such
request and the manner of disclosure. A member of the public
also may request disclosure of the private foundation, which
must be made in person or in writing. If the request is made in
person, the foundation shall provide a copy of the information
immediately and, if the request is made in writing, the
foundation shall provide the information within 30 days.
The provision also provides that private foundations are
required to state on the furnished summary that the more
detailed description is available upon request.

EFFECTIVE DATE

The provision applies to returns filed after December 31,
2003.

D. Disclosure that Form 990 is Publicly Available

(Sec. 204 of the bill)

PRESENT LAW

Under present law, there is no requirement that the IRS
notify the public that the Form 990 is publicly available.

REASONS FOR CHANGE

The information provided on Forms 990 is useful to the
public only to the extent that the public is aware that the
forms are publicly available. The Committee believes that the
availability of Forms 990 that have been filed by exempt
organizations will be increased by requiring the IRS to inform
the public regarding the availability of such forms.

EXPLANATION OF PROVISION

The provision requires the IRS to notify the public in
appropriate publications and other materials of the extent to
which Form 990, Form 990-EZ, or Form 990-PF are publicly
available.

EFFECTIVE DATE

The provision applies to publications or other materials
issued or revised after the date of enactment.

E. Disclosure to State Officials of Proposed Actions Related to Section
501(c) Organizations

(Sec. 205 of the bill and sec. 6104 of the Code)

PRESENT LAW

In the case of organizations that are described in section
501(c)(3) and exempt from tax under section 501(a) or that have
applied for exemption as an organization so described, present
law (sec. 6104(c)) requires the Secretary to notify the
appropriate State officer of (1) a refusal to recognize such
organization as an organization described in section 501(c)(3),
(2) a revocation of a section 501(c)(3) organization's tax-
exempt status, and (3) the mailing of a notice of deficiency
for any tax imposed under section 507, chapter 41, or chapter
42.\68\ In addition, at the request of such appropriate State
officer, the Secretary is required to make available for
inspection and copying, such returns, filed statements,
records, reports, and other information relating to the above-
described disclosures, as are relevant to any State law
determination. An appropriate State officer is the State
attorney general, State tax officer, or any State official
charged with overseeing organizations of the type described in
section 501(c)(3).
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\68\ The applicable taxes include the termination tax on private
foundations; taxes on public charities for certain excess lobbying
expenses; taxes on a private foundation's net investment income, self-
dealing activities, undistributed income, excess business holdings,
investments that jeopardize charitable purposes, and taxable
expenditures (some of these taxes also apply to certain non-exempt
trusts); taxes on the political expenditures and excess benefit
transactions of section 501(c)(3) organizations; and certain taxes on
black lung benefit trusts and foreign organizations.
---------------------------------------------------------------------------
In general, return and return information (as such terms
are defined in sec. 6103(b)) is confidential and may not be
disclosed or inspected unless expressly provided by law.\69\
Present law requires the Secretary to keep records of
disclosures and requests for inspection \70\ and requires that
persons authorized to receive return and return information
maintain various safeguards to protect such information against
unauthorized disclosure.\71\ Willful unauthorized disclosure or
inspection of return or return information is subject to a fine
and/or imprisonment.\72\ The knowing or negligent unauthorized
inspection or disclosure of returns or return information gives
the taxpayer a right to bring a civil suit.\73\ Such present-
law protections against unauthorized disclosure or inspection
of return and return information do not apply to the
disclosures or inspections, described above, that are
authorized by section 6104(c).
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\69\ Sec. 6103(a).
\70\ Sec. 6103(p)(3).
\71\ Sec. 6103(p)(4).
\72\ Secs. 7213 and 7213A.
\73\ Sec. 7431.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that State officials that are
charged with oversight of certain organizations described in
section 501(c) have an important and legitimate interest in
receiving certain information about such organizations' tax-
exempt status and tax filings, in some cases before the IRS has
made a final determination with respect to an organization's
tax-exempt status or liability for tax. By providing
appropriate State officials with earlier access to information
about the activities of certain section 501(c) organizations,
State officials will be able to monitor such organizations more
effectively and better protect the public's interest in
assuring that organizations that have been given the benefit of
tax-exemption operate consistently with their exempt
purposes.\74\
---------------------------------------------------------------------------
\74\ The staff of the Joint Committee on Taxation recommended the
adoption of a similar provision. Joint Committee on Taxation, Study of
Present-Law Taxpayer Confidentiality and Disclosure Provisions as
Required by Section 3802 of the Internal Revenue Service Restructuring
and Reform Act of 1998, Volume II: Study of Disclosure Provisions
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at
101-105.
---------------------------------------------------------------------------
The Committee stresses the importance of maintaining the
confidentiality of taxpayer return and return information and
believes it is important to extend existing protections against
unauthorized disclosure or inspection of return and return
information to disclosures made or inspections allowed by the
Secretary of return and return information regarding such
section 501(c) organizations.

EXPLANATION OF PROVISION

The provision provides that upon written request by an
appropriate State officer, the Secretary may disclose: (1) a
notice of proposed refusal to recognize an organization as a
section 501(c)(3) organization; (2) a notice of proposed
revocation of tax-exemption of a section 501(c)(3)
organization; (3) the issuance of a proposed deficiency of tax
imposed under section 507, chapter 41, or chapter 42; (4) the
names, addresses, and taxpayer identification numbers of
organizations that have applied for recognition as section
501(c)(3) organizations; and (5) returns and return information
of organizations with respect to which information has been
disclosed under (1) through (4) above.\75\ Disclosure or
inspection is permitted for the purpose of, and only to the
extent necessary in, the administration of State laws
regulating section 501(c)(3) organizations, such as laws
regulating tax-exempt status, charitable trusts, charitable
solicitation, and fraud. Disclosure or inspection may be made
only to or by designated representatives of the appropriate
State officer, which does not include any contractor or agent.
The Secretary also is permitted to disclose or open to
inspection the return and return information of an organization
that is recognized as tax-exempt under section 501(c)(3), or
that has applied for such recognition, to an appropriate State
officer if the Secretary determines that disclosure or
inspection may facilitate the resolution of Federal or State
issues relating to the tax-exempt status of the organization.
For this purpose, appropriate State officer means the State
attorney general or any other State official charged with
overseeing organizations of the type described in section
501(c)(3).
---------------------------------------------------------------------------
\75\ Such returns and return information also may be open to
inspection by an appropriate State officer.
---------------------------------------------------------------------------
In addition, the provision provides that upon the written
request by an appropriate State officer, the Secretary may make
available for inspection or disclosure returns and return
information of an organization described in section 501(c)(2)
(certain title holding companies), 501(c)(4) (certain social
welfare organizations), 501(c)(6) (certain business leagues and
similar organizations), 501(c)(7) (certain recreational clubs),
501(c)(8) (certain fraternal organizations), 501(c)(10)
(certain domestic fraternal organizations operating under the
lodge system), and 501(c)(13) (certain cemetery companies).
Such return and return information is available for inspection
or disclosure only for the purpose of, and to the extent
necessary in, the administration of State laws regulating the
solicitation or administration of the charitable funds or
charitable assets of such organizations. Disclosure or
inspection may be made only to or by designated representatives
of the appropriate State officer, which does not include any
contractor or agent. For this purpose, appropriate State
officer means the State attorney general and the head of an
agency designated by the State attorney general as having
primary responsibility for overseeing the solicitation of funds
for charitable purposes of such organizations.
In addition, the provision provides that any return and
return information disclosed under section 6104(c) may be
disclosed in civil administrative and civil judicial
proceedings pertaining to the enforcement of State laws
regulating the applicable tax-exempt organization in a manner
prescribed by the Secretary. Returns and return information are
not to be disclosed under section 6104(c), or in such an
administrative or judicial proceeding, to the extent that the
Secretary determines that such disclosure would seriously
impair Federal tax administration. The provision makes
disclosures of returns and return information under section
6104(c) subject to the disclosure, recordkeeping, and safeguard
provisions of section 6103, including the requirements that
such information remain confidential (sec. 6103(a)(2)), that
the Secretary maintain a permanent system of records of
requests for disclosure (sec. 6103(p)(3)), and that the
appropriate State officer maintain various safeguards that
protect against unauthorized disclosure (sec. 6103(p)(4)). The
provision provides that the willful unauthorized disclosure of
returns or return information described in section 6104(c) is a
felony subject to a fine of up to $5,000 and/or imprisonment of
up to five years (sec. 7213(a)(2)), the willful unauthorized
inspection of returns or return information described in
section 6104(c) is subject to a fine of up to $1,000 and/or
imprisonment of up to one year (sec. 7213A), and provides the
taxpayer the right to bring a civil action for damages in the
case of knowing or negligent unauthorized disclosure or
inspection of such information (sec. 7431(a)(2)).

EFFECTIVE DATE

The provision is effective on the date of enactment but
does not apply to requests made before such date.

F. Expansion of Penalties to Preparers of Form 990

(Sec. 206 of the bill and sec. 6695 of the Code)

PRESENT LAW

Under present law, income tax return preparers are subject
to a penalty of $250 with respect to any return if a portion of
an understatement of tax liability is due to a position for
which there was not a realistic possibility of success on the
merits, the preparer knew or reasonably should have known of
the position, and the position was not disclosed or was
frivolous.\76\ In addition, present law imposes a penalty on
income tax return preparers of $1,000 with respect to a tax
return if a portion of an understatement of tax liability is
due to a willful attempt to understate liability or to reckless
or intentional disregard of rules or regulations.\77\
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\76\ Sec. 6694(a).
\77\ Sec. 6694(b).
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that information returns play a
critical role in the oversight of exempt organizations, but
that many returns are not filed with complete and accurate
information. The Committee believes that imposing a penalty on
paid preparers of information returns will help to improve the
accuracy of the return.\78\
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\78\ The staff of the Joint Committee on Taxation recommended the
adoption of this provision. Joint Committee on Taxation, Study of
Present-Law Taxpayer Confidentiality and Disclosure Provisions as
Required by Section 3802 of the Internal Revenue Service Restructuring
and Reform Act of 1998, Volume II: Study of Disclosure Provisions
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at
99-101.
---------------------------------------------------------------------------

EXPLANATION OF PROVISION

The provision provides that a preparer (for compensation)
of an information return of an exempt organization is subject
to a penalty of $250 if the preparer omits or misrepresents any
information with respect to such return that was known or
should have been known by the preparer. The penalty does not
apply to minor, inadvertent omissions.
In addition, a preparer of such an information return is
subject to a penalty of $1,000 if the preparer recklessly or
intentionally misrepresents any information or recklessly or
intentionally disregards any rule or regulation with respect to
such return. With respect to any return, the $1,000 penalty is
reduced by the amount of any penalty paid by such person with
respect to the return for omissions and misrepresentations (the
$250 penalty imposed by the provision) or a penalty imposed by
section 6694.

EFFECTIVE DATE

The provision is effective for documents prepared after the
date of enactment.

G. Notification Requirement for Exempt Entities Not Currently Required
To File an Annual Information Return

(Sec. 207 of the bill and sec. 6033 of the Code)

PRESENT LAW

Under present law, the requirement that an exempt
organization file an annual information return does not apply
to several categories of exempt organizations. Organizations
excepted from the filing requirement include organizations
(other than private foundations), the gross receipts of which
in each taxable year normally are not more than $25,000.\79\
Also exempt from the requirement are churches, their integrated
auxiliaries, and conventions or associations of churches; the
exclusively religious activities of any religious order;
section 501(c)(1) instrumentalities of the United States;
section 501(c)(21) trusts; an interchurch organization of local
units of a church; certain mission societies; certain church-
affiliated elementary and high schools; certain state
institutions whose income is excluded from gross income under
section 115; certain governmental units and affiliates of
governmental units; and other organizations that the IRS has
relieved from the filing requirement pursuant to its statutory
discretionary authority.
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\79\ Sec. 6033(a)(2); Treas. Reg. sec. 1.6033-2(a)(2)(i); Treas.
Reg. sec. 1.6033-2(g)(1). Sec. 6033(a)(2)(A)(ii) provides a $5,000
annual gross receipts exception from the annual reporting requirements
for certain exempt organizations. In Announcement 82-88, 1982-25 I.R.B.
23, the IRS exercised its discretionary authority under section 6033 to
increase the gross receipts exception to $25,000, and enlarge the
category of exempt organizations that are not required to file Form
990.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that it is appropriate under present
law that certain small exempt organizations not be required to
file an annual information return. However, as a result, the
Secretary of the Treasury is not able to maintain a record of
the continuing existence of such organizations and the public
is unable to easily obtain basic information about the
organization, such as the organization's current address. The
absence of a record is especially problematic for charitable
exempt organizations. Although the Secretary publishes the
names of organizations to which charitable contributions may be
made, if the organization is not required to file with the
Secretary and alert the Secretary of its termination, the
Secretary does not know when to omit the organization from its
list of names. Accordingly, the Committee believes that exempt
organizations that do not have to file an annual information
return by virtue of the amount of their gross receipts should
file with the Secretary a simple, short annual notice. The
Committee does not intend that the annual filing be burdensome
and does not believe that a monetary penalty is appropriate for
a failure to file the notice. However, if an organization is
unable to file a notice with the Secretary for three
consecutive years, the Committee believes that revocation of
the organization's exempt status is an appropriate sanction
under the circumstances. In addition, to ensure equitable
treatment among exempt organizations, the sanction of loss of
exempt status is extended to consecutive failures to file a
required information return. \80\
---------------------------------------------------------------------------
\80\ The staff of the Joint Committee on Taxation recommended the
adoption of a similar provision. Joint Committee on Taxation, Study of
Present-Law Taxpayer Confidentiality and Disclosure Provisions as
Required by Section 3802 of the Internal Revenue Service Restructuring
and Reform Act of 1998, Volume II: Study of Disclosure Provisions
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at
98.
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EXPLANATION OF PROVISION

The provision provides that organizations that are excused
from filing an information return by reason of normally having
gross receipts below a certain specified amount (generally,
under $25,000) shall furnish to the Secretary annually the
legal name of the organization, any name under which the
organization operates or does business, the organization's
mailing address and Internet web site address (if any), the
organization's taxpayer identification number, the name and
address of a principal officer, and evidence of the
organization's continuing basis for its exemption from the
generally applicable information return filing requirements.
Upon such organization's termination of existence, the
organization is required to furnish notice of such termination.
The provision provides that if an organization fails to
provide the required notice for three consecutive years, the
organization's tax-exempt status is revoked. In addition, if an
organization that is required to file an annual information
return under section 6033(a) (Form 990) fails to file such an
information return for three consecutive years, the
organization's tax-exempt status is revoked. If an organization
fails to meet its filing obligation to the IRS for three
consecutive years in cases where the organization is subject to
the information return filing requirement in one or more years
during a three-year period and also is subject to the notice
requirement for one or more years during the same three-year
period, the organization's tax-exempt status is revoked.
A revocation under the provision is effective from the date
that the Secretary determines was the last day the organization
could have timely filed the third required information return
or notice. To again be recognized as tax-exempt, the
organization must apply to the Secretary for recognition of
tax-exemption, irrespective of whether the organization was
required to make an application for recognition of tax-
exemption in order to gain tax-exemption originally.
If upon application for tax-exempt status after a
revocation under the provision, the organization shows to the
satisfaction of the Secretary reasonable cause for failing to
file the required annual notices or returns, the organization's
tax-exempt status may, in the discretion of the Secretary, be
reinstated retroactive to the date of revocation. An
organization may not challenge under the Code's declaratory
judgment procedures (section 7428) a revocation of tax-
exemption made pursuant to the provision.
There is no monetary penalty for failure to file the
notice. The provision does not require that the notices be made
available to the public under the public disclosure and
inspection rules generally applicable to exempt organizations.
The provision does not affect an organization's obligation
under present law to file required information returns or
existing penalties for failure to file such returns.
The Secretary is required to notify in a timely manner
every organization that is subject to the notice filing
requirement of the new filing obligation. Notification by the
Secretary shall be by mail, in the case of any organization the
identity and address of which is included in the list of exempt
organizations maintained by the Secretary, and by Internet or
other means of outreach, in the case of any other organization.
In addition, the Secretary is required to publicize in a timely
manner in appropriate forms and instructions and other means of
outreach the new penalty imposed for consecutive failures to
file the information return.
The Secretary is authorized to publish a list of
organizations whose exempt status is revoked under the
provision.

EFFECTIVE DATE

The provision is effective for notices with respect to
annual periods beginning after 2003.

H. Suspension of Tax-Exempt Status of Terrorist Organizations

(Sec. 208 of the bill and sec. 501 of the Code)

PRESENT LAW

Under present law, the Internal Revenue Service generally
issues a letter revoking recognition of an organization's tax-
exempt status only after (1) conducting an examination of the
organization, (2) issuing a letter to the organization
proposing revocation, and (3) allowing the organization to
exhaust the administrative appeal rights that follow the
issuance of the proposed revocation letter. In the case of an
organization described in section 501(c)(3), the revocation
letter immediately is subject to judicial review under the
declaratory judgment procedures of section 7428. To sustain a
revocation of tax-exempt status under section 7428, the IRS
must demonstrate that the organization is no longer entitled to
exemption. There is no procedure under current law for the IRS
to suspend the tax-exempt status of an organization.
To combat terrorism, the Federal government has designated
a number of organizations as terrorist organizations or
supporters of terrorism under the Immigration and Nationality
Act, the International Emergency Economic Powers Act, and the
United Nations Participation Act of 1945.

REASONS FOR CHANGE

An organization that has been designated or otherwise
identified by the Federal government as a terrorist
organization pursuant to certain authority should not be exempt
from Federal income tax and contributions to such organizations
should not be deductible for Federal income tax purposes. The
Committee believes that the Federal government's designation or
identification of an organization as a terrorist organization
is grounds for suspension of tax-exempt status, and that in
such cases a separate investigation of the organization by the
Internal Revenue Service is not necessary. Further, because a
terrorist organization may challenge the Federal government's
designation or identification of the organization under the law
authorizing the designation or identification, recourse to the
declaratory judgment procedures of the Internal Revenue Code to
challenge the suspension of tax-exemption is not appropriate.

EXPLANATION OF PROVISION

The provision suspends the tax-exempt status of an
organization that is exempt from tax under section 501(a) for
any period during which the organization is designated or
identified by U.S. Federal authorities as a terrorist
organization or supporter of terrorism. The provision also
makes such an organization ineligible to apply for tax
exemption under section 501(a). The period of suspension runs
from the date the organization is first designated or
identified (or from the date of enactment of the provision,
whichever is later) to the date when all designations or
identifications with respect to the organization have been
rescinded pursuant to the law or Executive order under which
the designation or identification was made.
The provision describes a terrorist organization as an
organization that has been designated or otherwise individually
identified (1) as a terrorist organization or foreign terrorist
organization under the authority of section
212(a)(3)(B)(vi)(II) or section 219 of the Immigration and
Nationality Act; (2) in or pursuant to an Executive order that
is related to terrorism and issued under the authority of the
International Emergency Economic Powers Act or section 5 of the
United Nations Participation Act for the purpose of imposing on
such organization an economic or other sanction; or (3) in or
pursuant to an Executive order that refers to the provision and
is issued under the authority of any Federal law if the
organization is designated or otherwise individually identified
in or pursuant to such Executive order as supporting or
engaging in terrorist activity (as defined in section
212(a)(3)(B) of the Immigration and Nationality Act) or
supporting terrorism (as defined in section 140(d)(2) of the
Foreign Relations Authorization Act, Fiscal Years 1988 and
1989). During the period of suspension, no deduction for any
contribution to a terrorist organization is allowed under the
Code, including under sections 170, 545(b)(2), 556(b)(2),
642(c), 2055, 2106(a)(2), or 2522.
No organization or other person may challenge, under
section 7428 or any other provision of law, in any
administrative or judicial proceeding relating to the Federal
tax liability of such organization or other person, the
suspension of tax-exemption, the ineligibility to apply for
tax-exemption, a designation or identification described above,
the timing of the period of suspension, or a denial of
deduction described above. The suspended organization may
maintain other suits or administrative actions against the
agency or agencies that designated or identified the
organization, for the purpose of challenging such designation
or identification (but not the suspension of tax-exempt status
under this provision).
If the tax-exemption of an organization is suspended and
each designation and identification that has been made with
respect to the organization is determined to be erroneous
pursuant to the law or Executive order making the designation
or identification, and such erroneous designation results in an
overpayment of income tax for any taxable year with respect to
such organization, a credit or refund (with interest) with
respect to such overpayment shall be made. If the operation of
any law or rule of law (including res judicata) prevents the
credit or refund at any time, the credit or refund may
nevertheless be allowed or made if the claim for such credit or
refund is filed before the close of the one-year period
beginning on the date that the last remaining designation or
identification with respect to the organization is determined
to be erroneous.
The provision directs the IRS to update the listings of
tax-exempt organizations to take account of organizations that
have had their exemption suspended and to publish notice to
taxpayers of the suspension of an organization's tax-exemption
and the fact that contributions to such organization are not
deductible during the period of suspension.

EFFECTIVE DATE

The provision is effective for designations made before,
on, or after the date of enactment.

TITLE III. OTHER CHARITABLE AND EXEMPT ORGANIZATION PROVISIONS

A. Modify Tax on Unrelated Business Taxable Income of Charitable
Remainder Trusts

(Sec. 301 of the bill and sec. 664 of the Code)

PRESENT LAW

Charitable remainder annuity trusts and charitable
remainder unitrusts are exempt from Federal income tax for a
tax year unless the trust has any unrelated business taxable
income for the year. Unrelated business taxable income includes
certain debt financed income. A charitable remainder trust that
loses exemption from income tax for a taxable year is taxed as
a regular complex trust. As such, the trust is allowed a
deduction in computing taxable income for amounts required to
be distributed in a taxable year, not to exceed the amount of
the trust's distributable net income for the year. Taxes
imposed on the trust are required to be allocated to
corpus.\81\
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\81\ Treas. Reg. sec. 1.664-1(d)(2).
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Distributions from a charitable remainder annuity trust or
charitable remainder unitrust are treated in the following
order as: (1) ordinary income to the extent of the trust's
current and previously undistributed ordinary income for the
trust's year in which the distribution occurred, (2) capital
gains to the extent of the trust's current capital gain and
previously undistributed capital gain for the trust's year in
which the distribution occurred, (3) other income (e.g., tax-
exempt income) to the extent of the trust's current and
previously undistributed other income for the trust's year in
which the distribution occurred, and (4) corpus.\82\
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\82\ Sec. 664(b).
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In general, distributions to the extent they are
characterized as income are includible in the income of the
beneficiary for the year that the annuity or unitrust amount is
required to be distributed even though the annuity or unitrust
amount is not distributed until after the close of the trust's
taxable year.\83\
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\83\ Treas. Reg. sec. 1.664-1(d)(4).
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A charitable remainder annuity trust is a trust that is
required to pay, at least annually, a fixed dollar amount of at
least five percent of the initial value of the trust to a
noncharity for the life of an individual or for a period of 20
years or less, with the remainder passing to charity. A
charitable remainder unitrust is a trust that generally is
required to pay, at least annually, a fixed percentage of at
least five percent of the fair market value of the trust's
assets determined at least annually to a noncharity for the
life of an individual or for a period 20 years or less, with
the remainder passing to charity.\84\
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\84\ Sec. 664(d).
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A trust does not qualify as a charitable remainder annuity
trust if the annuity for a year is greater than 50 percent of
the initial fair market value of the trust's assets. A trust
does not qualify as a charitable remainder unitrust if the
percentage of assets that are required to be distributed at
least annually is greater than 50 percent. A trust does not
qualify as a charitable remainder annuity trust or a charitable
remainder unitrust unless the value of the remainder interest
in the trust is at least 10 percent of the value of the assets
contributed to the trust.

REASONS FOR CHANGE

The Committee believes that in years that a charitable
remainder trust has unrelated business income, an excise tax of
100 percent on such income is a more appropriate remedy than
loss of tax exemption for the year.

EXPLANATION OF PROVISION

The provision imposes a 100-percent excise tax on the
unrelated business taxable income of a charitable remainder
trust. This replaces the present-law rule that takes away the
income tax exemption of a charitable remainder trust for any
year in which the trust has any unrelated business taxable
income. Consistent with present law, the tax is treated as paid
from corpus. The unrelated business taxable income is
considered income of the trust for purposes of determining the
character of the distribution made to the beneficiary.

EFFECTIVE DATE

The provision is effective for taxable years beginning
after December 31, 2002.

B. Modify Tax Treatment of Certain Payments to Controlling Exempt
Organizations

(Sec. 302 of the bill and sec. 512 of the Code)

PRESENT LAW

In general, interest, rents, royalties, and annuities are
excluded from the unrelated business income of tax-exempt
organizations. However, section 512(b)(13) generally treats
otherwise excluded rent, royalty, annuity, and interest income
as unrelated business income if such income is received from a
taxable or tax-exempt subsidiary that is 50 percent controlled
by the parent tax-exempt organization. In the case of a stock
subsidiary, ``control'' means ownership by vote or value of
more than 50 percent of the stock. In the case of a partnership
or other entity, control means ownership of more than 50
percent of the profits, capital or beneficial interests. In
addition, present law applies the constructive ownership rules
of section 318 for purposes of section 512(b)(13). Thus, a
parent exempt organization is deemed to control any subsidiary
in which it holds more than 50 percent of the voting power or
value, directly (as in the case of a first-tier subsidiary) or
indirectly (as in the case of a second-tier subsidiary).
Under present law, interest, rent, annuity, or royalty
payments made by a controlled entity to a tax-exempt
organization are includable in the latter organization's
unrelated business income and are subject to the unrelated
business income tax to the extent the payment reduces the net
unrelated income (or increases any net unrelated loss) of the
controlled entity (determined as if the entity were tax
exempt).
The Taxpayer Relief Act of 1997 (the ``1997 Act'') made
several modifications to the control requirement of section
512(b)(13). In order to provide transitional relief, the
changes made by the 1997 Act do not apply to any payment
received or accrued during the first two taxable years
beginning on or after the date of enactment of the 1997 Act
(August 5, 1997) if such payment is received or accrued
pursuant to a binding written contract in effect on June 8,
1997, and at all times thereafter before such payment (but not
pursuant to any contract provision that permits optional
accelerated payments).

REASONS FOR CHANGE

The present-law rule that requires a controlling entity to
include as unrelated business income certain payments made by a
controlled entity applies without regard to whether the amount
of the payment is fair and reasonable under the circumstances
or would otherwise constitute unrelated business income if paid
by an organization not controlled by the exempt organization.
The Committee believes that the controlling organization should
not be subject to the unrelated business income tax if the
amount of the payment from the controlled entity is determined
in accordance with established arm's-length principles. The
Committee intends that the controlling organization be subject
to the present-law rule only to the extent that a payment made
by a controlled entity exceeds the amount that would have been
paid if the payment had been determined under established
arm's-length principles. In order to discourage controlled
entities from claiming deductions in excess of the arm's-length
amount, the Committee believes that it is appropriate to
subject the controlling organization to a penalty tax for
making excess payments.

EXPLANATION OF PROVISION

The provision provides that the general rule of section
512(b)(13), which includes interest, rent, annuity, or royalty
payments made by a controlled entity to a tax-exempt
organization in the latter organization's unrelated business
income to the extent the payment reduces the net unrelated
income (or increases any net unrelated loss) of the controlled
entity, applies only to the portion of payments received or
accrued in a taxable year that exceed the amount of the
specified payment that would have been paid or accrued if such
payment had been determined under the principles of section
482. Thus, if a payment of rent by a controlled subsidiary to
its tax-exempt parent organization exceeds fair market value,
the excess amount of such payment over fair market value (as
determined in accordance with section 482) is included in the
parent organization's unrelated business income, to the extent
that such excess reduced the net unrelated income (or increased
any net unrelated loss) of the controlled entity (determined as
if the entity were tax exempt). In addition, the provision
imposes a 20-percent penalty on the larger of such excess
determined without regard to any amendment or supplement to a
return of tax, or such excess determined with regard to all
such amendments and supplements.
The provision provides that if modifications to section
512(b)(13) made by the 1997 Act did not apply to a contract
because of the transitional relief provided by the 1997 Act,
then such modifications also do not apply to amounts received
or accrued under such contract before January 1, 2001.

EFFECTIVE DATE

The provision applies to payments received or accrued after
December 31, 2000.

C. Simplification of Lobbying Expenditure Limitation

(Sec. 303 of the bill and secs. 501 and 4911 of the Code)

PRESENT LAW

In general

An organization does not qualify for tax-exempt status
under section 501(c)(3) unless ``no substantial part'' of the
activities of the organization is ``carrying on propaganda, or
otherwise attempting, to influence legislation,'' except as
provided by section 501(h). \85\ Carrying on propaganda and
attempting to influence legislation commonly are referred to as
``lobbying'' activities. Thus, section 501(c)(3) permits a
limited amount of lobbying activity without loss of tax-exempt
status.
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\85\ Sec. 501(c)(3).
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For purposes of determining whether lobbying activities are
a substantial part of an organization's overall functions, an
organization generally may choose between two standards, the
``no substantial part'' test of section 501(c)(3) or the
``expenditure'' test of section 501(h).
Whether an organization meets the ``no substantial part''
test is based on all the facts and circumstances. There is no
statutory or regulatory guidance, and it is not clear whether
the determination is based on the organization's activities,
its expenditures, or both. Alternatively, under section 501(h),
certain organizations described in section 501(c)(3) can elect
to be subject to the expenditure test, \86\ which consists of
bright-line rules that specify the dollar amount of permitted
expenditures on lobbying activities.
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\86\ Organizations that do not make a section 501(h) election are
subject to the ``no substantial part'' test.
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Consequences of excess lobbying under section 501(h)

Organizations that make a section 501(h) election
(``electing charities'') are subject to tax if the electing
charity makes either ``lobbying expenditures'' or ``grass roots
expenditures'' in excess of a certain amount established for
each type of expenditure for each taxable year. Lobbying
expenditures are the sum of grass-roots expenditures and
``direct lobbying'' expenditures. \87\
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\87\ Secs. 501(h)(2)(A), 4911(c)(1), 4911(d).
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The expenditure limits are based on a ``lobbying nontaxable
amount'' for the taxable year and a ``grass roots nontaxable
amount'' for the taxable year. The lobbying nontaxable amount
is the lesser of $1 million or an amount determined as a
percentage of an organization's exempt purpose expenditures.
\88\ The grass-roots nontaxable amount is 25 percent of the
organization's lobbying nontaxable amount. An electing charity
that exceeds either of the spending limitations is subject to a
25 percent tax on the excess. An electing charity that exceeds
both of the spending limitations is subject to a 25 percent tax
on the greater of the excess of the lobbying expenditures or
the grass-roots expenditures.
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\88\ Exempt purpose expenditures generally are expenses incurred
for exempt purposes, such as amounts paid to accomplish exempt
purposes, administrative expenses such as overhead, lobbying expenses,
and certain fundraising expenses. Exempt purpose expenditures do not
include, for example, expenses not for exempt purposes, payments of
unrelated business income tax, or capital expenses in connection with
an unrelated business. See Treas. Reg. sec. 56.4911-4.
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An electing charity that normally exceeds either of two
``ceiling amounts,'' which are based on the expenditure limits,
will lose its tax exemption. \89\ The ``lobbying ceiling
amount'' is 150 percent of the electing charity's lobbying
nontaxable amount for the taxable year and the ``grass roots
ceiling amount'' is 150 percent of the grass-roots nontaxable
amount for the taxable year. For this purpose, ``normal''
expenditures are calculated based on a four-year averaging
mechanism. \90\
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\89\ Sec. 501(h)(1).
\90\ Treas. Reg. sec. 1.501(h)-3.
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Definitions

Grass-roots expenditures are defined as ``any attempt to
influence any legislation through an attempt to affect the
opinions of the general public or any segment thereof.'' \91\
For a communication to constitute grass-roots lobbying, it must
refer to ``specific legislation,'' reflect a view on such
legislation, and encourage the recipient of the communication
to take action with respect to such legislation (a ``call to
action''). \92\ A communication includes a call to action if it
incorporates one of four elements: (1) it urges the recipient
to contact a legislator, employee of a government body, or any
other government official or employee who may participate in
the formulation of legislation with the principal purpose of
influencing legislation; (2) it states the address, telephone
number, or similar information of a legislator or an employee
of a legislative body; (3) it provides a petition, tear-off
postcard, or similar device for the recipient to communicate
with government officials or employees who participate in the
formulation of legislation with the principal purpose of
influencing legislation; or (4) it states the position of one
or more legislators on the legislation, except that a
communication may name the main sponsors of legislation for
purposes of identifying the legislation without constituting a
call to action. \93\ In addition, a communication is presumed
to be grass-roots lobbying if the communication is a paid
advertisement that: (1) appears in the mass media within two
weeks before a vote by a legislative body or committee (but not
a subcommittee) on a highly publicized piece of legislation;
(2) reflects a view on the general subject of the legislation;
and (3) either refers to the legislation or encourages the
public to communicate with legislators on the general subject
of such legislation. \94\ The presumption is rebuttable if the
electing charity demonstrates that the timing of the
communication was not related to the legislation or that the
advertisement was of a type regularly made by the electing
charity without regard to the timing of the legislation (a
customary course of business exception). \95\
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\91\ Secs. 501(h)(2)(C) & 4911(d)(1)(A)
\92\ Treas. Reg. sec. 56.4911-2(b)(2)(i).
\93\ Treas. Reg. sec. 56.4911-2(b)(2)(iii). The regulations provide
that the first three elements constitute ``direct'' encouragement,
whereas the fourth element is ``indirect'' encouragement. This
distinction becomes relevant in determining whether a communication
meets one of the prescribed exceptions to lobbying, i.e., an indirect
call to action in a grass-roots communication may qualify as
``nonpartisan analysis, study or research'' (Treas. Reg. sec. 56.4911-
2(b)(2)(iv)), and in determining the proper allocation of expenses
between grass-roots and direct lobbying. Treas. Reg. sec. 56.4911-5(e).
\94\ Treas. Reg. sec. 56.4911-2(b)(5)(ii).
\95\ Id.
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Direct lobbying expenditures are ``any attempt to influence
any legislation through communication with any member or
employee of a legislative body, or with any government official
or employee who may participate in the formulation of the
legislation'' if the principal purpose of the communication is
to influence legislation. \96\ A communication would constitute
direct lobbying only if the communication ``refers to specific
legislation'' and reflects a view on such legislation.
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\96\ Sec. 501(h)(2)(A) and 4911(d)(1)(B) and Treas. Reg. sec.
56.4911-2(b)(1).
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Certain specified activities do not constitute attempts to
influence legislation and therefore expenditures for such
activities are not subject to the expenditure limits for
lobbying expenditures or grass-roots expenditures. In general,
such activities include: (1) making available the results of
nonpartisan analysis, study, or research; (2) providing
technical advice or assistance to a governmental body or to a
committee in response to a written request; (3) appearances
before, or communications to, any legislative body with respect
to a possible decision of such body that might affect the
existence of the organization, its powers and duties, tax-
exempt status, or the deduction of contributions to the
organization (so-called ``self-defense'' expenditures); (4)
certain communications to members of the electing charity; and
(5) communications with governmental officials or employees
that are not intended to influence legislation. \97\
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\97\ Sec. 4911(d)(2).
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Special rules for mixed lobbying expenditures

Expenses that serve both direct and grass-roots lobbying
purposes, e.g., communications that are sent to members and
nonmembers, or ``mixed lobbying'' expenditures, are subject to
special rules. The regulations specify how an electing charity
is to allocate mixed lobbying expenditures between direct and
grass-roots lobbying purposes. \98\ For example, for a mixed
lobbying communication that is designed primarily for members
(i.e., more than half the recipients are members) and that
directly encourages grass-roots lobbying (even if it also
encourages direct lobbying), the grass-roots expenditure amount
includes all the costs of preparing the material used for
purposes of grass-roots lobbying plus the mechanical and
distributional costs associated with the communication. If a
mixed lobbying communication encourages direct lobbying, but
only indirectly encourages grass-roots lobbying, then the
entire costs of the communication are allocated based on the
proportion of members and nonmembers receiving the
communication.
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\98\ Treas. Reg. sec. 56.4911-5(e).
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Disclosure of lobbying expenditures

An electing charity must disclose lobbying expenditures
annually on Schedule A of Form 990. In order to meet disclosure
requirements, electing charities are required to keep detailed
records of direct and grass-roots lobbying expenditures.
Required records of grass-roots expenditures include: (1) all
amounts directly paid or incurred for grass-roots lobbying; (2)
payments to other organizations earmarked for grass-roots
lobbying; (3) fees and expenses paid for grass-roots lobbying;
(4) the printing, mailing, and other costs of reproducing and
distributing materials used in grass-roots lobbying; (5) the
portion of amounts paid or incurred as current or deferred
compensation for an employee's grass-roots lobbying services;
(6) any amount paid for out-of-pocket expenditures incurred on
behalf of the electing charity for grass-roots lobbying; (7)
the allocable portion of administrative, overhead and other
general expenditures attributable to grass-roots lobbying; and
(8) expenditures for grass-roots lobbying of a controlled
organization. \99\
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\99\ See Treas. Reg. sec. 56.4911-6.
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REASONS FOR CHANGE

The Committee believes that the separate limitation on
grass-roots lobbying expenditures is an unnecessary
complication for electing charities. The Committee believes
that the overall limit on lobbying expenditures is a sufficient
ceiling on the lobbying activities of electing charities,
irrespective of the proportion of lobbying activities that are
grass-roots lobbying or direct lobbying.

EXPLANATION OF PROVISION

The provision eliminates the separate limitation for grass-
roots lobbying expenditures applicable to electing charities.
Electing charities remain subject to the overall limitation on
lobbying expenditures, which does not change in amount, but
electing charities are not required to limit grass roots
expenditures as a percentage of overall lobbying. Thus, an
electing charity is able to make tax-free any combination of
grass-roots and direct lobbying expenditures up to the lobbying
non-taxable amount and does not risk loss of tax-exemption as a
result of such expenditures until total lobbying expenditures
normally exceed the lobbying ceiling amount. For purposes of
the section 501(h) election, electing charities are not
required to distinguish between grass-roots lobbying and direct
lobbying, whether for mixed lobbying expenditures or otherwise.

EFFECTIVE DATE

The provision is effective for taxable years beginning
after December 31, 2002.

D. Expedited Review Process for Certain Tax-Exemption Applications

(Sec. 304 of the bill)

PRESENT LAW

Most organizations that seek tax-exempt status as a
charitable organization are required to file an Application for
Recognition of Exemption (Form 1023) with the IRS.\100\
Organizations that are not required to file Form 1023 include
churches, their integrated auxiliaries, and conventions or
associations of churches, and any organization (other than a
private foundation) that normally has gross receipts of $5,000
or less in a taxable year. Organizations that file Form 1023
within 15 months of the end of the month of the organization's
formation will, if the application is approved, be recognized
as tax-exempt from the date of formation. The IRS will
automatically grant an organization's request for an additional
12-month extension of the 15-month period. Otherwise, exemption
normally will be recognized as of the date the application was
received by the IRS. In appropriate circumstances, upon written
request, the IRS will expedite consideration of applications
for tax-exemption. For example, organizations formed to provide
relief to victims of disasters or other emergencies often
receive expedited consideration.
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\100\ Sec. 508(a).
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REASONS FOR CHANGE

Many social service organizations that want to apply for
government funding through grants or contracts are required as
a condition of application to have been recognized as an exempt
charitable organization. The Committee wishes to facilitate the
formation of charitable organizations that intend to work with
Federal, State and local governments to provide vital social
services to many of the neediest members of society by
implementing an expedited review procedure for exempt status
applications, and by waiving IRS user fees pertaining to such
applications filed by smaller social service organizations.

EXPLANATION OF PROVISION

The provision provides that the Secretary or his delegate
shall adopt procedures to expedite consideration of
applications for exempt status by organizations that are
organized and operated for the primary purpose of providing
social services. To be eligible, the organization must: (1) be
seeking a contract or grant under a Federal, State, or local
program that provides funding for social service programs; (2)
establish that tax-exempt status is a condition of applying for
such contract or grant; (3) include a completed copy of the
contract or grant application with the application for
exemption; and (4) meet such other criteria as the Secretary
may provide. Organizations that meet the eligibility
requirements described above (except for the requirement that
tax-exempt status is a condition of the contract or grant
application), and that certify that the organization's average
annual gross receipts over the four-year period preceding the
application was not more than $50,000 (or, in the case of an
organization in existence less than four years, is not expected
to be more than $50,000 during the organization's first four
years) are entitled to a waiver of any fee for application of
tax-exempt status.
For this purpose, social services is defined as services
directed at helping people in need, reducing poverty, improving
outcomes of low-income children, revitalizing low-income
communities, and empowering low-income families and low-income
individuals to become self-sufficient, including: (1) child
care services, protective services for children and adults,
services for children and adults in foster care, adoption
services, services related to the management and maintenance of
the home, day care services for adults, and services to meet
the special needs of children, older individuals, and
individuals with disabilities (including physical, mental, or
emotional disabilities); (2) transportation services; (3) job
training and related services, and employment services; (4)
information, referral, and counseling services; (5) the
preparation and delivery of meals, and services related to soup
kitchens or food banks; (6) health support services; (7)
literacy and mentoring programs; (8) services for the
prevention and treatment of juvenile delinquency and substance
abuse, services for the prevention of crime and the provision
of assistance to the victims and the families of criminal
offenders, and services related to the intervention in, and
prevention of, domestic violence; and (9) services related to
the provision of assistance for housing under Federal law.
Social services does not include a program having the purpose
of delivering educational assistance under the Elementary and
Secondary Education Act of 1965 or under the Higher Education
Act of 1965.

EFFECTIVE DATE

The provision applies to applications for tax-exempt status
filed after December 31, 2003.

E. Clarification of Definition of Church Tax Inquiry

(Sec. 305 of the bill and sec. 7611 of the Code)

PRESENT LAW

Under present law, the IRS may begin a church tax inquiry
only if an appropriate high-level Treasury official reasonably
believes, on the basis of the facts and circumstances recorded
in writing, that an organization (1) may not qualify for tax
exemption as a church, (2) may be carrying on an unrelated
trade or business, or (3) otherwise may be engaged in taxable
activities.\101\ A church tax inquiry is defined as any inquiry
to a church (other than an examination) that serves as a basis
for determining whether the organization qualified for tax
exemption as a church or whether it is carrying on an unrelated
trade or business or otherwise is engaged in taxable
activities. An inquiry is considered to commence when the IRS
requests information or materials from a church of a type
contained in church records, other than routine requests for
information or inquiries regarding matters that do not
primarily concern the tax status or liability of the church
itself.
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\101\ Sec. 7611. Prior to the year 2000 IRS restructuring, the
lowest level official who could initiate a church tax inquiry was an
IRS Regional Commissioner.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that the present-law church tax
inquiry procedures provide important safeguards against the IRS
engaging in unnecessary and intrusive examinations of churches.
However, the church tax inquiry procedures also have the effect
of hampering IRS efforts to educate churches with respect to
actions that are not permissible under section 501(c)(3). The
Committee believes that a clarification of the scope of the
church tax inquiry procedures to make it clear that the IRS may
undertake educational outreach efforts with respect to specific
churches (e.g., initiating meetings with representatives of a
particular church to discuss the rules that apply to such
church) will improve compliance with the law by churches.

EXPLANATION OF PROVISION

The provision clarifies that the church tax inquiry
procedures do not apply to contacts made by the IRS for the
purpose of educating churches with respect to the Federal
income tax law governing tax-exempt organizations. For example,
the IRS does not violate the church tax inquiry procedures when
written materials are provided to a church or churches for the
purpose of educating such church or churches with respect to
the types of activities that are not permissible under section
501(c)(3).

EFFECTIVE DATE

The provision is effective on the date of enactment.

F. Extension of Declaratory Judgment Procedures to Non-501(c)(3) Tax-
Exempt Organizations

(Sec. 306 of the bill and sec. 7428 of the Code)

PRESENT LAW

In order for an organization to be granted tax exemption as
a charitable entity described in section 501(c)(3), it
generally must file an application for recognition of exemption
with the IRS and receive a favorable determination of its
status. Similarly, for most organizations, a charitable
organization's eligibility to receive tax-deductible
contributions is dependent upon its receipt of a favorable
determination from the IRS. In general, a section 501(c)(3)
organization can rely on a determination letter or ruling from
the IRS regarding its tax-exempt status, unless there is a
material change in its character, purposes, or methods of
operation. In cases in which an organization violates one or
more of the requirements for tax exemption under section
501(c)(3), the IRS is authorized to revoke an organization's
tax exemption, notwithstanding an earlier favorable
determination.
In situations in which the IRS denies an organization's
application for recognition of exemption under section
501(c)(3) or fails to act on such application, or in which the
IRS informs a section 501(c)(3) organization that it is
considering revoking or adversely modifying its tax-exempt
status, present law authorizes the organization to seek a
declaratory judgment regarding its tax status (sec. 7428).
Section 7428 provides a remedy in the case of a dispute
involving a determination by the IRS with respect to: (1) the
initial qualification or continuing qualification of an
organization as a charitable organization for tax exemption
purposes or for charitable contribution deduction purposes; (2)
the initial classification or continuing classification of an
organization as a private foundation; (3) the initial
classification or continuing classification of an organization
as a private operating foundation; or (4) the failure of the
IRS to make a determination with respect to (1), (2), or (3). A
``determination'' in this context generally means a final
decision by the IRS affecting the tax qualification of a
charitable organization, although it also can include a
proposed revocation of an organization's tax-exempt status or
public charity classification. Section 7428 vests jurisdiction
over controversies involving such a determination in the U.S.
District Court for the District of Columbia, the U.S. Court of
Federal Claims, and the U.S. Tax Court.
Prior to utilizing the declaratory judgment procedure, an
organization must have exhausted all administrative remedies
available to it within the IRS. An organization is deemed to
have exhausted its administrative remedies at the expiration of
270 days after the date on which the request for a
determination was made if the organization has taken, in a
timely manner, all reasonable steps to secure such
determination.
If an organization (other than a section 501(c)(3)
organization) files an application for recognition of exemption
and receives a favorable determination from the IRS, the
determination of tax-exempt status is usually effective as of
the date of formation of the organization if its purposes and
activities during the period prior to the date of the
determination letter were consistent with the requirements for
exemption. However, if the organization files an application
for recognition of exemption and later receives an adverse
determination from the IRS, the IRS may assert that the
organization is subject to tax on some or all of its income for
open taxable years. In addition, as with charitable
organizations, the IRS may revoke or modify an earlier
favorable determination regarding an organization's tax-exempt
status.
Under present law, a non-charity (i.e., an organization not
described in section 501(c)(3)) may not seek a declaratory
judgment with respect to an IRS determination regarding its
tax-exempt status. The only remedies available to such an
organization are to petition the U.S. Tax Court for relief
following the issuance of a notice of deficiency or to pay any
tax owed and sue for refund in federal district court or the
U.S. Court of Federal Claims.

REASONS FOR CHANGE

The Committee believes that it is important to provide
certainty for organizations that have sought a determination of
their tax-exempt status. Thus, the Committee finds it
appropriate to extend the present-law declaratory judgment
procedures to all organizations that apply for tax-exempt
status as organizations described in section 501(c) or 501(d).

EXPLANATION OF PROVISION

The provision extends declaratory judgment procedures
similar to those currently available only to charities under
section 7428 to other section 501(c) and 501(d) determinations.
The provision limits jurisdiction over controversies involving
such other determinations to the United States Tax Court.\102\
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\102\ This limitation currently applies to declaratory judgments
relating to tax qualification for certain employee retirement plans
(sec. 7476).
---------------------------------------------------------------------------

EFFECTIVE DATE

The extension of the declaratory judgment procedures to
organizations other than section 501(c)(3) organizations is
effective for pleadings filed with respect to determinations
(or requests for determinations) made after December 31, 2002.

G. Definition of Convention or Association of Churches

(Sec. 307 of the bill and sec. 7701 of the Code)

PRESENT LAW

Under present law, an organization that qualifies as a
``convention or association of churches'' (within the meaning
of sec. 170(b)(1)(A)(i)) is not required to file an annual
return,\103\ is subject to the church tax inquiry and church
tax examination provisions applicable to organizations claiming
to be a church,\104\ and is subject to certain other provisions
generally applicable to churches.\105\ The Internal Revenue
Code does not define the term ``convention or association of
churches.''
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\103\ Sec. 6033(a)(2)(A)(i).
\104\ Sec. 7611(h)(1)(B).
\105\ See, e.g., Sec. 402(g)(8)(B) (limitation on elective
deferrals); sec. 403(b)(9)(B) (definition of retirement income
account); sec. 410(d) (election to have participation, vesting,
funding, and certain other provisions apply to church plans); sec.
414(e) (definition of church plan); sec. 415(c)(7) (certain
contributions by church plans); sec. 501(h)(5) (disqualification of
certain organizations from making the sec. 501(h) election regarding
lobbying expenditure limits); sec. 501(m)(3) (definition of commercial-
type insurance); sec. 508(c)(1)(A) (exception from requirement to file
application seeking recognition of exempt status); sec. 512(b)(12)
(allowance of up to $1,000 deduction for purposes of determining
unrelated business taxable income); sec. 514(b)(3)(E) (definition of
debt-financed property); sec. 3121(w)(3)(A) (election regarding
exemption from social security taxes); sec. 3309(b)(1) (application of
federal unemployment tax provisions to services performed in the employ
of certain organizations); sec. 6043(b)(1) (requirement to file a
return upon liquidation or dissolution of the organization); and sec.
7702(j)(3)(A) (treatment of certain death benefit plans as life
insurance).
---------------------------------------------------------------------------

REASONS FOR CHANGE

The term ``convention or association of churches'' was
added to the Code to ensure that hierarchical churches and
congregational churches would not be treated dissimilarly for
Federal income tax purposes merely because of their
organizational and governance structures. The Committee
understands that some congregational church organizations have
only churches as members, and that others have both churches
and individuals as members. The Committee is concerned that an
organization with the characteristics of a convention or
association of churches, including having a substantial number
of churches as members, might fail to be regarded as a
convention or association of churches merely because it
includes individuals in its membership. The Committee intends
that a congregational church organization that otherwise
constitutes a convention or association of churches not be
denied recognition as such merely because its membership
includes individuals as well as churches.

EXPLANATION OF PROVISION

The provision provides that an organization that otherwise
is a convention or association of churches does not fail to so
qualify merely because the membership of the organization
includes individuals as well as churches, or because
individuals have voting rights in the organization.

EFFECTIVE DATE

The provision is effective on the date of enactment.

H. Payments by Charitable Organizations to Victims of War on Terrorism
and Families of Astronauts

(Sec. 308 of the bill)

PRESENT LAW

In general, organizations described in section 501(c)(3) of
the Code are exempt from taxation. Contributions to such
organizations generally are tax deductible.\106\ Section
501(c)(3) organizations must be organized and operated
exclusively for exempt purposes and no part of the net earnings
of such organizations may inure to the benefit of any private
shareholder or individual. An organization is not organized or
operated exclusively for one or more exempt purposes unless the
organization serves a public rather than a private interest.
Thus, an organization described in section 501(c)(3) generally
must serve a charitable class of persons that is indefinite or
of sufficient size.
---------------------------------------------------------------------------
\106\ Sec. 170.
---------------------------------------------------------------------------
Tax-exempt private foundations are a type of organization
described in section 501(c)(3) and are subject to special
rules. Private foundations are subject to excise taxes on acts
of self-dealing between the private foundation and a
disqualified person with respect to the foundation.\107\ For
example, it is self-dealing if assets of a private foundation
are used for the benefit of a disqualified person, such as a
substantial contributor to the foundation or a person in
control of the foundation, and the benefit is not incidental or
tenuous.
---------------------------------------------------------------------------
\107\ Sec. 4941.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that payments by charities to
members of the Armed Forces of the United States (and their
immediate families) made by reason of death, injury, wounding
or illness and incurred as a result of our nation's military
response to the terrorist attacks of September 11, 2001, and to
individuals of the immediate families of astronauts killed in
the line of duty after December 31, 2002, should be treated as
consistent with the charity's exempt purpose, to the extent the
payments are made in good faith and pursuant to a reasonable
and objective formula that is consistently applied.

EXPLANATION OF PROVISION

The provision provides that organizations described in
section 501(c)(3) that make certain payments are not required
to make a specific assessment of need for the payments to be
related to the purpose or function constituting the basis for
the organization's exemption, provided that the organization
makes the payments in good faith and uses an objective formula
that is consistently applied in making the payments.
The provision applies to payments to a member of the Armed
Forces of the United States (as defined in section
7701(a)(15)), or to a member of such person's immediate family
(including spouses, parents, children, and foster children), by
reason of the death, injury, wounding, or illness of a member
of the Armed Forces of the United States that was incurred as a
result of the military response of the United States to the
terrorist attacks against the United States on September 11,
2001. The provision also applies to payments to an individual
of an astronaut's immediate family by reason of the death of
such astronaut occurring in the line of duty after December 31,
2002.
As under present law, such payments must be for public and
not private benefit and therefore must serve a charitable
class. For example, a charitable organization that assists the
families of members of the Armed Forces killed in the line of
duty may make pro-rata distributions to the families of those
killed, even though the specific financial needs of each family
are not directly considered. Similarly, if the amount of a
distribution is based on the number of dependents of a
charitable class of persons killed in the military response to
the attacks and this standard is applied consistently among
distributions, the specific needs of each recipient do not have
to be taken into account. However, it is not appropriate for a
charity to make pro-rata payments based on the recipients'
living expenses before the harm occurred if the result
generally provides significantly greater assistance to persons
in a better position to provide for themselves than to persons
with fewer financial resources. Although such a distribution
might be based on objective criteria, it is not a reasonable
formula for distributing assistance in an equitable manner.
Similarly, although specific assessments of need are not
required, payments that do not further public purposes are not
permitted. The provision does not change the substantive
standards for exemption under section 501(c)(3), including the
prohibition on private inurement. The provision also provides
that if a private foundation makes payments under the
conditions described above, the payment is not treated as made
to a disqualified person for purposes of section 4941.

EFFECTIVE DATE

For payments related to members of the Armed Forces, the
provision applies to payments made after the date of enactment
and before September 11, 2004. For payments related to
astronauts, the provision applies to payments made after
December 31, 2002.

I. Increase Percentage Limits for Certain Employer-Related Scholarship
Programs

(Sec. 309 of the bill)

PRESENT LAW

Gross income does not include any amount received as a
qualified scholarship by an individual who is a candidate for a
degree at an educational organization (sec. 117(a)). For this
purpose, a scholarship generally means an amount paid or
allowed to, or for the benefit of, a student to aid that
student in pursuing studies.\108\ However, an amount paid or
allowed to, or on behalf of, an individual to enable the
individual to pursue studies is not treated as a scholarship if
the amount represents compensation for past, present, or future
services.\109\ The determination of whether an amount is
properly treated as a scholarship or compensation for services
is made in light of all the relevant facts and circumstances.
---------------------------------------------------------------------------
\108\ Treas. Reg. sec. 1.117-3(a).
\109\ Treas. Reg. sec. 1.117-4(c).
---------------------------------------------------------------------------
Present law imposes excise taxes on the taxable
expenditures of a private foundation.\110\ A taxable
expenditure includes, among other things, any amount paid or
incurred by a private foundation as a grant to an individual
for travel, study, or other similar purposes by such
individual, unless such grant is awarded on an objective and
nondiscriminatory basis pursuant to a procedure approved in
advance by the Secretary.\111\ In the case of individual grants
to be made as scholarships or fellowships, the private
foundation must demonstrate to the satisfaction of the
Secretary that the grant: (1) constitutes a scholarship or
fellowship which would be subject to the provisions of section
117(a),\112\ and (2) is to be used for study at an educational
organization which normally maintains a regular faculty and
curriculum and normally has a regularly enrolled body of pupils
or students in attendance at the place where its educational
activities are regularly carried on.\113\
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\110\ Secs. 4945(a) and (b).
\111\ Secs. 4945(d)(3) and (g).
\112\ For the purpose of section 4945(g), the term ``scholarship or
fellowship'' refers to the provisions of section 117(a) as in effect
before the Tax Reform Act of 1986. Sec. 4945(g)(1).
\113\ Secs. 4945(g)(1) and 170(b)(1)(A)(ii).
---------------------------------------------------------------------------
Private foundations may in the course of their activities
make scholarship or fellowship grants to individuals to be used
for educational purposes. However, a private foundation's grant
program may not provide compensation, an employment incentive,
or an employee fringe benefit to persons employed by the
foundation or by another employer (including, for example,
employees of a ``related'' employer organization). Revenue
Procedure 76-47 provides advance approval guidelines to
determine whether grants made by private foundations under
employer-related grant programs to an employee or to a child of
an employee of the employer to which the program relates is
considered a scholarship or fellowship grant subject to the
provisions of section 117(a).\114\ To the extent that such
grants are considered scholarships or fellowships under these
guidelines, the Secretary will assume the grants are not
taxable expenditures subject to section 4945 taxes. Educational
grants that are not scholarships or fellowships under these
guidelines might, depending upon the circumstances, be taxable
under Chapter 42 of the Code.\115\
---------------------------------------------------------------------------
\114\ Rev. Proc. 76-47, 1976-2 C.B. 670. The revenue procedure
defines an employer-related program as a program that treats some or
all of the employees, or children of some or all of the employees, of
an employer as a group from which grantees of some or all of the grants
will be selected, limits the potential grantees for some or all of the
grants to individuals who are employees or children of employees of an
employer, or otherwise gives such individuals a preference or priority
over others in being selected as grantees.
\115\ Treas. Reg. sec. 53.4941(d)-2(f)(2).
---------------------------------------------------------------------------
Under Revenue Procedure 76-47, a grant made under an
employer-related grant program that satisfies seven conditions
and a percentage test is considered a scholarship or
fellowship.\116\ Grants awarded to children of employees and to
employees are considered as having been awarded under separate
programs for purposes of the revenue procedure, regardless of
whether they are awarded under separately administered
programs. All such grants must satisfy each of the seven
conditions to obtain advance approval of the grant program. The
percentage test applicable to grants to children of employees
requires that the number of grants awarded not exceed either 25
percent of the eligible applicants considered by the selection
committee in selecting grant recipients or 10 percent of those
eligible for grants (regardless of whether they submitted grant
applications). The percentage test applicable to grants to
employees requires that the number of grants awarded not exceed
10 percent of eligible applicants considered by the selection
committee in selecting grant recipients. If the seven
conditions are met, but the relevant percentage test is not
satisfied, then the question of whether the grants constitute
scholarships or fellowships is based upon all of the facts and
circumstances.
---------------------------------------------------------------------------
\116\ The seven conditions include: (1) the program must not be
used to recruit employees, to induce employees to continue their
employment, or to compel a course of action sought by the employer; (2)
the selection of grant recipients must be made by a committee
consisting of independent individuals; (3) the program must impose
identifiable minimum requirements for grant eligibility; (4) the
selection of grant recipients must be based solely upon substantial
objective standards that are completely unrelated to employment and to
the employer's line of business; (5) a grant may not be terminated
because the recipient or the recipient's parent terminates employment
with the employer; (6) the courses of study for which grants are
available must not be limited to those would be of particular benefit
to the employer or the foundation; and (7) the terms of the grant and
the courses of study for which grants are available must meet all other
requirements of section 117 and must be consistent with the
disinterested purpose of education for personal benefit rather than for
the benefit of the employer or the foundation.
---------------------------------------------------------------------------
Similar requirements and percentage limits apply to
determine whether educational loans made by a private
foundation under an employer-related loan program are taxable
expenditures.\117\ If an employer-related program encompasses
educational loans and scholarship or fellowship grants to the
same group of eligible employees or employees' children, the
percentage tests applicable to the loan program apply to the
total number of individuals receiving combined grants of
scholarships, fellowships, and educational loans.\118\
---------------------------------------------------------------------------
\117\ Rev. Proc. 80-39, 1980-2 C.B. 772.
\118\ Id.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that the quantitative limits set
forth in Revenue Procedure 76-47 are too low for employer-
related grant programs that provide scholarships or fellowships
to children of employees. The Committee believes that higher
percentage limits will encourage increases in grants made for
educational purposes. The Committee also believes that the
higher percentage limits should be available only in cases
where the foundation maintains a comparable grant program for
children who are not affiliated with the employer to which the
employer-related grant program relates.

EXPLANATION OF PROVISION

The percentage limits set forth in Revenue Procedure 76-47
for grants to children of employees are increased to 35 percent
of eligible applicants considered by the selection committee or
20 percent of those eligible for the grants. However, the
higher percentage limits are available only if the private
foundation meets the other requirements of the Revenue
Procedure and demonstrates that the foundation provides a
comparable number and aggregate amount of grants during the
same grant-program year to individuals who are not such
employees, children or dependents of such employees, or
affiliated with the employer of such employees. The provision
does not amend the percentage limits for grants to employees,
or the percentage limits of Revenue Procedure 80-39 relating to
loan programs or programs which encompass both loans and
grants.

EFFECTIVE DATE

Revenue Procedure 76-47 is to be amended effective for
grants awarded after the date of enactment.

J. Treatment of Certain Hospital Support Organizations in Determining
Acquisition Indebtedness

(Sec. 310 of the bill and sec. 514 of the Code)

PRESENT LAW

In general, income of a tax-exempt organization that is
produced by debt-financed property is treated as unrelated
business income in proportion to the acquisition indebtedness
on the income-producing property. Acquisition indebtedness
generally means the amount of unpaid indebtedness incurred by
an organization to acquire or improve the property and
indebtedness that would not have been incurred but for the
acquisition or improvement of the property. However, under an
exception, acquisition indebtedness does not include
indebtedness incurred by certain qualified organizations to
acquire or improve real property. Qualified organizations
include pension trusts, educational institutions, and title-
holding companies.

REASONS FOR CHANGE

The Committee believes that certain indebtedness of
qualified hospital support organizations should not be
considered acquisition indebtedness for purposes of the tax on
debt-financed income.

EXPLANATION OF PROVISION

The provision expands the exception to the definition of
acquisition indebtedness in the case of a qualified hospital
support organization. The exception applies to eligible
indebtedness (or the qualified refinancing thereof) of the
qualified hospital support organization.
A qualified hospital support organization is a supporting
organization (under section 509(a)(3)) of a hospital that is an
academic health center (under section 119(d)(4)(B)). The assets
of the supporting organization have to meet certain
requirements. First, more than half of the value of the
organization's assets at any time since its organization (1)
have to have been acquired, directly or indirectly, by
testamentary gift or devise, and (2) have to consist of real
property. In addition, the fair market value of the
organization's real estate acquired by gift or devise has to
exceed 25 percent of the fair market value of all investment
assets held by the organization immediately prior to the time
that the eligible indebtedness was incurred. These requirements
have to be met each time eligible indebtedness was incurred or
a qualified refinancing thereof occurs.
Eligible indebtedness means indebtedness secured by real
property acquired directly or indirectly by gift or devise, the
proceeds of which are used exclusively to acquire a leasehold
interest in or to improve or repair the property. A qualified
refinancing of eligible indebtedness occurs if the refinancing
does not exceed the amount of refinanced eligible indebtedness
immediately before the refinancing.

EFFECTIVE DATE

The provision applies to indebtedness incurred after
December 31, 2003.

K. Charitable Contribution Deduction for Certain Expenses in Support of
Native Alaskan Subsistence Whaling

(Sec. 311 of the bill and sec. 170 of the Code)

PRESENT LAW

In computing taxable income, individuals who do not elect
the standard deduction may claim itemized deductions, including
a deduction (subject to certain limitations) for charitable
contributions or gifts made during the taxable year to a
qualified charitable organization or governmental entity.\119\
Individuals who elect the standard deduction may not claim a
deduction for charitable contributions made during the taxable
year.
---------------------------------------------------------------------------
\119\ Sec. 170. Section references are to the Internal Revenue Code
of 1986 unless otherwise indicated.
---------------------------------------------------------------------------
No charitable contribution deduction is allowed for a
contribution of services. However, unreimbursed expenditures
made incident to the rendition of services to an organization,
contributions to which are deductible, may constitute a
deductible contribution.\120\ Specifically, section 170(j)
provides that no charitable contribution deduction is allowed
for traveling expenses (including amounts expended for meals
and lodging) while away from home, whether paid directly or by
reimbursement, unless there is no significant element of
personal pleasure, recreation, or vacation in such travel.
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\120\ Treas. Reg. sec. 1.170A-1(g).
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that subsistence bowhead whale
hunting activities are important to certain native peoples of
Alaska and further charitable purposes. The Committee believes
that certain expenses paid by individuals recognized as whaling
captains by the Alaska Eskimo Whaling Commission in the conduct
of sanctioned whaling activities conducted pursuant to the
management plan of that Commission should be deductible as
charitable contributions even though they are paid other than
directly to a charitable organization.

EXPLANATION OF PROVISION

The provision allows individuals to claim a deduction under
section 170 not exceeding $10,000 per taxable year for certain
expenses incurred in carrying out sanctioned whaling
activities. The deduction would be available only to an
individual who is recognized by the Alaska Eskimo Whaling
Commission as a whaling captain charged with the responsibility
of maintaining and carrying out sanctioned whaling activities.
The deduction would be available for reasonable and necessary
expenses paid by the taxpayer during the taxable year for: (1)
the acquisition and maintenance of whaling boats, weapons, and
gear used in sanctioned whaling activities, (2) the supplying
of food for the crew and other provisions for carrying out such
activities, and (3) storage and distribution of the catch from
such activities. The Committee intends that the Secretary shall
require that the taxpayer substantiate deductible expenses by
maintaining appropriate written records that show, for example,
the time, place, date, amount, and nature of the expense, as
well as the taxpayer's eligibility for the deduction. In
addition, the Committee believes that it is appropriate for the
taxpayer to provide such substantiation as part of the
taxpayer's income tax return, to the extent provided by the
Secretary.
For purposes of the provision, the term ``sanctioned
whaling activities'' means subsistence bowhead whale hunting
activities conducted pursuant to the management plan of the
Alaska Eskimo Whaling Commission.

EFFECTIVE DATE

The provision is effective for contributions made after
December 31, 2003.

L. Matching Grants to Low-Income Taxpayer Clinics for Return
Preparation

(Sec. 312 of the bill and new sec. 7526A of the Code)

PRESENT LAW

The Code provides that the Secretary is authorized to
provide up to $6 million per year in matching grants to certain
low-income taxpayer clinics. Eligible clinics \121\ are those
that charge no more than a nominal fee to either represent low-
income taxpayers in controversies with the IRS or provide tax
information to individuals for whom English is a second
language. No clinic can receive more than $100,000 per year.
---------------------------------------------------------------------------
\121\ Eligible clinics must be either: (1) part of an accredited
law, business, or accounting school; or (2) a tax-exempt organization.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that the existing low-income
taxpayer clinics provide an invaluable service to taxpayers and
have increased compliance with the Code by providing
representation and guidance to taxpayers who might otherwise be
uncertain about their rights and obligations under the Code.
Therefore, the Committee believes that creating a new matching
grant program, focused entirely on assisting taxpayers with the
preparation of their Federal tax returns, will also increase
compliance with our tax laws.

EXPLANATION OF PROVISION

The bill authorizes up to $10 million annually in matching
grants for low-income taxpayer assistance clinics. These
clinics may provide routine tax return preparation and filing
services to low income taxpayers.

EFFECTIVE DATE

The provision is effective for grants made after the date
of enactment.

TITLE IV. SOCIAL SERVICES BLOCK GRANT

(Secs. 401-403 of the bill)

PRESENT LAW

Social Services Block Grant Funding (``SSBG''), also known
as ``Title XX'' (because it is Title XX of the Social Security
Act), is a flexible funding stream, providing states with
resources to support a variety of social services. SSBG funds
can be used to assist the elderly and disabled so that they do
not need to enter institutions, to prevent child and elder
abuse, to provide child care, to promote and support adoption,
and for several other services. There are certain specified
limitations so that SSBG cannot fund most medical care, for
example, or cash welfare payments. It is a mandatory capped
entitlement, distributed by a population-based formula among
the states.
States use SSBG in differing ways. Much of the funding
supports local social service providers, including faith-
related organizations, through contracts with state and local
governments. Overall, in fiscal year 1999, SSBG spending was as
follows: 13.4 percent for ``prevention'' and case management;
13 percent for day care; 12.4 percent for child and adult
protective services; 10.9 percent for foster care; 7.4 percent
for home-based services. There are several other categories in
the expenditure data as well.
Prior to the 1996 welfare reform law, SSBG was funded at
$2.8 billion. That legislation reduced SSBG to $2.38 billion,
as part of achieving budgetary savings, and permitted states to
transfer up to 10 percent of their new Temporary Assistance for
Needy Families (TANF) welfare block grant allocations to SSBG.
(Any transferred funds are required to be spent on behalf of
families below 200 percent of poverty.) In 1998, as part of the
TEA-21 highway legislation, SSBG funding as further reduced,
declining to $1.7 billion for fiscal year 2001 and fiscal year
2002. The TANF transfer was further limited to 4.25 percent.

REASONS FOR CHANGE

The Committee believes that an increase in funding for SSBG
will allow social service organizations to provide more
assistance to families in need and disadvantaged individuals.
The flexible nature of SSBG permits states and localities to
choose their own priorities for the uses of the increased
funding.

EXPLANATION OF PROVISION

The provision increases SSBG funding to $1.975 billion for
fiscal year 2003 and $2.8 billion for fiscal year 2004. In
addition, the TANF transfer limit is restored to 10 percent.
These two measures provide additional resources to faith-
related social service organizations. Finally, the Secretary of
HHS is required to submit annual reports on SSBG expenditures
to the Congress.

EFFECTIVE DATE

The provision is effective for amounts made available for
fiscal year 2003 and for amounts made available each fiscal
year thereafter. The provision requiring annual reports applies
to such reports with respect to fiscal year 2002 and each
fiscal year thereafter.

TITLE V. INDIVIDUAL DEVELOPMENT ACCOUNTS

(Sec. 501-512 of the bill)

PRESENT LAW

Individual development accounts were first authorized by
the Personal Work and Responsibility Act of 1996. In 1998, the
Assets for Independence Act established a five-year $125
million demonstration program to permit certain eligible
individuals to open and make contributions to an individual
development account. Contributions by an individual to an
individual development account do not receive a tax preference
but are matched by contributions from a State program, a
participating nonprofit organization, or other ``qualified
entity.'' The IRS has ruled that matching contributions by a
qualified entity are a gift and not taxable to the account
owner.\122\ The qualified entity chooses a matching rate, which
must be between 50 and 400 percent. Withdrawals from individual
development accounts can be made for certain higher education
expenses, a first home purchase, or small-business
capitalization expenses. Matching contributions (and earnings
thereon) typically are held separately from the individuals'
contributions (and earnings thereon) and must be paid directly
to a mortgage provider, university, or business capitalization
account at a financial institution. The Department of Health
and Human Services administers the individual development
account program.
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\122\ Rev. Rul. 99-44, 1999-2 C.B. 549.
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REASONS FOR CHANGE

The Committee recognizes that the rate of private savings
in the United States is too low. In particular, many low-income
individuals either have inadequate savings or no savings at
all. The Committee believes that a tax-subsidized match by
financial institutions may help encourage more savings by low-
income working individuals. The program is intended to
encourage a pattern of individual savings and wealth
accumulation. Finally, the Committee believes that the program
will allow individuals to use their savings for three important
purposes: (1) to afford better educations; (2) to achieve home
ownership; and (3) to start their own businesses.

EXPLANATION OF PROVISION

The provision provides for a nonrefundable tax credit for
an eligible entity (i.e., a qualified financial institution)
that has an individual development account program in a taxable
year. The tax credit equals the amount of matching
contributions made by the eligible entity under the program (up
to $500 per taxable year) plus $50 for each individual
development account maintained during the taxable year under
the program. Except in the first year that each account is
open, the $50 credit is available only for accounts with a
balance of more than $100 at year-end (including matching
funds). The $50 credit is limited to seven years (the year the
account is created and the six years immediately thereafter).
The credit for matching funds is not allowed with respect to an
individual's account if such individual has outstanding student
loans, child support payments, or Federal tax liability. No
deduction or other credit is available with respect to the
amount of matching funds taken into account in determining the
credit.
The credit applies with respect to the first 300,000
individual development accounts opened before January 1, 2012,
and with respect to matching funds for participant
contributions that are made after December 31, 2004, and before
January 1, 2012. An account is considered open if at any time
the balance in the account exceeds $100 (including matching
amounts). The maximum amount of annual contributions to an
individual development account by an otherwise eligible
individual is limited to three times the maximum credit amount
for matching contributions for such year. The individual
development accounts will be available on the following basis:
(1) a maximum of 100,000 accounts may be opened after December
31, 2004 and before January 1, 2008; (2) a second 100,000
accounts may be opened after December 31, 2007 and before
January 1, 2010, if the entire 100,000 of authorized accounts
are opened after December 31, 2004 and before January 1, 2008
and the Secretary of the Treasury determines that these
accounts are being reasonably and responsibly administered;
\123\ and (3) a third 100,000 accounts may be opened after
December 31, 2009 and before January 1, 2012 if the previous
cohorts of 100,000 accounts have been opened under the schedule
described above and the Secretary of the Treasury makes a four-
part determination. Specifically, the Secretary will have to
determine: (1) that all previously opened accounts have been
reasonably and responsibly administered to date; (2) that the
individual development account program has increased net
savings of participants in the program; (3) whether
participants in the individual development account program have
increased Federal income tax liability and decreased
utilization of Federal assistance programs (e.g., Temporary
Assistance to Needy Families and Food Stamps) relative to
similarly situated individuals that did not participate in the
individual development account program; and (4) that the sum of
the increased Federal tax liability and reduction of Federal
assistance program benefits to participants in the individual
development account program is greater than the cost of the
individual development account program to the Federal
government. If the Secretary finds that any of the four
determinations has not been satisfied, the Congress will have
the discretion to authorize the third 100,000 accounts after
the Secretary makes his or her report to the Congress regarding
the four determinations. The third 100,000 accounts must be
equally divided among the States. For all accounts, the
Secretary will take steps to encourage use of individual
development accounts in rural areas.
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\123\ If less than 100,000 accounts are opened before January 1,
2008, then the number of accounts that can be opened after December 31,
2007 and before January 1, 2010 will be reduced to the lesser of 75,000
accounts or three times the number of accounts opened before January 1,
2007.
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Nonstudent U.S. citizens or lawful permanent residents
between the ages of 18 and 60 (inclusive) who meet certain
income requirements are eligible to open and contribute to an
individual development account. The income limit for
participation is modified adjusted gross income of $18,000 for
single filers, $38,000 for joint filers, and $30,000 for head-
of-household filers.\124\ Eligibility in a taxable year
generally is based on the previous year's modified adjusted
gross income and circumstances (e.g., status as a student).
Modified adjusted gross income is adjusted gross income plus
certain items that are not includible in gross income. The
items added are tax-exempt interest and the amounts otherwise
excluded from gross income under Code sections 86, 893, 911,
931, and 933 (relating to the exclusion of certain social
security and Tier 1 railroad retirement benefits; the exclusion
of compensation of employees of foreign governments and
international organizations; the exclusion of income of U.S.
citizens or residents living abroad; the exclusion of income
for residents of Guam, American Samoa, and the Northern Mariana
Islands; and the exclusion of income for residents of Puerto
Rico). The income limits are adjusted for inflation after 2003.
These amounts are rounded to the nearest multiple of 50
dollars.
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\124\ Married taxpayers filing separate returns are not eligible to
open an IDA or to receive matching funds for an IDA that is already
open.
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Under the provision, an individual development account
must: (1) be owned by the eligible individual for whom the
account was established; (2) consist only of cash
contributions; (3) be held by a person authorized to be a
trustee of any individual retirement account under section
408(a)(2); and (4) not commingle account assets with other
property (except in a common trust fund or common investment
fund). These requirements must be reflected in the written
governing instrument creating the account. The entity
establishing the program is required to maintain separate
accounts for the individual's contributions (and earnings
thereon) and for matching funds and earnings thereon (a
``parallel account'').
Contributions to individual development accounts by
individuals are not deductible and earnings thereon are taxable
to the account holder. Matching contributions and earnings
thereon are not taxable to the account holder. Any amount
(including earnings) in an individual development account and
matching contributions are disregarded for purposes of any
means-tested Federal programs.
The provision permits individuals to withdraw amounts from
an individual development account for qualified expenses of the
account owner, owner's spouse, or dependents as well as for
nonqualified expenses, subject to certain restrictions.
Qualified expenses include qualified: (1) higher education
expenses (as generally defined in section 529(e)(3)); (2)
first-time homebuyer costs (as generally provided in section 72
(t)(8)); (3) business capitalization or expansion costs
(expenditures made pursuant to a business plan that has been
approved by the financial institution); (4) rollovers of the
balance of the account (including the parallel account) to
another individual development account for the benefit of the
same owner; and (5) final distributions in the case of a
deceased account owner. Withdrawals for qualified expenses must
be made from funds that have been in the account for at least
one year and must be paid directly to the unrelated third party
to whom the amount is due, except in the case of expenses under
a qualified business plan, rollover, or final distribution.
Such withdrawals generally are not permitted until the account
owner completes a financial education course offered by a
qualified financial institution. The Secretary of the Treasury
(the ``Secretary'') is required to establish minimum standards
for such courses. Withdrawals for nonqualified expenses may
result in the account owner's forfeiture of matching funds. The
amount of the forfeiture is the lesser of: (1) an amount equal
to the nonqualified withdrawal; or (2) the excess of the amount
in the parallel account (excluding earnings on matching funds)
over the amount remaining in the individual development account
after the nonqualified withdrawal. If the individual
development account (or a portion thereof) is pledged as
security for a loan, then the portion so used will be treated
as a nonqualified withdrawal and will result in the loss of an
equal amount of matching funds from the parallel account. At
age 65, an individual may withdraw the balance of his or her
individual development account for nonqualified purposes
without losing matching amounts.
The qualified entity administering the individual
development account program generally is required to make
quarterly payments of matching funds to a parallel account on a
dollar-for-dollar basis for the first $500 contributed by the
account owner in a taxable year. Matching funds also may be
provided by State, local, or private sources. Balances of the
individual development account and parallel account must be
reported annually to the account owner. If an account owner
ceases to meet eligibility requirements, matching funds
generally may not be contributed during the period of
ineligibility. Any amount withdrawn from a parallel account is
not includible in an eligible individual's gross income or the
account sponsor's gross income.
Qualified entities administering a qualified program are
required to report to the Secretary that the program is
administered in accordance with legal requirements. If the
Secretary determines that the program was not so operated, the
Secretary would have the power to terminate the program.
Qualified entities also are required to report annually to the
Secretary information about: (1) the number of individuals
making contributions to individual development accounts; (2)
the amounts contributed by such individuals; (3) the amount of
matching funds contributed; (4) the amount of funds withdrawn
and for what purpose; (5) balance information; and (6) any
other information that the Secretary deems necessary. The
fiduciary requirements of Title 12 of the United States Code
with respect to insured depository institutions and insured
credit unions (as defined therein) continue to apply to those
financial institutions participating in the individual
development account program. Qualified entities are prohibited
from charging any fees with regard to the individual
development accounts.
The Secretary is authorized to prescribe necessary
regulations, including rules to permit individual development
account program sponsors to verify eligibility of individuals
seeking to open accounts and rules to allow a financial
institution (e.g., a tax-exempt credit union) to transfer those
credits to another taxpayer. The Secretary also is authorized
to provide rules to recapture credits claimed with respect to
individuals who forfeit matching funds.
The Secretary must submit annual reports to Congress on the
status of the qualified individual account program.

EFFECTIVE DATE

The provision is effective for taxable years ending after
December 31, 2004, and beginning before January 1, 2012.

TITLE VI. MANAGEMENT OF EXEMPT ORGANIZATIONS

(Sec. 601 of the bill)

EXPLANATION OF PROVISION

The provision authorizes $80 million to be appropriated to
the Secretary of the Treasury for each fiscal year to carry out
the administration of exempt organizations by the IRS.
The provision authorizes $3 million to be appropriated to
the Secretary of the Treasury to carry out the provisions of
Public Laws 106-230 and 107-276, relating to section 527.

REASONS FOR CHANGE

The Committee believes that the oversight and
administration of exempt organizations by the IRS is critical
to ensuring that exempt organizations operate consistent with
their exempt purposes and do not abuse the public trust. The
Committee believes that the IRS currently is underfunded in
this regard.
Public Laws 106-230 and 107-276 imposed substantial new
filing requirements on section 527 organizations and required
the IRS to establish and maintain electronic filing capability
and a searchable on-line database for public use. The Committee
believes that the efficient and successful completion of this
task requires separate funding by the Congress.

EFFECTIVE DATE

The authorizations are effective on the date of enactment.

TITLE VII. REVENUE PROVISIONS

A. Provisions Designed To Curtail Tax Shelters

1. Clarification of the Economic Substance Doctrine

(Sec. 701 of the bill and sec. 7701 of the Code)

PRESENT LAW

In general

The Code provides specific rules regarding the computation
of taxable income, including the amount, timing, source, and
character of items of income, gain, loss and deduction. These
rules are designed to provide for the computation of taxable
income in a manner that provides for a degree of specificity to
both taxpayers and the government. Taxpayers generally may plan
their transactions in reliance on these rules to determine the
federal income tax consequences arising from the transactions.
In addition to the statutory provisions, courts have
developed several doctrines that can be applied to deny the tax
benefits of tax motivated transactions, notwithstanding that
the transaction may satisfy the literal requirements of a
specific tax provision. The common-law doctrines are not
entirely distinguishable, and their application to a given set
of facts is often blurred by the courts and the IRS. Although
these doctrines serve an important role in the administration
of the tax system, invocation of these doctrines can be seen as
at odds with an objective, ``rule-based'' system of taxation.
Nonetheless, courts have applied the doctrines to deny tax
benefits arising from certain transactions.\125\
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\125\ See, e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d
Cir. 1998), aff'g 73 T.C.M. (CCH) 2189 (1997), cert. denied 526 U.S.
1017 (1999).
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A common-law doctrine applied with increasing frequency is
the ``economic substance'' doctrine. In general, this doctrine
denies tax benefits arising from transactions that do not
result in a meaningful change to the taxpayer's economic
position other than a purported reduction in federal income
tax.\126\
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\126\ Closely related doctrines also applied by the courts
(sometimes interchangeable with the economic substance doctrine)
include the ``sham transaction doctrine'' and the ``business purpose
doctrine''. See, e.g., Knetsch v. United States, 364 U.S. 361 (1960)
(denying interest deductions on a ``sham transaction'' whose only
purpose was to create the deductions).
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Economic substance doctrine
Courts generally deny claimed tax benefits if the
transaction that gives rise to those benefits lacks economic
substance independent of tax considerations--notwithstanding
that the purported activity actually occurred. The tax court
has described the doctrine as follows:

The tax law . . . requires that the intended
transactions have economic substance separate and
distinct from economic benefit achieved solely by tax
reduction. The doctrine of economic substance becomes
applicable, and a judicial remedy is warranted, where a
taxpayer seeks to claim tax benefits, unintended by
Congress, by means of transactions that serve no
economic purpose other than tax savings.\127\
---------------------------------------------------------------------------
\127\ ACM Partnership v. Commissioner, 73 T.C.M. at 2215.
---------------------------------------------------------------------------
Business purpose doctrine
Another common law doctrine that overlays and is often
considered together with (if not part and parcel of) the
economic substance doctrine is the business purpose doctrine.
The business purpose test is a subjective inquiry into the
motives of the taxpayer--that is, whether the taxpayer intended
the transaction to serve some useful non-tax purpose. In making
this determination, some courts have bifurcated a transaction
in which independent activities with non-tax objectives have
been combined with an unrelated item having only tax-avoidance
objectives in order to disallow the tax benefits of the overall
transaction.\128\
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\128\ ACM Partnership v. Commissioner, 157 F.3d at 256 n.48.
---------------------------------------------------------------------------

Application by the courts

Elements of the doctrine
There is a lack of uniformity regarding the proper
application of the economic substance doctrine. Some courts
apply a conjunctive test that requires a taxpayer to establish
the presence of both economic substance (i.e., the objective
component) and business purpose (i.e., the subjective
component) in order for the transaction to sustain court
scrutiny.\129\ A narrower approach used by some courts is to
invoke the economic substance doctrine only after a
determination that the transaction lacks both a business
purpose and economic substance (i.e., the existence of either a
business purpose or economic substance would be sufficient to
respect the transaction).\130\ A third approach regards
economic substance and business purpose as ``simply more
precise factors to consider'' in determining whether a
transaction has any practical economic effects other than the
creation of tax benefits.\131\
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\129\ See, e.g., Pasternak v. Commissioner, 990 F.2d 893, 898 (6th
Cir. 1993) (``The threshold question is whether the transaction has
economic substance. If the answer is yes, the question becomes whether
the taxpayer was motivated by profit to participate in the
transaction.'')
\130\ See, e.g., Rice's Toyota World v. Commissioner, 752 F.2d 89,
91-92 (4th Cir. 1985) (``To treat a transaction as a sham, the court
must find that the taxpayer was motivated by no business purposes other
than obtaining tax benefits in entering the transaction, and, second,
that the transaction has no economic substance because no reasonable
possibility of a profit exists.''); IES Industries v. United States,
253 F.3d 350, 358 (8th Cir. 2001) (``In determining whether a
transaction is a sham for tax purposes [under the Eighth Circuit test],
a transaction will be characterized as a sham if it is not motivated by
any economic purpose out of tax considerations (the business purpose
test), and if it is without economic substance because no real
potential for profit exists'' (the economic substance test).'') As
noted earlier, the economic substance doctrine and the sham transaction
doctrine are similar and sometimes are applied interchangeably. For a
more detailed discussion of the sham transaction doctrine, see, e.g.,
Joint Committee on Taxation, Study of Present-Law Penalty and Interest
Provisions as Required by Section 3801 of the Internal Revenue Service
Restructuring and Reform Act of 1998 (including Provisions Relating to
Corporate Tax Shelters) (JCS-3-99) at 182.
\131\ See, e.g., ACM Partnership v. Commissioner, 157 F.3d at 247;
James v. Commissioner, 899 F.2d 905, 908 (10th Cir. 1995); Sacks v.
Commissioner, 69 F.3d 982, 985 (9th Cir. 1995) (``Instead, the
consideration of business purpose and economic substance are simply
more precise factors to consider * * *. We have repeatedly and
carefully noted that this formulation cannot be used as a 'rigid two-
step analysis'.'').
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Profit potential
There also is a lack of uniformity regarding the necessity
and level of profit potential necessary to establish economic
substance. Since the time of Gregory, several courts have
denied tax benefits on the grounds that the subject
transactions lacked profit potential.\132\ In addition, some
courts have applied the economic substance doctrine to disallow
tax benefits in transactions in which a taxpayer was exposed to
risk and the transaction had a profit potential, but the court
concluded that the economic risks and profit potential were
insignificant when compared to the tax benefits.\133\ Under
this analysis, the taxpayer's profit potential must be more
than nominal. Conversely, other courts view the application of
the economic substance doctrine as requiring an objective
determination of whether a ``reasonable possibility of profit''
from the transaction existed apart from the tax benefits.\134\
In these cases, in assessing whether a reasonable possibility
of profit exists, it is sufficient if there is a nominal amount
of pre-tax profit as measured against expected net tax
benefits.
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\132\ See, e.g., Knetsch, 364 U.S. at 361; Goldstein v.
Commissioner, 364 F.2d 734 (2d Cir. 1966) (holding that an
unprofitable, leveraged acquisition of Treasury bills, and accompanying
prepaid interest deduction, lacked economic substance); Ginsburg v.
Commissioner, 35 T.C.M. (CCH) 860 (1976) (holding that a leveraged
cattle-breeding program lacked economic substance).
\133\ See, e.g., Goldstein v. Commissioner, 364 F.2d at 739-40
(disallowing deduction even though taxpayer had a possibility of small
gain or loss by owning Treasury bills); Sheldon v. Commissioner, 94
T.C. 738, 768 (1990) (stating, ``potential for gain * * * is
infinitesimally nominal and vastly insignificant when considered in
comparison with the claimed deductions'').
\134\ See, e.g., Rice's Toyota World v. Commissioner, 752 F.2d at
94 (the economic substance inquiry requires an objective determination
of whether a reasonable possibility of profit from the transaction
existed apart from tax benefits); Compaq Computer Corp. v.
Commissioner, 277 F.3d at 781 (applied the same test, citing Rice's
Toyota World); IES Industries v. United States, 253 F.3d at 354 (the
application of the objective economic substance test involves
determining whether there was a ``reasonable possibility of profit * *
* apart from tax benefits.'').
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REASONS FOR CHANGE

The Committee is concerned that many taxpayers are engaging
in tax avoidance transactions that rely on the interaction of
highly technical tax law provisions. These transactions usually
produce surprising results that were not contemplated by
Congress. Whether these transactions are respected usually
hinges on whether the transaction had sufficient economic
substance. The Committee is concerned that in addressing these
transactions the courts, in some cases, are reaching
conclusions inconsistent with Congressional intent. In
addition, the Committee is concerned that in determining
whether a transaction has economic substance, taxpayers are
subject to different legal standards based on the circuit that
the taxpayer is located. Thus, the Committee believes it is
appropriate to clarify for the courts the appropriate standards
to use in determining whether a transaction has economic
substance.

EXPLANATION OF PROVISION

In general

The bill clarifies and enhances the application of the
economic substance doctrine. The bill provides that a
transaction has economic substance (and thus satisfies the
economic substance doctrine) only if the taxpayer establishes
that (1) the transaction changes in a meaningful way (apart
from Federal income tax consequences) the taxpayer's economic
position, and (2) the taxpayer has a substantial non-tax
purpose for entering into such transaction and the transaction
is a reasonable means of accomplishing such purpose.\135\
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\135\ If the tax benefits are clearly contemplated and expected by
the language and purpose of the relevant authority, it is not intended
that such tax benefits be disallowed if the only reason for such
disallowance is that the transaction fails the economic substance
doctrine as defined in this provision.
---------------------------------------------------------------------------
The bill does not change current law standards used by
courts in determining when to utilize an economic substance
analysis. Also, the bill does not alter the court's ability to
aggregate or disaggregate a transaction when applying the
doctrine. The bill provides a uniform definition of economic
substance, but does not alter court flexibility in other
respects.

Conjunctive analysis

The bill clarifies that the economic substance doctrine
involves a conjunctive analysis--there must be an objective
inquiry regarding the effects of the transaction on the
taxpayer's economic position, as well as a subjective inquiry
regarding the taxpayer's motives for engaging in the
transaction. Under the bill, a transaction must satisfy both
tests--i.e., it must change in a meaningful way (apart from
Federal income tax consequences) the taxpayer's economic
position, and the taxpayer must have a substantial non-tax
purpose for entering into such transaction (and the transaction
is a reasonable means of accomplishing such purpose)--in order
to satisfy the economic substance doctrine. This clarification
eliminates the disparity that exists among the circuits
regarding the application of the doctrine, and modifies its
application in those circuits in which either a change in
economic position or a non-tax business purpose (without having
both) is sufficient to satisfy the economic substance doctrine.

Non-tax business purpose

The bill provides that a taxpayer's non-tax purpose for
entering into a transaction (the second prong in the analysis)
must be ``substantial,'' and that the transaction must be ``a
reasonable means'' of accomplishing such purpose. Under this
formulation, the non-tax purpose for the transaction must bear
a reasonable relationship to the taxpayer's normal business
operations or investment activities.\136\
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\136\ See, Martin McMahon Jr., Economic Substance, Purposive
Activity, and Corporate Tax Shelters, 94 Tax Notes 1017, 1023 (Feb. 25,
2002) (advocates ``confining the most rigorous application of business
purpose, economic substance, and purposive activity tests to
transactions outside the ordinary course of the taxpayer's business--
those transactions that do not appear to contribute to any business
activity or objective that the taxpayer may have had apart from tax
planning but are merely loss generators.''); Mark P. Gergen, The Common
Knowledge of Tax Abuse, 54 SMU L. Rev. 131, 140 (Winter 2001) (``The
message is that you can pick up tax gold if you find it in the street
while going about your business, but you cannot go hunting for it.'').
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In determining whether a taxpayer has a substantial non-tax
business purpose, it is intended that an objective of achieving
a favorable accounting treatment for financial reporting
purposes will not be treated as having a substantial non-tax
purpose.\137\ Furthermore, a transaction that is expected to
increase financial accounting income as a result of generating
tax deductions or losses without a corresponding financial
accounting charge (i.e., a permanent book-tax difference) \138\
should not be considered to have a substantial non-tax purpose
unless a substantial non-tax purpose exists apart from the
financial accounting benefits.\139\
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\137\ However, if the tax benefits are clearly contemplated and
expected by the language and purpose of the relevant authority, such
tax benefits should not be disallowed solely because the transaction
results in a favorable accounting treatment. An example is the repealed
foreign sales corporation rules.
\138\ This includes tax deductions or losses that are anticipated
to be recognized in a period subsequent to the period the financial
accounting benefit is recognized. For example, FAS 109 in some cases
permits the recognition of financial accounting benefits prior to the
period in which the tax benefits are recognized for income tax
purposes.
\139\ Claiming that a financial accounting benefit constitutes a
substantial non-tax purpose fails to consider the origin of the
accounting benefit (i.e., reduction of taxes) and significantly
diminishes the purpose for having a substantial non-tax purpose
requirement. See, e.g., American Electric Power, Inc. v. U.S., 136 F.
Supp. 2d 762, 791-92 (S.D. Ohio, 2001) (``AEP's intended use of the
cash flows generated by the [corporate-owned life insurance] plan is
irrelevant to the subjective prong of the economic substance analysis.
If a legitimate business purpose for the use of the tax savings 'were
sufficient to breathe substance into a transaction whose only purpose
was to reduce taxes, [then] every sham tax-shelter device might
succeed,''' citing Winn-Dixie v. Commissioner, 113 T.C. 254, 287
(1999)).
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By requiring that a transaction be a ``reasonable means''
of accomplishing its non-tax purpose, the bill broadens the
ability of the courts to bifurcate a transaction in which
independent activities with non-tax objectives are combined
with an unrelated item having only tax-avoidance objectives in
order to disallow the tax benefits of the overall transaction.

Profit potential

Under the bill, a taxpayer may rely on factors other than
profit potential to demonstrate that a transaction results in a
meaningful change in the taxpayer's economic position; the bill
merely sets forth a minimum threshold of profit potential if
that test is relied on to demonstrate a meaningful change in
economic position. If a taxpayer relies on a profit potential,
however, the present value of the reasonably expected pre-tax
profit must be substantial in relation to the present value of
the expected net tax benefits that would be allowed if the
transaction were respected.\140\ Moreover, the profit potential
must exceed a risk-free rate of return. In addition, in
determining pre-tax profit, fees and other transaction expenses
and foreign taxes are treated as expenses.
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\140\ Thus, a ``reasonable possibility of profit'' will not be
sufficient to establish that a transaction has economic substance.
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In applying the profit test to the lessor of tangible
property, certain deductions and other applicable tax credits
(such as the rehabilitation tax credit and the low income
housing tax credit) are not taken into account in measuring tax
benefits. Thus, a traditional leveraged lease is not affected
by the bill to the extent it meets the present law standards.

Transactions with tax-indifferent parties

The bill also provides special rules for transactions with
tax-indifferent parties. For this purpose, a tax-indifferent
party means any person or entity not subject to Federal income
tax, or any person to whom an item would have no substantial
impact on its income tax liability. Under these rules, the form
of a financing transaction will not be respected if the present
value of the tax deductions to be claimed is substantially in
excess of the present value of the anticipated economic returns
to the lender. Also, the form of a transaction with a tax-
indifferent party will not be respected if it results in an
allocation of income or gain to the tax-indifferent party in
excess of the tax-indifferent party's economic gain or income
or if the transaction results in the shifting of basis on
account of overstating the income or gain of the tax-
indifferent party.

Other rules

The Secretary may prescribe regulations which provide (1)
exemptions from the application of this bill, and (2) other
rules as may be necessary or appropriate to carry out the
purposes of the bill.
No inference is intended as to the proper application of
the economic substance doctrine under present law. In addition,
except with respect to the economic substance doctrine, the
provision shall not be construed as altering or supplanting any
other common law doctrine (including the sham transaction
doctrine), and this provision shall be construed as being
additive to any such other doctrine.

EFFECTIVE DATE

The bill applies to transactions entered into after the
date of enactment.

2. Penalty for Failure To Disclose Reportable Transactions

(Sec. 702 of the bill and new sec. 6707A of the Code)

PRESENT LAW

Regulations under section 6011 require a taxpayer to
disclose with its tax return certain information with respect
to each ``reportable transaction'' in which the taxpayer
participates.\141\
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\141\ On October 17, 2002, Treasury Department and the IRS released
new temporary and proposed regulations regarding the disclosure of
reportable transactions. The regulations are effective for transactions
entered into on or after January 1, 2003. Subsequent to the issuance of
the new regulations, the IRS announced that, in light of the numerous
comments received regarding the new regulations, the revised
regulations under section 6011 will permit taxpayers who entered into
transactions on or after January 1, 2003 (and before the filing date of
the revised regulations) to elect to apply the revised regulations.
Notice 2003-11, 2003-6 I.R.B. 1 (January 17, 2003).
The discussion of present law refers to the new regulations. The
rules that apply with respect to transactions entered into on or before
December 31, 2002, are contained in Treas. Reg. sec. 1.6011-4T in
effect prior to January 1, 2003.
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There are six categories of reportable transactions. The
first category is any transaction that is the same as (or
substantially similar to) \142\ a transaction that is specified
by the Treasury Department as a tax avoidance transaction whose
tax benefits are subject to disallowance under present law
(referred to as a ``listed transaction'').\143\
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\142\ The regulations clarify that the term ``substantially
similar'' includes any transaction that is expected to obtain the same
or similar types of tax benefits and that is either factually similar
or based on the same or similar tax strategy. Also, the term must be
broadly construed in favor of disclosureTemp. Treas. Reg. sec. 1-6011-
4T(c)(4).
\143\ Temp. Treas. Reg. sec. 1.6011-4T(b)(2).
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The second category is any transaction that is offered
under conditions of confidentiality. If a taxpayer's disclosure
of the structure or tax aspects of the transaction is limited
in any way by an express or implied understanding or agreement
with or for the benefit of any person who makes or provides a
statement, oral or written, as to the potential tax
consequences that may result from the transaction, it is
considered offered under conditions of confidentiality (whether
or not the understanding is legally binding).\144\
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\144\ Temp. Treas. Reg. sec. 1.6011-4T(b)(3).
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The third category of reportable transaction is any
transaction for which the taxpayer has obtained or been
provided with contractual protection against the possibility
that part or all of the intended tax consequences from the
transaction will not be sustained. Such protection can include
recission rights, the right to a refund of fees, contingent
fees, insurance protection with respect to the tax treatment,
or a tax indemnity or similar agreement.\145\
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\145\ Temp. Treas. Reg. sec. 1.6011-4T(b)(4).
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The fourth category of reportable transactions relates to
any transaction resulting in, or that is reasonably expected to
result in, a taxpayer claiming a loss (under section 165) of at
least (1) $10 million in any single year or $20 million in any
combination of years by a corporate taxpayer; (2) $5 million in
any single year or $10 million in any combination of years by a
partnership or S corporation; (3) $2 million in any single year
or $4 million in any combination of years by an individual or
trust; or (4) $50,000 in any single year for individuals or
trusts if the loss arises with respect to foreign currency
translation losses.\146\
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\146\ Temp. Treas. Reg. sec. 1.6011-4T(b)(5).
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The fifth category of reportable transactions refers to any
transaction done by certain taxpayers \147\ in which the tax
treatment of the transaction differs (or is expected to differ)
by more than $10 million from its treatment for book purposes
(using generally accepted accounting principles) in any
year.\148\
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\147\ The significant book-tax category applies only to taxpayers
that are reporting companies under the Securities Exchange Act of 1934
or business entities that have $100 million or more in gross assets.
\148\ Temp. Treas. Reg. sec. 1.6011-4T(b)(6). The regulations
exempt 13 types of transactions from the book-tax reportable
transaction category. See Temp. Treas. Reg. sec. 1.6011-
4T(b)(6)(iii)(A)-(M).
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The final category of reportable transactions is any
transaction that results in a tax credit exceeding $250,000
(including a foreign tax credit) if the taxpayer holds the
underlying asset for less than 45 days.\149\
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\149\ Temp. Treas. Reg. sec. 1.6011-4T(b)(7).
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Under present law, there is no specific penalty for failing
to disclose a reportable transaction; however, such a failure
may jeopardize a taxpayer's ability to claim that any income
tax understatement attributable to such undisclosed transaction
is due to reasonable cause, and that the taxpayer acted in good
faith.\150\
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\150\Section 6664(c) provides that a taxpayer can avoid the
imposition of a section 6662 accuracy-related penalty in cases where
the taxpayer can demonstrate that there was reasonable cause for the
underpayment and that the taxpayer acted in good faith. On December 31,
2002, the Treasury Department and IRS issued proposed regulations under
sections 6662 and 6664 (REG-126016-01) that limit the defenses
available to the imposition of an accuracy-related penalty in
connection with a reportable transaction when the transaction is not
disclosed.
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reasons for change

The Committee is aware that individuals and corporations
are increasingly using sophisticated transactions to avoid or
evade Federal income tax.\151\ Such a phenomenon could pose a
serious threat to the efficacy of the tax system because of
both the potential loss of revenue and the potential threat to
the integrity of the self-assessment system.
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\151\ In this regard, the Committee has concerns with the outcomes
and rationales used by courts in some recent decisions involving tax-
motivated transactions. For a more detailed discussion of recent court
decisions and other developments regarding tax shelters, see Joint
Committee on Taxation, Background and Present Law Relating to Tax
Shelters (JCX 19-02), March 19, 2002.
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The Committee over two years ago began working on
legislation to address this significant compliance problem. In
addition, the Treasury Department, using the tools available,
issued regulations requiring disclosure of certain transactions
and requiring organizers and promoters of tax-engineered
transactions to maintain customer lists and make these lists
available to the IRS. Nevertheless, the Committee believed that
additional legislation was needed to provide the Treasury
Department with additional tools to assist its efforts to
curtail abusive transactions. Moreover, the Committee believes
that a penalty for failing to make the required disclosures,
when the imposition of such penalty is not dependent on the tax
treatment of the underlying transaction ultimately being
sustained, will provide an additional incentive for taxpayers
to satisfy their reporting obligations under the new disclosure
provisions.

EXPLANATION OF PROVISION

In general

The bill creates a new penalty for any person who fails to
include with any return or statement any required information
with respect to a reportable transaction. The new penalty
applies without regard to whether the transaction ultimately
results in an understatement of tax, and applies in addition to
any accuracy-related penalty that may be imposed.

Transactions to be disclosed

The bill does not define the terms ``listed transaction''
\152\ or ``reportable transaction,'' nor does the bill explain
the type of information that must be disclosed in order to
avoid the imposition of a penalty. Rather, the bill authorizes
the Treasury Department to define a ``listed transaction'' and
a ``reportable transaction'' under section 6011.
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\152\ The provision states that, except as provided in regulations,
a listed transaction means a reportable transaction, which is the same
as, or substantially similar to, a transaction specifically identified
by the Secretary as a tax avoidance transaction for purposes of section
6011. For this purpose, it is expected that the definition of
``substantially similar'' will be the definition used in Temp. Treas.
Reg. sec. 1.6011-4T(b)(2). However, the Secretary may modify this
definition (as well as the definitions of ``listed transaction'' and
``reportable transactions'') as appropriate.
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Penalty rate

The penalty for failing to disclose a reportable
transaction is $50,000. The amount is increased to $100,000 if
the failure is with respect to a listed transaction. For large
entities and high net worth individuals, the penalty amount is
doubled (i.e., $100,000 for a reportable transaction and
$200,000 for a listed transaction). The penalty cannot be
waived with respect to a listed transaction. As to reportable
transactions, the penalty can be rescinded or abated only if:
(1) the taxpayer on whom the penalty is imposed has a history
of complying with the Federal tax laws, (2) it is shown that
the violation is due to an unintentional mistake of fact, (3)
imposing the penalty would be against equity and good
conscience, and (4) rescinding the penalty would promote
compliance with the tax laws and effective tax administration.
The authority to rescind the penalty can only be exercised by
the IRS Commissioner personally or the head of the Office of
Tax Shelter Analysis. Thus, the penalty cannot be rescinded by
a revenue agent, an appeals officer, or any other IRS
personnel. The decision to rescind a penalty must be
accompanied by a record describing the facts and reasons for
the action and the amount rescinded. There will be no taxpayer
right to appeal a refusal to rescind a penalty. The IRS also is
required to submit an annual report to Congress summarizing the
application of the disclosure penalties and providing a
description of each penalty rescinded under this provision and
the reasons for the rescission.
A ``large entity'' is defined as any entity with gross
receipts in excess of $10 million in the year of the
transaction or in the preceding year. A ``high net worth
individual'' is defined as any individual whose net worth
exceeds $2 million, based on the fair market value of the
individual's assets and liabilities immediately before entering
into the transaction.
A public entity that is required to pay a penalty for
failing to disclose a listed transaction (or is subject to an
understatement penalty attributable to a non-disclosed listed
transaction, a non-disclosed reportable avoidance transaction,
or a transaction that lacks economic substance \153\) must
disclose the imposition of the penalty in reports to the
Securities and Exchange Commission for such period as the
Secretary shall specify. The bill applies without regard to
whether the taxpayer determines the amount of the penalty to be
material to the reports in which the penalty must appear, and
treats any failure to disclose a transaction in such reports as
a failure to disclose a listed transaction. A taxpayer must
disclose a penalty in reports to the Securities and Exchange
Commission once the taxpayer has exhausted its administrative
and judicial remedies with respect to the penalty (or if
earlier, when paid).
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\153\ These categories of transactions are described in greater
detail below in connection with the provisions modifying the accuracy-
related penalty for listed and certain reportable transactions and a
penalty for understatements attributable to transactions that lack
economic substance.
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EFFECTIVE DATE

The bill is effective for returns and statements the due
date for which is after the date of enactment.

3. Modifications to the Accuracy-Related Penalties for Listed
Transactions and Reportable Transactions Having a Significant Tax
Avoidance Purpose

(Sec. 703 of the bill and new sec. 6662A of the Code)

PRESENT LAW

The accuracy-related penalty applies to the portion of any
underpayment that is attributable to (1) negligence, (2) any
substantial understatement of income tax, (3) any substantial
valuation misstatement, (4) any substantial overstatement of
pension liabilities, or (5) any substantial estate or gift tax
valuation understatement. If the correct income tax liability
exceeds that reported by the taxpayer by the greater of 10
percent of the correct tax or $5,000 ($10,000 in the case of
corporations), then a substantial understatement exists and a
penalty may be imposed equal to 20 percent of the underpayment
of tax attributable to the understatement.\154\ The amount of
any understatement generally is reduced by any portion
attributable to an item if (1) the treatment of the item is
supported by substantial authority, or (2) facts relevant to
the tax treatment of the item were adequately disclosed and
there was a reasonable basis for its tax treatment.\155\
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\154\ Sec. 6662.
\155\ Sec. 6662(d)(2)(B).
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Special rules apply with respect to tax shelters.\156\ For
understatements by non-corporate taxpayers attributable to tax
shelters, the penalty may be avoided only if the taxpayer
establishes that, in addition to having substantial authority
for the position, the taxpayer reasonably believed that the
treatment claimed was more likely than not the proper treatment
of the item. This reduction in the penalty is unavailable to
corporate tax shelters.
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\156\ Sec. 6662(d)(2)(C).
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The understatement penalty generally is abated (even with
respect to tax shelters) in cases in which the taxpayer can
demonstrate that there was ``reasonable cause'' for the
underpayment and that the taxpayer acted in good faith.\157\
The relevant regulations provide that reasonable cause exists
where the taxpayer ``reasonably relies in good faith on an
opinion based on a professional tax advisor's analysis of the
pertinent facts and authorities [that] . . . unambiguously
concludes that there is a greater than 50-percent likelihood
that the tax treatment of the item will be upheld if
challenged'' by the IRS.\158\
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\157\ Sec. 6664(c).
\158\ Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec.
1.6664-4(c).
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REASONS FOR CHANGE

Because the Treasury shelter initiative emphasizes
combating abusive tax avoidance transactions by requiring
increased disclosure of such transactions by all parties
involved, the Committee believes that taxpayers should be
subject to a strict liability penalty on an understatement of
tax that is attributable to non-disclosed listed transactions
or non-disclosed reportable transactions that have a
significant purpose of tax avoidance. Furthermore, in order to
deter taxpayers from entering into tax avoidance transactions,
the Committee believes that a more meaningful (but less
stringent) accuracy-related penalty should apply to such
transactions even when disclosed.

EXPLANATION OF PROVISION

In general

The bill modifies the present-law accuracy related penalty
by replacing the rules applicable to tax shelters with a new
accuracy-related penalty that applies to listed transactions
and reportable transactions with a significant tax avoidance
purpose (hereinafter referred to as a ``reportable avoidance
transaction'').\159\ The penalty rate and defenses available to
avoid the penalty vary depending on the category of the
transaction (i.e., listed or reportable avoidance transaction)
and whether the transaction was adequately disclosed.
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\159\ The terms ``reportable transaction'' and ``listed
transaction'' have the same meanings as previously described in
connection with the penalty for failing to disclose reportable
transactions.
---------------------------------------------------------------------------
Disclosed transactions
In general, a 20-percent accuracy-related penalty is
imposed on any understatement attributable to an adequately
disclosed listed transaction or reportable avoidance
transaction. The only exception to the penalty is if the
taxpayer satisfies a more stringent reasonable cause and good
faith exception (hereinafter referred to as the ``strengthened
reasonable cause exception''), which is described below. The
strengthened reasonable cause exception is available only if
the relevant facts affecting the tax treatment are adequately
disclosed, there is or was substantial authority for the
claimed tax treatment, and the taxpayer reasonably believed
that the claimed tax treatment was more likely than not the
proper treatment.
Undisclosed transactions
If the taxpayer does not adequately disclose the
transaction, the strengthened reasonable cause exception is not
available (i.e., a strict-liability penalty applies), and the
taxpayer is subject to an increased penalty rate equal to 30
percent of the understatement.
In addition, a public entity that is required to pay the 30
percent penalty must disclose the imposition of the penalty in
reports to the SEC for such periods as the Secretary shall
specify. The disclosure to the SEC applies without regard to
whether the taxpayer determines the amount of the penalty to be
material to the reports in which the penalty must appear, and
any failure to disclose such penalty in the reports is treated
as a failure to disclose a listed transaction. A taxpayer must
disclose a penalty in reports to the SEC once the taxpayer has
exhausted its administrative and judicial remedies with respect
to the penalty (or if earlier, when paid).
Once the 30 percent penalty has been included in the
Revenue Agent Report, the penalty cannot be compromised for
purposes of a settlement without approval of the Commissioner
personally or the head of the Office of Tax Shelter Analysis.
Furthermore, the IRS is required to submit an annual report to
Congress summarizing the application of this penalty and
providing a description of each penalty compromised under this
provision and the reasons for the compromise.

Determination of the understatement amount

The penalty is applied to the amount of any understatement
attributable to the listed or reportable avoidance transaction
without regard to other items on the tax return. For purposes
of this bill, the amount of the understatement is determined as
the sum of (1) the product of the highest corporate or
individual tax rate (as appropriate) and the increase in
taxable income resulting from the difference between the
taxpayer's treatment of the item and the proper treatment of
the item (without regard to other items on the tax return)
\160\, and (2) the amount of any decrease in the aggregate
amount of credits which results from a difference between the
taxpayer's treatment of an item and the proper tax treatment of
such item.
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\160\ For this purpose, any reduction in the excess of deductions
allowed for the taxable year over gross income for such year, and any
reduction in the amount of capital losses which would (without regard
to section 1211) be allowed for such year, shall be treated as an
increase in taxable income.
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Except as provided in regulations, a taxpayer's treatment
of an item shall not take into account any amendment or
supplement to a return if the amendment or supplement is filed
after the earlier of when the taxpayer is first contacted
regarding an examination of the return or such other date as
specified by the Secretary.

Strengthened reasonable cause exception

A penalty is not imposed under the bill with respect to any
portion of an understatement if it shown that there was
reasonable cause for such portion and the taxpayer acted in
good faith. Such a showing requires (1) adequate disclosure of
the facts affecting the transaction in accordance with the
regulations under section 6011,\161\ (2) there is or was
substantial authority for such treatment, and (3) the taxpayer
reasonably believed that such treatment was more likely than
not the proper treatment. For this purpose, a taxpayer will be
treated as having a reasonable belief with respect to the tax
treatment of an item only if such belief (1) is based on the
facts and law that exist at the time the tax return (that
includes the item) is filed, and (2) relates solely to the
taxpayer's chances of success on the merits and does not take
into account the possibility that (a) a return will not be
audited, (b) the treatment will not be raised on audit, or (c)
the treatment will be resolved through settlement if raised.
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\161\ See the previous discussion regarding the penalty for failing
to disclose a reportable transaction.
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A taxpayer may (but is not required to) rely on an opinion
of a tax advisor in establishing its reasonable belief with
respect to the tax treatment of the item. However, a taxpayer
may not rely on an opinion of a tax advisor for this purpose if
the opinion (1) is provided by a ``disqualified tax advisor,''
or (2) is a ``disqualified opinion.''
Disqualified tax advisor
A disqualified tax advisor is any advisor who (1) is a
material advisor \162\ and who participates in the
organization, management, promotion or sale of the transaction
or is related (within the meaning of section 267 or 707) to any
person who so participates, (2) is compensated directly or
indirectly \163\ by a material advisor with respect to the
transaction, (3) has a fee arrangement with respect to the
transaction that is contingent on all or part of the intended
tax benefits from the transaction being sustained, or (4) as
determined under regulations prescribed by the Secretary, has a
continuing financial interest with respect to the transaction.
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\162\ The term ``material advisor'' (defined below in connection
with the new information filing requirements for material advisors)
means any person who provides any material aid, assistance, or advice
with respect to organizing, promoting, selling, implementing, or
carrying out any reportable transaction, and who derives gross income
in excess of $50,000 in the case of a reportable transaction
substantially all of the tax benefits from which are provided to
natural persons ($250,000 in any other case).
\163\ This situation could arise, for example, when an advisor has
an arrangement or understanding (oral or written) with an organizer,
manager, or promoter of a reportable transaction that such party will
recommend or refer potential participants to the advisor for an opinion
regarding the tax treatment of the transaction.
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Organization, management, promotion or sale of a
transaction
A material advisor is considered as participating in the
``organization'' of a transaction if the advisor performs acts
relating to the development of the transaction. This may
include, for example, preparing documents (1) establishing a
structure used in connection with the transaction (such as a
partnership agreement), (2) describing the transaction (such as
an offering memorandum or other statement describing the
transaction), or (3) relating to the registration of the
transaction with any federal, state or local government
body.\164\ Participation in the ``management'' of a transaction
means involvement in the decision-making process regarding any
business activity with respect to the transaction.
Participation in the ``promotion or sale'' of a transaction
means involvement in the marketing or solicitation of the
transaction to others. Thus, an advisor who provides
information about the transaction to a potential participant is
involved in the promotion or sale of a transaction, as is any
advisor who recommends the transaction to a potential
participant.
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\164\ An advisor should not be treated as participating in the
organization of a transaction if the advisor's only involvement with
respect to the organization of the transaction is the rendering of an
opinion regarding the tax consequences of such transaction. However,
such an advisor may be a ``disqualified tax advisor'' with respect to
the transaction if the advisor participates in the management,
promotion or sale of the transaction (or if the advisor is compensated
by a material advisor, has a fee arrangement that is contingent on the
tax benefits of the transaction, or as determined by the Secretary, has
a continuing financial interest with respect to the transaction).
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Disqualified opinion
An opinion may not be relied upon if the opinion (1) is
based on unreasonable factual or legal assumptions (including
assumptions as to future events), (2) unreasonably relies upon
representations, statements, finding or agreements of the
taxpayer or any other person, (3) does not identify and
consider all relevant facts, or (4) fails to meet any other
requirement prescribed by the Secretary.

Coordination with other penalties

Any understatement to which a penalty is imposed under this
bill is not subject to the accuracy-related penalty under
section 6662. However, such understatement is included for
purposes of determining whether any understatement (as defined
in sec. 6662(d)(2)) is a substantial understatement as defined
under section 6662(d)(1).
The penalty imposed under this provision shall not apply to
any portion of an understatement to which a fraud penalty is
applied under section 6663.

EFFECTIVE DATE

The bill is effective for taxable years ending after the
date of enactment.

4. Penalty for Understatements From Transactions Lacking Economic
Substance

(Sec. 704 of the bill and new sec. 6662B of the Code)

PRESENT LAW

An accuracy-related penalty applies to the portion of any
underpayment that is attributable to (1) negligence, (2) any
substantial understatement of income tax, (3) any substantial
valuation misstatement, (4) any substantial overstatement of
pension liabilities, or (5) any substantial estate or gift tax
valuation understatement. If the correct income tax liability
exceeds that reported by the taxpayer by the greater of 10
percent of the correct tax or $5,000 ($10,000 in the case of
corporations), then a substantial understatement exists and a
penalty may be imposed equal to 20 percent of the underpayment
of tax attributable to the understatement.\165\ The amount of
any understatement is reduced by any portion attributable to an
item if (1) the treatment of the item is supported by
substantial authority, or (2) facts relevant to the tax
treatment of the item were adequately disclosed and there was a
reasonable basis for its tax treatment.
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\165\ Sec. 6662.
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Special rules apply with respect to tax shelters.\166\ For
understatements by non-corporate taxpayers attributable to tax
shelters, the penalty may be avoided only if the taxpayer
establishes that, in addition to having substantial authority
for the position, the taxpayer reasonably believed that the
treatment claimed was more likely than not the proper treatment
of the item. This reduction in the penalty is unavailable to
corporate tax shelters.
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\166\ Sec. 6662(d)(2)(C).
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The penalty generally is abated (even with respect to tax
shelters) in cases in which the taxpayer can demonstrate that
there was ``reasonable cause'' for the underpayment and that
the taxpayer acted in good faith.\167\ The relevant regulations
provide that reasonable cause exists where the taxpayer
``reasonably relies in good faith on an opinion based on a
professional tax advisor's analysis of the pertinent facts and
authorities [that] . . . unambiguously concludes that there is
a greater than 50-percent likelihood that the tax treatment of
the item will be upheld if challenged'' by the IRS.\168\
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\167\ Sec. 6664(c).
\168\ Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec.
1.6664-4(c).
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REASONS FOR CHANGE

The Committee is concerned that many taxpayers are engaging
in tax avoidance transactions that rely on the interaction of
highly technical tax law provisions. These transactions usually
produce surprising results that were not contemplated by
Congress. Whether these transactions are respected usually
hinges on whether the transaction had sufficient economic
substance. The Committee believes that the benefits that
taxpayers potentially obtain from these transactions
significantly outweigh the potential costs of engaging in such
transactions. In addition, the Committee believes taxpayers
will continue to engage in tax avoidance transactions until the
risk and cost to the taxpayer of engaging in the transactions
is increased. Thus, the Committee believes that taxpayers
should be subject to the imposition of a substantial strict
liability penalty for transactions that are determined not have
economic substance.

EXPLANATION OF PROVISION

The bill imposes a penalty for an understatement
attributable to any transaction that lacks economic substance
(referred to in the statute as a ``non-economic substance
transaction understatement'').\169\ The penalty rate is 40
percent (reduced to 20 percent if the taxpayer adequately
discloses the relevant facts in accordance with regulations
prescribed under section 6011). No exceptions (including the
reasonable cause or rescission rules) to the penalty would be
available under the bill (i.e., the penalty is a strict-
liability penalty).
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\169\ Thus, unlike the new accuracy-related penalty under section
6662A (which applies only to listed and reportable avoidance
transactions), the new penalty under this provision applies to any
transaction that lacks economic substance.
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A ``non-economic substance transaction'' means any
transaction if (1) the transaction lacks economic substance (as
defined in the earlier provision regarding the economic
substance doctrine),\170\ (2) the transaction was not respected
under the rules relating to transactions with tax-indifferent
parties (as described in the earlier provision regarding the
economic substance doctrine),\171\ or (3) any similar rule of
law. For this purpose, a similar rule of law would include, for
example, an understatement attributable to a transaction that
is determined to be a sham transaction.
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\170\ The provision provides that a transaction has economic
substance only if: (1) the transaction changes in a meaningful way
(apart from Federal income tax effects) the taxpayer's economic
position, and (2) the transaction has a substantial non-tax purpose for
entering into such transaction and is a reasonable means of
accomplishing such purpose.
\171\ The provision provides that the form of a transaction that
involves a tax-indifferent party will not be respected in certain
circumstances.
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For purposes of this provision, the calculation of an
``understatement'' is made in the same manner as in the
separate provision relating to accuracy-related penalties for
listed and reportable avoidance transactions (new sec. 6662A).
Thus, the amount of the understatement under this provision
would be determined as the sum of (1) the product of the
highest corporate or individual tax rate (as appropriate) and
the increase in taxable income resulting from the difference
between the taxpayer's treatment of the item and the proper
treatment of the item (without regard to other items on the tax
return),\172\ and (2) the amount of any decrease in the
aggregate amount of credits which results from a difference
between the taxpayer's treatment of an item and the proper tax
treatment of such item. In essence, the penalty will apply to
the amount of any understatement attributable solely to a non-
economic substance transaction.
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\172\ For this purpose, any reduction in the excess of deductions
allowed for the taxable year over gross income for such year, and any
reduction in the amount of capital losses that would (without regard to
section 1211) be allowed for such year, would be treated as an increase
in taxable income.
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Except as provided in regulations, the taxpayer's treatment
of an item will not take into account any amendment or
supplement to a return if the amendment or supplement is filed
after the earlier of the date the taxpayer is first contacted
regarding an examination of the return or such other date as
specified by the Secretary.
A public entity that is required to pay a penalty under
this provision (regardless of whether the transaction was
disclosed) must disclose the imposition of the penalty in
reports to the SEC for such periods as the Secretary shall
specify. The disclosure to the SEC applies without regard to
whether the taxpayer determines the amount of the penalty to be
material to the reports in which the penalty must appear, and
any failure to disclose such penalty in the reports is treated
as a failure to disclose a listed transaction. A taxpayer must
disclose a penalty in reports to the SEC once the taxpayer has
exhausted its administrative and judicial remedies with respect
to the penalty (or if earlier, when paid).
Once a penalty (regardless of whether the transaction was
disclosed) has been included in the Revenue Agent Report, the
penalty cannot be compromised for purposes of a settlement
without approval of the Commissioner personally or the head of
the Office of Tax Shelter Analysis. Furthermore, the IRS is
required to submit an annual report to Congress summarizing the
application of this penalty and providing a description of each
penalty compromised under this provision and the reasons for
the compromise.
Any understatement to which a penalty is imposed under this
provision will not be subject to the accuracy-related penalty
under section 6662 or under new 6662A (accuracy-related
penalties for listed and reportable avoidance transactions).
However, an understatement under this provision would be taken
into account for purposes of determining whether any
understatement (as defined in sec. 6662(d)(2)) is a substantial
understatement as defined under section 6662(d)(1). The penalty
imposed under this provision will not apply to any portion of
an understatement to which a fraud penalty is applied under
section 6663.

EFFECTIVE DATE

The bill applies to transactions after the date of
enactment.

5. Modifications to the Substantial Understatement Penalty

(Sec. 705 of the bill and sec. 6662 of the Code)

PRESENT LAW

Definition of substantial understatement

An accuracy-related penalty equal to 20 percent applies to
any substantial understatement of tax. A ``substantial
understatement'' exists if the correct income tax liability for
a taxable year exceeds that reported by the taxpayer by the
greater of 10 percent of the correct tax or $5,000 ($10,000 in
the case of most corporations).\173\
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\173\ Sec. 6662(a) and (d)(1)(A).
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Reduction of understatement for certain positions

For purposes of determining whether a substantial
understatement penalty applies, the amount of any
understatement generally is reduced by any portion attributable
to an item if (1) the treatment of the item is supported by
substantial authority, or (2) facts relevant to the tax
treatment of the item were adequately disclosed and there was a
reasonable basis for its tax treatment.\174\
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\174\ Sec. 6662(d)(2)(B).
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The Secretary is required to publish annually in the
Federal Register a list of positions for which the Secretary
believes there is not substantial authority and which affect a
significant number of taxpayers.\175\
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\175\ Sec. 6662(d)(2)(D).
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REASONS FOR CHANGE

The Committee believes that the present-law definition of
substantial understatement allows large corporate taxpayers to
avoid the accuracy-related penalty on questionable transactions
of a significant size. The Committee believes that an
understatement of more than $10 million is substantial in and
of itself, regardless of the proportion it represents of the
taxpayer's total tax liability.
The Committee believes that a higher compliance standard
should be imposed on any taxpayer in order to reduce the amount
of an understatement resulting from a transaction that the
taxpayer did not adequately disclose. The Committee further
believes that a taxpayer should not take a position on a tax
return that could give rise to a substantial understatement
penalty that the taxpayer does not believe is more likely than
not the correct tax treatment unless this information is
disclosed to the IRS.

EXPLANATION OF PROVISION

Definition of substantial understatement

The bill modifies the definition of ``substantial'' for
corporate taxpayers. Under the bill, a corporate taxpayer has a
substantial understatement if the amount of the understatement
for the taxable year exceeds the lesser of (1) 10 percent of
the tax required to be shown on the return for the taxable year
(or, if greater, $10,000), or (2) $10 million.

Reduction of understatement for certain positions

The bill elevates the standard that a taxpayer must satisfy
in order to reduce the amount of an understatement for
undisclosed items. With respect to the treatment of an item
whose facts are not adequately disclosed, a resulting
understatement is reduced only if the taxpayer had a reasonable
belief that the tax treatment was more likely than not the
proper treatment. The bill also authorizes (but does not
require) the Secretary to publish a list of positions for which
it believes there is not substantial authority or there is no
reasonable belief that the tax treatment is more likely than
not the proper treatment (without regard to whether such
positions affect a significant number of taxpayers). The list
shall be published in the Federal Register or the Internal
Revenue Bulletin.

EFFECTIVE DATE

The bill is effective for taxable years beginning after
date of enactment.

6. Tax Shelter Exception to Confidentiality Privileges Relating to
Taxpayer Communications

(Sec. 706 of the bill and sec. 7525 of the Code)

PRESENT LAW

In general, a common law privilege of confidentiality
exists for communications between an attorney and client with
respect to the legal advice the attorney gives the client. The
Code provides that, with respect to tax advice, the same common
law protections of confidentiality that apply to a
communication between a taxpayer and an attorney also apply to
a communication between a taxpayer and a federally authorized
tax practitioner to the extent the communication would be
considered a privileged communication if it were between a
taxpayer and an attorney. This rule is inapplicable to
communications regarding corporate tax shelters.

REASONS FOR CHANGE

The Committee believes that the rule currently applicable
to corporate tax shelters should be applied to all tax
shelters, regardless of whether or not the participant is a
corporation.

EXPLANATION OF PROVISION

The bill modifies the rule relating to corporate tax
shelters by making it applicable to all tax shelters, whether
entered into by corporations, individuals, partnerships, tax-
exempt entities, or any other entity. Accordingly,
communications with respect to tax shelters are not subject to
the confidentiality provision of the Code that otherwise
applies to a communication between a taxpayer and a federally
authorized tax practitioner.

EFFECTIVE DATE

The bill is effective with respect to communications made
on or after the date of enactment.

7. Disclosure of Reportable Transactions by Material Advisors

(Secs. 707 and 708 of the bill and secs. 6111 and 6707 of the Code)

PRESENT LAW

Registration of tax shelter arrangements

An organizer of a tax shelter is required to register the
shelter with the Secretary not later than the day on which the
shelter is first offered for sale.\176\ A ``tax shelter'' means
any investment with respect to which the tax shelter ratio
\177\ for any investor as of the close of any of the first five
years ending after the investment is offered for sale may be
greater than two to one and which is: (1) required to be
registered under Federal or State securities laws, (2) sold
pursuant to an exemption from registration requiring the filing
of a notice with a Federal or State securities agency, or (3) a
substantial investment (greater than $250,000 and at least five
investors).\178\
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\176\ Sec. 6111(a).
\177\ The tax shelter ratio is, with respect to any year, the ratio
that the aggregate amount of the deductions and 350 percent of the
credits, which are represented to be potentially allowable to any
investor, bears to the investment base (money plus basis of assets
contributed) as of the close of the tax year.
\178\ Sec. 6111(c).
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Other promoted arrangements are treated as tax shelters for
purposes of the registration requirement if: (1) a significant
purpose of the arrangement is the avoidance or evasion of
Federal income tax by a corporate participant; (2) the
arrangement is offered under conditions of confidentiality; and
(3) the promoter may receive fees in excess of $100,000 in the
aggregate.\179\
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\179\ Sec. 6111(d).
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A transaction has a ``significant purpose of avoiding or
evading Federal income tax'' if the transaction: (1) is the
same as or substantially similar to a ``listed transaction,''
\180\ or (2) is structured to produce tax benefits that
constitute an important part of the intended results of the
arrangement and the promoter reasonably expects to present the
arrangement to more than one taxpayer.\181\ Certain exceptions
are provided with respect to the second category of
transactions.\182\
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\180\ Temp. Treas. Reg. sec. 301.6111-2T(b)(2).
\181\ Temp. Treas. Reg. sec. 301.6111-2T(b)(3).
\182\ Temp. Treas. Reg. sec. 301.6111-2T(b)(4).
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An arrangement is offered under conditions of
confidentiality if: (1) an offeree has an understanding or
agreement to limit the disclosure of the transaction or any
significant tax features of the transaction; or (2) the
promoter claims, knows, or has reason to know that a party
other than the potential participant claims that the
transaction (or any aspect of it) is proprietary to the
promoter or any party other than the offeree, or is otherwise
protected from disclosure or use.\183\
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\183\ The regulations provide that the determination of whether an
arrangement is offered under conditions of confidentiality is based on
all the facts and circumstances surrounding the offer. If an offeree's
disclosure of the structure or tax aspects of the transaction are
limited in any way by an express or implied understanding or agreement
with or for the benefit of a tax shelter promoter, an offer is
considered made under conditions of confidentiality, whether or not
such understanding or agreement is legally binding. Treas. Reg. sec.
301.6111-2T(c)(1).
---------------------------------------------------------------------------

Failure to register tax shelter

The penalty for failing to timely register a tax shelter
(or for filing false or incomplete information with respect to
the tax shelter registration) generally is the greater of one
percent of the aggregate amount invested in the shelter or
$500.\184\ However, if the tax shelter involves an arrangement
offered to a corporation under conditions of confidentiality,
the penalty is the greater of $10,000 or 50 percent of the fees
payable to any promoter with respect to offerings prior to the
date of late registration. Intentional disregard of the
requirement to register increases the penalty to 75 percent of
the applicable fees.
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\184\ Sec. 6707.
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Section 6707 also imposes (1) a $100 penalty on the
promoter for each failure to furnish the investor with the
required tax shelter identification number, and (2) a $250
penalty on the investor for each failure to include the tax
shelter identification number on a return.

REASONS FOR CHANGE

The Committee has been advised that the current promoter
registration rules have not proven particularly helpful,
because the rules are not appropriate for the kinds of abusive
transactions now prevalent, and because the limitations
regarding confidential corporate arrangements have proven easy
to circumvent.
The Committee believes that providing a single, clear
definition regarding the types of transactions that must be
disclosed by taxpayers and material advisors, coupled with more
meaningful penalties for failing to disclose such transactions,
are necessary tools if the effort to curb the use of abusive
tax avoidance transactions is to be effective.

EXPLANATION OF PROVISION

Disclosure of reportable transactions by material advisors

The bill repeals the present law rules with respect to
registration of tax shelters. Instead, the bill requires each
material advisor with respect to any reportable transaction
(including listed transaction) \185\ to timely file an
information return with the Secretary (in such form and manner
as the Secretary may prescribe). The return must be filed on
such date as specified by the Secretary.
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\185\ The terms ``reportable transaction'' and ``listed
transaction'' have the same meaning as previously described in
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------
The information return will include (1) information
identifying and describing the transaction, (2) information
describing any potential tax benefits expected to result from
the transaction, and (3) such other information as the
Secretary may prescribe. It is expected that the Secretary may
seek from the material advisor the same type of information
that the Secretary may request from a taxpayer in connection
with a reportable transaction.\186\
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\186\ See the previous discussion regarding the disclosure
requirements under new section 6707A.
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A ``material advisor'' means any person (1) who provides
material aid, assistance, or advice with respect to organizing,
promoting, selling, implementing, or carrying out any
reportable transaction, and (2) who directly or indirectly
derives gross income in excess of $250,000 ($50,000 in the case
of a reportable transaction substantially all of the tax
benefits from which are provided to natural persons) for such
advice or assistance.
The Secretary may prescribe regulations which provide (1)
that only one material advisor has to file an information
return in cases in which two or more material advisors would
otherwise be required to file information returns with respect
to a particular reportable transaction, (2) exemptions from the
requirements of this section, and (3) other rules as may be
necessary or appropriate to carry out the purposes of this
section (including, for example, rules regarding the
aggregation of fees in appropriate circumstances).

Penalty for failing to furnish information regarding reportable
transactions

The bill repeals the present law penalty for failure to
register tax shelters. Instead, the bill imposes a penalty on
any material advisor who fails to file an information return,
or who files a false or incomplete information return, with
respect to a reportable transaction (including a listed
transaction).\187\ The amount of the penalty is $50,000. If the
penalty is with respect to a listed transaction, the amount of
the penalty is increased to the greater of (1) $200,000, or (2)
50 percent of the gross income of such person with respect to
aid, assistance, or advice which is provided with respect to
the reportable transaction before the date the information
return that includes the transaction is filed. Intentional
disregard by a material advisor of the requirement to disclose
a reportable transaction increases the penalty to 75 percent of
the gross income.
---------------------------------------------------------------------------
\187\ The terms ``reportable transaction'' and ``listed
transaction'' have the same meaning as previously described in
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------
The penalty cannot be waived with respect to a listed
transaction. As to reportable transactions, the penalty can be
rescinded or abated only in exceptional circumstances.\188\ All
or part of the penalty may be rescinded only if: (1) the
material advisor on whom the penalty is imposed has a history
of complying with the Federal tax laws, (2) it is shown that
the violation is due to an unintentional mistake of fact, (3)
imposing the penalty would be against equity and good
conscience, and (4) rescinding the penalty would promote
compliance with the tax laws and effective tax administration.
The authority to rescind the penalty can only be exercised by
the Commissioner personally or the head of the Office of Tax
Shelter Analysis; this authority to rescind cannot otherwise be
delegated by the Commissioner. Thus, the penalty cannot be
rescinded by a revenue agent, an appeals officer, or other IRS
personnel. The decision to rescind a penalty must be
accompanied by a record describing the facts and reasons for
the action and the amount rescinded. There will be no right to
appeal a refusal to rescind a penalty. The IRS also is required
to submit an annual report to Congress summarizing the
application of the disclosure penalties and providing a
description of each penalty rescinded under this provision and
the reasons for the rescission.
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\188\ The Secretary's present-law authority to postpone certain
tax-related deadlines because of Presidentially-declared disasters
(sec. 7508A) will also encompass the authority to postpone the
reporting deadlines established by the provision.
---------------------------------------------------------------------------

EFFECTIVE DATE

The provision requiring disclosure of reportable
transactions by material advisors applies to transactions with
respect to which material aid, assistance or advice is provided
after the date of enactment.
The provision imposing a penalty for failing to disclose
reportable transactions applies to returns the due date for
which is after the date of enactment.

8. Investor Lists and Modification of Penalty for Failure To Maintain
Investor Lists

(Secs. 707 and 709 of the bill and secs. 6112 and 6708 of the Code)

PRESENT LAW

Investor lists

Any organizer or seller of a potentially abusive tax
shelter must maintain a list identifying each person who was
sold an interest in any such tax shelter with respect to which
registration was required under section 6111 (even though the
particular party may not have been subject to confidentiality
restrictions).\189\ Recently-issued temporary regulations under
section 6112 contain elaborate rules regarding the list
maintenance requirements.\190\ The regulations apply to
transactions that are potentially abusive tax shelters entered
into, or acquired after, January 1, 2003.\191\
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\189\ Sec. 6112.
\190\ Temp. Treas. Reg. sec. 301-6112-1T.
\191\ Subsequent to the issuance of the new regulations, the IRS
announced that, in order to provide necessary clarification of the list
maintenance regulations, the effective date will be changed to the date
that revised regulations under section 6112 are filed. The delayed
effective date, however, will not apply to listed transactions or
transactions that are section 6111 shelters (as defined in Treas. Reg.
sec. 301.6112-1T(b)(1)). Notice 2003-11, 2003-6 I.R.B. 1 (January 17,
2003).
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The temporary regulations, issued in October 2002, provide
that a person is an organizer or seller of a potentially
abusive tax shelter if the person is a material advisor with
respect to that transaction.\192\ A potentially abusive tax
shelter is any transaction that (1) is required to be
registered under section 6111, (2) is a listed transaction (as
defined under the new temporary regulations under section
6011), or (3) any transaction that a potential material advisor
knows or has reason to know, at the time the transaction is
entered into, is a reportable transaction (as defined under the
new temporary regulations under section 6011).\193\
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\192\ Temp. Treas. Reg. sec. 301.6112-1T(c)(1).
\193\ Temp. Treas. Reg. sec. 301.6112-1T(b).
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The temporary regulations define an organizer or a seller
of an interest with respect to a potentially abusive tax
shelter if that person is a ``material advisor.'' A material
advisor is defined any person who (directly or indirectly)
receives, or is expected to receive, a minimum fee of (1)
$250,000 for a transaction that is a potentially abusive tax
shelter if all participants are corporations, or (2) $50,000
for any other transaction that is a potentially abusive tax
shelter.\194\
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\194\ Temp. Treas. Reg. sec. 301.6112-1T(c)(1) and (2).
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The Secretary is required to prescribe regulations which
provide that, in cases in which 2 or more persons are required
to maintain the same list, only one person would be required to
maintain the list.\195\
---------------------------------------------------------------------------
\195\ Sec. 6112(c)(2).
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Penalties for failing to maintain investor lists

Under section 6708, the penalty for failing to maintain the
list required under section 6112 is $50 for each name omitted
from the list (with a maximum penalty of $100,000 per year).

REASONS FOR CHANGE

The Committee has been advised that the present-law
penalties for failure to maintain customer lists are not
meaningful and that promoters often have refused to provide
requested information to the IRS. The Committee believes that
requiring material advisors to maintain a list of advisees with
respect to each reportable transaction, coupled with more
meaningful penalties for failing to maintain an investor list,
are important tools in the ongoing efforts to curb the use of
abusive tax avoidance transactions.

EXPLANATION OF PROVISION

Investor lists

Each material advisor \196\ that is required to file an
information return with respect to a reportable transaction
(including a listed transaction) \197\ is required to maintain
a list that (1) identifies each person with respect to whom the
advisor acted as a material advisor with respect to the
reportable transaction, and (2) contains other information as
may be required by the Secretary. In addition, the bill
authorizes (but does not require) the Secretary to prescribe
regulations which provide that, in cases in which 2 or more
persons are required to maintain the same list, only one person
would be required to maintain the list.
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\196\ The term ``material advisor'' has the same meaning as when
used in connection with the requirement to file an information return
under section 6111.
\197\ The terms ``reportable transaction'' and ``listed
transaction'' have the same meaning as previously described in
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------

Penalty for failing to maintain investor lists

The bill modifies the penalty for failing to maintain the
required list by making it a time-sensitive penalty. Thus, a
material advisor who is required to maintain an investor list
and who fails to make the list available upon request by the
Secretary within 20 business days after the request will be
subject to a $10,000 per day penalty. The penalty applies to a
person who fails to maintain a list, maintains an incomplete
list, or has in fact maintained a list but does not make the
list available to the Secretary. The penalty can be waived if
the failure to make the list available is due to reasonable
cause.\198\
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\198\ In no event will failure to maintain a list be considered
reasonable cause for failing to make a list available to the Secretary.
---------------------------------------------------------------------------

EFFECTIVE DATE

The provision requiring a material advisor to maintain an
investor list applies to transactions with respect to which
material aid, assistance or advice is provided after the date
of enactment.
The provision imposing a penalty for failing to maintain
investor lists applies to requests made after the date of
enactment.

9. Actions To Enjoin Conduct With Respect to Tax Shelters and
Reportable Transactions

(Sec. 710 of the bill and sec. 7408 of the Code)

PRESENT LAW

The Code authorizes civil action to enjoin any person from
promoting abusive tax shelters or aiding or abetting the
understatement of tax liability.\199\
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\199\ Sec. 7408.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee understands that some promoters are blatantly
ignoring the rules regarding registration and list maintenance
regardless of the penalties. An injunction would place these
promoters in a public proceeding under court order. Thus, the
Committee believes that the types of tax shelter activities
with respect to which an injunction may be sought should be
expanded.

EXPLANATION OF PROVISION

The bill expands this rule so that injunctions may also be
sought with respect to the requirements relating to the
reporting of reportable transactions \200\ and the keeping of
lists of investors by material advisors.\201\ Thus, under the
bill, an injunction may be sought against a material advisor to
enjoin the advisor from (1) failing to file an information
return with respect to a reportable transaction, or (2) failing
to maintain, or to timely furnish upon written request by the
Secretary, a list of investors with respect to each reportable
transaction.
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\200\ Sec. 6707, as amended by other provisions of this bill.
\201\ Sec. 6708, as amended by other provisions of this bill.
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EFFECTIVE DATE

The bill is effective on the day after the date of
enactment.

10. Understatement of Taxpayer's Liability by Income Tax Return
Preparer

(Sec. 711 of the bill and sec. 6694 of the Code)

PRESENT LAW

An income tax return preparer who prepares a return with
respect to which there is an understatement of tax that is due
to a position for which there was not a realistic possibility
of being sustained on its merits and the position was not
disclosed (or was frivolous) is liable for a penalty of $250,
provided that the preparer knew or reasonably should have known
of the position. An income tax return preparer who prepares a
return and engages in specified willful or reckless conduct
with respect to preparing such a return is liable for a penalty
of $1,000.

REASONS FOR CHANGE

The Committee believes that the standards of conduct
applicable to income tax return preparers should be the same as
the standards applicable to taxpayers. Accordingly, the minimum
standard for each undisclosed position on a tax return would be
that the preparer must reasonably believe that the tax
treatment is more likely than not the proper tax treatment. The
Committee believes that this standard is appropriate because
the tax return is signed under penalties of perjury, which
implies a high standard of diligence in determining the facts
and substantial accuracy in determining and applying the rules
that govern those facts. The Committee believes that it is both
appropriate and vital to the tax system that both taxpayers and
their return preparers file tax returns that they reasonably
believe are more likely than not correct. In addition,
conforming the standards of conduct applicable to income tax
return preparers to the standards applicable to taxpayers will
simplify the law by reducing confusion inherent in different
standards applying to the same behavior.

EXPLANATION OF PROVISION

The bill alters the standards of conduct that must be met
to avoid imposition of the first penalty. The bill replaces the
realistic possibility standard with a requirement that there be
a reasonable belief that the tax treatment of the position was
more likely than not the proper treatment. The bill also
replaces the not frivolous standard with the requirement that
there be a reasonable basis for the tax treatment of the
position.
In addition, the bill increases the amount of these
penalties. The penalty relating to not having a reasonable
belief that the tax treatment was more likely than not the
proper tax treatment is increased from $250 to $1,000. The
penalty relating to willful or reckless conduct is increased
from $1,000 to $5,000.

EFFECTIVE DATE

The bill is effective for documents prepared after the date
of enactment.

11. Penalty for Failure To Report Interests in Foreign Financial
Accounts

(Sec. 712 of the bill and sec. 5321 of Title 31, United States Code)

PRESENT LAW

The Secretary of the Treasury must require citizens,
residents, or persons doing business in the United States to
keep records and file reports when that person makes a
transaction or maintains an account with a foreign financial
entity.\202\ In general, individuals must fulfill this
requirement by answering questions regarding foreign accounts
or foreign trusts that are contained in Part III of Schedule B
of the IRS Form 1040. Taxpayers who answer ``yes'' in response
to the question regarding foreign accounts must then file
Treasury Department Form TD F 90-22.1. This form must be filed
with the Department of the Treasury, and not as part of the tax
return that is filed with the IRS.
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\202\ 31 U.S.C. 5314.
---------------------------------------------------------------------------
The Secretary of the Treasury may impose a civil penalty on
any person who willfully violates this reporting requirement.
The civil penalty is the amount of the transaction or the value
of the account, up to a maximum of $100,000; the minimum amount
of the penalty is $25,000.\203\ In addition, any person who
willfully violates this reporting requirement is subject to a
criminal penalty. The criminal penalty is a fine of not more
than $250,000 or imprisonment for not more than five years (or
both); if the violation is part of a pattern of illegal
activity, the maximum amount of the fine is increased to
$500,000 and the maximum length of imprisonment is increased to
10 years.\204\
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\203\ 31 U.S.C. 5321(a)(5).
\204\ 31 U.S.C. 5322.
---------------------------------------------------------------------------
On April 26, 2002, the Secretary of the Treasury submitted
to the Congress a report on these reporting requirements.\205\
This report, which was statutorily required,\206\ studies
methods for improving compliance with these reporting
requirements. It makes several administrative recommendations,
but no legislative recommendations. A further report was
required to be submitted by the Secretary of the Treasury to
the Congress by October 26, 2002.
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\205\ A Report to Congress in Accordance with Sec. 361(b) of the
Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001, April 26,
2002.
\206\ Sec. 361(b) of the USA PATRIOT Act of 2001 (Pub. L. 107-56).
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee understands that the number of individuals
involved in using offshore bank accounts to engage in abusive
tax scams has grown significantly in recent years. For one
scheme alone, the IRS estimates that there may be one to two
million taxpayers with offshore bank accounts attempting to
conceal income from the IRS. The Committee is concerned about
this activity and believes that improving compliance with this
reporting requirement is vitally important to sound tax
administration, to combating terrorism, and to preventing the
use of abusive tax schemes and scams. Adding a new civil
penalty that applies without regard to willfulness will improve
compliance with this reporting requirement.

EXPLANATION OF PROVISION

The bill adds an additional civil penalty that may be
imposed on any person who violates this reporting requirement
(without regard to willfulness). This new civil penalty is up
to $5,000. The penalty may be waived if any income from the
account was properly reported on the income tax return and
there was reasonable cause for the failure to report.

EFFECTIVE DATE

The bill is effective with respect to failures to report
occurring on or after the date of enactment.

12. Frivolous Tax Returns and Submissions

(Sec. 713 of the bill and sec. 6702 of the Code)

PRESENT LAW

The Code provides that an individual who files a frivolous
income tax return is subject to a penalty of $500 imposed by
the IRS (sec. 6702). The Code also permits the Tax Court \207\
to impose a penalty of up to $25,000 if a taxpayer has
instituted or maintained proceedings primarily for delay or if
the taxpayer's position in the proceeding is frivolous or
groundless (sec. 6673(a)).
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\207\ Because in general the Tax Court is the only pre-payment
forum available to taxpayers, it deals with most of the frivolous,
groundless, or dilatory arguments raised in tax cases.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The IRS has been faced with a significant number of tax
filers who are filing returns based on frivolous arguments or
who are seeking to hinder tax administration by filing returns
that are patently incorrect. In addition, taxpayers are using
existing procedures for collection due process hearings,
offers-in-compromise, installment agreements, and taxpayer
assistance orders to impede or delay tax administration by
raising frivolous arguments. These procedures were intended to
provide assistance to taxpayers genuinely seeking to resolve
legitimate disputes with the IRS, and the use of these
procedures for impeding or delaying tax administration diverts
scarce IRS resources away from resolving genuine disputes.
Allowing the IRS to assert more substantial penalties for
frivolous submissions and to dismiss frivolous requests without
the need to follow otherwise mandated procedures will deter
frivolous taxpayer behavior and enable the IRS to use its
resources to better assist taxpayers in resolving genuine
disputes.

EXPLANATION OF PROVISION

The bill modifies the IRS-imposed penalty by increasing the
amount of the penalty to up to $5,000 and by applying it to all
taxpayers and to all types of Federal taxes.
The bill also modifies present law with respect to certain
submissions that raise frivolous arguments or that are intended
to delay or impede tax administration. The submissions to which
this provision applies are requests for a collection due
process hearing, installment agreements, offers-in-compromise,
and taxpayer assistance orders. First, the bill permits the IRS
to dismiss such requests. Second, the bill permits the IRS to
impose a penalty of up to $5,000 for such requests, unless the
taxpayer withdraws the request after being given an opportunity
to do so.
The bill requires the IRS to publish a list of positions,
arguments, requests, and submissions determined to be frivolous
for purposes of these provisions.

EFFECTIVE DATE

The bill is effective for submissions made and issues
raised after the date on which the Secretary first prescribes
the required list.

13. Regulation of Individuals Practicing Before the Department of the
Treasury

(Sec. 714 of the bill and sec. 330 of Title 31, United States Code)

PRESENT LAW

The Secretary of the Treasury is authorized to regulate the
practice of representatives of persons before the Department of
the Treasury.\208\ The Secretary is also authorized to suspend
or disbar from practice before the Department a representative
who is incompetent, who is disreputable, who violates the rules
regulating practice before the Department, or who (with intent
to defraud) willfully and knowingly misleads or threatens the
person being represented (or a person who may be represented).
The rules promulgated by the Secretary pursuant to this
provision are contained in Circular 230.
---------------------------------------------------------------------------
\208\ 31 U.S.C. 330.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that it is critical that the
Secretary have the authority to censure tax advisors as well as
to impose monetary sanctions against tax advisors because of
the important role of tax advisors in our tax system. Use of
these sanctions is expected to curb the participation of tax
advisors in both tax shelter activity and any other activity
that is contrary to Circular 230 standards.

EXPLANATION OF PROVISION

The bill makes two modifications to expand the sanctions
that the Secretary may impose pursuant to these statutory
provisions. First, the bill expressly permits censure as a
sanction. Second, the bill permits the imposition of a monetary
penalty as a sanction. If the representative is acting on
behalf of an employer or other entity, the Secretary may impose
a monetary penalty on the employer or other entity if it knew,
or reasonably should have known, of the conduct. This monetary
penalty on the employer or other entity may be imposed in
addition to any monetary penalty imposed directly on the
representative. These monetary penalties are not to exceed the
gross income derived (or to be derived) from the conduct giving
rise to the penalty. These monetary penalties may be in
addition to, or in lieu of, any suspension, disbarment, or
censure.
The bill also confirms the present-law authority of the
Secretary to impose standards applicable to written advice with
respect to an entity, plan, or arrangement that is of a type
that the Secretary determines as having a potential for tax
avoidance or evasion.

EFFECTIVE DATE

The modifications to expand the sanctions that the
Secretary may impose are effective for actions taken after the
date of enactment.

14. Penalties on Promoters of Tax Shelters

(Sec. 715 of the bill and sec. 6700 of the Code)

PRESENT LAW

A penalty is imposed on any person who organizes, assists
in the organization of, or participates in the sale of any
interest in, a partnership or other entity, any investment plan
or arrangement, or any other plan or arrangement, if in
connection with such activity the person makes or furnishes a
qualifying false or fraudulent statement or a gross valuation
overstatement.\209\ A qualified false or fraudulent statement
is any statement with respect to the allowability of any
deduction or credit, the excludability of any income, or the
securing of any other tax benefit by reason of holding an
interest in the entity or participating in the plan or
arrangement which the person knows or has reason to know is
false or fraudulent as to any material matter. A ``gross
valuation overstatement'' means any statement as to the value
of any property or services if the stated value exceeds 200
percent of the correct valuation, and the value is directly
related to the amount of any allowable income tax deduction or
credit.
---------------------------------------------------------------------------
\209\ Sec. 6700.
---------------------------------------------------------------------------
The amount of the penalty is $1,000 (or, if the person
establishes that it is less, 100 percent of the gross income
derived or to be derived by the person from such activity). A
penalty attributable to a gross valuation misstatement can be
waived on a showing that there was a reasonable basis for the
valuation and it was made in good faith.

REASONS FOR CHANGE

The Committee believes that the present-law penalty rate is
insufficient to deter the type of conduct that gives rise to
the penalty.

EXPLANATION OF PROVISION

The bill modifies the penalty amount to equal 50 percent of
the gross income derived by the person from the activity for
which the penalty is imposed. The new penalty rate applies to
any activity that involves a statement regarding the tax
benefits of participating in a plan or arrangement if the
person knows or has reason to know that such statement is false
or fraudulent as to any material matter. The enhanced penalty
does not apply to a gross valuation overstatement.

EFFECTIVE DATE

The bill is effective for activities after the date of
enactment.

15. Extend Statute of Limitations for Certain Undisclosed Transactions

(Sec. 716 of the bill and sec. 6501 of the Code)

PRESENT LAW

In general, the Code requires that taxes be assessed within
three years \210\ after the date a return is filed.\211\ If
there has been a substantial omission of items of gross income
that total more than 25 percent of the amount of gross income
shown on the return, the period during which an assessment must
be made is extended to six years.\212\ If an assessment is not
made within the required time periods, the tax generally cannot
be assessed or collected at any future time. Tax may be
assessed at any time if the taxpayer files a false or
fraudulent return with the intent to evade tax or if the
taxpayer does not file a tax return at all.\213\
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\210\ Sec. 6501(a).
\211\ For this purpose, a return that is filed before the date on
which it is due is considered to be filed on the required due date
(sec. 6501(b)(1)).
\212\ Sec. 6501(e).
\213\ Sec. 6501(c).
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that extending the statute of
limitations if a taxpayer required to disclose a listed
transaction fails to do so will encourage taxpayers to provide
the required disclosure and will afford the IRS additional time
to discover the transaction if the taxpayer does not disclose
it.

EXPLANATION OF PROVISION

The bill extends the statute of limitations to six years
with respect to the entire tax return \214\ if a taxpayer
required to disclose a listed transaction \215\ fails to do so
in the manner required. For example, if a taxpayer entered into
a transaction in 2005 that becomes a listed transaction in 2006
and the taxpayer fails to disclose such transaction in the
manner required by Treasury regulations, the 2005 tax return
will be subject to a six-year statute of limitations.\216\
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\214\ The tax year extended is the tax year the transaction is
entered into.
\215\ The term ``listed transaction'' has the same meaning as
described in a previous provision regarding the penalty for failure to
disclose reportable transactions.
\216\ However, if the Treasury Department lists a transaction in a
year subsequent to the year a taxpayer entered into such transaction,
and the taxpayer's tax return for the year the transaction was entered
into is closed by the statute of limitations prior to the transaction
becoming a listed transaction, this provision does not re-open the
statute of limitations for such year.
---------------------------------------------------------------------------

EFFECTIVE DATE

The bill is effective for transactions entered into in
taxable years beginning after the date of enactment.

16. Deny Deduction for Interest Paid to IRS on Underpayments Involving
Certain Tax-Motivated Transactions

(Sec. 717 of the bill and sec. 163 of the Code)

PRESENT LAW

In general, corporations may deduct interest paid or
accrued within a taxable year on indebtedness.\217\ Interest on
indebtedness to the Federal government attributable to an
underpayment of tax generally may be deducted pursuant to this
provision.
---------------------------------------------------------------------------
\217\ Sec. 163(a).
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that it is inappropriate for
corporations to deduct interest paid to the Government with
respect to certain tax shelter transactions.

EXPLANATION OF PROVISION

The bill disallows any deduction for interest paid or
accrued within a taxable year on any portion of an underpayment
of tax that is attributable to an understatement arising from
(1) an undisclosed reportable avoidance transaction, (2) an
undisclosed listed transaction, or (3) a transaction that lacks
economic substance.\218\
---------------------------------------------------------------------------
\218\ The definitions of these transactions are the same as those
previously described in connection with the provision to modify the
accuracy-related penalty for listed and certain reportable transactions
and the provision to impose a penalty on understatements attributable
to transactions that lack economic substance.
---------------------------------------------------------------------------

EFFECTIVE DATE

The bill is effective for underpayments attributable to
transactions entered into in taxable years beginning after the
date of enactment.

17. Authorize Additional $300 Million Per Year to the IRS To Combat
Abusive Tax Avoidance Transactions

(Sec. 718 of the bill)

PRESENT LAW

There is no explicit authorization of appropriations to the
Internal Revenue Service to be used to combat abusive tax
avoidance transactions.

REASONS FOR CHANGE

The Committee believes that authorizing an additional $300
million to the Internal Revenue Service to be used to combat
abusive tax avoidance transactions will aid in the
implementation of the tax shelter measures the Committee is
simultaneously approving.

EXPLANATION OF PROVISION

The bill includes an authorization of an additional $300
million to the Internal Revenue Service to be used to combat
abusive tax avoidance transactions.

EFFECTIVE DATE

The provision is effective on the date of enactment.

B. Other Provisions

1. Affirmation of Consolidated Return Regulation Authority

(Sec. 721 of the bill and sec. 1502 of the Code)

PRESENT LAW

An affiliated group of corporations may elect to file a
consolidated return in lieu of separate returns. A condition of
electing to file a consolidated return is that all corporations
that are members of the consolidated group must consent to all
the consolidated return regulations prescribed under section
1502 prior to the last day prescribed by law for filing such
return.\219\
---------------------------------------------------------------------------
\219\ Sec. 1501.
---------------------------------------------------------------------------
Section 1502 states:

The Secretary shall prescribe such regulations as he
may deem necessary in order that the tax liability of
any affiliated group of corporations making a
consolidated return and of each corporation in the
group, both during and after the period of affiliation,
may be returned, determined, computed, assessed,
collected, and adjusted, in such manner as clearly to
reflect the income-tax liability and the various
factors necessary for the determination of such
liability, and in order to prevent the avoidance of
such tax liability.\220\
---------------------------------------------------------------------------
\220\ Sec. 1502.
---------------------------------------------------------------------------
Under this authority, the Treasury Department has issued
extensive consolidated return regulations.\221\
---------------------------------------------------------------------------
\221\ Regulations issued under the authority of section 1502 are
considered to be ``legislative'' regulations rather than
``interpretative'' regulations, and as such are usually given greater
deference by courts in case of a taxpayer challenge to such a
regulation. See, S. Rep. No. 960, 70th Cong., 1st Sess. at 15,
describing the consolidated return regulations as ``legislative in
character''. The Supreme Court has stated that ``* * * legislative
regulations are given controlling weight unless they are arbitrary,
capricious, or manifestly contrary to the statute.'' Chevron, U.S.A.,
Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844
(1984) (involving an environmental protection regulation). For examples
involving consolidated return regulations, see, e.g., Wolter
Construction Company v. Commissioner, 634 F.2d 1029 (6th Cir. 1980);
Garvey, Inc. v. United States, 1 Ct. Cl. 108 (1983), aff'd 726 F.2d
1569 (Fed. Cir. 1984), cert. denied 469 U.S. 823 (1984). Compare, e.g.,
Audrey J. Walton v. Commissioner, 115 T.C. 589 (2000), describing
different standards of review. The case did not involve a consolidated
return regulation.
---------------------------------------------------------------------------
In the recent case of Rite Aid Corp. v. United States,\222\
the Federal Circuit Court of Appeals addressed the application
of a particular provision of certain consolidated return loss
disallowance regulations, and concluded that the provision was
invalid.\223\ The particular provision, known as the
``duplicated loss'' provision,\224\ would have denied a loss on
the sale of stock of a subsidiary by a parent corporation that
had filed a consolidated return with the subsidiary, to the
extent the subsidiary corporation had assets that had a built-
in loss, or had a net operating loss, that could be recognized
or used later.\225\
---------------------------------------------------------------------------
\222\ 255 F.3d 1357 (Fed. Cir. 2001), reh'g denied, 2001 U.S. App.
LEXIS 23207 (Fed. Cir. Oct. 3, 2001).
\223\ Prior to this decision, there had been a few instances
involving prior laws in which certain consolidated return regulations
were held to be invalid. See, e.g., American Standard, Inc. v. United
States, 602 F.2d 256 (Ct. Cl. 1979), discussed in the text infra. see
also Union Carbide Corp. v. United States, 612 F.2d 558 (Ct. Cl. 1979),
and Allied Corporation v. United States, 685 F. 2d 396 (Ct. Cl. 1982),
all three cases involving the allocation of income and loss within a
consolidated group for purposes of computation of a deduction allowed
under prior law by the Code for Western Hemisphere Trading
Corporations. See also Joseph Weidenhoff v. Commissioner, 32 T.C. 1222,
1242-1244 (1959), involving the application of certain regulations to
the excess profits tax credit allowed under prior law, and concluding
that the Commissioner had applied a particular regulation in an
arbitrary manner inconsistent with the wording of the regulation and
inconsistent with even a consolidated group computation. Cf. Kanawha
Gas & Utilities Co. v. Commissioner, 214 F.2d 685 (1954), concluding
that the substance of a transaction was an acquisition of assets rather
than stock. Thus, a regulation governing basis of the assets of
consolidated subsidiaries did not apply to the case. See also General
Machinery Corporation v. Commissioner, 33 B.T.A. 1215 (1936); Lefcourt
Realty Corporation, 31 B.T.A. 978 (1935); Helvering v. Morgans, Inc.,
293 U.S. 121 (1934), interpreting the term ``taxable year.''
\224\ Treas. Reg. Sec. 1.1502-20(c)(1)(iii).
\225\ Treasury Regulation section 1.1502-20, generally imposing
certain ``loss disallowance'' rules on the disposition of subsidiary
stock, contained other limitations besides the ``duplicated loss'' rule
that could limit the loss available to the group on a disposition of a
subsidiary's stock. Treasury Regulation section 1.1502-20 as a whole
was promulgated in connection with regulations issued under section
337(d), principally in connection with the so-called General Utilities
repeal of 1986 (referring to the case of General Utilities & Operating
Company v. Helvering, 296 U.S. 200 (1935)). Such repeal generally
required a liquidating corporation, or a corporation acquired in a
stock acquisition treated as a sale of assets, to pay corporate level
tax on the excess of the value of its assets over the basis. Treasury
regulation section 1.1502-20 principally reflected an attempt to
prevent corporations filing consolidated returns from offsetting income
with a loss on the sale of subsidiary stock. Such a loss could result
from the unique upward adjustment of a subsidiary's stock basis
required under the consolidated return regulations for subsidiary
income earned in consolidation, an adjustment intended to prevent
taxation of both the subsidiary and the parent on the same income or
gain. As one example, absent a denial of certain losses on a sale of
subsidiary stock, a consolidated group could obtain a loss deduction
with respect to subsidiary stock, the basis of which originally
reflected the subsidiary's value at the time of the purchase of the
stock, and that had then been adjusted upward on recognition of any
built-in income or gain of the subsidiary reflected in that value. The
regulations also contained the duplicated loss factor addressed by the
court in Rite Aid. The preamble to the regulations stated: ``it is not
administratively feasible to differentiate between loss attributable to
built-in gain and duplicated loss.'' T.D. 8364, 1991-2 C.B. 43, 46
(Sept. 13, 1991). The government also argued in the Rite Aid case that
duplicated loss was a separate concern of the regulations. 255 F.3d at
1360.
---------------------------------------------------------------------------
The Federal Circuit Court opinion contained language
discussing the fact that the regulation produced a result
different than the result that would have obtained if the
corporations had filed separate returns rather than
consolidated returns.\226\
---------------------------------------------------------------------------
\226\ For example, the court stated: ``The duplicated loss factor *
* * addresses a situation that arises from the sale of stock regardless
of whether corporations file separate or consolidated returns. With
I.R.C. secs. 382 and 383, Congress has addressed this situation by
limiting the subsidiary's potential future deduction, not the parent's
loss on the sale of stock under I.R.C. sec. 165.'' 255 F.3d 1357, 1360
(Fed. Cir. 2001).
---------------------------------------------------------------------------
The Federal Circuit Court opinion cited a 1928 Senate
Finance Committee Report to legislation that authorized
consolidated return regulations, which stated that ``many
difficult and complicated problems, * * * have arisen in the
administration of the provisions permitting the filing of
consolidated returns'' and that the committee ``found it
necessary to delegate power to the commissioner to prescribe
regulations legislative in character covering them.'' \227\ The
Court's opinion also cited a previous decision of the Court of
Claims for the proposition, interpreting this legislative
history, that section 1502 grants the Secretary ``the power to
conform the applicable income tax law of the Code to the
special, myriad problems resulting from the filing of
consolidated income tax returns;'' but that section 1502 ``does
not authorize the Secretary to choose a method that imposes a
tax on income that would not otherwise be taxed.'' \228\
---------------------------------------------------------------------------
\227\ S. Rep. No. 960, 70th Cong., 1st Sess. 15 (1928). Though not
quoted by the court in Rite Aid, the same Senate report also indicated
that one purpose of the consolidated return authority was to permit
treatment of the separate corporations as if they were a single unit,
stating ``The mere fact that by legal fiction several corporations
owned by the same shareholders are separate entities should not obscure
the fact that they are in reality one and the same business owned by
the same individuals and operated as a unit.'' S. Rep. No. 960, 70th
Cong., 1st Sess. 29 (1928).
\228\ American Standard, Inc. v. United States, 602 F.2d 256, 261
(Ct. Cl. 1979). That case did not involve the question of separate
returns as compared to a single return approach. It involved the
computation of a Western Hemisphere Trade Corporation (``WHTC'')
deduction under prior law (which deduction would have been computed as
a percentage of each WHTC's taxable income if the corporations had
filed separate returns), in a case where a consolidated group included
several WHTCs as well as other corporations. The question was how to
apportion income and losses of the admittedly consolidated WHTCs and
how to combine that computation with the rest of the group's
consolidated income or losses. The court noted that the new, changed
regulations approach varied from the approach taken to a similar
problem involving public utilities within a group and previously
allowed for WHTCs. The court objected that the allocation method
adopted by the regulation allowed non-WHTC losses to reduce WHTC
income. However, the court did not disallow a method that would net
WHTC income of one WHTC with losses of another WHTC, a result that
would not have occurred under separate returns. Nor did the court
expressly disallow a different fractional method that would net both
income and losses of the WHTCs with those of other corporations in the
consolidated group. The court also found that the regulation had been
adopted without proper notice.
---------------------------------------------------------------------------
The Federal Circuit Court construed these authorities and
applied them to invalidate Treas. Reg. Sec. 1.1502-
20(c)(1)(iii), stating that:

The loss realized on the sale of a former
subsidiary's assets after the consolidated group sells
the subsidiary's stock is not a problem resulting from
the filing of consolidated income tax returns. The
scenario also arises where a corporate shareholder
sells the stock of a non-consolidated subsidiary. The
corporate shareholder could realize a loss under I.R.C.
sec. 1001, and deduct the loss under I.R.C. sec. 165.
The subsidiary could then deduct any losses from a
later sale of assets. The duplicated loss factor,
therefore, addresses a situation that arises from the
sale of stock regardless of whether corporations file
separate or consolidated returns. With I.R.C. secs. 382
and 383, Congress has addressed this situation by
limiting the subsidiary's potential future deduction,
not the parent's loss on the sale of stock under I.R.C.
sec. 165.\229\
---------------------------------------------------------------------------
\229\ Rite Aid, 255 F.3d at 1360.

The Treasury Department has announced that it will not
continue to litigate the validity of the duplicated loss
provision of the regulations, and has issued interim
regulations that permit taxpayers for all years to elect a
different treatment, though they may apply the provision for
the past if they wish.\230\
---------------------------------------------------------------------------
\230\ See Temp. Reg. 1.1502-20T(i)(2). The Treasury Department has
also indicated its intention to continue to study all the issues that
the original loss disallowance regulations addressed (including issues
of furthering single entity principles) and possibly issue different
regulations (not including the particular approach of Treas. Reg. Sec.
1.1502-20(c)(1)(iii)) on the issues in the future. See Notice 2002-11,
2002-7 I.R.B. 526 (Feb. 19, 2002); T.D. 8984, 67 F.R. 11034 (March 12,
2002); REG-102740-02, 67 F.R. 11070 (March 12, 2002); see also Notice
2002-18, 2002-12 I.R.B. 644 (March 25, 2002).
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee is concerned that the language and analysis
in the Rite Aid decision might lead taxpayers to attempt to
challenge other Treasury consolidated return regulations that
prescribe a tax result different from the result that would
occur if separate returns were filed.
The Committee is concerned that any such challenges may
lead to protracted litigation and commitment of Internal
Revenue Service resources to defending the consolidated return
provisions.
The Committee wishes to clarify that the fact that a result
under the consolidated return regulations differs from the
result under separate returns does not provide a basis to
challenge a Treasury consolidated return regulation.
The Committee believes that the result of the case with
respect to the type of factual situation in Rite Aid, involving
the ``duplicated loss factor'' portion of Treasury Regulation
section 1.1502-20, which Treasury has announced that taxpayers
need not follow, should not be overturned. Therefore, the
committee legislatively allows the specific result of the case
to stand for the taxpayer in Rite Aid or any similarly situated
taxpayers.
Apart from that specific result, the Committee disagrees
with the reasoning of the case and believes it should not be
applied to support any challenge to other consolidated return
regulations. The Committee also wishes to reaffirm the broad
authority of the Treasury Department to issue consolidated
return regulations.

EXPLANATION OF PROVISION

The bill confirms that, in exercising its authority under
section 1502 to issue consolidated return regulations, the
Treasury Department may provide rules treating corporations
filing consolidated returns differently from corporations
filing separate returns.
Thus, under the statutory authority of section 1502, the
Treasury Department is authorized to issue consolidated return
regulations utilizing either a single taxpayer or separate
taxpayer approach or a combination of the two approaches, as
Treasury deems necessary in order that the tax liability of any
affiliated group of corporations making a consolidated return,
and of each corporation in the group, both during and after the
period of affiliation, may be determined and adjusted in such
manner as clearly to reflect the income-tax liability and the
various factors necessary for the determination of such
liability, and in order to prevent avoidance of such liability.
Rite Aid is thus overruled to the extent it suggests that
there is not a problem that can be addressed in consolidated
return regulations if application of a particular Code
provision on a separate taxpayer basis would produce a result
different from single taxpayer principles that may be used for
consolidation.
The bill nevertheless allows the result of the Rite Aid
case to stand with respect to the type of factual situation
presented in the case. That is, the legislation provides for
the override of the regulatory provision that took the approach
of denying a loss on a deconsolidating disposition of stock of
a consolidated subsidiary \231\ to the extent the subsidiary
had net operating losses or built in losses that could be used
later outside the group.\232\
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\231\ Treas. Reg. Sec. 1.1502-20(c)(1)(iii).
\232\ The provision is not intended to overrule the current
Treasury Department regulations, which allow taxpayers for the past to
follow Treasury Regulations Section 1.1502-20(c)(1)(iii), if they
choose to do so. Temp. Reg. Sec. 1.1502-20T(i)(2).
---------------------------------------------------------------------------
Retaining the result in the Rite Aid case with respect to
the particular regulation section 1.1502-20(c)(1)(iii) as
applied to the factual situation of the case does not in any
way prevent or invalidate the various approaches Treasury has
announced it will apply or that it intends to consider in lieu
of the approach of that regulation, including, for example, the
denial of a loss on a stock sale if inside losses of a
subsidiary may also be used by the consolidated group, and the
possible requirement that inside attributes be adjusted when a
subsidiary leaves a group.\233\
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\233\ See, e.g., Notice 2002-11, 2002-7 I.R.B. 526 (Feb. 19, 2002);
T.D. 8984, 67 F.R. 11034 (Mar. 12, 2002); REG-102740-02, 67 F.R. 11070
(Mar. 12, 2002); see also Notice 2002-18, 2002-12 I.R.B. 644 (Mar. 25,
2002). In exercising its authority under section 1502, the Secretary is
also authorized to prescribe rules that protect the purpose of General
Utilities repeal using presumptions and other simplifying conventions.
---------------------------------------------------------------------------

EFFECTIVE DATE

The bill is effective for all years, whether beginning
before, on, or after the date of enactment of the bill.
No inference is intended that the results following from
this provision are not the same as the results under present
law.

2. Chief Executive Officer Required To Sign Corporate Income Tax
Returns

(Sec. 722 of the bill and sec. 6062 of the Code)

PRESENT LAW

The Code requires \234\ that the income tax return of a
corporation must be signed by either the president, the vice-
president, the treasurer, the assistant treasurer, the chief
accounting officer, or any other officer of the corporation
authorized by the corporation to sign the return.
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\234\ Sec. 6062.
---------------------------------------------------------------------------
The Code also imposes \235\ a criminal penalty on any
person who willfully signs any tax return under penalties of
perjury that that person does not believe to be true and
correct with respect to every material matter at the time of
filing. If convicted, the person is guilty of a felony; the
Code imposes a fine of not more than $100,000 \236\ ($500,000
in the case of a corporation) or imprisonment of not more than
three years, or both, together with the costs of prosecution.
---------------------------------------------------------------------------
\235\ Sec. 7206.
\236\ Pursuant to 18 U.S.C. 3571, the maximum fine for an
individual convicted of a felony is $250,000.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that the filing of accurate tax
returns is essential to the proper functioning of the tax
system. The Committee believes that requiring that the chief
executive officer of a corporation sign its corporate income
tax returns will elevate the level of care given to the
preparation of those returns.

EXPLANATION OF PROVISION

The bill requires that the chief executive officer of a
corporation sign that corporation's income tax returns. If the
corporation does not have a chief executive officer, the IRS
may designate another officer of the corporation; otherwise, no
other person is permitted to sign the income tax return of a
corporation. The Committee intends that the IRS issue general
guidance, such as a revenue procedure, to (1) address
situations when a corporation does not have a chief executive
officer, and (2) define who the chief executive officer is, in
situations (for example) when the primary official bears a
different title or when a corporation has multiple chief
executive officers. The Committee intends that, in every
instance, the highest ranking corporate officer (regardless of
title) sign the tax return.
The provision does not apply to the income tax returns of
mutual funds; \237\ they are required to be signed as under
present law.
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\237\ The provision does, however, apply to the income tax returns
of mutual fund management companies and advisors.
---------------------------------------------------------------------------

EFFECTIVE DATE

The provision is effective for returns filed after the date
of enactment.

III. BUDGET EFFECTS OF THE BILL

A. Committee Estimates

In compliance with paragraph 11(a) of rule XXVI of the
Standing Rules of the Senate, the following statement is made
concerning the estimated budget effects of the provisions of
the bill as reported.

ESTIMATED BUDGET EFFECTS OF THE ``CARE ACT OF 2003,'' AS REPORTED BY THE COMMITTEE ON FINANCE
[Fiscal years 2003-2013, millions of dollars]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Provision Effective 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2003-08 2003-13
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
I. Charitable Giving
Incentive Provisions

1. Provide charitable tyba 12/31/02 &. -204 -1,368 -1,218 ......... ......... ......... ......... ......... ......... ......... ......... -2,790 -2,790
contribution deduction for tybb 1/1/05.....
non-itemizers with cash
contributions in excess of
$250 for individuals and
$500 for joint returns; cap
on deduction of $250 for
individuals and $500 for
joint returns.
2. Tax-free distributions DOE &........... -48 -156 -248 -270 -258 -244 -231 -247 -352 -450 -471 -1,223 -2,974
from IRAs for charitable tyba 12/31/03...
purposes--taxpayer must have
attained age 70\1/2\ for
contributions made directly
to a charitable organization
and age 59\1/2\ for
contributions to a split-
interest entity.
3. Extend present-law section cma DOE......... -59 -154 -173 -185 -193 -201 -209 -217 -225 -234 -246 -965 -2,094
170(e)(3) deduction for food
inventory to all businesses
and provide special basis
rule for certain taxpayers;
modify the enhanced
deduction for charitable
contributions of donations
of food inventory to equal
the lesser of the item's
fair market value or twice
basis.
4. Enhanced charitable cma DOE......... -8 -17 -19 -21 -23 -25 -28 -31 -33 -37 -41 -113 -283
deduction for contributions
of book inventories, with
special fair market value
rule.
5. Expand charitable generally....... -1 -67 -133 -63 -1 -1 -1 -1 -1 -1 -1 -266 -271
contribution allowed for tyba 12/31/02...
scientific property used for
research and for computer
technology and equipment;
and temporary extension of
enhanced deduction for
qualified computer
contributions (through 12/31/
05).
6. Encourage contributions of cma DOE......... -3 -5 -9 -13 -16 -23 -32 -41 -51 -62 -75 -70 -332
capital gain real property
made for conservation
purposes.
7. 25% capital gain exclusion soeoa DOE....... -4 -21 -40 -59 -62 -65 -69 -72 -76 -80 -84 -251 -632
for sales or exchanges of
land or interest in land or
water to eligible entities
for conservation purposes.
8. Exclusion for government pra DOE......... -1 -2 -2 -3 -3 -3 -3 -3 -3 -3 -3 -12 -26
payments under Partners for
Fish and Wildlife Program.
9. Adjustment to basis of S cma DOE......... -8 -22 -30 -33 -37 -41 -45 -50 -55 -62 -68 -172 -453
corporation stock for
certain charitable
contributions.
10. Enhanced deduction for cma DOE......... -2 -4 -4 -5 -5 -6 -6 -6 -7 -7 -7 -26 -59
certain charitable
contributions of literary,
musical, artistic, and
scholarly compositions.
11. Certain mileage tyba DOE........ (\1\) (\1\) (\1\) (\1\) (\1\) (\1\) (\1\) (\1\) (\1\) (\1\) (\1\) -1 -3
reimbursements to charitable
volunteers excluded from
gross income.
12. Provide an equal enhanced cma 12/31/03.... ......... -17 -28 -31 -34 -38 -41 -46 -50 -55 -59 -148 -399
deduction for qualified
corporate contributions of
inventory to public schools
as currently allowed for
contributions to private
schools; computer technology
and equipment are not
eligible property.
------------------------------------------------------------------------------------------------------------------------------------------------
Total of Charitable ................ -338 -1,833 -1,904 -683 -632 -647 -665 -714 -853 -991 -1,055 -6,037 -10,316
Giving Incentive
Provisions.
================================================================================================================================================
II. Provisions to Improve
Oversight of Tax-Exempt
Organizations

1. Disclosure of written wdia DOE........ Negligible Revenue Effect
determinations.
2. Disclosure of name under rfa 12/31/03.... Negligible Revenue Effect
which an organization does
business and its Internet
Web site.
3. Modification to private rfa 12/31/03.... Negligible Revenue Effect
foundation reporting of
capital transactions.
4. Disclosure that Form 990 pomiora DOE..... Negligible Revenue Effect
is publicly available.
5. Disclosure to State DOE............. Negligible Revenue Effect
officials of certain tax
information related to
certain section 501(c)
organizations.
6. Expansion of penalties to dpa DOE......... Negligible Revenue Effect
preparers of Form 990.
7. Notification requirement fapba 12/31/03.. Negligible Revenue Effect
for exempt entities not
currently required to file.
8. Suspension of tax-exempt (\2\)........... Negligible Revenue Effect Total Rule
status of terrorist
organizations.
------------------------------------------------------------------------------------------------------------------------------------------------
Total of Provisions to ................ Negligible Revenue Effect
Improve Oversight of
Tax-Exempt
Organizations.
III. Other Charitable and
Exempt Organization
Provisions

1. Modify tax on unrelated tyba 12/31/02... - -4 -4 -5 -5 -5 -5 -6 -6 -6 -7 -23 -53
business taxable income of
charitable remainder trusts.
2. Modify tax treatment of proaa 12/31/00.. -32 -12 -13 -13 -14 -15 -16 -17 -18 -20 -21 -99 -191
certain payments to
controlling exempt
organizations.
3. Simplification of lobbying tyba 12/31/02... -1 -1 -1 -1 -1 -1 -2 -2 -2 -2 -3 -7 -15
expenditure limitation.
4. Expedited review process afa 12/31/03.... Negligible Revenue Effect
for certain tax-exemption
applications.
5. Clarification of DOE............. No Revenue Effect
definition of church tax
inquiry.
6. Extension of declaratory dma 12/31/03.... Negligible Revenue Effect
judgment procedures to non-
501(c)(3) tax-exempt
organizations.
7. Definition of convention DOE............. Negligible Revenue Effect
or association of churches.
8. Provide that certain pma DOE & pmb... Negligible Revenue Effect
payments by charitable 9/11/04; \3\....
organizations made by reason
of the death, injury,
wounding, or illness of
military personnel incurred
as a result of the war on
terrorism and astronauts
killed in the line of duty
(no sunset) are deemed
consistent with exempt
purposes.
9. Increase percentage limits gma DOE......... ......... -6 -9 -11 -12 -14 -15 -17 -19 -22 -25 -52 -150
for certain employer-related
scholarship programs under
Revenue Procedure 76-47 to
35% of eligible applicants
or 20% of eligible students.
10. Treatment of certain iia 12/31/03.... ......... -8 -16 -18 -19 -20 -20 -21 -22 -23 -23 -80 -189
hospital organizations as
qualified organizations for
purposes of determining
acquisition indebtedness.
11. Charitable contribution cma 12/31/03.... ......... (\1\) (\1\) (\1\) (\1\) (\1\) (\1\) (\1\) (\1\) (\1\) (\1\) -1 -4
deduction for certain
expenses in support of
Native Alaska subsistence
whaling.
12. Matching grants to low- DOE............. No Revenue Effect
income taxpayer clinics for
return preparation.
------------------------------------------------------------------------------------------------------------------------------------------------
Total of Other ................ -33 -31 -43 -48 -51 -55 -58 -63 -67 -73 -79 -262 -602
Charitable and Exempt
Organization
Provisions.
================================================================================================================================================
IV. Restoration of Social (\5\)........... -238 -946 -278 23 16 27 20 ......... ......... ......... ......... -1,395 -1,375
Services Block Grant Funding
(outlays) \4\.
V. Individual Development tyea 12/31/04 &. ......... ......... -24 -44 -39 -61 -76 -90 -104 -48 (\1\) -169 -487
Accounts--provide a tax tybb 1/1/12.....
credit to eligible entities
with respect to the first
300,000 individual
development accounts
established for low-income
workers.
VI. Management of Exempt DOE............. No Revenue Effect
Organizations.
VII. Revenue Provisions

A. Provisions to Curtail
Tax Shelters:
1. Clarification of ta 2/15/04...... -258 552 1,119 1,042 927 965 1,079 1,213 1,395 1,607 1,848 4,347 11,490
the economic
substance doctrine
and related penalty
provisions.
2. Provisions various dates... 35 92 115 119 120 124 131 139 150 164 179 604 1,366
relating to after DOE \6\...
reportable
transactions and tax
shelters.
3. Modification to ta DOE.......... ......... ......... 4 11 19 23 26 30 34 38 38 57 223
the substantial
understatement
penalty \7\.
4. Actions to enjoin DOE............. Negligible Revenue Effect
conduct with respect
to tax shelters.
5. Understatement of dpa DOE......... Negligible Revenue Effect
taxpayer's liability
by income tax return
preparer.
6. Impose a civil DOE............. (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) 1 3
penalty (of up to
$5,000) on failure
to report interest
in foreign financial
accounts.
7. Frivolous tax (\9\)........... 1 3 3 3 3 3 3 3 3 3 3 16 31
submissions.
8. Regulation of ata DOE......... No Revenue Effect
individuals
practicing before
the Department of
Treasury.
9. Amend Code section tyba DOE........ ......... ......... ......... 1 1 1 1 1 1 1 1 3 8
6501 to provide for
6-year statute of
limitations for
undisclosed listed
transactions.
10. Amend Code tyba DOE........ ......... ......... ......... 1 1 3 4 4 4 4 4 5 25
section 163 to
disallow a deduction
for deficiency
interest paid to the
IRS on underpayments
involving tax
motivated
transactions.
11. Additional $300 DOE............. No Revenue Effect
million tax law
enforcement
authorization for
the IRS \4\.
B. Other Provisions:
1. Affirmation of (\10\).......... Negligible Revenue Effect
consolidated return
regulation authority.
2. Require CEO rfa DOE......... Negligible Revenue Effect
signatures on income
tax returns.
------------------------------------------------------------------------------------------------------------------------------------------------
Total of Revenue ................ -222 647 1,241 1,177 1,071 1,119 1,244 1,390 1,587 1,817 2,073 5,033 13,146
Provisions.
================================================================================================================================================
Net Total.............. ................ -831 -2,163 -1,008 425 365 383 465 523 563 705 939 -2,830 366
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Loss of less than $500,000.
\2\ Effective for organizations that are designated or identified as a terrorist organization prior to, on, or after the date of enactment.
\3\ Effective for payments made after December 31, 2002, with respect to astronauts killed in the line of duty after December 31, 2002.
\4\ Estimate provided by the Congressional Budget Office.
\5\ Effective for amounts made available for fiscal year 2003 and for amounts made available each fiscal year thereafter. The proposal requiring annual reports would be with respect to fiscal
year 2002 and each fiscal year thereafter.
\6\ Effective dates for provisions relating to reportable transactions and tax shelters: the penalty for failure to disclose reportable transactions is effective for returns and statements the
due date of which is after the date of enactment; the modification to the accuracy-related penalty for listed or reportable transactions is effective for taxable years ending after the date
of enactment; the tax shelter exception to confidentiality privileges is effective for communications made on or after the date of enactment; the material advisor disclosure provisions
applies to transactions with respect to which material aid, assistance or advice is provided after the date of enactment; the investor list provision applies to transactions with respect to
which material aid, assistance or advice is provided after the date of enactment, and the penalty on promoters of tax shelters is effective for activities after the date of enactment.
\7\ Failure or substantial delay of forthcoming regulations for section 6011 of the Internal Revenue Code and other administrative actions to be taken by the Treasury Department or the
Internal Revenue Service would reduce the estimated revenue effects of these provisions.
\8\ Gain of less than $1 million.
\9\ Effective for submissions made and issues raised after the first list is prescribed under section 6702(c).
\10\ Effective for all taxable years, whether beginning before, with, or after the date of enactment.

Legend for ``Effective'' column: afa = applications filed after; ata = actions taken after; bia = bonds issued after; cma = contributions made after; dma = determinations made after; DOE =
date of enactment; dpa = documents prepared after; fapba = for annual periods beginning after; gma = grants made after; iia = indebtedness incurred after; pma = payments made after; pmb =
payments made before; pra = payments received after; pomiora = publications or materials issued or revised after; proaa = payments received or accrued after; rfa = returns filed after; soeoa
= sales or exchanges occurring after; ta = transactions after; tyba = taxable years beginning after; tybb = taxable years beginning before; tyea = taxable years ending after; and wdia =
written determinations issued after.

Note.--Details may not add to totals due to rounding.

Source: Joint Committee on Taxation.

B. Budget Authority and Tax Expenditures

Budget authority

In compliance with section 308(a)(1) of the Budget Act, the
Committee states that the revenue provisions of the bill as
reported involve new or increased budget authority.

Tax expenditures

In compliance with section 308(a)(2) of the Budget Act, the
Committee states that the revenue-reducing provisions of the
bill involve increased tax expenditures (see revenue table in
Part III.A., above). The revenue increasing provisions of the
bill involve reduced expenditures (see revenue table in Part
III.A., above).

C. Consultation with Congressional Budget Office

In accordance with section 403 of the Budget Act, the
Committee advises that the Congressional Budget Office
submitted the following statement on this bill.

U.S. Congress,
Congressional Budget Office,
Washington, DC, February 20, 2003.
Hon. Charles E. Grassley,
Chairman, Committee on Finance,
U.S. Senate, Washington, DC.
Dear Mr. Chairman: The Congressional Budget Office has
prepared the enclosed cost estimate for S. 256, the CARE Act of
2003.
If you wish further details on this estimate, we will be
pleased to provide them. The CBO staff contacts are Annabelle
Bartsch (for federal revenues) and Sheila Dacey (for federal
spending).
Sincerely,
Douglas Holtz-Eakin,
Director.
Enclosure.
U.S. Congress,
Congressional Budget Office,
Washington, DC, February 25, 2003.
Hon. Charles E. Grassley,
Chairman, Committee on Finance,
U.S. Senate, Washington, DC.
Dear Mr. Chairman: The Congressional Budget Office has
prepared the enclosed cost estimate for the CARE Act of 2003 as
ordered reported by the Senate Committee on Finance. This
estimate supersedes the one CBO provided on February 20, 2003,
which identified the bill as S. 256. Because the Committee is
now planning to report an original bill, this estimate deletes
any reference to S. 256. CBO's estimate of the budgetary impact
of the Care Act is unchanged.
If you wish further details on this estimate, we will be
pleased to provide them. The CBO staff contacts are Annabelle
Bartsch (for federal revenues) and Sheila Dacey (for federal
spending.
Sincerely,
Douglas Holtz-Eakin,
Director.
Enclosure.

CARE Act of 2003

Summary: The Care Act would provide taxpayers with several
incentives for charitable giving, restrict tax-shelter
activity, increase funding for the Social Services Block Grant
(SSBG), and increase the amount that could be transferred from
the Temporary Assistance to Needy Families (TANF) program to
SSBG.
CBO and the Joint Committee on Taxation (JCT) estimate that
enacting the bill would decrease governmental receipts by $596
million in 2003 and by about $1.7 billion over the 2003-2008
period. Over the 2003-2013 period, however, enacting the
legislation would increase governmental receipts by about $1.5
billion. The bill also would increase direct spending by $76
million in 2003, and $1.4 billion over the 2003-2008 period
(with a comparable total for the 2003-2013 period).
The bill also would authorize the appropriation of $83
million in 2003 and $491 million over the 2003-2008 period for
administering an expanded Individual Development Account (IDA)
program and handling filing of tax-exempt organizations.
Assuming that those amounts are appropriated, CBO estimates
that the resulting outlays would be $439 million over the 2003-
2008 period.
CBO has reviewed title IV of the bill and has determined
that it contains no intergovernmental mandates as defined in
the Unfunded Mandates Reform Act (UMRA). That title would
benefit states by increasing their ability to transfer TANF
funds to SSBG and also by increasing funding for SSBG in 2003
and 2004. JCT has determined that the remaining provisions of
the bill contain no intergovernmental mandates as defined in
UMRA and would not affect the budgets of state, local, or
tribal governments.
JCT has determined that the provisions relating to tax
shelters contain private-sector mandates. The total cost of
complying with those mandates would exceed the threshold
established by UMRA ($117 million in 2003, adjusted annually
for inflation). CBO has determined that title IV of the bill
contains no private-sector mandates as defined in UMRA.
Estimated cost to the Federal Government: The estimated
budgetary impact of the Care Act is shown in Table 1. All
revenue estimates were provided by JCT. The spending under the
bill falls in budget functions 500 (education, training,
employment, and social services), 600 (income security), and
800 (general government).
Basis of estimate: For this estimate, CBO assumes the CARE
Act will be enacted in the spring of 2003 and that the
authorized amounts will be appropriated for each year. These
estimates would change if the bill were enacted later in the
year. We estimated the bill's budgetary effect using CBO's
January 2003 baseline assumptions, updated to reflect
legislation that has cleared the Congress, particularly the
Consolidated Appropriations Resolution, 2003 (Public Law 108-
10).

Revenues

All estimates were provided by JCT. A number of provisions
would reduce revenues, and several would increase revenues. All
together, the bill's provisions would reduce governmental
receipts by $596 million in 2003 and by about $1.7 billion over
the 2003-2008 period. Over the 2003-2013 period, however,
enacting the legislation would increase revenues by about $1.5
billion.
Most of the revenue reductions would occur from the
provisions that allow tax-free distributions from individual
retirement accounts (IRAs) for charitable purposes, a 25
percent exclusion of capital gains for sales of land or water
for conservation purposes, and the deduction of a certain
amount of charitable contributions by taxpayers who do not
itemize. Other provisions that would reduce revenues include
enhancing deductions for contributions of food inventories,
adjusting the tax basis of certain stock for charitable
contributions, and providing a tax credit to eligible financial
entities for matching contributions to Individual Development
Accounts made by certain low-income workers. These provisions
together would reduce revenues by $326 million in 2003, by
about $5.7 billion over the 2003-2008 period, and by about $9.6
billion over the 2003-2013 period. The remaining provisions to
provide incentives to increase charitable giving would decrease
receipts by $48 million in 2003, by about $1.0 billion over the
2003-2008 period, and by about $2.1 billion over the 2003-2013
period.

TABLE 1.--ESTIMATED BUDGETARY IMPACT OF THE CARE ACT OF 2003
----------------------------------------------------------------------------------------------------------------
By fiscal year, in millions of dollars--
-----------------------------------------------------------------
2003 2004 2005 2006 2007 2008
----------------------------------------------------------------------------------------------------------------
Changes in Revenue

Estimated Revenues............................ -596 -1,252 -750 310 277 347

Changes in Direct Spending

Increased SSBG Funding:
Budget Authority.......................... 275 1,100 0 0 0 0
Estimated Outlays......................... 110 990 231 44 0 0
TANF Effect of New SSBG Funding:
Budget Authority.......................... 0 0 0 0 0 0
Estimated Outlays......................... -34 -114 25 41 46 36
Increased Transfer Authority from TANF to
SSBG:
Budget Authority.......................... 0 0 0 0 0 0
Estimated Outlays......................... 0 114 84 -82 -49 -50
Total Changes in Direct Spending:
Budget Authority...................... 275 1,100 0 0 0 0
Estimated Outlays..................... 76 990 340 3 -3 -14

Changes in Spending Subject to Appropriations

Individual Development Accounts:
Authorization Level....................... 0 4 1 1 1 1
Estimated Outlays......................... 0 1 1 1 1 2
Tax-Exempt Organizations:
Authorization Level....................... 83 80 80 80 80 80
Estimated Outlays......................... 23 90 80 80 80 80
Total:
Authorization Level....................... 83 84 81 81 81 81
Estimated Outlays......................... 23 91 81 81 81 82
----------------------------------------------------------------------------------------------------------------
Notes.--SSBG=Social Services Block Grant. TANF=Temporary Assistance to Needy Families.

Most of the revenue increases would result from provisions
restricting tax-shelter activity. The provision clarifying the
economic substance doctrine and the related penalty provisions
would decrease revenues by $258 million in 2003, but would
increase revenues by about $4.3 billion over the 2003-2008
period and $11.5 billion over the 2003-2013 period. The
remaining provisions, which relate to reportable transactions
and tax shelters and modifications of the substantial
understatement penalty and certain other penalties, would
increase revenues by $36 million in 2003, by $686 million over
the 2003-2008 period, and by about $1.7 billion over the 2003-
2013 period.

TABLE 2.--ESTIMATED REVENUE EFFECTS OF THE CARE ACT OF 2003
----------------------------------------------------------------------------------------------------------------
By fiscal year, in millions of dollars--
-----------------------------------------------------------------
2003 2004 2005 2006 2007 2008
----------------------------------------------------------------------------------------------------------------
Major Revenue Reducers

Charitable Contribution Deduction for -204 -1,368 -1,218 0 0 0
Nonitemizers.................................
Tax-Free Distributions from IRAs for -48 -156 -248 -270 -258 -244
Charitable Purposes..........................
Enhanced Deductions for Contributions to Food -59 -154 -173 -185 -193 -201
Inventories..................................
25 percent Exclusion of Capital Gains Taxes -7 -56 -60 -67 -70 -74
for Sales of Land or Water for Conservation
purposes.....................................
Adjustment to Basis of S Corporation Stock for -8 -22 -30 -33 -37 -41
Certain Charitable Contributions.............
Tax Credit for IDA Program Expansion.......... 0 0 -24 -44 -39 -61
Other Provisions.............................. -48 -143 -238 -268 -197 -151
-----------------------------------------------------------------
Subtotal................................ -374 -1,899 -1,991 -867 -794 -772
=================================================================
Major Revenue Raisers

Clarification of the Economic Substance -258 552 1,119 1,042 927 965
Doctrine and Related Penalty Provisions......
Provisions Relating to Reportable Transactions 35 92 115 119 120 124
and Tax Shelters.............................
Other Provisions.............................. 1 3 7 16 24 30
-----------------------------------------------------------------
Subtotal................................ -222 647 1,241 1,177 1,071 1,119
=================================================================
Net Effect on Revenues

Estimated Revenues............................ -596 -1,252 -750 -310 -277 -347
----------------------------------------------------------------------------------------------------------------
Notes.--components may not sum to totals because of rounding. IRA = Individual Retirement Account. IDA =
Individual Development Account.

Direct Spending

Title IV would increase the funding level for the Social
Services Block Grant in 2003 and 2004 and raise the percentage
of the TANF grant that states could transfer to SSBG. SSBG is
permanently authorized at $1.7 billion annually. Title IV would
increase funding for 2003 to $1.975 billion and for 2004 to
$2.8 billion. Funding would return to $1.7 billion in 2005 and
later. CBO estimates that states would spend the new funds a
little more slowly than regular SSBG funds, raising outlays by
$76 million in 2003 and about $1.4 billion over the 2003-2008
period. Title IV also would allow states to maintain the
authority to transfer up to 10 percent of TANF funds to SSBG.
That authority is scheduled to fall to 4.25 percent in 2004 and
after. In recent years, states have transferred about $1
billion annually.
Those provisions would affect TANF spending in two ways.
First, the additional SSBG spending would tend to reduce the
incentives for TANF transfers to SSBG. CBO estimates that
change would lower TANF spending by $148 million over the 2003-
2004 period, but raise it by a similar amount over the 2005-
2008 period. Second, maintaining the transfer authority at the
higher level would make it easier for states to spend their
TANF grants and would tend to accelerate spending relative to
current law. (Based on recent state transfers, CBO expects that
states would transfer an additional $400 million in 2004 under
the provision, but because some of this money would have been
spent within the TANF program anyway, only $114 million of
additional spending would occur in 2004.) The combined effect
of the provisions would be to increase net TANF spending over
the 2003-2008 period by $17 million, but lower it by 417
million over the 2009-2013 period. Thus, there would be no net
impact on TANF spending over the 11-year period as a whole.

Spending Subject to Appropriation

Title V would augment the existing Individual Development
Account program by providing an IDA tax credit to qualified
financial institutions for matching the IDA savings of low-
income individuals. The effect of those tax credits on reducing
federal revenues is estimated to total $168 million over the
2005-2008 period. (Those effects were included in the totals
discussed in the earlier section on revenues.) The bill also
would authorize the appropriation of $2.5 million for a report
on cost and outcomes of IDAs and $1 million in each year 2004
through 2011 for other administrative activities. Assuming
appropriation of the authorized amounts, CBO estimates outlays
of $1 million in 2004, $6 million over the 2004-2008 period,
and $10 million over the eight-year period.
The bill also would disregard any funds in IDA accounts for
purposes of qualifying individuals for federal means-tested
programs. It is possible that expanding the IDA program could
allow certain people with assets to participate in means-tested
programs who would otherwise be ineligible, but CBO estimates
that would have an insignificant effect (less than $500,000 a
year) on federal spending. While there are limited data on
current IDA participants, the available information indicates
most participants would not deposit enough into their accounts
to disqualify themselves from any federal means-tested program.
Title VI would authorize the annual appropriation of $80
million for the Internal Revenue Service for its administrative
costs related to filing of tax-exempt organizations. it would
authorize $3 million in fiscal year 2003 for the Department of
Treasury for its administrative costs related to filing of
section 527 political organizations.
Assuming the appropriation of the authorized amounts, CBO
estimates that implementing those provisions would cost $23
million in 2003 and $433 million over the 2003-2008 period.
Estimated Impact on state, local, and tribal governments:
CBO has reviewed title IV of the bill and has determined that
it contains no intergovernmental mandates as defined in UMRA.
That title would benefit states by increasing their ability to
transfer TANF funds to SSBG and also by increasing funding for
SSBG in 2003 and 2004.
JCT has determined that the remaining provisions of the
bill contain no intergovernmental mandates as defined in UMRA
and would not affect the budgets of state, local, or tribal
governments.
Estimated impact on the private sector: JCT has determined
that the provisions relating to tax shelters contain private-
sector mandates, and that the direct cost of complying with
those mandates would exceed the threshold established by UMRA
($117 million in 2003, adjusted annually for inflation), in
2003 and thereafter. CBO has determined that title IV of the
bill contains no private-sector mandates as defined in UMRA.
Previous CBO estimate: On February 20, 2003, CBO
transmitted a cost estimate for the CARE Act of 2003 as ordered
reported by the Senate Committee on Finance on February 5,
2003. CBO's estimate of the budgetary impact of the CARE Act of
2003 is unchanged. This estimate deletes any reference to S.
256 as the bill number of the CARE Act ordered reported by the
Senate Finance Committee.
Estimate prepared by: Federal Revenues: Annabelle Bartsch.
Federal Spending: Social Services Block Grant: Sheila Dacy;
Individual Development Accounts: Donna Wong; and Department of
Treasury: Matthew Pickford. Impact on State, Local, and Tribal
Governments: Leo Lex. Impact on the Private Sector: Kate
Bloniarz.
Estimate approved by: Peter H. Fontaine, Deputy Director
for Budget Analysis; and G. Thomas Woodward, Assistant Director
for Tax Analysis.

IV. VOTES OF THE COMMITTEE

In compliance with paragraph 7(b) of rule XXVI of the
Standing Rules of the Senate, the following statements are made
concerning the votes taken on the Committee's consideration of
the bill.

Motion to report the bill

The bill was ordered favorably reported by a voice vote, a
quorum being present, on February 5, 2003.

Votes on amendments

An amendment by Senator Baucus to require the chief
executive officer of a corporation to sign that corporation's
income tax return was agreed to by a voice vote.

V. REGULATORY IMPACT AND OTHER MATTERS

A. Regulatory Impact

Pursuant to paragraph 11(b) of Rule XXVI of the Standing
Rules of the Senate, the Committee makes the following
statement concerning the regulatory impact that might be
incurred in carrying out the provisions of the bill as amended.

Impact on individuals and businesses

With respect to the provisions that do not increase
revenue, the committee amendment to the bill modifies the rules
relating to (1) certain charitable giving incentives; (2)
disclosure of information relating to tax-exempt organizations;
(3) tax treatment and procedures relating to exempt
organizations; (4) restoration of funds for the Social Services
Block Grant; and (5) individual development accounts. Under
these provisions, taxpayers may elect whether to avail
themselves of the provisions. The Social Services Block Grant
provisions provide increased funding to States to support a
variety of social services, the low-income taxpayer clinic
provision authorize grants by the Secretary of the Treasury,
and the management of exempt organization provisions authorize
certain appropriations. Thus, the provisions do not impose
increased regulatory burdens on individuals or businesses.
With respect to the revenue-increasing provisions, the
committee amendment to the bill modifies the rules relating to
(1) the disclosure of reportable transactions and tax shelters;
(2) the substantial understatement penalty; (3) actions to
enjoin conduct with respect to tax shelters; (4) an
understatement of a taxpayer's liability by an income tax
return preparer; (5) the imposition of a civil penalty (of up
to $5,000) on a failure to report interest in foreign financial
accounts; and (6) frivolous tax submissions. These provisions
relate to taxpayers that engage in certain tax avoidance
transactions. Taxpayers that have not undertaken or planned to
undertake such transactions generally are not affected by the
provisions of the bill. Thus, the revenue provisions generally
do not impose increased regulatory burdens on individuals or
businesses.

Impact on personal privacy and paperwork

The provisions of the bill do not impact personal privacy.
Individuals either elect whether to avail themselves of the
provisions of the bill or are subject to the bill for engaging
in certain tax avoidance transactions. The bill does not impose
increased paperwork burdens on individuals. Individuals who
elect to take advantage of provisions in the bill may in some
cases need to keep records in order to demonstrate that they
qualify for the treatment provided. Individuals who elect to
engage in tax avoidance transactions, and certain advisors who
provide material aid, assistance, or advice with respect to
such transactions, may in some cases need to file certain
disclosure statements with the IRS.

B. Unfunded Mandates Statement

The information is provided in accordance with section 423
of the Unfunded Mandates Reform Act of 1995 (P.L. 104-4).
The Committee has determined that the following provisions
of the bill contain Federal mandates on the private sector: (1)
provisions relating to reportable transactions and tax
shelters; (2) modifications to the substantial understatement
penalty; (3) actions to enjoin conduct with respect to tax
shelters; (4) understatement of taxpayer's liability by an
income tax return preparer; (5) the imposition of a civil
penalty (of up to $5,000) on a failure to report interest in
foreign financial accounts; and (6) frivolous tax submissions.
The costs required to comply with each Federal private
sector mandate generally are no greater than the estimated
budget effect of the provision. Benefits from the provisions
include improved administration of the Federal income tax laws
and a more accurate measurement of income for Federal income
tax purposes.

C. Tax Complexity Analysis

Section 4022(b) of the Internal Revenue Service Reform and
Restructuring Act of 1998 (the ``IRS Reform Act'') requires the
Joint Committee on Taxation (in consultation with the Internal
Revenue Service and the Department of the Treasury) to provide
a tax complexity analysis. The complexity analysis is required
for all legislation reported by the Senate Committee on
Finance, the House Committee on Ways and Means, or any
committee of conference if the legislation includes a provision
that directly or indirectly amends the Internal Revenue Code
(the ``Code'') and has widespread applicability to individuals
or small businesses. For each such provision identified by the
staff of the Joint Committee on Taxation, a summary description
of the provision is provided, along with an estimate of the
number and type of affected taxpayers, and a discussion
regarding the relevant complexity and administrative issues.
Following the analysis of the staff of the Joint Committee on
Taxation are the comments of the IRS regarding each provision
included in the complexity analysis, including a discussion of
the likely effect on IRS forms and any expected impact on the
IRS.

Direct charitable deduction for nonitemizers (sec. 101 of the bill)

Summary description of provision
In the case of an individual taxpayer who does not itemize
deductions, the bill would allow a direct charitable deduction
from adjusted gross income for charitable contributions paid in
cash. This deduction would be allowed in addition to the
standard deduction. The deduction would be available only for
that portion of contributions that in the aggregate exceed $250
($500 in the case of a joint return). The maximum deduction
would be $250 ($500 in the case of a joint return). The direct
charitable deduction generally would be subject to the tax
rules normally governing charitable contribution deductions,
such as the substantiation requirements. The deduction would be
allowed in computing alternative minimum taxable income. The
direct charitable deduction would be effective for taxable
years beginning after December 31, 2002, and before January 1,
2005.
Number of affected taxpayers
It is estimated that the provision will affect
approximately 30 million individual income tax returns each
year the deduction is in effect.
Discussion
Individuals who do not itemize their deductions will need
to keep additional records (e.g., canceled checks, a receipt
from the donee organization, or other reliable written records)
in order to substantiate that a contribution was made to a
qualified charitable organization. The information necessary to
implement the provision should be readily available to
taxpayers (in the form of new tax return forms and
instructions). The direct charitable deduction is expected to
require an additional line on the individual income tax return
forms. The provision might result in an increase in disputes
with the IRS for taxpayers who are unable to substantiate a
claimed deduction. Additional regulatory guidance will not be
necessary to implement this provision. Any increase in tax
preparation costs is expected be negligible.

Department of the Treasury,
Internal Revenue Service,
Washington, DC, February 10, 2003.
Ms. Lindy L. Paull,
Chief of Staff, Joint Committee on Taxation,
Washington, DC.
Dear Ms. Paul: Enclosed are the combined comments of the
Internal Revenue Service and the Treasury Department on the
provision for a charitable deduction for non-itemizers from the
Senate Finance Committee's markup of the ``CARE Act of 2003,''
that you identified for complexity analysis in your letter of
February 5, 2003. Our comments are based on the description of
that provision in you letter and in JCX-04-03, Joint Committee
on Taxation, Description of the CARE Act of 2003, February 3,
2003.
Due to the short turnaround time, our comments are
provisional and subject to change upon a more complete and in-
depth analysis of the provision.
Sincerely,
Bob Wenzel,
Acting Commissioner.
Enclosure.

Complexity Analysis of Provision From the Care Act of 2003

CHARITABLE DEDUCTION FOR NON-ITEMIZERS

Provision: A taxpayer who does not itemize deductions would
be allowed a direct charitable deduction from adjusted gross
income for charitable contributions paid in cash. This
deduction would be available only for that portion of
contributions that in the aggregate exceed $250 ($500 in the
case of a joint return). The maximum deduction would be $250
($500 in the case of a joint return). The direct charitable
deduction generally would be subject to the tax rules normally
governing charitable contribution deductions, and would be
allowed in computing alternative minimum taxable income. The
provision would be effective for taxable years beginning after
December 31, 2002, and before January 1, 2005.

IRS and Treasury Comments

Two lines would have to be added to Forms 1040,
1040A, 1040EZ, 1040NR, and 1040NR-EZ for 2003 and 2004; one for
the allowable deduction and one to reflect the total of the
standard deduction and the charitable contribution deduction.
One line would be added to the TeleFile Tax Record for 2003 and
2004 (taxpayers would enter their total contributions on the
new line and TeleFile would calculate the allowable deduction).
No new forms would be required.
The new deduction would also have to be reflected
on Form 1040-ES for 2004 and in the instructions for Forms
1040X and 1045 for 2003 and 2004. Subsequent to enactment, the
IRS may have to advise taxpayers who make estimated tax
payments for 2003 how they can adjust their estimated tax
payments for 2003 to reflect the new deduction.
Information necessary for taxpayers to determine
their eligibility for the deduction, including the AGI
limitation applicable to cash contributions, and the
substantiation requirements, would have to be reflected in the
2003 and 2004 instructions for Forms 1040, 1040A, 1040EZ,
1040NR, and 1040NR-EZ and for TeleFile.
A worksheet (consisting of four lines) for
taxpayers to calculate their allowable deduction would have to
be reflected in the 2003 and 2004 instructions for Forms 1040,
1040A, 1040EZ, 1040NR, and 1040NR-EZ.
Changes to the TeleFile script for 2003 and 2004
would be required to allow the deduction to taxpayers who use
TeleFile.
All of the above changes would have to be reversed
for tax years beginning after December 31, 2004, to reflect the
termination of the charitable deduction for non-itemizers
(e.g., the lines would be removed from the Form 1040 series of
returns, the worksheet would be removed from the instructions
for these returns, and programming and script changes would be
necessary to eliminate the deduction).
Ensuring compliance with the new charitable
deduction would be difficult. The only means of verifying
amounts deducted would be through examination, and the normal
examination rate for such returns is relatively low.
Programming changes would be required to reflect
the new deduction on the tax returns.

VI. CHANGES IN EXISTING LAW MADE BY THE BILL AS REPORTED

In the opinion of the Committee, it is necessary in order
to expedite the business of the Senate, to dispense with the
requirements of paragraph 12 of rule XXVI of the Standing Rules
of the Senate (relating to the showing of changes in existing
law made by the bill as reported by the Committee).