Senate Report 110-1 - SMALL BUSINESS AND WORK OPPORTUNITY ACT OF 2007

[Senate Report 110-1]
[From the U.S. Government Publishing Office]

110th Congress Report
SENATE
1st Session 110-1

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SMALL BUSINESS AND WORK OPPORTUNITY ACT OF 2007

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January 22, 2007.--Ordered to be printed

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

R E P O R T

together with

ADDITIONAL VIEWS

[To accompany S. 349]

The Committee on Finance, having considered an original
bill, S. 349, to amend the Internal Revenue Code of 1986 to
provide additional tax incentives to employers and employees of
small businesses, and for other purposes, reports favorably
thereon and recommends that the bill do pass.

CONTENTS

Page
I. LEGISLATIVE BACKGROUND...........................................2
TITLE I--SMALL BUSINESS TAX RELIEF PROVISIONS.....................3
A. Extension of Increased Expensing for Small Business
(sec. 101 of the bill and sec. 179 of the Code)...... 3
B. Fifteen-Year Straight-Line Cost Recovery for Qualified
Leasehold Improvements, Qualified Restaurant
Improvements and New Restaurant Buildings (Sec. 102
of the bill and sec. 168 of the Code)................ 5
C. Fifteen-Year Straight-Line Cost Recovery for Qualified
Retail Improvement Property (sec. 102 of the bill and
sec. 168 of the Code)................................ 7
D. Expand Eligibility for Cash Method of Accounting (sec.
103 of the bill and secs. 446 and 448 of the Code)... 8
E. Work Opportunity Tax Credit (sec. 104 of the bill and
sec. 51 of the Code)................................. 10
F. Treatment of Professional Employer Organizations as
Employers for Employment Tax Purposes (sec. 105 of
the bill and new secs. 3511 and 7705 of the Code).... 15
G. Subchapter S Provisions (secs. 111-116 of the bill and
secs. 1361 and 1362 of the Code)..................... 24
1. Capital gain not treated as passive investment
income............................................. 24
2. Treatment of bank director shares................... 25
3. Treatment of banks changing from reserve method of
accounting......................................... 26
4. Treatment of sale of an interest in a qualified
subchapter S subsidiary............................ 27
5. Elimination of earnings and profits attributable to
pre-1983 years..................................... 28
6. Expansion of qualifying beneficiaries of an electing
small business trust............................... 28
TITLE II--REVENUE PROVISIONS.....................................29
A. Modification of Effective Date of Leasing Provisions
of the American Jobs Creation Act of 2004 (sec. 201
of the bill and sec. 470 of the Code)................ 29
B. Tax Treatment of Certain Inverted Corporate Entities
(sec. 202 of the bill and sec. 7874 of the Code)..... 30
C. Denial of Deduction for Punitive Damages (sec. 203 of
the bill and sec. 162(g) of the Code)................ 35
D. Denial of Deduction for Certain Fines, Penalties, and
Other Amounts (sec. 204 of the bill and sec. 162 of
the Code)............................................ 36
E. Revision of Tax Rules on Expatriation of Individuals
(sec. 205 of the bill and secs. 102, 877, 2107, 2501,
7701 and 6039G of the Code).......................... 39
F. Limit Amounts of Annual Deferrals Under Nonqualified
Deferred Compensation Plans (sec. 206 of the bill and
sec. 409A of the Code)............................... 51
G. Increase in Criminal Monetary Penalty Limitation for
the Underpayment or Overpayment of Tax Due to Fraud
(sec. 207 of the bill and secs. 7201, 7203, and 7206
of the Code)......................................... 54
H. Doubling of Certain Penalties, Fines, and Interest on
Underpayments Related to Certain Offshore Financial
Arrangements (sec. 208 of the bill).................. 56
I. Increase in Penalty for Bad Checks and Money Orders
(sec. 209 of the bill and sec. 6657 of the Code)..... 60
J. Treatment of Contingent Payment Convertible Debt
Instruments (sec. 210 of the bill and sec. 1275 of
the Code)............................................ 61
K. Extension of IRS User Fees (sec. 211 of the bill and
sec. 7528 of the Code)............................... 64
L. Modification of Collection Due Process Procedures for
Employment Tax Liabilities (sec. 212 of the bill and
sec. 6330 of the Code)............................... 64
M. Whistleblower Reforms (sec. 213 of the bill and sec.
7623 of the Code).................................... 66
N. Expand Denial of Deduction for Certain Excessive
Employee Remuneration (sec. 214 of the bill and sec.
162(m) of the Code).................................. 68
II. BUDGET EFFECTS OF THE BILL.......................................69
III.VOTES OF THE COMMITTEE...........................................73

IV. REGULATORY IMPACT AND OTHER MATTERS..............................73
V. ADDITIONAL VIEWS.................................................75
VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED............76

I. LEGISLATIVE BACKGROUND

Since the Fair Labor Standards Act of 1938, Congress has
required employers to pay a minimum wage to workers, with some
exceptions. Congress enacted the current general minimum wage
of $5.15 an hour in 1996. The decade that has passed since then
marks the longest period in history without an adjustment to
the minimum wage. A majority of states have enacted minimum
wages in excess of the current Federal level.
A full-time minimum wage worker earns about $10,712 a year.
Roughly two million workers are paid at or below the federal
minimum wage. Millions more would be affected by any increase,
because many workers earn slightly more than the minimum wage
and may also see an increase. According to some research,
smaller businesses employ a disproportionate share of workers
earning the minimum wage. Small business owners have therefore
argued that any increase in the minimum wage should be
accompanied by tax incentives targeted for small businesses in
order to lower their costs.
The Finance Committee has exclusive jurisdiction over tax
matters and held a hearing on January 10, 2007, entitled, ``Tax
Incentives for Businesses in Response to a Minimum Wage
Increase.'' The Committee heard from a variety of witnesses,
including labor economists, small business owners, and tax
experts.\1\ Following this hearing, the Committee held a mark-
up on January 17, 2007, to consider an original bill, S. 349
(the ``Small Business and Work Opportunity Act of 2007''), a
revenue-neutral bill containing a number of tax incentives for
small businesses and businesses that hire minimum wage workers.
With a majority and quorum present, the Committee favorably
reported the bill by unanimous voice vote on that date and this
report describes the provisions of the bill. The Committee
anticipates that the Senate may consider adding the substance
of this bill to H.R. 2, the ``Fair Minimum Wage Act of 2007,''
or similar legislation.
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\1\ The Committee heard testimony that while increasing the minimum
wage would benefit workers through increased wages, a minimum wage
increase may also have consequences of employers hiring fewer workers
or reducing workers' hours. Others testified that research has shown
moderate increases to the minimum wage have little or no adverse
employment impact with significant benefits to affected workers.
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TITLE I--SMALL BUSINESS TAX RELIEF PROVISIONS

A. Extension of Increased Expensing for Small Business

(Sec. 101 of the bill and sec. 179 of the Code)

PRESENT LAW

In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to deduct (or
``expense'') such costs under section 179. Present law provides
that the maximum amount a taxpayer may expense, for taxable
years beginning in 2003 through 2009, is $100,000 of the cost
of qualifying property placed in service for the taxable
year.\2\ In general, qualifying property is defined as
depreciable tangible personal property that is purchased for
use in the active conduct of a trade or business. Off-the-shelf
computer software placed in service in taxable years beginning
before 2010 is treated as qualifying property. The $100,000
amount is reduced (but not below zero) by the amount by which
the cost of qualifying property placed in service during the
taxable year exceeds $400,000. The $100,000 and $400,000
amounts are indexed for inflation for taxable years beginning
after 2003 and before 2010. For taxable years beginning in
2007, the inflation-adjusted amounts are $112,000 and $450,000,
respectively.\3\
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\2\ Additional section 179 incentives are provided with respect to
qualified property meeting applicable requirements that is used by a
business in an empowerment zone (sec. 1397A), a renewal community (sec.
1400J), or the Gulf Opportunity Zone (sec. 1400N(e)).
\3\ Rev. Proc. 2006-53, sec. 2.19, 2006-48 I.R.B. 996 (Nov. 27,
2006).
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The amount eligible to be expensed for a taxable year may
not exceed the taxable income for a taxable year that is
derived from the active conduct of a trade or business
(determined without regard to this provision). Any amount that
is not allowed as a deduction because of the taxable income
limitation may be carried forward to succeeding taxable years
(subject to similar limitations). No general business credit
under section 38 is allowed with respect to any amount for
which a deduction is allowed under section 179. An expensing
election is made under rules prescribed by the Secretary.\4\
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\4\ Sec. 179(c)(1). Under Treas. Reg. sec. 1.179-5, applicable to
property placed in service in taxable years beginning after 2002 and
before 2008, a taxpayer is permitted to make or revoke an election
under section 179 without the consent of the Commissioner on an amended
Federal tax return for that taxable year. This amended return must be
filed within the time prescribed by law for filing an amended return
for the taxable year. T.D. 9209, July 12, 2005.
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For taxable years beginning in 2010 and thereafter (or
before 2003), the following rules apply. A taxpayer with a
sufficiently small amount of annual investment may elect to
deduct up to $25,000 of the cost of qualifying property placed
in service for the taxable year. The $25,000 amount is reduced
(but not below zero) by the amount by which the cost of
qualifying property placed in service during the taxable year
exceeds $200,000. The $25,000 and $200,000 amounts are not
indexed. In general, qualifying property is defined as
depreciable tangible personal property that is purchased for
use in the active conduct of a trade or business (not including
off-the-shelf computer software). An expensing election may be
revoked only with consent of the Commissioner.\5\
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\5\ Sec. 179(c)(2).
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REASONS FOR CHANGE

The Committee believes that section 179 expensing provides
two important benefits for small businesses. First, it lowers
the cost of capital for property used in a trade or business.
With a lower cost of capital, the Committee believes small
businesses will invest in more equipment and employ more
workers. Second, it eliminates depreciation recordkeeping
requirements with respect to expensed property. In 2006,
Congress acted to extend the increased value of these benefits
and the increased number of taxpayers eligible for these
benefits for taxable years through 2009. The Committee believes
that the changes to section 179 expensing will continue to
provide important benefits if extended, and the bill therefore
extends these changes for an additional year.

EXPLANATION OF PROVISION

The provision extends for one year the increased amount
that a taxpayer may deduct and the other section 179 rules
applicable in taxable years beginning before 2010. Thus, under
the provision, these present-law rules continue in effect for
taxable years beginning after 2009 and before 2011.

EFFECTIVE DATE

The provision is effective for taxable years beginning
after December 31, 2009.

B. Fifteen-Year Straight-Line Cost Recovery for Qualified Leasehold
Improvements, Qualified Restaurant Improvements and New Restaurant
Buildings

(Sec. 102 of the bill and sec. 168 of the Code)

PRESENT LAW

In general

Depreciation of leasehold improvements

Generally, depreciation allowances for improvements made on
leased property are determined under MACRS, even if the MACRS
recovery period assigned to the property is longer than the
term of the lease. This rule applies regardless of whether the
lessor or the lessee places the leasehold improvements in
service. If a leasehold improvement constitutes an addition or
improvement to nonresidential real property already placed in
service, the improvement generally is depreciated using the
straight-line method over a 39-year recovery period, beginning
in the month the addition or improvement was placed in service.
However, exceptions exist for certain qualified leasehold
improvements and certain qualified restaurant property.

Qualified leasehold improvement property

Section 168(e)(3)(E)(iv) provides a statutory 15-year
recovery period for qualified leasehold improvement property
placed in service before January 1, 2008. Qualified leasehold
improvement property is recovered using the straight-line
method. Leasehold improvements placed in service in 2008 and
later will be subject to the general rules described above.
Qualified leasehold improvement property is any improvement
to an interior portion of a building that is nonresidential
real property, provided certain requirements are met. The
improvement must be made under or pursuant to a lease either by
the lessee (or sublessee), or by the lessor, of that portion of
the building to be occupied exclusively by the lessee (or
sublessee). The improvement must be placed in service more than
three years after the date the building was first placed in
service. Qualified leasehold improvement property does not
include any improvement for which the expenditure is
attributable to the enlargement of the building, any elevator
or escalator, any structural component benefiting a common
area, or the internal structural framework of the building.
However, if a lessor makes an improvement that qualifies as
qualified leasehold improvement property, such improvement does
not qualify as qualified leasehold improvement property to any
subsequent owner of such improvement. An exception to the rule
applies in the case of death and certain transfers of property
that qualify for non-recognition treatment.

Qualified restaurant property

Section 168(e)(3)(E)(v) provides a statutory 15-year
recovery period for qualified restaurant property placed in
service before January 1, 2008. For purposes of the provision,
qualified restaurant property means any improvement to a
building if such improvement is placed in service more than
three years after the date such building was first placed in
service and more than 50 percent of the building's square
footage is devoted to the preparation of, and seating for on-
premises consumption of, prepared meals. Qualified restaurant
property is recovered using the straight-line method.

REASONS FOR CHANGE

The Committee believes that taxpayers should not be
required to recover the costs of certain leasehold improvements
beyond the useful life of the investment. The 39-year recovery
period for leasehold improvements for property placed in
service after December 31, 2007 extends beyond the useful life
of many such investments. Although lease terms differ, the
Committee believes that lease terms for commercial real estate
are also typically shorter than the 39-year recovery period. In
the interests of simplicity and administrability, a uniform
period for recovery of leasehold improvements is desirable.
Therefore, the provision extends the 15-year recovery period
for leasehold improvements.
The Committee also believes that unlike other commercial
buildings, restaurant buildings generally are more specialized
structures. Restaurants also experience considerably more
traffic, and remain open longer than most commercial
properties. This daily use causes rapid deterioration of
restaurant properties and forces restaurateurs to constantly
repair and upgrade their facilities. As such, restaurant
facilities generally have a shorter life span than other
commercial establishments. The Committee bill extends the 15-
year recovery period for improvements made to restaurant
buildings, and applies the 15-year recovery period to new
restaurants, to more accurately reflect the true economic life
of such properties.

EXPLANATION OF PROVISION

The present-law provisions for qualified leasehold
improvement property and restaurant improvements are extended
for three months (through March 31, 2008). In addition, the
three-year rule for restaurant property is repealed. Thus,
newly constructed restaurant buildings and restaurant
improvements within the first three years also qualify for the
15-year recovery period.

EFFECTIVE DATE

The provision generally applies to property placed in
service after December 31, 2007. Repeal of the three-year rule
for restaurant property is effective for property placed in
service after the date of enactment, the original use of which
begins with the taxpayer after the date of enactment.

C. Fifteen-Year Straight-Line Cost Recovery for Qualified Retail
Improvement Property

(Sec. 102 of the bill and sec. 168 of the Code)

PRESENT LAW

A taxpayer generally must capitalize the cost of property
used in a trade or business and recover such cost over time
through annual deductions for depreciation or amortization.
Tangible property generally is depreciated under the modified
accelerated cost recovery system (``MACRS''), which determines
depreciation by applying specific recovery periods, placed-in-
service conventions, and depreciation methods to the cost of
various types of depreciable property.\7\ The cost of
nonresidential real property is recovered using the straight-
line method of depreciation and a recovery period of 39 years.
Nonresidential real property is subject to the mid-month
placed-in-service convention. Under the mid-month convention,
the depreciation allowance for the first year property is
placed in service is based on the number of months the property
was in service, and property placed in service at any time
during a month is treated as having been placed in service in
the middle of the month.
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\7\ Sec. 168.
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Generally, depreciation allowances for improvements made on
retail property are determined under MACRS. If a retail
property improvement constitutes an addition or improvement to
nonresidential real property already placed in service, the
improvement generally is depreciated using the straight-line
method over a 39-year recovery period, beginning in the month
the addition or improvement was placed in service. A special
provision provides a 15-year recovery period for qualified
leasehold improvement property.\8\
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\8\ Sec. 168(e)(3)(E)(iv).
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REASONS FOR CHANGE

The Committee believes that taxpayers should not be
required to recover the costs of certain improvements beyond
the useful life of the investment. The present law 39-year
recovery period for improvements to owner occupied (i.e., not
leased) retail property extends beyond the useful life of many
such investments. Therefore, the provision includes a 15-year
recovery period for qualified retail improvements.
Additionally, the Committee believes that retailers should
not be treated differently based on whether the building in
which they operate is owned or leased. The shorter 15-year
recovery period for leasehold improvements under present law
provides an unfair competitive advantage for those retailers
who lease space. As many small business retailers own the
building in which they operate their business, the Committee
believes this provision will provide relief to small
businesses.

EXPLANATION OF PROVISION

The provision provides a statutory 15-year recovery period
for qualified retail improvement property placed in service
before March 31, 2008. For purposes of the provision, qualified
retail improvement property means any improvement to an
interior portion of a building which is nonresidential real
property if such portion is open to the general public \9\ and
is used in the retail trade or business of selling tangible
personal property to the general public, and such improvement
is placed in service more than three years after the date the
building was first placed in service. Qualified retail
improvement property does not include any improvement for which
the expenditure is attributable to the enlargement of the
building, any elevator or escalator, or the internal structural
framework of the building.
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\9\ Improvements to portions of a building not open to the general
public (e.g., stock room in back of retail space) do not qualify under
the provision.
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For the purposes of this provision, retail establishments
that qualify for the 15-year recovery period include those
primarily engaged in the sale of goods. Examples of these
retail establishments include, but are not limited to, grocery
stores, clothing stores, hardware stores and convenience
stores. However, establishments primarily engaged in providing
services, such as professional services, financial services,
personal services, health services, and entertainment, do not
qualify. It is generally intended that businesses defined as a
store retailer under the current North American Industry
Classification System (industry sub-sectors 441 through 453)
qualify for the provision, while those in other industry
classes do not qualify under the provision.

EFFECTIVE DATE

The provision applies to property placed in service after
the date of enactment.

D. Expand Eligibility for Cash Method of Accounting

(Sec. 103 of the bill and secs. 446 and 448 of the Code)

PRESENT LAW

Section 446(c) of the Code generally allows a taxpayer to
select the method of accounting it will use to compute its
taxable income provided that such method clearly reflects the
income of the taxpayer. A taxpayer is entitled to adopt any one
of the permissible methods for each separate trade or business,
subject to certain restrictions. Permissible methods include
the cash receipts and disbursements method (``cash method''),
an accrual method, or any other method (including a hybrid
method) permitted under regulations prescribed by the Secretary
of the Treasury.
Section 448 generally provides that the cash method of
accounting may not be used by any C corporation,\10\ by any
partnership that has a C corporation as a partner, or by any
tax shelter. Exceptions are made for farming businesses and
qualified personal service corporations. Additionally, an
exception is provided for C corporations and partnerships that
have a C corporation as a partner if the average annual gross
receipts of the taxpayer is $5 million or less for all prior
taxable years (including the prior taxable years of any
predecessor of the entity). For this purpose, average annual
gross receipts is calculated for each tax year by averaging the
annual gross receipts for the three-year period ending in such
year. The test must be met for all prior tax years beginning
after December 31, 1985 in order for a taxpayer to be eligible
for the exception.
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\10\ For this purpose, a tax-exempt trust with unrelated business
income is treated as a C corporation with respect to the portion of its
activities that constitute an unrelated trade or business. Treas. Reg.
sec. 1.448-1T(a)(3).
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Section 471 provides that, regardless of a taxpayer's
overall method of accounting, the Secretary may require
taxpayers to maintain inventories on the accrual method if
necessary to clearly reflect income. This requirement is
generally applied to taxpayers for whom the production,
purchase, or sale of merchandise is an income-producing
factor.\11\ However, an exception is provided for taxpayers
whose average annual gross receipts does not exceed $1
million.\12\ Such taxpayers account for inventory as materials
and supplies that are not incidental pursuant to Regulations
section 1.162-3.\13\
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\11\ Treas. Reg. sec. 1.471-1.
\12\ Rev. Proc. 2001-10, 2001-02 I.R.B. 272 (January 8, 2001).
\13\ Under Treas. Reg. sec. 1.162-3, a deduction is permitted for
the cost of materials and supplies only in the amount that they are
actually consumed and used in operations during the tax year.
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When a taxpayer changes its method of accounting, there is
taken into account for the taxable year of the change
adjustments to taxable income necessary to prevent amounts from
being duplicated or omitted by reason of the change.\14\
Positive adjustments (i.e., additions to taxable income), if
initiated by the taxpayer and made with the consent of the
Secretary, are generally spread over four taxable years
beginning in the year of change.\15\ Negative adjustments
(i.e., reductions to taxable income) are generally taken into
account entirely in the year of change.\16\
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\14\ Sec. 481.
\15\ Rev. Proc. 2002-19, 2002-1 C.B. 696.
\16\ Ibid.
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REASONS FOR CHANGE

The Committee is sensitive to the trade-off between
competing priorities of simplification and accurate income
measurement in the tax system. Many taxpayers find the cash
method of accounting to be simpler to use than the accrual
method, which generally is considered to provide a more
accurate measurement of income for each taxable year. The
effect of the differences in income measurement is not
permanent, as the different methods produce the same total
amount of taxable income over time.
The present-law exception for small businesses with gross
receipts under $5 million \17\ reflects the view that, in the
case of small businesses, the benefits of simplification under
the cash method outweigh any impact on accuracy. The Committee
believes that the threshold has become outdated over time and
understates the maximum size of business which should be
eligible for use of the cash method. Accordingly, the Committee
provision increases the threshold and indexes it for inflation
to prevent it from becoming outdated in the future.
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\17\ The threshold is $1 million with respect to inventory
accounting.
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EXPLANATION OF PROVISION

Under the provision, eligibility to use the cash method
under the annual gross receipts exception is expanded to all
non-farm taxpayers other than tax shelters regardless of the
presence of inventories, and the threshold for the exception is
increased from $5 million to $10 million.
The provision also resets the December 31, 1985 testing
start date. Under the provision, the gross receipts test must
be met for all tax years ending on or after the date of
enactment. Thus, a taxpayer who did not meet the $5 million
gross receipts test in one or more years ending prior to the
date of enactment but meets the new $10 million test for all
tax years ending on or after the date of enactment is eligible
to use the cash method under the provision.
The $10 million threshold is indexed for tax years
beginning in calendar years after 2008. The indexed amount
applies in each year for the purposes of testing the average
annual gross receipts, calculated based on the prior three tax
years. Once a taxpayer has either met or not met the gross
receipts test with respect to a particular tax year, that
result cannot subsequently be changed by the effect of the
indexing. Thus, a tax year that ends on or after the date of
enactment for which the gross receipts test is not met causes
the taxpayer to be ineligible to use the cash method under the
gross receipts test exception in all tax years subsequent to
the year in which the test is not met, regardless of whether
the threshold is subsequently increased by indexing above the
amount of average annual gross receipts for the year in which
the test was not met.
Accounting method changes under the provision are deemed to
be initiated by the taxpayer and made with the consent of the
Secretary. Thus, the adjustments under section 481 are spread
over four years (in the case of a positive change) or taken
into account entirely in one year (in the case of a negative
change).
Taxpayers who are eligible to use the cash method under the
provision also are exempt from maintaining inventories on the
accrual method. Thus, the $1 million gross receipts threshold
of Rev. Proc. 2001-10 is effectively increased to $10 million
for taxpayers qualifying for the provision.

EFFECTIVE DATE

The provision is applicable to taxable years beginning
after the date of enactment.

E. Work Opportunity Tax Credit

(Sec. 104 of the bill and sec. 51 of the Code)

PRESENT LAW

In general

The work opportunity tax credit is available on an elective
basis for employers hiring individuals from one or more of nine
targeted groups. The amount of the credit available to an
employer is determined by the amount of qualified wages paid by
the employer. Generally, qualified wages consist of wages
attributable to service rendered by a member of a targeted
group during the one-year period beginning with the day the
individual begins work for the employer (two years in the case
of an individual in the long-term family assistance recipient
category).

Targeted groups eligible for the credit

Generally an employer is eligible for the credit only for
qualified wages paid to members of a targeted group.
(1) Families receiving TANF
An eligible recipient is an individual certified by a
designated local employment agency (e.g., a State employment
agency) as being a member of a family eligible to receive
benefits under the Temporary Assistance for Needy Families
Program (``TANF'') for a period of at least nine months part of
which is during the 18-month period ending on the hiring date.
For these purposes, members of the family are defined to
include only those individuals taken into account for purposes
of determining eligibility for the TANF.
(2) Qualified veteran
A qualified veteran is a veteran who is certified by the
designated local agency as a member of a family certified as
receiving assistance under a food stamp program under the Food
Stamp Act of 1977 for a period of at least three months part of
which is during the 12-month period ending on the hiring date.
For these purposes, members of a family are defined to include
only those individuals taken into account for purposes of
determining eligibility for a food stamp program under the Food
Stamp Act of 1977.
For these purposes, a veteran is an individual who has
served on active duty (other than for training) in the Armed
Forces for more than 180 days or who has been discharged or
released from active duty in the Armed Forces for a service-
connected disability. However, any individual who has served
for a period of more than 90 days during which the individual
was on active duty (other than for training) is not a qualified
veteran if any of this active duty occurred during the 60-day
period ending on the date the individual was hired by the
employer. This latter rule is intended to prevent employers who
hire current members of the armed services (or those departed
from service within the last 60 days) from receiving the
credit.
(3) Qualified ex-felon
A qualified ex-felon is an individual certified as: (1)
having been convicted of a felony under any State or Federal
law, and (2) having a hiring date within one year of release
from prison or date of conviction.
(4) High risk youth
A high-risk youth is an individual certified as being at
least age 18 but not yet age 25 on the hiring date and as
having a principal place of abode within an empowerment zone,
enterprise community, or renewal community (as defined under
Subchapter U of Subtitle A, Chapter 1 of the Internal Revenue
Code). Qualified wages do not include wages paid or incurred
for services performed after the individual moves outside an
empowerment zone, enterprise community, or renewal community.
(5) Vocational rehabilitation referral
A vocational rehabilitation referral is an individual who
is certified by a designated local agency as an individual who
has a physical or mental disability that constitutes a
substantial handicap to employment and who has been referred to
the employer while receiving, or after completing: (a)
vocational rehabilitation services under an individualized,
written plan for employment under a State plan approved under
the Rehabilitation Act of 1973; or (b) under a rehabilitation
plan for veterans carried out under Chapter 31 of Title 38,
U.S. Code. Certification will be provided by the designated
local employment agency upon assurances from the vocational
rehabilitation agency that the employee has met the above
conditions.
(6) Qualified summer youth employee
A qualified summer youth employee is an individual: (1) who
performs services during any 90-day period between May 1 and
September 15, (2) who is certified by the designated local
agency as being 16 or 17 years of age on the hiring date, (3)
who has not been an employee of that employer before, and (4)
who is certified by the designated local agency as having a
principal place of abode within an empowerment zone, enterprise
community, or renewal community (as defined under Subchapter U
of Subtitle A, Chapter 1 of the Internal Revenue Code). As with
high risk youths, no credit is available on wages paid or
incurred for service performed after the qualified summer youth
moves outside of an empowerment zone, enterprise community, or
renewal community. If, after the end of the 90-day period, the
employer continues to employ a youth who was certified during
the 90-day period as a member of another targeted group, the
limit on qualified first year wages will take into account
wages paid to the youth while a qualified summer youth
employee.
(7) Qualified food stamp recipient
A qualified food stamp recipient is an individual aged 18
but not yet 40 certified by a designated local employment
agency as being a member of a family receiving assistance under
a food stamp program under the Food Stamp Act of 1977 for a
period of at least six months ending on the hiring date. In the
case of families that cease to be eligible for food stamps
under section 6(o) of the Food Stamp Act of 1977, the six-month
requirement is replaced with a requirement that the family has
been receiving food stamps for at least three of the five
months ending on the date of hire. For these purposes, members
of the family are defined to include only those individuals
taken into account for purposes of determining eligibility for
a food stamp program under the Food Stamp Act of 1977.
(8) Qualified SSI recipient
A qualified SSI recipient is an individual designated by a
local agency as receiving supplemental security income
(``SSI'') benefits under Title XVI of the Social Security Act
for any month ending within the 60-day period ending on the
hiring date.
(9) Long-term family assistance recipients
A qualified long-term family assistance recipient is an
individual certified by a designated local agency as being: (1)
a member of a family that have received family assistance for
at least 18 consecutive months ending on the hiring date; (2) a
member of a family that have received such family assistance
for a total of at least 18 months (whether or not consecutive)
after August 5, 1997 (the date of enactment of the welfare-to-
work tax credit) \18\ if the individual is hired within two
years after the date that the 18-month total is reached; or (3)
a member of a family who are no longer eligible for family
assistance because of either Federal or State time limits, if
the individual is hired within two years after the Federal or
State time limits made the family ineligible for family
assistance.
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\18\ The welfare-to-work tax credit was consolidated into the work
opportunity tax credit in the Tax Relief and Health Care Act of 2006.
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Qualified wages

Generally, qualified wages are defined as cash wages paid
by the employer to a member of a targeted group. The employer's
deduction for wages is reduced by the amount of the credit.
For purposes of the credit, generally wages are defined by
reference to the FUTA definition of wages contained in sec.
3306(b) (without regard to the dollar limitation therein
contained). Special rules apply in the case of certain
agricultural labor and certain railroad labor.

Calculation of the credit

The credit available to an employer for qualified wages
paid to members of all targeted groups except for long-term
family assistance recipients equals 40 percent (25 percent for
employment of 400 hours or less) of qualified first-year wages.
Generally, qualified first-year wages are qualified wages (not
in excess of $6,000) attributable to service rendered by a
member of a targeted group during the one-year period beginning
with the day the individual began work for the employer.
Therefore, the maximum credit per employee is $2,400 (40
percent of the first $6,000 of qualified first-year wages).
With respect to qualified summer youth employees, the maximum
credit is $1,200 (40 percent of the first $3,000 of qualified
first-year wages). Except for long-term family assistance
recipients, no credit is allowed for second-year wages.
In the case of long-term family assistance recipients, the
credit equals 40 percent (25 percent for employment of 400
hours or less) of $10,000 for qualified first-year wages and 50
percent of the first $10,000 of qualified second-year wages.
Generally, qualified second-year wages are qualified wages (not
in excess of $10,000) attributable to service rendered by a
member of the long-term family assistance category during the
one-year period beginning on the day after the one-year period
beginning with the day the individual began work for the
employer. Therefore, the maximum credit per employee is $9,000
(40 percent of the first $10,000 of qualified first-year wages
plus 50 percent of the first $10,000 of qualified second-year
wages).

Certification rules

An individual is not treated as a member of a targeted
group unless: (1) on or before the day on which an individual
begins work for an employer, the employer has received a
certification from a designated local agency that such
individual is a member of a targeted group; or (2) on or before
the day an individual is offered employment with the employer,
a pre-screening notice is completed by the employer with
respect to such individual, and not later than the 28th day
after the individual begins work for the employer, the employer
submits such notice, signed by the employer and the individual
under penalties of perjury, to the designated local agency as
part of a written request for certification. For these
purposes, a pre-screening notice is a document (in such form as
the Secretary may prescribe) which contains information
provided by the individual on the basis of which the employer
believes that the individual is a member of a targeted group.

Minimum employment period

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

Other rules

The work opportunity tax credit is not allowed for wages
paid to a relative or dependent of the taxpayer. No credit is
allowed for wages paid to an individual who is a more than
fifty-percent owner of the entity. Similarly, wages paid to
replacement workers during a strike or lockout are not eligible
for the work opportunity tax credit. Wages paid to any employee
during any period for which the employer received on-the-job
training program payments with respect to that employee are not
eligible for the work opportunity tax credit. The work
opportunity tax credit generally is not allowed for wages paid
to individuals who had previously been employed by the
employer. In addition, many other technical rules apply.

Expiration

The work opportunity tax credit is not available for
individuals who begin work for an employer after December 31,
2007.

REASONS FOR CHANGE

The Committee believes that the experience with the credit
has been positive and wishes to extend and expand the credit.
In particular, the Committee believes that the credit can be
used to improve employment opportunities for broader classes of
qualified veterans and designated community residents. Also,
the Committee believes that the expansion of the vocational
rehabilitation referral group appropriately conforms
availability of the credit to a previous expansion of the
vocational rehabilitation referral program. Finally, the
Committee believes that a longer-term expansion will encourage
greater employer participation in the credit.

EXPLANATION OF PROVISION

Extension

The provision extends the work opportunity tax credit for
five years (for qualified individuals who begin work for an
employer after December 31, 2007 and before January 1, 2013).

Qualified veterans targeted group

The provision expands the qualified veterans' targeted
group to include an individual who is certified as entitled to
compensation for a service-connected disability incurred after
September 10, 2001. Being entitled to such compensation means
having a disability rating of 10-percent or higher for service
connected injuries.

Qualified first-year wages

The provision expands the definition of qualified first-
year wages from $6,000 to $12,000 in the case of individuals
certified as being entitled to compensation for a service-
connected disability incurred after September 10, 2001 (i.e.,
having a disability rating of 10-percent or higher).

High risk youth targeted group

The provision expands the definition of high risk youths to
include otherwise qualifying individuals age 18 but not yet age
40 on the hiring date. The provision also changes the name of
the category to the ``designated community residents'' targeted
group.

Vocational rehabilitation referral targeted group

The provision expands the definition of vocational
rehabilitation referral to include any individual who is
certified by a designated local agency as an individual who has
a physical or mental disability that constitutes a substantial
handicap to employment and who has been referred to the
employer while receiving, or after completing, an individual
work plan developed and implemented by an employment network
pursuant to subsection (g) of section 1148 of the Social
Security Act.

EFFECTIVE DATE

Generally, the extension of the credit is effective for
wages paid or incurred to a qualified individual who begins
work for an employer after December 31, 2007. The other
provisions are effective for individuals who begin work for an
employer after the date of enactment in taxable years ending
after such date.

F. Treatment of Professional Employer Organizations as Employers for
Employment Tax Purposes

(Sec. 105 of the bill and new secs. 3511 and 7705 of the Code)

PRESENT LAW

In general

Employment taxes generally consist of the taxes under the
Federal Insurance Contributions Act (``FICA''), the taxes under
the Railroad Retirement Tax Act (``RRTA''), the tax under the
Federal Unemployment Tax Act (``FUTA''), and income taxes
required to be withheld by employers from wages paid to
employees (``income tax withholding'').\19\
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\19\ Secs. 3101-3128 (FICA), 3201-3241 (RRTA), 3301-3311 (FUTA),
and 3401-3404 (income tax withholding). Sections 3501-3510 provide
additional rules.
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FICA tax consists of two parts: (1) old age, survivor, and
disability insurance (``OASDI''), which correlates to the
Social Security program that provides monthly benefits after
retirement, disability, or death; and (2) Medicare hospital
insurance (``HI''). The OASDI tax rate is 6.2 percent on both
the employee and employer (for a total rate of 12.4 percent).
The OASDI tax rate applies to wages up to the OASDI wage base
for the calendar year ($97,500 for 2007). The HI tax rate is
1.45 percent on both the employee and the employer (for a total
rate of 2.9 percent). Unlike the OASDI tax, the HI tax is not
limited to a specific amount of wages, but applies to all
wages.
RRTA taxes consist of tier 1 taxes and tier 2 taxes. Tier 1
taxes parallel the OASDI and HI taxes applicable to employers
and employees. Tier 2 taxes consist of employer and employee
taxes on railroad compensation up to the tier 2 wage base for
the calendar year. For 2007, the tier 2 employer rate is 12.1
percent, the employee rate is 3.9 percent, and the tier 2 wage
base is $72,600.
Under FUTA, employers must pay a tax of 6.2 percent of
wages up to the FUTA wage base of $7,000. An employer may take
a credit against its FUTA tax liability for its contributions
to a State unemployment fund and, in certain cases, an
additional credit for contributions that would have been
required if the employer had been subject to a higher
contribution rate under State law. For purposes of the credit,
contributions means payments required by State law to be made
by an employer into an unemployment fund, to the extent the
payments are made by the employer without being deducted or
deductible from employees' remuneration.\20\
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\20\ The ``SUTA Dumping Prevention Act of 2004'' (Pub. L. No. 108-
295), set standards for State law to prevent the practice of ``SUTA
dumping,'' a tax evasion scheme where shell companies are formed to
obtain low State unemployment insurance tax rates.
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Employers are required to withhold income taxes from wages
paid to employees. Withholding rates vary depending on the
amount of wages paid, the length of the payroll period, and the
number of withholding allowances claimed by the employee.
Wages paid to employees, and FICA, RRTA, and income taxes
withheld from the wages, are required to be reported on
employment tax returns and on Forms W-2.\21\
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\21\ Secs. 6011 and 6051.
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Employment taxes generally apply to all remuneration paid
by an employer to an employee. However, various exclusions
apply to certain types of remuneration or certain types of
services, which may depend on the type of employer for whom an
employee performs services.\22\ For example, remuneration
(subject to a dollar limit) paid to an employee by a tax-exempt
organization is excluded from wages for FICA purposes, and
services performed in the employ of certain tax-exempt
organizations are excluded from employment for FUTA
purposes.\23\ In addition, various definitions and special
rules apply to certain types of employers.\24\
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\22\ See, e.g., secs. 3121(a) and (b), 3231(e), 3306(b) and (c),
and 3401(a).
\23\ Secs. 3121(a)(16) and 3306(c)(8).
\24\ See, e.g., secs. 3121, 3122, 3125, 3126, 3127, 3231, 3306,
3308, 3309, 3401(a), 3404, 3506, and 3510.
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As discussed above, certain employment taxes apply only on
amounts up to a specified wage base. If an employee works for
multiple employers during a year, separate wage bases generally
apply to each employer. However, a single OASDI, RRTA tier 1 or
tier 2, or FUTA wage base applies in certain cases in which an
employer (a ``successor'' employer) takes over the business of
another employer (the ``predecessor'' employer) and employs the
employees of the predecessor employer.

Responsibility for employment tax compliance

Employment tax responsibility generally rests with the
person who is the employer of an employee under a common-law
test that has been incorporated into Treasury regulations.\25\
Under the regulations, an employer-employee relationship
generally exists if the person for whom services are performed
has the right to control and direct the individual who performs
the services, not only as to the result to be accomplished by
the work, but also as to the details and means by which that
result is accomplished. That is, an employee is subject to the
will and control of the employer, not only as to what is to be
done, but also as to how it is to be done. It is not necessary
that the employer actually control the manner in which the
services are performed, rather it is sufficient that the
employer have a right to control. Whether the requisite control
exists is determined on the basis of all the relevant facts and
circumstances. The test of whether an employer-employee
relationship exists often arises in determining whether a
worker is an employee or an independent contractor. However,
the same test applies in determining whether a worker is an
employee of one person or another.\26\
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\25\ Treas. Reg. secs. 31.3121(d)-1(c)(1), 31.3306(i)-1(a), and
31.3401(c)-1.
\26\ Issues relating to the classification of workers as employees
or independent contractors are discussed in Joint Committee on
Taxation, Study of the Overall State of the Federal Tax System and
Recommendations for Simplification, Pursuant to Section 8022(3)(B) of
the Internal Revenue Code of 1986 (JCS-3-01), April 2001, at Vol. II,
Part XV.A, at 539-550.
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In some cases, a person other than the common-law employer
(a ``third party'') may be liable for employment taxes. For
example, if wages are paid to an employee by a third party and
the third party, rather than the employer, has control of the
payment of the wages, the third party is the statutory employer
responsible for complying with applicable employment tax
requirements.\27\ In addition, certain designated agents are
jointly and severally liable with the employer for employment
taxes with respect to wages paid to the employer's employees.
These designated agents prepare and file employment tax returns
using their own name and employer identification number. In
contrast, reporting agents (often referred to as payroll
service providers) are generally not liable for the employment
taxes reported on their clients' returns. Reporting agents
prepare and file employment tax returns for their clients using
the client's name and employer identification number.
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\27\ Sec. 3401(d)(1) (for purposes of income tax withholding, if
the employer does not have control of the payment of wages, the person
having control of the payment of such wages is treated as the
employer); Otte v. United States, 419 U.S. 43 (1974) (the person who
has the control of the payment of wages is treated as the employer for
purposes of withholding the employee's share of FICA from wages); In re
Armadillo Corporation, 561 F.2d 1382 (10th Cir. 1977), and In re The
Laub Baking Company v. United States, 642 F.2d 196 (6th Cir. 1981) (the
person who has control of the payment of wages is the employer for
purposes of the employer's share of FICA and FUTA). The mere fact that
wages are paid by a person other than the employer does not necessarily
mean that the payor has control of the payment of the wages. Rather,
control depends on the facts and circumstances. See, e.g., Consolidated
Flooring Services v. United States, 38 Fed. Cl. 450 (1997), and
Winstead v. United States, 109 F. 2d 989 (4th Cir. 1997).
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Professional employer organizations

A professional employer organization (sometimes called an
employee leasing company) provides employees to perform
services in the businesses of the professional employer
organization's customers, generally small and medium-sized
businesses. In many cases, before the professional employer
organization arrangement is entered into, the employees already
work in the customer's business as employees of the customer.
The terms of a typical professional employer organization
agreement provide that the professional employer organization
is responsible for paying the employees and for the related
employment tax compliance. Legally, the employees may be the
employees of the customer, rather than the professional
employer organization; nonetheless, customers typically rely on
the professional employer organization to satisfy employment
tax obligations.\28\
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\28\ As discussed in the text above, the issue of whether a worker
is an employee of a particular entity for employment tax purposes is
generally determined by reference to section 3121(d), which
incorporates the common law definition of employee. This common law
definition also generally applies for purposes of who is an employee
for retirement plan purposes. In some cases, a professional employer
organization may provide benefits to workers who are legally the
employees of the customer. The IRS has issued guidance with respect to
how the retirement plan rules apply in such cases. For example, Revenue
Procedure 2002-11, 2002-1 C.B. 911, provides that employees of a
customer may be covered under a multiple employer defined contribution
plan of the professional employer organization if the customer adopts
the plan and certain other requirements are satisfied. See also Rev.
Proc. 2003-86, 2003-2 C.B. 1211.
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Income tax credits based on wages for employment tax purposes

The Code provides various income tax credits to employers
under which the amount of the credit is determined by reference
to the amount of wages for employment tax purposes.\29\ For
example, the amount of an employer's work opportunity credit is
based on a portion of FUTA wages paid by the employer to
employees who are members of certain targeted groups.\30\ In
addition, the credit for employer FICA tax paid on tips is
based on the employer share of FICA tax paid by the employer
with respect to certain tips treated as wages for FICA
purposes.\31\
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\29\ See, e.g., secs. 41 (credit for research expenses), 45A
(Indian employment credit), 45B (credit for employer FICA tax paid on
tips), 45C (credit for clinical drug testing expenses), 51 (work
opportunity credit), 51A (welfare-to-work credit), 1396 (empowerment
zone employment credit), 1400(d) (DC Zone employment credit), and 1400H
(renewal community employment credit).
\30\ Sec. 51(c)(1).
\31\ Sec. 45B(b)(1).
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Reporting by large food and beverage establishments

Certain reporting requirements relating to tips apply to
large food or beverage establishments.\32\ In the case of such
an establishment, an employer is generally required to report
the following information to the IRS each calendar year: (1)
the gross receipts of the establishment from the provision of
food and beverages (other than certain receipts); (2) the
aggregate amount of charge receipts (other than certain
receipts); (3) the aggregate amount of charged tips on the
charge receipts; (4) the sum of the aggregate amount of tips
reported to the employer by employees and certain amounts
required to be reported by the employer on employees' Form W-
2s; and (5) with respect to each employee, the amount of tips
allocated to the employee based on the receipts of the
establishment. The employer must also provide employees with
written statements showing certain information each calendar
year, including the amount of tips allocated to the employee
for the year.
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\32\ Sec. 6053(c).
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User fees

User fees apply to requests to the IRS for ruling letters,
opinion letters, determination letters, and similar
requests.\33\ The user fees that apply are determined by the
IRS and are generally required to be determined after taking
into account the average time and difficulty involved in a
request.
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\33\ Sec. 7528.
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REASONS FOR CHANGE

The IRS estimates that the portion of tax gap attributable
to FICA and FUTA taxes is $15 billion.\34\ An additional
portion of the tax gap is attributable to income taxes due on
unreported wages.
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\34\ Internal Revenue Service, IRS Updates Tax Gap Estimates, IR-
2006-28, and attachment (Feb. 14, 2006). The tax gap is the amount of
tax that is imposed by law for a given tax year but is not paid
voluntarily and timely.
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Professional employer organizations specialize in providing
employees and employment-related services, including employment
tax compliance, to their customers, which are generally small
and medium-sized businesses. In addition, a professional
employer organization can obtain economies of scale not
available to its individual customers. As a result,
professional employer organizations may improve employment tax
compliance.
Under present law, responsibility for employment tax
compliance generally rests with the employer. Uncertainty may
exist as to whether a professional employer organization or its
customer is the employer of the employees provided to the
customer, making it unclear which party bears employment tax
responsibility. In the case of noncompliance, the IRS may have
difficulty establishing either party's liability for unpaid
employment taxes. The Committee believes that improved
employment tax compliance can be achieved by providing rules
under which a professional employer organization that meets
certain standards and follows certain procedures is treated for
employment tax purposes as the employer of employees provided
to customers, and thus is responsible for employment tax
compliance, rather than the customers.

EXPLANATION OF PROVISION

Treatment of certified professional employer organization as employer
for employment tax purposes

Under the provision, if certain requirements are met,
solely for purposes of employment taxes and other obligations
under the employment tax rules, a certified professional
employer organization is treated as the employer of any work
site employee performing services for any customer of the
certified professional employer organization, but only with
respect to remuneration remitted to the work site employee by
the certified professional employer organization. In addition,
no other person is treated as the employer for employment tax
purposes with respect to remuneration remitted by the certified
professional employer organization to a work site employee.
Under the provision, if an individual (other than a self-
employed individual) who is not a work site employee, but who
performs services under a contract that meets the contract
requirements applicable to work site employees, then, solely
for purposes of a certified professional employer
organization's liability for employment taxes and other
obligations under the employment tax rules, a certified
professional employer organization is treated as the employer
of the individual, but only with respect to remuneration
remitted to the individual by the certified professional
employer organization.
Under the provision, exclusions, definitions, and special
rules that are based on the type of employer and that would
apply if the certified professional employer organization were
not treated as the employer under the provision continue to
apply. Thus, for example, if services performed in the employ
of a customer that is a tax-exempt organization would be
excluded from employment for FUTA purposes, the fact that a
certified professional employer organization is treated as the
employer for employment tax purposes does not affect the
application of the exclusion. Similarly, if remuneration for
agricultural labor \35\ or for catching fish \36\ would not be
subject to FICA taxes, the application of the exclusion is not
affected by the fact that a certified professional employer
organization is treated as the employer for employment tax
purposes under the provision.
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\35\ See sec. 3121(a)(8).
\36\ See sec. 3121(b)(20).
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The provision provides rules under which, on entering into
a service contract with a customer with respect to a work site
employee, a certified professional employer organization is
treated as a successor employer and the customer is treated as
the predecessor employer. Similarly, on termination of a
service contract with respect to a work site employee, the
customer is treated as a successor employer and the certified
professional employer organization is treated as a predecessor
employer. Thus, wages paid by the customer and the certified
professional employer organization to a work site employee
during a calendar year are subject to a single OASDI, RRTA tier
1 or tier 2, or FUTA wage base.
The provision does not apply in the case of a customer who
is related to the certified professional employer
organization.\37\ In addition, an individual with net earnings
from self-employment derived from a customer's trade or
business (i.e., a self-employed individual), including a
customer who is a sole proprietor or a partner of a customer
that is a partnership, is not a work site employee for
employment tax purposes with respect to remuneration paid by a
certified professional employer organization.
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\37\ Whether a customer and a certified professional employer
organization are related is determined under the rules of section
267(b) (relating to transactions between related taxpayers) or 707(b)
(relating to transactions between a partner and partnership). However,
rules based on more than 50 percent ownership are applied by
substituting 10 percent for 50 percent.
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A certified professional employer organization is eligible
for the FUTA credit with respect to contributions made to a
State unemployment fund with respect to a work site employee by
the certified professional employer organization or a customer.
An additional FUTA credit may be claimed by a certified
professional employer organization if, under State law, a
certified professional employer organization is permitted to
collect and remit contributions with respect to a work site
employee to the State unemployment fund.

Certified professional employer organization

A certified professional employer organization is a person
who has been certified by the Secretary, for purposes of being
treated as the employer for employment tax purposes under the
provision, as meeting certain requirements. These requirements
are met if the person--
demonstrates that the person (and any owner,
officer, and such other persons as may be specified in
regulations) meets requirements established by the
Secretary with respect to tax status, background,
experience, business location, and annual financial
audits;
computes its taxable income using an accrual
method of accounting unless the Secretary approves
another method;
agrees to satisfy the bond and independent
financial review requirements (described below) on an
ongoing basis;
agrees to satisfy any reporting obligations
imposed by the Secretary;
agrees to verify on such periodic basis as
prescribed by the Secretary that it continues to meet
the requirements for certification; and
agrees to notify the Secretary in writing
within such time as prescribed by the Secretary of any
change that materially affects whether it continues to
meet the requirements for certification.
Under the bond requirement, a certified professional
employer organization must post a bond for the payment of
employment taxes in a minimum amount and in a form acceptable
to the Secretary. The minimum amount is determined for the
period April 1 of any calendar year through March 31 of the
following calendar year and is the greater of (1) five percent
of the employment taxes for which the certified professional
employer organization is liable under the provision during the
preceding calendar year (but not to exceed $1,000,000), or (2)
$50,000.
Under the independent financial review requirements, a
certified professional employer organization must: (1) have, as
of the most recent review date (i.e., six months after the
completion of the certified professional employer
organization's fiscal year), caused to be prepared and provided
to the Secretary an opinion of an independent certified public
accountant that the certified professional employer
organization's financial statements are presented fairly in
accordance with generally accepted accounting principles; and
(2) provide to the Secretary, not later than the last day of
the second month beginning after the end of each calendar
quarter, from an independent certified public accountant an
assertion regarding Federal employment tax payments and an
examination level attestation on the assertion. The assertion
must state that the certified professional employer
organization has withheld and made deposits of all required
FICA, RRTA, and withheld income taxes for the calendar quarter,
and the attestation must state that the assertion is fairly
stated in all material respects. If a certified professional
employer organization fails to file the required assertion and
attestation with respect to any calendar quarter, the
independent financial review requirements are treated as not
satisfied for the period beginning on the due date for the
attestation.
For purposes of the bond and independent financial review
requirements, all professional employer organizations that are
members of a controlled group of corporations or under common
control are treated as a single organization.\38\ The Secretary
may suspend or revoke the certification of a person's certified
professional employer organization status if the Secretary
determines that the person does not satisfy the representations
or other requirements for certification or fails to satisfy the
applicable accounting, reporting, payment, or deposit
requirements.
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\38\ Whether entities are members of a controlled group of
corporations or under common control is determined under the rules of
section 414(b) and (c).
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Work site employee

A work site employee is an individual who: (1) performs
services for a customer of a certified professional employer
organization pursuant to a contract between the customer and
the certified professional employer organization that meets
certain requirements (described below); and (2) performs
services at a work site meeting certain requirements (described
below).\39\ Thus, if the contract or work site fails to meet
applicable requirements, the individual is not a work site
employee.
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\39\ As discussed above, a self-employed individual is not a work
site employee.
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The contract between the customer and the certified
professional employer organization must be in writing and, with
respect to an individual performing services for the customer,
must provide that the certified professional employer
organization will--
assume responsibility for payment of wages
to the individual, without regard to the receipt or
adequacy of payment from the customer;
assume responsibility for reporting,
withholding, and paying any employment taxes with
respect to the individual's wages, without regard to
the receipt or adequacy of payment from the customer;
assume responsibility for any employee
benefits that the contract may require the certified
professional employer organization to provide, without
regard to the receipt or adequacy of payment from the
customer;
assume responsibility for hiring, firing,
and recruiting workers in addition to the customer's
responsibility for hiring, firing and recruiting
workers;
maintain employee records relating to the
individual; and
agree to be treated as a certified
professional employer organization for employment tax
purposes with respect to such individual.
For purposes of whether an individual is a work site
employee, the work site where the individual performs services
meets the applicable requirements if at least 85 percent of the
individuals performing services for the customer at the work
site are subject to one or more contracts with the certified
professional employer organization that meet the above
requirements.\40\
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\40\ For this purpose, excluded employees under section 414(q)(5),
such as employees who are under age 21 or have not completed six months
of service, are not taken into account.
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Regulations

The Secretary of Treasury (``Secretary'') is directed to
prescribe such regulations as may be necessary or appropriate
to carry out the purposes of the provision. The Secretary is
also directed to develop reporting and recordkeeping rules,
regulations, and procedures to ensure compliance with the
provision with respect to entities applying for and receiving
certification as certified professional employer organizations.
These are to be designed in a manner to streamline, to the
extent possible, the application of the requirements of the
provision, the exchange of information between a certified
professional employer organization and its customers, and the
reporting and recordkeeping obligations of a certified
professional employer organization.

No inference with respect to other provisions

Nothing contained in the provision or the amendments made
by the provision is to be construed to create any inference
with respect to the determination of who is an employee or
employer (1) for Federal tax purposes (other than the purposes
set forth in the provision), or (2) for purposes of any other
provision of law.

Other rules

Income tax credits based on wages for employment tax
purposes
Under the provision, for purposes of various income tax
credits \41\ under which the amount of the credit is determined
by reference to the amount of employment tax wages or
employment taxes: (1) the credit with respect to a work site
employee performing services for a customer applies to the
customer (not to the certified professional employer
organization); (2) the customer (and not the certified
professional employer organization) is to take into account
wages and employment taxes paid by the certified professional
employer organization with respect to the work site employee
and for which the certified professional employer organization
receives payment from the customer; and (3) the certified
professional employer organization is required to furnish the
customer with any information necessary for the customer to
claim the credit.\42\
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\41\ Secs. 41 (credit for research expenses), 45A (Indian
employment credit), 45B (credit for employer FICA tax paid on tips),
45C (credit for clinical drug testing expenses), 51 (work opportunity
credit), 51A (welfare-to-work credit), 1396 (empowerment zone
employment credit), 1400(d) (DC Zone employment credit), 1400H (renewal
community employment credit), and any other provision as provided by
the Secretary.
\42\ Present law provides a deduction from taxable income (or, in
the case of an individual, adjusted gross income) that is equal to a
portion of the taxpayer's qualified production activities income (sec.
199). The deduction for a taxable year is limited to 50 percent of the
wages deducted in arriving at qualified production activities income.
To be taken into account, wages must be paid by the taxpayer to its
employees and reported on Form W-2. For this purpose, wages means wages
subject to income tax withholding, as well as elective deferrals and
certain other amounts. Under regulations dealing with wages paid by an
entity other than the common-law employer, a taxpayer may take into
account wages paid by another entity and reported by the other entity
on Form W-2 (with the other entity listed as the employer on the Form
W-2), provided that the wages were paid to employees of the taxpayer
for employment by the taxpayer. Treas. Reg. sec. 1.199-2(a)(2). The
provision does not affect the application of these rules.
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Reporting by large food and beverage establishments
Under the provision, if a certified professional employer
organization is treated for employment tax purposes as the
employer of a work site employee, the customer for whom the
work site employee performs services is the employer for
purposes of the reporting required with respect to a large food
or beverage establishment. The certified professional employer
organization is required to furnish the customer with any
information necessary to complete the required reporting.
User fees
Under the provision, the user fee charged under the program
for certifying a professional employer organization may not
exceed $500.

EFFECTIVE DATE

The provision is effective with respect to wages paid for
services performed on or after January 1 of the first calendar
year beginning more than 12 months after the date of enactment
of the provision. The Secretary is directed to establish the
certification program for professional employer organizations
not later than six months before the provision becomes
effective.

G. Subchapter S Provisions

(Secs. 111-116 of the bill and secs. 1361 and 1362 of the Code)

OVERVIEW

In general, an S corporation is not subject to corporate-
level income tax on its items of income and loss. Instead, an S
corporation passes through its items of income and loss to its
shareholders. The shareholders take into account separately
their shares of these items on their individual income tax
returns. To prevent double taxation of these items when the
stock is later disposed of, each shareholder's basis in the
stock of the S corporation is increased by the amount included
in income (including tax-exempt income) and is decreased by the
amount of any losses (including nondeductible losses) taken
into account. A shareholder's loss may be deducted only to the
extent of his or her basis in the stock or debt of the S
corporation. To the extent a loss is not allowed due to this
limitation, the loss generally is carried forward with respect
to the shareholder.

REASONS FOR CHANGE

Many small businesses are organized as S corporations. The
bill contains a number of provisions relating to these
corporations. These provisions modernize the S corporation
rules and eliminate undue restrictions on S corporations. The
Committee believes that these changes will improve the
operation of Subchapter S and therefore will benefit small
businesses.

1. Capital gain not treated as passive investment income

PRESENT LAW

Passive investment income

An S corporation is subject to corporate-level tax, at the
highest corporate tax rate, on its excess net passive income if
the corporation has (1) accumulated earnings and profits at the
close of the taxable year and (2) gross receipts more than 25
percent of which are passive investment income.
Excess net passive income is the net passive income for a
taxable year multiplied by a fraction, the numerator of which
is the amount of passive investment income in excess of 25
percent of gross receipts and the denominator of which is the
passive investment income for the year. Net passive income is
defined as passive investment income reduced by the allowable
deductions that are directly connected with the production of
that income. Passive investment income generally means gross
receipts derived from royalties, rents, dividends, interest,
annuities, and sales or exchanges of stock or securities (to
the extent of gains). Passive investment income generally does
not include interest on accounts receivable, gross receipts
that are derived directly from the active and regular conduct
of a lending or finance business, gross receipts from certain
liquidations, gain or loss from any section 1256 contract (or
related property) of an options or commodities dealer, or
certain interest and dividend income of banks and depository
institution of holding companies.
In addition, an S corporation election is terminated
whenever the S corporation has accumulated earnings and profits
at the close of each of three consecutive taxable years and has
gross receipts for each of those years more than 25 percent of
which are passive investment income.

EXPLANATION OF PROVISION

The provision eliminates gains from sales or exchanges of
stock or securities as an item of passive investment income.

EFFECTIVE DATE

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

2. Treatment of bank director shares

PRESENT LAW

An S corporation may have no more than 100 shareholders and
may have only one outstanding class of stock.
An S corporation has one class of stock if all outstanding
shares of stock confer identical rights to distribution and
liquidation proceeds. Differences in voting rights are
disregarded.\43\
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\43\ Sec. 1361(c)(4). Treasury regulations provide that buy-sell
and redemption agreements are disregarded in determining whether a
corporation's outstanding shares confer identical distribution and
liquidation rights unless (1) a principal purpose of the agreement is
to circumvent the one class of stock requirement and (2) the agreement
establishes a purchase price that, at the time the agreement is entered
into, is significantly in excess of, or below, the fair market value of
the stock. Treas. Reg. sec. 1.1361-1(l).
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National banking law requires that a director of a national
bank own stock in the bank and that a bank have at least five
directors.\44\ A number of States have similar requirements for
State-chartered banks. In some cases, a bank director enters
into an agreement under which the bank (or a holding company)
will reacquire the stock upon the director's ceasing to hold
the office of director, at the price paid by the director for
the stock.\45\
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\44\ 12 U.S.C. secs. 71-72.
\45\ See Private Letter Ruling 200217048 (January 24, 2002)
describing such an agreement and holding that it creates a second class
of stock. Nonetheless, the ruling concluded that the election to be an
S corporation was inadvertently invalid and that an amended agreement
did not create a second class of stock so that the corporation's
election was validated.
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EXPLANATION OF PROVISION

Under the provision, restricted bank director stock is not
taken into account as outstanding stock in applying the
provisions of subchapter S.\46\ Thus, the stock is not treated
as a second class of stock; a director is not treated as a
shareholder of the S corporation by reason of the stock; the
stock is disregarded in allocating items of income, loss, etc.
among the shareholders; and the stock is not treated as
outstanding for purposes of determining whether an S
corporation holds 100 percent of the stock of a qualified
subchapter S subsidiary.
---------------------------------------------------------------------------
\46\ No inference is intended as to the proper income tax treatment
of restricted bank director stock or other similar stock under present
law.
---------------------------------------------------------------------------
Restricted bank director stock is stock in a bank (as
defined in sec. 581), or a depository institution holding
company (within the meaning of sec. 3(w)(1) of the Federal
Deposit Insurance Act), if the stock is required to be held by
an individual under applicable Federal or State law in order to
permit the individual to serve as a director of the bank or
holding company and which is subject to an agreement with the
bank or holding company (or corporation in control of the bank
or company) pursuant to which the holder is required to sell
the stock back upon ceasing to be a director at the same price
the individual acquired the stock.
A distribution (other than a payment in exchange for the
stock) with respect to the restricted stock is includible in
the gross income of the director and is deductible by the S
corporation for the taxable year that includes the last day of
the director's taxable year in which the distribution is
included in income.

EFFECTIVE DATE

The provision applies to taxable years beginning after
December 31, 2006.
The provision also provides that restricted bank director
stock is not treated as a second class of stock for taxable
years beginning after December 31, 1996.

3. Treatment of banks changing from reserve method of accounting

PRESENT LAW

A financial institution which uses the reserve method of
accounting for bad debts may not elect to be an S
corporation.\47\ If a financial institution changes from the
reserve method of accounting, there is taken into account for
the taxable year of the change adjustments to taxable income
necessary to prevent amounts from being duplicated or omitted
by reason of the change.\48\
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\47\ Sec. 1361(b)(2)(A).
\48\ Sec. 481.
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Positive adjustments (i.e., additions to taxable income)
are generally spread over four taxable years beginning in the
year of change.\49\ Negative adjustments (i.e., reductions to
taxable income) are generally taken into account entirely in
the year of change.\50\
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\49\ Rev. Proc. 2002-19, 2002-1 C.B. 696.
\50\ Id.
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In the case of a financial institution that changes from
the reserve method and elects to be an S corporation for the
year of change, the adjustments are both included in the income
of the shareholders and are taken into account in computing the
tax on built-in gain under section 1374. If the change in
accounting method is made for the last taxable year prior to
becoming an S corporation, any adjustments for that year are
taken into account in computing the corporation's taxable
income, but not taken into account by the shareholders.

EXPLANATION OF PROVISION

The provision allows a bank which changes from the reserve
method of accounting for bad debts for its first taxable year
for which it is an S corporation to elect to take into account
all adjustments under section 481 by reason of the change in
the last taxable year it was a C corporation.

EFFECTIVE DATE

The provision applies to taxable years beginning after
December 31, 2006.

4. Treatment of sale of an interest in a qualified subchapter S
subsidiary

PRESENT LAW

Under present law, an S corporation that owns all the stock
of a corporation may elect to treat the subsidiary corporation
as a qualified subchapter S subsidiary (``QSub''). A qualified
subchapter S subsidiary is disregarded as a separate entity for
Federal tax purposes and its items of income, deduction, loss,
and credit are treated as items of the S corporation.
If the subsidiary corporation ceases to be a QSub (e.g.,
fails to meet the wholly-owned requirement) the subsidiary is
treated as a new corporation acquiring all its assets (and
assuming all of its liabilities) immediately before such
cessation from the parent S corporation in exchange for its
stock. Under Treasury regulations,\51\ the tax treatment of the
termination of the QSub election is determined under general
principals of tax law, including the step transaction doctrine.
The regulations set forth an example \52\ in which an S
corporation sells 21 percent of the stock of a QSub to an
unrelated party. In the example, the deemed transfer of all the
assets to the QSub is treated as a taxable sale because the S
corporation was not in control of the QSub immediately after
the transfer by reason of the sale, and thus the transfer did
not qualify for nonrecognition treatment under section 351.
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\51\ Treas. Reg. sec. 1.1361-5(b).
\52\ Example 1 of Treas. Reg. sec. 1.1361-5(b)(3).
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EXPLANATION OF PROVISION

The provision provides that where the sale of stock of a
QSub results in the termination of the QSub election, the sale
is treated as a sale of an undivided interest in the assets of
the QSub (based on the percentage of the stock sold) followed
by a deemed transfer to the QSub in a transaction to which
section 351 applies.
Thus, in the above example, the S corporation will be
treated as selling a 21 percent-interest in all the assets of
the QSub to the unrelated party, followed by a transfer of all
the assets to a new corporation in a transaction to which
section 351 applies. Thus, the S corporation will recognize 21
percent of the gain or loss in the assets of the QSub.

EFFECTIVE DATE

The provision applies to taxable years beginning after
December 31. 2006.

5. Elimination of earnings and profits attributable to pre-1983 years

PRESENT LAW

The Small Business Jobs Protection Act of 1996 provided
that if a corporation was an S corporation for its first
taxable year beginning after December 31, 1996, the accumulated
earnings and profits of the corporation as of the beginning of
that year were reduced by the accumulated earnings and profits
(if any) accumulated in a taxable year beginning before January
1, 1983, for which the corporation was an electing small
business corporation under subchapter S.

EXPLANATION OF PROVISION

The provision provides in the case of any corporation which
was not an S corporation for its first taxable year beginning
after December 31, 1996, the accumulated earnings and profits
of the corporation as of the beginning of the first taxable
year beginning after the date of the enactment of this
provision is reduced by the accumulated earnings and profits
(if any) accumulated in a taxable year beginning before January
1, 1983, for which the corporation was an electing small
business corporation under subchapter S.

EFFECTIVE DATE

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

6. Expansion of qualifying beneficiaries of an electing small business
trust

PRESENT LAW

Under present law, an electing small business trust
(``ESBT'') may be a shareholder of an S corporation. Generally,
the eligible beneficiaries of an ESBT include individuals,
estates, and certain charitable organizations eligible to hold
S corporation stock directly. A nonresident alien individual
may not be a potential current beneficiary of an ESBT.
The portion of an ESBT which consists of the stock of an S
corporation is treated as a separate trust and is generally
taxed on its share of the S corporation's income at the highest
rate of tax imposed on individual taxpayers (currently 35
percent). This income (whether or not distributed by the ESBT)
is not taxed to the beneficiaries of the ESBT.

EXPLANATION OF PROVISION

The provision allows a nonresident alien individual to be a
potential current beneficiary of an ESBT.

EFFECTIVE DATE

The provision is effective on the date of enactment.

TITLE II--REVENUE PROVISIONS

A. Modification of Effective Date of Leasing Provisions of the American
Jobs Creation Act of 2004

(Sec. 201 of the bill and sec. 470 of the Code)

PRESENT LAW

Present law provides for the deferral of losses
attributable to certain tax exempt use property, generally
effective for leases entered into after March 12, 2004. The
deferral provision does not apply to property located in the
United States that is subject to a lease with respect to which
a formal application: (1) was submitted for approval to the
Federal Transit Administration (an agency of the Department of
Transportation) after June 30, 2003, and before March 13, 2004;
(2) is approved by the Federal Transit Administration before
January 1, 2006; and (3) includes a description and the fair
market value of such property (the ``qualified transportation
property exception'').

REASONS FOR CHANGE

The Committee is aware that certain leasing transactions
entered into with foreign lessees prior to March 12, 2004 are
continuing to provide a benefit to the taxpayers who
participated in such transactions. The Committee finds these
transactions and their continuing benefit to be inappropriate.
Thus, the provision denies any future tax benefit with respect
to the transactions.

EXPLANATION OF PROVISION

The provision changes the effective date of the loss
deferral rules with respect to certain leases. Under the
provision, the loss deferral rules also apply to leases entered
into on or before March 12, 2004, if the lessee is a foreign
person or entity. With respect to such leases, losses are
deferred starting in taxable years beginning after December 31,
2006.
No inference is intended with respect to the tax treatment
of leases entered into on or before March 12, 2004, if the
lessee is not a foreign person or entity.

EFFECTIVE DATE

The provision is effective as if included in the provisions
of the American Jobs Creation Act of 2004 to which it relates.

B. Tax Treatment of Certain Inverted Corporate Entities

(Sec. 202 of the bill and sec. 7874 of the Code)

PRESENT LAW

Determination of corporate residence

The U.S. tax treatment of a multinational corporate group
depends significantly on whether the parent corporation of the
group is domestic or foreign. For purposes of U.S. tax law, a
corporation is treated as domestic if it is incorporated under
the law of the United States or of any State. Other
corporations (i.e., those incorporated under the laws of
foreign countries or U.S. possessions) generally are treated as
foreign.

U.S. taxation of domestic corporations

The United States employs a ``worldwide'' tax system, under
which domestic corporations generally are taxed on all income,
whether derived in the United States or abroad. In order to
mitigate the double taxation that may arise from taxing the
foreign-source income of a domestic corporation, a foreign tax
credit for income taxes paid to foreign countries is provided
to reduce or eliminate the U.S. tax owed on such income,
subject to certain limitations.
Income earned by a domestic parent corporation from foreign
operations conducted by foreign corporate subsidiaries
generally is subject to U.S. tax when the income is distributed
as a dividend to the domestic corporation. Until such
repatriation, the U.S. tax on such income generally is
deferred, and U.S. tax is imposed on such income when
repatriated. However, certain anti-deferral regimes may cause
the domestic parent corporation to be taxed on a current basis
in the United States with respect to certain categories of
passive or highly mobile income earned by its foreign
subsidiaries, regardless of whether the income has been
distributed as a dividend to the domestic parent corporation.
The main anti-deferral regimes in this context are the
controlled foreign corporation rules of subpart F (secs. 951-
964) and the passive foreign investment company rules (secs.
1291-1298). A foreign tax credit is generally available to
offset, in whole or in part, the U.S. tax owed on this foreign-
source income, whether such income is repatriated as an actual
dividend or included under one of the anti-deferral regimes.

U.S. taxation of foreign corporations

The United States taxes foreign corporations only on income
that has a sufficient nexus to the United States. Thus, a
foreign corporation is generally subject to U.S. tax only on
income that is ``effectively connected'' with the conduct of a
trade or business in the United States. Such ``effectively
connected income'' generally is taxed in the same manner and at
the same rates as the income of a U.S. corporation. An
applicable tax treaty may limit the imposition of U.S. tax on
business operations of a foreign corporation to cases in which
the business is conducted through a ``permanent establishment''
in the United States.
In addition, foreign corporations generally are subject to
a gross-basis U.S. tax at a flat 30-percent rate on the receipt
of interest, dividends, rents, royalties, and certain similar
types of income derived from U.S. sources, subject to certain
exceptions. The tax generally is collectedby means of
withholding by the person making the payment. This tax may be reduced
or eliminated under an applicable tax treaty.

U.S. tax treatment of inversion transactions prior to the American Jobs
Creation Act of 2004

Prior to the American Jobs Creation Act of 2004 (``AJCA''),
a U.S. corporation could reincorporate in a foreign
jurisdiction and thereby replace the U.S. parent corporation of
a multinational corporate group with a foreign parent
corporation. These transactions were commonly referred to as
inversion transactions. Inversion transactions could take many
different forms, including stock inversions, asset inversions,
and various combinations of and variations on the two. Most of
the known transactions were stock inversions. In one example of
a stock inversion, a U.S. corporation forms a foreign
corporation, which in turn forms a domestic merger subsidiary.
The domestic merger subsidiary then merges into the U.S.
corporation, with the U.S. corporation surviving, now as a
subsidiary of the new foreign corporation. The U.S.
corporation's shareholders receive shares of the foreign
corporation and are treated as having exchanged their U.S.
corporation shares for the foreign corporation shares. An asset
inversion could be used to reach a similar result, but through
a direct merger of the top-tier U.S. corporation into a new
foreign corporation, among other possible forms. An inversion
transaction could be accompanied or followed by further
restructuring of the corporate group. For example, in the case
of a stock inversion, in order to remove income from foreign
operations from the U.S. taxing jurisdiction, the U.S.
corporation could transfer some or all of its foreign
subsidiaries directly to the new foreign parent corporation or
other related foreign corporations.
In addition to removing foreign operations from U.S. taxing
jurisdiction, the corporate group could seek to derive further
advantage from the inverted structure by reducing U.S. tax on
U.S.-source income through various earnings stripping or other
transactions. This could include earnings stripping through
payment by a U.S. corporation of deductible amounts such as
interest, royalties, rents, or management service fees to the
new foreign parent or other foreign affiliates. In this
respect, the post-inversion structure could enable the group to
employ the same tax-reduction strategies that are available to
other multinational corporate groups with foreign parents and
U.S. subsidiaries, subject to the same limitations (e.g., secs.
163(j) and 482).
Inversion transactions could give rise to immediate U.S.
tax consequences at the shareholder and/or the corporate level,
depending on the type of inversion. In stock inversions, the
U.S. shareholders generally recognized gain (but not loss)
under section 367(a), based on the difference between the fair
market value of the foreign corporation shares received and the
adjusted basis of the domestic corporation stock exchanged. To
the extent that a corporation's share value had declined, and/
or it had many foreign or tax-exempt shareholders, the impact
of this section 367(a) ``toll charge'' was reduced. The
transfer of foreign subsidiaries or other assets to the foreign
parent corporation also could give rise to U.S. tax
consequences at the corporate level (e.g., gain recognition and
earnings and profits inclusions under secs. 1001, 311(b), 304,
367, 1248 or other provisions). The tax on any income
recognized as a result of these restructurings could be reduced
or eliminated through the use of net operating losses, foreign
tax credits, and other tax attributes.
In asset inversions, the U.S. corporation generally
recognized gain (but not loss) under section 367(a) as though
it had sold all of its assets, but the shareholders generally
did not recognize gain or loss, assuming the transaction met
the requirements of a reorganization under section 368.

U.S. tax treatment of inversion transactions under AJCA

In general
AJCA added new section 7874 to the Code, which defines two
different types of corporate inversion transactions and
establishes a different set of consequences for each type.
Certain partnership transactions also are covered.
Transactions involving at least 80 percent identity of
stock ownership
The first type of inversion is a transaction in which,
pursuant to a plan \53\ or a series of related transactions:
(1) a U.S. corporation becomes a subsidiary of a foreign-
incorporated entity or otherwise transfers substantially all of
its properties to such an entity in a transaction completed
after March 4, 2003; (2) the former shareholders of the U.S.
corporation hold (by reason of holding stock in the U.S.
corporation) 80 percent or more (by vote or value) of the stock
of the foreign-incorporated entity after the transaction; and
(3) the foreign-incorporated entity, considered together with
all companies connected to it by a chain of greater than 50
percent ownership (i.e., the ``expanded affiliated group''),
does not have substantial business activities in the entity's
country of incorporation, compared to the total worldwide
business activities of the expanded affiliated group. The
provision denies the intended tax benefits of this type of
inversion (``80-percent inversion'') by deeming the top-tier
foreign corporation to be a domestic corporation for all
purposes of the Code.\54\
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\53\ Acquisitions with respect to a domestic corporation or
partnership are deemed to be ``pursuant to a plan'' if they occur
within the four-year period beginning on the date which is two years
before the ownership threshold under the provision is met with respect
to such corporation or partnership.
\54\ Since the top-tier foreign corporation is treated for all
purposes of the Code as domestic, the shareholder-level ``toll charge''
of sec. 367(a) does not apply to these inversion transactions.
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In determining whether a transaction meets the definition
of an inversion under the provision, stock held by members of
the expanded affiliated group that includes the foreign
incorporated entity is disregarded. For example, if the former
top-tier U.S. corporation receives stock of the foreign
incorporated entity (e.g., so-called ``hook'' stock), the stock
would not be considered in determining whether the transaction
meets the definition. Similarly, if a U.S. parent corporation
converts an existing wholly owned U.S. subsidiary into a new
wholly owned controlled foreign corporation, the stock of the
new foreign corporation would be disregarded, with the result
that the transaction would not meet the definition of an
inversion under the provision. Stock sold in a public offering
related to the transaction also is disregarded for these
purposes.
Transfers of properties or liabilities as part of a plan a
principal purpose of which is to avoid the purposes of the
provision are disregarded. In addition, the Treasury Secretary
is to provide regulations to carry out the provision, including
regulations to prevent the avoidance of the purposes of the
provision, including avoidance through the use of related
persons, pass-through or other noncorporate entities, or other
intermediaries, and through transactions designed to qualify or
disqualify a person as a related person or a member of an
expanded affiliated group. Similarly, the Treasury Secretary
has the authority to treat certain non-stock instruments as
stock, and certain stock as not stock, where necessary to carry
out the purposes of the provision.
Transactions involving at least 60 percent but less than 80
percent identity of stock ownership
The second type of inversion is a transaction that would
meet the definition of an inversion transaction described
above, except that the 80-percent ownership threshold is not
met. In such a case, if at least a 60-percent ownership
threshold is met, then a second set of rules applies to the
inversion. Under these rules, the inversion transaction is
respected (i.e., the foreign corporation is treated as
foreign), but any applicable corporate-level ``toll charges''
for establishing the inverted structure are not offset by tax
attributes such as net operating losses or foreign tax credits.
Specifically, any applicable corporate-level income or gain
required to be recognized under sections 304, 311(b), 367,
1001, 1248, or any other provision with respect to the transfer
of controlled foreign corporation stock or the transfer or
license of other assets by a U.S. corporation as part of the
inversion transaction or after such transaction to a related
foreign person is taxable, without offset by any tax attributes
(e.g., net operating losses or foreign tax credits). This rule
does not apply to certain transfers of inventory and similar
property. These measures generally apply for a 10-year period
following the inversion transaction.
Other rules
Under section 7874, inversion transactions include certain
partnership transactions. Specifically, the provision applies
to transactions in which a foreign-incorporated entity acquires
substantially all of the properties constituting a trade or
business of a domestic partnership, if after the acquisition at
least 60 percent (or 80 percent, as the case may be) of the
stock of the entity is held by former partners of the
partnership (by reason of holding their partnership interests),
provided that the other terms of the basic definition are met.
For purposes of applying this test, all partnerships that are
under common control within the meaning of section 482 are
treated as one partnership, except as provided otherwise in
regulations. In addition, the modified ``toll charge'' rules
apply at the partner level.
A transaction otherwise meeting the definition of an
inversion transaction is not treated as an inversion
transaction if, on or before March 4, 2003, the foreign-
incorporated entity had acquired directly or indirectly more
than half of the properties held directly or indirectly by the
domestic corporation, or more than half of the properties
constituting the partnership trade or business, as the case may
be.

REASONS FOR CHANGE

The Committee believes that the inversions regime should
generally apply to companies that completed 80-percent
inversion transactions after public notice was given that
eventual legislation on this issue could be effective after
March 20, 2002.

EXPLANATION OF PROVISION

The provision generally extends the 80-percent inversion
regime of section 7874 to 80-percent inversions completed after
March 20, 2002 but on or before March 4, 2003, with certain
modifications as described below. A transaction otherwise
meeting the definition of an 80-percent inversion under the
provision (i.e., one completed after March 20, 2002 but on or
before March 4, 2003) is not treated as an 80-percent inversion
if, on or before March 20, 2002, the foreign-incorporated
entity had acquired directly or indirectly more than half the
properties held directly or indirectly by the domestic
corporation, or more than half the properties constituting the
partnership trade or business, as the case may be.
Under the provision, an 80-percent inversion that is
completed after March 20, 2002 but on or before March 4, 2003
is respected until the end of the last day of the foreign-
incorporated entity's taxable year that began in 2006. At the
end of that day, the inverted foreign-incorporated entity that
completed the 80-percent inversion (or if relevant, any
successor entity) is deemed to have transferred all of its
assets and liabilities to a domestic corporation in a
transaction that is generally treated as a nontaxable inbound
reorganization (``repatriation''). The basis of the assets of
the foreign-incorporated entity generally remains the same in
the hands of the domestic corporation, subject to any special
adjustments for importing built-in losses (e.g., sec. 362(e)).
Shareholders of the domestic corporation inherit the respective
bases of their shares of the foreign-incorporated entity.
On the day of the repatriation, the earnings and profits of
the inverted foreign-incorporated entity transfer over to the
domestic corporation. The transfer of such earnings and profits
is not a deemed dividend and does not result in a tax upon the
domestic corporation or its shareholders. In addition, any
foreign taxes attributable to such earnings and profits are not
creditable. However, shareholders may be subject to tax on
distributions of such earnings and profits.
Beginning on the day after the repatriation, the inverted
foreign-incorporated entity is treated for all tax purposes as
a domestic corporation. Thus, any income earned by the inverted
foreign-incorporated entity after the date of repatriation is
deemed to be earned by a domestic corporation, and therefore,
is fully taxable at U.S. corporate income tax rates. As a
further consequence of the repatriation of the inverted
foreign-incorporated entity, foreign subsidiaries become
controlled foreign corporations, subject to the rules of
subpart F.
It is intended that the Secretary will prescribe
regulations that are necessary or appropriate to carry out the
provision, including, but not limited to, regulations to
prevent the avoidance of the purposes of the provision.

EFFECTIVE DATE

The provision is effective for taxable years beginning
after December 31, 2006.

C. Denial of Deduction for Punitive Damages

(Sec. 203 of the bill and sec. 162(g) of the Code)

PRESENT LAW

In general, a deduction is allowed for all ordinary and
necessary expenses that are paid or incurred by the taxpayer
during the taxable year in carrying on any trade or
business.\55\ However, no deduction is allowed for any payment
that is made to an official of any governmental agency if the
payment constitutes an illegal bribe or kickback or if the
payment is to an official or employee of a foreign government
and is illegal under Federal law.\56\ In addition, no deduction
is allowed under present law for any fine or similar payment
made to a government for violation of any law.\57\ Furthermore,
no deduction is permitted for two-thirds of any damage payments
made by a taxpayer who is convicted of a violation of the
Clayton antitrust law or any related antitrust law.\58\
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\55\ Sec. 162(a).
\56\ Sec. 162(c).
\57\ Sec. 162(f).
\58\ Sec. 162(g).
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In general, gross income does not include amounts received
on account of personal physical injuries and physical
sickness.\59\ However, this exclusion does not apply to
punitive damages.\60\
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\59\ Sec. 104(a).
\60\ Sec. 104(a)(2).
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REASONS FOR CHANGE

The Committee believes that allowing a tax deduction for
punitive damages undermines the societal role of punitive
damages in discouraging and penalizing the activities or
actions for which punitive damages are imposed. If a taxpayer
deducts a payment for punitive damages, the amount of the
payment does not reflect the true after-tax punitive effect on
the taxpayer. The Committee is concerned that allowing a
deduction for such payments in effect shifts a portion of the
penalty to the Federal Government and to the public.
Furthermore, the Committee believes that determining the amount
of punitive damages to be disallowed as a tax deduction is not
administratively burdensome because taxpayers generally can
make such a determination readily by reference to pleadings
filed with a court, and plaintiffs already make such a
determination in determining the taxable portion of any
payment. The Committee also believes that reporting the amount
of any insurance payment for punitive damages to the IRS and
the taxpayer will promote effective tax administration and
foster compliance with the tax laws.

EXPLANATION OF PROVISION

The provision denies any deduction for punitive damages
that are paid or incurred by the taxpayer as a result of a
judgment or in settlement of a claim. If the liability for
punitive damages is covered by insurance, any such punitive
damages paid by the insurer are included in gross income of the
insured person and the insurer is required to report such
amounts to both the insured person and the IRS.

EFFECTIVE DATE

The provision is effective for punitive damages that are
paid or incurred on or after the date of enactment.

D. Denial of Deduction for Certain Fines, Penalties, and Other Amounts

(Sec. 204 of the bill and sec. 162 of the Code)

PRESENT LAW

Under present law, no deduction is allowed as a trade or
business expense under section 162(a) for the payment of a fine
or similar penalty to a government for the violation of any law
(sec. 162(f)). The enactment of section 162(f) in 1969 codified
existing case law that denied the deductibility of fines as
ordinary and necessary business expenses on the grounds that
``allowance of the deduction would frustrate sharply defined
national or State policies proscribing the particular types of
conduct evidenced by some governmental declaration thereof.''
\61\
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\61\ S. Rep. No. 91-552, 91st Cong, 1 Sess., 273-74 (1969),
referring to Tank Truck Rentals, Inc. v. Commissioner, 356 U.S. 30
(1958).
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Treasury regulation section 1.162-21(b)(1) provides that a
fine or similar penalty includes an amount: (1) paid pursuant
to conviction or a plea of guilty or nolo contendere for a
crime (felony or misdemeanor) in a criminal proceeding; (2)
paid as a civil penalty imposed by Federal, State, or local
law, including additions to tax and additional amounts and
assessable penalties imposed by chapter 68 of the Code; (3)
paid in settlement of the taxpayer's actual or potential
liability for a fine or penalty (civil or criminal); or (4)
forfeited as collateral posted in connection with a proceeding
which could result in imposition of such a fine or penalty.
Treasury regulation section 1.162-21(b)(2) provides, among
other things, that compensatory damages (including damages
under section 4A of the Clayton Act (15 U.S.C. 15a), as
amended) paid to a government do not constitute a fine or
penalty.

REASONS FOR CHANGE

The Committee is concerned that there is a lack of clarity
and consistency under present law regarding when taxpayers may
deduct payments made in settlement of government investigations
of potential wrongdoing, as well as in situations where there
has been a final determination of wrongdoing. If a taxpayer
deducts payments made in settlement of an investigation of
potential wrongdoing or as a result of a finding of wrongdoing,
the publicly announced amount of the settlement payment does
not reflect the true after-tax penalty on the taxpayer.\62\ The
Committee also is concerned that allowing a deduction for such
payments in effect shifts a portion of the penalty to the
Federal government and to the public. The Committee believes
that reporting the payments to the IRS and the taxpayer
promotes effective tax administration and fosters compliance
with the tax law.
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\62\ The Government Acountability Office (``GAO'') reported that
the majority of companies responding to a GAO survey deducted civil
settlement payments when their settlement agreements did not label the
payments as penalties. See, Government Accountability Office, TAX
ADMINISTRATION: Systematic Information Sharing Would Help IRS Determine
the Deductibility of Civil Settlement Payments (GAO-05-747).
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EXPLANATION OF PROVISION

The provision modifies the rules regarding the
determination whether payments are nondeductible payments of
fines or penalties under section 162(f). In particular, the
provision generally provides that amounts paid or incurred
(whether by suit, agreement, or otherwise) to, or at the
direction of, a government in relation to the violation of any
law or the investigation or inquiry into the potential
violation of any law \63\ are nondeductible under any provision
of the income tax provisions.\64\ The provision applies to deny
a deduction for any such payments, including those where there
is no admission of guilt or liability and those made for the
purpose of avoiding further investigation or litigation. An
exception applies to payments that the taxpayer establishes are
either restitution (including remediation of property), or
amounts required to come into compliance with any law that was
violated or involved in the investigation or inquiry, and that
are identified in the court order or settlement as restitution,
remediation, or required to come into compliance.\65\ The IRS
remains free to challenge the characterization of an amount so
identified; however, no deduction is allowed unless the
identification is made.\66\
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\63\ The provision does not affect amounts paid or incurred in
performing routine audits or reviews such as annual audits that are
required of all organizations or individuals in a similar business
sector, or profession, as a requirement for being allowed to conduct
business. However, if the government or regulator raised an issue of
compliance and a payment is required in settlement of such issue, the
provision would affect that payment.
\64\ The provision provides that such amounts are nondeductible
under chapter 1 of the Internal Revenue Code.
\65\ The provision does not affect the treatment of antitrust
payments made under section 4 of the Clayton Act, which continue to be
governed by the provisions of section 162(g).
\66\ If a settlement agreement does not specify a specific amount
to be paid for the purpose of coming into compliance but instead simply
requires the taxpayer to come into compliance, it is sufficient
identification to so state. Amounts expended by the taxpayer for that
purpose would then be considered identified. However, if an agreement
specifies a specific dollar amount that must be paid or incurred, the
amount would not be eligible to be deducted without a specification
that it is for restitution (including remediation of property), or
coming into compliance.
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An exception also applies to any amount paid or incurred as
taxes due.\67\
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\67\ Thus, amounts paid or incurred as taxes due are not affected
by the provision (e.g., State taxes that are otherwise deductible). The
reference to taxes due is also intended to include interest with
respect to such taxes (but not interest, if any, with respect to any
penalties imposed with respect to such taxes).
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The provision is intended to apply only where a government
(or other entity treated in a manner similar to a government
under the provision) is a complainant or investigator with
respect to the violation or potential violation of any law.\68\
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\68\ Thus, for example, the provision would not apply to payments
made by one private party to another in a lawsuit between private
parties, merely because a judge or jury acting in the capacity as a
court directs the payment to be made. The mere fact that a court enters
a judgment or directs a result in a private dispute does not cause a
payment to be made ``at the direction of government" for purposes of
the provision.
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It is intended that a payment will be treated as
restitution (including remediation of property) only if
substantially all of the payment is required to be paid to the
specific persons, or in relation to the specific property,
actually harmed by the conduct of the taxpayer that resulted in
the payment. Thus, a payment to or with respect to a class
substantially broader than the specific persons or property
that were actually harmed (e.g., to a class including similarly
situated persons or property) does not qualify as restitution
or included remediation of property.\69\ Restitution and
included remediation of property is limited to the amount that
bears a substantial quantitative relationship to the harm
caused by the past conduct or actions of the taxpayer that
resulted in the payment in question. If the party harmed is a
government or other entity, then restitution and included
remediation of property includes payment to such harmed
government or entity, provided the payment bears a substantial
quantitative relationship to the harm. However, restitution or
included remediation of property does not include reimbursement
of government investigative or litigation costs, or payments to
whistleblowers.
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\69\ Similarly, a payment to a charitable organization benefiting a
broader class than the persons or property actually harmed, or to be
paid out without a substantial quantitative relationship to the harm
caused, would not qualify as restitution. Under the provision, such a
payment not deductible under section 162 would also not be deductible
under section 170.
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It is intended that a payment will be treated as an amount
required to come into compliance only if it directly corrects a
violation with respect to a particular requirement of law that
was under investigation. For example, if the law requires a
particular emission standard to be met or particular machinery
to be used, amounts required to be paid under a settlement
agreement to meet the required standard or install the
machinery are deductible to the extent otherwise allowed.
Similarly, if the law requires certain practices and procedures
to be followed and a settlement agreement requires the taxpayer
to pay to establish such practices or procedures, such amounts
would be deductible. However, amounts paid for other purposes
not directly correcting a violation of law are not deductible.
For example, amounts paid to bring other machinery that is
already in compliance up to a standard higher than required by
the law, or to create other benefits (such as a park or other
action not previously required by law), are not deductible if
required under a settlement agreement. Similarly, amounts paid
to educate consumers or customers about the risks of doing
business with the taxpayer or about the field in which the
taxpayer does business generally, which education efforts are
not specifically required under the law, are not deductible if
required under a settlement agreement.
The provision requires government agencies to report to the
IRS and to the taxpayer the amount of each settlement agreement
or order entered where the aggregate amount required to be paid
or incurred to or at the direction of the government under such
settlement agreements and orders with respect to the violation,
investigation, or inquiry is least $600 (or such other amount
as may be specified by the Secretary of the Treasury as
necessary to ensure the efficient administration of the
Internal Revenue laws). The reports must be made within 30 days
of the date the court order is issued or the settlement
agreement is entered into, or such other time as may be
required by Secretary. The report must separately identify any
amounts that are restitution or remediation of property, or
correction of noncompliance.\70\
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\70\ As in the case of the identification requirement, if the
agreement does not specify a specific amount to be expended to come
into compliance but simply requires that to occur, it is expected that
the report may state simply that the taxpayer is required to come into
compliance but no specific dollar amount has been specified for that
purpose in the settlement agreement.
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The IRS is encouraged to require taxpayers to identify
separately on their tax returns the amounts of any such
settlements with respect to which reporting is required under
the provision, including separate identification of the
nondeductible amount and of any amount deductible as
restitution, remediation, or required to correct
noncompliance.\71\
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\71\ For example, the IRS might require such separate reporting as
part of, or in addition to, reporting of amounts that are not deducted
and that thus create a book tax difference on the schedule M-3.
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Amounts paid or incurred (whether by suit, agreement, or
otherwise) to, or at the direction of, any self-regulatory
entity that regulates a financial market or other market that
is a qualified board or exchange under section 1256(g)(7), and
that is authorized to impose sanctions (e.g., the National
Association of Securities Dealers) are likewise subject to the
provision if paid in relation to a violation, or investigation
or inquiry into a potential violation, of any law (or any rule
or other requirement of such entity). To the extent provided in
regulations, amounts paid or incurred to, or at the direction
of, any other nongovernmental entity that exercises self-
regulatory powers as part of performing an essential
governmental function are similarly subject to the provision.
The exception for payments that the taxpayer establishes are
paid or incurred for restitution, remediation of property, or
coming into compliance and that are identified as such in the
order or settlement agreement likewise applies in these cases.
The requirement of reporting to the IRS and the taxpayer also
applies in these cases.
No inference is intended as to the treatment of payments as
nondeductible fines or penalties under present law. In
particular, the provision is not intended to limit the scope of
present-law section 162(f) or the regulations thereunder.

EFFECTIVE DATE

The provision is effective for amounts paid or incurred on
or after the date of enactment; however the provision does not
apply to amounts paid or incurred under any binding order or
agreement entered into before such date. Any order or agreement
requiring court approval is not a binding order or agreement
for this purpose unless such approval was obtained before the
date of enactment.

E. Revision of Tax Rules on Expatriation of Individuals

(Sec. 205 of the bill and secs. 102, 877, 2107, 2501, 7701 and 6039G of
the Code)

PRESENT LAW

In general

U.S. citizens and residents generally are subject to U.S
income taxation on their worldwide income. The U.S. tax may be
reduced or offset by a credit allowed for foreign income taxes
paid with respect to foreign source income. Nonresident aliens
are taxed at a flat rate of 30 percent (or a lower treaty rate)
on certain types of passive income derived from U.S. sources,
and at regular graduated rates on net profits derived from a
U.S. trade or business. The estates of nonresident aliens
generally are subject to estate tax on U.S.-situated property
(e.g., real estate and tangible property located within the
United States and stock in a U.S. corporation). Nonresident
aliens generally are subject to gift tax on transfers by gift
of U.S.-situated property (e.g., real estate and tangible
property located within the United States), but excluding
intangibles, such as stock, regardless of where they are
located.

Income tax rules with respect to expatriates

For the 10 taxable years after an individual relinquishes
his or her U.S. citizenship or terminates his or her U.S. long-
term residency, unless certain conditions are met, the
individual is subject to an alternative method of income
taxation than that generally applicable to nonresident aliens
(the ``alternative tax regime''). Generally, the individual is
subject to income tax for the 10-year period at the rates
applicable to U.S. citizens, but only on U.S.-source
income.\72\
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\72\ For this purpose, however, U.S.-source income has a broader
scope than it does typically in the Code.
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A ``long-term resident'' is a noncitizen who is a lawful
permanent resident of the United States for at least eight
taxable years during the period of 15 taxable years ending with
the taxable year during which the individual either ceases to
be a lawful permanent resident of the United States or
commences to be treated as a resident of a foreign country
under a tax treaty between such foreign country and the United
States (and does not waive such benefits).
A former citizen or former long-term resident is subject to
the alternative tax regime for a 10-year period following
citizenship relinquishment or residency termination, unless the
former citizen or former long-term resident: (1) establishes
that his or her average annual net income tax liability for the
five preceding years does not exceed $124,000 (adjusted for
inflation after 2004) and his or her net worth is less than $2
million, or alternatively satisfies limited, objective
exceptions for certain dual citizens and minors who have had no
substantial contacts with the United States; and (2) certifies
under penalties of perjury that he or she has complied with all
U.S. Federal tax obligations for the preceding five years and
provides such evidence of compliance as the Secretary of the
Treasury may require.
Anti-abuse rules are provided to prevent the circumvention
of the alternative tax regime.

Estate tax rules with respect to expatriates

Special estate tax rules apply to individuals who die
during a taxable year in which he or she is subject to the
alternative tax regime. Under these special rules, certain
closely-held foreign stock owned by the former citizen or
former long-term resident is includible in his or her gross
estate to the extent that the foreign corporation owns U.S.-
situated assets. The special rules apply if, at the time of
death: (1) the former citizen or former long-term resident
directly or indirectly owns 10 percent or more of the total
combined voting power of all classes of stock entitled to vote
of the foreign corporation; and (2) directly or indirectly, is
considered to own more than 50 percent of (a) the total
combined voting power of all classes of stock entitled to vote
in the foreign corporation, or (b) the total value of the stock
of such corporation. If this stock ownership test is met, then
the gross estate of the former citizen or former long-term
resident includes that proportion of the fair market value of
the foreign stock owned by the individual at the time of death,
which the fair market value of any assets owned by such foreign
corporation and situated in the United States (at the time of
death) bears to the total fair market value of all assets owned
by such foreign corporation (at the time of death).

Gift tax rules with respect to expatriates

Special gift tax rules apply to individuals who make gifts
during a taxable year in which he or she is subject to the
alternative tax regime. The individual is subject to gift tax
on gifts of U.S.-situated intangibles made during the 10 years
following citizenship relinquishment or residency termination.
In addition, gifts of stock of certain closely-held foreign
corporations by a former citizen or former long-term resident
are subject to gift tax, if the gift is made during the time
that such person is subject to the alternative tax regime. The
operative rules with respect to these gifts of closely-held
foreign stock are the same as described above relating to the
estate tax, except that the relevant testing and valuation date
is the date of gift rather than the date of death.

Termination of U.S. citizenship or long-term resident status for U.S.
Federal income tax purposes

An individual continues to be treated as a U.S. citizen or
long-term resident for U.S. Federal tax purposes, including for
purposes of section 7701(b)(10), until the individual: (1)
gives notice of an expatriating act or termination of residency
(with the requisite intent to relinquish citizenship or
terminate residency) to the Secretary of State or the Secretary
of Homeland Security, respectively; and (2) provides a
statement to the Secretary of the Treasury in accordance with
section 6039G.

Sanction for individuals subject to the individual tax regime who
return to the United States for extended periods

The alternative tax regime does not apply to any individual
for any taxable year during the 10-year period following
citizenship relinquishment or residency termination if such
individual is present in the United States for more than 30
days in the calendar year ending in such taxable year. Such
individual is treated as a U.S. citizen or resident for such
taxable year and, therefore, is taxed on his or her worldwide
income.
Similarly, if an individual subject to the alternative tax
regime is present in the United States for more than 30 days in
any calendar year ending during the 10-year period following
citizenship relinquishment or residency termination, and the
individual dies during that year, he or she is treated as a
U.S. resident, and the individual's worldwide estate is subject
to U.S. estate tax. Likewise, if an individual subject to the
alternative tax regime is present in the United States for more
than 30 days in any year during the 10-year period following
citizenship relinquishment or residency termination, the
individual is subject to U.S. gift tax on any transfer of his
or her worldwide assets by gift during that taxable year.
For purposes of these rules, an individual is treated as
present in the United States on any day if such individual is
physically present in the United States at any time during that
day. The present-law exceptions from being treated as present
in the United States for residency purposes \73\ generally do
not apply for this purpose. However, for individuals with
certain ties to countries other than the United States \74\ and
individuals with minimal prior physical presence in the United
States,\75\ a day of physical presence in the United States is
disregarded if the individual is performing services in the
United States on such day for an unrelated employer (within the
meaning of sections 267 and 707(b)), who meets the requirements
the Secretary of the Treasury may prescribe in regulations. No
more than 30 days may be disregarded during any calendar year
under this rule.
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\73\ Secs. 7701(b)(3)(D), 7701(b)(5) and 7701(b)(7)(B)-(D).
\74\ An individual has such a relationship to a foreign country if
(1) the individual becomes a citizen or resident of the country in
which the individual was born, such individual's spouse was born, or
either of the individual's parents was born, and (2) the individual
becomes fully liable for income tax in such country.
\75\ An individual has a minimal prior physical presence in the
United States if the individual was physically present for no more than
30 days during each year in the ten-year period ending on the date of
loss of United States citizenship or termination of residency. However,
for purposes of this test, an individual is not treated as being
present in the United States on a day if the individual remained in the
United States because of a medical condition that arose while the
individual was in the United States. Sec. 7701(b)(3)(D)(ii).
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Annual return

Former citizens and former long-term residents are required
to file an annual return for each year following citizenship
relinquishment or residency termination in which they are
subject to the alternative tax regime. The annual return is
required even if no U.S. Federal income tax is due. The annual
return requires certain information, including information on
the permanent home of the individual, the individual's country
of residence, the number of days the individual was present in
the United States for the year, and detailed information about
the individual's income and assets that are subject to the
alternative tax regime. This requirement includes information
relating to foreign stock potentially subject to the special
estate and gift tax rules.
If the individual fails to file the statement in a timely
manner or fails correctly to include all the required
information, the individual is required to pay a penalty of
$10,000. The $10,000 penalty does not apply if it is shown that
the failure is due to reasonable cause and not to willful
neglect.

Immigration rules with respect to expatriates

Under U.S. immigration laws, any former U.S. citizen who
officially renounces his or her U.S. citizenship and who is
determined by the Attorney General to have renounced for the
purpose of U.S. tax avoidance is ineligible to receive a U.S.
visa and will be denied entry into the United States. This
provision was included as an amendment (the ``Reed amendment'')
to immigration legislation that was enacted in 1996.

REASONS FOR CHANGE

The Committee is aware that some individuals each year
relinquish their U.S. citizenship or terminate their U.S.
residency for the purpose of avoiding U.S. income, estate, and
gift taxes. By so doing, such individuals reduce their annual
U.S. income tax liability and reduce or eliminate their U.S.
estate and gift tax liability.
The Committee recognizes that citizens and residents of the
United States have a right not only physically to leave the
United States to live elsewhere, but also to relinquish their
citizenship or terminate their residency. The Committee does
not believe that the Internal Revenue Code should be used to
stop U.S. citizens and residents from relinquishing citizenship
or terminating residency; however, the Committee also does not
believe that the Code should provide a tax incentive for doing
so. In other words, to the extent possible, an individual's
decision to relinquish citizenship or terminate residency
should be tax-neutral.
The Committee recognizes that the American Jobs Creation
Act of 2004 altered prior law regarding expatriation in a
number of respects, including the replacement of the subjective
``principal purpose of tax avoidance test'' with objective
rules. Notwithstanding these changes, the Committee remains
concerned that the present-law expatriation tax rules (as
modified in 2004) are difficult to administer and could be made
more effective. In addition, the Committee is concerned that
the alternative method of taxation under section 877 can be
avoided by postponing the realization of U.S.-source income for
10 years.
Consequently, the Committee believes that the present-law
expatriation tax rules should be replaced with a new tax regime
applicable to former citizens and residents. Because U.S.
citizens and residents who retain their citizenship or
residency generally are subject to income tax on accrued
appreciation when they dispose of their assets, as well as
estate tax on the full value of assets that are held until
death, the Committee believes it fair to tax individuals on the
appreciation in their assets when they relinquish their
citizenship or terminate their residency. The Committee
believes that an exception from such a tax should be provided
for individuals with a relatively modest amount of appreciated
assets. The Committee also believes that, where U.S. estate or
gift taxes are avoided with respect to a transfer of property
to a U.S. person by reason of the expatriation of the donor, it
is appropriate for the recipient to be subject to an income tax
based on the value of the property.
The Committee also believes that the present-law
immigration rules applicable to former citizens are
ineffective. The Committee believes that the rules should be
modified to eliminate the requirement of proof of a tax
avoidance purpose, and to coordinate the application of those
rules with the tax rules provided under the new regime.

EXPLANATION OF PROVISION

In general

The provision generally subjects certain U.S. citizens who
relinquish their U.S. citizenship and certain long-term U.S.
residents who terminate their U.S. residence to tax on the net
unrealized gain in their property as if such property were sold
for fair market value on the day before the expatriation or
residency termination (``mark-to-market tax''). Gain from the
deemed sale is taken into account at that time without regard
to other Code provisions. Any loss from the deemed sale
generally is taken into account to the extent otherwise
provided in the Code, except that the wash sale rules of
section 1091 do not apply. Any net gain on the deemed sale is
recognized to the extent it exceeds $600,000 per covered
expatriate. The $600,000 amount is increased by a cost of
living adjustment factor for calendar years after 2007.

Individuals covered

The mark-to-market tax applies to U.S. citizens who
relinquish citizenship and long-term residents who terminate
U.S. residency (collectively, ``covered expatriates''). The
definition of ``long-term resident'' under the provision is the
same as that under present law. As under present law, an
individual is considered to terminate long-term residency when
the individual either ceases to be a lawful permanent resident
(i.e., loses his or her green card status), or is treated as a
resident of another country under a tax treaty and does not
waive the benefits of the treaty.
Exceptions to an individual's classification as a covered
expatriate are provided in two situations. The first exception
applies to an individual who was born with citizenship both in
the United States and in another country; provided that (1) as
of the expatriation date the individual continues to be a
citizen of, and is taxed as a resident of, such other country,
and (2) the individual was not a resident of the United States
for the five taxable years ending with the year of
expatriation. The second exception applies to a U.S. citizen
who relinquishes U.S. citizenship before reaching age 18\1/2\,
provided that the individual was a resident of the United
States for no more than five taxable years before such
relinquishment.
For purposes of the mark-to-market tax, an individual is
treated as having relinquished U.S. citizenship on the earliest
of four possible dates: (1) the date that the individual
renounces U.S. nationality before a diplomatic or consular
officer of the United States (provided that the voluntary
relinquishment is later confirmed by the issuance of a
certificate of loss of nationality); (2) the date that the
individual furnishes to the State Department a signed statement
of voluntary relinquishment of U.S. nationality confirming the
performance of an expatriating act (again, provided that the
voluntary relinquishment is later confirmed by the issuance of
a certificate of loss of nationality); (3) the date that the
State Department issues a certificate of loss of nationality;
or (4) the date that a U.S. court cancels a naturalized
citizen's certificate of naturalization.
In addition, the provision provides that, for all tax
purposes (i.e., not limited to the mark-to-market tax), a U.S.
citizen continues to be treated as a U.S. citizen for tax
purposes until that individual's citizenship is treated as
relinquished under the rules of the immediately preceding
paragraph. However, under Treasury regulations, relinquishment
may occur earlier with respect to an individual who became at
birth a citizen of the United Sates and of another country.

Election to be treated as a U.S. citizen

Under the provision, a covered expatriate is permitted to
make an irrevocable election to continue to be taxed as a U.S.
citizen with respect to all property that otherwise is covered
by the expatriation tax. This election is an ``all or nothing''
election; an individual is not permitted to elect this
treatment for some property but not for other property. The
election, if made, applies to all property that would be
subject to the expatriation tax and to any property the basis
of which is determined by reference to such property. Under
this election, following expatriation the individual continues
to pay U.S. income taxes at the rates applicable to U.S.
citizens on any income generated by the property and on any
gain realized on the disposition of the property. In addition,
the property continues to be subject to U.S. gift, estate, and
generation-skipping transfer taxes. In order to make this
election, the taxpayer is required to waive any treaty rights
that would preclude the collection of the tax.
The individual is also required to provide security to
ensure payment of the tax under this election in such form,
manner, and amount as the Secretary of the Treasury requires.
The amount of mark-to-market tax that would have been owed but
for this election (including any interest, penalties, and
certain other items) becomes a lien in favor of the United
States on all U.S.-situated property owned by the individual.
This lien arises on the expatriation date and continues until
the tax liability is satisfied, the tax liability has become
unenforceable by reason of lapse of time, or the Secretary of
the Treasury is satisfied that no further tax liability may
arise by reason of this provision. The rules of section
6324A(d)(1), (3), and (4) (relating to liens arising in
connection with the deferral of estate tax under section 6166)
apply to liens arising under this provision.

Deemed sale of property upon expatriation or residency termination and
tentative tax

The deemed sale rule of the provision generally applies to
all property interests held by the individual on the date of
relinquishment of citizenship or termination of residency.
Special rules apply in the case of trust interests, as
described below. U.S. real property interests (which remain
subject to U.S. tax in the hands of nonresident noncitizens),
with the exception of stock of certain former U.S. real
property holding corporations, are exempted from the provision.
Regulatory authority is granted to the Treasury to exempt other
types of property from the provision.
Under the provision, an individual who is subject to the
mark-to-market tax is required to pay a tentative tax equal to
the amount of tax that would be due for a hypothetical short
tax year ending on the date the individual relinquishes
citizenship or terminates residency. Thus, the tentative tax is
based on all income, gains, deductions, losses, and credits of
the individual for the year through such date, including
amounts realized from the deemed sale of property. Moreover,
notwithstanding any other provision of the Code, any period
during which recognition of incomeor gain had been deferred
terminates on the day before relinquishment of citizenship or
termination of residency (and, therefore, such income or gain
recognition becomes part of the tax base of the tentative tax). The
tentative tax is due on the 90th day after the date of relinquishment
of citizenship or termination of residency, subject to the election,
described below, to defer payments of the mark-to-market tax. In
addition, notwithstanding any other provision of the Code, any
extension of time for payment of tax ceases to apply on the day before
relinquishment of citizenship or termination of residency, and the
unpaid portion of such tax becomes due and payable at the time and in
the manner prescribed by the Secretary of the Treasury.

Deferral of payment of mark-to-market tax

Under the provision, an individual is permitted to elect to
defer payment of the mark-to-market tax imposed on the deemed
sale of property. Interest is charged for the period the tax is
deferred at a rate two percentage points higher than the rate
normally applicable to individual underpayments. The election
is irrevocable and is made on a property-by-property basis.
Under the election, the deferred tax attributable to a
particular property is due when the property is disposed of
(or, if the property is disposed of in a transaction in which
gain is not recognized in whole or in part, at such other time
as the Secretary of the Treasury may prescribe). The deferred
tax attributable to a particular property is an amount that
bears the same ratio to the total mark-to-market tax as the
gain taken into account with respect to such property bears to
the total gain taken into account under these rules. The
deferral of the mark-to-market tax may not be extended beyond
the due date of the return for the taxable year which includes
the individual's death.
In order to elect deferral of the mark-to-market tax, the
individual is required to provide a bond in the amount of the
deferred tax to the Secretary of the Treasury. Other security
mechanisms are permitted provided that the individual
establishes to the satisfaction of the Secretary of the
Treasury that the security is adequate. In the event that the
security provided with respect to a particular property
subsequently becomes inadequate and the individual fails to
correct the situation, the deferred tax and the interest with
respect to such property will become due. As a further
condition to making the election, the individual is required to
consent to the waiver of any treaty rights that would preclude
the collection of the tax.
The deferred tax amount (including any interest, penalties,
and certain other items) becomes a lien in favor of the United
States on all U.S.-situated property owned by the individual.
This lien arises on the expatriation date and continues until
the tax liability is satisfied, the tax liability has become
unenforceable by reason of lapse of time, or the Secretary is
satisfied that no further tax liability may arise by reason of
this provision. The rules of section 6324A(d)(1), (3), and (4)
(relating to liens arising in connection with the deferral of
estate tax under section 6166) apply to such liens.

Retirement plans and similar arrangements

Subject to certain exceptions, the provision applies to all
property interests held by covered expatriates at the time of
relinquishment of citizenship or termination of residency.
Accordingly, such property includes an interest in an employer-
sponsored qualified plan or deferred compensation arrangement
as well as an interest in an individual retirement account or
annuity (i.e., an IRA).\76\ However, the provision contains a
special rule for an interest in a ``retirement plan.'' For
purposes of the provision, a ``retirement plan'' includes an
employer-sponsored qualified plan (sec. 401(a)), a qualified
annuity (sec. 403(a)), a tax-sheltered annuity (sec. 403(b)),
an eligible deferred compensation plan of a governmental
employer (sec. 457(b)), an individual retirement account (sec.
408(a)), and an individual retirement annuity (sec. 408(b)).
The special retirement plan rule also applies, to the extent
provided in regulations, to any foreign plan or similar
retirement arrangement or program. An interest in a trust that
is part of a retirement plan is subject to the special
retirement plan rules and not to the rules for interests in
trusts (discussed below).
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\76\ Application of the provision is not limited to an interest
that meets the definition of property under section 83 (relating to
property transferred in connection with the performance of services).
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Under the special retirement plan rules, in lieu of the
deemed sale rule, an amount equal to the present value of the
individual's vested, accrued benefit under a retirement plan is
treated as having been received by the individual as a
distribution under the retirement plan on the day before the
individual's relinquishment of citizenship or termination of
residency. In the case of any later distribution to the
individual from the retirement plan, the amount otherwise
includible in the individual's income as a result of the
distribution is reduced to reflect the amount previously
included in income under the special retirement plan rule. The
amount of the reduction applied to a distribution is the excess
of: (1) the amount included in income under the special
retirement plan rule, over (2) the total reductions applied to
any prior distributions. It is not intended that the retirement
plan would be deemed to have made a distribution at the time of
expatriation for purposes of the tax-favored status of the
retirement plan, such as whether a plan may permit
distributions before a participant has severed employment.
However, the retirement plan, and any person acting on the
plan's behalf, will treat any later distribution in the same
manner as the distribution would be treated without regard to
the special retirement plan rule.
It is expected that the Treasury Department will provide
guidance for determining the present value of an individual's
vested, accrued benefit under a retirement plan, such as the
individual's account balance in the case of a defined
contribution plan or an IRA, or present value determined under
the qualified joint and survivor annuity rules applicable to a
defined benefit plan (sec. 417(e)).

Interests in trusts

In general
Detailed rules apply under the provision to trust interests
held by an individual at the time of relinquishment of
citizenship or termination of residency. The treatment of trust
interests depends on whether the trust is a ``qualified
trust.'' A trust is a qualified trust if a court within the
United States is able to exercise primary supervision over the
administration of the trust and one or more U.S. persons have
the authority to control all substantial decisions of the
trust.
Constructive ownership rules apply to a trust beneficiary
that is a corporation, partnership, trust, or estate. In such
cases, the shareholders, partners, or beneficiaries of the
entity are deemed to be the direct beneficiaries of the trust.
In addition, an individual who holds (or who is treated as
holding) a trust instrument at the time of relinquishment of
citizenship or termination of residency is required to disclose
on his or her tax return the methodology used to determine his
or her interest in the trust, and whether such individual knows
(or has reason to know) that any other beneficiary of the trust
uses a different method.
Nonqualified trusts
If an individual holds an interest in a trust that is not a
qualified trust, a special rule applies for purposes of
determining the amount of the mark-to-market tax due with
respect to such trust interest. The individual's interest in
the trust is treated as a separate trust consisting of the
trust assets allocable to such interest. Such separate trust is
treated as having sold its net assets for their fair market
value on the day before the date of relinquishment of
citizenship or termination of residency and having distributed
the assets to the individual, who then is treated as having
recontributed the assets to the trust. Any income, gain, or
loss of the individual arising from the deemed distribution
from the trust is taken into account as if it had arisen under
the deemed sale rules.
The election to defer payment is available for the mark-to-
market tax attributable to a nonqualified trust interest. A
beneficiary's interest in a nonqualified trust is determined
under all the facts and circumstances, including the trust
instrument, letters of wishes, historical patterns of trust
distributions, and the existence of, and function performed by,
a trust protector or any similar advisor.
Qualified trusts
If an individual has an interest in a qualified trust, the
amount of mark-to-market tax on unrealized gain allocable to
the individual's trust interest (``allocable expatriation
gain'') is calculated at the time of expatriation or residency
termination, but is collected as the individual receives
distributions from the qualified trust. The allocable
expatriation gain is the amount of gain which would be
allocable to the individual's trust interest if the individual
directly held all the assets allocable to such interest.\77\ If
any individual's interest in a trust is vested as of the day
before the expatriation date (e.g., if the individual's
interest in the trust is non-contingent and non-discretionary),
the gain allocable to the individual's trust interest is
determined based on the trust assets allocable to his or her
trust interest. If the individual's interest in the trust is
not vested as of the expatriation date (e.g., if the
individual's trust interest is a contingent or discretionary
interest), the gain allocable to his or her trust interest is
determined based on all of the trust assets that could be
allocable to his or her trust interest, determined by resolving
all contingencies and discretionary powers in the individual's
favor (i.e., the individual is allocated the maximum amount
that he or she could receive).
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\77\ Allocable expatriation gain is subject to the $600,000
exemption (adjusted for cost of living increases).
---------------------------------------------------------------------------
Taxes are imposed on each distribution from a qualified
trust. These distributions also may be subject to other U.S.
income taxes. If a distribution from a qualified trust is made
after the individual relinquishes citizenship or terminates
residency, the mark-to-market tax is imposed in an amount equal
to the amount of the distribution multiplied by the highest tax
rate generally applicable to trusts and estates for the taxable
year which includes the date of expatriation, but in no event
will the tax imposed exceed the balance in the ``deferred tax
account'' with respect to the trust interest. For this purpose,
the balance in the deferred tax account is equal to (1) the
hypothetical tax calculated under the ``regular'' deemed sale
rules with respect to the allocable expatriation gain, (2)
increased by interest charged on the balance in the deferred
tax account at a rate two percentage points higher than the
rate normally applicable to individual underpayments, for
periods beginning after the 90th day after the expatriation
date and calculated up to 30 days prior to the date of the
distribution, (3) reduced by any mark-to-market tax imposed on
prior trust distributions to the individual, and (4) to the
extent provided in Treasury regulations, in the case of a
covered expatriate holding a nonvested interest, reduced by
mark-to-market taxes imposed on trust distributions to other
persons holding nonvested interests.
The tax that is imposed on distributions from a qualified
trust generally is to be deducted and withheld by the trustees.
If the individual does not agree to waive treaty rights that
would preclude collection of the tax, the tax with respect to
such distributions is imposed on the trust, the trustee is
personally liable for the tax, and any other beneficiary has a
right of contribution against such individual with respect to
the tax.
Mark-to-market taxes become due immediately if the trust
ceases to be a qualified trust, the individual disposes of his
or her qualified trust interest, or the individual dies. In
such cases, the amount of mark-to-market tax equals the lesser
of (1) the tax calculated under the rules for nonqualified
trust interests as of the date of the triggering event, or (2)
the balance in the deferred tax account with respect to the
trust interest immediately before that date. Such tax is
imposed on the trust, the trustee is personally liable for the
tax, and any other beneficiary has a right of contribution
against such individual (or his or her estate) with respect to
such tax.

Regulatory authority

The provision authorizes the Secretary of the Treasury to
prescribe such regulations as may be necessary or appropriate
to carry out the purposes of the provision. In addition, the
Secretary of the Treasury may provide for adjustments to the
bases of assets in a trust or a deferred tax account, and the
timing of such adjustments, to ensure that gain is taxed only
once.

Income tax treatment of gifts and inheritances from a former citizen or
former long-term resident

Under the provision, the exclusion from income provided in
section 102 (relating to exclusions from income for the value
of property acquired by gift or inheritance) does not apply to
the value of any property received by gift or inheritance from
a covered expatriate. Accordingly, a U.S. taxpayer who receives
a gift or inheritance from such an individual is required to
include the value of such gift or inheritance in gross income
and is subject to U.S. tax on such amount. Having included the
value of the property in income, the recipient takes a basis in
the property equal to that value. The tax does not apply to
property that is shown on a timelyfiled gift tax return and
that is a taxable gift by the former citizen or former long-term
resident, or property that is shown on a timely filed estate tax return
and included in the gross U.S. estate of the former citizen or former
long-term resident (regardless of whether the tax liability shown on
such a return is reduced by credits, deductions, or exclusions
available under the estate and gift tax rules). In addition, the tax
does not apply to property in cases in which no estate or gift tax
return was filed, but no such return would have been required to be
filed if the former citizen or former long-term resident had not
relinquished citizenship or terminated residency, as the case may be.

Coordination with present-law alternative tax regime

The provision provides a coordination rule with the
present-law alternative tax regime. Under the provision, the
present-law expatriation income tax rules under section 877,
and the special present-law expatriation estate and gift tax
rules under sections 2107 and 2501(a)(3) (generally described
above), do not apply to a covered expatriate whose expatriation
or residency termination occurs on or after the date of
enactment.

Information reporting

Certain information reporting requirements under the law
presently applicable to former citizens and former long-term
residents (sec. 6039G) also apply for purposes of the
provision.

Immigration rules

The provision amends the immigration rules that deny tax-
motivated expatriates reentry into the United States by
removing the requirement that the expatriation be tax-
motivated, and instead denies former citizens reentry into the
United States if the individual is determined not to be in
compliance with his or her tax obligations under the
provision's expatriation tax provisions (regardless of the
subjective motive for expatriating). For this purpose, the
provision permits the IRS to disclose certain items of return
information of an individual, upon written request of the
Attorney General or his delegate, as is necessary for making a
determination under section 212(a)(10)(E) of the Immigration
and Nationality Act. Specifically, the provision permits the
IRS to disclose to the agency administering section
212(a)(10)(E) whether such taxpayer is in compliance with the
new tax rules, and to identify the items of any noncompliance.
Recordkeeping requirements, safeguards, and civil and criminal
penalties for unauthorized disclosure or inspection apply to
return information disclosed under this provision.

EFFECTIVE DATE

The provision generally is effective for U.S. citizens who
relinquish citizenship or long-term residents who terminate
their residency on or after the date of enactment. The due date
for tentative tax, however, may not occur before the 90th day
after the date of enactment. The portion of the provision
relating to income taxes on gifts and inheritances is effective
for gifts and inheritances received from former citizens or
former long-term residents (or their estates) on or after the
date of enactment, whose relinquishment of citizenship or
residency termination occurs after such date. The portion of
the provision relating to immigration and disclosure with
respect to former citizens is effective with respect to
individuals who relinquish citizenship on or after the date of
enactment.

F. Limit Amounts of Annual Deferrals Under Nonqualified Deferred
Compensation Plans

(Sec. 206 of the bill and sec. 409A of the Code)

PRESENT LAW

Amounts deferred under a nonqualified deferred compensation
plan for all taxable years are currently includible in gross
income to the extent not subject to a substantial risk of
forfeiture and not previously included in gross income, unless
certain requirements are satisfied.\78\ The requirements
include rules relating to distributions, acceleration of
benefits and funding. For example, distributions from a
nonqualified deferred compensation plan may be allowed only
upon certain times and events. Rules also apply for the timing
of elections. In general, elections to defer compensation for a
taxable year must be made not later than the close of the
preceding taxable year. Section 409A does not include rules
limiting the amount that may be deferred under a nonqualified
deferred compensation plan.
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\78\ Code sec. 409A.
---------------------------------------------------------------------------
A nonqualified deferred compensation plan generally
includes any plan that provides for the deferral of
compensation other than a qualified employer plan or any bona
fide vacation leave, sick leave, compensatory time, disability
pay, or death benefit plan. A qualified employer plan means a
qualified retirement plan, tax-deferred annuity, simplified
employee pension, and SIMPLE. A qualified governmental excess
benefit arrangement (sec. 415(m)) and an eligible deferred
compensation plan (sec. 457(b)) is a qualified employer plan.
If the requirements of section 409A are not satisfied, in
addition to current income inclusion, interest at the
underpayment rate plus one percentage point is imposed on the
underpayments that would have occurred had the compensation
been includible in income when first deferred, or if later,
when not subject to a substantial risk of forfeiture. The
amount required to be included in income is also subject to a
20-percent additional tax.
Under present law, Treasury is authorized to prescribe
regulations as are necessary or appropriate to carry out the
purposes of the provision.

REASONS FOR CHANGE

The Committee is concerned with the large amount of
executive compensation that is deferred in order to avoid the
payment of income taxes. Rank and file employees generally do
not have the opportunity to defer taxation on otherwise
includible income in excess of the qualified plan limits.
However, it is common for nonqualified deferred compensation
arrangements to allow executives to choose the amount of income
inclusion they wish to defer.\79\ The Committee is concerned
that the ability to defer unlimited amounts of compensation
gives executives more control over the timing of income
inclusion than rank and file employees. The Committee believes
that the amount of compensation that can be deferred to avoid
the payment of tax should be limited.
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\79\ See, e.g., Ellen E. Schultz and Theo Francis, As Workers'
Pensions Wither, Those for Executives Flourish, Wall St. J., June 23,
2006, at A1, and Deferring Compensation Also Creates A Company Debt to
Executives, June 23, 2006, at A8. Theo Francis, `Phantom' Accounts for
CEOs Draw Scrutiny, Wall St. J., June 13, 2005, at B1.
---------------------------------------------------------------------------

EXPLANATION OF PROVISION

The provision adds an additional requirement to the rules
governing the income inclusion of amounts deferred under a
nonqualified deferred compensation plan. Under the provision,
the annual aggregate amounts deferred under a nonqualified
deferred compensation plan by an individual may not exceed the
applicable dollar amount for the taxable year. The applicable
dollar amount is the lesser of (1) $1 million or (2) the
average annual compensation payable during the base period to
the participant by the employer maintaining the nonqualified
deferred compensation plan (or a predecessor or related entity)
and which was includible in the participant's gross income for
taxable years in the base period. Earnings (whether actual or
notional) attributable to nonqualified deferred compensation
are treated as additional deferred compensation and are subject
to the provision. Thus, such amounts are taken into account in
determining whether the limit on the amount deferred is
exceeded.
If the requirement is not satisfied, the present-law
sanctions for failure to satisfy section 409A apply. Thus, if
the requirement is not satisfied, all amounts deferred under
the nonqualified deferred compensation plan for all taxable
years are currently includible in gross income to the extent
not subject to a substantial risk of forfeiture and not
previously included in gross income. If the requirements of the
provision are not satisfied, as under present law, in addition
to current income inclusion, interest at the underpayment rate
plus one percentage point is imposed on the underpayments that
would have occurred had the compensation been includible in
income when first deferred, or if later, when not subject to a
substantial risk of forfeiture. The amount required to be
included in income is also subject to a 20-percent additional
tax.\80\
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\80\ These consequences apply under the provision to amounts
deferred after the effective date of the provision.
---------------------------------------------------------------------------
Earnings (whether actual or notional) in a subsequent
taxable year on amounts included in income under the provision
are includible in income in such subsequent taxable year to the
extent such earnings are not subject to a substantial risk of
forfeiture and not previously included in gross income. The
present-law sanctions under 409A (interest at the underpayment
rate plus one percentage point and a 20-percent additional tax)
also apply.
The base period is the five-taxable-year period ending with
the taxable year preceding the taxable year for which the
limitation is being determined (the ``computation year''). If,
before the beginning of the computation year, an election is
made to defer compensation for services performed in the
computation year, the base period is the five-taxable-year
period ending with the taxable year preceding the taxable year
in which the election is made. For example, suppose an
executive elects in 2008 to defer a portion of compensation to
be earned in 2009. The baseperiod for the 2009 computation year
would be 2003 to 2007. In the case that the individual does not perform
services for the employer for the entire five-year period, the base
period is the portion of such period during which the individual
performs services for the employer (or a predecessor employer). It is
intended that the Secretary of the Treasury issue guidance similar to
that under section 280G regarding the base period determination in
cases in which the individual does not perform services for the
employer for the entire five-year period.
As under section 409A generally, except as provided by the
Secretary, aggregation rules similar to the rules under section
414(b) and (c) apply. In addition, all nonqualified deferred
compensation plans maintained by all employers treated as a
single employer under these aggregation rules are treated as
one plan.
The provision applies to all amounts deferred under
nonqualified deferred compensation plans (as defined under
section 409A), including plans of both private and publicly-
held corporations.
As under section 409A generally, this limitation is not
intended to prevent the inclusion of amounts in gross income
under any provision or rule of law earlier than the time
provided in the provision. The provision does not affect the
rules regarding the timing of an employer's deduction for
nonqualified deferred compensation.
The regulatory authority of the Secretary of the Treasury
to prescribe regulations as are necessary to carry out the
purposes of section 409A generally applies to the provision.
Under such existing regulatory authority, it is expected that
the Secretary of the Treasury will issue guidance relating to
defined benefit arrangements, including the application of the
annual limitation and determination of the amounts deferred.

EFFECTIVE DATE

The provision applies to taxable years beginning after
December 31, 2006, with respect to amounts deferred after such
date (and earnings on such amounts). Amounts deferred (and
earnings on amounts deferred) in taxable years beginning before
January 1, 2007, are not subject to the provision. Taxable
years beginning on or before December 31, 2006, are taken into
account in determining the average annual compensation of a
participant during any base period.
The provision directs the Secretary of the Treasury, within
60 days after enactment, to issue guidance providing a limited
time period during which a nonqualified deferred compensation
plan adopted before December 31, 2006, may, without violating
the requirements of section 409A, be amended to provide that a
participant may, no later than December 31, 2007, cancel or
modify an outstanding deferral election with regard to all or a
portion of amounts deferred after December 31, 2006, to the
extent necessary to meet the requirements of the provision.
Amounts subject to the cancellation or modification are
currently includible in income to the participant to the extent
not subject to a substantial risk of forfeiture and not
previously included in income. Such guidance must also allow
nonqualified deferred compensation plans adopted before
December 31, 2006, to be amended to conform to the requirements
of the provision with regard to amounts deferred after December
31, 2006.

G. Increase in Criminal Monetary Penalty Limitation for the
Underpayment or Overpayment of Tax Due to Fraud

(Sec. 207 of the bill and secs. 7201, 7203, and 7206 of the Code)

PRESENT LAW

Attempt to evade or defeat tax

In general, section 7201 imposes a criminal penalty on
persons who willfully attempt to evade or defeat any tax
imposed by the Code. Upon conviction, the Code provides that
the penalty is up to $100,000 or imprisonment of not more than
five years (or both). In the case of a corporation, the Code
increases the monetary penalty to a maximum of $500,000.

Willful failure to file return, supply information, or pay tax

In general, section 7203 imposes a criminal penalty on
persons required to make estimated tax payments, pay taxes,
keep records, or supply information under the Code and who
willfully fail to do so. Upon conviction, the Code provides
that the penalty is up to $25,000 or imprisonment of not more
than one year (or both). In the case of a corporation, the Code
increases the monetary penalty to a maximum of $100,000.

Fraud and false statements

In general, section 7206 imposes a criminal penalty on
persons who make fraudulent or false statements under the Code.
Upon conviction, the Code provides that the penalty is up to
$100,000 or imprisonment of not more than three years (or
both). In the case of a corporation, the Code increases the
monetary penalty to a maximum of $500,000.

Uniform sentencing guidelines

Under the uniform sentencing guidelines established by 18
U.S.C. 3571, a defendant found guilty of a criminal offense is
subject to a maximum fine that is the greatest of: (a) the
amount specified in the underlying provision; (b) for a
felony,\81\ $250,000 for an individual or $500,000 for an
organization; or (c) twice the gross gain if a person derives
pecuniary gain from the offense. This Title 18 provision
applies to all criminal provisions in the United States Code,
including those in the Internal Revenue Code.\82\ For example,
for an individual, the maximum fine under present law upon
conviction of violating section 7206 is $250,000 or, if
greater, twice the amount of gross gain from the offense.
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\81\ Section 7206 states that making fraudulent or false statements
under the Code is a felony. In addition, this offense is a felony
pursuant to the classification guidelines of 18 U.S.C. 3559(a)(5).
\82\ In United States v. Booker, 543 U.S. 220 (2005), the Supreme
Court held that mandatory application of the Federal Sentencing
Guidelines is incompatible with the Sixth Amendment jury trial
requirement. As a result of this decision, the Federal Sentencing
Guidelines are effectively advisory, i.e., requiring a sentencing court
to consider the sentencing ranges under the Guidelines, but permitting
it to tailor a sentence in light of other statutory concerns.
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REASONS FOR CHANGE

The Committee believes that existing criminal tax penalties
do not adequately deter criminal behavior, which results in
increased noncompliance and an increase in the tax gap.
Increasing monetary penalties will raise the economic risk of
failing to comply with tax laws. In addition, classifying
certain willful failure to file cases as felonies should
discourage criminal tax violations by substantially increasing
the monetary and sentencing consequences of the offense
together with the long term repercussions associated with a
felony record.

EXPLANATION OF PROVISION

Attempt to evade or defeat tax

The provision increases the criminal penalty under section
7201 of the Code for individuals to $500,000 and for
corporations to $1,000,000. The provision increases the maximum
prison sentence to ten years.

Willful failure to file return, supply information, or pay tax

The provision increases the criminal penalty under section
7203 of the Code for individuals from $25,000 to $50,000 and,
in the case of an ``aggravated failure to file'' (defined as a
failure to file a return for a period of three or more
consecutive taxable years if the aggregated tax liability for
such period is at least $100,000), changes the crime from a
misdemeanor to a felony and increases the maximum prison
sentence to ten years.

Fraud and false statements

The provision increases the criminal penalty for making
fraudulent or false statements to $500,000 for individuals and
$1,000,000 for corporations. The provision increases the
maximum prison sentence for making fraudulent or false
statements to five years. The provision provides that in no
event shall the amount of the monetary penalty under the
provision be less than the amount of the underpayment or
overpayment attributable to fraud.

EFFECTIVE DATE

The provision is effective for actions and failures to act
occurring after the date of enactment.

H. Doubling of Certain Penalties, Fines, and Interest on Underpayments
Related to Certain Offshore Financial Arrangements

(Sec. 208 of the bill)

PRESENT LAW

In general

The Code contains numerous civil penalties, such as the
delinquency, accuracy-related, fraud, and assessable penalties.
These civil penalties are in addition to any interest that may
be due as a result of an underpayment of tax. If all or any
part of a tax is not paid when due, the Code imposes interest
on the underpayment, which is assessed and collected in the
same manner as the underlying tax and is subject to the
respective statutes of limitations for assessment and
collection.

Delinquency penalties

Failure to file
Under present law, a taxpayer who fails to file a tax
return on a timely basis is generally subject to a penalty
equal to 5 percent of the net amount of tax due for each month
that the return is not filed, up to a maximum of five months or
25 percent. An exception from the penalty applies if the
failure is due to reasonable cause. In the case of fraudulent
failure to file, the penalty is increased to 15 percent of the
net amount of tax due for each month that the return is not
filed, up to a maximum of five months or 75 percent. The net
amount of tax due is the excess of the amount of the tax
required to be shown on the return over the amount of any tax
paid on or before the due date prescribed for the payment of
tax.
Failure to pay
Taxpayers who fail to pay their taxes are subject to a
penalty of 0.5 percent per month on the unpaid amount, up to a
maximum of 25 percent. If a penalty for failure to file and a
penalty for failure to pay tax shown on a return both apply for
the same month, the amount of the penalty for failure to file
for such month is reduced by the amount of the penalty for
failure to pay tax shown on a return. If an income tax return
is filed more than 60 days after its due date, then the penalty
for failure to pay tax shown on a return may not reduce the
penalty for failure to file below the lesser of $100 or 100
percent of the amount required to be shown on the return. For
any month in which an installment payment agreement with the
IRS is in effect, the rate of the penalty is half the usual
rate (0.25 percent instead of 0.5 percent), provided that the
taxpayer filed the tax return in a timely manner (including
extensions).
Failure to make timely deposits of tax
The penalty for the failure to make timely deposits of tax
consists of a four-tiered structure in which the amount of the
penalty varies with the length of time within which the
taxpayer corrects the failure. A depositor is subject to a
penalty equal to 2 percent of the amount of the underpayment if
the failure is corrected on or before the date that is five
days after the prescribed due date. A depositor is subject to a
penalty equal to 5 percent of the amount of the underpayment if
the failure is corrected after the date that is five days after
the prescribed due date but on or before the date that is 15
days after the prescribed due date. A depositor is subject to a
penalty equal to 10 percent of the amount of the underpayment
if the failure is corrected after the date that is 15 days
after the due date but on or before the date that is 10 days
after the date of the first delinquency notice to the taxpayer
(under sec. 6303). Finally, a depositor is subject to a penalty
equal to 15 percent of the amount of the underpayment if the
failure is not corrected on or before earlier of 10 days after
the date of the first delinquency notice to the taxpayer and 10
days after the date on which notice and demand for immediate
payment of tax is given in cases of jeopardy.
An exception from the penalty applies if the failure is due
to reasonable cause. In addition, the Secretary may waive the
penalty for an inadvertent failure to deposit any tax by
specified first-time depositors.

Accuracy-related penalties

In general
The accuracy-related penalties are imposed at a rate of 20
percent of the portion of any underpayment that is
attributable, in relevant part, to (1) negligence, (2) any
substantial understatement of income tax, (3) any substantial
valuation misstatement, and (4) any reportable transaction
understatement. The penalty for a substantial valuation
misstatement is doubled for certain gross valuation
misstatements. In the case of a reportable transaction
understatement for which the transaction is not disclosed, the
penalty rate is 30 percent. These penalties are coordinated
with the fraud penalty. This statutory structure operates to
eliminate any stacking of the penalties.
No penalty is to be imposed if it is shown that there was
reasonable cause for an underpayment and the taxpayer acted in
good faith, and in the case of a reportable transaction
understatement, the relevant facts of the transaction have been
disclosed, there is or was substantial authority for the
taxpayer's treatment of such transaction, and the taxpayer
reasonably believed that such treatment was more likely than
not the proper treatment.
Negligence or disregard for the rules or regulations
If an underpayment of tax is attributable to negligence,
the negligence penalty applies only to the portion of the
underpayment that is attributable to negligence. Negligence
means any failure to make a reasonable attempt to comply with
the provisions of the Code. Disregard includes any careless,
reckless, or intentional disregard of the rules or regulations.
Substantial understatement of income tax
Generally, an understatement is substantial if the
understatement exceeds the greater of (1) 10 percent of the tax
required to be shown on the return for the tax year, or (2)
$5,000. In determining whether a substantial understatement
exists, the amount of the understatement is reduced by any
portion attributable to an item if (1) the treatment of the
item on the return is or was supported by substantial
authority, or (2) facts relevant to the tax treatment of the
item were adequately disclosed on the return or on a statement
attached to the return.
Substantial valuation misstatement
A penalty applies to the portion of an underpayment that is
attributable to a substantial valuation misstatement.
Generally, a substantial valuation misstatement exists if the
value or adjusted basis of any property claimed on a return is
200 percent or more of the correct value or adjusted basis. The
amount of the penalty for a substantial valuation misstatement
is 20 percent of the amount of the underpayment if the value or
adjusted basis claimed is 200 percent or more but less than 400
percent of the correct value or adjusted basis. If the value or
adjusted basis claimed is 400 percent or more of the correct
value or adjusted basis, then the overvaluation is a gross
valuation misstatement.
Reportable transaction understatement
A penalty applies to any item that is attributable to any
listed transaction, or to any reportable transaction (other
than a listed transaction) if a significant purpose of such
reportable transaction is tax avoidance or evasion.

Fraud penalty

The fraud penalty is imposed at a rate of 75 percent of the
portion of any underpayment that is attributable to fraud. The
accuracy-related penalty does not apply to any portion of an
underpayment on which the fraud penalty is imposed.

Assessable penalties

In addition to the penalties described above, the Code
imposes a number of additional penalties, including, for
example, penalties for failure to file (or untimely filing of)
information returns with respect to foreign trusts, and
penalties for failure to disclose any required information with
respect to a reportable transaction.

Interest provisions

Taxpayers are required to pay interest to the IRS whenever
there is an underpayment of tax. An underpayment of tax exists
whenever the correct amount of tax is not paid by the last date
prescribed for the payment of the tax. The last date prescribed
for the payment of the income tax is the original due date of
the return.
Different interest rates are provided for the payment of
interest depending upon the type of taxpayer, whether the
interest relates to an underpayment or overpayment, and the
size of the underpayment or overpayment. Interest on
underpayments is compounded daily.

Offshore Voluntary Compliance Initiative

In January 2003, Treasury announced the Offshore Voluntary
Compliance Initiative (``OVCI'') to encourage the voluntary
disclosure of previously unreported income placed by taxpayers
in offshore accounts and accessed through credit card or other
financial arrangements. A taxpayer had to comply with various
requirements in order to participate in the OVCI, including
sending a written request to participate in the program by
April 15, 2003. This request had to include information about
the taxpayer, the taxpayer's introduction to the credit card or
other financial arrangements and the names of parties that
promoted the transaction. A taxpayer entering into a closing
agreement under the OVCI is not liable for the civil fraud
penalty, the fraudulent failure to file penalty, or the civil
information return penalties. Such a taxpayer is responsible
for back taxes, interest, and certain accuracy-related and
delinquency penalties.\83\
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\83\ Rev. Proc. 2003-11, 2003-4 C.B. 311.
---------------------------------------------------------------------------

Voluntary disclosure policy

A taxpayer's timely, voluntary disclosure of a substantial
unreported tax liability has long been an important factor in
deciding whether the taxpayer's case should ultimately be
referred for criminal prosecution. The voluntary disclosure
must be truthful, timely, and complete. The taxpayer must show
a willingness to cooperate (as well as actual cooperation) with
the IRS in determining the correct tax liability. The taxpayer
must make good-faith arrangements with the IRS to pay in full
the tax, interest, and any penalties determined by the IRS to
be applicable. A voluntary disclosure does not guarantee
immunity from prosecution. It creates no substantive or
procedural rights for taxpayers.\84\ The IRS treats
participation in the OVCI as a voluntary disclosure.\85\
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\84\ Internal Revenue News Release 2002-135, IR-2002-135 (December
11, 2002).
\85\ Rev. Proc. 2003-11, 2003-4 C.B. 311.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee is aware that individuals and corporations,
through sophisticated transactions, are placing unreported
income in offshore financial accounts accessed through credit
or debit cards or other financial arrangements in order to
avoid or evade Federal income tax. Such a phenomenon poses 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. The IRS estimates
there may be several hundred thousand taxpayers using offshore
financial arrangements to conceal taxable income from the IRS,
potentially costing the government billions of dollars in lost
revenue. On February 10, 2004, the IRS announced that over
1,300 applications to participate in the OVCI initiative were
received, and that it had received over $175 million in taxes,
interest, and penalties from these cases.\86\ At the start of
the program, the clear message to taxpayers was that those who
failed to come forward would be pursued by the IRS and would be
subject to more significant penalties and possible criminal
sanctions. The Committee believes that doubling the civil
penalties, fines, and interest applicable to taxpayers who
participate in these types of arrangements and who do not
voluntarily disclose such arrangements (through the OVCI or
otherwise) will provide the IRS with the significant sanctions
needed to stem the promotion of, and participation in, these
abusive schemes.
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\86\ Internal Revenue News Release 2004-19, IR-2002-19 (February
10, 2004).
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EXPLANATION OF PROVISION

The provision doubles the amounts of civil penalties,
interest, and fines related to taxpayers' underpayments of U.S.
income tax liability through the direct or indirect use of
certain offshore financial arrangements. The provision applies
to taxpayers who did not (or do not) voluntarily disclose such
arrangements through the OVCI or otherwise. Under the
provision, the determination of whether any civil penalty is to
be applied to such underpayment is made without regard to
whether a return has been filed, whether there was reasonable
cause for such underpayment, and whether the taxpayer acted in
good faith.
The proscribed financial arrangements include, but are not
limited to, the use of certain foreign leasing corporations for
providing domestic employee services,\87\ certain arrangements
whereby the taxpayer may hold securities trading accounts
through offshore banks or other financial intermediaries,
certain arrangements whereby the taxpayer may access funds
through the use of offshore credit, debit, or charge cards, and
offshore annuities or trusts.
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\87\ These arrangements were described and classified as listed
transactions in Notice 2003-22, 2003-1 C.B. 851.
---------------------------------------------------------------------------
The Secretary of the Treasury is granted the authority to
waive the application of the provision if the use of the
offshore financial arrangements is incidental to the
transaction and, in the case of a trade or business, such use
is conducted in the ordinary course of the type of trade or
business in which the taxpayer is engaged.

EFFECTIVE DATE

The provision generally is effective with respect to a
taxpayer's open tax years on or after the date of enactment.

I. Increase in Penalty for Bad Checks and Money Orders

(Sec. 209 of the bill and sec. 6657 of the Code)

PRESENT LAW

The Code \88\ imposes a penalty on a person who tenders a
bad check or money orders. The penalty is two percent of the
amount of the bad check or money order. For checks or money
orders that are less than $750, the minimum penalty is $15 (or,
if less, the amount of the check or money order).
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\88\ Sec. 6657.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that it is appropriate to increase
the minimum amount of this penalty so that it is more
consistent with amounts charged by the private sector for bad
checks.

EXPLANATION OF PROVISION

The provision increases the minimum penalty to $25 (or, if
less, the amount of the check or money order), applicable to
checks or money orders that are less than $1,250.

EFFECTIVE DATE

The provision is effective with respect to checks or money
orders received after the date of enactment.

J. Treatment of Contingent Payment Convertible Debt Instruments

(Sec. 210 of the bill and sec. 1275 of the Code)

PRESENT LAW

Under present law, a taxpayer generally deducts the amount
of interest paid or accrued within the taxable year on
indebtedness issued by the taxpayer. In the case of original
issue discount (``OID''), the issuer of a debt instrument
generally accrues and deducts, as interest, the OID over the
life of the obligation, even though the amount of the OID may
not be paid until the maturity of the instrument. The holder of
the instrument includes the OID in income over the term of the
instrument.
The amount of OID with respect to a debt instrument is
equal to the excess of the stated redemption price at maturity
over the issue price of the debt instrument. The stated
redemption price at maturity includes all amounts that are
payable on the debt instrument by maturity. The amount of OID
with respect to a debt instrument is allocated over the life of
the instrument through a series of adjustments to the issue
price for each accrual period. The adjustment to the issue
price is determined by multiplying the adjusted issue price
(i.e., the issue price increased or decreased by adjustments
prior to the accrual period) by the instrument's yield to
maturity, and then subtracting any payments on the debt
instrument (other than non-OID stated interest) during the
accrual period. Thus, in order to compute the amount of OID and
the portion of OID allocable to a particular period, the stated
redemption price at maturity and the time of maturity must be
known. Issuers of debt instruments with OID accrue and deduct
the amount of OID as interest expense in the same manner as the
holders of such instruments accrue and include in gross income
the amount of OID as interest income.
Treasury regulations provide special rules for determining
the amount of OID allocated to a period with respect to certain
debt instruments that provide for one or more contingent
payments of principal or interest.\89\ The regulations provide
that a debt instrument does not provide for contingent payments
merely because it provides for an option to convert the debt
instrument into the stock of the issuer, into the stock or debt
of a related party, or into cash or other property in an amount
equal to the approximate value of such stock or debt.\90\ The
regulations also provide that a payment is not a contingent
payment merely because of a contingency that, as of the issue
date of the debt instrument, is either remote or
incidental.\91\
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\89\ Treas. Reg. sec. 1.1275-4.
\90\ Treas. Reg. sec. 1.1275-4(a)(4).
\91\ Treas. Reg. sec. 1.1275-4(a)(5).
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In the case of contingent payment debt instruments that are
issued for money or publicly traded property,\92\ the
regulations provide that interest on a debt instrument must be
taken into account (as OID) whether or not the amount of any
payment is fixed or determinable in the taxable year. The
amount of OID that is taken into account for each accrual
period is determined by constructing a comparable yield and a
projected payment schedule for the debt instrument, and then
accruing the OID on the basis of the comparable yield and
projected payment schedule by applying rules similar to those
for accruing OID on a noncontingent debt instrument (the
``noncontingent bond method''). If the actual amount of a
contingent payment is not equal to the projected amount,
appropriate adjustments are made to reflect the difference. The
comparable yield for a debt instrument is the yield at which
the issuer would be able to issue a fixed-rate noncontingent
debt instrument with terms and conditions similar to those of
the contingent payment debt instrument (i.e., the comparable
fixed-rate debt instrument), including the level of
subordination, term, timing of payments, and general market
conditions.\93\
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\92\ Treas. Reg. sec. 1.1275-4(b).
\93\ Treas. Reg. sec. 1.1275-4(b)(4)(i)(A).
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With respect to certain debt instruments that are
convertible into the common stock of the issuer and that also
provide for contingent payments (other than the conversion
feature)--often referred to as ``contingent convertible'' debt
instruments--the IRS has stated that the noncontingent bond
method applies in computing the accrual of OID on the debt
instrument.\94\ In applying the noncontingent bond method, the
IRS has stated that the comparable yield for a contingent
convertible debt instrument is determined by reference to a
comparable fixed-rate nonconvertible debt instrument, and the
projected payment schedule is determined by treating the issuer
stock received upon a conversion of the debt instrument as a
contingent payment.
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\94\ Rev. Rul. 2002-31, 2002-1 C.B. 1023.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee is aware that, in recent years, several
corporate taxpayers have issued convertible debt instruments
that also include a separate contingent feature, usually
consisting of an interest rate reset provision. The Committee
understands that the primary intent of these corporations is
simply to issue straight convertible debt instruments, and that
the contingency is unlikely to have any meaningful impact on
either the stated interest rate or overall economic yield of
the debt instrument. Rather, the contingency is incorporated
into the financing for the purpose of subjecting the debt
instrument to the contingent payment OID regulations, which
would not otherwise apply solely on the basis of the conversion
feature. As with straight convertible debt instruments, the
stated interest rate on contingent payment convertible debt
instruments typically is substantially less than the stated
interest rate would be on a nonconvertible debt instrument,
usually less than 400 basis points.
The Committee is aware that, in determining the comparable
yield on contingent payment convertible debt instruments under
the contingent payment OID regulations, borrowers and their
advisors take the position that the regulations call for using
a comparable noncontingent debt instrument that is also
nonconvertible. The net effect of applying the contingent
payment OID regulations in this manner (i.e., determining the
comparable yield on the basis of a noncontingent,
nonconvertible--rather than noncontingent, convertible--debt
instrument), is tosignificantly and artificially enhance the
interest deductions generated by what is essentially a straight
convertible debt instrument. Because the corresponding interest income
inclusions to holders of these debt instruments likewise is
significantly and artificially enhanced, the Committee understands that
the debt instruments almost exclusively are sold to and purchased by
tax indifferent holders.
Notwithstanding the endorsement of the taxpayer position by
the IRS in Rev. Rul. 2002-31, the Committee believes that
applying the contingent payment OID regulations in this manner
is inappropriate, from an economic standpoint and based upon a
reasonable interpretation of the plain meaning of the
regulations. Furthermore, applying the regulations in this
manner creates disparate tax treatment between contingent
payment convertible debt instruments and straight convertible
debt instruments that differ only on the basis of an
economically meaningless contingency.
The Committee believes that the methodology mandated by
this provision would require the comparable yield on a
contingent payment convertible debt instrument to be based upon
a truly comparable noncontingent debt instrument (i.e., one
that is convertible, like the actual debt instrument issued by
the taxpayer). This methodology would provide parity between
straight convertible debt instruments and contingent payment
convertible debt instruments, and eliminate the unwarranted tax
benefits that are currently attained merely by incorporating an
essentially meaningless contingency into an otherwise ordinary
convertible debt instrument.
In its ruling, the IRS indicated that determining the
comparable yield on contingent payment convertible debt
instruments based upon a contingent nonconvertible debt
instrument is more consistent with the overall economic
rationale of the contingent payment OID regulations. However,
the Committee believes that this view incorrectly assumes that
the economic rationale of these regulations deviates from the
rest of the OID rules--and, for that matter, general tax
principles--in giving tax significance to a conversion feature
in a debt instrument. The Committee recognizes that contingent
payment convertible debt instruments highlight a potential flaw
in the current tax system whereby both the Code and general tax
principles typically disregard the economic yield provided by
convertibility features in debt instruments. However, the
Committee believes that this issue should be addressed
legislatively through comprehensive reform of the tax treatment
of financial products, rather than through administrative
acquiescence in taxpayer self-help that is achieved using a
particular financial product designed specifically to obtain a
favorable tax result, particularly if that result is in
conflict with the current operation of the Code and general tax
principles.

EXPLANATION OF PROVISION

The provision provides that, in the case of a contingent
convertible debt instrument,\95\ any Treasury regulations which
require OID to be determined by reference to the comparable
yield of a noncontingent fixed-rate debt instrument shall be
applied as requiring that such comparable yield be determined
by reference to a noncontingent fixed-rate debt instrument
which is convertible into stock. For purposes of applying the
provision, the comparable yield shall be determined without
taking into account the yield resulting from the conversion of
a debt instrument into stock. Thus, the noncontingent bond
method in the Treasury regulations shall be applied in a manner
such that the comparable yield for contingent convertible debt
instruments shall be determined by reference to comparable
noncontingent fixed-rate convertible (rather than
nonconvertible) debt instruments.
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\95\ Under the provision, a contingent convertible debt instrument
is defined as a debt instrument that: (1) is convertible into stock of
the issuing corporation, or a corporation in control of, or controlled
by, the issuing corporation; and (2) provides for contingent payments.
---------------------------------------------------------------------------

EFFECTIVE DATE

The provision is effective for debt instruments issued on
or after date of enactment.

K. Extension of IRS User Fees

(Sec. 211 of the bill and sec. 7528 of the Code)

PRESENT LAW

The IRS generally charges a fee for requests for a letter
ruling, determination letter, opinion letter, or other similar
ruling or determination.\96\ These user fees are authorized by
statute through September 30, 2014.
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\96\ Sec. 7528.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes that it is appropriate to provide an
extension of these user fees.

EXPLANATION OF PROVISION

The provision extends the statutory authorization for IRS
user fees for two years, through September 30, 2016.

EFFECTIVE DATE

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

L. Modification of Collection Due Process Procedures for Employment Tax
Liabilities

(Sec. 212 of the bill and sec. 6330 of the Code)

PRESENT LAW

Levy is the IRS's administrative authority to seize a
taxpayer's property to pay the taxpayer's tax liability. The
IRS is entitled to seize a taxpayer's property by levy if a
Federal tax lien has attached to such property. A Federal tax
lien arises automatically when (1) a tax assessment has been
made, (2) the taxpayer has been given notice of the assessment
stating the amount and demanding payment, and (3) the taxpayer
has failed to pay the amount assessed within 10 days after the
notice and demand.
In general, the IRS is required to notify taxpayers that
they have a right to a fair and impartial collection due
process (``CDP'') hearing before levy may be made on any
property or right to property.\97\ Similar rules apply with
respect to notices of tax liens, although the right to a
hearing arises only on the filing of a notice.\98\ The CDP
hearing is held by an impartial officer from the IRS Office of
Appeals, who is required to issue a determination with respect
to the issues raised by the taxpayer at the hearing. The
taxpayer is entitled to appeal that determination to a court.
Under present law, taxpayers are not entitled to a pre-levy CDP
hearing if a levy is issued to collect a Federal tax liability
from a State tax refund or if collection of the Federal tax is
in jeopardy. However, levies related to State tax refunds or
jeopardy determinations are subject to post-levy review through
the CDP hearing process.
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\97\ Sec. 6330(a).
\98\ Sec. 6320.
---------------------------------------------------------------------------
Employment taxes generally consist of the taxes under the
Federal Insurance Contributions Act (``FICA''), the tax under
the Federal Unemployment Tax Act (``FUTA''), and the
requirement that employers withhold income taxes from wages
paid to employees (``income tax withholding'').\99\ Income tax
withholding rates vary depending on the amount of wages paid,
the length of the payroll period, and the number of withholding
allowances claimed by the employee.
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\99\ Secs. 3101-3128 (FICA), 3301-3311 (FUTA), and 3401-3404
(income tax withholding). FICA taxes consist of an employer share and
an employee share, which the employer withholds from employees' wages.
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REASONS FOR CHANGE

Congress enacted the CDP hearing procedures to afford
taxpayers adequate notice of collection activity and a
meaningful hearing before the IRS deprives them of their
property. However, the Committee understands that some
taxpayers abuse the CDP procedures by raising frivolous
arguments simply for the purpose of delaying or evading
collection of tax. The opportunity to delay collection of
employment tax liabilities presents a greater risk to the
government than delay may present in other contexts because
employment tax liabilities continue to increase as ongoing wage
payments are made to employees. A Governmental Accountability
Office study found that businesses with employment tax
liabilities were delinquent on more than twice as many periods
than individuals. On average, businesses requesting a CDP
appeal for delinquent employment taxes had not paid for nearly
1\1/2\ years and had a median employment tax liability of
$30,000.\100\ Thus, the Committee believes it is appropriate to
revise the CDP procedures in cases where taxpayers are liable
for unpaid employment taxes.
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\100\ Government Accountability Office, Tax Administration: Little
Evidence of Procedural Errors in Collection Due Process Appeals Cases,
but Opportunities Exist to Improve the Program, GAO-07-112, October
2006.
---------------------------------------------------------------------------

EXPLANATION OF PROVISION

Under the provision, levies issued to collect Federal
employment taxes are excepted from the pre-levy CDP hearing
requirement. Thus, under the provision, taxpayers have no right
to a CDP hearing before a levy is issued to collect employment
taxes. However, the taxpayer is provided an opportunity for a
hearing within a reasonable period of time after the levy.
Collection by levy is permitted to continue during the CDP
proceedings.

EFFECTIVE DATE

The provision is effective for levies issued on or after
the date that is 120 days after the date of enactment.

M. Whistleblower Reforms

(Sec. 213 of the bill and sec. 7623 of the Code)

PRESENT LAW

The Code authorizes the IRS to pay such sums as deemed
necessary for: ``(1) detecting underpayments of tax; and (2)
detecting and bringing to trial and punishment persons guilty
of violating the internal revenue laws or conniving at the
same.'' \101\ Generally, amounts are paid based on a percentage
of tax, fines, and penalties (but not interest) actually
collected based on the information provided.
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\101\ Sec. 7623.
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The Tax Relief and Health Care Act of 2006 (the ``Act'')
\102\ established an enhanced reward program for actions in
which the tax, penalties, interest, additions to tax, and
additional amounts in dispute exceed $2,000,000 and, if the
taxpayer is an individual, the individual's gross income
exceeds $200,000 for any taxable year. The reward floor in such
cases is 15 percent of the collected proceeds (including
penalties, interest, additions to tax and additional amounts)
if the IRS moves forward with an administrative or judicial
action based on information brought to the IRS's attention by
an individual. The available reward in such cases is limited to
30 percent of the collected proceeds.
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\102\ Pub. L. No. 109-432.
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Under present law, the Secretary is required to issue
guidance within one year of the date of enactment of the Act
for the establishment of the Whistleblower Office within the
IRS to administer the reward program. The Whistleblower Office
may seek assistance from the individual providing information
or from his or her legal representative, and may reimburse the
costs incurred by any legal representative out of the amount of
the reward. To the extent the disclosure of returns or return
information is required to render such assistance, the
disclosure must be pursuant to an IRS tax administration
contract.
The Act permits an individual to appeal the amount or a
denial of an award determination to the United States Tax Court
(the ``Tax Court'') within 30 days of such determination. Tax
Court review of an award determination may be assigned to a
special trial judge.
The Act also required the Secretary to conduct a study and
report to Congress on the effectiveness of the whistleblower
reward program and any legislative or administrative
recommendations regarding the administration of the program.

REASONS FOR CHANGE

A recent report by the Treasury Inspector General for Tax
Administration concluded that the IRS's informant reward
program has been an effective method of identifying and
collecting unpaid taxes.\103\ The report made several
recommendations for enhancing the effectiveness of the program,
including centralizing management of the reward program and
reducing the processing time for claims. The Act enhanced the
reward program by establishing a minimum reward for certain
cases and requiring the Secretary to establish a centralized
office. The Committee believes that further enhancements to the
reward program would make the program more attractive to future
informants wishing to report violations of the tax laws. The
Committee also believes that enhancements to the program will
provide assurance that informants' claims are not lost,
overlooked or forgotten, and that award amounts are determined
in a consistent and equitable manner.
---------------------------------------------------------------------------
\103\ Treasury Inspector General for Tax Administration, The
Informants' Rewards Program Needs More Centralized Management
Oversight, 2006-30-092 (June 2006).
---------------------------------------------------------------------------

EXPLANATION OF PROVISION

The provision modifies the reward program established under
the Act. Under the provision, this reward program applies to
any actions in which the tax, penalties, interest, additions to
tax, and additional amounts in dispute exceed $20,000 and, if
the taxpayer is an individual, the individual's gross income
exceeds $200,000 for any taxable year.
The provision also establishes the Whistleblower Office
under the Code, rather than pursuant to regulation as provided
in the Act. Although recognizing that many functions of the IRS
may be involved in evaluating or otherwise addressing an
informant's claim, the Congress intends that one office within
the IRS ultimately is responsible and accountable for
monitoring informant claims for reward and determining the
amounts to be rewarded. This will ensure that all claims are
considered and that awards are issued in a consistent, timely
and equitable manner.
In addition, the provision requires the Secretary to report
to Congress within six months of the date of enactment on the
implementation of this provision, including the operation of
the Whistleblower Office and the implementation of the
recommendations of the Treasury Inspector General for Tax
Administration.\104\
---------------------------------------------------------------------------
\104\ Treasury Inspector General for Tax Administration, The
Informants' Rewards Program Needs More Centralized Management
Oversight, 2006-30-092 (June 2006).
---------------------------------------------------------------------------
Finally, the provision authorizes the Tax Court to adopt
rules to preserve the anonymity, privacy, or confidentiality of
any person that may be identified during the appeal of an award
determination appeal.

EFFECTIVE DATE

The provision generally is effective for information
provided on or after the date of enactment. The provision
authorizing the Tax Court to adopt rules to preserve the
anonymity, privacy, or confidentiality of any person that may
be identified in the appeal of an award determination is
effective as if included in section 406 of the Act.

N. Expand Denial of Deduction for Certain Excessive Employee
Remuneration

(Sec. 214 of the bill and sec. 162(m) of the Code)

PRESENT LAW

Under present law, compensation in excess of $1 million
paid by a publicly-held corporation to the corporation's
``covered employees'' generally is not deductible.\105\ Covered
employees are the chief executive officer as of the close of
the taxable year and the four other most highly compensated
officers of the company as reported in the company's proxy
statement.
---------------------------------------------------------------------------
\105\ Sec. 162(m).
---------------------------------------------------------------------------
Subject to certain exceptions, the deduction limitation
applies to all otherwise deductible compensation of a covered
employee for a taxable year, regardless of the form in which
the compensation is paid, whether the compensation is for
services as a covered employee, and regardless of when the
compensation was earned. The deduction limitation applies when
the deduction would otherwise be taken.
Performance-based compensation is not subject to the
deduction limitation and is not taken into account in
determining whether other compensation exceeds $1 million. In
general, performance-based compensation is compensation payable
solely on account of the attainment of one or more performance
goals and with respect to which certain requirements are
satisfied, including a shareholder approval requirement.\106\
---------------------------------------------------------------------------
\106\ In addition, the following types of compensation are not
subject to the deduction limitation and are not taken into account in
determining whether other compensation exceeds $1 million: (1)
compensation payable on a commission basis; (2) payments to a tax-
qualified retirement plan (including salary reduction contributions);
and (3) amounts that are excludable from the individual's gross income
(such as employer-provided health benefits). Sec. 162(m)(4).
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Securities and Exchange Commission recently modified
the group of executives for whom compensation is required to be
disclosed under the Securities Exchange Act of 1934. Given
these modifications, the Committee believes that it is
appropriate to delink the definition of covered employee from
the Securities laws. The Committee also believes that the
denial of the deduction for certain excess employee
remuneration should apply to any individual who serves as the
Chief Executive Officer during the year, regardless of whether
that position is retained on the last day of the taxable year.
Under present law, the deduction limitations for certain excess
employee remuneration can be avoided by delaying payment of
compensation to a year in the future in which the individual is
no longer a covered employee. The Committee believes that it is
appropriate to continue to treat individuals as covered
employees if they had been covered employees in a preceding
taxable year.

EXPLANATION OF PROVISION

The provision modifies the definition of covered employee.
Under the provision, covered employees include any individual
who was the Chief Executive Officer of the company (or
individual acting in such a capacity) at any time during the
taxable year. In addition, covered employees include the four
officers with the highest compensation for the year (other than
the Chief Executive Officer). Under the provision, covered
employees also include individuals who previously were covered
employees for any preceding taxable year beginning after
December 31, 2006, with respect to the corporation or any
predecessor. In the case of an individual who is a covered
employee after December 31, 2006, covered employees also
include beneficiaries of such employees with respect to any
remuneration for services performed by such employee as a
covered employee (whether or not such services are performed
during the taxable year in which the remuneration is paid). For
example, under the provision, if the Chief Executive Officer
retires in November, compensation received in the year of
retirement, or paid under a deferral agreement in a succeeding
year, is subject to the deduction limitations for a covered
employee.

EFFECTIVE DATE

The provision is effective for taxable years beginning
after December 31, 2006.

II. 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 revenue
provisions of the ``Small Business and Work Opportunity Act of
2007'' as reported.

ESTIMATED REVENUE EFFECTS OF S. 349, THE ``SMALL BUSINESS AND WORK OPPORTUNITY ACT OF 2007,'' AS REPORTED BY THE COMMITTEE ON FINANCE--FISCAL YEARS 2007-2016
[Millions of Dollars]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Provision Effective 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007-11 2007-16
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
I. Small Business Provisions
A. General Provisions
1. Extension of increased tyba 12/31/09............... -- -- -- -2,964 -1,897 1,732 1,092 792 613 375 -4,861 -257
expensing for small business--
increase section 179 expensing
from $25,000 to $100,000 and
increase the phaseout threshold
amount from $200,000 to $400,000;
include software in section 179
property; and extend indexing of
both the deduction limit and the
phaseout threshold (sunset 12/31/
10).
2. Extension of the 15-year ppisa 12/31/07.............. -- -30 -88 -114 -112 -109 -100 -95 -100 -98 -345 -847
straight-line cost recovery
period for qualified leasehold
and restaurant improvements
(sunset 3/31/08).
3. 15-year recovery period for new ppisa DOE................... -22 -66 -94 -99 -99 -98 -97 -95 -93 -86 -379 -847
restaurant buildings (sunset 3/31/
08).
4. 15-year recovery period for ppisa DOE................... -22 -76 -119 -127 -123 -114 -106 -108 -109 -108 -467 -1,012
retail improvements (sunset 3/31/
08).
5. Increase gross receipts tyba DOE.................... -9 -278 -151 -52 -57 -63 -69 -76 -84 -92 -547 -931
threshold for cash accounting to
$10M regardless of inventories,
index for inflation, and reset
testing period.
6. Extension and modification of wpoifibwa 12/31/07.......... -- -150 -411 -569 -657 -726 -591 -302 -143 -75 -1,788 -3,624
combined Work Opportunity Tax
Credit and Welfare-to-work credit-
expansions on post 9/11 disabled
veterans, high-risk youth, and
vocational rehabilitation
referrals (sunset 12/31/12).
7. Treatment of certified (\1\)....................... -- -- -2 -3 -4 -4 -4 -5 -5 -6 -8 -32
professional employer
organizations as employers.
B. Subchapter S Provisions
1. Exclude capital gains from tyba DOE.................... -- -15 -30 -32 -34 -35 -37 -40 -43 -46 -111 -312
passive investment income.
2. Treatment of qualifying tyba 12/31/06............... -4 -10 -14 -18 -20 -21 -22 -23 -23 -23 -66 -178
director shares.
3. Recapture of bad debt reserves. tyba 12/31/06............... 11 27 -22 -40 -36 -23 -21 -22 -23 -24 -60 -173
4. Treatment of sale of interest tyba 12/31/06............... -1 -3 -3 -4 -4 -4 -5 -5 -5 -6 -15 -40
in a qualified subchapter S
subsidiary.
5. Elimination of all earnings and tyba DOE.................... -3 -2 -2 -2 -2 -2 -2 -2 -2 -2 -11 -21
profits attributable to pre-1983
years.
6. Expansion of qualifying DOE......................... -- -1 -2 -3 -4 -4 -4 -5 -5 -5 -10 -33
beneficiaries of an electing
small business trust.
Total of Small Business ............................ -50 -604 -938 -4,027 -3,049 529 34 14 -22 -196 -8,668 -8,307
Provisions.
II. Provisions That Raise Revenue
1. Modify the effective date for the tyba 12/31/06............... 1,018 1,662 896 407 290 288 260 135 -239 -629 4,273 4,088
application of the AJCA 2004 leasing
(SILO) provision--apply loss
limitation to leases with foreign
entities regardless of when the lease
was entered into.
2. Tax treatment of inversion tyba 2006................... 42 86 99 107 115 123 123 143 153 162 449 1,153
transactions.
3. Deny deduction for punitive damages dpoio/a DOE................. 3 37 29 30 31 32 33 34 35 36 130 299
4. Denial of deduction for certain generally apoio/a DOE....... 25 87 31 15 15 15 15 15 15 15 172 244
fines, penalties, and other amounts.
5. Impose mark-to-market on (\2\)....................... 13 57 54 50 46 43 41 39 38 36 220 417
individuals who expatriate.
6. Limitation on annual amounts which tyba 12/31/06............... 43 59 60 63 83 94 97 100 103 106 307 806
may be deferred under nonqualified
deferred compensation arrangements.
7. Increase in certain criminal aaftaoa DOE................. (\3\) (\3\) (\3\) (\3\) (\3\) (\3\) (\3\) (\3\) (\3\) (\3\) 1 5
penalties.
8. Double certain penalties, fines, oyo/a DOE................... 1 1 1 1 1 1 1 1 1 1 5 10
and interest on underpayments related
to certain offshore financial
arrangements.
9. Increase in penalty for bad checks comora DOE.................. 2 2 2 2 2 2 2 2 2 2 10 20
and money orders.
10. Change the tax treatment of diio/a DOE.................. 8 37 52 62 63 58 49 45 39 35 222 448
contingent convertible debt
instruments.
11. Extension of IRS user fees (sunset ra 9/30/14.................. -- -- -- -- -- -- -- -- 30 30 -- 60
9/30/16) (\4\).
12. Modification of collection due lio/a 120da DOE............. -- 58 50 28 20 17 20 23 26 29 156 271
process procedures for employment tax
liabilities.
13. Modifications to Whistleblower ipo/a DOE................... 1 6 15 23 32 42 51 63 79 90 77 402
reforms (\5\).
14. Modify definition of covered tyba 12/31/06............... 1 3 4 5 7 10 14 18 20 23 20 105
employee for denial of deduction for
excessive employee remuneration.
Total of Provisions That Raise ............................ 1,157 2,095 1,293 793 705 725 706 618 302 -64 6,042 8,328
Revenue.
-----------------------------------------------------------------------------------------------------------------------------------------------------
NET TOTAL................... ............................ 1,107 1,491 355 -3,234 -2,344 1,254 740 632 280 -260 -2,626 21
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Effective with respect to wages paid for services performed on or after January 1 of the first calendar year beginning more than 12 months after the date of enactment.
\2\ Generally effective for U.S. citizens who expatriate or long-term residents who terminate their residency on or after the date of enactment.
\3\ Gain of less than $500,000.
\4\ Estimate provided by the Congressional Budget Office.
\5\ Net of outlays.
Note.--Details may not add to totals due to rounding. Date of enactment is assumed to be April 1, 2007.
Legend for ``Effective'' column: aaftaoa = actions and failure to act occurring after, apoio/a = amounts paid or incurred on or after, comora=checks for money orders received after, diio/a =
debt intrument issued on or after, DOE=date of enactment, dpoio/a = damages paid or incurred on or after, oyo/a = open years on or after, ppisa = property placed in service after, ipo/a =
information provided on or after, lio/a = levies issued on or after, tyba = taxable years beginning after, ra = requests after, wpoifibwa = wages paid or incurred for individuals beginning
work after, 120da = 120 days after.
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 no 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 A, above). The revenue-increasing provisions of the bill
involve reduced tax expenditures (see revenue table in part 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 has not
submitted a statement on the bill. The letter from the
Congressional Budget Office has not been received, and
therefore will be provided separately.

III. VOTES OF THE COMMITTEE

In compliance with paragraph 7(b) of rule XXVI of the
standing rules of the Senate, the Committee states that, with a
majority and quorum present, the ``Small Business and Work
Opportunity Act of 2007,'' as amended, was ordered favorably
reported by a voice vote on January 17, 2007.
The Committee accepted the following resolution: It is the
sense of the Committee on Finance that the small business
provisions should be extended beyond the dates contained in the
Mark.

IV. 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, personal privacy and paperwork

The bill includes provisions to extend present-law tax
benefits, expand eligibility for other benefits, and update
Subchapter S of the Code. The bill also includes provisions
increasing certain penalties and extending IRS user fees. The
bill modifies the treatment of corporate inversion transactions
and individuals who expatriate, and imposes limitations on the
amount of compensation which may be deducted by employers or
deferred by employees under the Code. The bill includes a
provision to improve employment tax compliance by providing
rules under which certain professional employer organizations
is treated as the employer of employees provided to customers.
The bill includes various other provisions that are not
expected to impose additional administrative requirements or
regulatory burdens on individuals or businesses.
The provisions of the bill do not impact personal privacy.

B. Unfunded Mandates Statement

This information is provided in accordance with section 423
of the Unfunded Mandates Reform Act of 1995 (Pub. L. 104-4).
The Committee has determined that the following two tax
provisions of the reported bill contain Federal private sector
mandates within the meaning of Public Law 104-4, the Unfunded
Mandates Reform Act of 1995: (1) modifying the effective date
for the application of the AJCA 2004 leasing (``SILO'')
provision--apply loss limitation to leases with foreign
entities regardless of when the lease was entered into; and (2)
tax treatment of inversion transactions. The tax provisions of
the reported bill do not impose a Federal intergovernmental
mandate on State, local, or tribal governments within the
meaning of Public Law 104-4, the Unfunded Mandates Reform Act
of 1995.
The costs required to comply with each Federal private
sector mandate generally are no greater than the aggregate
estimated budget effects of the provision. Benefits from the
provisions include improved administration of the 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
Restructuring and Reform 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.
The staff of the Joint Committee on Taxation has determined
that a complexity analysis is not required under section
4022(b) of the IRS Reform Act because the bill contains no
provisions that have ``widespread applicability'' to
individuals or small businesses.

V. ADDITIONAL VIEWS OF SENATOR JOHN F. KERRY

I support the majority of the provisions in the Small
Business and Work Opportunity Act of 2007. I would have
preferred that this package move separately rather than in
tandem with a minimum wage bill. However, the reality is that
we need a tax package in order to advance minimum wage
legislation.
Most of the provisions are targeted and will help small
businesses. For example, the provision to provide fifteen-year
straight line cost recovery for qualified retail improvement
will help small businesses that own their stores. However,
there is one provision that I find troubling. This provision
would treat professional employer organizations as employers
for employment tax purposes.
The reason for including this provision is to improve
compliance. I am concerned that the provision which that makes
certified professional employer organizations liable for
payroll taxes may not actually result in improved compliance.
The Joint Committee on Taxation has estimated that this
provision has a ten-year cost of $33 million. If this provision
truly improved compliance, I would expect it to raise revenue.
This proposal lets the workers' real employer off the hook
for payroll taxes, and creates confusion about who is an
employer under labor laws. I know the language says it will not
affect other laws, but as a practical matter it will. It
confuses workers, who will not be able to tell who their real
employer is, and it sets a bad precedent that could make it
harder for workers to protect their rights under important
labor laws.
I realize the Committee has reported out this provision in
the past, but I believe this provision will result in
unintended consequences. The Committee should review this
proposal in order to address concerns that have been raised.
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).