I. Amendments to Title X of the 1997 Act Relating to Revenue-Raising Provisions

1. Exception from constructive sales rules for certain debt positions (Sec.1001(a) of the 1997 Act and Sec. 1259(b)(2) of the Code)

Present Law

A taxpayer is required to recognize gain (but not loss) upon entering into a constructive sale of an "appreciated financial position," which generally includes an appreciated position with respect to any stock, debt instrument or partnership interest. An exception is provided for positions with respect to debt instruments that have an unconditionally payable principal amount, that are not convertible into the stock of the issuer or a related person, and the interest on which is either fixed, payable at certain variable rates or based on certain interest payments on a pool of mortgages.

Description of Proposal

The proposal would clarify that, to qualify for the exception for positions with respect to debt instruments, the position would have to either itself meet the requirements as to unconditional principal amount, non-convertibility and interest terms or, alternatively, be a hedge of a position meeting these requirements. A hedge for this purpose would include any position that reduces the taxpayer's risk of interest rate or price changes or currency fluctuations with respect to another position.

Effective Date

The proposal would generally be effective for constructive sales entered into after June 8, 1997.

2. Definition of forward contract under constructive sales rules (Sec. 1001(a) of the 1997 Act and Sec. 1259(d)(1) of the Code)

Present Law

A constructive sale of an appreciated financial position generally results when the taxpayer enters into a forward contact to deliver the same or substantially identical property. A forward contract for this purpose is defined as a contract that provides for delivery of a substantially fixed amount of property at a substantially fixed price.

Description of Proposal

The proposal would clarify that the definition of a forward contract includes a contract that provides for cash settlement with respect to a substantially fixed amount of property at a substantially fixed price.

Effective Date

The proposal would generally be effective for constructive sales entered into after June 8, 1997.

3. Treatment of mark-to-market gains of electing traders (Sec. 1001(b) of the 1997 Act and Sec. 475(f)(1)(D) of the Code)

Present Law

Securities and commodities traders may elect application of the mark-to-market accounting rules. Gain or loss recognized by an electing taxpayer under these rules is treated as ordinary gain or loss.

Under the Self-Employment Contributions Act ("SECA"), a tax is imposed on an individual's net earnings from self-employment ("NESE"). Gain or loss from the sale or exchange of a capital asset is excluded from NESE.

A publicly-traded partnership generally is treated as a corporation for Federal tax purposes. An exception to this rule applies if 90 percent or more of the partnership's gross income consists of passive-type income, which includes gain from the sale or disposition of a capital asset.

Description of Proposal

The proposal would clarify that gain or loss of a securities or commodities trader that is treated as ordinary solely by reason of election of mark-to-market treatment would not be treated as other than gain or loss from a capital asset for purposes of determining NESE for SECA tax purposes, determining whether the passive-type income exception to the publicly-traded partnership rules is met or for purposes of any other Code provision specified by the Treasury Department in regulations.

Effective Date

The proposal would apply to taxable years of electing securities and commodities traders ending after the date of enactment of the 1997 Act.

4. Special effective date for constructive sale rules (Sec. 1001(d) of the 1997 Act and Sec. 1259 of the Code)

Present Law

The constructive sales rules contain a special effective date provision for decedents dying after June 8, 1997, if (1) a constructive sale of an appreciated financial position occurred before such date, (2) the transaction remains open for not less than two years, (3) the transaction remains open at any time during the three years prior to the decedent's death, and (4) the transaction is not closed within the 30-day period beginning on the date of enactment of the 1997 Act. If the requirements of the special effective date provision are met, both the appreciated financial position and the transaction resulting in the constructive sale are generally treated as property constituting rights to receive income in respect of a decedent under section 691. However, gain with respect to a position in a constructive sale transaction that accrues after the transaction is closed is not included in income in respect of a decedent.

Description of Proposal

The proposal would clarify the special effective date rule to provide that the rule does not apply if the constructive sale transaction is closed at any time prior to the end of the 30th day after the date of enactment of the 1997 Act.

Effective Date

The proposal would be effective for decedents dying after June 8, 1997.

5. Gain recognition for certain extraordinary dividends (Sec. 1011 of the Act and Sec. 1059 of the Code)

Present Law

A corporate shareholder generally can deduct at least 70 percent of a dividend received from another corporation. This dividends received deduction is 80 percent if the corporate shareholder owns at least 20 percent of the distributing corporation and generally 100 percent if the shareholder owns at least 80 percent of the distributing corporation.

Section 1059 of the Code requires a corporate shareholder that receives an "extraordinary dividend" to reduce the basis of the stock with respect to which the dividend was received by the nontaxed portion of the dividend. Whether a dividend is "extraordinary" is determined, among other things, by reference to the size of the dividend in relation to the adjusted basis of the shareholder's stock. In addition, a dividend resulting from a non pro rata redemption or a partial liquidation is an extraordinary dividend. Gain is recognized if the reduction in basis of stock exceeds the basis in the stock with respect to which an extraordinary dividend is received.

The consolidated return regulations provide similar basis adjustment rules with respect to dividends paid within a consolidated group of corporations. These rules provide that a dividend paid from one member of a group to its parent reduces the parent's basis in the stock of the payor and if such reduction exceeds the parent's basis, an "excess loss account" is created or increased. Except as provided in regulations, the extraordinary dividend provisions do not apply to result in a double reduction in basis in the case of distributions between members of an affiliated group filing consolidated returns or in the double inclusion of earnings and profits.

Description of Proposal

The proposal would provide coordination between the basis adjustment rules of section 1059 and the consolidated return regulations. These rules generally would provide that, except as provided in regulations, section 1059 will not cause current gain recognition to the extent that the consolidated return regulations require the creation or increase of an excess loss account.

Effective Date

The proposal generally would be effective for distributions after May 3, 1995.

6. Treatment of certain corporate distributions (Sec. 1012 of the 1997 Act and secs. 355(e)(3)(A)(iv) and 358(c) of the Code)

Present Law

The 1997 Act (Sec. 1012(a)) requires a distributing corporation ("distributing") to recognize corporate level gain on the distribution of stock of a controlled corporation ("controlled") under section 355 of the Code if, pursuant to a plan or series of related transactions, one or more persons acquire a 50-percent or greater interest (defined as 50 percent or more of the voting power or value of the stock) of either the distributing or controlled corporation (Code Sec. 355(e)). Certain transactions are excepted from the definition of acquisition for this purpose, including, under section 355(e)(3)(A)(iv), the acquisition by a person of stock in a corporation if shareholders owning directly or indirectly stock possessing more than 50 percent of the voting power and more than 50 percent of the value of the stock in distributing or any controlled corporation before such acquisition own directly or indirectly stock possessing such vote and value in such distributing or controlled corporation after such acquisition.

In the case of a 50-percent or more acquisition of either the distributing corporation or the controlled corporation, the amount of gain recognized is the amount that the distributing corporation would have recognized had the stock of the controlled corporation been sold for fair market value on the date of the distribution. The Statement of Managers states that no adjustment to the basis of the stock or assets of either corporation is allowed by reason of the recognition of the gain.

The 1997 Act (Sec. 1012(b)(1)) also provides that, except as provided in regulations, section 355 shall not apply to the distribution of stock from one member of an affiliated group of corporations (as defined in section 1504(a)) to another member of such group (an intragroup spin off) if such distribution is part of a such a plan or series of related transactions pursuant to which one or more persons acquire stock representing a 50-percent or greater interest in a distributing or controlled corporation, determined after the application of the rules of section 355(e).

In addition, the 1997 Act (Sec. 1012(c)) provides that in the case of any distribution of stock of one member of an affiliated group of corporations to another member under section 355, the Treasury Department has regulatory authority under section 358(c) to provide adjustments to the basis of any stock in a corporation which is a member of such group, to reflect appropriately the proper treatment of such distribution.

The 1997 Act also modified certain rules for determining control immediately after a distribution in the case of certain divisive transactions in which a controlled corporation is distributed and the transaction meets the requirements of section 355. In such cases, under section 351 and modified section 368(a)(2)(H) with respect to reorganizations under section 368(a)(1)(D), those shareholders receiving stock in the distributed corporation are treated as in control of the distributed corporation immediately after the distribution if they hold stock representing a greater than 50 percent interest in the vote and value of stock of the distributed corporation.

The effective date (Act section 1012(d)(1)) states that the forgoing provisions of the 1997 Act apply to distributions after April 16, 1997, pursuant to a plan (or series of related transactions) which involves an acquisition occurring after such date (unless certain transition provisions apply).

Description of Proposal

Acquisition of a 50-percent or greater interest

The proposal would clarify that the acquisitions described in Code section 355(e)(3)(A) are disregarded in determining whether there has been an acquisition of a 50-percent or greater interest in a corporation. However, other transactions that are part of a plan or series of related transactions could result in an acquisition of a 50-percent or greater interest.

In the case of acquisitions under section 355(e)(3)(A)(iv), the proposal clarifies that the acquisition of stock in the distributing corporation or any controlled corporation is disregarded to the extent that the percentage of stock owned directly or indirectly in such corporation by each person owning stock in such corporation immediately before the acquisition does not decrease.

Example: Shareholder A owns 10 percent of the vote and value of the stock of corporation D (which owns all of corporation C). There are nine other equal shareholders of D. A also owns 100 percent of the vote and value of the stock of unrelated corporation P. D distributes C to all the shareholders of D. Thereafter, pursuant to a plan or series of related transactions, D (worth 100x) merges with corporation P (worth 900x). After the merger, each of the former shareholders of corporation D owns stock of the merged entity reflecting the vote and value attributable to that shareholder's respective 10 percent former stock ownership of D. Each of the former shareholders of D owns 1 percent of the stock of the merged corporation, except that shareholder A (who owned 100 percent of corporation P and 10 percent of corporation D before the merger) now owns 91 percent of the stock of the merged corporation. In determining whether a 50-percent or greater interest in D has been acquired, the interest of each of the continuing shareholders is disregarded only to the extent there has been no decrease in such shareholder's direct or indirect ownership. Thus, the 10 percent interest of A, and the 1 percent interest of each of the nine other former shareholder of D, is not counted. The remaining 81 percent ownership of the merged corporation, representing a decrease of nine percent in the interests of each of the nine former shareholders other than A, is counted in determining the extent of an acquisition. Therefore, a 50-percent or greater interest in D has been acquired.

Treasury regulatory authority

The proposal would also clarify that the regulatory authority of the Treasury Department under section 358(c) applies to distributions after April 16, 1997, without regard to whether a distribution involves a plan (or series of related transactions) which involves an acquisition.

As stated in the Conference Report to the Act, with respect to the Treasury Department regulatory authority under section 358(c) as applied to intragroup spin-off transactions that are not part of a plan or series of related transactions that involve an acquisition of a 50-percent of greater interest under new section 355(f), it is expected that any Treasury regulations will be applied prospectively, except in cases to prevent abuse.

Section 351(c) and section 368(a)(2)(H) "control immediately after" requirement

The proposal would clarify that in the case of certain divisive transactions in which a corporation contributes assets to a controlled corporation and then distributes the stock of the controlled corporation in a transaction that meets the requirements of section 355 (or so much of section 356 as relates to section 355), the "control immediately after" requirement of section 351(c) and section 368(a)(2)(H) shall be deemed satisfied.

Effective Date

The proposal generally would be effective for distributions after April 16, 1997.

7. Certain preferred stock treated as "boot"--statute of limitations (Sec. 1014 of the 1997 Act and Sec. 354(a) of the Code)

Present Law

Under the 1997 Act, certain preferred stock received in otherwise tax-free transactions is treated as "other property." Exchanges of stock in certain recapitalizations of family-owned corporations are excepted from this rule. A family-owned corporation is defined as any corporation if at least 50 percent of the total voting power and value of the stock of such corporation is owned by the same family for five years preceding the recapitalization. In addition, a recapitalization does not qualify for the exception if the same family does not own 50 percent of the total voting power and value of the stock throughout the three-year period following the recapitalization.

Description of Proposal

The proposal would provide that the statutory period for the assessment of any deficiency attributable to a corporation failing to be a family-owned corporation shall not expire before the expiration of three years after the date the Secretary of the Treasury is notified by the corporation (in such manner as the Secretary may prescribe) of such failure, and such deficiency may be assessed before the expiration of such three-year period notwithstanding the provisions of any other law or rule of law which would otherwise prevent such assessment.

Effective Date

The proposal would apply to transactions after June 8, 1997.

8. Certain preferred stock treated as "boot"--treatment of transferor (Sec. 1014 of the 1997 Act and Sec. 351(g) of the Code)

Present Law

The 1997 Act amended section 351 of the Code to provide that in the case of a person who transfers property to a controlled corporation and receives nonqualified preferred stock, section 351(b) will apply to such person. Section 351(b) provides that if section 351(a) of the Code would apply to an exchange but for the fact that there is received, in addition to stock permitted to be received under section 351(a), other property or money, then gain but no loss to such recipient shall be recognized. The Statement of Managers to the 1997 Act states that if nonqualified preferred stock is received, gain but not loss shall be recognized.

Description of Proposal

The proposal would clarify that section 351(b) applies to a transferor who transfers property in a section 351 exchange and receives nonqualified preferred stock in addition to stock that is not treated as "other property" under that section. Thus, if a transferor received only nonqualified preferred stock but the transaction in the aggregate otherwise qualified as a section 351 exchange, such a transferor would recognize loss and the basis of the nonqualified preferred stock and of the property in the hands of the transferee corporation would reflect the transaction in the same manner as if that particular transferor had received solely "other property" of any other type. As under the 1997 Act, the nonqualified preferred stock continues to be treated as stock received by a transferor for purposes of qualification of a transaction under section 351(a), unless and until regulations may provide otherwise.

Effective Date

The proposal would apply to transactions after June 8, 1997.

9. Application of section 304 to certain international transactions (Sec. 1013 of the 1997 Act and Sec. 304 of the Code)

Present Law

Under section 304, if one corporation purchases stock of a related corporation, the transaction generally is recharacterized as a redemption. Under section 304(a), as amended by the 1997 Act, to the extent that a section 304 transaction is treated as a distribution under section 301, the transferor and the acquiring corporation are treated as if (1) the transferor had transferred the stock involved in the transaction to the acquiring corporation in exchange for stock of the acquiring corporation in a transaction to which section 351(a) applies, and (2) the acquiring corporation had then redeemed the stock it is treated as having issued. In the case of a section 304 transaction, both the amount which is a dividend and the source of such dividend is determined as if the property were distributed by the acquiring corporation to the extent of its earnings and profits and then by the issuing corporation to the extent of its earnings and profits (Sec. 304(b)(2)). Section 304(b)(5), as added by the 1997 Act, provides special rules that apply if the acquiring corporation in a section 304 transaction is a foreign corporation. Under section 304(b)(5), the earnings and profits of the acquiring corporation that are taken into account are limited to the portion of such earnings and profits that (1) is attributable to stock of such acquiring corporation held by a corporation or individual who is the transferor (or a person related thereto) and who is a U.S. shareholder (within the meaning of section 951(b)) of such corporation and (2) was accumulated during periods in which such stock was owned by such person while such acquiring corporation was a controlled foreign corporation. For purposes of this rule, except as otherwise provided by the Secretary of the Treasury, the rules of section 1248(d) (relating to certain exclusions from earnings and profits) apply. The Secretary is to prescribe regulations as appropriate, including regulations determining the earnings and profits that are attributable to particular stock of the acquiring corporation.

For foreign tax credit purposes, under section 902, a U.S. corporation that receives a dividend from a foreign corporation in which it owns at least 10 percent of the voting stock is treated as if it had paid the foreign income taxes paid by the foreign corporation which are attributable to such dividend. The Internal Revenue Service issued rulings providing that a domestic corporation that is a transferor in a section 304 transaction may compute foreign taxes deemed paid under section 902 on the dividends from both a foreign acquiring corporation and a foreign issuing corporation. Rev. Rul. 92-86, 1992-2 C.B. 199; Rev. Rul. 91-5, 1991-1 C.B. 114. Both rulings involve section 304 transactions in which both the domestic transferor and the foreign acquiring corporation are wholly owned by a domestic parent corporation.

Description of Proposal

The proposal would eliminate the cross-reference to section 1248(d) for purposes of determining the earnings and profits to be taken into account under section 304(b)(5). Instead, under the proposal, the direction to the Secretary to issue regulations would specifically include regulations to prevent the multiple inclusion of an item of income and to provide appropriate basis adjustments. The 1997 Act amendments to section 304, including the modifications under the proposal, are not intended to change the foreign tax credit results reached in Rev. Rul. 92-86 and 91-5.

Effective Date

The proposal generally would be effective for distributions or acquisitions after June 8, 1997.

10. Establish IRS continuous levy and improve debt collection (secs. 1024, 1025, and 1026 of the 1997 Act and secs. 6331 and 6334 of the Code)

Present Law

If any person is liable for any internal revenue tax and does not pay it within 10 days after notice and demand by the IRS, the IRS may then collect the tax by levy upon all property and rights to property belonging to the person, unless there is an explicit statutory restriction on doing so. A levy is the seizure of the person's property or rights to property. A levy on salary and wages is continuous from the date it is first made until the date it is fully paid or becomes unenforceable.

The 1997 Act provides that a continuous levy is also applicable to non-means tested recurring Federal payments and specified wage replacement payments.

Explanation of Provision

The proposal would clarify that the IRS must approve the use of a continuous levy before it may take effect.

Effective Date

The proposal would be effective for levies issued after the date of enactment of the 1997 Act (August 5, 1997).

11. Clarification regarding aviation gasoline excise tax (Sec. 1031 of the 1997 Act, and Sec. 6421(f) of the Code)

Present Law

Before enactment of the 1997 Act, aviation gasoline was subject to a 19.3-cents-per-gallon tax rate, with 15 cents per gallon being deposited in the Airport and Airway Trust Fund and 4.3 cents per gallon being retained in the General Fund. The 1997 Act extended the 15-cents-per gallon rate for 10 years, through September 30, 2007, and expanded deposits to the Trust Fund to include revenues from the 4.3-cents-per-gallon rate. The tax does not apply to fuel used in flight segments outside the United States or to flight segments from the United States to foreign countries.

Description of Proposal

The proposal would clarify the application of the gasoline tax refund provisions to aviation gasoline used in flight segments outside the United States and to flight segments from the United States to foreign countries.

Effective Date

The proposal would be effective as if included in the 1997 Act.

12. Clarification of requirement that registered fuel terminals offer dyed fuel (Sec. 1032 of the 1997 Act and Sec. 4101 of the Code)

Present Law

The 1997 Act provides that fuel terminals are eligible to register to handle non-tax-paid diesel fuel and kerosene only if the terminal operator offers both undyed (taxable) and dyed (nontaxable) fuel.

Description of Proposal

The proposal would clarify that the Code requires terminals eligible to handle non-tax-paid diesel to offer dyed diesel fuel and terminals eligible to handle non-tax-paid kerosene (including diesel fuel #1 and kerosene-type aviation fuel) to offer dyed kerosene. The proposal does not require that a terminal offer for sale kerosene as a condition of receiving diesel fuel on a non-tax paid basis. Similarly, the proposal does not require terminals that sell only kerosene to offer diesel fuel as a condition of receiving non-tax-paid kerosene.

Effective Date

The proposal would be effective as if included in the 1997 Act.

13. Clarification of treatment of prepaid telephone cards (Sec. 1034 of the 1997 Act and Sec. 4251 of the Code)

Present Law

A 3-percent excise tax is imposed on amounts paid for local and toll (long-distance) telephone service and teletypewriter exchange service. The tax is collected by the provider of the service from the consumer. In the case of so-called "prepaid telephone cards" the tax is treated as paid when the card is transferred by any telecommunications carrier to any person who is not a telecommunications carrier.

A "prepaid telephone card" is defined as any card or other similar arrangement which permits its holder to obtain communications services and pay for such services in advance.

Description of the Proposal

The proposal would clarify that payment to a communications service provider from a third party such as a joint venture credit card company is treated as payment made by the holder of the credit card to obtain communication services and the tax is treated as paid in a manner similar to that applied to prepaid telephone cards.

Effective Date

The proposal would be effective as if included in the Taxpayer Relief Act of 1997.

14. Modify UBIT rules applicable to second-tier subsidiaries (Sec. 1041 of the 1997 Act and Sec. 512(b)(13) of the Code)

Present Law

In general, interest, rents, royalties and annuities are excluded from the unrelated business income ("UBI") of tax-exempt organizations. However, section 512(b)(13) treats otherwise excluded rent, royalty, annuity, and interest income as UBI if such income is received from a taxable or tax-exempt subsidiary that is controlled by the parent tax-exempt organization.

Under the provision, interest, rent, annuity, or royalty payments made by a controlled entity to a tax-exempt organization are subject to the unrelated business income tax to the extent the payment reduces the net unrelated income (or increases any net unrelated loss) of the controlled entity. In this regard, section 512(b)(13)(B)(i)(I) cross references a non-existent Code section.

The provision generally applies to taxable years beginning after the date of enactment. However, the provision does not apply to payments made during the first two taxable years beginning on or after the date of enactment if such payments are made pursuant to a binding written contract in effect as of June 8, 1997, and at all times thereafter before such payment.

Description of Proposal

The proposal would clarify that rent, royalty, annuity, and interest income that would otherwise be excluded from UBI is included in UBI under section 512(b)(13) if such income is derived from a taxable or tax-exempt subsidiary that is controlled by the parent tax-exempt organization. The proposal further would clarify that the provision does not apply to any payment made during the first two taxable years beginning on or after the date of enactment if such payment is made pursuant to a binding written contract in effect on June 8, 1997, and at all times thereafter before such payment (but not pursuant to any contract provision that permits optional accelerated payments).

Effective Date

The proposal would be effective as of August 5, 1997, the date of enactment of the 1997 Act.

15. Clarification of provision expanding the limitations on deductibility of premiums and interest with respect to life insurance, endowment and annuity contracts (Sec. 1084 of the 1997 Act and Sec. 264 of the Code)

Present Law

Master contracts

The 1997 Act provided limitations on the deductibility of interest and premiums with respect to life insurance, endowment and annuity contracts. Under the pro rata interest disallowance provision added by the Act, an exception is provided for any policy or contract owned by an entity engaged in a trade or business, covering an individual who is an employee, officer or director of the trade or business at the time first covered. The exception applies to any policy or contract owned by an entity engaged in a trade or business, which covers one individual who (at the time first insured under the policy or contract) is (1) a 20-percent owner of the entity, or (2) an individual (who is not a 20-percent owner) who is an officer, director or employee of the trade or business. The provision is silent as to the treatment of coverage of such an individual under a master contract.

Reporting

The provision does not apply to any policy or contract held by a natural person; however, if a trade or business is directly or indirectly the beneficiary under any policy or contract, the policy or contract is treated as held by the trade or business and not by a natural person. In addition, the provision includes a reporting requirement. Specifically, the provision provides that the Treasury Secretary shall require such reporting from policyholders and issuers as is necessary to carry out the rule applicable when the trade or business is directly or indirectly the beneficiary under any policy or contract held by a natural person. Any report required under this reporting requirement is treated as a statement referred to in Code section 6724(d)(1) (relating to information returns). The provision does not specifically refer to Code section 6724(d)(2) (relating to payee statements).

Description of Proposals

Master contracts

The proposal would clarify that if coverage for each insured individual under a master contract is treated as a separate contract for purposes of sections 817(h), 7702, and 7702A of the Code, then coverage for each such insured individual is treated as a separate contract, for purposes of the exception to the pro rata interest disallowance rule for a policy or contract covering an individual who is a 20-percent owner, employee, officer or director of the trade or business at the time first covered. A master contract would not include any contract if the contract (or any insurance coverage provided under the contract) is a group life insurance contract within the meaning of Code section 848(e)(2). No inference would be intended that coverage provided under a master contract, for each such insured individual, is not treated as a separate contract for each such individual for other purposes under present law.

Reporting

The proposal would clarify that the required reporting to the Treasury Secretary is an information return (within meaning of Sec. 6724(d)(1)), and any reporting required to be made to any other person is a payee statement (within the meaning of Sec. 6724(d)(2)). Thus, the $50-per report penalty imposed under sections 6722 and 6723 of the Code for failure to file or provide such an information return or payee statement would apply. It would be clarified that the Treasury Secretary may require reporting by the issuer or policyholder of any relevant information either by regulations or by any other appropriate guidance (including but not limited to publication of a form).

Effective Date

The proposals would be effective as if included in the 1997 Act.

16. Clarification of allocation of basis of properties distributed to a partner by a partnership (Sec. 1061 of the 1997 Act and Sec. 732(c) of the Code)

Present Law

Present law, as amended by the 1997 Act, provides rules for allocating basis to property in the hands of a partner that receives a distribution from a partnership. Under these rules, basis is first allocated to unrealized receivables and inventory items in an amount equal to the partnership's adjusted basis in each property. If the basis to be allocated is less than the sum of the adjusted bases of the properties in the hands of the partnership, then, to the extent a decrease is required to make the total adjusted bases of the properties equal the basis to be allocated, the decrease is allocated (as described below) for adjustments that are decreases. To the extent of any basis not allocated to inventory and unrealized receivables under the above rules, basis is allocated to other distributed properties, first to the extent of each distributed property's adjusted basis to the partnership. Any remaining basis adjustment, if an increase, is allocated among properties with unrealized appreciation in proportion to their respective amounts of unrealized appreciation (to the extent of each property's appreciation), and then in proportion to their respective fair market values. If the remaining basis adjustment is a decrease, it is allocated among properties with unrealized depreciation in proportion to their respective amounts of unrealized depreciation (to the extent of each property's depreciation), and then in proportion to their respective adjusted bases (taking into account the adjustments already made).

For purposes of these rules, "unrealized receivables" has the meaning set forth in section 751(c) (as provided in Sec. 732(c)(1)(A)(i)). Section 751(c) provides that the term "unrealized receivables" includes certain accrued but unreported income. In addition, the last two sentences of section 751(c) provide that for purposes of certain specified partnership provisions (sections 731, 741 and 751), the term "unrealized receivables" includes certain property the sale of which will give rise to ordinary income (for example, depreciation recapture under sections 1245 or 1250), but only to the extent of the amount that would be treated as ordinary income on a sale of that property at fair market value.

Description of Proposal

The proposal would clarify that for purposes of the allocation rules of section 732(c), "unrealized receivables" has the meaning in section 751(c) including the last two sentences of section 751(c), relating to items of property that give rise to ordinary income. Thus, in applying the allocation rules of section 732(c) to property listed in the last two sentences of section 751(c), such as property giving rise to potential depreciation recapture, the amount of unrealized appreciation in any such property would not include any amount that would be treated as ordinary income if the property were sold at fair market value, because such amount would be treated as a separate asset for purposes of the basis allocation rules.

For example, assume that a partnership has 3 partners, A, C and D. The partnership has 6 assets. Three are capital assets each with adjusted basis equal to fair market value of $20,000. The other three are depreciable equipment each with adjusted basis of $5,000 and fair market value of $30,000. Each of the pieces of equipment would have $25,000 of depreciation recapture if sold by the partnership for its $30,000 value. A has a basis in its partnership interest of $60,000. Assume that one of the capital assets and one of the pieces of equipment is distributed to A in liquidation of its interest. A would be treated as receiving three assets: (1) depreciation recapture (an unrealized receivable) with a basis to the partnership of zero and a value of $25,000; (2) a piece of equipment with a basis to the partnership of $5,000 and a value of $5,000 (its $30,000 value reduced by the $25,000 of depreciation recapture); and (3) a capital asset with a basis to the partnership of $20,000 and a value of $20,000.

Under the provision, as clarified by the technical correction, A's $60,000 basis in its partnership interest would be allocated as follows. First, basis would be allocated to the depreciation recapture, an unrealized receivable, in an amount equal to the partnership's adjusted basis in it, or zero (Sec. 732(c)(1)(A)(i)). Then basis would be allocated to the extent of each of the other distributed properties' adjusted basis to the partnership, or $5,000 to the equipment (not including the depreciation recapture), and $20,000 to the capital asset. A's remaining $35,000 of basis would be allocated next among properties, if any, with unrealized appreciation in proportion to their respective amounts of unrealized appreciation (to the extent of each property's appreciation), but neither of the distributed properties to which basis may be allocated has unrealized appreciation. Basis is then allocated then in proportion to the properties' respective fair market values ($5,000 for the equipment and $20,000 for the capital asset). Thus, of the remaining $35,000, $7,000 is allocated to the equipment, so that its total basis in the partner's hands is $12,000; and $28,000 is allocated to the capital asset, so that its total basis in the partner's hands is $48,000.

Effective Date

The proposal would be effective as if enacted with the 1997 Act.

17. Clarification to the definition of modified adjusted gross income for purposes of the earned income credit phaseout (Sec. 1085(d) of the 1997 Act and Sec. 32(c) of the Code)

Present Law

The earned income credit ("EIC") is phased out above certain income levels. For individuals with earned income (or modified adjusted gross income ("modified AGI"), if greater) in excess of the beginning of the phaseout range, the maximum credit amount is reduced by the phaseout rate multiplied by the amount of earned income (or modified AGI, if greater) in excess of the beginning of the phaseout range. For individuals with earned income (or modified AGI, if greater) in excess of the end of the phaseout range, no credit is allowed. The definition of modified AGI used for the phase out of the earned income credit is the sum of: (1) AGI with certain losses disregarded, and (2) certain nontaxable amounts not generally included in AGI. The losses disregarded are: (1) net capital losses (if greater than zero); (2) net losses from trusts and estates; (3) net losses from nonbusiness rents and royalties; (4) 75 percent of the net losses from business, computed separately with respect to sole proprietorships (other than in farming), sole proprietorships in farming, and other businesses. The nontaxable amounts included in modified AGI which are generally not included in AGI are: (1) tax-exempt interest; and (2) nontaxable distributions from pensions, annuities, and individual retirement arrangements (but only if not rolled over into similar vehicles during the applicable rollover period).

Description of Proposal

The proposal would clarify that the two nontaxable amounts that are added to adjusted gross income to compute modified AGI for purposes of the EIC phaseout are additions to adjusted gross income and not disregarded losses.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1997.