17. FEDERAL RECEIPTS
Receipts (budget and off-budget) are taxes and other
collections from the public that result from the exercise
of the Federal Government’s sovereign or governmental
powers. The difference between receipts and outlays
determines the surplus or deficit.
The Federal Government also collects income from
the public from market-oriented activities. Collections
from these activities, which are subtracted from gross
outlays, rather than added to taxes and other governmental
receipts, are discussed in the following Chapter.
Growth in receipts. Total receipts in 2006 are estimated
to be $2,177.6 billion, an increase of $124.7 billion
or 6.1 percent relative to 2005. Receipts are projected
to grow at an average annual rate of 6.7 percent
between 2006 and 2010, rising to $2,820.9 billion. This
growth in receipts is largely due to assumed increases
in incomes resulting from both real economic growth
and inflation.
As a share of GDP, receipts are projected to increase
from 16.8 percent in 2005 to 16.9 percent in 2006. The
receipts share of GDP is projected to increase annually
thereafter, rising to 17.7 percent in 2010.
Table 17–1. RECEIPTS BY SOURCE—SUMMARY
(in billions of dollars)
2004 Actual
Estimate
2005 2006 2007 2008 2009 2010
Individual income taxes ..................................................... 809.0 893.7 966.9 1,071.2 1,167.2 1,245.1 1,353.3
Corporation income taxes ................................................. 189.4 226.5 220.3 229.8 243.4 252.4 257.6
Social insurance and retirement receipts ......................... 733.4 773.7 818.8 866.2 911.7 959.1 1,016.2
(On-budget) .................................................................... (198.7) (212.4) (225.6) (237.0) (247.2) (258.4) (273.0)
(Off-budget) .................................................................... (534.7) (561.4) (593.2) (629.2) (664.6) (700.7) (743.2)
Excise taxes ....................................................................... 69.9 74.0 75.6 77.2 79.0 81.0 82.9
Estate and gift taxes ......................................................... 24.8 23.8 26.1 23.5 24.3 26.0 20.1
Customs duties .................................................................. 21.1 24.7 28.3 30.6 31.9 33.9 35.3
Miscellaneous receipts ...................................................... 32.6 36.4 41.6 45.6 49.5 52.6 55.4
Total receipts ............................................................... 1,880.1 2,052.8 2,177.6 2,344.2 2,507.0 2,650.0 2,820.9
(On-budget) ............................................................... (1,345.3) (1,491.5) (1,584.4) (1,715.0) (1,842.4) (1,949.3) (2,077.7)
(Off-budget) ............................................................... (534.7) (561.4) (593.2) (629.2) (664.6) (700.7) (743.2)
Total receipts as a percentage of GDP ....................... 16.3 16.8 16.9 17.2 17.5 17.5 17.7
Table 17–2. EFFECT ON RECEIPTS OF CHANGES IN THE SOCIAL SECURITY TAXABLE EARNINGS BASE
(In billions of dollars)
Estimate
2006 2007 2008 2009 2010
Social security (OASDI) taxable earnings base increases:
$90,000 to $93,000 on Jan. 1, 2006 ....................................................................... 1.4 3.8 4.2 4.8 5.4
$93,000 to $97,200 on Jan. 1, 2007 ....................................................................... ................ 2.0 5.4 6.1 6.9
$97,200 to $101,400 on Jan. 1, 2008 ..................................................................... ................ ................ 2.1 5.5 6.3
$101,400 to $106,200 on Jan. 1, 2009 ................................................................... ................ ................ ................ 2.4 6.5
$106,200 to $111,300 on Jan. 1, 2010 ................................................................... ................ ................ ................ ................ 2.6
264 ANALYTICAL PERSPECTIVES
ENACTED LEGISLATION
Several laws were enacted in 2004 that have an effect
on governmental receipts. The major legislative changes
affecting receipts are described below.
WORKING FAMILIES TAX RELIEF ACT OF
2004
The Working Families Tax Relief Act of 2004 (2004
tax relief act), which was signed by President Bush
on October 4, 2004, was the fourth major tax measure
enacted during this Administration. In addition to extending
key parts of the President’s tax relief plan for
working families, which were scheduled to expire at
the end of 2004, this Act provided tax relief to certain
military personnel with families, created a uniform definition
of a qualifying child for tax purposes, and reinstated
a number of expired or expiring business-related
tax incentives. The major provisions of this Act that
affect receipts are described below. The year-by-year
effect of these changes (as well as some of the changes
provided in the 2001 and 2003 tax cuts) on various
provisions of the tax code is shown in Chart 17–1.
Chart 17–1. Major Provisions of the Tax Code Under the 2001, 2003 and 2004 Tax Cuts
Provision 2003 2004 2005 2006 2007 2008 2009 2010 2011
Individual Income Tax
Rates
Rates reduced to
35, 33, 28, and
25 percent
Rates increased
to
39.6, 36, 31,
and 28 percent
10 Percent Bracket Top of bracket increased
to
$7,000/$14,000
for single/joint
filers and inflation-
indexed
Bracket eliminated,
making
lowest
bracket 15
percent
15 Percent Bracket for
Joint Filers
Top of bracket for
joint filers increased
to 200
percent of top
of bracket for
single filers
Top of bracket
for joint filers
reduced
to 167 percent
of top
of bracket
for single filers
Standard Deduction for
Joint Filers
Standard deduction
for joint filers increased
to 200
percent of
standard deduction
for single
filers
Standard deduction
for
joint filers
reduced to
167 percent
of standard
deduction
for single filers
Child Credit Tax credit for each
qualifying child
under age 17
increased to
$1,000
Tax credit for
each qualifying
child
under age
17 reduced
to $500
Estate Taxes Top rate reduced
to 49 percent
Top rate reduced
to 48
percent
Exempt
amount increased
to
$1.5 million
Top Rate reduced
to 47
percent
Top rate reduced
to 46 percent
Exempt amount increased
to $2
million
Top rate reduced
to 45
percent
Exempt
amount increased
to
$3.5 million
Estate tax repealed
Top rate increased
to
60 percent
Exempt
amount reduced
to $1
million
265 17. FEDERAL RECEIPTS
Chart 17–1. Major Provisions of the Tax Code Under the 2001, 2003 and 2004 Tax Cuts—Continued
Provision 2003 2004 2005 2006 2007 2008 2009 2010 2011
Small Business, Expensing
Deduction increased
to
$100,000, reduced
by
amount qualifying
property
exceeds
$400,000, and
both amounts
inflation-indexed
Includes software
Deduction declines
to
$25,000, reduced
by
amount
qualifying
property exceeds
$200,000
and
amounts not
inflation-indexed
Does not apply
to software
Capital Gains Tax rate on capital
gains reduced
to 5/15 percent
Tax on capital
gains eliminated
for
taxpayers in
10/15 percent
tax
brackets
Tax rate on
capital gains
increased to
10/20 percent
Dividends Tax rate on dividends
reduced
to 5/15 percent
Tax on dividends
eliminated
for
taxpayers in
10/15 percent
tax
brackets
Dividends
taxed at
standard income
tax
rates
Bonus Depreciation Bonus depreciation
increased to 50
percent of qualified
property
aquired after
5/5/03
Bonus depreciation
expires
Alternative Minimum
Tax
AMT exemption
amount increased
to
$40,250/$58,000
for single/joint
filers
AMT exemption
amount reduced
to $33,750/
$45,000 for single
/joint filers
Tax Relief for Families
Extend accelerated expansion of the 10-percent
individual income tax rate bracket.—The Economic
Growth and Tax Relief Reconciliation Act (2001 tax
cut) created a 10-percent individual income tax bracket,
which applied to the first $6,000 of taxable income for
single taxpayers and married taxpayers filing separate
returns (increasing to $7,000 for taxable years beginning
after December 31, 2007 and before January 1,
2011), the first $10,000 of taxable income for heads
of household, and the first $12,000 of taxable income
for married taxpayers filing a joint return (increasing
to $14,000 for taxable years beginning after December
31, 2007 and before January 1, 2011). The 2001 tax
cut provided for annual inflation adjustments to the
width of the 10-percent tax rate bracket, effective for
taxable years beginning after December 31, 2008. The
Jobs and Growth Tax Relief Reconciliation Act (2003
jobs and growth tax cut) accelerated the expansions
of the 10-percent tax rate bracket scheduled to be effective
beginning in taxable year 2008, to be effective in
taxable years 2003 and 2004. For taxable years beginning
after 2004 and before January 1, 2011, the taxable
income levels for the 10-percent individual income tax
rate bracket were scheduled to revert to the levels provided
under the 2001 tax cut. The 2003 jobs and growth
tax cut also provided for annual inflation adjustments
to the width of the 10-percent tax rate bracket for taxable
years beginning in 2004. The 2004 tax relief act
extended the expansions of the 10-percent tax rate
bracket provided under the 2003 jobs and growth tax
cut through taxable year 2007 and provided for continued
annual inflation adjustments to the width of 10-
percent tax rate bracket for taxable years beginning
after 2004. As provided under the 2001 tax cut, the
10-percent tax rate bracket will remain in effect for
taxable years 2008 through 2010, and will be eliminated
for taxable years beginning after December 31,
2010.
Extend accelerated increase in standard deduction
for married taxpayers filing a joint return.—
Under the 2001 tax cut, the standard deduction for
married taxpayers filing a joint return, which was 167
percent of the standard deduction for unmarried indi266
ANALYTICAL PERSPECTIVES
viduals, was increased to double the standard deduction
for single taxpayers over a five-year period. Under the
phasein, the standard deduction for married taxpayers
filing a joint return increased to 174 percent of the
standard deduction for single taxpayers in taxable year
2005, 184 percent in taxable year 2006, 187 percent
in taxable year 2007, 190 percent in taxable year 2008,
and 200 percent in taxable years 2009 and 2010. The
2003 jobs and growth tax cut accelerated the increase
in the standard deduction for married taxpayers filing
a joint return to 200 percent of the standard deduction
for single taxpayers, effective for taxable years 2003
and 2004. For taxable years 2005 through 2010, the
standard deduction for married taxpayers filing a joint
return was scheduled to revert to the levels provided
under the 2001 tax cut. The 2004 tax relief act extended
the expanded standard deduction for married
taxpayers filing a joint return provided under the 2003
jobs and growth tax cut to apply to taxable years 2005
through 2008. As provided under the 2001 tax cut, the
standard deduction for married taxpayers filing a joint
return will remain at 200 percent of the standard deduction
for single taxpayers in 2009 and 2010, but will
decline to 167 percent of the standard deduction for
single taxpayers, effective for taxable years beginning
after December 31, 2010.
Extend accelerated expansion of the 15-percent
individual income tax rate bracket for married
taxpayers filing a joint return.—Under the 2001 tax
cut, the maximum taxable income in the 15-percent
individual income tax rate bracket for married taxpayers
filing a joint return, which was 167 percent
of the corresponding amount for an unmarried individual,
was increased to twice the corresponding
amount for unmarried individuals over a four-year period.
Under the phasein, the maximum taxable income
in the 15-percent tax rate bracket for married taxpayers
filing a joint return increased to 180 percent of the
corresponding amount for single taxpayers in taxable
year 2005, 187 percent in taxable year 2006, 193 percent
in taxable year 2007, and 200 percent in taxable
years 2008, 2009 and 2010. The 2003 jobs and growth
tax cut accelerated the increase in the size of the 15-
percent tax rate bracket for married taxpayers filing
a joint return to twice the corresponding tax rate bracket
for single taxpayers, effective for taxable years 2003
and 2004. For taxable years 2005 through 2010, the
size of the 15-percent tax rate bracket for married taxpayers
filing a joint return was scheduled to revert
to the levels provided under the 2001 tax cut. The
2004 tax relief act extended the expanded 15-percent
tax rate bracket for married taxpayers filing a joint
return provided under the 2003 jobs and growth tax
cut through taxable year 2007. As provided under the
2001 tax cut, the maximum taxable income in the 15-
percent tax rate bracket for married taxpayers filing
a joint return will remain at twice the corresponding
tax rate bracket for single taxpayers in 2008, 2009,
and 2010, but will decline to 167 percent of the corresponding
amount for single taxpayers, effective for
taxable years beginning after December 31, 2010.
Extend accelerated increase in child tax credit.—
Under the 2001 tax cut, the maximum amount of
the tax credit for each qualifying child under the age
of 17 increased from $500 to $1,000 over a period of
10 years, as follows: the credit increased to $600 for
taxable years 2001 through 2004, $700 for taxable years
2005 through 2008, $800 for taxable year 2009, and
$1,000 for taxable year 2010. The 2003 jobs and growth
tax cut accelerated the increase in the credit to $1,000
per child, effective for taxable years 2003 and 2004.
For taxable years 2005 through 2010, the credit was
scheduled to revert to the levels provided under the
2001 tax cut. The 2004 tax relief act extended the increased
credit of $1,000 per child for five years, for
taxable years 2005 through 2009. As provided under
the 2001 tax cut, the credit will be $1,000 per child
for taxable year 2010, but will decline to $500 for taxable
years beginning after December 31, 2010.
Accelerate increase in refundability of child tax
credit.—Prior to enactment of the 2001 tax cut, taxpayers
with three or more qualifying children could
be eligible for a refundable additional child tax credit
if they had social security taxes, even if they had little
or no individual income tax liability. However, taxpayers
with one or two children were not eligible for
the refundable additional child tax credit. The 2001
tax cut extended eligibility for the refundable credit
to taxpayers with one or two children. Under the 2001
tax cut, the additional child tax credit was refundable
to the extent of 10 percent of the taxpayer’s earned
income in excess of $10,000 for taxable years 2001
through 2004; the percentage was scheduled to increase
to 15 percent for taxable years 2005 through 2010. The
$10,000 income threshold was indexed for inflation beginning
in 2002. The 2004 tax relief act accelerated
to 2004 the increase in refundability to 15 percent that
had been scheduled for 2005 under prior law.
Tax Relief for Military Families
Modify treatment of combat pay for purposes of
computing the child tax credit and earned income
tax crcdit (EITC).—Compensation received by an active
member of the Armed Forces for service in a combat
zone or while hospitalized as a result of wounds,
disease, or injury incurred while serving in a combat
zone is not included in gross income for tax purposes.
The 2004 tax relief act provided that combat pay otherwise
excluded from gross income is treated as earned
income for purposes of calculating the refundable portion
of the child credit, effective for taxable years beginning
after December 31, 2003. The 2004 tax relief act
also provided that a taxpayer could elect to treat combat
pay otherwise excluded from gross income as earned
income for purposes of the EITC, effective for taxable
years ending after October 4, 2004 and before January
1, 2006.
267 17. FEDERAL RECEIPTS
Alternative Minimum Tax (AMT) Relief for
Individuals
Extend AMT exemption amount.—An alternative
minimum tax is imposed on individuals to the extent
that the tentative minimum tax exceeds the regular
tax. An individual’s tentative minimum tax generally
is equal to the sum of: (1) 26 percent of the first
$175,000 ($87,500 in the case of a married individual
filing a separate return) of alternative minimum taxable
income (taxable income modified to take account
of specified preferences and adjustments) in excess of
an exemption amount and (2) 28 percent of the remaining
excess. The AMT exemption amounts, as provided
under the 2003 jobs and growth tax cut, were: (1)
$58,000 for married taxpayers filing a joint return and
surviving spouses for taxable years 2003 and 2004, declining
in 2005 to $45,000; (2) $40,250 for single taxpayers
for taxable years 2003 and 2004, declining in
2005 to $33,750; and (3) $29,000 for married taxpayers
filing a separate return and estates and trusts, for taxable
years 2003 and 2004, declining in 2005 to $22,500.
The exemption amounts are phased out by an amount
equal to 25 percent of the amount by which the individual’s
alternative minimum taxable income exceeds: (1)
$150,000 for married taxpayers filing a joint return
and surviving spouses; (2) $112,500 for single taxpayers;
and (3) $75,000 for married taxpayers filing
a separate return, estates and trusts. The 2004 tax
relief act extended for one year, through taxable year
2005, the exemption amounts provided under the 2003
jobs and growth tax cut for taxable years 2003 and
2004. Effective for taxable years beginning after December
31, 2005, the AMT exemption amounts will decline
to $33,750 for single taxpayers, $45,000 for married
taxpayers filing a joint return and surviving spouses,
and $22,500 for married taxpayers filing a separate
return and estates and trusts.
Extend ability to offset the AMT with nonrefundable
personal credits.—A temporary provision of prior
law permitted nonrefundable personal tax credits to offset
both the regular tax and the alternative minimum
tax for taxable years beginning before January 1, 2004.
The 2004 tax relief act extended minimum tax relief
for nonrefundable personal credits for two years, to
apply to taxable years 2004 and 2005. The extension
did not apply to the child credit, the saver credit, or
the adoption credit, which were provided AMT relief
through December 31, 2010 under the 2001 tax cut.
Tax Simplification
Establish uniform definition of a qualifying
child.—The tax code provides assistance to families
with children through the dependent exemption, headof-
household filing status, child tax credit, child and
dependent care tax credit, and EITC. Under prior law,
each provision defined an eligible ‘‘child’’ differently,
thereby requiring taxpayers to wade through pages of
bewildering rules and instructions, resulting in confusion
and error. Under the 2004 tax relief act, effective
for taxable years beginning after December 31, 2004,
a qualifying child must meet the following three tests:
(1) Relationship—The child must be the taxpayer’s biological
or adopted child, stepchild, sibling, step-sibling,
foster child, or a descendant of one of these individuals.
(2) Residence—The child must live with the taxpayer
in the same principal home in the United States for
more than half of the taxable year. (3) Age—The child
must be under age 19 (under age 24 in the case of
a full-time student), or totally and permanently disabled.
However, prior-law requirements that a child be
under age 13 for the dependent care credit and under
age 17 for the child tax credit, were maintained. Neither
the support nor gross income tests of prior law
apply to qualifying children who meet these three tests.
In addition, taxpayers are no longer required to meet
a household maintenance test when claiming the child
and dependent care tax credit. Taxpayers generally can
continue to claim individuals who do not meet the relationship,
residency, or age tests as dependents if they
meet the dependency requirements under prior law,
and no other taxpayer is eligible to claim the same
individual as a qualifying child. A tie-breaking rule applies
if a child would be a qualifying child with respect
to more than one individual and if more than one individual
claims a benefit with respect to that child.
Expiring Provisions
Extend the research and experimentation (R&E)
tax credit.—The 20-percent tax credit for qualified research
and experimentation expenditures above a base
amount and the alternative incremental credit expired
with respect to expenditures incurred after June 30,
2004. The 2004 tax relief act extended these credits
for eighteen months, to apply to expenditures incurred
before January 1, 2006.
Extend the work opportunity tax credit.—The
work opportunity tax credit provides incentives for hiring
individuals from certain targeted groups. The credit
generally applies to the first $6,000 of wages paid to
several categories of economically disadvantaged or
handicapped workers. The credit rate is 25 percent of
qualified wages for employment of at least 120 hours
but less than 400 hours and 40 percent for employment
of 400 or more hours. Under prior law, the credit was
available for qualified individuals who began work before
January 1, 2004. The 2004 tax relief act extended
the credit for two years, to apply to qualified individuals
beginning work after December 31, 2003 and before
January 1, 2006.
Extend the welfare-to-work tax credit.—The welfare-
to-work tax credit provides an incentive for hiring
certain recipients of long-term family assistance. The
credit is 35 percent of up to $10,000 of eligible wages
in the first year of employment and 50 percent of wages
up to $10,000 in the second year of employment. Eligible
wages include cash wages plus the cash value of
268 ANALYTICAL PERSPECTIVES
certain employer-paid health, dependent care, and educational
fringe benefits. The minimum employment period
that employees must work before employers can
claim the credit is 400 hours. The 2004 tax relief act
extended this credit for two years, to apply to qualified
individuals who begin work after December 31, 2003
and before January 1, 2006. Under prior law the credit
was available with respect to qualified individuals beginning
work before January 1, 2004.
Extend tax incentives for employment and investment
on Indian reservations.—The 2004 tax relief
act extended for one year, through December 31,
2005, the employment tax credit for qualified workers
employed on an Indian reservation and the accelerated
depreciation rules for qualified property used in the
active conduct of a trade or business within an Indian
reservation. The employment tax credit is not available
for employees involved in certain gaming activities or
who work in a building that houses certain gaming
activities. Similarly, property used to conduct or house
certain gaming activities is not eligible for the accelerated
depreciation recovery periods.
Extend authority to issue Qualified Zone Academy
Bonds.—State and local governments are allowed
to issue ‘‘qualified zone academy bonds,’’ the interest
on which is effectively paid by the Federal government
in the form of an annual income tax credit. The proceeds
of the bonds have to be used for teacher training,
purchases of equipment, curriculum development, or rehabilitation
and repairs at certain public school facilities.
Under prior law, a nationwide total of $400 million
of qualified zone academy bonds were authorized to
be issued in each of calendar years 1998 through 2003.
In addition, unused authority arising in 1998 and 1999
could be carried forward for up to three years and unused
authority arising in 2000 through 2003 could be
carried forward for up to two years. The 2004 tax relief
act authorized the issuance of an additional $400 million
of qualified zone academy bonds in each of calendar
years 2004 and 2005; unused authority can be carried
forward for up to two years.
Extend authority to issue Liberty Zone Bonds.—
The Job Creation and Worker Assistance Act (2002 economic
stimulus act) provided authority to issue an aggregate
of $8 billion of tax-exempt private activity
bonds during calendar years 2002, 2003, and 2004 for
the acquisition, construction, reconstruction, and renovation
of nonresidential real property, residential rental
property, and public utility property in the New York
City Liberty Zone. Authority to issue these bonds,
which are not subject to the aggregate annual State
private activity bond volume limit, was extended
through calendar year 2009 under the 2004 tax relief
act. The 2004 tax relief act also extended for one year,
through December 31, 2005, an expired provision that
allowed certain bonds used to finance projects in New
York City to be eligible for one additional advance refunding.
Extend the District of Columbia (DC) Enterprise
Zone.—The DC Enterprise Zone includes the DC Enterprise
Community and District of Columbia census
tracts with a poverty rate of at least 20 percent. Businesses
in the zone are eligible for: (1) A wage credit
equal to 20 percent of the first $15,000 in annual wages
paid to qualified employees who reside within the District
of Columbia; (2) $35,000 in increased section 179
expensing; and (3) in certain circumstances, tax-exempt
bond financing. In addition, a capital gains exclusion
is allowed for certain investments held more than five
years and made within the DC Zone, or within any
District of Columbia census tract with a poverty rate
of at least 10 percent. Under prior law, the DC Zone
incentives were in effect for the period from January
1, 1998 through December 31, 2003. The 2004 tax relief
act extended the DC Zone incentives for two years,
through December 31, 2005.
Extend the first-time homebuyer credit for the
District of Columbia.—A one-time, nonrefundable
$5,000 credit is available to purchasers of a principal
residence in the District of Columbia who have not
owned a residence in the District during the year preceding
the purchase. The credit phases out for taxpayers
with modified adjusted gross income between
$70,000 and $90,000 ($110,000 and $130,000 for joint
returns). Under prior law, the credit did not apply to
purchases after December 31, 2003. The credit was extended
for two years under the 2004 tax relief act,
making it available with respect to purchases after December
31, 2003 and before January 1, 2006.
Extend deduction for corporate donations of
computer technology.—The charitable contribution
deduction that may be claimed by corporations for donations
of inventory property generally is limited to
the lesser of fair market value or the corporation’s basis
in the property. However, corporations are provided
augmented deductions, not subject to this limitation,
for contributions of computer technology and equipment
to public libraries and to U.S. schools for educational
purposes in grades K-12. The 2004 tax relief act extended
the augmented deduction, which expired with
respect to donations made after December 31, 2003,
to apply to donations made before January 1, 2006.
Extend the above-the-line deduction for qualified
out-of-pocket classroom expenses.—Teachers who
itemize deductions (do not use the standard deduction)
and incur unreimbursed, job-related expenses are allowed
to deduct those expenses to the extent that when
combined with other miscellaneous itemized deductions
they exceed two percent of adjusted gross income (AGI).
Under prior law, certain teachers and other elementary
and secondary school professionals were allowed to
treat up to $250 in annual qualified out-of-pocket classroom
expenses as a non-itemized deduction (above-theline
deduction), effective for expenses incurred in taxable
years beginning after December 31, 2001 and before
January 1, 2004. Unreimbursed expenditures for
269 17. FEDERAL RECEIPTS
certain books, supplies and equipment related to classroom
instruction qualified for the above-the-line deduction.
Expenses claimed as an above-the-line deduction
could not be claimed as an itemized deduction. The
2004 tax relief act extended the above-the-line deduction
for two years, to apply to qualified out-of-pocket
expenditures incurred after December 31, 2003 and before
January 1, 2006.
Extend Archer Medical Savings Accounts
(MSAs).—Self-employed individuals and employees of
small firms are allowed to establish Archer MSAs; the
number of accounts is capped at 750,000. In addition
to other requirements: (1) individuals who establish Archer
MSAs must be covered by a high-deductible health
plan (and no other plan) with a deductible of at least
$1,750 but not greater than $2,650 for policies covering
a single person and a deductible of at least $3,500
but not greater than $5,250 in all other cases (these
amounts are indexed annually for inflation); (2) taxpreferred
contributions are limited to 65 percent of the
deductible for single policies and 75 percent of the deductible
for other policies; and (3) either an individual
or an employer, but not both, may make a tax-preferred
contribution to an Archer MSA for a particular year.
Under prior law, no new contributions could be made
to an Archer MSA after December 31, 2003, except
for the following: (1) those made by or on behalf of
individuals who previously had Archer MSA contributions
and (2) those made by individuals employed by
a participating employer. The 2004 tax relief act extended
the Archer MSA program for two years, thereby
allowing new Archer MSAs through December 31, 2005.
Extend tax on failure to comply with mental
health parity requirements applicable to group
health plans.—Under prior law, group health plans
that provided both medical and surgical benefits and
mental health benefits, could not impose aggregate lifetime
or annual dollar limits on mental health benefits
that were not imposed on substantially all medical and
surgical benefits. An excise tax of $100 per day for
each individual affected (during the period of noncompliance)
was imposed on an employer sponsoring
a group plan that failed to meet these requirements.
For a given taxable year, the tax was limited to the
lesser of 10 percent of the employer’s group health insurance
expenses for the prior taxable year or $500,000.
The mental health parity requirements expired with
respect to benefits for services provided on or after December
31, 2004. The excise tax imposed on plans that
failed to meet the requirements expired with respect
to benefits for services provided after December 31,
2003. The 2004 tax relief act extended the mental
health parity requirements to apply to benefits for services
provided before January 1, 2006. The act also extended
the excise tax, but only with respect to benefits
for services provided after October 3, 2004 and before
January 1, 2006. Therefore, the excise tax on failures
to meet the mental health parity requirements did not
apply to benefits for services provided after December
31, 2003 and before October 4, 2004.
Extend tax credit for the purchase of electric
vehicles.—A 10-percent tax credit, up to a maximum
of $4,000, is provided for the cost of a qualified electric
vehicle. Under prior law, the full amount of the credit
was available for purchases prior to January 1, 2004.
The credit began to phase down in 2004 and was not
available for purchases after December 31, 2006. The
2004 tax relief act extended the full amount of the
credit for two years, making it available for purchases
in 2004 and 2005. As provided under prior law, the
credit is reduced by 75 percent for purchases in 2006
and is not available for purchases after December 31,
2006.
Extend deduction for qualified clean-fuel vehicles
and qualified clean-fuel vehicle refueling
property.—Under prior law, certain costs of acquiring
clean-fuel vehicles (vehicles that use certain clean-burning
fuels) and property used to store or dispense cleanburning
fuels, could be expensed and deducted when
the property was placed in service. For qualified cleanfuel
vehicles, the maximum allowable deduction was
$50,000 for a truck or van with a gross vehicle weight
over 26,000 pounds, $5,000 for a van or truck with
a gross weight between 10,000 and 26,000 pounds; and
$2,000 in the case of any other motor vehicle. The full
amount of the deduction could be claimed for vehicles
placed in service before January 1, 2004, but began
to phase down for vehicles placed in service after December
31, 2003, and was not available after December
31, 2006. The 2004 tax relief act extended the full
amount of the deduction for two years, making it available
for vehicles placed in service in 2004 and 2005.
As provided under prior law, the deduction is reduced
by 75 percent for vehicles placed in service in 2006
and is not available for vehicles placed in service after
December 31, 2006.
Extend suspension of net income limitation on
percentage depletion from marginal oil and gas
wells.—Taxpayers are allowed to recover their investment
in oil and gas wells through depletion deductions.
For certain properties, deductions may be determined
using the percentage depletion method; however, in any
year, the amount deducted generally may not exceed
100 percent of the net income from the property. Under
prior law, for taxable years beginning after December
31, 1997 and before January 1, 2004, domestic oil and
gas production from ‘‘marginal’’ properties was exempt
from the 100-percent-of-net-income limitation. The 2004
tax relief act extended the exemption to apply to taxable
years beginning after December 31, 2003 and before
January 1, 2006.
Extend tax credit for producing electricity from
certain renewable sources.—Taxpayers are provided
a 1.5-cent-per-kilowatt-hour tax credit, adjusted for inflation
after 1992, for electricity produced from wind,
270 ANALYTICAL PERSPECTIVES
closed-loop biomass (organic material from a plant
grown exclusively for use at a qualified facility to
produce electricity), and poultry waste. To qualify for
the credit, the electricity must be sold to an unrelated
third party and, under prior law, had to be produced
during the first 10 years of production at a facility
placed in service before January 1, 2004. The 2004
tax relief act extended the credit for two years, to apply
to electricity produced at facilities placed in service before
January 1, 2006.
Extend expensing of brownfields remediation
costs.—Taxpayers are allowed to elect to treat certain
environmental remediation expenditures that would
otherwise be chargeable to a capital account as deductible
in the year paid or incurred. The 2004 tax relief
act extended this provision, which expired with respect
to expenditures paid or incurred after December 31,
2003, to apply to expenditures paid or incurred before
January 1, 2006.
Extend provisions permitting disclosure of tax
return information relating to terrorist activity.—
Prior law permitted disclosure of tax return information
relating to terrorism in two situations. The first was
when an executive of a Federal law enforcement or
intelligence agency had reason to believe that the return
information was relevant to a terrorist incident,
threat or activity and submitted a written request. The
second was when the Internal Revenue Service (IRS)
wished to apprise a Federal law enforcement agency
of a terrorist incident, threat or activity. The 2004 tax
relief act extended this disclosure authority, which expired
on December 31, 2003, through December 31,
2005.
AMERICAN JOBS CREATION ACT OF 2004
The American Jobs Creation Act of 2004 (2004 jobs
creation act) was signed by President Bush on October
22, 2004. This Act repealed the extraterritorial income
exclusion of prior law, which had been declared a prohibited
export subsidy by the World Trade Organization.
This Act also provided a deduction against domestic
manufacturing income, provided certain tax relief
to U.S. businesses and industries, reformed and simplified
the taxation of overseas operations of U.S. multinational
firms, reformed the Federal tobacco subsidy
program, provided a temporary itemized deduction for
State and local general sales taxes, and included revenue-
raising provisions. The major provisions of this
Act that affect receipts are described below.
Extraterritorial Income
Repeal exclusion for extraterritorial income
(ETI).—Under the ETI provisions of prior law, certain
income attributable to foreign trading gross receipts
was excluded from gross income for U.S. tax purposes.
The 2004 jobs creation act repealed the ETI provisions,
effective for transactions after December 31, 2004. Certain
transitional tax rules apply to transactions occurring
in 2005 and 2006, providing taxpayers with 80
percent and 60 percent, respectively, of the tax benefit
that would have been otherwise allowable under the
prior law ETI provisions. Moreover, the ETI provisions
of prior law remain in effect for transactions in the
ordinary course of a trade or business if such transactions
are pursuant to a binding contract between the
taxpayer and an unrelated person and the contract was
in effect on September 17, 2003 and at all times thereafter.
Provide deduction for domestic manufacturing.—
The 2004 jobs creation act provided a deduction
equal to a portion of the taxpayer’s qualified production
activities income, phased in over six years.
When fully effective for taxable years beginning after
2009, the deduction would be nine percent (three percent
for taxable years 2005 and 2006 and six percent
for taxable years 2007, 2008, and 2009) of the lesser
of: (1) qualified production activities income for the taxable
year; or (2) taxable income (determined without
regard to the deduction) for the year. However, the
deduction for a taxable year generally is limited to an
amount equal to 50 percent of W–2 wages of the employer
for the taxable year.
In general, qualified production activities income
equals domestic production gross receipts in excess of:
(1) the cost of goods sold that are allocable to such
receipts; (2) other deductions, expenses, or losses directly
allocable to such receipts; and (3) a proper share
of other deductions, expenses, and losses that are not
directly allocable to such receipts or another class of
income. Domestic production gross receipts generally
are gross receipts derived from: (1) any sale, lease, rental,
license, exchange, or other disposition of (a) qualifying
production property (generally any tangible personal
property, computer software or sound recordings)
manufactured, produced, grown, or extracted by the
taxpayer in whole or in significant part within the
United States; (b) any qualified film produced by the
taxpayer (generally any motion picture film or videotape
for which 50 percent or more of the total compensation
relating to the production of such film is
for specified services performed in the United States);
and (c) electricity, natural gas, or potable water produced
by the taxpayer in the United States; (2) construction
activities performed in the United States; or
(3) engineering or architectural services performed in
the United States for construction projects in the
United States. In general, domestic production gross
receipts do not include any receipts derived from: (1)
the sale of food or beverages prepared at a retail establishment;
(2) the transmission or distribution of electricity,
natural gas, or potable water; or (3) the leasing,
licensing, or rental of property used by a related person.
Business Tax Incentives
Extend temporarily increased expensing for
small businesses.—In lieu of depreciation, a small
business taxpayer may elect to deduct up to $25,000
271 17. FEDERAL RECEIPTS
of the cost of qualifying property placed in service during
the taxable year. Qualifying property includes certain
tangible property acquired by purchase for use in
the active conduct of a trade or business. The amount
that a taxpayer can expense is reduced by the amount
by which the taxpayer’s cost of qualifying property exceeds
$200,000. The deduction is also limited in any
taxable year by the amount of taxable income derived
from the active conduct by the taxpayer of any trade
or business. An election to expense these costs generally
must be made on the taxpayer’s original return for
the taxable year to which the election relates, and can
be revoked only with the consent of the IRS Commissioner.
Effective for taxable years 2003 through 2005,
the 2003 jobs and growth tax cut: (1) increased the
maximum deduction to $100,000; (2) increased the annual
investment limit to $400,000; (3) expanded the
definition of qualifying property to include off-the-shelf
computer software; and (4) allowed taxpayers to make
or revoke expensing elections on amended returns without
the consent of the IRS Commissioner. The 2003
jobs and growth tax cut also provided for the indexation
of the maximum deduction amount and investment
limit, effective for taxable years beginning after 2003
and before 2006. The 2004 jobs creation act extended
for two years, effective for taxable years 2006 and 2007,
the changes provided in the 2003 jobs and growth tax
cut.
Modify recovery period for depreciation of certain
leasehold improvements.—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).
Under this system, depreciation is determined by applying
specified recovery periods, placed-in-service conventions,
and depreciation methods to the cost of various
types of depreciable property. Depreciation allowances
for improvements made on leased property are determined
under MACRS, even if the recovery period assigned
to the property is longer than the term of the
lease. Therefore, if the leasehold improvement constitutes
an addition or improvement to nonresidential
real property, the improvement is depreciated using the
straight-line method over a 39-year recovery period, beginning
at the midpoint of the month the addition or
improvement was placed in service. The 2004 jobs creation
act reduced the recovery period for qualified leasehold
improvement property from 39 years to 15 years,
effective for such property placed in service after October
22, 2004 and before January 1, 2006. For purposes
of this provision, qualified leasehold improvement property
is defined as any improvement to an interior portion
of a building that is nonresidential real property:
(1) made under or pursuant to a lease either by the
lessee (or sublessee) or by the lessor of that portion
of the building occupied exclusively by the lessee (or
sublessee), and (2) 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.
Modify recovery period for depreciation of certain
restaurant improvements.—Under MACRS, the
cost of nonresidential real property is depreciated using
the straight-line method over a 39-year recovery period.
The 2004 jobs creation act reduced the recovery period
for qualified restaurant property to 15 years, effective
for such property placed in service after October 22,
2004 and before January 1, 2006. For purposes of this
provision, qualified restaurant property is defined as
any improvement to a building if (1) such improvement
is placed in service more than three years after the
date such building was first placed in service and (2)
more than 50 percent of the building’s square footage
is devoted to the preparation of, and seating for onpremises
consumption of, prepared meals.
Modify income forecast method of depreciation.—
Under the income forecast method, a property’s
depreciation deduction for a taxable year is determined
by multiplying the adjusted basis of the property (determined
before adjustments for depreciation) by a fraction,
the numerator of which is the income generated
by the property during the year and the denominator
of which is the total forecasted or estimated income
expected to be generated prior to the close of the tenth
taxable year after the year the property was placed
in service. Any costs that are not recovered by the
end of the tenth taxable year after the property was
placed in service may be taken into account as depreciation
in such year. The cost of certain motion picture
films, sound recordings, copyrights, books, and patents
are eligible to be recovered using the income forecast
method. The 2004 jobs creation act stated that, solely
for purposes of computing the allowable deduction for
property under the income forecast method of depreciation,
participations and residuals may be included in
the adjusted basis of the property beginning in the
year such property is placed in service, but only if such
participations and residuals relate to income to be derived
from the property before the close of the tenth
taxable year following the year the property is placed
in service. Participations and residuals are defined as
costs the amount of which, by contract, varies with
the amount of income earned in connection with such
property. This act also stated that: (1) the amount of
income from the property to be taken into account
under the income forecast method is the gross income
from such property (disregarding distribution costs),
and (2) on a property-by-property basis, the taxpayer
may deduct the costs of participations and residuals
as they are paid, rather than accounting for them as
a capitalized cost under the income forecast method.
These changes were effective for property placed in
service after October 22, 2004.
272 ANALYTICAL PERSPECTIVES
Reform and simplify taxation of S Corporations.—
In general, S corporations do not pay Federal
income tax. Instead, an S corporation passes through
its items of income and loss to its shareholders. Each
shareholder separately accounts for his or her share
of these items on his or her individual income tax return.
A small business corporation (except those designated
ineligible under current law) may elect to be
an S corporation with the consent of all its shareholders,
and may terminate its election with the consent
of shareholders holding more than 50 percent of
the stock. Under prior law, a small business corporation
was defined as a domestic corporation with only one
class of stock and no more than 75 shareholders, all
of whom were individuals (and certain trusts, estates,
charities, and qualified retirement plans) and citizens
or residents of the United States. For purposes of the
75 shareholder limitation, a husband and wife were
treated as one shareholder. Ineligible small businesses
included financial institutions using the reserve method
of accounting for bad debts, insurance companies, corporations
electing the benefits of the Puerto Rico and
possessions tax credit, and Domestic International
Sales Corporations (DISCs) or former DISCs. The 2004
jobs creation act contained a number of provisions, generally
effective for taxable years beginning after December
31, 2004, that eased S corporation eligibility requirements
and affected the tax treatment of some S
corporation shareholders. Major changes: (1) increased
the limitation on the number of shareholders from 75
to 100; (2) allowed all members of a family to be treated
as one shareholder for purposes of the limitation on
the number of shareholders; (3) allowed an individual
retirement account (IRA) to be a shareholder of a bank
S corporation, but only to the extent of stock held on
October 22, 2004; (4) provided for the transfer of suspended
losses when stock in an S corporation is transferred
between spouses or as part of a divorce; and
(5) required the filing of information returns by qualified
subchapter S subsidiaries.
Repeal certain excise taxes on rail diesel fuel
and inland waterway barge fuels.—Under prior law,
diesel fuel used in trains and fuels used in barges operating
on the designated inland waterways system were
subject to a permanent 4.3-cents-per-gallon excise tax
that was deposited in the General Fund of the Treasury.
Under the 2004 jobs creation act, this tax declined
to 3.3 cents per gallon on January 1, 2005, will decline
to 2.3 cents per gallon on July 1, 2005, and will be
repealed effective January 1, 2007.
Provide tax credit for railroad track maintenance.—
The 2004 jobs creation act provided a 50-percent
business tax credit for qualified expenditures incurred
by eligible taxpayers for railroad track maintenance.
The credit, which is effective for expenditures
paid or incurred during taxable years beginning after
December 31, 2004 and before January 1, 2008, is limited
to the product of $3,500 times the number of miles
of railroad track owned or leased by an eligible taxpayer
as of the close of the taxable year. Qualified
expenditures are amounts expended for maintaining
railroad track (including roadbed, bridges, and related
track structures) owned or leased as of January 1, 2005,
by eligible taxpayers. Eligible taxpayers include: (1) certain
types of railroads and (2) a person who transports
property using the rail facilities of such railroads, or
anyone who furnishes railroad-related property or services
to such a person.
Suspend temporarily occupational taxes related
to distilled spirits, wine and beer.—Special occupational
taxes are imposed on producers and others engaged
in the marketing of distilled spirits, wine, and
beer. These taxes are payable annually, on July 1 of
each year. Under the 2004 jobs creation act, these occupational
taxes were suspended for the three-year period,
July 1, 2005 through June 30, 2008.
Tax Relief for Agriculture and Small
Manufacturers
Restructure incentives for alcohol-blended
fuels.—Under prior law an income tax credit and an
excise tax exemption were provided for ethanol and
renewable source methanol used as a fuel. In general,
the income tax credit for ethanol was 52 cents per
gallon, but small ethanol producers (those producing
less than 30 million gallons of ethanol per year) qualified
for a credit of 62 cents per gallon on the first
15 million gallons of ethanol produced in a year. A
credit of 60 cents per gallon was allowed for renewable
source methanol. As an alternative to the income tax
credit, blenders of alcohol fuels could claim a gasoline
tax exemption of 52 cents for each gallon of ethanol
and 60 cents for each gallon of renewable source methanol
blended into qualifying gasohol. The rates for the
ethanol income tax credit and exemption were each reduced
by 1 cent per gallon in 2005. The income tax
credit was scheduled to expire on December 31, 2007
and the excise tax exemption was scheduled to expire
on September 30, 2007. Neither the credit nor the exemption
applied during any period in which motor fuel
taxes dedicated to the Highway Trust Fund were limited
to 4.3 cents per gallon.
Under prior law, 2.5 cents per gallon of the tax on
alcohol-blended fuels was retained in the General Fund
of the Treasury, 0.1 cent per gallon was deposited in
the Leaking Underground Storage Tank (LUST) Trust
Fund, and the balance of the reduced rate was deposited
in the Highway Trust Fund.
The incentives for alcohol-blended fuels provided
under prior law were restructured under the 2004 jobs
creation act. The major changes provided in the act:
(1) repealed the gasoline excise tax exemption for most
alcohol-blended fuels, thereby levying the full amount
of the gasoline excise tax on alcohol-blended fuels sold
or used after December 31, 2004; (2) replaced the gasoline
excise tax exemption for alcohol-blended fuels with
two refundable excise tax credits (the alcohol fuel mixture
credit and the biodiesel mixture credit), to be paid
273 17. FEDERAL RECEIPTS
from the General Fund of the Treasury rather than
from the Highway Trust Fund; (3) provided that the
full amount of the excise tax on alcohol-blended fuels
(except for the 0.1 cent per gallon deposited in the
LUST Trust Fund) is deposited in the Highway Trust
Fund, effective for fuels sold or used after September
30, 2004; (4) extended the prior law income tax credit
for alcohol-blended fuels through December 31, 2010;
and (5) provided a new income tax credit for biodiesel
fuel and biodiesel fuel mixtures. The refundable alcohol
fuel mixture excise tax credit, effective for fuels sold
or used after December 31, 2004 and before January
1, 2011, is 51 cents for each gallon of ethanol (60 cents
for each gallon of renewable source methanol) used by
a taxpayer in producing an alcohol fuel mixture. The
refundable biodiesel mixture excise tax credit, effective
for fuels sold or used after December 31, 2004 and
before January 1, 2007, is 50 cents for each gallon
of biodiesel fuel ($1.00 for each gallon of agri-biodiesel
fuel) used by a taxpayer in producing a qualified biodiesel
fuel mixture. The income tax credit for biodiesel
fuel and biodiesel fuel mixtures is effective for fuels
sold or used after December 31, 2004 and before January
1, 2007, and is 50 cents for each gallon of biodiesel
fuel ($1.00 for each gallon of agri-biodiesel fuel) that
the taxpayer uses as fuel, sells at retail and places
in the fuel supply tank of the customer’s vehicle, or
uses in producing a qualified biodiesel fuel mixture.
Provide tax incentives for agriculture.—The 2004
jobs creation act provided a number of tax incentives
to taxpayers engaged in the agriculture business, which
included: (1) special rules for the recognition of gain
from the sale of livestock sold on account of drought,
flood, or other weather-related conditions; (2) modifications
allowing the small producer ethanol tax credit
to be passed through to members of a cooperative; (3)
extension of income averaging to taxpayers engaged in
the trade or business of fishing; (4) AMT relief for farmers
and fishermen using income averaging; and (5) expensing
of up to $10,000 of qualified reforestation expenditures.
Provide tax incentives for small manufacturers.—
The 2004 jobs creation act provided a number
of tax incentives to small manufacturers, which included:
(1) modification of the treatment of net income
from publicly traded partnerships as qualifying income
for regulated investment companies; (2) simplification
of the excise tax imposed on bows and arrows (with
further modifications provided in legislation modifying
the taxation of arrows and bows signed by the President
on December 23, 2004); (3) reduction of the excise
tax imposed on fishing tackle boxes from ten percent
to three percent; (4) repeal of the three-percent excise
tax imposed on sonar devices suitable for finding fish;
(5) extension of the placed in service date for bonus
depreciation for certain aircraft; (6) expensing and credits
allowed with respect to qualifying capital costs incurred
by small business refiners in complying with
the Highway Diesel Fuel Sulfur Control Requirements
of the Environmental Protection Agency; and (7) modification
of the qualified small issue bond capital expenditure
limit.
Tax Reform and Simplification for U.S. Business
Modify foreign tax credit.—Subject to various limitations,
U.S. taxpayers may credit foreign taxes paid
or accrued against U.S. tax on foreign-source income.
The 2004 jobs creation act made several changes to
the foreign tax credit rules. The major changes included
the following:
Modify foreign tax credit carryovers.—Under
prior law, the amount of creditable taxes paid or
accrued in any taxable year that exceeded the foreign
tax credit limitation in that particular year
was permitted to be carried back to the two immediately
preceding taxable years and carried forward
five taxable years and credited to the extent
that the taxpayer otherwise had excess foreign tax
credit limitation for those years. The 2004 jobs
creation act extended the excess foreign tax credit
carryforward period to ten years and limited the
carryback period to one year. In general, the extended
carryforward period is effective for excess
foreign taxes that can be carried forward to any
taxable year ending after October 22, 2004; the
shortened carryback period is effective for excess
foreign tax credits arising in taxable years beginning
after October 22, 2004.
Modify interest expense allocation rules.—
To determine taxable income for foreign tax credit
limitation purposes, a taxpayer must allocate and
apportion deductions between U.S.-source and foreign-
source income. Interest expense of a U.S. affiliated
group is allocated and apportioned between
U.S.-source and foreign-source income
based on the group’s total U.S. and foreign assets.
All members of a U.S.-affiliated group of corporations
generally are treated as a single corporation
and allocation of interest expense is made on the
basis of the assets of such members, ignoring the
debt and interest expense of foreign subsidiaries.
The 2004 jobs creation act modified the interest
allocation rules by providing a one-time election.
Under the election, foreign-source income would
be determined by allocating and apportioning interest
expense in an amount equal to the excess
(if any) of (1) the worldwide affiliated group’s total
interest expense multiplied by the ratio of foreign
assets of the worldwide affiliated group to total
assets, over (2) the interest expense of foreign
members of the worldwide affiliated group. These
changes in the interest expense allocation rules
are effective for taxable years beginning after December
31, 2008.
Recharacterize overall domestic loss.—A
taxpayer’s losses from foreign sources in excess
of income from foreign sources (an overall foreign
loss, or OFL) may offsets U.S.-source taxable income,
thereby reducing the effective tax rate on
274 ANALYTICAL PERSPECTIVES
U.S.-source income. To address this consequence,
to the extent that an OFL offsets U.S.-source taxable
income, foreign-source income in succeeding
years must be recharacterized as U.S.-source income
for foreign tax credit limitation purposes.
This OFL recapture rule has the effect of reducing
the foreign tax credit limitation in one or more
years following an OFL year, thereby reducing the
amount of U.S. tax that can be offset by the foreign
tax credit in those years. Under prior law,
there was no symmetrical treatment for overall
domestic losses that offset foreign source income
in a taxable year. The 2004 jobs creation act provided
that to the extent U.S.-source losses offset
foreign-source taxable income, U.S.-source income
in succeeding years is recharacterized as foreignsource
income for foreign tax credit limitation purposes
in a manner similar to the OFL recapture
rules. These changes with respect to overall domestic
losses are effective for taxable years beginning
after December 31, 2006.
Apply look-through approach to dividends
paid by a 10/50 company.—Special rules apply
in the case of dividends received from a foreign
corporation in which the taxpayer owns at least
10 percent of the stock by vote and which is not
a controlled foreign corporation (a ‘‘10/50 company’’).
Under prior law, dividends paid by a 10/
50 company out of earnings and profits accumulated
in taxable years after December 31, 2002
received ‘‘look-through’’ treatment based on the
character of the underlying earnings. In contrast,
dividends paid by a 10/50 company out of earnings
and profits accumulated in taxable years before
January 1, 2003 were subject to special basket
rules. Effective for taxable years beginning after
December 31, 2002, the 2004 jobs creation act generally
applied the look-through approach to dividends
paid by a 10/50 company, regardless of the
year in which the earnings and profits out of
which the dividends were paid were accumulated.
Consolidate foreign tax credit categories of
income.—Under prior law, the foreign tax credit
limitation rules were applied separately for nine
statutory limitation categories or ‘‘baskets.’’ Effective
for taxable years beginning after December
31, 2006, the 2004 jobs creation act generally reduced
the number of foreign tax credit limitation
categories from nine to two, with the foreign tax
credit limitation rules applied separately to passive
income and general income.
Provide AMT relief.—Taxpayers are permitted
to reduce their AMT liability by an AMT foreign
tax credit. Under prior law, the AMT foreign tax
credit was limited to 90 percent of the pre-credit
AMT. The 2004 jobs creation act repealed the 90-
percent limitation on the use of the AMT foreign
tax credit, effective for taxable years beginning
after December 31, 2004.
Modify subpart F rules.—Subpart F rules require
U.S. shareholders with a 10-percent or greater interest
in a controlled foreign corporation (CFC) to currently
include in income for U.S. tax purposes their pro-rata
share of the subpart F income of the CFC, whether
or not such income is currently distributed to the shareholders.
The 2004 jobs creation act made changes to
the subpart F rules, generally effective for taxable years
beginning after December 31, 2004. Principal changes
included the following: (1) The exceptions to the definition
of U.S. property were expanded to include: (a) securities
acquired and held by a CFC in the ordinary
course of its trade or business as a dealer in securities
and (b) obligations acquired by the CFC from a U.S.
person who is not a domestic corporation and is not
a U.S. shareholder of the CFC or a partnership, estate,
or trust in which the CFC or any related person is
a partner, beneficiary or trustee. (2) In general, the
sale of a partnership interest by a CFC would be treated
as a sale of a proportionate share of partnership
assets attributable to such interest. (3) The requirements
for gains or losses on commodities hedging transactions
to be excluded from the definition of foreign
personal holding company income were modified. (4)
The temporary exceptions from foreign personal holding
company income and foreign base company services income
provided for active financing income were modified.
(5) The subpart F rules relating to foreign base
company shipping income were repealed, and a safe
harbor was provided to treat certain rents derived from
leasing an aircraft or vessel in foreign commerce as
active income. (6) For purposes of the exception to the
definition of U.S. property, ‘‘banking business’’ was defined.
In addition, the anti-deferral rules applicable to
foreign personal holding companies and to foreign investment
companies were repealed; various other antideferral
rules were consolidated and modified.
Provide incentive to reinvest foreign earnings in
the United States.—Income 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. Under the 2004 jobs creation act, certain dividends
received by a U.S. corporation from controlled
foreign corporations were provided an 85-percent dividends-
received deduction. Various restrictions apply to
determine whether dividends are eligible for the deduction,
including a requirement that the funds be invested
in the United States. At the taxpayer’s election, the
deduction is available for dividends received either during
the taxpayer’s first taxable year beginning on or
after October 22, 2004, or during the taxpayer’s last
taxable year beginning before such date. Dividends received
after the election period will be taxed in the
normal manner under present law.
275 17. FEDERAL RECEIPTS
State and Local General Sales Taxes
Provide optional temporary deduction for State
and local general sales taxes.—An itemized deduction
is permitted for certain State and local taxes, including
individual income taxes, real property taxes,
and personal property taxes. Under prior law, a deduction
was not provided for State and local general sales
taxes (a tax imposed at one rate with respect to the
sale at retail of a broad range of classes of items).
Under the 2004 jobs creation act, effective for taxable
years beginning after December 31, 2003 and before
January 1, 2006, a taxpayer would be allowed to elect
to take an itemized deduction for State and local general
sales taxes in lieu of the itemized deduction for
State and local income taxes. The allowable deduction
could be determined by tallying the amount of general
State and local sales taxes paid on accumulated receipts,
or from tables prescribed by the Secretary of
the Treasury. A taxpayer tallying the amount of taxes
paid would be able to include taxes imposed at one
rate on the sale at retail of a broad range of classes
of items, as well as taxes imposed at a lower rate on
the sale at retail of food, clothing, medical supplies,
and motor vehicles. Taxes imposed at a higher rate
on the sale of motor vehicles would be deductible, but
only up to the amount that would have been imposed
at the general sales tax rate. The tables prescribed
by the Secretary of the Treasury would be based on
the average consumption of taxpayers on a State-by-
State basis and would take into account filing status,
number of dependents, adjusted gross income, and rates
of State and local general sales taxes. Taxpayers who
used the tables would be allowed to add to the table
amounts general sales taxes paid with respect to purchases
of motor vehicles, boats, and other items specified
by the Secretary that would not be reflected in
the tables.
Tobacco Reform
Reform the tobacco program.—Under prior law,
the Federal tobacco program had two main components:
a supply management component and a price support
component. The supply management component limited
and stabilized the quantity of tobacco marketed by
farmers through marketing quotas. Because marketing
quotas alone could not always guarantee tobacco prices,
Federal support prices were established and guaranteed
through the mechanism of nonrecourse loans available
on each farmer’s marketed crop. In 1982 legislation
was enacted to ensure that the nonrecourse loan program
was run at no-net-cost to the Federal government.
The 2004 jobs creation act repealed all aspects of
the Federal tobacco program, effective for crop years
beginning in 2005. Under the reformed program, quota
holders and producers of quota tobacco (owners, operators,
landlords, tenants, or sharecroppers who shared
in the risk of production) would be entitled to receive
payments in exchange for the termination of the quotas
and price supports of prior law. A base quota level
would be established for each tobacco quota holder and
each producer. Eligible tobacco quota holders would receive
$7 per pound on their basic quota allotment, paid
in equal installments over 10 years. Eligible producers
would receive $1 to $3 per pound, depending on the
extent of their quota-related activity in the 2002-2004
marketing years, multiplied by their base quota level,
paid in equal installments over 10 years.
Assessments would be imposed quarterly on each
manufacturer and importer of tobacco products sold in
the United States, effective for fiscal years 2005
through 2014. The assessments, which would be sufficient
to fund the payments to quota holders and producers
and other expenditures associated with the program,
would be based on the class of tobacco product
(cigarettes, snuff, chewing tobacco, pipe tobacco, rollyour-
own tobacco and cigars) and market share.
Miscellaneous Provisions
Permit stock life insurance companies to make
tax-free distributions from policyholder surplus
accounts.—Policyholder surplus accounts of stock life
insurance companies were established legislatively and
represent earnings of such companies that were
untaxed under prior law. Any direct or indirect distribution
to shareholders from an existing policyholder
surplus account of a stock life insurance company is
subject to tax at the corporate rate in the taxable year
of the distribution. Any distribution to shareholders is
treated as made: (1) first out of the shareholder surplus
account, to the extent thereof; (2) then out of the policyholder
surplus account, to the extent thereof; and (3)
finally, out of other accounts. A company may also elect
to subtract from its policyholder surplus account any
amount as of the close of a taxable year. For stock
life insurance companies, the 2004 jobs creation act
temporarily suspended the taxation of distributions to
shareholders from an existing policyholder surplus account.
The act also reversed the order in which distributions
reduce the various accounts, so that distributions
would be treated as: (1) first made out of the
policyholder surplus account, to the extent thereof; (2)
then out of the shareholder surplus account, to the
extent thereof; and (3) lastly out of other income. These
changes were effective for taxable years beginning after
December 31, 2004 and before January 1, 2007.
Modify method of accounting for naval shipbuilding
contracts.—Taxpayers generally must use
the percentage-of-completion method to determine taxable
income from long-term contracts. However, an exception
exists for certain ship construction contracts,
which may be accounted for using the 40/60 percentageof-
completion/capital cost method (PCCM). Under the
40/60 PCCM, 40 percent of the taxpayer’s long-term
contract income is subject to the percentage-of-completion
method, the remaining 60 percent must be reported
by consistently using the taxpayer’s exempt contract
method. Permissible exempt contract methods include
the percentage of completion method, the exempt-con276
ANALYTICAL PERSPECTIVES
tract percentage-of-completion method, and the completed
contract method. The 2004 jobs creation act allowed
qualified naval ship contracts to be accounted
for using the 40/60 PCCM during the first five taxable
years of the contract. The cumulative reduction in tax
resulting from the provision over the five-year period
must be recaptured and included in the taxpayer’s tax
liability in the sixth year. This change was effective
for contracts for which construction commenced after
October 22, 2004.
Defer gain on the disposition of electric transmission
property.—Gain on the sale or other disposition
of property is ordinarily recognized in the year
of sale. The 2004 jobs creation act permitted the gain
from certain sales of electric transmission property to
be recognized ratably over eight years beginning with
the year of sale, except to the extent proceeds of the
sale are not used to purchase replacement utility property.
To qualify for this treatment, the transmission
property must be sold to an independent transmission
company after October 22, 2004 and before January
1, 2007, and the proceeds from the sale must be used
to purchase replacement utility property. To the extent
the proceeds are not used to purchase replacement utility
property, gain is recognized in the year of the sale.
Expand resources eligible for the tax credit for
producing electricity from certain sources.—Taxpayers
are provided a 1.5-cent-per-kilowatt-hour tax
credit, adjusted for inflation after 1992, for electricity
produced from wind, closed-loop biomass (organic material
from a plant grown exclusively for use at a qualified
facility to produce electricity), and poultry waste.
To qualify for the credit under prior law, the electricity
had to be sold to an unrelated third party and had
to be produced during the first 10 years of production
at a qualified facility placed in service before January
1, 2006 and after December 31, 1999 for a poultry
waste facility, after December 31, 1992 for a closedloop
biomass facility and after December 31, 1993 for
a wind energy facility. Under the 2004 jobs creation
act, the credit was expanded to apply to electricity from
closed-loop biomass produced at a facility originally
placed in service before December 31, 1992 and modified
to use closed-loop biomass to co-fire with coal, other
biomass, or coal and other biomass before January 1,
2006. The credit for electricity produced by such facilities
would be equal to the otherwise allowable credit
multiplied by the ratio of the thermal content of the
closed-loop biomass fuel burned in the facility to the
thermal content of all fuels burned in the facility. The
2004 jobs creation act also expanded the credit to apply
to the following new qualifying sources: (1) open-loop
biomass (other than agricultural livestock waste nutrients)
used at a facility placed in service before January
1, 2006; (2) municipal solid waste, agricultural livestock
waste nutrients, geothermal energy, solar energy, small
irrigation power, landfill gas, and trash combustion
used at a qualifying facility placed in service after October
22, 2004 and before January 1, 2006; and (3) refined
coal produced at a qualifying facility placed in
service after October 22, 2004 and before January 1,
2009. For facilities using open-loop biomass, including
agricultural livestock waste nutrients, geothermal energy,
solar energy, small irrigation power, landfill gas,
or trash combustion, the credit period was reduced from
ten years to five years and (except for geothermal energy
and solar energy) the credit rate was reduced by
half. Facilities using refined coal could claim the credit
at a rate of $4.375 per ton (indexed for inflation).
Revenue Provisions
Modify tax treatment of corporate inversions.—
The 2004 jobs creation act addressed ‘‘inversion transactions,’’
which occur when a U.S. corporation reincorporates
in a foreign jurisdiction and replaces the U.S.
parent corporation of a multinational corporate group
with a foreign parent corporation. The 2004 jobs creation
act included provisions that addressed two types
of inversion transactions. These changes generally applied
to taxable years ending after March 4, 2003, effective
for companies (and certain partnerships) inverting
after that date:
Inversions with at least 80 percent identity
of stock ownership.—An inverting company generally
would continue to be taxed as a U.S. company
(that is, the inversion essentially would be
disregarded) if: (1) it acquired substantially all the
property of a U.S. corporation, (2) 80 percent or
more of its stock was held by former shareholders
of the U.S. corporation, and (3) its ‘‘expanded affiliated
group’’ did not have substantial business
activities in the country in which it was organized.
Inversions with at least 60 percent (but less
than 80 percent) identity of stock ownership.—
Any inversion gain recognized by an inverting
U.S. company generally would be taxed
and the use of tax attributes such as net operating
losses (NOLs) and foreign tax credits would be
limited if: (1) it acquired substantially all the
property of a U.S. corporation, (2) 60 percent or
more of its stock was held by former shareholders
of the U.S. corporation and (3) its ‘‘expanded affiliated
group’’ did not have substantial business activities
in the country in which it was organized.
Revise taxation of individuals who relinquish
U.S. citizenship or terminate long-term residency.—
An individual who gives up U.S. citizenship
or terminates long-term U.S. residency to avoid tax is
subject to an alternative tax regime for 10 years following
loss of citizenship or termination of residency.
The 2004 jobs creation act: (1) eliminated the subjective
‘‘principal purpose’’ standard and established objective
standards for determining whether former citizens or
long-term residents are subject to the alternative tax
regime; (2) provided tax-based rules for determining
when an individual is no longer a U.S. citizen or longterm
resident; (3) imposed full U.S. taxation on individuals
subject to the alternative tax regime who return
277 17. FEDERAL RECEIPTS
to the U.S. for extended periods; (4) imposed the U.S.
gift tax on gifts of stock of certain closely-held foreign
corporations that hold U.S.-situated property; and (5)
required individuals subject to the alternative tax regime
to file an annual return. These changes applied
to individuals who relinquished citizenship or terminated
residency after June 3, 2004.
Combat abusive tax avoidance transactions.—Although
the vast majority of taxpayers and practitioners
do their best to comply with the law, some actively
promote or engage in transactions structured to generate
tax benefits never intended by Congress. Such
abusive transactions harm the public fisc, erode the
public’s respect for the tax laws, and consume limited
IRS resources. The 2004 jobs creation act contained
several provisions designed to curtail the use of abusive
tax avoidance transactions. The major changes included:
(1) the imposition of new or increased penalties
on taxpayers who fail to disclose listed or reportable
transactions, report an interest in a foreign financial
account, or accurately report a listed or reportable
transaction; (2) the imposition of new or increased penalties
on tax shelter promoters who make false or
fraudulent claims to promote abusive tax avoidance
transactions, fail to maintain investor lists, or fail to
disclose listed or reportable transactions; (3) modification
of actions to enjoin conduct related to tax shelters
and reportable transactions; (4) expansion of the tax
shelter exception for Federal practitioner privilege to
apply to all tax shelters; (5) extension of the statute
of limitations for unreported listed transactions; and
(6) denial of a deduction for interest paid or accrued
on any portion of an underpayment of tax attributable
to an undisclosed listed transaction or an undisclosed
reportable avoidance transaction.
Modify taxation of partnerships.—Although a
partnership is a tax-reporting entity that must file an
annual partnership return, a partnership does not pay
Federal income tax. Instead, income or loss ‘‘flows
through’’ to the partners who are each taxed on their
distributive share of partnership taxable income. When
filing their Federal income tax return, each partner
must take into account their distributive share of certain
items of partnership income, gain, loss, deduction,
or credit. A partner generally is not taxed on distributions
of cash or property received from the partnership,
except to the extent that any money distributed exceeds
the partner’s adjusted basis in his partnership interest
immediately before the distribution. Taxable gain can
also result from distributions of property that were contributed
to the partnership with a fair market value
in excess of the adjusted basis (property with a builtin
gain) and from property distributions characterized
as sales and exchanges. The 2004 jobs creation act included
several provisions that affect the calculation and
allocation of partnership income and ownership interests.
The major changes, which generally were applicable
with respect to contributions of property, transfers
of partnership interests and distributions of partnership
property after October 22, 2004, included the following:
Disallow certain partnership loss transfers
and modify basis adjustments.—Built-in losses
with respect to contributed property would be
taken into account only by the contributing partner
and not by other partners. In determining
the amount of items allocated to partners other
than the contributing partner, the basis of the
contributed property would be the fair market
value at the time of contribution. If the contributing
partner’s partnership interest were transferred
or liquidated, the partnership’s adjusted
basis in the property would be based on the fair
market value at the time of contribution, and the
built-in loss would be eliminated.
Modify basis adjustment in stock held by
a partnership in a corporate partner.—In applying
the basis allocation rules to a distribution
in liquidation of a partner’s interest, a partnership
would be precluded from decreasing the basis of
corporate stock of a partner or a related person.
Any decrease in basis that would have otherwise
been allocated to the stock would be allocated to
other partnership assets. If the decrease in basis
exceeded the basis of the other partnership assets,
then the gain would be recognized by the partnership
in the amount of the excess.
Limit the transfer and importation of builtin
losses.—The basis of property with a net builtin
loss imported into the U.S. in a tax-free incorporation
or reorganization from persons not subject
to U.S. tax would be its fair market value,
thereby eliminating the built-in loss.
Reform the tax treatment for leasing arrangements
with tax-indifferent parties.—Certain leasing
arrangements (often referred to as sale-in/lease-out or
SILO arrangements) involving tax-indifferent parties
(including governments, charities, and foreign entities)
do not provide financing related to the construction,
purchase or refinancing of productive assets. Rather,
they involve the payment of an accommodation fee by
a U.S. taxpayer to the tax-indifferent party in exchange
for the right of the U.S. taxpayer to claim tax benefits
from the purported tax ownership of the property.
These arrangements usually result in no change in the
tax-indifferent party’s use or operation of the property,
and are designed to ensure that the U.S. taxpayer bears
only limited economic risk. The U.S. taxpayer enjoys
substantial current tax deductions, while postponing
the recognition of taxable income well into the future.
The 2004 jobs creation act limited a taxpayer’s annual
deductions or losses related to a lease with a tax-indifferent
party by: (1) modifying the recovery period of
certain property (qualified technological equipment,
computer software and certain intangibles) leased to
a tax-exempt entity to the longer of the property’s assigned
class life or 125 percent of the lease term; (2)
altering the definition of lease term for all property
leased to a tax-exempt entity to include the time period
278 ANALYTICAL PERSPECTIVES
a lessee is under a service contract or similar obligation
period; and (3) establishing rules to limit deductions
associated with such leases to the net income generated
from the lease unless the lease meets certain specified
criteria. These rules generally were effective with respect
to leases entered into after March 12, 2004, and
did not apply to short-term leases of five or fewer years,
with a modification for short-term leases of qualified
technological equipment. Disallowed deductions could
be carried forward and treated as deductions related
to the lease in the next taxable year, subject to the
same limitations, or taken when the taxpayer completely
disposed of its interest in the leased property.
Indian tribes and their instrumentalities were added
to the definition of tax-exempt entities required to depreciate
leased property on a straight line basis over
a recovery period equal to the longer of the property’s
assigned class life or 125 percent of the lease term.
Improve tax administration.—A number of provisions
included in the 2004 jobs creation act improved
tax administration. The major provisions: (1) clarified
the rules for payment of estimated tax with respect
to tax attributable to a deemed asset sale; (2) clarified
that the exclusion for gain on the sale or exchange
of a principal residence does not apply in cases where
the principal residence was acquired in a like-kind exchange
in which any gain was not recognized within
the prior five years; (3) allowed taxpayers to deposit
cash with the Internal Revenue Service (IRS) that could
subsequently be used to pay an underpayment of income,
gift, estate, generation-skipping, or certain excise
taxes; (4) authorized the IRS to enter into installment
agreements that provide for the partial payment of
taxes owed; (5) allowed the IRS to levy continuously
up to 100 percent of Federal payments to vendors; (6)
modified the rules regarding suspension of interest and
penalties where the IRS fails to contact the taxpayer;
(7) clarified the residence and income source rules relating
to U.S. possessions; (8) expanded the prior law provision
that disallowed a deduction for interest on certain
corporate convertible or equity-linked debt; (9) prevented
the mismatching of deductions for accrued interest
and original issue discount with their inclusion in
income in transactions with related foreign persons;
and (10) permitted private collection agencies to engage
in specific, limited activities to support IRS collection
efforts.
Reduce fuel tax evasion.—A number of provisions
included in the 2004 jobs creation act reduced fuel tax
evasion. These provisions, which generally were effective
after October 22, 2004, included: (1) codification
of the exemption from certain excise taxes for mobile
machinery vehicles; (2) modification of the definition
of an off-highway vehicle; (3) modification of the point
of taxation of aviation fuel from the sale by a producer
or importer to removal from a refinery or terminal,
or entry into the United States; (4) elimination of manual
dying of fuel and the imposition of penalties for
violation of fuel dying rules; (5) imposition of additional
registration requirements on bulk transfers of tax-exempt
fuel by pipeline, vessel or barge; (6) repeal of
the installment method for payment of the heavy highway
vehicle use tax and the elimination of reduced
rates for certain heavy highway vehicles; and (7) expansion
of taxable fuels to include transmix and diesel
fuel blend stocks.
Modify deductions for charitable contributions.—
The 2004 jobs creation act made several
changes to prior law rules regarding allowable deductions
for donations of contributed property. The major
changes included the following:
Modify rules for donations of patents and
other intellectual property.—In the initial year
of a contribution of a patent or other intellectual
property (other than certain copyrights or inventory),
the allowable deduction would be limited
to the lesser of the taxpayer’s basis in the donated
property or the fair market value of the property.
In addition, in that year and in future years, additional
amounts could be deducted based on a specified
percentage of the amount of royalties or other
revenue, if any, actually received by the donee
charity from the donated property. These additional
deductions would be allowed only to the
extent that the aggregate of the amounts calculated
exceeded the amount of the deduction
claimed in the initial year of the contribution. No
additional deductions would be permitted after the
expiration of the legal life of the patent or intellectual
property, or after the tenth anniversary of
the date the contribution was made. This change
was effective for contributions made after June
3, 2004.
Limit deductions for charitable contributions
of vehicles.—Under prior law, taxpayers
generally were permitted to deduct the fair market
value of donated vehicles, regardless of whether
the vehicle was actually used for a charitable
purpose or resold with the charity receiving some
revenue from the sale. Under the 2004 jobs creation
act, the amount of deduction for charitable
contributions of vehicles (generally including automobiles,
boats, and airplanes for which the
claimed value exceeded $500 and excluding inventory
property) would depend upon the use of the
vehicle by the donee organization. For vehicles
sold by the donee organization without any significant
intervening use or material improvement, the
amount of the deduction could not exceed the
gross proceeds from the sale. Deductions in excess
of $500 would have to be substantiated by a contemporaneous
written acknowledgement by the
donee. Strict penalties would be levied on donee
organizations knowingly furnishing false or fraudulent
acknowledgements. These changes were effective
for contributions made after December 31,
2004.
279 17. FEDERAL RECEIPTS
Require increased reporting for noncash
charitable contributions.—Under prior law, any
individual, closely-held corporation, personal service
corporation, or S corporation claiming a charitable
contribution deduction for a contribution of
property (other than publicly-traded securities) of
more than $5,000 ($10,000 in the case of nonpublicly
traded stock) was required to obtain a qualified
appraisal for the property. The 2004 jobs creation
act extended this requirement to all corporations.
In addition, the act required that all taxpayers
(whether an individual, a partnership, or
a corporation) provide a copy of the appraisal to
the IRS for deductions claimed in excess of
$500,000. The change was effective for contributions
made after June 3, 2004.
Modify treatment of nonqualified deferred compensation
plans.—Under prior law, the determination
of when amounts deferred under a nonqualified deferred
compensation arrangement were includible in the
gross income of the individual earning the compensation
depended on the facts and circumstances of the
arrangement. If the arrangement was unfunded, the
compensation generally was includible in income when
it was actually or constructively received. If the arrangement
was funded, then income was includible for
the year in which the individual’s rights were transferable
or not subject to a substantial risk of forfeiture.
Under the 2004 jobs creation act, all amounts deferred
under a nonqualified deferred compensation plan are
currently includible in the gross income of the individual
earning the compensation to the extent not subject
to a substantial risk of forfeiture and not previously
included in gross income, unless certain requirements
are satisfied. Such requirements include permissible
timing for deferral elections and distributions of deferred
amounts. If the requirements are not satisfied,
interest at the underpayment rate plus one percentage
point will be 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. In addition,
the amount required to be included in income will be
subject to a 20-pecent additional tax. These changes
apply with respect to amounts deferred in taxable years
beginning after December 31, 2004.
Modify list of taxable vaccines.—A manufacturer’s
excise tax is imposed at the rate of 75 cents per dose
on the following vaccines routinely recommended for
administration to children: diphtheria, pertussis, tetanus,
measles, mumps, rubella, polio, haemophilus influenza
type B, hepatitis B, chicken pox, rotavirus
gastroenteritis, and streptococcus pneumoniae. The tax
applied to any vaccine that is a combination of vaccine
components equals 75 cents times the number of components
in the combined vaccine. Amounts equal to net
revenue from the excise tax are deposited in the Vaccine
Injury Compensation Trust Fund to finance compensation
awards under the Federal Vaccine Injury
Compensation Program for individuals who suffer certain
injuries following administration of the taxable
vaccines. The 2004 jobs creation act added any vaccine
against hepatitis A and any trivalent vaccine against
influenza to the list of taxable vaccines.
Extend IRS user fees.—The IRS has authority to
charge fees for written responses to questions from individuals,
corporations, and organizations related to their
tax status or the effects of particular transactions for
tax purposes. The 2004 jobs creation act extended authority
for these fees, which had expired effective with
requests made after December 31, 2004, through September
30, 2014.
Establish specific class lives for utility grading
costs.—A taxpayer is allowed a depreciation deduction
for the exhaustion, wear and tear, and obsolescence
of property that is used in a trade or business or held
for the production of income. For most tangible property
placed in service after 1986, the amount of the depreciation
deduction is determined under MACRS using
a statutorily prescribed depreciation method, recovery
period, and placed in service convention. Under prior
law, the cost of initially clearing and grading land improvements
were depreciated over a seven-year recovery
period under MACRS as assets for which no class life
was provided. Under the 2004 jobs creation act, depreciable
clearing and grading costs incurred to locate
transmission and distribution lines and pipelines were
assigned recovery periods of 20 years for electric utilities
and 15 years for gas utilities. These changes were
effective for property placed in service after October
22, 2004.
Modify treatment of start-up and organizational
expenditures.—Under prior law, at the election of the
taxpayer, start-up and organizational expenditures
could be amortized over a period of not less than 60
months, beginning with the month in which the trade
or business began. The 2004 jobs creation act allowed
a taxpayer to elect to deduct up to $5,000 of startup
and $5,000 of organizational expenditures in the
taxable year in which the trade or business began.
However, each $5,000 amount was reduced (but not
below zero) by the amount by which the cumulative
cost of start-up and organizational expenditures exceeded
$50,000, respectively. Start-up and organization expenditures
that were not deductible in the year in
which the trade or business began would be amortized
over a 15-year recovery period. The change was effective
for start-up and organizational expenditures incurred
after October 22, 2004. Start-up and organizational
expenditures incurred on or before October 22,
2004 would continue to be eligible to be amortized over
a period not less than 60 months. However, all startup
and organizational expenditures related to a particular
trade or business, whether incurred before or
after October 22, 2004, would be considered in determining
whether the cumulative cost of start-up or organizational
expenditures exceeded $50,000.
280 ANALYTICAL PERSPECTIVES
Limit deduction for certain entertainment expenses.—
In general, deductions are not allowed with
respect to an activity generally considered to be entertainment,
amusement or recreation, unless the taxpayer
establishes that the item was directly related
to (or, in certain cases, associated with) the active conduct
of the taxpayer’s trade or business, or a facility
(such as an airplane) used in connection with such activity.
However, under prior law, this general entertainment
expense disallowance rule did not apply to entertainment
expenses for goods, services, and facilities to
the extent that the expenses were (1) reported by the
taxpayer as compensation and wages to an employee,
or (2) includible in the gross income of a recipient who
was not an employee as compensation for services rendered
or as a prize or award. For specified individuals
(officers, directors, and 10-percent-or-greater owners of
private and publicly-held companies), the 2004 jobs creation
act disallowed the deduction, to the extent that
such expenses exceeded the amount treated as compensation
or includible in income for the individual,
with respect to expenses for (1) nonbusiness activity
generally considered to be entertainment, amusement
or recreation, or (2) a facility used in connection with
such activity. This change was effective for such expenses
incurred after October 22, 2004.
Limit expensing of sport utility vehicles.—Under
prior law, taxpayers purchasing a sport utility vehicle
for business use could expense and deduct up to
$100,000 of the cost in the year the vehicle was placed
in service. The 2004 jobs creation act reduced the
amount of expensing allowed with respect to the cost
of a sports utility vehicle from $100,000 to $25,000.
The change was effective for property placed in service
after October 22, 2004.
PENSION FUNDING EQUITY ACT OF 2004
This Act, which was signed by the President on April
10, 2004, made changes to the Employee Retirement
Income Security Act of 1974 (ERISA) and the Internal
Revenue Code that affect the operation of private pension
plans. The major provisions of the Act: (1) established
a two-year temporary replacement of the benchmark
interest rate for determining funding liabilities
of private sector pension plans; (2) established temporary
alternative minimum funding standards that reduced
funding requirements for commercial airlines,
steel companies, and certain other employers; and (3)
allowed certain multiemployer plans to temporarily
delay the amortization of specified losses. This Act also
contained a number of other provisions including: (1)
modification of the definition of a property and casualty
insurance company and the requirements for such companies
to be eligible for tax-exempt status; (2) repeal
of the prior law provision requiring reductions in deductions
of mutual life insurance companies for policyholder
dividends; and (3) extension, through December
31, 2013, of the prior law provision that allowed employers
to transfer excess defined benefit plan assets
to a special account for health benefits of retirees.
UNITED STATES-AUSTRALIA FREE TRADE
AGREEMENT IMPLEMENTATION ACT
This Act implemented the U.S.-Australia Free Trade
Agreement (FTA), as signed by the United States and
Australia on May 18, 2004. The U.S.-Australia FTA
advanced U.S. economic interests by providing increased
access to Australia’s markets for American
services, manufactured goods, and agricultural products.
The Agreement, which will create jobs and opportunities
in both countries, solidified our relationship
with an important partner in the global economy and
set a strong example of the benefits of free trade and
democracy.
UNITED STATES-MOROCCO FREE TRADE
AGREEMENT IMPLEMENTATION ACT
This Act implemented the U.S.-Morocco FTA, as
signed by the United States and Morocco on June 15,
2004. The U.S.-Morocco FTA advanced U.S. economic
interests by providing increased access to Morocco’s
markets for American manufactured goods, agricultural
products, services, and investment. The Agreement provided
a significant opportunity to encourage economic
reform and development in a moderate Muslim nation
and was an important step in implementing the President’s
plan for a broader U.S.-Middle East Free Trade
Area.
THE AGOA ACCELERATION ACT OF 2004
The African Growth and Opportunity Act (AGOA),
enacted in May 2000, reduced barriers to trade, thereby
increasing exports, creating jobs, and increasing opportunities
for Africans and Americans alike. It gave
American businesses greater confidence to invest in Africa,
and encouraged African nations to reform their
economies and governments to take advantage of the
opportunities that AGOA provided. The AGOA Acceleration
Act, which was signed by the President on July
13, 2004, built on that success by extending trade preferences
for certain imports from designated sub-Saharan
African countries through September 30, 2015. The
deadline for expiration of these benefits had been September
30, 2008 under prior law. The AGOA Acceleration
Act also extended the prior law deadline for use
of third country fabric benefits from September 30,
2004 to September 30, 2007. Under this provision, any
AGOA country with a per capita GNP less than $1,500
enjoys duty-free access (subject to caps on the amount
of imports as measured by square meter equivalents)
to the U.S. market for apparel made from fabric originating
anywhere in the world. This Act also expanded
benefits by modifying rules of origin for certain apparel
components, such as collars and cuffs, and expanded
the scope of eligible goods to include ethnic fabrics
made on machines, rather than just those made by
hand.
281 17. FEDERAL RECEIPTS
THE MISCELLANEOUS TRADE AND
TECHNICAL CORRECTIONS ACT OF 2004
This Act, which was signed by the President on December
3, 2004, provided for the temporary suspension
of tariffs on about 330 new items, including a wide
variety of chemicals, and a number of pigments and
dyes that are for the most part not made in the U.S.
and needed by U.S. manufacturers. This Act also extended
suspensions of tariffs on a number of items,
refunded tariffs on specified imports, and made technical
corrections to several trade laws.
ADMINISTRATION PROPOSALS
REFORM THE FEDERAL TAX SYSTEM
On January 7, 2005, the President established an
Advisory Panel on Federal Tax Reform to develop options
to improve the tax system. The current tax system
is complex, is perceived by many as unfair, and distorts
household and business decisions. The excessive time
taxpayers spend to understand and comply with the
tax system is a burden and wastes resources. Taxpayers
spend an estimated six billion hours to comply with
the tax system at a cost of more than $100 billion
annually. Individuals and businesses need a tax system
that is simpler, and easier to understand and comply
with. Faith in the fairness of our tax system is undermined
when taxpayers believe others can exploit the
complexities of the law to avoid paying tax. At the
same time, Americans deserve a tax code that will allow
them to make decisions based more on economic merit,
free of the distortions generated by the tax system.
The economic costs associated with these distortions
can total hundreds of billions of dollars annually.
The Advisory Panel will broadly focus on revenueneutral
reforms that make the tax system simpler, encourage
economic growth, and promote fairness, while
recognizing the importance of homeownership and charitable
giving in American society. Information on the
Advisory Panel and its deliberations can be found at
www.taxreformpanel.gov. The Advisory Panel will provide
options for reforming the tax system to the Secretary
of the Treasury no later than July 31, 2005.
These options will help the Treasury Secretary and others
within the Administration develop specific recommendations
for the President.
Pending the outcome of fundamental tax reform, the
President will continue to propose important policy initiatives
including permanent extension of the increased
expensing for small businesses and the reductions in
taxes on capital gains and dividends provided in the
2003 jobs and growth tax cut. The President’s policy
initiatives also include permanent extension of the provisions
of the 2001 tax cut scheduled to sunset on December
31, 2010, permanent extension of the research
and experimentation tax credit, and extension of many
other expiring provisions. In addition, the President’s
initiatives include incentives for charitable giving,
strengthening education, investing in health care, protecting
the environment, increasing energy production,
and promoting energy conservation.
This Budget also includes proposals designed to increase
opportunities for saving by simplifying and
rationalizing the many tax preferred savings vehicles
provided under current law, improve tax compliance,
curtail abusive tax avoidance activities, and strengthen
the employer-based pension system.
MAKE PERMANENT CERTAIN TAX CUTS
ENACTED IN 2001 AND 2003
Extend permanently reductions in individual income
taxes on capital gains and dividends.—The
maximum individual income tax rate on net capital
gains and dividends is 15 percent for taxpayers in individual
income tax rate brackets above 15 percent and
5 percent (zero in 2008) for lower income taxpayers.
The Administration proposes to extend permanently
these reduced rates (15 percent and zero), which are
scheduled to expire on December 31, 2008.
Extend permanently increased expensing for
small business.—Small business taxpayers are allowed
to expense up to $100,000 in annual investment
expenditures for qualifying property (expanded to include
off-the-shelf computer software) placed in service
in taxable years 2003 through 2007. The amount that
may be expensed is reduced by the amount by which
the taxpayer’s cost of qualifying property exceeds
$400,000. Both the deduction and annual investment
limits are indexed annually for inflation, effective for
taxable years beginning after 2003 and before 2008.
Also, with respect to a taxable year beginning after
2002 and before 2008, taxpayers are permitted to make
or revoke expensing elections on amended returns without
the consent of the IRS Commissioner. The Administration
proposes to extend permanently each of these
temporary provisions, applicable for qualifying property
(including off-the-shelf computer software) placed in
service in taxable years beginning after 2007.
Extend permanently provisions expiring in
2010.—Most of the provisions of the 2001 tax cut sunset
on December 31, 2010. The Administration proposes
to extend those provisions permanently.
TAX INCENTIVES
Simplify and Encourage Saving
Expand tax-free savings opportunities.—Under
current law, individuals can contribute to traditional
Individual Retirement Accounts (IRAs), nondeductible
IRAs, and Roth IRAs, each subject to different sets
of rules. For example, contributions to traditional IRAs
are deductible, while distributions are taxed; contributions
to Roth IRAs are taxed, but distributions are excluded
from income. In addition, eligibility to contribute
282 ANALYTICAL PERSPECTIVES
is subject to various age and income limits. While primarily
intended for retirement saving, withdrawals for
certain education, medical, and other non-retirement
expenses are penalty free. The eligibility and withdrawal
restrictions for these accounts complicate compliance
and limit incentives to save.
The Administration proposes to replace current law
IRAs with two new savings accounts: a Lifetime Savings
Account (LSA) and a Retirement Savings Account
(RSA). Regardless of age or income, individuals could
make annual nondeductible contributions of $5,000 to
an LSA and $5,000 (or earnings if less) to an RSA.
Distributions from an LSA would be excluded from income
and could be made at anytime for any purpose
without restriction. Distributions from an RSA would
be excluded from income after attaining age 58 or in
the event of death or disability. All other distributions
would be included in income (to the extent they exceed
basis) and subject to an additional tax. Distributions
would be deemed to come from basis first. The proposal
would be effective for contributions made after December
31, 2005 and future year contribution limits would
be indexed for inflation.
Existing Roth IRAs would be renamed RSAs and
would be subject to the new rules for RSAs. Existing
traditional and nondeductible IRAs could be converted
into an RSA by including the conversion amount (excluding
basis) in gross income, similar to a currentlaw
Roth conversion. However, no income limit would
apply to the ability to convert. Taxpayers who convert
IRAs to RSAs could spread the included conversion
amount over several years. Existing traditional or nondeductible
IRAs that are not converted to RSAs could
not accept new contributions. New traditional IRAs
could be created to accommodate rollovers from employer
plans, but they could not accept new individual
contributions. Individuals wishing to roll an amount
directly from an employer plan to an RSA could do
so by including the rollover amount (excluding basis)
in gross income (i.e., ‘‘converting’’ the rollover, similar
to a current law Roth conversion).
Saving will be further simplified and encouraged by
administrative changes already planned for the 2007
filing season that will allow taxpayers to have their
tax refunds directly deposited into more than one account.
Consequently, taxpayers will be able, for example,
to direct that a portion of their tax refunds be
deposited into an LSA or RSA.
Consolidate employer-based savings accounts.—
Current law provides multiple types of tax-preferred
employer-based savings accounts to encourage saving
for retirement. The accounts have similar goals but are
subject to different sets of rules regulating eligibility,
contribution limits, tax treatment, and withdrawal restrictions.
For example, 401(k) plans for private employers,
SIMPLE 401(k) plans for small employers, 403(b)
plans for 501(c)(3) organizations and public schools, and
457 plans for State and local governments are all subject
to different rules. To qualify for tax benefits, plans
must satisfy multiple requirements. Among the requirements,
the plan generally may not discriminate in favor
of highly compensated employees with regard either
to coverage or to amount or availability of contributions
or benefits. Rules covering employer-based savings accounts
are among the lengthiest and most complicated
sections of the tax code and associated regulations. This
complexity imposes substantial costs on employers, participants,
and the government, and likely has inhibited
the adoption of retirement plans by employers, especially
small employers.
The Administration proposes to consolidate 401(k),
SIMPLE 401(k), 403(b), and 457 plans, as well as SIMPLE
IRAs and SARSEPs, into a single type of plan—
Employee Retirement Savings Accounts (ERSAs)—that
would be available to all employers. ERSA non-discrimination
rules would be simpler and include a new ERSA
non-discrimination safe-harbor. Under one of the safeharbor
options, a plan would satisfy the nondiscrimination
rules with respect to employee deferrals and employee
contributions if it provided a 50-percent match
on elective contributions up to six percent of compensation.
By creating a simplified and uniform set of rules,
the proposal would substantially reduce complexity. The
proposal would be effective for taxable years beginning
after December 31, 2005.
Establish Individual Development Accounts
(IDAs).—The Administration proposes to allow eligible
individuals to make contributions to a new savings vehicle,
the Individual Development Account, which would
be set up and administered by qualified financial institutions,
nonprofit organizations, or Indian tribes (qualified
entities). Citizens or legal residents of the United
States between the ages of 18 and 60 who cannot be
claimed as a dependent on another taxpayer’s return,
are not students, and who meet certain income limitations
would be eligible to establish and contribute to
an IDA. A single taxpayer would be eligible to establish
and contribute to an IDA if his or her modified AGI
in the preceding taxable year did not exceed $20,000
($30,000 for heads of household, and $40,000 for married
taxpayers filing a joint return). These thresholds
would be indexed annually for inflation beginning in
2008. Qualified entities that set up and administer
IDAs would be required to match, dollar-for-dollar, the
first $500 contributed by an eligible individual to an
IDA in a taxable year. Qualified entities would be allowed
a 100 percent tax credit for up to $500 in annual
matching contributions to each IDA, and a $50 tax
credit for each IDA maintained at the end of a taxable
year with a balance of not less that $100 (excluding
the taxable year in which the account was established).
Matching contributions and the earnings on those contributions
would be deposited in a separate ‘‘parallel
account.’’ Contributions to an IDA by an eligible individual
would not be deductible, and earnings on those
contributions would be included in income. Matching
contributions by qualified entities and the earnings on
those contributions would be tax-free.
Withdrawals from the parallel account may be made
only for qualified purposes (higher education, the first283
17. FEDERAL RECEIPTS
time purchase of a home, business start-up, and qualified
rollovers). Withdrawals from the IDA for other
than qualified purposes may result in the forfeiture
of some or all matching contributions and the earnings
on those contributions. The proposal would be effective
for contributions made after December 31, 2006 and
before January 1, 2014, to the first 900,000 IDA accounts
opened before January 1, 2012.
Invest in Health Care
Provide a refundable tax credit for the purchase
of health insurance.—Current law provides a tax
preference for employer-provided group health insurance
plans, but not for individually purchased health
insurance coverage except to the extent that deductible
medical expenses exceed 7.5 percent of adjusted gross
income (AGI), the individual has self-employment income,
or the individual is eligible under the Trade Act
of 2002 to purchase certain types of qualified health
insurance. In addition, individuals are allowed to accumulate
funds in a health savings account (HSA) or
medical savings account (MSA) on a tax-preferred basis
to pay for medical expenses, provided they are covered
by an HSA high-deductible health plan (and no other
health plan). The Administration proposes to make
health insurance more affordable for individuals not
covered by an employer plan or a public program. Effective
for taxable years beginning after December 31,
2005, a new refundable tax credit would be provided
for the cost of health insurance purchased by individuals
under age 65. The credit would provide a subsidy
for a percentage of the health insurance premium, up
to a maximum includable premium. The maximum subsidy
percentage would be 90 percent for low-income
taxpayers and would phase down with income. The
maximum credit would be $1,000 for an adult and $500
for a child. The credit would be phased out at $30,000
for single taxpayers and $60,000 for families purchasing
a family policy.
If the health insurance qualifies as an HSA highdeductible
health plan, an individual may opt to contribute
30 percent of the credit to a special HSA that
could only be used to pay for medical expenses. Individuals
could claim the tax credit for health insurance
premiums paid as part of the normal tax-filing process.
Alternatively, beginning July 1, 2007, the tax credit
would be available in advance at the time the individual
purchases health insurance. The advance credit
would reduce the premium paid by the individual to
the health insurer, and the health insurer would be
reimbursed directly by the Department of Treasury for
the amount of the advance credit. Eligibility for an
advance credit would be based on an individual’s prior
year tax return. To qualify for the credit, a health insurance
policy would have to include coverage for catastrophic
medical expenses. Qualifying insurance could
be purchased in the individual market. Qualifying
health insurance could also be purchased through private
purchasing groups, State-sponsored insurance purchasing
pools, and high-risk pools. Such groups may
make purchasing health insurance easier and help reduce
health insurance costs and increase coverage options
for individuals, including older and higher-risk
individuals.
Provide an above-the-line deduction for high-deductible
insurance premiums.—Current law provides
a tax preference for employer-provided group health insurance
plans, but not for individually purchased health
insurance coverage except to the extent that deductible
medical expenses exceed 7.5 percent of AGI, the individual
has self-employment income, or the individual
is eligible under the Trade Act of 2002 to purchase
certain types of qualified health insurance. Current law
also allows individuals to accumulate funds in an HSA
or MSA on a tax-preferred basis to pay for medical
expenses, provided they are covered by a high-deductible
health plan (and no other health plan). The Administration
proposes to allow individuals who contribute
to an HSA because they are covered under an HSA
high-deductible health plan in the individual insurance
market to deduct the amount of the premium in determining
AGI (whether or not the person itemizes deductions).
Individuals claiming other credits or deductions
or covered by employer plans, public plans or otherwise
not eligible to contribute to an HSA would not qualify.
The provision would be effective to taxable years beginning
after December 31, 2005.
Provide a refundable tax credit for contributions
of small employers to employee HSAs.—Under current
law, employers are provided a deduction for the
cost of health coverage provided to employees and the
value of that coverage is not subject to tax for the
employees. Nevertheless, many American workers in
small firms are currently without health coverage. In
order to provide an incentive to small employers to
sponsor group health coverage, especially high-deductible
health coverage that encourages cost consciousness,
the Administration proposes to provide a refundable
tax credit for employer contributions to employee HSA
accounts of up to $200 for single coverage and up to
$500 for family coverage. The subsidy would be provided
to for-profit employers that normally employ
fewer than 100 employees. The employer would be required
to maintain a high-deductible health plan (as
defined for purposes of the HSA) accessible to all employees,
but the employer would not be required to
make contributions toward employees’ premiums under
the plan. The employer would not be entitled to a deduction
for the amount reimbursed by the credit and
the credit could not be carried back or carried forward.
The amount of the employer contribution to the HSA
for which a credit is claimed would be maintained in
a special HSA that would be subject to the rules currently
applicable to HSAs, except that withdrawals in
excess of qualified medical expenses would subject the
HSA owner to a tax equal to 100 percent of the amount
of the withdrawal. Sole proprietors, partners and Scorporation
shareholders would be eligible for the credit
to the extent their business is a small employer or
284 ANALYTICAL PERSPECTIVES
has no employees. However, self-employed individuals
would not be entitled to any deductions for the amount
reimbursed by the credit. The HSA tax credit would
be effective for taxable years beginning after December
31, 2005.
Improve the Health Coverage Tax Credit.—The
Health Coverage Tax Credit (HCTC) was created under
the Trade Act of 2002 for the purchase of qualified
health insurance. Eligible persons include certain individuals
who are receiving benefits under the TAA or
the Alternative TAA (ATAA) program and certain individuals
between the ages of 55 and 64 who are receiving
pension benefits from the Pension Benefit Guaranty
Corporation (PBGC). The tax credit is refundable and
can be claimed through an advance payment mechanism
at the time the insurance is purchased. To make
the requirements for qualified State-based coverage
under the HCTC more consistent with the rules applicable
under the Health Insurance Portability and Accountability
Act (HIPAA) and thus encourage more
plans to participate in the HCTC program, the Administration
proposes to allow State-based coverage to impose
a pre-existing condition restriction for a period
of up to 12 months, provided the plan reduces the restriction
period by the length of the eligible individual’s
creditable coverage (as of the date the individual applied
for the State-based coverage). This provision
would be effective for eligible individuals applying for
coverage after December 31, 2005. Also, in order to
prevent an individual from losing the benefit of the
HCTC just because his or her spouse becomes eligible
for Medicare, the Administration proposes to permit
spouses of HCTC-eligible individuals to claim the HCTC
when the HCTC-eligible individual becomes entitled to
Medicare coverage. The spouse, however, would have
to be at least 55 years old and meet the other HCTC
eligibility requirements. This provision would be effective
for taxable years beginning after December 31,
2005. Finally, to improve the administration of the
HCTC, the Administration proposes to: (1) modify the
definition of ‘‘other specified coverage’’ for ‘‘eligible
ATAA recipients,’’ to be the same as the definition applied
to ‘‘eligible TAA recipients;’’ (2) clarify that certain
PBGC pension recipients are eligible for the tax credit;
(3) allow State-based continuation coverage to qualify
without meeting the requirements for State-based
qualified coverage; (4) for purposes of the State-based
coverage rules, permit the Commonwealths of Puerto
Rico and Northern Mariana Islands, as well as American
Samoa, Guam, and the U.S. Virgin Islands to be
deemed as States; and (5) clarify the application of
the confidentiality and disclosure rules to the administration
of the advance credit.
Allow the orphan drug tax credit for certain predesignation
expenses.—Current law provides a 50-
percent credit for expenses related to human clinical
testing of drugs for the treatment of certain rare diseases
and conditions (‘‘orphan drugs’’). A taxpayer may
claim the credit only for expenses incurred after the
Food and Drug Administration (FDA) designates a drug
as a potential treatment for a rare disease or condition.
This creates an incentive to defer clinical testing for
orphan drugs until the taxpayer receives the FDA’s
approval and increases complexity for taxpayers by
treating pre-designation and post-designation clinical
expenses differently. The Administration proposes to
allow taxpayers to claim the orphan drug credit for
expenses incurred prior to FDA designation if designation
occurs before the due date (including extensions)
for filing the tax return for the year in which the FDA
application was filed. The proposal would be effective
for qualified expenses incurred after December 31,
2004.
Provide Incentives for Charitable Giving
Permit tax-free withdrawals from IRAs for charitable
contributions.—Under current law, eligible individuals
may make deductible or non-deductible contributions
to a traditional IRA. Pre-tax contributions
and earnings in a traditional IRA are included in income
when withdrawn. Effective for distributions after
date of enactment, the Administration proposes to allow
individuals who have attained age 65 to exclude from
gross income IRA distributions made directly to a charitable
organization. The exclusion would apply without
regard to the percentage-of-AGI limitations that apply
to deductible charitable contributions. The exclusion
would apply only to the extent the individual receives
no return benefit in exchange for the transfer, and no
charitable deduction would be allowed with respect to
any amount that is excludable from income under this
provision.
Expand and increase the enhanced charitable
deduction for contributions of food inventory.—A
taxpayer’s deduction for charitable contributions of inventory
generally is limited to the taxpayer’s basis
(typically cost) in the inventory. However, for certain
contributions of inventory, C corporations may claim
an enhanced deduction equal to the lesser of: (1) basis
plus one half of the fair market value in excess of
basis, or (2) two times basis. To be eligible for the
enhanced deduction, the contributed property generally
must be inventory of the taxpayer contributed to a
charitable organization and the donee must (1) use the
property consistent with the donee’s exempt purpose
solely for the care of the ill, the needy, or infants,
(2) not transfer the property in exchange for money,
other property, or services, and (3) provide the taxpayer
a written statement that the donee’s use of the property
will be consistent with such requirements. To use the
enhanced deduction, the taxpayer must establish that
the fair market value of the donated item exceeds basis.
Under the Administration’s proposal, which is designed
to encourage contributions of food inventory to
charitable organizations, any taxpayer engaged in a
trade or business would be eligible to claim an enhanced
deduction for donations of food inventory. The
enhanced deduction for donations of food inventory
285 17. FEDERAL RECEIPTS
would be increased to the lesser of: (1) fair market
value or (2) two times basis. However, to ensure consistent
treatment of all businesses claiming an enhanced
deduction for donations of food inventory, the
enhanced deduction for qualified food donations by S
corporations and non-corporate taxpayers would be limited
to 10 percent of net income from the trade or
business. A special provision would allow taxpayers
with a zero or low basis in the qualified food donation
(e.g., taxpayers that use the cash method of accounting
for purchases and sales, and taxpayers that are not
required to capitalize indirect costs) to assume a basis
equal to 25 percent of fair market value. The enhanced
deduction would be available only for donations of ‘‘apparently
wholesome food’’ (food intended for human consumption
that meets all quality and labeling standards
imposed by Federal, state, and local laws and regulations,
even though the food may not be readily marketable
due to appearance, age, freshness, grade, size, surplus,
or other conditions). The fair market value of ‘‘apparently
wholesome food’’ that cannot or will not be
sold solely due to internal standards of the taxpayer
or lack of market, would be determined by taking into
account the price at which the same or substantially
the same food items (as to both type and quality) are
sold by the taxpayer at the time of the contribution
or, if not sold at such time, in the recent past. These
proposed changes in the enhanced
