IRS Restructuring and Reform Act of
1998
Conference Report page6
 
Explanation
of Provision
Acquisition
of a 50-percent or greater interest
The bill clarifies that the acquisitions described
in Code section 355(e)(3)(A) are disregarded in
determining whether there has been an acquisition of
a 50-percent or greater interest in a corporation.
However, other transactions that are part of a plan
or series of related transactions could result in an
acquisition of a 50-percent or greater interest.
In the case of acquisitions under section 355(e)(3)(A)(iv),
the provision clarifies that the acquisition of
stock in the distributing corporation or any
controlled corporation is disregarded to the extent
that the percentage of stock owned directly or
indirectly in such corporation by each person owning
stock in such corporation immediately before the
acquisition does not decrease.
Example : Shareholder A owns 10 percent of
the vote and value of the stock of corporation D
(which owns all of corporation C). There are nine
other equal shareholders of D. A also owns 100
percent of the vote and value of the stock of
unrelated corporation P. D distributes C to all the
shareholders of D. Thereafter, pursuant to a plan or
series of related transactions, D (worth 100x)
merges with corporation P (worth 900x). After the
merger, each of the former shareholders of
corporation D owns stock of the merged entity
reflecting the vote and value attributable to that
shareholder's respective 10 percent former stock
ownership of D. Each of the former shareholders of D
owns 1 percent of the stock of the merged
corporation, except that shareholder A (who owned
100 percent of corporation P and 10 percent of
corporation D before the merger) now owns 91 percent
of the stock of the merged corporation. In
determining whether a 50-percent or greater interest
in D has been acquired, the interest of each of the
continuing shareholders is disregarded only to the
extent there has been no decrease in such
shareholder's direct or indirect ownership. Thus,
the 10 percent interest of A, and the 1 percent
interest of each of the nine other former
shareholder of D, is not counted. The remaining 81
percent ownership of the merged corporation,
representing a decrease of nine percent in the
interests of each of the nine former shareholders
other than A, is counted in determining the extent
of an acquisition. Therefore, a 50-percent or
greater interest in D has been acquired.
Treasury
regulatory authority
The bill also clarifies that the regulatory
authority of the Treasury Department under section
358(c) applies to distributions after April 16,
1997, without regard to whether a distribution
involves a plan (or series of related transactions)
which involves an acquisition. As stated in the
Conference Report to the 1997 Act, with respect to
the Treasury Department regulatory authority under
section 358(c) as applied to intragroup spin-off
transactions that are not part of a plan or series
of related transactions that involve an acquisition
of a 50-percent or greater interest under new
section 355(f), it is expected that any Treasury
regulations will be applied prospectively, except in
cases to prevent abuse.
Section
351(c) and section 368(a)(2)(H) "control
immediately after" requirement
In general, the 1997 Act modifications to the
control immediately after requirement of Section
351(c) and section 368(a)(2)(H) were intended to
minimize certain differences in the results of a
transaction involving a contribution of assets to
controlled corporation prior to a section 355
spin-off that could occur depending on whether the
distributing or controlled corporation were acquired
subsequent to the spin-off.
The bill clarifies that in the case of certain
divisive transactions in which a corporation
contributes assets to a controlled corporation and
then distributes the stock of the controlled
corporation in a transaction that meets the
requirements of section 355 (or so much of section
356 as relates to section 355), solely for purposes
of determining the tax treatment of the transfers of
property to the controlled corporation by the
distributing corporation, the fact that the
shareholders of the distributing corporation dispose
of part or all of the distributed stock shall not be
taken into account for purposes of the control
immediately after requirement of section 351(a) or
368(a)(1)(D). For purposes of determining the tax
treatment of transfers of property to the controlled
corporation by parties other than the distributing
corporation, the disposition of part or all of the
distributed stock continues to be taken into
account, as under prior law, in determining whether
the control immediately after requirement is
satisfied.
Example 1 : Distributing corporation D
transfers appreciated business X to subsidiary C in
exchange for 100 percent of C stock. D distributes
its stock of C to D shareholders. As part of a plan
or series of related transactions, C merges into
unrelated acquiring corporation A, and the C
shareholders receive 25 percent of the vote or value
of A stock. If the requirements of section 355 are
met with respect to the distribution, then the
control immediately after requirement will be
satisfied solely for purposes of determining the tax
treatment of the transfers of property by D to C.
Accordingly, the business X assets transferred to C
and held by A after the merger will have a carryover
basis from D. Section 355(e) will require D to
recognize gain as if the C stock had been sold at
fair market value.
Example 2 : Distributing corporation D
transfers appreciated business X to subsidiary C in
exchange for 85 percent of C stock. Unrelated
persons transfer appreciated assets to C in exchange
for the remaining 15 percent of C stock. D
distributes all its stock of C to D shareholders. As
part of a plan or series of related transactions, C
merges into acquiring corporation A; and the
interests attributable to the D shareholders'
receipt of C stock with respect to their D stock in
the distribution represent 25 percent of the vote
and value of A stock. If the requirements of section
355 are met with respect to the distribution, then
the control immediately after requirement will be
satisfied solely for purposes of determining the tax
treatment of the transfers of property by D to C.
Section 355(e) will require recognition of gain as
if the C stock had been sold for fair market value.
The business X assets transferred to C and held by A
after the merger will have a carryover basis from D.
The persons other than D who transferred assets to C
for 15 percent of C stock will recognize gain on the
appreciation in their assets transferred to C if the
control immediately after requirement is not
satisfied after taking into account any
post-spin-off dispositions that would have been
taken into account under prior law.
Example 3 : The facts are the same as in
example 2, except that the interests attributable to
the D shareholders' receipt of C stock with respect
to their D stock in the distribution represent 55
percent of the vote and value of A stock in the
merger. If the requirements of section 355 are met
with respect to the distribution, then the control
immediately after requirement will be satisfied
solely for purposes of determining the tax treatment
of the transfers by D to C. The business X assets in
C (and in A after the merger) will therefore have a
carryover basis from D. Because the D shareholders
retain more than 50 percent of the stock of A,
section 355(e) will not apply. The persons other
than D who transferred property for the 15 percent
of C stock will recognize gain on the appreciation
in their assets transferred to C if the control
immediately after requirement is not satisfied after
taking into account any post-spin-off dispositions
that would have been taken into account under prior
law.
Effective
Date
The provision generally is effective for
distributions after April 16, 1997.
7.
Certain preferred stock treated as "boot"
--statute of limitations (sec. 6010(e)(2) of the
bill, sec. 1014 of the 1997 Act, and sec. 354(a) of
the Code)
Present
law
Under the 1997 Act, certain preferred stock received
in otherwise tax-free transactions is treated as
"other property." Exchanges of stock in
certain recapitalizations of family-owned
corporations are excepted from this rule. A
family-owned corporation is defined as any
corporation if at least 50 percent of the total
voting power and value of the stock of such
corporation is owned by the same family for five
years preceding the recapitalization. In addition, a
recapitalization does not qualify for the exception
if the same family does not own 50 percent of the
total voting power and value of the stock throughout
the three-year period following the
recapitalization.
Explanation
of Provision
The bill provides that the statutory period for the
assessment of any deficiency attributable to a
corporation failing to be a family-owned corporation
shall not expire before the expiration of three
years after the date the Secretary of the Treasury
is notified by the corporation (in such manner as
the Secretary may prescribe) of such failure, and
such deficiency may be assessed before the
expiration of such three-year period notwithstanding
the provisions of any other law or rule of law which
would otherwise prevent such assessment.
Effective
Date
The provision applies to transactions after June 8,
1997.
8.
Certain preferred stock treated as "boot"
--treatment of transferor (sec. 6010(e)(1) of the
bill, sec. 1014 of the 1997 Act, and sec. 351(g) of
the Code)
Present
Law
The 1997 Act amended section 351 of the Code to
provide that in the case of a person who transfers
property to a controlled corporation and receives
nonqualified preferred stock, section 351(b) will
apply to such person. Section 351(b) provides that
if section 351(a) of the Code would apply to an
exchange but for the fact that there is received, in
addition to stock permitted to be received under
section 351(a), other property or money, then gain
but no loss to such recipient shall be recognized.
The Conference Report to the 1997 Act states that if
nonqualified preferred stock is received, gain but
not loss shall be recognized.
Explanation
of Provision
The bill clarifies that section 351(b) applies to a
transferor who transfers property in a section 351
exchange and receives nonqualified preferred stock
in addition to stock that is not treated as
"other property" under that section. Thus,
if a transferor received only nonqualified preferred
stock but the transaction in the aggregate otherwise
qualified as a section 351 exchange, such a
transferor would recognize loss and the basis of the
nonqualified preferred stock and of the property in
the hands of the transferee corporation would
reflect the transaction in the same manner as if
that particular transferor had received solely
"other property" of any other type. As
under the 1997 Act, the nonqualified preferred stock
continues to be treated as stock received by a
transferor for purposes of qualification of a
transaction under section 351(a), unless and until
regulations may provide otherwise.
Effective
Date
The provision applies to transactions after June 8,
1997.
9.
Application of section 304 to certain international
transactions (sec. 6010(d) of the bill, sec. 1013 of
the 1997 Act, and sec. 304 of the Code)
Present
Law
Under section 304, if one corporation purchases
stock of a related corporation, the transaction
generally is recharacterized as a redemption. Under
section 304(a), as amended by the 1997 Act, to the
extent that a section 304 transaction is treated as
a distribution under section 301, the transferor and
the acquiring corporation are treated as if (1) the
transferor had transferred the stock involved in the
transaction to the acquiring corporation in exchange
for stock of the acquiring corporation in a
transaction to which section 351(a) applies, and (2)
the acquiring corporation had then redeemed the
stock it is treated as having issued. In the case of
a section 304 transaction, both the amount which is
a dividend and the source of such dividend is
determined as if the property were distributed by
the acquiring corporation to the extent of its
earnings and profits and then by the issuing
corporation to the extent of its earnings and
profits (sec. 304(b)(2)). Section 304(b)(5), as
added by the 1997 Act, provides special rules that
apply if the acquiring corporation in a section 304
transaction is a foreign corporation. Under section
304(b)(5), the earnings and profits of the acquiring
corporation that are taken into account are limited
to the portion of such earnings and profits that (1)
is attributable to stock of such acquiring
corporation held by a corporation or individual who
is the transferor (or a person related thereto) and
who is a U.S. shareholder (within the meaning of
section 951(b)) of such corporation and (2) was
accumulated during periods in which such stock was
owned by such person while such acquiring
corporation was a controlled foreign corporation.
For purposes of this rule, except as otherwise
provided by the Secretary of the Treasury, the rules
of section 1248(d) (relating to certain exclusions
from earnings and profits) apply. The Secretary is
to prescribe regulations as appropriate, including
regulations determining the earnings and profits
that are attributable to particular stock of the
acquiring corporation.
For foreign tax credit purposes, under section 902,
a
U.S.
corporation that receives a dividend from a foreign
corporation in which it owns at least 10 percent of
the voting stock is treated as if it had paid the
foreign income taxes paid by the foreign corporation
which are attributable to such dividend. The
Internal Revenue Service issued rulings providing
that a domestic corporation that is a transferor in
a section 304 transaction may compute foreign taxes
deemed paid under section 902 on the dividends from
both a foreign acquiring corporation and a foreign
issuing corporation. Rev. Rul. 92-86, 1992-2 C.B.
199; Rev. Rul. 91-5, 1991-1 C.B. 114. Both rulings
involve section 304 transactions in which both the
domestic transferor and the foreign acquiring
corporation are wholly owned by a domestic parent
corporation.
Explanation
of Provision
Under the provision, in the case of a section 304
transaction in which the acquiring corporation or
the issuing corporation is a foreign corporation,
the Secretary of the Treasury is to prescribe
regulations providing rules to prevent the multiple
inclusion of an item of income and to provide
appropriate basis adjustments, including rules
modifying the application of sections 959 and 961 in
the case of a section 304 transaction. It is
expected that such regulations will provide for an
exclusion from income for distributions from
earnings and profits of the acquiring corporation
and the issuing corporation that represent
previously taxed income under subpart F. It further
is expected that such regulations will provide for
appropriate adjustments to the basis of stock held
by the corporation treated as receiving the
distribution or by the corporation that had the
prior inclusion with respect to the previously taxed
income. No inference is intended regarding the
treatment of previously taxed income in a section
304 transaction under present law. The 1997 Act
amendments to section 304, including the
modifications under this provision, are not intended
to change the foreign tax credit results reached in
Rev. Rul. 92-86 and 91-5.
The provision also eliminates the cross-reference to
the rules of section 1248(d) for purposes of
determining the earnings and profits to be taken
into account under section 304(b)(5).
Effective
Date
The provision generally is effective for
distributions or acquisitions after June 8, 1997.
10.
Establish IRS continuous levy and improve debt
collection (sec. 6010(f) of the bill, secs. 1024,
1025, and 1026 of the 1997 Act, and secs. 6331 and
6334 of the Code)
Present
Law
If any person is liable for any internal revenue tax
and does not pay it within 10 days after notice and
demand by the IRS, the IRS may then collect the tax
by levy upon all property and rights to property
belonging to the person, unless there is an explicit
statutory restriction on doing so. A levy is the
seizure of the person's property or rights to
property. A levy on salary and wages is continuous
from the date it is first made until the date it is
fully paid or becomes unenforceable.
The 1997 Act provides that a continuous levy is also
applicable to non-means tested recurring Federal
payments and specified wage replacement payments.
Explanation
of Provision
The provision clarifies that the IRS must approve
the use of a continuous levy before it may take
effect.
Effective
Date
The provision is effective for levies issued after
the date of enactment of the 1997 Act (August 5,
1997).
11.
Clarification regarding aviation gasoline excise tax
(sec. 6010(g) of the bill, sec. 1031 of the 1997
Act, and sec. 6421 of the Code)
Present
Law
Before enactment of the 1997 Act, aviation gasoline
was subject to a 19.3-cents-per-gallon tax rate,
with 15 cents per gallon being deposited in the
Airport and Airway Trust Fund and 4.3 cents per
gallon being retained in the General Fund. The 1997
Act extended the 15-cents-per-gallon rate for 10
years, through September 30, 2007, and expanded
deposits to the Trust Fund to include revenues from
the 4.3-cents-per-gallon rate. The tax does not
apply to fuel used in flight segments outside the
United States
or to flight segments from the
United States
to foreign countries.
Explanation
of Provision
The bill clarifies the application of the gasoline
tax refund provisions to aviation gasoline used in
flight segments outside the
United States
and to flight segments from the
United States
to foreign countries.
Effective
Date
The provision is effective as if included in the
1997 Act.
12.
Clarification of requirement that registered fuel
terminals offer dyed fuel (sec. 6010(h) of the bill,
sec. 1032 of the 1997 Act and sec. 4101 of the Code)
75
Present
Law
The 1997 Act provides that fuel terminals are
eligible to register to handle non-tax-paid diesel
fuel and kerosene only if the terminal operator
offers both undyed (taxable) and dyed (nontaxable)
fuel.
Explanation
of Provision
The bill clarifies that the Code requires terminals
eligible to handle non-tax-paid diesel to offer dyed
diesel fuel and terminals eligible to handle
non-tax-paid kerosene (including diesel fuel #1 and
kerosene-type aviation fuel) to offer dyed kerosene.
The bill does not require that a terminal offer for
sale kerosene as a condition of receiving diesel
fuel on a non-tax-paid basis. Similarly, the
proposal does not require terminals that sell only
kerosene to offer diesel fuel as a condition of
receiving non-tax-paid kerosene.
Effective
Date
The provision is effective as if included in the
1997 Act.
13.
Clarification of treatment of prepaid telephone
cards (sec. 6010(i) of the bill, sec. 1034 of the
1997 Act, and sec. 4251 of the Code)
Present
Law
A 3-percent excise tax is imposed on amounts paid
for local and toll (long-distance) telephone service
and teletypewriter exchange service. The tax is
collected by the provider of the service from the
consumer. In the case of so-called "prepaid
telephone cards", the tax is treated as paid
when the card is transferred by any
telecommunications carrier to any person who is not
a telecommunications carrier.
A "prepaid telephone card" is defined as
any card or other similar arrangement which permits
its holder to obtain communications services and pay
for such services in advance.
Explanation
of Provision
The bill inserts the word "any" prior to
"other similar arrangement" to clarify
that payment to a telecommunications carrier from a
third party such as a joint venture credit card
company is treated as payment made by the holder of
the credit card to obtain communication services and
the tax is treated as paid in a manner similar to
that applied to prepaid telephone cards. The tax
applies to payments if the rights to telephone
service for which payments are made can be used in
whole or in part for telephone service that, if
purchased directly, would be subject to the
3-percent excise tax on telephone service. Also, the
tax applies without regard to whether telephone
service ultimately is provided pursuant to the
transferred rights.
Effective
Date
The provision is effective as if included in the
1997 Act.
14.
Modify UBIT rules applicable to second-tier
subsidiaries (sec. 6010(j) of the bill, sec. 1041 of
the 1997 Act, and sec. 512(b)(13) of the Code)
Present
Law
In general, interest, rents, royalties and annuities
are excluded from the unrelated business income
("UBI") of tax-exempt organizations.
However, section 512(b)(13) treats otherwise
excluded rent, royalty, annuity, and interest income
as UBI if such income is received from a taxable or
tax-exempt subsidiary that is controlled by the
parent tax-exempt organization.
Under the provision, interest, rent, annuity, or
royalty payments made by a controlled entity to a
tax-exempt organization are subject to the unrelated
business income tax to the extent the payment
reduces the net unrelated income (or increases any
net unrelated loss) of the controlled entity. In
this regard, section 512(b)(13)(B)(i)(I) cross
references a non-existent Code section.
The provision generally applies to taxable years
beginning after the date of enactment. However, the
provision does not apply to payments made during the
first two taxable years beginning on or after the
date of enactment if such payments are made pursuant
to a binding written contract in effect as of June
8, 1997, and at all times thereafter before such
payment.
Explanation
of Provision
The bill clarifies that rent, royalty, annuity, and
interest income that would otherwise be excluded
from UBI is included in UBI under section 512(b)(13)
if such income is received or accrued from a taxable
or tax-exempt subsidiary that is controlled by the
parent tax-exempt organization. The bill further
clarifies that the provision does not apply to any
payment received or accrued during the first two
taxable years beginning on or after the date of
enactment if such payment is received or accrued
pursuant to a binding written contract in effect on
June 8, 1997, and at all times thereafter before
such payment (but not pursuant to any contract
provision that permits optional accelerated
payments).
Effective
Date
The provision is effective as of August 5, 1997, the
date of enactment of the 1997 Act.
15.
Application of foreign tax credit holding period
rule to RICs (sec. 6010(k) of the bill, sec. 1053 of
the 1997 Act, and secs. 853 and 901 of the Code)
Present
Law
Section 901(k), as added by the 1997 Act, generally
imposes a holding period requirement for claiming
foreign tax credits with respect to dividends. Under
section 901(k), foreign tax credits with respect to
a dividend from a foreign corporation or a regulated
investment company (a "RIC") are
disallowed if the shareholder has not held the stock
for more than 15 days in the case of common stock or
more than 45 days in the case of preferred stock.
This disallowance applies both to foreign tax
credits for foreign withholding taxes that are paid
on the dividend where the dividend-paying stock is
not held for the required period and to indirect
foreign tax credits for taxes paid by a lower-tier
foreign corporation or a RIC where any of the stock
in the required chain of ownership is not held for
the required period. Foreign taxes for which credits
are disallowed under section 901(k) may be deducted.
Under section 853, a RIC may elect to flow through
to its shareholders the foreign tax credits for
foreign taxes paid by the RIC. Under this election,
the RIC is not entitled to a deduction or credit for
foreign taxes paid; the shareholders of an electing
RIC are treated as having paid their proportionate
shares of the foreign taxes paid by the RIC.
Accordingly, foreign tax credits are claimed at the
shareholder level and not at the RIC level.
Explanation
of Provision
Under the provision, the flow-through election of
section 853 does not apply to any foreign taxes paid
by the RIC for which a credit is disallowed under
section 901(k) because the RIC did not satisfy the
applicable holding period. Accordingly, such taxes
are deductible at the RIC level. The election of
section 853 applies only to foreign taxes with
respect to which the RIC has satisfied any
applicable holding period requirement.
Effective
Date
The provision is effective for dividends paid or
accrued more than 30 days after the date of
enactment of the 1997 Act.
16.
Clarification of provision expanding the limitations
on deductibility of premiums and interest with
respect to life insurance, endowment and annuity
contracts (sec. 6010(o) of the bill, sec. 1084 of
the 1997 Act, and sec. 264 of the Code)
Present
Law
Master
contracts
The 1997 Act provided limitations on the
deductibility of interest and premiums with respect
to life insurance, endowment and annuity contracts.
Under the pro rata interest disallowance provision
added by the Act, an exception is provided for any
policy or contract owned by an entity engaged in a
trade or business, covering an individual who is an
employee, officer or director of the trade or
business at the time first covered. The exception
applies to any policy or contract owned by an entity
engaged in a trade or business, which covers one
individual who (at the time first insured under the
policy or contract) is (1) a 20-percent owner of the
entity, or (2) an individual (who is not a
20-percent owner) who is an officer, director or
employee of the trade or business.76
The provision is silent as to the treatment of
coverage of such an individual under a master
contract.
Reporting
The provision does not apply to any policy or
contract held by a natural person; however, if a
trade or business is directly or indirectly the
beneficiary under any policy or contract, the policy
or contract is treated as held by the trade or
business and not by a natural person. In addition,
the provision includes a reporting requirement.
Specifically, the provision provides that the
Treasury Secretary shall require such reporting from
policyholders and issuers as is necessary to carry
out the rule applicable when the trade or business
is directly or indirectly the beneficiary under any
policy or contract held by a natural person. Any
report required under this reporting requirement is
treated as a statement referred to in Code section
6724(d)(1) (relating to information returns). The
provision does not specifically refer to Code
section 6724(d)(2) (relating to payee statements).
Additional
covered lives
The 1997 Act provision limiting the deductibility of
certain interest and premiums is effective generally
with respect to contracts issued after June 8, 1997.
To the extent of additional covered lives under a
contract after June 8, 1997, the contract is treated
as a new contract.
Explanation
of Provision
Master
contracts
The technical correction clarifies that if coverage
for each insured individual under a master contract
is treated as a separate contract for purposes of
sections 817(h), 7702, and 7702A of the Code, then
coverage for each such insured individual is treated
as a separate contract, for purposes of the
exception to the pro rata interest disallowance rule
for a policy or contract covering an individual who
is a 20-percent owner, employee, officer or director
of the trade or business at the time first covered.
A master contract does not include any contract if
the contract (or any insurance coverage provided
under the contract) is a group life insurance
contract within the meaning of Code section
848(e)(2). No inference is intended that coverage
provided under a master contract, for each such
insured individual, is not treated as a separate
contract for each such individual for other purposes
under present law.
Reporting
The technical correction clarifies that the required
reporting to the Treasury Secretary is an
information return (within meaning of sec.
6724(d)(1)), and any reporting required to be made
to any other person is a payee statement (within the
meaning of sec. 6724(d)(2)). Thus, the
$50-per-report penalty imposed under sections 6722
and 6723 of the Code for failure to file or provide
such an information return or payee statement apply.
It is clarified that the Treasury Secretary may
require reporting by the issuer or policyholder of
any relevant information either by regulations or by
any other appropriate guidance (including but not
limited to publication of a form).
Additional
covered lives
The technical correction clarifies that the
treatment of additional covered lives under the
effective date of the 1997 Act provision applies
only with respect to coverage provided under a
master contract, provided that coverage for each
insured individual is treated as a separate contract
for purposes of Code sections 817(h), 7702 and
7702A, and the master contract or any coverage
provided thereunder is not a group life insurance
contract within the meaning of Code section
848(e)(2).
Effective
Date
The provision s are effective as if included in the
1997 Act.
17.
Clarification of allocation of basis of properties
distributed to a partner by a partnership (sec.
6010(m) of the bill, sec. 1061 of the 1997 Act, and
sec. 732(c) of the Code)
Present
Law
Present law, as amended by the 1997 Act, provides
rules for allocating basis to property in the hands
of a partner that receives a distribution from a
partnership. Under these rules, basis is first
allocated to unrealized receivables and inventory
items in an amount equal to the partnership's
adjusted basis in each property. If the basis to be
allocated is less than the sum of the adjusted bases
of the properties in the hands of the partnership,
then, to the extent a decrease is required to make
the total adjusted bases of the properties equal the
basis to be allocated, the decrease is allocated (as
described below) for adjustments that are decreases.
To the extent of any basis not allocated to
inventory and unrealized receivables under the above
rules, basis is allocated to other distributed
properties, first to the extent of each distributed
property's adjusted basis to the partnership. Any
remaining basis adjustment, if an increase, is
allocated among properties with unrealized
appreciation in proportion to their respective
amounts of unrealized appreciation (to the extent of
each property's appreciation), and then in
proportion to their respective fair market values.
If the remaining basis adjustment is a decrease, it
is allocated among properties with unrealized
depreciation in proportion to their respective
amounts of unrealized depreciation (to the extent of
each property's depreciation), and then in
proportion to their respective adjusted bases
(taking into account the adjustments already made).
For purposes of these rules, "unrealized
receivables" has the meaning set forth in
section 751(c) (as provided in sec. 732(c)(1)(A)(i)).
Section 751(c) provides that the term
"unrealized receivables" includes certain
accrued but unreported income. In addition, the last
two sentences of section 751(c) provide that for
purposes of certain specified partnership provisions
(sections 731, 741 and 751), the term
"unrealized receivables" includes certain
property the sale of which will give rise to
ordinary income (for example, depreciation recapture
under sections 1245 or 1250), but only to the extent
of the amount that would be treated as ordinary
income on a sale of that property at fair market
value.
Explanation
of Provision
The technical correction clarifies that for purposes
of the allocation rules of section 732(c),
"unrealized receivables" has the meaning
in section 751(c) including the last two sentences
of section 751(c), relating to items of property
that give rise to ordinary income. Thus, in applying
the allocation rules of section 732(c) to property
listed in the last two sentences of section 751(c),
such as property giving rise to potential
depreciation recapture, the amount of unrealized
appreciation in any such property does not include
any amount that would be treated as ordinary income
if the property were sold at fair market value,
because such amount is treated as a separate asset
for purposes of the basis allocation rules.77
For example, assume that a partnership has 3
partners, A, C and D. The partnership has 6 assets.
Three are capital assets each with adjusted basis
equal to fair market value of $20,000. The other
three are depreciable equipment each with adjusted
basis of $5,000 and fair market value of $30,000.
Each of the pieces of equipment would have $25,000
of depreciation recapture if sold by the partnership
for its $30,000 value. A has a basis in its
partnership interest of $60,000. Assume that one of
the capital assets and one of the pieces of
equipment is distributed to A in liquidation of its
interest. A is treated as receiving three assets:
(1) depreciation recapture (an unrealized
receivable) with a basis to the partnership of zero
and a value of $25,000; (2) a piece of equipment
with a basis to the partnership of $5,000 and a
value of $5,000 (its $30,000 value reduced by the
$25,000 of depreciation recapture); and (3) a
capital asset with a basis to the partnership of
$20,000 and a value of $20,000.
Under the provision, as clarified by the technical
correction, A's $60,000 basis in its partnership
interest is allocated as follows. First, basis is
allocated to the depreciation recapture, an
unrealized receivable, in an amount equal to the
partnership's adjusted basis in it, or zero (sec.
732(c)(1)(A)(i)). Then basis is allocated to the
extent of each of the other distributed properties'
adjusted basis to the partnership, or $5,000 to the
equipment (not including the depreciation
recapture), and $20,000 to the capital asset. A's
remaining $35,000 of basis is allocated next among
properties (other than inventory and unrealized
receivables) with unrealized appreciation, in
proportion to their respective amounts of unrealized
appreciation (to the extent of each property's
appreciation), but neither of the distributed
properties to which basis may be allocated has
unrealized appreciation. Basis is then allocated
then in proportion to the properties' respective
fair market values ($5,000 for the equipment and
$20,000 for the capital asset). Thus, of the
remaining $35,000, $7,000 is allocated to the
equipment, so that its total basis in the partner's
hands is $12,000; and $28,000 is allocated to the
capital asset, so that its total basis in the
partner's hands is $48,000.
Effective
Date
The provision is effective as if enacted with the
1997 Act.
18.
Clarification to the definition of modified adjusted
gross income for purposes of the earned income
credit phaseout (sec. 6010(p) of the bill, sec.
1085(d) of the 1997 Act, and sec. 32(c) of the Code)
Present
Law
The earned income credit ("EIC") is phased
out above certain income levels. For individuals
with earned income (or modified adjusted gross
income ("modified AGI"), if greater) in
excess of the beginning of the phaseout range, the
maximum credit amount is reduced by the phaseout
rate multiplied by the amount of earned income (or
modified AGI, if greater) in excess of the beginning
of the phaseout range. For individuals with earned
income (or modified AGI, if greater) in excess of
the end of the phaseout range, no credit is allowed.
The definition of modified AGI used for the phase
out of the earned income credit is the sum of: (1)
AGI with certain losses disregarded, and (2) certain
nontaxable amounts not generally included in AGI.
The losses disregarded are: (1) net capital losses
(if greater than zero); (2) net losses from trusts
and estates; (3) net losses from nonbusiness rents
and royalties; (4) 75 percent of the net losses from
business, computed separately with respect to sole
proprietorships (other than in farming), sole
proprietorships in farming, and other businesses.78
The nontaxable amounts included in modified AGI
which are generally not included in AGI are: (1)
tax-exempt interest; and (2) nontaxable
distributions from pensions, annuities, and
individual retirement arrangements (but only if not
rolled over into similar vehicles during the
applicable rollover period).
Explanation
of Provision
The bill clarifies that the two nontaxable amounts
that are added to adjusted gross income to compute
modified AGI for purposes of the EIC phaseout are
additions to adjusted gross income and not
disregarded losses.
Effective
Date
The provision is effective for taxable years
beginning after December 31, 1997.
J.
Amendments to Title XI of the 1997 Act Relating to
Foreign Provisions 1. Application of attribution
rules under PFIC provisions (sec. 6011(b)(2) of the
bill, sec. 1121 of the 1997 Act, and sec. 1298 of
the Code)
Present
Law
Special attribution rules apply to the extent that
the effect is to treat stock of a passive foreign
investment company ("PFIC") as owned by a
U.S.
person. In general, if 50 percent or more in value
of the stock of a corporation is owned (directly or
indirectly) by or for any person, such person is
considered as owning a proportionate part of the
stock owned directly or indirectly by or for such
corporation, determined based on the person's
proportionate interest in the value of such
corporation's stock. However, this 50-percent
limitation does not apply in the case of a
corporation that is a PFIC. Accordingly, a person
that is a shareholder of a PFIC is considered as
owning a proportionate part of the stock owned
directly or indirectly by or for such PFIC, without
regard to whether such shareholder owns at least 50
percent of the PFIC's stock by value.
A corporation is not treated as a PFIC with respect
to a shareholder during the qualified portion of the
shareholder's holding period for the stock of such
corporation. The qualified portion of the
shareholder's holding period generally is the
portion of such period which is after the effective
date of the 1997 Act and during which the
shareholder is a
United States
shareholder (as defined in sec. 951(b)) and the
corporation is a controlled foreign corporation.
If a corporation is not treated as a PFIC with
respect to a shareholder for the qualified portion
of such shareholder's holding period, it is unclear
whether the attribution rules that apply with
respect to stock owned by or for such corporation
apply without regard to the requirement that the
shareholder own 50 percent or more of the
corporation's stock.
Explanation
of Provision
The provision clarifies that the attribution rules
apply without regard to the provision that treats a
corporation as a non-PFIC with respect to a
shareholder for the qualified portion of the
shareholder's holding period. Accordingly, stock
owned directly or indirectly by or for a corporation
that is not treated as a PFIC for the qualified
portion of the shareholder's holding period
nevertheless will be attributed to such shareholder,
regardless of the shareholder's ownership percentage
of such corporation.
Effective
Date
The provision is effective for taxable years of
U.S.
persons beginning after December 31, 1997 and
taxable years of foreign corporations ending with or
within such taxable years of
U.S.
persons.
2.
Treatment of PFIC option holders (sec. 6011(b)(1) of
the bill, sec. 1121 of the 1997 Act, and secs. 1297
and 1298 of the Code)
Present
Law | 
