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S. Rept. 110-206 - HEARTLAND, HABITAT, HARVEST, AND HORTICULTURE ACT OF 2007110th Congress (2007-2008)

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Committees:	Finance

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Calendar No. 446
110th Congress Report
SENATE
1st Session 110-206

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HEARTLAND, HABITAT, HARVEST, AND HORTICULTURE ACT OF 2007

_______

October 25, 2007.--Ordered to be printed

_______

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

R E P O R T

[To accompany S. 2242]

The Committee on Finance, having considered an original
bill (S. 2242) to amend the Trade Act of 1974 to establish
supplemental agricultural disaster assistance and to amend the
Internal Revenue Code of 1986 to provide tax incentives for
conservation and alternative energy sources and to provide tax
relief for farmers, and for other purposes, reports favorably
thereon and recommends that the bill do pass.

CONTENTS

Page
I. LEGISLATIVE BACKGROUND............................................3
II. EXPLANATION OF THE BILL...........................................3
TITLE I--SUPPLEMENTAL AGRICULTURAL DISASTER ASSISTANCE FROM THE
AGRICULTURE DISASTER RELIEF TRUST FUND............................3
A. Crop Disaster Assistance Program and Other Disaster
Assistance........................................... 3
TITLE II--CONSERVATION PROVISIONS.................................8
A. Provide Tax Credit for Eligible Farmland Enrolled in
the Conservation Reserve Program (sec. 201 of the
bill and sec. 30D of the Code)....................... 8
B. Exclusion of Conservation Reserve Program Payments
From SECA Tax for Individuals Receiving Social
Security Retirement or Disability Payments (sec. 202
of the bill and sec. 1402(a) of the Code)............ 9
C. Make Permanent the Special Rule Encouraging
Contributions of Capital Gain Real Property for
Conservation Purposes (sec. 203 of the bill and sec.
170 of the Code)..................................... 9
D. Provide Tax Credit for Recovery and Restoration of
Endangered Species (sec. 204 of the bill and new sec.
30D of the Code)..................................... 13
E. Deduction for Endangered Species Recovery Expenditures
(sec. 205 of the bill and sec. 175 of the Code)...... 17
F. Provide Exclusion for Certain Payments and Programs
Relating to Fish and Wildlife (sec. 206 of the bill
and sec. 126 of the Code)............................ 19
G. Provide Tax Credit for Easements Made Pursuant to
Certain U.S.D.A. Conservation Programs (sec. 207 of
the bill and sec. 30F of the Code)................... 21
H. Provide for Exempt Facility Bonds for Forest
Conservation Activities (sec. 208 of the bill and
sec. 142 of the Code)................................ 23
I. Deduction for Qualified Timber Gain and Timber REIT
Provisions (secs. 209-214 of the bill and new sec.
1203, and secs. 856, 857 and 4981 of the Code)....... 28
TITLE III--ENERGY PROVISIONS.....................................33
A. Credit for Residential and Business Wind Property
(sec. 301 of the bill and secs. 25D and 48 of the
Code)................................................ 33
B. Landowner Incentive to Encourage Electric Transmission
Build-Out (sec. 302 of the bill and new sec. 139B of
the Code)............................................ 36
C. Exception to Reduction of Renewable Electricity Credit
(sec. 303 of the bill and sec. 45 of the Code)....... 37
D. Expansion of Special Depreciation Allowance to
Cellulosic Biomass Alcohol Fuel Plant (sec. 311 of
the bill and sec. 168(l) of the Code)................ 43
E. Credit for Production of Cellulosic Biomass Alcohol
(sec. 312 of the bill and sec. 40 of the Code)....... 44
F. Extension of Small Ethanol Producer Credit (sec. 313
of the bill and sec. 40 of the Code)................. 46
G. Credit for Producers of Fossil-Free Alcohol (sec. 314
of the bill and sec. 40 of the Code)................. 47
H. Modification of Alcohol Credit (sec. 315 of the bill
and secs. 40, 6426 and 6427 of the Code)............. 48
I. Calculation of Volume of Alcohol for Fuels Credits
(sec. 316 of the bill, and sec. 40 of the Code)...... 50
J. Ethanol Tariff Extension (sec. 317 of the bill)....... 50
K. Elimination and Reductions of Duty Drawback on Certain
Imported Ethanol (sec. 318 of the bill).............. 51
L. Extension of Credits for Biodiesel (sec. 321 of the
bill and secs. 40A, 6426 and 6427 of the Code)....... 52
M. Extension and Modification of Renewable Diesel
Incentives (sec. 321 of the bill and sec. 40A(f),
6426 and 6427 of the Code)........................... 54
N. Treatment of Qualified Alcohol Mixtures and Qualified
Biodiesel Fuel Mixtures as Taxable Fuels (sec. 322 of
the bill and sec. 4083 of the Code).................. 55
O. Extension and Modification of the Alternative Fuel
Credits (sec. 331 of the bill and sec. 6426 and 6427
of the Code)......................................... 57
P. Extension of Alternative Fuel Vehicle Refueling
Property Credit (sec. 332 of the bill and sec. 30C of
the Code)............................................ 59
TITLE IV--AGRICULTURAL PROVISIONS................................60
A. Qualified Small Issue Bonds for Farming (sec. 401 of
the bill and sec. 147 of the Code)................... 60
B. Modification of Installment Sale Rules for Certain
Farm Property (sec. 402 of the bill and sec. 453 of
the Code)............................................ 61
C. Allowance of Section 1031 Treatment for Exchanges
Involving Certain Mutual Ditch, Reservoir, or
Irrigation Company Stock (sec. 403 of the bill and
sec. 1031 of the Code)............................... 62
D. Rural Renaissance Bonds (sec. 404 of the bill and new
sec. 54A of the Code)................................ 63
E. Agricultural Business Security Tax Credit (sec. 405 of
the bill and sec. 45 of the Code).................... 68
F. Credit for Drug Safety and Effectiveness Testing for
Minor Species (sec. 406 of the bill and new sec. 45P
of the Code)......................................... 69
G. Farm Equipment Treated as Five-Year Property (sec. 407
of the bill and sec. 168 of the Code)................ 71
H. Expensing of Broadband Internet Access Expenditures
(sec. 408 of the bill and new sec. 191 of the Code).. 72
I. Credit for Energy Efficient Electric Motors (sec. 409
of the bill and new sec. 45Q of the Code)............ 75
TITLE V--REVENUE RAISING PROVISIONS..............................75
A. Limitation on Farming Losses of Certain Taxpayers
(sec. 501 of the bill and sec. 461 of the Code)...... 75
B. Increase and Index Dollar Thresholds for Farm Optional
Method and Nonfarm Optional Method for Computing Net
Earnings from Self-Employment (sec. 502 of the bill
and sec. 1402(a) of the Code)........................ 76
C. Information Reporting for Commodity Credit Corporation
Transactions (sec. 503 of the bill and new sec. 6039J
of the Code)......................................... 79
D. Modification of Section 1031 Treatment for Certain
Real Estate (sec. 504 of the bill and sec. 1031 of
the Code)............................................ 80
E. Modification of Effective Date of Leasing Provisions
of the American Jobs Creation Act of 2004 (sec. 505
of the bill and sec. 470 of the Code)................ 81
F. Modifications to Corporate Estimated Tax Payments
(sec. 506 of the bill)............................... 82
G. Ineligibility of Collectibles for Nontaxable Like Kind
Exchange Treatment (sec. 507 of the bill and sec.
1031 of the Code).................................... 82
H. Denial of Deduction for Certain Fines, Penalties, and
Other Amounts (sec. 508 of the bill and sec. 162(f)
and new sec. 6050W of the Code)...................... 83
I. Increase in Information Return Penalties (sec. 509 of
the bill and secs. 6721, 6722, and 6723 of the Code). 87
J. Economic Substance Doctrine (secs. 511-513 of the bill
and sec. 7701, new sec. 6662B, and sec. 163 of the
Code)................................................ 88
1. Clarification of the economic substance doctrine.. 88
2. Penalty for understatements attributable to
transactions lacking economic substance, etc..... 95
3. Denial of deduction for interest on underpayments
attributable to noneconomic substance
transactions..................................... 101
III.BUDGET EFFECTS OF THE BILL......................................102

IV. VOTES OF THE COMMITTEE..........................................109
V. REGULATORY IMPACT AND OTHER MATTERS.............................109
VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED...........110

I. LEGISLATIVE BACKGROUND

The Finance Committee has exclusive jurisdiction over tax
matters and has previously held hearing and reported
legislation that included some of the provisions in this
legislation. The Committee anticipates that the Senate may
consider adding the substance of this bill to H.R. 2419, the
``Farm, Nutrition, and Bioenergy Act of 2007,'' or similar
legislation.

II. EXPLANATION OF THE BILL

TITLE I--SUPPLEMENTAL AGRICULTURAL DISASTER ASSISTANCE FROM THE
AGRICULTURE DISASTER RELIEF TRUST FUND\1\

---------------------------------------------------------------------------
\1\The description of this provision was supplied by the Majority
Staff of the Senate Finance Committee.
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A. Crop Disaster Assistance Program and Other Disaster Assistance

PRESENT LAW

The Farm Service Agency (``FSA'') of the United States
Department of Agriculture (``USDA'') offers various ongoing
programs for agricultural producers to facilitate recovery from
losses caused by natural events.\2\ Ongoing programs include
the Emergency Conservation Program (``ECP''), the Noninsured
Crop Disaster Assistance Program (``NAP''), the Disaster Debt
Set-Aside Program (``DSA''), and the Emergency Loan Program
(``EM'').
---------------------------------------------------------------------------
\2\For more information see the USDA FSA Ongoing Disaster
Assistance Programs for Agricultural Producers Fact Sheet, January 2007
available at http://www.fsa.usda.gov/Internet/FSA--File/
ongdisasst07.pdf.
---------------------------------------------------------------------------
ECP is a discretionary program funded through annual
appropriations that provides funding for farmers and ranchers
to rehabilitate farmland damaged by natural disaster and for
carrying out emergency water conservation measures during
severe drought. The natural disaster must create new
conservation problems that if untreated would (1) impair or
endanger the land; (2) materially affect the productive
capacity of the land; (3) represent unusual damage which,
except for wind erosion, is not the type likely to recur
frequently in the same area; and (4) be so costly to repair
that federal assistance is, or will be required, to return the
land to productive agricultural use.
NAP provides a low level of insurance to producers who grow
otherwise noninsurable crops. NAP provides coverage for crop
losses and planting prevented by disasters. Landowners,
tenants, or sharecroppers who share in the risk of producing an
eligible crop may qualify for this program. Before payments can
be issued, applications must first be received and approved,
generally before the crop is planted, and the crop must have
suffered a minimum of 50 percent loss in yield. Payments are 55
percent of the commodities' average market price on crop losses
beyond 50 percent. Eligible crops include commercial crops and
other agricultural commodities produced for food, including
livestock feed or fiber for which the catastrophic level of
crop insurance is unavailable. Also eligible for NAP coverage
are controlled-environment crops (mushroom and floriculture),
specialty crops (honey and maple sap), and value loss crops
(aquaculture, Christmas trees, ginseng, ornamental nursery, and
turfgrass sod).
DSA is available to those producers who are borrowers from
the Farm Service Agency in primary or contiguous counties that
have been declared by the President or designated by the
Secretary of Agriculture (``Secretary'') as a disaster area.
When borrowers affected by natural disasters are unable to make
their scheduled payments on any debt, FSA is authorized to
consider the set-aside of some payments to allow the farming
operation to continue. After a disaster designation is made,
FSA will notify borrowers of the availability of the DSA.
Borrowers who are notified have eight months from the date of
designation to apply. FSA borrowers may also request a release
of income proceeds to meet current operating and family living
expenses or may request special servicing provisions from their
local FSA county offices to explore other options.
EM provides emergency loans to help producers recover from
production and physical losses due to drought, flooding, other
natural disasters, or quarantine. Emergency loans may be made
to farmers and ranchers who own or operate land located in a
county declared by the President as a disaster area or
designated by the Secretary as a disaster area or quarantine
area (for physical losses only, the FSA administrator may
authorize emergency loan assistance). EM funds may be used to:
(1) restore or replace essential property; (2) pay all or part
of production costs associated with the disaster year; (3) pay
essential family expenses; (4) reorganize the farming
operation; and (5) refinance certain debts.

REASONS FOR CHANGE

Farmers and ranchers can wait years to receive assistance
from Congress when faced with a weather-related disaster such
as drought, floods or severe storms. The Committee believes
that a supplemental agricultural disaster assistance program is
appropriate to ensure that farmers have a dependable and timely
safety net when disasters strike. The Supplemental Agriculture
Disaster Assistance program creates a trust fund that will
cover losses not covered by crop insurance. To receive benefits
from the trust fund, farmers and ranchers must: (1) carry crop
insurance; and (2) be located in a Secretarially declared
disaster county or a contiguous county, or show proof of an
individual loss of at least 50%. Farmers carrying higher levels
of insurance will be eligible for higher payments. Each farmer
or rancher applying for supplemental disaster assistance must
show that whole farm income from crop production declined due
to the loss of a particular crop due to natural disasters. The
Committee believes that these additional accountability
measures will encourage farmers to participate in crop
insurance programs, and will target assistance to those farmers
and ranchers with the greatest need. The Committee believes
that Supplemental Disaster Assistance program will be
particularly useful to beginning farmers and ranchers who
cannot afford to wait years for disaster assistance and do not
have the equity to handle large scale crop losses due to
natural disasters.
The Committee believes that the creation of a trust fund,
funded through an allocation of tariff revenues, is the
appropriate mechanism to support this program. An amount equal
to 3.34% of revenues from all tariffs will be transferred to
the trust fund through December 31, 2012. Payments from the
trust fund could begin in crop year 2008. The creation of the
trust fund was modeled after Section 32 of the Act of August
24, 1935 (7 U.S.C. 612c), which sets aside a percentage of
tariff revenues for nutrition and other programs that broadly
benefit all sectors of U.S. agriculture.

EXPLANATION OF PROVISION

In general

The provision amends the Trade Act of 1974 to create an
Agriculture Disaster Relief Trust Fund (``ADTF'') that would
provide payments to farmers and ranchers who suffer losses in
areas that are declared disaster areas by the USDA. The trust
fund will be funded by an amount equal to 3.34 percent of the
amounts received in the general fund of the Treasury that are
attributable to the duties collected on articles entered, or
withdrawn from warehouse, for consumption under the Harmonized
Tariff Schedule. The ADTF could make payments under four new
disaster assistance programs: the crop disaster assistance
program, the livestock indemnity program, the tree assistance
program, and the emergency assistance program for livestock,
honey bees, and farm raised fish. In addition, the ADTF will
also fund a new pest and disease management and disaster
prevention program. Amounts not required to meet current
withdrawals may be invested in U.S. Treasury obligations with
interest credited to the ADTF. The ADTF may also borrow, with
interest, as repayable advances sums necessary to carry out the
purposes of the fund.

Crop Disaster Assistance Program (``CDAP'')

Generally, CDAP payments will be paid to producers located
in disaster counties on 52 percent of the difference between
the disaster program guarantee and the sum of total farm
revenue. Disaster counties include counties receiving disaster
declarations by the Secretary due to production losses
resulting directly or indirectly from adverse weather, counties
contiguous to such counties, and any farm whose production due
to weather was less than 50 percent of normal production. To be
eligible for CDAP payments, the producer must have purchased or
enrolled in both crop insurance for insurable crops at a
minimum of 50 percent of yield at 55 percent of price and NAP
for uninsurable crops. The Secretary may waive this requirement
under certain conditions.
The disaster program guarantee for insurable crops is equal
to the product of a measure of crop yield, the percentage of
crop insurance yield guarantee, the percentage of crop
insurance price elected by the producer, the crop insurance
price, and 115 percent. The disaster program guarantee for
noninsured crops is equal to the product of the yield as
determined by NAP for each crop, 100 percent of the NAP
established price, and 115 percent. The disaster program
guarantee is the sum of the disaster program guarantee for
insurable and noninsured crops.
Total farm revenue includes the sum of the estimated value
of crops and grazing, crop insurance and NAP indemnities
accruing to the farm, the value of prevented planting payments,
the amount of other natural disaster assistance payments
provided by the federal government to a farm for the same loss,
and an amount equal to 20 percent of any direct payments made
to the producer under section 1103 of the Farm Security and
Rural Investment Act of 2002. The estimated value of crops is
generally the product of actual crop acreage grazed or
harvested, estimated actual yields of grazing land or crop
production, and the average market price during the first five
months of the marketing year in which a farm or portion of a
farm is located.

Livestock Indemnity Program

The ADTF may also make payments under the livestock
indemnity program to eligible producers on farms that have
incurred livestock death losses in excess of normal mortality
rates during the calendar year due to adverse weather, as
determined by the Secretary. Indemnity payments are made at a
rate of 75 percent of the fair market value of the livestock on
the day before the date of death of the livestock as determined
by the Secretary.

Tree Assistance Program

The Secretary shall make payments to eligible orchardists
as follows. Assistance is in the form of (1) 75 percent
reimbursement for the cost of replanting trees lost due to a
natural disaster if tree mortality is in excess of 15 percent,
adjusted for normal mortality, or sufficient seedlings to
reestablish a stand; and (2) 50 percent reimbursement of the
cost of pruning, removal, and other costs incurred to salvage
existing trees or to prepare land to replant trees lost due to
a natural disaster in excess of 15 percent damage or mortality
adjusted for normal tree damage and mortality.

Buy-up NAP Coverage

Under NAP, FSA compensates eligible producers for losses of
noninsurable crops exceeding 50 percent of the expected yield
based on 55 percent of the average market price of the
commodity. This provision permits producers to buy additional
NAP coverage. Producers could purchase additional coverage
guarantee up to 60 or 65 percent, as elected by the producers,
of expected yield, and up to 100 percent of the average market
price of the commodity. Fees would be established and collected
by the Secretary to fully offset the cost of supplemental NAP
coverage.

Emergency Assistance for livestock, honey bees, and farm-raised fish

The Secretary shall use up to $35,000,000 annually from the
trust fund to provide emergency relief to producers of
livestock (including horses), honey bees, and farm-raised fish
due to losses from adverse weather or other environmental
conditions, such as blizzards and wildfires, as determined by
the Secretary, that are not covered under the authority of the
Secretary to make qualifying natural disaster declarations. For
purposes of the provision, farm-raised fish includes the
propagation and rearing of aquatic species (including any
species of finfish, mollusk, crustacean, or other aquatic
invertebrate, amphibian, reptile, or aquatic plant) in
controlled or semi-controlled environments.

Limitations

No eligible producer may receive more than $100,000
annually in total disaster assistance under this Act. A
producer is not eligible for benefits under the provision if,
as determined by the Secretary, such producer's adjusted gross
income (as defined in section 1001D(a) of the Food Security Act
of 1985\3\ or any successor provision) exceeds $2.5 million,
unless not less than 75 percent of the average adjusted gross
income of such producer is derived from farming, ranching or
forestry operations.
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\3\7 U.S.C. sec. 1308-3a(a).
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Pest and Disease Management and Disaster Prevention

The provision also establishes a new program under which
USDA will conduct early pest detection and surveillance
activities in coordination with State departments of
agriculture, will prioritize and create action plans to address
pest and disease threats to specialty crops, and will create an
audit-based certification approach to protect against the
spread of plant pests.

Sunset of provision

The authority provided by the provision shall be effective
only for losses that are incurred as a result of a disaster,
adverse weather, or another environmental condition that occurs
on or before September 30, 2012, as determined by the
Secretary.

EFFECTIVE DATE

The provision is effective on the date of enactment.

TITLE II--CONSERVATION PROVISIONS

A. Provide Tax Credit for Eligible Farmland Enrolled in the
Conservation Reserve Program

(Sec. 201 of the bill and sec. 30D of the Code)

PRESENT LAW

The Department of Agriculture administers various programs
designed to encourage conservation. Under the conservation
reserve program,\4\ eligible producers generally enter into
contracts under which they agree to establish long-term,
resource conserving covers on eligible farmland in exchange for
annual contract payments.
---------------------------------------------------------------------------
\4\The term ``conservation reserve program'' means the conservation
reserve program established under subchapter B of chapter 1 of subtitle
D of title XII of the Food Security Act of 1985.
---------------------------------------------------------------------------
Present law does not provide an income tax credit for
eligible farmland enrolled in the conservation reserve program.

REASONS FOR CHANGE

The Committee believes additional incentives should be
provided to encourage eligible producers to establish long-
term, resource conserving covers on eligible farmland.

DESCRIPTION OF PROVISION

In general, the provision establishes as a credit against
income taxes the conservation reserve credit. The credit is
elective, but a taxpayer may not claim the credit for a
particular year if the taxpayer receives a contract payment
from the Department of Agriculture pursuant to the conservation
reserve program for such year.
The conservation reserve credit requires the taxpayer to be
an eligible producer on eligible farmland enrolled in the
conservation reserve program. The credit is equal to the rental
value of any such property enrolled in the program, as
determined by the Secretary in consultation with the Secretary
of Agriculture. The Secretary may not allocate more than
$50,000 of conservation reserve credit to any one taxpayer for
any fiscal year. The credit is not includable in the taxpayer's
gross income and is not subject to Self-Employment
Contributions Act (SECA) tax.
The credit allowed under the provision is taken into
account after other credits (sections 21-27, 30, 30B, and 30C)
and may not offset the alternative minimum tax. A taxpayer is
not entitled to a deduction for any amount with respect to
which a credit is allowed under the proposal. In the event a
taxpayer terminates a conservation reserve program contract,
the Secretary may recapture a portion of the credit
corresponding to the portion of the taxable year during which
the contract was not in effect.
The provision establishes an annual conservation reserve
credit limitation of $750 million for each of fiscal years 2009
through 2012, which represents the total amount of credits that
may be allocated under the program for all taxpayers for such
years. Unallocated amounts with respect to any calendar year
are carried forward to the allowable allocation for the next
calendar year, except that no amount of conservation reserve
credit may be allocated to any taxpayer after fiscal year 2012.
The credit allowed under the provision may not exceed the
excess of the amount allocated to the taxpayer by the Secretary
of the Treasury, in consultation with the Secretary of
Agriculture, for the taxable year and all prior taxable years
over the credit allowed for all prior taxable years.

EFFECTIVE DATE

The provision is effective on the date of enactment and
applies with respect to conservation reserve program contracts
entered into before, on, or after such date.

B. Exclusion of Conservation Reserve Program Payments From SECA Tax for
Individuals Receiving Social Security Retirement or Disability Payments

(Sec. 202 of the bill and sec. 1402(a) of the Code)

PRESENT LAW

Generally, the Self-Employment Contributions Act (``SECA'')
tax is imposed on an individual's net earnings from self-
employment income within the social security wage base. Net
earnings from self-employment generally mean gross income
(including the individual's net distributive share of
partnership income) derived by an individual from any trade or
business carried on by the individual less applicable
deductions.\5\
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\5\Sec. 1402.
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REASONS FOR CHANGE

The Committee believes that the correct measurement of
income for SECA purposes in the cases of retired or disabled
individuals does not include conservation reserve program
payments.

EXPLANATION OF PROVISION

The provision excludes conservation reserve program
payments from self-employment income for purpose of SECA tax in
the case of individuals who are receiving social security
retirement or disability benefits. The treatment of
conservation reserve program payments received by other
entities is not changed.

EFFECTIVE DATE

The provision is effective for payments made after December
31, 2007.

C. Make Permanent the Special Rule Encouraging Contributions of Capital
Gain Real Property for Conservation Purposes

(Sec. 203 of the bill and sec. 170 of the Code)

PRESENT LAW

Charitable contributions generally

In general, a deduction is permitted for charitable
contributions, subject to certain limitations that depend on
the type of taxpayer, the property contributed, and the donee
organization. The amount of deduction generally equals the fair
market value of the contributed property on the date of the
contribution. Charitable deductions are provided for income,
estate, and gift tax purposes.\6\
---------------------------------------------------------------------------
\6\Secs. 170, 2055, and 2522, respectively. Unless otherwise
provided, all section references are to the Internal Revenue Code of
1986, as amended (the ``Code'').
---------------------------------------------------------------------------
In general, in any taxable year, charitable contributions
by a corporation are not deductible to the extent the aggregate
contributions exceed 10 percent of the corporation's taxable
income computed without regard to net operating or capital loss
carrybacks. For individuals, the amount deductible is a
percentage of the taxpayer's contribution base, which is the
taxpayer's adjusted gross income computed without regard to any
net operating loss carryback. The applicable percentage of the
contribution base varies depending on the type of donee
organization and property contributed. Cash contributions of an
individual taxpayer to public charities, private operating
foundations, and certain types of private nonoperating
foundations may not exceed 50 percent of the taxpayer's
contribution base. Cash contributions to private foundations
and certain other organizations generally may be deducted up to
30 percent of the taxpayer's contribution base.
In general, a charitable deduction is not allowed for
income, estate, or gift tax purposes if the donor transfers an
interest in property to a charity while also either retaining
an interest in that property or transferring an interest in
that property to a noncharity for less than full and adequate
consideration. Exceptions to this general rule are provided
for, among other interests, remainder interests in charitable
remainder annuity trusts, charitable remainder unitrusts, and
pooled income funds, present interests in the form of a
guaranteed annuity or a fixed percentage of the annual value of
the property, and qualified conservation contributions.

Capital gain property

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

Qualified conservation contributions

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

Special rule regarding contributions of capital gain real property for
conservation purposes

In general
Under a temporary provision that is effective for
contributions made in taxable years beginning after December
31, 2005,\7\ the 30-percent contribution base limitation on
contributions of capital gain property by individuals does not
apply to qualified conservation contributions (as defined under
present law). Instead, individuals may deduct the fair market
value of any qualified conservation contribution to an
organization described in section 170(b)(1)(A) to the extent of
the excess of 50 percent of the contribution base over the
amount of all other allowable charitable contributions. These
contributions are not taken into account in determining the
amount of other allowable charitable contributions.
---------------------------------------------------------------------------
\7\Sec. 170(b)(1)(E).
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Individuals are allowed to carry over any qualified
conservation contributions that exceed the 50-percent
limitation for up to 15 years.
For example, assume an individual with a contribution base
of $100 makes a qualified conservation contribution of property
with a fair market value of $80 and makes other charitable
contributions subject to the 50-percent limitation of $60. The
individual is allowed a deduction of $50 in the current taxable
year for the non-conservation contributions (50 percent of the
$100 contribution base) and is allowed to carry over the excess
$10 for up to 5 years. No current deduction is allowed for the
qualified conservation contribution, but the entire $80
qualified conservation contribution may be carried forward for
up to 15 years.
Farmers and ranchers
In the case of an individual who is a qualified farmer or
rancher for the taxable year in which the contribution is made,
a qualified conservation contribution is allowable up to 100
percent of the excess of the taxpayer's contribution base over
the amount of all other allowable charitable contributions.
In the above example, if the individual is a qualified
farmer or rancher, in addition to the $50 deduction for non-
conservation contributions, an additional $50 for the qualified
conservation contribution is allowed and $30 may be carried
forward for up to 15 years as a contribution subject to the
100-percent limitation.
In the case of a corporation (other than a publicly traded
corporation) that is a qualified farmer or rancher for the
taxable year in which the contribution is made, any qualified
conservation contribution is allowable up to 100 percent of the
excess of the corporation's taxable income (as computed under
section 170(b)(2)) over the amount of all other allowable
charitable contributions. Any excess may be carried forward for
up to 15 years as a contribution subject to the 100-percent
limitation.\8\
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\8\Sec. 170(b)(2)(B).
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As an additional condition of eligibility for the 100
percent limitation, with respect to any contribution of
property in agriculture or livestock production, or that is
available for such production, by a qualified farmer or
rancher, the qualified real property interest must include a
restriction that the property remain generally available for
such production. (There is no requirement as to any specific
use in agriculture or farming, or necessarily that the property
be used for such purposes, merely that the property remain
available for such purposes.) Such additional condition does
not apply to contributions made on or before August 17, 2006.
A qualified farmer or rancher means a taxpayer whose gross
income from the trade or business of farming (within the
meaning of section 2032A(e)(5)) is greater than 50 percent of
the taxpayer's gross income for the taxable year.
Termination
The special rule regarding contributions of capital gain
real property for conservation purposes does not apply to
contributions made in taxable years beginning after December
31, 2007.

REASONS FOR CHANGE

Gifts of conservation easements to organizations that are
dedicated to maintaining natural habitats, open spaces, or
traditional agriculture help protect our nation's heritage. The
charitable tax deduction for such conservation easements has
proven to be a valuable incentive for making such gifts. The
Committee believes that the special rule that provides an
increased incentive to make charitable contributions of partial
interests in real property for conservation purposes is an
important way of encouraging conservation and preservation, and
should be made permanent.

EXPLANATION OF PROVISION

The provision makes permanent the special rule regarding
contributions of capital gain real property for conservation
purposes.

EFFECTIVE DATE

The provision is effective for contributions made in
taxable years beginning after December 31, 2007.

D. Provide Tax Credit for Recovery and Restoration of Endangered
Species

(Sec. 204 of the bill and new sec. 30D of the Code)

PRESENT LAW

Present law does not provide an income tax credit for
endangered species recovery expenditures.

REASONS FOR CHANGE

The Endangered Species Act (``ESA'') of 1973 is a
comprehensive attempt to protect species at risk of extinction
and to consider habitat protection as an integral part of that
effort. The purpose of the ESA is to conserve the ecosystems
upon which endangered and threatened species depend and to
conserve and recover listed species. Under the ESA, species of
plants and animals (both vertebrate and invertebrate) may be
listed as either endangered or threatened according to
assessments of the risk of their extinction.
As of September 20, 2007, according to the U.S. Fish and
Wildlife Service (``USFWS''), a total of 607 species of animals
and 744 species of plants had been listed as either endangered
or threatened in the United States and its territories.
According to the USFWS, over 70 percent of the nation's
landscape is in private ownership and nearly two-thirds of
Federally listed endangered and threatened species are found on
private lands. With such a large number of the country's listed
species dependent upon private lands for their survival, and
many exclusively so, the goals of the ESA cannot be
accomplished without the Federal government becoming involved
to provide incentives for species protection on private lands.
For both plants and animals, the ESA has very few provisions
for restoration and managing habitats on private lands. Many
important habitats require restoration and management because,
among other things, they have been overrun by invasive species
or have been deprived of fire and other natural processes.
Although the ESA prohibits landowners from harming
endangered or threatened species, the Act itself contains only
a small number of incentives for landowners to undertake the
beneficial management actions that most species require for
recovery. In addition, while most private landowners care about
their land and want to practice good stewardship, they often
lack the time and resources to deal with complex regulations
and necessary management activities.
The Committee believes that tax credits for private
landowners who undertake habitat protection and restoration for
endangered species will provide some needed incentives to help
recover threatened and endangered species.

EXPLANATION OF PROVISION

In general

For eligible taxpayers, the provision establishes a credit
against income taxes for: (1) costs paid or incurred by an
eligible taxpayer for the taxable year (reduced by the amount
of government financing for conservation of a qualified
species, and not including costs required by a Federal, State,
or local government) pursuant to a habitat management plan
entered into under certain qualified habitat protection
agreements (``habitat restoration credit'') and (2) a
percentage of the loss in value to real property attributable
to an easement placed on the property pursuant to such
agreements (less any amount received in connection with the
easement) (``habitat protection easement credit''). The
allowable credit amount is 100 percent of costs paid or
incurred and the loss in value to property pursuant to
qualified perpetual habitat protection agreements; 75 percent
of costs paid or incurred and the loss in value to property
pursuant to qualified 30-year habitat protection agreements;
and 50 percent of costs paid or incurred pursuant to a
qualified habitat protection agreement.
For purposes of the habitat protection easement credit, the
loss in value is the difference between the fair market value
of the real property subject to the agreement determined on the
day before the agreement is entered into less the fair market
value of such property determined one day after the agreement
is entered into. To claim such credit, the eligible taxpayer
must own the real property with respect to which the easement
is placed, and include on the tax return for the taxable year a
qualified appraisal (within the meaning of section
170(f)(11)(E)) of the real property. The taxpayer's basis in
such property is reduced by the amount of basis allocated to
the easement under regulations prescribed by the Secretary.\9\
---------------------------------------------------------------------------
\9\See, e.g., Treas. Reg. sec. 1.170A-14(h)(3)(iii).
---------------------------------------------------------------------------
The habitat restoration credit is taken into account after
other credits (sections 21-27, 30, 30B, 30C, and the habitat
protection easement credit) and may not offset the alternative
minimum tax. If such credit is allowed for any expenditure with
respect to any property, the increase in the basis of such
property that would otherwise result from such expenditure is
reduced by the amount of the credit allowed. The habitat
protection easement credit is taken into account after other
credits (sections 21-27, 30, 30B, and 30C) and such credit may
offset the alternative minimum tax. Amounts allowed but in
excess of either limitation may be carried forward to the
succeeding taxable year. No deduction is allowed for any amount
with respect to which a credit is allowed. The Secretary of the
Treasury shall by regulations provide for the recapture of the
credit if such Secretary determines that the eligible taxpayer
has failed to carry out the duties required by the qualified
agreement and there are no other available means to remediate
such failure.
The sum of the two credits may not exceed the amount
allocated to the eligible taxpayer for the calendar year in
which the taxpayer's taxable year ends by the Secretary of the
Treasury, in consultation with the Secretary of the Interior
and the Secretary of Commerce, or by the Secretary of the
Treasury in consultation with the Secretary of Agriculture. If
the amount allowed as a credit exceeds the amount allocated for
such year, the excess may be carried forward to the next
taxable year for which the taxpayer has received an allocation.
If the amount allocated to a taxpayer for a calendar year
exceeds the amount allowed as a credit for such year, the
difference may be carried forward to the next taxable year and
treated as allocated to the taxpayer for use in such year. No
credit is allowed unless the appropriate Secretary certifies
that a qualified agreement will contribute to the recovery of a
qualified species.
The aggregate amount allocated by the Secretary of the
Treasury, in consultation with the Secretary of the Interior
and the Secretary of Commerce may not exceed in each year 2008
through 2012: $290,000,000 with respect to qualified perpetual
habitat protection agreements, $55,000,000 with respect to
qualified 30-year habitat protection agreements, and
$35,000,000 with respect to qualified habitat protection
agreements. The aggregate amount allocated by the Secretary of
the Treasury, in consultation with the Secretary of Agriculture
may not exceed in each year 2008 through 2012: $5,000,000 with
respect to qualified perpetual habitat protection agreements,
$2,000,000 with respect to qualified 30-year habitat protection
agreements, and $1,000,000 with respect to qualified habitat
protection agreements. No allocation is allowed after 2012,
except that unallocated amounts with respect to any calendar
year are carried forward to the allowable allocation for the
next calendar year.
Not later than 180 days after the date of enactment, the
Secretary of the Treasury, in consultation with the Secretary
of the Interior and the Secretary of Commerce, shall by
regulation establish a program to process applications from
eligible taxpayers and to determine how best to allocate the
credit. In allocating the credit, priority shall be given to
taxpayers with agreements (1) relating to habitats that will
significantly increase the likelihood of recovering and
delisting a species as an endangered species or a threatened
species (as defined under section 2 of the Endangered Species
Act of 1973), (2) that are cost-effective and maximize the
benefits to a qualified species per dollar expended, (3)
relating to habitats of species that have a Federally approved
recovery plan pursuant to section 4 of the Endangered Species
Act of 1973, (4) relating to habitats with the potential to
contribute significantly to the improvement of the status of a
qualified species, (5) relating to habitats with the potential
to contribute significantly to the eradication or control of
invasive species that are imperiling a qualified species, (6)
with habitat management plans that will manage multiple
qualified species, (7) with habitat management plans that will
create adjacent or proximate habitat for the recovery of a
qualified species, (8) relating to habitats for qualified
species with an urgent need for protection, (9) with habitat
management plans that assist in preventing the listing of a
species as endangered or threatened under the Endangered
Species Act of 1973 or a similar State law, (10) with habitat
management plans that may resolve conflicts between the
protection of qualified species and otherwise lawful human
activities, and (11) with habitat management plans that may
resolve conflicts between the protection of a qualified species
and military training or other military operation.
The Secretary of the Treasury shall request that the
appropriate Secretary consider whether to authorize under the
Endangered Species Act of 1973 takings by an eligible taxpayer
of a qualified species to which a qualified agreement relates
if the takings are incidental to (1) the restoration,
enhancement, or management of the habitat pursuant to the
habitat management plan under the agreement or (2) the use of
the property to which the agreement pertains at any time after
the expiration of the easement (or specified period of time
pursuant to a qualified habitat protection agreement), but only
if such use will leave the qualified species at least as well
off on the property as it was before the agreement was made.
Both types of incidental takings currently are authorized under
section 10(a)(1) of the Endangered Species Act of 1973
(enhancement of survival permits) and 50 C.F.R. part 17 (safe
harbor permits).
The Comptroller General of the United States shall
undertake a study on the effectiveness of the credits. Such
study shall evaluate the effectiveness of the credits in
encouraging landowners to enter into agreements for the
protection of the habitats of endangered and threatened
species, and the degree to which such agreements are effective
in preserving the habitats of such species and assisting in the
recovery of such species, and shall include recommendations for
improving the effectiveness of the credits. The Comptroller
General shall issue an interim report based on such study
within three years of the date of enactment and a final report
within five years of such date.

Definitions

Eligible taxpayer
An eligible taxpayer is (1) a taxpayer who owns real
property that contains habitat of a qualified species and
enters into a qualified perpetual habitat protection agreement,
a qualified 30-year habitat protection agreement, or a
qualified habitat protection agreement with the appropriate
Secretary with respect to such real property, and (2) a
taxpayer who is a party to a qualified perpetual habitat
protection agreement, a qualified 30-year habitat protection
agreement, or a qualified habitat protection agreement and, as
part of any such agreement, agrees to assume responsibility for
costs paid or incurred as a result of implementing such
agreement.
Qualified agreements
A qualified perpetual habitat protection agreement is an
agreement under which an easement is granted to the appropriate
Secretary, the Secretary of Agriculture, the Secretary of
Defense, or a State to protect the habitat of a qualified
species in perpetuity. A qualified 30-year habitat protection
agreement is an agreement under which an easement is granted to
the appropriate Secretary, the Secretary of Agriculture, the
Secretary of Defense, or a State to protect the habitat of a
qualified species for a period of not less than 30 years and
less than perpetuity. A qualified habitat protection agreement
requires agreement with the appropriate Secretary, the
Secretary of Agriculture, the Secretary of Defense, or a State
to protect the habitat of a qualified species for a specified
period of time.
In addition, each of the three types of qualified agreement
must meet the following requirements: (1) the agreement must be
consistent with any recovery plan that is applicable and that
has been approved for a qualified species under section 4 of
the Endangered Species Act of 1973; (2) the agreement must
include a habitat management plan agreed to by the appropriate
Secretary and the eligible taxpayer; and (3) the agreement must
require that technical assistance with respect to the duties
under the habitat management plan be provided to the taxpayer
by the appropriate Secretary or an entity approved by the
appropriate Secretary.
Habitat management plan
A habitat management plan means, with respect to any
habitat, a plan that (1) identifies one or more qualified
species to which the plan applies; (2) is designed to restore
or enhance the habitat of a qualified species or reduce threats
to a qualified species through the management of the habitat;
(3) describes the threats to the qualified species that are
intended to be reduced through the plan; (4) describes the
management practices to be undertaken by the taxpayer; (5)
provides a schedule of deadlines for undertaking such
management practices; (6) requires monitoring of the management
practices and the status of the qualified species; and (7)
describes the technical assistance to be provided to the
taxpayer and identifies the entity that will provide such
assistance.
Qualified species
A qualified species is any species listed as an endangered
species or threatened species under the Endangered Species Act
of 1973 or any species for which a finding has been made under
section 4(b)(3) of the Endangered Species Act of 1973 that
listing under such Act may be warranted.
Taking
A taking has the meaning given to such term under the
Endangered Species Act of 1973.
Appropriate Secretary
Appropriate Secretary has the meaning given to the term
``Secretary'' under section 3(15) of the Endangered Species Act
of 1973.

EFFECTIVE DATE

The provision is effective for taxable years beginning
after December 31, 2007.

E. Deduction for Endangered Species Recovery Expenditures

(Sec. 205 of the bill and sec. 175 of the Code)

PRESENT LAW

Under present law, a taxpayer engaged in the business of
farming may treat expenditures that are paid or incurred by him
during the taxable year for the purpose of soil or water
conservation in respect of land used in farming, or for the
prevention or erosion of land used in farming, as expenses that
are not chargeable to capital account. Such expenditures are
allowed as a deduction, not to exceed 25 percent of the gross
income derived from farming during the taxable year.\10\ Any
excess above such percentage is deductible for succeeding
taxable years, not to exceed 25 percent of the gross income
derived from farming during such succeeding taxable year.
---------------------------------------------------------------------------
\10\Sec. 175.
---------------------------------------------------------------------------

REASONS FOR CHANGE

The goal of the Endangered Species Act of 1973 is to
recover listed species and the ecosystems on which they depend
to levels where protection under such Act is no longer
necessary. Recovery is the process by which the decline of an
endangered species is arrested or reversed, and threats removed
or reduced so that the species' long-term survival in the wild
can be ensured. Section 4(f)(1) of such Act directs the
appropriate Secretary to develop and implement recovery plans
for the conservation and survival of endangered and threatened
species, unless the appropriate Secretary finds that such a
plan will not promote the conservation of the species. To the
maximum extent practicable, the recovery plan must incorporate
a description of management actions to achieve the plan's
goals, objective and measurable criteria for determining the
removal of species from the endangered species list, and
estimate the time required and cost to carry out the recovery
plan. The appropriate Secretary may procure the services of
appropriate private and public agencies in developing and
implementing a recovery plan.
According to an April 6, 2006, General Accountability
Office report entitled ``Endangered Species: Time and Costs to
Recover Species Are Largely Unknown'', as of January 2006, the
Fish and Wildlife Service and the National Marine Fisheries
Service had finalized and approved 558 recovery plans covering
1,049 species, or about 82 percent of the 1,272 endangered or
threatened species protected in the United States at that time.
Recovery plans contain management measures that landowners can
adopt on their land that will aid in the recovery of endangered
or threatened species, resulting in a public benefit. Such are
similar to measures undertaken for soil and water conservation,
which are entitled to a tax deduction. The Committee believes
that certain expenses of farmers made pursuant to a recovery
plan under the Endangered Species Act should be treated
similarly to expenditures by farmers made for soil and water
conservation.

EXPLANATION OF PROVISION

The provision provides that expenditures paid or incurred
by a taxpayer engaged in the business of farming for the
purpose of achieving site-specific management actions pursuant
to the Endangered Species Act of 1973\11\ to be treated the
same as expenditures for the purpose of soil or water
conservation in respect of land used in farming, or for the
prevention or erosion of land used in farming, i.e., such
expenditures are treated as not chargeable to capital account
and are deductible subject to the limitation that the deduction
may not exceed 25 percent of the farmer's gross income derived
from farming during the taxable year.
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\11\16 U.S.C. 1533(f)(B).
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EFFECTIVE DATE

The provision is effective for expenditures paid or
incurred after the date of enactment.

F. Provide Exclusion for Certain Payments and Programs Relating to Fish
and Wildlife

(Sec. 206 of the bill and sec. 126 of the Code)

PRESENT LAW

Under present law, gross income does not include the
excludable portion of payments made to taxpayers by the Federal
and State governments for a share of the cost of improvements
to property under certain conservation programs.\12\
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\12\Sec. 126.
---------------------------------------------------------------------------
The excludable portion is the portion (or all) of a payment
made under such programs that is determined by the Secretary of
Agriculture to be made primarily for the purpose of conserving
soil and water resources, protecting or restoring the
environment, improving forests, or providing a habitat for
wildlife, and is determined by the Secretary of the Treasury as
not increasing substantially the annual income derived from the
property. The excludable portion does not include that portion
of any payment that is properly associated with an amount that
is allowable as a deduction for the taxable year in which such
amount is paid or incurred.
Applicable conservation programs include (1) the rural
clean water program authorized by section 208(j) of the Federal
Water Pollution Control Act, (2) the rural abandoned mine
program authorized by section 406 of the Surface Mining Control
and Reclamation Act of 1977, (3) the water bank program
authorized by the Water Bank Act, (4) the emergency
conservation measures program authorized by title IV of the
Agricultural Credit Act of 1978, (5) the agriculture
conservation program authorized by the Soil Conservation and
Domestic Allotment Act, (6) the great plains conservation
program authorized by section 16 of the Soil Conservation and
Domestic Policy Act, (7) the resource conservation and
development program authorized by the Bankhead-Jones Farm
Tenant Act and by the Soil Conservation and Domestic Allotment
Act, (8) the forestry incentives program authorized by section
4 of the Cooperative Forestry Assistance Act of 1978, (9) any
small watershed program administered by the Secretary of
Agriculture which is determined by the Secretary of the
Treasury or his delegate to be substantially similar to the
type of programs described in items (1) through (8), and (10)
any program of a State, possession of the United States, a
political subdivision of any of the foregoing, or the District
of Columbia under which payments are made to individuals
primarily for the purpose of conserving soil, protecting or
restoring the environment, improving forests, or providing a
habitat for wildlife.

REASONS FOR CHANGE

Currently, there are a few Federal programs aimed at
encouraging landowners to protect and aid in the recovery of
endangered or threatened species. Partners for Fish and
Wildlife is a national voluntary cost-share program implemented
by the U.S. Fish and Wildlife Service to protect, enhance, and
restore important fish and wildlife habitats on private lands
through partnerships with landowners. The Landowner's Incentive
Program provides funding for states to staff their programs and
to fund conservation work with private landowners to restore
and maintain habitat for endangered, threatened, and other
imperiled species. State Wildlife Grant funds are used to
address species and their habitats that are identified in State
Comprehensive Wildlife Conservation Plans/Strategies (also
known as Wildlife Action Plans). Priority for use of these
funds is on those species of greatest conservation need. The
Private Stewardship Grant Program provides Federal grants on a
competitive basis to individuals and groups engaged in
voluntary conservation efforts on private lands that benefit
Federally listed endangered or threatened species, candidate
species or other at-risk species. Private landowners and groups
working with private landowners are able to submit proposals
directly to the U.S. Fish and Wildlife Service for funding to
support these efforts. Each grant must be matched by at least
10 percent of the total project cost in either non Federal
dollars or in-kind contributions. The Healthy Forests Reserve
Program is a voluntary program to restore and enhance forest
ecosystems to promote the recovery of threatened and endangered
species, improve biodiversity and enhance carbon sequestration.
The Committee believes that payments received by taxpayers
under the Partners for Fish and Wildlife Program, the Landowner
Incentive Program, the State Wildlife Grants Program, the
Private Stewardship Grants Program, the Forest Health
Protection Program, and the program related to integrated pest
management are similar to payments made under other government
programs that are excludable from gross income under present
law. Accordingly, the Committee believes it is appropriate to
extend the present-law exclusion to payments under these
programs.

EXPLANATION OF PROVISION

The provision expands the exclusion for the excludable
portion of certain payments to include the excludable portion
of payments made under the Partners for Fish and Wildlife
Program authorized by the Partners for Fish and Wildlife Act,
the Landowner Incentive Program, the State Wildlife Grants
Program, the Private Stewardship Grants Program authorized by
the Fish and Wildlife Act of 1956, the Forest Health Protection
Program authorized by the Cooperative Forestry Assistance Act
of 1978, and the program related to integrated pest management
authorized by section 8(i)(1)(A) of the Cooperative Forestry
Act of 1978.

EFFECTIVE DATE

The provision is effective for payments received after the
date of enactment.

G. Provide Tax Credit for Easements Made Pursuant to Certain U.S.D.A.
Conservation Programs

(Sec. 207 of the bill and sec. 30F of the Code)

PRESENT LAW

The Department of Agriculture administers various programs
designed to encourage conservation. Under the wetlands reserve
program\13\ and the grassland reserve program (referred to
herein as the working grassland protection program),\14\ land
owners generally place conservation easements on real property
in exchange for payments from the Department of Agriculture.
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\13\The term ``wetlands reserve program'' means the wetlands
reserve program established under subchapter C of chapter 1 of subtitle
D of title XII of the Food Security Act of 1985.
\14\The term ``working grassland protection program'' means the
working grassland protection program established under subchapter C of
chapter 2 of subtitle D of Title XII of the Food Security Act of 1985.
---------------------------------------------------------------------------
Present law does not provide an income tax credit for
easements placed on real property pursuant to the wetlands
reserve program or the working grassland protection program.

REASONS FOR CHANGE

The Committee believes that additional incentives should be
provided to encourage landowners to grant conservation
easements on real property pursuant to the wetlands reserve
program and the working grassland protection program.

EXPLANATION OF PROVISION

In general, the provision establishes two income tax
credits: (1) the wetlands reserve conservation credit; and (2)
the working grassland protection credit. The credits are
elective, but a taxpayer may not claim the credits if the
taxpayer receives a payment for an easement made pursuant to
the wetlands reserve program or the working grassland
protection program.
The wetlands reserve conservation credit requires the
taxpayer to grant to the Secretary of Agriculture an easement
pursuant to the wetlands reserve program. The credit is equal
to the applicable percentage of the wetlands reserve easement
value. The applicable percentage is the excess of 1 over the
applicable marginal tax rate assuming that the taxpayer sold
the easement on the date the easement is granted to the
Secretary of Agriculture. The wetlands reserve easement value
is the lesser of: (1) the wetlands reserve geographic area rate
for the area in which the real property is located multiplied
by the number of acres placed under easement and (2) the amount
of the payment the taxpayer otherwise would have received from
the Department of Agriculture in exchange for the easement
pursuant to the wetlands reserve program. The wetlands reserve
geographic area rate is a per-acre rate appropriate for
easements made under the wetlands reserve program in the
particular geographic area as determined by the Secretary of
Treasury in consultation with the Secretary of Agriculture.
The working grassland protection credit requires the
taxpayer to grant an easement in perpetuity or for a period not
less than 30 years to the Secretary of Agriculture or to a
State pursuant to the working grassland protection program. In
the case of an easement in perpetuity, the working grassland
protection credit for any taxable year is an amount equal to
the applicable percentage of the working grassland easement
value. The applicable percentage is the excess of 1 over the
applicable marginal tax rate assuming that the taxpayer sold
the easement on the date the easement is granted to the
Department of Agriculture or a State. The working grassland
easement value is the lesser of: (1) the working grassland
geographic area rate for the area in which the property is
located multiplied by the number of acres placed under easement
and (2) the amount of the payment the taxpayer otherwise would
have received from the Department of Agriculture pursuant to
the working grassland protection program. The working grassland
geographic area rate is a per-acre rate appropriate for
easements granted under the working grassland protection
program in the particular geographic area as determined by the
Secretary of Treasury in consultation with the Secretary of
Agriculture. In the case of a taxpayer who has entered into an
easement of at least 30 years, the amount of the working
grassland conservation credit is the lesser of: (1) 30 percent
of the amount determined under (1) above; and (2) the amount of
the payment the taxpayer otherwise would have received from the
Department of Agriculture pursuant to the working grassland
protection program.
The credits allowed under the provision are taken into
account after other credits (sections 21-27, 30, 30B, and 30C)
and may not offset the alternative minimum tax. A taxpayer is
not entitled to a deduction for any amount with respect to
which a credit is allowed under the provision. The Secretary of
Treasury shall by regulations provide for the recapture of the
wetlands reserve credit or the working grassland protection
credit if the Secretary, in consultation with the Secretary of
Agriculture, determines that the taxpayer has failed to carry
out the duties of the taxpayer under the terms of the easement
and there are no other available means to remediate such
failure.
The credit allowed under the provision may not exceed the
excess of the amount allocated to the taxpayer by the Secretary
of the Treasury, in consultation with the Secretary of
Agriculture, for the taxable year and all prior taxable years
over the credit allowed for all prior taxable years. The
taxpayer's basis in property subject to an easement under the
provision is reduced.
The provision establishes a national conservation credit
limitation of $1 billion, which represents the aggregate amount
of credits that may be allocated under the provision for all
taxpayers. The Secretary of Treasury, in consultation with the
Secretary of Agriculture, shall allocate the national
conservation credit limitation to taxpayers who grant easements
under the wetlands reserve program or the working grassland
protection program. No amount of national conservation credit
limitation may be allocated to any taxpayer after fiscal year
2012.

EFFECTIVE DATE

The provision is effective for easements granted after
September 30, 2007, in taxable years ending after such date.

H. Provide for Exempt Facility Bonds for Forest Conservation Activities

(Sec. 208 of the bill and Sec. 142 of the Code)

PRESENT LAW

Tax-exempt bonds

In general
Subject to certain Code restrictions, interest on bonds
issued by State and local government generally is excluded from
gross income for Federal income tax purposes. Bonds issued by
State and local governments may be classified as either
governmental bonds or private activity bonds. Governmental
bonds are bonds the proceeds of which are primarily used to
finance governmental functions or which are repaid with
governmental funds. Private activity bonds are bonds in which
the State or local government serves as a conduit providing
financing to nongovernmental persons. For this purpose, the
term ``nongovernmental person'' generally includes the Federal
Government and all other individuals and entities other than
States or local governments. The exclusion from income for
interest on State and local bonds does not apply to private
activity bonds, unless the bonds are issued for certain
permitted purposes (``qualified private activity bonds'') and
other Code requirements are met.
Qualified private activity bonds
As stated, interest on private activity bonds is taxable
unless the bonds meet the requirements for qualified private
activity bonds. Qualified private activity bonds permit States
or local governments to act as conduits providing tax-exempt
financing for certain private activities. The definition of
qualified private activity bonds includes an exempt facility
bond, or qualified mortgage, veterans' mortgage, small issue,
redevelopment, 501(c)(3), or student loan bond (sec. 141(e)).
The definition of an exempt facility bond includes bonds
issued to finance certain transportation facilities (airports,
ports, mass commuting, and high-speed intercity rail
facilities); qualified residential rental projects; privately
owned and/or operated utility facilities (sewage, water, solid
waste disposal, and local district heating and cooling
facilities, certain private electric and gas facilities, and
hydroelectric dam enhancements); public/private educational
facilities; qualified green building and sustainable design
projects; and qualified highway or surface freight transfer
facilities (sec. 142(a)).
In most cases, the aggregate volume of qualified private
activity bonds is restricted by annual aggregate volume limits
imposed on bonds issued by issuers within each State (``State
volume cap''). For calendar year 2007, the State volume cap,
which is indexed for inflation, equals $85 per resident of the
State, or $256.24 million, if greater. Exceptions to the State
volume cap are provided for bonds for certain governmentally
owned facilities (e.g., airports, ports, high-speed intercity
rail, and solid waste disposal) and bonds which are subject to
separate local, State, or national volume limits (e.g., public/
private educational facility bonds, enterprise zone facility
bonds, qualified green building bonds, and qualified highway or
surface freight transfer facility bonds).
Qualified private activity bonds generally are subject to
restrictions on the use of proceeds for the acquisition of land
and existing property. For example, generally no more than 25
percent of the net proceeds of a qualified private activity
bond may be used for the acquisition of land. In addition, the
term of qualified private activity bonds generally may not
exceed 120 percent of the economic life of the property being
financed.

Taxation of income from timber harvesting

In general, gross income for Federal income tax purposes
means all income from whatever source derived, including gross
income derived from a trade or business. An organization exempt
from taxation generally is subject to tax on its unrelated
business taxable income, generally defined to mean gross income
(less deductions) derived from a trade or business, the conduct
of which is not substantially related to the exercise or
performance of the organization's exempt purposes or functions,
that is regularly carried on by the organization. Special
unrelated trade or business income rules applicable to the
cutting of timber are contained in sections 512(b)(5) and 631.
Under these rules, the determination of whether income derived
from the cutting of timber constitutes unrelated trade or
business income depends upon a variety of factors.

REASONS FOR CHANGE

The Committee believes it is appropriate to provide certain
tax incentives to further the goal of permanently setting aside
working forests for conservation purposes. The Committee
believes that providing tax-exempt financing to nonprofit
organizations for the purpose of acquiring forests and forest
lands to be dedicated to certain conservation purposes will
increase their ability to purchase such properties from
commercial owners and operators, and that providing limited
exclusions from income tax to such nonprofit organizations will
enable them to conduct charitable and conservation activities
as they make debt service payments on the bonds.

EXPLANATION OF PROVISION

Overview

In general
The provision establishes a pilot project for forest
conservation activities by providing two types of tax benefits
available to qualified organizations that acquire forest and
forest lands for conservation management. First, the provision
provides for the treatment of qualified forest conservation
bonds as exempt facility bonds. Second, the provision provides
for the exclusion from gross income of income from certain
timber harvesting activities conducted by a qualified
organization on lands acquired with proceeds from qualified
forest conservation bonds.
Qualified organizations
Under the provision, an organization must be a qualified
organization to be eligible for the tax-exempt financing
benefit, and must be a qualified organization for whom
qualified forest conservation bonds have been issued (and
remain outstanding as tax-exempt bonds) to be eligible for the
income exclusion. In general, under the provision, a qualified
organization means a nonprofit organization: (1) substantially
all the activities of which are charitable, scientific, or
educational, including acquiring, protecting, restoring,
managing, and developing forest lands and other renewable
resources for the long-term charitable, educational,
scientific, and public benefit; (2) that periodically conducts
educational programs designed to inform the public of
environmentally sensitive forestry management and conservation
techniques; (3) whose board satisfies certain board composition
requirements designed to ensure that it represents public
conservation interests;\15\ (4) with governance provisions
contained in its bylaws that provide a supermajority vote of at
least two-thirds of the members of the board of directors is
required to approve and amend the qualified organization's
qualified conservation plan; and (5) that upon dissolution, its
assets are required to be dedicated to an organization exempt
from tax under section 501(c)(3) that is organized and operated
for conservation purposes, or to a governmental unit.
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\15\The provision requires that at least 20 percent of the board
members be comprised of representatives of the conservation community,
and that at least 20 percent of the board members be public officials.
Not more than one-third of the board members may be comprised of
individuals who have or had (during a prescribed five year period)
certain types of financial or contractual relationships with a
commercial forest products enterprise. A representative of the
conservation community is a person well-known in the community located
near the acquired forest land for dedication to the causes of
conservation and preservation, and may include a member of the board of
an established section 501(c)(3) organization with the primary purpose
of conservation or preservation. Such term does not include a public
official or a person described above who has or had certain types of
financial or contractual relationships with a commercial forest
products enterprise.
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Qualified forest conservation bonds

In general
The provision creates a new category of tax-exempt bonds,
``qualified forest conservation bonds.'' For purposes of the
Code, qualified forest conservation bonds are treated as exempt
facility bonds, and therefore, unless otherwise provided, are
governed by the same rules as exempt facility bonds. A
qualified forest conservation bond means any bond issued as
part of an issue if: (1) 95 percent or more of the net proceeds
of such issue are to be used for qualified project costs; (2)
such bond is issued for a qualified organization; and (3) such
bond is issued within 36 months of the date of enactment of the
provision. The maximum aggregate face amount of bonds that may
be issued is $1.5 billion.
The bonds are allocated by the Secretary generally as
follows: (i) 35 percent for qualified project costs with
respect to the cost of acquisition by any qualified
organization in the Pacific Northwest region; (ii) 30 percent
for qualified project costs with respect to the cost of
acquisition by any qualified organization in the Western
region; (iii) 17.5 percent for qualified project costs with
respect to the cost of acquisition by any qualified
organization in the Southeast region; (iv) 17.5 percent for
qualified project costs with respect to the cost of acquisition
by any qualified organization in the Northeast region.
The term ``Pacific Northwest region'' means Region 6 as
defined by the United States Forest Service of the Department
of Agriculture under section 200.2 of title 36, Code of Federal
Regulations. The term ``Western region'' means Regions 1, 2, 3,
4, 5, and 10 (as so defined). The term ``Southeast region''
means Region 8 (as so defined). The term ``Northeast region''
means Region 9 (as so defined).
If any region has not received a full allocation of its
bond limitation amount by the end of the period that is 24
months after the date of enactment, the Secretary may allocate
excess amounts to other regions in such manner as the Secretary
determines appropriate.
Qualified project costs
Qualified project costs include the cost of acquisition by
the qualified organization, from an unrelated person, of
forests and forest land that at the time of acquisition or
immediately thereafter are subject to a conservation
restriction that meets certain requirements.\16\ The
conservation restriction must: (1) be granted in perpetuity to
an unrelated charitable organization (other than a private
foundation) that is organized and operated for conservation
purposes, or to a governmental unit; (2) protect a relatively
natural habitat of fish, wildlife, or plants, or similar
ecosystem, or preserve open space (including farmland and
forest land) pursuant to a clearly delineated Federal, State,
or local governmental conservation policy and yield a
significant public benefit; (3) obligate the qualified
organization to pay the costs incurred by the holder of the
conservation restriction in monitoring compliance with such
restriction; and (4) require that an increasing level of
conservation benefits be provided whenever circumstances allow
it.
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\16\For this purpose, a person is related to another person if such
person bears a relationship to such other person described in section
267(b) (determined without regard to paragraph (9) thereof), or section
707(b)(1), determined by substituting 25 percent for 50 percent for
purposes of those determinations. If such other person is a nonprofit
organization, a person is related to such nonprofit organization if
such person controls directly or indirectly more than 25 percent of the
governing body of such nonprofit organization.
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The issuance of qualified forest conservation bonds
generally is subject to the rules applicable to issuance of
exempt-facility private activity bonds. However, the issuance
of such bonds is not subject to the State volume cap. In
addition, the restrictions on acquisition of land and existing
property do not apply to such bonds. For purposes of
determining the maximum maturity on such bonds, the land and
standing timber acquired with the proceeds of the bonds is
treated as having an economic life of 35 years.

Exclusion of certain qualified harvesting activity income from tax

Income from qualified harvesting activities
Under the provision, income, gains, deductions, losses, or
credits from a qualified harvesting activity conducted by a
qualified organization generally are not subject to tax or
taken into account for Federal income tax purposes. A qualified
harvesting activity means the sale, lease, or harvesting of
standing timber: (1) on land owned by a qualified organization
that it acquired with proceeds of qualified forest conservation
bonds; and (2) pursuant to a qualified conservation plan
adopted by the organization. Qualified harvesting activity does
not include any sale, lease, or harvesting for any period
during which the organization ceases to qualify as a qualified
organization.
Timber cutting and the sale or lease of timber is not a
qualified harvesting activity to the extent the timber
harvesting or removal exceeds prescribed limits. For this
purpose, the average annual area of timber harvested cannot
exceed 2.5 percent of the total area of the land acquired with
the proceeds of qualified forest conservation bonds; or the
quantity of timber removed from such land cannot exceed the
quantity that can be removed from such land annually in
perpetuity on a sustained-yield basis determined only with
respect to such land. Certain deviations from these
restrictions are permitted to protect the forest from
catastrophic danger, such as by fire or windthrow, or from
imminent danger from insect or disease attack.
The amount of income from a qualified harvesting activity
that may be excluded from gross income for a taxable year may
not exceed the amount used by the qualified organization to
make debt service payments during such taxable year for
qualified forest conservation bonds.\17\ The exclusion of
income from a qualified harvesting activity does not apply
during any period the organization fails to qualify as a
qualified organization, or after the bonds are no longer
outstanding or fail to qualify as tax-exempt bonds.
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\17\This debt service limitation does not apply to income that
otherwise is not subject to tax under other provisions of the Code
(e.g., income from harvesting if such harvesting activity is not an
unrelated trade or business within the meaning of section 513 with
respect to the qualified organization).
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Qualified conservation plan
A qualified conservation plan means a multiple land use
plan (a) designed and administered primarily for the purposes
of protecting and enhancing wildlife, fish, timber, scenic
attributes, recreation, and soil and water quality of the
forest and forest land, (b) mandates that conservation of the
forest and forest land is the single-most significant use of
the forest and land, and (c) requires that timber harvesting be
consistent with (1) restoring and maintaining reference
conditions for the region's ecotype (such as with respect to
types of trees), (2) restoring and maintaining a representative
sample of young, mid, and late successional forest age classes,
(3) maintaining or restoring the resources' ecological health
for purposes of preventing damage from fire, insect, or
disease, (4) maintaining or enhancing wildlife or fish habitat,
or (5) enhancing research opportunities in sustainable
renewable resource uses.

Recapture taxes

Once the qualified forest conservation bonds issued for a
qualified organization are no longer outstanding or cease to
qualify as qualified private activity bonds, the qualified
organization becomes liable for a recapture of tax benefits
(plus interest) for its excess harvesting activities. Under the
provision, if the average annual area of timber harvested from
the land exceeds the applicable 2.5 percent average annual area
limitation, the organization's income tax liability is
increased by the amount of the tax benefits (plus interest)
attributable to such excess harvesting.

EFFECTIVE DATE

The provision is effective for obligations issued on or
after the date that is 180 days after the date of enactment.

I. Deduction for Qualified Timber Gain and Timber REIT Provisions

(Secs. 209-214 of the bill and new sec. 1203, and secs. 856, 857 and
4981 of the Code)

PRESENT LAW

Treatment of certain timber gain

Under present law, if a taxpayer cuts standing timber, the
taxpayer may elect to treat the cutting as a sale or exchange
eligible for capital gains treatment (sec. 631(a)). For
purposes of determining the gain attributable to such cutting,
and the cost of the cut timber for purposes of the taxpayer's
income from later sales of the timber or timber products, the
fair market value of the timber on the first day of the taxable
year in which the timber is used. Also, if a taxpayer disposes
of the timber with a retained economic interest or makes an
outright sale of the timber, the gain is eligible for capital
gain treatment (sec. 631(b)). This treatment under either
section 631(a) or (b) requires that the taxpayer has owned the
timber or held the contract right for a period of more than one
year.
Under present law, for taxable years beginning before
January 1, 2011, the maximum rate of tax on long term capital
gain (``net capital gain'')\18\ of an individual, estate, or
trust is 15 percent. Any net capital gain that otherwise would
be taxed at a 10- or 15-percent rate is taxed at a 5-percent
rate (zero for taxable years beginning after 2007). These rates
apply for purposes of both the regular tax and the alternative
minimum tax.\19\
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\18\Net capital gain is defined as the excess of net long-term
capital gain over net short-term capital gain for the taxable year.
Sec. 1222(11).
\19\Because the entire amount of the capital gain is included in
alternative minimum taxable income (``AMTI''), for taxpayers subject to
the alternative minimum tax with AMTI in excess of $112,500 ($150,000
in the case of a joint return), the gain may cause a reduction in the
minimum tax exemption amount and thus effectively tax the gain at rates
of 21.5 or 22 percent. Also the gain may cause the phase-out of certain
benefits in computing the regular tax.
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For taxable years beginning after December 31, 2010, the
maximum rate of tax on the net capital gain of an individual is
20 percent. Any net capital gain that otherwise would be taxed
at a 10- or 15-percent rate is taxed at a 10-percent rate. In
addition, any gain from the sale or exchange of property held
more than five years that would otherwise have been taxed at
the 10-percent rate is taxed at an 8-percent rate. Any gain
from the sale or exchange of property held more than five years
and the holding period for which began after December 31, 2000,
which would otherwise have been taxed at a 20-percent rate, is
taxed at an 18-percent rate. The net capital gain of a
corporation is taxed at the same rates as ordinary income, up
to a maximum rate of 35 percent.
Real estate investment trusts (``REITs'') are subject to a
special taxation regime. Under this regime, a REIT is allowed a
deduction for dividends paid to its shareholders.\20\ As a
result, REITs generally do not pay tax on distributed income,
but the income is taxed to the REIT shareholders. A REIT that
has long term capital gain can declare a dividend that
shareholders are entitled to treat as long term capital gain.
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\20\A distribution to a corporate shareholder out of current or
accumulated earnings and profits of the corporation is a dividend,
unless the distribution is a redemption that terminates the
shareholder's stock interest or reduces the shareholder's interest in
the distributing corporation to an extent considered to result in
treatment as a sale or exchange of the shareholder's stock. Secs. 301
and 302. A distribution in excess of corporate earnings and profits is
treated by shareholders as first a recovery of their stock basis and
then, to the extent the distribution exceeds a shareholder's stock
basis, as a sale or exchange of the stock. Sec. 301. These rules
generally apply to REITs.
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REITs generally are required to distribute 90 percent of
their taxable income (other than net capital gain). A REIT
generally must pay tax at regular corporate rates on any
undistributed income. However, a REIT that has net capital gain
can retain that gain without distributing it, and the
shareholders can report the net capital gain as if it were
distributed to them. In that case the REIT pays a C corporation
tax on the retained gain, but the shareholders who report the
income are entitled to a credit or refund for the difference
between the tax that would be due if the income had been
distributed and the 35-percent rate paid by the REIT.\21\ In
effect, net capital gain of a REIT (including but not limited
to timber gain) can be taxed as net capital gain of the
shareholders, whether or not the gain is distributed.
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\21\Sec. 857(b)(3)(D). The shareholders also obtain a basis
increase in their REIT stock for the gross amount of the deemed
distribution that is included in their income less the amount of
corporate tax deemed paid by them that was paid by the REIT on the
retained gain. Sec. 857(b)(3)(D)(iii).
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Other REIT provisions

A REIT is also subject to a 4-percent excise tax to the
extent it does not distribute specified percentages of its
income within any calendar year. The required distributed
percentage is 85 percent in the case of the REIT ordinary
income, and 95 percent in the case of the REIT capital gain net
income (as defined).\22\ The amount of the excess of the
required distribution over the actual distribution is subject
to the 4-percent tax.
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\22\Section 4981. The definition is the excess of gains from sales
or exchanges of capital assets over losses from such sales or exchanges
for the calendar year, reduced by any net ordinary loss.
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A REIT generally is restricted to earning certain types of
passive income. Among other requirements, at least 75 percent
of the gross income of a REIT in a taxable year must consist of
certain types of real estate related income, including rents
from real property, income from the sale or exchange of real
property (including interests in real property) that is not
stock in trade, inventory, or held by the taxpayer primarily
for sale to customers in the ordinary course of its trade or
business, and interest on mortgages secured by real property or
interests in real property.\23\ Interests in real property are
specifically defined to exclude mineral, oil, or gas royalty
interests.\24\ A REIT will not qualify as a REIT, and will be
taxable as a C corporation, for any taxable year if it does not
meet this income test.
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\23\Section 856(c) and section 1221(a). Income from sales that are
not prohibited transactions solely by virtue of section 857(b)(6) is
also qualified REIT income.
\24\Section 856(c)(5)(C).
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Some REITs have been formed to hold land on which trees are
grown. Upon maturity of the trees, the standing trees are sold
by the REIT. The Internal Revenue Service has issued private
letter rulings in particular instances stating that the income
from the sale of the trees under section 631(b) can qualify as
REIT real property income because the uncut timber and the
timberland on which the timber grew is considered real property
and the sale of uncut trees can qualify as capital gain derived
from the sale of real property.\25\
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\25\Timber income under section 631(b) has also been held to be
qualified real estate income even if the one year holding period is not
met. See, e.g., PLR 200052021, see also PLR 199945055, PLR 199927021,
PLR 8838016. A private letter ruling may be relied upon only by the
taxpayer to which the ruling is issued. However, such rulings provide
an indication of administrative practice.
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A REIT is subject to a 100-percent excise tax on gain from
any sale that is a ``prohibited transaction,'' defined as a
sale of property that is stock in trade, inventory, or property
held by the taxpayer primarily for sale to customers in the
ordinary course of its trade or business.\26\ This
determination is based on facts and circumstances. However, a
safe-harbor provides that no excise tax is imposed if certain
requirements are met. In the case of timber property, the safe
harbor is met, regardless of the number of sales that occur
during the taxable year, if (i) the REIT has held the property
for not less than 4 years in connection with the trade or
business of producing timber; (ii) the aggregate adjusted bases
of the property sold (other than foreclosure property) during
the taxable year does not exceed 10 percent of the aggregate
bases of all the assets of the REIT as of the beginning of the
taxable year, and if certain other requirements are met. These
include requirements that limit the amount of expenditures the
REIT can make during the 4-year period prior to the sale that
are includible in the adjusted basis of the property,\27\ that
require marketing to be done by an independent contractor, and
that forbid a sales price that is based on the income or
profits of any person.\28\ There is a similar but separate safe
harbor for sales of non-timber property, with similar rules,
including a 4-year holding period requirement and a limit on
the percentage of the aggregate adjusted basis of property that
can be sold in one taxable year.\29\
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\26\Sections 857(b)(6) and 1221(a)(1). There is an exception for
certain foreclosure property.
\27\Aggregate expenditures (other than timberland acquisition
expenditures) during such period made by the REIT or a partner of the
REIT, which are includible in basis, may not exceed 30 percent of the
net selling price in the case of expenditures that are directly related
to operation of the property for the production of timber or the
preservation of the property for use as timberland, and may not exceed
5 percent of the net selling price in the case of expenditures that are
not directly related to those purposes.
\28\Section 857(b)(6)(D).
\29\Section 857(b)(6)(C).
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A REIT is not generally permitted to hold securities
representing more than 10 percent of the voting power or value
of the securities of any one issuer; nor may more than 5
percent of the fair market value of REIT assets be securities
of any one issuer.\30\ However, under an exception, a REIT may
hold any amount of securities of one or more ``taxable REIT
subsidiary'' (TRS) corporations, provided that such TRS
securities do not represent more than 20 percent of the fair
market value of REIT assets at the end of any quarter. A TRS is
a C corporation that is subject to regular corporate tax on its
income and that meets certain other requirements. A taxable
REIT subsidiary may conduct activities that would produce
disqualified non-passive or non-real estate income that could
disqualify the REIT if conducted by a REIT itself. Such
business could include business relating to processing timber,
or holding timber products or other assets for sale to
customers in the ordinary course of business. Such income would
be subject to regular corporate rates of tax as income of the
TRS.\31\
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\30\Section 856(c)(4)(B)(ii) and (iii). Certain interests are not
treated as ``securities'' for purposes of the rule forbidding the REIT
to hold securities representing more than 10 percent of the value of
securities of any one issuer. Sec. 856(m).
\31\A 100-percent excise tax is imposed on the amount of certain
transactions involving a TRS and a REIT, to the extent such amount
would exceed an arm's length amount under section 482. Sec. 857(b)(7).
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REASONS FOR CHANGE

The committee believes it is desirable to provide greater
equivalence to the capital gain tax treatment of timber gain,
regardless of whether the gain is recognized by a C corporation
or a REIT, or by an individual. The committee also believes it
is desirable to provide changes to the statutory rules
governing REITs, in order to clarify and facilitate timber REIT
operations.

EXPLANATION OF PROVISION

Elective deduction for 60 percent of qualified timber gain

The provision allows a taxpayer to elect to deduct an
amount equal to 60 percent of the taxpayer's qualified timber
gain (or, if less, the net capital gain) for a taxable year. In
the case of an individual, the deduction reduces adjusted gross
income. Qualified timber gain means the net gain described in
section 631(a) and (b) for the taxable year.
The deduction is allowed in computing the regular tax and
the alternative minimum tax (including the adjusted current
earnings of a corporation).
If a taxpayer elects the deduction, the 40 percent of the
gain subject to tax is taxed at ordinary income tax rates.\32\
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\32\Under the provision, because only 40 percent of the gain is
included in adjusted gross income and AMTI, only that amount of gain
would result in the phase-out of tax benefits.
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In the case of a pass-thru entity other than a REIT, the
election may be made separately by each taxpayer subject to tax
on the gain. The Treasury Department may prescribe rules
appropriate to apply this provision to gain taken into account
by a pass-thru entity.
In the case of a REIT, the election to take the 60-percent
deduction is made by the REIT. If a REIT makes the election,
then the timber gain is excluded from the computation of
capital gain or loss of the REIT and can no longer be
designated as a capital gain dividend to shareholders. Instead,
the gain is treated as ordinary income for purposes of applying
the REIT income distribution requirements, but for this purpose
60-percent of the amount of the gain is deductible by the REIT
in computing its income. REIT earnings and profits also exclude
the portion of the timber gain that is deductible. Thus, 40
percent of the gain is subject to the REIT distribution
requirements,\33\ and 40 percent of the gain increases REIT
earnings and profits. Accordingly, because REIT earnings and
profits have been increased by the 40-percent amount, there is
sufficient earnings and profits that a distribution of that 40-
percent amount that otherwise qualifies as a dividend would be
treated as an ordinary dividend distribution to shareholders.
Since this dividend is from a REIT and is not derived from an
entity that was taxed as a C corporation, it would not qualify
for the current 15 percent qualified dividend rates and would
be taxed at the ordinary income rates of the shareholders.
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\33\For purposes of the section 4981 excise tax on undistributed
REIT income, the amount treated as subject to the 95 percent
distribution requirement is the 40 percent of timber gain income that
remains after allowing the deduction.
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REIT shareholders obtain an upward basis adjustment in
their REIT interests, equal to the 60 percent of the timber
gain that is deductible by the electing REIT. Because the 60
percent of timber gain that was deductible by the REIT does not
increase REIT earnings and profits, a distribution of such 60
percent to the shareholder generally will not be treated as a
dividend (in the absence of other retained earnings) but as a
return of basis under the general rules of section 301(c).
Because the shareholders' basis has been increased by this 60
percent, this distribution would not exceed the shareholders'
basis and thus would be nontaxable return of basis, rather than
capital gain in excess of basis. However, if a REIT shareholder
has obtained such an upward basis adjustment for a REIT
interest and disposes of the interest before having held the
interest for at least 6 months, then any loss on disposition of
the interest is disallowed to the extent of such upward basis
adjustment.

Additional REIT provisions

Timber gain qualified REIT income without regard to 1 year
holding period
The provision specifically includes timber gain under
section 631(a) as a category of statutorily recognized
qualified real estate income of a REIT if the cutting is
provided by a taxable REIT subsidiary, and also includes gain
recognized under section 631(b). For purposes of such qualified
income treatment under those provisions, the requirement of a
one-year holding period is removed. Thus, for a example, a REIT
can acquire timber property and harvest the timber on the
property within one year of the acquisition, with the resulting
income being qualified real estate income for REIT
qualification purposes, even though such income is not eligible
for long term capital gain treatment under sections 631(a) or
(b). The provision specifically provides, however, that for all
purposes of the Code, such income shall not be considered to be
gain described in section 1221(a)(1), that is, it shall not be
treated as income from the sale of stock in trade, inventory,
or property held by the REIT primarily for sale to customers in
the ordinary course of the REITs trade or business.
For purposes of determining REIT income, if the cutting is
done by a taxable REIT subsidiary, the cut timber is deemed
sold on the first day of the taxable year to the taxable REIT
subsidiary (with subsequent gain, if any, attributable to the
taxable REIT subsidiary).
REIT prohibited transaction safe harbor for timber property
For sales to a qualified organization for conservation
purposes, as defined in section 170(h), the provision reduces
to 2 years the present law 4-year holding period requirement
under section 857(b)(6)(D), which provides a safe harbor from
``prohibited transaction'' treatment for certain timber
property sales. Also, in the case of such sales, the safe-
harbor limitations on how much may be added, within the 4-year
period prior to the date of sale, to the aggregate adjusted
basis of the property, are changed to refer to the 2-year
period prior to the date of sale.
The provision also removes the safe-harbor requirement that
marketing of the property must be done by an independent
contractor, and permits a taxable REIT subsidiary of the REIT
to perform the marketing.
The provision states that any gain that is eligible for the
timber property safe harbor is considered for all purposes of
the Code not to be described in section 1221(a)(1), that is, it
shall not be treated as income from the sale of stock in trade,
inventory, or property held by the REIT primarily for sale to
customers in the ordinary course of the REITs trade or
business.
Special rules for Timber REITs
The provision contains several provisions applicable only
to a ``timber REIT,'' defined as a REIT in which more than 50
percent of the value of its total assets consists of real
property held in connection with the trade or business of
producing timber.
First, mineral royalty income from real property owned by a
timber REIT and held, or once held, in connection with the
trade or business of producing timber by such REIT, is included
as qualifying real estate income for purposes of the REIT
income tests.
Second, a timber REIT is permitted to hold TRS securities
with a value up to 25 percent, (rather than 20 percent) of the
value of the total assets of the REIT.

EFFECTIVE DATE

The provision applies to taxable years beginning after the
date of enactment, but does not apply after the last day of the
first taxable year beginning after the date of enactment.

TITLE III--ENERGY PROVISIONS

A. Credit for Residential and Business Wind Property

(Sec. 301 of the bill and secs. 25D and 48 of the Code)

PRESENT LAW

Credit for residential energy efficient property

A personal tax credit is allowed for the purchase of
qualified solar electric property and qualified solar water
heating property that is used exclusively for purposes other
than heating swimming pools and hot tubs.\34\ The credit is
equal to 30 percent of qualifying expenditures, with a maximum
credit for each of these systems of property of $2,000 per
taxable year. A 30 percent credit is also allowed for the
purchase of qualified fuel cell power plants. The credit for
any fuel cell power plant may not exceed $500 for each 0.5
kilowatt of capacity.
---------------------------------------------------------------------------
\34\Sec. 25D.
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Qualifying solar water heating property means expenditure
for property to heat water for use in a dwelling unit located
in the United States and used as a residence if at least half
of the energy used by such property for such purpose is derived
from the sun. Qualified solar electric property is property
that uses solar energy to generate electricity for use in a
dwelling unit. A qualified fuel cell power plant is an
integrated system comprised of a fuel cell stack assembly and
associated balance of plant components that (1) converts a fuel
into electricity using electrochemical means, (2) has an
electricity-only generation efficiency of greater than 30
percent. The qualified fuel cell power plant must be installed
on or in connection with a dwelling unit located in the United
States and used by the taxpayer as a principal residence.
The credit is nonrefundable, and the depreciable basis of
the property is reduced by the amount of the credit.
Expenditures for labor costs allocable to onsite preparation,
assembly, or original installation of property eligible for the
credit are eligible expenditures.
Certain equipment safety requirements must be met to
qualify for the credit. Special proration rules apply in the
case of jointly owned property, condominiums, and tenant-
stockholders in cooperative housing corporations. If less than
80 percent of the property is used for nonbusiness purposes,
only that portion of expenditures that is used for nonbusiness
purposes is taken into account.
The credit applies to expenditures after December 31, 2005,
for property placed in service prior to January 1, 2009.

Energy credit for businesses

In general
A nonrefundable, 10-percent business energy credit\35\ is
allowed for the cost of new property that is equipment that
either (1) uses solar energy to generate electricity, to heat
or cool a structure, or to provide solar process heat, or (2)
is used to produce, distribute, or use energy derived from a
geothermal deposit, but only, in the case of electricity
generated by geothermal power, up to the electric transmission
stage. Property used to generate energy for the purposes of
heating a swimming pool is not eligible solar energy property.
---------------------------------------------------------------------------
\35\Sec. 48.
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The energy credit is a component of the general business
credit\36\ and as such is subject to the alternative minimum
tax. An unused general business credit generally may be carried
back one year and carried forward 20 years.\37\ The taxpayer's
basis in the property is reduced by one-half of the amount of
the credit claimed.\38\ For projects whose construction time is
expected to equal or exceed two years, the credit may be
claimed as progress expenditures are made on the project,
rather than during the year the property is placed in service.
Similarly, the credit only applies to expenditures made after
the effective date of the provision.
---------------------------------------------------------------------------
\36\Sec. 38(b)(1).
\37\Sec. 39.
\38\Sec. 50(c)(3).
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In general, property that is public utility property is not
eligible for the credit. Public utility property is property
that is used predominantly in the trade or business of the
furnishing or sale of (1) electrical energy, water, or sewage
disposal services, (2) gas through a local distribution system,
or (3) telephone service, domestic telegraph services, or other
communication services (other than international telegraph
services), if the rates for such furnishing or sale have been
established or approved by a State or political subdivision
thereof, by an agency or instrumentality of the United States,
or by a public service or public utility commission. This rule
is waived in the case of telecommunication companies' purchases
of fuel cell and microturbine property.
Special rules for solar energy property
The credit for solar energy property is increased to 30
percent in the case of periods after December 31, 2005 and
prior to January 1, 2009. Additionally, equipment that uses
fiber-optic distributed sunlight to illuminate the inside of a
structure is solar energy property eligible for the 30-percent
credit.
Fuel cells and microturbines
The business energy credit also applies for the purchase of
qualified fuel cell power plants, but only for periods after
December 31, 2005 and prior to January 1, 2009. The credit rate
is 30 percent.
A qualified fuel cell power plant is an integrated system
composed of a fuel cell stack assembly and associated balance
of plant components that (1) converts a fuel into electricity
using electrochemical means, and (2) has an electricity-only
generation efficiency of greater than 30 percent and a capacity
of at least 0.5 kilowatt. The credit may not exceed $500 for
each 0.5 kilowatt of capacity.
The business energy credit also applies for the purchase of
qualifying stationary microturbine power plants, but only for
periods after December 31, 2005 and prior to January 1, 2009.
The credit is limited to the lesser of 10 percent of the basis
of the property or $200 for each kilowatt of capacity.
A qualified stationary microturbine power plant is an
integrated system comprised of a gas turbine engine, a
combustor, a recuperator or regenerator, a generator or
alternator, and associated balance of plant components that
converts a fuel into electricity and thermal energy. Such
system also includes all secondary components located between
the existing infrastructure for fuel delivery and the existing
infrastructure for power distribution, including equipment and
controls for meeting relevant power standards, such as voltage,
frequency and power factors. Such system must have an
electricity-only generation efficiency of not less that 26
percent at International Standard Organization conditions and a
capacity of less than 2,000 kilowatts.
Additionally, for purposes of the fuel cell and
microturbine credits, and only in the case of
telecommunications companies, the general present-law section
48 restriction that would otherwise prohibit telecommunication
companies from claiming the new credit due to their status as
public utilities is waived.

REASONS FOR CHANGE

The Committee believes that the promotion of viable
alternative energy sources is essential to reduce dependence of
foreign oil and to reduce the harmful impacts of fossil fuel
consumption. As wind energy is a proven and effective
alternative means of electricity generation, the Committee
believes a credit for wind energy property should be made
available on similar terms to that provided for solar electric
generation under present law.

EXPLANATION OF PROVISION

Residential wind credit

The provision provides a 30 percent credit for qualified
small wind energy property expenditures made by the taxpayer
during the taxable year. The credit is limited to $4,000 per
taxable year. Qualified small wind energy property expenditures
are expenditures for property that uses a qualified wind
turbine to generate electricity for use in a dwelling unit
located in the U.S. and used as a residence by the taxpayer. A
qualifying wind turbine means a wind turbine of 100 kilowatts
of rated capacity or less that meets the latest performance
rating standards published by the American Wind Energy
Association.

Business wind credit

The provision provides a credit of 30 percent of the basis
of qualified small wind energy property placed in service
during the taxable year. The credit is limited to $4,000 per
taxable year. Qualified small wind energy property is property
that uses a qualified wind turbine to generate electricity for
use in the U.S. A qualifying wind turbine means a wind turbine
of 100 kilowatts of rated capacity or less that meets the
latest performance rating standards published by the American
Wind Energy Association. As part of the section 48 energy
credit, a basis reduction of 50 percent of the amount of the
credit applies.

EFFECTIVE DATE

The provision is effective for expenditures after December
31, 2007, for property placed in service prior to January 1,
2009.

B. Landowner Incentive To Encourage Electric Transmission Build-Out

(Sec. 302 of the bill and new sec. 139B of the Code)

PRESENT LAW

Gross income includes all income from whatever source
derived unless a specific exclusion applies.\39\
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\39\Sec. 61.
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REASON FOR CHANGE

The Committee believes that an incentive should be provided
for the build-out of electricity generated from certain
alternative energy sources.

EXPLANATION OF PROVISION

The proposal provides an exclusion from gross income for
any qualified electric transmission easement payment. For
purposes of the proposal, a qualified electric transmission
easement payment is any payment by an electric utility or
electric transmission entity pursuant to an easement or other
agreement granted by the payee for the right to locate on the
payee's property transmission lines and equipment used to
transmit electricity at 230 or more kilovolts primarily from
qualified facilities described in section 45(d) (without regard
to any placed in service date).

EFFECTIVE DATE

The proposal is effective for payments received after the
date of enactment.

C. Exception to Reduction of Renewable Electricity Credit

(Sec. 303 of the bill and sec. 45 of the Code)

PRESENT LAW

In general

An income tax credit is allowed for the production of
electricity at qualified facilities using qualified energy
resources.\40\ Qualified energy resources comprise wind,
closed-loop biomass, open-loop biomass, geothermal energy,
solar energy, small irrigation power, municipal solid waste,
and qualified hydropower production. Qualified facilities are,
generally, facilities that generate electricity using qualified
energy resources. To be eligible for the credit, electricity
produced from qualified energy resources at qualified
facilities must be sold by the taxpayer to an unrelated person.
In addition to the electricity production credit, an income tax
credit is allowed for the production of refined coal and Indian
coal at qualified facilities.\41\
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\40\Sec. 45.
\41\Collectively, the electricity production credit, the refined
coal production credit, and the Indian coal production credit are
referred to herein as the section 45 credit.
---------------------------------------------------------------------------

Credit amounts and credit period

In general
The base amount of the electricity production credit is 1.5
cents per kilowatt-hour (indexed annually for inflation) of
electricity produced. The amount of the credit is 2 cents per
kilowatt-hour for 2007. A taxpayer may generally claim a credit
during the 10-year period commencing with the date the
qualified facility is placed in service. The credit is reduced
for grants, tax-exempt bonds, subsidized energy financing, and
other credits.
The amount of credit a taxpayer may claim is phased out as
the market price of electricity (or refined coal in the case of
the refined coal production credit) exceeds certain threshold
levels. The electricity production credit is reduced over a 3
cent phase-out range to the extent the annual average contract
price per kilowatt hour of electricity sold in the prior year
from the same qualified energy resource exceeds 8 cents
(adjusted for inflation). The refined coal credit is reduced
over an $8.75 phase-out range as the reference price of the
fuel used as feedstock for the refined coal exceeds the
reference price for such fuel in 2002 (adjusted for inflation).
Reduced credit amounts and credit periods
Generally, in the case of open-loop biomass facilities
(including agricultural livestock waste nutrient facilities),
geothermal energy facilities, solar energy facilities, small
irrigation power facilities, landfill gas facilities, and trash
combustion facilities, the 10-year credit period is reduced to
five years commencing on the date the facility was originally
placed in service, for qualified facilities placed in service
before August 8, 2005. However, for qualified open-loop biomass
facilities (other than a facility described in sec.
45(d)(3)(A)(i) that uses agricultural livestock waste
nutrients) placed in service before October 22, 2004, the five-
year period commences on January 1, 2005. In the case of a
closed-loop biomass facility modified to co-fire with coal, to
co-fire with other biomass, or to co-fire with coal and other
biomass, the credit period begins no earlier than October 22,
2004.
In the case of open-loop biomass facilities (including
agricultural livestock waste nutrient facilities), small
irrigation power facilities, landfill gas facilities, trash
combustion facilities, and qualified hydropower facilities the
otherwise allowable credit amount is 0.75 cent per kilowatt-
hour, indexed for inflation measured after 1992 (currently 1
cent per kilowatt-hour for 2007).
Credit applicable to refined coal
The amount of the credit for refined coal is $4.375 per ton
(also indexed for inflation after 1992 and equaling $5.877 per
ton for 2007).
Credit applicable to Indian coal
A credit is available for the sale of Indian coal to an
unrelated third part from a qualified facility for a seven-year
period beginning on January 1, 2006, and before January 1,
2013. The amount of the credit for Indian coal is $1.50 per ton
for the first four years of the seven-year period and $2.00 per
ton for the last three years of the seven-year period.
Beginning in calendar years after 2006, the credit amounts are
indexed annually for inflation using 2005 as the base year; for
2007 the Indian coal credit is $1.544 per ton.
Special rules and other limitations on credit claimants and
credit amounts
In general, in order to claim the credit, a taxpayer must
own the qualified facility and sell the electricity produced by
the facility (or refined coal or Indian coal, with respect to
those credits) to an unrelated party. A lessee or operator may
claim the credit in lieu of the owner of the qualifying
facility in the case of qualifying open-loop biomass facilities
and in the case of closed-loop biomass facilities modified to
co-fire with coal, to co-fire with other biomass, or to co-fire
with coal and other biomass. In the case of a poultry waste
facility, the taxpayer may claim the credit as a lessee or
operator of a facility owned by a governmental unit.
For all qualifying facilities, other than closed-loop
biomass facilities modified to co-fire with coal, to co-fire
with other biomass, or to co-fire with coal and other biomass,
the amount of credit a taxpayer may claim is reduced by reason
of grants, tax-exempt bonds, subsidized energy financing, and
other credits, but the reduction cannot exceed 50 percent of
the otherwise allowable credit. In the case of closed-loop
biomass facilities modified to co-fire with coal, to co-fire
with other biomass, or to co-fire with coal and other biomass,
there is no reduction in credit by reason of grants, tax-exempt
bonds, subsidized energy financing, and other credits.
The credit for electricity produced from renewable sources
is a component of the general business credit.\42\ For
alternative minimum tax purposes, a taxpayer's tentative
minimum tax is treated as being zero when determining the tax
liability limitation for the section 45 credit for electricity
produced from a facility (placed in service after October 22,
2004) during the first four years of production beginning on
the date the facility is placed in service.
---------------------------------------------------------------------------
\42\Sec. 38(b)(8).
---------------------------------------------------------------------------
Special rules apply for eligible cooperatives claiming the
section 45 credit. For taxable years ending after August 8,
2005, eligible cooperatives may elect to pass any portion of
the credit through to their patrons. An eligible cooperative is
defined as a cooperative organization that is owned more than
50 percent by agricultural producers or entities owned by
agricultural producers. The credit may be apportioned among
patrons eligible to share in patronage dividends on the basis
of the quantity or value of business done with or for such
patrons for the taxable year.

Qualified facilities

Wind energy facility
A wind energy facility is a facility that uses wind to
produce electricity. To be a qualified facility, a wind energy
facility must be placed in service after December 31, 1993, and
before January 1, 2009.
Closed-loop biomass facility
A closed-loop biomass facility is a facility that uses any
organic material from a plant which is planted exclusively for
the purpose of being used at a qualifying facility to produce
electricity. In addition, a facility can be a closed-loop
biomass facility if it is a facility that is modified to use
closed-loop biomass to co-fire with coal, with other biomass,
or with both coal and other biomass, but only if the
modification is approved under the Biomass Power for Rural
Development Programs or is part of a pilot project of the
Commodity Credit Corporation.
To be a qualified facility, a closed-loop biomass facility
must be placed in service after December 31, 1992, and before
January 1, 2009. In the case of a facility using closed-loop
biomass but also co-firing the closed-loop biomass with coal,
other biomass, or coal and other biomass, a qualified facility
must be originally placed in service and modified to co-fire
the closed-loop biomass at any time before January 1, 2009.
Open-loop biomass (including agricultural livestock waste
nutrients) facility
An open-loop biomass facility is a facility that uses open-
loop biomass to produce electricity. For purposes of the
credit, open-loop biomass is defined as (1) any agricultural
livestock waste nutrients or (2) any solid, nonhazardous,
cellulosic waste material or any lignin material that is
segregated from other waste materials and which is derived
from:
forest-related resources, including mill and
harvesting residues, precommercial thinnings, slash,
and brush;
solid wood waste materials, including waste
pallets, crates, dunnage, manufacturing and
construction wood wastes, and landscape or right-of-way
tree trimming; or
agricultural sources, including orchard tree
crops, vineyard, grain, legumes, sugar, and other crop
by-products or residues.
Agricultural livestock waste nutrients are defined as
agricultural livestock manure and litter, including bedding
material for the disposition of manure. Wood waste materials do
not qualify as open-loop biomass to the extent they are
pressure treated, chemically treated, or painted. In addition,
municipal solid waste, gas derived from the biodegradation of
solid waste, and paper which is commonly recycled do not
qualify as open-loop biomass. Open-loop biomass does not
include closed-loop biomass or any biomass burned in
conjunction with fossil fuel (co-firing) beyond such fossil
fuel required for start up and flame stabilization.
In the case of an open-loop biomass facility that uses
agricultural livestock waste nutrients, a qualified facility is
one that was originally placed in service after October 22,
2004, and before January 1, 2009, and has a nameplate capacity
rating which is not less than 150 kilowatts. In the case of any
other open-loop biomass facility, a qualified facility is one
that was originally placed in service before January 1, 2009.
Geothermal facility
A geothermal facility is a facility that uses geothermal
energy to produce electricity. Geothermal energy is energy
derived from a geothermal deposit that is a geothermal
reservoir consisting of natural heat that is stored in rocks or
in an aqueous liquid or vapor (whether or not under pressure).
To be a qualified facility, a geothermal facility must be
placed in service after October 22, 2004 and before January 1,
2009.
Solar facility
A solar facility is a facility that uses solar energy to
produce electricity. To be a qualified facility, a solar
facility must be placed in service after October 22, 2004, and
before January 1, 2006.
Small irrigation facility
A small irrigation power facility is a facility that
generates electric power through an irrigation system canal or
ditch without any dam or impoundment of water. The installed
capacity of a qualified facility must be at least 150 kilowatts
but less than five megawatts. To be a qualified facility, a
small irrigation facility must be originally placed in service
after October 22, 2004, and before January 1, 2009.
Landfill gas facility
A landfill gas facility is a facility that uses landfill
gas to produce electricity. Landfill gas is defined as methane
gas derived from the biodegradation of municipal solid waste.
To be a qualified facility, a landfill gas facility must be
placed in service after October 22, 2004, and before January 1,
2009.
Trash combustion facility
Trash combustion facilities are facilities that burn
municipal solid waste (garbage) to produce steam to drive a
turbine for the production of electricity. To be a qualified
facility, a trash combustion facility must be placed in service
after October 22, 2004 and before January 1, 2009. A qualified
trash combustion facility includes a new unit, placed in
service after October 22, 2004, that increases electricity
production capacity at an existing trash combustion facility. A
new unit generally would include a new burner/boiler and
turbine. The new unit may share certain common equipment, such
as trash handling equipment, with other pre-existing units at
the same facility. Electricity produced at a new unit of an
existing facility qualifies for the production credit only to
the extent of the increased amount of electricity produced at
the entire facility.
Hydropower facility
A qualifying hydropower facility is (1) a facility that
produced hydroelectric power (a hydroelectric dam) prior to
August 8, 2005, at which efficiency improvements or additions
to capacity have been made after such date and before January
1, 2009, that enable the taxpayer to produce incremental
hydropower or (2) a facility placed in service before August 8,
2005, that did not produce hydroelectric power (a
nonhydroelectric dam) on such date, and to which turbines or
other electricity generating equipment have been added after
such date and before January 1, 2009.
At an existing hydroelectric facility, the taxpayer may
claim credit only for the production of incremental
hydroelectric power. Incremental hydroelectric power for any
taxable year is equal to the percentage of average annual
hydroelectric power produced at the facility attributable to
the efficiency improvement or additions of capacity determined
by using the same water flow information used to determine a
historic average annual hydroelectric power production baseline
for that facility. The Federal Energy Regulatory Commission
will certify the baseline power production of the facility and
the percentage increase due to the efficiency and capacity
improvements.
At a nonhydroelectric dam, the facility must be licensed by
the Federal Energy Regulatory Commission and meet all other
applicable environmental, licensing, and regulatory
requirements and the turbines or other generating devices must
be added to the facility after August 8, 2005 and before
January 1, 2009. In addition there must not be any enlargement
of the diversion structure, or construction or enlargement of a
bypass channel, or the impoundment or any withholding of
additional water from the natural stream channel.
Refined coal facility
A qualifying refined coal facility is a facility producing
refined coal that is placed in service after October 22, 2004
and before January 1, 2009. Refined coal is a qualifying
liquid, gaseous, or solid fuel produced from coal (including
lignite) or high-carbon fly ash, including such fuel used as a
feedstock. A qualifying fuel is a fuel that when burned emits
20 percent less nitrogen oxides and either SO2 or mercury than
the burning of feedstock coal or comparable coal predominantly
available in the marketplace as of January 1, 2003, and if the
fuel sells at prices at least 50 percent greater than the
prices of the feedstock coal or comparable coal. In addition,
to be qualified refined coal the fuel must be sold by the
taxpayer with the reasonable expectation that it will be used
for the primary purpose of producing steam.
Indian coal facility
A qualified Indian coal facility is a facility which is
placed in service before January 1, 2009, that produces coal
from reserves that on June 14, 2005, were owned by a Federally
recognized tribe of Indians or were held in trust by the United
States for a tribe or its members.

Summary of credit rate and credit period by facility type

TABLE 1.--SUMMARY OF SECTION 45 CREDIT
----------------------------------------------------------------------------------------------------------------
Credit period for
facilities placed in Credit period
Eligible electricity production or Credit amount for 2007 service on or before facilities placed in
coal production activity (cents per kilowatt- August 8, 2005 (years service after August 8,
hour; dollars per ton) from placed-in-service 2005 (years from placed-
date) in-service date)
----------------------------------------------------------------------------------------------------------------
Wind................................. 2 10 10
Closed-loop biomass.................. 2 \1\10 10
Open-loop biomass (including 1 \2\5 10
agricultural livestock waste
nutrient facilities)................
Geothermal........................... 2 5 10
Solar (pre-2006 facilities only)..... 2 5 10
Small irrigation power............... 1 5 10
Municipal solid waste (including 1 5 10
landfill gas facilities and trash
combustion facilities)..............
Qualified hydropower................. 1 N/A 10
Refined Coal......................... 5.877 10 10
Indian Coal.......................... 1.544 \3\7 \3\7
----------------------------------------------------------------------------------------------------------------
\1\In the case of certain co-firing closed-loop facilities, the credit period begins no earlier than October 22,
2004.
\2\For certain facilities placed in service before October 22, 2004, the 5-year credit period commences on
January 1, 2005.
\3\For Indian coal, the credit period begins for coal sold after January 1, 2006.

REASONS FOR CHANGE

The Committee believes that building additional renewable
energy infrastructure advances America's environmental and
energy independence goals. The Committee believes that
additional renewable energy infrastructure will be built if the
tax incentives for renewable energy are better coordinated with
certain federal spending programs.

EXPLANATION OF PROVISION

The provision provides an exception to the reduction in the
section 45 credit by reason of grants, tax-exempt bonds,
subsidized energy financing, and other credits. Under the
provision, the section 45 credit is not reduced by any loans,
loan guarantees, or grants to farmers, ranchers, or rural small
businesses issued by the Secretary of Agriculture under
authority granted by section 9006 of the Farm Security and
Rural Investment Act of 2002 (Pub. L. No. 107-171).

EFFECTIVE DATE

The provision is effective for facilities placed in service
after the date of enactment.

D. Expansion of Special Depreciation Allowance to Cellulosic Biomass
Alcohol Fuel Plant

(Sec. 311 of the bill and sec. 168(l) of the Code)

PRESENT LAW

Section 168(l) allows an additional first-year depreciation
deduction equal to 50 percent of the adjusted basis of
qualified cellulosic biomass ethanol plant property. In order
to qualify, the property generally must be placed in service
before January 1, 2013.
Qualified cellulosic biomass ethanol plant property means
property used in the U.S. solely to produce cellulosic biomass
ethanol. For this purpose, cellulosic biomass ethanol means
ethanol derived from any lignocellulosic or hemicellulosic
matter that is available on a renewable or recurring basis. For
example, lignocellulosic or hemicellulosic matter that is
available on a renewable or recurring basis includes bagasse
(from sugar cane), corn stalks, and switchgrass.
The additional first-year depreciation deduction is allowed
for both regular tax and alternative minimum tax purposes for
the taxable year in which the property is placed in service.
The additional first-year depreciation deduction is subject to
the general rules regarding whether an item is deductible under
section 162 or subject to capitalization under section 263 or
section 263A. The basis of the property and the depreciation
allowances in the year of purchase and later years are
appropriately adjusted to reflect the additional first-year
depreciation deduction. In addition, there is no adjustment to
the allowable amount of depreciation for purposes of computing
a taxpayer's alternative minimum taxable income with respect to
property to which the provision applies. A taxpayer is allowed
to elect out of the additional first-year depreciation for any
class of property for any taxable year.
In order for property to qualify for the additional first-
year depreciation deduction, it must meet the following
requirements. The original use of the property must commence
with the taxpayer on or after December 20, 2006. The property
must be acquired by purchase (as defined under section 179(d))
by the taxpayer after December 20, 2006, and placed in service
before January 1, 2013. Property does not qualify if a binding
written contract for the acquisition of such property was in
effect on or before December 20, 2006.
Property that is manufactured, constructed, or produced by
the taxpayer for use by the taxpayer qualifies if the taxpayer
begins the manufacture, construction, or production of the
property after December 20, 2006, and the property is placed in
service before January 1, 2013 (and all other requirements are
met). Property that is manufactured, constructed, or produced
for the taxpayer by another person under a contract that is
entered into prior to the manufacture, construction, or
production of the property is considered to be manufactured,
constructed, or produced by the taxpayer.
Property any portion of which is financed with the proceeds
of a tax-exempt obligation under section 103 is not eligible
for the additional first-year depreciation deduction. Recapture
rules apply if the property ceases to be qualified cellulosic
biomass ethanol plant property.
Property with respect to which the taxpayer has elected 50
percent expensing under section 179C is not eligible for the
additional first-year depreciation deduction.

REASONS FOR CHANGE

The Committee believes that the expensing provision should
include any cellulosic biomass alcohol and not be limited to
ethanol. Additionally, the Committee believes that the
provision should not be limited to certain processes.

EXPLANATION OF PROVISION

The provision changes the definition of qualified property.
Under the provision, qualified property includes property used
solely to produce cellulosic biomass alcohol. Cellulosic
biomass alcohol is defined as any alcohol produced by any
process from any lignocellulosic or hemicellulosic matter that
is available on a renewable or recurring basis.

EFFECTIVE DATE

The provision is effective for property placed in service
in taxable years ending after the date of enactment.

E. Credit for Production of Cellulosic Biomass Alcohol

(Sec. 312 of the bill and sec. 40 of the Code)

PRESENT LAW

In the case of ethanol, the Code provides a separate 10-
cents-per-gallon credit for up to 15 million gallons per year
for small producers, defined generally as persons whose
production capacity does not exceed 60 million gallons per
year. The ethanol must (1) be sold by such producer to another
person (a) for use by such other person in the production of a
qualified alcohol fuel mixture in such person's trade or
business (other than casual off-farm production), (b) for use
by such other person as a fuel in a trade or business, or, (c)
who sells such ethanol at retail to another person and places
such ethanol in the fuel tank of such other person; or (2) used
by the producer for any purpose described in (a), (b), or (c).
A cooperative may pass through the small ethanol producer
credit to its patrons. The credit is includible in income and
is treated as a general business credit, subject to the
ordering rules and carryforward/carryback rules that apply to
business credits generally. The alcohol fuels tax credit, of
which the small producer credit is a part, is scheduled to
expire after December 31, 2010.
Under the Renewable Fuels Standard Program all renewable
fuel produced or imported on or after September 1, 2007 must
have a renewable identification number (RIN) associated with
it. Producers and importers must generate RINs to represent all
the renewable fuel they produce or import and provide those
RINs to the EPA. For cellulosic ethanol, 2.5 RINs are generated
for every gallon produced.

REASONS FOR CHANGE

The Committee believes that the development of fuels from
cellulosic materials, such as corn stover, switchgrass, and
other organic materials that can be grown anywhere, is a
significant component in establishing the nation's energy
independence. Tax incentives are an important part of taking
this industry from the level of demonstration projects into a
practical and competitive fuel source. To encourage new
production capacity for this fuel, the provision provides a new
per-gallon incentive for cellulosic alcohol fuel producers.

EXPLANATION OF PROVISION

The provision provides an income tax credit for up to 60
million gallons of qualified cellulosic fuel production of the
producer for the taxable year. The amount of the credit per
gallon is $1.28 less the credit amount for alcohol fuel and the
credit amount for small ethanol producers as of the date the
cellulosic alcohol fuel is produced. This credit is in addition
to any credit that may be available under section 40 of the
Code. A small cellulosic alcohol fuel producer is not precluded
from also claiming the alcohol or alcohol fuel mixture credit,
or the small ethanol producer credit, if the requirements for
those credits are also met. For example, in the case of a
gallon of ethanol, a small producer may be able to claim 50
cents as a cellulosic alcohol producer, plus 51 cents under the
alcohol fuel mixture credit, and an additional 10 cents as a
small ethanol producer.
Qualified cellulosic fuel production is any cellulosic
alcohol which is produced by a small cellulosic alcohol fuel
producer during the taxable year which is sold by such producer
to another person (a) for use by such other person in the
production of a qualified alcohol fuel mixture in such person's
trade or business (other than casual off-farm production), (b)
for use by such other person as a fuel in a trade or business,
or, (c) who sells such alcohol at retail to another person and
places such alcohol in the fuel tank of such other person; or
(2) used by the producer for any purpose described in (a), (b),
or (c).
Cellulosic alcohol is alcohol that is produced in the
United States and is derived from any lignocellulosic or
hemicellulosic matter that is available on a renewable or
recurring basis. Examples of lignocellulosic or hemicellulosic
matter that is available of a renewable or recurring basis
includes dedicated energy crops and trees, wood and wood
residues, plants, grasses, agricultural residues, fibers,
animal wastes and other waste materials, and municipal solid
waste.
Generally, a small cellulosic alcohol fuel producer is a
cellulosic alcohol producer whose production capacity does not
exceed 60 million gallons.
The small cellulosic alcohol producer credit is limited to
domestic production. Only domestically produced cellulosic
alcohol sold for use, or used, in the United States qualifies
for the credit.
The small cellulosic alcohol producer credit terminates on
April 1, 2015.

EFFECTIVE DATE

The provision is effective for alcohol produced after
December 31, 2007.

F. Extension of Small Ethanol Producer Credit

(Sec. 313 of the bill and sec. 40 of the Code)

PRESENT LAW

The alcohol fuels credit is the sum of three credits: the
alcohol mixture credit, the alcohol credit, and the small
ethanol producer credit. Generally, the alcohol fuels credit
expires after December 31, 2010.\43\
---------------------------------------------------------------------------
\43\The alcohol fuels credit is unavailable when, for any period
before January 1, 2011, the tax rates for gasoline and diesel fuels
drop to 4.3 cents per gallon.
---------------------------------------------------------------------------
Taxpayers are eligible for an income tax credit of 51 cents
per gallon of ethanol (60 cents in the case of alcohol other
than ethanol) used in the production of a qualified mixture
(the ``alcohol mixture credit''). A ``qualified mixture'' means
a mixture of alcohol and gasoline, (or of alcohol and a special
fuel) sold by the taxpayer as fuel, or used as fuel by the
taxpayer producing such mixture. The term ``alcohol'' includes
methanol and ethanol but does not include (1) alcohol produced
from petroleum, natural gas, or coal (including peat), or (2)
alcohol with a proof of less than 150.
Taxpayers may reduce their income taxes by 51 cents for
each gallon of ethanol, which is not in a mixture with gasoline
or other special fuel, that they sell at the retail level as
vehicle fuel or use themselves as a fuel in their trade or
business (``the alcohol credit''). For alcohol other than
ethanol, the rate is 60 cents per gallon.\44\
---------------------------------------------------------------------------
\44\In the case of any alcohol (other than ethanol) with a proof
that is at least 150 but less than 190, the credit is 45 cents per
gallon (the ``low-proof blender amount''). For ethanol with a proof
that is at least 150 but less than 190, the low-proof blender amount is
37.78 cents.
---------------------------------------------------------------------------
In the case of ethanol, the Code provides an additional 10-
cents-per-gallon credit for up to 15 million gallons per year
for small producers. Small producers are defined generally as
persons whose production capacity does not exceed 60 million
gallons per year. The ethanol must (1) be sold by such producer
to another person (a) for use by such other person in the
production of a qualified alcohol fuel mixture in such person's
trade or business (other than casual off-farm production), (b)
for use by such other person as a fuel in a trade or business,
or, (c) who sells such ethanol at retail to another person and
places such ethanol in the fuel tank of such other person; or
(2) be used by the producer for any purpose described in (a),
(b), or (c). A cooperative may pass through the small ethanol
producer credit to its patrons.
The alcohol fuels credit is includible in income and is
treated as a general business credit, subject to the ordering
rules and carryforward/carryback rules that apply to business
credits generally. The credit is allowable against the
alternative minimum tax.

REASONS FOR CHANGE

The Committee believes that as the ethanol industry
continues to mature, it is appropriate to encourage small
producers to continue to participate in such industry.
Therefore, the bill extends the small ethanol producer credit
for an additional two years.

EXPLANATION OF PROVISION

The provision extends the small ethanol producer component
of the alcohol fuels credit for an additional two years
(through December 31, 2012).

EFFECTIVE DATE

The provision is effective on the date of enactment.

G. Credit for Producers of Fossil-Free Alcohol

(Sec. 314 of the bill and sec. 40 of the Code)

PRESENT LAW

The alcohol fuels credit is the sum of three credits: the
alcohol mixture credit, the alcohol credit, and the small
ethanol producer credit. Generally, the alcohol fuels credit
expires after December 31, 2010.\45\
---------------------------------------------------------------------------
\45\The alcohol fuels credit is unavailable when, for any period
before January 1, 2011, the tax rates for gasoline and diesel fuels
drop to 4.3 cents per gallon.
---------------------------------------------------------------------------
Taxpayers are eligible for an income tax credit of 51 cents
per gallon of ethanol (60 cents in the case of alcohol other
than ethanol) used in the production of a qualified mixture
(the ``alcohol mixture credit''). A ``qualified mixture'' means
a mixture of alcohol and gasoline, (or of alcohol and a special
fuel) sold by the taxpayer as fuel, or used as fuel by the
taxpayer producing such mixture. The term ``alcohol'' includes
methanol and ethanol but does not include (1) alcohol produced
from petroleum, natural gas, or coal (including peat), or (2)
alcohol with a proof of less than 150.
Taxpayers may reduce their income taxes by 51 cents for
each gallon of ethanol, which is not in a mixture with gasoline
or other special fuel, that they sell at the retail level as
vehicle fuel or use themselves as a fuel in their trade or
business (``the alcohol credit''). For alcohol other than
ethanol, the rate is 60 cents per gallon.\46\
---------------------------------------------------------------------------
\46\In the case of any alcohol (other than ethanol) with a proof
that is at least 150 but less than 190, the credit is 45 cents per
gallon (the ``low-proof blender amount''). For ethanol with a proof
that is at least 150 but less than 190, the low-proof blender amount is
37.78 cents.
---------------------------------------------------------------------------
In the case of ethanol, the Code provides an additional 10-
cents-per-gallon credit for up to 15 million gallons per year
for small producers. Small producer is defined generally as a
producer whose production capacity does not exceed 60 million
gallons per year. The ethanol must (1) be sold by such producer
to another person (a) for use by such other person in the
production of a qualified alcohol fuel mixture in such person's
trade or business (other than casual off-farm production), (b)
for use by such other person as a fuel in a trade or business,
or, (c) who sells such ethanol at retail to another person and
places such ethanol in the fuel tank of such other person; or
(2) be used by the producer for any purpose described in (a),
(b), or (c). A cooperative may pass through the small ethanol
producer credit to its patrons.
The alcohol fuels credit is includible in income and is
treated as a general business credit, subject to the ordering
rules and carryforward/carryback rules that apply to business
credits generally. The credit is allowable against the
alternative minimum tax.

REASONS FOR CHANGE

The production of ethanol consumes a significant amount of
fossil fuel. To encourage the use of alternative fuels in that
production process, the Committee believes it is appropriate to
provide an additional credit to small producers of ethanol that
displace 90 percent of the fossil-fuel use with bio-based
fuels.

EXPLANATION OF PROVISION

The provision adds a new component to the alcohol fuels
credit, the small fossil-free alcohol producer credit. The
credit provides an additional 25-cents-per-gallon credit for up
to 60 million gallons of alcohol produced at a fossil-free
facility during the calendar year for small producers. Small
producer is defined generally as a producer whose fossil-free
alcohol production capacity does not exceed 60 million gallons
per year. A fossil-free facility is one at which 90 percent of
the fuel used in the production of alcohol at such facility is
from biomass as defined in sec. 45K(c)(3).
The alcohol must (1) be sold by such producer to another
person (a) for use by such other person in the production of a
qualified alcohol fuel mixture in such person's trade or
business (other than casual off-farm production), (b) for use
by such other person as a fuel in a trade or business, or, (c)
who sells such ethanol at retail to another person and places
such ethanol in the fuel tank of such other person; or (2) used
by the producer for any purpose described in (1)(a), (b), or
(c). Only domestically produced alcohol, sold for use or used
in the United States qualifies for the credit. A cooperative
may pass through the small producer credit to its patrons.
The credit terminates after December 31, 2012.

EFFECTIVE DATE

The provision is effective after December 31, 2007.

H. Modification of Alcohol Credit

(Sec. 315 of the bill and secs. 40, 6426 and 6427 of the Code)

Income tax credit

The alcohol fuels credit is the sum of three credits: the
alcohol mixture credit, the alcohol credit, and the small
ethanol producer credit. Generally, the alcohol fuels credit
expires after December 31, 2010.\47\
---------------------------------------------------------------------------
\47\The alcohol fuels credit is unavailable when, for any period
before January 1, 2011, the tax rates for gasoline and diesel fuels
drop to 4.3 cents per gallon.
---------------------------------------------------------------------------
Taxpayers are eligible for an income tax credit of 51 cents
per gallon of ethanol (60 cents in the case of alcohol other
than ethanol) used in the production of a qualified mixture
(the ``alcohol mixture credit''). A ``qualified mixture'' means
a mixture of alcohol and gasoline, (or of alcohol and a special
fuel) sold by the taxpayer as fuel, or used as fuel by the
taxpayer producing such mixture. The term ``alcohol'' includes
methanol and ethanol but does not include (1) alcohol produced
from petroleum, natural gas, or coal (including peat), or (2)
alcohol with a proof of less than 150.
Taxpayers may reduce their income taxes by 51 cents for
each gallon of ethanol, which is not in a mixture with gasoline
or other special fuel, that they sell at the retail level as
vehicle fuel or use themselves as a fuel in their trade or
business (``the alcohol credit''). For alcohol other than
ethanol, the rate is 60 cents per gallon.\48\
---------------------------------------------------------------------------
\48\In the case of any alcohol (other than ethanol) with a proof
that is at least 150 but less than 190, the credit is 45 cents per
gallon (the ``low-proof blender amount''). For ethanol with a proof
that is at least 150 but less than 190, the low-proof blender amount is
37.78 cents.
---------------------------------------------------------------------------
In the case of ethanol, the Code provides an additional 10-
cents-per-gallon credit for up to 15 million gallons per year
for small producers. Small producer is defined generally as
persons whose production capacity does not exceed 60 million
gallons per year. The ethanol must (1) be sold by such producer
to another person (a) for use by such other person in the
production of a qualified alcohol fuel mixture in such person's
trade or business (other than casual off-farm production), (b)
for use by such other person as a fuel in a trade or business,
or, (c) who sells such ethanol at retail to another person and
places such ethanol in the fuel tank of such other person; or
(2) used by the producer for any purpose described in (a), (b),
or (c). A cooperative may pass through the small ethanol
producer credit to its patrons.
The alcohol fuels credit is includible in income and is
treated as a general business credit, subject to the ordering
rules and carryforward/carryback rules that apply to business
credits generally. The credit is allowable against the
alternative minimum tax.

Excise tax credit and payment provision for alcohol fuel mixtures

The Code also provides an excise tax credit and payment
provision for alcohol fuel mixtures. Like the income tax
credit, the amount of the credit is 60 cents per gallon of
alcohol used as part of a qualified mixture (51 cents in the
case of ethanol). For purposes of the excise tax credit and
payment provisions, alcohol includes methanol and ethanol but
does not include (1) alcohol produced from petroleum, natural
gas, or coal (including peat), or (2) alcohol with a proof of
less than 190. Such term also includes an alcohol gallon
equivalent of ethyl tertiary butyl either or other ethers
produced from alcohol. In lieu of a tax credit, a person making
a qualified mixture eligible for the credit may seek a payment
from the Secretary in the amount of the credit. The payment
provisions and credits are coordinated such that the incentive
is not claimed more than once for each gallon of alcohol used
as part of qualified mixture.

Renewable Fuels Standard Program

Under the Renewable Fuels Standard Program all renewable
fuel produced or imported on or after September 1, 2007 must
have a renewable identification number (RIN) associated with
it. Producers and importers must generate RINs to represent all
the renewable fuel they produce or import and provide those
RINs to the Environmental Protection Agency. For cellulosic
ethanol, 2.5 RINs are generated for every gallon produced.

REASONS FOR CHANGE

As the ethanol industry further matures, the Committee
believes it is appropriate to reduce the amount of the tax
incentive.

EXPLANATION OF PROVISION

Under the provision, the 51-cent-per-gallon incentive for
ethanol is adjusted to 46 cents per gallon beginning with the
first calendar year after the year in which the Environmental
Protection Agency receives RINs in an amount equivalent to 7.5
billion gallons of ethanol (including cellulosic ethanol).

EFFECTIVE DATE

The provision is effective on the date of enactment.

I. Calculation of Volume of Alcohol for Fuels Credits

(Sec. 316 of the bill, and sec. 40 of the Code)

PRESENT LAW

The Code provides a per-gallon credit for the volume of
alcohol used as a fuel or in a qualified mixture. For purposes
of determining the number of gallons of alcohol with respect to
which the credit is allowable, the volume of alcohol includes
any denaturant, including gasoline.\49\ The denaturant must be
added under a formula approved by the Secretary and the
denaturant cannot exceed five percent of the volume of such
alcohol (including denaturants).
---------------------------------------------------------------------------
\49\Sec. 40(d)(4).
---------------------------------------------------------------------------

REASONS FOR CHANGE

Gasoline can be used as a denaturant of alcohol. The
Committee believes it is inappropriate to allow a credit that
is intended to be for alcohol to be claimed on liquids that do
not constitute alcohol.

EXPLANATION OF PROVISION

The provision provides that the volume of alcohol eligible
for the credit does not include the volume of any denaturant.

EFFECTIVE DATE

The provision is effective January 1, 2008.

J. Ethanol Tariff Extension

(Sec. 317 of the bill)

PRESENT LAW

Heading 9901.00.50 of the Harmonized Tariff Schedule of the
United States imposes a cumulative general duty of 14.27 cents
per liter (approximately 54 cents per gallon) to imports of
ethyl alcohol, and any mixture containing ethyl alcohol, if
used as a fuel or in producing a mixture to be used as a fuel,
that are entered into the United States prior to January 1,
2009. The temporary duty under heading 9901.00.50 offsets the
alcohol fuels credit of 51 cents per gallon that is available
to taxpayers that blend ethanol with gasoline; both domestic
and imported ethanol is eligible for the alcohol fuels credit.
Heading 9901.00.52 of the Harmonized Tariff Schedule of the
United States imposes a general duty of 5.99 cents per liter to
imports of ethyl tertiary-butyl ether, and any mixture
containing ethyl tertiary-butyl ether, that are entered into
the United States prior to January 1, 2009.

REASONS FOR CHANGE

The Committee believes it is appropriate to extend the
tariff through the end of calendar year 2010.

EXPLANATION OF PROVISION

The provision modifies the existing effective period for
ethyl alcohol as classified under heading 9901.00.50 and
9901.00.52 of the Harmonized Tariff Schedule of the United
States from before January 1, 2009 to before January 1, 2011.

EFFECTIVE DATE

The provision is effective on the date of enactment.

K. Elimination and Reductions of Duty Drawback on Certain Imported
Ethanol

(Sec. 318 of the bill)

PRESENT LAW

Subheading 9901.00.50, Harmonized Tariff Schedule of the
United States (``HTSUS''), imposes an additional duty on
ethanol that is used as fuel or use to make fuel. Subsection
(b) of Section 1313 of the Tariff Act of 1930, as amended,
permits the refund of duty if the duty-paid good, or a
substitute good, is used to make an article that is exported.
Subsection (j)(2) of Section 1313 permits the refund of duty if
the duty-paid good, or a substitute good, is exported.
Subsection (p) of section 1313 permits the substitution on
exportation for drawback eligibility of one motor fuel for
another motor fuel. A person who manufactures or acquires
gasoline with ethanol subject to the duty imposed by subheading
9901.00.50, HTSUS, can export jet fuel (which does not involve
the use of ethanol) and obtain a refund of the duty paid under
subheading 9901.00.50, HTSUS.

REASONS FOR CHANGE

The Committee believes it is appropriate to eliminate the
ability to claim duty drawback on the substitution of jet fuel
for ethyl alcohol (ethanol), or an ethyl alcohol mixture, used
as a fuel. In addition, the Committee believes that it is
appropriate to eliminate the ability to claim duty drawback on
the substitution of a low-value ethyl alcohol for ethyl alcohol
(ethanol) subject to the duty under HTSUS subheading
9901.00.50.

EXPLANATION OF PROVISION

The provision eliminates the ability to obtain a refund of
the duty imposed by subheading 9901.00.50, HTSUS by
substitution of ethanol not subject to the duty under
subheading 9901.00.50, HTSUS for ethanol subject to the duty
imposed under subheading 9901.00.50, HTSUS, for drawback
purposes. The provision also prevents a petroleum product which
contains ethanol from being substituted for any other petroleum
product that is exported to obtain drawback.

EFFECTIVE DATE

The provision is effective for any good exported on and
after the fifteenth day after enactment.

L. Extension of Credits for Biodiesel

(Sec. 321 of the bill and secs. 40A, 6426 and 6427 of the Code)

PRESENT LAW

Income tax credit

Overview
The Code provides an income tax credit for biodiesel fuels
(the ``biodiesel fuels credit'').\50\ The biodiesel fuels
credit is the sum of the biodiesel mixture credit, the
biodiesel credit, and the small agri-biodiesel producer credit.
The biodiesel fuels credit is treated as a general business
credit. The amount of the biodiesel fuels credit is includable
in gross income. The biodiesel fuels credit is coordinated to
take into account benefits from the biodiesel excise tax credit
and payment provisions discussed below. The credit does not
apply to fuel sold or used after December 31, 2008.
---------------------------------------------------------------------------
\50\Sec. 40A.
---------------------------------------------------------------------------
Biodiesel is monoalkyl esters of long chain fatty acids
derived from plant or animal matter that meet (1) the
registration requirements established by the Environmental
Protection Agency under section 211 of the Clean Air Act and
(2) the requirements of the American Society of Testing and
Materials D6751. Agri-biodiesel is biodiesel derived solely
from virgin oils including oils from corn, soybeans, sunflower
seeds, cottonseeds, canola, crambe, rapeseeds, safflowers,
flaxseeds, rice bran, mustard seeds, or animal fats. The
language ``including'' indicates that this list is not
exclusive.\51\ Camelina is a plant from which oil can be
extracted.
---------------------------------------------------------------------------
\51\Treasury Notice 2005-62.
---------------------------------------------------------------------------
Biodiesel may be taken into account for purposes of the
credit only if the taxpayer obtains a certification (in such
form and manner as prescribed by the Secretary) from the
producer or importer of the biodiesel which identifies the
product produced and the percentage of the biodiesel and agri-
biodiesel in the product.
Biodiesel mixture credit
The biodiesel mixture credit is 50 cents for each gallon of
biodiesel (other than agri-biodiesel) used by the taxpayer in
the production of a qualified biodiesel mixture. For agri-
biodiesel, the credit is $1.00 per gallon. A qualified
biodiesel mixture is a mixture of biodiesel and diesel fuel
that (1) is sold by the taxpayer producing such mixture to any
person for use as a fuel, or (2) is used as a fuel by the
taxpayer producing such mixture. The sale or use must be in the
trade or business of the taxpayer and is to be taken into
account for the taxable year in which such sale or use occurs.
No credit is allowed with respect to any casual off-farm
production of a qualified biodiesel mixture.
Biodiesel credit
The biodiesel credit is 50 cents for each gallon of
biodiesel which is not in a mixture with diesel fuel (100
percent biodiesel or B-100) and which during the taxable year
is (1) used by the taxpayer as a fuel in a trade or business or
(2) sold by the taxpayer at retail to a person and placed in
the fuel tank of such person's vehicle. For agri-biodiesel, the
credit is $1.00 per gallon.
Small agri-biodiesel producer credit
The Code provides a small agri-biodiesel producer income
tax credit, in addition to the biodiesel and biodiesel fuel
mixture credits. The credit is a 10-cents-per-gallon credit for
up to 15 million gallons of agri-biodiesel produced by small
producers, defined generally as persons whose agri-biodiesel
production capacity does not exceed 60 million gallons per
year. The agri-biodiesel must (1) be sold by such producer to
another person (a) for use by such other person in the
production of a qualified biodiesel mixture in such person's
trade or business (other than casual off-farm production), (b)
for use by such other person as a fuel in a trade or business,
or, (c) who sells such agri-biodiesel at retail to another
person and places such ethanol in the fuel tank of such other
person; or (2) used by the producer for any purpose described
in (a), (b), or (c).

Biodiesel mixture excise tax credit

The Code also provides an excise tax credit for biodiesel
mixtures.\52\ The credit is 50 cents for each gallon of
biodiesel used by the taxpayer in producing a biodiesel mixture
for sale or use in a trade or business of the taxpayer. In the
case of agri-biodiesel, the credit is $1.00 per gallon. A
biodiesel mixture is a mixture of biodiesel and diesel fuel
that (1) is sold by the taxpayer producing such mixture to any
person for use as a fuel, or (2) is used as a fuel by the
taxpayer producing such mixture. No credit is allowed unless
the taxpayer obtains a certification (in such form and manner
as prescribed by the Secretary) from the producer of the
biodiesel that identifies the product produced and the
percentage of biodiesel and agri-biodiesel in the product.\53\
---------------------------------------------------------------------------
\52\Sec. 6426(c).
\53\Sec. 6426(c)(4).
---------------------------------------------------------------------------
The credit is not available for any sale or use for any
period after December 31, 2008. This excise tax credit is
coordinated with the income tax credit for biodiesel such that
credit for the same biodiesel cannot be claimed for both income
and excise tax purposes.

Payments with respect to biodiesel fuel mixtures

If any person produces a biodiesel fuel mixture in such
person's trade or business, the Secretary is to pay such person
an amount equal to the biodiesel mixture credit.\54\ To the
extent the biodiesel fuel mixture credit exceeds the section
4081 liability of a person, the Secretary is to pay such person
an amount equal to the biodiesel fuel mixture credit with
respect to such mixture.\55\ Thus, if the person has no section
4081 liability, the credit is refundable. The Secretary is not
required to make payments with respect to biodiesel fuel
mixtures sold or used after December 31, 2008.
---------------------------------------------------------------------------
\54\Sec. 6427(e).
\55\Sec. 6427(e)(1) and 6427(e)(3).
---------------------------------------------------------------------------

REASONS FOR CHANGE

The Committee believes it is appropriate to extend the
biodiesel incentives to further encourage the development and
use of this fuel. In particular, to encourage the participation
of small producers into the market, the Committee believes it
is appropriate to extend the small agri-biodiesel producer
credit an additional four years.

EXPLANATION OF PROVISION

The provision generally extends an additional two years
(through December 31, 2010) the income tax credit, excise tax
credit, and payment provisions for biodiesel (including agri-
biodiesel). The small agri-biodiesel producer credit is
extended an additional four years (through December 31, 2012).
The provision adds camelina to the illustrative and
nonexclusive list of sources of virgin oils for agri-biodiesel.

EFFECTIVE DATE

The provision is effective on the date of enactment.

M. Extension and Modification of Renewable Diesel Incentives

(Sec. 321 of the bill and sec. 40A(f), 6426 and 6427 of the Code)

PRESENT LAW

The Code provides a tax incentive of $1.00 per gallon
relating to renewable diesel that is part of a qualified
mixture with diesel fuel. This incentive may be taken as an
income tax credit, an excise tax credit, or as a payment from
the Secretary.\56\ The incentive is available only to the
person who produced and sold or used the mixture in their trade
or business and is based on the gallons of renewable diesel in
the mixture. The provisions relating to renewable diesel do not
apply after December 31, 2008.
---------------------------------------------------------------------------
\56\Secs. 40A, 6426(c), and 6427(e). For purposes of the Code,
renewable diesel is generally treated as biodiesel. The Code also
provides an income tax credit for renewable diesel that is not in a
mixture which is sold at retail to a person and placed in the fuel tank
of such person's vehicle or used by the taxpayer producing the
renewable diesel as a fuel in a trade or business. See sec. 40A(b)(2)
in conjunction with sec. 40A(f)(1).
---------------------------------------------------------------------------
``Renewable diesel'' is diesel fuel that (1) is derived
from biomass (as defined in section 45K(c)(3)\57\) using a
thermal depolymerization process; (2) meets the registration
requirements for fuels and fuel additives established by the
Environmental Protection Agency under section 211 of the Clean
Air Act (42 U.S.C. sec. 7545); and (3) meets the requirements
of the American Society of Testing and Materials (ASTM) D975 or
D396. ASTM D975 provides standards for diesel fuel suitable for
use in diesel engines. ASTM D396 provides standards for fuel
oil intended for use in fuel-oil burning equipment, such as
furnaces.
---------------------------------------------------------------------------
\57\``Biomass'' means any organic material other than (1) oil and
natural gas (or any product thereof) and (2) coal (including lignite)
or any product thereof (sec. 45K(c)(3)).
---------------------------------------------------------------------------
Pursuant to IRS Notice 2007-37, the Secretary provided that
fuel produced as a result of co-processing biomass and
petroleum feedstock (``co-produced fuel'') qualifies for the
renewable diesel incentives to the extent of the fuel
attributable to the biomass in the mixture. In co-produced
fuel, the fuel attributable to the biomass does not exist as a
distinct separate quantity prior to mixing.

REASONS FOR CHANGE

To encourage the further development of renewable diesel,
the Committee believes it is appropriate to extend the tax
incentives for this fuel. However, the Committee also believes
that less incentives are needed for renewable diesel produced
as part of the refining process of crude oil. Utilizing
existing refinery processes does not require significant
investment in new equipment to produce the renewable diesel.
Therefore, the Committee limits the incentive as it relates to
co-produced fuel.

EXPLANATION OF PROVISION

The provision provides that, on a per year basis, producers
of co-produced fuel may claim $1.00 per gallon for up to 60
million gallons of renewable diesel contained in a qualified
mixture. The 60 million gallons is determined on a per facility
basis. No credit is allowable for gallons in excess of 60
million gallons produced at a facility. As under present law,
the credit and payments are only for that volume of renewable
diesel contained in the qualified mixture and not the total
volume of co-produced fuel.
The provision extends the tax incentives for renewable
diesel (income tax credit, excise tax credit, and payment
provisions) an additional two years (through December 31,
2010).

EFFECTIVE DATE

The provision restricting the amount of credit allowable
for co-produced fuels is effective for fuels sold or used after
the date of enactment. The extension of the renewable diesel
incentives is effective on the date of enactment.

N. Treatment of Qualified Alcohol Mixtures and Qualified Biodiesel Fuel
Mixtures as Taxable Fuels

(Sec. 322 of the bill and sec. 4083 of the Code)

PRESENT LAW

An excise tax is imposed upon (1) the removal of any
taxable fuel from a refinery or terminal, (2) the entry of any
taxable fuel into the United States, or (3) the sale of any
taxable fuel to any person who is not registered with the IRS
to receive untaxed fuel, unless there was a prior taxable
removal or entry.\58\ The tax does not apply to any removal or
entry of taxable fuel transferred in bulk by pipeline or vessel
to a terminal or refinery if the person removing or entering
the taxable fuel, the operator of such pipeline or vessel
(excluding deep draft vessels) and the operator of such
terminal or refinery are registered with the Secretary.\59\ The
term ``taxable fuel'' means gasoline, diesel fuel, and
kerosene.\60\
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\58\Sec. 4081(a)(1).
\59\Sec. 4081(a)(1)(B).
\60\Sec. 4083(a).
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Diesel fuel is (1) any liquid suitable for use in a diesel
powered highway vehicle or diesel powered train, (2) transmix,
and (3) diesel fuel blendstocks identified by the
Secretary.\61\ By regulation, diesel fuel does not include
kerosene, gasoline, No. 5 and No. 6 fuel oils (as described in
ASTM Specification D 396), or F-76 (Fuel Naval Distillates MIL-
F-16884) any liquid that contains less than four percent normal
parafins, or any liquid that has a distillation range of 125
degrees Fahrenheit or less, sulfur content of 10 ppm or less
and minimum color of +27 Saybolt.\62\
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\61\Sec. 4083(a)(3).
\62\Treas. Reg. sec. 48.4081-1(c)(2)(ii).
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Biodiesel is monoalkyl esters of long chain fatty acids
derived from plant or animal matter which meet (1) the
registration requirements for fuels and fuel additives
established by the Environmental Protection Agency under
section 211 of the Clean Air Act, and (2) the requirements of
the American Society of Testing Materials D6751 (``ASTM
D6751'').
Biodiesel is not a taxable fuel because it has less than
four percent paraffin content. Ethanol and other fuel alcohols
also are not treated as taxable fuel. However, such fuels are
subject to the backup tax under section 4041 if sold for use or
used as a fuel in a diesel powered highway vehicle or diesel
powered train and not for a nontaxable use. In addition, such
fuels are taxable if used in the production of a blended
taxable fuel.\63\
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\63\Under Treas. Reg. sec. 48.4081-1(c), blended taxable fuel
generally means any taxable fuel that (1) is produced outside the bulk
transfer/terminal system and (2) by mixing taxable fuel with respect to
which tax has been imposed under sec. 4081(a)(gasoline, diesel fuel, or
kerosene) with any other liquid on which tax has not been imposed under
sec. 4081.
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The Code provides per-gallon tax incentives relating to
biodiesel fuel used in a qualified mixture. The taxpayer has
the option of taking the credit amount as an income tax credit,
excise tax credit against the tax imposed on taxable fuels
(``section 4081 liability'') or as a payment from the Secretary
in the amount of the credit. The credit is 50 cents for each
gallon of biodiesel used by the taxpayer in producing a
biodiesel mixture for sale or use in a trade or business of the
taxpayer. In the case of agri-biodiesel, the credit is $1.00
per gallon. No credit is allowed unless the taxpayer obtains a
certification from the producer or importer of the biodiesel
that identifies the product produced and the percentage of
biodiesel and agri-biodiesel in the product.
A qualified biodiesel mixture is a mixture of biodiesel and
diesel fuel that (1) is sold by the taxpayer producing such
mixture to any person for use as a fuel, or (2) is used as a
fuel by the taxpayer producing such mixture. Pursuant to
Treasury Notice, a mixture of 99.9 percent biodiesel and diesel
fuel is considered a mixture but such mixture is not a blended
taxable fuel because it contains less than four percent
paraffin content. Thus, while eligible for the biodiesel fuel
mixture tax credit and payment provisions, such fuel would not
be subject to tax until put in a motor vehicle for a taxable
use.
The Code also provides per-gallon tax incentives relating
to alcohol used in a qualified mixture. A qualified mixture
means a mixture of alcohol and gasoline, (or of alcohol and a
special fuel) sold by the taxpayer as fuel, or used as fuel by
the taxpayer producing such mixture. The credit is 51 cents if
the alcohol is ethanol (60 cents in the case of other
alcohols).

REASONS FOR CHANGE

The Committee notes that when it enacted the credit for
qualified biodiesel fuel mixtures, it intended that the
resulting mixture of biodiesel and diesel fuel would be a
taxable fuel and that the credit would be taken against the tax
imposed on that fuel if not used for a nontaxable purpose. For
biodiesel not in a mixture, it was intended that tax be imposed
on the fuel when it was sold at retail into the fuel tank of a
motor vehicle. It has come to the Committee's attention that
persons are exploiting the Treasury Notice by adding minute
amounts of diesel fuel to biodiesel in order to claim the full
amount of credit for biodiesel fuel mixtures, while not paying
any tax on the fuel because it does not meet the regulatory
definition of diesel fuel. The Committee believes that such
exploitation occurs to avoid both the imposition of tax and the
more restrictive rules governing biodiesel that is not in a
mixture, which require that the fuel be sold as motor fuel. The
Committee believes it is consistent with Committee intent and
appropriate to subject such fuel mixtures eligible for the fuel
mixture credits to the taxes applicable to diesel fuel (taxes
applicable to gasoline in the case of a mixture of alcohol and
special fuel).

EXPLANATION OF PROVISION

The provision adds qualified alcohol fuel mixtures and
qualified biodiesel fuel mixtures to the definition of taxable
fuel. The proposal also requires the Secretary to require
producers of these mixtures to file information reports with
the Secretary.
The provision modifies the certification requirements for
biodiesel. In addition to certifying that the product meets the
statutory definition of biodiesel and identifying the
percentage of biodiesel and agri-biodiesel in the product, the
provision also requires the importer or producer to provide
documentation that the biodiesel was tested by an independent
laboratory and found to meet the requirements of ASTM D6751.

EFFECTIVE DATE

The provision is effective for fuels removed, entered, or
sold after December 31, 2007.

O. Extension and Modification of the Alternative Fuel Credits

(Sec. 331 of the bill and sec. 6426 and 6427 of the Code)

PRESENT LAW

The Code provides two per-gallon excise tax credits with
respect to alternative fuel, the alternative fuel credit, and
the alternative fuel mixture credit. For this purpose, the term
``alternative fuel'' means liquefied petroleum gas, P Series
fuels (as defined by the Secretary of Energy under 42 U.S.C.
sec. 13211(2)), compressed or liquefied natural gas, liquefied
hydrogen, liquid fuel derived from coal through the Fischer-
Tropsch process, or liquid hydrocarbons derived from biomass.
Such term does not include ethanol, methanol, or biodiesel.
The alternative fuel credit is allowed against section 4041
liability and the alternative fuel mixture credit is allowed
against section 4081 liability. Neither credit is allowed
unless the taxpayer is registered with the Secretary. The
alternative fuel credit is 50 cents per gallon of alternative
fuel or gasoline gallon equivalents\64\ of nonliquid
alternative fuel sold by the taxpayer for use as a motor fuel
in a motor vehicle or motorboat, or so used by the taxpayer.
---------------------------------------------------------------------------
\64\``Gasoline gallon equivalent'' means, with respect to any
nonliquid alternative fuel, the amount of such fuel having a Btu
content of 124,800 (higher heating value).
---------------------------------------------------------------------------
The alternative fuel mixture credit is 50 cents per gallon
of alternative fuel used in producing an alternative fuel
mixture for sale or use in a trade or business of the taxpayer.
The mixture must be sold by the taxpayer producing such mixture
to any person for use as a fuel or used by the taxpayer for use
as a fuel. The credits generally expire after September 30,
2009.
A person may file a claim for payment equal to the amount
of the alternative fuel credit and alternative fuel mixture
credits. These payment provisions generally also expire after
September 30, 2009.
With respect to liquefied hydrogen, the credit and payment
provisions expire after September 30, 2014. Under coordination
rules, a claim for payment or credit may only be taken once
with respect to any particular gallon or gasoline-gallon
equivalent of alternative fuel.

REASONS FOR CHANGE

The Committee believes it is appropriate to extend the
alternative fuel excise tax credits to encourage the production
and use of these fuels. However, the Committee is concerned
with the carbon emissions from coal facilities and the impact
of such emissions on the environment. Therefore, the provision
imposes a carbon sequestration requirement for facilities
producing liquid fuel from coal as a condition of credit
eligibility.

EXPLANATION OF PROVISION

The provision extends the alternative fuel excise tax
credit, alternative fuel mixture excise tax credit and related
payment provisions through December 31, 2010, for all fuels
other hydrogen. The incentives for hydrogen are unchanged by
the proposal and will expire as provided under present law. The
provision provides that biomass gas qualifies for the credit.
The provision also provides that alternative fuel that is not
in a mixture may be used, or sold for use, as a fuel in
aviation for purposes of the credit.
Beginning on the date of enactment, to qualify as an
alternative fuel, liquid fuel from coal derived through the
Fischer-Tropsch process must be certified as having been
derived from coal produced at a gasification facility that
separates and sequesters at least 50 percent of such facilities
total carbon dioxide emissions. The sequestration requirement
increases to 75 percent on the earlier of (1) December 31,
2010, or (2) the date the Secretary determines that, taking
into account the recommendations of the Carbon Sequestration
Capability Panel, the sequestration rate should be 75 percent.
The Carbon Sequestration Capability Panel is composed of
one individual appointed by the National Academy of Sciences,
one individual appointed by the Chairman of the Committee on
Finance in consultation with the Ranking member of the
Committee, and one individual jointly appointed by the other
two members. The panel is to submit to the Secretary, the
Senate Committee on Finance, and the House Committee on Ways
and Means a report regarding the appropriate percentage of
carbon dioxide sequestration for purposes of liquid fuel
derived from coal through the Fischer Tropsch process. In
preparing its report, the panel shall consider whether it is
feasible to separate and sequester 75 percent of the carbon
dioxide emissions of a facility and the costs and other factors
associated with separating and sequestering such percentage of
carbon dioxide emissions. The report is to be submitted on the
date that is six months after the date of enactment. The
Secretary is to make his determination within 30 days of
receiving the report.

EFFECTIVE DATE

The provision is effective for fuel sold or used after date
of enactment.

P. Extension of Alternative Fuel Vehicle Refueling Property Credit

(Sec. 332 of the bill and sec. 30C of the Code)

PRESENT LAW

Taxpayers may claim a 30-percent credit for the cost of
installing qualified clean-fuel vehicle refueling property to
be used in a trade or business of the taxpayer or installed at
the principal residence of the taxpayer.\65\ The credit may not
exceed $30,000 per taxable year per location in the case of
qualified refueling property used in a trade or business and
$1,000 per taxable year in the case of qualified refueling
property installed on property which is used as a principal
residence.
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\65\Sec. 30C.
---------------------------------------------------------------------------
Qualified refueling property is property (not including a
building or its structural components) for the storage or
dispensing of a clean-burning fuel into the fuel tank of a
motor vehicle propelled by such fuel, but only if the storage
or dispensing of the fuel is at the point where such fuel is
delivered into the fuel tank of the motor vehicle. The use of
such property must begin with the taxpayer.
Clean-burning fuels are any fuel at least 85 percent of the
volume of which consists of ethanol, natural gas, compressed
natural gas, liquefied natural gas, liquefied petroleum gas, or
hydrogen. In addition, any mixture of biodiesel and diesel
fuel, determined without regard to any use of kerosene and
containing at least 20 percent biodiesel, qualifies as a clean
fuel.
Credits for qualified refueling property used in a trade or
business are part of the general business credit and may be
carried back for 1 year and forward for 20 years. Credits for
residential qualified refueling property cannot exceed for any
taxable year the difference between the taxpayer's regular tax
(reduced by certain other credits) and the taxpayer's tentative
minimum tax. Generally, in the case of qualified refueling
property sold to a tax-exempt entity, the taxpayer selling the
property may claim the credit.
A taxpayer's basis in qualified refueling property is
reduced by the amount of the credit. In addition, no credit is
available for property used outside the United States or for
which an election to expense has been made under section 179.
The credit is available for property placed in service
after December 31, 2005, and (except in the case of hydrogen
refueling property) before January 1, 2010. In the case of
hydrogen refueling property, the property must be placed in
service before January 1, 2015.

REASONS FOR CHANGE

The Committee believes that building additional renewable
fuel infrastructure advances America's environmental and energy
independence goals and for this reason want to extend the tax
incentive for alternative fuel refueling property.

EXPLANATION OF PROVISION

The provision extends for one year (through 2010) the
credit for installing non-hydrogen alternative fuel refueling
property.

EFFECTIVE DATE

The provision is effective for property placed in service
after the date of enactment, in taxable years ending after such
date.

TITLE IV--AGRICULTURAL PROVISIONS

A. Qualified Small Issue Bonds for Farming

(Sec. 401 of the bill and sec. 147 of the Code)

PRESENT LAW

Qualified small issue bonds are tax-exempt bonds issued by
State and local governments to finance private business
manufacturing facilities (including certain directly related
and ancillary facilities) or the acquisition of land and
equipment by certain first-time farmers. A first-time farmer
means any individual who has not at any time had any direct
ownership interest in substantial farmland in the operation of
which such individual materially participated. In addition, an
individual does not qualify as a first-time farmer if such
individual has received more than $250,000 in qualified small
issue bond financing. Substantial farmland means any parcel of
land unless (1) such parcel is smaller than 30 percent of the
median size of a farm in the county in which such parcel is
located and (2) the fair market value of the land does not at
any time while held by the individual exceed $125,000.

REASONS FOR CHANGE

The Committee notes that the loan limits for first-time
farmers have not been increased in more than two decades.
Similarly, the rules relating to the definition of substantial
farmland have not been increased in many years and, as a
result, have not kept pace with increases in land prices. Thus,
the Committee believes the tax-exempt bond rules for first-time
farmers should be updated.

EXPLANATION OF PROVISION

The provision increases the maximum amount of qualified
small issue bond proceeds available to first-time farmers to
$450,000 and indexes this amount for inflation. The provision
also eliminates the fair market value test from the definition
of substantial farmland.

EFFECTIVE DATE

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

B. Modification of Installment Sale Rules for Certain Farm Property

(Sec. 402 of the bill and sec. 453 of the Code)

PRESENT LAW

Taxpayers are permitted to recognize as gain on a
disposition of property only that proportion of payments
received in a taxable year that is the same as the proportion
that the gross profit bears to the total contract price (the
``installment method'').\66\ Notwithstanding this general rule,
with respect to any installment sale, the aggregate amount that
would be treated as ordinary income under section 1245 or
section 1250 for the taxable year of the disposition if all
payments to be received were received in the taxable year of
disposition (``recapture income'') is recognized in the year of
the disposition.\67\
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\66\Sec. 453.
\67\Sec. 453(i).
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REASONS FOR CHANGE

The Committee believes that the provision will encourage
the sale of farms to younger farmers that may not otherwise
qualify for traditional financing. While this proposal changes
the rules for the seller, it is expected to help buyers by
making the installment rules more favorable to sellers.

EXPLANATION OF PROVISION

The provision repeals the immediate recognition of
recapture income for sales of any single purpose agricultural
or horticultural structure (as defined in section 168(i)(13))
or any tree or vine bearing fruit or nuts.\68\
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\68\This property is 10-year property described in section
168(e)(3)(D).
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EFFECTIVE DATE

The provision is effective for installment sales after the
date of enactment.

C. Allowance of Section 1031 Treatment for Exchanges Involving Certain
Mutual Ditch, Reservoir, or Irrigation Company Stock

(Sec. 403 of the bill and sec. 1031 of the Code)

PRESENT LAW

An exchange of property, like a sale, generally is a
taxable event. However, no gain or loss is recognized if
property held for productive use in a trade or business or for
investment is exchanged for property of a ``like-kind'' which
is to be held for productive use in a trade or business or for
investment.\69\ If section 1031 applies to an exchange of
properties, the basis of the property received in the exchange
is equal to the basis of the property transferred, decreased by
any money received by the taxpayer, and further adjusted for
any gain or loss recognized on the exchange. In general,
section 1031 does not apply to any exchange of stock in trade
or other property held primarily for sale; stocks, bonds or
notes; other securities or evidences of indebtedness or
interest; interests in a partnership; certificates of trust or
beneficial interests; or choses in action.\70\
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\69\Sec. 1031(a)(1).
\70\Sec. 1031(a)(2).
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REASONS FOR CHANGE

The Committee believes that section 1031 should be
clarified to remove any doubt that an exchange of shares in
mutual ditch, reservoir, and irrigation company stock qualifies
for tax deferral treatment under section 1031. The Committee
intends this clarification would be for cases in which the
highest court or statute of the State in which the company is
organized recognize such shares as constituting or representing
real property or an interest in real property.

EXPLANATION OF PROVISION

The provision provides that the general exclusion from
section 1031 treatment for stocks shall not apply to shares in
a mutual ditch, reservoir, or irrigation company, if at the
time of the exchange: (1) the company is an organization
described in section 501(c)(12)(A) (determined without regard
to the percentage of its income that is collected from its
members for the purpose of meeting losses and expenses); and
(2) the shares in the company have been recognized by the
highest court of the State in which such company was organized
or by applicable State statute as constituting or representing
real property or an interest in real property.

EFFECTIVE DATE

The provision is effective for transfers after the date of
enactment.

D. Rural Renaissance Bonds

(Sec. 404 of the bill and new sec. 54A of the Code)

PRESENT LAW

Tax-exempt bonds

1. Subject to certain Code restrictions, interest on bonds
issued by State and local government generally is excluded from
gross income for Federal income tax purposes. Bonds issued by
State and local governments may be classified as either
governmental bonds or private activity bonds. Governmental
bonds are bonds the proceeds of which are primarily used to
finance governmental functions or which are repaid with
governmental funds. Private activity bonds are bonds in which
the State or local government serves as a conduit providing
financing to nongovernmental persons. For this purpose, the
term ``nongovernmental person'' generally includes the Federal
Government and all other individuals and entities other than
States or local governments. The exclusion from income for
interest on State and local bonds does not apply to private
activity bonds, unless the bonds are issued for certain
permitted purposes (``qualified private activity bonds'') and
other Code requirements are met.
The tax exemption for State and local bonds also does not
apply to any arbitrage bond.\71\ An arbitrage bond is defined
as any bond that is part of an issue if any proceeds of the
issue are reasonably expected to be used (or intentionally are
used) to acquire higher yielding investments or to replace
funds that are used to acquire higher yielding investments.\72\
In general, arbitrage profits may be earned only during
specified periods (e.g., defined ``temporary periods'') before
funds are needed for the purpose of the borrowing or on
specified types of investments (e.g., ``reasonably required
reserve or replacement funds''). Subject to limited exceptions,
investment profits that are earned during these periods or on
such investments must be rebated to the Federal government.
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\71\Secs. 103(a) and (b)(2).
\72\Sec. 148.
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An issuer of tax-exempt bonds must file with the IRS a
return that provides certain information regarding the bond
issuance.\73\ Generally, this information return is required to
be filed no later the 15th day of the second month after the
close of the calendar quarter in which the bonds were issued.
---------------------------------------------------------------------------
\73\Sec. 149(e).
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The tax exemption for State and local bonds also does not
apply to any arbitrage bond.\74\ An arbitrage bond is defined
as any bond that is part of an issue if any proceeds of the
issue are reasonably expected to be used (or intentionally are
used) to acquire higher yielding investments or to replace
funds that are used to acquire higher yielding investments.\75\
In general, arbitrage profits may be earned only during
specified periods (e.g., defined ``temporary periods'') before
funds are needed for the purpose of the borrowing or on
specified types of investments (e.g., ``reasonably required
reserve or replacement funds''). Subject to limited exceptions,
investment profits that are earned during these periods or on
such investments must be rebated to the Federal government.
---------------------------------------------------------------------------
\74\Sec. 103(a) and (b)(2).
\75\Sec. 148.
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Tax credit bonds

In general
As an alternative to traditional tax-exempt bonds, the Code
permits three types of tax-credit bonds. States and local
governments have the authority to issue qualified zone academy
bonds (``QZABS''), clean renewable energy bonds (``CREBS''),
and ``Gulf tax credit bonds.''\76\
---------------------------------------------------------------------------
\76\Secs. 1397E, 54, and 1400N(l), respectively.
---------------------------------------------------------------------------
A common feature of the present law tax-credit bonds is
that the taxpayer holding such a bond receives a tax credit,
rather than an interest payment. The amount of the credit is
determined by multiplying the bond's credit rate by the face
amount on the taxpayer's bond. The credit rate on the bonds is
determined by the Secretary and is to be a rate that permits
issuance of such bonds without discount and interest cost to
the qualified issuer. The credit is includible in gross income
(as if it were an interest payment on the bond), and can be
claimed against regular income tax liability and alternative
minimum tax liability.
Clean renewable energy bonds
CREBs are defined as any bond issued by a qualified issuer
if, in addition to the requirements discussed below, 95 percent
or more of the proceeds of such bonds are used to finance
capital expenditures incurred by qualified borrowers for
qualified projects. ``Qualified projects'' are facilities that
qualify for the tax credit under section 45 (other than Indian
coal production facilities), without regard to the placed-in-
service date requirements of that section.\77\ The term
``qualified issuers'' includes (1) governmental bodies
(including Indian tribal governments); (2) mutual or
cooperative electric companies (described in section 501(c)(12)
or section 1381(a)(2)(C), or a not-for-profit electric utility
which has received a loan or guarantee under the Rural
Electrification Act); and (3) clean renewable energy bond
lenders. The term ``qualified borrower'' includes a
governmental body (including an Indian tribal government) and a
mutual or cooperative electric company. A clean renewable
energy bond lender means a cooperative which is owned by, or
has outstanding loans to, 100 or more cooperative electric
companies and is in existence on February 1, 2002.
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\77\In addition, Notice 2006-7 provides that qualified projects
include any facility owned by a qualified borrower that is functionally
related and subordinate to any facility described in section 45(d)(1)
through (d)(9) and owned by such qualified borrower.
---------------------------------------------------------------------------
In addition to the above requirements, at least 95 percent
of the proceeds of CREBs must be spent on qualified projects
within the five-year period that begins on the date of
issuance. To the extent less than 95 percent of the proceeds
are used to finance qualified projects during the five-year
spending period, bonds will continue to qualify as CREBs if
unspent proceeds are used within 90 days from the end of such
five-year period to redeem any ``nonqualified bonds.'' The
five-year spending period may be extended by the Secretary upon
the qualified issuer's request demonstrating that the failure
to satisfy the five-year requirement is due to reasonable cause
and the projects will continue to proceed with due diligence.
CREBs also are subject to the arbitrage requirements of
section 148 that apply to tax-exempt bonds. Principles under
section 148 and the regulations thereunder apply for purposes
of determining the yield restriction and arbitrage rebate
requirements applicable to CREBs.
Issuers of CREBs are required to report issuance to the IRS
in a manner similar to the information returns required for
tax-exempt bonds. There is a national CREB limitation of $1.2
billion. The maximum amount of CREBs that may be allocated to
qualified projects of governmental bodies is $750 million.
CREBs must be issued before January 1, 2009.
Qualified zone academy bonds
``QZABs'' are defined as any bond issued by a State or
local government, provided that (1) at least 95 percent of the
proceeds are used for the purpose of renovating, providing
equipment to, developing course materials for use at, or
training teachers and other school personnel in a ``qualified
zone academy,'' and (2) private entities have promised to
contribute to the qualified zone academy certain equipment,
technical assistance or training, employee services, or other
property or services with a value equal to at least 10 percent
of the bond proceeds. Eligible holders of QZABs are limited to
financial institutions.
An issuer of QZABs must reasonably expect to and actually
spend 95 percent or more of the proceeds of such bonds on
qualified zone academy property within the five-year period
that begins on the date of issuance. To the extent less than 95
percent of the proceeds are used to finance qualified zone
academy property during the five-year spending period, bonds
will continue to qualify as QZABs if unspent proceeds are used
within 90 days from the end of such five-year period to redeem
any nonqualified bonds. For these purposes, the amount of
nonqualified bonds is to be determined in the same manner as
Treasury regulations under section 142. The provision provides
that the five-year spending period may be extended by the
Secretary if the issuer establishes that the failure to meet
the spending requirement is due to reasonable cause and the
related purposes for issuing the bonds will continue to proceed
with due diligence.
A total of $400 million of qualified zone academy bonds is
authorized to be issued annually in calendar years 1998 through
2007. The $400 million aggregate bond cap is allocated to the
States according to their respective populations of individuals
below the poverty line. Each State, in turn, allocates the
credit authority to qualified zone academies within such State.
Issuers of QZABs are required to report issuance to the IRS
in a manner similar to the information returns required for
tax-exempt bonds. In addition, QZABs are subject to the
arbitrage requirements of section 148 that apply to tax-exempt
bonds. Principles under section 148 and the regulations
thereunder apply for purposes of determining the yield
restriction and arbitrage rebate requirements applicable to
QZABs.
Gulf tax credit bonds
Gulf tax credit bonds may be issued by the States of
Louisiana, Mississippi, and Alabama. To qualify as Gulf tax
credit bonds, 95 percent or more of the proceeds of such bonds
must be used to (i) pay principal, interest, or premium on a
bond (other than a private activity bond) that was outstanding
on August 28, 2005, and was issued by the State issuing the
Gulf tax credit bonds, or any political subdivision thereof, or
(ii) make a loan to any political subdivision of such State to
pay principal, interest, or premium on a bond issued by such
political subdivision. In addition, the issuer of Gulf tax
credit bonds must provide additional funds to pay principal,
interest, or premium on outstanding bonds equal to the amount
of Gulf tax credit bonds issued to repay such outstanding
bonds. Gulf tax credit bonds must be a general obligation of
the issuing State and must be designated by the Governor of
such State. The maximum maturity on Gulf tax credit bonds is
two years. In addition, present-law arbitrage rules that
restrict the ability of State and local governments to invest
bond proceeds apply to Gulf tax credit bonds.
Gulf tax credit bonds must have been issued in calendar
year 2006. The maximum amount of Gulf tax credit bonds
authorized to be issued was $200 million in the case of
Louisiana, $100 million in the case of Mississippi, and $50
million in the case of Alabama. Gulf tax credit bonds may not
be used to pay principal, interest, or premium on any bond with
respect to which there is any outstanding refunded or refunding
bond. Moreover, Gulf tax credit bonds may not be used to pay
principal, interest, or premium on any prior bond if the
proceeds of such prior bond were used to provide any property
described in section 144(c)(6)(B) (i.e., any private or
commercial golf course, country club, massage parlor, hot tub
facility, suntan facility, racetrack or other facility used for
gambling, or any store the principal purpose of which is the
sale of alcoholic beverages for consumption off premises).
Issuers of Gulf tax credit bonds are required to report
issuance to the IRS in a manner similar to the information
returns required for tax-exempt bonds.

REASONS FOR CHANGE

The Committee believes that existing programs are not
meeting the financing needs of rural communities. The Committee
believes that additional incentives are needed to encourage
economic development in rural areas. Thus, the Committee
believes it is appropriate to provide rural communities with
additional financing tools in order to promote investment in
these underserved communities.

EXPLANATION OF PROVISION

The provision provides for a new category of tax-credit
bonds, ``Rural Renaissance Bonds.'' A Rural Renaissance Bond
means any bond if: (1) the bond is issued by a qualified issuer
pursuant to an allocation of the national limitation on such
bonds; (2) 95 percent or more of the proceeds of the bond are
to be used for capital expenditures incurred by qualified
borrowers for one or more qualified projects; (3) the qualified
issuer designates the bond as a Rural Renaissance Bond and such
bond is issued in registered form; (4) the bond meets the five-
year spending requirement (described below); and (5) the bond
is not Federally guaranteed (i.e., no portion of the bond is
guaranteed in whole or in part by the United States).
Under the provision, the term ``qualified issuer'' means:
(1) a rural renaissance bond lender; (2) a cooperative electric
company; and (3) a governmental body. A ``rural renaissance
bond lender'' means a cooperative which is owned by, or has
outstanding loans to, 100 or more cooperative electric
companies and is in existence on February 1, 2002, including
any affiliated lender which is controlled by such lender. The
term ``cooperative electric company'' means a mutual or
cooperative electric company (described in section 501(c)(12)
or section 1381(a)(2)(C), or a not-for-profit electric utility
which has received a loan or guarantee under the Rural
Electrification Act. The term ``governmental body'' means a
State, territory, possession of the United States, the District
of Columbia, Indian tribal government, and any political
subdivision thereof. Under the provision, a ``qualified
borrower'' means a cooperative electric company or a
governmental body.
The term ``qualified projects'' means: (1) a utilities
program described in section 381E(d)(2) of the Consolidated
Farm and Rural Development Act; (2) a distance learning or
telemedicine program authorized pursuant to chapter 1 of
subtitle D of title XXIII of the Food, Agriculture,
Conservation, and Trade Act of 1990; (3) the rural electric
programs authorized pursuant to the Rural Electrification Act
of 1936; (4) the rural telephone programs authorized pursuant
to the Rural Electrification Act of 1936; (5) the broadband
access programs authorized pursuant to title VI of the Rural
Electrification Act of 1936; and (6) the rural community
facility programs as described in section 381E(d)(1) of the
Consolidated Farm and Rural Development Act.
As with present-law tax credit bonds, the taxpayer holding
Rural Renaissance Bonds on a credit allowance date is entitled
to a tax credit. The amount of the credit is determined by
multiplying the bond's credit rate by the face amount on the
taxpayer's bond. The credit rate on the bonds is determined by
the Secretary and is to be a rate that permits issuance of such
bonds without discount and interest cost to the qualified
issuer. The credit is includible in gross income (as if it were
an interest payment on the bond), and can be claimed against
regular income tax liability and alternative minimum tax
liability.
Under the provision, at least 95 percent or more of the
proceeds of Rural Renaissance Bonds must be spent on qualified
projects within the five-year period that begins on the date of
issuance of such bonds. To the extent less than 95 percent of
the proceeds are spent as required during the five-year
spending period, bonds will continue to qualify as Rural
Renaissance Bonds only if unspent proceeds are used within 90
days from the end of such five-year period to redeem
outstanding bonds. The five-year spending period may be
extended by the Secretary upon the qualified issuer's request
demonstrating that the failure to satisfy the five-year
requirement is due to reasonable cause and the projects will
continue to proceed with due diligence.
The provision requires level amortization of Rural
Renaissance Bonds during the period such bonds are outstanding.
In addition, Rural Renaissance Bonds are subject to the
arbitrage requirements of section 148 that apply to tax-exempt
bonds. Principles under section 148 and the regulations
thereunder apply for purposes of determining the yield
restriction and arbitrage rebate requirements applicable to
Rural Renaissance Bonds.
The provision establishes a national limitation of
$400,000,000 on the amount of bonds that may be designated as
Rural Renaissance Bonds. The Secretary, in consultation with
the Secretary of Agriculture, shall make allocations of the
national limitation to at least 20 qualified projects, or such
lesser number of qualified projects based on the number of
applications filed 12 months after applications for allocations
have been solicited by the Secretary. In addition, no more than
15 percent of the national limitation may be allocated to
qualified projects located in any one State. Under the
provision, Rural Renaissance Bonds may not be issued after
December 31, 2008.

EFFECTIVE DATE

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

E. Agricultural Business Security Tax Credit

(Sec. 405 of the bill and sec. 45 of the Code)

PRESENT LAW

Present law does not provide a credit for agricultural
business security.

REASONS FOR CHANGE

The Committee believes that a security tax credit would
help the agricultural industry to properly safeguard
agricultural pesticides and fertilizers from the threat of
terrorists, drug dealers and other criminals. These safeguards
are necessary to help alleviate a heightened concern as to the
vulnerability of chemical storage facilities. This credit will
help ease the substantial increase in production costs faced by
agriculture related to installing improved security measures
that will better protect the American public from the potential
threat of terrorism or other illegal activities.

EXPLANATION OF PROVISION

The provision establishes a 30 percent credit for qualified
chemical security expenditures for the taxable year with
respect to eligible agricultural businesses. The credit is a
component of the general business credit.\78\
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\78\Sec. 38(b)(1).
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The credit is limited to $100,000 per facility, this amount
is reduced by the aggregate amount of the credits allowed for
the facility in the prior five years. In addition, each
taxpayer's annual credit is limited to $2,000,000.\79\ The
credit only applies to expenditures paid or incurred before
December 31, 2012. The taxpayer's deductible expense is reduced
by the amount of the credit claimed.
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\79\The term taxpayer includes controlled groups under rules
similar to the rules set out in section 41(f)(1) and (2).
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Qualified chemical security expenditures are amounts paid
by for: 1) employee security training and background checks;
(2) limitation and prevention of access to controls of specific
agricultural chemicals stored at a facility; (3) tagging,
locking tank valves, and chemical additives to prevent the
theft of specific agricultural chemicals or to render such
chemicals unfit for illegal use; (4) protection of the
perimeter of specified agricultural chemicals; (5) installation
of security lighting, cameras, recording equipment and
intrusion detection sensors (6) implementation of measures to
increase computer or computer network security; (7) conducting
security vulnerability assessments; (8) implementing a site
security plan; and (9) other measures provided for by
regulation. Amounts described in the preceding sentences are
only eligible to the extent they are incurred by an eligible
agricultural business for protecting specified agricultural
chemicals.
Eligible agricultural businesses are businesses that: (1)
sell agricultural products, including specified agricultural
chemicals, at retail predominantly to farmers and ranchers; or
(2) manufacture, formulate, distribute, or aerially apply
specified agricultural chemicals.
Specified agricultural chemicals means: (1) are fertilizer
commonly used in agricultural operations which is listed under
section 302(a)(2) of the Emergency Planning and Community
Right-to-know Act of 1986, section 101 or part 172 of title 49,
Code of Federal Regulations, or part 126, 127 or 154 of title
33, Code of Federal Regulations; and (2) any pesticide (as
defined in section 2(u) of the Federal Insecticide, Fungicide,
and Rodenticide Act) including all active and inert ingredients
which are used on crops grown for food, feed or fiber.

EFFECTIVE DATE

The provision is effective for expenses paid or incurred
after date of enactment.

F. Credit for Drug Safety and Effectiveness Testing for Minor Species

(Sec. 406 of the bill and new sec. 45P of the Code)

PRESENT LAW

Present law does not provide a credit for drug safety and
effectiveness testing for use in a minor animal species.

REASONS FOR CHANGE

The Committee believes that insufficient resources are
devoted to developing drugs for minor animal species such as
sheep and goats. The Committee believes that a tax incentive
for drug safety and effectiveness testing for use in minor
animal species will encourage more investment in this area.

EXPLANATION OF PROVISION

The provision establishes, at the election of the taxpayer,
a 50 percent credit for qualified safety and effectiveness
testing expenses incurred during the taxable year for certain
designated new animal drugs intended for use in a minor
species. The taxpayer's otherwise deductible expenses are
reduced by the amount of the credit claimed.
Safety and effectiveness testing is testing carried out
under an exemption for a new animal drug for use on a minor
species under section 512(j) of the Federal Food, Drug, and
Cosmetic Act (or regulations issued under such section) (the
``FFDC Act''). The testing must occur after a new animal drug
request is filed for designation under section 573 of the FFDC
Act but before the application with respect to such drug is
approved under section 512(c) of such Act. Moreover, the
testing must be conducted by or on behalf of the taxpayer who
applied for the designation or by the owner of the animals that
are the subject of the testing. Safety and effectiveness
testing may be taken into account under the provision only to
the extent such testing is related to the use of a new animal
drug for the minor species for which it was designated under
section 573 of FFDC Act.
A ``minor species'' means animals other than humans that
are not major species. A ``major species'' means cattle,
horses, swine, chickens, turkeys, dogs, and cats, as well as
any species the Secretary, in consultation with the Secretary
of Agriculture, adds by regulation.\80\
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\80\These definitions are intended to correspond with the
definitions provided in section 201 of the FFDC Act.
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Qualified safety and effectiveness testing expenses
comprise both in-house and contract expenses incurred by a
taxpayer\81\ in carrying on a trade or business or by a
taxpayer that owns animals that are the subject of safety and
effectiveness testing. For purposes of the provision, in-house
expenses are (1) wages paid or incurred to an employee for
safety and effectiveness testing or the direct supervision or
support thereof; (2) any amount paid or incurred for supplies
used in the conduct of safety and effectiveness testing; and
(3) under regulations prescribed by the Secretary, any amount
paid or incurred to another person for the right to use
computers in the conduct of safety and effectiveness testing.
Contract expenses are any amounts paid or incurred by the
taxpayer to any person (other than an employee of the taxpayer)
for safety and effectiveness testing.
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\81\Under the provision, the term taxpayer includes controlled
groups under rules similar to the rules set out in section 41(f)(1) and
(2).
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Qualified safety and effectiveness testing expenses do not
include amounts funded by any grant, contract, or otherwise by
another person or government entity. In addition, qualified
expenses will not be taken into account when determining the
section 41 credit for research and experimentation except for
purposes of calculating base period research expenses.

EFFECTIVE DATE

The provision is effective for expenses incurred after the
date of enactment.

G. Farm Equipment Treated as Five-Year Property

(Sec. 407 of the bill and sec. 168 of the Code)

PRESENT LAW

REASONS FOR CHANGE

The Committee believes that the depreciation incentive will
provide important economic benefits to encourage development
within the agricultural sector. The provision lowers the cost
of capital for property used in agricultural trades or
businesses which will lead to additional investment in more
equipment and employment of more workers.

EXPLANATION OF PROVISION

The provision provides a five year recovery period for any
machinery or equipment (other than any grain bin, cotton
ginning asset, fence, or other land improvement) which is used
in a farming business and placed in service before January 1,
2010, the original use of which begins with the taxpayer. For
these purposes, the term ``farming business'' means a trade or
business involving the cultivation of land or the raising or
harvesting of any agricultural or horticultural commodity.\84\
A farming business includes processing activities that are
normally incident to the growing, raising, or harvesting of
agricultural or horticultural products.\85\
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\84\Treas. Reg. sec. 1.263A-4(a)(4)(i).
\85\Treas. Reg. sec. 1.263A-4(a)(4)(ii).
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EFFECTIVE DATE

The provision is effective for original use property placed
in service after the date of enactment.

H. Expensing of Broadband Internet Access Expenditures

(Sec. 408 of the bill and new sec. 191 of the Code)

PRESENT LAW

A taxpayer is allowed to recover, through annual
depreciation deductions, the cost of certain property used in a
trade or business or for the production of income. The amount
of the depreciation deduction allowed with respect to tangible
property for a taxable year is determined under the modified
accelerated cost recovery system (``MACRS'').\86\ Under MACRS,
different types of property generally are assigned applicable
recovery periods and depreciation methods. The recovery periods
applicable to most tangible personal property (generally
tangible property other than residential rental property and
nonresidential real property) range from 3 to 25 years. The
depreciation methods generally applicable to tangible personal
property are the 200-percent and 150-percent declining balance
methods, switching to the straight-line method for the taxable
year in which the depreciation deduction would be maximized.
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\86\Sec. 168.
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In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to deduct (or
``expense'') such costs under section 179. The Small Business
and Work Opportunity Tax Act of 2007\87\ increased the amount a
taxpayer may deduct, for taxable years beginning in 2007
through 2010, to $125,000 of the cost of qualifying property
placed in service for the taxable year.\88\ In general,
qualifying property is defined as depreciable tangible personal
property that is purchased for use in the active conduct of a
trade or business. Off-the-shelf computer software placed in
service in taxable years beginning before 2010 is treated as
qualifying property. The $125,000 amount is reduced (but not
below zero) by the amount by which the cost of qualifying
property placed in service during the taxable year exceeds
$500,000. The $125,000 and $500,000 amounts are indexed for
inflation in taxable years beginning after 2007 and before
2011. For taxable years beginning in 2011 and thereafter (or
before 2003), the following rules apply. A taxpayer with a
sufficiently small amount of annual investment may elect to
deduct up to $25,000 of the cost of qualifying property placed
in service for the taxable year. The $25,000 amount is reduced
(but not below zero) by the amount by which the cost of
qualifying property placed in service during the taxable year
exceeds $200,000. The $25,000 and $200,000 amounts are not
indexed.
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\87\Pub. L. No. 110-28, sec. 8212 (2007).
\88\Additional section 179 incentives are provided with respect to
qualified property meeting applicable requirements that is used by a
business in an empowerment zone (sec. 1397A), a renewal community (sec.
1400J), or the Gulf Opportunity Zone (sec. 1400N(e)).
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REASONS FOR CHANGE

The Committee believes that it is appropriate to provide
the tax incentive of expensing to encourage the provision of
broadband services through new or upgraded equipment. In
particular, the Committee believes that the provision of such
services should be encouraged in rural areas and areas in which
residents tend to have incomes significantly lower than the
median. Because some such areas may be served by current-
generation broadband services, the tax incentive is provided
with respect to current generation broadband services for
residential subscribers if the area is not a saturated market.
The expensing incentive is provided without regard to whether
the local market is saturated, in the case of next generation
broadband service, because of the Committee's desire to
encourage wider availability of faster broadband service.

EXPLANATION OF PROVISION

The provision provides an election to treat any qualified
broadband expenditure paid or incurred by the taxpayer as not
chargeable to capital account, but rather, as a deduction. The
deduction is allowed in the first taxable year in which either
current generation or next generation broadband services are
provided through qualified equipment to qualified subscribers.
Expenditures are eligible for this election only for qualified
equipment, the original use of which commences with the
taxpayer. The provision applies for qualified broadband
expenditures incurred after the date of enactment and on or
before the first December 31 that is three years after such
date.
``Current generation broadband services'' are defined as
the transmission of signals at a rate of at least 5 million
bits per second to the subscriber and at a rate of at least 1
million bits per second from the subscriber. ``Next generation
broadband services'' are defined as the transmission of signals
at a rate of at least 100 million bits per second to the
subscriber and at a rate of at least 20 million bits per second
from the subscriber.
``Qualified broadband expenditures'' means the direct or
indirect costs properly taken into account for the taxable year
for the purchase or installation of qualified equipment
(including upgrades) and the connection of the equipment to a
qualified subscriber. The term does not include costs of
launching satellite equipment. For current generation broadband
services, only 50 percent of the otherwise allowable amount of
deduction is treated as qualified broadband expenditures.
Qualified broadband expenditures include only the portion
of the purchase price paid by the lessor, in the case of leased
equipment, that is attributable to otherwise qualified
broadband expenditures by the lessee. In the case of property
that is originally placed in service by a person and that is
sold to the taxpayer and leased back to such person by the
taxpayer within three months after the date that the property
was originally placed in service, the property is treated as
originally placed in service by the taxpayer not earlier than
the date that the property is used under the leaseback.
A qualified subscriber, with respect to current generation
broadband services, means any nonresidential subscriber
maintaining a permanent place of business in a rural area or
underserved area, or any residential subscriber residing in a
rural area or underserved area that is not a saturated market.
A qualified subscriber, with respect to next generation
broadband services, means any nonresidential subscriber
maintaining a permanent place of business in a rural area or
underserved area, or any residential subscriber.
For this purpose, a rural area means any census tract not
within 10 miles of an incorporated or census-designated place
with more than 25,000 people and not within a county or county
equivalent with overall population density of more than 500
people per square mile. An underserved area means a census
tract located in an empowerment zone or enterprise community
designated under section 1391 or the District of Columbia
Enterprise Zone established under section 1400, or any census
tract the poverty level of which is at least 30 percent and the
median family income of which does not exceed (1) for a tract
in a metropolitan statistical area, 70 percent of the greater
of the metropolitan area median family income or the statewide
median family income, and (2) for a tract that is not in a
metropolitan statistical area, 70 percent of the
nonmetropolitan statewide median family income.
A saturated market, for this purpose, means any census
tract in which, as of the date of enactment, current generation
broadband services have been provided by a single provider to
85 percent or more of the total potential residential
subscribers. The services must be usable at least a majority of
the time during periods of maximum demand, and usable in a
manner substantially the same as services provided through
equipment not eligible for the deduction under this provision.
If current, or next, generation broadband services can be
provided through qualified equipment to both qualified
subscribers and to other subscribers, the provision provides
that the expenditures with respect to the equipment are
allocated among subscribers to determine the amount of
qualified broad broadband expenditures that may be deducted
under the provision.
Qualified equipment means equipment that provides current,
or next, generation broadband services at least a majority of
the time during periods of maximum demand to each subscriber,
and in a manner substantially the same as such services are
provided by the provider to subscribers through equipment with
respect to which no deduction is allowed under the provision.
Limitations are imposed under the provision on equipment
depending on where it extends, and on certain packet switching
equipment, and on certain multiplexing and demultiplexing
equipment.
Expenditures generally are not taken into account for
purposes of the deduction under the provision with respect to
property used predominantly outside the United States, used
predominantly to furnish lodging, used by a tax-exempt
organization (other than in a business whose income is subject
to unrelated business income tax), or used by the United States
or a political subdivision or by a possession, agency or
instrumentality thereof or by a foreign person or entity. The
basis of property is reduced by the cost of the property that
is taken into account as a deduction under the provision.
Recapture rules are provided. No business credit under section
38 is allowed with respect to any amount allowed as a deduction
under the provision.

EFFECTIVE DATE

The provision is effective on the date of enactment and
applies to expenditures incurred after the date of enactment
and on or before the first December 31 that is three years
after such date.

I. Credit for Energy Efficient Electric Motors

(Sec. 409 of the bill and new sec. 45Q of the Code)

PRESENT LAW

There is no present law credit for energy efficient
electric motors.

REASONS FOR CHANGE

The Committee recognizes the need to reduce the consumption
of electricity, both to mitigate the harmful effects of
electricity generation from fossil fuels and to reduce demands
on the electrical grid. The Committee has long recognized the
potential to save energy from the promotion of more energy
efficient products, and believes that the provision of a tax
credit for energy efficient motors will increase the use of
such motors and result in less electricity consumption

EXPLANATION OF PROVISION

The provision provides a business tax credit for the
purchase of qualified energy efficient electric motors that
meet or exceed certain energy efficiency standards. The credit
equals $15 per horsepower and the aggregate amount of credit
that a taxpayer may claim for any taxable year cannot exceed
$1,250,000. A ``qualifying energy efficient motor'' is: (a) a
general- or definite-purpose electric motor of 500 horsepower
or less that meets or exceeds the efficiency levels specified
in Tables 12-12 or 12-13 of the National Electrical
Manufacturers Association MG-1 (2006); (b) the original use
begins with the taxpayer; and (c) is placed in service in the
United States. The provision applies to energy efficient motors
placed in service after the date of enactment and prior to 36
months from the date of enactment.
The basis of any property for which a credit is allowable
is reduced by the amount of the credit. The Secretary of the
Treasury, by regulations, is to provide rules for recapturing
the credit in the case of any property which ceases to be
property eligible for the credit. No credit is allowed with
respect to the portion of the cost of any property taken into
account for expensing under section 179.

EFFECTIVE DATE

The provision is effective for property placed in service
after the date of enactment and prior to 36 months from the
date of enactment.

TITLE V--REVENUE RAISING PROVISIONS

A. Limitation on Farming Losses of Certain Taxpayers

(Sec. 501 of the bill and sec. 461 of the Code)

PRESENT LAW

Farming income and expenses are reported by individuals,
estates, trusts, and partnerships on IRS Schedule F, Profit and
Loss from Farming. For taxpayers who materially participate (as
defined in section 469(h)), net farming losses are reported in
full as a reduction to income from both passive and nonpassive
sources. To the extent taxpayers do not materially participate
in the farming activity, the passive activity rules in section
469 may limit the ability to use such losses to reduce income
from nonpassive sources.
Farming income generally includes sales of livestock,
produce, grains, and other products; cooperative distributions;
Agricultural Program Payments; certain Commodity Credit
Corporation (``CCC'') loans (if an election is made to include
loan proceeds in income in the year received); certain crop
insurance proceeds and federal crop disaster payments; and
other income. Farm expenses generally include feed,
fertilizers, gasoline, fuel, and oil; insurance; interest;
hired labor; rent and lease payments; repairs and maintenance;
taxes; utilities; depreciation; and other business-related
expenses. Living expenses and other personal expenses are not
deductible farming expenses.

REASONS FOR CHANGE

The Committee believes that taxpayers receiving government
assistance through payment programs and loan programs should
not be allowed to claim unlimited amounts of losses from
farming activities.

EXPLANATION OF PROVISION

The provision limits the amount of losses that can be
claimed by an individual, estate, trust, or partnership on
Schedule F to $200,000 in cases where the taxpayer has received
Agriculture Program Payments or CCC loans. Losses that are
limited in a particular year may be carried forward to
subsequent years.

EFFECTIVE DATE

The provision is effective for taxable years beginning
after December 31, 2007.

B. Increase and Index Dollar Thresholds for Farm Optional Method and
Nonfarm Optional Method for Computing Net Earnings From Self-Employment

(Sec. 502 of the bill and sec. 1402(a) of the Code)

PRESENT LAW

In general

Generally, tax under the Self-Employment Contributions Act
(SECA) is imposed on the self-employment income of an
individual. SECA tax has two components. Under the old-age,
survivors, and disability insurance component, the rate of tax
is 12.40 percent on self-employment income up to the Social
Security wage base ($97,500 for 2007). Under the hospital
insurance component, the rate is 2.90 percent of all self-
employment income (without regard to the Social Security wage
base).
Self-employment income subject to the SECA tax is
determined as the net earnings from self-employment. An
individual may use one of three methods to calculate net
earnings from self-employment. Under the generally applicable
rule, net earnings from self-employment means gross income
(including the individual's net distributive share of
partnership income) derived by an individual from any trade or
business carried on by the individual, less the deductions
attributable to the trade or business that are allowed under
the SECA tax rules. Alternatively, an individual may elect to
use one of two optional methods for calculating net earnings
from self-employment. These methods are: (1) the farm optional
method; and (2) the nonfarm optional method. The farm optional
method allows individuals to pay SECA taxes (and secure Social
Security benefit coverage) when they have low net income or
losses from farming. The nonfarm optional method is similar to
the farm optional method.

Farm optional method

If an individual is engaged in a farming trade or business,
either as a sole proprietor or as a partner, the individual may
elect to use the farm optional method in one of two instances.
The first instance is an individual engaged in a farming
business who has gross farm income of $2,400 or less for the
taxable year. In this instance, the individual may elect to
report two-thirds of gross farm income as net earnings from
self-employment. In the second instance, an individual engaged
in a farming business may elect the farm optional method even
though gross farm income exceeds $2,400 for the taxable year
but only if the net farm income is less than $1,733 for the
taxable year. In this second instance, the individual may elect
to report $1,600 as net earnings from self-employment for the
taxable year. In all other instances (i.e., more than $2,400 of
gross farm income and net farm income of at least $1,733) a
person engaged in a farming business must compute net earnings
from self-employment under the generally applicable rule. There
is no limit on the number of years that an individual may elect
the farm optional method during such individual's lifetime.
The dollar limits in the farm optional method are not
indexed for inflation.

Nonfarm optional method

The nonfarm optional method is available only to
individuals who have been self-employed for at least two of the
three years before the year in which they seek to elect the
nonfarm optional method and who meet certain other
requirements. Specifically, an individual may elect the nonfarm
optional method if the individual's: (1) net nonfarm income for
the taxable year is less than $1,733; and (2) net nonfarm
income for the taxable year is less than 72.189 percent of
gross nonfarm income. If a qualified individual engaged in a
nonfarming business who elects the nonfarm optional method has
gross nonfarm income of $2,400 or less for the taxable year,
then the individual may elect to report two-thirds of gross
nonfarm income as net earnings from self-employment. If the
electing individual engaged in a nonfarming business has gross
nonfarm income of at least $2,400 for the taxable year, then
the individual may elect to report $1,600 as net earnings from
self-employment for the taxable year. In all other instances, a
person engaged in a nonfarming business must compute net
earnings from self-employment under the generally applicable
rule. An individual may elect to use the nonfarm optional
method for no more than five years in the course of the
individual's lifetime.
The dollar limits in the nonfarm optional method are not
indexed for inflation.

Other rules applicable to farm optional and nonfarm optional methods

In the case of a cash method trade or business, gross
income is defined as the gross receipts from such trade or
business less the cost or other basis of property sold in
carrying out such trade or business with certain adjustments.
In the case of an accrual method trade or business, gross
income is defined as the gross income from the trade or
business with certain adjustments. If an individual (including
a member of a partnership) derives gross income from more than
one trade or business then such gross income (including the
individual's distributive share of the gross income of any
partnership) is treated as derived from a single trade or
business.

Social Security benefit eligibility

Generally, Social Security benefits can be paid to an
individual (and dependents or survivors) only if that
individual has worked long enough in covered employment to be
insured. Insured status is measured in terms of ``credits,''
previously called ``quarters of coverage.'' For this purpose,
Social Security uses the lifetime record of earnings reported
for that individual. In the case of a self-employed individual,
net earnings from self-employment is used to calculate Social
Security benefit eligibility.
Up to four quarters of coverage can be earned for a year,
depending on covered wages for the year and the amount needed
to earn each quarter of coverage. For 2007, credit for a
quarter of coverage is provided for each $1,000 of wages.

REASONS FOR CHANGE

The Committee believes that taxpayers should have the
ability to earn four quarters of coverage for Social Security
benefits annually under either the farm optional method or
nonfarm optional method. Because the present-law dollar amounts
are not updated or indexed for inflation otherwise eligible
taxpayers have lost that ability. The bill makes needed changes
to those methods and ensures that they are indexed so the
problem will not reoccur in the future.

DESCRIPTION OF PROPOSAL

The provision modifies the farm optional method so that
electing taxpayers may be eligible to secure four credits of
Social Security benefit coverage each taxable year by
increasing an indexing the thresholds. The provision makes a
similar modification to the nonfarm optional method.

EFFECTIVE DATE

The provision is effective for taxable years beginning
after December 31, 2007.

C. Information Reporting for Commodity Credit Corporation Transactions

(Sec. 503 of the bill and new sec. 6039J of the Code)

PRESENT LAW

The Farm Security and Rural Investment Act of 2002\89\
authorizes a marketing assistance loan program through the
Commodity Credit Corporation (``CCC''). Under such program, the
CCC may make loans for eligible commodities at a specified rate
per unit of commodity (the original loan rate). The repayment
amount for such a loan secured by an eligible commodity
generally is based on the lower of the original loan rate or
the alternative repayment rate, as determined by the CCC, as of
the date of repayment. The alternative repayment rate may be
adjusted to reflect quality and location for each type of
commodity. A taxpayer receiving a CCC loan can use cash to
repay such a loan, purchase CCC certificates for use in
repayment of the loan, or deliver the pledged collateral as
full payment for the loan at maturity.
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\89\Pub. L. No. 107-171.
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If a taxpayer uses cash or CCC certificates to repay a CCC
loan, and the loan is repaid at a time when the repayment rate
is less than the original loan rate, the difference between the
original loan amount and the lesser repayment amount is market
gain. Regardless of whether a taxpayer repays a CCC loan in
cash or uses CCC certificates in repayment of the loan, the
market gain is taken into account either as income or as an
adjustment to the basis of the commodity (if the taxpayer has
made an election under section 77).
If a farmer uses cash instead of certificates, the farmer
will receive a Form CCC-1099-G Information Return showing the
market gain realized. For transactions prior to January 1,
2001, however, if a farmer uses CCC certificates to facilitate
repayment of a CCC loan, the farmer will not receive an
information return. For transactions after January 1, 2001, IRS
Notice 2007-63 provides that the CCC reports market gain
associated with the repayment of a CCC loan whether the
taxpayer repays the loan with cash or uses CCC certificates in
repayment of the loan.\90\ The CCC reports the market gain on
Form 1099-G, Certain Government Payments.
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\90\2007-33 IRB.
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REASONS FOR CHANGE

Income that is subject to information reporting is less
likely to be underreported. In contrast, the absence of
information reporting on many types of payments results in
underreporting and contributes to the tax gap.\91\ Thus, the
Committee believes it is important to ensure that information
reporting rules are applied consistently to payments that may
differ in form, but are economically equivalent. For this
reason, the Committee believes it is appropriate to codify the
IRS's administrative determination regarding information
reporting for the repayment of CCC loans.
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\91\The tax gap is the amount of tax that is imposed by law for a
given tax year but is not paid voluntarily and timely.
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EXPLANATION OF PROVISION

The provision codifies the requirements of IRS Notice 2007-
63 providing that the CCC reports market gain associated with
the repayment of a CCC loan, regardless of whether the taxpayer
repays the loan with cash or uses CCC certificates in repayment
of the loan.

EFFECTIVE DATE

The provision is effective for loans repaid on or after
January 1, 2007.

D. Modification of Section 1031 Treatment for Certain Real Estate

(Sec. 504 of the bill and sec. 1031 of the Code)

PRESENT LAW

An exchange of property, like a sale, generally is a
taxable event. However, no gain or loss is recognized if
property held for productive use in a trade or business or for
investment is exchanged for property of a ``like kind'' that is
to be held for productive use in a trade or business or for
investment.\92\ If section 1031 applies to an exchange of
properties, the basis of the property received in the exchange
is equal to the basis of the property transferred, decreased by
any money received by the taxpayer, and further adjusted for
any gain or loss recognized on the exchange. For purposes of
section 1031, the determination of ``like kind'' relates to the
nature or character of the property and not its grade or
quality.\93\ Therefore, improved real estate and unimproved
real estate are generally considered to be property of a ``like
kind'' as this distinction relates to the grade or quality of
the real estate.\94\
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\92\Sec. 1031(a)(1).
\93\Treas. Reg. sec. 1.1031(a)-1(b).
\94\Treas. Reg. sec. 1.1031(a)-1(c).
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REASONS FOR CHANGE

The Committee believes that sellers are currently using
section 1031 to defer gains on improved real estate exchanged
for farm property and also receiving the benefit of the farm
property's historical agricultural base involved in calculating
Agriculture Program Payments to include direct payments and
counter cyclical payments. The Committee believes that those
exchanges should not be like kind.

EXPLANATION OF PROVISION

The provision modifies section 1031 to disallow
nonrecognition treatment for exchanges of unimproved real
estate for which the owner is receiving Agriculture Program
Payments or Commodity Credit Corporation (``CCC'') loans for
improved real estate, unless the undeveloped land is
permanently retired from farm program payments.

EFFECTIVE DATE

The provision is effective for exchanges completed after
the date of enactment.

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

(Sec. 505 of the bill and sec. 470 of the Code)

PRESENT LAW

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

REASONS FOR CHANGE

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

EXPLANATION OF PROVISION

The provision changes the effective date of the loss
deferral rules with respect to certain leases. Under the
provision, the loss deferral rules also apply to leases entered
into on or before March 12, 2004, if the lessee is a foreign
person or entity. With respect to such leases, losses are
deferred starting in taxable years beginning after December 31,
2006.
No inference is intended regarding the appropriate present-
law tax treatment of transactions entered into prior to March
12, 2004, if the lessee is not a foreign person or entity. In
addition, it is intended that the provision shall not be
construed as altering or supplanting the present-law tax rules
providing that a taxpayer is treated as the owner of leased
property only if the taxpayer acquires and retains significant
and genuine attributes of an owner of the property, including
the benefits and burdens of ownership. The provision also is
not intended to affect the scope of any other present-law tax
rules or doctrines applicable to purported leasing
transactions.

EFFECTIVE DATE

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

F. Modifications to Corporate Estimated Tax Payments

(Sec. 506 of the bill)

PRESENT LAW

In general, corporations are required to make quarterly
estimated tax payments of their income tax liability. For a
corporation whose taxable year is a calendar year, these
estimated tax payments must be made by April 15, June 15,
September 15, and December 15.
Under present law, in the case of a corporation with assets
of at least $1 billion, the payments due in July, August, and
September, 2012, shall be increased to 115.00 percent of the
payment otherwise due and the next required payment shall be
reduced accordingly.

REASONS FOR CHANGE

The Committee believes it is appropriate to adjust the
corporate estimated tax payments.

EXPLANATION OF PROVISION

The bill increases the otherwise applicable percentage
(115.00 percent) by 7.00 percent.

EFFECTIVE DATE

The provision is effective on the date of enactment.

G. Ineligibility of Collectibles for Nontaxable Like Kind Exchange
Treatment

(Sec. 507 of the bill and sec. 1031 of the Code)

PRESENT LAW

An exchange of property, like a sale, generally is a
taxable event. However, no gain or loss is recognized if
property held for productive use in a trade or business or for
investment is exchanged for property of a ``like kind'' that is
to be held for productive use in a trade or business or for
investment.\95\ If section 1031 applies to an exchange of
properties, the basis of the property received in the exchange
is equal to the basis of the property transferred, decreased by
any money received by the taxpayer, and further adjusted for
any gain or loss recognized on the exchange. For purposes of
section 1031, the determination of ``like kind'' relates to the
nature or character of the property and not its grade or
quality. ``One kind or class of property may not, under that
section, be exchanged for property of a different kind or
class.''\96\
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\95\Sec. 1031(a)(1).
\96\Treas. Reg. sec. 1.1031(a)-1(b).
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REASONS FOR CHANGE

The Committee believes that section 1031 was designed to
encourage capital reinvestment for assets used in a trade or
business or held for investment. Because collectibles have
elements of both investment and personal use, the Committee
wishes to exclude collectibles from property qualifying for
nonrecognition treatment.

EXPLANATION OF PROVISION

The provision denies nonrecognition treatment for exchanges
of collectibles, as defined by section 408(m)(2).

EFFECTIVE DATE

The provision is effective for exchanges completed after
the date of enactment.

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

(Sec. 508 of the bill and sec. 162(f) and new sec. 6050W of the Code)

PRESENT LAW

Under present law, no deduction is allowed as a trade or
business expense under section 162(a) for the payment to a
government of a fine or similar penalty for the violation of
any law (sec. 162(f)). The enactment of section 162(f) in 1969
codified existing case law that denied the deductibility of
fines as ordinary and necessary business expenses on the
grounds that ``allowance of the deduction would frustrate
sharply defined national or State policies proscribing the
particular types of conduct evidenced by some governmental
declaration thereof.''\97\
---------------------------------------------------------------------------
\97\S. Rep. No. 91-552, 91st Cong, 1st Sess., 273-74 (1969),
referring to Tank Truck Rentals, Inc. v. Commissioner, 356 U.S. 30
(1958).
---------------------------------------------------------------------------
Treasury regulation section 1.162-21(b)(1) provides that a
fine or similar penalty includes an amount: (1) paid pursuant
to conviction or a plea of guilty or nolo contendere for a
crime (felony or misdemeanor) in a criminal proceeding; (2)
paid as a civil penalty imposed by Federal, State, or local
law, including additions to tax and additional amounts and
assessable penalties imposed by chapter 68 of the Code; (3)
paid in settlement of the taxpayer's actual or potential
liability for a fine or penalty (civil or criminal); or (4)
forfeited as collateral posted in connection with a proceeding
which could result in imposition of such a fine or penalty.
Treasury regulation section 1.162-21(b)(2) provides, among
other things, that compensatory damages (including damages
under section 4A of the Clayton Act (15 U.S.C. sec. 15a), as
amended) paid to a government do not constitute a fine or
penalty.

REASONS FOR CHANGE

The Committee is concerned that there is a lack of clarity
and consistency under present law regarding when taxpayers may
deduct payments made in settlement of government investigations
of potential wrongdoing, as well as in situations where there
has been a final determination of wrongdoing. If a taxpayer
deducts payments made in settlement of an investigation of
potential wrongdoing or as a result of a finding of wrongdoing,
the publicly announced amount of the settlement payment does
not reflect the true after-tax penalty on the taxpayer. The
Committee also is concerned that allowing a deduction for such
payments in effect shifts a portion of the penalty to the
Federal government and to the public.

EXPLANATION OF PROVISION

The provision modifies the rules regarding the
determination whether payments are nondeductible payments of
fines or penalties under section 162(f). In particular, the
provision generally provides that amounts paid or incurred
(whether by suit, agreement, or otherwise) to, or at the
direction of, a government in relation to the violation of any
law, or the investigation or inquiry into the potential
violation of any law which is initiated by such government,\98\
are nondeductible under any provision of the income tax
provisions.\99\ The provision applies to deny a deduction for
any such payments, including those where there is no admission
of guilt or liability and those made for the purpose of
avoiding further investigation or litigation. An exception
applies to payments that the taxpayer establishes are either
restitution (including remediation of property) for damage or
harm caused by, or which may be caused by, the violation or
potential violation, or amounts paid to come into compliance
with any law that was violated or involved in the investigation
or inquiry. The exception for restitution does not apply to any
amount paid or incurred as reimbursement to the government for
the costs of any investigation or litigation\100\ unless such
amount is paid or incurred for a cost or fee regularly charged
for any routine audit or other customary review performed by
the government.\101\
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\98\The provision does not affect amounts paid or incurred in
performing routine audits or reviews such as annual audits that are
required of all organizations or individuals in a similar business
sector, or profession, as a requirement for being allowed to conduct
business. However, if the government or regulator raised an issue of
compliance and a payment is required in settlement of such issue, the
provision would affect that payment.
\99\The provision provides that such amounts are nondeductible
under chapter 1 of the Internal Revenue Code.
\100\This exception from deductibility for reimbursements is
intended to include payments to reimburse a government for payments to
whistleblowers.
\101\The provision does not affect such costs or fees that are a
regular charge for a routine audit or customary review, nor does it
affect amounts paid or incurred in performing routine audits or reviews
that are required of all organizations or individuals in a similar
business sector, or profession, as a requirement for being allowed to
conduct business. However, if the government or regulator raised an
issue of compliance and a payment is required in settlement of such
issue, the provision would affect that payment.
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In the case of any court order or binding written
settlement agreement, if the amounts required to be paid exceed
$1 million, then the deduction is not allowed unless such court
order or written settlement agreement specifies that the amount
is for restitution, for remediation of property, or to come
into compliance with the law.\102\ The IRS remains free to
challenge the characterization of an amount so identified.\103\
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\102\The provision does not affect the treatment of antitrust
payments made under section 4 of the Clayton Act, which continue to be
governed by the provisions of section 162(g).
\103\If a settlement agreement does not specify a specific amount
to be paid for the purpose of coming into compliance but instead simply
requires the taxpayer to come into compliance, it is sufficient
identification to so state. Amounts expended by the taxpayer for that
purpose would then be considered identified. However, if an agreement
specifies a specific dollar amount that must be paid or incurred, the
amount would not be eligible to be deducted without a specification
that it is for restitution (including remediation of property) or
coming into compliance.
---------------------------------------------------------------------------
The provision does not apply to any amount paid or incurred
by order of a court in a suit in which no government is a
party.\104\
---------------------------------------------------------------------------
\104\Thus, for example, the provision would not apply to payments
made by one private party to another in a lawsuit between private
parties merely because a judge or jury acting in the capacity as a
court ddirects the payment to be made. The mere fact that a court
enters a judgment or directs a result in a private dispute does not
cause a payment to be made ``at the direction of a government'' for
purposes of the provision.
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The provision does not apply to any amount paid or incurred
as taxes due.\105\
---------------------------------------------------------------------------
\105\Thus, amounts paid or incurred as taxes due are not affected
by the provision (e.g., State taxes that are otherwise deductible). The
reference to taxes due is also intended to include interest with
respect to such taxes (but not interest, if any, with respect to any
penalties imposed with respect to such taxes).
---------------------------------------------------------------------------
It is intended that a payment will be treated as
restitution (including remediation of property) only if
substantially all of the payment is required to be paid to the
specific persons, or in relation to the specific property,
actually harmed by the conduct of the taxpayer that resulted in
the payment. Thus, a payment to or with respect to a class
substantially broader than the specific persons or property
that were actually harmed (e.g., to a class including similarly
situated persons or property) does not qualify as restitution
or included remediation of property.\106\ Restitution and
included remediation of property is limited to the amount that
bears a substantial quantitative relationship to the harm
caused by the past conduct or actions of the taxpayer that
resulted in the payment in question. If the party harmed is a
government or other entity, then restitution and included
remediation of property includes payment to such harmed
government or entity, provided the payment bears a substantial
quantitative relationship to the harm.
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\106\Similarly, a payment to a charitable organization benefiting a
broader class than the persons or property actually harmed, or to be
paid out without a substantial quantitative relationship to the harm
caused, would not qualify as restitution. Under the provision, such a
payment not deductible under section 162 would also not be deductible
under section 170.
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It is intended that a payment will be treated as an amount
paid to come into compliance only if it directly corrects a
violation with respect to a particular requirement of law that
was under investigation. For example, if the law requires a
particular emission standard to be met or particular machinery
to be used, amounts required to be paid under a settlement
agreement to meet the required standard or install the
machinery are deductible to the extent otherwise allowed.
Similarly, if the law requires certain practices and procedures
to be followed and a settlement agreement requires the taxpayer
to pay to establish such practices or procedures, such amounts
would be deductible. However, amounts paid for other purposes
not directly correcting a violation of law are not deductible.
For example, amounts paid to bring other machinery that is
already in compliance up to a standard higher than required by
the law, or to create other benefits (such as a park or other
action not previously required by law), are not deductible if
required under a settlement agreement. Similarly, amounts paid
to educate consumers or customers about the risks of doing
business with the taxpayer or about the field in which the
taxpayer does business generally, which education efforts are
not specifically required under the law, are not deductible if
required under a settlement agreement.
The provision requires government agencies to report to the
IRS and to the taxpayer the amount of each settlement agreement
or order entered where the aggregate amount required to be paid
or incurred to or at the direction of the government under such
settlement agreements and orders with respect to the violation,
investigation, or inquiry is least $600 (or such other amount
as may be specified by the Secretary of the Treasury as
necessary to ensure the efficient administration of the
Internal Revenue laws). The reports must be made within 30 days
of the date the court order is issued or the settlement
agreement is entered into, or such other time as may be
required by Secretary. The report must separately identify any
amounts that are restitution or remediation of property, or
correction of noncompliance.\107\
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\107\As in the case of the identification requirement, if the
agreement does not specify a specific amount to be expended to come
into compliance but simply requires that to occur, it is expected that
the report may state simply that the taxpayer is required to come into
compliance but no specific dollar amount has been specified for that
purpose in the settlement agreement.
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The IRS is encouraged to require taxpayers to identify
separately on their tax returns the amounts of any such
settlements with respect to which reporting is required under
the provision, including separate identification of the
nondeductible amount and of any amount deductible as
restitution, remediation, or required to correct
noncompliance.\108\
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\108\For example, the IRS might require such separate reporting as
part of, or in addition to, reporting of amouts that are not deducted
and that thus create a book tax difference on the schedule M-3.
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Amounts paid or incurred (whether by suit, agreement, or
otherwise) to, or at the direction of, any self-regulatory
entity that regulates a financial market or other market that
is a qualified board or exchange under section 1256(g)(7), and
that is authorized to impose sanctions (e.g., the National
Association of Securities Dealers) are likewise subject to the
provision if paid in relation to a violation, or investigation
or inquiry into a potential violation, of any law (or any rule
or other requirement of such entity). To the extent provided in
regulations, amounts paid or incurred to, or at the direction
of, any other nongovernmental entity that exercises self-
regulatory powers as part of performing an essential
governmental function are similarly subject to the provision.
The exception for payments that the taxpayer establishes are
paid or incurred for restitution, remediation of property, or
coming into compliance; the rules requiring identification of
those amounts in a court order or written settlement agreement
of $1 million or greater; and all the other requirements of the
provision including the requirement of reporting to the IRS and
the taxpayer, likewise apply in such cases.
No inference is intended as to the treatment of payments as
nondeductible fines or penalties under present law. In
particular, the provision is not intended to limit the scope of
present-law section 162(f) or the regulations thereunder.

EFFECTIVE DATE

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

I. Increase In Information Return Penalties

(Sec. 509 of the bill and secs. 6721, 6722, and 6723 of the Code)

PRESENT LAW

Present law imposes information reporting requirements on
participants in certain transactions. Under section 6721 of the
Code, any person required to file a correct information return
who fails to do so on or before the prescribed filing date is
subject to a penalty that varies based on when, if at all, the
correct information return is filed. If a person files a
correct information return after the prescribed filing date,
but on or before the date that is 30 days after the prescribed
filing date, the amount of the penalty is $15 per return (the
``first-tier penalty''), with a maximum penalty of $75,000 per
calendar year. If a person files a correct information return
more than 30 days after the prescribed filing date, but on or
before August 1, the amount of the penalty is $30 per return
(the ``second-tier penalty''), with a maximum penalty of
$150,000 per calendar year. If a correct information return is
not filed on or before August 1, the amount of the penalty is
$50 per return (the ``third-tier penalty''), with a maximum
penalty of $250,000 per calendar year.
Special lower maximum levels for this penalty apply to
small businesses. Small businesses are defined as firms having
average annual gross receipts for the most recent three taxable
years that do not exceed $5 million. The maximum penalties for
small businesses are: $25,000 (instead of $75,000) if the
failures are corrected on or before 30 days after the
prescribed filing date; $50,000 (instead of $150,000) if the
failures are corrected on or before August 1; and $100,000
(instead of $250,000) if the failures are not corrected on or
before August 1.
Section 6722 of the Code also imposes penalties for failing
to furnish correct payee statements to taxpayers. In addition,
section 6723 imposes a penalty for failing to comply with other
information reporting requirements. Under both section 6722 and
section 6723, the penalty amount is $50 for each failure, up to
a maximum of $100,000.

REASONS FOR CHANGE

The Committee believes the present law penalties for
failing to file accurate information returns are too low to
discourage noncompliance. The Committee believes that
increasing the information return penalties will encourage the
filing of timely and accurate information returns and generally
will improve tax administration and tax compliance.

EXPLANATION OF PROVISION

The provision increases the penalties for failing to file
correct information returns, failing to furnish correct payee
statements, and failing to comply with other information
reporting requirements. Specifically, the provision increases
the failure to file correct information returns as follows: the
first-tier penalty would be increased from $15 to $50, with a
maximum penalty of $500,000 per calendar year; the second-tier
penalty would be increased from $30 to $100, with a maximum
penalty of $1,500,000 per calendar year; and the third-tier
penalty would be increased from $50 to $250, with a maximum
penalty of $3,000,000 per calendar year. The maximum penalties
for small businesses would be: $175,000 if the failures are
corrected on or before 30 days after the prescribed filing
date; $500,000 if the failures are corrected on or before
August 1; and $1,000,000 if the failures are not corrected on
or before August 1.
The provision increases both the penalty for failing to
furnish correct payee statements to taxpayers and the penalty
for failing to comply with other information reporting
requirements penalties to $250 for each such failure, up to a
maximum of $1,000,000 in a calendar year.

EFFECTIVE DATE

The provision is effective with respect to information
returns required to be filed on or after January 1, 2008.

J. Economic Substance Doctrine

(Secs. 511-513 of the bill and sec. 7701, new sec. 6662B, and sec. 163
of the Code)

1. Clarification of the economic substance doctrine

PRESENT LAW

In general

The Code provides detailed rules specifying the computation
of taxable income, including the amount, timing, source, and
character of items of income, gain, loss, and deduction. These
rules permit both taxpayers and the government to compute
taxable income with reasonable accuracy and predictability.
Taxpayers generally may plan their transactions in reliance on
these rules to determine the federal income tax consequences
arising from the transactions.
In addition to the statutory provisions, courts have
developed several doctrines that can be applied to deny the tax
benefits of tax motivated transactions, notwithstanding that
the transaction may satisfy the literal requirements of a
specific tax provision. The common-law doctrines are not
entirely distinguishable, and their application to a given set
of facts is often blurred by the courts and the IRS. Although
these doctrines serve an important role in the administration
of the tax system, they can be seen as at odds with an
objective, ``rule-based'' system of taxation.
A common-law doctrine applied with increasing frequency is
the ``economic substance'' doctrine. In general, this doctrine
denies tax benefits arising from transactions that do not
result in a meaningful change to the taxpayer's economic
position other than a purported reduction in federal income
tax.\109\
---------------------------------------------------------------------------
\109\See, e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d
Cir. 1998), aff'g 73 T.C.M. (CCH) 2189 (1997), cert. denied 526 U.S.
1017 (1999). Closely related doctrines also applied by the courts
(sometimes interchangeable with the economic substance doctrine)
include the ``sham transaction doctrine'' and the ``business purpose
doctrine.'' See, e.g., Knetsch v. United States, 364 U.S. 361 (1960)
(denying interest deductions on a ``sham transaction'' whose only
purpose was to create the deductions). Certain ``substance over form''
cases involving tax-indifferent parties, in which courts have found
that the substance of the transaction did not comport with the form
asserted by the taxpayer, have also involved examination of whether the
change in economic position that occurred, if any, was consistent with
the form asserted, and whether the claimed business purpose supported
the particular tax benefits that were claimed. See, e.g., Klamath
Strategic Investment Fund, LLC v. United States, 472 F. Supp. 2d 885
(E.D. Texas 2007); TIFD-III-E, Inc. v. United States, 459 F. 3d 220 (2d
Cir. 2006); BB&T; Corporation v. United States, ----F. Supp. 2d ----,
2007-1 USTC P 50,130 (M.D.N.C. 2007).
---------------------------------------------------------------------------
Economic substance doctrine
Courts generally deny claimed tax benefits if the
transaction that gives rise to those benefits lacks economic
substance independent of tax considerations--notwithstanding
that the purported activity actually occurred. The Tax Court
has described the doctrine as follows:

The tax law . . . requires that the intended transactions
have economic substance separate and distinct from economic
benefit achieved solely by tax reduction. The doctrine of
economic substance becomes applicable, and a judicial remedy is
warranted, where a taxpayer seeks to claim tax benefits,
unintended by Congress, by means of transactions that serve no
economic purpose other than tax savings.\110\
---------------------------------------------------------------------------
\110\AACM Partnership v. Commissioner, 73 T.C.M. at 2215.
---------------------------------------------------------------------------
Business purpose doctrine
A common law doctrine that often is considered together
with the economic substance doctrine is the business purpose
doctrine. The business purpose doctrine involves a subjective
inquiry into the motives of the taxpayer--that is, whether the
taxpayer intended the transaction to serve some useful non-tax
purpose. In making this determination, some courts have
bifurcated a transaction in which independent activities with
non-tax objectives have been combined with an unrelated item
having only tax-avoidance objectives in order to disallow the
tax benefits of the overall transaction.\111\
---------------------------------------------------------------------------
\111\See, ACM Partnership v. Commissioner, 157 F.3d at 256 n.48.
---------------------------------------------------------------------------

Application by the courts

Elements of the doctrine
There is a lack of uniformity regarding the proper
application of the economic substance doctrine.\112\ Some
courts apply a conjunctive test that requires a taxpayer to
establish the presence of both economic substance (i.e., the
objective component) and business purpose (i.e., the subjective
component) in order for the transaction to survive judicial
scrutiny.\113\ A narrower approach used by some courts is to
conclude that either a business purpose or economic substance
is sufficient to respect the transaction.\114\ A third approach
regards economic substance and business purpose as ``simply
more precise factors to consider'' in determining whether a
transaction has any practical economic effects other than the
creation of tax benefits.\115\
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\112\``The casebooks are glutted with [economic substance] tests.
Many such tests proliferate because they give the comforting illusion
of consistency and precision. They often obscure rather than clarify.''
Collins v. Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988).
\113\See, e.g., Pasternak v. Commissioner, 990 F.2d 893, 898 (6th
Cir. 1993) (``The threshold question is whether the transaction has
economic substance. If the answer is yes, the question becomes whether
the taxpayer was motivated by profit to participate in the
transaction.'').
\114\See, e.g., Rice's Toyota World v. Commissioner, 752 F.2d 89,
91-92 (4th Cir. 1985) (``To treat a transaction as a sham, the court
must find that the taxpayer was motivated by no business purposes other
than obtaining tax benefits in entering the transaction, and, second,
that the transaction has no economic substance because no reasonable
possibility of a profit exists.''); IES Industries v. United States,
253 F.3d 350, 358 (8th Cir. 2001) (``In determining whether a
transaction is a sham for tax purposes [under the Eighth Circuit test],
a transaction will be characterized as a sham if it is not motivated by
any economic purpose out of tax considerations (the business purpose
test), and if it is without economic substance because no real
potential for profit exists (the economic substance test).''). As noted
earlier, the economic substance doctrine and the sham transaction
doctrine are similar and sometimes are applied interchangeably. For a
more detailed discussion of the sham transaction doctrine, see, e.g.,
Joint Committee on Taxation, Study of Present-Law Penalty and Interest
Provisions as Required by Section 3801 of the Internal Revenue Service
Restructuring and Reform Act of 1998 (including Provisions Relating to
Corporate Tax Shelters) (JCS-3-99) at 182.
\115\ 1ASee, e.g., ACM Partnership v. Commissioner, 157 F.3d at
247; James v. Commissioner, 899 F.2d 905, 908 (10th Cir. 1995); Sacks
v. Commissioner, 69 F.3d 982, 985 (9th Cir. 1995) (``Instead, the
consideration of business purpose and economic substance are simply
more precise factors to consider . . . We have repeatedly and carefully
noted that this formulation cannot be used as a `rigid two-step
analysis'.'').
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Recently, the Court of Federal Claims questioned the
continuing viability of the doctrine. That court also stated
that ``the use of the `economic substance' doctrine to trump
`mere compliance with the Code' would violate the separation of
powers'' though that court also found that the particular case
did not lack economic substance. The Court of Appeals for the
Federal Circuit (``Federal Circuit Court'') overruled the Court
of Federal Claims decision, reiterating the viability of the
economic substance doctrine and concluding that the transaction
in question violated that doctrine.\116\ The Federal Circuit
Court stated that ``[w]hile the doctrine may well also apply if
the taxpayer's sole subjective motivation is tax avoidance even
if the transaction has economic substance, [footnote omitted],
a lack of economic substance is sufficient to disqualify the
transaction without proof that the taxpayer's sole motive is
tax avoidance.''\117\
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\116\Coltec Industries, Inc. v. United States, 62 Fed. Cl. 716
(2004) (slip opinion at 123-124, 128); vacated and remanded, 454 F.3d
1340 (Fed. Cir. 2006), cert. denied, 127 S. Ct. 1261 (Mem.) (2007).
\117\The Federal Circuit Court stated that ``when the taxpayer
claims a deduction, it is the taxpayer who bears the burden of proving
that the transaction has economic substance.'' The Federal Circuit
Court quoted a decision of its predecessor court, stating that
``Gregory v. Helvering requires that a taxpayer carry an unusually
heavy burden when he attempts to demonstrate that Congress intended to
give favorable tax treatment to the kind of transaction that would
never occur absent the motive of tax avoidance.'' The Court also stated
that ``while the taxpayer's subjective motivation may be pertinent to
the existence of a tax avoidance purpose, all courts have looked to the
objective reality of a transaction in assessing its economic
substance.'' Coltec Industries, Inc. v. United States, 454 F.3d at
1355, 1356.
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Nontax economic benefits
There also is a lack of uniformity regarding the type of
non-tax economic benefit a taxpayer must establish in order to
satisfy economic substance. Some courts have denied tax
benefits on the grounds that a stated business benefit of a
particular structure was not in fact obtained by that
structure.\118\ Several courts have denied tax benefits on the
grounds that the subject transactions lacked profit
potential.\119\ In addition, some courts have applied the
economic substance doctrine to disallow tax benefits in
transactions in which a taxpayer was exposed to risk and the
transaction had a profit potential, but the court concluded
that the economic risks and profit potential were insignificant
when compared to the tax benefits.\120\ Under this analysis,
the taxpayer's profit potential must be more than nominal.
Conversely, other courts view the application of the economic
substance doctrine as requiring an objective determination of
whether a ``reasonable possibility of profit'' from the
transaction existed apart from the tax benefits.\121\ In these
cases, in assessing whether a reasonable possibility of profit
exists, it may be sufficient if there is a nominal amount of
pre-tax profit as measured against expected net tax benefits.
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\118\See, e.g., Coltec Industries v. United States, 454 F.3d 1340
(Fed. Cir. 2006). The court analyzed the transfer to a subsidiary of a
note purporting to provide high stock basis in exchange for a purported
assumption of liabilities, and held these transactions unnecessary to
accomplish any business purpose of using a subsidiary to manage
asbestos liabilities. The court also held that the purported business
purpose of adding a barrier to veil-piercing claims by third parties
was not accomplished by the transaction. 454 F.3d at 1358-1360 (Fed.
Cir. 2006).
\119\See, e.g., Knetsch, 364 U.S. at 361; Goldstein v.
Commissioner, 364 F.2d 734 (2d Cir. 1966) (holding that an
unprofitable, leveraged acquisition of Treasury bills, and accompanying
prepaid interest deduction, lacked economic substance).
\120\See, e.g., Goldstein v. Commissioner, 364 F.2d at 739-40
(disallowing deduction even though taxpayer had a possibility of small
gain or loss by owning Treasury bills); Sheldon v. Commissioner, 94
T.C. 738, 768 (1990) (stating that ``potential for gain . . . is
infinitesimally nominal and vastly insignificant when considered in
comparison with the claimed deductions'').
\121\See, e.g., Rice's Toyota World v. Commissioner, 752 F. 2d 89,
94 (4th Cir. 1985) (the economic substance inquiry requires an
objective determination of whether a reasonable possibility of profit
from the transaction existed apart from tax benefits); Compaq Computer
Corp. v. Commissioner, 277 F.3d 778, 781 (5th Cir. 2001) (applied the
same test, citing Rice's Toyota World); IES Industries v. United
States, 253 F.3d 350, 354 (8th Cir. 2001).
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Financial accounting benefits
In determining whether a taxpayer had a valid business
purpose for entering into a transaction, at least one court has
concluded that financial accounting benefits arising from tax
savings do not qualify as a non-tax business purpose.\122\
However, based on court decisions that recognize the importance
of financial accounting treatment, taxpayers have asserted that
financial accounting benefits arising from tax savings can
satisfy the business purpose test.\123\
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\122\See American Electric Power, Inc. v. United States, 136 F.
Supp. 2d 762, 791-92 (S.D. Ohio 2001); aff'd 326 F.3d.737 (6th Cir.
2003).
\123\See, e.g., Joint Committee on Taxation, Report of
Investigation of Enron Corporation and Related Entities Regarding
Federal Tax and Compensation Issues, and Policy Recommendations (JSC-3-
03) February, 2003 (``Enron Report''), Volume III at C-93, 289. Enron
Corporation relied on Frank Lyon Co. v. United States, 435 U.S. 561,
577-78 (1978), and Newman v. Commissioner, 902 F.2d 159, 163 (2d Cir.
1990), to argue that financial accounting benefits arising from tax
savings constitute a good business purpose.
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Tax-indifferent parties
A number of cases have involved transactions structured to
allocate income for Federal tax purposes to a tax-indifferent
party, with a corresponding deduction, or favorable basis
result, to a taxable person. The income allocated to the tax-
indifferent party for tax purposes was structured to exceed any
actual economic income to be received by the tax indifferent
party from the transaction. Courts have sometimes concluded
that a particular type of transaction did not satisfy the
economic substance doctrine.\124\ In other cases, courts have
indicated that the substance of the transaction did not support
the form of income allocations asserted by the taxpayer, and
have questioned whether asserted business purpose or other
standards were met.\125\
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\124\See, e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d
Cir. 1998), aff'g 73 T.C.M. (CCH) 2189 (1997), cert. denied 526 U.S.
1017 (1999).
\125\See, e.g., TIFD-III-E, Inc. v. United States, 459 F.3d 220 (2d
Cir. 2006).
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REASONS FOR CHANGE

Recent tax avoidance transactions have relied upon the
interaction of highly technical tax law provisions to produce
tax consequences not contemplated by the Congress. When
successful, taxpayers who engage in these transactions enlarge
the tax gap by gaining unintended tax relief and by undermining
overall respect for the tax system.
A strictly rule-based tax system cannot efficiently
prescribe the appropriate outcome of every conceivable
transaction that might be devised and is, as a result,
incapable of preventing all unintended consequences. Thus, many
courts have long recognized the need to supplement tax rules
with anti-tax avoidance standards, such as the economic
substance doctrine, in order to assure the Congressional
purpose is achieved. The Committee recognizes that IRS has
achieved a number of recent successes in litigation. The
Committee believes it is still desirable to provide greater
clarity and uniformity in the application of the economic
substance doctrine in order to assure such continued
application of the doctrine and to improve its effectiveness at
deterring unintended consequences. The Committee believes that
a stronger penalty imposed on understatements attributable to
non-economic substance transactions is desirable in this
connection, to deter taxpayers from entering such transactions
and thus improve compliance.
The Committee believes the same result with respect to
interest on underpayments that occurs with respect to
nondisclosed reportable transactions should also apply to
noneconomic substance transactions.

EXPLANATION OF PROVISION

The provision clarifies and enhances the application of the
economic substance doctrine. Under the provision, in a case in
which a court determines that the economic substance doctrine
is relevant to a transaction (or a series of transactions),
such transaction (or series of transactions) has economic
substance (and thus satisfies the economic substance doctrine)
only if the taxpayer establishes that (1) the transaction
changes in a meaningful way (apart from Federal income tax
consequences) the taxpayer's economic position, and (2) the
taxpayer has a substantial non-Federal-tax purpose for entering
into such transaction. The provision provides a uniform
definition of economic substance, but does not alter the
flexibility of the courts in other respects.
If the tax benefits are clearly consistent with all
applicable provisions of the Code and the purposes of such
provisions, it is not intended that such tax benefits be
disallowed if the only reason for such disallowance is that the
transaction fails the economic substance doctrine as defined in
this provision. Thus, the provision does not change current law
standards used by courts in determining when to utilize an
economic substance analysis.\126\
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\126\See, e.g., Treas. Reg. sec. 1.269-2, stating that
characteristic of circumstances in which a deduction otherwise allowed
will be disallowed are those in which the effect of the deduction,
credit, or other allowance would be to distort the liability of the
particular taxpayer when the essential nature of the transaction or
situation is examined in the light of the basic purpose or plan which
the deduction, credit, or other allowance was designed by the Congress
to effectuate.
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The provision is not intended to alter the tax treatment of
certain basic business transactions that, under longstanding
judicial and administrative practice are respected, merely
because the choice between meaningful economic alternatives is
largely or entirely based on comparative tax advantages.
Among\127\ these basic transactions are (1) the choice between
capitalizing a business enterprise with debt or equity;\128\
(2) a U.S. person's choice between utilizing a foreign
corporation or a domestic corporation to make a foreign
investment;\129\ (3) the choice to enter a transaction or
series of transactions that constitute a corporate organization
or reorganization under subchapter C;\130\ and (4) the choice
to utilize a related-party entity in a transaction, provided
that the arm's length standard of section 482 and other
applicable concepts are satisfied.\131\ Leasing transactions,
like all other types of transactions, will continue to be
analyzed in light of all the facts and circumstances.\132\ As
under present law, whether a particular transaction meets the
requirements for specific treatment under any of these
provisions can be a question of facts and circumstances. Also,
the fact that a transaction does meet the requirements for
specific treatment under any provision of the Code is not
determinative of whether a transaction or series of
transactions of which it is a part has economic substance.\133\
---------------------------------------------------------------------------
\127\The examples are illustrative and not exclusive.
\128\See, e.g., John Kelley Co. v. Commissioner, 326 U.S. 521
(1946) (respecting debt characterization in one case and not in the
other, based on all the facts and circumstances).
\129\See, e.g., Sam Siegel v. Commissioner, 45. T.C. 566 (1966),
acq. 1966-2 C.B. 3; but see Commissioner v. Bollinger, 485 U.S. 340
(1988) (agency principles applied to title-holding corporation under
all the facts and circumstance).
\130\See, e.g. Rev. Proc. 2007-3 2007-1 I.R.B. 108, secs 3.01(33),
(34), and (36) (IRS will not rule on certain matters relating to
incorporations or reorganizations unless there is a ``significant
issue''); compare Gregory v. Helvering. 293 U.S. 465 (1935).
\131\See, e.g., National Carbide v. Commissioner, 336 U.S. 422
(1949), Moline Properties v. Commissioner, 319 U.S. 435 (1943);
compare, e.g. Aiken Industries, Inc. v. Commissioner, 56 T.C. 925
(1971), acq., 1972-2 C.B. 1; Commissioner v. Bollinger, 485 U.S. 340
(1988), see also sec. 7701(l).
\132\See, e.g., Frank Lyon v. Commissioner, 435 U.S. 561 (1978);
Hilton v. Commissioner, 74 T.C. 305, aff'd 671 F. 2d 316 (9th Cir.
1982), cert. denied 459 U.S. 907 (1982); Coltec Industries v. United
States, 454 F.3d 1340 (Fed. Cir. 2006), cert. denied 127 S. Ct. 1261
(Mem) (2007).
\133\As examples of cases in which courts have found that a
transaction does not meet the requirements for the treatment claimed by
the taxpayer under the Code, or does not have economic substance, see
e.g., TIFD-III-E, Inc. v. United States, 459 F.3d 220 (2d Cir. 2006);
BB&T; Corporation v. United States, ----F. Supp.----, 2007-1 USTC P
50,130 (M.D.N,C, 2007); Tribune Company and Subsidiaries v.
Commissioner, 125 T.C. 110 (2005) ; H.J. Heinz Company and Subsidiaries
v. United States, 76 Fed. Cl. 570 (2007); Coltec Industries, Inc. v.
United States, 454 F.3d 1340 (Fed. Cir. 2006), cert. denied 127 S. Ct.
1261 (Mem.) (2007); Long Term Capital Holdings LP v. United States, 330
F. Supp. 2d 122 (D. Conn. 2004), aff'd 150 Fed. Appx. 40 (2d Cir.
2005); Klamath Strategic Investment Fund, LLC v. United States, 472 F.
Supp. 2d 885 (E.D. Texas 2007); Santa Monica Pictures LLC v.
Commissioner, 89 T.C.M. 1157 (2005).
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The provision does not alter the court's ability to
aggregate, disaggregate, or otherwise recharacterize a
transaction when applying the doctrine. For example, the
provision reiterates the present-law ability of the courts to
bifurcate a transaction in which independent activities with
non-tax objectives are combined with an unrelated item having
only tax-avoidance objectives in order to disallow those tax
motivated benefits.\134\
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\134\See, e.g., Coltec Industries, Inc. v. United States, 454 F.3d
1340 (Fed. Cir. 2006), cert. denied 127 S. Ct. 1261 (Mem.) (2007)
(``the first asserted business purpose focuses on the wrong
transaction--the creation of Garrison as a separate subsidiary to
manage asbestos liabilities.. . . [W]e must focus on the transaction
that gave the taxpayer a high basis in the stock and thus gave rise to
the alleged benefit upon sale...'') 454 F.3d 1340, 1358 (Fed. Cir.
2006). See also ACM Partnership v. Commissioner, 157 F.3d at 256 n.48;
Minnesota Tea Co. v. Helvering, 302 U.S. 609, 613 (1938) (``A given
result at the end of a straight path is not made a different result
because reached by following a devious path.'').
---------------------------------------------------------------------------

Conjunctive analysis

The provision clarifies that the economic substance
doctrine involves a conjunctive analysis--there must be a
judicial inquiry regarding the objective effects of the
transaction on the taxpayer's economic position as well as an
inquiry regarding the taxpayer's subjective motives for
engaging in the transaction. Under the provision, a transaction
must satisfy both tests, i.e., the transaction must change in a
meaningful way (apart from Federal income tax effects) the
taxpayer's economic position, and the taxpayer must have a
substantial non-Federal-tax purpose\135\ for entering into such
transaction, in order to satisfy the economic substance
doctrine. This clarification eliminates the disparity that
exists among the circuits regarding the application of the
doctrine, and modifies its application in those circuits in
which either a change in economic position or a non-tax
business purpose (without having both) is sufficient to satisfy
the economic substance doctrine.
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\135\A purpose of reducing non-Federal taxes is not a non-Federal-
tax business purpose if (i) the transaction will effect a reduction in
both Federal and non-Federal taxes because of similarities between
Federal tax law and the law of the other jurisdiction and (ii) the
reduction of Federal taxes is greater than or substantially coextensive
with the reduction of non-Federal taxes.
---------------------------------------------------------------------------

Non-Federal-tax business purpose

Under the provision, a taxpayer's non-Federal-tax purpose
for entering into a transaction (the second prong in the
analysis) must be ``substantial.''\136\
---------------------------------------------------------------------------
\136\See, e.g., Treas. Reg. sec. 1.269-2(b) (stating that a
distortion of tax liability indicating the principal purpose of tax
evasion or avoidance might be evidenced by the fact that ``the
transaction was not undertaken for reasons germane to the conduct of
the business of the taxpayer''). Similarly, in ACM Partnership v.
Commissioner, 73 T.C.M. (CCH) 2189 (1997), the court stated: ``Key to
[the determination of whether a transaction has economic substance] is
that the transaction must be rationally related to a useful nontax
purpose that is plausible in light of the taxpayer's conduct and useful
in light of the taxpayer's economic situation and intentions. Both the
utility of the stated purpose and the rationality of the means chosen
to effectuate it must be evaluated in accordance with commercial
practices in the relevant industry. A rational relationship between
purpose and means ordinarily will not be found unless there was a
reasonable expectation that the nontax benefits would be at least
commensurate with the transaction costs.'' [citations omitted]
---------------------------------------------------------------------------
An objective of achieving a favorable accounting treatment
for financial reporting purposes will not itself be treated as
a substantial non-Federal-tax purpose if the origin of such
financial accounting benefit is a reduction of Federal income
tax.\137\ For example, a transaction that is expected to
increase financial accounting income as a result of generating
tax deductions or losses without a corresponding financial
accounting charge (i.e., a permanent book-tax difference)\138\
should not be considered to have a substantial non-Federal-tax
purpose unless a substantial non-Federal-tax purpose exists
apart from the financial accounting benefits.\139\
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\137\However, if the tax benefits are clearly contemplated and
expected by the language and purpose of the relevant authority, such
tax benefits should not be disallowed solely because the transaction
results in a favorable accounting treatment. An example is the repealed
foreign sales corporation rules.
\138\This includes tax deductions or losses that are anticipated to
be recognized in a period subsequent to the period the financial
accounting benefit is recognized. For example, FAS 109 in some cases
permits the recognition of financial accounting benefits prior to the
period in which the tax benefits are recognized for income tax
purposes.
\139\Claiming that a financial accounting benefit constitutes a
substantial non-tax purpose fails to consider the origin of the
accounting benefit (i.e., reduction of taxes) and significantly
diminishes the purpose for having a substantial non-tax purpose
requirement. See, e.g., American Electric Power, Inc. v. United States,
136 F. Supp. 2d 762, 791-92 (S.D. Ohio 2001) (``AEP's intended use of
the cash flows generated by the [corporate-owned life insurance] plan
is irrelevant to the subjective prong of the economic substance
analysis. If a legitimate business purpose for the use of the tax
savings `were sufficient to breathe substance into a transaction whose
only purpose was to reduce taxes, [then] every sham tax-shelter device
might succeed,''') (citing Winn-Dixie v. Commissioner, 113 T.C. 254,
287 (1999)); aff'd, 326 F3d 737 (6th Cir. 2003).
---------------------------------------------------------------------------

Profit potential

Under the provision, a taxpayer may rely on factors other
than profit potential to demonstrate that a transaction results
in a meaningful change in the taxpayer's economic position or
that the taxpayer has a substantial non-Federal-tax purpose for
entering into such transaction. The provision does not require
or establish a specified minimum return that will satisfy the
profit potential test. However, if a taxpayer relies on a
profit potential, the present value of the reasonably expected
pre-Federal-tax profit must be substantial in relation to the
present value of the expected net Federal tax benefits that
would be allowed if the transaction were respected.\140\ In
addition, in determining pre-Federal-tax profit, foreign taxes
are treated as expenses to the extent provided in
regulations.\141\
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\140\Thus, a ``reasonable possibility of profit'' alone will not be
sufficient to establish that a transacgtion has economic substance.
\141\There is no intention to restrict the ability of the courts to
consider the appropriate treatment of foreign taxes in particular
cases, as under present law. However, the Treasury Department may, in
addition, choose to require treatment of foreign taxes as expenses as
provided in regulations.
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Other rules

The Secretary may prescribe regulations that provide (1)
exemptions from the application of the provision, and (2) other
rules as may be necessary or appropriate to carry out the
purposes of the provision.
No inference is intended as to the proper application of
the economic substance doctrine under present law. In addition,
the provision shall not be construed as altering or supplanting
any other common law doctrine or provision of the Code or
regulations or other guidance thereunder; and the provision
shall be construed as being additive to any such other
doctrine, Code provision, or regulations or guidance
thereunder.

EFFECTIVE DATE

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

2. Penalty for understatements attributable to transactions lacking
economic substance, etc.

PRESENT LAW

General accuracy-related penalty

An accuracy-related penalty under section 6662 applies to
the portion of any underpayment that is attributable to (1)
negligence, (2) any substantial understatement of income tax,
(3) any substantial valuation misstatement, (4) any substantial
overstatement of pension liabilities, or (5) any substantial
estate or gift tax valuation understatement. If the correct
income tax liability exceeds that reported by the taxpayer by
the greater of 10 percent of the correct tax or $5,000 (or, in
the case of corporations, by the lesser of (a) 10 percent of
the correct tax (or $10,000 if greater) or (b) $10 million),
then a substantial understatement exists and a penalty may be
imposed equal to 20 percent of the underpayment of tax
attributable to the understatement.\142\ Except in the case of
tax shelters,\143\ the amount of any understatement is reduced
by any portion attributable to an item if (1) the treatment of
the item is supported by substantial authority, or (2) facts
relevant to the tax treatment of the item were adequately
disclosed and there was a reasonable basis for its tax
treatment. The Treasury Secretary may prescribe a list of
positions which the Secretary believes do not meet the
requirements for substantial authority under this provision.
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\142\Sec. 6662.
\143\A tax shelter is defined for this purpose as a partnership or
other entity, an investment plan or arrangement, or any other plan or
arrangement if a significant purpose of such partnership, other entity,
plan, or arrangement is the avoidance or evasion of Federal income tax.
Sec. 6662(d)(2)(C).
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The section 6662 penalty generally is abated (even with
respect to tax shelters) in cases in which the taxpayer can
demonstrate that there was ``reasonable cause'' for the
underpayment and that the taxpayer acted in good faith.\144\
The relevant regulations provide that reasonable cause exists
where the taxpayer ``reasonably relies in good faith on an
opinion based on a professional tax advisor's analysis of the
pertinent facts and authorities [that] . . . unambiguously
concludes that there is a greater than 50-percent likelihood
that the tax treatment of the item will be upheld if
challenged'' by the IRS.\145\
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\144\Sec. 6664(c).
\145\Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec.
1.6664-4(c).
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Listed Transactions and Reportable Avoidance Transactions

In general
A separate accuracy-related penalty under section 6662A
applies to ``listed transactions'' and to other ``reportable
transactions'' with a significant tax avoidance purpose
(hereinafter referred to as a ``reportable avoidance
transaction''). The penalty rate and defenses available to
avoid the penalty vary depending on whether the transaction was
adequately disclosed.
Both listed transactions and reportable transactions are
allowed to be described by the Treasury Department under
section 6707A(c), which imposes a penalty for failure
adequately to report such transactions under section 6011. A
reportable transaction is defined as one that the Treasury
Secretary determines is required to be disclosed because it is
determined to have a potential for tax avoidance or
evasion.\146\ A listed transaction is defined as a reportable
transaction, which is the same as, or substantially similar to,
a transaction specifically identified by the Secretary as a tax
avoidance transaction for purposes of the reporting disclosure
requirements.\147\
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\146\Sec. 6707A(c)(1).
\147\Sec. 6707A(c)(2).
---------------------------------------------------------------------------
Disclosed transactions
In general, a 20-percent accuracy-related penalty is
imposed on any understatement attributable to an adequately
disclosed listed transaction or reportable avoidance
transaction.\148\ The only exception to the penalty is if the
taxpayer satisfies a more stringent reasonable cause and good
faith exception (hereinafter referred to as the ``strengthened
reasonable cause exception''), which is described below. The
strengthened reasonable cause exception is available only if
the relevant facts affecting the tax treatment are adequately
disclosed, there is or was substantial authority for the
claimed tax treatment, and the taxpayer reasonably believed
that the claimed tax treatment was more likely than not the
proper treatment.
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\148\Sec. 6662A(a).
---------------------------------------------------------------------------
Undisclosed transactions
If the taxpayer does not adequately disclose the
transaction, the strengthened reasonable cause exception is not
available (i.e., a strict-liability penalty generally applies),
and the taxpayer is subject to an increased penalty equal to 30
percent of the understatement.\149\ However, a taxpayer will be
treated as having adequately disclosed a transaction for this
purpose if the IRS Commissioner has separately rescinded the
separate penalty under section 6707A for failure to disclose a
reportable transaction.\150\ The IRS Commissioner is authorized
to do this only if the failure does not relate to a listed
transaction and only if rescinding the penalty would promote
compliance and effective tax administration.\151\
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\149\Sec. 6662A(c).
\150\Sec. 6664(d).
\151\Sec. 6707A(d).
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A public entity that is required to pay a penalty for an
undisclosed listed or reportable transaction must disclose the
imposition of the penalty in reports to the SEC for such
periods as the Secretary shall specify. The disclosure to the
SEC applies without regard to whether the taxpayer determines
the amount of the penalty to be material to the reports in
which the penalty must appear, and any failure to disclose such
penalty in the reports is treated as a failure to disclose a
listed transaction. A taxpayer must disclose a penalty in
reports to the SEC once the taxpayer has exhausted its
administrative and judicial remedies with respect to the
penalty (or if earlier, when paid).\152\
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\152\Sec. 6707A(e).
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Determination of the understatement amount
The penalty is applied to the amount of any understatement
attributable to the listed or reportable avoidance transaction
without regard to other items on the tax return. For purposes
of this provision, the amount of the understatement is
determined as the sum of: (1) the product of the highest
corporate or individual tax rate (as appropriate) and the
increase in taxable income resulting from the difference
between the taxpayer's treatment of the item and the proper
treatment of the item (without regard to other items on the tax
return);\153\ and (2) the amount of any decrease in the
aggregate amount of credits which results from a difference
between the taxpayer's treatment of an item and the proper tax
treatment of such item.
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\153\For this purpose, any reduction in the excess of deductions
allowed for the taxable year over gross income for such year, and any
reduction in the amount of capital losses which would (without regard
to section 1211) be allowed for such year, shall be treated as an
increase in taxable income. Sec. 6662A(b).
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Except as provided in regulations, a taxpayer's treatment
of an item shall not take into account any amendment or
supplement to a return if the amendment or supplement is filed
after the earlier of when the taxpayer is first contacted
regarding an examination of the return or such other date as
specified by the Secretary.\154\
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\154\Sec. 6662A(e)(3).
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Strengthened reasonable cause exception
A penalty is not imposed with respect to any portion of an
understatement if it is shown that there was reasonable cause
for such portion and the taxpayer acted in good faith. Such a
showing requires: (1) adequate disclosure of the facts
affecting the transaction in accordance with the regulations
under section 6011;\155\ (2) that there is or was substantial
authority for such treatment; and (3) that the taxpayer
reasonably believed that such treatment was more likely than
not the proper treatment. For this purpose, a taxpayer will be
treated as having a reasonable belief with respect to the tax
treatment of an item only if such belief: (1) is based on the
facts and law that exist at the time the tax return (that
includes the item) is filed; and (2) relates solely to the
taxpayer's chances of success on the merits and does not take
into account the possibility that (a) a return will not be
audited, (b) the treatment will not be raised on audit, or (c)
the treatment will be resolved through settlement if
raised.\156\
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\155\See the previous discussion regarding the penalty for failing
to disclose a reportable transaction.
\156\Sec. 6664(d).
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A taxpayer may (but is not required to) rely on an opinion
of a tax advisor in establishing its reasonable belief with
respect to the tax treatment of the item. However, a taxpayer
may not rely on an opinion of a tax advisor for this purpose if
the opinion (1) is provided by a ``disqualified tax advisor''
or (2) is a ``disqualified opinion.''
Disqualified tax advisor
A disqualified tax advisor is any advisor who: (1) is a
material advisor\157\ and who participates in the organization,
management, promotion, or sale of the transaction or is related
(within the meaning of section 267(b) or 707(b)(1)) to any
person who so participates; (2) is compensated directly or
indirectly\158\ by a material advisor with respect to the
transaction; (3) has a fee arrangement with respect to the
transaction that is contingent on all or part of the intended
tax benefits from the transaction being sustained; or (4) as
determined under regulations prescribed by the Secretary, has a
disqualifying financial interest with respect to the
transaction.
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\157\The term ``material advisor'' means any person who provides
any material aid, asistance, or advice with respect to organizing,
managing, promoting, selling, implementing, or carrying out any
reportable transaction, and who derives gross income in excess of
$50,000 in the case of a reportable transaction substantially all of
the tax benefits from which are provided to natural persons ($250,000
in any other case). Sec. 6111(b)(1).
\158\This situation could arise, for example, when an advisor has
an arrangement or understanding (oral or written) with an organizer,
manager, or promoter of a reportable transaction that such party will
recommend or refer potential participants to the advisor for an opinion
regarding the tax treatment of the transaction.
---------------------------------------------------------------------------
A material advisor is considered as participating in the
``organization'' of a transaction if the advisor performs acts
relating to the development of the transaction. This may
include, for example, preparing documents: (1) establishing a
structure used in connection with the transaction (such as a
partnership agreement); (2) describing the transaction (such as
an offering memorandum or other statement describing the
transaction); or (3) relating to the registration of the
transaction with any federal, state, or local government
body.\159\ Participation in the ``management'' of a transaction
means involvement in the decision-making process regarding any
business activity with respect to the transaction.
Participation in the ``promotion or sale'' of a transaction
means involvement in the marketing or solicitation of the
transaction to others. Thus, an advisor who provides
information about the transaction to a potential participant is
involved in the promotion or sale of a transaction, as is any
advisor who recommends the transaction to a potential
participant.
---------------------------------------------------------------------------
\159\An advisor shoud not be treated as participating in the
organization of a transaction if the advisor's only involvement with
respect to the organization of the transaction is the rendering of an
opinion regarding the tax consequences of such transaction. However,
such an advisor may be a ``disqualified tax advisor'' with respect to
the transaction if the advisor participates in the management,
promotion, or sale of the transaction (or if the advisor is compensated
by a material advisor, has a fee arrangement that is contingent on the
tax benefits of the transaction, or as determined by the Secretary, has
a continuing financial interest with respect to the transaction).
---------------------------------------------------------------------------
Disqualified opinion
An opinion may not be relied upon if the opinion: (1) is
based on unreasonable factual or legal assumptions (including
assumptions as to future events); (2) unreasonably relies upon
representations, statements, findings or agreements of the
taxpayer or any other person; (3) does not identify and
consider all relevant facts; or (4) fails to meet any other
requirement prescribed by the Secretary.
Coordination with other penalties
To the extent a penalty on an understatement is imposed
under section 6662A, that same amount of understatement is not
also subject to the accuracy-related penalty under section
6662(a) or to the valuation misstatement penalties under
section 6662(e) or 6662(h). However, such amount of
understatement is included for purposes of determining whether
any understatement (as defined in sec. 6662(d)(2)) is a
substantial understatement as defined under section 6662(d)(1)
and for purposes of identifying an underpayment under the
section 6663 fraud penalty.
The penalty imposed under section 6662A does not apply to
any portion of an understatement to which a fraud penalty is
applied under section 6663.

EXPLANATION OF PROVISION

The provision imposes a new, stronger penalty for an
understatement attributable to any transaction that lacks
economic substance (referred to in the statute as a
``noneconomic substance transaction understatement'').\160\ The
penalty rate is 30 percent (reduced to 20 percent if the
taxpayer adequately discloses the relevant facts in accordance
with regulations prescribed under section 6011). No exceptions
(including the reasonable cause or rescission rules) to the
penalty are available (i.e., the penalty is a strict-liability
penalty). Under the provision, outside opinions or in-house
analysis would not protect a taxpayer from imposition of a
penalty if it is determined that the transaction lacks economic
substance or is not respected as described below.
---------------------------------------------------------------------------
\160\Thus, unlike the present-law accuracy-related penalty under
section 6662A (which applies only to listed and reportable avoidance
transactions), the new penalty under the provision applies to any
transaction that lacks economic substance.
---------------------------------------------------------------------------
A ``noneconomic substance transaction'' means any
transaction if the transaction lacks economic substance (as
defined in the provision regarding the clarification of the
economic substance doctrine).\161\ For this purpose, a
transaction is one that lacks economic substance if it is
disregarded as a result of the application of the same factors
and analysis that is required under the provision for an
economic substance analysis, even if a court uses a different
term to describe the doctrine.
---------------------------------------------------------------------------
\161\That provision generally provides that in any case in which a
court determines that the economic substance doctrine is relevant, a
transaction has economic substance only if: (1) the transaction changes
in a meaningful way (apart from Federal income tax effects) the
taxpayer's economic position, and (2) the taxpayer has a substantial
non-Federal-tax purpose for entering into such transaction. Specific
other rules also apply. See ``Explanation of Provision'' for the
immediately preceding provision, ``Clarification of the economic
substance doctrine.''
---------------------------------------------------------------------------
For purposes of the bill, the calculation of an
``understatement'' is made in the same manner as in the present
law provision relating to accuracy-related penalties for listed
and reportable avoidance transactions (sec. 6662A). Thus, the
amount of the understatement under the provision would be
determined as the sum of (1) the product of the highest
corporate or individual tax rate (as appropriate) and the
increase in taxable income resulting from the difference
between the taxpayer's treatment of the item and the proper
treatment of the item (without regard to other items on the tax
return),\162\ and (2) the amount of any decrease in the
aggregate amount of credits which results from a difference
between the taxpayer's treatment of an item and the proper tax
treatment of such item. In essence, the penalty will apply to
the amount of any understatement attributable solely to a non-
economic substance transaction.
---------------------------------------------------------------------------
\162\For this purpose, any reduction in the excess of deductions
allowed for the taxable year over gross income for such year, and any
reduction in the amount of capital losses that would (without regard to
section 1211) be allowed for such year, would be treated as an increase
in taxable income.
---------------------------------------------------------------------------
As in the case of the understatement penalty for reportable
and listed transactions under present law section 6662A(e)(3),
except as provided in regulations, the taxpayer's treatment of
an item will not take into account any amendment or supplement
to a return if the amendment or supplement is filed after the
earlier of the date the taxpayer is first contacted regarding
an examination of such return or such other date as specified
by the Secretary.
As in the case of the understatement penalty for
undisclosed reportable transactions under present law section
6707A, a public entity that is required to pay a penalty under
the provision (but in this case, regardless of whether the
transaction was disclosed) must disclose the imposition of the
penalty in reports to the SEC for such periods as the Secretary
shall specify. The disclosure to the SEC applies without regard
to whether the taxpayer determines the amount of the penalty to
be material to the reports in which the penalty must appear,
and any failure to disclose such penalty in the reports is
treated as a failure to disclose a listed transaction. A
taxpayer must disclose a penalty in reports to the SEC once the
taxpayer has exhausted its administrative and judicial remedies
with respect to the penalty (or if earlier, when paid).
Regardless of whether the transaction was disclosed, a
penalty under the provision cannot be asserted until there has
been a review and approval by the Chief Counsel of the Internal
Revenue Service (or, if so delegated, a branch chief within the
office of Chief Counsel) and the taxpayer has had the
opportunity to submit a written statement in connection with
that review. Once the penalty has been asserted following such
National Office review, the penalty cannot be compromised for
purposes of a settlement without approval of the Chief Counsel
(or, if so delegated, a branch chief within the office of Chief
Counsel). The penalty can be compromised in such event only to
the extent the underlying understatement with respect to which
it was asserted is also compromised. Furthermore, the IRS is
required to keep records summarizing the application of this
penalty and providing a description of each penalty compromised
under the provision and the reasons for the compromise. If a
final adjudication of a court determines that the economic
substance doctrine does not apply, then a noneconomic substance
penalty asserted by the IRS in that case would not apply.
Any understatement on which a penalty is imposed under the
provision will not be subject to the accuracy-related penalty
under section 6662 or under 6662A (accuracy-related penalties
for listed and reportable avoidance transactions). However, an
understatement under the provision is taken into account for
purposes of determining whether any understatement (as defined
in sec. 6662(d)(2)) is a substantial understatement as defined
under section 6662(d)(1). The penalty imposed under the
provision will not apply to any portion of an understatement to
which a fraud penalty is applied under section 6663.\163\
---------------------------------------------------------------------------
\163\Nothing in the provision precludes the IRS from asserting
alternative grounds in a case in addition to a lack of economic
substance or from asserting other penalties; however, at the conclusion
of the case if there is a penalty under this provision then the
interaction with any other penalties would be as described in the text.
---------------------------------------------------------------------------

EFFECTIVE DATE

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

3. Denial of deduction for interest on underpayments attributable to
noneconomic substance transactions

PRESENT LAW

No deduction for interest is allowed for interest paid or
accrued on any underpayment of tax which is attributable to the
portion of any reportable transaction understatement with
respect to which the relevant facts were not adequately
disclosed.\164\ The Secretary of the Treasury is authorized to
define reportable transactions for this purpose.\165\
---------------------------------------------------------------------------
\164\Sec. 162(m). Under section 6664(d)(2)(A), in such a case of
nondisclosure, the taxpayer also is not entitled to the ``reasonable
cause and good faith'' exception to the section 6662A penalty for a
reportable transaction understatement.
\165\See the description of present law under the immediately
preceding proposal, ``Penalty for understatements attributable to
transactions lacking economic substance, etc.''
---------------------------------------------------------------------------

DESCRIPTION OF PROPOSAL

The provision extends the disallowance of interest
deductions to interest paid or accrued on any underpayment of
tax which is attributable to any noneconomic substance
underpayment (whether or not disclosed).

EFFECTIVE DATE

The provision applies to transactions entered into after
the date of enactment

III. BUDGET EFFECTS OF THE BILL

A. Committee Estimates

In compliance with paragraph 11(a) of rule XXVI of the
Standing Rules of the Senate, the following statement is made
concerning the estimated budget effects of the revenue
provisions of the ``Heartland, Habitat, Harvest, and Work
Horticulture Act of 2007'' as reported.

B. Budget Authority and Tax Expenditures

Budget authority

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

Tax expenditures

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

C. Consultation With Congressional Budget Office

In accordance with section 403 of the Budget Act, the
Committee advises that the Congressional Budget Office has not
submitted a statement on the bill. The letter from the
Congressional Budget Office has not been received, and
therefore will be provided separately.

IV. VOTES OF THE COMMITTEE

In compliance with paragraph 7(b) of rule XXVI of the
Standing Rules of the Senate, the Committee states that, with a
majority and quorum present, the ``Heartland, Habitat, Harvest
and Work Horticulture Act of 2007,'' as amended, was ordered
favorably reported by a voice vote on October 4, 2007.

V. REGULATORY IMPACT AND OTHER MATTERS

A. Regulatory Impact

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

Impact on individuals and businesses, personal privacy and paperwork

The bill includes provisions to extend present-law tax
benefits, expand eligibility for other benefits, and create new
tax incentives. The bill also includes provisions limiting
farming losses of certain taxpayers, codifying information
reporting on Commodity Credit Corporation transactions and
limiting section 1031 treatment for certain real estate and
collectibles. The effective date of AJCA relating to loss
limitations on SILOs is also modified under the bill. The bill
also denies a deduction for certain fines, penalties and other
amounts and increases information return penalties. Finally,
the bill includes provisions to clarify and codify the economic
substance doctrine and related penalties and to deny the
deduction for interest paid on certain tax motivated
transactions.
The bill includes various other provisions that are not
expected to impose additional administrative requirements or
regulatory burdens on individuals or businesses.
The provisions of the bill do not impact personal privacy.

B. Unfunded Mandates Statement

This information is provided in accordance with section 423
of the Unfunded Mandates Reform Act of 1995 (Pub. L. 104-4).
The Committee has determined that the following two tax
provisions of the reported bill contain Federal private sector
mandates within the meaning of Public Law 104-4, the Unfunded
Mandates Reform Act of 1995: (1) modifying the effective date
for the application of the AJCA 2004 leasing (``SILO'')
provision--apply loss limitation to leases with foreign
entities regardless of when the lease was entered into; and (2)
clarification of the economic substance doctrine and related
penalties. The tax provisions of the reported bill do not
impose a Federal intergovernmental mandate on State, local, or
tribal governments within the meaning of Public Law 104-4, the
Unfunded Mandates Reform Act of 1995.
The costs required to comply with each Federal private
sector mandate generally are no greater than the aggregate
estimated budget effects of the provision. Benefits from the
provisions include improved administration of the tax laws and
a more accurate measurement of income for Federal income tax
purposes.

C. Tax Complexity Analysis

Section 4022(b) of the Internal Revenue Service
Restructuring and Reform Act of 1998 (the ``IRS Reform Act'')
requires the Joint Committee on Taxation (in consultation with
the Internal Revenue Service and the Department of the
Treasury) to provide a tax complexity analysis. The complexity
analysis is required for all legislation reported by the Senate
Committee on Finance, the House Committee on Ways and Means, or
any committee of conference if the legislation includes a
provision that directly or indirectly amends the Internal
Revenue Code (the ``Code'') and has widespread applicability to
individuals or small businesses.
The staff of the Joint Committee on Taxation has determined
that a complexity analysis is not required under section
4022(b) of the IRS Reform Act because the bill contains no
provisions that have ``widespread applicability'' to
individuals or small businesses.

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

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

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