11/ The pension simplification provisions are described in a
separate memorandum to Pension Members.
22/ See Institute Memoranda to Tax Members No. 14-92, Closed-End
Fund Members No. 12-92, Unit Investment Trust Members No. 17-92,
Accounting/Treasurers Members No. 10-92, Operations Members No.
10-92, International Committee No. 6-92, Institutional Funds
Committee No. 2-92, and Transfer Agent Advisory Committee No. 12-
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March 23, 1992
TO: BOARD OF GOVERNORS NO. 19-92
TAX MEMBERS NO. 15-92
CLOSED-END FUND MEMBERS NO. 13-92
UNIT INVESTMENT TRUST MEMBERS NO. 20-92
ACCOUNTING/TREASURERS MEMBERS NO. 12-92
OPERATIONS MEMBERS NO. 11-92
INTERNATIONAL COMMITTEE NO. 7-92
INSTITUTIONAL FUNDS COMMITTEE NO. 3-92
TRANSFER AGENT ADVISORY COMMITTEE NO. 14-92
RE: CONGRESS APPROVES, AND PRESIDENT VETOES, TAX BILL
__________________________________________________________
The tax bill that Congress approved, and President Bush
vetoed, on Friday, March 20 contained numerous provisions of
interest to regulated investment companies ("RICs") and their
shareholders. Among the provisions of interest are those
relating to (1) tax simplification for investment companies
(e.g., repeal of the Code section 851(b)(3) "30 percent test" and
the requirement to report cost basis to mutual fund
shareholders), (2) expanded eligibility for deductible Individual
Retirement Account ("IRA") contributions and creation of a new
IRA to which nondeductible contributions could be made, (3)
certain penalty-free withdrawals from IRAs, (4) modified taxation
of capital gains, (5) foreign tax simplification, (6) repeal of
investment restrictions applicable to nuclear decommissioning
funds, (7) amortization of intangibles, (8) the amended "Taxpayer
Bill of Rights", (9) certain administrative changes and (10)
pension simplification1/1.
This memorandum briefly describes the House-Senate
compromise, which was passed by Congress and vetoed by President
Bush (the "Conference Committee bill"). Previous memoranda
describe provisions in the House and Senate tax bills in greater
detail.2/2 Anyone interested in obtaining copies of relevant
92, dated March 16, 1992; and to Tax Members No. 12-92, Closed-
End Fund Members No. 10-92, Unit Investment Trust Members No. 14-
92, Accounting/Treasurers Members No. 8-92, Operations Members
No. 8-92, International Committee No. 4-92 and Transfer Agent
Advisory Committee No. 11-92, dated March 2, 1992.
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Conference Committee Report and statutory bill language may do so
by calling the undersigned at (202) 955-3585.
I. Tax Simplification for Investment Companies
The Conference Committee bill contained all three
provisions relating to tax simplification for investment
companies that were contained in the House bill. First, the
Conference Committee bill would have repealed the 30 percent test
of Code section 851(b)(3).
Second, the bill would have required mutual funds and
brokers to generally report to mutual fund shareholders and the
Internal Revenue Service ("IRS") the cost basis of shares
redeemed, calculated under the single-category average cost
method. As under the House bill, this reporting requirement
would have applied only to accounts opened on or after January 1,
1994, but would have excluded accounts containing shares acquired
other than by purchase (such as by gift or inheritance). In
addition, as under the House bill, a shareholder could have
elected in the year of the first redemption from the account to
use another cost basis method (either first-in, first-out or
specific identification). The Conference Report indicated that
the Conferees expected that the IRS would have consulted with
representatives of the industries affected by the basis reporting
provisions to develop regulations necessary to implement the
provision.
Third, the bill would have generally permitted a bank
common trust fund with diversified assets to transfer its assets
to a RIC in a tax-free conversion.
II. Individual Retirement Accounts
The Conference Committee bill included the IRA provisions
that were contained in the Senate bill and that previously were
contained in the "Bentsen-Roth" bill that was introduced in
November 1991. Thus, the bill would have restored the universal
income tax deduction for IRA contributions and created a "special
IRA" under which contributions would not be deductible, but
earnings on amounts remaining in the account for at least five
years could be withdrawn tax-free. Individuals would have been
allowed to convert their existing IRAs into "special IRAs" if
income tax were paid on the earnings and previously-deducted
contributions.
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III. Penalty-Free Withdrawals
The Conference Committee bill would have permitted penalty-
free withdrawals from IRAs in several situations. First,
penalty-free withdrawals of up to $10,000 would have been
permitted for first-time home purchasers. The Conference
Committee bill would have expanded the House bill, which
permitted penalty-free withdrawals when the first-time homebuyer
33/ Unlike the House bill, the Conference Committee bill would
not have provided for indexing the cost basis of capital assets
for inflation.
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was the taxpayer or the taxpayer's child, by also permitting
withdrawals when the first-time homebuyer was the taxpayer's
spouse or grandchild. Second, penalty-free withdrawals not in
excess of the amount of qualifying educational expenses would
have been permitted. The Conference Committee bill would have
expanded the House bill's treatment by permitting penalty-free
withdrawals for qualifying expenses of the taxpayer's child or
grandchild without regard to whether they were dependents (as
required by the House bill). Third, like the House and Senate
bills, the Conference Committee bill would have permitted
penalty-free withdrawals for qualifying medical expenses.
Fourth, like the Senate bill, the Conference Committee bill would
have provided that the rule permitting penalty-free withdrawals
after an individual reaches age 59 1/2 would not apply to amounts
contributed during the previous 5 years. Fifth, modifying a
provision in the Senate bill, the Conference Committee bill would
have permitted penalty-free withdrawals from IRAs by persons who
had received unemployment compensation for 12 consecutive weeks,
if such withdrawals were made during the year in which such
unemployment compensation was received or the succeeding taxable
year. This provision would not have applied to amounts withdrawn
(1) from inherited IRAs or (2) that had been previously rolled
over from a qualified retirement plan. Finally, the Conference
Committee bill did not include the Senate provision that would
have permitted penalty-free withdrawals for the purchase of new
passenger automobiles and for living expenses of unemployed
persons.
IV. Modified Taxation of Capital Gains
The Conference Committee bill contained two provisions that
would have modified the taxation of capital gains. First, like
the House and Senate bills, the Conference Committee bill would
have excluded from tax 50 percent of the capital gains realized
upon the disposition of qualified small business stock acquired
by the taxpayer at its original issuance and held for more than
five years. RIC shareholders would have been eligible to claim
the 50 percent exclusion for gains on the sale of qualified small
business stock originally issued to the RIC only if (1) the RIC
held the stock for more than five years and (2) the RIC
shareholder held the RIC stock on which the capital gain dividend
was paid from the date the RIC acquired the qualified small
business stock through the date the qualified small business
stock was sold.
Second, the Conference Committee bill would have provided
progressive capital gains tax rates for individuals. 3/3 A similar
provision (with different rates) was included in the Senate bill.
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Under the Conference Committee bill, the marginal rate on
qualified capital gain would have been zero on gains otherwise
taxed in the 15 percent bracket, 14 percent on gains
44/ These regulations, which the Institute generally supports,
would permit nuclear decommissioning funds to invest in RICs
which meet certain conditions regarding assets and conduct. (See
Institute Memoranda to Tax Committee No. 27-90 and SEC Rules
Committee No. 47-90, dated September 4, 1990; and to Tax
Committee No. 38-90 and Institutional Funds Committee No. 6-90,
dated December 20, 1990.)
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otherwise taxed in the 28 percent bracket, 21 percent on gains
otherwise taxed in the 31 percent bracket and 28 percent on gains
otherwise taxed in the new 36 percent bracket. As under current
law, capital gains realized upon the disposition of a RIC's
portfolio securities would retain their character for purposes of
reduced capital gains tax rates when distributed to the RIC's
individual shareholders as capital gain dividends.
As under the Senate bill, the entire amount of qualified
capital gain would have been included in alternative minimum
taxable income and the holding period for long-term capital gain
treatment would have been increased from more than one year to
more than two years.
V. Foreign Investment Provisions
The Conference Committee bill included provisions that were
contained in the House and Senate bills for (1) taxing
investments in passive foreign corporations ("PFCs") and (2)
claiming the foreign tax credit when the amount of an
individual's creditable foreign taxes is no more than $200.
The mark-to-market system applicable to investments by RICs
in PFCs would have generally eliminated the RIC-level tax that
applies under existing law. Under a transition rule, also
contained in the House and Senate bills, RICs would have been
required to (1) mark to market all PFC stock in their portfolios
on the first day of the RIC's first taxable year beginning after
December 31, 1992, (2) pay a nondeductible interest charge on the
tax that would have been collected had the PFC shares been marked
to market in the prior years, and (3) distribute the mark-to-
market gains to their shareholders.
VI. Repeal of Investment Restrictions Applicable to Nuclear
Decommissioning Funds
The Conference Committee bill contained the provision in
the Senate bill that would have expanded the investment options
of nuclear decommissioning funds far beyond the scope of proposed
Treasury regulations4/4 by completely eliminating the present-law
investment restrictions that apply to nuclear decommissioning
funds.
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VII. Amortization of Intangible Assets
The Conference Committee bill included the House bill
provision that would have required that the purchase price for
certain intangible assets acquired from another party be
amortized over a uniform 14-year period. Among the acquired
intangible assets that would have been subject to the 14-year
amortization period proposed under the bill were goodwill, going
concern value and various customer-based intangibles, such as
investment management contracts. Like the House bill, the
Conference Committee bill would not have changed the tax
treatment of costs incurred in the creation of intangible assets
by a taxpayer, such as advertising expenses.
VIII. Taxpayer Bill of Rights
The Conference Committee bill adopted the Senate provision
in the Taxpayer Bill of Rights which would have required that IRS
Forms 1099 (and acceptable substitutes) sent to payees contain
the name, address and phone number of the payor's "information
contact." In addition, like the Senate bill, the Conference
Committee bill would have generally provided relief from
retroactive application of Treasury regulations, unless a
taxpayer elected to apply the regulations retroactively.
IX. Administrative Provisions
The Conference bill contained two administrative changes of
interest to RICs that were included in the House and Senate
bills. First, the bill would have modified the rules for
determining when to deposit amounts withheld under backup
withholding. Second, the bill would have redefined the term
"reproduction" (for purposes of certain recordkeeping
requirements) to include a reproduction from a digital image.
* * *
We will keep you informed of developments.
Keith D. Lawson
Associate Counsel - Tax