Joint Committee Report JCS-16-70: General Explanation of the Tax Reform Act of 1969

The congressional consideration of this Act lasted eleven months and one day. The schedule of the various actions by the committees on the bill was as follows:

Despite the comprehensive scope of the Tax Reform Act of 1969, the committees recognized that much remains to be done. In some cases, income tax problems had to be postponed for further analysis and study. Moreover, the entire area of estate and gift tax reform lies outside the scope of this Act and remains an area for future consideration.

On an overall basis, this Act provides an average reduction in tax liability of 10.6 percent; however, for returns with adjusted gross incomes of $3,000 or less, the average reduction is almost 70 percent and for those with incomes between $3,000 and $5,000 the average reduction is over 33 percent. The changes in tax liability provided by the reform and relief provisions in this Act are shown in table 2 of this general explanation which can be summarized as follows:

Percentage tax increase or decrease under the reform and relief provisions of the Tax Reform Act of 1969

 Adjusted gross    Percentage

These implications were considered particularly important in view of the inflationary pressures then persisting. The tax reform and tax relief provisions in this Act (including repeal of the investment credit), even without the effect of the extension of the surcharge and excise taxes, are expected to increase revenues by approximately $2.2 billion in calendar year 1970 and result in a net tax reduction of only $500 million in calendar year 1971. In fact, if the effect of continuing the surcharge at a 5 percent rate for the first six months of 1970 and the excise tax extensions on automobiles and communications services are also taken into account, the revenue effect of the Act is to raise $6.5 billion in 1970 and almost $300 million in 1971. It was considered important to maintain this fiscal balance in order not to refuel the inflationary fires. In terms of fiscal year effect, the provisions of this act are estimated to increase receipts by $3.7 billion in fiscal year 1970 and $2.7 billion in fiscal year 1971 (including the surcharge and excise tax changes).

In the long run, the revenue raised by the reform measures included in the Act is expected to amount to about $3.3 billion, before taking into account the repeal of the investment credit. After the repeal of the credit is taken into account, the revenue raised by the Act amounts to $6.6 billion.

All of the revenue figures shown in this document are based on 1969 levels of income. No attempt is made to take into account probable growth in general receipts or possible further revenue increases from the reform provisions of the Act as the economy grows or, on the other hand, possible further increases in the effect of the tax reduction provisions of the Act because of the same factors.

The Act makes substantial changes in the treatment of private foundations (certain sec. 501(c)(3) organizations--including religious, charitable, educational organizations--which are not broadly, publicly supported). The permissible activities of private foundations are tightened to require current distribution of income for charitable and similar purposes, to prevent self-dealing between the foundation and certain related ("disqualified") persons, to limit foundations' holdings of unrelated businesses, to prevent putting foundations' assets in jeopardy by financial speculation, and to give assurance that foundations' activities are properly restricted as provided by the exemption provisions of the tax laws. In addition, each foundation must pay an annual excise tax of 4 percent of its net investment income and must give extensive publicity to its activities.

An organization (whether or not a private foundation) organized after October 9, 1969, which fails to notify the Internal Revenue Service of its claim to be exempt under section 501(c)(3) is not exempt under this section even though organized and operated exclusively for the exempt purposes listed in the section.

Substantially all exempt organizations are required to file information returns with essentially the same data previously required only of private foundations. Substantially all of this information is to be available to the public.

2. Tax-exempt organizations generally

The Act restricts unrelated activities of tax-exempt organizations. First, an exempt organization acquiring debt-financed property (which, in effect, allows a sharing of its exemption with private businesses) is subject to taxation in the proportion in which the property is financed by the debt. Second, the unrelated business income tax is extended to virtually all tax-exempt organizations not previously covered, including churches (after 1975). Third, the unrelated business income tax is extended to the investment income of certain tax-exempt organizations set up primarily for the benefit of their members, such as social clubs and employees' beneficiary associations. Fourth, where a tax-exempt organization owns more than 80 percent of a taxable subsidiary, the interest, annuities, royalties and rents received by it are to be treated as "unrelated business income" and are subject to tax. Fifth, in the case of a taxable membership organization, the deduction for expenses incurred in supplying services, facilities or goods to members is generally to be allowed (after 1970) only to the extent of the income received from these members. Finally, the Act provides that the term "trade or business" for purposes of the unrelated business income tax includes any activity which is carried on for the production of income from the sale of goods or the performance of services.

3. Charitable contributions

The general charitable contribution deduction limit is increased to 50 percent (except for gifts of appreciated property) and the unlimited charitable deduction is phased out over a five year period. The extra tax benefits derived from charitable contributions of appreciated property are restricted in the case of gifts to certain private foundations, gifts of ordinary income property, gifts of certain tangible personal property (where unrelated to the charitable organization's exempt purpose) and so-called bargain sales. Finally, the two-year charitable trust rule is repealed and a number of changes are made to limit charitable deductions for gifts and the use of property, and in the case of charitable remainder and charitable income trusts.

4. Farm losses

Taxpayers who deduct farm losses against their nonfarm income generally must treat capital gains arising on the subsequent sale of farm assets as ordinary income. For individuals, this recapture rule applies only to losses over $25,000 and only if nonfarm income is over $50,000. The Act also provides for the recapture of depreciation on the sale of livestock and a more effective treatment of hobby losses. The holding period for cattle and horses is extended, provision is made for the recapture of soil and water conservation or land clearing expenditures on the sale of farm land and the costs of planting citrus groves are required to be capitalized.

5. Interest deduction

A deduction is denied (with a two-year delay in effective date) for 50 percent of interest incurred by a taxpayer on funds borrowed to carry investments to the extent the interest exceeds the taxpayer's net investment income, his long-term capital gains and $25,000. The disallowed interest, however, may be carried over to subsequent years.

6. Moving expenses

The Act broadens the definition of moving expenses for deduction purposes, provides that reimbursed taxpayers are to be treated in the same manner for such expenses as unreimbursed taxpayers, extends the moving expense deduction to self-employed persons, and increases the minimum 20-mile test to 50 miles.

7. Minimum tax

This tax, which applies to both individuals and corporations, supplements the action of the specific remedial provisions of the Act in curtailing tax preferences. It is computed by (1) totaling the amount of tax preferences received by the taxpayer (from the broad category of tax preferences specified in the Act), (2) subtracting from this total a $30,000 exemption and the amount of the taxpayer's regular Federal income tax for the year, and (3) applying a 10-percent tax rate to the remainder.

8. Income averaging

Income averaging is simplified and made more generally available by extending it to capital gains and certain other income, and permitting it to be used by taxpayers whose incomes increase 20 percent above the base period as compared with 33 percent under prior law.

9. Restricted property

In the case of so-called restricted stock and other restricted property, the interest in the property is taxed at the time of receipt unless there is a substantial risk of forfeiture. In the latter event, the property is taxed when the possibility of forfeiture is removed at its full value at that time, unless the recipient elects to be taxed in the year of receipt.

10. Accumulation trusts, multiple trusts, etc.

Beneficiaries of accumulation trusts, including multiple trusts, are taxed on distributions of accumulated income from trusts in substantially the same manner as if the income had been distributed to the beneficiary currently as earned, instead of being accumulated in the trust. In the case of capital gains, an unlimited throwback rule is provided (generally after 1971) for those gains allocated to the corpus of a trust which has accumulated its income.

11. Multiple corporations

Multiple surtax exemptions in the case of related corporations are withdrawn over a 6-year period. As a result, for taxable years beginning after December 31, 1974, a controlled group of corporations is limited to one $25,000 surtax exemption.

12. Corporate mergers

The Act provides tests to determine when "debt" is in fact "equity" so as to make the interest deduction unavailable where this "debt" is used in acquiring other companies. In addition, the use of the installment method of reporting gains is restricted where readily marketable debt is received. Limiting changes also are made in the treatment of original issue discount and other situations. In addition, the Treasury Department is provided with authority to issue guidelines distinguishing between debt and equity for tax purposes.

13. Stock dividends

The Act provides for the taxation of stock dividends where one group of shareholders receive a distribution in cash while the proportionate interests of other shareholders are increased.

14. Commercial banks

The special tax advantage that commercial banks derived under prior law because they were permitted tax deductions for building up bad debt reserves to 2.4 percent of outstanding uninsured loans is eliminated gradually over a period of 18 years. By 1988, banks will be required to base their tax deductions for additions for bad debt reserves on their actual experience. To provide for the possibility of substantial future losses, net operating losses incurred by commercial banks and other financial institutions in taxable years beginning after December 31, 1975, will be carried back 10 years instead of 3 years as under prior law. (This is in addition to the 5-year carryforward). Also, capital gains treatment is withdrawn for bonds held by banks and other financial institutions in the course of their business.

15. Mutual savings banks and savings and loan associations

The Act substantially reduces the special bad debt reserve deductions available to mutual savings banks and savings and loan associations. The 3-percent method is eliminated and the prior law 60-percent method is to be reduced to 40 percent over a 10-year period. In addition the intercorporate dividends deduction is allocated between the portion of income subject to tax and the portion allowed as a bad debt reserve deduction.

16. Mergers of savings and loan associations

In those cases where there is a tax-free reorganization or liquidation and section 381 applies (relating to carryovers in certain corporate acquisitions), the bad debt reserves do not have to be restored to income.

17. Depreciation allowed regulated industries

Depreciation in the case of certain regulated industries is limited for new property to straight line depreciation, unless the appropriate regulatory agency permits the company to take accelerated depreciation, and "normalize" its current tax reduction. For pre-1970 property, no faster method of depreciation may be used than was used in mid-1969. Generally, companies already on "flow-through" cannot change without permission of the regulatory agency, except for a provision permitting a company to elect in the first half of 1970 to shift to the straight-line-or-normalization rule as to new expansion property.

18. Earnings and profits adjustment for depreciation

Corporations must compute earnings and profits on the basis of straight line depreciation. This prevents the passing of the tax benefit of accelerated depreciation through to stockholders in the form of "tax-free dividends". This rule does not apply to foreign corporations deriving little income from the United States.

19. Natural resources

The percentage depletion rate for oil and gas wells is reduced from 27-1/2 percent of gross income to 22 percent. The depletion rate also is cut to 22 percent for minerals eligible for a 23 percent rate under prior law and to 14 percent for most minerals eligible for a 15 percent rate under prior law.

Percentage depletion for oil shale is applied on the value after retorting. Percentage depletion is also allowed for minerals (other than sodium chloride) extracted from the Great Salt Lake and other saline perennial lakes in the United States.

Carved-out and other production payments (including ABC transactions) are treated as if the payments were loans by the owner of the payment to the owner of the mineral property. This prevents the use of carve-outs to increase percentage depletion payments and foreign tax credits. It also eliminates the possibility of purchasing mineral property with money which is not treated as taxable income to the buyer. Finally, recapture rules are applied to mining exploration expenditures not subject to recapture under prior law and the foreign tax credit is disallowed to the extent foreign taxes are attributable to the deduction allowed against U.S. tax for percentage depletion.

20. Alternative capital gain tax rate

The Act gradually eliminates the alternative tax on long-term capital gains for individual taxpayers to the extent they have capital gains of more than $50,000. Long-term capital gains up to 50,000 received by individuals continue to qualify for the 25-percent alternative capital gains tax rate. However, the maximum tax rate on that part of long-term capital gains above $50,000 is increased to 29.5 percent in 1970, 32.5 percent in 1971, and 35 percent (one-half the 70 percent top tax rate applicable to ordinary income) in 1972 and later years. The alternative tax rate on corporate long-term capital gains income is increased to 28 percent in 1970 and 30 percent in 1971 and later years.

21. Capital gains and losses

The Act requires net long-term capital losses (in excess of net short-term capital gains) of individuals to be reduced by 50 percent before they offset ordinary income. Where separate returns are filed, the deduction of capital losses against ordinary income is limited to $500 for each spouse. Ordinary income tax treatment instead of capital gains treatment is provided for (1) employer contributions for plan years beginning after 1969 to pension and profit-sharing plans paid out as part of a lump-sum distribution, (2) gains from the sale of memorandums and letters by a person whose efforts created them (or for whom they were produced), (3) transfers of franchises, trademarks, and trade names where the transferor retains significant rights, powers, or continuing interests, and (4) contingent payments received under franchises, trademark, or trade name transfer agreements. In addition, corporations are granted a three-year loss carryback for net capital losses.

22. Real estate depreciation

Real estate depreciation allowances are substantially curtailed. The 200-percent declining balance method and other fast forms of depreciation are restricted to new residential housing. Other new real estate is restricted to the 150-percent declining balance method. Used properties acquired in the future are limited to straight line depreciation, except for used residential housing which is eligible for allowances at 125 percentage of the straight line method where the property still has a useful life of more than 20 years. In addition, stricter recapture rules are imposed, particularly for nonresidential property, to make sure that a larger proportion of gains on the sale of property (which result from accelerated depreciation allowances taken previously) are taxed as ordinary income.

23. Subchapter S corporations

In the case of subchapter S corporations (that is, corporations treated somewhat like partnerships), the Act limits (after 1970) the tax deductions for amounts set aside under qualified pension plans for shareholder-employees (one who owns more than 5 percent of the corporation's stock) to 10 percent of the compensation paid or $2,500, whichever is lees.

24. Arbitrage bonds

The Federal income tax exemption for interest payments on bonds issued by State and local governments is not to cover arbitrage bonds issued after October 9, 1969.

25. Amounts received under insurance contracts for certain living expenses

An individual whose residence is damaged or destroyed by fire, storm or other casualty is not to be taxed on insurance reimbursements for the extra living expenses he and his family incur because of the loss of use of his residence.

26. Deductibility of treble damages, fines, penalties

The Act codifies the judicial rule that deductions are not to be allowed for fines paid for the violation of any law and denies deductions for two-thirds of treble damage payments under the antitrust laws, for bribes of public officials, and for unlawful bribes or "kickbacks."

27. Deductibility of accrued vacation pay

Deductions for accrued vacation pay is not to be denied for any taxable year ending before January 1, 1971, solely because the liability to a specific person for vacation pay is not clearly estimated or because the amount of liability to each individual cannot be computed with reasonable accuracy. (This postpones for two additional years the effective date of Revenue Ruling 54-608.)

28. Deduction of antitrust damage recoveries

Recoveries of anti-trust and certain other damages are not to be taxed to the extent the related losses did not produce a tax benefit.

29. Corporate stock redemptions with appreciated property

In general a corporation is to be taxed on the appreciation in value of property it uses to redeem stock from its shareholders.

30. Reasonable accumulations by corporations

The Act gives protection from the special tax on accumulated earnings where a corporation accumulates amounts to redeem a deceased shareholder's stock to pay death taxes or to redeem stock from a private foundation which must be disposed of as an excess business holding under the Act.

31. Insurance companies

The Act revises three aspects of the treatment of life insurance companies: the treatment of contingency reserves under group insurance contracts, the limitation on the carryover of losses by an insurance company which changes the nature of its insurance business, and the application of the so-called phase III tax in the case of corporate spin-offs.

32. Deferral of gain upon sale of certain low-income housing projects

Gain realized from certain sales of Federally assisted lower-income projects (so-called FHA 221(d)(3) and 236 projects) is deferred to the extent that the proceeds are reinvested within a specified time in other Federally assisted low-income projects which limit the rate of return.

33. Cooperative per-unit retain allocations

A cooperative is permitted to deduct or exclude from gross income per-unit retain allocations paid during the 8-1/2 month period following the close of the taxable year whether paid in money ( or other property) or in qualified per-unit retain certificates.

34. Inclusion of foster children in the definition of dependents

The Act permits a foster child (as is already true in the case of the taxpayer's own children) to have gross income in excess of the amount of the personal exemption (if the child is less than 19 years of age or is a student) without the taxpayer losing the dependency exemption for the child where he furnished more than half the support.

35. Cooperative housing corporation

Income derived from a Governmental entity is not to be taken into consideration in determining whether individual tenant-stockholders of a cooperative housing corporation qualify for the deduction of their proportionate share of the interest and real estate taxes under the requirement that 80 percent of the corporation's income be derived from them.

36. Replacement of converted real property

The Act extends to two years (from the previous one-year period) the automatic time period during which taxpayers may replace without recognition of gain, property which has been involuntarily converted.

37. Change in reporting income on installment basis

Taxpayers are allowed to revoke retroactively an election to report on the installment basis by filing a notice of revocation within a specified time.

38. Constructive sales price

Rules are provided for determining the tax base for ad valorem manufacturers' excise taxes in the case of sales to affiliated companies.

39. Penalty for failure to pay tax or make deposits

The Act provides an additional charge of 1/2 of one percent (up to 25 percent) of the amount owed for failure to pay income tax (other than estimated tax) when due, unless there is reasonable cause.

40. Tax Court

The Tax Court is established as a court under Article I of the Constitution (instead of as an executive agency). A simplified, relatively informal procedure is provided for small claims cases.

41. Miscellaneous provisions

The Act also deals with the treatment of mutual fund shares under periodic payment plans, the exception from foreign base company income where the purpose of the corporation and the transaction was not to achieve a substantial reduction in income taxes, the exemption of a portion of the taxpayer's salary, wages, or other income from levy to pay Federal taxes under certain conditions involving support payments for minor children, and a change in the dividends-paid deduction for purposes of computing the personal holding company deduction.

The income tax surcharge was extended at a 5-percent rate from January 1, 1970, through June 30, 1970.

2. Excises

The reductions in the excise taxes on passenger automobiles and communications services scheduled to begin on January 1, 1970, are postponed until January 1, 1971.

3. Repeal of the investment credit

The investment credit is repealed with respect to property ordered or acquired after April 18, 1969. Property ordered under a binding contract before April 19, 1969, or on which substantial work had been completed before. April 19, 1969, may receive the investment credit under certain transition rules.

4. Pollution control facilities

Certified pollution control facilities with a normal useful life of 15 years or less which are added to plants in operation before January 1, 1969, may be amortized over a period of 60 months. This provision expires after December 31, 1974.

5. Railroad rolling stock

Five-year amortization is provided for railroad rolling stock (including rolling stock leased to railroads by lessors) placed in service before January 1, 1975. Repairs to railroad rolling stock (except locomotives) are treated as deductible expenses if they do not exceed 20 percent of cost and 50-year amortization is provided for new railroad gradings and tunnel bores.

6. Amortization of coal mine safety equipment

Five-year amortization is provided for certified coal mine safety equipment installed in order to comply with new Federal safety requirements and placed in service before January 1, 1975.

The personal exemption is increased from $600 to $625 ($650 from July 1 for tax withholding) in 1970, $650 in 1971, $700 in 1972, and $750 in 1973 and later years.

2. Percentage standard deduction

The percentage standard deduction is increased from 10 percent of adjusted gross income with a maximum of $1,000 to 13 percent with a $1,500 maximum in 1971, 14 percent with a $2,000 maximum in 1972, and 15 percent with a $2,000 maximum in 1973 and later years.

3. Minimum standard deduction and low income allowance

The minimum standard deduction of $200 plus $100 per exemption is increased to $1,100 in 1970, $1,050 in 1971, and $1,000 in 1972. In 1970 and 1971, the excess over the prior minimum standard deduction is reduced as income exceeds the nontaxable level (by $1 for $2 in 1970, and $1 for $15 in 1971) . After 1971, the full $1,000 minimum allowance will be available to all taxpayers.

4. Filing requirement for individuals

The income level at which filing a tax return is required is raised for the years 1970, 1971, and 1972, from $600 ($1,200 for a taxpayer age 65 or over) to $1,700 for a single person and $2,300 for a married couple plus $600 for each additional personal exemption to which the taxpayer is entitled on account of age. In 1973 and later years, these amounts are raised to $1,750 for a single person and $2,500 for a married couple plus $750 for each age exemption. The filing requirement remains at $600 for married couples filing separate returns until 1973 when it is raised to $750.

5. Tax treatment of single persons

A new tax rate schedule for single persons, effective in 1971, sets their tax liabilities at no more than 20 percent above those of married couples at the same taxable income levels. (Under prior law, the taxes of single persons could be 42 percent higher.) A new rate schedule for heads-of-households is approximately halfway between the new rate schedule for single persons and the rate schedule for joint returns. Married couples filing separate returns continue to use the prior law rate schedule for single persons.

6. Maximum tax on earned income

The maximum marginal tax rate on taxable earned income is not to exceed 50 percent (compared to 70 percent on other income) after 1971. In 1971, the maximum rate is 60 percent. Earned income eligible for this limit is earned income reduced by tax preferences in excess of $30,000.

7. Withholding of income tax

Withholding is changed to reflect the changes in the personal exemption, the standard deduction, the tax rates for single persons and the expiration of the surcharge as they become effective. New withholding procedures provide greater flexibility in withholding methods, broaden the allowance of additional withholding allowances for excess itemized deductions, exempt from withholding individuals who do not have a tax liability for the year, such as college students, provide for withholding on supplemental unemployment benefits, and allow voluntary withholding on certain types of payments such as pensions.

8. Computation of tax by Internal Revenue Service

The income level below which a taxpayer may have his tax computed by the Internal Revenue Service is raised from $5,000 to $10,000 and the Service is permitted to make the procedure more generally available.