Technical and Miscellaneous Revenue Act of 1988 (P.L. 100-647)

This document includes descriptions of the following:

In addition, COBRA also requires that two studies be conducted -- by the Secretary of Health and Human Services and the National Academy of Sciences -- of the current quality control system. These studies are to examine how to best operate the quality control system to improve program administration as well as to provide reasonable data on which to penalize States with excessive levels of erroneous payments. The National Academy of Sciences study was received by the Committee in February 1988; the HHS study was received in April 1988.

Table 1 illustrates the pending and projected sanction amounts and the HHS and CBO schedule for collecting these funds under current law.

   TABLE 1.--AFDC SANCTION AMOUNTS AND ESTIMATED COLLECTION

2. Foster care independent living initiatives

Foster care children who are eligible for services under the program are those who are eligible under Title IV-E for Federally-assisted foster care maintenance payments. Eligibility for Title IV-E is limited to those foster care children who would have been eligible for AFDC before they were removed from their home and placed in foster care.

The Secretary of Health and Human Services is required to provide Congress with a report on the program by July 1, 1988. The authorization level for this entitlement is $45 million for each of the two fiscal years. States did not begin receiving funds under the program until July 1987.

3. Due dates for self-employment demonstration project reports

The annual exempt amount under the earnings test is lower for beneficiaries under age 65 than for those 65-69. This year the exempt amount for those under age 65 is $6120, and the age 65-69 exempt amount is $8400. Thus, beneficiaries under age 65 begin to lose benefits at a lower earnings level than beneficiaries aged 65-69.

If a beneficiary dies, the annual exempt amount applicable at the time of death is prorated based on the number of months that he or she lived during the year. In addition, the higher exempt amount is applicable in the year a beneficiary reaches age 65, regardless of when during the year the beneficiary turns 65. If the beneficiary dies after his or her 65th birthday but still in the same year, the higher exempt amount applies. If, however, a beneficiary dies at age 64 in the year that he or she would have turned 65, the lower exempt amount applies. This may cause the benefits of an individual who reasonably expected to live until the end of the year, or reach 65 during the year, to be subject either to the prorated threshold or the lower threshold. This would, in some cases, necessitate the return of benefit overpayments by the beneficiary's estate.

The new law is being phased in over a 5-year period, beginning with those persons first eligible for social security benefits in 1986.

Workers who have 30 years or more of social security coverage are fully exempt from this treatment. For workers who have 26-29 years of coverage, the percentage in the first bracket in the formula increases by 10 percentage points for each year over 25, as illustrated below:

       Years of social       First factor in

       Years of social       First factor in

The beneficiary has the option of having his or her benefits continued through the hearing stage of appeal. If the earlier unfavorable determinations are upheld by the ALJ, the benefits are subject to recovery by the agency. (If an appeal is made in good faith, benefit repayment may be waived.) Medicare eligibility is also continued, but Medicare benefits are not subject to recovery.

The Omnibus Budget Reconciliation Act of 1987 extended this provision for one year. The Act authorized the payment of interim benefits to persons in the process of appealing termination decisions made before January 1, 1989. Such payments may continue through June 30, 1989 (i.e., through the July 1989 check).

The provision would be extended pending a report from the Secretary of Health and Human Services to the Committee on Ways and Means and the Committee on Finance. The report is to assess the impact of the continuation of benefits on the Social Security and Medicare Trust Funds and the rate of appeals of disability determinations to ALJs.

The provision protects blood donors by permitting access to the address information only to State agencies and blood donor facilities meeting requirements for confidentiality and security.

If the widow(er) dies before making application for the lump sum payment or dies before negotiating the benefit check, no lump sum death benefit is payable.

SSA currently requests that applicants voluntarily provide their social security numbers. Under Federal law, recipients of Aid to Families with Dependent Children, Supplemental Security Income, and Veterans' Assistance benefits are currently required to provide their social security numbers in order to receive benefits under those programs.

Those who are over age 65 when the worker dies and who are receiving spouses' benefits or those age 62-65 when the worker dies who are not entitled to their own retirement or disability benefits may receive reduced widow(er)s' benefits by filing a certificate of election rather than an application.

An application for a reduced widow(er)'s benefit is generally not effective for months before the month of filing. Thus, a break in entitlement could occur if the application were not filed in a timely fashion.

1. Calculation of Windfall Benefit Guarantee Amount in Month of Concurrent Entitlement Rather Than Concurrent Eligibility

When an individual applies for social security benefits, the Social Security Administration must ask the individual's pension administrator to compute a pension amount that would have been payable at the date of first concurrent eligibility for both the pension and social security (usually age 62) regardless of the pension amount which the person will actually receive upon entitlement. Processing delays and errors can occur when pension administrators make this fictitious computation of the pension amount.

2. Additional Social Security Technical Corrections

In addition, the provision would make it clear that the 1987 Act applies not only to Federal employees who join FERS by electing to become subject to chapter 84 of title 5, United States Code, but also to foreign service employees who join FERS by electing to become subject to chapter 22 of title 1, United States Code.

However, Section 205(p) of the Social Security Act provides that the Secretary of Health and Human Services shall accept the determination of the head of a federal agency as to whether a federal employee has performed service, as to the periods of such services and as to the amount of remuneration which constitute wages. The Office of Personnel Management has interpreted this section to mean that a federal agency may determine whether or not an employee's service constitutes social security covered employment. Because the civil service statute permits career SES employees to retain their pay, rank and retirement plan when they move to a presidential appointment, OPM has interpreted section 205(p) to mean that such individuals may avoid social security coverage in contravention of the coverage provisions of the Social Security Act (while retaining coverage under the old Civil Service Retirement System).

No other individuals receive such treatment. For example, individuals in the private sector or career civil servants in a non-SES job are mandatorily covered by social security when they take a presidential appointment.

(2) Due to an oversight in current law, when an individual accepts a mandatorily covered federal job and subsequently returns to his or her previous job or another non-covered federal job, he or she loses social security coverage.

(2) In addition, the provision would clarify that any civil servant who becomes covered by social security as a result of taking a mandatorily covered federal job would retain social security coverage in any subsequent federal job.

(2) The provision would be effective upon enactment.

II. Capital Gains and Losses (Title III of the 1986 Act)

III. Tax Shelters; Interest Expense (Title V of the 1986 Act)

IV. Corporate Tax Provisions (Title VI of the 1986 Act)

VI. Insurance Provisions (Title X of the 1986 Act)

VII. Pensions; Employee Benefits (Title XI of the 1986 Act)

VIII. Foreign Tax Provisions (Title XII of the 1986 Act)

X. Trusts and Estates; Minor Children; Generation-Skipping Transfer Tax (Title XIV of the 1986 Act)

An error in stating the amount of investment credit eligible for a transitional exception included in the Reform Act for a Spray Cotton Mills facility would be corrected.

Rehabilitation Credit

A typographical error in the specification of a plat number in one of the items listed in section 102(k)(3) of the introduced bill would be corrected.

b. For ownership changes occurring on or after June 21, 1988, the amendment would also provide that redemptions or other corporate contractions occurring in connection with an ownership change are taken into account for purposes of the threshold computation only to the extent provided in regulations.

B. Recognition of Gain or Loss on Liquidating Sales and Distributions of Property (General Utilities)

C. Amortizable Bond Premium

D. Regulated Investment Companies (RICs)

E. Real Estate Investment Trusts (REITs)

F. Real Estate Mortgage Investment Conduits (REMICs)

B. Source Rules

C. Subpart F

D. U.S. Taxpayers

E. Foreign Taxpayers

F. Miscellaneous Foreign Provisions

G. 1984 Act Technical

2. An error in the description of the number of housing units to be included in a Howard University facility for which a transitional exception was included in the Reform Act would be corrected.

B. Generation-Skipping Transfer Tax

B. Accounting Provisions

C. Partnership Provisions

D. Corporate Tax Provisions

E. Insurance Provisions

F. Estate and Gift Tax Provisions

1. Prior gifts

The amount of a gift deemed by virtue of a later transfer by either the original transferor or transferee would be reduced by the amount of any taxable gift resulting from the original transfer. Such amount would also be reduced by the amount of previous deemed gifts.

2. Terminations, lapses, etc.

Terminations, lapses, and other changes in interests in the enterprise would result in a deemed gift. One consequence of this amendment is that a deemed gift would occur upon the termination of an income interest in a grantor retained income trust.

3. Later transfer to original transferor

The rule deeming a gift whenever the original transferor or transferee later transfers an interest in the enterprise would not apply where the transferee transfers the interest back to the original transferor.

4. Effect of continuing interest in property

A transfer of property would not result in a deemed gift if the transferor or transferee retains a direct or indirect continuing interest in such property, for example by transferring the property to a holding company.

An amount would not be includible in a person's estate solely because that person received or retained certain debt lacking equity features. Such debt would have to meet specified requirements regarding term, interest rate, payment dates, voting rights and conversion.

2. Existence of sale, lease, or compensation agreement

An amount would not be includible in a person's estate solely because that person retained an arms length agreement with the enterprise for the sale or use of property or the providing of services which did not otherwise give that person an interest in the enterprise.

3. Options

An amount would not be includible in a person's estate solely because that person granted an option or, entered into some other agreement, to sell property at its fair market value at the time the option is exercised.

4. Retained income or rights

The statute would be clarified by deleting language requiring that the transferor's retained income or rights in the enterprise be a disproportionately large share of such income or rights in order for the provision to apply.

5. Treatment of spouse

Regulatory authority would be granted to specify the circumstances in which an individual and his spouse would not be treated as one person.

6. Substantial interest test

A substantial interest in an enterprise triggering the provision would exist if a person held such an interest either before or after the effective transfer. This change would be effective for transfers made on or after June 21, 1988.

7. Contribution

The estate would be given the right to require that the transferee pay his or her share of estate tax attributable to operation of the freeze provision.

If a plan subject to the health care continuation rules fails to satisfy the rules, all deductions for expenses paid or incurred for group health plans by the employer maintaining such plan are disallowed (sec. 162(i)) for the year of failure and all subsequent years up to and including the year of correction. In addition, the exclusion from income under section 106 for employer-provided health coverage does not apply to the employer's highly compensated employees for such time.

Amount of the excise tax

The amount of the excise tax for any failure to satisfy the health care continuation rules would be $100 per day during the noncompliance period with respect to such failure. This excise tax would apply separately with respect to each qualified beneficiary with respect to whom there has been a failure to satisfy the health care continuation rules.

Noncompliance period

30-day grace period

The excise tax generally would not apply to any failure if such failure was due to reasonable cause and not to willful neglect and such failure is corrected within the first 30 days of the noncompliance period with respect to such failure.

Audit rule

A special audit rule would override the inadvertent-failure and 30-day grace period rules described above. Under this special audit rule, if a failure with respect to a qualified beneficiary is not corrected by the date a notice of examination of income tax liability is sent and if the failure occurred or continued during the period under examination, the excise tax with respect to such qualified beneficiary would not be less than the lesser of (a) $2,500 or (b) the excise tax determined without regard to the inadvertent failure and 30-day grace period rules. To the extent that failures for any year are more than de minimis, $15,000 would be substituted for $2,500 in the preceding sentence.

One purpose of the special audit rule is to ensure that employers (and other persons liable for the tax, such as an insurance company or health maintenance organization (see discussion below)) have an incentive to monitor themselves for compliance with the health care continuation rules.

Maximum liability

The limit described above would not apply to failures to satisfy the health care continuation rules that are attributable to willful neglect. Under rules prescribed by the Secretary, a failure that originally was not attributable to willful neglect would become attributable to willful neglect when a person liable for the tax does not make or ceases to make reasonable efforts to correct such failure at a time during the noncompliance period when it is correctable and the person knows of such failure.

If an employer is liable for an excise tax attributable to a failure with respect to a multiemployer plan, such liability would be treated as if it related to a plan other than a multiemployer plan and thus would be subject to the limit described above.

Correction

A failure to satisfy the health care continuation rules would be considered corrected if--

Liable persons

Under a special rule, a person would be considered to cause a failure if (1) such person fails to comply with a written request of the employer (or, in appropriate cases, a written request of a qualified beneficiary or plan administrator) to make available with respect to qualified beneficiaries the same services and benefits that such person provides with respect to similarly situated active employees, and (2) such services and benefits are not made available by any person with respect to such qualified beneficiaries. Generally, the purpose of this rule is to make liable any party, such as an insurance company, that contracts with the employer to provide health coverage to the employer's active employees but refuses to provide coverage for the employer's qualified beneficiaries.

It is understood that when an employer changes from one insurance company to another, State law often imposes similar requirements on the new insurance company to continue to provide coverage to the employer's existing insureds. As is the case generally with respect to the health care continuation rules, these State laws are not affected by the special rule described above. The special rule and the State laws are to apply concurrently so that in any specific instance, the more extensive requirements will apply. Thus, for example, if under State law the qualified beneficiaries are entitled in one respect to greater rights than under the health care continuation rules such that compliance with State law automatically means compliance with the health care continuation rules, the State law rule becomes the operative rule with respect to that aspect.

There would be a safe harbor under which a person would not be considered to have caused a failure in whole or in part. The safe harbor would apply if (1) the person has in effect a written agreement with the employer that accurately reflects the parties' agreement in practice, and (2) the failure relates solely to a responsibility allocated under the written agreement to an entity other than such person. This safe harbor would not apply to the special rule described in the second preceding paragraph.

Waiver

In the case of a failure that is due to reasonable cause and not to willful neglect, the Secretary would be authorized to waive part or all of the excise tax to the extent that the tax would be unreasonably burdensome. The determination of whether a tax is unreasonably burdensome is to be made based on the seriousness of the failure and not on a particular taxpayer's ability to pay the tax.

In determining whether to exercise this waiver authority, the Secretary would take into account the extent to which the person liable for the tax monitored itself for failure to satisfy the health care continuation rules.

Deductibility

The excise tax would be nondeductible.

In addition, it would be intended that, with respect to taxable years beginning before January 1, 1989, the Secretary would exercise administrative restraint in applying the sanction technically applicable under present law, taking into account whether the employer has made all reasonable efforts to prevent and correct any violation of the health care continuation rules.

Under present law, new nondiscrimination rules apply to statutory employee benefit plans (sec. 89). The term "statutory employee benefit plans" includes accident or health plans and group-term life insurance plans. At the election of the employer, the term also includes qualified group legal services plans, educational assistance programs, and dependent care assistance programs.

Under the new nondiscrimination rules, a plan generally is required to satisfy 3 eligibility tests--a 50-percent test, a 90-percent/50-percent test, and a nondiscriminatory provision test--and a benefits test. Alternatively, a plan may satisfy an 80-percent coverage test, provided it also satisfies the nondiscriminatory provision test.

Nondiscrimination tests

This alternative test applies only to accident or health plans and group-term life insurance plans. For purposes of this alternative test, an individual will only be considered to benefit under a plan if such individual receives coverage under the plan; eligibility to receive coverage is not considered benefiting under the plan.

Valuation

The Secretary is to prescribe rules regarding valuation of different benefits. With respect to health coverage, the Secretary is to establish tables prescribing the relative values of different types of health coverage.

Definitions

For purposes of applying the new nondiscrimination rules, present law provides generally applicable definitions of the following: (1) highly compensated employee (sec. 414(q)) (see discussion below); (2) employer (including the employee leasing rules (sec. 414(b), (c), (m), (n), (o), and (t))); (3) line of business or operating unit (as present law permits the new nondiscrimination rules to be applied separately to separate lines of business or operating units (sec. 414(r))); and (4) employees who are excluded from consideration. These definitions, other than the line of business or operating unit rule, apply generally to all employee benefit plans, not only to statutory employee benefit plans.

The identity of the highly compensated employees is to be determined on an employer-wide basis, not on the basis of, for example, a line of business or operating unit.

A former employee is treated as a highly compensated employee of an employer if such employee was a highly compensated employee of the employer either when he or she separated from service or at any time after attaining age 55.

Qualification and reporting requirements

Employee benefit plans generally are subject to new qualification and reporting requirements (sec. 89(k) and (1)).

Effective date

In general, these rules are effective for years beginning after the later of--

The amendment would provide a group of interim and permanent rules that are intended to facilitate initial compliance with the section 89 rules.

Under the amendment, the temporary special valuation rule would apply to all years beginning before January 1, 1991, without regard to whether the Secretary issues different valuation rules prior to such date.

In addition, under the amendment, the Secretary is directed to issue rules facilitating the determination of which employees who separated from service prior to January 1, 1987, are highly compensated employees.

Also as discussed below, the amendment would require that the sworn statements regarding family status and core health coverage from another employer generally relate to the facts in existence on the plan's testing date. This requirement would not apply to years beginning in 1989, providing additional flexibility with respect to compliance in such years.

For years after 1989, rules prescribed by the Secretary are to permit employers a reasonable period to move from a written plan evidenced by a collection of separate written documents to a written plan evidenced by a stand-alone document.

Testing period

Under the amendment, an employer may designate in its plans a common 12-month period for testing all or some of its plans even if such plans have different plan years and even if none of the plans' plan years is the same as the common 12-month testing period. (The testing period chosen by the employer, whether it is this common 12-month period or each plan year, is referred to as the testing year.) This rule allows employers to avoid overlapping testing periods based on the use of different plan years for different plans.

Time for testing

Under present law, the nondiscrimination rules generally apply based on benefits available and provided during the entire year. Under the amendment, the rules generally would be required to be applied based on the benefits available and provided on one day in a year. However, adjustments would be required with respect to plans of the same type (i.e., plans providing benefits excludable under the same Code section) if during the year with respect to any such plan, there is a change in plan design or any election by a highly compensated employee to change his or her benefits in any way. Pursuant to these adjustments, such plan design changes and elections would be required to be taken into account as of the testing date, but would be pro-rated based on the period of time during which they were in effect during the year.

Under the amendment, an employer would be entitled to certain flexibility in choosing the date on which it measures the effect of a change in plan design on elections by nonhighly compensated employees.

The annual testing date is to be specified in the plan document. Such date is required to be the same for all plans of the same type (except that two groups of plans may have two different dates if the two groups are in different lines of business or operating units recognized under sec. 414(r)). Except to the extent provided above in the discussion of phased-in implementation, a plan's testing date may not be changed without the prior consent of the Secretary.

Sampling

Under the amendment, employers would be entitled to demonstrate compliance with section 89 on the basis of a statistically valid random sample of all employees that is not inconsistent with rules prescribed by the Secretary. Such random sampling may be performed only by an independent third party.

For this purpose, sampling will be treated as valid only if the statistical method and sample size produce a 99 percent level of confidence that the sample results have a margin of error not greater than 2 percent. Also, there may be a reasonable finite population correction in the minimum sample size where the number of employees to be sampled exceeds a specified level (e.g., the greater of (1) 20 percent of all employees or (2) 1,000 employees).

The sampling described above is only permissible for discrimination testing purposes. It is not permitted for purposes of identifying the highly compensated who have a discriminatory excess or the amount of such discriminatory excess.

Valuation

The amendment would modify the rules relating to the valuation of benefits in two respects that affect such valuation after the temporary special valuation rule described above no longer applies.

First, under the amendment, the Secretary would be directed, in prescribing the value of health benefits for the period after the temporary special valuation rule no longer applies, to take into account any managed care aspects of such benefits. For example, because of such managed care aspects, a health maintenance organization (HMO) may be able to provide greater health care coverage than an indemnity plan at the same cost to the employer. A valuation technique that focused only on plan coverages could thus overvalue the HMO. (This issue is implicitly addressed in the temporary special valuation rule because employers are permitted to use a plan's cost as its value.)

Second, both during and after the application of the temporary special valuation rule, in determining the benefits provided under a multiemployer plan, an employer generally may treat the contribution it makes to the plan on behalf of an employee as the benefit provided to the employee under such multiemployer plan. If the allocation of plan benefits between highly compensated employees and nonhighly compensated employees varies materially from the allocation of plan contributions, however, the employer is to adopt a general method of eliminating such material variation through an appropriate adjustment to plan contributions. If the plan contribution relates to benefits of different types (such as health benefits and group-term life insurance), a reasonable allocation is required.

This special rule for multiemployer plans would not apply to a multiemployer plan that covers any professional (e.g., a doctor, lawyer, or investment banker). No inference is intended from this provision that a plan covering a professional may be a multiemployer plan.

Definition of highly compensated employee

Under the amendment, employers would be entitled to elect to determine their highly compensated employees under a simplified method. The simplified method would be the same as present law with the following exception. The employer would not be required to determine the employees who (1) received more than $75,000 in annual compensation from the employer, or (2) received more than $50,000 in annual compensation from the employer and were members of the top-paid group. In lieu of these determinations, the employer would simply be required to determine the employees who received more than $50,000 in annual compensation from the employer.

An employer would not be entitled to make this election with respect to a current testing year unless (1) the employer did not maintain a top-heavy plan (sec. 416) at any time during such year, and (2) at all times during such year, the employer maintained business activities and employees in at least two geographically separate areas (within the meaning of sec. 414(r)(7)).

This modification of the definition of highly compensated employee would apply for all purposes for which the term applies (e.g., with respect to the discrimination rules applicable to qualified plans).

Part-time employees

Under present-law, under certain circumstances, employees who normally work less than 17-1/2 hours per week are disregarded in applying the nondiscrimination rules. There are also special rules for employees who normally work less than 30 hours per week.

The amendment provides a simplified method of determining the number of hours an employee is considered to work normally in a week. Under the amendment, until the end of the applicable testing year in which an employee commences work, an employee is considered to work normally the average number of hours such employee is scheduled to work during such year (disregarding any time the employee is not employed by the employer). The determination of the average scheduled hours is to be made in good faith and is to take into account periods in which it is expected that hours will be higher due to, for example, seasonal business cycles.

For subsequent testing years, an employee would be considered to work normally the average number of hours worked during the preceding testing year (disregarding any time the employee was not employed by the employer).

In determining the number of hours an employee has worked or is scheduled to work, rules similar to the qualified plan "hour of service" rules would apply.

Initial service requirements

Generally, under present law, for purposes of the nondiscrimination rules, employees who have not completed one year of service (or, in the case of core health benefits, six months of service) are disregarded. However, the one-year and six-month figures generally are reduced to the shortest initial service requirement applicable to any employee for eligibility in a plan of the same type (i.e., a plan providing benefits excludable under the same Code section) except that for this purpose core health plans are considered to be of a different type than other accident or health plans.

Under the amendment, the initial service requirement applicable under a multiemployer plan would not be taken into account in determining the extent to which the one-year and six-month figures are reduced. Thus, even if a multiemployer plan provides core health benefits to an employee on the first day such employee is employed by an employer, such fact would not in itself cause the six-month figure to be reduced to zero for such employer's core health plans.

This special rule for multiemployer plans would not apply to a multiemployer plan that covers any professional (e.g., a doctor, lawyer, or investment banker). No inference is intended from this provision that a plan covering a professional may be a multiemployer plan.

Comparability

For purposes of applying the 80-percent test to accident and health plans, in general, a group of plans are comparable and may be aggregated as one plan if the least valuable plan has a value of at least 95 percent of the value of the most valuable plan.

Under the amendment, an employer may elect to reduce the 95-percent figure to 80-percent and thus increase the range in value between plans that may be considered comparable. However, in any year that election is made, the 80-percent test is modified to be a 90-percent test; thus, if the election is made, a plan satisfies the nondiscrimination rules under section 89(f) if (1) it covers at least 90 percent of the employer's nonhighly compensated employees, and (2) it satisfies the nondiscriminatory provision test (sec. 89(d)(1)(c)). If made, this election generally applies to all accident and health plans maintained by the employer except that if the nondiscrimination rules are applied separately to separate lines of business or operating units, each such line of business or operating unit may make its own election.

Other coverage

Under present law, for purposes of applying the 75-percent benefits test to accident or health plans, an employer generally may disregard any employee or family member of an employee if such individual receives core health coverage from another employer of the employee or of the employee's spouse or dependents.

The amendment would expand this rule in two respects. First, under the amendment, an individual could be disregarded based on core health coverage received from another employer of any family member, including a parent. Second, with respect to testing accident or health coverage, the 80-percent test would be modified to have two parts: (1) the present-law 80-percent coverage requirement with the "other coverage" rule described above, and (2) a requirement that the plan be available to 80 percent of the employer's nonhighly compensated employees.

Sworn statements

Under present law, in order to use the other coverage rule described above or a special family coverage rule, an employer is required annually to obtain sworn statements on an IRS form to demonstrate whether individuals have core health coverage from another employer or, in the case of the family coverage rule, whether employees have a spouse or dependent. Present law permits employers to secure the sworn statements from a statistically valid sample of all employers.

The amendment would modify the sworn statement rule in several respects. First, under the amendment, the sworn statements would not be required to be on an IRS form; the IRS would be directed to supply language for inclusion on appropriate employer documents (such as enrollment forms). Second, after initial enrollment, the sworn statements (from all employees or only a sample) would be required to be collected no more frequently than once every three years except to the extent that an employee otherwise makes an election with respect to an employee benefit program (including an election not to participate). In addition, except to the extent provided above in the discussion of phased-in implementation, the triennial collection of sworn statements must relate to the facts in existence on the annual testing date. Sworn statements other than the triennial collections need only be taken into account with respect to testing dates following the collection of such statements.

The third modification would be that no nonhighly compensated employee (or family member) may be disregarded based on their receipt of other core health coverage unless the employer informs the employee that he or she has the right, if such other coverage ceases, to elect health coverage from the employer without regard to whether it is otherwise open season. For all purposes, such election is to be on the same terms as if such employee had initially elected health coverage from the employer and at a subsequent open season was changing such coverage.

A similar rule would apply in the case of the treatment of an employee as not having a family member. Thus, no nonhighly compensated employee may be treated as not having a family unless the employer informs the employee that he or she has the right, if the employee subsequently has a family, to elect health coverage for such family from the employer, without regard to whether it is otherwise open season. For such purposes, such election is to be on the same terms as if such employee had initially elected individual coverage or no coverage (as the case may be) and at a subsequent open season elected to cover his or her family.

The modifications described in the preceding two paragraphs would apply to years beginning after December 31, 1989.

Further, the amendment would modify a rule included in the introduced bill. Under the bill, an employer ("first employer") may treat an individual as having core health coverage from another employer without a sworn statement if (1) the first employer makes core health coverage available to the individual at no cost, and (2) such coverage and all other health coverage from the first employer are rejected. Under the amendment, the rule in (2) is modified to require only rejection of all core health coverage.

Line of business

The amendment would allow the safe-harbor rule to be applied based on the proportions in the preceding plan year if (1) no more than a de minimis number of employees shifted to or from the line of business or operating unit since the end of the prior year; or (2) the employees shifted to or from the line of business or operating unit since the end of the prior year contained a roughly proportional number of highly compensated employees.

Under the amendment, the first step described above would be modified so that only employees who perform at least 75 percent of their services for a particular line of business or operating unit would be required to be allocated to such line of business or operating unit pursuant to such first step.

Definition of plan

Under present law, each different option generally would be a different plan. Under the amendment, each different option would be valued separately, but would not be considered a separate plan. A plan would be a group of options with comparable values (under the present-law comparability rules). Thus, the 50-percent test and the 80-percent test would apply to such plans, as redefined. (Because comparable options could be aggregated to constitute a plan, comparable plans could not be aggregated.)

For purposes of the other applicable tests, all plans are tested together (unless the separate testing of family coverage is elected).

With respect to the nondiscrimination rules, the effect of these changes would be only one of terminology rather than of substance. It is included in the amendment because so many employers have been confused by the use of the term "plan" to refer to each different option. (For convenience, the present-law terminology is used throughout this document; that avoids the further confusion that would result if the terms were used in different ways in different parts of this document.)

These changes are not intended to limit the authority of the Secretary either with respect to allowing flexible means of satisfying the plan qualification requirements of section 89(k) or with respect to establishing an appropriately tailored sanction for violations of section 89(k).

Penalty for failure to report

Under present law, except to the extent provided by the Secretary, if an employer does not report the discriminatory excess to the affected employees and the IRS by the due date (with an extension) for filing the required forms, the employer is liable for a tax at the highest individual rate on the total value of benefits of the same type provided to employees with respect to whom the employer failed to report the discriminatory excess. This tax does not apply if the employer can demonstrate the failure to report was due to reasonable cause.

Under the amendment, the penalty tax with respect to an employee would be the penalty tax determined under present law reduced by the amount of the discriminatory excess properly reported by the employer in a timely fashion.

The same rule would apply in the case of amounts includible by reason of a failure to satisfy the qualification rules.

Treasury rules

Under the amendment, the Secretary would be required to issue rules by October 1, 1988, providing guidance under section 89 on which employers may rely. Such guidance is to address those areas not addressed by the statute or legislative history and with respect to which employers need immediate guidance in order to comply with the nondiscrimination rules.

Good faith

As is the case with respect to any statute for which there is no guidance issued by the Secretary, taxpayers are expected to make reasonable interpretations of section 89 based on the statute and its legislative history. The amendment clarifies that until the issuance of rules by the Secretary an employer's compliance with its reasonable interpretation, if made in good faith, constitutes compliance with section 89.

As employers have prepared to apply the rules, they have identified and proposed modifications of the rules that would simplify their administration of the rules without undermining the objective of nondiscrimination. The amendment includes such proposed modifications.

In addition, the amendment provides certain interim rules designed to ease implementation of the nondiscrimination rules for the first year for which they apply. Given that Treasury rules have not yet been issued and that employers maintain that they need guidance in order to comply with the rules in 1989, the amendment provides significant guidance and maximum flexibility to employers in testing their plans for 1989.

A marital deduction is allowed for Federal estate and gift tax purposes for an interest in property passing to a spouse if that interest is not terminable, i.e., it does not terminate and pass to a person other than the spouse. The terminable interest requirement insures that the property generally will be subject to transfer tax with respect to one spouse.

Generally, to avoid receiving a terminable interest, a donee spouse must have use of the property during his or her life and control over who will receive the property on his or her death. A special rule applicable to qualified terminable interest property (QTIP) allows a marital deduction where the donee spouse only has an income interest in the property if an election is made to include the property in his or her estate and any Federal estate tax is paid out of the QTIP.

The transfer of an interest in a joint and survivor annuity for two spouses may not qualify for the marital deduction. Because the spouse's interest may terminate and pass to the donor, it may be a terminable interest. The transfer may not qualify for the QTIP rule because the donee spouse may not have an income interest in the annuity if he or she predeceases the donor.

Unfunded deferred compensation provided under an eligible deferred compensation plan is includible in the income of the individual performing services (or his or her beneficiary) in the year in which it is paid or made available. On the other hand, with respect to any State or local government or nongovernmental tax-exempt organization, any unfunded deferred compensation not provided under an eligible deferred compensation plan is includible in income when and to the extent that it is not subject to a substantial risk of forfeiture.

Third, section 457 would not apply to nonelective deferred compensation provided to individuals other than in their capacities as employees.

For purposes of these rules, a deferred compensation plan would be considered nonelective only if all individuals (other than those who have not satisfied any applicable initial service requirement) with the same relationship to the payor are covered under the same plan with no individual variations or options within the plan. For example, if a nonemployee doctor receives deferred compensation from a hospital, such deferred compensation is to be considered nonelective only if all nonemployee doctors (who have satisfied any applicable initial service requirement) are covered under the same plan.

The exemption for nonelective deferred compensation plans for nonemployees is appropriate because such plans do not affect the incentives to maintain qualified plans (which may only be maintained for employees) and do not permit manipulation of tax liability.

The exemption for collectively bargained plans recognizes that prior to January 26, 1987, many taxpayers were not aware of the IRS position (as published that day in IRS Notice 87-13) that nonelective deferred compensation is subject to section 457. Therefore, collectively bargained agreements were entered into based on the assumption that section 457 did not apply to nonelective deferred compensation.

Under prior law (taxable years beginning before January 1, 1988), an employee's gross income for income and employment tax purposes did not include amounts paid or incurred by the employer for educational assistance provided to the employee (without regard to whether the education was job-related) if such amounts were paid or incurred pursuant to an educational assistance program that met certain requirements (sec. 127). This exclusion, which expired for taxable years beginning after December 31, 1987, was limited to $5,250 of educational assistance with respect to an individual during a calendar year and did not apply to education involving sports, games, or hobbies. (References below to the exclusion for educational assistance are to this exclusion under sec. 127.)

In 1984, Congress required that employers file information returns with respect to educational assistance programs under section 127 (sec. 6039D). The purpose of this requirement was to collect data with respect to the use of such programs to provide Congress with a means to evaluate the effectiveness of the exclusion.

The exclusion for educational assistance was intended to assist low-and middle-income employees in obtaining education that improved their skills and qualified them for better jobs. The exclusion for postgraduate education or education with respect to hobbies does not materially further this purpose.

To qualify for the credit, a low-income rental housing project must continuously comply with the requirements of the credit for a period of fifteen years after it is placed in service. The principal requirement is that a minimum percentage of housing units be continuously set-aside for use by individuals having incomes below prescribed levels. The minimum percentage is 40 percent for tenants having incomes of 60 percent or less of area median, or 20 percent for tenants having incomes of 50 percent or less of area median. A lapse in compliance with this or other Code requirements generally will result in the denial of the credit prospectively as well as a recapture of a portion of the tax benefits previously allowed, including an interest component to account for the time value of money.

The annual credit authority limitation for each State is equal to $1.25 for each individual who is a resident of the State. Ten percent of each State's credit authority is set aside for exclusive use for projects in which qualified nonprofit organizations participate. Credit authority lapses after December 31, 1989.

Beneficiaries of these programs are subject to two principal limits. First, the purchase price of homes for which the special assistance is received may not exceed 90 percent (110 percent in economically distressed areas) of the average purchase price of homes in the area where the assisted homes are located. Second, income of the mortgagor may not exceed 115 percent of the higher of area or State median income in nontargeted areas. In targeted economically distressed areas, the income limit is 140 percent of the higher of area or State median income for 2/3 of the financing provided. Income limits do not apply to 1/3 of the financing provided in these areas.

Subject to several exceptions, issuers of qualified mortgage bonds must satisfy the arbitrage restrictions that apply to all tax-exempt bonds. One of the exceptions permits issuers of these bonds, unlike issuers of governmental bonds, to retain arbitrage profits earned in temporary periods and use those profits for the benefit of assisted homebuyers.

Several modifications would be made to the rules governing these programs:

In a recent report, the General Accounting Office found that the average purchase price for all first-time-home buyers is 73 percent of average home purchase price. The proposal would create more targeted programs by reflecting this experience of first-time homebuyers.

The same report found that the present structure of the qualified mortgage bond and MCC income limit makes it easier for a single-person household to qualify for the programs than a family. Only 44 percent of assisted households were comprised of more than two persons. The proposal would target more benefits to families by adopting a family size adjustment generally applied in other Federal housing programs.

The GAO also found that in some areas of the country, housing prices are so high that a family with the maximum allowable income may have difficulty benefiting under the programs. In other areas of the country, housing prices were sufficiently low relative to income that families with the maximum allowable income could easily afford homes with conventional financing. The proposal would make the income limit more sensitive to these differing economic circumstances.

It is inappropriate to permit more liberal arbitrage rules for private activity bonds issued by quasi-private agencies than are permitted to state and local governments issuing governmental bonds. The proposal would extend the arbitrage rebate rules applicable to governmental bonds to all mortgage revenue bonds.

Requiring redemption of bonds with unspent proceeds and prepayments would reduce unnecessary revenue loss from the qualified mortgage bond program by limiting the amount of bonds that remain outstanding for long periods of time to that actually needed to finance mortgage loans and also would discourage earlier and larger issuance of bonds than otherwise required.

GAO found that the bond- and MCC-assisted population generally is younger and more likely to be single than the first-time homebuyer population generally. These buyers may be expected to "buy-up" as their marital status and incomes change. Additionally, a house provides a family with both consumption and investment benefits. Partial recapture of gain on disposition of bond--and MCC-assisted houses would target one special subsidy provided by the assistance to the consumption benefits. Further, GAO recommended a recapture provision to address use of the program by upwardly mobile buyers not requiring assistance. The proposal would adopt such a provision to target these programs more to people heeding longer-term housing assistance.

The credit is scheduled to expire after December 31, 1988.

In addition, Code section 41 provides a 20-percent income tax credit for qualified research expenditures incurred by the taxpayer in carrying on its trade or business, to the extent current-year expenditures exceed the average of the taxpayer's yearly expenditures in the specified base period (generally, the three preceding taxable years). The credit is scheduled to expire after December 31, 1988.

Under present law, the amount of the taxpayer's section 174 deduction for research expenditures is not reduced by the amount of any section 41 credit also allowed to the taxpayer for incremental research expenditures.

For similar reasons, present law provides that the basis of depreciable property must be reduced by the full amount of the investment tax credit in the case of transition property, and by the full amount of the rehabilitation credit; under prior law, the basis of investment credit property generally was reduced by one-half of the credit amount. Likewise, present law provides that a taxpayer's section 174 or 162 deductions are reduced by the amount of the "orphan drug" clinical testing credit for such expenditures, and that an employer's deduction for wages paid to employees is reduced by the amount of the employer's targeted jobs tax credit for the year.

Effective for taxable years beginning after August 1, 1986 and on or before August 1, 1987, U.S. R&D expenses incurred by U.S. persons are subject to statutory allocation rules of the 1986 Act. Under that Act, U.S. R&D expenses incurred to meet certain legal requirements may be allocated entirely to one geographic source; 50 percent of the remaining U.S. R&D expenses (after applying the legal requirements rule) are allocated to U.S. source income; and U.S. R&D expenses not allocated under the foregoing rules are allocated either on the basis of sales or gross income.

For taxable years beginning after August 1, 1987, all R&D expenses, including U.S. R&D expenses, are allocated under the 1977 Treasury regulations.

Expenses for R&D conducted in space, on or beneath the ocean outside the territorial waters of the United States or foreign countries, or on Antarctica, would be treated for these purposes as U.S. R&D expenses if incurred by U.S. persons and as foreign R&D expenses if incurred by persons other than U.S. persons.

The targeted jobs tax credit is available on an elective basis for hiring individuals from nine targeted groups. The targeted groups are: (1) vocational rehabilitation referrals; (2) economically disadvantaged youths aged 18 through 24; (3) economically disadvantaged Vietnam-era veterans; (4) Supplemental Security Income (SSI) recipients; (5) general assistance recipients; (6) economically disadvantaged former convicts; (7) economically disadvantaged former convicts; (8) Aid to Families with Dependent Children (AFDC) recipients and Work Incentive (WIN) registrants; and (9) economically disadvantaged summer youth employees aged 16 or 17. Targeted group membership must be certified.

The credit generally is equal to 40 percent of the first $6,000 of qualified first-year wages paid to a member of a targeted group. Thus, the maximum credit generally is $2,400 per individual. With respect to economically disadvantaged summer youth employees, however, the credit is equal to 85 percent of up to $3,000 of wages, for a maximum credit of $2,550.

The credit is not available for wages paid to a targeted group member unless the individual either (1) is employed by the employer for at least 90 days (14 days in the case of economically disadvantaged summer youth employees), or (2) has completed at least 120 hours of work performed for the employer (20 hours in the case of economically disadvantaged summer youth employees). Also, the employer's deduction for wages must be reduced by the amount of the credit.

The credit is available with respect to targeted-group individuals who begin work for the employer before January 1, 1989.

Authorization of appropriations

Present law also authorizes appropriations for administrative and publicity expenses relating to the credit through September 30, 1988. These monies are to be used by the Internal Revenue Service (IRS) and Department of Labor to inform employers of the credit program.

Because youths 18 to 21 have an unemployment rate significantly higher than those in the 22 to 24 age group, the targeted jobs tax credit could be more effectively utilized by restricting the category of economically disadvantaged youth to those under the age of 22. This may provide an incentive for employers to direct the benefits of this program to those individuals most in need.

The authorization for appropriations would be effective for the period October 1, 1988 through September 30, 1990.

The Omnibus Budget Reconciliation Act of 1987 (OBRA) delays treatment of shareholder expenses of publicly offered mutual funds as miscellaneous itemized deductions until taxable years beginning after December 31, 1987.

Exemptions from the 15-cents-per-gallon Highway Trust Fund rate are provided for off-highway business uses, including inter alia, use on a farm for farming purposes, use as supplies for vessels and trains, and use in construction activities. Further exemptions are provided for use by States and local governments and by nonprofit educational organizations.

In general, exemptions from the tax are realized by means of refunds (or credits against other tax payments) following tax-paid sales. The Treasury Department is authorized to adopt regulations permitting sales (on a case-by-case basis) without payment of tax when diesel fuel is sold directly by a producer to (1) a person who will use the fuel in a train or as a chemical feedstock and (2) States and local governments for their exclusive use. Fuel destined for use as heating oil also may be sold without payment of tax.

Pursuant to the Omnibus Budget Reconciliation Act of 1987, these provisions were effective on April 1, 1988.

All persons purchasing diesel fuel without payment of tax would be required to satisfy Treasury Department registration and bonding requirements, and expanded information reporting requirements similar to the Form 1099 requirements that apply to interest income would be imposed on sellers and exempt purchasers.

To curb the potential for tax evasion arising from expanding the number of persons qualifying to purchase fuel without payment of tax, expanded information reporting requirements would be adopted and Treasury's current authority to require registration and bonding of exempt purchasers would be extended.

A special interest-bearing refund would be provided for persons allowed to purchase fuel without payment of tax under the proposal (but not allowed to do so under present law) for tax paid after March 31, 1988, and before July 1, 1988.

For purposes of determining whether the 80 percent threshold is met, the ownership of certain corporations under common control may be aggregated.

For purposes of determining whether the more than 20 percent threshold is met, the ownership of corporations could be aggregated to the same extent that it is aggregated under present law for purposes of the 80 percent threshold.

Aggregation should be permitted for purposes of the portfolio stock dividends received deduction threshold to the same extent that it is permitted for purposes of the 80 percent threshold.

The change in the aggregation rules for purposes of determining whether the portfolio dividends received deduction has been exceeded would apply for dividends received or accrued after December 31, 1987.

Certain small businesses may use the completed contract method fully with respect to contracts to be completed within two years.

On the other hand, the percentage of completion method recognizes income throughout the life of the contract as the income from the contract, as measured by the ratio of contract costs incurred by the taxpayer that year compared to total estimated costs, is earned. If the estimated costs are incorrectly estimated by the taxpayer so that the taxpayer paid the incorrect amount of taxes based upon actual costs incurred, the taxpayer would be paid interest in the case of an overpayment, or the taxpayer would pay interest in the case of an underpayment.

Distribution rules

Amounts distributed from life insurance contracts (e.g., in a partial surrender of the contract) are treated first as a nontaxable recovery of basis and then as income to the recipient. Loans under life insurance contracts are generally not treated as distributions.

Under a deferred annuity contract, distributions prior to the annuity starting date are treated as income first and then as a nontaxable recovery of basis. Loans under deferred annuity contracts are treated as distributions.

Distributions from deferred annuity contracts generally are subject to a 10-percent additional income tax. This additional income tax does not apply in the case of distributions after the owner of the contract reaches age 59-1/2, dies, becomes disabled, or after the contract is annuitized. The additional income tax does not apply to distributions from life insurance contracts.

Basis rules

Under present law, a policyholder's investment in a life insurance contract for purposes of determining gain on the contract generally is determined without adjustment for the cost of current term insurance protection. In determining the amount of any loss from the complete surrender of a life insurance contract, courts have held that the cost of insurance protection is not included in basis.¹

Mortality and expense charges

The favorable tax treatment accorded the owner of a life insurance contract is available only for contracts that satisfy a statutory definition of life insurance. Under this statutory definition, a contract must satisfy either a cash value accumulation test or a test consisting of a guideline premium requirement and a cash value corridor test. In determining whether a contract satisfies the cash value accumulation test or the guideline premium requirement, the mortality charges taken into account are the charges specified in the contract, or, if none are specified, the mortality charges used in determining the statutory reserve for the contract. In determining whether a contract satisfies the guideline premium requirement, the expense charges taken into account are the charges specified in the contract.

b. Conforming changes to rules for deferred annuities

The additional income tax on early distributions from deferred annuity contracts would be conformed to the rule for life insurance contracts not satisfying a 20-pay model. Thus, the rate of the additional tax would be 15 percent and an exception to the tax would be provided for distributions after the later of the date the taxpayer reaches age 59-1/2 or 20 years from the date the annuity contract was issued.

c. Mortality and expense charges taken into account

For all life insurance contracts, the mortality charges taken into account for purposes of the definition of life insurance would be required to be reasonable as determined under Treasury regulations and could not exceed the mortality charges required to be used in determining the Federal income tax reserve for the contract. The expense charges taken into account for purposes of the guideline premium requirement would be required to be reasonable based on the experience of the company and other insurance companies with respect to similar life insurance contracts.

d. Study

The Treasury Department and the General Accounting Office (GAO) would be directed to conduct studies of the effectiveness of the revised tax treatment of life insurance and annuity products in preventing the sale of life insurance primarily for investment purposes. The studies would be required to be submitted to the House Ways and means Committee, the Senate Finance Committee, and the Joint Committee on Taxation by July 1, 1990.

Single premium life insurance contracts are currently being marketed in a manner intended to attract purely investment-oriented investors into the life insurance market. Such marketing results in the purchase of life insurance products for noninsurance purposes and defeats the reason that favorable tax treatment was originally accorded to life insurance.

The proposals reduce the Federal tax subsidy for the purchase of life insurance contracts that are not held until death. Consequently, the proposals discourage the use of inside buildup for noninsurance purposes by defining a class of policies that are not eligible for favorable tax treatment in the case of a distribution or loan.

Because of concern that tax-deferred investment products would continue to be sold in the form of deferred annuity contracts if no conforming changes were made in that area, the rate of the additional income tax on early distributions is raised to 15 percent and the age 59-1/2 exception is modified to conform to the proposed rules for life insurance contracts not satisfying a 20-pay model.

With respect to the determination of a policyholder's basis in a life insurance contract, present law is inconsistent in its treatment of the calculation of loss on surrender of a contract on the one hand, and gain or income from surrender of the contract on the other hand. The determination of gain should be conformed to the determination of loss. The proposal corrects this inconsistency with respect to contracts not satisfying a 20-pay model.

In addition, concerns have been raised that some insurance companies may be taking aggressive positions with respect to mortality and expense charges. Specifically, companies may be overstating mortality and expense charges and then rebating them to policyholders. It is appropriate to clarify that such practices are not reasonable with respect to any life insurance contract.

¹ This document may be cited as follows: Joint Committee on Taxation, Description of Possible Committee Amendment by Chairman Rostenkowski to H.R. 4333 (The Technical Corrections Act of 1988) (JCX-11-88), June 21, 1988.

² For a description of H.R. 4333 as introduced on March 31, 1988, see Joint Committee on Taxation, Description of the Technical Corrections Act of 1988 (H.R. 4333 and S. 2238) (JCS-10-88), March 31, 1988.

³ Under the Chairman's amendment, technical corrections to Titles I and IV of the Employee Retirement Income Act of 1974 (ERISA) or to the Public Health Service Act, as well as related corresponding amendments to the Internal Revenue Code, would be deleted from H.R. 4333 and included in a separate bill (H.R. 4845, introduced by Chairman Rostenkowski on June 16, 1988). (For a description of the Chairman's proposed committee amendment to H.R. 4845, see JCX-12-88.)

Table 1

¹ Disallowance notices issued to States. Amount has been reduced to reflect waivers by Secretary of HHS.

Part Five

[/*/ Editor's Note: Part Five was corrected in JCX-13-88 on June 21, 1988. This is the corrected version.]

¹Shoe Co., Inc., 80 F. 2d 230 (2nd Cir. 1935); Century Wood Preserving Co., 69 F. 2d 967 (3rd Cir. 1934).