There is a second remedial amendment that relates to the computation of amounts includable in income. The effective date in the Revenue Act of 1978 is with respect to plan years that end after 1979. It was pointed out that, in the case of fiscal year plans, employees might have to take amounts into income for 1980 that related to payments actually made during 1979. The Technical Corrections Act, as passed by the House, makes it clear that no amounts reimbursed prior to 1980 will be included in the income of employees.

In the attachment is a proposal that goes one step further. This additional proposal would say that, for purposes of determining whether or not a reimbursement in 1980 is taxable to the employee, no reimbursements in 1979 would be considered in applying the new rules. The effect of this proposal is not to count discriminatory payments in 1979 against employees in determining the tax treatment of payments in 1980.

So those two amendments have alleviated some of the problems. Of course, in the 1978 act itself there was a general postponement of the effective date through 1979 in recognition of the fact that employers might need some time to comply with the new provisions. We think that, with the changes already in the Technical Corrections Act plus the changes being proposed in the attachment, there is no need for further postponement of the effective date. Senator BYRD. What types of small businesses use medical reimbursement plans, primarily doctors and lawyers? Is that the situation?

Mr. FERGUSON. In some cases, doctors and lawyers may incorporate for that reason. Many other small businesses, prior to the 1978 act, had provided reimbursements for just one employee, and that limited coverage was the abuse this committee had in mind when the 1978 act was passed.

The problem that the committee saw-and that we saw from the standpoint of Treasury-was not that there is something necessarily wrong with permitting medical reimbursements on a tax-free basis. But if that is done, it should be done for a wide range of employees. Of course, in the pension area there is the requirement that tax benefits be available only if the coverage is nondiscriminatory. The intent in 1978 was to apply a similar type of rule in the health plan area.

Senator BYRD. Section 366 applies only to the self-insured as I understand it.

Mr. FERGUSON. That is right.

Senator BYRD. And not to the insured plans.

Mr. FERGUSON. That is right.

Senator BYRD. Mr. Kiley representing the Norfolk & Western Railway asked the committee for clarification in the way of a technical amendment to section 374. Do you have any comment on that?

Mr. FERGUSON. I was not present for his testimony and I am not sure what he is proposing, Mr. Chairman. It is hitting me out of the blue. Perhaps we could review the statement and be prepared at a later date, at markup or earlier, to give our views on his proposal. I am just not sure what he has in mind at this point.

Senator BYRD. I think that would be better than for the Chair to attempt to explain his position, just let the record speak for itself and then you can make your comment on it.

Mr. FERGUSON. Fine.

[Comment follows:]

Mr. Kiley's proposal relates to the application of the consolidated return regulations under Code section 1502. Upon the disposition of stock of an affiliated corporation, the corporation disposing of that stock must recognize income to the extent of the affiliate's "excess loss account." For this purpose, a disposition is deemed to have occurred if the stock of a subsidiary corporation becomes wholly worthless. Norfolk and Western Railway is the parent corporation of Erie Lackawanna Railway, which has an excess loss account. Erie Lackawanna is now involved in a reorganization proceeding under the Bankruptcy Act. Since it transferred railroad assets to ConRail in 1976, its financial position depends upon the finding of a special court under the Regional Rail Reorganization Act of 1973.

In Mr. Kiley's statement, he proposes that, for purposes of the consolidated return regulations, the stock of Erie Lackawanna not be considered worthless until the special court determination becomes final. We understand that the excess loss account would nevertheless be triggered no later than the year Erie Lackawanna is removed from the Norfolk and Western consolidated return. We also understand that, under the proposed amendment, Norfolk and Western could take no action subsequent to 1976 that would have the effect of preventing the triggering of an excess loss account with respect to Erie Lackawanna.

Based upon this understanding, we do not object to Mr. Kiley's proposal. However, we would oppose its inclusion in H.R. 2797. This proposal cannot reasonably be considered to be a technical correction to 1978 legislation.

Senator BYRD. There will be two additional panels. Will you be able to stay and then make comment on any of the witnesses that come up subsequently, too?

Mr. FERGUSON. I would be happy to stay if you would like, Mr. Chairman.

Senator BYRD. It might be helpful if you could.

Mr. FERGUSON. Thank you.

Senator BYRD. Thank you.

[The prepared statement and attachment of Mr. Ferguson follow. Oral testimony continues on p. 168.]

STATEMENT OF BRADFORD L. FERGUSON, ASSOCIATE TAX LEGISLATIVE COUNSEL, DEPARTMENT OF THE TREASURY

Mr. Chairman and members of the subcommittee, I am pleased to have the opportunity to present the views of the Treasury Department on three tax bills. The bulk of my statement will be devoted to H.R. 2797, the "Technical Corrections Act of 1979." The second bill for discussion is S. 873, a proposal to waive in limited instances the foreign residence or physical presence requirement for certain tax benefits accorded individuals living abroad. The third bill is S. 1549, which would defer payment of the excise tax in the case of sport fishing equipment manufactur

ers.

H.R. 2797 (TECHNICAL CORRECTIONS)

About 1 year ago, in the final days of the 95th Congress, there was a spate of legislative activity in the tax area. The conference reports on three major tax billsthe Revenue Act of 1978, the Energy Tax Act of 1978, and the Foreign Earned Income Act of 1978-were adopted on October 15, 1978. The Revenue Act alone comprises about 200 pages of statutory language and over 100 provisions, with many significant issues being resolved by the House-Senate conferees during the waning hours of the session. The draftsmen performed remarkably well under the severe time pressures; but as expected, there are some technical problems that need to be corrected.

The purpose of H.R. 2797 is to effect_the_needed technical changes. It deals with four tax acts adopted last Congress: the Revenue Act, the Energy Tax Act, the Foreign Earned Income Act, and the Black Lung Benefits Revenue Act. The bill was drafted initially by the staff of the Joint Committee on Taxation with the aid of

comments from Treasury, the Internal Revenue Service and tax practitioners. A few additional corrections were added to the bill after hearings in the Ways and Means Committee. But significantly, the bill has remained free of controversial substantive changes in the law; H.R. 2797 is simply an effort to reflect more accurately and clearly the Congressional intent underlying the four tax measures just mentioned. The extraordinary time pressures of last fall make passage of H.R. 2797 especially important; however, the need for technical corrections is not an isolated phenomenon. Regardless of the time devoted to consideration and drafting of statutory language, technical errors are inevitably discovered in major tax legislation. Problems range from clerical oversights, to ambiguous wording, to unforeseen and unintended implications of an amendment. These problems become apparent as IRS and Treasury begin to prepare regulations and forms and as taxpayers and practitioners seek to apply the new provisions to specific fact situations.

Prior to 1977, there was no established mechanism to correct the errors in tax legislation. Taxpayers and tax administrators simply had to deal with the statutes as originally drafted, and to accept many tax results that Congress did not intend. However, with the introduction of the Technical Corrections Act of 1977, a formal procedure was implemented to make technical modifications to the Tax Reform Act of 1976. The 1977 Corrections Act, like the bill you are now considering, was drafted initially by the Joint Committee staff with the cooperation of Treasury, IRS and taxpayer representatives.

Our experience with the 1977 Corrections Act is instructive. Once Congress has made a substantive decision on tax policy, both taxpayers and the Government have a strong interest in assuring that the policy is implemented by proper statutory language; the 1977 Act advanced this objective, and I believe the effort was well received by all individuals concerned with the tax system. At the same time, the process was impaired by delay; technical corrections for the Tax Reform Act of 1976 were not adopted until passage of the Revenue Act of 1978.

The protracted legislative course of the 1977 Corrections Act created a number of problems. For example, the delay affected IRS efforts to make timely and accurate changes in tax forms. A number of changes were made in the 1977 tax forms on the assumption that the pending 1977 Corrections Act would be enacted in 1977. When enactment was postponed until late 1978, the effective date of one of the corrections relating to community property laws and to the credit for the elderly was changed from January 1, 1977 to January 1, 1978-a change that required burdensome corrective action by the IRS to assure that affected taxpayers did not overpay their 1977 taxes.

A similar timing problem may arise in connection with the 1979 Corrections Act. Unless the bill is adopted before the close of this year, many taxpayers will encounter uncertainty and confusion in filing their 1979 tax returns. We believe that such expeditious passage is possible as long as the bill is not encumbered with substantive tax changes. As now drafted, H.R. 2797 is truly "technical" legislation. We hope that controversial provisions will continue to be excluded during Senate consideration of the bill.

Items already approved by Finance Committee

In view of the timing problems raised by the impending tax filing season, the Finance Committee has already approved a portion of H.R. 2797. On October 2, 1979, the Committee adopted eight technical corrections that are especially important for IRS administration. All of these changes are reflected in the 1979 tax forms and instructions that the IRS began printing last month.

The provisions already approved by the Committee are the following:

The Revenue Act of 1978 includes a new provision for an alternative minimum tax, payable if it exceeds the sum of a taxpayer's regular tax and add-on minimum tax liability. Under the new provision, alternative minimum taxable income is computed by subtracting all deductions from gross income and then adding back certain preference items. H.R. 2797 would permit persons who do not itemize deductions to use the zero bracket amount (formerly known as the standard deduction) in computing the alternative minimum tax.

As now drafted, the alternative minimum tax provision permits a new operating loss to provide a double tax benefit. Through a drafting error, the loss can be deducted currently in computing the alternative minimum tax and can also be carried over to reduce the tax liability of other taxable years. H.R. 2797 would correct this defect by prohibiting the deduction of a net operating loss against alternative minimum taxable income in those instances where the loss can be carried to another year.

The alternative minimum tax is imposed to the extent it exceeds a taxpayer's regular tax (including the add-on minimum tax). Certain "penalty" taxes are ex

55-169 - 80 - 11

cluded from the definition of "regular tax" and thereby do not reduce the alternative minimum tax. The Revenue Act expressly excluded from the "regular tax" definition such penalties as the taxes imposed on premature distribution from a certain pension and annuity plans or from individual retirement accounts. H.R. 2797 would extend the same treatment to the "penalty" tax imposed on premature redemptions of retirement bonds.

Under the alternative minimum tax, one of the tax preference items is "adjusted itemized deductions." The preference is deemed to result when certain itemized deductions exceed 60 percent of adjusted gross income (with modifications). The literal language of the Revenue Act requires, in the case of trusts and estates, that some deductions be counted twice in arriving at the modified adjusted gross income figure. The effect is to increase artifically the alternative minimum tax liability of a trust or estate. H.R. 2797 would rectify this error.

Present law permits deductions for state and local taxes to be excluded in computing the tax preference for adjusted itemized deductions. Under H.R. 2797, a deduction for foreign taxes would also be excluded from the preference.

The Revenue Act liberalized the rules for computing a cooperative's investment tax credit and permitted investment credits unused at the cooperative level to be flowed-through to its patrons. H.R. 2797 would make conforming changes so that the new rule would also apply to computation of the work incentive (WIN) credit and the jobs tax credit.

The Foreign Earned Income Act eliminated a prior requirement that taxable income be stacked in rate brackets on top of income excluded (under section 911) by Americans working abroad. With this change, it is appropriate for individuals who exclude foreign earned income to use the tax tables, and H.R. 2797 would so provide. Articles sold as supplies for fishing vessels are not subject to the 4 cents-a-gallon excise tax on fuels or the 6 cents-a-gallon tax on lubricating oil. However, a tax-free sale is often not available in the case of commerical fishing because the producer or supplier does not know the purpose for which the item is to be used or the intermediate seller does not want to perform the necessary paperwork to obtain the tax benefit. The Energy Tax Act eliminated a prior provision that permitted the purchaser to obtain a direct refund of 2 cents-a-gallon with respect to fuels and 6 cents-a-gallon with respect to lubricating oil. Since Congress did not intend to change the excise tax exemptions for commerical fishing vessels, H.R. 2797 would restore the 2-cent and 6-cent direct refunds where items are used on a commerical fishing vessel.

Other provisions in H.R. 2797

In addition to the eight items considered by the Finance Committee last month, the Technical Corrections bill contains 71 other amendments, not including changes that are purely clerical in nature. Detailed descriptions of these provisions are sent forth in the pamphlet prepared by the Joint Committee staff. Today, I would like to mention just a few of the most important of the provisions not yet considered on the Senate side.

Three amendments are necessary to coordinate properly the investment credit provisions contained in the Revenue Act and the Energy Act.

The Revenue Act was designed to make the investment credit permanent at a 10percent rate, rather than reverting after 1980 to a 7-percent rate as scheduled under prior law. However, the Energy Act restated the investment credit provisions of old law and was formally enacted after the Revenue Act. As a result, the Code may still technically retain a December 31, 1980 expiration date for the 10-percent credit. H.R. 2797 would clarify Congressional intent to make the 10-percent rate perma

nent.

Certain equipment may qualify for both the regular 10-percent investment credit and in additional 10-percent credit for energy property acquired after September 30, 1978 and before January 1, 1983. Under the Revenue Act, only one-half of the otherwise qualified investment is eligible for the regular investment credit where the taxpayer uses the special 5-year amortization provision for pollution control facilities and also finances the facilities with tax-exempt bonds. Congress intended also to reduce the special energy investment credit to 5 percent in the case of energy property, including certain pollution control equipment, financed by taxexempt bonds. But through interaction of the two provisions, the energy credit is effectively only 2.5 percent with respect to pollution control equipment subject to the limitations on the regular investment credit. This result was not intended, and the bill would amend the Code to provide a 5-percent energy investment credit to this property.

The Revenue Act extends the regular investment credit to certain rehabiliation expenditures attributable to buildings that are at least 20 years old. To preclude the

claiming of a double regular investment credit, the credit for rehabilitation expenditures is denied for property qualifying under other investment credit rules. As now written, the Code also prohibits a taxpayer from claiming both the energy investment credit and the regular investment credit for rehabilitation expenditures that qualify as expenditures for energy property. The bill would correct this unintended result.

Under the Revenue Act, no deduction is generally allowed for expenses incurred with respect to entertainment facilities. The Act specifically excepts "country club dues" from the new deduction disallowance rule. Congress did not intend the exception to be so restricted, and the bill would reflect the Congressional intent by deleting the word "country" from the exception for club dues.

The Revenue Act increased the capital gains deduction from 50 percent to 60 percent for individuals (so that 40 percent of individual capital gains would be subject to tax) and also reduced the alternative capital gains tax rate for corporations from 30 percent to 28 percent. H.R. 2797 contains several technical amendments to correct drafting errors and to clarify the application of these capital gains changes. Among the technical corrections are the following:

Prior to the Revenue Act, an individual in high rate bracket could elect to have the first $50,000 of capital gains taxed at a 25 percent rate in lieu of deducting onehalf of capital gains from gross income. This special "alternative tax" for individuals was repealed for taxable years beginning after December 31, 1978. Through inadvertence, the rules for calculating the alternative tax for taxable years prior to repeal were not altered to reflect the increase in the capital gains deduction from 50 percent to 60 percent. After consulting with Treasury staff and the Joint Committee staff, the Internal Revenue Service prepared its 1978 tax forms and instructions as though the conforming change were properly made, and the Technical Corrections bill would now formally correct this oversight in the Revenue Act.

The increase in the capital gains deduction for individuals was made effective for sales or exchanges after October 31, 1978. The reduced alternative capital gains rate for corporations was made effective for sales or exchanges after December 31, 1978. Left unclear was the treatment of payments received after the respective effective dates for sales or exchanges occurring before the effective dates. Under H.R. 2797, the capital gains tax reductions would apply in instances where the income is properly taken into account by the seller during a period after October 31, 1978 (in the case of individuals) or after December 31, 1978 (in the case of corporations). Another important change relates to the effective date of the targeted jobs credit. The Revenue Act was drafted to make the targeted jobs credit effective for wages paid or incurred through December 31, 1980. The statement of conference managers indicates that the expiration date is to be December 31, 1981. The statement of managers reflects the correct Congressional intent, and the Technical Corrections bill would rectify the clerical error in the Act.

Additions to H.R. 2797

Subsequent to the House adoption of H.R. 2797, numerous additions and modifications have been proposed. In consultation with the Finance Committee staff and Treasury staff, the staff of the Joint Committee on Taxation has compiled a list of those proposals that appear to fall within the proper scope of the Technical Corrections bill. A description of these items is attached to my statement. Treasury does not object to any of these items, and we support the adoption of the attached package of amendments to the bill.

S. 873 (AMERICANS ABROAD)

S. 873 would waive in certain cases the foreign residence or physical presence requirement which otherwise must be met by individuals living abroad in order to qualify for certain tax benefits. The Treasury Department does not oppose this legislation.

Present law provides a deduction for certain excess living costs incurred by individuals who have been resident in a foreign country for at least 1 taxable year or who have been physically present in a foreign country for at least 510 days in an 18-month period. Alternatively, certain individuals who live in camps and who satisfy this residence test or physical presence test may elect to exclude a limited amount of income earned abroad.

In the case of individuals who are required to leave a foreign country because of war or civil unrest before qualifying for the deduction or exclusion, subsection (a) of S. 873 would give the Secretary of the Treasury, after consultation with the Secretary of State, the authority to waive the residence or physical presence requirement if the individual establishes that he could reasonably have been expected to have