INTRODUCTION

The Senate Committee on Finance has scheduled a public hearing on May 17, 1989, on tax bills relating to (1) educational savings bonds (S. 353, Senators Exon, Shelby, DeConcini, Harkin, and Lieberman); (2) value added tax (S. 442, Senator Hollings); (3) estate freezes (S. 659, Senator Symms, S. 838, Senator Heflin, and S. 849, Senators Daschle, Heflin, Boren, and Symms); and (4) moratorium on certain State tax laws (S. 800, Senators Bradley, Lautenberg, Dodd, and Lieberman).

Part I of the pamphlet 1 is a summary of the bills. Parts II-V provides a description of the bills, including present law and effective dates. Part II describes S. 353; Part III describes S. 442; Part IV describes S. 659, S. 838, and S. 849; and Part V describes S. 800.

1 This pamphlet may be cited as follows: Joint Committee on Taxation, Description of Tax Bills: S. 353 (Educational Savings Bonds), S. 442 (Value Added Tax), S. 659, S. 838, S. 849 (Estate Freezes); and S. 800 (Moratorium on Certain State Tax Laws (JCS-11-89), May 11, 1989.

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I. SUMMARY OF THE BILLS

S. 353: Educational Savings Bonds (Senator Exon and Others) Interest income earned on a qualified U.S. Series EE savings bond issued after December 31, 1989, is excludible from gross income, if the proceeds of the bond upon redemption do not exceed qualified higher education expenses paid by the taxpayer during the taxable year. The exclusion is available only to taxpayers age 24 years or more at the time of bond purchase. "Qualified higher education expenses" are limited to tuition and required fees paid for the attendance of the taxpayer, the taxpayer's spouse, or a dependent of the taxpayer at an eligible institution.

S. 353 (introduced by Senators Exon, Shelby, DeConcini, Harkin, and Lieberman) would allow the exclusion of U.S. savings bond interest when the taxpayer pays tuition and required fees of any individual at an eligible educational institution. The bill no longer would limit the provision to payments of qualified expenses for the taxpayer or the spouse or dependents of the taxpayer.

S. 442: Value Added Tax (Senator Hollings)

S. 442 (introduced by Senator Hollings) would amend the Internal Revenue Code to impose a 5-percent value tax (VAT), effective for transactions occurring after December 31, 1989. The bill would provide a trust fund in the Department of the Treasury restricting the use of the revenue from the VAT to deficit and debt reduction. S. 659 (Senator Symms), S. 838 (Senator Heflin), and S. 849 (Senators Daschle, Heflin, Boren, and Symms)

Estate Tax Inclusion Related to Valuation Freezes

Under the Omnibus Budget Reconciliation Act of 1987, the value of certain property transferred pursuant to a valuation freeze is includible in the decedent's gross estate. The bills (S. 659, S. 838, and S. 849) would repeal this treatment retroactively from OBRA's enactment (i.e., property transferred after December 17, 1987).

S. 800: Moratorium on Certain State Tax Laws (Senator Bradley and Others)

New York State recently adopted legislation that requires nonresidents to pay income tax on their New York-source income based on the tax bracket they would be in if all of their income were New York-source. Prior to the legislation, nonresidents' tax brackets were determined solely by reference to their New Yorksource income.

S. 800 (introduced by Senators Bradley, Lautenberg, Dodd and Lieberman) would temporarily suspend the effect of this law and

any State legislation enacted in response to the New York law. In addition, the bill would establish a commission to study all such legislation.

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II. DESCRIPTION OF S. 353: EDUCATIONAL SAVINGS BONDS

Present Law and Background

Section 135 was added to the Internal Revenue Code by the Technical and Miscellaneous Revenue Act of 1988. This section provides that interest income earned on a qualified U.S. Series EE savings bond issued after December 31, 1989, is excludible from gross income, if the proceeds of the bond upon redemption do not exceed qualified higher education expenses paid by the taxpayer during the taxable year.2

The exclusion from gross income of interest on U.S. Series EE savings bonds is available only to taxpayers who are issued such bonds after having attained age 24.3 During the year the bond is redeemed, the taxpayer to whom such bond was issued must pay "qualified higher education expenses," meaning tuition and required fees for the enrollment or attendance of the taxpayer, the taxpayer's spouse, or a dependent of the taxpayer at an eligible educational institution. A taxpayer cannot qualify for the interest exclusion by paying for the education expenses of another person (such as a grandchild or other relative) who is not a dependent of the taxpayer.5

The exclusion provided by section 135 is phased out for certain upper-income taxpayers. A taxpayer's AGI for the year the bond is redeemed (not the year the bond was issued) determines whether or not the phaseout applies. For taxpayers filing a joint return, the phaseout range is for AGI between $60,000 and $90,000. For single taxpayers and heads of households, the phaseout range is for AGI between $40,000 and $55,000.7 The phaseout rate for the exclusion

2 If the aggregate redemption amount (i.e., principal plus interest) of all Series EE bonds redeemed by the taxpayer during the taxable year exceeds the qualified education expenses, then the amount of excludible interest is determined by multiplying the total interest received by a fraction, the numerator of which is the amount of qualified education expenses and the denominator of which is the sum of principal and interest on all Series EE bonds redeemed by the taxpayer during the taxable year (sec. 135(b)(1)).

3 Section 135(c)(1)(B). The exclusion will not be allowed if bonds are purchased by a parent (or other relative) and put in the name of a child or other dependent who is under the age of 24 at the time of purchase.

4 Eligible educational institutions are defined in section 1201(a) and 481(a)(1) (C) and (D) (i.e., nursing schools) of the Higher Education Act of 1965, as in effect on October 21, 1988, and in the Carl D. Perkins Vocational Education Act (subparagraph (C) or (D) of sec. 521(3)), as in effect on October 21, 1988. An eligible educational institution does not include proprietary institutions. "Qualified higher education expenses" do not include expenses with respect to any course or other education involving sports, games, or hobbies other than as part of a degree program (sec. 135(c)(2)(B)).

5 For purposes of section 135, a "dependent" is any person as to whom the taxpayer is allowed a personal exemption deduction under section 151.

6 Married taxpayers (within the meaning of sec. 7703) who file separate returns are not eligible for the exclusion under section 135 (sec. 135(d)(2)).

7 Section 135(b)(2). The phaseout ranges will be adjusted for inflation beginning in 1990. Such adjustments will be rounded to the nearest $50.

is applied gradually over the income phaseout range, as is the case with other income phaseouts provided for by the Code.8

Generally, all Series EE savings bonds can be purchased through payroll savings plans, at most commercial banks, at many savings and loan associations, and at other qualified financial institutions. Such bonds can be purchased in various denominations, ranging from $50 to $10,000. The purchase price is one-half the denomination (or face value) of the bond. In any one year, a person may purchase Series EE savings bonds with denominations (or face value) totalling up to $30,000. The interest rate on Series EE savings bonds varies, depending on how long the bonds are held. The interest rate on such bonds held for more than five years is based on the market rate for Treasury outstanding obligations with five years to maturity. Bonds held for less than five years earn interest on a fixed, graduated scale. Interest earned on Series EE savings bonds is paid when the bonds are redeemed.9

Explanation of the Bill

S. 353, introduced by Senators Exon, Shelby, DeConcini, Harkin, and Lieberman on February 7, 1989, would amend the term "qualified higher education expenses" under section 135 to include tuition and required fees paid by a taxpayer for the enrollment or attendance of any individual at an eligible educational institution.

Thus, under S. 353, if a person (who is at least 24 years old) purchases a Series EE savings bond after December 31, 1989, interest earned on that bond would not be subject to Federal income tax if, during the year the bond is redeemed, the purchaser pays for qualified education expenses of any individual (e.g., a relative who is not a dependent of the purchaser), provided that such education expenses paid by the purchaser exceed the proceeds (principal and interest) received upon redemption of the bond and the purchaser's AGI for the year of the redemption is below the phaseout range provided for by section 135(b)(2).io

Effective Date

The bill would apply to U.S. Series EE savings bonds issued after December 31, 1989.

8 For example, if taxpayer filing a joint return has a AGI of $75,000, then the interest exclusion otherwise provided for by section 135 would be reduced by one-half (($75,000-$60,000)/ $30,000).

9 See Congressional Research Service, Saving for College with Education Savings Bonds, March 22, 1989, pp. 3-6.

10 In contrast, present-law section 135 provides that interest on Series EE savings bonds is excludible from income only if, during the year the bond is redeemed, the person to whom the bond is issued pays tuition or required fees for his or her own education, or for the education of a spouse or dependent. Under current law, a taxpayer who pays for education expenses of another individual who is not a spouse or dependent would not be eligible for the interest exclusion provided for by section 135.