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Explanation of provision

This provision was sponsored by Senator Packwood. The provision permits a gift tax exclusion for the value, to the extent attributable to employer contributions, or any interest of a spouse in specified employee contracts, or true or plan payments, where two conditions exist. First, an employer must have made contributions or payments on behalf of an employee (or former employee) under an employee's pension, stock bonus, or profit-sharing plan, or trust which is qualified as an exempt plan for tax purposes (under section 401(a)), an employee's qualified retirement annuity contract (covered under a plan described in section 403 (a)), or a retirement annuity contract. purchased for an employee by an employer which is an educational organization (referred to in sec. 170(b)(1)(A)(ii)) or a publicly supported educational, charitable, or religious organization (referred to in sec. 170(b) (1) (A) (vi)). Second, the amount involved must not be considered as being attributable to contributions made by the employee. Where these two conditions exist, the value of the nonemployee's interest would be excluded from taxable gifts to the extent the value of that interest is attributable to the conditions of the employer and to the extent the spouse's interest arises solely by reason of the community property laws of the State.

This provision will have the effect of equating the gift tax treatment in a comunity property State with that resulting upon the death of an employee. The provision would also provide uniformity of treatment in common law and community property States. The amount of benefits payable to other beneficiaries which are attributable to the nonemployeee spouse's community interest in the value of the employer's contribution to the plan would be excluded from such spouse's taxable gifts for gift tax purposes.

This provision would not, in the case of the nonemployee spouse in the community property State, provide any exclusion for a property interest in the plan to the extent it is attributable to the contributions of the employee spouse.

Thus, the nonemployee spouse's community interest in the plan which is attributable to contributions made by the employee spouse could be subject to the gift tax, as under present law.

The provision would apply to calendar quarters beginning after December 31, 1976.

The provision would benefit participants in qualified pension and profit-sharing plans who live in community property States.

59. Outdoor Advertising Displays (sec. 2301 of the bill)

Present law

Under present law, gains from involuntary conversions of property (including casualties and condemnations) are, in general, allowed nonrecognition treatment where money realized from the involuntary conversion is reinvested, within a limited period of time, in property which is similar or related in service or use to the property converted (sec. 1033). A special rule is provided for condemnations of business or investment real estate (other than inventory property) under which more liberal rules are adopted for purposes of determining whether a purchase of replacement real estate qualifies as similar or related in service or use to the property converted (sec. 1033 (g)).

In the case of outdoor advertising billboards and displays, there is some question whether this property qualifies as real property eligible for the special replacement rules of section 1033 (g). The Internal Revenue Service has ruled that billboards are real property for purposes of the investment credit and depreciation recapture.1 However, this administrative interpretation has been successfully challenged in several court cases which hold that billboards are tangible personal property (and not real property) for purposes of the investment credit.2

Issue

Federal and State highway beautification statutes authorize the Government to condemn and purchase privately-owned highway billboards. Because of continuing restrictions on where highway billboards may be located, the former owners of condemned billboards (particularly small companies) are prevented from using their condemnation awards to build and situate replacement billboards; these taxpayers have been forced instead to reinvest their awards in other types of real property. The present uncertainties in the property classification of billboards may prevent these reinvestments from qualifying for treatment as involuntary conversion replacement property even though the condemned billboards have consistently been treated by the owners as real property.

Explanation of provision

This provision was sponsored by Senator Ribicoff. It establishes an election for taxpayers to treat outdoor advertising displays as real property. This election, once made, is irrevocable without the permission of the Secretary and it applies to all qualifying outdoor advertising displays of the taxpayer. Outdoor advertising displays do not qualify for the election where the taxpayer has previously treated the property as tangible personal property by claiming either the investment credit or additional first-year depreciation.

The provision also allows that replacement real property to be considered "like kind" property even though a taxpayer's interest in the replacement property is different from the real property interest held in a qualified outdoor advertising display which was involuntarily converted. This is to enable, for example, purchases of replacement property to qualify under section 1033(g) even though a fee simple interest in real estate is acquired to replace in part a billboard owner's leasehold interest in real property on which the billboard was located. The election under the provision may be made for purposes of classifying replacements of qualifying outdoor advertising displays in taxable years beginning after 1970.

This provision applies generally to companies which have had billboard property condemned under the Highway Beautification Act. Mr. Douglas Snarr has expressed an interest in this provision.

60. Interest on Certain Governmental Obligations for Hospital Construction (sec. 2308 of the bill)

Present law

In general, industrial development bonds are not eligible for exemption from the Federal income tax on interest income. The term indus

1 Rev. Rul. 68-62, 1968-1 C.B. 365.

2 See, e... Alabama Displays, Inc. et al. v. United States, 507 F.2d 844 (Ct. Cl. 1974); Whiteco Industries, Inc. et al. v. Commissioner, 65 T.C. No. 59 (1975).

trial development bond includes obligations from which all or a major portion of the proceeds are used in a trade or business by a person other than an exempt person. An exempt person is defined as a governmental unit or an organization described in section 501 (c) (3) and exempt from tax under section 501(a), except for unrelated trade or business activity.

Exceptions have been made for issues to finance certain facilities which possess elements of a public character and for the development costs of industrial parks. In addition, an exemption also is provided for certain small issues which do not exceed $5 million. The exempt activities of a public character include providing residential real property for families, sports facilities, convention or trade show facilities, certain freight and passenger transportation facilities, pollution control or waste disposal facilities, and certain local public utility facilities.

Public hospitals operated by governmental units may be financed with tax-exempt bonds, but private hospitals are not eligible for financing with industrial development bonds except under the small issues exemption.

Issue

The costs of constructing and equipping hospitals have increased rapidly in the past several years, and the committee was told, it is not possible now to construct a moderate-sized private hospital within the $5 million limitation. This is a matter of importance in rural areas where public hospitals have not been built.

The issue is whether there should be an exemption from the limitation under present law to permit the issue of tax-exempt bonds for private hospitals.

Explanation of provision

This provision was sponsored by Senator Bentsen.

The provision adds a special exception from the $5 million limit for small issues which will permit issues up to $20 million for a private hospital which is certified as necessary by the appropriate State health agency.

The provision is effective for obligations issued in taxable years beginning after December 31, 1976.

Revenue effect

It is estimated that this provision will decrease budget receipts by $1 million in fiscal year 1977, $3 million in fiscal year 1978, and $14 million in fiscal year 1981.

61. Group Legal Services Plans (sec. 2309 of the bill)

Present law

Prepaid group legal services plans are a recent, innovative means of providing legal services. Because of the relative novelty of these fringe benefit plans and the variety of their design, the tax treatment of the employer contributions on behalf of the employee and of the benefits received by the employee under such plans has not yet been clearly established.

However, depending on the structure of the plan, it appears that the employee will be required to include in his income either (1) his

share of the amounts contributed by his employer to the group legal services plan or (2) the value of legal services or reimbursement of expenses for legal services received under the employer-funded plan, or both. (If plans are funded with contributions which are partially taxable and partially tax-free to the employee, the employee may be required to include any benefits in income to the extent the contributions for the plan constitute amounts not previously included in the employee's income.)

Amounts contributed by the employer for an employee to a group legal services plan or the value of services or reimbursements if provided directly by the employer to the employee under a plan are deductible by the employer as ordinary and necessary business expenses, if they meet the usual standards for trade or business deductions.

Issue

The issue is whether it is necessary or appropriate to provide a tax incentive to promote prepaid legal services plans.

Explanation of provision

con

This provision was sponsored by Senator Packwood. The provision excludes from an employee's income amounts tributed by an employer to a qualified group legal services plan for employees (or their spouses or dependents) as well as any services received by an employee or any amounts paid to an employee under such a plan as reimbursement for legal services for the employee, his spouse, or his dependents. The exclusion does not apply to direct reimbursements made by the employer to the employee. There is no corresponding provision in the House bill.

In order to be a qualified plan under which employees are entitled to the tax-free benefits provided by the amendment, a group legal services plan must fulfill several requirements with regard to its provisions, the employer, and the covered employees. These requirements are designed to insure that the tax-free fringe benefits are provided on a nondiscriminatory basis with regard to contributions and benefits, as well as eligibility for enrollment, and to minimize the possibility of tax abuse through the misuse of such plans. Additional requirements include provisions for a written plan, notice to employees about benefits, contribution arrangements, IRS administration, the treatment of existing plans, and definitions and rules for partnerships and proprietorships, as well as corporations.

The provision also permits a trust created or organized in the United States, whose exclusive function is to form part of a qualified group legal services plan, to be exempt from income tax (new sec. 501 (c) (20)). Such a trust is to be subject to the rules governing organizations exempt under section 501(c), including the taxation of any unrelated business income.

Legislation excluding employer contributions and benefits provided to employees under group legal services plans has been requested by the Laborers' International Union of North America, AFL-CIO, and the National Consumer Center for Legal Services, Washington, D.C. The American Bar Association has also urged the adoption of a tax incentive for group legal services plans.

Effective date

This provision applies to taxable years beginning after December 31, 1973. Existing plans are allowed a transition period, in some cases extending through 1981, to conform to the requirements contained in this provision.

Revenue estimate

It is estimated that this provision will decrease budget receipts by $5 million for fiscal year 1977, $8 million for fiscal year 1978, and $33 million for fiscal year 1981 (and this revenue loss will continue to increase significantly thereafter).

62. Exchange Funds (sec. 2310 of the bill)

Present law

An exchange fund is an investment entity through which large numbers of investors pool stocks or debt securities which usually are highly appreciated in exchange for shares of the fund. These arrangements allow investors to diversify their concentrated ownership of one or a few securities into a broader variety of other stocks and securities (usually publicly-traded interests in listed companies) without paying taxes on the appreciation they have realized, in effect, at the time the different stock interests are exchanged for each other. Present law does not permit tax-free formation of an exchange fund as a corporation where the result is a diversification of the investor's portfolio. This restriction was added in 1966 after a period in the early 1960's when investment management firms publicly solicited individuals owning highly appreciated stocks or securities to pool their stocks tax-free in a newly formed corporation which would then manage the combined portfolio.

The 1966 legislation dealt only with swap funds in corporate form and did not deal with partnerships because at that time such funds could not operate in partnership form. Recently, however, a number of public syndications have been organized to sell exchange funds as partnership interests. In April, 1975, the Internal Revenue Service granted a private ruling to one fund which proposed to operate as a limited partnership, allowing investors to transfer appreciated stocks or securities to the fund without a current tax to the investor-limited partners. This ruling prompted the formation of other similar partnerships, including some which proposed to offer interests to investors privately (rather than by broad public solicitation). Several of these funds presently have ruling requests pending with the Service.

Issue

One tax issue raised by the appearance of exchange funds in partnership form is whether a tax-free diversification of stock investments should be permitted through use of the partnership form when the same result cannot be achieved, under present law, through a corporation or through a direct exchange of portfolio stocks for other similar stocks.

Another issue is whether the tax advantages of an exchange fund (namely, no tax to the investor on his appreciation at the time his stock is pooled with others and taxfree diversification of his invest

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