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ment assets) should be available through other forms, such as a trust, common trust fund, or a corporate reorganization.

Explanation of provisions

The House, on May 3, 1976, passed H.R. 11920 which deals with the tax treatment of partnership exchange funds and mergers of certain investment companies (generally mergers of personal holding companies with mutual funds), where a taxpayer's principal interest is to diversify his investments without current payment of any tax. In general, the House bill conforms the partnership tax rules to those for corporations in the case of exchange funds and, as a result, makes taxable the transfer of appreciated stocks or securities (as well as other property) to a partnership if, as a result, the transferor' investment interests are diversified.

Senator Bentsen sponsored the addition of the House-passed bill (H.R. 11920) to the Tax Reform Bill. Senator Talmadge sponsored the extension of the transitional rule in the House-passed bill from February 17, 1976, to March 26, 1976, the day before the House Committee on Ways and Means held hearings on the bill. Partnership exchange funds

The committee amendment adopts the House-passed bill to treat the original exchange of appreciated stocks for shares of a swap fund as a taxable sale or exchange with other investors made through the fund. Thus, the committee amendment is essentially the same as the provisions of H.R. 11920, with certain modifications. Family partnerships.—The provision adds an exception to the partnership rules of H.R. 11920, as passed by the House, for certain family partnerships. This was a suggestion made by the staff. Where stocks (or other property) are pooled within a single family group, the basic problems against which the partnership rules in the provision are directed give less reason for concern. The provision accordingly provides that property can continue to be transferred to a partnership tax free (in exchange for an interest in the partnership) if certain requirements are met. Thus, under this rule a family group may share the income from a pool of stocks so long as each contributing partner in effect bears the tax on the built-in gain which existed at the time he contributed that property to the folio.

Effective date. The provisions for partnership exchange funds apply generally to transfers made to a partnership after February 17, 1976.

The House bill added "grandfather" rules for certain funds under which the general effective date would not apply to completed transfers of property to a partnership after February 17, 1976, if several conditions are satisfied. First, the partnership must have filed for (or received) a private ruling from the Internal Revenue Service on or before February 17, 1976, relating to its character as an exchange fund. Second, the partnership must have filed a registration statement (if required by the securities laws to do so) with the Securities and Exchange Commission on or before February 17, 1976.1

1 This second requirement would not apply in the case of partnerships which plan to make a private offering within the meaning of the securities laws or which otherwise are not required to file a registration statement with the SEC.

The provision covers also several other exchange funds which had taken significant steps toward being formed before the February 17 date contained in the House bill, but, at that time, had not filed a tax ruling request or a registration statement with the Securities and Exchange Commission. The committee was informed that the reason was that there was a great deal of uncertainty over the status of the law, and informal contacts with Internal Revenue Service personnel indicated that the rulings would not be acted on until the Service's position in this area was clarified. As a result, these funds did not file their ruling requests or registration statements by February 17, 1976, although they had expended considerable sums of money and time in preparing for the organization of their fund, having been aware of the previous private ruling issued to the Vance Sanders Fund. The provision extends the date provided in the House bill until the time the House Committee on Ways and Means held hearings on its bill. Accordingly, the provision extends the cutoff date under the grandfather rules to March 26, 1976. In addition, in lieu of the dual conditions for grandfather treatment, the committee amendment imposes conditions in the alternative, so that a fund can qualify for grandfather treatment if it either filed a ruling request with the Service or a registration statement with the Securities and Exchange Commission before March 27, 1976.

The transitional provision provided in the House bill covers the following partnership exchange funds: Vance Sanders, State Street, Fidelity, American General, and Boston Company Exchange Associates. The extension of the transitional date from February 17, 1976, to March 26, 1976, covers the following additional exchange funds: Chestnut Street and Equity.


In order to cover the possible use in the future of trusts as exchange funds, the provision also adds a specific rule to the Code that gain (but not loss) will be recognized to the transferor on a transfer of property to a trust in exchange for an interest in other trust property where the trust would be an "investment company" (within the meaning of sec. 351) if the trust were a corporation. This is the same as the House bill.

Common trust funds

To cover the possible use of a bank's common trust fund as an exchange fund, the amendment provides that the admission of a participant to a common trust fund is to be considered to be the purchase of, or an exchange for, the participating interest in the fund. As a result, gain or loss will be realized by the participant on any transfer of property to the common trust fund. This is the same as the House bill.

Mergers of taro or more investment companies

The provision adds an exception to the definition of a taxfree "reorganization" in present law in order to require recognition of gain or loss on exchanges which, from an investor's standpoint, resemble the formation of an exchange fund. This exception is provided in specific terms in order not to change the application of the reorganization rules to transactions other than those which enable investors to obtain the primary advantages of an exchange fund. This is the same as the House bill.

Revenue effect

It is estimated that these provisions will increase budget receipts by less than $5 million in fiscal years 1977 and 1978 and increase budget receipts by $12 million in fiscal year 1981.

63. Special Credit for Wind-Related Energy Equipment (sec.. 2505 of the bill)

Present law

Under present law, no special tax credit or deduction is allowed for wind-related energy equipment (such as a traditional windmill) installed with respect to a residence.

However, a 10-percent investment credit is permitted for the capital costs of several types of business machinery, equipment, and facilities used in a trade or business or held for the production of income. As a facility used as an integral part of the production of electrical energy, wind-related energy equipment used to generate electricity may be entitled to the investment credit of present law (sec. 48 (a) (1) (B)(i)), unless it is a structural component of a building.


The issue is whether a tax credit should be provided for the installation of wind-related energy equipment to provide energy for certain residential and commercial uses.

Explanation of provision

This provision was sponsored by Senator Hathaway.

The provision establishes a refundable income tax credit for windrelated energy equipment installed on or adjacent to a residence. Like the solar and geothermal equipment credits, the credit for wind-related energy equipment is 40 percent of the first $1,000 of qualified expenditures, plus 25 percent of the next $6,400 (a maximum credit of $2,000). To qualify, both the equipment and its installation must be paid for by the individual (or individuals) using the edifice as a residence. Thus, the owner or a tenant may qualify, but a builder or developer adding the wind-related equipment to a house he does not intend to use as his residence would not qualify for this credit (although he might qualify for the investment credit given under this amendment for wind-related energy equipment installed for commercial or industrial purposes). This tax credit is to be allowed only for installations and expenditures made, or, in the case of an accrual basis taxpayer, incurred, through 1980. Before that time, the committee will review the credit to see whether it should be continued after 1980. Also, both the installation and the expenditure must occur after June 30, 1976. The credit is for both the expenditures for wind-related equipment itself and also for expenditures for its installation.

The wind-related energy equipment for which the credit may be claimed is that which uses wind-related energy to generate electricity to heat or cool a residence (or residences) or to provide hot water for use inside it, and (1) which meets such standards or criteria for performance as the Secretary of Housing and Urban Development may prescribe, (2) the original use of which commences with the taxpayer, and (3) which has a useful life of at least three years.

The wind-related energy equipment credit is a refundable credit. As a result, a taxpayer whose tax liability is less than the amount of the

credit would receive a refund of the difference, while the amount of his credit that equals the amount of his tax liability would be available to eliminate that liability.

The Committee amendment extends the investment credit (at an increased rate for a limited period of time) to wind-related energy equipment (such as windmills) installed for use in the trade or business of producing electricity or to generate electricity for use in a trade or business. The amount of the credit is to be 20 percent of the qualified wind-related energy equipment installation investment after May 25, 1976, and before January 1, 1982. After that time, the credit is reduced to 10 percent for this type of investment through 1986. Both the 20-percent and the 10-percent credits apply to the costs of the windrelated energy equipment itself, as well as the costs of its installation. This provision will benefit purchasers and manufacturers of windmills. Researchers at the University of Maine, among others, have expressed interest in it.

64. Income Earned Abroad by U.S. Citizens Living or Residing Abroad (sec. 2503 of the bill)

Present law and committee amendment

U.S. citizens who are working abroad may exclude (under section 911) income up to $20,000 of earned income for periods during which they are present in a foreign country for 17 out of 18 months, or during the period they are bona fide residents of foreign countries. In the case of individuals who have been bona fide residents of foreign countries for three years or more, the exclusion is increased to $25,000 of earned income.

The provision retains the exclusion for certain earned income of individuals abroad but makes three modifications in the computation of the exclusion. First, it provides, as did the House bill, that any individual entitled to the earned income exclusion is not to be allowed a foreign tax credit with respect to foreign taxes allocable to the amounts that are excluded from gross income under the earned income exclusion. Thus, foreign income taxes that are paid on excluded amounts are not to be creditable or deductible.

Second, it provides that any additional income derived by individuals beyond the income eligible for the earned income exclusion is subject to U.S. tax at the higher rate brackets which would apply if the excluded earned income were not so excluded. For the purpose of determining the rate brackets applicable to the nonexcluded income, the taxpayer is entitled to subtract those deductions which would be otherwise disallowed by reason of being allocable to the excluded earned income.

Since earned income is now subject to an exclusion with the other income being taxed at the higher brackets; any foreign tax credits disallowed by reason of being allocable to the excluded earned income are to be considered as those taxes paid on the first $20,000 or $25,000 of excluded income. For this purpose, the same rate of progressiveness is to be assumed on the foreign taxes as is the case for the U.S. taxes. Third, the amendment makes ineligible for the exclusion any income. earned abroad which is received outside of the country in which earned if one of the purposes of receiving such income outside of the country is to avoid tax in that country. The tax avoidance purpose does not have

to be the only purpose for receiving the money outside of the country in which earned, nor does it have to be the principal reason for receiving the money outside of that country.


Under the committee amendment, individuals who derive earned income in a foreign country which is taxed by that foreign country under a progressive rate system which is higher than the progressive rate system in the United States have excess foreign tax credits on their excluded earned income. These individuals are better off without the earned income exclusion, since they would then be able to use their excess credits against other foreign source income which they may derive. The issue is whether these individuals should be entitled to an election not to apply any earned income exclusion.

Explanation of provision

This provision was sponsored by Senator Fannin. The provision allows an individual to elect (in such manner and time as the Secretary of the Treasury prescribes) not to have the earned income exclusion apply. If an individual makes the election for a taxable year, the election is binding for all subsequent taxable years and may not be revoked except with the consent of the Secretary. This provision will benefit the Paris office of the law firm of Surrey, Karasik and Morse and members of the National Constructors Association.

65. Level Premium Annuity Contracts Held by H.R. 10 Plans (sec. 2508 of the bill)

Present law

Under present law, if an owner-employee1 is covered by a taxqualified plan (an "H.R. 10 plan"), the employer is not permitted to contribute to the plan more than $7,500 or 15 percent (whichever is less) of the owner-employee's earned income (secs. 401 (d) (5) and 404 (e)). If the plan is funded with level premium annuity contracts,. under which a fixed premium of $7,500 or less is paid without regard to the owner-employee's earnings, present law dealing specifically with H.R. 10 plans (1) permits contributions to be made to the plan in an amount sufficient to pay the premiums on the contract (subject to the requirement that the premium not exceed the owner-employee's average deductible amounts for a 3-year period), but (2) does not allow a deduction for amounts contributed for the owner-employee in excess of 15 percent of his earned income (secs. 401 (d) (5), 401 (e), and 404 (e)). However, under a separate provision which provides overall limitations on contributions to all qualified plans (sec. 415), the contributions on behalf of an owner-employee cannot exceed 25 percent of his earned income. (That provision is modified, in the case of certain lower-income owner-employees, by another provision in this bill-sec. 1503 of the bill as reported by the committee, the so called "jockeys amendment".)

1 An owner-employee is an employee who owns the entire interest in an unincorporated trade or business or, in the case of a partnership, is a partner who owns more than 10 percent of either the capital interest or the profits interest in that partnership (sec. 401 (c) (3)).

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