ment of the penalty in the United States Tax Court, but rather must pay the entire penalty and sue for refund in the U.S. District Court or Court of Claims.

This penalty only applies where a partnership return is required to be filed. Thus, an unincorporated organization which has properly elected (under section 761 (a)) not to be treated as a partnership is not subject to these penalties since no partnership return is required to be filed by that organization.1

Extension of statute of limitations

The bill amends Code sections 6501 and 6511 to extend the period of time in which assessments of deficiencies and claims for refund of tax attributable to "partnership items" may be made. These special periods of limitation apply only to partnership items that are attributable to "federally registered partnerships" (as discussed below).

With respect to deficiencies, the bill provides generally that the Service may assess a deficiency attributable to partnership items within 4 years after the partnership return for the partnership taxable year in which the item arose is filed. If the partnership return does not properly show the name and address of the person to be assessed the deficiency, the period of assessment will not expire until 1 year after that information is provided to the Service in the manner prescribed by regulations. In the case of partnership tiering arrangements, the Committee anticipates that the regulations will provide that this notification requirement is satisfied as to any taxpayer if each "pass through" entity within the tiering arrangement (e.g., partnerships, trusts, nominees, and subchapter S corporations) through which he traces his chain of ownership properly discloses the name, address and taxpayer identification number of their respective owners. If the partnership return is filed before the date prescribed by law for filing the return (determined without regard to extensions), the date filed will be considered the due date.

With respect to credits and refunds, the bill provides generally that the taxpayer may file a claim for credit or refund of tax attributable to partnership items within 4 years after the due date (including extensions) of the partnership return for the partnership taxable year in which the item arose. If the taxpayer has entered into an

'This rule applies to an election made under either subdivision (i) or (ii) of Treasury Regulation § 1.761-2(b) 2, relating to the method of electing not to be treated as a partnership.

For example, assume a partnership tiering arrangement that consists of Partnership A (the first tier partnership) that has as partners Partnership B, a simple trust and a subchapter S corporation. Partnership B has as partners Partnership C and a regular corporation. Assume further that Partnership A properly discloses the identity of its three partners; Partnership B does not disclose the identity of any of its partners; Partnership C discloses the identity of its partners and the trust and the subchapter S corporation properly disclose their beneficiaries and stockholders, respectively. In this instance, the partners of Partnership C and the regular corporation will not have satisfied the notification requirement because the reporting of their chain of ownership to Partnership A (the partnership in which the partnership item arose) is broken at Partnership B. On the other hand, the beneficiaries of the trust and shareholders of the subchapter S corporation will have satisfied the notification requirement because the reporting of their line of ownership to Partnership A is unbroken.

agreement with the Service to extend the period of time for assessing a deficiency attributable to partnership items, a claim for credit or refund of tax attributable to partnership items may be filed within 6 months after the expiration of the extension of time for assessment.

If a taxpayer incurs a net operating loss for a taxable year, the portion of the loss that is attributable to a partnership item may be carried back on a claim for refund filed at any time up to 4 years following the due date of the partnership return for the partnership taxable year in which the item arose.

These special periods of limitation for assessments or claims for refund of taxes attributable to partnership items are in addition to, and not a replacement of, the periods of limitations provided in present law.3

Similarly, if a claim for credit or refund for any item on a return, including partnership items, could be filed under present law rules at a time later than that which is provided by the special rules for partnership items, the special rules do not preclude the filing of the claim. Federally registered partnership

The special period of limitations applies only to partnership items flowing from "federally registered partnerships." A federally registered partnership means any partnership the interests in which have been offered for sale prior to the close of the taxable year in an offering required to be registered with the Securities and Exchange Commission, or any partnership which is or has been subject to the annual reporting requirements of the Securities and Exchange Commission. A partnership may not avoid the extension of the period of limitations by failing to register or report as required by the SEC. If a partnership is excused from registration or reporting by either a statutory or a regulatory exemption of the SEC, it is not to be treated as a federally registered partnership.

With respect to any taxpayer, a partnership item is attributable to a federally registered partnership if it arose in a federally registered partnership or is taken into account by the taxpayer by reason of a chain of ownership that includes a federally registered partnership. Partnership item

In determining whether an item is a partnership item, two tests are applied. First, the item must be one that is required to be taken into account by the taxpayer, or any other entity in which the taxpayer has a direct or indirect interest, under any provision of the partnership provisions (subchapter K of chapter 1 of the Code). Second, the Secretary of the Treasury must prescribe by regulation that the item is more appropriately determined at the partnership level than at the partner level. If either of these tests is not met, the item is not a part

3 Thus, for example, if a partnership with a taxable year ending January 31, 1980 files its return by the May 15, 1980 due date, these special rules provide that the Service may assess deficiencies with respect to partnership items through May 15, 1984. However, if a partner of that partnership files his calendar year 1980 income tax return (which is the return on which he would report these partnership items) by an extended due date of June 15, 1981, the Service may assess deficiencies attributable to any item in his return, including partnership items, through June 15, 1984 under present law period of limitation rules.

nership item. In addition, other items are partnership items to the extent they are affected by a partnership item.

4

An item is considered required to be taken into account under subchapter K if, under any reasonable characterization of the item, it may affect the basis in partnership property, the distributive share or the basis in the partnership interest of any two or more partners, one of whom is the taxpayer.5

Extension by agreement

Any general partner of the partnership in which the partnership item arose, or any other person authorized by the partnership in writing, may consent to extend the 4-year period of limitation for all partners. The partnership may restrict the authority of any (or all) general partner(s) to execute such a consent by notifying the Secretary of the Treasury in writing in the manner prescribed by regulations.

Effective date

The penalty provision of this bill is effective for returns for taxable years beginning after December 31, 1978.

The statute of limitation provision of this bill is effective for items arising in partnership taxable years beginning after December 31, 1978.

Revenue effect

This provision will have no effect on budget receipts.

'For example, if a federally registered partnership has additional gross income, which results in an individual partner having additional adjusted gross income, the partner's medical deduction (under section 213) may be reduced because his 3-percent adjusted gross income floor is increased. The reduction in the medical deduction will be treated as a partnership item and the amount of the additional tax attributable to the decreased medical deduction may be assessed during the 4-year period of limitations.

5 These general rules may be illustrated with the following example. Assume that partnership A (the first tier partnership) is a federally registered partnership. It has as partners Partnership B (a non-Federally registered partnership), a simple trust, and a subchapter S corporation (collectively, the second tier partners). Each of the partners, beneficiaries or shareholders, respectively, of the second tier partners is an individual taxpayer (ultimate taxpayers). Assume further that the Service assesses a deficiency against each of the ultimate taxpayers based on a disallowance of a deduction claimed by Partnership A. The deduction claimed by Partnership A is a partnership item as to each of the ultimate taxpayers for the following reasons. The deduction is taken into account under the provisions of subchapter K in computing the gross income and deductions of the second tier partners (i.e., Partnership B, the trust and the subchapter S corporation). As such it is a partnership item of each of those entities. The item is a partnership item to the partners of Partnership B, the beneficiaries of the trust, and the shareholders of the subchapter S corporation, because the taxable income of Partnership B, the distributable net income of the trust, and the undistributed taxable income, of the subchapter S corporation, all of which are taxable to the ultimate taxpayers, are each affected by the partnership item flowing from Partnership A. Furthermore, it does not matter that the intervening partnership B is a non-Federally registered partnership because once a partnership item has arise in a federally registered partnership or passed through a federally registered partnership it retains its status as a partnership item to all subsequent tiers.

F. Business Tax Reductions and Extensions

1. Corporate rate reductions (sec. 301 of the bill and secs. 11, 12, 244(a)(2), 247(a)(2), 511(a), 527(b), 528(b), 802(a), 821, 826 (c), 852(b), 857(b), 882, 922(a)(2), 962, 1351(d), 1551, ad 1561 of the Code)

Present law

Under present law, corporate income is subject to a normal tax of 20 percent on the first $25,000 of taxable income and 22 percent on taxable income in excess of $25,000. In addition, a surtax of 26 percent is imposed on corporate taxable income in excess of $50,000. This rate structure was enacted temporarily in the Tax Reduction Act of 1975 and has been extended through the end of 1978 in subsequent legislation.

For taxable years ending after December 31, 1978, the normal tax will be 22 percent on all corporate taxable income. In addition, the 26 percent surtax will be imposed on all taxable income in excess of $25,000. Thus, for taxable years ending after December 31, 1978, corporations will pay corporate income tax of 22 percent on the first $25,000 of taxable income and 48 percent on taxable income in excess of $25,000.

Reasons for change

The committee believes that reduction of the corporate tax rates is necessary to reduce unemployment and stimulate economic growth through capital investment. In addition, the committee believes that the reduction in corporate tax rates and the application of graduated rates to corporations will encourage growth in small business and provide tax relief to those companies. Tax relief in the form of rate reductions is especially needed for small companies that are not particularly capital intensive. Of the overall corporate rate cut of $5 billion, about $1 billion goes to corporations with taxable income of less than $100,000.

Graduated corporate tax rates will also reduce the abrupt jump in tax rates under present law as taxable income increases above $50,000, under the expiring temporary provisions, and above $25,000, under the permanent provisions in present law. The tax rate increase from 22 percent to 48 percent under present law constitutes a 118-percent increase. The committee believes that this increase imposes too great a tax burden on the increment to taxable income. A gradual increase from the lowest to highest corporate income tax rate will reduce this large increase in the marginal rate on incremental income.

Moreover, application of the graduated rates to corporations should reduce the impact of the tax laws in the selection of a form of organization for operation of a small business. Under present law, corporate tax rates increase from 22 percent to 48 percent for taxable income in (79)

excess of $50,000. Reduction in the corporate tax rates and application of graduated rates to corporations would reduce the relative importance of the tax laws on this choice. As a result, nontax economic factors will receive greater emphasis in selection of the corporate, partnership or sole proprietorship form for the operation of a small business.

Explanation of provision

The committee bill repeals the present normal tax and surtax and in their place imposes a five-step tax rate structure on corporate taxable income. Under the committee bill, the following tax rate structure will be applicable after December 31, 1978:

The bill continues the special rules for the tax treatment of mutual savings banks conducting a life insurance business, insurance companies, mutual funds (regulated investment companies), and real estate investment trusts. A number of conforming amendments are made to reflect the repeal of the normal tax and surtax and imposition of a graduated tax on corporations. These rules replace the existing rules restricting multiple surtax exemptions with new rules, similar in intent, to prevent abuse of the graduated rate structure.1

Effective date

The provisions are effective for taxable years beginning after December 31, 1978.

The bill specifically applies the rules for rate changes of fiscal year corporate taxpayers (sec. 21 of the Code) to allow these corporations the benefits of the new corporate rates for that part of their 1978-1979 fiscal year which falls in 1979. Under this provision, fiscal year taxpayers are to compute their tax liability for that year both without regard to these changes and taking these changes into account. The difference in these two amounts is then to be prorated over the fiscal year, and the tax reduction is allowed to the extent of the amount falling in 1979.

1 For example, under present law, controlled groups (under section 1561) are limited to one $50,000 surtax exemption which is apportioned among the members of the group. In order to conform to the graduated rate schedules, section 1561 is changed to limit a controlled group to a total of only $25,000 of taxable income in each of the rate brackets below the 46-percent bracket. Thus, if there are three members of a controlled group and if no plan for unequal apportionment is adopted, each member will be subject to tax at a rate of 17 percent of its first $8,333 of taxable income, 20 percent of its second $8,333, 30 percent on its third $8,333, 40 percent on its fourth $8,333 and 46 percent on its taxable income in excess of $33,333.