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(2) a tax-exempt organization which is organized primarily to conduct scientific research, which is described in section 501(c)(3), and which is not a private foundation; or

(3) an organization which is organized primarily to promote scientific research or scientific education by qualified organizations, which expends on a current basis substantially all its funds through grants and contracts for basic research or scientific education by a qualified organization, and which is described in either section 501(c)(3) or section 501(c)(6).

Special limitation

Corporate expenditures for scientific education would be eligible for the section 44F credit only to the extent exceeding the average of all charitable contributions made by the taxpayer to colleges and universities during the three preceding taxable years, excluding such contributions which were designated by the taxpayer for scientific education use (as defined for purposes of the credit, as would be amended by the bill).

Exclusion of payments from base period determinations

Under S. 1194, corporate expenditures for either basic research or scientific education which were included in the section 44F credit computation in a prior taxable year would be excluded, in calculating incremental expenditures in the taxable year, from the amount of base period expenditures for that prior year. Thus, as long as the taxpayer did not decrease the amount of its other expenditures qualifying under section 44F, the 25-percent credit would apply to 65 percent of all the taxpayer's qualifying basic research and qualifying scientific education expenditures in the current year (determined after application of the special limitation described above), whether the taxpayer had increased or decreased its basic research or scientific education expenditures in comparison with prior years.

For example, assume that the taxpayer's average in-house research expenditures in the base period are $1 million, and that in the current year the taxpayer again spends $1 million on in-house research wages and supplies plus $100,000 as a grant to a university for basic research and salary support in engineering. Under the bill, the taxpayer's qualifying current-year expenditures would be $1,065,000, and the credit would apply to the $65,000 excess over the base period average.

Assume in the second year that the taxpayer again spends $1 million on in-house research plus $80,000 on university basic research and faculty salary support, so that its qualified research expenditures for that year total $1,052,000. (The example assumes that the special limitation is not triggered.) The base period average would remain $1 million, since under the bill none of the university grants in the prior year would enter into the base period determination. Thus, the 25-percent credit would apply to $52,000 (i.e., 65 percent of the current-year expenditures for university basic research and faculty salary support).

Effective date

The provisions of section 3 of S. 1194 would apply to taxable years beginning after the date of enactment.

Explanation of Section 3, S. 1195 Expenditures for faculty wages and student loans

In general

Under section 3 of the bill, the category of corporate expenditures eligible for a 25 percent credit under Code section 44F would be expanded to include 65 percent of amounts paid or incurred 30 by a corporation31 to a qualified educational organization, pursuant to written agreement, for scientific education uses. The latter term would mean the education of students or faculty in engineering or engineering technologies, the physical, biological, and computer sciences or technologies, mathematics, and electronic and automated medical, industrial, and agricultural equipment and instrumentation operation.

To qualify as scientific education expenditures, the amounts would have to be used by the educational institution for payment of wages to faculty employees who are directly engaged in providing scientific education, or for funding scholarships or loans for students at the institution who possess a bachelor's degree or its equivalent and who are engaged in postgraduate study in mathematics, computer science and applications, engineering, or the physical or biological sciences. In addition, amounts to be used for wages would have to be paid to the educational institution pursuant to a written agreement which obligates the taxpayer to render a like amount to the recipient for at least three consecutive years. Eligible recipients for credit purposes

S. 1195 would define qualified organizations for certain section 44F purposes to mean

(1) an educational organization (as described in section 170(b)(1)(A)(ii)32 which is an institution of higher education (as defined in sec. 3304(f));33

(2) an area vocational education school (as defined in P.L. 94482):34

(3) an organization which is organized primarily to conduct scientific research, which is described in section 501(c)(3), and which is not a private foundation; or

(4) an organization which is organized primarily to promote scientific research or scientific education by qualified organizations, which expends on a current basis substantially all its funds through grants and contracts for basic research or scientific education by a qualified organization, and which is described in either section 501(c)(3) or section 501(c)(6).

30 The bill would repeal the contract research prepayment rule of present law (see note 24, supra).

31 See note 7, supra.

32 See note 4, supra. 33 See note 9, supra.

Exclusion of payments from base period determinations

Under S. 1195, corporate expenditures for either basic research or scientific education which were included in the section 44F credit computation in a prior taxable year would be excluded, in calculating incremental expenditures in the taxable year, from the amount of base period expenditures for that prior year. Thus, as long as the taxpayer did not decrease the amount of its other expenditures qualifying under section 44F, the 25 percent credit would apply to 65 percent of all the taxpayer's qualifying basic research and scientific education expenditures in the current year, whether the taxpayer had increased or decreased its basic research or scientific education expenditures in comparison with prior years. For example, assume that the taxpayer's average in-house research expenditures in the base period are $1 million, and that in the current year the taxpayer again spends $1 million on in-house research wages and supplies plus $100,000 as a grant to a university for basic research and salary support in engineering. Under the bill, the taxpayer's qualifying current-year expenditures would be $1,065,000, and the credit would apply to the $65,000 excess over the base period average.

Assume in the second year that the taxpayer again spends $1 million on in-house research plus $80,000 on university basic research and faculty salary support, so that its qualified research expenditures for that year total $1,052,000. The base period average would remain $1 million, since under the bill none of the university grants in the prior year would enter into the base period determination. Thus, the 25-percent credit would apply to $52,000 (i.e., 65 percent of the current-year expenditures for university basic research and faculty salary support).

Effective date

The provisions of section 3 of S. 1195 would apply to taxable years beginning after the date of enactment.

c. Tax Treatment of Payments and Loan Forgiveness Received by Certain Graduate Science Students

Present Law

In general

Subject to several limitations, gross income does not include amounts received as a scholarship at an educational institution or as a fellowship grant (Code sec. 117). In general, a degree candidate may exclude the entire amount of the scholarship or fellowship grant, except for any portion which is regarded as payment for services in the nature of part-time employment. An individual who is not a candidate for a degree is limited to an exclusion of $300 per month for a period of 36 months.

Future services as compensation

In general, scholarships or fellowship grants are not excludable from gross income if they constitute compensation for past, present, or future employment services or for services subject to the direction or supervision of the grantor, or if the funded studies or research are primarily for the benefit of the grantor (Treas. Regs. sec. 1.117-4(c)). However, amounts received under Federal programs that are used for qualified tuition and related expenses are not disqualified from the exclusion merely because the recipient agrees to perform future services as a Federal employee or in a health manpower shortage area (sec. 117(c)).

In 1977, the Internal Revenue Service ruled that awards made under the provisions of the National Research Service Awards Act to individuals who, in return for receiving the awards, must subsequently engage in health research or teaching or some equivalent service (and must allow the government to make royalty-free use of any copyrighted materials produced as a result of the research) are not excludable as scholarships or fellowship grants (Rev. Rul. 77319, 1977-2 C.B. 48). However, this ruling was overturned by the Revenue Act of 1978 for awards made during calendar years 19741979, and by subsequent legislation for awards made through 1983. Income from debt cancellation

As a general rule, income is realized when indebtedness is forgiven or cancelled (sec. 61(a)(12)). In the case of discharge when the taxpayer is in bankruptcy or is insolvent or the discharge of qualified business indebtedness, the discharge amount instead may be applied to reduce tax attributes of the debtor (secs. 108, 1017).

The Tax Reform Act of 1976 provided a special income exclusion rule for cancellation of certain student loans. The exclusion under that rule applied to debt discharges (prior to 1979) pursuant to a loan agreement under which the indebtedness would be discharged

if the individual worked for a period of time in specified professions in certain geographical areas or for certain classes of employers. This rule applied to student loans made to an individual to assist in attending an educational institution only if the loan was made by a government unit or agency. The rule was extended by the Revenue Act of 1978 to such discharges occurring through 1982.

Explanation of Section 4, S. 1194 and Section 4, S. 1195

In general

The bills would provide a new Code section under which gross income would not include amounts received by certain graduate science students as a scholarship, fellowship grant, or qualified student loan forgiveness. The exclusion generally also would extend to amounts received to cover expenses for travel, research, clerical help, or equipment incidental to the scholarship or fellowship grant, so long as such amounts are expended by the recipient, and to the value of contributed services and accommodations.

Qualified recipients

Under the bills, the new provision would apply to students having a bachelor's degree or its equivalent who are engaged in postgraduate study as a degree candidate in mathematics, engineering, the physical or biological sciences, or certain computer fields 35 at qualified educational organizations. The latter term would mean an educational institution that is described in section 170(b)(1)(A)(ii), 36 admits as regular students only individuals having a certificate of graduation from a high school (or the recognized equivalent of such certificate), is legally authorized to provide an educational program beyond high school, and provides an educational program for which it awards a bachelor's or higher degree. Qualified student loan forgiveness would be defined as forgiveness of a loan received by such science students for the purpose of financing their postgraduate study in certain specified fields (but only to the extent that the loan was actually expended for such postgraduate study), where the student is required to perform teaching services for a qualified educational organization on completion of the postgraduate course of study, under the terms of a written loan agreement and as a condition of receiving loan forgiveness.

Limitations on exclusion

The exclusion from gross income under the bills would not extend to amounts received as payment for teaching, research, or other services as part-time employment required as a condition to receiving the scholarship, fellowship grant, or qualified student loan. However, teaching, research, or other services would not be regarded as part-time employment if such activities are required of all candidates (whether or not recipients of funds) for a particular degree as a condition to receiving the degree.

35 In S. 1194, computer science; in S. 1195, computer science and applications. 36 See note 4, supra.

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