I. Report on the Return-Free System (Sec. 1591 of the Act)70

Prior Law

Taxpayers are generally required to file a paper document as their individual income tax return for the taxable year. These forms are currently the Form 1040 ("the long form"), the Form 1040A ("the short form"), and the recently created Form 1040EZ. In addition, the IRS is experimenting with magnetic tape return filing that allows approved return preparers to volunteer to file individual tax returns that they prepare with the IRS in a magnetic tape format. The return preparer retains the paper version of the tax return.

Reasons for Change

The ever-increasing paperwork burden on the Internal Revenue Service, the improved capabilities of computerized data processing, and expanded information reporting suggest that it may be possible to develop a return-free system for individuals. This system would relieve eligible taxpayers of most of the burden and expense of return preparation. Also, it would significantly reduce the volume of tax returns filed with the IRS. Consequently, Congress believed that it is appropriate to study the possibility of implementing the return-free system, which was first proposed in the President's tax reform proposal.

Explanation of Provision

The Act requires a report from the IRS setting forth:

(1) the identification of classes of individuals who would be permitted to use a return-free system;

(2) how such a system would be phased in;

(3) what additional resources the IRS would need to carry out such a system; and

(4) the types of changes to the Internal Revenue Code that would inhibit or enhance the use of such a system.

The report is to be submitted within 6 months of the date of enactment to the Senate Committee on Finance and the House Committee on Ways and Means.

In addition, the IRS is to consider conducting an in-house feasi bility test using previously filed information returns and individual income tax returns to test the practicality of the proposed system. A number of provisions of this Act provide that the Secretary of the Treasury or his delegate is to prescribe regulations. Notwith

70 For legislative background of the provision, see: H.R. 3838, as reported by the House Committee on Ways and Means on December 7, 1985, sec. 1345; H.Rep. 99-426, pp. 859-860; H.R. 3838, as reported by the Senate Committee on Finance on May 29, 1986, sec. 563; S.Rep. 99-313, pp. 217-218; and H. Rep. 99-841, Vol. II (September 18, 1986), p. 821 (Conference Report).

standing any of these references, the Secretary may, prior to prescribing these regulations, issue guidance for taxpayers with respect to the provisions of this Act by issuing Revenue Procedures, Revenue Rulings, forms and instructions to forms, announcements, or other publications or releases.

Effective Date

The report is due 6 months after the date of enactment.

TITLE XVI-EXEMPT AND NONPROFIT ORGANIZATIONS

A. Exchanges and Rentals of Donor or Member Lists of Certain Tax-Exempt Organizations; Distribution of Low Cost Articles by Charities (Sec. 1601 of the Act and sec. 513 of the Code) 1

General rules

Prior Law

While generally exempt from Federal income tax, charitable, educational, religious, and certain other organizations described in Code section 501(a) are subject to tax on any unrelated trade or business income (secs. 511-514). Under prior and present law, the tax applies to gross income derived by an exempt organization from any unrelated trade or business regularly carried on by it, less allowable deductions directly connected with the carrying on of such trade or business, both subject to certain modifications.

An unrelated trade or business is defined as any trade or business of a tax-exempt organization the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of the charitable, educational, religious, or other nonprofit purpose and function constituting the basis for its exemption (sec. 513(a)).

Revenues from mailing lists

The U.S. Court of Claims held in 1981 that income received by the Disabled American Veterans from other exempt organizations and commercial businesses for the use of its mailing lists constituted unrelated business taxable income, and did not constitute "royalties" expressly exempted from the tax under section 512(b)(2) (Disabled American Veterans v. U.S., 650 F.2d 1178 (1981)). The court found that the DAV, in renting its donor lists, operated in a competitive, commercial manner with respect to taxable firms in the direct mail industry; that these rental activities were regularly carried on; and that the rental activities were not substantially related to accomplishment of exempt purposes (apart from the organization's need for or use of funds derived from renting the mailing lists).

Distribution of low cost articles

Treasury regulations provide that the unrelated business income tax does not apply to income from an activity that does not possess

1 For legislative background of the provision, see: H.R. 3838, as reported by the House Committee on Ways and Means on December 7, 1985, sec. 1404; H.Rep. 99-426, pp. 866-68; H.R. 3838, as reported by the Senate Committee on Finance on May 29, 1986, sec. 1702; S.Rep. 99-313, pp. 884-85; and H.Rep. 99-841, Vol. II (September 18, 1986), pp. 822-23 (Conference Report).

the characteristics of a trade or business (within the meaning of sec. 162). For example, the regulations state that the tax does not apply where an organization "sends out low cost items incidental to the solicitation of charitable contributions" (Reg. sec. 1.513-1(b)). The regulations do not define the term "low cost."

Reasons for Change

The Congress concluded that the unrelated trade or business income tax should not be imposed on income from exchanges or rentals of donor or member lists among tax-exempt organizations eligible to receive charitable contributions, and that it is appropriate to specify the circumstances under which certain distributions of low cost articles incidental to soliciting charitable contributions are not treated as unrelated trade or business activities.

Explanation of Provisions

Revenues from mailing lists

The Act provides that, in the case of any organization exempt from tax under section 501 that is eligible to receive tax-deductible charitable contributions under section 170(c)(2) or section 170(c)(3), the term unrelated trade or business does not include any trade or business of such organization that consists of exchanging names and addresses of donors to (or members of) such organization with another such tax-exempt organization, or of renting donor (or member) names and addresses to another such tax-exempt organization. No inference is intended as to whether or not revenues from mailing list activities other than those described in the provision, or from mailing list activities described in the provision but occurring prior to the effective date, constitute unrelated business income.

Distribution of low cost articles

The Act provides that, in the case of any organization exempt from tax under section 501 that is eligible to receive tax-deductible charitable contributions under section 170(c)(2) or section 170(c)(3), the term unrelated trade or business does not include activities of such organization relating to the distribution of low cost articles incidental to the solicitation of charitable contributions.

For this purpose, an article is treated as low cost if it has a cost not in excess of $5 to the organization that distributes such item (or on whose behalf such item is distributed). Beginning in 1988, this dollar limitation is adjusted for inflation as provided in the Act. If more than one item is distributed by or on behalf of an organization to a single distributee in any calendar year, the aggregate of the items so distributed in the year to such distributee is treated as one article for purposes of the dollar limitation.

A distribution of low cost articles qualifies under the Act as incidental to soliciting charitable contributions only if

(1) the distribution is not made at the request of the distributee; (2) the distribution is made without the express consent of the distributee; and

(3) the articles distributed are accompanied both by a request for a charitable contribution (as defined in sec. 170(c)) to such organization, and also by a statement that the distributee may retain the low cost article regardless of whether the distributee makes a charitable contribution to such organization.

Effective Date

These provisions apply to exchanges and rentals of mailing lists and distributions of low cost articles occurring after the date of the enactment of the Act (October 22, 1986).

Revenue Effect

These provisions are estimated to reduce fiscal year budget receipts by $4 million in 1987, $8 million in 1988, $8 million in 1989, $9 million in 1990, and $11 million in 1991.