The Act also contains two special rules (applicable to all taxpayers, whether or not corporations) in conjunction with the repeal of the special capital gains rates. First, the Act provides that income from coal and domestic iron ore royalties (under sec. 631(c)) will be eligible for percentage depletion for any taxable year in which the maximum rate of tax on net capital gain is not less than the maximum rate on ordinary income. Second, the Act provides that any election to treat the cutting of timber as a disposition under section 631(a) made for a taxable year beginning before January 1, 1987, may be revoked on a one-time basis by the taxpayer without the permission of the Secretary of the Treasury. Any revocation of an election made in accordance with this provision will not be considered in determining whether a future election under section 631(a) by the taxpayer is allowed. If a taxpayer revokes an election without consent in accordance with this provision, and thereafter makes an election under section 631(a), any future revocations will require the permission of the Secretary of the Treasury. Effective Date The provision applies to taxable years beginning after December 31, 1986, regardless of whether the sale or other transaction giving rise to the gain occurred in a prior year. Thus, so long as gain is properly taken into income under the taxpayer's method of accounting in a taxable year beginning after December 31, 1986, it is subject to the provision. A transitional rule described above also applies the provision to taxable years beginning in 1986 and ending in 1987, in the case of gain properly taken into account under the taxpayer's method of accounting on or after January 1, 1987.* The provision applies to long-term capital gains recognized on the installment method in periods subject to the new alternative tax rates, without regard to when the sale was made. Installment sale gains properly taken into account under the installment method after December 31, 1986 are thus subject to the new provisions without regard to whether the sale was made prior to that date or in a prior taxable year. In the case of a pass-through entity that is not itself liable for tax, the provisions apply to gain properly taken into account by the partner or other taxable beneficial owner after December 31, 1986. For example, a calendar year corporate partner in a partnership that has a fiscal year ending January 31, 1987 would be subject to the new provision, and would have a 34 percent alternative tax rate, with respect to such partner's share of long-term capital gain resulting from a cash sale by the partnership during the partnership's fiscal year ending January 31, 1987, regardless of whether the sale occurred prior to, or on or after, January 1, 1987. Similarly, the new provision would apply to such partner's share of any * Congress intended the application of the alternative tax to long-term capital gain to depend solely on when gain is properly taken into income under the taxpayer's method of accounting. Thus, for example, the alternative tax rates applicable to a particular item of long-term capital gain under these provisions (28 percent or 34 percent, as the case may be) determines the alternative tax on such gain. However, in determining whether such alternative tax is less than the tax otherwise payable, the otherwise applicable rules of section 15 of the Code shall apply in determining the section 11 rates in the case of a corporate taxpayer whose taxable year includes but does not begin on July 1, 1987. (See Title VI, Part A). long-term capital gain properly taken into account by the partnership on the installment method during the partnership's fiscal year ending January 31, 1987, regardless of whether the installment sale occurred in an earlier partnership fiscal year. Revenue Effect The revenue effect of this provision is included with the revenue effect for the corporate rate changes (Title VI, Part A). C. Incentive Stock Options (Sec. 321 of the Act and sec. 422A of the Code) 5 Prior Law Under present and prior law, an employee is not taxed on the grant or exercise of an incentive stock option, and the employee is generally taxed at capital gains rates when the stock received on the exercise of the option is sold. No deduction is taken by the employer when the option is granted or exercised. Under prior law, in order to qualify as an incentive stock option, among other requirements, the options must have been exercisable in the order granted, and the employer could not grant the employee such options to acquire stock with a value of more than $100,000 (increased by certain carryover amounts) in any one year. Reasons for Change The Congress wished to eliminate certain restrictions on incentive stock options so that it will be easier for employers, particularly small and relatively new companies, to use the options as a means of attracting and motivating talented employees. The rule requiring options to be exercisable only in the order granted can make incentive stock options unavailable to companies which have experienced a decline in stock prices. The Congress believed that limiting the amount of incentive stock options an employer may grant to an employee in a year unnecessarily restricts the ability of smaller companies to offer a comprehensive compensation package which it may need to offer talented employees if it is to compete with larger, more established corporations for such employees. Explanation of Provision The Act repeals the requirement that incentive stock options must be exercisable in the order granted. The Act also changes the $100,000 limit to provide that under the terms of the plan the aggregate fair market value (determined at the time the option is granted) of the stock with respect to which incentive stock options are exercisable for the first time by any individual during any calendar year may not exceed $100,000. Effective Date The provision applies to options granted after December 31, 1986. 5 For legislative background of the provision, see: H.R. 3838 as reported by the Senate Committee on Finance on May 29, 1986, sec. 411; S.Rep. 99-313, p. 171; and H.Rep. 99-841, Vol. II (September 18, 1986), p. 107 (Conference Report). Revenue Effect The provision is estimated to reduce fiscal year budget receipts for 1987 through 1991 by less than $5 million annually. D. Tax Straddles (Sec. 331 of the Act and sec. 1092 of the Code) 6 Prior Law In general, if a taxpayer realizes a loss on the disposition of one or more positions in a straddle, the amount of the loss that can be deducted is limited to the excess of the loss over the unrecognized gain (if any) in offsetting positions (sec. 1092). An exception to the loss deferral rule applies to a straddle consisting of stock that is offset by a qualified covered call. For purposes of this exception, a call option is not treated as qualified if gain from the disposition of the underlying stock is included in gross income in a taxable year subsequent to the year in which the option is closed, and the stock is not held for more than 30 days following the date on which the option is closed. This rule is intended to prevent taxpayers from using covered call options to defer tax on income from unrelated transactions (by realizing a loss on the option in one year, and deferring realizing any gain on the related stock until the next year). Reasons for Change Under prior law, the exception to the loss deferral rule for qualified covered call options applies even where the straddle is used to defer tax on income from unrelated transactions. Such deferral may occur where gain from closing the option is included in gross income in a taxable year subsequent to the year in which the stock is disposed of at a loss. The Act amends the definition of a qualified covered call to exclude a covered call option in these circumstances. Explanation of Provision Under the Act, the qualified covered call exception to the loss deferral rule is denied to a taxpayer who fails to hold a covered call option for 30 days after the related stock is disposed of at a loss, where gain on the option is included in the subsequent year. Effective Date The provision applies to positions established after December 31, 1986. Revenue Effect This provision is estimated to increase fiscal year budget receipts by less than $5 million in each of fiscal years 1987 through 1991. For legislative background of the provision, see: H.R. 3838 as reported by the Senate Committee on Finance on May 29, 1986, sec. 422; S.Rep. 99-313, pp. 172-173; and H.Rep. 99-841, Vol. II (September 18, 1986), p. 108 (Conference Report). |