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Explanation of Provision

The Act requires the Treasury Department to conduct a study of property and casualty company taxation issues covering several areas. One issue is the tax treatment of policyholder dividends by mutual property and casualty insurance companies, including corporate minimum tax issues and regular tax issues relating to the tax treatment of policyholder dividends of mutual property and casualty insurance companies. In addition, the study is to cover the operation and effectiveness of the provisions in the Act relating to the regular and minimum tax of property and casualty insurance companies, and is to examine whether the revenue targets projected for the provisions are met. The Treasury Department has the authority under the Act to require the furnishing of information necessary to conduct the study. The results of the study, together with recommendations, are to be submitted to the Committee on Ways and Means of the House of Representatives, the Committee on Finance of the Senate and the Joint Committee on Taxation no later than January 1, 1989, so that Congress may take such further action as is appropriate.

7. Physicians' and surgeons' mutual protection associations (sec. 1031 of the Act)37

Prior Law

In general, under prior and present law, the gross income of a mutual insurance company (other than a life insurance company) includes gross premiums and other consideration, gross investment income, and gain from the sale or other disposition of property. Prior and present law provide a special deduction for dividends and similar distributions paid to policyholders in their capacity as such. In the case of corporations, gross income does not include any contribution to capital (sec. 118). However, under prior and present law, the provisions covering the taxation of nonlife mutual insurance companies have no specific provisions regarding paid-in capital or the distribution of such capital.

Premiums for liability insurance in carrying on any trade or business generally are deductible in the year they are paid or incurred if they represent ordinary and necessary business expenses and were not capital expenditures. For example, annual premiums paid by a physician for medical malpractice insurance generally are deductible. No deduction is allowed as an expense paid or incurred during the taxable year for a contribution to capital.

Reasons for Change

Congress determined that it is appropriate to provide for the tax treatment of organizations operating before 1984 as pooled malpractice insurance associations.

37 For legislative background of the provision, see: Senate floor amendment, 132 Cong. Rec. S7956-7958 (June 19, 1986); and H.Rep. 99-841, Vol. II (September 18, 1986), pp. 371-372 (Confer ence Report).

Explanation of Provision

Contributions to a pooled malpractice insurance association are currently deductible to the extent they do not exceed the cost of a commercial insurance premium for annual coverage and are included in the association's income. Refunds of such contributions are deductible to the fund only to the extent included in the income of the recipient. The provision applies to associations operating under State law prior to January 1, 1984.

Effective Date

The provision is effective for contributions and refunds after the date of enactment (October 22, 1986).

Revenue Effect of Part C (Property and Casualty Insurance

Company Taxation)

The provisions of Part C are estimated to increase fiscal year budget receipts by $871 million in 1987, $1,454 million in 1988, $1,636 million in 1989, $1,745 million in 1990, and $1,842 million in

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TITLE XI-PENSIONS AND DEFERRED COMPENSATION; EMPLOYEE BENEFITS; EMPLOYEE STOCK OWNERSHIP PLANS (ESOPs)

A. Limitations on Treatment of Tax-Favored Savings

1. Individual retirement arrangements (IRAs) (secs. 1201-1203 of the Act and secs. 219 and 408 of the Code)1

Prior Law

IRA deduction limit

Under prior law (sec. 219), an individual who had not attained age 702 generally was entitled to deduct from gross income (within limits) the amount contributed to an individual retirement arrangement (an IRA). The limit on the deduction for a taxable year generally was the lesser of $2,000 or 100 percent of compensation (earned income, in the case of income from self-employment). Prior to the Economic Recovery Tax Act of 1981 (ERTA), deductible IRA contributions were not permitted for any taxable year if an individual, for any part of the taxable year, was an active participant in a qualified pension, profit-sharing, or stock bonus plan (sec. 401(a)), a tax-sheltered annuity program (sec. 403(b)), a qualified annuity plan (sec. 403(a)), or a governmental plan (whether or not tax qualified). Nondeductible IRA contributions were not permitted.

ERTA provided that deductible IRA contributions (within limits) could be made by all individuals, without regard to whether an individual was covered under an employer's retirement plan.

Spousal IRA deduction

Under a spousal IRA, an individual was allowed an additional deduction for contributions to an IRA for the benefit of the individual's spouse if (1) the spouse had no compensation for the year; (2) the spouse had not attained age 702; and (3) the couple filed a joint income tax return for the year. If deductible contributions were made (1) to an individual's IRA and (2) to an IRA for the noncompensated spouse of the individual (a spousal IRA), then the annual deduction limit on the couple's joint return was increased to the lesser of $2,250 or 100 percent of compensation includible in gross income. The annual contribution could be divided as the spouses chose, so long as the contribution for neither spouse exceeded $2,000. If a spouse had a small amount of compensation, in

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. 1101; H.Rep. 99-426, pp. 682-85; H.R. 3838, as reported by the Senate Committee on Finance on May 29, 1986, secs. 1201-1204; S.Rep. 99-313, pp. 541-547; Senate floor amendment, 132 Cong. Rec. S7931-7932 (June 19, 1986); and H.Rep. 99841, Vol. II (September 18, 1986), pp. 373-380 (Conference Report).

cluding amounts less than $250, the spousal IRA deduction was not available under prior law.

Qualified voluntary employee contributions

Prior law allowed an employee who was a participant in a qualified plan, tax-sheltered annuity program, or government plan a deduction for qualified voluntary employee contributions made by or on behalf of the employee to the plan. The deduction allowed for contributions to an IRA was reduced by the amount of deductible voluntary employee contributions to a plan. Thus, the deduction allowed for the total of (1) an employee's contributions to an IRA and (2) the employee's qualified voluntary employee contributions to a plan (or plans) for a year, generally was limited to the lesser of $2,000 or 100 percent of compensation for the year.

Acquisition of gold and silver coins

Prior and present law provides that the acquisition by an IRA of any collectible is treated as a distribution from the IRA equal to the cost of the collectible and is includible in the IRA owner's income for the year in which the cost is deemed distributed. Under prior law, a collectible included any coin, including a coin issued by the United States.

Reasons for Change

The individual retirement savings provisions of the Code were originally enacted in the Employee Retirement Income Security Act of 1974 (ERISA) to provide a tax-favored retirement savings arrangement to individuals who were not covered under a qualified plan, a tax-sheltered annuity program, or a governmental plan maintained by their employer. At that time, individuals who were active participants in employer plans were not permitted to make deductible IRA contributions.

In the Economic Recovery Tax Act of 1981 (ERTA), Congress eliminated the active participant restriction and extended IRA availability to all taxpayers. At that time, the Congress articulated a concern about the level of savings generally and expressed a desire to provide a discretionary retirement savings arrangement that was uniformly available.

Congress determined that, since 1981, the expanded availability of IRAS had no discernible impact on the level of aggregate personal savings. In addition, many employers had adopted qualified cash or deferred arrangements, which permit employees to make discretionary contributions that are provided with tax-favored treatment essentially equivalent to that accorded to deductible IRA contributions. The limits on elective deferral under cash or deferred arrangements are substantially higher (even after the reductions included in the Act) than the limits on IRA contributions, but are subject to nondiscrimination rules designed to promote participation by lower-paid employees. In addition, many employees of taxexempt organizations are permitted to make significant elective deferrals under tax-sheltered annuity programs. Congress believed that the wide availability of the option to make elective deferrals under cash or deferred arrangements and tax-sheltered annuities

reduced the prior concern that individuals in employer-maintained plans should be able to save additional amounts for retirement on a discretionary basis.

Further, Congress determined that data had consistently shown that IRA utilization was quite low among lower-income taxpayers who could be the least likely to accumulate significant retirement savings in the absence of a specific tax provision. For example, for the 1984 tax year, only 7.8 percent of returns with adjusted gross income (AGI) under $30,000 (who represent 76 percent of all taxpayers) made IRA contributions, whereas 59 percent of returns with AGI of $50,000 or more made IRA contributions. It was clear to Congress, therefore, that utilization of the IRA deduction increased substantially as income increases.

Congress believed that those taxpayers for whom IRA utilization was the largest (i.e., higher-income taxpayers) would generally have saved without regard to the tax incentives. Congress further believed that the substantially lower tax rates provided by the Act, which themselves stimulate additional work effort and saving, eliminate the need for IRA deductions for higher-income taxpayers who participate in other tax-favored retirement plans. Thus, with respect to higher-income taxpayers, Congress found it appropriate to reinstate generally the rules prior to ERTA, which limit IRA deductions to those taxpayers who are not covered by an employerprovided pension plan.

However, Congress also wished to provide a tax incentive for discretionary retirement savings for all taxpayers. Therefore, the Act permits all individuals, including higher-income taxpayers who are covered by an employer's retirement plan, to make nondeductible contributions to an IRA with a continued deferral of tax on the earnings on these nondeductible contributions.

In addition, Congress recognized that the current spousal IRA deduction limit creates anomalous results in the case of a spouse whose compensation is less than $250 a year. The Act eliminates this anomaly for purposes of determining eligibility to make deductible or nondeductible spousal IRA contributions.

Explanation of Provisions

IRA deduction not available to active participants

In general

The Act generally retains the prior-law IRA provisions for taxpayers who are not active participants in an employer-maintained retirement plan and for taxpayers with adjusted gross income (AGI) below certain levels, and reduces the IRA deduction for active participants with AGI above those levels.

Under the Act, a taxpayer is permitted to make deductible IRA contributions up to the lesser of $2,000 or 100 percent of compensation (earned income, in the case of a self-employed individual) if: (1) in the case of a taxpayer who is not married, the taxpayer either (a) has AGI that does not exceed the applicable dollar amount or (b) is not an active participant in an employer-maintained retirement plan for any part of the plan year ending with or within the taxable year;

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