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Time to Simplify the Tax Code: AICPA Comments on JCT Report. In a February 7, 2002 letter to the Treasury Department, the American Institute of Certified Public Accountants provided comments on the Study of the Overall State of the Federal Tax System and Recommendations for Simplification issued by the Staff of Joint Committee on Taxation in April 2001. In its cover letter the AICPA states:

We believe the time is now to take decisive action to simplify the Code. First, Congress should repeal the alternative minimum tax for both individuals and corporations. Then the inconsistent phase-outs that make tax planning difficult for individuals and result in confusing marginal rates should be eliminated. Finally, the definitions and qualifications associated with filing status, dependency exemptions, and credits should be simplified and harmonized. These changes alone -- all of which are described in the Joint Committee study -- will make the Code more consistent, rational, fair, and transparent -- particularly for low and middle-income taxpayers. In our detailed comments we outline additional areas where we believe Congress might concentrate simplification efforts to reduce complexity for a broad range of taxpayers.

In our response document we have attempted to provide constructive comments on the vast majority of the Joint Committee's recommendations. There are, of course, some areas we were unable to address. The Joint Committee staff has provided a clear roadmap to the task ahead. We urge Congress to follow it and, hence, repeal the hidden tax burden imposed by complexity that adversely affects all taxpayers.

The full text of the American Institute of Public Accountants proposal follows:



TAX DIVISION
OF THE
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS

COMMENTS ON


RECOMMENDATIONS OF THE STAFF OF THE
JOINT COMMITTEE ON TAXATION
TO SIMPLIFY THE FEDERAL TAX SYSTEM


February 7, 2002


Table of Contents


Introduction

IX. ALTERNATIVE MINIMUM TAX

X. INDIVIDUAL INCOME TAX

Filing Status, Personal Exemptions, and Credits

Uniform definition of qualifying child

Dependent care tax benefits

Modifications to the earned income credit

Determinations relating to filing status

Income-Based Phase-outs and Phase-ins

Taxation of Social Security Benefits

Individual Capital Gains and Losses

Adopt a uniform percentage deduction for capital gains in lieu of multiple tax rates

Definition of "small business" for capital gain and loss provisions

Two-Percent Floor on Miscellaneous Itemized Deductions

Provisions Relating to Education

Definition of qualified higher education expenses

Combine HOPE and Lifetime Learning Credits

Interaction among provisions

Deduction for student loan interest



Exclusion for employer-provided educational assistance

Taxation of Minor Children

XI. INDIVIDUAL RETIREMENT ARRANGEMENTS, QUALIFIED RETIREMENT PLANS, AND EMPLOYEE BENEFITS

Individual Retirement Arrangements

Qualified Retirement Plans

Adopt uniform definition of compensation for qualified retirement plans

Modifications to minimum coverage and nondiscrimination rules

Apply uniform vesting requirements to all qualified retirement plans

Conform requirements for SIMPLE IRAs and SIMPLE 401(k) plans

Conform definitions of highly compensated employee and owner

Conform contribution limits for tax-sheltered annuities to contribution limits for qualified retirement plans

Simplification of distribution rules applicable to qualified retirement plans

Simplify minimum distribution rules

Adopt uniform early withdrawal rules

Make 401(k) plans available to all governmental employers

Redraft section 457 to separate requirements for governmental plans and plans of tax-exempt employers

Adopt uniform ownership attribution rules for qualified retirement plan plan purposes

Basis Recovery Rules for Qualified Retirement Plans and IRAs Qualified retirement plans

Employee Benefits

Modify cafeteria plan election requirements

Employees excluded from application of nondiscrimination requirements

XII. CORPORATE INCOME TAX

Structural issues Relating to the Corporate Income Tax



Corporate Integration

Mergers, acquisitions, and related tax-free transactions

Eliminate Collapsible Corporation Provisions

Section 355 "Active Business Test" Applied to Chains of Affiliated Corporations

Uniform Definition of a Family for Purposes of Applying Attribution Rules

Limit Application of Section 304

Post-Reorganization Transfers of Assets

Redemptions Incident to Divorce

Conform Treatment of Boot Received in a Reorganization with the Stock Redemption Rules

XIII. PASS-THROUGH ENTITIES

Partnership Simplification Recommendations

Modernize references to "limited partner" and "general partner"

Eliminate large partnership rules

Conform timing rules for guaranteed payments and other non- partner payments

S Corporation Simplification Recommendations

Excess passive income of S corporations

Trusts as permitted shareholders of S corporations

XIV. GENERAL BUSINESS ISSUES

Section 1031

Tax-free rollover of like-kind property

Property held for use in a trade or business or held for investment in a like-kind exchange

Low-income Housing Tax Credit

Rehabilitation Tax Credit

XV. ACCOUNTING AND COST RECOVERY PROVISIONS

Structural Issues Relating to Accounting for Capital Expenditures



Cash Method of Accounting for Small Businesses Amortization of

Organization Expenditures Depreciation -- Mid-Quarter Convention

Additional Accounting and Cost Recovery Provisions for Future Consideration

IX. INTERNATIONAL TAX

Anti-Deferral Regimes Applicable to Income Earned Through Foreign Corporations

Expand Subpart F De Minimis Rule

Look-Through Rules for Dividends from Noncontrolled Section 902 Corporations

Foreign Tax Credits Claimed Indirectly Through Partnerships

Conform Sections 30A and 936

Application of Uniform Capitalization Rules for Foreign Persons

Secondary Withholding Tax on Dividends From Foreign Corporations

Capital and of Certain Nonresident Individuals

U.S. Model Tax Treaties

Older U.S. Tax Treaties

X. TAX-EXEMPT ORGANIZATION PROVISIONS

Percentage Limits on Grass-Roots Lobbying Expenditures of Electing Charities Excise Tax Based on Investment Income

XIV. ESTATE AND GIFT TAX PROVISION -- Conform Certain Family-Owned and Small Business Provisions

XV. EMPLOYMENT TAX PROVISIONS

Structural Issues Relating to Worker Classification

Structural Issues Relating to Determination of Individuals Subject to Self-Employment Tax

XVI. COMPLIANCE AND ADMINISTRATION PROVISIONS

Penalties and Interest Overall

Interest

Estimated Tax



Accuracy Related Penalties

General Administrative Provisions

XVII. DEADWOOD PROVISIONS

Appendix A: AICPA Tax Policy Concept Statement 2 -- Guiding Principles for Tax Simplification

Appendix B: AICPA Simplification Recommendation -- Ownership Attribution Rules (April 30, 1997)

Appendix C: AICPA Legislative Proposal Regarding Tax on Self-Employment Income

Appendix D: AICPA Testimony Before House Ways and Means Subcommittee on Oversight Concerning Penalty and Interest Reform Proposals (January 27, 2000)

Introduction

[9] The American Institute of Certified Public Accountants (AICPA) has long been an advocate of simplification of the tax system. We are pleased to have the opportunity to offer our comments and feedback on the Study of the Overall State of the Federal Tax System and Recommendations for Simplification prepared by the Staff of Joint Committee on Taxation, issued April 2001.

[10] We congratulate the Joint Committee on Taxation on the study and commend Chief of Staff Lindy Paul and the Joint Committee staff for their dedication and efforts. The result of their labors is a study of the highest quality that provides an excellent understanding of both the sources of tax law complexity and its effect on the present system. The simplification recommendations presented are an excellent starting point for addressing complexity problems in the Internal Revenue Code. Even if it is not possible to enact all of the study's recommendations, the Joint Committee staff has pointed the way for Congress to bring meaningful relief to many taxpayers by addressing the most troublesome and burdensome sources of complexity in the Code.

[11] We believe the time is now to take decisive action to simplify the Code. First, Congress should repeal the alternative minimum tax for both individuals and corporations. Then the inconsistent phase-outs that make tax planning difficult for individuals and result in confusing marginal rates should be eliminated. Finally, the definitions and qualifications associated with filing status, dependency exemptions. and credits should be simplified and harmonized. These changes alone -- all of which are described in the Joint Committee study -- will make the Code more consistent, rational, fair, and transparent -- particularly for low and middle-income taxpayers.

[12] In addition, the AICPA believes that other areas where Congress might concentrate simplification efforts to reduce complexity for a broad range of taxpayers include; (1) simplifying capital gains taxation, (2) rationalizing the estimated tax safe harbors; (3) making expiring provisions permanent rather than enacting temporary extensions; (4) harmonizing and simplifying education incentives; (5) clarifying the rules for expensing and capitalization; (6)

changing the half-year age conventions for retirement plan distributions to full-years; (7) reforming the minimum distribution rules for retirement plan distributions; (8) replacing the 20-factor common law test for determining worker classification; (9) harmonizing the attribution rules throughout the Code; (10) simplifying the foreign tax credit; (11) simplifying application of subpart F; (12) limiting application of the PFIC rules; and (13) repealing the collapsible corporation provisions.

[13] To aid Congress as it undertakes this important effort, the AICPA has developed Tax Policy Concept Statement #2: Guiding Principles for Tax Simplification. The Statement offers recommended guiding principles to be used in development of simpler tax legislation and regulations (see Appendix A).

[14] In the following pages we have attempted to provide constructive comments on the vast majority of the Joint Committee's recommendations. There are, of course, some areas we were unable to address. The Joint Committee staff has provided a clear roadmap to the task ahead. We urge Congress to follow it and, hence, repeal the hidden tax burden imposed by complexity that adversely affects all taxpayers.

AICPA COMMENTS ON THE VOLUME II: RECOMMENDATIONS OF THE STAFF OF THE JOINT COMMITTEE ON TAXATION TO SIMPLIFY THE FEDERAL TAX SYSTEM

I. ALTERNATIVE MINIMUM TAX

Individual Alternative Minimum Tax (JCT page 7)

[15] The Joint Committee staff recommends that the individual alternative minimum tax should be eliminated.

[16] The AICPA supports the proposal to eliminate the individual alternative minimum tax. We strongly agree that it no longer serves the purposes for which it was intended. Further, legislative changes since its enactment have been effective in more closely conforming the regular tax base for individual taxpayers to the AMT base.

Corporate Alternative Minimum Tax (JCT page 10)

[17] The corporate alternative minimum tax imposes a tax on corporations, based upon the corporation's taxable income, adjusted for certain preference items, e.g., accelerated depreciation. The Joint Committee staff recommends the repeal of the corporate alternative minimum tax. The AICPA supports this decision as a significant reduction in complexity.

II. INDIVIDUAL INCOME TAX

Filing Status. Personal Exemptions. and Credits

Uniform definition of qualifying child (JCT page 44)

[18] The Joint Committee staff recommends that a uniform definition of qualifying child should be adopted for purposes of determining eligibility for the dependency exemption. the earned income credit. the child credit. the

dependent care credit. and head- of-household filing status. Under the uniform definition. a child would be a qualifying child of a taxpayer if the child has the same principal place of abode as the taxpayer for more than one half the taxable year. A child would be defined as an individual with a specified relationship to the taxpayer and who is less than a specified age. A tie-breaking rule would apply if more than one taxpayer claims a child as a qualifying child. Under the tie-breaking rule, the child generally would be treated as a qualifying child of the custodial parent.

[19] The AICPA supports the recommendation with the following modifications. We suggest that the law allow the parties involved in a divorce proceeding to allocate the exemption as is allowed currently. Allowing the parties involved to make the election is a negotiating tool. In addition, we suggest any law change include a transition rule for existing divorce decrees.

Dependent care tax benefits (JCT page 67)

[20] The Joint Committee staff recommends that the dependent care credit should be conformed to the exclusion for employer-provided dependent care assistance by: (1) providing that the maximum amount of expenses eligible for the credit is $ 5,000 regardless of the number of qualifying individuals: (2) eliminating the reduction of the credit based on adjusted gross income; and (3) providing that married taxpayers filing separate returns are eligible to claim up to one half of the otherwise allowable credit.

[21] The AICPA supports the recommendation. The proposal provides that all taxpayers will be treated the same regardless of whether or not there is an employer plan. The AICPA suggests that the JCT consider an additional simplification of combining the child care credit, child credit, and exemption allowances into a single provision.

Modifications to the earned income credit (JCT page 69)

[22] The Joint Committee staff recommends that the definition of qualifying child for purposes of the earned income credit should be conformed to the recommended uniform definition of qualifying child. including the tie-breaking rule. In addition, the Joint Committee staff recommends that earned income should be defined to include wages, salaries, tips, and other employee compensation to the extent included in gross income for the taxable year, plus net earnings from self employment.

[23] The AICPA supports the recommendations. The earned income credit calculation is quite complex. The instructions for claiming the credit include complicated questions and several worksheets. Simplifying the definition of qualifying child would eliminate some of the complexity. The second recommendation was included in the Economic Growth and Tax Relief Reconciliation Act of 2001, but we suggest that this provision be made permanent.

Determinations relating to filing status (JCT page 75)

[24] The Joint Committee staff recommends that head-of-household filing status should be available with respect to a child only if the child qualifies as a dependent of the taxpayer under the recommended uniform definition of qualifying child. An additional recommendation is that the surviving spouse status should be available only for one year and that the requirement that the

surviving spouse have a dependent be eliminated.

[25] The AICPA agrees that a uniform definition of child would eliminate some complexity in the tax laws (see comments above). We support the position that all other aspects of qualification for head-of-household status remain the same. We support the change to surviving spouse filing status. Changing the requirement from two years to one and eliminating the need to have a qualifying child will expand the usefulness of the provision and will add simplicity to the tax law.

Income-Based Phase-outs and Phase-ins (JCT page 79)

[26] The Joint Committee staff recommends eliminating the following phase-outs:

o The overall limitation on itemized deductions (sometimes referred to as the "PEASE limit").

o The phase-out of personal exemptions (sometimes referred to as PEP).

o The phase-out of the child tax credit.

o The partial phase-out of the dependent care tax credit.

o The phase-outs relating to individual retirement arrangements (IRAs).

o The phase-out of HOPE and Lifetime Learning credits.

o The phase-out of the deduction for student loan interest.

o The phase-out of the exclusion for interest on education savings bonds, and

o The phase-out of the adoption credit and exclusion.

[27] The AICPA supports the recommendation. The overall limitation on itemized deductions and the phase-out of personal exemptions are to be eliminated after 2009 as part of the Economic Growth and Tax Relief Reconciliation Act of 2001. However, the provisions will be reinstated after 2010. We suggest that the provisions be made permanent. Eliminating the phase-outs will simplify the tax law and eliminate some of the current law's marriage penalties. This position Is consistent with our previous positions as stated in the Joint 2000 ABA/AICPA/TEI Tax Simplification Recommendations and the 1998 AICPA Testimony before the House Ways and Means Committee on February 4, 1998. Our previous positions were more expansive and suggested that simplicity could be achieved by (1) eliminating all phase-outs; (2) substituting cliffs for phase-outs: or (3) providing consistency in the measure of income, the range of phase-out, and the method of phase-out.

Taxation of Social Security Benefits (JCT page 92)

[28] The Joint Committee staff recommends that the amount of Social Security benefits included in gross Income should be a fixed percentage of benefits for

all taxpayers. The Joint Committee staff further recommends that the percentage of included benefits should be such that the amount of benefits excludable from income approximates individuals' portion of Social Security taxes.

[29] The AICPA supports the position that a fixed percentage of the social security benefits be taxable. We recommend that the fixed percentage not exceed 50%, the percentage approximately equal to the portion paid by the recipient. Making this chance will simplify the tax law. Currently, taxpayers who receive social security benefits must complete a complicated worksheet to determine the taxable portion of benefits.

Individual Capital Gains and Losses

Adopt a uniform percentage deduction for capital gains in lieu of multiple tax rates (JCT page 97)

[30] The Joint Committee staff recommends that the current rate system for capital gains should be replaced with a deduction equal to a fixed percentage of the net capital gain. The deduction would be available to individuals whether itemized deductions or the standard deduction is claimed.

[31] The AICPA supports simplification of capital gains taxation. However, we believe a preferable approach is reflected in the Joint 2000 ABA/AICPA/TEI Tax Simplification Recommendations, which would simplify capital gains taxation by establishing a single preferential rate and a single long term holding period for all types of capital assets.

Definition of "small business" for capital gain and loss provisions (JCT page 109)

[32] The Joint Committee staff recommends that, for purposes of ordinary loss treatment under sections 1242 and 1244, the definition of "small business" should be conformed to the definition of "small business" under section 1202, regardless of the date of issuance of the stock.

[33] The AICPA supports the proposal. There should be a concerted effort to eliminate other inconsistencies in existing law. Further, as new law is drafted, lawmakers should strive for consistency in both concepts and definitions.

Two-Percent Floor on Miscellaneous Itemized Deductions (JCT page 111)

[34] The Joint Committee staff recommends that the two-percent floor on miscellaneous itemized deductions should be eliminated.

[35] The AICPA supports the proposal. The two-percent floor was added to the 1986 Act to prevent taxpayers from having to keep extensive records for small expenditures such as employee business expenses, investment expenses, and other miscellaneous itemized deductions. In addition, the intent was to remove some of the administrative problems for the IRS. However, we support the proposal because: (1) all business expenses would receive similar treatment (deductible without limitation); (2) attorney's fees for damage awards would be fully deductible: and (3) it would resolve the issue of the deductibility of investment advice. Currently, there are two conflicting court cases regarding the deductibility of investment advice incurred by a trust, which are

considered individuals for the two-percent floor limitation.

Provisions Relating to Education

Definition of qualified higher education expenses (JCT page 122)

[36] The Joint Committee staff recommends that a uniform definition of qualifying higher education expenses should be adopted. The uniform definition would include expenses for tuition, books, fees, supplies, and equipment required for enrollment or attendance. It would not include expenses with respect to any course or other education relating to sports, games, or hobbies other than as part of a degree program. The recommendation would retain the current treatment of room and board expenses under the separate education tax incentives.

[37] The AICPA supports the proposal, which would simplify the tax law. We suggest that the qualifying higher education expenses include room and board even though this would significantly expand the scope of the current education tax incentives that do not cover these expenses. Because qualified tuition must be reduced by scholarships and like items, including room and board as a qualified higher education expense would make the education tax incentives more broadly available. Further study could be devoted to combining the education incentives for additional simplification.

Combine HOPE and Lifetime Learning Credits (JCT page 126)

[38] The Joint Committee staff recommends that the HOPE credit and Lifetime Learning credits should be combined into a single credit. This single credit would: (1) utilize the present-law credit rate of the Lifetime Learning credit; (2) apply on a per-student basis; and (3) apply to eligible students as defined under the Lifetime Learning credit.

[39] The AICPA supports the proposal. Combining the credits would simplify the tax benefits and would remove the duplicative provisions of the credits relating to higher education expenses. This position is consistent with the Joint 2000 ABA/AICPA/TEI Tax Simplification Recommendations.

Interaction among provisions (JCT page 130)

[40] The Joint Committee staff recommends that restrictions on using education tax incentives based on the use of other education tax incentives should be eliminated and replaced with a limitation that the same expenses could not qualify under more than one provision.

[41] The AICPA supports this proposal. The Economic Growth and Tax Relief Reconciliation Act of 2001 included the provision that allows taxpayers to exclude from income withdrawals from an education IRA in the same year that a HOPE or Lifetime Learning credit is claimed. This is provided that the exclusion is not used for the same expenses for which the credits were claimed. We suggest that this provision be made permanent. The Joint Committee staff also recommended that taxpayers be allowed to fund an Education IRA in the same year that a contribution to a 529 plan was made on the taxpayer's behalf. We support these provisions because they will simplify the education incentives.

Deduction for student loan interest (JCT page 132)

[42] The Joint Committee staff recommends that the 60-month limit on deductibility of student loan interest should be eliminated.

[43] The AICPA supports this position. The Economic Growth and Tax Relief Reconciliation Act of 2001 included the temporary repeal of the 60-month rule. We suggest that this provision be made permanent because it simplifies the requirements for an interest deduction.

Exclusion for employer-provided educational assistance (JCT page 133)

[44] The Joint Committee staff recommends that the exclusion for employer-provided educational assistance should be made permanent.

[45] We support this position. The Economic Growth and Tax Relief Reconciliation Act of 2001 made the exclusion for employer- provided educational assistance permanent. However, because all provisions of the 2001 Act will be repealed effective January 1, 2011, we suggest that this provision be made permanent beyond 2011. This will: provide certainty to taxpayers wishing to take advantage of the exclusion; provide certainty to employers interested in providing educational incentives to their employees; and eliminate administrative problems.

Taxation of Minor Children (JCT page 144)

[46] The Joint Committee staff recommends that the tax rate schedule applicable to trusts should be applied with respect to the net unearned income of a child under age 14. The Joint Committee staff also recommends that the parental election to include a child's income on the parent's return should be available irrespective of (1) the amount and type of the child's income; and (2) whether their withholding or estimated tax payments were made with respect to the child's income.

[47] The AICPA believes simplification could be better achieved by eliminating the special rules for taxing the net unearned income of a child under age 14 at the parents' tax rate. The current rules are very complicated. We further believe that the tax revenue generated is not significant when compared to the complexity created by these provisions.

III. INDIVIDUAL RETIREMENT ARRANGEMENTS, QUALIFIED RETIREMENT PLANS, AND EMPLOYEE BENEFITS

Individual Retirement Arrangements (JCT page 149)

[48] The Joint Committee staff recommends that the income limits on eligibility to make deductible IRA contributions, Roth IRA contributions, and conversions of traditional IRAs to Roth IRAs should be eliminated. Further, the Joint Committee staff recommends that the ability to make nondeductible contributions to traditional IRAs should be eliminated. The Joint Committee staff also recommends that the age restrictions on eligibility to make IRA contributions should be the same for all IRAs.

[49] The AICPA supports the proposals. The recommendations will reduce the number of IRA options and conform eligibility criteria for remaining IRAs,

therefore simplifying the savings options for taxpayers without reducing benefits. Taxpayers will no longer need to apply various rules to determine eligibility. Instead, taxpayers will be able to focus on which tax-favored savings vehicle, if any, they consider most appropriate for their circumstances.

Qualified Retirement Plans (JCT page 155)

Adopt uniform definition of compensation for qualified retirement plans (JCT page 166)

[50] The Joint Committee staff recommends using a single definition of compensation for all qualified retirement plan purposes including determining plan benefits. The uniform definition would be all compensation provided to an employee by the employer for which the employer is required to furnish the employee a written statement on Form W-2, plus elective contributions.

[51] The AICPA supports the current flexibility for a small business owner to make contributions to a retirement plan based on basic wages without considering extraordinary compensation. Using a single definition of compensation may unduly add cost to small employers. Because all payroll data is becoming electronic, segregating the elements of employee compensation is not a burden. However, the ability to create a retirement plan that excludes some types of compensation is important to small business. Benefit plans should match the employer's budgetary constraints and benefits philosophy. Including or excluding certain elements of compensation helps to achieve this goal. We do not support adoption of this recommendation because it will hinder the ability of small employers to fund plans for all employees.

Modifications to minimum coverage and nondiscrimination rules (JCT page 173)

[52] The Joint Committee Staff recommends that the ratio percentage test under the minimum coverage rules should be modified to allow more plans to use the test. In addition, the Joint Committee staff recommends that excludable employees should be disregarded in applying the minimum coverage and general nondiscrimination rules. Finally, the Joint Committee staff recommends that the extent to which cross-testing may be used should be specified in the Code.

[53] The AICPA conditionally supports these recommendations as part of simplification of the employee benefit rules. We support the recommendation to codify the cross-testing rules to the extent that any such codification is consistent with the regulations as currently written.

Apply uniform vesting requirements to all qualified retirement plans (JCT page 183)

[54] The Joint Committee staff recommends that the vesting requirements for all qualified retirement plans should be made uniform by applying the top-heavy vesting schedules to all plans.

[55] The AICPA opposes adopting this vesting recommendation. The recommendation would eliminate an incentive that small employers rely upon to retain employees. Determining a participant's vesting amount is not unduly complex, even if the plan becomes top heavy. If a plan is not top heavy, we believe the seven-year vesting schedule should remain available to employers. However, the AICPA does recommend that, once a plan becomes top heavy, the

plan may not revert to the seven-year vesting schedule if it later is not top heavy. This modification will achieve the desired simplification.

Conform requirements for SIMPLE IRAs and SIMPLE 401(k) plans (JCT page 185)

[56] The Joint Committee staff recommends that the rules relating to SIMPLE IRAs and SIMPLE 401(k) plans should be conformed by: (1) allowing state and local government employers to adopt SIMPLE 401(k) plans; (2) applying the same contribution rules to SIMPLE IRAs and SIMPLE 401(k) plans; and (3) applying the employee eligibility rules for SIMPLE IRAs to SIMPLE 401(k) plans.

[57] The AICPA supports this recommendation. However, we also recommend eliminating the SIMPLE 401(k) plan, because it largely duplicates the Safe Harbor 401(k) rules. Eliminating the SIMPLE 401(k) plan would minimize complexity in choosing an appropriate plan form that meets employer objectives without removing benefits for small business. The SIMPLE IRA and the Safe Harbor 401(k) can satisfy the diverse needs of small business owners.

Conform definitions of highly compensated employee and owner (JCT page 188)

[58] The Joint Committee staff recommends that uniform definitions of highly compensated employee and owner should be used for all qualified retirement plan and employee benefit purposes. Accordingly, the Joint Committee staff recommends that many of the statutory terms and definitions be repealed.

[59] The AICPA supports the recommendation to conform the definition of owner and highly compensated employee as a simplification. Requiring an employer to apply different definitions and criteria for different employee benefit purposes makes compliance excessively burdensome. In many respects the various definitions and criteria overlap or contain only minor differences and, therefore, produce complexity without meaningful policy distinctions.

Conform contribution limits for tax-sheltered annuities to contribution limits for qualified retirement plans (JCT page 192)

[60] The Joint Committee staff recommends that the contribution limits applicable to tax-sheltered annuities should be conformed to the contribution limits applicable to comparable qualified retirement plans.

[61] The AICPA supports the provision as it offers simplification without reducing benefits. The Joint Committee staff recommendation would repeal the exclusion allowance applicable to contributions to tax-sheltered annuities. Therefore, such annuities would be subject to the contribution limits applicable to qualified retirement plans. The differences between the limits on contributions to qualified retirement plans and tax-sheltered annuities are largely historical. The qualified retirement plan limits are easier to apply than the present-law section 403(b) limits. Conforming the limits will reduce record-keeping and computational burdens, as well as eliminate the confusion resulting from differences between tax- sheltered annuities and qualified retirement plans.

Simplification of distribution rules applicable to qualified retirement plans Simplify minimum distribution rules (JCT page 194)

[62] The Joint Committee staff recommends that the minimum distribution rules should be simplified by providing that: (1) no distributions are required during the life of a participant; (2) if distributions commence during the participant's lifetime under an annuity form of distribution, the terms of the annuity will govern distributions after the participant's death; and (3) if distributions either do not commence during the participant's lifetime or commence during the participant's lifetime under a non-annuity form of distribution, the undistributed accrued benefit must be distributed to the participant's beneficiary or beneficiaries within five years of the participant's death.

[63] The AICPA supports these proposals. Eliminating the rules that require minimum distributions during the life of the plan participant and establishing a uniform rule for post-death distributions would significantly simplify a complex requirement that imposes burdens on plan participants and their beneficiaries. as well as plan sponsors and administrators who assist such individuals in complying with the rules.

Adopt uniform early withdrawal rules (JCT page 198)

[64] The Joint Committee staff recommends that the exceptions to the early withdrawal tax should be uniform for all tax-favored retirement plans and that the applicable age requirements for the early withdrawal tax and permissible distributions from section 401(k) plans should be changed from 59-12 to 55.

[65] The AICPA supports the proposal as part of simplification of distributions. Under the recommendation, the early withdrawal tax would not apply to distributions for first-time homebuyer expenses. educational expenses, or health insurance expenses of unemployed individuals. In addition, we support lowering the age requirement for penalty-free withdrawals from age 59-1/2 to age 55.

Make 401(k) plans available to all governmental employers (JCT page 201)

[66] The Joint Committee staff recommends that all state and local governments should be permitted to maintain 401(k) plans.

[67] The AICPA supports this provision. The recommendation will reduce complexity by eliminating meaningless distinctions between the types of plans that may be offered by different types of employers. The recommendation will also increase the fairness of the tax laws; there is no clear policy reason why some governmental employers, including the federal government, may adopt a 401(k) plan, but other governmental employers may not.

Redraft section 457 to separate requirements for governmental plans and plans of tax-exempt employers (JCT page 202)

[68] The Joint Committee staff recommends that the statutory provisions dealing with eligible deferred compensation plans should be redrafted to separate the provisions that apply to plans maintained by state and local governments from those that apply to plans maintained by tax-exempt organizations.

[69] The AICPA supports this recommendation in conjunction with other simplification proposals in this area. By separating these provisions,

employers and practitioners could more readily identify the requirements that apply to each type of plan. For example, an employer considering whether to establish an eligible deferred compensation plan would have to review only the requirements that would apply to its type of plan. This would make it easier for employers to understand and comply with the requirements. In addition, statutory amendments that affect only one type of employer would not cause confusion for the other type of employer. The new statutory structure would also reflect the differences in operation between the two different types of plan.

Adopt uniform ownership attribution rules for qualified retirement plan purposes (JCT page 204)

[70] The Joint Committee staff recommends that the attribution rules used in determining controlled group status under section 1563 should be used in determining ownership for all qualified retirement plan purposes.

[71] The AICPA supports this recommendation. Uniform attribution rules would enable the employer to perform a single ownership analysis for both preventing multiple tax benefits and for all relevant qualified retirement plan purposes.

Basis Recovery Rules for Qualified Retirement Plans and IRAs

Qualified retirement plans (JCT page 211)

[72] The Joint Committee staff recommends that a uniform basis recovery rule should apply to distributions from qualified retirement plans and IRAs. Under this uniform rule, distributions would be treated as attributable to basis first, until the entire amount of basis has been recovered.

[73] The AICPA supports this proposal. Under current law, an individual must not only keep track of his or her basis (the amount of after-tax contributions) as distributions are made, but also perform a variety of calculations depending on which basis recovery rule applies. The proposal would eliminate the need to calculate the amount of any distribution attributable to basis; instead, the individual would only need to keep track of his or her basis. This would provide significant simplification for recipients of distributions from qualified retirement plans and IRAs. In addition, by providing a uniform rule for all tax-preferred retirement savings vehicles, the proposal would eliminate potential mistakes due to taxpayers mistaking which rules apply in any particular case.

Employee Benefits

Modify cafeteria plan election requirements (JCT Page 221)

[74] The Joint Committee staff recommends that the frequency with which employees may make, revoke, or change elections under cafeteria plans should be determined under rules similar to those applicable to elections under qualified cash or deferred arrangements.

[75] The AICPA conditionally supports the recommendation. We applaud this effort as long as any employee election changes are not measured by comparing benefits paid prior to the change with benefits paid after the change. Any such prerequisite for an employee election change will increase complexity for both the employee and the employer.

Employees excluded from application of nondiscrimination requirements (JCT page 221)

[76] The Joint Committee staff recommends that a uniform definition of employees who may be excluded for purposes of the application of the nondiscrimination requirements relating to group- term life insurance, self-insured medical reimbursement plans, educational assistance programs, miscellaneous fringe benefits, and voluntary employees' beneficiary associations should be adopted.

[77] The AICPA supports this recommendation. A uniform definition of excludable employees would eliminate the need to determine different groups to be considered in testing different benefits, therefore, making nondiscrimination testing easier. Making the exclusion of these employees automatic, rather than elective, eliminates the need for an employer to test on both bases to determine which approach is advantageous.

IV. CORPORATE INCOME TAX

Structural issues Relating to the Corporate Income Tax

Corporate Integration (JCT page 229)

[78] The Joint Committee staff provides a detailed discussion of how the tax system could be improved by taxing corporate income once, otherwise known as integrating the corporate and shareholder- level taxes on corporate income. The study also details a number of methods that could be used to achieve full or partial integration, each of which has associated policy and administrative considerations.

[79] The AICPA supports corporate integration in concept. (See AICPA Statement of Tax Policy 10: Integration of the Corporate and Shareholder Tax Systems, 1993.) However, the JCT staff does not make a specific recommendation in this area.

Mergers, acquisitions, and related tax-free transactions (JCT page 238)

[80] The Joint Committee staff does an excellent job of explaining the tax law complexities associated with mergers, acquisitions, and related tax-free transactions and describes proposals for simplifying the law, and the associated policy issues. Because adopting any of the proposals would involve policy implications, the JCT staff concluded that no specific legislative simplification recommendation would be made with respect to these issues.

[81] Accordingly, the AICPA takes no position at this time. However, because of the vast and well-developed body of law dealing with corporate reorganizations, we believe that any changes in this area should be made using an incremental approach (e.g., conforming the definition of voting versus non-voting stock) rather than on a comprehensive basis.

Eliminate Collapsible Corporation Provisions (JCT page 249)

[82] The collapsible corporation provisions were enacted in the 1950s in order to prevent the use of certain corporations to avoid ordinary income treatment for the corporation's individual shareholders. At that time,

liquidating distributions of appreciated property were generally tax-free to the distributing corporation, with the individual shareholders claiming capital gain treatment thereon. The collapsible corporation provisions imposed ordinary income treatment on the individual shareholders receiving these distributions. The repeal of the General Utilities doctrine in the Tax Reform Act of 1986 eliminated the tax-free treatment of liquidating/distributions of appreciated property, thus rendering the collapsible corporation provisions unnecessary to the prevention of tax avoidance. The Joint Committee staff recommends the repeal of the collapsible corporation provisions as deadwood.

[83] The AICPA supports this decision as a long overdue step in the reduction of complexity.

Section 355 "Active Business Test" Applied to Chains of Affiliated Corporations (JCT page 251)

[84] Current law imposes an unjustifiable burden on certain holding companies seeking to make tax-free distributions under section 355. These holding companies must engage in certain preliminary transactions -- e.g., liquidations or reorganizations of affiliates -- to satisfy the "active business" test of section 355. Under present law, this test is imposed on a separate company basis. The Joint Committee staff recommends the test be made on an affiliated group basis.

[85] The AICPA supports this decision as a meaningful step in reducing complexity because it would eliminate the need to undertake the uneconomic preliminary transactions described above.

Uniform Definition of a Family for Purposes of Applying Attribution Rules (JCT page 253)

[86] The Joint Committee staff notes that the code contains 13 different definitions of "family" for purpose of attributing stock ownership, and recommends adopting a uniform definition.

[87] The AICPA supports this decision, and notes that it has previously recommended an even more expansive definition. (See Appendix B: AICPA Tax Simplification Recommendations, April 30, 1997, Ownership Attribution Rules.)

Limit Application of Section 304 (JCT page 259)

[88] The Joint Committee staff notes that section 304 was enacted as an anti-abuse provision largely to prevent individual shareholders from converting ordinary income into capital gains. The JCT seems to believe that section 304 has been manipulated by non-individual shareholders.

[89] The AICPA respectfully disagrees with this analysis. However, regardless of which analysis is more correct, we believe that modifying the application of section 304 for non-individual shareholders is a policy initiative that adds nothing to the cause of simplification. Accordingly, the AICPA opposes this recommendation.

Post-Reorganization Transfers of Assets (JCT page 261)

[90] The Joint Committee staff notes that there has long been uncertainty over whether the Code permits a post-reorganization transfer of assets following a Type D or F reorganization (the so-called "D with a drop" issue). The Joint Committee staff finds no policy justification for inhibiting such transfers, and accordingly recommends the explicit sanctioning of such asset dropdowns.

[91] The AICPA supports this decision as a meaningful reduction in complexity by eliminating an unwarranted stricture.

Redemptions Incident to Divorce (JCT page 263)

[92] The Joint Committee staff notes that complexity and uncertainty prevail under present law about whether the stock redemption incident to divorce by one spouse should be treated as a dividend to the other spouse. The Joint Committee staff recommends adopting a single standard for making this determination, while allowing the parties to fashion a mutually acceptable result.

[93] The AICPA supports this recommendation as a useful step in reducing complexity in this increasingly frequent situation. The IRS and Treasury issued proposed regulations in this area in August 2001 (REG-107151-00, 66 Fed. Reg. 40659 (8/03/01)).

Conform Treatment of Boot Received in a Reorganization with the Stock Redemption Rules (JCT page 267)

[94] The Joint Committee staff makes note of certain discontinuities in the treatment of boot received in a redemption versus in a reorganization. The Joint Committee staff recommends adopting the current redemption treatment as the uniform treatment for boot in both settings.

[95] The AICPA believes that the recommended treatment is one- sided, and tends to result in more expansive dividend treatment. Accordingly, the AICPA opposes this recommendation as resembling a policy initiative more than a simplification proposal.

V. PASS-THROUGH ENTITIES

Partnership Simplification Recommendations

Modernize references to "limited partner" and "general partner" (JCT page 277)

[96] The Joint Committee staff notes that Code section references to general and limited partners generally pre-date the widespread use of limited liability companies (LLC) and are based on distinctions made under state law. It further notes that the distinctions are difficult to interpret when applied to LLC owners, and the Federal statutes must, therefore, be modernized to accommodate persons who are partners under Federal tax law but not under state law.

[97] The AICPA applauds their efforts and agree both that the references need to be modernized and that, to be consistent with the underlying tax policy considerations, a separate provision- by-provision modification is appropriate. To the extent that specific Code sections do not adequately convey a clear meaning of these terms, we suggest that a general definition should be enacted under section 7701 to govern in the absence of section-specific applications.

[98] We agree that the relevant characteristic in modifying the references to general and limited partners is such person's participation in the management of the business of the entity. However, we are concerned with the general recommendation to substitute the term "limited partner" with a reference to "a person whose participation in the management of the business activity of the entity is limited under applicable state law. " Alternatively, the JCT staff suggests, on page 286, an approach based on actual performance of services, rather than on whether those services are allowable under state law. We believe that actual participation is a more appropriate measure for some of the provisions discussed (sections 736 and 1402), than participation allowable under state law. However. our objections to the actual participation approach center on the complications related to using an "hours-per-year" method to measure whether or not the person should be given limited or general partner status. We suggest that these areas of complexity can be overcome (and in some cases eliminated) by ignoring a de minimis level of services in determining whether or not the person is a "limited" or a "general" partner for Federal tax law.

[99] The following summarizes our observations and suggestions on the references to general and limited partners in the Code.

Recommended Statutory Default Definitions of Limited and General Partner under Section 7701(a)(2):

(A) General Partner -- A person not treated as a limited partner shall be considered a general partner.

(B) Limited Partner -- A person shall be considered a limited partner whose participation in the management or business activity of the entity is limited under either applicable state law or by the controlling partnership or operating agreement.

General Recommendation:

The AICPA recommends adoption of and reference to its proposed statutory definition under section 7701(a)(2) for the following code provisions:

1. At-risk rules (section 465(c)(7)(D)(ii)(I));

2. Special valuation rules for generation-skipping transfer tax (section 2701(b)(2)(B)(ii)):

3. Concept of "limited partner or limited entrepreneur" (sections 464(c)(1)(B) and (e)(2)(A); 1256(e)(3)(B) and (C), and (e)(4)(A); and 1258(d)(5)(C));

4. Material participation and active participation under the passive loss rules (section 469(h)(2)); and

5. Electing large partnership rules (section 772(f)).

Payments to Retiring Partners (Section 736(b)(3)(B):

The Joint Committee staff's recommendation substituting the requirement that the retiring partner be a general partner with

a requirement that the retiring partner must be subject to tax on self-employment income from the partnership causes us concern and is partially inconsistent with an existing AICPA proposal (previously submitted to the Congress and attached as Appendix C).

[100] Although the structural issues related to determining whether or not a partner is subject to self-employment tax are discussed (with references to the AICPA's proposal for modernizing the self-employment tax references to limited partners in section 1402), the JCT staff made no recommendations.

[101] We believe that incorporating references to income subject to self-employment tax in section 736(b)(3)(B) is not appropriate at this time, Until the issue is clarified, we suggest that actual participation by the partner be the measure of "general partner" status (rather than the extent of participation allowed under state law). However, once clarification is achieved under section 1402. the concept of self-employment income as the measure may be appropriate.

Foreign Currency Transactions (Section 988(c)(1)(E)(v)(I):

[102] A section 988 transaction includes entering into or acquiring any forward contract, futures contract, option, or similar financial instrument, but does not apply to a qualified fund, which is defined as a partnership meeting certain requirements and making an election. One of the requirements is that a partnership have at least 20 partners and that no partner have more than a 20-percent capital and profits interest in the partnership. A general partner will not be treated as failing the 20-percent ownership test if it has no ordinary income from a section 988 transaction that is foreign currency gain or loss.

[103] The AICPA recommends maintaining usage of the term general partner as defined in the AICPA's proposed statutory definition under section 7701(a)(2). Section 988 uses the term general partner without modifying the general usage of that term and, as such a standard definition would be appropriate.

1982 Act Partnership Audit Rules (Section 6231(a)(7)):

[104] In the context of general and limited partnerships, we accept the Joint Committee staff recommendation.

[105] In the context of a limited liability company, the AICPA recommends that the statute reflect the term general partner as used in existing reg. section 301.6231(a)(7)-(2). According to this regulation, general partners are the a member-manager(s). If no member managers are designated, than any [sic] member can be designated as the tax matters partner. In accord with this regulation, member-managers should be defined as the member vested with the exclusive authority to make management decisions to conduct the business for which the organization was formed.

Reporting Rules for Large Partnerships (Section 772(f)):

[106] While we agree with the Joint Committee staff's general recommendation to keep section 772(f) in conformity with section 469, the AICPA recommends retaining the elective large partnership reporting and auditing rules (see

below), and therefore, also recommends that our proposed statutory definition under section 7701(a)(2) be adopted.

Self-employment Tax Rules (Section 1402(a)(13)):

The Joint Committee staff did not make anv recommendations to section 1402. The AICPA recommends that the JCT staff consider simplification recommendations in this area as part of any future study or legislation. Attached as Appendix C is the AICPA legislative proposal regarding tax on self-employment income under section 1402.

Eliminate large partnership rules (JCT page 287)

[107] The Joint Committee staff recommends that the special reporting and audit rules for electing large partnerships (ELP) should be eliminated and that large partnerships should be subject to the general rules applicable to partnerships. The AICPA recommends that these rules not be repealed for the following reasons:

o The ELP rules are elective, thereby providing large partnerships with alternatives with respect to partnership reporting and audits. Partnerships that qualify are generally sophisticated in nature. These partnerships generally prefer flexibility, even if it results in a certain amount of complexity.

o The ELP rules were intended to simplify reporting for ELPs. Partners of ELPs benefit from the simplified reporting provided by these rules.

o Eliminating the ELP rules would seem to add temporary complexity for ELPs that have already established a system for partnership reporting under the current rules.

o Eliminating the ELP rules does not provide simplification to most partnerships that are not ELPs, except that they no longer need to evaluate a separate regime.

o The JCT staff speculates that. because the rules have not been widely elected by partnerships, the benefits probably do not outweigh the disadvantages and suggests that complexity is at least in part a reason for the few number of ELPs. The AICPA believes that the fact that few partnerships use these rules does not by itself create complexity in the tax system for the much larger population of partnerships that either are not eligible to make the election or, if eligible, choose not to make the election. Indeed, for those partnerships that elect these provisions, the rules facilitate simplicity by significantly reducing their tax compliance burdens. Further, the small number of existing ELPs is more likely due to market factors. Many of the partnerships that might have become ELPs instead became corporations in an effort to raise capital more effectively.



Conform timing rules for guaranteed payments and other non-partner payments (JCT page 291)

[108] The Joint Committee staff proposes treating all payments and transactions between partnerships and their partners as transactions occurring between related parties with respect to the timing of such payments. Specifically, the proposal would conform the timing rule for reporting partnership payments to partners in transactions where they are not acting in their capacity as partners to the timing rule for reporting guaranteed payments made to partners acting in their capacity as partners.

[109] The AICPA opposes adopting this recommendation. It would result in the partnership's accounting methods and tax year controlling the time for the reporting of payments made to the partners. In the case of payments made for the partners' performance of services, partners must include payments from the partnership based on the tax year in which the partnership deducts or capitalizes such payments under its method of accounting rather than the tax year in which the partners would have recognized the income under their own accounting methods, as currently required by section 707(a). This proposal would adopt the "aggregate" concept of partnership taxation by taxing the partnership's payments to the partners in the same manner as their distributive shares of partnership income. As a consequence, partners with different tax year-ends from the partnership's year-end could experience either an acceleration or deferral of income relative to the current rules.

[110] Although the "aggregate" concept of partnership taxation is appropriate for guaranteed payments and distributive shares of partnership income that are made to partners as partners [sic], we believe that the current "entity" concept of partnership taxation is the more appropriate approach to determining the tax treatment of payments made to partners who are not acting in their partner capacity.

[111] For valid business reasons, partners may engage in certain transactions with a partnership on an independent, third-party basis unrelated to their status as partners. Distinguishing between partners acting as partners and partners acting as third parties is comparable to shareholders of C and S corporations who are permitted to engage in similar transactions with their corporations on an independent, third-party basis and are bound by specific tax rules requiring them to be treated as "outsiders." The "matching" rules of section 267 provide sufficient safeguards against attempts to improperly defer income in related party transactions. We are concerned that adopting the JCT staff's proposal would not preserve the integrity of the "entity" concept for determining the tax treatment of partners when they act as independent, third parties in their dealings with the partnership. Accordingly, the AICPA does not recommend adoption.

[112] The explanation in the JCT proposal cites the complexity of current law regarding transactions between partners and partnerships involving the performance of services. We are concerned that this proposal could extend conformity of timing rules to transactions involving leases and sales of property and lending transactions that might create unwarranted tax results. We are also concerned about unintended impacts on Code sections outside Subchapter K; for example, determining whether to classify a distribution right as a qualified payment for estate and gift tax purposes under the special valuation rules of section 2701. The impact on these types of payments and transactions

needs to be addressed before adopting a rule to conform the timing of payments to partners to the time the partnership takes the payment into account.

S Corporation Simplification Recommendations

Excess passive income of S corporations (JCT page 295)

[113] The AICPA supports the Joint Committee staff's two-part proposal; however, we also recommend expanding the proposal to: (1) exclude gain from the sale of a controlled subsidiary from the definition of passive investment income; and (2) provide relief for a corporation whose S election terminated as a result of excess passive investment income. These proposals are discussed below.

Exclude Gain from the Sale of a Controlled Subsidiary from the Definition of Passive Investment Income

[114] Dividends from controlled subsidiaries are generally excluded from excess passive income under section 1362(d)(3)(E). We recommend a similar exclusion for gain on the sale of such subsidiaries, because the policy reasons for excluding dividends from controlled subsidiaries from the definition of passive investment income are equally applicable to gains from the sale of controlled subsidiaries and adoption of this provision would eliminate a trap for the unwary.

Provide Relief for Corporations Whose S Elections Terminated as a Result of Excess Passive Investment Income

[115] We strongly support the Joint Committee staff's proposal eliminating excess passive investment income as a terminating event. In conjunction with this proposal, we suggest the following:

1. A corporation that lost its S status as a result of excess passive investment income should be given an automatic waiver of the five-year waiting period to re-elect S status under section 1362(g).

2. If a corporation has filed a C corporation return because its S election terminated as a result of excess passive investment income and the statute of limitations is open for all years in which the corporation filed a C corporation return, an automatic waiver of the termination of the corporation's S election should be granted under section 1362(f), if: (1) the corporation and all its shareholders file amended returns consistent with the corporation's S election remaining in effect; and (2) the corporation pays any passive investment income tax owed with such amended returns (and properly paid any passive investment income tax owed with S corporation returns previously filed).

3. It a corporation has not filed a C corporation return because it failed to discover that its S election terminated as a result of excess passive investment income, upon discovery of the terminating event the corporation should be granted an automatic waiver of the inadvertent termination of its S

election under section 1362(f), if: (1) it files amended returns to pay any passive investment income tax owed; and (2) all its shareholders file returns consistent with the corporation's S election remaining in effect. If the statute of limitations is closed for the year in which the terminating event occurred or for a year in which tax under section 1375 was due but not paid, the corporation would not qualify for an automatic waiver, but could request a waiver by a filing a private letter ruling request with the IRS National Office.

[116] Implementation of these provisions would result in a more equitable treatment of corporations whose S elections have terminated as a result of excess passive investment income.

Trusts as permitted shareholders of S corporations (JCT 296)

Proposal to eliminate QSSTs

[117] The AICPA opposes eliminating qualified Subchapter S trusts (QSSTs). The Joint Committee staff's recommendation implies that QSST elections would not be available prospectively. Thus, it appears that existing QSSTs would be "grandfathered." In this case, current rules relating to QSSTs would have to be retained indefinitely and simplification would not result. Furthermore, eliminating the QSST rules for all trusts, including existing QSSTs, could adversely impact existing QSSTs and their beneficiaries and for the following reasons may not result in the desired simplification.

1. The current QSST rules, enacted in 1982, are generally well understood by tax practitioners and attorneys involved in drafting trust agreements. Many existing trust agreements include provisions that would allow the trust to qualify as a QSST if it acquires S corporation stock. These agreements specifically authorize the trustee to make a QSST election, but do not specifically authorize an electing small business trust (ESBT) election. Eliminating QSSTs as eligible S corporation shareholders would require that these trusts be reviewed and possibly revised, a time-consuming and costly process.

2. The taxation of S corporation income allocated to stock held by a QSST is straightforward. All income is taxed to the trust's sole beneficiary. Determining how to tax this income at the trust level under Subchapter J could be much more complex. For example, there is uncertainty about how the passive activity loss rules apply in the trust context.

3. Frequently S corporation stock is the only asset a QSST holds. QSSTs are commonly used to hold a child's interest in a family-owned S corporation. Eliminating the QSST rules and subjecting the trust to the Subchapter J rules could result in a much more complex trust return.

4. S corporation income allocated to shares of stock held by a QSST is taxed at the individual beneficiary level and, as a

result, frequently is not subject to tax at the highest individual income tax rate. Trust income, on the other hand, is subject to the highest individual rate of tax once it exceeds a de minimis amount. If the provision eliminating QSSTs on a prospective basis is enacted, yet the rules relating to the taxation of an ESBT remain unchanged (see discussion below), an increased tax burden on S corporation income allocated to a shareholder trust would result.

Simplification of ESBT rules

[118] The AICPA supports the proposal to simplify the electing small business trust (ESBT) rules with modifications. The Joint Committee staff's recommendation to subject the ESBT to the general rules of subchapter J would reduce the complexity inherent in utilizing this type of trust. However, it is important to understand that most of the complexity relating to ESBTs results from the ESBT eligibility requirements, and not from their taxation. Accordingly, we believe that the primary focus of simplification efforts should be on the eligibility requirements.

[119] In support of simplification, without creating opportunities for abuse, we favor the current rules regarding the taxation of ESBTs (other than the IRS's position in proposed regulations, which provides that the grantor portion of an ESBT holding S corporation stock should be treated as a separate trust), and recommend the following changes:

1. The concept of potential current beneficiaries should be eliminated. Because all S corporation items allocated to stock held by an ESBT are taxed at the trust level at the highest individual income tax rate, there is no significant policy reason for retaining two classes of beneficiaries -- potential current beneficiaries and beneficiaries.

2. If the concept of potential current beneficiaries is not eliminated, unexercised powers of appointment should not cause any person in whose favor the power could be exercised to be a potential current beneficiary until such power is actually exercised in his or her favor.

3. In determining the number of eligible shareholders, only the ESBT should be treated as a shareholder.

4. If a trustee elects ESBT status, taxation of the "S portion" should be governed by section 641(c), even if some or all of the S portion is also a grantor trust under Subpart E. This would eliminate uncertainty about the taxation of S corporation items when an ESBT election is made. The proposed regulations treat the grantor portion of an ESBT as a separate trust subject to taxation under sections 671-678. This creates uncertainty about the proper taxation of S corporation items when it is not clear if the trust is a grantor trust. A common example is when a grantor retains the right to substitute property of equivalent value, and it is unclear whether this power may be exercised in a fiduciary or non-fiduciary capacity.



VI. GENERAL BUSINESS ISSUES

Section 1031

Tax-free rollover of like-kind property (JCT page 300)

[120] The Joint Committee staff recommends that a taxpayer should be permitted to elect to "roll over" gain from the disposition of appreciated business or investment property described in section 1031, if like-kind property is acquired by the taxpayer within 180 days before or after the date of disposition (but not later than the due date of the taxpayer's income tax return). The determination of whether properties are considered to be of a like kind would be the same as under present law.

[121] The AICPA supports this position. Allowing rollovers could simplify these transactions and reduce transaction costs by eliminating the qualified intermediaries. The proposal allowing the taxpayer to receive cash from a transaction is consistent with other existing Code provisions such as sections 1033 (involuntary conversions), 1044 (rollover of publicly traded securities gain into specialized small business investment companies), and 1045 (Rollover of gain from qualified small business stock to another qualified small business stock). In addition, prior to its repeal, section 1034 allowed taxpayers to receive cash and roll over the gain on the sale of their principal residence if the proceeds were used to replace the residence within a certain time period.

Property held for use in a trade or business or held for investment in a like-kind exchange (JCT page 30)

[122] The Joint Committee staff recommends that for purposes of determining whether property satisfies the holding requirement under the section 1031 like-kind exchange rules a taxpayer's holding period and use of property should include the transferor's holding period and use for property; (1) contributed to a corporation or partnership in a section 351 or 721 transaction; (2) acquired by a corporation in connection with reorganization under section 368; (3) distributed by a partnership to a partner; or (4) distributed by a corporation in a section 332 transaction. In addition, the Joint Committee staff recommends that property whose use changes should not qualify for like-kind exchange treatment unless it is held for productive use in a trade or business or investment for a specified period of time.

[123] The AICPA supports this position as eliminating the confusion caused by inconsistent IRS rulings and court cases that are causing considerable uncertainty. The proposal would change the focus from the form of holding the property to the use of the property and add consistency. The proposal would also require that the property be held for a specified period of time if its use changes. This would provide guidance to taxpayers entering into like-kind transactions.

Low-Income Housing Tax Credit (JCT page 306)

[124] Under current section 42, a taxpayer owning qualified low- income rental housing can receive a tax credit that is allocated over a payout period of 10-years based on a statutorily prescribed present value calculation. The property, however. must satisfy the section 42 qualification requirements for

at least a 15-year period to avoid recapture of the accelerated portion of the credit. Complexity occurs because of the difference between the payout period and the compliance period when there is a recapture event. The Joint Committee staff recommends lengthening the credit payout period to 15 years to eliminate the complex recapture rules that occur because of the difference between the payout period and the compliance period. The proposal also recommends changing the calculation of the present value of the tax benefits of the credit over the revised longer payout period so that the present value of the tax benefits would remain the same despite the longer payout period.

[125] The AICPA supports this recommendation if the current present-value calculation for the credit is retained and revised as recommended by the JCT.

Rehabilitation Tax Credit (JCT page 307)

[126] The AICPA disagrees with the Joint Committee staff's proposed revision to eliminate the 10 percent rehabilitation tax credit for rehabilitation expenditures with respect to buildings first placed in service before 1936. The rehabilitation credit would only apply to certified historic structures. One reason for the change, as stated by the JCT, is the potential overlap of the two types of buildings, that is, certified historic buildings versus buildings that are simply old but not certified as historic. Other reasons are the complexity in computation, the additional recordkeeping burden, and renovation limitations.

[127] Although the proposal does reduce complexity, it also eliminates a significant policy goal. Enacted in 1978, this credit was intended to address the declining usefulness of existing older buildings throughout the country. The credit allowed for the efficient use of existing buildings by rehabilitation instead of demolition. Existing buildings are now much older than they were in 1978 and unless owners go through the complex application process to receive certified historic structure status, they will not qualify for the credit. It is a very time-consuming process to meet the certified historic structure definition, and therefore, many buildings that currently qualify for the 10-percent credit will not qualify as certified historic structures. If this proposal were enacted, these buildings will be demolished instead of rehabilitated. This does not meet the 1978 policy goal of preserving and maintaining existing building stock.

VII. ACCOUNTING AND COST RECOVERY PROVISIONS

Structural Issues Relating to Accounting for Capital Expenditures (JCT page 322)

[128] The Joint Committee staff thoroughly examined the issues raised by the tension between capitalizing and deducting expenditures, but made no legislative recommendation on these issues, deferring instead to IRS and Treasury.

[129] The AICPA supports this decision. Although legislative action may be appropriate in the future, it appears that IRS and Treasury have made significant progress in developing comprehensive guidance on these issues.

Cash Method of Accounting for Small Businesses (JCT page 328)

[130] The Joint Committee staff recommends that taxpayers with $ 5 million in average annual gross receipts be allowed to use the cash method of accounting

and should not be required to use an accrual method for purchases and sales of merchandise.

[131] The AICPA supports this recommendation. We acknowledge that the IRS issued a proposed revenue procedure in December 2001 that allows the use of the cash method for certain taxpayers with less than $ 10 million in average annual gross receipts. However, the proposed revenue procedure does not apply to most taxpayers that purchase and sell inventory. The AICPA currently is undertaking its own study of the inventory requirement and expects to submit recommendations to IRS and Treasury in the near future.

Amortization of Organization Expenditures (JCT page 332)

[132] The Joint Committee staff notes that the provisions regarding the amortization of organizational expenses are separated into two different Code sections: section 248 for corporations and section 709 for partnerships, and recommends combining these provisions in a single Code section.

[133] The AICPA supports this recommendation as an aid to understanding.

Depreciation -- Mid-Quarter Convention (JCT page 334)

[134] The Joint Committee staff notes that the Code provides several different conventions governing when certain property is considered placed in service for purposes of determining the starting and ending points of depreciation. The Joint Committee staff recommends eliminating the mid-quarter convention under which property placed in service during the last quarter of the tax year may under certain conditions be treated as having been placed in service (or disposed of) on the mid-point of that quarter.

The AICPA supports this recommendation.

Additional Accounting and Cost Recovery Provisions for JCT Future Consideration

[135] The AICPA recommends that the JCT staff consider the following additional tax simplification recommendations as part of any future study or legislation.

Reform tax depreciation lives and methods

[136] The number of separate depreciation schedules taxpayers must keep should be reduced (For example, 100% declining balance for existence of multiple lives, optional election of section 1245/1250(a), etc.). Also, there is a need to update the current revenue procedure (Issued in 1987) to reflect classes and types of assets that were in existence in prior years.

Eliminate section 263A for "small" manufacturers and "small" resellers

[137] Section 263A should be eliminated for small manufacturers and small resellers. "Small"' would be defined as an entity with gross receipts less than $ 10 million. Thus, the manufacturer or reseller would be required to capitalize costs based on full absorption (consistent with financial statement requirements), but would not be required to capitalize costs under the current

Uniform Capitalization requirements.

IX. INTERNATIONAL TAX

Anti-Deferral Regimes Applicable to Income Earned Through Foreign Corporations (JCT page 398)

[138] The Joint Committee staff's proposal would: (1) eliminate the rules applicable to foreign personal holding companies (FPHC) and foreign investment companies; (2) exclude foreign corporations from the personal holding company rules; and (3) include certain personal services contract income targeted under the present-law FPHC rules as subpart F foreign personal holding company income.

[139] The AICPA supports this recommendation as it would eliminate complex, redundant, and out dated anti-deferral regimes. A multitude of anti-deferral regimes have been enacted, which are sometimes overlapping and inconsistent with each other..

[140] The proposed changes would make foreign corporations' passive income subject to U.S. tax under either the controlled foreign corporation rules or the passive foreign investment company (PFIC) rules. As the JCT staff points out, eliminating the other anti-deferral regimes may result in certain gaps in coverage, but the gaps do not represent significant avenues for evading tax on passive foreign income.

Expand Subpart F De Minimis Rule (JCT page 419)

[141] The AICPA strongly supports the Joint Committee staff's proposal to modify the subpart F de minimis rule to be the lesser of five percent of gross income or $ 5 million.

[142] Subpart F contains a set of highly complex rules primarily designed to tax currently the passive income and other types of highly mobile income (collectively, "foreign base company income") of controlled foreign corporations (CFCs). Under the current de minimis rule F, if the gross amount of a CFC's foreign base company income for the tax year is less than the lesser of five percent of the CFC's gross income or $ 1 million, then no part of the CFC's gross income is treated as foreign base company income. The $ 1 million limitation has the effect of applying a smaller percentage of gross income test for those CFCs with gross income in excess of $ 20 million (because $ 1 million is less than five percent of any amount greater than $ 20 million).

[143] Accordingly, by increasing the dollar limitation prong of the de minimis rule the proposal would reduce complexity and filing burdens for taxpayers with CFCs engaged in active businesses and havIng on]y a relatively insignificant portion of the CFCs' gross income constituting foreign base company income. This proposal would particularly benefit smaller companies, by sparing them the difficulties and costs of understanding and complying with the subpart F rules.

Look-Through Rules for Dividends from Noncontrolled Section 902 Corporations (JCT page 421)

[144] The AICPA strongly supports the Joint Committee staff's proposal to immediately apply the "look through" approach to all dividends paid by a

so-called 1050 company, also known as a "noncontrolled section 902 corporation." This recommendation would also render moot the timing of the accumulation of the earnings and profits out of which the dividend is paid.

[145] The current rules for dividends from 10/50 companies are complex and result in significant compliance burdens for taxpayers. Dividends paid currently from a 10/50 company are categorized in a separate category (or "basket") for foreign tax credit purposes. Thus, a U.S. taxpayer with interests in multiple foreign corporate joint ventures in which the U.S. taxpayer owns at least 10 percent but no more than 50 percent) must perform multiple foreign tax credit limitation computations.

[146] New rules are scheduled to come into effect for dividends paid in a tax year beginning after December 31, 2002. Under these new rules, dividends paid from pre-2003-generated earnings will be categorized in a single 10/50 basket, whereas dividends paid from post-2002-generated earnings will be subject to "look through" rules. Thus, the new rules offer some simplification compared to the current rules but contain some additional complexity of their own.

[147] The JCT recommendation would further simplify taxpayers' record-keeping requirements by accelerating and completing the elimination of the separate basket approach.

Foreign Tax Credits Claimed Indirectly through Partnerships (JCT page 424)

[148] The Joint Committee staff recommends that a U.S. corporation should be entitled to claim deemed-paid foreign tax credits under section 902 with respect to a foreign corporation that is held indirectly through a foreign or U.S. partnership, if the U.S. corporation owns (through the partnership) at least 10 percent of the foreign corporation's voting stock.

[149] The AICPA strongly supports this recommendation as it would clear up an ambiguity created by the IRS published statements. Whether U.S. corporations may claim deemed-paid credits through passthrough entities is uncertain. In Rev. Rul. 71-141, the IRS concluded that a U.S. corporate partner in a U.S. general partnership could claim deemed-paid credits with respect to dividends paid by a foreign subsidiary owned through the partnership. However, the preamble to the 1997 final regulations under section 902 indicates that the IRS is unsure whether the principles set forth in Rev. Rul. 71-141 should apply in other contexts (such as in the case of limited partnerships or foreign pass-through entities). The JCT staff, however, believes that, generally. the same principles should apply in these other situations as well, and we concur.

Conform Sections 30A and 936 (JCT page 428)

[150] This Joint Committee staff proposal would combine the credit computation rules into one Code section and conform the application of the possessions tax credit across all possessions, should Congress choose to extend the credits past their current scheduled expiration of 2005.

[151] The Section 30A credit is a separate rule applicable only to operations in Puerto Rico. Although this credit is a subset of section 936 and is computed under the same general rules, it is contained in an entirely separate, non-adjacent Code section. This arrangement creates unnecessary complexity for

credit claimants in Puerto Rico.

[152] The AICPA supports this recommendation, as well as the renewal of the credits to which it relates. The harmonization of the possessions credit rules for all possessions should have the effect of rendering neutral the tax considerations of investing in one possession versus another.

Application of Uniform Capitalization Rules for Foreign Persons (JCT page 432)

[153] The Joint Committee staff recommends that U.S. generally accepted accounting principles (GAAP) be used for purposes of determining a foreign person's earnings and profits (E&P) and Subpart F income, instead of the uniform cost capitalization (Unicap) rules which are used by domestic taxpayers.

[154] The AICPA supports this proposal. Even in domestic situations, the Unicap rules are highly complex and burdensome to taxpayers. In our experience, many IRS auditors do not even understand them. Requiring foreign persons to determine their E&P and Subpart F income using the Unicap rules is very burdensome given the multiple sets of books that usually must be maintained already (e.g., for foreign financial accounting purposes, for foreign tax purposes for U.S. financial accounting purposes, for U.S. tax purposes, and for internal reporting purposes).

[155] It is also worth noting that the purpose of the Unicap rules is simply to defer recognition of deductions via the conversion of certain currently deductible period costs into capitalized product costs. Accordingly, only the timing of the recognition of tax revenues would be affected.

Secondary Withholding Tax on Dividends from Foreign Corporations (JCT page 436)

[156] The Joint Committee staff's proposal would eliminate the secondary withholding tax on dividends paid by certain foreign corporations.

[157] The AICPA supports this recommendation, given the clear redundancy and practical difficulties in administering this tax.

[158] The branch profits tax was enacted as a part of the Tax Reform Act of 1986 and was designed to replace the secondary, withholding tax. If a foreign corporation is subject to the branch profits tax, then no secondary withholding tax applies.

[159] Some foreign corporations are not subject to the branch profits tax as a result of particular provisions in U.S. tax treaties with certain countries. Many of these treaties, however, also prevent the imposition of a secondary withholding tax. Thus, the secondary withholding tax applies today only in very, limited situations where a treaty prohibits the application of the branch profits tax rules but not the secondary withholding tax. There are also significant enforcement and monitoring problems with the secondary withholding tax in the case of dividends paid by foreign corporations to foreign shareholders.

Capital Gains of Certain Nonresident Individuals (JCT page 440)

[160] The Joint Committee staff's proposal would eliminate section 871(a)(2), which imposes a 30-percent tax on certain U.S.- source capital gains of non-resident individuals.

[161] The AICPA supports this recommendation, given the statutory provision's very limited application today. Section 871(a)(2) applies to non-resident aliens who are present the United States for at least 183 days in a tax year. However, under the "substantial presence test" of section 7701(b), an individual who is present in the United States for at least 183 days generally is considered to be a resident. Thus, section 871(a)(2) can apply only if a foreign national spends at least 183 days in the United States but some or all of these days are not taken into account for purposes of section 7701(b) under very limited exceptions that rarely apply. Even where section 871(a)(2) otherwise would apply, in most cases the provisions of U.S. tax treaties would prevent its imposition.

U.S. Model Tax Treaties (JCT page 445)

[162] The Joint Committee staff calls for the Treasury Department to update and publish U.S. model tax treaties once per Congress.

[163] The AICPA generally supports the concept underlying this recommendation. Regularly updated model treaties would provide taxpayers and practitioners with helpful guidance regarding current U.S. tax treaty policy. However, an updated model treaty would be useful only if it contains changes that arise from thoughtful reflection on recent experience with existing treaties.

[164] Moreover, if Treasury were compelled to devote resources to the continual updating of the U.S. model treaty, we are concerned that insufficient resources would be available to deal with more pressing needs, such as more detailed guidance with respect to existing and newly signed treaties. as well as the expansion of the U.S. treaty network. Thus, the "once per Congress" requirement should be changed to a "once every five years" requirement, to allow sufficient time for the accumulation of additional experience and for thoughtful reflection, as well as a more appropriate allocation of resources.

Older U.S. Tax Treaties (JCT page 448)

[165] The Joint Committee staff proposes that the Treasury Department should report to Congress on the status of older U.S. tax treaties once per Congress.

[166] The AICPA generally supports the concept underlying this recommendation. Such a report would provide taxpayers and practitioners with helpful information regarding the status of U.S. tax treaty negotiations, and may allow for more informed public commentary on these negotiations. Some information, however, such as the priority given to a particular treat, seem to be too politically sensitive to disclose in a public report (e.g., a country given a lower priority than it believes it deserves could be offended). Other information, such as the impact of significant law changes on treaties, would seem to be more appropriately addressed at the time the law change is proposed, rather than in a periodic Treasury report. Moreover, we believe that a balance needs to be struck between updating old treaties and dealing with other important treaty-related matters, such expanding the U.S. treaty network and resolving important issues with respect to recently ratified treaties.



X. TAX-EXEMPT ORGANIZATION PROVISIONS

Percentage Limits on Grass-Roots Lobbying Expenditures of Electing Charities (JCT page 451)

[167] The Joint Committee staff recommends that the percentage limitation on grass-roots lobbying expenditures should be eliminated. The purpose of the section 501(h) expenditure test is to ensure, by using bright-line rules, that no substantial part of an electing charity's activities are lobbying. Accordingly, section 501(h) caps an electing charity's permissible overall lobbying expenditures. The separate limit for grass-roots expenditures does not increase or decrease the permitted amount of total lobbying expenditures; rather it limits grass-roots lobbying as a subset of total lobbying. Thus, an electing charity can spend up to $ 1 million on lobbying, but no more than $ 250,000 of that amount may be for grass-roots lobbying. In the absence of a significant policy rationale supporting the distinction between grass-roots lobbying and direct lobbying, the Joint Committee staff believes that the complexity caused by the distinction justifies elimination of the grass-roots expenditure limitation.

[168] The AICPA supports the recommendation to eliminate the separate expenditure limitation on grass-roots lobbying by certain tax-exempt organizations. Currently, charities that measure their permissible lobbying activity by making the section 501(h) election must distinguish between direct and grass-roots lobbying. Such charities must both understand the difference, then define and allocate expenses for grass-roots lobbying as a subset of total lobbying expenditures. This proposal would eliminate this largely unnecessary, burdensome process of definition and calculation that often results in inexact and incorrect information being provided to the IRS.

Excise Tax Based on Investment Income (JCT page 456)

[169] The Joint Committee staff recommends that the excise tax based on net investment income of private foundations should be eliminated. This excise tax was originally intended as a fee to fund administration of exempt organizations generally. However, even in its early years, the tax raised considerable more revenue that the IRS spent on supervision. Today, the tax continues to generate more revenue than necessary. In addition, there is no evidence that the amount of excise tax collected affects in any way the amount that is appropriated to the IRS for administration of programs related to exempt organizations. Thus, funds generated by the excise tax are not earmarked for their intended purpose, resulting in a tax on private foundations for purposes of the general treasury. In addition. because the tax counts toward a foundation's minimum qualified distributions, eliminating the tax would result in many cases in increased, charitable activity.

[170] The AICPA supports this proposal. The current two-tier federal excise tax -- imposing a one percent tax on a foundation's annual investment income if it maintains or increases its level of giving, but a two-percent tax if it does not -- is complex, misunderstood, and has not necessarily encouraged increased giving. To achieve the lower rate, a foundation must (1) maintain its five year average historic giving level as a percentage of the value of its current-year investment asset values: and (2) give its tax savings to charity by increasing its distributions by the one-percent tax reduction. In other words, the foundation can currently redirect the half of the two-percent excise tax to

charitable recipients.

[171] Eliminating the excise tax on investment income would make more money available for private foundations' support of its charitable grantees and programs. The burden of calculating net investment income, making estimated tax payments, and deciding whether to increase or decrease annual charitable distributions based on tax considerations would be eliminated.

XIV. ESTATE AND GIFT TAX PROVISION

Conform Certain Family-Owned and Small Business Provisions (JCT page 531)

[172] The AICPA supports the Joint Committee staff's proposal to conform the section 2032A special use rules with similar rules governing the section 2057 family-owned business deduction. This support is conditional on section 2057 expiring in two years. (Note: Both the recommendations and our comments focus on pre-2001 tax law.)

[173] In its February 2001 "Study on Reform of the Estate and Gift Tax System." the AICPA noted that targeted relief provisions like those found in Sections 2031(c). 2032A, 2057, and 6166 provide limited relief to a small number of business owners, land owners, and farmers without providing any benefit to holders of other illiquid and inaccessible assets, including retirement accounts, personal residences and other real estate, installment obligations, stock options, etc.

[174] Consequently, the AICPA does not support increasing targeted relief under sections 2031(c). 2032A, or 2057, or trying to extend the current liquidity relief measures under section 6166. Targeted relief has not been successful in the past, and it treats similarly situated taxpayers differently. The AICPA believes it would be difficult to structure targeted relief in a way that will be useful for taxpayers. In addition, the complexities of section 6166 make it unworkable for many taxpayers. Therefore, the AICPA favors implementing a new regime of broadened liquidity/payment relief measures by eliminating current sections 2031(c), 2032A, 2057, and 6166 and replacing them with broader, simpler provisions available to all taxpayers. If concerned about overuse, the government could limit the attractiveness of such a tax payment deferral regime by adjusting interest rates and the deferral period.

If the current transfer tax system is modified (and not repealed in 2010), the AICPA suggests then following:

o Although the appropriate increase in the applicable exclusion amount depends on Congress' specific goals, increasing the exclusion amount to $ 5 million per taxpayer would eliminate estate tax concerns for 90 to 95 percent of previously taxable estates. Also, the applicable exclusion amount should be indexed annually for inflation.

o The applicable exclusion amount should be made portable (i.e., $ 10 million per couple), so that any portion unused by the first spouse to die could be utilized by the surviving spouse. Although this can be accomplished under current law through effective tax planning, portability should be made an

explicit part of the law.

o The applicable exclusion amount should be modified so that it becomes a true exemption.

o If the estate tax rate structure is altered, across-the-board rate reductions and fewer brackets are preferable to simply reducing the highest marginal rate. In addition to reducing the rates affecting smaller estates, the top marginal rate should be reduced to a rate that is no higher than the maximum individual income tax rate.

o The full step-up in Income tax basis to fair market value for inherited assets should be retained as under current law.

o The state death tax credit should be retained in its current framework, as a credit instead of a deduction, and any revenue losses to the states should be minimized.

If the estate and generation skipping transfer taxes are repealed in 2010 as scheduled, the AICPA suggests the following:

o The carryover basis provisions should include a statutory safe-harbor as an alternative method for determine the basis of lifetime gifts and transfers at death. In some cases, an executor or beneficiary will not have adequate records to calculate carryover basis of assets held at death. A safe-harbor could be tied to inflation rates or other measures of price appreciation, based on historical published prices, or based on a statutorily allowed percentage of fair market value.

o Tax professionals, preparers, beneficiaries, and executors who use a "reasonable" method to determine carryover basis when adequate records do not exist should not be penalized under a carryover basis regime.

o If allowances for basis step-ups are included in a carryover basis regime, an elective safeharbor procedure should be included for allocating the allowable basis step-up pro rata to all assets and all beneficiaries in a taxable estate.

o An automatic, long-term holding period for all inherited assets should be provided as under current law.

XV. EMPLOYMENT TAX PROVISIONS

Structural Issues Relating to Worker Classification(JCT page 539)

[175] The Joint Committee staff discusses the general issues relating to proposals that would simplify the rules regarding worker classification but makes no specific recommendation in this area.

[176] The AICPA agrees that this is an area in need of simplification, and we stand ready to assist the JCT staff with the development of a legislative solution.

Structural Issues Relating to Determination of Individuals Subject to Self-Employment Tax (JCT page 551)

[177] The AICPA recommends that the JCT staff consider simplification recommendations in the section 1402 area as part of any future study or legislation. Attached as Appendix C is the AICPA legislative proposal regarding tax on self-employment income under section 1402.

XVI. COMPLIANCE AND ADMINISTRATIVE PROVISIONS

Penalties and Interest -- Overall (JCT 568-571)

[178] We believe the Joint Committee staff's proposals are an excellent response to the need for a comprehensive look at the Code's interest and penalty provisions. Our comments are based on considering the penalty and interest regime in its entirety. Individual comments and suggestions should not be accepted or rejected in a piecemeal fashion since the appropriateness of one provision often depends on the status of another. For a more detailed explanation of the AICPA's positions regarding the recommendations involving penalties and interest, please refer to the AICPA's testimony before the House Ways and Means Committee on January 27, 2000. (See Appendix D.)

Provide one interest rate for both individuals and corporate taxpayers

[179] The Joint Committee staff recommends providing one interest rate for overpayments and underpayments for both individuals and corporations, equal to the short-term applicable federal rate (AFR) plus 5 percentage points.

[180] The AICPA has qualified support for the proposal. We believe that adopting a single rate for underpayments and overpayments of all taxpayers will substantially reduce the administrative difficulties and financial inequities associated with the numerous differentials contained in the current regimen. However, the concept of a rate equal to the AFR plus five percent will establish an excessively high rate.

Exclude interest paid by the IRS from the income of individual taxpayers:

[181] In an attempt to equalize rates on an after-tax basis for individual taxpayers and corporations, the Joint Committee staff recommends that overpayment interest paid by the IRS to individuals be excludable from income.

[182] The AICPA believes that the recommendation is a constructive proposal in attempting to provide equivalent effective interest rates on underpayments and overpayments for individuals. In addition, we believe the proposal should be broadened to clarify the deductibility of deficiency interest attributable to trade or business or investment activities of a non-corporate taxpayer. Thus, section 163(h) should be modified to allow every taxpayer a deduction for interest attributable to a deficiency attributable to trade or business activities, regardless of the form in which the businesses is operated, or to

investment activities.

Convert the present law penalty for failure to pay estimated tax into an interest provision and certain other estimated tax "reforms"

[183] The Joint Committee recommends repealing the individual and corporate estimated tax penalties and replacing them with interest charges.

[184] The AICPA supports the proposal. Converting the estimated tax penalties into interest charges would result in a more accurate characterization because the penalties are essentially fees for the use of money.

Repeal the present-law penalty for failure to pay tax, and waive the $ 43.00 fee on installment agreements for taxpayers who agree to an automated withdrawal payment plan

[185] Current law contains a failure-to-pay penalty equal to 0.5% per month (or fraction thereof), up to a maximum of 25%. The Joint Committee staff recommends repealing the penalty for failure to pay taxes, noting the repeal would be consistent with a policy initiative begun by the IRS Restructuring and Reform Act of 1998, in which the failure-to-pay penalty rate was reduced. Also, the JCT recommends waiving the $ 43.00 fee on installment agreements for taxpayers who agree to an automated withdrawal payment plan.

[186] The AICPA supports the proposal. We believe that, because the rate of interest on underpayments is now tied to the market rate of interest, this penalty is a substitute for interest and should be repealed. Further, we support the provision to waive the installment agreements fee automated withdrawal plans. We believe that this withdrawal will provide an incentive to enter into these agreements and better ensure payment of taxes. Some states that offer automated withdrawal payment plans have shown high rates of adherence to installment agreements. We believe that this provision would similarly facilitate a higher rate of adherence to federal installment agreements.

Implementation of a late payment service change for failure to enter into an installment agreement with the IRS by the fourth month after assessment

[187] The Joint Committee staff recommends imposing an annual 5% late payment service charge on taxpayers who do not enter into an installment agreement within four months after assessment. The service charge would be imposed on the balance remaining unpaid at the end of the four month period.

[188] The AICPA opposes the proposal. We do not support establishing a service charge for failure to enter into an installment agreement. We believe that such a service charge will penalize taxpayers who already are struggling to pay their tax obligations.

Interest (JCT pages 568-569)

Allow abatement of interest if gross injustice would otherwise result.

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