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d. Repeal of vacation pay reserve

Present Law

Under present law, an accrual-method taxpayer generally is permitted a deduction in the taxable year in which all of the events have occurred that determine the fact of a liability and the amount thereof can be determined with reasonable accuracy. Nonetheless, in order to ensure the proper matching of income and deductions in the case of deferred benefits for employees (such as vacation pay earned in the current taxable year, but paid in a subsequent year), an employer generally is entitled to claim a deduction in the taxable year of the employer in which ends the taxable year of the employee in which the benefit is includible in gross income. Consequently, an employer generally is entitled to a deduction for vacation pay in the taxable year of the employee for which the pay (1) vests (if the vacation pay plan is funded by the employer) or (2) is paid and for amounts which vest or are paid within 2 1/2 months after the end of the employer's taxable year. Under a special rule, an employer can elect to deduct an amount representing a reasonable addition to a reserve account for vacation pay earned by employees before the close of the current year and paid by the close of that year or within 8-1/2 months thereafter.

Possible Proposal

The special rule that permits taxpayers a deduction for additions to a reserve for vacation pay could be repealed. Under this proposal, deductions for vacation pay would be allowed in any taxable year for amounts paid, or funded amounts which vest, during the year or within 2-1/2 months after the end of the year.

Arguments for the proposal

Pros and Cons

1. Allowance of a deduction prior to the time vacation pay is paid overstates the amount of the deduction because of the time value of money, thus, providing a tax subsidy for vacation pay relative to regular compensation.

2. The reserve for vacation pay is an exception to the general rule of not allowing reserves for Federal income tax purposes.

Argument against the proposal

Allowing a deduction for vacation pay permits a more proper matching of the cost of providing vacation pay to the income that gave rise to the obligation to pay vacation pay.

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e. Limitations on deductibility of advertising costs

Present Law

A deduction is allowed for all ordinary and necessary business expenses paid or incurred during the taxable year in carrying on a trade or business. No deduction is allowed for capital expenditures, including the cost of acquiring an asset having a useful life that extends substantially beyond the taxable year. Selling expenses, including costs relating to advertising and promotion of a product, are treated as ordinary and necessary business expenses and hence are fully deductible in the year paid or incurred.

Possible Proposals

1. Require that all or a specified portion of advertising costs paid or incurred during a taxable year be amortized over some period of time, rather than deducted currently.

2. Deny any deduction for advertising for, or promotion of, alcohol and/or tobacco products.

Arguments for the proposal

Pros and Cons

1. The benefit of amounts paid for advertising extend beyond the year of the expenditure. Requiring some portion of advertising costs to be deferred to a later year thus results in a more proper matching of the expenses with the income generated by them.

2. Advertising expenditures do not lead to increase competitiveness; they merely shift consumer buying priorities. Thus, there is no justification for a tax subsidy for these expenditures.

3. Permitting a current deduction for advertising costs creates a preference for businesses that invest in advertising over businesses that invest in tangible assets or other types of intangible assets, the costs of which must be depreciated or amortized.

4. Since it is difficult to determine precisely what portion of advertising costs benefits a particular year, it is appropriate to provide an assumed allocation of the benefit of such costs by statute.

5. Limitations on advertising deductions will have very little effect on those corporations which had the biggest tax increases under the 1986 Act. Rather, they would affect those that received the highest benefits from rate reduction.

6. Because of the adverse health effects of alcohol and tobacco products, it is inappropriate to allow a deduction for advertising and promoting them.

Arguments against the proposal

1. Advertising costs are costs of selling a product in the current taxable year, and do not create a separate and distinct asset having

a life that extends substantially beyond the end of the year. Accordingly, they should be fully deductible in the year incurred.

2. Severe definitional and administrative problems will result in trying to differentiate between advertising and promotional expenses, on the one hand, and fully deductible selling expenses on the other hand.

3. Even if some portion of advertising costs theoretically benefits future taxable years, it is only a de minimis amount. In any event, it is impossible to verify the degree or proper allocation of the benefit to future years.

4. It is not appropriate tax policy to restrict the deductibility of advertising expenses while retaining expensing for similar expenditures such as research and development.

5. Advertising provides a valuable service by providing information about prices and product quality that helps consumers make more informed decisions.

6. It is inappropriate to use discriminatory tax provisions to deal with non-tax issues involving alcohol and tobacco.

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f. Elimination of deferral of income of cooperatives

Present Law

Certain corporations are eligible to be treated as cooperatives and taxed under the special rules of subchapter T of the Code. In general, the subchapter T rules apply to any corporation operating on a cooperative basis (except mutual savings banks, insurance companies, most tax-exempt organizations, and certain utilities).

In general, a cooperative may adopt any fiscal year as a taxable year. For Federal income tax purposes, a cooperative generally computes its taxable income as if it were a taxable corporation, with one important exception-the cooperative may deduct from its taxable income patronage dividends paid. In general, patronage dividends are profits of the cooperative that are rebated to its patrons pursuant to a preexisting obligation of the cooperative to do so. In computing its taxable income for a taxable year, the cooperative may deduct patronage dividends that are paid up to eight and one-half months after the close of the taxable year.

Members of the cooperatives who receive patronage dividends must treat the dividends as income, reduction of basis, or some other treatment that is appropriately related to the type of transaction that gave rise to the dividend. For example, where the cooperative markets a product for one of its members, patronage dividends attributable to the marketing are treated as additional proceeds from the sale of the product and are includible in the recipient patron's income. Recipients of the patronage dividends generally take such dividends into account when received, even if the amounts are deducted by the cooperative in a prior period.

Thus, under present law, income earned by a cooperative generally is intended to be subject to one level of tax which is to be borne by the patron of the cooperative. Nevertheless, income earned by a cooperative may not be taxed to a patron until a period following the period in which the income was earned. This deferral may occur, for example, if the cooperative has a fiscal year and pays out its income for the fiscal year to calendar year taxpayers, but the distribution is during the portion of the fiscal year following the close of the calendar year.

Such deferral also may occur where the cooperative has a calendar year as a taxable year, but receives deductions for patronage dividends paid after the close of the calendar year while such dividends are taken into account by calendar year patrons only when received. Moreover, the period of deferral may be extended, in some cases for several years, where a cooperative pays patronage dividends to patrons that are themselves cooperatives.

Various provisions of the Tax Reform Act of 1986 (the "1986 Act") restricted the ability of other pass-through entities such as partnerships and trusts to use taxable years other than the calen

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