dar year in order to prevent deferral of tax by partners and beneficiaries. Other provisions of the 1986 Act limited the deferral of income arising from the ability of regulated investment companies and real estate investment trusts to receive dividends paid deductions for dividends paid after the end of the calendar year. Possible Proposal In order to prevent the deferral of income earned through a cooperative: 1. all cooperatives could be required to adopt the calendar year as their taxable year; and 2. cooperatives could be permitted to deduct patronage dividends only in the year that the dividends are paid. Pros and Cons Arguments for the proposals 1. The proposal would require income that is earned by a cooperative to be recognized currently either by the cooperative or by its patrons. The "single tax" regime for cooperatives would be preserved, since the cooperative would still receive a deduction at the time that patronage dividends are paid. 2. The proposal would reduce the advantage of cooperatives that compete with investor owned business enterprises. 3. The proposal is an extension of the provisions of the 1986 Act that attempted to limit the deferral of income through other passthrough entities. Arguments against the proposals 1. Under the proposal, cooperatives would be required to distribute all of their taxable income for a taxable year in order to avoid paying tax for that taxable year. To the extent that cooperatives distribute sufficient amounts to avoid paying tax, or to the extent that cooperatives actually pay tax, the amount of the cooperative's capital is diminished and would need to be replaced from other sources. This may be undesirable where the cooperative is not of a type that competes with investor owned business enterprises but rather is, for example, an entity used by small farmers to allow them to compete more effectively. 2. The calendar year may not be a "natural business year" for certain cooperatives, and use of the calendar year may be inconvenient for such cooperatives. g. Current accrual of market discount on bonds Present Law In general, present law requires inclusion of market discount on bonds only upon redemption or other disposition of the bond. Thus, a taxpayer who purchases a bond after original issue at a price less than its face amount (or adjusted issue price in the case of a bond originally issued at a discount) does not, absent an election, include in income any portion of the discount prior to disposition of the bond. Except in the case of tax-exempt obligations, market discount that accrues while the taxpayer holds such a bond is treated as ordinary income upon the disposition of the bond up to the amount of gain realized. Interest on indebtedness incurred or continued to purchase or carry a bond with market discount is deferred to the extent that such interest does not exceed the market discount accruing on the bond. Any interest expense so deferred is allowed when the market discount is recognized. Possible Proposals 1. Require market discount on all bonds to be included currently as interest income by the holder as such discount accrues on an economic basis. Holders of discount bonds would know the amount of economic accrual of market discount by requiring brokerage firms (or other intermediaries) to provide relevant information to purchasers of market discount bonds. As an alternative to economic accrual, the holder could be permitted to use a simplified method (e.g., straight line, proportional) for computing market discount allocable to a period. 2. Require current accrual only for market discount on bonds held by a defined class of "sophisticated" taxpayers, e.g., those that must accrue market discount on short-term obligations (i.e., banks, regulated investment companies, taxpayers using an method of accounting and taxpayers holding obligations primarily for sale to customers in the ordinary course of the taxpayer's trade or business). Arguments for the proposal Pros and Cons 1. From the holder's point of view, market discount is the economic equivalent of interest and is indistinguishable from original issue discount, which a holder must include in income on an annual basis. 2. Requiring current inclusion of market discount would help correct certain asymmetries in present law. For example, present law already permits acquisition premium to be deducted on a current basis. (142) 3. The proposal would eliminate the ability of taxpayers to offset, in effect, a capital loss against ordinary income, contrary to the general rules limiting the deductibility of capital losses. Where a bond that was purchased with market discount is later sold for an amount that is less than the taxpayer's original basis in the bond plus the amount of market discount that has accrued economically from the date of the acquisition, a portion of the accrued market discount (which is ordinary income) is offset by the capital loss resulting from decline in value of the bond. Under the proposal, the accrued market discount would be taken into account as ordinary income (with a corresponding increase in the taxpayer's basis in the bond) and any loss would be deductible as a capital loss. 4. The proposals would eliminate the need for the complex rules requiring deferral of interest on debt attributable to market discount bonds. Arguments against the proposals 1. Requiring current inclusion of market discount in income would interfere with the efficient operation of the capital markets. 2. Holders of market discount bonds would be required to pay tax on income before cash is actually received, creating liquidity problems. 3. Unless the proposal is limited to sophisticated taxpayers or broad reporting requirements are imposed on brokerage houses to provide the holder (and the Internal Revenue Service) with the amount of discount that must be included in income, the proposals may be difficult to administer for both the holder, since the computation of the amount of accrued income on an economic basis is complex, and the Internal Revenue Service, since the Service does not presently receive information relating to the purchase of bonds in the secondary market. h. Installment sales Present Law Under present law, a taxpayer who sells property ordinarily must recognize gain or loss at the time of the sale. However, a taxpayer who is eligible to use the installment method may defer the payment of tax and recognize gain from a sale of property in proportion to the payments received. In general, the installment method may be used to report gain from the sale of personal property on the installment plan by dealers in personal property who regularly sell on the installment plan, or for other sales of property where at least one payment is to be made after the end of the taxable year in which the sale is made. Use of the installment method is generally limited under the socalled "proportionate disallowance rule" for dealer sales of real property and dealer sales of personal property eligible to be reported on the installment method, as well as for sales of real property used in the taxpayer's trade or business or held for the production of rental income where the selling price of such real property is greater than $150,000. Under the proportionate disallowance rule, a pro rata portion of the taxpayer's indebtedness is allocated to, and is treated as a payment on, the installment obligations of the taxpayer. Use of the installment method is not allowed for sales pursuant to a revolving credit plan and for sales of publicly traded property. In addition, the installment method may not be used for purposes of the alternative minimum tax for sales that are subject to the proportionate disallowance rule. At the election of the seller, installment obligations arising from certain sales of residential lots and "timeshares" are not subject to the proportionate disallowance rule. Rather, such taxpayers may compute their tax liability under the installment method and are required to pay interest on the amount of deferred tax attributable to the use of the installment method. Possible Proposals 1. Use of the installment method would be repealed for all sales by dealers and for all non-dealer sales that are subject to the proportionate disallowance rule. 2. Same as proposal 1, except that, for non-dealer sales, payment of the tax due on account of the sale may be deferred for an appropriate period with an appropriate interest charge. Pros and Cons Arguments for the proposals 1. Repeal of the installment method would result in income being measured more accurately by both dealers and non-dealers, and would result in application of the same rules for regular tax purposes as are applied for alternative minimum tax purposes. 2. Repeal of the installment method would eliminate the need to apply the complicated provisions of the proportionate disallowance rule. 3. Liquidity problems are more likely to occur in the case of nondealer sales than in the case of dealer sales. Hence, an exception under which tax may be deferred with interest should be made for such sales. Arguments against the proposals 1. Both dealers and non-dealers suffer the same liquidity problems that the use of the installment method is intended to alleviate. 2. The proportionate disallowance rule is an appropriate limitation on the use of the installment method because it generally reflects the extent to which the seller has received cash. |