quisition or fails to allocate the securities or the proceeds of the disposition to accounts of participants or their beneficiaries. 2. The deduction could be repealed in its entirety. Pros and Cons Arguments for the proposals 1. The bills (H.R. 1311 and S. 591) limit the total revenue loss from the special estate tax deduction to the amount originally estimated and conform the provision to original Congressional intent. 2. The existence of special tax benefits for transfers of stock to an ESOP creates an incentive to maintain an ESOP as a primary source of retirement income for employees. The tax laws should not create an incentive for an employer to maintain one type of retirement plan to the exclusion of other types. If an employer experiences financial difficulty, employees with retirement savings concentrated primarily in employer stock may be subject to a double risk of loss. Not only would employees lose their jobs (and employer contributions to their retirement plan possibly would be reduced or eliminated), but they also may suffer from decreases in the value of the securities and the amount of dividends paid thereon. Moreover, if a plan is permitted to invest substantially in employer securities, a plan fiduciary could be subject to great pressure to time purchases and sales to improve the market in those securities, whether or not the interests of plan participants were adversely affected. Arguments against the proposals 1. Making frequent changes in the ESOP area creates uncertainty and thereby discourages the use of ESOPs. 2. The tax incentives historically afforded ESOPs represent an attempt to balance tax policy goals encouraging employee stock ownership with those encouraging employer-provided retirement benefits. The special tax benefits for ESOPs are designed to encourage the sales of stock to ESOPs by shareholders with whom the stock ownership has been concentrated, thereby expanding the individuals having an ownership interest in an employer. The estate tax deduction for sales of securities to an ESOP accomplishes this goal of expanded capital ownership by creating an incentive to transfer stock ownership from a decedent's family to the employees of the employer whose stock the decedent held. Revenue Effect [Fiscal years, billions of dollars] Proposal 1988 1989 1990 1988-90 5.4 Modify estate tax deduction for ESOPS.. 1.8 1.5 2.1 F. Tax-Exempt Organizations 1. Unrelated Business Income Tax on Certain Trade Association Income Present Law The Code imposes a tax on the unrelated business income of otherwise tax-exempt organizations (secs. 511-514). Although this tax generally applies only when an exempt organization receives income from an unrelated trade or business, special rules apply to certain types of organizations. In the case of social clubs (sec. 501(c)(7)), voluntary employee's beneficiary associations (sec. 501(c)(9)), and supplemental unemployment benefit trusts or group legal service organizations (secs. 501(c)(17), (c)(20)), the unrelated business income tax (UBIT) applies to all income of the organization other than exempt function income (sec. 512(a)(3)). The latter category of income (exempt function income) that is not subject to the UBIT consists of (1) income from dues, fees, charges, or similar amounts paid by the organization's members in connection with its exempt purposes; (2) certain investment income (or certain other types of income) set aside to be used for charitable purposes, or for purposes of paying life, sick, accident, or other benefits in the case of section 501(c)(9), 501(c)(17), or 501(c)(20) organizations; and (3) gain on certain dispositions of assets used by the organization in performing its exempt purposes. Under this rule, investment income and other nonexempt function income earned by social clubs and the specified mutual benefit organizations are subject to the UBIT. The legislative history of this rule reflects that since such entities are granted exempt status so that their members may join together to provide social facilities or other personal benefits without tax consequences, the Congress concluded that the tax exemption should be limited to membership receipts. If investment income could be earned tax-free, the members of such entities would receive personal benefits out of tax-free funds. Under present law, trade associations and similar organizations described in section 501(c)(6) generally are not subject to tax on interest, dividends, royalties, or certain rents, gains on recognition disposition of assets, or other types of income that generally are excluded from the UBIT (unless derived from debt-financed property or from certain controlled organizations). Thus, trade associations receive more favorable treatment of investment income than social clubs or certain other mutual benefit organizations. Possible Proposal The unrelated business income of trade associations could be computed in a manner similar to that applicable under present law to social clubs and certain other mutual benefit organizations. Thus, any investment income and other nonexempt function income of trade associations would become subject to the UBIT. As under present law, the UBIT would not apply to dues, fees, charges, and similar amounts received from members in connection with the association's exempt functions; certain investment or other income set aside for charitable purposes; or gain on certain dispositions of assets used in performing exempt purposes. Arguments for the proposal Pros and Cons 1. Exempting the investment income of a trade association from the UBIT allows the organization's members to obtain an immediate deduction for dues or similar payments to the organization in excess of amounts needed for current operations, but to avoid tax on a proportionate share of earnings from investing the surplus amounts. If the member had retained the surplus and invested that amount itself, the earnings thereon would be taxed in the year earned to the member. While investment income earned tax-free by the organization may be used to lower member payments (and hence member deductions) in later years, the member still has gained a benefit through tax deferral. 2. The broad exemption provided for investment income and certain other nonexempt function income of charitable organizations (sec. 501(c)(3)) can be justified on the ground that such organizations lessen the burdens of government that otherwise would have to be financed through tax revenues, and serve a broad class of beneficiaries within the public at large, rather than simply members of or donors to the organizations. By contrast, tax-exempt trade associations generally operate to provide facilities, goods, or services that benefit their members. A trade association can be viewed as a conduit or agency-type entity, since the organization operates on behalf of its members to promote the line of business to which they belong. To the extent the organization receives member payments for purposes such as advertising the goods in that line of business, exemption from UBIT for member payments may be justified even if exceeding expenditures within the organization's taxable year. However, this rationale does not extend to investment or nonexempt function income of the organization. Arguments against the proposal 1. It can be argued that the analogy of trade associations to social clubs is not persuasive. The very purpose of a social club is to provide private benefits of a recreational or social nature to its members; accordingly, Federal tax benefits for such organizations are limited for the reasons cited above. On the other hand, a trade association is entitled to exempt status only if its activities are aimed at improving the business conditions generally of a line of business, as distinguished from the performance of particular services for individual members of the organization. Thus, it can be argued that the special UBIT rules for social clubs (or certain other mutual benefit organizations) are not appropriate for trade associations. 2. If the members of the trade association had carried on directly the activities of their association, they generally would have been entitled to deductions for such expenditures; by contrast, personal expenditures for social or recreational activities at a country club are not deductible. Hence, it is not appropriate to extend the tax treatment of social club investment income to trade associations. 2. Excise Tax on Net Investment Income of Exempt Organizations Present Law Under present law (sec. 4940), private foundations generally are subject to a two-percent excise tax on their net investment income. This tax was imposed so that foundations would share some of the costs of government, particularly the cost of administering the tax laws relating to exempt organizations. While the section 4940 tax sometimes is referred to as an "audit fee," the tax receipts go into the general fund and are not earmarked for IRS use relating to foundations or other exempt organizations. Further, although the tax rate has been reduced since its enactment in 1969, the tax revenues for fiscal 1986 exceeded the total IRS costs of administering the combined exempt organization and employee plan programs. All tax-exempt organizations, including charitable and social welfare organizations, mutual benefit organizations, and pension trusts (sec. 401(a)), generally are subject to tax on any unrelated business taxable income. However, a specific statutory modification to the unrelated business income tax provides that the tax does not apply to dividends, interest, royalties, and certain other types of investment income, except where derived from debt-financed property or certain controlled organizations. Possible Proposal An excise tax of five percent could be imposed on the net investment income of all tax-exempt organizations, i.e., on the sum of gross investment income (including interest and dividends) plus net capital gain, less the expenses of earning such income. This excise tax would apply to all corporations or trusts that are tax-exempt from Federal income tax under section 501(a), including charitable, educational, religious, and scientific organizations; social welfare organizations; labor unions; trade associations; social clubs; other mutual benefit organizations; and trusts forming part of a qualified pension or profit-sharing plan (described in sec. 401(a)). Pros and Cons Arguments in favor of the proposal 1. In times of large Federal budget deficits, all organizations that benefit from the expenditures of the Federal Government should be called upon to contribute to reducing the budget deficits. Organizations that are exempt from Federal income tax benefit from direct Federal spending-for example, for national defense, maintenance of the banking system, aid to interstate transportation, etc.-as well as from Federal tax expenditures, such as exemption from income tax and, in some cases, the itemized deduction for charitable contributions. Accordingly, like other institutions in the econo |