eliminate his taxable income.1 To some extent, the Internal Revenue Service has been able to deal with this issue through regulations. To deal with this problem specifically, the Act instructs the Secretary of the Treasury to prescribe regulations under which items of tax preference (of both individuals and corporations) are to be properly adjusted when the taxpayer does not derive any tax benefit from the preference. For this purpose, a tax benefit includes tax deferral, even if only for one year. Congress, by adding this provision to the Act, does not intend to make any judgment about the authority of the Treasury to issue these regulations under prior law. The minimum tax is not imposed on tax preferences that make up a net operating loss that is carried forward to a succeeding taxable year. Instead, the minimum tax is imposed on those preferences when the net operating loss reduces taxable income. For preferences from taxable years prior to January 1, 1976, this tax rate will continue at 10 percent even if the net operating loss is deducted in a taxable year beginning after December 31, 1975. For preferences for taxable years beginning after December 31, 1975, the tax rate will be 15 percent. Thus, the year of the preferences, not the year when the net operating loss is deducted, is to determine whether the 10-percent or the 15percent rate applies. These changes all apply to individuals, estates, trusts, subchapter S corporations and personal holding companies. Effective date These changes are effective for taxable years beginning after December 31, 1975. Carryovers of regular taxes from taxable years. beginning before January 1, 1976, will not be allowed in years beginning after December 31, 1975. Revenue effect The changes in the minimum tax for individuals will raise $1.0 billion in fiscal year 1977, $1.1 billion in fiscal year 1978 and $1.5 billion in fiscal year 1981. 2. Minimum Tax for Corporations (sec. 301 of the Act and secs. 5658 of the Code) Prior law The minimum tax for corporations was the same as that for individuals except that the capital gains preference equalled 18/48 of net long-term capital gains (rather than one-half of such gains) and the preference for accelerated depreciation on personal property subject to a net lease did not apply. Reasons for change Congress believed that, as in the case of individuals, it was appropriate to raise the effective tax rate on corporate tax preferences subject to the minimum tax. However, because corporate income is already subject to two taxes the corporate income tax and the individual income tax-Congress felt that it was appropriate to retain the deduction for regular taxes in computing the corporate minimum tax. 1 For example, preference items giving rise to losses which are suspended under at risk provisions (sec. 465 or sec. 704 (d) of the Code) are not to be considered to give rise to a tax benefit until the year in which the suspended deduction is allowed. Similarly, investment interest which is disallowed (under sec. 163(d)) is to be treated as an itemized deduction for purposes of that preference only in the year in which it is allowed (under sec. 163(d)). Explanation of provision The Act raises the minimum tax rate for corporations to 15 percent. In place of the $30,000 exemption and deduction for regular taxes under prior law, it substitutes an exemption equal to the greater of $10,000 or regular taxes. It also eliminates the carryover of regular taxes. The "tax benefit" rule applies to corporations as well as to other taxpayers. Personal holding companies are generally treated as individuals under the minimum tax, and generally where the Act makes a change in the minimum tax that is different for individuals than for corporations, the rule for individuals is used for personal holding companies. Preferences of subchapter S corporations are generally attributed to shareholders under the minimum tax. However, the preference for itemized deductions will, of course, not apply to personal holding companies or to subchapter S corporations since these entities have no adjusted gross income from which to calculate their preference. The Act provides special rules for timber income of corporations, including both gains from the cutting of timber and long-term gains from the sale of timber. These rules have the effect of exempting timber income from the increase in the minimum tax for corporations. These rules provide that the item of tax preference for timber gains is to be reduced by one-third and then further reduced by $20,000. Also, the deduction for regular taxes is to be reduced by the lesser of (a) one-third or (b) the preference reduction described above. In effect, the adjustments compensate for the general minimum tax rate increases from 10 percent to 15 percent by scaling down the entire minimum tax base, as it relates to timber, by one-third and then subjecting that lower base to a 15-percent rate. This gives the same result as subjecting the normal tax base to a 10-percent rate. The reduction in timber preferences by $20.000 (two-thirds of $30,000), in effect, compensates timber for the loss of the $30,000 exemption. The Act also retains a regular tax carryover for timber. Taxpayers will first have to determine how much of their corporate income tax is attributable to timber income (including both gains from the cutting of timber and long-term gains from the sale of timber). This allocation is to be made under regulations prescribed by the Secretary of the Treasury. This allocation must be made for years prior to 1976 as well as future years, in order to determine how much of a corporation's existing regular tax carryover remains available for use in 1976 and subsequent years. Congress does not intend that there be a carryover of regular taxes not attributable to timber income. To the extent that regular corporate income taxes attributable to timber exceed the items of tax preference in a taxable year, they may be carried forward for up to 7 additional years. The amount of the carryover that may be deducted in a subsequent year is limited to timber tax preferences in that year, reduced by the timber preference reduction described above, minus the regular tax deduction for the year (as reduced by the regular tax adjustment described above). This has the effect of permitting a carry forward of timber-related regular taxes that are not used in the current year and limiting the use of that carry forward to the part of the minimum tax base that is attributable to timber-related capital gains income. Effective date Generally, the minimum tax changes are effective for taxable years beginning after December 31, 1975. However, for taxable years beginning in 1976, corporations are to compute their minimum tax under both prior law and the new law and pay the average of the two minimum taxes. Also, regular tax carryovers from prior years can be deducted in taxable years beginning before July 1, 1976 (as changed by later legislation).1 For financial institutions who are eligible for excess bad debt reserve deductions, the effective date is delayed until December 31, 1977. Revenue effect The increases in the minimum tax for corporations will increase budget receipts by $59 million in fiscal year 1977, $124 million in fiscal year 1978 and $204 million in fiscal year 1981. 3. Maximum Tax Rate (sec. 302 of the Act and sec. 1348 of the Code) Prior law Under prior law, the maximum marginal tax rate on taxable income from personal services was 50 percent. For this purpose, income from personal services (in the past this was referred to as "earned income") included wages, salaries, professional fees or compensation for personal services (including royalty payments to authors or inventors) and, for an individual engaged in a trade or business where both personal services and capital are material incomeproducing factors, a reasonable amount (not to exceed 30 percent) of his share of the net profits from the business. Personal service income for this purpose did not include deferred compensation, penalty distributions from owner-employee plans, lump-sum distributions from pension plans or distributions from employee annuity plans. The amount of personal service income eligible for the 50-percent maximum tax was reduced in three ways. First, it was reduced by trade or business deductions allowable under section 62 (which excludes most trade or business deductions of employees) properly allocable to personal service income. Second, it was reduced by a pro rata share of deductions from adjusted gross income used in computing taxable income (including all itemized deductions, the standard deduction and the deduction for personal exemptions). Third, it was reduced by the taxpayer's items of tax preference (as defined under the minimum tax) or the average of the taxpayer's tax preferences over the current year and the four preceding years, whichever is greater, in excess of $30,000. For married couples, the maximum tax only applies if they file a joint return, and taxpayers cannot use the maximum tax provision if they use income averaging. Reasons for change Congress believed that one way to reduce the incentive for making use of tax preferences was to continue the lower top bracket rate (i.e., 1 The Tax Reform Act of 1976 included an effective date of January 1, 1976, for the repeal of the carryover, but H.R. 1144 (P.L. 94-568) amended this to July 1, 1976. 50 percent) on personal service income but to reduce the amount of personal service income eligible for this benefit to the extent that the taxpayer uses tax preferences. This "preference offset" in prior law, however, was considerably weakened by the $30,000 exemption. Also, Congress thought it was appropriate to extend the benefits of the 50-percent maximum tax rate to deferred compensation. Under prior law, there were cases where an individual could retire on a pension; and, even though his before-tax income would fall, his after-tax income would rise because he would lose the benefit of the maximum tax. Explanation of provision The Act eliminates the $30,000 exemption to the preference offset and the five-year averaging provision. These changes will make the maximum tax a more effective deterrent to use of tax preferences and also will considerably simplify it. Also, the Act extends the benefits of the maximum tax to deferred compensation including pensions and annuities. This extension applies to pensions and annuities that are personal services income. For example, it excludes those pensions and annuities in which an individual buys the pension or annuity for himself where there is no connection with earning income with personal services. Income deferred under individual retirement accounts will also qualify for the maximum tax. Lump-sum distributions which are taxed under special rules and certain distributions from H.R. 10 pension plans or Individual Retirement Accounts (IRA's) do not qualify for the maximum tax. Effective date The changes in the maximum tax are effective for taxable years beginning after December 31, 1976. Revenue effect The changes in the maximum tax will increase revenues by $4 million in fiscal year 1977, $24 million in fiscal year 1978 and $43 million in fiscal year 1981. C. EXTENSION OF INDIVIDUAL INCOME TAX REDUCTIONS (Secs. 401-402 of the Act and Secs. 42, 43, and 141 of the Code) Prior law The Tax Reduction Act of 1975 (Public Law 94-12) enacted three individual income tax cuts for the first six months of 1975. These were an increase in the standard deduction, a general tax credit and an earned income credit. The Revenue Adjustment Act of 1975 (Public Law 94-164) enacted somewhat larger tax cuts for the first six months of 1976. Prior to the 1975 tax reduction, the minimum standard deduction (or low-income allowance) was $1,300. The Tax Reduction Act increased it to $1,600 for single returns and to $1,900 for joint returns for the year 1975. The tax reduction in the Revenue Adjustment Act of 1975, on a full-year basis, would have increased the minimum standard deduction to $1,700 for single returns and to $2,100 for joint returns. The percentage standard deduction was 15 percent prior to 1975. The Tax Reduction Act of 1975 and the Revenue Adjustment Act increased it to 16 percent for 1975 and the first half of 1976, respectively. The maximum standard deduction was $2,000 before 1975. The Tax Reduction Act of 1975 increased it to $2,300 for single returns and to $2,600 for joint returns for 1975. On a full-year basis, the Revenue Adjustment Act of 1975 would have increased it to $2,400 for single returns and to $2,800 for joint returns for 1976. The Tax Reduction Act of 1975 also provided a nonrefundable credit of $30 for each taxpayer and dependent for 1975. The Revenue Adjustment Act of 1975, on a full-year basis, would have increased this credit to the greater of $35 per capita or 2 percent of the first $9,000 of taxable income. In addition, the Tax Reduction Act of 1975 included a refundable. tax credit equal to 10 percent of the first $4,000 of earned income, phased out as adjusted gross income rises from $4,000 to $8,000. This earned income credit applied only to families who maintained a household for at least one dependent child for whom they were entitled to claim a personal exemption. The earned income credit was extended for the first six months of 1976 in the Revenue Adjustment Act of 1975. Also, the credit for 1975 was modified to provide that it be disregarded in determining eligibility for, or benefits under, Federal or federallyassisted aid programs, as long as the individual was a recipient of benefits under the program in the month before receiving a tax refund. resulting from the earned income credit. The Tax Reduction Act of 1975 provided that the changes in the standard deduction and the general tax credit be reflected in lower withheld and estimated taxes for the last eight months of 1975. The Revenue Adjustment Act of 1975 extended those same withholding |