Business Tax Issues in 2008






Prepared for Members and Committees of Congress



In early 2007, congressional action on business taxes began with a focus on small business, to
counter the purported adverse impact of an increase in the federal minimum wage on small
business. In May, Congress enacted the Small Business Tax Relief Act of 2007 as part of a larger
appropriations bill (P.L. 110-28). Among the act’s tax measures were an extension of the
“expensing” tax benefit for small business investment and an extension of the work opportunity
tax credit incentive for hiring members of targeted groups.
As 2007 progressed, Congress considered a number of narrow, sector-specific business tax items.
In part, these were provisions designed to promote certain types of economic activity—for
example, both the House and Senate considered energy tax provisions aimed at conservation and
alternative energy sources. Also, Congress considered extending a set of numerous temporary
targeted tax benefits that were scheduled to expire by the end of the year (the “extenders”).
Congress also looked to various aspects of business taxation as a means to raise tax revenue that
would offset the revenue loss from selected tax cuts it was considering—a key concern given the
large and continuing federal budget deficits and House and Senate procedural rules designed to
restrain deficit-increasing tax and spending legislation. For example, Congress showed
considerable interest in measures to restrict corporate tax shelters, several measures related to
international taxation, and a reexamination of the domestic production deduction enacted in 2004.
In the closing months of 2007, Congress began to consider broader revision in corporate taxation.
In October, Chairman Charles Rangel of the House Ways and Means Committee introduced H.R.
3970, a business tax bill with a variety of both tax cuts and tax increases. The bill was partly
formulated with an eye towards the international economy and the attractiveness of the United
States as an investment location. The bill also echoes the classic tax-reform approach of the Tax
Reform Act of 1986, proposing to couple its rate cut with a set of base-broadening measures.
In early 2008, Congress focused on stimulating the economy and renewing general farm
legislation. In February, Congress enacted the Economic Stimulus Act of 2008. The act’s two
business investment provisions provided for a temporary increase of small business expensing
and temporary “bonus” depreciation limits. In May, the Food, Conservation, and Energy Act of

2008 (P.L. 110-234) was enacted and modified several alternative fuel production tax credits.


Currently, other congressional deliberations regarding business taxation involve energy taxation
and the extenders (H.R. 6049, S. 3098, S. 2886, etc.). This report will be updated in the event of
significant legislative activity.






The Current System.........................................................................................................................2
Legislation in 2007..........................................................................................................................2
Proposed Tax Reduction and Reform Act (H.R. 3970).............................................................2
Small Business and Work Opportunity Tax Act of 2007 (P.L. 110-28).....................................3
Legislation in 2008..........................................................................................................................5
Economic Stimulus Act of 2008 (P.L. 110-185)........................................................................5
Food, Conservation, and Energy Act of 2008 (P.L. 110-234)...................................................6
Selected Business Tax Issues...........................................................................................................6
Research and Experimentation Tax Credit and Other Temporary Benefits..............................6
Energy Taxation........................................................................................................................7
Tax Shelters...............................................................................................................................8
International Taxation...............................................................................................................9
Appendix. Business Tax Legislation and Issues, 2001-2006..........................................................11
Author Contact Information..........................................................................................................13





t the beginning of the 110th Congress, increases in the federal minimum wage were being
considered, and both Congress and the Administration evinced support for a cut in small
business taxes as a way to partly offset the purported adverse impact of the minimum A


wage increase on small firms. In May 2007, Congress approved the Small Business Tax Relief
Act of 2007 as part of a larger appropriations bill, P.L. 110-28. Among the act’s provisions were 1
an extension of the increased “expensing” tax-benefit for small businesses and an extension of
the work opportunity tax credit (WOTC) incentive for hiring members of certain targeted groups.
As 2007 progressed, Congress considered a number of narrow, sector-specific business tax items.
In part, these were provisions designed to promote certain types of economic activity—for
example, both the House and Senate considered energy tax provisions aimed at conservation and
alternative energy sources. Also, Congress considered extension of a set of numerous temporary
targeted tax benefits that were scheduled to expire by the end of the year (the “extenders”).
Congress also looked to various aspects of business taxation as a way to raise tax revenue that
would offset the revenue loss from selected tax cuts it was considering. Revenues were a key
concern given the large and continuing federal budget deficits as well as House and Senate
procedural rules designed to restrain deficit-increasing tax and spending legislation. For example,
Congress demonstrated considerable interest in measures to restrict corporate tax shelters, several
measures related to international taxation, and a reexamination of the domestic production
deduction enacted in 2004.
In the closing months of 2007, Congress began to consider broader revision in corporate taxation.
In October, Chairman Charles Rangel of the House Ways and Means Committee introduced H.R.
3970, an omnibus business tax bill with a variety of both tax cuts and tax increases. In part, the
bill was formulated with an eye towards the international economy and the attractiveness of the
United States as an investment location—it contains, for example, a cut in the general corporate
statutory tax rate and a permanent increase in the small business expensing benefit. However, the
bill also echoes the classic tax-reform approach of the landmark Tax Reform Act of 1986,
proposing to couple its rate cut with a set of base-broadening measures, including a paring-back
of the deferral tax benefit for multinational firms and repeal of the domestic production
deduction.
In early 2008, Congress focused on stimulating the economy and renewing general farm
legislation. In February, Congress enacted the Economic Stimulus Act of 2008, P.L. 110-185. The
act’s two business investment provisions provided for a temporary increase of small business
expensing and temporary “bonus” depreciation limits. In May, the Food, Conservation, and
Energy Act of 2008 (P.L. 110-234) was enacted and modified several alternative fuel production
tax credits.
Currently, other congressional deliberations regarding business taxation involve energy taxation
and the extenders (H.R. 6049, S. 3098, S. 2886, etc.).

1Expensing describes the timing of certain business deductions permitted by the Internal Revenue Code. Generally,
it denotes an item that is permitted to be deducted entirely in the year the firm makes an outlay for the item. When
investment outlays are permitted to be expensed rather than deducted gradually—that is, depreciated or amortized—the
treatment constitutes a tax-deferral benefit similar to extremely accelerated depreciation. In terms of arithmetic,
expensing confers a tax benefit that is the equivalent of a tax exemption for income produced by the expensed
investment. See CRS Report RL31852, Small Business Expensing Allowance: Current Status, Legislative Proposals,
and Economic Effects, by Gary Guenther, for a more detailed discussion of the expensing provisions.




The United States has what tax analysts sometimes term a “classical” system for taxing corporate
income. That is, it imposes a tax on corporate profits—the corporate income tax—that is separate
and generally in addition to the individual income taxes that corporate stockholders pay on their
corporate-source capital gains and dividends. The corporate income tax applies a 35% rate to
most corporate taxable income, although reduced rates ranging from 15% to 34% apply to
corporations earning smaller amounts of income. The base of the tax is corporate profits as
defined by the tax code—generally gross revenue minus interest, wages, the cost of purchased
inputs, and an allowance for depreciation.
Since 1980, federal corporate tax revenue has generally varied between 1% and just over 2% of
gross domestic product (GDP). Congressional Budget Office (CBO) data show that corporate tax
receipts registered an “uptick” in fiscal years (FY) 2005 and 2007, rising to 2.3% and 2.7% of
GDP, respectively—an increase CBO attributed primarily to strong economic growth. However,
CBO also projects corporate tax revenue to recede in future years to a level closer to its long-term 2
average.
CBO data show a similar trend regarding corporate tax receipts as a share of total taxes, with an
“uptick” in FY2005 and FY2007 from 12.9% to14.4% of total federal revenues. CBO, again,
projects the percentage of total revenue from corporate tax revenue to recede to its historical 3
share.
Not all businesses are subject to the corporate income tax. Income earned by partnerships is
“passed through” and taxed to the individual partners under the individual income tax without
imposition of a separate level of tax at the partnership level. Also, businesses that have no more
than 100 stockholders and that meet certain other requirements (“S” corporations), as well as
certain other “pass through entities” are not subject to the corporate income tax, but are taxed in
the same manner as partnerships.

On October 25, 2007, Chairman Charles Rangel of the House Committee on Ways and Means
introduced H.R. 3970, the Tax Reduction and Reform Act, an omnibus tax bill containing
provisions affecting both individuals and businesses. On the individual side, the bill’s principal
focuses are reduction of the alternative minimum tax (AMT) and extension of a set of expiring
tax benefits. For businesses, the bill couples a substantial cut in the statutory corporate tax rate
with a permanent increase in the “expensing” benefit for small business investment with a set of

2 U.S. Congress, Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2008-2018
(Washington: GPO, 2008), p. 93. Available at the CBO website, at http://www.cbo.gov/publications/
bysubject.cfm?cat=0 visited June 16, 2008.
3 Ibid., p. 150.





revenue-raising provisions. Taken alone, the bill’s business provisions would reduce tax revenue 4
by an estimated $8.7 billion over 5 years and $1.0 billion over 10 years.
The bill’s proposed reduction in the statutory corporate tax rate is the largest of its proposed cuts,
both in terms of revenue loss and number of businesses affected. Under current law, corporate
taxable income is generally subject to a set of graduated rates: 15%, 25%, 34%, and 35%, with
the lower rates applying to lower increments of income. The bill proposes to replace the top two
rates with a single 30.5% rate. Since the bulk of taxable income in the corporate sector is earned
by firms subject to the highest rates, most taxable corporate income would benefit from the rate
reduction. Taken alone, the rate cut would reduce revenue by an estimated $151.7 billion over
five years—over half the estimated revenue loss from all of the proposed corporate tax cuts
combined.
A second tax cut in the proposal would make permanent a temporary increase in the “expensing”
benefit for equipment investment by relatively small businesses. In addition, the bill proposes to
extend for one year a set of other narrowly targeted temporary business tax benefits, most of
which expired at the end of 2007. (Note that Chairman Rangel subsequently introduced
extensions of these as part of another bill, H.R. 3996. Most recently, the extenders were included
in H.R. 6049, which passed the House on May 21, 2008.)
The proposal’s revenue-raising items are more numerous than the tax cuts, but smaller in size
(though some would reduce revenue by sizeable amounts). Together (and considered apart from
the tax cuts), the revenue-raising items would increase business taxes by $164.0 billion over five
years. The single largest item is repeal of the 9% deduction for domestic production, which—for
income attributable to domestic production—would generally offset 3.15 percentage points of the
proposal’s 4.5 percentage-point tax-rate reduction. A second sizeable revenue raiser would apply
to multinational firms: it would require firms that defer U.S. taxes on foreign-source income to
likewise defer deduction of costs attributable to the income. A third sizeable revenue raiser would
repeal the Last-In, First-Out (LIFO) method of accounting, and taxing the resulting recognition of
income over an eight-year period.
Congress has had a long-standing interest in tax policy towards small business—an interest that
continued in 2007, where action on small business taxation occurred in conjunction with federal
minimum wage legislation. The President and others took the position that an increase in the
federal minimum wage—an issue acted on early in 2007—should be coupled with consideration
of tax cuts for small business. The tax cuts were viewed by their proponents as a means of
offsetting the extra cost burden a higher minimum wage may place on small businesses.
Tax provisions were not included in the House-passed bill increasing the minimum wage (H.R.
2). However, on February 1, the Senate approved an amended version of H.R. 2 that included a
package of tax benefits for small business and a set of revenue-raising measures designed to
offset part of the revenue loss expected from the tax benefits. The House subsequently approved a
tax bill (H.R. 976; approved on February 16) containing a set of small business tax benefits more
modest in size than the Senate’s. In mid-March, both the House and Senate folded the tax

4 U.S. Congress, House Committee on Ways and Means, Estimated Revenue Effects of Proposals Contained in The Tax
Reduction and Reform Act of 2007 (Washington, Oct. 25, 2007). Published in the BNA TaxCore service, Oct. 26, 2007.





provisions into their respective versions of H.R. 1591, a supplemental appropriations bill.
However, on May 1 President Bush vetoed the bill because of its Iraq-related provisions. On May
24, both the House and Senate approved a modified appropriations bill (H.R. 2206) that included
the previous bill’s tax provisions (which became known as the Small Business and Work
Opportunity Act), the President signed the measure, and it became public law (P.L. 110-28).
As enacted, the Small Business and Work Opportunity Tax Act provided for tax cuts amounting to
an estimated $7.1 billion over 5 years and $4.8 billion over 10 years. The cuts were partly offset
by revenue-raising items amounting to $7.0 billion over 5 years and $4.4 billion over 10 years,
for a net revenue gain of $71 million over 5 years and $55 million over 10 years—a net effect 5
near to revenue neutrality. Taken alone, the revenue-losing and revenue-gaining measures in the
conference agreement fell between the House and Senate bills, in terms of their size. The Senate
version of the bill provided both for larger tax cuts and revenue offsets than did the House bill.
The act’s final tax cuts were generally, though not exclusively, targeted at small business. A
prominent provision was an extension of the “expensing” tax benefit for business investment in
machines and equipment—a tax benefit provided by Section 179 of the tax code. The provision is
linked to small business because it applies only to firms undertaking less than a certain level of
investment. The provision is a tax benefit in that it permits firms to deduct (“expense”) in the first
year of service a capped amount of investment outlays rather than requiring the outlays to be
deducted gradually in the form of depreciation, as is required with most tangible assets.
Permanent provisions of the Internal Revenue Code cap the expensing allowance at $25,000 per 6
year and begin a phase-out of the allowance when a firm’s investment exceeds $200,000.
However, temporary rules initially enacted in 2003 (and extended on several occasions) increased
the annual cap and threshold to $100,000 and $400,000, respectively. The increased amounts are
indexed for inflation occurring after 2003; the amounts for 2007 were $112,000 and $450,000.
The most recent extension was provided by TIPRA in 2006 and extended the increased allowance
and threshold through 2009. P.L. 110-28 extended the increased expensing allowance through

2011 and also increased the allowance to $125,000 and the phase-out threshold to $500,000.


Another temporary tax benefit the act addressed was the work opportunity tax credit (WOTC). In
general, WOTC permits employers to claim a tax credit equal to a specified percentage paid in
first-year wages to members of certain targeted groups, including families receiving Temporary
Assistance for Needy Families (TANF) support, qualified veterans, high-risk youth, and others.
Under prior law, WOTC was scheduled to expire at the end of 2007; P.L. 110-28 extended the
credit through August 2011 and made several modifications in qualification criteria for the 7
targeted groups.

5 Revenue estimates are by the Joint Committee on Taxation, and are taken from U.S. Congress, Joint Committee on
Taxation, Estimated Revenue Effects of Revenue Provisions Contained in the Conference Agreement for H.R. 1591,
JCX-25-07, Apr. 24, 2007.
6 The cap is reduced on a dollar-for-dollar basis by each dollar of investment exceeding $200,000. Thus, firms
undertaking investment in excess of $225,000 cannot claim the allowance under the permanent rules.
7 See CRS Report RL30089, The Work Opportunity Tax Credit (WOTC), by Linda Levine, for a description of the
WOTC.





The act modified the tax credit employers can claim against social security (FICA) taxes paid for
employees who receive tips. The modification was designed to keep the new, higher minimum
wage from having the effect of reducing the credit. Under both the act and prior law, the credit is
equal to the employer’s FICA tax on tips in excess of those meeting the minimum wage
requirement. Absent other changes, an increase in the minimum wage reduces the tax credit, by
increasing the threshold over which the tax credit is earned.
P.L. 110-28 increased the minimum wage to $7.25 from prior law’s $5.15 and would have
reduced the tax credit, absent other changes. However, the act provided that the credit will
continue to be calculated based on prior law’s minimum wage. The act also provided that both the
FICA credit and WOTC can offset a taxpayer’s alternative minimum tax.
The act contained two principal revenue-raising provisions. One increased the scope of the
“kiddie tax”—a provision that taxes children under the age of 18 at their parents’ tax rate on
unearned income exceeding a certain threshold. The act increased the applicable age by one year
(i.e., under age 19), or under 24, if full-time students. The second revenue-raising provision
lengthened the period after which interest and penalties are suspended for unpaid taxes, in cases
where the taxpayer has not received a notice from the IRS.

Recent economic indicators suggest that economic growth is slowing and the economy may be
headed for—or already in—a recession. In response to weaker economic growth, the Recovery
Rebates and Economic Stimulus for the American People Act of 2008 (H.R. 5140) was
introduced by Speaker Pelosi and passed by the House of Representatives on January 29. On
January 30, the Senate Committee on Finance reported the Economic Stimulus Act of 2008,
which contained provisions not included in the House bill. On February 7 the Senate adopted the
House bill with added rebates for retirees and the House adopted the revised bill. On February 13
the bill was signed into law as P.L. 110-185.
As enacted, the Economic Stimulus Act of 2008 provided for tax cuts amounting to an estimated 8
$134 billion over 5 years and $124.5 billion over 10 years. The cuts were not offset by revenue-
raising items. Among the tax cuts were two which affect business investment. These business tax
cuts were estimated to reduce federal revenue collections by an estimated $17 billion over 5 years
and $7.5 billion over 10 years.
The first business investment provision allows a temporary, one year increase in the limitations
on the expensing of certain depreciable business assets. As described above, expensing is a tax
benefit, provided by Section 179 of the tax code, which permits certain small firms to deduct

8 Revenue estimates are by the Joint Committee on Taxation, and are taken from U.S. Congress, Joint Committee on
Taxation, Estimated Budget Effects Of The “Economic Stimulus Act Of 2008, As Passed By The House Of
Representatives And The Senate On February 7, 2008, JCX-17-08, Feb. 8, 2008.





certain investments in the first year of service rather than gradually depreciating the asset over
time. The provision increased the amount of investment eligible for expensing from $128,000 to
$250,000 in 2008, and the start of the phase-out range from $510,000 to $800,000.
The second business investment provision allows for temporary “bonus” depreciation, for certain
property acquired in 2008, that permit firms to deduct an additional 50% of the cost of property in
the first year of service rather than gradually depreciating the whole value of the asset over time.
As enacted, the Food, Conservation, and Energy Act of 2008 renewed multiple agriculture-related
programs, at a cost of $289 billion over 5 years and $605 billion over 10 years. Among the tax-
provisions which affect businesses were several tax credits for the production of fuels from 9
alternative sources. These provisions are estimated to increase federal revenue collections by $1
billion over 10 years.

The tax code contains a set of relatively narrowly applicable tax benefits (the “extenders”) that
are temporary in nature—they each were enacted for only fixed periods of time, and are each
scheduled to expire on various dates. The benefits tend to be tax incentives: provisions designed
to encourage certain types of investment or activity thought to be economically or socially
desirable. As targeted tax incentives, the benefits tend to raise a similar policy question: according
to traditional economic theory, smoothly functioning markets and undistorted prices generally
allocate the economy’s scare resources in the most efficient way possible. Absent market
malfunctions—failures that economists believe are more the exception than the rule—economic
theory indicates that tax benefits or penalties that interfere with the market reduce economic
efficiency and reduce overall economic welfare. The question with each extender, then, is
whether there is a market failure or socially desirable goal that makes the incentive’s intervention
in the market desirable.
One extender is the research and experimentation (R&E) tax credit, which was first enacted in
1981, and which has been renewed on numerous occasions. The credit provides businesses a tax
benefit that is linked to the firms’ increase in research outlays in the current year over a statutorily
defined base period. The credit is based on economic theory’s notion that free markets do not
operate smoothly in the case of research and development—that absent government support,
firms would not spend as much on research as is economically efficient. (It could also be argued,

9 SeeCRS Report RL34696, The 2008 Farm Bill: Major Provisions and Legislative Action, by Ree Johnson et al., for
a more complete description of the Acts energy-related provisions.





however, that the amount of support provided by the R&E credit and several other extant research 10
subsidies more than compensate for the theoretical shortfall in research.)
The R&E credit’s most recent extension was provided by the Tax Relief and Health Care Act of
2006 (TRHCA; P.L. 109-432) in December 2006, and it expired at the end of 2007; the 2006
extension included an additional, alternative method that firms can use to calculate the credit,
which may result in additional tax savings for firms in certain circumstances. There has been
interest in the current Congress, however, in making the tax credit permanent.
The extenders in general have been a continuing issue for Congress—in part because their
temporary nature necessitates periodic action if they are not to expire, and in part because of the 11
strong support for many of the benefits. As noted above, an element of the Tax Reduction and
Reform Act (H.R. 3970) that was introduced in October 2007 proposes a one-year extension of a
number of expiring tax provisions, including the R&E tax credit. On October 30, Chairman
Charles Rangel of the House Ways and Means introduced a bill (H.R. 3996; the Temporary Tax
Relief Act) devoted only to extending expiring provisions and providing a “patch” that would
reduce the individual alternative minimum tax for one year. The alternative minimum tax bill that
Congress enacted in December, however, did not contain tax provisions other than those
pertaining to the alternative minimum tax.
The extenders have continued to receive congressional attention in 2008. H.R. 6049, the Energy
and Tax Extenders Act of 2008, which was passed in the House on May 21, 2008, provides a one-
year extension through 2008 for many of the expiring temporary tax provisions, while S. 2886,
the Alternative Minimum Tax and Extenders Tax Relief Act of 2008, proposes a two-year
extension through 2009 for the majority of the temporary tax provisions contained in the bill.
At the outset of 2007, Democratic leaders stated that energy taxation was an issue they intended
to address during the year. Their focus appeared to be two-fold: a revenue-raising, scaling-back of
tax cuts that were enacted in recent years for the petroleum firms and enactment of a new set of
incentives aimed at energy conservation and promotion of alternative energy sources. Those goals
were addressed, in part, in an energy bill (H.R. 6) the House passed in January 2007. The bill
contained both tax and non-tax provisions. Its tax measures restricted several tax benefits as they
apply to oil and gas production, and provided that the resulting tax revenues were to be used to
fund a reserve for energy efficiency and renewable energy.
In June, the Senate began consideration of its own, amended, version of H.R. 6, which included a
wide-ranging, non-tax (“policy”) component. While the Senate Finance Committee approved a
tax package of revenue-raising items and provisions to promote conservation and alternative
energy sources, the tax plan was not added to the policy component of H.R. 6 because of

10 See CRS Report RL31181, Research and Experimentation Tax Credit: Current Status and Selected Issues for
Congress, by Gary Guenther, for a more complete description of the R&E credit.
11 For a list of extenders addressed by TRHCA, see CRS Report RL33768, Major Tax Issues in the 110th Congress, by
Jane G. Gravelle, and for a broader discussion on extenders, see CRS Report RL32367, Certain Temporary Tax
Provisions (Extenders) Expired in 2007, by Pamela J. Jackson and Jennifer Teefy.





opposition to its revenue-raising provisions—especially a tax on oil and gas from the Gulf of 12
Mexico and restrictions on leasing transactions involving foreign property.
The House Ways and Means Committee approved a bill (H.R. 2776), on June 20, that—unlike
H.R. 6—was restricted to energy tax provisions. Like the Finance Committee measure, it contains
a mix of revenue raisers and tax benefits. The bill was approved by the House on August 4, 2007.
In broad outline, the Finance Committee legislation and House bills are similar in certain
respects, with their conservation and alternative fuels measures partly offset by revenue-raising
items. They differ, however, in the exact make-up of the respective components and in the
magnitude of their revenue effects. Specifically, the Finance Committee bill contains revenue-
losing items estimated to reduce revenue by a total of $32 billion over 10 years, and revenue-
raisers expected to increase revenues by the same amount, thus achieving approximate revenue
neutrality on a net basis. The House bill is likewise estimated to achieve revenue neutrality, but
the expected magnitude of its respective revenue raisers and revenue-losing provisions is smaller,
totaling $15 billion over 10 years in each case.
Prominent among the tax benefits in both bills is extension and modification of the tax credit for
production of energy from renewable sources provided by Section 45 of the tax code, although
the Finance Committee’s version would result in a larger revenue loss. The remaining revenue-
losing items in the two bills differ considerably.
A large revenue-raising item common to both bills is the denial of the tax code’s Section 199 13
domestic production deduction to certain oil- and gas-related income. The deduction was first
enacted with the American Jobs Creation Act of 2004 (P.L. 108-357) and it applies to the
domestic U.S. manufacturing, extractive, and agriculture industries in general, not just to the
petroleum industry. The deduction is phased in, with a rate equal to 6% of domestic production
income in 2007-2009, and a permanent rate of 9% in 2010 and thereafter. The House bill would
deny the deduction to all domestic production of oil and gas; the Finance Committee measure
would deny the deduction to integrated oil companies.
In December, the Senate failed to take action on an energy bill containing the tax provisions
advocated by the Finance Committee, and Congress instead approved comprehensive energy
legislation stripped of most of its tax elements (The Energy Independence and Security Act of

2007, P.L. 110-140).


Corporate “tax shelters” are another area where Congress may look for tax increasing revenues.
They concern policymakers because of their corrosive effect on tax equity and popular
perceptions about the tax system’s fairness. In popular usage, the term “tax shelter” denotes the
use of tax deductions or credits produced by one activity to reduce taxes on another: the first
activity “shelters” the second from tax. In economic terms, a tax shelter can be defined as a
transaction (for example, an investment or sale) that reduces taxes without resulting in a reduced

12 Heather M. Rothman, “Senate Energy Tax Package Could Be Doomed in House,” BNA Daily Tax Report, June 26,
2007, p. G-1.
13 Wesley Elmore, “Democrats Outline Early Agenda for 110th Congress, Tax Notes, Jan. 8, 2007; Kurt Ritterpusch,
Early Components in Democrats Oil Industry Rollback Plan Firm Up,” BNA Daily Tax Report, Jan. 5, 2006.





return or increased risk for the participant.14 But the term is so vague and general in most usages
that it could also be defined simply as a tax saving activity that is viewed as undesirable by the
observer using the term. Under most definitions, tax shelters can be either illegal and constitute
“tax evasion” or legal, comprising “tax avoidance.”
Congress has evinced considerable interest in tax shelters in recent years, and has enacted some
restrictions into law. The American Jobs Creation Act of 2004 (AJCA; P.L. 108-357) contained a
number of provisions designed to restrict tax shelters. In part, the act’s provisions were directed at
specific tax shelters—for example, leasing activities and the acquisition of losses for tax purposes
(“built in” losses). In addition, the act included provisions—for example, revised penalties and 15
reporting requirements—designed to restrict sheltering activity in general. In 2006, the Senate
version of the Tax Increase Prevention and Reconciliation Act (TIPRA, P.L. 109-222) contained a
number of tax shelter restrictions, but the provisions were not included in the conference
committee bill.
The Senate’s TIPRA provisions included what the bill termed a “clarification” of the economic
substance doctrine that has been followed in a number of court decisions applying to tax shelters.
Generally, the economic substance doctrine disallows tax deductions, credits, or similar benefits
in the case of transactions not having economic substance. The Senate version of TIPRA would
have integrated aspects of the doctrine into the tax code itself. A similar measure was contained in
the Senate version of the AJCA, but was not adopted.
Several bills in the 110th Congress have included codification of the economic substance doctrine
as a revenue-raising “offset” for tax cuts elsewhere in the tax code. These include S. 2242,
approved by the Senate Finance Committee on October 25, 2007, and H.R. 3970, proposed by
Chairman Charles Rangel of the House Ways and Means Committee, also on October 25.
There are some indications that Congress may look to the tax treatment of U.S. firms’ foreign
income in searching for additional tax revenue. In part, the focus on international taxation stems
from a concern about tax benefits that are perceived to promote foreign “outsourcing”—the
movement of U.S. jobs overseas.
Economic theory is skeptical about whether tax policy towards U.S. multinationals can have a
long-term impact on domestic employment, although short-term and localized impacts are
certainly possible. Taxes can, however, alter the extent to which firms engage in overseas
operations rather than domestic investment. Under current law, a tax benefit known as “deferral”
poses an incentive for U.S. firms to invest overseas in countries with relatively low tax rates.
Deferral provides its benefit by permitting U.S. firms to postpone their U.S. tax on foreign
income as long as that income is reinvested abroad in foreign subsidiaries. The benefit is
generally available for active business operations abroad, but the tax code’s Subpart F provisions
restrict deferral in the case of income from passive investment. If made, proposals to restrict
deferral may consist of expansion of the range of income subject to Subpart F.

14 These definitions are taken from Joseph J. Cordes and Harvey Galper, “Tax Shelter Activity: Lessons from Twenty
Years of Evidence,National Tax Journal, vol. 38, Sept., 1985, pp. 305, 307.
15 For a list and description, see CRS Report RL32193, Anti-Tax-Shelter and Other Revenue-Raising Tax Proposals
Considered in the 108th Congress, by Jane G. Gravelle.





In recent years, however, the thrust of legislation has been more in the direction of expanding
deferral and cutting taxes for overseas operations. For example, the American Jobs Creation Act
of 2004 cut taxes on overseas operations in several ways, while in 2006, TIPRA restricted
Subpart F in the case of banking and related businesses receiving “active financing” income and 16
in the case of the “look through” treatment overseas operations receive from subsidiary firms.
Further, several analysts have recently argued that attempts to tax overseas operations are either 17
counterproductive or outmoded in the modern integrated world economy. Traditional economic
analysis, however, suggests that overseas investment that is taxed at a lower or higher rate than
domestic income impairs economic efficiency.

16Lookthrough” rules generally apply the same treatment of particular items of income in the hands of the recipient as
in the hands of a payor. Thus, for example, a dividend paid to a parent firm out of active business income of a
subsidiary would remain active business income in the hands of the parent rather than dividend income (i.e., passive
investment income).
17 Mihir A. Desai and James R. Hines, Jr., “Old Rules and New Realities: Corporate Tax Policy in a Global Setting,
National Tax Journal, vol. 57, Dec. 2004, pp. 937-960. For a critique of Desai and Hines, see Harry Grubert,
Comment on Desai and Hines, “Old Rules and New Realities: Corporate Tax Policy in a Global Setting, National
Tax Journal, vol. 58, June 2005, pp. 263-278.







The major tax cuts enacted in 2001 and 2003 with the Economic Growth and Tax Relief
Reconciliation Act (EGTRRA; P.L. 107-16) and the Jobs and Growth Tax Relief Reconciliation
Act (JGTRRA; P.L. 108-27), respectively, focused more on individual income taxes than
corporate taxes, and included measures such as reductions in statutory tax rates, tax cuts for
married couples, and expansion of the child tax credit. JGTRRA, however, contained a number of
tax cuts aimed at businesses, as did legislation enacted in 2002, 2004, and 2006.
The most prominent business tax cuts can be summarized as follows: temporary “bonus”
depreciation provisions designed to spur investment spending; capital gains and dividend
reductions, intended (in part) to increase capital formation and the flow of savings to the
corporate sector; extension of a set of narrowly-applicable temporary tax benefits (the
“extenders”) that were addressed by several acts; and provisions enacted in 2004 designed to
boost U.S. manufacturing and competitiveness (the domestic production deduction and foreign
tax credit provisions).
The policy questions the business tax legislation raised—again, in broadest terms—were as
follows:
• What would be the impact of the investment incentives on the economy’s capital
stock? Does the reduced tax burden increase the supply of capital and saving,
thus increasing long-run growth? Or, is the economy’s supply of capital relatively
fixed, meaning the investment incentives simply interfere with the efficient
allocation of investment?
• Were the enacted business tax cuts effective in stimulating the economy in the
short run, thus aiding recovery from the 2001 recession? Or, do planning lags and
other factors make business tax cuts ineffective as a fiscal stimulus, meaning the
relation between the business tax cuts and economic recovery was serendipitous?
• What was the effect of the business tax cuts on the overall fairness of the tax
system? Did the reductions accrue primarily to relatively high-income
stockholders and corporate creditors, or were any reductions on tax progressivity
outweighed by positive employment effects?
• How did the business tax cuts affect U.S. economic competitiveness? Have
provisions such as the domestic production deduction helped revitalize domestic
manufacturing, or do the deduction and other competitiveness provisions
interfere with the efficient and flexible participation of U.S. businesses in the
world economy?
The Job Creation and Worker Assistance Act of 2002 (JCWA; P.L. 107-147) contained
temporary “bonus” depreciation provisions that permitted firms to deduct an additional 30% of
the cost of property in its first year of service rather than requiring that portion to be depreciated
over a period of years. The provision generally applied to machines and equipment (but not
structures) and was limited to property placed in service after September 11, 2001, and before





January 1, 2005. JCWA also temporarily extended the net operating loss “carryback” period (the
years in the past from whose income a firm can deduct losses) to five years from two years. The
provision only applied to losses in 2001 and 2002. JCWA also temporarily extended a set of
expiring tax benefits (the “extenders” discussed above), many of which applied to business taxes.
While a principal thrust of the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA; P.L.
108-27) was accelerating the effective date of individual income tax cuts enacted in 2001, the act
also contained a number of business provisions. JGTRRA’s tax cuts for dividends and capital
gains applied to individual income taxes, but nonetheless reduced the tax burden on stockholders’
corporate-source income. Under the U.S. classical method of business taxation, corporate source
income is taxed twice: once under the corporate income tax and once under the individual income
tax—an instance of double-taxation that is thought by economists to inefficiently restrict the flow
of capital to the corporate sector. JGTRRA’s reductions were an incremental step in the direction
of removing the double-taxation—a reform economists term tax “integration.” The reductions
were temporary, and were originally scheduled to expire at the end of 2008.
In addition to its capital gains and dividend reduction, JGTRRA increased bonus depreciation to

50% and extended its coverage to the period between May 5, 2003, and January 1, 2005.


JGTRRA also temporarily (for 2003, 2004, and 2005) increased the “expensing” allowance for
small-business investment from $25,000 to $100,000.
The American Jobs Creation Act of 2004 (AJCA; P.L. 108-357) grew out of legislation
designed to end a dispute between the European Union (EU) and the United States over a U.S. tax
benefit for exporting (the extraterritorial or ETI provisions) that had been determined to
contravene the World Trade Organization agreements’ prohibition on export subsidies. The EU
objected to the ETI benefit, and imposed countervailing tariffs authorized by the WTO. AJCA
repealed ETI, but also enacted a set of new WTO-legal business tax cuts designed, in part, to
offset the impact of ETI’s repeal on domestic businesses. However, the scope of AJCA
substantially transcended ETI and its offsets, and the act was, in its final form, an omnibus
business tax bill.
Aside from ETI’s repeal, AJCA’s most prominent provisions were a new domestic production
deduction equal to 9% of income from domestic (but not foreign) production, and a set of tax cuts
for multinational firms, including more generous foreign tax credit rules governing interest
expense. AJCA also temporarily extended the $100,000 small business expensing allowance
(through 2007).
The Tax Increase Prevention and Reconciliation Act of 2006 (TIPRA; P.L. 109-222) extended
JGTRRA’s reduced rates for dividends and capital gains for two years, through 2010. TIPRA also
extended JGTRRA’s $100,000 small-business expensing-allowance for two years, through 2009.
(In early 2007, P.L. 110-28 extended the increased expensing allowance through 2010.)
The Tax Relief and Health Care Act of 2006 (TRHCA; P.L. 109-432) was passed in the post-th
election session of the 109 Congress. Many of the extenders had expired at the end of 2005, and
TRHCA extended them, generally for two years (through 2007).





Donald J. Marples
Specialist in Public Finance
dmarples@crs.loc.gov, 7-3739